• Andrew O'Brien

COVID-19 and economic rebalancing

The well documented logistical issues in getting sufficient equipment for the UK to tackle COVID-19 and debate about the future resilience of the UK economy has rightly brought back into focus the balance of the UK economy.

We have been here before, of course, after the last recession. Then, it was a recognition that the UK was heavily dependent on financial services and a huge structural trade deficit which fueled concern. It was George Osborne that famously called for a “March of the Makers” in his 2011 Budget Speech and in 2012, he followed this up with a call to “repair the disastrous model of economic growth which created those debts. A model that saw manufacturing almost halve as a share of our national economy, while the national debt doubled.”

Yet the past nine years have not been marked by a change in our economic balance. If anything, things have become more imbalanced. Manufacturing has still not recovered its pre-financial crisis peak. Fits and starts have seen the manufacturing sector get close to where it was, but COVID-19 could sink this long and slow recovery.

Why does this matter?

As I argued in a previous piece for this website, this concern (or lack of concern) about manufacturing speaks to the heart of the different philosophies which dominate Conservative economic thinking. Those focused on Smithian growth and comparative advantage tend to assume that there is no hope in “rebalancing” the economy. If anything, the economy is already balanced to what the UK is naturally good at, which are services – particularly financial and legal services. We just have to let things be.

Schumpeterians are more concerned about balance because there is a view, correct in this writer’s view, that growth is primarily driven by new technologies and the productivity improvements these create. Without a strong industrial base, we are likely to miss out on the benefits of the 4th Industrial Revolution and decarbonisation.

But even beyond this, all the arguments that dominated before COVID-19 and Brexit still ring true.

Firstly, there is there productivity puzzle. Some would argue that the productivity of services is badly measured and there may be some truth in that. However, the UK seems to be increasingly dominated by sectors where productivity is low and has been low for some time. Retail, hospitality, financial and business services. Good productivity data is hard to find on these sectors, but even in a much-vaunted area such as financial and business services, the UK still has lower levels of productivity than USA, France and Germany. So not only are we specializing in sectors with generally low rates of productivity, we are not even that productive in those sectors compared with our competitors (see Millward in Floud & Johnson, Cambridge Economic History of Modern Britain). Manufacturing has had generally higher levels of productivity than other sectors of the economy and productivity growth is critical to living standards.

Secondly, there is the balance of payments. The UK is running one of the largest (if not proportionally the largest) current account deficits in the world. As has been brought to the fore by recent protests, due to Empire the UK was able to run up a huge investment surplus with the rest of the world during the 18th, 19th and early 20th Centuries. Not only did this create a huge pool of domestic assets, but also a regular income which the UK was able to live off for many decades. As Piketty has shown in Capital and Ideology, the UK was earning between 5-8% of national income during the 19th and early 20th Century through overseas investments. However, the two world wars forced the UK to sell off those assets. Yet this created a huge wealth of assets which the UK has been able to sell and trade off decades to fund our large trade deficit with the rest of the world. Yet these assets have been run down in the 21st Century and the income from them no longer offsets the costs of our trade deficit, as it did at the start of the last century.

This has created two main problems. In the first instance, it has forced the UK to maintain high asset values in order to be able to continue to meet that trade deficit. This links directly into problems such as the housing shortage in the UK. Arguably, the UK has to continue to keep a housing shortage, to artificially inflate the value of property in order to be able to continue to sell those assets and attract further foreign investment to pay for goods. The alternative would be run away inflation. In short, the UK cannot resolve many of its key domestic structural problems without addressing its trade deficit. The second problem is the increasing lack of strategic control and direction of the economy itself. As the UK has found during COVID-19, it cannot marshal its resources in the same way that its competitors can because so many decisions are made outside of the UK. We are far less resilient to the winds of global markets and decision making.

