(FORTUNE Magazine) – OLD BUT STILL hotly controversial, the idea of letting private industry do more of government's work has caught fire in the 1980s. Pressed by tax revolts and spending limits, federal and local officials are buying more and more services from corporations. They have accumulated enough evidence lately to evaluate the risks and rewards. What they find is impressive. Turning government work over to business can cut costs 20% or more -- often much more -- without loss of quality. Although there's no way of accurately measuring the growth of these contracts, county and city governments, especially those in the West and Southwest, seem to have moved faster than the federal government. Private industry has always provided services such as garbage collection and road mending in many places. Not only are governments now contracting for more of these traditional services, such as public transportation, but they are also finding new functions to put out to bid. At some small airports -- such as Enid, Oklahoma, and North Myrtle Beach, South Carolina -- the Federal Aviation Administration no longer staffs control towers. The FAA provides funds and local authorities hire entrepreneurs to control air traffic. Los Angeles County and New York City have turned public golf courses over to private operators. Government is starting to reach far beyond contracting for services by looking to private industry to finance, design, build, and run public facilities from waste-water treatment plants to prisons. The U.S. Army has invited the biggest engineering companies in the U.S. to consider creating and operating an entire base for the new Tenth Mountain Division at Fort Drum in New York State. The contractor would have to find the financing, which could run to $1 billion. (The Army would furnish the soldiers.) All this activity quickens the entrepreneurial juices. Companies have sprung up to operate jails and airport towers. Two big accounting firms, Arthur Young and Touche Ross, help cities and states figure out what to turn over to the private sector. Writers and lecturers churn out books and schedule seminars on what's awkwardly known as privatization. Big players in the game expect to grow bigger. Browning-Ferris Industries of Houston is second among industrial waste-removal companies only to Waste Management Inc. of Oak Brook, Illinois. Browning-Ferris's contracts to collect city garbage have increased from 220 in 1981 to 340 today. Parsons Corp. of Pasadena, California, a big international engineering company, sees a lot of business coming from government. Parsons is financing and building the $20- million first phase of a waste-water treatment plant it will operate for Chandler, Arizona. Chandler plans to double, and then redouble, the plant's capacity. Parsons is also bidding on a $100-million treatment plant for Jefferson Parish, Louisiana, and is interested in the Fort Drum scheme. The long and redolent history of government contracting, from Revolutionary War scandals right up to some of today's bloated defense contracts, gives ample warning that a private contract is no guarantee that the work will be done honestly or efficiently. The idea of contracting raises troublesome questions. Will a contractor motivated by profit faithfully perform a public service? Or will he make a low-ball bid just to get a contract and then goose up his price -- or worse, walk away from a vital function if it becomes unprofitable? Experienced public officials have come up with good answers to these questions. They are leery of the bargain-basement offers competitive bidding may produce. In certain cases, if the law allows, they may rely on other approaches, such as ''requests for proposals.'' A request for proposal lets officials choose the most promising all-around contractor. When they have to use competitive bidding, tough standards can weed out unqualified bidders. Canny officials write careful standards into contracts, monitor performance closely, and invoke cancellation and penalty clauses. Big cities seldom turn & all of any function over to private enterprise. By keeping active in, say, garbage collection, the municipality can maintain competitive pressure on contractors and step in to replace one who fails. New York City ignored these rules in dealing with Broadway Maintenance Corp., which monopolized streetlight maintenance in three boroughs from 1953 to 1978. Broadway Maintenance always made the lowest bid, and the city didn't fuss much if it didn't do all the work agreed on. When officials audited performance in 1978, City Controller Harrison J. Goldin said the deal with Broadway Maintenance ''smelled to high heaven.'' But New York's plight worsened that year, when Welsbach Electric Corp., which already had a monopoly in the city's two other boroughs, underbid Broadway Maintenance and won the contract for the whole city. After receiving a record 180,000 complaints in one year about lights that didn't work, New York got smart. In 1981, it divided the city into eight service areas, allowing no company to contract for streetlight maintenance in more than two areas. Complaints are down 57%. ''There is absolutely no advantage in replacing a public monopoly with a private monopoly,'' says Professor Dick Netzer, director of the Urban Research Center at New York University. ''What you really are after is competition.'' Phoenix, a well-run city of 866,000, encourages municipal departments to join the competition with private contractors. Beginning