17 May 2018

Why public services need the private sector

By John Redwood

Bread and circuses are as much public services as water and healthcare. Listening to the UK debate you would be forgiven for missing this essential truth.

The big issue of what kind of a relationship or partnership we should have between the private sector and the public sector is very much back on the agenda.

The Opposition is now challenging what had been an agreed way of proceeding between Labour, Conservatives and Liberal Democrats in the previous two decades.

Labour seem to think the only true public service is one where all assets are owned by the state and all the employees are employed by the state. They dislike free enterprise. They spend time thinking about how they can tax it more, regulate it to excess and nationalise it where possible.

Any government now in office is going to have to clarify what role it thinks is appropriate for the private sector and to make the case as to why the private sector is involved. It would be very helpful if more people involved in these matters understood just how much the private sector was undertaking already.

There are two conclusions I set out to establish in this essay. The first is everything from bread to water and from circuses to healthcare is a public service, however it may be delivered.

The second is there is always some private sector involvement in the provision of any public service. The policy question is not whether there should be any private sector activity, but how much, and where is the boundary between public and private drawn. The army marches on its stomach, but the food comes from the private sector. Private sector trains run on public sector track to public sector timetables. Patients see private sector GPs and take private sector medical care paid for by their public sector NHS.

The complicated reality of the railways

Let’s take the railways. We hear in the blue corner that everything is fine with the railways as they are. From the red corner we hear that there’s nothing wrong with the railways that nationalisation wouldn’t put right. The public tire of the old battle of “public vs private”, “nationalisation vs privatisation”. Those of us who study it need to explain that the railway is a far more complex operation than that.

The railway today in my view is largely a nationalised industry as normally defined. All the assets involved in the track, signalling and stations and a lot of railway property are in public ownership. Network Rail’s employees have public sector jobs.

The Department for Transport through the Secretary of State for Transport can and does direct Network Rail. He reviews their programmes and their budgets because it is public money going in and public money at risk.

The private sector is the more limited part. It provides the engines and carriages. It runs train services and manages ticket sales, a much smaller portion of the railway than providing the track, signals and stations.

Running trains is a highly regulated activity. It is organised by contractors who have to bid for a contract and win it. Increasingly governments of all persuasions have wished to interfere more and more with what the private contractor can or cannot do. The Government lays down the timetable, the standards of performance, and many details of the service.

Worse still is the dilution of the private enterprise role in bringing private capital into the industry so the cost of providing the trains are not a direct cost to the taxpayer. The private companies are also supposed to bring management expertise to run very good services within this regulated entity over the public sector assets. It is becoming all too common for the private sector contractor to bid too tightly on the contract to get it only a year or two into the contract to decide they cannot make money out of it because the bidding terms were driven too high. Unable to complete their contract they willingly surrender it, leaving the state with the financial liabilities and with the need to take over the business.

This becomes a highly political argument. Those who want a completely nationalised answer say “there you are, private sector involvement was always going to be a waste of time, these people just game it against you. If they get a winning contract they run it, if they get a losing contract they don’t run it”. People who like the free enterprise model say it’s because they’re not actually given any scope because they’re so heavily regulated that they find it very difficult to supply the management expertise and improvement they would like.

The NHS’s public/private partnership

The other big area where there is much misunderstanding about the nature of the service is the NHS. The general view is this is an example of a completely nationalised approach. It isn’t as simple as the soundbites suggest because there is a considerable private sector involvement and delivery within the NHS.

Most GPs, for example, are free enterprise small businesses. This goes back to the original foundation of the health service when the doctors did not want to be part of the nationalised service. The compromise was struck that they would mainly have to be state employees if they wished to be hospital doctors but the very wide-ranging general practice would be kept out of the nationalisation. GPs were to remain free enterprise contractors.

The pills and potions come from profit-making companies. What is interesting in the NHS is this very important part of treatment is all bought in from the private sector. Much of what the NHS does is to buy and administer private sector chemical medicines. Practically all the research that goes into delivering new generations of chemical medicines is carried out by for-profit companies.

Much of the cleaning and catering is contracted out. That started under the Conservatives. The Labour Party came into office and decided to carry on with it. We now have a mixed economy in the health service with local determination. Many hospitals use private sector for profit catering and cleaning companies, whilst others use in-house. If you review it, as some people do, you discover that some private sector catering and cleaning is good and some isn’t so good. You find that some in-house catering and cleaning is very good and some isn’t so good. There are very mixed results. The advantage of the contracting out system is of course you can get rid of the bad more early.

