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

Rethinking the selfare state 26
consumers may favour a different quality-cost trade-off than their proxy, yet possess no
direct or effective means of asserting this preference.
Furthermore, while Shleifer argues that private ownership tends to favour innovation,
he does not distinguish between forms of innovation which improve quality, and those
which improve cost efficiency While it is true that in some services efficiency is a critical
element of quality (consider, for instance, courier services, where faster turnaround
benefits both customer and firm), there are others where more efficient service comes at a
substantial quality cost. Consumers have an interest in having their preferences met; what
better incentives does the contracting out of services give to providers to meet those
preferences?
This draws attention to another set of contractibility problems. Let us assume, as is
likely to be the case with respect to certain services, that the preferences of consumers are
heterogeneous—that is, both varied and variable. The terms of a contract between proxy
and provider can anticipate some of these preferences ex ante; however, any significant
change in preferences will effectively represent an uncontracted-for circumstance. The
residual control rights in such situations lie with the provider. This creates a principalagent
divergence, since the agent has no profitable interest in meeting the demands of the
consumer (since the contract does not stipulate any remuneration for doing so, and the
consumer cannot censure an unresponsive provider by “unsubscribing”). As with purely
public provision, supply-side subsidies provide no reliable incentive mechanism through
which the consumer can influence directly the content of the market to meet his or her
changing demands.
Additionally, as Trebilcock notes, contracting out has the potential to create
unintended but persistent monopolies:
[T]here may be so much flexibility built into [a] contract that the firm can
adapt to future changes in such a way as to exercise some monopoly
power. The resulting bilateral monopoly becomes a more severe problem
as the contract lengthens in duration. [Furthermore,] incumbent contract
holders often have a considerable advantage at renewal time over their
competitors. Government will not want to cause a disruption by changing
contractors. […] It is in a significantly better position at renewal time than
its competitors who must start from scratch in bidding for the contract
renewal and must purchase all the necessary assets, often from the
incumbent if the assets are highly specific. 43
Such de facto monopolies introduce the risk of driving prices back up above competitive
levels, and may counteract the cost-effectiveness advantages imputed to supply-side
subsidies in the first place.
Finally, contracting out may invite problems of its own in some contexts. For
example, Hart, Shleifer and Vishny view the objective function of a number of
government activities as sufficiently complex or contingent that precise specification, by
contract, legislation, regulation, or otherwise, of objectives and ready monitoring of the
achievement of these objectives are infeasible. 44 An extreme example is the formulation
and implementation of a country’s foreign or defense policy, where the complexity of
objectives and unforeseeable contingencies render delegations of these functions to