Contract writing: The difference between successful privatization and a public held hostage

Contract writing: The difference between successful privatization and a public held hostage

The city of Chicago has been dabbling in elements of so-called “privatization,” and with mixed results. There's Rahm's “managed competition” to help bring down garbage collection prices. There's the Chicago skyway lease. There's the possible future Midway sell off. There's contracted out call centers. Most infamously, of course, there's the parking meter deal. As the last example demonstrates, not all of the attempts have been successful. So what is the difference between successful privatization and a bad deal that holds the public hostage to private prerogative?

Firstly, let's call these activities what they are. Hiring a contractor for call centers is simply a way to get a better price. Public money is still paying for it, and only the execution has been privatized. Bringing in “managed competition” is again a way to make city run services compete at a reasonable price level by forcing them in to price competition with private companies. The service is still paid for by the public, but the execution may be privatized. Leasing city assets is privatization of public asset operation and limited rights even as the assets are still publicly owned. Selling off Midway airport would be pure asset privatization.

Although in some cases the city is attempting to attain price savings by forcing city service prices down to the private level and in others the city is leasing their assets' cash flows, any problems with these contracts cannot be blamed on “privatization” as a concept. Whether public monopoly operation is privatized, public monopoly ownership itself is privatized, or execution of the public's monopolistic services is privatized, the outcomes of these “privatizations” should not be mistaken for the true workings of the private market because these deals involve public monopolies unattainable in the private sector.

The difference between a good deal and a bad deal is the way the contract is written. Following below, we'll deal with the three types of privatization mentioned above, and the difference between a good and a bad contract for each.

 

City services operations

Rahm's managed competition in garbage collection involves competing bids for city service contracts. Although market influence may reduce the price and result in more efficient use of public funds, the city picks its favorite bid, leaving the public vulnerable to all of the dangers attached to guaranteed public contracts.

The problem with issuing guaranteed service contracts is that the public is held hostage by the monopolistic (the government is the only one allowed to provide this service, in this case through a private contractor) contract and how wise its signers were (and how honest they were in representing public interests), as well as how well the monopolistic service is performed. Contracts with short terms and limited scopes are generally better because they limit the range, power, and length of the given monopoly. Hiring a contractor for year-long call center service doesn't put anything at stake. Because of the unbalanced and powerful nature of monopolies, service contracts, when issued, should always come with numerous stringent conditions and limitations in order to protect the public. Hiring the call center contractor is especially responsible if the contract stipulates that poor service will result in termination and that the contract lasts only one or two years and may or may not be renewed. As with any contract, the more clear and thorough the terms, the better the parties (notably the public in this case) are protected.

It's still preferable, however, not to sign a contract and bind the public at all. With a contract the public is stuck with a service and a price for a specified duration. Termination is difficult. Public service contracts are often pricey, political (unions), and ineffective. Private service contracts run a risk of dissatisfaction with service. The best option, then, is for no contract at all, or at least a very limited contract.

 

True privatization doesn't include the public giving guaranteed monopolistic contracts to anybody.  Each individual gets to choose instead. Here's how this might be done in garbage collection, and how it might look:

Rather than guaranteeing public money to anybody, the city should disconnect tax dollars from garbage collection. The city's collection service would switch to a pay per user model, where every customer is automatically enrolled to start with and billed each month, carrying over all current customers. Prices could and would vary among the different neighborhoods based on density of customers and other factors involved in costs.

While the city's service continues to operate, private competition would be legalized throughout the city. The city would make sure each competitor is providing a minimum level of service, and “certify” each one to that effect. Every property owner could make a decision to “hire” city service or one of the private competitors. If the percentage of residents choosing city service in any neighborhood dropped below 30 percent, for example, city service would cease in that area, accompanied by a letter stating that all property owners must retain garbage collection service from some provider, and that service will default to the most popular provider in the area unless the customer chooses another one.

If at least forty percent of the landowners in a neighborhood declare that they would switch to city service and want it to start again, the city service must start again until customers once again drop below thirty percent. If the city service hasn't served any customers for a period of five years, it will be completely abolished.

 

That is an example of a practical and effective way to transition to private services without any guaranteed public contracts. Since the city (having to serve blocks with only one house on the block and employing overpaid union workers) likely loses money on garbage collection, this would save the taxpayers money and introduce constant competition in services. It would also eliminate the waste, inefficiency, and corruption that accompany monopolistic guaranteed public contracts.

 

Asset Leases and Asset Operations

Any deal that fits in to this category should be subject to more intense cash flow and cost benefit analyses than those made by the city of Chicago in deals of the past. Ultimately, though, the difference between a lease or operations contract that is advantageous to the public and one that holds them hostage lies in the duration of the contract, the scope of the contract, and the conditions within the contract. Leasing a Lincoln Park event space for 10 years carries far fewer problems than what Chicago has done with its parking meters.

These contracts are of a risky nature, especially when involving public monopolies. They therefore require stringent, specific and extensive conditions on level of service, what can or cannot be done with the transferred or operated asset, and other stipulations to protect the public.

Both the Chicago skyway lease and the parking meter lease suffer from very long durations. The public has been stuck with the skyway for the next hundred years. It cannot be removed or otherwise changed. A century is far too long to assume anything about transportation needs.

