EEF blog

Data released this morning showed that consumer price inflation was stable at 2.8% in the 12 months to March.

Although this was in line with what forecasters expected to see, it is some way above the level of inflation forecast even at the beginning of this year. In January, we forecast that inflation would come in at about 2.5% in the three months to March. In January 2012, we thought inflation would be at 1.7% by now.

One of the key reasons inflation has been higher than expected is the unforseen depreciation of sterling that we’ve seen since the start of the year. As I laid out in a blog back in January, a weaker sterling means more expensive imports, and is therefore likely to add a few percentage points to inflation.

Some of the other reasons inflation in 2013 may well be higher than previously expected include:

• an unexpectedly large increase in petrol prices at the start of the year, caused by a combination of higher crude oil prices and a weaker pound
• higher domestic energy prices that have been announced in the past few months
• changes to the MPC's remit that increase the chance of QE and could therefore intensify downward pressure on sterling

For now, our forecasts suggest that inflation will fall back to the Bank of England’s target of 2.0% in late 2013/early 2014, but as the constant upward revisions to inflation forecasts have shown – and as Macmillan may or may not have said – that rather depends on 'events, dear boy, events'.

The need for a more strategic, less political, approach to major infrastructure decisions is gaining support.  Sir John Armitt is carrying out a review of the issue for the Opposition whilst the Government has announced that it is looking into making more use of independent expertise in shaping infrastructure policy. 

Those calling for a new approach point to a long track record of damaging prevarication and policy reversals on issues like airport capacity and nuclear power. That the UK too often tends to ‘muddle through’ rather than invest strategically and consistently for the long-term. EEF is in that camp.

From a manufacturing perspective, quality infrastructure in areas like transport, energy and communications underpins the ability to do business and compete in an increasingly globalised world. It enables firms to source raw materials and components, fuel industrial processes, get products to market and internationalise their operations.

At the heart of the problem is the ability to make and stick to decisions on long-term issues. For a number of years, the UK has repeatedly struggled to forge and sustain a political consensus on issues like airport capacity or investing in our roads. EEF believes an independent infrastructure commission, along the lines being considered by the Armitt Review, could help overcome this issue.

Such a body could institutionalise the benefits of independent analysis and an apolitical perspective that commissions can bring to bear on complex and long-term issues. The Turner Commission, for example, has helped forge a political consensus on pensions’ policy. However, for such a body to be acceptable and effective, two key criteria would need to be met.

First, the new body would need to be strictly advisory, with decisions remaining firmly with politicians. Major infrastructure decisions often involve getting the balance right between competing objectives, such as trade-offs between economic and environmental considerations.  A lack of legitimacy would hinder rather than help build and sustain a stable approach to controversial issues.   

Second, the commission would have to have the right of initiative. It would be hamstrung from tackling politically controversial but pressing issues were it only able to deliver advice at the request of government on an agenda set by the government. To be effective, it would need the power to initiate inquiries into subjects of its own choosing at a time of its own choosing.

This week the focus is on Pharmaceuticals. The sector includes the manufacture of medicines, vitamins, drugs for veterinary use, vaccines and diagnostic preparations.

About the sector  

• In 2012 the pharmaceuticals sector contributed around £9.7 billion of output to the UK economy.
• Pharmaceuticals make up 9% of UK manufacturing. 
• The sector employs around 45000 people, who work in over 450 firms. 
• Pharmaceuticals is the second most export intensive manufacturing sector with half of output exported. 
• The sector is R&D intensive accounting for almost 40% of total R&D investment in manufacturing and around 10% of global R&D.

The UK pharmaceuticals sector is an important global player. Of the top 50 global pharma companies 37 have sites in the UK. These companies account for around 90% of the turnover in the industry. The UK is regarded as a world leader in small molecule pharmaceuticals.  Over the past decade or so the UK has developed around a fifth of the top 75 leading global medicines, second only to the US.

Overseas markets are important to the pharmaceuticals sector and over the past decade export growth to non-EU markets has slightly outpaced that to the EU. In recent years export growth has been particularly strong to markets in the Middle East, Eastern Europe and South America.

