Statement before the U.

S Senate Committee on Homeland Security and Government Affairs On

Outside the Box: Reforming and Renewing the Postal Service, Part II Promoting a 21st Century Workforce

R. Richard Geddes Visiting Scholar American Enterprise Institute Associate Professor, Department of Policy Analysis and Management And Director, Cornell Program in Infrastructure Policy Cornell University September 26, 2013

The views expressed in this testimony are those of the author alone and do not necessarily represent those of the American Enterprise Institute.

Dear Chairman Carper, Ranking Member Coburn, and distinguished members of the Committee: thank you for the opportunity to submit written testimony to the U.S. Senate Committee on Homeland Security and Government Affairs on Reforming and Renewing the Postal Service. I am R. Richard Geddes, Associate Professor in the Department of Policy Analysis and Management at Cornell University, Director of the Cornell Program in Infrastructure Policy, and Visiting Scholar at the American Enterprise Institute. This statement is a follow-up to my oral and written testimony submitted to the Committee on February 13, 2013 for its hearing on, Solutions to the Crisis Facing the U.S. Postal Service. The Committee has since then produced a draft bill on postal reform entitled S. 1486, the Postal Reform Act of 2013. This proposed legislation has many appealing aspects. However, there are several issues that could be better addressed. One of the main concerns is the overall direction in which the S. 1486 legislation takes the Postal Service. By this I mean the degree to which S. 1486 advances the USPS further along the reform course established by the 1970 Postal Reorganization Act, or backs away from that timetested course. By creating the modern USPS, the 1970 PRA adopted a more utility-like, commercial model for the Postal Service, in which rates and fees were set to reflect costs (and reduce political influence), wages were established by negotiation between management and employees (rather than set by Congress), and the firm was subject to a break-even constraint (instead of the perennial losses incurred since 1946). However, the new USPS retained important elements of a government agency. First, USPS remained an independent agency within the executive branch. That is, it was not converted into a state-owned enterprise because an enterprise structure with ownership shares even if held entirely by the government was not created. Second, USPS retained two governmentenforced monopolies (the mailbox monopoly and the delivery monopoly) with attendant monopoly regulation, including controls on market-dominant rates and a prohibition against entry into other markets. In retrospect, there is broad agreement that the 1970 PRA was a necessary, successful reform. Today, too, there is broad agreement that additional reforms are critically needed to allow the USPS to adapt to the realities of the 21st centurys dynamic communications marketplace. The alternative is to condemn the USPS to remain on a fiscally unsustainable path dependent on taxpayer subsidies. In broad terms, the only plausible direction for further reform is, I believe, to continue down the path pioneered by the 1970 act. Indeed, this is the direction taken by virtually all other industrialized countries regarding fundamental postal reform. To be clear, it is important to distinguish three key postal reform concepts: Commercialization: This refers to a set of reforms that grants postal managers more flexibility over rates and decisions to enter new markets. Commercialization is typically

accompanied by relaxation or elimination of the firms monopoly privileges (and other special rights), a step which also allows relaxation of regulatory measures established to prevent abuse of monopoly privileges. It also includes more pricing flexibility. Corporatization: This refers to creating an organizational structure for the firm (which may remain a state-owned enterprise) that is similar to that of a large, publicly traded corporation. Corporatization includes adopting a corporate-style board of directors with explicit fiduciary duties to the shareholder(s), as well as executive pay scales that are less constrained by government regulations. It includes subjecting the Postal Service to the standard laws and norms reflected in modern U.S. corporate law. Privatization: This refers to the act of actually transferring ownership shares (sometimes called residual claims) to private owners via a public sale of those shares. This transfer reduces taxpayers ownership interest in the post.

Other industrialized countries long ago recognized the need for major reforms of their postal sectors. As demonstrated in a report for the European Commission issued this week, 25 of the 27 countries that are members of the European Union have repealed their postal monopolies. The remaining two EU member countries (Cyprus and Romania) will follow suit in the near future, as will the three other countries in the European Economic Area: Norway, Iceland, and Liechtenstein. All of these countries have allowed their posts to become more commercial and more responsive to market dynamics. All (but Cyprus) have corporatized the post office. Indeed, two countries have fully privatized their post offices (Malta and the Netherlands). In five other countries, the government now owns less than 100 per cent of the post office: Germany (25.5%); Belgium (50%); Austria (52.8%); Romania (75%); Greece (90%). The United Kingdom has recently announced plans to sell a majority of Royal Mails shares. While circumstances certainly vary across countries, the broad orientation of sound postal reform has not. Whether one takes guidance from the success of the Postal Reorganization Act in the United States or the more recent reforms in other industrialized countries, the pole star for viable, financially sustainable reform must be moving the USPS further toward a commercialized, businesslike entity. Such a change would fulfill a process begun at least as early as 1970. From this perspective, I would like to offer several specific comments and suggestions related to the proposed legislation and to U.S. postal reform in general. 1. Much commentary regarding postal reform discussions has focused on the 2006 PAEA's requirement that USPS make annual prepayments to the Retiree Health Benefit (RHB) Fund of $5.5 billion. However, the USPS's present fiscal crisis is unrelated to that requirement.

