Many of the most pressing problems facing the state today have developed as a result of a flawed doctrine of neoliberalism, argues Gwyn Bevan. In the light of failures in privatisation and outsourcing, he calls for a new political settlement.
Gwyn Bevan will be speaking at the LSE Festival event “How Did Britain Come to This?” on Saturday 17 June 2023
In May 2023, the Guardian reported that, in 2002, Chris Goodall had highlighted the regulatory risks from the takeover of Southern Water by Private Equity (PE) shareholders. And that, although that report would normally have been released under the 20-year rule, it is being kept secret. Goodall had predicted that “Large external private equity shareholders would load the company with debt and Ofwat inevitably would lose any regulatory control. For example, it would prove extremely difficult to ensure that water companies invested enough in sewage control.”
In 2021 when the Environment Agency damned the environmental performance of England’s nine water and sewerage companies as “the worst we have seen for years”, only three were then still listed on the London Stock Exchange (LSE). The six worst were Southern and South West, which were “terrible across the board”, and Anglian, Thames, Wessex, Yorkshire Water, which “required significant improvement”. Of those, South West Water is still listed on the LSE, which raises questions about the original design of the regulation of England’s privatised water and sewage system.
The photo below of Trevaunance Cove at St Agnes in Cornwall, which was taken on the last day of the school half term holidays in November 2022, shows the consequence of foul water being discharged into the sea by South West Water.
The privatisation of water and sewage illustrates Paul Battalden’s observation: “Every system is perfectly designed to get the results it gets”. It is one example of our institutions proving to be incapable of effective governance of the financialisation of private suppliers of our public services.
The privatisation of water and sewage is an example of our institutions proving to be incapable of effective governance of the financialisation of private suppliers of our public services.
The core principle of financialisation is Milton Friedman’s neoliberal doctrine that “there is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits”. He proposed that doctrine in 1970, to end executives practising “pure and unadulterated socialism” on the mistaken belief that the “social responsibilities” of business ought to include “providing employment, eliminating discrimination, avoiding pollution”.
The neoliberal means of incentivising executives to follow Friedman’s doctrine was to link their remuneration to increases in shareholder value. This redirects the “social responsibilities” of business to financial engineering: eg, basing corporations in tax havens, and mergers and acquisitions. Bayliss et al explain how private equity has used a financial instrument known as “whole business securitisation” via Cayman Island-registered subsidiaries (to get round obstacles in UK legislation) so “the public are paying heavily for a debt-laden system of water financing, structured in the interests of PE investors”.
The case of Carillion – a cautionary tale
The stated objective of government contracting with the private sector is to deliver the best possible public services and value for money for the taxpayer. Financialisation of suppliers through a series of acquisitions and mergers restricted competition to a few big firms.
Carillion was formally recognised as a Strategic Supplier with over 450 contracts worth £2 billion involving transport, justice, education and defence. A report for the House of Commons explained that the reason why, on 15 January 2018 it went “went into compulsory liquidation rather than administration [was] because it had no real assets left to sell. It had contracts, but they were either too complex or insufficiently valuable for the banks to lend against”. Its flagrant breach of the government’s Prompt Payment Code resulted, after its collapse, in its 30,000 subcontractors being owed £2 billion and, according to the Financial Times, a New York-based hedge fund making £4 million by short-selling Carillion’s shares.
The joint report by the House of Commons Business, Energy and Industrial Strategy and Work and Pensions Committees identified failings by four institutions. First, the pensions regulator: Carillion’s pensions schemes were left with liabilities of around £2.6 billion. Second, its auditor KPMG: “In failing to exercise – and voice – professional scepticism towards Carillion’s aggressive accounting judgements”. Third, the Financial Reporting Council: for being “timid in challenging Carillion on the inadequate and questionable nature of the financial information it provided and wholly ineffective in taking to task the auditors who had responsibility for ensuring their veracity”. Fourth, Carillion’s remuneration committee: for “continuing to ensure those at the top of Carillion would suffer less from its collapse than the workers (2,000 lost their jobs) and other stakeholders”.
Flawed foundations
Neoliberalism is based on a misreading of Adam Smith’s Wealth of Nations, published in 1776, which famously observed: “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest”. These examples were of markets that worked so well because they satisfied a stringent set of conditions. Each was a small self-managed enterprise and whether it thrived or failed depended on its local reputation. Each market was contestable, it was easy for new entrants to replace the suppliers failing on quality and price. Consumers were skilled repeat buyers who knew what they wanted, their willingness to pay, and easily assessed the price and quality of what was on offer.
Those markets exemplified Smith’s famous metaphor of working like an “invisible hand”. Governments could only make privatisation and outsourcing work for services that do not satisfy those stringent conditions through the visible mechanisms of regulation and written contracts. But the vulnerability of those mechanisms has been exposed by another institution of neoliberalism, namely financialisation, which has incentivised the private sector to behave opportunistically.
In Britain now, market failures are the problem of government.
My book, How did Britain come to this?, is about a century of systemic failures in governance. The minimal state of the 1920s and 1930s allowed William Beveridge’s five giants to grow: Want, Disease, Ignorance, Squalor and Idleness. The post-war Attlee governments established the planned state to tackle them. The systemic problems of the Attlee settlement in the 1970s, included “stagflation” (high rates of inflation and unemployment); the need for a loan from the International Monetary Fund; council estates that were “slums in the sky”, and failures in governance of public services and nationalised industries.
The Thatcher governments, from 1979 to 1990, established the neoliberal state to tackle those problems through marketisation. In the USA in 1981, Ronald Reagan in his inaugural presidential address famously set out the case for the Thatcher settlement in one sentence: “In our current crisis, government is not the solution to our problems: government is the problem”.
In Britain now, market failures are the problem of government. We need a new political settlement, the enabling state, that regulates markets where they can work effectively (not just for shareholders and senior executives) and develops alternatives through devolved government where they do not.
This post draws on analysis contained in the author’s forthcoming book, How did Britain come to this (LSE Press, 2023).
All articles posted on this blog give the views of the author(s), and not the position of LSE British Politics and Policy, nor of the London School of Economics and Political Science.
Image credit: Photo by Garry Knight, public domain.
