Privatization in Local Governments
KeywordsLocal Government Public Service Private Company Public Employee Privatize Service
The process by which a company or organization is transferred from the local government to the private sector (private company) so that the latter will hold ownership and control thereafter.
We can set the early nineteenth century as the moment when public services in general started to be provided by local governments. These basic services formed the incipient local welfare state. Since this time, the scope of municipal public services has spread at different paces in all developed countries. However, at the end of the twentieth century, a neoliberal policy named the “new public management” (NPM) theory proposed a market liberalization policy, which included the privatization of municipal services. This theory predicted significant improvements stemming from privatization: greater efficiency and quality of remaining government activities, lower taxes, and smaller government size. In the services that are privatized, the profit-seeking approach of private companies will lead to cost cutting and greater customer satisfaction.
In addition to this privatization process, there has been a contradictory trend in recent years in Europe, since increasing public services have been devoted to local governments, while at the same time budget restrictions have significantly limited local governments’ ability to provide services. In an attempt to reduce the political impact, municipal incumbents have considered privatization, as opposed to direct public provision, as a way to provide services without increasing service-connected taxes, thus reducing the service-specific deficit.
Apart from NPM and fiscal stress, other factors led to privatization of local government services in Europe. First, the emergence of populist political movements that were critiques of bureaucracy and waste in government. Second, the growth of public choice ideas in academia that gradually affected the think tanks and then the views of politicians, particularly conservative politicians. Third, the wave of private sector reforms in the 1980s that led to structural change in many large financial corporations. These changes were exported to the public sector by consultants that had both private and sector practices (John 2001).
Supporters of privatization claim that private market companies can more efficiently deliver many goods or service than government due to free market competition. They argue that this will lead to lower prices, improved quality, a decrease in excessive regulation, and less corruption. Most authors think that not everything should be privatized, due to shortcomings such as market failures and natural monopolies. However, if we move to the extreme line of thought, some think that everything should be privatized, including the local government itself.
Factors that Influence the Decision to Privatize Local Government Services
Some studies claim that conservative local governments privatize more due to ideological underpinnings. Conservative local governments prefer small governments and believe in the higher efficiency of market competition, while progressive local governments are reluctant to let the private sector provide public services. Conservative politicians that privatize public services may gain political support from local companies located in the municipality. According to this, conservative local governments may get electoral support from privatization, while progressive local governments may face disappointment from their voters. Privatization is thought to provide cost savings to taxpayers. However, these cost savings depend on many factors, and sometimes it is difficult to create and benefit from competition among service providers (Sundell and Lapuente 2012). Sometimes, privatization of local government services is hampered because European local governments are afraid of losing political support of public employee unions. Actually, some surveys claim that a high degree of unionization of public employees makes privatization more difficult. Coalition governments are also thought to be preventing local governments from privatizing, due to the necessary agreement among parties with different ideologies. The greater the number of coalition members, the higher the probability that at least one party will veto the privatization. Therefore, conservative, majority local governments are the most likely to adopt privatization policies (Sundell and Lapuente 2012). We must keep in mind that the local government will still be held responsible for the cost and quality of the service that has been privatized.
Advantages of Privatization in Local Governments
Municipally owned companies tend to suffer from political interference or populist factors. For example, obliging the municipally owned company to purchase supplies from local manufacturers (even when they are more expensive than buying from other suppliers), forcing an industry to freeze its prices/fares to satisfy the electorate or control inflation, or increasing its staffing to reduce unemployment. Privatization is thought to prevent all these negative factors.
Quality of privatized services is ensured because service provision is periodically reviewed to verify the level of quality.
By privatizing a municipal nonprofitable company, the local government eliminates the need to provide tax-funded resources to cover losses.
Contracts are competitively bid to maximize taxpayers’ savings.
Private, for-profit services should not have lower quality than publicly provided services.
Privatized services benefit from technological innovations developed by the private sector. Private companies may invest retained earnings on research.
Economies of scale. Small local governments face high unit costs if they operate their own services, because they cannot achieve economies of scale. These municipalities may benefit from privatizing services to companies that work with several municipalities and thus get economies of scale.
Continuous performance controls and accountability are implemented by the local government.
Lower capital investment required from the local government. Private companies may use retained earnings to purchase new capital equipment that lowers unit production costs.
Flexibility in service provision by private sector. Private companies have more flexibility than governments to use part-timers to meet peak periods of activity, to fire unsatisfactory workers, and to allocate workers across a variety of tasks.
