Committee for Enterprise,
Trade and Investment
Tuesday 10 September 2002
MINUTES OF EVIDENCE
Industrial Derating
(Mr John Simpson)
Members present:
Mr Neeson (Deputy Chairperson)
Mr Armstrong
Mr Clyde
Dr McDonnell
Ms Morrice
Dr O’Hagan
Mr Wells
Witnesses:
Mr J Simpson
The Deputy Chairperson (Mr Neeson):
Welcome, Mr Simpson.
Mr Simpson:
I thank the Committee for inviting me. I was interested to see that the Committee is examining this aspect of the overall rating system because it is an important issue in the context of the review of rating policy.
As the Committee can see from my submission, the time has come for us to be prepared to abolish industrial derating on the grounds of equity and effectiveness. Many businesses will defend the continuation of derating on the basis that they would incur an extra cost if it were abolished. If I were in their position, I would say that also. Equally, there are hundreds, if not thousands, of businesses that, having considered the impact of rating policy, regard industrial derating as implicitly unfair. For instance, if I were involved in the development of the tourist industry or services related to information technology I would be asking what differences there were between my sector’s contribution to the economy and that of the manufacturing firms to justify differential treatment. In short, in view of the other aspects of derating, the argument of inequity among ratepayers is a strong one.
The second argument in relation to inequity concerns impact. If £60 million a year is being spent to improve the Northern Ireland economy, we must decide on how best to use that money. If it is decided that, instead of creating a level playing field for rating, industry should be derated, which would cost £60 million, I must ask myself whether that money could be better spent. In my paper, I suggest that £60 million is the equivalent of, for want of a better estimate, a couple of thousand jobs a year in new industry, or is the equivalent of the base on which the Executive could leverage the borrowing of several hundred million pounds for the reinvestment and reform initiative that is on everyone’s minds. If inequity is to be avoided, and if impact and value for money are to be maximised, industrial derating can no longer be justified. That lesson has been learnt in England, Wales and Scotland, where these decisions were made a long time ago.
Mr Wells:
Have you had the opportunity to consider the CBI evidence to the Committee on this issue?
Mr Simpson:
I understand that the CBI argued the opposite case.
Mr Wells:
Yes. The CBI argument is based on equity also. It has no problem with the creation of a level playing field for Northern Ireland industry and its competitors in the rest of the UK and the Irish Republic. However, it states that until we grapple with, and solve, the issue of the differential in electricity prices, a major component of our industry’s input costs will remain higher. Therefore, industrial derating, which affects many companies that are high energy users, such as the cement industry and companies such as Shorts, should not be abolished until that problem has been tackled.
Mr Simpson:
I respect the CBI’s argument, but it is a spurious one. In our economy, we do not consider the structure of all costs and say that, to be fair to one region, we must equalise its costs with those of other regions. Other differences exist, the most significant of which, particularly in the private sector, is that firms here operate at lower labour costs than firms in most regions in Great Britain. An equation that takes account of electricity prices, rates, corporation tax, shipping materials in, and exporting the finished product cannot be applied to the real world. We cannot build a business sector on the basis that for firms to respond competitively to the market, all costs in all regions must be equalised.
If the gap in electricity prices is significant in your thinking, a second point to make is that the gap is narrowing. In a few years time there will not be a major difference in cost. We should not regard the comparison of the costs of one factor, such as electricity, as the right way to approach this matter. However, if you are going to choose to focus on that single cost, you should note that, given the way in which competition in the electricity industry is developing, you will have a diminishing argument.
Mr Wells:
Invest Northern Ireland (INI), formerly the Industrial Development Board (IDB), is pitching for new investment for Northern Ireland. It is in competition with the Irish Republic, which has abolished rates, and with other parts of the world that have soft arrangements for the equivalent of property taxes. One of the major cards that INI can play, in addition to Northern Ireland’s good, well-skilled workforce, is that companies that invest in Northern Ireland do not have to pay any form of rates. Is it wise to remove that card from the pack for INI?
