Select Committee on Trade and Industry Minutes of Evidence


Memorandum by the TUC

INTRODUCTION

  This memorandum has been drawn up in response to the Trade and Industry Committee's investigation into the competitiveness and productivity of UK manufacturing industry, both before and after the 11 September attack on the World Trade Centre (WTC).

THE WORLD ECONOMY

  The biggest single problem facing the manufacturing sector in the short-term is the collapse in world export markets—in 2001 they grew by only 1 per cent and in 2002 our export markets are expected to grow by only 2 per cent. This compares with nearly 12 per cent growth in 2000 (HMT Pre Budget Report, November 2001).

  The United States economy is showing the first tentative signs of a slow recovery but there is no sign of increased orders for UK manufacturing exports. Even more seriously growth in the Eurozone is still slowing. Latest figures show the annual GDP Eurozone growth rate in the third quarter slowed again to 1.4 per cent, while industrial production slumped with a fall of 4.3 per cent in November 2001 compared with a year ago. For the manufacturing sector the Eurozone markets are far more important to us than the US—we export over £100 billion worth of goods to the Eurozone against just under £30 billion to the US.

IMPACT OF THE 11 SEPTEMBER EVENT

  The short-term position facing manufacturing is grave. Latest figures show that over the past 12 months:

    —  manufacturing exports were down 4.5 per cent in the year to November 2001: we expect the manufacturing trade deficit to reach £26 billion in 2001;

    —  manufacturing output fell by 4.7 per cent over the 12 months to November 2001; engineering output fell by nearly 11 per cent, textiles by 12 per cent, metals by 4 per cent;

    —  the sector lost 146,000 jobs over the year to November 2001: we expect another 150,000 to go in 2002;

    —  investment is down 14 per cent over the 12 months to Q3 2001 and 28 per cent below the last investment peak.

  The overall economic impact of the 11 September attack on the world's industrialised economies has been limited by the prompt action of the world's central banks and some governments. The attack has worsened and accelerated a fall in world trade that was already well underway, but it did not trigger the widespread economic collapse that the terrorists may have hoped for. The OECD believes the attack may delay the economic recovery by depressing confidence and increasing uncertainty (OECD Economic Outlook, December 2001). In the UK the wider economic effects have been even more limited. Early fears that the attack would damage consumer confidence in the UK have proved unfounded.

  However, the UK manufacturing sector has been the most exposed to the economic consequences of the 11 September attack, mainly through the aggravation of the downturn in world export markets. Some industries in the UK will have been placed under additional pressure, most directly in aerospace with the cut-backs in airplane orders. Other industries such as print may be facing knock-on impacts from reduced orders from the entertainment, tourist and travel industries. The UK high tech engineering industries have also been badly affected by a structural downturn in demand for mobile phones, but this was well underway before the 11 September attack.

  We are sceptical that 11 September has significant long-term implications for the overall competitiveness and productivity of UK manufacturing. The OECD has raised the possibility that transaction costs for international trade will rise because of higher security and insurance charges and delays and lack of flexibility in business meetings. This might change the relative profitability of production for domestic and international markets, and possibly increase the share of trade with Europe at the expense of trade with the rest of the world (for most UK firms "domestic" will include Western Europe). However, this is very unlikely to be significant, as the extra costs are relatively small and some—such as the disruption to transatlantic business traffic—likely to prove temporary.

  The more far reaching change would be if concerns about security of supply and greater uncertainty of delivery times meant firms increased inventories and moved away from "lean" production. Similar concerns might encourage firms to source nearer their home markets and away from regions seen as vulnerable to political instability or terrorist attack. However, at this stage we are not convinced these concerns will have a major impact on business decision-making about sourcing locations or business organisation in the UK manufacturing sector.

  The TUC's Memorandum on globalisation to the House of Lords Economic Affairs Committee concluded that the big changes in shares of world trade had been driven by the intensification of trade and investment flows between the EU economies. If uncertainty about the global economy persists there may be the further concentration of direct investment flows between and within the major industrialised economic blocs. An increase in the perceived risk of foreign direct investment to particular regions may make investment in relatively safe economic environments such as Europe more attractive, reducing foreign direct investment flows to the non-industrialised world. However, we expect these impacts to be relatively small. Weak investment and trade flows in the immediate future are more likely to reflect the economic downturn than firms and investors fleeing to safe havens. A strong recovery in world trade is likely to see a re-assertion of previous patterns of trade and investment.

PRODUCTIVITY

  The Government's objective as expressed in the Treasury's November 2000 Productivity Report The Evidence and the Government's Approach is an ambition "to have a faster rise in productivity than its main competitors over the next decade so that it closes the productivity gap". This is a reasonable formulation. Productivity improvements take place over relatively long periods of time, and policies designed to increase productivity are very unlikely to yield quick results. Moreover, productivity growth in the short-term is strongly affected by cyclical changes in output, not least in the manufacturing sector, and short-term changes may give a misleading picture of the underlying trend. However, while the Government's target is achievable it is undoubtedly challenging. Productivity growth in the UK will have to increase at a faster rate than in our major competitors and there is no guarantee that the G7 economies will not also see improvement in their productivity growth rates over the next decade.

