THE PROPER SCOPE OF GOVERNMENT: A S R W V · 2013-02-05 · THE PROPER SCOPE OF GOVERNMENT: THEORY...

THE PROPER SCOPE OF GOVERNMENTTHEORY AND AN APPLICATION TO PRISONS

OLIVER HART

ANDREI SHLEIFER

ROBERT W VISHNY

When should a government provide a service in-house and when should itcontract out provision We develop a model in which the provider can invest inimproving the quality of service or reducing cost If contracts are incomplete theprivate provider has a stronger incentive to engage in both quality improvementand cost reduction than a government employee has However the private con-tractorrsquos incentive to engage in cost reduction is typically too strong because heignores the adverse effect on noncontractible quality The model is applied to un-derstanding the costs and benets of prison privatization

I INTRODUCTION

As a general rule government employees provide most ser-vices paid for with tax revenues such as the police the militaryoperation of prisons re departments and schools collection ofgarbage and so on Yet in some cases these services are pri-vatized through government contracting out their provision toprivate suppliers The choice between in-house provision and con-tracting out has proved to be controversial Advocates of govern-ment contracting point out that private suppliers deliver publicservices at a lower cost than public employees do Savas 19821987 Logan 1990 The critics of government contracting whilequibbling with these gures stress that the quality of public ser-vices that private contractors deliver is inferior to that deliveredby public employees AFSCME 1985 Shichor 1995 In this paperwe develop a theory of government ownership and contracting

q 1997 by the President and Fellows of Harvard College and the Massachusetts Instituteof TechnologyThe Quarterly Journal of Economics November 1997

We are grateful to Matthew Ellman for research assistance and to OrleyAshenfelter Gary Becker Pranab Bhardan John DiIulio John Donahue HenryFarber Randall Filer Edward Glaeser Joseph Harrington Martin Hellwig Ste-ven Kaplan Lawrence Katz John Kwoka W Bentley MacLeod John MatsusakaSam Peltzman Rohan Pitchford Raghuram Rajan Sherwin Rosen Jean TiroleLuis Ubeda Michael Whinston Chenggang Xu Luigi Zingales and two refereesfor comments We have also beneted from the reactions of seminar audiences atthe University of Southern California California Institute of Technology HarvardUniversity McGill University London School of Economics University of Chi-cago Princeton University University of Miami Cornell University Law SchoolECARE George Washington University Johns Hopkins University University ofWashington Seattle the Industry Economic Conference at Australian NationalUniversity Canberra and the Harvard Political Economy group Finally we aregrateful to the National Science Foundation for support of this work

that may throw light on the cost and quality of service under al-ternative provision modes

The perspective we adopt is that of incomplete contractsGrossman and Hart 1986 Hart and Moore 1990 Hart 1995Suppose that a public-spirited politician chooses between havinga service delivered by a public agency and contracting it out Inthe rst case the politician hires public employees and givesthem employment contracts specifying what they need to do Inthe second case the politician signs a contract with a private sup-plier who in turn contracts with his (or her) employees If thepolitician can sign a complete or comprehensive contract (witheither employees or a contractor) he can achieve the same out-come in each case From the traditional incentive viewpoint mo-tivating the contractors and the public employees presents thesame problem to the politician even in the presence of moral haz-ard and adverse selection To understand the costs and bene-ts of contracting out we need to consider a situation wherecontracts are incomplete and where residual rights of control inuncontracted for circumstances are important in determiningagentsrsquo incentives

The assumption of contractual incompleteness is not hard tomotivate once it is recognized that the quality of service the gov-ernment wants often cannot be fully specied Indeed critics ofprivatization often argue that private contractors would cut qual-ity in the process of cutting costs because contracts do not ade-quately guard against this possibility Critics of private schoolsfear that such schools even if paid for by the government (egthrough vouchers) would nd ways to reject expensive-to-educate children who have learning or behavioral problemswithout violating the letter of their contracts Critics also worrythat private schools would replace expensive teachers withcheaper teachersrsquo aides thereby jeopardizing the quality of edu-cation In the discussion of public versus private health care thepervasive concern is that private hospitals would nd ways tosave money by shirking on the quality of care or rejecting theextremely sick and expensive-to-treat patients In the case ofprisons concern that private providers hire unqualied guardsto save costs thereby undermining safety and security of prison-ers is a key objection to privatization Our model tries to explainboth why private contracting is generally cheaper and why insome cases it may deliver a higher while in others a lower qual-ity level than in-house provision by the government

Many discussions of privatization lump together the issue of

QUARTERLY JOURNAL OF ECONOMICS1128

public or private ownership with the issue of competition Thatis those who advocate privatization often do so on the groundsthat private ownership allows the benets of competition to bereaped We believe that the identication of privatization withcompetition is misleading In principle it is possible to have sev-eral government-owned rms competing to supply the public orseveral management teams competing for the right to run a gov-ernment enterprise (eg a prison) It is also possible to have aprivate rm with no effective competitors (a monopoly) Our analy-sis is based on the idea that the fundamental difference betweenprivate and public ownership concerns the allocation of residualcontrol rights rather than the degree of competition per seCompetition may strengthen the case for privatizationmdashin factwe show that it does under some conditionsmdashbut only becausethe allocation of residual control rights is different underprivatization

In the next section we present a model of government con-tracting that focuses on quality issues The basic idea is that theprovider of the servicemdashwhether a government employee or a pri-vate contractormdashcan invest his time to improve the quality of theservice or to reduce its cost The cost reduction has an adverseeffect on quality Neither innovation is contractible ex ante How-ever both types of innovation to be implemented require the ap-proval of the owner of the asset such as a prison a hospital or aschool If the provider is a government employee he (or she)needs the governmentrsquos approval to implement either improve-ment since the government retains residual control rights overthe asset As a result the employee receives only a fraction of thereturns to either the quality improvement or the cost reductionMoreover an additional limit to how well a government employeecan be effectively compensated for either improvement arises be-cause the employee is replaceable

In contrast if the provider is a private contractor he has theresidual control rights over the asset and hence does not need toget government approval for a cost reduction At the same timeif a private contractor wants to improve quality and get a higherprice he needs to negotiate with the government since the gov-ernment is the buyer of the service As a consequence the privatecontractor generally has a stronger incentive both to improvequality and to reduce costs than the government employee hasBut the private contractorrsquos incentive to engage in cost reductionis typically too strong since he ignores the adverse impact onquality

