The Hidden Cost of Privatization

Why some goods and services should stay in the public domain
While the business of business is business, the business of government is not.  This piece points out that while there may be a role for public-private partnerships, not only are the cost savings doubtful, but their effect on the ends of government are extremely worrisome.  Public-private partnerships conflate public and private interests, and in conflicts between them, the private interests win out.

In the End of Laissez-Faire, Keynes posed what has become a central task of our time: determining the “agenda” of government, what it should do and not do. We must distinguish, as Keynes puts it, the “technically social services from the “technically individual” ones. The technically individual services can be provided privately, and thus privatized if they are provided publically, whereas the technically social services cannot. Individuals cannot provide them themselves - it is not in their interests to do so, so if they are to benefit from them, governments must supply them.

Trump and others would have us believe that there are few such “technically social” services - the defense of the nation being, perhaps, the only one. Most government services, they argue, can be provided privately, and provided more efficiently privately. A government agenda, in Keynes’s sense, does not exist. The business of government is no different than that of a business; the government, in fact, is a business, best run by those successful in business, and business criteria, such as profitability and efficiency, should decide what it does “in house” and what it contracts out.

This conception of government, of course, is not new. “Small government” has been a hallmark of the Republican Party for decades, and the privatization of government properties and services has been increasing worldwide since the 1980s. In the earlier period it centered on the privatization of state-owned enterprises, but in more recent times it has shifted to government services (after the 1980s, there were not many government enterprises left to sell off). Privatization today is both more varied and extensive than it was in the past, and since its objective seems to be nothing less than the privatization of the state itself, the question of the state’s “agenda” is critical. We must address the questions about the government that Keynes raised almost a century ago, and we must address them, as Keynes emphasized, without the laissez-faire presumptions of his times and ours, for it is not the case, as he famously wrote, that “private and social interests always coincide.”

Technically Social Services

One of the best examples of a “technically social service” is the macroeconomic one of the Keynesian theory: the recovery from a recession. This recovery, as Keynes would say, is not within the “sphere of the individual.” It is something that only governments can effect, for as Keynes demonstrates in The General Theory, recoveries require increases in the expenditure on products, and neither firms nor households are in a position to increase spending in recessionary times.

In a recession, sales fall and unemployment rises. Firms sell less than they can produce with the productive capacity they have, and sometimes even less than they do produce (when sales fall further than expected). Some firms cannot “break even” on their sales, covering their costs with their revenues, the financially weak ones lose their businesses to creditors, and the losses and slack sales of the recession depress the finances and outlooks of all.  

Banks tighten credit as firm bankruptcies rise, making it more difficult to finance production, and firms cut costs as profits decline, setting off a vicious cycle of cost reductions that reduce employment and thus sales, and sales declines that squeeze profits and thus force cost cuts. And while sales would revive, and growth would return, if firms increased their investment expenditure, this is not something firms normally do in a recession.

Small firms lack the funds for investment, and larger, established enterprises, the incentive. Why invest in new facilities when the ones on line cannot be fully or profitably utilized? Capacity utilization rates are too low, and sales too uncertain, for firms to undertake an expansion, and this is the case even though profits would rise if they did. For firms invest to increase their own profits, not the profits of their class, so that the effects of investment on the aggregate profit have no bearing on decisions to invest.[1]

This is not to say that firms would postpone investment indefinitely. The “urge to action,” as Keynes says, is strong, and the growth drive of firms even stronger. Firms that have the funds for investment will be seeking profitable outlets for them. They will seek out new markets for products - though these will probably be found abroad - or develop new products or technologies in the hope of profiting from them in more propitious times. Yet, “animal spirits” can dim for long periods of time, and the losses of recessions can make firms more wary of the risks of investment. The fear of loss can overtake the hope for gain, and the recovery from a recession is too important to leave to the vagaries of business confidence.

The situation of households in a recession is similar to that of firms. Recessions depress their finances also, and increases in spending are even more unlikely in their case than in that of firms. Their borrowing is more limited than the borrowing of firms, and savings less, and, except for the highest income households (the “1 %”), they have fewer and less liquid assets too. Many have their life savings invested in their homes, and houses are difficult to sell in recessions - in the last recession their prices plummeted - while other households have no wealth at all.

The unemployed have little income to spend; they must draw on their savings or that of their families and friends. And while the employed have income, and the employed are a much greater group than the unemployed, their jobs, or the jobs of others in their families, may be the next ones cut. Their jobs are at risk and incomes uncertain, and just as the losses of a recession make firms more cautious in their spending, the unemployment and stagnating wages of recessions make households more cautious in theirs.

