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Comment: Reflecting on a workshop on Post-Brexit Industrial and Regional Policy. By Professor Sumon Bhaumik

Friday, June 9th, 2017


In March, Professors from the University of Sheffield (Sumon Bhaumik (pictured above), Heather Campbell and Philip McCann) sat around the table with peers from Aston (David Bailey) and Warwick (Nigel Driffield) Business School to discuss post-Brexit industrial and regional policy. They were joined by representatives from regional bodies, trade bodies, and the private sector including representatives of Oxford Economics, Performance Engineered Solutions Ltd, Sheffield City Region, South and East Yorkshire Federation of Small Businesses, South Yorkshire International Trade Centre, The Company of Cutlers in Hallamshire, and West Yorkshire Combined Authority.

The view about the likely impact of Brexit on trade, investment and corporate performance was mixed. The private sector view emphasized the positive economic news in the immediate aftermath of the referendum, and the ability of the private sector companies to strategize better for Brexit, which is expected at this stage, than for the financial crisis of 2008, which was unexpected. There was general consensus that the significant depreciation of the pound sterling could spur exports and firm performance, at least in the short term. The impact of Brexit on onshoring was also viewed as a potential opportunity, especially for SMEs. There was some optimism about UK’s ability to strike trade deals relatively quickly with countries from the Middle East and Latin America.

This optimism was tempered by the uncertainty about the new trade deal between the UK and the EU. In particular, there was concern among some workshop participants about the impact of the loss of single market access to the organisation of supply chains, and the implications of imposition of tariffs on industries such as automobiles whose components crossed UK’s international borders a number of times before they are used in the final product. The discussion, however, suggested that divergence between EU and UK regulations, especially about rules of origin and product standards, could pose a greater challenge to businesses than tariff barriers. The difficulties of contract enforcement in an environment of diverging regulations was also highlighted, and there was some concern about the general impact of Brexit on bureaucracy about all matters related to cross-border transactions. It was also felt that while any dip in the UK’s ability to attract FDI in the short run would recover, it might not recover to the pre-Brexit trend.

There was general consensus around the table that if the Brexit deal restricts free movement of labour, skill shortage – indeed labour shortage for some sectors such as agriculture and hospitality – might prove to be the biggest challenge facing UK businesses, in particular, those in the Midlands and Northern England. It was argued that, to begin with, there should be closer cooperation between the universities and the private sector to ensure that the labour force of the future not only has high levels of skills but can also adapt quickly to the rapid changes in technology that are manifested through increased use of AI and robotics. The panel was also mindful of the need to shape labour market policies in a way that facilitates inclusive growth in the future, such that post-Brexit policies and private sector performance have the necessary democratic legitimacy. Further, some on the panel felt that policies regarding skill development should be devolved to the regions that have greater understanding of the skill requirements of the local companies.

Many on the panel felt devolution of the power to the regions would enable policies better suited to local economies in post-Brexit UK. In particular, it was felt that, given the heterogeneity in the industrial composition of the regions that make up the UK, it is imperative to seek their views before any new trade deal or industrial strategy is finalised. Some on the panel voiced concerns about lack of engagement with central government to date to discuss the regions’ trade and industrial policy needs. Some felt that elected mayors might be able to better negotiate with the central government, and that they would also be helped by access to greater financial resources. However, it was also felt that regions would have to cooperate – for example, within the framework for the Northern Powerhouse – rather than compete for resources within a zero-sum bidding framework.

Paucity of time left some issues undiscussed. In particular, future discussions would have to reflect on whether effective devolution of economic power to the regions requires that they be given the power to borrow to invest in physical and human capital. This, in turn, would require a discussion about the financial infrastructure, such as a “muni” bond market, to facilitate such borrowing. Issues such as these, as well as discussion of policies formulated by the individual regions, are expected to be part of ongoing discussions involving the stakeholders represented at the workshop.


This workshop has been supported through The University of Sheffield’s ESRC Impact Accelerator Account

Prof Sumon Bhaumik comments: ‘Inside the machine: how two Nobel winners taught us how companies tick’

Thursday, October 20th, 2016

Originally posted on The Conversation 17 October 2016

One of the most notable evolutions in economic theory is the change in how we look at companies. No longer do we see a black box which uses some process or technology to turn inputs into outputs. These days we think of a business as a nexus of contracts among different stakeholders – shareholders, creditors, managers, workers, customers, suppliers and so on.

This evolution has led us to look at corporate governance through the design of contracts between those stakeholders. Oliver Hart and Bengt Holmström have laid the foundation to enable us to do that. The 2016 Nobel prize in Economics went some way to acknowledging this contribution.

