The Pin Factory Blog

The much criticised flagship HS2 rail project, which seeks eventually to build a new £50+ billion high-speed rail route between London and Scotland, has had a difficult few months.

Phase 1 from London Euston to Birmingham is due for completion by 2026, whilst the construction of Phase 2 – a Y-configured route from Birmingham to take in both Manchester and Leeds - is scheduled to operate from 2033. 

Recent confirmation of heavy investment in several much smaller rail projects in the North and the Midlands, a series of legal challenges to HS2 and even bureaucratic foul-ups at the Department for Transport (DfT) have all been negative for the project’s future.  And, at the macro-economic level, the UK economy is basically flat-lining thereby substantially deferring the year when the UK’s public sector net debt (PSND) will eventually start to fall – it recently passed through the previously unimaginable £1 trillion threshold.

As such, further deep public expenditure cuts seem certain as the UK seeks to protect its treasured AAA sovereign debt rating. Whilst the HS2 project has many flaws, such as its environmental impact, its weakest case remains financial. Quite simply, the numbers don’t stack up. And, even assuming that the optimistic passenger growth projections until 2033 are accurate, it is difficult to discern how a decent commercial return can be generated. A Tory minister was quoted in the Spectator recently as saying that the project was 'effectively dead'.

Compared with other EU countries, HS2’s projected Phase 1 capital costs per mile are way higher, whilst its claimed financial benefits are seriously inadequate. A Benefit-Cost Ratio (BCR) analysis by the DfT for Phase 1 barely shows a positive return, even before many risk factors. Not surprisingly, the DfT prefers to focus on the various contentious non-commercial benefits. In times of economic crisis, previous Governments have axed major projects. Within the next three years, the highly uneconomic HS2 project is a strong candidate to be shunted into the sidings.

The recently announced postponement of a decision on the controversial HS2 project, ostensibly on environmental grounds, raises various questions. The Government claims to have found a spare c£500 million, which would enable additional tunnelling to be built in the Chiltern Hills area, where opposition to HS2 is particularly strong. To be fair, £500 million of additional investment – when compared with the £45.5 billion invested in the Royal Bank of Scotland – may not seem a vast amount.

However, as the ASI’s recent publication High Speed Fail pointed out, the financial case for HS2 is already very weak, even before further tunnelling expenditure. Put simply, the numbers do not ‘stack up’. Indeed, assuming that HS2 eventually reaches Scotland, over £50 billion will have been spent. Given that the recent Autumn Statement revealed that the UK’s already horrendous public debt – now close to £1 trillion – continues to rise well ahead of expectations, the case for pushing HS2 into the siding gets stronger.

After all, like virtually all high-speed lines, HS2 will probably be loss-making, even with the pay-as-you-go funding model proposed by the Department of Transport. Between now and mid-January, expect the Treasury to crawl over the numbers, especially those relating to the capital cost and the projected size of the fare-box once Phase 1, between London Euston and the West Midlands, is operational. By Treasury standards, the projected Benefit Cost Ratio (BCR), which was sharply downgraded earlier this year to just 2x (including wider economic impacts), is very modest.

There is, though, considerable momentum behind the HS2 project, especially from those believing – rather optimistically - that it will sharply narrow the north/south divide. Of course, there is no certainty that the Government’s decision next month on HS2 will be final. The focus, though, will be on the financial analysis within the Treasury who will be very hard-pushed to claim the numbers really do ‘stack up’.

The sorry plight of the Euro-zone provides a robust case for the primacy of floating exchange rates. In years past, many initiatives were undertaken to fix exchange rates – many ended in tears. After all, as Lady Thatcher so elegantly put it ‘you can’t buck the market’. This sentiment is particularly valid in today’s currency markets where vast sums of money change hands – often on spurious rumours.

Where the Euro-zone ends up is anybody’s guess – its denouement, though, seems nigh. Whilst Greece’s chaos is a tragedy for the country, the fact that ten-year yields in Italy have breached the critical 7% yield threshold is immensely worrying. As an EU big hitter, Italy’s current financial plight greatly increases the risk of contagion.

Aside from Ireland, Portugal and Greece, there are other potential casualties. The French Government is petrified that its credit rating may be cut, whilst its banks are exposed to large ‘haircuts’ on bad debts. Germany is desperately worried it may become the Euro-zone’s ‘lender of last resort’. Spain, whose position seems less grim compared with Italy, is also in the firing line. Expect, too, more reports of large transfers of deposits from the weaker Euro-zone member banks into Germany, Switzerland and the UK.

When the Euro was being debated, many siren voices predicted it would end in tears – and they were right. A combination of political myopia, hubris and sheer EU pigheadedness drove the project forward. Had the EU retained individual currencies, notably the Deutschmark, varying economic performances would be reflected by exchange rate movements. Hence, Italy’s old lire would be weak, to the benefit of its exporters’ competitiveness.

Instead, struggling Euro-zone members are locked into too high an exchange rate despite their profound wish to grow their economies. Of course, some companies dislike floating exchange rates, but currency risks can be insured against via banks. Let the case for floating exchange rates prevail.

The profound financial crisis at the heart of the EU provides an ideal opportunity to address the issue of the Common Agricultural Policy (CAP) which was set up in the 1950s mainly at the instigation of Germany and France. Currently, it accounts for annual expenditure of over €50 billion and represents a colossal percentage – some 40% - of total EU costs. Central to its operation are many concepts – subsidies, quotas, levies and intervention prices – that are anathema to most free market economists. 

Not surprisingly, the CAP has also given rise to such Pythonesque features as butter mountains and wine lakes. Whilst some progress has been made in reforming the CAP in recent years, the reality is that it remains a highly expensive anachronism of post-war recovery – and very unsuited to today’s competitive economy.

Inevitably, in the short term, the EU’s focus will be on saving the euro as the markets continue to home in on the dreadful public finances of both Italy and Spain – whilst accepting that Greece’s case is virtually beyond recall. Amongst the more sensible proposals for resolving the euro crisis is a currency split between two EU blocs – the northern and southern countries, with France’s membership underpinning the latter.

In any event, the euro crisis is giving rise to fundamental thinking about the future of the EU. Indeed, within the UK, eurosceptics are becoming far more vocal, with continuing calls for a referendum on the UK’s future EU participation. Furthermore, at some juncture, the UK may need to make further financial contributions to saving the euro – whether directly, through the IMF or bilaterally as with the Ireland.

In return, the UK should demand concessions of its own, including major cuts in CAP payments and, in the long term, its abolition. Its replacement should be based on individual national agricultural policies. Remember, the PR executive mantra - every crisis provides an opportunity.

With the on-going eurozone crisis, the UK economy is now enveloped in unremitting gloom. Of course, if you over-spend as conspicuously as has been the case over the last decade, the return to normalcy will be immensely challenging – and time-consuming. After years of excess debt, the UK is now experiencing the first elements of a ‘hard landing’.

Last week, the UK retail sector had a shocker, possibly its worst week for generations. The mighty Tesco announced that its core UK like-for-like sales growth over the last quarter, excluding petrol and VAT, fell by almost 1% - its worst performance for 20 years. Whilst Sainsbury’s underlying figures were less gloomy, recent data from other less defensive retailers is far worse. The retail electronics sector remains in a desperate state. Both Dixons and especially Comet (owned by Kesa) are struggling whilst HMV’s share price continues to plummet. Last Wednesday, Mothercare stunned the market, with a trading statement that sent its shares spiralling down by 42% - an astonishing fall for a reputable high street retailer.

In assessing these figures, remember that annual inflation is c5%, so that these like-for-like sales figures are, in real terms, even more depressing.
Currently, optimism is a rare commodity in the retail sector, which partly explains the widely reported last-minute re-drafting of the Prime Minister’s conference speech. The prospects for Christmas already look very grim. Few retailers expect their post-Christmas trading statements to be favourably received.

However, the benefits of a market-led economy mean that it can adjust readily to changed circumstances. Tesco, for example, has already launched parts of its ‘Big Price Drop’ campaign, which – despite an adverse impact on margins – should boost sales. In time, as debt levels revert closer to equilibrium, shoppers will return in greater numbers and lift the high street gloom. But the stark lesson for governments remains – never lose control of public borrowing.

The UK bus sector has prospered in recent years, despite all the prophecies of gloom when Lady Thatcher’s Conservative Government decided that competition was the best answer to reversing decades of under-investment, lousy service and poor time-tabling.

First up was the 1980 Transport Act which introduced competition on long-distance coach routes. Subsequently, sector leader, National Express, saw demand rise sharply.  And, despite serious setbacks on the railways, National Express’ bus operations have continued to thrive, with much expanded services. Apart from travelling on much more comfortable buses, passengers are also being offered highly competitive fares. For example, single fares of c£13 are currently available on the six-hour plus London to Newcastle route.

Given that these fares are just 3x the cost of a one-station hop on the London Underground, they offer remarkably value – as National Express sharpens its pencil in the face of competition. On the shorter routes, the stimulus was provided by the 1985 Transport Act, which introduced bus competition locally - the franchise arrangements for London, though, are very different.

In recent months, both sector leader, First Group, and the ever-controversial Stagecoach have reported robust revenues and divisional operating profit increases of an impressive c20%. Whilst all bus operators have to cope with rising fuel prices, heavy investment is underway. First Group plans to invest £160 million over the next two years in modernising its fleet – with 955 new buses.

Looking forward, the UK bus sector stands to gain from the rising costs of motoring. When introduced in the 1980s, the aggressive bus competition initiatives were roundly condemned, especially with regard to the viability of many poorly patronised rural routes: some now receive substantial subsidy. A few bus businesses remain Local Authority-owned and they are ripe to be sold off.

Overall, though, the story of UK buses since the 1980s has been impressive. Embracing the competitive market has been fully vindicated.

Reams of paper have been used to design a safety mechanism for the UK banking sector.

Given that the near collapse of the UK banking system took place in 2008, there is a strong feeling that the Independent Commission on Banking’s (ICB) 363-page Final Report deals with yesterday’s problems.

Two further general observations are warranted about the Report.

First, as Eamonn and other ASI bloggers have noted, it accorded disappointingly little priority to promoting competition. Regrettably but perhaps understandably, given the size of the existing banks with which any newcomer would be competing.

Secondly, many would argue that the central problem is not the banks themselves but some of those running those banks that needed massive subsidies simply to survive.

After all, HSBC is still powering ahead. Admittedly, its enviable status is mainly due to heavy Asian exposure. And, if memory serves, Lloyds did pretty well under the prudent management of the late Sir Brian Pitman.

Not surprisingly, the Government reacted to the ICB’s Final Report by aiming for the long grass. Conveniently, it homed in on 2019, the year when Basle III – with its much higher capital requirements - kicks in.

In the intervening eight years, the Treasury will focus on Royal Bank of Scotland (RBS), the owner of the NatWest and of up-market Coutts. Its unprecedented collapse featured prominently in Alistair Darling’s fascinating memoirs.

RBS received an astonishing £45.5 billion investment from the Government.

Its shares now trade at just above 20p, compared with the Government’s average c50p entry price – the taxpayers’ paper loss is now approaching £30 billion. Selling down this 83% stake now seems years away.

The 41% publicly-owned Lloyds did derive some benefit: the ICB reined back on its interim proposals for further divestments beyond the 632 branches earmarked for disposal under Project Verde.

More worryingly, given the impending Eurozone crisis, further taxpayer support for the banking sector cannot be ruled out.

Back in 2001, over 72% of Britons owned their own home. In the subsequent decade, this figure has fallen back to 67% and, by 2021, is expected by the National Housing Federation (NHF) to decline further to below 64%. The NHF also expects that, by next year, more Londoners will be renting homes rather than actually owning them. Does this trend matter – and why is it taking place?

Part of the explanation for the latter lies in the increased level of renting, due mainly to financial reasons but also due to more enlightened rental legislation. However, it is the far lower level of new house-build that is of major importance to the housing market. Compared with the previous Labour government’s ambitious target of 250,000 new houses per year, just 105,000 new houses were built in England during the last financial year; this was the lowest figure since the 1920s when ‘the land fit for heroes’ pledge proved to be illusory.

