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Social Market Foundation | Newsletter May 2012 | Page 1

Newsletter: May 2012 Welcome to the May newsletter Wednesday’s growth figures demonstrate clearly the considerable challenges facing the UK economy. Coming just a day after the European backlash against austerity saw the collapse of the Dutch Government, the –0.2% growth estimate has put the Chancellor’s June 2010 strategy under considerable political pressure. He needs a growth strategy that gives the economy a much-needed boost but without adding to the deficit. In the last newsletter, Ian Mulheirn outlined the basis for such a plan: an increase in growth-boosting infrastructure funded either by temporary tax rises or by cutting lowgrowth measures. Two weeks ago the International Monetary Fund came out in favour of the same approach in its recent World Economic Outlook. Ian Mulheirn looks today at why this plan can help the Government out of both a political and economic hole (see page 2). A potent growth plan is the best way to boost the UK economy and strengthen the public finances in the coming years, but other policy challenges cannot be ignored. In the long-term we may all be dead, but before then we’ll be retired. So policymakers also need to consider long-term trends that will affect households’ private finances. With automatic enrolment due to begin later this year, the SMF’s Nigel Keohane is leading a scenario planning project

looking at the forces that will determine household savings over the next 20 years, and how policymakers might need to respond. Nigel discusses some of the emerging themes on page 4. In higher education, with the new fee regime kicking in from this September, Ryan Shorthouse looks at the importance of helping students assess quality and value for money in HE (see page 5). And as the London Mayoral race reaches its climax this week, we take a look at a version of the SMF’s plan for lowcost loans for childcare being proposed by Ken Livingstone. Ryan Shorthouse looks on page 7 at why the national political parties should take up the idea. This newsletter also contains information about our exciting events programme. We are pleased to be welcoming a number of excellent speakers to the SMF over the coming weeks, including US economist and bestselling author Robert Shiller and also Ha-Joon Chang, Anna Vignoles and John Van Reenen. Be sure to regularly check our website or sign up online for updates so you can be first to book. Finally, party conference season will soon be upon us so take a look at our information on page 7 and find out how the SMF can work with you at this year’s party conferences.

Contents Director’s note: Recovery ahoy? Ian Mulheirn 2 Forthcoming events Tomorrow’s savings: later, longer, less, Nigel Keohane Getting bang for students’ buck, Ryan Shorthouse

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Professor Avner Offer talks to the SMF about reciprocity in the welfare system

Livingstone’s childcare funding scheme : a step in the right direction, Ryan Shorthouse 7 Party Conferences 2012

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The Market Square

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

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Social Market Foundation | Newsletter May 2012 | Page 2

Director’s Note: Osborne’s alternative Mulheirn Director’s note: Recovery Ian ahoy? Ian Mulheirn Wednesday’s growth figures were as bad as anyone could have anticipated. And while there’s a good chance that they’ll change – the recession could yet be revised away – none of this alters the fact that the UK economy is in the doldrums. Being economically becalmed is bad enough, but we’re even slipping into a recession without a meltdown in the Eurozone. As navigators know, one risk of being stuck in the doldrums in a ship under sail is your vulnerability to rapid climatic changes such as violent storms and hurricanes. If the Eurosquall gets worse, we’re in deep trouble. So the question for Captain Osborne is how he plans to get us underway. Back in June 2010, at the emergency budget, the Government’s plan was to allow loose monetary policy and a devalued sterling to boost exports and hence stimulate corporate investment. In other words our neighbours would tow us out of the doldrums and into the trade winds. But unremitting bad news from our main trading partner, the Eurozone, hasn’t helped and growth there looks as far away as ever. That’s not the government’s fault, but it has rather sunk their strategy. The growth part of the plan has failed and needs a rethink. If foreigners won’t help out HMS UK, we’re going to have to get back to fair winds under our own steam. But with households and government retrenching, it’s hardly surprising that UK corporations have no incentive to invest. The government has staked its reputation on ending the deficit. And it’s taken as self-evident by most commentators that a deficit reduction strategy (austerity) is the antithesis of a growth strategy (fiscal stimulus). On this reading, the question is only about how much more bad data it will take before Mr Osborne junks deficit reduction and opts for a borrowing-fuelled stimulus. In response to yesterday’s figures the Treasury’s response was that ‘one thing that would make the situation worse is more borrowing’. The Government’s attachment to deficit reduction is unwavering. The Chancellor isn’t going to ditch the deficit reduction plan.

