State aid to attract new firms - that's got to be good, right?

 

An X Factor contest to attract a Tesla gigafactory sets the stage for crony capitalism

The big worry is that the Government will harness its state aid powers to tilt the deck towards politically favoured regions

RYAN BOURNE27 May 2021 • 4:00pm

You could say conditions are ripe in the UK for crony capitalism.

Brexit has precipitated a consultation on revising “state aid” rules, with the prospect of fewer strictures on subsidies or tax incentives to attract certain investments. The Prime Minister and his local champions in Parliament are keen for “ribbon-cutting” successes to show the “levelling up” agenda in action. Add to that the pressure of net zero commitments and the political need to offset job losses from decarbonisation, and the Government is desperate for high-profile inward green investment.

So news the Government’s Office for Investment recently called on regional agencies to submit rapid location proposals for a new car factory, coupled with Elon Musk’s UK visit, sent the rumour-mill into overdrive that the Tesla boss is looking to open a electric vehicle plant or “gigafactory” in Britain. Tees Valley Mayor Ben Houchen and Teesside MPs, in fact, seemingly fired the starting gun on a very public regional beauty contest to woo Musk, also said to include South Wales.

Musk’s entrepreneurialism on electric vehicles is exciting and revolutionary. It is understandable that local champions such as Houchen would want this cutting-edge industry and a massive investment in their constituency, not least given the surging demand for electric vehicles as anti-carbon incentives proliferate. The problem is using regional contests to determine factory locations tends to be economically destructive.

The US has seen a proliferation of these spectacles, with companies playing state governments off against one another to “attract” the factory. “Winning” sometimes boosts local job creation, but most evidence suggests the financial and other incentives fail to lift regional economic growth, while leaving taxpayers worse off nationally. Companies get bungs for investment projects that often would have happened anyway, but with socially wasteful rent-seeking and copycat behaviour the result.

Tesla has a particular history of exploiting this competition for factory locations. In 2007, the company flipped its proposed car plant from New Mexico to California after the latter promised bigger tax exemptions. During a location hunt for a $5bn plant to produce lithium ion batteries in 2013, the company invited Washington state economic development officials to discuss its idea. When the officials arrived, they realised six other states had also been invited. The company wanted the message to be clear: this was a competition.

In fact, the “urgency” sought by the Office for Investment for these UK location proposals could be straight out of Tesla’s playbook. Back in 2013, the company gave US states just three weeks to submit opening location proposals for its “gigafactory.” After twisting arms, touring 100 sites, and playing hot and cold in public and private negotiations, the contest eventually saw the company extract a total of $1.4bn of company-specific financial incentives, made up of tax abatements and free land, to settle in Reno, Nevada.

Nevada’s Governor celebrated the win, as no doubt Houchen would if Musk set up on Teesside. Yet while “winning” like this no doubt brings observable, well-paid jobs and political prestige, the regional incentives themselves tend to, at best, simply displace activity across the country, as higher taxes are imposed elsewhere. Economist Matt Mitchell of George Mason University likens the process to a gardener fertilising some plants by composting others.

“At best” because, usually, the specific incentives do not affect the final location decision at all. The skills of the local workforce, the benefits of being around other similar companies, and the broader conditions of the region are usually more important considerations. Research, again in the US, has suggested that just one-in-eight regional economic development subsidies change a plant location from what we would otherwise expect. Taxpayers usually lose out for nothing.

That is not to say the effects of Musk’s location shopping are all economically destructive. His recent move away from California has exposed how overzealous regulation and high taxation have bad economic consequences. If the UK is going to prosper post-Brexit, it will need a generally pro-growth tax environment, reasonably priced energy, supporting infrastructure, a high-skilled workforce and a much more liberal land-use regime, all of which would help secure major investments like Musk’s.

What we should not do, however, is have regional or national politicians grant companies sweetheart deals dependent on where they locate. Not only do these tend to disappoint as companies promise the world — analysis up to 2018 suggested Tesla in Nevada was $1bn short of its $5.5bn investment promise, and had only created two-thirds of the projected jobs — but tilting the deck leads to inefficiency and other companies seeking out similar favours.

British regions have much less resource autonomy than US states, of course. So, in reality, “regional contests” here would be more limited by definition. Good. The bigger worry is that rather than focusing on the overall environment for business, the Government will harness its state aid powers to tilt the deck towards politically favoured regions.

For similar reasons, this would be the wrong path for Britain to go down. Not only would the Government find itself needing to step in with bigger bungs to ensure “unattractive” regions get a piece of the action, but other major companies would start demanding incentives to fulfil projects they intended anyway.

If Musk’s Tesla gets subsidies to locate in a given UK region, then other firms will ask: why not us too? Reports already suggest Nissan is demanding tens of millions of pounds in support for its own gigafactory proposal, including help with energy costs. And if the US experience shows us anything, it is that once one factory investment decision becomes a gaudy X Factor-style location contest, other businesses demand similar treatment.

