Privatization:
Downsizing government for principle and profit

(Part 1: The United States)
by Edward Herman

The U.S. government is encouraging private HMOs to service much of the Medicare system, and the debate rages over whether Social Security should be shifted to private management. Privatization of such public functions is one of the mantras of the New World Order. Economic, political and media elites assume that privatization provides undeniable benefits and moves us toward a good society.

But while it sometimes reduces costs, privatization is often less efficient than public enterprise, and frequently is socially harmful, taking a disproportionate toll on women and minorities. Privatization also weakens democracy by bypassing unions and shifting power away from governments and non-profit organizations, which can respond to democratic political processes. Instead, power moves to corporations that serve only the interests of their owners and financiers.

Privatization means the shift of activities from the government and nonprofit sectors to the market. It may take the form of the sale of public (or non-profit) sector assets to private companies or the contracting out of services previously supplied by public employees.

Privatization is not new. In France before the Revolution of 1789, the King farmed out government tax collecting to individuals in a system notorious for corruption. Along with contracting out the provision of supplies for the French armed forces, private tax collecting was the basis of many great fortunes. Ending this system was one of the French Revolution's accomplishments.

Throughout the nineteenth century, the U.S. government engaged in massive privatization through the sale of millions of acres of public land (a domain greatly extended by the Louisiana and Alaska purchases and the seizure of Mexican territory) . Many tycoons derived their fortunes from shrewd and sometimes fraudulent public land acquisitions. Abuses in the use and disposal of public property have continued throughout the twentieth century, manifested in both periodic scandals (such as Teapot Dome) and the subsidized use of public property, which continues today through, for example, under priced sales of national forest timber, bargain-rate use of mineral lands, and commercial broadcasters' free use of valuable air rights.

Western European and Third World governments have commonly owned airlines, railroads, telecommunications and electric power systems, and sometimes banks, petroleum refining and other industrial enterprises. But in the United States government has been largely excluded from activities of interest to private business, and its periodic entry into these fields has been limited and often stripped away. The government did take over many private sector activities during both World Wars I and II, but it speedily privatized them after the wars.

Since 1932, Congress, under the prodding of business, has made periodic surveys of government activities that compete with the private sector, with a view toward minimizing government competition. Ronald Reagan's Office of Management and Budget formalized the pressure on government agencies to minimize in-house production, ordering government managers to consider contracting out all functions, including data processing, janitorial services and vehicle maintenance.

Despite this long-standing bias against public enterprise in the United States, with the rise of monopoly power in railroads, electric power, and telephones during the late 19th and early 20th centuries the government created a regulatory apparatus. It grew with urbanization and the need for water supply and waste disposal, and the coming of the automobile and road building. The public sector grew further with the social democratization that accompanied the Great Depression and World War II, including the growth of organized labor and a new governmental health and welfare apparatus.

Privatizers from the early 1970s onward have been selling off government property-mainly water and waste water facilities, parking garages, roads, airports, public lands and buildings, and mortgage portfolios. But privatization in the United States has focused mainly on the contracting out of government services, including the operation of government-owned facilities.

State and local governments carry out most public economic activity, and contracting out at these levels has soared over the past decade. The Mercer Group, an Atlanta consulting firm, estimates that between 1987 and 1995 the number of municipalities contracting-out services increased as follows: janitorial from 52% to 70%, street maintenance 19% to 38%, solid waste collection 30% to 50%, and data processing operations 16% to 31 %.

This new wave of contracting-out ignores historical lessons. A great deal of current government provision of services originated in the failures of contracting during the late nineteenth century and into the 1920s, under political systems that were often corrupt. Ending such arrangements and turning them over to public agencies was a major accomplishment of the 1920s and later.

Roots of the new privatization wave

The privatization wave over the past twenty years is rooted in increased corporate power. This growth, based partly on greater capital mobility, has led to renewed aggressiveness by business, political successes (including the elections of Ronald Reagan, British Prime Minister Margaret Thatcher, and neoliberals widely), and a parallel weakening of labor.

Enhanced corporate power has also contributed to the triumph of neoliberal ideology. Central beliefs of this ideology include the efficiency of the private market, the inefficiency of government, and the dual menaces of inflation and budget deficits. With neoliberalism in place, helped by corporate domination of think-tank funding and the mass media, along with great influence within the ivory tower, scaling back government was an obvious policy thrust.

