PRIVATIZATION



The term "privatization" describes a shift in the ownership of assets or the provision of services from the government or public sector to the private sector. The scope of privatization, however, varies greatly in different parts of the world. In the former Soviet bloc countries of Eastern Europe, privatization means changing the ownership and control of all major industries and utilities from the national government to the private sector. These industries can range from telephone companies to automobile manufacturers. In western Europe—and especially in the United Kingdom—industries deemed vital to the welfare of the citizenry, such as coal, are returning to private sector ownership. In the United States, where there has been comparatively little government control or ownership of the means of production, privatization has had its greatest impact on traditional local or state services, such as trash collection and prisoner incarceration. As the privatization trend gains momentum in the United States, however, many services traditionally provided by the federal government, such as Social Security, are increasingly being considered for privatization.

On a scale grander than, for instance, municipal trash collection, privatization is viewed by its proponents as a rediscovery of the free enterprise philosophies of Scottish economist Adam Smith (1723-1790), and a repudiation of German political philosopher Karl Marx (1818-1883) and English economist John Maynard Keynes (1883-1946). Under Marxism the state dominated all areas of economic activity; Keynesian economics called for state intervention in market economies so as to manipulate business cycles, especially recessions. Smith, on the other hand, is identified with what came to be known as laissez-faire economics—"laissez-faire" being a French phrase meaning "allow to do." Tibor Machan (1939-), a philosophy professor at Auburn University, viewed the privatization movement as springing from a long held vision of Western liberalism. "This vision conceived individuals and their voluntary institutions—churches, corporations, professional associations, labor unions, and the like—as the source of the values of civilization," he wrote. 'The State is a supporting mechanism, as referees are to sporting events. The work of living and developing life's values are tasks for free human beings. The State serves them when conflicts arise." Privatization detractors, however, claim there are downsides to privatization such as accountability, employee dislocation, and a compromised response to the needs of the citizenry. Privatization, especially in the United States, has come to encompass a variety of economic and political changes including the transfer of assets, services, and responsibilities from the state to the private sector; a lessening in the regulatory powers of government; and an increase in the individual's responsibility in meeting his or her own needs. Regardless of definition, privatization is driven by both specific public policy decisions and general socioeconomic trends.

FORMS OF PRIVATIZATION

CONTRACTING OUT.

Privatization, especially as implemented in the United States by local governing bodies, generally takes one of four forms. The first and probably the most prevalent is "contracting out," which can be described as public sector choice and public sector financing, with private sector production of the selected service. Under contracting out, the citizenry makes elected officials aware of a collective need such as trash pickup. The government then generally chooses via competitive bidding a private contractor to provide the service. The government is also responsible for financing these respective services—generally through its taxing powers. Hence, the government finances the service while the private sector provides it. The government determines the service level and pays the amount specified in the contract, but leaves production decisions to the private contractor. Although the service is ultimately paid for by the taxpayer, the government makes the actual payment to the provider. This scenario usually happens when a municipal or state government for various reasons seeks to contract out, to the private sector, a service it has traditionally provided. The government workers who had previously performed the job often undergo "employee dislocation"—a polite term for layoffs, transfers to less desirable positions, etc.

Foremost amongst critics of contracting out are the state and city employee unions, which must contend with shrinking membership rolls, a lessening of dues, and angry, dislocated members. For instance, one of the traditional government services being increasingly contracted out is the incarceration of criminals in prisons owned and operated by private corporations such as Corrections Corporation of America (CCA). So prevalent has this practice become that in 1998 CCA began building a 2,304-bed prison in California without a firm commitment from the state to use the facility. The prison was built in anticipation of a future California need for more correctional facilities. CCA staffs its prisons not with state correctional employees but with CCA employees. As to be expected the California Correctional Peace Officers Association, the labor union representing California prison guards, is fighting any attempt by CCA to house state prisoners. According to an article in the Wall Street Journal, "The powerful and politically savvy California prison-guards union is dead set against expanding the use of private-sector prisons much beyond the state's current contracts for about 5,000 beds." Union president Don Novey vowed to "fight like hell" any CCA attempt to house state prisoners. "They can do anything they want with the feds," he added. The unions may be bucking a trend difficult to reverse. CCA, which was founded in 1983 and went public in 1986, was operating 77 prison facilities nationwide by 1998. The federal government also makes use of private for-profit prisons, housing 1 of every 20 federal prisoners in such facilities.

Surprisingly, services may be contracted out to other government agencies if the price is right. According to the Wall Street Journal, in 1998 the Federal Aviation Administration sought bids for contracting out the operation of its payroll computers. The lowest bidder, beating out IBM and two other private companies, was the U.S. Department of Agriculture.

