Jeremy Warner: Can Mandy fix it as UK manufacturers stare into the abyss?

Outlook: To the CBI manufacturers' dinner in Birmingham, where the unambiguous message from the industrialists of the West Midlands is that the Government must act urgently to prop up companies starved of credit and demand. Time is fast running out. Initiatives announced to date have either been slow to take effect, suffer from lack of definition or have stalled, and in any case are widely thought insufficient.

Much of my reporting and commentary over the past 15 years has been on finance, banking, the housing market and the creative industries. In the post-industrial society we seemed to have moved into, this was where the action was. With these industries in the doldrums, it is to manufacturing, until a year ago a backwater of the British economy, that everyone looks for salvation.

Is this realistic, or just wishful thinking? Few doubt that Britain needs a more balanced economy, with reduced dependence on consumption and a bigger role for business investment and trade. Nor is there any doubt about Britain's need for a massive programme of infrastructure renewal, particularly in energy but also transport, that might fuel such a revival.

There was no shortage in Birmingham of enthusiasm for green-collar jobs, electric cars, and the myriad of other business opportunities presented by the shift to a low carbon economy. Yet for the time being, the main event is not expansion, but survival. With the banks, the damage was self-inflicted. Manufacturers are innocent bystanders, yet they have become swept up by the maelstrom along with the banks and in many cases are suffering even more acutely.

I'd not fully grasped until talking to some of the business leaders at Thursday's dinner quite how dire the situation has become. Manufacturing and related service-based companies will go bust in their thousands over the next six months unless something is done. It may be that the policy initiatives so far announced will eventually work, but for many, time is fast running out. The problem is both credit and demand. If there is no demand, companies need more credit to tide them over, yet credit is the one commodity you just can't get.

The banks were rescued with taxpayers' money because they were thought too important to the economy to be allowed to fail. The catastrophic consequences for savings and credit provision of a major bank failure are all too obvious. But now we are seeing the same contagion that did for the banks moving into the real economy, threatening the existence not just of badly managed companies but of viable businesses which in their own way are just as much a part of the backbone of the economy as the banking system.

If such businesses are allowed to fail, the skills, processes, capital equipment and markets that sustained them will disappear for good. It's unlikely, given the scale of the collapse in demand, that many will be picked up from the receiver and given a new lease of life.

It is vital that Britain comes through the contraction with a decent amount of manufacturing capacity left intact to take advantage of the upturn. It's hard to see where the jobs of the future are going to come from if not in high value-added manufacturing and contracting. Financial services certainly won't be providing them for a long time to come.

Yet as things stand, the UK manufacturing sector is facing its biggest cull since the early 1980s, which knocked out swaths of British industry. The tragedy is that this time much of what is threatened is world class, or at least long-term viable.

One of the companies at the centre of this unfolding disaster story is Jaguar Land Rover (JLR). Some of its difficulties are specific to the company. The Indian conglomerate Tata seriously overpaid when it bought the company from Ford last year, and finds itself saddled with debts it is struggling to refinance. Yet others – an absence of demand, and of trade and purchase credit – are common to all manufacturers. If these companies are allowed to go bust, they will be gone for ever. Preserving the Tata connection is particularly important, since it potentially opens the gateway for British expertise to what will eventually be the world's biggest auto market: India.

The scale of the problem is illustrated by the following, fictitious, example as told by John Neill, chief executive of the car parts and logistics group Unipart. One of his biggest-selling automotive parts is fuel tanks. Each tank requires a valve to make it function. If the supplier of these valves goes bust for lack of credit, the whole supply chain grinds to a halt. The fuel tanks can't be made, nor can the cars for which they are intended. The insolvency of the valve supplier thus threatens the viability of at least two other companies further down the manufacturing chain, and possibly several of those up the chain too. As with the banks, everything is interlinked, threatening systemic failure.

All this may sound unduly alarmist, but I kid you not. Domino effects of this sort are all too possible given the scale of the inventory adjustment now afflicting global industry.

David Smith, chief executive of JLR, urges the Government to get on with it and implement the £2.3bn loan guarantee scheme promised for the automotive industry. Unless the infusion comes soon, it may be too late. But is it going to be enough, and what more can the Government offer while holding true to the principles of the single European market and the free trade agenda? All over the world, economic nationalism is again on the rise. Is there any more that Peter Mandelson, a former European trade commissioner and now Business Secretary, can reasonably do without dabbling in the very same protectionism he so frequently condemns?

At the CBI dinner, Lord Mandelson warned that the Government's pockets were not limitless, but one possibility is the sort of wage subsidy widely practised on the Continent. These schemes come in various shapes and sizes. The purpose, however, is to preserve skills and jobs by subsidising short-time working as an alternative to redundancy.

Is this not just a bung by another name, and therefore a form of protectionism? Not really, for the idea is in effect to put companies into cold storage so that they can begin anew once demand returns. Perhaps surprisingly, some British manufacturers are resistant to such subsidy, believing that once hooked on paying employees to do nothing, it could take years to get rid of the habit. There is also the issue of how to apply such subsidy so as not to support what are fundamentally "bad" companies which deserve to be put out of business by the downturn.

In Holland, only companies that can show they have suffered a genuine demand shock can apply, but it may be that more wide-ranging filters would need to be introduced. One of the few genuine competitive advantages Britain has right now is its flexible labour market, which ought to allow the country to take swift advantage of any eventual upturn. Wage subsidy would obviously interfere with this advantage.

Another potentially attractive idea would be to give National Insurance holidays to companies which had suffered a serious demand shock, though again this would suffer from problems of definition and create uproar among companies denied the benefit. Whichever way you cut it, subsidising employment in a fair and equitable way ain't easy, even on a national scale, let alone when the international dimension is taken into account.

It's a slippery slope, with potentially very serious consequences for the public finances and international relations. It may, in any case, be better to use any government money avail-able to act on the demand side of the equation, rather than the supply side. In France and Germany, they do both. Besides paying people to do nothing, they also provide incentives to scrap the old banger and buy a new one.

Yet in the end, all these solutions are somewhat artificial. The best outcome would be simply for credit to start flowing again, allowing the market to decide in the usual way which companies survive and which fail. This has become the Holy Grail of public policy everywhere. Unfortunately, there is so far very little sign of success.

Still, there is some reason for hope. The proposed £50bn "Asset Purchase Facility", details of which were published by the Bank of England yesterday, may provide some relief. The idea is that the Government uses the facility to buy high-grade commercial paper and corporate bonds. In so doing, the Government may help to get the corporate bond market functioning again, allowing larger corporates to start securitising their debt in the normal way. This in turn should help to free up credit elsewhere in the banking system for SME lending.

We've seen these initiatives fail before, and there are no guarantees this time either. To halt and reverse the present contraction in credit, the Government may end up having to nationalise one or more of the major domestic banks outright, taking full control of the balance sheet. It may be undesirable, but it is surely better than sitting back and watching what remains of our manufacturing sector go to the wall.