How to be conned: Part 2
I had promised not to go through line by line the so-called "academic study" (aka "Sutranet Work Package 2" hence SWP2) covered in my previous blog, but like watching some terrible disaster unfold before your eyes it holds a terrible fascination and it is difficult to look away. Having said that, it would normally be tempting and wise to completely ignore it, but it now appears it is being touted around Scotland (and quite possibly Brussels) as a serious "academic" study of the dreadful impact of state involvement in Scottish ferry services.
I am sorry about going into some detail here but it is necessary. Those with only a passing interest in these issues can skip to the Adam Smith bit at the end here, which basically explains everything.
I have been one of the strongest critics of SE policy in this area over the past several years but have always argued from the public interest perspective and took every available opportunity to make my criticisms directly to the Executive and to parliament.
During the first parliament (1999-2003) I argued strongly that an independent Regulator should be appointed in this sector. As UK experience had shown, this was an almost automatic safeguard when any essential service sector was opened up to competitive tendering. Apart from offering operational and strategy formulating opportunities, it would be potentially cost effective (cost reducing) in replacing a multitude of SE departments and sub-departments which had overlapping responsibilities in this area. And anyone who argues (as previous Ministers did) that an independent Regulator is not needed here should explain why policy makers dealing with other essential service sectors subject to competitive tendering feel the need for them - and to imagine what would happen if they did not have such a Regulator, and what would replace this role and function.
I also pointed out in a letter to the then Minister a year ago that an independent Regulator would also fulfill the role of an "independent authority" that the Commission said was necessary for the award of such tenders. As I note in that letter, the Commission actually stated in 2003 that for tendering such maritime services;
It may be possible to argue that SE evaluating bids and deciding to award tenders to SE-owned incumbents is a process consistent with SE being an "independent authority" in the meaning of the 2003 Commission Communication, for example, as I note in my letter it could be argued that Chinese Walls help prevent cross-contamination of bids and the evaluation process here.
But is is undeniably much more difficult to make such an argument than would have been (and would be) the case had an independent Regulator been appointed with one of his/her responsibilities being to carry out such duties.
It is also the case that SE evaluating and deciding bids from its own firm makes it much easier for firms to claim that was the process has been fixed to favour CalMac/Northlink, even if such claims are unreasonable and unfounded. An independent Regulator would have nullified much of the basis of lobbying and complaints such as in the so-called "academic study" (SWP2) referred to here. What we are now witnessing is the direct outcome of failures to adopt sensible and well-established policy solutions. If you think that having an independent Regulator is a waste of public money, just wait and see how much public money is liable to be wasted by not having one.
At the same time, there were elements of the proposed CalMac tender (if you decide you are going to have a tender) which I acknowledged years ago were sensible and consistent with the public interest and EC law here, these aspects included (a) tendering the Calmac routes as one bundle to facilitate economies of scale and scope (b) separating out route operations and vessel/infrastructure ownership into two separate companies. Route operations may be subsidised through PSOs under EC Maritime Cabotage law, but not the building or leasing of vessels under this law. Separating out the two aspects by creating two separate companies facilitated transparency in this process (c) using PSOs to justify subsidising aspects of route operations.
The explicit dropping of PSOs as a policy tool here in the second parliament 2003-2007 was a error about which I have written at length on these pages. Many of the restrictions in the CalMac and Northlink tenders are - and should be - interpretable as PSOs and this should be acknowledged retrospectively at the earliest opportunity.
With this background, I will make brief comments about some of the most egregious statements in SWP2 which prompted this note and the previous blog. One of the recurring themes of this SWP2 "report" is that state-owned ferry companies here fail to keep to their business plans and have called (and will call) for extra subsidy over and above that which was part of their original bid.
Absolutely right, and why has that been the case (and promises to be still the case in the future)? Because European case law here (as I have noted in the past) makes it clear that operators of a publicly subsidised tender can reduce subsidy attributable to loss-making activities (e.g provision for foot passengers) by cross-subsidising with profitable activities on the same services. But when you look at the history of why subsidy shoots up for the public operator on such services, as often as not it is because cherrypickers have come in and creamed off much of the demand for that profitable segment of a market, leaving the high cost rump to the public service, and increased subsidy as a consequence.