Contracting out for services is the most popular form of privatization for state and local governments. The number of state and local governments contracting out with private firms to provide final services to consumers and intermediate services to the government has increased substantially in the past decade. The Wall Street Journal reported on a 1998 survey that found 73 percent of local governments using private janitorial services and 54 percent using private trash collectors, up from 52 and 30 percent, respectively, a decade earlier. In most cases contracting out has resulted in the same level of service but at a substantially lower cost—generally in the range of 10 to 30 percent lower.

FRANCHISING.

Franchising is another form of privatization according to E. C. Pasour Jr., a professor at North Carolina State University. Franchising is a monopoly privilege awarded to a private firm that provides the service but with the price of the service being regulated and determined by the state. Most utilities, such as gas, electricity, and telephone service, are provided under the franchise form of privatization. A relatively recent service, cable TV, is also generally awarded as a monopoly privilege. Another important distinction of monopoly franchising is that the consumer makes direct payments to the provider for the service.

USER FEES.

A variation on franchising and contracting out is user fees. Under this system of privatization, the consumer pays a set fee to cover all or part of the service costs. A municipality may, for instance, charge a set fee per household for trash collection rather than pay for that service out of a general tax pool.

LOAD-SHEDDING.

The last form of privatization is "load-shedding," whereby the government steps aside entirely. The consumer is responsible for deciding whether or not to make use of the service, the selection of the provider, and all payments for the service. Load-shedding is most often associated with trash collection. An extreme example of load-shedding, however, is the privately owned section of Route 91 in California. Tolls for traveling this stretch of road range from 60 cents at night to $3.20 during peak rush hours. There are of course alternate routes maintained by state and local road commissions for drivers wishing to avoid the toll.

ARGUMENTS FOR PRIVATIZATION

Proponents of privatization argue that government providers have no real incentive to hold down costs or to provide quality service. Private firms, on the other hand, are motivated by a profit motive that depends on holding costs down. The lower the cost incurred by the firm in satisfying the contract, the greater the realized profit. Private providers are also motivated by competition from other potential service providers. Competition between potential private suppliers to win a contract generally results in the lowest cost to the government and the taxpayer for the specified level of service. "Competitive markets are rooted in private property, and there is no way to stimulate competitive conditions under conditions of government financing or government production," Pasour wrote.

Political ideology aside, traditional government services are generally privatized in hopes of saving money. While there is no large body of empirical evidence supporting or refuting the idea that privatization saves money, the literature is replete with anecdotal evidence that it does in fact save tax dollars. Some of this savings is due to the generally lower wages and fringe benefits paid by private firms but much of it comes from increased productivity. Lower labor costs resulting from privatization can arise from either lower wages or less labor input. The first reason would indicate that the government, prior to privatization, was paying wages higher than necessary for a given skill, while the second reason would indicate that the government was hiring more workers then necessary to complete the given tasks. Government agencies are normally less productive per paid labor hour than private firms. Private firms also generally have more flexibility than governmental agencies to use part-timers to meet peak loads, to fire unsatisfactory workers, and to allocate workers across a variety of tasks. Moreover, in contrast to its private sector counterparts, governments tend not to reward individual initiative or punish aberrant behavior, contributing to lower productivity. In other words, government is not motivated by profit and loss. According to Pasour, "Government agencies are generally not profit-seeking enterprises, and profit and loss considerations have relatively little effect on (their) production and marketing decisions. That is, bureaucrats and politicians do not face incentives that foster good performance."

Private firms may also be more innovative, using different approaches to providing a service. Government, by contrast, tends to stick with known approaches since changes often create problems, especially with an entrenched bureaucracy or a strident municipal union. Private firms may also use earnings to finance research or to purchase capital equipment relating directly to the service, while governments may not be able or willing to allocate revenue in the same manner given the many competing demands for tax dollars.

Another contributing factor to this cost disparity is the general overall efficiency of the private sector. The private sector has a strong incentive to operate efficiently. Private firms spending more money and employing more people to do the same amount of work will have lower profit margins and decreased profits. In the long run they will no longer be able to compete in a market economy. The disciplining effect of competition, however, does not affect the public sector. Government agencies generally operate in a noncompetitive environment and therefore can charge more for their services and be less concerned with consumer satisfaction. Government services that are provided in a noncompetitive market also deny the consumer comparability. The consumer or taxpayer has no real way of evaluating the price of a government service. This tends to make government less responsive to consumer needs. The private sector generally offers the consumer a higher quality of service while keeping costs under control.

OPPOSITION TO PRIVATIZATION

Ultimately privatization is a political process. As such any move toward privatization, no matter the economic benefits, will have political repercussions especially if privatization causes worker displacement. The burden of privatization falls most heavily on the public workforce. Because their jobs and income are at risk, public employees and their unions strongly oppose privatization. A 1992 survey of the 24 largest American cities showed that the greatest political opposition to privatization came from public employees and the unions representing them. Although it is not unusual for privatization to result in layoffs of public sector employees, seldom do the layoffs reach the level that workers and their unions predict. When layoffs are inevitable governments can often employ a number of strategies to lessen the burden on public employees while making the privatization process more palatable. Governments may assign displaced workers to other government jobs and positions or they may encourage or require contractors to hire laid-off workers or offer them first consideration when jobs open up. Governments may also offer early retirement incentives to workers facing a layoff.

