Privatization in British Columbia: lessons from the sale of government laboratories

~ ~ t h ~ ~ H ~ - ~ ~ I Privatization in British Columbia: W.T. Stunbury lessons from the sale of

government laboratories

Abstract: Among the more controversial privatizations that the Province of British Columbia announced in March 1987 were the sale of the soil, dairy and environmental laboratories. The last two performed testing to monitor private firms' compliance with provincial health and environmental regulations. A review of the three transactions offers lessons concerning both the process of privatization in British Columbia and the limits to privatization by contracting-out. Privatization of elements of government regulatory functions presents three problems: first, private sector contractors may be subject to conflict of interest; secondly, complex and costly contract-monitoring arrangements may be required to ensure the quality of work performed by contractors; and finally, failure of the contractual arrangements will have implications beyond the contract itself, ultimately affecting the government's ability to achieve its regulatory objectives.

A striking feature of the privatization process was the inducements offered to government employees to get them to become private-sector contractors. The province even accepted uncompetitive bids from employee groups, contradicting its own primary objective of privatization, to increase efficiency based on competition. The case studies also demonstrate that transaction and transition costs of privatization may be substantial, particularly for small operations.

Sommaire: L'une des privatisations les plus controversties annonckes par la Colombie-Britannique en mars 1987 fut la vente des laboratoires danalyse des sols, des produits laitiers et de I'environnement. II incombait aux deux derniers de ces Ctablissements de proceder A des tests dans les entreprises privCes pour s'assurer que les rkglenients provinciaux sur la sante et I'environnement y ktaient respect&. L'ktude de ces trois transactions est rtvtlatrice du processus de privatisation en Colombie-Britannique et des contraintes pouvant resulter de la sous-traitance. L a privatisation de certains elements de la fonction gouvernementale de rkglemen- tation presente trois probkmes : premih-ement, les entrepreneurs du secteur prive peuvent se trouver en situation de conflit d'inttrCt; deuxihement, des dispositions

Kathryn Harrison is a Ph.D. candidate, Department of Political Science, University of British Columbia. W.T. Stanbury is UPS Foundation Professor of Regulation and Competition Policy, Faculty of Commerce and Business Administration, University of British Columbia. We are grateful to the anonymous referees of this journal for their very helpful comments, to Sandra Carter for superb word processing services, to the UPS Foundation for its financial support, and to the individuals who were interviewed.

CANADIAN PUBLIC ADMINISTRATION I ADMINISTRATION PUBLIQUE DU CANADA VOLUME 33, NO. 2 (SUMMER.&Tl?), PP. 165-197.

KATHRYN HARRISON AND W.T. STANBURY

complexes et cotiteuses de surveillance des contrats peuvent s’avtrer ntcessaires pour verifier la qualitt des travaux effectuks par les entrepreneurs; et finalement, le manquement aux dispositions du contrat a des repercussions qui touchent non seulement celui-ci, mais nuit tgalement P la capacitk du gouvernement d’atteindre ses objectifs de rtglementation.

Un fait ttonnant a accompagne le processus de privatisation : les employks du gouvernement ont t t t invitts devenir des entrepreneurs privts. La province a mEme accept6 des offres non concurrentielles de groupes d’employts, contredisant ainsi I’objectif premier de la privatisation, soit accroitre I’efficacitt par la concur- rence. En outre, les etudes de cas montrent que les cotits de transaction et de transition de la privatisation peuvent Etre considtrables, surtout pour des optrations de petite emergure.

When Bill Vander Zalm, the premier of British Columbia, announced in March 1987 that, in principle, every provincial crown corporation and the hospitals and universities were up for sale, he was caught up in the world- wide enthusiasm for privatization. In its broadest terms, privatization is any action that strengthens the role of market forces at the expense of government intervention. In practice, privatization has taken two main forms: the sale of government assets, including part or all of crown corporations to private investors, and the contracting-out of the production of government services to privately owned firms. In British Columbia these two types have been combined.

By October 1987 Premier Vander Zalm had announced plans for an ambitious privatization program, including the sale of one crown corporation, several parts of another, and the contracting-out of eleven operations of line departments.’ Within two years the province had completed nineteen transactions generating some $1,392 million from the sale of assets, including $741 million for the mainland natural gas division of B.C. Hydro (see Table 1). Seven of the transactions involved both the sale of assets and a multi-year contract with the purchaser (usually former government employees) to provide services to the province. In addition, the province arranged the sale of assets and services contracts for the maintenance of highways and bridges throughout the province. The value of the services contracts will exceed $650 million over three years.

While British Columbia’s privatization efforts have probably been among the most extensive of any provincial government (Saskatchewan’s are comparable), they have been much smaller than either the federal government or the high profile efforts of the Thatcher government in

1 The total value of the assets and services was estimated to be $3 billion, the number of employees affected was put at 7,240 and the estimated budgetary savings was put at about $25 million annually. See Vancouver Sun, October 23, 1987, pp. A1-A2; Globe and Mail (Toronto), October 24, 1987, p. A4; and Maclean’s, November 2, 1987, pp. 14-15.

166 CANADIAN PUBLIC ADMINISTRATION

LESSONS FROM I ‘ H E SALE O F GOVERNMENT LABORATORIES

Britain.‘ At the same time, Premier Vander Zalm’s privatization program had an important precedent in British Columbia itself, namely the pioneering efforts of Premier W.R. Bennett’s government over the period 1979 to 1985 (see Table 2).

Among the smaller but more controversial government operations to be privatized by the Vander Zalm government were the soil, dairy and environment laboratories which, among other tasks, tested samples for the enforcement of health, safety and environmental regulations. The leader of the opposition suggested that after privatization “proper safety checks for milk, food, water and air quality” will be at risk.3 The British Columbia Government Employees’ Union (BCGEU) sponsored advertisements in newspapers stating that “our environmental safety will be second to making a profit” and “the milk and dairy products our children need to grow” will be threatened.‘ The BCCEU also noted that the private labs expected to bid for the government labs were the ones that sell their services primarily to the private firms being monitored by provincial regulatory authorities.

This paper focuses on two main issues: the possible limits of privatization, specifically as they relate to contracting-out activities associated with inputs to regulatory functions; and the process by which assets and/or government activities have been privatized in British Columbia. With respect to the privatization process we consider the following matters:

- the interdependence of asset sales and services contracts when made with the same private firm;

- the incentives offered to government employees by the province to induce them to create firms to bid on assets/activities to be privatized;

- the bidding process itself; and - the direct and indirect transactions costs associated with privatization.

2 For example, the value of all the assets privatized over the past six years by all provinces ($4 billion) is considerably less than the value of federal assets privatized over the past four years ($5.9 billion excluding the CDC, a mixed enterprise; $13.1 billion including the CDC).

Even if Saskatchewan completes the three large deals it has announced (Potash Gorp., Sask Energy, and CAMECO, the total for all provinces is $7.5 billion or only 5.4% of the total value of the assets of all provincial crown corporations.

Between 1977 and 1987 the U.K. government sold all or part of thirteen crown corporations by public offerings raising f25.5 billion (about $50 billion). In addition, it made twenty-four private sales, including nine management buy-outs, raising another f 1.33 billion). The proportion of Gross Domestic Product attributable to state-owned industry fell from 9% to 5%. Some one million jobs were transferred from the public to the private sector. The proceedr of privatization transactions in the U.K. totalled f 19 billion between 1979/80 and 1987/88. See Howard Hyman, “Privatisation: The Facts,” in Cento Veljanovski, ed. Pn’uatisation and Competition (London: Institute of Economic Affairs, 1989). pp. 191-219. 3 4

Vancouver Sun, December 1, 1987, p. A4. Ibid., November 14, 1987, p. A17.

167 ADMINISTRATION PUBLIQUE DU CANADA

Tab

le 1

. Pr

ivat

izat

ion

Tran

sact

ions

by th

e V

ande

r Zal

m G

ouer

nmnz

t in

Briti

sh C

olum

bia,

198

8-89

Date o

f Tr

ansa

ctio

n C

row

n cw

p.la

sset

Se

lling

pri

ce

1. J

an.

1988

2. J

an.

1988

3. A

pril

1988

c

Q,

00

4. M

ay 1

988

5. J

uly

1988

2 6.

