privatization of government services: pressure-group resistance and service transparency

Privatization of Government Services: Pressure-Group Resistance and Service Transparency*

W E R N E R Z. HIRSCH

University of California, Los Angeles, CA 90095

EVAN OS B OR NE

Wright State University, Dayton, OH 45435

Even when efficiency gains can be expected from contracting out municipal services, it surprisingly rarely occurs. Political pressure by interest groups, especially unions, is usually assumed responsible. We argue that the effectiveness of such pressure is actu- ally a function of a service's "transparency," which determines voter's knowledge of the quality and cost of the service as well as the tax burden. A model is presented of the interplay between union opposition to contracting and service transparency. Policies are offered to increase transparency and make contracting optimal for governments.

!. Introduction

Recent years have witnessed increased interest in the privatization of government service production, particularly at the county and municipal level. It is often argued that under certain circumstances, privatization via contracting out can reduce cost, and significant empirical evidence supports this assertion (e.g., Borcherding et al., 1982). Yet relatively little contracting out has occurred. For example, Los Angeles County, the largest county in the United States, with a board of supervisors totally committed to privatization, contracted out a mere 1.17 percent of its budget in 1987-88 (Hirsch, 1989); 1 and the City of Los Angeles 1.99 percent of its budget in 1998-99.

Four major factors can limit the extent of contracting out by municipal governments: the role of pressure groups; noneconomic factors, such as accountability in the production of services; absence of significant efficiency gains; and distributional effects. We focus primarily on the role of pressure groups, particularly municipal labor, in opposing efficient privatization and contend that the stock of relevant information about public services held by the public is a potential offsetting factor to interest-group pressure in a government's decision to privatize and that the stock of public information is to some degree under the control of that government.

With rational voters and self-interested government, greater provision of information can improve the efficiency of the public sector. Our approach implies that governments may be able to overcome labor's otherwise decisive resistance to contracting out by increasing what we will call the "transparency" of service production.

JOURNAL OF LABOR RESEARCH

Volume XXI, Number 2 Spring 2000

316 JOURNAL OF LABOR RESEARCH

We concentrate on one particular class of privatization, contracting out, and one type of government, municipal. Unless otherwise specified, the terms "privatization" and "government" thus take these meanings. However, it should not be difficult to gen- eralize the analysis to other local, state, and federal government services, as well as to other types of privatization. Section II summarizes the status of contracting out by local governments; Section III analyzes various actors that might affect the privatization decision; Section IV builds a simple model of that decision; Section V analyzes the effect of enhancing transparency of a service; and Section VI explores some policy implications of the theory.

II. Status of Local-Government Contracting For the U.S. some data are available on contracting out by municipal governments. They unfortunately report only whether or not a particular service is contracted out, rather than the extent. Among the services that historically have been most commonly contracted out are solid waste disposal, street construction, management and operation of facilities, building repair, ambulance services, vehicle repair and maintenance, archi- tectural and engineering services, and legal counsel. Small cities are often at the fore- front of privatization (Florestano and Gordon, 1980).

More recent survey data exist for the states of Washington, Oregon, and Idaho. In 1980-1990, in counties with populations over 50,000, and in cities with more than 250,000 inhabitants, there was little contracting out of services such as judging, zoning, or policing and firefighting. Concerns other than production cost often explain these results. But among services devoid of such considerations, only solid-waste collection and road services were heavily contracted out; 73 percent and 53 percent, respectively, of these states' counties contracted out at least some of these two services. There was much room left for contracting out other services: contracting out of vehicle maintenance and repair was 29 percent, management and operation 18 percent, parks 13 percent, recreation services 13 percent, and day-care services 0 percent. The percent- ages for municipalities are similar (Hirsch, 1991). Although contracting out has increased in recent years, it is still very limited for many services. In 1995, while 70 percent of local governments surveyed reported contracting out sanitation services and 50 percent contracted out solid-waste collection, less than 20 percent contracted out ambulance services, bill collection, street sweeping, municipal cafeterias, and jail-food services (Beales et al., 1995).

