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What Is Privatization of Public Services – Definition, Pros & Cons

By Michael Lewis

bridgeSince the beginning of civilization, there has been tension over the role of government and the provision of services paid for with public funds (tax dollars). Before the advent of democracies, ambitious, enterprising men sought the favor of royalty in order to gain political power and riches at the expense of the population.

American governments, whether federal, state, or local, have not been immune from this trend where politicians manipulate the economy to fill their own pockets, as well as the purses of their friends. Boss Tweed and his cronies at Tammany Hall bilked New York City taxpayers of more than $200 million in the building of public works by private contractors. The Credit Mobilier of America scandal with Union Pacific during Ulysses S. Grant’s presidency reverberated for decades. According to The Atlantic, privatization leads to crony corruption, citing the example of Edward Snowden and Booz Allen Hamilton.

Unfortunately, history is also full of examples where government services are bureaucratic, excessively expensive, and unresponsive to citizen needs. Economic growth is impeded through excessive, unnecessary regulation. The U.S. Postal Service and the National Railroad Passenger Corporation (Amtrak) are examples of government services often cited for their inefficiency and taxpayer costs. The question is not whether to privatize government services, but which services, if any, would be better provided by private contractors acting on behalf of the government. Therefore, it is crucial to understand the mechanics of privatization, its appeal, and its impact upon costs, services, and citizen satisfaction.

Understanding Privatization

Simply stated, privatization is the transfer of government functions to the private sector. For example, the Federal National Mortgage Association (FNMA), initially founded in 1936 to provide financing for home mortgages, was converted into a private corporation in 1968.

Since the formation of the country, there has been a persistent and prevalent view that government is intrusive, wasteful, overly expensive, and improperly interferes with the conduct of business to the detriment of the governed. “The best minds aren’t in government,” said Ronald Reagan. “If any were, business would steal them away.” His economic adviser Milton Friedman was even more damning, stating, “The government solution to a problem is usually as bad as the problem.”

According to a 2013 Pew research poll, about one in four Americans have a favorable opinion about the Federal Government while more than half think highly of their state and local governments. Unfortunately, while Americans dislike big government, they also distrust big business. Even though 22% of those polled in a 2012 Gallup poll had quite a lot or a great deal of confidence in big business, almost one in three Americans have “very little trust” in corporations.

This antipodal feeling has led to periods where privatization of government services is hugely popular, and other periods where government recaptured the responsibility to deliver services and asserted control. Policies are, more often than not, a function of choosing the least unpopular political course rather than developing an optimum solution.

The Drivers of Privatization

There are a variety of factors that affect a government’s decision to privatize its services:

  • Ideology. The concept that government should be limited was perhaps best summarized by Henry David Thoreau who said, “That government is best which governs least.” Those sentiments remain strong as expressed by Senator Rand Paul, who said, “We don’t need bigger government. We need to shrink the size of government.”
  • Greed and Corruption. With billions of dollars flowing into the coffers of government every day, the wonder is not that we have corruption, but so little of it. Politicians are notoriously vulnerable to the temptation of selling their honor to maintain or increase power. Transferring a lucrative government service to a private business to ensure campaign contributions, votes, and personal riches is a favorite tool of corrupt politicians and profit-seeking entities.
  • Economic. As the ability of governments to finance public services through taxes and other revenues is squeezed, officials seek to off-load their responsibilities to private entities who can more easily reduce costs by lowering wages, reducing service levels, and surreptitiously raise revenues without public scrutiny. This is particularly true for those services which are generally unpopular with voters, such as the management and operation of prisons. According to the Bureau of Justice Statistics, there were more than 1.6 million prisoners in federal and state prisons at the end of 2010, of which 128,195 were housed in for-profit facilities. The proportion of inmates in commercial facilities continues to grow even though evidence suggests the following:
    • Cost savings have not materialized as expected
    • Private prisons actually cost more than public prisons
    • Private facilities often refuse prisoners who cost more to house, such as violent offenders
    • Private prisons have lower staff levels and provide less training to employees, leading to more assaults on guards and inmates than in public facilities
  • History. Public utilities such as gas, water, electricity, and sanitation services are provided to citizens nationally through a combination of public, private, and quasi-public entities. On the other hand, communication services such as the telephone, telegraph, television, and transportation were developed initially by private organizations, sometimes with government assistance, but remain heavily regulated to ensure that these services are available to all citizens.
  • Efficiency. Smaller, less bureaucratic private entities often deliver equal or better service with less expense than their government counterpart subject to Civil Service rules and regulations on a federal or state level. The Federal Government generally outsources facility maintenance to local cleaning companies for a fee, rather than hire and manage cleaning staff.
  • Effectiveness. Private charter schools are often cited for their quality and cost when compared to public school systems.
  • Deniability or Reduction in Liability. The usage of private contractors can reduce the government’s liability for certain duties. In January 2012, according to a New York Times article, there were 113,491 employees of defense contractors in Afghanistan compared to about 90,000 American soldiers, with more contractors dying in 2011 than soldiers.

