Sunday, March 30, 2008
Manufacturing's comeback chance
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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With apologies to any of them who might be reading this, is it time we dumped the investment bankers, accountants and consultants and concentrated on the people who make things, Britain's manufacturers?

Does the credit crunch a term Mervyn King has now taken to using mark the point at which we should go back to basics, by rediscovering the things that made Britain great? A week in which Jaguar and Land Rover have been sold to India's Tata may seem a curious time to be asking such a question.

That sale, however, just exchanges one foreign owner, Ford, for another. And unless Tata plans to ship the whole lot to Mumbai, which it shows no sign of planning to do, the sale should be regarded as an expression of confidence in UK manufacturing.

Can manufacturing revive? Should it, or should we accept that while the credit crunch has dealt a short-term blow to financial services, and sullied the reputations of some of the masters of the universe in the City and Canary Wharf, that is where Britain's advantage lies?

When Labour came to power more than a decade ago, the City had reasons to be nervous. Despite the charm offensive that preceded Tony Blair's election, there were uncertainties over how City-friendly a Labour government could ever be and about how rapidly it would want to take the country into the euro.

Those fears were groundless. Despite the current qualms over the taxation of non-doms, new Labour presided over a golden age for the City. Manufacturing, in contrast, has struggled, losing more than a million jobs. In the past 10 years manufac- turing output has risen by 2.8% in total, not per year. The output of business and financial services, which has twice the weight in gross domestic product as manufacturing, has risen by 57%. Pushing paper has been a lot more profitable than moving metal.

If we take financial services on its own, its rise mirrors manufacturing's fall. IFSL (International Financial Services London) records that its share of GDP has increased from 6.6% to 9.4% since 1996, during which time manufacturing has dropped from 21.1% to 13.2%.

This is a tale of two sectors, and it is also a regional story. Nearly 22% of London's GDP is accounted for by financial services, compared with under 5% in northeast England. That does not mean, incidentally, that more than a fifth of London workers are employed in the City and Canary Wharf. "City-type" employment, 338,000 according to IFSL, is relatively small, accounting for only just over 1% of all jobs in the UK. The "City", including Canary Wharf, contributes 2%-3% to the British economy, not as much as is commonly supposed.

There will be some shrinkage over the next year or so in City-type jobs. The broader financial-services sector, similarly, faces much weaker growth. To what extent can manufacturing take up the slack? Nobody would be more pleased than me, given my West Midlands roots, to see it happen. The good news is that 2007 was a strong year for the sector, one of the best for a long time, and the evidence so far this year is encouraging.

The CBI's measure of export orders currently equals its best level since 1995, helped by the pound's fall in recent months against the euro. That fall, given something like official endorsement by the Bank of England last week, recalls the all-too brief flowering of UK manufacturing in the wake of sterling's September 1992 departure from the European exchange rate mechanism.

A report, Global Challenge, by the Engineering Employers' Federation (EEF) and accountants BDO Stoy Hayward, found that Britain's manufacturers were responding positively to the challenges from China and India.

Many UK firms are now niche players but most have adapted to years of intense global competition and, until recently, a strong pound. Productivity growth in the sector is stronger than in the rest of the economy, and has had to be.

Three-fifths of manufacturers in Britain locate their research and development activity here. Most rely on a diverse range of markets, limiting their vulnerability to America's problems or a consumer downturn in Britain. Even with Libor (the London interbank offered rate) at 6%, manufacturers will feel the impact of the credit crunch less than other sectors.

Steve Radley, the EEF's chief economist, even has some "man bites dog" evidence of a return of some manufacturing activity to these shores from low-cost locations like China. High transport costs, coupled with quality and reliability problems have led to demands from some customers for production to be located closer to home. It is too soon to say it is a trend but it is an encouraging development.

John Hutton, the enterprise secretary, thinks that the revival of nuclear power has the potential to generate 100,000 skilled manufacturing jobs in Britain. Hutton also sees a new wave of what he describes as "green collar" jobs, those related to the design and manufacture of low-carbon, environmental products.

There is, however, an enormous way to go. The sheer scale of Britain's manufacturing trade deficit underlines the depth of the problem. Last year manufacturing trade was in deficit by 61 billion, of which 55 billion was in finished goods. A return to the situation of a quarter of a century ago when manufacturing trade was in surplus (and always had been) looks inconceivable. The financial- services sector, in contrast, runs a surplus of 25-30 billion.

Not only that, but history is not on manufacturing's side. The EEF hopes for a stabilisation of its share of Britain's economy but is cautious about predicting a rise in that share. There is no known instance of manufacturing in any country permanently reversing the natural decline that is associated over time with a bigger share for services. Rules, of course, are there to be broken. It would be good if British manufacturers could break this one.

PS: With the Nationwide reporting a fifth successive fall in house prices, immediately and clumsily after an increase in the rates it is charging new borrowers, memories are stirring of the early 1990s. In prime minister's questions, Gordon Brown claimed rates rose to 18% then, while Nick Clegg, the Liberal Democrat leader, said the rise by the Bank of England recently was proportionately the same as then.

Both were wrong. The rate peak was 15%, not 18%, but it had doubled from 7.5% to get to that point. In any case, jousting about the early 1990s misses the point. The current situation is very different.

Then we had an economic crisis that spilled over into housing. Now, as Mervyn King put it, "the heart of the problem is not in the real economy; it is in the financial sector itself". He thinks, as do I, that the outlook for house prices in the coming years is broadly stable.

To achieve that, however, the Bank has to help solve the problems in the financial sector to prevent a vicious cycle developing. That means dealing with the overhang of assets which is bearing down on the markets while not exposing the taxpayer to losses. We are still awaiting details of how it plans to take a leaf out of the Federal Reserve's book and do that, despite plenty of positive noises. This is not the moment for a leisurely review of the options. Time is of the essence.

The Bank insists it is doing its bit and is fed up with unfavourable comparisons with the European Central Bank, which announced new liquidity operations on Friday. The Bank says it has increased long-term funding by 113% during the crisis, compared with 80% for the ECB.

What about an April rate cut, or will the monetary policy committee wait for its inflation report in May? I had thought May but April is coming up fast and starting to look irrestistible. More on this next week.

From The Sunday Times, March 30 2008