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Pursuing ‘efficiency’ in the public sector: why privatisation is not necessarily the answer

The long-held belief that the private sector is more efficient than the public sector is not supported by theory or evidence.

“The reality is that government employees around the world are known not to be as efficient as the private sector.” —Paul Fletcher, Liberal Party, Member for Bradfield

“The efficiency of the public system is about half of that of the private system.” Peter Lindsay, Liberal Party, former Member for Herbert

There is a common misconception that the private sector is inherently more efficient at the provision of public services. But this is not supported by theory or evidence.

My recent report for the Centre for Policy Development outlines why market-based solutions — such as privatisation or outsourcing — won’t necessarily make our public service more effective or efficient.

The field of economics has developed a thorough understanding of the concept of efficiency. Unfortunately, this knowledge is generally expressed in the jargon of the field and has not tended to inform the public debate on efficiency of the public sector. This leads to misconceptions, such as that markets will always drive efficiency.

Not supported by theory

Abstract economic models predict that the tough and invisible hand of the market ensures no effort is wasted on production of items or the provision of services that people are not willing to pay for. And, where there are limits to what can be made or provided, effort goes towards those goods and services that have the highest value in terms of the amount that people are willing to pay.

The model is limited, however, for the real world departs from the model in many important ways. Discussions of “market failure” make it seem as though private sector primacy is at least partially right; that markets are generally more efficient except in special cases where they fail. However, in public service markets, these special conditions are common rather than exceptional.

Public services are provided mainly in areas where standard competitive market conditions do not apply. For example, distributional outcomes are often important: public services are generally thought best to follow need rather than willingness or capacity to pay (like justice or disability services), and minimum service levels are often desired even if they are high cost (like services to rural and remote communities).

Outsourcing also creates a “principal-agent” situation, which is where an individual or organisation (an agent) is carrying out work on behalf of someone else (the principal), and where there is a tendency for the work to produce outputs that are suited to the needs of the agent rather than the principal.

Furthermore, many fields of public activity involve networks and scale efficiencies (roads, statistical collection, meteorology services, and so on) and these are most efficiently delivered as single public systems.

Not supported by evidence

A review of 129 reports and case studies undertaken by Graeme Hodge found that outsourcing works well in some cases and badly in others. And it is worth noting that many studies that found benefits did not take into account the broader economic and social costs of outsourcing. For example, outsourcing frequently results in significant job cuts, and the welfare costs of increased unemployment may exceed any savings. This lack of support for private sector primacy continues to be found in more recent studies. Public and private hospitals show similar efficiency levels once their different roles are taken into account. Public and private schools show similar levels of attainment once the demographic profile of the students is factored in.

Making the right decision

Misunderstanding efficiency not only biases some towards outsourcing or privatisation, it can also cause those who support the public provision of a service, to argue against efficiency or argue it is not important. This is a mistake as pursuing efficiency is critical tool in achieving any aim. Given the scale and significance of the work that the public sector undertakes, it’s clearly important to have it operate efficiently. Allowing mistaken notions of efficiency to drive policy will result in “efficiency reforms” that actually increase waste.

To be clear, I am not suggesting that the implementation of outsourcing in the public sector is inherently bad public policy. There must be, however, an independent and thorough investigation into the advantages and disadvantages of in-house and outsourced service provision before any outsourcing decisions are made.

When it comes to outsourcing, too many of our politicians have tunnel vision. They can only see the private sector as efficient and are blind to its failures. Our public services do a lot for us; they need to be efficient. But we won’t achieve that by blind faith in market solutions. If you don’t want public services run down, it’s important to look both ways (left and right) before outsourcing.

This article is based on research conducted for the Centre for Policy Development. For more detail, see the report ‘Decoding Efficiency’, available here.

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