While it's encouraging to see Chancellor Jeremy Hunt’s plan for growth focus on enterprise and education, it's imperative that detailed plans are drawn up in conjunction with industry to aggressively scale up green energy, digital and the creative industries, says Thomas Aubrey.
In a recent speech, Chancellor Jeremy Hunt set out his vision for long-term prosperity in the UK – recognising that the UK must increase its rate of productivity growth. He highlighted a number of key sectors that might help drive the UK economy forward including: digital, the creative sector, green energy, financial services, life sciences and advanced manufacturing.
Identifying which sectors to support is a critical part of any industrial strategy. Productivity is generally driven by a handful of growing high value-added sectors, which in turn support higher demand for lower value-added and largely non-tradeable services. Table 1 demonstrates the variation in value-added per hour by broad sectors. Identifying which sectors to support really matters for productivity growth. The good news is that Table 1 shows the Chancellor’s priority sectors are all high value-added (green).
Table 1: Value added per hour of broad sectors
Digital (computer programming and information service activities) and creative industries (television & video production) both lie within Information & Communication with a value-added per hour of £55.37. Electricity generation, which is within Utilities, is not only high value-added but can also drive growth across other sectors by providing a cheap and dependable source of low carbon energy. Financial Services – including banking, insurance and fund management – generates value-added per hour of £98.55. Pharmaceuticals – a subsector of Manufacturing – has value-added per hour of £156.92, while Manufacturing more broadly generates £48.77 of value-added per hour. Crucially, all of these sectors are above the median value of £41.18 (excluding real estate activities which is mostly imputed rent for housing).
The fact that low value-added and non-tradeable sectors have not been chosen should be seen as a positive step in trying to drive productivity growth higher. Tradeable goods and services are much more likely to generate higher value-added due to the ability of firms to scaleup. Moreover, moving employment from higher value-added to lower value-added activities will result in a lower rate of productivity growth.
In addition, prioritised sectors should also demonstrate the potential to increase in size enabling firms within these sectors to scaleup and take advantage of rising demand. This is why fossil fuel extraction despite having the highest value added per hour is not seen as a priority sector.
The ageing population across the developed world will increase demand for life sciences and financial services, while the growing shift towards digitised communications has increased demand for computing services as well as media and entertainment consumption. Finally, the demand for low carbon energy alongside advanced manufacturing, enabling the delivery of complex products, will continue to rise.
While these two prioritisation steps are relatively straight forward, it is also critical to assess whether the UK’s firms and workers have the necessary capabilities to succeed compared to international competitors. For example, the government recently decided to support the UK semiconductor industry with billions of pounds to help ramp up the production of compound semiconductors. While the UK leads in many areas of chip design through firms like ARM, it doesn’t have much of a capability in manufacturing. Most of the world’s semi-conductors are manufactured in Taiwan, South Korea, Japan, the US and China. In Europe, Germany dominates semi-conductor manufacturing. Hence it doesn’t makes sense to throw money at a sector which requires vast amounts of capital investment – given that the UK has a limited competitive advantage.
Government support for a sector should also be dependent on the existence of a detailed plan by companies including specific government actions to help support existing clusters and improve competitiveness. This is what Singapore has undertaken with its transformation maps. In addition, the continual monitoring of the performance of prioritised sectors provides insight as to whether the industrial strategy is on track.
Since 2019, the private sector (excluding real estate activities) has grown by 1.6% or just over 0.5% per annum. While this is at least positive, between 1997 and 2006 when the UK last experienced robust productivity growth, it was 1.7% per annum; more than three times higher. And although all G7 economies have experienced much lower growth since the financial crisis, the UK has fared poorly and according to the IMF has a weaker economic outlook.
So how well are the UK’s prioritised sectors doing? A disaggregation of the prioritised subsectors in Table 2 indicates that electricity generation has experienced an increase in productivity growth, along with the digital and creative industries. A key challenge for the government is how it can help these sectors expand to make up a larger proportion of the economy.
However, financial services and life sciences have stagnated, and advanced manufacturing is mostly in decline. While the government often trumpets life sciences and advanced manufacturing as UK success stories, the data suggests otherwise as highlighted in the UK innovation report,[1] a point also noted in a paper by Diane Coyle and Jen-Chung Mei on Diagnosing the UK productivity slowdown: Which sectors matter and why?. The manufacturing of pharmaceuticals has fallen by nearly a third since 2009 indicating falling competitiveness.
Table 2: Subsector disaggregation Q3 2019 – Q3 2022[2]
Life sciences and advanced manufacturing have also been negatively affected by failings in the UK’s regulatory and trade policy as a result of Brexit. Creating a new set of regulations for UK firms for such a small share of the global market is a major disincentive for firms to set up shop in the UK. Moreover, it places UK firms at a disadvantage as trade frictions and higher regulatory costs reduce international competitiveness. Until this issue is addressed, it’s unlikely that these sectors will be able to help drive growth. While the Chancellor recognised the importance of regulation in his speech, it remains unclear whether the government will actually address the trade-off between sovereignty and growth.
Regulatory alignment with key trading blocks is fundamental in supporting productivity growth for these sectors, which is why Switzerland is accepting US FDA approved medical devices for use alongside the European Union rules. The Labour Party also appears to be heading in this direction from a growth policy perspective in order to reduce the obstacles and costs faced by UK-based firms.
While it is encouraging to see the Chancellor’s prioritised sectors, it is imperative that detailed plans are drawn up in conjunction with industry to aggressively scale up green energy, digital and the creative industries. In addition, the government must finally address the issue of regulatory alignment if it wants to see life sciences and advanced manufacturing succeed. The longer it takes the government to recognise this, the harder it will be to turn these increasingly uncompetitive industries around and drive productivity upwards.
[1] See p.24 for manufacturing and p. 47 for pharmaceuticals
[2] The disaggregation uses Tang & Wang 2004; the ‘within’ effect is value added per hour in the sector and the ‘between’ effect measures labour reallocation.
Image: “UK Secretary of State for Health Jeremy Hunt and Dr. Mark Davies visit the Center for Total Health 25424” by tedeytan is licensed under CC BY-SA 2.0.
The views and opinions expressed in this post are those of the author(s) and not necessarily those of the Bennett Institute for Public Policy.
