What exactly are we paying for? The legacy of privatising utilities
All-round expertise is lacking, but urgently needed to run key public services efficiently
Public utilities in Britain are in crisis. Thames Water teeters on the edge of bankruptcy, while campaigners draw attention to the dismal environmental standards of that and other water companies.
Spiralling energy prices have breached the Bank of England’s inflation targets. The undersupply of social housing has created a rental crisis. Light-touch regulation of financial services, which led to the banking crisis in 2008, is replaced by ever-expanding rule books whose complexity even expanded compliance departments struggle to master.
The Thatcherite revolution, with its emphasis on deregulation and privatisation, is now widely perceived as a failure. Today, widespread demands for more regulation to protect consumers are occasionally punctuated by calls to promote growth by regulating less.
Legislation to create Great British Energy has just received Royal Assent, and we will soon be commuting on Great British Railways. The signature privatisation of the present decade is the disposal of the government’s stake in what is again NatWest Bank, acquired after the newly regulated financial institution failed in 2008.
How did we get here? And where should we go now?
The performance of Britain’s nationalised industries in the pre-Thatcher years had mostly been dismal. Most seriously, the Central Electricity Generating Board failed to deliver the wildly expensive and ambitious plans put forward in the 1960s to supply Britain’s electricity from atomic power, and did not succeed in building an export industry around the technology.
The Treasury’s engagement with nationalised industries became a vain attempt to stop them acting as a black hole for taxpayers’ funds or obstructing the attempted control of inflation. As Ian Byatt, head of the government economic service through the 1980s, and then first director of water regulation, subsequently explained: “The failure to resolve tensions led to inefficiency and poor financial discipline.”
The claim of the reformers was that profit-driven private enterprise was generally more efficient and innovative than institutions managed directly by the central government and administered by civil servants. New regulatory agencies would represent the inescapable public interest in the activities concerned and devise a framework of rules.
Competition between providers was to be encouraged, but if a monopoly continued, as seemed inevitable in industries such as water and electricity distribution — with massive sunk costs in distribution networks — pricing policy would be constrained by regulatory determinations.
Provided they complied with the regulations, shareholder-controlled firms and their managers would be allowed, even encouraged, to make as much money as possible for their financiers and their managers. Privatisation began with the tentative disposal of British Railways hotels to established hoteliers, reached its zenith with the stock exchange flotation of British Telecom and British Gas, and ended in the 1990s with the break-up of British Rail itself.
Privatisation had not been central to the plans that Thatcher’s advisers had framed in opposition. The sale and flotation of state industries reached the Thatcher government agenda because of the large capital requirements of the telecoms sector, most urgently for investment in digital switching. A government determined to keep public expenditure within restrictive borrowing targets was anxious to take this investment off the public balance sheet. The conclusion, reached with some reluctance, was that this could only be done by removing the whole operations of British Telecom, now separated from the Post Office, from government accounts.
And that required the sale of at least half of the equity. Initially, large investment institutions were unenthusiastic about buying a slice of a nationalised industry but then advisers had the idea of appealing to the public at large, and the heavily publicised offer was four times oversubscribed.
Attracted by a small discount, two million people bought at least a few BT shares, many of them becoming shareholders for the first time. Wider share ownership became a professed objective of privatisation, culminating in the “Tell Sid” advertising campaign to promote the stock of British Gas in 1986.
Aspects of this programme were an undoubted success, as anyone who has recently visited what was once a British Rail hotel can testify. Older relatives may recall the British Rail sandwich, without pleasure, and remember the days when there was a long waiting list to become a subscriber (as customers were then called) to the telephone network.
The notion that you could buy your own phone and choose between competing providers was beyond imagination. British Airways became an internationally competitive airline and low-cost competitors made travel affordable to a much wider audience.
A plethora of new regulatory agencies emerged — Ofwat (water), Oftel (telecoms), Ofgas and Offer, subsequently merged into Ofgem (energy), the Financial Services Authority (now the Financial Conduct Authority), and many others. The term Quango (quasi-autonomous non-governmental organisation) was imported from the US to describe this new phenomenon, expressing an ambiguity about status which persists to the present day.
But there is now widespread and well-founded dissatisfaction with the performance of these bodies. The water crisis seems urgent — how can you go bust providing water to the households and businesses of London at high prices while maintaining inadequate environmental safeguards? But Thames Water has so far avoided that fate only with eye-wateringly expensive emergency funding.
The present government looked for fresh wisdom from the not entirely happy experience of financial services. Sir Jon Cunliffe, a former deputy governor of the Bank of England, chaired a commission to review governance of water. Some 93 per cent of respondents to his inquiry judged the performance of the regulatory framework in the industry to have been “poor” or “very poor”.
