Competition in Government
1 March 1996 . Number 2
2nd Annual International Summit on Service to the Citizen
Denver: February 28, 1996
It is a pleasure to have the opportunity to participate in this 2nd Annual International Summit on Service to the Citizen. This conference comes at an appropriate time, as governments around the world face unprecedented financial challenges.
I would like to talk for a few minutes about the imperative for competition in government --- how service to the citizen can only be preserved and improved in the current environment by incorporating competition. Underlaying this discussion is the fundamental economic principle that competition generally lowers costs and improves products.
Further, my presentation is not about smaller or larger government. There will always be legitimate debate about the role of government and the extent of its intervention in our lives and the economy. Instead I will talk about delivering at the lowest cost the quantity and quality of services the democratic process has determined to be appropriate. There should be little debate about that.
There are two imperatives for incorporating competition into government --- a moral imperative and a financial imperative.
The Moral Imperative
Government has a moral imperative to spend no more than necessary to produce the required quantity and quality of services. It is very fundamental. Government is supposed to be the servant of the people. The money that people earn belongs to the people first, not to government.
The Fiscal Imperative
Moreover, there is a fiscal imperative for spending no more than necessary. Governments throughout the world face a very grim fiscal future.
In the United States, for example, the Congressional Bipartisan Commission on Tax and Entitlement Reform reports that by 2012 federal revenues be sufficient to cover only entitlements and interest on the national debt. There will be no revenues for discretionary spending, including defense. Further, by 2030 it would require a 70 percent increase in federal revenues relative to the Gross Domestic Product to finance current service levels. The law of diminishing returns makes it highly unlikely taxes can be raised enough to produce this much revenue.
And it is no better in other countries. Canada runs substantial deficits at both the federal and provincial level. European nations, where government's share of national income is up to 60 percent, are attempting to reduce the high costs their economies can no longer support. And, as the recent French experience suggests, it is a difficult, if not impossible task.
Competition and Monopoly
Monopoly generally violates the public interest. A monopoly can charge higher prices, and produce products of lesser quality, because consumers have no choice. It is not that monopolists are evil --- it is that they, like all of us, tend first to serve their own interests. A monopoly can increase its revenues by violating the interests of consumers.
In contrast, competition tends to serve consumers. Producers compete on price and quality. Producers in a competitive market are not morally superior to monopolists. They, like monopolists and the rest of us, tend to seek their own best interests. And in a competitive market, the producer prospers by serving the interests of consumers. Choice empowers consumers and polices producers.
Public policy recognizes this. Public policy is generally opposed to private monopoly. Where monopoly is unavoidable, it is regulated by government in an effort to protect the interests of consumers.
This same principle is carried over to the operation of government itself. Laws and regulations require government to purchase services and supplies through the competitive market.
But there is an exception. Government does not subject its procurement of labor to competition. And labor represents the largest share of public expenditures --- 60 percent of current expenditures at the US state and local government level.
With respect to labor, government operates as a monopoly. And monopoly is no better in government that it is in the private sector. People who work in government, like everyone else, generally seek their own best interests. Too often in government, the incentive structure rewards managers based upon the size of their budget or the size of their staff. The public manager who serves the interests of consumers by providing the same or better service while reducing costs or reducing staff imperils his or her career advancement.
The Government Cost Crisis
Because of the non-competitive nature of government labor, there is no economic brake on costs, only a political brake --- and that is a pretty ineffective brake. As a result there is a general tendency for unit costs to rise above inflation, and to be higher than in the competitive market. Government employee compensation is often at above market levels, as is demonstrated by the artificially low turnover (average tenure) rates. Inefficient work rules often increase public costs unnecessarily. Sick time usage is much greater in government than in the competitive market.
The lack of competition has led to a situation in which services of the same or higher quality can often be purchased through the competitive market for 20 to 60 percent less, despite the fact that competitive contractors must pay taxes and earn profits.
Government's fundamental fiscal problem is costs not funding. Higher tax revenues is not the answer. Because costs are insufficiently controlled, providing additional revenues to government is like pouring water into a leaking bucket.
And there is another dimension. An increasing body of economic research indicates that higher taxes retard economic growth --- this is called the "deadweight" loss of taxation. One study found that for every dollar increase in US taxation, $0.40 is sacrificed in economic growth.
