Written evidence from Swansea Business
School
MANUFACTURING AND TRADE IN WALES
PROBLEMS AND
OPPORTUNITIES
Preamble
A1. The weaknesses of the Welsh economy
are well known and there is little point in re-iterating them
here. Furthermore, the relatively high dependency of the Welsh
economy on manufacturing is also well known, as are the continued
concerns about the decline in manufacturing in general and in
Wales specifically.
A2. Economic development policy in Wales
has until recently concentrated almost entirely on inward investing
manufacturing concerns. Indeed, WDA statistics regularly report
the strength of the manufacturing sector in Wales, although this
is inevitably based on the activities of external, inward investing
firms. It is however now widely accepted that the products of
manufacturing concerns attracted to Wales are at the mature stage
of their life cycles. All the technical development, design, marketing,
distribution and financing is complete. Consequently the products
are unsophisticated and are at the final stage of the life cycle.
The aim is to sell as many as possible and reap the rewards before
the product finally becomes obsolete. The skill level is basic
and consequently pay is commensurate with limited skill.
A3. Inward investment it is often argued
has a multiplier effect; local businesses are encouraged to supply
goods and services, thus increasing the effectiveness of the original
investment. The reality however is that suppliers exist in economic
space but not in geographic space.
A4. Success has been associated with the
single criterion of employment, whether in manufacturing or indeed
of late, services. But wealth creation and economic development
do not come solely from the provision of employment. In reality,
success in employment provision has served to depress longer-term
development because the skills required are entirely inappropriate
to an economy pursuing self-sustaining growth. The skills required
by inward investing manufacturing firms are largely basic assembly
skills. Managerial, financial, research and development, engineering,
technical and marketing skills drive the modern economy, but these
remain firmly rooted outside Wales.
THE BASIC
PROBLEM OF
THE WELSH
MANUFACTURING SECTOR
Three fundamental weaknesses in Welsh manufacturing
can be identified
B1. FDI has been successful in providing
employment but as countless surveys and reports have noted and
to which reference has been made above, the products are inevitably
at the end of life cycle; all the development and associated "quality"
work is complete.
B2. There is a limited multiplier effect
from FDI, which is again well known.
B3. More fundamentally, and a greater strategic
problem for the future. The WDA's much publicised contemporary
activities in the manufacturing sector are based upon products
for which there is derived demand. It is products for which there
is final demand that drive the economy, attract customer loyalty
and are demand inelastic. The derived demand criticism can also
be laid at the door of more recent FDI, such as the food industry.
AN ALTERNATIVE
APPROACH—THE
"DIAMOND" AND
SPECIFIC PROPOSALS
C1. It is not therefore the intention of
this submission to re-iterate these problems, enough has already
been written about the problems of the Welsh economy and the role
of manufacturing within it. The intention of this submission is
to identify issues that have been omitted and to suggest alternative
measures that might lead to further encouragement of the manufacturing
sector.
C2. It is also assumed it is the intention
of government at all levels that manufacturing is to remain at
the heart of economic policy. Manufacturing is fundamental to
economic well being, international competitiveness, an important
source of employment, innovation, growth and fundamentally, can
have a significant multiplier effect in the economy.
C3. Economic well being, especially in the
regions, must to a great extent depend upon manufacturing and
the productivity and competitiveness that it brings. Indeed, contemporary
regional development policy rejects the previous piece meal approach
to development and offers a more strategic approach based on Porter's
"diamond" theory, the role of clusters and thus productivity
and competitiveness. The weakness of the Welsh manufacturing sector
and threats to it are not simply the problems of manufacturing
per se but the fact that the sectors within which Welsh manufacturers
operate are not providing the bases for the competitiveness critical
to successful application of the diamond.
C4. The Swedish economist Gunnar Myrdal
was one of the first economists to examine and consider the issues
of regional and sub national economies. He described two generic
economic systems—virtuous circles of growth and vicious
circles of decline. Porter's work could form the basis of reversing
what must be regarded as the current—and longstanding—vicious
circle of decline of the Welsh economy.
