Rethinking the Welfare State: The prospects for ... - e-Library

Rethinking the selfare state 24
adult correctional facilities in the United States, where the government pays a private
corporation to operate prisons, often with considerable savings and even “improved”
services. 34
“Contracting-out” is simple in principle, if not always in practice. 35 Essentially, like a
firm hiring a web designer on contract or a homeowner looking for the best price on a
renovation, the government tenders a contract for a particular service on the open market.
Private corporations make offers, and the government chooses the bidder who makes the
best offer, according to the relevant criteria. This introduces competitive pressure into the
market: contractors have an incentive to lower their dollar costs and to introduce new and
more creative services. Innovation can be rewarded. Contractors who fail to deliver do
not see their contracts renewed. Those who do not provide a good “product” are never
hired, and are forced to “exit” the market. This aspect of market efficiency is often
referred to as “the competition effect,” which Hrab, following Vickers and Yarrow,
defines as:
the generally held belief that the market discipline provided by
competition between firms is conducive to an organization that is
customer oriented, efficient, technologically superior and better able and
willing to adapt to change [because of] internal efficiency and allocative
efficiency as firms seek to lower costs in order to offer a lower price to
consumers than competitors and gain market control. 36
In addition to the operation of competitive pressure, contracting-out creates incentives on
the part of the provider in favour of efficient service delivery in the form of residual
claims (the “ownership effect”). As Shleifer points out:
[Ownership of production and distribution assets by the actual provider]
gives the owner control and bargaining power in situations where
contracts do not specify what has to be done. As a consequence,
ownership strengthens the owner’s incentives to make investments that
improve the ways or reduce the costs of using the assets, because the
owner has the power to reap more of the rewards of these innovations […]
An owner of a postal business who invents a better way to deliver mail
can implement this innovation and profit from it. In contrast, if the
government or someone else owns the business, the inventor needs the
agreement of the owner to implement the innovation, and thus must share
the benefits of the invention with this owner. Without the bargaining chip
provided by ownership, the incentives to invest and innovate are lower. 37
The transfer of this “bargaining chip” to the private provider creates incentives on the
part of the provider to maximize profit through cost-effective delivery, but also provides
more discretion to innovate and invest, since the provider now has the authority to make
decisions in uncontracted-for circumstances.
Private enterprises also have recourse to more effective means of disciplining
managers. Unlike public enterprises, private firms face “hard” budget constraints. 38
Funds must be raised through new equity or debt investment, and if resources are wasted,