outsourcing

Sometimes you set out to do something and then notice that whatever it is you did causes more grief elsewhere. So you end up with a different and often larger problem. America is in such a mode right now. Our leadership, such as it is, has fallen prey to the outsourcing game. Only when a government outsources it’s called “privatization”. The explanation is normally that by offloading a service – firefighting for instance – to a private organization the government doing the privatizing will save money. Taxes can go down. Local deficits can be cut. And no one will notice because the service still is provided. The taxpayers get something for nothing. Wow. Why didn’t we think of this before?

Because it’s a sham.

The New York Times has a good story about this exact circumstance in a Californian location called Costa Mesa.

I don’t want to repeat that story. What I want us to focus on is the inherent destabilization it implies.

While it is correct that a private contractor can deliver services in such a contract for a lower cost in the short term, there are hidden longer term costs that society ends up paying that nullify the advantage. For, just as outsourcing by a private business ends up lowering the average wages of the people delivering that service, so too does government privatization.

There is no way around it.

The way a privatized service can cost the government less is because the service provider pays lower wages, gives out fewer benefits, or employs fewer people. So we get rid of higher cost public workers and employ fewer and worse paid private workers. The aggregate wages in society go down. So too do pensions. So too does society’s ability to buy things. That means many local small businesses get less traffic and start to suffer. Eventually the entire local economy shrinks to a lower level of activity more in accord with the reduced purchasing power circulating within it.

This is all inevitable.

Advocates of privatization either don’t care about these longer term trends, or try to argue that there are offsetting benefits. Those so-called benefits are usually in the form of the fired workers ending up doing something “more productive”, so the net social cost is either zero or even a positive. It’s called enhanced productivity. Or the allocation of resources from low value uses to higher value uses.

There is a reason why economics is called the dismal science. You cannot get something for nothing. But privatization makes it look as if you can.

Now, I am not saying we all should be happy paying public workers high wages. There is plenty of evidence suggesting that public workers are paid less than their private industry peer groups anyway. The point is more direct: we delude ourselves if we think privatization solves anything. All it does is mask a deeper social problem: the economy is sputtering enough that it looks as if we cannot afford some of those services anymore. The problem is not the cost of those services, nor the public budgets that appear under stress. It is that our economy has underperformed for decades now and is not growing the way it ought to.

The small government dream is thus a focus on the wrong problem. Government deficits are more symptom than a disease. We are looking in the wrong place fro solutions.

The problem with this is that it is the middle class who benefits disproportionately from government spending. The poor get some support, but they are far less likely to partake of the full gamut of government largesse. They are far less likely to drive along publicly funded roads. They spend less time in publicly funded schools. They are less likely to own a home and thus get tax credit for mortgage interest. And so on. So while it may appear from the headlines that the poor get a good deal from government programs, the middle class does even better.

What about the rich?

Well, they too get a good deal. They also use the system a fair bit. But they are also more likely to opt out and buy services privately – schools for instance – and the big difference is that they contribute more in tax dollars. So they pay more for the services.

No. Big government is a middle class benefit by and large.

Indeed I think that the modern middle class is largely a function of big government.

Think about it.

Without big government the middle class would be paying for all sorts of things from its current income. That implied subsidy from the rich would not be there, so the cost/benefit would shift negatively for the middle class wage earners. Of course the middle class could forgo the services, but that would imply a loss in standard of living. You don’t get anything for nothing after all.

I am not writing off the poor, or applauding the rich, I am simply pointing out the bind we are stuck in. And it is some bind.

All those small government efforts popping up around the world will impoverish the middle class. It is unavoidable. So if you are hell bent on austerity take a moment to figure out what you will end up without. Because you will, assuredly, end up without something.

The counter argument is an illusion.

As I said earlier it hinges on the notion that by cutting government we are freeing up resources that the private sector is more able to deploy productively. So the short term pain will be offset by long term gain.

No so much. Alternatively: if you believe that, I have a bridge here in New York I want to sell you.

Let’s take a look at the private sector record. First up: the dot-com bubble. Good allocation of resources there. Yes we ended up with some neat stuff, but there was an extraordinary amount of collateral damage along the way. Just how many of those ridiculous internet businesses can you remember? Not to mention just how many survived? Second: the real estate bubble. That worked out well. Now, I realize that there are a lot of revisionist free market types claiming that the entire crisis was the result of ill advised government attempts to force poor people to buy houses they couldn’t afford, but I don’t agree. Frankly I get a bit tired of the narrative that says it is always the government in cahoots with poor people that disturbs the serenity of the wealthy. Besides, I don’t get how perfect markets seem always to get discombobulated by the government. Aren’t markets supposed to be efficient? And wouldn’t that mean they can see through, and adjust for, the government ruse? Apparently not.

Anyway, we have two very bad recent episodes of private sector ineptitude. So shifting resources out of government does not always end up enhancing social welfare.

But it does seem to end up enhancing some people’s welfare. Which is why small government has so many ardent adherents. If you run the business that benefits from the privatizing, then you are a winner. If you are a worker in that business, then you win to the extent you have a job, but you probably lose because your wages and benefits will be lower than the displaced public worker.

Hang on. Didn’t I just say that public workers are paid less than private workers? So how can it be that wages go down in general after privatization? Simple. Its dynamics. In the current state public workers earn less than their peers. Then again there are exceptions to this – California prison guards for instance. But let’s stick with the general case. In order to justify a low cost bid and thus to win the privatized contract, a private business has to squeeze out costs. Otherwise there’d be no advantage to privatization. Not only does the privatized service need to be a replication of the public service, but it needs to turn a profit. So there’s overhead to add to the overall cost. So now the cash flow has to be divided between the workers and the capitalist owning the business. That’s easy: wages go down. Or benefits get cut.

I am sure we can all think of examples where this scenario didn’t play out. Waste is not just a public sector problem. The US defense budget is a classic example of things going hopelessly wrong. The Pentagon seems to have the entire argument backwards. They outsourced a ton of stuff and ended up paying more than if they had kept it all in-house.

That is not my point. I want to focus on the logic of the small government effort. It is an illusion. At the end of the day, small government inevitably leads to small service. And since the middle class gets the biggest return on those services, in an austerity program it is the victim, unwitting or not, of the cuts.

Which brings me to ask: why, then, is it the middle class agitating for austerity? The poor may be ticked off. And the rich may be indifferent. But the main body of support for bashing the public worker unions, and for cutting big government programs comes from middle class voters. Whenever asked voters want to retain the services, but cut the cost. They imagine that government is one huge pile of waste. If only that waste is eliminated they can get the magic of extra service at no extra cost.

Paper shuffling is not the exclusive domain of the public sector. Anyone who has worked in a bank knows that. Bureaucracy is endemic to modern society. So it is a fool’s game to imagine you can have small government without losing some service along the way, or without lowering aggregate wealth somehow.

Yes, productivity should offset the loss. And, no, recent history tells us productivity is not the engine driving wealth it once was for most of us. Until wages get more of a share in productivity growth, smaller government will remain a dream. It is a dream in which the middle class gives up stuff and gets nothing back. In other words it shrinks. So when we wake up from this dream America will be a smaller place.

I wonder if that’s what the voters want?