Friday, April 15, 2011

Is the pendulum swinging on outsourcing civic services?

Conventional wisdom on the delivery of civic services holds that service quality can be improved only if urban local bodies (ULBs) outsource or contract out or even privatize their services. In-house service delivery is perceived as fundamentally inefficient and inherently poor in quality. Accordingly, in recent years, there has been a clearly pronounced trend towards outsourcing civic utility services - water, sewerage, solid waste management, IT operations, customer care centers, etc - in many Indian cities.

In this context, Stephen Goldsmith, the deputy mayor of New York, and an one-time Republican Party star for privatizing government services when he was mayor of Indianapolis, has triggered off a debate on the merits of privatization of civic services with this very interesting op-ed column,

"Usually, when government officials talk about spending less money, they talk about outsourcing services to the private sector. And in many cases, that can be very effective. But union leaders often argue that it would be more cost-effective to give the work to city employees - and sometimes, they are right...

Mayor Bloomberg requested that I review all information technology, or IT, contracting. After conducting a thorough review, I have concluded that much of the solution lies not in more outsourcing to the private sector, but rather in employing city workers to perform more of our IT work. So in the weeks and months ahead, we will decisively shift more work from consultants outside government to our talented public employees. This will save taxpayers millions of dollars a year."

As part of this review, the Bloomberg administration has sought to consolidate the city's 40 separate data server rooms into a handful of centralized data centers. This project, expected to yield taxpayer savings of atleast $100 mn over the next five years, is being executed using public employees,

"To build our new data center, instead of hiring an outside vendor for project management and quality assurance as we would have done in the past, we insourced the work to the Department of Information Technology and Telecommunications' project management team... Using the know-how of city staff to oversee these projects will save an additional $25 million over and above the $100 million we will save from having fewer server rooms and other efficiencies. That center where the mayor stood was built in record time, from start to finish in only six months."

He also wrote about other successes with in-sourcing,

"Our Business Express tool - which helps businesses get permits faster - and our expanded 311 online program are both now led by insourced city employees, not consultants. The Finance Department is hiring 45 city employees to replace outside consultants, almost entirely in its technology department. That will save millions more."

And about the way forward,

"At the same time as we intelligently insource, we need to tighten our oversight over outside contractors. Competent and honest vendors respond best when they are well-managed by able city officials. We are proposing, therefore, to expand a high-level city vendor management office - and in the process, reduce the cost of outside projects and test whether certain projects are even necessary.

And we are going to start challenging all components of technology contracts, and ensure that the city does not pay a markup to a consultant for work we could just as well do internally. We must also focus on subcontractors - companies hired by our own vendors to help them complete their assignments... Insourcing the management of projects and important decisions about scope and cost will allow us to save taxpayer dollars, enhance service delivery and ensure that IT vendor resources throughout the city are delivering on time and on-budget for New Yorkers."

Predictably, this has re-ignited the debate about the merits of in-house service delivery and outsourcing of municipal services. Here are a few observations

1. As Mildred Warner writes, "Contracting out only saves money if there are technological innovations or economies of scale that come from moving functions out." It therefore becomes critical to objectively and accurately assess the costs and benefits of any such initiative. However, as we have seen with the numerous examples of high-profile failures with mergers and acquisitions with big private firms, such decisions are difficult to make.

It is no surprise that in recent years there have been a large number of cases of reverse contracting - bringing previously privatized services back in house - from cities across the world. A study for the International City Managers Association (ICMA) by Mildred Warner and Amir Hefetz finds that the reasons for reverse contracting are problems with service quality (61%), lack of cost savings (52%), improvements in public delivery (34%), problems with monitoring (17%) and political support to bring the work back in house (17%). As can be seen, the "reversals reflect problems with service quality and lack of cost savings in contracted services" instead of the usual suspect of political opposition.

2. There is a fundamental incentive challenge - private firms have incentives to reduce quality to enhance profits and governments have the incentive to reduce costs. This means that the city managers have to effectively police and re-align the incentives of the contractors. At the same time, they have to bear in mind the need to ensure that life-cycle costs of delivering the service is optimized.

However, this requires that the city managers have the requisite professional competence and integrity to effectively carry out this responsibility. Unfortunately, there are very few cities which have the required numbers of professionally competent (upto speed with the latest technologies and processes) and honest managers.

3. It is no surprise that there are massive delays in all types of projects being executed in our cities. Monitoring and supervision, even of internally executed projects, have never been a strength of public systems. It is therefore unreasonable to expect municipal governments to do an effective job of external contract management, especially those involving complex and difficult to quantify outcomes.

Monitoring the adherence with service levels involves rigorous data collection and supervisory over-sight which is often beyond the competence of public officials and their bureaucratic systems. As can be expected, project management is one of the weakest areas of urban governance.

4. The most critical determinant of the success of any contracting agreement is the ability to monitor with reasonable degree of accuracy the achievement of outcomes. However, it is difficult to quantify the outcomes, leave alone the quality, of many civic services. Sometimes, it is difficult to even define and monitor certain outcomes. Performance-based contracts, which are successfully implemented across the private sector, is therefore difficult to structure for civic service delivery.

Further, even when it is possible to quantify outcomes and their quality, the process of data collection is a source of concern. It is either gamed by the contractor, in collusion with the supervising public officials, or its reliability suspect due to the sheer inefficiencies within public bureaucracies.

5. Compounding the problem is the absence of adequate competition and depth in the market for service providers. In the US itself, for most local government services the average number of alternative providers is less than two. Only one third of the 67 most common local government services have two or more alternative providers in the market. Reflecting the virtual absence of choice, fully 75% of contracts are given to the incumbent without re-bidding. The situation is far worse in developing countries like India. In other words, "all privatization does is substitute a private monopoly for a public one".

6. Cronyism and corruption is rampant in all our urban local governments. However it is not the exclusive preserve of our local bodies. Chicago's parking meter privatization is the most high-profile example of incompetence, short-sightedness, and corruption that characterises contracting of civic services.

Contracting out civic services, especially in the larger cities, require a highly professional bid process management. It should be free from external interference and decisions should be taken on purely professional and objective considerations. It is difficult to replicate such environments in most Indian cities.

The net result is a completely compromised bid process, in which extraneous considerations prevail over professional qualifications. The willingness of most service providers to play this game only makes the process even murkier. The result is a badly designed/structured contract (often done to favor certain parties) awarded to a contractor with neither the expertise nor the intent to execute the project effectively. Failure, criticism and controversy is therefore inevitable.

None of this is to oppose outsourcing and privatization and advocate in-house civic service delivery. As Nicole Gelinas writes, "Privatization of government services can be a tool for competent governments but it's not a cure for incompetence... privatization doesn't obviate the need for government competence and honesty, as well as for the democratic checks and balances that encourage these traits". Governments should decide to use outsourcing and privatization based on the specific project and the local market conditions and not on ideological considerations. Elliott Scalar has this standard for making privatization decisions,

"Three factors drive the decision: the number of interactions required between the service supplier and the purchasing organization; the ability of the purchasing organization to judge the quality of the product; and the nature of control over the physical assets and people involved in delivering the goods. The general rule of thumb is that when the number of interactions is high, quality is not easily determined and control over assets is required, you should keep the function in-house. If the reverse is true, you can outsource."

John Donahue prescribes this standard,

"Tasks that are well-defined, easy to monitor and available from competitive suppliers — call them 'commodity tasks' — are prime candidates for privatization. Tasks that are complex and mutable, lack clear benchmarks or are immune from competition — 'custom tasks' — should be kept in-house."

All this ultimately boils down to the original Coasean theory about firms and transaction costs - firms exist because the transaction costs associated with doing ancillary activities externally are simply too large. In this case, certain services, instead of being outsourced, are more effective if done internally within the civic utility.

The final word should go to an excellent meta-study of privatization across the world of water distribution and garbage collection by Germà Bel, Xavier Fageda, and Mildred E. Warner, which finds,

"Privatization of local government services is assumed to deliver cost savings but empirical evidence for this from around the world is mixed. We conduct a meta-regression analysis of all econometric studies examining privatization for water distribution and solid waste collection services and find no systematic support for lower costs with private production. Differences in study results are explained by differences in time-period of the analyses, service characteristics, and policy environment. We do not find a genuine empirical effect of cost savings resulting from private production. The results suggest that to ensure cost savings, more attention be given to the cost characteristics of the service, the transaction costs involved, and the policy environment stimulating competition, rather than to the debate over public versus private delivery of these services."

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