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Will Privatization Reduce Costs?

  • Lindqvist, Erik

    ()

    (Research Institute of Industrial Economics (IFN))

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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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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  1. Oliver Hart & Sanford Grossman, 1985. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Working papers 372, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. 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.
  3. Silverman, Elaine & Skinner, Jonathan, 2004. "Medicare upcoding and hospital ownership," Journal of Health Economics, Elsevier, vol. 23(2), pages 369-389, March.
  4. Besley, Timothy J. & Ghatak, Maitreesh, 2004. "Competition and Incentives with Motivated Agents," CEPR Discussion Papers 4641, C.E.P.R. Discussion Papers.
  5. Oliver Hart & Andrei Shleifer & Robert W. Vishny, 1996. "The Proper Scope of Government: Theory and an Application to Prisons," NBER Working Papers 5744, National Bureau of Economic Research, Inc.
  6. 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.
  7. Dalen, Dag Morten & Moen, Espen R. & Riis, Christian, 2006. "Contract renewal and incentives in public procurement," International Journal of Industrial Organization, Elsevier, vol. 24(2), pages 269-285, March.
  8. Andrei Shleifer, 1998. "State Versus Private Ownership," NBER Working Papers 6665, National Bureau of Economic Research, Inc.
  9. Sloan, Frank A. & Picone, Gabriel A. & Taylor, Donald H., Jr. & Chou, Shin-Yi, 2000. "Hospital Ownership and Cost and Quality of Care: Is There a Dime's Worth of Difference?," Working Papers 00-11, Duke University, Department of Economics.
  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. Ohlsson, H., 1998. "Ownership and Production Costs Choosing Between Public Production and Contracting Out," Papers 1998-6, Uppsala - Working Paper Series.
  12. Edward L. Glaeser & Andrei Shleifer, 1998. "Not-For-Profit Entrepreneurs," Harvard Institute of Economic Research Working Papers 1852, Harvard - Institute of Economic Research.
  13. 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.
  14. 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.
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