Contracting: Theoretical Propositions,

Empirical Realities

Mildred Warner

Presented to Economic Policy Institute

Washington, DCApril 4, 2003

Based on research with Amir HefetzDept of City and Regional Planning, Cornell University

215 W. Sibley Hall, Ithaca, NY 14853-6701 mew15@cornell.edu

Outline Data

Theoretical Propositions, Empirical Realities Why Limited Privatization Market Solutions for Regional Service Delivery An Assessment of Efficiency, Equity and Voice The Dynamics of Contracting

Implications for Governance

Theoretical Propositions

Markets Can Provide Public Goods

Competition Promotes Efficiency

Market Provision Enhances Consumer Voice

Private Sector Management can be applied to the public sector

Empirical Realities Governments have always used markets

But privatization yields uneven results

Competitive markets do not always exist Efficiency not always secured

Citizen voice may not be enhanced Difference between citizen and consumer interests

Limits to new public management Government is more than a business

Data International City County Management Association Surveys

of Alternative Service Delivery 1982, 1988, 1992, 1997

Scope: 64 specific services 6 service delivery options (entirely public, mixed public/private, for

profit, non profit, inter-municipal cooperation, franchises Factors motivating restructuring

Sample Frame: All cities over 10,000, All counties over 25,000. Response rate 31% (roughly 1400 municipalities).

U.S. Census of Government Finance Files 1987, 1992, 1997

Privatization Trends

58.4%

68.8%

56.7%55.5%

11.9% 8.5%15.1%14.3%

23.6%21.4%17.3%

21.5%

0.0%

20.0%

40.0%

60.0%

80.0%

1982 1988 1992 1997

Public Employee EntirelyInter Municipal CooperationPrivatization (For-Profit & Non-Profit)

U.S. Cities & Counties, Number: 1982=1675, 1988=1627, 1992=1444, 1997=1460.

Source: International City/ County Management Association, Profile of Alternative Service Delivery Approaches, Survey Data, 1982, 1988, 1992, 1997, Washington DC.

Why are the Trends Flat?

Government has always used private providers Privatization - new name for longstanding practice

Government service provision is dynamic New services, service shedding, contracting out and

contracting back-in

Government managers use a variety of mechanisms to secure public service delivery

Contracting out is more common in public works, support services, human services

Dynamics of Service Provision

New Service: 9.9%

NewContracting -Out: 15.9%

ContractingBack - In:

9.8%

ServiceShedding:

19.8%

StableProvision:

44.4%

Average percent of total provision across all places.Source: International City/ County Management Association, Profile of Alternative Service Delivery Approaches, Survey Data, 1992 to 1997, Washington DC.

Government Structures Markets New Contracting Out - 90 % of all responding

governments (on average 8 services)

Contracting Back-In - 86% of all responding governments (on average 4.5 services)

Contracting back-in varies more by municipality than by service market conditions more important than service characteristics

Mixed Public/Private Provision averages 15-20% for most services

(ICMA Data 1997)

I. Limited Privatization: Government Failure or Market Failure?

Do government managers and labor opposition limit privatization? Management attitudes, monitoring, opposition

Or is it a result of structural features of markets? Scale and cost considerations, income

Used discriminant analysis on 1400 municipalities to determine if restructuring patterns differed by metro status.

Results

1. Structural Features are more important than management in explaining differing restructuring patterns by metro status.

Privatization is favored by richer suburbs Higher cost metro and rural communities have heavier

reliance on public provision

These structural features explained 87% of the variance

2. Government management, labor opposition and monitoring only explained 13% of variance.

Limits to Public Entrepreneurship

Market approaches to government reinforce uneven landscape of public services - especially for higher cost rural and core metro areas

Private markets undermine redistributive goals - focus state and local government on economic competitiveness.

Equity is undermined.

II. Are Markets a Solution to Regionalism?

Fragmented metropolitan areas make regional integration of service delivery difficult. Local government boundaries do not coincide with

the economic boundaries of the metro area.

Political fragmentation leads to inequity High need inner city Low need but higher tax base suburbs.

Planners’ ideal solution - regionalism Political consolidation politically unpopular. Representative regional government is rare.

Market solutions to regionalism are common Privatization to gain scale

Inter-municipal cooperation to address service integration

Evaluate use of markets to address regional service delivery on efficiency, democracy and community grounds.

Market solutions potentially address efficiency concerns, but they fail to address democracy and community building concerns.

Results Discriminant analysis of 1400 municipalities shows

market solutions are biased toward richer suburbs.

Suburbs have wider range of choice in market approaches - use both inter-municipal cooperation and privatization.

Core metro communities rely less on cooperation - have internal economies of scale.

Suburbs do not cooperate with higher cost rural and inner city neighbors.

III. Efficiency, Voice and Equity

Public choice theory argues market solutions enhance public sector efficiency and promote consumer/citizen voice. Competition promotes efficiency.

Promoting consumer sovereignty enhances citizen voice.

Inequality justified as preference - This privatized view of the city undermines equity.

Results Probit analysis of 1000 metro governments from 1992

and 1997 comparing for profit privatization and inter-municipal cooperation

Both cooperation and for profit privatization show efficiency gains Technical monitoring is required to ensure efficiency under

privatization.

Only cooperation shows positive equity and voice effects.

Municipalities that privatize more, rank lower on voice and equity measures.

IV. Privatization and Its Reverse What explains the direction of contracting - new

contracting out and contracting back-in? Principal Agent Theory - budget maximizing bureaucrats,

labor opposition

Transactions Costs - contract specification, information, monitoring

Public Service - citizen deliberation, public value

Probit Model of 621 governments Respondents to both the 1992 and 1997 ICMA surveys

Dependent Variables: Level of contracting out or back-in

Contracting Out Results Less contracting out if there is

Opposition

Attempts to Decrease Costs

Principal Agent Problems

Lack of Competition

Less Monitoring (most governments don’t monitor)

Managers who monitor more (reflects contracting problems)

Citizen complaint mechanism kept in house

Contracting Back-In Results More Contracting Back-In if there is

Opposition

Principal Agent Problems

Political Climate favoring privatization

Lack of Competition

Managers who monitor

Citizen Voice

Contracting Back-in is a substitute for monitoring

Theoretical Implications

Principal Agent problems are important in explaining levels of contracting out and back-in

Transactions Costs also explain differences in contracting direction (monitoring, attempts to decrease costs, market competition)

Public Service is also important - citizen voice, political climate favoring reduced government role result in more contracting back-in (opposite from popular expectations)

Monitoring is key

Limits to Privatization

It’s all in the contract Competition, public deliberation, transparency,

quality, efficiency

Government provision is about more than efficiency Community building, equity, voice

Challenges the New Public Management Recognize the complexity of governmental

responsibility - beyond contract management

Theoretical Myths - Empirical Realities Theory: Market Solutions for Public Goods

Reality: Market Solutions Have Market Failures

Lack of competition Uneven distribution of market solutions

Lack of full information and high transactions costs Problems with monitoring and citizen voice Loss of social benefits not specified in contract

Theory: Competition among local governments increases efficiency

Reality: Competition increases inequality, promotes a privatized view of the city

Theoretical Myths - Empirical Realities

Theory: Differences in services reflect citizen preference

Reality: Inequalities reflect market structure, not citizen preference

Theory: Market solutions enhance democratic expression

Reality: Private markets reduce citizen to a consumer.

Theory: Citizen and consumer voice are similar

Reality: Consumer choice exacerbates externalities that divide the metro region, e.g. service choice based on race and income rather than the broader public good.

Markets and Government

To use markets, government must play a market structuring role Competition is not secured, contracts and

monitoring important

Government is about more than efficiency Equity and voice may be more important

Public management must secure public value Service, community identity, human dignity,

sustainability

Implications for Governance Governance now involves a network of public and

private actors. This limits traditional government roles in ensuring Public control

Accountability

Representation

Balance of Interests (public and private)

Public/Private Partnerships - Market Solutions are here to stay Need to address the governance deficit in these arrangements.

Thank you