The rise of the shadow state: the truth about outsourcing

Contractors like Serco, G4S and Clearel have become "too big to fail", while it's taxpayers' money they're consuming.

People’s eyes tend to glaze over when you mention public service commissioning. It’s hardly the most sexy subject to write about. But it matters. It matters, for a start, because it’s a huge industry. A study by Oxford Economics estimates that it employs 1.2 million people, and creates or supports a further 2.3 million jobs. According to the research, the current outsourced market for public services has an annual turnover of £82bn, representing around 24 per cent spend on public services in the UK.

And it matters because outsourced public services have an impact on the entire economy, in terms of wage levels, benefit demands and spending power. It matters because these services are vital to our social fabric and have knock-on effects – effects that can help or hinder not only the people they serve, but their friends and relatives. What happens to a child in a children’s home or a prisoner in jail affects all of us.

And a report released today by Social Enterprise UK, the national membership body for social enterprise, has produced some stark conclusions about how the face of our public services has changed.

1. Rise of the giants

Here’s a list of things that one company, Serco, operates: prisons and young offenders institutions. The National Nuclear Laboratory. Transport services like the Docklands Light Railway and Barclays Cycle Hire. Security services for the National Borders Agency, and maintenance services for missile defence systems. Air traffic control services. Leisure services. Management for hospitals and pathology services.  Waste collection for local authorities. Education services for local authorities. Government websites.

If the company were to go under, it would cause severe disruption to public services. The growth of such contractors that are “too big to fail” began under New Labour and has continued apace. Why did it happen? In the report, Matthew Taylor, former director of policy for the Labour Party, provides a clue: “One of the funny stories I heard about this is that the government wanted to move into agile commissioning. And immediately, all the large providers employed a Head of Agile. Of course, smaller providers can’t afford a Head of Agile.” The biggest companies are best placed to meet Government guidelines.

In the early years of outsourcing under New Labour, the commissioners at local and national level lacked experience and confidence, so they went with the biggest firms, whom they felt they could trust. Rather than tear up these contracts, in recent years they simply expanded them with “bolt-ons”, in many cases due to fear of litigation. It’s an understandable fear – the larger the corporation, the more litigious it’s likely to be, and the West Coast Mainline debacle shows how costly and politically hazardous it is to be embroiled in such a case.

This is the situation today: in March this year, the UK Border Agency issued contracts worth £1.7bn for asylum seeker services (including accommodation). All eight contracts went to three companies: G4S, Serco and Clearel. Nearly a quarter of the £3.3bn contracts for the Work Programme went to one company (Ingeus). And cuts within the public sector have reduced the volume and skill of commissioners, meaning that they will choose to “buy safe” more often than not. This lack of genuine competition, as we’ll see, removes the main incentive to provide quality of service.

2. Goliath is killing David

It’s also forcing smaller charities and social enterprises out of the market. Many are making redundancies and turning away from public service markets in order to survive, just when they are needed most. They cite procurement policy as one of the biggest barriers to their sustainability.

I’ve already written, at length, about one enterprise which went bust as a result of signing up to the Government’s Work Programme. It wasn’t the only one - earlier this year Groundwork South West also went into administration. The deals favour the prime contractors: by June 2012, 96 charity providers had dropped out, 27 unable to make it work.

“There’s an ebbing away of confidence,” Peter Holbrook, CEO of Social Enterprise UK, tells me. “We’ve seen companies go to the wall, or being sidelined, and of course it makes you nervous. These days you increasingly have to work with a private contractor. It means small charities are getting crumbs from the table” This is the problem with the payment-by-results (PBR) system. Payments for these hard-to-reach jobless cases may be some time coming, if they come at all. Not-for-profit organisations, having failed by definition to build in a layer of profit to their business model, don’t have the capital reserves to wait for results. Essentially, they find themselves out-manoeuvred by the bigger companies that sub-contract to them. And this matters because...

