Private vs. the Public Option: The “Rule of Two”

Much of the current health care debate centers on the provision of private health insurance versus the public option. On one side of the debate are those who point to private enterprise as the fruit of entrepreneurial efforts and capitalism, which leads to greater operational efficiency and lower consumer prices. The other side sees a government option as free of the greed of capitalism – namely, no profits and lower prices for consumer. As to having lower consumer prices, both sides cannot be right.

The idea of substituting public provision for private provision of goods is not new.  A review long established and well-accepted economic literature shows some clear insight – private goods and services are significantly lower cost to consumers than the government option. Evidence that the private sector is so much more efficient than the public sector led economist Thomas Borcherding (“The Sources of Growth in Public Expenditures in the U.S., 1902-1970, Duke University Press, 1977) to conclude a “Bureaucratic Rule of Two: Removal of an activity from the private sector to the public sector will double its unit costs of production.” The astounding claim of “Rule of Two” is a testable hypothesis, one that Professors James T. Bennett and Manuel H. Johnson, who later became Vice Chair of the Federal Reserve, set out to examine with real world empirical evidence (see Better Government at Half the Price, 1981).

Bennett and Johnson realized that simply comparing the books of public and private enterprises was not always straightforward and accurate, since public enterprises often fail to include a proper accounting of all costs, including capital costs, such as depreciation and interest expenses. The costs of employee benefits, particularly pensions, are often excluded from government accounting as well. In addition, opportunity costs, a benefit that is forgone, such as the lost taxes on private enterprises when replaced by public provision, are never included in the books of government enterprises but are absolutely necessary when comparing a private vs. public option.

Bennett and Johnson evaluated a wide range of services and found the following examples:

  • Private refuse collection firms provided twice the service at half the cost;
  • Private fire service firms operated at half the costs of public fire departments;
  • Private debt collectors could operate at 40% of the cost of a government agency;
  • It costs the government three times more to repair a similar sized ship than a commercial ship repair enterprise;
  • Federal hydroelectric plants were significantly higher cost to operate and had nearly 50% more employees;
  • Private airlines consistently outperformed government-owned airlines, leading to sweeping trend of deregulation across the globe;
  • Weather forecasting costs were cut in half when a portion of the costs were outsourced to a private firm;
  • Policing services, and more commonly, private ambulance services, undercut the cost of publicly provided services; and
  • Amid the falling quality of public schools and calls for vouchers, there is evidence that public institutions employ 40% more labor than private institutions.

Their work finds the “Rule of Two” to be, in fact, supported by empirical evidence. But there are other examples, such as the many failed attempts by government municipalities to provide broadband services. And, there are examples of the inefficiency of government provision of medical goods, including evidence that: VA hospitals stays were once 3 times longer than voluntary hospitals, after correcting for patient age and surgical procedure; for-profit hospitals give pay increases much less frequent than public hospitals; publicly run hospitals cost millions of dollars more to run than for-profit hospitals, after adjusting for bed-size, patient volume and the number of facilities; and it costs the government twice as much to process medical claims than the private sector. As you look to the states increasing provide consumers homeowners insurance, such as Florida, you will also find the states with the highest insurance premiums. The incentives for the government to be efficient with your tax dollars are simply not there. And, once the government takes over a sector, it is likely to expand its scope without regard to costs. As the late Senator Patrick Moynihan noted:

“For governments inherently, routinely, automatically favor creatures of government. They know no other way. They recognize the legitimacy of no other institution.”

So, the idea of having government provide private goods is not a new idea.  As policymakers look toward reforming health care in the U.S., they should think about the “Rule of Two” when it comes to the public option and avoid turning private provision into more costly (or lower quality) public provision.

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3 thoughts on “Private vs. the Public Option: The “Rule of Two”

  1. As a former contracting officer for the federal government on A-76 Public-Private competitions since 1985, I can truly say that Government should not be in the business of commercial type work. That should be left up to industry. However, I would also say that government oversignt and independence is an absolute MUST when work that citizens are reliant on is outsourced. This is exactly why we have that terrible group called TSA at airports today, not because they were needed, but because private contractors performing screenings didn’t do their jobs and their was literally no government surveillance of their work products….thus we end up with TSA a much worse run and more costly organization. Do we regret this? You bet we do, but can we now ever go back.

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