On 15 January 2018, Carillion went into liquidation. It was a major construction, civil engineering and facilities management company in the UK and was involved in a large number of public- and private-sector projects. Many of these were as a partner in a joint venture with other companies.
It was the second largest supplier of construction and maintenance services to Network Rail, including HS2. It was also involved in the building of hospitals, including the new Royal Liverpool University Hospital and Midland Metropolitan Hospital in Smethwick. It also provided maintenance, cleaning and catering services for many schools, universities, hospitals, prisons, government departments and local authorities. In addition it was involved in many private-sector projects.
Much of the work on the projects awarded to Carillion was then outsourced to other companies, many of which are small construction, maintenance, equipment and service companies. A large number of these may themselves be forced to close as projects cease and many bills remain unpaid.
Many of the public-sector projects in which Carillion was involved were awarded under the Public Finance Initiative (PFI). Under the scheme, the government or local authority decides the service it requires, and then seeks tenders from the private sector for designing, building, financing and running projects to provide these services. The capital costs are borne by the private sector, but then, if the provision of the service is not self-financing, the public sector pays the private firm for providing it. Thus, instead of the public sector being an owner of assets and provider or services, it is merely an enabler, buying services from the private sector. The system is known as a Public Private Partnership.
Clearly, there are immediate benefits to the public finances from using private, rather than public, funds to finance a project. Later, however, there is potentially an extra burden of having to buy the services from the private provider at a price that includes an element for profit. What is hoped is that the costs to the taxpayer of these profits will be more than offset by gains in efficiency.
Critics, however, claim that PFI projects have resulted in poorer quality of provision and that cost control has often been inadequate, resulting in a higher burden for the taxpayer in the long term. What is more, many of the projects have turned out to be highly profitable, suggesting that the terms of the original contracts were too lax.
There was some modification to the PFI process in 2012 with the launching of the government’s modified PFI scheme, dubbed PF2. Most of the changes were relatively minor, but the government would act as a minority public equity co-investor in PF2 projects, with the public sector taking stakes of up to 49 per cent in individual private finance projects and appointing a director to the boards of each project. This, it was hoped, would give the government greater oversight of projects.
With the demise of Carillion, there has been considerable debate over outsourcing by the government to the private sector and of PFI in particular. Is PFI the best model for funding public-sector investment and the running of services in the public sector?
On 18 January 2018, the National Audit Office published an assessment of PFI and PF2. The report stated that there are currently 716 PFI and PF2 projects either under construction or in operation, with a total capital value of £59.4 billion. In recent years, however, ‘the government’s use of the PFI and PF2 models has slowed significantly, reducing from, on average, 55 deals each year in the five years to 2007-08 to only one in 2016-17.’
Should the government have closer oversight of private providers? The government has been criticised for not heeding profit warnings by Carillion and continuing to award it contracts.
Should the whole system of outsourcing and PFI be rethought? Should more construction and services be brought ‘in-house’ and directly provided by the public-sector organisation, or at least managed directly by it with a direct relationship with private-sector providers? The articles below consider these issues.
Articles
Carillion collapse: How can one of the Government’s biggest contractors go bust? Independent, Ben Chu (15/1/18)
The main unanswered questions raised by Carillion’s collapse The Telegraph, Jon Yeomans (15/1/18)
Carillion taskforce to help small firms hit by outsourcer’s collapse The Telegraph, Rhiannon Curry (18/1/18)
Carillion Q&A: The consequences of collapse and what the government should do next The Conversation, John Colley (17/1/18)
UK finance watchdog exposes lost PFI billions Financial Times, Henry Mance and George Parker (17/1/18)
PFI not ‘fit for purpose’, says UK provider Financial Times, Gill Plimmer and Jonathan Ford (6/11/17)
Revealed: The £200bn Cost Of ‘Wasteful’ PFI Contracts Huffington Post, George Bowden (18/1/18)
U.K. Spends $14 Billion Per Year on Carillion-Style Projects Bloomberg, Alex Morales (18/1/18)
Carillion may have gone bust, but outsourcing is a powerful public good The Guardian, John McTernan (17/1/18)
PFI deals ‘costing taxpayers billions’ BBC News (18/1/18)
Taxpayers will need to pay £200bn PFI bill, says Watchdog ITV News (18/1/18)
The PFI bosses fleeced us all. Now watch them walk away The Guardian, George Monbiot (16/1/18)
Carillion’s collapse shows that we need an urgent review of outsourcing The Guardian, David Walker (16/1/18)
Carillion collapse: What next for public services? LocalGov, Jos Creese (16/1/18)
Taxpayers to foot £200bn bill for PFI contracts – audit office The Guardian, Rajeev Syal (18/1/18)
Official publications
A new approach to public private partnerships HM Treasury (December 2012)
Private Finance Initiative and Private Finance 2 projects: 2016 summary data GOV.UK
PFI and PF2 National Audit Office (18/1/18)
Questions
- Why did Carillion go into liquidation? Could this have been foreseen?
