Is UK industry sliding into recession?

JUST WHEN it looked like it was motoring along the road to recovery, the long-suffering manufacturing sector has slammed into reverse again. Shock figures last week showed factory output slumped by a disastrous 0.8% in August - the biggest fall in nearly two years.

Following declines of 0.6% and 0.4% in June and July respectively, it was the first time output had fallen for three months in succession since January 2002, prompting warnings from the British Chambers of Commerce that industry could be heading back into recession.

Pinning the blame on poor performance by the transport equipment, electrical and optical equipment and machinery sectors, the Office for National Statistics said manufacturing's recovery had 'definitely slowed'.

Reinforcing its message, it slashed its estimate of the sector's trend rate of growth from 1.5% to a 0.5% decline.

Although the news stunned the City, where economists had pencilled in a 0.3% output rise, the omens from recent industry surveys had been less than encouraging.

The closely watched CIPS/Reuters purchasing managers' report showed manufacturers suffered their worst month for more than a year in September, while the CBI reported shrinking order books and export demand at its lowest since February.

'What had been a steady recovery since the end of last year has definitely come off the boil,' says Andy Scott, director of international competitiveness at the CBI.

'Sluggish global markets have been exacerbated by record oil prices and rising interest rates. One of the frustrations for firms is the climate they operate in is heavily influenced by factors outside their control. Great uncertainty is what most manufacturers are facing right now.'

There is little doubt manufacturing has been the victim of a slowing global economy, but there is also the deeper problem of long-term decline. Over the past 50 years, it has dwindled from a powerful economic force into a sickly sector.

It has come to be seen as worthy but dull, past its sell-by date. Information technology and the services sector - spanning everything from banking to retail - seem sexier, highly profitable and the places to be. Manufacturing conjures up images of metal bashing in greasy, grimy factories little changed since the industrial revolution. Many people leaving university today would never dream of going into industry.

Manufacturing's contribution to the economy has slumped by a quarter over the past decade. Back in 1992, it accounted for 21.2% of total output, falling to 15.9% in

2002. Once, it was more than 40%. On the flip side, the financial services industry has blossomed, its share of output rising from 24% to 30.4% over the same period.

It is a pattern straight out of an economics textbook. As economies mature and living standards rise, people's spending on manufactured goods tends to grow by proportionately less than their income. But the sector has also been hit by a wave of companies opting to shift production to cheaper countries, such as China and India. Rover, Hornby and Dyson are among the scores of British firms that have moved their operations abroad.

But economists say the latest output collapse points to something more sinister.

'When you're getting three falls in a row, you can't just say that it is down to economic evolution. It's more problematic than that,' says Jonathan Loynes at Capital Economics.

Amicus, Britain's biggest manufacturing union, says 10,000 industry jobs are being lost every week and claims that, if the current trend continues, the workforce will have disappeared by 2032. It blames higher interest rates for the stalled recovery.

'Manufacturing shouldn't be sacrificed to take the heat out of the South East housing market,' a spokesman says. 'The mood is one of anger, insecurity and fear. It is tragic that tens of thousands of highly skilled workers are becoming taxi drivers or going on long-term incapacity benefit.'

On the factory floor, firms are doing their best to survive through a continual drive for efficiency improvements.

It is not just workforces and production processes that are under scrutiny but also more prosaic areas such as supply chains, end-service delivery and logistics. Manufacturers not prepared to get leaner and keener could find themselves a dying breed.

With manufacturing dwindling in importance, does any of this really matter? Well, yes, for two main reasons. First, no sector is an island within the economy and the big fear is that the industry slump will be felt elsewhere. There are signs this has already started to happen, with services sector growth well down on the brisk pace seen at the start of the year.

Many of those who have lost their manufacturing jobs will be spending less as a result. And talk of a manufacturing recession could knock consumer confidence in general - bankers or shop workers may put plans to buy a new car or home computer on ice until economic worries have passed.

Second, having successfully engineered a slowdown in consumer spending and the housing market, the Bank of England had been hoping manufacturing would pick up the growth baton to drive the economy forward. That now looks a distant prospect and it is difficult to see where the economy's firepower will come from in the months ahead.

The manufacturing setback has raised the prospect that the economy expanded by less than its long-term 'trend' growth rate, reckoned to be about 0.6%, in the third quarter. The National Institute of Economic and Social Research estimates 0.4%.

Chancellor Gordon Brown's 3% to 3.5% growth forecast for this year and next is looking increasingly out of reach.

'Tough rivalry from overseas'

FOR the past few months, electrical equipment maker Lewden has been flying by the seat of its pants.

After more than 50 years in the business, the Leyton, north east London, based company which makes electrical parts for the Ministry of Defence and industry is being buffeted by forces beyond its control.

'Business is extremely slow and we are having to contend with stiff competition from abroad, particularly China and Eastern Europe,' says operations director Anthony Wilkins.

Lewden's corporate strategy has been to chase more orders in a bid to boost productivity, rather than slash overheads by firing staff or freezing investment.

'Too many firms make a knee-jerk decision to cut back when times are tough,' Wilkins says. The company employs about 100 staff, a number that has remained reasonably stable as it continues to hire when employees leave. Hefty pay increases are a thing of the past though. Last week's annual pay round saw wages rising by between 2.5% and 3%.

Wilkins is upbeat about Lewden's future. The firm is fighting for larger contracts and MoD work is starting to pick up again. 'It is not all doom and gloom,' he says. 'The market is hard, but as long as you are proactive, you can keep the business ticking over. We are optimistic that things will improve. We just have to ride out this rough patch.'

Spreading the risk of failure

ROBERT Whittle, managing director of Enfield-based Foodafayre, has weathered the downturn by making niche, specialist products but spreading risk over several markets.

The company makes pastry and biscuit cups for the food industry, which then fills them with sweet or savoury treats. But rather than using plain pastry, its products are made from filo pastry, cheese pastry and tortilla shells.

Foodafayre sells to four markets - manufacturing, catering, retail and European - to hedge its bets.

'In the run-up to Christmas is always good and trading is buoyant,' says Whittle. 'But, in the wider food industry, conditions are more difficult and competition is cut-throat.'

He points to a polarisation between large, cumbersome manufacturers, who find it harder to adapt to fluctuating conditions, and smaller firms able to dig out higher profit margins. 'The minnows like ourselves are faring better,' he says.