How inevitable was the decline of the UK’s Engineering industry?

My last post identified manufacturing as being one of three sectors in the UK which combined material scale relative to the overall size of the economy with a long term record of improving total factor productivity. Yet, as us widely known, manufacturing’s share of the economy has been in long term decline, from 27% in 1970 to 10.6% in 2014. Manufacturing’s share of employment has fallen even further, as a consequence of its above-average rate of improvement in labour productivity. This fall in importance of manufacturing has been a common feature of all developed economies, yet the UK has seen the steepest decline.

This prompts two questions – was this decline inevitable, and does it matter? A recent book by industry veteran Tom Brown – Tragedy and Challenge: an inside view of UK Engineering’s Decline and the Challenge of the Brexit Economy, makes a strong argument that this decline wasn’t inevitable, and that it does matter. It’s a challenge to conventional wisdom, but one that’s rooted in deep experience. Brown is hardly the first to identify as the culprits the banks, fund managers, and private equity houses collectively described as “the City” – but his detailed, textured description of the ways in which these institutions have exerted their malign influence makes a compelling charge sheet against the UK economy’s excessive financialisation.

Brown’s focus is not on the highest performing parts of manufacturing – chemicals, pharmaceuticals and aerospace – but on what he describes as the backbone of the manufacturing sector – medium technology engineering companies, usually operating business-to-business, selling the components of finished products in highly competitive, international supply chains. The book is a combination of autobiography, analysis and polemic. The focus of the book reflects Brown’s own experience managing engineering firms in the UK and Europe, and it’s his own personal reflections that provide a convincing foundation for his wider conclusions.

His analysis rehearses the decline of the UK’s engineering sector, pointing to the wider undesirable consequences of this decline, both at the macro level, in terms of the UK’s overall declining productivity growth and its worsening balance of payments position, and at the micro level. He is particularly concerned by the role of the decline of manufacturing in hollowing out the mid-level of the jobs market, and exacerbating the UK’s regional inequality. He talks about the development of a “caste system of the southern Brahmins, who can’t be expected to leave the oxygen of London, and the northern Untouchables who should consider themselves lucky just to have a job”.

This leads on to his polemic – that the decline of the UK’s engineering firms was not inevitable, and that its consequences have been regrettable, severe, and will be difficult to reverse.

Brown is not blind to the industry’s own failings. Far from it – the autobiographical sections make clear what he saw was wrong with the UK’s engineering industry at the beginning of his career. The quality of management was terrible and industrial relations were dreadful; he’s clear that, in the 1970’s, the unions hastened the industry’s decline. But you get the strong impression that he believes management and unions at the time deserved each other, and a chronic lack of investment in new plant and machinery, and a complete failure to develop the workforce led to a severe loss of competitiveness.

The union problem ended with Thatcher, but the decline continued and accelerated. Like many others, Brown draws an unfavourable comparison between the German and British traditions of engineering management. We hear a lot about the Mittelstand, but it’s really helpful to see in practise what the cultural and practical differences are. For example, Brown writes “German managers tend to be concerned about their people, and far slower to lay off in a downturn. Their training of both management and shop-floor employees is vastly better than the UK… in contrast many UK employees have expected skilled people to be available on demand, and if they fired them then they could rehire at will like the gaffer in the old ship yards”.

For Brown, its no longer the unions that are the problem – it’s the City. It’s fair to say that he takes a dim view of the elevated position of the Financial Services sector since the Big Bang – “Overall the City is a major source of problems – to UK engineering, and to society as a whole. Much that has happened there is crazy, and still is. Many of our brightest and best have been sucked in and become personally corrupted.”

But where his book adds real value is in going beyond the rhetoric to fill out the precise details of exactly how the City serves engineering firms so badly. To Brown, the fund managers and private equity houses that exert control over firms dictate strategies to the firms that are usually pretty much the opposite of what would be required for them to achieve long-term growth. Investment in new plant and equipment is starved due to an emphasis on short-term results, and firms are forced into futile mergers and acquisitions activity, which generate big fees for the advisors but are almost always counterproductive for the long-term sustainability of the firms, because they force them away from developing long-term, focused strategies. These criticisms echo many made by John Kay in his 2012 report, which Brown cites with approval, combined with disappointment that so few of the recommendations have been implemented.

“I do not suffer fools gladly”, says Brown, a comment which sets the tone for his discussion of the fund management industry. While he excoriates fund managers for their lack of diligence and technical expertise, he condemns the lending banks for outright unethical and predatory behaviour, deliberately driving distressed companies into receivership, all the time collecting fees for themselves and their favoured partners, while stiffing the suppliers and trade creditors. The well-publicised malpractice of RBS’s “Global Restructuring Group” offers just one example.

One very helpful section of the book discusses the way Private Equity operates. Brown makes the very important point that not enough people understand the difference between Venture Capital and Private Equity. The former, Brown believes, represents technically sophisticated investors creating genuine new value –
“investing real equity, taking real risks, and creating value, not just transferring it”.

But what too many politicians, and too much of the press fail to realise is that genuine Venture Capital in the UK is a very small sector – in 2014, only £0.3 billion out of a total £4.3 billion invested by BVCA members fell into this category. Most of the investment is Private Equity, in which the investments are in existing assets.

“The PE houses’ basic model is to buy companies as cheaply as possible, seek to “enhance” them, and then sell them for as much as possible in only three years’ time, so it is extremely short-termist. They “invest” money in buying the shares of these companies from the previous owners, but they invest as little as possible into the actual companies themselves; this crucial distinction is often completely misunderstood by the government and the media who applied the PE houses for the billions they are “investing” in British industry… in fact, much more cash is often extracted from these companies in dividends than is ever invested in them”.

To Brown, much Private Equity is simply a vehicle for large scale tax avoidance, through eliding the distinction between debt and equity in “complex structures that just adhere to the letter of the law”. These complex structures of ownership and control lead to a misalignment of risk and reward – when their investments fail, as they often do, the PE houses get some of their investment back as it is secured debt, while trade suppliers, employees and the taxpayer get stiffed.

To be more positive, what does Brown regard as the ingredients for success for an engineering firm? His list includes:

  • an international outlook, stressing the importance of being in the most competitive markets to understand your customers and the directions of the wider industry;
  • a long-term vision for growth, stressing innovation, R&D, and investment in latest equipment;
  • conservative finance, keeping strong balance sheet to avoid being knocked off course by the inevitable ups and downs of the markets, allowing the firm to keep control of its own destiny;
  • a focus on the quality of people – with managements who understand engineering and are not just from a financial background, and excellent training for the shop floor workers.
  • The book focuses on manufacturing and engineering, but I suspect many of its lessons have a much wider applicability. People interested in economic growth and industrial strategy necessarily, and rightly, focus on statistics, but this book offers an invaluable additional dimension of ground truth to these discussions.

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