  The available evidence suggests to us that the relative productivity performance of the whole economy has improved somewhat over the 1990s. However, we are concerned that the productivity gap for the manufacturing sector is even worse than for the economy as a whole and that the sector has been slipping further behind in recent years. We believe that the weak performance of the manufacturing sector in recent years is frustrating further progress towards meeting the overall productivity objective. Without a significant improvement in manufacturing's relative performance we doubt that the overall productivity objective can be met.

  Latest figures show that US manufacturing productivity measured as output per hour worked was 55 per cent higher, France 32 per cent and Germany 29 per cent higher than the UK in 1999 (NIESR, February 2002). Part of the gap is explained by lower investment intensities in UK manufacturing and part by all the other factors ("total factor productivity") that influence productivity levels, such as work organisation and practices. The UK manufacturing sector has a significant gap on both sides. Differences in investment levels are more important in explaining the gap against Germany and France than against the United States. This is shown in the table below.

THE MANUFACTURING PRODUCTIVITY GAP IN 1999
Output per hour worked in 1999 Labour productivityTotal factor productivity*
US155143
France132110
Germany129121
UK100100


  NOTE: *difference in productivity levels attributable to all other factors apart from investment in physical equipment and skills.

  Source: NIESR, February 2002.

  The Committee's Second Report published in January 2001 noted that it was impossible to measure progress towards the government's objectives because of problems in getting consistent and up to date international comparisons of productivity levels. The Office for National Statistics has announced a welcome major work programme on improving statistical measures of productivity at international, sectoral, and regional levels. However, even as more up to date figures become available we would urge caution in reading too much into short-term changes in productivity performance.

PRODUCTIVITY—THE CHANCELLOR'S INITIATIVE

  The Government's productivity agenda rests on two pillars: macro-economic stability and micro-economic reform in areas of market weakness—investment in physical and human capital, promoting innovation and R&D; strengthening competition; and encouraging enterprise and entrepreneurship. In October 2000 the Chancellor of the Exchequer wrote to the TUC and CBI inviting them to look at the underlying causes of poor productivity and to set out practical measures to address them. The TUC and CBI set up four working groups—on investment, innovation, best practice and skills. These groups submitted their reports in October 2001. The TUC and the CBI have agreed to set up a new permanent joint body with the support of the government to follow up the report's recommendations, act as an early consultation body for new government proposals, and to develop further areas where we believe joint action is feasible. The following section is based on the group reports and the work of independent expert advisors.

INVESTMENT

  The UK manufacturing sector has suffered from a long period of relative under-investment. Work undertaken by Nigel Pain of the NIESR for the TUC-CBI investment productivity group in 2001 showed that investment as a share of industrial output has been falling over the past 25 years. This is shown in the table below. Not only is there no sign of catch up, but also the UK's relative position against France and Germany appears to have declined. The most recent work by NIESR suggests that in the market sectors of the economy lack of physical investment accounts for about 40 per cent of the labour productivity gap with Germany and 60 per cent of the gap with France.

INVESTMENT INTENSITY IN MANUFACTURING 1975-97
Share of output1975-80 1981-901991-97
Germany11.0%12.1% 14.1%
France13.5%14.6% 13.5%
United States11.4%10.8% 11.0%
United Kingdom13.0% 12.1%11.5%


  Source: CBI-TUC Productivity Investment Group.

MACRO-ECONOMIC STABILITY

  Historically, the greater macro-economic instability of the UK economy has been seen as a major barrier to investment. Here the news is encouraging but not conclusive. The economy as a whole clearly has been more stable in recent years, with consistently low inflation. We should therefore expect to see greater certainty and stability reflected in firms setting lower rates of return ("hurdle rates") for new investment projects. The CBI-TUC Investment Group concluded that hurdle rates have fallen for some manufacturing firms based on comparing the results of a CBI survey first carried out in 1994 and a similar survey carried out for the Group in early 2001. There are some important cautions—firms seem to apply hurdle rates in a flexible manner and final decisions on projects rest on a range of factors that are hard to quantify. However, lower hurdle rates have not translated into higher investment—overall business investment in manufacturing remained weak in both 1999 and 2000 despite the recovery in output from the Asian crisis. Short-term problems facing the sector may be masking improvements in the underlying economic environment that will show through in a stronger investment performance in the longer term.

MANUFACTURING AND THE NEW ECONOMY

  A further puzzle which the Group did not specifically look at is why there was no new technology driven boom in productivity in the UK manufacturing sector in the second half of the 1990s similar to that seen in the US. A recent study shows that changes in output per worker in US and UK manufacturing moved in a similar way between the early 1980s and the early 1990s, but then they diverged very sharply from the mid-1990s onwards (The New British Economy, Keller and Young, NIESR Review, July 2001). This divergence is a key reason for the different overall productivity performances of the UK and the US economies.

