Most introductory economics students know that markets naturally tend towards equilibrium. In their homework, these students also have likely been told to assume that there is no government interference in the economy in question.
This simplifying classroom assumption is one that some argue should extend to our understanding of actual markets in the United States. Many conservative and libertarian economists have long held the belief that a free market, acting outside the purview of the federal government, is able to achieve a more efficient allocation of resources than its regulated counterpart.
The role of government in markets is a tricky question. Government actions certainly complicate equilibria, but many believe they are a necessary tradeoff in ensuring equal access and “fairer” solutions despite small losses to economic efficiency. Privatization plays an integral role in the U.S. economy, and when executed properly, it provides American citizens with high-quality government services at lower costs, all without sacrificing social welfare.
The Rise of Privatization
As a tool of government spending, privatization, the transfer of an enterprise from the public sector to the private sector, has expanded rapidly in the 21st century. Although the Congressional Budget Office was unable to find “any comprehensive information about the size of the federal government’s contracted workforce” in a March 2015 report to the House Budget Committee, it was able to estimate that in 2012, federal agencies paid over $500 billion to contractors for goods and services. The same report found that since 2000, the amount spent on government contracts has grown as a percentage of the total budget and at a rate faster than inflation, indicating that the recent rise of privatization continued during both the Bush and Obama administrations.
A large majority of privatization efforts are uncontroversial and follow common sense. In the same 2015 report, the CBO noted that it is outrageous to expect a federal agency to make its own pencils or office supplies when it can buy them at a lower price by contracting out to a private supplier. Such mutually-beneficial transactions adhere to the economic principles of comparative advantage and the efficient allocation of resources.
In an interview with the HPR, Alan Trager, Director of the Public-Private Partnerships Initiative at the Johns Hopkins School of Advanced International Studies, explained that governments seeking to transfer responsibilities to the private or non-profit sectors can go one of three ways. One method, complete privatization, sells public assets and transfers government control to the private sector. Another is “outsourcing—where a government makes a decision to use a contracting method to extend the reach of government but where the work is done by the private sector.” Outsourced services are still considered public assets but those that are privatized are not.
A compromise has emerged in many areas of government that bridges the gap between government control and full privatization: the public-private partnership. According to Trager, PPPs are unique in that they are “a sharing of resources, risks, and decisions.” The collective responsibility over decision-making gives governments the power to govern over an asset collaboratively with the private sector, instead of handing over full control to a contracted firm.
Proponents of PPPs cite the economic efficiency of the private sector, which often provides higher quality goods and services than the government while simultaneously favoring a government role in the oversight process. In an interview with the HPR, Todd Herberghs, Executive Director of the National Council for Public-Private Partnerships, said that at least 50,000 public entities at the local through federal levels could potentially benefit from a PPP.
However, as Harvard economics professor Oliver Hart explained in an interview with the HPR, while shared control between private firms and the government sounds good on paper, it can be rather ambiguous from a contracting perspective. Hart, who received a Nobel Prize for his work in the field of contract theory, established the concept of “incomplete contracts,” the idea that all contracts are incomplete because they are unable to fully predict an uncertain future.
By Hart’s logic, PPP contracts that share control rights between the public and private sector are incomplete by definition. Shared control can be litigated in a contract, but contract theory dictates that there will always be areas that are uncovered—meaning the million-dollar question for PPPs, according to Hart, is who retains control rights in an unforeseen scenario.
Herberghs likens the lifespan of a PPP contact as a long-term “marriage” between public and private sectors. To Herberghs and other PPP proponents, a way of circumventing issues that Hart raises is to force the private sector to maintain minimum standards of service quality over the life of a contract and also relinquish its control rights at contract’s end.
Privatization in Practice: Private Prisons
Though most private-public partnerships help the government better serve Americans, some areas of public-private entanglement have been seen as harmful to society. One such area is the American prison system. The incarceration process in some areas has effectively been outsourced; private companies are contracted to provide this public service without adequate shared control or oversight. In 2015, the Bureau of Justice Statistics reported that approximately 7 percent of state prisoners and 18 percent of federal prisoners were incarcerated in private, for-profit prison facilities, totaling over 100,000 inmates.
Organizations like the American Civil Liberties Union see these figures as troubling. A November 2011 report published by the ACLU entitled “Banking on Bondage: Private Prisons and Mass Incarceration” concluded that the United States’ high levels of incarceration, highest internationally in both absolute and per capita measures, is due, in part, to the private prison industry that profits off the imprisonment of Americans.
