MR KEN MACIVER, MR JONATHAN WOOD, MR PETER BUDD AND MR DAVID MARSHALL

MONDAY 4 FEBRUARY 2002

  40. Last year you were concerned that the changes to the ECGD policy would have an adverse effect on the industry's competitiveness. The section of the memorandum headed "maintaining the UK aerospace investment climate" seems to bear that out. Can you elaborate on the problems you have experienced?
  (Mr Marshall) Yes, as you say, we brought it to your attention a year ago, the issue fundamentally being the government's plan to put ECGD into a trading fund status, which seemingly has the benefit of taking the Treasury out of the loop but in doing so, of course, as we have started to fear, risks making ECGD not competitive with other export credit agencies from other governments, hence a part of the competition that we are also in after we have done research and technology and the development, when we are trying to win the business, and we may find ourselves uncompetitive. That was the fear. I think we pointed out something like one third of ECGD's commitment is to the aerospace industry. If you add up the civil part and the military, we are probably their single biggest customer.

  41. Is that having an effect now?
  (Mr Marshall) Yes, it is. I will write to you privately. Obviously these deals are sensitive and there is no doubt that there have been times and there are times at the moment when that position of ECGD does not appear to be allowing companies to compete against competitors overseas, where their credit agencies are underwriting the risks. In a way ECGD has taken a harsher position since September 11 because the risk on some of those airlines has increased as a result. So, if you like, the problem is worse.

  42. That would help. We did do an investigation and we went to other countries about ECGD as well.
  (Mr Marshall) As yet the final position does not seem to have been settled. There was to have been a statement this month, I have not yet heard of one planned, on where it is going to finally settle. We are seeking to try to persuade ministers that we must not get ourselves in a situation where ECGD cannot be competitive. We need to establish to everybody's satisfaction that whatever status they go into they will be competitive with the US or other competitive countries.

  43. Chairman, could I just ask another question arising from the evidence. It is about the supply chain situation because you do say in your position paper on investing in the future, under your heading globalisation, that supply chains operate increasingly on a worldwide basis and you also talk about the present situation, where I think it is 82.5 per cent of the total number of companies United Kingdom based are responsible for 71.1 per cent of the value of contracts allocated in the sample years of the survey that you did and the Lean Manufacturing guide actually says that the aim would be to reduce the number of suppliers—supply base reduction. Do you think this is going to have an effect on the UK supply business to the aerospace industry, particularly the SMEs?

  (Mr Wood) Most of the SMEs do not directly avail themselves of ECGD.

  44. This is not connected with ECGD; that is just a question about the supply chain.
  (Mr Wood) Potentially, rationalisation of the supply chain within the UK certainly does affect UK SMEs. One of the things we have been working hard at is to become better SMEs, more effective, more lean, more able to go out into the global market-place and get opportunities of our own and not be so completely reliant upon UK buyers, for example. There is evidence of this happening. They just have to become better and we are becoming better. There is clear evidence of that through the programme that the Society has been operating, helped by the DTI. SMEs have increased their effectiveness in the region of 20 per cent generally.

  45. But you do not see the danger that the business would go outside the country?
  (Mr Wood) Ultimately, yes, it will if either political or market decisions are taken that those organising and running the contracts will deal with local supply chains.
  (Mr Maciver) That is correct. There is a tendency—it is decreasing—to look beyond our own boundaries so that Europe will become effectively a single market. Whether that would apply to the United States may take longer. You mention two trends. There is no question that companies like my own want strong suppliers at this level who in many cases can bring together products from other sub-suppliers. You may see a divide. In some parts of the world we take part in kits where they simply go into our assembly areas and they are assembled in a very short time indeed. We have some very, very good examples of this in this country. We have also seen some of the smaller companies making absolutely every effort, you are absolutely correct in what you say here, to improve. The fear I have is that there are some who still do not have sufficient awareness of this and therefore we will see perhaps fewer companies, hopefully a stronger base, but there will be some casualties and those companies which have not addressed productivity will suffer, particularly at a time like this when there is an overall squeeze on the industry. The SBAC has an excellent programme aimed at helping smaller companies on an affordable basis to achieve the right level of productivity and, indeed, to improve the way the whole supply chain works. So this is something that concerns all of us. It is not just the small companies but those that depend on them which are acutely concerned as well and want to see a strong supply base, but it will be, I think you will agree, a painful period.
  (Mr Wood) It certainly will be. It is and has been. The process of change in small companies is undoubtedly painful, just like it can be in larger organisations, but it is just tends to be a bit more personal. These times will be challenging. The good companies will survive and the bad ones will not.