III. Impediments to Contracting Out Accountability. We focus on the ability of labor to prevent privatization through political pressure. However, we first note that numerous considerations enter into the privatization decision beyond production costs. For example, resources must be spent to obtain a level of service production in accordance with what the electorate expects, and there is a risk of social loss if what is expected is not delivered. Such factors are some- times referred to as accountability in service production (Hirsch, 1991). Contracting out is unlikely when accountability costs are very high. Assigning the services performed

WERNER Z. HIRSCH and EVAN OSBORNE 317

by the judiciary, planning and zoning commissions, or legislatures to the private sector would result in unreasonably high accountability costs, since the private sector may compromise fundamental principles of representative government. Thus privatization of those services is foreclosed ab initio.

Note that accountability is related to, but is not merely the cost of, monitoring the performance of a private firm. The latter issue refers to the costs of policing performance, while accountability is more closely related to the consequences when performance does not occur at the expected level or with the necessary quality. Monitoring costs have been extensively studied by, among others, Laffont and Tirole (1986) and Vickers and Yarrow (1988), and such costs are at least implicit in the production costs for each type of service production. The term "accountability" provides a useful way of explaining why the services of lawmakers and judges (except by mutual agreement of all parties) are not privatized. We do not explore this issue further, but note that it may foreclose privatization regardless of potential efficiency gains.

Lack of Efficiency Gains. Private production is not necessarily always more efficient than public production. For example, economies of scope can occur when the organization overseeing the production of a number of services is able to efficiently deliver them as a package, a circumstance likely to favor public production. There may, for example, be certain efficiencies when one organization simultaneously deliv- ers fire, police, and ambulance services. If any of these services (e.g., police) cannot be privatized for other reasons, it may be advantageous to produce the whole set of services in-house.

Another reason for a lack of efficiency gains from contracting may be that many municipal governments require their employees to live within the city's limits. For example, policemen and firemen who live within the jurisdiction can not only come more expeditiously to a crime scene or fire, but also, since they protect their own family and home, are strongly motivated to provide quality services. We confine our attention here to services where privatization will yield efficiency gains, but note that there are some cases where it may not be justified even apart from accountability considerations.

Labor Opposition. Municipal unions have powerfully resisted contracting out services that they have traditionally performed. A representative characterization of such resistance was given by Gerald McEntee, the President of the American Federation of State, County and Municipal Employees, who claimed that

contracting out often results in higher costs, poorer quality of service, loss of government flexibility and accountability, corruption and social costs. Competition for contracts is more often the exception rather than the rule. Where bidding ostensibly occurs, there is often collusion and, as the onslaught of political scandals on all levels of governments indicates, the system is hardly foolproof.

The public eventually pays dearly for contracting out - - in economic terms such as increases in prices and unemployment and in social terms. Women and minorities are disproportionately affected by privatization because they, more so than white male workers, rely on public employment as a means of social and economic advancement (McEntee, 1987).


There is substantial documentation of labor's ability to effectively oppose governments' privatization decision as i.s suggested by Becker (1983) and to do so to their advantage. Hirsch (1995) found, in a nationwide study, that the difference between a state's public and private unionization rate was a highly significant predictor of the extent of contracting out; the greater the difference, the more contracting out of municipal services. Chandler and Feuille (1994) examined one service, sanitation, and found that the presence of union workers combined with cooperative relations between the city and the union reduces both the likelihood that a city considers contracting out and the likelihood of doing so.

Unions can exert direct pressure on municipal governments and thus affect factor ratios, working conditions, and compensation levels. Toward this end, they might oppose privatization and seek to accomplish their objective by imposing political costs on elected officials who vote for privatization.

Labor is often assisted by legislatures, which prescribe hiring practices for public employees (e.g., residency laws), salaries (e.g., prevailing-wage laws), and work rules. As a result, governments can face artificially high compensation levels or constraints on factor ratios in production. In the presence of unionized labor, these constraints can either be explicit (through union contracts) or implicit (through the fear of union political power). In either case, the government production function has fewer possibilities for input substitution than that faced by the private firm.

