How the Post Office can be set free

The solution is to create a publicly owned company which reproduces commercial disciplines

THE DEBATE about the future of the Post Office is warming up again. The market in postal services, already transformed by fax, e-mail and the private courier, faces further upheaval as collection, sorting and bulk transport of mail is opened up to pan-European competition.

There is no reason why your letter to France could not be collected and taken to France by the French PTT rather than the Royal Mail, and no reason why the two carriers should not compete directly for your business. The only natural monopoly in postal services is the local delivery network.

The post is very much a network business, rather like airlines. Other national postal carriers are already competing, as airlines compete, by forging alliances to establish the best network. The Dutch Post Office acquired TNT in 1996. The German Post Office took a 25 per cent stake in DHL earlier this year.

The UK Post Office needs to be set free to respond to these initiatives. It is a profitable organisation, and it needs to put more of those profits back into the business (it is currently required to hand over too much to the Government). It needs to be able to tap the market for funds when it sees fit. And above all it needs freedom to make acquisitions and enter into joint ventures.

So why don't we just privatise its operations? The short answer is that the Government is committed to keeping them in the public sector. And if we give it more freedom in the public sector, it will be our money that it spends. The Treasury, that zealous guardian of the taxpayer's money, has always resisted demands by nationalised industries to invest more, because such investment counts as public investment, paid for by higher taxes or higher borrowing.

However, a knee-jerk reaction against public investment is old Treasury thinking. In opposition, Gordon Brown repeatedly declared that Britain needed to invest more. In office he has changed the control system of public spending to relax the constraints on public investment. New Treasury thinking is the so-called "golden rule" that government current spending must not exceed current income, but capital spending is not constrained. So under the new rules the Post Office could be allowed to invest more, even if that does drive up public borrowing.

The only good reason for stopping such investment is that it might be unproductive. Here the Treasury has a stronger argument. The Post Office borrows at the same low rate as the Government, because lenders believe the taxpayer stands behind them. The hurdle rate for its investment is thus too low. Demand for these cheap funds exceeds supply, so the Treasury rations them, both to prevent misallocation of resources (excessive investment in postal services) and to stop the Post Office gaining an unfair advantage over its competitors.

However, capital rationing is incompatible with commercial freedom. The solution is to allow the Post Office to borrow all it wants, but on commercial terms and at a commercial price. The Government must formally remove its guarantee on Post Office borrowing. This, however, requires a major rethink of the Post Office's status and of the incentives and disciplines under which its managers work.

London Economics has been doing research in this area for some years, and has long argued for the Independent Publicly Owned Company or Corporation (Ipoc) which would reproduce commercial discipline inside the public sector. An independent Post Office, like the independent Bank of England or the independent BBC, would be set objectives by government and then be allowed to get on and manage. There would be no ministerial interference in pay, no Treasury control over investment, no sudden changes in the price of stamps or the Post Office's required cash contribution, just because the government of the day has problems with its own finances.

Experience from other institutions and other countries shows the benefits of creating an arm's-length relationship between the owners of an organisation, who set long-term objectives, and the managers who take all the short- term decisions. The rules of the game in an Ipoc are that the managers can do what they like, but if at the end of (say) five years they have not delivered, their jobs are on the line. This is essentially how the modern plc is run. Shareholders appoint managers to run the company and deliver a profit. They can do as they please while they are in charge, but if they fail to deliver the profits, they go.

There are important differences between the Post Office and a normal plc. Like most other organisations in the public sector it has a social objective - for example, to maintain a universal letter delivery service. These objectives could be spelt out in a charter. The task of the Ipoc would be to meet these social objectives in the most cost-efficient way.

This would in practice require the imposition of three key disciplines on the Ipoc, which mirror the three main commercial disciplines on the managers of a plc:

t Cost discipline in the plc comes from the objective of maximising profits. This would be reproduced in the Ipoc by setting profit targets.

t Price discipline in the plc comes from competition, or failing that from regulation. The Post Office already faces stiff competition in much of its business. The monopoly part (letters under pounds 1) would need to be regulated.

t Investment discipline in the plc comes from the requirement to make a commercial rate of return and the ultimate threat of takeover or bankruptcy if too many projects make losses. The Post Office as an Ipoc must be subjected to the same disciplines of market rates of interest (no government guarantee) and the ultimate sanction of losing the business if it fails.

To impose the proper discipline on potential lenders to the Post Office, the Government must formally remove its guarantee. It must also spell out what would happen in the event that the Ipoc running the Post Office fails to meet its targets. This would be a public sector version of bankruptcy, in which lenders to the Ipoc would lose money (no government bailout) and those running the Ipoc would lose their jobs.

People will argue that this is unrealistic - that postal services are too important to be allowed to cease. But this is to confuse the activity (postal services) with the Ipoc that manages the activity. The activity must always continue, but we must have institutional arrangements whereby it can be taken out of the hands of a failed Ipoc, which is then wound up.

Wouldn't it be simpler just to privatise and regulate? Not necessarily. The key to getting public sector organisations to perform more efficiently lies not in the change in ownership per se, but in the accompanying changes in incentives and culture.

In the end it all comes down to human behaviour. We could get results from the Post Office operating as an Ipoc under a charter as good as from a Post Office plc - and we would avoid the well-known privatisation problem of selling it off too cheaply.

Bill Robinson is Director of the Strategy and Policy Practice at London Economics