Why We Need Reform

President Bush recently named a nine-member commission to study postal reform--the first time a U.S. president has created such a commission since the Johnson administration. That action is timely and necessary, since the Postal Service's structure will certainly change dramatically at some point in the not-too-distant future. It can be altered deliberately now by design, or chaotically in the future by default. The President's Commission on the Postal Service enjoys a rare opportunity to accomplish the former.

The U.S. Postal Service is gigantic by almost any standard. In 2002 it earned $66.5 billion in revenue. It employed 854,000 people, a number greater than the population of Delaware. It handles about 40 percent of the world's mail. Proper organization of such an entity is clearly important for U.S. economic health.

The Postal Service was formed through the Postal Reorganization Act of 1970. While the act had several goals, its main aim was to create a new service with the financial and managerial independence that the old, highly politicized Post Office had lacked. Among its new powers, the USPS could negotiate wages, set prices with regulatory oversight, borrow from the Treasury, and independently sue and be sued. The act exempted the USPS from federal, state, and local taxes, and granted it the power of eminent domain. The Postal Service was to become fiscally self-sufficient by breaking even over time. The act left undisturbed two key elements of the Post Office's structure, however: a monopoly over letter delivery (as well as a mailbox monopoly) and government ownership.

The act was an improvement over the old Post Office. The productivity of the postal system improved. The cost of the postal system was shifted onto mail users, and away from direct taxpayer subsidies. The Postal Service was, in many ways, operated in a more businesslike manner.

But the act also failed in important ways. It failed to reduce cross subsidies from monopolized to competitive mail classes, but rather appears to have exacerbated them. It failed to keep postal wages comparable to private sector wages, an express aim of the act. Although it did reduce the direct cost to the Treasury, it did not maintain taxpayers' equity in the Post Office, but rather allowed it to be dissipated through recurring deficits. The Postal Service's net worth is now negative $1.36 billion, down from positive $1.7 billion when the Postal Service began in 1971.

Although it has made progress recently in cutting costs, the Postal Service appears to be in a slow-motion train wreck. Its revenue base is eroding. For the first time in recent history, in 2002 the number of pieces of first-class mail delivered (the way one would measure demand for first-class mail) actually declined, by 1.28 billion pieces, or 1.23 percent. The number of first-class letters mailed has declined only twice since 1945, and never by so large a percentage. First-class mail constitutes over 57 percent of the Postal Service's total revenue from mail. The decline caused the Postal Service's revenue from first-class mail to fall by $607 million, or 1.7 percent.

The Postal Service's other big mail class is standard mail, mostly advertising items, accounting for almost 25 percent of revenues from mail delivery. The number of standard mail pieces delivered declined more precipitously, by 3 percent, while revenues from that class increased slightly because of rate hikes.

Other mail classes also showed declines. The number of priority mail pieces declined by 10.7 percent. The number of express mail pieces declined by 8.6 percent. The number of periodicals mailed declined by 1.8 percent. The number of packages mailed declined by 1.64 percent. International airmail pieces declined by 15.4 percent. Unsurprisingly, the Postal Service's financial condition has suffered as a result. Its net loss in 2002 was $700 million, on top of a $1.7 billion loss in 2001.

The reason for this decline in demand is clear. In the thirty-two years since the act was implemented, a momentous transformation has taken place in the communications marketplace. New communications technologies that were only an idea in 1970 are now in wide use. Through electronic mail, people can communicate written messages instantaneously anywhere in the world at low cost. New technologies, such as direct broadcast satellite (DBS) allow users to receive those messages without accessing their computers. The wide availability of facsimile machines and cellular phones, as well as lower long-distance telephone rates, have also played their part. Innovations in communications technology are likely to continue apace, causing further declines in the demand for physical mail delivery.

Additional rate increases are not the solution, as they will only encourage further substitution into alternative communications services. Nor is enhanced commercial freedom for the Postal Service, in its current form, a viable alternative. That would only encourage it to compensate for revenue shortfalls by unfairly competing in its nonmonopolized services with private firms that do not enjoy the Postal Service's wide variety of privileges and immunities.