Pharmaceuticals and manufacturing output 2000=100

Source: ONS

Past, present and future trends 

Over much of the past decade growth in the pharmaceutical sector has out-performed wider manufacturing with annual growth averaging over 5% between 2000 and 2009. However, the sector as recorded declining output over the past three years; in contrast to other parts of manufacturing this contraction is a result of structure changes in the industry rather than a consequence of the economic downturn. Increasing competition from generic drugs as patents expire, regulatory changes and decisions to invest in faster-growing emerging markets have all hit growth and these factors will continue to influence medium-term prospects.

The global market for prescription and over-the-counter (OTC) drugs will continue to grow in the next three years, reaching an estimated value of $1.2 trillion in 2016. Expansion in emerging markets is expected to be particularly brisk.

Policy changes in the UK, such as the Patent Box should continue to make the UK attractive for research-intensive pharmaceuticals companies and some have committed to continued investment in the UK on the back of such annoucements. However, the sector will need to adapt and respond to a number of key challenges. These include; changes in pricing - including in the UK - for pharmaceutical products; increased demand for customised products and growing supply chain complexity and a rising burden of disease combined with declining government healthcare budgets.

In the short term we are forecasting another year of declining output in the pharmaceuticals sector in 2013 followed by modest growth in subsequent years. 

Last week Citi published a briefing entitled “Why is investment so weak?” and goes through some of the facts and figures underlying the current underperforming investment picture. A few of the points made relate back to our own report and survey on the subject, Invest for Growth, published back at the beginning of March.

The Citi briefing makes a clear point that the tax landscape is not encouraging companies to invest, with the cutbacks to capital allowances in previous budgets and, despite the continual cutting of the UK’s headline corporation rate, the effective marginal tax rate has not fallen. I know this is something close to the heart of my colleague Andrew Johnson, and he blogged about this in November last year, ahead of the Autumn Statement.

Our own survey showed that out of all the tax system policy levers the government could pull, 28% of companies said that higher capital allowances would have the biggest positive impact on their investment in the UK. This was particularly important for small and medium sized firms. The recent increase in the Annual Investment Allowance is a move in the right direction yet internationally the tax environment continues to change as countries seek to improve the efficiency of their tax system, and the UK needs to ensure it remains competitive and predictable in the long-term. An EEF member, Stuart Fell, told us about his view as an SME in a guest blog at the end of 2012.

34% of manufacturers said a change to the tax system would have the biggest positive impact on investment in the UK

60% said a change to the tax system was among the top three changes that would positively impact investment in the UK

The Citi briefing also looks at investment intentions and makes the point it is often hard to distinguish whether these investment objectives are planned in the UK or overseas. Of the manufacturers we surveyed, over two-fifths have some production overseas, up from one-third in 2009. Our survey also showed that decisions on where to locate investment can be finely balanced and will be influenced by a range of factors relating to the business environment and what the business is trying to achieve. We asked companies about the balance of investment in the UK compared with overseas.

The data showed an overall shift in preference towards more overseas investment in the next three years compared to the last three years. Of those manufacturers with some of their production located overseas: 

• Around 80% had made some investment overseas in the past three years and a similar proportion is planning overseas investment in the next three years.
• One third said they invested more overseas than in the UK in the past three years and this is expected to slightly decrease in the next three years, with 30% planning to invest relatively more overseas in the next three years.
• Looking to the UK’s investment position in the next three years, fewer companies are planning to invest more in the UK than overseas compared to the past three years. And the proportion of companies investing only in the UK will remain approximately the same at 20%.

Investment overseas is not restricted to companies with operations abroad; some companies with no production outside the UK are also looking at overseas investment opportunities. Some 15% are looking to invest overseas in the next three years for the first time. Of these companies, almost half are planning to invest more overseas than in the UK which is not surprising as a first foreign investment is likely to be a significant undertaking.

 The Citi paper also makes the point that “the relative cost of capital has risen, in contrast to the pre-crisis trend, encouraging firms to expand via jobs rather than investment”. Making new investment in capital equipment is critical to manufacturers achieving their objectives and staying ahead of the competition. Half of companies in our survey report increasing their investment on capital equipment in the past three years, a reasonably consistent picture across all sizes of company, and just over a tenth report decreasing investment.

