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<div class="">January 15, 2013</div>
<h1>When Public Outperforms Private in Services</h1>
<h6 class="">By
<span>
<a href="http://topics.nytimes.com/top/reference/timestopics/people/p/eduardo_porter/index.html" rel="author" title="More Articles by EDUARDO PORTER"><span>EDUARDO PORTER</span></a></span></h6>
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<p>
Few corporate sagas capture the virtues and vices of state-owned companies and private enterprise better than the drama of <a href="http://topics.nytimes.com/top/news/business/companies/bp_plc/index.html?inline=nyt-org" title="More information about BP Plc" class="">BP</a>’s roller-coaster ride between failure and success. </p>
<p>
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. </p>
<p>
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. </p>
<p>
But then, in 2005, a <a title="Article on string of BP accidents. " href="http://www.nytimes.com/2010/07/13/business/energy-environment/13bprisk.html?pagewanted=all&_r=0">BP refinery in Texas City blew up</a>, killing 15 and injuring around 170. In 2006, a leak in a BP pipeline spilled hundreds of thousands of gallons of <a href="http://topics.nytimes.com/top/news/business/energy-environment/oil-petroleum-and-gasoline/index.html?inline=nyt-classifier" title="More articles about oil." class="">oil</a>
in Prudhoe Bay, Alaska. And in 2010, an explosion on the Deepwater
Horizon oil rig killed 11 and resulted in the biggest offshore <a href="http://topics.nytimes.com/top/reference/timestopics/subjects/o/oil_spills/gulf_of_mexico_2010/index.html?inline=nyt-classifier" title="More articles about oil spills." class="">oil spill</a>
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. </p>
<p>
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.
</p>
<p>
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 <a title="Review of state privatization initiatives." href="http://reason.org/studies/show/annual-privatization-2011-state">statehouses</a> and <a title="Review of municipal privatization initiatives." href="http://reason.org/studies/show/annual-privatization-2011-local">city halls</a> around the country consider privatizing everything from <a href="http://topics.nytimes.com/top/news/health/diseasesconditionsandhealthtopics/medicare/index.html?inline=nyt-classifier" title="Recent and archival health news about Medicare." class="">Medicare</a>
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.
</p>
<p>
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. </p>
<p>
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. </p>
<p>
“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. </p>
<p>
“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.” </p>
<p>
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. </p>
<p>
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. </p>
<p>
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 <a title="Study on impact of Argentina’s water privatization." href="http://www.iadb.org/res/publications/pubfiles/pubs-233.pdf">number of children dying of infectious and parasitic diseases tumbled</a>. (Most water companies were nonetheless renationalized by a later government.) </p>
<p>
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. </p>
<p>
The pursuit of financial rewards, by private companies or even nonprofit
organizations, can directly undermine public policy goals. </p>
<p>
A recent study found that <a title="Study on Pell grants and college fees." href="http://econweb.umd.edu/%7Eturner/LTurner_FedAid_Apr2012.pdf">private universities and colleges collect higher fees from poor students who receive Pell Grants</a>,
absorbing over half the value of federal aid. Public colleges, by
contrast, do not discriminate against those who get aid. </p>
<p>
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. </p>
<p>
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. </p>
<div class="">
<p>E-mail: <a href="mailto:eporter@nytimes.com">eporter@nytimes.com</a>;</p>
<p>Twitter: @portereduardo </p> </div>
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