Carillion’s collapse raises awkward questions about contracting out

WHAT do high-speed railways, school lunches and army bases have in common? Perhaps not much, which may be one reason for the dramatic collapse of Carillion, a jack-of-all-trades contractor that did a bewildering array of work for Britain’s public sector. On January 15th the firm went into liquidation, casting doubt on the prospects of its 43,000 employees, 30,000 subcontractors and the fulfilment of government contracts stretching three decades into the future.

The company’s fall is a story of commercial overreach and miscalculation (see article). But it is also the story of a political philosophy. Carillion exemplified a way of running the state that was pioneered under Margaret Thatcher and which went on to conquer the world. Where once governments provided public services, they now commission them from private companies. The idea is to subject moribund state monopolies to the competition and innovation of the market. Yet a string of failures in Britain, of which Carillion is the latest, means that the country which converted the world to “contracting out” risks becoming a cautionary tale. Voters are flirting with a Labour opposition that has already vowed to renationalise industries and now says it would bring many public contracts back in-house. The Carillion affair could mark the collapse not just of a company, but of an idea.

The bigger they come

In a sense, Carillion is a good example of how a failure of contracting-out is better than a failure in the public sector. Its losses will be borne chiefly by shareholders and creditors, not taxpayers. Look closer, however, and the demise highlights how contracting will not live up to its promises unless it changes.

Even if taxpayers are not bailing Carillion out, they may still bear hundreds of millions of pounds in costs because of project delays, the transfer of contracts and the continuing need to provide vital services. And Carillion could yet bring down thousands of subcontractors. The company had become almost too big to fail. Its fragility should have disqualified it from HS2, a decades-long high-speed rail project. Instead, ministers seemed to see the £1.4bn ($1.9bn) contract as a lifeline.

This moral hazard is aggravated by the market’s unhealthy concentration. Only three companies operate private prisons in Britain, for instance. A billion-pound contract to redevelop a London hospital attracted only two bidders. The government routinely commissions massive, long-term projects based on fewer quotes than voters would get for refitting their kitchen.

There is also the taint of private-sector greed. Carillion’s board ensured that the bonuses of its managers cannot be clawed back. And this week the National Audit Office reported that the Private Finance Initiative (PFI), an accounting gimmick designed to get borrowing off the government’s balance-sheet, has led to billions in extra costs without clear benefit.

How to fix all this? PFI, though flawed, is only part of the problem. Its use has been falling. More broadly, the remedy for bad management and weak competition in the private sector is not, as Labour says, to revert to bad management and no competition in the public sector. Britons may have forgotten the 1970s, but one reason for contracting-out was that public-sector roads, services and hospital-building were often shoddy and wasteful.

Instead, Britain needs to make its private markets more efficient, by improving commissioning and lowering barriers to entry. More standardised contracts would make the tendering process less burdensome, encouraging small and foreign firms to bid, despite lacking big English legal departments. That would increase the competition faced by firms like Carillion, part of whose competitive advantage was its knowledge of how to navigate the complex contracting process.

A couple of decades ago inexperienced civil servants were routinely diddled by armies of lawyers hired by private firms. Today’s commissioners are better, but still fall for false economies. They favour low bids, only for bidders to renegotiate terms upwards later. Commissioning teams, and the bodies that audit them, have been squeezed by spending cuts, a small saving next to the size of the contracts. Overstretched bureaucrats are also more likely to award contracts to known outfits, like Carillion, which offer to roll lots of services into one tempting bundle—giving the company the whip hand.

Some quarters of government seem to believe that the efficiency and innovation of the private sector happen by magic. In reality they come about only when contracting-out is subject to the discipline of a real market. Without competition, private-sector managers are no more dynamic than the bureaucrats they replaced. If the government cannot create a market worthy of the name, voters may decide to throw out the idea altogether. That would be costly indeed.