UD-17

A mature democracy has many bureaus. Some bureaus supply specific goods or services, like national defense, police, fire protection, and waste removal. Others are instituted only to purchase, or procure. Such bureaus decide which private contractors will be hired to provide services, they monitor the services, and they may administer the payments. Some bureaus are practically always fully financed by the government, as in the usual case of national defense. Others charge a fee for services, like the postal service, mass transit, national airlines, and parks. Bureaus like the postal service and mass transit are typically also protected from competition. They have a legal monopoly, receive subsidies or tax breaks, or are favored by other restraints on competition or by special privileges.

Privatization: A condition that a legislature aims to achieve when it decides to stop supplying some good or service or to reduce the government’s role in the supply.

For some services provided through the government, the time eventually comes when the legislature decides that it no longer wants to supply them or that it wants to reduce the government’s role in their supply. Either conditions have changed or the legislature regards the initial decision to supply as a mistake. We call this new decision a decision to privatize. Its goal is the condition of privatization.

The opposite of privatization is socialization. Socialization occurs when the legislature hires people to provide a good or service that was previously supplied privately or when it increases the government's role in the supply. Socialization was popular during the earlier part of this century. The most socialized societies today -- in other words, the societies with the largest proportion of services provided through government bureaus -- seem to be North Korea, Cuba, and the oil-rich Arab-Muslim dictatorships.

In more capitalist countries, there has been a pronounced trend in recent years toward privatization. The two countries with the largest populations -- Mainland China and India -- have been shifting from socialization to privatization. Many of the newer democracies in the former Soviet Union are privatizing government companies that they inherited from the socialist governments they replaced. Still other countries in Asia, South America and Africa are being persuaded by international aid agencies or pressured by citizens to privatize some bureaus. Finally, older, western democracies like England and the United States are privatizing services that they had earlier socialized.

Privatization ranges from what we might call complete privatization to various forms of incomplete privatization. Complete privatization is the goal of a government decision to lay off all the government workers who supply some good or service. The aim is to turn the choice of whether to supply over to the market economy. Subsequently, if the good or service is supplied at all, it will be supplied privately in anticipation of profit or through the giving of philanthropists.

Complete privatization means quitting -- selling off, or liquidating, the bureau. The legislature completely abandons responsibility for providing a good or service. An example is a government that decides to quit supplying air travel services. The U. S. government has never owned a commercial airline company. The governments of many other countries, however, have either owned an airline themselves or have heavily subsidized a private airline. The leaders of developing countries have been especially inclined to want their own airline, or "flag carrier." Since these countries initially lack the technology and training, they typically pay a foreign company or government to help them get started. The foreigners help to purchase aircraft; to train and hire pilots, mechanics, workers, and other personnel; to design the airports; to arrange schedules; to decide rates; and so on. During the time that the foreigners help the airline, the government pays large subsidies.

Complete privatization: liquidating a bureau that supplies a good or service.

When the foreigners leave, the government continues the subsidies, expecting the airline to someday be profitable. However, in some cases, it never becomes independently profitable and the government eventually decides to put a halt to the waste. It decides to liquidate by selling off the assets.

There are various forms of incomplete privatization. The most important is contracting out. Contracting out means buying goods or services under contract instead of having them produced by government bureaus. It may occur at various levels. At the lowest level, the sub-department of a bureau may contract out part of its services while providing the rest itself. At the highest level, the legislature may direct the accounting bureau to contract out all of the services previously supplied by a bureau. In addition to contracting out, a government may privatize by deciding to charge user fees (Chapter Fifteen), by subsidizing demand through a voucher system, or by breaking up government-sponsored monopolies by permitting free competition from private suppliers.

These other forms of privatization are discussed in Chapter Eighteen. The purpose of this chapter is to consider the kind of complete privatization implied by the term "selling off a bureau." In our discussion, we shall focus on two main issues. The first is whether complete privatization will occur at the most efficient time. In a democracy, complete privatization is the result of a decision by elected politicians. We have seen in this book that political decisions often result in inefficiency. Important sources of this inefficiency are bureaucracy, rent seeking by pressure groups, and rational ignorance by ordinary voters. We shall see that when a service is already being provided, there are individuals who have a special interest in delaying or retarding liquidation. Especially important are those who are likely to lose their jobs or other benefits.

