Comments to the UK’s Department for Business and Trade Regarding the Modern Industrial Strategy Green Paper

Introduction

The Information Technology and Innovation Foundation (ITIF) appreciates the opportunity to provide comments to the United Kingdom (UK)'s Invest 2035: The UK's Modern Industrial Strategy Green Paper. ITIF is a nonprofit, non-partisan public policy think tank based in Washington, D.C., committed to articulating and advancing pro-productivity, pro-innovation, and pro-technology public policy agendas around the world that spur growth, prosperity, and progress.

Based on the makeup of the Green Paper, ITIF's response targets the following questions:

▪What are the UK's strengths and capabilities in [advanced manufacturing, clean energy industries, creative industries, defence, digital and technologies, financial services, life sciences, and professional and business services]?

▪What are the barriers to R&D commercialisation that the UK government should be considering?

▪How can the UK government best use data to support the delivery of the Industrial Strategy?

▪Where you identified barriers in response to Question 7 which relate to competition, what evidence can you share to illustrate their impact and what solutions could best address them?

▪How can regulatory and competition institutions best drive market dynamism to boost economic activity and growth?

▪What are the main factors that influence businesses' investment decisions? Do these differ from the growth-driving sectors and based on the nature of the investment (e.g., buildings, machinery & equipment, vehicles, software, RDI, workforce skills) and types of firms (large, small, domestic, international, across different regions)?

▪What are the main barriers faced by companies who are seeking finance to scale up in the UK or by investors who are seeking to deploy capital, and do those barriers vary for the growth-driving sectors? How can addressing these barriers enable more global players in the UK?

▪The UK government currently seeks to support growth through a range of financial instruments including grants, loans, guarantees and equity. Are there additional instruments of which you have experience in other jurisdictions, which could encourage strategic investment?

▪How should the Industrial Strategy accelerate growth in city regions and clusters of growth sectors across the UK through Local Growth Plans and other policy mechanisms?

▪What are the key risks and assumptions we should embed in the logical model underpinning the Theory of Change?

▪How would you monitor and evaluate the Industrial Strategy, including metrics?

What Are the UK's Strengths and Capabilities In [Advanced Manufacturing, Clean Energy Industries, Creative Industries, Defence, Digital and Technologies, Financial Services, Life Sciences, and Professional and Business Services]?

The industrial policy green paper lists the following as key growth-driving sectors: Advanced Manufacturing, Clean Energy Industries, Creative Industries, Defence, Digital and Technologies, Financial Services, Life Sciences, and Professional and Business Services. It's not clear what advanced manufacturing is, as it includes defense production, life sciences and clean energy. As such, we would suggest narrowing that down to be more specific.

More importantly regardless of the unique strengths and capabilities of the UK, to unlock the growth potential of each identified subsector, a sustainable long-term industrial policy strategy should not just be top down, but bottom up, driven by industry.

Rather than the government attempt to identify the most important sectors, the focus should be on providing for a process whereby industry that wants to self-organize to develop its own sector specific competitiveness strategy is able to do so and find support from government. This should feature as part of the Sector Plans which will partner with business, devolved governments, regions, experts and other stakeholders so that the industry itself can steer the right direction for growth.

There should be three distinguishing criteria. The first is that the sector is an export sector, which has a direct impact on the overall competitiveness of the UK (an export or traded sector is one that sells a significant share of its output outside a particular geographical area). For example, the UK's financial services sector is considered an export sector because it serves clients globally. Therefore, in addition to a bottom-up strategy driven by the industries themselves, the UK government's industrial strategy should target subsectors that are predominantly export sectors as a way to drive growth. The second is that the sector has above average value-added output per work hour. There is little point focusing on sectors will below average output and wages. Finally, the democratic nations will at some point need to align their industrial strategies in order to ensure that China does not dominate too many critical sectors, especially defense and dual use, but more generally advanced technology sectors. To the extent UK officials can, they should use competing against China as a criteria for sector selection.

What Are the Barriers to R&D Commercialisation That the UK Government Should Be Considering?

The green paper rightly identifies that the UK has high quality research institutions, and that accelerating the rate of innovation, and the adoption and diffusion of ideas, technologies and processes is essential for unlocking productivity growth.

