The Pin Factory Blog

Yesterday the Chancellor announced the great idea of withdrawing child allowances from those who shouldn't need them. It’s such a great idea that, desperate for money as he is, he has deferred it to 2013.

To avoid the expense of means testing, he plans to give all mothers child allowances, as now, but then ask “households with a higher rate taxpayer” to own up to taking the money on their tax returns. Then the Revenue will add the allowances to the tax bill. Give the mother the money and then take it back from the richest member of the household who may, of course, be a lodger.

But “households” don’t do tax returns, individuals do. So, whose tax return does it go on if the mother has little or no income? And suppose the mother forgets to tell the higher rate taxpayer that she’s had the money? Or he forgets?

The tax advantage of not being married, or in a formal partnership, will increase sharply. Didn’t David Cameron make a big fuss about promoting marriage? This does the opposite.

Finally, the bureaucracy in administering all this will increase sharply.

Osborne has made this change in a ham-fisted way that will remove most of the good that comes from it, and missed an opportunity for better reforms. Even Gordon Brown wouldn't have dreamt up an approach as silly.

The blame game is played very differently in China and the UK.  In China, the two executives most responsible for the tainted milk scandal get death sentences.  In Gordon Brown’s Britain, no one is to blame for the financial crisis.  Certainly not him nor the Governor of the Bank of England (who’s actually most to blame, see ASI Briefing Financial Crisis: Is regulation cure or cause?, nor Chairman of the FSA, nor any Bank director.  The blame lies, he says, with global events and market failure, all nebulous concepts that cannot be penalised.

In Brown’s world, an engine driver who ignores red signals and runs his train into another is not to blame.  It is a rail network failure.

The FSA was created, inter alia, to prosecute insider dealers.  How many have they prosecuted in 10 years?  Not one.

Obama has proclaimed a new age of responsibility.  Good for him.  Let’s see some recognition of personal responsibility here.  Let’s strip Fred Goodwin of his £500,000 a year pension and let’s put Mervyn King in gaol.

If C P Snow was with us now, he would recognise civil servants and business people as two cultures divided by a common language, namely money.  Awarding franchises to whomever forecasts, or pretends to forecast, the highest growth in passenger traffic has finally been shown to be as daft as it is.  How the then Transport Secretary, Justine Greening, a chartered accountant who holds an MBA from one of the world’s most prestigious business schools, failed to recognise the fallacy is beyond words.

The taxpayer cost of this fiasco is reckoned to be £40M and that is before all the consultants involved in the two consequential investigations climb aboard the gravy train (sorry).

No other country uses this system.  No surprise there.  It makes it most likely that the winners will go bust. Recognising that much brings on consequential guesswork to establish the size of the bond that would then be called in.  The franchise system also ensures that UK rail travel will remain more expensive than elsewhere in Europe.

The fiasco is re-igniting the debate between those who think the railways should be re-nationalised and those who want a return to the pre-nationalisation structure where large rail companies were responsible for their own track.  Clearly the advocates of the former policy have forgotten how dreadful British Rail was. The mini-monopolies of the earlier system were not much better.  John Major’s government envisaged that competition between different train operators using the same tracks would increase quality and reduce cost.  The former has worked to some extent.  Rush hours and Network Rail failures apart, the travel experience is better but it certainly has not reduced the price.  The franchise process ensures that prices cannot be reduced because the train companies are desperate to service the cost of the franchise.

All these systems use Discounted Cash Flow whereby one forecasts the profits from the immediate years as well as one can, based on a good appreciation of what the near future holds in store.  The “out years” are all rolled into a single number called “Residual Value” and placed far away in a box on the extreme right of the Excel sheet where the calculations are done.  In theory, forecasts are made of passenger numbers, inflation etc and discounted to a single Residual Value.  It is all quite complex and naïve recipients of the results tend to look at the immediate years and not worry about the number beyond as being too complex and too far off.

Using this inattention, the scam is to put the balancing number needed to secure the contract into the Residual Value box and derive the forecasts from that.  It is hard to imagine Atkins, the transport consultant involved, being party to anything this trivial but the essence of the scam is making the out year forecasts fit the Residual Value required as distinct from deriving the values from the forecasts.  An outsider, even one as illustrious at Atkins, would have difficulty in distinguishing the two processes, especially when, as seems to have been the case, inflation has not been properly accounted for.

But the issue is not what went wrong so much as what should be done in future.  In essence a train operator should only bid for what they can control and leave the unknowns to government.  Franchising should therefore not be based on a single number but on a table showing year by year tolls for the use of the infrastructure as a function of passengers carried.  This should not be by train, as road tolls operate, because that would encourage over-crowding but by passenger mile which would encourage more trains.  Where more than one operator uses the same track, some control would also be required to ensure capacity exists.  The passenger mile fees should be on a diminishing curve so that additional passengers are more profitable for the operator and/or more price discountable.  And the bids should be at present values leaving the actual future year payments to be adjusted by inflation, defined as the inflation then relevant to train operating costs.

