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Social Market Foundation | Newsletter December 2012 | Page 1

Newsletter: December 2012 Welcome to the December newsletter As the fallout from the Chancellor’s third Autumn Statement continues, one thing is clear: the country’s economic woes are not going away any time soon. Drawing on our publication Fiscal Fallout, which examined the implications of the UK’s economic performance on the public finances, the SMF has been a leading voice in highlighting what the economic situation means for public spending both in the run up to, and aftermath of the Autumn Statement. SMF analysis of the Autumn Statement featured in the Times, Independent, Guardian, Financial Times, BBC Newsnight and the New Statesman. As Ian Mulheirn discusses on page 2 of this newsletter, the Office for Budget Responsibility made a surprising aboutturn on its assessment of the economic problem in the UK, indicating the there is more spare capacity in the economy than its own models suggest. Ian examines how the OBR figures suggest that the Chancellor, who implemented wide -ranging supply-side measures on 5 December, has misdiagnosed the problem. As the Autumn Statement was published, Senior Economist Nida Broughton got to work examining the figures. On page 3 , Nida discusses why this statement spells bad news for public services, with some £31bn of cuts yet to be meted out after 2015. The Government also announced a new replacement for the troubled Private Finance Initiative. On page 6 Nigel Keohane looks at the pros and cons of the new PF2 scheme.

The growing interest in the need for a more activist industrial policy is one area where there is no shortage of ideas. In November the SMF brought together two of the leading lights in this area - Lord Heseltine and Shadow Business Secretary Chuka Umunna MP- to discuss the tools available to government to boost Britain’s industrial base. A write-up of this event is on page 4. Since the last newsletter, the SMF has been busy producing reports on topics from the Universal Credit to savings policy, and next week we will launch the latest: a look at the policy levers available to improve the UK’s chronically low dementia diagnosis rates. Information on our recent publications is available on page 7. Our successful Chalk + Talk series, sponsored by the Economic and Social Research Council, continues to be popular, and we have a stellar line up of speakers for the New Year. Following on from recent seminars led by Professor Nicholas Crafts and Paul Corrigan, we will hear from SMF founder Lord Skidelsky, Professor John Hills, and the OBR’s Steve Nickell in the New Year. Full listings are on page 5 With the UK Think Tank of the Year and Economic and Think Tank of the Year awards under our belt, and a diverse range of high profile events and publications delivered this year, 2012 has been an excellent year for the SMF. Thank you for your continued support and interest. Happy Christmas!

Contents Autumn Statement: Fiddling while Rome burns? Ian Mulheirn Autumn Statement: the deepest cuts Nida Broughton

2

3

Lord Heseltine and Chuka Umunna MP debate industrial policy

4

Forthcoming SMF events

5

PFI Reloaded Nigel Keohane

6

Recent publications

7

The Market Square

8

www.smf.co.uk │@smfthinktank Social Market Foundation, 11 Tufton Street, London, SW1P 3QB

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Social Market Foundation | Newsletter December 2012 | Page 2

Director’s Note: Autumn Osborne’sStatement: alternative Fiddling while Rome Ianburns? Mulheirn Ian Mulheirn The Autumn Statement was a strange creature. The Chancellor has gone to great lengths to implement a bunch of expensive supply side measures to help the economy grow. But at the same time, the Office for Budget Responsibility appears to have gone in the opposite direction, suggesting that it’s the demand side, not the supply side of the economy that is where the problem lies. That would imply a rather different set of measures to the ones we saw this week. In the run-up to Wednesday’s statement, the government set a few hares running about how it was going to reallocate current to capital spending to boost growth. Since capital spending tends to raise economic output by more than current spending, building schools and roads could provide a sorely needed boost to the stagnant economy. Just what the doctor ordered. And such a shift was exactly the sort of thing the Social Market Foundation advocated last February as a way to provide a fiscal stimulus without deviating from the Chancellor’s deficit reduction plan.

