Examination of Witnesses (Questions 244-259)|
TUESDAY 5 MARCH 2002
244. Good morning, gentlemen. We are pleased
to welcome you here. You are not one of the organisations we have
ever had in the past. I realise you are fairly new, so perhaps
you could just start by telling us a bit about the Engineering
and Machinery Alliance, and where you fit into the kind of patchwork
of trade associations we have in the UK.
(Mr Legg) Certainly. First of all, may
I introduce myself. I am Mike Legg, and I am Chairman of the Engineering
and Machinery Alliance. Peter Davis is Director General of the
British Plastics Federationone of the biggest members of
EAMA. EAMA is an umbrella association of eight trade associations.
It is very new; it was formed in November last year primarily
by a group of trade associations that all have like-minded interest
as far as manufacturing is concerned, as far as SMEs are concerned,
and with an emphasis on capital goods. They are fairly close to
the record on investment that features in our paper quite a lot.
They basically represent a turnover of £20 billion, 4,000
companies and 400,000 employees. It is quite a substantial representation
as an organisation.
245. That is helpful. Perhaps could you lighten
the picture you have painted in your document about the problems
that manufacturing are going through. The 4,000 firms is a very
representative sample of the manufacturing sector of the economy.
What has happened to this sector? If you had been formed five
years ago would it have only been 4,000 firms in the Alliance?
Perhaps you could give us some idea of how you have seen the last
five years and the changes? Has the rate of decline accelerated?
(Mr Legg) I think it is quite clear that manufacturing
in the UK has gone through significant change. One of the major
problems, of course, is that it is getting a bad press. People
continuously talk about its declining percentage contribution
to GDP, down to 18 per cent. One of the reasons for that, and
I think the Secretary of State for the DTI mentioned this recently,
is that a lot of services and functions of manufacturing companies
have been out-sourced; so the reduction in manufacturing may be
slightly over-stated. Having said that, there is no doubt that
we have been suffering (and this is manufacturing as a whole in
the UK) primarily from long-term under-investment over many, many
yearsand here we are talking about 30 years or sowhich
has really reduced our ability to compete, our productivity and
our competitiveness. Coming back to the EAMA representation, EAMA's
member associations are very representative of the small and medium
enterprises. 92 per cent of our member companies are SMEs, and
by far the majority of their customers are SMEs. This is something
I really wanted to highlight as much as anything today, because
I appreciate you have had a lot of representation from larger,
more established associations than ourselves all saying very similar
things, as far as I can understand, as far as the problems facing
manufacturing are concerned emanating to a large extent from this
historical under-investment and, therefore, competitiveness. I
would like to emphasise the role of SMEs, because they do contribute
over 50 per cent of the employment in manufacturing in the UK,
and they contribute over 33 per cent of output of manufacturing
in the UK. Their role should never be underestimated. They, in
particular, are the ones that have suffered. They have suffered
in the long-term from under-investment. A lot of the reason for
that under-investment is short-termism, difficulty of raising
the finance, and the high cost of finance to SMEs in the UK. Given
that that already made them fairly weak in the competitive market,
and that we are facing (even SMEs) much more competition in the
global marketplace, and seeing all the time major OREM companies
are out-sourcing their components overseas rather than putting
the business with UK SMEs, given that they have a long-term structural
problem of under-investment, they have suffered inordinately from
the economic circumstances of the last three years, where we have
had a less than competitive exchange rate with the euro. I think
it is no secret that the OREMs, particularly in the automotive
and aerospace industries, have declared their intent to source
more components overseas because of the purchasing power of the
pound. A typical example of this, of course, is Nissan in the
UK, where they have clearly stated they are dramatically increasing
the percentage of components they are going to source from overseas.
They are one of our most successful, most productive car plants
in Europe and yet they still cannot make a profit in the current
exchange rate. Given that situation, the SMEs are finding themselves
today, after three years of this serious problem, very much under-financed.