Looking ahead, manufacturers are also, on balance, planning to increase investment in capital equipment over the next three years; 45% of companies expect investment to increase with one in ten planning to scale it back. This pattern is again consistent across all sizes of company but firms in the transport and machinery sectors are most upbeat about future investment plans.

At the beginning of this month, the Government published a new skills strategy, Rigour and Responsiveness in Skills.

At EEF we like a strategy (as long as it is clear, concise and benefits manufacturers). We published our own strategy in our Route to Growth campaign, where we called for an Industrial Strategy that resulted in a stronger, better-balanced economy.  Within our strategy skills plays a leading role.

Unlike others, we praised the publication of this new Government strategy. We went against some critics who argued that it provided nothing new, but isn’t that what we have long been calling for – consistency?

If Government had published a strategy that was completely off-track from the Richard Review, Wolf Report and work by the UKCES on Employer Ownership, then yes we would be the first to criticise, but for me it takes the key ideas from the good work that has been done and provides a roadmap for the skills system in the near future.

Manufacturers have long called for a responsive skills system that puts the employer (and the learner) in the driving seat.

Our Skills for Growth report clearly demonstrated the current failings in the skills market, much of which stems from a lack of rigour and responsiveness – the fundamental elements of this new strategy.

So what is Government committing to and how will it benefit manufacturers?

First up is a stronger focus on raising standards – recognising those good quality FE colleges and providers and cracking down on those that deliver poor provision. Only one in five manufacturers finds it easier to find a responsive training provider now than two years ago (pretty low considering the hike in the number of providers in recent years).

If we are to curb the growing number of ‘inadequate’ providers and signpost employers to the ‘outstanding’ ones, we need to give employers accessible and accurate information on the quality of provision. 

Perhaps unbeknown to many young people, UCAS offers a service called Progress that allows pre-16 and post-16 year olds to find courses and providers in a selected area that meets their needs. Why not take this one step further and adopt the ‘trip-advisor- approach to providers that allows users to rate their value?

This then relates to the objective to use funding to improve responsiveness. The Employer Ownership Pilots have clearly demonstrated that employers are willing to step up and take ownership; investing above and beyond the public money they have been allocated. Let’s now focus on how SMEs can be more involved in these Pilots, and not forgetting our preference for Apprenticeship funding to be routed directly to the employer.

We need to ensure that qualifications are relevant and recognised by industry.

Our own stats revealed only one in five companies find vocational qualifications more relevant now than two years ago. Government is beginning to crack down on this, with a commitment to ensure only the best, quality qualifications remain. The success of University Technical Colleges demonstrates how employer involvement can be of real benefit so a commitment to focus on those qualifications with strong employer input is welcomed.

Next up - Traineeships - which will offer a combination of work preparation, high quality work placement and training in English and maths. With the focus now on Apprenticeships at Level 3 and above (an ambition we welcome and have called for), there will be a gap in the market. If Government works with employers on the design and the development of Traineeships, this model could provide the springboard many young people - who haven’t quite reached the attainment levels required by employers - need to enter onto an Apprenticeship, into HE or full-time employment.

And finally, my favourite subject - Apprenticeships....

Two-thirds of EEF members offer Apprenticeships

....a commitment to reform Apprenticeships to ensure that quantity is matched by quality. Standards must be set by employers and an Apprentice’s competence must not be judged in a ‘tick-box’ manner but looking at what they can do at the end of the training - which should essentially be the job.

 75% of EEF members said ALL their apprentices were given permanent roles upon completion of the training).

It may not be perfect but this strategy is a positive step forward. Government must not lose momentum however and we will be pushing for swift implementation.

Data released by ONS today showed that manufacturing grew in February despite difficult demand conditions in export markets. Industrial production figures were also up, which probably takes the UK away from the knife-edge of a triple dip.

Key data:
- Output in manufacturing grew 0.8% in February
- The largest upward contributions to growth came from mechanical equipment; transport equipment; and basic metals & metal products
- Sectors faring worse were electronics; food & drink; and pharmaceuticals
- The trade deficit worsened as exports fell and imports rose
- Exports to EU countries increased 0.6%
- Exports to non-EU countries fell 4.7% driven by a fall in exports to the US

Manufacturing grew by 0.8% in February but this was on the back of a fall in output of 1.9% in January, which was worse than previously thought. Manufacturing would now have to grow 1.6% in March to avoid a contraction in output in the first quarter. This level of growth would not be unprecedented, as monthly figures are highly volatile, and there was growth of 1.6% as recently as December.