Statement will increase output by a meagre 0.1%. This was no ‘Autumn Statement for growth’, whatever the rhetoric. What this statement was really about was supply side measures, and here the Chancellor has really pulled out the stops. Raising the personal allowance and capping fare rises will make work pay more for the middle classes. Eroding benefits will sharpen work incentives by making life more uncomfortable for those out of work or on low wages. The populist fuel-duty give-away will cut the costs for firms and families. And the corporation tax cut will marginally encourage investment. But it is very unlikely that these measures will do anything to stimulate growth, in the shortterm at least.

And here the OBR seems to be saying that the Chancellor has misdiagnosed the problem. Last month the SMF replicated the OBR’s models for estimating how much of the current deficit will remain once the economy gets back to normal. Had the OBR stuck to its models, they would have said that the demand shortfall in the economy was relatively minimal. In that world, supply side policies might make Uprating benefits by just 1% for three years will some sense. But the OBR junked its models wholesale, suck demand out of the economy adopting a totally different technique. Now they’re saying In the event, the investment is a pretty paltry £2.3bn next that the economy is suffering from a large and increasingly year and £3bn after that. On its own, that might boost persistent shortfall in demand. output by about the same amount: a piddling 0.1 % of GDP The OBR seems to be saying that the in each year. Unfortunately, even this microscopic growth measure is all but cancelled out by where the funds have Chancellor has misdiagnosed the problem been raised from. The decision to uprate benefits by just 1 % for three years will suck demand out of the economy from The biggest threat to the supply side of the UK economy is next April, all but off-setting any stimulus effect of the from a yawning output gap. Weak demand means that investment plan. Quite apart from the fairness debate, if you unemployed workers will slip into permanent inactivity, capital will depreciate. need to save money from the welfare bill, it would have while Incentives to invest will remain weak, been far wiser to wait until the economy is back on its feet. and banks will see no advantage to By contrast, one bright spot – and it was only a spot – was calling time on their zombie the decision to raise £600m from limiting pension tax relief company clients. This is all very bad for top earners. Cutting spending on measures that news for our future prosperity and encourage people to take money out of the economy is an our society. But action on demand excellent example of a demand-friendly cut. Well done the from the Chancellor was entirely Lib Dems. They should have done more. rhetorical . Frenetic activity on the Unsurprisingly, then, for all the infrastructure investment supply side looks like fiddling while chat, the OBR estimates that the measures in the Autumn Rome burns. This article first appeared on the New Statesman blog www.smf.co.uk │@smfthinktank Social Market Foundation, 11 Tufton Street, London, SW1P 3QB

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Social Market Foundation | Newsletter December 2012 | Page 3

Autumn Statement: the deepest cuts Nida Broughton, Senior Economist Beyond all the debate about targets and rules, the message from Wednesday’s Autumn Statement is that public services face years of deep retrenchment The Autumn Statement has brought news of yet more public sector cuts. In a repeat performance of last year, the Chancellor has pencilled in more spending reductions to come after 2014-15. This is to ensure that the Office for Budget Responsibility assesses that he remains on track. The cuts announced in the Autumn Statement involve extending the annual reduction in current spending in the first two years of the next parliament for an extra year, to 2017-18. In particular, the Chancellor outlined explicit cuts to welfare expenditure of around £5 billion in annual spending in 2017-18.

The real impact of the extra fiscal pain outlined by George Osborne looks set to fall hard on public services. That figure has already made a few headlines. But what’s clear from the budget document is that this is just the tip of the iceberg. The real impact of the extra fiscal pain outlined by George Osborne (and in last year’s Autumn Statement) looks set to fall hard on public services. While we know what cuts are planned out for 2014-15, where the axe will fall in the next parliament hasn’t yet been spelt out. But the broad implications of the figures are clear. The Chancellor has set out a total spending envelope that has current spending – on benefits and public services – falling between 2014-15 and 2017-18. But even with the cuts announced to welfare spending, the welfare bill is set to go on rising above the rate of inflation, due to things like an ageing population claiming their pensions, and rising rental costs driving up housing benefit.

