Privatization Runs Aground in the U.K

One of the central pieces of the argument for privatization since the 1970s has been the idea that the private sector is inherently more efficient than the public sector, usually because of the discipline imposed by market competition (although various other explanations have been offered).

When one is interested in trying to counter this argument like I am, you pay attention to the fact that the U.K (which has been a pioneer in privatization since the Thatcher years but continuing at full speed through both New Labour and the Tory governments that followed) is experiencing a crisis of privatization:

• the recent collapse of Carrillion, which held billions and billions worth of public-private construction and facilities managment contracts, all the way from the high-profile H2 high-speed rail project to cleaning and cafeteria services in local hospitals and schools. Carillion is not the only one of these firms in danger of going under. 
• the bailout of Virgin-owned East Coast Rail, which will cost the government hundreds of millions of pounds only two years after the railroad was re-privatized (it had briefly been taken over by the government when the previous privatized operator went belly up during the Great Recession).
• dozens of charter schools which are requesting emergency bailouts due to their rising deficits.
• the calamitous fire at Grenfell Tower, which was badly exacerbated by the decision by the Kensington and Chelsea Tenant Managment Organization to use cheaper and extremely flammable cladding as part of a beautification and renovation project.
• And many more.
• Seriously,  a lot more. 

Thus, it was interesting to see a highly unusual article in the New York Times (which practically has “sclerotic welfare state” and “burdensome regulations” in its house style guide when it comes to discussing Europe) which reveals that:

“A report by the government’s National Audit Office shows that taxpayers are expected to pay nearly $285 billion to private contractors for projects and services over the next 25 years. The agency also found that with changing economics, schools could cost 40 percent more, and hospitals 70 percent more, when undertaken through private-finance initiatives rather than through the government.”

Back when I was just starting as a policy blogger, I wrote a series of essays about the virtues of the public sector, trying to find other aspects where the public sector might have an advantage that might compensate for the supposed superior efficiency of the private, one of which I’ll quote below:

As I discussed in part 1 of this series, “Public Virtues” will examine those areas in which the public sector has an economic advantage, and compare and contrast those where the private sector is supposed to have an advantage. And where better to start than the profit motive, the first principle of capitalism that’s been held up, not just as an explanation of why corporations get better and better at making widgets if people give them money, but why the public sector is inherently and unalterably inefficient, technologically stagnant, and uncompetitive. The profit motive, as everyone knows who’s lived in the capitalist world, basically holds that because people want to make a profit, they are pushed towards the maximization of their resources, and thus seeking to make profits, they make the system as a whole more efficient and productive.

However, most honest thinkers, i.e those not professionally involved in proving that capitalism is infallible, admit that the profit motive only spurs innovation and efficiency where it actually exists. Where it doesn’t, you wind up with market failures.  And where the market fails, that’s the natural place for the public sector. The debate, however is how often and where this happens.

…In the modern corporate world, Wall Street has created expectations of 5% quarterly earnings growth as essentially normal – should a publicly-traded company fall below this mark, ratings agencies will downgrade your stock and investors will start to flee; even in privately-held companies will find their access to credit threatened if your bankers feel you’re not a solid risk anymore. Now, in many areas, this modern, high-octane version of the profit motive produces amazing results in terms of increasing productivity of widget production.

However, it also has distorting effects that I think exacerbates the extent of market failures in the current economy. To give a good example, let’s look at newspapers. The problem with newspapers is that their product doesn’t really change from quarter to quarter, and their consumer base (i.e, the total universe of potential buyers) doesn’t really change from quarter to quarter either. So how do you generate 5% quarterly earnings growth, when advertising revenue is declining? The answer is you lay off reporters and save on labor costs. But this means a weaker product, which further exacerbates your consumer base problem.

So, if we think about how the public stacks up against the private, we have to conclude that, even if given public sector inefficiency (which is not conceded except for the sake of argument), wherever the profit margin (especially if we’re talking about 5% quarterly earnings growth) is equal to or more than the inefficiency of the public sector, then government should prevail in the face of the private sector.

 

The same phenomenon I discussed more generally is especially true when it comes to private companies whose main business is servicing public-private contracts; there’s unlikely to be huge swings in how many of these contracts there are from quarter to quarter, because (when it comes to services contracts) the number of hospitals, schools, prisons, etc. doesn’t change that often, and (when it comes to construction contracts) current political practices like debt ceilings or acceptable debt-to-GDP limits how many public works contracts are generated at any given time.

We see this problem arise in many of the cases I described at the beginning of the article: Carillion went under in no small part because it needed to show unrealistic rates of growth, so it started ludicrously underbidding in an attempt to win enough contracts to convince the banks that it was still good for its debts; with East Coast Rail, there’s only so much railway traffic that goes through London-York-Newcastle-Edinburgh, and railroads involve a lot of fixed expenditures, so it’s hard to generate growth (rather than a steady rate of return).

Now, keep in mind, my conclusion was based on an assumption that there would be some margin of inefficiency of the public sector which had to weighed against profit margins. If it turns out that the private sector is less efficient by double-digit percentage points, than it’s no contest: governments should always provide public services, even if only for fiscal reasons.