Downsizing government for principle and profit
(Part 1: The United States)
by Edward Herman
The U.S. government is encouraging private HMOs to service
much of the Medicare system, and the debate rages over whether
Social Security should be shifted to private management. Privatization
of such public functions is one of the mantras of the New World
Order. Economic, political and media elites assume that privatization
provides undeniable benefits and moves us toward a good society.
But while it sometimes reduces costs, privatization is often
less efficient than public enterprise, and frequently is socially
harmful, taking a disproportionate toll on women and minorities.
Privatization also weakens democracy by bypassing unions and shifting
power away from governments and non-profit organizations, which
can respond to democratic political processes. Instead, power
moves to corporations that serve only the interests of their owners
Privatization means the shift of activities from the government
and nonprofit sectors to the market. It may take the form of the
sale of public (or non-profit) sector assets to private companies
or the contracting out of services previously supplied by public
Privatization is not new. In France before the Revolution
of 1789, the King farmed out government tax collecting to individuals
in a system notorious for corruption. Along with contracting out
the provision of supplies for the French armed forces, private
tax collecting was the basis of many great fortunes. Ending this
system was one of the French Revolution's accomplishments.
Throughout the nineteenth century, the U.S. government engaged
in massive privatization through the sale of millions of acres
of public land (a domain greatly extended by the Louisiana and
Alaska purchases and the seizure of Mexican territory) . Many
tycoons derived their fortunes from shrewd and sometimes fraudulent
public land acquisitions. Abuses in the use and disposal of public
property have continued throughout the twentieth century, manifested
in both periodic scandals (such as Teapot Dome) and the subsidized
use of public property, which continues today through, for example,
under priced sales of national forest timber, bargain-rate use
of mineral lands, and commercial broadcasters' free use of valuable
Western European and Third World governments have commonly
owned airlines, railroads, telecommunications and electric power
systems, and sometimes banks, petroleum refining and other industrial
enterprises. But in the United States government has been largely
excluded from activities of interest to private business, and
its periodic entry into these fields has been limited and often
stripped away. The government did take over many private sector
activities during both World Wars I and II, but it speedily privatized
them after the wars.
Since 1932, Congress, under the prodding of business, has
made periodic surveys of government activities that compete with
the private sector, with a view toward minimizing government competition.
Ronald Reagan's Office of Management and Budget formalized the
pressure on government agencies to minimize in-house production,
ordering government managers to consider contracting out all functions,
including data processing, janitorial services and vehicle maintenance.
Despite this long-standing bias against public enterprise
in the United States, with the rise of monopoly power in railroads,
electric power, and telephones during the late 19th and early
20th centuries the government created a regulatory apparatus.
It grew with urbanization and the need for water supply and waste
disposal, and the coming of the automobile and road building.
The public sector grew further with the social democratization
that accompanied the Great Depression and World War II, including
the growth of organized labor and a new governmental health and
Privatizers from the early 1970s onward have been selling
off government property-mainly water and waste water facilities,
parking garages, roads, airports, public lands and buildings,
and mortgage portfolios. But privatization in the United States
has focused mainly on the contracting out of government services,
including the operation of government-owned facilities.
State and local governments carry out most public economic
activity, and contracting out at these levels has soared over
the past decade. The Mercer Group, an Atlanta consulting firm,
estimates that between 1987 and 1995 the number of municipalities
contracting-out services increased as follows: janitorial from
52% to 70%, street maintenance 19% to 38%, solid waste collection
30% to 50%, and data processing operations 16% to 31 %.
This new wave of contracting-out ignores historical lessons.
A great deal of current government provision of services originated
in the failures of contracting during the late nineteenth century
and into the 1920s, under political systems that were often corrupt.
Ending such arrangements and turning them over to public agencies
was a major accomplishment of the 1920s and later.
Roots of the new privatization wave
The privatization wave over the past twenty years is rooted
in increased corporate power. This growth, based partly on greater
capital mobility, has led to renewed aggressiveness by business,
political successes (including the elections of Ronald Reagan,
British Prime Minister Margaret Thatcher, and neoliberals widely),
and a parallel weakening of labor.
Enhanced corporate power has also contributed to the triumph
of neoliberal ideology. Central beliefs of this ideology include
the efficiency of the private market, the inefficiency of government,
and the dual menaces of inflation and budget deficits. With neoliberalism
in place, helped by corporate domination of think-tank funding
and the mass media, along with great influence within the ivory
tower, scaling back government was an obvious policy thrust.
