Figure 1: Caricature
Troelstra as minister
(A. Hahn, 1913)
In several previous columns attention has been paid to the positive incentives, which derive from private property. Therefore it is logical to now study the effects of privatizations in the public sector. The new institutional economics offers useful insights, which are summarized here. Also, ways of market regulation are presented. Several experiences with free markets are described. Finally, the radical criticism of E. Tonkens and the PvdA commision Van Thijn are discussed.
Privatization is the transfer of a state enterprise to the private sector1. It can concern commercial activities, such as financial services (credits, insurances), or the construction of cars, airplanes, ships and houses. It can also concern public services, such as waste disposal or energy distribution (quasi-collective goods). Even in existential services such as education and health care, free markets and privatization are possible. The budget mechanism (state planning) is replaced by the price mechanism. Privatization is often a transition to profitable production, because the aim of profit is an incentive for effective actions2. However, when desired, the state can transfer the production to a non-profit organization. This happens indeed, for instance in nursing3.
The transition from public to private production is far-reaching to such an extent, that the supply of the product must generally be regulated in some form. Privatization and new regulation go together. The state chooses in fact a different form of organization for its services. The changed regulation makes it complicated to evaluate the effect of privatization in isolation. As an illustration this column will present several empirical evaluations further on. There the importance of the market form will indeed become apparent. For instance, the state will often be the only buyer on the market4. Then it is true that the production is privatized, but not the demand. This is called outsourcing. Sometimes the costs are completely covered by public funds (taxation), whereas in other cases the consumer must pay a personal contribution (principle of benefit).
So regulation implies formulating and imposing market rules by the state. This is studied by the new institutional economics (NIE). The state can impose the market targets by means of regulation, but can also dictate the market procedures. Sound procedures can reduce the transaction costs on the market. The formulation of market targets is only possible to a limited extent, because the state rarely disposes of all relevant information, which is needed for stating the targets. Besides, the economy is dynamic, so that the imposition of future targets is notoriously subjective and speculative. The advantage of free markets is, that consumers can make their own judgement about the targets of enterprises. Enterprises offer solutions on the market, and thus create a continuous innovation. The directions of private enterprises are exposed to market incentives to perform optimally.
The privatization has also become popular, because the economists have developed a more positive opinion about economic cooperation. In the past it was believed, that cooperation between enterprises would be hurtful for the consumer, because it leads to price agreements between the producers. See the column about industrial concentrations. For instance, this fear was the reason, that at the time the public branch organizations (PBO) were given a tripartite structure, that is to say, with state interference besides the organizations of entrepreneurs and workers5. The state supervises the general interest. In the same way, during the twentieth century various anti-cartel laws have been introduced in order to prevent, that producers make mutual agreements6. See the column about the European market. However, nowadays it is realized, thanks to NIE, that cooperation between enterprises is sometimes desirable.
As an illustration, now the book The economics of business enterprise (in short EBE; see voetnoten) will be amply consulted. Suppose for instance, that two producers cooperate in research and development. This can be socially profitable, among others because a general standard is established. Or suppose, that a producer wants to profile by means of quality and reliability. Then he must be able to supply selectively merely the retail trade with a similar reputation (see for such examples paragraph 15.3.2 in EBE). The maintenance of a reputation is a legitimate manner to profile the concerned product, and sometimes the only means to prevent market failure. Agreements about exclusive selling rights are sometimes needed in order to avoid under-investments in the enterprises. Therefore one must actually weigh for each contract, whether trade agreements are hurtful (p.508 in EBE)7.
Since the economic cooperation is no longer a taboo, there are new opportunities to create free markets for public goods. The incentive to privatize is partly caused by the unsatisfactory experiences with state enterprises. It became clear, that state enterprises can hardly be stimulated to perform better. The insight, that the state is an ineffective owner, grew during the seventies of the last century, when the global competition intensified. Since 1980 many state enterprises have been privatized. The experience shows, that subsequently such enterprises indeed begin to produce more efficiently8. Obviously, the problem remains, that sometimes the state wants to or even must impose certain quality requirements. Then yet some supervision is required, which is accompanied by regulation. New institutions are established in a learning process, where the states imitate each other's innovations.
The regulation of markets is complicated, because the decisions are made in the chain electorat → political state → markets. In each of these two arrow the principal-agent problem occurs. In the electorat, interest groups are active, and lobby politics for their interests (p.506 in EBE). This is called rent seeking, because they demand subsidies from the state. Sometimes their demand does not coincide with the general interest. Deregulation can reduce this risk (p.514). Furthermore, when the state concludes regulations and contracts, they are usually incomplete, due to lacking information. Experiments have been done with various indicators in order to check the performances of the privatized enterprise. Note that the state itself sometimes also tries to seek rent. The public choice theory emphasizes, that here the state is sometimes tempted to exploit the enterprise (p.512).
