Center for Local, State, and Urban Policy Policy Report Number 1 • February 2004 UNIVERSITY OF MICHIGAN Privatization: Issues in Local and State Service Provision BY ELISABETH R. GERBER, CHRISTIANNE K. HALL, AND JAMES R. HINES JR. Summary hile many states and localities are turning to privatization as a way to provide services to their citizens, surprisingly little is known about these choices. Much of the debate over Wprivatization pays little attention to the rationales and consequences of private vs. public service provision. With an eye toward advancing understanding about privatization, the University of Michigan’s Offi ce of Tax Policy Research (OTPR) and Center for Local, State, and Urban Policy (CLOSUP) sponsored a series of studies on privatization. This empirically grounded research can provide policymakers with a sound basis for assessing whether and how privatization should be undertaken. This report begins by providing a historical background of privatization and a discussion of the nature and prevalence of privatization in the United States. Section II provides an overview of the empirical research on cost savings, quality, equity, employment, and political effects of privatization. The fi ndings from the papers commissioned by OTPR and CLOSUP are presented alongside fi ndings from other previously published research. Our review of the literature suggests the following conclusions about privatization: • Private providers may or may not be more effi cient than public providers. Whether privatization leads to greater cost savings depends largely on whether there is competition in service provision. • The quality of privatized services may or may not be higher than publicly provided services. Gov- ernments can play an important quality assurance role by monitoring and evaluating the delivery of privatized services. • In developing and transitional economies, privatization may reduce access to goods and services, particularly for low-income groups. Comparable studies need to be conducted to assess the distri- butional consequences of privatization programs in the United States. • Privatization might lead to more rational labor market policies. However, the employment effects of privatization are more nuanced than commonly assumed by either proponents or opponents of privatization. Privatization tends to lead to substitution of high-skill for low-skill workers and reduction in total employment levels, but no change in net wages. • Political considerations strongly infl uence both if and how policymakers contract-out services to private providers. Section III addresses some of the unique considerations for state and local governments, to help policymakers and government offi cials understand the potential benefi ts, costs, and risks of privatizing particular government services. The fi nal section of this report identifi es avenues for further research. Privatization research is still in its infancy; questions abound, and there is much empirical ground yet to cover. Center for Local, State, and Urban Policy UNIVERSITY OF MICHIGAN ment in education, health, pensions, 6.7 percent of the labor force in other I. Introduction unemployment assistance, welfare, and, in developed market economies, but only many countries, direct ownership of in- 1.5 percent in the United States. Histori- HISTORICAL BACKGROUND dustry. Furthermore, certain traditional cally speaking, “America kept private in government activities, such as provision the fi rst place” (Donahue, 1989, p. 6). of national defense, now consume much There are several features of priva- rowth of the government higher fractions of national income than tization in the United States that sector is one of the con- they did in earlier eras. distinguish it from privatization else- spicuous features of industrial G The rapid expansion of the public where. In contracting-out services, economies in the twentieth century. sector raises many important ques- the U.S. government retains control of In 1913, U.S. government spend- tions about the appropriate role of the planning, fi nancing, and monitoring ing represented 7.5 percent of U.S. government in a market economy. functions that allow it to shape how Gross Domestic Product (GDP); by Concern over the cost of excessive gov- these services are provided. Thus, in the 1990, U.S. government spending was ernment ownership of industry led to United States, private providers are sub- 33 percent of GDP. The American the gradual privatization (then known as ject to more government oversight and experience of rapid government growth “de-nationalization”) efforts of the regulation than in other countries where, is common among high-income coun- Adenauer government in Germany in by virtue of their ownership of formerly tries. In 1913, Spanish government the early 1960s and the Thatcher gov- public assets, private entities have more spending was 11 percent of GDP, and by ernment in the United Kingdom in the discretion in service delivery. Another 1990, 42 percent of GDP. Comparable early 1980s. The perceived successes of distinguishing feature of privatization fi gures for Japan are 8 percent in 1913 German and British privatization efforts in the United States is the preeminent and 32 percent in 1990; for France, 17 attracted worldwide attention and en- role of state and local governments (see percent in 1913 and 50 percent in 1990; couraged similar privatizations in France, below). and for the Netherlands, 9 percent in Italy, Spain, Japan, Chile, Mexico, the The private provision of government 1913 and 54 percent in 1990 (Heston, former Soviet Bloc, and elsewhere. services has had a long history in the et al., 2002). United States. In recent years, however, Government growth has been infl u- the breadth of privatization efforts has enced by many political, economic, and PRIVATIZATION IN THE UNITED expanded signifi cantly. Privatization social factors. It has taken the form of STATES initiatives now encompass an unprec- greatly expanded government involve- Privatization in the United States edented range of service areas. Current took a distinct form from that of other privatization proposals in the United countries. Whereas States not only include traditional issues More than 80 percent of in other countries such as trash collection, but many other privatization involved service areas as well, such as elementary American cities currently use selling off public assets, and secondary education and social wel- in the United States fare assistance, areas once considered to some form of privatization. privatization largely be exclusively public-sector domain. consisted of contracting- out public duties to private organizations. The unique nature of privatization in PRIVATIZATION AT THE STATE the United States is due to a scarcity of AND LOCAL GOVERNMENT LEVEL government assets. In the 1970s, state- Although some privatization has oc- owned enterprises claimed on average curred at the national level, state and 2 Center for Local, State, and Urban Policy UNIVERSITY OF MICHIGAN local governments are responsible for the Table 1. Percentage of Local Governments (cities and counties) lion’s share of privatization efforts in the United States. Surveys of local govern- ment offi cials indicate that more than Most Commonly Contracted-Out Services 80 percent of American cities currently Service 1982 1988 1992 1997 use some form of privatization (Greene, Vehicle towing and service 80 80 86 82 2002, p. 2). Operation of day-care facilities 72 34 88 79 While a signifi cant amount of Operation/management of hospitals 30 24 61 71 Operation of homeless shelters n/a 43 59 66 contracting-out is taking place in local Legal services 51 55 50 53 government, overall levels of privatiza- tion have remained somewhat stable since the early 1980s. Survey data from Least Commonly Contracted-Out Services the International City/County Manage- Service 1982 1988 1992 1997 ment Association (ICMA, various years) Crime prevention 10421 “Profi le of Alternative Service Delivery Police/fi re communications 4121 Approaches” show that privatization Fire prevention/suppression 5143 to for-profi t and non-profi t fi rms rose Traffi c control/parking enforcement 2122 only slightly, from 22 percent of all local Prisons/jails n/a113 government services in 1982 to 24 per- cent in 1997 (Warner and Hefetz, 2001, Note: Data comes from surveys conducted by the International City/County Management Association. Questions p. 2). However, for every eight services about some services were not included in all of the surveys, indicated as n/a in the table. contracted out during that time pe- Source: Greene 2002, pp. 159-162. riod, fi ve were brought back in-house, suggesting that dissatisfaction with priva- tization has led some cities and counties to reevaluate service delivery mecha- Papers sponsored by the der Galetovic (University of Chile). “Priva- nisms (Warner and Hefetz, 2001, p. 15). University of Michigan, Offi ce tizing Highways in the United States.” One of the neglected but important of Tax Policy Research (OTPR) Feiock, Richard (Florida State University), facets of privatization is that, in practice, and Center for Local, State, and Urban Policy (CLOSUP), Carl Dasse (Florida State University), and it is a dynamic and reversible process. and presented at a research James Clingermayer (Murray State Uni- The use of contracting by local gov- conference “Privatization: versity). “Contractor and Sector Choice ernments varies signifi cantly by service Issues of State and Local Public for Municipal Services