The debate should start by recognising that the NHS is very complicated and uses a lot of private activity. Labour, interestingly, went further than the Conservatives dared go when it came to the question of contracting out. Mr Blair decided all that mattered was the patient experience.  He said the public monopoly was not delivering enough capacity for certain types of operation. The NHS was not doing enough cataract operations quickly enough, not doing enough knee joint operations quickly enough.

The Labour government brought in capacity from private sector hospitals to tackle the shortages. This was contentious with the Left in his party but Mr Blair drove it through. It turned out not to be contentious with most of the patients. They saw nothing wrong with being offered a knee operation six months earlier than they could get it in an NHS hospital in a rather smart private sector hospital when the bill was sent to the NHS rather than themselves.

The second issue is that government needs to clarify its role. The public sector under all parties does use the private sector very extensively. The private sector has all sorts of roles: in general terms it’s a big supplier of goods and services, it also acts quite often as an adviser through consultancies. The NHS is regularly trying to improve its management but it nearly always appoints private sector consultants rather than relying on its own in-house expertise. The private sector is often a financier of public provision one way or another as well as being a direct provider.

What is a public service?

In the UK debate you get the feeling some people think the only things that count as public service are the things that are delivered by the public sector or they think are delivered by the public sector. Everyone agrees the NHS is a public service and quite a lot of people think the railways is a public service. Many don’t think what you buy in Tesco is a public service even though it is your bread and butter.

This is rather curious because to me they are all public services. I think the provision of bread is as important as the provision of water. Is the provision of water a public service in modern terms? It has been privatised but it has many of the characteristics of the traditional public service. It’s still a monopoly with regulated prices.

Those who wish to make a very simple-minded debate about it just recognise two models. So to them a public sector service is a monopoly which employs public sector staff using public sector assets, providing the service free at the point of use. They think that’s how the health service works because they often don’t know GPs are private contractors and they leave aside the issue of the drug supply.

If a public service has to be entirely provided by the public sector the nearest you get to it is the nuclear deterrent and the army. But if you take the army, the army can’t fight without the private sector because it buys all its weapons and a lot of its ideas from the private sector.

At the other end of the spectrum is the much more commonplace model of companies competing to provide goods or services using private sector assets, employing private sector staff and charging the customers. In other words, normal life as we know it delivers most of our public services by using a competitive free enterprise market.

Hybrid services

There are many hybrid types. We need more work and analysis to help inform those who generate public policy and manage public services. Which of these different hybrids might work best? Which elements from them we need to bring together?

I found helpful in trying to work out how many hybrids there were to bear in mind certain polar opposites where government has to make choices. Some of the big choices are: should you charge the person for the service when they acquire it, or should you offer it free at the point of use? This is probably the most important issue from the public’s point of view, because obviously all things being equal the public like free services.

Is the service is going to be provided by a monopoly or is it going to be open to competitive challenge? Is there choice? There are plenty of complexities over that.

There is the issue of ownership. Who puts up the money, who provides the capital, who owns the assets you use to trade? Are they owned in the public sector or the private sector? Who is employed and who is responsible for paying the staff? Are the staff employed by the state or one of its branches and paid directly by the taxpayer or are they paid for by the private sector?

Between those two extreme models that we just looked at, at least eight different types.

There are some cases where there is a public sector monopoly with public sector staff and assets, but they charge the end user the cost and a mark-up.

The BBC is a case in point – it’s a public sector monopoly of a certain kind of broadcasting, using public sector staff and assets. They charge a cost and a mark-up through the specific licence fee you need to pay to use their services. They’ve managed to get into the rubric that if you’re using any kind of media services you need to pay a fee to the BBC regardless of whether you watch them.

There are public sector monopolies that employ private sector staff and assets to provide a free service. A good example of that is domestic refuse collection. In every part of the country domestic refuse is a state monopoly. I have to use the council service and I don’t pay anything extra for it. It’s included within the tax I pay to the local authority. It’s all done by private sector staff using private sector assets because it is a fully contracted-out service.

There are public sector monopolies employing private sector staff and assets charging the end user. This is rarer but it could involve a local monopoly leisure facility for example. The state has put in the leisure facility but it’s contracted out to the private sector to run it and it does charge when we go to it. A toll bridge where there’s no easy substitute where you’ve got to drive 50 miles out of your way if you don’t use it is another example.

