Manufacturing In The Uk

5. Manufacturing's share of the UK economy shrank from 19% in 1998 to 12% by 2007. Does this matter and, if so, how could policy revitalise British manufacturing?

In this essay I will examine the extent to which the decline in manufacturing as a share of UK GDP is something we should be concerned about. The six factors I will weigh up are the inevitability of this decline, whether it is likely to last, what is says about Britain's competitiveness, the simultaneous growth in the financial sector, how the decline relates to short-termism and the political issues it raises. I will then present policy measures aimed at improving the manufacturing sector. Before analysing the different factors it is vital that we interpret the figures correctly. Although manufacturing declined as a percentage of GDP between 1998 and 2007, according to figures from the Office for National Statistics manufacturing output was actually 3% higher in 2007 than in 19981. Manufacturing declined in relative terms, as other sectors of the economy grew at a faster rate, but not in absolute terms. Therefore the picture is more of an industry which is still recording positive, but slow growth. One reason for this sluggish growth is that much of the lower value manufacturing, such as the mass production of consumer goods, has been outsourced to low-wage countries such as China, where the average wage for a factory worker is a small fraction of what that same worker would be paid in the UK. This is a largely inevitable process, and as such should not overly concern us. All western economies have experienced a similar "hollowing out" of production processes, with unskilled, manual work moving abroad, and contrary to popular belief, the share of manufacturing in GDP in the UK is on a par with other advanced industrial nations. Data from the World Bank, for instance, shows the share of manufacturing in GDP in France is 11%2, almost identical to Britain's 12%. Another reason why the decline in manufacturing as a percentage of GDP may not matter is that some of the work which has been outsourced to countries where wages are low may in the not too distant future be brought back to the UK. This is due to rising wages in the countries, mainly in South and East Asia, where many consumer goods are produced, eroding their previously huge comparative advantage in producing lower value items. Over in the US, a recent survey of large US manufacturing companies by the Boston Consulting Group3 revealed that 37% of them were actively considering bringing more manufacturing jobs back onshore. Therefore to a certain extent, the issue of a slow growing UK manufacturing sector could resolve itself over time. What should concern us however is that our manufacturing sector has grown at a slower rate than that of our competitors; Spain, France, the US and Germany all recorded faster manufacturing growth than the UK over the period 1993-2004, according to a report by the EEF4. This is important as the sclerotic manufacturing growth is symptomatic of a loss of competitiveness in the British economy. In the competitiveness rankings drawn up by the World Economic Forum, Britain has slipped from 4th to 12th place over the last decade5. British schoolchildren ranked 16th in the world for science, 25th for reading and 28th for maths, according to the OECD`s 2009 PISA report6. That compares with a 2000 PISA ranking of 4th for science, 7th for reading and 8th for maths. A particular reason for the slow growth in manufacturing is that the UK provides a fairly poor system of vocational education compared to other countries such as Germany. In the UK a particular problem is a lack of employer engagement in vocational education schemes and low quality standards. During the years of the Labour government, this general loss of competitiveness didn't make itself apparent, as increases in state spending helped buoy the UK's growth. With the austerity programme the current government is implementing however, the erosion of our competitiveness is coming back to bite us, as contraction in the public sector is not being exceeded by expansion in the private sector; this is evidenced by the fact we are now officially back in recession. Therefore slow growth in manufacturing matters because it is a signal that our competitiveness is falling, which is now affecting the whole private sector and hence our ability to grow the economy out of the economic mire we are currently in. Furthermore, the declining share of manufacturing in the UK economy was mirrored by an equally rapid rise in financial services' share of the economy. This matters because by the time of the 2008 recession financial services accounted for around 10% of UK economic output. The economy was therefore dangerously lopsided and vulnerable to any decline in this particular industry. In addition, as opposed to the manufacturing sector, what happens in the financial services sector can have huge repercussions in the rest of the economy, due to the reliance of businesses on banks for loans and for depositing money. Therefore when some banks in the sector, such as Royal Bank of Scotland, HBOS and Northern Rock experienced financial difficulties due to the drying up of global capital markets, the government felt obliged to spend billions of pounds propping them up. The repercussions of this are still being felt today, as the current government is imposing austerity measures to try and curb the debt which was racked up in order to finance the bank bail outs. However, I would also argue that although the country became too reliant on the financial services sector, this is not necessarily to say that the answer to this is to turn solely to manufacturing. Greater emphasis could also be put on developing other service sector industries, such as IT, professional services and the pharmaceutical industry, as it must be recognised that although we should wish for a stronger manufacturing sector, the UK has less of a comparative advantage in manufacturing than it has in services. Professional services, such as legal services and accountancy, are particular strings to Britain's bow. An issue related to the rise in financial services is Britain's short term view of investment. This is part of the reason for the slow growth in manufacturing. Businesses have trouble securing investment funds for projects with a longer time horizon. UK firms also spend less of their retained profit on investment and more on placating shareholders in the short term, for example through larger dividend payments. The upshot of all this is that UK research and development spending as a proportion of GDP is half a percentage point lower than the OECD average7. Therefore the slow growth in manufacturing matters as it is a consequence of low levels of investment in the British economy, which will undoubtedly affect our economy's long run growth potential. What is interesting is that even though there has been no actual decline in the manufacturing sector when the figures are examined, there is a perception among the public that this is the case; this creates pessimism and fuels the idea that Britain is a nation whose power in the world is waning. Therefore British manufacturing is a very important political issue. This is particularly the case for the Conservative Party, which alienated millions of workers in the former manufacturing heartlands of the north during the 1980's, as many of the old coal mines, steel works and car factories were privatised, with resulting job losses. Any political party which manages to revitalise British