Manufacturing false hopes: why Brexit will hit the makers

In the wake of the referendum, Leavers have been too quick to celebrate manufacturing’s better-than-expected performance

April 19, 2018
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Despite Britain’s lacklustre economic performance since the referendum one bright spot in the economy has been manufacturing. But hopes that Brexit might rebalance the economy away from finance and towards industry are as likely to be dashed as George Osborne’s rhetorical ambition in his 2011 budget of “a Britain carried aloft by the march of the makers.” The revival of manufacturing since the referendum owes much to a resurgent European economy, highlighting the risks to industrial firms once Brexit throws sand in the cogs of trade with Britain’s main trading partner.

Worryingly, that revival has already faltered this year. The output of Britain’s factories stagnated in January and fell by 0.2 per cent in February. A widely followed purchasing-manager survey of manufacturing conditions compiled by IHS Markit suggested that output grew in March. That could prove too optimistic given the disruption caused by snow.

Things looked rosier last year as manufacturing for once was in the economic vanguard. Factory production in the final quarter of 2017 was 3.8 per cent higher than in the three months to June 2016, when the referendum was held. That outstripped Britain’s dominant business and financial services sector which grew by only 2.6 per cent over the same year and a half. Since business and financial services are three times as big as manufacturing (which makes up only 10 per cent of GDP), the outperformance of the makers made little difference to overall economic growth. GDP increased by 2.7 per cent over that period, equivalent to a disappointing annual rate of 1.8 per cent.

One reason why manufacturing did relatively well was the steep fall in the pound after the referendum. Since Britain’s factories export a lot—a third of their total turnover in 2017 was exported—they gained particularly from the depreciation in sterling which made foreign sales more profitable. Exports of goods excluding oil and erratic items (such as privately held gold) grew in volume by 8.1 per cent between the three months to June 2016 and the final quarter of 2017. That contrasted with a smaller rise in similar imports, of 5.4 per cent.

But British exporters respond nowadays more to demand in foreign markets than to changes in their competitiveness. The decisive influence in improving manufacturing’s fortunes last year was the revival of the economy around the world and in particular in the European Union, which buys half of Britain’s goods exports.
“One reason why manufacturing did relatively well was the steep fall in the pound”
The euro area at the heart of the EU grew last year by 2.5 per cent, its fastest for a decade. That raised demand for British exports. And because many British factories form part of European supply chains they benefited from the strong upturn in eurozone manufacturing whose output surged by 5.4 per cent in the year to December. In keeping with this, the faltering performance of British manufacturing so far this year has mirrored a sharper reverse in the euro area where factory output fell by 2 per cent in February.

The intimate linkages between factories in Britain and Europe underline why manufacturing is vulnerable to Brexit even if tariffs on goods are avoided through a free trade agreement such as the one between Canada and the EU. The stumbling-block will be new non-tariff barriers such as border checks to ensure that products meet EU technical standards and comply with rules of origin. The local-content rules will be necessary in order to ensure that British firms are genuinely contributing a big share of the value of a product and are not being used as a conduit into the European customs union by countries subject to EU tariffs.

The imposition of non-tariff barriers as Britain leaves the EU will hurt manufacturing. The government’s leaked economic analysis of the impact of Brexit showed that chemicals would be hardest hit through a Canada-style free-trade agreement. Motor vehicles would also be hurt badly with food and drink another prominent victim. All these manufacturing sectors would incur more damage than finance, where the City is vulnerable because of the loss of passporting rights that allow cross-border services to be provided out of London.

This helps to explain one of the most striking findings of the projections, that the North-East would be the English region most afflicted by Brexit, followed by the North-West and West Midlands. The three regions have especially high concentrations of manufacturing in their economies. By contrast southern regions where manufacturing is less prominent got off more lightly in the analysis.

Despite the gloomy outlook there have been some breaks in the cloud for example in the car industry. French carmaker PSA recently announced a plan to raise van production at its Vauxhall plant in Luton in an investment of around £100m. Nissan and Toyota are pressing ahead with new models at their British factories. Yet these announcements are overshadowed by the slump in investment in the car industry, from £2.5bn in 2015 to £1.7bn in 2016 and £1.1bn in 2017. And Jaguar Land Rover indicated on Friday that it is cutting 1,000 jobs at its plants, blaming in part Brexit-induced uncertainties as well as consumers’ reluctance to buy vehicles that run on diesel.

The bigger and more ominous picture is that capital spending in manufacturing rose by just 0.4 per cent between 2016 and 2017, compared with 2.7 per cent for all other businesses. Indeed investment last year in manufacturing was 5 per cent lower than in 2015 whereas it was 3.1 per cent higher for the rest of business.

The government finally got round to setting out an industrial strategy at the end of last year. That may help manufacturers a bit in the long run. But it is unlikely to compensate for the harm inflicted on the makers through a Brexit that severs the close ties between British and European factories. That is why the argument for staying in a customs union, though rejected by Theresa May, remains potent. It has provoked a rebellion in the Lords, and may yet win over enough Tory backbenchers in the Commons to enforce a change of course.