Respected UK advocates of a deficit-funded stimulus, including the FT’s Martin Wolf, NIESR’s Jonathan Portes and Simon Wren-Lewis of Oxford University, point to mounting evidence that this adherence to austerity may be a mistake. But putting the economics of whether the policy is wise to one side, it’s clear that, politically, such a tight u-turn would cause HMS UK to list so badly as to imperil the government, quite apart from leaving Mr Osborne’s career on the rocks. So what’s needed is as much a political as an economic exit strategy for the government. One that allows the Chancellor to stick to the deficit plan while also providing a massive fiscal boost in the form of infrastructure investment. If you subscribe to the conventional wisdom about the stimulus or austerity binary choice, there is no such exit strategy. That’s wrong. Deficit hawks can also engineer a fiscal stimulus through infrastructure investment, funded by cutting low-growth spending and temporarily raising taxes. The two are not opposites. If the Chancellor followed the SMF’s funded stimulus plan, or indeed the last week’s advice from the IMF on this, he could rightly claim a much bigger stimulus than that being proposed by Labour while sticking rigidly to the deficit reduction plan – as politically he must. The macroeconomic debate about growth is largely apolitical. But only a combination of good politics and economics will give us a growth plan worthy of the name. The clamour for the Government to throw deficit reduction overboard doesn’t offer the Chancellor the needed facesaving solution. His opponents may as well ask him to walk the plank. Nor would mutiny be in anyone’s interests right now, with sovereign debt markets in their current febrile state. A funded stimulus plan to get the economy moving again provides the political and economic answer. The Chancellor should take it.

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

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Social Market Foundation | Newsletter May 2012 | Page 3

Forthcoming SMF events Professor Robert Shiller: Finance and the Good Society Committee Room 2, House of Lords | 12.45pm Top US Economist Robert Shiller, who famously predicted the dot-com crash and the sub-prime bubble, will explore the themes in his new book Finance and the Good Society. The Times columnist Philip Collins and Oxford University Professor Avner Offer will respond.

Chalk+ Talk: Ha-Joon Chang - Towards a selective industrial policy SMF, 11 Tufton Street, SW1P 3QB | 12.30pm Ha-Joon Chang, author of "23 Things They Don't Tell You About Capitalism" and Reader in Economics at the University of Cambridge will discuss industrial policy and what role governments can play in fostering innovation in industry. Contact: rbaker@smf.co.uk / 0207 227 4404 or visit www.smf.co.uk/events

Paying your dues: should we be charitable to tax avoiders? SMF, 11 Tufton Street, SW1P 3QB | 08.30 am The last in the SMF’s series of three breakfast roundtables on tax avoidance and evasion, this event will look at the cap on charity tax relief and ask whether the policy will have unintended consequences. Contact: rbaker@smf.co.uk / 0207 227 4404 or visit www.smf.co.uk/events

Chalk+ Talk: Professor Anna Vignoles - Learning to earn? Appraising the UK's human capital policy SMF, 11 Tufton Street, SW1P 3QB | 12.30pm Leading expert on skills and human capital Anna Vignoles of the institute for Education will consider how the UK compares to other countries. Contact: rbaker@smf.co.uk / 0207 227 4404 or visit www.smf.co.uk/events

Chalk+ Talk: Professor John Van Reenen on quality in management SMF, 11 Tufton Street, SW1P 3QB | 12.30pm Contact: rbaker@smf.co.uk / 0207 227 4404 or visit www.smf.co.uk/events www.smf.co.uk │@smfthinktank Social Market Foundation, 11 Tufton Street, London, SW1P 3QB