THE PROPER SCOPE OF GOVERNMENT 1129

We analyze this model in Section III and establish severalpropositions concerning the relative efciency of in-house pro-vision and government contracting In general the bigger theadverse consequences of (noncontractible) cost cutting on (non-contractible) quality the stronger is the case for in-house pro-visionThe efciency of in-house provision also turns on thestrength of the incentives of government employees and on theimportance to the government of generating quality innovationsThe conclusions emerging from the model are generally ex-tremely intuitive including the result that private provision isgenerally cheaper but may generate either higher or lower qual-ity Section III also briey addresses a key omission from themodel namely the possibility of ex post competition between con-tractors which typically strengthens the case for privatizationFinally Section III examines the consequences of moving awayfrom the assumption of benevolent government and incorporat-ing such elements as corruption and patronage into the model Afuller treatment of competition and politics is left to future work

In Section IV we apply our framework to discuss privatiza-tion of prisons Should the government contract out the opera-tions of prisons to private rms who then have power overincarceration and treatment of convicts Private prisons havebeen growing rapidly in the United States although they stillhold only about 3 percent of prisoners Critics voice a strong con-cern about the quality of private incarceration including thequality of prisoner life the incidence of prison violence by in-mates and use of force by guards escapes and to a lesser extentrehabilitation We show that our model can be used to organizeif not resolve the debate over prison privatization

Our results may help in thinking about other governmentservices as well The parameters of the model namely the ad-verse quality effects of cost reduction the importance of qualityinnovation the incentives of government employees as well aspossibilities of competition which we do not model may shedlight on the wisdom of privatization of such activities as defenseprocurement garbage collection police and armed forces educa-tion and health In Section VI we discuss these examples andconsider some of the new issues they raise

Ours is not the rst normative analysis of government con-tracting1 Some of the issues addressed in our paper are raised in


1 There is also a considerable literature on positive aspects of contractingsee eg Shleifer and Vishny 1994 and Savas 1982 1987

the now-classic book by Wilson 1989 Economists working inthis area have generally focused on traditional adverse selectionand moral hazard problems raised by contracting Laffont andTirole 1993 Tirole 1994 as well as on competitive and anti-monopoly problems following privatization Vickers and Yarrow1988 Some recent studies have examined contractual incom-pleteness Schmidt 1996 Shapiro and Willig 1990 Laffont andTirole 1993 Unlike our work they have emphasized informa-tional losses from contracting or the costs of having multiplebosses Theoretically our paper is new primarily in deemphasiz-ing the role of incomplete information in contracting and empha-sizing quality issues In this regard our paper is related to thework of Holmstrom and Milgrom 1991 1994 who in a compre-hensive contracting framework show that providing an agentwith strong incentives to pursue one objective such as protscan lead to his shirking on other objectives such as quality Ourframework is different from theirs although the issues we areinterested in are similar In addition the existing literature isprimarily theoretical and does not go into the problems of specicsectors such as prisons in much detail2

II THE MODEL

A Basic Assumptions

In this section we present a simple model of the choice be-tween the public and private provision of a good such as prisonhospital or school services

Suppose that society represented by the government wantsa certain good or service to be provided We assume that consum-ers cannot buy this good directly in the marketplace eg becauseit is a public good3 One possibility is to contract out the provisionof this good eg the government can write a contract with a pri-vate company to run a prison for ve years4 A second possibilityis to provide the good ldquoin-houserdquo eg the government can ar-


2 There are some exceptions For example Vickers and Yarrow 1988 dis-cuss the possible decline in quality at British Telecom following privatization andprice cap regulation Domberger Hall and Li 1995 examine the consequencesfor price and quality of contracting out cleaning services

3 This assumption makes good sense in the case of prisons but is more con-troversial in the case of schools or hospitals

4 An alternative interpretation is that the government regulates the privatecompany for ve years In this case the contract simply describes the regulatorypolicy We do not deal explicitly with regulation in this paper but note that anyregulatory policy can be interpreted as an (incomplete) contract and vice versa

range for public employees to run the prison The model is basedon the idea that the crucial distinction between these arrange-ments concerns who has residual rights of control over the non-human assets used to provide the servicemdashwe call these assetsthe ldquofacility Frdquo (eg the prison) If the good is publicly providedthen the government (represented by a bureaucrat) as ownerhas residual control rights over the facility If the good is pri-vately provided then the private provider as owner has residualcontrol rights over the facility Residual control rights matter be-cause they determine who has the authority to approve changesin procedure or innovations in uncontracted-for contingencies5

We suppose that the facilitymdashpublic or privatemdashis run by asingle managerworker M There is also a single bureaucrat orpolitician represented by G We start by considering the casewhere the bureaucrat perfectly represents the interests of soci-ety ie there is no agency problem between the bureaucrat andsociety6 Later we consider self-interested bureaucrats andpoliticians

We assume that G and M are able to write a long-term con-tract specifying some aspects of the good or service to be providedand the price In fact we suppose that a long-term contract isrequired in the case where F is private in order to support rela-tionship-specic investments7 We call the good thus described inthe contract the ldquobasicrdquo good and denote its price by P0 P0 hasdifferent interpretations according to whether the facility F isprivate or public If F is private ie M owns F then P0 is theprice that M as an independent contractor receives for providingthe basic good If F is public ie G owns F then P0 is the wagethat M receives as an employee In the latter case provision ofthe basic good can be regarded as part of Mrsquos job description ie


5 See Grossman and Hart 1986 What may be more important is not whoowns the physical prison but who has the right to use it (perhaps for a restrictedperiod of time) For example the government may own the prison but sell theright to operate it to a private company for n years (a franchising arrangement)In this case the private company has residual control rights during the n yearperiod In this paper we do not distinguish between physical ownership and pos-session of the right to use the prison

6 To be more precise we assume that Grsquos utility function is given by thewelfare of the rest of society excluding M A justication for this is that the politi-cal process aligns Grsquos and societyrsquos interests (since M has negligible voting powerhis interests receive negligible weight) As will become clear if G placed the sameweight on M rsquos utility as on the rest of society the rst-best could be achieved

7 We do not model these relationship-specic investments explicitly Theymight correspond to physical investments eg building the prison For the ideathat a long-term contract is required to support relationship-specic investmentssee Klein Crawford and Alchian 1978 and Williamson 1985

M does not get paid unless he provides the goodAlthough G and M can specify some aspects of the good or

service in advance we suppose that there are others that theycannot specify We have in mind that various contingencies canarise which call for some modication of the basic good For in-stance M can suggest a way to modify the prison to increase secu-rity Alternatively M may nd a way to reduce costs by hiringcheaper (or fewer) guards Our assumption is that there are somany possible contingencies ex ante that it is impossible to antici-pate them all and contract on how to deal with them in advance8

Instead the parties revise the contract ex post once it is clearwhat the relevant contingencies are We refer to the basic goodmodied to allow for relevant contingencies as the ldquomodiedgoodrdquo

The modied good yields a benet B to society and costs themanager C to produce C is a cost borne directly by M For ex-ample B might be the social benet from having a prison withfew ghts between inmates and well-fed and healthy prisonersAlthough B cannot be measured or veried (it does not show up inany accounts) we suppose that it can be represented by a dollaramount Similarly C can be represented in dollars

The manager can manipulate B and C through prior effortchoices We assume that M can devote effort to two types of ldquoinno-vationrdquo relative to the basic good a cost innovation and a qualityinnovation We suppose that a cost innovation leads to a reduc-tion in costs C but is typically accompanied by a reduction inquality (ie B) Similarly a quality innovation leads to an in-crease in quality but is typically accompanied by an increase incosts We write

B B b e i + (= -0 ( ) )b

C C c e = -0 ( )

where e i denote effort devoted to the cost innovation and qualityinnovation respectively c(e) $ 0 is the reduction in cost corre-sponding to the cost innovation b(e) $ 0 is the reduction in qual-ity corresponding to the cost innovation and b (i) $ 0 is thequality increase net of costs from the quality innovation9 Thefunction b plays a key role in this model it measures how much


8 For a further discussion see Hart 19959 We need to keep track of the separate cost and quality components of the

cost innovation (c and b) but not of the quality innovation

(noncontractible) quality falls because of a (noncontractible) costcut and hence serves as the variable that critics of privatizationfocus on

We make standard assumptions about the convexity concav-ity and monotonicity of b c and b b(0) 5 0 b 9 $ 0 b 0 $ 0 c(0) 50 c 9 (0) 5 yen c 9 0 c0 0 c 9 (yen) 5 0 b (0) 5 0 b 9 (0) 5 yen b 9 0b 0 0 b 9 (yen) 5 0 c 9 2 b 9 $ 0 Note that the assumptions c9 2 b 9$ 0 b 9 0 say that the quality reduction from a cost innovationdoes not offset the cost reduction and the cost increase from aquality innovation does not offset the quality increase The for-mer in particular is an important substantive assumption sinceone can imagine in principle that cost cutting by a contractor(eg failing to train prison guards) produces social damage inexcess of cost savings Our assumptions rule out this case al-though it can be easily analyzed

The managerrsquos ex ante effort cost must be added to C to getMrsquos overall costs We write total effort costs as e 1 i and assumea zero interest rate (no discounting) Hence Mrsquos overall costs are10

C e i C c e e i + + + + = -0 ( )

One important assumption we make is that both the cost andquality innovations can be introduced without triggering abreach of the contract for the basic good That is although eachinnovation leads to a change in quality (in the case of the costinnovation a reduction in quality) the initial contract is suf-ciently vague or ldquoincompleterdquo that neither innovation violates it

We also assume that i e b and c are observable to bothG and M but are not veriable (to outsiders) and hence can-not be part of an enforceable contract Similarly Grsquos benetsand Mrsquos costs are observable but not veriable or transferablewhich means that revenue and cost-sharing arrangements areinfeasible11

We suppose that G and M are at least partially locked intoeach other once their relationship is under way Specically thereis no facility available other than F that can supply society andthere is no other potential customer for the service (eg a prison)


10 In an earlier version of this paper we assumed a more complicated cost-of-effort function in which e and i were substitutes (along the lines of the multi-tasking work of Holmstrom and Milgrom 1991) The current model generatessimpler and easier-to-interpret results

11 For a more extensive discussion of veriability noncontractibility andrevenue and cost-sharing arrangements see Hart 1995

apart from G However M rsquos labor services may be partially sub-stitutable (see below) Finally we assume that M and G are riskneutral and that there are no wealth constraints A time-line ispresented in Figure I

B Default Payoffs

As noted the parties want to renegotiate the contract at date1 once they learn the nature of potential quality improvementsand cost reductions We assume that G and M divide the gainsfrom renegotiation according to Nash bargaining ie they splitthe surplus 5050 This means that the partiesrsquo default payoffsmdashthat is what occurs in the absence of renegotiationmdashinuencenal payoffs

We take the point of view that any cost or quality innovationrequires the agreement of the owner of the facility F since imple-menting these innovations involves a change in the way F is usedOnly the owner (the possessor of the residual control rights) hasthe right to approve such a change Thus in the case of a publicfacility G needs to agree to any cost or quality innovationwhereas if the facility is private M can implement these innova-tions without Grsquos agreement However even if the facility is pri-vate it is not in Mrsquos interest to introduce a quality innovationwithout the approval of G since no payment will be forthcomingfor an uncontracted-for quality improvement unless G agrees tomake it ie unless a new contract is written

It remains to discuss the extent to which the fruits of Mrsquosefforts e and i are embodied in Mrsquos human capital Suppose thatif M has an idea about how to reduce costs or increase qualitythen a fraction of the benets of this idea requires Mrsquos participa-tion but the remainder can be realized without M because someaspects of Mrsquos ideas become public knowledge (at least within theorganization) In particular assume that in the case where F ispublic G can realize a fraction 0 (1 2 l ) 1 of the net social


FIGURE I

gains 2 b(e) 1 c(e) 1 b (i) from innovation without M by hiring adifferent manager and paying him at cost If F is private G canobtain none of these benets since M has the residual controlrights and can prevent any innovations (and can also avoid beingreplaced) The parameter l is very important since it effectivelymeasures the weakness of the incentives of government employ-ees In the case l 5 1 the public employee (warden) is irreplace-able and hence can command the same share of the total rentsin the negotiation with G as a private manager (but in contrastto a private manager a public warden will have to get Grsquos permis-sion to implement a cost reduction)

We can sum up the above discussion as follows(A) If F is privately owned then in the absence of renegotia-

tion the cost innovation is implemented (since it is inMrsquos interest to implement it and M has the residual con-trol rights) but the quality innovation is not (since nopayment from G will be forthcoming) That is G rsquos defaultpayoff is B0 2 P0 2 b(e) and Mrsquos default payoff is P0 2 C0

1 c(e) 2 e 2 i(B) If F is publicly owned then in the absence of renegotia-

tion both cost and quality innovations are implementedHowever G must replace M and hence gets only a share(1 2 l ) of the gains from these innovations That is Grsquosdefault payoff is B0 2 P0 1 ( 1 2 l ) 2 b(e) 1 c(e) 1 b (i)and Mrsquos default payoff is P0 2 C0 2 e 2 i

C The First-Best

Consider as a benchmark the rst-best situation where e andi are contractible (or equivalently where long-term contracts de-scribing the modied good can be written) In this case G and Mwould choose e and i to maximize the total net surplus from theirtrading relationship and divide the surplus between them usinglump-sum transfers That is in the rst-best G and M solve

(1) max + + e i

b e c e i e i

[ ( ) ( ) ( ) ]- - -b

Given our assumptions (1) has a unique solution (ei) charac-terized by rst-order conditions

