EEF blog

A headline in the Daily Telegraph this morning read “UK slides in manufacturing rankings”. This was on the back of a survey from Deloitte which measured businesses’ perceptions of competitiveness drivers like wages, skills levels and the policy environment.

Deloitte ranked the UK in 17th place out of 26 countries, falling to 20th place in the next five years.

Whilst this suggests that perceptions of the UK’s business environment are not ideal, it does not indicate that the UK’s manufacturing businesses are not competitive; far from it. The fact that the UK remains one of the world’s largest manufacturing nations is testament to our businesses’ abilities to compete and innovate despite the pressures of a high-wage, high-cost economy.

True, the UK is ranked well below the US (in 4th position) and Germany (in 8th), countries which also experience similar high costs. But this is not something that reflects badly on our businesses. Rather, it suggests more needs to be done to enhance the UK (in reality and in perception) as a place to do business, such as: enhancing skills provision; promoting investment through the tax system; and reducing the regulatory burden on business. 

EEF's take on the Emergency Budget was simple: job well done on deficit reduction, but there needed to be more about longer-term growth and rebalancing.

Echoing EEF's comment piece in the Telegraph before the Budget, a piece in the FT by Mohamed El-Erian, the Chief Executive of PIMCO, one of the leading global investment management firms, writes about the false debate between growth versus austerity:

"The majority of industrial countries need to adopt both fiscal adjustment and higher growth as twin policy objectives....Squaring the circle of growth and fiscl stability needs policies that focus on long-term productivity gains...[with a] new emphasis on infrastructure and technology investment."

Given the need to complement austerity with growth, EEF's key concerns about the Budget hinged on a few key announcements: the government maintaining savage cuts to capital spending (around 1.5% of GDP) and cutting the level of capital allowances to 18% and lowering the Annual Investment Allowance to £25,000.

Deep cuts to capital spending limit long-term productivity and economic growth - it places a cap on future growth. The cut to capital allowances makes the investment needed to rebalane the economy more expensive.  

On Wednesday, the Institute of Fiscal Studies detailed analysis of the Emergency Budget echoed our view on capital allowances:

"Cutting capital allowances is not a good way to raise money [because] capital allowances are an efficient way to promote investment. The reform is not a simplification."

And a leader on the Budget in today's Economist notes that:

"...Mr Osborne should not have accepted inherited plans to trim capital spending by as much as 1.5% of GDP; a growing economy needs modern roads, railways and the like."

With the experts worried that the Budget didn't quite deliver the investment needed for growth and rebalancing, Martin Wolf writes about the implications for the government and the economy:

"The biggest economic point in the Budget is the need to rebalance the economy away from debt and government consumption. Moreover, the Office of Budget Responsibility believes this is likely to happen....A surge in fixed investment and net exports is forecast....the average contribution to growth of gross fixed capital formation and net exports was 0.5 percentage points and minus 0.3 percentage points, respetively between 2000 and 2008; these figures are expected to jump to 1.2 and 0.7 percentage points between 2011 and 2015."

Given the deep cuts to capital spending and the higher cost of investments, rebalancing is less likely. Wolf continues:

"The depressed level of investment, the low interest rates and the big fall in the real exchange rate make these shifts conceivable. But they are far from assured....[The Chancellor] assumes what is still to be proved: a rebalancing of the UK economy....Mr Osborne may believe this Budget was unavoidable. So, too are the risks the government now runs."

UPDATE: Krugman queries El-Erian's piece, asking what the policy recommendations are and invoking Keynes about all being dead in the long run.

El-Erian's point was not so much about specific policies (though his view does have specific policy implications, very much in line with our views on capital spending and investment allowances.) What El-Erian is trying to say is that growth and deficit reduction can and should be complementary aims, and that the current simplistic debate pits them as contrasting visions.

Combining El-Erian's subtle point with Wolf's critique is extremely relevant to the UK: once the public sector has been pared back and reformed, we cannot simply assume that the private sector will fill the void. We need to lay the foundation for future growth - through investment in infrastructure and new technologies - now.

There were no easy choices on deficit reduction and the Budget was never going to tick all our boxes - that's why we were supportive of the decisions the Chancellor made on deficit reduction, such as the VAT rise.

And rebalancing our economy will be an easier job with the deficit firmly under control. But now that we've had a Budget that made investment in growth more difficult, it's up to the other parts of government to support rebalancing. Whether that's a Green Investment Bank, support for bank lending or a carbon tax we can still move towards a better balanced economy through some strategic policy choices.

But it is important to remember that rebalacing isn't simply matter of preventing the public sector from crowding out the private sector - the public sector filled a void over the past decade because there was minimal private sector growth.

Sure the private sector will eventually drive growth and jobs outside of London and the South East, but only in the long run. But in the long run...well, lets just say its what comes before that matters.  

While the Chancellor faced and made plenty of tough decisions in his Budget, we worry that he didn't do enough to support growth. 

