Bulletin – January 2013 Why High Tech Manufacturing is not the solution to an over-valued Exchange Rate

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January 1, 2013 by johnmillsjml

Exchange Rate Reform Group

BULLETIN  –   January 2013

 

 

Why High Tech Manufacturing is not

the solution to an

over-valued Exchange Rate

 

The UK economy is clearly struggling to compete with other countries in world markets for low tech products. On the contrary, we are currently doing much better in high tech sectors such as cars, aircraft, arms and pharmaceuticals. There is therefore a widespread belief that the way to rebalance the UK economy towards manufacturing is to move as fast as possible towards high tech production, where there is a common perception that productivity and wages are higher than they are in lower tech industries. Unfortunately, views of this sort are based to far too great an extent on a combination of poor analysis, mistaken assumptions and wishful thinking. This Bulletin explains why this is so, why policies based on these foundations are all too likely to end in failure, and what really needs to be done to get  manufacturing industry in the UK back to being sufficiently competitive for us to be able to pay our way in the world.

 

Why is the UK economy currently doing better with high tech than low tech manufacturing?  There is plenty of evidence that the UK’s remaining manufacturing capacity involved in international sales is relatively high tech. In the third quarter of 2012 (2012 Q3), of total manufactured exports of just over £64bn, Office for National Statistics (ONS) figures show that 11.4% were Chemical Products, 11.3% were Vehicles, 11.2% consisted of Machinery, 9.1% were Pharmaceutical Products, 8.9% were Electronic Products, 8.7% was Refined Petroleum and 8.4% was accounted for by Aerospace. Just under 70% of all our exports were thus accounted for by these seven industries, all of which are clearly placed at the high end of the high tech/low tech spectrum. If we are doing much better with exports in these sectors than we are in low tech production such as Metal Products (2.4%), Plastic Products (1.8%), Apparel (1.6%) and Games and Toys (0.2%), is it not obvious that the future lies in the UK moving towards high tech rather than low tech manufacturing?

 

 

The answer unfortunately is “no” and here is why this is the case. The reason why we have an edge in relatively high tech manufacturing is not because in the long term we have a natural advantage in these activities. It is because they all involve a large amount of technical skill and management experience and because all of them involve complex supply chains and marketing structures which take a long time and major investments to bring together. They are thus much more difficult to attack by low cost base competitors than industries which are simpler. They therefore tend to survive much longer against low cost competition in conditions where low tech industries get wiped out relatively quickly. It does not, however, follow that high tech industries are immune from competition from low cost competitors indefinitely. It just means that it takes longer to attack and copy them. In the end, however, the very high UK cost base will take its toll and these high tech industries will succumb just as low tech ones have, only more slowly.

 

What policy conclusions can be drawn from the vulnerability of our high tech industries to low cost competition? If the foregoing analysis is correct, a number of key policy conclusions follow from it. These are:

 

1.A     If the UK persists in maintaining a cost base which is charged out through an over-valued exchange rate at much too high a high level to be internationally competitive, our high tech export industries will be worn down just as the low tech ones have been. The cost base encompasses all locally incurred charges. Typically, including wages, salaries and the costs of all local services and bought in supplies, these amount in total to an average of about 60% of manufacturing businesses’ total costs. These then have to be charged out in turn to the rest of the world as export prices. By far the largest influence on the amount at which the cost base is charged out to the rest of the world is the exchange rate. The notion that we are safe to rely on these high tech industries in future if we continue with our current exchange rate policies is thus fraught with danger.

 

1.B     It also means that relying on high tech industries being a better bet for the UK to encourage than low tech ones involves completely misunderstanding the process whereby high tech industries become established. Given a UK cost base which is far above the international average – as is currently the case – it is not easier, but far more difficult to establish high tech industries in the UK than it is elsewhere. Of course there will always be exceptions but there will never be enough of them to buck the trend towards further de-industrialisation. Furthermore, because high tech industries are more complex and difficult to establish than low tech ones, the risk of failure is much higher, a factor which is further accentuated if they are already handicapped by an exceptionally high cost base.

 

1.C    Given the right international competitive conditions, low tech industries are therefore much easier to establish than high tech ones. Their location, however, if they involve internationally tradable goods, will always tend to be to places in the world where the cost base is charged out at a relatively competitive rate.  Because they involve well known technologies which are relatively cheap and simple to get into production, the risks of getting into the wrong technology are comparatively low.

