The politics of the UK’s relationship with the European Union is front and centre in the press once again. Commentators and politicians are making their positions clear on what it should look like early and often. Furthermore, resolving the actual timing of any public vote on the matter is also becoming a matter of urgency.

Tomorrow, the House will debate an amendment to the Queen’s speech, which ‘respectfully regret(s) that an EU referendum bill was not included in the Gracious Speech’.

All these public declarations may well be valid, but the UK’s starting point is a four-decade long relationship with our European neighbours, which has – for good or bad – led to stronger trade links, a strong European voice on global issues such as security and climate change, and a leveling of the competitive play field in areas such as employment rights.

There is no shortage of campaign groups setting out why the huge cost and regulatory burden stemming from Europe means we should get out AND, in the other corner, the benefits of influence, trade and investment mean we’d lose if we weren’t in.

With our economy still struggling to get back on a stronger growth path, it is surely critical that significant long-term decisions (like that of our relationship with Europe) that have implications for certainty, confidence and ultimately much needed investment across UK businesses are a little more thoughtful.

Perhaps, therefore, an amendment which

‘respectfully regrets that the debate on an EU referendum bill lacks any clear evidence base on the advantages and disadvantages of membership, quantification of the wins from renegotiating any part of the UK’s relationship with the EU and clear priorities for future reform of the EU’.

While the headlines would not be as eye catching, it would at least demonstrate that there is a clear understanding of the issues that both the public and business need to hear about.  In order to decide what is in the UK’s long-term economic interests we must start by presenting some level headed answers to the following questions (although I’m sure there are plenty more)

• how have the recent pressures from the eurozone crisis changed the economic and political dynamics of the region and what does this mean for the UK?
• with the rest of the world forging closer links as economic blocs on trade, investment and technology, where does the UK fit into this picture?
• what is the real size of the prize  from opting out of EU-generated regulation , how much would need to be replaced by domestic regulation and how much impact would this have on how business operates?
• in key areas of policy and regulation could the UK do more to be influential leaders or are we happy to be followers?

If we get some answers to these questions in tomorrow’s debate I’ll be back on Thursday with an update. If not Thursday, it will need to be soon.

If you have any thoughts on where our relationship with the EU goes from here and, specifically, what it means for business let us know as part of our EU Challenge

Another piece of good news on the manufacturing front as production rose by 1.1% in March - the second consecutive monthly gain. But today's data still leaves output down 0.3% in the first quarter - in line with the first estimates published last month.

As the chart below shows it's been far from smooth sailing over the past year with a volatile profile of monthly output changes across manufacturing.

Month-on-month % change in manufacturing output

Source: National Statistics

Also encouraging in today's data was the broad-based gains across the sector in March. Most sub-sectors posted some growth - the few exceptions being food, textiles and rubber and plastics. Over the quarter the strongest performers continue to be the transport sectors - motor vehicles and other transport.

The divergence in performance across different manufacturing sectors has been a feature of the industry over the past couple of years. Indeed - there's been something of a three-speed recovery with some up, some downs and some steady as she goes as shown below.

Index of production Jan 2010 = 100

Source: National Statistics

For many manufacturers weak demand at home and in major European markets has been a major factor in their performance over the past few years. But there are some sectors bucking the trend in both directions. Other transport - which is largely aerospace - has more long term certainty over orders, is benefiting from demand for more efficient planes and from robust demand in emerging markets. The sector has seen fairly consistent growth since the start of 2010.

In contrast, the pharmaceutical sector is navigating a fairly unique set of challenges as it faces up to competition from generic drug manufacturers, patent expiration on some blockbusters and squeezed healthcare budgets. 

The food sector sits in the middle as domestic and export demand has stayed pretty steady, but households may switch between own-label and premium brands as incomes have come under pressure.

The rest of the year is likely to bring more of the same sector diversity. Overall we expect manufacturing output to steadily increase over the course of the year, but gains with the sector will not be evenly spread.

The UK’s relationship with Europe has been the subject of on-off debate since we joined four decades ago. Since the Prime Minister’s speech earlier this year, the debate is not only on, but likely to heat up as head into the European elections next year.

It’s worth a quick recap on what the PM did and didn’t say in January:

• Britain should play a committed and active part in the EU to ensure access to the Single Market is not compromised.
• Changes are needed to ensure the EU is able to address the challenges facing today’s Europe.
• Five principles to guide changes to the EU – competitiveness, flexibility, power flowing back to member states, democratic accountability and fairness.
• A pledge that in the first half of the next parliament the government would;
  • As part of the potential moves to create a new treaty for the EU, seek a new settlement for Britain.
  • Hold a referendum in 2017 to determine whether Britain would remain part of the EU or not.
• Routes not on the table;
  • Britain seeking entry into the currency union.
  • Exiting the EU but remaining part of the single market (akin to the approach taken by Switzerland and Norway).

