Why the Government's industrial strategy will fail

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Industrial strategy Productivity The Entrepreneurial State

Mathew Lawrence

June 25, 2018 3 mins

We are an economy of technological leaders and laggards, of DeepMind and Debenhams. Building a prosperous and just society will require bridging that gap between firms at the innovation frontier and those in the everyday economy.

Critically, this will require an industrial strategy that recognises the public sector’s crucial role in enabling and supporting innovation and technological adoption, underpinned by an entrepreneurial state that is confident in shaping and co-creating markets.

While the top 1% of firms have seen average productivity growth of around 6% per year since 2000, one-third of UK companies have seen no rise in productivity at all. This – not cutting edge innovation – is at the heart of our productivity crisis.

And it isn’t just a UK phenomenon. Across the OECD, labour productivity in the manufacturing sector at the global frontier increased at an average annual rate of 3.5% over the 2000s, in contrast non-frontier firms managed just 0.5%. In the services sector, productivity of frontier firms grew 5%, but actually fell by 0.1% in non-frontier firms.

If the productivity growth of firms in each of the bottom three quartiles could match that of the quartile above them, it would increase UK productivity by around 13%

A critical factor in explaining these productivity gaps is the slowing rate of diffusion of technologies from the minority of frontier firms to the majority of slow-adopting everyday firms: three-quarters of productivity improvements related to technological change are estimated to come from the broader adoption of technologies as companies catch up with sector leaders.

In other words, to boost productivity we need to accelerate the effective adoption of best practice across the economy as a whole, not just support innovation at the frontier.

And closing the gap between leaders and laggards could prove transformative. As Andy Haldane, chief economist of the Bank of England, points out: if the productivity growth of firms in each of the bottom three quartiles could match that of the quartile above them, it would increase aggregate UK productivity by around 13%.

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That’s a big boost to the economy, which is going to be particularly important as we manage demographic change. Given that employment growth contributed almost half of all increased output in the major global economies in the past half century, our ageing society requires a step change in productivity – otherwise the rate of per capita GDP growth among advanced economies will experience a historic fall.

The pace at which we adopt new technologies is critical to determining the health of our economy in the decades ahead – that requires focusing on five things: the cost of developing and deploying these technologies, the relative cost of capital and labour, the broader economic benefits of automation, the balance of economic power between labour and capital, and social and regulatory acceptance. All these factors are strongly affected by public policy, and that means the state has a key role to play.

A critical factor in explaining these productivity gaps is the slowing rate of diffusion of technologies from the minority of frontier firms to the majority of slow-adopting everyday firms

In our automation discussion paper, the IPPR Commission on Economic Justice proposes the establishment of a new body, Productivity UK, to drive firm-level productivity across the economy. Its goal would be to help small and medium-sized businesses to understand the productivity-raising potential of new technologies and to accelerate their introduction, through information and advisory services, and grants and loans for investment.

Crucially, a national adoption programme must also increase worker engagement in the process. If automation and other digital technologies are to bring better, and better-paying, jobs then workers should be involved in their introduction – with trade unions key to achieving this.

Seizing the immense opportunity that digital technologies offer will require much greater public ambition. The Government’s industrial strategy contains a welcome commitment to a more entrepreneurial state, one that actively shapes new markets and industries. But the focus is primarily on firms operating at the frontiers of technology, with policy shaped to support new forms of innovation.

Yet great gains are to be made from supporting the creativity and capability of ordinary workers and businesses in the everyday economy to integrate new technologies. Such a twin track approach would make for a truly entrepreneurial state – one that delivers benefits for everyone.