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26 January 2019

Tragedy and Challenge

Tag(s): Politics & Economics, Business, People
In my blog This Year’s Reading List (2) which I published earlier this month[i] I recommended Tragedy and Challenge: An Inside View of UK Engineering’s Decline and the Challenge of the Brexit Economy by Tom Brown. I said I would return to it with a separate blog of its own and rated it as my Business Book of the Year. The distinguished Evening Standard Business columnist Anthony Hilton wrote “It ought to be the business book of the year. It will not be though, because it does not take any prisoners.” Indeed it does not as in a searing analysis of the tragic decline of British engineering Mr Brown does not only criticise the usual suspects of management and the unions, but places far more blame on British politicians, City fund managers and private equity investors.

Tom has worked in UK manufacturing for over 40 years plus invaluable stints in the US, Germany and Italy.  He has chaired 15 companies including stock market quoted, private equity backed and university spinoffs. He offers an incisive insight into the challenges facing engineering companies, as well as the impact this has on the economy, people’s working lives, and society in general.

His far flung experience has not only given him a very direct understanding of what befell UK engineering, but also an insider’s knowledge of what it is really like to deal with the City, fund managers, private equity investors, and modern governance and remuneration policies. He has also learnt about the realities behind our lack of exports and the very serious problem of short-termism, where his personal experiences bring these issues to life in a way politicians and academics miss.

No one in business can write the truth about dealing with the City while they are still working and hope to avoid reprisal, and when they retire most people prefer a quiet life, but it is obvious that Mr Brown has an urge to set out his beliefs and has not modified them to be politically acceptable like so many of the worthy but boring and in the end useless reports that have been produced.

The book is actually set out as five books. The first covers the formative experiences of Tom Brown’s working life and this is useful as it provides a platform of credibility that this is an exceptional individual with a vast knowledge of what he is talking about and we should listen to what he has to say. In book 2 he describes and explains the causes of the decline of UK engineering, covering government policy and macro-economics, the 'City', inappropriate corporate strategies and values, the impact of ownership, engineering leadership, industrial relations, outsourcing and globalisation, changing social attitudes, and historic context and momentum. Book 3 covers the consequences of decline in macro-economics, working life and society at large. Book 4 shows that in spite of all this there have been survivors and winners and here Tom explains their success strategies, contrasting those that are quoted and those that have remained private with a strong preference for the latter. Finally in book 5 Tom makes a comprehensive series of recommendations and conclusions. He covers what he calls Brexit necessities and other engineering related recommendations; changes required from politicians and regulators; reforming taxation; refocusing education; and making the changes effective.

But before these five books his introduction presents in largely graphic form a penetrating analysis of the decline of British engineering, as compared to the US and Germany.  He starts with a simple anecdote.
 “How often have I been told by some City type that the decline in UK ‘metal bashing’ was inevitable?
‘What do you expect?’ he asks.’ Of course it’s all gone to China.’
I ask him what car he drives.
The latest Mercedes or BMW he proudly confides, the coupé, the top of the range.
‘That’s a nice bit of bashed metal,’ I reply. ‘Surprising it’s not Chinese.’ “

Tom graduated from New College, Oxford the year before I did. He read Physics combined with Politics, Philosophy and Economics, an unusual combination but perhaps an indicator of the type of man he has become, that is an engineer who also understands the big picture. In his final year he decided as I did to take up a business career, which to him unquestionably meant in manufacturing industry.

Unlike today, many able graduates went into manufacturing then; GKN alone recruited eighty each year in the UK and it was with GKN that Tom started in 1970. His early experiences included a trip to the US, quite unusual then, and an MBA at IMD in Lausanne, where I also studied when I was with Sony. He learnt German in 4 weeks in order to run an engineering company in South Tyrol – which was a life-changing experience, teaching him how engineering companies should be run, in contrast with his observations of some of the British subsidiaries. This showed him why the Germans are so successful in this field. Then after a spell consulting with McKinsey he became CEO of a stock market quoted engineering group, at the age of 38, perhaps the youngest CEO of a quoted company at that time.

In due course he was a main board director of 22 independent companies, three as CEO and 15 as Chairman ranging from seven quoted on the London stock markets, through Private Equity investments, a Venture Capital Trust, a QUANGO, and family ownership to spin-offs from Cambridge University’s Cavendish Laboratory. He retired in 2015, wrote this book in 2016, rewrote large parts of it because of the referendum result in 2016 and brought it out in 2017.

The author concludes that, while some decline was inevitable due to global factors, the example of Germany shows that it did not need to be so precipitate; some responsibility lies with management and unions, but ultimately poor governments, the City, and decaying social attitudes were to blame.

Let me briefly focus on these last three factors and then I’ll conclude by summarising Tom’s recommendations for change.

Poor governments: Tom has a low opinion of our general political leadership who have presided over eight manufacturing crashes in his 45 years in business. Manufacturing includes food and drink which are more resilient in a recession while sales of cars and computers fall. So each new crash brings cutbacks as the only way businesses can survive. In the end most of them don’t. Debt has spiralled out of control but most of this debt is for housing or consumption. Less than a quarter of bank lending is for investment. The Bank of England no longer controls the money supply, it directly controls just the notes and coins in circulation (about 3% of the total), and only has indirect control over fractional reserve banking through setting base interest rates and determining reserve requirements. These are far less than they need to be to avoid another banking crisis and the next is inevitable.

