"Insourcing," the Revival of British Manufacturing

♠ Posted by Emmanuel in China,Outsourcing,Supply Chain at 4/28/2008 01:43:00 AM

Listen up as you're likely to read more about this practice in the near future. Among the latest buzzwords to hit little ol' me is insourcing. In contrast to the phenomena of outsourcing where firms located in industrialised countries move their activities to LDCs to take advantage of lower costs abroad, insourcing concerns the opposite. Insourcing happens when firms that sought greener pastures elsewhere discover that, gee, the grass isn't really greener on the other side. The Guardian has an interesting story about this trend happening in Blighty. Yes, it's anecdotal evidence and all that, but it makes for an interesting read nonetheless. With the finance sector in dire straits in Britain--those who handle circulating capital for you Marxists out there--the manufacturing industry (Marx's industrial capital) is making something of a comeback. Here are the Cliff's Notes for you readers with short attention spans:

(1) Britain has supposedly neglected its industrial sector for a long time, taking a hands-off approach to industrial policy while its European neighbours have exhibited greater protectionism;
(2) In contrast, most of the policy breaks have gone to the finance sector as its share of economic activity has steadily increased over the years;
(3) With Britons feeling the effect of a credit crunch--let them eat subprime--manufacturing is becoming the unlikely sector where the country is pinning its hopes;

What follows are the reasons for a putative revival of fortunes for UK manufacturing:

(4) Labour in China isn't as inexpensive as it was just a few years ago;
(5) Quality concerns over tainted toys and whatnot have increased customer preference for goods made in the UK;
(6) With commodity prices being as high as they are, it matters less where goods are made, especially in cases where raw materials cost is the major contributor to costs;
(7) With the British pound relatively weak against the Euro (see above chart), making stuff at home to sell to the EU--the destination of over 60% of the UK's exports and its largest export market--becomes comparatively attractive than having stuff made elsewhere;

Bring it on home, indeed. There is also stuff about the government pursuing the promotion of green industries, but given the chequered history of British involvement in industrial policy, that may require a leap of faith. Fear of outsourcing is so 2004, dahling. From the Guardian:

It may be a struggle to imagine a Britain in which the main topic of conversation over the table at dinner parties is no longer house prices, a comfortable berth in a top City firm is no longer an object of desire for every bright young graduate, and a few hours at Bluewater or Ikea is no longer considered a great family day out. But when the credit crunch, with its day-to-day drama of bank bail-outs and mortgage rationing, fades away, it may leave behind a very different country.

Mervyn King, the governor of the Bank of England, has repeatedly said he would like to see a 'rebalancing' of the economy. For too long, consumers have been borrowing to prop up their spending, saving next to nothing, and banking on rising house prices to make the sums add up. And banks have been devising ever more sophisticated funding models to raise the money to lend to them.

But with the days of cheap borrowing over for the foreseeable future, and the housing boom at an end, it will take families a very long time to rebuild their finances. King and his colleagues at the Bank would like to see a band of doughty exporters up and down the country step forward, helping a new, more stable, less spendthrift economy rise, phoenix-like, from the ashes of the debt-fuelled boom of the past five years.

One such export hero could be Danny Bamping, managing director of Bedlam Puzzles, who has benefited from the fact that consumers have begun to shun toys made very cheaply in countries in the Far East. Mattel, maker of the Barbie doll, had to recall millions of toys - all made in China - because of lead in the paint, and because children were swallowing bits of them. 'The Mattel issue worked in our favour,' admits Bamping, who has appeared on the BBC's Dragon's Den

But until 2007, like many Western toy manufacturers, Bedlam Puzzles made all its games in China. It decided to move production to the UK last year, partly because of soaring costs in China. In just one year, its costs there had increased by about 20 per cent. A stronger yuan, increased shipping costs and the time lag in getting products to the UK market were also factors.

China's loss is the UK's gain. Indeed, this trend of 'insourcing' production back to the UK is one factor contributing to a mini-revival of the manufacturing sector, according to trade body the EEF. The pound's weakness against the euro is also helping to make UK goods cheaper in the eurozone. Last year, says the EEF, saw the best conditions for a decade. Figures published last Thursday from the CBI tempered this optimism, however: output has fallen slightly and manufacturers reported their biggest increase in costs since 1990. Nevertheless, as the credit crunch continues to hog the headlines, manufacturing is holding up relatively well.

Tomorrow, David Frost, director-general of the British Chambers of Commerce, which represents many of the UK's small firms, will underline this in a speech to members: 'If you lived your life in London you would often be left with the impression that the economy was about to fall off a cliff,' he will say. 'From my visits around the country I can assure you it is not. When I speak to our members, be it in Aberdeen, Birmingham, St Helens or Rotherham, they not only inspire me with their success, but they tell me that while business is challenging, they are doing well. They are succeeding in tough export markets.'

Economists agree. In this post-credit-crunch world, they say, hitherto-neglected manufacturing could play a larger role. Andrew Sentance, one of the independent members of the Bank's Monetary Policy Committee, said in a speech last week that 'strong domestic demand and a strong pound need to give way to a period of weaker growth of domestic demand, accompanied by a more competitive currency'. He added: 'This process of rebalancing is likely to benefit sectors more heavily dependent on overseas demand, such as manufacturing industry.'

So now that the City and consumer spending are running out of steam, could resurgent manufacturers help the UK stave off recession - and work that rebalancing trick? The City has long contributed more wealth to the UK economy than the manufacturing sector has, but its growth has accelerated massively over the past decade. In 1992, finance and business services accounted for 24 per cent of Britain's GDP, compared with 21 per cent for manufacturing. By 2004 - the latest available figures - the gap had widened to 32 per cent and 14 per cent. The Office for National Statistics estimates that in 2002, 10 million workers in the UK were employed in 'financial and business services', compared with one in 10 in 1981. Only about 3 million workers are now employed in manufacturing, down from almost 4.5 million in 1994.

