EEF blog

Back in July 2009 EEF Published Manufacturing Our Future. In this we commented that:

“Just as today’s internet giants began life with one computer in a garage, advances in design and digital manufacturing mean that tomorrow’s manufacturing multinationals will start from equally humble beginnings.”

And an article in this week’s economist suggests that 3D printing could be just the technological advance that drives advances in tomorrow’s manufacturing:

“As with computing in the late 70s it [3D printing] is currently the preserve of hobbyists and workers in a few academic and industrial niches. But like computing before it, 3D printing is spreading fast as the technology improves and costs fall.”

In fact, 3D printing could be a real game-changer for industry

“By reducing the barriers to entry for manufacturing [it should] promote innovation. If you can design a shape on a computer, you can turn it into an object. You can print a dozen, see if there is a market for them, and print 50 more if there is, modifying the design using feedback from early users. This will be a boon to inventors and start-ups, because trying out new products will become less risky and expensive.”

And 3D printing really could be open to anyone. An exciting example of this is the RepRap project which was showcased at NESTA’s recent personal manufacturing seminar. RepRap have developed a replicating 3D printer that prints about 50% of its own parts, with the other parts are easy to obtain from a hardware shop or online. RepRap has a website called Thingiverse, where you can download designs that others have created to print on your printer.

With costs of 3D printing falling (the Economist notes that a 3D printer now costs less than a laser printer did in 1985) the potential for a paradigm shift in how we produce is really here. Open-source designs combined with simple production methods could lead to a form of modern manufacturing which combines elements of mass- and bespoke-production.
 

As we blogged about back in September, over the last decade productivity in manufacturing has grown at nearly double the rate of the whole economy.

In fact, in the five years between 2002 and 2007 manufacturing productivity consistently grew at around 5% a year, roughly in line with growth rates in the US.

Figure 1: Average annualised productivity growth, 2002 – 2007
 

Since the recession ended manufacturing productivity growth has been even more impressive. In the last year productivity grew by 7.9%, compared with 2.0% in the economy as a whole.

We should be ambitious about the contribution manufacturing can make to the economy.

Companies used the recession as an opportunity to boost their productivity. Now is the time to build on this. As EEF’s State of British Industry report (to be released on Monday) will show, the challenge now is capitalising on this productivity growth to drive transformational growth in the next decade.

The government is expected to release its growth strategy on Monday. The government must take this opportunity to provide the kind of framework that will support and catalyse growth in manufacturing.

The government can promote business growth and investment by improving access to finance

SMEs in particular are still struggling to access the funding they require, so it is encouraging that the Prime Minister noted in his speech on Monday that opening up access to finance and getting banks lending will be crucial to drive growth. Government should promote access to finance through facilitating greater transparency around lending policies; encouraging increased competition in the banking sector; and promoting alternatives to bank lending.

The government could take better advantage of green opportunities if more resources are given to the Green Investment Bank

The scale of investment needed to really capitalise on the opportunities in green technologies will not be met by the current plans for a £1bn Green Investment Bank. The government should be more ambitious: estimates suggest that the development of a low carbon infrastructure and low-carbon technologies will require £5bn of funding over the next five years.

The government will maximise the returns to its investment, if it is clear about its plans, and the kinds of support that will be available.

In many areas of government spending, greater details are required. Particular areas the government should clarify include which types of adult apprenticeship will be funded by the £250mn announced; and how funding to help firms commercialise their innovative ideas will be allocated. 

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.

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.  

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

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

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

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

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

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

So the long slog of fiscal consolidation begins today.

And the new government has got off to a good start by delivering the £6.24bn in savings through cuts in the cost of government itself.

Because it's a big spending the deparment, the Department for Business was never going to be immune from the tough decisions.

Where EEF have concerns, however, is the uncertainty around investments in energy security: where commercial contracts are involved, the government need to fairly quickly provide some certainty for the companies concerned.

