What might Brexit mean for UK manufacturing?

The question of how UK manufacturing will fare post-Brexit is often presented in the somewhat simplified terms of a transactional relationship between UK manufacturers and EU markets. ‘Leavers’ contend that because the EU sells more goods to the UK than the UK sells to it, we will have the upper hand in negotiations.  But that position overlooks the nature of modern manufacturing, which today relies on complex networks of companies, scattered across the globe, all dependent on each other to produce finished goods and services.

In order to unpick how much UK manufacturing depends on access to the EU Single Market we need to consider the issue from three different but connected perspectives: the manufacturing trade environment, the impact on foreign direct investment, and the importance of manufacturing value chains and networks.

In terms of trade, the UK has run a deficit since 1998, largely caused by a deficit in traded goods. According to the Office of National Statistics, the 2015 deficit was around 6.9% of GDP, although this is partly offset by a surplus in services, resulting in a balance of -2.1% of GDP. Clearly the devaluation of the pound in the immediate aftermath of the EU referendum may have a positive impact on exports - UK exports are currently around 20% cheaper than they were pre-referendum - which makes UK goods more affordable and appealing to international markets. However, the impact of this devaluation is likely to be short-lived. Already there is evidence of inflationary pressure affecting imports used by UK manufacturers. As price increases flow through supply chains, the cost of finished goods will also increase, offsetting competitive advantage gained through a weak pound. In the long term, the way to address the UK’s deficit is through trade - ensuring that we export more than we import - and for that we require access to international markets, both in Europe and beyond.

In recent years, the UK has been very good at securing foreign direct investment, but the Japanese Government, in its letter to the United Kingdom and European Union, challenged any assumptions that this would continue untroubled by Brexit. The letter, delivered just before the G20 meeting, was remarkably explicit, raising five substantive issues that would deter future investment: uncertain trading conditions, additional customs duties, inability to access services and make financial transactions seamlessly across Europe, inability to access workforces with the right skills, and the need to deal with different sets of regulations and standards in the UK and the EU. The Japanese Government’s warning was stark: “Japanese businesses with their European headquarters in the UK may decide to transfer their head-office function to continental Europe if EU laws cease to be applicable in the UK after its withdrawal”.

As commentators have noted, the Japanese letter makes it clear that the UK is not just negotiating with the EU over Brexit, but it also has to strike a deal that satisfies the requirements of other international trade partners. Failure to do so will isolate the UK further from the international community and runs the risk that future foreign direct investment will be more difficult to secure.

The third issue is that of global supply chains. Today’s manufacturers do not operate within the boundaries of a single country.  To describe a manufacturer as British – in competition with, say, its US or German or Japanese counterparts – is somewhat misleading.  Competition in modern manufacturing takes place between interdependent groups of firms, often from different countries, that share knowledge and collaborate with one another to produce goods and deliver services. Raw materials are typically sourced in one location, intermediate inputs (such as parts and components) are produced in another and then exported somewhere else for further processing and/or assembly into final products. And it’s not just supply chains that function across boundaries: the knowledge-intensive aspects of manufacturing such as R&D, design and professional services are similarly geographically dispersed.

For manufacturers to be competitive they need access to high quality production ‘inputs’. These inputs include not only components, systems and specialised services but also workers, finance and even infrastructure, many of which are imported from abroad. Data from the OECD shows that a considerable proportion of UK exports rely on UK manufacturers first bringing in inputs from abroad, processing them and then exporting them.  In 2011 the content of UK exports that had been previously imported was around 23%, and that figure appears to be higher than for the other major EU manufacturing economies.

Conversely, over half (52.5%) of UK manufacturing domestic value added is driven by foreign final demand, and a significant proportion of what the UK exports are not final goods, but products and services that are further processed by another country before reaching the consumer. Of the UK’s total exports of domestic value-added in 2011, 63.7% were not final goods.

So the picture complex. The assumption that the balance of trade deficit strengthens the UK's hand in Brexit negotiations only holds if the factories using these imports are confined to the UK. If the tariffs on importing intermediate goods become too high, however, there may come a tipping point where it might be more competitive to move some activities (and factories) to the EU.

While uncertainty remains over what Brexit actually means, it is clear that the impact on manufacturing will be significant. For manufacturing to thrive and prosper we need an agreement with the EU that is open, transparent and enables international trade, investment and knowledge to flow with ease. Anything less runs the risk of damaging the long-term health of UK manufacturing.