There are competitive services provided free by the public sector with choice to the end user, but it’s still using public sector staff and assets. A very good example of this is schools. Schools, particularly in urban areas, compete with each other. My constituents can decide whether they want to send their son or daughter to school A, B or C and they apply for a place. They do not have to pay for that place because it will be taken care of by a combination of national and local taxation. There’s competition over schools but not over their ownership.

There are competitive services provided free by the public sector using private sector staff and assets. The GP service is the obvious prime example.

There are competitive services provided by the public sector but charging the end user and that includes public sector leisure activities, public sector catering facilities and any municipal trading.

There are private sector monopolies, using private sector staff and assets and charging the end user. These are quite rare. A regional domestic water monopoly is a very good example of this. I have to have my water from a stated supplier as do most people around the country. It is an entirely private sector activity and they certainly charge me. It is also of course quite heavily regulated so the quality and quantity of water they supply is regulated and the way they charge is regulated. They mustn’t get to the point where because the person hasn’t paid they cut them off because people clearly need water, particularly if they’re in great financial difficulties.

There are private sector competitive businesses, employing private sector staff and assets that do not charge the end user. The older examples include free newspapers and free-to-air commercial television. This is becoming one of the fastest-growing models because this is where the great American tech companies have decided to pitch their tent. If you take the case of Facebook, why do 2.2bn people use their service? I’m sure it has something to do with what it does for them but I think the main reason is it’s free.

Facebook and others have taken that style of doing business and said “well, we’ll give you all this wonderful free access, but what we’re going to do is we’re going to keep bombarding you with adverts as part of the price to pay. Most people accept that deal.”

I don’t personally use Facebook but if I did I would be quite relaxed about that model. Some of us say if you send me adverts that are relevant to me that’s a bonus. When I go shopping it’s good to know there’s a new product or I can get it cheaper somewhere else. Other people think it’s very intrusive and they say “how did you know I liked chocolate? I don’t want to see another chocolate advert on your Facebook pages”.

This is the new row, a fascinating row – is it an invasion of privacy that Facebook knows quite a lot about you and targets the ads? how far can a business go in targeting the ads? Apparently sending general ads is fine, but targeting political ads is not fine. If they’ve worked out you might be a Republican and they sendyou a pro-Trump ad then many throw up their hands in horror and decide this is a step too far. Then paying for a free service becomes an invasion of privacy. These are going to be very interesting battles.

This is very much a public service. The Facebooks of this world are going to find they can no longer claim to be cheeky chappy challengers who don’t play by the rules. They are going to get a whole load of rules thrown at them about content and what is fair practice on adverts. They may even be required to pay a bit more tax, although they still seem to be well ahead of the tax authorities. The larger they become the more heavily regulated they will be. This is an incredibly popular business model, even after all the rows. The advertising revenues for Facebook are growing at 50 per cent per annum at the moment and it’s already a corporation with something like £50bn of accumulated cash, so it’s done very well.

So what is privatisation?

When I designed some models for privatisation and took them to Margaret Thatcher in the 1970s, I was always conscious that there were at least two very important elements to a successful privatisation.

The most obvious is the transfer of assets and the risk from the public sector to the private sector. When the public sector owns a water company, the public sector is responsible for putting all the capital in. It’s responsible to all the customers if something goes wrong. When it’s had enough of all this risk, or doesn’t have enough money to modernise this water business, it can transfer it to private shareholders. They take the risk and put up the capital allowed under a regulated pricing system to make a reasonable return so that it’s worth their while doing so. That’s how a lot of people see privatisation.

In government, I very rapidly came to the conclusion that far more important was the introduction of competition into monopolies. We had a mighty battle in the 80s over British Telecom. It was the first really big privatisation Margaret Thatcher was persuaded to do and when I persuaded her to do. When I persuaded her to do it I had two main battles to fight on her behalf.

The first was with the City who thought it was too big to sell. So I found a way of avoiding dependence on them by direct mail share selling and by selling to foreigners. As soon as they realised they didn’t have a monopoly on the new shares they started to cooperate, as they often do.

The bigger problem I had was with the Treasury, because the Treasury saw the opportunity to make a lot of money for the state. In order to do so they wanted to sell the monopoly. By definition, a monopoly ought to be able to make more money because it has complete pricing power subject to regulation and doesn’t have pesky competitors trying to take its profits away.

