hail shale - Institute of Directors

Big Picture
All hail shale
WINTER 2012/13

Big Picture
Published three times a year by the Institute of
Directors, Big Picture draws on the expertise of the
IoD Policy Unit and external contributors.
The purpose of Big Picture is to:
o Present leading-edge thinking;
o Highlight key public policy issues affecting business;
o Look over the horizon at strategic issues likely to
have an impact on business in the future;
o Provide an insight into public policy issues in an
accessible format;
o Suggest solutions to the ‘big picture’ questions facing
business.
IoD members are welcome to submit ideas to the journal, or articles for
possible publication. Please email Kathryn Allix at: kathryn.allix@iod.com.

Big Picture
Editor in Chief
Graeme Leach, Chief Economist and Director of Policy at the IoD
Policy Unit Editor
Mike Harris, Head of Policy Development at the IoD
Consultant Editor
Tom Nash
Sub Editor
Ingrid Farmer
Graphics and Design
Alex Grant
Production and Distribution
Lisa Robertson, Kathryn Allix
Cover illustration
Ian Dodds
CONTRIBUTORS
Corin Taylor
Senior Economic Adviser at the IoD
Dan Lewis
Chief Executive of Future Energy Strategies
Graeme Leach
Chief Economist and Director of Policy at the IoD
Alexander Ehmann
Head of Regulation and Employment at the IoD
Richard Baron
Head of Taxation at the IoD
James Stanfield
Director of Development at the E.G. West Centre at
Newcastle University
William Moore
Economic Intern at the IoD
© Copyright Institute of Directors, December 2012. All rights reserved.
Reproduction in whole or in part without written permission is strictly prohibited. Opinions expressed are
those of the authors and do not necessarily reflect IoD policy. The IoD accepts no responsibility for the
views expressed. Readers should consult their professional advisers before acting on any issue raised.

4 Big Picture
Contents
WINTER 2012/13
6
20
28
COVER STORY
All hail shale
Corin Taylor, Senior Economic Adviser
at the IoD, and Dan Lewis, Chief
Executive of Future Energy Strategies,
set out the benefits of shale
development in the US and examine
the enormous potential of Britain’s own
shale gas resources. They argue that
the Government should grasp the
opportunity to develop what could be
a vital part of this country’s future
energy mix.
Still going down?
Graeme Leach, IoD Chief Economist
and Director of Policy, looks at the
vulnerability of the euro and whether
recent interventions by the European
Central Bank have changed the game.
Industrial
inaction:
controlling the
super unions
Alexander Ehmann, Head of Regulation
and Employment at the IoD, considers
the rise of the ‘super unions’ and
proposes a range of reforms to update
the UK’s strike laws.

40
50
66
76
How to get rid of
corporation tax
Richard Baron, Head of Taxation at the
IoD, explains how we could improve
the tax system by eliminating
corporation tax.
Flying into
the future
In comprehensive new research, Corin
Taylor, Senior Economic Adviser at the
IoD, analyses the constraints on the
UK’s airport capacity and sets out a
holistic long-term plan to address the
country’s aviation challenges.
Profit in education
– not a dirty word
James Stanfield, Director of
Development at the E.G. West Centre
at Newcastle University, examines the
existing role played by for-profit
companies in the education sector, and
questions the prejudice against
extending their remit.
Future cities –
the survival of
the fastest
William Moore, Economic Intern at the
IoD, describes the future dynamics of
the world’s major cities.
5

6 Big Picture

SNAPSHOT
o The UK has not had many
positive energy stories in
recent years, but the
discovery and exploitation
of the country’s potentially
huge shale gas reserves
could prove to be just the
boost the economy needs.
o The UK has a major
opportunity to develop a
cheap and reliable
domestic source of energy,
creating jobs, reducing the
need for gas imports and
improving the environment
by replacing coal in
electricity generation.
o Cheap gas-fired turbines
powered by UK shale
resources could also prove
to be the perfect
complement to renewable
generation, providing
power when the wind isn’t
blowing and the sun isn’t
shining.
o The UK faces a range of
energy issues, from falling
North Sea production to
declining coal and nuclear
capacity. Shale gas
development does not
magically solve all the UK’s
energy problems, but it can
mitigate their impact.
o The Government should be
enthusiastic about
developing what could be a
vital part of the UK’s future
energy mix.
All hail shale
The UK could do with some good energy news. North Sea
production is declining. Our mostly foreign-owned utilities
are over-indebted, putting a major hurdle in the way of a
new nuclear programme. Fuel poverty is a serious worry.
The renewables programme is adding far more to industrial energy
costs than comparable programmes in our competitor countries.
And there is still a major question mark over carbon capture and
storage, without which coal has little future.
Gas will no doubt play a major role, not just as a bridging fuel or a
back-up to wind, but in its own right, providing relatively clean,
cheap and secure energy. Globally, we are poised to enter what the
International Energy Agency (IEA) has described as a “golden age of
gas”. 1
But that may come as little comfort to the UK, if it has to
import the vast bulk of its supply.
Fortunately, the UK has huge quantities of gas still to be tapped. And
advances in shale extraction technology are bringing these resources
closer by the day. Shale gas has the potential to make up for a good
part of falling North Sea gas production, generating local jobs, keeping
energy prices down, bringing in tax revenues, and cutting carbon and
improving air quality by replacing coal in electricity generation.
The UK has a massive opportunity, if the Government chooses to
embrace it.
THE US SHALE BOOM
All hail shale 7
Corin Taylor, Senior Economic Adviser at the IoD,
and Dan Lewis, Chief Executive of Future Energy
Strategies, set out the benefits of shale
development in the US and examine the enormous
potential of Britain’s own shale gas resources.
The UK is not the US, but there can be no understanding of this
country’s shale gas opportunity without a thorough grasp of how
unconventional production has transformed America.
Production
Since its 2005 low, US natural gas production has increased by
28%. Shale gas production has accounted for the bulk of this rise,
increasing from 0.39 trillion cubic feet (tcf) in 2000 to around 5
tcf in 2010, accounting for 23% of all US natural gas production.
By 2035, shale gas is expected to account for 49% of US natural
gas production.
1 International Energy Agency, Golden Rules for a Golden Age of Gas, 2012.

8 Big Picture
CHART 1
US natural gas production 1990-2035
Trillion cubic feet
30
25
20
15
10
5
0
History 2010 Projections
Source: US Energy Information Administration, Annual Energy Outlook 2012: Early Release Overview.
CHART 2
1990
1995
Alaska
2%
2000
2005
23%
26%
9%
9%
10%
21%
2010
Henry Hub Gulf Coast natural gas spot price
$ per million British Thermal Units
14
12
10
8
6
4
2
0
Shale gas
Tight gas
Non-associated offshore
Coalbed methane
Associated with oil
Non-associated onshore
2015
2020
49%
21%
7%
1%
7%
7%
9%
Prices
We need not be resigned to constantly rising power prices. US natural
gas prices are now at a 10-year low, while peak wholesale electricity
prices fell by 24-39% in the first six months of 2012. Shale gas is not
the only reason for these falls, but it certainly helps.
Source: US Energy Information Administration, ‘Natural gas spot and futures prices’.
2025
2030
2035
Jan 08
Apr 08
Jul 08
Oct 08
Jan 09
Apr 09
Jul 09
Oct 09
Jan 10
Apr 10
Jul 10
Oct 10
Jan 11
Apr 11
Jul 11
Oct 11
Jan 12
Apr 12

“US natural gas prices
are at a 10-year low,
while peak wholesale
electricity prices fell by
24-39% in the first six
months of 2012.”
All hail shale 9
US natural gas prices are now de-indexed from oil prices. In addition
to the rapid development of shale gas, a crucial part of this has been a
highly liquid trading hub – Henry Hub – which is located at the
crossover point of many major pipelines governing gas markets on the
East Coast of America. When oil prices began to increase again in
2009, natural gas prices continued to fall. All over the US, oil-linked
gas contracts have been torn up.
Industry and exports
US industry now benefits from some of the lowest natural gas prices in
the world, leading to production moving back to the US, especially in
the chemical industry. In a recent report, Citigroup projected that, by
2020, up to 3.6 million new jobs could be created in the energy
sector and the wider economy from the shale energy boom, boosting
GDP by 2.0-3.3%. 2
According to PwC, shale gas could save US manufacturers alone up to
$11.6bn a year in natural gas costs by 2020, while one million new
manufacturing jobs could be created by 2025. 3
LNG import terminals, constructed before the shale gas boom, are
now being refitted for export. The US Energy Information
Administration expects the country to become a net exporter of LNG
by 2016 and a net exporter of natural gas overall by 2021. 4
Environment
According to the International Energy Agency, US CO 2 emissions have
fallen by 450 million tonnes over the last five years, more than any
other country. There are several reasons for this, including the
recession, more efficient technology, increasing renewable generation,
and, importantly, the displacement of coal by gas for electricity
generation.
Shale oil potential
US unconventional production is not limited to shale gas. According
to Citigroup, shale oil production could increase more than four-fold
by 2020, from 0.7 million to 3 million barrels a day. Conventional
deep water production is also forecast to increase rapidly, while overall
US oil production could increase from 5.8 million barrels a day in
2011 to 10.2 million by 2020, surpassing its peak in the 1970s.
To say that this would be a massive change would be an
understatement. It would effectively re-localise oil market pricing and
signal the end of OPEC’s ability to keep oil prices high. We have
already seen this start to happen with the growing difference between
WTI (West Texas Intermediate) and Brent Crude oil prices – this is
perhaps not dissimilar to the de-indexation of Henry Hub gas prices
from the oil price.
2 Citi Global Perspectives & Solutions, Energy 2020: North America, the New Middle East? March 2012.
3 PricewaterhouseCoopers, Shale Gas: A renaissance in US manufacturing, December 2011.
4 US Energy Information Administration, Annual Energy Outlook 2012: Early Release Overview, p. 2.

10 Big Picture
TABLE 1
Trillion cubic
feet
Eastern Europe/
Eurasia
Middle East
Asia/Pacific
OECD Americas
Africa
Latin America
OECD Europe
World
“The IEA estimates
that shale reserves
alone are sufficient
for 60 years of
global gas
production.”
Total
reserves
6,145
4,838
4,520
4,308
2,613
2,507
1,978
26,557
A ‘GOLDEN AGE’ OF GAS
But it is not just the US. Shale and other unconventional gas
resources have enormous global potential.
Reserves
The International Energy Agency estimates technically-recoverable gas
reserves at 27,000 tcf, including 12,000 tcf of unconventional reserves,
of which shale accounts for 7,000 tcf. Shale reserves alone are sufficient
to account for 60 years of total global natural gas production. 5
These reserves are widely distributed, with almost every region of the
world, apart from the Middle East, possessing large shale gas deposits.
Remaining technically-recoverable natural gas resources at end-2011
Of which
conventional
reserves
4,626
4,414
1,236
1,589
1,307
812
848
14,868
Of which
unconventional
reserves
1,519
424
3,284
2,719
1,307
1,695
1,130
11,689
Unconventional Unconventional
of which shale of which tight
gas
gas
424
141
2,013
1,978
1,059
1,165
565
7,346
Production
There is of course a difference between technically-recoverable
reserves and those that are economic to recover – and the latter will
always be smaller than the former. But production forecasts are
similarly impressive.
According to the International Energy Agency, provided shale gas is
developed at scale outside of the US, world natural gas production
could rise by more than 50% by 2035, with unconventional
production accounting for around a third of the total. In this scenario,
gas accounts for 34%, and renewables 31%, of global energy demand
growth. BP’s forecasts are similar. 6
The basic story, then, is quite straightforward. There are large global
reserves of unconventional natural gas; unconventional production is
likely to account for an increasing share of global gas production; and
natural gas will become an increasingly important energy source, as
demand for coal and oil starts to flatten out. Gas and renewables are
likely to be the biggest energy growth stories over the next few decades.
353
283
706
424
247
530
106
2,684
Unconventional
of which coalbed
methane
706
0
565
318
0
0
71
1,660
Source: International Energy Agency, Golden Rules for a Golden Age of Gas, 2012, Table 2.1 (converted to trillion cubic feet).
5 International Energy Agency, Golden Rules for a Golden Age of Gas, 2012, Tables 2.1 and 2.6 (converted to
trillion cubic feet).
6 BP, Energy Outlook 2030, January 2012.

“The basic story is
straightforward. Gas
and renewables will be
the biggest energy
growth stories in the
next few decades.”
BOX 1
Estimates of the UK’s shale gas reserves
THE UK’S POTENTIAL
All hail shale 11
The UK may not experience a US-style shale boom, but our shale
resources have enormous development potential. UK shale gas could
help to support a cleaner, cheaper and more secure energy system.
LNG imports from the US – not viable
The first part of this article described the immense benefits that shale
gas has brought to the US and the future export potential. Given that
UK gas currently costs around $8-9 per million British Thermal Units
(MMBTU), compared to US gas costing $2-3 per MMBTU, it might be
tempting to believe that the UK can import large quantities of cheap
US gas in the years ahead. Unfortunately, at current production,
liquefaction and shipping costs, it doesn’t look likely:
o Firstly, Pacific Basin gas prices are far higher than those in the
UK, so the most profitable export route will always be to Asia
rather than Western Europe.
o Secondly, and more importantly, some energy analysts forecast a
return from the current $3 Henry Hub gas price to $5 in the near
future. With the costs of export currently around $4 per MMBTU,
exporting gas to the UK would actually be a loss-making
enterprise, unless UK gas prices increased substantially.
This view was confirmed in a recent Deutsche Bank report, which
forecast that, once transportation costs were taken into account, US
LNG would be no cheaper than the UK’s own National Balancing
Point (NBP) gas price. 7
The UK is therefore unlikely to be importing
US gas at scale anytime soon. As a country, we have to look to our
own resources.
UK shale resources
Estimates of UK shale resources are being constantly updated, as the
UK is still in the exploration stage, but the prospects look very
promising indeed, as Box 1 illustrates.
o In 2010, the British Geological Survey (BGS) estimated the UK’s onshore shale reserves at 5.3 trillion
cubic feet. At the time of writing, the BGS was set to revise its onshore data substantially upwards,
possibly to as high as 200 tcf.
o The exploration companies themselves have far higher estimates from their onshore fields: Cuadrilla
– 200 tcf; Dart Energy – 76 tcf; Eden Energy – 12.8 tcf; IGas – 4.6 tcf. This adds up to nearly 300 tcf
in total.
o Offshore reserves could be far higher still. The BGS has said that they could be 5-10 times larger
than onshore reserves – potentially up to 1,000 tcf. Offshore reserves are, however, far harder to
extract.
o By comparison, UK gas consumption runs at around 3 tcf a year.
7 “Price of US LNG at parity with UK NBP prices from 2016 – Deutsche Bank”, Gas to Power Journal, Friday 3
August 2012.

12 Big Picture
“The UK’s shale
resources have
enormous potential
and could support a
cleaner, cheaper and
more secure energy
system.”
CHART 3
Recovery rates, though, do vary by location and geology. In the US,
shale gas recovery rates average 18%. 8
There may be reasons to
expect recovery rates in the UK to be lower:
o UK shale gas may or may not be harder to recover, given the
different geological conditions and greater population density.
o UK planning laws are more stringent.
o In the UK, unlike in the US, mineral ownership rights belong to
the Crown Estate and not the landowner, meaning that the
landowner may have less incentive to allow shale drilling.
Nevertheless, technological improvements are increasing the proportion
of reserves that are economic to recover. And UK reserves may be of
good quality. According to Cuadrilla, the Bowland Shale is around 10
times thicker than leading US shale gas plays – although it is still early
days, recovery in the UK could potentially be quite rapid.
The UK’s energy squeeze
The UK is experiencing and will experience a number of problems
with its energy supply:
1. Gas production from the UK Continental Shelf has declined
rapidly over the last decade, from 103 to 41 million tonnes of
oil equivalent per annum. By 2030, production is expected to
fall to just 18 million tonnes of oil equivalent. The number of
people employed directly and indirectly by the oil and gas
industry, currently 440,000, will therefore fall.
2. Gas imports are rising rapidly. In 2000, the UK produced 13%
more gas than it consumed, which it exported. In 2011, it
produced 49% less than it consumed, which it imported. By 2030,
imports are projected to increase to 74% of consumption.
Declining North Sea gas production and gas imports as a percentage of demand
Million tonnes of oil equivalent
120
100
80
60
40
20
0
Net UKCS production
Projected net UKCS production
(Left-hand scale)
8 Centre for Global Energy Studies, July 2010.
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
Gas import dependency
Projected gas import dependency
(Right-hand scale)
Source: Department of Energy and Climate Change, UKCS Oil and Gas Production Projections, March 2012.
80%
70%
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
Net gas imports as % of net gas demand

“Carried out carefully
and under thorough
regulation, fracking is
no more dangerous
than conventional
extraction.”
3. The UK’s energy and climate policies are adding more to
industrial electricity prices than comparable programmes in
competitor countries, putting UK industry at a disadvantage
and making a rebalancing of the economy more difficult. By
2020, US policies are projected to add nothing to industrial
electricity prices, Chinese policies to add £10 per megawatt
hour (MWh), German policies to add £17 per MWh and British
policies to add £28 per MWh, of which £20 will be accounted
for by the costs of the renewables programme.
4. The proportion of households in fuel poverty has risen from
6% in 2003 to 16% in 2010. So far, most of the rise has been
due to the impact of higher gas prices, but the latest Department
of Energy and Climate Change projections show that
renewables subsidies and other climate and energy policies are
set to add 7% to domestic gas prices and 27% to domestic
electricity prices by 2020. Improved energy efficiency may
reduce the bill impact, but fuel poverty could rise still further.
5. By 2020, the UK is set to lose around 20GW of coal and
nuclear generation, around a fifth of total electricity
generating capacity. A new nuclear programme is vital, but will
not achieve scale until sometime after 2020, while carbon
capture and storage (CCS), which is vital for coal generation to
continue, is not yet proven commercially.
An economic boost
Developing UK shale does not solve all of these energy problems on
its own, but it could make a major contribution to mitigating their
impact, providing a major economic boost.
In the US, where shale gas recovery rates average 18%, shale gas
production increased from virtually zero to sufficient to meet over a
fifth (22%) of US natural gas consumption in only a decade. If, over
the next 10 years, the UK is roughly half as successful on both
measures as the US has been over the last 10 years, it would mean
that shale gas could account for around 10% of 2011 UK gas
consumption, and that around 10% of the UK’s onshore shale reserves
prove to be economic to recover.
If, in this way, the UK is half as successful at developing shale gas as
the US, the benefits could be enormous, as Box 2 sets out.
THE ENVIRONMENT
It is impossible to talk about shale gas without discussing the
environmental concerns. Using gas in place of coal for electricity, and
in place of petrol and diesel for road transport, would lead to big
improvements in air quality and a reduction in CO 2 emissions. The
process of extracting shale gas, however, has been heavily criticised on
environmental grounds. But if carried out carefully and under
thorough regulation, hydraulic fracturing (‘fracking’) is no more
dangerous than conventional hydrocarbon extraction.
Air quality and carbon emissions
In 2011, the UK used 42 million tonnes of coal in electricity
All hail shale 13

14 Big Picture
BOX 2
Estimating the economic benefits of shale for the UK
The following are very indicative calculations, designed to provide an appreciation of the big picture
surrounding UK shale:
o In 2011, the UK consumed 2.9 tcf of gas. 10% of 2011 UK gas demand is therefore 0.29 tcf. If 10%
of the 300 tcf of onshore reserves estimated by the exploration companies were economic to
recover, then 30 tcf would be sufficient to meet 10% of current UK gas demand for 103 years.
o 10% of 2011 UK gas demand is equal to 8 million tonnes of oil equivalent, 8% of total UK oil and gas
production in 2011. The UK oil and gas industry provides direct and indirect employment for 440,000
people. Assuming that jobs are directly proportional to production, then an extra 8% of 2011
production would generate 35,000 extra jobs, helping to offset job losses from a decline in
conventional oil and gas production in the UK.
o Between 2011 and 2022, conventional UK gas production is forecast to decline by 13 million tonnes
of oil equivalent. If shale production rose to 8 million tonnes of oil equivalent, it would offset 60% of
the projected fall in conventional production.
o 8 million tonnes of oil equivalent also represents 20% of projected UK gas imports in 2022. This
would be sufficient to keep gas imports at the 2011 level of 49% of demand, rather than imports
rising to a projected 59% of demand.
generation, 9
emitting around 90 million tonnes of CO2. 10
Were this to
be replaced with gas, which emits around half as much carbon, the
UK could save around 45 million tonnes of CO2, around 8% of the
2011 total. Although UK shale is unlikely to be sufficient to replace all
coal-fired generation, it could make a major contribution to
decarbonisation in its own right, as well as supporting the further
development of renewables.
According to DECC’s projections, around 25GW of renewable
generation will be added to the grid by 2020, much of which will be
in the form of intermittent sources such as wind and solar. UK shale
gas can support this development, ensuring that the lights stay on
when the wind isn’t blowing and the sun isn’t shining.
Natural gas emits far fewer particulates and other pollutants than coal
and diesel. Using natural gas in place of coal for electricity generation
and switching over buses and other vehicles to natural gas could
reduce the 29,000 annual deaths from poor air quality in the UK. 11
Hydraulic fracturing
There are several environmental issues associated with hydraulic
fracturing, detailed in Table 2. They are not to be taken lightly, but at
the same time must be put into perspective.
Good practice can significantly reduce many of these environmental
risks. Multiple casing of wells ensures that fracking fluid cannot enter
the water table, while proper site construction and disposal of fracking
fluid will ensure that there are no surface leaks. Real-time seismic
monitoring minimises earthquake risks.
9 Department of Energy and Climate Change, Digest of UK Energy Statistics (DUKES), Annual Tables, Table 2.7,
‘Supply and consumption of coal’.
10 Department of Energy and Climate Change, 2011 UK Greenhouse Gas Emissions, Provisional Figures, March
2012, Figure 3.
11 Simon Moore and Guy Newey, The forgotten crisis of Britain’s poor air quality, Policy Exchange, July 2012.