Mr Simpson:
We must be realistic. When a business is deciding where to place new investment, it will consider the underlying costs and its competitive position. It will also take account of the degree to which the Government of the area alters cost structures. The argument is that industrial derating makes a big difference. However, we are spending approximately £60 million a year on derating just to allow existing firms to stay where they are. Hypothetically, if that money could be loaded at the front end to make it much more attractive for new firms while taking it away from existing firms, who should have established their competitive base, I would have some sympathy for the argument.
What we seem to be saying is that in the hope that we might marginally attract new businesses, we will offer them the equivalent of 1·5% of their labour costs in derating. That is a small difference. If we need to do something to front-load the attraction of investment, it is not justified by backloading the underpinning of finances of existing businesses. That is an old argument: you want to focus your development policy on making changes happen, and if, over time, businesses have established themselves, they should be able to justify themselves in the competitive market in the conditions they are facing.
In recent years, the competitive position of most manufacturing firms in Northern Ireland —there are one or two significant exceptions — has improved. Five or six years ago, I can recall expecting to see significant losses in the company results. However, with one major exception, we are not seeing continuous major losses. We are seeing businesses converting to the real world and saying, “We will compete”.
Mr Wells:
It reminds me of the story of the SDLP Mayor of Armagh. A bomb exploded in Armagh, and the mayor was asked whether he felt that it would deter tourists from visiting the city. He said that he had never met a tourist in Armagh who had been deterred by the bombing. He needed to talk to the thousands of tourists throughout the world who would have come to the area, but did not. You said that you have not come across firms that have been put off relocating. People here may not have been deterred by the bombing, but what about the people who were?
Mr Simpson:
That is an interesting argument and a fair point. I do not believe that there are people in the finance houses of New York and the political chambers of Washington who fulfil that bill. If I tried to persuade people to take an interest in Northern Ireland, I would want to sell features other than derating.
Mr Wells:
Representatives from the Northern Ireland Committee of the Irish Congress of Trade Unions (NICICTU) discussed the same issue with the Committee last week. They came up with an interesting figure, and I would be interested in your opinion, as an economist, on it. They said that abolishing derating and rate relief on vacant properties would generate income of £100 million per annum, which could be used to lever £1·4 billion of infrastructure investment. How is that possible under the Government’s present policy of spending only revenue on capital investment?
Mr Simpson:
My interpretation of that is similar to the comment that I made by way of introduction. One option is to think of the money as a way of levering further investment. I would have put the ratio more modestly, but there is a ratio involved. This is made possible because of the agreement that the Treasury reached with the Executive on the reinvestment and reform initiative proposals. In the past, Northern Ireland did not have permission to borrow, which is Mr Wells’s point about financing initiatives from revenue. The Treasury agreed that if there is to be capital investment, we may borrow the capital provided we organise Northern Ireland’s finances to ensure that there is the capacity to repay it at the national loans fund rate, which is an especially attractive rate of borrowing. NICICTU is right to say that if the concentration is on public sector investment, that mechanism will increase leverage.
Vacant property is another issue — I am ducking it, just putting it to one side. If the only change to be made were the abolition of derating, the Northern Ireland Exchequer of the Department of Finance would have £60 million a year more, which is — at national loans funds rate — cover for borrowing a significant amount. NICICTU put a figure on that amount — I would talk about £500 million, but the amount is considerable.
Dr O’Hagan:
You are saying that industrial derating is not a big incentive for foreign investment coming here. Should we go down the road of industrial derating; do nothing, or should some other process be put in place?
Mr Simpson:
The answer to your question goes in two different directions. If £60 million were freed up, the Assembly would have the choice about how to spend it. A question for another day, but which is relevant to your agenda, is that if the money were freed up, would it be spent on economic development — not just industrial development but broad-based economic development, using other means — or would it be spent on public infrastructure?
There is no right answer to the question. Public infrastructure needs to be reinforced, but, equally, Invest Northern Ireland — the agency that is at the forefront — needs the ability to be more flexible in its approach. I am sure that the Deputy Chairperson does not want me to open up the debate on how Invest Northern Ireland should approach its policy and, therefore, its spending. We would all have ideas on how to make it more imaginative. I hope that we will see evidence of that in the next couple of years.
Dr O’Hagan:
Is the figure of £60 million exact or an estimate? You mentioned £60 million, and NICICTU mentioned £100 million last week. How accurate is the figure of £60 million?
