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Cornell University Press 184 pages.

Review by Edward Herman

This book by Elliott Sclar, a professor of Urban Planning at Columbia University, is essential reading for anyone who wants to understand the bases and consequences of the still powerful drive to privatize. The mainstream media and most writers on the subject have been naively or calculatedly apologists for privatization.  Sclar is a critic, but he is relatively unbiased, uses economic and organization theory with a sure hand, and his work is based on serious original research.

Sclar does not condemn privatization, but shows that while it has a definite place in the arsenal of public management, it has real and sometimes overwhelming deficiencies. One of his most compelling themes is that the standard model used in support of privatization, which assumes contracting for a simple product in a competitive market, is very often inapplicable to the public sector. Many public services are complex, and the frequently detailed contracting agreement and need to monitor its implementation are a far cry from buying a good or simple service in a spot market. Furthermore, the markets for such complex products are usually not very competitive, and they become less so after contracts are let.

He uses as one example the management of the 2,700 motor vehicles owned and previously maintained in-house by the city of Albany, but contracted out to a number of retail repair shops in the early 1990s. How do you fix contract terms that create proper incentives and prevent contractor padding of bills for this complex arrangement? In a case like this privatization brings with it built-in “principal-agent” and “moral hazard” problems, because the agents (private repair shops) have interests that conflict with those of the principal (the public authority) and there is a hazard that they will abuse their position if they can get away with it (overcharging, undermaintaining). This threat is exacerbated by the fact that there is “asymmetric information,” with the contractor knowing much more about the actual work and its costs than the public authority.

This situation was made more difficult in Albany because the in-house operation had never developed a very good cost accounting system, which made monitoring more difficult. The problems involved here cannot be solved by contract terms, which have to leave much open to take account of uncertain future maintenance demands. But this means that continuous monitoring is required to protect the city's interests, which adds significantly to the costs of contracting out—and gives public ownership and management a built-in efficiency advantage. If these “transactions costs” (of contracting and monitoring) are skimped on the agent's abuses can make privatization costlier still. Sclar shows that in Albany the system worked badly and the city suffered substantial net losses from privatization.

In the ideology and standard model of privatization all such problems will be solved because competition will drive costs down to minimum levels. Sclar argues convincingly that this model is frequently inapplicable to real world cases. For complex products like management of a large automotive fleet, a prison system, road building and highway maintenance, a welfare system, or school food services, there are usually only a modest number of initial bidders. Sometimes these bidders collude with one another. On other occasions the low bidder makes a below-cost offer because of desperation to get the business, often hoping to raise the price after landing the contract. This was a classic procedure in military contracting known as “buy now, get well later.” Sclar notes how readily this can be used by the contractor, because once the contract is let rival bidders are often acquired or otherwise disappear, and with the contractor investing in fixed assets and cultivating public managers and legislators, public officials may have little incentive or even abiity to contest contractor demands. He notes that New York City pays a huge price to its privatized school bus system because nobody could take it over easily, including the city itself, which no longer owns the buses.

Another factor that makes the protective and disciplinary role of competition weak or non-existent is that under privatization a primary form of competition is buying, lobbying, and manipulating regulators and legislators. This perverse development is completely “natural” as this is an entirely logical and very effective route to getting contracts on favorable terms and preventing effective monitoring. This perversity is reinforced by the fact that the politicians favoring privatization are often supported by (and virtual agents of) businesspeople seeking public assets and contracts, and they are also sometimes privatization ideologues.

Sclar describes in detail Massachusetts Governor William Weld's privatization of a segment of the state's highway maintenance operation after his election in 1990, and promise to establish “entrepreneurial government.” Here again the product was complex and the costs of negotiating and monitoring a contract would be very substantial, if done properly. Contracting out was also not justified by any deficiencies in in-house maintenance, but was based on Weld's links to business interests with a stake in privatization, along with his seeming ideological fervor and belief in the inherent beneficence of privatization. There were not many bidders, and there were none that did all the kinds of work that had been done by the state's maintenance operation. The road-building contractor who won the contract presented the usual moral hazard problems, including the fact his firm did private work that competed with carrying out his state road contract work responsibilities. Sclar shows that the moral hazard problems were realized—the work was done haphazardly, much of the work supposedly privatized was carried out by state workers, and there was strong evidence that “entrepreneurial government” in this case cost Massachussetts taxpayers a lot of money.

