How should companies that operate private prisons be paid?

Private Prisons

I am not a proponent of privatizing prisons. Since I am not yet in charge, there are private prisons in the United States. In 2010 there were just under 100,000 people incarcerated in private prisons in the US. (Although no longer for federal prisoners). There are also private prisons in other countries, both the UK and Australia have a higher percentage of their prisoners in private prisons than the US does.

Payment per Inmate

Private prison operators get paid by the government. This takes several forms, but is typically based on the number of prisoners that are incarcerated[1]. For a profit-minded business, the incentives are clear: maximize the number of people incarcerated while keeping costs as low as possible. These motivations can reduce overall costs of prisons[2]-which is why privatized prisons can be attractive to governments.

This often doesn’t work out too well for inmates, private prisons tend to have more issues with violence, overcrowding, and general unpleasantness. A 2016 DOJ report found that privately run federal prisons were 9 times more likely to place prisoners in solitary confinement, and had higher levels of prisoner complaints on issues like food and treatment by prison staff.

Paying per inmate creates three different perverse incentives for the prison management company. First, unlike most of us, the company would prefer a world which has as many people incarcerated as possible. Second, they are encouraged to keep costs as low as they can get away with. This isn’t necessarily bad, a true efficiency gain is a genuine improvement, but excessive cost cutting can contribute to the problems cited above. Lastly, private prisons have no incentive to keep prisoners from reoffending, and may even have an incentive for them to come back to the prison after they have been released.

Melaleuca, Peterbourough, and Doncaster

In a women’s prison in Australia called Melaleuca, the last point is being addressed. For each prisoner that doesn’t return within two years Sodexo (the company that runs the prison) will get AUS $ 15,000. This is supposed to get the company to provide programs and services to reduce recidivism.

The UK has piloted similar programs at two privately run prisons for about half a decade now. At one prison, Peterbourough, the project is conducted through a Social Impact Bond.[3] At another prison, HMP Doncaster, Prison management company Serco’s payments are partially dependent upon the reconviction rate of released prisoners. If the rate does not fall from 58% to 53% the government will get 10% of the value of the contract back, if it falls below 52% Serco will be entitled to additional payments.

One motivation behind these sorts of programs is that the government only needs to pay for programs that are successful in meeting a certain target. Programs that do not meet their goals do not cost the government anything. This should allow for attempting a greater variety of programs and policies. 

Did it work?

Despite somewhat positive early results, the most recent results out of the prisons were mixed. At Doncaster, the most recent cohort of released prisoners had a proven reoffending rate of 54.6% as this is greater than the 53% target, Serco must pay back part of the contract. At Peterborough, larger scale policy changes meant that the social impact bond could not be properly evaluated.

The success of the individual programs and policies used to reduce recidivism need to be evaluated separately from the general payment policies. Just because recidivism was not reduced does not mean that the pay for success program failed. It just means that the programs used to reduce recidivism were not as successful as hoped. Maintaining these sorts of payment schemes should encourage companies to experiment with different policies and ideas.

 

Careful What You Pay For

Having some payment based on reoffending is almost certainly an improvement over simply paying on a per prisoner basis, but it is not without risks. The advantage of any sort of metric based rewards system is that it encourages performance on a certain specific metric. The problem with these systems is that they encourage performance on a certain specific metric. Funders will get exactly what they pay for and very little else.

There are myriad examples of this happening: Food corporation Green Giant had a problem, customers kept finding bits of insects in their bags of frozen peas.  Presuming their customers were not fans of entomophagy, Green Giant management decided to institute a rewards system for workers who found insect parts. The employees started finding many insect parts, because they were bringing insects from home, just to ‘find’ them and claim the reward[4].

How to reduce reoffending (without doing any work)

Even without outright fraud, there are lots of ways for a company to meet a target without actually making improvements. Imagine a prison which exclusively makes money from rehabilitating prisoners. Pretend the prison management company gets paid $10,000 for every year a released prisoner goes without committing a crime, and that this is its only source of funding. The prison management company likely would do some of the following[5]:

  • Try to house inmates who are unlikely to commit crimes after their release. The most valuable inmates are the ones who are least likely to commit crimes in the future. Additionally, the prison will try to avoid those people who it deems more likely to commit crimes in the future.
  • Release a lot of prisoners. A prisoner in prison has no chance of making the prison any money, whatever the prison can do to get people out so they can not commit crimes, it will do.
  • Take In a lot of prisoners. To release as many as possible, the prison management company will need to get as many people into the prison as possible.
  • Provide services for those that can be cheaply helped. It might benefit the prison’s bottom line to fund programs that increase the likelihood of someone not reoffending in the future. They will not offer these programs for everyone, but just for the prisoners who they believe are worth the cost.
  • Release young prisoners. If a prisoner is released at 25 and lives a crime free life until they are 80, the company will get $550,000. A prisoner who is released at 60 and lives a crime free life until 80 is only worth $200,000 to the company. This means that younger prisoners are more likely to get whatever services the company can offer, and older prisoners are likely to be ignored.
  • Keep costs as low as possible. Presumably the prison would still need to house prisoners for the duration of their sentences. It would have no incentive to fund improvements, unless it thought these improvements would help recidivism.

