Privatization: Implications for Public Management
by Annmarie Hauck Walsh
The power of privatization as a message derives from the limits of large-scale government that the twentieth century has demonstrated on both sides of the now melted-down iron curtain. The century opened with great optimism about the potential of reformed government and collective action, from the Progressive Era in America to socialism in Russia. It ends with clear realization that what government can achieve is limited both by persistent patterns of power seeking and by the inability of bureaucracies to deliver outcomes that approach objectives. Current advocacy of privatization is a response to this end-of-the-century realization that assumes market forces in a competitive environment can provide better value than government bureaucracy has been able to supply. But perhaps we should open the 21st century with more realism about what and how large scale organizations, business or government, or both in partnership, can deliver to society.
The term privatization denotes movement from collective action to private control. Privatization, however, usually entails interdependence between the public and private sectors. The concepts of private property and common goods, of market competition and collective action, need to be considered jointly. An essential component of any type of privatization is support from the public sector, support which requires a substantial level of government competence and public accountability.
Many post-communist nations have attempted privatization without simultaneously building government competence to support privatized functions. Support includes developing frameworks of law and regulation and at least minimal "social safety nets"; these developments are essential concomitants to rapid privatization. Privatization in Central and Eastern Europe and the republics of the former Soviet Union, however, has been focused largely on changes in ownership, price deregulation, and development of capital markets, with predictable backlash from voters who experience the impacts of the changes.
For over one hundred years, societies with market economies have painstakingly, incrementally forged political compromises that produce social safety nets and frameworks of law and regulation, giving capitalism stability. The scale and scope of these changes wax and wane with social and political shifts, but even the most radical privatization proposals in the West do not contemplate complete undoing of either.
Tensions between private control and collective action are characteristic of all societies. These tensions arise at two levels: major political shifts in interpretation of a nation's social contract; and procedural changes, sector by sector or program by program, to shake up vested institutional relationships that have become dysfunctional (be they rooted in mismanagement by government or in corrupt and inequitable exercise of private power). Reverberation between these two levels, grand strategy and procedural tinkering, produces much of the energy that fuels political reform.
Louis Winnick ("Is Reinventing Government Enough?" IPA Report, Winter 1995) highlights the differences among political reforms between new approaches to how government performs and new approaches to what government should do. Winnick argues that how government performs is not simply a procedural issue; it affects policy issues, "of the broad distribution of public and private roles in society, and of `who gets what' from the political system." Changes in grand strategy (the what) and changes in procedure (the how) invariably affect the distribution of resources among citizens, families, communities, social classes, interest groups, and business (the who). A missing component from much of the privatization debate concerns these distributive effects of reforms. There is no neutrality in either the reforms of grand strategy, changing what government does, or in procedural reforms, changing how government undertakes its tasks. In debating privatization, there should be closer analysis of who the winners and losers are expected to be, and, more importantly, evaluation after the fact -- by either data or the democratic "howl meter" -- of who the winners and losers have actually been.
There are varying types of privatization. One type can be categorized as load shedding. Load shedding occurs when a society determines that it should no longer pay for a good or service with collective funds. It answers the question: "Should we pay for some good or service individually, out of our own resources, or should we pay for it collectively with funds raised through one form or another of taxation?" (John D. Donahue, The Privatization Decision, 1989.) Another type of privatization is illustrated by contracting. Contracting utilizes collective payment, but provides delivery of the good or service by private persons or corporations rather than by government employees. Load shedding impacts grand strategy, changing what government does; contracting affects procedural reforms, changing how government undertakes its tasks. Both have substantial distributive implications, determining who gains and who loses.
Many current privatization proposals include load shedding. Public budget cutting and deficit reduction, elimination of agencies or services, sale or lease of public assets to private parties, reducing regulation of business, all are strategies to reduce the size and influence of government in society, to change the fundamental balance between private and collective resources. These choices entail removing public services from collective payment or transferring ownership of enterprises.
Sale of commercial and industrial assets has been the most important element of privatization in countries where large portions of commercial or industrial activity had been government-owned. In contrast, in the United States, pruning public services is on the current agenda of government downsizing.
Load shedding of public services tends to generate new demands on government. A municipality may go out of the solid waste collection and disposal business, enabling property owners to contract directly with the vendor of their choice. In this example, however, the municipality has increasing regulatory responsibilities. Property owners cannot be allowed to have garbage pile up in their backyards, nor should they be subjected to monopoly contractors charging exorbitant prices. The municipality may remove itself from service delivery, but it assumes responsibilities for the more difficult roles in inspection, licensing, price monitoring, environmental regulation, and law enforcement.
The federal government might eliminate a cabinet level department. The costs and benefits of that decision depend on what functions are eliminated, what functions are shifted, and what new functions may be required. In another load shedding example, the federal government may reduce subsidies (e.g., agricultural, transportation, education, welfare). Analysis is needed to determine where the costs are shifted -- to the economy, to state or local government, to users, to groups that can or cannot absorb them.
Two centuries of economic theorizing still build on Adam Smith's proposition in the Wealth of Nations: "The sovereign has the duty of erecting and maintaining certain public works and certain public institutions, which it can never be for the interest of any individual, or small number of individuals, to erect and maintain because the profit could never repay the expense to any individual or small number of individuals though it may frequently do much more than repay it to a great society."
Under this formulation, there are complex linkages among the questions of what government should do, how it should do it, and who should benefit. For example, what level of environmental protection and improvement does a society choose to define as a public good that benefits society? How can this be effectively and efficiently provided? At what point does regulation become counter productive? How can market incentives be used? How can public environmental agencies achieve improved management? Who shall benefit and who shall pay? What balance of corporate and individual tax base shall be struck? What balance of short-term and long-term benefit shall be sought? The formulation of these questions is not new, but their systematic incorporation into privatization debates is not typical.
