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August 16, 2009

Economist's View - 4 new articles

How Will We Know when the Economy Turns the Corner?

One question I am asked fairly often is how we will know when the economy turns the corner and we are on our way to a solid recovery. My answer is that we will be able to detect upticks in the data, though this may come with a bit of a lag, the important but harder task will be to understand why the data are showing improvement.

In order to be convinced that the economy is on solid footing and headed to better times, I will want to see several things. First, though not necessarily foremost, that banks are being recapitalized with private sector funds, and that this is happening without the aid of government guarantees or other such programs that encourage capital infusions (which is hard to determine while the government programs are in place). Second, I will want to see private sector non-residential investment improving, another sign that private sector funds are moving back into circulation. Presently, this hasn't even started heading back upward, though there are signs the decline is slowing:

And there are other important factors too, e.g. consumption rebounding (though not to pre-crisis debt sustained levels), stabilization in housing markets, and so on. The point is that a self-sustaining recovery will require that the private sector be the primary driver of new economic activity, and that is what I will be looking for.

Once the economy does start to recover, the hard but critical part will be to determine how much of the recovery is self-sustaining (as it will be if private sector funds are driving the activity), and how much is being driven by government stimulus programs. If the recovery is self-sustaining, and we are fairly certain of that, then we can begin to carefully wind down the government programs supporting the economy. But if the recovery is mostly due to government stimulus and there is little sign that the financial and real sectors are attracting robust levels of private sector funds, then pulling back on government programs could be disastrous and plunge the economy right back into recession. In fact, in such a case, we may need to provide even more stimulus to fully bridge the gap until the private sector can support the economy on its own.

So, in answer to the question, we will have a pretty good idea when the economy turns the corner, but it will take awhile to determine why, and we cannot risk pulling back on government programs until we are sufficiently certain that the private sector can support normal economic activity without the government's help.


"A Public Option Isn't a Curse or a Cure"

This was in today's links and received quite a few comments, so I'll put it into its own post in case people want to continue the discussion (I think the post below this one refutes some of the main points, e.g. that the public sector can never win a fair fight or be innovative):

A Public Option Isn't a Curse, or a Cure, by Richard Thaler, Commentary, NY Times: [T]he question of whether a "public option" should be part of the health care solution ... is a red herring, and is getting in the way of genuine reform.
In debating the public option — that is, an insurance option run by the government — the politicians themselves are making exaggerated claims about its pros and cons. We hear from the right that an insurance plan run by the government will drive all private-sector insurers out of business and be the first step toward socialism, if not communism. The left claims that only a public option can give evil insurers the competition they need to create much-needed reform.
To evaluate these contentions, we need to know some details about how a public option would work in practice. And those details have been missing.
For example, President Obama has said that the public plan would be required to break even financially, but Congress hasn't decided how to make that happen. ... Nailing down this detail is crucial. If the public option does not have to break even — if, in fact, it is to receive government subsidies — then it is correct to worry that it would destroy competition, not foster it. ...
A second detail is whether the government will grant the public plan the power to impose special deals with suppliers like hospitals and drug companies — a move that would dampen, not enhance, competition with the private sector. But let's assume that the public option does have to break even and can't make any special deals. What should we expect to happen?
Here is a thought experiment: Can you think of a domain where a government-run business competes successfully with private-sector companies? ...President Obama mentioned one such example: the market for overnight shipments. This market now has two main private suppliers, FedEx and UPS, and one public one, the United States Postal Service. When you have to send something overnight, which one do you use? Most shippers choose one of the private companies. ...
More generally, it is hard to find examples where government-run businesses compete with private companies and win. One reason is that governments are not very good at innovation. As the great 19th-century economist Alfred Marshall wrote, "A government could print a good edition of Shakespeare's works, but it could not get them written."
But what about the often-stated fact that Medicare has much lower operating costs than private insurance companies? Won't this allow the public option to compete successfully? As Victor Fuchs ... recently argued in The New England Journal of Medicine, this is not an apt comparison because the new public plan would have marketing and other administrative costs that don't apply to Medicare with its captive market.
All of this leads me to conclude that if we impose sensible rules on the public option, it will neither save nor destroy the health care system because it will simply not get much market share. And if we do not impose those rules, the public option will hurt rather than help.
So here's some free advice to members of Congress: ...
To the Republicans, I say this: If you can get real assurances that the public option has to break even, and that it will get no special deals from suppliers, let the Democrats have it but ask for concessions on tort reform in return. (That could actually save some money.) The resulting public plan will be too small to notice.
To the Democrats, I say this: If you want competition in health care, you won't get it if the public option can make deals its competitors can't. So either give the Republicans hard assurances that the public option would have to break even and not get special treatment, or, better yet, just give it up to ensure that some useful health care reform is passed. A public option is neither necessary nor sufficient for achieving the real goals of reform, and those goals are too important to risk losing the war.