in 1977, Phoenix opened areas of the city to bids for garbage collection. Browning-Ferris won the first area with a bid of $2.47 per household per month, against the city's bid of $2.64. SCA Services of Boston won another section in 1980, and National Serv-All Inc., a small Indiana company, took on a third area in 1983. Along the way an interesting thing happened. The more the city's public works department competed, the sharper it got. In 1984 the department won back the sector awarded to SCA, which has since been split up and absorbed by Waste Management and a Canadian company. AS IT TURNS OUT, the city made a mistake in signing up National Serv-All, which had bid only 1 cent per household per month less than the city. Serv-All couldn't work that cheaply. Within months, the company was raising cash by selling equipment given it by the city. Service fell apart last Thanksgiving and Christmas, when garbage piled up faster than Serv-All could collect it. Waste Management took over the contract in January. Says Phoenix Mayor Terry Goddard, 38, ''The Serv-All case makes me a lot more cautious. It was a false economy to take a bid that was low by 1 cent.'' But Phoenix still wants to open more services to private contractors. Los Angeles County and four counties around it have created the largest and most varied showcase of government contracting -- and furnished the most convincing evidence of success. Barbara J. Stevens, a former Columbia University professor who runs a New York research company, Ecodata Inc., studied the area and wrote a 573-page report on the counties' performance, published recently by the Department of Housing and Urban Development. Stevens analyzed eight types of service in ten cities that contracted for each service and ten that didn't. The contractors won by a wide margin. The municipal departments held their own only in preparing payrolls. In the other seven services, they were markedly more expensive, averaging from 37% more for maintaining trees to 96% more for laying asphalt on city streets. Stevens also made careful comparisons of quality: Were garbage-can lids replaced? Was grass cut to uniform heights and properly edged? She found no significant qualitative difference between municipal and contracted services. Stevens's research showed that government tends to pay more than necessary for low-skilled jobs. For example, the cities paid janitors $1,234 a month on average; contractors paid them $881. Contractors get more work out of employees because government gives more vacations, holidays, and sick leaves, and tolerates more absenteeism. Contractors use more part-timers and give foremen greater freedom to hire and fire, while making them responsible for equipment. Contractors paid bottom dollar on labor-intensive jobs, but on the capital-intensive jobs they used better equipment than the cities and paid to get the most skilled workers. Asphalt-paving crewmen earned $29,049 a year on the average from contractors, compared with $18,384 from cities. The 84 cities of Los Angeles County have the choice of furnishing their own services, buying them from the county government, or contracting for them privately. Many are choosing contractors. Pasadena discovered that it could save $250,000 a year, or 25%, by hiring janitorial services. About 21% of the city's $130-million operating budget goes to contractors. City Manager Donald F. McIntyre says the list of contractors will keep growing. At the southern end of Los Angeles County, Rolling Hills Estates broke off a contract it had with the county prosecutor to handle all its cases, mostly involving violations of building and other town codes. City Manager Harry R. Peacock says the service ''was totally inadequate.'' Rolling Hills Estates now pays a private law firm to act as town prosecutor. Rancho Palos Verdes, next door, closed its public works department and turned the care of parks, buildings, and roads over to an engineering company. After much political controversy, culminating in the election of a new Board of Supervisors in 1980, Los Angeles County plunged into contracting. By the end of 1984 the county had signed 434 contracts worth $108 million to do work that civil servants had done before. The county estimates current savings at $21 million a year in a budget of $6 billion. After Touche Ross had helped the county department of health services identify where it could save by contracting, the county turned feeding, housekeeping, laundry, and other nonmedical services in several hospitals over to private companies. The county has put contractors in charge of half its 20 golf courses. Parks Director Ralph S. Cryder says the privately run courses are more attractive and popular and make more money than those the county runs. But Cryder plans to keep some courses under the county wing in case a contractor defaults. He is also putting some parks under private management. CONTRACTING in Los Angeles has survived a lot of opposition. Civil service unions represent 63,556 out of 74,852 Los Angeles County employees and don't like the spread of contracting. Paul D. Nawrocki, research director of Local 660 of the Service Employees International Union, put together a 2 1/2-inch- thick volume of complaints about the performance of contractors in Los Angeles County. ''Contracting,'' Na- wrocki says, ''is an ideological program -- a philosophical attack on government -- that overrides any consideration of cost.'' He complains that government workers