Select Committee on Trade and Industry Minutes of Evidence


Examination of Witness (Questions 300-319)

MS PATRICIA HEWITT

WEDNESDAY 13 MARCH 2002

Dr Kumar

  300. Secretary of State, in your statement earlier you said that among the doom and gloom scenario of manufacturing you highlighted four particular aspects of manufacturing where it has been a success story: the motor industry, pharmaceutical, biotechnology and aerospace. Is it really the Department's strategy to focus on these four or is it just the outcome of what has emerged over the years? What I am trying to tease out from you is, is there a deliberate policy of the Department for things we are good at we will focus on those and the things that we are not good at in different sectors we will leave them for somebody else, and you mentioned textiles and other aspects. Are we focussing the strategy for those particular sectors and leaving the others that we are not good at to somebody else?
  (Ms Hewitt) No, we are not. I absolutely do not want to leave that impression at all. I was simply making a point that we have got some really strong companies and some very strong sectors and it is important that we all recognise that because there is, you know, far too much, particularly in the media, and parts of the city, just talking manufacturing down, that was simply a "for example" list. With steel, which I do not think I did mention in the list, and as you very well know, we have one of the most productive industries in the world and we are creating real leading-edge products. I think I am right in saying the 70 per cent of the steel used in modern cars did not exist in terms of steel products just 10 years ago. Our strategy is not to say, right we will go for this sector but not that sector, it is to say, how can we help companies that want to be world class to become world class and to innovate and to use the new technologies regardless of what sector they are in. Technical textiles is a very good example of that, an industry that a lot of people write-off, it is typical, traditional, old-fashioned manufacturing but within it we have firms—including firms that were on the brink of disaster when they were making low value added clothing—who switched and used those skills to move into technical textiles and are now world leaders, because we are world leaders in that sector, it is a small sector, but growing and we need more companies doing that sort of thing.

  Chairman: I think Lindsay Hoyle wants to come in on this area.

Mr Hoyle

  301. You did mention steel, a very important sector, what can be done to protect that part of manufacturing, especially with the announcement of the United States?
  (Ms Hewitt) Indeed. I cannot remember whether you were in the House when I made a statement last week in immediate response. Obviously we are dismayed by the action that the American administration has taken, and the Prime Minister repeated that just an hour, or so, ago this afternoon. What are we doing about it? First of all, of course, we have already initiated the case against the United States in the WTO Dispute Resolution Panel because we are absolutely clear that the USA is in breach of the WTO rules. We also made it clear that we expect to get compensation if we win that case. Those discussions with the USA should begin very quickly. Of course WTO dispute cases take a long time to resolve. In the short-term what we are doing, and we are working on this very fast, with our European colleagues is to look at the safeguard measures that should be taken within the WTO rules, particularly to deal with the very big problem of steel products from other parts of the world being diverted from the American market into the British and other parts of the European market. The third thing that we are doing is to work very, very closely with our companies, unions and trade associations and the companies customers in America to try and get product exemptions from the list of proposed tariffs. The irony here is that there are American manufacturing companies and their workers who depend upon our steel companies for very high value added products, for instance in aerospace, and if they cannot get those products it is going to hamper the recovery in manufacturing and thereby the economy within the United States. For instance yesterday, or the day before, I was talking to Tony Pedder at Corus about how we ensure that his key customers in America are making the appropriate representations in Washington and we will continue to do that during the 120 day period there is for discussion about exclusions decision from the tariff list.