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Social Market Foundation | Newsletter May 2012 | Page 4

Tomorrow’s savings: later, longer, less Nigel Keohane, Deputy Director There has been much criticism in recent weeks that the March Budget offered only piecemeal reforms to promote economic recovery. A similar criticism could be made about other long-term challenges that are unaddressed such as the need to re-build the financial resilience of UK households and the growing costs of longevity. It is clear that UK households had insufficient savings to insulate themselves from the economic crash at the end of the last decade, with almost a quarter of British households without any liquid savings. The low level of active pension saving is also well known. Despite this, there remains little understanding of whether households will reform their ways and save adequately in the future. Or which parts of the population public policy makers should really be worrying about.

continue to work, something that may become an important political pressure point in the years ahead. Twenty years from now, younger workers and even those approaching middle age are likely to feel the weight of student loan repayments, delaying their savings in pension schemes, as the impact of the 2012 HE funding reforms kick-in. This may prove to be just one of the ways in which government becomes more involved in helping people to smooth consumption over their lifetimes. Meanwhile, the long-term trend towards older homeownership, combined with housing supply constraints, will see many unable to build their assets through property. While they may not be exposed to many of the housing-related risks that hit households in recent years, it is also unlikely that they will be able to use property as an asset.

To address these questions, SMF is carrying out research looking at the long-term trends that will determine savings adequacy twenty years from now. This indicates that the convergence of a series of long-term demographic, economic and social trends is set to pose significant new challenges, risks and opportunities.

Twenty years from now, younger generations are likely to feel the weight of student debt repayments, delaying their savings

SMF is carrying out research looking at savings adequacy twenty years from now

These are just a few of the dynamics we’re exploring. Our research indicates that there are other factors that are potentially no less important but where there is greater uncertainty: will economic growth return speedily? How quickly will heavily-indebted households pay down their debts? Will the Government’s autoenrolment succeed in reversing the decline in workplace pensions? In large part these are unknowables, but it doesn’t mean we should not try to think through the eventualities and plan accordingly.

To take a few examples: by 2032, people will be living on average three years longer, whilst participating in less generous pensions as defined benefit schemes peter out. This will leave people having to work later to build up an adequate pension pot. For many this may be as much an opportunity as a threat. However, some groups – for instance those in manual jobs or in sectors less amenable to flexible part-time work – will struggle to

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Social Market Foundation | Newsletter May 2012 | Page 5

Getting bang for students’ buck Ryan Shorthouse, Researcher Liam Burns, re-elected the President of the NUS last week, wants to shift his organisation’s focus away from tuition fees to the quality of teaching students receive. Good. With most institutions tripling their fees, it’s time to make sure students get value for money. Whilst NUS have been busy directing their anger towards government, they have missed the real problem that needs addressing. It’s not that the new fee arrangements are putting off students from poor backgrounds. Rather, it’s that despite fees unlocking greater revenue for universities over the past decade, the average level of student satisfaction – as measured by the National Student Survey – has flatlined. Government is hoping that students will become more discerning customers, shunning poor-performing institutions, to incentivise universities to offer a better quality experience. But students need to be able to make informed choices.

sector, need to prioritise these indicators in their assessments of institutions. But giving applicants the tools to choose wisely is not enough. This is because there is still a cap on university places. Since demand for HE places forever exceeds supply, poor-quality universities are in effect guaranteed customers. So there is little incentive for universities to improve their service. The priority must be to finance the abolition of the cap to ensure universities are required to respond to the needs of their students. In the absence of complete liberalisation, an alternative would be to make university funding for undergraduate tuition dependent on revenue from subsequent graduate earnings. The SMF advocated this approach in Funding Undergraduates: with universities taking out loans, rather than students, the amount they borrowed would be entirely dependent on how each cohort of their graduates performs in the labour market. Such a payment by results model, with high-performing universities able to borrow more, would encourage institutions to invest much more in the quality of provision, regardless of any cap on student numbers.

