DECLINE

THE REASONS BEHIND BRITAIN'S GROWING FAILURE TO COMPETE IN WORLD MARKETS.

Decline in Exports continues, Balance of Trade stuck in the red.

Britain's declining share of world trade is beginning to cause concern. The latest body to report the UK's poor performance is the Item Club, a respected Think Tank sponsored by Ernst and Young.
Item Club review, July 2006, reported by Allister Heath in 'The Business':
"British exporters have fallen behind in the race to sell goods to China, reinforcing concerns about the ability of UK plc to compete with its main rivals, a leading think tank will warn on Monday.
Plummeting competitiveness caused by surging costs and weak productivity growth mean that the UK is selling only $5.5 billion a year to China, compared with $30.7bn for Germany, $9bn for France and $6.9 billion for Italy, the research from Ernst and Young's Item Club reveals.
Peter Spencer, the Item Club's chief economic adviser, said: "The whole thing looks absolutely shocking. There is no good news in this report at all.
Until UK manufacturers manage to break out of the vicious circle of low profitability, low investment and a lack of cost control the medium-term prospects for exports remain poor". He also said that the UK economy had just enjoyed "seven years of plenty" based on heavy spending by government and the consumer. Now these sectors are over-borrowed and can no longer take the lead in driving the economy. This leaves GDP growth critically dependent on exports, investment and ultimately the strength of the world economy. The (Item) club is predicting that export growth for 2006 will officially stand at 15% - however once these figures are adjusted for VAT fraud the headline figures stand at a much more modest 9%.
Spencer said: "When seen against the background of the boom in world markets, it's actually very disappointing"

What are the wider implications of poor export performance?

Bill Jamieson in 'The Business' sets the scene, under the headline, "Speedy growth followed by a soft landing? I wouldn't count on it". He questions the sustainability of UK economic growth based on government spending and high levels of consumer debt: ......"The composition of these (growth) numbers begs searching questions about the quality and sustainability of the growth story. It is largely the result of continued buoyancy both in consumer and government spending. And both are a function of high and unsustainable borrowing. The strength of the consumer sector in particular looks ever more vulnerable as evidence mounts of astonishing levels of personal debt and rising insolvencies.
Similarly the public finances are showing signs of stress......
If momentum in these two areas proves as short-lived as many fear then exports and investment need to take up the strain of the growth story."

Key Issues behind the headlines

The Item report contrasts Britain's poor export performance to China with those of other European countries and postulates low productivity, high costs and a lack of investment as the root causes.
But does this analysis go deep enough? Are there still more fundamental issues underlying Britain's under-performance in world markets and if so, what are they?

First - a popular misconception about the importance of manufacturing to Britain's future...
Manufacturing represents a major chunk of the value of world trade. But for some mysterious reason, many commentators (including the Item Club in another report) seem to feel that a lack of competitiveness and the decline in Britain's competence in manufacturing industries is of little concern - services represent the future, they assert.
The facts indicate otherwise.
In 2005, the value of UK manufactured exports was £209 billion, and the value of services exports £110 billion. However, the trade balance shows a dramatically different picture - the value of imports compared with exports shows a deficit of £67 billion for manufactured goods and a surplus of £23 billion for services.
These figures reveal two things:

• The value of manufacturing to Britain in the wider world - say twice that of services.
• The growing failure of Britain to compete in world markets in advanced manufacturing industries.

BALANCE OF TRADE TRENDS

The following table shows the true magnitude of Britain's decline in world trade.
The years chosen are 1982, when the Conservatives came to power under Margaret Thatcher, 1997, the year New Labour were elected and the latest figures for 2005. This shows that the disastrous slide in manufactured exports and the balance of payments has occurred under both governments.
One point to notice is that the growth of services exports is far slower than the precipitous decline in manufacturing. So, whilst the growth of exports in services is to be welcomed, it is not compensating for the far faster decline in manufacturing.

Balance of trade (red = deficit, black = surplus)
£billion

So, manufacturing industry is crucial to Britain's economic well-being - a fact that is played down by many commentators.
But there are other issues of concern.....

Second - A failure to distinguish between the Symptoms of decline and the deeper Causes.
Most commentators seem to feel that poor productivity and a lack of cost competitiveness are the main causes of the UK's export problems and that they can be fixed in the medium term. Whilst these observations are valid, it can be argued that this analysis ignores much deeper and more difficult problems, many of which are hard to fix.

