uk industrial policy: old tunes on new instruments?

221© 2002 OXFORD UNIVERSITY PRESS AND THE OXFORD REVIEW OF ECONOMIC POLICY LIMITED

UK INDUSTRIAL POLICY: OLD TUNESON NEW INSTRUMENTS?

OXFORD REVIEW OF ECONOMIC POLICY, VOL. 18, NO. 2

JOHN BEATHUniversity of St Andrews and ELSE, UCL1

This paper discusses the current Labour government’s industrial policy—as most recently reflected in itsdocument on manufacturing strategy—in the context of industrial policy in the UK over the last 50 years andthe form that it has taken elsewhere in Europe. It concludes that the thematic priorities for UK industrial policyin the 1960s—international competitiveness, innovation, competition, and skills—continue to be the keythemes of UK policy today. The paper presents data that illustrate the gaps that exist in key indicators ofperformance between the UK and its main economic competitors. The difference between the 1960s and the2000s is that there are new instruments of policy. Two areas in particular are focused on—competition policyand technology policy—and an attempt is made to assess the likely effectiveness of these new instruments. Thepaper concludes that the international evidence base for these new approaches is reasonably robust but that itis still too soon to tell if they are having the hoped-for impact on the performance of the UK economy.

Gone are the days when industrial policy meant planning,picking winners, pumping subsidies into firms. The newpolicy is about skills, about innovation and enterprise.Above all, it’s about competition to create dynamic, inno-vative firms. (Rt Hon. Stephen Byers, Secretary of State forTrade and Industry, February 2000)

I. INTRODUCTION

There is a lack of consensus about what industrialpolicy actually comprises. Certainly, it is the case

that it covers those policies that are directed atmicroeconomic objectives (such as stimulating therate of innovation or the growth of exports) ratherthan macroeconomic objectives (such as low infla-tion and full employment). A narrow view ofwhat constitutes industrial policy would restrictattention to policies that target particular firms andindustrial sectors.2 However, a broader view, andone that seems to fit better with what the presentgovernment has called its ‘manufacturing strategy’

1 This paper began as a talk given at the Economics Section of the British Association for the Advancement of Science, in Glasgow,4 September 2001. In this version I am grateful for advice and comments received from members of the Review’s editorial boardand from Andrew Glyn, Chris Jensen-Butler, David Ulph, and an unnamed referee. The usual disclaimer applies.

2 For example, the sort of selective industrial assistance used in the past to support aerospace, shipbuilding, steel, and vehiclemanufacture or, currently, the policy of ‘industrial clusters’.

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(Department of Trade and Industry (DTI), 2002),would include any policy that shapes or influencesthe competitiveness of a country’s firms and indus-tries. What I argue is that, in fact, Labour’s newindustrial policy is evolutionary rather than revolu-tionary and I suggest that much of the terminologyand many of its features can be found in theindustrial strategies of previous governments (forexample, in the National Plan of 1965). I alsosuggest that, in a European context, this strategy isquite close to that which has been pursued for sometime in Germany. While a full discussion of UKindustrial policy would include a diverse range ofgovernment policies—trade policy, infrastructurepolicy, technology policy, and competition policy—I restrict my attention to the last two of these.

II. THE EVOLUTION OF INDUSTRIALPOLICY

In order to justify the claim that I made in theintroduction, it is necessary to start with a review ofpost-war industrial policy. In general terms, over theperiod since the 1950s, the best-performing coun-tries in terms of growth and international tradeshares have been those which implemented somekind of industrial policy. For example, the USAmaintained its industrial leadership only in areaswhere there was a significant amount of stateintervention and support (e.g. aerospace and de-fence, nuclear energy, and various fields of elec-tronics).

With the rise of the Japanese and East Asianeconomies during the 1950s and 1960s, the newlyindustrialized economies were encroaching on theestablished markets of the traditional suppliers.Industrial restructuring in Europe, essentially thephasing out of non-viable sectors, was hampered bysocial considerations, and the industrial policieswhich followed were essentially defensive. Vertical(i.e. sectoral) industrial policies along with restric-tions on trade were implemented.3

However, it became clear to policy-makers duringthe 1960s that trade performance and technological

improvement4 should be the key objectives of indus-trial policy. For example, this was the period thatsaw the favouring of ‘national champions’ designedto narrow the technological gap and respond to thecompetitive challenges of US and Japanese firms inworld markets. At the national level, across Europe,there was an increase in the number of state-ownedfirms. For example, in the UK British Leyland wasnationalized, as, in Sweden, were the shipyards andsteelworks. Anastassopoulos et al. (1987) point outthat while in 1965 only 19 of the 200 largest compa-nies outside of the USA were European publiclyowned companies, by 1975 29 were, and by 1985 thenumber had risen to 38. As Jacobsen and Andréosso-O’Callaghan (1996, p. 280) note, ‘economic inter-nationalization and political nationalization combinedto put state-owned multinational enterprises at theforefront of European industrial development’. Itwas in Italy and France, traditionally interventionistcountries, that this trend was the most noticeable. Incountries such as Germany and the UK, on the otherhand, the initial stance was to look first at ways ofimproving the operation of the market system andonly subsequently at active intervention.

In the UK prior to 1960, policies aimed at supportingindustry could be categorized into four groups:regional policy, competition policy, policies to stimu-late investment and provide funds for industry, andpolicies to encourage the exploitation of inventions.

There have been policies to stimulate investmentsince the 1940s, often linked with regional policy inthe sense that the incentives in certain regions weremore generous. Initial and investment allowances,essentially a tax credit for investment, were intro-duced in 1945 and lasted until the mid-1960s, whenthey were replaced by investment grants. Thereplacement reflected a concern with two featuresof tax credits: they are only of value to firms whichhave taxable profits and there are inherent delaysinvolved in such a scheme.5 Grants had their ownproblems, most notably the concern that they subsi-dized investment in loss-making firms and so werenot a very well targeted form of investment incen-tive. Regional policy, as I have indicated, has alwaysdepended partly on these incentives. However,

3 For example the Multi-fibre and Voluntary Restraint agreements.4 The theme of the ‘technological gap’ featured strongly in an influential book by the French commentator J.-J. Servan-

Schreiber (1967).5 It is worth noting this point in view of the recent introduction of tax credits for R&D.

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these have been supplemented by other instrumentsof policy. Examples of these are infrastructuralinvestment (often with EU support), special plan-ning regulations (for example in the 1980s therewere the ‘enterprise zones’ in large cities designedto foster urban regeneration), and support for in-ward investment by overseas companies.