Public Private Competition in Garbage Collection

The public option for health care appears to be dead, so this is a bit late, but I keep hearing that there are no examples of public-private competition, let alone successful ones. But there are examples of this, and they have been successful.

We are used to the argument that the private sector can discipline and usually beat the government in terms of providing services at minimum cost (though I should note that is not always true). What is harder to find is anything written on how the government can do the same to the private sector, force them to provide innovative services at minimum cost (the point of the public plan in health care), partly because nobody ever seems to ask that question. Thus, an important part of this description of public-private competition to provide garbage collection services in Phoenix to note is that the discipline runs both ways, government forces the private sector to lower costs and be innovative, and the private sector forces the government to do the same (e.g. see the part at the end where the private firm loses the contract to the government and vows to win the next contract with its experimental truck).

This article was written in 1984, so it is untainted by the current debate, but this was also a time period when there was a lot of enthusiasm and interest in privatization. Hence, many of the articles written around this time are slanted toward examining how the private sector can discipline the government, not the other way around. Still, the story below makes clear that the city did force the private sector to continue to innovate and improve. Another interesting point is that the private sector contractor claims that the bidding process is much improved when the city is forced to participate (e.g. in specifying specs, see the full article for more on this point), a benefit of public-private competition that is often overlooked (I couldn't find much written on the Phoenix experiment more recently, so I don't know for sure how well the program has performed since the 1980s and 1990s when most of the articles on the Phoenix experiment appeared, but it does appear that currently the city won contracts in two of the three regions where private sector competition is present):

