How do private and public companies differ?

The battle between capitalism and socialism as the best system to organize our economy is continuing.  In some localities the debate is actually entering the test phase with socialist practices being established, thereby giving results that can be compared to capitalist practices.  For example, New York City is moving ahead on  establishing publicly owned grocery stores.

What can we expect to find when there is a debate about private providers (capitalism) and public providers (socialism)?  In this article I use economics to identify the pros and cons of private and public provision, and then let you decide which approach wins.

 My first task is to more specifically explain the differences between private provision and public provision of products.  One key difference is the origin of funding for the providers.  Private companies are funded by private individuals, usually called investors.  The  number of individuals can vary from one, in the case of a one-person firm, to millions for very large national and international companies owned by stockholders.

In contrast, public companies are funded directly by a government, which could be local, state, or national.  But since governments acquire their funding from citizens in the government’s jurisdiction, it is really the citizens paying taxes to the government who are the funders.

While funding of companies ultimately comes from individuals in both socialist and capitalist situations, there is a key difference in how the funds are acquired.  Investors willing provide funds to companies based on their evaluation of the company’s prospects. There is often risk that the company will not perform as expected, and the higher the risk the more promised profits investors will require if the company is successful.

 With public investments, funds come from individuals through taxation. Paying taxes is not an option.  Hence, for those taxpayers who are not in favor of a particular public investment, they still must help fund the investments.  This is the opposite of private investing.  However, one long-run option that can be used by citizens opposed to a particular public investment is to eventually move to another governmental jurisdiction. This is often called “voting with your feet.” 

Evaluations for private and public projects are also different.  Most private projects must promise profitability before investors will fund them.  Investors of private projects are expecting to earn profits.  Indeed, the expectation of earning profits is the main reason for the investment.  While some consider “profits” to be a negative word, profits are what determines a successful private project.   Profits mean all costs have been covered by the project’s revenues plus other funds generated to compensate the investors for taking the risk of potentially losing money.  Profits are a signal the project is successful.

In contrast, most, but not all, public projects create no profits.  This has two important implications.   First it means the costs of the public project can be lower than if the project was developed privately because profits are not part of total costs. Second,  this means some public projects are developed that would not be developed privately due to higher private costs.  Low-cost public housing built for people with low income is a good example.  

Finally, there is the important difference of  innovation between private and public projects.   Investors in public projects are always looking for ways to improve their profits.   While this may sound greedy, there are benefits.  If private projects can be improved to make them more attractive to users and to investors, both sides – investors and users – can benefit.  Today, we often see this happening in the technology industry. Competing companies are motivated to improve so as to attract more buyers.

This motivation doesn’t exist for public providers because there are usually no or limited competitors. However, competition can exist if people are willing to move.  This is called “moving with your feet,” and it is a way to generate competition between governments.  We’ve seen this competition exist between states.

 Walden is a Reynolds Distinguished Professor Emeritus at North Carolina State University.  His new book, “North Carolina in the Anxious Age,” will be published by The UNC Pess in October.