Mr Berry

  302. Secretary of State, one of the few reasonably hard bits of evidence, it seems to me, on the whole debate of the productivity gap is that the key factor is inadequate investment in capital equipment. Your memorandum identifies that, explaining two thirds and more of the productivity gap. However important other things might be that is the big story. I think the key question for me is, apart from ensuring that the macro economy is conducive to investment, and the macro stability, what else do we do to address the key problem, the lack of capital investment or inadequate capital investment?
  (Ms Hewitt) What we have to do—I agree with you that investment is a key factor, it is not the only factor it is absolutely the crucial factor—get the economic stability right and then we can put in place the right tax incentives to encourage investment. I would point there to the very significant cuts that the Chancellor has introduced, such as the corporation tax, the improvements in capital allowances, the tax credit, the very important tax credit for R&D by small and medium-sized firms and the Chancellor's announcement in the pre-Budget Report that that will be extended in this Budget to the large firms as well. All of that, I think, helps to create a climate in which companies are more likely to invest than they were in the past. There is then more that we can do. In aerospace, for instance, we are looking at how we and the industry together increase the levels of investment in R&D, because they are not high enough, they need to be raised and, frankly, I would prefer to see taxpayers' money, which is limited in size, devoted to R&D or research technology and development than simply going into launch aid. So there are specific sector issues there. There are other ways in which we can support investment. If you look at regional selective assistance, about £250 million a year at the moment, the lion's share of that goes to manufacturing, supporting investment that companies are willing to make. What we are seeking to do, also, as we look at the SME manufacturing set is to make it easier for them to get the funding that they need, and particularly in manufacturing that is the real issue. The regional venture capital funds are now up and running. A new and real breakthrough there in terms of European thinking that we have led, where we are putting in public money, and using that to bring in very substantial amounts of private sector investment and investment from the European Investment Bank. Those are operating now, they are not confined to manufacturing but they will be very useful for manufacturing companies. We have put in place, also, early growth funding designed to produce the smaller amounts of money, up to about £50,000, to close a gap that was quite clearly identified for companies that are start up or just after start up and are finding it impossible to get finance but who are not really yet ready for equity finance but also work to help small companies, including those small manufacturing companies, to become ready as they grow for equity finance. There is a lot being done there to create new institutions as well as a better framework of tax incentives to get the primarily private investment that we need.

  303. I take your point about the importance of venture capital and the venture capital funds in relation to SMEs. We, again, have received evidence that when SMEs go to the clearing banks they have to pay very high interest rates because of the perceived riskiness of small companies as opposed to a medium or large one. I am not entirely clear why small should be more risky than large in this day and age but there we are. The evidence is very clear that SMEs do face higher interest rates from the clearing banks. Given that we are talking about a very substantial increase in investment here to do anything about the productivity gap and, to repeat, that is the key reason, above all it is the lack of investment, is there anything we can do to affect the mind set of clearing banks in terms of their attitudes to small and medium sized businesses?
  (Ms Hewitt) Before I come to that, I would mention also the Small Firms Loan Guarantee Scheme.

  304. Yes.
  (Ms Hewitt) Do not forget that we offer guarantees of up to 70 or 85 per cent on commercial bank loans of up to £250,000. Now that is a pretty significant degree of risk sharing between Government and the banks. This is across the piece, not specifically manufacturing, but if you look at the work of the Bank of England and their annual reports on finance for small firms, they do not believe that there is any general, across the board, long term inadequacy of debt financing for SMEs and, indeed, provision of long term finance by the banks to the SMEs did rise quite significantly in the third quarter of last year. I think there is a much more specific problem and I have to say I draw this in part from just the stories I hear around the country but there is no doubt at all that a number of smaller companies in the manufacturing sector, including some in the very high tech innovative sector, have found it almost impossible to get the banks interested in them. I was very struck over the last couple of years by the number of real technology star companies who said that if it had not been for the DTI's Smart Scheme, which is a grant, not investment, a grant for taking the idea to prototyping, they would simply not have survived, they would not have been able to get to the stage where they could get equity and/or bank finance. I think there is an issue there and certainly we identified some time ago the problem of smaller amounts of equity for the company that is growing but is not at the point where the venture capitalists kick in where the threshold is half a million pounds if you are lucky and probably higher because of the transaction costs involved. We are plugging that gap.

