Select Committee on Trade and Industry Minutes of Evidence

Examination of Witnesses (Questions 244-259)




  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 Federation—one 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 years—and here we are talking about 30 years or so—which 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 industry—which 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.

Mr Djanogly

  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 trade—I 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 non-European countries?
  (Mr Legg) At a guess I would say 50:50, but it is a pure guess.[1]

  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 in manufacturing.

  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[2]. 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 registrations—and one has to look at how many of those are actually imports—it 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 members—and 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 get better.

Dr Kumar

  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.


  254. 1979!
  (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.

Dr Kumar

  255. Acquisition growth—can you explain that?
  (Mr Legg) If you take a quoted company—perhaps 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 UK—number 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

2   Note by witness: Eurostat Monthly Productivity Output Statistics (February 2002) shows that Germany achieved a higher production output compared to the UK. Back

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