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Outsourcing of Public Sevice Provision: When is it more efficient?

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  • Andreas Knabe

    (Otto-von-Guericke-University Magdeburg)

  • Peter Birch Sorensen

    ()
    (Department of Economics, University of Copenhagen, Denmark)

Abstract

Outsourcing to for-profit producers of social services will enable a local government to achieve a given service quality at lower budgetary cost. In the absence of appropriate cost sharing arrangements between the government and the service provider, outsourcing provides an incentive for producers to lower quality in order to reduce costs. The cost reductions per se tend to be efficiency-improving, but to prevent a deterioration of service quality policy makers must spend more resources on monitoring quality. Moreover, the greater effort exerted under private service provision will have to be compensated by higher factor rewards. Hence public in-house provision may be more cost-efficient than outsourcing. This is particularly likely to be the case when the quality of the service is difficult to measure so that marginal monitoring costs are high. The paper shows that these results emerge both when politicians are benevolent and when they distribute rents in exchange for political support. We also show that risk aversion and uncertainty about the potential for cost savings implies a bias against outsourcing. However, if contracts between policy makers and service providers allow appropriate cost sharing arrangements, we find that a version of the Coase Theorem holds: policy makers can then implement exactly the same optimal allocation under public as under private provision.

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Bibliographic Info

Article provided by Finnish Economic Association in its journal Finnish Economic Papers.

Volume (Year): 19 (2006)
Issue (Month): 1 (Spring)
Pages: 3-15

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Handle: RePEc:fep:journl:v:19:y:2006:i:1:p:3-15

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Web page: http://www.taloustieteellinenyhdistys.fi
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  1. Andrei Shleifer, 1998. "State Versus Private Ownership," Harvard Institute of Economic Research Working Papers 1841, Harvard - Institute of Economic Research.
  2. Bennedsen, Morten & Schultz, Christian, 2003. "Outsourcing, Market Structure and Elections," Working Papers 07-2003, Copenhagen Business School, Department of Economics.
  3. Jeffry M. Netter & William L. Megginson, 2001. "From State to Market: A Survey of Empirical Studies on Privatization," Journal of Economic Literature, American Economic Association, vol. 39(2), pages 321-389, June.
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