Monday, 5 January 2015

Jersey International Finance Centre: Real or Mirage?

The recent news reports that the Jersey International Finance Centre will go ahead and Chief Minister, Ian Gorst, sees it as an engine to revitalise the economy fill me with disquiet.

Lee Henry, managing director of the States of Jersey Development Company, which will develop the site, says: “We have 2.8m sq ft of office space in Jersey but very little categorised as Grade A [prime]. We’re hopeful that by creating this dedicated district for finance we will attract a flow of new tenants.”

It seems very much like a throwback to the old days of Keynesian economics, where the States will invest heavily in office space in order to secure a boost to the economy, and an end to the struggle out of recession. The recovery in the UK, fragile though it is, has been built on austerity measures.

So far, the States Quango – the Jersey Development Company – has produced precious little in the way of returns from the existing Waterfront. The return last year was a paltry dividend to the States of £21,489, and the flow of fund back from the States (for instance in a subsidy on Liberation Station) exceeded that.

Recently honoured Jurat Tibbo – made an OBE - has been a long time non-executive director of the JDC from its days when it was the Waterfront Enterprise Board, and has been in receipt of Non-Executive Directors - £15,000 for 15 days' commitment per annum over many years - that is £1,000 per day. That’s almost as much as the return to the States. Mark Boleat, meantime, picks up £40,000 per annum for his 15 days work.

But at least a little is flowing back to the States, although most seems to be swallowed up by running costs.

Managing Director Lee Henry stated last year – “It remains the position today based on independent professional advice that the JIFC scheme will generate a net return in the order of £50 million for the public.”

What is missing from this rhetoric is a cash flow projection showing when we might expect returns of that order to the public. Without any kind of budget, there can be no test on whether the rhetoric is simply a piece of wishful thinking, where the goal posts for the date when funds of that order appear to recede year by year into the future. Unless we have that, we cannot tell whether any project will be a success or not.

The other concern is too much office space available, and having to heavily discount rents in order to fill it. Karl Beitel’s study in 2000 of supply side effects noted that there are two lags in the adjustment of supply to demand in office vacancy rates.

“In the first lag, rents do not immediately track changes in the office vacancy rate, as a result of the long-term nature of office rental contracts (typically about five years in duration).”

“The second lag occurs between the start of construction and project completion, and is between one and two years. Together with the delay in the supply response to changes in rents, the current volume of new supply coming onto the market is responding to market conditions approximately three years earlier. Supply therefore lags changes in demand on the upside of the cycle, and will tend to systematically overshoot the downturn in demand as the cycle reaches maturity and employment growth begins to slow”

The result, Beitel argues, is “the speculative overproduction of space.” If this is the case, and the supply of office space exceeds demand, there may well be a shift in the private sector regarding rents, and that in turn will put pressure on the “International Finance Centre” to reduce rents in order to compete.

In Jersey’s circumstances, this could also mean office space left vacant in the more central areas of town, and shifting to the periphery of the waterfront. This may develop its own supporting infrastructure in the way of local shops and outlets for office workers, but that in turn will draw footfall from the high street.

Moreover, by the States entering the commercial property market in this way, there will be a commensurate boom in the building trade. If this exceeds supply, expect immigration to come to the forefront, as there is a demand for workers to service the expansion.

Of course, once the boom is over, the States will be left with an over inflated building industry with insufficient demand to finance its continuance. In such circumstances, construction companies, developers, and ancillary supporting businesses may well go out of business, leading to unemployment.

For a government to meddle with an large injection of capital expenditure into the business cycle is of course very much a Keynesian solution. The danger, as Chancellor Anthony Barber found out in the UK in the 1970s, is that can destabilise the economy and cause an inflationary boom.

It will also crowd out private sector schemes, such as that proposed by Le Masurier, which are far more central and close to the high street. A private sector commercial scheme will always be responding to the markets, but when the States pump money into their own schemes (whether by funding or borrowing), this will bring them into competition with private enterprise, which may well be unable to compete on such generous terms.

In conclusion, the vision of an “International Finance Sector” is both harmful in distorting the market, both for developers, builders and the labour market, and the plans lacks sufficient quantitative forecasting against which its success or failure can be measured.

Being able to measure the success or failure of the project for the Finance Centre is a basic scientific approach. Once projected cash flows exist giving a time frame for the return to the States of the investment – as per Mr Henry’s statement, there will be a method of measuring the success or failure of it. Then when the project is complete, at the end of a given period, it will be easy to see whether it’s succeeded – or failed. And at the moment, this is simply what we do not have!

No comments: