Select Committee on Trade and Industry Minutes of Evidence


Examination of Witnesses (Questions 63-79)

MR MARTIN TEMPLE, MR DOUGLAS PEEDLE AND MR MICHAEL BAUNTON

TUESDAY 5 FEBRUARY 2002

Chairman

  63. Good afternoon, Mr Temple. This is the second hearing we have had on competitiveness and productivity and will be one of our major inquiries. In some respects we have gone over bits of the ground already with you and your colleagues in previous hearings and in the predecessor committees, but we are very grateful to you for coming along today. I think we would maybe want to start with how you see the state of play in manufacturing at the moment, and perhaps in introducing your colleagues and yourself you could also tell us a bit about the EEF and the number of organisations and people you have under your umbrella, and how you see the state of manufacturing industry in the UK at the moment.

  (Mr Temple) I am Director General of the EEF and I have brought with me Mike Baunton, who is President of Perkins Engines in the UK, and Vice President of Caterpillar Inc. He is also, amongst many other activities, Chairman of Industry Forum, so has very great knowledge on what is happening out on the ground. I also have with me Douglas Peedle, Deputy Chief Economist at the EEF. The EEF is a business representative organisation, mainly supplying services to companies. We have about 6000 member companies dominated by the engineering manufacturing sector; we do representation work as well but we also work for a large number of companies on a more commercial basis, so I would say that generally we are working with about 10,000 companies at any point in time, and we are linked with a lot of other trade associations and trade bodies in our budget representations—there are about 23 of those—and through an informal grouping called the Manufacturing Alliance. If I can just then take us into the economic situation as we see it, the engineering manufacturing sector has certainly been in recession last year. We saw that, between the period of last year, manufacturing was falling by about 5.7 per cent and engineering by about 11.1 per cent, but when you compare that over the 1990-1992 period, which is the last major recession that we saw in manufacturing, those figures were 6.5 and 13.2 per cent, so these are very similar figures over one year compared to a very deep recession in manufacturing over nearly a two-year period some ten years ago. Clearly the dominant factor there has been the world slowdown. All industries have been cutting output but it has been most noticeable in quarter four of last year, where we saw pretty well every sector dipping noticeably further in terms of output and orders and we also saw every region, with the exception of the Northern Ireland, dipping noticeably in terms of sector representation, orders and output. Over the year, electronics and electrical goods showed the worst falls: it is interesting inside the figures, though, and probably relating to the consumer spending that has been going on, that those people in consumer goods tended to fare a little bit better within that grouping and again, in quarter four last year, we saw a substantial change in employment prospects and investment plans—a serious dip. When you look at the graphs, they are not just a little gentle slope but quite a step change down. That also reflects itself in intense pressure on margins and prices—again, a step change in people's view about that and their prospects for quarter one would reflect a similar view. That in my view suggests that there is, over the current period of time, absolutely intense pressure on people in the overall manufacturing sector, dominated by cash flow, which is not surprising when one is looking at margins and prices under pressure: they have also clearly had a hit on volume which was not the case in previous years, and this, clearly, is having a massive impact on their investment prospects which is probably what worries us most. I can talk about whether there will be a recovery later, but perhaps I can ask Mike Baunton to talk a little bit on the way they are looking at the future investment side of the result of this.
  (Mr Baunton) Chairman, thank you for inviting me. In terms of the experience that I have and in terms of Industry Forum, I am also a director of the Society of Motor Manufacturers & Traders and, when you look at the automotive industry, the figures for motor vehicles are well publicised but underlying that there is a substantial resourcing of components away from the UK to overseas locations, much of which has yet to hit in terms of unemployment numbers and the lack of investment going forward. I have been at pains to talk to government ministers and to civil servants about this effect because I think a lot of the statistics do not show this factor and I am very worried and we are seeing now in the press that more and more companies are going bankrupt as a result of the loss of orders, and I think there is a lot more to come. So it is quite worrying.

