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Official Report (Hansard)

Session: 2007/2008

Date: 05 March 2008

COMMITTEE FOR 
FINANCE AND PERSONNEL

OFFICIAL REPORT
(Hansard)

Update on Varney Review of the Competitiveness of Northern Ireland

5 March 2008

Members present for all or part of the proceedings: 
Mr Mitchel McLaughlin (Chairperson) 
Mr Mervyn Storey (Deputy Chairperson) 
Mr Roy Beggs 
Dr Stephen Farry 
Mr Simon Hamilton 
Ms Jennifer McCann 
Mr Declan O’Loan 
Ms Dawn Purvis 
Mr Peter Weir

Witnesses:

Mr Michael Brennan ) 
Mr Peter Jakobson ) Department of Finance & Personnel 
Mr Richard Pengelly )

The Chairperson (Mr McLaughlin):

We are joined by Michael Brennan, Peter Jakobson and Richard Pengelly from the Department of Finance and Personnel. I remind everyone that the session is being reported by Hansard. The Committee agreed that it would not make a formal submission to the second Varney Review, because most of the issues being covered fell outside our remit. The Committee decided to continue to focus instead on its scrutiny of the Department of Finance and Personnel’s co-ordination and strategy role in relation to the review. The Committee for Enterprise, Trade and Investment is making a co-ordinated submission on the questions that were raised by the Varney Review, and it has called for evidence.

The Committee will move directly into questions since we have had sight of the Department’s submission.

Mr Storey:

Following the second Varney Review, how will the Programme for Government’s target to close the productivity gap with the GB average — excluding the south-east — be achieved?

Mr Michael Brennan (Department of Finance and Personnel):

Sir David Varney’s key observation was that many of the economic policy levers that trigger economic growth are already within the remit of the Executive and the Assembly. His first report identified a large number of areas on the supply side of the economy that needed to be improved or transformed. We are not saying that transforming the supply side will be the be-all and end-all, but it will be a necessary — if insufficient — step towards improving regional productivity. That was a helpful observation from the first report.

Sir David’s current work involves engaging with key stakeholders in Northern Ireland, and he is looking at the areas on which we need to focus our attention, such as the four key drivers of productivity: skills; enterprise; innovation; and investment in infrastructure. He is looking at what we can do to change our existing policies and programmes, and what we need to do differently to get the supply side of the economy right, without ignoring the demand side and the role that fiscal instruments could play, for example, through R&D tax credits or training tax credits. They obviously have a role to play in promoting regional productivity.

Sir David is quite right in stating that we must focus on the supply side, but that still allows us to suggest proposals on the demand side. That is the way to raise regional productivity, to bring about convergence with the public service agreement target going from 94% to 97% of the UK gross value added average, excluding the greater south-east.

Mr Weir:

You mentioned training and R&D tax credits in your submission. Will you put more flesh on the bones as to how those would operate in practice and what level of thinking has been put into how they could be assessed? How would people qualify for the tax credits?

Mr Brennan:

The rationale for focusing on R&D tax credits and on training tax credits is very much linked to the acknowledgement that the key to transforming the economy is to bring in additional high-value added foreign direct investment (FDI). Multinational companies are very efficient at managing their tax exposure; therefore, putting corporation tax to one side, those companies are looking for a pool of efficient, well-educated, skilled people, and a good science infrastructure. We need to think about the incentive mechanisms that we can put in place to encourage those companies to come to Northern Ireland and to change the infrastructure for existing companies here.

If the economy were left to its own devices, it probably would not provide the science infrastructure and skills that those companies are looking for. The Varney Review acknowledged that market failures existed in training and R&D tax credits. That simply means that the market will not provide what industry needs without Government intervention. Therefore, we are considering how we could shape specific proposals on R&D tax credits and training tax credits.

We are telling companies that we will give them tax allowances on any expenditure that they make on R&D in Northern Ireland. For example, we could introduce a 300% or 400% tax credit, which would allow companies to invest significantly on R&D and then write that off against their profit tax exposure. Therefore, it is a subtle way of allowing multinational companies to reduce their exposure to corporation tax. However, the trigger mechanism is that they have to invest in R&D assets or in the skills that they will employ in their projects in Northern Ireland.

The Chairperson:

The submission to the Varney Review states that less than 3% of firms felt that tax credits were the most effective incentive offered by the public sector, and the take-up was around 24%. Professor Harris’s research indicated that he supported R&D over selective financial assistance. He also concluded that although R&D tax credits would improve the performance of existing businesses, there is a significant time lag between operating a tax credit and improving output performance. Is that the silver bullet?

Mr Brennan:

It is not the silver bullet. The report by Professor Harris was critical of the current R&D tax credit regime and indicated two flaws regarding its application to Northern Ireland. First; in the current make up of industry in Northern Ireland, some companies will not engage in R&D in the first place. Secondly; the companies that may have the potential to engage in R&D were not aware of the scheme, and, when they became aware of it, they flagged up the excuse that it was too complex to get involved in.

Those were two significant problems that existing industry in Northern Ireland was confronted with when it came to either applying or knowing about R&D tax credits.

The proposal under Varney II is to make the tax allowance sufficiently generous so that it will apply to large FDI projects that are thinking about coming to Northern Ireland. The proposal would be highly attractive because it would eliminate deadweight — by that I mean the minimising of the effectiveness or value for money of a project due to deadweight. Such companies do not exist in Northern Ireland at the moment. If they were to come here, any benefit would be 100% genuine and of high additional value.

The trigger for that benefit is to get the threshold right. The current R&D tax credit threshold in the UK is around 200% to 250%. If the threshold for large companies that came to Northern Ireland were bumped up to 400%, for example, that would be large enough to be an attraction. It would also be generous in that it would generate a net present value in gross earnings for the Exchequer.

The Chairperson:

Earlier evidence to the Committee on responses to the existing regime indicated that the system is too complex and clumsy. Some people felt that the existing R&D tax credit regime was not worth the trouble. Will you be addressing that criticism?

Mr Brennan:

If an R&D tax credit can be constructed that is sufficiently generous, it could be a carrot to be dangled in front of large FDI projects, perhaps at the investment conference. Those companies are very knowledgeable about tax, and they know how to manage it. The Harris Report pointed out the problem that existing companies in Northern Ireland did not have the resources to manage the existing R&D tax regime.

The Chairperson:

What is the role of DFP officials in the Varney Review II?

Mr Brennan:

We have a number of roles. At the strategic level, we have been co-ordinating Varney’s interaction with the Northern Ireland Departments. For example, we have facilitated meetings with an interdepartmental group of officials, so that Sir David has been able to meet with a collection of officials from the stakeholder Departments. The Department of Finance and Personnel has had an economist based in the Treasury working with the Varney team to ensure that it has access to the correct data. We have also been the contact point for Sir David and his team to seek additional information. This morning, for example, we were able to relay queries on the skills agenda to the Department for Employment and Learning. We have a facilitation, data-input and policy-advice role.

The Chairperson:

That is slightly less positive and proactive than the impression that we had initially been given.

Mr O’Loan:

I was going to ask about that, so that removes one of my questions.

I am sceptical about the whole process. I am concerned that it shifts the focus of our thinking from what we can do for ourselves to the old idea of there being a solution in London that can be handed to us on a plate. Psychologically, that is dangerous. I know that it is work in progress, but what can you say about the added value that will come out of the Varney II process?

Mr Brennan:

At the minimum, it is very helpful to have a person such as Sir David Varney, with the Treasury resources that he has to support him, providing an external, objective critique of the Northern Ireland Executive and Assembly’s economic development policy. I cannot see a downside to having that.

I mentioned the importance of getting the supply side right. If the Varney team and the Treasury are able to flag up where we may be weak in correcting inadequacies or flaws in the supply side dynamic, that is also positive.

Mr O’Loan:

That is a brief answer, and I do not object to that because there is not much more to be said. It does not remove my anxiety about the process. It is work in progress, and we will watch this space.

Mr Beggs:

You said that it has been recognised that R&D tax credits have not been as successful as they could have been in Northern Ireland. Are you hopeful that changes can be made to simplify the process and increase uptake in the future? Will there be some positive tax changes to increase R&D investment in Northern Ireland?