Jul

y 19

88

> 2: P 9 2 G

7. J

uly

1988

8. J

uly

1988

E

9. J

uly

1988

6 10

. Se

pt. 1

988

5 11

. n.

a. 1

988

$ 12

. Se

pt. 1

988-

M

arch

198

9

W n 8 z

soil

Lab

orat

ory

Dis

tribu

tion

fund

on o

f th

e Q

ueen

’s

Dep

t. of

Hig

hway

s sig

n pl

ant

Exp

o ’8

6 la

nds

BC

Ste

amsh

ip C

o. (9

0%)

BC

Hyd

ro’s

mai

nlan

d na

tura

l gas

Prin

ter

divi

sion

Tel

kwa

fore

st n

urse

ry

Six

fore

st n

urse

ries

B

C H

ydro

’s ra

il di

visi

on

Env

iron

men

tal L

abor

ator

y Su

nshi

ne H

ills

Gol

f Cou

rse

Cer

tain

ass

ets o

f M

inis

try o

f H

ighw

ays u

sed

for r

oad

and

brid

ge m

aint

enan

ce

$140

,000

’

$352

.000

’

$859

,674

’

$145

mill

ion

(pre

sent

val

ue)*

$6

mill

ion

+ 30%

of

gam

blin

g pr

ofits

$7

41 m

illio

n pl

us $44 m

illio

n in

inco

me

taxe

s ove

r 5 y

ears

(p

rese

nt v

alue

) $1

82,0

00

$5 m

illio

n pl

us $

3.9

mill

ion

in s

eedl

ings

over

5 y

ears

$3

8.3

mill

ion

$950

,000

’s6

$1 m

illio

n $3

6.9

mill

ion.

’ T

en o

f the

dea

ls w

ere

with

em

ploy

ee-

base

d fi

rms,

18

with

pri

vate

sect

or fi

rms.

In

each

ca

se th

e bu

yer a

lso

rece

ived

a 3

-yea

r con

trac

t for

se

rvic

es. T

heir

tota

l val

ue is

ove

r $65

0 m

illio

n.

13.

Dec

. 198

8 L

oan

port

folio

of BCEC

$68.

2 m

illio

n3

c

m rD

71

C

W r s W U

C n > z > U >

Tab

le 1

. Co

nclu

ded

Dat

e of

Tran

sact

ion

Cro

wn

corp

.Ia.n

et

Selli

ng p

rice

14.

Dec

. 198

8 A

sset

s of

Prov

inci

al E

duca

tiona

l $2

4 3,

000’

15.

Jan.

198

9 D

airy

Lab

orat

ory

$2 16

,000

’

16. J

an.

1989

B

.C. H

ydro

’s V

icto

ria n

atur

al g

as

$16.

7 m

illio

n4

17.

Feb.

198

9 B

.C. S

econ

d M

ortg

age

Prog

ram

$3

00 m

illio

n’

18.

Apr

il 19

89

Kok

sila

h fo

rest

nur

sery

$6

25,0

00‘

19.

June

198

9 W

estw

ood

Plat

eau

land

s (57

0 he

ctar

es)

$63

mill

ion

Med

ia C

entr

e

divi

sion

NOTE

S:

1.

The

buy

er a

lso

sign

ed a

mul

ti-ye

ar c

ontr

act t

o pr

ovid

e go

odds

ervi

ces

to t

he p

rovi

nce.

2.

Priv

ate

estim

ates

put

the

pres

ent v

alue

at $

120

mill

ion

to $

125

mill

ion.

3.

T

wo

deal

s ba

sed

on b

ook

valu

e of

$75

mill

ion.

The

tota

l book

valu

e of

BCE

C lo

ans i

s $2

53 m

illio

n.

4.

$6 m

illio

n w

as p

aid

imm

edia

tely

; $10

.7 m

illio

n is

to b

e pa

id u

pon

com

plet

ion

of V

anco

uver

Isl

and

natu

ral gas p

ipel

ine.

Vig

as h

as

prom

ised

to

spen

d $6

5 m

illio

n to

ser

ve n

ew c

usto

mer

s, a

$1.

5 m

illio

n en

dow

men

t to

Uni

vers

ity o

f Vic

tori

a, a

nd to

incr

ease

em

ploy

men

t. T

he p

rovi

nce

gave

Vig

as so

me

fran

chis

e ri

ghts

and

has

com

mitt

ed $

25 m

illio

n to

a c

onve

rsio

n pr

ogra

m.

5.

The

pro

vinc

e st

ill re

tain

s tit

le to

the

mor

tgag

es a

nd th

e re

spon

sibi

lity

for t

he ri

sk o

f los

ses.

6

. Z

enon

Env

iron

men

tal

Inc.

pai

d $8

50,0

00 a

nd B

C R

esea

rch

Cor

p. p

aid

$100

,000

for c

erta

in a

sset

s.

7.

B.C.

Aud

itor

Gen

eral

, Ann

ual R

epor

t, M

arch

199

0, p

. 251

.

SOUR

CE:

Tabu

latio

n by

the

aut

hors

from

var

ious

pro

vinc

ial g

over

nmen

t doc

umen

ts a

nd p

ress

rep

orts

.

KAI’HRYN HARRISON A N D W.T. STANBURY

Table 2. Privatization Actions in Britirh Columbia, 1979-85

1. Free dirhibutia $shares in a crown corporatiun (to residents) B.C. Resources Investment Corp. ($151.5

million in assets)

2. Sale of assets together with contracting-out Three ski hill operations in Provincial parks

in 1984 ($1.4 million for assets); amount of contract n.a.

3. Sale of assets Wildlife Review magazine (amount n.a.) Assets of golf course together with 20-year

lease on the operations (amount n.a.) Insurance Corp. of B.C. general insurance

division (1985) ($9 million) Beautiful B.C. magazine (1983) ($760,000)

Pacific Coach Lines (inter-city bus lines) (1984) (amount ma.)

4. Transfer of a unit from a line department to a non-profit society which receives government grants Pearson Hospital (long term care and

Royal Hudson Steam Train Woodfibre Ferry (transferred to a private

rehabilitation)

firm which is paid a subsidy)

5 . Contractingout of services to private sector firms Food services for correctional institutions Service of court documents Supervision of community service orders Crown counsel (prosecutors of criminal

Chaplain services Court reporting Production of educational videos Monitoring and maintenance of Fraser

cases)

Valley dykes

provincial parks

Maintenance and other services in

Aerial photography Licensing of securities, insurance and real

Audit of shared-cost programs Technical support for computer systems

Data entry for the minister of finance Treasury bond registration and transfer

Linen services for hospitals “HandyDart” mini-bus service for handi-

Intra-governmental mail services Records storage Computer support services (Legislature) Child care group homes services Vehicle licensing in small communities Barnston Island ferry Janitorial services for government offices

estate brokers and salespersons

(BC Systems Corp.)

services

capped persons

~

SOURCE: A. Lorenz, S. Muraca, D. Rusheinski and W.T. Stanbury, “Privatization in British Columbia, 1979 to 1985 (Vancouver: Faculty of Commerce and Business Administration, University of British Columbia, January 1989, mimeo).

With respect to the possible limits to privatization, we consider the following questions:

- What are the risks and benefits of privatizing laboratories that are used to help enforce health, safety and environmental regulations?

- If such laboratory-testing is privatized, what monitoring or oversight regime must the government set up to ensure the objectivity and quality of the tests used to enforce government regulations?


LESSONS FROM T H E SALE OF GOVERNMENT LABORATORIES

- Does privatization in the form of contracting-out result in a net reduction in the size or scope of government activity?

Contracting-out differs from the privatization of crown corporations in that the question is not what functions government should perform, but how it should go about performing them. Rather than reducing the scope of government activity, contracting-out represents the adoption of new arrangements for production and delivery of public goods and services by taxpayers. Of course, contracting-out is not new. Historically, governments have relied heavily on the private sector to build roads, to manufacture military equipment, and to supply a variety of intermediate goods and services used by governments, from office stationery to janitorial services. However, as the range of activities that are contracted-out increases, the question arises whether there are some government activities that cannot be privatized successfully.

Privatization of the provincial government laboratories is controversial because it represents a rare attempt to privatize an important element of a government “oversight” activity, which includes police services, monitoring the government’s own contracts, and enforcement of government regulation. Specifically, government labs are used to test samples to determine if they comply with various health, safety and environmental regulations. The sale of the assets of government labs together with the contracting-out of lab testing services to a privately owned lab raises three important analytic and policy issues. First, there is the potential conflict of interest created when a private lab, heavily dependent on business from private sector clients, is asked to test samples which may be used to convict a client of violating a regulation. Secondly, the quality of the contracted services (laboratory testing) has important implications for the government’s ability to satisfy its regulatory objectives, such as protecting the environment. Thirdly, there are the potentially larger costs of government setting up a regime to monitor the performance of private labs providing testing services for the enforcement of regulatory programs. These issues are explored in more detail below.

The balance of the paper is organized as follows. First, we review British Columbia’s privatization process in general terms and how it was applied to the three laboratories. The following section provides an analysis of the privatization process. Then we will explore the limits of privatization by focusing on the contracting-out of laboratory work that is used to enforce environmental and other regulations. Finally, we draw some conclusions.

