Educators are anxiously watching the progress of the country’s first experiment in school privatisation, and the current picture is not a pretty one.

When Education Alternatives Inc took over the running of 32 public schools in Hartford, Connecticut, a year ago, it sold itself to the city school board with a failsafe contract: if EAI didn’t save the board money, it wouldn’t be paid. Even at the time, the deal may have seemed too good to be true to some observers.

Free-market advocates have made grand claims for the privatisation of the United States’ troubled urban schools. The profit motive, they say, can cut out the flab of the education bureaucracy, improving grades while cutting costs.

But while EAI has billed Hartford $5.5 million (Pounds 3.4m) for work renovating school buildings and installing computer systems, so far the board has refused to pay. EAI insists it has saved money; the board says that under its accounting EAI has not delivered a surplus from the existing school budget.

Companies such as EAI claim public schools are potentially a huge growth market, but the snags have sent its stock into decline. This month, as it announced losses of more than $7m in the year, its share price fell by nearly a third.

Privatisation schemes across the US have been bitterly opposed by teachers’ unions, who see them partly as a back-door attack on pay. In the tiny school district of Wilkinsburg, Pennsylvania, the switch to private management by Alternative Public Schools, a Tennessee firm, brought teacher lay-offs and has provoked a court battle.

In Washington DC the school board voted recently to allow individual public schools to sign up with private management companies, after bitter political infighting. EAI is already running inner-city schools in Baltimore, Maryland. It recently saw its contract there extended for a year, with evidence - though much of it disputed - of slight improvements in grades.

Hartford’s problems are typical of north-eastern cities that have seen companies, jobs and middle-class people leaving for the suburbs in a time of low economic growth. The city spends heavily on its 24,000 students but its grades are the lowest in the state.

EAI says that since taking over the schools it has laid out $9m of its own money in a $20m initial investment to modernise the system. At the same time it claims to have saved the board several million dollars by helping to negotiate a freeze in teachers’ salaries and an early retirement programme.

But sceptics suggest that EAI, which predicted it would be able to cut costs by between 5 and 10 per cent, has overestimated the amount of fat that exists to be trimmed. The board’s lawyers say the books do not show any savings.

The two sides have already exchanged letters claiming breach of the five-year contract, in a relationship that observers say was uneasy from the start. The company is eager to take over the management of the city’s entire $200m school budget to prove to investors that it is a rapidly growing company, but board members have baulked.

So far they have resisted calls from local teachers to abandon the contract altogether. That would likely spell disaster for EAI’s finances and bring a significant setback for the whole privatisation movement, in which the company is a major player.

“We are very committed to our partnership in Hartford,” said Chris Bauer, an EAI spokesman. “We hope that we can resolve any issues quickly and amicably. It’s a top priority and we continue to work with the board.”