Competition policy legislation has been in placesince 1948, when the Monopolies and MergersCommission (MMC) was established. However, itwas not until the 1965 Monopolies and Mergers Actthat mergers were controlled. The MMC’s role wasto advise the government on whether or not amerger was against the public interest. This per-spective changed with the Competition Act of 1980,which introduced powers to investigate anti-com-petitive practices by firms, including the efficiencyof public bodies with state-endowed monopolies. Ofcourse, ever since the UK joined the EU in 1973,European rules of competition have applied. Thesewere contained in Articles 85 and 86 of the Treatyof Rome and were designed to prevent economicintegration from being hindered by cartels and mono-polies. European competition policy has always hadthe power to exempt restrictive practices wherethese would promote technical or economic progress,provided that consumers also have a share of theresulting benefits. A form that this has recentlytaken is the exemption of technological alliancessuch as research joint ventures.

The innovation of the 1960s was the attempt tomimic French indicative planning. Bodies were setup to focus on industrial strategy (the NationalEconomic Development Council (NEDC)) and in-dustrial reorganization (the Industrial ReorganizationCorporation (IRC) and the National Enterprise Board(NEB)). As part of this process there was theNational Plan of 1965 and the later Industrial Strat-egy.6

The idea of a planning institution that would coordi-nate the plans of the main sectors of the economyemerged in 1961 and as a result the NEDC (alongwith its supporting office (NEDO)) was set up. Thistripartite body involving government, management,and labour was concerned with finding ways inwhich obstacles to faster economic growth might beovercome. Complementary to it were similarly tri-partite Economic Development Committees (EDCs)for individual industries. Their remit was to exploreways of enhancing growth and efficiency in theirindustry. The National Plan7 which was published in1965 was based on a 4 per cent per annum growthtarget and laid out a set of policies that weredesigned to achieve that. It accepted that in somecases this might require policies to strengthen theforces of competition and that in others there mightbe a need to supplement market forces.8 However,it did accept that each case needed to be judged onits merits. The action programme involved cuttinggovernment spending on aid and defence and em-phasizing forms that directly assisted economicgrowth: improved training of the labour force andthe application of modern technology in Britishindustry.9 The small scale of British industry relativeto its main competitors was seen as a problem andso it was proposed that government should assist inthe process of rationalization and, in some instances,take the initiative. The quality of industrial manage-ment was also seen to need enhancement andmanagement education and the professionalizationof industrial management was seen as crucial.

As today, improving productivity was a key objec-tive; this was to be achieved through increasedindustrial investment and what was needed was alonger-term perspective. This was to be provided bythe EDCs, which were to focus industry attention onthe longer-term picture. Special efforts were to beput into attracting foreign inward investment. Anactive labour-market policy was proposed. As the

6 During the latter half of the 1960s and 1970s there were also forms of price control. The National Board for Prices and Incomeswas set up in 1965 to report as part of the Labour government’s prices and incomes policy. Though abolished by the Conservativegovernment in 1971, it re-emerged in 1973 as two bodies, the Pay Board and the Prices Commission. These bodies were abolishedby the 1980 Competition Act.

7 Department of Economics Affairs (DEA, 1965). In Part II of the Plan, there was a detailed analysis for every industry, coveringoutput, exports and imports, manpower and productivity, investment, technological change, structural change, and conditions forgrowth.

8 ‘In other cases, such as the regional distribution of industry, and transport, important social costs arise which are not expressedin market prices; and Government action is required.’ (National Plan, para. 12, p. 3.)

9 These two remain constant planks of industrial policy to this day.

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Plan itself stated (DEA, 1965, paras 47–50, pp. 10–11),

Britain’s place in the world is going to rely increasinglyon her technological skill. We cannot afford to havepeople working well below their capacities because ofinadequate training and skill. The Industrial Inquiry re-vealed the rapidly growing demand for skills of manytypes and the danger that growth will be held back byshortages of these skills. [It] also revealed the need forlarge movements of labour between industries. . . . Theprogress of industrial training will be kept under continu-ous review.

Special attention was to be paid to speeding eco-nomic growth in regions where it had been low, andattracting new industries was seen as the wayahead. Part of this was assumed to occur throughfirms moving from areas where the pressure onresources was high to those where there was anexcess of resources.

The credibility of the National Plan was destroyedby the restrictive measures that the governmenttook to deal with the sterling crisis of 1966, andindicative planning never recovered. The plan thatfollowed the 1967 devaluation of sterling was morea survey of the possible uses of resources based ontwo alternative growth rates than a plan and had farless in the way of industrial detail. In the 1970s,under the aegis of the NEDC, the trend was forinvestigations into the fortunes of individual sectors,looking into reasons for low productivity or poorcompetitiveness. This was accompanied by selec-tive intervention, in the form of help to particularfirms and industries. The role of the IRC, set up in1966, was to encourage concentration and ration-alization in industry in order to promote greaterefficiency and international competitiveness. It wasfirmly rooted in Prime Minister Harold Wilson’sbelief that what was needed was access to econo-mies of scale along with investment in new methodsof production and new products. While this was acasualty of the 1970–4 Heath Conservative govern-ment, it was reformed in 1975 as the NEB, oneagency that survived the replacement of the Labourgovernment by a Conservative one in 1979.10

The Industrial Strategy, launched in 1975, was alsoa form of indicative planning. The idea was thatthere should be a 5-year prospective look at the mostimportant sectors of industry, along with an analysisof past performance.11 The implications of alterna-tive medium-term growth assumptions would beworked out and those sectors that mattered most forachieving the government’s economic objectiveswould be selected using one of three criteria:

• industries that were intrinsically likely to besuccessful based on past performance andcurrent prospects;

• industries which had such potential if appropri-ate action were taken;

• industries whose performance had most effecton the rest of the economy.

The identification of such industries was popularlyreferred to as ‘picking winners’. In fact, this notionwas never really put into practice as the diagnosispointed to the need to support a rather wide range ofindustries and the Industrial Strategy was de factoa general strategy. Indeed, one reviewer of thepolicies of this period (Silberston, 1981) has com-mented that ‘the weight of policy has been directedat helping old industries to survive rather thanencouraging new products and new technology’.

The 1980s were a period of great scepticism aboutthe pursuit of interventionist policies. Privatization,which was based on the view that there was a needfor microeconomic reform to sharpen private incen-tives and correct for government failure, started inthe UK with the Conservative government electedin 1979, but soon spread across Europe. In the UK,industrial support measures were withdrawn andregional expenditures declined. In 1986 in France alist of privatizable companies was determined andby 1994 the share of manufacturing employmentaccounted for by state-owned firms had fallen fromthe 1984 figure of 16 per cent to 7 per cent. Thereunification of Germany led to intense effortsthrough the Treuhandanstalt to privatize the state-

10 While the NEB had a wide remit, many of its resources were used up in supporting ‘lame ducks’, such as British Leyland andRolls-Royce.

11 The basic unit of operation was the tripartite sector working party that supplemented the pre-existing EDCs. There were 40groups in total.

