EEF blog

During last night's leaders' debate on the economy, Brown and Cameron clashed on manufacturing investment and capital allowances.

Capital allowances are incredibly vital to manufacturers' competitiveness. They are how the tax system reflects the cost of investing in new machines. So while the staff costs count as an expense that immediately reduces the amount of tax a company pays, investment costs are only counted as an expense over 30 years.

On average, manufacturers replace their machines every 7-8 years, which means the tax system artificially adds to the cost of investing in machinery in the UK.

The Conservative Party is likely to reduce the level of capital allowances from 20% to 12.5% - which means the tax system will take 53 years to reflect the cost of modern machines.

On it's own this proposal would be extremely damaging to manufacturers' competitiveness. Consequently, EEF have been raising this issue with the Conservative Party for the past year, and have been working constructively to help them firstly understand the investment needs of modern manufacturers and secondly on how to modernise the tax system to match those needs.

And they have listened, acknowledging that many modern machines are only really productive for a few years before technology moves on. They have also committed to working with EEF to find ways of improving the tax system - by adopting our recommendations on the Short Life Asset regime - to reflect the real costs and shorter lives of modern machines.

EEF's proposals essentially say that modern machines have become like computers (in fact, most machines are powered by sophisticated computer systems): advances in technology makes them obsolete long before the machine stops working. So we've recommended that the tax system treats machines like it does computers, allowing manufacturers to write of the full cost of their invesments within eight years.

And because rebalancing our economy must remain a priority, EEF will continue to work with which ever party/parties that form the next government to ensure that the UK has a tax system that enables manufacturing and a balanced economy to flourish.

For background, here's each of the three parties views on investment and capital allowances:

Is the UK at risk of catching the economic virus plaguing Greece and threatening Spain, Portugal and Italy?

No, but...

The UK is likely to feel the affects.

At the start of the year, we warned that sovereign debt crises - the risk that a government can't repay its debts - was one of the key risks to the global economic recovery. Unfortunately for Portugal, Italy, Greece and Spain (the 'PIGS'), their economies are being threatened by significant debt and deficit problems.

Greece is clearly the worst hit, Spain is next in line and Portugal and Italy are hoping an IMF and EU led quarantine of Greece will help prevent contagion.

So what are the prospects for the UK?

A note by BNP Paribus (hat tip FT Alphaville) sums up the issue very nicely:

"The downgrade of Spain has put the focus on the UK.

The current UK election campaign has created a phoney fiscal debate where all parties have created the impression that fiscal consolidation might be possible without significant expenditure cuts or rising taxes. That will prove to be an illusion.

The fact that high fiscal debt and deficit levels are mirrored by an over leveraged private sector suggests that the UK simply cannot grow out of its high debt levels. External surpluses [i.e. more net exports] will be required, [suggesting] the exchange rate has to give in.

Today’s TV debate among the three party leaders will be closely watched and is viewed as the final chance for the Conservatives to turn the polls in their favour. Failure to do so will result in a sharply lower sterling."

So with EU economy - our main trading partner - clearly suffering, the pound is likely to come under further pressure. A weaker sterling will certainly help exports, but only if its a slow and steady reduction. Sharp falls in the value of the pound often go too far, raising slightly after the overshoot.

But with imported input costs already on the rise, and manufacturers arleady cautious about getting into markets because of economic uncertainty, further exchange rate volatility and rising input costs would certaintly temper the benefits of a lower pound.

And that's all the more reason for parties to come clean about their economic plans in tonight's debate and the last week of campaigning.

Public sector spending as % of GDP. Source: CEBR

One of the reasons EEF has constantly urged more detail on how parties intend to repair the public finances is because the how will determine where in the UK the cuts will hit the hardest.

Let's go back to the IFS report released yesterday.

It suggests that each of the three parties' plans would put public sector spending at around 40% of GDP by 2017-18. Currently, it's about 48% of GDP.

But a report out today by the Centre for Economic and Business Research suggests that there will be some pretty painful cuts across the regions for this to become a reality.

A look at the chart above shows the scale of cuts to be expected outside of London and the South East (which themselves probably won't be spared from cuts).

But we can see that within England, for example, public spending accounts for two-thirds of the North East economy, and over 50% in the North West and Y&H.

