Privatization

Chris Dillow on the privatization of government services:

Creating markets: ... My point here is a simple one. Whether effective markets and private ownership can be created depends upon particular institutional and technical conditions.

This is, of course, a variant on Coase's famous point (pdf) - that there are costs to market transacting. These costs must be weighed against the costs of other forms of economic organisation - be it the firm or state control.

This applies to issues much nearer home. Whether public sector services should be privatized depends upon precise institutional detail: is it possible to write contracts which ensure a high quality of service without excessive rent-seeking? In Coasean terms, is the cost of market transacting lower than the cost of in-house production?

The answer will vary from service to service and place to place. .... It all depends upon subtle details.

I wrote about this a bit in 2007 in "Markets are Not Magic":

To listen to some commentators is to believe that markets are the solution to all of our problems. Health care not working? Bring in the private sector. Need to rebuild a war-torn country? Send in the private contractors. Emergency relief after earthquakes, hurricanes, and tornadoes? Wal-Mart with a contract is the answer. ...

Markets don't work just because we get out of the way. When government contracts are moved to the private sector without ensuring the proper incentives are in place, there will be problems - waste, inefficiency, higher prices than needed, etc. There is nothing special about markets that guarantees that managers or owners of companies will have an incentive to use public funds in a way that maximizes the public rather than their own personal interests. It is only when market incentives direct choices to coincide with the public interest that the two sets of interests are aligned.

If there is no competition, or insufficient competition in the provision of government services by private sector firms, there is no reason to expect the market to deliver an efficient outcome, an outcome free of waste and inefficiency. Why would we think that giving a private sector firm a monopoly in the provision of a public service would yield an efficient outcome? If the projects are of sufficient scale, or require specialized knowledge so that only one or a few private sector firms are large enough or specialized enough to do the job, why would we expect an ideal outcome just because the private sector is involved? If cronyism limits the participants in the marketplace, why would we expect an outcome that maximizes the public interest?

There is nothing inherent in markets that guarantees a desirable outcome. A market can be a monopoly, a market can be perfectly competitive, a market can be lots of things. Markets with bad incentives produce bad outcomes, markets with good incentives do better. ...

For government goods and services, when incentives consistent with a competitive outcome are present, we should get government out of the way and privatize, and there are lots of circumstances where this will be appropriate. There is no reason at all for the government to produce its own pencils and pens, buying them from the private sector is more efficient so long as the bids are competitive.

When competitive conditions are not met but can be regulated, the regulations should be put in place and the private sector left to do its thing... There's no reason for government to do anything except ensure that the incentives to motivate competitive behavior are in place and enforced.

But rampant privatization based upon some misguided notion that markets are always best, privatization that does not proceed by first ensuring that market incentives are consistent with the public interest, doesn't do us any good. ...