House of Commons - Foreign Affairs

Select Committee on Foreign Affairs Eighth Report

FINANCIAL MANAGEMENT

Spending Review 2004

13. On 12 July this year, the Chancellor of the Exchequer, Rt Hon Gordon Brown MP, set out the results of the Government's Spending Review 2004 (SR 2004) in a statement to the House of Commons.[18] This Review sets the level of departmental expenditure for the period (or 'triennium') 2005-08.[19] In his statement, the Chancellor identified three key "priorities" for future Government spending, the first of which was, "to meet the security and defence needs of our country."[20] In this context, he made specific reference to the work of the FCO:

This recognition by the Chancellor of the key importance of the FCO's work in strengthening Britain's security is very welcome.

14. For the Foreign and Commonwealth Office, and its agencies, the key implications of the Review are set out in the table below (figure 1).[22] We discuss in greater detail, later in our Report, the Chancellor's specific financial provision for security measures and the FCO's two agencies (see paras 147-50 and 183-88).

15. On the face of it, this appears to be a relatively satisfactory settlement for the FCO but upon closer inspection it is not as good as it seems. The Office's total Departmental Expenditure Limit (DEL) is set to rise by an average of 1.4% during each year of the SR04 triennium. This is lower than the majority of other departments, the average rise being 3.4%. Removing the administration budget, which will primarily fund the security improvements, from these figures gives an average annual real terms decrease of -0.7% to FCO programme expenditure. To go even further, removing the BBC World Service, British Council and Conflict Prevention Fund gives an average annual real terms decrease to the remaining programme budget of -2.7% per annum.

Figure 1: outcome of Spending Review 2004 for FCO (£ million)

	2004-05	2005-06	2006-07	2007-08
Foreign and Commonwealth Office Resource Budget of which, Administration Budget Capital Budget Total Departmental Expenditure Limit	1,503 632 71 1,461	1,581 638 84 1,539	1,687 740 119 1,630	1,723 772 117 1,649
BBC World Service	225	239	246	252
British Council	181	193	199	204
Conflict Prevention	74	74	74	74

Source: HM Treasury[23]

16. This somewhat disappointing settlement also needs to be set in context. The 2003-04 Departmental Report painted a relatively bleak, and surprisingly candid, picture of the Office's financial prospects.[24] It stated that the last Spending Review (SR 2002) gave the FCO an operational budget which rose more slowly than United Kingdom inflation. On the other hand, staff pay and international subscriptions (the UN, Council of Europe, etc.) were rising faster than inflation, and these comprised around 55% of the Office's core budget. Public expectations of, and expenditure on, foreign policy activities was increasing, with growing demands on the Office in the war against terrorism, in Afghanistan, in the provision of travel advice, etc. The FCO had also had to cope with greatly increased expenditure as a result of the conflict in Iraq, which resulted in the re-deployment of considerable resources (see paras 29-31 below).

17. In addition, there are other constraining factors not specifically mentioned in the annual report, such as the cost of improving security at posts and the impact of the falling returns from the asset recycling programme (see paras 72-78 below). Greater opportunities for, and lower costs of, foreign travel and an increasing proportion of the civil population with overseas links are also bound to increase pressure on consular resources. With so many fixed costs, the increasing squeeze on existing resources and steadily rising demand for its services, the annual report's description of managing the Office's finances as a, "challenging task," seems a considerable understatement.[25]

18. As would be expected, the Foreign Office has not sought to criticise this settlement in any way.[26] However, one incident during the last financial year illustrates the financial pressure being felt by the Office at this time. In March 2004, reports appeared in the media about the British Embassy in Kuwait. It was reported that the British Ambassador, Mr Christopher Wilton, had sent a telegram to the Permanent Under-Secretary informing him that the embassy was "broke".[27] He complained about the, "hopelessly inadequate," budget he was given, in the face of rising costs and a decaying building. He therefore proposed to close the Embassy on 11 March and re-open on the first day of the new financial year: 3rd April.

