Nov 2007 28

One of the cardinal virtues that the NHS is supposed to possess is a high degree of equality.  The system clearly fails to deliver quality care relative to other developed country healthcare systems on a host of measures from control of infection to cancer survival to mortality amenable to healthcare.  However, it is felt to be an expression of social solidarity that, quality aside, we are all in the same boat with regard to healthcare.  This principle has been enshrined in the World Health Organisation’s ranking of healthcare systems but in a very imperfect manner that was more focussed on how the system was funded and allocated resources than on the actual results for people from different socio-economic groups.

There is a debate to be had on whether equality, as opposed to generally higher standards, is the right objective for a health service.  However, the Telegraph reports a Civitas study showing that even on the measure of equality the NHS is failing to deliver.  Rates of heart bypass operations, for example, are 30 per cent lower in the poorest groups.  The middle class are proving much better able to play the system and this translates into better standards of care.  "Although the poor, the least educated and ethnic minorities visit their GP more often than more affluent, well-educated people, they are less likely to be referred to a specialist."  Even if equality is treated as all-important the NHS is still failing.

Nov 2007 27

There’s a fascinating poll up on the BBC News web site today. The related story is about the Capital Gains Tax debate, in which Alistair Darling announced that Taper Relief would be abolished – a decision he is now under great pressure to reverse.

Darling’s proposal would simplify CGT, which is of course welcome, but would also raise the rate by 80% for many people, which is of course not very welcome at all.

The CBI and the Conservatives, as well as some extremely prominent individuals from the world of business, have urged Darling to abandon the change, slamming it as both poorly thought-out and dangerous both to Britain’s competitiveness and to short term stability. The Federation of Small Businesses has proposed a halfway house alternative designed to protect small businesses, too. The potential for people rushing to sell their assets in British businesses before the tax hike occurrs in April means that there is a lot of pressure for the Chancellor to make a decision one way or another soon.

So faced with this complex issue, the BBC has offered the public the chance to vote on the question "Should Capital Gains Tax be reformed?"

The first problem with this is that it provides a Yes or No choice on an issue where there are any number of answers. It rather depends what you think they mean by ‘reform’, a word both loaded with political meaning and deeply ambiguous. What kind of reform could they be referring to?

Does voting ‘Yes’ mean:

1) you support Alistair Darling’s original proposal to increase the rate of CGT – reforming CGT as it used to be.

2) you support getting rid of Alistair Darling’s CGT proposal and going back to how it was before – reversing Darling’s decision (i.e. completely the opposite of option 1).

3) you support getting rid of Alistair Darling’s CGT proposal and replacing it with the Tories’ suggestions.

4) you support getting rid of Alistair Darling’s CGT proposal and replacing it with the FSB’s idea or any one of the numerous other alternatives.

5) you believe CGT should be further reformed in any one of a myriad of ways irrespective of Darling’s proposal.

The fascinating thing here is not only that the idea of boiling down a question to which there are at least five answers into a yes-or-no ever seemed a good idea, but that over 4000 people still felt able to  vote one way or another. Amazingly, only 9% chose to vote "Not Sure". Nor did the others balance out equally as one might have expected due to the ambiguity of what "Yes" or "No" means. Overwhelmingly, "Yes" won, receiving 60% of the vote – double what "No" received.

Politically, and in campaign terms, this is a handy reminder of the power of the positive. People aren’t stupid; they weren’t being foolish voting like this. We all evolved as social animals, wanting and needing to be a productiove part of a group. Thus, faced with a question to which one’s opinion could be justifiably be identified as "Yes" or "No", people overwhelmingly identified themselves as Yes supporters.

It’s not a perfect rule – it is definitely possible to set a debate up as something where a gruff, Churchillian "Never" is attractive (for example in the North East Regional Assembly Referendum), whilst some people always like to be contrary – but for campaigners it is always worth bearing in mind whether opportunities exist to harness such trends.

And if you’re wondering, I voted "Don’t Know".

Nov 2007 27

Reuters report that the Public Accounts Committee has found that many PFI deals have been very expensive, up to 14 per cent more than before the PFI deal was put in place.

Getting private companies involved in the running of public services is a very good idea.  However, the important qualities that the private sector can bring to public services – efficiency, innovation and a focus on customer priorities aren’t made use of much in PFI deals.  PFI deals typically have the private sector borrow, put fixed capital (such as a hospital or a prison) in place and then leave the operation of services within the public sector.  In other cases private firms will be asked to undertake particular functions, such as cleaning, rather than the wholesale operation of a facility or service.