Examples of Government Privatization

Federal, state, and local governments have privatized various operations since the founding of the country. Examples where for-profit entities currently provide services to citizens through the auspices of government include:

  • Road and Bridge Construction and Operation. Many states have licensed the construction and operation of private toll roads in lieu of using taxpayer dollars to build state roads. Furthermore, in his 2013 State of the Union address, President Obama referred to a “Fix-It-First” program for roads and bridges, as well as a “Partnership to Rebuild America” affecting ports, pipelines, and schools. While the details of these programs have not been released, it is certain that they will broaden the use of privatization by the Federal Government.
  • Administrative Services. Sandy Springs, Georgia, a community of 90,000, elected to outsource nearly all of its administrative services, excluding police and fire services. A number of states have outsourced the administration of public welfare.
  • Utilities. Indianapolis opened up five dozen city services to competitive bidding, including trash collection, pothole repair, and waste water services. Philadelphia privatized more than 49 city services, including golf course management and printing.

Education, social welfare, defense, and even departments such as Homeland Security have been proposed for some form of privatization at one time or another.

trash collection

Privatization Methods

The transfer of government services and assets can occur through a combination of strategies:

  • Competitive Bidding. The government entity decides which services to transfer and oversees a process where private companies bid to provide the service. All government entities – local, state, and federal – have extensive policies and procedures to control the public bidding process and ensure that the selected contractors are the best option for the their respective taxpayers.
  • Vouchers. Citizens, with government assistance, choose between public and private providers. Currently, there are efforts to provide vouchers in education and Medicare, where seniors would choose health insurance from private insurers.
  • Asset Sales. Governments at all levels regularly sell property or assets to commercial entities. These sales range from local police departments auctioning recovered, but unclaimed property, to office buildings and lands no longer needed by the Federal Government.

Is Privatization the Right Policy for American Taxpayers?

Advantages

While there is much truth to the many claims of the abuse of privatization and the problems that often accompany it, opponents fail to recognize that governments cannot provide all things to all people. Citizens have an insatiable desire for services, especially if someone else is picking up the tab. At the same time, taxpayers are increasingly reluctant to raise taxes to support even critical services. As a consequence, government officials ranging from local municipalities to the Federal Government are forced to find other sources of revenue, cut costs, and ration services.

The American Legislative Exchange Council (ALEC), a conservative corporate-funded 501(c)(3) and longtime advocate of privatization, claims that transferring government functions to private for-profit entities has a number of benefits:

  1. Lower Taxes. Wexford County, Michigan privatized its emergency medical service in 1994, resulting in an improvement in service, reduction in administrative services, and lower costs, saving county taxpayers more than $300,000 in the first year alone.
  2. Increased Efficiency. North of Boston, a privately owned and operated incinerator, turns garbage into energy for 20 towns with a combined population of more than a half-million residents. The towns now pay only $22 per ton to have their garbage taken away, compared to $100 per ton that is charged by the government-operated landfill.
  3. Improved Effectiveness. Wexford County, Michigan is privatizing the operation of its animal shelter, following a State of Michigan inspection where cages were found to be unsatisfactory and in need of immediate replacement.
  4. Lack of Political Influence. According to U.S. District Attorney for the Northern District of Illinois Patrick Fitzgerald, “Illinois roads were made more dangerous when state employees issued drivers’ licenses to truck drivers in exchange for bribes, intended to finance campaign contributions to former Governor George Ryan’s political warchest.” Transferring responsibility to a private entity with adequate supervision eliminates the likelihood that officials will meddle in the provision of services.