IV. A Model of the Privatization Decision

We argue that the privatization decision is best understood as a game involving three players: (1) voters who reward or punish the government based on its decision and on their information set, (2) pressure groups that are directly affected by the decision, and (3) the government that must decide whether or not to privatize. The decision is char- acterized by several stylized facts. First voters have the ultimate verdict on whether services will be provided publicly or privately. They approve or reject governments according to their performance in the production of public services. However, voters do not operate in a full-information environment. In particular, we may assume that voters have little knowledge about how the service is produced, i.e., its production function; how costly production is, i.e., its cost function; and the quality of the service they receive, i.e., the service's quantity and grade. They also may know little about how the quality of the service and the cost of producing it affect their tax burden. Because acquisition of information by voters is costly, they treat that cost as a constraint against which they optimally amass relevant information, which therefore tends to be incomplete.

Second, labor is interested in maximizing its compensation from participation in service production. Because municipal workers not only tend to vote according to the relation between election results and their incomes but also provide funding or other assistance to their favored candidates, they can force governments that act against their interests to incur political costs. On the other hand, their ability to extract rents through pressure on governments is limited. At some point diminishing returns set in. Service


production becomes so costly, inefficient, or of such low quality that voters will increas- ingly agitate for changes in production method. Government will eventually find this countervailing pressure irresistible, even in light of the penalties government officials will receive from labor.

Third, the government thus also faces certain trade-offs. On the one hand, increasing the rents that workers earn through service production, whether in the form of higher salaries, more generous benefits, or favorable work rules, contributes to labor peace and, ceteris paribus, the re-election of officials. However, inflated costs or lower service quality will antagonize the electorate, increasing the chances that government officials will not be able to retain power. We thus assume throughout that a key motivation for government officials is to be re-elected, and that these considerations affect their privatization decision.

We can think of labor and government as playing a simple game in which each selects one of two strategies. Government can choose Privatize or Not Privatize, and labor can choose Oppose or Not Oppose. Labor opposition serves two functions. If labor chooses to oppose and the service is not privatized, labor will be able to obtain compensation above what it would achieve in a competitive market. Let w refer to this premium, which can refer not simply to higher wages, but also to higher benefits, better working conditions, more restrictive work rules, etc. Labor will obtain w only if chooses to oppose and the service is not privatized.

To be credible, labor must impose costs on the government that defies it. Let b refer to these costs paid by a government that privatizes despite pressure. Finally, if labor chooses Oppose it will obtain reputational benefits if government chooses Not Pri- vatize and reputational costs if it privatizes. Let d and c refer to these benefits and costs, respectively, b, c, d, and w are all nonnegative.

Table 1 depicts the payoffs to this simple game. To conserve on notation, we assume that government's monetary cost in the absence of privatization is equal to labor's benefit in its presence, i.e., simply w. In addition, we assume that the premium is the result of labor pressure rather than being inherent in public production, so that absent privatization each party obtains a payoff of O. The results are robust to alter- ations in these assumptions.

There is one (weak) Nash equilibrium in pure strategies regardless of the parameter values, in which the Government plays Privatize and Labor chooses Not Oppose. 4

Table 1

The Basic Game in Normal Form

Labor

Privatize

Government

Not Privatize

Oppose

( w - b , - c)

(0, w + d)

Not Oppose

(o, o)

(o, o)


For the cases under study in this article, this is the preferred outcome. However, {Not Privatize, Oppose} may also be a strong Nash equilibrium if w < b, i.e., if the wage penalties when the service is not privatized in spite of labor opposition are less than the political costs if it is. Note that an implication of the analysis is that if the cost advantage to privatization is particularly compelling, i.e., w is quite large, the service may be privatized despite labor opposition. However, government will be unwilling to privatize services where cost savings do not outweigh the political costs. The task at hand is to rule out the latter Nash equilibrium. The ability of labor to punish government officials is what drives this result, and in the next section we examine the role of voter information in reining in this ability.