The second issue concerns how the liquidation is to be administered. Given that a legislature makes a decision to liquidate, how can the liquidation be most efficiently carried out? What procedure should a government follow if it wants to liquidate a bureau?

The second part of this chapter shows why there is a tendency to delay liquidation beyond the optimal time for it to occur. Part three shows how the privatization can be made more attractive in order to persuade voters and pressure groups to permit it to occur sooner. Part four describes various aspects of the administration of a bureau's privatization.

In theory, liquidating a bureau is a simple act. A government agency or think tank conducts a study and determines that the bureau's costs are greater than its benefits. The study shows either that a private company could supply the service more efficiently in the market or that the resources being used to supply the service could be used elsewhere in the economy to generate greater consumer satisfaction. The study is sent to the legislature, where a bill is passed directing the chief executive to shut down the bureau after, say, one month. At the end of a month, all the employees are laid off, the assets are sold to the highest bidder, and all the debts are paid. A surplus is used to finance some other project or to reduce taxes. A shortfall can be financed by borrowing, the loan being repaid over time.

Two reasons why legislatures often delay liquidation beyond the optimal time:

1. Losers ordinarily face lower costs and higher

individual benefits of forming pressure groups.

2. Voters do not know the true value of the

liquidation to them.

This is the theory. Practice is different. The most important difference seems to be that legislatures often delay liquidation until much later than its most efficient time. There are two reasons. First, the people who expect to lose from liquidation can ordinarily form a pressure group at lower costs than those who expect to gain. Second, voters ordinarily do not know the full economic inefficiency of the service. Some of the costs of continuing operation are hidden from view and voters do not have sufficient incentive to discover them (see Chapter 7). Especially important are delayed civil service costs, such as pensions and other benefits that current workers will not draw until some future time. Voters often are unaware that liquidation will save such costs. In this part, we discuss these causes of delay in greater detail.

We have pointed out that liquidation involves selling off assets. Let us assume for now that the assets can be sold for the exact amount that is owed. In this case, there is no debt or money left over. We will discuss the complications arising from debt in part four. Our interest here is to identify the people affected by the liquidation and who, as a result, have some incentive to put pressure on politicians. Our first step is to classify the gainers and losers.

We can identify four possible classes of direct gainers from liquidating a bureau.

They are (1) taxpayers, (2) the recipients of the other government services, (3) people who are in favorable positions to buy the auctioned assets, and (4) the auctioneer. People in these classes may have an incentive to try to influence legislators either individually or by joining pressure groups. On the other side there are three possible classes of direct losers: (1) the laid off administrators and employees of the bureau, (2) the suppliers of resources to the bureau, and (3) the people who no longer receive the discontinued service. Individuals in these groups may also have an incentive to influence legislators. We consider each set in turn, showing in the process why the losers ordinarily exert the strongest influence.

Taxpayers usually have only a small incentive to pressure politicians to liquidate a bureau. The reason is that their benefits are usually uncertain and small. Legislators seldom specify exactly what they intend to do with saved funds. Suppose, however, that they commit themselves to reducing taxes. Our first consideration is that taxes are often concealed. For example, suppose that the liquidation results in a lower sales tax on businesses. Competition will ultimately compel businesses to reduce prices of consumer's goods. However, ordinary citizens may be unable to tell whether a decrease in prices is due to a lower tax or to some other change in market conditions. Even if taxpayers could easily find out their tax savings, they may choose not to do so. They may stay rationally ignorant.

If there is a large number of taxpayers, the tax savings to each one would probably be small. The taxpayers may have little incentive to pay attention to them. Third, because taxpayers are numerous, they are likely to face high collective decision making costs. We conclude that taxpayers would ordinarily have little incentive to form a pressure group in an effort to promote the privatization.

Consider a relatively small national government service, such as a national arts museum. The tax savings from liquidating the museum may hardly be noticeable. Taxpayers have little incentive to pay attention to the issue of privatization, much less to join a pressure group. They work in dissimilar professions, live in different parts of the country, are members of different political parties and other organizations, and have different political and social views. The liquidation would tend to be delayed.

