Does manufacturing matter?

Reports of the demise of UK manufacturing have been greatly exaggerated, but challenges lie ahead. The government must concentrate less on increasing the size of the sector and more on making it globally competitive

By Vicky Pryce FRSA

Since the recession in 2009 – which, in hindsight, appears to have been exacerbated by an overreliance on the City and the financial sector for increased productivity and growth – the former Labour government and the coalition have sought to rebalance the economy. They have placed greater emphasis on alternative sources of competitive strength, including manufacturing. This is partly a response to the fact that Germany, which has a relatively large and export-focused manufacturing sector, seemed to recover from the recession much more quickly than the UK, although its growth rate has slowed down rapidly this year because of instability in the eurozone. But can manufacturing really increase the UK’s prosperity and substitute for a shrinking government and a smaller financial sector?

This is not a new debate. There are few issues in economics that generate such strong and opposing views as the role of manufacturing. On the one hand, there is a view that grew to prominence in the 1980s that might be characterised as ‘manufacturing does not matter’; as long as we have strong growth, its split by sector is not important. At the other end of the spectrum is the view – most closely associated with Nicholas Kaldor and new Keynesian economics – that manufacturing is the key driver of growth in an economy. According to this view, the sector should account for a rather more significant share of GDP than it currently does.

My view lies somewhere between these two extremes. It is essential that the UK exploits opportunities for growth in output and employment wherever they exist, whether in manufacturing, services or construction. The government’s role is to identify barriers to growth and seek to address them. We know that some of our most productive and competitive businesses are in manufacturing, in both established areas such as pharmaceuticals and aerospace, and emerging areas such as life sciences. For me, this means there is a clear case for the government to take action, where appropriate, to promote manufacturing growth. But what matters is the dynamism and competitiveness of the sector, not its absolute size.

Throughout the time I spent working for the government during the first decade of this century, the role of the state in setting industrial policy was a subject of constant debate. Business secretaries of state often looked at the German, French and Korean models – as well as the Japanese one, before the stagnation there – as examples to follow. But there is no doubt that picking winners leads to pitfalls from which we take a long time to recover. And the German and French models do not always work. Look at what happened to the Germans when their economy grew so little between 2000 and 2005 that they began to try to emulate the Brits. Meanwhile, the inefficiency of the French government’s capital spending still haunts it today.

Due to the lack of economic growth following the financial crisis, the policy climate is once again becoming more interventionist. November’s UK growth review emphasised medium-sized companies’ need for funds, while the chancellor is looking at the ‘credit easing’ option, whereby the government provides direct help to small and medium-sized businesses. A fair share of any additional money, if it ever materialises, will go to manufacturing firms.

Manufacturing has, in fact, benefited disproportionately from government support. The vast majority of the funds for business support channelled through the Department for Business, Innovation and Skills (BIS) and its predecessors in the past few decades has gone to manufacturing. Large sums of money have been made available to, say, the aerospace sector, rather than, say, design. Moreover, innovation policy, including R&D tax credits, has predominantly focused on things that can be seen and added up, touched and verified. Although the Department for Culture, Media and Sport is concerned with some softer issues, including many of the creative industries, it has a small budget. And it is only recently that BIS has established a unit that looks after the needs of the professions, in particular business services, which now account for some 20% of GDP and an increasing percentage of our exports.

The bias in government policy has, if anything, been towards manufacturing and industry. This becomes clear whenever there is an announcement of special help given to manufacturing firms to preserve, for example, 500 jobs and whenever there is an outcry from the regions following closures that threaten industrial jobs. Much larger job losses in the services sector seem to be treated in a less emotive way and attract little follow-up action after they have been announced.

Yet in the case of manufacturing, the government regularly sets up task forces, organises retraining, redeploys sacked workers and pours money into the region concerned. At times, the secretary of state becomes involved in trying to attract potential buyers and push a deal through, which usually attracts great publicity. Just think about the fuss over Kraft’s acquisition of Cadbury. It almost made chocolate a strategic national asset in the minds of many people, a bit like what happened with yoghurt in France when a foreign country put the national brand, Danone, under threat.

Despite the fact that we have vibrant service sectors that employ four-fifths of those in work, we care about manufacturing. Let’s accept that. But do we understand it as a nation? In particular, in the middle of the current rebalancing debate, do we understand how good we are at manufacturing? We remain the seventh-largest manufacturing nation in the world. Just before the latest recession hit, we were producing as many cars as we were during the peak period of the 1960s, although the companies that produce them now are almost all foreign owned. Fortunately, Jaguar Land Rover, now a subsidiary of Tata, the Indian conglomerate, has just announced an investment in a new production facility in the Midlands. Nissan and BMW are also investing more in their UK plants.