Despite fees unlocking greater revenue for universities over the past decade, the average level of student satisfaction has Even though fees have increased, there is flatlined no guarantee that students that will have Sadly, there is currently a lack of good, reliable data. Employment outcomes are not good enough on their own. an enhanced experience Impressive graduate salaries may be the result of the type of students the university is able to attract, or their decadesold reputation among employers, rather than any reflection of their contribution to the human capital of their students. League tables use a range of indicators – such as spend per pupil and entry requirements – but, again, many of these may not be a measure of what the university adds, but a simple reflection of their status. Fortunately, research by Graham Gibbs has found there are good proxy measures of how universities are performing, such as class sizes, teaching standards, and the quality and quantity of feedback. Students need to be directed to this information. And QAA, the regulator of teaching in the

And competitive pressures need not apply only at the point of admission. If external degrees were much more widespread and normalised, as the Universities Minister wishes, it could mean that students are much more able to pick and choose modules and courses at different institutions. Even though fees have increased, there is no guarantee that students will have an enhanced experience. If a liberalised HE market is some way off, there are other ways to strengthen competition if we wish to drive up the quality of HE for students.

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

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Social Market Foundation | Newsletter May 2012 | Page 6

Avner Offer talks to the SMF on the economy of obligation and the welfare system Chalk + Talk is the Social Market Foundation’s lunchtime lecture series, bringing the best policy output from the world of academia right into the heart of Westminster.

But reliance on contracts is not without its dangers, and these attempts to lock in the future are far less effective than economic theory would have us believe.

Launched in July 2011, these regular roundtable talks have seen a distinguished line-up of academics present their policy thinking on topics from competition in healthcare to unemployment.

Contracts project into unknown future, where original obligations can be relaxed as a result of litigation or public policy. Not only that but people’s myopia and problems of asymmetric information mean that many can find themselves insufficiently protected. Moreover, financial contracts are often seen as cheap alternatives to government provisions, but this is far from true – intermediation fees and civil litigation are expensive transaction costs that state systems do not incur. For example, according to US statistics, civil litigation costs 0.75% of GDP for transfers of 1% of GDP.

At the most recent event, on 26 April, Professor Avner Offer discussed his latest paper, The Economy of Obligation: Indeterminate Contracts and the Cost of the Welfare State .

Offer argues that the state is therefore better placed to respond to social needs. PAYGO does not try to lock in the future but instead encourages cooperation as individual transmissions over time (as in a private pension, for example) are converted into transfers between different sections of the society at each point in time (working age taxpayers fund state pension recipients). The level of these transfers is then appropriately varied in response to the will of the electorate. A huge part of western governments’ expenditure is paid out in social transfers financed on a pay-as-you-go basis. But do private insurance markets offer a more efficient way to organise such protection? Professor Avner Offer of All Souls College, Oxford, argued that governments are more reliable than markets when it comes to managing social risk. Financial markets promote transmitting risks over the individual life cycle using financial contracts for future or contingent delivery.

One question that arises from this analysis is whether the state is always robust in this role. The state is arguably vulnerable to capture by finance, in this case arguing for the superiority of market-administered social transfers. But policy is also vulnerable to the myopic choices of voters and politicians, and its actions are limited by taxable capacity, intergenerational generosity, and demands of security. In light of the limitations of both the market and the state in this area, it seems inevitable that neither can do the job alone.