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owned enterprises of the former Democratic Re-public and, by 1994, 17,000 firms (or parts thereof)had been sold. Elsewhere in Europe the privatizationprocess was more measured, but none the lessevident. However, it was in the UK that this declinein the number of state-owned firms was mostspectacular. In 1979 an indicator of the impact ofpublic enterprise on the UK economy was calcu-lated to be 25 per cent. By 1991 this had fallen to 4.5per cent.12

While the 1980s saw the discussion of a positiveindustrial policy slip off the agenda for discussion inthe UK, the 1990s can be characterized by a returnto this more activist stance, both in Europe generallyand in the UK in particular. Debate over the relativeeconomic performance of both the UK and Euro-pean economies sparked a renewed interest insources of competitiveness and the role of the statein assisting this. Indeed, both the Commission andthe UK government published competitiveness pa-pers.13 It has been argued that this also involved amove away from the vertical targeting approach ofthe 1960s and 1970s to more horizontal, sector-neutral policies reflecting the view that one cannot‘pick winners’.14 Policies that are directed at educa-tion and the science base, at competition, and atinternational competitiveness can be argued to havethis sector-neutral form.15

In 1993, the Office of Science and Technologypublished the White Paper entitled, Realising OurPotential: A Strategy for Science, Engineeringand Technology. This placed greater emphasis on

applied research and the commercialization of thescience base, a view that continues to be at theforefront of official thinking, as is obvious in therecent consultation papers on research by the HigherEducation Funding Councils. The assumption is thatif there is closer affiliation between industry and thescience base, this will speed up the rate of commer-cialization of basic research. One problem with thisis that there is no really clear evidence that the linksbetween the science base and industry in the UKare significantly worse than in other countries. Nordoes it follow that they are necessarily a crucialfactor in determining the rate of commercialization.For example, short-termism and the inability of smallinnovative companies to get access to finance maybe far more crucial.16 A second point is that it mayresult in innovation short-termism in the sense thatit encourages incremental innovation rather thanmajor breakthroughs. The policy proposal that cameout of those White Papers was the TechnologyForesight Programme. The 15 panels with membersdrawn from industry, government, and academia,were to identify and promote new technology acrossthe various sectors. The obvious danger is that this isjust a ‘high-tech’ form of the old policy of ‘pickingwinners’, only this time in science rather than industry.

Technology policy has also been a cornerstone ofEU industrial policy through the ESPRIT programmeand support for the formation of large collaborativeR&D programmes to respond to the large-scaleinitiatives that were under way in the USA and inJapan. This was formalized in the various Technol-ogy Framework Programmes that started in 1984.17

12 This figure is reported in Jacobsen and Andréosso-O’Callaghan (1996, p. 283). It averages together the share of non-agriculturalemployment, the share of value added in manufacturing and services, and the share of non-agricultural fixed-capital formation.

13 Commission of the European Economies (1994); DTI (1994, 1995).14 Nevertheless, it is still the case that the most noticeable trend at the European level is the increase in the proportion of spending

on regional measures, which account for more than half of all EU state aid to industry.15 Cowling et al. (1999) argue that this is far from clear. For example, if the comparative advantage of advanced economies lies

in knowledge-intensive industries, technology policy might best be targeted at these. Even where one wants to encourageproductivity improvement across all industries, there will be certain industries where obstacles may be greater and it may beappropriate to target these in particular. Moreover, 50 per cent of the UK government’s spending on R&D is on two sectors: defenceand civil aerospace.

16 This has been highlighted in a recent report published by the Bank of England (2001).17 One recent feature of European policy is the move towards decentralization of decision-making in the area of technology policy.

The Regional Innovation and Technology Transfer programme and the Regional Innovation and Strategy programme involvestimulating technology transfer and innovative activity. However, both require significant local input in their funding, design, andimplementation. They do involve sectoral targeting, but embody a degree of economic democracy that may enhance theireffectiveness as instruments of technology and regional industrial policy.

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III. THE KEY ELEMENTS OFCURRENT UK INDUSTRIALPOLICY

The stated objective of the Labour government thatwas elected in 1997 was to put in place a frameworkthat would produce the stable macroeconomic envi-ronment within which a new industrial policy couldoperate. That new industrial policy was set out at theend of 1998 in the Competitiveness White Paper,Our Competitive Future: Building the Knowl-edge Driven Economy (DTI, 1998), and mostrecently in the DTI’s paper on ‘manufacturingstrategy’.18 The key problem identified is the well-documented gap in productivity between the UKand its major economic competitors such as France,Germany, and the USA.19 The productivity gap isattributed to lower levels of skill, investment, R&D,and innovation, and the assumption is that throughknowledge, skills, innovation, enterprise, and theeffective harnessing of the science base this gapcan be closed.20 The government strategy has threeaims:

• to encourage long-term research and invest-ment;

• to promote competitive markets;21

• to equip the labour force with the requisite skillsand aspirations.22

Hence, one can identify the three planks of thepresent Labour government’s industrial policy: com-petition policy, technology policy, and education andtraining policy. I only discuss the first two of these

here, as the third is discussed elsewhere in this issueof the Review.

IV. THE INDUSTRIAL PICTURE

In order to put these planks of current industrialpolicy into perspective, it is necessary to considerthe UK’s industrial performance. Table 1 showsclearly the gap in labour productivity between theUK and the USA, Germany, and France. It alsoshows the relatively poor performance of the UKover the last 50 years. There has been a slow-downin the growth rates of productivity over the period,though this experience has also been shared byFrance, Germany, and Japan. In the last decade, thegrowth rate in the USA has picked up.23

Technological improvements are, in part, embodiedin new capital. As Table 2 shows, the UK hasperformed significantly worse than its competitorswhere levels of capital intensity are concerned. Thegap in 1999 is very striking, though there are groundsfor optimism in the relatively stronger growth per-formance of the UK in the last decade. A furtherreasons for optimism concerns the improvements inquality of capital, something that is not captured inthe data below. There is evidence that in recentyears investment in information and communica-tions technology has been growing significantly andthat this is beginning to have an impact on outputgrowth.24

It is now possible to assemble data on stocks ofhuman capital and Table 3 provides some compara-tive data on these. These show that over the last 25

18 DTI (2002). This document in fact identifies ‘seven pillars for manufacturing success’: macroeconomic stability, investment,science and innovation, best practice, raising skills, modern infrastructure, and dynamic competitive markets.

19 Recent research by the National Institute of Economic and Social Research (NIESR) suggests that in 1999 the gap betweenthe UK and the USA was 55 per cent, with France 32 per cent, and with Germany 29 per cent. There were no sectors in whichthe UK was the productivity leader. It had higher productivity in petroleum products and food, drink, and tobacco than Germany,and in paper, printing, and publishing than France. Nevertheless, Office of National Statistics data show that manufacturingproductivity in the UK grew by more than 40 per cent over the 1990s, a cumulative rate of 3.4 per cent p.a. However, all of thisgrowth occurred in two periods: 1990–5 and 1998–2000.

20 In September 1999, the Secretary of State for Industry gave an address to the British Association entitled ‘Prospering ThroughScience’.