As our Chief Executive, Terry Scouler, said today,

“The task of repairing the public finances is a significant one and we don't have to look too far to see what happens when governments don't act quickly to address deficits.

“Given the tough decisions it faces the government is right to make an early start and proceed with a focus on reducing the cost of government and ensuring value for money.  The Efficiency and Reform Group should formalise the process of bringing transparency to what should be an ongoing process of improving public sector productivity.

“However, the decision to freeze funding for frontline investments from the previous government’s Strategic Investment Fund could have significant consequences on investments already underway. Where commercial interests are involved these must be resolved as quickly as possible.”

In March, EEF called for VAT to rise to 20% as part of tax reforms designed to rebalance the economy.

Today, the BBC released a poll showed that 24 of the 28 independent economists that help guide HM Treasury forecasts believed VAT is likely to rise as part of the package to cut the deficit. The IFS - which exposed the massive holes in the parties' pre-election budget plans - also expects VAT to go up.

And a closer look at the coalition agreement between the Conservatives and the Liberal Democrats suggests the new government has left the door open to a VAT rise.

But why a VAT rise?

To help rebalance our economy, we need to look at where the balance of the tax burden lies. Currently, the VAT rate in the UK is below the EU average, and typically, VAT rises are less damaging than other taxes - a slightly higher tax rate on spending will help shift our economy away from debt-fuelled consumption, while higher taxes on investment or profits simply punishes productive companies trying to grow and invest in the UK.

This shift in tax receipts will have reinforced the economic trend towards debt-fuelled consumption: households need to supplement higher taxes with borrowing to finance relatively lightly taxed consumption.

EEF's recommendation of a 20% VAT rate from 1 January 2012 would accomplish two goals.

Firstly, it would provide a boost to spending before the VAT rise, helping to reinforce the recovery through 2011.

It would also raise almost £12 bn a year.

That revenue could - and should - be used to rethink and realign priorities for public sector spending cuts. In particular, the government could offset some of the economically damaging cuts to capital budgets built into the last government's plans and ignored during the election.

The coalition government can either find ways to repair the public finances by cutting into economic muscle, or do it in ways that boost growth at the same time.

We think a VAT rise is not only needed to raise revenue, but is also economically rational to help rebalance the economy.

During last night's leaders' debate on the economy, Brown and Cameron clashed on manufacturing investment and capital allowances.

Capital allowances are incredibly vital to manufacturers' competitiveness. They are how the tax system reflects the cost of investing in new machines. So while the staff costs count as an expense that immediately reduces the amount of tax a company pays, investment costs are only counted as an expense over 30 years.

On average, manufacturers replace their machines every 7-8 years, which means the tax system artificially adds to the cost of investing in machinery in the UK.

The Conservative Party is likely to reduce the level of capital allowances from 20% to 12.5% - which means the tax system will take 53 years to reflect the cost of modern machines.

On it's own this proposal would be extremely damaging to manufacturers' competitiveness. Consequently, EEF have been raising this issue with the Conservative Party for the past year, and have been working constructively to help them firstly understand the investment needs of modern manufacturers and secondly on how to modernise the tax system to match those needs.

And they have listened, acknowledging that many modern machines are only really productive for a few years before technology moves on. They have also committed to working with EEF to find ways of improving the tax system - by adopting our recommendations on the Short Life Asset regime - to reflect the real costs and shorter lives of modern machines.

EEF's proposals essentially say that modern machines have become like computers (in fact, most machines are powered by sophisticated computer systems): advances in technology makes them obsolete long before the machine stops working. So we've recommended that the tax system treats machines like it does computers, allowing manufacturers to write of the full cost of their invesments within eight years.

And because rebalancing our economy must remain a priority, EEF will continue to work with which ever party/parties that form the next government to ensure that the UK has a tax system that enables manufacturing and a balanced economy to flourish.

For background, here's each of the three parties views on investment and capital allowances: