The Work Programme (WP) is the Coalition Government’s £5bn replacement for the range of programmes – including the Flexible New Deal – designed to assist unemployed people back into work. While the WP learns from and builds upon previous initiatives it also represents a departure. Its key characteristic is a more thorough-going application of the Payment by Results approach.

Last week the Social Market Foundation published a brief report on the Work Programme, which got a fair bit of coverage in the mainstream media. The headline conclusion is that all is very much not well with the new approach, as currently structured. The programme is, as they put it, at risk of “financial collapse”.

Even if assistance for the unemployed isn’t particularly your interest, this debate is important. It has much broader resonance in the light of current directions for public service reform.

The SMF argument revolves around a combination of three things: the demanding performance expectations DWP has placed upon contractors; the reduced financial resources available to support each unemployed client; and the deterioration in the economic environment.

The SMF has crunched some numbers, using recently available data from the Flexible New Deal, and projected forward the likely levels of performance under the WP. It arrived at the conclusion that the vast majority of contractors are unlikely to be able to meet the expectations placed upon them, which could trigger widespread contract default. Even if the Government do not consider poor contractor performance to have voided the contracts, the likely level of performance will not generate sufficient resources to make the activities financially viable for the contractors.

The SMF identifies the arrival of the recession – with the consequent increase in the number people needing help and the reduction in the number of vacancies – as pushing already challenging targets for successful work placements even further out of reach. The SMF argues that this is all likely to be particularly problematic for small voluntary sector and not-for-profit providers of specialist secondary services to the primary contractors. The extent to which that is the main issue perhaps needs further exploration. Today’s Inside Housing notes that some housing associations have already turned their back on WP because either it didn’t make financial sense from the start or they are not getting referrals from primary contractors at the anticipated rates – which is a rather different problem from not being able to secure a successful placement for the people who are referred. Some are setting up alternative local schemes to help the unemployed.

The core of the solution to these problems, from the SMF perspective, is to reduce performance expectations in general and change the nature of the contracts under the WP so that performance expectations can vary over time in systematic ways related to the economic cycle. As the economy enters recession expectations around rates of successful work placement can be scaled back, whereas in times of strong economic performance and labour shortages the Government could reasonably press for more ambitious targets to be met. A number of other proposals are advanced, including the need to consider increasing the outcome payments per placement during recession in order to ensure the viability of WP providers. The argument here is that “widespread financial failure among providers will ultimately be more costly for taxpayers and jobseekers”.

The Government response to the SMF report is predictably negative. The principal line of argument is methodological: it is to rubbish the idea that you can use data from the Flexible New Deal to make any inferences about the WP because they are not the same. It is clearly true that the programmes are not the same. It is equally true that forecasting of any type is a challenge, and that challenge is magnified in periods of economic turbulence. But, with all the usual caveats in place, I would have said that the SMF has been pretty fair in its assessment. If anything, it has been relatively optimistic. Therefore the conclusion that the WP is going to miss its targets so spectacularly is even more of a challenge to the approach.

The Social Market Foundation can rightly claim to have strongly influenced the development of the approach embodied in the Work Programme. And it is happy to make the claim. Its 2009 publication Vicious Cycles made proposals for reforming active labour market policy in ways that are very similar to those subsequently used in the WP.

It is therefore, perhaps, all the more striking that it is the SMF that is raising these concerns about the programme.

On the other hand, it means that the extent of the critique of the WP offered by the SMF is limited. It is largely technical. It is about tweaking the system to make it more viable, rather than questioning whether the approach adopted is the right one.

But I think there are some more fundamental questions that should be asked about the WP.

The programme was established in the face of a recession. How is it that no one involved in structuring the contracts apparently considered that performance might be correlated to the state of the economy? If you accept the premise that the WP is a good approach, then that would appear a fairly elementary oversight.

When you study public economics one of the starting points is that markets are not good at dealing with systemic risks. Indeed, this is often identified in the general economic textbooks as one of the key market failures. That is why private insurance markets do not cope well with things like unemployment or mortgage payment protection. If the volume of claims is correlated to the economic cycle then that’s problematic for the financial viability of the insurance scheme. The argument – in combination with others – can be used as a justification for mechanisms of social protection. The analogy with the WP is clear. The service being provided is critically dependent upon the economic cycle – both in terms of the rate of inflow of clients and the rate of outflow – so performance is inevitably going to vary significantly. And, arguably, at the times the service is most urgently or extensively required, it is going to be least able to deliver. It is therefore obvious from the outset that contracting with the private sector for the service is going to need to be flexible. But flexibility changes incentives. It might well be possible to argue that the level of flexibility required is such as to render the whole approach problematic.

The SMF modelling work was based upon performance under the Flexible New Deal and the WP was found wanting. Yet, the whole argument for switching to the WP was that it should be more effective and efficient than the preceding system. Otherwise, what was the point? If we consider that the levels of outcome performance achieved under FND are as good as we’re going to get then the WP better be cheaper. If, on the other hand, we are paying the same as under the FND then we should reasonably expect better outcomes. Otherwise, again, what’s the point? If the only way for the WP to remain viable would be to expect the same level of performance as the FND and to pay the same for it then all the policy has achieved is the privatisation of policy delivery.

The argument that it may be necessary to increase outcome payments in order to avoid the financial failure of contractors, because it would work out to be more costly for taxpayers and jobseekers, is one that needs closer scrutiny. The whole point of moving to the WP is to sharpen incentives. If you move to a system is designed to ensure that contractors do not fail then you have largely removed those incentives. If you don’t think that allowing providers to fail for underperformance is acceptable because it impacts negatively upon jobseekers and the taxpayers then maybe, just maybe, the whole premise of the payment by results/contracting out approach is flawed. Or, rather, it works in theory but the practical politics of it mean that it cannot be made to work in practice.

Why is this important? Well it is important because the Government is considering applying the Payment by Results regime to a policy area near you. It is an integral part of the agenda set out in the Open Public Services white paper. The Work Programme is one of two areas of activity – the other being projects under the Ministry of Justice aimed to reduce reoffending – held out as successfully blazing a trail for this approach. If the WP is deeply flawed – and the SMF are not the only organisation to raise concerns – then that is an issue of much broader significance.

The management consultants and market fundamentalists are gung-ho for Payment by Results. It is seen as a mechanism of wide applicability for delivering better public sector performance. It may well work in some spheres. In areas that are not cyclical or where contract failure does not impose unacceptable or disproportionate costs, for example, it may be possible to write appropriate contracts. But the suggestion that it can be applied all over the place needs very careful scrutiny. The absence of detailed critical engagement with these arguments is worrying.