EEF blog

NOTE: In a three-part series, Stephen Radley, EEF's Director of Policy and External Affairs, will assess the future for UK manufacturing. The first installment will look at how UK manufacturers weathered the recession, the second will look at the prospects for growth and the third - which will coincide with the launch of EEF's Manifesto for Manufacturing - will set out what the next government can do to rebalance the economy.

Like the rest of the economy, manufacturing has been through a tough time over the past 18 months. But more recent signs - including EEF's latest quarterly sruvey of members - suggest that the mood amongst manufacturers is changing.

But just because things are looking brighter for manufacturing, we shouldn’t be complacent.

The recession will have damaged supply chains, some companies will struggle to find the skills they need to meet increased orders and businesses will remain vulnerable if they cannot access the additional working capital they need in the early stages of a recovery.

But the more positive figures should also serve remind us of the major strides that manufacturers had made before the banking crisis hit. 

Even up to the middle of 2008, many manufacturers were reporting their best results for at least a decade: Investment intentions were strong. Profitability was soaring. And employment was expanding.

These gains were achieved on the back of a fundamental rethink of what UK manufacturers needed to do to compete in world markets. The recession of the early years of the last decade had shown that too few manufacturers had the right strategies to cope with the rise in competition from lower labour cost countries and with unfavourable movements in exchange rates.

One of the most significant changes has been a shift away from competing on costs.

EEF research in 2004 showed over a third of companies aggressively cutting prices in response to lower labour cost competition. By 2007, this proportion had fallen to just one in eight firms.  In addition, almost half of them had considered but rejected this option, recognising that this was not a sustainable response to low-cost competition. 

In contrast, nearly six in ten manufacturers had taken action to increase focus on innovation with a further 30% either planning to or considering it.  Companies also reported that they were seeking to compete by developing niche products and service offerings. Reflecting these changed priorities, more manufacturers reported that design and development rather than production and assembly would be a key source of competitive advantage in the future.  

Their commitment to these strategies is illustrated by last year’s annual EEF Innovation Monitor which showed that despite the recession, manufacturers reported an increase in most forms of innovation and expected this to continue. Our research also showed that companies were taking a longer view of investment with payback periods lengthening and were increasingly focusing on more intangible forms of investment such as research and development, design and marketing and organisational change. 

This change of tack has already started to deliver results.

After lagging behind the rest of the world’s major advanced economies in the 1990s, UK manufacturers were second to only the United States in improving productivity in the years before the recession. And despite the biggest contraction in world trade since the last world war, a recent EEF survey showed that over a third of manufacturers had managed to expand their exports, with a further 16% maintaining export volumes. Indeed, some 15% recorded an increase of 10% or more in exports. 

We are also starting to see some manufacturers starting to bring production back from abroad. Our most recent research showed one in seven firms doing this, in part reflecting disappointment with the cost savings and quality standards achieved by their investment abroad and concerns over getting products to market fast enough.

But it also demonstrates that more manufacturers have found that they can compete from a relatively high wage cost location like Britain...and it's why UK manufacturers are leading the economy out of recession.

It's a good start to the UK's first Manufacturing Week.

First EEF's Manufacturing Outlook shows that Britain’s manufacturers are looking to the future with greater confidence about the prospects for recovery: orders are returning and companies are consequently the most upbeat since the financial crisis began in mid-2007.

And then today's PMI's showed sustained strength, and the best export-orders since July 1996! More importantly, the Eurozone PMIs showed renewed strength in German and French manufacturing...again, more good news for exporters.

But we have to be cautious about predicting a strong rebound, as a number of factors could knock growth off track.

The recovery depends on world markets continuing to grow, and the financial system’s ability to provide finance is yet to be fully tested. And investment plans are also likely to remain on hold until manufacturers get a better sense of how a new government plans to repair the public finances.

2009 was a painful year for most manufacturers, but it looks like the sector ended the year on a strong note.

