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Outsourcing of Public Service Provision: When is it More Efficient?

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  • Peter Birch Sørensen

    (Institute of Economics, University of Copenhagen)

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    Abstract

    We set up a model of public service provision to study the factors determining whether outsourcing to for-profit and not-for-profit producers of social services will enable a local government to achieve a given service quality at lower budgetary cost. 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.

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    Bibliographic Info

    Paper provided by Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics in its series EPRU Working Paper Series with number 04-06.

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    Length: 26 pages
    Date of creation: Apr 2004
    Date of revision:
    Handle: RePEc:kud:epruwp:04-06

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    Keywords: outsourcing; public goods provision; public sector reform;

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    1. Andrei Shleifer, 1998. "State versus Private Ownership," Journal of Economic Perspectives, American Economic Association, vol. 12(4), pages 133-150, Fall.
    2. Hart, Oliver & Shleifer, Andrei & Vishny, Robert W, 1997. "The Proper Scope of Government: Theory and an Application to Prisons," The Quarterly Journal of Economics, MIT Press, vol. 112(4), pages 1127-61, November.
    3. Edward L. Glaeser & Andrei Shleifer, 1998. "Not-For-Profit Entrepreneurs," NBER Working Papers 6810, National Bureau of Economic Research, Inc.
    4. 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.
    5. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, December.
    6. Jens Lundsgaard, 2002. "Competition and Efficiency in Publicly Funded Services," OECD Economics Department Working Papers 331, OECD Publishing.
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