(2) + 1- cent cent =b e c e( ) ( )

(3) 1cent =b ( )i


At the social optimum the marginal social benet of spendingextra effort to reduce costs measured to take account of marginalquality deterioration must equal the marginal cost of that extraeffort which equals one Similarly the marginal social benet ofspending extra effort to improve quality must equal the marginalcost of that extra effort which again equals one

D Equilibrium under Private Ownership

Suppose that M owns F Then in light of (A) the renegotia-tion takes place over the quality innovation The gains from rene-gotiation are b (i) which are split 5050 (There is symmetricinformation about i) The partiesrsquo payoffs are

(4) + U B P i b eG = - -0 0 1 2 ( ) ( )b

(5) + 12 + U P C i c e e iM = - - -0 0 b( ) ( )

Note that because M can reduce costs without seeking Grsquos ap-proval G bears the full brunt of quality deterioration resultingfrom cost reduction

Since the parties are assumed to have rational expectationsM chooses e and i to maximize UM that is to solve

(6) max 12 + e i

i c e e i

( ) ( ) b - - Denote the (unique) solution by (eMiM) (where M stands for own-ership by M) The rst-order conditions for (6) are

(7) 1cent =c eM( )

(8) 12 1cent =b ( )iM

There are two deviations from rst-best here First M ignores thedeterioration of quality resulting from cost reduction and henceexaggerates the social benet of cost reduction Second becauseM must get Grsquos approval to implement a quality improvement onthe margin he gets only half the benets of that improvementwhich stunts his incentive to improve quality

The total surplus SM under M rsquos ownership is then given by

(9) + + + ( S U U B C b e c e i e iM G M M M M M M= = - - - -0 0 ( ) ( ) ) b

The price P0 is chosen to allocate this surplus between the partiesaccording to their relative bargaining positions at date 0 The for-mula for SM reects the fact that the parties bargain efciently


ex post but there is a distortion in relationship-specic invest-ments e and i

E Equilibrium under Public Ownership

Suppose that G owns F Then in light of (B) the renegotiationtakes place over the fraction l of both the cost and quality innova-tions that G cannot appropriate l 2 b(e) 1 c(e) 1 b (i) The gainsare split 5050 and so the partiesrsquo payoffs are

(10) + (1 2) + + (U B P b e c e iG = - - -0 0 l b( ) ( ) )

(11) + 2 + + U P C b e c e i e iM = - - - -0 0 l b( ) ( ) ( )

Note that in the case l 5 1 when the manager is completelyirreplaceable the parties split the gains from innovation 5050M chooses e and i to solve

(12) max 2 + + e i

b e c e i e i

[ ( ) ( ) ( ) ]l b- - -

Denote the (unique) solution by (eGiG) (where G stands for owner-ship by G) The rst order conditions for (12) are

(13) + 1l 2 ( ( ) ( ))- cent cent =b e c eG G

(14) 2 1l bcent =( )i

In contrast to the private ownership case because the publiclyemployed M needs to negotiate the cost reduction with G hetakes account of quality reductions that may result from cost-cutting innovations However there are new distortions in thecase of public ownership First for both quality and cost innova-tion the public manager needs the approval of G and hence sur-renders half the gains from trade Second if l 1 the publicmanager can be replaced and hence has even weaker incentivesto innovate Both of these factors stunt a public managerrsquos in-centives

The total surplus SG under G ownership is given by

(15) + + +S U U B C b e c e i e iG G M G G G G G= = - - - -0 0 ( ) ( ) ( ) b

Again the price P0 is chosen to allocate the surplus at time 0 ac-cording to relative bargaining power

F The Choice of Ownership Structure

The optimal ownership structure is the one that produces thelargest total surplus (the division of surplus can always be ad-


justed through P0) That is G ownership is superior to Mownership

(16) + + ( +

+ (

Ucirc gtUcirc - - - gt -

- -

S Sb e c e i e i b e c e

i e i

G M

G G G G G M M

M M M

( ) ( ) ) ( ) ( ) )

bb

Renegotiation under symmetric information ensures that allownership structures yield an ex post efcient outcome The onlydifference between the ownership structures concerns the choiceof the ex ante investments e and i

III ANALYSIS OF THE OPTIMAL OWNERSHIP STRUCTURE

A Main Results

A comparison of (1) and (6) shows that private ownershipleads to two distortions relative to the rst-best First M ignoresthe fact that e reduces noncontractible quality b(e) in otherwords that he damages G through his effort to reduce costs Sec-ond M places 50 percent weight on the gains from quality innova-tion b (i) as opposed to 100 percent weight It follows immediatelyfrom the rst-order conditions (2) (3) (7) (8) and concavity thate is inefciently high and i is inefciently low under privateownership

PROPOSITION 1 eM e iM i

The private ownership equilibrium is illustrated in Figure IIConsider next public ownership A comparison of (1) and (12)

shows that under public ownership M does worry about the dam-age b(e) The reason is that M cannot implement the cost reduc-tion without Grsquos permission and so they bargain about the netsurplus 2 b(e) 1 c(e) from the cost-reducing innovation HoweverM places weight l 2 on the gains from cost innovation 2 b(e) 1c(e) and on the gains from quality innovation b (i) as opposed to100 percent weight in the rst best It follows from the rst-orderconditions (13)ndash(14) that e and i are both inefciently low underpublic ownership Moreover i is lower under public than underprivate ownership unless l 5 1 ie unless M is irreplaceable

PROPOSITION 2 eG e iG iM i (with iG iM unless l 5 1)

The public ownership equilibrium is also illustrated in Figure IIThe trade-off between public and private ownership is now


FIGURE II


fairly clear Private ownership leads to an excessively strong in-centive to engage in cost reduction (eM e) and to moderatemdashalthough still too weakmdashincentives to engage in quality improve-ment (iM i) Public ownership removes the excessive tendencyto engage in cost reduction but replaces this with a weak incen-tive to engage in both cost reduction and quality improvementWhich arrangement is superior therefore depends on which dis-tortion is less damaging

The next two propositions provide conditions under whichprivate ownership and public ownership can be ranked

PROPOSITION 3

(1) Suppose that the function b(e) is replaced by u b(e) whereu 0 Then for u sufciently small private ownership is su-perior to public ownership(2) Suppose that the function b(e) is replaced by u b(e) and thefunction c(e) is replaced by f c(e) where u f 0 Then for u f sufciently small and l 1 private ownership is superiorto public ownership