- Identify the projects in which Carillion has been involved.
- What has the government proposed to deal with the problems created by Carillion’s liquidation?
- What are the advantages and disadvantages of the Private Finance Initiative?
- Why have the number and value of new PFI projects declined significantly in recent years?
- How might PFI projects be tightened up so as to retain the benefits and minimise the disadvantages of the system?
- Why have PFI cost reductions proved difficult to achieve? (See paragraphs 2.7 to 2.17 in the National Audit Office report.)
- How would you assess whether PFI deals represent value for money?
- What are the arguments for and against public-sector organisations providing services, such as cleaning and catering, directly themselves rather than outsourcing them to private-sector companies?
- Does outsourcing reduce risks for the public-sector organisation involved?
The linked articles below look at the state of the railways in Britain and whether renationalisation would be the best way of securing more investment, better services and lower fares.
Rail travel and rail freight involve significant positive externalities, as people and goods transported by rail reduce road congestion, accidents and traffic pollution. In a purely private rail system with no government support, these externalities would not be taken into account and there would be a socially sub-optimal use of the railways. If all government support for the railways were withdrawn, this would almost certainly result in rail closures, as was the case in the 1960s, following the publication of the Beeching Report in 1963.
Also the returns on rail investment are generally long term. Such investment may not, therefore, be attractive to private rail operators seeking shorter-term returns.
These are strong arguments for government intervention to support the railways. But there is considerable disagreement over the best means of doing so.
One option is full nationalisation. This would include both the infrastructure (track, signalling, stations, bridges, tunnels and marshalling yards) and the trains (the trains themselves – both passenger and freight – and their operation).
At present, the infrastructure (except for most stations) is owned, operated, developed and maintained by Network Rail, which is a non-departmental public company (NDPB) or ‘Quango’ (Quasi-autonomous non-governmental organisation, such as NHS trusts, the Forestry Commission or the Office for Students. It has no shareholders and reinvests its profits in the rail infrastructure. Like other NDPBs, it has an arm’s-length relationship with the government. Network Rail is answerable to the government via the Department for Transport. This part of the system, therefore, is nationalised – if the term ‘nationalised organisations’ includes NDPBs and not just full public corporations such as the BBC, the Bank of England and Post Office Ltd.
Train operating companies, however, except in Northern Ireland, are privately owned under a franchise system, with each franchise covering specific routes. Each of the 17 passenger franchises is awarded under a competitive tendering system for a specific period of time, typically seven years, but with some for longer. Some companies operate more than one franchise.
Companies awarded a profitable franchise are required to pay the government for operating it. Companies awarded a loss-making franchise are given subsidies by the government to operate it. In awarding franchises, the government looks at the level of payments the bidders are offering or the subsidies they are requiring.
But this system has come in for increasing criticism, with rising real fares, overcrowding on many trains and poor service quality. The Labour Party is committed to taking franchises into public ownership as they come up for renewal. Indeed, there is considerable public support for nationalising the train operating companies.
The main issue is which system would best address the issues of externalities, efficiency, quality of service, fares and investment. Ultimately it depends on the will of the government. Under either system the government plays a major part in determining the level of financial support, operating criteria and the level of investment. For this reason, many argue that the system of ownership is less important than the level and type of support given by the government and how it requires the railways to be run.
Articles
The case for re-nationalising Britain’s railways The Conversation, Nicole Badstuber (27/8/15)
Lessons from the Beeching cuts in reviving Britain’s railwa The Conversataion, Andrew Edwards (7/12/17)
Britain’s railways were nationalised 70 years ago – let’s not do it again The Conversation, Jonathan Cowie (1/1/18)
FactCheck Q&A: Should we nationalise the railways? Channel 4 News, Martin Williiams (18/5/17)
Britain’s railways need careful expansion, not nationalisation Financial Times, Julian Glover (5/1/18)
Right or wrong, Labour is offering a solution to the legitimacy crisis of our privatised railways Independent. Ben Chu (2/1/18)
Whether or not nationalisation is the answer, there are serious questions about the health of Britain’s railways Independent. Editorial (2/1/18)
Why Nationalising The Railways Is The Biggest Misdirect In Politics Huffington Post, Chris Whiting (5/1/18)
Questions
- What categories of market failure would exist in a purely private rail system with no government intervention?
- What types of savings could be made by nationalising train operating companies?
- The franchise system is one of contestable monopolies. In what ways are they contestable and what benefits does the system bring? Are there any costs from the contestable nature of the system?
- Is it feasible to have franchises that allow more than one train operator to run on most routes, thereby providing some degree of continuing competition?
- How are rail fares determined in Britain?
- Would nationalising the train operating companies be costly to the taxpayer? Explain.
- What determines the optimal length of a franchise under the current system?
- What role does leasing play in investment in rolling stock?
- What are the arguments for and against the government’s decision in November 2017 to allow the Virgin/Stagecoach partnership to pull out of the East Coast franchise three years early because it found the agreed payments to the government too onerous?
- Could the current system be amended in any way to meet the criticisms that it does not adequately take into account the positive externalities of rail transport and the need for substantial investment, while also encouraging excessive risk taking by bidding companies at the tendering stage?
Do you want to get drunk this festive season in the most tax efficient way: i.e. minimise the amount of tax you pay for the volume of alcohol that you drink? Do tax rates vary or are all alcoholic drinks taxed in the same or similar way?
The UK government imposes two different types of tax on alcohol. One is a specific or fixed tax per unit, referred to as excise duty or excise tax. This varies depending on the type of alcohol and is the focus of this blog. The other is VAT, which is 20% of the price for all alcoholic drinks. The price on which VAT is based includes the impact of the excise tax.
How does the implementation of excise tax differ between alcoholic drinks? Both the tax rate itself and the unit of output on which it is based vary: i.e. the volume of liquid vs the volume of pure alcohol within the liquid.
For example, with lager, beer and spirits the excise tax depends on the units of alcohol in the drink rather than the number of litres. The tax works in the following way. It is based on the alcohol by volume or ABV of the lager, beer or spirit. This is often displayed on the bottle or can. ABV is the percentage of the drink that is pure alcohol. Therefore, if a one-litre bottle of lager has an ABV of 1%, then 10ml of the bottle contains pure alcohol. Ten millilitres of pure alcohol is one unit of alcohol. If a one litre bottle of lager had an ABV of 5% it contains 5 units of alcohol.
Excise duties on spirits are the simplest of all the alcohol taxes. The rate for 2017/18 is 28.74p for each percentage of ABV or unit of alcohol in a one-litre bottle. Most spirits have an ABV of 40%. This means that there are 40 units of alcohol in a litre bottle and the excise tax payable on that bottle is £11.50 (40 × 28.74p). If a litre bottle had an ABV of 57%, such as Woods Navy Rum, then the excise tax would be or £16.38 (57 × 28.74p). Although the volume of liquid is the same in each case, the excise tax has increased by £4.88 because the alcohol content has increased.
For cider and wine the system is quite different. Within certain bands of alcoholic strength, the excise duty is based on the volume of the drink rather than by its ABV. For example, the excise tax on a litre of cider with an ABV of between 1.2% and 7.5% is 40.38p. This has the effect of reducing the tax rate per unit of alcohol as the alcoholic content of the cider increases (up to a limit of 7.5%). For example, the rate of excise tax per unit of alcohol for a litre bottle of cider with an ABV of 2% is 20.19p (40.38/2) whereas for a litre bottle of cider with an ABV of 7.5% it is just 5.39p (40.38/7.5). Wine is taxed in a similar way. A litre of wine with an ABV of between 5.5% and 15% is taxed at 288.65p per litre.
The excise tax rates per unit of alcohol for different drinks are illustrated below.
|
Drink
|
ABV
|
Excise tax per
unit of alcohol
|
| Beer/lager |
5%
|
19.08p
|
| Beer/lager |
8%
|
24.77p
|
| Spirits |
1-100%
|
28.74p
|
| Wine |
12.5%
|
21.90p
|
| Wine |
15%
|
19.24p
|
| Cider |
5%
|
8.08p
|
| Cider |
7.5%
|
5.39p
|
The table clearly shows that cider with an ABV of 7.5 per cent is by far the most tax effective way of consuming alcohol.
Although this blog is a rather light-hearted look at excise tax, it does help to illustrate the strange anomalies of the system used in the UK. Research by the Institute for Fiscal Studies (IFS) has indicated that heavier drinkers are more likely to switch between different alcoholic products in response to price changes. They also tend to drink products with more units of alcohol in them: i.e. spirits such as whisky and gin. For these reasons, the IFS has suggested that the excise tax rates on cider and spirits should be increased.
In the November budget, the Chancellor announced plans to introduce a new excise tax rate on still cider with an ABV of between 6.9% and 7.5%.
The excise taxes on cider and wine are based on the volume of liquid because of the European Community Directive 92/84/EEC. It will be interesting to see if the government changes this system to one based on alcohol content once the UK had left the European Union.
Articles
Budget 2017 – Why is white cider being taxed more? BBC News (22/11/17)
Is it time for a flat tax on alcohol – health campaigners can drink to that The Telegraph, Christopher Snowdon (15/2/17)
Traditional cider makers say tax on strong brands will hurt their business The Guardian, Rob Davies (22/11/17)
Minimum price would increase cost of 70% of alcohol BBC News (15/12/17)
Designing alcohol taxes IFS, Kate Smith (24/4/17) .
Questions
- Explain the difference between an ad valorem tax and a specific tax.
- Illustrate the impact of an ad valorem tax and a specific tax on a demand and supply diagram.
- What is the excise tax rate per unit of alcohol on a litre bottle of cider with an ABV of 6%?
- What is the economic rationale for imposing excise tax on alcohol?
- How will the external costs of consuming alcohol differ from those of smoking cigarettes? Draw a marginal external cost of consumption curve for both products to illustrate the difference.
- Compare the impact of increasing excise tax rates on cider and spirits with introducing a minimum unit price for alcohol.
- In April 2012 the government in England and Wales imposed a ban on ‘below cost’ pricing of alcohol. Explain how this policy works and what impact you think it has had.
We are coming into the big spending season, with Black Friday, Cyber Monday, the run-up to Christmas and then the winter sales. So will we all be rational maximisers and weigh up the utility we expect to receive from items against the price we pay (plus any other cost, such as time spent searching/shopping)? Or will we use a set of heuristics which make life easier and that we have found to be useful in helping us choose – heuristics such as buying things we’ve liked before, or going for things on special offer?
The answer is that we do probably use a set of heuristics, at least for many items. And don’t the retailers and the marketing firms they employ know this!
They will use all sorts of tricks of the trade to persuade us to part with our money. These tricks are designed to nudge us (or push us), without us feeling manipulated or conned – at least until we’ve bought their product.
And the tricks are getting more sophisticated. They include special offers which are not as good as they seem, time-limited offers which stimulate us to buy quickly without carefully thinking about what we’re doing, cunning positioning of products in shops to encourage us to buy things we had not planned to buy, adverts which play to our idealised perceptions or the ‘good life’ or what we would like to achieve, and packaging or display which make the product seem better than it is.
Also we are increasingly faced with targeted advertising where our smart devices capture information about our spending habits and tastes through our previous online spending or our search behaviour. This is then fed to advertisers to tailor adverts specifically to us on our mobiles, tablets, laptops and even, soon, on our smart TVs.
We may have a general desire to maximise utility from our spending, but market failures, such as consumers having imperfect information about products and a present bias (see also) in decision making, make us easy targets for the advertising and marketing industry. They understand the heuristics we use and try to take maximum advantage of them.
Happy shopping!
