Openness and Comparative Advantage
An Atlantic Article gets something wrong and something right about Britain's economic troubles.
There was an article in the Atlantic by Derek Thompson. His piece argues the case that Britain is an increasingly poor country. This is down to three things: deindustrialization, lack of investment, and lack of openness to foreigners. This caused something of a retort amongst British policy-makers who accused Thompson of nostalgia for manufacturing. Torsten Bell expanded on the criticism of the article by arguing against Thompson’s assumption that the UK is overeliant on banking. Bell and others have written extensively that the UK’s services sector is diversified, competitive at the international level, and should remain the cornerstone of the economy. Thompson is an American of the Collisonite variety. In the words of Sam Bowman, he is a ‘booster’. Bell, along with others like Giles Wilkes, are characterized as doomsters.
The more useful dichotomy here is between competitive advantage versus comparative advantage. Competitors associate Britain’s diminishing role in advanced technology products with decline and believe this can be remedied. Public and private power should be harnessed to make Britain more competitive in areas it is uncompetitive. Comparatives are, more often than not, more supportive of the Treasury, do not support transformational changes in macroeconomic policy, and broadly accept the drift to services. To them, the UK needs optimization rather than transformation, and many of the problems stem not from economists or policymakers but from politicians and demagoguery. This schism is one of specifics, as opposed to a clash of different worldviews. Both communities agree about the importance of openness, less as a set of policy prescriptions and more as an instinct on how best to succeed in economics and life.
A lack of openness
Thompson’s article reasonably mentions the lack of automation: something I have discussed previously. He has ample evidence to argue degrowth mindsets, deindustrialization, and low investment are major problems. But the third pillar of his argument, that Britain’s decline is down to the denigration of foreigners and lack of openness, is preposterous. The UK has a higher proportion of foreign-born workers than the U.S. It has increased immigration to record levels in recent years, mitigating a reduction in EU migration with non-European migration. Would a closed-off nativist island have a perpetual trade deficit with the rest of the world? Britain's current-account deficit could reach 9% of GDP by 2023 — fuelled by our chronic trade deficit in energy and goods. From 2020 the UK’s tariff rate is lower than that of the EU and the U.S. Our nuclear power stations are owned by the French state. Over half of our wind farms are owned and operated by foreign entities. 56.3% of the value of the UK stock market is owned by foreigners, compared to 40% for the U.S. Our rich list is topped by Sri and Gopi Hinduja — two brothers of Indian extraction.
If that sounds like me making a triumphal point about how open we are, it is not. I am making the point that there are few places where promoters of all-encompassing openness have got their way more than low-growth Britain. In Thompson’s piece, we are given a picture of nativists closing Britain off from the world like the Tokugawa Shogunate. But there are few nations where the insufficiently open have less power. They have next to zero purchase in the Tory party, which I am told has made a byline for the Hard Right. George Osborne, after campaigning on a platform of reducing immigration to the tens of thousands in 2010, actively boasted 7 years later about how he and his fellow ministers never took it seriously. Johnson, our supposedly Trumpian figure, scrapped immigration limits altogether. Taking all this into account, how can anyone say the UK’s problems come from a lack of openness?
Comparative advantage
The comparative advantage critics of Thompson do not contest his concerns about British isolationism. Their contrary opinion is primarily around the characterization of the UK as too reliant on banking. They argue, with some reasoning, that UK services are reasonably diversified, have a strong research component, and that we have some world-leading competencies in pharmaceuticals. We are also the second-largest exporter of services worldwide. This is not insubstantial, and it has kept our trade deficit acceptable for the last 30 years. They argue that, instead of pursuing a manufacturing renaissance that will never come, we should double down on our fundamentals and put more money into education and improve British urban infrastructure in line with London.
This Resolution Foundation paper is a key totem for the comparatives. It makes the case that Britain is strong across a diverse range of services and is well-placed in promising new industries. This deserves some interrogation. It is true that strict ‘finance’ is not as all-dominating as one might initially think. The three largest sectors the UK is strong in are finance, insurance and pensions, and ‘other business services’. Together, these made up close to 30% of total exports in 2019. In these fields, our comparative advantage is amongst the highest. But what does ‘other business services’ entail? It can mean merchanting, research and development, architectural engineering, marketing, advertising, and accounting. Under other definitions, it can mean legal services and auditing. It is a really irritating taxonomy that obscures more than it reveals.
