Useful Second-Bests

Some free-market advocates argue that any action short of complete privatization of publicly owned resources and infrastructure is a betrayal of free-market principles. My previous post agreed that some “half-way” measures may actually foreclose complete privatization because they create special interest groups that will lobby against such action. At the same time, I argued that some intermediate steps towards privatization may be necessary for complete privatization to ever take place.

In this post, I want to make the additional case that there may be some halfway measures that fall short of complete privatization without foreclosing it, and that—even if they don’t accelerate true privatization—these measures may be useful second-best solutions when there is strong opposition to outright privatization. Two such halfway measures are certain kinds of public-private partnerships and user-fee driven public agencies.

Public-private partnerships are a common if not the most common way of building new highways in Europe. The term has also been used to describe a way of financing and operating transit lines in the United States. But these are two very different institutions. For simplicity, I’ll call them the “lease model” and the “franchise model,” though these are not terms commonly used in the transport industry.

Under the lease model, the government offers to allow private companies to build a highway or other transport facility. Companies may bid on the right to build in a particular location. The winning bidder puts up private capital to pay for the facility and has the right to toll it for several decades. At the end of that time, the facility reverts to public ownership (which would probably put operations and maintenance out to bid to the same or another company). Taxpayers put up no money (though they may provide right of way), and the private investors accept all the risk that tolls may not earn them a profit.

The State of Indiana adopted this model when it offered to lease the Indiana Tollway. Several consortia of companies bid on that lease and the winner ended up paying the state $3.8 billion for a 75-year lease to collect tolls while operating, maintaining, and where demand exists, improving the tollway.

Under the franchise model, a transit agency asks private companies to bid on building and/or operating a transit line. The bids are invariably negative: the agency has to pay the company to provide the transit service. While American transit agencies have a proven track record of using franchises to save money on bus operations, in the case of new construction, the savings may be small or non-existent.

When Denver’s Regional Transit District (RTD) adopted this model to build three new rail lines, the purpose wasn’t to save money but to subvert voter intent. Voters had agreed to increase sales taxes to build new rail lines but put a limit on the amount of debt RTD could incur at one time. When (predictably) costs ballooned after the measure passed, RTD contracted out construction so that the private companies could borrow the money—money that RTD was still obligated to pay out of tax revenues but that was not on RTD’s books as debt.

Obviously, the franchise model is not efficient and even encourages waste. But I don’t see any serious free-market problems with the lease model, particularly if the contracts place as few restrictions as possible on both parties.

Another model that falls short of complete privatization yet is worth considering is that of a government agency funded exclusively out of user fees. For example, Florida and Texas allow counties to create toll road authorities. The authorities can sell bonds, build roads, and repay the bonds out of tolls. They cannot collect taxes and, if they default on a bond (which rarely if ever happens), county taxpayers are not obligated to cover the loss.

Another example is state land agencies, which manage their lands in trust for public schools or other programs. These agencies charge user fees, some of which go to agency operations and some of which go to the beneficiaries. They can even sell their land or other nonrenewable resources, in most cases putting the revenues from nonrenewable resource sales into a permanent fund for the beneficiaries. The fact that the courts treat these agencies as fiduciary trustees makes them legally obligated to operate at a profit.

When an environmental group in Washington urged the state land agency to reduce timber cutting to protect a rare species of wildlife, the agency agreed to do so—provided the environmentalists maintained returns to the beneficiaries by outbidding timber companies for the timber. The environmental group quickly raised nearly $20 million to do so.

In short, county toll agencies and state land trusts largely face the same incentives as private businesses. Ardent free-marketeers may argue that such agencies cannot be truly be insulated from politics, but so far both county toll agencies, at least, have been no more influenced by politics than private service companies. On the other hand, there are plenty of examples of private owners who are either subsidized and/or subject to a variety of political and regulatory pressures.

Neither the lease model nor the user-fee model forecloses complete privatization. Indeed, they may actually hasten privatization once these models prove that user fees are sufficient to operate well-managed infrastructure and resources.

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.

  • Nuanced Privatization by Dru Stevenson

    Professor Stevenson agrees that much so-called privatization does not deserve the name. It both fails to shrink the government and also creates new constituencies for government spending–the private firms who win lucrative contracts. That said, we must think very carefully about what a more privatized world would look like, and whether we would really prefer it in all cases. Are we comfortable, for example, with the largely religious education system that would likely replace state-run schools?

  • 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