  64. I think this mirrors or confirms fears that we expressed some 18 months ago when we — the previous Trade & Industry Select Committee — did some work on the car industry, and we were conscious that the price of getting the placement of models in particular sites in the UK was often the redirection or sourcing outwith the UK. Really what I was going to say, however, was it is not just outside the UK but outside the euro zone as well, is it not, and there are central eastern suppliers who now seem to be coming in, because one gets the impression this is not just a UK malaise. Am I right in saying there has been a 6 per cent drop in German manufacturing as well and an even higher one in France and Italy? Am I not correct?
  (Mr Baunton) I could not quote the absolute numbers but certainly you are quite right—there has been substantial sourcing to Europe in the broadest context, not just euroland but certainly areas with low labour costs and, now, with relatively high quality and high technical capabilities, so it is not just a UK malaise although I would have to say that the consolidation of some of the manufacturers, not just in the car industry, has tended to focus some of the higher volumes into areas like France and Germany for components, but there is still no question that your point is certainly valid—the move is generally across the whole of Europe, not just the euro zone.
  (Mr Temple) We would agree with your figures of the German situation.

  65. So is this unremitting gloom? Is there a chink of light at the end of the tunnel yet?
  (Mr Temple) This is always the problem we have when discussing these subjects; there is no doubt that we have a serious period of time to exist through, if you like. There are the serious issues of investment for medium and long-term stability of manufacturing in the UK. Those are real. But we also have to realise we are still a massive manufacturing nation: we have still some excellent companies based here with superb products and a great market position and, in a way, it is those very companies one is saying we must not squander the fact that we have them here and they have a world position and we should not let that go by default, or ignore anything we might possibly do to ease this very difficult period. Certainly this is not a meltdown: this is a very high pressure situation for survival for a number of reasons, but there is a lot to save and a lot to nurture.

  66. Would you care to forecast in which quarter you might see a recovery beginning?
  (Mr Temple) I did not bring a coin with me!

  67. A foresight?
  (Mr Temple) We can look at what economic forecasters are giving us, first of all, and then link it to some anecdotal information which might be helpful. Certainly there are an increasing number of economic forecasters who would say that the second half of the year there is every prospect of starting bottoming-out and coming up a bit, particularly out of the US. The work we have done would not contradict that at all. What we have found, talking to companies around the UK, is that there are quite a lot now who are seeing volumes stabilise and perhaps even increase a wee bit. They have seen some of the stocks going through the system—for example, one of the electronics people from the north west was telling me yesterday that stocks had gone through the system; they were seeing more normal levels coming. One or two of the people—even the steel industry—were saying that steel was still being made in volume; there are issues of world capacities but they were seeing their ability to get volume orders in the distance coming there and it was the first time they had seen that for many moons. Even the white goods people were saying that they had still managed to keep a reasonable volume coming into the plants. But absolutely every single one of them was saying the pressure on margins and so on was dramatically greater. For example, the white goods people were telling me that the average price for a washing machine had dropped from £360 to £290 in the last few months due to the import pressure and the retail market pressure and so on. So the competitive scene on prices and margins is as unabating as ever and that looks as though it will continue through the year—even regardless of the volume changes. The general view is of an upturn towards the end of the year, still overall a year of recession for manufacturing but coming into a positive growth next year. Issues around that are clearly currency, US economy, will it be a double dip or not - all those sort of things—but by and large it will be reasonable to assume that will be the trend.

Mr Berry

  68. Before I ask about investment, could I ask you to comment on this: some economists would argue that market pressures are precisely the mechanism that improves productivity by forcing low productivity firms to go bust and encouraging others to improve their performance. It is very easy to find a lot of economists who essentially are free market analysts who say that we should not be moaning about market pressures; this is precisely the key mechanism that improves productivity. How do you feel about that?
  (Mr Temple) If we look at the general scenario, what we do have in the UK at the moment is a stable economy, and that has been very important for manufacturing. With that there are certain consequences—we know that. That puts pressure on certain areas, not least of which the manufacturing area. You can draw two conclusions from that: one is that business must do something and government must also try and do certain things, and there is no doubt that manufacturers see productivity as one of the great areas they have to address themselves: they must be the drivers of it; and there is room to achieve quite a lot, and that is why the EEF embarked on the exercise it did because it realised there was a massive area of self-help here, and the evidence was that, where certain productivity issues had been addressed correctly, they had shown great success. It improved profitability and productivity. We felt it was important to get the debate set rather clearly without spin or commercial approach to it, if you like, as to what the benefits and the facts may be. So I think you are right: we see that as being a very important part of survival in whatever times, be it the tough commercial world we are in and the somewhat difficult times that we have had, probably because of the sterling issue which we are all aware of, and which is an international event.
  (Mr Baunton) Adding to that, the general comment I would agree with. The Germans and the Japanese who have lived with strong currencies in the past have certainly benefited from that in terms of driving their productivity and efficiency improvements, so the economists' theory is correct. The problem for the UK has been the speed at which the currency has moved and the fact that many of the businesses are dependent on relatively large contracts, and, therefore, those contracts can be lost which can undermine the very volume base of the business. From my Industry Forum experience, we have examples of UK-based companies that have dramatically improved productivity in specific plants and areas—double-digit type, 15/20 per cent type productivity improvements—but to replicate that across a complete plant and through a complete industry takes a lot of time, and you simply cannot respond quickly enough to what has been a very rapid movement of currency.

