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Privatization During an Economic Downturn: Still Inefficient and Problematic
Altaf Rahamatulla on October 26, 2009 - 12:02pm
The Center on Budget and Policy Priorities (CBPP) estimates that in 2010 and 2011, states will face a combined budget deficit of $350 billion. As states grapple with the recession and search for the best methods to alleviate economic and budgetary pressures, some lawmakers continue to propose privatization as an effective policy. In the past few months, there have been proposals to privatize functions across the board: county zoos, libraries, custodial services, parking enforcement, youth shelters, group homes, ambulance services, airports, and transit networks. Wisconsin, for instance, has increasingly privatized the construction engineering services. Just in the past two years, the state outsourced 125 construction engineering jobs, each of which could have been completed by a state worker at a lower cost. Unfortunately, some officials are embracing this "everything must go" attitude towards public assets and services.
The lure is the supposed promise that privatization will deliver a short-term budget fix. Yet many privatization efforts, as this Dispatch will highlight, have cost taxpayers hundreds of millions of dollars and botched services for the public. That privatization continues to move forward despite such a poor track record reflects pure ideology that the private market delivers the most efficient outcomes, even without demonstrable results. Some states may also be making the more cynical decision to pursue immediate short-term infusions of capital at the expense of long-term financial cost in pursuit of short-term electoral gains. In any case, privatization comes at the expense of long-term investments in the community, sustainable budget policy and public accountability. This Privatization Update is part of a series; for past analysis, please visit the Reform Government Contracts and Restrict Privatization section of our website and see our March 2009 and November 2008 Stateside Dispatches
Table of Contents:
Recent Privatization Debacles
In recent months, there have been several examples of wide-raging problems with privatization, with even key proponents like Indiana and the City of Chicago finding high-profile privatization projects mired in failure.
Indiana Welfare Privatization Fails: In 2007, Indiana initiated an overhaul of its welfare system and granted IBM a $1.34 billion contract to provide services. From the outset, several Indiana lawmakers and advocacy organizations recognized the inherent faults in such a system, and called for an immediate halt to further privatization. In fact, two Republican legislators, Rep. Suzanne Crouch and Sen. Vaneta Becker, drafted legislation, HB 1691, which sought to prohibit the Family and Social Services Administration from expanding welfare privatization until a complete review was conducted to examine the effects and progress of the program.
Critics continually assailed the deal, warning that Texas took similar steps and failed miserably after the privatization of their welfare system left thousands of people without benefits for which they were eligible. Texas also experienced other critical failures after outsourcing welfare to Accenture. For example, a massive computer crash destroyed hundreds of the Texas Attorney General's records, including 8 months of work and evidence in 81 Medicaid fraud cases. Texas officials were not informed of issues that should have raised concern, such as lags in reporting and record retrieval failure.
Indiana's experience with IBM soon led to failure as well, as thousands needing financial help were denied access despite qualifying for help because of implementation errors. As Lois Rockhill, Executive Director of Second Harvest Food Bank related, "[p]eople needing Food Stamps, cash assistance and health coverage have very little wiggle room. Falling through the cracks is almost like falling through the gallows with a noose around your neck. You are at the end of your rope." As more Indiana families faced the prospect of unemployment, rising costs, and foreclosure and turned to the government for support, a privatized welfare system failed to provide necessary services to the state's most vulnerable residents.
This month, Indiana officials announced that they would be canceling the state's contract with IBM. Republican Gov. Mitch Daniels (who championed privatization efforts in the past, leased the Indiana Toll Road and proposed outsourcing the state lottery) admitted that the privatization initiative was a "flawed concept that simply did not work out in practice." He also cited the lack of face-to-face contact and county-based case management, inefficiency of welfare call centers, high error rates, and poor timeliness as the major problems created by the privatized system.
Kids for Cash: A recent scandal in Pennsylvania illustrates the potential dangers of privatized services. Two judges, Mark Civarella Jr. and Michael Conahan, received over $2.6 million in the past seven years from Pennsylvania Child Care LLC, a private company that operated a juvenile detention center, and a subsidiary, Western Pennsylvania Child Care LLC. The judges, who were instrumental in closing the county-run facility, assisted in securing a 20-year, $58 million contract for the company, used public money to finance the lease, and aggressively sentenced children for minor infractions in order to fill slots in the center.