21 ‘My approach is clear—competition wherever possible, regulation only where absolutely necessary.’ (Stephen Byers, ‘TheImportance of People and Knowledge—Towards a New Industry Policy for the 21st Century’, address at the London BusinessSchool, October 1999)

22 Enhancing consumer skills has also featured under the initiative entitled, Modern Markets: Confident Consumers.23 Sector-level data cited in Crafts and O’Mahony (2001) indicate that the adverse productivity position of the UK relative to

its competitors has been in services rather than manufacturing.24 Crafts and O’Mahony (2001, p. 284), cite Oulton (2001) as evidence.

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Table 1Relative Labour Productivity

UK Germany France Japan USA

GDP per capita (1999) 100 111 121 91 126Growth rates (% p.a.)

1950–99 2.53 3.65 3.53 4.23 1.671973–99 2.13 2.29 2.56 2.78 1.081989–99 1.92 1.87 1.32 2.70 1.471995–9 1.30 1.15 1.16 1.22 2.08

Source: Crafts and O’Mahony (2001).

Table 2Relative Capital Intensity


Capital per hour (1999) 100 132 146 165 142Growth rates (% p.a.)

1950–99 3.74 3.84 3.59 5.70 2.201973–99 2.97 2.37 3.07 4.79 2.171989–99 2.54 1.17 1.94 3.89 2.221995–9 1.00 0.49 0.88 1.20 2.48


Table 3Levels of Skill

UK Germany France USA

1978–9Higher 6.8 7.0 9.4 15.8Intermediate 21.8 58.5 40.1 11.4Low or none 71.4 34.5 50.5 72.8Relative skills 100 109.1 108.0 103.3

1993Higher 13.5 11.4 11.0 22.1Intermediate 30.9 60.7 50.1 17.5Low or none 55.6 27.9 38.9 60.4Relative skills 100 106.5 103.9 102.3

1998Higher 16.6 13.5 16.4 24.1Intermediate 34.6 63.8 51.2 18.1Low or none 48.8 22.7 32.4 57.8Relative skills 100 105.5 105.3 100.5


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years, the UK appears to have closed the skills gapwith the USA. However, there is still a significantskills gap between the UK and its major Europeancompetitors. While the UK matches them in termsof those with higher skills, the gap in intermediateskills is striking.25 It is, of course, these latter skillsthat Prais (1995) has argued are the important onesfor economic performance.

Table 4 provides a snapshot of UK manufacturingand shows the size of each sector, its growth overthe last decade or so, and measures of its R&Deffort and the quality of its stock of human capital.

International competition is increasingly based onthe creative exploitation of knowledge, and empiri-cal studies show that relative knowledge stocks arean important source of comparative advantage inthe trade between nations. As Fagerberg (1988,1996) has shown, if the pattern of international trade

is studied, the general rule seems to be that countriesthat gain market share also display faster productiv-ity growth and increase their technological capabil-ity more than other countries. Thus, it is technologi-cal competition rather than price competition thatmatters the most, and there is now a rich literature inthe economics of growth in which technology, com-petitiveness, trade, and growth are linked.

The models in that literature point to innovation,and imitation, as the main factors explaining tradeand growth. However, innovation is not an exog-enous element, but depends on things such asincentives, skills, and the economic (and social)environment in which these operate. This is illus-trated in the recent study by Carlin et al. (2001a).They use industry-level OECD data for 14 countriesto explore the impact of relative unit labour costs onexport market shares and explore the determinantsof differences across countries in the sensitivity to

Table 4UK Manufacturing, Performance Indicators

Sector Percentage of Average annual R&D as a Percentage ofwhole economy percentage percentage employees with

in 1995 growth of value added degrees(1991–2001) (average 1991–2000)

Electrical and optical 2.78 5.5 6.6 18.8of which,computers and office equipment 0.51 16.1 5.5 27.5communication equipment,TV, radio 0.79 6.4 12.9 20.9

Chemicals and man-made fibres 2.39 3.1 18.5 26.4of which,pharmaceuticals 0.68 6.6 44.2 n.a.

Plastic and rubber products 1.06 1.4 0.8 7.5Transport equipment 2.04 0.9 13.4 11.0Publishing, printing, paper, and pulp 2.75 0.6 0.3 <19.4Food, drink, and tobacco 2.85 0.4 1.1 8.1Non-metallic minerals 0.81 –0.2 1.1 9.2Machinery and equipment 1.92 –0.8 5.2 12.2Basic and fabricated metals 2.52 –0.9 0.9 7.0Textiles 1.07 –4.0 0.4 <8.5Manufacturing 21.85 1.0 7.0 12.9

Source: DTI (2002, Table 2).

25 ‘Higher’ is university level; ‘intermediate’ comprises technical qualifications, such as, in the UK, Higher NationalDiploma.

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Figure 1Business Expenditure on R&D

Source: Economic Trends, various issues. (Series measured at constant purchasing power parity.)

costs. Specifically they estimate the following equa-tion:26

The country dummies are, of course, trends inmarket shares and the second step in their analysisinvolves trying to explain these where they aresignificant. The econometric results from estimat-ing the above equation yield significant values forthe a

k coefficients with a

0 positive and a

1 … a

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negative. Three technology variables were explored:R&D, patenting, and investment in fixed capital.Only the last was significant and positive and theauthors interpret it as capturing embodied technicalprogress. Additional analysis to explain countrydummies finds that they appear to be positivelyrelated to three institutional factors: a human capitalvariable, a measure of disembodied technicalprogress,27 and a variable that captures the struc-ture of corporate ownership. Thus, they concludethat there is the conventional negative relationshipbetween export-market share and relative unit la-bour costs, that technology has an impact throughinvestment but not through R&D and patenting,

and that there is also a role for institutionalfactors. They argue that R&D does have anindirect role to play, in that it dampens the sensitivityto changes in costs.

Thus, the evidence is that knowledge has becomeimportant in every economy because of the role ofinformation and communications technology in trans-forming production methods28 and the whole e-commerce and e-business revolution. The informa-tion revolution itself has increased the pace ofscientific advance as knowledge flows have in-creased, aided by the ease of travel, advances incommunication, and the growth of trade and foreigndirect investment. This has all served to increase thepace of innovation and imitation, as can be seen inthe growth of business R&D shown in Figure 1. Thisshows the UK in last place in the list.

In response to the resurgence in recent years in thetheory and analysis of economic growth (see, forexample, Aghion and Howitt, 1998), there havebeen numerous empirical studies showing that theconvergence across economies is slow and that thecatch-up phenomenon of traditional theory is notevident. Not surprisingly, then, a key question foreconomic policy in general and industrial policy inparticular is whether or not it can be used to

26 While it is possible to decompose the unit cost variable into its components—wage rates, productivity, and the exchange rate—this appears to add little explanatory value in the long term, but there is clear evidence of a short-run difference. Wage rates andproductivity have a consistent and immediate standard textbook effect and the lag in the adjustment in the ‘a’ coefficients is dueto the impact of the exchange rate.

