Posted on Tuesday 9 April 2013 by Ulster Business
PwC's Esmond Birnie and Martin Fleetwood, pictured after the firm's budget breakfast event at Crumlin Road Gaol.
PwC chief economist Dr Esmond Birnie launches his Budget assessment with a seemingly bizarre reminder that Easter week sees Germany celebrating a century of English motor manufacturing.
"On 28 March 1913, production of the Morris Oxford started at the Cowley plant in Oxford. A century later it turns out 100,000 Minis for BMW and the German company has just invested a further £750m in its UK operations," he comments.
Birnie says the renaissance of the UK motor industry is one clue as to the Chancellor's hopes for recovery: "New passenger car registrations in the EU were down 8% in 2012 and they fell 10.5% year-on-year in February alone, yet for the first time in nearly half a century the UK makes more cars for export than we import."
He points to Mini engines made at Cowley's sister plant in Warwickshire; Range Rover's top-selling Evoque from Halewood on Merseyside and Nissan's Quasqai and Juke models made in Sunderland.
"Making high-quality products for export creates jobs, wealth and a profitable supply chain," says Birnie, "and that's something we should remember in Northern Ireland," says the economist.
PwC tax partner Martin Fleetwood agrees: "The Chancellor laboured the theme that he wants investors to see that the UK is open for business. I suspect that's why we've seen an emphasis on support for R&D, innovation and a further cut in the rate of corporation tax. A balanced economy needs a mixture of inbound investment, an internationally competitive indigenous business and an entrepreneurial small firms' sector, and that's what he's trying to encourage."
But encouragement aside, both Martin and Esmond acknowledge that the Budget will have a very limited impact on short-term prospects for Northern Ireland. The Budget saw the Chancellor give with one hand and then take away with the other. The region gets £94m as part of the infrastructure investment programme, but loses £40m as the price of further austerity across the UK public sector, leaving the Executive with a net £54m of new money to spend over the next two financial years of 2013/14 and 2014/15.
And while £54m is useful, Esmond Birnie says it needs to be seen in context: "It costs around £25m to build a mile of motorway so the new money might just pay for the A2 upgrade at Jordanstown, which is just over two miles and will cost around £60m. So, in the context of infrastructure spending, £54m is not a lot of money. The Executive's departmental expenditure limits for capital spending (Capital DEL or CDEL) are actually better than they were expected to be when the Northern Ireland 2011-15 Budget was struck, but CDEL is still well below the level of 2008-09 and 2009-10."
The problem, Birnie says, is that the public sector is under severe pressure to reduce spending and the private sector is not big enough or sufficiently internationally competitive to compensate: "It's not that the Northern Ireland public sector is too big, it's that the private sector is too small and too inwardly focused, relative to the overall size of the working population. Given the current global and eurozone economies, any short-term rebalancing of the local economy is largely impossible and medium-term transition will be very challenging."
Which raises the question of corporation tax. Both men agree that reducing the level of corporation tax will be attractive to inbound investors and both agree that the steady erosion of the headline UK rate from 28% to a proposed 20% in 2015 reflects the UK government's acceptance that low corporation tax incentivises investment. It's also clear that the lower the UK headline rate falls, the less it will cost the Executive, in terms of a cut to the block grant to bring a Northern Ireland rate down to say, 12.5%.
The problem, says Martin Fleetwood, is timing. "If the power to set and vary corporation tax was devolved to the Executive tomorrow, it would be around four years before it could realistically be introduced and, according to most estimates, another 10-15 years before the value of new corporation tax would comfortably exceed the cost to the block grant. That's not to say it would not be very beneficial, but it would be a long-term benefit with a fairly hefty short-term cost."
To plug that short-term gap, Fleetwood says the tax incentives already in place, together with those introduced in the recent Budgets and Autumn Statement, make the UK and Northern Ireland particularly attractive to inbound investment: "It may be April Fool's Day, but on 1 April 2013, the smartest businesses will be embracing the new UK Patent Box regime, which allows UK companies to benefit from an effective 10% tax rate on profits attributable to patents."
So what puts the Patent Box on a par with reducing corporation tax? Put simply – if a company sells a product that has at least one patented invention embedded within it, then regardless of how minor that patented invention is, the entire sales revenue attributable to that product could potentially fall within the Patent Box. And with the Patent Box applying to every company that develops and produces a tangible product, that means that thousands of businesses can potentially come within the regime and find themselves with substantial profits taxable at an effective rate of 10%.
"As well as the Patent Box, the improved incentives for R&D announced in the Budget further incentivise our biggest manufacturing exporters and those SMEs receiving R&D grants or undertaking R&D subcontract work for clients," says Martin Fleetwood. "Cutting Corporation tax to 20% in 2015 takes the UK to the bottom of the G20 corporation tax ladder; with Turkey, Saudi Arabia and Russia the only other G20 countries to offer a 20% rate."
