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Will Privatization Reduce Costs?

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  • Lindqvist, Erik

    ()
    (Research Institute of Industrial Economics (IFN))

Abstract

I develop a model of public sector contracting based on the multitask framework by Holmström and Milgrom (1991). In this model, an agent can put effort into increasing the quality of a service or reducing costs. Being residual claimants, private owners have stronger incentives to cut costs than public employees. However, if quality cannot be perfectly measured, providing a private firm with incentives to improve quality forces the owner of the firm to bear risk. As a result, private firms will always be cheaper for low levels of quality but might be more expensive for high levels of quality. Extending the model to allow for differences in task attractiveness, I find that public firms shun unattractive tasks, whereas private firms undertake them if incentives are strong enough.

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Bibliographic Info

Paper provided by Research Institute of Industrial Economics in its series Working Paper Series with number 736.

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Length: 33 pages
Date of creation: 17 Mar 2008
Date of revision:
Handle: RePEc:hhs:iuiwop:0736

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Keywords: Privatization; Public Sector Contracting; Incomplete Contracts; Contracting Out;

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References

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  1. Dalen, Dag Morten & Moen, Espen R & Riis, Christian, 2004. "Contract Renewal and Incentives in Public Procurement," CEPR Discussion Papers 4540, C.E.P.R. Discussion Papers.
  2. Ohlsson, Henry, 1998. "Ownership and Production Costs - Choosing Between Public Production and Contracting Out," Working Paper Series 1998:6, Uppsala University, Department of Economics.
  3. Jonathan Levin & Steven Tadelis, 2007. "Contracting for Government Services: Theory and Evidence from U.S. Cities," NBER Working Papers 13350, National Bureau of Economic Research, Inc.
  4. Schmidt, Klaus M., 1996. "The costs and benefits of privatization: An incomplete contracts approach," Munich Reprints in Economics 19773, University of Munich, Department of Economics.
  5. Andrei Shleifer, 1998. "State Versus Private Ownership," NBER Working Papers 6665, National Bureau of Economic Research, Inc.
  6. Edward L. Glaeser & Andrei Shleifer, 1998. "Not-For-Profit Entrepreneurs," NBER Working Papers 6810, National Bureau of Economic Research, Inc.
  7. Grossman, Sanford J. & Hart, Oliver D., 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Scholarly Articles 3450060, Harvard University Department of Economics.
  8. Besley, Timothy J. & Ghatak, Maitreesh, 2004. "Competition and Incentives with Motivated Agents," CEPR Discussion Papers 4641, C.E.P.R. Discussion Papers.
  9. David E. M. Sappington & Joseph E. Stiglitz, 1987. "Privatization, information and incentives," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 6(4), pages 567-585.
  10. Domberger, Simon & Jensen, Paul, 1997. "Contracting Out by the Public Sector: Theory, Evidence, Prospects," Oxford Review of Economic Policy, Oxford University Press, vol. 13(4), pages 67-78, Winter.
  11. Schmidt, Klaus M, 1996. "The Costs and Benefits of Privatization: An Incomplete Contracts Approach," Journal of Law, Economics and Organization, Oxford University Press, vol. 12(1), pages 1-24, April.
  12. Oliver Hart & Andrei Shleifer & Robert Vishny, 1996. "The Proper Scope of Government: Theory and an Application to Prisons," Harvard Institute of Economic Research Working Papers 1778, Harvard - Institute of Economic Research.
  13. Sloan, Frank A. & Picone, Gabriel A. & TaylorJr., Donald H. & Chou, Shin-Yi, 2001. "Hospital ownership and cost and quality of care: is there a dime's worth of difference?," Journal of Health Economics, Elsevier, vol. 20(1), pages 1-21, January.
  14. Holmstrom, Bengt & Milgrom, Paul, 1991. "Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design," Journal of Law, Economics and Organization, Oxford University Press, vol. 7(0), pages 24-52, Special I.
  15. Silverman, Elaine & Skinner, Jonathan, 2004. "Medicare upcoding and hospital ownership," Journal of Health Economics, Elsevier, vol. 23(2), pages 369-389, March.
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Cited by:
  1. Andersson, Fredrik, 2010. "On the Cost-vs-Quality Tradeoff in Make-or-Buy Decisions," Working Papers 2010:2, Lund University, Department of Economics.
  2. Spagnolo, Giancarlo & Bergman, Mats A. & Lundberg, Sofia, 2012. "Privatization and Quality: Evidence from Elderly Care in Sweden," SITE Working Paper Series 19, Stockholm Institute of Transition Economics, Stockholm School of Economics.

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