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5 August, 2021updated 12 Oct 2021 04:33

Government subsidies are the new normal, not a symptom of Brexit

When the UK government's subsidy towards Nissan's £1bn electric vehicle hub in Sunderland was announced, critics claimed it was a sign of post-Brexit weakness. This is not the case.

By Ben van der Merwe

nissan-sunderland-subsidy

At the announcement of the construction of a ‘gigafactory’ at Nissan’s plant in Sunderland, a huge government subsidy was revealed. Such policies are used all over the world, but how vital are they to securing investment? (Photo by Oli Scarff/AFP via Getty Images)

Nissan’s plans for a £1bn electric vehicle (EV) hub in Sunderland have been greeted with great fanfare by the UK government, with the investment described by Prime Minister Boris Johnson as a “pivotal moment” for the UK’s post-EU future.

The government is backing the investment with £100m in subsidies, equivalent to 35% of Nissan’s total capital investment costs, and providing the land at agricultural rates. 

Critics have suggested the subsidy is a sign of post-Brexit Britain’s undesirability as an investment location, but the government argues that the Nissan deal is vital to both local regeneration efforts and the future of the UK’s car industry as a whole.

In fact, the UK is far from alone in Europe in using government subsidies to promote strategic industries. The real question is whether they will work, and whether they will help or hinder the government’s ambition to ‘level-up’ the UK’s most deprived regions.

Batteries are a strategic priority for the government

The Nissan car plant itself is expected to create 909 new jobs, as well as a further 4,500 throughout the UK supply chain. The hub will also include an electric battery ‘gigafactory’, built by Chinese company Envision, with enough capacity to power up to 10,000 Nissan EVs per year. The Envision plant is expected to create a further 750 new jobs, and will be the first large-scale battery production facility in the UK.

Beyond the immediate impact on jobs, however, the battery plant is key to the government’s post-Brexit industrial strategy.

By 2026, battery electric vehicles exported from the UK will need to be composed of 55% local content to qualify for tariff-free access to the EU. The rules will also mean that batteries, which typically make up 40% of an EV’s value, will need to be sourced from either the UK or EU.

As such, the government is racing to secure a position for the UK in the global EV battery supply chain. The expansion of Envision’s factory in Sunderland is expected to increase output from 1.7 gigawatt-hours (GWh) to 9GWh, enough to power 100,000 new Nissan electric cars each year.

Meanwhile, UK company Britishvolt announced earlier in 2021 that it had acquired Blyth power station for the site of its own gigafactory, with an eventual output of 35GWh. The factory is not expected to start operations until 2023.

There are also broader strategic reasons behind the government’s batteries push. The sale of new combustion-powered vehicles is set to be banned in the UK from 2030 and in the EU from 2035, meaning the UK auto industry’s transition to EVs is essential for its survival.

The Faraday Institution estimates that demand for UK-produced EV batteries will grow to 140GWh per year by 2040, with the potential for 78,000 new jobs in the battery industry. Reaching this level of output is estimated to require investment of approximately $12bn and the creation of bespoke deals with the UK’s major auto producers: Nissan, PSA, Jaguar Land Rover and BMW.

Who holds the advantage in the battery race?

The UK possesses a key advantage in the battery race. The relatively high proportion of renewable energy in the country’s national grid could allow battery manufacturers to reduce their production-stage carbon emissions. Gigafactories in Poland, Germany and Asia, by contrast, are powered to a significant extent by fossil fuels.

However, European battery manufacturers have already announced deals with the likes of Volkswagen, PSA, Renault and BMW, leaving the UK at risk of falling behind. 

There are already 20 gigafactories planned or built across the EU. Germany alone has five currently in operation, with 12 more in the pipeline.

As the Faraday Institution puts it: “There is no reason to suppose that these firms will naturally gravitate towards establishing all, or even any serious proportion, of their European battery manufacturing capacity in the UK. 

There is no reason to suppose that these automotive firms will naturally gravitate towards establishing all, or even any serious proportion, of their European battery manufacturing capacity in the UK. Faraday Institution

“If, on the contrary, they enter long-term relationships with overseas battery suppliers, then the chances of securing UK gigafactories (and hence the chances of sustaining an electric vehicle production industry in the UK) will diminish.”

A recent report by industry body SMMT predicted that 90,000 jobs could be lost by 2030 if the UK auto industry fails to transition to EVs. The report said that the government needs to increase UK battery production capacity to 60GWh by 2030 in order to secure the future of the UK’s electric car industry.

The report called for a number of subsidies to boost the industry, including an increase in research and development (R&D) tax credits, more generous capital allowances and the removal of plant and machinery from the business rates valuation.

The Faraday Institution’s survey of battery manufacturers found that, while proximity to EV manufacturers was the most important consideration in their location decisions, they were also influenced by investment incentives

The report concluded by recommending that the UK “match or come closer to matching the financial and administrative incentives that have been offered by other European countries to electric vehicle battery manufacturing firms”.

The UK is not alone in offering hefty subsidies

With European governments racing to secure a dominant position in the production of EV batteries, state subsidies are far from uncommon. 

France and Germany have pledged $1.18bn (€1bn) and $830m, respectively, for a joint project to expand their battery production, while Germany was recently reported to have offered a subsidy of $1.18bn to Tesla for a single gigafactory.

The EU is keen to reduce imports of batteries from China, the current market leader. In January, the bloc launched a $3.43bn scheme, involving more than 40 companies, to support the sector in addition to $3.79bn already allocated for battery research. Poland and Hungary, meanwhile, have created special economic zones to offer tax advantages to EV battery producers.