Bringing Competition to Government
The most effective mechanism for incorporating competition in government is competitive contracting (or competitive tendering). A wealth of experience has been reported around the world on the savings --- both the direct savings from competitively contracted services and the "ripple effect" savings from the influence of competition on internal functions threatened with competition. And government departments can compete for contracts. There is considerable evidence that government departments participating in competitive procurements routinely reduce their costs and improve their service quality.
This raises an important point. It is not that the private sector is superior to the public sector, rather it is that competition is better than monopoly. Public agencies have demonstrated time and again their ability to improve efficiency and effectiveness in competitive situations. And in so doing, they better serve the citizen.
Principles of Competitive Contracting
There are two fundamental principles of competitive contracting:
First: the contracting agency should retain full policy control. The public agency determines service levels, service standards and awards the contract to the responsible and responsive proposer whose price is the lowest. The public agency monitors contract compliance and terminates contracts in cases of unsatisfactory performance.
Second: the contracting agency should facilitate a competitive market. Contracts should be subjected to routine competitive, generally they should be re-bid at no more than five year increments. Contract sizes should be no larger than necessary. This means that a single public service may be provided a multiple contractors. This allows smaller entrepreneurial firms, including disadvantaged business enterprises to compete. And it lowers prices. All contract rates should be determined through the competitive process --- there should be no renegotiation or subsequent negotiation of contract rates. Where there are large capital purchase requirements, it may be less costly for the government agency to make the purchase and lease the capital assets to the contractors. This reduces the barriers to entry for smaller firms, increases competition and lowers prices.
But there are obstacles to competitive contracting.
Public managers often oppose competitive contracting because it lowers costs and reduces staff size, both factors whose increase tends to be directly related to career advancement.
But by far the most important obstacle is labor. Let's take this issue straight on. Competitive contracting has often been criticized as a mechanism for lowering costs on the "backs of labor." This is just plain wrong. In the competitive market, employee compensation is determined by the competitive market. But in government, employee compensation is determined by political processes. As a result, employee compensation is often above market, and governments frequently have more employees than they need to perform their functions. To the extent that government pays more than market for employee compensation, it does so on the backs of the private sector labor that pays the largest portion of taxes. It is an issue of fairness. Government employees are protected from the market, to the detriment of private employees. Even so, as governments have competitively contracted they have used a variety of strategies to ease the transition for their employees, such as converting to competitive contracting at a rate that avoids layoffs, or requiring contractors to consider public staff for employment. But the labor issue raises the most fundamental question. A government that serves its employees first fails in its fundamental calling to be the servant of the people.
There are a number of approaches for incorporating competition into government.
Compulsory measures: Governments have made competitive contracting compulsory for local governments in the United Kingdom and the Australian state of Victoria. Compulsory competitive contracting has been imposed upon public transit (urban transport) in the United Kingdom, New Zealand, Denmark, and Colorado. Compulsory competitive contracting has been opposed on the basis that it restricts local control. But compulsory competitive contracting is nothing more than an extension of existing laws and regulations that require governments to use the competitive market to obtain supplies and outside services.
Public prerogatives legislation: Often government labor contracts limit or prohibit competitive contracting of services. Public prerogatives legislation preserves the policy prerogatives of government by not allowing collective bargaining over issues such as competitive contracting, the assignment of staff and other factors that can artificially raise the costs of public service provision.
Petition of interest legislation: Petition of interest legislation allows private companies to challenge government to subject particular services to the competitive market, by establishing a public process by which companies can demonstrate their financial and technical capability to provide public services. The petition of interest approach allows markets for public services to develop based upon the abilities and resources of potential private suppliers.
Purchasing organizations: There is a trend toward establishment of government organizations that purchase public services, but do not provide services directly --- separation of policy from operations. Government owned operating entities are either sold to employees or private investors or "corporatized" as publicly held operations that compete in the competitive market under the same set of laws, regulations and taxes as private companies. The US Advisory Commission on Intergovernmental Relations refers to such organizations as "providing organizations." One advantage of "providing organizations" is that there is no internal constituency opposed to competitive contracting, because there are no internal operating departments. "Providing organizations" engage in "steering" rather than "rowing" consistent with Steve Savas' principle as cited in Reinventing Government.
The Fundamental Value: Serving the People
The governance crisis of the emerging 21st century is about values --- it is about the most
fundamental of democratic values --- that government should be the servant of the
people. And for government to serve the people, it must spend no more than necessary
to produce its services. Government can achieve this ideal by incorporating competition.
There is both a moral and fiscal imperative for comprehensively incorporating competitive incentives into government.
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