Several criteria are used in the analysis and assessment of the privatization of the laboratories. The first is economic efficiency and effectiveness. Has privatization reduced the total cost to society of performing the work of the labs? This requires that the price received for the sale



of assets, all transactions costs and any increase in monitoring costs be evaluated. Is the privatized function performed as well as it was by government? The second set of criteria relate to the process by which changes in public policy are made and implemented. Is the decision founded on a priori analysis? Are the facts disclosed to the public so they can make their own judgment?

The prlvatization process in British Columbia General aspects

The Vander Zalm government devised its privatization program over a period of several months in 1987 with the recommendations of two advisory committees. One was a high-profile committee of prominent business people who reviewed crown corporations for privatization candidates (in less than three weeks). The second was a less visible committee of government personnel who performed a more general review of government operation^.^ The proposals for privatization of the three laboratories were within the jurisdiction of the second committee, which was comprised of representatives from central departments, though they presumably discussed their proposals with executives in line departments6 It is unclear whether the proposal to privatize the laboratories originated within individual departments, the advisory committee, or the cabinet. The fact that all three of the province’s laboratories were included, even though their functions and clients varied widely, suggests the possibility that the committee assumed that “all labs ‘ are equal” and that their privatization raised no special issues. It is also conceivable that senior executives in the two line departments involved, encouraged by their political masters to suggest candidates for the government’s program, would volunteer their labs for privatization.’ Finally, either bureaucrats or politicians may have been responding to pressure from private labs, which resented the subsidized services provided by government labs to private sector clients. Commercial environment and soil labs in British Columbia had been pressuring politicians to contract-out lab services to them for several

5 A useful review of the process can be found in Auditor General of B.C., Annual Rqor t to 6he Legislative Assembly offeri t id Columbia (Victoria: Queen’s Printer, March 1989). 6 Interviews with Heather Dickson, project director, laboratories, Government Restructuring Privatization Group, Province of B.C., conducted in October and November 1988 and January 1989. Hereafter cited as Dickson interview. 7 The laboratories probably were more vulnerable to privatization than many other units in line departments as they were distinctive operations physically removed from the rest of the department.


LESSONS FROM THE SALE OF GOVERNMENT LABORATORIES

Table 3. Indtuements Offered to B.C. Government Employees to Become Owners andlor Employees of F i m Acquiring Government Assets andlor Contracts for Services

Training opportunities Free, two-day training workshops on how to operate a business for employee groups who are

Free consulting time from a private firm to assist employees to develop a business proposal, Free help from financial institutions to review employee business proposals, and Extension of existing ministry training policies to include training related to privatizing a

Financial incenlaves Continuation of some benefits for six months following departure from the public sector to any

employees who buy a privatized venture as well as any current employees who go to work for them at the time the venture is established,

Preference for valid employee-based groups making a bid within 5 per cent of other bids, other things being equal,

Flexibility in the terms of initial contracts if an employee group buys the operation, Flexible financial arrangements such as lease to purchase, Leaves of absence without pay to employees who wish to pursue training or other activities

associated with the privatization of a specific venture, such as preparing a proposal, and Public notification of the priority of employee bids over public bidding.

Transition arsirlunce Preference for proposals which stressed job protection for existing employees and that used

Early retirement incentive program and special pension options, and Extension of in-service status for one year to any employees whose job is privatized, for any

employee re-employed within one year of being privatized (later altered to three years), the granting of a leave of absence for the time spent outside the public service and the reinstatement of their previous service.

affected by privatization and who are interested in making a proposal,

government enterprise.

public service standards in determining benefit entitlements,

SOURCE: Various documents on privatization published by the Province of British Columbia.

years.’ In any case, no studies of the potential benefits or problems associated with privatizing the laboratories were done prior to the announcement that they were “on the block.” Nor were lab employees or even relatively senior managers within the affected departments aware of the initiati~e.~

A central element of British Columbia’s privatization program has been a variety of inducements to encourage employee ownership of privatized operations, (see Table 3).” In general, the province sought to negotiate

8 Personal communication, Andy Lynch, former director of the environment lab. 9 Interview with Dr. Rick Wilson, director of air management, Waste Management Branch, B.C. Ministry of Environment, conducted in November 1989. Hereafter cited as Wilson interview. 10 See, for instance, British Columbia, Info Line, “Government Restructuring,” November


K A T H R Y N HARRISON AND W.T. STANBURY

and, if possible, arrange sale of assets and subsequent contracts with “valid employee groups” without ever seeking bids from the private sector. If no satisfactory employee bids were received and the government proceeded to request other proposals, subsequent bids submitted by valid employee groups were given a 5 per cent price preference relative to other bids.

Privatization of the soil lab The soil lab performs analyses of soils, plant tissue, animal feed and water for the agricultural sector. For example, the nutrient content of soils, plant leaves and irrigation water samples is determined to assess fertilizer requirements. The provincial lab’s clients included the ministries of Agriculture and the Environment as well as private farmers and livestock owners. The soil lab did not perform analyses in support of regulatory enforcement actions.

On January 21, 1988, the province announced that the assets of the soil lab had been sold for $140,000 to Griffin Laboratories Corporation, a new firm created and owned by former lab employees. Consistent with the policy of giving preference to employee groups, the sale was made without the solicitation of outside bids. Griffin also received contracts to provide lab tests for the ministries of Agriculture and the Environment for five and three years respectively. l 1 The characteristics of this transaction are compared to those of the other two lab transactions in Table 4.

Privatization of the dairy lab Prior to privatization the provincial dairy lab tested milk and other dairy products for various clients, including the federal and provincial governments, local municipalities, agricultural researchers and the Dairy Herd Improvement Service (DHIS), which is operated by the British Columbia Federation of Agriculture. Most of the lab‘s work was done for private clients at subsidized rates. For example, 87 per cent of the lab‘s testing was for DHIS, in support of a project to monitor herd productivity. An additional 3 per cent of tests measured the butterfat content of milk and

3, 1987 and February 4, 1988. (Info Line was established on October 30, 1987 to disseminate information about privatization and decentralization to government employees and to the public.) 1 1 At the time of the sale, the government noted that Griffin Laboratories included six of the eight lab employees, the other two being placed elsewhere in government. However, the project director for the lab privatization later indicated that the lab was actually sold to three employees, who offered employment to three others (see B.C., Info Line, February 18. 1988). This is not consistent with the government’s definition of a “valid employee group” as one which “represents a majority” of the affected employees, all of whom have “contributed equity to the proposed enterprise” (Auditor-General of B.C., Annuul Report, March 1989, p. 113).


Tab

le 4

. A

naly

sis of

Priv

atiz

atio

n of

Gov

ernm

ent L

abor

ator

ies

in B

ritis

h Co

lum

bia

Labo

rato

ty

Attr

ibut

e of

priv

atiz

atio

n tr

amat

ion

Dai

ry

Soil

Env

iron

men

t

Scal

e of

oper

atio

ns

prio

r to

priv

atiz

atio

n $6

48,0

00 o

pera

ting

budg

et

in 1

9861

87

$559

,000

oper

atin

g bu

dget

in

198

7188

$4

mill

ion

budg

et; 6

0 em

ploy

ees;

$2.

3 m

illio

n fo

r di

rect

test

ing

in 1

9871

88

2 N

umbe

r of

bidd

ers

2 N

one;

pri

ce n

egot

iate

d w

ith e

mpl

oyee

gro

up

$140

,000

Fo

rmer

em

ploy

ees w

ho

crea

ted

a ne

w f

irm

5

year

s w

ith MOE a

nd

3 ye

ars w

ith M

in. o

f A

gric

ultu

re

$130

,000

p.a

. for

5

year

s

$950

,000

’ Pr

ivat

e fi

rm, Z

enon

5 ye

ars;

at l

east

$2.

8 E

nvir

onm

enta

l Inc

.

mill

ion

p.a.

Selli

ng p

rice

of

asse

ts

Buy

er

$2 16

,000

Fo

rmer

em

ploy

ees w

ho

crea

ted

a ne

w f

irm

$3

0,00

0 p.

a. f

or 3

yea

rs

Con

trac

t for

ser

vice

s

Cla

imed

savi

ngs

Non

e $1

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were used by commercial dairies to determine payment to dairy farmers. It is for that reason that the project director responsible for privatization of the dairy lab suggested that “the reality is that the dairy lab doesn’t have any safety functions.”“

However, about 3 per cent of the tests performed by the lab were used by the province for public health andor consumer protection regulation. l3 Testing was performed in response to consumer complaints, requests from inspectors from the ministries of Health and Agriculture, and to determine product compliance with the B.C. Milk Act. For instance, milk was tested for water adulteration, efficiency of pasteurization and coliform count., On occasion, lab staff provided analyses and expert testimony in support of litigation. In addition, about 4 per cent of the lab’s tests were health-related requests by commercial dairies used to monitor their own product quality and that of the raw milk provided by farmers.