Taxpayers are unlikely to form pressure groups to promote liquidation because:

1. Their tax savings are uncertain

2. They are rationally ignorant of their prospective

gains

3. They face high costs of collective decision

making and a free rider problem.

We do not want to generalize too much. Taxpayers in local jurisdictions often have incentives to promote privatization. An example is garbage collection. Assume that the town government uses a government bureau to collect garbage and to dispose of it somewhere outside the city. A proposal is made to liquidate and to give the budget savings back to taxpayers. Since the politicians in the government must reveal the size of the garbage collection budget, a taxpayer may be able to approximately determine his share of the tax bill. He can compare this with the price he expects to be charged by a private company for the same service. He can find the private company's price by comparing his town to a similar town in which private companies supply the garbage collection services. Assuming that the private service is cheaper, he would cast his vote for a politician who introduced a bill to quit supplying the service. He may also join a pressure group. Of course, it is unlikely that each taxpayer would make this calculation. But a newspaper or opposing candidate might calculate the potential gain to the average taxpayer and then publicize it.

We conclude that although many voter-taxpayers may benefit from a liquidation, there are many cases in which the benefit to each one would be small and uncertain. Moreover, the costs to the beneficiaries of joining together in a pressure group would often be high. Under these circumstances, trying to pressure legislators to quit an inefficient service will be low on their priority list of ways to improve their well-being.

The second class of possible gainers are the consumers of other government-supplied services. These people may gain if the legislature agrees to use the money it saves and earns by selling off a bureau to increase the services supplied by other bureaus. However, legislators seldom specify the services they expect to increase. As a result, voters are usually uncertain whether the legislators will increase the particular service they consume. The decision to increase a service is made jointly by politicians during the budget review. Each politician presumably has a priority list, but the actual decision must be made collectively. Thus, even if a legislator promises to vote for a shift in funds to a particular service, he will not be able to keep his promise unless other legislators cooperate. Under these conditions, the uncertainty of consumers about which other government services will increase dampens the incentive to join privatization pressure groups.

Consumers of other services that may be increased as a result of liquidation are unlikely to form pressure groups because they are likely to be uncertain about whether the services they consume will, in fact, be increased.

If the government competitively hires a competent and trustworthy auctioneer, the benefits to the auctioneer and the buyers of the auctioned goods are likely to be small. These beneficiaries are unlikely to pressure the government to liquidate.

If a bureau possess-es assets, efficient privatization demands that those assets be auctioned off. In this event, there are two possible sets of direct beneficiaries: the buyers of the auctioned assets and the auctioneer. Regarding the asset buyers, if the auction is widely advertised and if the assets are fairly auctioned, the gain to any particular buyer is likely to be small and uncertain. Regarding the auctioneer, the benefits depend on how the government handles the auction. Suppose that the government hires the auctioneer by soliciting the lowest bid from a pool of auctioneer applicants that it determines are qualified.

Then the gain to the auctioneer who succeeds in obtaining the job would be small. Moreover, no single auctioneer would be certain that he would win the bidding. Thus, if the auction is managed properly, the pressure on legislators is likely to be small.

Now we turn to the prospective losers. The first class of these are the administrators and employees. In the event of liquidation, they will certainly lose their jobs. It is possible that after the liquidation, the government-provided service would be replaced by a private business service. Indeed, administrators and employees may start their own companies. If they expect this to happen, they may expect their losses to be substantially lower. However, if the service itself is in low demand, private supply would be unprofitable. Even if it is in high demand, the employees of the government bureau may not be competent enough to get jobs with a private company that supplies it. Many years of bureaucratic inefficiency may have so dulled their skills and habits that they would be at a disadvantage relative to workers accustomed to competitive market conditions. In this case, they would have to acquire new skills and work habits before obtaining a job that they regard as suitable. Besides, business success in the market economy is always uncertain.

Because administrators and employees are likely to lose a substantial amount individually as a result of liquidation and because there is a small number of them, they have an incentive to form pressure groups to stop or delay the liquidation.

The number of administrators and employees who expect to lose their jobs is likely to be low. At the same time, the personal losses to many of them will be relatively high. Moreover, the administrators and employees will certainly know about their prospective losses. In addition, they may be part of a close knit group. The administrators and employees of a bureau often interact face-to-face on a daily basis. They may have annual picnics or other social events. Employees may have a union or similar association. In this event, the costs of coming together for the purpose of trying to stop the liquidation are relatively low. In other words, the cost of forming a pressure group or of converting an existing organization into a pressure group is likely to be low. The same conditions are likely to be present for administrators, who ordinarily have regular meetings.

If a liquidated bureau is replaced by private companies, we cannot be sure whether the people who supplied resources to the bureau will lose or gain in net. They will surely lose their opportunities to supply to the bureau. However, private companies also demand resources. Nevertheless, it may not be profitable for private companies to replace a bureau's services. Moreover, even if private companies emerge, they may buy from different suppliers. It is possible, for example, that the resource suppliers to the bureau were being given special treatment by the government bureau and that the quality of their services is below that which private companies can obtain from competitors at the same prices.

If resource suppliers anticipate losses, they will have an incentive to pressure the legislature against liquidation. An example might be a relatively small town in which a government university is located. If the government decides to liquidate, the private universities that emerge in its place may decide to locate elsewhere. As a result, the many local, small business owners who service the government university will lose their main source of income. To avoid this, they may join together to try to persuade the legislature not to liquidate.

Depending on the situation, other suppliers of resources may have an incentive to form pressure groups in an effort to stop or delay liquidation.

Recipients of the service are likely to be more scattered. However, it may be easy in some cases for the administrators and employees to identify them and organize them into a political force. Often the employees have direct contact with the recipients, making it comparatively easy for the employees to recruit them as supporters.

Two factors lead us to conclude that the losers from liquidation are more likely to try to pressure politicians than the gainers: (1) they are more likely to know about their losses than gainers are to know about their gains and (2) the cost of forming a pressure group is likely to be lower. Accordingly, we can suggest that, in many cases, the balance of political pressure will favor the losers even though the gains from liquidation exceed the losses.

Recipients of the government-supplied good or service may sometimes have an incentive to join others to pressure the government to stop or delay privatization.

We should also recognize the role of the media. It is easy for the media to pick out specific losers from liquidation for interviews and sympathetic reports. There is usually only a small number of these losers and they are either employees of the bureau or recipients of the bureaucratized service. They know about their losses and stand ready to complain about them. The media may even be manipulated by pressure groups. Beneficiaries of liquidation are more difficult to identify. Although there is usually a large number of them, they are often unaware of or uncertain about the size of their benefits. It would be possible to interview specialists, such as economists. However, the economists' arguments are often more complex than the average viewer, listener, or reader is prepared to deal with. So they are less appealing to the media. Accordingly, the media typically report the losses and neglect the gains.

Legislators also play a part. They could reduce uncertainty by specifically designating that the savings will be used in a particular way. But they do not ordinarily do this.

The media typically report the losses due to privatization while neglecting the gains, since the former are easier for most of the public to understand.

Liquidation in a democracy is likely to be delayed beyond the optimal time.

From the standpoint of efficiency, liquidation should occur when the expected future benefits of the service no longer exceed the expected future costs. However, typical (i.e., functional) politicians and political parties look at the situation in terms of elections. To them, liquidation should occur when it will lead to an increase in votes. Suppose that the liberal party advocates liquidation at the most efficient time while the conservative party opposes the liquidation or promises to delay it. The conservatives will almost definitely receive the votes of the prospective losers. And they may not lose many votes from the prospective gainers, since the gainers (1) are unlikely to realize that they stand to gain and (2) are unlikely to be organized into pressure groups. It follows that under ordinary circumstances, liquidation will not occur until the gains from liquidation greatly outweigh the losses. Liquidation in a democracy is likely to be delayed beyond the optimal time.

One reason that liquidation is delayed is that current taxpayers typically do not have to pay the full costs of the service. Some of the costs of running the bureau are deferred. That is, part of the cost must be paid by future taxpayers, who are not represented in any politician's constituency. To understand how, we must consider the civil service.