  The authors suggest that the manufacturing sector has experienced both a slowdown in capital deepening (investment intensity) and the rate of "technical progress" (all the other factors which account for productivity growth). They conclude, "We seriously doubt that this is related to technological factors and see it more as a reflection of the general difficulties faced by manufacturing as a consequence of the high value of the pound". It is certainly true that UK manufacturing output has stagnated over the past five years, while US manufacturing output has boomed. The exchange rate issue is addressed later in this memorandum.

  The findings suggest that "new economy" productivity gains in parts of UK manufacturing have been masked rather than not existing in the first place. Productivity growth may therefore be stronger in the medium-term than recent trends would suggest. However, we would also expect manufacturing industry in other EU states to also experience a similar boost to productivity over the next few years.

PUBLIC INFRASTRUCTURE

  The Group were also concerned at the UK's very weak performance in public sector investment—far worse than almost any other economy in the EU or the US over the past 20 years. Bad transport infrastructure links must impose additional costs and reduce efficiency for firms in many ways—higher transport costs, greater uncertainty in delivery times, reduced labour mobility. It also appears to be a factor influencing inward investment, and as shown below this remains critical in improving UK manufacturing performance. However, it is hard to quantify exactly what the impact on overall performance and competitiveness on manufacturing has been from persistent under-investment in the infrastructure.

INWARD INVESTMENT

  Inward investment has been of great importance in improving the productivity and investment levels within UK manufacturing. Foreign firms invest significantly more per worker and have made a disproportionate contribution to investment growth. There is convincing evidence that there has been significant direct and indirect spillover effects helping improve technical efficiency and productivity in UK owned manufacturing companies (UK Fixed Capital Formation: Determinants and Constraints, by Ashworth, Hubert, Pain, and Riley, NIESR, CBI-TUC Productivity Investment Group, September 2001).

  We expect over the medium term that both foreign direct investment (FDI) flows and inward investment projects to increase in importance for manufacturing and spread into the service sector as business continues to restructure and trade linkages intensify between the EU economies. The introduction of the single currency may see even stronger economic and industrial linkages develop between industry within the Eurozone. The UK will not be alone in benefiting from foreign investment—foreign ownership in French manufacturing in 1997 was higher that in the UK.

  However, evidence presented to the Investment Group shows that in the second half of the 1990s UK multi-nationals operating in France invested significantly less per worker employed than the average for all multi-nationals operating in France. Moreover, French multi-nationals operating in Britain invest between 30 and 40 per cent more per worker in real terms than UK multi-nationals operating in France (CBI-TUC Productivity Investment Group, September 2001). This suggests to us that British owned multi-nationals are behaving in a different way to foreign owned multinationals even when operating within a similar macro-economic environment, similar tax regimes, and a similar regulatory framework.

INSTITUTIONAL RELATIONSHIPS—SHORT TERMISM AND THE ROLE OF THE CITY

  The TUC has been concerned that the predominance given to shareholder value in the current system of corporate governance in the UK weakens the long term performance of companies by encouraging Directors to promote the share price through excessive dividend payments at the expense of building up organic growth through investment and innovation. This bias is encouraged both by the widespread use of share based incentives for top executives and the lack of information and consultation rights for workers and other stakeholders in the business. We also suspect that these factors have encouraged some UK firms to either over-react to 11 September or use the attack to justify unrelated cutbacks which otherwise might have been more subject to public challenge and debate.

  The issue of the relationship between industry and the financial institutions was raised across a number of the CBI-TUC Productivity Working Groups. The Investment Group's report concluded "there is evidence of capital market imperfections in the UK, with some firms facing an apparent cost premium for external finance" (p 9). However, hard evidence on this point was not easy to find, in large part because of the difficulty in making valid international comparisons. There was a concern that investment analysts in the City often had a poor understanding of particular sectors within manufacturing. In addition, the Group broadly welcomed the Myners Report that identified weaknesses in the role of trustees of pensions funds that encouraged short termism in the way investment decisions were being made. The Best Practice Working Group identified ways in which the Company Law Review and Myners could help encourage both directors and trustees to look more closely at the implementation of Best Practice as a means of improving company performance.

PROFITABILITY

  A further reason for low investment given in the past is low profitability. Manufacturing profitability has undoubtedly fallen rapidly over the past few years. However, manufacturing profitability measured by net rates of return was significantly higher over the 1990s than in the 1980s or the 1970s. The UK had relatively high profitability rate for non-financial companies in the 1990s compared with Germany, the US, Japan, Canada, the Netherlands and Spain (International comparisons of profitability, Economic Trends, January 2000). Manufacturing in the UK has historically been less profitable than services, a position which may be somewhat unusual compared with some economies, including the US and Germany. It is possible that investment may in consequence have become increasingly biased towards service-orientated activities where better returns can be made. However, the gap between rates of return in manufacturing and rates of return on capital invested in the rest of the economy narrowed in the 1990s compared with previous periods.

