gao general government division · private sector through such activities ... • will...

GAO

GAO/GGD-98-87

April 1998

United States General Accounting Office

General Government Division

Privatization

Questions Stateand LocalDecisionmakersUsed WhenConsideringPrivatizationOptions

GAO/GGD-98-87

Over the past several years, state andlocal governments have increased theiruse of various types of privatization.Privatization is commonly defined asany process that is aimed at shiftingfunctions and responsibilities, in wholeor in part, from the government to theprivate sector through such activitiesas contracting out or asset sales.1 A1997 Council of State Governments’survey found that state agenciesresponsible for transportation,corrections, higher education, andsocial services had all increasedprivatization activities since 1988.2

According to the International City/County Management Association, citygovernments have also increased thenumber and types of servicescontracted, such as child welfareprograms, health services, streetmaintenance, and data processing.3

Congress and the administrationindicated an interest in having thefederal government increase its use ofprivatization. In light of this interest,we were asked by the Chairman of the

1See Terms Related to PrivatizationActivities and Processes (GAO/GGD-97-121, July 1997).2Private Practices: A Review ofPrivatization in State Government, Councilof State Governments (Lexington, KY: Nov.1997).3International City/County ManagementAssociation Municipal Year Book 1994:Alternative Service Delivery in LocalGovernment, 1982-1992 (Washington, D.C.:1994), p. 28.

Preface

GAO/GGD-98-87

House Task Force on Privatization toidentify lessons learned by state andcity governments in implementingprivatization efforts. Our subsequentreport, Privatization: Lessons Learnedby State and Local Governments (GAO/GGD-97-48, Mar. 14, 1997), discussedprivatization lessons learned by, andthe related experiences of, the states ofGeorgia, Massachusetts, Michigan,New York, and Virginia as well as thecity of Indianapolis, Indiana.

This publication responds to a requestfrom the task force Chairman andseveral other Members of the House ofRepresentatives that we identify thecritical questions that state and localdecisionmakers found useful whenconsidering whether to privatize agovernment activity. The questions inthis publication were identified bydecisionmakers in the state and localgovernments we discussed in ourMarch 1997 report and correspond tothe lessons learned by thosegovernments. In preparing thispublication, in March 1998, weprovided privatization officials fromthe six governments a draft of thequestions for their review andcomment. All six governmentsconcurred with the questions andprovided comments, which we haveincluded as appropriate.

GAO/GGD-98-87

Major contributors to this publicationwere John K. Needham, Donald L.Bumgardner, Kiki Theodoropoulos,and Marlene Zacharias. If there areany questions on the material in thispublication, please contact me on(202) 512-8676.

J. Christopher MihmAssociate Director, FederalManagement and Workforce Issues

GAO/GGD-98-87

Contents

Preface 1

Introduction 6

Political Champion 8

Questions Concerning Political Champion Issues 9

Implementation Structure 10

Questions Concerning Implementation Structure 11

Legislative and Resource Changes 12

Questions Concerning Legislative and Resource Changes 13

Reliable Cost Data 14

Questions Concerning Reliable Cost Data 15

Strategies for Workforce Transition 16

Questions Concerning Workforce Transition 17

Monitoring and Oversight 18

Questions Concerning Monitoring and Oversight 19

Notes 20

GAO/GGD-98-87

GAO/GGD-98-87

The six governments we visitedtailored their approaches toprivatization to their particularpolitical, economic, and laborenvironments. We selected the statesof Georgia, Massachusetts, Michigan,New York, and Virginia because, at thetime, they had the most extensiveprivatization efforts involving activitiesthat correlate with those performed atthe federal level. We selected the cityof Indianapolis because it was citedmore frequently by the panel ofprivatization experts we consultedthan any other city or state for itsprivatization experience. On the basisof our review of the relevant literature,the views of a panel of privatizationexperts, and our work at the state andlocal governments, we identified--asshown in the figure--six lessons thatwere generally common to all of thegovernments in implementingprivatization initiatives.

Introduction

GAO/GGD-98-87

Figure: Lessons Common to State and Local Governments

GAO/GGD-98-87

Privatization can be best introducedand sustained when there is acommitted political leader to championit. In the six governments, a politicalleader or, in one case, several leadersworking in concert played a crucialrole in introducing privatization.These leaders built internal andexternal support for privatization,sustained momentum for theirprivatization initiatives, and adjustedimplementation strategies whenbarriers to privatization arose.

The chief executive (i.e., the governoror mayor) was the political championfor the most recent privatizationefforts in Georgia, Massachusetts,Michigan, New York, and Indianapolis.In Virginia, key state legislators and thegovernor worked together to introducenew privatization initiatives.

Political Champion

GAO/GGD-98-87

Questions Concerning PoliticalChampion Issues

1. Who in the government will provide leadership in assessingthe case for privatization and supporting the privatization effortonce it is under way?

2. Is the activity viewed by policymakers and otherstakeholders as one the government should (1) provide andproduce, (2) provide but not produce, or (3) not produce, andhave other options to improve the activity been considered?

