The economic consequences of Mr Hammond

Last week, in an interview in The Independent, the Defence Secretary, Mr Philip Hammond, announced yet another miracle flowing from London’s hosting of the Olympic Games. As a result of his involvement in the crisis over the provision of security services to the Games, he has undergone a Damascene conversion. He had laboured under a ‘prejudice’ ‘that the private sector was always more efficient, capable and preferable to the state’. But the breach by G4S, the world’s largest security firm, of its contract with the London Organising Committee of the Olympic and Paralympic Games (LOCOG), has caused him to ‘rethink his scepticism towards the public sector’ and to realise that ‘we can’t always rely on [the] private sector’.

Mr Hammond’s views completely misrepresent what went wrong in this deplorable episode and display a profound misunderstanding of the working of public procurement which is truly worrying in someone in his position.

The fundamental failure over the provision of security personnel was not that of G4S, it was that of LOCOG. Olympic contracting has demonstrated one of the worst failings of the public expenditure process. Initial estimates of cost are made palatable by being, to put it mildly, optimistically low. Once the initial investment is made, it is difficult to wind back, and though the eventually realised costs far exceed the estimate, this typically becomes merely another problem for the taxpayer. The bid for the Olympics was made on the basis of their cost being less than £2.5 billion, but the realised public expenditure has been at least £11 billion.

Security costs have made a woeful contribution to all this. LOCOG initially estimated that it would need 10,000 security personnel, of which 8,000 would be volunteers or come through a publicly funded recruitment scheme, and in December 2010 it contracted with G4S to provide the remaining 2,000. Problems with the recruitment scheme were completely eclipsed when, for reasons which are not adequately known, towards the end of 2011 the 10,000 figure became 23,700! After completely revising its plans, including now utilising 7,500 military personnel, in December 2011 LOCOG recontracted with G4S that G4S would supply the bulk of the extra personnel. In the end, G4S was to provide 13,700 personnel. This is to say that, merely 6 months before the start of the Games, G4S agreed to provide nearly 7 times as many personnel as it had agreed to provide a year earlier.

The recruitment of the 13,700 personnel was always an impossibility. If LOCOG truly believed that, by agreeing this contract, it had an absolute guarantee that the personnel would be provided, then it admits to a naive faith in what the law of contract can do for you that stretches credulity. Inevitably, the personnel were not recruited and, just two weeks before the Games, an extra 3,500 military personnel (a figure later raised by 1,200) were deployed to fill the gap that had been left by G4S’s now acknowledged failure. Why the quite chimerical December 2011 contractual ‘solution’ to this most serious of problems was ever thought to be plausible, and why the inevitable crisis was allowed to reach the eleventh hour, are also not adequately known, and a thorough inquiry must take place.

From the perspective of the law of contract, the public sector emerges quite well from this episode in one sense, but emerges extremely badly in a much more important sense. Contracting which involves drastic revision of the initial specifications is very likely to lead to substantial costs which would be avoided by more careful planning, and LOCOG undoubtedly sustained such costs in the course of its negotiations with G4S. In December 2010, LOCOG agreed to pay G4S £86 million. One year later, this became £284 million. But at least the December 2011 agreement has given LOCOG a contractual claim for the extra costs of using the military as substitute security personnel.

However, LOCOG has been uncommonly fortunate in the way this has played out. It was crucial that LOCOG was able to call on the military as a substitute, though, of course, a remedy of this kind plays no part in the normal working of the law of contract. If LOCOG had not been able to call on the military, there would have been no substitute personnel and the Games, it appears, would have had to be cancelled. Without the military, finding G4S to be in breach would be completely irrelevant because such a finding does not, by magic, solve the claimant’s real problems. LOCOG’s incompetent contracting would have been exposed as useless, to itself and to a humiliated nation.

But what of the private sector party, G4S? One’s concerns about its role are certainly no less grave than those about LOCOG. But this episode is not a private sector failure in any clear way but rather an illustration of a long identified shortcoming of the public/private contracting that took place between LOCOG and G4S. Why on Earth did G4S agree to provide the extra personnel? In the absence of hard information, I would speculate that G4S was so conscious of the vast business that it did with a wide range of government departments that it was prepared to do all it could to help LOCOG. Mr Nick Buckles, the CEO of G4S, has said his company had always taken a wider view of the Olympics contract: ‘We did this purely because we wanted to have a successful security operation at the Olympics. It is not particularly financially lucrative for us. It was much more about, ironically, reputation and building reputation for the future’.

It would appear that G4S has now rendered one service for which LOCOG and the government should be grateful. It has, so far, largely absorbed the blame for this episode, and the role of LOCOG’s incompetence has not emerged. Instead, we are subjected to views like Mr Hammond’s. One wonders what the government would be prepared to pay for such extremely effective public relations work, though, of course, G4S will not be submitting an invoice for this particular item. Happily, when dealing with so contrite a party, the government appears to be sufficiently magnanimous as to put past misfortune behind it. Despite Mr Buckles himself saying that the reputation of his company is ‘in tatters’, G4S will maintain its wide portfolio of government work.

One of the objections to the sort of contracting that took place between LOCOG and G4S is that it can make it extremely difficult to sheet home the ultimate responsibility a public purchaser always bears to ensure a service actually is provided to the public. The purchaser can attribute failures to the private sector provider and any shortcomings in its own contract negotiation and management escape censure. Effectively co-opted into government, that provider may well find it wise to take a wider view of all this. This episode seems to be dramatic evidence that there is something to this objection.

Mr Hammond is, in the end, pleased that it was necessary to deploy over 12,000 military personnel to provide security services for the Games. They did, it is universally agreed, a fine job. But they were able to do so because, as Mr Hammond tells us, they had access to ‘massive resourcing’. I am confident that Mr Hammond’s own department will retain its status of having in some respects the worst record of failure in public procurement of all government departments. But, after his conversion, he can see the wisdom of the way the military has, by long tradition, done it, now telling us that: ‘The G4S model says “here is a cost envelope within which I have to deliver an outcome and I have to do it incredibly leanly with very little resilience” … The military came at it from the exact opposite extreme. “What’s the job that needs to be done? OK, we’ll do it. Whatever it takes, we’ll provide massive resourcing”’.

But who was responsible for adopting the ‘cost envelope’ rather than the ‘massive resourcing’ approach to Olympic security? We can be pretty sure it wasn’t G4S, which would enthusiastically have seized the opportunity to take the latter approach. It was LOCOG that initially chose the ‘cost envelope’ approach; that grossly underestimated security costs even on this basis; and that, in December 2011, overwhelmingly compounded the emerging problems by even more grossly overestimating the ‘cost envelope’ approach’s chance of success at that time. The Olympic security crisis was caused because LOCOG’s security contracting was part of the wildly optimistic underestimation of the cost of hosting the Olympics that misled the public into agreeing to pay for them.

It is very worrying that Mr Hammond does not understand this episode, which was grave in itself, and only narrowly escaped being one of the most blatantly embarrassing government failures ever. And it is this that Mr Hammond thinks should lead us to take a more favourable view of ‘the merits of the public sector’!

This article was previously published at the IEA.