Top officials in the waning months of the Obama administration seemed to agree. In August 2016, then-Deputy Attorney General Sally Yates issued a memo that asserted the ultimate goal of the Obama-era Justice Department to be “reducing—and ultimately ending—our use of privately operated prisons.” Yates cited findings by the Justice Department’s Office of Inspector General showing that private prisons failed to perform as well as prisons operated by the Federal Bureau of Prisons in key areas of safety and security. These private prisons also failed to operate at significantly lower costs.
Current Attorney General Jeff Sessions, however, has since rescinded Yates’ directive, arguing that a roll back of Bureau of Prison contracts to private prison operators “impaired the Bureau’s ability to meet the future needs of the federal correctional system.”
Trager sees the privatization of prisons as a result of government motivation to “take the risk and cost of as many services as possible and push it off its balance sheet to the private sector,” noting that this approach “doesn’t necessarily accomplish the financial goal and sometimes produces a worse social outcome.” Other modern attempts towards privatization, however, are less cut-and-dry. One such attempt is happening in a service that affects every community in America: public education.
Public-Private Tensions in Education
National tensions over the “right” path for American elementary and secondary education were on full display during Education Secretary Betsy DeVos’s Senate confirmation hearings. The issues facing the public education system are numerous, and many believe that a shift towards privatizing schools would benefit American students. DeVos and the current administration are of the position that school choice “is the civil rights issue of our time.”
School choice would allow students greater flexibility to attend a school of their choosing, no matter whether public, private, or charter. One way school choice is implemented is by giving students and their families a government-subsidized voucher that can be used to pay tuition at a school other than their neighborhood school. This system represents a shift away from the public asset model that has defined American elementary and secondary education for decades. Could this more private, more competitive education system allow students to realize better educational outcomes?
Economic theory and research studies indicate that it is certainly possible. A joint experimental survey conducted by Matthew Chingos of the Brookings Institution and Paul Peterson, director of the Program of Education Policy and Governance at the Harvard Kennedy School, followed over 2,500 students in New York City. Chingos and Peterson found that African-American students who received school vouchers were significantly more likely to attend and complete college than those who did not receive vouchers.
In an interview with the HPR, Peterson noted that given America’s inability to address the issues that face “big city school systems, which people have now been trying to fix for 50 years,” his research serves as evidence that the United States should seriously consider expanded voucher programs.
On another axis of school choice, charter schools, research is more mixed. A report from Stanford’s Center for Research on Education Outcomes show that nationally, differences in educational outcomes between charter schools are stark. Only 29 percent of charter schools performed better compared to traditional public schools in math, while 40 percent had no discernable difference, and 31 percent were significantly weaker than traditional schools. Opponents of increased school choice often cite these statistics to show that many alternative options perform worse than public schools, essentially nullifying the key motive to privatize.
Trager emphasized that in a public-private partnership, governance and oversight should be shared between the government and the private sector. In education, this governance could come in the form of standardized achievement expectations across all schools. Standardized expectations would allow the government to ensure a minimum level of student achievement across school type, potentially eliminating charter school differences shown in the CREDO survey. Peterson agreed on the importance of holding schools accountable for student achievement: “whether it’s a voucher school, or a charter school, or a public school … we should have this for all students.”
Limits of Privatization
Hart sees the case for privatization as existing on a spectrum between extremes of assets that should certainly exist under government control, like foreign policy and the judicial system, and no-brainer candidates for privatization, like municipal snow and garbage removal. For areas where privatization’s role is less clear, maximizing social benefits like higher college matriculation rates while minimizing social costs like violence in prisons lies at the heart of the privatization debate. To what extent the government can entrust these services to the private sector depends largely on the financial incentives of the private partner.
Government differs from for-profit firms most notably in its dual, oft-competing objectives of social welfare and economic efficiency. Trager and Hart posit that it is possible for a given public-private partnership to be attractive when paired with a non-profit or cooperative partner, but not with a for-profit partner, as the former is more likely to value the government’s social priorities over their bottom lines. For-profit partners, on the other hand, have a greater incentive to minimize costs, which may lead to sacrificing social benefits in pursuit of economic efficiency. Non-profit partners, to borrow Hart’s metaphor, are a “half-way house” that blend the incentives of economic efficiency and equitable social outcomes.
In most instances, therefore, the question of privatization is not if the government should partner with the private sector, but who it should partner with. The marriage of the public and private sectors in public-private partnerships bodes well for America, so long as the partners remain committed to their shared goals, and to each other.
Image Source: Wikimedia Commons (Public Domain)