After unsuccessful negotiations with an employee group, a Request for Proposals (RFP) was published by the province in May 1988. The RFP stated that a program to certify private laboratories would be established within the Ministry of Agriculture by the former manager of the dairy lab. The government lab auditor would inspect certified private labs at least once per month. Labs seeking accreditation would be required to demonstrate their competence by analysing standardized samples prepared either by government laboratories in Ontario or an unspecified British Columbia “reference iab.”14

In December 1988 the province announced the sale of the dairy lab to an employee group. The new firm, JR Laboratories, owned by eleven of the former lab employees, assumed operation of the lab in January 1989.15 The employee group paid $216,000 for the assets and also received a three-year contract to perform tests worth approximately

12 Dickson interview. 13 British Columbia “Request for Proposals for Dairy Laboratory,” (Victoria: B.C. Privatization Group, 1988). 14 Two common techniques to assess accuracy of laboratory testing are to have several labs analyse identical samples (known as “split samples”) or to have labs analyse samples with composition known in advance only to the sample submitter (“blind control samples”). Labs seeking accreditation will be required to demonstrate their capability to perform certain tests used to determine milk pricing by analysing control samples prepared by the Agriculture Canada lab in Ottawa and the Central Milk Testing Laboratory in Guelph. With respect to other tests, they will analyse split samples and control samples prepared by an unspecified “BC reference lab.” The particular tests with the greatest implications for public health and regulatory compliance are in the latter category. 15 Two other former employees elected to remain with the province, as allowed by the terms of the contract with the BCGEU.



$30,000 per year.16 Most of the privatized lab’s revenue will come from the private sector.

The Request for Proposals (RFP) indicated that the province expected to designate the privatized lab as the exclusive provider of certain tests: testing to determine payments to producers, finished product testing required by the provincial Milk Act, and finished product testing ordered by dairy inspectors. In exchange for this monopoly, the province said it would establish a “market-based maximum price” for those services. It is unclear how this price will be established in the absence of a competitive market. It is clear, however, that in the future, private firms will pay the full cost of tests that were previously subsidized. Other services will be subject to private arrangements between the privatized lab and its clients. The RFP indicated that the province will contract with the privatized lab for its own testing requirements, including legal support services and expert testimony in regard to enforcement actions under the Milk Act.

Privatization of the environment lab The tests performed by the environment lab were used by Ministry of Environment (MOE) staff for several different purposes. Ambient environmental quality monitoring programs generally do not involve directly monitoring polluter emissions. However, field staff collect stack or effluent samples to monitor polluter compliance with permits issued under the provincial Waste Management Act. The act requires that permit holders monitor their own emissiotdeffluents, which they normally do through contracts with private labs. The provincial lab’s own results from compliance monitoring were therefore compared with permit-holders’ compliance reports as a way of auditing the private labs’ performance. Thirdly, the lab used special procedures to analyse samples that were to be used as evidence in court. Finally, the lab provided other services, including emergency analyses in the event of spills or accidents, maintenance of air quality monitors in the field, and development of analytical methods to detect new contaminants of interest to the Ministry of Environment.

When the proposed privatization of the environment lab was announced, the intent was to sell the entire lab, retaining only three of the sixty lab employees in government service.” Later, Ministry of Environment staff

16 Dickson interview. The contract is quite small since most of the labs business will be arranged privately. 17 I f compliance monitoring indicates a problem, MOE staff would collect additional samples to support possible enforcement action. The ministry’s lab would use special procedures to analyse these “legal samples,” in order to ensure the results’ credibility in court. The environment lab technicians periodically appeared in court as expert witnesses. 18 Wilson interview.


K A I ' H R Y N HARRISON AND w:r. SI'ANBURY

raised concerns with privatization of the labs compliance monitoring functions. As a result, the eventual restructuring of the lab was much more complex, as we shall describe below.

Like the dairy lab, the Request for Proposals for the environment lab contained various provisions intended to ensure standards of service would be maintained by the successful bidder.lg Bidders were asked to specify how they would avoid conflict of interest in providing tests and testimony in support of MOE litigation. At the same time, the RFP expressly encouraged the successful bidders to seek industrial clients to generate more revenue for the privatized lab.

Although more than twenty prospective bidders purchased the confidential RFP, ultimately only two bids were received. The sale of the laboratory assets for $850,000, together with a five-year contract with Zenon Environmental Inc. of Burlington, Ontario, was announced by the minister of environment on September 30, 1988. Zenon offered to hire the current lab employees under the terms of their B.C. Government Employees Union contract. The other bidder would not have guaranteed continued employment for lab employees nor adopted the union contract.

The minister claimed that privatization of the environment lab "will maintain the highest standard of environmental testing for the province, while providing the ministry with a wider, more comprehensive set of data and improved ability to monitor pollution hazards."'" He also stated that the government would save at least $1.1 million over the term of the contract. Details of the contract were not made public. However, the project director responsible for the lab privatization confirmed that the province guaranteed Zenon $2.8 million per year in business for five years."

Analysis of the privatization process Interdependence of asset sales and contract for services

When a government simultaneously sells assets to a private firm and contracts with that firm to provide goods and/or services, the prices of the assets and the services are interdependent. For example, if the province wanted to show that contracting-out resulted in savings over intra-

19 British Columbia, "Request for Proposals to the Province of British Columbia for the Environmental Laboratory" (Victoria: B.C. Privatization Group, 1988). 20 Ibid. Negotiations for the contract with Zenon were not completed until December 1988 and Zenon assumed operation of the lab in January 1989. 21 Dickson interview. Note that the direct costs of testing prior to privatization were only $2.3 million in fiscal years 1986/87 and 1987/88 (Environmental Lab RFP, p. 15). Presumably, some level of indirect costs has been assumed in estimating savings.

178 C A N A D I A N PUBLIC: ADMINISTRATION


government production it could sell the assets for less than their true market value to the contractor and insist that the per unit contract price for services be noticeably below the province’s estimated cost of production. This is tempting, since efficiency gains are frequently the putative objective of privatization, and it is often difficult to estimate the value of specialized used assets being sold by the province.

British Columbia has provided little substantive information on its privatization transactions. This, of course, limits “second guessing.” However, the B.C. auditor general did examine the privatization of the soil lab. The province received independent appraisals of the soil lab’s equipment on two bases: orderly liquidation ($2 10,000) and the market value for continued use ($470,000). The equipment was sold for $130,000. The province estimated that transaction costs of liquidation, auction fees, rent during the liquidation period, and severance pay would total $206,000 if the lab was simply closed. As for the value in continued use, the province believed that the soil lab could only be expected to earn $30,000 per year over the next five years, only a 6 per cent return on the appraised market value. It “concluded that in this case, the appraised value is not appropri- ate.” However, the auditor general concluded that “the Government had insufficient information to adjust the independent appraisal of the soil labs equipment.” He was not able to express an opinion on the future cost savings, said to amount to 22 per cent of the government’s estimate of future operating costs ($3 million over five years).“ In response to the auditor general’s criticisms, the government argued that it had pursued goals of regional development and fairness to employees, in addition to the “value-for-money” objective considered by the auditor general.

One of the soil lab employees, who was not included in the newly formed company, suggested that “taxpayers were ripped off when the Government sold the lab ... for $140,000.”23 At least one of the soil lab‘s competitors, who did not have an opportunity to bid for the lab as it was sold to employees, feels that the assets were “given away” and is concerned that the privatized lab will have an unfair competitive advantage over the other three soil testing labs in the province.24

The province has not attempted to demonstrate that the taxpayers received a fair price from the sale of the assets of.the dairy lab. The project director for the dairy lab privatization suggested that the price received reflected only the depreciated value of the lab’s assets. Since most of the

22 23 price was $140,000, including $130,000 for the equipment. 24 Confidential interview.

Auditor General of B.C., Annual Report, March 1989. pp. 89, 90. British Columbia, Info Line, “Soil Lab Raises Key Issues,” February 18, 1988. The total

179 ADMINISTRATION PUHLIQUE DU CANADA


new firm’s business will be with the private sector, the project director argued that the province could not exercise much leverage to increase the sale price of the assets. However, this neglects the fact that the privatized lab was also awarded the exclusive right to provide certain services required by private sector clients. Furthermore, the privatized lab is the only one in the province currently capable of providing the type of testing required by DHIS, which will constitute 87 per cent of the new firm’s busines~.‘~ The province is, in fact, providing the purchaser with a unique profit potential, even though that profit will come from the private sector.