They have tried hard to keep their share of the marketplace by
cutting margins, thinking that the exchange rate issue was a short-term
thing; and I think we all felt that; all the pundits in the City
have been saying the euro has been far too under-valued for the
last three years. It transpires that it is still weak and the
consequence of this is that these companies, who have been taking
very low margins, have made little or no profit at all, which
has left their financial situation very difficult: a) as far as
reinvesting retained profits is concerned, because they do not
have those profits to reinvest; or b) their balance sheets have
been weakened, which means they are not able to actually borrow
the capital they need to invest. It is hoped that in our paper
we have made it quite clear we believe one of the major ways out
of this problem for SMEs is to invest in new high technology equipment;
this is the prime way in which they can improve their productivity
and their competitiveness. Because of the current economic situation,
basically we believe that government should take a much bigger
lead in helping to turn round this decline that has been happening
in manufacturing, and for SMEs in particular. We believe that
if we can turn this round and kick start some reinvestment it
would be very timely at the moment; because it is hoped that there
must be worldwide economic recovery/European recovery fairly soon.
What we do not want to do is be caught out when this recovery
comes, that our firms are going to be ill-equipped to be able
to meet the demands of that upturn.
(Mr Davis) We are the British Plastics Federation
but we do lead a grouping of nine associations who are machinery,
tool making sectors but also the plastics, rubber and the coatings
industrywhich is paints. We are representing 6,000 companies,
many of which are large and medium sized companies, in addition
to a substantial number of SMEs as well. We very much support
what Mike has said about the effects on our member companies.
It is fair to say that we have had a very difficult situation,
particularly in the last year, for our member companies. As Mike
has mentioned, we have lived with the over-valued pound and the
weak euro for about three years now, and over that time the kind
of long-term investments that our members need to make in R&D,
in training and marketing have all been the things that have had
to be pared back substantially in order to be competitive and
to carry on business; but it has had a substantial effect on that
sector. The examples of Dyson, Motorola and others are well known;
but in the coatings side the Committee may wish to know that there
is now no British automotive paint industry, with the exception
of one small Japanese-owned plant in Sunderland. All the paint
used in our automotive industry (and of course we had a 9 per
cent decline in 2001 in the cars produced here) is actually imported
from outside of the UK. This is one of a number of instances we
have of the effect that has been with us for quite some time now.
We are particularly concerned about the effect on investment in
machinery, as Mike has mentioned; but also the drop in the research
and development undertaken within our industry; and also the effect
on training as well. The Polymer National Training Organisation,
based in Telford, has experienced a 20-30 per cent drop in the
numbers being trained in that facility up in Telford, which tells
its own particular story.
246. Do you see this as a picture of unremitting
gloom? You mentioned there is the possibility of recovery but
in order to achieve that, from your point of view, there will
have to be some government assistance. We can look at that in
a minute. Do you see any green shoots; do you see anything that
would give us any grounds for optimism?
(Mr Legg) Absolutely definitely, yes. I would say
there are some wonderful examples in the UK of successful companies,
particularly where they concentrate in niche markets, where they
have invested in R&D. I think our major worry is that there
are some good companies that are suffering very badly at the moment.
During a downturn it often does weed out the weaker companies,
which is not a bad thing as far as market forces are concerned.
In actual fact, what we are seeing in this present circumstance
is that manufacturing is suffering in a way where some of (not
the fat) the muscle is being cut away. I return to what I said
before about the financial condition of these companies. Even
if they want to, if they have the will and the capability to invest,
they are going to find it very difficult. Certainly as far as
the overall industry is concerned in the UK, I do not see any
reason why certain sectors should not do extremely well in the
UK. I would quote there the aerospace industry is doing reasonably
well at the moment. In that respect I would draw attention to
the fact that quite a lot of the contracts for the A380 Airbus
have been awarded overseas, which was a bit of a surprise; the
fuel systems were awarded overseas; the undercarriage was awarded
overseas. That is a big blow to British manufacturing; and a big
blow to those companies who have the capability in aerospace to
produce these sorts of product. Again, in aerospace it is a very
good example where you have some very good companies at the top,
but you have got some excellent subcontract companies underneath
doing subcontract machining, for instance. Airbus themselves would
say that they would prefer, if possible, to keep a lot of that
subcontract work in the UK; but, I have had it said to me, they
believe that there is not a strong enough base of companies in
the UK that have the right level of equipment and the right skill
levels and, for that reason, they have been forced to put work
overseas. While we are talking about successes, I think automotives
is successful. Okay, some of these inward investment plants are
suffering on profitability at the moment; but nobody can deny
the success of Nissan or Honda in the UK in terms of productivity.
