EEF blog

The US, EU and China are embroiled in a dangerous game of chicken.

Not only are "Buy American" and "Buy Chinese" provisions proliferating, but the countries have lodged official complaints with WTO over trade in raw materials, computers and (yes) poultry.

These might seem like small issues, but the more cases that are brought before the WTO, the greater the danger a protectionist sentiment will proliferate across the major economies.

International trade has already fallen off the map as a result of the recession. And while the temptation of protectionism is tangible, these tit for tat measures on trade are souring relations between the countries.

But neither should an economy be allowed to take a 'beggar-thy-neighbour' response to their economic woes.

That's a fine line to walk, but hopefully we can avoid a full blown trade war.

A couple of weeks ago, the Financial Director at a manufacturing company in Crawley took me to task for suggesting that the economic outlook had stabilised. He said the only thing that's happened is that the "second derivative has turned positive".

Now for the non-engineers, -mathematicians and -economists, that translates to 'the pace of contraction is slowing' or in plain english 'things are still getting worse, but we ain't in freefall anymore'.

Well, now Free Exchange is poking fun of an FT article that says "Eurozone recovery loses momentum":

"Now recovery, in this case, must be taken to mean a declining rate of contraction, since the European economy has not yet begun expanding outright. This therefore means that the FT is warning us about the rate of change of the rate of change of the rate of change of output. The European economy is contracting, and it's contracting more slowly than it was, but the slowing rate of decline is experiencing a deceleration, or something.

They might have just said that the bottom is not quite as close as some had recently hoped, no?"

In geek speak, that means the third (or maybe even the fourth) derivative is negative.

To you and me, it just means the recession has further to run.

The UK's defence industry is on shaky ground.

While long-lead times provided the industry with a buffer against the worst of the recession, the dire state of public finances and the cost of financing two, now one, war has left few new equipment orders (outside of bullets and aircraft carriers, that is).

And the future for the industry is looking bleaker. Some sort of defence review is imminent. Lord Drayson, recently reshuffled back to defence procurement, has even been tweeting about "strategic acquisition reform in defence". But any decision on defence spending needs to be part of a broader strategic security review.

One defence chief told me that MoD orders and R&D spending serve as the foundation for credibility in export markets. If its good enough for the British army, then its good enough for anybody in the world, even the US.

The Eurofighter Typhoon is case in point. Back in May, the government committed to another round of Eurofighters has given the jet a leg-up in international markets. And these markets are hotting up.

As The Times puts it:

"Defence companies are preparing for the biggest surge in orders for fighter jets since the Cold War, with nearly $100 billion (£61 billion) of business thought to be up for grabs — but the stakes are higher than ever for those manufacturers chasing the contracts.

The winners of big orders will gain entry to new markets and guarantee multibillion-dollar revenue streams for decades; the losers may be forced out of the fighter market altogether because the cost of developing new aircraft has risen so high that they might not be able to challenge in future.

BAE Systems, Europe’s largest defence company, is one of the best-placed. It is part of the consortium building the Eurofighter Typhoon, a leading contender in many of the competitions."

Because of MoD's commitment to the Eurofighter, it's in line to win lucrative contracts in India and Brazil. Meanwhile, jets like the Russian MiG, the French Rafale and the Swedish Grippen are in danger of being relegated to second-class status. Even the future for Boeing's F15 and F18 is uncertain as the US prefers the Lockheed Martin F35 and the Eurofighter.

So while cuts in the defence budget are likely, they need to be strategic, taking in to account our broader security needs as well as our long-term economic competitiveness.

Quick and dirty cuts may save money, but will only push the industry out of the UK.

There's a debate raging between economists, regulators and commentators about the nature and purpose of regulation after the recession ends.

A key issue right now is about companies that are 'too big to fail'.

What are the arguments?

One side suggests that if big businesses like AIG, GM and the banks are too big to let fail because of the wider consequences to the economy, we should have smaller companies.

Not suprisingly, many think this is an oversimplistic arguement. Two issues come to mind. Firstly, size does not necessarily correlate to systemic risk to the economy (AIG failing and pulling the whole financial sector - and eventually the economy - down with it). Secondly, if a big company is about to fail and poses risks to the economy, shouldn't we come up with better ways to let them fail while preventing the shockwaves from tearing down the economy.

Free Exchange sums it up perfectly:

"It's hardly ever the market capitalisation of a firm that makes it dangerous; it's how leveraged the firm has become, or how interconnected it is with other financial institutions. Targeting size will reduce some of the benefits from scale in banks while leaving smaller but dangerous firms free to go on destabilising financial systems.

It's also curious that upon determining that too-big-to-fail is a problem many observers conclude that firms need to be shrunk, rather than concluding that big firms need to be better at failing. If attempts to control the size of firms are likely to prove ineffective and excessively costly, then why not develop measures to improve the procedures for failure of systemically-important institutions?

