Manufacturing: Marching on the spot

An apparent recovery will not last, and the Chancellor's 'march of the makers' is no closer to reality

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The Independent Online

George Osborne's political radar has clearly been on the blink of late after hugely unpopular tax raids on Tory-voting grannies and the pasty-eating classes. But it is the Chancellor's economic crystal-ball gazing which has been coming back to bite him for the past year – none more so than his prediction of a "Britain carried aloft by the march of the makers".

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That infamous, vainglorious soundbite from the 2011 Budget looks more ridiculous by the day as official manufacturing statistics tell us that a sector accounting for about 10 per cent of the economy has been virtually stagnant for the past year – managing growth of just 0.3 per cent in the 12 months to January.

But if you believe the evidence from the financial information firm Markit and the Chartered Institute of Purchasing & Supply this week, the UK's makers are finally on the march, or at the very least enjoying a purposeful stroll. According to that survey – much more timely than the official data and perused closely by the Bank of England's rate-setters – the pace of growth has quickened for the second month in a row to the speediest since last May. Compared with the eurozone, where only Austria and Ireland are showing any growth at all in their manufacturing sectors, Britain is positively booming. Domestic orders are up, export orders are up, and overall manufacturing output is on the rise.

So far so good. But how long can it last? A closer look at the evidence suggests the current apparent "upturn" among British manufacturers is in fact on borrowed time. It's a Wile E. Coyote moment: the hapless cartoon hunter's legs are whirring in mid-air after running out of road, and it's mere seconds before gravity takes its course and he plunges to the canyon floor with a puff of smoke.

Alarmist talk from an avowed economic pessimist? Hardly. Take a look at the warning signs. A consistent trend of Markit's surveys in recent months – not just in manufacturing but services too – is that firms are relying on back orders to lift output despite apparently strong headline numbers (see chart) for overall activity. When output is growing at a faster pace than new business wins, it is a clearly unsustainable state of affairs.

According to the detailed figures, the stocks of finished goods in manufacturers' warehouses is also growing at its fastest pace on record. A score over 50 signals growth in these surveys, and in March this particular indicator hit 53.7 – the highest ever. The historical average is 47. Perhaps unsurprisingly the steepest gain in stockpiles comes from consumer goods. The picture is different in the US where the manufacturing growth looks more sustainable: the resulting share bounce suggests the markets think the world's biggest economy has turned the corner.

Another reason to sweat is a sudden build-up in inventories among UK businesses between July and September, shown by the official data and continued – albeit to a lesser extent – in the final quarter of last year. This is also borne out by the latest Markit/Cips survey.

Rising inventories can be positive; for example if a company like Apple were to build up stocks of thousands of iPads before releasing a new model. But most of the time it is unplanned: firms have been caught off-guard by a sudden slump in demand and can't cut production quickly enough, so it is rising stockpiles which add to growth rather than consumer spending. The trend typically points to lower future production and eventually to falling employment as businesses cut staff to reflect lower demand. The detailed fourth-quarter GDP figures have since shown another £1bn of goods added to stockpiles. When firms eventually eat into those inventories, watch for the steady rise in unemployment.

All this comes in a climate of rocketing input and output costs thanks to rising oil prices pushing up the cost of fuel, components, plastics and transport, as well as sapping domestic demand. But input prices have seen a much steeper rise than "factory gate" prices since January: the largest over any two-month period since November 1992. This signals further pressure on margins, cut-throat competition and a limited ability to raise prices in line with costs. With manufacturers this squeezed, it's a big ask for them to play their part in a business investment splurge, which is supposed to drive the recovery over the next few years.

If this was a real manufacturing recovery, you'd be expecting firms to be taking on staff. But confidence is low. March saw little change in manufacturing employment despite a modest increase in February. Instead companies are mainly shedding jobs under cost-cutting initiatives or simply not replacing leavers. The latest official jobs figures are some way behind the surveys but they show that manufacturers shed 95,000 jobs in the two years to December, with 7,000 of those going in the final quarter of last year.

There are a few bright spots: namely that Britain's makers are hunting out sales in other markets as Europe falters, shifting their wares in Japan, Africa and Asia. But in the short term at least, it will be of little import when their biggest export market has been hammered by austerity.

The irony of Osborne's original boast is that the "march of the makers" was never going to get us out of the economic hole we're in: it was doomed to failure as soon as he opened his mouth because the sector is too small to carry the weight. What the Chancellor should be focusing on is nurturing the financial sector to sell products to China's burgeoning middle class – the biggest growth market of the coming decade. The bankers got us into this mess – and it is they, not manufacturers, who will get us out of it.