  46. Can I just go back to the ECGD again. Our credit agency works along OECD rules and, by and large, our investigations have suggested that we are not maybe the most generous but we are not necessarily the worst. Could you be a wee bit more explicit? Is it the time taken to give decisions about underwriting or is it that they are being scared by the sums involved?
  (Mr Marshall) Whatever is causing them to do it, I think it is the need, first of all, that if they become a trading fund then they have to make a real rate of return at a level set. If that rate of return then forces them to take only certain risks in the market when they are lending on credit, then the portfolio of credit that they will take on is likely (and it looks to be turning out to be at the moment) to be less able to take on some of the risks associated with our industry.

  47. Are these risks in the civil sector or in the defence sector?
  (Mr Marshall) I think they are in both, but we are particularly noticing it in the civil sector post 11 September because, of course, the risk of some of those customers has gone up.

  48. Has the degree of default increased? How significant is the default?
  (Mr Marshall) I do not think the default is a significant issue. It is the perception that it is significant that is the issue.

  49. The OECD operates on a kind of, you might say, geographical basis as well in that it chooses certain countries and allocates amounts of money to them and decides, regardless of what the industry is, if that figure is exceeded or is near the top, then the chances are future contracts will not be underwritten until these matters are resolved. Have you done any analysis of that character to suggest that perhaps country A has reached its credit limit, as it were, or that the ECGD is not quick enough in moving from one country to another?. If a country does not use up all its credit and it is lying idle, perhaps another country could benefit from being allocated more credit if it was felt that they could meet their responsibilities?
  (Mr Marshall) The answer, Chairman, is, no, we have not done this analysis to see whether this is the cause. What we have done is pick up from the companies that come to us and say, "Look, I am having this problem and I am attributing it to the position that the credit agency is now taking and because I am in competition with the US or some other country, with a different credit agency, we appear to be disadvantaged because they are offering . . ."

  50. I appreciate you are the messenger but I think you have, with respect, a somewhat simplistic view of the nature of the problem because there are a number of criteria which are employed. To be perfectly frank, as far as the ECGD is concerned, I do not think it is the sharpest tool in the box, but I do not think by the same token we can necessarily blame them when they have a number of responsibilities across the industrial spectrum. That is a different matter. I wanted to get a feel there. It might be that you could provide us with additional information and we could take that up because obviously our ability to trade as a country is essential.
  (Mr Marshall) We are the only people moving our credit agency into this unusual status where essentially the Government will not be the lender of last resort.

  Chairman: There are a number of arguments about where we are. There is an awful lot of credit that can be achieved without going to government agencies at the present moment. It depends if they can go to one but they have gone to another.

  51. On the question of government support, what sort of support do you feel that you get from the DTI, particularly in relation to statistical help? Do you feel they do as good a job as other countries would get?
  (Mr Marshall) Statistical help in what sense?

  52. Industrial national statistics, in other words measures of productivity.
  (Mr Marshall) I hope I am not saying this wrongly but I think we probably provide the statistical input to them on our industry.

  53. You will want comparatives, will you not, it is a two-way flow?
  (Mr Marshall) They undertake work themselves. I think one of the problems we find is that because they work to a different coding system or a coding system that defines industry sectors it does not always line up with, if you like, the aerospace industry as it is now and so we often find comparisons difficult. I think we have a good understanding between us of what the industry is and, therefore, that work, if you like, is quite good. The support there, I do not think, is too bad or something that we would complain about. In other words, I think what I am saying is they understand our industry enough statistically not to be arguing with us about the numbers, it was not an issue on the research and technology issue.
  (Mr Maciver) There is a complete common understanding. In fairness to Mr Marshall and his colleagues a lot of the basis for that comes from the research work done within the SBAC itself. There is no disagreement.