  69. Coming to currency specifically, which is important, in your submission talking about investment, which is clearly a key factor, you say the key determinants of investment are demand or expectations of demand and the exchange rate. How important is the exchange rate? We, as a Committee, have had occasions where ministers in the past have told us that in the long term the exchange rate does not matter. More recently there are statements that seem to suggest that there is a feeling that it might be slightly over-valued relative to the euro. How important are the exchange rates, in your view, as a factor determining investment in manufacturing?
  (Mr Baunton) There are companies like my own which are very significant exporters from the UK. We have virtually no choice but to price in the currency of our competitors, and that means for euroland we have to price in euros and, because of the nature of our business, we are quoting business today for 2003 and 2004 deliveries in prices in euros for that time. I have no idea what the exchange rate is going to be relative to the pound, which determines a large chunk of my cost base, so all I can do is try and off-set as much of that risk as I can by sourcing as much of my materials in euros as I possibly can, bearing in mind that my labour costs and obviously the overheads are going to be continuing in pounds for the moment. But you also have companies who are not strong exporters getting hurt by the companies that are manufacturing in lower cost locations, and they also indirectly are being forced to match those prices, even though those companies in some cases are taking advantage of the strength of sterling and weakness of the euro, or of other currencies—whether Turkish liras or whatever—but they are able to undercut significantly UK manufacturers, so the pressure is just as relentless on manufacturers in the UK that are not exporting, and it comes all the way back to productivity and the other issues. The problem is, however, if you do not respond then you lose share and volume and that undermines the very base of your business: if you do respond, your margins get cut to ribbons and you then cannot afford to invest because you have no profit and no significant cash flow to play with.
  (Mr Temple) That is the essence in this debate: you can survive and do quite a lot to help that survival by outsourcing and things like that—but re-investing in the business for the medium/long term is probably the biggest impact we have had here. It is so easy just to blame currency, and that is why I think you have brought in the productivity aspect. A lot of companies are doing self-help—outsourcing, improving their productivity—but ultimately the margins are shot to ribbons and that is why you cannot invest and that is when we will really suffer in the next four or five years' time, when we find we are lagging behind the others.

  70. Finally, assuming for the sake of argument that it is possible for the government to influence exchange rates, what would you be asking the government to do as a Federation?
  (Mr Temple) We are not particularly asking them to influence exchange rates as such. We do not see that as probably terribly practical. We see as most important, probably, a stable economy, and then to make sure that anything that is created by our own hand, be it from regulation or that which can be created by our own hand like stimulating investment or innovation, would be of great benefit. There are some elements that we would look at, particularly in view of the urgency of the situation, where you would say, "You have to look at that cash situation as well": "You have to look at those instant periods of time where people are trying to survive—they probably have a good business but took a big hit on them", and that is why we have asked on, for instance, the climate change levy, which sounds corny but it is really a key part, and the minimum funding requirement, which is not straight out of the Treasury but companies will have to put money in there. So there is a whole series of elements that you have to look at, and look at the cash flow situation in the medium term as well.
  (Mr Baunton) Just to add to that, there is a significant issue with the indecision, or perceived indecision, of government on whether we are going into the euro and, if so, at what rate. I understand that the rate cannot be determined but that indecision is a problem for industries like ours where we are having to invest for production in 2007 and 2008; we have to determine where that investment is going to go. If we had a clear view that we were going to go into the euro and had some broad indication of the timing, that would make some of our investment decisions easier and we would have a clearer view of where to place that investment.

