Private prisons

There has recently been much heat generated over the issue of private prisons, but I would argue very little light has been shed on the topic, see for example, MacDoctor here, Not PC here, Kiwiblog here, Whale Oil here, The Standard here, Keeping Stock here, Liberty Scott here. So I will see if I can let in a little light, although this is not guaranteed!! The question as to which goods or services the government should provide has been addressed in a paper by Oliver D. Hart, Andrei Shleifer and Robert W. Vishny, published in 1997. The paper is 'The Proper Scope of Government: Theory and an Application to Prisons'. "Quarterly Journal of Economics", 112(4) November: 1127-61.

The HSV model considers the choice between in-house production and contracting out. The provider, government or private, can invest in improving the quality of service or reducing cost. Given incomplete contracts, the private provider has a stronger incentive to engage in both quality improvement and cost reduction than a government employee has. However, the private contractor's incentive to engage in cost reduction is typically too strong because he ignores the adverse effect on noncontractible quality. Cost are always lower under private ownership but quality may be higher or lower under a private owner.

Hence the focus of the HSV model is on quality. Here quality has a broad interpretation. It can stand for how well prisons treat prisoners, how clean utilities keep the water, how well schools educate their pupils, how long it takes for a letter to reach a remote area or how innovative car makers are etc. The basic idea is that the provider of the service, whether it be the government or a private firm, can made an investment to increase the quality of the service or a investment to reduce the cost of the service. It is important to note that quality is reduced by any cost reductions. Neither of these two investments are ex ante contractible. But to implement either of the innovations requires the agreement of the owner of asset. The asset can be thought of as, say, a school or a hospital or a prison. If the owner of the asset is the government then the provider of the service, who will be a government employee, requires the approval of the government to invoke either investment since, in this case, the residual control rights reside with the government. As a result, the employee will receive just a fraction of the returns to either innovation, even if implemented.

If on the other hand the provider is a private sector contractor, then the contractor has the residual control rights and thus does not need the government's agreement for a cost reduction. However, if the contractor wishes to improve the quality of the service and receive a higher price for it, then they have to renegotiate with the government since the government is the purchaser of the service. Under the assumption that the contractor is successful in obtaining an increase in price they capture all such gains. Thus a private contractor will generally face stronger incentives, than a government employee, to improve quality and reduce costs but the incentive to reduce costs can be too strong since the contractor ignores the negative impact this has on quality.

HSV examined the conditions that determine the relative efficiency of in-house provision versus outside contracting of government services. Their theoretical arguments suggest that the case for in-house provision is generally stronger when noncontractible cost reductions have large deleterious effects on quality, when quality innovations are unimportant, and when corruption in government procurement is a severe problem. In contrast, the case for privatisation is stronger when quality reducing cost reductions can be controlled through contract or competition, when quality innovations are important, and when patronage and powerful unions are a severe problem inside the government.

They then apply this analysis to several government activities using the available evidence on the importance of various factors. They conclude that the case for in-house provision is very strong in such services as the conduct of foreign policy and maintenance of police and armed forces, but can also be made reasonably persuasively for prisons. In contrast, the case for privatisation is strong in such activities as garbage collection and weapons production, but can also be made reasonably persuasively for schools.

With regard to prisons HSV write (p. 1152-4)

Prisons seem to fit reasonably well into our framework. Although in some respects prison contracts are very detailed, they are still seriously incomplete. There are significant opportunities for cost reduction that do not violate the contracts, but that, at least in principle, can substantially reduce quality. Moreover, from the available evidence we have the impression that the world may not be far from the assumptions of Proposition 4. First, the welfare consequences of quality deterioration might be of the same magnitude as those of cost reduction (b(e) and c(e) are comparable). Second, the opportunities for quality innovation are limited (beta(i) is small). Under these conditions, Proposition 4 suggests that public ownership is superior.

Would ex post competition between prisons for inmates strengthen the case for privatization? One possibility is that convicts themselves choose the prison in which to serve their sentences, but this is probably a bad idea, since prisoner choice would encourage contractors to attract customers by allowing gangs, drugs, and perhaps even easy escapes. A more plausible alternative is to have judges choose a private prison to send a convict to, with the idea that judges would send more inmates to higher quality prisons and fewer to lower quality prisons. Private contractors would then have the appropriate incentives to invest in quality improvements, and to avoid excessive cost reductions, to bring in more business. At the moment, such schemes have not been tried, in part because there is a shortage of prison capacity in the United States, but it is possible that they could be tried in the future. One potential disadvantage of such judge choice is that some judges might actually choose lower quality prisons because they want the inmates to get a stiffer penalty, whereas other judges might choose prisons that are soft on inmates. Contractors would then cater to the preferences of the judges, which need not coincide with social welfare.

Finally, the choice of whether to privatize prisons depends on the importance of corruption and patronage. Patronage does not appear to be a huge problem in prison employment in the United States, since the union premium as of this writing is not large. Corruption appears to be a greater concern, at least judging from the available anecdotal evidence. To begin, private prison companies are very active politically. For instance, ESMOR evidently lobbies politicians and makes political contributions to receive contracts {The New York Times, July 23, 1995}. The wife of Tennessee governor Lamar Alexander invested early and profitably in the stock of Corrections Corporation of America, which subsequently got involved very deeply in the privatization of Tennessee prisons with the governor’s endorsement {The New Republic, March 4, 1996, p. 9}.

A related problem is that contract enforcement cannot be taken for granted. The INS report concludes that ESMOR’s changes in policies “hindered INS ability to effectively perform its oversight functions.” The report also notes that ESMOR told its guards not to share information with the INS officials working on the premises, and in one instance encouraged the INS to reassign an officer who complained about the performance of the Elizabeth, New Jersey, facility several months prior to the riot. The report indicates that ESMOR violated the contract in some instances, and also pursued policies preventing the INS from enforcing the contract. But it is also clear from the report that the INS did not do what it could to enforce this contract. The INS report vividly illustrates how a government bureaucracy with relatively weak incentives has trouble enforcing a contract with a private supplier determined to reduce its costs, even if this involves violations of the contract and not just the issues on which the contract is silent.

In sum, our model suggests that a plausible theoretical case can be made against prison privatization. This case is weakened if competition for inmates can be made effective, but strengthened by the relevance of political activism by private contractors. One instance in which the case against prison privatization is stronger is maximum security prisons, where the prevention of violence by prisoners against guards and other prisoners is a crucial goal {The New York Times Magazine 1995}. In many cases, the principal strategy for preventing such violence is the threat of the use of force by the guards.We have shown that it is difficult to delineate contractually the permissible circumstances for the use of such force. Moreover, hiring less educated guards and undertraining them—which private prisons have a strong incentive to do—can encourage the unwarranted use of force by the guards. As a result, our arguments suggest that maximum security prisons should not be privatized so long as limiting the use of force against prisoners is an important public objective. Consistent with this view, only 4 of the 88 private prisons in Thomas’s {1995} census of private adult correctional institutions in the United States are maximum security. In contrast, private half-way houses and youth correctional facilities, where violence problems are less serious, are common {Shichor 1995}.

So there is a case to be made for private prisons, but it may not be as strong as for other services currently provided by the government, and it is at its weakest for the case of maximum security prisons.