What is needed, Cunliffe concluded, is greater and more co-ordinated regulation. A new agency should take over the existing powers of Ofwat to determine prices and review investment plans, as well as the Drinking Water Inspectorate’s prescription of water quality standards, the Environment Agency’s restrictions on sewage emissions, and Natural England’s role in the overall management of water resources. The new agency should base its exercise of these multiple powers on cost-benefit analysis.
So this super-regulator will need to employ a team of people with financial skills and economic expertise, environmental and public health expertise, detailed operational knowledge of the mechanics of water supply and wastewater disposal, plus the managerial skills required to integrate these capabilities and review the activities of a large and dispersed workforce. It is an ambitious, admirable objective. No such teams exist today and the creation of them will require its members to acquire a wide range of skills, and hone them through practical experience, a demanding but necessary task.
We do need to establish and train groups of people with that background, and it is obvious what they should be doing: they should form the executive management and board of a water company. The water industry illustrates particularly clearly the need for management to possess a range of professional skills which were inadequately provided when the activity was, historically, the responsibility of municipal water boards or more recently that of a corporation controlled by an international financial institution or consortium.
A privatised water company requires effective accountability to a range of stakeholders — water consumers in households and businesses, homes, streets and businesses relying on the disposal of wastewater, wild swimmers and river users, and a broad population which often derives unseen benefits from water management.
Balancing these legitimate and at times conflicting needs and expectations is the characteristic duty of a corporate board. Most people who work for businesses traditionally recognised that necessity. Yet the neoliberal era ushered in a doctrine that the primary, even the only, purpose of a corporation was to maximise its value for its shareholders. I recall an executive director of a failed bank expressing regret for the events which provoked the 2008 crisis. He observed: “The regulator should have stopped us doing that.” His excuse exemplified the confusion between the functions of the regulator and the functions of the board of the business that is at the heart of our present problems.
There are, of course, people and institutions whose primary interest in corporate activity is the opportunity to enrich themselves. But I am not alone in saying that I do not want these people and institutions supplying my drinking water. Nor do I want them running schools and hospitals or entrusted with my savings.
The idea that such arrangements will work if institutions whose purpose is to maximise the value of their shares are constrained by a sufficiently extensive rule book is implausible and has failed. This invites smart and greedy people to find ways to extract revenue from the business while pushing the limits of the rules. And that is what has happened in water. Financial institutions have taken advantage of the regulations governing the cost of capital and the regulatory asset base to pay themselves large dividends and their executives substantial bonuses, while bills increase and dissatisfaction with performance grows.
Water and sewerage are capital-intensive businesses, but raising capital for them is not very difficult. Investment there is long-term and low risk; the ownership of water pipes represents exactly the kind of activity appropriate for pension saving and other dull but necessary investments. The principal uncertainties of returns relate less to the business than to the future of the regulatory regime.
The need for complex financial engineering is minimal. The expertise of firms like Macquarie, the Australian investment bank, and KKR, one of the US’s most aggressive private equity firms, is not relevant or required, since the major challenges for the management of these industries are technological not financial.
I would like to see London’s water supply in the hands of people whose principal concern is to provide reliable and effective service to the people of London, and for whom the objective of providing exceptional returns to investors on a three-to-five-year timescale is secondary. I look with gratitude to 19th century figures such as Dr John Snow — the first water regulator, who saved thousands from cholera by removing the handle from the water pump in Soho’s Broad Street (now Broadwick Street), and Joseph Bazalgette, who planned and supervised the construction of the embankments, which contain the sewers of London.
It is people like them, with both relevant expertise and a sense of public purpose, we need today. One trained as a doctor, one as an engineer; both exemplified the combination of subject specific knowledge, practical experience acquired through apprenticeship, and adherence to a regulatory code. It is a background which used to be characteristic of the professions we once admired, and sometimes still do.
This essay is not a call for water nationalisation. We know that the state-owned water industry was underinvested and overmanned. Delays and overruns at HS2 and Hinkley Point C serve as potent and continued reminders of the persistence of poor public management.
We need to give institutions providing public utility services the freedom to deploy professional management skills in their operation. The role of regulators should be similar to those that apply in other professional activities — not to duplicate or replace the management of the business, but to ensure that the individuals who occupy senior positions have the relevant abilities and experience (of which financial expertise is a small, if necessary, part). It should be clear policy that egregious failure to serve the public interest leads quickly and inevitably to loss of the operating licence.
We do not need and should not want a still more extensive rule book, nor nationalisation, nor financial restructuring. Instead, we should seek a better model of the structure and governance of public utilities.