Curing insanity with madness

Ideas@TheCentre – The CIS newsletter (Sydney), 5 August 2011

Peter Saunders has always been an outspoken academic. So it is no surprise that he was not afraid to question one of the key beliefs of economic liberals in last week’s Ideas@TheCentre: the assumption that free trade is always and everywhere beneficial and prosperity enhancing.

Peter claimed that the British government’s decision not to award a new contract to a British-based manufacturer of railway rolling stock and instead give it to Germany’s Siemens had negative net effects for Britain. British workers, who had been laid off as a consequence, were relegated to welfare, potentially outweighing any cost savings. The decision will also weaken Britain’s manufacturing sector, Peter worries. He also implies that maybe the Germans were bending the EU rules on procurement, which prohibit favouring national companies, so Britain should have done the same.

It all sounds pretty plausible when you first read it but I am afraid our esteemed colleague is still wrong. However, let’s first say where Peter is right.

I agree that the relative decline of manufacturing in Britain is an unfortunate development. For the nation that once started the Industrial Revolution it is embarrassing that it is no longer a major industrial producer. Its move into the post-modern economy, dominated by (financial) services, has probably gone too far. Such sectoral change, even in highly developed countries, is by no means inevitable as Peter’s German counterexample demonstrates.

In principle, there is nothing wrong with being a service economy. If this is where your comparative advantage lies, so be it. Nevertheless, the focus on the financial sector has led to an enormous imbalance in the British economy – both structurally and geographically. Put simply, there is the prosperous South East of the country, powered by the City of London, and then there’s the impoverished remainder. Peter finds this dangerous for the country – and he is right.

Where he is wrong is the analysis of the causes of the British disease. Free trade cannot be blamed for it. Blame disastrous industrial policies instead.

According to the Distribution of Industry Act 1945, each new factory or factory extension had to be approved by government bureaucrats. The idea was to control in which parts of the country companies could operate. Believe it or not, in the 1950s more than 20% of all applications for new factories were rejected — not because there was something wrong with them but because the government believed they were in the wrong place. Later the approval process extended to office buildings too.

The result of such policies – and there were many more interventions – was to drive companies to places that were politically desirable but did not make economic sense. A study by British think tank Policy Exchange published a few years ago concluded that for every job successfully redistributed by the Distribution of Industry Act, four other jobs had been destroyed elsewhere.

As an MP remarked in a Commons debate in 1945, the Act was ‘the very antithesis of private enterprise. This is bureaucracy and Socialism carried to the last limit.’ It took until 1979 until the Act was finally repealed by Margaret Thatcher’s government. By then, however, the damage had been done and Britain was already in a downward spiral of deindustrialisation.

Peter’s concern that the British taxpayer could gain from favouring national workers does not hold, either. Laid-off workers would only cost taxpayers if they remained permanently on welfare. But no one knows better than Peter himself that there are ways to wean people off welfare. This, of course, comes with the caveat that the British government does not put too many obstacles in the way of companies creating jobs.

Favouring domestic companies is also risky. The European Union mandates free trade among member states, which means governments must consider all bids and tenders for public business fairly and transparently. Failure to comply puts offending governments, and their taxpayers, on the line for hefty fines. For all its bureaucratic waste and meddling regulations, I applaud the EU’s commitment to a free market among member states. In fact, that’s the EU’s single greatest achievement.

The decline of manufacturing in Britain is a serious issue that has been encouraged by government intervention. To use another government intervention to reverse this development is trying to cure insanity with madness. The only way forward for Britain is to go back to the policies that had once made it an economic superpower: free trade, secure property rights and an enterprise culture. It’s back to the future – or Britain won’t have a future as a prosperous nation.

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