V. Voter Information, Labor Pressure, and Privatization

Voters are interested in maximizing some function defined around the quality of the service, i.e., its quantity and grade, and their tax burden for receiving the service. How- ever, they must solve this problem against the constraint of costly information. Cogni- tive limitations (discussed by such economists as Conlisk (1996); and by psychologists) s and because time is a scarce resource (Stigler, 1995), cause voters to possess incomplete information when evaluating government performance. The missing information concerns, among others, the questions of how costly service production is, whether the production method that the government uses is technologically efficient, and what these inefficiencies contribute to their tax burden.

We assume that voters "acquire" information prior to the game between labor and government presented above. To do so voters must spend valuable time, and the rate at which time is converted into information is a function of time spent. This function depends on certain parameters governing the information's accessibility to voters, i.e., the productivity of time. The more frequently a voter is in contact with a service, the lower is the time cost of acquiring information. A voter might, for example, be able to readily observe details of the quality of residential sanitation pickup, Thus, we view such a voter as possessing more information about that service than one that he seldom encounters directly, such as municipal accounting or civilian support activities in the police department. It is important to note that a voter may find it easy to acquire information about one aspect of service production while it is costly to do so about another aspect.

In addition, the voter will acquire information because he is aware that knowledge about different services is of different value to him. He may be much more concerned, for example, about the performance of the police than about lawn maintenance at municipal buildings. Ceteris paribus, he will acquire more information about the for- mer service than the latter. This value is driven by exogenous voter preferences, and there is presumably little government can do to change the value of information as such.

The policy opportunity occurs because of the government's ability to influence the amount of information rational voters acquire. Suppose that voters wish to maxi- mize the value of information about a service, in the face of some function I =f(t ; d, 0), that converts time into information. I is information acquired about the service; t is time


spent; d is a parameter summarizing the productivity of time spent in the production of information about that service; and b is a parameter summarizing the opportunity cost of a voter's time. As d increases the service is more transparent, and as d decreases the service is more opaque, so that 16 > 0. In addition, there are diminishing returns to time spent, so that I t = O, ltt= 0. The solution to such a problem will implicitly define l*(d, 6, ~), the voter's optimal production of information. ~ is a set of parameters describing the service's value to the voter, i.e., the importance or marginal benefit of acquiring additional information. This function will be nondecreasing in d and nonincreasing in 6. In fact, it is useful to suppose that there is some level of full information [, so that at equilibrium the voter will have obtained some fraction of full information y = I*/[.

A fully informed electorate would be able to punish any government officials who use service production to redistribute wealth from taxpayers to pressure groups via service provision; and the more information the electorate has, the lower is the power of such groups. 6 We model this relationship by assuming that more voter information lowers the political costs of privatization in the face of labor opposition, so that the payoff for the outcome { Privatize, Oppose } is now (1 - 6)b. Table 2 contains the new payoff matrix in the presence of varying amounts of voter information.

For a given b and w, a higher stock of information possessed by the public is more likely to eliminate {Not Privatize, Oppose} as a Nash equilibrium. The requirement for that combination to be an equilibrium is that (1 - a) b > w. Thus, the results of the altered game are consistent with the above intuition that the government always privatizes in the face of a fully informed electorate, as in that case ~ = 1 and the condition must hold. In general, more information dilutes the impact of labor opposition, making (Not Privatize) less likely.

VI. Policy Implications for Municipal-Government Performance

We argue that the cost of acquiring information about a service should be included in the analysis of privatization decision, together with labor pressure, production costs, accountability, and distributional effects. Improving the transparency of opaque services that would be privatized except for strong union opposition can make privatization an optimal government strategy. The result could be higher service quality at lower cost. A low degree of unionization is thus neither necessary or sufficient for privatization to occur.