  54. Given the movement within NATO and the SBAC towards member countries specialising in different aspects of defence what effect will this have on the United Kingdom aerospace industry?
  (Mr Maciver) I do not think that it has been discussed in the context of the aerospace industry. It would be quite a dangerous route to narrow down the basis of the industry, there would have to be a very high degree of trust entailed in that and I do not think that is a major issue for the short-term. Clearly there are some areas where we are stronger than others but in the broad terms we have a capability across the range. I do not think the discussions on specialisation which would apply certainly to some areas would apply to aerospace. The final platform, the aircraft or the uninhabited aerial vehicle, whatever it is, if it is a European it will certainly be a collaborative project and we will seek to participate in as broad a part of that product as possible.

  55. Is it likely that certain parts of the plane would tend to be made in a particular country?
  (Mr Maciver) That has been an issue in the past. We would much prefer to see a regime where business was assigned on merit rather than on a share out because that has been a very inefficient way of developing the industry in the past, especially where there are a number of instances where, in effect, we have taught people how to do things to enable them to participate in programmes. From a purely commercial point of view that is not desirable nor does it result in a strong industry long term. We would much prefer to see a commercial environment in which to work aerospace.

  56. Could I take you on to the possible fiscal incentives that might be of interest. In Annex D of your evidence you referred to the R&D tax credit scheme, which you say is a positive step forward but you have some criticisms of it. In relation to that R&D or to other things what are the kind of fiscal measures that you are looking at to maintain the right climate for investment in the United Kingdom, both for yourselves as an industry but more generally to encourage and boost investment in the country?
  (Mr Marshall) The one that we particularly latched on to was the announcement at the time of the last Budget when the government wanted to consider extending R&D tax credits to industry as a whole, not just limited to SMEs. We then undertook a consultation process, we were very energetic with other parts of industry and out of that came a clear message from the industry that the so-called volume scheme of judging our tax credits, where it is basically the total amount of R&D you spend, not an incremental amount from one year to the next, was what the industry felt was important. There are also very important issues about the definition of what is R&D, and that is important to us as well. From that consultation they announced most recently that they would now want to look at a volume scheme and have consulted on the nature of the volume scheme. We have put in evidence a submission that we wish for the most simple option they provided, we think a simple scheme is very important. We think one that gives wide coverage is very important because development, as well as technology, is hugely expensive in our industry and needs to be encouraged. Of course it needs to be a scheme that provides an adequate amount of funding. We do not know how much the Treasury are going to put aside for this but we hope that they follow that advice. We shall see when the Chancellor announces. That would probably be the most important incentive this year as opposed to business as a whole.

  57. If I can just press you a bit more on the issue of a volumetric scheme. I can understand that given the scale of investment required for your industry that makes sense to you, nevertheless the idea of the R&D tax credit, as I understand it, is that it is an incentive to get levels of investment up across the piece and, therefore, it would seem to me that something that is based on the incremental approach, boosting it from one year to the next or one period to the next, would feel like that is more related to increasing investment rather than providing subsidy for investment that would happen anyway. Am I wrong about that?
  (Mr Marshall) We felt you were in our submission.

  58. Why?
  (Mr Marshall) I suppose crucially what we do is to benefit the industry in this country. We do not want it to make that investment somewhere else. For example, a company like Rolls- Royce, which is in Canada as well as here, where there is a volumemetric R&D scheme if it starts to make comparisons, which is inevitably the case, between one regime and another a scheme that is less advantageous in our industry and will obviously worsen its position. I think that while, as has been pointed out, we are congratulated on being an industry, with a few others, at a world level of spend in R&D it is because the industry itself is prepared to spend as much as it does and because, at the other end of the scale, we know the government spends the least. This, in a sense, might be a way by which some of this is redressed. Its importance is in covering the whole R&D spectrum, not the research and technology spectrum.

  59. Just to clarify, the support for a volume based scheme is entirely based on the issue of international competition and mobility, it is nothing to do with incentive?
  (Mr Marshall) We think it would be an incentive to have a volume scheme.

  Richard Burden: Because of the internationals!

  Mr Berry: I notice in your submission you refer in very glowing terms to the Canadian situation, indeed you basically say that the government's decision to invest through R&D tax credits has enabled the industry to make substantial gains, etc, and that is what you identify as the driving force behind the progress made in Canada. Are you able to tell us how much the Canadian R&D tax credit scheme costs their Treasury?

  Chairman: You can send us a note on that.