Privatizations on a large scale are considered to be structural reforms. They are the consequence of fundamental (qualitative) changes in the social knowledge and morals. This is explained well in the book Political economy in macroeconomics (in short PEM)9. The reforms are radical to such an extent, that the policy measures must be attuned in a coherent package. An example of such a package is the Washington consensus, dating from the late eighties (see p.619 in PEM)10. On the one hand, there is the desire to swiftly realize the reform. On the other hand, the consequences are uncertain, which pleads in favour of a gradual (phased) transition. The dynamics of a reform are so large, that unavoidably some groups or circles fear to be hurt in their interests. They will resist the reform, and organizing sufficient support becomes a problem in itself (p.624 in PEM).
The NIE refers to such obstacles with the term path dependency. The success of the reform partly depends on political leadership. The political management becomes more difficult, according as the electorat is more heterogeneous (p.632). Often politics will do conflicting promises during the reform (time inconsistency), simply in order to keep the democratic majority. Or the state manipulates the reform agenda (p.641). It presents the first phase of the reform as an experiment, which can be reversed. This gives an extra guarantee to the electorat, that the outcome will not be damaging. In other situations the success can be furthered by a single shock-wise reform (p.628). Or the losers in the reform are compensated.
The reform must often be postponed, until a window of opportunity appears (p.636). The electorat must develop a sense of urgency about the reform (p.406). Sometimes this requires the previous emergence of a crisis. Incidentally, during the crisis the rent seeking will also be less profitable (p.440). In many cases the new morals must settle in the conscience (cognition) of the electorat. Incidentally, this also holds for the politics itself, which has a notoriously short-term horizon. A striking phenomenon is, that the necessity of reforms is sometimes most convincingly stated by a party, which previously always has combatted them! (p.431). Ideas and means must be collected in order to make the reform possible (p.408). During privatizations, indicators must be developed for supervising the performances of the private enterprises. This is explained in The economics of business enterprise.
For instance, the state can regulate the height of the capital efficiency (p.515 in EBE). However, this creates a moral hazard, such as the excessive use of capital goods. Moreover, this indicator does not really stimulate effectiveness. Therefore, in this situation the state must also regulate the production technique. On the other hand, the state is tempted to reduce the allowed capital efficiency after a while (hold-up). As an alternative the state can regulate the profit rate, so that the enterprise can be rewarded in the case of an increased effectiveness (p.516 in EBE). This approach commonly has the form of a price policy. But the profit rate is merely a useful indicator, as long as the state is informed about the production costs. The enterprise does not run much risk, as long as the state guarantees its existence. In practice, regulation is often simply a collusion between the enterprise and the state (p.516).
As an alternative, the profit rate can be regulated by means of a tax on profits (p.519). Or the concession for the supply of the public goods can be granted by means of an auction. The highest bidder apparently has the heighest expectations of profit. Obviously, this introduces the danger that the quality of the supplied good is undermined, because the contracts are never complete (p.523). A special situation occurs for the case of public goods, that are supplied by means of pipe networks. For, this pipe network remains the property of the state, because its privatization is not beneficial (p.525). Thus the network manager can remain inefficient. However, in other branches privatization is fairly simple, such as in various types of maintenance, the disposal of waste, cleaning, or renovation. Here good results have been obtained. Saving around 20% have been realized, the innovation increases, the product prices fall, and (therefore?) the supply increases (p.531-532).
In Europe the policy with regard to privatizations is different in each state. After the Second Worldwar the states invest in the reconstruction of their economy. The profits are huge. During this period France and Great Britain have nationalized many branches, including banking and the car- and aviation-industries. Therefore, later these states have again privatized a lot, and the (English) book The economics of business enterprise mainly refers to the British experiences. During the same period, Germany and the Netherlands have avoided the state ownership of enterprises. They have preferred other instruments of state intervention. Here the seventies are particularly interesting, because then the goal of the interventions changes. During this period the interventions aim to support failing enterprises and to conserve employment.
