People’s eyes tend to glaze over when you mention public service commissioning. It’s hardly the most sexy subject to write about. But it matters. It matters, for a start, because it’s a huge industry. A study by Oxford Economics estimates that it employs 1.2 million people, and creates or supports a further 2.3 million jobs. According to the research, the current outsourced market for public services has an annual turnover of £82bn, representing around 24 per cent spend on public services in the UK.

And it matters because outsourced public services have an impact on the entire economy, in terms of wage levels, benefit demands and spending power. It matters because these services are vital to our social fabric and have knock-on effects – effects that can help or hinder not only the people they serve, but their friends and relatives. What happens to a child in a children’s home or a prisoner in jail affects all of us.

And a report released today by Social Enterprise UK, the national membership body for social enterprise, has produced some stark conclusions about how the face of our public services has changed.

1. Rise of the giants

Here’s a list of things that one company, Serco, operates: prisons and young offenders institutions. The National Nuclear Laboratory. Transport services like the Docklands Light Railway and Barclays Cycle Hire. Security services for the National Borders Agency, and maintenance services for missile defence systems. Air traffic control services. Leisure services. Management for hospitals and pathology services. Waste collection for local authorities. Education services for local authorities. Government websites.

If the company were to go under, it would cause severe disruption to public services. The growth of such contractors that are “too big to fail” began under New Labour and has continued apace. Why did it happen? In the report, Matthew Taylor, former director of policy for the Labour Party, provides a clue: “One of the funny stories I heard about this is that the government wanted to move into agile commissioning. And immediately, all the large providers employed a Head of Agile. Of course, smaller providers can’t afford a Head of Agile.” The biggest companies are best placed to meet Government guidelines.

In the early years of outsourcing under New Labour, the commissioners at local and national level lacked experience and confidence, so they went with the biggest firms, whom they felt they could trust. Rather than tear up these contracts, in recent years they simply expanded them with “bolt-ons”, in many cases due to fear of litigation. It’s an understandable fear – the larger the corporation, the more litigious it’s likely to be, and the West Coast Mainline debacle shows how costly and politically hazardous it is to be embroiled in such a case.

This is the situation today: in March this year, the UK Border Agency issued contracts worth £1.7bn for asylum seeker services (including accommodation). All eight contracts went to three companies: G4S, Serco and Clearel. Nearly a quarter of the £3.3bn contracts for the Work Programme went to one company (Ingeus). And cuts within the public sector have reduced the volume and skill of commissioners, meaning that they will choose to “buy safe” more often than not. This lack of genuine competition, as we’ll see, removes the main incentive to provide quality of service.

2. Goliath is killing David

It’s also forcing smaller charities and social enterprises out of the market. Many are making redundancies and turning away from public service markets in order to survive, just when they are needed most. They cite procurement policy as one of the biggest barriers to their sustainability.

I’ve already written, at length, about one enterprise which went bust as a result of signing up to the Government’s Work Programme. It wasn’t the only one - earlier this year Groundwork South West also went into administration. The deals favour the prime contractors: by June 2012, 96 charity providers had dropped out, 27 unable to make it work.

“There’s an ebbing away of confidence,” Peter Holbrook, CEO of Social Enterprise UK, tells me. “We’ve seen companies go to the wall, or being sidelined, and of course it makes you nervous. These days you increasingly have to work with a private contractor. It means small charities are getting crumbs from the table” This is the problem with the payment-by-results (PBR) system. Payments for these hard-to-reach jobless cases may be some time coming, if they come at all. Not-for-profit organisations, having failed by definition to build in a layer of profit to their business model, don’t have the capital reserves to wait for results. Essentially, they find themselves out-manoeuvred by the bigger companies that sub-contract to them. And this matters because...

3. Profit and public service don’t always mix

I’ve previously written on this with regard to one company the public does know about due to the Olympic fiasco: G4S. But the report has a lengthy section about a sector of the industry which hasn’t received quite so much coverage: children’s services. It’s an area that was highlighted by the recent Rochdale scandal, but this element of the story was somewhat buried by the other details.