27 This variable is total factor productivity.28 For example, CADCAM (computer-aided design and manufacturing).

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influence the rate of technological progress andcatch-up.

Technology doesn’t automatically flow from leaderto follower. Mechanisms need to be in place toenable followers to understand best practice and toexploit it effectively. What studies of growth doshow is that R&D expenditures provide a significantpositive contribution to productivity growth.29 Theintensity of R&D within an economy matters fortwo reasons: it has a direct effect on the rate ofdomestic innovation and has an indirect effect be-cause it gives one the capability to absorb knowl-edge from others (Cohen and Levinthal, 1989).However, R&D is not sufficient; there have to beother capabilities in place, not least a work-forcewith the requisite mix of skills.30

Knowledge is thus increasingly important—as wecan see, for example, if we look at the change overtime in output and trade data. Figures 2–4 use dataproduced by the OECD. They show that whetheryou look at value added, labour productivity, orexport shares, the new ‘knowledge-based’ indus-tries significantly outperform the traditional indus-tries in the economy.

While these charts are for the OECD as a whole,this phenomenon, the growth of a knowledge-basedeconomy, has also been the case in the UK. Ac-cording to calculations by the DTI, between 1980and 1996 the share of knowledge-based industries intotal UK output rose from around 17 per cent to 23per cent, and UK employment has been growingmost rapidly in the knowledge-based sectors. As ashare of our total exports of goods, knowledge-based products account for more than 20 per cent.31

Moreover, of the UK’s exports of services in 1998,more than half were knowledge based.32

As Table 1 illustrated, while productivity has beengrowing, a gap still exists between the UK and itsmain rivals. This has been attributed to the relativelylow level of investment relative to GDP in the UK.Figure 5 shows what has been happening to busi-ness investment per worker over the last threedecades. While the UK has significantly increasedinvestment per worker, there is still a gap betweenit and its main commercial rivals in the world market.

Probably more importantly, the UK spends far lessof its GDP on research and development—some-thing like 45 per cent less than in the USA and Japan.Figures 6 and 733 show the UK in last place, in termsof both gross expenditure on R&D and businessexpenditure on R&D.34

Finally, if you measure the research intensity of thelabour force,35 although the UK is ahead of France,it still lags some way behind Germany, Japan, andthe USA, as Figure 8 illustrates.

V. COMPETITION

The empirical evidence in the last section stronglysuggests that the key to competitive advantage is thecapability of firms and other institutions to acquireand absorb knowledge, to exploit it to develop newproducts and processes, and to learn from bestpractice. To be fair, this was something that wasidentified in the 1998 Competitiveness White Paper(DTI, 1998). It pointed to four areas36 in which theUK needed to enhance its capabilities, and in these

29 Obviously, the import of new technologies from abroad will boost productivity, but R&D spending has been shown to bean important factor in explaining why the USA has a productivity lead over the UK and Germany in the manufacturing sector.A recent study of 170 manufacturing firms in the UK has found a positive and significant effect of a firm’s own R&D expenditureon its productivity growth, though the scale of the effect differs across sectors (see Wakelin, 2001).

30 Research at the NIESR has shown the importance of the ‘skills gap’ in explaining why there is a productivity gap betweenGermany and the UK. See O’Mahony (1992).

31 For our main EU competitors, the figures are: Germany, 11 per cent; France, 16 per cent; and Italy, 7 per cent.32 In 1996, the equivalent figure for Japan was 53 per cent, for Germany 46 per cent, and for the USA 37 per cent.33 The data from which these charts were produced comes from various issues of Economic Trends. Since 1995 there has been

an annual article each August presenting detailed R&D statistics for the UK and comparative data for a number of OECD countries.34 Business includes firms, public corporations, and research associations serving businesses.35 Measured as the percentage of the labour force who are ‘research workers’.36 These are: the creation and exploitation of scientific knowledge and technology, enterprise and innovation, finance for

entrepreneurial firms, and skills and training.

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Figure 2Growth of Value Added: OECD, 1985–94

0 2 4 6 8

Manufacturing

High Technology Indus try

ICT manufacturing and services

Bus iness sector

Knowledge-based industries

Annual average growth rate (%)

0

10

20

30

40

50

High-tech Medium-hightech

Medium-lowtech

Low

Per

cent

1985 1990 1995

0 0.5 1 1.5 2 2.5 3 3.5 4

Business sector

Manufacturing industry

High and medium high technologyindustries

Annual average growth rate (%)

Figure 4Export Market Share, Manufacturing Industry

Figure 3Labour Productivity Growth: OECD, 1985–96

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Figure 5Business Investment per Worker

Source: DTI, UK Competitiveness Indicators, 2nd edn, p. 37.

Figure 7Business R&D as a Percentage of GDP, 1988–99

Figure 6Gross Expenditure on R&D as a Percentage of GDP, 1988–99

0

0.5

1

1.5

2

2.5

3

3.5

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Perc

ent


0

0.5

1

1.5

2

2.5

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Perc

ent


0

2000

4000

6000

8000

10000

1974-79 1980-89 1990-99

1995

US$

UK Germany France USA Japan

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one can see the drivers of recent policy initiatives: oncompetition, on technology, on regions, and on train-ing and skills. In this and the next section, I want tofocus on the first two of these.

It is a widely held view that competition is a goodthing and there is no doubt that it is this belief that hasdriven the process of privatization and de-regulationthat we now see all around the world. Competition37

matters for productivity and innovation for tworeasons. The first is that it provides incentives tofirms to improve their technology and the way thatthey organize and operate.38 The second reason isthat it provides a selection mechanism.39 First,there is the fact that as a firm becomes moreefficient relative to its rivals, it will increase itsmarket share and the average cost of production inthe industry will fall.40 Second is the turnover asso-ciated with entry to and exit from an industry.

Entrants will come with new products and/or newprocesses and firms that exit will have outdatedproducts and/or production processes.41 If both ofthese forces (incentives and selection) do indeedhave beneficial effects on innovation, productivity,and international competitiveness, it would be quiteappropriate for a government to undertake a reviewof its competition policy to ensure that it wasdesigned in such a way as to harness these. This is,in fact, one of the things that has happened under thepresent Labour government.

In 2000, the Competition Act came into force.42 Inintroducing it the Secretary of State said ‘Strongcompetition . . . provides a spur for firms to innovate,increase productivity and provide real choice forconsumers. It equips them to compete in the globalmarket place’ (Byers, 2000). However, he admittedthat companies might also need to collaborate to

Figure 8Research Intensity, 1993

0 0.2 0.4 0.6 0.8

USA

Japan

EU

France

Germany

Italy

UK

Per cent

37 Competition here need not mean the very large number of firms of textbook perfect competition. Empirical studies of industryconcentration (a measure of competition) and efficiency in the UK and the USA have pointed to the greatest efficiency beingassociated with intermediate levels of concentration. Bresnahan and Reiss (1991) find that entry reduces price, with most of thecompetitive impact coming from the first two entrants to challenge an incumbent monopolist. By the time the number of entrantreaches five, the effect on price levels out. This confirms the standard result that emerges from the Cournot model of oligopoly.

