DISTINGUISHING PUBLIC-PRIVATE PARTNERSHIPS: Privatizing, Contracting, and Special Arrangements

The range of ways that government and public agencies can utilize private companies and non-profit organizations is broad and confusing.  Government is not a business and should not be run as one. However, there is much to be gained by harnessing the flexibility, speedy decision-making, innovativeness, and profit-driven efficiency or value-driven passion of non-government actors.

Still, it is easy and misleading to lump the entire spectrum of public-private-partnerships (P3) relationships into one misleading category.  It’s sometimes done as part of an effort to cut budgets or “downsize government” while pretending that “increased efficiencies” won’t turn reduced expenditures into reduced services. It’s sometimes used to shift blame for inadequate public investment or management failures onto someone else. 

All types of P3 agreements are partnerships between public and non-public organizations.  However, the three types discussed here -- privatization, contracting-out, and “special arrangements” -- each have different underlying assumptions resulting in different roles for the public and non-public partners and therefore different effects on society.   Understanding the differences is vital for deciding which are actually good deals.

PRIVATIZATION

Privatization, involves the selling off of public assets, usually to a for-profit corporation, occasionally to a non-profit.   At its best, privatization hopes to make up for a long-term lack of public resources (money and managerial skill) by tapping into non-governmental capital and administrative staffs.  Politically, it is usually a tactic for dealing with declining public revenue or simply reducing future growth in public budgets.  (In recent years, this is often because of the deficits created by the failure of earlier tax cuts to generate the promised trickle-down economic improvements and increased tax revenues.) 

Turning a public asset into a profit-seeking investment is an implicit abandonment of public responsibility for any of the direct and indirect public value the asset or decision-making processes related to it may have.   Implicitly, if not explicitly, privatization rests on a belief that private, market-based activity is a better creator of public value than public programs.  Or even more bluntly, that government simply cannot run anything well.  The underlying Conservative if not Libertarian philosophical belief is that government is an inherently coercive force, the mere presence of which erodes the personal liberty of individuals to exercise unfettered control of their property.

Privatization is at the heart of most current Republican proposals for infrastructure development – highways, airports, canals, even the space station.  The core idea is to sell or simply give ownership or long-term (e.g. 75 year) control of public assets (or some other form of equity interest) to private firms, giving them the right to charge user fees and control the use, keeping any profits they make.  In exchange, they may promise to invest in some amount of upgrading and perhaps expansion.  In many cases, the give-away also comes with a promise of continued public direct or indirect subsidies to guarantee future profits. 

 

MARKET DYNAMICS

Of course, it is possible that privatization is a “sweetheart deal”, a giveaway of public assets to private interests at less than their true market value – although this seldom includes the true “public value” which includes the non-economic benefits that public ownership provides.  A massive “fire sale” of public assets was how Russia and Chile conducted their “shock treatment” to “desocialize” their economies. 

In theory, being the owner gives companies a vested interest in regular maintenance and continued investments to ensure the long-term viability of the project.  However, the motivation of private firms is profit – sometimes maximized through long-term stewardship but just as often focused on short-run extraction at the expense of sustainability.   In any case, profit-seeking firms will only be interested in acquiring project with profit-making potential.  Smart firms will “cherry-pick” projects – usually those with high use, or that users have few alternative options, or that serve high-income populations.   Currently “free” infrastructure will become tolled.  People who cannot pay will not be able to use the facility, or will have their living standards cut in some other area.  Every possible cost will be “externalized”.   Services that do not contribute to the bottom line will be cut.  Future investment will tend to focus on providing more to those who can pay the most for it.

The one silver lining would be if all the money gained by the public sector through the purchase or through on-going revenue-sharing were added to the current level of public infrastructure spending and used to improve and expand the majority of our nation’s infrastructure that does not have sufficient profit-generating potential – that which serves rural areas, low-income populations, non-profitable infrastructure.  But unless written into the privatization-authorizing legislation, this is not likely to happen – and even if written in there are ways to use the funds as a one-time windfall or to allow even further tax cuts that further reduce public resources.

Similarly, unless carefully written into the transfer agreement, the loss of public control and oversight inherent in privatization eliminates requirements for universal service, equitable access and hiring, environmental protection, or any social goal other than that required by the general market regulations for all businesses – which are themselves currently being weakened by the same groups pushing for privatization.

 

STILL, SOMETIMES…

It is possible that privatization will lead to service upgrades and increased efficiency for those users that the vendors decide are capable of paying “Trump Tolls” for it – a form of income-based rationing that usually goes unnoticed in our market-based society.  It is possible that privatization will inject more resources into infrastructure projects than the public sector could afford – especially since public revenues are being so drastically reduce by new tax-cuts for the wealthiest businesses and individuals.  And, for highway projects, it is possible that the higher user fees required for profitable operation of privatized projects will induce people to drive less, reducing congestion and pollution; but it will also make it more expensive to take trains and transit if they, too, have be sold off.

