EEF blog

Lord Heseltine today published his review No stone unturned in pursuit of Growth. The review is a welcome recognition of some of the key issues that are holding the UK economy back from the growth that the UK needs.

• The need to improve the competitiveness of the UK as a place to do business, and
  
• The need to have a more joined-up government placing a greater focus on growth.

Lee outlined some of the aspects we thought this review needed to address in her blog yesterday, in particular the need for changes that lead to a reduction in the hurdles that companies face in successfully investing and innovating across our economy.

So what do we think?

Lord Heseltine’s review has provided some much-needed thinking on how we can create a more competitive and stronger economy.

Now the proverbial baton has now been passed to the government. The government needs to consider the proposals carefully to ensure that they offer value for money, that the proposals will not lead to unintended consequences that could adversely affect industry and how they can be made to work in practice.

Some of the review's recommendations in brief 

The review is very wide-ranging and makes 89 recommendations focusing on how the government interacts and impacts industry. Recommendations cover issues ranging from the structure of the private sector to the structure of government, the link and relationship between central and local government, as well as specific policy areas such as skills and innovation. There is too much to cover effectively in one blog so I have summarised some of the key areas.

Improving the structure of government

The review recognises the lack of ownership of the growth problem across government, with many departments not placing a sufficient focus on the extent to which their policy impacts growth. The review recommends

• Setting a clear economic strategy;
  
• Establishing a growth council chaired by the PM with the aim of driving the government's growth agenda;
  
• Establishing sector councils; and
  
• A range of recommendations aimed at strengthening the civil service.

Establishing a central group to focus on and drive growth is a positive move and in line with the recommendations we set out in EEF’s A route to Growth. Making sure the group has the teeth it needs to make a difference is important – it should focus not only on strategy but also on implementation, and how it interacts with and works across government and with other areas of government (i.e. sector councils if established) needs to be clear so that it doesn’t become just another bureaucratic step in the policy process.

Increasing control at the local level

Lord Heseltine identifies a lot of the key issues at the local government level – the need to rationalise local government and simplify its funding, the need to get better value for money from expenditure and to improve the way it engages with business. Recommendations include

• Giving LEPs the resources and authority to drive local growth and act as an effective ‘business voice’ on key issues;
  
• Consolidating ‘growth-related’ local funding (e.g. business services, houses, infrastructure, skills) into a single pot and allocating on a competitive basis over a longer time horizon; and
  
• Encouraging a local government landscape with fewer, single-tiered, authorities.

Heseltine rightly points to the need for simplification of local government. Dealing with one authority rather than several is easier for businesses. Giving LEPs the tools and funds to make a real impact on issues such as planning and transport, and the power to cut through the obstacles to growth at the local level makes sense and may well drive efficiency across areas like procurement.

Simplifying local funding and driving efficiencies by making it more competitive are good ideas. However, government needs to make sure that LEPs and local authorities are up to the task before giving them control of large pots of public money and there are areas where it should be cautious about giving them additional powers. Plus the government must not underestimate the administrative task of running and assessing a five-yearly competition for a £50bn fund.

Boosting science and innovation

Broadly speaking, the review correctly identified the problems with innovation and science: the UK spends less on R&D and innovation than many competitor nations and there are issues with the procurement of innovative goods, namely that public sector procurement can too often tend towards ‘best price’ and ‘off the shelf’ solutions rather than looking at long term value, and the impact of decisions on industry. Recommendations include

• Committing to long-term stability of science funding;
  
• Greater use of public procurement standards across government;
  
• A role for LEPs in delivering innovation policy; and
  
• Expanding the TSB’s area of responsibility.

While many of these are in line with current policy, the role of LEPs and an expanded role for TSB need to be carefully thought through to ensure the right level of resources are provided and incentives are aligned.

Improving support for businesses, including advice and support for exporting

The review identified problems with the provision of advice and support to UK businesses. It suggested access to and knowledge of the right advice and support are not helping UK performance, including the UKs export performance. The review suggests some solutions to address this issue including

• Using the Chambers of Commerce to be one-stop shop for business with easy access to business services including advice and support on exporting.
  