Articles
How shops use tricks to get you spending The Conversation, Cathrine Jansson-Boyd (16/11/17)
ColourPop looks to Qubit for next-gen personalization guidance Retail Dive, Dan O’Shea (13/6/17)
Channel 4 to offer 100% ad targeting across All 4 platform, seeking partners for linear equivalent The Drum, Jessica Goodfellow (14/11/17)
How Google aims to bring TV advertising into the 21st century The Drum, Ronan Shields (19/10/17)
How to Use Heuristics to Your Marketing Advantage MarketingProfs, Cam Secore (12/11/15)
Questions
- Does the use of heuristics contradict the assumption that consumers behave rationally?
- Give some examples of heuristics that you yourself use.
- Other than those identified above and in the first article, what ‘tricks’ might companies play on you to persuade you to buy their products?
- Is advertising personally targeted to individual consumers desirable for them?
- Give some examples of present bias in people’s behaviour.
- What factors should a retailer take into account when deciding whether to make pre-Christmas discounts?
- Explain what is meant by ‘affect heuristic’ and how the advertising industry uses the concept in setting the background to or scenario of an advertisement.
- Have you ever been persuaded into buying something you didn’t want? Why were you persuaded?
With first Houston, then several Caribbean islands and Florida suffering dreadful flooding and destruction from Hurricanes Harvey and Irma, many are questioning whether more should be spent on flood prevention and reducing greenhouse gas emissions. Economists would normally argue that such questions are answered by conducting a cost–benefit analysis.
However, even if the size of the costs and benefits of such policies could be measured, this would not be enough to give the answer. Whether such spending is justified would depend on the social rate of discount. But what the rate should be in cost-benefit analyses is a highly contested issue, especially when the benefits occur a long time in the future.
I you ask the question today, ‘should more have been spent on flood prevention in Houston and Miami?’, the answer would almost certainly be yes, even if the decision had to have been taken many years ago, given the time it takes to plan and construct such defences. 
But if you asked people, say, 15 years ago whether such expenditure should be undertaken, many would have said no, given that the protection would be provided quite a long time in the future. Also many people back then would doubt that the defences would be necessary and many would not be planning to live there indefinitely.
This is the familiar problem of people valuing costs and benefits in the future less than costs and benefits occurring today. To account for this, costs and benefits in the future are discounted by an annual rate to reduce them to a present value.
But with costs and benefits occurring a long time in the future, especially from measures to reduce carbon emissions, the present value is very sensitive to the rate of discount chosen. But choosing the rate of discount is fraught with difficulties.
Some argue that a social rate of discount should be similar to long-term market rates. But market rates reflect only the current generation’s private preferences. They do not reflect the costs and benefits to future generations. A social rate of discount that did take their interests into account would be much lower and could even be argued to be zero – or negative with a growing population.
Against this, however, has to be set the possibility that future generations will be richer than the current one and will therefore value a dollar (or any other currency) less than today’s generation.
However, it is also likely, if the trend of recent decades is to continue, that economic growth will be largely confined to the rich and that the poor will be little better off, if at all. And it is the poor who often suffer the most from natural disasters. Just look, for example, at the much higher personal devastation suffered from hurricane Irma by the poor on many Caribbean islands compared with those in comparatively wealthy Florida.
A low or zero discount rate would make many environmental projects socially profitable, even though they would not be with a higher rate. The choice of rate is thus crucial to the welfare of future generations who are likely to bear the brunt of climate change.
But just how should the social rate of discount be chosen? The following two articles explore the issue.
Articles
How Much Is the Future Worth? Slate, Will Oremus (1/9/17)
Climate changes the debate: The impact of demographics on long-term discount rates Vox, Eli P Fenichel, Matthew Kotchen and Ethan T Addicott (20/8/17)
Questions
- What is meant by the social rate of discount?
- Why does the choice of a lower rate of social discount imply a more aggressive climate policy?
- How is the distribution of the benefits and costs of measures to reduce carbon emissions between rich and poor relevant in choosing the social rate of discount of such measures?
- How is the distribution of the benefits of such measures between current and future generations relevant in choosing the rate?
- How is uncertainty about the magnitude of the costs and benefits relevant in choosing the rate?
- What is the difference between Stern’s and Nordhaus’ analyses of the choice of social discount rate?
- Explain and discuss the ‘mortality-based approach’ to estimating social discount rates.
- What are the arguments ‘for economists analysing climate change through the lens of minimising risk, rather than maximizing utility’?