BOX 3
What is fracking?
In the early 1980s, George Phydias Mitchell, a Texan born to Greek parents, came up with the radical idea of
drilling much deeper into the gas-bearing shale rock to extract natural gas. After nearly 20 years of
experimentation, his company finally found the right formula for the economic exploitation of tight shale gas.
Hydraulic fracturing, or ‘fracking’, literally breaks open the rock along fractures and releases the trapped
gas. This is done by firing a cheap combination of high pressure water, sand as a propping agent to
open up the fractures, and some chemicals. These follow after the vertical well has been drilled, which
is encased with steel and concrete to prevent the well’s collapse and the escape of gas or fracking fluid.
A more recent discovery has been to drill horizontally outwards from the vertical well as far as 5,000
feet. Hydraulic fracturing horizontally requires much more water but it also means that one drill pad can
cover a much larger area and extract much more gas. This is known as multi wellpad drilling.
The fracking itself only lasts a few weeks but the well will keep producing gas for 30-40 years as it
would typically be connected to the gas network.
TABLE 2
Environmental risks of hydraulic fracturing
RISK
Water
Methane migrating to the water
table as a result of drilling
Chemicals used in the fracking fluid
polluting ground and surface water
Large quantities of water
Earthquakes
Earthquakes caused by the fracking
process
Fugitive emissions
Leaks from the shale wells of
methane or other pollutants
PERSPECTIVE
Methane can sometimes migrate in any case, although any
migration caused by fracking needs to be taken seriously.
The chemicals used in fracking fluid are generally less than 0.5%
of the total, and are used in all walks of life. For example, Sodium
Chloride is salt, Polyacrylamide is used for water treatment and in
cosmetics, Borate salts are found in laundry detergent, Citric Acid
is used in food additives and Sodium/Potassium Carbonate is
found in ordinary detergents. Disposing of chemicals safely is not
a unique problem for shale gas drilling.
Large quantities of water are, of course, used in many industrial
and leisure activities.
In 2011, two earthquakes were caused by the activities of Cuadrilla,
one measuring 1.5 and the other measuring 2.3 on the Richter
scale. For comparison, the British Geological Survey publishes a
record of earthquakes around the British Isles in the last 50 days.
Based on a search conducted on 15 August 2012, in the previous 50
days there were five earthquakes measuring more than 1.5, of
which two measured 2.3 and one 2.7. 12
Coal mining has also
caused earthquakes of a similar magnitude for a long time. It
should also be noted that earthquake magnitudes are exponential,
not linear. According to the British Geological Survey, an earthquake
below 3.0 is generally not even felt, let alone the cause of damage.
Not a problem uniquely confined to shale gas wells, but to coal
mining as well.
12 British Geological Survey, ‘Earthquakes around the British Isles in the last 50 days; Last updated:
13.40, Wednesday August 15, 2012’.
All hail shale 15

16 Big Picture
TABLE 3
Environmental controls in England and Wales
RISK
Groundwater pollution
Surface spills
Disposal of used fracking fluid
Over-abstraction of water
Fugitive methane emissions
“Earthquakes caused
by hydraulic fracturing
are no larger than
those that have been
caused by coal mining
for years.”
The UK has numerous regulatory bodies (including the Department of
Energy and Climate Change, the Environment Agency and the Health
and Safety Executive) and regulations to monitor and oversee the
drilling process, as outlined in Table 3.
CONTROLS
Water Framework Directive and Groundwater Daughter Directive
through the Water Resources Act and Environmental Permitting
Regulations (EPR). These regulate discharges to groundwater
and require disclosure of chemicals.
Planning regime for site construction standards. The EPR
regulate discharges to surface water and groundwater.
Mining Waste Directive through the EPR. A waste management
plan must be approved by the Environment Agency. Euratom
Treaty applies if there are naturally occurring radioactive
materials, via the EPR.
Abstraction licensing under the Water Resources Act.
Borehole regulations (Health and Safety Executive) to protect
human health. Conditions under Petroleum Licences (DECC) for
flaring and venting. Mining Waste Directive may apply.
Source: Tony Grayling, the Environment Agency’s Head of Climate Change and Communities, Managing the environmental
risks of shale gas extraction, Presentation to the UKERC Annual Assembly, University of Warwick, 20 June 2012.
Safety
Several scientific reports on safety in the UK have also been published,
including by the Energy and Climate Change Select Committee,
DECC, and the Royal Society and Royal Academy of Engineering (see
Box 4 for more details). The findings of these reports include:
o Carried out properly and under strict regulation, hydraulic
fracturing is safe.
o Problems are generally due to poor standards, rather than the
hydraulic fracturing process itself.
o Environmental issues are generally little different from those of
conventional hydrocarbon extraction.
o Earthquakes caused by hydraulic fracturing are no larger than
those that have been caused by coal mining for years.
In the US, over 20,000 shale wells have been drilled. The US Environmental
Protection Agency is currently undertaking a major study on the safety of
hydraulic fracturing. Although there have been problems at a small
number of wells, these are generally due to poor practice, rather than the
nature of the process itself. The UK, of course, has the opportunity to learn
from mistakes made in the US.
The International Energy Agency has also set out a number of ‘golden
rules’ for unconventional gas exploration to address environmental
concerns. Following these golden rules would add at least 7% to
costs, but would make significant shale gas development outside of
North America far more acceptable. 13
13 International Energy Agency, Golden Rules for a Golden Age of Gas, 2012.

Looking at the views of insurers is crucial to understanding the
environmental risks of hydraulic fracturing, as their conclusions will
affect their own profits. A recent report from the major insurance
brokerage Willis found that, if best practice is followed, there is no
reason for insurers to deny cover. The report concluded:
“While hydraulic fracking operations will continue to pose a measure of
pollution and contamination risk – just like the upstream oil and gas
industry or any other industrial process in general – the extent of the
problem has, in some quarters of the media at least, perhaps been blown
somewhat out of proportion...
“Our study has shown that cover is much more likely to be provided to
those buyers who can demonstrate that they have completely bought into
the highest standards of the industry. Indeed, the contrast between
contractors who do indeed adhere to these standards and those who do
not is already very pronounced.” 14
Shale gas and the technique used to extract it attract strong views on
either side of the debate. An examination of the evidence base
indicates that the environmental risks of hydraulic fracturing should be
placed alongside those of conventional hydrocarbon extraction. In
other words, the risks of fracking should not be put in a class of their
own. Should hydraulic fracturing be no more risky than conventional
14 Willis, All Fracked Up? Just how concerned should energy insurers be about hydraulic fracturing? Energy
Market Review, April 2012, p. 28.
All hail shale 17
A drilling rig in the Tioga State Forest, Pennsylvania

18 Big Picture
BOX 4
Conclusions of UK scientific reports on the safety of hydraulic fracturing
Energy and Climate Change Committee, May 2011:
“There is no evidence that the hydraulic fracturing process poses any risk to underground water aquifers
provided that the well-casing is intact before the process commences. Rather, the risks of water
contamination are due to issues of well integrity, and are no different to concerns encountered during the
extraction of oil and gas from conventional reservoirs. However, the large volumes of water required for
shale gas could challenge resources in regions already experiencing water stress.” 15
Report commissioned by DECC on the Cuadrilla earthquakes, April 2012:
“Based on the induced seismicity analysis done by Cuadrilla and ourselves, together with the agreement to
use more sensitive fracture monitoring equipment and a DECC agreed induced seismic protocol for future
operations, the authors of this report see no reason why Cuadrilla Resources Ltd. should not be allowed to
proceed with their shale gas exploration activities and recommend cautious continuation of hydraulic
fracture operations at the Preese Hall site. In respect of future shale gas operations elsewhere in the UK, we
recommend that seismic hazards should be assessed prior to proceeding with these operations.” 16
Royal Society and Royal Academy of Engineering, June 2012:
“Natural seismicity in the UK is low by world standards. On average, the UK experiences seismicity of
magnitude 5 ML (felt by everyone nearby) every twenty years, and of magnitude 4 ML (felt by many people)
every three to four years. The UK has lived with seismicity induced by coal mining activities or the
settlement of abandoned mines for a long time. British Geological Survey records indicate that coal miningrelated
seismicity is generally of smaller magnitude than natural seismicity and no larger than 4 ML.
Seismicity induced by hydraulic fracturing is likely to be of even smaller magnitude. There is an emerging
consensus that the magnitude of seismicity induced by hydraulic fracturing would be no greater than 3 ML
(felt by few people and resulting in negligible, if any, surface impacts. Recent seismicity induced by
hydraulic fracturing in the UK was of magnitude 2.3 ML and 1.5 ML (unlikely to be felt by anyone).” 17
hydrocarbon extraction, it follows that there can be net benefits to
the environment from using unconventional gas in place of coal in
electricity generation and oil in road transport.
CONCLUSIONS
Shale gas development does not magically solve all the UK’s energy
issues. North Sea production will still fall, the renewables programme
will still increase energy prices for industry, and coal and nuclear will
still decline in capacity. But what shale gas development can do is
mitigate the impact of these trends, providing a big economic boost
in the process:
o Shale gas development can counter falling North Sea production,
halting the increase in gas imports.
o UK shale gas can offer a cheap and reliable energy source for
industry, potentially reducing the number of job losses.
o Shale gas can also help to reduce price rises for consumers,
reducing the number of people in fuel poverty.
15 House of Commons Energy and Climate Change Committee, Shale Gas: Fifth Report of Session 2010-12,
May 2011.
16 Dr Christopher Green, Professor Peter Styles and Dr Brian Baptie, Preese Hall Shale Gas Fracturing: Review
and Recommendations for Induced Seismic Mitigation, April 2012.
17 The Royal Society and the Royal Academy of Engineering, Shale gas extraction in the UK: A review of
hydraulic fracturing, June 2012.

BOX 5
The views of IoD members
All hail shale 19
o Expanding renewables creates jobs directly, and so can
developing shale gas, especially in less affluent parts of the country.
o With coal and nuclear set to decline in importance, at least
before new nuclear power stations come on stream, new gas
plants powered by UK shale can help to fill the electricity
generation gap, as well as acting as a vital back-up to wind and
other renewables.
A mix of power sources is vital, and domestic shale gas is unlikely to
account for a majority of the UK’s electricity generation, or even of its gas
usage. But it could and should play an important role. In the US, shale gas
accounts for around a quarter of overall gas production, and yet that has
been sufficient to revolutionise the gas market, cutting costs for industry
and replacing coal in electricity generation. The same economic and
environmental benefits could be realised in the UK, if we allow shale
development to happen.
Our own research into the views of IoD members found them to favour careful, well-regulated shale gas
development in the UK. To inform the IoD’s research in this area, 1,095 IoD members were surveyed in a
Policy Voice poll in April 2012. Their views were not unanimous, but were positive overall. 58% thought
that extensive development of the UK’s shale reserves would have a positive impact on British
businesses. Just over a third (36%) thought that the risks of hydraulic fracturing were significant. By
comparison, 17% thought that the risks were insignificant and 27% that they were neither significant
nor insignificant (19% did not know). Almost half (48%) agreed that the benefits outweighed the risks,
compared to 18% who thought that the risks outweighed the benefits.

20 Big Picture

SNAPSHOT
o The eurozone remains highly
vulnerable to a break-up
between the core and
peripheral economies. The
centrifugal forces pulling the
euro apart remain stronger
than the centripetal forces
holding it together.
o The survival of the euro in its
current form depends on
huge purchases of peripheral
country bonds by the ECB –
the ‘Draghi Plan’ – to drive
down yields. But even this
only provides a temporary
solution, buying time.
o The competitive losses in
the peripheral economies
are so large that external
devaluation (euro exit) will
probably prove more
attractive than internal
devaluation (decade-long
austerity, sharp falls in
wages and massive
unemployment).
o The Draghi Plan is
conditional on peripheral
economies accepting further
austerity measures and an
erosion of fiscal sovereignty.
There is no certainty that
countries such as Spain will
sign such a memorandum
with the ‘Troika’ – the ECB,
EU and IMF.
o If the monetary option fails
(monetisation of debt), the
fiscal option (mutualisation
of debt) is even less likely to
succeed. Hybrid solutions,
such as issuing a banking
licence to the European
Stability Mechanism (ESM)
rescue facility, are not likely
to gain traction.
Still going
down?
Still going down? 21
Graeme Leach, IoD Chief Economist and Director
of Policy, looks at the vulnerability of the euro
and whether recent interventions by the
European Central Bank have changed the game.
In the Spring edition of Big Picture, I argued that the eurozone
was heading for a break-up in 2012. 1
Slightly tongue-in-cheek, I
speculated that the break-up might come in time for some cheap
summer holidays in the ‘Club Med’ economies this year.
Clearly the break-up hasn’t happened yet. Do I still think the euro is
‘going down’? My best response to this question is to quote the
economist Rudiger Dornbusch:
“In economics things take longer to happen than you think they will,
and then they happen faster than you thought they could”.
The main argument of this article is that the centrifugal forces
pulling the euro apart are still stronger than the centripetal forces
holding it together. However, the proposed ‘Draghi Plan’ does
provide a temporary way out, if it were to be fully implemented. 2
As
Daily Telegraph economics correspondent Jeremy Warner has
written, “Mr Draghi has at least managed to buy a bit more time.
The endgame has been pushed further, possibly quite a lot further,
into the future”.
The IoD has consistently argued that massive bond purchases by the
ECB (unlimited open market operations) to drive down bond yields
in the peripheral economies would provide a way out of the crisis.
Our consistent position has been that it would work, but was highly
unlikely to happen on the required scale.
What has changed recently is that ‘Super Mario’ has managed to
persuade the ECB board – and enough German politicians – that
outright monetary transactions are necessary because the
‘convertibility risk’ of the euro is threatened by speculation about a
break-up (see below). Using this argument enables him to outflank
the criticism that bond purchases are merely printing money to
finance public debt.
Speculation alone over the potential impact of the Draghi Plan was
sufficient to calm financial markets over the summer, after Mr
Draghi said the ECB would do “whatever it takes to preserve the
euro”. His ‘bring it on’ demeanour towards financial markets
showed just how powerful a role the ECB could take, unleashing
1 Graeme Leach, “This sucker is going down”, Big Picture, Spring 2012, No. 13, pp. 6-15.
2 The German Constitutional Court (GCC) has ruled that the European Stability Mechanism (ESM) and the EU’s
Fiscal Compact are compatible with the country’s Basic Law. However, the GCC ruling is double-edged, because
it effectively blocks Eurobonds and debt pooling and stipulates that any ESM package for Italy or Spain would
require a vote in the Bundestag.

22 Big Picture
“The centrifugal forces
pulling the euro apart
are still stronger than
the centripetal forces
holding it together.”
unlimited firepower to cap yields in the Club Med economies. Super
Mario scared off the bond vigilantes. If the threat was enough to calm
markets, the obvious thought is what would happen if the ECB began to
operate massive bond purchases way in excess of its previous Securities
Market programme? (Although sterilisation of the purchases means that
outright monetary transactions are not the same as quantitative easing.)
There can be little doubt that massive purchases would drive down yields. 3
The issue is whether or not the ECB will be allowed to engage in
quantitative easing on the required scale. The announcement of potentially
unlimited ‘outright monetary transactions’ by the ECB, in the face of
Bundesbank opposition, is the equivalent of drinking at the last chance
saloon for the euro. There would be no credible policy alternative left to
prevent a peripheral break-up, should outright monetary transactions fail.
Speaking about the eurozone crisis, US economist Paul Krugman has
stated that:
“Either the Germans have to accept something they consider unacceptable
(printing money), or they have to accept something that they consider
unacceptable (the break-up of the euro).”
Krugman’s point is a simple one. Either the ECB aggressively buys
peripheral debt and caps the borrowing costs of the Club Med
economies, or the game is over. This conclusion is the inevitable
consequence of crisis-hit eurozone countries having issued debt in a
currency they can’t print.
Let’s examine why.
POSSIBLE POLICY RESPONSES
For ease of explanation we’ll examine the four potential policy responses
to the crisis, with the Draghi Plan last of all. 4
They are:
1. Political union
The rapid formation of a United States of Europe – a unitary state –
with a single political entity, single fiscal policy and substantial northsouth
fiscal transfers, would be the ultimate game-changer. But this is
obviously not going to happen any time soon. All too often the
answer to EU problems is said to be ‘more Europe’, but change on this
scale requires years and decades to effect, not weeks and months. The
challenges to national sovereignty and resistance to fiscal redistribution
are so great that no effective solution is likely from this source.
2. Mutualisation of debt
Mutualisation is meant to obscure differences in creditworthiness and
covers a range of quasi-fiscal union proposals from common eurozone
debt issuance, to mutualisation above certain thresholds of debt, and
rescue facilities such as the European Financial Stability Facility (EFSF)
and European Stability Mechanism (ESM).
3 In order to deal with German concerns about deficit financing by printing money, and the inflationary threat, the
outright monetary transactions will focus on the short end of the yield curve (one to three-year maturities) and
will also be sterilised (the ECB will take in deposits to counter the expansionary impact of outright monetary
transactions on the money supply). Financial market sentiment was also boosted by the announcement that the
ECB will forego seniority and be ranked alongside any other bond holder in the event of a default.
4 Theoretically, there is an additional policy option to avoid the peripheral economies departing the euro, namely
that the core economies such as Germany depart the euro instead – leading to a sharp appreciation in the
replacement currency. This would also avoid countries such as Greece facing higher debt servicing costs –
denominated in euros – due to the depreciation of any new drachma against the euro. However, such a
scenario is highly unlikely because it would require Germany to be the country that killed the euro – a
fundamental geo-political shift on this scale seems improbable.

“The issue is whether
or not the ECB will be
allowed to engage in
quantitative easing on
the required scale.”
Still going down? 23
Sovereign political opposition to the fiscal option is intense, especially
in northern economies such as Germany and the Netherlands.
German political opposition sees the fiscal option as a handout to
irresponsible governments, and only to be engaged in if very tough
binding fiscal controls are put in place as part of any rescue package.
Germany worries about moral hazard – more money has to be
dependent on more fiscal control of the peripheral economies,
otherwise there will be even more good money thrown after bad in
the future. The problem, of course, is that the loss of sovereignty
implied is too high a price for Club Med governments.
Yes, Germany will agree to a form of fiscal union, providing its
concerns about moral hazard are met – with a hard, binding fiscal
pact. But unfortunately its concerns about moral hazard are so great
that the political consequences for countries such as Greece and Spain
seem unacceptable.
There are also fundamental challenges to the rescue packages already
agreed, with potential contributors to the funds, such as Spain and
Italy, also at risk of being bailed out themselves, putting an even
greater ‘circumscribed’ fiscal burden on the remaining contributors
such as Germany. And underpinning all these debates are the ‘old
arguments’ between Germany and France. The French want political
control over the ECB and the Germans want budgetary discipline.
Negotiations in November, to extend the fiscal adjustment
programme in Greece, only promise temporary respite. And there is
no certainty of success in the negotiations. At the time of writing,
there is deep disagreement between the IMF and the EU over whether
the country’s 120% of GDP debt-target should be put back from 2020
to 2022. At present it is forecast to be an eye-watering 190% in 2013.
Without agreement, Greece may not get its next disbursement, and
could be forced to default. However, some form of temporary
compromise is likely – a sticking plaster.