I wanted competition because I wanted improvement in the service. The most obvious way of getting improvement is to introduce competitive challenge. A compromise was reached between the PM and her Chancellor where we were allowed to have one licensed competitor to BT when we went ahead with the privatisation. They set up a business called Mercury which only competed on the long line and business services.

That was very important because we wouldn’t have the City of London we have today without the privatisation of BT. The public monopoly was quite incapable of supplying enough lines for capacity for the City. The Mercury challenger cracked that problem and enabled the City to expand very quickly as a result.

Later we did the second phase and opened it up to much wider competition. As a result, we now have world standard telecoms, competitive and providing much more capacity at a cheaper price.

In order to quality as a privatisation in British government definitions there has to be a genuine and substantial transfer of risk from public to private. The private sector will often try to do is gain access to the good bits of owning the asset as they want the upside, but try and shuffle off as much of the downside as possible. It’s usually best to say “No, you take all the risks”. There may be occasions when the risk is too big for them to take. For example when you’re privatising the electricity industry you may indeed need to say something about long-term nuclear decommissioning liabilities because they may become very large indeed. There may be things the state has incurred which the state has to keep a stake in resolving in due course.

There’s usually money passing from private to public when they buy the assets. That’s often the main motivation of government, particularly under IMF reform programmes, to bring in cash by selling assets. You can have privatisations that work very well going the other way.

There are some assets that are so badly used and so heavily loss-making in the public sector that it makes sense to give them away with a dowry as long as you have got rid of all the liabilities. Some of those sales can be very successful, leading to a private sector led turnaround of the business.

Raising capital

One of the often correct observations about privatisation is that the capital provided by the private sector will normally be dearer than that provided by the government itself. Particularly in an age of quantitative easing where prime rates have been taken down to somewhere near 0 per cent and long rates have been taken down to vanishingly low levels, it is clearly going to be cheaper if the Government simply says “we’re going to borrow the money”.

However, it is often better and cheaper for someone in the private sector to borrow the money at a dearer rate. The private sector may well have better capital discipline. The UK government until recently has had a very bad record of controlling capital costs on big projects. They often end up two or three times the initial budgeted level. If you try doing that in the private sector you would go bankrupt. So on the whole they tend not to do that.

The private sector may be better at creating a high-wage, high-productivity environment, so they employ fewer people which can be better value as well as better for people working for higher wages. If a mistake is made in the investment then the private sector shareholders pay out rather than the taxpayer, so that’s obviously a way it can be a lot cheaper for taxpayers if something does go wrong. The private sector may take on a not very profitable public sector activity but it finds ways of levering and harnessing it to other activities which do make a rather better return.

The fruits of privatisation

What happened as a result of the major privatisations in the 80s and 90s? The railways had been in continuous decline from nationalisation shortly after the Second World War, with users turning to cars and trucks and away from the trains. There was a reversal in this trend following privatisation. Even John Prescott, coming in as Secretary of State in his early days after the Conservative action, was full of praise for the way the privatised railways were growing their business. More and more passengers and more freight were added each year in a way it hadn’t been able to do in the nationalised years up to the early 1980s.

There were a couple of bad accidents. The accident record of the privatised industry was not worse than under the nationalised railways. There have been bad accidents under nationalisation as well, but nobody likes bad accidents. Labour used them as an excuse to renationalise the bulk of the railway forming Railtrack into Network Rail.

The electricity industry in its early days as a privatised industry was extremely successful. It switched substantially from coal-generated to gas power and raised its fuel efficiency as a result. That made a huge difference to pricing and efficiency and meant we had a very good carbon gain as well. Coal is worse environmentally as well as being dearer because of the low efficiency of the system, so it did change their behaviour very dramatically.

More recently it’s become extremely heavily-regulated, not just by Labour, but also by the Coalition government. The current Conservative government is trying to make it a bit more complicated again with some kind of price cap. As a result we have lost that early competitive thrust which delivered more and cheaper power. We now have scarce and dearer power as a result of the advent of so much regulation.

Telecoms was completely transformed in the way I have described. It demonstrates the favourable impact of competition on technology, efficiency, choice and costs.

The water industry undertook a lot of investment. It spent more than it was able to do in the public sector once privatised. The efficiency gains were quite limited because there was no competition. Proper competition in the residential sector as well as the competition now grudgingly introduced in the business sector would make quite a big difference.