It is the saving, not the spending, of households that typically rises in a recession, and that saving is a wholly rational response to their situation. Although most workers keep their jobs during recessions, the fact that they do is no comfort to those that do not, and workers do not know which of them will lose theirs. They must prepare for the eventuality of their unemployment, spending less money today to ensure having some to spend tomorrow, and though the needed savings will vary with the finances of workers and security of their jobs - the wealthy need not save at all - the deeper and longer the recession, the greater will be both the need to save and the number that save. The unemployed will lack earnings for longer periods, and the fear of job loss will rise. More and more households will cut spending, and while these cuts in spending will worsen the recession, reducing further employment and income in the nation, households, like firms, decide their spending on the basis of their own interests. They do not, and cannot, concern themselves with the interests of the nation or households as a whole.

But, while households cannot spend their way out of a recession, their government can do that spending for them. It can increase its spending, providing the amount needed for a revival of the economy. And, insofar as the government represents the populace, and is entrusted with its interests - as is supposed to be the case in a democracy - it must increase its expenditure. The welfare of the public requires it. 

Public Goods

The standard texts of economics place little importance on government services. Markets are assumed to work well; they can “fail,” but their failures are rare. And since governments can also fail, or operate inefficiently or incompetently, the government agenda is practically bare. It includes only those services that markets cannot provide at all, in any amount whatsoever, and these “public goods” are difficult to find.

A public good has two distinguishing characteristics: it is “non-excludable” in use and “non-rivalrous” in consumption. The first of these properties means that the good is available for free, as there is no way of limiting or restricting its use, whereas the second means that the good is available to all. It can be consumed by one individual without reducing its availability to another. Its consumption does not destroy it, as the consumption of a hamburger or loaf of bread does. The good remains for others to enjoy and many can do so at the same time and over time. The public at large can benefit from it.

This “non-rivalrous” characteristic occurs in the case of many goods. Creative works (such as literature, music, and art) have it - a Jane Austen novel can be, and has been, enjoyed by many -  as do the information and digital products of modern technologies (such as computer software, the internet, and media streams). But the other characteristic of a public good - the illimitability of its use - is more uncommon. The use of most goods and services can be restricted, limited to those who pay to acquire, enjoy, or license them. Individuals can be excluded through user (or entry) fees and purchase prices, and the excludability of a good removes it from the list of “public goods.” It is decisive.

If individuals can be excluded from the consumption of a good, sales revenues can cover costs. Its production can be profitable, so its private provisioning is possible. But if that excludability is not possible, if individuals can enjoy the good without paying for it or its use, they will “free ride” off the payments of others. Firms will not expect much, if any, profit from its sale, and the good would have to be provided publicly to be provided at all.

The example of such a “public good” favored in economics is the defense of a nation. Its defense defends everyone in the nation, as its arsenals and armed forces protect its territories as a whole. A nation’s defense is thus not only “non-rivalrous,” it is also “non-excludable,” and since the defense itself is not free, and individuals do not pay for services they can acquire for free[2], the government has to fund it. It can be financed through the government only, by its tax revenues or borrowings, and thus provided through it only. 

While national security fits the economists’ notion of a public good, it’s not clear what other government services do. Pollution reduction used to be cited in the literature, but its exemplification of a public good is now disputed[3], and many goods and services traditionally provided publicly, such as education, roads and other infrastructure are not “purely” public. Their use can be restricted, through user fees or other charges, but the fact that their use can be limited does not mean that it should. Their access by all may be in the public interest.

Take, for example, the use of roads. These can be tolled, and many are toll roads. Tolls contribute to the expense of maintaining roads, and can even pay back their construction costs.  Yet, many besides the users of a road benefit from it – the businesses on its route to name just a few. These would be hurt along with its users if its tolls reduced traffic flows, so that while tolls can be charged, and the maintenance expense of the road depends on its use, fees for its use must not impede its use. They must be affordable, within the income constraints of users, and in some cases no tolls should be charged at all (as is the case with the interstate highway system of the US). For, as Adam Smith emphasized in The Wealth of Nations, roads and other transport facilities should be undertaken by governments not to increase the revenues  of the “sovereign,” or “defray” the expenses, but to “facilitate the commerce of the nation.”