38 The mechanism at work could well be the competitive threat posed by rivals. A recent econometric study has provided evidencethat high-market-share firms pre-emptively innovate. Specifically, it finds a significant positive effect of market share on measuresof innovative activity and that increased product-market competition in an industry tends to stimulate innovative activity (Blundellet al., 1999).

39 This distinction can be found in Carlin et al. (2001b).40 After studying the performance of a sample of 670 UK companies, Nickell (1996) concluded that competition was associated

with a significantly higher rate of total factor productivity growth.41 An argument that is sometimes made is that ‘shake-out’ during a recession weeds out the weaker firms and ensures that only

the fittest survive through to the boom. In fact, Geroski and Gregg (1997), using data from the recession of the early 1990s, findevidence that casts doubt on the view that recessions promote restructuring that enhances firms’ innovative capacity. Firms thatare badly affected by recession concentrate on cost restructuring (closing plants, cutting wages). While they emerge ‘leaner’, theevidence indicates they are only temporarily ‘fitter’.

42 The Act gave the Director General of Fair Trading increased powers and the MMC became the Competition Commission.

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increase their competitive position. He saw the actas bringing in a ‘tough but intelligent competitionregime’. By referring to both competition and coop-eration, he was signalling that competition policywas a complex matter. The Act contains two keyprohibitions. Chapter 1 prohibits anti-competitiveagreements by firms—such as cartels; chapter 2prohibits the abuse by firms of a dominant positionin a market. These are very close in form to the twoArticles of the Treaty of Rome that govern Euro-pean competition law, and in that sense the new actharmonizes EU and UK law.43 If the prohibitionshave been breached, firms can be fined up to 10 percent of turnover over a 3-year period or may besubject to claims for damages for past anti-competi-tive behaviour.44 Thus, it is now the case that thereis some consonance between US, UK, and EUcompetition law.

The new law has essentially created an independentcompetition authority, because it is the CompetitionCommission (and not the Secretary of State) thatwill have the determining responsibility for mergerdecisions.45 Previously, mergers were assessedagainst a ‘public interest’ criterion. Under the newlaw this has become quite specific: will the mergerbring about a substantial lessening of competition?Of course, it may happen that a proposed merger,even if it lessens competition, may have offsettingbenefits. There is still the possibility for the Secre-tary of State to intervene, but this is likely to be verymuch the exception.

I mentioned above the possible tension betweencompetition and collaboration. In the knowledgeeconomy, companies need to innovate to stay aheadin business. However, an important channel fordeveloping new ideas is to learn from other compa-nies or enter into collaborative joint ventures inresearch. This clearly poses a difficult question forthe competition authorities: when does collaborationend and market fixing begin?

In such a complex economy, we need a sophisticatedcompetition policy. This is why . . . the Office of FairTrading will consider issues on a case-by-case basis. Indoing so it will look at the actual effects of the agreementsor conduct in particular markets. And as markets change,so the effects and the analysis may change. (Byers, 2000)

In July 2001 the government set out its proposals forreform of the competition regime (DTI, 2001):strong, pro-active, and independent competitionauthorities, a merger regime based on the criterionof competition, competition authorities that have thepower to investigate the workings of markets andtake decisions on action independent of govern-ment, criminal sanctions against cartels, and redressfor third parties damaged by action found to beillegal. These are the proposals now embodied in theEnterprise Bill that is currently going through parlia-ment.46

VI. TECHNOLOGY POLICY

The earlier discussion has highlighted the fact thatindustrial policy needs to be designed with R&D andinnovation in mind. Industrial R&D builds usually onthe basic and strategic science that is carried out inuniversities. Such knowledge is typically generic innature in that it can often be exploited in a numberof ways to produce commercial output. Moreover,it is quite expensive to produce. However, if it canbe codified, it can be used by any one individualwithout the amount available to any other user beingreduced. In other words, it is a classic example of apublic good. Such goods are most efficiently pro-vided publicly and this explains the role of centralgovernment in higher education and its funding ofbasic and strategic science through the ResearchCouncils. In the Comprehensive Spending Reviewin 1999, an extra £1 billion was committed toenhancing the science and engineering base, with£400m of additional funding provided by theWellcome Trust through a partnership scheme. In

43 Evidenced by the fact that the new UK act will be directly subject to European jurisprudence in this area.44 Severe though this may seem, it is still not as draconian as the original European legislation on competition. Derek Morris,

chairman of the Competition Commission, has remarked on the fact that in AD 97, the Romans introduced a law that punishedprice-fixing by death or banishment to Britain!

45 One might note in passing the similarity with the government’s action in 1997 to make the Bank of England’s Monetary PolicyCommittee independent and responsible for monetary policy.

46 The Labour government’s industrial strategy for the current Parliament has been set out in a document jointly produced byHM Treasury and the DTI (2001). I return to this in the final section.

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July 2000, the government set out its policy forscience and innovation in the White Paper entitled,Excellence and Opportunity.47 This committedthe government to funding basic and strategic re-search, to encouraging knowledge transfer and theeffective exploitation of knowledge and new tech-nology, and to taking action to build public trust andconfidence in science.

So much for policy towards blue-sky research. Letme now turn to industrial R&D. As the relativeimportance of knowledge-based sectors in theeconomy grows, it is increasingly going to be thecase that entry costs will take the form of R&Dspending—whether to generate the new good ortechnology, or to build the capacity to absorb andexploit the new technologies. R&D creates knowl-edge. The market failure is not simply that of itsbeing a public good, it is also the fact that it is a goodwith strong complementarities. By that I mean thatdifferent pieces of knowledge can frequently beusefully combined and this implies that knowledgespill-overs are an important consideration to bear inmind in the design of policy.

These factors give us good reason to suppose thatthe market allocation of resources to R&D will notbe as efficient as we should like. For example, thepublic-good nature of knowledge means that thecost of adding a user is zero. However, the marketwill not recognize this and available knowledge willnot be as widely disseminated as is socially desir-able. Moreover, firms that respond only to privatereturns in deciding how much to allocate to R&D,when there are in fact uncompensated spill-overs,will do too little.48 There is also a considerableamount of microeconomic evidence of inter- andintra-industry spill-overs from R&D. While esti-mates vary, there are studies suggesting that socialrates of return to investment in R&D could be morethan twice the private rate of return.49 The spill-overphenomenon has been a factor in framing the‘clusters’ approach to industrial policy.

