Prudent Privatization

Too often, political rhetoric overshadows careful analysis.
January 14, 2009 AT 3:00 AM
By Stephen Goldsmith  |  Contributor
Professor of practice at the Harvard Kennedy School and director of the Innovations in American Government Program

Local and state officials across the country now face urgent questions concerning how to fund infrastructure deficits and gaping budget holes. Last year, for example, New York Governor David Paterson surprised many with his announcement that he would consider leasing state assets (such as bridges and highways) to private contractors to fix the budget. This has triggered a round of arguments for and against the idea of privatization.

Most of the voices in the debate focus on the wrong issue -- public ownership -- while ignoring the real issue: public value.

The privatization debate is consumed by political rhetoric taking the place of careful analysis. Some on the right argue that private ownership is always more efficient (i.e., a more efficient monopoly) and some on the left claim that corporations are corrupt and that it is somehow un-American for companies to make a profit delivering public services, even if they do it better, faster and cheaper than government.

In fact, determining whether to sell or lease a public asset should depend upon the terms of the deal itself and the uses of the proceeds. But these nuanced and difficult questions rarely surface in the public debate. This is partly because few governments, including at the federal level, have a distinct capital budget, reducing the incentive for long-term investments and encouraging financial sleight-of-hand. Furthermore, many cases show that asset sales are last-ditch attempts to fill budget gaps rather than principled efforts to provide public goods at a better price.

This motivation is understandable. City, county and state budgets across the country are structurally out of balance as they face falling tax revenues and promises for public services that far exceed what taxpayers or the economy can bear. Over the last 10 years, state spending on education, health care, welfare, corrections and trust-fund benefits increased 100 percent, and many states are on track to double again between 2000 and 2010. Crisis requires action, and it may be better to sell an asset than to allow a government to renege on promises or lapse into bankruptcy.

However, despite these tough conditions -- or perhaps because of them -- glossing over the problem by selling assets delays disaster rather than preventing it. Those who favor privatization should not support monetizing a physical asset to fill a budget hole without dealing with the underlying conditions that created the hole in the first place.

So when does private financing, ownership or operation of public infrastructure make the most sense? When it is part of a broader plan to correct the poor maintenance of existing infrastructure and to build the transportation, energy and environmental projects needed to keep our economy healthy and support our growing population.

The need for a comprehensive plan to maintain and expand our physical infrastructure is undeniable. Over a quarter of the nation's bridges are rated as structurally deficient; nearly 50 percent of the 257 waterway locks operated by the Army Corps of Engineers are functionally obsolete; airport capacity increased from 1991-2001 by only 1 percent while air traffic grew by 35 percent; and worsening urban highway congestion is estimated to produce an annual drain on our economy of $78 billion. In addition, water and wastewater infrastructure demands are mounting; the EPA projects that $277 billion in drinking water infrastructure improvements is needed over the next 20 years to comply with regulations and ensure a safe water supply.

The good news for states and localities is that they hold valuable physical assets that they can leverage to create positive local change. Monetizing these assets can play a critical role in resolving their capital and infrastructure needs.

A few principles might help guide the debate to determine when such a transaction makes sense, and how to structure a sale or lease to ensure the partnership is engineered to produce public value efficiently:

o It rarely makes sense to sell a capital asset to fund an operational hole.

o Success should not be measured by how much privatization has occurred but by how well government performs as a result. Accountability for public and private entities is critical.

o Management efficiencies should help offset borrowing costs. Better technology, the benefits of shared services or larger-scale providers often embed solutions into the financing.

o Government should be clear about what it wants to control, such as pricing, access and equity, and what risks it wants to shift, such as construction, operations and financial responsibilities. But it should be flexible regarding the process used to manage the projects.

o Always use a transparent and competitive process with clear evaluative terms.

o Government as seller should be represented by sophisticated and experienced advisers.

o Consider the effect on existing workers; they can almost always be incorporated into the solution. The process should recognize and attempt to accommodate the existing labor force if it expresses an interest in participating in a manner that increases productivity and efficiency.

Living by these principles can make or break a deal. Chicago, when arranging its Skyway transaction, handled these deal points correctly. Similarly, Indiana approached the lease of its toll road in exactly the right way. The state was well advised, controlled the rates, set the terms for pavement quality and, most important, invested the proceeds to fully fund the state's infrastructure deficit. Over a decade ago, however, Atlanta showed how not to manage a wastewater infrastructure privatization with a process driven by politics, inaccurate baseline data and unclear performance standards. That city's leaders chose the same private partner we did when I was mayor of Indianapolis for a similarly sized transaction. One worked and the other did not.

Government can derive enormous benefit from public partnerships and asset sales. However, whether to do them at all and whether they'll succeed depend greatly on the process and the purpose.