INNOVATION AND R&D

  The manufacturing sector is critical in addressing the wider problem of under-investment in research and development because 80 per cent of all R&D performed in UK businesses is undertaken in the UK manufacturing sector. This share has not changed significantly over the past decade. Latest figures suggest that at the end of the 1990s total investment in R&D in the UK accounted for just over 1.8 per cent of GDP compared with 3 per cent in Japan, 2.7 per cent in the US, 2.4 per cent in Germany, and 2.2 per cent in France. Moreover, over the 1990s the UK's relative performance has fallen.

INVESTMENT IN R&D IN THE 1990S
Share of GDP1991 19951999 (or latest)
Japan2.8%2.8% 3.0%
United States2.7%2.5% 2.7%
Germany2.5%2.3% 2.4%
France2.4%2.3% 2.2%
UK2.1%2.0% 1.8%


  Note: all figures gross expenditure on R&D; Japan and France are 1998. US figure excludes most capital investment.

  Source: Economic Trends, August 2001.

  The underlying gap for the UK is even greater than these figures suggest, as in 1999 nearly 40 per cent of UK government funded R&D was for defence related purposes compared with 23 per cent in France, 8 per cent in Germany and 5 per cent in Japan. Only the US had a bigger share, with 53 per cent of government funded R&D going on defence. Defence orientated R&D will still have important spin-offs, but may be of less direct benefit to the economy than civil orientated R&D. The bias towards defence programmes mean that the UK appears to offer relatively high direct levels of support for business R&D compared with other OECD economies.


FISCAL INCENTIVES

  Both the TUC and the CBI have welcomed the Government's proposed tax credit to encourage more investment in research and development. The evidence suggests that one reason that business under-invests in R&D is because of important "spillover effects" so there are significant differences between the return to an individual company and the returns for the economy more generally. Fiscal incentives can have a role in helping bridge that gap. A recent study by the OECD suggested that in 1999 when all forms of tax incentive were taken into account the UK's treatment of R&D expenditure was effectively neutral, while tax incentives were more generous in several OECD economies including Japan, France, the US and Canada (The New Economy: Beyond the Hype, OECD, 2001, p 48). The TUC's Budget Submission calls for the implementation of the tax credit for larger firms in the 2002 Budget in order to maximise R&D expenditure in the UK. However, fiscal incentives alone will not be sufficient. Not all economies that offered generous tax breaks were big investors in R&D. Moreover, Germany was the exception of a big investor in R&D despite an unfavourable tax system.

BUILDING REGIONAL INSTITUTIONS

  The TUC-CBI Innovation Group received a presentation by Dr Rebecca Harding of SPRU that showed how strong intermediaries in both Germany and the US had helped stimulate R&D and above all ensured that technology was transferred to industry. The Group had different views at how effective these arrangements really were compared with the UK. However, the TUC is convinced that a key reason for the greater success in Germany (and the US) in technology transfer has been the creation of strong regional institutions with a central focus on building collaborative networks between universities, venture capitalists, patent lawyers and industry at the regional level. In Germany the role is fulfilled by the Fraunhofer Institutes and in the US by the University Industry Research Centres. Government policy is moving in the right direction, but we believe that the present position still appears too fragmented and confusing without a sufficiently strong regional focus. We cannot recreate the German or the US system, but we believe we need to bring the existing regional institutions—the Faraday Partnerships, the University Technology Centres and the Regional Development Agencies—closer together to create and develop similar regional collaborative networks.

BUILDING PARTNERSHIP AND BEST PRACTICE

  There is hard evidence that building partnership relationships improves productivity and performance. A recent TUC analysis of the 1998 Workplace Employment Relations Survey found workplaces with partnership practices were far more likely to have higher productivity than workplaces without partnership practices. We welcome the Government's positive support for the work of the TUC's Partnership Institute and the CBI's Fit for the Future Campaign, including the recently announced additional funding to support part of the follow up to the CBI-TUC Best Practice Working Group's recommendations.

  The CBI-TUC Productivity Best Practice Group defined best practice as "a way of managing that continuously draws on all available sources of knowledge and experience to deliver a fundamental and sustainable advantage in achieving the organisation's goals". The importance of work practice and organisation cannot be under-estimated in closing the productivity gap, especially in the manufacturing sector. The Group's report noted that if UK manufacturing could match the average levels of Best Practice in our major competitors, then GDP would eventually benefit by £60 billion.

WORK ORGANISATION AND NEW TECHNOLOGY

  The Innovation Group looked at how new technologies are being applied in the manufacturing sector, drawing on comparative work by Professor Toby Wall and others of the ESRC Centre for Organisation and Innovation at Sheffield University (A Digest of Evidence from Studies of Process Innovation and Performance, discussion paper by Professor Toby Wall, TUC-CBI Productivity Innovation Group 2001).