As for the environment lab, the province has not released the appraisals and details of the cost savings done in support of the sale, although some figures have been released. The “market for continued use” for the individual pieces of equipment was appraised at $2.25 million in March 1988, compared to the sale price of $850,000. The business evaluator hired by the Privatization Group suggests that the $2.25 million figure is high because it assumes that a purchaser would make use of each piece of equipment.26 The “liquidation value” is said to be substantially less than $2.25 million, but has not been released. The assessed “business value” of the environment laboratory of $700,000 to $1.2 million reflects the consultant’s estimate of the amount that a business would be willing to pay for the expected “profit stream.”

Although the price paid for the assets falls within the reported range for the business value, several questions remain. For example, why would the value of the business be so much less than the value for continued use of the equipment? This estimate of the business value necessarily reflects a trade-off between what the government can obtain for its assets and the price it must pay to replace their services. It appears that in order to get a low price for contract services with the purchaser, the province accepted a reduced price for the assets of the lab. Staff in the Privatization Group and the Ministry of Environment suggest that this was in fact the case: the province accepted $850,000 for the assets of the lab because it got a “good deal” on the Zenon contract for services.”

Estimated savings and transaction costs As indicated above and in Table 1, the value of the three lab transactions is small. To put them in perspective, they were less than 0.1 per cent of the

25 In fact, the dairy lab has considerable expertise with respect to infrared milk testing, having been one of the first labs in the world to develop the capability. 26 Personal communication, Janet Heino, Clarkson Group, management consultants, November 1988. 27 Wilson and Dickson interviews.



increase in British Columbia’s government spending in 1989/90 over 1988/89. The potential savings, therefore, are likely to be even less. This raises the question whether the potential savings of privatizing the labs were outweighed by the province’s transaction costs of selling the assets and contracting for services with the new owner. Many of these transaction costs are essentially invariant with respect to the size of the transaction.

The province did not claim any savings from the privatization of the dairy lab. In the case of the environmental lab, the project director for the transaction suggested that the deal with Zenon had a net present value of $1.2 million. After subtracting the $850,000 received for the assets, the remaining $350,000 is said to be the present value of savings over the next five years. This is not consistent with the $1.1 million in savings reported by the minister unless an extremely high discount rate is used.28 It would be interesting to compare that $350,000 with the transaction costs of the privatization, including the cost of relocating, retraining, or terminating the employment of the twenty lab staff that elected to remain with the province after privatization, as well as the costs of privatization group staff and their consultants. Moreover, as will be discussed below, these savings pale in comparison to the potential costs of weakened enforcement of environmental regulations for a period of at least one year during transition to the privatized lab.

British Columbia’s Privatization Group has provided no supporting evidence for the reported savings to taxpayers for either the environmental or soil labs, despite the fact that detailed appraisals of the government operations were conducted by accounting firms prior to the sales. Several questions remain concerning the comparison of the costs of in-house operation and contracting out. What level of indirect costs was assumed? These often add 30 per cent or more to the direct costs, which are much easier to estimate.2Y What transaction and transition costs, if any, were

28 The $600,000 per year being supplied by industry for audits by the B.C. Research Corporation (discussed below) was not included in the reported savings as it would have been collected anyway. 29 For example, the Saskatchewan Department of Public Participation estimates that the “adjusted public sector delivery cost” is equal to the stated service costs with the following adjustments: 1. I2 to I .26 times stated salary costs plus I .47 times space rental charges plus up to $4951 per employee for unallocated central services plus 1.0856 times the stated service cost for unallocated interest expenses plus $55,000 per employee in the old government pension plan plus an adjustment for unallocated insurance premium. To obtain the adjusted private sector delivery cost the private sector bid price must be increased by 4% for contracting cost and reduced by the amount of corporate and municipal taxes paid. See Saskatchewan Department of Public Participation, “Costing Government Services” (Regina, January 1989, mimeo).

181 ADMINISTKAIION PUBLIQUE DU CANADA

KATHRYN HARRISON A N D W.T. STANBURY

included? These costs would have to be factored into any proper social cost-benefit analysis of the change.30

Role of competition One of the suggested rationales for privatization is that competitive pressures on private sector suppliers means that they will be more efficient than government departments in producing the same product or service. Yet competition was all but absent in the sale of the British Columbia labs. The soil lab was sold to an employee group without any competition, although this action was consistent with the province’s policy of encourag- ing employee ownership even at some cost to the taxpayers. Only two bids each were received for the dairy lab and the environment lab. The purchasers of the soil and environment labs did not have to enter a separate competition for the testing contracts they received, even though there were competitive private labs already in existence within the province (see Table 4).

The sale of the environment labs assets in one offering had the effect of reducing competition in the market for lab services within British Columbia. Several employees had expressed interest in purchasing some of the assets, but the province only accepted offers to purchase all of the assets. Prices for assets and contract services might have been more competitive if the operation had been subdivided and bids invited to contract for portions of the lab‘s work. Only two bids were submitted, apparently because most private labs and groups of lab employees were unable to find the funds to acquire all the assets. Moreover, it appears that the province has established a dominant private environment lab (Zenon) through privatization. If the same contract is reopened for bidding in the future, Zenon may be the only lab in the province with sufficient capacity to bid on it.

It appears that the purchaser of the environment lab has been guaranteed at least $2.8 million per year, whether or not the ministry provides that amount worth of business. If the contract price per unit is artificially low because of the “bargain” price at which the assets were sold, the owners of existing private labs in British Columbia are worse off, as they will have to compete in the future with a government-subsidized competitor. This

30 It might be argued that there are also indirect efficiency benefits of privatization, e.g., the sale of some assets or contracting-out of some services could encourage other units in the government to re-evaluate their activities. They might, as a result, become more efficient (and/or responsive to their clients).


LESSONS FROM T H E SALE OF G O V E R N M E N T LABORATORIES

result is attributable to the government’s efforts to overcome employees’ opposition by offering them an economically attractive deal.3’

The staff in the Privatization Group argued that integration of the sale of assets with the subsequent contract for services is an advantage, since it allows government to bargain with the purchaser in establishing the price of the contract. However, this ignores the fact that the province’s only “bargaining chip” is the possibility of accepting a reduced price for its own assets. Contracting-out a very specialized service previously performed by government employees often puts the crown into a bilateral monopoly situation for at least some period after privatization. Indeed, both the government and the newly created private firm have a strong incentive to contract with each other since both have very few alternatives. Economic theory indicates that the price and output configuration in a bilateral monopoly situation is indeterminate.

The situation with the dairy lab was different. Most of the privatized lab’s business will be with the private sector, including provincially subsidized DHIS work for the B.C. Federation of Agriculture. However, the province did have some control over the availability of that business to the privatized lab through its authority to certify the lab and grant it a monopoly to supply certain tests. Moreover, the dairy lab is the only one in the province currently offering the particular type of test required by DHIS, the lab’s main client. Although new labs might enter that market, it is unlikely that competitors could offer the years of experience with the test that enhances the privatized lab’s credibility, an important asset in the laboratory business.

Treatment of government employees The B.C. Government Employees’ Union was not consulted or informed of the government’s privatization initiatives prior to the October 1987 announcement, although estimates of the number of government employees affected ranged from 7200 to 15,400. Not surprisingly, the union has been active in opposing privatization and seeking job protection for its members.

Of the original staff of sixty in the environment lab, six were transferred to a new provincial Data Standards Group, created in May 1988. After the privatization announcement, several contract appointments were allowed to expire, and many lab employees sought work elsewhere. Thus, by the

31 In Britain the Thatcher government gave the employees of privatized enterprises an opportunity to acquire shares at below the market price. Further, the issue price was deliberately underpriced. See John Vickers and George Yarrow, “Privatization in Britain,” in Paul W. MacAvoy et al., Primfiration and Slate-Oumed Enterprises (Boston: Kluwer Academic Publishers, l989), pp. 209-45.

183 ADMINISTRATION PLIBLIQUE DU CANADA


time the sale was announced, only thirty-two lab employees remained, with the lab functioning at a reduced scale. Under the terms of the September 1988 contract between the province and the BCGEU, twenty of these employees elected not to move to Zenon, despite Zenon’s willingness to accept the union contract.” The province had to try to find alternative positions for those employees. The costs of relocation or retraining them could not have been taken into account at the time the $1.1 million savings were reported, since the minister would not yet have known how many staff would elect to remain with the government. This development also indicates that Zenon was required to assume its contractual obligations with more than one-half its staff consisting of new employees.

