Does privatization of human services provide the benefits of market competition?

Tools to Assess Whether Privatization is the Best Choice for Children
by the National Association of Child Advocates

The political pressure to privatize children’s programs is often largely based on the assumption that private industry, with the benefit of market competition, can provide better services at a cheaper price. But the nature of human services precludes true competitive markets in many cases. Advocates and policy makers need to scrutinize whether private industry really can provide better services or cheaper prices, when a children’s service is in question.

A competitive market should have four characteristics: many buyers and sellers, low market entry and exit barriers, sufficient information and a homogeneous product. But as economists understand, not every market is a perfectly competitive market. In a typical effort to privatize human services, none of the elements which characterize a competitive market exists. The result is that privatization of human services can actually cost more than public administration.

Case in Point – the Impact of Privatization on Price and Services

When there are only a few buyers and sellers instead of many: Both the bidders and the purchaser have control over the price – the price they set helps determine the price the market will bear. Most commonly, where there are only a few sellers, they can afford to charge more than providing the service will cost them. In essence, they have a monopoly.

Example: In Arizona, the state enacted legislation that set a formula to determine pricing for the contract to privatize their welfare system. Ultimately only one company submitted a bid. Since state legislation mandated that privatization occur on a set time frame, this prevented the state from selecting among bidders for the best services or cheapest price.

When there are high market barriers to entry instead of low market entries: New companies need access to lots of capital to enter the market. This means that even when there is new demand for a product or service and prices rise, few companies will enter the market to force the price back down. If they do enter the market, they can be expected to charge a higher rate. In the human services industry, the public sector agency has already made the necessary initial investments. Although many privatization efforts do
not allow the public agency to bid, when offered the opportunity to bid, the public agency often can continue to provide the service at a lower cost than a new private vendor.

Example: In Indianapolis the public agency won the bid to provide fleet maintenance contract services as the lowest cost bidder.

When there is insufficient information: Vendors are likely to charge more in order to ensure that they can meet their expenses and profit margins given unknown variables such as costs. With a long-term contract, vendors also may charge more to cover anticipated future increases in costs. If costs subsequently fall, the purchaser will not get the benefit of those savings. If the vendor underestimates costs, the initial price may be low but the state may end up paying for large cost overruns in order to ensure that services are provided.

Example: When Kansas privatized its child welfare system, it was unable to provide the bidders complete and accurate information about the state’s current costs of providing foster care. As a result, bidders severely underbid and Kansas has since experienced large cost overruns. Similarly, when Connecticut privatized the administration of its child care program, there was insufficient information on costs and the selected vendor underbid. Ultimately, in order to continue to provide adequate services the state agency was forced to significantly increase their payments per case.

When there is a highly customized product rather than a homogeneous one: While several states might be privatizing similar systems, generally each state is so unique that the product must be tailored to its needs, producing several markets rather than one.

Example: In many states, the purchase of child support automation has resulted in large delays and cost overruns because of the need to customize the computer systems to that state’s particular legal and organizational structure.

 

NACA is a nationwide network of state and local child advocacy organizations. Its mission is to improve the lives and living conditions of children by strengthening child advocacy organizations in states and communities. Information on NACA and on its 63 member organizations can also be found at www.childadvocacy.org or by contacting Deborah Stein, NACA Devolution Project Director at (202) 289 0777.

The “Privatization” issue section at www.stateaction.org provides additional resources to help policymakers and advocates evaluate privatization proposals. These include additional NACA fact sheets focused on children’s services, a model assessment bill with indicators applicable in many areas, and information and model bills on prison privatization.