  Professor Wall reported the results of a comparative survey of manufacturing companies in the UK, Japan, Australia and Switzerland looking at the adoption of nine practices—total quality management, just in time, integrated computer technology, total productive maintenance, team based working, empowerment, learning culture, outsourcing and supply chain partnering. UK companies were more likely to implement technology and technique related practices such as just in time or integrated computer technology than people related practices such as team working, empowerment or learning culture. However, overall UK firms were less likely to adopt new practices than foreign companies. Moreover, UK firms were less likely to adapt new practices than foreign owned companies operating in the UK, and UK companies operating abroad were less likely to operate these practices than foreign owned multinationals operating in the same economy. Finally, even when new practices were introduced, UK firms reported less success with them than did foreign companies.

  A further survey of UK single site manufacturing companies found a strong and positive association between the introduction of people practices such as empowerment and learning culture and subsequent improvements in productivity and performance. Yet these were the practices UK firms were especially weak in introducing compared with foreign firms. There was also a positive link between "integrated computer technology" practices and productivity, but not on profit and a somewhat weaker link between profit sharing and productivity and profit. Practices strongly believed to influence performance according to conventional wisdom—such as total quality management, just in time, or bonus pay—appeared to have no statistically significant effect.

  We believe that this is an important piece of work and we strongly support the recommendation in the Innovation Task Group's report that the DTI should undertake a national audit in collaboration with the CBI and the TUC to establish more systematically what work practices are most likely to generate higher levels of productivity.

ENTERPRISE AND ENTREPRENEURSTHE MIDDLE MARKET

  Part of the Government's approach to boost productivity is concerned with small firms and start-ups. It is very unlikely that this end of the market is going to make much difference to the aggregate productivity performance of the UK manufacturing sector. Over 70 per cent of the manufacturing workforce is in large or medium sized firms and industrial restructuring is shifting employment towards larger firms.

  Our overall view is that the small firm sector is characterised by high rates of churning and that the returns from past policy initiatives and significant expenditures on encouraging start-ups and the small firm end of the SME sector have not offered good returns. We would strongly urge policy to focus much more on overcoming barriers to performance and greater productivity growth in medium sized firms and upwards, as this is far more likely to improve aggregate productivity performance over the medium term. Moreover, it is important not to think of the enterprise element in the Government's productivity programme as only applying to start ups. Encouraging more "entrepreneurial" attitudes in the management of medium and large firms—particularly in introducing Best Practice—could be even more important.

  The TUC-CBI best practice work group emphasised the importance of shifting the focus of policy for manufacturing towards the middle firms who often were unable to access many of the productivity related support services supported and funded by government. The group also identified the key role of a relatively small number of large manufacturing companies in the UK, notably their leverage on the supply chain in terms of both orders and spreading best practice.

SKILLS

  The most recent estimate of the skills composition of the workforce for 1999 show that the UK matched Germany and France in terms of graduate level qualifications, but was far behind in intermediate skills. The United States was even worse than the UK in terms of vocational skills but offset this deficit by deploying large numbers of graduates. NIESR estimate that since 1995 the relative position against Germany has not changed, that against France has deteriorated somewhat, while the position against the US has improved slightly. NIESR estimate that for the market sectors of the economy skills accounted for about 25 per cent of the productivity gap against Germany and 14 per cent of the gap against France. However, skills did not play a significant role in explaining higher productivity in the US compared with the UK. These estimates are for the whole economy, but it is likely they are equally true for the manufacturing sector.

BRITAIN'S VOCATIONAL SKILLS DEFICIT IN 1999
% of workforceHigher skills Intermediate skillsLow skills
Germany15%65% 20%
France16%51% 32%
UK15%28% 54%
US28%19% 57%


  Source: NIESR 2002.

  A recent survey of the economic evidence by the OECD suggests that investing in training by employers tends to increase profits, productivity, and wages (OECD Economic Outlook, December 2001, p 163). Studies of employer training in the US, the Netherlands, Spain and Ireland all show a positive link to productivity. A UK study estimated that a 5 percentage point increase in the incidence of training would increase the level of productivity by 4 per cent, while a US study estimated that a 10 per cent increase in training in US companies increased labour productivity by 3 per cent.

  Given this evidence, it is surprising that UK has such a large vocational skills gap against Germany and France and strongly suggests the voluntarist approach favoured in the UK (and the US) has led to under-investment in vocational skills. The November Pre-Budget Report came to a similar conclusion and announced proposals to pilot schemes for fiscal incentives to encourage individuals to take time off for training. The TUC's Budget Submission supported the CBI-TUC Productivity Training Group's recommendations for tax credits to help employers involved in basic skills education and for employers providing support for employees to achieve their first level 2 qualification. However, the TUC believes that the problem of the vocational skills gap will not be fully addressed without some form of mandatory requirement on UK employers to train.

TRADE, COMPETITIVENESS AND THE EXCHANGE RATE

  The trade deficit on manufacturing goods has been growing significantly in recent years, and is likely to exceed £25 billion in 2001. The deficit is unlikely to widen very much in 2002, mainly because imports have dropped as well as exports. However, there is an obvious danger that the upward trend will be resumed when the world economy recovers in 2003 onwards. The deficit is not as yet a serious macro-economic constraint but could become so in the medium term if current trends are continued. A recent estimate by the Engineering Employers Federation suggested that unless the manufacturing growth rate improved over the 1990s the manufacturing trade deficit could reach £80 billion by 2010.

