Since the 1980s, a mindset of aversion to risk has filled civil servants with the fear of doing anything more than facilitating the private sector. Risktaking is not supposed to be part of their job description. Indeed, we often hear that government does not know how to invest and should never use its resources to set a direction for change, let alone dare to ‘pick winners’.
Although the governments of many countries have spent staggering amounts to keep their economies on life support during both the financial crisis and, more recently, the health pandemic, the neo-liberal economics which took hold in the Thatcher–Reagan era continue heavily to influence thinking, which still portrays governments as clunky, bureaucratic machines that suppress the animal spirits of the wealth-creating private sector – no matter how much the latter are bailed out crisis after crisis. These problematic theories about government lead to problematic practices that, for a variety of reasons, get in the way of a mission-oriented approach. Indeed, they put governments in the position of picking up the mess –whether through bailouts or redistributional policies – instead of shaping our economies to create wealth differently so our societies are more resilient, inclusive and sustainable in the first place.
This link between theory and practice is exactly what the great economist John Maynard Keynes meant when he said: ‘Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.’1 Below, I debunk five of the most common myths about government and explain why they’re problematic for a mission-oriented approach to changing capitalism.
Myth 1: Businesses create value and take risks: governments only de-risk and facilitate
A fundamental assumption in common perception – but also nested deep in economic theory – is that value is uniquely created inside business. Government’s job is to set the rules of the game, regulate, redistribute and fix market failures. Even central banks are seen in conventional theory as simply ‘lenders of last resort’, despite the fact that they prevented the entire financial system from falling apart after the 2008 financial crisis. The result is that, in many areas, public institutions have lost the confidence to act. Even more important, they have lost the capability to act. If the public sector is not seen as a value creator, then it does not need to invest in its own capabilities, including strategic management, decision science and organizational behaviour – though even universities (not always considered models of efficiency) teach these subjects to managers. Indeed, rather than finding ways to work actively with business on public problems, the public sector has ended up frequently privatizing undertakings and outsourcing public contracts, hoping to save public money in the often mistaken belief that the private sector is more efficient, when in reality its aim is profit. Far from achieving its aims, this ideology of privatization and outsourcing has led to high costs, poor service, capture of government contracts by a small number of firms, and contracts that often leave taxpayers with risks they thought had been transferred to private firms, as discussed below in Myth 4, and that socialize risks while privatizing rewards.
The other side of that ideological coin is the belief that only business creates value. Here, risk-taking entrepreneurs, driven by the motive of profit, deserve a special place in society because only they, in the end, generate the tax revenues on which government depends, push innovation forward and create jobs. But the truth is not that simple. How private firms create value has been analysed extensively in the field of microeconomics, and its equivalent in business literature. There is no question that businesses create value and need to make profits, and should be free to do so. The issue is understanding how this occurs. Economics talks about the ‘production function’. It explains how value is created within the firm (the microeconomic theory of value) by combining capital (tangible, such as machinery, and intangible, such as knowledge) with labour and technology.2 In business studies, value is understood as being created inside the company by bringing together managerial expertise, strategic thinking and a dynamic (changing with circumstances) division of labour between workers.3
All this ignores the massive role of government in creating value, and taking risk in the process. In The Entrepreneurial State I argued that Silicon Valley itself is an outcome of such high-risk investments by the state, willing to take risks in the early stages of development of high-risk technologies which the private sector usually shies away from.4 This is the case with the investments that led to the internet, where a critical role was played by DARPA, the Defence Advanced Research Projects Agency inside the US Department of Defense – and also by CERN in Europe with its invention of the World Wide Web. Indeed, not only the internet but nearly every other technology that makes our smart products smart was funded by public actors, such as GPS (funded by the US Navy), Siri (also funded by DARPA) and touch-screen display (funded initially by the CIA). It is also true of the high-risk, early-stage investments made in the pharmaceutical industry by public actors like the National Institutes of Health (NIH) –without which most blockbuster drugs would not have been developed. And the renewable energy industry has been greatly aided by investments made by public banks like the European Investment Bank or the KfW in Germany, with private finance often too risk-averse and focused on shortterm returns.5 On the demand side, it required organizations such as the Small Business Innovation Research Programme (SBIR), housed in the US Department of Commerce, to create markets for small and medium-sized enterprises (SMEs) by designing procurement policy so it is focused on helping SMEs provide goods and services via department budgets (about 3 per cent of the budget).
Globally, the actions of public agencies across the entire innovation chain have also been crucial, allowing innovation powerhouses to emerge: in Taiwan, the role of the Industrial Technology Research Institute; in Israel, that of the Office of the Chief Scientist; in Japan, the Ministry of International Trade and Industry; and in Singapore, the Agency for Science, Technology and Research.6 The Republic of Korea has been especially successful in developing electronics. It first made its entrance into the semiconductor industry in the 1970s, when it attracted US companies looking for cheap assembling facilities, and spent the following decade implementing widespread industrial policy measures that included supporting business groups capable of mass production and exporting consumer electronics. This led to the launch of the first commercial dynamic RAM product in 1984.7
In all of these cases, without ambitious public investment the private sector would have proved unwilling to invest in areas where the required funding was large, long-term and highly uncertain. Only after the risk had been absorbed by the public sector did private businesses take advantage of the new opportunities created by the innovation. Thus, the empirical evidence paints a very different picture from the theory based on highly dubious assumptions.