When they did introduce competition into the business sector in Scotland, people went back to the businesses and asked them what they thought about it. They said there hadn’t been a lot of change in pricing, but they really liked the flexibility over quality and specification of water they gained. With a monopoly, they had to have one kind of water with the additives that the water company put in to make it completely safe for tap drinking. If you’re making soft drinks you do not want that. You don’t need the additives. They often have to take the additives out so they’re very grateful to have additive-free water, for example. Some industrial processes didn’t need clean water, they just wanted reliable water, so they were able to get more of the specification they wanted.

Infrastructure Investment

The related debate is about private infrastructure. There’s widespread agreement that more private infrastructure is a good idea as you get a free lunch from the government point of view. In telecoms most people accept this is now going to be more or less entirely privately financed. There’s a lot of extra infrastructure going in with fibre-optic cables to provide the broadband capacity we need to have a properly wired modern economy.

On the Conservative side there’s an agreement in principle you could have a new road with road pricing. The relief motorway around Birmingham and the Dartford crossing were both put in by private capital remunerated by a toll. This approach is not going anywhere because we don’t have a free competitive system. It’s extremely difficult finding a route because of environmental and planning issues to actually develop a new for-profit motorway as an alternative to the free routes already out there. The investors in the north of Birmingham route are struggling because they are up against a free competitor. Because the Dartford crossing was effectively a monopoly, the private sector was rewarded up to the maximum permitted very quickly. The asset was then returned free to the state. That turned out to be quite a good model from the state’s point of view.

In railways you could have a return to private investment but you have to solve the problem of the lack of investment return and the constant fascination of politicians to intervene and tell you how to run your business, which puts off quite a lot of normal people.

There is insufficient investment in energy at the moment in the UK owing to a lack of regulatory clarity and consistency. To encourage investors is a 25-50 year asset you want to know what the pricing and tax structure is going to be over the whole 25-50 years. Successive governments have had a habit of constantly changing the rules after the investment has been made which doesn’t make for happy investors.

That’s part of the reason why we haven’t had very much private infrastructure when they say they want to invest. Other reasons include the slow pace of planning and licence granting for large projects, uncertainty over what an infrastructure investment looks like to the providers of capital and arguments over how much risk the private sector can and should take.

What other forms of partnership make sense? In the case of capital provision design build, operate schemes are now quite popular for all comers. Both political parties have used them. Contracted out services remain a core to introducing private enterprise into public provision. Provision of specialist services by the private sector for the public is becoming more and more popular

The public sector doesn’t do digital well. As we go through the digital revolution it relies more and more on digital companies, digital consultants, private telecoms provision in order to modernise public services. Public services on the whole are behind private services in adopting the digital revolution. Digital is a Trojan Horse for the private sector, which is something Mr Corbyn has to worry about.

The private sector will continue to supply many of the goods and services the public sector needs. How far should that go? In the case of medicine it goes a very long way. It includes research and development, manufacture and supply. There are various levels of supply. One of the things the public sector has to get better at is using just in time and modern management systems.

The public sector has so much need for processing capacity, for data storage, for data processing and data use. This nearly all comes from the private sector.

The government is edging towards what it calls “one government” where you tell them about something in one part of the government and the rest of government will automatically know. In some ways that’s very helpful, in other ways it’s rather scary.

It’s very important for one to always tell the truth because they can swap stories around the different departments. You need to tell the same thing to the revenue, to the benefit department and the council. You have to make sure you live where you say you live because all this data they hold about you in order to tax your home and your work and your purchasing is going to be coordinated. They will build up a very intimate picture of how you live your lives and how you run your finances and they will need a lot of support from the private sector over this whole data area.


The flora and fauna of public service are very varied. Government and council led services use the private sector to supply them goods and services, to act as contractors and sub-contractors, to provide capital, staff and risk sharing.

Public services should include the many services like bread and circuses that are entirely private sector activities, as well as services like the NHS and the railways which are organised, regulated and part owned by the state.

There are many hybrid systems between the competition free enterprise model of the bread supply and the monopoly state run model of the army. We need first to understand the complex interaction of public and private in a service like the railway before we can debate nationalisation.

Services provided free to the user will always be popular with many, but we need to understand who is paying for them. Competition and choice are the best ways of raising standards, keeping costs under control and powering innovation. Public and private monopolies tend to exploit customers and disappoint on innovation, service quality and cost.

This is an edited version of a lecture given by John Redwood at All Souls’ College, Oxford on April 27. 

John Redwood is the Conservative Member of Parliament for Wokingham.