While contracts are commonplace, they are generally not simple. They might be designed at times when the objectives of stakeholders differ (the so-called “agency problem”). For example, shareholders may want to maximise a company’s profits, while managers may want to build an empire through mergers and acquisitions.

There is also something called “asymmetric information”, where the actions of one set of stakeholders are not visible to other stakeholders in the company. Everyone can read the financial statements, but shareholders cannot directly see how much effort the managers put in to drive profits.

Shareholders can, however, enter into a contract with a company’s leaders that would give the managers an incentive to work in the interest of the shareholders. Pay can be linked to observable measures of a company’s performance. Similarly, shares and stock options may be included. In the Nobel citation, Holmström, a Finnish professor working at the Massachusetts Institute of Technology, was credited with demonstrating how shareholders should design an optimal contract for a CEO whose actions they would not be able to fully monitor.

Contracts can also be incomplete. It is either not possible or too expensive to write contracts that take into account all possible future outcomes. It is precisely the incompleteness of contracts that provides a rationale for corporate governance. This follows from research carried out by Hart, a British professor working at Harvard.

Hart of the matter

Consider, for example, a simple executive pay scheme in a company where shareholders own the company but control lies with the management. The relationship offers both an agency problem and asymmetric information. As mentioned earlier, one option for shareholders would be to write a contract that links the compensation of the managers to an observable outcome such as revenue or profit.

But profits can be affected by factors out of a manager’s control, and a contract that takes into account all combinations of managerial effort and external factors is impractical. Managers generally act in groups and so it may also prove difficult to assign an outcome to one person. You can write contracts that penalise the group if a product fails or a plant proves inefficient, of course, but Holmström argued that uncertainty about the causes of such failures would mean that monitoring would be necessary and hence the associated costs are unavoidable.

You could judge the performance of managers against that of their peers to decide compensation (a supermarket CEO might cheer that sales are up 10%; shareholders less so if other stores are up 12%). But this approach would still only work if you can successfully remove the influence of common external factors affecting how managers perform.

In this case, where simple contracts may not be easy to design or enforce, we need a mechanism – corporate governance – that ensures that the interests of non-managerial stakeholders are not undermined. Hart views corporate governance as a mechanism to allocate rights to control a company’s non-human assets among the stakeholders.

Credit due

An interesting implication of this perspective on corporate governance is a rationale for debt. Suppose the shareholders of a firm are mainly interested in short-term profits, while managers prefer grandiose empire building that brings private perks and benefits. Any contract that attempts to address this conflict is likely to be incomplete, unable to account for every influence over the company’s future profits.

This opens up the possibility of a significant dispute between the shareholders and the managers about the latter’s compensation. Managers might claim low profits came despite their best efforts, rather than because of their poor efforts or judgement.

How can debt help in this case? A debt contract can enable the creditor to enforce liquidation of a firm if it cannot meet its repayment obligations. If the firm performs well and can meet these obligations, control over the assets of the company remains with the managers. If, on the other hand, the company performs poorly and cannot repay the creditors then it can be liquidated. At the time of liquidation, after the creditors have been repaid, the residual (or remaining) rights over the company’s assets are with the shareholders – the managers have no rights over these assets any more.

In other words, where contracts between shareholders and managers are incomplete, debt taken on for whatever reason can force an alignment of objectives. In the words of Hart and Sanford J Grossman: “managers can avoid losing their positions only by being more productive.” Productive managers are precisely what shareholders want. A company’s capital structure can, therefore, be used to both discipline managers and give outsiders (creditors) an incentive to enforce the discipline. Hart and Grossman also examined how control is exerted in work on voting rights.

Holmström and Hart do not provide all the answers to resolve the problems associated with weak corporate governance. They do, however, induce us to think about a firm as a microcosm of the society in which we live, where stakeholders with different objectives compete for power and control. Their work has helped us to move away from one-size-fit-all rules about things such as financial structure and pay and has led us to focus on making contracts and mechanisms that work. That is a transforming contribution to corporate governance research.

Author: , Chair in Finance, Sheffield University Management School

Comment: George Osborne’s ‘march of the makers’ will need Europe on its route map. By Prof Sumon Bhaumik

Monday, February 1st, 2016

This article was originally published by Prof Sumon Bhaumik on The Conversation. Read the original article.

The UK economy is in recovery, according to the latest government figures – but what is, on face value good news, is tempered by concern at the pitifully small contribution made by the manufacturing sector. Growth has been driven almost entirely by the services sector, and in particular by the business services and finance industries.

