British manufacturing has recorded a welcome improvement in recent months. But the upturn is fragile, and the sector faces major threats. Unless it is nurtured and supported, the tentative manufacturing recovery could easily go into reverse.

The recent British Chambers of Commerce quarterly economic survey (QES) shows that the manufacturing sector recorded advances across many areas in the first three months of 2006. The net balances of manufacturing firms responding to our survey registered Q1 advances in UK sales and orders, export sales and orders, and plant and machinery investment. The export balances increased markedly. But the manufacturing sector recorded Q1 declines in its net balances for employment, cashflow, and profitability confidence.

In the domestic UK market, the manufacturing balances remain weak by historical standards. We are disappointed that the manufacturing sector’s ‘confidence balances’ remained weak in Q1. The large fall in profitability confidence was particularly worrying.

The QES results have been confirmed by official figures published by the Office of National Statistics. Manufacturing output rose 0.7 per cent between February and March – stronger than expected. The sector also recorded a 0.7 per cent quarter-on-quarter increase in Q1 2006. But this improvement comes after a dismal performance in 2005.
Manufacturing output still shows a year-on-year fall of 0.6 per cent in Q1, after a decline of 1.1 per cent in 2005 as a whole. In spite of the recent progress, the sector continues to display serious weaknesses, and there is no evidence of sustained recovery.

Manufacturing suffers from skill shortages, a poor transport system, and severe regulatory burdens, while margins are being squeezed by higher energy and raw material costs.

The manufacturing sector’s longer-term record is alarming. Output has declined in three out of the last five years. The share of manufacturing in UK GDP is falling steadily, and is now below 15 per cent. The decline in manufacturing jobs has been particularly dramatic, from 7.13 million in 1978 (26.5 per cent of the workforce) to 3.37 million in 2005 (10.9 per cent of the workforce).

The manufacturing recession in 2001 and 2002 was disturbingly steep, in contrast to the benign general UK background – the economy as a whole had escaped recession post-2000 – and given that the sector had already undergone savage restructurings in the early 1980s and the early 1990s.

Manufacturing was in technical recession in the first half of 2005, and the level of output is still lower than in 1999.

The QES manufacturing results for Q1 are pleasing overall. But it is very worrying that the sector has persistently failed to sustain a meaningful recovery since 2002. In our recent quarterly economic forecast, we predicted that manufacturing output would record minimal annual average growth of less than one per cent in 2006 and less than two per cent in 2007, even though we assume positive modest growth from now onwards, in contrast to the declines seen during 2005.

It is important to avoid both pessimism and complacency when we consider the prospects of manufacturing. In spite of huge obstacles, we have seen impressive improvements in manufacturing productivity and competitiveness over the past two decades. But these improvements have been secured predominantly through massive job reductions, while output increases have played a much smaller role. These job losses have been the result of painful and necessary restructuring.

But we reject the view that further manufacturing declines are inevitable. The BCC strongly believes that a flourishing manufacturing sector is a vital ingredient of Britain’s long-term economic success. It is essential for manufacturing to move to a position in which strong productivity growth can be sustained without large falls in employment, while output grows at a more rapid pace than in the past.

British manufacturing is at a crossroads. If the recent upturn is to provide the basis for long-term success, and not go into reverse, three minimal conditions must be met. First, business interests must be taken into account when the Bank of England takes decisions on interest rates. Recent modest progress should not be used to support the clamour for higher rates.

Second, more aggressive action must be taken to reduce the oppressive regulatory burden, and the threat of higher taxes on business must be removed.

Third, the government must demonstrate more vigorously the seriousness of its commitment to tackle the UK’s shortcomings in critical areas: skills, transport, exports, productivity, innovation and enterprise. The fragile upturn must be nurtured to secure sustained recovery.