We discussed the civil service in Chapter Thirteen. It refers to all long-term employees of government bureaus. Civil service contracts give the employees future claims to government receipts of money and services. Because the claims are enforceable in court, the government has an obligation to pay them. Employee claims against the civil service are part of the government debt. Ultimately, this means that citizens must somehow pay it. However, it is incurred by a particular government agency. Suppose that the Department of Education hires a new mid-level administrator and, after a trial period, certifies that he is qualified. As a result, let us assume, he acquires a right to post-employment benefits or retirement pay equal to one half of his ordinary earnings. Then hiring adds to what we call thecivil service debt. This refers to all claims against the government that exist as a result of contracts with civil service employees and that will not be paid off until the future.

Why does the government incur civil service debt? The main reason is that politicians quickly discover that government debt is a means of deferring and concealing the costs of a bureau. We can see this with a simple example. Suppose that the mayor of a small town wants to hire three new police officers in order to enhance her image as a "crime-fighter" and thereby improve her chances of being reelected. Assume further that if she pays them entirely in money, the cost would be $120,000. However, she need not pay them entirely in money. She can offer the officers a combination of pay plus a bundle of claims against future taxpayers. Let us suppose that she can offer a bundle worth $30,000. Then she could reduce the current cost to $90,000. With the savings she could either reduce the burden to current taxpayers or hire another officer. This is cost deferring. The bill for the services will have to be paid by the future taxpayers when the new officers begin to receive their retirement and other benefits.

Civil service debt: all claims against the government that exist as a result of contracts with civil service employees and that will not be paid off until the future.

Government workers often ask for deferred benefits in their negotiations with the government. For example, the police, bus drivers, subway operators, or trash collectors may know that a mayor and legislature ordinarily have less to lose if they agree to increase their deferred benefits than if they give a comparable increase in pay. If the workers demand a pay raise, the politicians might not agree because they would be afraid that unhappy voter-taxpayers would replace them in the next election. By imposing the burden on future taxpayers and partly concealing it, incumbents and their political parties may avoid displeasing today's voter-taxpayers.

An alternative way to finance additional current spending on government services is to issue government bonds. Why don't governments simply borrow money instead of deferring benefits to government employees? One answer is there may be laws or constitutional restrictions against it. Local and state governments in the U.S. are typically prohibited from borrowing; or their borrowing is restricted to specific classes of projects, such as bridges and roads, which are regarded as long-term investments. Even national governments may face borrowing limitations or a balanced budget requirement. In these cases, the politicians have no alternative.

Civil service debt is a means for politicians to defer and conceal the costs of a bureau.

There may be a political reason, however. Both methods -- borrowing to finance higher pay and deferring pay -- have the effect of raising rates of interest. In both cases, this is because of an increase in the demand for loans. Government borrowing increases the demand for loans directly, while deferring payments does so indirectly. As employees realize that they have more future security but less current income, they borrow in order to finance their purchases of cars, houses, children's education, vacations, and other items. The two methods of financing will not have exactly the same effect on interest rates, but the difference is not likely to be great.

In the minds of voters, there is a more direct link between the government borrowing of money to finance a bureau than there is to its deferring some of the costs of financing. Voters are not likely to realize that these two methods are similar in their effects. Thus, politicians usually prefer to defer the costs than to borrow.

To see the political reason for not borrowing, put yourself in the shoes of someone who is harmed by higher interest rates. If the government has increased its borrowing, you can readily and properly blame the politicians for the higher rates. However, if the rise in rates is due to increased government employees' borrowing, you may be uncertain who to blame. This is why we say that deferring benefits conceals the costs more than government borrowing.

The deferred nature of civil service benefits may delay liquidation beyond the efficient time. Let us suppose that legislators are deciding whether to abolish a bureau. They have calculated that the benefits of the bureau’s service to consumers are slightly less than the current costs plus the deferred costs. Voters, however, are not likely to know about the deferred costs. Moreover, many voters may not even care about them. They may expect future generations to pay them. A politician who decides to support a liquidation at the optimal time will not gain votes by doing so because voters are unlikely to know or care about the true cost savings. The liquidation is likely to be delayed until the losses become substantially higher than the amount needed to economically justify the liquidation.

Two ways to reduce delay in liquidating a bureau:

1. Pay compensation to bureaucrats

2. Pay compensation to beneficiaries of the

service

There are at least two ways to reduce the inefficient delay in liquidating a bureau. Both involve paying compensation. First, compensation can be paid to workers who lose their jobs as a result of the liquidation. Second, compensation can be paid to the former beneficiaries of the government service. We discuss each in turn.