Myth 2: The purpose of government is to fix market failures
By ignoring the possibility that government can contribute to value creation, economic theory also assumes that markets can only be fixed, not created, by government policy. Markets may fail due to information asymmetries (such as when buyers and sellers do not have the same information), or positive externalities (such as funding public goods, basic research or public health) or negative externalities (such as pollution). In the case of the latter, government needs to step in with a policy such as a carbon tax – ‘make the polluter pay’. In addition, government can also redistribute value, or wealth, through taxation. In macroeconomics (the study of the economy as a whole), the theory of taxation is central to understanding redistribution of value and focuses public action on making existing systems more efficient rather than transforming them.
Market failure theory (MFT) – the idea that public policy can at best fix market failures – has its origins in neoclassical ‘welfare economics’, the study of how economic decisions produce the well-being of society at large. MFT’s starting point is the so-called first fundamental theorem (FFT) of welfare economics.8 The theorem states that markets are the most efficient allocators of resources under three specific conditions: one, there is a complete set of markets, so that all goods and services supplied and demanded are traded at publicly known prices; two, all consumers and producers behave competitively; and three, an equilibrium exists (the forces of change in opposing directions are balanced – for example, the demand for bananas exactly matches the supply at a given price). Under these three conditions, the allocation of resources by markets is optimal in the way described by the economist Vilfredo Pareto: no other allocation will make a consumer or producer better off without making someone else worse off. Government, therefore, has no role at all in value creation.
According to MFT, violation of any of the three assumptions leads to inefficient allocation of resources by markets – market failures. If markets are not Pareto-efficient, then everyone could be made better off by public policies that correct the market failure. MFT suggests that governments intervene when the market fails due to positive externalities, negative externalities and information asymmetries. Sometimes, government can do things that are in the interests of the whole community: for example, it can provide mass vaccination to control polio, or free education for all. This public good is a positive externality. But according to MFT, to justify such an action government must provide what the private sector does not or cannot. In the case of negative externalities, government must devise market mechanisms to internalize external costs.
In addition to all this, in the 1960s and 1970s a new theory emerged in advanced economies which cast doubt on any government market-fixing and effectively argued for an even more limited government role: that government failure is even more dangerous than market failure. It was called public choice theory and it attempted to apply neoclassical welfare economics to political decision-making. Public choice theory looks at how the actions of agents (voters, bureaucrats, politicians) involved in policy could be considered from an economic-efficiency perspective. It assumes that agents, including government ones, are self-interested in the same way that private-market actors are assumed to be in neoclassical theory.9 While in markets competition and the profit motive tend to enforce efficient choices, in collective decision-making processes in politics and public administration, according to public choice theory, the same discipline is absent. Policymaking is therefore considered to be subject to capture by interest groups, in particular those most able to influence policymakers because they have power or money. Capture might involve nepotism, cronyism, corruption, rent-seeking (making excessive profits, as from a winning a monopoly), misallocation of resources (backing ailing companies or ‘picking losers’) or unfair and damaging competition with private initiatives (crowding out). Capture by special interests is all the more possible, it is argued, because collective action by voters tends to be weak. Rational voters have little reason to take an interest in political decisions since most of these have only a tiny impact on their lives. In public administration, the lack of competitive pressures leads to ‘bureaumaximizing’ behaviour, whereby departments and agencies look after their own survival rather than the ‘common good’.
If that is true, government intervention will not necessarily result in a more efficient outcome even where market failure is clear. Rather, there could also be ‘government failure’. For example, decisions aimed at improving welfare could make things even worse than they would have been under market failure.10 By this approach, market failure is a necessary but not sufficient condition for governmental intervention; it is sufficient only if the gains from intervention outweigh the losses from government failure.11 From this perspective, there is a trade-off between two inefficient outcomes – one generated by free markets (market failure) and the other by government intervention (government failure). Some economists suggest the solution lies in correcting failures such as imperfect information.12 Others, especially public-choice advocates, argue for leaving resource allocation to markets (which may be able to correct their failures on their own), or the creation of market-type discipline within public agencies.13
But just as MFT is a theoretical construct, so is its alter ego, public choice theory. The axiom underlying public choice theory is that bureaucrats and politicians behave like free-market actors: they rationally seek to maximize their ‘utility’. Self-interested bureaucrats and politicians are effectively entrepreneurs who compete to gain control of a monopoly, the state.14 But, rather as with MFT, no empirical evidence was advanced to support this idea. It was just assumed that social, constitutional and ethical concerns never motivated bureaucrats and politicians. And it was assumed that the public and private sectors were competitors and one side or the other could be a loser.
That is why, if government dares to do anything ambitious, it risks being accused of crowding out private investment. Government investment in a sector, say aircraft-building as with Airbus, the European aerospace company, is assumed to be likely to rob the private sector of profitable opportunities. But the charge assumes a static view of investment possibilities – that there are only a given number of possibilities at any one time – as well as that the public and private sectors are competitors rather than partners. Lurking deeper is the familiar conviction that only the private sector creates value and – by extension – that government investment may destroy it.
In reality, the whole idea of governments crowding out the private sector is usually false. Government investment often has the opposite effect. When structured strategically it can crowd in private investment, stimulating funding that might not have happened otherwise and expanding national output, which benefits public and private investors alike. Public investment in Apollo inspired rapid advances in computing and digital technology through contracts with the private sector. Relatively small government stakes in Airbus have helped build the world’s biggest aircraft company, with operations and suppliers across Europe. The history of technological breakthroughs shows that public investment, particularly when made early in the innovation process, absorbs major uncertainties and long-term risks that private investors can be reluctant to take on. Indeed, public investment in the early, high-risk stage of areas like nanotechnology, biotechnology and green technology were critical to the later proliferation of small start-ups, some of which later scaled up. An alternative theory must thus be based on market shaping and market co-creation, a concept we return to in Chapter 6.
