Taming the public sector hybrid

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There is too much inconsistency in the way the UK’s privatised industries are managed and financed. A new and comprehensive plan is needed.

The privatisation of air traffic control was highly controversial. Yet when the government made a £30m loan to the business, ahead of a regulatory review to allow it to raise charges to airlines, it became clear that NATS was not a true private company. Ordinary businesses faced with a fall in trade do not put their prices up to recover their costs: they put prices down to stimulate demand. That is how airlines have reacted to September 11. The risk that demand will not grow as rapidly as expected is precisely the kind of risk that shareholders in an ordinary company expect to bear.

But the airlines that hold a majority stake in NATS are not shareholders, but stakeholders. They did not expect to take any significant equity risk and are neither able nor willing to do so.

NATS is simply the latest of many hybrid institutions, neither public agencies nor private businesses. Others include old Railtrack, new Railtrack, and the special purpose vehicles that have proliferated under the public finance initiative; restructured and thinly capitalised water companies such as Glas Cymru; hospitals grouped in quasi-autonomous NHS trusts; and the oldest and most anomalous case of all – the BBC, which is part public service, part media empire.

Each of these institutions is different. Each has a distinctive funding and capital structure, and a distinctive mechanism through which its management is appointed. These differences exist not because of differences in the appropriate form of organisation for their functions, but because of accidents of history.

The problem with this proliferation is not simply administrative untidiness. It is the resulting combination of complex legal rules and contractual arrangements combined with uncertainty about how these arrangements will work when they run into trouble.

Who bears what risks, who is responsible for what, who is accountable for what to whom? Mostly there are no clear answers to these questions, and even if the formal structure seems to offer clear answers they are – as in the case of NATS – overridden at the first sign of crisis. This ambiguity in responsibility and accountability was the principal cause of the poor performance of Britain’s nationalised industries. It led to repeated and inconsistent interventions that undermined the responsibility of managers without transferring that responsibility to anyone else. Unwillingness to delegate responsibility combined with readiness to assign blame is the hallmark of bad management everywhere, and is still endemic in Britain’s public services.

The best direction of reform would be a common model of a public service corporation, appropriate to the wide range of activities that need to be distanced from political control but cannot be provided by a competitive private market.

The real issues are about management, not finance. Begin by getting rid of the distraction of off-balance sheet financing. Many of these arrangements – from telecommunications privatisation to air traffic control – sprang from a desire to take the cost of public services out of public sector accounts. This made some sense when the Conservatives in the 1980s had tied themselves to the mast of public sector borrowing targets. Today it directly undermines the Chancellor’s reputation for provident finance.

The similarity of title between the special purpose vehicles of Britain’s public private partnerships and Enron’s notorious special purpose entities is not coincidental. The object of both is much the same – to exploit the accounting loophole that allows you to leave out liabilities of associated undertakings if you introduce third party equity.

After Enron companies will now come under pressure to abandon this practice and the British government should give a lead. The only significant economic difference between government borrowing and private sector borrowing which is secured against contracts with the public sector or repaid from levies on beneficiaries of public services, is that government borrowing is cheaper.

The objective should not be to divide the existing activities of the public sector into public and private functions – that necessitates these complex and unworkable contracts. It should be to fuse the different strengths of private and public sectors. What is needed in a public service corporation is a combination of public sector ethos with private sector discipline of autonomy, audit and accountability.

The delivery of public services is a government responsibility. You do not change that fact by changing the formal status of the body that delivers them. Instead you risk tension between the responsibilities of companies and directors and the reality of ultimate political control. The wise politician will exercise the resulting authority sparingly: by making good appointments and allowing those appointed to get on with the job: by using headhunters to find management, and regulators to review investment programmes and changing structures; by insisting that everything that can be contracted out in competitive markets is; and by refusing to become involved in day to day operations.

Ultimate ownership by government means that government should be the principal source of finance – on the balance sheet. There is probably something to be said for equity type finance in which the return to investors is related to performance. But it needs to be clear – which it is not at present – what performance criteria govern these returns. What were Railtrack shareholders entitled to expect?

The process of audit needs to be systematic – and involve not just financial but also performance audit. A combination of the National Audit Office and the regulatory agencies could develop the necessary expertise. One bizarre aspect of the current developments is that claims of commercial confidentiality are used to withhold information about privately provided public services. Even if the plans for the London Underground are a good idea, we cannot tell. We need more information about performance, not less. We also need decisive procedures for bringing about management changes when audit demonstrates that these are necessary.

NATS was and is a missed opportunity to define structures relevant to the whole process of public sector reform. The next opportunity – the restructuring of Railtrack – should not also be missed.

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