With imperfect competition an important character-istic of international markets in high-tech goods,firms in these markets can earn pure profits. Thisgives national governments the opportunity to usepolicy in a strategic fashion. If successful, such apolicy can be used to shift some of this profit fromforeign to domestic firms. This ‘rent-shifting’ argu-ment is a recent addition to the more traditionalmarket-failure arguments for policy. There is asense, of course, in which it is itself a market-failureargument—the market failure being the presence ofimperfect competition. But, whereas the conven-tional case tends to argue for a reduction in themarket failure, this argument actually seeks toexploit its presence.

Since domestic firms will benefit from the shifting ofprofit, they are always likely to favour such support.If, in addition, the labour market were also imper-fectly competitive, then labour would be able toextract a portion of the extra rents accruing to firmsand hence unions would also be likely to be in favourof the policy.

Thus, there are several reasons why a governmentmight wish to develop an industrial policy thatfocuses on research and development. The first isthe strategic trade policy argument. In an openeconomy, if the firms in a country have a bettervariety of good or a better process of production,then they will have a larger share of the worldmarket, and GDP and welfare will rise. This is arent-seeking argument and is the essence of Spen-cer and Brander (1983) and Brander and Spencer(1983, 1985). However, the second and most com-monly cited argument for subsidizing R&D is basedon the claim that the social rate of return exceeds theprivate rate of return. The two general reasons forthis are that neither consumers’ surplus nor benefi-cial knowledge spill-overs are taken into account inthe decisions that firms take on how much to investin R&D. In the UK, the government has chosen todo this by means of tax credit for R&D.50

47 The Minister for Science, Lord Sainsbury, used this as the topic of his address to the British Association’s meeting in 2000.48 There is the added problem that when there are multiple research paths leading to the same goal, we get the problem of wasteful

duplication. Given the total resources devoted to R&D, energy is dissipated across many essentially equivalent projects. In a caselike this it may be necessary to pursue a policy of restricting entry. We should then need to consider the trade-off between maintainingthe incentive to invest in R&D and the social cost of market power.

49 See, for example, Jaffe (1986) and Bernstein and Nadiri (1988).50 In fact, R&D tax credits were introduced in the USA in 1981 and have operated since, apart from a 1-year lapse (1995–6).

Hall (2001) has reported that in the USA the evidence is that the elasticity of R&D spending with respect to the tax credit exceedsunity and, hence, the loss of tax revenue is exceeded by the induced R&D spending.

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This policy has been examined in recent papers byGriffith (2000), and Griffith et al. (2001). Thesecond of these endeavours to take into account theeffect that R&D spill-overs have on absorptivecapacity and finds that the social rate of return toR&D in the UK is in the region of 90 per cent. Workby Bloom et al. (1999) also suggests that taxchanges significantly affect the level of R&D.While the impact elasticity is small, over the long runthey estimate it to be about (minus) unity. This wouldseem to justify a policy of increasing business R&Dby subsidizing it through the tax credit. In view of thisand the apparent link between R&D and productiv-ity and the fact that, as we have also seen above, theUK has the lowest R&D intensity in the businesssector of any of the G5 countries, it would appear tobe a sensible policy initiative and a natural policy toolfor a market-oriented government that wants toincrease R&D expenditures as it gives firms thefreedom to decide where and how to spend theirR&D budgets.

While studies on R&D subsidies show that theyincrease R&D spending, it does not follow from thisthat they are necessarily desirable. They may beexpensive to administer, they may provoke taxcompetition, or they may, as Goolsbee (1998) hasargued has been the case in the USA, simplyincrease the rents of fixed factors such as scientistsand engineers. As he points out, most R&D spend-ing is actually salary payments for R&D workers,whose supply is quite inelastic. When the govern-ment increases R&D spending through subsidies ordirect provision, a significant fraction of the in-creased spending goes directly into higher wages.Goolsbee suggests that, as a result, conventionalstudies may overestimate the real effect of govern-ment R&D spending by 30–50 per cent. In theextreme case of completely inelastic supply, theywould have no effect on the real level of R&Dspending.

What this is suggesting is that industrial policy in thesense of policy towards R&D may be rather morecomplex than it seems at first blush. To illustrate this,let me use the analytical framework suggested byLeahy and Neary (1997, 1999). Suppose that thereare two countries producing goods that are exportedto a global market. Since we need to allow for bothintra-industry and inter-industry spill-overs, we need

two industries and we can suppose that each isproducing a homogeneous good. Thus, R&D takesthe form of investment by firms in cost-reduction. Ifwe denote the unit costs of the domestic firm inindustry i as c

id, we can write this as c

id =

ci(x

id, x

jd, x

if), where the xs are the levels of R&D.

The equivalent cost function for the foreign firm isc

if = c

if(x

if, x

id). Since we are considering a small

country selling in a global market, we can think of thetypical domestic firm as maximizing its profits fromexports and so write these as π

id = Ri(q

id, q

if) – (c

id

– si)q

id – Γ

i(x

id) – σ

ix

i. Γ is the R&D cost function.

This formulation allows for the domestic govern-ment to have two instruments of industrial policy: anexport subsidy s and an R&D subsidy σ. Whenfirms make their output decisions, the subsidy ratesand R&D are given and so, for the domestic firm, itsoutput reaction function is given by

.

The welfare measure in the domestic country issimply profits net of subsidy payments, and itschange is simply the sum of the change attributableto each industry. The latter is given by the followingexpression:

Policy involves choosing the export and R&D sub-sidies and this induces changes in outputs and R&Dlevels. On the right-hand side, the first term is thecost of the export subsidy and the fourth term isadditional spending on R&D. These costs are offsetby two benefits: the lower costs of production fordomestic industries (the third term) and the addi-tional share of the export market (the second term).As a benchmark, assume that, given the subsidyrates, firms choose simultaneously output and R&D.In this case we can work out the optimal subsidyrates. These are:

Qif is the reaction function for the foreign firm and

b is the spill-over parameter. The division of labourbetween the two instruments is clear. The exportsubsidy delivers the output (market share) effectand the R&D subsidy the cost of production effect.Both of these subsidies are positive.

0d i

dii id d

i i

Rc s

q q

π∂ ∂= − + =

∂ ∂

.i

d f d d dii i i i i i if d

i i

dRdW s dq dq q dc dx

q dx

Γ∂= − + − −

∂

ˆ ˆ and 0.fi

jijf d

i i j

cdQRs q

q dq xσ β

∂∂= = − >

∂ ∂

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However, typically firms operate in a strategicsetting. In particular, they are likely to choose R&Dand so determine their level of costs in advance ofthe market game. In this case, the first-order condi-tion that characterizes the firm’s optimal choicebecomes

The first of the terms on the right-hand side is thestand-alone effect that characterized the non-stra-tegic case, while the second is an additional effectthat arises because the firms are now operating in astrategic setting. The sign of this second effectdepends on whether we are dealing with strategiccomplements or strategic substitutes. Typically, theeconomics literature assumes that it is the latter. Acase in point might be if the firms are racing toacquire a patent. However, that is not necessarilythe case. If patents are non-exclusive,51 then therecan be an advantage in having a rival firm bear theburden of the discovery costs. In this case the‘waiting game’ features of the rivalry can mean that

.

