Pitfalls of privatisation: ideologues will repeat mistakes

Government services are on the auction block, and a contestability mantra is ringing out in Canberra. They’re decisions steeped in political ideology, but with management outcomes the bureaucracy must get its head around.

With the assistance of private sector legal and business advisors, two taskforces within the Department of Finance are currently working on $11.7 million worth of scoping studies to assess four candidates for outright sale: the Australian Mint, Defence Housing Australia, Australian Hearing Services and the Australian Securities and Investments Commission registry. The recent Mid-Year Economic and Fiscal Outlook also confirmed Finance would look at privatisation options for the sensitive Intra-Government Communications Network, a web of fibre optic cables between hundreds of government sites in Canberra.

The ICON study will be paid for out of the department’s normal budget and, according to a spokesperson, Finance Minister Mathias Cormann is to make further announcements about it “in due course”. The government will consider the studies and make a decision on each as it crafts this year’s budget.

There’s calls for those studies to be conducted as impartially as possible, given the mixed report card on privatisation — in Australia and elsewhere — over many years. According to public management professor Janine O’Flynn, the research literature clearly shows decisions about whether to privatise or retain an area of business inside government must be made on a case-by-base basis. Nevertheless, it has become a political battleground, with “two very distinct camps”.

“On the Right it’s almost faith that if you outsource, you’ll save money and get better quality and so on, and on the Left it’s the exact opposite, which is that if you outsource it will be a disaster and only the state can do it,” she told The Mandarin.  “The truth is somewhere in between … in that there are some areas where each of those scenarios plays out.”

O’Flynn thinks we’ll see more government business pushed out to the private sector in the next few years, particularly at the Commonwealth level. “The government’s been very clear on that; they want to do it, and they will do it,” she said.

Too often, she says, governments focus mainly on the potential dollar savings and lose sight of other potential costs of privatisation. These include strategic costs, such as the loss of valuable skills, knowledge and experience developed by the public service, and issues arising from the process of establishing and managing relationships with external providers. Over time, a loss of capability can make it more difficult to select external providers, and make sure they keep performing to a high standard.

She says the situation with offshore detention centres is a “classic example” where the costs of outsourcing appear to outweigh the benefits, but the government does not have the capacity to take over.

“We know now from all the evidence that was presented to Senate inquiries [last] year that it’s much more expensive to have it done by others, but there’s no way that government’s going to step in and do it again,” O’Flynn said. In an article published last March, she warned that:

“… the most complex and potentially risky areas of outsourcing are inevitably in situations where the government hands over its monopoly on legal force to external parties or involves them in sensitive areas, points stressed in the US Commission on Wartime Contracting report …

“Even if we knew that there were value for money and relational benefits in the case of Manus Island (and we don’t), the strategic costs accruing to the Australian government in this case are profound politically, ethically and morally. Creating multibillion-dollar contracts with large multinational firms for the handling of asylum seekers is not only strategically risky for government, it has surely pushed us over the edge of our tolerance for outsourcing.”

“Unless you know what you want to buy, and you’ve got the capability within the departments to do that relatively intelligently, and then monitor to see if what you’ve bought is what you wanted, then outsourcing is forever problematic,” O’Flynn said. “That, to me, is the pragmatics of that debate. In some areas it’s much easier to specify what it is that you want to purchase and to be able to monitor if it’s been done, and in others it’s not.”

Does outsourcing hollow out government?

One scenario: an agency can become hollowed out over time by poorly planned outsourcing, leaving it paralysed as a weak consumer, sometimes in a highly distorted market with very little competition. And when important skills do walk out the door, it’s often a case of not knowing what you’ve got until it’s gone.

“We see it happen all the time, and IT is a perfect example,” O’Flynn, co-author of the Rethinking Public Service Delivery tome in 2012, said. “People say ‘well, you can outsource desktops, and you can outsource this and that’, but what about the sort of IT strategy and architecture that an organisation needs to operate? And what happens when you allow that to be driven by an external party because you’ve lost the capability to know what it is that you need? It happens all the time.”