We are thus at a decisive moment in U.S. postal history. The model upon which the Postal Service was created, that of an independent, government-owned agency enjoying a legally enforced monopoly, is inappropriate for the United States today. Inexorable, secular technological change cannot be addressed through minor bureaucratic renovations. The reforms recommended by the president's commission must represent a bold departure from the outdated 1970 model.

The performance of the Postal Service suffers because of the two key elements of the Post Office left intact by the 1970 act: legally enforced monopoly and government ownership.

The Monopoly Power. The adverse economic effects of legally enforced monopolies are well known. The firm will misallocate resources by charging excessively high rates for its monopolized services (here the delivery of addressed letters), and will not minimize costs, as would a firm facing rigorous competition. A monopoly firm will also be slow to innovate. Indeed, those are some of the rationales offered for enforcement of antitrust law.

The standard response is that, in certain cases, the social benefits of enforcing a monopoly in some industries exceed the social costs. Here the benefits allegedly include the provision of universal delivery service, or guaranteed letter delivery to all communities.

But the logical link between the desirability of universal service and the need for enforced monopoly does not exist. First, firms facing competition have a strong business incentive to provide service to all communities. All else equal, customers will prefer dealing with a firm that has a universal delivery network over one that does not; universal service is an important and valuable asset. Private delivery firms such as United Parcel Service and Federal Express currently stress the fact that they "go anywhere" when advertising their services. While private delivery firms may lose money on particular delivery routes, they have a strong incentive to nevertheless maintain universal service for its business value.

Second, if a regional delivery firm is too small to offer nationwide delivery itself, it has a strong incentive to contract with another firm to provide such an offering.

Third, the experience of other countries that have eliminated their postal monopolies strongly suggests that universal service is not harmed by competition. Sweden and New Zealand, both with remote hinterlands, have eliminated their postal monopolies, and delivery service to rural areas has been maintained.

Fourth, a host of recent statistical studies demonstrate that the cost of serving rural customers is in fact not significantly higher than the cost of serving urban customers. Arguments for the delivery monopoly invariably assume that the cost of rural service is significantly higher, and that rural communities would therefore not receive letter delivery service in a competitive market. But if there are no significant cost differentials, such arguments disappear.

Finally, if the provision of universal service remains a source of concern, the government can issue licenses to particular firms with the proviso that they maintain universal service. If necessary, detailed conditions can be placed on those licenses. To reiterate, universal service simply does not imply legally enforced monopoly. The social benefits of the postal monopoly are thus likely to be zero.

Regarding the social costs of the postal monopoly, the 1970 act created the Postal Rate Commission to control the Postal Service's rates. For a variety of reasons, however, the commission is unlikely to be effective at controlling the Postal Service, and that failing raises the social costs of the delivery monopoly.

First, the act did not give the commission the power to actually set rates. The commission merely recommends rates and classifications to the Board of Governors of the Postal Service after the Postal Service has requested a rate increase. The board has the authority to overrule its own regulator on rate increases, provided it is unanimous. In an analogously regulated investor-owned electric utility, the utility's board of directors would have the authority to overrule the state public utility commission on rate matters.

The postal Board of Governors has used that power twice. It overruled in 1981, raising first-class rates to 20 cents after being thrice rebuffed by the commission. The board also voted unanimously to overrule the commission and implement the rate increases effective July 1, 2001. The chilling effect of the board's veto power may have a greater effect on the commission's decisions than its actual use.

Second, the commission is weak because the Postal Service is government-owned. Because it is government-owned, there are no tradable shares and thus no share prices. Because there are no share prices, the commission cannot reduce the wealth of stockholders by reducing rates, or by threatening to do so. A public utility commission can shrink equity values by refusing to raise rates, raising them slowly, or by reducing them. This important power normally places substantial pressure on managers in a private firm because private ownership allows the firm to create strong links between shareholder wealth and the interests of managers, which are necessarily eliminated by government ownership.