The coalition had certainly prepared the ground for the raft of tough measures this Budget would bring forward in order to get the public finances back into the black.  But the Chancellor not only needed a deficit reduction plan that was achievable, he needed to present one which supported longer term economic growth and investment.  

You can read EEF's Budget recap, but the numbers speak for themselves on the first objective.  Last week the Office for Budget Responsibility forecast an even larger structural deficit in the public finances that previously expected.  But significant cuts to welfare budgets, a new bank levy, cuts to investment allowances and an increase in VAT were among the measures announced today to help plug the gap. 

On the spending side, the government are sticking the savage cuts to capital budgets announced by the previous government.  And while individual department spending totals won’t be revealed until the Autumn, Ministers will be spending the Summer identifying cuts of around 25% of their budgets. 

Not all the revenue raised will be used to pay down the deficit as there were some giveaways for lower income households and pensioners and the Chancellor stuck with his pre-election pledge to cut the headline rate of corporation tax, choosing to do it over time rather than in one hit. Together the measures will bring public sector net borrowing down to 2% of GDP by the end of the parliament.  It was an aggressive deficit reduction plan, but one that looks to be deliverable.   

We are less convinced that the measures will also deliver the longer-term, better balanced growth the economy needs.  The Chancellor stated that business investment and exports need to make a greater contribution to growth, but the cuts to investment allowances are at odds with this.  The headline rate of corporation tax provides only one signal that the UK is open for business.  For smaller companies investing in modern machinery after April 2012, there will be cashflow consequences from the change that will hurt their ability to reinvest in their own competitiveness.   

Writing in today's Telegraph, EEF's Chief Executive Terry Scouler has called on the Chancellor to use his first Budget to make tough choices on deficit reduction, but also kick-start private sector investment in jobs, technology and growth.

Rather than rush for a draconian and unacheivable 80:20 split between spending cuts and tax rises, EEF believe that deficit reduction and growth can and should be complementary aims.

That's why we've been pushing for a 60:40 split, with a VAT rise minimising the need for savage cuts to captial spending and to capital allowances.

Capital spending is government funding of new roads, schools, hospitals and energy infrastructure - invest in any of these and you boost productivity and growth. Savage cuts to capital spending may be a politically easier target, but would inevitably fall most heavily on a small number of departments with responsibility for infrastructure and national security. This would have an immediate impact on businesses, including manufacturers, that count on Government as a major customer.

Capital allowances are how the tax system recognises the cost of investing in new machines and equipment. Cutting the level of capital allowances would make investing in the UK almost prohibitively expensive and force manufacturers to compete on labour cost, a battle they simply cannot win.

So we've opted for a 60:40 split with taxes on consumer spending (a VAT rise to 20%) to fill the hole in the public finances.

Unfortunately, the Chancellor appears wedded to higher spending cuts, as Stephanie Flanders blogged last week:

"Remember, too, that Mr Osborne and his advisers have always been much taken with the overwhelming historical evidence suggesting that raising taxes to cut large deficits can damage economic growth - whereas spending cuts do not. In fact, this same evidence suggests that cuts can even help, by supporting market and business confidence.

You may not endorse these arguments. There are those who say the research doesn't apply in this era of banking crisis and deeply fragile global demand. The point is that Mr Osborne does. And so does his team."

Like Osborne's advisors, we've done our homework too. But don't listen to us, just read a recent paper by Harvard economics professor Alberto Alesina on the right balance for fiscal adjustment:

"...evidence drawn from several episodes of fiscal adjustments in the late eighties and nineties (following the recessions and the large increase in public spending of the seventies and early eighties)...[shows ] spending cuts are much more effective than tax increases in stabilizing the debt and avoiding economic downturns....In the case of successful fiscal adjustments about 70 per cent of it came from spending cuts and in the case of expansionary almost 60 per cent."

The chart below shows the results of Alesina's research. On balance, a 60:40 split is likely to deliver deficit reduction and growth.

It’s hardly groundbreaking. Research conducted by EEF has revealed that many of the UK’s manufacturers think climate change policy is a burden on their business. You’d be forgiven to think its manufacturers whinging about extra costs and being forced to do something they’d rather not.  

Yet a serious, methodical review of the current climate change policy landscape shows that they have a point.  The effectiveness of policy must really be judged against four tests. It must create clear, reliable and transparent incentives. It must ensure regulation targets the right places. Regulation must be simple and not administratively burdensome. And it must take clear account of the impact on the competitiveness of those businesses subjected to regulation. Climate change policy currently fails on all of these points.  

Manufacturers are subjected to a confusing mix of regulatory sticks and incentives which are failing to address the unique challenges they face. Manufacturers are directly subject to the Climate Change Levy. Some will be regulated by the EU Emissions Trading Scheme (EU ETS) and/or have a Climate Change Agreement (CCA). Many now fall under the Carbon Reduction Commitment Energy Efficiency Scheme (CRC).  

