Dr. Neil Blake, Chief Economist and Director Business Strategies Limited
The Changing Make Up of the UK Economy

Introduction

This paper looks at structural change in the UK economy with special reference to what has happened over the past twenty-years or so. This is done in terms of both the sectoral composition of GDP and the implications for the location of economic activity. From a property perspective, it is argued that, the spatial dimension of economic activity is at least as important as the sectoral aspects.

It is argued that, although the relentless drift from manufacturing to services has continued, more has happened spatially than a shift of activity from north to south and a general urban-rural drift. Although the hot spots of prosperity remained firmly anchored in the south, new technology has helped to arrest the decline of the northern regions and it is now possible that the urban-rural drift is, for the time being, a thing of the past.

The focus of the paper is entirely on the UK but the conclusions that are drawn could be applied to other developed countries, which have experienced industrialisation, de-industrialisation and the emergence of a new service-orientated economy.

1. The Sectoral Breakdown on Output & Employment

The are well known trends in the sectoral composition of GVA ¹ in the UK. These date back to the early post-war years and have been described by the name de-industrialisation. Basically, there has been a gradual fall in the proportion of the economy, both output and employment, accounted for by the producers of goods, such as manufacturing and mining, and an offsetting increase in the share taken by service industries. This has, so far, not been a process of one off adjustment but one of more-or-less continuous change. This is glaringly obvious in Figure 1 which shows the shares of GVA taken by manufacturing and by financial and business services since 1970. The rate of change in GVA shares over the last ten years has been similar to that in the previous twenty years.

The increase in the share of financial and business services in GVA is the most spectacular but there has also been a sustained increase in the share taken by distribution, hotels and catering, particularly since 1980. Surprisingly, perhaps, there has been no sustained increase in the current price share taken by transport and communications over the past thirty years as falls in relative prices have countered an increase in the volume share. Table 1 summarises the changing make up of the economy since 1981 by broad industry group.

Changes in the distribution and nature of employment go even further than the sectoral shifts illustrated in Table 1. Not only has there been a general drift from manufacturing to services but for all industries, including manufacturing, there has been a general drift from manual to non-manual work. The are now far fewer shop floor type jobs and more managers and administrators, professionals and associates and people with jobs in selling and personal services.

^* share of GVA plus the adjustment for financial services.
Note that the 1981 share of mining and quarrying in affected by high oil prices and high levels of oil production.
Source: ONS (National Accounts, Annual Employment Survey, Labour Force Survey), Business Strategies.

The three most important potential explanations of the changes in industry mix are:

• changes in the pattern of final demand,
• changes in the pattern purchases made by industry and
• changes in international competitiveness.

Starting with changes in the pattern of final demand, a major trend since the mid-seventies has been a sustained increase in the share of expenditure contributed by consumers. This reflects a mixture of rising real incomes and increase in wealth as well as major changes to the financial system which has tended to make credit much easier to obtain. The ongoing growth in consumer spending has included spending on a large amount of manufactures although their share in the total has tended to fall as their relative price has fallen. This has left a considerable amount of spending power to go into a number of growth areas - leisure services, hotels and catering and monetary services. The latter is made up of changes paid to banks, commissions paid to financial services salesmen and increasingly by fees paid to manage the every increasing amounts of savings in life assurance and pension funds.

The increased importance of consumer spending to the economy explains the increased share of distribution, hotels and catering in GVA but only goes part of the way to explaining the rapid growth of financial and business services. Part of it does reflect the increased spending on monetary services but, as Figure 2 shows, consumer spending only accounts for just over a quarter of total spending in financial and business services:

Just over a quarter of total spending on financial and business services comes from consumers. Over sixty per cent is purchases from industry. The general growth in industry alone cannot explain the big increase in financial and business' share so what we are looking at is a combination of a sustained increase in the share of industries total sales which are bought in and/or a sustained increase in the share of bought in goods and services which are supplied by financial and business services. In other words what we are observing is the growth in contracting out.

To say that this is just a change in the way that industry organises itself, however, would inadequate. It is not just what companies buy in a lot more business services (it is business rather than financial services which are important here) that were previously supplied in-house, though this has undoubtedly happened, but also that the nature of what they require has been changing and new products and services are increasingly specialised and are much more likely to be bought in. The obvious examples of the latter are telecommunications services and computer services, as well as marketing, accounting and legal services. The growth in industry's demand for these services represents more than just a fashion for contracting out new services. It reflects the impact of new technology and the pressure for manufacturing, and other industry, to become higher "value added" in response to foreign competition. New technology means less direct labour inputs and a greater need for outside specialist help. More contracting out means a greater demand for legal services to look after the contractual relationships and the growth of new markets means a bigger demand for marketing and advertising.