Fleetwood says the contention that low corporation tax is simple, clear and transparent and easily understood by inbound investors, is correct. But he adds that a new generation of mobile investors are highly sophisticated: "These inbounds deal in seemingly complex tax incentives every day. They choose tax regimes to suit their complex businesses – research goes where the universities and R&D incentives lie and manufacturing goes where the skills, logistics, infrastructure and training dominate. In putting emphasis on R&D, skills and tax incentives for innovation, the Chancellor is actively hunting for companies like BMW, who can use these incentives to develop and build a new generation of sophisticated vehicles for export markets."
That, he says is good news for Northern Ireland's firms and especially those in high technology sectors, like life sciences and aerospace. "The improved R&D tax credit, which also comes into force on 1 April, will cut the cost of doing R&D in the UK, making R&D centres more globally competitive for inward investment and indigenous companies. And, for the first time, large companies will be able to get cash credit on R&D, as will smaller businesses – those with less than 500 employees and undertaking R&D for customers or receiving grant funding towards R&D."
He acknowledges that it's accepted that companies investing in R&D are more likely to become exporters and profitable international businesses, so this is too is good news for Northern Ireland. However, he concedes that only a few big players already into technology and/or high value export markets are ready to expand their operations thanks to the Chancellor's proposals.
Esmond Birnie agrees. He says Northern Ireland won't benefit from these measures as much as other regions, because of the structure of the private sector and that means 2013 will not see much evidence of recovery.
"Currently 64,900 people are unemployed, an increase of 3,600 (5.9%) on the year and Northern Ireland now has the second highest claimant count unemployment of all the 12 UK regions. It rose by almost 6% year on year, while overall UK unemployment fell by around 4.2% over the same period. Redundancies in the year to February 2013 were over 80% up on the prior year and we see little indication that the local economy is stabilising enough to recover these losses," he points out.
Birnie puts the local unemployment situation into context by looking back to the start of the recession: "The most recent unemployment data illustrate the extent of the job loss since the downturn began in mid-2008. Since that time, we've lost 34,550 private sector jobs, with public sector employment having fallen by 12,420 over the same period. In the final quarter of 2012, around 1,800 jobs were lost in construction and manufacturing outweighing growth of around 1,070 jobs in services and other sectors. And with average wages having grown by around 1.2%, over the past year, while inflation averaged 2.7%, pressures on disposable income have been tightening."
He says the further downgrading of official growth forecasts for 2013 and 2014 further emphasises the difficulties facing the Executive in attempting to drag Northern Ireland out of a deep downturn: "The Office for Budget Responsibility (OBR) has revised forecast 2013 UK growth downwards from 1.2% to 0.6% and this implies that growth in Northern Ireland this year will be marginal at best – probably not more than 0.2%. Given sluggish global growth, continued eurozone unrest and our private sector lacking the critical mass to fix the problem; regrettably therefore, we see no indication that, for the short term at least, things will improve."
With the pessimistic conclusion that 2013 will be a continuation of 2012, what's the answer? Both Birnie and Fleetwood point to Scotland and Wales; and more recently to the English regions for answers, which, Esmond Birnie says, comes down to devolution.
"Under the Scotland Act, the Scottish Parliament will move from raising less than 15% of its own budget to around 30%, with the Act replacing part of the UK income tax with a Scottish rate of income tax (SIT) from April 2016. There will be devolution of land tax and landfill tax from April 2015; extensive new borrowing powers from April 2015 and the potential to create or devolve other taxes from enactment of the Act, subject to the agreement of the UK Government," says Birnie.
And he thinks Wales is headed in the same direction: "The Silk Commission is reflecting the devolution already happening in Scotland. The final outcome of the Silk Commission is likely to be a recommendation that the National Assembly for Wales be granted broadly similar powers to Scotland, with perhaps even greater flexibility around income tax."
Martin Fleetwood says an unprecedented level of devolution is also headed for the English regions under proposals recommended by Lord Heseltine's No Stone Unturned report: "Heseltine has recommended devolving around £49bn of Westminster funding to the English regions, including radical reform of how the regions are funded.
And while we don't know just how much money will actually be devolved, the Chancellor's Budget accepted – entirely or in part – around 80 of Heseltine's 89 recommendations."
Fleetwood concludes that all of this adds up to a growing willingness in Westminster to drive a new programme of devolution across the UK: "Devolution in Scotland and Wales, reform of the funding mechanisms for English regions and an implicit commitment to reforming the Barnett Formula contained in the coalition's Programme for Government, all add up to a new approach to regional autonomy and financing. Northern Ireland needs to be at the forefront of that debate."
Does this add up to Northern Ireland needing a Plan B for economic recovery and regeneration? Esmond Birnie says no: "We've had around 15 reviews of the local economy since the 1950s and they all said the same thing.
R&D, innovation, skills and exports, supported by strong university/business links and a can-do political regime with a relentless focus on developing and internationally competitive private sector.
"Every review endorses the one that came before; we just need to get on with it and make sure we maximise the opportunities of devolution in terms of tax incentives and devolved powers. Right now, we're facing a crisis and there's no one to help us except ourselves. Maybe this is the wakeup call we've needed all along."