Part of the design of neoliberal politicians and intellectuals has been to weaken the state as a power center that might serve ordinary citizens and challenge the rule of the market. The success of these efforts is evident in both Britain and the United States, where formerly liberal parties now denounce big government, genuflect to market-based solutions, and contribute to eroding the welfare state.

Governments' budgetary problems gave further impetus to privatization. As the Wall Street Journal pointed out in 1995, referring to talk of selling the federal oil reserves, "Both Congress and the White House want to change budget-accounting rules so they can count money raised by selling assets toward reducing the deficit-even if such sales would reduce government income... in future years." At the state and local level, "cash-strapped cities, such as Wilmington, Delaware, want the up front cash they can get by selling the local sewage-treatment plant, or look to private ownership as a way to finance improvements of existing facilities."

The new global economic order itself has contributed greatly to these financial difficulties. Capital has fled from urban cores, leaving them in fiscal straits, and corporations have bargained aggressively with governments to extract concessions as conditions for their keeping jobs in place (or to induce them to move). All governments have had to limit business taxes and spending on social benefits in order to provide a "favorable investment climate," leaving them under financial stress. Intel Corporation, for example, bargained so effectively in 1995 with Rio Ranchos, a small New Mexico town eager to be the site of an Intel plant, that the town was forced to sharply cut its school budget.

Another force for privatization has been the growing power of financial markets, which reward and penalize governments as they meet or fall short of market policy standards. Financial market players want low inflation and balanced budgets. They are keen on privatization because it yields short term revenues and is a mark of commitment to neoliberalism.

Privatization has also been pressed by innumerable entrepreneurs eager to buy up government property and provide services previously supplied internally. Partly in anticipation of privatization opportunities, many of them had obtained political leverage by funding the electoral campaigns of politicians now in office.

Efficiency gains or wage reductions?

Although the privatizers claim that their objective is to increase efficiency, this is contradicted by their indiscriminate actions and their frequent disposal of public enterprises noted for efficiency. There is also evidence that they are often responding to financial and political pressure. Furthermore, many bids for government property and contract service base their savings largely on shifting from union to non-union and contingent labor.

Take, for example, contracting of the cleaning service for state buildings in Buffalo, New York in 1992. While initially claiming that the low contractor offer was based on efficiency improvements, state officials eventually admitted to the Buffalo News that the savings would come from the use of "more part-time workers at lower salaries and with fewer benefits." Study after study has shown that contractors offer lower wages and limited if any health and pension benefits. But gains from lower wages and benefits are not true "efficiency" improvements, which imply a reduction in the use of resources such as labor and materials. They are actually income transfers from wage earners to employers (profits) and to government managers and taxpayers.

Even the nominal savings in privatization may be illusory or short-lived. A common phenomenon in contracting out was made famous in the weapons contracting formula "buy in, get well later." The contractor bids low, knowing that he can obtain cost adjustments after the government gets locked into the contract and would find it difficult to cancel and locate another source, or do the job in-house.

The most famous case was Lockheed's bid to produce the C-5A giant transport plane in the 1960s, which led to a huge cost overrun that doubled the price before a single plane was produced. Lockheed's contract had an automatic cost-based price escalation clause that was soon dubbed the "golden handshake."

Even fixed-price contracts could be raised through "improvements" offered by the contractor or demanded by the Pentagon-a process known as "gold-plating." One result of this abusive contracting system was that for decades the major contractors had profit rates on their Pentagon business roughly twice those in their commercial operations.

Many years ago the U.S. government did weapons research and produced many of its weapons in government arsenals. This was gradually phased out in favor of farming out research and production to private sellers. But without in-house production and research capabilities the government's bargaining position was reduced. It no longer had the option of producing for itself, and lacked the expertise to be a knowledgeable buyer, and so could be taken advantage of more easily. This point applies to other public functions-without a skilled body of managers and technicians the government is a ready victim in contract negotiations with knowledgeable private parties.

Contracting out is at an initial cost disadvantage compared to in-house production. It requires the additional expense of writing and evaluating contracts and then monitoring performance over their lives-the latter entailing a permanent bureaucratic apparatus on top of that deployed by the contractor. If that apparatus is skimped on, politicized, or corrupt, the road is open to massive cost escalation. Contracting out is often not able to overcome the disabilities of monitoring costs and potential corruption.

