by Dennis Polhill

Privatization is a word that is greatly misperceived and unfairly imaged. Its very mention causes adrenalin rushes in government employees. Privatization is a word that is used with great caution, suspicion and trepidation in the public sector… if we don’t
talk about it, maybe it will go away. The premier national trade group of the public works field lost members the first time it offered a seminar on privatization. One can witness bureaucrats shifting brain circuits when certain words register.

Private Sector
To build an understanding of privatization, one must begin with reasonable and rational definitions. Who is the private sector and who is the public sector? The public sector is all of us collectively and the private sector is all of us individually. This
applies both to actions and to property ownership. In all societies both must coexist. One cannot exist without the other.

There are two types of privatization: contracting out (or out-sourcing) and divestiture. When the failed socialist states of the world mention the word privatization, they are referring to divestiture. Under Margaret Thatcher from 1980 to 1988 the
United Kingdom divested itself of 40% of its state sector. When Russia, Poland, Venezuela, and Mexico use the word privatization they are not talking about contracting out. In the US, the definitional perception is the opposite. Privatization means contracting out. People carry on protracted conversations using the word privatization without the faintest perception of divestiture ever entering their thoughts. U.S. business owners even talk about “privatizing” functions in their private companies that they cannot perform efficiently in-house. In the US, privatization typically means out-sourcing.

Divestiture is putting ownership and control of assets in the hands of the people (private parties). Control by the people means allowing the people to exploit the assets by using them to create value by filling unfilled needs. In US history, divestiture has been effectively used to foster economic growth and individual freedom. There is no better example than the Homestead Act. The federal government owned all of the land and sold it off cheaply to farmers on the condition that they would “work” the land. This divestiture program did much to make America the economic success that it is today.

Divestiture is a method used by countries to stimulate economic growth. The
greatest economic success of the post World War II Marshall Plan was West Germany. Though Germany’s per capita share of the Marshall Plan was small (only 45 % of the average) Germany’s annual economic growth rate of 22.5 % was nearly triple the economic growth rate of other Marshall Plan countries (8.4 %). This is attributed, in part, to Germany’s quick decisions to divest itself of state owned businesses and property.

Other economic success stories that put property ownership in the hands of the people as part of an overall divestiture strategy include Japan, Hong Kong, South Korea, Taiwan, and Singapore.

Deregulation is the third prong of the privatization triad-the first two being contracting out and divestiture. Had the Homestead Act provided cheap land, but denied them the freedom to work it, no value could have been created by the people. Similarly, West Germany’s post World War II transition was. from a fascist state to a free market. A fascist states allows private ownership of property, but controls critical aspects such as quantity of goods, product mix, resources to be used, product specifications, etc.

A current example worthy of note is that Argentina outright abolished 36 regulatory agencies. In the last few years, Argentina has gone from a 300% annual inflation rate to one of the strongest economies in South America. The point is that the free use of property permits people to create value via innovation. Every regulation denies at least a tiny degree of freedom to the owner and results in a cost to society’s economy. Excessive regulation can be the death of 1,000 cuts to property ownership and to an economy. Regulations should be imposed discretely and sparingly. Where regulation is excessive or no longer necessary, it should be rolled back.

Why does privatization work? As the economic theories of Marx., Engels, Lenin, and Keynes are discredited, the names Hayek, Friedman, and Sowell are ascending as the new leaders of dominant economic thought. In Free to Choose, Friedman identifies four categories of spending.

  • Category I – You spend your money on yourself.
  • Category II – You spend your money on someone else.
  • Category III – You spend someone else’s money on yourself.
  • Category IV – You spend someone else’s money on a third party.

The efficiency with which purchasing trade-off decisions are made diminishes sequentially from Category I to IV. Consider the example of buying a wristwatch and deciding to pay an extra $10 for an extra feature. The trade-off decisions are made with less efficiency as the category number increases. The decisions of the most efficient bureaucracies of the world (sole proprietors) are all Category I spending decisions. As organizations grow in size, decisions creep in that are increasingly Category II, III and IV. Thus, large organizations are very often less efficient than small ones. All government spending decisions are in the least efficient Category IV. Obviously when government functions can be moved out of Category IV, economic efficiencies result.
When does privatization make sense? Economic efficiency is what elevates society’s total wealth and standard of living. Conversely, economic inefficiency detracts from the total (and in turn individual) wealth. Thus, the test for privatizing (whether it be divestiture or out-sourcing) should be an economic test. If the activity can be performed more efficiently privately then it should be privatized.

The term economic efficiency has sometimes become rhetoric to create a smoke screen to forestall privatization. Government accounting does not yield true cost-of-service information, but private contracts do. Various overhead, administrative, tax, regulatory, and liability expenses are typically misallocated or not counted at all by governments. Not recognizing costs does not mean that they do not exist. It merely means that they are hidden. The aforementioned economic efficiency test should be applied fairly and honestly. To do this, government cost accounting must become complete, accurate, and honest.

How much savings can be expected by privatizing? This is difficult to answer because so little has been done, because government cost accounting is so poor, because the bureaucracy generally does not buy into the concept of economic efficiency, and because the definitions have become garbled. Precision-tuned numbers will not exist until the previous list of obstacles is diminished. In terms of conceptual numbers, even Ted Gaebler, author of Reinventing Government, an friend of big government irrespective of cost, has quoted 22% as the inherent cost burden that government must bear just to be open. Obviously the savings potential is a function of the quality of the contract, the sophistication of the activity (high tech versus low tech), the availability of qualified bidders, measurability of the work, the amount of uncertainty that the bidder must account for in the bid, the extent to which incentives can be installed in the contract, and so on.

Institutional Resistance
Since implementing privatization amounts to shifting the paradigm and contradicting conventional bureaucratic thinking, it is a much easier matter to bungle away the savings (either intentionally or not) than it is to succeed. The questions that follow failure are far easier to address: “Everyone knew it wouldn’t work. This proves that we are already as efficient as is humanly possible” versus “Why didn’t we do this sooner? Are there more savings to capture? Think of the money that has been wasted and the other things that could have been accomplished.”

The incentives that are offered to government managers need to change. Because of ease of measurement, a bigger budget and a bigger staff implies more responsibility and, in turn, more status, power and salary. To succeed in making government more efficient through privatization is counter to basic instincts. To say that privatization is a tool to be used by managers when appropriate, is to say that privatization will not be done.