Borrowing is one thing that government can do more affordably than the private sector.  Getting private firms in to do the borrowing is to choose perhaps the least useful contribution they can make to the running of public services.  When particular functions are handed over to the private sector they often do not have the flexibility to improve efficiency.

Instead, government and private sector both try to get the best price, for them, that they can.  Sometimes government gets the upper hand but that risks putting the private firm out of business.  If the private firm is put out of business, as in the case of Metronet, that means yet more cost to taxpayers and delays in the provision of important improvements in services.  More often, the private sector wins out and the taxpayer faces a bigger bill than they otherwise would.

By allowing the private sector to run services instead of just contracting out small functions or building facilities we can avoid this entire, expensive, zero-sum game.

Nov 2007 27

OK children- I’m going to explain how not to sell a company

We’ve blogged before
about selling the family silver. In the Earl of Stockton’s immortal words:

"First of all the Georgian silver goes. And then all that nice furniture that used to be in the salon. Then the Canalettos go."

Very distressing for all concerned. But even more distressing when you let it go too cheap.

We’ve just had the National Audit Office report on the bungled sale of QinetiQ, previously the Defence Evaluation and Research Agency (DERA). It confirms our worst fears- taxpayers lost a packet.

Briefly, in 2003 the government sold a stake in QinetiQ to private equity players, the Carlyle Group. Their job was to act as a "strategic partner" to help get the company ready for floatation on the stock market. That duly came in 2006, when Carlyle sold its stake for a large profit.

The NAO’s headline findings are these:
  • Carlyle got in too cheap, or in NAOspeak, "we consider that more money might have been raised from the 2003 sale to Carlyle, which generated total proceeds of £155 million" (para 13)… "weak competition (see paragraph 2.10) and the negotiated reductions in value (see paragraph 2.26) suggest that greater proceeds might have been achievable from the sale to Carlyle" (para 4.12)
  • MOD bungled the sale by failing to agree a key longterm contract with QinetiQ before appointing Carlyle as preferred bidder (cf Virgin’s appointment as preferred bidder on the Crock); because of that and other loose ends, Carlyle was able to beat down the price by £55m from their initial valuation after becoming preferred bidder (para 6)
  • Senior management got far too much gravy – huge helpings of equity were made available to senior management in a juicy incentive scheme developed by Carlyle, with virtually no input from MOD (see below); in NAOspeak "we consider that the returns in this case exceeded what was necessary to incentivise management" (para 9)
  • Wild inequity between taxpayers and "partners" Carlyle- "We have calculated that the Department made a notional internal rate of return of 14 per cent from the privatisation" (para 14)…. "Carlyle made an internal rate of return of 112 per cent on their investment in QinetiQ" (para 15)

In other words, the catastrophic combination of politicos keen to raise some dosh, and bureaucrats incapable of commercial implementation has once again cost taxpayers a packet

Their dire performance is really underlined when you read the NAO’s recommendations to avoid future problems. They are such statements of the bleedin’ obvious that you’d blush to mention them to a six year old. Eg:

"If marketing activity demonstrates that there is limited interest in the opportunity, the public sector should reconsider the timing and structure of the proposed deal. In the public sector the impetus is often to press ahead in difficult circumstances rather than to attempt to maximise proceeds. It is not unusual for private sector deals to be postponed if the market is less favourable than anticipated."

Well, who could possibly have known that?

Clearly, MOD had no idea whatsoever about normal practice in the real world, and in all probability nobody was interested in finding out. The job was not to maximise taxpayer value but to satisfy Whitehall’s asset sale target. Whatever the cost.

As for those laughing-all-the-way-to-the-bank senior managers… just like Cedric the Pig and the other civil servants who cashed out when the utilities got privatised, the boys at QinetiQ had the luck of Larry. Not only were they sitting in the chairs when the music stopped, defence and tech stocks performed extraordinarily well between them getting wedged and the floatation. Here’s the NAO’s table of who got what between the 2003 sale and the 2006 floatation:

As we can see, Carlyle made £332m and the executive directors made gzillions. CEO Sir John Chisholm creamed off £26m, a return on his initial investment of 19,900%. Nice work if you can get it.

So much for the grisly facts, but there’s another very interesting aspect of this report. For the first time in living memory, the NAO has produced a report in which it records a serious disagreement between itself and the department under scrutiny.

Whitehall convention has been for the NAO and the department to lock themselves in a smoke-free room until they can agree a "form of words" to appear in the report. In effect, it’s a joint report. That can be helpful because it means the PAC doesn’t have to waste time trying to pin down the facts. But of course, the danger is obvious, and more than once, the truth has been smothered.