Chairman

  305. The point that was put to us by one of the engineering consortium trade associations was that there was up to a five per cent premium being charged by banks for small company borrowing. If you are not aware of that, and from your answer it seems you are not, then could we ask you to go back and look at that and write to us about it because we get the impression there is a penalty being imposed on some of the small and medium sized enterprises, particularly in the engineering and manufacturing areas, and that does not seem to have reached your radar screen yet, Secretary of State. I would like to think you might have a look at it. I think this was what Roger Berry was alluding to. There is a gap in the market where there is a penalty having to be paid by people who we would like to think should be rewarded and not penalised in the way that I have suggested.
  (Ms Hewitt) I am sorry I did not specifically comment on that. It is quite obvious that large companies have got much greater access to a range of financial instruments, including corporate bonds, which enable them to reduce their cost of capital and to get it down much closer to the very low long term interest rates which now operate within the United Kingdom and are now pretty close to those in Germany and the United States which, of course, has not been the case for years and years and years whereas the small companies for debt finance are dependent on the banks and are paying a bank rate plus, particularly of course when they are dependent on overdraft rates and that is where significant amounts of funding for small companies are coming from. Of course there is an issue there. Part of the difficulty, part of the problem there is SMEs are over dependent on debt finance which is why, as I say, we identified quite early on a gap in equity finance for SMEs which we are filling. We also, with the Small Firms Loan Guarantee Scheme, seek to moderate the disability suffered, the handicap suffered, by all SMEs, including the manufacturing ones, in not being able to access those more advantageous rates of gaining capital. Part of the purpose of the equity schemes we have put in place for regional venture capital funds is if we can demonstrate that those are successful then we think that in turn will have an influence on behaviour within the market and we may well create a much better market for capital investment through equity in those small but growing companies.

  306. Can I ask you to get your officials to talk to the EAMA, that umbrella group for engineering and manufacturing, it is an assorted group which is quite representative, about 4,000 firms, and ask your officials to ask them what they are talking about. The impression we get is all the qualifications you have just given do not actually affect a significant number of small businesses that are trying to get relatively inexpensive borrowing facilities. I think that it might well be that there is a gap here. I would like to think that you could (a) look at the issue and (b) come back to us on it. It was raised by a not insignificant group of small manufacturing companies.
  (Ms Hewitt) Of course, Chairman.

  307. That is all we are asking you. I am not disputing the argument you are advancing, I am merely saying that there may well be a lacuna, hopefully not a lacunae but there will be at least a gap there which could be addressed and if it is not within your tenure at the present moment it might be that you will be richer for coming here this afternoon.
  (Ms Hewitt) No, no. I do not want to leave any misapprehension here. We have been looking at this issue of finance for SMEs since we were elected and we have been acting on it as I have described, and I will not go back over that.

  308. That is fine.
  (Ms Hewitt) We talk all the time to the various engineering bodies because it is very useful to do so but certainly I will talk to my officials about whether they have had a recent conversation and we will have a look at whether there is anything further we can do. Let me assure you my officials are in touch with those trade associations, and certainly when I talk to the various engineering bodies, and indeed to others in the SME manufacturing sector, we do generally talk about finance for SMEs as well as the range of other issues that we have already, to some extent, touched on today.

  309. Just following up on something you said about equity finance and transaction costs and trying to encourage SMEs into equity finance. What assessment have you made of the cost of the proposals for the European Union and their directive on the prospectuses and the barriers that will create for small and medium-sized businesses to try and access equity?
  (Ms Hewitt) That is a matter on which my colleagues in the Treasury are in the lead. I know, because we have recently discussed it with Treasury colleagues, we are concerned that the proposals may create new barriers rather than doing what we want to do, which is to create a really large and deep capital market for SME financing across the European Union. It was one of the goals of the Lisbon Summit, it is undoubtedly one of things that hold our SMEs back compared with America, where it is so easy for an entrepreneur to access capital, from friends and families and business and financial institutions. We need to do that. We are better placed in the United Kingdom than in the rest of the European Union. On our latest competitive indicators we have the highest level of venture capital investment as proportionate GDP within the European Union but compared with America it is still much too difficult for our high tech entrepreneurs, our manufacturers to get access to particularly those smaller amounts of funding that they need in the start-up and early growth phase.

  310. Given the fact we are unique is there a chance of us building up an alliance to make sure that a qualified majority does not bring us through?
  (Ms Hewitt) The Chancellor has an extraordinary track record in building successful alliances across Europe, you might remember the saga of the withholding tax, so we will continue to make the arguments about the framework that is needed on the Prospectus Directive and a whole host of other matters to try and get the right pilot for entrepreneurialism and manufacturing specifically right across the European Union.

  Chairman: Before we move on to exchange rates Mr Djanogly is going to ask one question.

Mr Djanogly

  311. What is in the Prospectus Directive that the Treasury should be dealing with the matter?
  (Ms Hewitt) I am not sure. I think the point about it is that it falls within the Action Plan for Financial Services that is being taken forward by finance ministers and to which, I have to say, I contributed when I was Economic Secretary at the Treasury.