There is some truth to charges of inefficiency in public enterprises and non profit service activities. Many of these have become over bureaucratized, over-staffed and politicized. Free market proponents speak of "state failure" to counter claims of "market failure" by the private sector. But many state and nonprofit enterprises and services have done well, and when they have done poorly it is often the result of conservative macroeconomic policy and crippling state intervention. When macro-policy is designed to keep a large reserve army of unemployed labor, labor strenuously resists staff cuts and public agencies find it harder to trim staff. Underfunding, political appointments, and capture of regulatory agencies by corporate interests frequently undermine the functioning of government entities. Such damaging interventions are often deliberate, as in the case of the Reagan-era budget cuts and political appointments to the Environmental Protection Agency and the Corporation for Public Broadcasting, both designed to demoralize and weaken the organizations. In these cases and others the damage inflicted reflects corporate efforts to undermine public bodies through the political process.

Privatization and competition

Conservatives assume that government sells or contracts out its operations under competitive conditions, and that such competition then and later will restrain exploitation of the contracting authority and the public. This is some times correct, but often is not. There are frequently only a few local bidders for contracts, and they sometimes collude, divide markets and rig prices. One contractor testifying in a national antitrust action noted that "as far back as I can remember" Northern Virginia contractors met annually to carve up contracts that the Virginia highway department was expected to allocate during the year. Numerous suits have been brought and won against Waste Management Inc., Browning Ferris and SCA Services for collusion and price fixing in the trash disposal industries.

In major contracting-out businesses there has been steady growth of national operators, like Waste Management and Browning Ferris in waste disposal and ARA in food services. These large operators are able to undercut local firms, some or all of whom disappear, making it possible for the large firms to "get well" later. More generally, once contracts are won, systems installed, relationships cultivated, and rivals driven from the market, the power of the contractor is strengthened and it becomes costly for a public agency to shift the service elsewhere.

In contrast, changing from private to public ownership can increase competition. When the Tennessee Valley Authority (TVA) was organized in the 1930s, for example, it broke up the cartel-like high pricing policy of the private electric utilities in the Tennessee Valley, and private companies hated the TVA because it increased competition. As many U.S. and global markets have few sellers (oligopolies), and as private oligopolists often collude, publicly owned firms can disturb cozy private market arrangements.

Corruption

Corruption is built in to the privatization process. Bid ding on contracts is not carried out in perfect markets, and in real world markets, with only a few sellers, they almost always seek political influence as a rational business strategy. In a process dubbed the "revolving door," it is now standard procedure for companies seeking contracts to hire former politicians and managers of public agencies to lobby on their behalf. The New York Times noted recently that one reason federal Justice Department and prison officials have warmed up to privatizing prisons, despite their experience that privately run prisons costs more, is that private industry's ranks "now include many former colleagues as senior and other law enforcement officials have taken positions at private corrections companies, Washington's latest revolving door profession."

Corruption operates at many levels: contributing to political election campaigns, cultivating politicians and other public officials, hiring them or their friends, relatives and staff, and straightforward bribery.

Less service for your money

Another secret to the profitability of privatization is reductions in service. Contractors reap their ''efficiency'' savings by hiring cheaper and less well-trained labor, with higher turnover rates, and by cutting the quantity, quality and scope of service. There may be fewer service personnel or fewer trash collections or lavatory cleanings. Older, more polluting school buses may be used, and bus and train stops at out-of-the-way places may be terminated. Or charges may be imposed on services formerly provided free, thereby pricing poor customers out of the market.

Contracting out of hospital management and purchases of nonprofit hospitals by large HMO systems are classic cases of service reductions. These contractors and HMOs have strong incentives to exclude unhealthy customers and scale down usage for the remainder. To this end they systematically impose barriers to usage, through toughened standards for referrals to specialists, perverse incentives to doctors on their payrolls, and cuts in staff quantity and quality. To some extent these changes offset occasional lavish usage under cost-plus systems, but contracted and HMO systems have established a direct conflict between the interests of patients and medical servers. They also entail large bureaucratic expenses for evaluation, review and collection, plus incentives to exclude the poor.

The largest hospital system, Columbia/HCA Health care, is currently the owner of 350 hospitals in 38 states, and continues to gobble up public hospitals left and right. Its CEO, Richard Scott, says that "Healthcare is a business like anything else," and "Is any fast-food restaurant obligated to feed everyone who shows up?" His company has a 20% gross profit target, and he has been meeting that goal, partly by lower costs for large scale purchase of medical equipment and supplies, but more importantly by union avoidance, "reengineering" nursing personnel (increasing their workloads, substituting non-nurses), and "cream skimming" (taking billable patients, dumping non-billables on other hospitals).

