Stephen King: Let's not get sentimental over manufacturing

Policy makers should accept that individual sectors in an economy will both wax and wane

It's amazing how people stick to their most cherished beliefs in the face of overwhelming evidence to the contrary. Every fervent England football fan knows that England are a far better team than Greece - and, for that matter, Portugal and France. "We woz robbed," they will say - a refrain familiar to all those who have followed England's nigh-on 40-year trail of football failure. Every fan suffering from Henmania believes that Tiger Tim should be Wimbledon champion, even though, after years of trying, he hasn't managed to progress beyond the semi-finals.

It's amazing how people stick to their most cherished beliefs in the face of overwhelming evidence to the contrary. Every fervent England football fan knows that England are a far better team than Greece - and, for that matter, Portugal and France. "We woz robbed," they will say - a refrain familiar to all those who have followed England's nigh-on 40-year trail of football failure. Every fan suffering from Henmania believes that Tiger Tim should be Wimbledon champion, even though, after years of trying, he hasn't managed to progress beyond the semi-finals.

And every widget-maker knows that manufacturing activity is the bedrock upon which the British economy is built. Without it, we'd all be in serious trouble. The nation can only be guaranteed lasting prosperity if manufacturing is thriving.

The latest exposition of this view comes from the TUC. Its report on the economy, Manufacturing Now: Delivering the Manufacturing Strategy, starts off with a series of straightforward observations about manufacturing industry, but then goes on to bemoan the fact that, on international comparisons, Britain and the US are both doing very badly. Noting that job losses in manufacturing have been greater in either country than in continental Europe, the TUC concludes that "the more active European approach to industrial policy and collective bargaining together with stronger employment protection appears to have been more successful in sustaining employment in the manufacturing downturn than the Anglo-Saxon model".

The odd thing about this statement is not what it says but, rather, what it doesn't say. Job losses in manufacturing in the UK have undoubtedly been severe. Does this mean, though, that Europe has got things right? Scratch the surface and it's a lot less obvious. Even with those manufacturing job losses, UK unemployment is remarkably low compared with its European neighbours. The left-hand chart shows unemployment across a range of major European countries: on a comparable basis, the UK looks very good indeed.

Manufacturing has, of course, been in decline for many years. The TUC points out that, since Labour came into power in 1997, job losses in manufacturing have been severe in the UK, whereas other European countries have seen job gains. But the story has been going on for a lot longer than that. And yet the nostalgia for the good old days refuses to go away. We don't rejoice in the dynamism of our service sector. Instead, we sob inconsolably about an area of the economy that, quite frankly, is no longer the driving force behind our overall economic prosperity.

If you want proof of this, take a look at the right-hand chart. This shows the level of total economic value added, and the manufacturing component of that total, since 1970. I've indexed both lines to equal 100 in 1970. As a result, you can see the relative performance of manufacturing compared with the economy as a whole over the last 30 years. The comparison is stark. The economy as a whole has continued to expand even though manufacturing, on its own, has done very little. Indeed, manufacturing output today is not much higher than it was in 1972 and 1973.

What should we conclude from this comparison? There are two obvious possibilities. The first is a conclusion of regret: if only manufacturing had been looked after properly, the economy would have grown even more quickly. The second is a conclusion of reality: the economy has expanded at a reasonable rate - not too hot, not too cold - precisely because manufacturing was allowed to wither on the vine. Had manufacturing been supported by state aid and the like, the chances are that we would have ended up with a relatively larger manufacturing sector but a relatively smaller economy.

Quite simply, manufacturing profitability in the UK is not very good, even though the profitability of UK plc is actually rather impressive. In the October 2002 edition of Economic Trends (published by the Office for National Statistics), data showed that, while the rate of return on capital for the UK as a whole was impressively high - 4th out of a league table of 23 countries - the rate of return on manufacturing alone was shockingly low - 13th out of a list of 13 countries. Admittedly, these kinds of international comparison are fraught with difficulty. Nevertheless, the disparity between the economy as a whole and the manufacturing sub-sector is substantial.

Put another way, it makes perfect sense to invest in the UK as a whole, but it doesn't make a lot of sense to invest specifically in manufacturing. And, surprise, surprise, that's exactly what the data confirm. Total business investment is now higher than it was two or three years ago, despite the global recession, but manufacturing investment on its own is now quite a lot lower.

To be fair, the latest period of manufacturing demise is partly a reflection of events beyond the average widget-maker's control. The combination of loose fiscal policy and, by international standards, relatively high interest rates, has contributed to a much stronger level of sterling than anyone had any right to expect. That, in turn, has seriously hindered export performance and, hence, the relative success of Britain's manufacturing industry.

The real problems, though, surely lie in the rest of Europe. Germany is, perhaps, an extreme example but Germany, synonymous with manufacturing success, is sadly also now synonymous with broad economic failure. High unemployment, low tax revenues, a capital exodus and a welfare system that is now creaking under the strain: these are the legacies associated with a desire to maintain a broad manufacturing base.

There is no doubt that manufacturing is important. Its importance, though, is not an argument to suggest that Britain - or, indeed, other European countries - should pursue a "manufacturing" strategy. Policy makers should be more interested in pursuing an "economy" strategy and be prepared to accept that individual sectors within an economy will both wax and wane. Let's face it, the main manufacturing threat to Britain comes not from Germany, nor from France, but from China and other parts of Asia. Whether we like it or not, they are in the manufacturing ascendancy because they have the skills and they pay themselves a lot less.

And there's really nothing new about any of this. Peter Cook wrote a sketch way back in 1961 about an orchestral percussionist who, in a music shop, was pondering the relative merits of British and Japanese triangles:

"There we are. Beautiful, isn't it? The Eternal triangle, made in England - what a beautiful bit of work, built by craftsmen in the Cotswolds out of real Sussex ore. It's a work of art."

"It did fall to pieces in your hands, sir."

"... I don't want any of your vulgar long-lasting foreign filth. Give me an Eternal, the gentleman's triangle."

Forty years later, and nostalgia for British manufacturing "craftsmanship" lingers on.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com