3. Profit and public service don’t always mix

I’ve previously written on this with regard to one company the public does know about due to the Olympic fiasco: G4S. But the report has a lengthy section about a sector of the industry which hasn’t received quite so much coverage: children’s services. It’s an area that was highlighted by the recent Rochdale scandal, but this element of the story was somewhat buried by the other details.

It used to be the case that charities would bid for council contracts to care for vulnerable children, and would cross-subsidise themselves from fundraising and other means to do so. It was never going to last: private equity firms gradually took over. The report says: “Sovereign and 3i are the big contenders, but it is hard to pinpoint which firm owns what; their waters seem to be in perpetual motion, as they buy one another and take one another over, and offload assets.”

These companies operate by buying up cheap housing stock around the country, to which vulnerable children can be shunted. Two London boroughs now have no children’s homes at all. There are 101 homes in Lancashire alone, even though Lancashire has a population of less than 1.5 million. London has 130 homes, for a population of 7.8 million.

Ann Coffey MP is quoted: “They may take a child into care for the first time, after a final event has happened. So a child may have gone one more time, missing from home, and he or she is removed. The authority then thinks, ‘Where the hell have we got a place?’ Not ‘What does this child need?’ It’s the most terrible market failure.”

And the report cites a horrific statistic, one that shows Rochdale, much as we’d like it to be, was unlikely to be an isolated case. Ofsted figures published in May 2012 revealed that children’s homes in England— caring for 4,840 children, including 1,800 girls — had reported 631 suspected cases of young residents being sold for sex in the past five years. These are just the reported cases: it’s likely to be far higher.

It’s not hard to see how the practice of moving children around can exacerbate the problem. Once a child is removed from its own local authority, it loses contact with its team of social workers, its grandparents, neighbours and others who might be able to spot the signs of abuse. One girl at the centre of the Rochdale case was moved from Essex and placed in a one-to-one home, where she was the only resident. She never woke up with the same staff member in the home who had been there when she went to sleep.

The sector has responded to these criticisms, claiming “the simple connection of cheapness isn't accurate” with regard to the shifting of children. But it’s still hard to disagree with Coffey’s conclusion that the sector is “murky to say the least.” As Holbrook says: “There’s no problem with upscaling if you’re doing something like buying paperclips. But most public services rely on human relationships, so upscaling leads to a huge degradation in the quality of service.” And what about the staff in those homes?

4. Robbing Peter to pay Paul

Almost all the jobs being advertised by private care firms are at the UK minimum wage. This isn’t a living wage, as we all know. The staff are paid by the minute and aren’t paid travelling time. A care worker for a private company is interviewed. She was paid 14 pence per minute, and travelled from appointment to appointment on buses in Islington: “An average day that I was doing at the time, and this wasn’t very long because I couldn’t afford to keep it going, I’d start at 9, do 45 minutes with one person, another 45 minutes at 10, a half hour at 12, a break, a quarter hour at 4, another 15 minutes at 4.30, a half hour at 5 and another hour from 8 til 9. So that’s a 12-hour day for 4 hours’ money.”

Companies are making offers to contractors that aren’t mathematically possible if they’re providing jobs with a minimum wage, national insurance contributions, a pension scheme and training. Savings in one area invariably mean higher costs elsewhere:  “No local authority should make that deal: even just on the pragmatic basis that it will be their own residents who are on the receiving end of that low wage, their own housing benefit department making up the carer’s rent shortfall, their own health and children’s services that come under strain when poverty is rife.” We’re seeing a degradation of service for short term profit gains.

As the anonymous care worker describes: “The public face of the company is all very welcoming. They’re always very hazy around money. It’s all, ‘Don’t you worry, there’ll be lots and lots of work for you’. We were all on zero-hours contracts, so basically they weren’t obliged to give us any work. There are hundreds of people out there working like this, I’d meet people all the time, for jobs that required two carers, and I never met anybody who was being paid any differently. I know the hours for tax credits have changed now, but most people were on housing benefit.”

This also means there’s a large section of the workforce that isn’t preparing for old age and retirement: a problem that will also have to be dealt with further down the line. It’s no surprise staff turnover is high, and this feeds into the quality of care.

5. We reward failure. All the time.

Again, I could cite the catalogue of failures I wrote about prior to the G4S debacle. Or the £529,770 that was lost from staff fraud or abuse from the Flexible New Deal 2010-11. Or the chaos that followed the privatisation of our court translation services. Or A4E’s company director payments, which saw the-then CEO Emma Harrison pay herself £8.6m, in a year when fewer than 4 in every 100 unemployed people seen by the firm managed to secure jobs for longer than 13 weeks. Or the nine prisons put out to tender in November in 2011 in spite of high-profile failings in the private sector (as the report says, in the very same bidding round the Wolds was returned to the public sector following the expiration of G4S’s contract, having seen poor inmate behaviour and high levels of drug abuse). Or the closure of Southern Cross as a result of complex financial deals designed to maximise financial gain, which left taxpayers picking up the pieces. Or...

There’s nothing inherently wrong with a market. But cases like these show that we’re getting all the downsides of privatisation – the stripping away of money through profits, above all – and none of the upsides, because there isn’t genuine competition. This is market failure, pure and simple.

6. The profits don’t even stay in the UK, let alone improve services

Social enterprises reinvest the money they make in service improvements. Private companies don’t: for every level of sub-contracting, profits are taken out in the form of shareholder dividends. The total amount of money being taken out of the social economy as a result is hard to quantify.

But one thing’s clear: money which has been allocated by Government to communities and issues that need it is being stripped away. Here’s one example: “Private equity companies work to extract as much financial value as they can from the companies they take over, in a relatively short timeframe. One of the ways they do this is through sale-and-leaseback deals on residential care homes for children and adults. This leads to extreme volatility in a market where stability is a fundamental requirement.”

But perhaps the most galling thing is that nearly half the money raised by this practice doesn’t even stay in the UK. A 2010 report by the Office for National Statistics showed that more than 40 per cent of shares in UK companies are held by overseas investors: this had increased by almost 25 per cent in just two years.

7. We can’t hold these companies to account

There have been moves towards openness - through the FOI Act and the publication of every contract worth over £100,000. But this legislation has been trumped by commercial confidentiality laws. You can find out how much a company has bid for a contract, but not how much lower it was than that of the next lowest bidder, so the number has no context.  

As the report says, in business, there are mechanisms for accountability. A company’s CEO is answerable to non-executive directors, who can ask questions on behalf of shareholders. MPs don’t have the same power. And as Holbrook tells me: “I was involved in a Dispatches programme on Virgin’s move into health care, and an ex-employee emailed me to say she’d wanted to speak out but couldn’t due to a confidentiality agreement. There’s far less opportunity for whistle blowing within large providers.” On top of this, the service giants regularly make use of Britain’s defamation laws - which like the bidding process, favour those with the most money behind them - whether confronted by traditional media or online scrutiny.  

Equally murky is the “revolving doors” culture – both revolving in, with corporate staff appointed to government posts, and revolving out, with public servants taking on high-ranking private sector jobs once they leave office. Alan Cave, a central architect of the Work Programme as a civil servant, left to join Serco, one of its main beneficiaries, this year, while Phil Wheatley, former head of the National Offender Management Service, is now a G4S adviser.

8. This is the Shadow State

Only one in five people polled by Social Enterprise UK knew that the majority of children’s homes are now owned by private companies. The majority of people polled for the report had never heard of Atos or Serco, yet these firms and others like them, are receiving and are responsible for many billions of pounds of taxpayers’ money.

This is an argument that can and should be depoliticised. There’s nothing left wing in saying a local community should benefit from a local contract. And there’s nothing in traditional conservative thought to encourage private companies, say, buying up assets, loading them with debt, and passing that debt back to the service users. Yet it’s quietly, inexorably, grown over the last few decades. Tomorrow, I’ll describe what can be done to fight it.

The second part of Alan White’s work on the shadow state will be published on his blog tomorrow.

UPDATE 3 January 2013 13:45 This article originally stated that clinical failures had lead to London hospitals being forced to lend money to Serco. This was incorrect and has been removed.
 

A security guard working during the London Olympics. G4S's failure there is just one chapter in the outsourcing story. Photograph: Getty Images

Alan White's work has appeared in the Observer, Times, Private Eye, The National and the TLS. As John Heale, he is the author of One Blood: Inside Britain's Gang Culture.

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We're racing towards another private debt crisis - so why did no one see it coming?

The Office for Budget Responsibility failed to foresee the rise in household debt. 

This is a call for a public inquiry on the current situation regarding private debt.

For almost a decade now, since 2007, we have been living a lie. And that lie is preparing to wreak havoc on our economy. If we do not create some kind of impartial forum to discuss what is actually happening, the results might well prove disastrous. 

The lie I am referring to is the idea that the financial crisis of 2008, and subsequent “Great Recession,” were caused by profligate government spending and subsequent public debt. The exact opposite is in fact the case. The crash happened because of dangerously high levels of private debt (a mortgage crisis specifically). And - this is the part we are not supposed to talk about—there is an inverse relation between public and private debt levels.

If the public sector reduces its debt, overall private sector debt goes up. That's what happened in the years leading up to 2008. Now austerity is making it happening again. And if we don't do something about it, the results will, inevitably, be another catastrophe.

The winners and losers of debt

These graphs show the relationship between public and private debt. They are both forecasts from the Office for Budget Responsibility, produced in 2015 and 2017. 

This is what the OBR was projecting what would happen around now back in 2015:

This year the OBR completely changed its forecast. This is how it now projects things are likely to turn out:

First, notice how both diagrams are symmetrical. What happens on top (that part of the economy that is in surplus) precisely mirrors what happens in the bottom (that part of the economy that is in deficit). This is called an “accounting identity.”

As in any ledger sheet, credits and debits have to match. The easiest way to understand this is to imagine there are just two actors, government, and the private sector. If the government borrows £100, and spends it, then the government has a debt of £100. But by spending, it has injected £100 more pounds into the private economy. In other words, -£100 for the government, +£100 for everyone else in the diagram. 

Similarly, if the government taxes someone for £100 , then the government is £100 richer but there’s £100 subtracted from the private economy (+£100 for government, -£100 for everybody else on the diagram).

So what implications does this kind of bookkeeping have for the overall economy? It means that if the government goes into surplus, then everyone else has to go into debt.

We tend to think of money as if it is a bunch of poker chips already lying around, but that’s not how it really works. Money has to be created. And money is created when banks make loans. Either the government borrows money and injects it into the economy, or private citizens borrow money from banks. Those banks don’t take the money from people’s savings or anywhere else, they just make it up. Anyone can write an IOU. But only banks are allowed to issue IOUs that the government will accept in payment for taxes. (In other words, there actually is a magic money tree. But only banks are allowed to use it.)

There are other factors. The UK has a huge trade deficit (blue), and that means the government (yellow) also has to run a deficit (print money, or more accurately, get banks to do it) to inject into the economy to pay for all those Chinese trainers, American iPads, and German cars. The total amount of money can also fluctuate. But the real point here is, the less the government is in debt, the more everyone else must be. Austerity measures will necessarily lead to rising levels of private debt. And this is exactly what has happened.

Now, if this seems to have very little to do with the way politicians talk about such matters, there's a simple reason: most politicians don’t actually know any of this. A recent survey showed 90 per cent of MPs don't even understand where money comes from (they think it's issued by the Royal Mint). In reality, debt is money. If no one owed anyone anything at all there would be no money and the economy would grind to a halt.

But of course debt has to be owed to someone. These charts show who owes what to whom.

