privatization

Private firms offer a route to financing infrastructure

Posted on by j.giglio

President Trump and his advisors have identified recruiting private firms as active participants as one solution to the choking shortage of money to finance critical infrastructure needs. He’s right, but maximizing the private sector’s impact will require the administration to think outside the box.

If properly structured, public-private partnerships could tap into billions of dollars of private capital hungering for low-risk investment opportunities that offer decent returns. Piles of dough would be deposited on the front steps of city halls and state houses with the steely hand of the private sector at the tiller, minimizing the need for scarce taxpayer dollars to get infrastructure projects underway.

This means designing such partnerships as overtly commercial enterprises able to demonstrate reasonable prospects for earning reliable income streams large enough to pay consistent returns to their private investors. Not a simple challenge to be sure. But scarcely one that’s beyond the capabilities of Wall Street’s more innovative investment bankers.

Making this work on a sufficiently large scale would require significant rethinking of how government deals with private firms (which may be overdue anyway), since some of these partnerships may require user charges to generate the necessary income streams. If approached creatively, this could actually enhance the likelihood that the activities of these partnerships would meet environmental goals and other regulatory mandates that serve the public interest.

In many jurisdictions, the public may not sit still for turning over the responsibility to operate an infrastructure project to the private sector because they know a business’ natural instinct is to maximize profits. Government could set up some sort of regulatory commission to oversee the project like they do for utility companies. But a better approach might be to set up an independent commercial corporation fully funded by user fees to build, own, and operate the infrastructure asset so taxpayers can participate in any upside from the project.

The state or local government could solicit bids from private investors to buy shares of equity ownership in return for annual dividends paid by the corporation. That brings private equity capital to the corporate balance sheet, reducing the amount of debt capital it has to issue.

In theory, government’s incentive is to offer the most service for the lowest cost. Private investors, on the other hand, have the opposite incentive: to charge the highest user fees the market can bear while providing the least service it can get away with.

But a second class of private investors would likely purchase equity shares in the enterprise mainly because they have a vested interest in assuring better roadways or other transportation infrastructure in the area. These investors might be private utility companies, local banks, and other local firms whose future revenue growth depends heavily on rising levels of economic activity. This class of owners would push for user fees that make sense from a financial standpoint and service levels that meet public needs in a financially responsible manner.

This model may be a reliable way to ensure that, for example, the original cost of every facility is evaluated on a lifecycle basis so customers and operators alike don’t wind up being confronted by expensive ongoing maintenance nightmares. There would also be the certainty of long-term financial commitments so taxpayers never have to deal with orphaned facilities displaced by disruptive technologies such as autonomous ride sharing vehicles.

This model holds owners responsible for sound asset management in a clear and unambiguous way. Opportunities for abuse by limited-life warranties, guarantees written by “paper companies” that melt into the woodwork when push comes to shove, and the kind of multi-party finger pointing that only ends up enriching the legal profession would be minimized. These realities are unlikely to be lost on the relevant parties.

Alternative models based on elaborate legislative mandates might accomplish the same thing. That is, if you believe the necessary legislation could be passed without being riddled with compromises, trade-offs, escape clauses and weasel language.

originally published: April 15, 2017

Privatization is as American as guns

Posted on by j.giglio

It’s surprising that privatization makes some people feel uneasy. It just makes me feel long in the tooth, since privatization is as American as handguns.

Privatization is an arrangement under which private firms become involved in the financing, designing, building, owning or operating of public facilities or services. Another name for such arrangements is public-private partnerships. The underlying concept is that the public and private sectors both benefit by cooperating to provide services.

Public-private partnerships are more common than most people realize. For example, governments have always used private firms to prepare the engineering and architectural designs for public buildings. Essential public services such as electricity, gas, and telephone communications have traditionally been provided by private firms functioning as regulated monopolies.

More recently, private firms operate prisons, sanitation services, toll roads and other functions normally associated with public agencies.