With that they have brought about quite a transformation in the
subcontract market that is producing components for them. I think
what is frustrating is that many of the subcontract companies
have taken the necessary action to invest and to generate the
skill levels to adopt modern, lean manufacturing techniques; but
they are seeing a lot of the advantage they got from doing that
being totally eroded by the currency situation, where their competitors
from overseas enjoy a 15 per cent price advantage without doing
anything. Therefore, it is a crying shame, I think, that these
companies who have adopted modern manufacturing methods and are
showing some vision are losing contracts to overseas on components.
247. When you talk about price differentials,
what proportion of exports would be European, to your mind? What
proportion of trade overseas would be with Europe?
(Mr Legg) Total manufactured tradeI am sorry
I could not say at the moment. I do not have that statistic. Maybe
we can come back with that.
248. Would it be more with Europe than with
(Mr Legg) At a guess I would say 50:50, but it is
a pure guess.
249. I only say that because the pound and dollar
exchange rate has been pretty much solid over the last ten years.
(Mr Legg) Absolutely right; but I think you have to
remember that the consequence of the weaker euro means that the
European manufacturers are more competitive against our people
in the American market and the other world markets.
250. German manufacturing fell by about 7 per
cent last year?
(Mr Legg) Yes.
251. So much for the advantage of the euro!
(Mr Legg) That is a good point, Chairman! I think
German manufacturing was probably in line with a lot of manufacturing
around the world, where we have a global slowdown, particularly
252. The point I am getting at is, the fall
in Britain was roughly about that order as well, was it not?
(Mr Legg) I would say, as far as German manufacturing
is concerned, it is coming from such a high level; whereas the
UK manufacturing was already weak. German manufacturing has shown
significant growth over the previous decade relative to manufacturing
in the UK.
The rate of attrition in the UK has been quite a bit greater,
I would suggest.
(Mr Davis) Chairman, if I could just
give some points on your question about unremitting gloom or are
there some green shoots. I think there are both, to be realistic
about it. We have just published an Industrial Trends survey of
about one-fifth of all our member companies in the plastics industry;
and it does show that plant utilisation has fallen steadily over
the last four years, with only 3 per cent of firms expecting to
operate at more than 90 per cent in 2002. It is very marked indeed
in the automotive sector, where 90 per cent of firms are expecting
to operate between 51-70 per cent of capacity in 2002. The automotive
sector is certainly a very bleak spot. Despite new car registrationsand
one has to look at how many of those are actually importsit
is quite a bleak sector. Construction and building, where a great
deal of plastics is used, is doing very well, and holding up well
because of the strength of the home market. Packaging, because
consumers are still in the shops at the moment, is holding up
well. Whereas electrical and electronics is very down and very
subdued indeed. When we surveyed our membersand I am very
happy to leave a copy of our survey with the Committee Clerk,
there was a fair degree of optimism about the latter part of 2002;
but when you analysed it there were not actually any specific
grounds for optimism and just a general hope that things will
253. Mr Legg, you identified at great length
a lack of capital investment and you highlighted some of the major
reasons. This lack of capital investment, has it always been low?
If I asked you to say was there a golden age when there was not
lack of capital investment, I would be interested to know when
that golden age was. I always remember for most of my adult life
this has always been the case. I cannot remember any time when
people were saying, "We have wonderful years"; it has
always been a lack of capital investment. Is it not just the nature
of global capitalism that we find ourselves in this situation,
and this is how things are and we have to accept it? Or is there
something which government can do to reverse this decline and
lack of capital investment? Are there a couple of things you think
government should be doing, which it is not doing, in order to
make this process irreversible?
(Mr Legg) As far as a golden age is concerned, I have
to agree, I cannot remember when it might have been, but I guess
it may have been earlier in the 20th century.
(Mr Legg) You are right, as far as the records we
have been looking at are concerned which are over the last 20
or 30 years, there has always been this under capital investment
in the UK. You went on to ask if this is related to the global
capital movement situation - I do not think it is. What we have
to remember is that in the UK (and we have tried to show this
in the statistics we have included in our presentation) we have,
unfortunately, a short-term culture. Capital investment is typically
a long-term thing which should show returns over a ten-year period,
or something like that. Typically in the UK our management have
been looking for much faster returns on their capital; and we
believe this is partly, if not wholly, to do with the rate of
returns that the institutional investors have required of major
manufacturing companies in the UK. Typically, dividend requirements
have been much higher in the UK than they have in, for instances,
Germany or Italy. What this has meant is that we have had lower
retained profits in the companies and, therefore, less retained
profits to invest in capital. What is also evident from this short-termism
is that a lot of major companies have shown that they prefer the
acquisition route for growth, rather than investing in their own
company and growing internally.