In one case, Civarella sentenced a 17-year-old to a detention facility and five months of boot camp for helping a friend steal DVDs. In another instance, the judge sentenced a 15-year-old girl to wilderness camp for mocking a school official on MySpace. Many of the children had no legal counsel when appearing in court and the judges failed to explain that such services were available to them or their parents. The two judges plead guilty earlier this year and were charged with racketeering, extortion, bribery, money laundering, fraud and other crimes last month. Interestingly, Pennsylvania has the second highest number of privatized juvenile detention centers in the country.
This illustrates that privatization is a recipe for disaster, particularly when providing social services to vulnerable populations, such as the youth, elderly and poor, where public accountability is most necessary. Nevertheless, lawmakers still pursue such initiatives, even in the face of mounting evidence exposing the potential pitfalls of privatization. Michigan House Republicans released a report, Moving Michigan Forward: Investing in our Future, that offers an unsustainable plan claiming to reinvigorate the economy and close the burgeoning budget deficit. The plan mainly relies on massive cuts to education and health care, freezing enrollment in the earned income tax credit program, and a proposal to privatize the juvenile justice system.
As Beth Arnovits, Director of the Michigan State Council on Crime and Delinquency relates, although the current system needs reform, this kind of privatization plan would only exacerbate the problem and endanger provision of needed services. She points out, "[f]rom a public policy perspective it is not in the best interest of the counties, the kids or the state to do this. It’s also not real savings...[a]ny potential saving, which is smaller than what is budgeted here, would be offset by how we would screw these kids up." In this case, the predominant danger of privatization is placing profit above the needs of the youth. Equally troubling, there is no system in place for proper oversight of privatized detention facilities. A 2004 US Department of Justice study of privatized juvenile detention centers found almost 3,000 allegations of sexual abuse.
Chicago's Parking Meters Leased for $1 Billion Less than Their Worth: Outsourcing social services is not the only instance of flawed privatization. In December 2008, Chicago leased its parking meter system to a private corporation for 75 years for approximately $1.15 billion. The deal was pushed through the City Council at a furious pace -- Mayor Richard Daley introduced the plan only two days before its approval by city aldermen.
Not only was the deal hastily moved through the Council, but meter rates immediately rose and they are expected to increase drastically over the next few years. By 2013, it will cost $6.50 per hour to park in the Loop, $4 downtown and $2 in neighborhoods. At the time of the deal's passage, it cost $3 in the Loop, $1 downtown, and $0.25 to $0.75 in surrounding neighborhoods. A report by the Inspector General discovered that the City ultimately received $1 billion less than it should have, citing the system's worth as $2.13 billion over the 75-year period. The Inspector General also found that city lawmakers failed to properly deliberate the plan in council, search for other methods of revenue generation, or calculate whether or not the deal was in the best interest of Chicago residents.
The public outcry was immediate. Residents are unhappy with astronomical rate increases and advocates criticized the lack of transparency in the process. In August, the Independent Voters of Illinois-Independent Precinct Organization (IVI-IPO) sued, claiming the city was illegally using taxpayer dollars to benefit a private company and that it had violated state law by removing the ability of City Council to set future parking policy and by allowing a private firm to exercise police powers. The case is moving forward after a Cook County judge decided last month that the plaintiffs had grounds to sue state officials.
Washington, DC experienced similar failures in the privatization of parking meters. In 2006, the city's auditor issued a report that highlighted several examples of contract abuse and mismanagement and found that the private management of parking meters was financially imprudent, increased costs by $9 million from 1999 to 2005, and lacked proper oversight.
AFSCME - Safety Net for Sale: The Dangers of Privatizing Social Services
IRP Poverty Dispatch - Privatization of Social Services
The Dallas Morning News - Abuse figures murky for juvenile centers
Harvard University - Implement National Board of Review to Oversee Private Juvenile Justice Centers
Left in Alabama - Privatization and the Juvenile Justice System: A Tale of Abuse, Neglect, and Lack of Oversight
National Center for Juvenile Justice - State Juvenile Justice Profiles
National Juvenile Defender Center - The Use and Abuse of Juvenile Detention
Office of the District of Columbia Auditor - Auditor's Examination of Parking Meter Contract Administration and Financial Management
Office of the Inspector General - An Analysis of the Lease of the City's Parking Meter
Privatization of Public Services Costing Taxpayers
The bottom line is that privatization does not usually deliver the savings for taxpayers promised by its proponents. Public accountability is lost and, unsurprisingly, contractors take advantage of the system to profit at the expense of the public.
