ECONOMIC TRUTHS: Manufacturing's bright future - Britain's export industry, against the odds, has not only sustained strong growth, it has done so in the new development area of technology

ECONOMIC TRUTHS: Manufacturing's bright future - Britain's export industry, against the odds, has not only sustained strong growth, it has done so in the new development area of technology - Being of cheery disposition, I am wounded by the charge that eco

by DAVID SMITH, economics editor of the Sunday Times
Last Updated: 31 Aug 2010

Being of cheery disposition, I am wounded by the charge that economic commentators always look on the dark side of life. We don't, it is just that bad news usually makes a better story. Ask any economist when the demand for his or her services is greatest and it is invariably when there is a crisis.

Like undertakers or company liquidators, we benefit from other people's woes. Not for nothing is it called the dismal science.

It is therefore gratifying to be able to present some good news. I refer to the increasingly impressive performance of British manufacturing in the face of adversity. Indeed, its ability to keep its head above water and secure a return to growth has been one of the most extraordinary stories of recent times.

Cast your mind back three years, when sterling had begun its dramatic rise on the foreign exchanges. Two possibilities suggested themselves: the pound's rise would be short-lived, brought to an abrupt halt perhaps by the election of a Labour government; or, it would continue strong, bringing predictable woe for manufacturing exporters. It happened in 1980-81 (the Thatcher overvaluation) and in 1990-92 (the exchange-rate mechanism overvaluation), so why not in 1998-99?

The parallels were surely too strong to ignore. We had a new prime minister, Tony Blair, just as we did with Margaret Thatcher in 1980 and John Major in 1990. We had a new monetary regime, Bank of England independence, just as we did with early Tory monetarism and the ERM. And we had, it seemed, a manufacturing sector which, being used to a competitive exchange rate, was going to suffer from an exceptionally high one.

But, while manufacturing suffered a 'technical' recession (two quarters of falling output), and looked sickly compared with the rest of the economy, the predicted collapse did not occur. Remember, output declined by a fifth in the early-80s recession and it fell sharply from 1990-92. Also, vis-a-vis the Deutschmark, the pound has been higher - between 5% and 10% - than during the ERM period.

So what has been happening, and how do we square the overall positive performance of the sector with individual parts which have been anything but?

The first point is that what seemed to be a high exchange rate problem in the early 1980s and '90s may, in fact, have been a high interest rate problem. In both cases, industry was hit by the double whammy of a high pound and a punitive cost of borrowing (17% at it peak in the early '80s, 15% in the early '90s). This time, interest rates have been, by British standards, low.

Second, the time of greatest recent distress for manufacturers was when a strong currency was combined with weak or non-existent export growth, thanks to the Asian economic crisis and sluggish growth in the larger European economies. A year or so ago, when we thought export orders were suffering as a consequence of sterling's strength, the real culprit may have been export-market weakness.

Third, and most encouraging, are the significant changes within manufacturing itself. For most of us, manufacturing, conjures up a vision of a welding shop or a line of lathes. But, as Michael Saunders of Salomon Smith Barney, the investment bank, points out, Britain now boasts a substantial high-tech manufacturing sector. In fact, it accounts for 14.5% of all manufacturing in Britain, compared with 12% in France, 9.5% in Germany and an EU average of 10%. Among member countries of the Organisation for Economic Cooperation and Development only Japan, the US and South Korea have a bigger share of high-tech. It is in this area, moreover, where all the growth has been coming.

If we take the electrical investment goods component of manufacturing, where much of the high-tech activity is concentrated (computers, mobile phones, office machinery and so on), output has risen by a staggering 60% over the past three years, nearly 150% since 1993. The rest of manufacturing, meanwhile, has barely grown at all during this time, even with the assistance between 1993-95, or a very competitive exchange rate, and some areas, notably clothing and footwear, have been disastrous.

What this tells us is that a profound, healthy shift is taking place within manufacturing, away from the old, stagnant, low-tech parts, and towards the hot-growth areas of high-tech. The next time the OECD does the figures Britain will have an even bigger high-tech share.

This does not mean we should ignore the 80% or so of manufacturing that is not classified as high-tech and there are encouraging signs here. At the end of last year, overall manufacturing productivity was rising at an annual rate of 5% as a result of rising output and some tough decisions on slimming down workforces.

The key to making a broader economic success of a vibrant high-tech sector is ensuring it spreads to other parts of industry - and that may now be happening. In spite of the strength of sterling, and perhaps in part because of it, it is possible to look forward to a new, more optimistic era for UK manufacturing.

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