If public officials had to list 10 reasons for their rising interest in public-private partnerships, the first nine would be saving money. This is driven by tight fiscal conditions and taxpayer demand for more services than governments have the resources to provide.

Since private firms must pay taxes and earn profits- two costs that public agencies don’t have- it is reasonable to wonder how profit-generating firms can deliver services at lower costs than public agencies can.

The usual answer involves vague references to “private sector efficiency.” But such vapid cliches undermine privatization’s credibility. An important factor that enables private firms to deliver services less expensively is that few of them are subject to the regulations that hamstring public agencies. As a result, their procurement procedures are simpler, faster and more strategic.

Private firms are always on the lookout for new technologies and other tools that promise to make  service delivery more effective. They understand we did not get out of the Stone Age because we ran out of stones. Most public agencies are risk averse. so the only practical way for government enterprises to get things done in new and better ways is to let private firms assume the risk of failure.

Public agency managers rarely have the option of choosing a supplier based on timely delivery, quality, and lower life cycle costs. They’re usually restricted to a small group of suppliers who have mastered  the intricacies of government contracts, are willing to dot every “i”, cross every “t” (often several times) and wait months to be paid.

Avoiding “waste, fraud and abuse” guide public agency procurement. The standard assumption seems to be that the public would rather waste countless extra dollars to avoid any possibility of losing a single dollar to fraud or abuse. And few public agency managers can be expected to lay his or her career on the line to exploit more efficient trade-offs.

The bottom-line focus of most private firms forces them to live in the real world, where practical results, not procedures, are what count, That’s why private managers can exploit the benefits of just-in-time inventory management, economies of scale in purchase orders, and meaningful supplier performance measures to make their operations more efficient.    ·

Greater efficiency also means being able to aggressively exploit new technology to improve customer service, streamline production, and reduce costs. But there’s always some risk in being among the first to embrace new technology.

Private managers are paid to accept and manage risk; public sector managers are paid to avoid risk. This, coupled with elaborate procurement rules, is why public agencies usually end up with trailing  technology. They prefer not to “risk the public’s money” until a better technology has been so totally proven that it’s often obsolete.

Persuading government officials to outsource the risk of developing, financing, operating, and maintaining new innovative technology is a full time job, one with plenty of opportunity for overtime.

originally published: March 29, 2014

Why not privatize public jobs?

Posted on by j.giglio

Recently, the small band of Republicans in the Massachusetts Senate attempted unsuccessfully to tack an amendment repealing the so-called Pacheco law- the nation’s strongest anti-privatization law- onto a transportation bond bill. When moves like this are debated, the quality of managers, one of the most important reasons why governments need access to private-sector expertise, is almost never mentioned.

These days, privatization is usually defined as a process through which government contracts with private firms to deliver services traditionally delivered by public agencies. In theory, there is no reason why any government service could not be privatized. This extends all the way to sacred cows such as police and fire protection, elementary and secondary education, and even the armed forces.

Such presumably boundless potential may be why debates about how far privatization should go have become unnecessarily philosophical, involving stained-glass abstractions such as “public versus private goods,” “economic externalities,” “natural monopolies” and, of course, “the proper role of government.”

All of which ignore what may be a more pragmatic question: Has Americans’ growing mood of disenchantment with the apparent shortcomings of government increased their willingness to rely more on private companies to provide public services?    ·

If it has, we ought to ask ourselves how profit-seeking, tax-paying private companies may be able to deliver better services for less than not-for-profit, tax-free public agencies. Privatization advocates cite a number of reasons such as operating efficiency, easier access to capital, better technology, the absence  of conflicting goals and better management.

The role the latter plays in producing and delivering high-quality services with maximum efficiency is dangerously underrated. Efficiency requires managers who are bright, well-trained and highly motivated. The most obvious way to attract and hold on to such managers is to pay better than the competition.

