EEF blog

Alongside the Budget last week, the government published the Plan for Growth.

The Plan prioritises four key ambitions for the UK:  

• To create the most competitive tax system in the G20;
• To make the UK one of the best places to start, finance, and grow a business;
• Encourage investments and exports;
• Create a more educated, flexible workforce.

Furthermore, each of these ambitions is backed by ‘measurable benchmarks’. For example under tax a benchmark is to have the lowest corporate tax rate in the G7.

The coalition makes clear that the focus on growth begun with the Growth Review will continue over the whole parliament.

Now compare this with the recommendation in our Budget Submission where we called for a Growth Mandate, featuring:

• Prioritisation of four key areas;
• Measurable indicators of success;
• A parliament-long focus on growth.

That’s a pretty good correlation. But before we award the Chancellor and Business Secretary an A+ there are a couple of reasons to pause for thought.

We called for a Growth Mandate and we chose that name deliberately. We wanted the Growth Mandate to match the Fiscal Mandate with its clarity, predominance in the setting of the budget, and currency in the media.

It might seem a subtle point but by publishing the Plan for Growth as a separate 126 page document, co-authored by HMT and BIS, the government has risked the Plan succumbing to the fate of so many other such documents in the past.

In the past, such documents seemed to be de rigueur for a budget. Endless publishing of strategies seemed to overtake and blur each other, making the direction of travel less clear, not more.

Now, that’s not happened yet. But the challenge for the government is to give the Plan for Growth the necessary backing to give it ongoing relevance.

Secondly, we need to see real prioritisation. We suggested focusing on tax, finance, skills, and regulation – the top four concerns our members have with the UK business environment.

The Plan for Growth is a little patchy here. The tax and skills ambitions are good. But making the UK a great place to start, finance, and grow a business is a bit loose. It could potentially cover all manner of government actions to support growth.

And while there are multiple worthy areas where the government could make progress, the point of prioritising, particularly in an era of such limited resources, is to focus on the most important issues.

The final area to watch is the measurable benchmarks. It is good that the government has shown willingness to be held to account.

However the choice of some indicators is not exactly stretching (home to most top universities outside U.S. - already the case) and some are not within the government's ability to directly influence (increase in exports to key target markets). The number of them looks on the high side too – giving it a ‘scorecard’ feel rather than creating an expectation for concrete progress on each indicator.

Despite these cautions the Plan for Growth has the potential to be very positive. The real test will not be in its writing but in its delivery. We’ll be doing our part by watching carefully on how the government follows through.

Regular readers of this blog should take a look at the Infor Manufacturing Blog.*

My first post for the blog looks at why investment in innovation and IT have helped manufacturers drive the broader economic recovery. However, I also flag up some of the key challenges firms face when innovating in the UK:

"Tackling technical troubles [while innovating] can cost firms time and money as they strive to get to market quickly.

Yet in competitive global markets, time and money are luxuries that most manufacturers do not have."

UK manufacturers don’t compete on price or labour, they compete on innovation and technology. The longer it takes, the more cash is spent in developing and commercialising innovation, the less likely the company will generate a return on its investments in innovation.

What does this mean for the Chancellor's Budget in under two weeks time? Well, R&D tax credits could play a part here.

Right now, the UK only provides tax credits for research and tax breaks for patents. Yet it’s the time-consuming and costly development phase of R&D where the value of innovation – the profits, the jobs & the growth – is generated. And because we don’t support development and commercialisation, other countries reap the economic benefit of our innovative ideas.

The bottom line is that we can't take growth for granted: firms will invest, innovate and grow; they have to if they want to stay in business. The question is whether the Chancellor give them a reason to invest, innovate and grow in the UK?

* Full disclosure: Infor and EEF have a long-standing relationship. This includes partnering with our economists on two reports: the 2008 IT & Productivity survey and our 2010 Innovation Monitor. Infor are also the lead partner for EEF's Future Manufacturing Awards.

Over the weekend, the Prime Minister committed the government to "taking on the enemies of enterprise":

"...for over a decade in this country the enemies of enterprise have had their way.
 
Taxing.  Regulating.  Smothering. Crushing.  Getting in the way.

...

So I can announce today that we are taking on the enemies of enterprise.
 
The bureaucrats in government departments who concoct those ridiculous rules and regulations...The town hall officials who take forever with those planning decisions...The public sector procurement managers who think that the answer to everything is a big contract....
 
There's only one strategy for growth we can have now...

...and that is rolling up our sleeves and doing everything possible to make it easier for people to start a business and to grow a businesses.

While the wags may have focused on the alliterative powers of the PM's speech writer, we support the PM's focus on doing everything to make it easier for people to start and to grow a business in the UK.

That's why we've put together a Manufacturers' Most Wanted - the top ten 'Enemies of Enterprise' for manufacturers planning to grow over the next 5-10 years.

As we said yesterday, the government can't take growth for granted - not all growth is equal and it doesn't have to happen in the UK.