Part (1) of Proposition 3 follows from the fact that as u reg 0the damage to quality from cost reduction disappears Underthese conditions private ownership leads to the efcient choiceof e (since c 9 (e) oslash 2 b 9 (e) 1 c 9 (e)) Since the level of i is alwayscloser to the rst-best under private ownership than under publicownership private ownership dominates public ownership Part(2) follows from the fact that as u f reg 0 e eM and eG all con-verge to zero Thus only the choice of i matters private owner-ship is better than public ownership because it yields a level of icloser to i

Proposition 3 has a very natural interpretation There arebasically two cases when private ownership is unambiguously su-perior The rst case is when the deterioration of quality fromcost reduction is small In this case the stronger incentives thata private contractor has to reduce costs and improve quality areboth desirable The second case is when the opportunities for costreduction (and hence the damage to quality as well) are smalland the government employees have relatively weak incentives( l is small) In this case the private contractor would notdo much of the potentially damaging cost reduction and hisstronger incentive to make quality innovations gives him the


edge over in-house provision Both of these are extremely intui-tive cases

The cases where in-house provision is superior are given bythe following result

PROPOSITION 4

(1) Suppose that b(e) c(e) 2 s d(e) where s 0 Then for ssufciently small and l sufciently close to 1 public owner-ship is superior to private ownership(2) Suppose that b(e) c(e) 2 s d(e) where s 0 Supposealso that the function b (i) is replaced by t b (i) where t 0Then for s t sufciently small public ownership is superiorto private ownership

Part (1) follows from the fact that as s reg 0 the social gainsfrom cost reduction 2 b(e) 1 c(e) converge to zero the qualitydamage fully offsets the cost savings Thus the weak incentivesfor cost reduction under public ownership are socially efcientIn contrast the incentives for cost reduction under private own-ership are inefcient since the private owner ignores the sub-stantial damage b(e) If l is close to 1 the incentives for qualityinnovation under public ownership are similar to those under pri-vate ownership and so public ownership dominates privateownership

Part (2) replaces the condition l close to 1 with the conditionthat t is small In this case i iM and iG are all approximatelyzero and so only the choice of e matters For s small public own-ership is superior to private ownership because it delivers a so-cially more efcient level of e

Proposition 4 as well has a very natural interpretation Pub-lic ownership is most likely to be better when the adverse effectof cost reduction on quality is large But that is not enough Forpublic ownership to be denitely superior it must also be the casethat either quality improvement is unimportant or that govern-ment employees do not have weaker incentives in quality im-provement ( l is large) If one of the latter conditions holds thenprivate contractors are not signicantly superior at improvingquality and hence public ownership is preferred12


12 We have analyzed private ownership under the assumption that the pri-vate owner actually manages the rm This is not a bad assumption for the casewe are most interested inmdashprisons In situations where ownership is separatedfrom control some of the trade-offs that we have identied are still likely to berelevant In particular the owners and managers of a private rm will still havean excessive tendency to reduce costs since they can collectively divide the gains

Finally we consider the costquality comparison between pri-vate and public ownership

PROPOSITION 5 Costs (C0 2 c(e)) are always lower under privateownership Quality (B0 2 b(e) 1 b (i)) may be higher or lowerunder private ownership

We know that e is higher under private ownership than un-der public ownership (eM e eG) and hence costs are alwayslower under private ownership Quality may be higher or lowersince although e is higher so is i One case where quality ishigher under private ownership is when b 9 (e) is small (more pre-cisely we replace b(e) by u b(e) and let u reg 0) then quality is deter-mined by differences in i and not differences in e On the otherhand if b 9 (i) is small quality is higher under public ownershipin this case quality is determined by differences in e rather thandifferences in i

Proposition 5 explains what we believe to be the basic styl-ized facts namely that private contracting typically yieldsgreater cost efciency but there is ambiguity about quality Wecould not get ambiguity if we had a simpler model in which therewas no investment in quality improvement In that model therewould be a straight trade-off between quality and cost withpublic provision delivering more quality at a higher cost Thatmodel (ie one without b ) would resemble the comprehensivecontracting treatment of Laffont and Tirole 1993 Chapter 4who argue that higher powered incentives (which might be asso-ciated with private ownership) lead to both lower costs and qual-ity Our model in contrast explains why in somemdasharguablymostmdashcases private provision leads to both lower costs andhigher quality

B Competition

Perhaps the single most important issue that our model doesnot deal with is ex post competition between the suppliers of thegood To take the simplest case suppose that consumers buy the


from cost reduction among themselves ignoring the adverse quality impact onsociety The implications for quality innovation are more complicated To the ex-tent that the manager of a private rm is less replaceable than the manager of apublic rm (because the private companyrsquos shareholders are dispersed say) theprivate company managerrsquos incentives to innovate will be greater than the publicmanagerrsquos However to the extent that the manager of a private rm must sharethe fruits of his innovation with both the owner(s) and the government as opposedto just the government the private managerrsquos incentives to innovate will besmaller (on the latter effect see Laffont and Tirole 1993 and Hart and Moore1990)

good or service directly from a contractor without any govern-ment intervention even in nancing Suppose also that consum-ers can assess the quality on their own (a good assumption withmost goods a plausible assumption for education and probablythe wrong assumption for health) Suppose nally that the sup-pliers are perfectly competitive at every quality level In thiscase a private contractor would face exactly socially optimal in-centives since on the margin he gets a lower price for any qual-ity shortfall resulting from a cost reduction and a higher price forany quality improvement through innovation (that is he receives2 b(e) 1 c(e) 1 b (i)) Private supply in this case delivers the rst-best On the other hand a public manager needs to negotiate anyinnovation with the government and might be replaceable so hisincentives to innovate are stunted In this extreme casemdashwherethere is no need for the government at allmdashthe private sectordelivers the rst-best and public provision is inefcient

Of course in most interesting cases the situation is morecomplicated and some government role is needed at least in -nancing For example in education most arrangements wouldallow for the government to pay for the service of at least someconsumers (eg through vouchers) The idea is that the govern-ment needs to participate in the nancing of these services toreduce the inequality of consumption across consumers As longas consumers can assess quality and have a choice among com-petitive suppliers however private suppliers would still pay fordeterioration in quality resulting from cost reduction because theconsumers can go elsewhere Even in the case of government -nancing competition strengthens the case for contracting out

The objections to private competitive supply typically focuson more subtle distributional issues related to inefcient sortingof consumers We discuss these objections in Section V in the con-text of health care and education13

C Alternative Views of Government Corruption and Patronage

In this subsection we relax the assumption that the bureau-cratpolitician acts on behalf of society and allow for him to beself-interested This self-interest can express itself in a number


