July 09, 2007
Tom Ulen on Volokh's Privatization
Posted by Christine Hurt

Privatization is hot. For the past 30 years or so, many counties have been rethinking what governmental duties should be in public hands and which in private hands, as well as the appropriate scope of governmental regulation of private entities. The trend has been toward placing fewer social functions in public hands and more in private hands and toward less regulation. These developments are observable most dramatically in the transition economies and the developing world, where the distance to be traveled from state domination was greatest.

But they are also observable in the developed world, including the United States. Consider these examples: the State of Indiana has turned over management of the Indiana Toll Road to a private corporation; the federal government has turned over the management of many of the national parks to private companies; the Bush Administration proposed in 2005 that the privatization of the Social Security System, a move that several other countries have already made; and both the federal and state governments have invited private profit-maximizing corporations to take over a substantial and increasing fraction of their incarceration obligations (about which more in a moment). Recently, the Governor of Illinois proposed that the operation of the State’s lotteries be leased to a private entity for a period of 75 years in exchange for a lump-sum payment of $10 billion, to defray part of the $41 billion unfunded liability of the state pension systems. (The Illinois House defeated the proposal 78-6.) And it is only a matter of time before some states seek to privatize their public universities.

There are numerous arguments in favor of each of these instances of privatization. One is that there was no compelling reason for these activities to be managed by public rather than private entities. In some instances, these privatizations are corrections of mistakes made long ago. In others, the technology of production and distribution has changed so that the case for public ownership is no longer compelling: public utilities are good examples. Another reason for privatization is a desire on the part of governments to raise revenues without increasing taxes (as in Illinois). Like a distressed business or individual, they are selling off their valuable assets.

But there are also arguments to be made against some privatizations (but not against all privatizations). Economists distinguish between public and private goods and generally hold that public entities (or closely regulated private entities) should provide public goods while private entities provide private goods. (The principal reason for this distinction is that private entities will provide a socially suboptimal amount of a public good. Of course, a private entity could be induced to provide more of a public good if the government were to subsidize its costs of production or its output price.) So, economists tend to break out in rashes if the government proposes to privatize an essentially public good, like national defense or, as happened several years ago with disastrous results in my home town of Champaign, fireworks displays.

Additionally, anyone, not just economists, might grow nervous if the government privatized for inappropriate reasons—for instance, to enrich a campaign contributor or pursuant to an agreement not to disclose embarrassing or sensitive information.

Finally, one might be opposed to privatization because it might create a powerful political constituency that might have a potentially deleterious effect on public policy debates. Interest groups who do or might benefit considerably from particular policies have a strong incentive to seek to influence government to adopt (or not to change) those policies. Thus, by privatizing some governmental duties, the government may be creating a new interest group that will seek to influence public policy in its favor. This was precisely one of the contentions of those who opposed the privatization of Social Security: their fear was that the private, profit-maximizing companies who were to manage the billions of dollars in Social Security assets might become deeply invested in nudging public policy so as to increase their returns on those assets. To take but one example, if those managing firms were heavily invested in the shares of companies that created environmental harms, they might then have a powerful incentive to lobby the state and federal governments not to enforce environmental regulations more assiduously because those actions might increase the costs (and thereby lower the profits) of the firms in which they were heavily invested. And the government might be inclined to listen to this lobbying because of its concerns for the solvency of the Social Security System.

Alexander Volokh’s "Privatization and the Law and Economics of Political Advocacy" is a first-rate discussion of this latter concern about privatization. The article elaborates a simple but powerful model of political advocacy and then uses the predictions of that model to examine the behavior of those involved in the private prison market. The upshot of this examination is that whatever else one might say about privatization, at least in the case of private prisons the prediction that the privatized firms or those who work for them will seek to influence public policy in a socially adverse fashion is not borne out.

I shall briefly describe Volokh’s model of political advocacy, paying special attention to its predictions, and then briefly summarize its application to the matter of private prisons. I find the article so well-written and so persuasively argued that I have only some minor suggestions for improvement and for future work to pursue.

Volokh begins the development of his model of political advocacy by noting that a monopolist has exactly the right incentives to decide how much advocacy to engage in. The costs and benefits of advocacy accrue to one firm. So, that firm has every reason to calculate the net benefits, if any, and to engage in a privately optimal amount of advocacy. But suppose that a second firm appears and takes 10 percent of the market. Now, the benefits of political advocacy by the firm with the 90-percent market share accrue in part to the other firm. And this will, Volokh argues, tend to reduce the amount of political advocacy that the larger firm engages in. Because, for similar reasons, the smaller firm will have no incentive to engage in industry-increasing political advocacy, the total amount of political advocacy is likely to decrease.