Changes in international competitiveness also have implications for the sectoral distribution of industry. UK manufacturing industry has struggled against the growth of foreign competition for well over a hundred years but this has surged in the post-war years with the recent manifestations being the growth of the Asian tigers and, more recently still, the emergence of China as a major manufacturing base. These developments have exposed the fact that countries like the UK are at a major competitive disadvantage particularly, but not solely, in bulk or commoditised manufactures. This has led to the demise of many UK industries and limited the growth of others and such weakness of manufacturing alone would explain the growing share of services in the economy. However, manufacturing's share has not been falling in a stagnant economy. The weakness of manufacturing has more than been offset by growth elsewhere so it must be more that a simple question of the UK being unable to compete against foreign competition.

Part of the answer is that manufacturing is still able to compete. Foreign competition has led to a specialisation in higher value areas where countries like the UK still have a comparative advantage and that the economy is becoming more open. A significantly higher share of the sales of manufacturing industry were exports in 1997 compared with 1992 (although recent problems associated with the strength of sterling may have halted this trend). Note also that the other broad sector to have experienced a significant increase in the share of sales accounted for by exports is financial and business services which has been the most rapidly growing part of the economy. Lack of data make it difficult to take these comparisons back much further but if we go back to 1990, less than four per cent of the sales of financial and business services were exported. Financial and business services are clearly not only growing much more quickly than other industries but their international openness/exposure is increasing more rapidly than any other sector except manufacturing.

Table 2 also gives a broad geographical breakdown of the destination of exports. Interestingly, while exports as a whole have become less focused on the EU, there has been a small increase in the proportion of exports of financial and business services going to the EU although, as with most exports of services, the EU remains a minority market.

We can some up the broad trends in the macro economy as follows. Changes in tastes, technology and international competitiveness have led to:

• A bigger share of expenditure taken up by consumers, by exports and by spending by industry on bought in goods and services.

• More spending on services and less on goods.

• An occupation drift away from manual, shop floor, type work to management and administration, professionals and associates and selling and personal services.

Two implications of this for property, the first obvious, the second less so, are:

1. Less demand for industrial space (though not necessarily for warehousing space) and more demand for retail and office space.

2. An increased demand for commercial property where there are clusters of exporting service industries.

2. The Location of Industry

Point "a" above makes the obvious point that as the composition of British industry has changed so have its property needs. Less manufacturing means less demand for industrial property. More office jobs and more retailing means more offices and more retail space. Point "b" touches on a new area, that for property it is not just the volume of output and employment that matter but where it is. The relocation of industry from one part of the country to another has much greater property implications than if it merely stays in the same place. Having considered changes in the sectoral and occupational composition of the economy, It is to this question of changes in the spatial shares of output and employment that we now turn.

A simple analysis of the changing sectoral composition of the economy, together with some other ideas -- particularly the urban-rural drift theory -- would suggest that the inevitable consequences have been the decline of the big, usually northern, industrial centres and the expansion of the, usually southern, service centres.

This analysis, though simple, does ring true. If we accept it at face value, however, we will miss much that has changed in the UK over the past ten-to-fifteen years. In particular we need to think about how regional comparative advantage can change, what place new technology has to play in this and the way that urban-rural drift fits in with everything else.² To try and pick out the less obvious spatial characteristics of recent economic change we would like to take the liberty of trying run through a brief and heavily stylised economic and geographical history of the UK -- and all of that in just two sides of A4!

i). Industrialisation - new technology leads to the long-term expansion of manufacturing industry. Manufacturing industry tends to cluster in cities or in extended urban areas (conurbations). For a variety of reasons, often to do with the proximity of raw materials, these centres of manufacturing tend to be in what we can loosely describe as the "north" (which to be more precise includes not just the north of England but also much of the midlands, Wales and Scotland. Some cities such as Liverpool, grow as centres of trade and commerce as much as manufacturing. London expands massively as a centre of manufacturing, trade and commerce.