C5. Economic success depends on a number
of inter-related and complex factors, the most important of which
is national competitiveness. This is, according to Porter, the
nation's ability to achieve or maintain an advantageous position
over the other nations in a number of key industrial sectors.
C6. This submission might be a timely reminder
of Porter's diamond theory, which updates and draws upon a long
tradition of economics and indeed regional economics by developing
the idea of what is essentially cluster theory. This theory suggests
that, given certain circumstances, firms gain advantages that
provide mutual strengthening and thus competitive advantage. This
idea has its roots in the much earlier work of Marshall (agglomeration
economics), Myrdhal (vicious and virtuous circles) and the "stratified
diversification" adopted by the Tennessee Valley Authority
during the great depression. It is perhaps worthwhile outlining
the ideas behind the diamond theory
THE "DIAMOND"
APPROACH
D1. The most successful competitive advantages
are achieved when a set of four key competitiveness enhancing
elements are in place. These four elements mutually reinforce
one another and generate a situation of cumulative causation.
It is, according to Porter, "a mutually reinforcing system"
and that "the effect of one determinant is contingent upon
the state of the others". However, what is implied in the
diamond approach is that the successful application of the entire
approach relies essentially on success in two sectors of the economy,
manufacturing excellence and new firm formation.
D2. The first of these four elements are
the demand conditions, requiring a strong sophisticated and demanding
home market with an international outlook. Pressure is brought
to bear on local firms by local consumers to ensure they are innovative
and responsive to changes in taste, leading to strong competition
amongst firms. Particular emphasis is placed on home demand as
the driving force in providing the impetus to upgrade, innovate
and compete. Businesses are sensitive to the demands of their
closest customers thus the characteristics of home demand are
fundamental in driving competition. Specific demand conditions
include—inter alia—a healthy local economy, sophisticated
and demanding buyers, a rate of growth in the home market and
fundamentally, segmentation and specialisation in products.
D3. The second element is factor conditions.
Factors of production are developed and refined over time with
highly specialised factors being distinguished from general factors.
There is a significant difference between "basic factors"—natural
resources, climate, location—and "advanced factors"—sophisticated
skills, education levels, research facilities, economic infrastructure.
The latter is the more significant for competitive advantage because
whilst basic factors may be regarded as somehow endowed (such
as coal in South Wales), advanced factors are a result of investment
by individuals, businesses and government. However, the most successful
basis for competitive advantage is specialised advanced factors.
Specific factor conditions include—inter alia—human
resources such as skills, physical resources (such as land and
climate), technical and scientific knowledge and education, infrastructure,
including telecommunications.
D4. The third is firm strategy, structure
and rivalry: This requires the best possible environment, within
which firms can be created, organised and managed. This requires
a particular form of corporate governance and industrial and market
structure.
Specific factor conditions include—inter
alia—strategic awareness by the individual organisation,
organisational structure, organisational objectives and sustained
commitment, managerial practices and attitudes and national culture,
prestige and priority.
D5. Central to this element is the role
of new firms. Domestic rivalry—and the subsequent competitive
advantage—depends on the creation of new businesses to create
new competitors. Porter notes that
"invention and entrepreneurship are at the
heart of national advantage"
but requires a favourable environment;
"what looks like chance (in new business
creation) is actually differences in national environments".
D6. There is a hidden problem which serves
to depress those factors required for the diamond approach to
succeed and thus the main aim of regional policy, that of self
sustaining growth. This problem is that of organisation size.