Myth 3: Government needs to run like a business
The conviction that government should simply administer without risktaking runs deep. We’re told that government should not transgress beyond ensuring a level playing field in the economy (such as by preventing monopolies), maintaining law and order and regulating where necessary (for example in food safety). The assumption is that not only should the public sector emulate private-sector disciplines, but it ought also to slough off significant slices of activity traditionally held in the public domain to the private sector, such as public transport and public health. This is to avoid the sort of failures that public choice theorists believe they had identified, for example swollen bureaucracies inefficiently running services such as public-health laboratories or stifling competition by controlling electricity prices.
In business schools, mainly in the USA, public choice theory influenced the development of New Public Management (NPM), which gathered momentum in the 1980s. Several strategies were high on the NPM list. One was to introduce some equivalent of the profit motive into the public sector to improve performance – for instance, efficiency targets. An example of this kind of thinking was UK legislation in 1990 to create an internal market in the National Health Service, under which the government became a purchaser instead of a provider of health services and external suppliers could bid against NHS ones.
Another strategy has been contracting out, franchising or privatizing government services. The purpose here is to address the principal–agent problem: citizens (the principals) cannot hold public-sector employees (their agents) accountable in the way shareholders can the managers of a corporation – in theory at least. Citizens’ main sanction in a democratic society is voting, which is intermittent, might have only an indirect effect on bureaucrats and is a poor substitute for the discipline of the profit motive. Because the latter and accountability are held to be weaker in the public sector than in the private sector, the public sector is likely to be less efficient. And there is the idea – which will be a major theme of this book –that government should limit itself to technical efforts to counter market failure and enhance public-sector efficiency by introducing market discipline.15
NPM policies were widely implemented in advanced economies in the 1980s and 1990s, in particular in the UK, New Zealand and Australia.16 By the mid 1990s, however, concerns were growing about the effectiveness of NPM. Deregulation, shareholder value and new government practices, such as setting up arm’s-length agencies and outsourcing, were not always working as well as the theory said they should. For instance, deregulation was encouraging highly risky behaviour, as with the banks; shareholder value was enriching executives at the expense of long-term investment; and outsourcing was leading to loss of public control over the quality of services and products.
Trying to run public institutions as though they were businesses has had severe consequences. Hospital patients have discovered they are ‘clients’; students and passengers are ‘customers’. Static metrics of efficiency have been introduced into evaluation exercises. These involve value-for-money calculations and cost–benefit analysis (CBA), concerned with allocative or distributive efficiency which parallels economic production to satisfy consumer preferences with the most efficient combination of resources. CBA involves making the best use of fixed resources at a fixed point in time, calculated by using existing market prices. Yet ambitious projects such as going to the moon or setting up the welfare state involved fundamental uncertainty and feedback loops across many different sectors. Feedback loops occur when a system’s output amplifies the system (positive feedback) or hinders the system (negative feedback). Fundamental uncertainty and feedback loops are hard to capture with static metrics such as CBA. One example is the enormous difficulty UK governments have experienced in reliably estimating the cost of offshore wind-generated electricity as little as six months in advance, let alone the twenty-five years which would be a typical planning horizon for energy ventures of this sort. In general, cost estimates have tended to be too high, which is a major failing when set against the certainty of climate change and the pressing need to de- carbonize energy production as much as possible.
Myth 4: Outsourcing saves taxpayer money and lowers risk
Starting in the 1970s, the key idea of NPM – that government’s attempts to make things better for people could actually make them worse – firmly gripped politicians, businesspeople and bureaucrats themselves, first in the USA and later elsewhere. Many citizens, whether defined as consumers or users, came to regard government as inefficient and state-owned enterprises as a prime example of government’s shortcomings. The impetus was to try to make the public sector as ‘efficient’ as the private sector. Hence NPM led to proposals to a) privatize publicly owned companies; b) decentralize and/or break up big public organizations; and c) introduce metrics such as performance pay. One way to reduce the risk of government ‘doing harm’ was to outsource and privatize public services. In theory, outsourcing and privatization would ameliorate the principal–agent problem in the relationship between government and citizens, save money and improve services. The practice turned out to be quite different.
The theory took strong hold, especially in the UK from Prime Minister Margaret Thatcher’s first Conservative government in 1979 through to the 1990s and 2000s under New Labour. Its practice took three forms: privatization, public–private ventures and outsourcing. Paradoxically, what was presented as a market-oriented strategy was accompanied by centralization of the state machine, for example by weakening the powers of local government over housing. Many state-owned enterprises in gas, electricity, water, railways, telecommunications and so on were privatized –sometimes with perverse results. While domestic nationalized industries were being abolished, ironically it seemed acceptable that foreign nationalized industries could take over running the same enterprises: today, Électricité de France (EDF) supplies gas and electricity in the UK; MTR, majority-owned by the government of Hong Kong and operator of the Hong Kong metro, is part of a consortium which runs Crossrail, London’s huge underground railway development; Abellio, wholly owned by the Dutch national rail operator, runs bus and rail services around the UK. Between 1980 and 1996 the UK accounted for 40 per cent of the total value of all assets privatized across the OECD.17 Encouraged by multilateral institutions such as the World Bank and International Monetary Fund (the ‘Washington consensus’), developing countries also privatized their state-owned enterprises. At the same time, the Private Finance Initiative (PFI) favoured by New Labour sought to establish government partnerships with private companies to build and run public assets such as hospitals, schools, prisons and defence facilities.
NPM naturally argued for smaller government and conventional management of the public finances including, in some versions of the theory, a balanced budget. The government ought to spend no more than its revenues over a given budgetary period, avoid borrowing that increased the national debt and preferably reduce the national debt. This was the underlying ideology of Thatcherism, if not always its practice. After eighteen years out of office, New Labour was anxious not to frighten the fiscal horses and risk being accused of financial irresponsibility. Instead of borrowing at the cheap rates government could command to upgrade hospitals, schools, roads and so on, New Labour adopted PFI so that private companies would finance these undertakings and the government would repay them over the coming years.
