How bleak is the future for UK manufacturing?
Tue, Feb 3 2009, 06:09 GMT
by Trevor Williams
With the volume of world trade dropping fast and global growth measured at market exchange rates set to contract by about 1%, its worst performance since 1945, it is no surprise that global industrial production is falling sharply. The countries most affected by this fall in world trade growth, and therefore seeing the biggest falls in industrial production, are not surprisingly those economies most exposed to international trade. This includes the UK, where industrial production in the year to November was down by 7% and is likely to have fallen by an annual 8% in December when those figures are released later this week. Other countries are even worse off, but we concentrate on the UK in this briefing.
A global downturn is hitting industrial production in most countries...
IMF figures show that world trade and industrial production are falling very sharply, see chart a. This suggests quite a bleak future for UK manufacturing output, with a weaker exchange rate unlikely to help boost exports at a time when global export volumes are declining so sharply. And this at a point when the global financial crisis is likely to set back output growth in the UK services sector more severely than in many other countries. The reason is that UK firms have been at the forefront of global trade in the financial instruments most affected by the current financial crisis, and so, coupled with the deregulation, the UK’s services sector has grown much faster than its manufacturing sector, especially since 1994, see chart b. This suggests that, if growth in services is significantly slower as expected, then the strong likelihood is that UK overall economic growth will also be well below the average of the last decade, when annual average growth in real (inflation-adjusted) terms was 2.9%. The chart suggests that the vast majority of the growth in the UK economy for well over a decade has come from the services sector. And it is unlikely that this could be replaced by any other industry any time soon.
...but UK manufacturing exports are up on the year as a weaker exchange rate and slower economic growth than elsewhere helps the manufacturing sector...
Despite the slower growth in the world economy, however chart c shows that UK export growth of manufactured goods has risen compared with year ago levels. Now, this is likely to be unsustainable with world trade volumes falling sharply, but it does suggest that the prospects for the sector are not universally bleak. Chart d shows that the fall in the exchange rate has been very pronounced, and this should mitigate imports as well as help exports. What are the chances that UK manufacturing output gives a positive surprise in the years ahead? In terms of UK exports, the share of manufacturing out of the total has been falling, even though generally the value of these exports has risen pretty consistently, see chart e.
The reason why manufacturing goods share of total UK exports has fallen is because services exports have risen even faster, driven by the boom in global financial services in the past decade. It is also interesting to note that the manufacturing sector is more competitive in terms of productivity than many suppose, see chart f, with growth in productivity faster than in the services sector (though this is partly due to falling employment levels in manufacturing). However, our calculations suggest that if the pound’s trade weighted exchange rate stays weak, and UK economic growth remains well below that of its key export partners, the UK’s trade deficit could turn from its current account deficit of £26.6bn last year, into a small surplus by 2011/2012, see chart g. This outcome also assumes that wage inflation stays low, so the UK sees all of the benefits of the fall in the exchange rate in an improvement in its relative unit labour costs compared with other countries. The scenario of a current account surplus and a sharp rise in manufacturing output and exports is also dependent on a strong recovery in global trade growth.
...and so the prospects for UK manufacturing firms are not universally bleak
These are big ifs, but suggest that the possibility exists for the fall in the exchange rate to help rebalance the UK economy in the years the come, away from its decade long dependence on services and consumer spending towards manufacturing and investment. The end result will still be weaker UK economic growth on average in the years ahead than in the last decade - we estimate that annual trend growth will be 2 to 2.25%, so well below the 2.9% per year recorded in the last 10 years. However, to write off UK manufacturing because of the very poor short terms prospects for output is to possibly misread the likely good performance of some sectors within it in the years to come.