IPA's recent work in Central Europe presents another example of these complex linkages. The success of privatization reforms by governments emerging from communism depends heavily on how public management develops the capacity to organize equitable transfers; to replace commercial revenues with tax, accounting and budgeting systems; to develop at least minimal regulatory structure, including property and contract law; and to provide new approaches to "safety net" functions that cope with unemployment, income inequities, and other distribution problems of transition. Load shedding calls for increase in the scope of private action but mandates a concomitant strengthening of public management capability.
Contracting, or outsourcing, encompasses the vast majority of privatization arrangements in the United States. These arrangements entail governments' contracting with private corporations -- both investor-owned and non-profit -- to deliver goods or services paid for by the public. These arrangements maintain collective financing and public ownership, but utilize private service delivery. Contracting has been a central part of American government for more than a century, spanning social services, utilities, waste management, space and military design, production, and management. To illustrate only the tip of the iceberg, American governments procure from private sector suppliers pencils, planes, foster care, asphalt, fire engines, training programs, school lunches, management of nuclear weapons plants, program evaluation, research and development, and technical assistance to foreign countries. These contracting arrangements are long-standing practices which have significantly increased in scale and scope.
In the United States, as requirements for deficit reduction press toward shrinkage of government (or at least for reduction of the rate of growth of government and decentralization of both authority and tax burdens to the states and their local governments), the how questions of public administration have become crucial. How can we get the best results from public budgets that survive? Contrary to popular belief, increase in government contracting is usually associated with aggregate increase in government spending. For example, an increase in government defense contracting in the 1980s contributed to staggering budget deficits. Although cost savings have been achieved from some contracting arrangements (most examples occurring at the local level), overall trends show that an increase in private sector participation in a government activity is associated, understandably, with an increase in total government expenditure in the sector involved.
So, if expenditures cannot significantly be reduced by outsourcing, what are other reasons for implementing this type of privatization? One is to focus management on the core function of the agency ("stick to your knitting"). This challenges each public agency to define its central mission and benchmarks for assessing results. Outsourcing support functions can then simplify the organization to focus on improvement of mission performance. Definition and implementation of this approach requires substantial sophistication on the part of government managers. A second reason combines the issues of scale and specialization. There are services that a general purpose organization is not well suited to provide internally. Examples include highly technical services such as rocket design and small scale services such as foster care. A third reason for outsourcing is to shake up vested interests and shake out bureaucratic procedures, with change in whatever direction looked to as a catalyst of improved results.
A major reason for outsourcing is to replace internal monopoly with external competition. Outsourcing for this purpose, however, will not be successful if the result replaces internal monopoly with private monopoly. In the absence of competition, market incentives do not discipline cost and performance. This is a crucial factor to consider for transition in post-communist countries, where private, local suppliers may be in short supply. Limited competition is also a problem in the United States, from defense contracting, where a single firm develops the expertise for whole weapons systems, to local social services where suppliers provide fixed facilities and continuity of care. Lack of competition also can arise from an agency's preference to deal repeatedly with the same suppliers, or from contracts rooted in corrupt relationships. Government monitoring, based on results measurement and rules, struggles to compensate for lack of competition. Both load shedding (reducing collective payment) and outsourcing (reducing public sector delivery) provide well-documented opportunities for corruption, conflict of interest, and mismanagement. The layering-on of procedural rules has nowhere reduced this risk.
Other forms of privatization involve complex partnerships that do not fit the mold of classic contracting, although contracts underlie their relationships. These include joint ventures, public insurance and lending schemes, sale of government and municipal bonds and notes, use of publicly financed vouchers for private purchase from private suppliers (e.g., school vouchers and food stamps), free public services and subsidies to businesses (e.g., the geological survey and agricultural commodity supports), land development agreements, and many more. They are too numerous and diverse to catalogue here, but all forms of contracting clearly illustrate an important point. We should take the "out" out of the phrase "contracting out." Contracting is not a process of taking responsibility out of government, as long as the government is paying the price and promising the product to the public.
Effective strategy for contracting must start with assessing the market for competition, but move on to developing public management capability to support privatization. Herein lies a major challenge that the public sector has not been meeting effectively. Businesses long-engaged in contracting relationships have recognized that effective contracting requires special management capabilities: project leadership, design of specifications, market analysis, arms-length negotiating, monitoring progress against realistic benchmarks, cost and price assessment, accountability and quality assurance. The private sector develops these capabilities when deciding to outsource a service. Without development of these critical areas of management skill, government contracting tends to produce unsatisfactory results.
Privatization and competent government are a crucial partnership. They are not opposing alternatives. Business and government are not engaged in a zero sum game. Government needs strengthened competence to manage effectively load shedding, contracting, and specialized partnerships.
The public management skills needed for sustained, successful, public-private relationships require leadership and clarity of executive responsibility. The investigative transcripts of the space shuttle Challenger explosion of ten years ago illustrate most poignantly what can happen when public managers and private contractors are not sure of "who's in charge here?" The failure of the partnership between the Federal Aviation Administration and IBM to develop up-to-date software for air traffic control over a decade of trying imposes huge costs on the deregulated airline industry, as well as public safety risks.
In summary, privatization agendas must tackle complexity. The ultimate success or failure of privatization and deficit reduction, in terms of both specific results and long-term public opinion, depends on improvement in public administration. Perhaps we need at the end of the century a rebirth of the activism and optimism of the Good Government Reform movements that business and volunteer groups generated at its beginnings, with added realism of lessons learned.
From IPA Report, Spring 1996
Annmarie Hauck Walsh is IPA Trustee and Luther H. Gulick Scholar in Residence. She was President of IPA from 1982-88.