Romesh Vaitilingam interviews Paul Grout for Vox

June 2009

Transcription of an VoxEU audio interview [http://www.voxeu.org/index.php?q=node/3669

Romesh Vaitilingam: Welcome to VoxTalks, a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam, and today's interview is with Professor Paul Grout, from the Centre for Market and Public Organization at the University of Bristol. We met in June of 2009 when we spoke about his new report called Private Delivery of Public Services. I began by asking Paul to give an overview of the history of the delivery of public services by both the private sector and the public sector, starting from around the 1970s.

Professor Paul Grout: Well, the 70s is a good point to start, actually, because that probably, now viewing from the early part of the 21st Century, was the high point of delivery of public services by the public sector. Indeed, at that point, there was so much public involvement in the delivery of public services throughout the world, with the exception really of America, the public services and the public sector had almost become intertwined in people's minds.

Since then, of course, there has been huge waves of privatization, movement towards public/private partnerships, and now growth in the not for profit sector. So there has been quite a significant movement away from the public delivery.

So now, one needs to be quite cautious and draw a very clear line between public services and the public sector. Probably the biggest movement has been as a result of privatization.

At around about 2003, about $3 trillion worth of assets had been privatized into the private sector from the public sector. This amounted to about 80 per cent of the whole global stock market, and outside of the US, it was almost 40 per cent of the world's stock market.

Now, all of these activities weren't public services, but a large amount was, and that gives some kind of indication. Even PPPs, which are much more what you might think of as the new kid on the block, in Europe alone there has been €200 billion worth of PPPs signed and closed up to about 2007.

Romesh: So your report describes these, basically, three different models of private involvement in public services, privatization, which you mentioned; Public/Private partnerships, the PPPs; and then these not for profit organizations. Can you explain more to me what these three different models are and why you might think about using one rather than the other?

Paul: It is probably better to do it the other way around and talk a little bit about generally why you might be interested in having something that isn't public sector at all. There are two big obvious reasons why it is good to have the private sector around. One is that there is something innately different in the private sector. One of the obvious things is that the private sector is interested in profit in a way that the public sector isn't, and will be motivated to maximize those profits wherever possible.

Given the contracts aren't complete, and therefore you can't just simply get the private sector to replicate what the public sector would do or vice versa, you will always have a lot of grey areas. What you will find in the private sector is you were then expecting these grey areas and the private sector will introduce activities and be motivated to do things that maximize profits.

Unfortunately, this will even be at the point at which quality may suffer.

In the public sector, you have much less incentive to be efficient or at least a good reason why that often doesn't happen. But of course, at least quality then will be taken into account. So the sector may be quite critical.

Where the downside of an activity, in terms of quality where you chase costs would be very bad, brain surgery being an obvious example, you may want this to remain in the public sector. So, some of the public innate inefficiency is worth bearing for the fact that you don't really want reductions in quality.

In the other extreme, things like dust bins, where the world doesn't come to an end if the dust bins don't get emptied for a week, you may be very concerned about cost. It may be very useful to have a private sector operator who is chasing the efficiencies, even though the quality may be slightly lower as a result.

So, at a very simple level, you can view the sort of trade off between the private sector, which has lower costs but unfortunately less interest in quality, against a public sector would be more driven by quality but costs would be rather low. So that is one of the obvious reasons that there is literally something different about the sectors.

The other big story is that actually it isn't really about the differences in the sectors so much as competition. And the private sector is very good because it enables competition because you can have lots of private sector producers. So this in a sense is the private sector bringing benefits in an indirect way in that it just enables to have more players.

Either of these reasons, as the evidence seems to suggest, are actually quite important. This would tend to suggest that you may then just want private delivery. But actually, that is probably not a good model for lots of services.

So, the initial wave of privatization basically did exactly this, just took public services out of the public sector and put them into the private sector.

The fact that this isn't appropriate for lots of services is why we now have, later, interest in partnership models rather than full privatization models and even more recently renewed interest in not for profit models.

Romesh: Let's talk about how these different models of private delivery of public services, what we know about how well they perform. Perhaps we can start with privatization, as that was the first big movement starting, I guess, in the early 1980s in the UK and then it spread around the world since then. So, I guess that particular form has been a great success story, would that be right?

Paul: Yes, I think that you can generally portray it around the world as a great success story. Although, I think, to be absolutely honest, it was also driven by political motives as well. It is relatively well documented, that where you have more privatization, this does tend to lead to a tendency for people to be more right wing in their voting habits, although that is not absolutely generally true.

