What Future for Social Policy?: Public-Service Privatization: Ideology or Economics?
Sclar, Ellioti D.
In a February 1993 New York Times op-ed article, a municipal bond analyst for a major security rating service argued that the cure for New York City's fiscal problems was to force it into...
...That in turn puts pressure on political leaders to make government more cost effective...
...Only rarely will the provision of products to government and profits to sellers coincide in the manner idealized by Adam Smith...
...The writer's only evidence that this could work was an anecdote about a small Michigan town that did precisely that and reportedly saved massive amounts of money...
...The second situation is a variant of the first...
...3) the perception of public work...
...It is difficult to argue that the replacement of lower cost direct-service personnel by higher cost supervisors is a cost-efficient reorganization...
...I have been studying the economics of public-service privatization for six years...
...In fact, bureaucracies grew and costs increased...
...there is a pervasive belief that public workers are overpaid and underemployed...
...Some local school districts find it is more economical to provide school bus service...
...Blame is thus shifted from the private contractor back to the stereotypical public bureaucrat from whom no one expects any better...
...But this regulation was prompted by the finding that close to $200 million per year in taxpayer money ends up in the coffers of organized crime through the contracting system...
...Total hospital costs were expected to decline and both hospitals and government were supposed to cut their billing bureaucracies because of the system's simplicity...
...No one seriously defends the proposition that hammers should cost $80 or toilet seats $600...
...The instance in which savings were achieved is hailed as proof positive that more privatization would save more money...
...Even if the public sector operates as efficiently as possible, there is an inherent inflationary bias in the cost of many public services...
...How did Dwyer know that the proposed privatization would actually save rather than cost money...
...Consider the history of one Reagan era effort to use markets to shrink red tape and bureaucracy: hospital reimbursements by Medicare...
...There is no reason to believe that public managers will be more successful with archaic and ineffective techniques than private managers were...
...Occasionally, when news stories about fraud or price fixing became politically intolerable, miscreant contractors were given a slap on the wrist...
...Once scandal erupted, the city's Department of Investigations was forced to reconstruct the chain of events that led to an influence-tainted contracting process...
...More important, the much vaunted competitive market of many bidders never materialized...
...They have customarily been called "make-buy" decisions...
...Second, the issue of public-sector productivity must become central to a progressive agenda...
...It was easy up to eleven or twelve," said his chief aide David Cohen...
...2. Public Sector Productivity...
...When the legislation was written, the advocates, many acting from sincerely held beliefs about the beneficence of markets, were trying to put a truly competitive bidding system in place...
...Thus, some automobile manufacturers find it is more economical to produce the components that go into their vehicles, while others find parts suppliers a more cost-effective option...
...The decline of a high-wage manufacturing economy in the United States is a well-known fact...
...The RTD's decisions increasingly reflect the political calculations it must make among its contractor stable, its unions, and the state legislature...
...Because of its vital mission, it needed to be subsidized...
...Such third-party payment is a form of contracting out...
...the highest is $58.75 and the lowest $54.65...
...In fact, public employees have made no real wage gains in recent years, and their earnings have remained 4 percent to 5 percent below those of private-sector employees in comparable occupations...
...If we create still more artificial markets through expanded privatization of traditional services, the public sector' will become less effective on two counts: regulation will absorb ever more resources and government will lose its ability to do for itself...
...Other more ambitious ventures are on the drawing board...
...Thus if everything worked out ideally, overall budgetary savings have an outer limit of about 10 percent...
...Yet for the editors and most readers of that day's paper it was probably the case that neither the idea nor the evidence seemed implausible...
...Thus, although a second look under the guise of privatization may yield some overlooked nook or cranny where buying is cheaper than making, this is not what privatization advocates have in mind...
...The only thing I can say for sure is that the cost savings case in a large number of instances is dubious at best...
...Computers help mainly by making information more accessible, not in 330 • DISSENT Public-Service Privatisation education's central mission of guiding human development...
...The idea is simple...
...In Massachusetts, the Weld administration vigorously opposed a recently enacted law that mandates strict cost studies before privatization efforts can proceed...
...The needs of the riding public become even more difficult to accommodate in light of the needs of these other, more powerful groups...