Contractor Costs Add to New York MTA Public Transit Deficits: New York's Metropolitan Transit Authority (MTA), which is responsible for New York City's subway system, commuter rail lines and some bridges and tunnels, has faced cyclical deficits in recent years. Last month, State Comptroller Thomas P. DiNapoli released an audit of the MTA's use of contractors and found that as the agency has been increasing fares and accepting public revenue to cover budget gaps, they have spent excessively on contractors without proof that it was a more affordable alternative. The audit cites that 15% of the MTA's operating budget goes to private contracts. In most cases, the authority could not prove cost effectiveness. The value of contracts tripled between 2006 and 2008, even though the actual number of contracts declined by 35% during that time. Almost 25% of all service contracts were non-competitive.
Partly due to excessive contractor costs, the MTA confronted a $1.2 billion deficit this year. New York lawmakers passed an "MTA bailout plan", which included a 0.34% payroll tax on businesses that are located in the 12 counties served by the MTA, a $0.50 taxi surcharge, and increased fees for driver's licenses and vehicle registration. In total, the plan will generate $1.76 billion annually. MTA fares also increased, but not as sharply as they would have if the state had not take action. DiNapoli commented, “[t]he MTA has raised fares and received more tax dollars to cover its deficits and debt. At the same time, the MTA expanded its use of personal service contracts without a thorough evaluation of the need or cost-effectiveness of those contracts. Now more than ever, every dime counts, and the MTA needs to manage public resources more carefully."
Wisconsin Department of Transportation's (WSDOT) Excessive Use of Contractors: The Wisconsin Legislative Audit Bureau conducted an audit of the WSDOT's use of state and private construction engineers in the quality assurance process for highway projects. In the past five fiscal years, the agency outsourced approximately half of all construction engineering work. At the peak, WSDOT private consultants were involved in 65% of all state highway projects. The audit additionally reviewed WSDOT cost benefit analyses of all engineering services from March 2007 to June 2008. During this period, 125 construction engineering jobs were outsourced, or about 60% of the total, that could have been done at a lower cost by state workers. In the end, using private contractors over state workers cost the state $1.2 million. The graph to the right depicts the trends over the past five years.
The review of the data spurred the bureau to recommend that WSDOT "electronically track the extent to which consultants serve as construction engineers on each state highway project, including whether they serve as the project leader or as inspectors."
Privatizing Worker's Compensation Insurance Programs: Both Oklahoma and Colorado are considering privatizing their worker's compensation insurance programs, CompSource Oklahoma and Pinnacol Assurance. Officials in each of these states are referencing Nevada and West Virginia as prime examples of the proper way to privatize worker's compensation. For instance, Oklahoma Rep. Dan Sullivan, citing rate decreases in Nevada, claimed, "I don’t think there’s any question that that’s the way we need to go... It is a policy decision—is providing workers’ compensation insurance a core function of government?"
However, Jane Moskowitz, a Nevada Division of Insurance actuary, states that the results of privatization have been a bit more complicated than the situation Rep. Sullivan frames. Moskowitz finds that employers in the residual market are generally dissatisfied with the private transition. She explains further that these employers are now paying surcharges on their policies that augment their insurance costs by up to 25%. A similar sentiment was expressed by Roy Wood of the National Council of Compensation Insurance. Woods argues that small business policyholders would likely see rates increase because they would be unable to subsidize them as the state-run program currently does.
In 2001, the Connecticut Department of Administrative Services (DAS) finalized an $80 million deal with ACE Financial Solutions to take on $150 million in possible liability from workers' compensation claims. The deal resulted in savings of $13.5 million in 2002 and 2003 and reduced the number of claims the state handled. Unfortunately, the state's Office of Fiscal Analysis found that although the state saved money over that period, it was highly improbable that it would save money in the long run. Further, the short-term savings were mainly a result of the state using bond money to pay for the contract.