Indeed, the UK is world-leading with the amount of R&D expenditure on higher education as a percentage of GDP. Yet, similar to the Canadian system which is comparable in terms of the level of investment given to higher education, there is a distance lack of robust technology transfer systems and pathways to commercialization, meaning this type of R&D expenditure is unable to provide the economic benefits that other R&D like business R&D can provide. The reason for this is because UK universities have few incentives to improve and build on research to commercialize, or foster an environment that rewards entrepreneurialism. The University of Nottingham takes as high as a 49.9 percent stake in spinouts where its own resources are used to develop the technology. This contrasts to the University of Sheffield that is proactively increasing the commercialization of its spinouts by holding only up to a 20 percent stake. At the end of the day, the principal mission of UK research universities and researchers is to publish scholarly articles. That will not do the trick in terms of generating needed innovation commercialization and production in the UK.

There is no mystery of what global best practice in university and government lab tech transfer is. The poor UK performance is not because they can't figure out how to do it. It's that they are not motivated to do it effectively. To rectify this gap between research and commercialization, the government should reassess the criteria it holds for university funding, and introduce funding tied to the performance of the university across certain benchmarks. These benchmarks should include the employability of STEM students after graduation as an indicator of a highly skilled graduate workforce, the percentage contribution that universities make to UK tech commercialization, the proportion of spinouts that develop directly from the university's R&D efforts, a demonstration that current university R&D is aligned to UK industry needs (including share of research funded by industry). Universities that do better on these metrics should get more government support. Universities that do worse should get less.

How Can the UK Government Best Use Data to Support the Delivery of the Industrial Strategy?

The UK government should collect more data on the innovation effort of UK companies, similar to the EU-wide Innovation Survey. This survey measures the innovation efforts of companies, of which the collected data are displayed in summary statistics and used to compile indicators and inform further research activities. One such example is the Flemish Government, which uses said statistics to better align its economic policy with real developments in the business world. The UK should execute a similar survey that collects statistics on UK business innovation, including both process and product innovation, that can feed into the industrial strategy and inform future policy actions.

Where You Identified Barriers in Response to Question 7 Which Relate to Competition, What Evidence Can You Share to Illustrate Their Impact and What Solutions Could Best Address Them?

At the end of the day, the UK must decide what is most important: reversing its century-long slide in economic competitiveness and its more recent productivity stagnation, or supporting social policy goals imported from the continent, especially around data regulation and competition policy. There is no doubt that the EU model harms innovation and company growth; it's just that the EU prioritizes other goals.

The UK government needs to make a choice: competitiveness and growth or heavy-handed regulation in the service of social policy. It can have one but not both. To argue otherwise is wishful thinking.

The green paper places emphasis on the UK's digital markets, however, there is little evidence to suggest that the UK's digital markets are failing, and it is important to recognize that the mere notion of more competition in the sense of having more firms in a market is not the solution to fostering innovation. If it were, African nations with almost no large businesses and masses of small micro-business would be the most innovative in the world.

The new Digital Markets, Competition, and Consumers Act (2024) (DMCCA) works against U.S. competitiveness, innovation and productivity goals. The designation of firms as having Strategic Market Status (SMS) is one such example, which does not admit of a clear legal standard and therefore leaves firms guessing as to whether certain activities might bring them within SMS designation. This type of regulatory environment disincentivizes firms from wanting to compete in UK markets.

The UK should be careful not to align itself to the EU model that would negatively impact UK digital markets. The UK government should work with the Competition Markets Authority (CMA) to align the CMA's work on the DMCCA with the government's political priorities, namely the desire for economic growth. This should be evidenced in the guidance the CMA's Digital Markets Unit (DMU) is currently drafting, with greater emphasis given for example to the pro-competitive justifications available under the new regime, which would signal to firms a more balanced and proportionate approach than the EU.

How Can Regulatory and Competition Institutions Best Drive Market Dynamism to Boost Economic Activity and Growth?

The short answer is by doing much less than they are now. Moreover, the UK government needs to do more to align regulator responsibilities with government policy, which would reinforce the government's mission and unite regulators to the same purpose that would lead to a clearer, more coordinated regulatory environment. Too many UK regulatory agencies appear untethered from any overall national strategy, other than the strategy of expanding their regulatory reach and power. The UK government should be careful not to have the CMA use the DMCCA for protectionist means that ultimately impacts overall UK innovation that relies on open markets.

Secondly, the CMA should align itself to promoting dynamic or "Schumpeterian" competition. Specifically, the existence of market power does not by itself indicate that market failure exists, and it has long been understood that competition is not merely an equilibrium where price equals marginal cost, as neoclassical economics holds. Rather, as Schumpeter explained, innovation or dynamic competition occurs through "gales of creative destruction" whereby firms compete for the market by creating a new product, only to be challenged by additional leapfrog competition that supplants the formerly dominant firm with a still newer product that not just dazzles consumers but allows for the firm to recoup the costs of its innovation.^[1]

The CMA and DMU should embrace the idea of Schumpeterian competition and ensure that firms have the right market conditions to engage in this leapfrog and innovation competition. This means embracing firm size neutrality and seeing the value that big and medium sized firms can bring to the economy not just in terms of business R&D, but also employment and downstream productivity for suppliers that work with bigger firms.

