Contracting: Theoretical Propositions, Empirical Realities Mildred Warner Presented to Economic Policy Institute Washington, DC April 4, 2003 Based on research with Amir Hefetz Dept of City and Regional Planning, Cornell University 215 W. Sibley Hall, Ithaca, NY

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 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

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 % 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