It was later revealed that DAS hired an inexperienced firm to evaluate the contract before deciding to go forward with privatization, resulting in "overestimates and overpayments...from misinformation and misadvice [and] improper oversight." Connecticut Attorney General Richard Blumenthal emphatically concluded that, "[p]rivatization spawned inefficiency, incompetence, and increased costs. We must reform conditions--lack of funding and procedures--that led to this bungled deal. The case proves privatization is no panacea. The state must adhere strictly to legal procedures mandating careful analysis of costs and benefits before any privatization deal."
Office of the New York State Comptroller - Metropolitan Transit Authority: Contracts for Personal and Miscellaneous Services
Wisconsin Legislative Audit Bureau - Construction Engineering in State Highway Projects
Oregon Department of Consumer & Business Services - Oregon Workers' Compensation Premium Rate Ranking
State of Connecticut, Attorney General's Office - Attorney General Investigation Finds $80 Million Rowland-Era Worker's Comp Deal Badly Botched
State of Connecticut, Attorney General's Office - Loss Portfolio Arrangement
Privatization of Public Assets Driven by Short-Term Goals
Airports: Over a decade ago, Congress authorized the creation of a pilot airport privatization program. Tucked into the Federal Aviation Reauthorization Act of 1996, Section 149 detailed a program that would allow up to five airports to form long-term leases with private entities "as a means of generating access to various sources of private capital for airport improvement and development." An interested entity would submit an application to the Federal Aviation Administration (FAA). To attract private investors, the legislation permitted the US Secretary of Transportation to provide exemptions from federal statutory and regulatory requirements. The exemptions would have to be approved by 65% of the airlines serving the particular airport. That same body is responsible for approving any fare or fee increases above the rate of inflation. The program additionally offers private contractors access to federal grants through the Airport Improvement Program (AIP).
Just one airport in the country has made use of the program since its inception. In March 2000, The Port Authority of New York and New Jersey signed a $35 million, 99-year lease with a British company, National Express, to privatize Stewart International Airport in Newburgh, NY. Partly due to tensions with the surrounding community and the state, National Express backed out of the deal and the Port Authority reacquired the airport lease for approximately $73 million in 2007. According to the FAA, though a few airports have expressed interest in privatizing since the passage of the 1996 legislation, there is only one airport currently being considered for the pilot program.
Even in light of the failure of previous attempts, airport privatization still is being pursued by several cities in an effort to encourage economic recovery and increase city revenues.
- Chicago Midway Airport: In October 2008, Chicago approved a $2.5 billion, 99-year lease of Midway Airport to the private corporation Midway Investment and Development Company LLC. The deal would have allowed Midway Investment to collect revenue from parking concessions, landing fees and passenger facility charges, while the city would have continued providing police and fire protection. Chicago would have been the first major city to participate in the FAA's privatization program. However, the deal fell apart earlier this year, as Midway Investment could not front the cost of the lease due to the national financial crisis. Phineas Baxandall, a senior analyst at the United States Public Interest Research Group (US PIRG) believes that circumstances surrounding the Midway Airport are an indication of overall trends. In the National Journal, Baxandall comments that the public is wary of infrastructure privatization deals and the Obama administration is more restrained in its approach to privatization compared to those in past years. He concludes, "[w]hat was different about the Midway deal was that a private entity would manage broader policies and planning with a directer interest in maximizing profits rather than advancing public goals. The public would have relied upon the master contract agreement to keep the private operator in line, much like consumers rely on their contract right with an HMO, but without an exit option for 50 years... the collapse of the Midway deal is part of a larger trend against such deals."
- New Orleans' Louis Armstrong International Airport: New Orleans is considering privatization of the city-owned Louis Armstrong International Airport and will accept initial bids for long-term lease beginning early next year. The airport's governing board submitted a preliminary application to the FAA in August, which was approved the last month. Initial estimates project that airport privatization can garner $1.25 billion for the city. Nevertheless, there are several obstacles to the the project, including the city's ability to recover economically and continue its rebuilding process.
- Detroit's Mayor Intends to Pursue Airport Privatization: Detroit is being hit particularly hard by the recession. Historic levels of unemployment and foreclosure, population decline, and falling revenues, prompted Mayor Dave Bing to claim that the city now "hangs by a thread." This month, the Mayor announced that he seeks to privatize several public services, including Coleman A. Young International Airport, as part of an overall package that he claims will offer the city economic stability. Nevertheless, unions and candidates for both city council and the charter revision commission have derided the plan. As John Riehl, the head of AFSCME Local 207 in Detroit, stated, "I don't have any confidence that [private contracts] are going to save... Generally, we see that they cost more money...it reflects a lack of investment."
