Back in 2012, it was generally agreed that it was not just vital for the UK economy to recover from recession, but also important that the recovery should lead to a better balanced economy. Growth, it was hoped, would be due more to strength in exports and business investment and less to consumer and government spending, particularly if such spending was financed by borrowing.
George Osborne reflected this sentiment when, in his 2012 Budget, he set a target for UK exports at the end of the decade. He hoped that exports of goods and services would double from £499billion in 2011 to £1trillion by 2020.
Today, the Office for National Statistics has released its first estimate of the level of exports in 2014. It shows exports totalled £500million, virtually unchanged from their level in 2011. When the Chancellor originally set his target, exports would have had to increase by 8% a year to achieve it. Three years later, hitting the target now requires export growth of more than 12% a year over the next six years. Even when the global economy and world trade were very strong in the decade up to 2008, the UK only managed export growth of 6% a year. An ambitious target has become an unachievable one.
Part of the explanation for the poor performance of UK exports is weak demand in Europe, still the destination for half of the UK's exports. Since 2011, exports of goods (regional data on exports of services are not yet available) to the EU-28 countries have fallen by 10.4%. But exports to the rest of the world are up only 0.2% over the same period. There are some good stories to tell: exports to China are up 31% over the last three years. But other countries have done even better in these markets. And the UK's gains in China have been offset by falls in exports to other markets, in particular the US.
The drop in UK exports over the last three years suggests that, barring a small number of successful industries, such as aerospace and automobiles, the UK lacks the capacity to produce significantly more goods and serviices for export. This is the result of a hollowing-out of the UK's industrial capacity that has been going on for the last 35 years. New analysis of the UK's economic fitness, which we published in December, shows the UK's export basket has become less diverse and the average good or service exported less complex since 1995.
An export revival in the UK cannot be based on a narrow range of goods and services. A sustainable improvement in export performance will only happen if the government adopts an explicitly pro-export industrial and innovation strategy.
An important element of this new industrial strategy should be backing existing and emerging industrial clusters. These are hotbeds of entrepreneurialism, innovation, productivity gains and economic diversification. They are proven areas of competitive advantage and ideally placed to develop new goods and services to enable the cluster to widen its scope and broaden the UK's industrial capacity and export potential. Policymakers should identify clusters of industries where the UK has the capabilities required for a bigger global presence and focus its industrial policies on specific support for developing them. Our analysis suggests three factors are crucial to the success of a cluster: strong networks, a high level of innovation (and access to finance to fund it) and a skilled workforce. These are the areas where the government should concentrate its help.
An industrial strategy that focuses on clusters would be a strategic departure from the approach of much of the last three decades, when growth has been promoted through mainly sector-neutral horizontal policies. But without a shift of this nature, there is little prospect of the export revival that the Chancellor was hoping for when he set his target, and little hope of a rebalancing of the economy.