Services, not industry, to drive UK rebalancing act

A barman pulls a pint of beer at a public house in Leeds, northern England October 13, 2008.

LONDON (Reuters) - Britain is finding its way to a new and better-balanced version of its economy, but it will still be services that lead the way and not the revival of manufacturing promised by politicians.

Three decades after fellow Conservative Margaret Thatcher dealt a series of death blows to heavy industry and refocused the economy on booming property and services sectors, Chancellor George Osborne has put manufacturing at the centre of his policies.

In his 2011 budget he talked of the need to rebalance the economy away from unsustainable public and private debt and said he wanted "a Britain carried aloft by the march of the makers".

On reducing debt, some progress has been made. The government is inching closer to its deficit reduction targets, and households and companies are cutting their debt.

Likewise, some manufacturers have defied the economic gloom with bumper profits and expect further growth.

"For several years beyond 2012 we see 8 to 10 percent of revenue growth in aerospace," the chief executive of industrials group GKN (GKN.L), Kevin Smith, said last month. Profits at companies like Rolls-Royce Holdings Plc (RR.L), the world's second-largest maker of aircraft engines, are also rising.

But while analysts expect a small revival in manufacturing over the next few years, they say it is unlikely to become a major driver of long-term growth.

"The rebalancing process away from financial and consumer services and towards industry is unlikely to persist indefinitely," consultancy Capital Economics wrote in its latest quarterly review. "In the longer run, manufacturing is likely to continue its structural decline in response to competition from abroad."

NOT JUST BANKING

Manufacturing, excluding energy, accounts for almost 13 percent of Britain's GDP, while the finance and business services sector makes up 31 percent. The latter -- dominated by business-to-business services ranging from accounting and IT to media and advertising -- is by far the largest single contributor to national output.

The picture is broadly similar in France, but both look enviously at Germany, whose high-end industrial output accounts for around a fifth of GDP. All three have seen their role in global production steadily decline in the face of cheaper factories in Asia and other developing economies.

It is Rolls Royce's brand of sophisticated manufacturing, and new businesses in life sciences and green energy, that Osborne and others want to boost.

"There's no reason why we can't be a centre for strategic technology development to service the global economy," George Freeman, who had a 15-year career in technology venture capital before becoming a member of parliament last year, told Reuters.

As demand at home and abroad slumped, however, manufacturing shrank in July for the first time in two years and contracted further in August, the latest survey of sector purchasing managers showed this week.

The sector's prospects will brighten when the global economy improves, and analysts say the full benefits of the weaker pound are yet to come through.

But other obstacles remain.

A year ago a leading business lobby CBI asked 121 executives at big British and overseas companies operating in Britain how attractive the country was as a place to invest.

Manufacturers' rating of Britain was much lower than the marks it received from those working in services, and lower than the overall rating by all executives.

All respondents said Britain's attractiveness relative to other countries had declined over the last decade, with taxation, regulation and access to loans and grants cited as the biggest deterrents.

WHY BOTHER?

The government has announced a host of reforms in an attempt to assuage such concerns, including cuts to corporation tax to make it the lowest in the G7 by 2014, and to promote advanced manufacturing.

But Nomura economist Philip Rush echoes many analysts in saying overall manufacturing can at most raise its share of GDP by several percentage points.

Making more goods, which can be easily traded, would help boost exports -- another of Osborne's ambitions.

But many economists are simply sceptical that Britain even needs to wean itself off its reliance on the huge services sector, where it has competitive advantages ranging from the English language's dominance to the City of London's historical base as a centre for law, accounting and finance.

Philip Booth of the Institute of Economic Affairs, a free-market think-tank, wrote in a blog last month: "In a world of free trade, countries specialise in what they are best at and trade with other countries -- they do not need to be diverse."

The ultimate goal should be to encourage sustainable growth in all sectors, rather than seek to rebalance the economy by radically changing the contributions of different components.

"We do not believe that it's a zero-sum game," said Adam Marshall, policy director at the British Chambers of Commerce, a business lobby.

"We do not need to shrink one sector of our economy in order to grow another. We need to grow both."

(Reporting by Olesya Dmitracova; editing by Patrick Graham)