Third, the structure of the ratemaking process prevents the Postal Rate Commission from imposing a true revenue constraint. The commission must simply take the Postal Service's costs as given, and try to allocate those costs across the various mail classes as best they can. Under private ownership, denying rate increases will reduce equity values, as noted. However, the Postal Service can simply claim inability to meet its costs, such as payroll, forcing the commission to either raise its rates or risk overdrafts. Indeed, in his 1994 testimony, the Postal Service's main revenue witness, John H. Ward stated, "Despite maximum allowable annual borrowing for operating and capital purposes ($1 billion for operating purposes and $2 billion for capital purposes--net), the end-of-year cash and investment balances would be less than the amount necessary to fund one bi-weekly payroll (currently about $1.1 billion)." What is the commission to do if Postal Service paychecks will begin bouncing without a rate increase? The commission consequently has little power to constrain Postal Service costs. The break-even constraint is thus considerably softer than the revenue constraint of a private competitive firm.

Fourth, the Postal Rate Commission does not have the power to regulate the quality of postal services. On July 25, 1990, the commission formally advised the Postal Service of its opinion that it should not implement a plan to downgrade nationwide first-class delivery standards. On the very next day, Postmaster General Anthony Frank responded in a letter stating that, "After consideration of the opinion, we have concluded that it does not warrant changing our scheduled Saturday implementation of overnight standard changes." The commission is thus unable to determine such critical variables as the number of deliveries per day, per week, and the speed of deliveries. A public utility commission, in contrast, has control over variables like the reliability of electric power by linking allowed rates of return to outages. Additionally, performance standards for a privately owned, regulated utility are expressly stated. In telecommunications, for example, details like time until dial tone, length of repair waits, and speed of infrastructure expansion are expressly specified.

Fifth, the commission is weak because it lacks adequate information on Postal Service operations. The Postal Service has the best information on its operations, and the commission depends upon the Postal Service to provide that information. As former chairman Clyde S. DuPont stated, the Postal Rate Commission lacks

explicit statutory authority . . . to prescribe or require the Postal Service to collect particular types of data. Although our discovery powers are generally sufficient to permit us to test and clarify evidence presented in our proceedings, the service has treated the actual collection of data as its exclusive domain. It reserves the design of its statistical systems and the data to be released as a matter of unilateral discretion. . . . Thus, the commission and the parties to our proceedings have been tied to the data the Postal Service is willing and able to make available.[1]

Importantly, this is in contrast to the information disclosure requirements faced by a privately owned regulated utility, which includes subpoenas, audits, and other measures. The control the Postal Service enjoys over its information is likely to significantly weaken the commission's ability to regulate it.

Postal scholars have noted that the commission is weak, and that this essentially allows the Postal Service to price in an unconstrained manner. As political science professor John T. Tierney stated, "It hardly seems an acceptable situation that a government agency enjoying a monopoly over certain of its services has the ultimate power to put into effect whatever rates it chooses."[2]

It is unlikely that regulation is effective at keeping the social costs of the Postal Service's monopoly low. Given the enforced monopoly's low social benefits and high social costs, society would be better off if it were repealed. The Postal Service would also be better off, since its incentives for innovation and cost efficiency would improve. Nor will the Postal Rate Commission become an effective regulator simply by granting it more powers through legislation. A change in the Postal Service's ownership structure is critical to reform.

Government Ownership. The second major oversight of the 1970 reform was leaving the Postal Service government-owned. The rationale for government ownership remains unclear. Even the Postal Service does not assert that government ownership is necessary to ensure universal delivery service, which would be absurd.

It is useful to recount the views of the last commission to study reform in 1968, commonly known as the Kappel Commission. Notably, most members of that commission believed that the Postal Service would be better off under investor ownership. Nevertheless, the Kappel Commission suggested several reasons for retaining government ownership:

If the postal system had begun after the country had reached an advanced stage of technological, social and economic development, it would in all likelihood have emerged as a private industry suitably regulated to ensure satisfactory service levels and fair prices. Most members of this Commission would favor an investor-owned postal system [emphasis added].

We recognize, however, that formidable barriers stand in the way of a transfer of the existing postal system to private ownership. The Post Office has had two hundred years as a Government operation. Time has nurtured the attitude that the postal service must be a Government responsibility.