Part of the design of neoliberal politicians and intellectuals
has been to weaken the state as a power center that might serve
ordinary citizens and challenge the rule of the market. The success
of these efforts is evident in both Britain and the United States,
where formerly liberal parties now denounce big government, genuflect
to market-based solutions, and contribute to eroding the welfare
Governments' budgetary problems gave further impetus to privatization.
As the Wall Street Journal pointed out in 1995, referring to talk
of selling the federal oil reserves, "Both Congress and the
White House want to change budget-accounting rules so they can
count money raised by selling assets toward reducing the deficit-even
if such sales would reduce government income... in future years."
At the state and local level, "cash-strapped cities, such
as Wilmington, Delaware, want the up front cash they can get by
selling the local sewage-treatment plant, or look to private ownership
as a way to finance improvements of existing facilities."
The new global economic order itself has contributed greatly
to these financial difficulties. Capital has fled from urban cores,
leaving them in fiscal straits, and corporations have bargained
aggressively with governments to extract concessions as conditions
for their keeping jobs in place (or to induce them to move). All
governments have had to limit business taxes and spending on social
benefits in order to provide a "favorable investment climate,"
leaving them under financial stress. Intel Corporation, for example,
bargained so effectively in 1995 with Rio Ranchos, a small New
Mexico town eager to be the site of an Intel plant, that the town
was forced to sharply cut its school budget.
Another force for privatization has been the growing power
of financial markets, which reward and penalize governments as
they meet or fall short of market policy standards. Financial
market players want low inflation and balanced budgets. They are
keen on privatization because it yields short term revenues and
is a mark of commitment to neoliberalism.
Privatization has also been pressed by innumerable entrepreneurs
eager to buy up government property and provide services previously
supplied internally. Partly in anticipation of privatization opportunities,
many of them had obtained political leverage by funding the electoral
campaigns of politicians now in office.
Efficiency gains or wage reductions?
Although the privatizers claim that their objective is to
increase efficiency, this is contradicted by their indiscriminate
actions and their frequent disposal of public enterprises noted
for efficiency. There is also evidence that they are often responding
to financial and political pressure. Furthermore, many bids for
government property and contract service base their savings largely
on shifting from union to non-union and contingent labor.
Take, for example, contracting of the cleaning service for
state buildings in Buffalo, New York in 1992. While initially
claiming that the low contractor offer was based on efficiency
improvements, state officials eventually admitted to the Buffalo
News that the savings would come from the use of "more part-time
workers at lower salaries and with fewer benefits." Study
after study has shown that contractors offer lower wages and limited
if any health and pension benefits. But gains from lower wages
and benefits are not true "efficiency" improvements,
which imply a reduction in the use of resources such as labor
and materials. They are actually income transfers from wage earners
to employers (profits) and to government managers and taxpayers.
Even the nominal savings in privatization may be illusory
or short-lived. A common phenomenon in contracting out was made
famous in the weapons contracting formula "buy in, get well
later." The contractor bids low, knowing that he can obtain
cost adjustments after the government gets locked into the contract
and would find it difficult to cancel and locate another source,
or do the job in-house.
The most famous case was Lockheed's bid to produce the C-5A
giant transport plane in the 1960s, which led to a huge cost overrun
that doubled the price before a single plane was produced. Lockheed's
contract had an automatic cost-based price escalation clause that
was soon dubbed the "golden handshake."
Even fixed-price contracts could be raised through "improvements"
offered by the contractor or demanded by the Pentagon-a process
known as "gold-plating." One result of this abusive
contracting system was that for decades the major contractors
had profit rates on their Pentagon business roughly twice those
in their commercial operations.
Many years ago the U.S. government did weapons research and
produced many of its weapons in government arsenals. This was
gradually phased out in favor of farming out research and production
to private sellers. But without in-house production and research
capabilities the government's bargaining position was reduced.
It no longer had the option of producing for itself, and lacked
the expertise to be a knowledgeable buyer, and so could be taken
advantage of more easily. This point applies to other public functions-without
a skilled body of managers and technicians the government is a
ready victim in contract negotiations with knowledgeable private
Contracting out is at an initial cost disadvantage compared
to in-house production. It requires the additional expense of
writing and evaluating contracts and then monitoring performance
over their lives-the latter entailing a permanent bureaucratic
apparatus on top of that deployed by the contractor. If that apparatus
is skimped on, politicized, or corrupt, the road is open to massive
cost escalation. Contracting out is often not able to overcome
the disabilities of monitoring costs and potential corruption.
