Research Questions Cost-Efficiency of Privatization

Public debate over government contracting has centered largely on issues of accountability. But recent scholarship on the efficiency of using contractors to deliver government services shows that a broader discussion is warranted. The assumptions about the relative efficiency of government contracts are on shaky ground, and cost measurements show no clear advantage to private contractors. Holes in the Theory The belief that private contractors perform more efficiently than government agencies rests on the expected effects of competition and private ownership. But privatization advocates often fail to examine the extent to which these conditions pertain in contracting markets. In his book You Don't Always Get What You Pay For: The Economics of Privatization, Professor Elliott Sclar, director of the Center for Sustainable Urban Development (CSUD) at Columbia University's Earth Institute, takes a critical look at contract markets and performance. As it turns out, the conditions needed for efficient contracting are often not present or are costly to obtain. Sclar found governments often buy services in uncompetitive markets. In contract markets where there are few buyers or sellers, prices can be out of line with the benefits of a purchased service. Governments often buy things nobody else does, such as garbage collection or sewer maintenance. Companies may collude with each other, or only a small quantity of suppliers may be able to compete for a contract. Contracts themselves are often very complex and expensive to monitor. Sclar found government agencies fail to write contracts appropriately, with clear definitions for the purchased goods. Governments also typically ask for goods or services that are not immediately available on the market. Companies have to make a service to order, and governments need to expend resources to ensure they get what they paid for. Sometimes, Sclar found, the contracted services may just be too complex to oversee efficiently. Contracting relationships are also jeopardized by conflicts of interest and informational imbalances. For example, long-term contracts are particularly hard to administer. Sclar found contractors may begin by providing a cost-efficient service, but later on, they may be in a position to leverage market power over an agency and charge high prices. No Clear Cost Savings to Contracting Sclar's analysis, which was drawn from case studies of privatization, seems to be accurate even when contractor performance in entire sectors is measured. Many surveys of certain types of privatization have shown no clear advantage to privatization. In one study, where all published econometric analyses of city water and waste production services were compiled, no strong link was found between how the service was provided (by contractor or by government workers) and how much it cost. Other factors were much more important in determining costs, including market structures, industrial organization and the capacity of government to hold contractors accountable for performance. Another study of contracting also found no discernible savings when governments used private contractors to administer prisons. While half of all private prisons surveyed may have generated cost savings, a quarter resulted in losses, and the final quarter showed no change. A 2002 study produced similar findings with regard to contracting out administrative staffing for child welfare programs. Recent experiments with privatization on a large scale have also produced unsatisfactory results. The state of Texas gave a comprehensive contract for the administration of nearly all social benefit services. But severe service delays developed, and the state had to end the contract for many of the services it outsourced. At the federal level, an ongoing effort to contract out tax collection services has suffered from massive inefficiencies. Government workers have been shown to be nearly four times as efficient as the contractors in collecting past due debts. Indeed, the only tenable argument made for tax privatization is that it is politically difficult to secure enough funding to hire government workers to do the same job. The House passed a bill to repeal this program on Oct. 10. A Pragmatic Approach to Contracting Most of the academic literature shows government contracting is a sensitive business that requires diligence, planning and management resources, and that it may be unsuited to certain goods and services. Additional rules for overseeing contracting processes may be necessary to ensure agencies prepare properly for contracting, and weigh all options for service provision. In Massachusetts, for example, a commission evaluates proposals for using private contractors prior to implementation. In a separate paper, Sclar found the commission saved money in Massachusetts by preventing inefficient contracting. He concluded:
    The privatization law has created an atmosphere where state agencies are forced to think like private firms as opposed to assuming that a private provider working under contract will automatically solve any problem at a lower cost. It compels state agencies to think through the pitfalls that lie ahead and prods them to be sure they are making the highest and best use of scarce resources in difficult fiscal times. It avoids the squandering of public funds on untested ideas that has plagued privatization efforts in so many other places.
When agencies do not take it for granted that contracting is always efficient, they should be better prepared to manage contracts and may be more willing to reform service delivery systems by more effective means than privatization. At the very least, this research shows that policymakers have good reason to examine the cost-efficiency of the rapidly expanding federal contracting industry — which has doubled in size in the last five years. Any review of contracting practices should determine the conditions under which privatization is a viable way of improving government performance.
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