At the moment, the EU – and particularly the eurozone – is regarded as having a negative impact on the UK’s economic performance. Weak economies are acting as a drag on UK exports and prospects, economic and political, have been an on-going source of business uncertainty for several years. Europe’s institutions also have a significant influence on our regulatory burden. Moreover, there is some wariness about whether the reforms is it embarking on to address sovereign debt problems and shore up the banking sector will tie individual members states even closer together.

These events and issues are clearly rising to the surface as more consideration is given to what our relationship with Europe should look like. This is only part of story. The EU and the rest of the world will continue to change in the future and the not only needs to consider what is right for now, but what will be right for our economy in a decade’s time. First and foremost we need to see a marked improvement in the quality of debate and economic analysis on the decisions we face and we think these fall into three areas. Do the disadvantages of membership outweigh the benefits of membership or vice versa? What is the size of the prize of any renegotiations? Where is the rest of world heading in the next decade and how does the UK and the EU need to change in response.

For an export and investment focused sector like manufacturing, these questions are particularly pertinent.

In the coming months, EEF will be setting out some thoughts on these questions, but first our EU Challenge is open for business. We want to hear from companies – what’s  the good, the bad and the ugly of the EU.  AND important how does this impact on the day to day running of businesses and the ability to compete in global markets. 

Let us know. Tell us what’s good or bad about Europe, with a brief description of the direct consequences for your business. Does the EU need to change? Email us at euchallenge@eef.org.uk

Yesterday we predicted (along with most others) that GDP would be flat in the first quarter of this year. ONS instead gave us a much-needed upside surprise with a quarterly growth rate of 0.3% across the economy.

% quarter on quarter change

The UK's large service sector seems to have a had a good run over the past three months with output increasing by 0.6%. Excluding the quarter which included the effects of the Olympics, that's the best one for services since 2011q3.

Conditions in manufacturing, on the other hand, were still pretty weak. The headline was a quarter-on-quarter contraction of 0.3%. We don't get a lot of information about the economy from these first estimates, but we can tell that manufacturing had a particularly poor January - when output fell by 1.6%.  A quick calculation would therefore suggest that February and March were rather better, with likely to have expanded in both months.

The overall number was consistent with our Business Trends Survey last month which showed a balance of companies seeing output and orders fall in the first few months of the year, but with expectations that this would start to pick in the second quarter.

So, does mean everything is looking up? It's good news, but the reality check is that the economy is the same size as it was 6 months ago. We see progress in manufacturing with companies looking for growth in new markets and focusing on innovation. But overall progress in the economy will need to be measured over several quarters. In the meantime the focus on growth enhancing actions from government must continue. 

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

About the sector  

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

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

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

Pharmaceuticals and manufacturing output 2000=100

Source: ONS

Past, present and future trends 

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

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

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

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

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

There was a similar theme across other PMIs.

Manufacturing PMI 50= no change

Source: Markit Economics and ISM 

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

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

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

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

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

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

EEF Business Trends Survey - % balance of change

The OBR confirmed what other forecasts were already suggesting: the economy isn’t getting any bigger any quicker, and the deficit is taking longer to come down.

Despite this context, the Chancellor made a raft of announcements targeted at small businesses, large corporates, employees, parents and beer drinkers. There may be some political wisdom in the approach, but there are economic questions about whether reprioritised resources were focused sufficiently on growth enhancing measures.

Summary of key measures in Budget 2013:

Actions on the headline rate of corporation tax; the R&D tax credit, innovation schemes and growth vouchers are just about enough to label this a business-friendly budget. These moves will help push the UK up the ranking as an investment location of choice. But the reality of the next couple of years is that business investment growth is again going to come in weaker than expected making the path to better balanced growth an uphill one.

The mix of initiatives in this Budget, given the severe constraints on the public finances, really needed to be tilted much more on those that would deliver bigger growth dividends, such tax cuts on labour and capital and more spending on infrastructure. Next stop for bold decisions … the Spending Review.

Should FLS be put on steroids?  Will it ever make a difference to SME lending? Just a couple of lending related questions in the press this morning.