Manufacturing productivity in the UK had increased by 50% in the 10 years prior to the crisis and the UK has been steadily moving to more advanced manufacturing production by becoming part of a global supply chain. In fact, in 2010, the UK was running out of capacity to meet increased demand for goods from emerging markets, which it was supplying both directly and via Germany’s export market for finished goods.

We are still world leaders in sectors such as aerospace, pharmaceuticals, chemicals, defence equipment and energy products. Productivity remains higher than in the service sector and there is more on-the-job apprenticeship training. Manufacturing creates employment in many related service areas: in fact, one study suggested that every manufacturing job creates four non-manufacturing jobs. Even if this is an overestimate, the multiplier effect is certainly significant.

Arguably, we worry too much when we look at the statistics for manufacturing. The distinction between manufacturing and services is becoming more and more blurred. The most successful companies will be those that combine a manufacturing and a service element in the package that they offer customers.

In 2005, the UK manufacturing sector accounted for about 14% of the total value of services exports. And there is further to go: a recent BIS report concluded that manufacturing firms in the UK had not, on the whole, been as swift to develop new service opportunities as their counterparts in the US or Germany.

Obstacles to growth

But given the impact of globalisation, and particularly the availability of cheaper labour abroad, will we ever return to the ‘golden age’ of the 1960s, a period of major manufacturing successes? We can only answer this question by looking at the ever-increasing challenges we face.

The first of these is, of course, the current economic slowdown. In the short term, growth in both the UK and the key European export markets is likely to remain subdued. The International Monetary Fund, for example, is forecasting UK growth of 1.3% in 2011 and 1.8% in 2012. Growth throughout the eurozone is expected to be very weak. The potential uncertainty over the euro may persist and, combined with the impact of fiscal retrenchment in many OECD economies and private-sector deleveraging, it may hold back growth for some time. Unlike the Germans, we do not seem to be producing in bulk the sort of goods that are in demand in China and the other BRIC nations. This is a major drawback.

The globalisation of supply and value chains presents another considerable challenge. Competition takes place at every stage of the supply chain, not just at the level of the finished product. Emerging economies, notably China and India, are not only competing on the basis of lower costs, but also on the high value-added parts of the value chain. Globalisation is not all bad news, however. As emerging economies become wealthier, they present significant opportunities for higher-value goods and services.

Closely linked to globalisation has been the ongoing – and, some would argue, accelerating – change in technology. This provides huge scope for innovation, which, while it creates new markets, increases competition in existing ones. The government has actively promoted cross-industry and university or business collaboration through the Technology Strategy Board; it now hopes to do so through the creation of new innovation centres that will focus on technologies with serious growth potential. The UK has remained a centre of innovation and has done well in attracting internationally mobile investment and skilled researchers and developers, including both people and facilities. The competition from advanced countries for brains and resources has, however, remained intense and the emerging markets are gearing up in this area.

The application of new technology, and innovation more generally, will be essential if the UK is to compete for the development of sustainable, environmentally friendly goods that can help tackle climate change. In many countries, government subsidies that favour particular technologies are distorting the competitive environment and the search for the cheapest and best solutions. But the main gain will be in business practices, particularly in the manufacturing sector, that make ‘green’ concerns part of their mainstream production processes. This is where engineering and technological ingenuity will help.

All these challenges become more urgent in the context of broader demographic change. As the average age of the population increases in both the developed world and the emerging economies, the pattern of demand can be expected to change. Healthcare is the obvious candidate for additional (relative) demand, but it is by no means the only area in which the age of the population will have an impact. We can expect to see more blending of manufactured goods and services, for example in remote health monitoring. Tougher immigration policies may affect the UK’s competitiveness in this area.

How firms and the government prepare for, and react to, these challenges will be key to determining whether or not the overall impact is positive or negative. The manufacturing sector must continue to move into higher value-added areas of production (both higher-value goods and higher parts of the value chain for those goods). These areas offer the biggest scope for growth in wages and profits, and enable firms to limit the threat of competition from low-cost producers.

Innovation is key to securing a growing share of that higher-value production, which all industrialised nations will be trying to exploit. As well as new or enhanced products that better address the requirements of wealthier customers, such innovations can include more efficient methods of production that reduce cost, speed up production time or improve quality.

Most innovation involves small, incremental improvements to existing products or processes. Genuinely disruptive innovations – ones that change the whole nature of the market – are relatively rare. These may come from existing companies, but they may also arise in new firms or from firms that previously operated in another sector.

State support

What, then, is the role of the government in all this? In principle, it should not engage in activity that the private sector can readily do itself. There should always be a ‘market failure’ test for any potential policy intervention: namely, it must be shown to address a real problem in the market and it must do more good than harm (so the benefits must exceed the costs). The government should not, in my view, deliberately divert resources from one sector, or one group of companies, to another through selective tax breaks or unbalanced regulation.