Lower cost for hiring civil servants.
The local government frees human resources that can be devoted to key areas that need additional staff.
Savings can be invested in other key municipal areas.
In cities with growing population, it can be difficult for local governments to meet the increasing demand for public services. Through privatization, companies may respond fast to this increasing demand.
Should natural monopolies exist, local governments should apply antitrust legislation and/or create institutions to deal with anticompetitive behavior of companies delivering privatized services.
Disadvantages of Privatization in Local Governments
Job loss for government employees. Sometimes, when privatizing a service, the contract obliges the company that wins the bidding to hire the public employees who were providing the service previously. Besides, local governments sometimes reallocate public employees to other government departments or negotiate with them early retirement incentives.
Problems in the bidding process. Potential suppliers may initially offer a pretty low price to the government, less than actual production costs, to get the privatized service. Subsequently, the company would request a higher price after the government has dismantled its own production system. Such “lowballing” may be reduced if the local government requires long-term contracts or if it sets contracts that allow the local government to grant the privatized service to another company should this “lowballing” occurs.
Privatization of key local government services makes them lose control over essential public services.
Cost of managing contracts including quality check and audit of performance. Local governments need to take several important precautions before privatization, in order to avoid legal liability. These precautions include detailed performance specifications for service providers, guidelines for the evaluation of competitive bids, and labor relations precautions. Some ways to monitor the privatized service are continuous cost comparisons, performance appraisals, complaint sheets from customers, citizen satisfaction surveys, periodic reports from contractors, and field observations.
Potential for favoritism or bias in contract decisions, incentives for corruption. Benefits of cost savings because several companies compete to get the contract sometimes are damped down when it is difficult to create competitive bidding.
Sometimes it is complicated to perfectly specify which activities privatization will include.
Clear definition of the problems privatization is expected to solve may be difficult.
Setting the parameters and indicators that will rule the privatization contract.
Privatization decision may have overestimated the benefits of privatization and underestimated its costs.
Real competition must be encouraged. Competitive environment is claimed as one of the factors to support privatization. Private companies have a strong incentive to operate efficiently, while this incentive is missing under public ownership. If private firms consume more inputs to provide the same output, competition will lead to lower margins, lost customers, and decreased profits. However, this effect of competition does not occur in the public sector. Therefore privatization produces the public benefits of lower costs and high quality only if a competitive environment exists, and accordingly, privatization cannot be expected to produce these same benefits in the absence of competition. Considering this fact, municipal governments must make sure that the bidding process follows ethical standards.
In many instances, privatization has triggered corruption, especially in municipalities from developing countries.
Privatizing a municipal nonprofitable company may oblige the company to raise prices in order to become profitable.
Experiences of Privatization in Local Governments
British local governments are, within Europe, those who have applied NPM, and thus, privatization, to the highest extent. In fact, the UK has been exceptional in this privatization process, triggered by the conservative governments during the 1980s and 1990s, the weakness of the state in the UK, and the influence of ideas from the USA. One great organizational change was the “compulsory competitive tendering” legislation, which obliged local governments to have local services delivered through competitive tendering. The idea was to split the provision of public services in two parts: purchasing function exercised by the local government and the provider function, made by private sector companies. Although this legislation has been already repealed, it changed the way local governments provided services in the UK (John 2001).
Focusing on outputs rather than on inputs: quality-oriented and citizen-friendly management
Integral cost accountability
Open and transparent processes
Decentralization of authority
German local authorities reacted more slowly to NPM ideas. In the 1980s there was resistance to the privatization ideas, which German local governments associated with conservative trends from the USA and the UK. These ideas appeared to undermine the rule of law principle that governs German municipal sector, which means that municipal services are completely regulated by law. Reforms leading to privatization started in the 1990s, changing the German municipal bureaucracy, partly affected by reunification and fiscal stress. Some cities such as Cologne and Hanover introduced new policies first. After these first years of early adoption of privatization, German local governments started to foster the privatization process, for example, the municipal water service, telecommunications, and waste management. An interesting case is the city of Potsdam, which privatized its water supply and sewage disposal services through a globally operating investor. Just 2 years later, Potsdam re-municipalized these services that had been privatized. Actually, in Germany there has been a growing number of binding local referenda in which privatization of municipal services has been rejected by the local citizens.
