Export success requires all the elements of trade to be aligned

The comparison of UK goods and services export performance confirms the importance of focus and control.

UK services exports have grown impressively in the last decade as the UK has been successful in selling to the world’s largest and fastest growing markets. This success does not appear to have been unduly hampered by regulatory burdens, infrastructure weaknesses or uncompetitive exchange rates. My previous blog highlighted the importance of market focus and agility as drivers of export success. It may well be that services are by their nature more agile and hence it is easier to change direction quickly in response to market changes than is the case with goods.

The UK has world leading capability in financial services and business services but is also able to generate a positive trade balance in a number of other service sectors. While it is likely that greater liberalisation of services’ markets in Europe would further boost UK exports, the sector has been able to thrive despite the restrictions that exporters currently face.

By contrast, although there are pockets of success, the UK has found it much harder to succeed as an exporter of goods. This to a large extent reflects the limited presence of the UK in certain fast growing markets and the mismatch of the UK’s goods portfolio to global demand. The decline in manufacturing over the last two decades appears to have limited the ability of the UK to move either quickly – the UK’s agility – or at scale, to meet the needs of the fast growing BRICs for industrial goods for example.

One stand out difference between services and goods is the stronger domestic position of UK based services companies. The UK has a thriving services sector and UK companies are strongly represented in the domestic market with a lower import share of final output than for goods. This provides companies with more direct control over their operations, pricing and supply chain and appear to lead to stronger market performance.

Offshoring may have delivered short-term benefits but created long-term challenges

EY research shows that the UK has offshored a greater share of its manufacturing capability than the USA, Germany and France since 1995 and there appears to be a correlation between the increased use of offshoring and the decline in the UK’s balance of trade in goods exports over the last two decades. UK manufacturers today import around 60% of the final value of their products compared to US manufacturers who import around half this proportion.

In a survey of UK manufacturers, we found that UK manufacturers have tended to contract out their manufacturing rather than either build or buy facilities in other countries. This appears different to the approach taken by Germany. Between 2010 and 2014 for example, German companies invested in 409 projects a year on average in Europe outside of Germany, compared to 256 projects from the UK.

Even more striking is the difference in project types. German companies undertook on average 165 manufacturing and 54 logistics projects a year compared to 29 and 10 respectively from the UK. German companies do appear to have taken a different approach to offshoring than their UK counterparts and this has allowed them to retain more control – greater agility – over their extended value chain.

Offshoring can offer immediate cost benefits and provides proximity to customers but as pursued by UK business to date, it might:

  • Reduce control over both quality and costs, we noted earlier that any benefits of competitive exchange rate movements are dampened by changes in import costs:
  • Potentially help support the establishment of foreign competitors that are able to gain scale and knowledge from contract manufacturing;
  • Limit the scope for process and product innovation by weakening collaboration opportunities across the value chain. Several US manufacturers have flagged this as a major issue to us.

FDI or ODI?

The UK’s FDI performance is seen as a success story with the UK leading in Europe year on year for the number of projects attracted. However over half of the UK’s FDI projects are accounted for by sales and marketing establishments by international companies. It is true that this brings activity into the UK but it is also possible that these organisations will be seeking to substitute UK supply and could therefore weaken the UK’s domestic base. Germany has a similar profile of inbound FDI but as discussed above, appears to balance this more with more strategic Overseas Direct Investment (ODI).

While it seems right to celebrate the UK’s FDI success, such as attracting more manufacturing FDI projects than Germany in 2014, the overall impact is less clear. It would seem sensible to undertake a more thorough analysis of the costs and benefits of FDI. It is also worth be worth understanding if a different approach to ODI is one of the factors creating the apparent greater agility that German goods exporters appear to enjoy in terms of their ability to switch market focus.

Should the UK have an integrated trade target?

The relative performance of UK goods and services exports highlights the issue of the balance between domestic and external capability. Initiatives to improve UK performance generally focus on one aspect be it Exports, FDI or Reshoring. The potential benefit of a more integrated approach to the various elements of trade would appear to be a priority area for further discussion. It is possible for example that an export target may not be the most appropriate way to drive trade success and a broader target incorporating a aggregation of FDI, ODI and Exports is more useful.


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