Mr Simpson:
My understanding from what Mr Wells was saying is that the figure of £60 million for industrial derating is official in the Government statement. The other £40 million must be an estimate they have made for the lack of rates on empty property. That raises an interesting set of issues. At the moment there are many empty properties. I presume that the business community, particularly property owners, would be the last to volunteer to pay rates on unoccupied properties.
Mr Armstrong:
Most people look on rates as a type of tax. As you say, derating has been abolished in the rest of the UK. However, industry in the UK is self-sufficient, whereas Northern Ireland is a small country that makes many products for export. There must be some incentive to enable Northern Ireland to compete with other countries. If Northern Ireland does not have derating, something else must be put in its place. The argument is currently about abolishing derating. However, Northern Ireland must hold on to something that will encourage small companies and would persuade them that although they would have to pay a small percentage of their revenue, they would become more profitable.
Mr Simpson:
You are correct to argue that anything that takes something away, such as derating, will be unwelcome. Some firms will say: “Look what this is doing to our cost structure”, and: “We must compete in order to export”. My only answer is that a large proportion of industrial derating is on businesses that sell on the home market. Its focus is not to encourage trade outside Northern Ireland. It is evenly spread. The argument is that derating is not sufficiently focussed to make a difference and that we ought to consider policy issues. I believe that Dr O’Hagan had those issues in mind; that we ought to consider policies that will make a difference. In other parts of the UK, derating has been abolished on the grounds that it is too thinly spread to be effective.
A Scottish industry in Inverness could make the same argument that you have just made. However, to encourage industry in the north east of Scotland, people there are arguing about different things and being more precise. Scotland has its own agencies such as the Highlands and Islands Development Board. We have to say that if a thin layer of funding is put across the firms that employ 100,000 people in manufacturing, at no point is it thick enough to make a substantial difference — but it does make a difference to the finances of the Northern Ireland Executive.
Mr Armstrong:
What is the point of changing until you have something else in its place? You have to have the other measure in place before you go forward. There is nothing in place at present, so why change?
Mr Simpson:
That is a fair point. I would not be so negative about the other things that we are ready to put in place. The easiest answer is that most of the Departments have got schemes that they cannot advance because funds are not available. If the necessary funds became available to the Executive, would they allow the enhancement of the transportation strategy, the labour training strategy and ‘Invest Northern Ireland’? The answer is potentially yes. Mr Armstrong asks not to take the existing rule away until something is put in its place. However, there are plenty of bids to use the funding, and they would benefit the whole economy. Mr Armstrong is concerned that that will not do anything for the firm that would have to pay £1,000 in rates that it does not pay now. There is a distinction between the particular impact and the general impact, and therein lies the difficulty. Proposing to abolish derating will never be popular with manufacturing industry, but it is popular with the rest of the businesses in the economy who are keeping quiet because there is no merit in shouting from the rooftops that they would like a fairer system. The hotel groups, IT groups and many other service industries will say that it would be fairer to abolish de-rating.
Mr Armstrong:
Some industries occupy buildings that are not used 24 hours a day. The owners of those businesses think that they are being discriminated against regarding rates. How do you propose to deal with those industries that need vast amounts of space for their business but are rated similarly to small firms?
Mr Simpson:
One of the effects of derating is that there is a minimal cost in keeping empty space. Owners will provide heat and light, but they do not pay rates on the space. Therefore if there was a proposal to take away industrial derating it should be done with a period of notice. You will then find that firms will become conscious of the costs of space. There is some evidence in the PIEDA Report that one of the effects of industrial derating has been to affect property rents as much as business costs.
I agree with Mr Armstrong. If I had adequate space and industrial derating were abolished, I would ask myself if I needed such a large warehouse or so much space for storage or temporary production. There will be an incentive to use space more effectively across all industries. I thought that Mr Armstrong was going to say that the impact of the derating would be bigger away from Belfast than in Belfast, and I do not think that that is a strong argument.
Mr Armstrong:
Equestrian centres have vast amounts of space that cannot be utilised any better because the space is required for the business. What will happen in that situation?
Mr Simpson:
If the business needs the space then it has to pay the rates. If there is a public policy case for doing anything to encourage people to take their businesses forward, that has to be argued on its own merit. The case for giving them incentives to grow is not met by simply saying that they have derating, because it is a passive thing.