Similarly, the Information Commissioner Office (ICO) and UK government should reevaluate their approach to data protection, recognizing that overly strong data protection hinders growth. A report conducted by the National Bureau of Economic Research found that the introduction of the General Data Protection Regulation (GDPR) positively correlated with the exit of around one third of apps from Europe. It concluded that whatever privacy benefits brought forward by the GDPR, substantial costs were felt in foregone innovation. The UK should capitalize on its departure from the EU to curate a thriving data economy that makes data protection compliance easier, and data more accessible for sharing. Again, those who say that the UK can have its cake and eat it too (stringent EU-style data regulations and a thriving data economy) are engaged at best in wishful thinking. There are ways to provide baseline privacy rules while enabling the UK to have the most dynamic data economy in the world. But the ICO does not appear to have any interest in achieving this.

What Are the Main Factors That Influence Businesses' Investment Decisions? Do These Differ From the Growth-Driving Sectors and Based on the Nature of the Investment (e.g., Buildings, Machinery & Equipment, Vehicles, Software, RDI, Workforce Skills) Across Different Regions?

The UK Government should conduct a thorough exploratory analysis of why UK businesses are underinvesting, especially in ICT. Businesses' investment decisions are influenced by a variety of factors, including economic conditions, access to capital, regulatory environments, and the specific needs of the firm. Overall however, the fall in UK productivity compared in particular to the United States, France and Germany, is due to lower growth in both capital and skills. The United States for example produces 28% more value added per hour than the UK. This capital does not only include human and fixed capital, but also intangible capital like ICT. Again when compared to the United States, France and Germany, the UK had the largest slowdown in ICT capital, representing an underinvestment in the ICT of businesses. This translates into slower growth across the board.

The Government should also address the preference for short-term gains over long-term growth, and the rampant short-termism of the UK financial system that leads firms to limit long-term investments. Different types of firms-large versus small, domestic versus international-may experience these influences differently, depending on their resources and market positions. Addressing these issues requires the government to investigate the reasons for the UK's investment shortcomings and implement appropriate regulatory reforms to encourage long-term investment strategies across various sectors and firm types.

In addition, as the House of Commons Library publication Business Statistics show, the UK is cursed by have too few "middlestadts" (mid-sized corporations that power the German economy) and large corporations. As the MIT Press book "Big is Beautiful" showed, small business are less innovative, less productive and invest less in capital as a share of sales than large firms. The UK will not solve its capital investment (and by extension, productivity) crisis, if it cannot create larger firms. This means at best adopting size neutrality as a core principle of all UK policy and ending the large array of special privileges and subsidies for "mom and pop" business, that bias UK industrial structure in favor of small firms.

What Are the Main Barriers Faced by Companies Who Are Seeking Finance To Scale Up in the UK or by Investors Who Are Seeking To Deploy Capital, and Do Those Barriers Vary for the Growth-Driving Sectors? How Can Addressing These Barriers Enable More Global Players in the UK?

The main barrier preventing growth in several sectors is union resistance to automation, rooted in confusion about the interaction between automation, technology and jobs. Crucially and significantly, the rate of automation will never exceed the rate of compensating job creation, and therefore the UK government should work with unions to transition focus away from net job loss to easing displaced workers' transition into new jobs. All too often union priorities are antithetical to UK priorities, especially when it comes to automation.

Technology-driven automation is central to the process of increasing our living standards, because better "tools" can help firms produce more, which in turn means workers can earn more and companies can offer competitive prices. Most workers are concerned about only one type of technology driven productivity, namely where technology replaces workers. There is another type of technology-driven productivity however, where technology makes workers more productive, and both are necessary and beneficial to boosting productivity and per-capita GDP. Automation increases net welfare even if more desirable jobs are automated, because overall GDP increases as society reaps the benefits of more plentiful goods and services. Limiting automation to protect workers will hurt growth because the general standard of living fails to improve. Therefore, the UK government should encourage the automation of work within sectors that will translate into an overall increase in welfare, focusing on supporting the transition of workers into other roles.

The UK Government Currently Seeks to Support Growth Through a Range of Financial Instruments Including Grants, Loans, Guarantees and Equity. Are There Additional Instruments of Which You Have Experience in Other Jurisdictions, Which Could Encourage Strategic Investment?