Thus, although the drive toward privatization has been justified on grounds of supposed efficiency improvements that will result from substituting the market for bureaucrats, apart from the fact that a layer of monitoring bureaucrats is still needed on top of any in the private sector, in reality privatization is more menacingly “political” than in-house management. It is driven not only by ideology but by interests who want to take over state activities, and the principal-agent and moral hazard problems, combined with the regular mobilization of political influence, makes for both diminished accountability and higher levels of corruption than with state bureaucrats responsible to elected officials. Sclar gives many illustrations of this politicization. He also shows that although privatization can sometimes save money, this is far from inevitable when the service (including monitoring and other “transactions costs”) is properly costed and when account is taken of contractors “getting well later.”

Sclar also addresses the issue of “external effects,” regularly ignored by privatization enthusiasts. These are societal costs and benefits that the market fails to take into account, like the positive effects of free public education on productivity and democratic citizenship, or the negative impact of the commercialization of broadcasting on program quality. Sclar notes that the U.S. Postal Service provides cheap local mail service to everybody, whereas Federal Express and similar operations engage in “cream skimming,” catering to business and the affluent. Similarly public schools and libraries and public hospitals offer a democratized service, whereas their privatized counterparts exclude large numbers unable to pay. Public transport also brings external benefits, including not only cheaper transport for the less affluent but also reductions in pollution and other negative effects of reliance on private automobiles.

Sclar doesn't make this point, but one of the external benefits of public service is that workers are more likely to be unionized and receive higher wages and benefits and have more security. This would not justify feather-bedding and serious over-payment, but the decent treatment of the workforce adds to total community welfare and is a positive feature of public service. Sclar may also underrate the frequency with which claims of an efficiency advantage of contracting out rest on the use of non-union, low wage, low benefit labor, and the corollary diminution in the quantity and quality of service and social welfare.

Ideologically driven privatization in the supposed interest of efficiency can be very costly to society. In his 1996 drive to slash public budgets, right-wing premier of Ontario, Canada, Mike Harris, closed down the government's water-testing laboratories, privatized water testing, and did not require testing results to be sent to any public authorities. This resulted in a lag in warning the public of E.coli bacteria in the drinking water of Walkerton that resulted in 7 deaths and hospitalization of 2,000. Harris has put his plans for further privatization of municipal services on at least temporary hold.

Although Sclar stresses the ideological basis of efforts to privatize, he may not give sufficient weight to the importance of the interests eager to capture formerly public business for themselves —like the security dealers pressing for privatization of Social Security—who are served by and promote that ideology. He may also give less than its proper weight to the deeper political basis of the privatization drive. British Prime Minister Margaret Thatcher was very explicit that her selling off of state-owned housing and other state assets to the working class was to wean them away from the Labor Party and left by making them into property owners. She has not been alone in deliberately using privatization as a means of weakening popular forces and consolidating the power of capital. The West's support of Yeltsin's privatization program, hugely corrupt and beggaring the population, was also based on the desire to make the transformation to capitalism irreversible.

Western leaders, the IMF, and privatization ideologists recognize and exploit privatization's political dimension. Governments can be mobilized to serve ordinary citizens and enact legislation threatening corporate welfare; so shrinking governments' civil functions, making them more dependent on the private sector, reducing the size of unions in government service, and strengthening the corporate community by transferring to it the ownership or management of public properties, significantly increases the power of capital— economically, socially, and politically. Privatization in the United States, as elsewhere, is an important part of the corporate and right-wing effort to undermine the democratic gains of the past half century and weaken democracy.

Sclar contends, nevertheless, and persuasively, that there is a place for contracting out, and that where it can improve efficiency it should be part of the arsenal of public management. But he shows that in practice it has been used far more often than real efficiency would dictate, at a substantial social cost. He also shows that reform can come from within publicly managed bodies where workers can improve efficiency without any threat from privatization, when freed from political constraints and allowed to perform as they see fit.

Sclar's book is a work of enlightenment, that taken seriously in dealing with questions of public management and privatization would help advance both efficiency and democracy. It should be studied closely by anybody with a serious interest in these important issues.                       Z

Edward Herman is an economist, media analyst, and author of numerous works on politics and the media.