What does Carillion really mean for taxpayers?

Every quarter, thousands of companies enter liquidation. In July to September 2017, the latest available data, some 4,152 new insolvencies were recorded. In total, 25,479 companies were undergoing some sort of insolvency proceedings in that period.

A construction company collapsed recently and filed for liquidation. True, it was a major government contractor and its failure means some of these will now have to be re-tendered. But it’s not something out of the ordinary: the directors made bad decisions, racked up losses, and the company went to the wall.

What happened and what it really means for taxpayers:

Q: What was Carillion and what happened to it?

A: It was a private construction and facilities management company. The firm held a number of public sector contracts, three of which ultimately proved so unprofitable that the company failed to keep up with its debt repayments. . When creditors refused to provide £300 million of additional funding it needed to meet short-term obligations, it forced it file for liquidation.

Q: What’s all this talk of a government bailout? Is the taxpayer going to rescue this company?

A: No. Carillion’s banks asked the government for guarantees on its debts but the government refused and banks refused to show Carillion more leniency so the company went into liquidation.

Q: OK, but is this going to cost taxpayers?

A: Well there hasn’t been a conventional bailout but some disruption and associated costs are inevitable. For example contracts will have to be re-tendered where there was not a joint-venture agreement in place requiring the partner to step in. There will also be a cost for keeping the services for which Carillion was responsible running temporarily. But the main losers are the shareholders and creditors – mainly Barclays, HSBC, Lloyds, RBS and Santander – who have been lending Carillion money, and of course employees whose jobs are now under threat. The projects, however, will still go ahead and most employees are likely to find jobs with the new operators.

Q: So has this company been ripping us off for years, banking massive profits for running our public services?

A: If a company collapses it means it’s making too little profit, not “too much”. Margins in the construction sector vary between 0.8 per cent and 2 per cent, which means that the costs have to rise only by that amount to wipe out any profits.

Q: But weren’t they paying dividends?

A: Carillion suspended paying dividends in July last year when the company issued a profit warning. But it hasn’t been booking losses for long. In 2016 it made a pre-tax profit of just under £150 million on turnover exceeding £6 billion, although some have questioned whether the company’s earlier profits numbers were flattered by flaws in allocating costs to the right time under project accounting rules. As Warwick Business School professor John Colley said, “project accounting, which tends to recognise losses late in the project, effectively when the project starts to run out of money. There will no doubt be serious retrospective scrutiny of the accounting. Balfour Beatty is still recovering from some similar issues, but it did not have the same debt levels and also had key assets to sell.”

Q: Any company making a profit delivering public services is surely money which should remain in the treasury?

Privatisations of the 1980s and 1990s brought huge efficiency savings to telecoms, energy and water, precisely due to the profit motive. Governments don’t run them in the same way, because the decision makers, ministers and civil servants, lack the incentives to take politically difficult but sensible action. Without those incentives, costs swell and taxpayers carry the can.

Importantly, companies do not make profit by just deciding to be extremely greedy, but by finding ways to provide goods and services at a price customers are willing to pay. Competition, meanwhile, forces wasteful companies out of business because customers won’t pay their high prices and shareholders won’t tolerate their low earnings. This doesn’t happen in government in the same way. Private companies can’t pass laws to force customers to pay higher prices or investors to accept poor returns.

Q: So what does privatisation got to do with it?

A: Nothing. Carillion was never a publically-owned company. Some have confused privatisation (selling public sector businesses) with outsourcing (contracting an outside supplier to deliver a service).

Q: What about its relation to PFI?

A: Carillion was also in the business of managing some of the facilities it built. Frequently, when it was contracted to build a school or a hospital, it was also contracted to maintain it: carry out repairs, run the canteen, maintain the grounds etc.

Such arrangements are known as a private finance initiative (PFI). Under PFI, the public sector contracts a private company (generally a special purpose vehicle (SPV) established for that specific project) to supply services over a contract period. The services generally comprise the supply and subsequent maintenance of a new facility such as a school or hospital. In exchange for those services, the public sector body pays an agreed annual fee – a unitary charge. The cost of building the facility is met by the SPV, funded by shareholders (equity) and banks/insurance companies (debt).

Carillion was engaged in several PFI deals. But the story of its demise isn’t an indictment of PFI or public-sector contracting. PFI brings private-sector management to the public services and transfers risk from taxpayers to the private sector. Carillion took on the risk, and when it went bad, it was primarily shareholders and not taxpayers who paid the price. In this way, it’s a story of PFI doing what it was intended to do.

Of course, PFI is far from perfect. Some contracts have proved to be poor value for money and they also hide debt off the government balance sheet since future obligations are not included. But it’s too simplistic to condemn PFI contracts as unequivocal failures. Shareholders, rightly, have been wiped out.

Q: So what is the difference between outsourcing and privatisation?

A: Privatisation is when public assets are sold to private investors (eg, Royal Mail) whereas outsourcing is when a service is transferred to an outside provider. Companies often outsource some functions. Many businesses hire cleaners to do the vacuuming and dusting rather than making their own employees do it.

Q: What about Carillion’s pension deficit? Will taxpayers be forced to pay for it?

A: The pensions will be covered out of something called the pension protection fund (PPF). The PPF is funded by a levy on eligible schemes, and Carillion’s is one such scheme.