Privatize

Government Not Privatize

Table 2

Normal Form, Taking Account of Voter Information

Labor Oppose Not Oppose

(w-(l - a)b, -c) (0, O)

(0, w + d) (0, O)


Note that voters' lack of information goes beyond production costs. For example, in relation to police patrols, the ultimate output in which voters are interested is presumably public safety. However, the level of "safety," which in economic terms can be defined as the risk of incurring various sorts of losses resulting from criminal activities, often is not immediately obvious to voters and yet is costly to obtain. Thus, the missing information at equilibrium involves not just production cost but the quantity and quality of the service output, and lowering costs of acquiring information can be important for efficient privatization decisions.

Of course, the decision becomes more complex once we include these factors. Voters will presumably wish to trade off information about the quality of the service and its production costs in the light of their valuations of their tax burden. Government may thus have to decide whether to lower the cost of acquiring information on the "per crime prevented" cost of police action or on the number of crimes occurring in various portions of the jurisdiction over time, or both. Although the greater complexity changes the particulars of the government's problem, the basic insights of the previous section - - that if the government has tools at its disposal to lower the acquisition cost for information, voters desirous to offset labor's opposition to prevent privatization may decide to do so - - remain undisturbed.

There are several major strategies to improve service transparency, and our sug- gestions undoubtedly do not exhaust the possibilities: contracting out input services, wide dissemination of relevant information about services, use of single-service agencies, and reliance on user fees.

Contracting Out Inputs to Public Services. Public services can be divided into inputs and outputs. Output services benefit constituents directly and are an argument of the public's final evaluation of a government's performance. Examples include fire and police services. Input services enter the production function of output services and are not valued directly by voters in and of themselves. For example, voters are seldom directly concerned with the maintenance of city vehicles, but such maintenance is a required input in the production of many output services, including police and fire protection.

Many output services are highly unionized. In 1987, for example, full-time local- government employees in the U.S., producing such output services as fire protection, teaching, police protection, sanitation, public welfare, and highway workers, had unionization rates of 64.9, 58.1, 53.7, 50.2, 48.4, and 44.4 percent, respectively (U.S. Bureau of the Census, 1991). 7

Since the public has little, if any, contact with input services compared to output services, and therefore little information about them, equally strong labor resistance will be more effective for input than for output services. When the latter do not lend themselves to privatization, be it because of extensive labor resistance or accountability concerns, the efficiency of service provision may nonetheless be enhanced by contracting out the constituent input services.


Police departments are a good example. While sworn officers tend to perform the functions that raise the greatest accountability problems and are also highly unionized, significant portions of departments' budgets are devoted to other activities. For example, in the police department of the University of California at Los Angeles, in 1992-93, 8 compensation of sworn officers accounted for 62 percent of the department's compensation expenditures, but only 48 percent of its budget. More generally, Marcus (1993) has documented the cost savings achieved by the United States Navy through the contracting out of numerous input services.

Wide Dissemination of Relevant Information. The earlier analysis indicates that public officials have a relatively easy time in privatizing highly transparent services, since the electorate is likely to be more vigilant about their quality and cost. Services with low cost-of-acquisition parameters d will, other things equal, most likely already have been privatized. However, when a service is opaque, then even with substantial dif- ferences in production cost and low accountability consequences under private provision, the service may not be contracted out. Remedial strategies could thus focus on enhancing the service's transparency. One strategy is for municipal governments to provide service recipients with clear, cogent information on a service's quality and cost.

Publicly available summaries of the details of service provision, such as budgets and manpower tables, can lower cost of information acquisition by making any amount of time spent on learning such details more productive (i.e., by raising 6). Such summaries could include comparisons over time and with other municipalities. As was argued earlier, when the cost of information is lower, service recipients will tend to acquire more information and consequently more readily support efficient privatization. This development, combined with transparency devaluing labor's resistance and thereby reducing political penalties facing elected officials, enhances the chances of privatization.

Single-Service Agencies. A third strategy involves arrangements under which a service is free-standing and thus rendered and financed by a separate agency. Toward this end, a single-purpose district can be created. Presently existing elementary and secondary school, junior college, sanitation, mosquito control, library and cemetery districts are examples. The creation of such agencies can result in information about service production emanating from a single, readily accessible source. A clearly iden- tifiable set of officials can also be held responsible for a service's quality and cost. In addition, such agencies can create bureaucratic organizations that economize on information-acquisition costs.