Ms Morrice:
I am keen to push the traditional manufacturing sectors in Northern Ireland. I often argue that we can sail into the dot.com industries or the information age, but that that is transient. We have a reputation for textiles, food products and shipbuilding, and we should not scoff at that. We should develop that more because, for example, clothes will always be needed. In the light of that, it would be right to differentiate between the industries and support the manufacturing sector. My argument, therefore, is that we should keep industrial derating to support the manufacturing base because Northern Ireland needs it. What is your argument to the contrary?
Mr Simpson:
I also want to have a system that supports the expansion of business in Northern Ireland — particularly of business that will add value by selling to the rest of the world. Derating, however, is not focused on doing that. Derating is a passively available sum of money, whether you are expanding your business or not. It is available whether you are exporting or selling outside Northern Ireland or not. It is not incentive related. That is the core of the issue that we are talking about.
Ms Morrice:
There are no strings attached. Do you want strings attached to any money that is given?
Mr Simpson:
What you call “strings”, I would call “well-informed policy”.
Ms Morrice:
In other words, the Government would only give firms the money if they agreed to export, carry out research or innovate.
Mr Simpson:
Government support is given for a reason; derating is available despite the fact that it is insignificant for a great many firms.
Ms Morrice:
There is a strong lobby in the other direction. The trade unions were on your side of the argument. Although they are ready to look at arguments to the contrary, they are leaning towards the removal of industrial derating. There is the question of potential job losses. We have just lost 400 jobs at Bombardier. Could more jobs be lost if we take away this incentive?
Mr Simpson:
In your position it is reasonable to be apprehensive about doing anything to increase the costs of businesses functioning in Northern Ireland, however it is located. I understand that. However, any consequential impact on business by removing derating would be very small and short-lived. The Bombardier case, which is in our minds at the moment, is not significantly altered by whether or not Bombardier is getting derating. It is dealing with production planning and the flow of work in a way in which the nature of its cost structure through derating would be of very minor impact. I have come back to the argument that if we find methods of being focused and delivering policy, then there is an argument. However, this is not focused.
Given Ms Morrice’s previous experience, industrial derating must offend her in terms of her understanding of European policy. It is an operating aid, which the Competition Commission, if it notices it, should say is not the kind of thing to be encouraged across Europe.
Ms Morrice:
It depends on which hat I am wearing, whether it is the pro-European one or the Northern Ireland one.
Mr Simpson:
Far be it from me to comment on your dress style.
Ms Morrice:
What would you suggest implementing if we were to take away derating? If we removed the support for Bombardier provided by industrial derating — I do not have the exact figures — what should we put in its place to get Bombardier going in the right direction?
Mr Simpson:
I can answer that question relatively easily. The most potent incentive that Bombardier can be offered is launch aid with new projects. That is a major issue in the aircraft assembly business. Bombardier will often argue that its competitors get launch aid, and that it also deserves it. That becomes an important issue between the Department of Enterprise, Trade and Investment here and the Department of Trade and Industry in London. The second important issue is that when there is a skills shortage, mechanisms that use funding to support the firm’s ability to enhance skill development are more important than anything else.
As a result of the work that we carried out in west Belfast and the Greater Shankill, Bombardier is volunteering to be involved in a major labour training exercise, which will help the firm in terms of recruitment and will help those areas of need. That will be much more significant than anything that ever happens through derating.
Ms Morrice:
Would launch aid be legal in European terms?
Mr Simpson:
Yes, it can be. It is a technical issue, but I believe that it can be legal.
Mr Wells:
I am sorry; it is Alasdair McDonnell’s turn to speak.
Dr McDonnell:
I will be brief because Jim Wells wants to come in, and he is far brighter than me. Most of the ground has been covered, and I broadly agree with much that has been said about equity. However, do you feel that abolishing derating would push any firms under?
Mr Simpson:
Hypothetically, that is possible. However, if a firm is so close to going under that derating makes the difference, then it must be in a vulnerable position anyway.
Dr McDonnell:
All we are doing is buying six months.
Mr Simpson:
Yes, possibly.