Mr Brennan:

HM Treasury’s pre-Budget report last October indicated the need to examine tax credits in general. R&D was flagged up as being a complex matter, so there is UK-wide acknowledgement that the process may require simplification. When the Harris Report was published, we sent it directly to the Treasury. Therefore, Treasury is aware of the report’s criticism of the system’s complexity and of the inconsistency in applying a tax credit regime to an economy such as that in Northern Ireland, which is dominated by very small firms. I presume that the complexity and administration costs of applying for R&D tax credits must be examined.

As I said to the Chairperson earlier, the specific proposal in Varney II seeks significantly enhanced tax allowances for small- and medium-sized enterprises and, in particular, for large FDI projects, which have the capacity to manage such things as the tax credit system.

Mr Beggs:

Apart from tax issues, have any lessons emerged from the process so far? Recently, I visited a company in my constituency that has been very successful and exports goods internationally. Some people there said that there seems to be a psychological block when it comes to manufacturing and that it is not being considered as a career; yet there are some very successful manufacturing companies.

It strikes me that there needs to be a cultural shift in Northern Ireland. People want their kids to go into the public sector because that is an easy option. However, we must focus on the needs of the economy and the needs of companies to have workforces. That company was experiencing difficulties in recruiting workers locally.

Mr Brennan:

In many ways, the review has been a revelation. I sat in on several meetings that Sir David has had in recent weeks. It has been a revelation to him, in many ways, that tax is not the big issue among the fundamental concerns about the way in which the economy is working. The issues are about skills availability and the place of manufacturing in a modern, dynamic economy.

I sat in on the presentation from the Institute of Chartered Accountants in Ireland. Its representatives were right to flag up the importance of moving to a knowledge-based economy. That does not simply mean a service-based economy; it means getting the right types of manufacturing jobs. That takes us back to the availability of skills and whether we have people who are educated in science, technology, engineering and maths. That is what modern, vibrant manufacturing sector is looking for now.

Sir David Varney seems to be picking up on those issues. Initially, he found people here to be pessimistic about the opportunities and potential for growth and expansion in the local economy. He is bullish about presenting the positives that exist in Northern Ireland, such as the light regulatory framework, the legal framework, the English language, the infrastructure and the skills potential. All of those are significant positives, but it takes someone, such as Varney, to put them all together and present them to people to make them realise the potential that exists here.

The Chairperson:

Two significant elements of our economic perspective are the all-island economy and the EU task force. To what extent do we have an advocate for those elements as regards Varney, his responses and in changing conditions? Do we have a champion who is engaged in the process? We had hoped that DFP had some sort of role, but that does not seem to be the case.

Mr Brennan:

I am sorry. I do not understand the question.

The Chairperson:

Those two issues may, or may not, be on Varney’s radar screen: our view is that they should be.

Mr Brennan:

Those issues are on Sir David Varney’s radar. For example, he has engaged with senior officials in Dublin about the potential to exploit the benefits of all-island economic co-operation. Also, in virtually all his meetings in recent weeks, he has laboured the findings of the recent Annual Competitiveness Report 2007 from Forfás, which he regards as the single most important document that Northern Ireland can learn from. I am not up to speed on how close the EU task force is to delivering its report or its interaction with the Department.

Mr Richard Pengelly (Department of Finance and Personnel):

The EU task force is due to report in mid-April, so it is at the end of its work. The departmental officials who are working on the EU task force issue are clued-in to what is happening with Varney II, and Sir David is aware of their work. Given the different timings, the task force has run its course and will report soon.

Mr Storey:

There has been a lot of talk about the investment conference in May. What is the Department’s role in the preparation for that conference? Other than what has been discussed this morning, what will be put on the table to instil potential investors with confidence that there is a product in Northern Ireland that they can benefit from?

Mr Brennan:

That takes me back to the answer that I gave Mr Beggs. Sir David, looking at the situation from a fresh perspective, identified many areas of potential growth. When those are joined together in a package in order to sell Northern Ireland plc to a room of chief executive officers from the US, for example, they seem impressive.

The areas include the skills potential, the infrastructure that we are implementing, our light-regulatory system, our membership of the EU, our legal framework, and our English-speaking population. All those things tick the correct boxes to attract potential investment. As the large FDI companies are adept at managing their tax exposures, the rate of corporation tax in Northern Ireland will not be the overriding factor that determines whether the chief executive officers at the conference decide to invest in Northern Ireland.

Mr Pengelly:

Although our colleagues in DETI are leading the preparations for the investment conference, we are working with them, particularly on the work that Mr Brennan spoke of. To build on what he said; the Department’s key role is to ensure that, in the dialogue that takes place between ourselves, through our Ministers, and the Varney team, Varney II is not — to use the old SWOT terminology — presented as a critique of the weaknesses of our economy, but is instead an advocate for the opportunities for businesses to invest and flourish in Northern Ireland. Therefore, the conference is a joint-logistical exercise. DETI is taking the lead because of the economic aspect, but we are working closely with DETI.

Dr Farry:

I apologise for my late arrival. I welcome the witnesses, and apologise if my questions have already been asked. If that happens, just cut me off. This is a —

The Chairperson:

OK, that will do. [Laughter.]

Dr Farry:

The temptation was too great.

The Chairperson:

I could not resist.

Mr Storey

Dr Farry is not raising taxes today.

Dr Farry:

The Department’s submission is very much a position paper on Varney II. Will the Department be presenting a rebuttal of Varney I? The analysis of the Northern Ireland economy in Varney I may be good, but its recommendations are weak. There are two main problems.

First, there is a the lack of appreciation of the all-Ireland dimension of the Northern Ireland economy — there is much talk of how Northern Ireland compares to the Republic of Ireland, but there is no reference to how they could join together as an economic entity in parallel with the UK economy.

Secondly, the Varney Report states that Northern Ireland can be a dependent region of the UK and flourish because of the benefits of the Barnett formula. It also states that the generation of income and output elsewhere is not a problem as long as Northern Ireland gets its share. I find that troubling. Is the Department still planning a rebuttal to Varney I? The Institute of Chartered Accountants in Ireland are keen to continue the battle on issues arising from it.

Mr Brennan:

As regards the Executive’s submission to the formal call for evidence for Varney II, a couple of concerns about Varney I were flagged up, and Sir David was challenged about them.

The first concern, which was raised in the Institute of Chartered Accountants in Ireland’s presentation, related to exempting banks and utilities from exposure to the lower rate of corporation tax. That was a key issue that ERINI had been pressing. That matter was not addressed in Varney I; nevertheless, it must be addressed. I suspect that the Treasury will take legal advice about attempts to exempt one competing sector rather than another and will probably point out inconsistency with EU competition laws. That is why, for example, several years ago, the Irish Republic’s Government were obliged to standardise corporation tax rates. They offered two rates — one for indigenous companies and one for non-indigenous companies — and, following a challenge under EU law, they were forced to harmonise the rates at 12·5%. That matter highlights a flaw in Varney I, and we have flagged that up to Sir David.

Secondly, in Varney I, assumptions on the likely inward flow of FDI to Northern Ireland have an impact on the net present cost figures of £1 billion over 10 years into the Northern Irish economy and £2·2 billion over 10 years to the UK economy. Sir David Varney considered that the steady flow assumptions of FDI into the Irish Republic’s economy would continue, and made projections using that flat rate. He also had a problem accepting ERINI’s methodology of applying the Republic of Ireland economy’s growth rate pro rata to Northern Ireland.

However, even if we accept that, we must question whether it is right to assume that there could not be a step change in the Northern Ireland economy’s FDI growth rate — over and above that experienced in the Republic of Ireland in recent years. Therefore, the Executive’s response to Varney II also flags up that concern.

The answer to the question is yes. There were some specific concerns about the first report that we are continuing to challenge in the second.

Dr Farry:

Looking to the future, the Minister said that the regional economic strategy will be informed by the Varney II discussions. When is that strategy likely to emerge? The major investment conference is imminent, and, given that these matters will still be a work in progress, I am concerned that we will go into the conference without a full knowledge and understanding of the Executive’s economic policies. Northern Ireland will only get one bite at that cherry.