The crisis in private debt

Bearing all this in mind, let's look at those diagrams again - keeping our eye particularly on the dark blue that represents household debt. In the first, 2015 version, the OBR duly noted that there was a substantial build-up of household debt in the years leading up to the crash of 2008. This is significant because it was the first time in British history that total household debts were higher than total household savings, and therefore the household sector itself was in deficit territory. (Corporations, at the same time, were raking in enormous profits.) But it also predicted this wouldn't happen again.

True, the OBR observed, austerity and the reduction of government deficits meant private debt levels would have to go up. However, the OBR economists insisted this wouldn't be a problem because the burden would fall not on households but on corporations. Business-friendly Tory policies would, they insisted, inspire a boom in corporate expansion, which would mean frenzied corporate borrowing (that huge red bulge below the line in the first diagram, which was supposed to eventually replace government deficits entirely). Ordinary households would have little or nothing to worry about.

This was total fantasy. No such frenzied boom took place.

In the second diagram, two years later, the OBR is forced to acknowledge this. Corporations are just raking in the profits and sitting on them. The household sector, on the other hand, is a rolling catastrophe. Austerity has meant falling wages, less government spending on social services (or anything else), and higher de facto taxes. This puts the squeeze on household budgets and people are forced to borrow. As a result, not only are households in overall deficit for the second time in British history, the situation is actually worse than it was in the years leading up to 2008.

And remember: it was a mortgage crisis that set off the 2008 crash, which almost destroyed the world economy and plunged millions into penury. Not a crisis in public debt. A crisis in private debt.

An inquiry

In 2015, around the time the original OBR predictions came out, I wrote an essay in the Guardian predicting that austerity and budget-balancing would create a disastrous crisis in private debt. Now it's so clearly, unmistakably, happening that even the OBR cannot deny it.

I believe the time has come for there be a public investigation - a formal public inquiry, in fact - into how this could be allowed to happen. After the 2008 crash, at least the economists in Treasury and the Bank of England could plausibly claim they hadn't completely understood the relation between private debt and financial instability. Now they simply have no excuse.

What on earth is an institution called the “Office for Budget Responsibility” credulously imagining corporate borrowing binges in order to suggest the government will balance the budget to no ill effects? How responsible is that? Even the second chart is extremely odd. Up to 2017, the top and bottom of the diagram are exact mirrors of one another, as they ought to be. However, in the projected future after 2017, the section below the line is much smaller than the section above, apparently seriously understating the amount both of future government, and future private, debt. In other words, the numbers don't add up.

The OBR told the New Statesman ​that it was not aware of any errors in its 2015 forecast for corporate sector net lending, and that the forecast was based on the available data. It said the forecast for business investment has been revised down because of the uncertainty created by Brexit. 

Still, if the “Office of Budget Responsibility” was true to its name, it should be sounding off the alarm bells right about now. So far all we've got is one mention of private debt and a mild warning about the rise of personal debt from the Bank of England, which did not however connect the problem to austerity, and one fairly strong statement from a maverick columnist in the Daily Mail. Otherwise, silence. 

The only plausible explanation is that institutions like the Treasury, OBR, and to a degree as well the Bank of England can't, by definition, warn against the dangers of austerity, however alarming the situation, because they have been set up the way they have in order to justify austerity. It's important to emphasise that most professional economists have never supported Conservative policies in this regard. The policy was adopted because it was convenient to politicians; institutions were set up in order to support it; economists were hired in order to come up with arguments for austerity, rather than to judge whether it would be a good idea. At present, this situation has led us to the brink of disaster.

The last time there was a financial crash, the Queen famously asked: why was no one able to foresee this? We now have the tools. Perhaps the most important task for a public inquiry will be to finally ask: what is the real purpose of the institutions that are supposed to foresee such matters, to what degree have they been politicised, and what would it take to turn them back into institutions that can at least inform us if we're staring into the lights of an oncoming train?