EEF blog

Over the past 30-months, EEF have been campaigning for a more competitive and predictable business tax system, because for many manufacturers, the tax system is close to breaking.

The new government did its best to say to businesses in the June Budget that it was committed to creating a more competitive corporate tax regime. It's measures hit the target for big firms, but were wide of the mark for growing, capital intensive companies.

Part of the changes it wants to make are on tax policy making, essentially creating a more transparent, deliberative and consultative approach creating new tax legislation. And it is going to set out a detailed road map for future tax reform. Here the government should be applauded for restoring much needed predictability to the system. 

But despite the government's best intentions, tax is still on the boardroom agenda and isn't likely to go away anytime soon.

Why?

For large, mobile multinationals, both the business and personal tax regimes remain relatively uncompetitive, with too much uncertainty remaining over key reforms (e.g. to the taxation of foreign profits). Right now, businesses now when changes are likely to happen, but not what changes are planned.

The key test for the Treasury will be whether its road map for reform provides the enough details on which reforms it is planning and why to calm concerned manufacturers.

If not, we're likely to see a growing list of companies headed for the exit.

Last week we asked 'What is rebalancing anyway?'  We argued that it wasn't necessarily abour sectors or regions, but rather a balanced economy is one where there is a trade balance and a balance between investment and spending.

And so to the UK's recent trade performance.  The UK's trade balance hasn't been getting any better, even with a weaker exchange rate, disappointing expectations for a positive contribution to growth from net trade.  This is an issue we've debated in the past. 

What we've not highlighted is that what growth in exports there has been over the past year has come from manufacturing - exports of non-manufactured goods and services have declined in three out of the past four quarters (as shown in the chart below).  The relatively stronger export performance of manufacturing chimes with a range of survey indicators, all of which have had a strong export theme - including our own Manufacturing Outlook.   

Manufacturing makes up a shade under 50% of total UK exports, but so far in this recovery it's been doing a fair bit of the work on export growth.  So back to rebalancing - while it's not necessarily about different sectors of the economy, the foundations for manufacturing to play an important role in this process are certainly there.  And with the World Trade Organisation forecasting a bumper year for global trade, the opportunities should be there too. 

Export growth

The customer is king, right?

That's what I've learned from the many manufacturers I've talked to over the years. Focus on your existing and potential customers and let your business objectives flow from that.

If you're customers aren't happy - if you continually miss orders, raise prices or don't deliver on quality - they go elsewhere. Then you're in trouble.

The competitive pressure to gain and keep customers is the basis of growth, investment, innovation and jobs in capitalist economies.

One of the key customer relationships to breakdown during the recession - with tensions persisting in the recovery - is between banks and businesses.

So you'd hope that banks are working hard to restore those relationships, right?

Well, the rhetoric is there. In a KPMG report released recently - Creating a new mould for banking - we have a fantastic quote on trust on confidence:

"Banks’ reputations are arguably at their lowest ebb since the 1930s, and recovery is happening only slowly. 'The reputation of banks has fallen steadily through the crisis and continues to fall,' said one respondent. 'We expect a long process of rebuilding relationships and trust with customers. It will be a major focus. It will take four to five years to rebuild. The average [customer] doesn’t take much prodding to decide they don’t like their banks."

So you'd expect banks to change, to respond, to adapt to the threat of losing customers, right? That's how competitive markets work, right?

Well, further along in the report, the rhetoric on trust and customers falls a bit flat. When asked to set out what's driving changes to their business models, banks say that regaining customer trust just isn't that important. Instead, they are reactively changing in response to regulatory pressures.

Rebalancing our economy requires a strong, competitive financial services sector. But these responses are rather worrying: do banks understand the depth of feeling within business about banks; do they understand the competitive costs of the loss of customer trust?

As we thought, Cable's speech turned out to be less capitalism bashing and more of a statement on combating economic short-termism through competition.

There were some headline signals on where government policy might head, for example away from taxing profits and income and towards taxing land and property.

And sure there was spiv-bashing for the activists.

But while Cable had some very salient points to make about how greed tries to kill competion (remember, that's Adam Smith's first law of the market), he only touched on the solution: competition.

Sure we could regulate the banks to death, split them up and force them to keep excessive levels of capital. Elements of each of these are probably necessary to help make the UK's financial system more stable and secure.

But more imporantaly, we need to increase the flow of capital from financial markets to businesses and entrepreneurs.

Government can achieve this by improving transparency and competition in bank lending, encouraging alternatives to bank lending and simplifying its own support for finance. But at the same time, it is vital that any greater regulation of the finance sector does not spill over into industry generally.  

In our response to the government’s Green Paper - 'Financing a Private Sector Recovery', EEF has recommended a range of actions that the government should consider to improve relations between businesses and the banks, improve competition across the sector and improvements to existing government interventions.  

Key recommendations include:

• Improve transparency over the total cost of lending and lending criteria 
• Increase transparency on the criteria used to make lending decision, including the use of personal guarantees.  This should increase non-price competition in the sector and improve business/banking relationships.
• Consider tax incentives to encourage alternatives to bank lending
• To encourage other sources of lending aside from banks, government should consider extending tax incentives for small equity investments to debt also
• Combine government-backed equity funds into a single source of finance
• Grouping the various equity funds into a single place would help firms understand what is available in total from government. This could also improve investment decisions by concentrating funding more effectively e.g. by providing rounds of investment in particular companies rather than spreading funding very thinly by operating funds on a distributed basis.

Each of these recommendations are designed, in some way to improve competition and transparency in the finance system.