Dr McDonnell:
I am being oblique, but you mentioned rating empty property. Can you give the Committee any information on that? I have long held the view that derelict or semi-derelict properties around Belfast could be charged partial rates of 35% or 40% rather than being rate free. Would that make a major contribution? Do you have any information on empty property?
Mr Simpson
I do not have a strong view on what we should do with empty property. One of the effects of imposing even partial rates on empty property will be to accelerate demolition of property that is never going to be used again, because it may as well be knocked down as pay one third or one half of the rates on it. One consequence will be that we will need to think more clearly about what we mean by our urban redevelopment policy. As a result of our exercise, one issue that is very much in our minds for the Shankill and west Belfast areas — and it also applies elsewhere — is that there is a great deal of property that is no longer appropriate to this century. We do not have an urban regeneration policy that will revitalise some of the inner city areas, particularly along the arterial roads. If we introduce rates on empty properties, we will see people demolishing them, and empty spaces starting to appear. If that were part of a bigger process, which then put incentives in place for regenerating those areas, rating empty property would be a good idea. However, it does not become a single stand-alone issue. If we are going to rate empty property, it must be because we want to see a policy and a process of change.
Dr McDonnell:
You mentioned a figure of £60 million, which would be the product of the rating of industrial property. Would that be an extra profit, or is it more equitable to dilute the burden as a whole?
Mr Simpson:
I shall put myself in Dr Farren’s shoes to answer that. Dr Farren is presented by the Treasury with the argument that Northern Ireland cannot continue to finance itself from rates in such a favourable way relative to the rest of the United Kingdom, and it is time to put the house in order. If funds become available in this way — and I agree with the Minister on this — they would have to be put into the Executive funding, so that they can do more.
Mr Wells:
The only reason that I rather rudely interrupted was to follow on from what Jane Morrice said. It was not an attempt to cut in.
Dr McDonnell:
You do it all the time.
Mr Wells:
Perhaps Dr McDonnell should get first crack at the questions the next time round. My point is relevant to the points raised by Ms Morrice and Dr McDonnell. If the £60 million were intended to provide further incentives for inward investment, it would make life a lot easier for this Committee. However, that is not what is going to happen. The Minister for Regional Development, wise man that he is, will snaffle all of that money and perhaps even raise a loan on the basis of it for infrastructure spending for roads, sewers and water.
We all accept that it is vital that that work be done. It might cost £100 million, but improving a sewer will not do anything to increase employment in anything other than the construction industry on a temporary basis. In other words, a good sewer going into Shorts is a great idea, but it will not employ one extra person in that factory. If it is not hypothecated to the Department of Enterprise, Trade and Investment, then surely it will ultimately hamper industrial investment in Northern Ireland.
Mr Simpson:
I agree with Mr Wells that, to make the case as convincing as possible, it would be nice to be able to present it as two sides of an equation. In 2002, the problem in answering his question is that Invest Northern Ireland has more money than it knows how to spend. It does not have the bids to take the funding that is available. If we look at the way in which the Executive’s funding allocations have been altered in the last couple of years, we will see that Sir Reg Empey’s Department has, without too much protest, released funds for other purposes because Invest Northern Ireland and its predecessors have not been able to justify the original allocation.
When more business activity flows into Northern Ireland that could change; for the moment, however, the best that I can offer in the circumstances is that the Confederation of British Industry and other business interests make the case very strongly that one of the biggest deterrents to business at the moment is that we are so far behind with our transportation policy. It is not the most popular thing to argue, but there are few cities in Britain or in Europe with cross-city roads and communications as bad as Belfast’s.
The Westlink in Belfast is a disgrace by the standards of most other European cities. Because of my European connections, I have had to visit several cities there — not necessarily capitals — and they are all installing better communications in a way that makes us look as if we have not learnt the lesson. Dublin has the same problem. It is an all-island problem, and any of you who have driven across the island will have seen it.
What is the trade-off? If the trade-off were that, as a result of doing this, the Westlink would be upgraded within the next five years instead of the next 15 years, I would try and sell that to the public.
The Deputy Chairperson:
As well as the improvement of the A2, with which I am sure you would entirely agree.
Mr Simpson:
I would not mention that road in your presence.
