The Government’s manifesto commitment restraining fiscal policy and central Bank control of monetary policy are often blamed for having brought about a ‘twin-track’ economic headache: a buoyant service sector and a manufacturing recession.
The Government argues that a strong pound is needed to squeeze inflationary pressure out of the export-intensive manufacturing sector while higher interest rates are required to do the same thing for the less-traded service sector.
The Treasury has recently been arguing that improvements in manufacturing competitiveness following the 1992 ERM devaluation have been dissipated by management failure to achieve real efficiency gains in world markets. This view appears to be supported by the high level of economy-wide earnings growth, and a fall in manufacturing productivity. Recently the Chancellor has gone on the offensive in ‘naming and shaming’ manufacturing incompetence.
Beneath this is a rather surprising undercurrent of indifference to industrial policy, which could be a fatal flaw in the new Labour project. Downing Street and Peter Mandelson should note that there are valid explanations for these short-term productivity blips.
First, while manufacturing may be small relative to services, it is a highly export-intensive sector of the economy. So recent sterling strength has cut output disproportionately for export-sensitive manufacturers. Policy uncertainty about the duration of the downturn has also made employers reluctant to shed precious skilled labour in the short run. It is not surprising, then, that recent measures of output per worker in itself a crude measure of productivity have registered a modest fall.
It is normal for pay to show a faster rate of increase than prices. Earnings growth less price inflation merely represents the extent to which real output in the economy is growing the growth of productivity. After all, the benefits of real productivity growth must be distributed, as earnings or profits.
But earnings in manufacturing of more than 5% would only be consistent with an inflation target of 2.5% if business achieved real efficiency increases of 3%. The authorities’ new, gloomier estimates of what economy-wide potential productivity might be (apparently 2.5% and falling) appear to be confirmed by manufacturing productivity growth of only 1.2% in 1997.
It is, therefore, crucial to note recent research from the London Business School’s Centre for Economic Forecasting, using CBI employment survey responses (such as the Engineering Employers’ Federation’s data). This suggests the ‘corrected’ earnings growth figures are quite innocuous to the Bank’s underlying inflation target.
The LBS research estimates that manufacturing employment fell by 264,000 between 1993 and 1997 as compared to the official estimates of 191,000 (annual averages). Similar analyses indicate that output levels in manufacturing have probably been understated in Office of National Statistics (ONS) data.
These ‘corrected’ figures suggest true manufacturing productivity growth in 1997 was a healthy 3.2%. The ‘official’ ONS data also seems to have overestimated the productivity performance of the service sector.
Yet we should not be surprised by these revisions. Average productivity growth among surviving firms has always tended to be faster in manufacturing than in services, due to factors that include technical progress and export competition.
Service sector productivity will generally lag behind manufacturing because it is hard to measure, and hence improve, due to the intangible output characteristics of services.
An analysis of UK performance suggests that, apart from a bad blip in the 1970s, UK manufacturing productivity tended to grow at the surprisingly brisk rate of 4% a year between 1960 and the mid-1990s.
These figures compare favourably with most of our European partners and in some sectors, such as engineering, productivity growth may have been even faster.
Is it not time the EEF’s pleas to Whitehall about the plight of UK manufacturing were taken more seriously? Over to you, Mr Brown.
David Kernohan is an economist and research and policy adviser at the Engineering Employers’ Federation