However, taking the strategic substitutes case astypical, the R&D subsidy will be adjusted down-wards to take account of the strategic over-invest-ment.52 Thus, the optimal R&D subsidy is the sumof a positive term to correct for spill-over and anegative term to correct for the strategic over-investment. It can be written as

If, instead, the two domestic firms were to collabo-rate, they would internalize the spill-over external-ity53 and, in the absence of strategic behaviour inR&D, there would be no need for an R&D subsidy.

However, when there is strategic behaviour, R&Dpolicy is again needed, but since the problem is tocorrect for the strategic over-investment, it is nega-tive: an R&D tax is called for.54

What is the message that this economic analysis hasfor industrial policy? It is not that there is no case forthe subsidizing of R&D. As theory suggests, therecan be a good case for doing this and the evidenceis that it does boost R&D spending in general.55

However, the analysis points to the fact that, in anideal world, one would like to look at industries on acase-by-case basis and, depending on the balanceof forces, the end result could involve taxation orsubsidy. This case-by-case approach to the designof industry policy is one of the messages that hascome out of the new industrial economics.

VII. CONCLUSION

What I have sought to show in this paper is that inindustrial policy, the themes that were central in the1960s remain the themes of the 2000s. What haschanged is that the tools of industrial policy appearnow to be more highly refined. Under the presentLabour government there are three general princi-ples driving industrial policy, as identified in thepolicy documents that have been published.

It is necessary to put in place the requisite knowledgeand skills base. This has three component parts:

• a properly funded science and engineering base;• an appropriately skilled work-force;• an enterprise culture.

It is necessary to create a regulatory frameworkthat drives innovation, encourages growth, and in-creases productivity. The elements in that are:

ˆ .j ij i

j i

c cq q

x xσ β α

∂ ∂= − +

∂ ∂

0 .d d d fi i i id d f di i i i

d dQ

dx x q dx

π π π∂ ∂= = +

∂ ∂

51 Say because re-engineering is relatively straightforward.52 Nevertheless, as Leahy and Neary show, it will still remain positive.53 This is part of the rationale in European competition policy for permitting pre-market collaboration.54 As Beath et al. (1989) show, introducing timing into the R&D model further complicates the policy prescriptions: there are

cases where R&D should be subsidized and cases where it should be taxed.55 As flagged in the Budget of 2001 and set out more clearly in HM Treasury and Inland Revenue (2001), a volume-based tax

credit was introduced for all firms in the 2002 Budget. R&D spending can be offset against tax liability and so the net return toinvesting in R&D is raised. I am not questioning the stimulating effect that tax credits are likely to have on R&D spending. Thereis ample empirical evidence of this. See, for example, Hall and Van Reenen (2000), as well as the paper by Griffith et al. (2001)already cited.

0f

idi

dQ

dx<

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REFERENCES

Aghion, P., and Howitt, P. (1998), Endogenous Growth Theory, Cambridge, MA, MIT Press.Anastassopoulos, J. P., Blanc, G., and Dussuage, P. (1987), State-owned Multinationals, Wiley, New York.Bank of England (2001), Financing of Technology-based Small Firms, London, Bank of England.Beath, J., Katsoulacos, Y., and Ulph, D. (1989), ‘Strategic R&D Policy’, The Economic Journal, 99, 74–83. (Reprinted

in D. Audretsch (ed.) (1998), Industrial Policy and Competitive Advantage, Cheltenham, Edward Elgar, Vol.1, 523–32.

Bernstein, J., and Nadiri, M. (1988), ‘Interindustry R&D Spillovers, Rates of Return, and Production in High-techIndustries’, American Economic Review, 78, 429–34.

Bloom, N., Griffith, R., and Van Reenen, J. (1999), ‘Do R&D Tax Credits Work? Evidence from an International Panelof Countries 1979–1994’, Institute for Fiscal Studies, Working Paper No. W99/8.

Blundell, R., Griffith, R., and Van Reenen, J. (1999), ‘Market Share, Market Value and Innovation in a Panel of BritishManufacturing Firms’, Review of Economic Studies, 66, 529–54.

Brander, J. A., and Spencer, B. J. (1983), ‘Strategic Commitment with R&D: The Symmetric Case’, Bell Journal ofEconomics, 14, 225–35.

— — (1985), ‘Export Subsidies and International Market Share Rivalry’, Journal of International Economics, 18,83–100.

Bresnahan, T., and Reiss, P. (1991), ‘Entry and Competition in Concentrated Markets’, Journal of Political Economy,99, 977–1009.

Byers, S. (2000), ‘A New Era in Competition’, address given to The Social Market Foundation, February.Carlin, W., Glyn, A., and Van Reenen, J. (2001a), ‘Export Market Performance of OECD Countries: An Empirical

Examination of the Role of Cost Competitiveness’, The Economic Journal, 111, 128–62. — Haskel, J., and Seabright, P. (2001b), ‘Understanding “The Essential Fact About Capitalism”’, National

Institute Economic Review, 175, 67–84.Cohen, W., and Levinthal, D. (1989), ‘Innovation and Learning: The Two Faces of R&D’, The Economic Journal, 99,

569–96.Commission of the European Economies (1994), Growth, Competitiveness, Employment: The Challenges and Ways

Forward into the 21st Century, Brussels, CEC.

• effective competition;• a modern framework of company law;• a flexible labour market with an appropriate

safety net.

There should be appropriate support for business byway of

• explicit business support;56

• promoting innovation through university–firmlinks and support for regional clusters;57

• supporting start-ups and providing incentives toinvest in R&D;58

• helping to enable established industries to mod-ernize.

It is clear that the government sees itself as justbeginning to implement its industrial strategy and soit is too soon to say whether the old tunes played on newinstruments will do better than the old tunes on theold instruments.59 What is true is that the tunes donot seem to have changed. However, as the govern-ment has committed itself to publishing its evidencebase, UK Competitiveness Indicators, on a regularbasis, we should be able to return in a few years timeand judge if the melody sounds better.

56 What is in mind here seem to be schemes such as the DTI’s ‘Business Links’ scheme.57 Support such as Regional Selective Assistance and supporting the work of the Regional Development Agencies.58 The R&D tax credit, which originally applied only to small firms, was extended in the 2002 Budget to all firms.59 In a recent statement of the government’s industrial policy agenda (Productivity in the UK: Enterprise and the Productivity

Challenge) the Chancellor and the Secretary of State for Industry state: ‘Four years ago the Government set its central economicobjective of high and stable growth and employment. In the last Parliament we began by reforming the macroeconomic framework. . . and we began a programme of structural economic reforms. These achievements have only been the start. . . . Just as we putstability and work first in the last Parliament, we will put enterprise and productivity first in this Parliament.’

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