Large organisations with products at the end of the life cycle
require employees with limited skills, specific to that particular
product. These skills are of little or no use elsewhere. This
has been the weakness of the Welsh economy, and is a weakness
that is likely to continue with present policies. The size structure
of employing organisations is the important, indeed fundamental
determinant of new firm formation. There is a growing body of
literature, based on empirical research which strongly suggests
a causal link between the number of new firms in any given economy
and economic growth and well being. Research undertaken in 2002
for Barclays Bank sought to identify regions with greater entrepreneurial
potential. The research confirmed the findings of countless researchers
over the past 20 years, that the number of small firms in an area
is a fundamental determinant of new firm formation.
D7. The relationship between economic change
and the effect of organisational size cannot be over emphasised.
The extent to which a local economy is dominated by large or small
organisations is the main determining influence on the rate at
which new firms are set up and thus economic health. Large plants
do not make good incubators because of their mechanistic structures
and need for specialist and often product specific skills. These
skills are of little or no use to employees who may consider establishing
a new firm. The larger the incubator (in employment terms), the
lesser the number of potential new firm founders, small incubators
are the most prolific in providing new firm founders. There is
a clear statistical relationship between incubator size and spin
off; the number of individuals leaving to start a new firm will
decline as incubator size increases. There is consistent evidence
that small plants lead to successful development of an indigenous
business sector. Indeed, it is the major factor. There is a simple
reason for this; small organisations need and develop many skills;
large plants inevitably develop individuals with a single, product
specific skill, entirely useless in any other work situation.
This is what I have called the "causal
chain." The number of new firms is determined by the number
of small firms (because of the greater spin off rate), which in
turn directly determines economic well being.
D8. The fourth and final are related and
supporting industries. Ready access to supply chains and close
proximity to related industries. Investment in advanced factors
has a "spill over" effect, successful businesses group
into clusters, mutually reinforcing innovation, competition and
development. Economies external to the individual firm are internalised
within the industry cluster This is a development of cluster theory
and requires—inter alia—internally competitive suppliers,
related industries, domestic suppliers and appropriate managerial
and technical personnel.
D9. The key to understanding the diamond
model and indeed to its successful application is interaction
between these factors; it is this interaction that establishes
and sustains competitive advantage. Take for example a link between
demand conditions and factor conditions. A strong home demand
for a particular commodity will stimulate firms into training
and education, which leads to a distinctive uniquely skilled workforce.
This in turn provides a skill level that maintains the nation's
competitive advantage. Similarly, groups of rival firms competing
with each other (firm strategy, structure and rivalry) encourages
specialist suppliers to establish to provide external economies
and a specific supply chain (related and supporting industries)
thus enhancing competitive advantage.
D10. Porter's model has changed the thinking
on national (and regional) economic development, moving the emphasis
from national natural advantage to national competitiveness and
the role within that of business. It provides an interesting and
challenging model of economic development, although it can be
argued that, at the present time, Wales lacks many of the individual
factor attributes required by the model and is unlikely to develop
them in the foreseeable future.
D11. However, the model itself is open to
criticism. The first and obvious is the sample; the countries
used by Porter included three of the world's leading economies
with economic and cultural environment fundamentally different
to Wales—and for the matter Great Britain. Furthermore,
it largely ignores the role of government, which can be central
to certain developments such as education. In addition, cluster
theory is not new and there is the dangers that clusters and the
businesses involved can themselves become non-competitive and
complacent if worldwide competition fails to emerge. Finally,
there has been some criticism of late of the whole approach to
clusters.
D12. It is not suggested that the adoption
of the so-called diamond model is the panacea for the Welsh economy
and Welsh manufacturing. What it does is to reject a piece meal
approach and consequently the need for a clear strategy with full
support and resources from all levels of government.