The sum of all this policy? Confusion and mixed, muddied incentives. Policy overlaps are frequent and reporting requirements are not harmonised, creating immense complexity and administrative burden. This complexity serves only to confuse the very signals to change behaviour that policies were brought in to stimulate. In addition, policy is generally extremely blunt. It fails to take into account the work already achieved, the technological boundaries of manufacturing processes and the host of other barriers manufacturers face when trying to improve the energy efficiency of their operations. Perhaps most worryingly government has yet to really grasp the cumulative impact of all this policy on the competitiveness and profitability of manufacturers.  

In short, our analysis shows that the current direction of travel risks undermining a healthy and vibrant manufacturing base. These are serious concerns at a time when there is a growing recognition that a vibrant manufacturing sector will need to be a linchpin in a healthy British economy. While we recognise that government has its hand tied in addressing European legislation, we are challenging government to rethink the UK measures used to regulate manufacturers in this area.  

To start with, we believe that the government should reform the current energy tax – the Climate Change Levy (CCL) into a carbon based tax. A variable tax which was set according to the carbon content of fuels would begin to provide the right price signals to energy suppliers and energy consumers. It would provide a stronger incentive to energy users to reduce high-carbon energy and fuel use, use high-carbon fuels more efficiently and to provide electricity generators with a stronger incentive to invest in lower-carbon forms of energy.  

As a first step users of energy currently subject to the CCL should be taxed according to the carbon content of the fuels they use. But the medium-term goal should be to extend the carbon tax throughout the entire economy so all of society shoulders the cost of tackling the threat of climate change – not just industry and business. Government must set in train preparations for this as soon as possible.  

Any reform of energy taxation must be accompanied by voluntary negotiated agreements which provide tax relief for industry, like the current Climate Change Agreements (CCA). While CCAs are supported by manufacturers and have proven to deliver significant reductions in carbon dioxide, we believe that these agreements are ripe for further reform. Government must recognise that each manufacturing sector operates differently and that individual, tailored solutions may be required. We want to see government adopt an approach which uses the carrot of tax relief to encourage improvements in energy efficiency – but in the context of what individual manufacturers are rationally able to achieve. We also believe government can go further to use these agreements to streamline other, existing regulation. 

Competitiveness concerns must be taken more seriously. While government appears to be taking greater consideration of the competition implication of its decisions, it must go further and at greater speed. In particular, government must routinely consider the cumulative impacts of its policy on manufacturers’ ability to compete and remain profitable.    And, finally, we’d like to see a shake-up of the Carbon Trust. Too few manufacturers report that the advice and support that this body provides is hitting the spot. The Carbon Trust must move away from its too-often simplistic 1-2-1 intervention approach and concentrate instead on the common barriers faced by individual manufacturing sectors. Only by getting to the heart of manufacturing processes can the substantial cuts in carbon dioxide that government is seeking be made.  These are the messages EEF will be taking to government. It’s time for government to take manufacturers’ concerns more seriously.  

Ahead of next week’s crucial Budget, we try to indentify some of the key issues which are most likely to affect our members.

The PM said yesterday that the coalition government will,

“do what we can in the Budget to ensure that we have in this country a tax regime, support for apprenticeships and support for training that will want to make businesses locate, stay and invest in Britain."

This is encouraging news.

Whilst the budget will focus on the spending cuts and tax rises that will be needed to reduce the UK’s fiscal deficit, policy is required to support the business investment that will ultimately drive economic growth in the UK.

Business investment suffers heavily after a recession.

After the recession in the 1980s ended it took five quarters for levels of annual business investment to begin to grow again, and fourteen quarters for investment to return to pre-recession levels. After the 1990s recession ended it took ten quarters for business investment to make a sustained recovery.

Quarter on quarter change in GVA; and business investment in the 1990s

The size of public sector cuts to come mean that economic growth will only happen with private sector investment. The UK cannot afford to wait as long for investment to recover this time.

Germany, according to Dani Rodrik, an economics professor at Harvard.

His rationale is that if much of Europe needs to get their respective fiscal houses in order, then Germany's half of the bargain is to reduce its own imbalances by increasing domestic expenditure:

"But trying to redress budget deficits in the midst of a collapse in domestic demand makes problems worse, not better.

So Europe needs a short-term growth strategy to supplement its financial-support package and its plans for fiscal consolidation. The greatest obstacle to implementing such a strategy is the EU’s largest economy and its putative leader: Germany.

If Germany wants the rest of Europe to swallow the bitter pill of fiscal retrenchment, it...must pledge to boost domestic expenditures, reduce its external surplus, and accept an increase in the ECB’s inflation target. The sooner Germany fulfills its side of the bargain, the better it will be for everyone."

Hmmmmm...a growth strategy to supplement fiscal consolidation? Might be a few lessons in that for the new Coalition government.