Public Policy: Using Market-Based Approaches - Department for ...

Public Policy: Using Market-Based Approaches
measure or it may be prohibitively costly to include a provision for every
possible contingency. Incomplete contracts 93 in competitive tendering can lead
to two main problems, cost reductions being achieved at the expense of quality
(‘quality shading’) and fears of the ‘hold-up’ problem previously discussed. In
the case of prison procurement, quality shading is of particular interest because
the economics literature has cited this as the main reason that private sector
involvement in prison services is inadvisable.
QUALITY-SHADING
Quality shading means that the private sector firm running the prison service
reduces costs partly or mainly by reducing the quality of the service provided.
Quality shading has been found in privately provided prisons in the US, which
have been subject to a great deal of criticism. 94 It arises where there are multiple
objectives to be pursued, some of which are more readily observable than
others. Agents will tend to focus efforts on improving the performance of the
measurable output to the detriment of the others. Hart, Shleifer and Vishny
(1997) developed this idea in relation to public-sector procurement, and
concluded that, where non-contractible quality is important, the public-sector
should retain both ownership and management of the service. One of the public
services they concluded was therefore unsuited to private sector management
was prison management.
Because issues of incomplete contracts have been central to the introduction of
competition to prison services, features of the procurement process designed to
control for quality are considered in detail in the following section, along with an
evaluation of the quality of private prison services in practice.
Hart et al. (1997) concluded that prison management was unsuited to private
sector involvement on the grounds that the quality of prison services is very
important, but costly for a private sector provider to deliver and difficult to specify
in a contract. Whilst the first two points are without dispute, HMPS has shown
that it is possible to contract for quality: this has been an important part of
contract design and monitoring, as discussed in detail below. Whilst the quality
shading problems associated with incomplete contracts have been limited largely
through designing contracts that are as complete as possible, HMPS has also
tried to address this potential problem through the bid evaluation procedure and
more recently through incentives for enhanced performance. It is worth noting
that firms face additional incentives to deliver a high-quality service arising from
the fact that they care about their reputation. This is particularly important given
the need for bidders to demonstrate a proven track record in security services to
be considered for the contract.
93 Because virtually all contracts are incomplete, this potential issue is one of degree rather than existence. However
for simplicity here we use the term ‘incomplete contracts’ to refer to contracts that are sufficiently incomplete to
cause the problems discussed.
94 See for example Logan (1990) and Shichor (1995) for a summary of evidence for and against private prisons in
the US.
96