Firms are going to get themselves and financial systems in trouble, no matter what rules are adopted; of that we can be sure. Best then to build a resilient and flexible regulatory regime that attempts to make players pay for the unavoidable presence of a government backstop."

'Too big to fail is too big to exist' is a fantastic soundbite, but its also an overly simplistic proclamation on the cause of the current crisis. We need to be smarter than that.

We need better, more effective regulation that prevents future crises without sacrificing growth in the process.

If you're looking for insights on the state of the Chinese economy, look no further than Brad Setser's Follow the Money blog.

His most recent post on China looks at the good and bad news on China's economy.

The good news?

The Chinese economy is growing (government spending will account for 6 percentage points of the 7.2% forecast growth) and its economy is rebalancing (China needs less savings and more domestic consumption).

The bad news?

It's not clear whether or not this growth is sustainable. Imports are picking up, but rather than feeding demand for capital goods (which would benefit UK manufacturers), the Chinese are simply stocking up on relatively cheap commodities. That means China's growth isn't necessarily driving a global turnaround.

It's hard going trying to pick through the mass (and morass) of economic commentators and data for any clear signs on where the economy is headed.

Two handy signs of economic activity are demand for boxes (for shipping things) and freight traffic (for shipping bigger things!).

Today, the FT has a story on the fall in demand for rail freight. While analysts suggest the data show the economy is still struggling, the data reflect rail freight traffic in the first quarter. We already know that this was the worst part of the recession - the destocking phase in which there was little international trade.

Unfortunately, we can't draw conclusions about current activity. But look to any future stats on boxes or freight traffic to tell confirm if the economy is moving again.

This week:

For more info check out our weekly Economic Update.

EEF's latest Pay Bulletin adds to the mixed news on the economy Jeegar talked about earlier.

Our results show earnings growth in manufacturing continued to slow in the three months to May, falling to a new record low of 0.8% from 1%.

Manufacturers continue to do their utmost to hold on to skilled workers as around two-thirds of all settlements were pay freezes.

David Yeandle, EEF's Head of Employment Policy, said:-

"These latest figures demonstrate not just the severity of the downturn since last autumn but the serious efforts that companies have taken to control their costs. Compared to previous recessions this period has also been marked by employees and their representatives working positively with employers to manage pay as a way of helping maintain employment levels."

EEF members can log in to read the full report.

That's what we're likely to get from the data in the coming months, mixed signs of the state of the economy. One day the recovery will be around the corner, the next it will have suffered a setback. 

And what does that mean about the underlying health of the economy?

Nothing profound, but that we're simply in a recession with so many economic forces pulling the economy in different directions, that finding a single driving trend will be difficult.

So after last week's good news on the economy (stabilising business surveys and house prices), this week brings a fall in retail sales, less credit for businesses and households and industrial trends stagnating yet again.

The most worrying news, however, comes from oil prices - which are on the up - and earnings - which are still falling. The tension between the two suggests that consumer spending could fall further, weighing on any recovery. And that's despite the money being pumped in to the economy by the Bank of England.

And the outlook abroad isn't much better. Industrial production continued to slump in the US and China's growth looks to be driven by stockpiling rather than a geniune turnaround.

So we're back where we started: more mixed news on the economy.

The only real conclusion is that a sustained recovery hasn't taken root.

The Government lanuched its 'Digital Britain' report, a communications blueprint of sorts for the nation.

What's in it for business? Cloud computing.

One MD I spoke with 2 weeks ago said he cut his IT overheads by 30% by using an online supply chain management tool. So rather than have costly software, computers and servers (with all the costly consultants to get it up and running), this company went online. It's the same difference between having Microsoft Word installed on your computer or using GoogleDocs online. You can access your information from anywhere in the world. Cloud computing boosts productivity and cuts costs.

So what does Digital Britain offer by way of the broadband network needed to support cloud computing? Not much.

The report made a commitment to roll out a Universal Service of 2Mbps by 2012.

Really? That's the best the government could hope for?

Singapore set out a 10-year strategy in 2005 to improve broadband speeds and access. It now has 99% penetration and speeds of 100Mbps. Likewise, two-thirds of all Japanese households have access with average speeds of 90Mbps.

Broadband speeds tend to double every 20 months. So by the time we have universal 2Mbps in 2012, top speeds in the UK could be around 160-200Mpbs, and the equivalent of 300-400Mbps elsewhere in the world.

Will Britain really be the 'digital capital of the world' as the Prime Minister suggested yesterday?

Not with our paltry ambitions.

And businesses, competeting globally and looking online to cut costs and boost productivity, could eventually see Britain as a digital backwater.