It used to be the case that charities would bid for council contracts to care for vulnerable children, and would cross-subsidise themselves from fundraising and other means to do so. It was never going to last: private equity firms gradually took over. The report says: “Sovereign and 3i are the big contenders, but it is hard to pinpoint which firm owns what; their waters seem to be in perpetual motion, as they buy one another and take one another over, and offload assets.”

These companies operate by buying up cheap housing stock around the country, to which vulnerable children can be shunted. Two London boroughs now have no children’s homes at all. There are 101 homes in Lancashire alone, even though Lancashire has a population of less than 1.5 million. London has 130 homes, for a population of 7.8 million.

Ann Coffey MP is quoted: “They may take a child into care for the first time, after a final event has happened. So a child may have gone one more time, missing from home, and he or she is removed. The authority then thinks, ‘Where the hell have we got a place?’ Not ‘What does this child need?’ It’s the most terrible market failure.”

And the report cites a horrific statistic, one that shows Rochdale, much as we’d like it to be, was unlikely to be an isolated case. Ofsted figures published in May 2012 revealed that children’s homes in England— caring for 4,840 children, including 1,800 girls — had reported 631 suspected cases of young residents being sold for sex in the past five years. These are just the reported cases: it’s likely to be far higher.

It’s not hard to see how the practice of moving children around can exacerbate the problem. Once a child is removed from its own local authority, it loses contact with its team of social workers, its grandparents, neighbours and others who might be able to spot the signs of abuse. One girl at the centre of the Rochdale case was moved from Essex and placed in a one-to-one home, where she was the only resident. She never woke up with the same staff member in the home who had been there when she went to sleep.

The sector has responded to these criticisms, claiming “the simple connection of cheapness isn't accurate” with regard to the shifting of children. But it’s still hard to disagree with Coffey’s conclusion that the sector is “murky to say the least.” As Holbrook says: “There’s no problem with upscaling if you’re doing something like buying paperclips. But most public services rely on human relationships, so upscaling leads to a huge degradation in the quality of service.” And what about the staff in those homes?

4. Robbing Peter to pay Paul

Almost all the jobs being advertised by private care firms are at the UK minimum wage. This isn’t a living wage, as we all know. The staff are paid by the minute and aren’t paid travelling time. A care worker for a private company is interviewed. She was paid 14 pence per minute, and travelled from appointment to appointment on buses in Islington: “An average day that I was doing at the time, and this wasn’t very long because I couldn’t afford to keep it going, I’d start at 9, do 45 minutes with one person, another 45 minutes at 10, a half hour at 12, a break, a quarter hour at 4, another 15 minutes at 4.30, a half hour at 5 and another hour from 8 til 9. So that’s a 12-hour day for 4 hours’ money.”

Companies are making offers to contractors that aren’t mathematically possible if they’re providing jobs with a minimum wage, national insurance contributions, a pension scheme and training. Savings in one area invariably mean higher costs elsewhere: “No local authority should make that deal: even just on the pragmatic basis that it will be their own residents who are on the receiving end of that low wage, their own housing benefit department making up the carer’s rent shortfall, their own health and children’s services that come under strain when poverty is rife.” We’re seeing a degradation of service for short term profit gains.

As the anonymous care worker describes: “The public face of the company is all very welcoming. They’re always very hazy around money. It’s all, ‘Don’t you worry, there’ll be lots and lots of work for you’. We were all on zero-hours contracts, so basically they weren’t obliged to give us any work. There are hundreds of people out there working like this, I’d meet people all the time, for jobs that required two carers, and I never met anybody who was being paid any differently. I know the hours for tax credits have changed now, but most people were on housing benefit.”

This also means there’s a large section of the workforce that isn’t preparing for old age and retirement: a problem that will also have to be dealt with further down the line. It’s no surprise staff turnover is high, and this feeds into the quality of care.