To stay within the spending plans set out, the implications for departmental spending are dire. Public services will have to be cut even harder to accommodate the rising welfare bill. Now, with an extra year of austerity, departmental spending will see a cut of just over £31 billion between 2014 and 2018, in 2018’s figures. As we set out in our recent publication, Fiscal Fallout, the impact on many departments will be huge. A cut of £31 billion means an average real terms cut of around 8.8% for all departments between 2014-15 and 2017-18. If Government wanted to protect departmental spending on health, education and international development, as it broadly did in the last spending review, other departments would have to reduce spending by 18.8% over the three years.

But the one that people will ultimately feel most keenly – a further big cutback to public services – is buried deep in the numbers That devastating round of cuts will come on top of an unprecedented squeeze in the preceding four years. In total, between 2010 and 2018, some departments such as the Home Office and Ministry of Justice could shrink by almost a third if the spending reductions are evenly spread, or almost 40% if some departments are protected. There are many stories that come out of the Autumn Statement. But the one that people will ultimately feel most keenly – a further big cutback to public services – is buried deep in the numbers. When all the commentary about targets and rules is over, that will be the tough reality that the next government will have to face.

Read the SMF’s full response to the Autumn Statement online at:

http://www.smf.co.uk/media/news

www.smf.co.uk │@smfthinktank Social Market Foundation, 11 Tufton Street, London, SW1P 3QB

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Social Market Foundation | Newsletter December 2012 | Page 4

Lord Heseltine and Chuka Umunna MP debate industrial policy

In November the Social Market Foundation brought together Lord Michael Heseltine, author of the recent growth review, and Shadow Business Secretary Chuka Umunna MP to debate industrial policy, in conversation with the BBC’s Evan Davis. The event was the first public discussion with Lord Heseltine on the topic following the launch of No Stone Unturned in Pursuit of Growth. The wide-ranging discussion looked at what Government can do to boost industry and examined whether and how an activist industrial policy is achievable. On the need for a more activist industrial policy, Lord Heseltine revisited lessons learned from the past and from other countries. Describing the United States as the “biggest force feeder of its industrial base in the developed world”, Heseltine concluded that state intervention works. Chuka Umunna agreed that the US has a peculiarly interventionist approach to industry given its reputation. Citing the economist Ha-Joon Chang, he said: “the US has the best industrial policy because they have convinced everyone that it doesn't exist”. But both remained critical of the UK’s current approach to industrial policy. “We are amateurs, completely out of touch with standard practice in any other country," said Heseltine. Acknowledging that there is renewed interest over the need for a more activist industrial strategy, Evan Davis challenged both speakers to set out the tools they would use if they had responsibility for such a strategy. Lord Heseltine drew attention to the recommendations in his growth review No Stone Unturned and emphasised the need for bigger and more powerful chambers of commerce in the major cities and to boost the powers of Local Enterprise Partnerships. Heseltine said that £60bn is currently spent in London on projects for the regions, and this should be devolved. Chuka Umunna agreed that using the strengths of regions and devolving power to drive growth was important, but that there would be a real need to ensure democratic accountability if such policies took off. He emphasised the potential to use government procurement to support job growth, and discussed how he would use the market to spot developing sectors to boost growth. A full recording of the event, as well as a Storify of collected tweets about the event is available from the SMF website at: http://www.smf.co.uk/media/news/lord-heseltine-and-chuka-umunna-mp-debate-industrial-policy/

www.smf.co.uk │@smfthinktank Social Market Foundation, 11 Tufton Street, London, SW1P 3QB

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Social Market Foundation | Newsletter December 2012 | Page 5

Forthcoming SMF events A Future State of Mind: Facing up to the Dementia Challenge Dining Room A, House of Commons | 12.45pm (please allow 15 minutes to get through security) Speakers: Rt Hon David Blunkett MP, Chris Skidmore MP, Professor Sube Banerjee, Nida Broughton This event will see the launch of a new report drawing on in-depth interviews with people with Alzheimer’s and their carers, and a wealth of research, to identify the barriers to early diagnosis in the UK. The research proposes new policies to better incentivise the health system to diagnose dementia earlier.