 Commerce, of course, increases the income in a nation, and thus could increase tax revenue. But that rise in tax revenue is not, for Smith, the reason for the promotion of commerce. It should be facilitated not because it generates revenue for the government, or satisfies “special interests,” but because it serves the public interest.  All of the public, regardless of the particularity of their pursuits, has an interest in the commerce of the nation, for, as Smith puts it, in a society with a developed division of labor, a “very small part of a man’s wants” can be supplied by his own labor. He supplies the “far greater part of them” by exchanging his product for the products of others, and every one “thus lives by exchanging, or becomes in some measure a merchant…”

The public investments of Smith’s government are “public works,” not assets. They are decided on the basis of their contributions to the public, and the interests of the public are not just an agglomeration of individual or competing interests either. The public has interests in common, such as the extension of markets and protection of persons and their properties, and the justness of laws and law enforcement matters too, as do educational opportunities.

Smith highlights the importance of an educated public in his discussion of the functions of government. The government must facilitate the instruction of the people as well as the commerce of the nation, and this was the case even though that instruction could be provided privately, as the charges for it could be, and were, exorbitant. The wealthy could afford them, but the public at large could not. The “common people” had neither the time nor money for the instruction of their children; so that for them to be educated, the government would have to either subsidize the instruction or provide it (Smith advocated the establishment of “little” schools in all towns).   

Discussions of the advantages of education usually focus on its economic benefits, to both the educated and the nation. These economic benefits, however, were not so significant in Smith’s times, as the jobs available to the “common people” were menial, requiring little skill or understanding, and indeed, it was because they were that their education was paramount. It counteracted the “dulling” of the mind that occurred in the performance of their simple, uninterrupted and repetitive tasks, and was needed not for the advancement of their fortunes, but for the development of their minds. They had to have some minimal understanding of the world, and ability to learn about it, to act intelligently within it, and respect the others in it. A “civil” society required an educated public.

The importance of education for life in a nation in our times is even greater than it was in Smith’s. For we now have democratically elected governments, and, as Smith says, the uneducated are subject to “foolish and rash” acts. They can vote against their interests, voting for candidates whose actions would hurt their interests or the interests of all. Self-interest, as Keynes says, is “not necessarily enlightened,” and it can only become enlightened through education.

Public-Private Partnerships

Governments have found new ways of privatizing services. They “partner” with private enterprises in the provisioning of services, forming various types of “public-private partnerships.” Thus, in the case of an infrastructure project, such as the development of a new highway or water treatment plant, the government could contract out its development to a private company (usually an investment bank or a “special purpose vehicle”). The private concern would finance, design, and construct the facility in exchange for a monthly payment over a specified time (usually 20 to 30 years).[4] The specified payments would cover the estimated present value of the project, and if the facility is already developed – for example some existing highway or public utility - its operation and maintenance could be contracted out or the facility itself leased, with agreed upon payments provided for the services in the first case, and for the public use of the facilities in the second.[5]

While public-private partnerships are contractual agreements in the case of infrastructure partnerships, they need not entail contracts. Thus, in the US, local school boards “partner” with private schools in their districts, subsidizing the purchase of an  education from them (through “educational vouchers”), or allocating some of the school budget to privately run “chartered” schools.” And the health care reforms of the Obama administration also entail public-private partnerships. In this case the government partners with the private (for profit) insurance companies; it subsidizes the purchase of their policies (on the “exchanges”) in exchange for some standardization of policies and coverage (they have to provide some basic coverage at non-discriminatory prices). But, although public-private partnerships take a variety of different forms, the objective of all is the same: making the public investment or service profitable enough to be provided privately.

Public-private partnerships separate the provisioning of government services from their funding. The private enterprise provides the service, whereas the government provides the funding. But, if the government covers the costs of the service, why not provide it itself? Why spend the time and money forming the partnership, and monitoring its outcomes, if it is going to pay for what is done anyway.

The answers to these questions center on the greater efficiency of private enterprise and the consequent cost savings of public-private partnerships. Yet, studies of their use in infrastructure investment provide little support for this presumed cost saving, and, as the critics of these partnerships argue[6], there is little reason to believe that they would save money.  Governments can finance investment at a lower cost than private companies can, and, unlike the investments of governments, those of private concerns must earn a profit. Their capital costs for the same investment will be higher than that of the government’s, and the government must cover all of these in its payments to them. And since private enterprises can fail, and some of those partnered by governments have failed,[7] bail out money has to be factored in as well. The government, as Malcolm Sawyer emphasizes, cannot allow the disruption of essential services (such as air traffic control), and thus must bail out the firms providing them.

