Carillion shows that capitalism works

The collapse of construction giant Carillion is unfortunate. Shareholders are wiped out, services disrupted, 20,000 jobs are at risk and there will be ramifications down the supply chain. But most worryingly, the incident gives new impetus to a misguided and false agenda against capitalism and the private sector. It comes at a time when the public mood is already turning towards the state for solutions. The left has jumped on the Carillion bankruptcy to promote a nationalisation agenda, pushing to bring outsourced service back into the public sector.

And the collapse of the construction giant is definitely bad news from the tax payer. Contracts will have to be replaced, many presumably at a higher cost. Competing firms have seen their share price rise in anticipation.

Labour fears that private firms will “walk away with the most profitable contracts, while the taxpayer bails out loss-making parts of the business”. This is a predictable soundbite but as usual utterly nonsensical. Private firms will of course only bid for profitable business. The loss-making contracts were mispriced by Carillion – that’s part of the reason why they went bust. The government will have to pay more to replace the contractor – characterizing that as a bailout is political opportunism at best, economic illiteracy at worst.

Predictably, the profit motive is again being demonized by people who are unaware of the role profit/ loss plays in a capitalist economy (as we explain here). The naïve argument regards profit as ‘money left on the table that could be invested in our public services’ and implies that no company should ever outsource any service or buy any product from a profit-making company. As a believer in free market capitalism, it is infuriating to repeatedly being faced with this false argument.

The company has left a large hole in its pensions fund (minimum £600 million) and the tax-payer funded Pension Protection Fund is picking up the bill. Though politicians can hardly lecture on the prudence of funding pensions liabilities, this is a legitimate complaint. However, having such protection in place in the first place removes large parts of the moral responsibility from companies to fund their pensions properly: if the worst should happen, their employees are covered. Interfering with fee market incentives have consequences – that’s advice politicians would do well to heed.

Bizarre claims that profits were privatized but losses socialized, that shareholders have been bailed out, abound – from people seemingly referring to past dividends and oblivious to the fact that Carillion shares are now worthless. To be sure, shareholders are to blame: they hardly provided exemplary corporate governance. The former chief executive is reportedly still receiving a £660,000 salary until October 2018, two years after he left the firm. There is no clawback provisions on bonuses received while he was leading the company towards collapse. But these are private matters for shareholders, who ended up paying the ultimate price for their sloppiness, and should be of no concern to politicians. There is however surely lessons to be learned on how to structure pay in order to provide the right incentives. The old ‘reward for failure’ adage justifiably springs to mind. Capitalism sometimes has itself to blame for its bad press.

But in a free market, companies sometimes goes bust. That is how capitalism rewards the best providers and punishes the bad. It is how it is supposed to work. Contrary, was the services to be brought under public management, incentives to excell would evaporate -a public company, with no risk of collapse, would be void of the mechanisms that propel a competitive, free market towards innovation, efficiency and customer service.

What the fiasco really exposes is poor procurement in the public sector – and we shouldn’t be surprised. Milton Friedman pointed out the moral hazard in public sector procurement when he described the incentives in spending other people’s money on other people: ‘Don’t economize and don’t seek highest value’. The extra bill left to the taxpayer is the consequence of bad procurement, of unacceptable concentration risk in choosing one provider for numerous services, of too little focus on value for money. These are all pitfalls of any procurement procedure. A company who gets it wrong faces consequences. Not so for the public servants who contracted Carillion. Their jobs are presumably safe, their organisation immune to the threat of bankruptcy. The Tory government is left taking the blame. Unjustifiably, so is capitalism.

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