 

Most of these depend on the particulars of the exact payment metric. A payment metric that paid out based on the percentage of released prisoners who reoffended, would not encourage prisons to take in and release as many prisoners as possible.

A single clear metric is very easy to manipulate. It is likely better to use a lot of metrics. Prison management companies could be paid based on how many prisoners they housed, how many went on to commit crimes, the number of violent incidents, the type of prisoners, and possibly dozens of other metrics. While this might be harder to manipulate, it is also harder to keep track of, and may be difficult to find the right balance of metrics and payments.

All payments are based on some sort of metric. Currently that metric is the number of prisoners incarcerated. In select prisons, such as Melaleuca, another metric involving recidivism has been added. While finding the perfect mix of metrics is somewhere between difficult and impossible, improving on the current system seems manageable. Certainly, it is worth trying.

 

 

 

 

 

 

References, Sources, and Further Reading

http://www.bbc.com/news/world-us-canada-37124183

http://www.pri.org/stories/2016-09-01/australia-uk-have-higher-proportion-inmates-private-prisons-us

http://www.investopedia.com/articles/investing/062215/business-model-private-prisons.asp

https://www.theguardian.com/us-news/2016/aug/12/private-federal-prisons-more-dangerous-justice-department

http://www.newyorker.com/news/news-desk/why-the-u-s-is-right-to-move-away-from-private-prisons

http://qz.com/849774/in-australia-sodexo-owned-private-prison-company-melaleuca-will-get-cash-for-every-freed-inmate-who-does-not-come-back/

http://www.abc.net.au/news/2016-11-28/prison-to-get-2415k-for-every-prisoner-who-does-not-return/8062174

http://www.russellwebster.com/disappointing-outcomes-for-peterborough-and-doncaster-prison-pbr-pilots/

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/341682/pbr-pilots-cohort-1-results.pdf

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/449505/doncaster-pbr-pilot-cohort-2-results.pdf

https://www.theguardian.com/us-news/2016/aug/12/private-federal-prisons-more-dangerous-justice-department

http://knowledge.wharton.upenn.edu/article/the-problem-with-financial-incentives-and-what-to-do-about-it

 

 

 

 

[1] In addition, many contracts provide a guaranteed income for the prison company regardless of how many prisoners they actually house.

[2] Although it is not clear if they actually do

[3] A social impact bond allows private parties to pay the upfront costs of a program, and the government only pays the investors if certain targets are met. Private parties buy into the social impact bond, the money from which is used to provide programs (mostly mentorship) to help short term prisoners not reoffend. If the reoffending rate does not drop by 7.5% The investors don’t get any money.

[4] http://knowledge.wharton.upenn.edu/article/the-problem-with-financial-incentives-and-what-to-do-about-it/

[5] Admittedly, I do not know what sort of control prison management companies have on decisions of release and who enters the prison. I would guess their roles in these things are largely indirect.

 

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Why is Flying in Canada so Expensive?

(This is part 2 of an unintentional series on expensive Canadian things. Part 1 is here)

 

Flying within Canada is very expensive. It was ranked 70th of 75 in Kiwi.coms Aviation price index which gives the average cost to fly 100km.

On a couple random dates in October the cheapest flight I could find from Vancouver to Montreal was 450$ US, or about $600 Canadian. Partially, this is an expensive ticket because Canada is a big place, but a flight to Montreal out of Seattle on the same dates was $100 (USD) cheaper. This is true, even with the US ticket having more taxes and fees. Having to pay both US and Canadian fees, plus immigration fees, adds up.

While it’s true that Canadian Airports charge high landing fees to airlines. Mostly, it’s an expensive ticket because there are only two choices on airlines: Air Canada, and WestJet.

Departing Toronto Pearson

 

Duopoly 

Air Canada and WestJet are basically the only choices when flying domestically within Canada. Porter serves a few eastern cities, and there are airlines with awesome names like Air North, and Bearskin, which will take you to places that are even colder than Montreal or Toronto. There are also a few other Canadian airlines who mostly fly to places that are not Canada such as Air Transat, and Sunwing.