And that's what will help tackle the financial short-termism that caused a painfully deep recession and help prevent a protracted recovery.

Reading the papers this morning, it's easy to get distracted by the war of words brewing between the Business Secretary Vince Cable and the outgoing head of the CBI Richard Lambert.

The Business Secretary has launched a review into corporate governance and economic short-termism, attacking the worst of the excesses of the past decade:

"Short-termism and shareholder disengagement are an increasing problem for our economy. Short-term investors and financial gamblers value a quick buck above all else, for example, by driving company boards into accepting takeover bids that make no economic sense.  We need shareholders that act like long-term owners, alive to the risks of instability and the broader consequences of how the companies they own behave...Alongside ongoing work into the shape of regulation and narrative reporting, we aim to put responsible shareholders back in the driving seat of our economy."

Richard Lambert from the CBI - already at the Lib Dem conference chairing a fringe event - pushed back in this morning papers:

"It's odd that he thinks it sensible to use such emotional language...Mr Cable has harsh things to say about the capitalist system: it will be interesting to hear his ideas for an alternative."

And already the twit-o-sphere is linking Cable to every Marx from Karl to Groucho.

Well, the Business Secretary's could have chosen better words. By singling out 'corporate' excess, Mr Cable is intentially trying to tap in to a rich vein of public frustration with fat cat financiers.

But in doing so, he also casts a shadow over many legitimate businesses and sectors - such as manufacturing - that invest for the long-run. And he also runs the risk of any much needed regulation of short-termism in parts of financial markets spills over into the rest of the economy.

Yet casting Mr Cable as against the capitalist system and as a Marxist, is to willfully ignore everything we know about Mr Cable, who is a keen student of Adam Smith.

In the Wealth of Nations, Adam Smith sets out his laws of the market.

His first law of the market is self interest, or the profit motive. Ask the Business Secretary and I doubt he'll have any problem with this law.

But if the first law that motivates markets is essentially greed - Mr Cable's murky economic short-termism - what ensures that the economy isn't overwhelmed and ruined by profiteers?

It's Adam Smith's second law of the market: competition. This is the famous 'invisible hand' that allows markets to self-correct against greed as as firms compete on prices or wages. For Smtih, competition keeps greed in check and ensures the profit motive works for the benefit of society.

Look at Mr Cable's comments again in this light, and what he appears to be saying is that the second law wasn't working properly over the past decade and that this market failure needs to be corrected.

It also means that he's not attacking capitalism - he just wants it to work better. And it means that he's likely a better disciple of Adam Smith  than many calling him a Marxist.

Yesterday I argued that growth in manufacturing is not necessarily part of rebalancing.

However, I also said that what rebalancing requires is a more productive economy and an economy that invests more.

Funnily enough, in the last decade productivity in manufacturing has grown at nearly double the rate of the whole economy…

Figure 1: Productivity in manufacturing and the whole economy (Index: 2000=100)

And, manufacturing investment is now growing too. In the last quarter, investment by manufacturers grew by 8% while investment in the rest of the economy fell by 6%.

So although growth in manufacturing is not necessarily part of rebalancing, manufacturing certainly can be a major driver of a better balanced economy.

At the moment it seems you can't go a day without someone mentioning how important "rebalancing the economy" is. But what is rebalancing all about? 

It seems no-one is really sure:

Industrial rebalancing? (The Independent)

“A'rebalancing' of the economy away from a reliance on finance and the City”

Sectoral rebalancing? (Nick Clegg)

"We are trying to rebalance the economy so that parts of our economy are not over-reliant on the public sector."

Regional rebalancing? (The Guardian)

“rebalancing an economy that is overly dependent on London and the south-east”

In a pure economic sense, rebalancing is not really any of these things. Simply put, a balanced economy is one where there is a trade balance (external balance) and a balance between investment and spending (internal balance).

So how does this approach fit in with how the government's aim to “rebalance” towards manufacturing/the private sector/the regions?

Arguably more growth coming from manufacturing*; the private sector; and the regions would support the move towards a more balanced economy. But rebalancing isn't necessarily about a smaller finance industry, or a smaller pubilc sector. Ultimately, what rebalancing requires is a more productive economy and an economy that invests more.

*More on this (here)

Regulation is an essential part of a well-functioning society and can deliver major benefits.

However, where it is excessive, ill-conceived or poorly implemented, it can impose significant cost on individuals, businesses and the wider economy with little or no benefit.

Just over half of UK manufacturers see regulation as obstacle to growing their business. But desipite promiseses from successive governments to reduce the costs of regulation, only to see them rise year on year.

So if we're going to live up to the Chancellor's aim of making the UK economy saying ‘Open For Business’, then we need a bold new approach to regulation.

You should take a detailed look at the report, but in Reforming Regulation: Improving competitiveness, creating jobs, we argue that far-reaching reform is needed in two areas.

Firstly, we need a robust and transparent system of measuring and controlling the costs of regulation is essential. We need to make a substantial reduction to the regulatory costs faced by manufacturers and the first place to start is by understanding the burdens borne by business

Secondly, policymakers need to develop some fresh-thinking about they develop regulation. We need to break out of this stale cycle that sees new legislation and regulation introduced, simply for businesses to complain about the costs yet more cumbersome government bureacracy. We need to be more smarter about regulation - and alternatives to regulation.

There have been some positive early signs from the coalition on making a fresh start.

Now need to see decisive action that will turn these intentions into results that actually help business to deliver a re-balanced economy.