Economic View: Prepare to greet thy makers

One of the most encouraging pieces of UK economic news last week came not from the usual round of official data but from the results of a company, Rolls-Royce. It was the aero-engine company, of course, not the car bit which is now part of BMW - though that has some intriguing economic lessons to teach too.

The story was simply that the company produced better-than-expected profits and the shares shot up. They have not yet reached their pre-11 September highs (see first graph) but they have performed extremely well over the past year.

The overall outlook for the world aircraft industry has not particularly improved over the past 12 months, so the earlier collapse of the share price was a bit of an overreaction to the industry's previous malaise. Indeed, the two main airframe manufacturers, Boeing and Airbus, are having quite a tricky time, although for rather different reasons. But what has happened is that the professional investment community has at last cottoned on to the fact that it is perfectly possible to make money in a British manufacturing industry even in a difficult market environment.

Many people quite rightly ponder how UK manufacturing industry can prosper against competition from low-wage China and, increasingly, India too. The Rolls-Royce success story points to two aspects of manufacturing where it is possible to compete.

One might be called "craft manufacturing", that is manufacturing where products are individually assembled and where a high element of skill is involved not just in the design but also in the production. The other is the attaching of service to a product.

Craft manufacturing is quite different to production line manufacturing. A production line for a medium-technology product can be located more or less anywhere in the world and the people making the product do not need to know anything about its use. Most of the added value is in the design and marketing, not the manufacture.

My most recent experience of that is ski boots. I bought a pair last week in Canada and the label proudly proclaimed they had been styled in Italy. Underneath, however,was a little stamp saying they were made in Estonia - a country not noted for tough downhill skiing since its highest point is 1,043 feet above sea level.

In the case of aircraft engines, by contrast, the product needs to be put together by people who know a lot about it. So they will tend to be made in advanced, developed countries. It would be perfectly possible to build an engine manufacturing plant in Estonia and it would probably be fine. But detaching manufacturing from design and development has risks. Further, one of the key elements in Rolls-Royce aircraft engines is that they tend to retain a high performance over their whole lives. You only know how well an engine has performed after it has been in service for a decade or more. So the reputation for quality of assembly is crucial and a company has to be sure that the quality will be maintained if it is shifting production overseas.

We have other examples in the UK, including motor racing cars and to some extent the assembly of the new Rolls-Royce Phantom. The engineering is German but the crafting of the interior, as well as final assembly, is done in Sussex. That is near to several custom boatbuilders, another successful example of craft manufacturing.

By the same token, many instances of excellence can be found elsewhere in Europe, in places where it is still worth making products locally. Thus Paris retains a substantial garment business, one of the few examples of a textile industry remaining within a large European city. It is worth paying the premium to have the goods made near the shops. Germany still has a sufficient edge in engineering excellence almost to justify its extremely high labour costs. Northern Italy has much the same: did you know that the exquisite curved glass panels on the London Eye were made there by what is apparently the only company in the world with the expertise to do the job?

The second element illustrated by Rolls-Royce is the money in servicing products. Half the turnover of the company comes from dealing with the engines that it has fitted over the years. This base is so huge that the work can cushion the swings in new civil engine orders. I suppose much of the cost of those ski boots was in the hour or so spent getting them fitted - money that went to the retailer in the Canadian resort rather than the Estonian factory workers.

The point here is that while services account for some 70 per cent of the UK economy (see right-hand graph) and production only 23 per cent, manufacturers can survive if they can attach service to their product. The number of people employed in manufacturing in the UK will continue to fall gradually, as it is falling in just about every mature, developed country. But it will not disappear suddenly, and individual manufacturing companies will be able to prosper by switching emphasis from making things into servicing things.

As a general proposition, it must be right to focus on areas that are likely to grow rather than those that are likely to contract. The shift from manufacturing to services is so established, so apparently all-conquering, that it must be right to invest money and talent in the latter. But it is important to recognise that some areas of manufacturing will also prosper over the next few years. That success needs to be reinforced just as forcefully as success in finance or education. Rolls-Royce should remind us it is both/and, not either/or.