Former departmental secretary Paul Barratt recalls exactly that happening in the 1990s. “You can end up prisoner of a contractor,” he told The Mandarin.

“You end up working for them. Only they know the subject adequately and then you are reliant on them. I think in those late ’90s contracts, departments lost their high-level IT people and internal IT capability, the sort of capacity that enabled them to be a smart buyer. They should not be in a position where they know less at a strategic level than the people they’re buying from.”

Barrett also remembers the private sector’s fabled creativity and innovation — one of the key benefits expected from outsourcing — failing to materialise. And he saw the problems that political bias can cause during his 18-month tenure as secretary of Defence in 1998-99. Then prime minister John Howard “was determined that everyone would outsource”, he says, even in at least one case when scoping work showed it would be more expensive. “Finance said ‘you’re using the wrong costing models; use these ones’. That made it even more expensive and Finance said ‘well, do it anyway’. It was ideological,” he said.

Another situation where outsourcing ends up costing the taxpayer more is when lots of work is pushed out to the private sector, but this is not followed by the vaunted savings from reducing the size, cost and complexity of the public agency.

“A great example is employment services,” O’Flynn explained. “The Howard government outsourced all of the job placement services for job seekers, and it’s created this huge monitoring infrastructure, so the Department of Employment spends a lot of time monitoring these providers — and I mean micro-monitoring providers. [The department’s] actual size might not have gone down that much at all, but what they’ve done is substitute out of delivery staff into contract managers. And those contract managers now spend extraordinary amounts of time micro-managing that system.

“It’s incredible. It’s become extraordinarily bureaucratic in a way that it was never envisaged to be.”

In a 2009 political science paper, three Melbourne academics picked over the gulf between Howard’s small-government rhetoric and the red-tape reality, concluding that the situation “casts some doubt over John Howard’s credentials as a neo-liberal”.

As with assessing a potential loss of workforce capability, O’Flynn says public servants often find themselves without all the facts they need to accurately evaluate the financial case for privatisation.

“It’s a really interesting question, because some of it is around [knowing] the costs that we’re modelling,” she explained. “What is the baseline that we’re starting from; do we have very good robust knowledge of what it’s costing us now? That’s actually pretty hard in many cases to get.

“And are we buying the same thing afterwards, or something different? The comparison issue is also a pretty important one. Lots of times we buy something quite different when we go out than what we had before. What we saw in local government contracting in Victoria was this movement in some councils away from what was considered a very blue-ribbon level of service to a much more modest one. So of course it will be cheaper, but you’re not delivering the same thing.”

What happens when it all goes wrong?

Last week, it emerged the Department of Veterans Affairs terminated a contract with Writeway Research Service, which provided investigation reports to support DVA’s decisions on compensation and pension claims from Australian Defence Force members since the 1990s, after allegations the signature of the Australian Signals Directorate’s chief was forged in a letter Writeway received from a Defence official and gave to DVA.

It’s early days in what is sure to be an intriguing saga, but there are already suggestions this could expose the department to significant legal and financial risk.

There are plenty of examples of provider failure, like when the company running Western Australia’s prison transport and Supreme Court holding cells 10 years ago had its contract terminated following an embarrassing courthouse escape and the extreme physical neglect of transferees, two of whom died as a result. The government took most of the blame and paid out millions in compensation.

There is also a long list of privatisation success stories, where savings and service improvements have resulted. But when it all goes wrong, the failure often exposes a loss of core competency that makes it very difficult for the government to step back in.

“I think when you start to lose core competence, any good organisational theorist or economist will tell you you’re getting into very dangerous territory,” said O’Flynn. And she raises another interesting question that underscores the need to retain core competencies.

“What if a provider goes bust? It happens. That’s what the market’s all about. People forget that in the debate. They just assume that the private providers will be efficient and profitable and so on, but guess what? Some of them go bust, and then what happens? … The government steps back in. It has to have the capability to do that, and that’s one of the risks, of course, to having it provided by other parties.

“Other parties can fail, and in fact, the whole basis on which we assume we’ll get cost savings is that some of them will. We want them to be competing in a vibrant, competitive market — and in a vibrant, competitive market, some businesses go bust.”