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And the Winner is….The Public Sector

| Written by David Morris | 3 Comments | Updated on May 18, 2011 The content that follows was originally published on the Institute for Local Self-Reliance website at http://www.ilsr.org/and-the-winner-is-the-public-sector/
public or private signpost better

Unlike the public sector, the private sector is bred for efficiency. Left to its own devices, it will always find the means to provide services faster, cheaper, and more effectively than will governments.
James Jay Carafano, Private Sector, Public Wars

I suspect the vast majority of Americans would agree with Mr. Carafano.  They probably consider the statement self-evident.  The facts, however, lead to the opposite conclusion.  When not handicapped by regulations designed to subsidize the private sector, the public sector often provides services faster, cheaper and more effectively.

Consider the results of recent privatization initiatives in three key sectors:  health, education and national defense.

Health

Alone among all industrialized nations, the US relies on private for profit insurance companies to manage its health care system.  The result?  The US has by far the most expensive health care system in the world both in total cost and as a percentage of GDP.

But we don’t have to look abroad to evaluate the comparative costs of private and public health systems. Consider Medicare.

Small privatization efforts under Medicare began in the 1980s but did not become full-borne until 1997 when the Republican Congress, with the support of President Clinton, created Medicare+Choice.   Secure in their faith that the private is always superior to the public the Republicans agreed to a program in which private insurers would receive the same amount as the service cost under Medicare.

The public sector proved uncompetitive. Private insurers began pulling out en masse. In 2000, more than 900,000 patients were dropped from the Medicare+Choice program.

No one should have been surprised.  Private insurers have a huge handicap.  Their overhead costs-marketing, profits, etc.—dwarf those of Medicare: slightly under 17 percent compared to about 5 percent for Medicare.

How did the Republican Party react to this real world challenge to their foundational belief in the efficiencies inherent in a private enterprise system?  They changed the rules. Having proven unable to win in a fair fight, private insurers were now given a handsome subsidy when Medicare Advantage replaced Medicare+Choice. The federal government now pays private insurers on average 14 percent more per member than the same care would cost under traditional Medicare.

The huge subsidy allowed private insurers not only to make a profit but to offer some low cost goodies, like membership to gyms, Medicare doesn’t offer.  Today, about 8.5 million Medicare beneficiaries nationwide are enrolled in some form of private Medicare plan—nearly 20 percent of all Medicare beneficiaries.

Astonishingly, having proven that private health insurance costs more Republicans have now made the further privatization of Medicare the centerpiece of their budget deficit plan.  Instead of directly insuring seniors their new plan would have the government give them a voucher to buy private insurance.  The government would save money because the value of the vouchers would rise at a slower rate than health care costs.

New Yorker business writer James Surowiecki sums up the conclusions of an analysis of the plan by the non-partisan Congressional Budget Office, “seniors would have to spend more and more of their income on private insurance and out-of-pocket expenses, or go without… Ryan’s plan would actually increase the amount of money Americans spend on health care, since private insurers aren’t as good at curbing costs as Medicare.  But taxpayers would pay less.”

Education

In 1958, the federal government established a student loan program.  The federal Treasury made the loan directly.  In 1965, as part of his Great Society initiative, LBJ wanted to dramatically expand the program, but ran up against budget rules that discriminated against direct lending. A direct loan showed up as a total loss in the year it was made, even though most of it would be paid back with interest in future years.  A guaranteed loan, on the other hand, which placed the full faith and credit of the United States behind a private bank loan, would appear to have no up front budget cost at all because the government’s payments for defaults and interest subsidies would not occur until later years.

Knowing that a major direct loan program would show up as increasing a deficit already growing because of the expanding Vietnam War, the Democratic Congress opted to replace direct loans from the government with bank loans guaranteed by the government.

For the next 27 years, the direct loan program disappeared.  Finally, in 1990 Congress eliminated the unfair rules.  The new unbiased regulations led the Bush Administration to conclude that direct loans would be less costly and simpler to administer.  In 1992, Congress created a direct lending pilot program.  In 1993, President Clinton proposed replacing the guarantee program with direct loans as part of his own deficit reduction plan.

But in 1994 Republicans took over the House of Representatives.  And as conservatives are wont to do, they refused to let facts get in the way of ideology. Led by Newt Gingrich, they tried to completely eliminate direct lending. To their surprise, college and university officials, frustrated by a guaranteed loan system the Government Accountability Office labeled a “complicated, cumbersome process” involving thousands of middlemen, fought back.

Ultimately, Congress stopped short of eliminating direct lending. Instead, it prohibited the Department of Education from encouraging colleges to switch to the direct loan program.   Even without such encouragement, colleges recognized a good deal when they saw one and began shifting to direct loans.  By 1998, about 35 percent of all student loans were direct loans from the government.

