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Wednesday, June 27, 2012

Primer : Profit Motive and Public Institutions

Barry, My Liege :

There appears to be a trend of appointing successful business people to the governing boards of public bodies. The University of Virginia created headlines recently with its attempt to introduce business methodology into a publicly supported University.

It is no secret that public funding at State and local government levels for the support of public education is in danger due largely to lower tax collections. Additionally, there does exist a political philosophy which encourages the demise of public education for some reason.

In response, some institutions are downsizing in order to meet the lower level of tax support available today, while others are applying business models in an attempt to increase revenues.

However, My Liege, there is a fundamental contradiction between a business model and a public model.

As we go forward, it will be well to remember this contradiction.

In a business model, the objective is to reduce costs in order to increase profits. In some cases, costs can be reduced for the business by having other entities pay the costs. The economic term for this is 'externalized costs'.

For example, automobile manufacturers are not required to pay all the costs which their products incur ; costs such as air pollution, road construction and maintenance and costs associated with accidents are all borne by the society at large.

If automobile manufacturers were required to pay all the costs they create, the price of an automobile would be so high that the companies would sell very few cars.

But, public institutions have different objectives. In most cases, public institutions attempt to provide services which have 'externalized benefits' ; in other words, the benefits which public institutions create accrue to society at large and not to the institution.

For example, consider a public water delivery agency which charges very low prices and attempts to provide all people with clean water. Society at large will benefit from its operations even though the fees the agency charges its customers will barely cover its out of pocket costs.

Were we to privatize that water agency, the profit seeking managers would logically raise rates, cut off customers who are slow to pay, defer maintenance on its system and skimp on water quality testing and treatment.

Clearly, society as a whole is better off with a public agency than with a private company delivering water.

We will be wise to remember this contradiction as we seek to work our way out of the current recession.

For more on the growing trend to finance public works with private funds, see this article :

http://www.sfgate.com/news/article/More-mega-projects-turning-to-private-investors-3690367.php

Your faithful servant,

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