Chairman

  71. Is that a matter, then, of timing as much as the value of the currency because at that moment, when the gap is such for us to join, it would require us to go through the somewhat traumatic process of devaluation. Would that be compatible with the objective that we have at the present moment of stability? The UK economy you say is stable and you are happy about that: but, almost by definition, the hoops and hurdles that would have to be gone through to achieve a well-organised evaluation would require some destabilising, tight-belt reductions in public expenditure, a countdown on inflation, and discouragement of unnecessary imports, all of which would have to be carried out simultaneously. Would there not be difficulties?
  (Mr Baunton) Let me give you a graphic example of an issue confronting my own company. We are about to launch stage 2 engines, because of the emissions legislation, and at the time we were making the decision on the investment to machine the major components of those engines, we were confronted with the choice of where to put that investment — was it going to go to the UK or elsewhere? It was clear that we were not going to be in the euro anyway before the next generation of emissions which is 2006/2007, so £100 million of investment has gone out of the UK that should have been in the UK. I had no choice. If we had a clear view that we are going into the euro and it looks likely that that might be by 2007, then for the engines I am starting to design today which will be launched in 2007 I would dearly love to bring investment back into this country. So yes, it needs a stable economy but I am worried about the indecision. The stable economy is keeping us whole in terms of today's business but future decisions are being made on timeframes that are partly out of my control, so the investment would be lost for another three or four year period if, indeed, it went elsewhere.
  (Mr Temple) You also get the dilemma that you have seen a lot of manufacturing industry or business in general where there is a split about pro or not pro euro. A lot of it relates to stability and speed of change but, interestingly, a lot of the debate has gone way beyond the economic area and into the socio-political debate as well, so it is very difficult for us always to square up some of these elements, and often the big international companies are in a much more substantial position to change where they choose to operate, hence you will get a much more definitive answer from somebody like Michael on this question than perhaps a lot of other manufacturing businesses would give.

Mr Djanogly

  72. I heard on the radio today that Dyson are relocating to the Far East and they stated the main reason as the relative cost of employment. Do you think that this is something we are going to be seeing more of? I would be interested to know whether entry into the euro would be likely to encourage or discourage any such movement.
  (Mr Temple) First of all, we also have heard that news and one needs to know a little bit more about it, but I was also talking to another producer of vacuum cleaners about this and they had changed I think their process time from 15 minutes to 5 minutes, which struck me as rather quick for making a vacuum cleaner but anyhow—that is the time it takes on the production line. It took me somewhat longer to get it out of the box, I might say! But I think the issue here is that there is no doubt that you come back again to currency and the issues around it: it is not a matter of whether we should be in or out of the euro—there is no doubt that the differential level of currency has been very painful and, even in that illustration I have given you, substantial productivity gains have sometimes meant that it has been hard to off-set some of the major issues around currency, particularly when you have a high productivity item like that which really is very fine margins in there. It might be quite a complex piece of equipment but it is a very fine margin item, and that is when other issues as well come into the debate and you count everything, including labour costs.

  73. But you did say that a lot of manufacturers are deciding to relocate their supplies to Europe to off-set currency. Why would a company like Dyson move to the Far East? Presumably you are not going to be able to source any more easily from Europe, are you, if you move your production to the Far East? Is it to do with employment costs?
  (Mr Temple) They said it was and it is clearly—

  74. Is that more of an advantage than currency fluctuation?
  (Mr Temple) There is no doubt that labour cost is a significant element in certain product areas. In the assembly of things like this, it is a factor. Productivity is one factor, and currency is a major factor too. It is very hard for me to comment because I have only done what you have done—read the reports—on exactly where the balances were, but the danger of following that line is that you would write pretty well everything off in manufacturing. You have to understand where the added value is, what the inherent technologies are and, also, where people are selling them and what the composite position is. That is why you have to take the individual merits rather than making a general assumption from the Dyson position.