displaced by contracts are mostly blacks and Mexicans in low-skilled jobs who get replaced by lower-paid workers. County officials reply that only 34 workers have actually lost jobs. Most workers in the 2,200 positions eliminated by contracts have found other jobs with the county or work for contractors. Nationally the fiercest opposition to contracting comes from the American Federation of State, County, and Municipal Employees. In Passing the Bucks, a book the union published in 1984, it cites a string of horror stories about contracting, apparently in the belief that readers live in some Utopia where corruption or incompetence among civil servants would be unimaginable. Because of political and labor opposition, contracting hasn't spread as much in the rest of the country as it has in the less-unionized Southwest and West. Nevertheless, city governments in the Midwest and East have made some interesting deals. Three years ago Louisville faced the awful prospect that it wouldn't be able to open a new $73-million, 404-bed downtown hospital, built to replace the old General Hospital. The owner, the University of Louisville, decided it couldn't afford projected deficits even greater than the old hospital's $5 million a year. No government body was willing to pick up more than part of the deficit. Then Humana Inc., a Louisville-based chain of for-profit hospitals, agreed to lease the hospital for 40 years, starting at $6.5 million a year for the first four years; it also promised to subsidize the medical school, treat all the county's indigent patients for a fixed government payment, and turn over 20% of the pretax profits to the university. Last October, Humana gave the university $205,000 as its share of profits over 16 months, plus a voluntary $327,000 bonus. Humana earned $1 million even though it says it absorbed $21 million in unreimbursed costs for indigent and other patients. This year Humana Hospital-University, as it is known, expects to make more, according to executive director Gary V. Sherlock -- but he acknowledges that as an inner-city hospital, it will probably never match the profits of other Humana hospitals. Humana claims tough management and the economies of mass purchasing for its 85 U.S. hospitals enable it to operate 17% more efficiently than competing hospitals. In Louisville, Sherlock has cut the hospital payroll by 18% relative to the number of patients and fired managers who failed to meet newly written objectives. Private admissions are up from an average of 34 to 58 a day. Sherlock attributes this success with paying patients in part to 28 new programs and services the old hospital didn't have, including burn and acute dialysis units. IN NEWARK, New Jersey, a basket-case Eastern city with a tradition of machine politics and an entrenched bureaucracy, Mayor Kenneth Gibson has pushed contracting with surprising success. In 1977 Newark gave out a tree- trimming contract that got the job done for $19 per tree, compared with $50 ! per tree when city workers did it. In 1978 the city hired private snowplowers, and in 1979 contracted for garbage collection in one-third of the city. Other services, such as catch-basin cleaning, the demolition of abandoned buildings, and some street sweeping, are also being contracted out. The New Jersey attorney general recently filed a civil complaint against 40 companies, alleging that they rigged garbage collection bids. Included in the complaint were Pet-Am Co., which had the Newark garbage contract for the first three years, and James Petrozello Co., which now has it. The case has yet to be tried, but Newark officials say they are satisfied with privatization. Private collectors use bigger and better vehicles than the city and have a work force with an average age of 25. The average age of the city's sanitation men is 55, according to Alvin L. Zach, the director of engineering, and many are slowing down. An independent survey in 1982 showed Pet-Am collecting 5.4 tons of garbage per man per day compared with 3.4 tons for the city, though the private workers were more likely to spill garbage and leave it. The study estimated the city was saving $2.5 million to $5 million over the three-year life of the contract. Newark is about to privatize garbage collection in another third of the city. Government bafflegab makes it hard to determine just how well the federal government is doing with privatization. The Eisenhower Administration began the program to push contracting, which is now governed by the Office of Management and Budget's Circular A-76. That document requires federal agencies -- except where restricted by Congress -- to buy commercially available services and products unless the savings wouldn't exceed 10%. But civil service unions and bureaucrats who would rather build than dismantle empires continue to resist. Joseph R. Wright Jr., deputy director of OMB, admitted to Congress last fall that A-76 ''has not been effectively implemented.'' In most cases the federal experience seems to be about the same as the municipal experience. For instance, a 1984 Department of Defense survey of 235 contracts found that private bids on average were 24% below government estimates, which had already been cut 7% when competition loomed. A 1981 General Accounting Office report said it cost 50% more to use federal employees to clean government buildings than to use contractors. Congress has since limited the General Services Administration's contracting for custodians; existing civil