D13. The problems of the Welsh economy being
based on goods for which there is a derived demand (and to which
reference is made in section b) is graphically illustrated by
examining existing clusters. Statistics provided by the dti (2003)
list 14 Welsh clusters in all. The largest clusters are in metal
processing, employing 36,000; electronics which includes both
components and television and associated products (based mainly
on inward investment) employing 22,000 and automotive components
employing 12,000. For completeness, it should of course be noted
that the largest cluster of all is agriculture and livestock,
employing over 54,000. There is no recognisable cluster of creative
industries or biotechnology outside the health service; toys and
games employs 2,000. Interestingly, the one sector often identified
as typifying the "new" Welsh economy —aerospace—employs
just 5,650, mostly in Flintshire, but not, arguably, in any form
of cluster.
SPECIFIC PROPOSALS
E1. If it is the wish of the committee to
investigate ways in which the manufacturing sector might be encouraged
and improved in Wales (and for that matter throughout the UK)
and the ideas behind the diamond approach notwithstanding, then
there has to be radical programme, probably driven both by WAG,
its agencies with support and funding from central government.
There is little point in examining and repeating the many problems
facing the Welsh economy and of course, Welsh manufacturing. It
is important that academics interested in helping to resolve these
problems, in addition to presenting appropriate models of growth
and change, suggest practical ways in which such ideas can remove
these problems and improve the economy. Before doing so however,
it is worth re-emphasising the appeal made by Cardiff Business
School in its position paper presented to this committee, that
there is a strong case for establishing a system that records
accurately changes taking place in the economy. Academics and
government policy makers continue to work in the dark,
E2. First and foremost. Almost all government
and quasi-government financial schemes (and indeed the measurement
of economic success) are linked in some way to job creation criteria.
In reality, productivity gain and competitiveness often result
in little additional labour and indeed the shedding of labour.
This job creation criterion should be removed.
E3. A fundamental change in the way that
FDI schemes are evaluated is suggested. For FDI schemes, the adoption
of the Production Mandate concept as developed in Canada, is suggested.
Incentives are offered on the basis of a "production mandate"
prerogative. The idea is to attract and encourage investor with
new products and processes. Financial and other incentives remain,
but offered on the basis of the amount of "mandate"
(ie autonomy) given to local management to purchase locally, the
amount of mandate to undertake research and development, product
development and innovation at the Welsh site.
E4. The main government scheme of financial
support is Regional Selective Assistance under the terms of the
1982 Industry Act. This scheme has been heavily criticised in
England. In February 2004 the House of Commons Public Accounts
Committee severely criticised the scheme, noting that it had largely
failed to impact upon unemployment or improve the relative wealth
of the poorer English regions. Improvements in manufacturing emanate
from productivity gains and inevitably the use of high technology.
The basis upon which RSA is decided works against the encouragement
of productive manufacturing and the scheme should be used to improve
productivity and competitiveness. This scheme should be simplified
and made more relevant.
Specifically, remove the job creation criteria
and make the scheme more transparent. In addition to the job creation
criteria, present awards under the scheme are based on the twin
concepts of "additionality" and "viability".
However, the additionality criteria and the viability criteria
are mutually exclusive. If, to quote the scheme "the project
will not go ahead in time or scale without assistance from the
public sector" then the project was probably not viable in
the first place.
E5 . Remove the additionality concept for
all publicly funded schemes. The criticism of "additionality"
noted above applies to almost all public funding schemes and should
be removed. Consider a "reverse" additionality; investment
and support is based on what the initial investment further develops
in terms of further additional spending outside the organisation.
E6. There are specific schemes, some current
and others no longer available that directly encourage, assist
or expand schemes that improve productivity and competitiveness:
SEFIS—the Small Firms Engineering Investment
Scheme was available throughout the UK in the early 1980s. Its
intention was to assist small firms to purchase new advanced capital
equipment. A grant of 30% was available, paid as of right upon
invoice. A very successful scheme, although to some extent regionally
imbalanced and the funds were quickly used up.
The WDA has a similar programme (TEP), which
can provide a grant of 50% of cost to a maximum of £10,000.
However, the scheme is not straightforward. It is based on additionality,
is aimed at a so-called "technical step" (rather than
straight purchase of capital equipment) and requires support and
clearance from the Innovation Technology Council.