255. Acquisition growthcan you explain
(Mr Legg) If you take a quoted companyperhaps
Invesys or TI (which is part of the same group now)they
have tended to have extremely tough requirements on internal capital
expenditure requests, typically two-year payback or less, which
is much higher than their counterparts in Germany, for instance.
As against that, therefore, they have made it quite tough internally
for their managers to persuade them to invest the capital in new
high technology equipment; but they have not been slow to go out
and purchase companies or groups of companies.
256. How long would it be in Germany?
(Mr Legg) To be honest with you, I do not think they
particularly use the pay-back method of doing their capital justification.
They tend to look at it, as I have said, over a longer period.
This is also partly to do with the fact that the banks are prepared
to look at a longer term point of view. Sources of capital, we
believe, have been a hindrance to capital investment in the UK,
particularly in the SMEs. Typically, a large amount of finance
in SMEs is coming from bank borrowings, bank overdrafts or asset
finance. There has been aversion in the UK to equity finance in
SMEs. Whereas in Germany, for instances, there has often been
regional support from the banks and from regional government to
help investment, I do not think we have had that level of encouragement
in the UK. If I can come back to your important point about what
do we believe government could do if it was able to change this
long-term cultural trend of under-investment in the UKnumber
one in my mind, clearly, is that we need the government to come
out and say quite clearly that they value manufacturing, they
recognise the importance it plays to the economy as a whole and
basically, in doing that, to boost confidence in manufacturing;
because there is no doubt that people working in manufacturing
feel the underdogs and they get a bad press all the time. It is
very difficult to recruit new people into engineering and manufacturing
because, all the time they see in the newspapers that this is
an industry in decline and therefore, "If I go into it now
will I still have a job when I'm 45-50?", all these sorts
of things are part of what I have described earlier as the downward
spiral. What I think government needs to do is to reverse this
downward spiral, to raise the profile of manufacturing which,
in itself, will boost the confidence of manufacturing.
257. Do you think government is not doing that
strongly enough at the moment?
(Mr Legg) I believe the DTI is doing that quite strongly.
258. But not government?
(Mr Legg) I think the major problem is the Treasury.
I believe the DTI has some excellent programmes; it is limited
with finance. I think some of its actions in the past have been
tinkering around the edges. I think the problem is so serious
that we need more than a tinkering around the edges, and we need
something dramatic to turn it around. I certainly believe that
the major problem we have is to persuade the Treasury, because
I believe that the Treasury have the opinion that we leave things
to market forces; and if this country is going to have satisfactory
economic growth through consumer expenditure in service industries
they are happy to let manufacturing just go away. I think that
is a very serious problem because, in the short-term, maybe that
is working but, in the long-term, manufacturing is creating wealth
for this country, it is creating an enormous amount of jobs, and
it is creating a lot of business for the services industries.
It has been mentioned on numerous occasions how much the service
industry actually does depend on the manufacturing industry itself.
That is one reason why it is extremely dangerous to take the attitude
of, "Leave it to free market forces". I think it needs
some management, primarily because of the long-term nature of
decisions that have to be made in manufacturing, rather than short-term.
Manufacturing is very much being influenced by short-term factors
at the moment, and that is the reason why I think government should
take some action, and the Treasury in particular should take some
action, and to persuade the City as well; because there is no
doubt at all that manufacturing is not in favour in the City.
We saw it flirting with the dot.coms a year or 18 months ago which
was absolutely disastrous. I would have hoped they would have
seen sense and come back to the blue chip solid manufacturing
companies that return dividends on a continuous basis; but even
now our engineering and our manufacturing companies are trading
on relatively low PE ratios, which staggers me.
259. So we need a cultural change?
(Mr Legg) We need a cultural change, and I believe
it is only government that can actually do that. I think if government
does take that initiative to kick-start it, I think manufacturing
industry and SMEs themselves are quite capable of carrying it
on; it will be self-generating, if you like. At the moment, everybody
is so depressed, everybody has weak balance sheets and weak finances,
it is very difficult for somebody to break out of this mould in
the present circumstances.
1 Note by witness: We have consulted with our
members and believe that 57 per cent of our exports are with Europe
and 43 per cent are elsewhere. Back
Note by witness: Eurostat Monthly Productivity Output Statistics
(February 2002) shows that Germany achieved a higher production
output compared to the UK. Back