Jul 16, 2018

Government Privilege: Contracting Abuses

Matthew D. Mitchell Senior Research Fellow , Tad DeHaven Research Analyst

This is the second in a series of short commentaries on The Bridge that discusses the various types of privileges that governments bestow on particular businesses or industries.

Economist Paul Samuelson famously argued that certain goods—public goods—will tend to be underprovided by private markets. There are plenty of examples of privately-provided public goods (over-the-air radio). But most people seem convinced that government must finance the provision of at least some public goods—national defense being the most-commonly cited example.

But just because there is a case for the government to finance certain public goods, it does not mean that there is a case for the government to actually provide those goods. Quite likely, the government does not have a comparative advantage in building tanks or aircraft. Government bureaucracies are notoriously inefficient. They lack the economic incentive to provide innovative, quality goods and services in a timely fashion. And as monopoly providers, they can exploit their position to limit supply and charge the public an excessive price. 

So that leaves private contracting.

But as economist Luigi Zingales explains in his book, A Capitalism for the People, governments contracting with private interests has its own set of risks:  

“The problem with many public-private partnerships is best captured by a comment that George Bernard Shaw once made to a beautiful ballerina. She had proposed that they have a child together so that the child could possess his brain and her beauty; Shaw replied that he feared the child would have her brain and his beauty. Similarly, public-private partnerships often wind up with the social goals of the private sector and the efficiency of the public one. In these partnerships, Republican and Democratic politicians and businesspeople frequently cooperate toward just one goal: their own profit.”

When President Dwight Eisenhower warned against the “unwarranted influence” of the “military-industrial complex,” he was concerned that certain firms selling to the government might obtain untoward privilege, twisting public resources to serve private ends. It is telling that one of those contractors, Lockheed Aircraft, would become the first company to be bailed out by Congress in 1971.

For many observers, the George W. Bush administration’s “no-bid” contracts to Halliburton and Blackwater appeared to exemplify the sort of deals that Eisenhower had warned of. It is true that federal regulations explicitly permit contracts without open bidding in certain circumstances, such as when only one firm is capable of providing a certain service or when there is an unusual or compelling emergency. In any case, a report issued by the bipartisan Commission on Wartime Contracting in 2011 estimated that contractor fraud and abuse during operations in Afghanistan and Iraq cost taxpayers an estimated $31 to $60 billion. This includes, but is not limited to:

“requirements that were excessive when established and/or not adjusted in a timely fashion; poor performance by contractors that required costly rework; ill-conceived projects that did not fit the cultural, political, and economic mores of the society they were meant to serve; security and other costs that were not anticipated due to lack of proper planning; questionable and unsupported payments to contractors that take years to reconcile; ineffective government oversight; and losses through lack of competition.”

Governments may also award contracts to perform a service that has more to do with serving a parochial interest than with providing a benefit to the paying public. For example, Congress may order the Pentagon to procure more tanks even though the Pentagon itself says the tanks aren’t needed. Paying General Dynamics hundreds of millions of dollars to produce unneeded tanks in order to protect jobs in particular congressional districts may be an abuse even if the underlying process by which the contract was awarded is legitimate.

True privatization occurs when ownership and ultimate responsibility is transferred from the public to the private sector. A public-private partnership is a hybrid model.   

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Unfortunately, the rampant examples of private firms securing undue financial rewards from government contracts has led some to conclude that the underlying problem is  the profit model itself. Indeed, critics often associate these negative outcomes with the “privatization” of government services. But those who label a government contract or public-private partnership as privatization are mistaken. True privatization occurs when ownership and ultimate responsibility is transferred from the public to the private sector. A public-private partnership is a hybrid model.   

Sometimes contracts are awarded through favoritism. Sometimes they are awarded by merit. And sometimes contracts that were lawfully awarded end up wasting or misusing taxpayer money. It’s important to remember that had the government not contracted with a private firm in these cases, the government agency itself would have provided the service, allowing it to be a monopolist.  The reality is that not all privileges are clear-cut when it comes to the government contracting with the private sector.

Learn more: In The Pathology of Privilege: The Economic Consequences of Government Favoritism, Matthew D. Mitchell identifies multiple forms of government granted privilege (including tax privileges), and explains their consequences. The full special report is free of charge via pdf, and is available as an ebook and paperback for purchase at Amazon.com and CreateSpace.com.

Photo credit: Liz Gregg / Mood Board/Shutterstock

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