This still leaves many areas in which the government has a role to play, as long as it can design and implement policies effectively. These areas include helping small, growing firms to gain access to finance, promoting links between business and universities, and supporting the development of networks and clusters for innovation. Many of these policies will, and should be, generic in nature: in other words, the government should support firms in all sectors of the economy. Sometimes, however, the policy, or the way it is delivered, should be tailored to the particular needs of the manufacturing sector, which is why, in England, we have a bespoke Manufacturing Advisory Service.

Successful innovation requires skilled and capable employees. Government investment in the supply of skilled labour will have an impact on the UK manufacturing sector’s ability to prosper in the years ahead. This investment is important at the graduate and postgraduate level, as well as at lower qualification levels, such as those generally gained during apprenticeships. Tight public budgets mean that individuals are having to bear more of the cost of higher education. As yet, it is unclear what impact this will have on the number of future graduates, as well as how well they are prepared for the world of work. The government has taken steps to protect numbers in science, technology, engineering and mathematics subjects, which are likely to be of particular benefit for the manufacturing sector. On the other hand, it is possible that students who leave university with large debts will be (even) more reluctant to join manufacturing SMEs because such companies tend not to offer fixed career paths.

The overall business environment for UK firms must remain favourable if we are to keep existing businesses here and attract new ones from overseas. This means being competitive on a range of policies, including the tax system, transport infrastructure and appropriate – but not excessive – regulation. This is an area in which perception matters as well as reality; we need to offer a favourable impression to potential inward investors. The UK has traditionally had a strong reputation for openness, and the latest data (2010) for the World Bank’s Ease of Doing Business Index ranked the UK fifth in the world, behind Singapore, New Zealand, Hong Kong and the US. This put it one place higher than in 2009.

The UK’s manufacturing sector clearly has an important role to play in contributing to growth and prosperity, but we should expect it to change considerably in the coming decades. Already, it is much smaller – in 2009, it contributed slightly more than 11% of GDP, compared with 32% in 1970 – and, while it is unclear whether it will contract further, we are unlikely to see it increase significantly in comparison with other sectors. So the notion that rebalancing the economy will see a significant expansion in manufacturing’s share of GDP is unrealistic. The trend towards a smaller manufacturing sector is one we have seen in all major economies.

Moreover, the sector’s best chance of success lies in its becoming more specialised and more productive. This means that employment may well continue to fall, but employees will become more highly skilled. Although we are unlikely to see the emergence of ‘ghost towns’ of the kind that appeared in the 1980s – not least because manufacturing now forms a much smaller part of the national, regional and local economies – changes in the location and size of the sector are likely to have a disproportionate impact on particular areas.

We need to accept that manufacturing will continue to face major challenges in the short term due to the ongoing weakness in the world economy. In the longer term, it will feel the effects of the changing nature of global production as economies such as India and China move up the value chain and intensify the level of competition. But there are also huge opportunities, since those same economies will increasingly provide a new source of high-earning potential customers. The UK has, in fact, proved to be resilient, and highly innovative, in this respect. 

Reports of the demise of UK manufacturing have, therefore, been highly exaggerated. We may, however, have to accept that it will be smaller than in the past, albeit much more dynamic. And while UK manufacturing can remain globally competitive, this may be at the expense of employment.

It is essential that government policy continues to support growth and employment throughout the economy, directing investment and skilled people to the areas in which they can be most productive.


Vicky Pryce FRSA is senior managing director at FTI Consulting. She was previously joint head of the Government Economic Service and director general of economics at the Department for Business. Photography: Pixeleyes


Solderpad: open-source electronic design

Almost 80 people have signed up to an RSA-backed initiative that aims to apply the principles of open-source software to hardware electronic projects.

Andrew Back FRSA and Paul Downey FRSA set up the Solderpad website earlier this year as a way of enabling students, designers, engineers and people who work in the electronics industry to collaborate virtually on the design of electronic projects. These can range from something as small as an alarm clock to something as ambitious as a car or satellite.

Traditionally, restrictive or unclear licensing rules and a lack of interoperability among electronic tools have made it hard for designers to share and improve on existing hardware projects. Solderpad enables people to publish their projects online – including details of the components used and rights granted – and invite other site members to contribute their ideas and feedback. To date, 26 projects have been published on the site.

Solderpad has benefited from a £1,155 RSA Catalyst grant, which Back and Downey are using to cover the first year’s website hosting costs. They aim to maintain a free service for individual users, which they will fund by charging a subscription fee for organisations that want to run private projects via the website.

Back now hopes to increase participation through the RSA’s networks. “We envisage that projects will be designed by organisations from a range of geographies but manufactured locally, creating opportunities for established businesses and new micro-enterprises,” he said. “We’re also keen to work with universities to facilitate collaborative research and make their work more public.”

For more information or to offer your support to the project, please email the Fellowship team or visit solderpad.com