It is instructive to briefly discuss the then Dutch state interventions11. The capital flows of the state are controlled by the Nationale Investeringsbank (NIB), and later (after 1972) also by the Nederlandse Herstructureringsmaatschappij (Nehem). Incidentally, the Nehem never was a success. The NIB is a cooperation of the state and banking (a find of PvdA minister Lieftinck). During the post-war reconstruction it stimulates investments in promising projects. The stimulation of export is an important goal. Since the late sixties it also supports the restructuring of withering branches. This often happens by means of the granting of special credits, which reduce the risk of the participating banks. Furthermore, during the seventies the ministry of Economic Affairs gives wage subsidies (so-called employment funds) to individual enterprises, as well as tax deduction for investments.
Sometimes loss participation is preferred, where the state promises to cover possible losses. The state wants to avoid by means of this support, that it buys the enterprises, The hope is that the maintenance of private property will result in an efficient operation. This policy has been applied energetically, with support funds rising to 15 milliard guilders in 1980, for a total GDP of roughly 250 milliard (so more than 4%). Unfortunately, it turns out that this approach creates moral hazards for the direction, namely the shifting of the entrepreneurial risks to the state. Then the direction prefers an extremely risky policy. Some examples: in 1975 the state tries to reconstruct the enterprise Nederhorst with the help of Ogem. This fails. In 1983 Ogem itself fails. Dramatic is also the failure of the ship-yard Rijn Schelde Verolme in 1983. Such negative experiences make state support unpopular12.
In the Netherlands Graaiers of redders? (in short GR) is an interesting evaluation of the privatization of public services13. Concretely, the markets for hospital care, public bus transport, and energy are analyzed. It turns out that the privatizations improve the operation, distribution of operational information, and client service (p.13 in GR). Investments are made in places, where the demand is highest (p.25). The choice options increase (p.21). But it also becomes clear, that the regulation of markets remains necessary. Many public supervisors are established, which must guard the general interest (p.16). Consider accessibility, reliability, durability, and quality. Incidentally, some politicians believe that solidarity and employment in the various branches are also a general interest (p.31)14. Research shows, that the electorat is divided about the idea of privatizations. Nevertheless, people get used to it.
It turns out, that thanks to privatization the innovation increases. In the studied branches the privatization leads to more production against lower product prices (p.166). The states loses its direct influence, when enterprises are sold. However, by means of contracting (individual choice, concession, regulation) the client and the state yet obtain more influence (p.167, 172). Moreover, the free markets stimulate a better supply of information (p.168). Often the state reduces the subsidies to the enterprise after a privatization (p.181). The enterprises must perform better, which obviously also increases the labour intensity of their personnel (p.174). According to the authors of GR, free markets are a learning process, which requires some time. Therefore their continuation is desirable.
Since hospitals are traditionally non-profit organizations, the production is not commercial. Furthermore, the patients already before had a free choice. The privatization concerns notably the financing. A supervisory body has been established, namely the Nederlandse Zorgautoriteit. The privatization of the insurance leads to shorter waiting-lists of the hospitals (p.47, 80), but not (yet) to a better quality (p.75). The client service and the supply of information improve. Various indicators have been developed (p.82). Incidentally, this requires an administrative accountability, which is not popular among the personnel.
Public bus transport
The privatized public bus transport is put out to tender, and concessions are granted15. The provinces and urban regions, which form the transport authority, can dictate in their concessions, what they want (p.124). Sometimes this is done in too much detail. The administration imposes the legal fares. There are experimental contracts. The experiences are mixed: the number of realized kilometers increases, but the number of lines decreases (p.115). The wages are under pressure (p.122)16.
The market for energy has been opened completely for the production and sales. The distribution by means of the network is owned by the state. It is unclear, what is the price effect of the free markets (p.154). The customers can choose, but this is accompanied by yearly returning search costs17.
Until now this column consults the common insights of the political and institutional economics. They are supported by other social sciences, such as the psychology and sociology. But especially within the latter discipline there are also groups, which advocate another approach. The present paragraph gives an illustration of this, namely the book Mondige burgers, getemde professionals (in short BP) by the Dutch sociologist E. Tonkens18. Notably her views about the privatization of public services will be analyzed. Although she focuses on the care sector (medicine, nursing, youth counseling), her theory has the pretence to be generally valid. Since the eighties of the last century the health care changes due to an increasing specialization, individualism, and scarcity of means. Reforms are unavoidable, and here the free markets and privatization must also be considered.