13 Another kind of competition may also be important Suppose that con-sumers cannot buy from contractors directly ie the government must buy ontheir behalf but there are many (similar) contractors Then if one contractor doesa bad job the government can always switch to another Such switching is pos-sible whether contractors are private or public Thus it is not immediately clearthat competition of this sort makes private provision more attractive

of ways First the politician may be corrupt in the sense of beingwilling to use his control rights to extract money (or campaigncontributions) for himself from the contractor Second the politi-cian may use his control rights to pursue political objectives otherthan the public interest such as catering to interest groups thatmight support him in the election These alternative character-izations of political behavior matter for the choice of the optimaldelivery mode

To illustrate these issues we describe two simplemdashbut possi-bly importantmdashcases In one of them corruption leads to an ex-cessive tendency to privatize In the other patronage leads toexcessive in-house provision

Suppose that the privatization decision is made by a higherlevel politician at some date 2 12 before date 0 (see Figure I) Sup-pose also that the politician is not involved in F rsquos operations afterthe privatization decision that is contracting decisions pass to abureaucrat who is assumed to be honest In contrast the politi-cian takes monetary bribes

Under these conditions the politician has a simple choice Hecan privatize F (a prison)mdashin which case he arranges to sell it toa private company owned by M (the future owner-manager of F )Suppose that the politician can set the price articially low andextract a bribe from M ie the politician can avoid selling Fthrough competitive bidding Alternatively the politician cankeep F public and appoint M as the future manager (the warden)In this situation we suppose that the politician can extract abribe from M in return for Mrsquos future benets as manager

Under reasonable assumptions the politician can extract ahigher bribe if he privatizes F than if he does not If the politicianprivatizes F then at date 0 M is in a bilateral bargaining positionwith the bureaucrat G concerning the terms of the contract Thetotal surplus to be divided is given from (9) by SM Under theassumption of Nash bargaining M receives 12SM through theprice P0 Now move back to date 2 12 At this date as long asthere are many potential (identical) rms and managers who canrun the prison the politician can offer to sell F to whoever paysthe highest bribe the highest bribe is of course 12SM and so thisis the politicianrsquos payoff

Now consider the case where the politician keeps F publicHow much would M pay for the privilege of being the wardenThe problem M faces is that prior to a contract with G beingwritten he has no job security ie if the prison is public thereis nothing to stop the bureaucrat from replacing M with another


manager at date 0 (no relationship-specic investments have yetbeen made) Hence Mrsquos future payoff is zero which means thatthis is also the politicianrsquos bribe The conclusion is that the cor-rupt politician always wants to privatize F even if this is so-cially inefcient

An equally important consideration ignored by assumingthat politicians act in the public interest is that politicians oftencater to special interest groups such as labor unions to win elec-tions Stigler 1971 Becker 1983 Politicians may choose to usepublic money to provide jobs for the workers who then favor themin the elections or to pay such workers wages above marketlevels If spending public resources to transfer wealth to suchinterest groups is easier with in-house provision than with con-tracting then politicians would have a bias toward too little pri-vatization Shleifer and Vishny 1994 Patronage thus has theopposite effect to corruption it leads to an excessive bias towardin-house provision Interestingly excessive employment in publicrms may lead to excessively high quality (if having more peopleincreases quality) For example the quality of service in someEuropean state airlines such as Air France and Lufthansa maybe excessively high and a possibly lower quality at private air-lines is no evidence of lower efciency

Avoiding excessive public spending on politically powerful in-terest groups is indeed one of the principal goals of privatizationthroughout the world In the United States public sector unionsare a powerful special interest group that has delivered some ofthe most vocal opposition to government contracting includingprivatization of prisons AFSCME 1985 Some evidence suggeststhat the presence of strong public sector unions as well as softbudget constraints of the government are important obstacles toprivatization of local government services in the United StatesLopez-de-Silanes Shleifer and Vishny 1997

Positive considerations thus suggest an important trade-offbetween privatization and in-house provision To the extent thatcorruption is a serious problem the case for privatization isweaker than it is under benevolent government14 But to the ex-


14 A similar set of issues arises when the politician is lazy or unmotivatedSuch a politician like his corrupt counterpart may write bad contracts that failto protect the public award contracts to inefcient suppliers pay excessive pricesfail to supervise contractors fail to enforce important contractual provisions etcBecause privatization locks the government into these bad arrangements lazi-ness of politicians like corruption tends to point against privatization

tent that political patronage is a severe problem the case for pri-vatization is stronger A reformer considering privatization musthave a clear idea as to whether corruption or patronage is a big-ger problem in his polity

IV PRIVATIZATION OF PRISONS

A Overview

Privatization of prisons refers to the contracting out by thegovernment of the operations of prisons to private companies Inthe middle ages prisons were typically private but by the twenti-eth century governments in most countries had taken over theiroperation In the United States today while private companiesby law are restricted from meting out punishment and publicemployees are usually present even in private prisons to makedecisions on issues that can be interpreted as changes in the se-verity of prisonersrsquo punishment almost all the other activities re-lated to incarceration can in principle be privatized Privateprisons have grown rapidly in the United States in the last de-cade from a capacity of about 1200 prisoners in 1985 to almost50000 prisoners at the end of 1994 Thomas 1995 Still privateprisons house only about 3 percent of the total prison populationDespite their quantitative insignicance private prisons havestimulated an extensive debate on the cost and quality aspects ofprivate incarceration (eg AFSCME 1985 Donahue 19881989 Logan 1990 1992 Shichor 1995 and others) Althoughthere are no large sample studies of either cost or quality compari-sons of public and private prisons the available literature is in-formative enough for us to assess the relevance of the incompletecontracting approach to the study of prison privatization

Private prisons are perhaps 10 percent cheaper per prisonerthan public prisons15 The major reason for the lower costs ap-pears to be the roughly 15 percent wage premium for publicguards over private guards Donahue 1988 Part of the labor costdifference is that private contractors do not pay the public unionwage premium another part is that they hire lower quality work-


15 The comparisons are often disputed by critics of prison privatizationsince private prisons apparently get somewhat less violent prisoners Donahue1988 Shichor 1995 and since some of the costs of private incarcerationmdashsuchas the continued need for public oversightmdashare often ignored in the comparisonOn the other hand some of the costs of public prisons such as forgone tax reve-nues and often even capital costs are also often ignored in the comparisons

ers Since labor accounts for two-thirds of the incarceration coststhe differences in labor costs can roughly account for the 10 per-cent cost saving from private prisons

