Select Committee on Treasury Written Evidence

Memorandum submitted by EEF


  1.  EEF, the manufacturers' organisation, has a membership of 6,000 manufacturing, engineering and technology-based businesses and represents the interests of manufacturing at all levels of government. Comprising 11 regional associations, the Engineering Construction Industries Association (ECIA) and UK Steel, EEF is one of the UK's leading providers of business services in health, safety and environment, employment relations and employment law, manufacturing performance, education, training and skills.

  2.  EEF welcomes the opportunity to contribute to the Treasury Select Committee Inquiry into "globalisation and its impact on the real economy". Manufacturers have always been exposed to the intense pressures of the world economy. Globalisation has resulted in companies having to expand their focus from their domestic and traditional trading partners to incorporate new and expanding markets. Companies have also had to assess where manufacturing functions are best located to service key and growing markets, and how and where their production process can be carried out most efficiently and effectively.

  3.  Therefore, policy makers face a different challenge in order for the UK to remain a competitive location for business in the global market place. EEF believes that is crucially important that Government focus on investment in skills, R&D, innovation and in ensuring that the UK retains a globally competitive tax regime in order to bolster our ability to be best placed to exploit the benefits of globalisation.


  4.  The latest wave of globalisation has been characterised by the emergence of low cost economies, particularly from Asia, and their integration into global supply chains and trade networks. This has led to quite considerable change in the competitive landscape in which UK business operates. The last few years have seen a huge increase in the importance of lower cost countries as competitors. A survey of EEF members in 2004[44] revealed that China was identified as presenting the most significant competitive challenge to UK companies by 57% of respondents, up from just 18% in a 2001. The competitive threat from developed economies has declined over the same period.

  5.  The integration of low cost economies, such as China and India, into the global supply chains brings opportunities as well as challenges for UK companies and the economy as a whole. EEF's survey of competitive challenges revealed that UK companies are feeling the impact of low cost economies through customers demanding lower prices in an attempt to drive costs down in the supply chain. Firms also indicated that globalisation had led to increased price competition in both domestic and export markets. This stems not only from direct competition from low cost economies, but also developed countries taking advantage of lower wages by investing or outsourcing in lower cost Asia or Latin America. Competitive pressure from firms outside the UK producing higher value added goods was less pronounced, with only around one in 10 companies describing it as significant. Furthermore, the source of such technology-based challenges currently remains confined to developed economies in North America and Europe.

  6.  Our survey also acknowledged the opportunities that low wage economies can offer. Low cost economies can form an important part of companies' business strategies to reduce costs and increase competitiveness. In a more recent survey of UK-based manufacturing companies carried out by EEF[45], 45% of respondents said they had outsourced the manufacture of parts and components or other manufacturing functions abroad and a further fifth of companies were considering it. In addition, just over 30% of firms had opted to make a more significant commitment to an overseas location by investing abroad. By choosing to invest in a lower cost location, such as China or India, firms can take advantage of the large wage cost differential for production of lower value added products while refocusing efforts on higher value added activities in their UK-based operations.

  7.  Operating in an increasingly internationalised world can also bring new trading possibilities. While Europe and North America account for around three-quarters of the UK's merchandise exports, the emergence of fast-growing transition economies provides further opportunities for companies to look to new trade partners. However, in 2005, only around 1% of the UK's exports were destined for either China or India. Companies are not expecting their key trade partners to change substantially over the next five years. Figure 1 shows that half of manufacturers think that key growth opportunities lie in the old EU (previously EU-15) countries in the next five years, up slightly from 2002.

  8.  Transition economies have made less of an impact on companies when it comes to future business opportunities. The biggest change in attitude between 2002 and 2004 was about growth prospects in Central and Eastern Europe (including the 10 new EU entrants). However, while almost three-fifths of companies view China as a competitive threat over the next five years, only 20% see it as an opportunity for growth. This is somewhat surprising given its entry into the World Trade Organisation (WTO) at the end of 2001, which might have been expected to boost perceptions of the trade prospects on offer. China, for example, has been sucking in exports from across the globe. While some sectors of the UK economy have undoubtedly benefited, other countries may have been quicker out of the starting blocks. UK firms, therefore, need to be less reliant on the slower growing European markets and to take advantage of trade opportunities in faster growing emerging markets.

Figure 1



Source: EEF/NOP World Competitive Challenges Survey 2004.

  9.  Clearly, no developed economy is immune from the effects of globalisation and the net impact on the UK economy need not be a negative one. However, there is a role for government policy in ensuring business is able to meet the competitive challenges and harness the opportunities that globalisation brings. Government's response should fall mainly in areas where it can enhance the UK's competitive position and ensure the UK remains an attractive place for business to locate and operate. It will therefore be vital to ensure that all the key aspects of the UK environment—taxation, regulation, skills, the science base, transport and the planning system—remain competitive.


  10.  As noted above a growing number of manufacturing and service based companies are seeking to take advantage of low cost economies through outsourcing and investing aboard. As firms expect competitive pressures to intensify in the medium term, it is likely that the trend will continue and firms will look beyond China and India for outsourcing possibilities. In this context government's role is more about helping to ensure that companies make offshoring decisions for the right reasons. That is, firms should choose offshoring if it can deliver genuine long term efficiency gains for business, not because the UK business environment is "pushing" production overseas.

  11.  EEF's survey on competitive challenges showed that companies were generally responding to the threats posed by globalisation with a combination of strategies—cost cutting measures, such as outsourcing, along with increasing innovation and moving into niche markets. Government policy should recognise the need for a range of strategies and support companies' efforts to move up the value chain, through innovation and R&D. In addition, there may also be a need for government supported agencies to assist firms in looking beyond low cost economies as a destination for low cost production. Existing government support from UK Trade and Investment (UKTI) in this area is concentrated on SMEs and new to export firms—there would appear to be a case to revisit the remit of UKTI in this respect.

  12.  We believe it is counterproductive for government to attempt to restrict offshoring activities. If done for the right reason there are benefits to both business and the wider economy, as outlined above. Firms, however, need to be responsive to this changing business environment and this requires a flexible and adaptable labour force. The requirements of business and occupations will change in response to the decline of some lower valued added activities and rapid growth in other sectors of the economy. A flexible and skilled workforce is needed to support these adjustments.


  13.  Capital investment is a key component in firms' efforts to raise manufacturing productivity and therefore competitiveness. The UK has long been seen as under-investing in capital equipment and technology. Despite the rise in capital expenditure in the first quarter of this year, the recovery in manufacturing investment has been disappointing. Since the third quarter of 2003, manufacturing investment has risen by 21% but it is still 27% below the peak it hit at the end of 1998. This raises questions as to whether the government should be doing more to promote investment. EEF analysis suggests that, although the government could do more through measures such as capital allowances to ease the constraints faced by manufacturers in financing investment, it will be just as important to focus on getting the overall business environment right.

  14.  Before identifying what the government could do to promote business investment, it is important to understand the reasons for its current low level. Part of the reason could be that the statistics are telling a misleading story given that the prices of some capital goods have been falling. Indeed, EEF members have commented that some machine tools have either fallen in price or provide much greater functionality for the same cost. However, falling prices are is likely to provide more of an explanation when looking at other parts of the economy where investment in IT is proportionately higher and which have therefore benefited more from falling prices of computers and other IT equipment. In addition, international comparisons show UK manufacturing investment as a proportion of its gross value added falling in this decade, while it has increased or remained stable in other major OECD countries. This suggests factors other than falling prices account for the weakness of UK manufacturing investment.

  15.  Part of the explanation lies in the growing investment by UK manufacturers in lower cost locations abroad. Not all this investment abroad will be replacing capital expenditure in the UK. For example, some of the investment will be driven by the desire to establish a presence in growing markets in addition to developing the UK base. Similarly, the cost savings realised by moving some lower value added activities out of the UK can free up funds to invest in other activities in the UK. Nonetheless, the UK will be increasingly competing with other locations, particularly low cost ones, when manufacturers decide where to put their next investment. EEF research in its "Where Now for Manufacturing?" report revealed that manufacturers that had invested abroad had generally achieved their objectives and were planning further moves of this kind. Generally, these moves involve a partial relocation of some lower production but some companies are also examining where they should do final assembly, testing, quality control and even research and development.

  16.  UK manufacturers also tend to rely on internal funds to finance investment. An EEF study of productivity differences with France and Germany[46] showed that around a third of UK manufacturers saw shortage of internal finance as the major constraint on investment—double the proportion in Germany and a third more than in France. Manufacturing investment is therefore likely to be squeezed by increases in costs that they are unable to pass on to their customers. This is supported by the strong correlation that official statistics reveal between manufacturing profitability and manufacturing investment. This points to the need to:

    —  avoid increases in taxation that add to the cost of business such as employer National Insurance Contributions, business rates and environmental taxes;

    —  ensure that other costs faced by manufacturers are not out of line with their competitors. Particularly pressing currently are energy costs with the prices paid by UK companies pushed above that paid by our competitors. The key factor driving this is our rising dependence on gas imports, coupled with a lack of storage facilities;

    —  help manufacturers to reduce costs through the business improvement programmes offered by organisations such as the Manufacturing Advisory Service;

    —  provide support to small firms in accessing finance through measures such as the Small Firms Loan Guarantee Scheme; and

    —  address the cashflow constraints faced by firms through providing enhanced first year capital allowances or an investment tax credit targeted at firms with low or no profits. In addition, enhanced capital allowances should be used to promote objectives regarded as important to the UK such as investment in energy efficient products and processes.


  17.  The emergence of low-cost countries, notably India and China, as major players in the global economy has profound consequences for the UK. It has been clear for some time that the UK cannot compete on price alone. EEF's "Where Now for Manufacturing?" report revealed that two-thirds of companies were responding to growing competition by increasing their focus on innovation and that almost half were developing niche markets or customising their products. It is therefore vital that the UK environment enables UK manufacturers to innovate effectively. This should encompass the activities traditionally associated with innovation such as expanding the science base and investing in research and development, as well as other activities such as design and marketing and the less dramatic but vital incremental developments companies make in products, processes and services.

  18.  This part of our submission draws on a major piece of research completed by EEF, including a survey of 500 manufacturers. It shows that companies are being driven to innovate by the dual pressures of meeting customer demand and rising competitive pressures. The increasing focus on innovation is illustrated by the fact that three-quarters of companies have increased their spending on innovation over the past three years and that over half of them plan to do so in the coming three years.

  19.  Our surveys and face to face interviews revealed that much of what companies regarded as innovation included improvements to existing products, processes and services or the introduction of new ones that had a degree of novelty but could not be described as major technological breakthroughs. About three-quarters of innovating firms had introduced a new or significantly improved product or process in the past three years. About half of firms had also undertaken some form of service innovation, illustrating the growing importance to manufacturers of developing revenue streams based on their product or process knowledge.

  20.  Encouragingly, companies appear to be achieving results with about four fifths of innovators reporting improvements in productivity, turnover, profitability and market share. However, they also experienced a number of problems. For example, most innovators collaborated with outside organisations, including customers, companies in their supply chain and the research base, to draw on their expertise and resources and as a way to reduce costs. However, nearly half of firms struggled to find the right partner and to get universities and other scientific institutions to understand their business needs.

  21.  However, the most significant problems reported by companies related to their internal capabilities. These included implementing projects in time, keeping costs under control and the adaptability of staff. Many of these are skills issues, particularly in terms of recruiting people with university-level research skills and in also accessing and developing the required management skills.

  22.  Companies also reported problems with external finance for innovation projects. For a little under half of firms, the cost of external funding is an issue, while about one third of firms do not know where to go for funding and find that investors tend to offer sums of money that are either too large or too small for their needs. Regulation is also a growing issue, though this can cut both ways. On balance, product standards regulation was seen by members as positive for innovation but given that a significant number of firms regarded it negatively, there is an ongoing need to ensure that regulation in these areas relates to outcomes and is not so prescriptive that it reduces the scope for innovation. The impact on innovation should therefore be explicitly considered when designing and implementing new regulations.

  23.  Mid-sized firms (those with 250-499 employees) performed poorly relative to both larger employers (500 employees and above) and also medium-sized companies (100-249 employees) on many indicators. These include the amount of innovation they did, the results it yielded, their contacts with the research base and their ability to access outside sources of assistance. Companies in this size band will often have either reached a plateau after an initial growth phase or will have downsized as a result of competitive pressures. In many cases they will lack the resources to take on the more risky forms of innovation. The government has recently recognised this by extending the benefits of the R&D tax credit for SMEs to mid-sized firms. However, it will also be worth investigating whether other forms of support, particularly brokerage and information and advice, could be extended to mid-sized firms.

  24.  Our research also showed that government support makes a difference. Companies accessing support were more likely to have increased their spending on innovation or to be planning to do so and also tended to achieve better results. Particularly influential in driving up recent spending were financial support (R&D tax credit, grants), general advice and help with networking. Future spending plans were affected most by support related to access to new markets (overseas and through government procurement) and to public research. This highlights the need to make better use of the large amounts of money to stimulate innovation that the government spends purchasing goods. Firms that we interviewed report that procurement practices tended to be slow, bureaucratic and risk-averse.

  25.  Our survey also asked companies about the influence of various factors on their innovation decisions. We have used the responses shown in Figure 2 to group our recommendations on how the government should support innovation under five headings.

Figure 2



Source: EEF/GfK NOP Innovation Survey 2006.


  26.  This category includes tax treatment, government procurement, and help enforcing Intellectual Property Rights. Discussions with our members indicate that the R&D tax credit can play a useful role in encouraging greater innovation but that it needs to make a greater contribution than currently to reducing the cost of undertaking R&D if it is to make a difference. In a global economy where other countries are increasingly making efforts to attract R&D, it is also important to ensure that incentives in the UK remain globally competitive. The tax credit needs also to be publicised better and the procedures for claiming it should be simplified.

  27.  It will also be important for the Gower Review to address the enforcement of Intellectual Property Rights, given that companies will only undertake expensive innovation projects if they can be confident about recouping costs in the long-term.


  28.  Our recommendations under this heading relate to helping companies to draw on high level skills from universities and other parts of the research base. Human resources are key to successful knowledge transfer between the research and industrial base. Graduates and others working in research need to have a complementary mix of science and commercial skills but it is also important to encourage the exchange of people between research and industry. This is recognised in the government's Science and Innovation Investment Framework, correcting the past over-emphasis on creating spin-out businesses from universities—an issue identified in the Lambert Review.

  29.  Supplementing the technical skills of students, researchers and existing workers with enterprise, creativity and design understanding has a double benefit. Improved understanding across the research base of commercial issues will make collaboration with industry more effective. Students with commercial skills will be better at working with the research base to develop new market opportunities from new technology when entering industry. They can help provide the "translator" resource that many businesses find difficult to develop.

  30.  Schemes allowing a student to work in a business for short period, such as the STEP (Shell Technology Enterprise Programme) and the DTI's Knowledge Transfer Partnerships (KTPs), have been very positively received by business. We have heard numerous examples, particularly of PhD students, helping a company to resolve innovation problems and to identify new opportunities for innovation. Often longer-term relationships result from the initial exchange, which ensures ongoing links with universities.

  31.  We therefore recommend that the number of graduates involved in Knowledge Transfer Partnerships should be expanded and that access to this and the STEP programme should be improved by promoting it through more frequently used channels such as the Manufacturing Advisory Service and Business Links.

  32.  The Engineering and Physical Sciences Research Councils' new "Integrated Knowledge Centres" aim to be a place for closer university-business collaboration on emerging technologies with market potential. They offer a good model for research and business staff to work alongside each other and should be rolled out more widely.


  33.  A key part of innovation is finding the right people to talk to and getting access to them. For manufacturers, this often means finding funding, gaining access to public research and finding partners for collaboration. Many of the manufacturers that we interviewed expressed a desire to move away from the constraints associated with their reliance on internal funding. This is a particular issue for mid-sized companies, who have to grapple with new models of financing as they grow from the SME stage.

  34.  Improving the ability of companies to absorb new knowledge and to translate it into commercially viable outcomes is also critical. The heavy emphasis placed by companies in our survey on gaining expertise in product development and in design and physical facilities from their collaborative relationships suggests a lack of capacity in these areas. For as long as these capacity issues exist, companies need to be able to work alongside researchers to tailor emerging knowledge into commercially-relevant work streams.

  35.  Knowledge Transfer Networks (KTNs) seek to help disseminate new technology and identify collaborations in specific technology areas, but they are not necessarily the actual means for collaboration. What are still sometimes missing from the UK knowledge transfer system are "proof of concept" facilities or technology development institutes that are widely available and clearly signposted to business. This role is filled in Germany, for example, by the Fraunhofer institutes that provide common facilities and skilled personnel (including representatives from universities and business) to carry out industrially-relevant applied research that is close to the market. They are a well-known entry point for business innovation and provide brokerage services to other relevant programmes and collaborations.

  36.  We recommend that:

    —  the government introduces a brokering function to build awareness of and introduction to different funding options, including less well-known options such as mezzanine funding and risk sharing innovation finance facilities available at the EU level from 2007. Mezzanine finance may be suitable for established businesses with innovation seen as too risky for traditional bank finance and where the company is concerned not to give up equity. It might take the form of convertible or preference shares. This brokerage could be provided by RDAs who already have some involvement through regional venture capital funds;

    —  the government should widen the scope for national level risk-sharing innovation finance facilities. This would follow the lead of the new EU scheme to be implemented in 2007 by the European Investment Bank to improve access to debt finance for companies involved in large scale and risky R&D projects;

    —  current efforts to help companies find the right innovation partners should be co-ordinated so that all information about collaboration opportunities is fed into an easily accessible and searchable facility for business;

    —  RDAs and Research Councils, with participation from the Knowledge Transfer Networks, should work together more closely to match the company needs and research opportunities that the respective organisations have identified. This will ensure companies looking for partners are not limited to partners based in their region;

    —  more attention is focused on improving engagement and outreach by universities and Research Councils with business. The RDAs and KTNs provide some mechanisms for doing this but may not have strong links with the more traditional manufacturing sectors. One way of widening engagement would involve working with organisations such as MAS which have extensive links with more traditional industries but which traditionally have not had an innovation focus. In addition, KTNs require a more extensive marketing effort to broaden their membership; and

    —  more "proof of concept" facilities, where business and researchers can work alongside each other to mature and direct emerging technology towards commercial viability, are developed.


  37.  Companies are looking beyond their existing commercial contacts for information with just over half of innovators having some form of contact with universities. Encouraging greater and more effective contact would be beneficial, provided that information can be packaged in a commercially relevant context for companies less experienced in innovation. This may involve some assistance from another source, such as a private technology transfer organisation, to help translate the information into a more usable form.

  38.  Whilst government should not be the sole provider of such information, companies in our survey rated the quality of what they had received from DTI programmes such as Foresight and Global Watch Service, which aim to help companies benefit from innovative practice and technologies from overseas.

  39.  We recommend that:

    —  DTI's Global Watch Service should be maintained and made available to the widest possible audience. Recently, support for DTI Global Watch Secondments has been removed and any further cutbacks should be resisted;

    —  as part of the review of UK Trade and Investment's (UKTI) remit, the government should review whether its new mandate on promoting the UK science base overseas should include activities such as identifying new overseas technologies and market opportunities, perhaps utilising the expertise of the Global Watch Service;

    —  Research Councils should work more closely with the RDAs to increase business awareness of the results of work funded by them; and

    —  the government should investigate the scope for further assistance with the costs of using external experts such as a technology transfer consultancy to translate information from the research base into analysis of commercial opportunity. Such a scheme would be similar to the UKTI Export Market Research Scheme, which provides part funding for companies commissioning a market research study into new export market opportunities.


  40.  Ultimately, it is up to companies themselves to improve their ability to develop, apply and market new ideas. However, the experience with best practice programmes in the UK is that they deliver substantial gains in company performance for fairly small scale sums of public money. There may therefore be some role for organisations such as Business Links or MAS to develop programmes or diagnostic tools to help companies raise their effectiveness or signpost them to existing programmes. However, there is also a danger that these organisations become overloaded with different responsibilities. It is therefore important that their remit is confined to areas of genuine market failure.


  41.  The need for different and higher level skills will underpin the UK's ability to become a more flexible and innovative economy. Companies facing growing competition need to remain ahead by innovating and moving into the production of higher value-added products and services. Skills shortcomings can slow the pace of innovation. Equally important is the link between skill acquisition and productivity. Having an adequately skilled workforce plays a major role in optimising companies' productivity growth. In addition to its direct impact on productivity and efficiency, an inadequately skilled workforce can reduce the value and effectiveness of investment in capital equipment—a further driver of productivity growth. In addition to the higher level skills already identified above, employers recognise that the skills they will need to operate in a more global economy will change in the medium term, as illustrated in the chart below. There are roles for government, business and individuals in making sure that these skill needs are met.

  42.  Employers spend an estimated £33 billion per year on training (including wage costs), in addition publicly funded post-16 training provision (excluding sixth forms and PCDL) directed through the LSC amounts to a further £7 billion. However, there are a number of factors undermining this investment—some of which could be addressed by government policy. Some of the key problems stem from a lack of information or appropriate training provision and for some firms available funding for training is also a barrier. One further reason why firms training activities are not generating sufficient improvements in workforce skills is that the link between training plans and longer term business strategy is often not firmly established.

  43.  Some recent policy announcements should go some way to improving the situation—the roll out of an independent skills brokerage services in the regions to help companies source training provision more easily where it is available, is a welcome step. As are the proposals to improve the quality of Further Education announced in a recent White Paper and the proposals to introduce learning accounts for individuals. The development of new learning accounts for individuals should contribute to a more demand-led system of education and training provision.

Figure 3



Source: EEF/NOP World Skills Survey 2005.

  44.  However, some fundamental problems remain. Employers continue to find the post-16 learning and skills sector difficult to navigate. A plethora of sectoral and regional skills agencies have been established to provide a range of services to employers and to make the supply of training provision more responsive to employer needs. However, there is little evidence to suggest that this latter aim in particular is being met by the current post-16 education and training system. Furthermore, the learning and skills and business support sector tends to separate skills and training needs from wider business improvement assistance. EEF is developing proposals for reform in this respect and will publish its findings later in the summer.

  45.  Government should also focus on ensuring compulsory education meets the needs of individuals and employers. Before people enter the workforce the school system must equip them with a minimum level of competence in the fundamental skills necessary for progression and participation in society. These include literacy, numeracy and use of ICT, and will provide the foundations for all other learning. Furthermore, getting these fundamentals right is particularly important if more people are to be encouraged to study science, technical, engineering and maths (STEM) at a post-compulsory level.

  46.  In addition to academic responsibilities, schools also have a role in developing "soft skills" such as communication, team-working and problem solving skills. It is vital that these are developed before entry into the workforce. Provision of unbiased careers advice and guidance is also a function schools should perform. For companies in manufacturing to attract talent into the industry in future, young people must be provided with comprehensive information about career options and the routes that can be followed after compulsory education to achieve career goals.


  47.  The UK has traditionally enjoyed the benefits of low taxation relative to most of its major competitors. Compared with most other EU countries this is still the case. However, OECD statistics show that the UK has moved from having a taxation burden below the OECD average in 1997 to one that was above it in 2005. Only a handful of countries such as South Korea and Iceland have seen the tax burden (as measured by general government receipts as a share of GDP) rise faster over this period.

  48.  Much of the increase in UK taxation has been borne initially by business, particularly through increased National Insurance Contributions, fuel duties and environmental taxes. Over time some of these added costs may be passed on by business. For example, higher National Insurance Contributions are likely to be absorbed in lower wage rises in the long run but in the ensuing period the extra costs will have damaged costs and undermined business investment.

  49.  It is important to keep rates of corporation tax competitive, particularly as there is some evidence of a relationship between relative corporation tax rates and a country's ability to attract inward investment. However, for many manufacturers, the priority will lie with minimising taxes that affect the cost of doing business.

  50.  The rising complexity of the tax code has also attracted criticism from business. The complexity of tax incentives and the frequent changes made undermine their effectiveness and also are a drain on management time. There is a case for limited intervention by government to address areas of market failure but these should be the exception rather than the rule. The administrative burden of taxation should also be reduced through improvements to the early stages of the tax policy-making process and better assessment of the real-world impact of tax changes.


  In this submission, EEF has attempted to portray some of the key policy choices facing the UK Government in a globalised economy. It remains crucially important that the UK face up to the new challenges ahead, and take the tough decisions which will help play a role in underpinning our competitive position in an ever changing global market place.

June 2006

44   EEF (2004) Where now for manufacturing? Back

45   EEF/GfK NOP Innovation Survey 2006 Back

46   EEF (2004) Catching up with the continent Back

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