The public benefits of co-operatives

On mutuality
Recently, I had lunch at an august financial institution in the City. After we'd talked about the really important things like whether old Joe was still the leading light fund manager and why young Priscilla had moved banks, we got down to business. They wanted to talk about mutuality. And not how to polish off the last few mutuals in the financial sector. No, the talk was about how to create new examples of mutuality in public services and utilities.

Why should hard-nosed money men want to create institutions whose shares cannot be tracked on the market? The answer is they had recognised something that politicians are only beginning to suspect. Namely that the mutual structure is well suited for certain public services - better than a simple privatisation and a whole lot better than leaving the operation in the public sector and subjecting it to torture by the Private Finance Initiative (PFI).

With the market man's usual optimism they reasoned as follows: If this was the best thing to do, sooner or later someone would do it. If my hosts had meanwhile worked out the problems, they could make a pound or two by offering sound advice. Moreover, this was not just a British thing. If the UK government mutualised a utility, that would create a whole new product for the British financial sector to export. Those foreign governments with services unsuitable for privatisation might be only too happy to follow this new example.

Mutuality has been under pressure in the financial sector, as everyone knows. How can it be struggling there but be the idea of the future for some utilities and public services? The answer lies in the structure of the product market. Financial services are competitive, nothing is more so. The average customer/member of a mutual building society or insurance company does not value his or her voting rights. If the society does something they don't like they simply move the account. They trust the competitive market to protect their interests. In economist's jargon, with "exit" so easy, "voice" is given little importance. Now consider water, or air traffic control. You don't like the service? Tough. Your only choices are to bathe in milk or fly somewhere else. In those circumstances a voice in the governance structure is highly valued. And the bigger your commercial exposure to the service in question, the more valued that voice is.

Of course, it is generally an option to privatise the service and regulate the price. With no possibility of competition, however, the regulation tends to become pervasive and highly politicised, losing much of the benefit of privatisation. Moreover, the greater a monopoly something is, the less risky it is to run and the less reason there is to pay super-normal returns to private shareholders. Mutuals would finance themselves by issuing bonds or, perhaps, preference shares. Consumers would pay less since their finance costs would be only a little more than the UK government pays on its bonds - way below the returns institutional shareholders demand.

British privatisations have, on balance, been a success but much more so in some sectors than others and (as a recent study for the IPPR shows) the distribution of gains has been lousy. The shareholders have generally done very well (hence the windfall tax), the customers have done all right to so-so and the employees have been skinned. Mutuality, by putting the customers in charge, could distribute the gains better without the need for price control or regulation, which can always become a political football.

There are, of course, potential problems with the management of a mutual just as there are with PLCs. Some people fear that the consumer-elected board would not be able to stop the management getting lazy and indifferent without the takeover threat. But the board can stimulate such a threat by franchising the entire management, perhaps to a commercial company, and instructing it to achieve a range of targets. If the targets are missed, the management loses the franchise and is replaced. The board itself would be kept honest by having to stand for election. Its main concern would probably not be millions of domestic consumers but the smaller number of companies and local authorities who were big consumers of its product. They would have enough commercial exposure to take a close interest in how the mutual was run.

The sad fact is that in the UK the state has generally made a crummy capitalist. It has chronically denied finance to its enterprises because of concerns about public borrowing statistics. And whatever the theory, it has seldom left managements at arm's length to manage but interfered with pricing and other decisions on political grounds. Mutualisation removes artificial borrowing restrictions and day-to-day political interference, at a stroke.

As an idea, it fits well with the Blair zeitgeist. It conforms with the anti-statist mood and chimes well with the trend to devolution - unbundling government and allowing people, in this case consumers, to take more responsibility.

Where might the Government start? The obvious place is Scottish water. There is a manifesto commitment to retaining "democratic control" but the companies are strapped for investment funds. And this is a case where PFI is not suitable. Moreover, there is a sweetener for the Treasury. The Scottish water companies are carrying debts of pounds 1.3bn. If the assets were given away to consumers in a mutualisation, those debts would be given away too. The companies would refinance them and repay the Treasury. Hey presto, a nice lump sum off the PSBR, just like an old-time privatisation.

`Effects of UK Utility Reform', Dr Eleni Markou and Professor Catherine Waddams Price, IPPR, 1997.

Gerald Holtham is the director of the Institute for Public Policy Research