The reaction to Carillion shows how politicians get the economy wrong

Graeme Leach
The situation with Carillion is lamentable, but the thought of the state running everything is far, far worse (Source: Getty)

The response of politicians to the demise of Carillion has been a little disturbing.

The government has immediately underwritten all wages due to public sector contracts, and the official opposition has gone a step further, calling for these services to be insourced, instead of being outsourced to the private sector.

Given the scale of Carillion’s involvement in key public services such as health, the government did not have much choice politically. In order for these crucial services to continue to be delivered, the wages of Carillion employees obviously need to to be paid.

Read more: Carillion’s brutal demise is testament to free market mechanisms

The key point though is that the government should have taken the opportunity to state emphatically that this was a one-off – the state would have been paying fees to Carillion anyway if it had continued to trade.

By not doing so, the government has introduced a moral hazard by suggesting that private sector suppliers to the public sector will be too big to fail from now on.

The wider economic consequences are significant also. Indeed, they go to the heart of why all companies should be allowed to fail. Estimates suggest that, across the globe, 25 per cent to 70 per cent of productivity growth is attributable to the entry and exit of firms in the economy.

Indeed, the notion of zombie companies – only held afloat by record low interest rates – reinforces this point, and could be a significant explanation of why productivity growth has been so low in the wake of the financial crisis. The unintended consequences of the government bailing out companies are far and wide.

The employment and pension consequences of corporate failure are obviously horrible for those caught up in it, but this does not provide a case for state intervention.

If 20,000 micro companies each lost one job, nobody would be calling for state intervention. And yet, the aggregate UK-wide employment consequences of Carillion’s demise would be the same – around 20,000 jobs.

Tough love is the best route to prosperity in the long term. So how does this tough love work?

There are many potential channels with regard to the entry and exit of firms.

On the exit side, low-productivity firms are pushed out by market forces if they fail to provide goods and services that consumers want, at a price they are willing to pay, compared with their competitors.

On the entry front, new entrants emerge as a result of product and process innovation – look at the rise of Google or Facebook. The most successful economies will be those that can develop more of the faster growing companies while shedding the underperforming ones.

This is hardly rocket science, but it is hugely important for long-term prosperity, and comparisons of per capita GDP.

Perhaps my biggest fear is that the leader of the opposition, Jeremy Corbyn, is calling for the replacement of what he calls the “broken system” of outsourcing with insourcing.

Markets are not perfect – they are made up of imperfect people. But just as we must oppose private sector monopolies and excess market power, economic history teaches one even more powerful point: the worst possible economic structure is a public sector monopoly.

A public sector monopoly will be led by producer, not consumer, interests. And it gets worse. Producer interests would demand more and more money, while performance in crucial areas like healthcare deteriorated at the same time.

Corbyn obviously loves state-run economies such as Venezuela, but does he realise that the situation there got so bad that the government stopped publishing health statistics? Way to go Jeremy.

The situation with Carillion is lamentable, but the thought of the state running everything is far, far worse.

Read more: PMQs live: Theresa May faces questions on Carillion

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