Adam Hawksbee: Only by making full expensing permanent can Hunt stimulate the investment British manufacturing needs | Conservative Home

Adam Hawksbee is Deputy Director of the think tank Onward.

The recent history of British deindustrialisation is both simple and underappreciated. Thirty years ago, manufacturing generated about one in every six pounds of the UK’s economic output; by 2009, after the financial crisis, the figure was one in every ten pounds. It has stayed at that level ever since.

So the 1990s and 2000s represented the tail-end of a transition towards a service-based economy – a sectoral shift which has now largely stopped. We are left with a manufacturing base that is smaller, but stable and highly productive, providing opportunities in places that need it most and underpinning our economic resilience.

But energy prices, interest rates, and a tight labour market have hit these firms hard. When the Chancellor delivers the Autumn Statement next week, he should prioritise British manufacturing.

His speech will rightly focus on restoring growth and increasing private investment. But in recent decades even liberal economists like Larry Summers have recognised that the location of growth and type of investment matters just as much as overall levels, and that governments should target left behind places and R&D intensive firms.

This is where manufacturing can play a unique role. It drives innovation outside of the South, generating 40 per cent of productivity growth in the West Midlands and the North West between 1997 and 2017. Investment in manufacturing tends to be locationally sticky, creating the long-term anchor industries that underpin regeneration.

And as more countries deploy scientific capabilities as part of geopolitical power struggles, it is increasingly important that we maintain manufacturing capacity for strategically important technologies.

Support for manufacturing to date has been, at best, piecemeal. In the absence of coordinated industrial policy, firms have been left to navigate a fractured set of skills programmes and poorly targeted subsidies.

There are some exceptions: the “Made Smarter” programme, designed by ministers but delivered by metro mayors, has helped thousands of firms to adopt advanced technology and export to new markets.

But more must be done. Jeremy Hunt should take two big steps when he stands up to the dispatch box next week.

First, he should make full expensing permanent. Capital allowances and the headline rate of corporation tax have been hugely volatile over the past ten years, adding to the uncertainty facing businesses. Hunt rightly introduced full expensing in the Spring Budget earlier this year, meaning firms could write off investment in productivity-enhancing plant and machinery from their corporate tax bill in exactly the same way as they can for day-to-day expenses.

Onward called in 2021 for the extension of enhanced capital allowances to increase investment by manufacturing firms, given the outsized importance of machinery to their productivity; recent IFS research has even revised down the cost of the policy from around £10 billion a year to £1-3 billion.

But full expensing means little if it is a temporary measure. In practice only a small number of the biggest firms invest more than the previous Annual Investment Allowance. And these large firms – often in pharmaceuticals, aerospace, defence or automotive – make investment decisions over significant time horizons.

A three-year window for full expensing means they’ll just shuffle forward planned purchases, instead of making genuinely new investments. This means, in the blunt words of tax guru Dan Niedle, temporary full expensing is “a waste of money”.

Making full expensing permanent would provide firms with much needed certainty, particularly as Rachel Reeves has hinted Labour would continue the policy. Hunt could even go further, expanding it to investments in buildings or simplifying the tax treatment of intangibles. He could also change the tax treatment of debt-financed investment, to ensure that firms taking advantage of full expensing aren’t borrowing for bad purchases.

Regardless, the underpinning principle is clear: the targeting of tax incentives matters as much as, if not more than, the headline rate.

Second, the Autumn Statement should unlock investment from pension funds. Only the largest firms benefit from full expensing and the vast majority of Britain’s manufacturers are SMEs – many of which can’t access the capital to grow.

Too many of Britain’s cutting-edge start-ups are moving abroad, listing on foreign stock exchanges, or folding due to a lack of long-term capital investment needed to scale up. Less than half of Britain’s most innovative firms reach their second funding round, compared to around two thirds of American ones.

British pension funds continue to shy away from these investments, meaning firms lose out on a critical source of capital. UK pensions amount to a mere ten per cent of the domestic venture capital pool, compared to 72 per cent in the US.

The Treasury has shown appreciation of the challenge when it announced the so-called Mansion House Reforms earlier this year to encourage more investment by pension funds into assets such as venture capital. Although a good first step, the five per cent target is still well below the largest US or Canadian pension funds, which invest respectively 13 per cent and 21 per cent of their assets in this investment category.

A new Onward report by Zachary Spiro and Allan Nixon argues we need to tackle the three root causes holding back pension investment in British manufacturers: a fragmented market, outdated industry attitudes, and a preoccupation on keeping down costs at the expense of returns.

The biggest single step the Chancellor could take is the creation of a Science Superpower Fund – an investment vehicle housed within the British Business Bank made up of cash from smaller pension funds, local government pensions, and private savers, looking to invest in promising British companies.

The Autumn Statement could also include a raft of smaller measures to get pensions funds working harder for growth: new tax credits to encourage smaller pensions to wind up, active capitalisation of public sector pension schemes, stronger transparency and reporting requirements to target under-performing funds, and reformed regulatory duties for pension fund trustees.

There is a risk that calls for a focus on manufacturing sound like what’s sometimes called bring-backery, harking to an era of heavy industry that is long gone.

But what we make, how we make it, and who makes it, have all changed for the better. Much of our domestic manufacturing is now advanced, R&D-intensive manufacturing – just as likely to be in life sciences or aerospace as more traditional areas like automotive or food and drink.

As economist Jonathan Haskel has observed, within most manufacturing firms the distinction with a services firm fades away; developers, designers, and project managers are as common as engineers and machine operators.

And while manufacturing will never employ as many people in low-skilled roles as it did in the early 20th Century, the jobs it provides are stable, technical and well paid with good opportunities for progression. When paired with apprenticeships and adult skills programmes, they’re one of the surest routes for social mobility in many of this country’s left-behind places.

It’s a myth that Britain no longer makes things. But the people and places that are designing the next wave of British goods and looking to export them around the world are under immense pressure. This Autumn Statement, it’s these businesses and towns that should be at the forefront of the Chancellor’s mind.