Manufacturing faces decline unless UK adopts ‘defensive strategy’

Good afternoon. Last week I was trying to make the argument for bolder engagement with Brussels on the basis that another five years of stasis would lead to a permanent destruction of commercial, personal and intergovernmental relationships that would be hard to recover.

This is, no doubt, just as some Brexiters intended when they negotiated the Trade and Cooperation Agreement (TCA), which creates structural barriers to EU-UK trade that will deepen over time, even if the UK does nothing to actively plot a divergent course.

Two reports on the UK’s international trade prospects that have come out in the last week — one from the Resolution Foundation and one from the Midlands Engine trade body — make for chilling reading in this regard.

They document in detail how the UK’s advanced manufacturing sectors, starting with cars and chemicals, are facing structural decline because of their reliance on highly integrated EU supply chains from which they are being squeezed out over time.

This matters because while the UK is a services-oriented economy, in terms of trade nearly half UK exports are from manufacturing (and nearly half of those to the EU) and in areas like the Midlands and the north they support better-paying jobs. Modern industry is also, of course, supported by professional and technical services. 

Low-productivity manufacturing set to rise

The Resolution Foundation spells out why the current situation will lead to the ongoing atrophying of advanced UK industry; to be replaced by lower-productivity manufacturing. In short, the total amount of work will probably remain the same, it will just pay less well. The British frog is being slowly boiled. 

The challenge is that the UK’s Brexit settlement will continue to harden on a relative basis even if the UK stands still. That’s because the EU internal market is deepening over time, while actively using its own regulatory heft (carbon taxes, subsidies, car battery recycling regulations etc) and sheer market size to encourage the onshoring of supply chains to which the UK now has reduced access.

Both the reports are clear that unless the UK reassesses the fundamental parameters of its relationship with the EU, the UK’s decline will not be arrested — despite all the ‘good ideas’ set out recently by trade groups, the Lords’ EU select committees and the laudable Trade and Business Commission report that I mentioned last week. (I’ll be reporting from the related Trade Unlocked conference next week.)

So proposals, for example Labour’s idea for a veterinary deal to reduce sanitary and phytosanitary checks for animal products, or indeed the government’s announcement this week of a new commission to boost ecommerce, can’t obscure the Brexit-sized elephant in the room. We should definitely do these things, but they won’t really move the needle.

Or as Shania Bhalotia and her colleagues at the Resolution Foundation put it:

“Politicians are united in their desire to reverse the decline of manufacturing exports since the TCA was implemented. But the proposed changes are small: they would reduce trade costs for specific sectors, but are not material for the economy overall, and do not offer much hope of avoiding the structural shift out of higher-value manufacturing.” 

There will be those who see this as a counsel of despair — and as I said last week, there is a real risk politicians lose heart when they realise how hard this is going to be — but actually it is the opposite.

As the Resolution Foundation report argues, the UK still badly needs a ‘defensive strategy’ to reduce the impact on industry — unilateral alignment on EU regulation and standards, digitising borders and doing vet deals etc — in order to create breathing space for change.

As Professor Jun Du and colleagues at Aston University put it in the Midlands Engine report:

“While it will take time to effect improvements in the EU-UK trade relationship, that time will allow policymakers to work on developing firm capabilities and competitiveness domestically, which will help firms to export when conditions are right. This builds up business confidence and the firm’s preparedness for change.”

Of course any UK government, of whatever stripe, actually needs to do that stuff — sort out planning, invest in skills etc — but it also at some point needs to ask how long it wishes to passively acquiesce in making people poorer?

I mentioned last week the EU-UK Forum annual conference themed around “A New Relationship” but, as I reported with my Brussels-based colleague Andy Bounds, the conference actually served to highlight the gaps between the two sides.

Brussels moves on

For all the high-level diplomatic warmth generated by Rishi Sunak signing the Windsor framework, on a host of core EU-UK issues — negotiations to rejoin the Horizon science programmes, electric vehicle tariffs, repatriating euro clearing to the EU and financial services co-operation — at an institutional and official level the relationship grinds slowly.

The EU UK Forum panel on regulatory divergence provided a chilly reminder that — for all the new energy in the UK debate around possible Brexit ‘fixes’ — there is instinctively much less enthusiasm and bandwidth in Brussels for change.

The panel included a rare public appearance by Stefan Fuehring, the lead EU Commission official overseeing the TCA, who was at pains to repeat that the five-year review of the TCA starting in 2026 was an “implementation” review and not a moment for “revising, revisiting or renewing, let alone amending” the deal. As he said:

“There’s almost on a bi-weekly basis a report [on how to improve the existing Brexit deal] coming from the Tony Blair Institute, the UK in a Changing Europe, the House of Lords and so on. My job is to follow all these, of course, but I’m not aware that in the last two years any such report has come out of the EU system. We have really moved on now with this debate [over Brexit] and I think the next decade is one where we’ll deal with future member states, rather than a past member state.” 

Such EU Commission orthodoxy is the starting point for any future discussion, but I still believe it doesn’t necessarily have to be the endpoint if a future British government made a conscious decision to reframe the discussion. 

It will take a major diplomatic heave, but the arrival of a new UK government next year and the 2026 TCA implementation review still has the potential to provide a political inflection point in the relationship. 

But it will be difficult to argue the domestic political case unless and until the realities set out in those two reports are acknowledged and actively fed into the public discussion on Brexit. 

For now, and on a day when the Boris Johnson show and personality politics once again consumes the news agenda, heads remain collectively in the sand.

Brexit in numbers

This week’s chart comes courtesy of the Resolution Foundation report, and shows the UK lagging the G7 competitors since the Trade and Cooperation Agreement came into force. 

The report makes several really fundamental — but often under-appreciated — points about the challenge facing advanced UK manufacturing.

• Advanced manufacturing provides a large proportion of the higher-paying, higher productivity jobs in the Midlands and the north.

• These jobs are found in sectors like cars, chemicals, aerospace and pharmaceuticals that rely more deeply on access to integrated EU supply chains hit hardest by Brexit.

• While the overall volume of UK manufacturing activity will hold up as some manufacturing is repatriated into the UK, as Brexit progresses, we “are likely to see a shift to lower-productivity manufacturing”.

• This is because, as we’re already seeing with chemicals and autos, over time higher-productivity UK manufacturers will be shut out of those supply chains as EU businesses gravitate inexorably to other EU businesses with which they can trade friction-free.

It’s a vicious circle which won’t be arrested if we stick to the current ‘red lines’ advanced by both Conservative and Labour parties. 

As the Resolution Foundation states: “Preventing further supply-chain damage and allowing manufacturers to take advantage of the larger market means revisiting the relationship with the EU.”

Britain after Brexit is edited by Gordon Smith. Premium subscribers can sign up here to have it delivered straight to their inbox every Thursday afternoon. Or you can take out a Premium subscription here. Read earlier editions of the newsletter here.