Neil Carmichael MP: The Coalition has rightly embraced Lord Heseltine's industrial policy

Neil Carmichael is the Member of Parliament for Stroud and a member of the Education Select Committee. Follow Neil on Twitter.

Thirty years ago, Edward Heath asserted “Britain cannot rely on doing other peoples washing”. His meaning was plain; we were in danger of becoming a service economy at the expense of manufacturing and engineering. Today, the Coalition Government is facing up to the consequences of successive governments (especially the last one) having failed to understand the implications of ignoring many such warnings.

Rebalancing the economy is proving difficult, not least because of the huge cultural change necessary to support the reversal of several now ingrained assumptions and the impact of complacency. To make matters worse, we are operating in a global economy where new emerging economies – some are former colonies and several others we virtually ignored – are powering ahead as their middle classes expand, continental links are forged, and investors find easy opportunities.

Domestically, we are badly hampered by the deficit and overall debt. We must secure a sound financial footing because the risks of high interest rates and an endemic lack of confidence in our economy could be fatal. To sum up the challenge we confront, it is a mixture of structural failures in the real economy, robust competition from unexpected quarters and a debt ridden financial system.

Game changing action is called for and this should comprise of a boost to infrastructure investment, radical rethink about strategies for exporting, creation of conditions for small and medium sized firms to gain sufficient critical mass to become bigger market players, developing ‘banks for business’, tackling regional underperformance, and redoubling efforts to reform education and the labour market.

Before each of these measures is discussed in more detail, it is worth considering Germany’s capacity to create frameworks for growth and prosperity. The striking features of German economic and industrial policy are rationalism and boldness as opposed to incrementalism and interference. The absorption of the old German Democratic Republic (GDR) is a case in point. At the time of unification, the GDR was an economic wasteland, producing poor products for quickly vanishing markets yet, today, many parts of East Germany are thriving with sophisticated supply chains, modern infrastructure, productive factories, successful exporters and an increasingly adaptable workforce. Britain can bring about the same economic revolution in our underperforming regions.

Business needs an effective infrastructure but it can also be effective in providing one. Business requires several conditions for successful delivery of infrastructure including timely and consistent decision making, ability to realistically apportion risk, and access to funding. Private Finance 2 – the successor to the overly complicated, cumbersome and hugely expensive Private Finance Initiative – is set to be a useful mechanism for public sector capital investment, not least because it is characterised by transparency and seeks to ‘align public and private interests’. Government departments should be preparing their programmes and planning the centralised procurement mechanisms.

Other larger infrastructure projects require government to signal commitment and even a sense of urgency. Here, the decision to postpone any decision about increasing the UK’s airport capacity is an example of excessive caution risking unintended but, potentially, detrimental consequences in terms of global competitiveness and, more immediately, missing the advantages of a major construction project. Put simply, stronger signals in support of infrastructure investment are necessary to underpin the National Infrastructure Plan, loan guarantees and additional capital commitments.

Britain’s export record is a matter of widespread concern, especially against the background of Sterling’s recent significant decline in value (devaluation is not, however, a panacea). Latin America, India and China are all developing economies where our near neighbours have achieved significant export successes as opposed to Britain’s more measured performance. Two changes could make a difference. Firstly, United Kingdom Trade and Investment (UKTI) should focus on providing economic analysis on emerging markets and match this information up with clearly identified and promoted specialist sectors back at home. Second, a more sophisticated understanding of supply chains would enable smaller firms to develop products and sales opportunities. In essence, potential exporters need to know more about the possibilities abroad.

The size, definition and behaviour of firms have often been hotly debated by industrial economists but several characteristics of British firms are well known. There is little dispute about the huge number of start-ups, micro-businesses, vehicles for entrepreneurs and established small firms, many of which have thrived in their own terms. Too many, however, are either created with an exit plan requiring maximum value at the time of sale or simply fail to grow into larger businesses with the critical mass to invest, evolve and flourish. The contrast between Britain with very few substantial medium sized firms and, for instance, Germany with ample numbers of often family, privately or employee owned businesses is striking. This kind of business is the type where long term investment, product development and market penetration are the hallmarks.

Britain needs more of these bigger businesses. To create a culture where they could become the norm would require new forms of ownership and modern, responsive leadership. Taxation incentives should be geared to encourage capital investment including forms of mergers and takeovers, new forms of ownership, and research and development.

Britain’s large financial services sector contributes massively in terms of gross domestic product and, of course, services much of the real economy. Ringfencing bank activities as provided for in the Financial Services (Banking Reform) Bill is one step in the right direction but creating a new banking culture where professional advice, local decision making, more clarity in assessing risk and increasingly innovative ways of funding business plans will all combine to produce a vibrant SME sector.

Regional underperformance amounts to a chronic waste of resources and has continued to do so since disparities were first properly analysed in the 1950s. Lord Heseltine’s report, “No stone left unturned: in pursuit of growth”, makes the case for strong cities and regions. City leaderships – civil and business – should be defining their specialisms through existing firms, universities and their labour markets. The role of a city as a ‘growth pole’ for its region is central to effective supply chains and international recognition.

Since 2010, 1.2 million new jobs have been created in the private sector but, as the Bank of England’s Inflation Report (February 2013) notes, the “strength of the private sector employment since mid-2010 contrasts with the weakness of private sector output growth”. Various explanations for this divergence have been advanced but one recurring theme is poor productivity through a lack of skills and training. In this policy area, the Coalition Government is moving radically and swiftly but business, too, must engage with the education establishment in order to push the skills agenda in the right direction.

Joining these six themes together produces an economic vision of powerful interlinked cities with significant industrial activity represented by large firms with sufficient ‘punch’ to develop export markets and able to draw on a skilled and adaptable labour force. Lord Heseltine’s report does so in more detail; the Coalition Government’s positive response to it – accepting virtually all recommendations – signals the right intentions and, if backed up by determined leadership, the prospects for Britain’s economy will dramatically improve.