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Critiques Submitted to the Committee

Economic Research Institute of Northern Ireland

Sir David Varney’s Review of the Competitiveness of Northern Ireland: 
A Critique by the Economic Research 
Institute of Northern Ireland

May 2008

Introduction

1. The Economic Research Institute of Northern Ireland (ERINI) welcomes the opportunity to provide the Committee for Finance and Personnel with a short critique of Sir David Varney’s Review of the Competitiveness of Northern Ireland (hereafter Varney 2). This is the second review concerning Northern Ireland that has been undertaken by Sir David, the first being his examination of the case for a differential rate of corporation tax for the region (Varney 1). Since that study concluded (erroneously in our view) that it would not be possible for Northern Ireland to have a separate corporation tax regime because of the cost and political implications for the rest of the UK, there were high expectations that Varney 2 would make serious alternative proposals for tackling the low growth trajectory that Northern Ireland has been on for the past decade.

Findings of the Review

2. The Review provides a description of the Northern Ireland economy that builds on the work in Varney1 and which will be familiar to local commentators and analysts. The main points it makes are:

  • A young population and a good education system.
  • Good communications links with the rest of the UK, Ireland and Europe.
  • A reasonable rate of growth compared to other peripheral UK regions.
  • Low unemployment.
  • Significant structural weaknesses.
  • A disproportionately large public sector.
  • Public sector wage and pension arrangements that are significantly higher than in the private sector.
  • Productivity levels that are among the lowest in the UK.
  • Inactivity levels that are the highest in the UK (with obvious implications for the level of Incapacity Benefit).
  • The lowest employment rate in the UK.
  • Large deficiencies in the stock of skills and qualifications in the workforce.

3. It must be emphasised that this is only a description of the economy or, more correctly, a description of the symptoms the economy exhibits. It is based on benchmarking economic phenomena such as employment, productivity and so on against either the UK or other economies or the performance of other regions normally using simple ratios. While this is an essential first step the real task is understanding how these observations can be fitted together in a way that is consistent with economic principles and explains how the economy works. In short what is missing from Varney 2 is a model of the local economy that can explain what the statistics say and give some help in working out what the response of the economy will be to changes in policy. This need not be a technical or econometric model but it has to be conceptually consistent.

4. Providing an explanation of how the Northern Ireland economy works is a considerable challenge. How, for example, is it possible to reconcile Northern Ireland having the highest growth rate of any region outside the Greater South East between 1997 and 2006 with the heavy structural deficiencies and poor skill base identified in the review? This is not a question that Varney 2 can answer.

Recommendations of the Review

5. In the absence of a conceptual model of the economy the temptation is to fall back on prescriptions that address the symptoms. This is evident in the recommendations in Varney 2 which are largely about process and structures. There is also rather worryingly some basic misunderstandings about local structures in Northern Ireland and how these differ from the situation in Great Britain. This is most clearly apparent in the reference to local authorities and the planning system which is applicable in GB but not to Northern Ireland. The following paragraphs summarise and provide comment on the main recommendations of Varney 2.

Employment

- Rapid roll out of Pathways to Work to get those on Incapacity Benefit back to work.
- Joining up benefit and employment delivery in one department.
- Ensuring that workforce policies are joined up.
- Better assessment of local skills needs.
- More use of Local Employer Partnerships to get people back to work.
- UK Government to help the Executive to push through welfare reforms.

6. All of these recommendations are for actions already underway or within the gift of the Executive. Welfare reform is also technically a responsibility of the Executive but if this means differential (lower) benefit rates in Northern Ireland any savings would accrue to the UK exchequer since these payments are in Annually Managed Expenditure.

Skills

- Early implementation of the Bain Review and the 14-19 strategy to ensure there are no gaps between school and further education.
- Making improvements in basic skills a priority.
- Developing a ‘pledge’ in both the public and private sectors to bring all eligible workers to Level 2.
- Promoting apprenticeships.
- Consider how the FE system can deliver intermediate skills.
- Better career advice for students.
- Possible bursaries for skills in short supply.
- Partnerships with Foreign Direct Investment firms.
- Attracting graduates and students from outside Northern Ireland and promoting cross-border mobility.

7. Again all of these actions are either underway or well advanced in planning. If the Executive wishes to promote particular university degrees it could, for example, offer to repay student loans (with a maximum cap) for those successfully completing such degrees. Of course, the best way of producing more graduates and encouraging others to come to Northern Ireland is to have a healthy demand from employers at competitive graduate salaries. This is not a point the Review dwells upon.

Investment

- Review the planning system to make it more responsive to investors needs.
- Review InvestNI and improve working links with development authorities in the UK and Ireland.
- UKTI and IDA to assist InvestNI to hone its FDI offer.