One way to reduce the political resistance to liquidation is to offer severance pay. Severance pay is money given to a worker at the time she is laid off. It not only reduces worker opposition to the liquidation, it also affects voter empathy. Knowing that the workers will be compensated, the typical voter will feel a lesser social duty to continue the bureau in order to provide security for the bureau worker. Also, because severance pay is highly visible, it is likely to be reported by the media.

Severance pay must be used cautiously, however. The reason is that it is also a means of deferring costs. To see this, put yourself in the shoes of a person who is deciding whether to take a job with an existing government bureau. You expect that the bureau may be liquidated in the near future but you are uncertain whether and when this will happen. Other things equal, if you expect to receive severance pay at the time of liquidation, you will regard the bureau job as more desirable. Because of this, a promise of severance pay in the event of liquidation is a means for politicians to hire more employees with less current money. It is a kind of deferred benefit to the employees. The main thing that makes it different from other deferred benefits is that it is uncertain.

Severance pay: money given to a worker at the time she is laid off.

Severance pay (1) reduces worker opposition to the liquidation and (2) reduces voter empathy for workers.

When we discussed deferred pay earlier in the chapter, we showed that it is a means of concealing the true costs of hiring workers. Not knowing the true costs, voter-taxpayers will not put pressure on politicians to quit supplying a service even though it is efficient to do so. The voter-taxpayers will remain rationally ignorant of the true costs. As a result, the use of severance pay may, on this account, contribute to a delay in the time of liquidation.

One way to avoid part of the deferred cost aspect of severance pay is to make the amount of severance pay vary with the length of service. Under this scheme, relatively new employees would receive only a small amount while employees with high seniority would receive a large amount.

If a government does use severance pay, it is best to make the decision to do so at the time of hiring and to make it universal for all government employees. For example, the legislature might make a general policy of giving a certain per cent of one's total previous salary in severance pay to a worker who is laid off during a liquidation.

From the point of view of the bureaucrat, severance pay is a kind of job loss insurance. But from the point of view of the voter-taxpayer, it is a means of dampening the incentive to form pressure groups in a case where such pressure groups would delay the liquidation beyond the optimal time.

As in the case of workers, the former beneficiaries of government services may arouse sympathy from voters and the press. Such sympathy can delay a liquidation. Beneficiaries may also form or join pressure groups. If they are compensated for the liquidation, the sympathy and incentive to form a pressure group will be reduced. Precisely how much compensation is adequate would have to be determined separately for each case. For an example, a legislature may decide to give each former beneficiary an amount of money equal to her share of the total costs of the bureau over some period of time. Suppose that the three-month budget for the service has been, on average, $3 million. Suppose further that there are 10,000 beneficiaries. Then the legislature may pass a law that gives each beneficiary $300 in compensation.

We define reliance compensation as special benefits to consumers who have come to rely on the continued receipt of a liquidated bureau’s services. An argument can be made that liquidation should require that such consumers receive this compensation. This is a problem of how uncertainty-bearing should be allocated. We can learn something about the issue by considering a private company. When a private company goes out of business, its remaining customers lose a purchasing opportunity. Long-term customers may have relied on this opportunity. Private parties can avoid bearing this uncertainty, however. For one thing, a customer can demand a contract which specifies that the company must compensate her in the event of liquidation. If she expects that the losses will be so high that compensation is impossible, she can require collateral or guaranty. Or a customer can purchase from a company that has a reputation for stability and longevity. Typically, she must pay a higher price or accept less service in order to avoid the uncertainty. But she has the opportunity to do so if she wishes.

Many consumers, of course, choose not to pay the higher price for the reduced uncertainty. Assuming that they have experience in the market, we must deduce that, when they choose the lower price, they are also choosing to bear the uncertainty themselves. More generally, we assume that consumers in private markets can choose their level of reliance.

Reliance compensation: compensation paid to individuals who are damaged by a liquidation because they have come to rely on the services supplied by a bureau.