19. The Committee raised this matter with the Foreign Secretary, who sent us a copy of Mr Wilton's full and frank telegram as a restricted annex. The Foreign Secretary told us that:

Mr Wilton's telegram was a colourful and successful effort to attract attention to a specific end-of-year funding difficulty in the Embassy in Kuwait. Towards the end of the financial year it is not unusual for posts to face overspends or underspends on their budget allocation. But as FCO resources have become more tightly stretched, Ambassadors have been told to do everything they can to avoid overspends. So Mr Wilton was right to draw the problem to the attention of officials in London. As usual with such cases, the FCO was able to make good the shortfall in the budget of the Embassy to remove the likelihood of an overspend.

The telegram may have been merely a "colourful" way of attracting attention and crying for help, but it does suggest that the increasingly tight fiscal regime in the Office is capable of doing real damage to the work done by posts, and putting staff under increasing and unsustainable pressure. From the extensive conversations we have had with other FCO officials serving around the world, we fear that this is not a one-off incident, but indicative of much wider problems being experienced by the whole Office.

20. We note with concern that the FCO has now confirmed a press report that the Office was seeking bids for early retirement from 60-80 Senior Management Staff (SMS).[29] We recommend that the FCO, in its response to this Report, state how many bids it has received from its Senior Management Staff for early retirement, whether compulsory early retirements will be made if the figure of 60-80 voluntary early retirements is not achieved, and the operational implications for the Department—including possible losses of embassies and high commissions overseas—of reducing its Senior Management Staff by 60-80.

21. We conclude that HM Treasury's recognition of the importance of the Foreign Office's work and the commitment of resources to specific areas, such as security, is welcome. We further conclude, however, that overall the latest spending review settlement will only add to the increasing financial pressure under which the Office now operates and which is putting so much of its valuable work in jeopardy.

Efficiency savings

22. One of the key planks of 2004 Spending Review was the Chancellor of the Exchequer's commitment to gaining annual efficiency savings of at least 2.5% per annum across Government. This followed the findings of Sir Peter Gershon, formerly head of the Office of Government Commerce (OGC), who was commissioned by the Chancellor to undertake a review of efficiency in Government.[30]

23. This injunction applies equally to the FCO as to other departments and it will be expected to realise savings of at least £120 million over the SR 04 triennium.[31] This will be achieved primarily in five ways:

relocation of about 450 posts out of London, and a reduction in the total number of civil service posts by 310;
"rationalisation of back office function", principally from Human Resources and Finance Directorates (saving about £30m);
improved ICT resulting in greater productivity (about £25m);
more efficient procurement practices (about £11m); and
efficiency savings achieved by the British Council and BBC World Service (about £30m).[32]

As can be seen, the Spending Review specifies where £96 million of the savings will be found, leaving the remaining £24 million to be recouped from efficiencies resulting from relocation and staff cuts.

24. The Foreign Office already has a history of achieving significant efficiency gains. As part of its previous Spending Review settlements, it committed itself to achieving efficiency savings of 3% per annum in SR2000 and 2.5% in SR2002. In our Report last year, we expressed our concern that the Department was unable to demonstrate that it was making genuine efficiency savings rather than simply cutting budgets. In its evidence to our inquiry in 2003, the Foreign Office told us that: "Because the efficiency savings are already budgeted in, the savings are, for the most part, sure to be fulfilled—the only question is whether they are met through efficiencies or through cutting activity."[33] Sir Michael Jay later told the Committee in oral evidence that: "Inevitably the continued call by the Treasury to achieve significant efficiencies may mean cuts in FCO core activities."[34] The Committee went on to raise its concern on this matter in its Report.[35]

25. We repeated these concerns to the FCO during this year's inquiry. It told us that:

Given the scale of the savings to be achieved, the rather disappointing Spending Review settlement and the constraints on the FCO's budget identified above, this would seem to be a challenging task, and one which we intend to monitor closely.

26. Another important question is for how long such savings will continue to be viable. The head of the BBC World Service, Nigel Chapman, told us in oral evidence that there had to come a time when efficiency savings were no longer viable owing to the nature of 'diminishing returns'—that is to say further reductions in the costs to deliver services will progressively become more difficult to find without affecting services provided.[37] He believed that the World Service would have to look, "very carefully," at its bid for the next Spending Review in the light of this truism.

27. We believe that such constraints must also apply to the FCO, particularly as 2005/6-7/8 will represent the Office's third triennium of achieving such savings. The Office is a people-intensive department, with significant fixed costs and increasing demands on its services. Reductions in staff and relocations cannot be used repeatedly to make genuine savings. There must come a time, probably sooner rather than later, when the belt can be tightened no further, and 'efficiency savings' will simply become a euphemism for budget cuts.

