May include foreign partsby Andy Neely, Carlos López-Gómez / November 16, 2016 / Leave a comment
The question of how UK manufacturing will fare post-Brexit is often presented as a transactional relationship between UK manufacturers and European Union 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 this overlooks the nature of modern manufacturing, which relies on networks of companies scattered across the globe, all dependent on each other to produce finished goods and services.
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 (FDI), and the importance of manufacturing value chains and networks.
First, 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 per cent of gross domestic product, although this is partly offset by a surplus in services, resulting in a balance of -2.1 per cent of GDP. Clearly the devaluation of the pound in the immediate aftermath of the EU referendum may have a positive impact on exports but this 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 rise, offsetting the 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 investment, but in its letter to the UK and EU, written after the Brexit vote, the Japanese government challenged any assumptions that this would be unaffected by Brexit. The letter 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 the right skills, and the need to deal with different regulations and standards in the UK and the EU. “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,” it warned. As commentators have noted, the UK must strike a deal that satisfies its international trade partners beyond the EU: failure risks isolation from the international community and could make future foreign investment in Britain harder to secure.
The third issue is that of global supply chains. Today’s manufacturers do not always 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—can sometimes be misleading. Competition in modern manufacturing takes place between interdependent groups of firms, often from different countries, that share knowledge and collaborate 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: knowledge-intensive activities such as research and development, design and professional services are similarly dispersed.
For manufacturers to be competitive they need access to high-quality production “inputs.” These include not only components, systems and specialised services but also workers, finance and even infrastructure, many of which are imported. Data from the Organisation for Economic Co-operation and Development shows that a considerable proportion of UK manufacturing exports rely on imported inputs. In 2011 the content of UK exports that had been previously imported was around 23 per cent, and that figure appears to be higher than for the other major EU manufacturing economies.
Conversely, more than half (52.5 per cent) of UK manufacturing’s domestic value added depends on foreign final demand, and a significant proportion of what the UK exports is not final goods but products and services that are further processed in another country before reaching the consumer. Of the UK’s total exports of domestic value-added in 2011, 63.7 per cent were not final goods.
So the picture is complex. The assumption that the UK’s balance of trade deficit strengthens its hand in Brexit negotiations only holds if the final destination of these imports is the UK. If the tariffs on importing intermediate goods become too high, there may come a tipping point where it would be more cost-effective for some activities (and factories) to relocate to the EU.
For manufacturing to thrive and prosper we need an agreement with the EU that is open, transparent and that enables international trade, investment and knowledge to flow with ease. Anything less runs the risk of damaging the long-term health of UK manufacturing.
On the 17th of January 2017, Prospect hosted a roundtable discussion with the contributors to: Brexit Britain: the trade challenge. This report is designed to act as a guide for parliamentarians, officials and businesses with a stake in the UK’s changing relationship with the world following Brexit. The discussion was chaired by Tom Clark, Editor of Prospect. Participants included Tasmina Ahmed-Sheikh MP, Miriam González and Vicky Pryce.
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