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Rebooting Economy XII: Is private sector inherently more efficient than public sector?

Prasanna Mohanty     August 1, 2020

Since 1970s it has been repeatedly said that the private sector is inherently efficient and hence the global emphasis on its growth, more often than not, at the cost of public sector. What evidence exists in academic studies and economic history to substantiate this?

Here we look at some of this evidence.

No ownership model is intrinsically more efficient 

In 2015, the United Nations Development Programme (UNDP) published a paper "Is the Private Sector more efficient? A cautionary tale" analysing all existing global studies on comparative efficiencies of public and private sectors with a view to assist in "achieving the UN Sustainable Development Goals (SDGs)" rolled out 2015 for the next 15 years.

It captured the substance and nature of the debate in its entirety, better than any known study. Its two important conclusions were: (i) "no model of ownership" - public, private or mixed - "is intrinsically more efficient" than the other and (ii) efficiency under all ownership models "depends on competition, regulation, autonomy and wider issues of institutional development". 

The third conclusion (the middle one in the box) was that the literature on comparisons lacks academic rigour, sector-specific, and often inconclusive.

It explained this conclusion: "Most literature comparing ownership models looks at specific service sector: health, education, water, sanitation, and so on. The literature that compares public and private provision, in general, tends to be made up of opinion pieces and lacks rigour in comparison to academic and policy studies. The rigorous literature that does exist suggests that efficiency depends on factors such as country context, the sector, the market the firm operates in and the firm's organisation, rather than ownership." 

This is primarily because private sector efficiency is a neoliberal economic construct pushed in 1970s (first) by the Chicago school of economics to promote private sector and limit the role of states (government) in running economies. In 1980s this was pushed and imposed on non-Anglo-Saxon countries by the World Bank and International Monetary Fund (IMF) when these countries sought loans to tide over their economic crisis. (For more read 'Deconstructing Neoliberalism II: How neoliberal ideas can wreak havoc on economies ')

Two major elements of this push were (a) handing over ownership of public-owned enterprises to private entrepreneurs and (b) public-private partnerships (PPP).

Hence, all comparative efficiency studies focus on these two developments.

Efficiency Test 1: Ownership change designed to undermine public enterprises

Stiglitz et al published a cross-study in 2011 comparing how change in ownership from public to private changed their performance, "Ownership change, institutional development, and performance". It found no conclusive proof of private sector superiority.

It pointed out that "a basic insight is that institutional quality matters more than ownership". It held that profitability (measure of efficiency) post-ownership change was "most directly tied" to protection of private investors against expropriation and better enforcement of contractual rights". It also highlighted that more likely, such ownership change happened in case of public enterprises "that perform well, biasing traditional tests of performance effects of privatisation".

Stiglitz wrote elsewhere that the theoretical case for such change "at best, is weak or non-existent". In the foreword to a book on neoliberalism, he wrote how a few individuals grabbed "previously state-owned resources for a pittance and become millionaires - or billionaires".

He added, "Russia became a country (after the fall of communism towards the end of 1980s) marked by great inequality, with a Gini co-efficient as bad as many in Latin America" and that "by some estimates, $1.5 trillion in assets were stolen" in Russia.

The Guardian carried an interesting report in 2013 that marked 20 years of ownership change in the UK rail, "'The private sector is superior'. Time to move on from this old dogma". It cited the rail regulator's report to say that "the single remaining state-run mainline rail service (East Coat rail services), required less public subsidy than any of the 15 privately run rail franchises in Britain".

The ownership change happened in 1993 with the promise of eliminating subsidies, increasing efficiency and reducing fares (through competition). The UK's parliamentary reports show the subsidies stood at 2.74 billion pounds at the time of change (1993-94), went up to 7.48 billion pounds in 2006-07, and touched 7.1 billion pounds in 2018-19. The UK has some of the most expensive rail tickets in Europe.

The 2013 Guardian report had further pointed out that "some of the UK's largest private care home providers effectively bankrupted themselves and had to be saved by public intervention". (This is a subject of wider study by economists drawing attention to the pitfalls of takeover and financialisation of care homes by private equity (PE) firms).

Similarly, it said the banking system "is only standing today due to monumental public backing" and that "private finance is much more expensive than direct public investment: the cost of capital under the heavily used private finance initiative was estimated by the Financial Times in 2011 to have added 20 billion pounds to the taxpayers' bill".

There are other high public costs to private businesses.