Private operation, furthermore, presumes a buyer and a seller. It is clear that an organization with the Post Office's earnings record would not attract investors. Our contractors estimated the current appraised value of postal fixed assets at approximately $1.7 billion. That figure, together with the $5 billion modernization requirement estimated by the Post Office, would make for formidable stock and bond issues. It is highly improbable that issues of the size necessary to complete financing within a reasonable period could be undertaken in these times.[3]

Aside from the unsatisfying assertion that there is a public perception of inevitable government ownership, the commission issued two arguments questioning the feasibility (as opposed to the desirability) of placing ownership in private hands. First, the Post Office's earnings record would not attract investors, and second, the size of the issue is simply too large for the capital markets to absorb. The first of these arguments ignores the fact that the Postal Service's poor earnings record is itself a function of government ownership.

Under government ownership, there are no well-defined residual claimants. Residual claimants are those who have property rights to the cash flows of an organization, such as stockholders in a privately owned, publicly traded corporation, or the partners of a partnership. While "residual claimants" may seem like an arcane term, it implies what we normally think of as "accountability." Without a well-defined group of owners, it is unclear to whom the firm should be accountable. A common criticism of the Postal Service is that it lacks accountability to any specific group. Indeed, in 1981 after first-class rates rose to 20 cents, consumer advocate Ralph Nader noted that:

The new 20-cent first-class stamp represents not only runaway postal costs but also the unchecked power of the Postal Service. The new rate came about because the mail system's Board of Governors deliberately overrode the Postal Rate Commission (P.R.C.), which, on three separate occasions, had found the latest increase unnecessary. We can only conclude that the Postal Service is no longer accountable to anyone-not to the P.R.C., not to the President, not to Congress and certainly not to the American people.[4]

Without a well-defined group of residual claimants, an enterprise has no incentive to increase the size of its cash flows through cost minimization and revenue maximization. Regarding the Postal Service's performance record and public offerings, the capital markets would take into account the change in incentives brought about by private ownership in pricing its shares. Additionally, the value of the Postal Service is a direct function of the institutional arrangements made before its public offering, regarding pension liabilities and health care costs, for example. There is no reason why those arrangements cannot be made attractive to investors.

The Kappel Commission's second argument against private ownership was that postal services in the United States were simply too large for the capital markets to absorb. Given today's global capital markets, that argument seems obsolete, whatever plausibility it might have had in 1968. Moreover, nothing prevents public offerings from being undertaken in installments over a period of years, if necessary.

Both of the above contentions are now called into question by Deutsche Post's successful large November 2000 offering, in which investors applied for eight times more than the number of shares actually available. The Dutch post office has similarly privatized. Additionally, there have been successful privatizations of large telecommunications firms, including British Telecom, Deutsche Telekom, Telefonica, Telstra, Telmex, and others. Given the large privatizations in the United Kingdom and elsewhere over the past twenty years, it is doubtful that similar arguments could credibly be made today. Such an offering is now feasible and investors view postal shares as profitable.

These appear to be the Kappel Commission's only arguments against privatization, a strategy it otherwise clearly preferred.

What Reform Should Entail

Postal reform today must address the twin problems left unresolved by the 1970 act. The social benefits of addressing both--monopoly power and government ownership--are enormous.

Numerous other network industries, including trucking, airlines, natural gas, and railroads, were demonopolized in the 1970s and 1980s, creating huge benefits for consumers. The evidence from other countries that have eliminated or greatly limited their postal monopolies suggests that consumers of delivery services in the United States will also benefit from demonopolization of the Postal Service. Any serious postal reform must address the delivery monopoly.

A first, critical step in that process is to decouple the Postal Service's delivery monopoly from its universal service mandate. The Postal Service continues to argue, despite the lack of logic, that it needs a monopoly over letter delivery in order to ensure universal delivery service. The best way to address that concern is to move responsibility for universal service to another entity. Congress should delegate that responsibility to the Postal Rate Commission. The commission can then address universal service concerns through licensing arrangements. The experience in other countries, such as New Zealand, indicates that the issuance of licenses can be quite liberal and universal service will be maintained. The broad issuance of licenses would inject much-needed competition into the letter delivery industry.