There is some truth to charges of inefficiency in public enterprises
and non profit service activities. Many of these have become over
bureaucratized, over-staffed and politicized. Free market proponents
speak of "state failure" to counter claims of "market
failure" by the private sector. But many state and nonprofit
enterprises and services have done well, and when they have done
poorly it is often the result of conservative macroeconomic policy
and crippling state intervention. When macro-policy is designed
to keep a large reserve army of unemployed labor, labor strenuously
resists staff cuts and public agencies find it harder to trim
staff. Underfunding, political appointments, and capture of regulatory
agencies by corporate interests frequently undermine the functioning
of government entities. Such damaging interventions are often
deliberate, as in the case of the Reagan-era budget cuts and political
appointments to the Environmental Protection Agency and the Corporation
for Public Broadcasting, both designed to demoralize and weaken
the organizations. In these cases and others the damage inflicted
reflects corporate efforts to undermine public bodies through
the political process.
Privatization and competition
Conservatives assume that government sells or contracts out
its operations under competitive conditions, and that such competition
then and later will restrain exploitation of the contracting authority
and the public. This is some times correct, but often is not.
There are frequently only a few local bidders for contracts, and
they sometimes collude, divide markets and rig prices. One contractor
testifying in a national antitrust action noted that "as
far back as I can remember" Northern Virginia contractors
met annually to carve up contracts that the Virginia highway department
was expected to allocate during the year. Numerous suits have
been brought and won against Waste Management Inc., Browning Ferris
and SCA Services for collusion and price fixing in the trash disposal
In major contracting-out businesses there has been steady
growth of national operators, like Waste Management and Browning
Ferris in waste disposal and ARA in food services. These large
operators are able to undercut local firms, some or all of whom
disappear, making it possible for the large firms to "get
well" later. More generally, once contracts are won, systems
installed, relationships cultivated, and rivals driven from the
market, the power of the contractor is strengthened and it becomes
costly for a public agency to shift the service elsewhere.
In contrast, changing from private to public ownership can
increase competition. When the Tennessee Valley Authority (TVA)
was organized in the 1930s, for example, it broke up the cartel-like
high pricing policy of the private electric utilities in the Tennessee
Valley, and private companies hated the TVA because it increased
competition. As many U.S. and global markets have few sellers
(oligopolies), and as private oligopolists often collude, publicly
owned firms can disturb cozy private market arrangements.
Corruption is built in to the privatization process. Bid ding
on contracts is not carried out in perfect markets, and in real
world markets, with only a few sellers, they almost always seek
political influence as a rational business strategy. In a process
dubbed the "revolving door," it is now standard procedure
for companies seeking contracts to hire former politicians and
managers of public agencies to lobby on their behalf. The New
York Times noted recently that one reason federal Justice Department
and prison officials have warmed up to privatizing prisons, despite
their experience that privately run prisons costs more, is that
private industry's ranks "now include many former colleagues
as senior and other law enforcement officials have taken positions
at private corrections companies, Washington's latest revolving
Corruption operates at many levels: contributing to political
election campaigns, cultivating politicians and other public officials,
hiring them or their friends, relatives and staff, and straightforward
Less service for your money
Another secret to the profitability of privatization is reductions
in service. Contractors reap their ''efficiency'' savings by hiring
cheaper and less well-trained labor, with higher turnover rates,
and by cutting the quantity, quality and scope of service. There
may be fewer service personnel or fewer trash collections or lavatory
cleanings. Older, more polluting school buses may be used, and
bus and train stops at out-of-the-way places may be terminated.
Or charges may be imposed on services formerly provided free,
thereby pricing poor customers out of the market.
Contracting out of hospital management and purchases of nonprofit
hospitals by large HMO systems are classic cases of service reductions.
These contractors and HMOs have strong incentives to exclude unhealthy
customers and scale down usage for the remainder. To this end
they systematically impose barriers to usage, through toughened
standards for referrals to specialists, perverse incentives to
doctors on their payrolls, and cuts in staff quantity and quality.
To some extent these changes offset occasional lavish usage under
cost-plus systems, but contracted and HMO systems have established
a direct conflict between the interests of patients and medical
servers. They also entail large bureaucratic expenses for evaluation,
review and collection, plus incentives to exclude the poor.
The largest hospital system, Columbia/HCA Health care, is
currently the owner of 350 hospitals in 38 states, and continues
to gobble up public hospitals left and right. Its CEO, Richard
Scott, says that "Healthcare is a business like anything
else," and "Is any fast-food restaurant obligated to
feed everyone who shows up?" His company has a 20% gross
profit target, and he has been meeting that goal, partly by lower
costs for large scale purchase of medical equipment and supplies,
but more importantly by union avoidance, "reengineering"
nursing personnel (increasing their workloads, substituting non-nurses),
and "cream skimming" (taking billable patients, dumping
non-billables on other hospitals).