28. We conclude that, while it is right and proper for all government departments to strive at all times to make the very best use of taxpayers' money, the efficiency savings agreed as part of the 2004 Spending Review will place a considerable strain upon the Foreign Office's operations in the coming years. Given the FCO's significant fixed costs, people-intensive nature and the increasing demands and expectations being placed upon it, we fear that 'efficiency savings' will effectively mean cuts in programme budgets. We recommend that, in its response to this Report, the FCO provide specific, detailed evidence that it will achieve genuine efficiency savings in order to meet HM Treasury's targets and not simply cut its activities.

The impact of Iraq

29. The Annual Report made clear in a number of places that the conflict in Iraq had resulted in considerable additional expenditure for the Foreign Office. This included the costs of supporting the Coalition Provisional Authority (CPA) and the United Kingdom's Special Representative in Iraq.[38] We have commented on the FCO's important work in Iraq elsewhere.[39] The Annual Report noted that at the height of the Iraq crisis, the FCO had redeployed five per cent of its London-based staff.[40] In our Report last year, we expressed our concern that the Department appeared to be bearing the burden of the extra expenditure of the Iraq conflict from its own resources. We recommended that HM Treasury should meet in full the Foreign Office's claim on the contingency fund—the Government's reserve—to make up for its unpredicted extra expenditure.[41] We were pleased to be told this year that the FCO's claim for the financial year (FY) 2003-04 had been successful.[42]

30. The FCO's work in Iraq continues, however, and the costs remain significant. In one of its memoranda to this year's inquiry, the FCO told us that:

In another memorandum, the FCO stated that it was unable to give a, "definitive list of all the re-tasking and deferred or discontinued activity," that resulted from the cost of the FCO's work in Iraq.[44] It noted, however, that: "In concentrating effort on particular countries and regions there is a corresponding reduction given to other countries and regions."[45]

31. We conclude that the additional work being carried out by the FCO in support of the Government's policies in Iraq will remain critical for some time to come. We recommend that the additional costs incurred by the FCO in carrying out this work should be met in full by the Government from the contingency reserve.

Costs of EU and G8 Presidencies

32. In 2005, the United Kingdom will hold the Presidency of the Group of eight major industrialised democracies (the G8) and will host the organisation's annual summit in Perthshire, Scotland.[46] In addition, in the latter half of 2005 it will also hold the rotating Presidency of the European Council. Both of these responsibilities will place a considerable burden upon the resources of the FCO and the British Government more widely.

33. We raised the question of how the presidencies will be financed in both our inquiry last year and this.[47] Most recently, the FCO told us that:

This seems to be a very modest allocation for two events of such importance to the United Kingdom's reputation in the world. The security costs alone of hosting the main G8 Summit and the various European Councils will be very considerable. We were given to understand last year, however, that these costs would be borne by other departments.[49]

34. We conclude that the United Kingdom's Presidencies of the G8 and the EU in 2005 represent an historic opportunity for this country to help set the world's political agenda in a number of key areas. It would be unthinkable that such an opportunity should be wasted owing to insufficient funds. We recommend that the Government ensure that it allocate adequate resources to meet the running costs of the G8 and EU Presidencies. We further recommend that the FCO's other activities must not be allowed to suffer as a result of these additional responsibilities.

18 HC Deb, 12 July 2004, col 1129 ff. Back

19 For further details, see: HM Treasury, 2004 Spending Review: New Public Spending Plans 2005-2008, Cm 6237, July 2004 (hereafter referred to as: 2004 Spending Review). Back

20 HC Deb, 12 July 2004, col 1131 Back

21 HC Deb, 12 July 2004, col 1132 Back

22 2004 Spending Review, p 133 Back

23 2004 Spending Review, p 133 Back

24 Departmental Report 2003-04, pp 162-3 Back

25 Ibid., p 162 Back

26 Ev 69 [FCO] Back

27 "We're broke so embassy must close, says Our Man in Kuwait", Daily Telegraph, 10 March 2004 Back

28 Ev 67 Back

29 "Foreign Office jobs to go to pay for 'summit grandeur'", The Times, 15 August 2004, p 4; and AR 48 Back