Inducements offered to government employees

It is very clear that the Vander Zalm government has provided a large number of inducements to government employees to become owners and/or employees of firms that acquire government assets or obtain contracts to sell goods or services to the province. These can be grouped into three categories as indicated in Table 3. Of particular significance are three features of these inducements. First, it was government policy not to go to public bids unless it failed to reach a satisfactory arrangement for the sale of assets and/or contract for services with a “valid employee-based group.” This process is hardly conducive to efficiency or public accountability. Secondly, there was up to a 5 per cent bid preference for private firms controlled by former government employees. Thirdly, the province has made public no estimate of costs of these inducements, which could be substantial relative to the small size of most of the privatization transactions.

The employee incentive features of the British Columbia privatization program reflect the influence of British advisers. The minister responsible for privatization spent a week in Britain meeting with officials involved with the United Kingdom program, and the province seems to have followed British advisers’ and other privatization proponents’ advice to get the employees “on board” by offering them incentives such as bid preference, while avoiding direct negotiation with public employees’ unions.s3 Oliver Letwin, a former adviser to the Thatcher government who also advised the British Columbia government, suggested that “once the employees are on

32 Wilson interview. 33 See, for example, Madsen Pirie. “Principles of Privatization.” in M.A. Walker, ed., Privatization: Tactics and Techniques (Vancouver: The Fraser Institute, 1988). pp. 3-14; Oliver Letwin, “International Experience in the Politics of Privatization,” ibid., pp. 49-68.



side there is no need to negotiate.” Another British proponent of privatization, a tape of whose speech on privatization was distributed to members of the British Columbia cabinet, stated, “We don’t need to negotiate with union leaders - to do that places them in a position of undeserved a~thority.”’~

The incentives offered to employees are consistent with a government strategy of weakening militant union opposition by turning public sector employees into small business entrepreneurs. The price of this approach is the imposition of an invisible tax on British Columbia taxpayers to pay for the employee incentives. Ironically, in accepting employee bids without competition, the government went so far to encourage employee ownership that it contradicted its primary objective, a reduction in the cost of government services through reliance on private sector competition.

Analysis: limits to contracting-out Conflict of interest

The privatization of the three government laboratories in British Columbia resulted in a number of new institutional arrangements designed to cope with the potential conflict of interest that could arise when provincial officials rely on a private lab to perform tests used to enforce health, safety or environmental regulations. The most extreme conflict would arise in the situation where there is only one lab in the province capable of performing the tests required by both the government and regulated firms. This would occur if there are significant economies of scale, or it is economically or technically impractical to rely on out-of-province labs.

If, however, the lab testing business is a structurally competitive market - that is, economies of scale are not sufficiently important so that at least several rivals exist in the province - the government has little to worry about concerning potential conflict of interest. It would have a choice of labs, and no lab is likely to be dependent on either the private firms from whom the samples were provided or on the government. Similarly, if there is only one private lab, but the province accounts for a substantial fraction of its business, the lab is less likely to give in to the temptation to fail to find a violation of the regulatory standard. The severity of conflict of interest problem, therefore, depends upon the degree of competition in the market for lab testing services.

It should be noted that there is a good reason why the situation of a monopoly lab owned by the same government that is also the regulator does not give rise to incentives to fudge test results in favour of the government. First, the employees in a government lab are unlikely to gain

34 Quoted in Vancouver Sun, September 4, 1987, p. H4.



any pecuniary reward by biasing the test results. Secondly, if they did bias the results to support a prosecution by the regulator, they would be subject to cross-examination by the accused company’s lawyer. If the proper protocol has not been followed, this fact will be exposed. Should that occur, the lab employees’ loss of professional reputation for objectivity would be enormous. However, in the case of a monopoly pzuate lab, in the absence of a monitoring regime by the province, if the lab biases the results against an enforcement action, the matter never gets to court because there is no evidence that the regulatory standard has been violated.

To summarize, a laboratory may err in either of two ways. It could detect violations where none exist (type 2 error), or it could fail to detect a violation where one has in fact occurred (type 1 error). A government lab has no pecuniary incentive to allow type 1 errors, and if it allows type 2 errors, it is likely to be caught by those harmed by the bias. In contrast, if a conflict of interest exists as a result of an uncompetitive industry structure, a private lab may well have an incentive to allow type 1 errors. Further, if the government’s oversight of private labs is insufficiently rigorous, one cannot expect individual citizens, each having a minor interest in environmental protection, to police the lab’s performance.

The different kinds of service performed by the environment lab presented different degrees of concern with regard to conflict of interest. Ambient environmental monitoring and research programs generally do not present the potential for a direct conflict of interest. However, the potential for conflict of interest with activities such as auditing industries’ lab results and providing legal support in enforcement actions is unavoid- able.

With respect to conflict of interest, Zenon (buyer of the environment lab) has agreed to forgo testing for other clients that would be in direct conflict of interest with MOE enforcement samples, if the MOE provides Zenon with warning of when and where it will be collecting samples expected to be used in court. Thus, Zenon will not be in a position of providing testimony for both the prosecution and the defendant. However, it could have substantial business with the defendant in other cases. The MOE’S legal advisers believe that other work that Zenon may do for the defendant will not hinder the credibility of its expert testimony in The MOE also note that in the next few years Zenon will likely rely on the province for most of its business, which suggests that any perception of bias would be in favour of the province.

One way to try to overcome the potential conflict of interest in practice (where government cannot rely on a structurally competitive market in lab

35 Wilson interview.


LESSONS FROM THE SALE O F GOVERNMENT LABORATORIES

testing services), is for the province to establish a regime to monitor the performance of the private lab. How this was done in British Columbia is now described.

Transfer of the audit function to BC Research Corporation

In May 1988, the minister of environment and parks announced a “program to improve environmental monitoring in the province.”36 The audit and method development role of BC Research Corporation was announced at the same time as the Request for Proposals (RFP) was issued for the remaining assets and activities of the environment lab. The minister also announced the creation of a six-person Data Standards Group (DSG) consisting of former environment lab staff. DSG’s job will be to monitor the results from the privatized lab as well as BC Research’s performance. The audits performed by DSG will consist of desk work, as it will not have access to laboratory equipment.

Until recently, BC Research was a non-profit organization, and it retains a reputation for credibility and independence. Ministry staff originally approached BC Research to suggest that the latter purchase the lab. Although BC Research was not interested in purchasing the entire operation, it did agree to undertake the environment lab‘s compliance- related functions. However, it would only do so if it could also be given the task of developing new methods for the privatized lab, a research role more consistent with its normal operations.

This arrangement provided for the most sensitive tests to be performed by BC Research, so that the environment lab’s remaining functions could be contracted with a successful purchaser with less stringent restrictions. In the future, a fraction of samples submitted by permit-holders to their own contract labs will be split, with half the sample going to BC Research to verify the commercial lab’s accuracy. Similarly, BC Research will audit Zenon’s analyses for the province. BC Research agreed not to perform any monitoring for industry that would directly conflict with its new audit role. However, it will continue to perform analyses and other services for industry not directly related to British Columbia waste management

36 In March 1988 BC Research Corporation became a private profit-oriented business. It had been a non-profit society for forty-four years. However, all voting shares continue to be held by B.C. Research Council, a non-profit society with directors from the province, industry and academia. The Corporation intends to encourage broader industry participation in the future (BC Research Corporation, Newsletter, Summer 1988, p. 1).



permits.” The province will rely on audit arrangements with Environ- ment Canada’s regional laboratories for one type of test.

In the past, the ministry’s audit program was not planned and coordinated by the lab, though it obviously played a critical role in analysing samples collected to monitor compliance. As proposed, the new audit program would constitute a more thorough and extensive program; 30 to 40 per cent more samples would be analysed than previou~ly .~~ It was planned to phase in the program over two years, with 5 per cent of industry’s lab analyses and 2.5 per cent of the privatized lab analyses being audited in the first ear, increasing to 10 and 5 per cent respectively in the second

The audit program was established by order-in-council. The regulation designates BC Research to audit permit-holders’ environmental monitoring data in exchange for fees to be paid by permit holders directly to BC Research. The fees paid by permit holders to BC Research will total approximately $600,000 per year. The RFP originally suggested that the successful bidder for the environment lab would also be required to pay BC Research for auditing services. However, after negotiations with the successful bidder (Zenon), the Ministry of Environment subsequently agreed to pay approximately $400,000 per year to BC Research for a portion of the work to develop new tests and for BC Research’s audit of the privatized environment lab. Zenon will not be required to pay any fees to BC Research. BC Research will thus receive about $1 million in annual revenue for the audit and method development program.