...Ignoring its own contracting procedures, the RTD allowed Mayflower to "revise" its initial bid and keep its routes...
...It views transit as necessary only for a marginal population in a society where the truly productive drive cars...
...and (4) the emergence of a vigorous promarket political ideology...
...Public workers with health and pension benefits and some job protection now stand in stark contrast to the taxpayer/workers in the private sector who have been stripped of comparable status...
...Even though 60 percent to 75 percent of typical public-service spending is for employee costs, only about half to two-thirds of that is spent on direct service provision—the costs that would be immediately avoided through privatization...
...The balance is spent on management, materials, debt services, and so on...
...Let us consider each of these...
...The perception that public workers have surged ahead of private workers is a reflection of deindustrialization in the private sector rather than profligacy in the public sector...
...It was nothing more than a presumption based upon conventional wisdom...
...If we are to change this situation, two actions are imperative...
...The only study done by New York City before it embarked on its privatization venture suggested that it would likely cost the city an additional $61 million...
...In the absence of personal risk, governments institute regulations to protect public resources...
...Instead, they were divided into three independent bidding "packages," each of which contained a mix of high and low revenue routes...
...Thus, if privatization moves into the areas of more traditional public service, we will need even more bureaucracy to handle the burgeoning oversight and supervision functions...
...others find contracting less expensive...
...In this case every effort was made to ensure that it would be...
...The two major determinants of the productivity of bus drivers are the amount of congestion on the streets and the number of people boarding the bus...
...When New York City attempted to privatize the Parking Violations Bureau, city officials hoped to find perhaps two or three competitors to bid on the project...
...The best ideas in modern policing require more officers to spend more time walking the streets...
...The intellectual and political shortcomings of this approach have been abundantly demonstrated by the high rates of productivity achieved by Japanese, and, increasingly, American, industry with management methods based on cooperation rather than coercion...
...Many Americans believe that the government that governs least, governs best...
...However, thanks to the new conventional wisdom, it pursues its ideological goal under the banner of a pragmatic concern for government efficiency...
...Yet as it is typically the case in public contracting, the situation evolved into one of oligopoly—competition among a few sellers...
...Cost and efficiency considerations are now beside the point...
...The routes were carefully chosen to be representative of the entire system...
...More money will be spent for less output, the worst outcome for liberals and progressives, but tolerable for conservatives...
...Privatization occurs when political leaders move beyond traditional "make-buy" decisions and seek to have private organizations take over provision SUMMER • 1994 • 335 Public-Service Privatization of goods or services central to the mission of the public sector...
...Hospitals tell those who are about to overstay the allowed DRG that they have to leave because government bureaucrats won't allow any more money for their care...
...No one contractor could have all of them...
...Economists do not call such determinations privatization...
...No one has come up with an inexpensive alternative to regulation for protecting public resources...
...When the real problems of a less than ideal world are taken into account, the likelihood that short-term savings rather than short-term cost increases will occur is small...
...By the time the cold war ended, the long and well-documented history of lowball initial contracts followed by massive cost overruns had made it impossible to argue that national defense privatization was cost efficient...
...This information will be fed into a centralized data base for the use of all state agencies engaged in contracting...
...The belief that sufficient sellers existed to sustain a competitive market was bolstered by economic studies that demonstrated that large firms do not have inherent cost advantages over smaller ones in the provision of bus services...
...The general rule is that when internal costs are lower than external ones, organizations "make" the product...
...In Philadelphia, which is now heralded as a model of privatization success, only about fifteen small operations have actually been privatized, such as a single nursing home and a single parking garage...
...Average Americans will suffer a worse drop in their living standards if the public sector is permitted to become more inefficient...
...Such is the danger in viewing privatization as a simple cost-effective solution to a public service problem...
...The Social Security Administration, which administers Medicare, had to expand its bureaucracy in order to monitor local hospitals more closely...
...The two hardest ones were Lincoln's Birthday and Flag Day...
...When the calculus is reversed, they "buy" from outside suppliers...
...In 1988 the RTD had an operating budget of about a hundred million dollars per year...
...The cold war has ended, but not the political influence of defense contractors over the federal budget...
...As long as the electorate believes this, it does not matter whether it is true: it gives elected officials and their political rivals an alternative to defending harder choices...