24 Big Picture
CHART 1
The Draghi Plan
Crisis-hit countries New
Primary market
Countries issue
sovereign bonds
Secondary market
Investors trade
in bonds
3. Hybrid schemes
The most significant hybrid scheme is probably the proposal to issue
the ESM rescue facility with a banking licence. This would enable it to
leverage its capital by borrowing potentially unlimited funds from the
ECB – and intervene directly in markets to drive down spreads on
periphery debt. The idea is that this could reinforce the carry trade
incentives in the ECB’s Long-Term Refinancing Operation (LTRO) to
purchase bonds.
However, Germany has all sorts of problems with such an approach,
believing it could unleash the beast – potentially unlimited
commitments with little or no control. An immediate problem is that
the ECB is not meant to lend to governments, whilst the rescue funds
are very clearly state institutions. A rescue facility with a banking
licence could engage in bond purchases at primary auctions, 5
something that is anathema to the Germans. To Germany, giving the
ESM a banking licence would be a de facto ability to print money. The
ECB is prevented from buying bonds in primary markets.
4. Monetisation of debt
At the end of July, ECB President Mario Draghi indicated that plans
were underway for the ECB to intervene in periphery economy bond
markets to drive down yields and put in place yield caps. Merely
suggesting this could happen was enough to inject welcome stability
into financial markets. The new Draghi Plan is the old Securities
Market Programme on an epic scale with bells and whistles.
The Draghi Plan is a combination of sensible economics
(conditionality) and slick public relations (convertibility).
1 submit request for aid
2 austerity requirements
3 buys bonds
4 buys bonds
previously: bond purchases only
made under exceptional
circumstances, without conditions
being imposed
European Stability
Mechanism
(ESM)
€
European Central
Bank (ECB)
5 Primary bond markets refer to government debt auctions. Secondary markets trade bonds sold at primary
auctions.

“The new Draghi Plan
is the old Securities
Market Programme on
an epic scale with bells
and whistles.”
Still going down? 25
Instead of trying to make the case for ‘printing money’ – always a
difficult sell to the Germans – Draghi has let the emphasis fall on the
issue of ‘convertibility risk’. In other words, the existential systemic
threat to the euro warrants aggressive bond purchases to maintain
convertibility, because the functionality of the currency is under threat
with a potential break-up.
In the face of Bundesbank opposition, the ECB has effectively agreed
to the monetisation of debt – printing money to buy bonds in the
secondary market – whilst dressing the policy in the clothes of
convertibility risk.
But don’t think the Bundesbank or German public opinion can be
ignored. The old issue of moral hazard comes to the fore again. If you
buy bonds to drive down yields, what incentive is there for the debtor
nation to impose fiscal austerity measures?
The Draghi Plan attempts to overcome this problem with
conditionality. The ECB will only engage in secondary market
purchases after the country has applied to the EFSF/ESM/IMF for a
bailout – which could also act as the trigger for the rescue fund to
purchase debt in primary auctions. Conditionality requires that in
return for a bailout strictly enforceable conditions are applied.
WILL THE DRAGHI PLAN BE IMPLEMENTED?
Whether or not the Draghi Plan is likely to be fully implemented is a
very moot point. Germany is giving out very mixed messages to it.
Finance Minister Wolfgang Schäuble has said that monetary financing
of state deficits is an anathema: “If we start doing that, we won’t
stop”. Bundesbank President Jens Weidman has warned that ECB bond
purchases, even in the secondary market, “could become addictive
like a drug”. Press reports suggest that Weidman threatened to resign
over the issue.
In contrast, Chancellor Merkel and the other German member of the
ECB board, Joerg Asmussen, are sending out more positive signals.
Discussing the issue of convertibility, Asmussen has stated that, “a
currency can only be stable if its future existence is not in doubt”.
And so the battle lines are drawn, between the traditionalists and the
progressives. The traditionalists argue that the very concept of an
independent central bank is under challenge, with the risk that it
could lose control of the money supply. The Draghi Plan is almost
certainly a violation of the letter and spirit of the no bailout clause in
the Maastricht Treaty, with only the lame excuse that the ECB would
be buying debt in the secondary as opposed to the primary market.
Moreover, in the wake of the announcement of outright monetary
transactions, the German Constitutional Court stated that:
“An acquisition of government bonds on the secondary market by the ECB,
aiming at financing the Members’ budgets independently of the capital
markets is prohibited as well, as it would circumvent the prohibition of
monetary financing.”
Traditionalists also point to the potential exposure of taxpayers if the
bailout policies go wrong and the Bundesbank and ECB need

26 Big Picture
recapitalising. The bottom line here is the systemic hole 6
at
the heart of the euro project – countries don’t control
the currency in which they issue their debt and as a
result there is a liquidity-insolvency negative
feedback loop which could require massive
quantitative easing to overcome, if financial
markets decide a country is bankrupt.
On the other side of the battle lines
stand the progressives, who argue that
the very existence of the currency is
under threat, that the downside risks
are so immense that exceptional
circumstances call for exceptional
measures, and that the Draghi Plan is
not that exceptional when the
importance and role of conditionality is
recognised.
But conditionality also raises its own issues.
Who will blink first? The ECB has indicated
strongly that even with German agreement
(and that of other countries with issues, such as
the Netherlands and Finland), the Draghi Plan
could only be implemented and triggered by a debtor
country application to the EFSF/ESM/IMF for a bailout
subject to very strict conditions. Could Greece or Spain sign a
‘fiscal memorandum’ effectively giving up fiscal sovereignty? Could
they sell even more austerity to their electorates? I doubt it. Could
Chancellor Merkel sell weak conditionality and printing money to the
German electorate? I doubt that also.
The practical issues are immense as well. Who decides which bonds
the ECB buys? Who decides the level at which yields are to be
capped? The ECB is not answerable to any Parliament, but it would be
acquiring a quasi-fiscal role.
WHERE DO WE GO FROM HERE?
It is difficult to believe that the status quo can hold. Greece is behind
with its austerity plan, Club Med money supply is contracting,
headline unemployment rates are touching 25% in Greece and Spain,
structural reforms can’t generate the growth to offset the austerity
measures, and there is a yawning gap between the interest rate on
debt and GDP performance – requiring a sustained fiscal primary
surplus (the fiscal balance before interest payments). Something has
to give.
The Draghi Plan, fully implemented, could be the game-changer
which has been lacking over the past two years. We shouldn’t
underestimate its potential firepower. However, the scale of its
potential impact is part of the reason the Bundesbank opposes it –
because it is a fundamental challenge to the status of an independent
central bank.
6 See Graeme Leach, “This sucker is going down”, Big Picture, Spring 2012, No. 13; and Pulse Economic
Outlook, Institute of Directors, December 2011.

“Could Greece or
Spain sign a ‘fiscal
memorandum’
effectively giving up
fiscal sovereignty?
Could they sell even
more austerity to their
electorates?”
Even if the Draghi Plan is fully implemented, it will only buy time. It
won’t provide a permanent solution to the eurozone crisis. In the long
term the competitive losses in the Club Med economies make it very
difficult to believe that all the adjustment will stem from an internal
devaluation – falling wages, austerity and rising unemployment.
What happens if a country such as Greece or Spain backslides on its
austerity plan? Does the ECB stop bond purchases? If it does, the
bond market will implode. If it carries on, German public opinion will
explode. The recent compromise with Greece is probably the limit of
northern European patience.
Without full implementation of the Draghi Plan, the odds favour shortterm
exits from the euro over the next 12-18 months. Even with full
implementation of the Plan there will almost certainly be long-term
exits from the euro. So, to end where we began, yes, the currency is
still likely to go down. The Draghi Plan offers only a glimmer of hope
that break-up might not occur.
Mass public demonstrations in Greece in November, against the next
€9.4bn wave of public spending cuts, have been followed by a
general strike in Spain. The Greek economy is predicted to contract by
6.5% this year and by 4.5% next year, having already been in
recession for four years!
Eurozone finance ministers have given Greece two more years – until
2016 – to meet deficit reduction targets, but the next tranche of loans
cannot be released until there is agreement on how to make Greek
debt sustainable. Any agreement is then subject to ratification by
national Parliaments.
What a mess.
Still going down? 27

28 Big Picture

SNAPSHOT
o The past two years have
seen a noticeable increase
in strike action. The
number of working days
lost in 2011 to industrial
disputes was the highest
since 1990.
o Much of the regulatory
framework governing
industrial action was forged
in the 1980s and needs to be
updated. This article
presents 10 recommendations
for reform.
o The Government should
introduce a requirement
that 50% of union members
balloted in a dispute must
support strike action, not
just a majority of those
voting. Electronic voting
should be permitted.
o The information on ballot
papers should be
improved, and a six-month
‘longstop’ date imposed so
that continuing strike
action would need a fresh
mandate.
o Strike bans should be
considered in essential
services in order to protect
key national infrastructure.
o A distinction needs to be
drawn between many
responsible unions in the
private sector which have
agreed to flexibility in
order to save jobs, and the
more confrontational
public sector unions.
Industrial inaction: controlling the super unions 29
Industrial
inaction: controlling
the super unions
Alexander Ehmann, Head of Regulation and
Employment at the IoD, looks at the rise of the
‘super unions’ and proposes a range of reforms
to update the UK’s strike laws.
“The most conservative man in the world is the
British Trade Unionist when you want to change
him.” – Ernest Bevin
1926 REVISITED?
In early September, at the TUC’s 2012 annual Congress in Brighton,
delegates voted overwhelmingly to look into the practicalities of
organising a general strike in protest at government spending cuts.
The motion, proposed by the Prison Officers’ Union, was seconded
by the National Union of Rail, Maritime and Transport Workers
(RMT). Speaking in support, RMT leader Bob Crow said:
Brothers and sisters, we as a
trade union movement have to
stand firm with the leadership and
this gives us an opportunity to
reaffirm our beliefs and reaffirm our
faith for what we stand for. Pass this
resolution, get out on the demo on
October 20th, coordinate action, and
if it means a general strike let’s do it
and get on with it.”
(Applause/Cheers) 1
Later that month, TUC General Secretary Brendan Barber sent a
warm letter of support to trade union confederations in Greece as
they embarked on a 24-hour general strike, expressing the “solidarity
of the British trade union movement and its six million workers for
your general strike tomorrow to protest against austerity.” 2
Four days
later, Mr. Barber sent a further message of solidarity to trade unions
in Spain to support their own call for a general strike on the same
day as the European TUC’s ‘Day of Action’. 3
1 Source: TUC, Unedited verbatim report of the Tuesday sessions of the 2012 Congress, available on the
TUC website: www.tuc.org.uk/the_tuc/tuc-21467-f0.pdf.
2 Available on the TUC website: www.tuc.org.uk/international/tuc-21452-f0.cfm.
3 Available on the TUC website: www.tuc.org.uk/international/tuc-18555-f0.cfm.

30 Big Picture
“At a time when the
economy is emerging
from recession, strikes
could be hugely
damaging for the
prospects of recovery.”
CHART 1
The success of the September Congress motion compels the TUC to
look at whether a general strike might be feasible, not that one will
necessarily take place. 4
Indeed, in a subsequent interview with the
BBC’s ‘Today’ programme, Brendan Barber downplayed the
possibility. 5
But the ongoing debate has thrown the climate of
industrial relations into sharp relief.
Much of the regulatory framework governing industrial action was
forged in the 1980s. Aspects of this framework now need updating, not
only to take into account changes in working practices over the past 30
years, but also to address a more immediate concern. The Government’s
commitment to deficit reduction, and its attendant implications for levels
of public spending, appears likely to spark a new wave of strikes. At a
time when the economy is tentatively emerging from recession, albeit
with an extremely uncertain and vulnerable outlook, such strikes could
be hugely damaging for the prospects of recovery.
INDUSTRIAL ACTION: ON THE RISE
Over the past two years, there has been a noticeable increase in strike
ballots and industrial action. According to the Office for National
Statistics, 1.4 million working days were lost in the UK in 2011 from
149 stoppages of work arising from labour disputes. The 2011 ‘days
lost’ figure was the highest since 1990, and the stoppages figure the
highest since 2006 – and considerably higher than the figures for
2010 (92) and 2009 (98). In all, more than 1.5 million workers were
involved in labour disputes during 2011, almost 12 times the number
involved in 2010, and higher than the average number of workers
involved in the 1980s. 6
Working days lost due to labour disputes, cumulative 12-month totals
August
2007
August
2008
August
2009
August
2010
August
2011
Source: Office for National Statistics, Labour Disputes Statistics. Data not seasonally adjusted.
Thousands
August
2012
1600
1200
4 “TUC backs ‘general strike’ motion over spending cuts”, BBC News website, 11 September 2012, available at:
www.bbc.co.uk/news/uk-politics-19562394.
5 “Some of my colleagues may talk about that [a general strike]. I don't hear too many people calling for a
general strike.” Source: “Anti-austerity marches take place”, BBC News website, 20 October 2012, available at:
www.bbc.co.uk/news/uk-20007496.
6 Source: Labour Disputes, Annual Article 2011, Office for National Statistics, 15 August 2012, p. 3.
800
400

CHART 2
Working days lost in the UK, public/private split, 2002–2011
%
100
90
80
70
60
50
40
30
20
10
0
Industrial inaction: controlling the super unions 31
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: Office for National Statistics, Labour Disputes Statistics.
“In 2011, only 51 (5%)
of the 964 ballots
calling for strike action
resulted in a negative
vote, a remarkably
low figure.”
Private Public
The latest statistics suggest a similarly high number of disputes over
the 12 months to August 2012, with 1.25 million working days lost
from 127 stoppages over that period (see Chart 1). 7
The number of strikes in the public sector in 2011 (88) was almost
double the number recorded in 2010 (47), 8
with the number of
working days lost increasing from 313,100 to 1,267,200. Not only
does this figure account for 92% of the total number of working days
lost, the ONS also notes that it is a record high since comparable
records began in 1996, and the third time in 10 years that the
number of working days lost in the public sector has exceeded 1
million. 9
Chart 2 demonstrates the public/private sector split in the
number of working days lost over the period from 2002 to 2011.
There is a further angle to the labour disputes statistics worthy of note
beyond the absolute number of strikes: the conspicuously high
‘success rate’ of strike ballots. Annual trade union ballot data for the
period 2002 to 2011 is presented in Table 1. The table demonstrates
the high percentage of ballots calling for strike action that result in
‘yes’ votes, with 94% in 2011 and an average of 85% over the past
10 years. In 2011, only 51 (5%) of the 964 ballots calling for strike
action resulted in a negative vote, a remarkably low figure.
The figures in Table 1 are strongly suggestive of a lack of an effective
counterweight to the desire of union leaderships to pursue industrial
action. The more recent ballots tell an even more interesting story.
As Table 2 highlights, there have been at least five disputes over the
last year – including the threatened strike of Border Agency staff prior
7 Source: Labour Market Statistics, October 2012, Office for National Statistics, 17 October 2012, pp. 11-12.
8 Source: Labour Disputes, Annual Article 2011, Office for National Statistics, 15 August 2012, p. 1 and p. 16.
9 Source: Labour Disputes, Annual Article 2011, Office for National Statistics, 15 August 2012, p. 14.

32 Big Picture
TABLE 1
Trade union ballots 2002–2011
Year
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
10-year average
Number of
ballots calling
for ‘strike
action’
738
825
901
781
1,291
713
794
561
555
964
812
Number of
ballots voting
FOR strike
action
613
684
746
663
1,094
637
658
458
487
904
694
% of ballots
voting FOR
strike action
83%
83%
83%
85%
85%
89%
83%
82%
88%
94%
85%
Number of
ballots voting
AGAINST
strike action
113
125
142
109
140
64
123
93
61
51
Source: Office for National Statistics, Labour Disputes, Annual Article 2011, 15 August 2012, Table 11a, p. 17.
TABLE 2
Turnout and voting patterns in recent strike ballots
Date
July 2012
November 2011
November 2011
November 2011
November 2011
Function (Union)
Border Agency (PCS)
to the London Olympics – in which strike action has been supported
by as little as a quarter of those actually balloted. In the case of the
Border Agency dispute led by the Public and Commercial Services
(PCS) union, strike action was supported by just 11% of those balloted.
REDRESSING THE BALANCE:
REFORMING THE BALLOTING PROCESS
There are a variety of contributing factors to the disparity between the
respective levels of support of those voting and those balloted,
including poor member data and the relatively outmoded paper-based
ballots required for union action. But the fact that an ‘outraged
minority’ can trigger widespread and potentially damaging industrial
action illustrates the clear need to improve the validity of the present
ballot system.
Health/Civil service/Local authority (Unite)
Public sector (GMB)
Local government (Unison)
Health (Unison)
Source: IoD compilation from data published by PCS/Unite/GMB/Unison.
Turnout
20%
31%
33%
30%
25%
102
Support (of
those who
voted)
57%
75%
79%
77%
84%
% of ballots
voting
AGAINST
strike action
15%
15%
16%
14%
11%
9%
15%
17%
11%
5%
13%
Support (of
those
balloted)
11%
23%
26%
23%
21%

“It is necessary to
address the present
situation where
strike action can
be approved for
indefinite periods.”
Industrial inaction: controlling the super unions 33
To achieve that, a higher threshold for strike action should be
instituted. For a strike to be deemed valid, the support of a majority of
both the members voting and of the members balloted should be
required – a so-called ‘double lock-in’ vote. However, this move
should be accompanied by a quid pro quo. A key obstacle to securing
greater support for strike action is the current postal ballot system,
which many unions would like to see replaced by an electronic voting
system. Provided that a fair and transparent system of electronic
voting can be delivered, there is no reason why – in return for asking
for a higher level of legitimacy – the union movement should not be
allowed to embrace technological advances to increase participation.
In addition to these changes, it is necessary to address the present
situation where strike action can be approved for indefinite periods,
with the only requirement being that the first action (i.e. a strike)
must take place within one month of the ballot. This acts as a perverse
encouragement to take strike action even if negotiations are ongoing
and making headway. This rule should be abolished and two changes
introduced in its place: a requirement for ballot papers to carry the
detail regarding the precise number of strike days being suggested;
and ‘longstop’ dates for successful ballots beyond which they cease to
be effective. An appropriate period for the latter proposal might be
six months.
The first of these two changes helps union members to understand
fully what it is they are voting on, including the likely impact of strike
action on their employer, its customers, and their own personal
circumstances. It also ensures that union leaders are not given a
mandate for more strike action than the membership believes it had
committed itself to. The second change means that members’ support
for continuing industrial action must be tested again after a period of
time, when circumstances and attitudes may have changed.
UNION MEMBERSHIP AND THE
EMERGENCE OF ‘SUPER UNIONS’
Alongside the rise in industrial militancy, the other notable feature of
the union movement’s recent history is its rapid consolidation in
response to diminishing membership. In 1978 the UK had 485
registered trade unions. By 2011, this number had dropped to 154. 10
This reflects a decline in union membership over the same period. In
1978/79, total union membership peaked at in excess of 13 million
people; in 2011 approximately 6.4 million employees were trade
union members. 11
An illustrative example of union amalgamation can be found in the
experience of the National Union of Tailors and Garment Workers
(NUTGW). The NUTGW was founded as the Tailors and Garment
Workers' Union in 1920 with the merger of the Scottish Operative
Tailors and Tailoresses' Association and the United Garment Workers'
Union. In 1932, it was joined by the Amalgamated Society of Tailors
and Tailoresses and renamed itself the ‘National Union of Tailors and
Garment Workers’. It was subsequently joined by the United Ladies'
Tailors' Trade Union and the Waterproof Garment Workers' Trade
Union before, in 1991, merging into the General, Municipal,
Boilermakers and Allied Trades Union (GMB).
10 Data from the UK Certification Officer, available here:
www.certoffice.org/CertificationOfficer/files/f6/f696caa2-376a-48f8-bc75-d3d084e71514.pdf.
11 Source: N. Brownlie, Trade Union Membership 2011, Department for Business, Innovation & Skills, April 2012, p. 7.

