EEF blog

Some important issues were raised at Wednesdays All Party Parliamentary Group on rebalancing sectorally. Speakers included EEF’s Chief Executive Terry Scuoler, Professor David Bailey from the University of Coventry, Dr Elizabeth Garnsey from the University of Cambridge and Lord Peter Mandelson. 

Together the panel provided a stimulating contribution to the debate on how the government can support the manufacturing sector and rebalancing. Some of the issues discussed included

• Raising capital intensity in the manufacturing sector through
  -   Recalibrating the financial model to improve access to finance with a particular focus on improving availability of finance for small and medium sized businesses. 
  -   Improving capital allowances to encourage more investment. 
• Focusing tax incentives and government support on high growth sectors, areas where the UK has a comparative advantage and exporting.
• Increasing commitment to building and maintaining our comparative advantage in knowledge, specialisation, innovation and skills. 
• Developing an intelligent focus on supply chains to improve the UKs ability to compete globally.
• Establishing a clear and pervasive commitment by the Government to a growth strategy with measurable indicators to track success.  

The top priority for the government should perhaps be the last item for two simple reasons

1. a clear plan for growth will lay the foundation from which the other issues can considered and actions implemented, and
2. a clear plan for growth will provide the business community with some measure of certainty in an environment plagued by uncertainty.

Next month we will come up to what might have been an important milestone for the government.

23 March will be one year since it launched its ‘Plan for Growth’ – the ambitions and accountability framework designed to structure the government’s economic policy.

At the time we had been calling for a ‘Growth Mandate’ – effectively an economic strategy to match the clarity of its fiscal strategy – the ‘Fiscal Mandate’.

Sadly the Plan for Growth has so far proved to be a very poor cousin of the Fiscal Mandate.

For a start, I don’t think many even in the Westminster bubble could name the Plan for Growth as the government’s overarching economic strategy. It has no visibility in the same way the deficit-reducing Fiscal Mandate has.

(For example witness calls from later in 2011 here and here for some kind of ‘plan for growth’ – even though the government strategy is literally called ‘The Plan for Growth’.)

But this failure is really a symptom and not a cause of where the government’s strategy is falling down.

The Plan for Growth set out four ambitions for the UK of 2015:

• To create the most competitive tax system in the G20
• To make the UK one of the best places in Europe to start, finance, and grow a business
• To encourage investment and exports as a route to a more balanced economy
• To create a more educated workforce that is the most flexible in Europe

It’s not that these areas are wrong or unworthy. It’s that they’re a little too vague and too broad to have enough meaning either for businesses or people on the street, or, importantly, for Whitehall policy-makers looking for a way to prioritise economic policy initiatives.

It doesn’t have to be like this.

How about changing:

‘encourage investment and exports as a route to a more balanced economy’

To:

‘increase the proportion of annual ouput accounted for by net investment and exports by five percentage points’.

This is stretching and not wholly within the government’s control – but it certainly would make a difference to the overall economy levers and the government is not without levers it could pull.

Underneath the ambition we could have measurables including increasing the proportion of companies exporting more than 25% of their turnover or increasing the market capitalisation of AIM by 10%. The government could then introduce policies to support these.

The government does seem to know the kinds of areas it needs to focus on. It just needs to be sharper with both its ambitions and its accountability framework.

23 March 2012 will not be a heralded date for the government progress on its Plan for Growth, even if it does try this.

What it could be is an opportunity for the government to refocus its economic strategy into something meaningful for the UK economy.

On Monday this week we had a story in the FT claiming that the real Merlin lending targets for UK banks didn’t actually appear in the final published document.

Instead ‘stretch’ targets, insisted on by the government were used – even though the banks have no expectation that demand will emerge sufficient to meet these figures.

Separately there are ‘real’ targets, which are about 10% lower, that the banks, happily enough, look on course to meet.

HMT seems at odds with Business Minister Mark Prisk on this but the whole story creates uncertainty around how tough the agreement really is.

No doubt this sets up a nice wheeze for both the politicians and the banks at the end of the process next February where both can save face on lending results.

The politicians can say they pushed the banks as far as they could and can make threatening noises all through the year about what will happen if the banks don’t meet the targets, all the time being less than frank about what these targets actually are.

Next year, the banks can justifiably point to the real agreement on lending, which they believe they will honour, and say that demand hasn’t materialised for the government’s ‘stretch’ ambitions.

Of course left out of all this game playing in the press will be what’s really happening to access to finance in the UK and whether it is improving.

From the start we were sceptical about the value of lending targets – gross or net, stretch or real – as a tool to deliver better credit conditions for UK firms. The targets are hard to enforce and potentially meaningless (if net lending continues to contract, credit could conceivably still be withdrawn from SMEs, as Vince Cable himself said in March 2010).

That’s not to say we want Merlin to fail. If it turns out that credit conditions improve and Merlin has had some role in that, great. And it’s encouraging to see from our latest credit conditions survey that availability of finance, including for smaller firms, appears to be improving.

But the bigger risk is that Merlin ‘succeeds’ however that’s framed and that debate on improving access to finance is shut down.

Already the government seems to use Merlin and the banks’ own set of commitments as an excuse for doing little to improve access to finance.