...Every privatization can be justified by ideological advocates as either money saving or quality improving...
...Yet it would be equally fair to cite it as proof of the damage caused by the profit motive...
...And patients became subject to a new form of eviction from hospitals...
...How do I know that...
...Putting the Debate Into Perspective In general there are two situations in which outside purchase of service can be cost saving...
...That was so far below cost that the RTD's privatization auditors concluded that Mayflower lost money at that price...
...Through the prodigious production of books, reports, model legislation, op-ed pieces, and so on, in which an idealized neatly competitive market is contrasted to the messy problems of everyday service delivery, conservatives have gained the advantage in the debate over public services...
...Public officials often concede that many privatizations are more expensive...
...Even the most optimistic of privatization advocates typically hold that savings of fifty percent are the best one can hope for through individual privatizations...
...Consistent with its new labor agreement with the RTD, Amalgamated Transit Union Local 1001 tried to win back the service provided by Mayflower through submission of its own bid...
...After all, the primary goal for private firms is profits, not public service...
...I estimate the present in-house cost for the same service at about $52...
...Conservatives, who generally oppose government programs because of their redistributional effects, have been able to seize upon this healthy skepticism, along with public concerns about the high cost of government service, to argue that markets provide a less expensive alternative...
...Typical of the strategy that large firms use to keep small ones out, Mayflower won the first and largest contract with a bid of $28.26 per revenue hour...
...Privatization carries the risk that the public sector will sink into a morass of ineffective regulation of overpriced and inefficient but politically connected contractors...
...Since publicsector employees need to be paid wages that are competitive with private-sector alternatives, these added costs are not easily offset by productivity improvements...
...The appeal of privatization is that it implies that it is possible both to maintain services and to cut taxes...
...Only about 20 percent of private-sector workers graduated from college compared to over 40 percent of public employees...
...Stories such as these have become the stock-in-trade of privatization advocates, in much the same way that conservatives used tales of "welfare queens" to gut the human service budgets in the last decade...
...But since some portions of the public budget, such as police and fire protection and portions of health care and education, would be politically and culturally hard to privatize, at most, about 20 percent of the budget is really at issue...
...These prices were more reflective of a profitable operation...
...Let's begin by considering the economics of public work...
...Even when individual corruption is not the issue, market incentives often have perverse outcomes...
...These are situations that by definition do not have thriving natural private markets, situations in which government is the sole or principal customer...
...So the 338,459 hours of privatized service cost the RTD an additional three million dollars over the cost of direct-service provision in 1993...
...Investigators asked First Deputy Mayor Norman Steisel why the city had proceeded despite its internal cost study...
...But what if the conventional wisdom is wrong...
...Thus it now costs the RTD approximately $61 per revenue hour for its purchase of contract service...
...At this point the issue of privatization was transformed from one of economics into one of politics...
...But until someone invents a new way to get around the problem of public risk, gains from reform are likely to be marginal at best...
...What happened...
...In the past it may have been necessary for government to maintain office supply warehouses where federal agencies could shop for supplies...
...The problem, of course, is that quality is in the eye of the beholder...
...By comparison, operating costs on publicly supplied services have risen on average only 1.9 percent per year...
...Once Mayflower had broken the ice, contracts to the two other winners, Laidlaw and ATC Vancom, were written at prices of $61.19 and $48.01 respectively...
...To the extent that we seek to have private organizations provide these goods and services, it frequently involves maintaining a stable of contractors who bid against each other in an artificial market created and supervised by government...
...1. Deindustrialization...
...In fact, in the three years following the privatization the average operating cost of the system increased by $8 million per year...
...Contracting then becomes even less a process of competitive bidding and more one of spreading the work around to keep the suppliers afloat...
...By implication, the privatization of 20 percent of the system should have led to savings of about eight million dollars per year...
...It is difficult to envision America sustaining itself as a progressive democracy with that role impaired...
...First, loose generalizations about the cost effectiveness of privatiza tion must not stand unchallenged...
...Thus hospitals have market incentives to be "efficient...
...The entire effort went forward on nothing more than the unproved but strongly held belief that privatization had to be cost saving...
