(The following article first appeared in the Winter 2005 edition of Impact.)

With increasing budgetary shortfalls at the local, state and federal level, government agencies are seeking to emulate the operating practices of private businesses in order to address their fiscal problems. This approach obviously has merit, but it’s limited by fundamental differences between the incentives that public and private sectors face.

In the private sector, there are three primary incentives that force efficiency and cost control into business operations: financial reward, competition and survival. Unfortunately, these three incentives are, for all practical purposes, absent with government agencies.

FINANCIAL REWARD

In the private sector, organizations produce a service or product that customers are willing to buy. The more customers value this product or service for its cost and quality, the better the opportunity for financial reward for the business owners and employees.

Government agencies are not producers in this sense. Instead, they buy products and services from the private sector, but with very few exceptions, do not continue the process of selling products and services. They are more like a final consumer, and there is no accompanying financial reward to taxpayers, administrators, or civil servants — i.e., the people who might be considered business owners and employees — if citizens value the quality and cost of the work a government agency does. Without this immediate financial reward, there is far less incentive to force efficiency and cost control into the government operation.

In fact, a well-disciplined government budget may have negative consequences for government workers. The frugal government administrator who has funds left at the end of the fiscal year may lose these surplus funds and even find his or her budget reduced by the same amount in the following year. In contrast, a private-sector manager who underruns his or her department’s budget will tend to be encouraged and rewarded, since the cost savings will help the company make more money.

COMPETITION

Competition in the private sector — whether in the sale of automobiles, telecommunications or toothpaste — drives businesses to meet the varied wants and desires of the consumer better than their rivals do. Businesses that succeed in this competition earn better financial rewards, even as they offer lower prices, better quality and more choices for consumers.

Unfortunately, there is rarely competition within or between government agencies to force efficiency, lower cost and better customer service into government operations. If we do not like the cost or service quality when our state issues a driver’s license, we cannot go to another government agency across the street to get a better deal. In the absence of such a choice, we are often forced to endure the inefficiency, poorer service, higher costs and limited hours of a government monopoly that lacks competition.

SURVIVAL

This final incentive results in the complete, unmitigated transformation of a private company’s operations. When a business’s inability to compete for financial rewards threatens it with bankruptcy, the company has no choice but to rapidly and effectively re-engineer its business practices to focus on the customer’s desire for quality goods, efficient service and lower cost. Bankruptcy is a last-resort makeover that punishes business owners and employees with lost money and lost jobs.

In contrast to the private sector, government agencies rarely face a genuine threat of bankruptcy. A state government will usually continue to have a Department of Natural Resources no matter how poorly it does it job or satisfies citizens. No DNR employee worries that his or her place of business will disappear like Eastern Airlines.

Politicians who focus on making government run more like a business, rather than on reducing it to its proper role, are forgetting the inevitable effect of incentives. They are being penny-wise and pound-foolish.

#####

Michael Heberling, Ph.D., is an adjunct scholar with the Mackinac Center for Public Policy and president of the Baker College Center for Graduate Studies in Flint, Michigan. Permission to reprint in whole or in part is hereby granted, provided the author and his affiliation are cited.