Kindly sponsored by

SMF Chalk + Talk: Lord Robert Skidelsky SMF, 11 Tufton Street, SW1P 3QB | 12.30pm

Kindly supported by

Lord Robert Skidelsky, Emeritus Professor of Political Economy at the University of Warwick will discuss the themes of his recent book How Much is Enough? And ask whether economic growth is a self-evident good.

SMF Chalk + Talk: Professor John Hills Kindly supported by

SMF, 11 Tufton Street, SW1P 3QB | 12.30pm Professor John Hills, Professor of Social Policy and Director of the Centre for the Analysis of Social Exclusion at the London School of Economics, will discuss equality and the welfare state.

SMF Chalk + Talk: Stephen Nickell CBE

Kindly supported by

SMF, 11 Tufton Street, SW1P 3QB | 12.30pm Stephen Nickell, Warden of Nuffield College, Oxford, and member of the Budget Responsibility Committee, will examine the issue of economic demand and the state of the UK’s housing market.

For more information and booking, please visit www.smf.co.uk/events or contact Lisa Perrin on 0207 227 4404

www.smf.co.uk │@smfthinktank Social Market Foundation, 11 Tufton Street, London, SW1P 3QB

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Social Market Foundation | Newsletter December 2012 | Page 6

PFI reloaded? Nigel Keohane, Deputy Director On Wednesday, the Chancellor announced a major overhaul of PFI. It isn’t quite that. And, as ever with PFI, everything may not be quite as it seems. PFI has gone from darling to Cinderella over the last decade. It has been roundly attacked as being timeconsuming and poorly procured; locking the Government into inflexible contracts; and lacking transparency about the future liabilities resting with the state. Perhaps the strongest criticism in times of austerity has been PFI’s excessive costs. So will the review lead to better value for money? A glance at some of the principal reforms – contract flexibility, more public sector equity and more private sector equity – suggests that improvements may not be as significant as they may seem.

Will the review lead to better value for money? The first is potentially the most appealing politically: to make sure that the state is not locked into paying for goldplated services (such as IT contracts, security services and catering) through the lifetime of the PFI. Everyone has their favourite example of excess – the £333 light bulb replacement or the £875 Christmas tree for the Treasury office. Therefore, limits will be put on these services and break clauses put into contracts that will allow the state to source these services from other providers. The Treasury hopes this will save significant sums of money. All good, so far. But this assumes that these costs all stemmed from poor procurement and fast-thinking private sector firms outwitting government procurers. But this is only partially the case. These services provided on -going assured revenue streams to the companies that raised the finance for these projects. Deleting these discretionary services and introducing break clauses is likely to make these projects more risky and less attractive propositions for providers who will consequently raise the unitary payments they demand from government.

allow the Government to ‘become a shareholder in projects and share in the on-going investor returns’. This may also boost the ability the Government has to direct and manage the project, with the Government placing directors on project boards. While this policy has some clear attractions and has been pursued locally through joint ventures, this too includes hidden costs and limitations. Limitations, because the Chancellor’s fiscal targets and the accounting rules significantly constrain the scope for investing large upfront sums in these projects. We might expect, then, a small number of high profile projects with the Government taking a significant stake and many projects quietly agreed with minimal government stake. Costs, because the Government will have to go through a very expensive and lengthy procurement process only to carry half the risk itself.

PFI has gone from darling to Cinderella over the last decade Third, the reluctance of institutional investors to put their money into infrastructure projects has spurred the Government to reduce the risk on their debt finance for such investors by increasing the level of equity in a PF2 project. Because the costs of sourcing equity finance from the market are higher than debt finance this will simply push up the costs of PFI schemes. All of which rather poses the question of why bother in the first place – why not simply change the accounting rules so that the state can make the investments itself at its own low rate of borrowing. That would give the Government greater flexibility at much lower costs of capital. Understandably, perhaps for cosmetic reasons, changing the rules is not something that the Chancellor wished to consider.

Second, the Government wants the taxpayer to take stakes of up to 49% in PFI projects. In the review’s words, this will

www.smf.co.uk │@smfthinktank Social Market Foundation, 11 Tufton Street, London, SW1P 3QB

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Social Market Foundation | Newsletter December 2012 | Page 7

Recent publications Jam Tomorrow? The next 20 years of savings policy By Nigel Keohane This report of an SMF scenario-planning exercise elucidates the evolving policy challenges for long term savings in the UK. The report highlights important emerging tensions that policy-makers will need to address – now and in the coming decades – to re -build households’ financial resilience and ensure that individuals save adequately for later life.