...Through bulk buying and decentralized distribution locations, this arrangement brought far-flung federal agencies good value for their dollars...
...There are two problems with this vision...
...The average length of a hospital stay for that "bundle" is 332 • DISSENT Public-Service Privatisation determined from past experience and hospitals are reimbursed for a covered individual's stay with a flat fee based on that average...
...Thus only between one-third and one-half of total public spending is even amenable to short-term privatization...
...In 1993, it was $56.34...
...2) public sector productivity...
...When Edward Rendell ran for mayor of Philadelphia, he would challenge audiences to name the fourteen paid holidays given employees...
...For small firms with limited resources it will feel even worse...
...So it is not surprising that politicians across the political spectrum chant the mantra of privatization...
...Instead, the first fifty findings are typically dismissed either as methodologically flawed studies or as the results of incorrectly administered privatization efforts...
...Are there ways to streamline regulatory and oversight functions...
...But modern communications and overnight package services are such that even the most remote government locations can now get next day delivery from large discount office suppliers at low negotiated prices...
...Two factors in particular cause the difficulty: the need for accountability and the lack of competitive markets for most services that the public sector provides...
...The first is where government can avail itself of an existing efficient private market...
...However, they defend them as a management tool...
...From their point of view, such competition or the threat of it is the only way to move their employees to accept change in the workplace...
...Thus, when Mayor Rendell of Philadelphia contracts out the management of a parking garage or a nursing home, he is turning to an established private market for a service of known quality and price...
...The question is whether regulation is being efficiently carried out...
...The intention was to create a system in which the RTD was continually purchasing transportation service from the lowest priced seller...
...Even mild social democratic interventions such as national health services or single-payer national health insurance systems are thought to lead to gross inefficiency, bureaucracy, and even loss of democratic freedom...
...However, the shift in relative aggregate position has left public workers more politically exposed and vulnerable...
...Most products that can be purchased advantageously by public agencies are already being purchased...
...Effective social work requires intense and long-term contact between clients and agency personnel...
...Since typically between 60 percent and 75 percent of any government budget is made up of labor costs, it is assumed that if private firms replace government agencies in the direct provision of services, costs simply have to fall...
...Competitive markets do not naturally exist for many of the products for which government is responsible, such as education, law enforcement, treatment and care for the indigent and ill, aerospace exploration, and national defense...
...On the other hand, if one believes, as conservatives do, that beyond national defense and police protection the public sector adds little value to society, that is precisely the desired outcome...
...Although the debate over the cost effectiveness of privatization is frequently carried on as a pragmatic examination of alternatives, it is in fact a deeper ideological debate about the proper role of the public sector in society...
...Because government loses the ability to provide for itself, these bidders are not allowed to fail...
...Although there was much initial interest in the service, three national private companies ultimately captured the market: Mayflower Contract Services, Inc., Laidlaw, and ATC Vancom...
...Indeed, the preamble to the Colorado transit privatization legislation makes no bones about its view that the less transit service provided the better...
...3. The Perception of Public Work...
...The danger here is that ever more costly and complex public supervision of both the bidding process and the administration of contracts will be required...
...In a February 1993 New York Times op-ed article, a municipal bond analyst for a major security rating service argued that the cure for New York City's fiscal problems was to force it into bankruptcy and then to massively privatize public services...
...Such costly regulatory undertakings have sharply diminishing returns...
...But where everyone bears the risk, no one bears the risk...
...The reasons for inflation in hospital costs are not germane to this article, but the reasons for bureaucratic expansion are quite germane Hospitals quickly learned to increase staff in their medical records departments to ensure that their patient diagnoses maximized Medicare reimbursement...
...Undoubtedly...
...The abuses of the few necessitate regulations for the many...
...Such complex privatizations invite negotiated price making and influence peddling...
...Indeed, according to Rendell, a city worker could qualify for up to sixty-seven paid days off between sick leave, bereavement leave, and vacation...
...When they stay longer than the statistical average, the hospital bears the additional cost...
...It may well be the case that the public sector is doing a very efficient job within its constraints...
...The evidence from the history of defense contracting, NASA, Medicare and Medicaid, and so on, cannot be overstated...
...the contractors are now an integral part of the Denver transit process and must be politically accommodated...
...After four years the packages were to be reopened to competitive bidding...
...In the successful campaign to privatize some transit services in the Denver area, the conservative proponents were careful to have the legislation written to preclude comparing cost alternatives in terms of true taxpayer savings...
...However, given the complexity of the job, only one firm bid...
...Prices among the three 334 • DISSENT Public-Service Privatization vary little...
...Once contractors get into the public process they do not fade quietly into the night when needs change...
...The creation of Diagnostically Related Groups, or DRGs, was hailed by its champions in 1983 as a way to streamline the cumbersome reimbursement process...
...Because the most important services are highly labor intensive, they are not easily enhanced through labor-saving technology or workplace reorganization...
...And since privatization is essentially a process in which a privately paid worker is substituted for a public one, the economic case for it frequently comes down to the claim that the employment cost differential between the two is sufficient to offset the added costs of private-sector supervisors, overhead, and profits, plus the costs of public oversight and supervision of the contracting process...
...In the private sector business owners bear the finan cial risk for inefficient or fraudulent use of resources...
...More drastic action was impossible because the government had no alternatives...
...So privatization will save money and it will then be possible to have more service at the same level of taxation or the same amount of SUMMER • 1994 • 329 Public-Service Privatization service at lower taxation...
...From his perspective, the scandal was a teapot tempest stirred up by bureaucrats trying to hold on to useless jobs at taxpayer expense...
...Finally, it is the public sector that is the dispenser of social justice...
...The result is that it is possible to push ahead with the real conservative agenda of shrinking the public sector even as costs are increasing...
...Getting out of the mess will be far more difficult than getting in...
...Thus, it may well be that certain agencies can be drastically reorganized through "make-buy" decisions...
...Neither of these are improvable by the driver, whether publicly or privately paid...
...Such is the power of conventional wisdom...
...In 1989, the first year of privatization, the average cost of a contract hour was $41.95...
...He said the decision to proceed was based on "an intuitive 'sense that this was worth doing . . . an opportunity that was ripe for privatization...
...In such situations price is not driven as much by cost as by political or market power and hence the ability to impose a price on the buyer...
...The only question is how the work will be divided among the three firms in the RTD's "contractor stable...
...A teacher generally becomes less effective by being asked to teach larger classes...
...The only way to guard against corruption is to have a great deal of oversight with interagency checks and balances...
...It no longer matters whether contracting is less or more expensive...
...Ever more costly supervision is put in place to yield less and less effective additional protection of public resources...
...Leaving aside the possibility that the reported cost saving was nothing more than an accounting fiction, the town in question is so small that it falls within the bounds of statistical error on the census of the nation's largest city...
...That the right's concern is ideological rather than pragmatic is revealed by the penchant among conservative privatization advocates to oppose careful cost analyses...
...When examples of privatization gone awry are presented, advocates often argue that the efforts failed because the competitive bidding process was not sustained...
...Yet the conventional wisdom is so strong that citing fifty cases in which privatization lost money does not offset the evidence of a single case in which savings were attained...
...It is impossible for smaller local firms to compete against such big operations, especially when they are willing to sustain large losses...
...Any advantage in aggregate publicsector compensation stems from the fact that people with less education have fared worse than those with more education in all job markets in recent years...
...That is obviously not the outcome liberals and progressives want...
...If we were to peel back the layers of regulation in almost any agency with a long history of contracting, we would find a series of responses to specific abuses of the public trust by contractors and public officials...
...Because that finding was so contrary to the conventional wisdom, it was ignored by city officials...
...Efficiency Is Not Always What It Seems When confronted with analyses that show that particular privatization measures will lose money, advocates argue that savings will come in the long run, in some unspecified future when both direct-service personnel and agencySUMMER • 1994 • 331 Public-Service Privatization management personnel have been reduced to a handful of contract managers...
...In the debate in the Colorado legislature that preceded this change, privatization advocates claimed that the state could expect savings in the range of 40 percent...
...It is ironic that just as American industry is finally making a break from discredited nineteenthcentury Tayloresque concepts that link productivity to strict discipline of workers, the public sector appears to be rushing headlong back in time...
...It was supposed to be a textbook example of a competitive privatization...
...336 • DISSENT...
...Two benefits were supposed to flow from this...
...First, it ignores the macro-economics of public-sector costs...
...Furthermore, attempts to shrink mid-level management through privatization have only a slim chance of success in the long run...
...Its support is rooted in its ideological desire to shrink government—particularly programs like education, transportation, medical care, and housing, which foster a redistribution of goods and services to those at the bottom of the social order...
...Accountability...
...If American firms have to compete in a new market-driven international economy, they will be in serious trouble if the social and public infrastructure that supports them is grossly inefficient...
...Using these estimates, the advocates proclaimed that total privatization would create savings of forty million dollars per year...
...In addition, under the terms of the privatization, the contractors retain all fare revenue, estimated at about $5 per hour...
...Indeed, Mayor Rendell makes no bones about his appeal to this latter group of blue- and white-collar Philadelphians to support his drive for privatization...
...He didn't...
...As with the welfare queen stories, the illustrations are not necessarily false...
...He bitterly observed that these high-ranking public officials were only trying to save hard-pressed taxpayers some money...
...It arises when new technologies render older forms of organization obsolete...
...The Cuomo administration recently unveiled plans to require every company bidding on contracts in New York State to fill out a detailed questionnaire about its financial background and any criminal history of the firm or its principals...
...One potential bidder explained to investigators that it would have taken a year before his firm could feel sufficiently knowledgeable to make a proposal...
...This kind of "red tape" is frequently cited by privatization advocates as proof of the inefficiency of bureaucrats...
...4. ProMarket Ideology...
...The blame for this situation is laid directly at the feet of public-sector labor unions and spineless public officials...
...There is no longer even the pretense of competition...
...Every organization, whether public or private, has to decide how to organize its resources...
...That loss does not include the costs of contract supervision or the attrition costs for paying drivers, mechanics, and cleaning personnel made redundant by the change but who could not be legally terminated...
...If you don't think the service is necessary in the first place, "better" may mean "less...
...If patients are discharged more quickly, the hospitals keep the difference...
...But they distort the true image of ordinary public employment...
...Illnesses can be bundled together in a DRG or disease category...
...In the public sector this risk is borne by the taxpayers...
...When asked to explain their opposition, the secretary for administration replied: "The governor has said that privatization may make sense if it delivers better services, even if there is no budget savings" (emphasis added...
...Hence, the less cost oversight, the better...
...In the first year of the program, the RTD spent 8 percent of the contract price on supervision...
...The explanation for such outrageous prices was that the defense industry had become a ward of the state...
...Roots of the Privatization Argument Four separate but related factors contribute to the notion that privatization is cost saving: (1) deindustrialization...
...There is a large gray area here, having to do with the unique conditions faced by each organization and the alternatives available in the external markets...
...Although the fiscal crisis in the public sector is in large part a result of economic stagnation, it also has a unique root that feeds political support for privatization...
...second, it ignores the historical reasons for the size of public agencies...
...The loss of high wages in the private sector shrinks the federal and state tax bases that support public services...
...Lack of Competitive Markets...
...The reality is that red tape and mid-level management are needed as the most cost-effective way to stop abuse...
...Had it maintained the same high level of supervision, these costs would have added another $1.5 million to the loss...
...For the vast majority of firms this imposition will feel like one more case of bureaucratic harassment...
...For reasons never made clear, after 1991, the RTD cut back supervision to a skeleton staff of about two people...
...The Denver market is now shared by these three contractors...
...New York Newsday columnist Jim Dwyer, commenting upon the influence peddling scandal that arose from the Dinkins administration's attempt to privatize the Parking Violations Bureau, defended the culprits and chastised those who brought the abuse to public attention...
...It is therefore no accident that privatization is most vigorously pushed by the political right...
...When issues such as accountability and competition are taken into consideration, it is not clear that any real savings will occur as a SUMMER • 1994 • 333 Public-Service Privatization result of widespread privatization...
...We would have less service at the same level of taxation or greatly reduced service at only moderately reduced tax levels...
...A Case Study: Denver Transit In 1989 the Denver Regional Transportation District (RTD) privatized approximately 20 percent of its fixed-route bus operations...
Vol. 41 • July 1994 • No. 3