3. Should the government involve the private sector in theactivity or is the activity so intimately related to the publicinterest that it is inherently governmental?

4. Will private sector participation improve performance of theactivity? That is:

• Are there substantial problems in current service delivery?• Are there benchmarks that indicate potential for cost savings

or service quality improvements?• Will privatization increase choices available to

citizens?

5. Do policymakers, agency officials, and other stakeholdersagree on the goals the privatization is to achieve?

6. Will the users of the service, interest groups, or publicofficials be resistant to changes in service providers? If so,how will this resistance be mitigated?

7. Is there a need for an advisory group or commission toidentify activities that are candidates for privatization and tobuild consensus for it?

GAO/GGD-98-87

Once political leaders introduceprivatization, governments need toestablish an organizational andanalytical structure to implement theprivatization effort. This structure caninclude commissions, staff offices, andanalytical frameworks for privatizationdecisionmaking. Five of the sixgovernments we reviewed establishedgovernmentwide commissions toidentify privatization opportunitiesamong government activities and to setpolicies to guide privatizationinitiatives. The commissions werecreated either by the chief executive(in Georgia, Michigan, New York, andIndianapolis) or by the state legislature(in Virginia). Massachusetts did notuse a commission; instead, cabinetsecretaries selected the governmentactivities to privatize. Thegovernments found that privatizationcan take various forms, such ascontracting out and asset sales, andthat implementation strategies andanalyses need to be tailored to theproject or situation and will likely varydepending on the form of privatization.

Implementation Structure

GAO/GGD-98-87

1. Given the nature of the activity, what type of privatizationwould be most viable and best serve the public interest (e.g.,contracting out, managed competition, divestiture)?

2. Is the activity already performed in the private sector?

3. Is there a competitive marketplace? If not, can one becreated?

4. Are there barriers to entry by private firms, such assignificant start-up costs? If so, can they be mitigated?

5. Are there factors that could limit the use of privatization,such as “natural monopolies,” in which production cannot beduplicated (e.g., a single source for city water supply); and“public goods” that cannot sustain private markets? If so, howcould these factors be mitigated?

6. Will the contractual arrangements and the type of servicepermit the government to switch from one service provider toanother without serious disruption in the flow of service orundue cost at the end of the contract or option year?

7. Will there be an office and/or knowledgeable staff availableto collect and analyze performance and cost data and providetechnical assistance to agencies?

8. Have the legal, financial, and technical risks/liabilities to thegovernment been identified, considered, and evaluated?

9. What will be done with the activity’s current facilities,technology, and other resources?

Questions ConcerningImplementation Structure

GAO/GGD-98-87

Governments may need to enactlegislative changes and/or reduceresources available to governmentagencies in order to encourage greateruse of privatization. Georgia, forexample, enacted legislation to reformthe state’s civil service and to reducethe operating funds of state agencies.Virginia reduced the size of the state’sworkforce and enacted legislation toestablish an independent state councilto foster privatization efforts. Theseactions, officials told us, sent a signalto managers and employees thatpolitical leaders were serious aboutimplementing privatization.

Legislative and Resource Changes

GAO/GGD-98-87

1. Are there statutory or regulatory barriers to private sectorperformance of the activity? That is:

• Are there laws, tax policies, regulations, or grantrequirements that either mandate or constrain who canperform the activity?

• What are the implications of these legal and regulatoryrequirements for a potential privatization?

2. Will there need to be a change in the statutory or regulatoryrequirements to ensure a successful privatization for aparticular activity? That is:

• Is there support for such a change?• Are the changes to laws or regulations feasible in the current

political and economic environment?

3. Are there relationships with other state or federal programsprescribed by law that could inhibit or prohibit a change inservice providers (e.g., interservice support agreements,intergovernmental agreements)?

4. What incentives are most appropriate for improvingperformance and maximizing savings through privatization(e.g., using savings to improve other agency activities)?

5. If there are savings from the privatization, either initially orover the long term, how will they be distributed (e.g.,reinvested through service improvements, tax reductions, ordeficit reduction)?

6. Under what conditions will the private sector provideneeded equipment or facilities that are not owned by thegovernment?

Questions Concerning Legislativeand Resource Changes

GAO/GGD-98-87

4Complete costs are generally defined asthe fully allocated costs of an activity.These include all direct and indirectpersonnel costs, materials and supplies,equipment, capital depreciation cost, rent,maintenance and repairs, utilities,insurance, personnel travel, operationsoverhead, and general and administrativeoverhead.

Reliable and complete cost data ongovernment activities are needed toassess the overall performance ofactivities targeted for privatization, tosupport informed privatizationdecisions, and to make these decisionseasier to implement and justify topotential critics. Most of thegovernments we surveyed usedestimated cost data, because obtainingcomplete cost4 and performance databy activity from their accountingsystems was difficult. However,Indianapolis and more recently Virginiaused new techniques, such as activity-based costing to obtain more preciseand complete cost data. Although theuse of estimated cost data can save agovernment the time and costassociated with preparing moreaccurate data, the resultingimprecision can have negativeconsequences. For example, inMassachusetts, the State Auditorquestioned savings reported fromprivatized activities because aninadequate cost analysis was donebefore the privatization.