Similarly, in Switzerland, municipalities, such as Bern, have introduced NPM philosophy. A number of other cities, such as Lucerne, Zurich, and Winterthur, have adopted a similar set of reforms (John 2001).
Nordic countries have been reluctant to full privatization. Sweden, Norway, Denmark, and Finland took NPM ideas slowly. As far as corruption is concerned, we said above that corruption sometimes is connected to privatization. However, we must point out that privatizations in the Nordic countries have not led to greater corruption, since these countries rank in the first positions in all the lists of comparative international corruption.
Swedish municipalities adopted a business model in a way to reform their bureaucracies. Local governments introduced management by objectives and UK-inspired purchaser–provider process. In many cities, such as Stockholm, the privatization process was driven by financial stress, since the local government sought budget savings. In Sweden, to ensure that privatized services are efficient, courts can prevent local governments from making decisions that may jeopardize competition, unless they are justified by public interest.
In the 1970s, many Norwegian municipalities adapted to the philosophy of corporate management. However, privatization has not been adopted to a high extent. In Denmark there have been some reforms aimed at rationalizing bureaucracy, under the influence of conservative governments of the 1980s, which sought to simplify regulation and introduce market style on public services. Besides, there was a transforming trend to privatize public organizations into private sector companies. However, Danish local authorities have not implemented NPM reforms that much. There have been some initiatives at the local level, and local authorities have focused on total quality management, decentralization, and enhancing the influence of users on public service provision (John 2001).
Finland has reformed its municipal sector to promote results-orientated management and the use of market mechanisms (privatization). Simultaneously, the central government does not monitor local governments because of the constitutional principle of local self-government. Some municipalities have developed standards of service quality (John 2001). As regards municipal production in Finland, municipal reforms in progress are increasingly exploiting markets and competition, as a way to provide welfare services more efficiently.
In France, the local sector has not applied privatization as extensively as in the UK. However, there have been reforms in the provision of local government services, such as water. Due to decentralization reforms and the lower involvement of the central government in municipal issues, local governments sought partners in the private sector. During the 1980s and 1990s, there was a continuous privatization of local government services. Private sector ideas and practices (NPM) have influenced the public sector. France’s powerful system of public law principles is against the NPM assumptions of efficiency and flexibility (John 2001).
Like France, Spain has a tradition of private sector provision by companies founded in the late part of the nineteenth century. Since 1975, when the transition to democracy started, Spain privatized many local services, such as water, public transport, waste collection, and street cleaning. Such reforms have also taken place in Portugal, where municipalities have privatized their water supply and waste management services. As in France, NPM reforms in Spain have been rejected by the traditional municipal bureaucracy, the strong legal regulations of municipal services, and the principle of “rule of law.” These thorough regulations reduce local governments’ flexibility to implement NPM reforms such as privatization. Accordingly, Spain is one of the European countries where privatization of local government services has been more limited (John 2001). However, some municipal services such as water provision, garbage collection, and street cleaning are widely privatized in Spain. In fact, the lack of economic sustainability has always been an important issue for the particular case of waste services in Spain. In an attempt to reduce the political repercussions, local decision-makers might view new governance models (such as privatization) as a chance to raise tariffs without much public opposition. Indeed, referring to the Spanish waste sector, Bel and Miralles (2010) find that “policy makers may have used privatization as a means of reducing the political cost of increasing service-specific taxes, thus reducing the service-specific deficit.”
Italy’s local government privatization differs from France and Spain, since there is less experience of municipal services privately provided. Many functions were provided in-house, such as cultural and social services; others, such as water, refuse collection, and disposal and transport, were provided by semiprivate entities’ communal agencies. Moreover, the move to more flexible forms of service delivery has been much slower than local governments of other countries. Italian political parties had no ideological commitment to privatization. Since that time, the growth of the importance of business people in Italian politics has meant more public commitment to business practices. Strong mayors have pursued privatization policies. In Trieste, for example, privatization has been advanced with the selling off of land and contracting out of municipal services (John 2001). For example, Rome is working toward the privatization of the municipal waste company, but there is opposition from the citizens.