In total, there have been over 700 projects financed through PFI in the UK since 1998, with a capital value of around £60 billion. Under the current payment arrangements, these will cost the public purse a cumulative total of nearly £310 billion by 2047–8 – more than five times the original capital outlay. The UK’s National Audit Office estimates that the cost of a PFI project is typically around 40 per cent higher than an identical project financed by government borrowing.18 Many public services were also outsourced. While PFI was largely about building and running infrastructure, outsourcing was mainly about handing services over to the private sector to manage, notably IT. HMRC (Her Majesty’s Revenue and Customs), DVLA (the Driver and Vehicle Licensing Agency), the NHS and local authorities awarded enormous IT contracts to external suppliers. Public services, including rubbish collection, school meals, building maintenance, prisons and even ambulance and probation services, were placed in the hands of private providers, often by local authorities: at its peak in 2012–13, the value of outsourcing contracts awarded by the latter reached £708 million.19
Since then, however, the value of local-government outsourced contracts has steadily fallen. The trend is similar for central-government IT outsourcing. Public organizations have increasingly found that outsourcing has not delivered the quality and reliability of services they had expected and has often not been good value for money either. In 2011, for example, the UK government basically gave up on an IT system for patient records in the National Health Service after spending almost £10 billion on it. The causes of the failure were complex, but a decade after the project’s inception in 2002 the private contractor had still not delivered the software. A member of the House of Commons Public Accounts Committee, which reported on the saga, described it as ‘one of the worst and most expensive contracting fiascos in the history of the public sector’.20 In 2016, the DVLA ended two decades of outsourcing its IT, took it back in house and trained its staff, who built a new online application in just seven weeks. The spectacular collapse in 2018 of Carillion, one of the UK’s biggest suppliers of outsourced services to government, showed how exposed the government had become to private-sector failure. It also underlined the flaw in NPM theory that assumed public-sector failures were likely to be more serious than private-sector ones. It was the biggest corporate fiasco the Official Receiver (a civil servant and an officer of the court who helps to administer insolvencies) had ever dealt with. Carillion collapsed under the weight of a £7 billion debt mountain, compared with its annual sales of £5.2 billion. According to a report by the Institute for Government, a British think tank, more than 2,000 people (out of a workforce of 18,000) were made redundant and 30,000 suppliers, subcontractors and short-term creditors were owed £2 billion – illustrating how hard it is for government to hold private contractors accountable when supply chains are so long.21 Another 75,000 people in the supply chain were affected and 450 projects were disrupted, including building hospitals and railways, providing school meals and maintaining prisons and homes for the armed services, often leading to long delays in completion and higher costs.22
A report by the National Audit Office found that the collapse had put back the completion of the Royal Liverpool University Hospital, a PFI project, until at least 2022, five years behind schedule, and would cost more than £1 billion to build and run compared with the original estimate of £746 million, partly because of serious construction faults under Carillion. The Department of Health and Social Care paid £42 million to end contracts with PFI investors in the project. Another major PFI project, the Midland Metropolitan Hospital in Birmingham, was due to open in 2022, four years late, at a cost of £988 million, some £300 million over budget.23 Carillion’s failure led to accusations by BlackRock, the giant fund manager that was one of the company’s investors, that the company thought about ‘how to remunerate executives rather than actually what was going on in the business’.24 The Institute for Government said the government had created a ‘corporate monster’ with ‘low-margin, high-risk’ projects – an endemic weakness of the outsourcing model of procurement, particularly for long-term contracts, where contractors are tempted to underbid to increase market share and hope they can increase their margins as the project progresses. It accepted that the government had tried to improve training for civil servants and reformed outsourcing procedures, but said that many departments were still not following best practices and the government was signing risky projects which could collapse in the future, a reference both to Carillion’s undercharging and pressure on civil servants to award contracts to the lowest bidder. A combination of weakened publicsector capacity and private-sector ineptitude partly caused by managerial capture of the company (an outcome advocates of shareholder value did not anticipate) had proved disastrous.
In the 1990s and early 2000s, the USA also went in for outsourcing in a big way. In 2006–8 there were nearly four times as many federal contract workers as federal employees (7.6 million compared with 2 million). But by 2015 the ratio had fallen to 2:1, with 3.7 million federal contract workers compared with 2 million federal employees. The federal government spent an estimated $300 billion on private contractors in 2003–4 and $500 billion in 2012.25 In 2017, a Government Accountability Office report stated that federal contractor expenditures were $438 billion for the fiscal year 2015 – nearly 40 per cent of the government’s discretionary spending. In civilian agencies, a whopping 80 per cent of contractor expenditures were for services. The largest category was for ‘professional supported services’, and the report noted that ‘contractors performing these types of services are at a heightened risk of performing inherently governmental work.’26 Translation: work that should largely belong to government workers is going to contractors – as it has in the UK.