Activities are commonly interpreted as a mixture of markets, state, and civil society. Tonkens has a preference for a derived mix, namely markets, bureaucracy and professionals. Each of these circles has its own morals (p.148). The market reacts to scarcity, and wants to limit the costs. The bureaucracy aims at justice and precision. Professionals are motivated by their professional morals, which incidentally vary for each profession. Therefore professional jobs can not be subjected to universal morals19. For instance, care prospers thanks to the dedication and selflessness of the suppliers (p.148)20. And education requires trust (p.150). The universal morals of the market and the bureaucracy disrupt care (p.149). Moreover, Tonkens sees no problems in the rising costs of care (See p.18 and 233 in BP)21.
Tonkens mentions the generally assumed advantages of free markets: effectiveness, transparency, freedom of choice, customer service, and quality (p.55 in BP). Next she argues, that these advantages do not hold for care. The effectiveness on the market is undermined by the costs of advertising, wages in conformity with the market, procedures for inviting tenders, and the collection of data in order to measure the performance (p.62-64, 86, 153). Tonkens notably criticizes the performance measurements (see the whole chapter 11 in BP). Her aversion concerns the costs, but most of all she believes that control is an expression of distrust. See the following. The term transparency expresses, that free markets are accompanied by the spread of product information. In care various performance indicators have been developed. However, Tonkens believes, that these indicators present a distorted picture of reality (p.61, 64, 88, 98, 144).
Tonkens believes that freedom of choice in care is undesirable, because the search costs for the best supplier are high. This is also elaborated further on in this paragraph. Advertising would confuse the consumer. The customer service is undermined, because competition leads to an increased scale and thus to anonimity (p.58). Besides, the suppliers will opportunisticly select the for them most profitable consumers (p.59). Since the consumer can hardly judge the supplied quality, the suppliers have little incentives for improving the quality (p.64). These are the arguments of Tonkens. For the moment, your columnist will draw up a provisional conclusion.
The statements of Tonkens are not new. Institutional economics (NIE) has been developed especially for a better understanding of the human behaviour on markets and within organizations. All these problems do not justify the conclusion, that free markets are by definition undesirable. It is necessary to judge on a case-by-case basis, what mixtures of markets and organization yield the most satisfying result. The popular public choice theory learns, that groups and circles primarily defend their own interests. This theory has been the basis, among others, for the well-known principal-agent model. Tonkens remains silent in her book about these insights, although they did become common in sociology22. Incidentally, the behavioural economics and the social psychology also emphasize the opportunism in human behaviour.
Thus the criticism by Tonkens of the privatizations and free markets is, that the supply of public services (notably in the "soft" sectors such as care and education) is a group process, which therefore is unfit for free markets. The ideology of the sector and the morals of markets are irreconcilable (p.237)23. She uses ideological ad philosophical arguments in order to support her criticism. Her starting point is, that the sector requires trust, harmony and solidarity (p.160,234). Investments must be done in social capital (p.97). The loyal reader of the Gazette knows, that a certain trust and a good reputation are indeed indispensable for keeping the transaction costs in markets low. Enterprises are always embedded in their own networks. The Dutch economist P. Frijters even calls the enterprises "contact makers".
Tonkens believes that this hallmark of markets is insufficient. For, the core of markets remains the freedom of choice, so that the consumer can change his supplier, when desired. This is called the exit option (p.118 in BP). Freedom of choice appeals to the personal interest, and affects solidarity and self-sacrifice. Free markets are a stimulus for egocentrism (p.45, 59). This hurts the relation between the supplier and his consumer (p.69). Relations and networks must be maintained (p.97, 146, 167). In care, based on free markets, there is insufficient investment in this, because the benefits of relations become only apparent in the long run (p.115, 122, 130). Besides, the consumers experience their own choice as an obligation and a burden. When the exit option is removed or strongly discouraged, then they no longer have search costs (p.129)24.
The consumers do need a way to express their preferences. Tonkens wants to realize this by means of the dialogue, so deliberations and planning. She calls this the voice (p.119-120, 231). The voice is necessarily collective, and is expressed by groups and circles. Here the problem is obviously, that such circles do not emerge spontaneoulsy. Tonkens finds the solution in a left-wing phenomenon from the sixties of the last century, namely politization. Politization is the stimulation of the political debate and of criticism of society in general (p.123, 235)25. Tonkens calls this voice the vivid disagreement (p.125). It leads to a group polarization, so that the collective morals (doctrine) is reinforced. Tonkens calls this an ethics of life (p.120, 140). This will guarantee the general (public) interest. The voice method is accompanied by various problems, which unfortunately Tonkens does not address. Therefore, see here.