But official statistics ignore newer, growth areas of manufacturing - those that focus on providing services or design and innovation, according to Steve Radley, chief economist at the EEF. 'Manufacturers don't just produce goods any more. They also offer services, and are focusing more on innovation and design. The lines are becoming blurred between companies manufacturing and companies that offer services.'

For example, a huge growth area for defence manufacturers - one of the few large 'old-style' heavy industries left in the UK - is providing repair and maintenance services for the hardware they sell to the Ministry of Defence. Shipbuilding and services group VT makes just as much money from providing this type of 'lifetime care' as it does from selling the ships in the first place. According to the EEF, more than half of the 3 million people employed in manufacturing now work in areas other than production, such as research and development, sales and support services.

Radley says companies are increasingly trying to focus on niche, hi-tech sectors such as clean energy, or research and development in the pharmaceuticals or biotech industries. The EEF is resolutely upbeat. Radley says manufacturing represents a bigger slice of the economy than official statistics suggest because a lot of the services the manufacturers provide are not recognised. It points out that, in 2007, manufacturers were planning to invest more in expanding their business than they have since 1995. Last year over a quarter more firms reported plans to increase output compared with those which were cutting back.

While the weakness of the pound is one factor helping Britain's manufacturers, particularly in the eurozone, the soaring cost of raw materials such as oil and metals is also encouraging the trend of bringing production back to the UK. China's main advantage as a manufacturing base is low costs, but higher commodity prices are eroding it. John Parker, chief executive of the Cast Metals Federation, says that in the past six months members have started reporting that customers who had switched their orders to Chinese foundries are now placing orders in the UK.

'The difference now is the cost. A few years ago, the price of, say, a manhole cover might be 50 per cent lower in China than in the UK. But because of the huge increase in international metals prices - which everyone has to pay - the benefit of low labour costs is much less pronounced. Add to this concerns over quality and delivery, and castings produced in the UK become much more attractive.' [Parker's] members - who make items ranging from manhole covers to components for water pipes - are also benefiting from the boom in construction in the developing world.

But little of the credit for these successes goes to the government. According to the EEF, between 2000 and 2005 the British government spent far less on research and development in industry than Canada, France, Germany, Italy, Japan or the US. In 2005, it spent just 0.006 per cent of GDP on R&D, a third of what Germany and Italy spent and less than a tenth of Japanese spending.

Industry executives complain that while the government has given the City special treatment - such as the preferential tax status of 'non-doms' - manufacturing has been left to sink or swim.

One managing director of a steel fabricating firm, who did not want to be named, says: 'The government abandoned manufacturing and its contribution to the country a long time ago. I feel we're on our own.' He says rivals in Germany, Japan and France get bigger tax breaks on investment in new plants.

Lack of government support for British manufacturing is a long-running complaint. In the 1980s, for example, the Conservative government questioned whether the UK needed its own car manufacturing industry. Radley says: 'Some politicians have argued that we could do away with manufacturing altogether. That is very naive and ignorant. The credit crunch shows the risks of being overdependent on one part of the economy.'

Lack of government support for the UK manufacturing sector has been an ongoing theme. Unlike the French, the Italians or the Germans, British politicians have always fought shy of propping up loss-making industries. Continental governments also stand accused of flouting competition rules at home - not allowing their national energy companies to be taken over by foreigners, for example. Yet, the complaint runs, these same firms, whose markets are protected at home, are quick to take advantage of the UK's open-market philosophy. This means that most of the UK's energy industry is owned by French, German, Spanish or US companies. As a result, the UK increasingly has to rely on foreign companies to supply new power plants. John Garside, principal fellow at the Warwick Manufacturing Group, says that because of this free market approach, 'we are approaching the position of having to rely on overseas companies for technical expertise'.

The car industry is a good example of the strengths and weaknesses of this approach to manufacturing. The indigenous British-owned car-manufacturing industry - MG Rover, TVR - has disappeared. Some of the world's most efficient foreign car makers - Japan's Nissan, for example - have replaced them.

But however efficient the UK has become at making things, however good British firms become at carving lucrative niches, if foreign-owned companies decide to move production overseas, they will move the rest of their activities - including R&D and design - away too.

As Radley says: 'There is a worry that if production goes overseas, innovation will follow. Foreign ownership has been very good for UK manufacturing. New ideas have come in. But the danger is that foreign-owned companies have a bias to locate higher-value activities like R&D in their home countries.' Garside agrees: 'These foreign-owned companies are not here for our benefit. They hold the intellectual property and choose where to locate their development centres.' The EEF says the government needs to make it attractive for foreign-owned companies to locate activities such as research and development here.

Last November the government announced a review of manufacturing, which will report this summer. It will concentrate on how British industry can put the UK at the 'forefront of developing and manufacturing new green technologies'. Focusing on 'green technologies' such as renewable energy makes sense: the UK is one of the windiest places in Europe, with hundreds of miles of coastline that can be exploited to generate renewable energy. Yet a lack of government support - and an obsession with the free market - means the UK lags behind most of Europe on renewables. Even if the government's review does represent a genuine attempt to do more for manufacturing in this area, it could come too late. Garside says: 'The government is big on promoting sustainability. But how can we influence the design of these products if there's no one capable of doing it left in the UK?'

Manufacturing is bearing up well - for the moment - in the face of the credit crunch. Economists certainly expect this sector to grow more quickly than financial services in the short term. But because much of British manufacturing is in foreign hands, the cultural ties to this country are not as strong. If they are to stay, the government needs to do more to make it worth their while.