Since NPM is supposed to be about efficiency, you would hope that this at least saved the taxpayer money. It seems not. A study by the Project on Government Oversight, an independent watchdog in the USA, shows that the federal government approves service-contract billing rates – deemed fair and reasonable – that pay contractors 1.83 times more than the government pays federal employees in total compensation, and more than twice the total compensation paid in the private sector for comparable services. One study found that, in the UK, reported public administration costs had risen by 40 per cent in real terms between 1985 and 2015. Over the same period, the civil service was cut by a third and public spending doubled. Outsourced operations saw their costs rise the fastest. The numbers of service failures, complaints and judicial challenges also rocketed.27 Similar problems afflicted privatized industries too and would not surprise, for example, many UK rail travellers. It is true that British Rail, the old stateowned undertaking, was a byword for poor service (though not always for poor engineering). But a quarter of a century after a complex public–private arrangement replaced full state ownership of the railways, fares have tended to rise faster than wages and inflation, the fare structure is complicated and poor service such as unpunctuality frustrates passengers.28 In the year to June 2019, only 64.7 per cent of trains arrived at their stations on time.29
Meanwhile, the amount of public subsidy to the sector has more than doubled since privatization, meaning that the profits made by the private operators are ultimately underwritten by the taxpayer.30 In March 2020, as passenger numbers collapsed under the impact of COVID-19, the government temporarily suspended all rail franchises and replaced them with management contracts, effectively renationalizing the railways, at least for the duration of the health crisis.31 Like US taxpayers, UK rail customers can be forgiven for wondering whether surrendering services to the private sector has brought good value for money.
Big consultancy firms have been among the biggest winners from outsourcing. Although contracts with firms such as McKinsey, one of the best-known names in the consultancy business, involve millions of taxpayers’ money, details can be hard to pin down. But there are some tantalizing glimpses. When the UK began to exit the EU, the Big Four consultancy firms (Deloitte, Ernst & Young, KPMG and PwC) saw their profits rise by 20 per cent. Government spending on these companies rose from £77 million to £464 million32 between 2018 and 2019 – which is ironic, given that Brexit was meant to save the state money. One could argue that this was just to manage the transition or the setting-up of a project, but the trend has been towards an addiction to consulting companies to manage basic operations. There have been two reasons for this. One is the erosion of internal capacities, due partly to budget cuts and partly to lower ambition for government’s role. The other reason is the fear of failure.
Early in 2020, the Financial Times reported: According to a National Audit Office report in 2016, the government is spending more on consultants despite them costing twice as much as civil servants. It found a total of 47 temporary staff were on a daily rate of more than £1,000, compared with 30 senior civil servants with comparable pay. Nor is value for money assured. A University of Bristol study published last year concluded that English NHS acute care hospital trusts became less efficient even as they spent more on outside experts. Despite the best efforts of the NAO and other analysts, however, it can be hard to piece together the full picture. Joshua Pritchard, outsourcing and procurement lead at the Reform think tank, says: ‘Without greater transparency in government contracting, it is impossible to examine the total amount spent, the additional benefits being delivered, or whether departments have guaranteed value for money in these deals.’33 Such concerns have only been amplified by a string of controversies involving top consultancy firms in recent years. Insiders have lambasted McKinsey’s recent restructuring of US security agencies, including the CIA and the National Securities Agency, for hampering key decision-making processes and ultimately increasing organizational inefficiencies.34 McKinsey won its multi-million-dollar contracts without competitive bidding. Ostensibly this was to accelerate project timelines; in reality, it removed from outsourcing procedures the most basic checks for quality control and accountability.
Such ‘no-bid’ contracts have increased in use over recent years, and alongside poorly drafted contracts and inefficient performance monitoring have entrenched unsatisfactory outcomes.35 A quantitative analysis of 120 NHS hospital trusts in the UK between 2010 and 2014 found that spending more on management consultants led to a significant rise in inefficiencies and was linked to no improvement in patient outcomes.36 Over the same time period, NHS expenditure on consultants almost doubled from £313 million to £640 million.37 A UK parliamentary inquiry into the spectacularly failed contract between UK Trade and Investment (a government department to help UK businesses with overseas trade, replaced in 2016 by the Department for International Trade) and PA Consulting, a UK management consultancy, highlighted that the outsourcing firm had taken advantage of the government’s lack of expertise in securing good-value deals on behalf of taxpayers – a fact it emphasized was a ‘regular cause for concern’.38
A telling instance of the reduction of government capability is that in 1970 the public sector employed 47 per cent of architects in the UK, mostly with local authorities. Today it is less than 1 per cent.39 This partly reflects the sharp fall in the provision of new public housing by local authorities, but it is also consistent with the outsourcing trend across government. An important reason why the UK struggled to provide enough testing during the coronavirus pandemic was that laboratory capacity, including a once extensive and well-resourced network of public laboratories, had been run down over the previous twenty years.40
But the recent explosion of outsourcing public-service functions to consultants has also harboured a darker side. At the height of the European refugee crisis in 2015, the German government paid McKinsey over €29 million to develop ‘fast-track’ migrant processing centres. The streamlined procedure it developed coincided with increased numbers of refugees being assigned to a temporary residency status that denied them key rights, such as that of family reunification. Legal experts have noted that the neglect of human rights considerations within McKinsey’s reorganization has triggered thousands of appeals, effectively shifting the backlog from migrant centres to the German courts.41 That management consultants can be so bluntly deployed in such an intricate area of human rights law demonstrates how far this thinking has encroached into public policy. More worryingly, it suggests that public values are being sacrificed in the name of efficiency.
Experts question whether the advice consultants give really enhances what an organization’s staff can do themselves, and whether the money could be better spent on research into medicines and health-care provision. Use of consultants also raises important questions of accountability, especially when one of their projects goes wrong, and conflicts of interest – for example, when a consultant works simultaneously for a global-health client and a client in a sector such as coal, which harms health. Unfortunately, the secrecy surrounding many consultancy contracts makes it hard to answer these questions definitively.42
Schemes like PFI and outsourcing involve complex contracts. Economic theories of contract and property rights are clear that the more complicated a product is, the greater the likelihood of asymmetries of information, whereby the seller – say a private provider of prison services – has more information than the buyer, the government.43 This leads to several difficulties for government. Trying to manage asymmetrical contracts and remedy their intrinsic weaknesses piles extra costs on the buyer. The government cannot give up its legal and political responsibilities to provide certain services, notably law and order and defence, so private providers can cut corners because the government will continue to pay for the service, at least until it can find an alternative way of providing it – a case of ‘moral hazard’. And, as we have seen in Carillion’s case, there is a risk that poor contracting leads to the problem being dumped back into taxpayers’ laps.