If the PM lives up to his words and tackles these 'Enemies of Enterprise', he can ensure the UK captures all the benefits - the jobs, the investment and the exports - that the right type of long-term, balanced growth in manufactring can generate.

1.        Lower Capital Allowances: Inefficiently taxing investment in the UK.
The UK’s capital allowance regime is inefficient, outdated and uncompetitive, and the government’s plans to lower the level of allowances from 20% will add to the cost of investing in technology and growth in the UK.

2.        Tax Complexity & Uncertainty: Raising risks to long-term investments in the UK.
The government’s departures from its ‘New Approach to Tax Policy Making’, such as the decision to retain revenues from the Carbon Reduction Commitment, have unnecessarily increased uncertainty for firms making long-term investment decisions.

3.        The Carbon Reduction Commitment: Unnecessarily & inefficiently taxing production in the UK.
Combined with the carbon floor price and the CCL, the CRC provides triple taxation of carbon, inefficiently raising the cost of producing in the UK.

4.        The Climate Change Levy: Taxing electricity consumption at 10x EU minimum.
The EU requires the UK to have the CCL, but the UK has unilaterally chosen to impose a levy 10 times the EU minimum.

5.        The Lack of Competition in Lending: Entrenching a risk-averse approach to lending to UK manufacturers.
Not enough competition means it’s harder for growing firms to secure the loans they need on reasonable terms and tougher to switch providers when service standards aren’t up to scratch.

6.        The T&C’s Attached to Bank Lending: Capping the flow of finance to growing UK manufacturers.
From personal guarantees to impossible covenants, the range of T&Cs attached to lending places a cap on manufacturers’ ability – and willingness – to invest in the UK.  

7.        Inadequate Impact Assessments: Consistently underestimating the burden of red tape on UK manufacturing.
Poor Impact Assessments – such as for the Default Retirement Age and the Carbon Floor Price – fail to accurately assess the additional and cumulative impact to business of UK and EU regulations. These assessments need to improve if the government is the scale of the barriers to private sector growth.

8.        The Default Retirement Age: Reducing labour market flexibility.
Rapid introduction leaves firms scrambling to comply with red tape and complicates plans to manage workforce skills.

9.        10 Years of Tinkering with Apprenticeships: Making apprenticeships and funding unstable.
The lack of stable funding and overuse of centrally-planned targets have made good-quality apprenticeships harder to come by for both students and manufacturers.

10.    Failure to Deliver STEM Skills in Schools: Shrinking the future workforce of manufacturing.
Without a solid foundation in STEM skills, students are less likely to have the skills needed to begin an apprenticeship, pursue an engineering degree or even seek a career in manufacturing.

 

In 2010, in his ‘emergency budget’, George Osborne boldly set out the coalition’s plans for eliminating the structural deficit over the course of the parliament.

This fiscal plan, though tough, gave necessary signals to the market that the deficit would be reined in and removed a key source of uncertainty.

But now it is 2011 and the new challenge to the government is supporting growth - and that's what we need from Budget 2011. The Manufacturer runs a good summary piece on our submission.

2011 is the year the public sector cuts really start to bite and where private sector growth must take up the slack.

Just as we needed a Fiscal Mandate in 2010, in 2011, we now need a Growth Mandate. EEF's CE, Terry Scuoler outlines the Growth Mandate in today's Telegraph. It will signal that the government is serious about our business environment and helping the private sector deliver the growth we need.

The reality is that we need to see this commitment because manufacturers have a choice on where to invest and the smart money is on investing in an economy that offers a business environment that can compete with the best in the world. We need that economy to be the UK.

The Growth Mandate would set out priority areas for growth that the government would address and against which it will be measured. Like the Fiscal Mandate, the Growth Mandate should span the lifetime of a parliament. As the FT picks up we think each subsequent Budget and policy announcement showing further incremental progress.

This multi-year view must be taken. The fiscal mandate cannot be threatened so a big bang approach is not viable. But the barriers to growth must gradually and consistently be dismantled.

And like the fiscal mandate a long term view on the growth mandate will deliver a confidence dividend to businesses who will see the business environment progressively improving.

Each Budget should therefore report, relative to the last budget on the following measures:

• The change in total tax costs faced by businesses;
• Estimates of the net change in bank and non-bank external finance to non-financial companies;
• The change in total climate and environment policy costs faced by businesses;
• All new and withdrawn regulations, and the change in the total cost of all regulation;
• The change in the proportion of companies facing skills shortage and hard-to-fill vacancies; and
• The change in apprenticeship starts at each level.

The challenge is that this holds the government to account for delivering consistent progress.

But a growth mandate isn’t a replacement for action at Budget 2011. Instead, Budget 2011 offers the first opportunity for the government to take small steps forward to support growth – small steps that point to large ambitions.

We see four key areas, mentioned in the Independent, where progress needs to be shown:

- Tax;
- Access to finance;
- Skills; and
- Regulation.