manufacturing could reap large benefits in the polls. This is part of the reason why the current government attaches so much importance to this sector. George Osborne in his 2011 budget made reference to "the march of the makers", while the government has said it wants to see a British "manufacturing renaissance". The six factors I have examined lead me to believe that the declining share of manufacturing as a percentage of UK GDP matters chiefly because it is a symptom of an economy which is losing competitiveness. I do not believe manufacturing is inherently the best way for the country to pay its way in the world, although clearly manufacturing has a part to play as part of a broader economic base. Therefore although it may be politically expedient to champion manufacturing above all else, it is vital that the UK makes the most of and builds upon already existing comparative advantages in services, as well as trying to forge new ones in the manufacturing sector. The issue of whether the decline in UK manufacturing as a percentage of GDP matters is almost as hotly contested as the potential policy prescri ptions for such a decline. Two main strands of thought exist. Some would argue that the job of the government be limited to creating a level playing field for all firms and all sectors of the economy. The government, should then get out of the way and allow the market to decide where resources are allocated and which industries rise and fall. In contrast, others, such as the Labour leader Ed Miliband, support a more active industrial policy, with the government offering tax breaks to specific industries, doing more to lure business to the UK, and attempting to "pick winners". I would argue that the correct way to address sluggish manufacturing growth lies somewhere between the two. I do not believe that the government should attempt to back specific firms or industries over others. Firms are undoubtedly better at analysing the business case for an investment than the government, as they will have greater knowledge of the industry they operate in than the state, and so will be able to predict more accurately potential costs and benefits from investment. It is also difficult for any government to be completely unbiased when making an investment decision, as they will factor in political considerations. For instance, the current government could decide that in order to broaden its appeal to Scottish voters, it will offer tax breaks to manufacturing firms which set up in Scotland, regardless of whether or not Scotland is the right place for these firms to invest. This will not only reduce government tax receipts but also damage other areas of Britain which would otherwise have received the investment. Another issue related to this is the power that vested interest groups could have over government decision making. Firms would lobby the government to give special treatment to their industry. In the US for example, the farming industry has been very successful at persuading the US government to subsidise their industry. Total US farming subsidies in 2012 are expected to total around $11 billion8. However, we cannot expect manufacturing to flourish without government support. There are various measures the government could take to improve the competitiveness of the economy generally, which would help manufacturing grow alongside other sectors of the economy. The UK tax system is one area which is ripe for reform. In 1997 the UK was deemed to have the 4th most competitive tax regime in the world according to the World Economic Forum. By 2010, we had slipped to 95th place9. Our top income tax rate is the highest among the ten major economies in the world, even approaching the astronomically high levels seen in Nordic countries such as Sweden and Norway, and was labelled in an IFS report as "inefficient, overly complex and frequently unfair". Scrapping the 50p income tax rate is one policy measure which could be taken to improve the competitiveness of the UK economy. This would bring our top rate in line with the OECD average and increase the incentive for entrepreneurs to work in Britain. It could also bring in more revenue for the government; an IFS report in 2009 calculated the revenue maximising marginal income tax rate to be 39.8%, compared to the current highest rate of 50%9. Exemptions and reduced rates on VAT could be strictly limited or removed altogether to increase revenue and reduce market distortions. Financial Services, for example, are exempt from VAT, at a cost of £10 billion a year to the taxpayer10. Capital gains, corporation tax and income tax rates could be aligned more closely, making it more difficult for people to avoid paying tax and cutting administration costs. A far simpler tax system with fewer loop holes, a broader base and lower marginal rates would enhance the UK's global competitiveness, making the UK a more attractive place for manufacturing firms to invest. Reforms could also be made to the education system. Greater emphasis could be placed on creating more high quality apprenticeships, which have for too long been viewed as inferior to university education. This would equip UK workers with the practical skills manufacturers require, instead of them gaining a university degree which is purely theoretical, which would in turn increase the productivity of manufacturing firms. Part of the reason German manufacturing has blossomed over the last decade is down to a sophisticated government-subsidised apprenticeship scheme which combines study at a college or university with on the job training. Investment in engineering and the sciences should be increased. There could especially be a drive to increase the number of students continuing with sciences and maths at A-level, through improving careers advice for 16 year olds, and engineering could be made much more widely available in schools throughout the UK. The government could subsidise maths, science and engineering degrees at university, to provide a financial incentive for students to take these subjects. An increase in the number of students graduating with engineering, maths and science degrees would make graduates more employable, encouraging high end manufacturing and service firms, such as pharmaceutical or IT companies, to relocate to Britain. To conclude, with the right policy prescri ptions, such as the ones I have mentioned above, Britain can develop its service and manufacturing industries, and thus diversify away from an excessive reliance on financial services, helping us to raise the long run growth rate of our economy and ensure a better future for the next generation. The decline of manufacturing as a proportion of our national income should act as an alarm bell, letting us know that Britain has become less competitive relative to other developed countries and has adopted an economic model based on short-termism instead of taking a longer term view of investment. The relative decline of manufacturing compared to other sectors of the economy in no way signals the death knell of the manufacturing sector. It is unlikely that there will be anything as dramatic as a "manufacturing renaissance", as the government hopes. Insofar as there is a "march of the makers", it is doubtful whether the UK economy will be "carried aloft" by it, despite George Osborne's best wishes. However, through the implementation of the right policies and the avoidance of the temptation to pick winners, the government can preside over a manufacturing sector which does record faster growth and creates more jobs for people in the UK.