Sale or ownership transfer of public assets can be appropriate in some situations.  A property may have no current or anticipated future use, although the future is hard to predict.   The price offered for purchase of an asset may be so high that it totally dwarfs any current or possible public value or use.  The transfer of ownership might be guaranteed to lead to a full range of irresistibly positive outcomes, from significant job and tax revenue growth to environmental and social wellbeing, with extremely few potential bad effects.  Or it may be possible to surround the sale with so many requirements and such powerful enforcements that it will provide as much or more public value across the full range of public sector concerns as if it had stayed in public ownership – although the profits of such a contract might be low and therefore the interest of profit-seeking firms minimal, making contracting out probably a better strategy.

 

CONTRACTING OUT

Contracting, or outsourcing, is enormously varied but fundamentally describes hiring private (or non-profit) firms to accomplish particular tasks, run particular programs, or manage particular public resources.  While it is assumed that any for-profit vender intends to make money from the arrangement, “contracting out” retains – at least theoretically – public oversight, responsibility, and accountability.   While letting go of operations, the agency retains control of planning in response to both the political system’s demands and the region’s future needs.  The public agency also oversees the vendor, primarily by setting appropriate goals and on-going performance-evaluation criteria through sophisticated contracting.   While some vendor’s bids may include bringing assets and resources to the partnership, and while they may buy and retain ownership of certain equipment needed for the work, they do not have an equity/ownership interest in the program itself. The gain in public value comes, in theory, from “lifting the bureaucratic wet blanket” off workers and operations.

At its best, vendors are able to significantly improve the efficiency of a program through the application of better operational systems and labor-relations, new technologies, decision-making flexibility and speed.  However, contracting out is often used as part of a budget-cutting campaign, which undermines the vendor’s ability to deliver these benefits.  When the primary focus is cutting costs and reducing public expenditures, the greater efficiency is seldom enough and vendors almost always end up pushing some combination of lower wages, worsening working conditions, reduced service and maintenance, or failure to invest in future technologies or upgrades.

 

A GROWTH STRATEGY

In fact, when well done, contracting out is seldom less costly than direct public agency operations because of the need for continued oversight and renegotiations.  Neither does contracting out allow the elimination of all state staff formerly involved – good oversight requires in-house technical expertise as well as extensive training in the new skill of “management through contracts” and contract management.

A vendor may even be more expensive than in-house operations depending on how risks are apportioned.  A vendor that has to supply fuel for a transit system, for example, will have to pad their bid in order to cover the uncertainty about price increases.   On the other hand, well done outsourcing may reduce the future increase of costs by encouraging vendors’ post-selection opportunities for innovation, operational changes, and other efficiency-increasing tactics – a giving up of service-model control that is hard for most public agencies to accept.

Still, if the goal is to improve and increase public service, out-sourcing can be a powerful tool.   Private firms can draw on wider pools of expertise (and pay higher salaries) than most agencies or governments.  They can make operational decisions and implement changes faster with fewer required stakeholder negotiations.  Not being stuck in one contract forever, they may be able to risk more innovative ideas.

Even if more troubled situations, outsourcing may make sense.  If the public program is significantly dysfunctional and the agency in charge is simply incapable of regaining control then outsourcing may be the only way out of the box.  Similarly, if the agency/program needs significant new investment to get back on its feet, but there is an action-killing public perception based on past experience that the agency is incompetent and bloated, then even a well-meaning and highly skilled leadership team might find outsourcing a necessary step towards regaining public support and its enabling of future investment.  However, in either case, the odds of success diminish if the emphasis is on cost reductions rather than improved operations.

 

ADVICE FROM THE FIELD

A recent gathering of outsourcing practitioners at MIT described some of the essentials of successful contracting.  First was the requirement of acknowledging and implementing the continued responsibility to set direction and metrics along with on-going and check-point operational and contract oversight.  Second was the need to be extremely smart about how to align the vendor’s profit-seeking motivation with the agency’s public mission at both the macro and micro levels. There was a place for non-performance penalties, but the impact of incentives for meeting targets and better-than-mandated outcomes was much more helpful in focusing the vendor’s attention.  For example, tying the level of payment to the number of riders, customer satisfaction, equipment availability, on-time operations, and other key metrics. 

Third was avoiding confusing and potential buck-passing by establishing clear delineation of roles, responsibilities, and areas of leadership for each contractual party.  This allows the agency to focus on planning while the vendor focuses on making operations more efficient.   Related to this was the suggestion that agencies not lock the service model into the RFP, instead allowing the RFP winning vendor to propose service-improving, cost-reducing, efficiencies.  (Attendees pointed out that few vendors would be likely to suggest suggestions before the RFP was awarded because nothing would prevent their competitors from simply using the idea in their own bid.  However, it was also acknowledged that allowing post-selection changes to the contract would require extremely careful RFP wording and very brave political leadership.)  One generally approved exception to the role separation was the sharing of data collection and storage systems so that everyone was working off the same data.