Symptoms of Decline

Certainly poor productivity and high cost are a problem - but there are other important symptoms of decline. Here are some:

• The general decline of manufacturing industries

  For some time, many politicians, economists and policy makers have professed not to care about the decline of manufacturing and certainly they have done little to help halt it. If this is so, they cannot understand what 'manufacturing' is all about. Many seem to see it as assembly lines manned by semi-skilled workers.
  The reality is that manufacturing industries research, design, develop, engineer, test and construct systems and products for consumer and industrial markets. The outputs of manufacturing industries often represent the cutting edge of technology. In the US, it is estimated that out of 29 industry sectors dependent on advanced knowledge and high technology, 25 are in manufacturing. Manufacturing companies are complex to manage, and to be successful need special knowledge and long-term dedication from their leaders and staff. Many also require consistent and heavy investment in Research and Development and innovation. Innovation is the process of incrementally improving and developing families of products and systems and requires detailed long-term attention. This is one of the special skills of the Germans and Japanese. BMW cars, Boeing aircraft, Honda engines and MicroSoft software are more the result of continuous innovation than break-through inventions.
  The wholesale loss of manufacturing industries not only places the UK at a major disadvantage in the competitive world of modern industry, depriving many of the opportunity of skilled work, but it also robs Britain of its capacity to compete in export markets. The £ exchange rate is of less importance to well-managed, highly efficient companies offering unique high value-products than it is to inefficient high-cost, low value producers.

• The decimation of larger UK-owned companies in science and technology.

  Large companies are major drivers of exports, as they have the R&D capability and international marketing infrastructure to operate globally.
  The fact that there are very few large UK quoted science, technology and capital equipment ('manufacturing') companies left seems to escape comment - many have been sold to foreign competitors.
  We can name most of the remaining ones in the FTSE 100 off the top of our heads:
  BAe Systems, Rolls Royce, GSK, Astra Zeneca, Shires Pharma, BOC, Smiths Industries, Smith and Nephew, Corus, ICI.........
  This leaves a huge hole in the following industries, all of which can be regarded as export intensive:
  • IT hardware
  • Mechanical engineering
  • Electronic and electrical equipment
  • Semi-conductors
  • Office, accounting and computing equipment
  • Radio, TV and telecommunications equipment
  • Speciality Chemicals - a rapidly declining sector in the UK
  • Automotive manufacturing
  • Industrial and capital equipment manufacturing
  • Computer software, except for standard software.
  • And for good measure, Investment Banking and international Consulting - and probably to come, Stock Exchanges!
  These industries might be described as representing the knowledge and technology-based sinews of a modern economy.

• Lack of investment in Research and Development, Innovation and modern equipment.

  Whilst British universities contain world-class examples of excellence in science and technology, producing the highest number of citations and academic papers per head of population in the G8 nations, too little of this excellence is translated into industrial R&D - the lowest amongst major developed nations , or into patents and new or improved products. There is glaring evidence of a serious lack of coordination and understanding between government, universities, industry and institutional investors. Whilst the government continues to exhort all to invest in science and modern technologies, university science departments are closing for lack of support and British companies generally invest far less than international competitors in capital equipment, research and innovation. Meanwhile the wholesale disposal of quoted UK technology companies to foreign competitors continues unabated.

The real underlying Causes.

Behind the symptoms of decline described above lie some deeper causes that must be understood, accepted as problems and addressed before Britain can move forward and regain some of the lost ground.

• The values and behaviour of the investment industry

  The UK investment colossus, which in reality is dominated by huge American, German, Dutch and Swiss banks, exercises more power over industry than in any other developed nation. It can be argued that investment institutions now dominate managements' agendas and actions.
  Research by Professor Andrew Tylecote of Sheffield University and Dr Paulina Ramirez of the University of Ireland concluded that the UK investment markets have a greater aversion to long-term investment in technology companies than those of any other developed country.
  The UK has an investment system that is dominated to a greater degree than that of any other country by impersonal institutions which are obsessed with short-term returns and do not care for or have much interest in, individual companies in which they invest. (author's interpretation of researchers' conclusions, agreed by the researchers).
  Their first instinct in the case of any trouble is to sell the shares, their second is to try to cause a takeover, and only as a last resort will they engage with the management. Even when they do, the effects can be simplistic and destructive, because they understand little of how companies really work, as engagement is not their natural style, and their people are not trained or competent to do it, being mainly financial analysts without any experience of working at senior levels in industry.
  US investment institutions have much more company-specific expertise and a significant proportion of investors tend to seek long-term and engaged relationships with the companies in which they invest. There are many more technology investors and venture capitalists in the US than in Britain.
  Success in advanced technology industries requires consistent long-term commitment to innovation, research and investment in modern plant and equipment. There are few investors in the UK who understand this or care about the long-term success of the companies they invest in if this gets in the way of maximising short-term returns.