In the case of India, ownership changes have happened with free handover of huge public assets of public sector undertakings (PSUs) to private enterprises; defunding of PSUs for many years (state-owned telecom companies, publicly-run schools and hospitals etc.) to vacate space for private enterprises (telecom, hospitals, and schools) and debt waivers (Rs 29,474 crore of Air India's debt was shifted out in 2019 and more is on the anvil to "sweeten the deal" for private take over).

Such incidences make comparisons between public and private sector efficiencies futile.

In 2006 audit report the Comptroller and Auditor General of India (CAG) had pointed out several such incidences: (i) core assets of Modern Bread, like leasehold land and plant and machinery, were not valued before the change of ownership (ii) leasehold land housing the plant and fully developed township of BALCO were not valued (iii) non-core assets were not identified and properly valued for BALCO and India Petrochemicals (IPCL) (iv) real estate, land and building of VSNL and Paradeep Phosphates were "either discounted or not considered" in absence of clear title for which the administrative ministries made no effort (v) only one of three operational mines of Hindustan Zinc (HZL) was valued (vi)  "far too conservative assumptions" were made in valuation of 7 out of 9 PSUs under the discounted cash flow methodology without recording reasons for such assumptions etc.

The Russia, UK and India examples lead to questions that beg for answers: Is private enterprise really private or inherently carry substantial public money and natural resources? How does one compare efficiencies when the ownership change is structurally designed to benefit private enterprises?

Efficiency Test 2: PPPs designed to benefit private enterprises

A 2004 IMF paper examined the impact of public-private partnerships (PPP) in providing infrastructure assets and services.

Talking about PPPs taking off in many countries across the world, it concluded: "However, it cannot be taken for granted that PPPs are more efficient than public investment and government supply of services. One particular concern is that PPPs can be used mainly to bypass spending controls, and to move public investment off budget and debt off the government balance sheet, while the government still bears most of the risk involved and faces potentially large fiscal costs."

In India, the PPP model has already failed and abandoned during the later years of the UPA era. In the case of National Highway Authority's projects, which used PPPs extensively, it was revealed through "internal paper" of the erstwhile Planning Commission and RTI reply that financial institutions, mostly the public sector ones, had given loans nearly twice the total project costs (TPCs) in the case of just 20 projects.

While the TPCs were Rs 13,646 crore, banks lent Rs 25,940 crore without collaterals or guarantees to private partners. This meant half the money was not even meant for these projects and must have been diverted by private partners. Besides, the NHAI gave 40% viability gap funding (VGF) upfront.

Taken together, this would mean for a project cost of Rs 100 crore, the private partner is walking away with Rs 230 crore (Rs 90 crore of additional loan without collateral and Rs 40 crore of VGF). Later, the private partners did not even pay that. The NHAI's road projects contributed significantly to the rise in NPAs subsequently.

The NHAI PPPs even allowed private partners to walk away at any time, which some did, and allowed toll collections far in excess of the agreed amount through gross understatement of vehicular traffic projections, until in the case of some, like the Gurgaon Expressway flyover, they were caught and toll booths dismantled.

What would be the score of efficiency of these private partners?

Now, in the midst of the health crisis caused by the COVID-19 pandemic, the government has revived the very same PPP model in healthcare even while the private healthcare has spectacularly failed to respond to the crisis in India and the US.

In May 2020, the government think tank Niti Aayog wrote to the chief secretaries of states asking them to set up medical colleges in PPP mode, provide 40% VGF plus handover government-run district hospitals to private partners. (For more read 'Rebooting Economy X: COVID-19 puts question mark on private sector's efficiency in healthcare ' and 'Coronavirus Lockdown XI: Why India's health policy needs a course correction ')

There is more to the inefficiencies of private healthcare.

In India, there is a flood of complaints about private healthcare facilities: black marketing beds, giving false COVID-19 test results for money, refusal to treat and overcharging costs, apparent failure of some state governments to rein them in.

More than four months after the Disaster Management Act of 2005 was invoked to give sweeping powers to requisition such services and COVID-19 cases have gone up sharply (total cases crossed 1.5 million in India on July 29) the Karnataka government is still negotiating with private healthcare for beds and charges.

What would be the efficiency score of private healthcare in India?

Efficiency Test 3: Damage to human rights, further marginalisation of workers

A UN report tabled in the General Assembly in September 2018 looked at the impact of change in ownership from public to private.

Its finding said such ownership change "often involves the systematic elimination of human rights protections and further marginalisation of the interests of low-income earners and those living in poverty" and as some "aspects of criminal justice system are privatised, many different charges and penalties are levied with far greater impact on the poor, who then must borrow to pay them or face default".

