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The Privatization of Some Government Services - What Works, and What the Concerns Are

May 15, 2018

Ronald W. Nossek, CPA
Partner

The concept of privatizing certain government services and operations has been around for years, and there are numerous examples of where privatization has worked and where it has failed.  Today, with more and more state and local governments finding it difficult to manage their annual operating budgets—and, in some cases, finding it impossible to afford needed infrastructure and employee benefit costs—the notion of privatization is perhaps more provocative than it has ever been.   

That said, the concept has always been somewhat controversial, due to friction between the financial and social aspects of privatization. So before any government entity leaps at the idea of privatizing its services, careful consideration need to be paid to the many advantages and many challenges it brings. 

Positive Aspects of Privatization: 

Increased Efficiency—To begin with, the private sector is often more efficient in providing service at a lower cost than government, as it is typically not bound by public employee collective bargaining agreements and related employee benefit structures.  Additionally, government often lacks the incentive and motivation to provide services in an economically efficient manner.  Conversely, without economic efficiency, the private sector runs the risk of failure.  Governments don’t go out of business, but the private sector entities can.  

Revenue Influx—Next and equally important, privatization agreements can generate revenues through the sale of assets that can help fund public needssuch as infrastructure improvements—that governments are incapable of financing through taxation and borrowing.  Discipline must be exercised by the government to avoid using these resources in a short-term fashion, such as merely to close existing structural budget deficits.  

Flexibility—The private sector does not require voter approval to make necessary business decisions relative to the operation of the asset or service.  Government can be motivated by political influences, and often lacks the political will to increase user fees or taxes to generate the revenue necessary to fund operations or, when necessary, reduce personnel to cut costs 

Expertise and Specialization—Lastly, the private sector often has access to more expertise in service areas than the government is typically willing to afford.  This attribute can provide a higher quality of service to the customer and can reduce the cost of problem-solving when they arise.   

Challenges of Privatization 

Loss of Control—This is always the primary obstacle when it comes to considering privatized government services, that the government and its citizens may lose control of the asset or service once the agreement is in place. While a government is accountable to its citizens, the private sector is accountable to its shareholders, and this can lead to a decline in service quality.  This risk can be mitigated, however, through a well thought-out and negotiated agreement by identifying performance standards necessary to ensure quality.  

Cost of Service—Another major factor. Profit motivation can increase costs and/or reduce quality of service for the public and the government if the private operator chooses to increase revenue and decrease costs to achieve its profit goals. This is directly tied to loss of control, as citizen voters and possibly the government itself may have no recourse to that decision by the private operator.   

Long-term ContractPrivatization contracts are typically long-term agreements (often 50 to 99 years) and, as such, can become outdated and end up reducing the quality of service to the user.  Additionally, the profit motivation of the public sector could hinder its desire to invest in technological or other capital improvements that were not available at the time the contract was agreed upon.   

Failure to PerformPut simply, the private sector could fail to perform, and the government would then be forced to either find another private sector partner or step back into providing the service again itself.  This can be a very expensive ordeal, because once the asset or service is privatized, bringing it back is very difficult.   

Again, privatization can be a very efficient way to improve service delivery and provide economic resources to governments.  However, governments must be prepared to retain an oversight operation in areas such as quality of service and performance standards to ensure the private entity is meeting its obligations. Whatever the decision, the “privatization vs. non-privatization” question needs to be answered through careful, strategic thought and planning; this is the only way it will work. 

Ronald W. Nossek, CPA, is a partner with BlumShapirothe largest regional business advisory firm based in New England, with offices in Connecticut, Massachusetts and Rhode Island. The firm, with a team of over 500, offers a diversity of services, which include auditing, accounting, tax and business advisory services. Blum serves a wide range of privately held companies, government and non-profit organizations and provides non-audit services for publicly traded companies. To learn more visit us at blumshapiro.com. 

 

 

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