There is noticeable growth in only two manufacturing industries for which data are readily available: chemicals (and chemical products) and transport equipment. Most other industries have moved sideways between 2010 and 2014.

At a political level, this is problematic on two counts. First, this trend doesn’t alleviate concerns about UK’s exposure to future shocks to the global financial system. Second, the government has raised expectations about a “rebalancing” of the economy towards manufacturing – the chancellor of the exchequer, George Osborne, has made much of creating “a Britain carried aloft by the march of the makers”. But the numbers still don’t seem to bear that out.

Experts have offered a number of explanations about the persistent weakness of the manufacturing sector, some more justifiable than others. These include the persistence of low global demand for goods and commodities, the amount of debt in the household sector and its impact on household consumption, and the strength of the British pound.

Since the figures reported above are not forward-looking by their very nature, they do not tell us whether there are structural factors that could prevent the rebalancing of the economy back towards manufacturing industry and how feasible it would be. The challenge for rebalancing is significant.

Author provided

Data available from the World Bank suggest that of the major developed and emerging market economies of the world, only South Korea has been able to increase the manufacturing sector’s share of GDP between 1996 and 2014.

While the UK manufacturing sector’s share is considerably lower than that of Germany, it is comparable to that of France and the US. This, in turn, raises the question about the ability of a single country to significantly rebalance its economy in favour of manufacturing when global growth is weak and when many countries – for example, the “Make in India” initiative – are trying to do the same thing.

Finding the right niche

Perhaps the most important question for the UK’s manufacturing sector is where firms and corresponding industries are located along global value chains (GVCs). Recent research from the European Central Bank suggests that as the global production system becomes increasingly dominated by value chains – Apple, for example, has its intellectual property and design in the US, sources its chips from South Korea and assembles its phones, etc, in China – it will be important to “look beyond industries to understand trade and production patterns. Countries [would] specialise in specific business functions involving specific tasks rather than specific industries”.

The strategic focus, correspondingly, would have to be not so much in the development of entire industries but rather to find niche areas of expertise high up in the GVCs of a relatively wide portfolio of industries. This in turn has implications for innovation capacity that is both much discussed and where the UK, with a score of 62.42 for the Global Innovation Index, is ranked second globally – ahead of the US (5th, 60.10), Germany (12th, 57.05), South Korea (14th, 56.26) and Japan (19th, 53.97). While productivity growth continues to be a challenge, therefore, there is at least some evidence that the UK may be well positioned to grab a niche relatively high up GVCs, where much of the value is created.

This brings us to the two issues with huge political implications. First, are we asking the right questions about manufacturing sector growth and its share in the economy? If the future of manufacturing lies in innovation, will we see an inevitable period of industrial decline as industries in which UK firms do not have competitive advantage shrink while new industries and firms grow to make their mark?

Steel worker: left behind in the quest to modernise?
Reuters photographer

Second, what is the objective for growth of the manufacturing sector? Is the objective a more diversified UK economy that is not heavily reliant on the financial sector – or is there an unspoken subtext about generating demand for a well-paid and organised sector labour force harking back to the post- World War II era of manufacturing growth. While innovation-driven manufacturing sector growth may be quite feasible, it may not necessarily lead to the creation of a large number of well-paid jobs for people with all skills levels.

Going it alone?

Then there is the question of how at British exit from the EU might affect all this. While crystal ball-gazing is hazardous, two things immediately come to mind. If the future of UK manufacturing lies in an innovation-led move up the GVC ladder, it would need an economy that encourages innovation and clusters of enterprises that may be costly to develop within borders of a single country whose resources are limited. To the extent that Brexit would raise the transactions cost of forming these eco-systems and clusters in cooperation with other European countries, it would be more prudent to stay in than stay out.

Further, since integration with GVCs quite likely has implications for skill gaps at one end of the labour market and structural unemployment at the other, it may be imperative for the UK to be part of the intra-EU flow of labourers. Retraining of labourers in sunset industries to prepare them for sunrise parts of the sector sounds good in theory – and makes for good political speeches – but it cannot possibly be a substitute for free mobility of labour within 28 countries that will present opportunities for workers with particular skills to find the right niche and industries with particular needs to hire the right workforce.

Policymakers, in other words, would have to have clarity about the objective for manufacturing growth and rebalancing: either achieving greater diversity within our GDP portfolio so that we are not overexposed to future financial crises, or creating the space for a certain kind of employment. Importantly, it would be prudent to make those choices within the the EU.