It further said the neoliberal shift to private ownership had changed the very definition of personal freedom: "Freedom is thereby redefined as an emaciated public sector alongside a private sector dedicated to profiting from running key parts of the criminal justice system and prisons, determining educational priorities and approaches, deciding who will receive health interventions and social protection, and choosing what infrastructure will be built, where and for whom."

Yes, private contractors run prisons in the US. Powerful private corporates "force their customers to forego the use of our public legal system for the adjudication of disputes... and instead use secretive arbitration panels that are stacked in favor of the companies" as Stiglitz wrote in his 2019 book "People, Power and Profits".

In the same book, Stiglitz also wrote how under the legendary Steve Jobs Apple got together with Google, Intel, and Adobe secretly to agree not to "poach" each others' employees ("anti-competition conspiracy"), which was exposed, and led to a lawsuit which was settled for $415 million.

He also mentioned that Disney and a host of film studios similarly paid a huge settlement for illegal anti-poaching conspiracy and that fast-food franchise agreements have such provisions. Such practices undermine both competition and wages.

Efficiency Test 4: Push for private enterprises at the cost of public ones

Why country after country undermines the public sector and follows the neoliberal construct of private sector efficiency when no evidence and no economic theory validate it and let the impression gain that the public sector is inherently corrupt, incompetent, and inefficient?

The UNDP report of 2015 mentioned earlier listed 7 reasons: (i) political support to undermining public sector benefits (ii) neoliberal push (Public Choice theory) that the public service is inherently self-serving and need to be checked (iii) commercial gains (profits) for consultants and businesses (iv) politicians' need for deflecting criticism of their own failures (v) relatively lower pay for professional posts in public sector (vi) obstructive public sector labour unions and unhelpful bureaucrats and (vii) "both elected leaders and senior administrators benefit from creating a 'permanent revolution' of ceaseless reforms and reorganisation of the public service... the temptation to appear to be shaking up supposedly lazy and incompetent bureaucrats is all too great".

Public Choice theory of neoliberal economist James McGill Buchanan successfully attacked state and public institutions theorising that government failure is the rule and it happens because private interests "capturing" policymakers through nepotism, cronyism, corruption or rent-seeking, misallocation of resources and crowding out private investment, etc.

He or anyone else never explained how by handing over everything to the very same private sector that caused all of these ills would remedy and not worsen these problems. (For more read 'Deconstructing Neoliberalism I: What is Crab-walk strategy; is it relevant for India in present times? )

Efficiency Test 5: Multiple market failures

Market failure, rather private sector failure (market is defined as all private sector structures that facilitate exchange of goods and services), is the biggest problem but receives the least attention from economists and policymakers.

In fact, history is replete with such evidence.

The 1929 Great Depression and 2007-08 Great Recession were caused by the private financial sector companies through their misadventures. There are a series of regional or country-specific economic crises caused by the financial misconducts of private financial companies and/or the neoliberal push for capital and financial market liberalisation without putting effective regulatory mechanisms in place by the World Bank-IMF: burst (2000-01), Asian financial crisis (late 1990s), Latin American crisis (1990s-2000s), Japan crisis (1990s-2000s) and many others.

Economic crises would persist because in spite of the severe consequences of 1929 and 2007-08, that led to millions of people losing jobs and incomes and the collapse of many big private companies, the neoliberal economists continue to insist that "recession" is cyclical, inevitable and most importantly, "a good thing, part of the economy's adjustment to change" and that fiscal austerity is required to fight recession, as economist Paul Krugman wrote about their bizarre economic constructs.

Neoliberal economists also insist unemployment is good because it is voluntary (not for lack of jobs) and workers like to take breaks from backbreaking labour to relax; workers' wages should be low because higher wages lead to high cost of production and loss of employment; cutting tax for the rich benefits the non-rich (trickle-down effect) etc. (For more read 'Deconstructing Neoliberalism IV: How neoliberals won the world but India can ill afford their economics ')

There is yet another element to the debate of efficiency in the public and private sector.

It is no secret that the private sector thrives on public hand-outs in normal times (tax holidays, concessions and outright corporate tax cuts; cheap land, mines, forests and other natural resources' infrastructure and human capital built with public money etc.) and public bail-outs during crises (stimulus packages, grants, and loans). (For more read 'Rebooting Economy IX: Why is private sector dependent on public money in times of crisis? ')

That is why the maxims "privatisation of rewards and socialisation of risks" and "privatisation of profit and socialisation of loss" ring true.

At the end of it all, where does private sector efficiency stand?

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