The Department of Health Security in Indiana recently fined
Columbia/HCA for understaffing, and doctors and nurses at the
Good Samaritan hospitals in San Jose, California, have complained
bitterly at the medical damage wrought by the "economies"
installed following Columbia/HCA's takeover in 1996. Lee County,
Florida officials calculated that in 1994 the public hospital
there provided $13 million in "charity/uncompensated care,"
whereas Columbia/HCA's three hospitals in the county provided
$1 million in such unprofitable service.
The benefits of being public
Public corporations, nonprofits, and in-house government activities
can bring benefits to communities that are neglected by market-oriented
businesses. They are more open to unions and provide more secure
jobs than private companies. The security and benefits of such
jobs are of great value to workers, but the market gives them
no weight. The stability of government spending and jobs also
helps mitigate recessions, since governments need not cut their
spending when consumer demand and private investment fall.
In transportation there are enormous social costs associated
with the growth of auto travel -- pollution, congestion, and urban
sprawl. Public transportation in the form of trains and buses
is a vital means of reducing those huge costs. But in a privatizing
world, trains and buses are not given credit for limiting auto
travel, and so are not seen as deserving of public subsidies.
Instead, once privatized, transit riders are expected to pay the
full cost of transit in their fares. Inevitably, this leads to
lower ridership, driving up the social costs from auto use.
Another illustration of the damage from privatization is the
preference given private over public broadcasting. Public stations
can focus on "public service" programming, including
information that helps to promote democratic citizenship. In contrast,
private broadcasting marginalizes public affairs in favor of entertainment,
under bottom line pressures and in response to advertiser preferences.
Private broadcasters also resort heavily to audience-drawing sex
and violence, which have anti-social consequences.
Privatization reduces accountability. Governments can be voted
out, but private owners are insulated from the opinions of ordinary
citizens and contractors are protected by legal agreements. In
fact, governments frequently try to fob off difficult problems
onto contractors, but this often makes for confusion, because,
while allocating tasks to third parties, the government often
cannot escape its own responsibilities.
This is most obvious when the government assigns to private
parties jobs that require the application of sovereign powers
of government. In the case of prisons, now rapidly being privatized,
where the prisoners are held by force and are subject to possible
parole or penalties for misbehavior, to what extent can private
contractors dispense such sovereign actions? Don't they have a
conflict of interest in dealing with parole and extended sentences
when their economic interest calls for higher prison occupancy?
Isn't there a danger that the drive for profits will lead to hiring
unqualified and inadequately trained personnel and the mistreatment
As Princeton political scientist John DiIilio wrote in 1987,
"The history of private sector involvement in corrections
is unrelievedly bleak, a well-documented tale of inmate abuse
and political corruption." A dramatic illustration of this
tendency made front page news in 1995, when a riot by immigrant
detainees in an Immigration and Naturalization Service (INS) prison
operated by Esmor Corporation led to "a scathing report detailing
an atmosphere of abuse and penny pinching in the jail for illegal
immigrants and asylum seekers. Poorly paid, ill trained guards
physically and verbally abused detainees, shackling them with
leg irons, roughing them up with no reason in the middle of the
night." Esmor had obtained a contract with the INS despite
having no experience, by hiring the campaign manager of a New
York politician to lobby for their interests. Because of the public
nature of the functions of running prisons, the American Bar Association
resolved in 1986 that privatization of prisons should be halted
"until the complex constitutional, statutory, and contractual
issues are satisfactorily developed and re solved." These
issues have certainly not been resolved, but privatization is
moving ahead full speed, because of inflated perceptions of possible
budget savings, the political revolving door, and the emergence
of a new "prison-industrial complex."
Privatization versus democracy
Margaret Thatcher, Augusto Pinochet and others have deliberately
used privatization as a means of weakening popular forces and
consolidating the power of capital. The West's support of Boris
Yeltsin's privatization program, hugely corrupt and beggaring
the population, is also designed to make the transformation to
capitalism irreversible. These leaders, and the IMF, recognize
privatization's political dimension. Governments can be mobilized
to serve ordinary citizens-so that shrinking their functions,
making them more dependent on the private sector, reducing public-sector
unions, and strengthening capital diminishes the democratic threat.
Privatization in the United States has been part of this global
corporate and right-wing effort to undermine the democratic gains
of the past half century.
Edward Herman is an economist, media analyst, and a regular
columnist for Z magazine.
World in United States