Is Privatization a ‘Race to the Bottom’

New report obfuscates the practice of privatization, ignores public sector financial unsustainability

Privatization is a tool long used successfully by governments, yet it remains a ripe target for rhetorical attacks by ideological opponents. The latest example comes from a recent In the Public Interest (ITPI) report suggesting that contracting out government services creates a “race to the bottom” and “sets off a downward spiral in which reduced worker wages and benefits can hurt the local economy and overall stability of middle and working class communities.”

Unfortunately, the report paints an overly simplistic scenario regarding the practice of privatization and ignores the financial unsustainability of government worker benefits.

In essence, the report argues that the privatization of government services is a driver of economic inequality. On one side, you have an idealized portrayal of government employment in which “many of the resulting jobs provide important pillars of economic security, including decent family-supporting wages, affordable benefits, sick time off, and secure retirement.”

On the other side, you have the private sector, tempting governments to use competitive contracting to lower service costs. Once they do, according to the report, “the subsequent contracted positions offer lower wages, reduced benefits, and little or no retirement security” and “these positions turn into poverty-level jobs.” The report then goes on to offer a cherrypicked array of case studies of how contracting out public jobs led to lower pay scales in several job sectors.

What’s missing in this simplified analysis is any sense of perspective.

First, many of the case studies cited involve jobs requiring relatively little specialized knowledge or training, such as custodians, bus drivers, food service workers, and trash collectors. The fact that governments may be paying these workers higher-than-market-rate wages and benefits-as indicated by competitive bids from private firms-may indicate that governments are simply overpaying for certain types of work. On a personal level, we can all sympathize with a former public sector worker in a situation where he transitions to a private company offering lower pay for the same work. But at the same time, does that justify asking taxpayers to overpay for certain services, especially at a time when there are so many competing spending priorities and lingering fiscal challenges?

Second, though the report implies that privatization necessarily yields a race to the bottom in terms of wages, it’s important to understand that the case studies cited in the report do not represent a wide range of the types of services contracted. What about the mid-level manager, water plant technician, or other professional who may see his position opened up to privatization? It’s common experience for governments to require companies to offer positions to current employees at similar levels of pay, but with market-rate benefits packages, such as 401(k)-style retirement programs instead of defined-benefit pensions. From the employees’ perspective, that may indeed be a step down, but from the taxpayers’ perspective, you are simply moving employees into a situation where the benefits they receive look a lot like those received by the vast majority of taxpayers themselves. And it’s important to remember that, in difficult fiscal environments, public employee unions themselves often agree to actions (e.g., pay freezes, cost-of-living-adjustment freezes, increased employee contributions to healthcare, etc.) that could similarly be seen by the rank-and-file employees as a step down.

Third, the report ignores the vast gap between what governments have promised workers in terms of defined-benefit pensions and post-employment healthcare benefits and what they’ve actually set aside to fund those promises. According to various estimates, state and local governments are facing between $1 trillion to over $4 trillion in unfunded pension liabilities. Retiree healthcare plans face similar massive underfunding, with Moody’s estimating a $530 billion unfunded liability in retiree healthcare at the state level and others estimating over $1 trillion in unfunded retiree healthcare at the state and local levels.

Reckoning with the false and financially unsustainable promises made to government employees by politicians is going to require major actions. Forward thinking politicians are working to transition workers to more financially sustainable retiree benefit packages, such as shifting from defined benefit pensions to 401(k)-style defined contribution plans. In other cases, places like California are reducing benefits for future workers and pouring more money into shoring up unsustainable benefit plans. And cities like Chicago and Detroit are beginning to eliminate employer-sponsored health insurance for retirees, cut health insurance subsidies to retirees and even send retirees to the Obamacare exchanges (which unions object to, realizing it’s a step down).

We should also not forget that the more money devoted to overpaying some public workers or covering retirement benefits for a workforce that’s no longer working, the less money available to fund current services, which certainly has an impact on overall current government employment.

The bottom line is that while it is true that privatization can sometimes have an impact on worker pay and benefits, so can the actions (and inactions) by governments themselves that have nothing to do with privatization. To selectively focus on privatization as a supposed driver of the challenges facing government workers in terms of pay and benefits-as a reader might reasonably infer from the ITPI report-is misguided.

Overall, the underlying assumption of the ITPI report seems to be that government’s primary function is to serve as a jobs program, with costs a secondary consideration.

Policymakers who believe that government’s primary role is to deliver services to taxpayers at the maximum value per dollar spent should be wary of the report’s recommendations, which include prescriptive mandates like forcing contractors to pay certain levels of pay and benefits, and even prohibiting privatizations that involve saving taxpayer money through any decrease in worker wages and benefits. These sorts of proposals are not intended to promote better privatization, but rather make it so unappealing and painful to both government administrators and potential private sector partners that privatization never happens in the first place.

And this would be counterproductive, because state and local governments are facing continuing fiscal challenges in the coming decades, and privatization can be a powerful tool to help policymakers control costs and deliver public services in an era of frugality and financial restraint.

Leonard Gilroy is director of government reform at Reason Foundation and is the editor of the Privatization & Government Reform Newsletter, available here. This article was featured in the June 2014 edition of the newsletter.