Today's Index of Production figures for December suggest that manufacturing grew by 0.8% between q3 and q4 last year.

Although that strong growth reflects a weak summer - there were plenty of shutdowns in August - the growth in the Autumn was broad-based. And that's (hopefully) a sure sign that there's decent amount of momentum behind the recovery.

Will q1 2010 be just as strong? I'm beginning to change my mind. Activity could fall off because of the wintery start to the year, but we're starting to hear more positive stories from manufacturers about their prospects.

Many companies I've spoken with over the past 6 months said that spring 2010 was always their target date for recovery - the question was what happened in between now and then. The encouraging news is that spring is getting closer and the potential pitfalls - exchange rate volatility, slower global growth and withdrawal of stimulus - are falling by the wayside.

Two big concerns remain: China and the public finances.

Can China avoid a wage-price inflationary bubble without derailing its economy? Can the (next) UK government credibly repair the public finances?

Those are the two big questions remaining for 2010.

Another day, another set of data suggesting that UK manufacturing is starting to shake off the worst of the recession.

And that's good news because without exports, there's little else in the economy that's going to give the wider recovery the spark it needs.

This morning, the CIPS/Markit UK Manufacturing Purchasing Managers' Index put manufacturing activity at 56.7 - a 15 year high. Anything above 50 on the index indicates growth, the higher the number, the stronger the growth.

The survey showed that growth was fairly broad based. New orders were the strongest in six years because of both domestic and export demand.

And even the employment index managed to squeak above 50.

The one (small) red-flag in the report was on the cost side. The strong global manufacturing recovery - especially in China, which posted a record PMI for January - and the weak sterling are pushing up costs of imported raw materials. that means manufacturers are likely to keep one eye on inflation and continued cost control.

EEF have long said that tax reform needs to be central to rebalancing our economy.

But because of silly Whitehall turf wars, the good work coming from BIS on industrial activism and a manufacturing strategy has often existed apart from the realities of the tax system.

For example, the Strategic Investment Fund of £950m is being put to use to encourage investment in growing markets and supply chains.

But the capital allowance regime actively discourages manufacturing investment.

How? 

Manufacturers replace their equipment, on average, ever 7-8 years. With a capital allowance level of 20%, the tax system only recognises that investment over 28 years. That gap raises the cost of investing in modern machinery in the UK. Looking across the tax system, you get similar disincentives to invest in manufacturing.

But at a speech on Monday night at a Progress event, Pat Macfadden, the BIS Minister linked the two issues of tax and industrial activism.

It was a first for the government and an extremely welcome recognition that building a balanced economy requires strategy that is implemented across government, not just by a forward-looking BIS department.

Today’s data confirm that manufacturing is now out of recession.  But they also continue to raise questions over the health of the wider economy.

Previously, we've said that weaker growth in Q4 would be a good thing, because a strong q4 would most likely have come at the expense of a weak start to 2010.

But at 0.1% q-q, GDP growth was very weak in q4. Not even a strong boost from manufacturing of 0.4% q-q could boost growth in the wider economy. 

So while exports remain the best prospect for a turnaround, the next six months will be uncertain one for the recovery.

Read our reaction on the BBC website.

Back in December, the head of construction company told me the following:

"No one has got to grips with what's just happened to us. Which means the don't really understand what it takes to get us out of this. And that leaves us drifting."

His comment got to the heart of the matter - do we really know where we are , why we've gotten here and where we want to go as an economy?

A couple of recent reports on the state of government in the UK suggests why we haven't come to grips with our problems:

"a conspicuous lack of a single coherent strategy for government as a whole...inhibits the ability to set overall government priorities and translate them into action."

Another report by Whitehall Manderins comes to similar conclusions and makes the following recommendations:

• improve the quality of legislation by slowing down the legislative process and improving scrutiny;
• strengthening Commons Selet Committees; and
• stopping the frequent shifting of Ministers.