Also with both of these leases, but particularly with the parking meter deal, the scope is so large as to constitute a monopoly. It's a transfer of public monopolistic privilege such as the private sector would never be able to acquire on its own. Giving a monopoly over public assets to a private company or consortium is akin to giving birth to a cartel. It results in power over the public and is certainly not in public interest.

Privatizing a public monopoly restricts competition and is not indicative of competitive privatization, nor will it have the same effects. Giving private entities control or ownership of public monopolies is more akin to corporate cronyism than capitalism. Using public power to grant special privilege to private enterprise is the definition of corruption.

 

There is a way to privatize parking meters in Chicago, but for true privatization and the benefits thereof the method and contract terms would need to be much different. A wiser method follows below.

In order to privatize the parking meters without guaranteed monopolistic contracts that hold the public hostage, sell (or lease) parking meters piecemeal. Why not treat meters a lot like the boat slips in Chicagos marinas?

The city could set up a website and sell each of the thousands of metered spaces in online auctions. There could be rules attached to the sales contracts, such as the stipulation that no individual can own more than a certain number of spaces, say 500. After sale, however, there would be a freely traded market in metered spaces. Businesses would buy them so that their customers could park right out front. Residents would buy them to have a space on the street in front of their place, and set highly personalized parking time rules, reserving their space during certain times and leaving it to customers at others. Investors would buy up one side of the street and get in a price war with the owner of the next block. Prices would vary throughout the city, discouraging congestion where it is a problem and encouraging traffic in areas that need it.

Meter owners would improve them, inserting technologies such as fobs that turn the meter green, carried on key chains by individuals the owner wants to be able to park there. Meter owners might form a collective whereby a driver pays a monthly rate to park at any metered space that is owned by a member of the collective – sensors in the car and the meter would automatically turn the meter green when an authorized car parks nearby. Owners might contract out with the city or with private companies for enforcement.

Alternatively, the city could sell leases, where after the initial sale there is a monthly rent on each space. The key, though, is that selling to many different owners and allowing a market for spaces would foster competition, diversity in products, consumer choice, and dynamic prices that vary throughout the city. The city would no longer subsidize parking by creating price ceilings throughout much of the city.

Here again there is a massive contrast between true market-driven privatization and guaranteed monopolies bequeathed in contracts with the public sector – like a crown the king would give a chosen heir. Instead of being beholden to monopoly power, the market's best characteristics could manifest in the parking meters throughout the city, resulting in a multitude of consumer choices and prices, and dynamically responding to the economy and the market. Even while the people more directly own parking spaces, nobody is given special privileges or holds power over anybody else, and owners are held in check for fear of their competition.

 

While both options are technically a form of privatization, one is market-driven and the other is public monopoly-driven. The chief difference is in the nature and wisdom of the contracts. Again, in the market-driven case the public is not being bound, and public power is not being used for private benefit.

 

Asset Sales

When it comes to selling (or for that matter leasing) assets, the city ought to ask itself three important questions.

  1. Does the cost-benefit financial analysis check out? Are we getting enough short term cash to compensate us for long term cash flow loss?
  2. Are we selling an asset better left in the public sector such that selling it may be a detriment to the citizens, whether because they need free use of the asset or because the asset is of a monopolistic nature and would concentrate, in private hands, power over a needful asset?
  3. Have we written the sale contract so that the public doesn't have any obligations going forward, especially those that must be fulfilled after the term of the current administration? Is the contract written so as not to concentrate monopolistic advantages such that this power concentration could come back to haunt the public?

 

It's often a good idea to sell public assets, either because the public has no business owning them and spending tax dollars on them, or because they are not financially worth holding on to. The ideal situation to sell in, however, is that which sees the public failing to break even on an asset that a shrewd businessman would likely be able to “fix” and run at a profit. It's also acceptable to sell profitable assets as long as the contract is the result of tough negotiation and therefore properly compensates the public for their asset. That is, the short term cash must be worth the long term revenue. Ideally the businessman will be able to run the asset more efficiently and can even be convinced to pay more than the assets current fair market value. In these cases, both when the public is operating the asset at a loss or at a profit, the public is operating it less efficiently and therefore wasting taxpayer dollars. The public will be better off offloading the asset.

There are also times when the public so miserably fails in operating an asset that it's worth it to pay a hefty amount of money to offload it to a private investor, possibly try to include sale conditions that shape that investor's ownership and use of the asset, and avoid the negative cash flows that would have resulted without sale.

In all cases, however, potential sales should first pass muster in the three areas noted above. The success of the Midway privatization will be determined by how it answers these questions.

 

By now the reader should see the theme, the dividing line between successful privatization and that which binds the public's hands or fails to represent them. It is, as always, in the contract, which should refrain from using public power to grant monopolies to private parties, and should avoid binding the public with long-term guaranteed contracts.

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  • How can we get the parking meters back under public control and kick out JPM?

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    C M Snyder

    IIT produced engineer with the ambition to develop property in Chicago and help return some of the Chicago sense of place to areas of the city that are losing it. Investors and engineers solve problems for a living, so I offer my strong opinions on what these are and how they might be solved.

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