Entrepreneurs Can Do Everything Government Can Do, Only Better, by Eugene Linden, Inc., Dec. 1, 1984: Chuck Walbridge and Ron Jensen both see themselves as solid businessmen. There is a certain irony in this perception: Although both may be solid, Jensen is not a businessman at all, but a government bureaucrat.
That hasn't kept him from competing with Walbridge, however. Last year, for example, the two bid on the same contract, with Walbridge coming up the winner. Jensen has vowed that it won't happen again."We will be analyzing every cost to see where we might have gone wrong," he says. Walbridge, for his part, admits that Jensen is a tough competitor...
Jensen is director of the Public Works Department of Phoenix -- a city that regularly invites private companies to bid against its own agencies on various contracts. It was such a contract, the one for garbage collection, that was awarded in the summer of 1983 to Walbridge's company...
The ... concept behind privatization is not as new as it may seem. U.S. government administrations have long vacillated between providing services themselves and contracting them out. During the early 1800s, for example, privately operated bridges, tollroads, fire departments, and street lights were commonplace. Subsequently, gross abuses by both private contractors and public officials led to an outcry that caused governments to start providing the services themselves. Now the wheel has turned full circle, and privatization is seen as a solution to the problem of governmental bloat -- a way for governments to provide improved public services and reduce expenditures at the same time. ...
Walbridge's company, National Serv-All, is a 27-year-old, family-owned garbage-collection and -disposal business... It was Chuck Walbridge's father, Glen, who launched the family in the garbage business ... in Anderson, Ind...
Chuck Walbridge, who took over in 1979, concentrated on learning the business: how to deliver the service and how to keep the customers satisfied. ... Small as the company was, Walbridge was keenly interested in efficiency and innovation, and he constantly searched for ways to lower costs and improve service. Toward that end, he struck up a relationship with International Harvester Co.'s engineering division, which was located in Fort Wayne, and began testing Harvester's new trucks, making suggestions about improvements. He also began designing his own vehicles, trying out different bodies and control systems. In his quest to keep up-to-date with the latest advances in garbage collection, he made his first trip to Phoenix in 1975.
At the time, Phoenix had not yet begun to contract out its garbage collection, but it did use an innovative collection system designed to minimize labor costs and beat the desert heat. The system was built around a fleet of one-person trucks with mechanical arms that could pick up large, standardized containers. (Today, such containers are so big that transients occasionally take up residence in them, and Walbridge instructs his men to shake the containers before dumping them.) Walbridge was fascinated by the idea and inquired where it had come from. He was told that Phoenix was working with a system developed by a small Arizona company with the unlikely name of Government Innovators Inc.
Government Innovators is a story in its own right. Founded in 1971, it had grown out of the lunchtime bull sessions of a group of entrepreneurially minded bureaucrats in nearby Scottsdale, Ariz. For entertainment, they had often brainstormed about how they would improve their departments if they could keep the money they saved. Among the ideas they came up with was one for automated garbage trucks. The idea seemed like a natural -- so much so that they even designed the equipment and went looking for a company to produce the system. When they found no solid offers, they decided to do it themselves, building the nation's first automated garbage-collection system within the Scottsdale Public Works Department. Subsequently, some of them left public service and formed Government Innovators.
Curious about the possibilities of such a system, Walbridge purchased one of Government Innovators' trucks and took it back to Fort Wayne. Over the next few years, he experimented with various modifications, which he discussed with people at the company. They were duly appreciative. ... Walbridge's knowledge of equipment and systems stood him in good stead in 1983, when National Serv-All suddenly found itself competing nationwide against the giants of the garbage-collection industry. ...
Walbridge was ... impressed with the situation he encountered when he returned to Phoenix in 1982. There had been changes since his first visit seven years earlier. For one thing, the city had begun inviting bids for city contracts, largely in response to the budgetary constraints arising from the tax revolt of the late 1970s. That was a situation faced by government officials all over the country...
The center of privatization activity in Phoenix has been Ron Jensen's Public Works Department, which began inviting bids on garbage-collection contracts in 1978. From the beginning, the city stipulated that the Phoenix Sanitation Division would hold onto 50% of the business, to ensure that garbage collection would continue in the event that a private vendor proved unable to deliver service for one reason or another. The other 50% was put out for bidding, with the sanitation division competing against private vendors for two of the four available five-year contracts.
