Nuanced Privatization

As Sheldon Richman explains, what American politicians pass off as “privatization” is usually merely government contracting. Government outsourcing now permeates the military establishment, schools, social service agencies, prisons, and even regulatory enforcement. Hiring private contractors, as Richman points out, does not shrink the size of government or the scope of government services; if anything, it expands it by allowing the government to do ever more. The “privatization” that is merely government outsourcing creates incentives for private firms to lobby for the expansion of the relevant government services—besides the private prison operators lobbying for longer sentences and more criminalization, other entrepreneurs lobby for the state to start new social service programs that the contractors expect to run, and so on. Such contracting has the additional insidious result of skewing tangential markets in the private sector, because the large firms that get lucrative government contracts can then underprice (and eventually eliminate) their competitors in other markets, using the taxpayer dollars they receive as leverage rather than competing fairly.

Worse, outsourcing often is a bad deal for the taxpayers—one-quarter of federal contracts have no competitive bidding (thus, no competitive pricing), and many firms that lock in a government contract can later raise the price dramatically, knowing that the agency involved cannot easily switch to another contractor. The government is certainly less efficient than the private sector; but less efficient still is the government hiring the private sector to do the government’s job. True privatization is the government withdrawing from a field and leaving it entirely to the private sector.

One quibble I have with Richman’s discussion concerns the following:

Government elementary and secondary schools could be turned over to the people who work in them or the students’ parents, or both groups, who would be free to decide how to run them—without tax money. A government university could become the property of its students, members of its faculty and staff, or both. Some schools might organize as joint stock companies with tradable shares, while others might become consumer or producer cooperatives.

Devolving educational institutions to local communities is a fine idea in principle, but Richman seems unaware of the type of corporate entity typically used for such endeavors. Nonprofit or “non-stock” corporations, trusts, institutes, and benefit corporations are the usual model for such community-benefit organizations. Believing in free markets does not necessarily mean believing that all goods and services are best provided by for-profit entities. Certain useful institutions, like schools, parks, and hospitals, originated in the nonprofit (religious) sector; they often work reasonably well as projects of philanthropists or volunteer organizations.

Richman makes a useful contribution to the literature in this area by opening the discussion about how privatization should proceed—that is, the most effective way for the government to turn over its assets or activities to the private sector. We could take these points a few steps further.

Not all government assets and services are the same. It is very different to have the government withdraw from an area where it is competing with private entities, whether charities or for-profits, than to withdraw from areas where it (government) has long been the sole provider. In the former scenario, where the government is competing with existing private-sector alternatives (schools, certain social services for the poor, etc.), it is relatively easy to withdraw from the field and let new or existing private firms occupy and compete for the newly available market share. The latter situation, where the government has traditionally been a sole provider, is more complicated. Hasty privatization in these scenarios can easily result in an anticompetitive, government-created monopoly due to the lack of available competitors, the potential for obtaining an exclusive market by bribing officials, and the cultural tradition by which consumers expect a sole provider and feel uneasy about competitors.

Even where there are nonprofit and for-profit competitors with the government, as in education, we must ask the extent to which hefty government subsidies already skew the area—as with student loan programs. Under our current regime, privatizing all the state universities would merely result in more tax dollars flowing to private universities, due to the prevalence of the government loans and subsidies for education. As tempting as it might then seem to abruptly terminate all Stafford Loan programs, grants, and subsidies, there would be significant risks (i.e., market-skewing consequences) in taking drastic measures all at once. The for-profit schools are arguably more dependent on federal student loan programs (and have a higher default rate among graduates) than are the nonprofit religious schools, who receive a share of their income from private donors.

Thus, we also need to ask ourselves whether we want most of the surviving schools and universities to be religious schools. This was the situation before the government moved into the field and started competing in education. Religious movements pioneered the development of large-scale educational institutions, and the government entered the arena in the nineteenth century to provide a nonsectarian alternative. One very possible scenario after a government divests itself of educational activities would be a return to the sectarian domination of the field. Education is not, it turns out, terribly profitable without a great deal of non-tuition revenue, either from religious tithes or from taxpayer subsidies (student loan and grant programs). Religious groups will continue to have the resources and willpower to prop up their schools and colleges; it is unclear whether secular counterparts will do the same. Some will object that private, non-sectarian schools like Harvard University and the University of Phoenix thrive without religious funding, but they have long depended upon government funding as opposed to tuition that students pay out-of-pocket. It is not clear how many of these secular institutions would remain viable without the government throwing money at education. Perhaps it would be perfectly acceptable to return to sectarian-dominated education, but it is worth discussing beforehand.

Finally, it would be helpful to inquire as to the type of market failures or conditions that led to the government moving into an area in the first place—like public transportation. Was it merely demand by the poor for free stuff? Or were private firms that provided certain services (like mass transit) simply unable to survive, due to the market conditions? There is some historical evidence for this in the case of transportation. While we can imagine private firms providing public services that we now take for granted, there are situations in which an insufficient number of consumers would be willing to pay the prices for a service that the private firm would have to charge in order to stay in business. Government programs are, of course, often nothing more than redistribution—voters demanding free services— and these should be the first candidates for government contraction. These are, perhaps, the majority. Yet the cases where the government stepped in because of a genuine, chronic market failure—a useful service was for some reason unprofitable—we should proceed with more caution. These situations may be good candidates for turning the field over to nonprofits, trusts, volunteer associations, and non-stock institutions.

Also from This Issue

Lead Essay

  • From State to Society by Sheldon Richman

    In a sweeping essay, Sheldon Richman explains why private property and free competition are superior to state-provided goods and services. He warns against granting “private” corporate monopolies, which are not true privatizations, but act as arms of the state. He adds that for many state activities, the best way to privatize is not to provide the service at all — as in the case of punishing victimless crimes, which no one should do. For legitimate services, he recommends a “homesteading” approach, in which stakeholders in a public service, such as a school, would receive shares in a new, independent corporation.

Response Essays

  • The Incremental Approach to Privatization by Leonard Gilroy

    Leonard Gilroy argues for the benefits of incremental privatization. The general public, he writes, must still be convinced that private entities can perform many of the services that have for a long time been provided by monopoly government entities. To win them over, demonstrations will be necessary, and these should be incremental in nature. Gilroy cites several such attempts and argues that they have successfully built support for the idea of privatization.

  • Paying Attention to Incentives by Randal O'Toole

    Randal O’Toole argues that the difference between success and failure in privatization is primarily a matter of incentives. He cites examples of failed incentive structures, like British Rail and New Zealand’s fishing quota system, as well as some successes: Denver’s Regional Transit District has contracted bus service that runs for half the cost of its government-operated lines, and Atlantic City has an entirely private bus fleet.

The Conversation