PRIVATIZATION



Privatization 179
Photo by: Steven Frame

Defined in the strictest of terms, privatization means the sale of public utilities to private concerns. But as Public Works magazine noted, "in the broader sense of the term …and the definition that applies to most contemporary discussions, privatization is the contract operation of a public utility or service by a private entity. It most often occurs in solid waste management, water/wastewater treatment, fleet maintenance, road/bridge building and maintenance, and municipal management." Small businesses that provide services in these and other areas (for-profit school academies, for instance) have been among the biggest winners in the growing national trend toward privatization. As Public Works commented, "opportunities abound for private concerns to offer to manage public services with a close eye on cost and efficiency."

Privatization efforts in America today are in large part a reaction to dissatisfaction with government performance and/or unhappiness with the level of taxation that is levied on individuals and businesses by municipal, state, and federal governments to pay for services. This trend has grassroots origins, with local governments in the forefront and state and federal levels of government trailing behind. The purpose of privatization is to take advantage of the perceived cost efficiencies of private firms. Indeed, proponents of the practice say that privatization results in better performance of needed services at lesser cost. "The government usually allows the firm to choose how it will satisfy the contract," wrote Simon Hakim and Edwin Blackstone in American City and County. "For example, a contract may specify trash removal services for the area residents a certain number of times per week. The firm is normally allowed to choose the methods it will use to perform the requirements of the contract, the trash trucks, used, and the number of workers on each trash truck. The profit motive will encourage the firm to produce the services efficiently at the least cost, a motive absent in government provision of services." Even after privatization, however, government monitoring is necessary in order to ensure that satisfactory services are provided to residents.

GROWTH OF PRIVATIZATION

"Privatization may be a popular buzzword today, but the concept has been around since the first municipality hired Joe and his wagon to pick up the trash instead of getting city employee Frank to do it," remarked Public Works. "The difference today is that privatization is encroaching into all areas of public administration. And governments are expecting public agencies to compete—dollar for dollar—with private operators or surrender management of services. For years, our country has supported the idea that a public workforce was the best provider of essential services. Public employees would reliably and efficiently protect the public safety and deliver water and power; maintain roads and bridges; collect refuse and treat sewage…. In return, public employees enjoyed a certain job stability and a wide range of desirable benefits." But proliferating responsibilities, fiscal belt-tightening, sometimes lackluster performance by workers, and—in the cases of larger cities, especially—festering problems with infrastructure led increasing numbers of city planners and public policy makers to look to privatization.

Today, several of the nation's largest cities, including New York, Indianapolis, Philadelphia, and Phoenix have contracted out a broad spectrum of services that were previously attended to exclusively by city employees. Indeed, New York City opened up bidding from private companies on 40 different municipal services in 1995alone. Smaller cities and towns have instituted outsourcing philosophies as well, and many service businesses, both large and small, have garnered significant new contracts as a result. American City and County reported that various analyses indicate that this trend will likely continue. "Cost pressures, both internal and external, are rated as the most important reasons that officials decided to privatize a service," stated a report on privatization conducted by a coalition of Illinois academic, business, and municipal groups. "The main obstacle is the lack of information or evidence of the benefits of privatization. Many officials also report they would like more information on certain aspects of privatization. It can be deduced that providing additional information on privatization to city officials will lead to increased acceptance."

VARIATIONS IN PRIVATIZATION

The term privatization has been applied to three different methods of increasing the activity of the private sector in providing public services: 1) private sector choice, financing, and production of a service;2) public-sector choice and financing with private sector production of the service selected; 3) and deregulation of private firms providing services. In the first case, the entire responsibility for a service is transferred from the public sector to the private sector, and individual consumers select and purchase the amount of services they desire from private providers. For example, solid-waste collection is provided by private firms in some communities. The third form of privatization means that government reduces or eliminates the regulatory restrictions imposed on private firms providing specific services.

The second version of privatization refers to joint activity of the public and private sectors in providing services. In this case, consumers select and pay for the quantity and type of service desired through government, which then contracts with private firms to produce the desired amount and category of service. Although the government provides for the service, a private firm carries out the actual execution of it. The government determines the service level and pays the amount specified in the contract, but leaves decisions about production decisions to the private firm.

ADVANTAGES AND DISADVANTAGES OF PRIVATIZATION

The merits and drawbacks of privatization have been subjects of considerable debate among business-people, city leaders, and public employees alike. Indeed, each element of privatization—from its apparent cost-saving properties to its possible negative impact on minority workers—provokes strong reaction. About the only thing that everyone can agree on is that the trend has been enormously beneficial to owners of small- and mid-sized businesses. Following are some privatization issues that communities, public providers, and private providers all need to consider:

COSTS AND PRODUCTIVITY

Proponents of privatization argue that whereas government producers have no incentive to hold down production costs, private producers who contract with the government to provide the service have more at stake, thus encouraging them to perform at a higher level for lower cost. The lower the cost incurred by the firm in satisfying the contract, the greater profit it makes. On the other hand, the absence of competition and profit incentives in the public sector is not likely to result in cost minimization. Of course, small- and mid-sized companies also need to make sure that they do not sacrifice an acceptable profit margin in their zeal to secure a contract.

Although private firms may pay lower wages and fringe benefits than local governments, the major cause of the cost differences between the private and governmental sectors is employee productivity. Lower labor costs may arise either from lower wages (which means that the government was paying wages higher than necessary for a given skill) or from less labor input (which means that the government retaining more employees than necessary to fulfill need). Private firms have more flexibility than governmental units to use part-timers to meet peak periods of activity, to fire unsatisfactory workers, and to allocate workers across a variety of tasks. Moreover, critics of municipal governments argue that they are less likely to reward individual initiatives or punish aberrant behavior when compared with their private sector counterparts.

Finally, supporters of privatization argue that the trend has spurred improvements in performance by public service providers. "Evidence shows that public agencies should be allowed to bid on contracts along with private operators," wrote Blackstone and Hakim, "since this exposure to competition has led many public agencies to improve their service delivery and significantly reduce costs."

Service. Expected quality of service varies from community to community, depending on a wide range of factors such as historical service levels, local taxation, and possible changes in service requirements. Moreover, Public Works observed that good service is sometimes defined differently by citizens, public service providers, and private service providers. "Response time and public confidence need to be taken into account when judging the pros and cons of private/public," stated Public Works. "Stability may be a concern in the eyes of the public; a government agency cannot walk away at the end of a contract period."

Operating Philosophies. Proponents of privatization state that private firms may be more likely to experiment with different and creative approaches to service provision, whereas government tends to stick with the current approach since changes often create political difficulties for elected officials. In addition, private firms may use retained earnings to finance research or to purchase new capital equipment that lowers unit production costs. On the other hand, government may not be able or willing to allocate tax revenues to these purposes as easily, given the many competing demands on the government's budget.

Regulatory Realities. In some cases, local, state, and federal regulations may determine whether a service can even be handed over to a private provider. Moreover, "the ultimate responsibility (in the eyes of the public, if not the courts) rests with the public agency that assigns operating rights to a private concern," stated Public Works. "The local government will still be held responsible for the cost and quality of the service under contract."

Competition. Supporters of privatization often cite the competitive environment that is nourished by the practice as a key to its success. Private owners have a strong incentive to operate efficiently, they argue, while this incentive is lacking under public ownership. If private firms spend more money and employ more people to do the same amount of work, competition will lead to lower margins, lost customers, and decreased profits. The disciplining effect of competition does not occur in the public sector. Still, even advocates of privatization agree that private ownership produces the public benefits of lower costs and high quality only in the presence of a competitive environment. Privatization cannot be expected to produce these same benefits if competition is absent. Given this reality, analysts strongly encourage municipal governments to make sure that the bidding process is an ethical one.

Monitoring and Enforcement. Critics of privatization of government services contend that problems sometimes arise in various aspects of the process, including the bidding process, the precise specification of the contract, and the monitoring and enforcement of the contract. For example, some observers have raised concerns that potential suppliers may initially offer a price to the government that is less than actual production costs to induce the government to transfer the service to the private sector or to win the contract. Subsequently, the contractor would then demand a higher price after the government has dismantled its own production system. Such "low-balling" in the bidding process may be reduced if the local government requires relatively long-term contracts, or constructs contracts that give them flexibility in hiring and firing outside firms.

Public Personnel Management magazine also noted that governments need to take several important precautions before handing out a contract in order to avoid litigation and legal liability. These precautions include detailed performance specifications for service providers, guidelines for the evaluation of competitive bids, and labor relations strategies. For their part, private bidders need to make certain that these precautions are reasonable ones that will not unduly impact their ability to perform both profitably and professionally.

Commonly utilized methods of contract monitoring, meanwhile, include performance appraisals, tracking complaints, citizen satisfaction surveys, reports from contractors, field observations, and ongoing cost comparisons.

Employment. Privatization is understandably viewed as an alarming trend by public employee groups. In some cases, privatization results in layoffs of public sector employees, although governments often reassign them to other government jobs, place them with private contractors, or offer them early retirement programs. These possibilities have been particularly upsetting to public employee unions, which have been at the forefront of efforts to block privatization. Indeed, one of the principal objections to privatization is that it replaces positions that featured compensation that could be used to support a family with private sector spots that offer modest compensation. Indeed, critics such as the Journal of Commerce and Commercial 's David Morris contend that private companies are only able to promise meaningful financial savings over public agencies because of the comparatively low salaries they pay their workers. Another charge leveled at privatization initiatives is that they too often have a disproportionate impact on minorities. "Governments often hire minorities in larger proportions than other workers," wrote Blackstone and Hakim. "Thus, if government size is reduced, relatively more minority workers are likely to lose their jobs." In recognition of these fears, some service contracts now require private contractors to hire affected public employees or give them hiring preference.

Demographic and Geographic Factors. Smaller municipalities may incur relatively high unit costs if they operate their own services as a result of not being able to achieve economies of scale. These localities may benefit from turning to a contractor that serves multiple communities. Privatization is also more acceptable in fast-growing communities. If services are being expanded to cover new residents, private contractors are less likely to displace existing public sector employees. Finally, contracting out varies with the number of services provided to residents. As the number of services increases, differences in the cost and effectiveness with which they are provided become more apparent. Therefore, municipalities providing diverse services may be more open to exploring private sector options than those localities where services are more limited.

FURTHER READING:

Blackstone, Edwin, and Simon Hakim. "Private Ayes: A Tale of Four Cities." American City and County. February 1997.

Elam, L.B. "Reinventing Government Privatization Style—Avoiding the Legal Pitfalls of Replacing Civil Servants with Contract Providers." Public Personnel Management. Spring 1997.

Kodrzycki, Yolanda. "Privatization of Local Government Services: Lessons for New England." New England Economic Review. May/June, 1994.

Layne, Judy. "An Overview of the Privatization Debate." Optimum. June 2000.

Lieberman, Ira W. "Privatization: The Theme of the 1990s—An Overview." Columbia Journal of World Business. Spring 1993.

Morris, David. "The Downside of Privatization." Journal of Commerce and Commercial. February 9, 1996.

"Private/Public Partnership: A Balancing Act." Public Works. September 1997.

Schine, Eric. "America's New Watchword: If It Moves, Privatize It." Business Week. December 12, 1994.

Schriener, Judy, Stephen H. Daniels, and William J. Angelo. "Gold in the Hills of Privatization." ENR.. October 24, 1994.

Sturdivant, John N. "Privatization: It Often Doesn't Work, Increases Costs and Lacks Accountability." Site Selection. April 1996.



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