Backs turned
Carillion shows how deep economic ignorance runs in the UK
Philip Booth
If the Carillion crisis has shown anything, it is the wanton disregard of the political class for the discipline of economics. In other scientific fields, it would be impossible to make statements such as “the Sun goes around the Earth”, or “the Earth is flat”, without being ridiculed. Indeed, in the climate change debate, those who argue that industrial activity will not lead to dangerous global warming are vilified and labelled deniers.
When it comes to economics, however, it seems possible to say that black is white or to deny shades of grey with impunity, and this is so in the debate surrounding Carillion. This is not a new problem. William D Coleman, in his brilliant book, Economics and Its Enemies, told of 200 years of what he described as “anti-economics” in public discourse.
It might be argued the economic logic is not simple and is not widely discussed, so we would not expect politicians to understand the intricacies of PFI funding. This might be true. But, I also don’t have the knowledge to verify that the Earth goes around the Sun – I believe those who tell me and listen to how they tie in observable facts with indisputable theory.
In the case of economics, it seems possible even for practitioners to totally ignore the precepts of the discipline and make incorrect statements that receive rapturous applause. One of many examples of this was on Question Time on Thursday, when Sir Howard Davies, who is as tied to the economic establishment as anybody else, stated that the Government can borrow more cheaply than the private sector and so, unless there were cost savings elsewhere, PFI would always be more expensive.
So, why is it a myth that cheap government borrowing can lower the cost of direct government provision of infrastructure?
At the moment, the Government can borrow at about 1.75pc. It would cost Costain, for example, much more to borrow money. So, if we are going to build a road, according to the myth, the Government should borrow and build it itself rather than hire Costain and then pay Costain a fee over, say, 30 years. This is because Costain would factor in its higher cost of borrowing when determining its fee.
But, the reason Costain pays more to borrow is that there are risks attached to the building of the road. It might be more expensive to build than expected (as Carillion found out with the Aberdeen bypass) or, if the Government is paying the contractor according to how much traffic uses the road, the revenues might be less than expected.
When the Government builds the road, it hides that risk away. It is true that people are willing to lend to the Government at 1.75pc because they know they will get their money back. But the risk that the road will be an expensive failure is shoved off balance sheet and borne by the taxpayer. In a government-funded scheme, if costs over-run, the taxpayer picks up the bill. Under the PFI scheme, if costs over-run, Costain’s shareholders and possibly their other financiers pick up the bill.
We should not think these risks are trivial. The Humber Bridge was expected to cost £28m when building started, but a combination of lack of use and higher-than-expected building costs meant that the debt reached £440m before being restructured and partly written off in 1997. A conservative estimate of the losses on Britain’s post-war nuclear power programmes is £32bn. These losses were entirely borne by taxpayers.
Sometimes when PFI schemes fail, the Government does end up paying some of the bills. This may be because
‘The failure of PFI is not a failure of capitalism. But embracing PFI is not the same as embracing markets’
of bad contract design. But it only happens if private providers of finance have taken their losses first. That is why it was so important that the Government did not rescue Carillion: the banks and the other debt holders rightly took the first hit.
But, does this mean that PFI or contracting out is always and everywhere a good thing? This takes us to the second myth. It is often argued that the use of PFI and contracting out is an indication of the embracing of free markets and “neo-liberalism”, including by Labour governments. It is nothing of the sort.
No sane person believes that the Government should do everything in-house. If the Government rejects the contracting out of catering services, for example, will it continue this reasoning and grow all its own food on government-owned farms with government employees? Would any sensible government employ a direct workforce for the tunnelling necessary for HS2? The idea is ridiculous.
Once the Government has decided to provide a road, a railway line, or a hospital, the market mechanism has essentially been rejected. How it provides the infrastructure is a matter of prudent government management.
Contracting out involves the creation of a supply chain, the transfer of risk, changes to the timing of cash flows, the design of contracts, and so on. There are costs and benefits that come with this.
For example, when the Government contracts out services or uses PFI, complex contracts require monitoring. But, on the other hand, when the Government uses its own workforce, there is lost flexibility and the Government incurs costs of managing the workforce directly.
These are exactly the dilemmas that face private firms when they decide whether to contract out or do things in-house. For example, one firm might decide to employ its own security staff because specific local knowledge is required to keep its premises safe. Another firm might hire G4S because its premises are small and can be monitored remotely by CCTV cameras.
The failure of contracting out or PFI is not a failure of capitalism. At the same time, embracing PFI and contracting out is not the same as embracing markets.
However, the idea that, because the Government can borrow money cheaply, it has an advantage over the private sector is a myth. Direct provision simply hides away the costs. Indeed, one of the benefits of contracting out infrastructure provision is that it reveals the cost of projects to the Government immediately.
We know today that Hinkley Point is a financial disaster: with the first nuclear power programme, we had to wait decades to find out.