  The major contributor to the growth of the deficit has been trade with the non-OECD economies. In 2001 the UK has a small deficit on trade in goods with the Eurozone and was close to balance on trade with the United States. The trade position against both the US and the Eurozone has improved in recent years, while the historical trade deficit with Japan has been stable. In contrast, the trade deficit on goods with non-OECD economies (excluding oil exporters) has grown explosively from close to balance in 1995 to £18 billion in 2001. This mainly reflects a worsening deficit with China and the "Dynamic Asian Economies" (DAEs) of South East Asia. The main deterioration has been in manufactured consumer goods, notably clothing and footwear and electrical goods and equipment.

GROWING DEFICIT ON OUR TRADE IN GOODS 1995-2001
Trade balance on goods (current prices) 19952001
Eurozone-£4.1 billions -£2.9 billions
United States-£1.7 billions -£0.9 billions
Japan-£5.5 billions -£4.9 billions
Non-OECD economies-£0.8 billions -£18.0 billions
World-£12.0 billions -£33.1 billions


  Note: all figures balance of payments basis; non-OECD excludes oil exporters. Goods include non-manufactured food, drink, tobacco, oil, and raw materials and "miscellaneous" items.

  Source: National Statistics; TUC estimates.

  The stong pound against the euro is not responsible for the entire deterioration in the trade deficit, although we believe it has been an important factor. The overall deficit has been created through a combination of the loss of markets to low cost producers in traditional areas such as textiles; the replacement of Japan as a major source of cheap electronic products by even more price competitive Asian producers; and the struggle to grow markets and hold market share in the face of a persistently high exchange rate against the euro. This reflects both short term problems such as the exchange rate and an underlying long term lack of competitiveness caused by under-investment and low productivity.

  The strong pound/weak euro has had a major direct impact on price sensitive sectors such as steel and textiles. However, the wider impacts on manufacturing have shown up more strongly in terms of profitability and productivity rather than export volumes. Some key industries such as motor manufacturing in the 1990s switched from producing for home to producing for European export markets and such restructuring is not easily reversed. The UK continues to run modest surpluses in areas of strength such as capital goods and chemicals, but these have failed to grow in recent years and have not offset further loss of ground in areas of relative weakness. The UK has done well in the rapidly expanding markets of the US in recent years, but so too has the rest of Europe. Economies such as Germany have built up a significant surplus on their trade in goods with the US that has helped offset increased imports from non-OECD Asia economies.

  The Pre Budget Report rightly points out that much of the recent fall in manufacturing output is linked to the fall in demand for manufactured goods—especially some high tech goods—in world markets rather than any significant change in the exchange rate. The global downturn has seen manufacturing output fall in a number of OECD economies, most obviously the US and Japan, with some of the biggest falls in economies with a large high tech sector such as Finland, Ireland, and the Netherlands. However, over the 12 months to October 2001 the UK manufacturing sector had experienced a bigger decline in output than across the Eurozone as a whole. Some of these differences might be explained by cyclical timing and the UK's somewhat higher dependence on high tech manufacturing. However, the recent fall in UK manufacturing output comes on top of a prolonged period of stagnant growth, one of the worst growth records in the OECD. The UK has not done as well in areas such as relative strength such as chemicals and much worse in sectors such as metals and motors. It is hard not to see some connection between this stagnation and the persistently over-valued exchange rate.

MANUFACTURING OUTPUT GROWTH ACROSS THE OECD 1995-2001
Output change 1995 to Q3 2001 (1995=100) Output change over latest 12 months
Ireland220Luxembourg +7.5%
Hungary193Czech Republic +4.9%
Korea157Korea +4.8%
Poland156Slovak Republic +4.2%
Finland144Hungary +3.6%
Mexico140Greece +2.3%
Austria136Portugal +2.2%
Switzerland126Belgium +1.8%
Luxembourg125Austria +1.6%
United States125Canada +1.5%
Denmark124Switzerland +1.2%
Sweden124Denmark +0.7%
Canada123Spain +0.4%
Slovak Republic122Australia -0.2%
Germany120New Zealand -0.2%
Spain119Norway -0.5%
Portugal118Italy -1.2%
Belgium118France -1.4%
France118Poland -2.2%
Czech Republic117Germany -3.2%
Australia117UK -4.4%
Greece115Ireland -4.6%
Netherlands111Netherlands -5.6%
Turkey110Sweden -5.7%
New Zealand106Finland -5.8%
Italy106Mexico -6.0%
UK102 United States-6.3%
Norway102Turkey -13.7%
Japan94Japan -13.9%
Eurozone119 Eurozone-2.7%


  Note: latest is 12 months to October 2001, seasonally adjusted.