34 Big Picture
CHART 3
Trade union membership levels in UK from 1892 to 2011
Membership (millions)
14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
1892
1895
1898
1901
1904
1907
1910
1913
1916
1919
1922
1925
1928
1931
1934
1937
1940
1943
1946
1949
1952
1955
1958
1961
1964
1967
1970
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
Source: N. Brownlie, Trade Union Membership 2011, Department for Business, Innovation & Skills, April 2012, Chart 1.1.
“Super unions
covering multiple
employers are able to
co-ordinate strike
action in vast swathes
of the economy.”
As will be clear from that brief potted history, until the 1990s the
NUTGW (and its various consolidations) was relatively homogenous.
The mergers that took place were based around broad professional
characteristics and all iterations involved the term ‘tailor’ as a
descriptor of the union's membership. In 1991, however, the union
was subsumed into the GMB, an entity which refers to itself as
‘Britain’s General Union’. The GMB is now discussing a further merger
with the public sector union Unison to create the UK’s largest union of
2 million members, spanning both public and private sector employers.
The advent of ‘super unions’ such as the GMB has been as common a
development over the last few decades as the demutualisation of
building societies, prompting a comparison with the ‘too big to fail’
arguments often levelled at the consolidated financial services sector.
However, unlike the private sector, where mergers are subject to
market and competition scrutiny, the only legislation governing union
mergers requires that members must approve the merger in a ballot.
REDRESSING THE BALANCE: CLIPPING
THE WINGS OF THE SUPER UNIONS
The three largest unions (Unite, Unison and the GMB) – which represent
no specific trade or profession – represent over half the total union
membership in the UK. Super unions covering multiple employers are
able to co-ordinate strike action in vast swathes of the economy, as was
seen with the public sector strikes in November 2011. Such co-ordinated
action is much harder to achieve where there is a multiplicity of unions.
Fewer unions also inevitably means fewer union leaders, which reduces
the prospect of dissenting voices bringing balance to debate.
Union consolidation has arguably now gone too far (particularly in the
public sector), and it is necessary to question whether this is enabling

“There is a need to
reverse the ability
for existing super
unions to wield
disproportionate
strike power.”
Industrial inaction: controlling the super unions 35
a disproportionately large power-base to develop against employers
(particularly the Government). 12
The costs and benefits of any future
union mergers – to union members themselves, to UK citizens and to
employers – should therefore be very carefully examined. To do that,
new criteria for permitting future amalgamations should be drawn up,
either by establishing a quasi Competition Commission-type body for
unions, or extending the remit of the Certification Officer.
Since such a change would only affect future consolidations, there is a
need to remove the ability of existing super unions to wield
disproportionate strike power by drawing together a variety of
employee roles, locations and disputes to deliver maximum impact.
Two actions are necessary:
o An interim requirement to localise workplace disputes, so that
unions negotiate pay at the lowest possible level of employer. If a
dispute is specific to a particular school, hospital or local
authority, the ballot and any subsequent strike action should be
limited to these institutions and not the wider union membership
in other locations.
o A full market review of the trade union movement as it is
currently structured. An evaluation should be made of whether,
akin to the British banking industry, divestment of union activities
is necessary to bring greater choice and stability to the union
movement, and to ensure the power to disrupt does not rest in
disproportionately few hands.
PUBLIC AND BUSINESS OPINION
The Ipsos-MORI Research Archive holds data on the studies the
company has conducted into public attitudes towards trade unions
since the mid-1970s. The time series makes clear the significant
impact of the 1992 Trade Union and Labour Relations (Consolidation)
Act 13
on public perceptions of union power – as Table 3 illustrates. In
September 1978, 82% of those polled agreed that the trade unions
had too much power. Since then, the proportion believing the unions
to be too powerful has been on a path of generally steady decline,
bottoming out at 24% in August 1995. Intriguingly, though, Ipsos
MORI’s latest survey, conducted in June 2011, found an increase in
concern. At 35%, the proportion agreeing that unions had too much
power is far lower than the high water mark of the 1970s and 80s.
Nevertheless, the figure needs to be considered in relation to a
dramatically reduced union membership base. Might this start to
indicate a renewed shift in the balance of public opinion?
The business community has typically demonstrated even greater
concern about the extent of union power, and held stronger views on
the use of strike ballots. To take an example from this year, IoD
members – the majority of whom represent small and medium-sized
organisations – were extremely concerned at the potential collateral
12 Quite apart from the impact on UK labour disputes, a lack of choice and specialism in union representation is
not necessarily beneficial to the members themselves. Whilst, as Dwight D. Eisenhower rightly noted, “Only a
fool would try to deprive working men and working women of their right to join the union of their choice”, it is
worth focusing on the word ‘choice’ in that quotation. At present, an employee seeking to be represented faces
the prospect of super unions that are increasingly distant from member interests, intent on pursuing a highly
political agenda. The astonishingly low turnouts in union general secretary elections (16% in the Unite election
that elevated Len McCluskey to the top job, for example), arguably evidence a lack of interest in these leaders’
political campaigns among the great majority of union members.
13 The Act itself was not a single piece of legislation, but was the culmination of six pieces of legislation
introduced from 1980 to 1993.

36 Big Picture
TABLE 3
Proportion of public agreeing that “Trade unions have too much power in Britain today”.
October 1975
August 1977
September 1978
September 1979
July 1980
November 1981
August 1982
August 1983
August 1984
August 1989
Dec 1989-Jan 1990
August 1990
February 1992
December 1992
August 1993
August 1994
August 1995
June 2011
Agree (%)
Source: Ipsos MORI, Attitudes to Trade Unions 1975-2011.
75
79
82
80
72
70
71
68
68
41
35
38
27
24
26
26
24
35
Disagree (%)
16
17
16
16
19
22
21
25
24
42
54
45
64
56
55
56
57
52
Net
+59
+62
+66
+64
+53
+48
+50
+43
+44
damage they might suffer during the proposed fuel drivers’ strike. As
Chart 4 illustrates, 82% believed that the strike would have a negative
impact on their business were it to go ahead. Two-fifths of directors
believed that the potential impact would be very negative, and only
one in ten believed that their organisation would be unaffected.
Although the strike was ultimately called off, the dispute caused a
great deal of uncertainty and disruption as businesses prepared
contingency plans to cope as best they could.
Given the wider business disruption and economic damage that
industrial disputes can cause, it is perhaps not surprising to find
business leaders supporting restrictions on the ability to strike. In
research conducted by the IoD in February 2010, 51% of the 1,600
members surveyed supported an outright ban on strikes in the public
sector, and 26% a ban on strikes in the private sector. At present, only
members of the armed forces, the police and prison officers are
banned by law from striking. Table 4 on page 38 shows the degree of
support among directors for similar strike-prevention legislation in
other sectors and industries.
As Table 4 demonstrates, there is majority support among IoD
members for an outright ban on strike action in 'crucial' services.
These are perceived to extend beyond public services such as the fire
-1
-19
-7
-37
-32
-29
-30
-33
-17

CHART 4
Business concern at potential impact of 2012 fuel strike
Industrial inaction: controlling the super unions 37
Q: “Fuel tanker drivers belonging to the Unite union have voted for strike action in a
dispute over working practices. If a strike were to go ahead, what impact would you
expect it to have on your organisation?”
11%
43%
2%
5%
Significant negative impact Slight negative impact
39%
Slight positive impact Significant positive impact
No impact
Source: IoD Policy Voice survey, March/April 2012. 991 members of the IoD were polled between 29 March and 4 April.
brigade and the health service, to private sector roles in the electricity
generation and water industries.
The IoD therefore proposes that the Government should consider
prohibiting strikes in a wider set of essential services than is presently
covered, such as utility providers. Additionally, in order to protect
against damaging strikes in other ‘near-essential’ services, the current
prohibition on the replacement of striking staff with Agency Workers
should be removed. This would allow organisations subject to strike
action to continue providing some services with replacement staff. In
order to make the latter recommendation workable, it is necessary to
secure an accompanying increase in the amount of time employers
receive as warning of impending strike activity. Two weeks would
ensure that employers have a reasonable chance of being able to
put arrangements in place for replacement staff, which the present
one-week notification would not.
TEN RECOMMENDATIONS FOR REFORM
This article has explored business concerns about disproportionately
powerful super unions, the vulnerability of key elements of our
national infrastructure to industrial action, and the potential exposure
of the nascent – but weak – economic recovery to a new wave of
strikes. That said, it is necessary to recognise that British trade unions
are not inherently destructive. There is a distinction to be drawn
between many mature, responsible unions in the private sector which
during (and since) the financial crisis have agreed to flexibility in order

38 Big Picture
TABLE 4
Restricting the ability to strike
Q: “Do you think that any of the following should be prohibited from striking?”
Sector/industry
Fire brigade
Doctors
Nurses
Electricity generation
Water industry
Teachers
London Underground
Postal services
Civil servants
Overground railways
Local government
Airline/airport staff
Bank workers
None of the above
Yes (%)
73
67
60
57
53
47
44
43
41
40
40
33
22
21
Yes (number)
1,162
1,059
Source: IoD Policy Voice survey, February 2010. 1,592 members of the IoD were polled between 28 January and 11 February.
“The Government’s
approach has been to
tiptoe around the
problem. It should now
be prepared to act to
protect the economy.”
to save jobs, and the politicised, more confrontational public sector
unions.
In the private sector, Ellesmere Port and the resurgent automobile
industry shows the benefits that flexible and intelligent union
engagement can bring. But in public sector monopolies immune from
international competition, union bosses have exploited the inaction of
successive governments to build positions of unbridled power. Their
strangleholds, facilitated by arcane trade union laws, must be
loosened. Since coming to office in June 2010, the Government’s
approach has largely been to tiptoe around the problem. It should
now be prepared to act to protect the economy – and crucial parts of
our national infrastructure – from deliberately disruptive sabotage. Box
1 summarises our 10 recommendations for reform.
961
912
850
754
708
690
654
643
631
518
354
337

BOX 1
10 proposals for reforming the UK’s framework of strike laws
Industrial inaction: controlling the super unions 39
To address the challenges regarding strike ballots and their legitimacy, the IoD proposes:
1 – A double lock-in vote.
Introduce the requirement that 50% of union members balloted must support strike action as well
as a majority of those voting.
2 – The introduction of electronic voting.
In order to ensure higher participation rates in strike ballots, amend legislation to allow for ballots
to be conducted electronically.
3 – Abolishing the requirement for industrial action to begin within 28 days of
the ballot.
This will remove the perverse incentive for a union to start strike action in order to keep the ballot
valid, even when negotiations are making promising headway.
4 – Improving ballot paper information.
Require all ballot papers to detail the precise number of days of industrial action. Strike action
could not exceed these days without a re-ballot of members.
5 – A six-month ‘longstop’ date on ballots.
Introduce a period of six months from a successful ballot in which strike action can be taken.
Beyond this date, further action beyond the initial six months would require a successful
subsequent ballot of union members.
To deal with the challenges regarding union membership and super unions, the IoD proposes:
6 – A quasi ‘Competition Commission for unions’.
The Certification Officer or an alternative body should be given new powers to conduct a market
review into the present impact of the consolidation of unions, and to introduce new criteria for the
permitted amalgamation of unions in the future.
7 – Localised employer ballots/pay bargaining.
Require that unions ballot/negotiate pay at the lowest possible level of employer. If a dispute is
school/local authority/hospital-specific, the ballot and strike action should be confined to the
appropriate unit.
To address public and business concerns, the IoD proposes:
8 – A key service strike ban.
Prohibit industrial action in essential services. These would include the fire service, doctors, nurses
and key utility providers.
9 – Remove the prohibition on Agency Workers.
Ensure that organisations that are subject to strike action have the option of maintaining their
service levels with the temporary replacement of staff with Agency Workers.
10 – Increase the strike notice period.
Increase the length of time employers are given as notice of impending strike action. The present
one-week notice period should be raised to two weeks to allow for negotiation and any transitional
planning.

40 Big Picture

SNAPSHOT
o Corporation tax distorts the
balance between debt and
equity, imposes heavy
burdens and taxes profits
that are re-invested. It is grit
in the engine of business,
and could be replaced with a
radically different tax on
returns to capital.
o The replacement system
would tax dividend and
interest payments at 30%,
replacing both corporation
tax on profits and income tax
on these forms of income.
o The effective rate would be
far lower than 30%, because
substantial proportions of
profits are not paid out, but
are retained for reinvestment.
The overall tax
burden would be
substantially less than
under the current system.
o Total tax would equal
returns that were made
within the circle of UK
companies and distributed
outside that circle.
o A system of credits would
ensure that payments
through chains of
companies were not taxed
more than once.
o Special measures would
accommodate new injections
of capital, returns of capital
and investment overseas.
o Introducing the new system
would be challenging, but
worth the prize.
How to get rid
of corporation
tax
RADICAL REFORM OF THE TAX SYSTEM
In May, the 2020 Tax Commission, set up jointly by the Institute of
Directors and the Taxpayers’ Alliance, published its report, The
Single Income Tax. 1
The guiding principle was that whenever
income arises, it should be taxed once, and only once, at 30%
(but with a generous personal allowance for each individual, and
with no national insurance charge). The result would be a vastly
simpler and more effective tax system than the one we have now.
We outlined the Commission’s proposals in the previous issue of
Big Picture. 2
One important type of income is returns on capital, whether in the
form of dividends or of interest. Here, we set out why corporation
tax is ripe for replacement, and how the tax on returns to capital
that the 2020 Tax Commission has proposed as its replacement
would work.
WHAT’S WRONG WITH
CORPORATION TAX?
How to get rid of corporation tax 41
Richard Baron, Head of Taxation at the IoD,
shows how we could improve the tax system by
eliminating corporation tax.
If an individual engages in a business and makes a profit, that is
taxed. Since a company has legal personality, it would seem
logical to treat it in the same way, and tax the profits it makes.
That is what corporation tax does. Each company must compute
its profits each year, and pay tax on those profits.
This case for corporation tax is in fact based on a serious
misunderstanding. Companies may have legal personality, and
they may write cheques to HM Revenue & Customs (HMRC), but
they do not in fact suffer tax burdens. They are mere conduits for
economic activity. The sufferers of tax are the shareholders, the
employees, the customers (who have to pay higher prices) and the
suppliers (who can only be offered lower prices). If the objective is
to tax returns to capital, it makes sense to cut out the middleman,
and tax the suppliers of capital, the shareholders and bondholders,
directly on their returns.
1 Available at: www.iod.com/MainWebSite/Resources/Document/tax_commission_report_2012.pdf.
2 Richard Baron, “The future of tax”, Big Picture, Summer 2012, No. 14, pp. 26-33.

42 Big Picture
“There are several
problems with
corporation tax: it
encourages loan
capital over share
capital; it takes a
huge amount of
work to administer;
and it gives no great
help to companies
that want to invest.”
Under the current system, returns to capital are taxed in two ways:
o Profits after deducting interest expense (but before deducting
dividends) suffer corporation tax, and there is further tax on
individuals who receive dividends and who pay tax at more than
the basic rate. The income tax rates on individuals are lower than
the tax rates on their other income, reflecting the fact that
corporation tax has already been applied to the profits.
o Returns on loan capital – that is, interest – are taxed as income
of the recipient company or individual.
The result is to tax returns to share capital and returns to loan capital
differently, and that is the first problem with corporation tax. It
encourages loan capital over share capital. The bias is accentuated by
the opportunity to find lenders who will not be taxed on interest
received, either because they are overseas or because they have taxdeductible
losses or expenses to cover their interest income. Indeed,
the use of complicated financial structures that exploit the treatment
of interest is a major headache for the tax authorities.
The second main problem with corporation tax is that it takes a huge
amount of work to administer. Companies would have to compute
their accounting profits each year in any case, but that is not enough
for tax purposes. Expenditure must be re-categorised, purely for tax
purposes. Many items must be disallowed for tax purposes, including
capital expenditure that is too trivial to capitalise in the accounts.
Special allowances must then be computed for some of the
disallowed items. Furthermore, the complexity of large businesses
means that merely collecting the data and doing the computations is
not enough. An extra layer of controls needs to be added, to ensure
that the computational systems are administered correctly and do
what they are supposed to do. Indeed, a large company must now
appoint a ‘senior accounting officer’, who must maintain appropriate
systems and certify the state of those systems to the Revenue.
Finally, corporation tax gives no great help to companies that want
to invest. Retained and re-invested profits are subject to corporation
tax, just like distributed profits. There are tax allowances for
investment in plant and machinery, but these allowances are only
given gradually, and corporation tax must be paid in the meantime.
There are no tax allowances for investment in buildings, apart from
the plant and machinery elements in them.
We would benefit considerably from a system that simply taxed
returns to capital when they were paid out, avoiding the need to
compute taxable profits, and that did not tax profits that were
retained for re-investment. Such a system could also treat returns to
debt and equity equally. That is precisely what the 2020 Tax
Commission has proposed.
THE BASIC MECHANISM:
DIVIDENDS AND INTEREST
Under the proposed system, there would be no corporation tax.
Instead, dividends and interest, which represent returns to capital,
would be taxed once, at 30%, and there would be no further
taxation of such income.

EXAMPLE 1
How to get rid of corporation tax 43
30% might seem high, compared to the corporation tax rate of 22%
that the UK will have from 2014 onwards. However, the rate would
replace not just corporation tax, but also income tax that individuals
must pay when they receive dividends or interest. In addition,
substantial amounts of profits are not distributed, and would be taxfree,
instead of suffering corporation tax. The overall effective rate
would therefore be a good deal lower than under the current system.
We shall explain the system using examples with dividends, but the
system would be the same for interest.
The objective is to ensure that when a UK company makes a return
on its capital, and that return is paid out to an investor that is either
an individual or a non-UK company, tax is levied. The tax may be
levied when the return leaves the circle of UK companies, or it may
be levied earlier, on a payment between UK companies. But it is only
levied once.
The recipient of income has the tax liability, but the payer deducts
the tax from the income, and passes it to the Revenue, a bit like PAYE
or the deduction of interest on bank accounts at source. There are
two reasons for this approach. The first is that it avoids the need for
millions of individuals to complete tax returns and pay tax after the
year-end. The second is that it ensures that tax is collected, even
when the recipient is not a UK taxpayer.
UK company C pays a dividend to shareholder S, where S is an individual or a non-UK company.
C’s profits to distribute are £100, giving a tax liability of £30. C pays £70 to S and £30 to HMRC. There
are no further UK tax liabilities or credits. If S is a foreign individual or company, S may be able to claim
credit for the UK tax suffered against any tax in their own country, depending on that country’s tax laws.
Profit
£100
£70
C S
£30
HMRC
When a dividend is paid to a UK company, it gets a credit equal to the
net dividend, which it can use to cover its own dividend payment
(Example 2). The generation of fresh credits at each step in a chain of
companies (C to D and D to F in Example 2) would not lead to a
growing mountain of credits that could be used to reduce tax,
because each step would use up the credits that had been generated
at the previous step, at the same time as generating fresh credits.
Thus, the quantity of credits in existence would never exceed the
amount of dividends that had given rise to tax, and that had not yet
left the circle of UK companies by being paid to individuals or to non-
UK companies. 3
3 There is an exception to this rule, when investors outside the circle of UK companies put capital into the
circle. This is discussed later.

44 Big Picture
EXAMPLE 2
UK company C pays a dividend to UK company D, without a UK-UK election.
C’s profits to distribute are £100, giving a tax liability of £30. C pays £70 to D and £30 to HMRC. C
therefore does exactly the same as in example 1, so C does not need to know whether the shareholder
is a UK company. This will often be helpful, because companies can have many shareholders, and may
not know the status of all of them.
D, however, does know that it is a UK company, and it can therefore apply a special treatment to itself.
Moreover, it needs to do so. D may simply pass on the £70 as a dividend to its shareholders, and it
would be quite wrong to impose an additional layer of taxation when it does so. The return to capital
was made in C, and should only be taxed once, at the point where C transfers it to D.
D therefore claims from the Revenue dividend credits of £70, the net amount it has received from C.
These credits are only accounting entries: the Revenue does not give D any money. The credits entitle D
to pay dividends of up to £70 net, to any kind of shareholder, without accounting for any tax. The
recipients still have no further tax to pay. But when D makes such payments, it uses up its credits and
they are cancelled.
We may consider two types of shareholder, to which D might pay a dividend.
o The first type of shareholder is an individual or a non-UK company, S. Then there is nothing
more for the UK tax system to do. The return to capital was made in C, and it was taxed when
the money passed from C to D.
o The second type of shareholder is another UK company, F. It is treated exactly like D. It
receives a dividend of £70, which represents a return to capital that was taxed when C paid a
dividend to D. F can, therefore, claim dividend credits of £70, just like D. When F pays money
out to its shareholders, whom we shall call Z, it can pay dividends of up to £70, without
accounting for any tax.
Profit
£100
Profit
£100
£70
C D
£30
HMRC
£70 £70
C D F
£30
HMRC
Credit £70:
No tax due
£70
S
Credit £70:
No tax due
£70
Credit £70:
No tax due
Z

EXAMPLE 3
The generation of credits could, however, lead to accumulations of
credits in places where they would be of little use. Holding companies
and financial institutions, in particular, would tend to accumulate
credits, because they tend to receive more in dividends or interest
than they pay out in those forms. This accumulation of credits would
encourage them to acquire more and more trading businesses, so that
the surplus credits could be used against distributions of the profits of
the trading businesses. It would be wrong for the tax system to
encourage such a trend (or to discourage it: the tax system should
avoid influencing patterns of ownership in any direction).
In order to avoid such consequences, the 2020 Tax Commission’s plan
would make credits transferable. A UK company with credits that it
did not want to use itself would be entitled to give or sell them to
another UK company. The credits would still have to be generated by
the payment of dividends or interest on which tax was actually paid.
Thus the desired result, to levy tax on returns to capital that were
generated by UK companies and paid out to entities that were not UK
companies, would still be achieved.
UK company C pays a dividend to UK company D, under a UK-UK election.
How to get rid of corporation tax 45
C is going to distribute profits of £100 to D, which C knows is a UK company. D might, for example, be
C’s holding company, or a major shareholder.
In those circumstances, it would be possible to offer C and D the option of a joint election. The effect of
such a UK-UK election would be that C could pay D the full £100, without accounting for tax.
Correspondingly, D would not acquire any tax credit. If D wanted to pay the money on to its
shareholders, it would have to account for tax in full, or make payments under a further UK-UK election.
Elections could only be made between UK companies. If parts of a dividend were going to UK companies
and parts to other types of shareholder, only the parts that were going to UK companies could be
covered by elections, and tax would have to be levied on the other parts. This would ensure that tax was
always levied when returns to capital were paid outside the circle of UK companies.
INVESTMENT AND DIVESTMENT
The objective is to tax returns to capital, not the investment or the
return of the capital itself. But movements of capital can be used as a
substitute for returns to capital. For example, buying back a
proportion of each shareholder’s shares is just as good a way of
rewarding shareholders as the payment of dividends.
The solution is to treat movements of share or loan capital like
payments of dividends and interest. Overall, only returns to capital
will get taxed, because the original investment of capital will be
matched by the ultimate return of capital.