8. The current InvestNI set of instruments to attract FDI are obsolescent. A review would only be worthwhile if it produced proposals for an FDI offer that was competitive with the IDA and that means tackling the corporation tax disparity.

Innovation

- Support clusters based on world class expertise and university excellence.
- Improve the take up of R&D Tax Credits.
- Imbed a third stream of finance for university research.
- Seek ways to allow NI businesses to access research support in GB.
- Collaborate with the UK and Irish Governments to align long term science research

9. The review acknowledges that in some respects NI is well advanced in innovation policy and the construction of a supportive innovation environment. Although the Review says that adjusting for size and structure Northern Ireland is spending a proportionate amount on R&D it is the case that the bulk of this spend is concentrated in a very few larger firms. The way forward is to attract more significant FDI that is R&D oriented but the Review is careful to rule out any enhancement to the R&D Tax Credit scheme to make Northern Ireland a more attractive place to undertake such activity.

Enterprise

- Look at low take up of Small Firms Loan Guarantee.
- Review financial assistance to small firms to remove possible market distortions.
- Investigate barriers to growth faced by small firms and examine collaboration with the RoI in developing suitable interventions.
- Minimise regulatory burdens.

10. The small firm environment in Northern Ireland is remarkably stable with fewer births proportionately than GB but also fewer deaths. Some believe that this lack of ‘churn’ is symbolic of a stagnant small firm sector lacking in the essential dynamic of creative destruction. However, the simple truth about small firms is that they tend to remain small (less than 25 employees) throughout their life.

Public Sector Reform

- Pushing ahead with the RPA reform agenda on value for money studies.
- Manipulating the public sector pay system to bring public sector pay into better alignment with private sector pay.
- Further public sector asset disposals.
- Transfer of some public sector operations to the private sector.
- Developing better delivery models for public services.
- Aligning public investment with the economic priority.
- More use of PPPs.

11. This is, perhaps, the most controversial area of the Review and it is the one which has been backed up most directly by the UK Government through the Prime Minister’s announcement that a further £1 billion of asset sales can be retained by the NI Executive over the CSR period (making £1.2 billion in total). The most difficult issue is clearly public sector pay which Sir David sees as a significant source of the public sector ‘crowding out’ private sector activity by attracting the brightest and the best into public rather than private employment. This is a complex issue. Public and private sector pay differentials are not large at lower levels, for example, and public sector employment has been a major factor in bringing gender equality to the workforce. There is also some research to suggest that some people are pre-disposed to public sector employment independent of wage considerations. If savings are to be ‘reinvested’ in public services rather than public infrastructure this will generally mean hiring more public sector workers which might be though contrary to the claim that the public sector is already too big. Clearly the Executive will wish to give some very serious thought to the implications of interfering with the established pay mechanisms in the public sector and a great deal more research on this issue is required.

General Comments

12. In its response to the call for evidence to Varney 2 ERINI forecast that the message from the Review was more likely than not to be one of self help. This is very much the case. Virtually all of the recommendations of the Review are for matters that are the responsibility of the Executive. More disturbing, however, is the absence of new thinking in the Review. It is organised around the Treasury’s ‘five drivers of growth and productivity’ framework which is the standard for all regions. Indeed the conclusions of the Review could be applied in large measure to any of the regions of the UK outside the Greater South East even if the institutional arrangements differ from those in Northern Ireland. All of these regions are following the same basic agenda and there is nothing in Varney 2 to suggest that the Northern Ireland version of this agenda will produce a radically different performance for this region compared to the rest. Indeed this argument can be taken further. The five drivers framework or something close to it has been around for at least a decade and in some senses much longer yet there is no evidence that the rankings of the UK regions in terms of economic performance have changed in any significant way in that time. Poor regions a decade ago remain poor regions today. In no case has any region moved from the bottom of the list to anywhere near the top by following these policies. Indeed there is strong evidence that since 1997 all of the net job creation in the peripheral UK regions has been in the public sector so that regional policy has essentially been a massive transfer of public expenditure from the southeast to the rest of the country rather than the flourishing of the private sector in the regions. This is the context in which Varney 2 should have been written but wasn’t.

13. We must now look to the future. Under the present UK government Northern Ireland is not going to be given the flexibility in fiscal instruments that it need to be competitive with the Republic of Ireland. Renewing that case will have to await a change in Westminster. In the meantime the Executive faces difficult choices. Even within the framework of the five drivers there probably are not the resources available to adequately fund all the actions required and the possibility is growing that within the next two years Northern Ireland will be in recession and struggling to hold onto the gains made in recent years. For the time being there is probably no better strategy than to focus on the fundamentals of education and skills and upgrading the infrastructure needed to connect to the rest of the world.

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