In August 1988 the Ministry of the Environment announced that “British Columbia’s new quality assurance y g r a m for environmental monitoring will go into action on August 15.” This did not occur, however. In fact, no testing was performed by BC Research for several months, although the provincial lab ceased its audit role as of August 15. On November 8 one of the environment lab employees who had been transferred to the newly created Data Standards Group resigned on the grounds that he could not continue “to be involved in this seriously failed program for reasons of personal ethic^."^' He asked the auditor general to investigate what he

year. Ll

37 “A Quality Assurance Program for Waste Management Permit Analyses in BC,” Appendix B to the contract between the Province of British Columbia and BC Research Corporation, August 28, 1988. 38 Wilson interview. 39 It should be noted that all labs, including BC Research, also have their own internalquality control programs. 40 B.C. Ministry of Environment, News Release, ‘Checking System for Environmental Monitoring Now in Place,” August 10, 1988. 41 Doug Sandberg, letter of resignation to Earle Anthony, assistant deputy minister, Ministry of Environment, November 8, 1988.



perceived as “abuse of government funds” and “disintegration of environmental monitoring programs” in the province.42 The former employee alleged that none of the two thousand water pollution audits and one hundred checks on air monitors scheduled to have been completed since August 15 had been done by BC Research. A Ministry of Environment spokesman, Dr. Rick Wilson, confirmed that “nobody is checking the numbers coming in from industry to determine if they are correct or

The ministry’s press release in August 1988 suggested that BC Research’s work would follow “data standards established by the Ministry.” However, four months later there were still no standards of performance for BC Research’s $1 million program nor for the $100,000 “bridging contract” with the MOE, as would be standard practice in contracts for laboratory services.

Ministry staff acknowledge unfortunate delays in getting the BC Research program off the ground, but suggest that by mid-November BC Research had begun limited testing for two MOE regions and was expected to perform some auditing in all regions of the province by ~ e a r - e n d . ~ ~ They stress that, in the interim, industrial permit holders continued to monitor their own emissions. However, problems with BC Research’s and Zenon’s performance persisted.

In February 1989, Environment Canada initiated its own review of Zenon’s performance. The federal government relies on analyses performed for the province in accordance with joint federal-provincial air and water quality monitoring programs, and is thus concerned about the quality of test results in its own databases. The federal reviewers’ report identified several problems. The quality of analyses performed by Zenon since privatization were called into question as a result of delays in analyses and inexperienced staff. However, the report was particularly critical of BC Research’s role. The authors concluded that “BC Research is not functioning in an audit role and the Ministry does not have the capability by itself

42 Doug Sandberg, letter to Auditor General of British Columbia, November 9. 1988. 43 Vancouver Sun, November 10, 1988, p. A19. 44 Particular concerns with BC Research’s audit program included reliance on outdated methodologies and reliance on only split samples in the quality assurance program, without inclusion of blind reference samples. Without blind samples, the lab being audited (whether Zenon or a polluter’s contract lab) is fully aware of when it is being audited and that it is not being checked at other times. Environment Canada, “B.C. Ministry of Environment Contribution to National Monitoring Programs: Data Quality Review,” prepared for Conservation and Protection, Pacific and Yukon Region by P.D. Kluckner, V. Lawrence and P. Brunet, March 1989.



to adequately audit the performance of its laboratory contractor^."^^ As of March 1989, BC Research had yet to check the calibration of any of the air quality analysers located throughout the province, throwing into question all data collected after August 1988.

Both Zenon and BC Research also performed poorly in a routine cross- Canada comparison of laboratory accuracy coordinated by Environment Canada. In a “round robin” test performed in the spring of 1989, Zenon placed fifty-fifth out of sixty-seven labs, and BC Research, the lab responsible for auditing Zenon and other private labs, placed sixty-fifth. Prior to privatization, the government lab usually ranked in the top quarter or half of the labs tested. In October the lab manager reported that problems with backlogs and staff morale had been resolved. Zenon placed fourth out of sixteen labs in the most recent round robin.

Monitoring the dairy lab The proposed dairy lab certification program raises several questions. The accuracy of milk composition testing performed by the privatized lab, which is used to determine the price farmers receive from dairies, will be monitored by independent government and university-affiliated laboratories in Ontario. The capabilities of the privatized lab and other labs in British Columbia to perform quality testing of raw and pasteurized milk will be audited by a “reference lab.” The latter tests are those with implications for public health and regulatory compliance, including tests for infection in raw milk and for efficiency of pasteurization of finished products.46

Since privatization, the new firm (JR Laboratories) has served as one of British Columbia’s two reference labs; the other is a lab owned by a dairy. The two labs alternate the reference function m~nthly.~’ The implications of this arrangement are problematic. First, in months that the commercial dairy’s lab serves as the reference lab, it audits the accuracy of its competitors’ labs as well as that of the privatized lab. In auditing the privatized lab‘s performance, the dairy reference lab is in a position of monitoring the

45 Ibid. 46 Testing raw milk for commercial dairies involves monitoring dairy farmers’ sanitary conditions. Prior to privatization, the provincial lab provided the service for all but one dairy in the province (which had its own lab) at less than cost. Since sale of the lab and the intent to rely on the user-pay principle were announced, several dairies have developed their own laboratory capabilities and applied for certification to monitor their suppliers’ performance. Testing finished product involves monitoring the dairies’ compliance with the Milk Act. The RFP indicated that the privatized lab would receive exclusive designation to perform that testing, since it would not be desirable for dairies to audit their own compliance. 47 Interview with Ray Cheung, JR Laboratories, November 1989.



privatized labs oversight of the dairy’s own compliance with the Milk Act. While the reference lab has an incentive to alert the province to any bias to its disadvantage, there is a disincentive for it to report any bias in its favour. Secondly, during the months that the privatized lab serves as the reference lab, it is in a position of checking its own accuracy.

Reliance on a British Columbia reference laboratory to monitor private labs’ performance is problematic, since it will be difficult for the province to audit the auditor - that is, the reference lab. For composition testing the province can rely on two highly respected labs in Ontario which, importantly, do not have an interest in the outcome. For other tests, the reference lab will be put in a position of auditing its competitors and itself (or of not being audited) for the very tests that are most critical to public health. Although there will be a lab inspector within the British Columbia government, he will have no access to testing equipment.

Although the new arrangement avoids blatant conflict of interest, such as ownership of the privatized lab by a private dairy, or allowing the contract lab to provide analyses for both the defendant and the prosecution in the same legal action, indirect conflict of interest has not been avoided. Commercial dairies and other private sector clients will pay for most of the privatized lab’s work. The lab will therefore have a financial interest in the firms being monitored for regulatory compliance. Although the labs exclusive designation to perform certain tests could be revoked in the event of biased performance, it would be very difficult for the province to detect such a bias (particularly since the lab has been designated as a reference lab) and perhaps even more difficult to locate an alternative contractor if it did detect bias.

Accountability of the monitoring agency For the environment lab, the arrangements between MOE and BC Research fail to provide for clear performance standards and lines of accountability. BC Research’s audit role is authorized by government regulation rather than required by a contract with the province. The problems with this approach have been demonstrated during the transition period. Although BC Re- search was authorized to begin auditing on August 15, 1988 - the date that the environment lab ceased to perform that function - the MOE and BC Research had not yet completed the details for BC Research to invoice permit holders for testing. BC Research did not begin to send out invoices until November. It received its first funding for the audit program from the MOE on October 1, and began limited testing in mid-November. In the absence of a contractual arrangement, which organization is to be held responsible for performance of auditing when problems arise in the future?

19 1 ADMINISTRATION PUBLIQUE DU CANADA


The absence of clear requirements for BC Research’s performance, whether contractual or regulatory, raises the question of what recourse will be available if problems with BC Research’s performance persist. The province could withdraw the authorizing regulation, thereby terminating BC Research’s program. However, there would be no alternative candidate within the province to undertake the audit program. Another concern is that the polluting firms’ personnel will be present whenever split samples are collected for shipment to BC Research and their own contract labs. Thus there is nothing to prevent the firms and their laboratories from knowing which results are being checked and, more importantly, from knowing that the other 90 per cent or more of their compliance reports will not be checked.

BC Research will continue to obtain most of its business from industry. In fact, a list of recent clients includes mining and pulp and paper firms that have presented serious environmental concerns in British Columbia. Thus conflict of interest will not be avoided, although BC Research’s agreement to forgo certain types of work will avoid direct conflicts.

While having BC Research perform the audit function is preferable to transferring the function to any of the private labs, BC Research’s audit role is a poor substitute for compliance auditing by the province. If Environment Canada privatized its own regional laboratories, following the lead of the federal Department of Fisheries and Oceans which privatized its British Columbia lab in 1986, there would be no remaining government labs in British Columbia. If the province loses access to the federal lab or if BC Research’s program encounters continued difficulties, it is difficult to imagine whom the province could turn to for independent compliance auditing.

