Stability means calming the productivity see-saw

The boom and bust cycle created uncertainty which deterred investment in manufacturing, argues STEPHEN RADLEY. He calls for government action to help boost productivity

As the chancellor often reminds us, stability has been a key feature of the UK economy in recent years. After decades of boom and bust, this is no mean achievement. Yet in at least one important area boom and bust remains, and it is another of the chancellor’s favourite topics -productivity in manufacturing.

Given the need for sustained improvements in productivity just to stay in the game, the volatility of our productivity performance is critical to our competitive future.

During the 1990s levels of productivity in manufacturing went through four phases.

It started the decade at just over 2.5%. A world recession and an over-valued pound within the exchange rate mechanism then spurred companies into action, and productivity grew by 5% and upwards for three years. In the four years from 1995 it collapsed, and there was no improvement in output per employee over this period. Only in 1999 did the productivity beast stir again, with an annual improvement of 3.6% and faster increases in the second half.

Regular improvements are needed to survive in an increasingly competitive world. The growth of e-business makes this a reality, as it is much easier for customers to demand significant and sustained reductions in costs. Becoming more cost-efficient, reducing faults and speeding delivery times will be the bare minimum needed just to stay in the supply chain.

But greater efficiency is unlikely to be enough. E-business offers tremendous opportunities, but there is a danger for manufacturers of becoming producers of commodity goods whose prices are forced ever downwards.

More profitable opportunities lie in developing new products with a high design content, increasingly customised to the needs of the individual customer.

New technology makes this possible, but not easy. Significant investment in new equipment, in R&D and reorganised production is required to make small-batch production efficient.

For now, higher skill levels, deeper capital markets and a sophisticated and prosperous customer base gives Britain and other mature economies an advantage over lower-cost rivals, but this will disappear unless the necessary investment takes place.

It will be up to manufacturing to make this happen but it is important to understand why it has failed to sustain the improvement in the past.

One of the key reasons for a lack of investment has been uncertainty. Big swings in growth prospects, inflation, the cost of borrowing, and exchange rates have undermined confidence and made it hard to assess whether the planned investment will be profitable enough.

With export margins at a 25-year low, the cash available for investment is also limited. The conservative attitude of lenders also hasn’t helped, with shorter payback periods and higher rates of return required for investment to go ahead than is the case in other countries.

Though domestic and world economies have become more stable recently, an over-valued and volatile currency remains a problem, and a solution in the short term seems unlikely. UK adoption of the euro is several years away at the earliest, nor would it be welcome at its current rate.

Industry will have to bite the bullet, but the government can still help it in a number of ways.

First, it could extend 100% first-year capital allowances from computers to all machinery and equipment – machinery only gets a 40% allowance at the moment. This is an anomaly, given that machine tools are largely computer-controlled.

It should also consider extending tax credits, along the lines of the successful scheme which operates in the US.

Equally, it should copy the US approach to regulation. The flexibility provided by deregulation is a crucial contributor to the success of its new economy. By contrast, UK manufacturers are faced with a growing burden of regulation.

Finally, the government should put a stop to another element of boom and bust – the careers of DTI ministers. Three incumbents in three years has continued the revolving door policy of the Conservatives. Some of the chancellor’s much-lauded stability would be welcome here.

Stephen Radley is chief economist at the Engineering Employers’ Federation