Although the PAEA required the USPS to make a new annual payment of $ 5.5 billion to the Postal Service Retiree Health Benefits Fund for 10 years, it is sometimes forgotten that the Postal Accountability and Enhancement Act (PAEA) also relieved USPS of annual payments equal to about $ 5.0 billion. Those reduced payments include the annual escrow payment of $ 3.0 billion and military pension payments equal to about $ 2.0 billion. When PAEA's price cap took effect in December 2007, postage rates were already high enough to cover the escrow and military pension payments, having been considered in the previous rate case before the then-named Postal Rate Commission. Hence, the net effect of the new RHB payments was to create an annual shortfall of about $ 0.5 billion (which USPS should have been able to address through greater efficiencies associated with PAEA). Since the RHB payments are not the source of USPS's current fiscal problems, relieving USPS of the RHB payments is unlikely to address the main impediments to creating a self-sustaining and efficient Postal Service. Relieving USPS of the RHB payments is equivalent to cash transfers from taxpayers to the USPS, helpful in the short term but of little value for long-run structural reform.

2. Eliminating the price cap is critically important, but there remains a real risk of excessive pricing for monopoly and market dominant products.
If the RHB payments are not the main source of the current fiscal crisis, what was? More than anything else, the problem in the PAEA is the statutory price cap on all market dominant products. No other industrialized country has placed the bulk of postal products under a statutory cap. In 2006, the volume of first class mail was falling. This meant unit costs were rising (because it takes more than half as many employees to collect and deliver half as much mail). A price freeze in real terms (i.e., 2006 rates plus inflation) was ill-considered in light of a likely continuing decline in mail volume. The recession made matters even worse than could be foreseen at that time. Eliminating the statutory price cap is a necessary step towards creating a financially viable Postal Service. S. 1486 is commendable in this respect. Judging from the experience of other industrialized countries, Inspector General David Williams's studies are correct USPS can and should raise prices. However, giving USPS unlimited pricing freedom creates a foreseeable risk in another dimension. USPS will able to raise rates to create super-normal profits on products for which it has the benefit a legally enforced monopoly (postal or mailbox) or for which there is no effective competition. These "monopoly rents" can be used to cross-subsidize either other market dominant products or competitive products (despite safeguards in the PAEA). Many monopolies (public and private) engage in such behavior. So far, almost all industrialized countries have found it necessary to retain some sort of regulatory control over "abuse of dominant position" by their commercialized post offices even after they have abolished the postal monopoly. I therefore suggest that the postal monopolies be repealed over a relatively short transition period (say, 3 years). While the postal monopoly it is less and less important economically, repeal will be (as in other countries) an important step towards incentivizing the Postal Service and its employees. In addition, the mailbox should be opened to all carriers meeting basic standards of reliability, administered by the PRC and subject to the householder's right to limit access to the Postal Service only. Raising the delivery

costs of private carriers to give the Postal Service an artificial competitive advantage is wasteful and environmentally harmful. It also reduces incentives to develop an innovative, efficient Postal Service. In addition, the PRC should continue to require USPS to keep proper accounts for its market dominant products. PRC should also be able to review market dominant rates according to clearly defined statutory standards (the list of standards in current section 3622 is not "clearly defined"). To the keep PRC on track, the Antitrust Division or FTC might be made a necessary party to any such proceeding.