Britain’s leading house-builders are still struggling, most noticeably the highly indebted Barratt Developments and Wimpey. But for them and others, including market leader Persimmon, it is the challenge facing potential buyers to secure mortgages that is pivotal. Having lived though the era of high Loan-to-Value mortgages – epitomised by Northern Rock’s 125% much-maligned Together promotion – banks are understandably implementing far more cautious lending policies especially as property prices – outside London - are not expected to rise appreciably.

In all probability, it will take many years for the property market to recover fully although the NHF’s figures suggest a long-term decline in property ownership despite the popularity of the 1980s ‘right-to-buy policy’. Given the undoubted freedom that property ownership - within sensible financial limits - confers, this would be a retrograde development in furthering the concept of the property owning democracy – a policy that MPs from across the political spectrum have endorsed for decades.

Back in 2001, over 72% of Britons owned their own home. In the subsequent decade, this figure has fallen back to 67% and, by 2021, is expected by the National Housing Federation (NHF) to decline further to below 64%. The NHF also expects that, by next year, more Londoners will be renting homes rather than actually owning them. Does this trend matter – and why is it taking place?

Part of the explanation for the latter lies in the increased level of renting, due mainly to financial reasons but also due to more enlightened rental legislation. However, it is the far lower level of new house-build that is of major importance to the housing market. Compared with the previous Labour government’s ambitious target of 250,000 new houses per year, just 105,000 new houses were built in England during the last financial year; this was the lowest figure since the 1920s when ‘the land fit for heroes’ pledge proved to be illusory.

Britain’s leading house-builders are still struggling, most noticeably the highly indebted Barratt Developments and Wimpey. But for them and others, including market leader Persimmon, it is the challenge facing potential buyers to secure mortgages that is pivotal. Having lived though the era of high Loan-to-Value mortgages – epitomised by Northern Rock’s 125% much-maligned Together promotion – banks are understandably implementing far more cautious lending policies especially as property prices – outside London - are not expected to rise appreciably.

In all probability, it will take many years for the property market to recover fully although the NHF’s figures suggest a long-term decline in property ownership despite the popularity of the 1980s ‘right-to-buy policy’. Given the undoubted freedom that property ownership - within sensible financial limits - confers, this would be a retrograde development in furthering the concept of the property owning democracy – a policy that MPs from across the political spectrum have endorsed for decades.

Virtually no Chief Executive has been as vital to the success of his company – and to its share price – as Apple’s CEO, Steve Jobs. Due to recurring serious illness, he has recently resigned as Chief Executive; his effective departure is a massive loss to Apple which he founded in the 1970s. 

Following his return in 1996, Apple has thrived, due in part to the staggering success of iPhones, iPads and iPods, notwithstanding selling over 60 million computers since 1997. tOnly recently, Apple became the most valuable company globally, a status that oil giant, Exxon, has now regained. Significantly, too, Apple’s market value lies far ahead of Microsoft, whose Bill Gates is the only realistic competitor to Jobs as the sector’s leading light.

Increasingly, Jobs is being regarded as one of the great entrepreneurs in history. His business philosophy is based on the intricate design of electronic appliances that millions of consumers covet. Who would have thought, perhaps a decade ago, that iPhones would become a global phenomenon, especially amongst young people? Indeed, history may rate Jobs alongside such legendary names as the peerless Thomas Edison, arguably the world’s first professional inventor; Henry Ford, the father of mass production; and leisure’s Walt Disney. 

Apple has thrived on the back of entrepreneurship, brilliant design and identifying consumer trends with a ruthless zeal. Its success has not been driven by endless subsidies that so many western nations offer across various industries: the UK chemicals sector is a particularly egregious example. Apple has thrived in a generally open market. As such, along with Microsoft, Apple has created a vast number of jobs in recent years, both in the US and throughout Europe.

As the media eulogises Steve Jobs on his retirement from day-to-day management, remember that the open market commercial environment, in which Apple has prospered, is key to its success.