Between Public and Private Enterprise: The Role and Structure of Special-Purpose Governments

Conor Clarke is an attorney in the Office of Legal Counsel of the U.S. Department of Justice and Henry Hansmann is the Oscar M. Ruebhausen Professor Emeritus of Law at Yale Law School. This post is based on their recent paper.

Special-purpose governments and the difference between public and private organizations

What is a government as distinguished from a private organization? The term “government” may bring to mind an organization that provides or regulates a broad array of services. But that description fits only a minority—roughly 40,000 — of the 90,000 (mostly local) governments in the United States. The Census labels most American governments “special-purpose” governments, which usually undertake only a single activity, such as water supply, fire protection, or trash collection. There is little between these special-purpose governments and those that provide a broad array of services. That is, there are virtually no two-, three-, or four-purpose governments.

The services provided by special-purpose governments overlap almost completely those provided by general-purpose governments (including counties, municipalities, and townships). Special-purpose governments also resemble, in important respects, private organizations such as cooperatives, condominiums, mutuals, and nonprofits. Examining these institutions together provides an opportunity to pursue fundamental questions concerning the difference between governments and private organizations, as well as the reasons why local governments have the legal and organizational structures that we observe.

Public versus private enterprise

The absence of a clear borderline between governmental and nongovernmental organizations is reflected in the absence of a widely accepted definition of what it means to be a “government.” But there is one attribute that seems generally to characterize services provided by governments, whether general-purpose or special-purpose. That characteristic is substantial market power vis-à-vis the residents of the government’s associated territory. Governmental services exhibit economies of scale that render a single provider of services the least-cost mode of production, and therefore a natural monopoly.

There is a straightforward logic to using a government to provide territorially monopolistic services. The residents served by the government also control it, and can use that control to prevent the government from exploiting its monopoly position. This is also the economic role typically played by private cooperatives, including—for example—the numerous and often large cooperatives found in utilities (electricity, gas, water, telephone service) and agriculture. In these and other situations, cooperatives arise where a monopoly may be unavoidable, but customer exploitation can be avoided by making the customers the collective owners of the firm. Viewed in this light, democratic governments perform the same consumer protection function as private cooperatives.

A starker difference between governments and private cooperatives concerns formation. Formation of both a special-purpose government and a private cooperative is likely to begin with a proposed service to be provided and a proposed territory to be served, followed by a solicitation of the residents. The cooperative will be collectively owned and operated by the residents who choose to become members—but those who do not wish to join need not become members and are not subject to any assessments if they do not use the service. Not so with a special-purpose government. Formation of these two forms of organization differs in whether residents of the territory are compelled to join the organization—and to pay a share of its costs—once it is formed.

In the case of a service such as electricity, where charges are based principally on metered use and can thus largely be avoided by simply declining to use the service, there is little difference between the two arrangements. But the difference is particularly important for shared physical improvements such as roads, street lighting, and sidewalks. If a qualified majority of the owners of houses facing a given street wish to form a special district to install sidewalks along the street, they can force all of the residents fronting on the street to both accept the sidewalks and pay the assessed share of the cost, thus avoiding free riders. That is, a special-purpose government can force residents to consume and finance the service it provides, and not just—as in the electricity distribution example—accept the availability of the service. But there are no sidewalk cooperatives.

Single-and general-purpose governments

Almost as a rule, local governments in the United States provide either a single service or a broad and largely unbounded range of services. The divide between single and general appears despite the absence of any legal reason why several services cannot be provided by the same district; the enabling statutes for special purpose governments impose no such restriction. Why does this divide exist? Our primary hypothesis for the divide between single- and general-purpose governments involves the costs of collective decision-making. Both private firms and governments can benefit when their owners or members have relatively homogenous interests.

Voting rights in widely-held business corporations, for example, are generally tied to possession of shares of a single class of common stock that, for most purposes, leaves the shareholders all equally interested only in a single, simple, and clear measure of the firm’s performance—namely, the firm’s earnings per share. The result is that shareholders are affected identically (in proportion to their ownership) by decisions the firm makes. The same is true of cooperatives. The sometimes-huge U.S. farmer cooperatives that market a large fraction of the nation’s staple crops generally focus their activities on a single crop. Firms often seem to sacrifice substantial economies in other aspects of their organization for the sake of having a homogeneous class of owners.

In governments, likewise, heterogeneous interests can create conflict, inefficient decisions, and exploitation of one group by another; homogeneous interests can help avoid this. To see this, consider a single-purpose government established to provide irrigation to farmers in a semi-rural community consisting of a small town surrounded by farms. If assessments levied by the district are made proportional to the number of acres a farmer has in agricultural production, and votes in the special-purpose government are allocated in the same way, the farmers’ interests in the management of the government are likely to be heterogenous in only one dimension: the number of gallons per acre that the water system will produce.  All will want that water distributed at the lowest cost per gallon possible. Majority voting based on acreage should yield the per-acre amount of water preferred by the median voter, which is likely to be close to the average demand, which in turn is likely to be a good approximation to the efficient level of total water distribution.

And what about the large number of general-purpose governments that provide many services? Our hypothesis is that, in effect, general-purpose governments offer a solution to the cost of collective decision-making that is the polar opposite of that offered by single-purpose governments. When many services are provided by a general-purpose government, the supply of individual services is not voted upon one by one, but rather is typically determined by general administrators who are chosen in broadly spaced general elections. In this situation, residents who have an unusually strong preference concerning one individual service out of many are unlikely to be sufficiently numerous to form a coalition that will control the government, and then to use that control to cross-subsidize services that disproportionately benefit that coalition. At the same time, virtually all residents share a common interest in having their municipal services—whatever they may be—provided with competence, at low cost, and without corruption. Rather than fight over the division of the pie, residents might well choose to enlarge the overall pie simply by having the municipality—and all of its various services—managed by officials who are relatively competent and disinterested.

The divide between single-purpose and general-purpose governments may also explain the persistence and relative stability of the Supreme Court’s exception to the one-person-one-vote rule first expressed in Salyer Land Company v. Tulare Water District (1973). (And the problems of heterogenous interests described above seem fairly captured by the extension of that exception to a rare district that provided two services in Ball v. James (1981).) As some scholars have noted, the standards the Supreme Court used to apply the exception—whether the government has a “disproportionate effect” on landowners and “relatively limited authority”—leave much to be desired. But the sharp divide in fact between single-purpose governments and general-purpose governments has allowed the law to function with a vague standard like “limited purpose” without creating ambiguity with respect to the treatment of any given organization.

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