• Strengthen international chambers, especially in key growth markets.

The Review’s focus on support for improving access, advice and support for business services is positive. Industry will welcome the Review’s focus on support for exports which needs to be better resourced, better marketed and more accessible.

Trade data out today and it's not a pretty picture for 2012q2.

The deficit in trade in goods (ex oil) increased more than £2.5 billion in 2012q2 compared with 2012q1, with the overall trade deficit increasing by more than £3 billion. This doesn't bode for rebalancing our economy towards generating more growth from trade.

Our gold, silver, and bronze medal export destinations of Germany, the U.S., and France each saw falls of around £400-500 million in exports in 2012q2 (but conversely imports from Germany and the U.S. actually rose slightly).

More positively our gold medal export destination for growth, South Korea, saw UK exports continue to increase (by over £350 million) in 2012q2. China, our silver medal growth destination, was largely static.

So what to make of all this?

As we noted in our press comment, it's important not to get too worked up given the one-off factors in 2012q2 especially the Jubilee holidays but also the weather.

But on the other hand 2012q3 will need to see a serious bounce back to avoid the conclusion that rebalancing is off track.

What is the government's role in promoting exports as part of focusing *110%* on growth?

Three noteworthy mentions:

Strategic goal of doubling exports to £1 trillion by 2020

UKTI support for exporters

UKEF - finance products for exporting

The government's goal to get exports to £1 trillion was announced around the time of Budget 2012. It certainly is ambitious...requiring similar export growth to that seen in fast-growing export countries like South Korea every year up to 2020. But it is an important - and measurable - benchmark by which the government can hold its more detailed export promotion activities to account.

UK Trade and Investment is an effective government agency providing a range of services to promote UK exporters (and inward investment into the UK). Services include the Overseas Market Introduction Service that is a vital route into new markets - especially for companies new to exporting.

Then there is the recently renamed UK Export Finance agency. This agency is charged with making it easier for firms to trade by providing finance products to improve the cashflow and migitate the risk of trading with overseas customers.

While the intent of both agencies is good, the awareness of the support they offer is not so good - especially for the little-known UK Export Finance.

That's another reason the government's events at Lancaster House during the Olympics have been important - not just for highlighting opportunities to overseas investors and customers - but also to hopefully raise the profile of what support is avaiable to UK companies.

The challenge is how to build on this momentum and keep increasing awareness - this is where the government needs to think carefully about its near-universal ban on promotional/marketing spend. Is it really worth saving a few £ million on marketing spend if we're relying on trade delivering £ billions more in growth to drive the UK recovery?

At the start of the year we identified four main challenges to growth over 2011: government cuts, access to finance, commodity prices, eurozone trainwreck.

This was also in the context of what we already knew to be weak consumer demand driven by reductions in real incomes, a weak housing market, and higher unemployment.

Domestic demand was undoubtedly weak and with the uncertain spillover impact of government cuts to come, the fear was it could become weaker.

The big shift since the start of the year has been the substantial weakening in external demand.

Though we might try to claim we had this risk in our sights, our flagging of the eurozone as a risk was more in the nature of an apocalyptic Lehman-scale financial markets meltdown. The sort of risk that was undoubtedly hugely negative but hard to be specific about.

While that unfortunate scenario could still yet materialise, the actual impact of the crisis that we are seeing, the generalised downward pressure on overall external demand is something we perhaps didn’t appreciate.

So how exactly is the eurozone crisis impacting on us?

Felicity has spoken about the three generalised impacts outlined by Mervyn King in May. But these generalised impacts hide a lot of complexity and specificity.

While the eurozone-wide challenges are the main threat to external demand, there’s actually a wide variety of challenges faced by the specific markets in Europe where we are now seeing weakness.

So with this in mind, we’re coming out in the next few days with a series of blogs on:

Specific challenges to eurozone countries that are key UK export markets;

The spillover of the crisis into external demand more generally via confidence impacts on markets outside of Europe;

Why in the medium term, we still have reason to be optimistic about the prospects for UK manufacturing, despite the impacts on Europe;

Why the UK cannot afford to take opportunity for granted and must compete hard to attract investment and drive growth.