It begs the question: what happens to these economies when the public spending axe eventually falls?

If we know how the cuts will impact their economies, we can begin to think about how the private sector - including strong manufacturing companies in those regions - can begin to fill the void and prevent entrenched regional disparities from worsening.

A day after being slated by the IFS, the Darling, Cable and Osborne gave speeches on their economy policies and priorities.

Vince Cable was up first. With the Lib Dems rise in the polls, he's come in for some hard questioning recently, and their proposals focus on regulating the banks and personal tax issues.

Darling's was next and his speech focused on his experience as Chancellor - which an FT poll of City types labels as 'impressive' - and contrasting his record with what he calls the Tories "lack of judgement".

Despite being labelled as inexperienced by the City, Osborne is still the punters' favourite to become the next Chancellor - his focus is on regulating banks and corporate tax reforms. The challenge for Osborne is to ensure his tax proposols don't undermine manufacturing and a balanced economy.

What's EEF's view?

Like we said this morning - we need more from all the parties on their vision for the economy and how they intend to make it a reality.

Unfortunately, we've seen precious little detail to match the scale of the rhetoric coming from the parties.

Yesterday, the Institute of Fiscal Studies launched a detailed and scathing assesment the three main political parties plans for repairing the public finances.

The essential point of their criticism echoes what EEF have long been saying: the superficial debate on when to begin tightening is detracting from the more important debate on how you cut spending and raise taxes.

• The Tories have yet to account for £52.5bn in spending cuts and £3 billion in tax rises.
• Labour have to account for £45 billion cuts and £7bn in tax rises
• The Lib Dems have to account for just £34.4 bn in spending cuts - they're plans require no further tax rises.

The phoney war of words on the planned NICs rise is a storm in a tea-cup compared to the parties' vast unexplained plans to repair the public finances.

But the real story behind the IFS report relates to the tax challenge EEF set out a month ago.

Firstly, VAT is almost certainly going to go up.

But that's alright: VAT in the UK is lower than the EU average and is one of the least damaging tax rises possible.

Another issue close to manufacturers' competitiveness is on capital allowances and the Conservative Party proposals to reduce the level of capital allowances to 12.5% to pay for a 3p cut in the rate of corporation tax.

The IFS's verdict?

"...the Conservatives’ proposed changes to capital allowances would make corporation tax more complicated, not simpler.

If the package is revenue-neutral then on average there would be no change in firms’ overall tax burden. However, some firms would benefit and others would lose.

The losers would be firms that invested heavily but made little profit – notably in the manufacturing and transport sectors but also some capital-intensive service-sector firms.

The winners would be less capital-intensive but more profitable firms, historically typified by the financial sector.

...by reducing the generosity of capital allowances, the Conservatives would weaken the incentive for firms to invest in new equipment in the UK.

It is difficult to imagine that this is the most efficient way of financing a cut in corporation tax rates."

Back at the start of the year, we said the election was worrying the markets. That's no longer true.

It's the politicians that are worrying the markets.

While the politicians are increasingly talking about politics, the economy - and questions on how to repair the public finances and generate balanced growth - is simply forgotten as political posturing heats up in advance of a hung parliament.

While we have seen little in the way of detail about how the main parties would repair the public finances, we’ve seen even less on how they would rebalance our economy towards higher investment and increased net exports.

Coming out of the recession, there has been a lot of noise about the importance of manufacturing to our economy. But so far, the election has only focused on the public finances half of the economic equation. Economic growth and the role of manufacturing have unfortunately taken a back seat.

What our economy needs is an honest debate on the wisdom of ring-fencing spending budgets at the expense of economically damaging cuts in capital spending.

We should be talking about the details of fundamental tax reforms – including a VAT raise – that boost revenues and encourage capital investment and business growth.

And we need to see real details on how more productive government spending and targeted investment could boost manufacturing growth, even as we scale back the public sector.

The shift to a better, more balanced economy will require the next government to think and act differently. And with less than ten days left before the general election, the political parties need to refocus on rebalancing or risk repeating the follies of the past 30 years.

First quarter GDP numbers are out this morning, showing that dispite a frosty start to the New Year, the modest economic recovery remained on track.

