The new contractual state in Britain

Mick Moran - Member of SPERI's International Advisory Board & Professor Emeritus at Manchester Business School

The answer to these questions is that there are transaction costs to using the market.  The cost of obtaining a good or service via the market is actually more than just the price of the good.  Other costs include search and information costs, bargaining costs, and policing and enforcement costs.  If you are a supermarket chain sourcing food it may be better to own the farm than to make a contract with the farmer.

Coase’s great insights do not seem to have penetrated the minds of policy makers in the UK in the last generation, or if they have they do not seem to have been impressed by his arguments.  For over that time we have seen the dismantling of  large parts of a command economy where the state directly provided services, and its replacement by a web of contracts: by a system where services have been contracted out to private providers, and where the state takes on the policing and enforcement costs over these contracts.  The scale of this – in policing and incarceration, in welfare, in education – is constantly growing.

The long term impact, not only on the state but on the structure of the wider economy, is startling.  My colleagues in CRESC at Manchester, for instance, have shown that while in the mid 1980s the UK FTSE 100 contained large numbers of  industrial giants (remember ICI, Pilkington, GEC?),  by the new millennium the industrial giants had shrunk in number and had been joined in the FTSE 100 not only by big commercial enterprises like  supermarket chains, but by the products of the new contractual state.

There were two categories: the ‘outsourcing’ specialists (Capita, the Compass Group and Serco); and the utilities giants (such as BT and Centrica.)  The latter remind us that the new contractual state goes well beyond conventional outsourcing.  Privatisation has created a franchise state: a system where the state contracts for the provision of public services with private providers, creating franchises which – in the case of rail, for instance  – create private monopolies.  The scale of employment in the biggest of these outsourcing enterprises (Serco)  now dwarfs the numbers employed by the biggest of the industrial enterprises remaining in the FTSE index.

At the beginning of the privatisation and outsourcing revolution in the 1980s the new contractual state was presented as, among other things, a solution to what was perceived to be backstage manipulation by Whitehall and a lack of clear lines of accountability.  The new contracts would write down openly what had hitherto been concealed.  But in practice the age of contractualism has created exactly the kind of problems which a reader of Coase would have predicted.  Search and information costs have been huge, as have the costs of monitoring and policing the web of contracts.  Three big problems are emerging.

First of all, the contractual state has been beset by a lack of transparency.  The world of utilities in particular is marked by webs of contracts that are virtually impossible for even an expert observer, let alone a conscientious citizen, to work out.  The CRESC report on the rail franchise system, for instance, shows that the profits of the train operating companies are embedded in an opaque accounting system, while the opaqueness of the financing system for the rail infrastructure has led to the creation of £30 billion of debt which is formally off the public financing balance sheet but which has, almost in a fit of absent mindedness, become a public liability.  Transparency is of course also a prerequisite of accountability – the very thing promised in the early accounts of privatisation and outsourcing.

Lack of transparency has been compounded by serious abuses. As Coase reminded us, contracts have to be monitored.  Monitoring is especially important when the tasks that are contracted out involve dealing with the poorest and most vulnerable.  The policing and control of just about the most vulnerable group in Britain – immigrants seeking asylum – is now substantially contracted out, and has been the subject of successive scandals.

Finally, incompetence has been one of the hallmarks of the new contractual state.  Coase did not, of course, argue that contracting arrangements in markets were necessarily inferior to keeping things ‘in house’ in a command system.  On the contrary, the whole thrust of his work was to remind us of the contingencies that need to be borne in mind in making decisions about whether to contract.  The one great service that the new contractual state has done is to remind us not automatically to think ‘private provision efficient, public provision incompetent’.  To disabuse ourselves of that illusion we only have to think of SERCO and overcharging for electronic tagging of offenders (which seems to have been the result of complete incompetence, not conscious dishonesty), or G4S and the fiasco of security provision at the London Olympic games.

Coase’s intellectual legacy in the age of the new contractual state is thus clear: it is comparatively simple to outsource and franchise. But making sure the resulting contracts are designed and policed in the public interest is quite another matter.