None of that is complex although compressing it to a single paragraph may make it seem so.  The underlying principles here are that the operator should only pay for what it can control and has an incentive both to improve the travel experience and to reduce costs to passengers.

Have you noticed how quiet the government has been on the EU since the election? An unwritten part of the Coalition Agreement, perhaps even the glue in the Agreement, is that neither party will pursue its pre-election ambitions for the UK’s relationship with Europe. David Lidington, our brilliant but shy Minister for Europe, has a mission to stay out of the headlines. T S Eliot’s Mister Macavity could take lessons from him.

For example, the Coalition has been fierce on regulation with plans for one in, one out, budgets, committees and deregulation but all these apply to Whitehall regulation not Brussels. Yet the EU contributes two thirds of UK regulation in terms of burden. We have not had a whisper about that.

It is especially odd that the Chancellor has said nothing about the transfer to Brussels of financial sector regulation.

The EU Work plan has about 30 proposed new laws (directives and regulations) for 2011/12. We should now be seeing the impact assessments as part of the consultation process which should, but usually does not, take place before legislation is finalized.

Given this Vacuum, should business, and notably the financial sector, now create its own mechanism for reviewing future EU legislation and publishing its conclusions?

As reported in our letter to The Times of June 24, the Chancellor and Prime Minister seem to have agreed the French inspired proposals to hand financial regulation, albeit not supervision, over to Brussels. We surmised that to have been the price of Sarkozy’s attendance at the G20 meeting in April.

What was puzzling us then and since is why neither the City nor the Tories have risen up in protest. Do they believe Lord Mandelson’s soothing words that he will see the City all right? More likely is that the large British banks would actually prefer EU to British regulation and are lobbying to that end. Angela Knight has said as much in Parliament’s house magazine in the last few days. This is carrying hostility to the FSA too far. EU regulation is bound to blunt the UK's pre-eminence in financial services.

The financial crisis has revealed just how dumb our banks can be. Little seems to have changed since. Will someone please stand up for our last remaining major industry?

The Daily Telegraph reported (16th January) that UK taxpayers would likely be called to contribute up to another £30bn. to further bail out RBS and Lloyds TSB.  Their source was the Bank of England’s Financial Policy Committee’s (FPC) evidence to the Treasury Select Committee.  The problem is largely artificial: banking fogeys see the crash as having arisen from inadequate capital to withstand shocks.  They are wrong: more capital may have averted the need for the bailouts but capital shortage did not cause the crash.

The new international regulations-to-be (Basel III) focus on complex increases in tiered capital requirements.  The fogeys, in pressing for higher capital ratios, are pressing for shareholders, including us, to bail out the banks once again. This new money, if the EU allowed the Treasury to do that, would sit on bank’s balance sheets waiting to withstand another 2008-like crash.

In the middle of a recession that is not going to happen. You may as well treat a patient dying of hypothermia with a liberal application of ice packs.

Requiring higher capital ratios will also cause banks to lend less and especially less to SMEs, the very businesses which could lead us out of recession if they had the cash to do so.

The FPC has a built in problem with trying to balance growth, which always involves risk, and stability, i.e. the absence of change.  The problem is partly cyclical: just now we need growth but if and when growth again becomes unhealthy, we will need the ice packs.

Select Committees involve a lot of MPs showing and witnesses avoiding the questions.  The best example of this time wasting during this particular session (yes, I watched two hours of it) was when Andrew Bailey was asked why UK borrowers paid higher interest rates, and UK lenders to banks lower, than their continental counterparts, i.e. why are UK bank margins wider at both ends? The British Bankers’ Association must have been proud of Bailey’s evasion but why did the Chairman, Andrew Tyrie, let him get away with it? The reality is that banking debates are full of technical confusions. 

The high point of the session was the discussion between Brooks Newmark MP and Michael Cohrs, an independent, and independent minded, member of the FPC.  It was this exchange that gave the Daily Telegraph its headline but it was a lot smarter than that.  Rather than cut back on lending or increasing shareholder equity, banks could, and should, sell off their other assets.

The IMF suggests, to placate public opinion, two taxes: the Future Bailout Fund and FAT (Financial Activities Tax). So how, exactly, can these be collected and what will happen to the money? The IMF has no mechanism for assessment or collection nor is there any other global tax collector, Inshallah. So each country will levy what it knows about and the total is more or less that the global figure should be. Well actually it will be less with profit flipping: "honest guv, our foreign activities make the money". Bank HQs will be translocating at great speed.

And when the national governments have collected the cash and, a few years on, there is a banking failure in country A, who thinks countries B, C, D… will cough up the readies from the Future Bailout Fund to help them out? Come to that, hands up those who think the money will still be there?

Tim Ambler is Honorary Senior Research Fellow, London Business School and Senior Fellow, Adam Smith Institute.

Ed Milliband’s cheap soundbites on the banking crisis could prove very expensive for British taxpayers as wealth from London shifts to the US.  Not only is the US the most litigious nation on earth but one has the impression that they see it as economic warfare.  We cannot be sure but it is at least possible that US firms losing out in the competitive marketplace immediately, but confidentially, cry “foul”. We should be alert to the dangers of firms using regulation as a form of protectionism.