At 0.2%, GDP growth in the first quarter was off the 0.4% consensus, but closer in line with our 0.3% forecast. We do believe, however, this first quarter estimate is likely to be revised up, if only slightly. Business surveys suggest decent levels of activity in March, but this upside will be tempered by weaker than expected levels of consumer spending.

What's clear though is that the economy needs clear decisions about how and when the next government will repair the public finances: this will determine whether or not the strong recovery and manufacturing will continue to drive balanced growth.

As the disruption from volcanic ash enters its sixth day we're starting to pick up some of the immediate and potential impacts this could have on UK manufacturers.  Inevitably the closure of airspace across large parts of Europe has left business people as well as holiday-makers stranded - EEF has produced some information for companies dealing with the consequences of this. 

But the effects are wider than this.  Our Manufacturing Advantage report showed that in the past couple of year around 30% of manufacturers had increased the number of overseas suppliers they use and more than half of companies said that customers are increasingly located overseas.  This has led to companies making some formal assessment of supply chain risk on average once a quarter.  Our survey also showed that manufacturers had identified strategic supply chain failure, logistics problems and supplier disruptions as potential risks to their global supply chains. 

While a large proportion of trade is by sea, road and rail, air freight is used for transporting samples, spares for maintenance contracts and some overseas orders - inbound and outbound.  Some disruptions to these activities have been reported and we may not know the full extent of the impact of this for some weeks.  At the moment companies that use air freight are seeking alternatives and extra storage for orders.  There are some concerns that letters of credit may need to be renegotiated.  Others have been impacted by international sales visits and attendance at overseas trade fairs being suspended.      

Some flights are now operating out of UK airports.  If normality returns to the skies shortly the economy wide impact of the disruption should be short lived, but seismic activity along the North American and Eurasian plates is proving difficult to forecast. 

UK exporters saw a return to better form in February.  National Statistics data show a rebound in sales meaning that the value of manufactured exports was up 6% in the past three months compared with a year ago.

'Rethinking growth - the building blocks of an export-led recovery' is our latest report and it shows that manufacturers have been making good inroads into export markets, leaving the UK better placed to take advantage of an upturn in the world economy.  But an export-led recovery won't necessarily happen on its own.  Exporting is a team game requiring ambition from manufacturers, a collaborative approach from banks to provide the finance and the right foreign exchange risk management tools and world class export support services. 

Manufacturers have expanded their global outlook - more than 90% are involved in export and over the past four years our survey notes further progress in in tapping into new and emerging market opportunities - especially in the Middle East and Asia.  Many manufacturers rely heavily on overseas markets with over 40% of companies deriving more than half their turnover from export sales.  And the increased diversity of export markets helped cushion the blow of the global downturn for some.

However, changes have had to be made in response to the changed economic environment and more than half of companies have re-thought their export strategy.  However, a number of hurdles could still stand in their way - particularly the uncertainty around exchange rates and volatility of Sterling. 

Despite this, the long term ambition for the vast majority of manufacturers (80%) is to continue to extend their reach into new export markets.  This is critical given that many of the UK's traditional markets in Europe are tackling many of the same problems as Britain and are likely to grow slowly.  We will only see a sustained export led recovery if manufacturers continue to diversify into emerging markets.  Achieving this depends on continued access to high quality export support services provided by UKTI to help sell the sector abroad.

The foundations for recovery are there, and if we are to rebalance the economy the next government must build on these and ensure the funding tap for essential trade support services is not turned off.

So the Labour Party has today been the first Party to launch its election manifesto.  As far as business issues are concerned, there were no great surprises and even some of the new ideas were heavily trailed in the press over the weekend.

One such proposal is a plan to extend Paternity Leave from its current two weeks paid leave, to four weeks leave (with the option for this to be used flexibly).  Labour also wants to legislate to extend the right to request flexible working to older workers.

Over the course of the election we are likely to see all of the political parties engaged in a race to the top on family-friendly and flexible working policies.
It is very difficult for business to raise concerns about the pace of change in this area, without being tagged as dinosaurs. And many employers do recognise the business benefits of these policies.  At the same time, however, it is the employer that usually has to cope with the corresponding costs and administrative burdens. 

Instead of always hitting business therefore, what we would really need is a wider debate about how society addresses work/life balance issues – perhaps through the tax system or care provision.   Whether or not this is recognised during this campaign remains to be seen.