Monthly growth figures can be highly volatile
(month on month %change in manufacturing output)

Looking back over the past few months, the economic picture has been relatively weak, but this was to be expected, particularly given the malaise we have seen in a number of key markets, particularly Europe.

Therefore, what was perhaps surprising in today’s stats was the relative strength of goods exports to EU markets, which grew 0.6% in February, compared with goods exports to non-EU countries which fell 4.7% in February (though largely driven by the US sequester). But looking over the less volatile three-month period, this is reversed.  Goods exports to the EU fell 2.2% and goods exports to non-EU countries have actually increased 2.6%.

Indeed, despite difficult economic conditions, manufacturers have increased sales to non-EU markets in the past couple of years; in the third quarter of 2012, goods exports to non-EU countries hit a record high. And looking ahead to the next three months our Business Trends survey shows that companies expect export orders to improve.

So, while the weakness in Europe seems unlikely to abate any time soon, markets outside of the EU are faring better.  It’s too soon to write off manufacturing’s contribution to a better balanced economy.

Last week we published the findings of our first major survey on transport issues. There was a clear message from manufacturers on aviation policy. Air links underpin export-led growth, but the UK’s infrastructure needs investment to remain attractive to exporters.

The international connectivity provided by air links is vital to exports and manufacturing accounts for half of UK exports. Outward-looking manufacturers place a premium on quality aviation infrastructure. The majority of manufacturers for whom exports account for more than half of turnover say that aviation infrastructure is critical to their business. It’s easy to understand why.

First, air freight carries 40% of the UK’s exports of goods and commodities by value. It is particularly important for high-value, low weight, products in growth markets such as optical, electronic and medical equipment. 

Second, our survey provides clear evidence that the more a manufacturing business exports, the more important aviation infrastructure is to growth-related activities like identifying new business opportunities, deciding where to invest and building relationships with customers.

We need to give these export-intensive businesses every reason to locate and expand in the UK. And world-class air links is a key consideration for them. Unfortunately, the current state of the UK’s aviation infrastructure is acting as a barrier to their operations and growth plans.

Three-quarters view it as an impediment to building and sustaining relationships with customers, whilst more than half believe it gets in the way of managing their supply chains and moving their products. Crucially, more than a third see it as a barrier to investing in the UK.

So it is vital that the Airports Commission, the independent body established to look at the UK’s capacity needs, takes full account of the importance of aviation to the UK’s long-term growth prospects and the government’s target to double the nation’s exports to £1tn by 2020.

EEF will be making the case loud and clear.

Some facts 

• In 2012 the Electronics sector contributed around £8.2 billion of output to the UK economy.
• Electronics makes up almost 6% of UK manufacturing. 
• The sector employs around 138 thousand people, who work in over 6000 thousand electronics firms. 
• Manufacturing companies in the UK electronics sector range from small contract manufacturers to full scale semiconductor production.

Last month Labour's An Enterprising Nation, the report of their Small Business Taskforce, reported last month and included interesting proposals for how to reinvigorate our banking system to the benefit of SMEs. This a theme close to our hearts being the main subject of EEF's Finance for Growth report last November.

Labour appears to have accepted the banking proposals, which broadly is to pilot a network of local banks to lend to SMEs, 'Sparks', under an overarching wholesale institution, the 'Spark Umbrella', that would raise money on debt markets to finance their operations. The Sparks would be initially capitalised by public money, focused on particular geographical areas, and accountable to local stakeholders such as local authorities, LEPs, and business organisations. The geographical focus potentially makes sense as although competition in UK SME banking generally is a problem in some areas it is particularly acute.

There's a lot to like in the proposals, especially the following points:

The identification that 'we need a far more diverse small business banking services sector to give our small businesses access to the best financial services in the world.' This is something we have raised repeatedly - SMEs have too few options on the High Street and too few beyond it.

'...there is a lack of pluralistic competition [in UK SME banking]. With the big banks dominating the market there is little pressure on any of them to improve availability, lower prices or improve service.' It may seem an obvious point but it is worth spelling out again given all the competing rationales circulating for the government's 'business bank' - a lack of competition holds down credit availability, keeps prices higher than they otherwise would be, and leads to poor service.

