Booz Allen and the Big Business of Big Government

Booz Allen Hamilton Cyber Solution Center.
Jeffrey MacMillan | Washington Post | Getty Images
Booz Allen Hamilton Cyber Solution Center.

The revelations by Edward J. Snowden, the guy who leaked the existence of Prism and other government monitoring operations to The Guardian, is drawing attention to another important issue: the vast amount of money private contractors make from selling goods and services to the government.

Snowden was employed by Booz Allen Hamilton for three months, according to the company. Booz Allen, which went public in 2010 and is largely owned by the famously connected Carlyle Group, is ostensibly part of the private sector. But it is hugely dependent on government spending for its profits.

Binyamin Applebaum and Eric Lipton profiled Booz Allen in The New York Times this weekend.

The company, based in Virginia, is primarily a technology contractor. It reported revenues of $5.76 billion for the fiscal year ended in March and was No. 436 on Fortune's list of the 500 largest public companies. The government provided 98 percent of that revenue, the company said.

(For the latest Booz Hamilton stock price, click here.)

As Slate's Matt Yglesias points out, having this kind of wealth transferred from the public to the private sector creates an enormous incentive for rent-seeking lobbying.

An established government bureaucracy has, of course, considerable capacity to lobby on behalf of its own interests. That's particularly true when the bureacracy's leadership can claim possession of secret information. But it's also constrained in certain respects. The National Security Agency can't bundle campaign contributions, give money to independent expenditure campaigns, or offer nice paydays to former congressional staffers.

But if you take a few billion dollars worth of intelligence spending and transfer it onto the Booz Allen balance sheet, then political organizing around the cause of higher intelligence spending can avail itself of the tools of private enterprise along with the tools of bureaucratic politics.

One of the problems created by government contracting is that it expands the universe of potential so-called rent-seeking, trying to obtain your share of existing wealth. That is creating additional support for growing the government spending pie. So instead of capitalists lobbying for less regulation and lower taxes, you get capitalists lobbying for more spending and favorable regulation. This is one of the reasons that the growth of government spending is so closely connected with an increasing share of goods and services being provided to the government by outside contractors.

You can see by the chart below that much of this growth came under the supposedly conservative Republican administration of George W. Bush.

One way of reading that is to say that the attempt by conservatives to privatize more government services has wound up creating a new sector of the economy desperately dependent on government spending, and therefore highly incentivized to lobby for the growth of spending.

This can be enormously profitable. The Carlyle Group's stake in Booz Allen was purchased in 2008 for $910 million. Between special dividends and appreciation of the equity stake, Carlyle made $2 billion in profits on that investment, according to Forbes.

One thing that hasn't received a lot of attention is that Booz Allen's ties to the government give it a funding advantage over similarly situated companies. For one thing, the buyers of its bonds know that—at the very least—Booz Allen's payables are unlikely to go unpaid. Its counter-party risk is close to zero because its counter-party is the government. What's more, to the extent that Booz Allen is providing very important government services, the government is unlikely to let the company go out of business. It's too connected to fail.

There's a strong tendency toward the monopolization of provision of services to the government in part because of the barriers to entry created by the funding advantage and lobbying activities of established government contractors. This is exacerbated in security and intelligence work because of the built-in security-clearance barriers. Monopolization leads to both overpricing and poorer products.

The truth is that we know painfully little about government contractors. Too much of the work they do is classified, providing little room for public oversight. What's more, the government simply doesn't collect enough information about the contractors with whom it does business.

Here's the abstract of a 2011 paper from M.A. Thomas, an assistant professor of international development at The Paul H. Nitze School of Advanced International Studies of Johns Hopkins University.

As the volume of government contracting increases, so does the importance of monitoring government contractors to guard against market concentration, rent seeking and conflict of interest. Doing so, however, is impossible without knowing the identity and organizational structure of contractors. At present, the government does not collect information on organizational structure. Using STATA to analyze data from a new government database, this paper takes a first look at contractor organizational structure. The complexity of the structures makes clear that better data are needed if the government and the public are to be able to hold contractors accountable.

Of course, the odds of getting better data on contractors are exceedingly low because they have very strong incentives to prevent the passage of rules that would reveal rent seeking, monopolization and conflicts of interest.

—By CNBC's John Carney. Follow him on Twitter @Carney.

CORRECTION: This version corrected that the Carlyle Group's stake in Booz Allen was purchased for $910 million.