To keep the department's bids honest, Phoenix arranged to have them prepared by the city auditor, who made sure that they represented costs fairly on a basis comparable to those used by the private contractors. This task was easier in Phoenix than elsewhere because the city uses cost accounting. Thus, for example, the city's equipment fleet is centralized in one division of the Public Works Department and then "rented out" to various departments at a per-mile or per-hour rate calculated to reflect overhead. Management overhead is likewise apportioned among the department, right down to a fraction of the city manager's salary.
All of these systems were in place in 1982 when Walbridge returned to Phoenix... Walbridge believed National Serv-All would be in a strong position vis-a-vis other competitors, thanks to his own knowledge of the city's equipment and collection system. "I had helped to design the [Harvester] trucks Phoenix was using," he says."We knew more about them than anyone else. While Waste Management and the others buy their equipment, we custom design our own. . . . One of the reasons we beat [both the giants and the city] was that we planned to take their bodies off and put our [more efficient] bodies on." Although the city did have an advantage in knowing the actual costs of maintaining the equipment, says Walbridge, "I felt we had about a 15% advantage in productivity. Our system would load barrels faster, and our compactors gave our bodies more capacity."
In the end, that proved to be the difference. Walbridge's winning bid for contained garbage was a mere penny lower than the city's (on a unit-per-household-per-month basis). Waste Management came in third, SCA Services fourth, and Browning-Ferris Industries fifth. The thinness of the margin notwithstanding, the city conceded defeat and awarded the contract to National Serv-All. ...
National Serv-All might lose the Phoenix contract when it comes up for bid again in four years. Not that Walbridge expects to lose. "Phoenix is exceptional as far as cities go," he says. "They have a better understanding of business, and they are fair." But, in a fair contest, he believes he can usually underbid a government agency. "A city is hobbled by a low-bid requirement in the purchase of equipment, which sometimes forces them to take equipment that may not be the best. I can buy what I want." That means, for example, that a city might be unable to purchase Government Innovators truck bodies, which cost 10% more than other models, but reduce overall costs by about 20%. Adds Kevin Walbridge, "We're motivated, while cities are still cities. They will always be bureaucratic."
Marvin Andrews and Ron Jensen don't agree. They believe that government workers can be motivated to keep costs down, if only because they want to hold on to their jobs. "Quite frankly, we learn from the experience of going through the contracting process," says Jensen. "When we lose a bid, it's up to us to figure out why we lost it. Where were our costs too high? Was it equipment costs? Labor costs? And this whole feeling of competition gets to the unions, too."
This past August, Jensen's department demonstrated just how serious it was about the process, turning in the low bid on a major contract for both contained and uncontained refuse. The city's bid, moreover, was low by a substantial margin, thanks in part to its planned purchase of a fleet of new trucks. National Serv-All -- which came in fourth in the bidding -- was taken by surprise. "What they did," says Walbridge, "was to tighten up their specs on their trucks. It was smart on their part -- the new truck is a first-class piece of machinery." Walbridge says he is now working on an experimental truck that will allow National Serv-All to do better the next time around.
While stimulated by the competition, Walbridge is still not thrilled by the Phoenix approach to privatization. Granted, it works in Phoenix, but elsewhere -- he says -- it is subject to abuse. After all, many governments are less scrupulous than Phoenix's, and Walbridge would prefer not to spend $30,000 preparing a bid only to find that the competition is rigged, or that the process is so murky that he cannot figure out what is going on."I understand a private bid, but it is very difficult to know how a city formulates its bids."
Walbridge's cautions notwithstanding, it is precisely the competitive discipline imposed by Phoenix's system that makes the city an attractive place for National Serv-All to do business. Only by applying private-sector standards to its employees and departments -- and by subjecting them to competitive pressures -- is the city government able to keep track of its real costs, and thereby to come up with detailed job specifications. Without competition, privatization in Phoenix would be subject to all the problems and pitfalls that Walbridge encountered in other cities.
From that perspective, the Phoenix system -- a system of sound management leavened with a touch of entrepreneurism -- may well hold the key to the future of privatization in America. If it does, Chuck Walbridge is liable to find himself competing with government bureaucrats like Ron Jensen for years to come.

Update: I meant to include this 2003 article as an example of government's ability to innovate:

Ron Jensen, Phoenix's public works director, was the driving force behind the development of the first automated collection truck system "He actually is the one who started the privatization effort here as well," Franklin says.

Tinkering with Equipment

Obviously, automation relies on equipment, which Franklin remembers vividly as the biggest hurdle. "I started as a mechanic in 1979 and worked on the stuff that the city was running. Most of the equipment was farm machinery hydraulics and stuff built in the basement," he says. "We had a hydraulics shop that had eight or nine people working internally, building a lot of components. We built our own lifts and did those things to support ourselves because the industry wasn't mature enough."


links for 2009-08-16

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