Embedding green industrial policy in a growth strategy for the UK

Abstract

The major long-run economic challenge facing the UK is slow productivity growth. In 2023, the UK economy is about a quarter smaller than it would have been if output per hour had grown at the same rate after the global financial crisis as it had in the previous three decades. This stagnation of productivity has led to a flatlining of real wages and living standards.1

In this article, we consider the role of a modern industrial strategy – coordinating a range of ‘industrial policies’ – in shaping such an approach. How can the UK, an open and service-based economy with a small domestic market (relative to the US, the EU, and China) but with significant strengths in areas of high-value manufacturing and clean-tech innovation, design and implement an industrial strategy that can generate much-needed productivity growth, boost resilience and deliver against its ambitious net zero targets?

Delivering net zero requires significant increases in investment and innovation across infrastructure, transport and urban systems this decade. Investment needs are estimated to rise to an additional £50 billion per annum by 2030 – much of which is expected to come from the private sector.2 Improving the UK's productivity performance also requires increased investment in innovation, infrastructure and skills, with a key role for business investment.3 On aggregate, business investment in the UK is around 10 per cent of gross domestic product (GDP), compared with over 12 per cent on average across France, Germany and the US – and the UK has performed poorly versus these comparators and a broader set of advanced economies for some time.

Net zero investments are attractive because in addition to addressing the climate crisis, they will improve energy security (by reducing reliance on imported fossil fuels with volatile prices) and generate a variety of other economic and health-related co-benefits (for example, through improved resource efficiency, opportunities for innovators serving new markets, and cleaner air). Globally, there is no route towards long-run growth without addressing the climate crisis – which unabated will have devastating consequences for people's lives and livelihoods.4 Indeed, the net zero transition is “the growth opportunity of the 21st century”.5 There are reasons to be optimistic. Socioeconomic tipping points – where new clean solutions consistently out-compete incumbents – have already been achieved in electricity, and the evidence suggests that these can soon be achieved across a broader range of clean technologies with increased investment in research, skills, development and deployment.6

Industrial policy encompasses interventions that seek to change the structure of the economy in order to achieve a key, typically growth-related, goal.7 Such interventions span a range of policy instruments (including subsidies, regulation, public investment, innovation support and skills programmes) that create incentives for businesses to invest in ways that are consistent with that goal.8 Within this framework, green industrial policies seek to steer investment and growth towards environmental sustainability. Such approaches are increasingly being adopted given the urgency of tackling the climate crisis, the large-scale investment it requires, and the reality that, for security and resilience purposes, certain domestic capabilities are needed. In the US, the Inflation Reduction Act has committed large-scale and long-term government support for specific clean technologies and sectors seeking to crowd in substantial private sector investment, while the EU is responding with its Green Deal Industrial Plan.9

The presence of numerous market failures and path dependencies in innovation systems (in both the invention and deployment of new technologies) implies that strong policies are needed to enable net zero investment and innovation in the required timeframes.10 The obvious market failure is the greenhouse gas externality whereby the costs of emissions are not captured in market prices. This provides the economic justification for crucial environmental policies such as carbon taxes, regulation and standards. While such levers are necessary for the net zero transition, experience shows how they can be politically difficult to implement at the required scale and pace.

Government can further mobilise private sector investment into priority areas such as net zero via increasing the use of ‘blended finance’ approaches, for example with financial instruments such as first-loss capital or pure grants, co-investment to create scale in underinvested markets or guarantees.20

How can support best be targeted to specific sectors or technologies? For advanced economies such as the UK, the challenge relates not just to supporting the investments needed to achieve domestic net zero targets, but also to capturing growth opportunities where domestic firms and innovators are able to create products and services competitively and meet growing global demand. An effective and credible industrial strategy for the UK needs to be informed by a hard-headed understanding of what sort of economy it is and can plausibly be.

Understanding the potential for support for clean technologies to generate meaningful growth and jobs in the UK requires insights from a range of datasets and consultation with key stakeholders in order to understand where strengths and opportunities are located, as well as the specific barriers that policy can address. Recent ‘deep dives’ on sustainable growth opportunities in CCUS and tidal stream provide examples of this type of approach, highlighting areas of technological specialisation as well as relevant products that the UK already exports competitively.28 And the UK must learn from previous experiences where a more strategic approach to building supply-side capabilities might have led to a different outcome. Offshore wind provides a case study – while the UK has led in its deployment and is specialised in related innovation, it is not specialised in the trade of relevant products overall.29

A holistic view of the UK's innovation system is needed. Building on the excellence in the ‘golden triangle’ of London, Oxford and Cambridge will also be a crucial part of a green industrial strategy, and UK innovation policy more broadly. An analysis of the estimated returns to public investment in innovation suggests that innovation in clean technologies in the golden triangle generates particularly high returns in that same region, as well as in the rest of the country via knowledge spillovers.34

Crucially, it could highlight where synergies or trade-offs between growth and net zero objectives exist, and how these can best be managed.

Finally, the support of citizens, consumers and workers is necessary for the delivery of net zero policies. The experience of Ultra Low Emission Zone (ULEZ) expansion in London shows how opposition voices in specific areas can be very prominent and shape the national debate on broader net zero policies, even when public support overall is high. It is therefore crucial that the distributional aspects of a green industrial strategy (and net zero policies in general) are understood, managed fairly and perceived to be so. This is particularly the case for households that need to make upfront investments in low-carbon heat, energy efficiency and decarbonising transport, which can be unaffordable for many (despite leading to significant savings later), particularly in a cost-of-living crisis.38 In the labour market, the net zero transition is expected to lead to net job creation overall,39 but it will involve a lot of change for many workers and disruption for some. Effective education and skills policies will therefore be needed not only to deliver the net zero transition, but also to ensure that opportunities are accessible and that the transition for workers is a smooth one.40 A clearer national vision and communication of net zero and green industrial policies and how these fit into an overall economic strategy, accompanied by more participatory decision-making at the local and community level,41 are likely to help to achieve lasting support for policies that can make the economy stronger, more resilient as well as more sustainable in the years ahead.