  75. Do you think these questions are going through a lot of manufacturers' minds at the moment?
  (Mr Temple) Absolutely. This is the big debate.
  (Mr Baunton) Yes. In fact, we make engines in Asia but the cost in freight of bringing the engines back here is significant, and the supplies of high quality, high technology parts is not yet comparable in Asia for the technologies that we need so we can still export competitively, but the labour content of our engines is very small and we are continuing to drive that productivity improvement, so we are in a different position. I suspect, however, that a vacuum cleaner is relatively cheap to ship around the world and I suspect also that a lot of its components, because they are electrical and plastic parts, would also come from Asia.
  (Mr Temple) If you look at the statistics between 1997 and 2000, there was around a 20 per cent per annum growth in the importation of these items that are typically component parts, and when you looked at those it was not always but somewhat typically the lower value-added end components that were being outsourced where labour content was a major issue. You say is this taxing manufacture? Yes, that is one of the ways in which they have been managing to survive within the context of a relatively high currency. They have been trying to drive productivity at home but also import from afar as well.

  76. Does that mean, therefore, that we could see a relatively safe environment for larger companies but more medium-sized companies with perhaps smaller products going to the Far East?
  (Mr Temple) That has been the trend, you see, and that is what we are saying. When you lose your OEMs, your original equipment manufacturers, you have a great chance of losing your supply-chain people—the tier 2s, the tier 3 people—and that is the great worry. You might have other people left in that area, but you have to make sure there is enough business there to keep that supply chain. It is a critical mass issue that you have to have, and that point is at the heart of the manufacturing debate. It is the loss of the supply lines. This is basically at the heart of Mike's point: if you lose the medium/long term investment by the big guys, then all the other elements that flow into the system also suffer.

Sir Robert Smith

  77. To pin down the language on the euro, you are talking very much about wanting an end to indecision. Would a statement that we were never going to join be the end to it? Would that provide an end to that indecision and help with your investments?
  (Mr Baunton) Yes, it would, and I suspect the investment decisions of our customers, because many of them are doing the same as us—investing overseas almost to hedge their bets in terms of this indecision. If there was a clear decision then we would be able to make much more concrete plans.

  78. If the decision was not to join, would you be able to decide to invest here?
  (Mr Baunton) We would run down investment here, I suspect, because the companies that are already moving their production from here to other locations would continue to do so, so it would not be positive for the UK if we were not to go in. But that is purely my own company's views; not necessarily the view of the EEF or other companies.
  (Mr Temple) We did a survey at the beginning of last year of over a thousand companies and we asked them about where their business was, the direction, what currencies they were working in and so on and so forth—a fairly complex series of questions—but essentially it was to understand their trading patterns and then discuss the position in Europe. When it came to the question around the euro, it was not unusual that you had 8 per cent completely on one side which would be "Never"; 10 per cent were "Yes, regardless"; and then exactly in the middle the remainder was split precisely 50/50 which was "Yes, but.../No, perhaps...", and we then were asking questions about why they had their views, because when we had discussed their business intentions they had been very eurozone-orientated. They had seen components coming from there, markets, competition and their own expansion very often in there, so you wondered why there was such indecision when, clearly, the direction of the business was quite clear. The responses were quite varied but there was a distinct high level saying they were concerned about a lot of the social issues, a lot of the ways in which Europe worked—nothing to do with the economics of this debate. The next aspect was taxation which people were worried about and the issues around who would tax them and for what and how, and then a whole series of other points. We then said "Should your concerns be addressed to your satisfaction"—now you might say that is a big "should"—"what would your view be?", and it was a 74 per cent vote for. Now, you can take from that what you will but the inference would be that, in pure economic terms, it was probably going to be better as a general rule.
  (Mr Baunton) Finally, for clarification, as an international business, it is not just the euro we deal with; we deal with the Japanese yen, the US dollar and many other currencies. The issue for us with the euro is obviously the proximity of the European market and the importance of that market to our UK manufacturing.

Mr Lansley

  79. Before we move away from the eastern location decisions, have you had an opportunity to look at foreign direct investment into the UK and the characteristics of that, and what does that tell you about the kind of businesses who choose to be in the UK as distinct from manufacturers in your membership who are having to consider out-sourcing not only parts but sometimes assembly from the UK?
  (Mr Temple) If you look at the foreign direct investment, the graph continues to go up in overall terms. You have to remember that also includes acquisitions as well as investment in new plant and equipment, but if you look at the projects—and it is measured by projects in this case—the ones in manufacture have absolutely plummeted in the last eighteen months to two years, and that is absolutely the opposite version of the overall investment in the UK figure, which would suggest that, for the moment, overseas companies are taking an extremely cautious view about manufacturing investment in the UK.


 
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