Transit Infrastructure: Generally, the public is wary of large-scale privatization of infrastructure. A 2007 poll conducted by the National Association of Realtors found that 84% of Americans were against privatization of highways. For example, following Texas Gov. Rick Perry's announcement that he was planning to allow Cintra-Zachry, a private investment firm, to build and manage the Trans Texas Corridor (TTC), the public steadfastly displayed its opposition. While Cintra-Zachry would profit from establishing tolls, the public stood to lose long-term revenue and influence in the transportation planning process.
Melissa Cubria and Kari Wohlschlegel of Texas PIRG point out that, "Rick Perry was re-elected with only 39 percent of the vote, and his three opponents campaigned strongly against the TTC. In fact, Governor Perry is now at odds with his party, as the state GOP party officially opposes the Corridor." This past month, the state's Department of Transportation affirmed the public's sentiment and declared that it would not proceed with TTC. A Texas Transportation Commission member bluntly stated why the project failed, "[t]he reason that's being given for the no-build option is that people don't want it. They said 'Hell no.'"
Federal lawmakers have additionally expressed their disapproval of such projects. For instance, in 2007, Rep. James L. Oberstar of Minnesota, chairman of the House Committee on Transportation and Infrastructure, affirmed in a letter that he and his colleagues would "work to undo" any road privatization deals that did not "protect the public interest and the integrity of the national system."
However, due to the recession, desire for immediate revenue generation, and the need for massive investment in infrastructure, several states and cities continue to embrace these type of projects. Presently, officials around the country are considering privatization of almost 79 roads. For instance, Arizona officials are moving ahead with privatization plans since the passage of a bill permitting public-private partnership to construct toll roads. Some other well-known instances of road privatization in recent years include Indiana's East-West Toll Road, the Chicago Skyway, and the SR91 Express Lanes in California.
Additionally, several cities are now initiating or planning privatization of entire transit systems.
- New Orleans, LA: NORTA, the New Orleans Regional Transit Authority, intends to pay a subsidiary of Veolia Environnement, a multinational French corporation, $56.3 million each year, and up to $600 million in the next ten years, to manage, operate, and finance streetcar and bus lines
- Savannah, GA: The city has begun negotiating with Veolia to operate its bus system.
- Houston, TX: Earlier this year, the city awarded Parsons Corp. a $1.5 billion contract to construct, operate, and maintain four light-rail lines.
- Phoenix, AZ: Valley Metro, Phoenix's public transportation system, outsources its bus services completely. Alternate Concepts, Inc., operates the city's new 20-mile light rail, and there are plans to outsource 37 miles more of rail in the near future.
- Los Angeles, CA: The city has outsourced 21 out of 200 bus lines.
Pitfalls: Although these projects promise substantial savings and a way for officials to generate short-term revenue, US PIRG finds, there are several pitfalls of infrastructure privatization, including:
- Loss of public control, transparency, proper government oversight, and ability to set standards;
- Transportation planning driven by profit rather than public needs;
- The eventual loss of public money;
- Private entities potentially enter into risky and unstable financial investments;
- Unreliable and excessive toll and fare increases.
Jacobs Consultancy Focus - New Interest in U.S. Airport Privatization
Federal Aviation Administration - Louis Armstrong New Orleans Privatization Pilot Program Fact Sheet (September 2009)
Federal Aviation Administration - Airport Privatization Pilot Program: Application Procedures (September 16, 1997)
Detroit Crisis Turnaround Team - Full Report
American Society of Civil Engineers - 2009 Report Card for America's Infrastructure
US PIRG - Private Roads, Public Costs
Texas PIRG - The Trans Texas Corridor: Evaluating and Protecting Against Risks to the Public from Private Toll Roads
States and Cities Taking Action
Given the ongoing failures of privatization, a number of cities and states are seeking new rules to rein in or even prohibit privatization.
Proposed Privatization Reform in Chicago: In response to the parking meter privatization debacle and the aggressive privatization efforts pursued by Chicago's Mayor Daley, Alderman Scott Waguespack introduced a public interest ordinance on leasing city assets with intent to provide city taxpayers enhanced protections and augment the ability of aldermen to critique future lease deals.