An explicit theme of the discussion was that firing current workers, reducing their pay, or worsening their working conditions was a prescription for failure – the main source of expertise and knowledge about what is going badly and how to fix it lies with the current workforce.  (The participating vendor’s agreement with this idea probably makes them unusual and also may be part of why they have been so successful.)  One vendor said they tried to sign contracts that passed the benefit of key incentives on to the workers, while noting that dealing with the need for “culture and behavioral change” went faster and deeper when workers felt they were part of the team rather than the enemy.   Several people pointed out that a vendor stuck with a fixed operational model can only create efficiencies through cost cutting and job intensification, both of which are likely to reduce rather than improve customer service and satisfaction.   

Perhaps most telling was former Massachusetts Secretary of Transportation Fred Salvucci’s comment that the standard right-left political argument about contracting totally misses the point.  Contracting out simply does not work as a strategy for retrenchment without service quality decline, contrary to most Conservative proponents.  But simply preserving public sector jobs without finding ways to revitalize and expand service is a Liberal trap that leaves the agency running an increasingly despised service.

 

SPECIAL ARRANGEMENTS

Special arrangements describe an even more varied set of usually “one-off”, unique contractual or informal arrangements between public agencies and private businesses, foundations, social investors, individual donors, “Friends of…” groups, and other non-profits.  Widely used in social services, recreation, conservation, and educational sectors, these provide important opportunities for public agencies to expand the range of public value they provide. However, while often presented as “generous donations” from the outside party, these arrangements are seldom without cost to the public agency and can easily divert the agency’s limited capacity away from its core mission. Even though these are more accurately described as “public-private partnerships” than the previous two types of P3s, these special arrangements also create endless opportunities for favoritism, mismanagement, and scandal. 

Real estate developers and other businesses are often required to “mitigate” the increased traffic congestion, environmental degradation, or other negative effects of their projects through improvements to a nearby intersection, upgrading of a nearby park or playground, or other compensatory actions.  Even when not required to, a business may offer to help pay for, or even build, public improvements or programs.  Business associations or Business Improvement Districts (BIDs) are frequently put in charge of downtown “pocket parks”.  In some situations, a private partner’s ability to create ancillary revenue opportunities in a traditionally passive asset both creates a new business and adds to the sustainability of the public resource.  Universities or non-profits are given a long-term lease and some degree of primary access to a public facility in exchange for investment in upgrading, maintenance, and operations while preserving an acceptable level of public use.  “Friends…” groups are allowed to raise money and oversee some amount of improvements and/or operations/activity in a public park or other facility.   All these, and more, are examples of public-private partnerships.  These kinds of P3s are individually negotiated.  At their best, they are a win-win proposition. 

 

GETTING TO YES

But getting to success is difficult.  The public agency has to have a predictable, transparent, and timely decision-making process capable of handling the infinite and unpredictable variety of partnership proposals that drop in at unpredictable times in unpredictable numbers. The public agency has to have or create both an internal culture and organizational processes that permit its staff to give up some degree of control over its facility operations, programming, and even its long-term investment plans.  Agency leaders have legitimate fears that entering into a P3 will open them to attacks for abandoning their Agency’s responsibilities or for benefiting one constituency over the general public, or that they’ll get blamed for the private partner’s failures.

Some offers of “help” actually do advance the agency’s mission and serve the broadest possible constituency, or frees up funds for other needed work without becoming an excuse for future budget cuts.  On the other hand, some projects primary benefit a particular (usually well-off) constituency or simply increase the value of the contributor’s property or business.  The projects a partner is willing to fund, no matter how worthwhile, may not fit with the current priority needs and plans of the Public Agency, or may be focused on a particular subpopulation that is not the Agency’s constituency of top concern at the current time. 

In addition, once approved, the agency needs sufficient staff to oversee the partner’s work, even if the arrangement is a mostly “hands-off” relationship supposedly requiring little agency involvement, new programs need evaluation, new facilities need maintenance and staffing.  Even an offer of “free” help is really a diversion of limited agency resources, especially staff time – the “opportunity cost” to the Agency, the diversion of attention from other projects, may be prohibitive.

The ultimate point of a P3 is to create value and the ultimate issue is how to divide that added value between the public, the agency, and the private partner.  No matter which type of arrangement the public sector uses, these are fundamentally political questions that elected leaders should be required explain before they public allows them to proceed.

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Thanks to Fred Salvucci for comments on earlier drafts.

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Related previous posts:

> PUBLIC-PRIVATE PARTNERSHIPS:  The Priority Must be Enhancing Public Value

> Why the Public Sector Can’t Be “Run Like A Business”   

> Making Government Work (Better)  

> Getting More Eggs from the Golden Goose:  “Nobody in this country got rich on their own”   

 

 

 

 

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