Too public to fail? The moral hazard with public institutions.

Although it copes most of the headlines lately by being the most extreme case, the financial problems of Greece's public institutions are not one of a kind... If you have a quick look worldwide you will see cities, councils, regions... having similar problems to pay their bills. You can find near-bankrupt cities in the US (specially in California and Florida) Italy, Spain, Ireland, Portugal, Japan... Public management at its worst seems to be the common factor, with some institutions walking on the edge of default.

We are not talking about having trouble finding money for new investments or projects, as this would be a totally normal (although not desirable) situation in the actual environment. They are struggling even to pay the most basic of services, like electricity or waste disposal. This problem may not be totally evident to citizens because said services are still being provided, but it is serious enough for everyone to be concerned about it. 

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

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

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

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

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

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

Article first published as Too Public to fail? The Moral Hazard with Public Institutions. on Blogcritics.