It should be emphasized that the proposed improvements to the audit program that were to accompany privatization could have been achieved readily without privatization. At the time of the privatization announcement, the ministry was already planning to increase the frequency of its audits.48

Conclusions With respect to the privatization process in British Columbia, we can draw a number of conclusions:

- The province has adopted a policy of providing very little substantive information concerning the asset sales and subsequent contracts for services.

48 Wilson interview.



- What information is available suggests that the Vander Zalm government has accepted a less-than-market price for the assets, perhaps to obtain a lower price for contracted services so that it can claim “savings” attributable to privatization.

- British Columbia taxpayers have subsidized the privatization process in a variety of ways, notably through multiple inducements given to government employees to get them to create/join private firms that acquire government assets and/or contract for services.

- In the case of the three labs, the province has failed to appreciate the significance of the degree of competitiveness of the market for the provision of services following privatization. Privatization that creates an unregulated monopoly with barriers to entry is hardly conducive to greater efficiency.

- The direct and indirect transaction costs associated with privatization of the labs appear to be large relative to the potential savings. They may have exceeded the gains. However, because of government secrecy it is impossible to be more precise.

- A clearly beneficial effect of privatization of the labs is that it will result in much greater reliance on the user-pay principle rather than implicitly subsidizing private firms. There is no obvious reason that much of the work requested by private clients must be done in a government lab, and certainly no reason why the province should subsidize it. Further, regulated firms, who would not otherwise seek monitoring services in the future, will also have to pay for compliance testing performed by the privatized dairy lab and BC Research. This could have been done, however, without privatizing the labs.4g

The British Columbia experience indicates that privatization can, paradoxically, lead to more government intervention, though in a different form - for example, certification (regulation) of private labs. It may lead to oversight by one private contractor of another, or more formal contract monitoring by government officials.

Turning now to the matter of the possible limits to privatization, we found that privatizing government labs can present a problem where other government programs rely on performance of these functions. A contractor’s performance will have repercussions beyond the contract in question. This is most obvious where lab testing inputs are used to enforce health and safety regulations. Conflict of interest is a potential concern where the

49 The $600,000 per year that will be collected from industry for BC Research’s audit function has not been included in the province’s reported savings from privatization, since it amounts to a transfer.



market for lab services used by government regulators has few private (or other public) suppliers. Then it is necessary for government to create an arms-length public or private monitoring regime. As noted in the case of the privatized environmental lab, this can be both costly and awkward. And, as experience thus far with BC Research’s program has shown, there is no guarantee of success. When the province arranged for BC Research to perform an audit function, it was then required to monitor BC Research’s performance. In essence, it must oversee the contracted overseer, resulting in a “daisy chain” of arrangements. Thus, the provincial Data Standards Group will monitor BC Research, which monitors private labs, which perform testing for firms, which are required by government regulation to provide a pollution control service to the public. Similarly, for legal analyses that will be performed by the privatized lab for the government, the Data Standards Group will oversee BC Research, which will oversee Zenon’s performance as it monitors compliance of polluters subject to regulation. The complexity of the contracting and monitoring arrangements has become mind-boggling. Further, the costs of additional testing performed by each level of oversight could conceivably outweigh any cost savings associated with privatization.

Although government contracting for laboratory testing is not unusual, complete reliance on private labs for regulatory compliance testing is rare. The U.S. Environmental Protection Agency has a multi-million dollar program to contract for laboratory services. Nevertheless, it maintains in- house capacity in each region for compliance audits, legal analyses, and emergency testing5’ Within British Columbia, the federal Department of Fisheries and Oceans (DFO) privatized its laboratory function in 1986. However, DFO staff were uncomfortable with the potential for conflict of interest in relying on private labs for enforcement-related testing. Therefore, DFO subsequently arranged for Environment Canada’s regional laboratories to provide support for DFO enforcement actions.

American regulators were made painfully aware of the tremendous costs of reliance on unsatisfactory private lab results by the IBT scandal several years ago. Industrial Bio-Test Laboratories is estimated to have performed 35 to 40 per cent of all toxicology testing in the United States prior to 1981. About half of its work was used to support federal registrations of pesticides, food additives, cosmetics, drugs and other products. However, it was later learned not only that IBT’S testing techniques were inadequate,

50 Personal communication, Bob Courson, director of environmental services division, EPA Region X. See also U.S. Environmental Protection Agency, User’s Guide to the Contract Lab Program (Washington, D.C.: Office of Emergency and Remedial Response, EPA, December 1986).



but that results were routinely fabricated and falsified. As a result, hundreds of chemicals are now in everyday use in several countries based on suspect IBT testing that declared them “~afe .”~’

With the sale of the environment lab, it was possible to limit, but not eliminate, potential conflicts of interest by transferring the audit function to BC Research, which agreed not to accept work from other clients that would directly conflict with its audit role. However, the provincial Ministry of Environment will have less control over BC Research than it would a government lab, as demonstrated during the difficult transition period. Although problems with BC Research’s audit role may be resolved eventually, that arrangement cannot serve as a model for privatization for at least two reasons. First, the existence of BC Research, a research organization with lab capabilities which was willing to forgo certain types of work for business firms, was entirely fortuitous. Secondly, British Columbia will continue to rely on Environment Canada for some audit services.

Many of the tests performed for the provincial government by the three privatized labs do not, however, have regulatory implications. There is no obvious reason not to contract out those tests, if testing procedures that meet the province’s requirements can be performed at less cost, and if there is an adequate fallback position to ensure provision of emergency testing in the event of problems with the contractor. In fact, this appears to be the case with the services offered by the soil lab. While it is not clear that these conditions were met by the privatizations, a more important matter is the role of the environment and dairy labs in regulatory compliance testing.

Proponents of privatization often analyse alternative arrangements for provision of a government service by considering only the characteristics of the particular service, without attention to its context in broader government program^.^' This understates the complexity of arrangements in practice, particularly the need for levels of contract oversight and their associated costs. Secondly, it understates the significance of the relationship among government services. The quality of performance of a particular service can have widespread repercussions. This is particularly true when one considers elements of a government oversight function, which, by definition, are tied to another government objective (e.g., monitoring

5 1 Keith Schneider, “Faking It: The Case Against Industrial Bio-Test Laboratories,” The Amicus Journal 4 (Spring 1983). pp. 14-26. 52 See, for example, E . S . Savas, Pnuatamtion: The Key to B e t h Government (Chatham, NJ: Chatham House, 1987), ch. 4.



compliance with environmental regulations is inextricably related to the goal of environmental protection).

The application of a test result determines the suitability of different privatization arrangements. The same type of analyses are performed by the environment lab for the purpose of routine monitoring, litigation, and compliance auditing. Similarly, a particular type of test performed at the dairy lab may be used by private dairies to set their prices or by government inspectors to lay charges against those dairies. Arrangements that are satisfactory for one application may not work well for another.

Although it is clear that privatization of both the dairy and environment labs will result in conflict of interest, it is less clear how important the conflict will be in practice. It seems unlikely that a private lab would intentionally report false or misleading results for several reasons. First, there will be some government oversight. Secondly, it is not obvious that it would be in a business’ interest to hire a biased lab, since eventual discovery could be very damaging to a firm’s reputation. Thirdly, it is not obviously in the lab‘s interest to risk getting a reputation as a biased lab. However, in the case of the IBT scandal, each of these implausible motives did in fact occur! Although real bias may be unlikely, the “apprehension of bias” could be sufficient to destroy public and legal credibility. In the context of enforcing government regulations, the laboratory tests which determine compliance with environmental or health standards must be above reproach, and like Caesar’s wife, must also appear to be above reproach.

While the success or failure of the new arrangements will not be known for years, the early experience with BC Research provides reasons for great concern. The privatization of the environment and dairy labs does not appear to have served the interests of British Columbians. The savings reported by the province are undocumented and questionable. Even if they are accepted at face value, they are strikingly small relative to the risks of privatization, namely the reduced ability of the province to enforce its health and environmental regulations.

Addendum In his annual report on March 1990, British Columbia’s auditor general drew these conclusions about the privatization of the environment lab. Between June and October 1989

the ministry did not have an adequate system to ensure that the quality of work performed by the privatized laboratory met its expectations. The quality assurance program designed by the ministry did not include the procedures required of a sound monitoring system. In addition, the procedures that had been implemented were not operating satisfactorily .... We analyzed the ministry’s



data and concluded that the direct costs of the services provided during the first year of the contract were more than they would have been had the ministry continued to operate the Environmental Laboratory (p. 144).

This is consistent with our analysis.


Privatization in British Columbia: lessons from the sale of government laboratories

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