Beyond the EV sector, investment incentives have become an increasingly popular tool used by governments to attract foreign capital. Between 2009 and 2015, 48% of high-income countries increased the generosity of their investment incentives in at least one sector, while only 23% reduced their generosity.

Far from the UK’s investment incentives being a symptom of post-Brexit malaise, the value of investment incentives offered by the British government has declined substantially since 2016. Data from market intelligence company Wavteq shows that the total value of incentives has halved in the past 12 years, falling from $2.4bn (£1.72bn) between 2010 and 2015 to $1.2bn between 2016 and 2021.

The largest UK recipient of investment incentives, Wavteq’s data shows, has been creative industries in the South East, which has benefitted from $188m in incentives since 2010. However, the North East, West Midlands and Wales have also received hefty subsidies for their automotive industries, worth $186m, $180m and $99m, respectively.

Wavteq estimates that the $3.6bn in investment incentives offered by the UK government since 2010 has helped to create 153,000 new jobs, while also safeguarding a further 67,000.

However, the toll of the subsidy regime on public finances is significant. OECD figures show that in 2018, the British government spent 0.33% of GDP on subsidising corporate R&D, whether directly or indirectly through tax breaks. 

Only Russia, due to its exceptionally large direct government financing of R&D, was more active in promoting innovation through the use of public funds, spending 0.40% of GDP. By contrast, Germany spent just 0.06% of GDP on subsidising corporate R&D, while the EU as a whole spent 1.17%.

Unlike Germany and the rest of the EU, however, the UK government’s support for R&D is overwhelmingly provided indirectly via tax incentives. Less than one-quarter of UK subsidies for innovation are provided by direct government financing (24%), compared with 100% for Germany and 71% for the EU as a whole.

Where the UK's subsidies fall down

The lack of direct government involvement in funding innovation may be the weak point of the UK’s subsidy regime. Numerous studies have found that, at the aggregate level, tax incentives result in little to no new investment. At the same time, for every 10% increase in corporate tax incentives, a World Bank study found, corporate tax revenue declines by 0.35 percentage points of GDP.

Nissan’s investment in the UK was primarily driven by a desire to overcome European trade barriers, so the UK’s membership of the European Economic Community was critical. Henry Loewendahl, Wavteq

A survey by the World Bank found that investors rate the importance of low tax rates significantly below other considerations such as political, legal and macroeconomic stability, market size, skills and physical infrastructure.

Tax incentives might therefore play a role in attracting companies to parts of the UK that already have the necessary skills, infrastructure and supplier networks to support them. However, they are unlikely to play a major role in the government’s 'levelling up' agenda aimed at bringing in high-skilled, high-paying jobs to left-behind areas.

In the case of Nissan’s original investment in Sunderland, investment incentives played no major role – instead, the decision was driven by labour market, infrastructure and trade considerations.

Speaking to Investment Monitor, Henry Loewendahl, CEO of Wavteq and author of Bargaining with Multinationals: The Investment of Siemens and Nissan in North East England, said: “Nissan’s investment in the UK was primarily driven by a desire to overcome European trade barriers, so the UK’s membership of the European Economic Community was critical. 

“The UK’s commitment to labour market deregulation under the Thatcher government was also vital for Nissan as the company wanted to establish lean production systems that would be a key source of competitive advantage. The North East of England was away from the centre of the UK’s car industry, but at the same time it had a very strong industrial base.”

How tax incentives can be effective

Where studies have found tax incentives to be effective is during the final stage of the site-selection process, in cases where investors are considering a shortlist of similar options, all of which have the necessary structural features of a desirable investment location.

Incentives are a necessary part of the economic development policy mix but they should have very clear objectives. Henry Loewendahl

The subsidy arms race over the future of battery production in Europe gives every indication of being a result of this process. With the future of a highly strategic sector up for grabs, and numerous countries offering similarly suitable investment environments, subsidies are being used to tilt location decisions.

“Fundamentally, it comes down to competition for the investment and the massive spillover economic development benefits through the supply chain that follow such investments,” says Loewendahl. 

“These benefits enable multinationals to negotiate up the incentives they can get, and find ways to maximise the government support when there are regulatory limits to incentives as in the EU.

“The automotive sector is also a low-margin industry, with long-term profit margins in the single digits for most manufacturers. Therefore, incentives are taken into consideration as they can significantly lower the start-up costs and increase profitability.”

Well-designed and strategically targeted investment incentives may therefore tilt the balance in location decisions, but bringing high-tech industries to the UK’s most left-behind regions is likely to require a more involved approach by government.

The Faraday Institution estimates that, of the 78,000 new jobs that could be created in the battery supply chain by 2040, 75% would require qualifications at Levels 2 or 3, with 20% requiring employees with qualifications at Level 6 or above. 

More than one in every three workers with a degree-level qualification or higher lives in London or the South East (34%), according to government data. By contrast, just 13% live in the North East or North West – key targets of the government’s levelling up agenda.

“Incentives are a necessary part of the economic development policy mix but they should have very clear objectives,” says Loewendahl

“They should be focused on the economic activities that are most strategic for the location, be well administered and be limited to the maximum needed to win the investment. There should also be key performance indicators attached to the incentives awarded and tracked, with clawbacks if indicators are not achieved."

If the UK wants a subsidy regime to compete with the likes of Germany, it may not be the size of the funding that matters, but how it is delivered.

Subsidies for strategic industries are essential for ensuring that UK manufacturing doesn’t lose out from the transition to net zero, but without a more comprehensive package of educational and infrastructural reform, left-behind regions are unlikely to see the benefits.

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