 

1.D    Both high and low tech industries in the medium to longer term are therefore equally critically dependent on the cost base being charged out to the rest of the world at a competitive rate.

 

Is it true that employees in high tech industries have higher productivity and thus higher wages and salaries than those in low tech industries?  There is a widely held view that high tech industries must be more productive than low tech ones, and that they therefore pay higher wages to more productive workers. It is certainly true that on average manufacturing jobs are much better paid than the average for the whole economy. By 2012 Q3, manufacturing was generating 10.6% of UK GDP but only employed 8.3% of the UK labour force, so productivity (gross value added per person or GVA) was 37% higher on average in manufacturing at an annualised £58k than it was at £42k in the Service Sector. It does not follow from this, however, that productivity is always greater in high tech than in low tech industries and ONS figures – again from 20132 Q3 – do not show this is always the case. GVA is exceptionally high in Chemical and Pharmaceutical Products (£141k) and 15% above the manufacturing average for Computers and IT (£68k) and Machinery (£66k), but 4% below average for production of Transport (£55k). On the other hand, relatively low tech industries such as those producing Food Products, Beverages and Tobacco at £66k are above average. Much higher GAV values are, in fact to be found in Electricity and Gas (£143k) and Water Management (£109k), while in Mining and Quarrying the figure is a remarkable £404k. None of these latter activities have any significant export component. On the hand, industries which are particularly vulnerable to  low cost foreign competition tend to have low GAV figures. Textiles, Beverages and Leather Products come in at £33K, and Rubber and Plastic Products at £38k.

 

As to the Service Sector, some components of which do make significant contributions to the UK’s foreign earnings, one of the larger sections of the labour force (2.1m) is in Accommodation and Food Services with a dismally low GAV of only £21k – less than half the £45k average for the whole Economy. Financial and Insurance Services at £119k not surprisingly score high, as does Real Estate at £243k, but the rest of the Service Sector has average productivity mostly well below the national average.

 

What are the crucial lessons to learn from these figures:  There are a number of important conclusions which can be drawn from this data, these being:

 

2.A     Productivity is generally much higher in manufacturing than it is in services and higher in industries which are protected by complex production processes and supply chains than in those which are more vulnerable to low cost competition. Our high tech industries are, however, just as vulnerable in the longer term to low cost competition as those which are easier to attack.

 

2.B     Manufacturing industry in the UK cannot survive unless it has highly productive work forces because of the high cost base in which it has to operate. Intense competition from abroad, however, keeps wages down in those sectors of the economy involved in producing goods for export, particularly in industries with technology which it is relatively easy to copy. The UK thus combines highly productive labour forces in its manufacturing industry with relatively low pay.

 

2.C    This is, however, a major source of weakness especially over the medium to long term. To compete successfully internationally, the UK needs to have a significant proportion of its most talented people in manufacturing. While this is true at every level, it is particularly crucial for senior management. The most able people capable of filling these positions will only be attracted to make career decisions in favour of making and selling products instead of going into the media, the City, the Civil Service or the professions if earnings are at least as high if not higher in manufacturing than in other occupations. In fact, in the UK, for a very long time now, a career in industry has been seen by most talented people as being at the bottom of their list of priorities, which in turn is very largely an exchange rate issue. The over-valued pound we have had for most of the last two hundred years – but especially since about 1980 – has made it much harder to make money in industry in the UK than in countries with much more favourable exchange rate policies. As a result, a career in manufacturing in the UK has consistently been less attractive financially than other options. The result is that most industries in the UK have for a very long time been poorly managed by international standards, making themselves vulnerable both to foreign takeovers and to having more talented people from abroad being recruited for top management positions.

 

2.D    The only solution to the UK’s lack of export competitiveness and the weakness of its manufacturing sector is therefore to have an exchange rate which is sufficiently low to provide the UK with a cost base which is competitive internationally. This is not only crucial to ensuring the survival of our remaining high tech manufacturing capacity but also to enabling us to regain our ability to compete in the world in industries which do not have the protection of technology and experience which it is difficult to copy. This is the only way in which we will regain enough manufacturing capacity capable of competing in international markets to enable us to pay our way in the world.

 

 

 

Published by the Exchange Rate Reform Group

JML House, Regis Road, London, NW5 3ER

Tel: 020 7691 3833 * Fax: 020 7691 3834

E-mail: john.mills@jmlgroup.co.uk  *  Website: http://www.johnmillsblog.co.uk

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