After a while, cities expanded through considerable public as well as private investment. The prospect of continued population and economic growth meant that local authorities could borrow for capital investment knowing that the there would be a wider tax base in future to pay for it.

ii). New Industries, New Locations - Britain's manufacturing economy was never free from the extremities of the economic cycle but the inter-war years, 1919-1938, saw a much more severe jolt to the system. The loss of major markets for staple products and the dislocation of the international financial system produced severe decline in some industries and in some localities. At the same time, there was a wave of growth in new industries such as motor vehicles, aerospace and consumer electronics. Unlike the old staples such as coal, textiles, metals and shipbuilding, the new industries were much more evenly spread across the country with many actually preferring the south and parts of the midlands to the old northern conurbations. This was in part due to an early manifestation of the urban-rural drift and in part a desire to be close to the expanding consumer markets. The growth of the new industries and decline of the old in the inter-war years was the first manifestation of the north-south divide in the UK.

iii). De-industrialisation - Although the growth of new industries and the recovery of the international economy after 1945 led to a new period of expansion for British manufacturing the fastest growing industries were already in the service sector. Once the dislocations of the immediate post-1945 era were over higher incomes meant an expansion in retailing, leisure services and monetary services. Within manufacturing, the old staples remained in difficulty and the newer, often consumer orientated; industries were the fastest growing. This, roughly 1950-1975, was the classic period of the urban-rural drift with most of the undesirable urban locations in the "north" and most of the desirable rural locations in the "south". Service industries expanded across the country but the "south" had a comparative advantage in tradeable services such as finance and business services which were not dependent on the region's manufacturing export base. London presented a mixed picture. As a large urban manufacturing centre it displayed urban-rural type losses on a large scale. It also began to suffer the run down of London as a port but at the same time many of the newer industries were present in London and it was by far the countries largest tradeable services centre.

iv. Collapse & Boom - The long-term problems of the northern industrial cities came to a head in the early seventies. A series of events, chief of which was the first oil shock, killed off much of what was left of the old staple industries and did considerable damage to some of the newer industries as well. With the loss of their industrial export base the economic rationale for many cities as major population centres really ceased to exist. Not only did manufacturing decline but also there was a loss of population and a decline in local services, which depended on the prosperity once, provided by manufacturing. To some extent only inertia and the social security system prevented an even bigger outflow of population and an even more severe collapse.

At the same time as many northern areas were in major decline the drift to services was continuing apace and the "south" was benefiting disproportionately. This was particularly so from the mid-eighties when financial liberalisation gave a new spur to the growth of financial services. So great, in fact, were the financial services boom that it temporarily halted the long-term decline of employment in London. The big beneficiaries, however, were in the rest of the SouthEast and parts of East Anglia and the SouthWest.

This expansion of the north-south divide produced big property market implications. There were booms in residential and commercial property prices in the "south" as supply struggled to keep up with demand. This produced both a construction boom and severe macro-economic consequences in the shape of a spill over of the asset price boom into the rest of the economy and the eventual severe tightening of monetary policy.

v. Recession in the South - At the end of the previous era "Collapse & Boom", which was around the late eighties, the regional development of the UK had followed a path which was close to that which our initial simple analysis had suggested. That is the decline, sometimes relative, sometimes absolute, of the manufacturing dominated "north" and the expansion of the service orientated south" and within that the continued decline of cities and the expansion of smaller towns. Around then, however, the course of events began to change in an interesting way.

The eighties boom had created severe cost pressures in the "south", particularly for property but also for labour so some correction was to be expected. The eighties also saw the increased availability of, and investment in, information technology and the use of telecommunications, much of it associated with the financial services boom. As tends to happen, when times are good there is plenty of money around for investment but less incentive to make that investment pay. When the going gets tough, however, there is pressure to make that investment pay. This is broadly what happened between the late eighties and early nineties. In an attempt to cut costs and restore profitability during the early nineties recession there was a radical change, particularly in retail banking and in insurance.

Instead of being tied to traditional locations, largely in the south of the country, new technology and ways of working meant that tradeable services were now much more footloose. The most obvious manifestation of these changes was the growth of call centres which allowed financial services providers to deal directly with customers. There were also changes further down the financial services production process even where high street branches were retained with banks setting up large, data processing centres, usually in the "north", which replaced back office jobs in the high cost "south". An illustration of the extent of these changes is clearly given in Figure 3 which shows the share of financial services jobs location in Scotland and Yorkshire:

Having been on a long-term downwards trend, the share of financial services employment in both Scotland and Yorkshire and the Humber started to increase around about 1989 and by the beginning of 1999, together they accounted for some 17 per cent of the UK total up from around 12 per cent in 1989.