A few thoughts from a business perspective.  The latest survey data available on SME attitudes to finance - the BDRC SME Finance Monitor - showed last week that across SMEs (excluding those that are 'permanent non-borrowers') schemes that aim to reduce the cost of finance, such as FLS, do indeed increase companies' appetite for borrowing. So while weak trading conditions and uncertainty clearly continue to impact on SME's investment plans and external finance needs, for some at least, if you change one of the supply conditions - in this case the price of finance - demand will increase.   

As we wrote about last week, large numbers of SMEs would borrow but for some factor holding them back – that factor is very often discouragement (whether directly or indirectly) from finance providers or concerns about the costs and T&Cs on lending.  FLS can help with some of these factors. Six months in, if there are lessons to be learnt about making the scheme more effective, for example to a wider range of finance providers, to have more transparency about the split between mortgages and business lending or to put a lot more oomph into promoting to businesses, then let's do it.

But this is only temporary (whether extended at Budget or not) and doesn't fix the strained relationships between banks and businesses. Fundamentally our view is that the SME banking sector is simply not competitive enough - we need more dynamism and choice in the market for small companies.

Government also needs to take a hard look at the state of competition by immediately launching a review of further actions it could take to increase switching and bring forward new challengers. And it should also think hard about how to focus its proposed Business Bank on the key issue of competition in SME banking.

Any measures brought forward at Budget on SME finance need to both improve FLS and get cracking on competition.  

For more info see our Budget submission and our report on Finance for Growth

With the usual speculation heating up, last week the PM provided some context for next week’s Budget. We were again reminded of the dangerous imbalances that had built up in our economy and that the coalition’s three pronged approach to sorting them out remained the only real course of action.

PM: First, a clear plan to deal with the deficit; secondly reforming our banks so they serve the economy and third, restoring our competitiveness.

For much of the past three years the coalition has repeatedly emphasised its commitment to deficit reduction. EEF has supported government’s efforts to maintain its fiscal credibility, but with the rules now at breaking point the Budget needs to be attacking the UK’s growth challenges with a great deal more vigour.

EEF’s submission to HM Treasury ahead of the Budget builds on the themes of banking reform and competitiveness set out in the Prime Minister’s speech.

EEF CEO: “Having made it clear that it is sticking to its current economic course, the government must also demonstrate that it has the strategy to deliver the stronger economy that will pay down the deficit. This means accelerating action that will deliver public investment in key areas and unlock investment by the private sector.” 

On banking – as we have set out previously – the focus must be on increasing competition in SME banking. Government should now conduct a short review of options to increase competition in SME business banking that must include: an incentive to encourage switching banks; lowering barriers to new entrants; and moves to full account number portability.

On increasing competitiveness:

1. Commit to long-term compensation for energy intensive industries from environmental taxes.

2. Create the demand-led system of training and funding that has long been promised and commit to keeping decisions on skills funding national rather than devolved them to LEPs.  

3. Reallocate all departmental underspends and receipts from any future sales of public assets to infrastructure spending. Additional funding must be focused on projects that can provide a timely and significant boost to the economy such as local road maintenance and bringing forward planned upgrades to heavily-congested major roads. The government also needs to ensure that committed expenditure gets into projects as fast as possible.  

We do not, however, see the wholesale implementation of Lord Heseltine’s ‘Single Pot’ recommendations as the silver bullet on growth. What we must see in government’s response to the review is clear safeguards in place to ensure that significant amounts of taxpayers’ money are used effectively. In practice this will mean clear evidence that devolving control of funding delivers better value for money, LEPs demonstrating the capability to take on significant new responsibilities and control must being devolved gradually as LEPs prove their value in driving local growth.

To round off the poor economic news for the end of 2012, estimates for fourth quarter GDP growth for most of the eurozone countries were published today. Output across the 17 member bloc contracted by 0.6% in the three months to December compared with the previous quarter. Inevitably there was some variation in performance across the region, but the direction was pretty much one way - down.

% quarter on quarter change in GDP

Overall that leaves eurozone GDP around 0.5% lower in 2012 than in 2011.  The good news is that the scale of the actual contraction last year wasn't anything like as bad as some of the worst case forecasts that we presented a year ago, when the possibility of a break-up of the eurozone was still very much on the table.

That said, there have been consequences for UK exporters. Goods exporters from the UK, particularly to the euro-periphery fell last year. Sales to the rest of the world compensated to a degree, growing by almost 5% year-on-year. EEF's Executive Survey showed that just under half of survey respondents expected to see some growth in their business as a result of increasing sales to emerging markets. With weak demand likely to persist in Europe this approach will need to become a mainstay of manufacturers' strategies, particularly if the UK is to get on track to meet the government's stretching target to double exports by 2020. 

% change in goods exports by market