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

As Stonecash and Jensen (2004) observe, if the private sector were inherently
more efficient than the public sector, outsourcing to private firms should result
in larger savings than services outsourced to an in-house team. However, the
balance of evidence shows that observed outsourcing savings are achieved
whether the service provider winning the contract is public or private. 29 These
savings come both from better management of resources and higher
productivity of inputs, and in some cases also from lower wages for staff. 30
Moreover, other studies have shown that simply changing from public to private
ownership may yield little efficiency benefits if competition is not introduced at
the same time. 31 Together this all suggests that it is the introduction of
competition that leads to greater efficiency.
The introduction of ex ante competition for the market
Some services can be characterised as natural monopolies as the characteristics
of demand and supply mean that they may be most efficiently supplied by one
supplier. For example, on rural bus routes there may be insufficient demand to
support more than one provider, or indeed in some circumstances the route may
only be profitable at all with a subsidy. In such cases, where it is not possible to
have competition ‘in’ the market, the use of tendering may make it possible to
have competition ‘for’ the market where rival firms bid for the right to run the
monopoly service. 32 Although this ex-ante competition is not a total substitute
for competition ‘in’ the market, in circumstances where competition in the
market is not possible it can yield many of its benefits. For example, it may not
be economic to have two competing bus operators on a local bus route.
However, by allowing competing companies to compete for the right to provide
the monopoly service, some of the monopoly profits can be recouped ex-ante.
In addition, this could be combined with limits on fares to prevent the
exploitation of monopoly power.
APPLICATIONS
Section 7 – Market-Based Mechanisms
Competitive tendering can be used in situations where a government obligation
to provide a particular service can be separated from the actual delivery of the
service. This has been used in a number of applications ranging from cleaning
29 Domberger et al. (1995) ‘The determinants of price and quality in competitively tendered contracts’, Economic
Journal. This study looks at contracts for cleaning services awarded through competitive tender, comparing those
tendered with those not tendered, and those contracted out with those won by the in-house team. Domberger et
al find it is the tendering of the contract for competition that leads to observed reductions in price, and conclude
that contracting out rather than awarding contracts to an in-house team has a negligible impact on both price and
quality; Domberger, Meadowcroft and Thompson (1986) ‘Competitive tendering and efficiency: the case of refuse
collection’ Fiscal Studies 8. This paper reports similar conclusions with respect to refuse collection, as savings
from introducing competition through the tender process are of a similar order whether the contract is awarded
to a private contractor or the in-house team.
30 Cubbin, J. Domberger, S. and Meadowcroft, S. (1986) ‘Competitive tendering and refuse collection: identifying the
sources of efficiency gains’, Fiscal Studies 8.
31 Pollitt performs a social cost benefit analysis of the Scottish electricity generating companies and finds negligible
benefits. He suggests that this is due to the lack of restructuring as remaining vertically integrated may have
impeded entry by competitors into the home market. Pollitt, M. (1999) ‘The restructuring and privatisation of the
electricity supply industry in Scotland’, Mimeo.
32 Demsetz, H. (1968) ‘Why regulate utilities?’, Journal of Law and Economics.
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