So as well as the desire to improve incentives, lots of privatization was also going hand in hand with governments that wished to move the economy more toward the right. The general message there, I think, if you take a broad brush, is that yes, privatization led to greater investment, lower prices, improved productivity. This isn't the case everywhere, but generally that is true.

There are also two related messages which I think are worthwhile. One is that the benefits are greatest where they have been associated with liberalization of activity. So it is not actually moving it to the private sector alone that matters, it seems to be that you need to liberalize and free up the market.

So, reduced regulation, reduced control and general liberalization seem to be important. That message that it is not just privatization, that you get more of an effect if you liberalize the markets, is true both across all the developing countries and has been found throughout the OECD as well.

Romesh: What about public/private partnership? This seems to have caused more controversy. There seems to be a lot of debate, certainly in this country, about the pros and cons. And that is still continuing. What is the evidence we have on their performance?

Paul: Yes, I mean, that is more complex. Of course the reason that you are doing it is in itself more complex, and that is worth taking into account. Often you can't just implement simple, full privatization models. It would be impractical. If you think of an urban road network, very hard to charge for that. There may be poverty in a country, in which case the government can't really just step back and push something out into the private sector.

For some activities, the only purchase is ever the government. Like national defense and things of that sort, and lots of areas that have been anti privatization pressures. So, all of these things have led government, partly politically and partly for good economic reasons, to move toward more of a partnership model, which is often easier to sell, as well.

The partnership process, you could think of it very crudely as two different waves. The first wave is really just an outsourcing wave, where you have a series of contracts between the public sector and the private sector delivery.

These models have generally, throughout the world, been very successful. There's no doubt, if you look at the data, that it has led to cheaper delivery. It appears that the evidence suggestst that a lot of this is purely the result of the competition rather than the fact that it is the private sector that's doing it.

In lots of instances, for instance, where there's contracting competitions, the public sector delivery mechanism may themselves be allowed to compete in the auction as one of the possible suppliers. And the evidence is showing that where the public sector wins the auction, they themselves are vastly an improvement on the old public sector delivery mechanism.

So, you don't have to have the private sector doing this to get most of the benefits.

There is some evidence that it still matters if the private sector player wins, but the competition seems to be the big driver. So, the outsourcing part is relatively straightforward. There's not even a lot of evidence that quality has been reduced as well.

Much more complex are the more modern partnership models. Well, I call them modern, they have been around for a long while, but there has been a big new wave of what we think of as PFI type of partnership models.

The structure of these models is typically the private sector invests a large amount of money up front, they sign a very long contract with the public sector, 25 years; even 40 years is quite common. The private sector owns the asset, which may be a road or a hospital building, and the public sector buys the service year on year from the private sector.

Now, these models, there's good economic argument for them in the sense that one of the worries of the old public sector delivery model is that the private sector would buy, say, a road, the private sector would build it, and then just basically walk away and build another road for someone somewhere else.

If anything went wrong ten years down the line, and this would be true for a hospital building or something, then you have a very complex legal battle if you wanted to prove that it was actually the private sector builder that was at fault.

So, the attraction of buying the service, that is, you only pay while the product, the road, or the building is delivering the service, means that as soon as problems arise, the private sector loses money.

So, therefore, they have a much stronger incentive to build a good asset that will last for a long time, and of course, have the incentive to get it built quickly so that the money starts flowing quickly.

So, this sort of model is a slightly different model. It's been very, very popular. You can see politically why it's hugely popular, because the government doesn't have to find the money for the road straight away, and they don't have to find the money.

They pay over 25 years, over 40 years, so you can get your infrastructure improved very rapidly without having to do a lot of government expenditure, although of course, the commitment for the government is still the same.

Now, growth in this area has really been in the, kind of, 90s. That was the huge growth area, and it's still going on now. So when you're talking 25 and 40 year contracts, we haven't really got to see these all the way through. What evidence there is does suggest that things do get delivered much more quickly, which is good.

There's not really enough evidence to know yet whether the quality is a lot better. We'll have a much clearer view of that say, in about 10 years time.

But the simple idea of 'things get delivered on time' seems to be very strong. They aren't any cheaper. That seems to be the case. In fact, on the contract, they look a lot more expensive than public sector delivery, but the history of public sector delivery has always been one of cost effectiveness.

