“Privately provided services cost more because the private sector has to make a profit.” So goes the common refrain against the private provision of government services. Its most recent task has been to prop up critiques of the provincial government’s proposed extension of private health provision from blood testing, ultrasounds and x-rays to include CT scans.
The anti-profit argument sees profits as an additional cost on the price of privately provided services, a cost which can be avoided if governments do the business in their place. At first glance this much seems obvious. If it is to survive, a private firm requires a surplus on its balance sheet more often than not. Being free of that requirement, governments should be able to reduce the prices charged to customers.
What’s missing from this argument is the cost of investment capital. In order to get investment capital, somebody, somewhere has to lock up money in a long-term investment instead of spending it immediately. Their reward for this delay of gratification is the profit on successful investments. From the customer’s point of view, this profit is the cost of capital.
The government’s only source of investment capital is from taxpayers. Even when it borrows off financial markets outside its jurisdiction, its credibility as a borrower is backed by the capacity of its taxpayers to one day repay those loans. When a government banishes profit from its books it is banishing the potential profits of the taxpayers who fund its investments. For every dollar governments save taxpayers by providing services without recording a profit, they cost taxpayers a dollar of lost investment opportunity.
As a thought experiment, a taxpayer saves one thousand dollars. She invests it in the TSX, which has a long-run average return of ten per cent. After the average year she’s one hundred dollars better off. She then pays (through taxes) for taxpayer- funded, privately-provided healthcare. However the provider has also invested one thousand dollars. He expects to make a similar return on this investment as he would on any other, so the healthcare costs one hundred dollars more as a result of his return on investment. Our taxpayer ends up level with where she started.
As another thought experiment, the same taxpayer saves one thousand dollars but the government taxes it and invests it in providing healthcare. It does not record any return on this investment and so charges one hundred dollars less than the private provider. However the taxpayer has lost her investment capital and her potential return on it. When this previously unseen side of the equation is brought into view, she’s not actually one hundred dollars better off.
Some people might object that the benefits of private investment accrue only to those with money to invest in the first place. They may well be right but the exact same people usually have the answer to their objection: use taxes to redistribute income and services. Moreover, there is a separate reason to favour the profit-driven model over the non-profit one.
In the contrived thought experiments above, all investment returns were the same tidy ten per cent. In the real world different investments give different returns for reasons that nobody can consistently foresee. The whole point of profit from a societal point of view is to drive the discovery of more valuable investments, that is, investments which create more value for less initial outlay.
Good investments are expanded as investors rush to share in their profitability; foolish investments are abandoned as investors rush to avoid losses. A CT scanning clinic which does the same job with fewer resources is more profitable, as is one with more output for the same resources. Banishing the profit motive reduces the incentive to find such innovations and removes the penalty for not finding them.
The claim that private sector profits inflate the costs of privately provided services is true only in the narrow sense that profits are not seen in government books. When the potential investment returns forgone are considered, the banishment of profit from government activities is a chimerical gain. When the loss of the information and incentives that profit normally creates is considered, this banishment actually reduces efficiency in the long run.
There are legitimate arguments to be made in favour of governments acting to solve many societal problems, but government immunity from the function of profit is not one of them.