We saw that most dramatically in the case of last year’s NAO probe into the NHS Supercomputer, when after a bitter Whitehall fight, the Department of Health nobbled the NAO report (see this blog). And the NAO has picked up a lot of flak about it ever since (eg see the Peter Oborne vid here).

Now, with Sir John Bourn on the way out, it looks like he’s decided to throw cozy convention to the wind. Try this:

"4.12 The Department considers that its strategy to introduce a strategic partner maximised overall value and that seeking to achieve greater proceeds from the initial sale could have lowered eventual receipts. We recognise that the strategic partner model had benefits in improving the value of the business in advance of a flotation. We consider, however, that weak competition (see paragraph 2.10) and the negotiated reductions in value (see paragraph 2.26) suggest that greater proceeds might have been achievable from the sale to Carlyle. The Department and UBS Warburg disagree with this assertion. Various other indicators support our view."

The NAO’s view is backed by a detailed analysis, including a revaluation of the company at the time of sale, subsequent performance relative to the market sector, and the fact that the net assets of QinetiQ were sold for less than their fair book value.

The MOD’s response?

"The Department does not accept that the book value of QinetiQ at incorporation is a robust measure of the value of the business at that time and considers that it is not possible to derive an accurate estimate of the return it has achieved over the whole privatisation." (para 4.13)

It is not possible to derive an accurate assessment of the return it has achieved. Just think about that for a moment.

In effect, the MOD is telling us it sold an extremely valuable taxpayer asset to the private sector without having any idea what it was worth.

Would you do that?

Would a six year old child do that?

No, of course not.

But in Whitehall it’s par for the course.

In the case of QinetiQ, MOD gave away £400-500m that rightly belonged to taxpayers. Yet nobody has been fired or resigned.

On 3 December, the PAC will be grilling MOD officials. We’re booking our place now.

Nov 2007 26

An excellent piece by Ian Morley in the Financial Times presents a devastating critique of Alistair Darling and Gordon Brown. It’s worth reading the article in full, but here are the main challenges to the Government:

1. Causing great damage by raising taxes on small businesses and entrepreneurs when a more targeted measure on private equity chiefs would have been far easier.

When it comes to the government’s tax changes, the law of unintended consequences starts to become apparent. It will not be the Russian billionaires, private equity or hedge fund managers that suffer but many of the high-quality and technically skilled non-domiciles from the US and Europe who have up until now been attracted to working and living in London. They have created that dynamism that has helped London overtake New York as the major international financial centre.

The greatest and most immoral impact will hit the small business entrepreneur, the real innocent victim. It would have been easier to focus the tax measures on a handful of private equity people – perhaps by differential tax on the gains they make on their clients’ risk capital as opposed to their own – rather than to have increased by 80 per cent the tax on hundreds of thousands of small entrepreneurs that are the life blood of the true economy.

2. Raising taxes on private equity at the precise time when the market was turning.

The current, ill-thought-through demands for greater transparency and controls on private equity and hedge funds, proposals to tax the supposedly rich "non-domiciled" residents and plans for an 80 per cent increase in the effective capital gains tax charge on selling long-term business assets … are all occurring precisely at that inflection point when the market would have adequately dealt with managers’ egos and profits by deflating one and denting the other.

Government intervention now is, therefore, unnecessary. In hindsight, this will be seen not just as bad timing but throwing out the baby, the bath water and the bathtub as well.

3. Removing regulatory control of banks from the Bank of England.

The seeds of this mess were planted 10 years ago in what, at the time, was seen as a master stroke of financial management. The Bank of England was given freedom over interest rates in exchange for giving up direct control of the banks, which was then handed on to the Financial Services Authority. It meant that the chancellor could thereafter blame the bank if it got interest rates wrong yet take credit for giving it independence if they got it right, the ultimate politician’s win-win scenario.

The problem with this split responsibility, made more complicated by the ever-encroaching power of the Treasury, was that the FSA is in fact a regulator, not a market player and, unlike the Bank of England, has no real experience of daily involvement in the markets. It was, therefore, not surprising that as soon as the first major banking crisis came, the collapse of Northern Rock, a case study of collateral damage, the FSA got caught out by not having its pulse on the market.

4. Northern Rock.

Outside Scotland, the north-east based Northern Rock is the only serious financial institution in the heartland of Labour. That may be affecting the government’s handling of the situation. There was no way the City banks and money markets could be seen to destroy the mortgage lender while private equity managers picked over its bones.

These charges make a serious case for the Government to answer. Taxpayers will not forget the matter quickly. For the future, it’s clear that alleviating the burden of tax as soon as possible is essential to getting the economy back on its feet.

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