References and Bibliography

1. Timetric. Index of Production UK. 12 April 2012. Available from: http://timetric.com/topic/industrial-production-indicators-ons-uk/ (Accessed 14 April 2012) 2. University of Cambridge Institute for Manufacturing . Manufacturing Industry Statistics 2009. September 2009. Available from: http://www.ifm.eng.cam.ac.uk/cig/09stats/international.html (Accessed 15 April 2012) 3. Boston Consulting Group. Press Releases: More Than a Third of Large Manufacturers Are Considering Reshoring from China to the U.S. 20 April 2012. Available from: http://www.bcg.com/media/PressReleaseDetails.aspx?id=tcm:12-104216 (Accessed 24 April 2012) 4. Engineering Employers Federation. High Value: How UK Manufacturing Has Changed. November 2007. Available from: http://www.strath.ac.uk/media/departments/siom/documents/media_90370_en.pdf (Accessed 8 April 2012) 5. HM Treasury and the Department for Business, Innovation and Skills. Plan for Growth. March 2011. Available from: http://cdn.hm-treasury.gov.uk/2011budget_growth.pdf (Accessed 15 April 2012) 6. Department for Education. Major international study shows England's 15-year-olds performing poorly in mathematics, science and reading. 7 December 2010. Available at: http://www.education.gov.uk/inthenews/inthenews/a0070042/major-international-study-shows-englands-15-year-olds-performing-poorly-in-mathematics-science-and-reading (Accessed 16 April 2012) 7. Alain Anderton. Economics. Fifth Edition. Navarra, Spain; Graficas Estella; 2008. 8. Financial Times. US Farm Subsidies Attacked Amid Boom. 22 February 2012. Available at: http://www.ft.com/cms/s/0/3e2343a4-5d62-11e1-869d-00144feabdc0.html (Accessed 17 March 2012) 9. Centre for Economics and Business Research. The 50p Tax: Good Intentions, Bad Outcomes. November 2011. Available at: http://www.cebr.com/wp-content/uploads/50p-Tax.pdf (Accessed 14 April 2012) 10. Financial Times. IFS Hits at "Frequently Unfair" Tax System. 14 September 2011. Available from: http://www.ft.com/cms/s/0/f0e8eb46-de10-11e0-a115-00144feabdc0.html. (Accessed 14 April 2012)

Other sources which gave me inspiration when writing the essay were:

. Michael Todaro/Stephen C. Smith. Economic Development. Eleventh Edition. Westford, USA; Courier; 2011. . UK Parliament. Budget 2011 Statement. 23 March 2011. Available at: http://www.parliamentlive.tv/Main/Player.aspx?meetingId=7925&st=12:32:40 Accessed 1 April 2012) . The Economist. The Midlandstand. 11 February 2012. Available at: http://www.economist.com/node/21547264 (Accessed 15 March 2012) . World Economic Forum. The Future of Manufacturing: Opportunities to Drive Economic Growth. April 2012. . Lee Kuan Yew. From Third World to First: The Singapore Story 1965-2000. New York, USA; HarperCollins; 2000.