Private enterprises may be more efficient than governments, but for a public-private partnership to save taxpayer money, the efficiency of the private firm has to be high enough to offset the higher capital costs of its investment, as well as the cost of enforcing its contract and risk of its failure. And, here, we must remember that the cost savings of private firms can come at the expense of employees and suppliers - governments generally pay more - and at the cost of the services provided as well.  These can be cut, and/or their quality degraded, as has happened in the case of many privatizations (such as that of the prisons).[8]

Costs can be reduced in ways other than through productivity increases. Their reduction may have more to do with the reduction of services or incomes than with efficiency gains, and the profit that drives the economizing of private firms is not received by the people that actually fulfill the government contracts either. The engineers and architects that design the new public facility, and managers that organize its work, are employees of enterprises, as are the construction workers that build it. They can work for the government also, and work as well for it as they do for private employers. For, their performance on the job depends more on the rewards of doing it, and the regard in which the job is held, than the fear of job loss. Indeed, that fear can be counterproductive.  

The cost savings of public-private partnerships are certainly doubtful; yet, their effect on the government budget is not the critical consideration. What is more worrisome is their effect on the ends of government.  Public-private partnerships conflate public and private interests, and in conflicts between them, the private interests win out. Governments acquiesce to those interests, and do so if for no other reason than livelihoods depend on the wellbeing of businesses. They provide the jobs.

Private interests dominate the affairs of nations, and public-private partnerships not only reflect the influence of these interests, they also increase it. Government is run more like a business. Investments become “assets”, and citizens “customers”, officials are elected (and appointed) because of their success in business, and services decided by profitability. And since the profitability of a service depends on the relation between benefits and costs, values have to be placed on benefits to the public. The worth of these, in monetary terms, has to be determined, and this requires valuing such invaluable products as clean air and water, healthy and cultured lives.

Of course the means of government are not unlimited, and the services have to be decided. But the means depend on taxes, and taxes can be levied for public purposes (such as they are for health care in many countries), and in the capitalist nations, at least, there is no reason to believe that the resources available would not be sufficient for those purposes. The government spending would not necessarily draw resources out of the private sector, or be inflationary, for, resource scarcity is not, and probably never has been, the central economic problem of capitalist nations. It is the unemployment of resources, not their availability, which has limited the income of these countries and periodically impoverished them.

While the business of business is business, the business of government is not. It has its own functions, an “agenda,” as Keynes puts it. This government agenda must be decided by the interests of the public, and these interests, as we have argued, are not just an agglomeration of individual interests. The public has interests in common, and the determination of these interests, and the actions on them, occur through the institutions of government. Government provides a public space, places and times for public discourse on the affairs of the nation, such as the public hearings of government agencies, the constituent gatherings of elected officials and electoral campaigns. And the political matters discussed through these avenues are decided, and acted on, in the legislature of the government, while the laws enacted there are enforced through the judiciary. The government substantiates the public purpose, keeping it in the conscience of the nation, and this, arguably, is its most important function.


[1] The fact that firms, as Kalecki famously said, “get what they spend,” does not mean that individual firms get what they spend. Kalecki’s theory is macroeconomic, it holds not in the case of the individual firm, but in that of firms as a whole.

[2] Of course they may pay for them, out of respect for the labor of others and right to fair pay, but this regard for others is not in the purview of economics.

[3] Some argue that pollution could be reduced privately, through contracts between polluters and those hurt by their pollution. The latter would agree to pay the former a specified sum in exchange for some amount of pollution reduction, and the amount done would then reflect its “real worth”: the value of the production it reduced or resources it used. See Coase’s discussion in his seminal 1960 article on “The Problem of Social Cost.” 

[4] Sometimes it is only the finance and development of the facility that is contracted out, and, in others the operation and maintenance of the facility is contracted also.

[5] If there are user fees for the facility, the private enterprise may acquire the right to set and collect them, and the government may then add to the user fee revenues through “availability payments.”

[6] See, in particular, Malcolm Sawyer’s discussion in his paper on “Private Finance Initiative and Public Private Partnerships: The key issues” (in Critical Essays on the Privatisation Experience, Basingstoke: Palgrave Macmillan, 2008).

[7] See the report on the Texas highway public-private partnership in the San Antonio Express News (September, 2016).

[8] It should be noted, here, that services are notoriously difficult to monitor as there is no real measure of their quality, so the adequate oversight of their provision, by the public or a public agency, is not possible. 

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