The principal insights here are that "industry-increasing political advocacy is a public good" and that "[p]rivatizing part of the industry therefore introduces a collective action problem." (p. 10.) If one imagines, as seems to fit many instances, that privatization results in a continuing and large public sector and a smaller private sector, then the upshot of privatization is that the amount of advocacy will decrease, for two reasons. First, the small private sector—like the firm with a 10 percent market share—will engage in no advocacy. They will choose, rather, to free ride on whatever industry-increasing advocacy the larger firm chooses to do. Second, the public sector—like the former monopolist now left with a 90 percent market share—will cut back on advocacy because it is enjoying only a fraction of the benefits.

Let me make two brief comments about this fascinating model. First, although I do not question the basic correctness of the model, I wonder if Volokh might take some time to investigate another implication. If the collective action problem of political advocacy in a non-monopolized industry is so evident, isn’t it likely that many industries that face the problem have found methods of surmounting the problem? After all, K Street in Washington, DC, and similarly situated streets in every state capital are lined with the offices of lobbyists who put the case to political decisionmakers on behalf of numerous industry associations. How have those lobbyists been able to persuade the disparate members of industries—some of which are, no doubt, mixtures of public and private sectors like those imagined by Volokh—to contribute to the association’s lobbying efforts on behalf of all? How do they punish or exclude nonpayers from the benefits of their advocacy? Volokh notes that a concentrated industry is more likely to be able to find a method of solving the collective action problem. Are there some examples from the privatization experience?

Second, I would urge Volokh to look at and cite the literature on experimental public goods games. The gist of many of those games is that people tend to invest far more in public goods than simple self-interest would seem to dictate. This effect is particularly strong in repeated games. Why might this be important to Volokh’s theory? If real people tend to invest in public goods games in instances like those that characterize the circumstances of political advocacy, then, contrary to the prediction of the model that Volokh has carefully articulated, perhaps the same or even more political advocacy happens after privatization as happened before.

These possibilities—that industries find a way to solve the collective action problem and that real people facing public goods issues do not behave in the manner that economists hypothesize that they might—deserve some attention.

The second half of Volokh’s paper applies the model to the facts about private prisons. The fascinating information in those pages (on the percentage of prisoners in federal and state prisons who are being supervised by private firms, on the amount of money spent by and the policies advocated by the California Correctional Peace Officers Association, on the anti-incarceration advocacy of nearly every state director of prisons, and so on) is not to be missed. Volokh makes the case very persuasively that privatization has not resulted in an increase in advocacy for incarceration. Indeed, Volokh reports that he has "found a single piece of advocacy of arguable pro-incarceration advocacy by a private firm." (p. 31.) And "there is little hard evidence that private firms advocate stricter criminal law at all." (p. 32.)

Let me conclude with two brief comments about where to go next with this superb work. First, I would very much have liked Volokh to take a swing at this pitch: how generalizable are your findings about prisons to other instances of privatization? Would the privatization of Social Security have been a disaster? How about the privatization of public roads, public universities, and state lotteries? Clearly, the more likely it is that privatization does not have adverse social effects on public advocacy, then there is one less matter to worry about in debates about privatization.

Second, near the end Volokh raises a fascinating research possibility. What explains the pattern of privatization among the states? Why have some states embraced privatization while others have not? Professor Volokh, speaking only of the privatization of prisons, cites only one factor: "The states where privatization has gained a foothold aren’t randomly chosen; rather, privatization emerges where corrections officers’ unions are weak and fails to emerge where the unions are strong." (p. 47.) There are no doubt other factors—such as the prevailing political majority party, the mix of rural and urban, demographic factors in the state, and the recent growth rate of the economy—that might play a role in a state’s willingness to privatize prisons and other governmental activities. I very strongly encourage Professor Volokh to pursue this econometric study.

One more matter. I wish that matters of privatization, like all matters of public policy, were decided by appeal to the clear thinking exhibited in this article. And I wish that the public debate on these matters was vigorous, informed, and capable of changing people’s minds. Alas, it is not. (See Louis Menand, "Fractured Franchise: A Review of Bryan Caplan, The Myth of the Rational Voter: Why Democracies Choose Bad Policies (2007)," The New Yorker (July 9 & 16, 2007), at 88-91 and www.newyorker.com, and Arthur Lupia, "Deliberation Disconnected: What It Takes to Improve Civic Competence," 65 Law & Contemp. Probs. 133 (2002).) Nonetheless, those who value reason must keep trying: if their efforts are as lucid and persuasive as Alexander Volokh’s, they will, I hope, have an impact.

Finally, one has got to love a law review article that cites the estimable Canadian band, Bare Naked Ladies, for support of an assertion regarding the theory of second best.

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