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

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Social Market Foundation | Newsletter May 2012 | Page 7

Livingstone’s childcare funding scheme: a step in the right direction Ryan Shorthouse Since the SMF launched the idea for a low cost loan to help parents cover the significant upfront costs of childcare, there has been considerable interest in the idea from academics, policymakers and politicians alike. Soon after The Times reported that the idea was being seriously considered by the Treasury, Labour’s London Mayoral Candidate Ken Livingstone proposed a version of our idea if elected. Under the SMF’s proposed National Childcare Contribution Scheme, all working parents would be able to access up to £10,000 from government to pay for their childcare costs for children under the age of five. They would repay this money on an income-contingent basis where the main earner contributes 6% of their gross monthly income above the personal tax allowance. An interest rate of 3% above inflation would be applied and contributions would end once all the assistance has been paid in full, or after 20 years, whichever is earliest. Modelling conducted for the report shows the surplus from the interest rate would cover the shortfall from write-offs after 20 years of the lowest earners, making the scheme costless to government. 57% of parents who expressed an opinion reported that they thought the scheme was a good idea and just over a quarter, across all income groups, said they would use the scheme if it were available. Livingstone’s policy of distributing grants and interest-free loans to a select number of parents to help them afford upfront childcare free is therefore a hugely welcome step for Londoners. But what Ken Livingstone can’t do, if elected Mayor, is extend the benefits of this scheme to the wider taxpayer and to parents living outside London. The SMF model is a national scheme, which brings many advantages over the scheme Livingstone can propose. It would entail lower capital costs because it uses the government balance sheet and collects contributions efficiently and cheaply via the tax system. This means the interest rate charged to parents is lower than in a commercial scheme.

The income-contingent nature of the SMF proposal would also protect families who could no longer afford to repay. Livingstone’s scheme by contrast will be more risky for parents with repayment due whatever the family’s financial circumstances. Due to the inevitable constraints of a localised scheme, Livingstone’s interest-free loans would be only available to 10,000 families, and the proposed grants to just 1,200 families. The eligibility for the proposed support is contingent on having a household income below £40,000 per year. But research clearly shows that families across most of the income spectrum struggle with childcare costs. A national scheme could cater for all working families and even make the policy pay for itself. Limiting the eligibility to lower-income families increases the risk of bad debt, driving up the interest rate for borrowers for any given level of cost. As Livingstone proposes interest-free loans, the cost of the scheme per family will be significant. But by applying a low interest rate and allowing better-off families into the scheme, a national version of the Livingstone plan could be made to cover its costs. Polling for our report showed a roughly equal mix of parents from different social backgrounds are keen to take advantage of such a national scheme. Livingstone’s proposal offers grants and loans to cover upfront fees. These fees can be punishingly expensive so this is particularly welcome. But on-going costs are an even bigger problem for families in London and elsewhere. The SMF scheme proposes that parents be allowed to draw down up to £10,000 to cover any type of childcare cost. Ken Livingstone is right to propose loans to help parents smooth the high costs of childcare, particularly in London. While his scheme is a step in the right direction, it is inevitably limited by being a local programme. The Labour Party, now it has launched its Childcare Commission, would be wise to scale-up the idea to a national level. Our report, A Better Beginning, offers a blueprint for how.

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

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Social Market Foundation | Newsletter May 2012 | Page 8

Party Conferences 2012 At the half way point of the electoral cycle, this year’s party conference season will be a crucial opportunity to reflect on the Coalition Government’s record so far and to contribute to the developing policy agenda. The Olympics and the Queen’s Diamond Jubilee will place Britain firmly in the international spotlight this year. But, with the UK now officially back in recession, rising dissent over the Government’s reform agenda in areas from health to welfare, and uncertainty over the future of the Eurozone, will 2012 be remembered for very different reasons? The SMF will be at the centre of the most relevant policy discussions and debates at this year’s conferences. You can play a part in this through following our live party conference blog and Twitter updates, attending a debate, or by partnering with us.

over a decade. Our events have become known for their professionalism, high profile speakers and innovative debates. This, coupled with our independent, cross party approach, makes us an excellent choice for any organisation wishing to engage intelligently and constructively in the issues facing policymakers, politicians and the public at this crucial time. Our themes document, now available to download, outlines some of the hot topics that we would like to debate this autumn and explains how you can work with us this year. To discuss ways that you can work with the SMF, please contact our dedicated party conference manager, Rachel Baker on 020 7227 4404 or RBaker@smf.co.uk.

