Kaveh Pourvand: Why the cheapest bid can cost economy dear

Sheffield Forgemasters
Sheffield Forgemasters
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GEORGE Osborne has set great store by the need to rebalance the economy as the UK tries to scrape its way out of the downturn. One might have expected this to have involved real support for our stricken manufacturing sector. Indeed, the Chancellor himself said he wanted to see Britain “held aloft by the march of the makers”. And yet the Government has missed a series of opportunities to re-energise ailing UK industries.

In a new paper for the think tank Civitas, I studied two cases in which procurement contracts were given to overseas bidders said to be more competitive than British firms: the award of the Thameslink contract of 1,200 new train carriages to German-based Siemens rather than Derby-based Bombardier, and the £452 million ship-building contract for four new Royal Navy transport vessels which went to Korean-based shipbuilder DSME.

In both cases the Government followed the “supermarket shopping” approach to procurement, whereby large scale public contracts are put out to tender in the same way you or I would purchase grocery items. Like the frugal shopper, the Government picks the lowest-priced item that meets its requirements. Defenders of this approach say it ensures companies offer the best price: the Government should not show any partiality towards domestic bidders as that would not help get the best value for taxpayers’ money.

The problem with this is that the economics of certain industries, such as ship or train-building, are very different from pasta production. There are few buyers – typically only governments – and contracts are often for a small volume of very high-value items that take considerable time to build. If, say, a large train manufacturer loses a major contract bid it may have to wait years before it can bid again. Since it has no money coming in, the company is unlikely to innovate and invest to try and win the next contract; it will inevitably cut staff and reduce capacity. This sets in motion a chain reaction in the wider economy: as one site closes, its suppliers are also likely to go bust. It doesn’t take a genius to realise that this is unlikely to render British train manufacturing more competitive the next time a major contract comes round.

The economics of the energy sector are very similar to ship-building and train manufacturing. The contracts are simultaneously very long-term, high in value and few in number. Building strong domestic capacity in nuclear power similarly needs strategic direction from the state. As in other British sectors, this has been missing in recent years.

One of the most baffling decisions by the present government was to rescind the £80 million loan to South Yorkshire engineering firm Sheffield Forgemasters. The loan, initiated by Lord Mandelson under the last Labour government, was conditional on Forgemasters building a 15 kilotonne press, which is used to produce the ultra-large forgings that are an essential component of modern nuclear reactors. Had the press been built, Forgemasters would have been among the small handful of companies worldwide with such capability. But the incoming coalition government said it needed to save money.

The rationale of the Forgemasters loan was to make a tentative step towards strengthening the domestic supply chain in one key energy sector, thereby allowing the domestic economy to accrue more of the benefits from the planned nuclear expansion. Instead, the chance to build capacity in a key sector was lost in the hope that commercial banks would fill the funding gap, which they did not.

Large parts of British industry are caught in a Catch 22: they cannot obtain government contracts because the sector lacks the capacity to be cost-competitive, yet that capacity cannot be built without government contracts. Meanwhile, the overseas firms that beat British firms in procurement tenders operate in industries which have been given carefully targeted support by their respective governments.

This is not to argue that government should always favour British bids: value for money should always be an important consideration.

But it is not the only consideration. There needs to be more recognition of the trade-offs involved in procurement decisions: between securing taxpayer value and avoiding inefficiency on the one hand, and maintaining domestic capability in key sectors on the other.

The great appeal of the supermarket approach to procurement is that it absolves civil servants and politicians of the need to exercise judgements for which they are subsequently accountable. Instead, difficult political decisions that involve weighing up several valid but competing criteria are reduced to the administrative procedure of finding the lowest price. This is not the way to rebalance the economy.