On tax we need the government to appreciate that firms make decisions based on the basket of taxes they face, not just the headline rate. We need reform on the R&D tax credit and capital allowances that properly account for the costs manufacturers face. The environmental tax burden needs to be reduced. Any support we give for a Carbon Tax is conditional on reductions in other energy taxes.

Finance remains a problem for firms post crisis. We need the Independent Commission on Banking to deliver measures that not only make the banking system safer but also increase competition – because growing firms often get their first lending deals secured through banks looking to enter the market. We also need more alternative sources of finance – both non-bank debt and venture capital, critical funding for firms that aren’t ready for bank debt.

Future funding and demand for 14-19 diplomas needs to be reviewed with the aim of increasing support and improving delivery. And the government should introduce a pilot initiative through the Growth & Innovation Fund to support SME collaboration on industry placements

On regulation the government needs to match its rhetoric with action by reviewing the cumulative impact of thresholds for regulation and commit to further action on reform as appropriate. As scope for simplification of individual regulations has largely been exhausted, commitment to structural reform of entire regulatory domains is needed

All these examples provide initial opportunities for government action to support growth.

In 2011, George Osborne will deliver his second budget. We believe his challenge is to set the Growth Mandate for a private sector-led recovery.

FT Alphaville highlights a near 50-year low in 10-year gilts and puts the blame for this fall squarely at the feet of bearish comments from new MPC member Martin Weale in the Times:

'It would be “foolish” to rule out the possibility of a double-dip downturn, even if it was not the Bank’s central prediction, said Dr Martin Weale, the newest member of the Monetary Policy Committee (MPC). He also feared that the Bank’s central outlook — which is for growth of about 2.8 per cent in 2011 and 3.2 per cent in 2012 — could be too optimistic…

Dr Weale said that the Bank’s latest economic forecasts, published on August 11, had a 10 per cent outside chance of four-quarter long economic contractions in 2011 and 2013. “The forecast is putting a significant chance on the economy contracting over a four-quarter period,” said Dr Weale.'
 

The link between Weale's bearish-ness and the drop in gilt yields raises questions about what effect yields will have on business investment (remember - the Chancellor and the OBR are staking their reputations on fiscal restraint lowering 10-yr yields and so helping to encourage business investment).

So what's pushing 10-yr yields close to record lows?

Well three factors: global risk, domestic weakness and fiscal consolidation.

Let's breifly take those in turn.

1. Global risk. With the global recovery stumbling and sovereign default still a moderate risk, investors are seeking safety in the arms of US, UK and German government bonds. As demand for these longer-term bonds goes up, so does their price, pushing down the yield. So far, so good. The problem is the affect on business investment. If financial markets are shunning risk, then its because there's something worrying about the state of the global economy. Concerns about the global recovery makes businesses uncertain - and that's why most are sitting on piles of cash and holding off on investment.

2. Domestic (UK) risk. Well, a weak economy typically favours bonds as investors move out of relatively riskier equities in favour of relatively safer goverment bonds. This is the sentiment behind the Weale-driven dip in yields. But yet again, domestic weakness will make businesses cautious about investing.

3. Fiscal consolidation. I'll put this upfront so there is no second guessing our views: this isn't a 'deficit denier' arguement. There is a deficit, it needed to be tackled and EEF supports most of the government fiscal consolidation plans. And tackling the structural deficit will provide downward pressure on gilt yields (or at the very least limit any upward pressure). The question we're raising about the affect on investment. The government is making a 'crowding out arguement' that says shrinking the deficit will lower rates and boost private sector investment. Not only is this arguement weak - all interest rates were low prior to the recession, which was part of the problem behind the financial crisis, so there's only a weak case for the government to make. Add on top the uncertainty caused by their unnecessarily deep capital spending cuts, and you've got businesses being cautious about investment because they've got concerns about their public sector-related orders.

So in reality, two of the three drivers pushing gilt yields down will naturally imply only limited growth in business investment. And the government's gamble on fiscal consolidation boosting investment actually cuts both way, providing an uncertain benefit.

In some ways the coalition government’s economic policies were always going to be dictated by the prevailing economic and fiscal situation. At a time when the UK’s public sector net debt stands at nearly 64% of GDP, tax rises and cuts to public sector spending were more or less inevitable. But the choices the government takes in how to raise taxes and cut spending says as much about the state of the economy as it does about the government’s economic world view.

The coalition’s approach – somewhere between the Third Way and Thatcherism – is based around a faith in markets and business. This 'Two Thirds Way' is based on the belief that our economic competitiveness requires a smaller government and smaller government debt, which should then reduce long-term interest rates and encourage private sector investment and growth. In the Emergency Budget, however, it appears a traditional free market purist approach was tempered by a concern for low-income earners, as business taxes were cut alongside a higher personal allowance threshold for income taxes.

The government also departed from the traditional free market approach with some more interventionist tax measures, including the banking levy and creating tax incentives for start-ups to locate outside of the greater South East. The 'Two-Thirds Way' ultimately favours markets over government, but sees a distinct, but targeted role for government in encouraging investment and regulating 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.