Moreover, it is clear that the negative impact of outsourcing and related practices has frequently gone beyond problems with quality, reliability and cost, important as they are. Put simply, privatization and outsourcing can remove tasks from people with long experience of doing them (civil servants) and give them to people whose experience may be much less (private companies). This is a matter of policy, not inherent capability, as the presence of foreign nationalized industries running privatized UK businesses illustrates. The consequence, however, has often been to hollow out government’s capacity, run down its skills and expertise and demoralize public servants, who feel they cannot do their jobs as well as they would like to.
But the real tragedy of this addiction to outsourcing to management consultancies is that it only further undermines the internal capacities of the public sector. This consequence was brought into sharp focus as the COVID-19 pandemic unfolded. Rather than focusing on retraining NHS staff and redeploying civil servants to run its test-and-trace system, as Germany did,44 the UK government outsourced its pandemic response to a patchwork of consultancy firms. In October 2020, news outlets reported that consultants from Boston Consulting Group (BCG) were being paid as much as £6,250 a day to work on the test-and-trace system.45 At the time of writing, the full scale of pandemic-related spending on management consultants remains unclear, but its implications for public-sector capabilities are unambiguous. As Lord Agnew, Conservative peer and Minister of State at the Cabinet and HM Treasury put it in September 2020, Whitehall has been ‘infantilized’ by the reliance on consultancy firms. Not only is outsourcing outrageously expensive, but it deprives ‘our brightest [civil servants] of opportunities to work on some of the most challenging, fulfilling and crunchy issues’.46 In other words, their development – and thus the growth of the public sector – is stunted.
The more private providers undertake public activities, the more government accountability is reduced because capabilities have been diminished and it is harder to change poor policy. Risks are not taken, and rewards are not reaped. The result is a self-fulfilling prophecy: the less government does, the less it takes risks and manages, the less capacity it develops and the more boring it is to work for. At the same time, the more attractive it is to work for a private provider or consultancy firm, the more talent is siphoned away from government.
Myth 5: Governments shouldn’t pick winners
The first three myths lead to the idea that government should not steer the economy but only facilitate it. This is often expressed as: governments should stick to the basics and not ‘pick winners’. Sarah Palin, the Republican vice-presidential candidate in the 2008 US election, once said: ‘Our government needs to adopt a pro-market agenda that doesn’t pick winners and losers, but it invites competition and it levels the playing field for everyone.’47 And even in less ideological circles, well-meaning civil servants often begin white papers stating why their strategy is ‘not about picking winners’. Yet this is a false problem. Of course policymakers need to make decisions about what forms of support to provide, and hence to pick.
‘Picking winners’ refers to government efforts to steer the economy and stimulate activity by choosing and often supporting technologies, businesses and sectors it believes are important and will succeed. There can be many reasons for making a particular choice, including seizing a technological lead, diffusing knowledge, creating jobs, raising productivity and incomes, boosting regional development and defence. Industrial policy – an overall strategy to encourage the development and growth of all or part of the economy, often with an emphasis on manufacturing – can be seen as picking winners writ large. Indeed, whenever the government tries to stimulate a technology or a sector to develop, it is in the broad sense picking winners. The real problem is when losers pick the government.
Many of the objectives may be worthwhile, but picking winners has acquired derogatory overtones because of government’s alleged inability to choose wisely – even though the private sector may not be good at picking winners either. Government interventions, it is claimed, too often fail and leave the taxpayer to pick up the tab. They prove that risk is the business of the private sector and, perhaps more importantly, that the private sector either attracts less bad publicity when its ventures fail or has a higher tolerance for bad publicity. Advocates of the ‘need to not pick winners’ point to cases such as Concorde, the Anglo-French supersonic airliner that flew from 1976 to 2003. It was a technological triumph but cost vastly more than forecast to build and never led to a supersonic revolution in commercial air travel. Another case, in the USA, was Solyndra, a solarpower panel start-up that in 2009 received a $535 million guaranteed loan from the US Department of Energy (DoE), only to file for bankruptcy four years later.