The political debate is actually a rent seeking by the various interest groups. All these groups must make high costs in order to propagate their view and to defend their own interests. The decisions proceed slowly, also when reforms are urgently needed, and even a stalemate situation is conceivable26. On the other hand, as soon as consensus has been reached about a doctrine, then social innovation will be stifled. Tonkens understandably remains silent about these costs and dangers. She does stress, that the ethics of life (the group morals) must not be imposed by means of commands and sanctions, in a hierarchical manner (p.142). The individuals must be disciplined in an informal way, by means of the social dialogue. The collective morals naturally impose certain choices on the individual. Since the relation is based on trust, the supplier can feel less responsible. Possible contracts are qualitative (p.143)27.
Tonkens has a second ideological objection against free markets, in addition to the exit option. For, markets require some transparency for each supplier of care. Since its direction wants to excel in her performance, the workers in care must register their efforts. This creates discontent among the workers. Tonkens even sees a class conflict between the supervisor (in casu the direction) and the workers in care! (p.108) Moreover, the registrations result in standards, so that the workers can no longer offer work done to measure (p.92). In personalized work the knowledge of the specific case is mobilized (called metis) (p.93, 107). Tonkens wants to minimize the reports, and therefore the accountability (p.238). Contracts must be based on confidence, and be free of manipulative performance-incentives (p.143, 146) and of supervision by means of performance measurements (p.143).
This completes the résumé of Tonkens' criticism on free markets and privatization. She addresses many practical problems, which are also mentioned by institutional economics. This is right and useful. However, your columnist believes that the ideological part of her argument is not satisfactory, because it is rather doctrinal. She states, that branches such as care and education are fundamentally different from other activities. This ignores, that any conceivable activity is human. Existential virtues such as cost control and transparency do have a universal value, also in care. The market does not at all block a mutual trust. On the other hand, functional distrust is a virtue as well, because it encourages learning processes28. In care this is perhaps especially true, because the patient (consumer) has so much to lose.
And the professional honour of a worker in care is not of another order than those of, say a car mechanic. Empirical studies show again and again, that free markets (and privatization) can result in positive effects, which are absent in other ways of control. Thus the free markets do contribute to the improvement of the public services. Here it must be noted, that the market regime can have many forms. The introduction of the market mechanism is a learning process, and moreover path-dependent.
In 2002 the PvdA commission Van Thijn presents the report Grenzen aan de markt about agency and privatization. The traditional reason for the existence of the social-democracy is the nationalization of activities. During the past century it has been ideologically integrated in capitalism, but this was never done with enthusiasm. The most recent attempt to modernize the social-democracy was the radical centre, twenty years ago. The radical centre is fairly positive about privatizations. The commission Van Thijn is clearly not yet convinced29. It dislikes the learning process of trial and error in the development of the institutions of markets. Negative experiences with privatized markets (so-called quasi-markets) are seen as an inducement to abandon the reform, and to nationalize the activity again30.
The view of the commission is expressed om p.128 of its report: "The social-democracy aims at a type of society, where other motives and values than economic ones help to determine the social dynamics; where the idea of profits is bounded". It questions the social scarcity, just like Tonkens. The consequences are accepted: "[In the mixed public sector] there is room for liberalization, free markets with significant state regulation, various forms of internal and external autonomy of state agencies, public service by social organizations with a public task, which compete without the aim of profit, and services by state agencies" (p.127). In short: the commission holds on to the status quo of the seventies.
Note that nevertheless here the social-democracy differs from the christian-democracy. The christian-democracy propagates the social enterprise, without the aim of profit, based on private law. The PvdA report advocates a public enterprise, based on public law. Her trust in the state control is unshaken. It is true that the poor experiences with such organizations is acknowledged, as well as the ideas of the public choice theory (p.41, 47), and the rise of new public management (p.41, 53). But the commission decides to do nothing with them31.
The preceding text illustrates the need for collective learning in the formulation of policies. This is partly done by means of the European liberalization, which strongly regulates state subsidies. This learning process never ends. Certainly when the individual identity is at stake, separate circles can subbornly stick to their doctrine. An example: at the initiative of the PvdA, in 2015 the state has formed the State cleaning organization (RSO), which brings the cleaning of offices back under state control. This was promised in the party program of 2012. The PvdA is notably irritated by the supposed high work load in the private cleaning and care branches. Your columnist, himself at the time still a PvdA member, believes that the nationalization is not a good solution. Besides, this measure illustrates the relation between politics and interest groups. After the establishment of the PvdA in 1946, some wanted to change it into a popular party, but this fits poorly with its inclination to criticize and polarize. In the left-wing Spekman executive the propagation of particular interests was even rather popular. (back)