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SECTION 7 Market-Based Mechanisms We have seen in the previous sections that market failures and social objectives lead to government involvement in sectors of the economy. We have also seen that government intervention can bring its own problems. One reaction to this problem is to ask whether, even when a market failure exists, an unregulated private sector may be more desirable than government intervention. Government failure might outweigh the market failure it is trying to correct. However, a third option may be to change the mechanism the publicsector uses. Government failure results from the loss of certain advantages of free-market provision: such as incentives for efficiency and the role of the price mechanism in allocating resources. One approach, therefore, is to try to introduce these disciplines into the mechanism the public-sector uses. We refer to such mechanisms as ‘market-based mechanisms’, which we define as mechanisms that attempt to use market forces to reduce the problem of government failure. The use of market-based mechanisms is unlikely to completely eliminate the impact of government failure. Nor is it guaranteed that their use will reduce this problem; that depends on how well they are designed and implemented. However, the careful use of market-based mechanisms can help to overcome some government failures. For example, in many cases it is possible for governments to achieve their objectives by setting obligations that private firms have to meet or, where it is decided to keep service provision entirely in the public sector, by introducing customer choice to give a more efficient allocation of resources. For our purposes we divide market mechanisms into five broad categories. However, any particular application may involve a combination of more than one of these categories. In this section we describe each of these mechanisms in turn, before noting the problems that need to be taken into account when considering the use of these mechanisms. The mechanisms we consider are: ● competitive tendering of service provision; ● introducing user choice; ● marketable permits (‘cap and trade’;) ● taxes and subsidies; ● regulating access. In addition, we consider the use of auctions as a means to value scarce resources. 42
Competitive tendering of service provision Some areas of public policy involve the public sector directly providing services to the public. For example, the criminal justice system has traditionally involved the public sector directly providing a number of services: a police force, courts and prisons. As noted in section 6, pure government provision of a service can lead to inefficiencies due to the absence of the discipline the profit motivation provides, and conflicts between the incentives of those working in the public sector and the overall goal of policy makers. In some cases, these problems can be resolved by tendering for the supply of the particular service. This is similar to the use of franchises in the private sector, where, although overall control may rest with a single firm, the operation of a particular activity is delegated to other firms or individuals. Competitive tendering of service provision is often possible as in many cases a government obligation to supply a particular service need not involve government delivery of the service. In many cases, governments can meet their objectives by using the private sector to undertake all or part of the actual delivery of the service. For example, even though the government has a commitment to provide prisons, this commitment can be met by using private sector firms to run these prisons. By placing the provision out to competitive tender, governments can introduce competition into areas of the economy that may previously have been insulated from this process. Moreover, this tender process need not only involve private sector firms. Research suggests that it is the introduction of competition, regardless of whether the winner is in the private or the public sector, which delivers the main benefit in improving the efficiency of service provision. 23 BENEFITS OF THIS SYSTEM The benefits of competitive tendering can be divided into two main types: ● the reduction of costs through incentives to increase efficiency; and ● the introduction of ex ante competition for the market. The reduction of costs through incentives to increase efficiency Section 7 – Market-Based Mechanisms It was noted in section 6 that government delivery of services can suffer from a lack of efficiency as the incentives of individuals carrying out the delivery of the service may differ from the government’s overall objective. For example, if there is prestige attached to having a large department size, then this can directly conflict with the objective to provide a service on the most efficient basis. Even 23 Domberger et al. (1995) ‘The determinants of price and quality in competitively tendered contracts’, Economic Journal; and Domberger, Meadowcroft and Thompson (1986) ‘Competitive tendering and efficiency: the case of refuse collection’, Fiscal Studies 8. 43
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Page 5 and 6: Contents Acknowledgements vi Forewo
Page 7 and 8: Contents Section 11 Emissions Tradi
Page 9: Foreword There is increasing intere
Page 12 and 13: SECTION 1 Introduction and summary
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Page 22 and 23: SECTION 2 Using market mechanisms U
Page 30 and 31: SECTION 3 Lessons for the design an
Page 40 and 41: SECTION 4 Introduction This part of
Page 78 and 79: SECTION 8 Framework for assessing m
Page 81 and 82: Part IV Case Studies 73
Page 83 and 84: ● the Green and White papers behi
Page 85 and 86: A prison failing to deliver on its
Page 87 and 88: Table 9.3 Companies providing priso
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Page 91 and 92: detect any deviation from a collusi
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Page 95 and 96: (e.g. lighting). This impact could
Page 97 and 98: MARKET POWER The full benefits of c
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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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Section 9 - Competitive Tendering o
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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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Section 9 - Competitive Tendering o
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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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