46 Big Picture
EXAMPLE 4
UK company G raises share capital of £700 from UK company H, without a UK-UK election,
£800 from UK company J, under a UK-UK election, £1,200 from non-UK company K, and £300
from individual M, a total of £3,000. G issues one share per pound received.
The investment by H will be treated like a payment of a dividend from H to G. If H has credits to cover the
payment, it will send £700 to G and not account for any tax. H may very well have credits available, because
it may have received capital in the past from individual or non-UK investors, and that will have generated
credits, as explained below. If, however, H does not have credits available, it will send £700 to G and £300 to
HMRC. In either case, it will receive 700 shares. And in either case, G will get dividend credits of £700.
The UK-UK election between G and J means that J will send G £800, and will receive 800 shares. No
credits will be used, nothing will be paid to HMRC, and no credits will be generated for G to use.
K will send G £1,200, and will receive 1,200 shares. No tax will be due at this stage, but G will still get
credits of £1,200. It might seem odd to allow credits to be generated when no tax has been paid, but
they are generated because money is being injected into the circle of UK companies. At some stage, that
money will come out of the circle again. That return of money injected should not give rise to tax,
whether it occurs on a formal buyback or on the payment of dividends. The aim is to tax only returns
that are generated within the circle through the use of capital. The generation of credits on the injection
of capital into the circle will ensure that the return of the amount injected will not be taxed.
M will send G £300, and will receive 300 shares. The tax treatment will be the same as the treatment of
K’s investment, and for the same reason: money is being injected into the circle of UK companies. No
tax will be due at this stage, but G will still get credits of £300.
TABLE 1
G’s capital-raising
Subscriber
H
J
K
M
Total
Cash to G
£
700
800
1,200
300
3,000
Cash to HMRC
(if no credits used)
At the end of this, G will have credits to cover dividend payments, or share buybacks, of £2,200.
Furthermore, a buyback will be treated exactly like a dividend payment. If shares held by a UK company
are bought back without a UK-UK election, or shares are bought back from an investor that is not a UK
company, there will be a use of credits by G (or a payment of tax if G has run out of credits), and a
generation of credits in a UK company that sells shares back to G. If shares held by a UK company are
bought back under a UK-UK election, there will be no tax consequences. If shares are bought back from
an investor that is not a UK company, there will be a use of credits by G (or a payment of tax if G has run
out of credits), and no further tax consequences.
These tax consequences would only apply to the issue and redemption of share and loan capital, not to
trading in the secondary market. There would therefore be scope for distortion. UK companies that wished
to invest in other companies, and that were not offered the option of a UK-UK election, might prefer to let
others subscribe and then buy in the secondary market. Investees, on the other hand, would prefer to
receive subscriptions of capital from those whose investments would generate credits. The result would be
that issues of capital would tend to be to individuals and non-UK companies, which would then sell shares
to UK companies at a profit. While this problem would be a real one, it should not be too great. Investee
companies would be aware of the opportunity for subscribers to profit by selling their investments, and
would price share and bond issues accordingly. Thus the benefit should be largely captured by the
companies that sought capital to put to productive use. That would be a satisfactory result.
£
300
0
0
0
300
Credits for G to use
against future payouts
£
700
0
1,200
300
2,200

Q pays tax of £100, and pays £900 to P.
P gets a credit of £900 x (10/90) x (70/30) = £233.33.
INVESTMENT OVERSEAS BY UK COMPANIES
Money does not only come into the UK from abroad. UK companies
also invest capital in non-UK companies.
The suggested approach is illustrated below.
How to get rid of corporation tax 47
When a UK company invests capital in a non-UK company, that
should be treated like a dividend payment to a non-UK company. Tax
would be due, except to the extent that credits were available to
cover the payment.
When a UK company receives dividends or interest from a non-UK
company, the desired result is that there should be total tax, UK and
foreign, of at least 30% of the profits that give rise to the dividend. If
the foreign tax is less than 30%, the UK should only tax to top the
rate up to 30%. If it is more than 30%, the UK should simply not
impose further tax.
The foreign tax will include both corporation tax on profits, and
withholding tax on payments abroad.
The way to achieve the desired result is as follows. If the foreign tax
rate exceeds 30%, give a full credit in the UK recipient company for
the amount of dividend received. It will then be able to pass the
dividend on to its investors without accounting for any tax. If, on the
other hand, the foreign tax rate is lower than 30%, give a credit (in
terms of dividends to be paid) of:
Dividend received x foreign tax rate x 100 – UK tax rate
100 – foreign UK tax rate
tax rate
Capital returned to the UK company would also generate credits,
even though its return would normally not suffer foreign tax, but it
would only be allowed to generate credits up to the amount of the
capital originally invested abroad.
EXAMPLE 5
A UK company, P, which currently has no dividend credits, owns all of the shares in a non-UK
company Q, which is based in a country where the tax rate is 10%. Q makes profits of £1,000,
and pays the greatest possible dividend to P. P then pays out all it can to its sole shareholder, an
individual, R.
P pays R £233.33 free of tax, leaving it with £666.67. The tax on this, at 30%, is £200.
P pays R a further £466.67, and pays HMRC £200.
R receives £233.33 + £466.67 = £700, just as he would have received on a distribution of £1,000 of
profit made in the UK.
Total tax collected is £300, made up of £100 in Q’s country and £200 in the UK.

48 Big Picture
“The challenge of
introducing the new
system would be
great, but the prize
would be worth
winning.”
ANTI-AVOIDANCE
A great many tax avoidance opportunities in the existing system
would simply vanish. However, some opportunities would remain,
and measures would be needed to prevent avoidance. These would
include the following.
o Interest can be effectively paid without a loan, or interest, being
apparent at all. Leases of assets for the bulk of their useful lives
are like this: such a lease is commercially equivalent to the
purchase of an asset with a loan. Interest payments that were
wrapped up in such packages would therefore have to be isolated
and taxed.
o Profits might be distributed to a non-UK holding company by the
holding company over-charging for goods or services, rather than
by the payment of dividends. Transfer pricing rules would be
needed to ensure that only market prices were charged for goods
and services.
o In order to prevent a loss of tax through UK companies in foreign
ownership making a profit, then changing their residence to
outside the UK, then making distributions, there would have to
be a deemed distribution of all assets when a company ceased to
be resident in the UK.
THE TRANSITION
The transition to the proposed system would markedly change the
tax environment for businesses. In the long term, the change would
be highly beneficial. But the change would create difficulties for some
companies in the short term, and transitional measures would be
needed.
In particular, capital structures that have been designed to be optimal
under the current tax regime would no longer be optimal. The
advantage of using debt rather than equity would be removed, and
tax would arise on interest payments where it might not currently
arise. Debt agreements also incorporate clauses that determine what
amounts must be paid if the tax regime changes. Such clauses might
well have adverse effects in the context of the change proposed here.
It might well be necessary to continue to apply some features of the
existing tax regime to existing debt.
There would also be a number of legal issues to manage. The UK has
a large network of tax treaties. They were made on the assumption
that the UK would have a corporation tax on profits, and they also
limit the extent to which tax may be imposed on dividends and
interest paid abroad. These treaties would require revision. Another
concern would be the effect of European Union law, which constrains
the policy decisions of member states in relation to direct taxes. Such
difficulties should not, however, be insuperable.

“The UK could
advertise itself to the
world as a country with
a very simple regime
for taxing corporate
profits, and one that
was friendly to
business investment.”
How to get rid of corporation tax 49
THE CHALLENGE AND THE PRIZE
The change that is proposed here would allow the UK to advertise
itself to the world as a country with a very simple regime for taxing
corporate profits, and one that was friendly to business investment.
In particular, the absence of tax on profits that were retained for use
in businesses would give businesses that wanted to invest a far better
deal than the current system of tax-deductible depreciation, and
without the complexity of the current system. The challenge of
introducing the new system would be great, but the prize would be
worth winning.

50 Big Picture

SNAPSHOT
o Aviation provides
significant benefits to the
economy, contributing
£50bn to UK GDP, £8bn in
tax, and supporting
921,000 jobs. As the highgrowth
markets continue to
power ahead, flying will
become even more
important.
o Aviation is bad for the
global and local
environment, but quieter
and cleaner aircraft and
improved operational and
ground procedures can
allow aviation to grow in a
sustainable way.
o The UK faces four related
crunches – hub capacity
now; overall capacity in the
South East by 2030;
excessive taxation; and an
unwelcoming visa and
border set-up.
o This article sets out a
holistic aviation plan,
putting forward 25
recommendations to
address six key areas.
1. Making the best shortterm
use of existing
capacity.
2. Making speedy decisions
about where new runways
should be built.
3. Surface access and
integration with the wider
transport network.
4. Noise and other
environmental mitigation
measures.
5. Taxation.
6. Visas and borders.
Flying into
the future
Flying into the future 51
In comprehensive new research, Corin Taylor,
Senior Economic Adviser at the IoD, analyses the
constraints on the UK’s airport capacity and sets
out a holistic long-term plan to address the
country’s aviation challenges.
GROWING AVIATION SUSTAINABLY
Aviation is great for the economy, but bad for the environment. In
the current economic climate we need all the growth we can get,
but we also need to preserve our natural world. Fortunately,
technological and operational improvements allow aviation to
grow in a sustainable way.
The economy
Aviation contributes £50bn to UK GDP, supports 921,000 jobs,
contributes nearly £8bn in tax, and generates further benefits
through its role in facilitating tourism. 1
Air transport also supports
trade, with 30% of all UK exports by value transported by air and
35 million (m) business passengers passing through UK airports
every year.
The UK and world economies are shifting, and both trends mean
that aviation will be increasingly important. Knowledge-based
services and high-tech manufacturing have both become more
important to the UK economy – and these rely more on air
services than other parts of the economy. The high-growth
markets are also accounting for an increasing share of global GDP
and UK trade, at the same time as the EU is accounting for a
smaller share – direct long-haul flights to a range of new
destinations, primarily in Asia, are therefore vital.
The global environment
According to the Committee on Climate Change, with reasonable
fuel efficiency improvements and a gradual uptake of sustainable
biofuels, UK aviation demand can increase by 75-125% on its
2010 level, without carbon dioxide (CO 2) emissions increasing
beyond their 2005 amounts.
Operational measures can also make a large difference. Continuous
descent approaches (CDAs) and continuous climb departures
(CCDs) can reduce CO 2 emissions at these stages of the flight (and
can also contribute to lower noise levels). Trials show that making
every stage of the flight as efficient as possible (the fuel optimum
profile or ‘perfect flight’) can reduce CO 2 emissions by 10%.
1 See: Oxford Economics, Economic Benefits from Air Transport in the UK, 2011, Table 3.1.

52 Big Picture
Improved ground procedures can reduce CO 2 emissions too. A Boeing
747 can consume a tonne of fuel and emit several tonnes of CO 2
during an average 17-minute taxi to take off. But towing the aircraft
with a tug would use just 20-30 litres of fuel. And electric tugs are also
on the horizon.
The local environment
While aircraft noise is a significant concern, the noise footprint of
airports is tending to shrink rather than grow, as airline fleets become
progressively quieter:
o In 1980, there were 944,000 people living in the 57 decibel (dB)
noise contour around Heathrow. By 2010, that number had
fallen by three-quarters to 228,700. Over the same period, the
number of flights rose from 273,000 to 449,000 a year.
o The noise footprint of the new Boeing 787 Dreamliner is 60%
smaller than other similarly-sized aeroplanes, while the Airbus
A380 produces three to four-times less noise on landing than
other large aircraft.
It’s not just noise. Air quality also matters:
o The new Bombardier CSeries aircraft will emit up to 50% less
nitrogen oxide (NO x) than current aircraft of a similar size, while
successive generations of Rolls-Royce Trent engines are becoming
ever cleaner.
o In addition to reducing CO 2 emissions and noise, many of the
operational improvements outlined above, including towing
aircraft to and from the runway, will also result in improvements
in air quality.
o Finally, the impact of road access to airports, both on carbon
emissions and on local air quality, will fall over time, as car
engines become cleaner and as the uptake of electric cars
gradually increases.
THE FOUR CRUNCHES
The UK has always been an open trading nation, and we increasingly
rely on aviation to take our goods and people to the world and to
bring the world to our shores. Unfortunately, as a country, we are
beginning to close up, making it a little harder to get here. As global
trade, tourism and aviation continue to grow rapidly, the UK is
beginning to allow itself to be squeezed, in four related ways.
Crunch 1: South East capacity
The projections in this section quote from the Department for
Transport’s (DfT) 2011 ‘unconstrained demand’ forecasts. We have
used the unconstrained forecasts as they give us the best picture of
likely demand. Forecasts are liable to be wide of the mark – the DfT’s
2000 forecasts overestimated demand growth – but they nevertheless
give us a useful insight.
Overall, the UK has plenty of capacity. In 2010, 211m passengers
passed through UK airports, which currently have the capacity to
handle 372m passengers a year. By using the current set of runways to
the maximum (which may include constructing new or extended
terminal buildings, lifting planning restrictions and making other
improvements), UK airports would have the capacity to handle 540m

“Overall, the UK has
plenty of airport
capacity. The real
issue is where that
capacity is located.”
Flying into the future 53
passengers a year. This is similar to the number of passengers
projected to be using UK airports by 2050 (520m).
The real issue is where that capacity is located. The DfT forecasts show
that the South East will need new runway capacity by 2030, but no
airports outside the South East will need new runways before 2040.
o In 2010, 126m passengers used the five London airports –
Heathrow, Gatwick, Stansted, Luton and City.
o These five airports are currently able to handle 181m passengers
a year. By using their current runways to the maximum, that
capacity could be increased to 188m passengers.
o However, the DfT forecasts that 204m passengers will want to fly
from these airports by 2030, and 294m by 2050.
o By contrast, the other UK airports currently have the capacity to
handle 191m passengers a year, a figure that could rise to 352m
if all runways were used to the maximum. But demand is far
lower. In 2010, demand was 85m, a figure forecast to rise to
141m in 2030 and 226m in 2050.
o All of the individual airports outside of the South East have plenty
of spare capacity. No airport outside of London will need a new
runway before 2040.
Table 1 sets out the DfT’s capacity assumptions and unconstrained
demand forecasts for each UK airport, up to 2050:
o Areas shaded green are where no new capacity is needed;
o Areas shaded amber show where more terminal capacity and/or
other improvements are required;
o Areas shaded red show where demand is forecast to be larger
than the maximum use of the existing runway/s.

54 Big Picture
TABLE 1
Unconstrained demand forecasts for UK airports, 2010-2050 (millions of passengers per year)
Airport
Heathrow
Gatwick
Stansted
Luton
London City
Manchester
Birmingham
Edinburgh
Glasgow
Bristol
Liverpool
Belfast International
East Midlands
Newcastle
Aberdeen
Belfast City
Leeds/Bradford
Southampton
Prestwick
Cardiff
Bournemouth
Exeter
Doncaster Sheffield
Humberside
Inverness
Newquay
Norwich
Plymouth
Teesside
Blackpool
Coventry
Total London
Total outside London
TOTAL
“Heathrow has no
more room. No
forecasts are
necessary – the
numbers speak for
themselves.”
Capacity Unconstrained demand
2008 Max use 2010 2020 2030 2040 2050
86
42
35
10
8
30
18
20
12
7
12
10
25
6
5
4
5
5
3
12
2
2
2
1
1
1
2
1
3
3
0
181
192
373
86
42
35
17
8
56
27
20
20
12
20
23
25
20
10
4
12
7
15
12
6
12
2
12
8
3
3
4
10
8
2
188
353
541
Source: Department for Transport, UK Aviation Forecasts, August 2011, unconstrained terminal passenger forecasts by airport (central
forecast). Totals may not sum due to rounding.
65
30
20
8
3
20
9
8
6
5
5
4
4
4
3
2
3
2
2
1

“At current levels for
carbon credits, UK Air
Passenger Duty could
more than offset the
entire emissions of the
global air transport
industry.”
CHART 1
Flying into the future 55
o In 2011, Heathrow handled 1.5m tonnes of freight, 65% of the
total for UK airports. No other UK airport handled more than
300,000 tonnes of freight.
o In 2010, 36% of Heathrow’s passengers were transferring onto
other flights. Of these, 88% were transferring onto international
flights. No other UK airport comes close to this proportion of
transfer passengers. At Gatwick, the airport with the second
highest proportion of transfer passengers, only 8% were
connecting in 2010.
Heathrow’s terminals may be able to accommodate more passengers,
but the airport has a regulated limit of 480,000 Air Traffic Movements
(ATMs) a year, and in 2011, ATMs reached 476,000. Under existing
arrangements, Heathrow has no more room. No forecasts are
necessary – the numbers speak for themselves.
Crunch 3: Tax
Since its introduction in 1994, Air Passenger Duty (APD) has risen
from £5 within Europe and £10 outside of Europe, to between £13
and £184, depending on the distance and class of travel. In 2011-12,
APD raised £2.6bn, a three-fold increase on a decade ago and a
seven-fold increase on 1995-96, the first full year of receipts. The UK
now levies the highest taxes on flying in the world.
Only six of the 27 EU member countries apply APD. Several countries,
including Ireland, the Netherlands and Denmark, have recently
reduced or abolished it.
APD is levied at a much higher rate than the environmental costs of
flying would suggest. At the 2007 rates of APD, aviation covered its
climate change costs with around £100m to spare. Since 2007, APD
rates have risen substantially. At current levels for carbon credits, APD
could more than offset the entire emissions of the global air transport
industry.
Rates of UK aviation tax per person compared to EU average
€ 250
€ 200
€ 150
€ 100
€ 50
€ 0
Economy short haul
Economy medium haul Economy long haul Max rate in any class
UK EU average excluding UK
Source: House of Commons All-Party Parliamentary Group for Aviation, Inquiry into Aviation Policy and Air Passenger Duty, August 2012, p.10.

56 Big Picture
“The UK trades about
20 times as much with
high-growth countries
with daily (or better)
direct flight
connections as it does
with countries with
poor connectivity.”
Crunch 4: Visas and borders
Since 2010, the UK has tightened up the visa regime for long-term
economic migrants and restricted the ability of non-EEA students to
work in this country after completing their studies.
At the same time, the UK has also made it more difficult and timeconsuming
to visit, both for tourism and for business. The UK visitor
visa application process is longer and more expensive than the
Schengen process, costing around 50% more and with a form that
has twice as many questions. It can take up to 12 weeks to process a
UK visitor visa application.
Border queues have also at times been embarrassingly long. Maximum
queuing times have regularly been over two hours. Targets to ensure
that at least 95% of non-EEA arrivals wait for a maximum of 45
minutes were regularly missed at Heathrow before the Olympics, and
early indications are that performance has started to slip once again,
now that the Games are over.
Why they matter
These four crunches matter immensely, for a number of reasons.
Firstly, aviation will become increasingly important to our own
economy as the world economy shifts rapidly towards the highgrowth
markets. By 2050, Goldman Sachs estimates that the BRIC
countries will account for nearly 40% of world GDP and emerging
markets overall over 70%. And the UK trades about 20 times as much
with high-growth countries with daily (or better) direct flight
connections as it does with countries with poor connectivity. A similar
pattern holds for investment.
Secondly, there is no doubt that good point-to-point airports are vital,
and direct routes from the UK’s manufacturing heartlands to China’s
growing metropolises would provide an important economic boost. But
the UK already has numerous point-to-point airports. By contrast, it only
has one hub airport, which is already full. Hub airports really do matter.
The key reason for this is that a range of routes and a high frequency of
services are only made viable by the transfer passengers connecting
through a hub airport. 2
And global businesses want to locate in cities
that are well connected, both in range of destinations and frequency of
flights, even if they have to pay a premium in office rent and salaries to
do so.
Thirdly, Heathrow’s lack of spare capacity is already leading to a
number of difficulties. In busy periods, planes regularly circle before
landing and queue before taking off, leading to delays and extra
emissions. Heathrow’s number of global connections has also shrunk.
The number of destinations served by the airport has fallen from 227
in 1990 to 180 today. 3
Heathrow has daily direct flights to 26 cities in
the US and Canada, but to only three in South America. Its market
share of European airports serving mainland China (11%) trails rivals
such as Paris (18%). And for many UK regions, the most important
hub airport is now Amsterdam, not Heathrow. 4
Fourthly, it is clear that exorbitant levels of Air Passenger Duty are
2 The importance of transfer passengers to sustaining routes at Heathrow is illustrated by the fact that in 2010
there were 39 routes at Heathrow on which more than 50% of passengers were transferring, and a further 92
routes on which more than 25% of passengers were transferring.
3 By contrast, Amsterdam’s Schiphol airport serves 313 destinations, and both Frankfurt and Paris Charles de
Gaulle serve more than 250.
4 Since 1990, the number of British regional airports with flights to Heathrow has fallen from 21 to 6. Three times
as many regional airports – 18 – have direct links to Amsterdam.