Reading all the commentary on the latest Irish sovereign debt crisis there’s a lot of wise words being bandied around the UK about why Ireland should never have joined the euro. Like Greece earlier in the year some even darkly foretell that Ireland may eventually have to leave the monetary union to resolve its economic malaise.

There’s three questions that come to mind in response to these views:
• Is the currency union to blame?
• Is it realistic for Ireland to pull out of the euro?
• What’s the impact of the eurozone stress on the UK and in particular our exporters to places like Ireland?

On the first, most commentators agree that Ireland enjoyed a sustained real economy boost before succumbing to a debt-fuelled property boom. Currency union kept interest rates down from what they otherwise might have been. This exacerbated the debt binge – but it’s at least questionable whether it caused it. And although export growth tapered off at around this time, Ireland has remained consistently and massively in trade surplus.

Similarly New Zealand has its own currency but it also had large increases in private debt fuelled by cheap credit at the same time. But in New Zealand’s case the monetary authority tightened the interest rate screws to dampen the inflation it saw in housing prices, loans were made more expensive but still the bubble continued. And by having higher interest rates the exchange rate jumped up as investors and then speculators piled into the Kiwi. New Zealand’s export sector was badly squeezed and NZ has consistently been in trade deficit. The level and volatility of the exchange rate is consistently cited as an issue for NZ exporters.

Similarly the UK has its own currency, so the vicious euro hasn’t wreaked its havoc here either. But just like Ireland and NZ, private debt in the UK soared during the credit boom. And just like Ireland, major banks in the UK have failed. Surely not to the same extent but Robert Peston points out the difference is one of scale not kind.

This is not to say that joining the euro was a great idea; it may be just as many are saying that it was a bad call and that if Ireland wasn't in the euro now, everything would be rosy. But clearly it's more complicated than simply having the euro = bad/not having the euro = good. There are costs and benefits of both options and the debate at the moment is a bit revisionist and one-sided.

I think that the banking sector is a much more significant factor than the currency union for explaining the current mess. The bad loans in the Irish banks represent a failure of regulation of the financial sector. Ireland has the misfortune of being more exposed than most and the Irish Government guaranteeing all the Irish banks’ debts.

So what now? Should Ireland dump the euro, restore the punt and devalue its way to prosperity? A recent BBC article showed the fallacy in this logic. If Ireland dumps the euro and looks to devalue its new currency immediately, the value of its euro-dominated debt will go through the roof. This greatly heightens the chance of default and, anticipating this, investors rapidly withdraw their capital from Ireland before the cross-over to the new currency. That would make a bad situation worse.

What does all this mean for the UK can be boiled down to impacts on demand for our exports and systemic impacts on our financial system.
The Govt’s attitude so far is illustrated by its willingness to participate in the ‘bailout’ of Ireland. But many of Mr Osborne’s Conservative colleagues have questioned why the UK is helping.

Both Cameron and Osborne have stressed the national interest angle, the interlacing of the economies etc. But what if another bailout is needed or, more likely to involve the UK perhaps, the EFSF proves insufficient faced with multiple bailouts. Where then does the interest lie?

The stability growth of the eurozone matters for UK exporters. It matters directly; without it demand for our exports will be lower as eurozone consumers confidence and consumption dips. Even in its parlous state, Ireland still accounts for 6% of UK exports and perhaps more surprisingly, since the end of the recession, Ireland has accounted for 4% of UK export growth.

A similar calculus is possible with other eurozone countries, such as Portgual, supposedly next in line. Although Portugal makes up a much smaller proportion of UK exports, its share of UK export growth, since the end of the recession, exceeds 1%, which is not trivial.

And the more bail outs there are, the more the systemic health of the banking system comes into considerations. I don’t think it’s beyond possibility that it could be in UK banks’ (and via their lending to businesses, the economy’s) interests to support further bailouts, or a replenishing of the EFSF, if the situation became severe enough. The involvement of the IMF in the bailouts already suggests the importance of these issues is wider than just Europe or the eurozone.