The main reason, the Seattle-Montreal Itinerary is so much cheaper is because along with Air Canada, Delta, United, and American will also sell you tickets. It’s the old recipe: more firms, more competition, lower prices.

Freedoms of the Air

With so much traffic just south of the boarder, and all major Canadian airports served by multiple US carriers, one might imagine passengers could simply book a ticket from Vancouver to Montreal through an intermediate US stop. For example, YVR-ORD-YUL. This would allow US Carriers to compete with Canadian ones, without flying directly from Canadian airport to Canadian Airport. Of course, there would be the hassle and fees involved with customs, but since most Canadian Airports have US pre-Clearance facilities, you could connect in a US airport like any domestic US passenger.

This is an impossibility. Flight searches will not display any options involving connecting in the United States. The reason for this has to do with a set of rules with the decidedly romantic name of ‘The Freedoms of the Air.’ These are negotiated between countries and govern what foreign carriers are allowed to do.  Almost nowhere in the world (except for the EU) is a foreign airline allowed to operate domestic flights within a country that does not share its flag.  Not only can US carriers not fly from Vancouver to Montreal directly, they cannot even sell tickets on this route, regardless of the actual path the aircraft takes. The same is also true if you start and end in the US, you cannot go from one US destination to another and connect in Canada.

 Room for more?

If the cause of expensive fares is limited competition, is there room for more competition to bring them down?

In markets where there is too little competition firms typically have higher profits. High profits are not something the airline industry has been historically known for and Canadian Airlines are no exception.

acvswj

 

2015 was a good year for pretty much every Airline[1], but Air Canada has typically struggled to make money. WestJet has been better, but it is not a market that new companies are leaping to enter. Furthermore, barriers to entry and large capital costs (planes aren’t cheap) have always made it hard to start a new airline. Canadian airline startups may be further hampered by requirements that cap foreign investment in airlines at 25%.

Maybe the problem isn’t the number of firms but rather their type. Ultra-low cost carriers (ULCCs) have been successful all around the world. Ryanair, Spirit, AirAsia, Norwegian, and company have all managed to make money by squeezing more people into planes and then charging them for everything. Canada has no low cost carriers. Until now. Startup carrier NewLeaf[2] recently started offering flights out of Winnipeg to secondary cities across Canada such as Kelowna and Hamilton. NewLeaf has not gotten off to a strong start, suspending some flights due to minimal demand.

As domestic competition is likely to remain limited, Canadian travelers will likely be stuck with expensive tickets for a while. Unless Canada wants to give 8th  or 9th freedom rights to US Carriers. Doing so would probably be bad for the Canadian airline industry, it might not be so bad for Canadians though.

Article Seven

It won’t happen. Even if the Canadian government were interested in doing this, which they arn’t, it’s not certain it would be legal. The issue comes from the international rules concerning cabotage established at the 1944 Chicago Convention. Cabotage is when a foreign carrier transports people or goods within a country, same as the 8th and 9th freedoms of the air. One of the rules (article seven) is that countries cannot give cabotage rights exclusively to another country or airline[3]. What this means is not entirely clear. The most likely interpretation of this is that the US and Canada could not make an agreement with Canada that only US airlines can conduct cabotage in Canada. An alternative interpretation could imply that Canada may not offer cabotage to US carriers without also offering it to the airlines of other countries.  At present, the only country that currently allows foreign cabotage is Chile. It seems unlikely that Canada will be the second.

Unless NewLeaf or another Low Cost Carrier is successfully able to come on the scene, it seems that Canadians will have to continue to fly on Air Canada and WestJet, and that domestic fares will remain high.

 

Sources, References, and Further Reading.

http://www.cbc.ca/news/canada/manitoba/newleaf-puts-brakes-on-winnipeg-flights1.3766914

https://en.wikipedia.org/wiki/Freedoms_of_the_air

http://www.bloomberg.com/news/articles/2016-09-12/can-these-new-airlines-bring-canada-s-sky-high-fares-back-to-earth

http://www.icao.int/publications/Documents/7300_9ed.pdf

https://books.google.com/books?id=yhGFiwvGg5cC&pg=PP7&source=gbs_selected_pages&cad=3#v=onepage&q&f=false

 

 

 

 

 

[1] Also, the only year in which I worked for one. Not a coincidence.

[2] As a virtual New Leaf owns no airplanes, but sells tickets onto flights run and operated by other airlines such as Flair Air. Most of the regional US airlines also function in a similar manner.