If you look, there has been a big study done in the European Union of PFI Partnership roads relative to public sector roads. The extra cost of the signing of the contract of the PFI roads has turned out to be almost exactly the same as what the cost overrun was on the public sector.

So although the PFI look a lot more expensive, when you take the cost overruns into account, they roughly cancel out. So those bits of the story are looking quite promising. There have been some pretty irregular stories of PFI contracts and PPPs that haven't gone well, but there are plenty of horrendous stories in the public sector as well, so you can't read much into those.

It's worth mentioning two other points that are quite interesting here. One is renegotiation, globally; renegotiation of these 25 or 40 year contracts is a huge problem. In a big World Bank study, they found that three quarters of all water concessions were renegotiated within a few years, and half the road concessions.

So what these 25 year contracts mean is, has to be dealt with very carefully and it matters a lot what the quality of the legal system is. It is quite clear if you look where the money has been spent over the last 15 or 20 years, countries that do quite well on corruption indices get a lot more of this money than countries that do very badly.

And the other issue is there's been a big problem about procurement, which of course may also relate to the renegotiation. Procurement in the old public sector model was one of the less exciting jobs in the sector.

You know, you procured the hospital. Somebody came along and built it, but it was the people who ran it, people who controlled it, these were the people who had the power. And this would be the same in road networks and things of that sort.

Of course, now, in these new models, that power, the control of the organization, is going over to the private sector. So within the public sector, the procurement job, getting this job done properly and cheaply, is actually now really important.

In fact, if you sign a 25 year contract with a single supplier, then in a sense that single supplier is in a monopoly position for the next 25 years. So, the contract up front and the competition needs to pull out any profitability that will happen to that. That is quite important.

So there has been a bit of a mismatch around the world between the people, historically, who were in these procurement positions, and suddenly the scale of the job that they are being requested to do. This, again, globally is a problem. And there has been a problem in the sort of advanced European economies as well as elsewhere.

So there's a little bit of uncertainty about how this model will play out. Politically, it's not hugely popular with the unions. Globally, the word partnership was jumped on to some extent because it wasn't privatization, which was a bit unpopular, but now the same thing is happening to the word partnership. Which makes it, of course, not for profit, it was the next place to go.

Romesh: I was going to say, what about this model? This is a model with which I think most people are a bit less familiar, but it is talked about quite a bit in the UK these days, particularly, and maybe elsewhere, too.

Paul: Globally, it is becoming important. And one does wonder the extent to which this has been, the movement is all, if profit incentives are bad and are unpopular electorally, than not for profit must be good. Of course then you're just replacing one set of incentives with another set of incentives. But you are quite right, there is definitely a move in the UK, there's a move elsewhere in Europe, and globally. And the delivery of lots of projects around the world have historically been done by not for profit organizations, NGOs, but this actually definitely a growth area.

The evidence is really mixed. There is plenty of evidence to show that not for profit organizations are more efficient in some areas, but then there are plenty of other examples.

So there is no clear message at all that comes through that literature. I should say, however, of course, quite a bit of this literature is in the medical markets in the US, which may be a little bit specialized and might not, therefore, transfer to NGOs in Europe or NGOs in Africa or something of that sort. But there's no clear message coming through.

There are certain clear things. There is definitely a clear message that, if you look at what we refer to as pro social behavior, the willingness of employees and people in the organization to go the extra mile beyond what's required in any contract beyond what's required for their personal career concern there's undoubted evidence that this is much stronger and much higher in not for profit than for profit organizations.

However, the critical question is is that because non profit organizations just attract these kind of people, or is it that as they leave a for profit to a not for profit organization, people actually do more of the giving of the extra mile, that is, they do more pro social behavior?

The evidence on this, what we have, is not hugely strong at the moment, but unfortunately what it does suggest is that people don't seem to change their behavior. So what we seem to have out there is a group of people who engage in pro social behavior, who are caring, who are always willing to go the extra mile.

And, although these are attracted to the non profit deliverers, this doesn't actually make them do more of it. So in some sense there's more of a transfer of this, rather than that the not for profit actually means that we deliver more pro social motivation in society.

So there's lot of uncertainty as to whether the real drive for this is much more of a political drive. The sort of underlying economics show that it's obviously the way to go forward. There does appear to be a little bit of a history here that politicians keep moving towards something that looks like it, may be more saleable to the electorate.

