New Thinking: Financing (green) industrial strategy

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New Thinking: Financing (green) industrial strategy

Matthew-photo smallFinancing (green) industrial strategy – lessons from history

Matthew Lockwood, IGov Team, 7th October 2016

An intriguing aspect of the (now not so) new government is its interest in industrial strategy. In the green community, there is a lot of hope that this interest will provide an opportunity for a more active green industrial strategy – for example, see here, here and here. However, attempts to develop such a strategy are not new, they have been tried in various forms before several times, including the 2006 Environmental Innovations Advisory Group, the 2008 Commission on Environmental Markets and Economic Performance, and the 2009 Low Carbon Industrial Strategy, none of which had a major effect in the end. Will things be different this time round?

There are some signs that the current context for reviving industrial strategy is unusually supportive. One is that the issue has attention and support at the highest political level, including powerful advisor Nick Timothy and the PM herself. Another is that the Treasury, usually unremittingly hostile to industrial policy on the grounds that government should not ‘pick winners’, now appears to be politically marginalised, at least for now.

However, it remains the case that the UK has often struggled with industrial policy, especially compared with competitors, which have tended to be more successful at it. In the past we have spent less on industrial policy than other countries, such as such as Germany, Japan, the US, and Nordic countries. There has been an abiding fear of capture by failing companies in dying sectors, based on the 1970s experience of bail-outs of British Leyland and Cammel Laird. There has been a tendency for industrial policy to slide into regional policy, partly because it is not selective by sector or firm, a tendency perhaps echoed in Greg Clark’s enthusiasm for localism.

Why has the UK had such difficulty in designing and maintaining effective policies for developing new industries? Peter Hall’s 1986 study of the history of economic policy making in Britain in comparative perspective suggests the answer may lie in a number of institutional patterns with deep historical roots. These include fragmented business and labour organisation leading to conflict, rather than strategic cooperation for improving productivity and innovation, the power of a hostile Treasury noted above, and a strong stream of economic liberalism in the British Conservative party, which may yet sink Theresa May’s new agenda for intervention just as Harold Macmillan’s proposed Industrial Reorganisation Bill failed as it was thought too radical for Conservative opinion in the 1930s.

However, one of the deepest and most important of the institutional challenges arising from historical legacies is the nature of the relationship between industry and finance. Britain industrialised early, in manufacturing areas such as textiles with low costs of entry, meaning that companies could finance investments largely through retained earnings and raising equity through what were mainly local stock exchanges. According to the fascinating account in Colin Mayer’s book on the nature of the corporation, local banks did play some role in financing industry through the 18th century, but a series of banking failures over the 19th century, and the unwillingness of the Bank of England to underwrite local banks, led to consolidation of finance in national institutions which were much more conservative. These banks were more risk averse and required quicker returns, and most crucially, were distant from and know little about industry. They were also increasingly outward facing, with the Empire meaning that banks were more heavily oriented to overseas lending than in other countries. The failure of the City of London to invest significantly in British industry, especially in small and medium sized businesses with potential growth, was noted in the MacMillan Committee report of 1931. Even now, only 5% of lending from major UK banks goes to UK corporates, with a much smaller proportion going to SMEs.

By contrast, in countries like Germany and the US, which industrialised later in the era of steel and chemicals, companies needed larger investment banks that were, in Hall’s words, ‘interested in industrial modernization, capable of financing it, and influential enough to enforce it on recalcitrant firms’. In Germany, banks also took equity positions in firms, and sat on their boards.

There are thus some deep-seated institutional problems with the role of finance in industrial policy in the UK. However, this does not mean that these problems could not be addressed and attempts made to overcome them. Mayer outlines the story of the Industrial and Commercial Finance Corporation. This was set up in 1945 by the Bank of England and other banks, rather against their wishes, with the view of preventing the new Labour government from establishing a state owned national investment bank. Expectations were low; the Deputy Governor of the Bank of England said: ‘I don’t much believe in this body and hope and expect that they won’t do much. However, according to Mayer, the ICFC was ‘an immense success’, highly profitable from 1948 onwards, and after it was allowed to raise external funds after 1959, it became the largest provider of capital for unquoted companies in the UK. It focused on small manufacturing companies. It had local branches, lending staff with considerable technical expertise, and made investments for the long term. However, after a merger in the 1970s and renamed as Investors in Industry, it was sold off and eventually floated on the stock exchange in 1994 as 3i. Once sold off, 3i gradually drifted away from essentially providing venture capital for emerging companies into financing management buy-outs of established ones, losing its original raison d’etre.

The story of the ICFC and 3i has obvious ramifications for the closest thing we have had to it in recent years, i.e. the Green Investment Bank (whose headquarters, symbolically perhaps, is at a distance from the City of London, in Edinburgh). As James Murray of BusinessGreen points out, the GIB could play an essential role in a new industrial strategy. Indeed, the history of the relationship between finance and innovative emerging industry in the UK outlined above suggests that something like a GIB, which includes funds specially aimed at smaller projects, would be essential. But just as with 3i, the GIB is now being sold by its original owner (i.e. the state), and despite the retention of a green focus in its Articles of Association, a key question is whether it will continue to provide venture capital to emerging firms in green sectors or, like 3i, drift into a different kind of business. If that happens, then history suggests that the prospects for successful green industrial strategy in Britain will be much diminished.

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