The most controversial and interesting issues raised by pri-vate prisons concern the quality of service Quality covers orderin the prisons (security of prisoners escapes staff conduct towardprisoners violence by guards and between prisoners disciplinaryprocedures etc) amenities that prisoners receive (quality offood health care dental care mental care clothes quality offacilities prison work entertainment access to legal help etc)and rehabilitation (vocational training other education paroleprocedures etc) Objections to prison privatization typically fo-cus on quality To quote DiIulio 1987 ldquoThe history of privatesector involvement in corrections is unrelievedly bleak a well-documented tale of inmate abuse and political corruption Inmany instances private contractors worked inmates to deathbeat or killed them for minor rule infractions or failed to pro-vide inmates with the quantity and quality of lifersquos necessities(food clothing shelter etc) specied in their often meticulously-drafted contractsrdquo This account is not extreme among those bycritics of private prisons such as Webb and Webb 1963 and Shi-chor 1995 Chapter 2 On the other hand Logan 1992 reportsthe results of a survey of three womenrsquos prisons in New Mexicothat point to superior quality of the private prison The centralquestion of prison privatization is whether the poor history is agood guide to the present and the future

Our theoretical analysis helps organize some of the thinkingabout prison privatization around the questions of what contractscan and do accomplish Accordingly we show rst that many ofthe quality problems in incarceration can actually be addressedthrough contracts Nonetheless we also show that serious andunavoidable incompleteness remains even in the ldquobest practicerdquoexisting contracts Moreover the incompleteness takes the formdescribed in the model contractors have an opportunity to reducecosts in ways that may lead to a substantial deterioration of qual-ity We also address the highly pertinent problems of corruptionand poor enforcement of contracts We conclude by applying themodel to the choice of prison privatization

B What Contracts Can Accomplish

To assess the possibilities of contracting we examine modernldquobest practicerdquo in the United States One measure of best practice


is accreditation by the American Correctional Association apseudo-public body that issues standards for good prisons (egACA 1990) and accredits prisons that meet them The ACA pro-poses 463 standards for adult correctional institutions coveringsuch matters as administration and management of prisons(including personnel policies staff training and developmentbookkeeping scal management etc) physical plant (includingbuilding and safety codes security inmate housing prison sizeetc) operations (including rules and discipline security proce-dures inmate rights special connement etc) services (includ-ing inmate classication food hygiene health care socialservices etc) and inmate programs (work education recreationmail visiting library religion etc) Of these standards 38 aremandatory and cover training and staff development buildingand safety codes security and control safety and emergency pro-cedures inmate rights classication food service sanitation andhygiene health care and work in correctional industries To getACA accreditation which is renewed every three years an insti-tution must meet all 38 mandatory standards and 90 percent ofthe nonmandatory standards In general only a small percentageof either public or private prisons get ACA accreditation How-ever even if a private prison does not get ACA accreditation aprison contract can use some or many ACA standards as con-tract provisions

ACA standards tend to be process rather than outcome ori-ented They typically insist that a facility have a written set ofrules or a policy manual dealing with specic matters as well asstaff to attend to these matters ACA standards usually do notspecify the content of these rules Presumably a manual helpstrain prison staff as well as enabling inmates to complain (orsue) if the written rules are violatedmdashsomething they could notdo without a manual to point to On some matters such as foodand health ACA actually does specify minimum quality stan-dards that would be relatively difcult to get around On foodACA species the number of meals that must be served caloricintake time between meals conditions for preparation and keep-ing of food as well as palatability It also refers to the standardsof the American Dietetic Association on food quality A 1990 con-tract between the Corrections Corporation of America (CCA) andthe Metropolitan Government of Nashville and Davidson CountyTennessee illustrates the role that ACA standards can play incontracting This contract covers the construction and three years


of operation of a prison by CCA to be compensated by a xedconstruction fee plus a per-diem rate for prisoners The contractspecies that CCA must achieve accreditation of the prison by theACA within two years of the service commencement day andmore generally relies on ACA standards particularly in the mat-ters of amenities and service The contract also species thatthree government employees must be permanently present at thepremises including the Contract Monitor in order to monitorcontract performance as well as review disciplinary and appealsreports A reading of this contract suggests that if best practiceis followed many aspects of the quality of incarceration can beaddressed through contracting

C Contractual Incompleteness

Although contracts can address some quality issues in sev-eral important areas incompleteness is evident and could inprinciple compromise the quality of service delivered by a privatecontractor The two crucial areas we consider are use of force andquality of personnel These areas have been the focus of much ofthe criticisms of private prisons (eg Shichor 1995)

The mandatory ACA standard on the use of force is not espe-cially detailed ldquoWritten policy procedure and practice restrictthe use of physical force to instances of justiable self-defenseprotection of others protection of property and prevention of es-capes and then only as a last resort and in accordance with ap-propriate statutory authority In no event is physical forcejustiable as punishment A written report is prepared followingall uses of force and is submitted to administrative staff for re-viewrdquo A separate but equally vague mandatory standard gov-erns the use of rearms The Tennessee contract allows the use ofdeadly force to prevent escapes and of nondeadly force to enforceinstitutional regulations and orders which is a weak restrictionindeed

In the area of the quality of personnel the ACA (non-mandatory) standards require that a procedure be used to deter-mine stafng needs and that the vacancy rate be kept under 10percent for any eighteen-month period Correctional ofcers arealso required to receive 120 hours of training in their rst yearand 40 hours in subsequent years Little is said about the qualityof the training (except for topics covered) or the quality of theofcers The Tennessee contract follows the ACA on training but


also species that ldquoat the time the facility opens and during therst year of the contract a minimum of 25 percent of contractorrsquossecurity employees will have at least one year of corrections secu-rity experience Davidson County residents will be given a hiringpreference in stafng the facilityrdquo What is most interesting aboutthese standards is how few there are and how much discretionthe contractor has in saving costs on personnel

Does contractual incompleteness lead to the deterioration ofquality Unfortunately no systematic evidence is available onthis matter We can get a glimpse of the issues by looking at two(very small sample) reports The rst is a comparative evaluationof two public prisons and one private (CCA-managed) prison inTennessee done by that statersquos government State of Tennessee1995 Although this evaluation has concluded that all three pris-ons are overall of extremely high quality with the implicationthat a cheaper private prison is a good deal for the state (see alsoThe New York Times September 19 1995) it is clear from thebody of the report that the level of violence is higher in the pri-vate prison ldquoThe number of injuries to staff and prisoners is ameasure of the security and safety of the facility During the f-teen month period the private prison reported signicantly more(214) injuries to prisoners and staff compared to 21 and 51 forthe two state prisons respectively The private prison also re-ported 30 incidents of the use of force compared to 4 and 6 re-spectively for the state prisonsrdquo The Tennessee report minimizesthis evidence because of the possible differences in reportingpractices but it is suggestive nonetheless