Smithians would say that this forces the UK to be more competitive because we have to prove our worth in global markets. There may be some truth in that, but it also leaves politicians will little wiggle room about how transitions are made when a sector or business is no longer competitive. This can create significant socio-economic dislocation. It also assumes that other countries allow their businesses to make decisions purely on the basis of competition, rather than allowing national strategic interests to influence business decisions. As we enter more protectionist times, this approach will be put under the test.

The Climate Crisis & Rebalancing

As we embark on a fourth industrial revolution, it is an interesting thought experiment would be to consider what would have happened to the UK if we had never led the way in the first industrial revolution and had never developed a large manufacturing capacity. Some may argue that we would have been better for it, avoiding the mistakes that a “first mover” generally makes. However, one only has to look at the different trajectories of Belgium and Netherlands (the former industrialized, the latter slow to industrialize) to see the difference that manufacturing makes during periods of rapid technological progress.

We are now likely to see a huge transition in decarbonization. Services will play a role, but a lot will be focused on manufacturing. This is not only about manufacturing the renewables, the batteries and EVs for the future. It is also about finding more efficient ways to reuse materials and low-carbon ways of creating everyday items. The UK has an opportunity to be a world leader in those fields with our R&D, but if they are made overseas the benefits of such an approach are unlikely to trickle down through the rest of our society.

What do Conservatives do?

The first thing is to not ignore this. The Conservatives since 2010 have rediscovered “Industrial Strategy” and this belief in the need of a strategic state to cultivate manufacturing and industry is critical. The lack of active industrial strategy during the Thatcher and Blair years severely undermined the UK’s economy. The Conservatives must stick to Industrial Strategy despite the siren voices that are already calling for them to ditch it because of a lack of results. Industrial Strategy hasn’t failed to deliver results so far because the UK has decided to be strategic, it has failed because the UK has not been strategic enough or properly resourced its strategic intent.

There are three broad areas that the Conservatives need to rapidly implement.

Number One, as Sam Bowman and Stian Westlake have successfully argued, the Conservatives also need to embrace far reaching tax reform to prioritize productive capital investment. We simply don’t incentivize capital investment enough and this undermines competitiveness. Manufacturing and industry are capital intensive by their nature, our tax system needs to reward that kind of investment.

Number Two, we must look at the structure of UK business itself, which is currently not suited to manufacturing and reindustrialisation. Patience, a long-term planning horizon and a desire to innovate rather than sell out for a quick buck are the order of the day. Some have focused on competition policy but we need to go beyond that. As I have argued elsewhere, we need to confront corporate structure if we want to embed the right behaviours. Just look at British businesses in the 18th and early 19th Century to see the critical importance of culture in industrial success.

Number Three, we need to look at energy infrastructure. Transportation and broadband are important, the latter may be useful in raising productivity in the services industry which will continue to dominate the UK’s economy in the years ahead. Yet energy infrastructure continues to lag behind. Decarbonisation demands that we invest more in renewables, yet investment has been slowing in recent years. We risk squeezing supply, increasing prices and undermining competitiveness. Infrastructure investment must include a large amount of investment in energy infrastructure to increase supply, resilience and reduce cost. The Government should also socialise the cost of this transition, as proposed in the Helm review, recognising that reindustrialization is a public good. New incentives would need to be created in order to stimulate continued investment in low carbon alternatives, but asking an already weak industrial sector to pick up the tab for decarbonisation is suicidal.

There are substantial political gains to be made from this. Firstly, it will advance the levelling up agenda which aims to reduce regional inequality. Secondly, higher productivity from industry will raise living standards and increase prosperity. Thirdly, economic growth can be hard to "see" but this kind of agenda will leave clear legacies behind it in the form of new power infrastructure, new products and jobs that the public will easily feel. Finally, it will restore dignity to communities in the North and Midlands which feel underappreciated by London and the South East. We must not underestimate the cultural impact of "industry".

This Government must redouble its effort to rebalance our economy after COVID-19. There is much discussion of building back better, but any programme which ignores the need for economic rebalancing is not complete. We still have time to make the most of the coming technological moment, but we are rapidly running out of time.


©2019 by One Nation Economics. Proudly created with