UK Manufacturing decline is the real story of the Budget
Scott Newton |
Most of the comment on the Budget has concentrated on the very large government borrowing requirement revealed by the Chancellor. But that figure is just symptomatic of a crisis rooted in Britain's recent economic history; the crisis derives from the contraction of British manufacturing.
All developed economies have experienced a reduction in the contribution of manufacturing to GDP over the past forty years, but its fall here has been more rapid than in any comparable economy. In 1979 manufacturing accounted for almost 30 per cent of the UK's GDP. Rapid decline followed, as large parts of British industry closed down while the financial and service sectors expanded. By 2007 just 14 per cent of the GDP could be attributed to manufacturing.
The retreat of the manufacturing sector has been accompanied by a growing deterioration of the balance of payments current account: the difference between exports and imports. Even though there were times in the 1950s and 1960s when the current account went into the red, it was very rare for the deficit to be equivalent to more than 1 per cent of GDP. The special circumstances of the oil crisis in 1973 led to a deficit worth 4 per cent in 1974, but the Wilson and Callaghan governments transformed this into a 0.5 per cent surplus by 1978. Thereafter the position became far more volatile, and by the end of the 1980s the current account deficit was approaching 5 per cent of GDP. Since 2000 it has consistently exceeded 2 per cent, reaching 3.4 per cent and 2.9 per cent of GDP in 2006 and 2007 respectively.
For many years this weak external position did not create problems for the domestic economy. Living standards rose and there was continuous economic growth from the early 1990s until early 2008. During the 1960s and 1970s successive governments had struggled to generate current account surpluses, believing that prosperity could not otherwise be sustained. More recently, it seemed that those fears had been misguided, and the country could afford to forget the external position. But this conviction was illusory.
The expansion of the last 12 years in particular has resulted from significant inflows of foreign capital and a dramatic expansion of credit, accompanied by the growth of the financial sector. However, this process was largely built on the belief that asset prices, notably property, would continue to rise indefinitely. And indeed, the returns from speculative ventures were so lucrative that a giant inverted pyramid of lending developed, with the consequences with which we are now all familiar.
The arrival of the global crisis in 2007 hit the UK especially hard. As asset prices fell, money and credit disappeared from the banks, which were completely or partially nationalised to prevent the catastrophic failure of the UK financial sector. The cushion of lending, which had sustained living standards by compensating for the diminishing contribution of exports, deflated fast.
Now the UK has to make a serious adjustment, since the credit which had allowed its citizens to enjoy the good years has gone and is unlikely to return very soon. Even when it does, the probability of it reaching its old levels is remote. The resulting fall in economic activity has caused the collapse in tax revenues and the very large borrowing revealed in the Budget. The manufacturing base of the economy is not large enough to compensate, via exports, for the loss of income generated by the financial crisis. We cannot look to finance and services to fill the gap. The City of London has contracted in the current crisis. Services tend to be less internationally tradable than goods, (take pizzas or hairdressing, for example). And at least 20 per cent of all service sector activity is dependent on manufacturing anyway.
What form of adjustment is required? The economy needs a stronger manufacturing sector, capable of earning more abroad than it has done during the past three decades. The recent Department for Business, Enterprise and Regulatory Reform paper, New Industry, New Jobs [pdf], shows the government taking welcome steps towards the construction of a strategy for the revival of British industry. But the volume of resources available is limited and more spending on industrial regeneration will be needed over the coming decade. Some of the extra spending will come from resumed growth, but a diversion of funds away from areas less likely to make an immediate contribution to wealth creation may also be necessary. These areas could include defence (necessitating fewer foreign engagements and the abandonment of expensive commitments such as Eurofighter and Trident), public sector IT projects, ID cards (already rumoured to be on the way out), and higher education expansion. This process will take years. In the meantime, British people have to face static or declining standards of living, characterised by growing pressure on public services, austerity in pay, higher taxes, and large-scale unemployment. This is the real story of a Budget, which has revealed the true cost to a country of living beyond its means for over a generation.
Please note: Views expressed are those of the author.About the author