The proposed ordinance would require that city council members are notified of a potential sale or lease of a public asset and provided with the objectives of the project, the type of assets under consideration, and a time line of key events. It would also mandate that before the sale or lease of any public asset worth more than $1 million, the city hold a public hearing, make the exact language of the lease agreement and any pertinent documents relating to the plan public record, and permit an independent third party to evaluate the deal. Finally, the ordinance would only allow a maximum of 30-year lease agreements.
Prohibiting the Sale of Milwaukee Water Works: Following reports that officials were considering the sale or lease of Milwaukee Water Works as a means to fund various city services, Wisconsin Rep. Frederick P. Kessler introduced a bill to prohibit privatization of the public utility, adding that such an initiative would result in higher rates and reduced quality and service.
Food in Kentucky State Prisons: Families of inmates in Kentucky have complained that prisoners are receiving reduced quantity and quality of food. Rep. Brent Yonts contends that since the state entered into a $12 million food service contract with a Pennsylvania firm, Aramark, inmates have received less food and the inferior quality has led to the spread of illness in at least one prison. Rep. Yonts introduced a bill, BR 114, that would end the contract and only permit state employees, volunteers, or inmates to provide food service.
Reports and Messaging
A number of recent reports provide guidance to lawmakers in pursuing contracting reforms.
States Need To Provide More Effective Reporting on Contractors: In light of the failures and cost of privatization in these cases, states should make more of an effort to provide concise and meaningful data on the use of contractors and the extent of privatization. In some of the cases highlighted above, the public did not receive clear and comprehensive data until an audit was conducted.
In The State of State Disclosure: An Evaluation of Online Public Information About Economic Development Subsidies, Procurement Contracts and Lobbying Activities, Good Jobs First finds that states provide some level of disclosure of contracts, but that there is significant "room for improvement." Increasing transparency in the budget process is an essential reform to affect progressive change at the state level. To better serve constituents, ensure effective use of public revenue, and promote a fairer and more sustainable budget process, lawmakers must work towards more stringent transparency and reporting requirements.
Enhancing Online Expenditure Transparency: CALPIRG effectively makes the case for enhanced web-based transparency in their report, California Budget Transparency 2.0: Online Tools for Better Government. The report evaluates California's web-based transparency tools and offers a broader perspective on the emerging trend toward online expenditure disclosure.
The report notes that "at least 29 states currently mandate that residents be able to access a searchable online database of government expenditures. These states have come to define 'Transparency 2.0' — a new standard of comprehensive, one-stop, one-click budget accountability and accessibility." There are countless advantages to implementing this level of transparency: it enjoys bipartisan and public support, increases civic engagement, is affordable, permits a more precise view of expenditures, and allows for greater future savings and a more targeted approach to economic development.
The Public Interest Should Always be the Primary Concern: Illinois PIRG released Privatization and the Public Interest, which argues that Chicago's aggressive privatization efforts in recent years are faulty, do not provide long-term savings, and suffer from lack of public accountability. The report concludes that in the future, the city should adhere to a series of principles and standards that would ensure the best interest of the public is always in mind.
Call for Responsible Contracting: In a recent report, The Road to Responsible Contracting, the National Employment Law Project (NELP) highlights the need for greater standards to be attached to federal contracting projects. Citing limited benefits offered to employees, low wages, and substandard circumstances, the authors find that contractors who partake in substandard practices, "impose significant costs on taxpayers because their employees must rely on public safety net programs to make ends meet."
An evaluation of the current federal contracting system discovers little to no consideration of responsible practices. The authors offer several recommendations to improve the process, including more comprehensive screening of potential bidders, giving preference to contractors who provide sustainable wages and benefits, and improving contractor oversight and enforcement of labor standards.
AFSCME - Legislative Approaches to Responsible Contracting
AFSCME - Power Tools for Fighting Privatization
CALPIRG - California Budget Transparency 2.0
Good Jobs First - The State of State Disclosure
Illinois PIRG - Privatization and the Public Interest
NELP - The Road to Responsible Contracting
PrivatizationWatch.org - Services Being Privatized
The San Diego Daily Transcript - The failed 'managed care' experiment