The original SMART scheme aimed to provide a
grant of up to 25% for new product and/or process development
and was straightforward. The WDA's replacement scheme (SMART Cymru)
was launched in September 2003, is a phased scheme with grants
of up to 75% at the initial development stage. However, the application
process is complex and the scheme is again additional.
E7. A more imaginative approach to funding.
Public funding sources—especially investing funds rather
than grant aid—should not be awarded on the basis of investment
return criteria. The problem is the appropriateness of funds and
the delivery mechanism. There have been arguments made in the
past for some form of development bank, although with a remit
to be more adventurous. There are, according to the Rowntree Foundation
problems with debt and failure to repay "soft" loans,
the SFLGS is relatively expensive and there still remains the
problem of addressing the equity gap. Whatever the requirements
of due diligence, a more adventurous approach from Finance Wales
should be required.
E8. Provision of manufacturing incubator
units and funding for their development along the lines of the
Business Incubator Fund available in England. Such a fund would
assist all manufacturing and not simply high technology.
E9. Adoption of the SME tax incentives that
have proved so successful in Ireland and elsewhere. The success
of the Republic of Ireland has highlighted the use of taxation
as an important tool in economic development since it can be manipulated
to encourage economic growth. Zero tax rates have been offered
in the past, and taxation rates as low as 10% have been available
to manufacturing concerns that export. Corporation tax in Ireland
has been as low as 12½%, compared to 30% in the UK. In addition,
capital allowances have been used to encourage investment. The
significance is that tax incentives and capital allowances encourage
successful, profitable and growing business. In addition to tax
incentives, the IDA does not use grant aid as the single tool
of economic development. Investors have been offered equity in
place of grant; any grant aid that was offered was conditional
upon a strategic and measurable growth programme, including training,
use of local suppliers and encouragement of local management and
not—as has been the case in Wales—solely upon the
provision of employment. The focus has been on emerging sectors
such as the health care, electronics, software, high technology
and more recently, e-commerce. In addition, the IDA is separated
into two functions. One deals with inward investors, the other
with encouraging indigenous business. The two have successfully
worked side by side; inward investors are required to source within
Ireland, thus the skills and training levels of the newly introduced
industries reflect in local firms.
THE NEW
FIRM AND
SME SECTOR IN
WALES—SOME
POTENTIAL SUCCESS
INDICATORS
F1. This brief paper is based on research
into new firms in West Glamorgan, which began trading between
1980 and 1987. The research was in two stages; firstly all new
firms (within a strict definition of newness) were identified,
these amounted to 2,509 in total. This provided an insight into
the general direction new firms were taken the local economy.
Secondly, field research was then undertaken between 1990 and
1991 on a sample of 300 of these, which included both surviving
and non-surviving firms. Employment data was as at 1991. Although
on the face of it the data appear dated, this is the most recent
in-depth research into new firms in Wales.
F2. In general, successful firms established
in sectors that had a larger "market footprint". This
means that the product or service could be "exported"
from the region and/or was of use in the provision of external
economies though not necessarily, it should be emphasised, as
simply sub-contractors. This concept of the larger "market
footprint" is very much in keeping with research undertaken
throughout the UK.
F3. Of the 2,509, supposed "mature"
industries played an important role. Activities 3,410 to 3,480
of the 1980 Standard Industrial Classification represent advanced
engineering practices, as do those industries involved in the
general machine shop. Fifty firms were involved in these Activities
and accounted for one third of all firms in Division 3 (Metal
Goods and Engineering). A great deal of this was due to the role
of new technology-based equipment in lowering barriers to entry
and increasing productivity.
F4. In Division 4 (Other Manufacturing)
103 firms (39% of the Division) established in innovative or high
technology sectors. Of these, 21 firms (8%) were in activities
classified as high technology. The classification of innovation
and high technology were based on research elsewhere. Many of
these were not necessarily "innovative" in a technical
sense, but were based on and provided development capability,
often because of the type of product or the market footprint.