Another tactic is to allow the affected employee union to bid on jobs—that is, compete head-to-head with the private sector. A similar tactic is employee ownership whereby the displaced workers are offered an ownership interest in a private company or offered financial assistance in forming their own company. The latter strategy proved to be popular in the United Kingdom but less so in the United States.

In spite of privatization's accelerated growth at the local level in the United States, there have been many backlashes and not just from employee unions. Consumer and institutional dissatisfaction with privatization most often occurs when the service directly affects people's welfare as opposed to such services as trash pickup. Charges of brutality and mistreatment of prisoners in for-profit prisons are not uncommon. Likewise, consumers complain about the higher and higher prices associated with various managed health care plans and for-profit hospitals. Also under attack is the privatization of a wide variety of government services designed to help the country's poorer citizens. In 1997 the administration of President Bill Clinton stopped Texas from turning over to Lockheed-Martin the procedure for deciding which applicants are eligible for Medicaid, food stamps, and welfare. In 1998 Florida sought, amid much controversy, federal approval to privatize, on an experimental basis, the management of welfare and Medicaid in five counties. Social worker and child-welfare advocate Sky Westerflund, head of the Kansas chapter of the National Association of Social Workers, worried that private companies overseeing welfare would be more concerned with the well-being of their bottom line than the well-being of children. "Every single decision is based on that capitated rate," Westerflund told the Wall Street Journal. "Their question is: Can we afford this."

A 1998 Wall Street Journal article posed the question, "Is making a profit by serving the poor a terrible notion that smacks of a Dickens novel, or is it a welcome move towards efficiency?" Representative Barney Frank of Massachusetts answered in part. "Private citizens should not have life-or-death power over other private citizens when you're talking about basic necessities. The financial motive should not be at work when we're talking about benefits." Joseph Stiglitz, a former economic adviser to President Clinton, disagreed. "Wal-Mart makes profits off poor people, but it makes them better off. It's providing high quality and low price," he countered. Stiglitz went on to argue that it makes little difference if social services are provided by for-profit companies or nonprofit government agencies. "Rather, the key is whether the ultimate consumers can choose between competing providers. It is competition, not private ownership, that makes the market work well."

U.S. GOVERNMENT PRIVATIZATION

While much privatization in the United States has taken place at the state and local level, the federal government is also turning over some of its operations to the private sector. In mid-summer 1998 the U.S. government finalized the $2.4 billion privatization of the U.S. Enrichment Corporation (USEC). USEC was a government-run corporation responsible for U.S. uranium enrichment operations. The U.S. Department of the Treasury received $1.9 billion from the public sale of 100 million USEC shares and $500 million in cash, which was borrowed by USEC from various banks. USEC controls 75 percent of the North American uranium enrichment market and 40 percent of the world market. USEC will also broker the purchase of Russian uranium for the federal government. The move to privatize the government's uranium enrichment operations was started by President Richard M. Nixon in 1969. In 1993 Congress passed legislation creating USEC as an independent government-owned corporation. President Clinton approved plans for privatization in 1997.

The federal government has also privatized the 750 former employees of its Office of Personnel Management (OPM) responsible for doing background checks on potential government employees. The former federal workers are now shareholders in and employees of US Investigation Services Inc. (USIS). USIS now does background checks for the federal government but is free to contract for the same type of work on the open market. USIS now counts as its customers state and local governments, casinos, and airlines. When James King took over OPM in 1993 he found the investigation unit overstaffed and under-worked. OPM was required to charge other federal agencies for investigative work done on their behalf on a break-even basis. But because of federal downsizing, the number of new federal employees was declining and OPM's investigation unit was losing about $1.5 million a month. In 1994 King laid off 400 workers and began turning the unit into a private employee-owned company. In 1996 the new company took over with an exclusive contract protecting itself from competition for three years. Employees now own 90 of USIS while management, which was recruited from the outside, owns the rest. OPM estimates that in the first 15 months of operation USIS has saved taxpayers nearly $20 million.