Mr Brennan:

The regional economic strategy will very much be a work in progress. Varney II will really be the starting point of the process to revise the strategy. The assessment in Varney I was a good start, and we will see where we get to with Varney II, which must take on board the Programme for Government and reflect its key PSA goals for the economy. In addition, there must be engagement with the key stakeholder Departments. Given that the next Varney report might challenge existing economic policies, there is no point in the Department issuing a regional economic strategy now.

Dr Farry:

Nevertheless, if a potential investor wishes to use the conference as a platform for taking decisions, and he or she asks about the Executive’s economic policies for Northern Ireland, we will not be able to speak definitively, but merely give indications, because the process will not have been completed.

Mr Brennan:

We will be able to do two things. At a general level, we will be able to flag up six or seven strong, positive key points about Northern Ireland’s economic environment. Secondly, we will be able to flag up the Programme for Government’s key goals and aims, which specifically identify the skills and investment required for the types of jobs that we are attempting to attract. Specific measures such as investment in science, technology, engineering, maths and skills can send strong signals. Therefore, the key areas of interest for potential investors will be addressed. Granted, we will not be able to produce a glossy booklet outlining the new regional economic strategy, but we will be in a position to give potential investors a good steer on specific questions and on what we can offer.

The Chairperson:

With respect to the response to Varney I, the Committee has already written to the Executive because it wants to be appraised of their formal response or rebuttal. From your answer, it appears that no specific rebuttal was made. It seems that specific questions have been raised in submissions to Varney II rather than there being a formal response to Varney I.

Mr Brennan:

It has been an iterative process. The Varney team has been meeting Ministers and their officials directly, who have been relaying their individual concerns. There has been a series of engagements on the flaws that various Departments identified in the first report. The processes have been happening in parallel. The two fundamental concerns about Varney I have been addressed by the Executive: the FDI flow assumption and the exemption of banks and utilities. Those were the two big flaws in the first report from DFP’s perspective.

Mr Pengelly:

The other point is the sheer logistics involved, bearing in mind that Varney II was announced the same day that the Varney I Report was published. The timescale has been compressed to ensure that something tangible is in place before the investment conference is held. Everyone has been working flat-out to get the appropriate responses into Varney II. Ultimately, the Executive will want to consider Varney I and Varney II as a package.

Dr Farry:

I am concerned that there has not been a formal statement by a Minister — Peter Robinson or anyone else — on the Floor of the Assembly to give Members a chance to respond to Varney I. This is not a micro-issue in a silo in the Department of Finance and Personnel: it is one that has broad implications across our economy. The Department has identified a number of flaws. I know that the Institute of Chartered Accountants in Ireland has identified a wider range of issues: others will have their own lists of issues. I am concerned that the response to Varney I takes a narrow focus and does not reflect the wider concerns, not just in Government, but across the business community and in wider society too.

Mr Brennan:

To be blunt, a number of the concerns expressed — the “wider concerns”, as you put it — are simplistic. It is questionable whether the Executive would accept them as “wider concerns”, and whether there is any validity in them.

Dr Farry:

The report’s failure to acknowledge an all-island dimension to the Northern Ireland economy is one example. You may call it simplistic: I think it is fundamental.

Mr Brennan:

The first Varney Report did flag up —

Mr Farry:

No. What the first Varney Report did was to look at the economy and made comparisons with the Republic of Ireland, as two separate entities in the same island. It did not consider how Northern Ireland functions in the context in which we have a competitor separated from us by a land border. That dimension was ignored. That is the flaw with a London-centric approach; as opposed to a Belfast-centric approach, which would pick that up.

Mr Brennan:

The Executive’s first paper to Varney flagged up the North/South dimension and the uniqueness of our situation. That was reiterated in a number of meetings with the Varney team.

Mr Pengelly:

I think that the member’s substantive point is that, although the Executive made that point following Varney I, if it was not accepted by Sir David, has there been a rebuttal? As I said, it probably comes down to the logistics: given the compressed timetables of Varney II, the focus is completely on having a proactive engagement and achieving something in the end. The points you make are absolutely valid: we will relay them to the Minister and take his view on them.

The Chairperson:

That is helpful. As Chairperson, I am concerned because the Committee has written asking to be brought up to speed in respect of any responses. We have not yet received an answer. We will be pursuing that issue, as it falls within the entitlement of this scrutiny Committee.

Thank you very much, gentlemen.

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