Unbiased Analysis of Today's Healthcare Issues

Contracting for Government Services

Written By: Jason Shafrin - Oct• 01•07

Local governments provide a variety of services which are highly valued by their residents. From police protection to waste disposal, from snow plowing to utility meter reading, the local government is charged with providing the infrastructure necessary for a smooth functioning economy and a high level quality of life. But should local governments outsource these tasks to the private sector or provide the services themselves?

This is the question analyzed in an NBER working paper by Jonathan Levin and Steven Tadelis (earlier draft for free available here). On the one hand, using government provision is often inefficient due to the low incentives faced by city employees. On the other hand, cost relating to specifying and implementing performance requirements of a private supplier may also create inefficiencies. The authors claim the following:

  • “If contracting difficulty m increases, the principal will be more likely to use an employment contract, while the optimal quality may increase or decrease. If the importance of quality s increases, the principal will be more likely to use an employment contract, and optimal quality will increase.

Services where quality or performance is difficult to measure are poor candidates for privatization. According to the authors’ data, the most difficult service to contract are police services, drug/alcohol treatment programs, inspection/code enforcement and fire prevention. The services where quality is easily seen are waste collection, utility meter reading, vehicle towing, and operation of recreation facilities.


The authors use information from 1043 cities from the International City/County Management Association’s (ICMA’s) 1997 and 2002 Service Delivery surveys. Supplementary information is provided by the U.S. Census. To better understand which services are easily contractible, the authors conducted a survey of 23 city managers.

The authors use a multinomial logit regression in order to investigate which factors influence the probability that a city will privatize a given service.


Here is what the authors concluded from their data:

  1. Cities are more likely to privatize services for which it is easier to specify, enforce or adjust performance standard.
  2. Cities are more likely to privatize services for which sensitivity to quality is low. As city residents are the final consumers of services, and city administrators are ultimately accountable to residents, this suggests that privatization should be less likely for those services where city residents are more likely to react to quality problems.
  3. Smaller and rural cities may be less responsive to contracting difficulties. For instance, if the city simply does not have the capacity to provide the service, then they will privatize. On the other hand, if there are no business which will provide the desired service, then they local government may have to do it in-house.
  4. The authors claim that city managers who have had experience working with private contractors are more likely to have fewer difficulties working with private firms and thus are more likely to privatize. While the learning argument is somewhat convincing, empirical, this may simply be the result that some cities are more ideologically in favor of privatization and others prefer more socialized services.
  5. Cities run by mayors may be less likely to privatize services as compared to cities run by managers. The authors claim that politicians (mayors) may be are more responsive to quality in order to please their constituents but may care less about the cost.
  6. Cities with strong government unions will be less likely to privatize.
  7. If financial constraints cause administrators to focus more on economic considerations, then debt-constrained cities would be more responsive to contracting difficulties.


According to this model, it is difficult to tell whether or not medical care should be provided publicly or privately. Quality or performance is extremely difficult to judge and thus contracting based on performance (i.e.: P4P) is destined to fail. If a person dies after a surgery, is that the surgeons fault or was the person just in critical health? This may lead individuals to think that public provision is ideal. However, having a public sector surgeon who is less motivated and cares less about their reputation may lead to inefficiencies.

For vaccinations, quality is easy to judge–people are either vaccinated or they are not. This may lead individuals to think that vaccinations should be privatized to save money. However, it is difficult to contract the number of individuals who are vaccinated. For instance, if firms were paid based on the number of people they vaccinate they may have an incentive to vaccinate individuals even when they should not receive them (if they are sick and should not receive the vaccine until they recover) or the firm could inflate the number of people vaccinated by fraud.

Thus, whether or not medical services should be public or private is not so simple, and a case-by-case analysis may be needed.

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