The paper does put the limited size of UK banking into context, but the methodologies used to calculate Britain’s comparative advantages lead to some strange results. According to figure 9, the UK has a marked advantage in 3D printing. Consider me skeptical about that. We have no market leaders in this space. Consider me doubly skeptical of us having a small advantage in robotics — which the report suggests. Apparently, our competency in both these areas is more pronounced than in aerospace, despite Britain being only behind the U.S., France, and Germany in aerospace exports. We also apparently have a comparative advantage in ‘clean’ technology. If this were so, wouldn't developing a battery industry be a little easier? Based on figure 10, Saudi Arabia has the highest revealed technological advantage for clean technologies. ‘Clean’, as is often the case, is being used very broadly at the patent office. I think this is the peril of using patents to determine a country’s competency in a given technology. I think a much more accurate understanding can be garnered by looking at production, exports, major companies, their operations, and in the case of determining Saudi Arabia’s clean technology pioneer status — common sense.
It is understandably hard to measure these things. But I think the paper in some cases undermines the argument for comparative advantage. Based on figure 25, the UK economy is specialized in charges for intellectual property (IP). Geopolitical realities are making that source of revenue vulnerable. We could very well be entering a golden age of industrial espionage as China seeks to counter American-associated export controls. IP rent-based revenues also rest on other countries buying into comparative advantage and not seeking to develop their own services. Figure 34 argues there is a correlation between specialization in services and higher GDP per capita. Therefore service specialization is fine. But the only countries with greater specialization in services and greater wealth than the UK on the chart are Ireland, Iceland, and Luxembourg. More relevant comparisons: the U.S., Germany, and Australia (big diversified economies), are less specialized in services yet notably richer.
The paper also concedes the UK’s specialism in services is associated with greater inequality. This is because, while the top jobs in services are astoundingly productive, services on average pay less than goods producers. Services also tend to concentrate in London to take advantage of the obvious network effects. Regional data implies that deindustrialized northern England and Wales are trailing noticeably behind the richer South in average IQ scores, primarily due to inward migration trends. This is hypothesized as both an effect of service domination and a reinforcer of it. The many promising Northern and Welsh graduates go south, the gap widens, and so on and so forth. There seems very little room to configure an economy that remains so dominated by inevitably London-centric services yet somehow distributes its gains effectively between Shoreditch, Bradford, and Truro. Historically, what made non-Southern or metropolitan parts of the UK rich was primary resource extraction (coal & north sea hydrocarbons) or manufacturing (read the plot against Mercia). I do not think that fundamental reality has changed. As long as the economy is lopsided, I would anticipate regional inequalities to accelerate, exacerbating all the problems that chronic regional disparities bring. This will have to be mitigated by more taxes on the South.
The comparatives argue we do not value what we are best at enough, and that we are overly nostalgic about manufacturing. They often argue that, because ministers love going around factories wearing hard hats, there is a bias toward manufacturing. I find this unconvincing. The high-visibility jackets and visits to Port Talbot are more an exercise in placation than a sign of action. British politicians might be more likely than Chinese officials to tour factories, but this says nothing about priorities. In American conservative circles, the term is ‘Boob bait for the bubbas’. Speaking tough and looking industrious with no intention of changing anything. It is a nice day out for the Spads and mixes up the tedium of Westminster. I think this strategy of empathetic inertia is fairly popular among both parties across multiple policy domains but has been refined by the Tories into an art form. One of Bell’s notable articles asked ‘why to be a poor Germany?’ Like Thompson’s phantom nativists, this is an exercise in straw-manning. No one who likes industrial policy thinks Britain can match German industrial output. But on a number of metrics, from capital equipment to R&D spending, we are close to or below the world average. Improving our manufacturing position relative to Germany, especially in light of its recent troubles, is attainable and desirable. Bell and others argue specialization is sticky, and what countries are good at now is predictive of what they will be good at in the future. The stat he uses is:
“of the top 10 products the UK specialized in back in 1989, seven were in our top 10 in 2019.”
Simplified, you can change your economy by 30% in 30 years. So maybe you can change it by 50% in 50 years? This indicates the economy is far more malleable than is being suggested.
But it also neglects that all the truly consequential economies have, at one point in their development, dramatically changed what they are good at. If we concede we cannot do this, we will have to accept a more mediocre status.