Government agencies and bureaus are different. Recipients of government services ordinarily cannot make contracts with the government to avoid bearing the uncertainty that expected services will not be supplied. Citizens do not ordinarily give their agents and bureaucrats the power to commit future resources for this purpose. Nor can recipients choose their level of reliance from among competing companies. The government is typically the only provider of the service. As a result, consumers of a bureau’s services cannot ordinarily choose their level of reliance. Thus, reliance compensation may be a sensible policy.

The actions required to administer a liquidation are (1) stop hiring and buying the resources (2) pay compensation, if appropriate, and (3) sell off the assets. We discuss each in turn.

Ordinarily, it is easy to stop buying the non-human resources. Human resources -- administrators, laborers, and bureaucrats at various levels are a different matter. If they are not specialized, they may be transferred to other bureaus. They can substitute for people who the other bureaus would have hired. The possibility of transfer is limited, however, by the rate of employee turnover in the other bureaus and their rates of growth, If workers do not quit or retire from other bureaus and if other bureaus are not growing, there would be no transfer opportunities.

More importantly, most human resources are specialized to some degree. Each job differs in some measure from other jobs and each prospective employee has different experience and aptitude. The transfer of people who are specialized with respect to one bureau to specialist positions in another bureau is usually unwise from the standpoint of the efficiency of the target bureau. Requiring the chief of a bureau to accept transferred employees takes away his ability to choose what he regards as the most suitable workers for the job. So it seems best to avoid this practice.

It might be thought that the bureau charged with liquidation (the liquidation bureau) should transfer the less specialized bureaucrats, while laying off the more specialized ones. However, the bureaucrats at the liquidation bureau are not likely to be skilled in deciding the level of specialization of a worker in a bureau they aim to liquidate. Moreover, they may not even be motivated to do this job efficiently. After all, the liquidation bureau itself has the same bureaucratic characteristics and faces the same kinds of political pressure as other bureaus. In ordinary circumstances, it is best to minimize the complexity of the liquidation bureau's task.

Recommendation: bureaucrats should not usually be transferred from a liquidated bureau to another bureau.

The best policy is usually to lay off all the workers and to compensate them with severance pay. If a worker is indeed qualified for a different government job, she can apply for it and get it.

Suppose that the money received from selling off assets is too low to pay compensation to workers and beneficiaries. How should the shortfall be financed? Assume that the bureau had been financed with general tax funds. Then general tax funds should be used to pay for the liquidation. If the amount is high, however, there is no reason to place all of the burden on current taxpayers. It may be paid off over time. Suppose that the annual budget for the bureau had been $1 million and that the shortfall is $12 million. Then $12 million may be borrowed from private markets for a period of time such that repayments of $1 million per year would exactly pay off the loan. At 8%, the loan could be paid off in approximately 13 years.

Recommendation: A substantial shortfall in liquidating a bureau should be paid off over time.

Whenever the government sells assets, it should use a competitive bidding process if possible. To obtain the highest price, it is best to turn the job over to a private auctioneer, who receives a commission on the proceeds. A goal should be to insure that potential bidders are well informed -- given the cost of informing them. Thus the government agent who is charged with choosing auctioneers should ordinarily choose one who promises to advertise widely and who makes a contractual promise to conduct a fair auction. A potential problem is that an auctioneer may violate the contract. For example, he may have an incentive to allow some of the assets to be sold at a lower-than-market price in exchange for a kickback. To avoid this, the government must have a means of monitoring the auctioneer and it must threaten him with punishment if he violates the contract.

Recommendation: Assets should be liquidated by employing an auctioneer whose services are obtained through competitive bidding. The auctioneer must make a contract to conduct a fair auction. The government should effectively monitor the auctioneer and threaten to punish him if he violates the contract.

Like all government programs, a liquidation program must ultimately be the responsibility of government. Unlike most government programs, however, the demand for the service of privatizing is temporary. Because a permanent liquidation agency is not necessary, the legislature should set a deadline for achieving the liquidation goal and then cut off funding for the agency chosen to do the liquidating.

Recommendation: the agency chosen to conduct a liquidation should be a new or recently established one. The agency should be headed by a non-partisan.

