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The costs of privatization: It may not save the state money

Gov. Mark Dayton and the Republican Legislature face a $6.2 billion deficit and a legal mandate to produce a balanced budget. They differ on how to address this task.

Gov. Mark Dayton and the Republican Legislature face a $6.2 billion deficit and a legal mandate to produce a balanced budget. They differ on how to address this task. One thing is certain: Some will argue that a solution is the privatization of state functions or services. For those who think privatization yields immediate savings, that is not necessarily correct. Privatization also forces critical tradeoffs in equity, service delivery to the poor, and perhaps in public safety, quality and accountability.

Privatization has multiple meanings. One definition is the selling off of state-owned enterprises that can make money as private businesses. This is what privatization generally has meant outside the United States, especially in former communist countries, where government enterprises such as utilities are sold to investors. Minnesota does not have these types of enterprises to sell.

Perhaps Minnesota could sell its prisons to be run privately, or maybe some transportation functions. Selling off prisons means a loss of control over them and the possibility of worker strikes. Privatizing snow plowing might save some money, but coordinating a massive fleet of private vendors to plow the roads is a costly logistical issue.

Second, privatization means contracting with private or nonprofit vendors to provide goods or services. Already Minnesota contracts out several billion dollars with vendors to provide many health and other services. There is little evidence here and in the research on privatization that this type of contracting saves money. Often the reason to do this type of contracting is to give more flexibility in service delivery, or to use vendors who have technical expertise the state lacks. But this flexibility and expertise is often costly.

Transaction costs
Also, contracting out often incurs significant transaction costs. Shifting state functions to third parties means expenses in phasing out and reorganizing the government and doing the bidding process to find vendors. When contracts are let, monitoring and compliance costs are incurred. Taxpayers should not foot the bill for contracts if there is no oversight to ensure that money is being spent properly.

These costs are often ignored when privatizing. A 2007 Legislative Auditor report noted that in 2005 more than $4.7 billion was contracted out to nonprofits for health services. It found little accountability and oversight for the money. It echoed a 1992 report that found little oversight given to technical contracts awarded by the state. Thus, taxpayers often do not know if they are getting quality services for their money.

David Schultz
Courtesy of Hamline University
David Schultz

There is also the assumption that letting contracts saves money because of vendor competition. Yet the Legislative Auditor and others have found that competitive bidding environments rarely exist. Often only one vendor is available, because of technical skill or capacity, or because the contract needs to be for such a time period that it all but renders competition nil. Private monopolies replace public ones, but with less accountability.

Finally, with contracting out there is the potential for government actually to expand and not contract its reach. With government contracts comes increased supervision and control over private and non-profit entities. Those ideologically opposed to big government who see contracting out as a solution may find in fact Big Brother’s reach gets even larger.

The shedding or unloading of state functions
Third, privatization means the shedding or unloading of state functions. This means that there are some functions the government will no longer perform or fund. Private vendors and citizens are on their own to decide how to distribute and receive these services. This type of privatization asks a normative question regarding what we want government to do.

Load shedding implicates tough choices with clear losers. Government workers lose jobs, as is true with other types of privatization. But as with any type of privatization, research suggests that load shedding means many people, especially the poor, will not receive some services. Equity is lost; the more affluent make do, the poor do without.

Approximately 76 percent of the budget goes to education and health and human services. Throw in public safety and local government aid and that totals more than 90 percent of the budget. No matter which privatization option is considered, the question becomes what do we not want the state to do that we feel the private sector can and will provide in a way that will not hurt the poor, affect quality of services, and which can save the taxpayers money?

Privatization forces tradeoffs. It may make sense in some situations, but thinking cost savings is the only issue is naive. Instead, a host of issues, including quality, equity, control and fairness must also be addressed.

David Schultz is a professor at Hamline University School of Business, where he teaches classes on privatization and public, private, and non-profit partnerships. He is the editor of the Journal of Public Affairs Education (JPAE).