Input costs have risen
At the same time as weakened demand both domestically and globally, input costs have risen rapidly over the past few years, driven by emerging markets’ growing economies and appetites for commodities. The principal costs are fuel, raw materials and wages. The long 2000s boom in commodity prices culminated in the 2008 bubble, when China injected a massive stimulus into its own heavily manufacturing-based economy to offset the drop in demand caused by the financial crisis. This was the main driver of increases in the prices of many key manufacturing inputs. Prices for manufacturers in general saw a price rise of 4% in 2008 – however, it was mostly towards the beginning of the year – July’s year-on-year rise in costs was 9%. This inflation is likely to have contributed to the spike in formal defaults for manufacturing, given that it came at the same time as a deep fall in demand. Producer price indices only measure material inputs and thereby exclude the effect of the level of wages in the sector; during much of 2008 overall wage growth hovered around 3–4%.
As manufacturers of fabricated metals and of paper have experienced more formal defaults than other manufacturing subsectors, examining them is instructive in order to understand the stresses on manufacturers. These two industries saw inflation far higher than that for manufacturers in general during 2008. Inputs for publishers rose at around 8% and those for metal manufacturers hit 14% over the year, compared to just 4% for manufacturers in general. A second wave of price rises occurred in 2010, taking producer price inflation back to 9% and 10% for publishers and metal manufacturers respectively. In 2010, formal defaults remained elevated in both industries. Over the period 2005–2013 as a whole, fabricated metal manufacturers experienced a 40% rise in costs while demand was virtually stagnant. The higher rate of formal defaults reflects that trend.
Over the short to medium term, the global economy is likely to see a period of stagnant or falling costs. In fact, this has already begun: the latest producer price index showed that prices fell 7.4% over the year to September. This will alleviate pressure on margins. Combined with rising demand, it will ensure trading conditions improve for UK manufacturers.
Definition: A formal default is defined as a company entering into administration, receivership, company voluntary appointment or liquidation.