“The last 50 years of
aviation policy in the
UK can fairly be
described as a
timeline of indecision.”
Flying into the future 57
having a negative impact. APD was one of the main reasons cited by
the CEO of Air Asia X for pulling out of the UK earlier this year, and it
is also now damaging the UK’s regional airports. For example,
passengers flying out of Newcastle this year are expected to pay a
total of £49m in APD, almost as much as the airport’s turnover last
year of £52m. The Netherlands’ short-lived experiment with APD is
revealing. The tax generated €300m but was estimated to have
caused a loss of €1.3bn to the broader Dutch economy.
Finally, the UK is not benefitting as much as it could be from the
growth in tourism. In 2011, £18bn was spent by overseas visitors to the
UK. Of this total, just £318m was spent by Indian visitors, £302m by
Brazilian visitors and £259m by Chinese visitors (excluding Hong Kong).
But the opportunity is vast. Chinese visitors (excluding Hong Kong)
spent an average of nearly £1,500 per visit, nearly three times the
average for all visitors. Yet the UK attracted just 109,000 Chinese visitors
in 2010, compared to France’s 907,000 and Germany’s 511,000.
A LONG-TERM PLAN FOR GROWTH
The UK requires a holistic aviation plan, to overcome previous failures
to get new runways built, to ensure integration with the wider
transport network and to ensure smoother journeys to and from the
UK. Below we outline the key considerations for that plan, together
with 25 specific policy recommendations.
A holistic plan
The first important consideration underpinning a holistic plan is that
many of the proposals that have been made this time around have
been made before. The 2003 Future of Air Transport White Paper was
particularly comprehensive, recommending a third runway at Heathrow
and a second runway at Stansted, with land safeguarded for a possible
second runway at Gatwick after 2019. But the White Paper failed to
ensure that additional runways were constructed. Nine years after its
publication, we are effectively back to square one. 5
Indeed, the last 50
years of aviation policy in the UK can fairly be described as a timeline of
indecision, as other countries have expanded their hub airports.
The second consideration is that the main role for government is not a
financial one, with the exception of improved surface access to
airports. Rather, central government’s main role is to overcome
planning obstacles by making a firm decision about where new
capacity should go. Outside of London, the planning system has not
prevented new runways or runway extensions from being built, but in
the South East, no local council supports a new runway at their local
airport, or the construction of a new airport.
The third consideration is that a single solution is not enough. Most
options, in isolation, fail to provide enough extra capacity to meet the
forecast increase in demand. 6
Moreover, given that it will be at least a
decade before any new runway can be opened (and probably closer
to 15 years, considering that the Davies Commission will not conclude
until 2015), a number of solutions are needed to address immediate
5 The notable exception to this being that Gatwick has new owners as, shortly, will Stansted – offering the
prospect of genuine competition between London’s main airports.
6 London and the South East will have a forecast capacity shortfall of 16m in 2030 and 57m in 2040. Hub capacity
will account for almost the entire shortfall. Only a new hub airport or a four-runway Heathrow are sufficient to meet
the shortfall. A combination of a third runway at Heathrow and a second runway at Gatwick or Stansted would be
sufficient to meet the overall capacity shortfall, but may not provide enough additional hub capacity.

58 Big Picture
“Heathrow will need a
third runway by 2020
and a fourth by 2030,
while Gatwick will
also need a second
runway by 2030.”
pressures. And capacity cannot be considered separately from other
factors, such as the wider transport network, visas and borders, and
the environment.
In view of those considerations, the holistic approach we set out
below covers six principal areas:
o Making best use of existing capacity in the short term.
o Making decisions about where increased capacity should go in
the short term, so that new runways can open in the medium term.
o Surface access and integration with the wider transport network.
o Noise and other environmental mitigation measures.
o Taxation.
o Visas and borders.
THE RECOMMENDATIONS
Making best use of existing capacity
It is unlikely that any new runways will open within the next 10 years.
The need for short-term measures to make the best use of existing
capacity is paramount.
Recommendation 1: Continue with operational freedoms at
Heathrow, but do not introduce mixed-mode.
Operational freedoms can reduce delays, limit stacking and help
Heathrow to recover from disruption. They do not allow an increase in
night flights or flights overall, and can only be used when certain
triggers are met. Mixed-mode, however, should not be introduced. It
would deliver a small increase in capacity for a large increase in noise,
and the planning process would take almost as long as for a third
runway.
Recommendation 2: Reduce the level of regulation of Stansted and
Gatwick.
Now that Stansted is being sold, the case for the airport having
significant market power, and therefore being subject to price controls,
is weaker. Competition is preferable to regulation, and the new owners
will have a strong incentive to provide an attractive pricing regime to
grow traffic. A similar case can also be made for Gatwick. The current
price control arrangements expire in 2014, the appropriate time for
any deregulation to come into effect. The Civil Aviation Authority
should look again at the market power of both airports. In addition,
‘fifth freedoms’ already enjoyed by airports outside the South East
should be extended to Gatwick, Stansted and Luton.
Recommendation 3: Promote airports outside the South East.
All of the airports outside the South East have considerable spare
capacity and are part of the solution in the short term. Promoting
non-South East airports should include: a campaign overseas;
improving surface access; reducing regulation; introducing codesharing
between rail and air on the West Coast Main Line, primarily
for Birmingham Airport; and introducing a unilateral regional airport
open access policy.

Flying into the future 59
Recommendation 4: Accelerate plans to open up Channel Tunnel
passenger rail services to competition.
Eurostar already has a market share of 80% between London and Paris
and Brussels. Competition and direct services to cities such as
Amsterdam and Frankfurt could result in similar shifts to rail for
journeys beyond Paris and Brussels, benefitting the environment and
reducing a little of the pressure on Heathrow. The Channel Tunnel has
50% spare capacity for passenger services, but there are several issues
hindering the development of competition, which need to be
overcome as soon as possible.
Recommendation 5: Ensure that the remaining parts of the Single
European Sky package are implemented swiftly.
The Single European Sky is composed of several regulations to create a
pan-European framework for air traffic management. The most
significant change is to re-organise European airspace from national
borders into functional blocks. This should improve the management of
higher flight volumes, allow more direct flight paths and reduce delays.
New capacity
According to the Department for Transport’s unconstrained demand
forecasts, Heathrow will need a third runway by 2020 and a fourth by
2030, while Gatwick will also need a second runway by 2030. By
contrast, no airport outside of the South East will need a new runway
before 2040. The IoD supports the growth of airports outside the
South East, but new runways will not be necessary for some time.
A range of possible solutions to the UK’s aviation capacity crunch have
been advanced. In the IoD’s view, the two recommendations below
represent the best options for increasing both overall capacity and,
crucially, hub capacity.
Recommendation 6: Allow Heathrow to expand by one, or
preferably two, runways.
Heathrow is the UK’s only hub airport. Unless one or more other
airports can be developed as hubs, the only way to increase the UK’s
hub capacity is to increase Heathrow’s capacity:
o Heathrow is already full – an expansion of the airport is therefore
the only option that does not rely on forecast increases in
demand or shifts in the location of demand. Heathrow expansion
can be funded privately, without any risks to the taxpayer.
o According to the DfT’s forecasts, demand at Heathrow will
increase to 115m by 2030 and 140m by 2040. This is clearly far
more than a third runway can meet. A fourth runway would meet
a larger proportion of the demand shortfall up to 2040. It may
be possible for Gatwick to compete as a hub airport with
Heathrow, but it would be more sensible to see additional
capacity at Gatwick as complementing, rather than competing
with, Heathrow.
o Heathrow is the location of choice for airlines. Previous attempts
to move traffic away from Heathrow through the London Traffic
Distribution Rules failed – as soon as the rules were lifted in
1991, Virgin Atlantic moved to Heathrow.

60 Big Picture
o Heathrow is well located for road access and well located for
surface access from London via public transport. The rail
infrastructure improvements currently planned or underway –
including Crossrail, a Western access line to the Great Western
Main Line, HS2, the Piccadilly Line upgrade, and a Southern rail
link to Heathrow – will further improve surface access.
It is outside the IoD’s competence to determine which runway
solutions would be best at Heathrow. We note four possibilities, in
isolation or in possible combination. Further work is clearly needed to
evaluate these options in more detail. Most of these options,
unfortunately, involve the demolition of a number of houses, although
other proposals, including the proposal by Foster and Partners for a
new hub airport, also involve the demolition of homes:
o A short third runway to the North, at Sipson.
o A close-parallel runway to the South of the existing Southern
runway, which could be contained almost entirely within the
existing airport boundary, together with the demolition of
Terminal 4 and its relocation to the central area.
o Reconfiguration of the runway at RAF Northolt to serve as a third
(or a fourth) runway, with a fast rail link between the terminals.
o The construction of two pairs of close parallel runways
immediately to the West of the existing site, with Terminals 2, 3
and 5 retained and a new Heathrow West terminal.
The downsides of Heathrow expansion are noise, local air pollution
and road congestion. They are far more serious issues at Heathrow
than at other possible locations for new capacity. But they are not
insurmountable problems – we set out below how stringent noise and
other environmental measures should be applied, and how public
transport could become the mode of choice to access Heathrow.
Recommendation 7: Allow Gatwick to build a second runway.
A second runway at Gatwick airport would complement expansion of
Heathrow, as well as being important in its own right. Gatwick has
improved remarkably since it was acquired by new owners, and will
continue to grow its traffic. It is already the busiest single runway
airport in the world:
o Gatwick is currently about 80% full, and is likely to be completely
full over the next 15 years. The DfT forecasts show that, even with
expansion of Heathrow, demand at Gatwick will increase steadily.
o The airport is well located for rail access, and its rail services will
improve after the Thameslink upgrade is completed in 2018. It is
currently far better located than Stansted for rail access.
o The investment risk would fall on the airport, not the taxpayer.
o It remains to be seen whether London can accommodate two hub
airports, as per New York. A larger Gatwick may remain a very
busy point-to-point airport, or start to develop a hub offering. A
second runway at Gatwick would offer a low-risk way of finding
out whether two hub airports in the South East are feasible –
certainly far less risky than Stansted.
Gatwick’s legal agreement with West Sussex Council prevents
construction of a new runway before 2019, but there is no reason for
approval not to be granted before that date. This would allow

BOX 1
The main alternative options for increasing airport capacity
Flying into the future 61
Aside from expansion at Heathrow and/or Gatwick, a variety of alternative ways of increasing the UK’s
airport capacity have been advanced, but all have their drawbacks:
A new hub airport in the Thames estuary or North Kent
o It could only be financed if Heathrow were to close.
o For most people, the new airport would be located on the ‘wrong’ side of London and would be
considerably harder to get to by road and rail. In this respect, Hong Kong is not a relevant comparison, as
Hong Kong has no hinterland.
o Rail improvements planned or underway will transform Heathrow’s connectivity. In order to provide good
links to a new Thames estuary airport, this sort of rail infrastructure would have to be built (not to
mention new roads), but it is already being built to serve Heathrow.
o Businesses around Heathrow and Heathrow airport workers would be severely disadvantaged.
‘Heathwick’
o Linking an airport that is already full with one that is likely to be full once the rail link opened would be an
expensive way of adding no extra capacity at all, although this equation would change if a second runway
was built at Gatwick.
o A long transfer between airports of at least 15 minutes would make the hub experience appalling.
Other hub airports offer a quick transfer, often within the same terminal.
o Heathrow and Gatwick are no longer under the same ownership, reducing the likelihood of smooth
operations for passengers transferring between the two airports.
Birmingham airport
o The IoD supports the development of Birmingham airport. The runway extension, set to open in 2014,
and code-sharing arrangements with the new West Coast Main Line rail operator, would increase the
airport’s attractiveness.
o However, making full use of Birmingham airport would not meet the South East capacity shortfall, and
would add no extra hub capacity. Greater use of Birmingham airport should be seen as an interim
measure, before new runways open. It is no substitute for more capacity in the area of greatest demand.
A second runway at Stansted
o Over the last few years the airport has stagnated, with passenger numbers falling steadily from 23.8m in
2007 to 18m in 2011. New owners will undoubtedly improve the airport and grow traffic. But Stansted
currently has about 50% spare capacity.
o The airport has no immediate hinterland outside of London and would need substantial infrastructure
improvements, including a fast rail link to London, better rail links to the Midlands, and improved road
access via the A14.
o Stansted has not been a location of choice for full-service airlines, and is still dominated by Ryanair.
New capacity at Stansted would not be likely to be hub capacity.
A four-runway Stansted
o Many of the same arguments apply. At present, demand is only sufficient to fill one half of Stansted’s
runway, so building an extra three would risk being a very poor investment.
o A four-runway Stansted would be unlikely to compete effectively with Heathrow, as it is considerably
less well located for surface access.
The best, however, should not be the enemy of the good. If the IoD’s preferred options are not feasible, then
expansion of Stansted would probably be the next best choice given that it is already there, that much of the
surface access infrastructure already exists, and that Heathrow would not need to close to fund construction.
construction to begin after the expiry of the legal agreement, and the
runway to open in the mid 2020s.
Gatwick is unlikely to be able to expand beyond a second runway. But
expansion of Heathrow and a second runway at Gatwick would be
likely to offer sufficient extra capacity, at least until 2040.

62 Big Picture
Surface access and wider transport integration
The UK has suffered from the failure, over many decades, to
implement an integrated transport policy. Planning rail and airport
developments together, in particular, would maximise the benefits of
investment in both modes, which is especially important when
resources are limited. The recommendations in this section do depend
somewhat on the airport capacity solutions that are actually chosen –
finite resources mean that those airports building new runways should
be prioritised.
Recommendation 8: Transform Heathrow’s rail connectivity by
constructing the Heathrow Hub and running the HS2 line directly
through Heathrow.
Although rail access to Heathrow will improve dramatically over the
coming years, constructing the ‘Heathrow Hub’ could lead to even
greater benefits. It involves a large station on the Great Western Main
Line with an airport terminal above. Passengers would get off the
train, check in and pass though security at the terminal and board a
fast airside tracked transit to their gate. HS2 should also run through
the Heathrow Hub.
Recommendation 9: Improve and extend rail services to Gatwick.
Gatwick’s rail services will improve when the Thameslink upgrade is
complete in 2018, but more capacity will be needed on services to
Victoria. In addition, better links could be made to the West Coast
Main Line via the West London Line, and to Reading.
Recommendation 10: Extend Crossrail to Stansted.
Extending Crossrail to Stansted would allow direct access to the
airport from a number of points in London. It would be preferable to
reducing journey times for the Stansted Express, which only serves
Liverpool Street and Tottenham Hale.
Recommendation 11: Introduce smart ticketing and code-sharing
between rail and air.
For most airports, the most relevant improvement would be to
introduce smart ticketing, removing the need to purchase a ticket prior
to travel and making journeys to and from the airport faster and more
flexible. Existing rail services could all benefit from smart ticketing.
For long distance services to airports, principally Birmingham airport
at present, but potentially Heathrow airport on the Great Western
Main Line and HS2 as well, the most important improvement would
be to introduce code-sharing between rail and air, allowing plane
tickets to be combined with a journey on any relevant rail service.
Noise and other environmental mitigation
If no new capacity is added, then noise and other local environmental
problems will diminish over time, as aircraft steadily become quieter
and cleaner, operational procedures improve and road transport
becomes less polluting. But if new runways are built, then noise and
local air pollution will affect people who are currently less affected, or
not affected at all. Regardless of compensation measures, any airports
building new runways (or any new airports) should be subject to the
strictest environmental standards.

Flying into the future 63
Recommendation 12: Airports building new runways, or a new
airport, should be subject to strict noise measures.
No planes above a stringent noise threshold should be permitted to
use the airport, except in an emergency. The noise limits should also
fall further over time.
In addition, the angle of descent should be increased above 3 degrees
(the current angle at Heathrow) so that planes are higher above
people’s homes when they land. This would particularly apply to
narrow-bodied aircraft, although it may also be possible to increase
the angle of descent for wide-bodied aircraft as well.
Recommendation 13: Airports building new runways, or a new
airport, should be required to implement best practice ground
procedures.
These measures would be important to limit local air pollution and
would include towing aircraft to and from the runways, using fixed
electrical ground power and using electric vehicles for airport
operations.
Recommendation 14: Airports building new runways, or a new
airport, must have a strategy to reduce air pollution and CO 2
resulting from road access to the airport.
Over time, CO 2 and air pollution from road transport will gradually
fall, as engines become cleaner, the uptake of hybrid and stop-start
non-hybrid engines increases, and as electric car technology develops.
But these improvements are unlikely to come fast enough, especially
for Heathrow.
A strategy should be adopted to reduce harmful emissions from road
access, with measurable goals. It should both inform, and be informed
by, improvements to public transport services to the airport – if public
transport services are improved, it will be easier to restrict car access.
Recommendation 15: A balance needs to be struck regarding night
flights.
Night flights are by far the most damaging for local communities, but
the solutions are likely to differ between airports. For airports that
serve as express freight gateways, principally East Midlands, Edinburgh
and Stansted, where express couriers operate their own aircraft, a
number of night flights do need to be allowed. For airports that build
new runways, flights between 23:00 and 06:00 should be severely
restricted or banned completely. Last year, Frankfurt airport balanced
the opening of a fourth runway with a ban on flights between 23:00
and 05:00.
Taxation
The UK levies the highest taxes on flying of any country in the world,
reducing our attractiveness as a destination and benefitting European
airports and airlines at the expense of UK ones.
Recommendation 16: Freeze Air Passenger Duty (APD) rates in cash
terms.
APD is already too high, but a freeze in cash terms is a necessary first
step.

64 Big Picture
Recommendation 17: Offset the impact of the EU Emissions Trading
System (ETS).
Including aviation in the ETS should not add to the overall tax burden
on flying. An allowance should be introduced against APD to cover
100% of the impact of the ETS.
Recommendation 18: Carry out a comprehensive analysis of the
economic impact of APD and the ETS.
An economic analysis of the total impact of APD on growth and
employment in the UK is needed. The review should also establish fare
price elasticities of leisure and business travel and investigate the
impacts of the ETS charge.
Visas and borders
The benefits of more airport capacity, better integration with the
wider transport network and reduced levels of taxation would be
considerably reduced if the UK continues to make it difficult and timeconsuming
for people from outside the EU to come to this country.
Recommendation 19: Employ more permanent border staff.
Between March 2011 and March 2012, Border Force staff fell by 10%
at Heathrow and by 6% nationwide, contributing to longer queuing
times. During the Olympics, performance improved because extra
staff were drafted in.
Other things equal, more border staff will mean shorter queuing
times. The use of automatic e-gates is increasing, but at the moment
these can only be used by EEA passengers.
Recommendation 20: Modernise Border Force working practices to
maximise the use of limited staff resources.
Rosters should be made more flexible, on-call schemes introduced,
and better use made of airline passenger information.
Recommendation 21: Accelerate development of advance-clearance
systems.
Advance-clearance systems enable passengers on low-risk routes to be
screened by immigration in advance of their arrival in the UK and
have the potential to reduce queuing times substantially.
Recommendation 22: Fast-track lanes should not come at the
expense of improvements at the border for all visitors.
Fast-track lanes are to be welcomed insofar as they will smooth the
entry of important businesspeople into the UK, but they are no
substitute for improving the border experience for all people entering
this country, for leisure as well as business.
Recommendation 23: Encourage airports to contribute to improved
performance at the border.
People arriving at UK airports do not recognise the administrative
division between the airport operations and the border operations.
Quite naturally they see arrival as one continuous process – landing,
taxiing to the gate, passing through the border, collecting baggage,
and proceeding with their onward journey. It is therefore in the interests
of airports themselves that border processes run swiftly and smoothly.