To encourage strategic investment and prompt better automation within sectors, the UK government should let companies expense machinery, equipment and software for tax purposes in the first year. Ideally, they would go beyond that by introducing a time-limited investment tax credit. And of course, it should ensure that little or no support in the above financial instruments goes to non-traded firms, and it should ensure size neutrality in these.

How Should the Industrial Strategy Accelerate Growth in City Regions and Clusters of Growth Sectors Across the UK Through Local Growth Plans and Other Policy Mechanisms?

The UK government should employ a "growth pole" strategy, a 1960s and 1970s regional economic planning strategy that focused investment to a limited number of locations, to pursue its Local Growth Plans. This strategy encourages economic activity within the region that translates into raised levels of regional welfare. Such a strategy, which operates on the basis of agglomeration economies-the notion that economic benefits arise when businesses and workers are concentrated to a specific geographic area-are especially important in the current innovation era where different regions offer their own strengths to contribute to an innovation economy.

The UK government should identify no more than 3 to 5 locations across the UK with strengths to sustain a regional growth center. The government should work closely with local and devolved governments to identify bold, highly localized policies that catalyze the innovation potential of the region, driven by the overarching purpose to close regional innovation gaps across the UK. This effort should be coupled with direct R&D funding for each identified region and specific exemptions for firms that choose to operate within these locations, incentivizing businesses to set up headquarters outside traditional locations and mobilizing capital beyond the Greater South East region.

What Are the Key Risks and Assumptions We Should Embed in the Logical Model Underpinning the Theory of Change?

The UK currently places too much focus on sustainability, inclusivity, and security, which risks diffusing actions and losing focus on the overall goal of long-term economic growth. For example, the green paper discusses the UK entering a new major investment cycle in the context of advanced manufacturing, but highlights Net Zero as one of the opportunities for UK manufacturing investment. Whilst reaching Net Zero targets is an important goal, driving investment into UK manufacturing should be to boost the growth of the sector, not as a vehicle to reach climate targets.

This does not mean that Net Zero targets cannot play a role, as the green paper identifies clean energy as another key area for growth. This however should be treated in similar fashion to the other key growth sectors such that the overarching purpose is to grow the sector, rather than reach net zero targets, which instead would act as a positive consequence of boosted growth in the UK's clean energy industries. More importantly, it is not clear that the UK has a real advantage in these sectors compared to many other nations, and ultimately energy-green or brown-is just not big enough to power UK industrial revival.

The problem with trying to shoe-horn in inclusivity into a UK competitiveness and growth strategy is that it will for the most part water down and weaken the former efforts, despite what the "we can have our cake" advocates would like everyone to think. It is critical for the UK government to keep its eyes firmly on the key priorities -innovation, productivity and competitiveness-and anything, including inclusivity and green, will distract from that goal and weaken efforts.

Having limited, but very specific and targeted objectives, such as increasing the growth rate of a sector, would serve the Industrial Strategy far better in the long term. The single goal for the UK government should be to turn around the UK's lagging competitiveness performance, rather than view competitiveness through the lens of sustainability, inclusivity and security.

How Would You Monitor and Evaluate the Industrial Strategy, Including Metrics?

The UK government should use the Hamilton Index and its supported analytical statistic known as "location quotient" (LQ) to evaluate the Industrial Strategy.

ITIF's Hamilton Index covers 10 advanced and strategically important industries, including IT and information services, pharmaceuticals and biotechnology, machinery and other equipment, of which the green paper identifies as key sectors for growth. LQ measures any region's level of industrial specialization relative to a larger geographic unit-in this case, a nation relative to the rest of the world. LQ is a ratio calculated as an industry's share of a country's economy divided by the industry's share of the global economy. By this measure, the relative bright spots among advanced industries in the UK have been "other transport" (firms such as Rolls Royce engines) and IT services (including software, AI, e-commerce) , which in 2020 were performing 27 percent and 25 percent above average, respectively.

IT services have been in relative decline since 2007 when it performed 62 percent better than the global average. And even more humbling has been the UK's performance in absolute terms-namely, its global market share of advanced industries. On that score, it is practically fading from view. Consider that in IT services the UK's output amounted to a mere 4 percent global market share in 2020, down from 8.6 percent in 2007. Across all 10 industries in ITIF's index, the UK's global market share had dropped by nearly half since the turn of the century-from 4 percent in 2000 to just 2.1 percent in 2020, while it's LQ is just 0.67 behind nations like India, Mexico, Poland, Russia, and Turkey. Relative to the size of its economy, the UK's output in these industries has been in a long, steady decline, dragged down in recent decades by underperformance in 8 out of the 10 industries of ITIF's index.

Thank you for your consideration.

Endnotes

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