A currency war is on hold – though it depends on the performance of the US Economy

 “The prospect of a full blown trade war is unlikely; it benefits nobody” … “it is not in China's interest to provoke the US”
World_First

Additionally, currency intervention… “May go off US agenda if QE2 works/economy grows” … “I suspect that a war will be averted”
JeffreyPeel

“The G20 is split - Washington consensus is dead. But sanity may prevail. No-one really wants no-win #cwars or #fx wars”
JeffreyPeel

Chinese currency depreciation is not win-win

JohnPullin asked “What will be effects on scarcity of raw materials including strategic metals?”

“that is defintely one of the aces up China's sleeve and should we see supply concerns come to the fore then the pressure will rise”
World_First

“If the West achieves its objectives re. Chinese revaluation may mean more expensive input costs”… “may be good for US steel and other traded goods though - China hasn't all aces”
JeffreyPeel

For UK manufacturers the largest impact of currency wars is likely to be price volatility

We asked whether the UK would “be collateral damage from fx volatility?”

“you have a point. To an extent it depends how much the Chinese are prepared to pump-prime and how much US resists”
JeffreyPeel

“we are advising manufacturing clients to hedge at these GBP levels to negate volatility and lock in profit”
World_First

Or, as we put it on twitter: "currency war is on hold as QE2 gets going & eurozone distracts markets. But..." "QE2 could go down like the Titanic if it hits China's raw materials iceberg." "So for now, UK manufacturers have little to worry about, except maybe protecting themselves from #fx volatility."

Do UK companies have anything to fear from currency wars?

Join the debate!
(Monday, 15 November 2010, 15.00 - 15.45)

On Monday 15th November follow @EEF_Economists on twitter, or use the 'hashtags' #fx and #cwars.

Pre-debate, we've put together some background information: 

Currency wars: the story so far

Currency wars: the best of the press

Currency wars: the view from manufacturing

--

16/11/2010 Update

Here is a summary of the discussion -

Currency wars debate: some conclusions

In the G20 meeting in Seoul last week one of the key issues was how to avoid the currency wars which threatening global economic recovery. Although some agreement was made over continuing discussions, tensions have not dissapated. On Monday 15th November at 3pm EEF is hosting a twitter debate on the impact of currency wars on the UK, and UK companies. 

As a background to this, here are some key articles and blogs that have been written on currency wars in the last couple of months:

What is a currency war?

The BBC’s animated guide: http://ow.ly/388kiOr, if you’d prefer something to read, Stephanie Flanders’ summary is here: http://ow.ly/38bb7

When did this one start?

The first rumblings of currency hostility started in March 2010 when 130 bipartisan US Congressmen sent a letter last week to US Secretary of Commerce Gary Locke, calling for the government to identify China as a currency manipulator. However, it was Guido Mantega, Brazil’s finance minister, whose announcement on September the 28th branded competitive depreciations as “currency wars”. Reported by the FT: http://ow.ly/38bp8

Who is fighting whom?

The BBC’s Andrew Walker sets out the key players and the main battlegrounds: http://ow.ly/388oq What impact could currency wars have on the global economy?Competitive depreciation could represent a very serious risk to the global recovery. In particular, the global rebalancing which debtor countries are relying on to boost growth could be hindered by surplus countries accumulating excess reserves to boost their own exports. The FT reported here: http://ow.ly/38bOK

What has happened with currency wars in the past?

Douglas Irwin at the Wall Street Journal summarises how high tariffs and currency wars caused problems in the 1930s: http://ow.ly/38bxy

What happened at the G20?

According to the Guardian "the summit set vague "indicative guidelines" to measure imbalances" however "the leaders were unable to agree on how to identify when global imbalances pose a threat to economic stability, merely committing themselves to a discussion of a range of indicators in first half of 2011": http://ow.ly/39MMK  

Therefore, questions remain: What would trade wars mean for the UK? Crucially, how will UK companies be affected if exchange rates become increasingly volatile, or if currency tensions lead to increased protectionism?

Join the debate! On Monday 15th November follow @EEF_Economists on twitter, or use the 'hashtags' #fx and #cwars. The debate will start at 3pm and last for 45 minutes. 

