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Executive Summary

The Privatization of Public Service
Lessons from Case Studies

By Elliott Sclar

This study reports on three case studies of public service reorganization in the United States. Although only two entailed the transfer of responsibility for service delivery from the public to the private sector, all have at one time or another been characterized as "privatization."

Each case covered at least four years, so the findings are less likely to be affected by temporary "start-up" factors. Selection of the cases was based on the availability of information-public documents, newspaper accounts, and personal interviews. Each appeared to be a strong candidate for privatization, since they all involved physical, "blue collar" work that is thought to be the easiest type of service to deliver through contracting. The types of tasks involved are also routinely performed in the private sector.

In the case of vehicle maintenance in Albany, N.Y. and state highway maintenance in Massachusetts, the privatization was carried out as its advocates initially planned. In Indianapolis, privatized vehicle maintenance was abandoned in favor of internal reorganization.

As for Albany and Massachusetts, there was no evidence that contracting saved money or improved service quality. In Indianapolis, however, substantial savings and an improvement in the quality of work can be documented.

In Albany, the best estimate is that the city is overspending by at least 20% under privatization, not counting the added costs of contract auditing and supervision. By contrast, Indianapolis can document savings in the range of 8-29%. It is not possible to estimate the true costs (or benefits) in the Massachusetts case, although the loss probably ranges from 9% to 27.5%.

Why did things not turn out as well as the privatization advocates predicted? For one thing, the tasks that make up the bulk of public service are often more complex than privatization advocates maintain, and the complexity translates into extra costs to administer the contracting process, monitor work, and evaluate performance. These can easily outweigh savings from lower production costs. Private organizations themselves often find that the administrative costs of performing tasks in-house are less than the transaction costs of using the market when key elements of their mission are at stake.

When any private or public organization decides to buy rather than make, it must go shopping. It either shops in what could be called a spot market or in a contract market. Spot markets are akin to "buying off the rack," while contract markets are like custom tailoring. Spot markets typically offer standardized products; examples include office supplies and motor vehicles. Some services that organizations can readily provide for themselves also fit in the spot market category. A business firm might use its own bookkeepers to prepare its payroll or it might hire an outside service. A periodicals publisher might process its own subscriptions and mail its own journals, or it might hire an outside fulfillment company.

Where the choice is between spot purchases of standardized products or internal production, the decision depends on a comparison of production costs. Typically products available in spot markets are available from many sellers, and product quality is relatively obvious. Competition maintains downward pressure on prices and focuses average quality to suit the tastes of buyers.

In contract markets, the choice of sellers is usually more limited. Product quality and prices are not as easily observed and compared. Consequently, decisions to contract out involve specification of the product, negotiation of prices, close monitoring of quality, and anticipation of contingencies. The decision to make or buy involves not only analysis of the comparative production costs typical of spot markets, but also the transaction costs of contract design and monitoring when much relevant information is nonexistent or only available at significant cost.

In much of the privatization debate, transaction costs are typically ignored. The product is routinely treated as if it is sold in a spot market, as if all one needs to do is announce the availability of the contract, specify the relevant conditions and terms, and wait for bidders to beat a path to the door.

The appealing simplicity of privatization through competitive contracting should be examined in light of experience and in comparison to alternative methods of improving public sector efficiency. A prominent option is the refashioning of labor-management relations, typified by the Indianapolis story.

Enhancing efficiency in public service provision may be possible without the participation of business firms. Given the transaction costs involved in a change-over to contracting, labor-management consultation could provide an economical shortcut. From this standpoint, it ought to be the option of first resort.

Public services can be complex to perform and administer. While contracting will always have a role to play, experience and analysis, rather than ideology, must be brought to bear to achieve the best balance of public and private participation. These cases analyzed here point up the hazards of premature conclusions as to what is easy to contract out. Problems of accountability and control can be daunting. The findings in this study do not augur well for decisions to expand the scope of contracting to ever-larger and more complex public services.

 

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