The private sector, having tasted the profits of guaranteed loans, fought back, led by Sallie Mae, the former Student Loan Marketing Agency.  Set up in 1972 as a non-profit, government sponsored enterprise (GRE) supervised by the US Treasury, in 1997 Sallie Mae obtained Congressional approval to privatize.  That allowed it to originate its own loans and acquire other companies. The new private profit making company quickly bought out its two major rivals.

 

Sallie Mae also purchased student loan collection companies.  By 2006 it dominated all aspects of the student loan industry. According to CBS News, in 2005 nearly a fifth of its revenue came from collection agencies.  Sallie Mae’s fee income increased by 228 percent between 2000 and 2005, from $280 million to $920 million while its stock price increased 1,600 percent from 1995 to 2005.

Colleges began to shift back to guaranteed loans.  Wondering why they would do so to the detriment of their students, U.S. News and World Report investigated.  It found that private lenders were supplying college official with free meals and drinks, golf outings and sailboat cruises. “Lenders offer the prospect of millions of dollars in profits to universities–if they drop out of the Education Department’s direct-loan plan.

 

A 2006-2007 investigation by New York Governor Eliot Spitzer and Attorney General Andrew Cuomo uncovered a pattern of kickbacks and bribes to universities.

Private lenders worked not only to maximize their share of the market but to maximize their profits from each loan by changing the rules.  U.S. News and World Report noted, the student loan industry “used money and favors, along with their friends in Congress and the Department of Education, to get what they wanted.”

In 1998, Congress allowed massive penalties and fees to be imposed on delinquent student loans, making it more profitable for the lenders and guarantors when students defaulted than when they repaid the loan on time.  Congress also allowed for collection rates of up to 25 percent to be applied to the debt.

In 1999, lawmakers created a new interest-rate formula that boosted the lenders profits.

 

Student loans were specifically exempted from state usury laws and from coverage under the Truth in Lending Act.

Adding insult to injury, in 2005, the private lenders convinced Congress to make all student loans non-dischargeable in bankruptcy.

 

The loss to the taxpayers ran into the tens of billions of dollars.  The loss to students may have run even higher.

In 2005 the Congressional Budget Office compared the impact on taxpayers of a guaranteed loan and a direct loan.  For every $1 of loan guarantee the federal government incurred taxpayers lost 15 cents.  For every $1 loans made directly by the federal government, taxpayers made 2 cents.

On a $3,000 student loan repaid in 10 years, the CBO estimated the cost to taxpayer for a guaranteed loan would be $450.  A direct loan, however, would benefit taxpayers by $63.

The 2008 elections gave us a Democratic Congress and a Democratic President.  In 2010, they ended 40 years of giveaways to the private sector and eliminated the guarantee loan program.  Today all federal student loans are direct loans. The Congressional Budget Office estimates this will generate almost $68 billion in savings over the next ten years.

Military

 

As early as the late 1970s the federal government began contracting out but privatization took center stage with Bill Clinton and Al Gore’s Reinventing Government initiative.

From then on politicians would boast about how much they had reduced federal payrolls while at the same time avoiding the unpleasant fact that on their watch the number of private contractors had increased even faster.

The Pentagon embraced privatization most eagerly, contracting out for a wide variety of services, including weapons engineering, security enforcement, training, tech support, food and outfitting management, and even frontline military strength to a new entity,  the Private Military Company (PMC).

 

Secretary of Defense William Cohen led the effort. “During the summer of 1997 he assembled a committee that included leading executives from private industry to offer their wisdom about the road ahead”, Duke law professor Laura Dickinson writes in Outsourcing War & Peace.  “Cohen then proceeded to pursue a reform path that aimed to modernize defense by embracing the rhetoric, practices, and methodologies of American businesses. This embrace is perhaps most apparent in his Defense Reform Initiative, which he launched in the fall of 1997 as an effort to ‘aggressively apply to the Department those business practices that American industry has successfully used to become leaner and more flexible in order to remain competitive.’

The Pentagon has always employed contractors for specialized functions that were not large in scope and not fundamental to regular military operations. This changed in the early 1990s.  Peter Singer writes, ”In 1992 a relatively little-known, Texas-based oil services firm called Halliburton was awarded a $3.9 million Pentagon contract. Its task was to write a classified report on how private companies, like itself, could support the logistics of U.S. military deployments into countries with poor infrastructure. … it is hard to imagine that either the company or the client realized that 15 years later this contract (now called the Logistics Civilian Augmentation Program or LOGCAP) would be worth as much as $150 billion.”

The number of private military contractors soared, exceeding by 1999 the total combined number of active military troops, civilian employees, reserves and National Guards.

