Can industrial strategy and competition go hand in hand?

17th October, 2018

Competition is a central tenet of capitalism, and one of the main drivers that encourage firms to innovate, improve productivity and lower prices. As firms fight each other for market share, they have to find innovative solutions to produce better and at lower costs. To keep competition fair and healthy, firms need a level playing field, so that the best performers – not the most subsidised – are rewarded.

This is why it is important to preserve market competition. But local industrial strategies, by deliberately favouring specific industries, firms and locations, can distort competition and result in sub-optimal situations – where intervention benefits a few firms but not the wider local economy. Those implementing them at the local level should always consider this effect.

There are several cases where a local industrial strategy can do more damage than good to the economy:Supporting an industry or firm just because they are large employers. It can be tempting for a place to disproportionately invest in favour of a large employer or industry, especially if a large proportion of the local economy relies on it. Often large employers are represented on LEP boards, giving them even greater leverage over spending decisions. But this is not necessarily the best use of money in the short-term, nor is it a good strategy for the future. In fact, trying to preserve declining industries might help maintain jobs for a few more years, but this may only slow down an irreversible process of decline.

Offering advantages and compensations to attract specific firms. Areas could also be tempted to provide subsidies or tax rebates to encourage specific companies to settle. In the US, some states have paid up to $2 million per job to lure big tech companies. Such distortive policies are less likely to happen in the UK because of EU regulation on State Aid. Nonetheless, local councils are still allowed to grant small business rates relief at their discretion. But places should consider whether that money could be used more efficiently to address broader growth drivers, rather than benefiting only particular firms.

Implementing local procurement in order to retain economic value locally. The concept of local procurement suggests that local authorities and other public bodies should favour local businesses in their calls for tender, so the money stays in the local area and supports local jobs. But here again, favouring specific businesses can be damaging both to market competition (local firms are discouraged to be more productive because they are protected from external competition) and to public efficiency (choosing a local contractor might come at a higher cost to the public purse). And currently, there is no evaluation evidence that local procurement supports the local economy.

Is it then possible to implement a local industrial strategy without distorting market competition too much? Our report sets up a number of recommendations to ensure that industrial strategies benefit beyond individual firms.

First, focusing on “horizontal” (i.e. cross-sector) rather than vertical, sector-based interventions, can avoid the kind of distortive effects highlighted above. Suppose a shortage of skills is identified in the local market. Giving subsidies for training to one firm or one industry could give them a significant advantage and distort competition, while a cross-sector intervention would reach similar outcomes (higher skills achievement) without the risk of distortion.

However, a firm-based subsidy could work if the firm employs a large number of workers, provides relatively generic training, and if workers are then able to work elsewhere. This is because, while there is a potential risk of market distortion, this is outweighed by the benefits that accrue to the wider economy as many local workers get to develop skills that can be used in other firms and industries.

Finally, regarding local procurement, authorities should help small local companies to enter public procurement bids, and remove the excessive red tape to make it more accessible for firms that have less administrative resources. But public procurement decisions should not be solely taken based on location.

Local industrial strategies should not go against the requirement of having a free and competitive market. But attention must be paid to potential market failures. The best way to reconcile both those elements is to focus on interventions that answer the needs of the most important local sectors, but also benefit other firms and the rest of the economy. This is exactly what the propositions above aim to do – providing, of course, that the interventions identify and target the right issues and the right needs. 

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