The second issue that must be addressed is accountability, or ownership. This presents the President's Commission on the Postal Service with a golden opportunity. Many postal workers have built their careers on expectations of a government-owned post, and the transition to a competitive market may disrupt those careers. It thus seems appropriate that postal workers receive shares in the new investor-owned entity.

The issuance of ownership shares to postal workers and managers is a case where fairness and economic efficiency are aligned: employees would receive compensation for the disruption of their careers, while efficiency would be enhanced through improved incentives to innovate, keep costs down, improve service, issue new products, and become more responsive to customers' needs. Shares would have to be sold on the equity markets as well; otherwise postal employees would be able to trade shares only with each other. Such public trading of shares would improve corporate governance.

The ownership transition would require a host of additional institutional changes. Those changes can be appreciated by considering the institutional setting in which a typical privately owned, publicly traded corporation operates. For example, the Postal Service would have to be given additional commercial freedom to divest underperforming activities and make other prudent business decisions, such as the closing of unprofitable post offices. It may wish to replace them with counter services using other outlets, for example grocery stores, or sell them to another provider.

Importantly, the Postal Service must also be relieved of any privileges and immunities it has enjoyed, such as special borrowing privileges and exemption from taxation and the antitrust laws. It would also face the same disclosure requirements facing any publicly traded firm. A crucial aspect of the ownership transition is that any aspect of government sponsorship or government preference be eliminated. Otherwise, the Post Office would continue to benefit from a perception of government support.

Summary

Reform of the U.S. Postal Service is necessary and timely. Demand for its core services is declining. Because that decline is due to the widespread and increasing use of new communications technologies, it is likely to continue. The Postal Service is sustaining losses as a result, which will also continue to worsen.

The Postal Service is unable to respond to this new environment because of two key elements of its structure left intact by the 1970 act--a monopoly over letter delivery and government ownership. The putative motive for the delivery monopoly is ensuring universal service, but universal service simply does not require a legally enforced monopoly. The Postal Rate Commission does not have adequate authority to constrain that monopoly.

Many other network industries in the United States have been successfully demonopolized, and postal monopolies in other countries have been eliminated.

There is no legitimate rationale whatsoever for continued government ownership. The social benefits flowing from the selling of ownership shares in the Postal Service are enormous. Postal employees could be given a stake in the firm, and it would become accountable to a clearly defined group. Since prices for its ownership would be established, it would be possible to link managerial compensation to a meaningful measure of firm performance. The Postal Service would then have the incentive to keep costs down, to create new and innovative products, and to become more responsive to customers' needs.

The minimum, key reforms that must take place to improve postal services in the United States are:

• The Postal Service's monopoly power must be decoupled from its universal service mandate.
• Congress should make universal service the responsibility of the Postal Rate Commission rather than of the Postal Service. That would leave Congress and the commission free to guarantee universal delivery service in the best way possible, including the use of other firms, which would end the postal monopoly.
• Ownership shares in the Postal Service should be issued (as was done in Germany and the Netherlands). Postal employees should become part owners of the firm, but shares should trade on the open market as well.
• The Postal Service should be granted additional commercial flexibility to divest underperforming activities and make other prudent business decisions such as the closing of unprofitable post offices.
• The Postal Service should be relieved of any privileges and immunities it enjoys, such as special borrowing privileges and exemption from taxation and the antitrust laws. In a competitive market, it is crucial that no one firm receive any particular government-bestowed benefits.

Notes

1. Clyde S. DuPont, "The Postal Rate Commission," in Perspectives on Postal Service Issues, ed. Roger Sherman (Washington, D.C.: AEI Press, 1980), 115.

2. John T. Tierney, U.S. Postal Service: Status and Prospects of a Public Enterprise (Boston: Auburn House, 1988), 210.

3. President's Commission on Postal Reorganization, Towards Postal Excellence (Washington, D.C.: Government Printing Office, 1968), 2.

4. Ralph Nader, "Price Fixing by the Postal Service," The Nation, December 12, 1981, 631.

Rick Geddes is assistant professor in the Department of Policy Analysis and Management at Cornell University and the author of Saving the Mail: How to Solve the Problems of the U.S. Postal Service (AEI Press, 2003). He is a research fellow at the Hoover Institution and an adjunct scholar at AEI.