Sparks would aim to make a profit. We don't need a state-created institute as a 'lender of last resort', lending to companies that have little chance of paying back a loan. The whole analysis of the supply side of the UK SME banking system is that profitable opportunities are going unfunded - this is holding back growth.

The retail presence of Sparks in local communities is also essential. The front end of our banking system is broken - changing the retail landscape must be part of the solution.

At the high level then I think these proposals are definitely on the right track - the focus on diversity and competition, the change in the front end of banking, and the commercial focus of interventions.

Some of the detailed points of the proposals are a little more questionable. For example I'm not sure the analysis of the PSNB impact of the Spark Umbrella's borrowings is correct. With government supplying all the equity, I think the NAO would view these entities as being part of the public sector, even if they were operated at armslength. Reducing this shareholding below 50% could be a way around this...

There are also questions about whether the Sparks would be enabled to take deposits off their SME customers. By not taking deposits the Sparks may be able to get around some of the regulations governing banks that can be onerous for new competitors but crucially, by not offering current accounts the Sparks would be missing the key channel by which SMEs then apply for other types of bank finance. Firing up the SME current account market is absolutely essential.

As well as the Sparks idea this report also includes good ideas for boosting dynamism in the market more generally, including by supporting the creation of challenger banks, introducing risk-based capital requirements to match the different business models new lenders might pursue, and legislating for comprehensive bank data portability. This last is crucial as it is a major barrier to firms switching banks - with showing a new bank your banking history time-consuming and often only partial - and a lack of switching discourages new entrants.

To be fair to the government, it is pushing action in some of these areas already for example through the introduction of the seven day redirection service to give companies more confidence bills won't fall through the cracks if they switch banks.

But the competitive environment and the pace of switching needs more attention. Currently only around 8% of SMEs switch banks each year despite much wider dissatisfaction. The government should draw all ideas for creating a more competitive environment (separate from structural changes a la the Business Bank) into a focused review aimed at generating more competition. 

Yesterday's manufacturing PMI continued the run of disappointing industrial data for the first quarter. The average indicator for the first three months comes in at 48.9 - below the 50, no change mark, and a touch weaker than the average across 2012q4. The survey for March pointed to sluggish export demand (pretty much in line with EEF's Q1 Business Trends Survey) remaining a source of weakness, indicating that rebalancing growth towards more trade and investment remains an uphill challenge.

There was a similar theme across other PMIs.

Manufacturing PMI 50= no change

Source: Markit Economics and ISM 

With the exception of a decent February in Germany, manufacturing activity across the eurozone has remained fairly depressed since the start of the year. In March, surveys showed that output declined across all participating countries and inflows of new business remained weak. In France and Italy, the manufacturing PMI has been showing contraction for 13 and 20 consecutive months respectively. The continued run of downbeat data from the region, still the UK's biggest market, is part of the reason why activity indicators have disappointed at home.

The US has, however, been a source of better news. Manufacturing activity has been in positive territory since last September, although the headline number softened a little in March, this was mainly due to an easing in growth in domestic orders.   

And in China the news was better but not brilliant. The manufacturing PMI recovered - with production, orders and exports all up on the month - following the New-Year related dip in February. However the pick-up was somewhat weaker than expected, leading to a verdict of steady growth rather than acceleration.

Global manufacturing activity has therefore remained pretty subdued on the first quarter of the year and the UK is facing many of the same demand and competition challenges as much of the rest of the world.  EEF's last manufacturing survey pointed to expectations that the demand outlook would begin to improve in the second quarter of this year, with strong positive balances of companies planning for increased output and export orders (see chart).

Global events in recent weeks have placed a few more bumps on the road for global manufacturing. Firstly crisis hit Cypriot banks and the will they/won't they bail out saga marked another confidence sapping event in the eurozone, even if any direct impact on the wider eurozone economy would be relatively minor. Secondly, the US will see spending cuts kicking in through this year which will take some of the gloss off the more positive data readings on employment and the housing market over the past few quarters.

We still expect the UK manufacturing outlook to pick up though 2013, but risks to the outlook have returned.   

EEF Business Trends Survey - % balance of change