Re-municipalization of Municipal Services
There are empirical indications that in recent years, a comeback of public/municipal sector-based provision of public services has been gaining momentum and that a pendulum swing toward a “re-municipalization” is under way (Wollmann and Marcou 2010). The reasons for re-municipalization are diverse, but they stem mainly from the failures of water privatization. If a government-owned company providing an essential service (such as the water supply) to all citizens is privatized, its new owner(s) could lead to the abandoning of the social obligation to those who are less able to pay or to regions where this service is unprofitable. Even the World Bank has called for a “rethink” of privatization policies, with the argument of the negative impact of a profit-driven service delivery model on workers, low-income households, and the environment. Some municipalities have experienced the effects of privatization, making this level of government a key player in public–private debates. Many municipalities are frustrated with the broken promises, service cutoffs to the poor, the lack of integrated planning, and pressures from international institutions forcing them to contract out to private firms. As a result, many municipalities have begun to push back. This trend is making practitioners and policy makers question the neoliberal ideology of market-based service delivery (McDonald et al. 2012).
A striking fact about the re-municipalization of Paris waters is that it has been a highly political move undertaken with little public pressure or participation. Instead, there were numerous and detailed audits proving the potential for financial savings, more than arguments about managing water as a “public good.” The transition was difficult, particularly on the financial management side and in terms of personnel. But despite these challenges, the return to in-house delivery provided impressive financial outcomes. Overall, the preliminary assessment is encouraging, with Paris’ water systems moving from opaque, fragmented, and short-term management to a more integrated, transparent, longer-term, and progressive approach. A similar process occurred in some other European cities such as Grenoble (France). Italian citizens recently voted in a referendum against privatization of municipal public provision of water service.
Since the early 2000s, public enterprise in Cologne (Germany) has undergone a major transformation. This has seen the creation of the country’s largest municipal service consortium and the return into public hands of key public services like waste management.
The local government of Barcelona (Spain), currently ruled by a progressive party, is now trying to re-municipalize the water service. This service is now provided by a private company, and the municipality is paving the way so that the service is again provided in-house. This is not the only service the municipality wants to retake, and experts announce great budget costs of this re-municipalization process, since huge compensations will have to be paid to the private companies that are currently providing the municipal services.
In other services, such as electricity, re-municipalization occurs mainly in Germany. Reasons for this trend are low quality of service, high costs, end of contracts, and higher control by the municipality. In municipal public transportation, British and French local governments are leading the process of re-municipalization. Regarding urban waste management, Germany and France are mainly retaking its provision in-house. The re-municipalization of street cleaning is taking place mostly in the UK and Germany.
The diversity of experiences at the local level in Europe, in terms of privatization, is extensive. The privatization took place mainly in the UK and the Netherlands. In the remaining European local governments, the changes have been slower. This aspect of governance appears to be an Anglo-Saxon idea, with only the Netherlands trying to imitate this philosophy. Municipal privatization has attracted local governments with fiscal stress by the promise of cost savings and higher, private-financed, investment. In the southern European local governments, the strong central state is hidebound by legal rules, procedures, and professional corps. Local bureaucrats and politicians are less focused on the quality of services and are less likely to find reforms attractive. The evidence suggests that NPM reforms found their natural expression in some northern countries, but did not transfer to the classic southern countries. The attraction of municipal privatization is Western Europe-wide and cannot be restricted to the north. Rather than a strict north–south divide, a variegated pattern has emerged. The adoption of these ideas is particular to contexts. Ideas cross nations and between levels of government. Reformers adapt them to fit in with their own systems of government. Ideas may also engage with older practices. In Scandinavia many of the management reforms followed on from the previous experiments with private sector ideas in the corporate management revolution (John 2001).
Neither public nor private managers will always act in the best interests of their shareholders (agency problem). Privatization will be effective only if private managers have incentives to act in the public interest, which includes, but is not limited to, efficiency.
Profits and the public interest are best intertwined when the privatized service is provided in a competitive market. It takes competition from other companies to enhance managers’ behavior.
When these conditions are not met, continued governmental involvement will likely be necessary. The simple transfer of ownership from public to private hands will not necessarily reduce the cost or enhance the quality of services.
Liberalization and privatization of public services have largely negative effects on employment and working conditions and varied effects on productivity and service quality. Positive effects and better performance as compared to other countries were mostly the result of superior regulation rather than of competition or private corporate initiative. Privatization has also led to inequality among consumers depending on their consumer power or the place where they live. Hence the nature of service provision should not be left to the “free” role of market forces, but ensured by strong, comprehensive, and accountable regulation that makes sure that all important quality aspects are met and that the universal character of public service provision is retained (Hermann and Flecker 2013).
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