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

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SECTION 2 Using market mechanisms Using a market-based mechanism in place of traditional policy designs can create significant benefits, in the form of lower costs and better services, but only if sufficient care is given to their design and implementation. This part of our report identifies the main lessons from our analysis. Through the case studies, in particular, we have gleaned practical insights as to how marketbased mechanisms can be best designed and made to work successfully. These lessons provide valuable insights for policy-makers across government as to how competition-based policies can achieve a range of policy objectives more effectively. This part of our report is structured as follows: we first describe our generic conclusions on applying such mechanisms; we then discuss specific lessons for the three particular mechanisms studied: competitive tendering, user choice and tradable permits. Continuing role for the public sector Our first lesson may seem paradoxical. Market-based mechanisms – even where a service is contracted out to private sector providers – do not remove the role of the public sector in managing or regulating how services are provided. Instead, they involve a different kind of government intervention. When a service is transferred to the private sector through a competitive tender, for example, the public sector still has to manage the contract with the external supplier. Total public-sector resource requirements may be more, less or the same as before, but they are likely to be of a different kind. There is often a sound rationale for government intervention in a market. Without government, certain goods may not exist at all. Others may be provided only to a minority of users, in an undesirable quantity or at an excessive price. Without compulsory taxation, for example, prisons may not exist. While all (lawabiding) citizens benefit from the protection provided by their existence, individual citizens benefit whether or not they pay for them. In economic jargon, prisons are a public good as the service they provide to society is non-rival 2 (my neighbour’s consumption does not affect my consumption) and non-excludable (all benefit whether they contribute or not). Conversely, although the free market may provide education without government, this may be only for those able to pay for it. This might be considered unacceptable in a fair society and may conflict with the government’s social objectives. 2 The same is not true of prisons themselves, which do display rivalry characteristics: one detained prisoner occupies a prisoner place that could have been used by another offender. 14
Section 2 – Using market mechanisms Although a pure free-market may lead to too little education, it can lead to too much production of other products. Without government controls and restrictions, pollution would rise to unacceptable levels. In the absence of government intervention, for example, a factory owner will not bear the costs that pollution emitted from his factory imposes on others. As a result the factory may find it cheaper to use a technology that produces higher levels of pollution, despite the fact this leads to a higher cost for society. In economics, the impact of the factory’s decision on the rest of society is known as a negative externality. 3 Other goods may again be provided by the market, but at excessive prices. Economies of scale in production may make it inefficient to have more than one national electricity grid. Without government intervention, the monopoly producer could take advantage of its market power by charging very high prices to consumers. These examples of market failure suggest there can be a legitimate role for government in many sectors of the economy. 4 Market failure alone is a necessary but not sufficient condition for government intervention. In some cases government intervention may lead to other problems, such as inefficiency and corruption, that could outweigh the original market failure. If there is a government intervention that can reduce the market failure without giving rise to additional problems, then government intervention can be positively beneficial. However, state intervention can take many forms. An administrative system can lead to services being provided at an excessively high cost or poor quality if the incentives to minimise costs and improve quality are weak. Services may also be provided in the wrong quantities if there is no signal to tell providers which goods are most popular and so should be produced in greater quantities. In the private sector rising demand encourages firms to produce more but under a pure ‘administrative’ system, it can just lead to longer queues. Careful use of market mechanisms by government can reduce or eliminate these problems. We emphasise “careful” since such mechanisms require the public sector to devote significant resources to their design, implementation and operation in order to achieve the desired result. In Table 1 we list a number of market-based mechanisms which can be used to address the problems with pure private provision identified above, while avoiding some of the inefficiencies of an administrative system. The choice regarding which market-based mechanism to use will depend on a number of factors. However, a useful starting point is the nature of the market failure that provides the rationale for 3 Externalities arise when the cost of a good to society is different from the cost to the individual. Pollution is a negative externality as the cost to society is greater than the private cost, education is a positive externality as the benefit to society can be greater than the private benefit. 4 An additional rationale relates to the cost of obtaining relevant information. For example, if consumers lack information on the quality of different products they may inadvertently purchase a poor-value product, or the risk of making such a mistake could mean that they do not make any purchase at all. Governments can alleviate this issue by trying to disclose information. This is not dealt with at length in our report. 15
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Page 5 and 6: Contents Acknowledgements vi Forewo
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SECTION 8 Framework for assessing m
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Part IV Case Studies 73
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● the Green and White papers behi
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A prison failing to deliver on its
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Table 9.3 Companies providing priso
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Section 9 - Competitive Tendering o
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detect any deviation from a collusi
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at HMPS began as an equal mix of th
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(e.g. lighting). This impact could
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MARKET POWER The full benefits of c
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However, it should be noted that te
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on competition is uncertain. The ab
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Controlling for problems of asymmet
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Procurement process design One way
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however, financial deductions are m
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The Independent Monitoring Board at
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Figure 9.1: Difference between the
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‘While there were staff in the pu
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design the invitation to tender and
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and demand conditions. Second, we d
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DEMAND Anyone can apply to a local
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● Rent deposit guarantee by the l
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The Green Paper stated the Governme
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It was not an objective of ODPM or
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DESCRIPTION OF MARKET MECHANISM The
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Once the outcome is determined, fee
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DEVELOPMENTS OVER TIME The major mo
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Concerns about capacity constraints
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from those already located within t
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In several areas, registrations by
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Controlling for information problem
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extent though, it was competition b
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Section 10 - Choice-Based Letting i
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levels are reducing and new tenants
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desired effect of limiting points-c
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efficiency savings in some areas. T
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SECTION 11 Emissions Trading Introd
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Section 11 - Emissions Trading coex
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Section 11 - Emissions Trading emis
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A more detailed and diagrammatic de
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The costs of monitoring and reporti
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INITIAL ALLOCATION OF PROPERTY RIGH
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only 242 in the second year. The di
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COST-EFFICIENT EMISSIONS REDUCTIONS
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consultants to Defra of £11 per to
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Participation has helped us to rais
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Section 11 - Emissions Trading emis
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SECTION 12 Issues in the implementa
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