[3]  The actual text is: “…Each contracting State undertakes not to enter into any arrangements which specifically grant any such privilege on an exclusive basis to any other State or an airline of any other State, and not to obtain any such exclusive privilege from any other State.”

Should We Get Rid of the $100 Bill?

In the past few days I’ve seen several articles about the elimination of high denomination bills. Lawrence Summers suggests a moratorium on high denomination notes, and cites this paper by Peter Sands which argues the benefits of removing high denomination notes. I found it interesting, and have used it as the primary source for what follows.

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A Picture of Some Money. Image Source:ptmoney.com

 

Who uses high denomination notes?

No one will be surprised that the most common dollar bill is the $1. You likely have some of the 11.4 billion $1 bills currently in circulation in your wallet right now. What is likely not in your wallet is the second most common bill-the $100. There are nearly as many $100s as there are $1s. In terms of the monetary value, the $100 bill kills it, with about 80% of the all the value of cash coming from $100 bills.

Despite this prevalence, almost none of us use $100 bills in our daily lives. If we need to spend a bunch of money, we reach for our Visa or MasterCard instead. This is better. It gives us an electronic record of the transaction, removes the necessity and stress of carrying large amounts of cash, and might even give us some frequent flyer miles.  So if most people aren’t using $100s to buy things, who is?

A huge chunk of the $100s are outside of the United States, but estimates of what percentage that “huge chunk” is very widely between 25% and 75%. High denomination notes are attractive to the sort of people who do not want to keep their money in the formal banking system. This could because they do not trust their local banking system or currency, or it could because the money has been attained illegally. The people who really benefit from high denomination notes are those people who need to move very large sums of money (think millions of dollars) without the banking system.

Cash is particularly attractive to drug trafficking organizations, because they deal with large sums of money, and because they often have to move that money across international borders. In the largest drug cash seizure so far, $205.6 Million was seized by the Mexican government, virtually all of it was in genuine $100 dollar bills.  In 2010, currency exchanges in the UK stopped selling the €500 note due to their prevalence in crime. At the time, it was estimated that 90% of all the €500 euro notes in the UK were in the hands of organized crime. Some denominations continue almost exclusively in the hands of criminal organizations. The Canadian $1000 bill was discontinued in 2000 following a request from the RCMP, but about a billion Canadian dollars’ worth remain in circulation, essentially all in the hands of criminal organizations. High denomination notes make it easier to store money in cash, which helps with tax evasion, they also make it easier to engage to bribery.
Since cash must be physically transported, usually in a clandestine manner, there are benefits to using as a high a denomination as possible. A million dollars in $20 Bills weighs about 110lbs and takes around four briefcases. As anyone who has ever smuggled a million dollars in 20s through an airport[1] will tell you, that is an irritatingly cumbersome burden. Much better to take the million dollars in 100s where it will weigh only about 22lbs and could fit in a single briefcase, better still to take it in €500 euro notes where it would weigh just a few pounds and you could easily fit into the sort of bag the qualifies as a ‘personal item’ on Spirit Airlines.

euro-note-1205315_640

A different picture of money

What notes should we get rid of?

Most high denomination notes are from the major rich country currencies. The two most popular notes in terms of illegal activity are the US $100 bill and the €500 bill.  These are attractive due to their high value, and the widespread use and acceptance of euros and dollars.

Here is a list of most of most of the world’s highest denomination bills currently in circulation[2].

HDNotesTable

While there are higher value notes, the €500, €200, €100, and $100 notes are probably the notes that would have the biggest bang for buck (as it were) in making life more difficult for criminal organizations. However, eliminating high denomination notes of all currencies would be useful. Pretty much everywhere, high denomination notes are not widely used by the general population. The exception to this might be cash-centric Japan where the ¥10,000 note is used in normal transactions.

Arguments for retaining high denomination notes 

Legitimate Use

There are two basic situations where law abiding folks might want to have large denomination notes. One is storing money “under the mattress” or somewhere that is not a traditional bank account.  Even when this is not being done as a method of tax evasion, which is often the case, this does not seem a compelling reason to keep these notes. Unless one is storing many millions of dollars, storing it in 20s is not that much less convenient than storing it in 100s. I imagine that the number of people who are storing millions of dollars in legally acquired cash to be trivially small.

Another argument for legitimate use is that large denominations come in handy in emergency situations where normal financial systems do not work properly. This is especially true for refugees who will need to transport as much money as they can in some form of cash.  I do not know how much money the typical refugee travels with, but I would guess that it is not the sort of quantity that would be prohibitive to carry in $20 or $50 notes.  Wealthier refugees who would have large amounts of money to transport (a small minority) might also have more options about how they transport their wealth.

