The past and future of manufacturing: observations 3
As I observed in my previous blog, and my The Telegraph op ed that it referred to, while the UK’s manufacturing employment has shrunk in all sub-sectors, some areas saw a larger decline than others. The two key reasons for reduced hours worked in manufacturing are clear: automation (or other productivity improvements) and globalisation. The former allows businesses to produce the same amount of output with less labour; the latter means that production shifts overseas (but might still remain labour intensive).
I may return to productivity in more detail later, but for now, increases in productivity (output per hour worked) explain reductions in hours worked in only a small number of UK manufacturing subsectors. From 1998 to 2018, productivity increased substantially (by more than 2% per year, or 49% over the 20 year period) in computers and electronics, textiles and apparel, and pharmaceuticals. In all other sub-sectors, a decline in employment also reflects a significant reduction in actual output. [Note: textiles is a special case; its productivity increased by almost 79%, but its output also dropped by 50%, and hence its hours worked dropped by 72% — the largest decline among sub-sectors.]
For the sub-sectors where the culprit for reduced employment is mostly reduced output (rather than increased productivity), it is instructive to understand the reasons behind this apparent loss of competitiveness. The exact sources of competitive advantage will be different from one sector to another. For example, energy intensive industries benefit from low-cost fuel sources, capital intensive sectors — including those amenable to automation — from a low cost of capital (e.g., due to low systematic risk or favourable tax policies), and labour intensive activities from high quality and/or low cost labour. For some manufacturing, proximity to low-cost raw materials can also be critical, as can other local supply chain factors. Innovation and application of best practice management and leadership methods (such and lean manufacturing) tend to be important across the board.
The chart above picks up on one aspect: the cost competitiveness of the UK’s labour supply. The left hand panel shows, for each sub-sector, the UK’s and other OECD (and related) countries’ so called “unit labour cost” (ULC). The best way to think about this is as the cost of labour adjusted for productivity. In other words, for each unit of output (say, valued in real US dollars), how much did the business need to spend on its labour (also in real US dollars)? The proportion of output that is not paid for labour is then the “capital share”* that accrues to the businesses’ owners.
[* Note: the measure used in national accounts for the value added accruing to capital is called “gross operating surplus” (GOS). It is not identical to what business leaders or accountants would recognise as “profit”, as the latter is typically measured after interest, tax, depreciation and amortisation. Probably the closest equivalent to GOS in company accounts would be EBITDA (earnings before interest, tax, depreciation and amortisation).]
Putting the textiles sector to one side (see comment above), the chart indicates that — broadly speaking — the higher the unit labour cost, the larger the reduction in hours worked in the UK since 1998. The relationship is of course not one-to-one, but the UK’s relatively lower labour costs and/or higher labour productivity appear to have kept its pharmaceuticals sector competitive, with only a limited reduction in hours worked (and, in fact, no reduction in output). At the other extreme, metal, wood, rubber and plastics products have seen large reductions in employment, partly due to the UK’s unit labour costs being amongst the highest in comparator countries.
A single metric, such as the ULC, doesn’t of course explain everything — but it does illustrate that it is the combination of labour costs per hour and productivity that determine part of companies’ cost competitiveness in the global market. In the manufacturing sector on average, the UK happens to be fairly “middling” on both, but digging deeper, one middling position divided by another renders the UK’s overall unit labour costs among the highest in the comparison set, after Norway and Germany. [However, since Germany has not lost all that much manufacturing share, yet again, it’s important to emphasise that this is only one factor at play.]