We have been running successful and highly respected fringe events at the major political party conferences for Take a look at our Party Conference microsite, new for 2012 at www.smf.co.uk/events/party-conferences/ party-conference-themes or download a printable PDF of the SMF’s 2012 Party Conference themes document.

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

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Social Market Foundation | Newsletter May 2012 | Page 9

The Market Square www.smf.co.uk/marketsquare 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. Get involved in the discussion by commenting on posts, voting on our ideas, and sharing through social media.

Going cap in hand to the charities Ian Mulheirn : 17 April 2012 The Chancellor’s budget decision to cap income tax relief has caused a hullabaloo. Wealthy donors and their beneficiaries are in open revolt, saying that charities will be hit hard by the measure. And a lobbying alliance of the wealthy and the charity sector is not something that politicians are likely to defy. That there will be some cap seems certain. But in the face of this firestorm the government has been curiously reticent in defending its plan. Pointing to the need to curb the minor problem of fraudulent charity giving understandably angered many. There are good arguments for capping donations tax relief, which tend to get less of a hearing. A look at the evidence also points to some ways in which the Chancellor could appease the charity sector while keeping most of his savings.

of donors. So since charities get less than the government spends on tax relief, the state has a dilemma. The cap is expected to save the Treasury up to £100m per year from charity donors. So should it spend that extra £100m on schools or the NHS, services that the electorate as a whole (not just wealthy donors) want to see provided? Or should it reverse its policy and spend that money on tax relief for only £66m to go to privately favoured charities, ranging from famine relief to donkey sanctuaries? The case for doing the latter is perhaps weaker at a time when public services are being cut to the bone and ministers lose sleep about the government’s creditworthiness. Nevertheless, the growing clamour now looks very likely to force some kind of concession from the Treasury. And here the evidence has interesting things to say about how the Chancellor could recast his cap to make sure that government saves some cash and charities maximise giving.

So what possible justification could there be for cutting tax breaks on giving?

Recent research shows that how tax relief is offered really matters to maximising donations. Where the charity directly claims the tax rebate on behalf of the donor, as with Gift Aid, the scheme looks more like a matching proposition. You give £1 and the government will match it with a further 25p. Under Gift Aid for higher rate taxpayers, the basic rate half of their tax break goes straight to the charity in this way. But they reclaim their rebate on the other 20% - the gap between basic and higher rate income tax - through self assessment.

First it’s worth asking the question of how much charities actually benefit from tax relief on donations. This depends how donors respond. If they aim to give a fixed amount of their post-tax income, regardless of government policy, then the charity can expect to get the full value of any tax break that applies.

Field experiments indicate that the matching design can wring up to three times as much in donations for every pound spent on the match as the tax rebate version. And this is in spite of the fact that economic theory would suggest that how the tax relief is delivered should have no impact on donor behaviour.

But what if donors want the charity to get a fixed amount – say a round million pounds? In this case, the availability of a tax top-up might cause them to cut their net donation from what it would otherwise have been. Here the donor benefits but the charity does not. Cutting relief in the first case would hit the charity, but in the second, the total received would be unchanged.

Yet under the government’s current proposal both parts of the donors’ tax relief will be subject to the cap. This makes little sense. The smart move for Mr Osborne would be to un-cap the tax relief that boosts giving while screwing down the cap on the rebate. Both the Big Society and the broke state would be the winners.

Which of these effects dominates is an empirical question. Several studies suggest that charities get significantly less than £1 for every £1 of tax relief paid out, because people reduce the amount they give in response to the top-up. The evidence isn’t conclusive but a reasonable approximation would be that perhaps two-thirds of tax relief gets to the charity. The residual ends up in the pockets

This article first appeared on the New Statesman's economics blog

Also on the Market Square: A passport to the mainstream Ryan Shorthouse Toll roads: A thin end of the wedge? Nigel Keohane

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

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SMF May 2012 newsletter