  312. It is not related to financial services, it is related to the prospectus, is it?
  (Ms Hewitt) Yes, but, of course, the Financial Services Authority in Britain is the listing authority, prospectuses fall there. I am very happy to explore this in more detail, that is a very interesting question, and perhaps I can let the Committee have a note on this. That is my understanding of the position.

  Chairman: We are always interested to know why the Treasury is where it should not be. We realise that Leviathan tendencies of the Chancellor, much as some of us respect him, have to be curtailed, that is not necessarily for us at every turn.

Linda Perham

  313. Secretary of State, you did mention in your opening remarks about the change in the exchange rate in the 1990s and the strength of the pound in particular over the euro since its introduction has been mentioned by many witnesses to this inquiry and others as a serious obstacle to competitiveness and investment. The memorandum from the Department does acknowledge that companies have sought to maintain their export volumes and market share by cutting profit margins. There is also the example of Toyota, a very successful and efficient company which is running at a loss in the United Kingdom because of the exchange rates. Is there anything the Government can do to assist businesses in this climate?
  (Ms Hewitt) As I said before I have no doubt at all that the weakness of euro, which is quite a long-standing problem now, is causing very real difficulties for a lot of our manufacturers who are dependent on exports into the euro-zone. As we say here, they are doing a remarkable job in sustaining their productivity, in some cases improving it and sustaining their export volumes but, of course, not making much of a margin on those exports. We do not have as a Government an exchange rate target. We have seen what happened in the past when governments tried to follow both an inflation rate target and an exchange rate target. As far as euro membership is concerned I think the potential benefits to manufacturing and, indeed, other parts of the economy are very clear in terms of trade, transparency, costs and currency stability. The conditions have to be right for the economy as a whole and looking ahead, not simply in the short-term but in the long term, and hence the five economic tests—which I will not recite to the Committee—and the process of assessment of those tests and the decision-making that I think is very well known to the Committee. I would just reinforce the point, if you look back not just at the experience post our expulsion in the exchange rate mechanism but much longer across the post-war period it is not at all obvious that changes in exchange rates explain over the medium to long term the success or failure of different countries' manufacturing sectors. We saw over a long post-war period a very, very steady decline and a very substantial decline in the value of sterling against the deutschemark. We also saw a very steady decline in our relative productivity. There are some core issues there to do with productivity which cannot be accounted for by the exchange rate. The problem for companies, you mentioned Toyota, and many other is absolutely clear.

Sir Robert Smith

  314. Following on on the same theme, some witnesses have emphasised to us that whilst there is the issue about the exchange rate the other thing affecting their investment decisions is their uncertainty about when they will know if or if not we are going to join the euro. Are you aware of that extra dimension of uncertainty as a barrier?
  (Ms Hewitt) Of course. That is a point that has been made to me frequently. The timetable is very clear. The Prime Minister and the Chancellor have said that the assessment of the five economic tests will take place and will be done before June of next year and it will be on the basis of that assessment that we decide whether or not to recommend to Parliament, and then to the British people in a referendum, joining the single currency.

  315. We had evidence from Caterpillar in particular of their decision not to invest £100 million here because they want to be in European market but they obviously did not want to be exposed to the currency risk in that market and therefore did not chose here. Whilst you are saying it is clear what the timetable is they still feel the uncertainty is there in terms making those investment decisions. In a sense you are saying that come next June they will then have a much clearer idea?
  (Ms Hewitt) I am aware of the situation with Caterpillar. Of course at this point we have not made the assessment and we have not made a decision whether or not to recommend entry and take it to a referendum. The timetable is absolutely clear. I think it is also worth stressing on the inward investment front that despite those issues the exchange rate and the single currency issue is only one factor in a company's decision on inward investment. We remain quite significantly the number one destination for foreign direct investment in Europe. Volumes of foreign direct investment have declined over the last year because of the downturn, but in terms of our share of that investment we remain number one and if you look across the world we are the number two only to America in terms of the amount and proportion of foreign direct investment that we attract. We are a very attractive inward investment environment, not least because we have this outstanding science base. We are a very good place for high technology, high value added R&D and production. We are going to keep it that way. Where we identify real problems, we have been talking about investment but there are infrastructure issues above all the skills issues, we are addressing those as well in order to maintain our place as a very good destination for investment.