The Department of Health Security in Indiana recently fined Columbia/HCA for understaffing, and doctors and nurses at the Good Samaritan hospitals in San Jose, California, have complained bitterly at the medical damage wrought by the "economies" installed following Columbia/HCA's takeover in 1996. Lee County, Florida officials calculated that in 1994 the public hospital there provided $13 million in "charity/uncompensated care," whereas Columbia/HCA's three hospitals in the county provided $1 million in such unprofitable service.

The benefits of being public

Public corporations, nonprofits, and in-house government activities can bring benefits to communities that are neglected by market-oriented businesses. They are more open to unions and provide more secure jobs than private companies. The security and benefits of such jobs are of great value to workers, but the market gives them no weight. The stability of government spending and jobs also helps mitigate recessions, since governments need not cut their spending when consumer demand and private investment fall.

In transportation there are enormous social costs associated with the growth of auto travel -- pollution, congestion, and urban sprawl. Public transportation in the form of trains and buses is a vital means of reducing those huge costs. But in a privatizing world, trains and buses are not given credit for limiting auto travel, and so are not seen as deserving of public subsidies. Instead, once privatized, transit riders are expected to pay the full cost of transit in their fares. Inevitably, this leads to lower ridership, driving up the social costs from auto use.

Another illustration of the damage from privatization is the preference given private over public broadcasting. Public stations can focus on "public service" programming, including information that helps to promote democratic citizenship. In contrast, private broadcasting marginalizes public affairs in favor of entertainment, under bottom line pressures and in response to advertiser preferences. Private broadcasters also resort heavily to audience-drawing sex and violence, which have anti-social consequences.

Accountability

Privatization reduces accountability. Governments can be voted out, but private owners are insulated from the opinions of ordinary citizens and contractors are protected by legal agreements. In fact, governments frequently try to fob off difficult problems onto contractors, but this often makes for confusion, because, while allocating tasks to third parties, the government often cannot escape its own responsibilities.

This is most obvious when the government assigns to private parties jobs that require the application of sovereign powers of government. In the case of prisons, now rapidly being privatized, where the prisoners are held by force and are subject to possible parole or penalties for misbehavior, to what extent can private contractors dispense such sovereign actions? Don't they have a conflict of interest in dealing with parole and extended sentences when their economic interest calls for higher prison occupancy? Isn't there a danger that the drive for profits will lead to hiring unqualified and inadequately trained personnel and the mistreatment of prisoners?

As Princeton political scientist John DiIilio wrote in 1987, "The history of private sector involvement in corrections is unrelievedly bleak, a well-documented tale of inmate abuse and political corruption." A dramatic illustration of this tendency made front page news in 1995, when a riot by immigrant detainees in an Immigration and Naturalization Service (INS) prison operated by Esmor Corporation led to "a scathing report detailing an atmosphere of abuse and penny pinching in the jail for illegal immigrants and asylum seekers. Poorly paid, ill trained guards physically and verbally abused detainees, shackling them with leg irons, roughing them up with no reason in the middle of the night." Esmor had obtained a contract with the INS despite having no experience, by hiring the campaign manager of a New York politician to lobby for their interests. Because of the public nature of the functions of running prisons, the American Bar Association resolved in 1986 that privatization of prisons should be halted "until the complex constitutional, statutory, and contractual issues are satisfactorily developed and re solved." These issues have certainly not been resolved, but privatization is moving ahead full speed, because of inflated perceptions of possible budget savings, the political revolving door, and the emergence of a new "prison-industrial complex."

Privatization versus democracy

Margaret Thatcher, Augusto Pinochet and others have deliberately used privatization as a means of weakening popular forces and consolidating the power of capital. The West's support of Boris Yeltsin's privatization program, hugely corrupt and beggaring the population, is also designed to make the transformation to capitalism irreversible. These leaders, and the IMF, recognize privatization's political dimension. Governments can be mobilized to serve ordinary citizens-so that shrinking their functions, making them more dependent on the private sector, reducing public-sector unions, and strengthening capital diminishes the democratic threat. Privatization in the United States has been part of this global corporate and right-wing effort to undermine the democratic gains of the past half century.

Edward Herman is an economist, media analyst, and a regular columnist for Z magazine.

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