• A serious deficit in management skills.

  The long term investment aversion of institutional investors is mirrored by the top managers of many quoted companies, who place the highest priority on pleasing the City. Contemporary top managers' skill base has therefore become increasingly financial and their outlook increasingly short-term, which has greatly exacerbated the problems.
  Many studies have revealed a lack of skills and often interest in the sort of leadership and managerial capabilities that will engender high performance in organisations - and many business schools are felt to concentrate their teaching on business analysis, not the practical skills that lead to healthy, successful organisations. The UK came late to the idea that management was a serious professional activity in itself. The result has been the dominance of specialist activities like accountancy, rather than concern for the practice of leadership and general management. The US has a tradition of professional management and a more supportive investment industry - Germany and Japan have traditions of long term dedication to technological excellence and involving their workforces. The results of these differences can be starkly seen in the performance of foreign-owned companies in Britain, as compared with their domestic counterparts.

• A lack of political will and understanding.

  Chancellor Gordon Brown has presided over a long period of macro-economic stability, and he is to be congratulated for his part in this success.
  But when it comes to tackling the underlying causes of industrial decline, he, like most politicians, retreats into high-minded generalities. Mr Brown exhorts us all to buy into the vision of Britain as a world-leading hothouse of science and technology - whilst presiding over a headlong retreat from science and technology industries and praising an investment industry that is totally hooked on short-termism and speculation. Government incentives to invest in R&D may have some effect, but not much if institutional investors aren't interested - it is the investment industry that currently calls the shots, not managers or politicians.
  But even worse, the UK government has adopted what some have called the 'Bambi and mother' approach to promoting and protecting British industrial interests. Despite the ubiquitous rhetoric about free trade; most governments, led by the US, take overt and covert action to protect their economies. Meanwhile, British industry stands unprotected in the hostile forest of global competition, whilst the UK government bleats pathetically about free trade, and the predators carry off the spoils.

Summary

• Britain has a dire and worsening problem in technology and research-based industries. Most of these industries are in the 'manufacturing' sector, which accounts for a large part of the value of world export trade.
• The balance of trade problems do not stem from a lack of growth in international trade or UK economic instability. The government has managed the economy well - it has also offered many incentives for investment. World trade has grown considerably in recent years. The problems are squarely rooted in the catastrophic decline of manufacturing industry.
• The issues behind the decline are partly low productivity and high costs, but these are symptoms of deeper problems. Amongst these problems are the decimation of companies in the technology and research-based sectors. Many of these enterprises have been sold to foreign competitors, who over time tend to decrease R&D activity in the UK. Other serious issues are poor leadership and marked under-investment (with a few exceptions) in Research and Development and capital equipment.
• The root causes of under-investment and underperformance have been shown to be short-termism, risk aversion and a lack of commitment to technology investment by most UK investment institutions, which now dominate the industrial agenda. Research has shown that this phenomenon is more marked in the UK than any other developed economy.
• The manifestations of these problems are and will be very poor export performance, a loss of share in world trade, permanent balance of trade deficits, a spiral of disinvestment, continued competitive failure and a 'dumbing down' of UK industry.

What is described above is no 'medium-term' problem which can be solved by random and uncoordinated quick fixes. The problems are complex, systemic and very serious - and there are too few signs that anyone in authority understands or is currently willing to confront them.
The bright spots? Britain is still a country with a well-spring of inventiveness and enterprise.
Away from the spotlight of the financial markets, there are many successful and innovative companies that can compete with the best. Many universities are following the example of Cambridge, and are spinning off a cascade of small high-tech companies. Long-term, it needs the various elements - government, managers, universities and investors - to be co-ordinated in a strategy of consistent support for innovative enterprise. If any of the vital players refuse to collaborate, the strategy will fail. And above all, we need to make sure when the next generation of high tech. companies need serious investment that the sources of long-term capital support are available.

ENDPIECE.

'Having Their Cake' 2002: "With the weakening of the indigenous technology and industrial base is likely to come an increasingly 'skewed' economy, overly dependent on consumer and government spending and financial and leisure services, losing world market share in key industries and with worsening balance of payments problems...."

APPENDICES.