Many of those who have pursued or advocated such cherrypicking activities in the past were participants in the workshop which produced this Report. For them to complain about the actual or potential danger of the public service operator overshooting subsidy targets is a bit like muggers complaining about their victim's hospital bills. This would be laughable if some who should know better were not in danger of treating SWP2 seriously
Apart from that, perhaps one of the most remarkable statements in SWP2 is about a policy that was designed to do exactly the opposite from what the authors of SWP2 claim, they say;
Nothing could be further from the truth. Once the case for keeping the CalMac routes in one network bundle was made for economies of scale reasons (and such a case for route bundling was indeed successfully made, just as for the ScotRail rail network, and is legitimate under EC rules) then no-one could be expected to build (or find surplus to requirements) assets with a 20-30 life for a 5-6 year tender for an individual route, let alone an entire fleet. If instead the vessels (generally custom-designed for the routes) had been left in CalMac (the operator) ownership, that combined with incumbency would actually have strengthened that company's advantages against other bidders and made it impregnable. That is one reason why incumbents elsewhere in Europe have generally won the tenders even for just single routes - they own the ships necessary to carry out the business. As noted above the CalMac / VesCo solution is actually closer to the spirit (as well as the the letter) of EC law (by effectively opening up the tender process to other EC bidders) than are many solutions adopted elsewhere in Europe. Then SWP2 says;
The writers of this document do not even seem to know what the tenders refer to - Western Isles actually constitutes only a minority of the CalMac network routes (and tender). As far as specifying matters such as ports to be served, schedules and pricing is concerned, absolutely this is and should be the case and is recognised as such in the 1992 Maritime Cabotage Regulation which applies here (but which the authors do not refer to). Maximum prices, minimum frequency and schedules integrated with other forms of public transport such as rail and bus are basic elements in what should have been, and still should be, the specification of PSOs on a route by route. That is why they are called PSOs (Public Service Obligations) and not PPOs (Private Profit Opportunities). As far as specifying vessels is concerned, see my previous note above. Then SWP2 says;
For "inflexibility" of specifications (what should for the most part be termed PSOs), see above. As far the comment that "the inevitable yet unsatisfactory outcome of this is that the only bidder left to bid in recent tenders has been a state-owned carrier", the reality is that that not only do PSOs conditions reduce profit opportunities for commercial firms (which is the other side of the coin of the public service aspect), CalMac only has to make a deficit subsidy to fulfil its terms of reference in pursuit of these PSOs, a commercial firm would have to make a profit over and above this deficit subsidy to satisfy its shareholders. But the real clincher as to why CalMac/Northlink could be expected to win the current tenders is not because it is state owned, it is because it is a domestic firm that is the incumbent operator. Incumbency provides major advantages against entrants, as Western Ferries has well demonstrated in the Gourock-Dunoon route and as an SE background study on this issue showed;
So it is not surprising that CalMac had (legitimate) incumbency advantages
over other (commercial) firms in the bidding process. Indeed it would
have been amazing had it been otherwise. SWP2 concludes;
You are darned right it wouldn't, as a professional analyst of markets (efficient and inefficient) for more years than I care to admit, this is at least one point on which I could wholeheartedly agree with the authors of this Report. Not only does it not please me, if a student submitted it, I would tell them to go away, check the facts of the matter, do it again (or find some other more suitable line of study). It is a disgrace. But this is just one visible symptom of the malaise that the previous administration left this sector in. At the very least the new Scottish government needs to mount a robust rebuttal of nonsense like this wherever it appears, once thing is sure, this won't be the last of its kind.
I will leave the last word to Adam Smith. He would have immediately worked out what was happening in the gathering of commercial interests that constituted this "Workshop". But why, he would also have asked, was public money being used to subsidise this lobbyists convention?
Adam Smith got it just right. Someone should have passed on his sage advice (as relevant today as it was more than 230 years ago) to these bureuacrats who provided EC taxpayers money to help subsidise this farrago.
Neil Kay 29th July 2007