  Source: OECD Economic Indicators, January 2002.


THE EXCHANGE RATE

  There are great uncertainties about what the competitive and sustainable rate might be, and there are significant contrasts between export sectors. The economic evidence suggests the current range for a sustainable rate will lie somewhere between 1.3 to 1.5 euros to the pound. However, even at the upper limit of the possible range the pound has been too high. At the time of writing the pound was around 1.6 euros to the pound. The exchange rate against the euro over the past 12 months is shown in the figure below.


  The exchange rate cannot be predicted with any precision but, unfortunately, there is little chance that market forces will cause the pound to fall against the euro over the next 12 months. UK economic growth will be stronger than in the Eurozone or the US, while inflation will be below the Eurozone average. This will keep the pound strong. The pound would fall if the balance of payments deficit grew to unsustainable levels, but the markets are showing no concern at the projected deficit in 2002.

  UK rates have been cut rapidly in recent months, but so have European and US rates. There remains at the time of writing a significant gap in nominal rates between Eurozone (3.25 per cent) and the UK (4 per cent). The gap is larger in real terms if the UK's lower inflation rate is taken into account. At best, UK reductions in interest rates to date have offset upward pressures of the pound but have done nothing to bring the rate down. A further narrowing of the gap between UK and Eurozone interest rates might produce a modest depreciation. However, experience shows the relationship between the exchange rate and interest rates is highly uncertain. Moreover, the gap in short term market interest rates between the UK and the major European economies have narrowed significantly in recent years and there is no longer any significant gap in long-term interest rates.

  Other policy options to either weaken the pound or strengthen the euro in the short term are limited. The exchange rate might be changed by direct intervention by the world central Banks (the US Fed, the ECB, Bank of Japan and Bank of England) to strengthen the euro against the dollar. The ECB-led intervention in late 2000 succeeded in putting a floor under the euro. However, then the ECB was confronting rising inflation caused in part by the weak euro. Today, the problem is not inflation but weak demand and falling exports across Europe, making it very unlikely that the ECB would welcome a stronger euro in the short term.

  An early decision on the euro by the UK government might cause a depreciation if the markets believed the entry rate would be somewhat lower than the current exchange rate. The TUC has urged the government to take a clearer and firmer stance on the UKs entry into the single currency to remove uncertainty and reassure inward investors in particular. However, the Government has made clear that no decision will be made until the Treasury completes the assessment of the five economic tests in 2003.

INDUSTRIAL AID

  The TUC is realistic about what governments can do in the face of a short-term collapse in world export markets for UK manufactured goods. Governments cannot be expected to subsidise private firms and their shareholders to produce goods for which there are no markets. Nonetheless, we believe that a more active policy stance in support of manufacturing to lesson the shocks from the world trade collapse and to set down the building block for an active medium term strategy are essential. Even where measures have little direct impact in the short term, it is nonetheless important for the government to move ahead with them as quickly as possible. The more than can be done to restore manufacturing confidence in the future and encourage firms to think about the longer term, the less damage will be done by short-term decisions in the face of immediate economic pressures.

  Direct support offered to manufacturing in Britain has been one of the lowest in Europe. The TUC has analysed the EU Commission's latest report on State Aids covering the three years between 1997 to 1999 (The Ninth Survey on State Aid in the European Union July 2001). This shows that UK State aid for the manufacturing sector represented about 35 per cent of the EU average, measured in euros per person employed in manufacturing, Moreover, by this measure the UK provided less in State aids than any other EU country with the exception of Portugal. This is shown in the table below.

STATE AID FOR MANUFACTURING COMPARED

Euros per worker employed in manufacturing, constant 1998 prices
Annual average 1997-99Euros per worker Index UK = 100
Ireland1,683523
Denmark1,453451
Luxembourg1,380429
France1,235384
Germany1,211376
Italy1,108344
Belgium1,003311
Finland   968301
Greece   876272
Austria   696216
Spain   567176
Sweden   557173
Netherlands   530 165
UK   322 100
Portugal   19360
EU15   916 284


  Source: EU Commission Ninth Report on State Aids, July 2001.

  High levels of spending in some countries can be explained by specific problems and policies. The very high figure for Ireland reflects the Commission's decision to classify Ireland's generous corporation tax concessions as State aid. Most State aid provided by Germany goes to help restructure industry in the former East Germany (but even in the former West Germany State aid was still higher than in Britain). Italy has severe regional problems, while Spain is one of the few EU states to give significant direct support to traditional sectors such as shipbuilding and steel. Even taking these special factors into account, the UK still remains well behind the rest of the EU.

  The Survey is not a comprehensive picture of industrial support across the Union or in the UK as it only includes State aid that has to be notified to the Commission under EU rules. There are other ways in which industry can be helped, for example, though labour market policies and public investment that do not count as State aid. However, UK spending on active labour market measures and public investment as a share of GDP are also low by EU standards. There are no comparative statistics to show whether the UK spends more or less on training support which is of disproportionate benefit to manufacturing, such as Modern Apprenticeships, than other EU countries. However, the total sums involved are not big enough to significantly change the UK's relative position.