One of the most hotly debated privatization issues in the United States in the 1990s revolved around Social Security. Begun in 1935 with passage of the Social Security Act, coverage of U.S. citizens had become nearly universal by 1956. In 1983 legislation was passed assuring the financial health of the Social Security system well into the 21st century. But because a large number of baby boomers will be retiring in the first decade of the new century, some analysts predicted a severe depletion of social security funds by 2030. Emboldened by spectacular gains in equity markets in the 1980s and 1990s, proponents of privatization argued that everyone would be better served if workers had more freedom in determining where their payroll taxes go. The Wall Street Journal divided Social Security privatizers into two groups: part-way privatizers and hard-core privatizers. The former would prefer payroll taxes going into individual retirement accounts and Social Security accounts. The latter would opt for workers being allowed to put most if not all of their Social Security contributions into individually chosen accounts similar to mutual funds. As of 1999, all Social Security taxes were invested in U.S. Treasury bonds. President Clinton was in favor of investing 15 percent of the Social Security trust fund in stocks, but Federal Reserve Chairman Alan Greenspan opposed any such move. Greenspan worried about Social Security taxes being allocated for political rather than economic considerations, as well as wondering what would happen if the bull market of the 1980s and 1990s turned into a bear market in the 21st century. As pointed out in a Fortune article, all mutual fund advertisements contain the disclaimer, "Past performance cannot guarantee future results."

PRIVATIZATION OUTSIDE THE UNITED
STATES

The privatization movement began not in the United States but in the United Kingdom—and it began with a vengeance. During her administration, Margaret Thatcher, prime minister from 1979 to 1990, privatized gas, electricity, telephones, trains, and most other state-owned companies in an effort to overhaul Great Britain's socialized and centralized economy, reversing a trend started by the post-World War II defeat of Winston Churchill by Clement Attlee. Attlee and his Labour Party took over the leadership of Britain's government and "sought to scale and control the commanding heights of their national economies," according to Daniel Yergin and Joseph Stanislaw, authors of The Commanding Heights: The Battle between Government and the Marketplace that Is Remaking the World. Attlee's Labourites favored a mixed economy marked by strong and direct government involvement in the nation's economy via fiscal management, state-owned and state-run companies, and an expanded welfare state. But by the 1980s the British economy and British productivity had become moribund. The Guardian, although an British left-of-center newspaper, nevertheless praised Thatcher's revitalization of her country's economy. "With her privatizations, she slimmed down a state that had become flabby and overstretched, reconciling Britain forever to the market," it said. "She effected the change brutally, and with great pain, but it was a change we had to make."

In the former Marxist economies of Eastern Europe, major privatization efforts have taken place following the fall of the Berlin Wall in 1989. Privatization in the West has been gradual and it has left the basic structure of the Western countries intact. In Eastern Europe, however, the social, political, and economic infrastructure has been overturned; privatization has been both a part and a cause of this dramatic change. Prior to the fall of the Berlin Wall the socialist state totally dominated each country's economy. The government dictated production, cost, and the distribution of resources, goods, capital, and labor. "We pretend to work while they pretend to pay us," was a common saying. Privatization in Eastern Europe has changed all this while ushering in free enterprise and market determination of economic factors.

SEE ALSO : International Privatization

[ Michael Knes ]

FURTHER READING:

Eggers, William D., and John O'Leary. "Overcoming Public Employee Opposition to Privatization." In Private Cures for Public Ills: The Promise of Privatization, edited by Lawrence W. Reed. Irvington-on-Hudson, NY: Foundation for Economic Education, 1996.

Feigenbaum, Harvey, Jeffrey Henig, and Chris Hamnett. Shrinking the State: The Political Underpinnings of Privatization. Cambridge: Cambridge University Press, 1998.

Georges, Christopher. "Social-Security 'Privatization' Effort Makes Headway." Wall Street Journal, 22 June 1998. "Government Finishes Privatization Sale of U.S. Enrichment." Wall Street Journal, 29 July 1998.

Lipsher, Marc. "Busting into the Prison Business." Wall Street Journal, 27 May 1998.

Manikaw, N. Gregory. "How to Screw up Social Security." Fortune, 15 March 1999.

Miller, Marjorie. "Thatcher's Influence Still Felt in Britain." Detroit News, 14 May 1999.

Pasour, E. C., Jr. "Privatization: Is It the Answer?" In Private Cures for Public Ills: The Promise of Privatization, edited by Lawrence W. Reed. Irvington-on-Hudson, NY: Foundation for Economic Education, 1996.

Reed, Lawrence W., ed. Private Cures for Public Ills: The Promise of Privatization. Irvington-on-Hudson, NY: Foundation for Economic Education, 1996.

Sharpe, Anita. "Psyched Up: More States Turn Over Mental-Health Care to the Private Sector." Wall Street Journal, 24 January 1997.

Wessel, David, and John Harwood. "Selling Entire Stock!: Capitalism Is Giddy with Triumph; Is It Possible to Overdo It?" Wall Street Journal, 14 May 1998.

Yergin, Daniel, and Joseph Stanislaw. The Commanding Heights: The Battle between Government and the Marketplace that Is Remaking the World. New York: Simon & Schuster, 1998.



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