“The UK must end up
with an airports
system that allows for
a flexible response to
changing economic
circumstances, travel
patterns and
technology.”
Recommendation 24: Overhaul the visa application process.
Robust checks need to be carried out, but there are two
improvements that should be made. Firstly, visa processing times need
to be speeded up. UK visas can take up to three months to process, a
deplorably long time. Secondly, there should be better integration
with the Schengen visa application process. It should be possible to
apply for a Schengen visa and a UK visa at the same time, with a
single form containing questions common to both systems followed
by Schengen-specific and UK-specific questions, together with
payment of the two fees.
Recommendation 25: Remove international students from the
target for net migration during the period of their study.
This is a key move to increase the attractiveness of the UK as a
destination for higher education. UK universities are already big export
earners, and the economy benefits more widely from links established
with intelligent and ambitious people from growing economies
overseas who study in the UK.
FLYING INTO THE FUTURE
Flying into the future 65
Above all, the UK must end up with an airports system that allows for
a flexible response to changing economic circumstances, travel
patterns and technology. Most airport expansion projects can be
funded privately. With sufficient capacity growth, there is no reason
why this country cannot continue to be a world-class trading hub,
well connected to all the major economies, today’s and tomorrow’s.
For further in-depth exploration of the issues raised in this article,
see the full report, Flying into the future, available on the IoD’s
website at: www.iod.com.

66 Big Picture

SNAPSHOT
o ‘Profit’ and ‘education’ are
held by many to be
unseemly bedfellows. But
for-profit companies
already play an important
role throughout the sector,
providing nursery and
specialist education,
inspections, qualifications
and a wide range of local
authority services.
o It is difficult to justify any
continuing government
policy that prevents forprofit
companies from
competing on a level
playing field in providing
mainstream publiclyfunded
schooling.
o The 2011 Open Public
Services White Paper set
out an ambitious plan to
end government
monopolies in the delivery
of public services. But in
practice, innovations like
the Government’s ‘free
schools’ policy are not
nearly bold enough.
o If the Government was
prepared to take its Open
Public Services agenda to
its logical conclusion in
education, then it should
be looking to more radical
solutions, such as the
introduction of ‘education
passports’.
o Until such reforms have
been introduced, the
prospects for
transformational change
within the sector will
remain severely limited.
Profit in education – not a dirty word 67
Profit in
education –
not a dirty
word
James Stanfield, Director of Development at the
E.G. West Centre at Newcastle University,
examines the existing role played by for-profit
companies in the education sector, and questions
the prejudice against extending their remit.
In September 2011, Deputy Prime Minister Nick Clegg declared
his support for more diversity and parental choice in education,
but rejected the idea of running publicly-funded schools for a
profit:
“To anyone worried that, by expanding the mix of providers in our
education system, we are inching towards inserting the profit motive
into our school system, again, let me reassure you. Yes to greater
diversity; yes to more choice for parents. But no to running schools for
profit, not in our state-funded education sector.” 1
Four months later, in January 2012, the Swedish education
company International Education Schools (IES) became the first
for-profit company to be awarded a contract (£21m over 10 years)
to run a new publicly-funded ‘free school’. So, where does this
leave the Coalition’s policy on education? Is the UK education
sector now open for business? Or does it remain one of the least
attractive service sectors in the UK for private investment and
entrepreneurial talent?
THE EXISTING ROLE OF FOR-PROFIT
COMPANIES IN EDUCATION
Contrary to popular belief, for-profit companies already play an
important role in our state-funded education sector.
Premises, nursery and specialist provision
Every physical item located inside a publicly-funded school,
including the school building itself, has been provided by for-profit
companies operating in highly competitive markets. For-profit
companies also dominate the provision of state-funded nursery
schooling in many areas across the country. And for-profit
1 “Nick Clegg rules out running free schools for profit”, BBC News website, 5 September 2011.

68 Big Picture
“It is difficult to
understand why the
Government is
prepared to allow
for-profit companies
to provide schooling
to children up to the
age of five, but not
beyond.”
companies such as the Cambian Group also receive public funds to
help run pupil referral units (PRUs) and specialist schools catering for
children with severe learning difficulties. 2
However, this lies in stark
contrast to the primary and secondary sector where the Government
continues to direct all public funds to government schools, thereby
discriminating against all private alternatives, despite the fact that they
may be able to provide a better quality of service. Within the European
Union, there is already widespread government support for a variety of
private alternatives and the focus is increasingly on what works best.
Greece and the UK are now the only two countries that do not allow
public funds to be distributed to a variety of different education
providers. 3
From a public policy perspective, it is therefore very difficult to
understand why the Government is prepared to distribute public
funds to for-profit companies that provide schooling to children up to
the age of five, but not beyond that point. Or why such companies
are deemed capable of delivering world-class schooling to excluded
children or those with severe learning or emotional difficulties, but not
to all other primary and secondary school children. What logical
explanation could there possibly be for such a dramatic shift in policy
between nursery schooling and primary and secondary schooling?
Local authority services
For-profit companies also work with local authorities to help deliver a
variety of services to schools, from school meals to special educational
needs. For example, Babcock International Plc has entered into a joint
venture with Surrey County Council (Babcock 4S) 4
to provide a range
of support services to schools, including consultancy, ICT
programmes, training and development, and project management.
According to the company’s website, Babcock 4S recently presented
Surrey County Council with a £1.2 million dividend as a result of
efficiencies delivered, whilst continuing to raise education standards.
Other examples of for-profit companies providing education services
on behalf of local authorities include Arvato Ltd in Sefton, Merseyside;
Devon Norse Ltd in Devon; and Cambridge Education in Islington.
Qualifications and inspections
Edexcel, a for-profit company owned by Pearson, is the UK's largest
awarding body, offering academic and vocational qualifications and
testing to schools and colleges. Even Ofsted, which has the important
role of inspecting schools and maintaining standards across the sector,
relies on a number of for-profit companies to carry out the majority of
its school inspections. Again, this can only beg the question as to why
companies such as Serco and Tribal Group are deemed capable of
inspecting the quality of publicly-funded schools, but not of owning
and managing the schools themselves. 5
Common sense suggests that
if these companies have developed a good understanding of what a
good school should look like, they will also be better placed than
many to set up, own and manage a publicly-funded school.
2 See: www.cambiangroup.com.
3 See Private Education in the European Union, Eurydice, 2000.
4 See: www.babcock4s.co.uk.
5 The distinction between private sector ownership and private sector management in this debate is
important. While ‘ownership’ refers to a privately-owned school which receives government funds,
‘management’ refers to a government school (or specific services related to the school) being managed by a
private company for a specific period of time. When a company owns a school it will obviously have
much more freedom and scope to develop and expand the school.

BOX 1
IES Breckland
Source: http://breckland.iesschools.co.uk.
Profit in education – not a dirty word 69
Free school management
Finally, as noted above, in September 2012 the Swedish education
company International English Schools helped to launch IES Breckland, in
Brandon, Suffolk – the first free school in England managed by a forprofit
company. This suggests that while for-profit companies in principle
are now allowed to manage publicly-funded free schools, public funds
are still not allowed to be distributed to these same companies if they
were to establish exactly the same kind of school outside of the free
school process. This confusing and contradictory state of affairs is a
direct result of the Government’s on-going refusal to direct public funds
to a variety of different educational providers. As a result, the only way
that it can increase choice and variety within the existing monopoly
structure is to set up new government schools and then outsource the
management of these schools to successful private education companies.
In September 2012, IES Breckland became the first free school
in England to be managed by a for-profit company. According to
the school’s website, “IES Breckland is a school for the future, a
school for the community, a school where children are treated
as individuals. It will be recognised by all as the outstanding
local secondary school, where high standards will be set and
expected from all.
“Our vision for IES Breckland is for it to be a stimulating, secure
and inclusive centre of both academic and vocational
excellence in which students from all backgrounds and faiths in
Brandon and its surrounding area are equally valued. We will
together create a school that has, as its core focus, the delivery
of high quality secondary education.”
THE PRIVATE EDUCATION SECTOR
The notion that for-profit companies cannot be trusted to, or are not
capable of, owning and managing publicly-funded schools is rather
undermined by the scale and success of the private education sector.
There are currently 489 mainstream private schools owned and
managed by for-profit companies, educating 82,528 children, which
represents approximately 15% of all pupils educated in the
independent sector (82,528 of 562,885). 6
Approximately 83% of these
schools are non-selective, and 41% charge fees that are similar to the
national average per-pupil funding in the publicly-funded sector.
Outside of schooling, there are also hundreds of for-profit education
companies, such as the Early Learning Centre (ELC), which sell a
variety of learning products and services direct to parents. The ELC
opened its first store in 1974 and now has 215 stores across the UK,
together with over 80 stores in 19 countries internationally. When
6 James Croft, Profit-Making Free Schools, Adam Smith Institute, 2010. p. 7.

70 Big Picture
BOX 2
The for-profit sector in overview
There are 489 independent mainstream for-profit schools in England educating a total of
82,528 pupils. The schools in snapshot:
o 72% preparatory (up to age 13)
o Average size 205 pupils
o 83% non-selective
o 80% urban or semi-urban
o 99% secular
o Average fees £7,500 (£3,000 - £15,000)
o Socially and ethnically diverse in terms of pupil composition
Source: James Croft, Profit-Making Free Schools, Adam Smith Institute, 2010.
“To suggest that forprofit
companies are
just out to make a
quick buck from
children’s schooling
is a cheap and
unjustified slur.”
learning materials are purchased from the ELC, it’s doubtful that
parents are concerned with the legal status of the Centre or with what
motivates the company to sell its products and services. If the profit
motive plays such an important role in helping companies such as the
ELC meet the learning needs of parents and children, why should the
same not also apply if the ELC decided to open and manage a school?
In fact, wouldn’t trusted brands such as Mothercare or the ELC be
particularly well placed to expand into different types of schooling if
given the opportunity?
The existing role of for-profit companies in both the public and
private education sectors suggests that this type of organisation is
already trusted and deemed capable of providing a variety of
educational services. It is therefore difficult to justify any existing
government policy which continues to discriminate against and
restrict for-profit companies from competing with their public
counterparts on an open and level playing field. To claim that forprofit
companies are just out to make a quick buck from children’s
schooling (as suggested by Stephen Twigg, the Shadow Education
Secretary 7
), is a cheap and unjustified slur against the thousands of
companies and their employees working tirelessly to help deliver a
variety of educational services to children across the country.
Of course, this is not to suggest that all for-profit companies operating
in education will always deliver a world-class service. Just as in any
other sector of the economy, the level of service provided by different
education companies will also differ. However, at the risk of stating the
obvious, this will be related to the way in which each company is
managed, not because of a fundamental conflict between the profit
motive and children’s schooling.
OPEN PUBLIC SERVICES
An ambitious plan to bring about the end of government monopolies
in the delivery of public services was set out by the Coalition
Government in its July 2011 Open Public Services White Paper. Writing
7 “Stephen Twigg warns against 'quick buck' school profit”, Sean Coughlan, BBC News website, 31 May 2012,
available at: www.bbc.co.uk/news/education-18262859.

“If the Government
now recognises the
right of patients to
choose health
provider, why can this
approach not now be
applied to education?”
Profit in education – not a dirty word 71
in the Daily Telegraph in May 2012, the Prime Minister outlined his
determination to bring an end to the closed state monopoly where
central government dictates what people get, and how they get it:
“I want truly open public services, where people can choose the hospitals
and schools they go to, with the right information at their fingertips to
make that choice; where different providers, from the private and
voluntary sectors, can come in and offer new services that people can
access free.” 8
Building on the reforms previously introduced by New Labour, the
delivery of NHS services has become the first government monopoly to
be challenged. The right of patients to choose is now enshrined in the
NHS Constitution. 9
The Any Qualified Provider (AQP) approach,
allowing patients to choose from a list of qualified providers – whether
state, charitable or private – when they are referred by their GP, is also
now being rolled out across the NHS. The question of whether a
provider of health services is non-profit or for-profit will therefore
become increasingly irrelevant. Instead, the focus is now on what works
best for each individual patient, and guaranteeing value for money for
the taxpayer. In short, public funds follow the patient. The Government
hopes that choice of treatment and provider will become a reality for
patients in the vast majority of NHS-funded services by 2013/14.
The rationale of this approach is relatively straightforward. Because
there are now a number of different organisations that are capable of
providing similar services, it is impossible for any government to
decide prior to the event which will be the best provider for each
different patient at any one point in time. The only way to guarantee
that each patient gets access to the best possible provider is to allow
each patient to the make the choice themselves. 10
Once again, these
developments raise important questions. If the Government now
recognises the right of patients to choose between a variety of
different health providers, and is now pragmatically focused on what
works best, why can this approach not now be applied to education?
Why should parents not also exercise the right to choose what works
best in terms of their children’s education?
FREE SCHOOLS AND HALF MEASURES
Sadly, in education, recent reforms have been much less ambitious
than in health. Despite the increasing role of for-profit companies in
the sector, primary and secondary schooling in England remains a
government-controlled monopoly consisting of 326 local authorities
and 20,086 government primary and secondary schools, educating a
total of 7,451,875 children.
The Government’s flagship policy has been the introduction of free
schools, non-selective state schools (or public sector entities funded by
taxpayers), independent of local authority control. However, free
schools are not private or independent institutions. While they may be
independent of local authority control, they are certainly not
independent of the Secretary of State for Education or the
8 David Cameron, “Brick by brick, we’re tearing down the big state”, Daily Telegraph, 28 March 2012.
9 The NHS Constitution states that: “You have the right to make choices about your NHS care, and information
to support these choices.” See:
www.nhs.uk/choiceintheNHS/Rightsandpledges/NHSConstitution/Pages/Yourrightstochoice.aspx.
10 In a sign of things to come, Circle recently became the first for-profit company to take over the management
of an entire NHS hospital (Hinchingbrooke). It has also opened two brand new hospitals in Reading, which
now provide a variety of NHS-funded services. See: www.circlepartnership.co.uk.

72 Big Picture
“For the free schools
policy to be genuinely
transformative, forprofit
education
companies must be
free to open new
schools in response to
demand.”
Department of Education. To a certain extent, local government
control has simply been supplanted by central government command,
and while the current Secretary of State may be very supportive, it is
impossible to predict what impact a possible change in government
would have on the policy.
While IES Breckland is clearly a positive step in the right direction, it is
unlikely to be replicated across the country by IES or any other forprofit
education company within the existing policy framework. Unless
companies such as IES are allowed to set up new IES free schools as
and where they please, then little progress will be made. Without this
freedom, IES will not be able to realise the benefits that come with
developing a chain of schools, and may be reluctant to make longterm
investments in the sector. 11
The profit motive would play an
important role in the development of school chains, as it would
provide companies with a clear incentive to expand and multiply.
Without the profit motive there will certainly be less of an incentive to
replicate success.
It also remains unclear how viable these local non-profit educational
trusts will be in the long run, especially after those who set them up
have retired. The unpredictable nature of these trusts will increase the
risks facing any potential private investor. In the case of IES Breckland,
Sabres Education Trust was set up by a small group of local parents.
After its application proved successful, the trust then decided to
outsource the management of the school to a private education
company. However, this raises questions concerning the role and
purpose of the education trust. For example, why not simply miss out
the middle man (the trust) and allow for-profit companies to apply,
set up and manage free schools themselves?
All of this confusion suggests that the Government has failed to make
a clear distinction between parental demand (groups of parents
demanding a new school in their local area), and the ability of these
groups to set up and run a school themselves. However, there is
clearly an important difference between the two. If parents want a
new school in their local area, then the only option they currently
have is to set up a new free school themselves. But in a normal, open
market, where there was excess parental demand in a specific
geographical area you would expect a number of education
companies, either local, national or global, to be attracted to the
location. And as soon as one provider showed an interest, more would
be expected to follow.
For the free schools policy to be genuinely transformative, for-profit
education companies must be free to offer their services to parents
and open new schools in response to demand. If they remain fettered,
the impact of free schools is likely to be muted. The number of new
free schools being introduced represents a very small proportion of
the school population indeed. By the end of 2013, there will be an
estimated 193 free schools – with only a handful of these being run
by for-profit companies. In other words, the projected number of free
schools by the end of 2013 will represent just 1% of publicly-funded
schools in England. Without reform, therefore, the Government’s free
school policy is likely to result in the opening of a relatively small
number of new schools, but will do nothing to tackle the problems
which continue to plague the rest of the sector. While free schools are
11 For a more detailed discussion about the benefits of chains see James O’Shaughnessy, Competition
Meets Collaboration: Helping school chains address England’s long tail of educational failure, Policy
Exchange, October 2012.

“Without reform, the
Government’s free
school policy will do
nothing to tackle the
problems plaguing the
rest of the sector.”
Profit in education – not a dirty word 73
a welcome initiative, they should be celebrated as a glimmering of
what an open and entrepreneurial environment makes possible – not
as the culmination of that process.
To give credit where it is due, the Coalition Government has
dramatically increased the number of academies in England, from 203
in May 2010 to 1,807 by May 2012. Academies enjoy the same
freedoms as free schools, but are former local authority schools
instead of entirely new schools. To date, though, for-profit companies
have been restricted from managing academies, which suggests that
the Government’s policy on academies is now lagging behind its
policy on free schools. For consistency, and to allow the academy
programme to fulfil its potential, these restrictions also need to be
removed and for-profit companies permitted to develop and manage
chains of academies across the country.
THE EDUCATION PASSPORT
If the Government is prepared to take its Open Public Services agenda to
its logical conclusion in education, and is genuinely interested in what
works best, then it should be looking to more radical solutions. In
particular, it should be seeking to address the fundamental flaw in the
vast majority of state education systems around the world –
governments’ propensity to distribute public funds to institutions rather
than to parents. As soon as this happens, governments tend to set up
their own schools which then crowd out the majority of private
alternatives. The result: government monopoly. With governments then
responsible for the majority of schools across the country, they have
little option but to get involved with almost every aspect of how those
government schools operate and what they teach.
To break this cycle, the Government could do worse than to examine
the system of ‘education passports’ put forward by the Institute of
Directors in 1999. 12
These payment passports are analogous to
education vouchers in the economic literature. The IoD argued that a
voucher system with a top-up facility could create a truly world-class
12 Graeme Leach, Choice, Choice, Choice, Institute of Directors, 1999.

74 Big Picture
“The Government needs
to address the
fundamental flaw in
state education systems
around the world – the
propensity to distribute
funds to institutions
rather than parents.”
education system for the 21st century. If parents chose to send their
children to existing state schools, and not exercise any top-up option
at a private school, then education would remain free at the point of
use. In advancing the new system, the IoD also pointed out that the
debate over market forces in education is not new, quoting John
Stuart Mill, from On Liberty:
“If the government would make up its mind to require for every child a
good education, it might save itself the trouble of providing one. It might
leave to parents to obtain the education where and how they pleased,
and content itself to helping pay the school fees... an education
established and controlled by the state should only exist, if it exists at all,
as one among many competing experiments.”
In a universal system of education passports, all public funds would be
directed to parents, not schools, with parents then free to choose their
preferred school. As a result, all questions relating to who should be
allowed to set up a new school, or whether a new school should be
permitted at all, would no longer be the concern of politicians, civil
servants, academics or policy experts. Instead, the Government would
simply give purchasing power to parents, who would be responsible
for choosing between different types of provision. As in the NHS, this
is the only way to guarantee that people get access to the best
opportunities available.
The three basic principles of the education passport system are as follows:
o The value of the passport is the average cost of a state school place;
o Parents are allowed to top up the payment with their own
contribution towards fees;
o Both parents and schools are unconstrained – parents can spend
the voucher payment at any publicly-funded or private school
and these schools have freedom over their waiting list choices.
Since the IoD initially recommended this reform over a decade ago,
nothing has changed with reference to the fundamental problem
facing the sector referenced above – that the Government directs
public funds to schools instead of parents. Until this very simple and
common sense reform has been introduced, the prospects for
transformational change within the sector will remain severely limited.
The current controversy surrounding the role of the profit motive in
education is therefore best viewed as a red herring. Instead, two key
questions prevail. First, should parents have the right and freedom to
choose the nature and form of education which their children receive,
or should the government continue to dictate? Second, should our
education sector be open and inclusive, allowing a variety of different
providers to compete on a fair and level playing field? When Milton
Friedman was interviewed in 2003, he was questioned about his
future vision of education and whether he thought that schooling
would be provided exclusively by the for-profit sector. His reply
encapsulates one of the principal tenets of this article:
“No, I see competition. Let parents choose. I would expect an open
market where there would be a wide variety of schools. There would be
for-profit schools, charter schools, parochial schools, and government
schools. Which survived would depend on which ones satisfied their
customers.” 13
13 Milton Friedman, quoted in “Choice and Freedom”, Education Next, Winter 2003, Vol. 3, No. 1.