Commendable as the banks actions are, it shouldn’t be a surprise to anyone that they will primarily act in their own interest and not necessarily go as far as would be warranted in the interests of the wider economy.

We’ve consistently called for progress in four areas:

• Improved competition in the banking sector;
• Increased sources of finance outside banks;
• Better real business expertise in the financial sector;
• Better customer services.

Rather than hiding behind Merlin’s smoke and mirrors the government should be thinking hard how it can address these areas.

On Monday we published Economic Prospects, 2011: detailing our views on what the year ahead is likely to hold for manufacturing. Over the last few days we’ve set out what we think are likely to be the biggest challenges for manufacturing in the coming year. These include: Eurozone instability; commodity price inflation; and access to finance. The fourth challenge is the likely impact of government spending cuts.

In 2011 government spending will fall substantially and manufacturers are concerned about the impact of this. Nearly one fifth of manufacturers expect to see a direct loss of orders. In addition, 40% of companies expect to see a loss of orders through their supply chains. It is not only lost orders that are a concern: a quarter of manufacturers surveyed were worried about cuts to business support programmes.

There is some good news too: one in six companies expect that the government’s spending cuts will make the business environment clearer, and a few saw new market opportunities arising from a change in spending focus. What is more, 45% of manufacturers thought that reducing the deficit would improve market confidence in the UK economy.

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.

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 UK’s trade deficit in goods improved in September, falling to £8.2 bn compared with £8.5 bn in August.

The value of exported goods rose by £0.5bn over the month, and there was an increase in import values of £0.2bn. This is good news in both cases - increased exports mean there is a potential for more balanced economic growth, while continued demand for imports reflects strength in consumer demand.

The value of UK exports has grown markedly and is currently nearly 25% higher than at the low-point of the recession. Year on year growth in exports is well above the long-term average.

What is more, the outlook for trade is good.

Emerging markets are providing opportunities for export growth. Between 2004 and 2009 (the last complete year for which there is data) the volume of exports to BRIC countries rose by 77%. The proportion of UK exports going to China and India more than doubled. UK manufacturers are keen to take advantage of these opportunities and have been developing their presence in emerging markets. This is already paying dividends: according to UKTI in the first eight months of 2010 alone goods exports to China rose by 44%, to £4.5 billion. Even better news is that recent surveys have repeatedly showed companies reporting increased export orders. One thing is clear: exports have the potential to drive growth.

However, the global marketplace is likely to become an increasingly competitive environment. And the potential for trade wars is threatening the global recovery. The government is rightly keen to promote UK exports, something which is clear from current Trade Mission to China. The importance of trade missions should not be understated. However a long-term strategy for growth is what industry needs to provide the clarity and certainty that will enable the necessary investment to drive exports. Therefore, manufacturers will be looking to the Prime Minister to make good on his commitments to back industries where the UK has a competitive advantage in the government’s upcoming White Paper on growth, and the Manufacturing Framework.

The manufacturing PMI for October is out and – at 54.9 – it is both higher than expected and indicative of an acceleration in manufacturing output.  The PMI now shows that there have been thirteen months of expanding output, and eleven months of faster-than-average expansion in manufacturing sector since the recession ended.

Figure 1: Manufacturing PMI

This is good news, but after two months of data suggesting that growth was slowing, it must be remembered that the PMI is a volatile indicator. The last time manufacturing came out of recession the PMI was so volatile that it returned to the below-fifty level associated with contraction for some time. Manufacturing output was also unsteady.

At this stage of the recovery, growth cannot be taken for granted. As we have already noted, there remain significant downside risks to the recovery. Given that increased exports are currently driving growth, the possibility of a global currency war is particularly concerning. In addition reduced domestic demand as a result of consumer caution following public sector cuts will hurt companies who are more UK-focused. For these reasons, the government must deliver on its growth strategy. It can do this by: becoming a better partner to business; providing clarity and stability; and investing in the UK’s productive capacity.

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 government can spur on regional and sub-regional growth if it sets out clearly what LEPs will do; how they will operate; and how they will be funded

If LEPs are going to drive economic growth then the government will have to:
- get the right balance between central and sub-national government
- ensure LEPs have a clear remit and are focused on the right issues
- achieve a critical mass for LEPs
- secure engagement from business
- deliver value for money

The government can reduce the burden on business by providing greater stability and predictability in the tax system

If the UK is going to have an internationally competitive tax regime, the government must provide a road map for which corporate, environmental and personal tax reforms it will seek over the next few years and explain how these changes will rebalance the economy by supporting investment.

The burden on business can also be reduced through pursuing alternatives to regulation

The government has made a good start by introducing a “one in one out” policy on regulation, but it must recognise that the cost of regulation is also a cumulative effect from the layers of regulations that have built up over time.  For this reason the government should consider seven-yearly sun-setting reviews and consultations with business and use these to discuss alternatives to regulation.

The government can only ensure that businesses will receive the support they need in the coming months if changes to business support are properly communicated and managed

The need to reduce public spending along with the transition from RDAs to LEPs will inevitably lead to changes in business support, but the government should do everything it can to smooth this transition. Businesses will need clarity over which services will continue to receive funding even if the delivery mechanisms, brokerage and costs are still to be determined.