But government agencies are at a serious disadvantage when it comes to attracting good managers. The salaries of elected officials tend to impose an artificial ceiling on how much public agency managers can be paid. This ceiling usually ignores the realities of the marketplace, but elected officials are reluctant to advocating higher salaries for themselves because they believe it looks bad to voters.

Since managers rarely earn more than their elected bosses, comparatively low pay means too many government agencies lack the management talent they need to deliver services efficiently.

Few professional managers are independently wealthy. Their choice of where to work reflects the financial realities of paying mortgages, supporting their families and providing for their children’s education. For the best managers, the public sector is rarely where they can earn the most.

Sadly, some recent newspaper reports have gone after the Massachusetts Convention Center Authority, one of the quasi-public authorities where managers can earn salaries that, though still not comparable, are at least closer to what professional managers can command in the private sector. One report criticized the increased compensation some MCCA employees earned thanks to performance-based incentives.

Perhaps it’s not a coincidence that the MCCA might be the best-managed public agency in Massachusetts. Executive Director James Rooney is an outstanding manager and knows that using performance-based incentives that link compensation to performance is a tool that can help him attract and maintain talent.

Given the uniquely American attitude toward government and civil servants, there is little likelihood that these salary constraints will ever disappear. So the only practical way to assure that public agencies are consistently well-managed may be to tum at least some of them over to private companies that are willing and able to pay top dollar for superior managers.

originally published: March 5, 2014

Privatization: Old wine in new bottles?

Posted on by j.giglio

Privatization, or public-private partnerships, is an arrangement under which the private sector becomes involved in the financing, design, construction, ownership, and/or operation of public facilities or services. The underlying concept is that both the public and private sectors can benefit from cooperating to provide services and/or facilities.

The concept is a valid one, as long as public officials consider privatization’s impact on tomorrow’s taxpayers, not just what the effect will be during their own terms in office.

Privatization is more common than most people realize. Governments routinely use private firms to prepare engineering and architectural designs for public facilities. Essential public services such as electricity, gas and telecommunications have traditionally been provided by private firms that function as regulated monopolies. Public-private partnerships are as American as handguns.

But the concept of private firms operating public libraries, prisons, sanitation services, toll roads or other functions normally associated with public agencies is newer. Contemporary privatization represents a collaborative effort, with the public and private sectors sharing risks, rewards and responsibilities.

Interest in privatization is increasing, partially driven by fiscal challenges. The assumption is that private firms can often deliver these services for less, even though they must pay taxes and make a profit ­ expenses that public agencies do not have.

How is this possible? There are at least five factors that can work in a private firm’s favor:

Higher salary and incentives: A public agency’s salary structure and inability to offer things like stock options may make it impossible to attract a sufficient number of talented managers.

Faster procurement: Public purchasing processes are often constrained by regulations originally implemented to prevent fraud. Purchases can take an inordinately long time to complete.

Economies of scale: By providing the same service to a number of public entities, a private firm can develop both market power and specialized expertise. This can be particularly critical for high-technology services.

Less restrictive work rules: Public sector collective bargaining agreements often saddle public agencies with work rules that prevent implementation of new and more efficient procedures. Private firms are often in a better position to negotiate rules that promote efficiency.

Availability of tax deduction: Finally, private firms have access to two federal subsidies that are not available to public agencies: tax deductions for accelerated depreciation on capital equipment and interest payments on borrowed funds.

Sadly, the nation’s most restrictive anti-privatization law all but prevents Massachusetts taxpayers from reaping benefits from public-private partnerships. Under the so-called Pacheco law, named after its author, State Sen. Marc Pacheco, state managers must overcome virtually insurmountable obstacles before contracting out any service currently delivered by state employees. As a result, few privatizations have even been attempted during the two decades the law has been in effect.

The privatization debate has waxed and waned since 13 colonies became the United States of America. Should we let government take care of our problems or should we rely on private enterprise? As governments struggle to figure out how to handle mega-problems created by a stagnant economy, the prudent use of privatization is more important than ever.

originally published: August 3, 2013