Profit in education – not a dirty word 75

76 Big Picture

SNAPSHOT
o For the first time in history
the number of people
living in urban areas now
exceeds those in rural
areas. By 2050, two-thirds
of the world’s population
is expected to live in
urban areas.
o The future is almost certain
to be characterised by more
and bigger ‘megacities’ –
those with a population
above 10 million.
o By 2025, emerging
economies are expected to
account for two-thirds of
the world’s largest urban
agglomerations.
o Most of the globe’s urban
dwellers currently live in
cities of fewer than
500,000 people.
o The nature of cities is likely
to change, with the
‘aerotropolis’ concept an
example of how future
competitive success could
be dependent on
developing a city around an
airport, rather than the
other way around.
o Future competitiveness
between cities will be
based on connectivity and
the survival of the fastest.
In many instances
emerging economies are
leading the way.
Future cities – the survival of the fastest 77
Future cities –
the survival
of the fastest
William Moore, Economic Intern at the IoD,
examines the future dynamics of cities.
THE FUTURE URBAN LANDSCAPE
If you don’t think about cities, think about this statistic. According
to McKinsey, between now and 2025, 65% of global GDP growth
will be in 600 cities.
In 2008, the number of people worldwide living in urban areas
exceeded those living in rural areas for the first time in history. 1
This is a dramatic increase from 1950, when the number of people
living in urban areas worldwide was approximately 29%. 2
This
trend is likely to increase exponentially even within the next few
decades. The United Nations’ World Urbanization Prospects report
predicts that that by 2030, at least 60% of the global population
(approximately 4.9 billion) will live in urban areas and that by
2050, 67% (approximately 6.3 billion) will do so.
There is an uneven distribution, however, in the levels of urbanisation
across the world. By 2015, the percentage of people living in urban
areas in North America and Europe is expected to hit 83% and 74%
respectively. This is far greater than in Africa or Asia (41% and 48%
respectively). Thus, the proportion of the population living in urban
areas in the UK is projected to reach 80%, compared to 56% in
China and 33% in India. Nevertheless, in 2050 the fastest rates of
urban population growth are expected to be recorded in Africa and
Asia. 3
Between 2015 and 2050, it is estimated that the percentage of
the population living in urban areas in Africa and Asia will grow by
17%, compared to 5% in North America and 8% in Europe.
Indeed, the greatest changes to the global urban landscape in the
coming decades are likely predominantly to take place in Africa
and Asia. Asia currently has the largest urban population with
around 2 billion people living in urban agglomerations. By 2050,
this is expected to exceed 3.3 billion. Africa, which currently has
one of the smallest urban populations, is expected to have the
second largest by 2050. Its urban population is predicted to more
than treble, reaching approximately 1.3 billion people.
1 Source: United Nations, Department of Economic and Social Affairs, Population Division, World
Urbanization Prospects: The 2011 Revision. The Population Division of the UN’s Department of Economic
and Social Affairs has been issuing, every two years since 1988, revised estimates and projections of
the urban and rural populations of all countries in the world and of their major urban agglomerations.
2 The principal difficulty when considering the precise change to the urban landscape is how to define
the term ‘urban’. The United Nations Population Division relies upon national statistics institutions to
collect its data, each of which differs to an extent in their definitions of what constitutes an urban area.
It is important to bear this in mind when drawing comparisons between nations and urban agglomerations.
3 United Nations, Department of Economic and Social Affairs, Population Division, World Urbanization
Prospects: The 2010 Revision.

78 Big Picture
CHART 1
Location of the world’s megacities and percentage of urbanisation – 2010
Percentage
urban
81-100%
61-80%
41-60%
21-40%
0-20% Population sizes of megacities
30+ million 25-30 million 20-25 million
15-20 million 10-15 million
Source: United Nations Population Division (http://esa.un.org/unpd/wup/index.htm).
THE RISE OF MEGACITIES
Alongside the increasing phenomenon of urbanisation, there has been
a rise both in the number of ‘megacities’ in the world – those with
more than 10 million inhabitants – and in the size of those cities’
populations. In 1950, there were only two megacities in the world:
New York and Tokyo. Both of these cities had populations of around
12 million people. By 2010, there were 23 megacities (see Chart 1).
By 2025, this trend is expected to continue, reaching an expected 37
megacities worldwide (Chart 2).
The growth in megacities is mainly a phenomenon of the emerging
economies. In 2010, 14 of the new megacities born since 1950 were
to be found in either Africa or Asia. More specifically, 17 of the new
megacities were located in the BRIC or N-11 4
economies. 5
Similarly,
eight of the additional 14 new megacities expected to grow by 2025
are predicted to come from either the BRIC or N-11 economies. If this
comes to pass, these emerging economies will account for 68% of the
world’s largest urban agglomerations by 2025.
THE WORLD’S LARGEST
EMERGING MEGACITIES
In 2010, Tokyo was the world’s largest megacity with a population
size of approximately 36 million, and is predicted to remain the
world’s largest urban agglomeration by 2025. The BRIC economies,
led principally by China and India, are expected to produce some of
4 The N-11, or ‘Next 11’, economies are the 11 countries – Bangladesh, Egypt, Indonesia, Iran, Mexico,
Nigeria, Pakistan, Philippines, Turkey, South Korea and Vietnam – identified in 2005 by Goldman Sachs as
having a high potential of becoming, along with the BRICs, the world’s largest economies in the 21st
century.
5 Source: Goldman Sachs, Global Economics Paper No:134.

CHART 2
Future cities – the survival of the fastest 79
Location of the world’s megacities and percentage of urbanisation – 2025
Percentage
urban
81-100%
61-80%
41-60%
21-40%
0-20% Population sizes of megacities
30+ million 25-30 million 20-25 million
15-20 million 10-15 million
Source: United Nations Population Division (http://esa.un.org/unpd/wup/index.htm).
the next largest. India’s megacities of New Delhi and Mumbai are
predicted respectively to be the second and fourth largest megacities
in the world, with populations exceeding 25 million people.
In 2010, China had four megacities, with two, Shanghai and Beijing,
being in the top ten by size of population, both with in excess of 15
million inhabitants. By 2025, it is predicted that China will have seven
megacities – all of which will have populations exceeding 11 million,
with Shanghai and Beijing exceeding 22 million. 6
China will have
more megacities than any other country in the world.
The world’s emerging economies have therefore driven much of the
change in the rankings of the largest urban agglomerations. With the
exception of Japan, the more developed nations have fallen behind.
New York has dropped from being the world’s largest urban
agglomeration in 1950, to being the fourth largest in 2010, and is
expected to fall still further by 2025.
THE FASTEST GROWING
MEGACITIES, 2015–2025
The top dozen fastest growing megacities between 2015 and 2025
will be located in either Africa or Asia. Lagos, Nigeria, is expected to
be the fastest growing megacity with growth of 75% between 2010
and 2025 (see Chart 3). Four out of the top five cities predicted to
grow most quickly between 2015 and 2025 are from the N-11
economies. Kinshasa in the Democratic Republic of Congo is predicted
to be the second fastest growing megacity, with an expected
6 The Chinese government has plans to merge the nine cities surrounding the Pearl River Delta, which
include the cities of Shenzhen and Guangzhou-Guangdong, to make one megacity of approximately 42
million people. It is unclear, however, how long this process will take or whether the UN will consider this
as a single megacity or as a conglomeration of several megacities. As such it has not been considered as
a single megacity for the purposes of this article.

80 Big Picture
CHART 3
Expected population growth rate of megacities 2015-2025
Lagos
Kinshasa
Bangalore
Hyderabad
Dhaka
Lahore
Shenzhen
Beijing
Chennai
Delhi
Karachi
Guangzhou
Shanghai
Wuhan
Chongqing
Tianjin
Manila
Bangkok
Mumbai
Istanbul
Bogotá
Cairo
Jakarta
Kolkata
Lima
Mexico City
Chicago
Los Angeles
Sao Paulo
New York
Buenos Aires
Paris
London
Rio de Janeiro
Moscow
Osaka-Kobe
Tokyo
0
10 20 30 40
% Growth Rate
50 60 70 80
Source: UN Department of Economic and Social Affairs, Population Division, World Urbanization Prospects 2011.
population growth of 73%. Bangalore and Hyderabad in India are
projected to increase in size by 59% and 54% respectively, with Dhaka
in Bangladesh close behind (53%).
The megacities predicted to show the slowest growth are primarily
those located in developed nations. London, for example, is ‘only’
expected to grow by 15% between 2015 and 2025. The population
of Tokyo, despite remaining the world’s largest urban agglomeration,
is projected to increase by 4.7%. By the standards of their
counterparts in the BRIC and N-11 economies, the growth of these
megacities looks positively sluggish in comparison, as the chart above
illustrates.

“The megacities
predicted to show the
slowest growth are
primarily those
located in developed
nations.”
Future cities – the survival of the fastest 81
WHAT ABOUT SMALLER CITIES?
Megacities will play a crucial role in the future global urban landscape.
However, most (52%) of the globe’s urban dwellers currently live in
cities of fewer than 500,000 people. Even by 2025, megacities will
only account for approximately 10% of the world’s urban population.
Between 2010 and 2025, it is expected that around 45% of the
increase in urban dwellers will be accounted for by small cities of
fewer than 500,000 people.
WHAT’S DRIVING INCREASING
URBANISATION?
Three major factors are shaping the global urban landscape, varying in
importance between urban agglomerations. The first is the result of
natural population growth and changing demographics within urban
areas. Many of the emerging economies, for example, are
experiencing increased rates of life expectancy, whilst still maintaining
relatively high birth rates.
The second factor is rural-urban migration, or ‘rural flight’, with the
socio-economic benefits that cities offer acting as a strong pull factor
for those living in rural areas. This was previously held as the principal
factor influencing urbanisation rates, 7
and, whilst that is now debated,
by 2050 it is nevertheless predicted that only five countries in the
world will have rural populations that are not in decline. 8
The third factor is the blurring over time of the boundaries between
urban and rural areas, particularly due to the growth in transportation
and communication networks. As cities expand, they often merge
with other districts and urban areas, increasing the size of the urban
population artificially. All three factors have contributed towards
global urban growth, though they clearly vary in importance and
relevance between different cities.
THE EFFECTS OF GLOBALISATION
Cities are now more globally integrated than at any other time in
history. Globalisation can be overwhelmingly positive for the
development of an urban agglomeration: the integration of global
economies can expand market opportunities and lead to the growth
and influx of technological and managerial expertise, resulting in
greater opportunities for wealth creation. Conversely, though, the
integration of global economies has meant that urban agglomerations
are more susceptible to external market shocks. This was particularly
evident in the global recession of 2008. As most economic activity
takes place in cities, urban dwellers are more exposed to the effects of
economic fluctuations, often resulting in a loss of job opportunities
and investment. Cities are very much at the mercy of the global
economy, and will continue to be so.
Clearly globalisation and urbanisation are about more than just
people. Many fast-growing emerging economy cities will remain far
7 Somik V. Lall, Harris Selod & Zmarak Shalizi, Rural-Urban Migration in Developing Countries, World Bank Policy
Research Working Paper 3915, World Bank Group, May 2006.
8 United Nations, Department of Economic and Social Affairs, Population Division, World Urbanization Prospects:
The 2011 Revision.

82 Big Picture
“Many fast-growing
emerging economy
cities will remain far
poorer than slowergrowing
advanced
economy cities.”
poorer than slower-growing advanced economy cities. What
ultimately matters for businesses is the size and growth of the urban
economies.
Table 1 shows the 50 most dynamic cities in the world, according to
the McKinsey Global Institute Cityscope database. The dynamism
measure shows the $ billion increase in the size of these urban
economies over the 2010–2025 period, together with the percentage
change in growth.
Table 1 shows that:
o The 10 largest urban economies in the world in 2025 will still be
dominated by advanced economies. According to McKinsey, in
rank order they will be Tokyo, New York, Shanghai, Los Angeles,
Beijing, London, Paris, São Paulo, Moscow and Chicago.
o Emerging economies such as China will dominate dollar growth
in urban economies over the 2010-2025 period.
THE ‘AEROTROPOLIS’
The term ‘aerotropolis’ was first coined by John D. Kasarda from the
University of North Carolina’s Kenan-Flagler Business School. 9
Kasarda’s
vision is that airports will dictate future cities and urban landscapes. In
order for cities to compete and thrive, he believes, airports can no
longer be situated on the periphery connected by inadequate
transport links. The most efficient cities will be those that have the
airport in their centre and have established other communication and
transport networks that serve to intertwine the city with the airport so
that, in effect, the airport becomes the city.
In other words, the airport is not only in the aviation business but also in
real estate and urban planning. Underpinning the aerotropolis idea is
that in order for cities and districts to remain competitive, they need to
be able to maintain their position as innovators and producers. To ensure
this, they need the ability to move people, goods and ideas as quickly
and efficiently as possible through the value chain. According to Kasarda,
this can only be delivered by state-of-the-art connectivity by broadband
and air transportation. The aerotropolis is therefore not just an airport at
the centre of a city, but a city that serves this vision of efficiency:
“It is the way you reduce time, the way you reduce costs, the way you
reduce speed...it is where the elastic mile, the friction of space, community
without propinquity, and trade routes all come together.”
The megacities of the world aren’t competing against their rural
districts or other smaller cities within close proximity. Rather they are
competing against other world megacities. It is less the survival of the
fittest, more the survival of the fastest. The most important issue is
speed and proximity to market. Cities that have the greatest
connectivity and provide a platform for greater speed in relation to
the supply chain are going to be the most competitive. This helps to
explain why, despite being 7,000 miles apart, Las Vegas and Macau
are competing to become the gambling capital of the world.
Companies aren’t competing against one another; it is their supply
9 Kasarda, J. D., and Lindsay, G., Aerotropolis. The way we’ll live next, Farrar, Straus and Girroux, 2011.

TABLE 1
Rank
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
City
Shanghai
Beijing
Tianjin
São Paulo
Guangzhou
Shenzhen
New York
Chongquin
Moscow
Tokyo
Wuhan
Los Angeles
Foshan
Istanbul
Nanjing
Chengdu
Hangzhou
Dongguan
Singapore
Shenyang
London
Houston
Dallas
Xian
Washington
Paris
Suzhou
Mexico City
Riyadh
Hong Kong
Bangkok
Buenos Aires
Doha
Rio de Janeiro
Dalian
Wuxi
Seoul
Chicago
Delhi
Ningbo
Jinan
Xiamen
Jakarta
Miami
Kuwait City
Qingdao
Sydney
Atlanta
Brasilia
Taipei
Country
China
China
China
Brazil
China
China
US
China
Russia
Japan
China
US
China
Turkey
China
China
China
China
Singapore
China
UK
US
US
China
US
France
China
Mexico
Saudi Arabia
China
Thailand
Argentina
Qatar
Brazil
China
China
South Korea
US
India
China
China
China
Indonesia
US
Kuwait
China
Australia
US
Brazil
Taiwan
% growth
344%
398%
385%
109%
292%
270%
32%
418%
111%
18%
404%
44%
360%
155%
402%
435%
335%
375%
104%
346%
29%
64%
67%
523%
53%
27%
389%
80%
165%
89%
185%
100%
179%
97%
319%
362%
72%
33%
344%
358%
348%
491%
209%
61%
123%
295%
53%
57%
139%
88%
Total growth
($bn)
861.5
821.7
495.7
475.7
426.9
382.1
372.7
370.0
362.7
343.9
332.2
319.7
300.1
291.5
275.4
251.7
236.5
235.5
231.4
222.5
221.1
218.8
216.3
212.6
207.5
207.2
204.8
204.4
202.9
199.1
194.6
192.6
176.3
175.2
171.9
170.2
167.0
165.0
163.9
160.8
150.2
149.3
147.7
144.34
144.33
142.0
141.8
141.7
141.03
141.0
Population (m)
22.3
18.8
11.1
19.7
11.1
10.4
18.9
15.7
11.6
36.4
9.8
12.9
7.2
11.0
7.2
7.7
6.2
8.2
5.1
6.1
14.9
6.0
6.4
6.5
5.6
11.8
4.1
20.1
5.2
7.1
6.9
13.1
1.3
11.8
3.9
3.5
9.8
9.5
16.3
3.5
3.4
3.5
9.6
5.6
2.3
3.7
4.6
5.3
3.7
6.8
30.9
29.6
15.2
23.2
14.9
13.7
19.7
19.4
12.7
36.7
13.1
15.0
10.8
14.9
9.9
11.2
8.8
11.4
5.8
8.4
16.2
7.7
8.6
9.1
6.6
12.9
6.5
21.6
8.1
8.2
9.4
15.2
1.6
13.6
5.7
5.4
9.5
10.2
21.4
5.1
5.7
5.3
12.8
7.2
3.2
5.1
5.8
6.8
5.0
6.9
50 dynamic cities
2010 2025 2010 2025
GDP ($bn)
250.7
206.2
128.8
437.3
146.1
141.5
1,180.3
88.6
325.8
1,874.7
82.2
731.8
83.5
188.2
68.5
57.8
70.5
62.7
222.7
64.3
751.8
341.1
324.9
40.6
392.2
764.2
52.7
255.1
122.7
224.5
105.0
191.7
98.8
180.9
53.8
47.0
233.3
496.4
47.6
45.0
43.2
30.4
70.7
235.9
117.5
48.1
268.9
249.7
101.6
160.3
1,112.2
1,027.9
624.4
912.9
573.0
523.6
1,553.1
458.6
688.5
2,218.6
414.4
1,051.5
383.6
479.7
343.9
309.6
307.0
297.9
454.1
286.9
972.9
559.9
541.2
253.3
599.7
971.4
257.5
459.5
325.6
423.6
299.6
384.3
275.1
356.1
225.7
217.2
400.3
661.4
211.4
205.7
193.4
179.8
218.4
380.2
261.8
190.1
410.6
391.4
242.6
301.3
Source: ‘The Cities Issue’, Foreign Policy magazine, September-October 2012.
Future cities – the survival of the fastest 83

84 Big Picture
chains that are competing. It is the supply chain that creates true
competitive advantage by securing the best resources and delivering
them quickly and efficiently to market. It is the airport that guarantees
this vision and acts efficiently to serve the needs of the market. Whilst
the Internet has helped create this phenomenon, it couldn’t happen
without the airport. According to Kasarda, air travel has become the
physical Internet, moving goods and services around the globe as
efficiently and effectively as the Internet itself.
THE IMPLICATIONS FOR THE UK
The aerotropolis idea has already had a significant impact on the
future urban landscape. China has the largest number of megacities in
the world and some of those cities have grown substantially in
accordance with the aerotropolis model. The reason that China’s
megacities have grown so big, so quickly is due in substantial part to
the cheap transportation spawned by the jet engine, and the
attendant increase in access to foreign markets. 10
The Pearl River Delta,
the ‘factory of the world’, has been successful because it has
concentrated production around air transit. China has understood the
strategic importance of the aerotropolis and plans to build 100 new
airports by 2020. The implications for the UK are obvious. A debate
about a new short runway at Heathrow hardly satisfies the strategic
vision within the aerotropolis concept. If the concept is valid, then
bolder initiatives need to be considered, such as ‘Boris Island’, the Isle
of Grain proposals advanced by Foster, or a three or four-runway
Heathrow.
Emerging economies such as China are not just catching up with the
advanced economies. In many instances they are leading the change
10 World Bank Group, World Development Report 2009: Reshaping Economic Geography.

“We are moving into a
world characterised by
connectivity and the
survival of the fastest,
via the Internet and
transport networks.”
Future cities – the survival of the fastest 85
in urbanisation and transport systems because they have no
alternative, due to the high levels of congestion and pollution they are
experiencing.
China already has the world’s largest car market, with the number of
vehicles projected to explode from 200 to 600 million by 2030.
Annual car purchases are projected to jump from 14.5 million to 50
million by 2020. The dire congestion and pollution implications are
forcing infrastructure investment and innovation, with the Chinese
spending $500 billion (9% of GDP) on infrastructure, albeit not always
in the most efficient way. However, new and innovative approaches to
urbanisation and transport are evident, which display the vision,
determination and implementation we need in the UK:
o Over the past five years the Chinese have constructed 20,000
miles of expressway.
o China’s latest bullet trains travel at more than 300 miles per hour.
o The Chinese are investigating next generation ‘maglev’-style
trains, which could travel at up to 600 miles per hour.
o Over the next three years China plans to build 70 new airports,
including a new mega-airport in Beijing, with double the
passenger capacity of Atlanta – currently the world’s busiest airport.
o The Chinese firm Broad Group has pioneered new modular
construction techniques, which promise to build a 220-story
skyscraper in just 90 days in Changsha. This building will be
taller than the 160-story Burj Khalifa in Dubai, which took six
years to complete.
We are moving into a world characterised by connectivity and the
survival of the fastest, via the Internet and transport networks. The UK
cannot afford to languish in the slow lane.
São Paulo, Brazil

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