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Too Public to Fail? The Moral Hazard with Public Institutions

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Although it tops most of the headlines lately by being the most extreme case, the financial problems of Greece’s public institutions are not one of a kind.  If you have a quick look worldwide you will see cities, councils, regions, having similar problems to pay their bills. You can find near-bankrupt cities in the US (especially in California and Florida) Italy, Spain, Ireland, Portugal, Japan.  Public management at its worst seems to be the common factor, with some institutions walking on the edge of default. We are not talking about having trouble finding money for new investments or projects, as this would be a totally normal (although not desirable) situation in the actual environment. They are struggling even to pay the most basic of services, like electricity or waste disposal. This problem may not be totally evident to citizens because said services are still being provided, but it is serious enough for everyone to be concerned about it. 

The question is, why are services still being provided if they are not being paid? Well, because public institutions enjoy preferential treatment from their suppliers and vendors. This preferential treatment is not precisely earned by being a good customer, but because of their size. The public sector represents a very big part of the total earnings for some of these suppliers and vendors, so they cannot afford to stop providing them. They prefer the prospect of being paid ten months later (and this is not an exaggeration) than losing such a big client. They simply have no other option but to bear this load, specially when talking about local companies whose only client is the city council.

This creates a big problem though, as the inability of public institutions to pay their bills creates a highly destructive domino effect. Suppliers and vendors do not enjoy the same preferential treatment with their other business partners; they must pay on time as specified on their agreed terms or otherwise their partners will immediately stop serving them. As they do not get the money public institutions owe them, the disruption in their cash-flow creates a need for factoring or other ways of financing. And while this can be good for the financial sector, it is devastating for the companies being forced to use it. Some companies get strangled by those extra financial costs to the point their business is no longer profitable. In the end, this companies are forced to close or go bankrupt, leaving their employees jobless just because they had the worst client possible, a public institution.

Politicians love to talk about how bailing-out a troubled bank could create moral hazard by rewarding companies for their reckless management. While this was/is totally true, allowing public institutions to avoid their financial responsibilities and transferring the burden to their privately-owned partners should raise even more morality concerns! However, governments are not moving a single finger to solve the situation, failing to realize how this is killing their economies; affecting specially the SMEs (Small and Medium Enterprises) that rely more on their public clients. 

I am sure you will have heard often that measuring the variety and the health of SMEs is one of the best barometers for knowing the real state of a country’s economy.  Slowly killing them cannot be good.

Unfortunately, this issue does not have an immediate solution, as public institutions have to exist and we cannot let them fail. It does not matter how liberal you are, they have to be there, you cannot privatize a city council. There is no magic solution, but restoring the ‘circle of life’ is not that difficult. You only need one thing, for them to pay their bills on time. 

Just put public institutions on a severe diet, make them lose some ballast, push for more efficient management. Control every single expense and make sure the little money they have available goes where it matters most, the taxpayer. And again, make them pay their bills!  Paying them will enable taxpayers to religiously pay taxes. Because taxes, at the end of the day, are nothing more than a public institution’s income.

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About Totaliberal

  • Glenn Contrarian

    Totaliberal –

    I would recommend that you provide specific examples of exactly how said public institutions are at fault.

    For instance, one could be the fact that the retirement age in Greece – at least up until last year – was 55, and in France it was 60. When the two governments wanted to increase the retirement age, there were widespread riots. America, on the other hand, has a retirement age that varies – depending on the choice of the individual – of 62, 65, or 70 (IIRC). Unfortunately, there are those who want to raise our retirement age even higher.

  • Dr Dreadful

    Raising the retirement age makes sense if, with advances in modern medicine, sanitation, nutrition and general health, people are going to be living and staying healthier for longer. As average life expectancy goes up, financing retirement beginning in your late 50s or early 60s with the potential to continue for 25-30 years or more (almost as long as your working career!) becomes much trickier.

    Young people just entering the workforce most especially should think hard before planning to retire in their 50s or 60s. Average life expectancy for them is likely to be even higher.

    (Unless the world economy collapses due to extreme climate change, in which case all bets are off.)

  • Leroy

    Failures of public institutions have been prompted by unwise associations with private enterprises, i.e., it’s a failure of ‘privatization’.

    It is private banks and financial enterprises that have dragged public agencies into risky and dangerous financial affairs.

    They dangle the hope of huge financial rewards to the decision makers in front of their noses to suborn them.

  • Christopher Rose

    I don’t think there should be a retirement age at all; people should expect to work to support themselves unless there are medical reasons that they can’t.

  • Leroy

    That just increases unemployment. We already have too many workers chasing too few jobs.

    Reduce the workweek in proportion to productivity increases.

  • totaliberal

    I think the point 4- Christopher Rose makes is the one people never remember (or want to). Retiring early puts extra pressure on social security systems as developed countries already have a problem of their population growing older. Whether you like it or not, they must adapt to this change in demographics, otherwise social security costs would skyrocket and the people who are still working would get strangled with taxes to support said social security systems.

    We should not forget that social security aids are contingency measures, one should not look at them as ‘something I have earned during my work life’.

    On the other hand you have more or less what Leroy says, increasing retirement age could make it even more difficult for young people to access a job.

    However, with the article I was referring to excessive and unnecessary spending by public institutions, not to the amounts spent in social measures.

  • Leroy

    Why should the Greek citizen be saddled with paying for the gambling losses of the banks? Those citizens did not participate in the huge rewards reaped by the banks. The citizens didn’t participate in the big bonus plans and favorable benefits bestowed on bank officers. They didn’t even signup to back the bets of bankers.

    Yet, when a bailout is required, the investments of bondholders are protected and the calamity is dumped on innocent bystanders: Greek citizens. You can’t blame the Greeks for rioting.

  • totaliberal

    They did sign for paying pensions to people who had been dead for a long time; they did sign for flagrant absenteeism at work; they did sign for having a much higher number of civil servants than other, more populated, European countries; they did sign for management recklessness…
    But as I said in the article, it is not only a Greek problem, you can see the same has happened in lots of other countries. While the banks were fine, governments were profiting from them like there was no tomorrow and kept spending beyond reason. Not only banks are guilty here.

    The only innocents I can think of in this story are taxpayers. But in any case rioting is never acceptable… it is the last thing they need.

  • Leroy

    Americans should take this as a warning: do NOT privatize Social Security. The inevitable result would be corruption and bankruptcy. You cannot mix public affairs with private acquisitiveness.

    We’ve seen it here ourselves in the disastrous results of repealing Glass-Steagal.

    It’s a familiar story: private interests take over the assets and set about complicated ways of distributing the proceeds from those assets to themselves then leave a broken ruin behind. And the citizens and taxpayers will be stuck with the liabilities.

    Don’t do it!

    Privatization is a big failure.

  • totaliberal

    I think if Greece was a warning of something it would be a warning of just the opposite, as the unbearable load of an inefficient and overstaffed public sector is what has taken the country down.

  • Clavos

    Dead on, Totaliberal.

  • zingzing

    but also ignoring other factors at play.