Reliable Cost Data

GAO/GGD-98-87

1. Has evidence been presented on the potential for significantenhancements to economy, efficiency, or effectiveness? Thatis:

• Has a cost/benefit analysis of a possible privatization beendone, including the effects of shifting costs to servicerecipients?

• Have tangible benefits--such as operating and capital costsavings, higher quality services, more or better servicedelivery options--been identified?

• Would providing potential contractors with a draft “requestfor proposals” yield useful information on what cost andservice quality improvements might be possible withprivatization?

2. Have the complete costs of alternative service providersbeen considered (i.e., costs of retaining the activity in-house;cost implications of a long-term commitment; start-up andcapital investment costs; conversion costs, including the sale ofsurplus property and transactional costs involved in displacinggovernment employees; and government costs to monitorprivate sector performance)?

3. Does the relevant government office have the accountingsystems to produce complete cost data in order to make a validcomparison to the private sector’s cost? If not, are costestimates acceptable for making such a comparison, and/orwould the use of activity-based costing methods be feasible ona case-by-case basis?

4. If the private sector is unable to meet its contractualobligations, have potential alternatives and the estimated costsof resuming responsibility for the operation been considered?

Questions Concerning ReliableCost Data

GAO/GGD-98-87

We found that governments needed todevelop strategies to help theirworkforces make the transition to aprivate sector environment. Suchstrategies, for example, might seek toinvolve employees in the privatizationprocess, provide training to helpprepare them for privatization, andcreate a safety net for displacedemployees. For example, all sixgovernments developed programs orpolicies to address employee concernswith possible job loss due toprivatization. These strategiesincluded offering workers earlyretirement, severance pay, or a buyoutor, if the activity was taken over by aprivate firm, ensuring that employees’concerns about compensation issueswere addressed.

Because Virginia found that employees’concerns were one of the biggestbarriers to privatization, the governordirected state officials to identify waysfor departing state workers to competein the private sector. This led to thepassage of the Workforce TransitionAct, which mitigated some of theemployees’ concerns, such as job loss,training, and benefits.

Strategies for Workforce Transition

GAO/GGD-98-87

1. What role will the government agency initially have inconsidering privatization as a strategy? Will the agency beallowed to compete with private sector firms and submit aproposal to perform the service? If so, under what terms andconditions? How will the competition process be coordinatedwith the regular procurement process? Who will oversee thecompetition process?

2. If the activity is privatized, what will be the impact on theemployment status and the portability of their pensions andbenefits? Will training be provided to government employees?

3. What will be the impact on union employees? How will thegovernment comply with contractual and civil servicerequirements?

4. Do requirements of current labor contracts pose a challengeto privatization? If so, what are the implications of theserequirements for the privatization, and can these contracts berevised?

5. Will public policies, such as equal employmentopportunities, be changed if the service provider is changedand government employees transfer to the private sector?

Questions Concerning WorkforceTransition

GAO/GGD-98-87

When a government’s role in thedelivery of services is reduced but noteliminated through privatization,monitoring and oversight is neededthat evaluates compliance with theterms of the privatization agreementand evaluates performance indelivering services.

Officials from all six governmentsworked to enhance their employees’skills so that they could undertakemore sophisticated especially forcomplex activities, such as wastewatertreatment or the medical care ofprisoners. Monitoring performancesometimes required new or innovativeapproaches. For example, Virginiaused a newly designed approach tomeasure the performance of its twocontractor-operated child supportenforcement offices. Virginiaestablished quarterly and semiannualreporting requirements in the contract,using statistical measures to comparethe performance of contractor-operated child support offices with ahypothetical office with similarities insuch areas as size and demographics.

Monitoring and Oversight

GAO/GGD-98-87

1. Can the government maintain necessary control andaccountability for activities that have been contracted out?That is:

• Does the government have and will it maintain the capacity(e.g., the expertise, staff, funding) to provide suitableoversight of private sector performance?

• If not, can the agency recruit, attract, retain, and trainemployees with the necessary knowledge and skills?

• Does the government retain the legal authority to provideeffective oversight?

2. If the activity has been divested, does the government retainregulatory responsibilities after the divestiture?

3. Have the criteria (e.g., cost, quality, customer service,timeliness) that will be used to evaluate the privatized activitybeen defined?

4. What incentives and penalties will be used in contractualarrangements to ensure desired performance?

5. Are performance and cost requirements specified andmeasurement systems in place?

6. Does the government agency have an effective qualitycontrol system in place, or can it be developed to determineconformance to contractual requirements?

7. Do potential contractors have a record for effectiveperformance and quality control on prior projects?

8. Will there be sufficient funding to pay for oversight andquality control?

Questions Concerning Monitoringand Oversight

GAO/GGD-98-87(410307)

Notes

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