User Fees. Many attributes of user fees resemble those of a single-service agency. One difference is that no elected officials can be readily identified and held responsible. Financing a service via user fees allows voters to more precisely estimate the per- unit cost of service production and relate it to their tax burden. Such knowledge tends to increase the reward to elected officials if privatization is successful.

The enhanced transparency resulting from user fees has a further advantage over a consolidated government budget. Service users aware of the marginal cost of each unit


of service consumpt ion may act more rat ionally in demanding a service of specified

quality. For such a scheme to work, it must be possible to carefully define a "uni t" of

service production, as in fact is the case with regard to solid waste collection.

VII . Conclusions

While in recent years overall un ioniza t ion in the Uni ted States has decl ined signifi-

cantly, this trend is pr imari ly a private-sector phenomenon . Relat ively high levels of

unioniza t ion in munic ipa l labor forces cont inue to create opportunit ies for munic ipa l labor to effectively oppose contract ing out. Rather than focus s imply on labor resist-

ance, we argue that a service's transparency, which determines voters ' knowledge about

the quality, production, and cost funct ions of a service, as well as the effect on voters '

tax burden, is critical in de termining whether a service should be contracted out. This

f ramework helps explain why contract ing out is not more prevalent.

Our analysis also suggests several strategies to neutral ize labor opposi t ion and

increase privatization. In addit ion to enhanc ing the attention paid to contract ing out

input services, these steps include enhanc ing t ransparency by providing more infor-

mat ion on a service 's quality, cost, and tax implicat ions; es tabl ishing s ingle-service

agencies; and wider application of user fees, Such initiatives can decrease the political

costs of privatization to publ ic officials, while improving the performance of munic i - pal governments .

NOTES

*We are indebted to Trudy Cameron, Janet Currie, Daniel Mitchell, Peggy Musgrave, and Duncan Thomas for helpful comments and advice.

1The Los Angeles County data may somewhat understate the amount of contracting out because the total spending from which they were calculated includes transfer payments. The City data do not include public works construction investments and were provided by City Administrative Officer Keith Comrie on Sep- tember 4, 1998.

2Valletta (1989) has documented that collective bargaining increases expenditure within a municipal department, but not overall city expenditures, suggesting that unions may be able to achieve better wages and more employment at the expense of other city spending. Freeman and Valletta (1988) also found that collective bargaining has a positive effect on wages, while Marlow and Orzechowski (1996) found that the extent of union membership among public employees was positively related to public-sector salaries.

3An example of a restriction on the government's technological possibilities is urban mass transit, with its peak-hour demand pattern combined with management's inability to schedule accordingly. The 1985 agree- ments between the Southern California Rapid Transit District and the Amalgamated Transit Union Division 1277 and the United Transportation Union, for example, prohibited subcontracting except under unusual circumstances. The latter agreement also stated that "regular operators shall be guaranteed eight hours' pay time per day within a spread of ten hours from the initial sign-on time" (p. 5).

4The payoffs are such that a mixed-strategy equilibrium does not exist.

SThe simple model is a generalization of several features of information processing in the cognitive science literature, Psychologists have postulated and experimentally verified (Kinchla et al., 1983; Mangun and Hill- yard, 1990) the existence of an "attention-operating characteristic," in which more information gleaned from

W E R N E R Z. H I R S C H and EVAN O S B O R N E 325

one source comes at the expense of information not gathered from another. In addition, Sternberg (1984) developed a model of intelligence as consisting partly of the ability to cope with novelty, and adjust behav- ior accordingly.

6Of course, there are some voters who benefit from inefficient production, but we assume that such groups would be a minority in a fully informed electorate.

7Rates for municipal employees were even higher, i.e., 72.5 percent for public welfare, 67.4 percent for firemen, 59.3 percent for police, and 53.3 percent for sanitation workers.

8These data were provided in private communications from Kit Espinosa of the UCLA Police Department.

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