service jobs for custodians can be contracted only to workshops for the handicapped. The OMB estimates that federal officials have identified $15 billion in annual operating expenditures that could be privatized under Circular A-76, saving $3 billion a year. The President's Private Sector Survey on Cost Control, more commonly known as the Grace Commission after its chairman, J. Peter Grace, makes even grander forecasts. It says the government could save $11.2 billion over three years by privatizing Washington's Dulles and National airports, the government's fleets of vehicles, all military commissary stores, and much of the Coast Guard's work. The Grace Commission may have gone overboard, but who would have expected airport control towers to go private? The impetus to contract at airports came out of the controllers' strike of 1981, which forced the FAA to shut down 80 towers at small airports. After finding that contractors could run these towers at less than half its own cost of $240,000 a year, the FAA decided to let local authorities contract with private operators for the service, with the FAA putting up the money. The scheme is in effect for about a dozen towers, and the FAA would like to farm out 120 more. Mark A. Jones, director of operations for a Kansas company called Midwest Air Traffic Control Service, says he can run a tower with fewer people than the FAA and pay controllers $16,000 to $18,000 a year compared with the typical FAA pay of $24,000 to $31,000. The FAA says the contract towers have an excellent safety record. The idea of privately financing public works may seem bizarre, but look how it worked for Chandler, Arizona. Chandler lies in what is becoming known as Silicon Desert, and its population grew from 30,000 in 1980 to 60,000 today. Back in 1982, Chandler realized it would need another waste-water treatment plant by 1985. Without the new plant, Motorola, Intel, and other prime industrial catches with facilities in Chandler would have had to go elsewhere to expand. But Chandler learned that it wouldn't become eligible for a federal grant before the late 1980s. In 1983 Parsons Corp. was willing to take the risk of borrowing with a variable-rate tax-exempt industrial bond, which turned out to be cheaper than any financing Chandler could arrange. Parsons figured it could finish by the end of 1985 and is meeting the deadline. Chandler's sewage fees will go up less than half as much as they would have with a city-built plant. THE SQUEEZE of having to uncrowd jails quickly while cutting budgets has forced federal and state officials to look with favor on companies that will finance, design, build, and run jails. The Nashville-based Corrections Corp. of America operates five facilities, including detention centers built for the Immigration and Naturalization Service in Houston and Laredo, Texas. At Houston in 1984, the company charged the INS $23.84 a day per detainee, compared with the U.S. average of $26.45 a day it costs the INS to run its own facilities -- and Correction Corp.'s figure includes capital costs, while the INS's covers only operating costs. The company completed the Houston center more than a year ago; had the INS built it, cumbersome review and approval procedures would have delayed completion until 1986. Turning prisoners over to profit-seeking companies bothers many officials. Another new company in this field, Buckingham Security Ltd. of Lewisburg, Pennsylvania, has bought the land to build a $25-million maximum-security prison in North Sewickley Township, Pennsylvania. But the state will make no commitment to turn prisoners over to Buckingham until a lot of questions are answered. Who chases escapees? Who is liable for the prisoners when they are in jail or being transported? A recent conference of governors in Washington suggested that ''states may wish to explore the option'' of contracting prisons but should do so ''with great care and forethought.'' The limits of how much of its functions government can pass to profit- seeking companies aren't visible yet. Most authorities would balk at turning police and fire departments over to the private sector, yet Scottsdale, Arizona, has an excellent for-profit fire department. It grew out of a private fire-protection service that existed before the town was incorporated. Rural/ Metro Corp.'s $2.3-million contract with Scottsdale averages out to $20 per capita per year, compared with an average of $50 for public fire departments in similar cities. Scottsdale's fire insurance rates, the best measure of the firemen's effectiveness, are average. Even where no policy to contract services exists, a kind of privatization may occur. In a sense the country's police are being privatized. Because Americans feel the need for greater protection, the number of private guards has grown much faster since 1970 than the number of publicly sworn law enforcement officers. The U.S. has about 1.1 million guards, compared with 580,000 police officers. The mail is also being privatized as users grow fed up with the plodding U.S. Postal Service and turn to more efficient and reliable commercial couriers, such as Federal Express and Airborne Freight. In theory, since the public sector doesn't have to make a profit or pay taxes and can generally borrow money more cheaply than the rest of us, government should be able to underbid the private sector. But it doesn't work that way. The bracing winds of competition more than make up for the built-in advantages of government.