The result?  An unmitigated mess.   Contracts were shoveled out the door so fast the military lacked even basic information about the burgeoning force of private contractors. This was clearly evident when Congress asked the Army how many contract service workers it had.  The Army’s answer?  Somewhere between 124,000 and 605,000!

Did privatization save money? Usually not.  One Congressional study found that contracts for intelligence support cost, on average, almost twice as much as in-house work.

Almost all of today’s logistics firms operate under “cost-plus” contracts–a structure ripe for abuse.

But privatizing the military has cost us more than just money.  As Maj Kevin P. Stiens and Lt. Col. (Ret.) Susan L. Turley observed, “Not only did the cost savings fail to materialize, outsourcing caused other tangible losses.  The government lost personnel experience and continuity, along with operational control, by moving to contractors.”

Walter Pincus opined in the Washington Post, “Particularly frustrating for organizations that require specialized expertise and experience, such as intelligence agencies, are organic personnel who leave for better pay with contractors after the government has trained them, obtained their security clearances, and given them experience…The government pays to get the worker qualified, then ends up leasing back . . . former employees.”

Our national security now depends on millions of workers with divided loyalties. “Private employees have distinctly different motivations, responsibilities and loyalties than those in the public military, Air Force Colonel Steven Zamperelli writes, “[T]hey are hired, fired, promoted, demoted, rewarded and disciplined by the management of their private company, not by government officials or the public.”

“The privatized military industry introduces very real contractual dilemmas into the realm of international security”, Peter Singer maintains,  “For governments, the public good and the good of the private companies are not identical . . . [and] these two parties’ interests will never exactly coincide.”

In 2008 at least 12 U.S. soldiers were accidentally electrocuted inside their bases in Iraq.  Later it was discovered that the private contractor, KBR, knew there were potentially serious electrical problems in the facility’s construction. But its contract didn’t cover “fixing potential hazards.” It only required repairing items already broken!

Singer offers another reason many are concerned about our increasing reliance on private contractors,  “Many worry that the lack of control due to outsourcing could weigh even heavier and even put an entire military operation at risk. Consider what happened during the 2004 Sadr uprising, where a spike in attacks on convoys caused many companies to either withdraw or suspend operations, causing fuel and ammunition stocks to dwindle.”

 

It may be too late to turn the clock back on private military companies so long as government officials boast about reducing the size of the federal workforce while actually increasing it and lack the political courage to reinstitute a draft that would bring troop and troop support levels back to where they need to be.

Nevertheless, the pendulum seems to be swinging back. For the first time in 30 years, the 2008 National Defense Authorization Act encouraged what has come to be known as “insourcing”, bringing back in house tasks that have been outsourced.  Stiens and Turley drily assert, “one of the primary benefits of insourcing is to undo outsourcing efforts that brought neither cost savings nor improved mission performance.”

So there we have it.   Three disparate examples of privatization, all leading to the same conclusion. Privatization hurts.  Unlike the public sector, the private sector is bred to maximize profits.  Left to its own devices, it will always find a more profitable way to provide services even when that means increasing their cost, reducing their effectiveness and endangering the national security.

 

 

 

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About David Morris

David Morris is co-founder of the Institute for Local Self-Reliance and directs its initiative on The Public Good. He is the author of the New City States, Seeing the Light, and three other non-fiction books. His essays on public policy are regularly published by On the Commons, Alternet, Common Dreams and the Huffington Post.

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  • http://www.heritage.org James Carafano

    I don’t agree with your analysis. In each case you cite where the private sector failed, it was because governments skewered markets and would not let them operate efficiently. The case of defense contractors is a case in point. If you read my book you will note that where there were failures it was usually because the government was a bad customer…not because the private sector could not efficiently deliver services. If governments could deliver better services than the market place then the Soviet Union would be the world’s largets and most productive economy. Hmmm?

  • John

    James, you wrote a book using that kind of reasoning? Wow. I guess anyone can put words on a page.

    We have plenty of models from around the world, and not just the U.S, of private and public markets. You can’t get around health care no matter what you say or do. Even if you want to argue that governments create unfair advantages, aren’t there some things where profit shouldn’t just be the primary motivating factor for delivering a service (ie, read health care here James). If government isn’t going to deliver these services, then who?

    I had to take a double take at your Soviet Union comment, because I almost spit all my coffee out over my keyboard as I read it. You’re supposed to be a historian correct? Maybe you should study the history of China. Taking one country that was torn apart by it’s many internal philosophical differences, and holding it up as if to say, “Here, look… see it will never work.” is poor scholarship and even worse reasoning, even for a response comment in a blog.

  • Michael

    Thanks, David. I shared your excellent article on Facebook. Serving in the military was hard enough. I hate to imagine what it would have been like had I had to rely on a mercenary or a private sector resupply company during a firefight in Vietnam. Fortunately, I now benefit from one of the most efficient health care systems in the country—the VA.