There are several alternative ways of administering liquidation. These include creating a new agency, delegating the task to an existing agency, and contracting out. We can describe no rule for deciding which of these is best. However, we can say two things. First, the task should not be assigned to an agency that has existed for a long period of time, especially if it is known to have been subject to special interest pressure. For such an agency, networks of influence and rent-seeking specialists will have already emerged to facilitate the rent-seeking and other pressure. It would not take long for the existing network and specialists to link with the groups of people who expect to lose due to liquidation. Second, the administration will be least subject to rent-seeking pressures if a person known to be non-partisan, other things equal, is chosen to head the administration. What is important is to choose someone who is sensitive to the need to compensate the losers and who will want to avoid being unduly influenced by the special interests. Of course, such a person should also be competent at carrying out the liquidation job. There is no reason to believe that the best person for the job is a citizen. The market for liquidation specialists is international. So it might be best to hire a foreigner to administer the privatization.

The legislature of a former socialist nation may decide to liquidate many of its businesses at once. A danger is that the legislature will create a new liquidation bureau to liquidate one business at a time over a long period. Not only would such a liquidation bureau be subject to the same pressures as other bureaus, the staggered schedule of liquidation would give some pressure groups opportunities to observe the operations of earlier liquidation efforts. This would enable them to develop more effective delaying strategies and would lead to greater waste. It is important to realize that if liquidation reduces waste, this reduction starts immediately. To delay a planned liquidation invites pressure groups to perform actions that cause further waste.

3. Tell the difference between the two types of privatization: complete privatization and contracting out.

4. Complete privatization, or liquidation, is a simple matter. Put yourself in the shoes of a chief executive who is ordered by the legislature to quit supplying some service. Tell what you would do. (Be sure to consider the possibility that money would be left over or that it may not be possible to pay off all the debts.)

5. Define liquidation of a bureau and give an example that is different from the text.

7. Suppose that the government quits providing a service that is no longer economically efficient for it to provide by selling off its assets. Who gains from this?

8. Suppose that the government quits providing a service that is no longer economically efficient for it to provide by selling off its assets. Who loses from this?

9. In discussing the three classes of direct beneficiaries from a liquidation, the text reaches the following conclusion: "we can suggest that, in many cases, the balance of political pressure will favor the losers even though the gains from liquidation exceed the losses.” By discussing each of the beneficiaries, tell why the pressure from them is likely to be weak.

10. In discussing the three classes of direct losers from a liquidation, the text reaches the following conclusion: "we can suggest that, in many cases, the balance of political pressure will favor the losers even though the gains from liquidation exceed the losses.” By discussing each of the losers, tell why the pressure from them is likely to be strong.

12. How could politicians reduce uncertainty among the beneficiaries of liquidation about the amount of benefits they will receive?

13. By taking the viewpoint of a politician, tell why liquidation is likely to be delayed beyond the most efficient time. In your discussion, disregard the deferred benefits to civil service workers.

14. Why does a democratic government incur debts to civil service employees? In your answer, (a) describe the goal that such debts enable politicians to achieve and (b) show that at least one alternative way of achieving the goal is less desirable.

15. Explain why politicians are likely to think it more desirable to defer the costs of supplying government services (a) by giving civil service workers deferred benefits instead of (b) by borrowing in the loan market.

16. If civil service debt delays liquidation beyond the optimal time, why don’t legislators finance their current supply of services without incurring civil service debt?

17. Name and describe two ways of making liquidation more politically attractive. In other words, tell how to reduce the political pressure against liquidation and to increase the political pressure for it.

18. Explain how giving laid off workers severance pay helps to reduce the opposition to a liquidation. Then explain how, on the other hand, it may contribute to a further delay in the liquidation.

19. "When a liquidation occurs, the former beneficiaries of the service should be compensated because they had relied on its continuing supply." Evaluate this statement.

20. In administering a liquidation, what should the government do in order to obtain the highest price for the assets its sells?

21. In administering a liquidation, what should the government do if there is a shortfall of funds -- i.e., if the debts owed exceed the revenue from the assets?

22. If a liquidation bureau is used to liquidate other bureaus, how can the probability be minimized that it will be influenced by pressure groups?

Gunning’s Address
J. Patrick Gunning
Professor of Economics/ College of Business
Feng Chia University
100 Wenhwa Rd, Taichung
Taiwan, R.O.C.
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