Professor Andy Neely, Head Institute for Manufacturing, University of Cambridge.
Dr. Carlos López-Gómez, Head of Knowledge Exchange, Policy Links, Centre for Science, Technology & Innovation Policy (CSTI), University of Cambridge.

Why I'm in! Voting in the UK's referundum on the EU

So the UK's referendum on membership of the EU is fast approaching and I thought it about time I wrote a blog on why I'm voting for the UK to remain. The first reason is that fundamentally I am pro-Europe. I don't think the EU is perfect. There are clearly elements that need reform and there are valid questions of sovereignty, but I don't believe we have much hope of delivering meaningful reform if we exit and just shout from the sidelines. I was at a debate at the Royal Society recently on the impact of leaving the EU. The audience was overwhelmingly in favour of staying and one of the phrases that stuck in my mind was "corridor diplomacy". By leaving we'd be relegated to trying to have corridor conversations with those making decisions. It has to be better to be in the room where the discussion is taking place than standing in the corridor outside!
 

Second, I think the economic case is clear. The Brexit campaign continually quotes £350 million a week we give to the EU, although when pushed they acknowledge that the net contribution is actually significantly lower. The IfS - in their report - Brexit and the UK's Public Finances - suggest that the UK's net contribution to the EU stands at around £8 billion (0.4% of national income or around £150 million per week). If we stopped making this contribution we could reduce public spending by £8 billion a year (or divert that money elsewhere - to the National Health Service). Just to put things in perspective, public spending is forecast to be £801 billion in 2018-2019 (the year when the money would be available), so the net effect of an extra £8 billion is relatively small - around 1% of public spending.

More importantly, however, is the other side of the argument. What would be the effect of Brexit on the UK economy? If the economy shrinks then tax receipts would fall and this could have a far greater impact on the economy and the public finances than the "saved" £8 billion. The IfS report reviews eight different studies examining the impact of Brexit on the economy - six of which forecast a negative impact (ranging from a 1.2 to 7.9% reduction in GDP). One group - Economists for Brexit - predicts a 4% growth in GDP, while the group other predicts the possibility of a small growth. The balance of evidence is that the economy is likely to shrink in the short term at least. A 0.6% reduction in GDP would wipe out the £8 billion savings.

While the economists can argue over their forecasts, my job brings me into contact with lots of different people. Inevitably a common topic of conversation is the referendum. The vast majority of people I talk to would err on the side of remain and indeed many of them provide anecdotal evidence of adverse economic impact. Just yesterday I was talking with the manufacturing director of a FTSE 250 sized firm. They told me that the analysis they had completed suggested that their firm would take a £2 million hit on profits (around 4%) if we left the EU because of increased regulatory and trade burdens. Their argument was that as part of the world's largest trading block we have relatively free movement of goods and services (as well as people). Leaving the trading block will undoubtedly increase paperwork and red tape! In a separate conversation, with a Managing Director of one of the large banks, I learned that the bank had already seen a downturn in merger and acquisition activity - something they blamed on uncertainty about what will happen to the pound if we decide to exit.

Beyond economics, of course, there is then the argument about migration. Brexit will mean that we take back control of our borders! We can stop people coming to the UK! Yet European countries that agree trade deals with the EU also end up agreeing to the free movement of people! So when the Brexit campaign claim we can have a trade deal agreed with the EU immediately, that will be better than the one we have already - by being within the market - and yet we'll also be able to take back control of our borders, the argument just doesn't stack up.

The two final issues that I have been thinking about are safety and security, and sovereignty. The first of these - safety and security - is pretty clear. Part of the reason for creating the European Union was to seek to create a safer, stronger and more secure Europe. I don't see many people - on either side of the campaign - arguing that the EU has not delivered this. This leaves sovereignty - which I think is actually the strongest argument for Brexit. I can understand those who argue that we should have control over those who create laws for us. That we should be able to vote for EU representatives, but don't we do that by electing members of the European Parliament and asking them to ratify proposals from the EU on our behalf. By engaging with Brussels we gain influence - having representatives there allows us to engage in policy discussions. I can live with a little less direct control and share sovereignty with the rest of Europe, if this delivers the benefits of better and more open trade, increased safety and security and the opportunity to move, live and work freely throughout the EU.