Of course bribing the Saudis to sell warplanes (British Aerospace) and US doctors to sell drugs (GlaxoSmithKlein) is wrong, but ask yourself why, in highly competitive markets, they should be indulging in those expensive practices if their (US) competitors are not.  Is there a possibility that the US suppliers were simply out-bribed? Bear it mind that they have to be a lot more careful as their boards loaded with lawyers as ours are not.

Following the BP catastrophe in the Gulf of Mexico, President Obama stoked up the compensation claims by stressing the word British in BP.  He apologised later but the damage was done. So the US taxpayer makes up on fining foreigners what they lose in the marketplace.

Law-breaking individuals should certainly be prosecuted and penalised.  At the same time it is clear that Barclays and the other banks involved were not corrupt as corporations.  Even if senior executives knew of malpractice, the Boards certainly did not, still less the vast majority of employees.

Three quarters of the fines already levied on Barclays were by US regulators.  There is a tsunami of other fines and damages in the course of being claimed by US regulators, state and city governments, e.g. Baltimore, and private individuals.

Fining by UK regulators is one thing.  There is less of an incentive for the government to collude with firms to keep out certain groups of competitors.  Penalties and fines transferring to the US is quite another matter and it needs to be balanced.  And where are the British lawsuits against US interests?  Would we even be allowed to hold such suits in British law courts as Pax Americana has tended to be weighted in their direction?  Should corporations foot the bill for what a tiny minority of employees have done?  Should actions be limited to those employees?

Politicians should be careful what they wish for.  Yes, justice should prevail but it should be speedy and well balanced.  We do not need a judicial enquiry because the consequence could well be the handing over of the UK’s last successful sector, financial services, to the US and its lawyers, through protectionism under the guise of regulation. 

Liam Fox’s announcement that the army will be cut from 101,000 regulars to some 82,000 by 2020 means, on current numbers, that we will have more civil servants fighting for us, or maybe themselves, than we will have soldiers. At the last count, we had 85, 781 civilians in the MOD. Of course some of those are deployed with service personnel and it is argued that we have civilianised more service roles than other countries.

Civilians cost less per head than service personnel but the trouble with that argument is that it reduces the jobs for soldiers when they are not fighting or training. Roughly speaking, military personnel spend on third of their time in each of the three roles, namely active service, training and recharging the batteries at home. And reservists are cheaper because their employers pay for the third role.

The MOD/armed forces comparison is complicated by the civilian deployment with the services and the converse: service personnel driving desks. Every MOD administrative job seems to need a military and a civilian staffer to supervise each other although that is not as bad as it was. In Germany, the 19,710 service personnel are assisted by 7,190 civilians. Grossing that up gives about 35,000 civilians with the armed forces leaving 51,000 at the centre.

The difficult question to which the Defence Analytical Service and Advice people do not seem to have the answer (their website is excellent by the way) is the number of service personnel doing civilian jobs. And where does one draw the line between headquarters required by the army (Andover) and other MOD offices?

One thing is obvious: the ratio of civil servants to armed forces is wrong. We do not need one civil servant for every soldier. Dr Fox should cancel the cut in army regular active forces and cut the desk drivers, both civilian and military, instead – starting with the most senior.

In opposition, the Tories were keen to invigorate the House of Commons EU Scrutiny Committee, both to restore legislative authority to the House and to ensure that proposed new EU legislation was properly challenged. Successive governments hitherto have ensured that the Scrutiny Committee never came to any conclusions, still less held the Executive or the EU to account.

Before the election, the Tories promised to enable the Committee to do what it is supposed to do. A pamphlet co-authored by Theresa May spelt out what was required. In February, David Cameron made much the same point: “And one of the biggest constitutional changes in our history - our membership of the European Union - has practically passed Parliament by. We are hopeless, totally hopeless, at scrutinising the European legislation, regulation and spending that affects our country.”

What a difference an election day makes! All other select committees are having chairmen chosen democratically by back benchers – the sole exception is the EU Scrutiny Committee. David Cameron and the Chief Whip have decided that Ministers will vote too.

Has the Executive woken up to the threat of having an EU Scrutiny Committee that does its job? The government’s independence and room for negotiation in Brussels would be certainly be compromised – not least their current freedom to wave through regulations in the spirit of European co-operation, even when they are bad for Britain. With 30 new Directives on the way now, this is a very pertinent topic. It is vital that the Committee has a chairman who will make sure that EU matters receive proper Parliamentary attention.

It is worth remembering that EU regulations burden British industry twice as much as their Whitehall counterparts. On that basis, they should get twice as much attention. But one gets the impression that the Government, briefed by their civil service mandarins of course, would rather bury all EU matter in the sand. It would be much better if David Cameron followed through on what he said in opposition.

Tim Ambler is a Fellow of the Adam Smith Institute and an Honorary Research Fellow at the London Business School. For a review of the EU Scrutiny Committee’s work see Ambler and Chittenden (2009), Worlds Apart: The EU and British Regulatory Systems, British Chambers of Commerce.