Romesh: We're nearly two years into a global financial crisis and at least a year into a global economic downturn that's worse than anything that's been seen in the post second world war period. What impact do you think these phenomena are going to have on this whole debate about private involvement in public services? And I guess there's a broader issue of the public reaction against these dirty capitalism words like privatization and profit and competition.

Paul: That's a very hard question to call at the moment. There's no doubt that there's a shortage of cash around. People are still closing very, very big PPP, Pier five type deals, but it's not so easy. And the question is will this be a permanent or just a temporary blip? And that's hard to call. One of the things that I think is quite important here, which leads me to think that it will be somewhat of a temporary blip, is that if you think at a slightly larger level, one of the big movements that's going alongside this privatization movement we've been discussing, are the privatization of the protection of individuals in their old age.

The movement now globally is to put this back onto the individuals via pension schemes of various sorts. The World Bank is pushing very much. They want countries to introduce these individual various pillars for people to look after themselves.

You're finding this all through Western Europe, basically driven a lot by demographics. The simple pay as you go public system just can't cope into the future.

So what you're going to have is an ever growing, or at least for the next 20 or 25 years, ever growing investor institutions that need to invest very long term in relatively safe assets. And they're going to need a home for this money.

At the same time, a sort of natural home for a lot of this money is these very, very long infrastructure schemes with very, very long contracts signed. So you can see there's a quite a natural fit there.

Historically, the protection of people in their old age, which was locked up by the public sector at the time when the public sector was doing these infrastructure projects, you can see there's quite a neat fit with if it's the private sector that are now looking after their old age protection through private pension schemes globally that money now would sort of go into these very same infrastructures that were being delivered by the public sector.

So I can see that fit actually working out quite well in the long run. Therefore, I personally anticipate that although the growth in these schemes is to a large extent being driven by political pressures, those political pressures don't go away.

So when it's easier again in the near future, hopefully, to fund these operations, they will continue. But there seems to be in the longer scheme of things a more natural fit that would suggest that you can easily see that this model will continue. Really, it is there, I think.

Romesh: Final question, Paul. You've been involved in research in this area for many years, tracking I guess from the early 80's privatizations, seeing how they worked out. And you're still very much involved in looking at non profit organizations now. What do you see as the research agenda for the future in this area? What are the big questions that we need to answer? Where do we really need more evidence?

Paul: The whole issue of the not for profit, non profit, relative to the private sector is one where there's a huge amount of theoretical research, there's a large amount of experiments about pro social behavior and that kind of stuff. And there isn't matching yet a literature that can really answer the question of if governments decide to put a lot of their provision of public services through this not for profit route, what is that going to do? Is it going to make things better, et cetera?

As I said, the one place where there is a reasonable amount of evidence is the US, but that may not transfer, so we may be looking at something different. So I think that's clearly an area that people need to look at in great detail.

The issue of ongoing quality dimensions in partnership models is something that people will be put to bed. Eventually, one hopes, there will be a clear message coming out of that. A problem that we haven't really seen at all yet that we need to stop to think about is the transfer of these assets as they get towards the end of their contractual life.

Because how these models are typically constructed is that the private sector will build a road, the public sector will commit to buy from them the services of this road for 25 years, or a hospital building or something of that sort, or a water facility, and then at the end of that period, this is then transferred to the public sector who then make a decision with what they do with that asset at that point.

You can easily see that as you approach this closing time, the incentive for the private sector to keep these assets in good condition starts to deteriorate quite rapidly. So how all that will play out is something that will start to become of considerable interest and we don't really know a lot about.

Another area I think that we need to a lot more thinking about is the whole issue of risk transfer. We know that bearing risk is important for incentives.

But we don't know a huge amount of how much risk is really transferred from the public to the private sector, when the private sector is called in to deliver public services, because obviously there's an inherent role for the public.

They can't walk away in the way that they can walk away from other activities. E commerce companies could go down wholesale in 2000 and 2001, and the government doesn't have to be involved. Public service delivery companies can't go down wholesale in markets.

Therefore who ultimately owns the risk and how this is all packaged is important. And again actually this comes back to the not for profit. Because there's clearly an issue of what is appropriate risk transfer for the private sector, may not be appropriate risk transfer if we're going to have a lot of not for profit delivery.

And I don't think people have thought very much of what these optimal contracts would look like for delivery and transfer of risk into the not for profit sector.

So there are plenty of things to think about and hopefully I'll be spending some time thinking about some of these in the future.

Romesh: Paul Grout, thank you very much.