And yet the idea that government cannot pick winners is historically inaccurate.48 In fact, during periods of technological shifts, government can play a critical role in co-ordinating industrial efforts and setting standards that create markets. But they must make the decision to pick a strategy – and tilt the playing field in that direction. We saw this in the 1990s, when the government of South Korea recognized the enormous potential of high-definition (HD) technology. At the time, the electronics industry was undergoing a shift from analogue to digital products, and South Korea was still a mass-producer of analogue TVs. To build the necessary capabilities to shift to HD products, the South Korean government set up a committee dedicated to co-developing HD TV – comprised of three ministries and more than a dozen private firms, universities and government research institutes – which resulted in the creation of a ‘grand research consortium’. The consortium, which was led by the Video Industrial R&D Association of Korea, included the Korea Electronics Institute, the Korea Institute of Industrial Technology, Samsung, LG, Hyundai, Daewoo Electronics and other private-sector firms. With $100 million in combined funding from the government and the private sector, it focused on the technology transfer and absorption from the USA and Japan. The government co-ordinated the work of leading companies to develop standards for digital TV emerging from the USA while also encouraging competition between the companies.49 Meanwhile, Korean companies established research teams and centres in the USA that were close to universities and other research institutes.50 In October 1993, after the consortium presented the first prototype for digital TV broadcasting and receiving, the Korean government moved to support the second phase of the project – the industrialization and commercialization of a new prototype. Two years later, the consortium started the development and miniaturization of ASIC chips, and many companies competed to scoop the contract for the final commercial product – which was ultimately launched by Samsung in 1998.51
Not all strategies of this type succeed, of course; that is part and parcel of trial and error. But sometimes picking winners is confused with state support for troubled industries, for example when the UK government attempted to help the domestic car industry by forming British Leyland in 1968 and shipbuilding by creating Upper Clyde Shipbuilders that same year. Neither company was successful. But picking winners in the sense of backing what are deemed to be the innovations, sectors and businesses of the future is quite different from trying to keep ailing industries and companies alive. And in the narrow sense of selecting a winning business, governments, just like venture capitalists, will win some and lose some. The same year that the US government made the $535 million guaranteed loan to Solyndra, it also made a similar loan of $465 million to Tesla – now a global leader in the electric revolution that is transforming the automotive industry. China is the world’s biggest producer of pencils because it set out to develop a competitive industry, not because it started with comparative advantages in technology or the supply of graphite. Chinese state-owned firms invested in technology and labour, and the government provided cheap finance, tariff protection of domestic producers, lax forest management policies to keep wood cheap, and generous export subsidies.52
If a government is to act as an investor of first resort and steer an economy towards meeting goals such as a digital revolution or the green transition, of course it will need to make bets and pick winners. But it should pick a direction, and within that direction take a wide portfolio approach. In other words, not pick one technology, or a random sector (usually one of those that lobbies hardest), or even a type of firm (SMEs) – but a direction that can foster and catalyse new collaborations across multiple sectors and have as a key spillover the growth of firms that engage with it. In that sense it is not about picking winners, but picking the willing. Without the government making bets, we would not have the internet or Tesla. However, the manner in which government does so is important. If it puts all of its eggs in one basket, then there is a danger that it picks wrong and loses everything. But if it acts more like a venture capitalist and structures its investments as a portfolio, then this risk is reduced. Indeed, it was because Obama was interested in steering the economy along a green transition that the DoE provided guaranteed loans to Tesla, Solyndra and other green companies. The fact that one of these failed is only normal; as any venture capitalist will confirm, many failures are required before a success arrives. The real problem is the practice of socializing risks and privatizing rewards, which we return to in Chapter 6.53 The government bailed out the failed company (Solyndra) but got none of the upside for the successful company (Tesla). Moreover, US citizens knew about the government’s role in the failure of Solyndra – which was widely described in the media – but not about its role in the success of Tesla, which was marketed as a private-sector success. This only reinforced the narrative that government should not try to pick winners.
It’s also worth remembering that valuable lessons can be learned from failures. It has been argued, for example, that the nationalization of British Leyland in 1975 – triggered by the near-bankruptcy of the car manufacturer – prevented the British car industry from collapse and made possible the future development of a flourishing sector. Nationalizing Rolls-Royce in 1971 had a similar result. As a leading aero-engine manufacturer, Rolls- Royce is now at the heart of the UK aerospace industry, which is ‘that rare thing, a world-beating advanced manufacturing sector based in Britain’.54 And returning to Concorde, although it is no longer flying the investment that went into it produced an array of productive spillovers in different sectors: the high air resistance of supersonic flight meant that engineers had to develop novel cooling systems in Concorde’s wings and windows, and a new paint that was twice as reflective to avoid overheating.55 The challenge of making measurements on Concorde’s Olympus engines led Sir David McMurtry to invent the touch-trigger probe, revolutionizing the field of co-ordinate measurement and founding Renishaw, one of the UK’s bestknown engineering firms, in the process.56 These spillovers do not mean that Concorde was worth the investment, or good value for money, but they should surely be taken into account in any evaluation of that investment.
And yet no proper evaluation exists that does so. Crucially, however, the way in which the debate has been framed is misleading in a much more fundamental sense. Market failure implies that ‘pure’ private goods or markets can exist independently of public or collective action: value can be created in the private sector irrespective of government. The subtle and insidious effect of this widely held view is to constrain civil servants with an ideology that says they can as easily do harm as good and chip away at their confidence in their ability to create public value. Civil servants are supposed to implement government policy while at the same time speaking truth unto power. But if government is seriously restricted in what it does, and civil servants do not have the freedom to find out what works, they are likely to become cautious and government’s ambition will shrink. Ethos and creativity are crushed. A government that lacks imagination will find it more difficult to create public value.
In reality, value emerges from the interaction of the public and private sectors and civil society. Warren Buffett once said – quite rightly – that ‘society is responsible for a very significant percentage of what I’ve earned.’57 Indeed, the market and the economy itself can be regarded as outcomes of the interactions between these sectors. Government policy is not just ‘intervention’. It helps to shape markets, as do many other institutions within and between the public and private sectors: regulators, trade unions, business lobby groups and so on. Government action may be a precondition for others to become involved in a changing economic landscape. More than that, government can actively co-create value with business and civil society.
Taken together, these five myths might make one believe that the smaller government is, the better. So instead of thinking about how government can help create public value and build the capabilities to do so, most contemporary political debate about government revolves around its size (ill defined, but often measured by government spending as a percentage of GDP) and budgets. It is much less often about skills and non-financial resources such as training, knowledge, networks and access to expertise. These bear no relation to the size of government or any organization, but are closely associated with real efficiency. And government needs capabilities at many levels, from the top of the political tree to the saplings of local government and specialist agencies.