Fiscal Fallout: The challenge ahead for public spending By Ian Mulheirn, Nida Broughton, Ben Lucas and Henry Kippin This paper, jointly published with the RSA’s 2020 Public Services Hub, examines the scale of the cuts to come at the next spending review. Replicating models used by the Office for Budget Responsibility, the paper discusses the deep cuts required to get the Government’s deficit reduction plan back on track, examining the implications for departmental spending since 2010, and considers how policymakers must re-evaluate public service delivery to meet the challenge.

The Sink or Swim? The impact of the Universal Credit By Dr Nigel Keohane and Ryan Shorthouse Based on in-depth interviews and discussion groups with low income families with children, the research shows that the Universal Credit changes - including monthly payment and Housing Benefit paid to claimants in the social rented sector - will leave many households struggling to cope. The report makes new recommendations so that the Universal Credit can be made to work with the grain of Government policy, and to help people to help themselves.

www.smf.co.uk │@smfthinktank Social Market Foundation, 11 Tufton Street, London, SW1P 3QB

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Social Market Foundation | Newsletter December 2012 | Page 8

The Market Square www.smf.co.uk/marketsquare

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Reading the latest Work Programme numbers Ian Mulheirn | 27 November 2012 Today’s long-awaited Work Programme performance figures were rather worse than even the SMF anticipated. Overall performance for the first 12 months of the scheme was 2.3% compared to the minimum performance level, set by DWP, of 5.5% (see our briefing note if you find these figures (understandably) baffling). Every provider fell well short of the minimum, below which the Department for Work and Pensions (DWP) threatens contract termination. So will the department follow through on their threat and sack all the Work Programme providers? Obviously not. Partly that’s because if they did so they’d have no employment service, but mainly it’s because the Department recognises that its minimum performance figures were based on no reliable analysis. The minimum performance figure is calculated to be 10% above the proportion of sustained jobs DWP thought would happen in the absence of any programme to help people back to work. That ‘policy off’ level was estimated by the Department at 5%. In the light of today’s figures, DWP’s analysis suggests that providers are preventing half of their jobseekers from finding work. That’s clearly an absurd conclusion, and so by implication is DWP’s minimum performance level. But aside from the fact that DWP’s baseline is all wrong, there’s a more positive reason they don’t want to ditch the programme. That’s that it is beginning to sort the wheat from the chaff when it comes to helping people back to work.

It’s still early days, but the chart below shows a frequency distribution of performance across the 40 different prime contracts. The best performer is Ingeus’s contract in the East Midlands, which got just over 4% of referrals into sustained employment in year one. There is then a large bunch of providers between 2% and 3%, with Prospects bringing up the rear. It’s worth also noting DWP’s minimum performance level way up to the right of the chart in splendid irrelevance. The performance range is substantial. The best performing contract is apparently more than five times as effective at getting people into sustained employment as the worst. Now there are lots of things going on here, and regional variation plays a large part in driving different performances. But if I was running one of the companies in the middle of the pack, I’d be very urgently trying to find out what Ingeus is doing in the East Midlands to have such great success. If others can learn from the best performers, the Work Programme will be working, whatever DWP’s arbitrary targets suggest

Provider Year 1 performance distribution DWP Minimum performance level: 5.5%

No. providers

A market square is a social hub where people come together to trade goods and chew the fat. The SMF's Market Square is an ideas exchange, where the SMF team blog about the latest issues and test out new thinking.

8 6 4 2 0

Performance band (percentage points)

Also on the Market Square: Is the Chancellor trying to wriggle off the hook of his own fiscal rules? No. - Ian Mulheirn Hard times ahead for the Chancellor - Nida Broughton

www.smf.co.uk │@smfthinktank Social Market Foundation, 11 Tufton Street, London, SW1P 3QB

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SMF December 2012 Newsletter