State aid - good or bad?

 JOHN COLLINGRIDGE

State aid is Johnson’s silver bullet — but can any PM be trusted to spend it wisely?

John Collingridge

Sunday December 27 2020, 12.01am, The Sunday Times

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Few phrases have more capacity to divide businesses leaders than state aid. But it is one that we will hear a lot more about in the brave new post-EU world. Boris Johnson swept to victory last December by promising to “get Brexit done” and put British industry first. He would change public procurement rules to “buy British”: “We’ll back British industry by making sure we can intervene when great British businesses are struggling.”

It was this vision of a land of milk and honey, freed from the shackles of European influence, that was so enticing for voters, particularly in post-industrial areas. Many of those former Labour “red wall” seats had suffered decades of decline, leaving people increasingly reliant on unstable and low-paying jobs.

So it is easy to understand why they lapped up the promises of injections of taxpayer cash combined with muscular protectionism. But this is alien territory for a Conservative government, supposedly the party of free markets — and is a policy with a chequered history.

Now comes the hard part: repaying that faith. We have seen the early evidence of this policy in action already, with the £400m acquisition of a 45% stake in OneWeb, the bust satellite operator. That deal was the brainchild of Dominic Cummings, the prime minister’s now former senior adviser. The hope is that OneWeb’s satellites can be used to connect fibre-optic broadband blackspots in rural England, and develop Britain’s own satellite navigation system to rival the European Galileo system and America’s GPS.

Yet to some experts, this looks like a costly gamble doomed to failure. So concerned was Whitehall with that deal that it insisted on a rare ministerial direction from business secretary Alok Sharma — the equivalent of the civil service washing its hands of it.

If you want a salutary reminder of the pitfalls of a state-sponsored technology arms race, a trip to south Wales is not a bad place to start. In the 1990s, Britain was desperate to attract Asian companies to these shores. The government persuaded South Korean giant LG to open a plant in Newport in 1996, promising to create 6,100 jobs; in return it was handed a grant of £200m. Japan’s Fujitsu was lured to open a factory in Newton Aycliffe in Co Durham in 1991. But both collided with economic realities: the crashing price of electronics, from LCD screens to semiconductors. Fujitsu closed its factory in 1998 and LG quit Newport in 2006. Westminster bet against globalisation and was found wanting.

Yet just a few miles away from the failed Fujitsu plant is an example where state aid can go right. The Nissan factory in Sunderland opened in 1986 with a generous helping of regional aid, and has been one of the great industrial success stories, as I report elsewhere.

Airbus’s factories in Filton and Broughton are also examples of how state aid can work. The government was a reluctant investor in the Airbus consortium at its formation in 1969; scarred by its involvement in — and the taxpayer cash thrown at — Concorde, it initially refused to join. Eventually it did — and its subsequent investments in Airbus, via “repayable launch aid” for specific planes, have paid dividends. The initial investment in the A320 proved so lucrative that Airbus eventually had to persuade the government to take a haircut on its holding in return for more work on future projects.

That question of state aid is likely to be posed again soon, as Covid-19 scythes through once-healthy businesses of strategic significance, especially as lockdowns spread. The green book, the Treasury bible on how to invest, has been amended so that more weight is placed on supporting neglected areas.

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When it comes to a business such as Rolls-Royce, the Derby jet engine-maker whose crashing shares and swollen debt pile leave it in a perilous position — or a target for a cash-rich US predator — there should be no hesitation in intervening.

When a cash-strapped Airbus comes calling for support to develop the next generation of low-emission aircraft and wings, a similar decision should be made. Getting back around the table as a shareholder is wishful thinking in a post-EU world, but would give the government crucial influence just as the aerospace giant faces huge decisions on future tech, and Hamburg tries again to grab work from its Welsh wing factory.

And if Boris Johnson is serious about sustaining an automotive industry that can survive beyond the combustion engine, he could do worse than inject funds into battery factories and target aid to attract electric car parts suppliers.

But where do you draw the line? Taxpayer funds are under a pressure never seen before, and the government has a patchy record when it comes to picking winners.

The deal agreed with Europe will not allow ministers a completely free hand when it comes to doling out state cash to support private enterprise. France, fond of state aid itself, wants checks on Britain’s use of the stimulus. The UK will still be subject to common binding principles that will prevent it from giving distorting bungs, and recourse for the EU to recover illegal subsidies.

Another problem, as evidenced by OneWeb, is with the prime minister himself. He is so keen to be popular, and so open to special pleading, that he risks throwing away taxpayer cash on pet projects, rather than supporting viable and promising causes where there is a serious strategic case.

The biggest role of government here should be as a helping hand for business, providing an initial boost if needed, or helping it get over big investment hurdles such as a completely new technology, but then stepping back to let innovation and enterprise take over.

Picking winners is fiendishly hard, but a good place to start is where we have a technological edge to begin with. Part of the problem is that you only find out if you’ve backed a winner years later.

john.collingridge@sundaytimes.co.uk