Although these criticisms are slightly sensational as they come just months before an election, they are all too familiar to businesses at the sharp end of frequent changes to the tax and skills systems, for example.

EEF raised these issues last year - first in our report on the competitiveness of the tax system, and then again in Manufacturing. Our Future. report which set out a government-wide strategy to rebuild our economy.

So what's the key challenge for the next parliament given these criticisms about the state of government?

Thinking and acting differently, because we can't afford to drift any longer.

We've argued that the key to UK's prospects in 2010 depend on how it fared at the end of 2009.

Did consumers spend more in the Christmas season? If so, did that shopping splurge come at the expense of spending in the New Year?

A stronger December 2009, therefore, could signal a weak start to 2010 and the recovery.

Well, the good profit results from the high street retailers was a strong sign of a healthy Chistmas.

Today, data on the public finances suggests the government got a big boost in VAT receipts - a sure sign that spending jumped in December 2009. As Barclays Capital write:

"On the revenue side, central government receipts were 1% y/y higher in December, well off the low of -22.3% y/y seen in March 2009 but still substantially below the growth of close to 4% that was typically seen prior to the financial crisis. Income tax receipts remain weak, down 8.4% y/y, but VAT receipts have recovered somewhat, rising by 4.4% y/y (the strongest growth since September 2008), giving further credence to the view that pre-Christmas spending was firm."

Next Tuesday we get the Q4 GDP numbers. My guess is that strong q4 growth (anything above 0.6% q-q) is likely to be a bad sign for the recovery. Weaker growth is likely to be a good thing.

Like any good economist, we're expecting 0.6% - so on the one hand...and on the other...

A jobless recovery...but a recovery nonetheless. 

The markets might be disappointed in today's jobs data from the US, but a look at the details and a little knowledge about previous recession suggests that the US recession ended in July or August of 2009 and that the labour market is on the mend.

If you look at previous US recessions, two sure signs that a recession is 'officially' over are the ISM new orders index above 55 for three consecutive months and the number of temporary workers on the rise. (Official dating of recessions is done by a group of academics months, sometimes years after the fact, so economists look for clues in current data.)

So the key stat in today's numbers are the temporary employee figures. They've been on the rise since July...the same time that manufacturing new orders started rose above 55 (on the ISM index) since late 2007.

That's not to say that the economy is going to bounce back strongly in 2010 or that the labour market in the States is going to add jobs at a steady clip. But it does suggest that companies are seeing a pick up in activity and are taking on temporary workers because they're uncertain if the orders will last.

The real question is when will businesses be confident enought to start taking on permanent staff rather than temps, how many permanent workers do they take on and how quickly?

That will determine the strength of the recovery.

The electoral cycle is complicating the economic cycle.

Markets, worried just as much as we are about how the UK economy will fare in what's set to be a stormy 2010, are also worried about the prospect of a hung parliament or a minority government.

Any new government will need to set a credible plan to address the perilous state of public finances. But a hung parliament or a minority government will find it very difficult to push through the necessary tough reforms.

If that happens, we're worried that businesses and consumers will become extremely cautious about investment and spending, weakening economy. And the markets are worried that a weak government and economy will mean the tough choices are pushed back, worsening an already decaying fiscal position.

That means that sterling is being buffeted about by investors second guessing the outcome of the election and the growing tension between the renminbi and the dollar. And a volatile exchange rate prevents manufacturers from taking advantage of export opportunities in growing markets, reinforcing business caution and the weak economy.

Consequently, bond holders are starting to shy away from UK government bonds...what happens when the Monetary Policy Committee decides to unwind its quantitative easing programme, but can't find any buyers for UK gilts? Prices will fall and interest rates will rise...undermining the economy.

The market's belief that the UK economy is risky is self-reinforcing, helping the UK economy get off to a rocky start to 2010.

So, yes, the election is about the economy, stupid. But the economy is very much about the election as well.

ps In case you were wondering, there's absolutely no snow in Westminster. Must be all the hot air.