spea magazine

Just Curious: Q&A

Deal or No Deal?

John Mikesell discusses privatization: What works and why?

slot machinesWhy has privatization become so popular?
Present discussions about privatization get a bit confused because different sorts of transformations may be involved. To understand the movement, it is helpful to distinguish between pure privatization – which strictly means that the government is no longer going to provide the service in question and the service is going to be financed, operated, and managed by the private sector – and contracting or outsourcing – which means that the government is still going to be responsible for providing the service (including paying for it out of government revenues), but its delivery will be done by a private contractor, using employees and properties owned by that contractor for doing the work.

The general motives behind these sorts of privatization – and there is a considerable track record here, both in the United States and globally – have fallen into three primary categories: a desire for smaller government, a desire for improved operating efficiency and responsiveness to clients, and a desire for cash. The former almost certainly has the least logic behind it – American government as measured by civilian employment, taxes, government purchases, or government spending (the areas directly impacted by privatization) is small in comparison with that of the other civilized democracies and the impact of government on private life is so much more than the areas touched by privatization that these privatization activities are mostly symbolic. But, more importantly, government exists to serve and whether the demand for that service is small or big should determine its size, not some naive concept that small government should be an objective by itself. Right sizing should be the operative principle for government, just as it is for private enterprises.

Does privatization really save money?
Sometimes contracting saves money or improves service quality, sometimes government production is better. Medicare is far more efficient in terms of low cost of administration than private American health insurers, the Veterans Health Administration hospital system is a much better system than the systems available to other Americans, and the IRS is a more efficient and lower cost debt collector than private contractors.

Property tax assessment done by private appraisal firms is superior to the work done by elected property tax assessors. (It is not clear why property tax assessors are elected at all, as a matter of fact. Technical competence, not politics, ought to be the selection criteria here. We would not want IRS auditors to be elected, after all. For the same reasons, it is far from clear why we elect sheriffs, clerks, recorders, auditors, surveyors, and coroners. Wouldn’t the public be better served if the test for employment in these administrative positions were technical competence, not the ballot box?)

The answer to the money-saving question is that there is no general answer. If the government is providing private goods and services under some misguided concept of social provision and control, the answer is easy: privatization will save. If the government is paying its employees more than the value of their performance and a private contractor will pay the market wage, then contracting out can yield savings to the public. In the case of basic government services (protection, education, etc.), there may or may not be savings and, where the quality and quantity of service outcomes are difficult to measure and specify in a contract, finding clear savings may be difficult.

In what sectors has privatization worked best? In what sectors has it worked poorly?
Privatization has worked best when it is carried out in sectors where the government didn’t belong in the first place. In other words, when government is involved in provision of private goods and services or exploitation of natural resources, the results of pure privatization have been great in terms of efficiency and service to the public.

The global pattern is clear – when governments shed their coal mines, airlines, telephone systems, housing, petroleum and petrochemical firms, steel-making, automobile manufacturing, electricity generation and distribution, and other private goods or service-providing operations, the performance of those firms improves and the drain they place on the government budget goes away. Governments just do not do a good job of producing private goods and services. The record of the former Soviet Union stands as a stark reminder of these failures. Getting out of a business that it should have never been in in the first place is always a good idea for a government. Savings from contracting production of government services, however, have to be considered on a case-by-case basis and cannot be easily generalized.

What are the pitfalls to look out for in privatization? How can they be avoided?
The most important pitfall is to assume that privatization – either pure privatization or outsourcing – is something to be done as an objective on its own. Privatization for privatization sake is a sure way for the public to lose. The question that needs to be asked is a pragmatic one: Will the public be better served if an asset is sold or retained and will the service be produced more efficiently and effectively by private or public producers? The answer is not the same for all assets or for all government services. You have to run the numbers.

Indiana’s Governor Mitch Daniels has talked about privatizing the Hoosier Lottery. Your reaction?
The real question is why has it taken so long to raise the question? Why should states be selling such a service in the first place? Gambling is not a core government service by any means and states leave the operation of casinos, a competitor to lotteries, to private operators. Indeed, the casinos offer a cheaper gambling service than do state lotteries. In Indiana, the casinos compete very successfully with the lottery and produce more revenue to state and local governments than does the lottery. Many lottery operations are already done on contract with private firms so any advantage that privatization could offer has already been gained, at least for prevailing game offerings – allowing video instant games or casino-like products could change the profit potential. The greatest gain might be in terms of getting the state out of a business that is laden with so many social and, possibly, moral issues. Although it would be important to make sure that the state received full market value for its lottery franchise, for the state to be rid of this operation would be a movement in the right direction.

John L. Mikesell is professor of public finance and policy analysis at the School of Public and Environmental Affairs, Bloomington, specializing in state and local government finance and sales and property taxation. Professor Mikesell is editor-in-chief of Public Budgeting and Finance, the journal of the American Association for Budget and Program Analysis and the Association for Budgeting and Financial Management, and his column on sales taxation is a regular feature of State Tax Notes. He is also author of Fiscal Administration, the standard budgeting text in many graduate public administration programs. Professor Mikesell was awarded the Wildavsky Award for Lifetime Scholarly Achievement in the Field of Public Budgeting and Finance by the Association for Budgeting and Financial Management in 2004.