5. We reward failure. All the time.

Again, I could cite the catalogue of failures I wrote about prior to the G4S debacle. Or the £529,770 that was lost from staff fraud or abuse from the Flexible New Deal 2010-11. Or the chaos that followed the privatisation of our court translation services. Or A4E’s company director payments, which saw the-then CEO Emma Harrison pay herself £8.6m, in a year when fewer than 4 in every 100 unemployed people seen by the firm managed to secure jobs for longer than 13 weeks. Or the nine prisons put out to tender in November in 2011 in spite of high-profile failings in the private sector (as the report says, in the very same bidding round the Wolds was returned to the public sector following the expiration of G4S’s contract, having seen poor inmate behaviour and high levels of drug abuse). Or the closure of Southern Cross as a result of complex financial deals designed to maximise financial gain, which left taxpayers picking up the pieces. Or...

There’s nothing inherently wrong with a market. But cases like these show that we’re getting all the downsides of privatisation – the stripping away of money through profits, above all – and none of the upsides, because there isn’t genuine competition. This is market failure, pure and simple.

6. The profits don’t even stay in the UK, let alone improve services

Social enterprises reinvest the money they make in service improvements. Private companies don’t: for every level of sub-contracting, profits are taken out in the form of shareholder dividends. The total amount of money being taken out of the social economy as a result is hard to quantify.

But one thing’s clear: money which has been allocated by Government to communities and issues that need it is being stripped away. Here’s one example: “Private equity companies work to extract as much financial value as they can from the companies they take over, in a relatively short timeframe. One of the ways they do this is through sale-and-leaseback deals on residential care homes for children and adults. This leads to extreme volatility in a market where stability is a fundamental requirement.”

But perhaps the most galling thing is that nearly half the money raised by this practice doesn’t even stay in the UK. A 2010 report by the Office for National Statistics showed that more than 40 per cent of shares in UK companies are held by overseas investors: this had increased by almost 25 per cent in just two years.

7. We can’t hold these companies to account

There have been moves towards openness - through the FOI Act and the publication of every contract worth over £100,000. But this legislation has been trumped by commercial confidentiality laws. You can find out how much a company has bid for a contract, but not how much lower it was than that of the next lowest bidder, so the number has no context.

As the report says, in business, there are mechanisms for accountability. A company’s CEO is answerable to non-executive directors, who can ask questions on behalf of shareholders. MPs don’t have the same power. And as Holbrook tells me: “I was involved in a Dispatches programme on Virgin’s move into health care, and an ex-employee emailed me to say she’d wanted to speak out but couldn’t due to a confidentiality agreement. There’s far less opportunity for whistle blowing within large providers.” On top of this, the service giants regularly make use of Britain’s defamation laws - which like the bidding process, favour those with the most money behind them - whether confronted by traditional media or online scrutiny.

Equally murky is the “revolving doors” culture – both revolving in, with corporate staff appointed to government posts, and revolving out, with public servants taking on high-ranking private sector jobs once they leave office. Alan Cave, a central architect of the Work Programme as a civil servant, left to join Serco, one of its main beneficiaries, this year, while Phil Wheatley, former head of the National Offender Management Service, is now a G4S adviser.

8. This is the Shadow State

Only one in five people polled by Social Enterprise UK knew that the majority of children’s homes are now owned by private companies. The majority of people polled for the report had never heard of Atos or Serco, yet these firms and others like them, are receiving and are responsible for many billions of pounds of taxpayers’ money.

This is an argument that can and should be depoliticised. There’s nothing left wing in saying a local community should benefit from a local contract. And there’s nothing in traditional conservative thought to encourage private companies, say, buying up assets, loading them with debt, and passing that debt back to the service users. Yet it’s quietly, inexorably, grown over the last few decades. Tomorrow, I’ll describe what can be done to fight it.

The second part of Alan White’s work on the shadow state will be published on his blog tomorrow.

UPDATE 3 January 2013 13:45 This article originally stated that clinical failures had lead to London hospitals being forced to lend money to Serco. This was incorrect and has been removed.