FACTS AND FIGURES

1. UK research base.

   • Some British universities are world class. The UK has a high quality science research base. However, there is great concern in some quarters about the rash of closures of Physics and Chemistry departments.
   • The number of academic papers and citations produced per head is the highest amongst the G8 nations (Thompson ISI)
     However, this apparent advantage has historically not been translated into practical innovation in industry or into new products and services.
   • The number of patents generated in Britain per million inhabitants was exceeded by the US and 15 of the largest developed countries. The US achieved 70% more, Germany and Finland twice as many and Sweden three times.
   • The UK stands 8^th in Europe, behind Germany, Ireland, Austria, Sweden, Netherlands, Finland and Spain in terms of revenues generated in industry from new or improved manufactured products. (DTI)

2. Also the UK also stands well behind all OECD countries in maintaining spend on industrial R&D.

   • Only the UK amongst OECD countries had a lower share of GDP spent on R&D in 2000 than in 1981. In Britain, in 2000, it was 1.9%, in the US, 2.7% and Germany, 2.5%. The R&D spend of foreign-owned companies in Britain declined by 3% in 2004. So foreign-owned companies are not bridging the gap caused by generally dire R&D investment by UK companies.
     (OECD).
   • Dividends paid to investors by UK FTSE 100 companies in 2005 were 164% of R&D spend, as opposed to 46% in US S&P 500 companies and less than 20% in Germany, France and Japan. Capital expenditure in many British companies has trailed behind the levels of many foreign competitors. This is not just a trivial statistic, as research indicates that there are strong links between R&D, related capital spend, and added value of output, productivity and eventually profitability. The needs for R&D and capital expenditure are highest in advanced, physics, chemistry and knowledge-based industries. (DTI, NIESR).

3. Foreign-owned companies are dominating the UK industrial scene and are better managed than UK comparators.

   • Foreign-owned manufacturing companies in Britain created 24% more gross added value per head than British counterparts and had 133% higher net capital expenditure - they also paid substantially higher wages. (NIESR)
   • In 2002, 40% of UK's top exporting companies were foreign-owned, and nearly 50% of Britain's gross exports come from foreign-owned companies. In 2002, about 10% of the largest (FTSE 100) British companies were left in the once-mighty high added-value physics and chemistry-based sectors, as opposed to over 20% in the US, and over 50% in Germany, Japan and France.
     Amersham International, Britain's largest bio-tech company, was recently bought by GE of America.
     By comparison, there are twenty nine companies in general utility, services and retailing sectors, which export virtually nothing. (Authors' research)
   • Productivity and added value per head is lower in Britain than in many developed countries. Furthermore, the gap between Britain and foreign competitors is not narrowing, despite government exhortation, many studies and investigations by Harvard Business School professors.
     Gross Domestic Product per head in the UK came 17^th out of 20 developed countries in 2000. The UK was just ahead of Portugal. Ireland came 2^nd. By 2003, this figure had improved - Britain came 15th, behind the US, France, Norway and Ireland, amongst others. (Institute of Economic Affairs)
     
     In 2003, the UK came 15^th out of 21 developed countries in productivity per head, lagging the US, France and Germany, as well as many smaller countries. (OECD).

4. UK share of world trade is in long-term decline

   Share of world exports - % change.

   Country	1999-2003
   Germany	plus 4.7
   UK	minus 14.2
   US	minus 20.9
   China	plus 69.8

READING AND RESEARCH

Management:

• Managers, not MBA's,

  Prof. Henry Mintzberg, Prentice Hall, 2004.

• Final Report of the Council for Excellence in Management and Leadership,

  2002

• The Life and Times of the CEO

  , Harrington and Steele, Cranfield University, 1999.

• The Link between Management and Productivity

  , Dorgan, Dowdy and Rippin, McKinsey Quarterly, 2006. A study of 700 companies in UK, Germany and US concludes that good management is the key to performance - and the UK compares poorly with other countries.

Industry and Finance

• Financialisation and Strategy - Numbers and Narrative

  , Julie Froud, Prof. Karel Williams et al - Routledge 2006.)

• UK Corporate Governance and Innovation

  - Research paper by Prof. Andrew Tylecote, University of Sheffield and Dr. Paulina Ramirez, University of Ireland.

• In the Mirror of the Market

  - The disciplinary effects of Company/Fund manager meetings. Dr. John Roberts, Judge Business School, University of Cambridge et al.

• Built to Last

  , James Collins and Jerry Porras, Random House, 2000