  316. Certainly you would not want to be accused of not doing all the other things. One thing you did say in your earlier answer to Linda Perham though was that if you looked historically at exchange rate fluctuations they maybe did not correlate necessarily with disasters that were being predicted. Is this not really quite a different currency situation where there has been the political creation on our doorstep of this huge single currency zone which has not been there before in the same way and, whilst everyone is talking about the economy, the reality is that an added factor for investment is not just to look at the economic situation but to look at the political situation in making an investment decision?
  (Ms Hewitt) Clearly, as I have said, companies make their investment decisions on the basis of a whole range of factors. In some cases the determining factor may be wage costs, by definition that tends to be for the kind of lower value added production where wage costs are a very high proportion of total costs. We are not going to make a really good living in future by trying to attract, or to keep, low wage commodity manufacturing. That is not where our competitive future lies. For other companies the key factor will be the availability of highly skilled engineers where we are very good, despite the difficulties of getting enough of them. We have very good top quality engineers and the excellence of our science base: Boeing for instance, which has got this wonderful partnership with Sheffield University for a new Metals Institute, said recently in order to fulfil their ambition to be one of the best aerospace companies in the world they have to go to where the best scientists and engineers are, that means coming to the United Kingdom and specifically to Yorkshire. That was a key factor for them. In other cases, as for Caterpillar I believe, issues to do with the exchange rate were important. If you look across the board, we get more inward investment than anybody else. The other point that does need to be made about the exchange rate development is, yes, there was a very sharp rise in that 1996/1997 period in the sterling against the euro exchange rate but, of course, if you look at what has happened to sterling against the dollar, that has been really fairly stable until recently when it went down. We have actually had a different experience in the dollar/sterling exchange rate from that in the sterling/euro exchange rate which of course confirms the point, which is not a semantic one it is a real one, that the issue here is the sustained weakness of the euro rather than an over-valuation of the pound, which is how it is sometimes put.

Chairman

  317. On the other hand, a lot of our supply chain companies are more vulnerable to the kind of deterioration of our trading position against the euro than against the dollar. For example, last year this Committee in a previous Parliament took evidence from Corus who were quite strong in the fact that the euro was a major factor in their withdrawal from the UK steel production area. Perhaps I could ask you this. We know that at the end of the day, and the Treasurer never stops from telling us, sorry the Chancellor never stops from telling us—I say the word Treasurer because in an old fashioned way that is what he is in a number of respects, and that is how I think he sees himself, although I am not asking you to comment on that, Secretary of State—the Chancellor, the good doctor will turn round and he will say "I have the last word" but can we get an assurance from you that you will have the second last word because, let us face it, you have a responsibility for trade, for industry and by your own admission for manufacturing and if we are not about that in relation to our currency what are we about? I would hate to think that the distance between Victoria Street and Whitehall and the Treasury is that great but we sometimes worry that it is because there is not that convergence of minds on a number of issues in relation to the manufacturing economy and in relation to getting and keeping British workers in British jobs at the present moment.
  (Ms Hewitt) I do not really accept that.

  318. I wish to be convinced to the contrary, that is why I am asking the question.
  (Ms Hewitt) Let me develop the point, Chairman, if I may. I have a very close working relationship with the Chancellor. I think that the Treasury and DTI officials are building a closer working relationship than perhaps has sometimes been the case in the past. That is enormously important. You only have to look at last year's pre Budget Report and the work that the Treasury has done since 1997 on productivity to see the importance that the Chancellor attaches to high tech, high value added manufacturing. I think he and I have a common view of the importance of high value added manufacturing to our future prosperity, to high quality, high wage jobs and to raising productivity across the whole economy.

  319. In the interim period there are an awful lot of people employed in rather lower grade manufacturing jobs which are essential to keeping British skills in place and if you look at the car industry and we look at the fact that the supply chain is losing a great number of jobs because our people are over priced as against our central European and often German competitors because of the euro. We know the big picture, we know the macro, we know the short to medium to long term view, but it is the very short to just about short that we are worried about and we will lose an awful lot of people if something is not done about it.
  (Ms Hewitt) We are all concerned about the immediate situation but motor car manufacturing is not a low technology, low productivity job at all.


 
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