[Vision2020] When Public Outperforms Private in Services

[Art Deco]

  [image: The New York Times] <http://www.nytimes.com/>

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January 15, 2013
When Public Outperforms Private in Services By EDUARDO
PORTER<http://topics.nytimes.com/top/reference/timestopics/people/p/eduardo_porter/index.html>

Few corporate sagas capture the virtues and vices of state-owned companies
and private enterprise better than the drama of
BP<http://topics.nytimes.com/top/news/business/companies/bp_plc/index.html?inline=nyt-org>’s
roller-coaster ride between failure and success.

Ten years ago, BP was the darling of the energy world — the unprofitable
duckling transformed by privatization under the government of Margaret
Thatcher into a highly profitable swan.

The London civil servants of the 1960s and ’70s who all but ignored
profitability as they issued directives across British Petroleum’s bloated
corporate network were replaced by highly motivated managers who were
rewarded for cutting costs, reducing risk and making money. The company’s
more incongruous businesses — food production and uranium mines, for
instance — were sold. Payroll was cut by more than half. Oil reserves
jumped. The time it took to drill a deepwater well plummeted. Profits
soared.

But then, in 2005, a BP refinery in Texas City blew
up<http://www.nytimes.com/2010/07/13/business/energy-environment/13bprisk.html?pagewanted=all&_r=0>,
killing 15 and injuring around 170. In 2006, a leak in a BP pipeline
spilled hundreds of thousands of gallons of
oil<http://topics.nytimes.com/top/news/business/energy-environment/oil-petroleum-and-gasoline/index.html?inline=nyt-classifier>in
Prudhoe Bay, Alaska. And in 2010, an explosion on the Deepwater
Horizon
oil rig killed 11 and resulted in the biggest offshore oil
spill<http://topics.nytimes.com/top/reference/timestopics/subjects/o/oil_spills/gulf_of_mexico_2010/index.html?inline=nyt-classifier>in
the history of the United States. These days, BP’s stock trades about
25
percent below where it was before the disaster off the coast of Louisiana,
about the same place it was a decade ago.

BP’s bumpy ride is recorded in “The Org: The Underlying Logic of the
Office,” a compelling new book by Ray Fisman, a professor at Columbia
Business School, and Tim Sullivan, the editorial director of Harvard
Business Review Press. “The Org” aims to explain why organizations — be
they private companies or government agencies — work the way they do.

The book offers telling insight on a topic that has ebbed and flowed across
the world over the last 30 years, as governments of all stripes have set
out to privatize state-owned enterprises and outsource services — what does
the private sector do better than government, and what does it do worse?
Long dormant in the United States, the debate has acquired new urgency as
governments from Washington to
statehouses<http://reason.org/studies/show/annual-privatization-2011-state>and
city
halls <http://reason.org/studies/show/annual-privatization-2011-local>around
the country consider privatizing everything from
Medicare<http://topics.nytimes.com/top/news/health/diseasesconditionsandhealthtopics/medicare/index.html?inline=nyt-classifier>to
the management of state parks as a possible solution to their budget
woes. One of the authors’ chief insights is that every organization faces
trade-offs — inherent conflicts between competing objectives. The challenge
is to manage them. This is way more difficult than it sounds.

While in government hands, British Petroleum paid too little attention to
profitability, constrained by its need to please elected officials who
often cared more about keeping energy cheap and employment high. But in
private hands, it may have cared about profits far too much, at the expense
of other objectives. “BP veered from being a company that made sure nothing
blew up to one focusing on cost-cutting at all costs,” Professor Fisman
said.

The success or failure of an organization often depends on whether it can
clearly identify its goals and align the interests of managers and
employees to serve them. Yet whatever reward structure an organization
picks can skew incentives in an undesirable way.

“The Org” tells us of the sociologist Peter Moskos, who joined the
Baltimore police force to study police behavior. The police hierarchy
demanded arrests, so police officers arrested people: 20,000 in one year in
the Eastern District alone, out of a local population of 45,000. One
officer set a record by locking up people for violating bicycle
regulations. Unsurprisingly, perhaps, Baltimore’s murder rate continued to
climb.

“The more we reward those things that we can measure, and not reward the
things we care about but don’t measure, the more we will distort behavior,”
observed Burton Weisbrod, a professor of economics at Northwestern
University who was a pioneer in research on the comparative behavior of
nonprofit institutions, corporations and government organizations. As
Professor Fisman and Mr. Sullivan put it: “If what gets measured is what
gets managed, then what gets managed is what gets done.”

Rewarding teachers for how well their students perform on standard math and
reading tests will encourage lots of teaching of reading and math, at the
expense of other things an education might provide. Private prison
operators who bid for government contracts by offering the lowest cost per
inmate will most likely focus on cutting costs rather than tightening
security. Unsupervised apple pickers who are paid by the apple will
probably pick them off the ground.

This insight is important to the debate over the competence of public and
private organizations because it underscores a significant difference in
how they meet their goals. Profit is one of the most potent incentives
known to man — a powerful tool to align managers’ interests with corporate
goals. But it also has drawbacks. With earnings as the overriding,
nonnegotiable priority, private enterprise often has little wiggle room to
handle the tension between conflicting objectives.

There are instances in which privatization can help achieve broad social
goals. After Argentina privatized many of its municipal water supply
systems in the 1990s, investment soared, the network expanded into
previously underserved poor areas and the number of children dying of
infectious and parasitic diseases
tumbled<http://www.iadb.org/res/publications/pubfiles/pubs-233.pdf>.
(Most water companies were nonetheless renationalized by a later
government.)

Still, our recent memory of mortgage banks blindly offering risky mortgages
to shaky borrowers and bundling them into complex bonds to sell to unwary
investors should dispel the notion that the profit motive inevitably aligns
incentives in a socially desirable way.

The pursuit of financial rewards, by private companies or even nonprofit
organizations, can directly undermine public policy goals.

A recent study found that private universities and colleges collect higher
fees from poor students who receive Pell
Grants<http://econweb.umd.edu/%7Eturner/LTurner_FedAid_Apr2012.pdf>,
absorbing over half the value of federal aid. Public colleges, by contrast,
do not discriminate against those who get aid.

This suggests a good rule of thumb to determine when a private company will
outperform the public sector: if the task is clear-cut and it’s possible to
define concrete goals and reward those who meet them, the private sector
will probably do better. “If I can write a perfect contract in which I pay
for a concrete observable outcome, can rule out cream-skimming and can
ensure the measure is not gamed, there is no reason that the private sector
can’t do it better,” Professor Fisman said.

But if the objectives are complex and diffuse — making it difficult to
align profit with goals without undermining some other desirable outcome —
the profit motive could well make conflicts more difficult to manage. In
these cases, privatization is probably not the best solution. In their rush
to save money by outsourcing services, governments might forget that.

E-mail: eporter at nytimes.com;

Twitter: @portereduardo

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Art Deco (Wayne A. Fox)
art.deco.studios at gmail.com
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