Private vs. Privatization

The free market is understood to be the optimal delivery mechanism for most goods and services.  As competition intensifies, the weaker competitors are selected out and the stronger competitors are selected in.  The stronger competitors grow and evolve to meet the demands of a particular consumer base.  Friedrich von Hayek called this behavior of the market a "spontaneous order" and posited spontaneous order as a generalized Theory of Evolution.  Darwinian Evolution can itself be described as a special case of spontaneous order, as can language, memetics, pedestrian traffic, the popularity of music, the price mechanism, Wikipedia, and the order of the universe.  For his work on the price mechanism, Hayek won the 1974 Nobel Prize in Economics.

The market is a remarkably efficient way to coordinate the relative scarcity of goods with the tastes and preferences of the world’s six-billion people; nevertheless, there are externalities that are not properly valued by the market.  The resolution of the negative effects of externalities has often been the province of government.

While theories of the market economy have been accepted by the mainstream, they’ve been grossly misunderstood.  What’s been happening lately in the American economy has been a wave of “privatization”.  Privatization is when a public entity is essentially released to the forces of the market.  The rationale is that, by subjecting public entities to the competition and accountability of a market economy, the typical inefficiencies of government agencies will be eliminated.  However, privatization is like releasing rabbits in Australia, in the sense that the architect of that plan failed to realize that the environment in which rabbits evolved to an equilibrium was fundamentally different from that of the Australian outback.  Rabbits, along with a score of other introduced European mammals, are now considered a major threat to indigenous Australian marsupial species.  In ecology (and many other fiedls), we’ve learned the lesson that species which evolved in one environment create major disturbances if transported into another.  Why can’t we learn this lesson in economics?

Privatization’s popularity arises from a misunderstanding that because private is “good”, all we have to do to improve a government service is to make it private.  This over-simplified understanding of the market ignores why private is good: because private entities evolve organically; they are selected by a consumer base that collectively knows far more about its own preferences than central government planners.  Privatization also ignores the fact that government services are designed as solutions to externalities, which, by definition, cannot be solved by privatization. 

Fannie Mae and Freddy Mac were two such privatized entities.  When they failed, politicians pointed to the fact that they were “private” to say that the problem was too much capitalism.  What had actually happened is that they were not private; they were privatized.  Nothing had changed except that ownership had been effectively transferred from the government to private investors.  In the case of privatized institutions, investors know that the fact those institutions fill a role deemed important enough to justify their creation by the government in the first place means that they cannot be allowed to fail.  Therefore there is no risk to investment, because when such large, semi-governmental privatized corporations do fail, they are simply bailed out by taxpayers.  This is a classic example of capitalism for the gains, socialism for the losses.

Citizens in Japan lament the privatization of their postal service in 2004 under Junichiro Koizumi’s administration.  Before the change, the post office operated on a mild percentage of taxpayer dollars, yet, since private is good, the post office was privatized as a stimulus measure.  The only thing that actually changed was the description.  Only now, instead of being overseen by politicians, the inherently unprofitable post office is subject to the profit motive.  Costs have risen substantially since privatization, while services have not. 

Privatization essentially amounts to throwing an institution designed to resolve an externality into a market by definition incompatible with that institution.  Privatization skips the formative stage where the entity chooses a market niche.  It skips the intermediate stage where the entity is subjected to efficiency-inducing competition and accountability to ownership, and it goes straight into the too-big-to-fail stage.  Privatization is like a toddler, who, instead of first practicing on a tricycle and training wheels, goes straight for a motorcycle.