What matters are the investments that government makes internally –being innovative in how it operates – and externally in the economy in areas that drive long-term productivity growth. The countries in Europe that have the highest debt-to-GDP ratios – which in 2019 were Greece, Italy and Portugal – are also the ones that have not made the necessary investments in the economy, such as in R&D, education, innovation agencies and dynamic public financial institutions.58 So, NPM encourages government to take up as little space as possible. But, as previously noted, this has led to outsourcing and privatization. Instead of government going to the moon, it’s more as if in recent decades it has been taken for a ride.__
Mariana Mazzucato (2021), Mission Economy: A Moonshot Guide to Changing Capitalism, Allen Lane, London
1 John Maynard Keynes, General Theory of Employment, Interest, and Money (London: Macmillan, 1936), p. 383.
2 R. M. Solow, ‘Technical Change and the Aggregate Production Function’, The Review of Economics and Statistics, 39 (3) (1957), pp. 312–20; P. M. Romer, What Determines the Rate of Growth and Technological Change? (Washington, DC: World Bank Publications, 1989).
3 N. Bloom and J. Van Reenen, ‘Measuring and Explaining Management Practices across Firms and Countries’, The Quarterly Journal of Economics, 122 (4) (2007), pp. 1351–1408; M. Mazzucato, The Value of Everything: Making and Taking in the Global Economy (London: Allen Lane, 2018). For a microeconomic theory of value see H. R. Varian, Microeconomic Analysis (New York: W. W. Norton, 1992). For a business strategy view of value creation in business see M. E. Porter, Competitive Advantage: Creating and Sustaining SuperiorPerformance (New York: Free Press, 1985).
4 M. Mazzucato, The Entrepreneurial State: Debunking Public Sector vs Private Sector Myths (London: Penguin, 2018).
5 M. Angell, The Truth about the Drug Companies: How they Deceive Us and What to Do about It (New York: Random House, 2005); M. Mazzucato and G. Semieniuk, ‘Financing Renewable Energy: Who is Financing What and Why It Matters’, Technological Forecasting and Social Change, 127 (2018), pp. 8–22.
6 H.-J. Chang, The Political Economy of Industrial Policy (Basingstoke: Macmillan, 1994) and ‘The Political Economy of Industrial Policy in Korea’, Cambridge Journal of Economics, 17 (2) (June 1993), pp. 131–57 https://doi.org/10.1093/oxfordjournals.cje.a035227
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8 K. J. Arrow, ‘An Extension of the Basic Theorems of Classical Welfare Economics’, in J. Neyman (ed.), Proceedings of the Second Berkeley Symposium on Mathematical Statistics and Probability (Berkeley: University of California Press, 1951), pp. 507–32.
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35 P. Verkuil, Outsourcing Sovereignty: Why Privatization of Government Functions Threatens Democracy and What We Can Do about It (Cambridge: Cambridge University Press, 2007) doi:10.1017/CBO9780511509926
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37 Ibid.
38 https://publications.parliament.uk/pa/cm201617/cmselect/cmpuba cc/772/77203.htm#_idTextAnchor004 (accessed 14 July 2020).
39 Finn Williams, ‘Finding the Beauty in Bureaucracy: Public Service and Planning’ (Lendlease, 2018) https://www.lendlease.com/uk/better-places/20180823-findingthe- beauty-in-bureaucracy/
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41 https://www.washingtonpost.com/world/europe/how-mckinseyquietly- shaped-europes-response-to-the-refugeecrisis/2017/07/23/2cccb616-6c80-11e7-b9e2- 2056e768a7e5_story.html (accessed 31 August 2020).
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44 https://www.theguardian.com/world/2020/sep/18/covid-test-andtrace-uk-compare-other-countries-south-korea-germany 45 https://www.theguardian.com/world/2020/oct/14/consultants-feesup- to-6250-a-day-for-work-on-covid-test-system
46 https://www.theguardian.com/politics/2020/sep/29/whitehallinfantilised- by-reliance-on-consultants-minister-claims
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49 As documented in K. Lee, C. Lim and W. Song, ‘Emerging Digital Technology as a Window of Opportunity and Technological Leapfrogging: Catch-up in Digital TV by the Korean Firms’, International Journal of Technology Management 29 (1–2) (2005), p. 50: ‘[t]he whole project was divided into digital signalling (satellite and terrestrial), display (CRT, LCD, PDP) and ASIC chips (application-specific integrated circuits chips, encoding, decoding, demultiplexer, display processor). Each unit, GRI or private firm, was assigned to different tasks with some intentional overlaps among them, namely two units to undertake the same task to avoid the monopoly of the research outcomes. While each unit is supposed to share the results with other firms, the private companies are observed to have tended to do research on diverse aspects of the digital TV technology and to keep important or core findings to themselves.’
50 Ibid.
51 United Nations Industrial Development Organization, 2020, ‘Industrialization as the Driver of Sustained Prosperity’ https://www.unido.org/sites/default/files/files/2020- 04/UNIDO_Industrialization_Book_web4.pdf
52 http://www.civitas.org.uk/pdf/PickingWinners.pdf
53 https://www.nytimes.com/2020/07/01/opinion/inequalitygoverment-bailout.html (accessed 4 July 2020).
54 http://www.civitas.org.uk/pdf/PickingWinners.pdf
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56 https://www.ati.org.uk/media/ufvdpces/ati-insight_13- spillovers.pdf; https://www.renishaw.com/en/heritage–32458 (accessed 3 July 2020).
57 M. Mazzucato and R. Kattel, ‘Getting Serious About Value’, UCL Institute for Innovation and Public Purpose (IIPP PB 07, 2019) https://www.ucl.ac.uk/bartlett/publicpurpose/ publications/2019/jun/getting-serious-about-value
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