3. The obligation to provide public services should be clearly separated from USPS's authority (and mission) to provide efficient and innovative products.
It is evident that many legislators feel strongly that the Postal Service should continue to provide certain services even though revenues do not fully cover the costs incurred. Examples include maintaining money-losing post offices (especially in rural areas), continuing inefficient network facilities, providing extra days of delivery in areas that receive relatively little mail, and giving non-profit organizations preferential rates. In total, these "extra" or "non-commercial" public services amount to a fairly small portion of the Postal Services total business. Conflation of the (large) commercially viable portion of the postal business and the (small) public interest portion of postal business is a fundamental obstacle to creating an efficient and self-sustaining Postal Service. Congress exercises authority over the entire postal business in order to ensure provision of a relatively small portion of public services. For its part, the Postal Service justifies special privileges for the entire business as a necessary support for a small portion of services provided as public services. The solution is decoupling the public service obligation from the authority to manage the commercially viable portion of the business. The Postal Service should have normal, corporate authority to operate the commercially-viable portion of the business, including new nonpostal products. In addition, however, the Postal Service should be obliged to provide public services that Congress determines are required for the public interest. The Postal Service should be compensated for net cost of such public services from public funds. The Postal Service should not be expected to cover the net cost of such public services by raising prices for its commercial customers in an increasingly competitive market. Even if such a tax were feasible, it is not fair to the Postal Service or its customers. Although many believe that Congress should require the Postal Service to provide public services, it is reasonable that such requirements be disciplined by the need to pay for services rendered (this was a basic premise of the Postal Reorganization Act, but it has been forgotten over time). In effect, "public interest services" should be a viewed as a special product of the Postal Service purchased transparently by government. Again, this is the conclusion that other industrialized countries have reached.

4. To become efficient and self-sustaining, the Postal Service should be separated from government, not further integrated into government.
The only way to make the Postal Service self-sustaining, innovative, and efficient is to separate Postal Service management, and their managerial decisions, from government. A self-sustaining, innovative, and efficient Postal Service must respond quickly and strategically to the market, which is changing

rapidly. Government necessarily responds to conflicting political demands, usually slowly. Hence, I believe that adding the Secretary of the Treasury to the Board, giving the Board rulemaking-type authority, and plans to give the Postal Service special access to contracts for the provision of government services, are steps in the wrong direction. All move in the opposite direction from the 1970 act and make the USPS more like a government agency.

5. Standstill provisions should be dropped.

Provisions of S. 1486 that forbid (1) changes to service standards for first class or periodicals and (2) closure or consolidation of network facilities for 2 years are unduly constraining. They postpone necessary changes for two years and invite vested interests to renew political pressure on Congress in two years. Fundamental postal reform should have been started many years ago. A further two-year delay hardly seems a first step in the right direction.

6. Reform must allow and incentivize the Board and senior management to operate the Postal Service more efficiently and innovatively, including giving them opportunities to raise additional revenues.
The Postal Service operates in an environment of rapidly changing commercial demands. Ninety percent of all mail is sent by business and organizations, and their needs are evolving with new technologies. To meet the needs of its customers, the Postal Service must have a true Board of Directors with the same expertise and the same fiduciary duty to shareholders (the people of the United States) as the board of any normal corporation. As far as possible, the Board must have the same freedom to attract and compensate managers, to set prices, to restructure existing products and introduce new products, and to negotiate with employees as the boards of the private corporations against whom the Postal Service is necessarily competing to win the business of its commercial customers. The USPS has a valuable commercial asset in a network that allows it to deliver to all U.S. addresses six days per week. It also has a valuable brand name. The key to sustainable postal reform is to give the USPS sufficient commercial freedom to use those assets to generate as much revenue as possible. This means the Postal Service must be corporatized, that is, freed from Congressional interference in its daily operations and subject to the same rules and norms as provided by corporate law applicable to typical publicly traded corporations. Conrail provides a successful precedent from another previously ailing industry. Although some postal commentators refer to USPS as a state-owned enterprise, this is inaccurate. USPS is an independent agency within the federal government like the FCC or SEC. Corporatization also implies that the Postal Service must face the same incentives for efficiency and innovation as private companies. Special legal privileges like the postal monopoly and mailbox monopoly must be repealed. For the Postal Service as for any private company failure to provide a better service than its competitors must have negative consequences. Reestablishing the Postal Service as a typical company would also will give Postal managers clearer authority to manage the business. It will decrease political influence as the USPS becomes more commercially focused. It will simplify the

problem of reforming postal employee benefits. It will allow the Postal Service to engage in new businesses. It will tend to create a level playing field for both the Postal Service and private competitors.

7. Overseas experience suggests that the Postal Service can be self-sustaining even in an electronic marketplace.
Fortunately, the international experience with postal reform indicates that posts that were formerly government-owned monopolies can, if given the necessary commercial freedoms, be sustainable even in a competitive electronic marketplace. Moreover, in overseas reform, the actual realized net cost of the Universal Service Obligation has proven to be much less than feared if reasonable flexibility is allowed. Despite drastic declines in mail volumes, the U.S. still enjoys a far higher mail volume (and letter volume) per capita than other industrialized countries. Moreover, U.S. letter rates are below those in other industrialized countries, suggesting the possibility of upward pricing flexibility. Although the USPS is now far behind many other posts in becoming more commercialized, the situation is not hopeless if comprehensive legislative reform is adopted promptly.