Disadvantages

Opponents of privatization claim that privatization is simply a scheme to divert taxpayer dollars to create long-term revenue streams and profits for corporations. The Public Interest, a resource center dedicated to “ensuring that public contracts with private entities are transparent, fair, well-managed, and effectively monitored,” as well as meeting the needs of the community, lists a number of potential drawbacks to privatization:

  1. Higher Costs for the Public. Privatization often raises costs for the public and governments. In reviewing the proposed privatization of the Milwaukee Water Works, the nonprofit consumer group Food & Water Watch reports that the private water service would cost 59% more than public water service.
  2. Declines in Service Quality. Atlanta, Georgia canceled a 20-year contract to run its drinking water system due to tainted water and poor service. Since the City of Chicago sold its parking meters operation to a private firm in 2008, parking rates have jumped to $6.50 per hour with additional increases built-in for the next five years, causing a drop in downtown small business sales due to visitors refusing to pay the high rates. Mayor Rahm Emmanuel ordered an independent audit of the contract after receiving unsubstantiated charges of almost $30 million from the private contractor.
  3. Limited Flexibility. Privatization can bind the hands of policyholders for years. The Chicago parking meter contract sold to a Morgan Stanley group is for 75 years, and the Chicago Skyway Toll Bridge System was leased to a private company for 99 years. Indianapolis also sold its parking meter operation for 50 years, while the State of Indiana sold control of a toll road for 75 years.
  4. Corruption and Fraud. Privatization opens the doors to unscrupulous behavior by politicians and businessmen. The Washington Post recently reported the finding of the Inspector General that $450,000 in payments made to former Republican congresswoman Heather Wilson by four government contractors did “not meet even minimum standards” for federal payments, including an absence of any details about actual services provided. The contractor reimbursed the Energy Department for the payments.

Proponents for privatization presume that government entities are always less efficient than for-profit organizations – a presumption that is simply not true. For example, Medicare’s cost of administration as a percentage of claim dollars paid is considerably less than any private insurer – less than 2% historically, according to the Congressional Budget Office.

Opponents of privatization point out that commercial entities have a primary purpose to make a profit, often targeting a goal in excess of 10% pretax. According to them, it is illogical that profits can be reached in every case of privatization by eliminating waste; it is far more likely that service levels will be reduced or costs cut by lowering manpower or salary levels. While there are reasons to justify privatization of some government services, they claim returning savings to taxpayers by privatization is unlikely.

congress

Final Word

As in many issues, a winner-takes-all psychology energizes partisanship, inflames emotions, and obscures facts. Many city governments are on the verge of bankruptcy, struggling to provide the most basic services to their citizens. State governments, many of whom manage with balanced budget restrictions, have eliminated services and ceased critical investments in education, security, and infrastructure. The Federal Government has an unprecedented national debt of almost $53,000 for every man, woman, and child in the country. All measures to improve the situation, including privatization, must be on the table if the country is to prosper.

At the same time, ardent foes of government should recognize that some services and assets cannot be outsourced or sold without drastic harm. Noted conservative Norm Ornstein, resident scholar at the conservative think-tank American Enterprise Institute for Public Policy Research (and the author of the aforementioned “The Atlantic” article), recognized this reality when he stated, “There will always be a need to mediate between public and private functions, and public and private responsibilities. But we have let the mania for privatization, and the willingness of politicians to pander to anti-government sentiment, to take it too far. It is time to bring it back.”

Should all government services be privatized? Should any? If so, which ones?

Michael Lewis
Michael R. Lewis is a retired corporate executive and entrepreneur. During his 40+ year career, Lewis created and sold ten different companies ranging from oil exploration to healthcare software. He has also been a Registered Investment Adviser with the SEC, a Principal of one of the larger management consulting firms in the country, and a Senior Vice President of the largest not-for-profit health insurer in the United States. Mike's articles on personal investments, business management, and the economy are available on several online publications. He's a father and grandfather, who also writes non-fiction and biographical pieces about growing up in the plains of West Texas - including The Storm.

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  • Nina

    Great article. Intelligent and accurate factually!

    • Michael Lewis

      Thanks, Nina, for writing and your kind words. Which side of the issue do you favor?

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