A resurgence in British manufacturing is the best way to revive our economy after coronavirus

Britain is teetering on the brink of an economic recession of the kind we have never seen before in our lifetime.

Economic recovery from this virus will not be easy anywhere in the world, but it will be considerably harder for the UK as a result of our fundamental imbalances unless we find new ways of getting our economy growing again.

Yesterday, my new Institute – the John Mills Institute for Prosperity – published an extensive piece of research on how Britain can best plan its recovery, with the support of former Labour MP Caroline Flint.

Locking down about a third of the UK economy was relatively easy, but getting average living standards back to where they were in 2019 – or even 2007 before the financial crisis – is going to be much more difficult. Without some radical changes in policy, we face another decade of stagnant incomes and overstrained and underfunded public services.

The underlying problem is our dismally low growth rate. UK GDP per head has increased recently at less than 1 per cent per annum with our rising population taken into account. When the rising costs of climate change, health expenditure, education, training, social care and our aging population are factored in, it is then all too easy to see why real incomes may well be lower in 2030 than they are now.

The only way to overcome this problem is to get the growth rate up – to 3 per cent or 4 per cent a year, which is about the world average. If everyone else can do this, why can’t we?

The answer is that economic growth comes largely from manufacturing, not services, and we have allowed our economy to deindustrialise to a greater extent than any other advanced economy. Even as late as 1970, nearly a third of our GDP came from manufacturing. Now it is less than 10 per cent.

This matters hugely for four reasons. First, productivity gains are much easier to achieve in manufacturing than they are in services, so the less manufacturing there is, the lower the overall growth rate.

Second, deindustrialisation has left large swathes of our country with far too little to sell to the rest of the world to pay their way, and far too dependent on subsidies from London.

Third, manufacturing jobs tend to be more secure, better paid and more fulfilling than those in much of the service sector.

Fourth, we depend on selling goods overseas to pay for the food, raw materials and other goods we import, and we don’t produce enough to cover these costs. This is why we have a huge balance of payments deficit – averaging close to £100bn – every year.

Why has manufacturing collapsed in the UK to the extent which it obviously has? Simply because it costs much more to produce most products in the UK than it does elsewhere and this is very largely an exchange rate problem.

About one-third of average manufacturing costs are machinery, raw materials and components, for which there are world prices. Two-thirds are locally incurred costs on direct labour, management salaries, overhead costs of all kinds and provisions for profit and taxation. It is the exchange rate which determines the rate at which all these domestic costs are charged out to the rest of the world

Now, here is the problem which dominates UK policy-making. We are good at selling services overseas. We have natural advantages in our language, our geography, our legal system, our universities, and our financial skills. As a result, services have recently flourished in the UK with an exchange rate as high as $1.50 to the pound.

For manufacturing where we lack natural advantages, however, being at this sort of level is lethal. We therefore need a far lower rate – about parity with the US dollar – to make it worth siting manufacturing facilities in the UK rather than somewhere else such as China or Germany.

So why don’t we just rely on services and forget manufacturing? There are two key explanations as to why this would be a disastrous mistake.

First, it is notoriously difficult to increase productivity in services, so relying on them to get the growth rate up will never work. The second is that services are too difficult to sell abroad in big enough quantities to avoid us constantly having a big foreign payments gap. Although services make up over 80 per cent of our economy, they produce no more foreign earnings than manufacturing with 10 per cent.

So what do we need to do to get the growth rate up 3 per cent or 4 per cent per annum, so that we can trade ourselves out of the coronavirus crisis without incomes falling?

We need to get manufacturing as a percentage of GDP back up – from 10 per cent to at least 15 per cent. To do this, we need to get investment as a percentage of our national income up from its current 17 per cent closer to the world average of 25 per cent.

And to make that happen, as most of the new investment we need – in mechanisation, technology and power – has its natural home in the privately-owned highly competitive internationally traded light industrial sector, it has to be profitable.

This is where the exchange rate is crucial. If we don’t make investment and exporting profitable, we will spend the 2020s, like the 2010s, bogged down in import and debt-led deflation and stagnation instead of investment and export-led growth.

John Mills is an entrepreneur and economist, and the founder and chair of JML. Read his latest publication, 'Manufacturing a Recovery from Coronavirus', here