  UK spending on regional and industrial aid and in support of science and innovation has increased in real terms since the mid-1990s. However, the present plans show a fall in overall spending on regional and industrial support in 2002-03. The totals for 2003-04 are under revision as part of the Third Spending Review, but current plans show a further decline in that year compared with 2001-02. These figures do not include spending on the new R&D tax credit that the Government is committed to introducing in the 2002 Budget.

UK SPENDING ON INDUSTRIAL AND REGIONAL AID
£million constant 1999-2000 prices 1995-96
(outturn)
2000-01
(est outturn)
2001-02
plans
2002-03
plans
Regional and other industrial1,223 1,5301,6901,521
Trade, science and technology2,264 2,4032,5152,659
Sectoral specific*465 475636132
Total of above3,952 4,4084,8414,312


  Note: *aerospace, shipbuilding, coal, steel, motors. To provide consistency, figures relate to central government spending only in all years and exclude spending by local government and public corporations.

  Source: HMT Public Expenditure Statistical Analyses 2001, TUC estimates

DEVELOPING A NEW APPROACH TO REGIONAL INDUSTRIAL AID

  The TUC Budget Submission calls for a major increase in short-term aid, channelled primarily through the Regional Development Agencies, because we believe there is an urgent need for such aid in the short-term and an institutional structure now exists that can deliver it to where it is most needed. However, we are acutely aware that for the medium term we need a more sophisticated approach to state aids than simply comparing aggregate numbers and asking the government to spend more.

  We believe the DTI with the help of the CBI and the TUC urgently needs to establish how countries such as the Netherlands, France, West Germany and Sweden are developing their manufacturing sectors and what lessons can be applied in the UK. For example, are other EU States providing similar types of allowable aid to the UK but on a bigger scale or are they doing different things and the UK is missing a trick in what can be done within EU competition rules. As noted above, we are not convinced the balance is right within the existing aid programmes and the EU Commission figures do suggest the UK has an unusually strong focus on aid for small firms—we need to find out if this is really true and restructure our national programmes accordingly. We also need to look at what more might be done to focus aids on developing new industries such as biotechnology and environmental products which the DTI's Foresight programme has identified as a major future growth area (for example, both the Netherlands and Sweden appear to give a higher priority in these areas than most other EU States). A further factor which may be important is whether firms in the rest of Europe are better at demanding and making use of the aid that is available—in other words, is there a demand as well as a supply side problem.

  We may conclude from such an exercise that as well as spending more on those allowable direct aids which demonstrably have a positive impact, we could help as much by developing regional institutions and networks, by changing the relationship between City and industry and between managements and workforces. The TUC has consistently argued that the high productivity economies of Europe have developed strong social partnership arrangements at workplace, regional and national level. By comparison, social partnership remains under-developed at all levels in the UK.

  As indicated above, we believe the regional dimension to be of great importance in helping improve the overall performance of the UK's manufacturing sector. We strongly welcome the Government's intention to make the English Regional Development Agencies "the key agents" in driving forward the Government's new regional economic policy framework (Productivity in the UK: the Regional Dimension, HMT, November 2001). The TUC is reviewing how trade unions at both national and regional level can play a constructive and positive role in developing this agenda with HMT and the DTI and by the end of April we hope to publish a statement on the role of the RDAs in regional economic development, including the role of trade unions.

MANUFACTURING STRATEGY FOR THE MEDIUM-TERM

  At the recent DTI-led Manufacturing Summit the TUC put forward a six point plan for follow up action to provide both short-term help for the manufacturing sector and to set out a medium term industrial strategy. The TUC also strongly supports the Government's commitment to an R&D tax credit for larger firms. The TUC's six-point plan for manufacturing is set out below:

    —  Firstly, full implementation of a medium term industrial strategy building on the proposals set out in the joint 2001 White Paper Opportunity for All on enterprise, skills and innovation. Some of the ideas—such as the Manufacturing Centres of Excellence—are already being implemented.

    —  Secondly, building on the next steps set out in the Pre-Budget Report on the regional dimension to delivering higher productivity. We need to create coherent regional networks with RDAs taking a strategic lead on the implementation of industrial policy.

    —  Thirdly, DTI to draw up a programme showing how they intend to follow up the agenda set out in the CBI-TUC Productivity Initiative reports as an integral part of the medium-term strategy for manufacturing.

    —  Fourthly, a reinvigorated campaign to encourage social partnership agreements between firms and trade unions. The DTI has recently announced extra support for the Partnership Fund and to promote best practice.

    —  Fifthly, the DTI to conduct an urgent review of state aids in Europe to identify in what ways other countries support their manufacturing sectors at both national and regional level and what lessons this might have for both the level and balance of industrial support in the UK.

    —  Sixthly, allocation of funds to the DTI under the Third Spending Review for the medium-term strategy and extra help short-term help for industry and the regions in the 2002 Budget.


 
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