The City: When Tom talks about the City he is not talking about the Civic City which I love but the Commercial City which has been allowed to gain far too big a share of the economy. Big Bang was designed to modernise what was seen to be an out-of-date Old Boys Club characterised by long liquid lunches. But the changes went too far allowing a level of deregulation that encouraged US based banks to come over and take over British merchant banks and stock brokers. Eventually all these discreet operations merged into huge institutions whose balance sheets, most of which consist of debt, dwarf the economy. “Fraud and malpractice are widely spread, with a very cavalier attitude to the law” writes Tom, citing the recent LIBOR case as an example.

The culture of paying huge bonuses for short term achievements leads to a very shaky structure. These bonuses are not justified in the long term as these crashes demonstrate. Banking is simply not as profitable in the longer term as is pretended. But when the crash comes the banks are seen to be too big to fail and the taxpayer bails them out.

The City’s effect on UK engineering has been particularly malign, according to Tom. When Big Bang occurred UK engineering was already in bad shape and needed patient investment to build up long term markets. Instead the City saw this as an opportunity for lots of Mergers and Acquisitions with high fees for themselves. Most of these failed and still fail to deliver long term shareholder value and the process is more destructive than constructive.

Social attitudes:  According to Tom changing attitudes in UK society have also contributed to the decline of engineering. “The Western world has experienced an unprecedented increase in wealth in my lifetime. Driven not by financial services but by engineering – particularly by the microprocessor, the most important invention since the internal combustion engine, following electricity, and before that the steam engine. The microprocessor has transformed productivity, quality, and efficiency in just about every product and service, as well as creating many completely new ones, and most of the enormous increases in wealth are ultimately attributable to it (it certainly isn’t banking). Despite this most people now in the UK are not enthusiastic engineers but have become addicted to consumerism and property, both fuelled by debt, and favour soft study courses hopefully leading to ‘cool’ jobs. Consequently there is now a sad and serious lack of interest in engineering, and hence also of the skills and attitudes to support it. And although very intangible, these attitudes are very important.”

I have quoted this at length as I think this is one of the most important points in the book. He is showing that the decline of UK engineering in a country that started the first industrial revolution with people like Arkwright and Watt and contributed strongly through people like Faraday, Thomson and Turing to the other great innovations that Tom referred to, has affected us all badly and to some extent came with help from us all.

Recommendations for change: in the final pages of the book Tom lays out all the changes he believes are necessary, not just those that are politically realistic because hje wants to emphasise the fundamental sea change that has to happen. I only have space here to summarise them without making all the argument:

Engineering Related Recommendations:
  • Support for short time working on the German Kurzarbeit model, and so mitigate the need for redundancies during recessions.
  • Expand the Technology Innovation Centres, known as ‘Catapults'. There are just seven in the UK compared with the sixty insitutes of the German Fraunhofer
  • Encourage import substitution, e.g. in automotive supply chain
  • Establish an engineering investment fund
  • Establish better dialogue between engineering firms and politicians
Changes required from politicians and City regulators
  • Implement recommendations of Kay Review (2012) e.g. improve professionalism of fund management by full disclosure of costs,and rebate of income from stock lending
  • Fund managers’ performance incentives to be long term
  • Detailed annual reports by fund managers covering fees & expenses, major disposals & purchases, personal investment in the fund and many more
  • Annual meetings of unit trusts as investment trusts do
  • Grass roots overhaul of fund management
  • Major trimnming of Combined Code of Corporate Governance
  • Two tier boards with appropriately selected employee representation on the supervisory board
  • Full investigation pf private equity affairs, particularly with a view to preventing abuse of treating debt as equity
  • Investigation of the accountancy profession by the Competition and Markets Authority
  • Get away from stop-go economics
  • Further controls of banks to prevent repetitive bad practices
  • End fractional reserve banking
  • Encourage more start–up banks, to increase genuine competition
  • Reintroduce the balance of payments as a key focus of economic policy
  • Establish long term energy policy with regards to cost and security of supply
  • Rebalance the economy between London and the rest of the country- key is recovery of manufacturing
  • Serious investment in infrastructure
Reforming taxation
  • International coordination of taxation and much tougher dealings with tax havens, including Ireland and Luxembourg
  • Reform National Insurance which is a tax on jobs
  • Tax fossil fuels to reduce dependence.
  • Raise capital allowances to a realistic rate, including buildings, then hold them steady.
  • UK should participate in the Financial Transaction Tax
  • Limit the tax deductibility of interest charges
  • Promote Venture Capital as opposed to PE
  • Thorough overhaul of Business property rates
  • Introduce ‘mansion tax’ but abolish stamp duty
  • Abolish capital gains tax, reintroduce indexation (including that of losses) so as not to tax inflation on long term investments and then tax net gains and losses with other forms of income
  • Thorough overhaul of tax system thought through from first principles; tax those things we want to discourage, incentivise those things we want to encourage
Refocusing education
  • Far higher investment in primary education. The return on this investment will be massive
  • At secondary schools encourage much more interest in engineering
  • Introduce prestigious engineering qualification at better universities equivalent to the German Doctor of Engineering
  • Encourage vocational training in place of ‘soft’ jobs which have no future
  • Encourage better teaching of foreign languages as a basis of conversation rather than as an academic exercise where spelling and punctuation mistakes get penailised
  • Phase out all private schools starting by removing these schools’ charitable status
  • Encourage better attitudes to study throughout the sysem
Overall: do not focus on SMEs, avoid tinkering, decide on a limited number of initiatives, do them well, keep them simple, avoid too many exclusions, and don’t keep changing them.

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