The deepness of the recession in the "south" was added to by other factors such as the depressed state of local demand following the collapse of the house price bubble and the loss of many of the south's manufacturing jobs in the "new industries" (see Section 2 above) which by now were as susceptible to foreign competition as the older industries of the "north" had been. The growth areas for manufacturing jobs now appeared to be in places such as the North East, Wales and Scotland which were hefty beneficiaries of foreign direct investment.

vi. The New Order? - The apparent end of the comparative advantage in the south associated with the growth of call centre technology specifically and information technology generally could have spelt the end of regional imbalance in the UK. Indeed, there has been a substantial narrowing of unemployment differentials. The prosperity gap has, however, patently failed to disappear. What has happened is that the "south" has capitalised on other areas of comparative advantage?

New technology may have made possible the flow of financial services, and other, jobs from "south" to "north" but it has also created new markets particularly in business services. The "south" always had a comparative advantage in tradeable business services but new technology means that business services can reach more distant markets. For example, call centre jobs may have gone "north" but a disproportionate number of jobs involved in writing and maintaining the software have stayed in the "south". The same goes for the support for the new automated manufacturing plants of the "north". Nor are new jobs in the "south" all computer services related. Business services such as accountancy, legal services, marketing and consultancy are more able to service non-local markets.

This is one of the reasons for the boom in business services employment. Which as Figure 6 shows, has been a major feature of the UK economy for some time. Figure 4 shows regions such as Scotland and Yorkshire have not fared as well with business services employment as they have with financial services employment (c.f. Figure 3) Figure 4 shows that London has also lost share, though there has been something of a bounce back since 1993. The important thing about London is that is still has a very large share (nearly a quarter) of jobs in the most rapidly growing sector. Other areas in the "south" have also done well in the rapidly growing areas of business services.

On top of this, the fastest growing of tradeable services are still international services (as they have the biggest potential market). London continues to dominate internationally traded services in the UK. The upshot is that in the New Regional Economic Order the decline of the "north" has stabilized with the creation of new service industry jobs and some new jobs in manufacturing. This has not, however, meant a loss of jobs in the "south" (although arguably it may be associated with a weakening of job security in the "south"). The "south" has become even more dominant in the faster growing business services and has managed to grow its share of economic activity and of the better paying jobs.

One paradoxical feature of business services growth is that, as new technology has increasingly relaxed geographical constraints on location, the more the industry has tended to cluster -- the cluster in London and parts of the south of England being the obvious example. In addition, cities are also re-inventing themselves as retailing and leisure centres after many years when the drift was to out of town locations. It may be too early to say that the urban-rural drift has ended but, London aside, there have been signs of a stabilization of employment in some major cities and even expansion in some (of which Leeds and Cardiff are probably the best examples). In the case of London, it is clearly the economic hotspot of the moment and although it is bound to suffer cyclical fluctuations in the future, the long running secular decline of London as a place of employment looks to have come to an end.

vii. Future Risks - The danger to the new, call centre based service industries of the "north" is that the new technology that made them could easily become its undoing. If new technology could make these services footloose within the UK then could it make them internationally mobile? Equally is the next step from call centres a fully automated service possibly based on Internet or digital TV technology? Such developments are probably less of a risk to the "south" which is already concentrated on higher value added sectors, but it is a definite risk to the "north". No doubt call centres still have many years of life in them yet but their prospects are probably limited. If the revival of the northern urban economies is to continue there will eventually have to be attempts at diversification away from call centre and service industry processing jobs into business services and further concentration on cities as retail, cultural and leisure centres.

3. Conclusions

The UK economy has undergone ongoing major structural change. This has manifested itself not only in big changes in the sectoral make up of the economy but also in big changes in the location of industry. At the UK level, the big change is the drift from manufacturing to services. At the regional level it is more complex that a simple shift of activity from manufacturing intensive areas to service intensive areas. New technology has permitted some service industries, financial services being the best example, to become much more geographically diverse than was previously the case. At the same time the continued growth of other service industries has more than plugged the gap in the south of the country.

Underlying this has been a hint of change in the relationship between urban and rural areas. The urban-rural drift, which had long characterised the UK economy, is showing signs of leveling off. Many of the faster growing service industries have a tendency to cluster in urban areas and some big cities have even seen robust growth (and not just London). In this context, government policy of trying to concentrate development in brownfield sites might not be as difficult as might be imagined.

As far as property markets go, the message on the one hand is that cities are back and on the other that supply constraints in places like London and the SouthEast are likely to continue to cause periodic shortages and period of rapid property value inflation.

Neil Blake
September 1999

² The urban-rural drift theory is the idea that changing technology, and other factors, makes rural locations more attractive to industry than the old urban areas. Strictly speaking, the theory only ever applied to manufacturing but it has come to be used as a general theory for spatial differences in economic development in the UK.