Civil servants should be paid more to stem the Whitehall talent drain that contributed to the £40m west coast rail fiasco, according to Britain's former chief mandarin, Lord O'Donnell.

In the wake of the decision to restart the bidding process for the London-Glasgow franchise, the former cabinet secretary said government departments were suffering from "skills shortages", particularly in procurement. The move will cost the taxpayer £40m in compensation to the four shortlisted bidders and wiped £240m off the share price of FirstGroup, the company that had been designated the winner under a process now deemed to have been deeply flawed.

Speaking on BBC Radio 4's Today programme, O'Donnell said: "It raises some issues about skills of the civil servants, there is no doubt about that.

"But we are suffering from some areas where there are skills shortages … such as procurement."

O'Donnell also warned ministers: "Attacking their own staff is self-defeating and a mistake."

Margaret Hodge, chair of the powerful Commons public accounts committee, called on civil servants to "raise their game", while Whitehall expert Peter Riddell said the west coast fiasco "goes to the heart of the civil service's credibility and reputation for competence".

O'Donnell said higher pay for procurement specialists would help departments retain staff who were otherwise lured to better paid posts in the private sector. He added that "an arbitrary constraint like the prime minister's salary is not helpful".

"[Procurement officials] get bid away from departments quite a lot," O'Donnell said. "They get taken back to the private sector, who pay them vastly more." For procurement officials, remuneration was "a measure of how much they are valued."

Three unnamed civil servants involved in the west coast procurement process have been suspended following the reversal. Rail industry consensus was coalescing around three names in particular on Wednesday night, but the DfT was keeping a tight lid on identities.

O'Donnell said the inquiry into the west coast debacle, which is due at the end of the month, must establish whether the fault lay with the government's franchising policy or the implementation of that policy.

"It is important that they get to the bottom of it and if there are mistakes made by civil servants they should be accountable for that.

We need to be clear about what is a policy decision by ministers and what is an implementation decision by the civil servants."

On Wednesday the newly appointed transport secretary, Patrick McLoughlin, who had previously defended the bidding process in parliament as fair and robust, announced a pause in the franchising programme while the entire system was reviewed. It means Virgin Trains is now the favourite to continue operating the line into next year on a temporary basis.

McLoughlin said he was angry and admitted the fault lay "only and squarely within the Department for Transport", adding that the mistakes were "deeply regrettable and unacceptable". The DfT has admitted that it miscalculated the riskiness of FirstGroup's winning bid – which offered to pay the government £13.3bn over 15 years – and as a consequence had asked for an excessively small financial guarantee from the company.

Also speaking on Today, Hodge said: "It exposes in a very stark way that the present conventions on accountability between civil servants and ministers to parliament and the public aren't working.

"It's yet another example … of where the civil servants themselves have not really captured and taken on the role that is expected of them in today's society.

"People came into the civil service in the past because they were interested in policy, they wanted to devise policy. Today, the job of a civil servant is much more about delivering programmes, and that requires a different set of skills."

Riddell, who is the director of the Institute for Government, said while mistakes should not tarnish the whole civil service, "errors, particularly as costly and serious in their consequences as over the franchise, inevitably overshadow the successes".

"At a time when relations between some ministers and some senior civil servants are already strained, the disclosures could hardly be more damaging."

Beyond the £40m compensation bill for shortlisted companies and others involved in franchise auctions that will now be paused, the department may also find itself a hostage to the operators running the rest of Britain's railways, as the timetable for renewing contracts slips. An industry source said: "I think they have no option but to extend franchises that are next for renewal. It will cost them a fortune."

Virgin Trains, which looked set for imminent extinction, is confident it will be allowed to run the west coast service in the interim, and Sir Richard Branson said he hoped a new, transparent process would mean his company could also soon target the east coast line again.

It has emerged that the previous transport secretary, Justine Greening, had ordered an investigation in late August when she was first informed by officials that a "small procedural error" may have occurred. She is said to be "fully supportive" of McLoughlin's targeting of officials, who she believes suppressed information when giving categorical assurances that Virgin had no basis for a legal appeal.

But the news raises the question of whether ministers were reshuffled by David Cameron last month in part to save them from resigning. Greening's then deputy, the new Northern Ireland secretary, Theresa Villiers, was a major proponent of controversial longer franchises and took the decision to give the west coast franchise to FirstGroup.

The shadow transport secretary, Maria Eagle. said: "The prime minister should come clean on when he knew, and on any connection with the decision to conduct a wholesale clearout of Tory transport ministers before this fiasco became public."

The DfT discovered the flaws as it was preparing to contest the judicial review Virgin sought in the high court after losing the franchise on 15 August. McLoughlin said: "Some of the points Richard Branson made were found to be correct, but there were things that were more wide-ranging … That's why I took the decision last night to go back to the drawing board."