Manufacturing hit by perfect storm of supply shocks and potential global recession

Manufacturing accounts for around 16% of global GDP, although its contribution varies considerably around the world. In 2020, for example, while manufacturing represented around 19% of GDP in North America, it contributed over a third of economic activity in East Asia, according to Statista.

As economies mature, economic activity naturally tends to shift away from manufacturing and into higher-added-value activities in the service sector. The process of globalisation over the past 40 years has accelerated this trend, with companies in advanced economies shifting output to lower-cost bases in China and other emerging economies.

The pandemic had a significant adverse impact on manufacturing output. The economic lockdowns put in place to contain the spread of the COVID-19 virus curbed both demand for manufactured goods and manufacturers’ ability to produce them. In the UK, for example, the total value of manufacturers’ product sales fell by an unprecedented 10.8% to £358.7 billion in 2020, from £402.2 billion in 2019, with sales declining in nearly all manufacturing divisions, according to the Office for National Statistics. The manufacture of pharmaceuticals was one of the exceptions.

The pandemic exposed the dangers of relying on far-flung global supply lines and has caused many companies to reconsider their manufacturing strategies. However, this process had already begun prior to the outbreak of COVID-19, due to growing trade tensions between the US and China and the imposition of sanctions on China by the Trump administration. Increasing labour costs in China also prompted businesses to consider reshoring their output or moving production to other regions. The head of Asia’s largest pharmaceutical company – Takeda of Japan – said in June 2022, for example, that the era of globalisation based on outsourcing functions to cut costs was over. Russia’s invasion of Ukraine in February 2022 further exposed the fragility of global supply chains.

However, some regions continue to benefit from outsourcing. Southeast Asia has been a major beneficiary, with western and Chinese companies shifting output from China to nearby countries such as Vietnam, which benefits from a relatively cheap, abundant and hard-working labour force.

In the UK, the impact of the pandemic has complicated the analysis of the effects of Brexit on production. Supply chains have been rationalised to avoid the multiple criss-crossing of manufacturing components across the English Channel. Companies such as car makers have switched to local subcontractors. However, many manufacturers have reported facing added bureaucracy and paperwork when exporting to the UK. Manufacturers are also awaiting clarity on Brexit import controls. Originally due to be implemented in mid-2022, these controls have now been pushed back to the end of 2023.

UK manufacturing has largely recovered from the pandemic-related slump, but its long-term decline as a proportion of GDP is expected to continue. In 2021, manufacturing accounted for 9.7% of total economic output and 7.3% of jobs in the UK, according to a research briefing by the House of Commons library. In 1970, it contributed around 30% of GDP. The decline in manufacturing’s importance has been much greater in the UK than other advanced economies. In Germany, manufacturing accounts for the equivalent of 23% of GDP, while in France it is 11%, the USA 12% and in Italy 17%.

After recovering strongly as economies – and demand – opened up following the easing of pandemic-related restrictions, manufacturing output in the UK and other parts of the world has gone into reverse in the first half of 2022, with fears that worse is to follow. Sharply higher inflation – the result of supply-and-demand imbalances caused by the pandemic, as well as disruption to the supply of key commodities following Russia’s invasion of Ukraine – is squeezing consumers’ incomes and raising investment costs for businesses. In addition, central banks around the world are tightening monetary policy – a trend that is expected to continue over the rest of the year.

Higher borrowing costs are hitting consumers and businesses alike. In June, Goldman Sachs projected a 30% probability of the US entering a recession over the next year, up from 15% previously. Over the next two years, the investment bank puts the odds at 48%, up from 35% previously. It added that, if there were to be a recession, it would “most likely be shallow”. Given that the US remains the world’s largest economy, a slowdown in the US would inevitably affect global growth and the prospects for UK manufacturers.