Seigniorage

Seigniorage is the amount that a government makes from printing money. Central banks typically define this as the interest from bonds received from issuing new banknotes, minus the cost of making the banknotes in the first place.  Nothing of value is created in this process, but it does give the government a convenient revenue stream.

This ends up being a lot of money, especially for the United States. The seigniorage on US $100 bills is worth around $23.1 Billion annually. This number is directly related to two things: the amount of currency in circulation and interest rates.

Removing the $100 bill would not get rid of all of this 23.1 Billion, much of it would be replaced by seigniorage on $20 Bills or other smaller denomination notes. Exactly how big the end result would be is tricky to estimate, but something in the nature of $6 Billion is a reasonable guess[3]. That is a lot of money. However, the net impact of eliminating $100 bills would not be that great. Some of this will likely be offset by increased tax revenue as the cost of using cash transactions to hide taxable income increases.

It is also worth considering who is paying these billions of dollars. if the primary users of the $100 bill are people engaged in shady activity outside of the US, then the US government receiving money to essentially help facilitate these transactions seems questionable at best.

Lastly, there is the issue of interest rates. Seigniorage is most valuable when interest rates are high. At the moment they are not. If interest rates are negative, hording large quantities of cash becomes an increasingly attractive idea. Why pay a bank to hold your cash when you can do it for free? Due to the very low interest rates that currently prevail, seigniorage is less beneficial than it has ever been.

Effectiveness

Finally, there is the simply issue of efficacy. Will the removal of high denomination notes actually make things tougher on the worlds criminals?  No one is suggesting that criminals will give up being criminals just because they can’t get large bills, but would it have any effect at all? There are lots of things that are easily transferable, anonymous, and valuable. Gold or diamonds are certainly possibilities, as are things like bitcoin.  While all of these are substitutes, they have their disadvantages: gold is heavy, diamonds are hard to spend, and bitcoin is volatile.

So far, cash has been preferred over these items. The best substitute for cash, has been different cash. In 2010 when the UK decided to restrict the use of the €500 bill, a 2012 report found that there was “a smooth transition by criminal organizations from use of €500 note to €200 note and high denominations banknotes in other currencies (particularly the $100 Bill).” This strongly reinforces the idea that for eliminating high denomination notes to be an effective irritant for criminals, there needs to be a multinational effort to eliminate as many of them as possible.

High denomination foreign notes as an alternative to a local currency or banking systems

In parts of the world where there is little trust in the local currency, local banking system, or both, foreign currency is often seen as a way to securely store wealth. This partially explains the large amount of US cash that is overseas. This is a mixed blessing. It’s nice in that it allows people an alternative to a broken system, but in doing so slows the motivation to fix that system. This is especially true for the nations elites who have both the greatest power when it comes to motivating policy change, as well as best access to foreign currency.  As with the refugee case, unless one is regularly transporting very large amounts of money, storing wealth in 20s or 50s is not that much more annoying than storing it in 100s.

Sentimental Reasons

I like hundred dollar bills.  They are one of those special sort of things. Rather like an expensive car or a fancy drink, they make you feel like you are living a more exciting life just by being near them. There is this sort of wonder of having a relatively large sum in such a compact and easily spendable package. While I am in favor of their elimination on practical grounds, I will be a little bit sad if they go.

I support a multinational effort to get rid of high denomination notes

Getting rid of high denomination notes is a pretty cheap policy.  it is clear that the legitimate uses of these notes are far overshadowed by the illegitimate ones. Moreover, the legitimate users that are harmed the most are the ones with the most money. These people will likely find the loss of high denomination notes annoying, but nothing more.

It is true, that the impact on any particular criminal enterprise will likely be slight, but this is a broad policy. Raising the costs of the major drug cartels and terrorist groups by even a percentage point or two could have a significant impact globally, given the scale of these operations. Combine this with even a slight reduction in tax evasion and the benefits are pretty compelling.

Additionally, there has never been a better time to do this. Improvements in electronic payments, mobile banking, and other alternatives to cash have made cash less important generally. Low interest rates mean seigniorage is less valuable than it has been in the past. We should do this, the sooner the better.

 

[1] It looks like people do actually smuggle large amounts of cash through airports. Though, they usually are a bit sneakier than just shoving it into their carry-on.

[2] The previous champion the 10,000 Singapore dollar note was scrapped in 2014 to prevent money laundering

[3] This is Peter Sand’s guess, it is arrived at by taking 23B, assuming that 75% of the value will be replaced by $20s and other lower denomination notes. 24B*0.75 =18B and 24B-18B=6B.

Sources and Further reading: