The Use of Contracts: Non-profits and Private Firms

Topics Last Week n Guest Lectures in PMIA n Individual case n Group cases u Group 1 pls stay after class u Check with your group, drop by Wednesday! n Questions about the readings for this week. What did you think of it? n Definitions n C& E, Kooiman: Effectiveness & Governance

Topics n Housekeeping: u Internship UNU u Cases F Group 2 pls stay after class F Check with your group, drop by Wednesday! F Group 2 get questions asked by group 3, etc. F All teams read Ch. 6 of “Tools for Innovators” on Team Management n Questions about the readings for this week. What did you think of it? Now Presentation! n Markets, public-private partnerships & contracts u Privatization

Public Management n Does Public Management only concern Government Bureaucracies? No, it is the combination of organizational management with societal issues, such as AIDS, technological development and so on. In other words, public management also entails working with the private sector. It encompasses the (mal)functioning of society as a whole.

Public Management n Today, we mainly focus on the relationship between the state, or more specific, the government and the market(s). n We discuss contracting out: u Rafles case dealt with a private firm u La Alianza case dealt with a non-profit organization n Topics: u Relation between government and markets; u Shortcomings of both markets and governments; u Difference between contracting and Public- Private Partnerships

The Market n Often people (in the US) state that Government is too big, the Market is better! n Market: u demand & supply determine an efficient level of production (less problems of control or training) u competition minimizes costs u regulates quality n Government: u demand & supply don’t balance: pressure to spend the whole budget by the end of the year u inefficiency can lead to higher budgets and more employees to solve the problems

The Market n “The theory of the market is at once an explanation of what is wrong and what can be done to make things right. If the problem is a set of perverse incentives, the key is to change them. Instead of encouraging government to grow and rewarding bureaucrats with ever-larger budgets, the fix is to replace the government's monopoly with the discipline of vigorous competition.” n Political left and right have supported market- based solutions. Competition will discipline the government in two related ways: u more market, less government; u government must adapt business tools

The Market n Yet, every major policy initiative launched by the federal government since World War II — including medicare...— has been managed through PPPartnerships. Waste & fraud in govt have involved these partners in combination with weak govt management & oversight n Paradox: People want more market, but the actual practice does not prove their point. n This class is not about less government and more market, it is about better governance.

The Market n Simple contracting process: u govt managers specify specs for goods and services u advertise bids u open bids publicly at a pre-determined place u award contract to lowest bidder who complies with specifications n Advantages for the government: u standardized products (less problems of control and training) u many suppliers u (passive role in design of products)

The Market n But during & after WWII, contracting evolved: u cooperative venture (much closer than arms’ length) u no predetermined price, but costs plus fee u promoting innovation & social change n Indeed some contracts came closer to PPPartnerships n Truman & Eisenhower examples n What are actually the other policy tools the govt has?

The Market n Other policy tools: u regulation u tax incentives u loan programs u (income) transfers n Consequence of the new forms of contracting out: the difference between public and private blurred n Market’s function best when you ‘ve got arms- length transaction, large numbers of buyers and sellers for relatively undifferentiated goods

The Market n Many markets are different (imperfect in economic terms, i.e. they are less efficient). For example, there are only a few suppliers. The gvmnt needs: u to be able to differentiate between types of markets; u the capacity to manage its contract effectively n In addition, goals (which foster efficiency) are have to be balanced with other goals (justice, responsiveness, etc.)

Problems in contracting & PPP n PPPartnerships means that the govt goes outside its traditional command-and-control hierarchy. The central problem then becomes “inducing an agent to behave as if he were maximizing the principal’s welfare” n Both the contract and the hierarchy are efforts to create “stable and predictable patterns that reduce the many uncertainties that result from negotiating through difficult problems with limited knowledge” u but our knowledge/information is limited u agents also have other interests, they can shirk u principals thus need to monitor

Problems in contracting & PPP n So how to deal with conflict-of-interest and monitoring problem u Define the contractor’s job F yet, most (public) organizations have fuzzy goals F public org’s goals are the product of law F complex environment u Choosing the contractor F adverse selection: do we have the best possible contractor? Conflict-of-interest is inevitable. u Selecting Incentives and Sanctions F Measuring and rewarding quality is difficult F fuzzy goals, etc u Monitoring Performance F It costs money, not spent on primary task

Problems in Markets Supply side and demand side problems n Supply u existence of the market for goods and services u competition F (4 examples) F barriers of entry u externalities (side effects: costs and benefits that the market does not capture) n Demand side u defining the product: cooperative alliance u information about the product: budget cuts? u Gamesmanship and internalities

Conclusions n The variety of market failures helps explain why the expansive promises of PPPartnerships have often been elusive. n The issue is not to choose between the market or government. It is, rather, how to strike the best balance between them—and how to manage the problems that this balance creates. n We now have mixed public-private power. Don’t think in opposites like govt control, private flexibility, efficiency vs. accounta- bility.The issue hinges the government’s mgmt of private agents to pursue public interests

Conclusions n Given the public’s demands & societal complexity, PPPartnerships are here to stay n The problems of all principal agent relationships are magnified by imperfect markets n So, be careful with privatization. It works worst when there are many externalities and monopolies, limited competition, and efficiency is not the main public interest n In the search for public/private balance seek the public interest.

Topics n Housekeeping: u Internship UNU u Cases F Group 2 pls stay after class F Check with your group, drop by Wednesday! F Group 2 get questions asked by group 3, etc. F All teams read Ch. 6 of “Tools for Innovators” on Team Management n Questions about the readings for this week. What did you think of it? Now Presentation! n Markets, public-private partnerships & contracts u Privatization