Examples include Toys and Games, Plastic Products and Travel Goods,
products that further develop skills and, more importantly, customer
(market) commitment.
F5. Other sectors that were successful were
printing, repackaging, repairs (not motor repairs), nursing homes
and (surprisingly) plant hire and civil engineering. Personal
services were also notable, especially fitness centres, sporting
facilities and training and educational establishments. Interestingly,
the first three were operated on manufacturing principles.
F6. A balanced team approach was stronger
in manufacturing; successful firms had a balance of technical,
marketing and administration skills in their founders, or in some
cases recruited these skills early on. Two thirds of firms that
survive had such a balanced team approach.
F7. Fifty-six per cent of firms used personal
savings, either as the sole source or with bank lending. The data
are unclear, due to clouding by multiple funding packages, but
43% of firms which funding only on debt failed very early on.
F8. Perhaps the most interesting aspect
of this research was the employment generation, which was substantial.
There was a notable contrast between employment created by new
firms and by inward investment. During the period 1983 to 1987
(the temporal data available on inward investment at that time),
2,975 jobs were provided or safeguarded by WDA and (then) Welsh
Office activities. However, during the same period, new firms
that did not exist before 1980 had created almost 2,000 jobs.
It is important to note that the jobs created by new firms was
a sample of 12% whereas the employment quoted for traditional
policy was for all organisations. It is therefore clear that in
all probability, new firms actually created far more jobs than
inward investors. The 255 firms still trading in 1991 employed
just less than 3,500, of which 65% were in manufacturing.
F9. The research also pointed to a number
of other issues:
— new firms played an important role
in diversification ie moving the economy away from large employers
and the public sector;
— one in 10 firms were in high technology
sectors (including those classified as services by the Standard
Industrial Classification eg Software Houses);
— substantial proportion of employment
provided was for skilled employees;
— over half of the firms established
with capital costs of less than £5,000 and a third for less
than £2,000;
— the majority of employment came from
only a few new firms;
— the service sector accounted for
almost 80% of all new firms. This is again important because traditionally
it is in the service sector that Wales lags behind. The majority
of employment was however in new manufacturing firms; and
— the manufacturing base was maintained
in the face of contemporary economic collapse.
F10. This research also points to a previously
unrecognised phenomenon. Growth in new firms appears to be related
to the amount of turbulence within the economy. It therefore follows
that if an economy is static and dominated by one or a few employers,
the rate of indigenous growth is likely to be small.
RECENT EVIDENCE
ON THE
SME SECTOR
G1. As a part of this submission, brief
research was undertaken to establish the current position of those
new manufacturing firms that had completed the original questionnaire
between 1990 and 1991.
G2. Of the original 106 manufacturing firms
that completed the original questionnaire, 30 were found still
to be trading, a survival rate of 28%, substantially higher than
the 4% or so suggested by research. Of these, 23 completed a brief
questionnaire.
G3. The 23 firms came into being at different
times between 1980 and 1987. However, the total employment in
1991 was 354; current total employment is 434, an increase of
23%.
G4. Of these firms, 11 were in "other
manufacturing" and in engineering, all of which represented
advanced engineering practices.
G5. Only six of the 23 firms had contacted
a public sector advisory service within the recent past and 10
reported that all or most of their suppliers were regarded as
local ie within south Wales.
G6. Updating the original data continues
as part of a wider research project at Swansea Business School.
However, what this initial brief analysis clearly
shows is a greater than expected survival rate of new manufacturing
firms, employment gain and a substantial multiplier. It also calls
into question the role of the wider advisory services, in keeping
with the original research. The importance of these preliminary
research findings is not the numbers but in the magnitude of the
growth in employment and the need for critical mass in terms of
new firm formation.
Dr John Ball
12 March 2004
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