David Cameron has led a band of ministers and businessmen to China this week, apparently the largest such delegation since King George III. They are there to promote our exports and the mission follows a similar one to India in July.

China continues to boom with close to 10% growth projected for this calendar year. While growth may abate somewhat in coming years (perhaps to closer to 7-8%pa), China will still comfortably outperform leading developed economies. The thinking goes that we need our exports going to fast-growing countries, like China, to sustain our own overall growth.

And here’s where the challenge comes in because right now, the UK exports only a small amount of its exports to China (c2%) and other fast-growing emerging markets. Most of our exports go to developed economies, particularly in Europe, where growth prospects are weaker. The Prime Minister is fond of saying that more of our exports go to Ireland than the BRIC economies combined.

I’ve wondered before about why this is the case and how it compares with other developed countries. But I’ll wonder again…

The table above shows a series of developed countries’ goods exports to China in 2005 and 2009 and the average annual growth rates of this trade between those years (note many went backwards 2008-09). It is UN data with values converted into U.S. dollars to allow comparison. I think it throws up some interesting comparisons and also points to some interesting explanations for trade patterns.

Australia and New Zealand share many of the same barriers the UK has to getting into the Chinese market e.g. language/culture, distance to market, regulatory/legal differences. Yet trade growth with China has been much faster for Australia and New Zealand than the UK. For Australia, China is its number one export destination.

For me the simplest answer is the most important one. It's what these countries are selling. In Australia’s case mainly minerals and fuels like iron ore and coal; in New Zealand’s case mainly dairy, meat, wool, and wood – in other words raw materials and food. These are in essence feeding into Chinese production either through its factories or the mouths of its workers.

But as a side point it might also be worth noting that New Zealand has a free trade agreement with China, the first developed country to have such an agreement and Australia has been in FTA negotiations with China since 2005. Where is the UK on similar arrangements?

How about Canada and the United States? Their exports to China are more similar to the UK’s, including goods like motor vehicles and parts, industrial machinery, and chemicals. Growth in U.S. and Canadian goods exports outpaces the UK’s – though the difference is very much more modest.

A closer look reveals that their exports still include a fair chunk of raw materials including wood pulp, timber, iron and steel, and crude petroleum. Again demand for these exports seems driven by Chinese production. The demand for goods used in production is very different from the demand for goods consumed by a growing affluent Chinese middle class. Similarly the export of raw materials contrasts sharply with UK exports of manufactured goods.

That brings me to the comparison with France. France’s export goods to China are probably most similar to the UK’s and focus on manufactured goods, many for final consumption. From the table above the difference in growth is almost identical; France’s performance has been strikingly similar to ours over 2005-09.

France, who secured their own recent round of Chinese trade deals worth $20 billion, showed very similar growth in exports to China over the last few years. French exports to China include engines and other power-generating machines, aircraft, pharmaceuticals, and vehicles. The UK exports many similar items particularly engines and other power generating machines, pharmaceuticals, and vehicles.

Both countries are coming from a fairly low base – but is that more reflective of Chinese demand than poor penetration from our exporters? I think the close match in performance with France, and relatively modest additional growth for Canada and the U.S., suggests the UK isn’t doing that badly in China, given what we sell.

Does that mean that the trade odyseey from Cameron and Co is a waste of time? Should we give up on our dynamic, modern manufacturing sector and work out ways to send the Chinese more raw materials? I don't think so.

George Osborne said this week that what made this delegation’s trip to China different was not any new announcements or action from the UK or its government so much as the state of Chinese development. In his view, China is now in a position to start buying the sorts of exports the UK produces (including services) in much greater volumes. This is because China is ready to enter a new phase of growth in domestic consumption, rather than simply continually increasing its growth through exports.

If Osborne’s right, I think that’s what makes China such a great opportunity for UK manufacturers now, not its exceptional growth rate per se. The similarity of the UK's export growth performance to China with other developed countries may be reason to believe we haven't been doing too badly. But it also suggests that the competition will be fierce between developed countries seeking to capitalise on a new wave of growth driven by Chinese demand.