Mr Armstrong:
You state that the profitability impact of derating would be about 2·7% on annual profits. Some companies are performing well and people are depending on them, but they are not making much more than 2·7% profit. If you take United Dairy Farmers and go back to the farming structure, many farmers would like to make 2·7% profit. If that money were taken out of United Dairy Farmers’ budget, many people on the ground would be affected. Would it not be better to let the £60 million you are going to get from derating stay where it is, rather than spend it elsewhere?
Mr Simpson:
My understanding is that profit margins in the dairy sector and across the farming community are very tight, and the past five years have seen an unprecedented deterioration in the situation. Bear in mind, however, that industrial derating, whether it exists or not, will do very little for the dairy farmer. It will do something for the dairy processor, but it will only put a fraction of a penny on the wholesale price of milk.
Mr Armstrong:
But we need that fraction.
Mr Simpson:
We would do better to get the dairy industry sorted out in European terms and not rely on Northern Ireland’s derating having a very indirect effect to do it. We should be tackling other problems that would have a more dramatic impact.
Mr Armstrong:
But if that £60 million is helping someone to continue in business, it should stay until something else is put in its place — do not jump the gun.
Mr Simpson:
I cannot disagree that it may have some impact on a dairy processing company and its viability, but it is the supplying farmers, at the end of the auction link, who are losing out in the present dairy arrangements and who are getting a lower price. By and large, the processors are still making a profit. It is the same with the beef industry; when beef prices were down the red-meat processors were not losing money. Dairy processors are more vulnerable, but they are not completely vulnerable.
Mr Armstrong:
Tesco recently recommended that the industry should pay farmers an extra two pence a litre for their milk, but Tesco was not going to lose any of its profit.
Mr Simpson:
We are talking about where the profit margins go in the chain that runs from the farm to the processor to the distributor and on to the retailer. What happens at the retailer’s point is not going back up the line to the farmer.
Mr Armstrong:
All the profits of United Dairy Farmers go straight back to the farmers.
Mr Simpson:
That is if the diary farmers are getting a decent price. We are arguing, however, as to whether derating would make a difference to that price, and my conclusion is that the difference would only be a very small fraction.
Mr Armstrong:
It means a great deal to the individual farmer.
Mr Simpson:
It would mean more to the farmer if it were a significant change. Our point of disagreement is that the margin when it gets back to the farmer will be immeasurably small.
The Deputy Chairperson:
In your written submission, in relation to the PIEDA report, you say that one of the consequences of derating would be enhanced property returns and that an end to derating would, over time, produce a trade-off in property rentals that would reduce the impact of the change. Can you elaborate on that?
Mr Simpson:
That means that where industry rents property in which to conduct its business, one of the derating impacts is that the property market reflects the knock-on effect of what the industry can afford to pay. According to the PIEDA research evidence, derating has partly impacted in property developers being able to charge slightly higher rents. Although it is a small effect, it is not what was intended. PIEDA think that it is worth mentioning, and so do I.
Importantly, if derating were taken away, the property market would not discriminate any more between the end users, and the process of the property market getting a higher rent because industrial derating is in place will be eroded. I have been challenging Mr Armstrong on small differences, and he could come back at me and rightly argue that there is another small difference the other way.
The Deputy Chairperson:
The other issue is timing, and, following on from the points Mr Armstrong has made, probably the most impassioned plea against change came last week from the Ulster Farmers’ Union. At the same time we see Bombardier in difficulties with its profits and so on. If change is to come about, is it something that should happen overnight, or should it be phased? What way should the Department approach it?
Mr Simpson:
My intuitive suggestion is that you give notice that it would be abolished as from 1 April 2005. From 1 April 2003 it should be removed to the extent of one third; in 2004 it should be removed to the extent of two thirds; and in 2005 there should be full imposition. There is an argument that we should phase the change just as a matter of human interest. There may be an argument that it should change at a different rate for businesses below a certain size. Although that would attract a certain amount of sympathy, it would be too difficult to implement.
The Deputy Chairperson:
Thank you very much for coming along this morning. We have really appreciated your evidence. The Committee will be reporting to the Assembly in due course, but we have not yet established a timetable for that.
Mr Simpson:
Thank you for the invitation to attend.