While CCA private prisons in Tennessee are widely regardedas a success of private prison management ESMORrsquos detentionfacility in Elizabeth New Jersey operated for the Immigrationand Naturalization Service (INS) is widely regarded as a failurein part because a riot broke out at that facility on June 18 1995The ESMOR facility housed foreign nationals who were caughtattempting to enter the United States illegally through Kennedyand Newark airports and who were awaiting deportationmdashnotexactly a hard core criminal crowd ESMOR won the INS contractby signicantly underbidding another private competitor in partbecause it assumed in its bid lower wage rates for prison staffThe contract actually specied the types of workers that ESMORwas supposed to hire but it turned out to be possible within thecontract to hire as guards individuals who previously guarded


goods in warehouses With respect to training ESMOR evidentlyjust violated the contract the INS reports that ESMOR ldquodid notmeet requirements of the contractrdquo in this area

Overall the ESMOR facility was seriously understaffedguards did not receive enough training guards were implicatedin incidents of physical abuse of prisoners and supervision ofstaff by management was lacking When the riot broke out theguards immediately ran away and called the police from a payphone INS attributed many of the problems at the facility toESMORrsquos cutting corners principally on labor The evidence inthe report points to the possibility of cost savings by private con-tractors at the expense of quality as well as to the governmentrsquosfailure to respond to explicit contract violations by the contractor(see footnote 14)

In sum while systematic evidence on the quality of incarcer-ation by private and public prisons is not available the existingshreds of evidence suggest that in important dimensions such asprison violence and the quality of personnel prison contracts areseriously incomplete This incompleteness can and sometimesdoes give rise to quality shortfalls in private contracting

D What Does Our Model Say about Prison Privatization

Prisons seem to t reasonably well into our framework Al-though in some respects prison contracts are very detailed theyare still seriously incomplete There are signicant opportunitiesfor cost reduction that do not violate the contracts but that atleast in principle can substantially reduce quality Moreoverfrom the available evidence we have the impression that theworld may not be far from the assumptions of Proposition 4First the welfare consequences of quality deterioration might beof the same magnitude as those of cost reduction (b(e) and c(e)are comparable) Second the opportunities for quality innovationare limited ( b (i) is small) Under these conditions Proposition 4suggests that public ownership is superior

Would ex post competition between prisons for inmatesstrengthen the case for privatization One possibility is that con-victs themselves choose the prison in which to serve their senten-ces but this is probably a bad idea since prisoner choice wouldencourage contractors to attract customers by allowing gangsdrugs and perhaps even easy escapes A more plausible alterna-tive is to have judges choose a private prison to send a convict to


with the idea that judges would send more inmates to higherquality prisons and fewer to lower quality prisons Private con-tractors would then have the appropriate incentives to invest inquality improvements and to avoid excessive cost reductions tobring in more business At the moment such schemes have notbeen tried in part because there is a shortage of prison capacityin the United States but it is possible that they could be tried inthe future One potential disadvantage of such judge choice isthat some judges might actually choose lower quality prisons be-cause they want the inmates to get a stiffer penalty whereasother judges might choose prisons that are soft on inmates Con-tractors would then cater to the preferences of the judges whichneed not coincide with social welfare

Finally the choice of whether to privatize prisons depends onthe importance of corruption and patronage Patronage does notappear to be a huge problem in prison employment in the UnitedStates since the union premium as of this writing is not largeCorruption appears to be a greater concern at least judging fromthe available anecdotal evidence To begin private prison compa-nies are very active politically For instance ESMOR evidentlylobbies politicians and makes political contributions to receivecontracts The New York Times July 23 1995 The wife of Ten-nessee governor Lamar Alexander invested early and protablyin the stock of Corrections Corporation of America which subse-quently got involved very deeply in the privatization of Tennesseeprisons with the governorrsquos endorsement The New RepublicMarch 4 1996 p 9

A related problem is that contract enforcement cannot betaken for granted The INS report concludes that ESMORrsquoschanges in policies ldquohindered INS ability to effectively performits oversight functionsrdquo The report also notes that ESMOR toldits guards not to share information with the INS ofcials workingon the premises and in one instance encouraged the INS to reas-sign an ofcer who complained about the performance of the Eliza-beth New Jersey facility several months prior to the riot Thereport indicates that ESMOR violated the contract in some in-stances and also pursued policies preventing the INS from en-forcing the contract But it is also clear from the report that theINS did not do what it could to enforce this contract The INSreport vividly illustrates how a governmentbureaucracy with rela-tively weak incentives has trouble enforcing a contract with a pri-


vate supplier determined to reduce its costs even if this involvesviolations of the contract and not just the issues on which thecontract is silent

In sum our model suggests that a plausible theoretical casecan be made against prison privatization This case is weakenedif competition for inmates can be made effective but strength-ened by the relevance of political activism by private contractorsOne instance in which the case against prison privatization isstronger is maximum security prisons where the prevention ofviolence by prisoners against guards and other prisoners is a cru-cial goal The New York Times Magazine 1995 In many casesthe principal strategy for preventing such violence is the threatof the use of force by the guards We have shown that it is difcultto delineate contractually the permissible circumstances for theuse of such force Moreover hiring less educated guards and un-dertraining themmdashwhich private prisons have a strong incentiveto domdashcan encourage the unwarranted use of force by the guardsAs a result our arguments suggest that maximum security pris-ons should not be privatized so long as limiting the use of forceagainst prisoners is an important public objective Consis-tent with this view only 4 of the 88 private prisons in Thomasrsquos1995 census of private adult correctional institutions in theUnited States are maximum security In contrast private half-way houses and youth correctional facilities where violence prob-lems are less serious are common Shichor 1995

V OTHER ACTIVITIES

In some ways our model was constructed to t prisons How-ever it can help analyze other activities as well as we show inthis section We also examine some of the modelrsquos limitations

A Straightforward Cases Garbage Collection and WeaponsProcurement

In the case of garbage collection the damage to quality re-sulting from the private contractor hiring inferior employees orfailing to maintain the equipment is probably trivial (b(e) is low)Our analysis then implies that private provision is superior Thisresult obtains even though in garbage collection ex post competi-tion is extremely expensive since it is essential that the samecompany pick up garbage from neighboring houses Donahue


1989The superiority of private provision in garbage collection isdocumented by several empirical studies Donahue 1989

Weapons procurement is another case where our modelpoints to the superiority of private provision Although the dam-age to quality from cost reduction might be signicant to a largeextent this problem can be dealt with contractually throughthe requirement that weapons meet well-specied performancerequirements Moreover quality innovation is enormously impor-tant in weapons design and the incentives of private suppliersare probably stronger than those of public employees As a conse-quence if b(e) can be limited through contracts Proposition 3points to the superiority of private ownership

B Foreign Policy

In many situations the nature of the service that the govern-ment wants to be performed is extremely complex and unpredict-able so any contract is inherently extremely incomplete Mostactual decisions of the contractor have to be renegotiated at thegovernmentrsquos initiative which exposes the government to thehigh costs of paying up to the contractor who has a lot of powerFor example as Wilson 1989 shows it is virtually impossible todescribe in advance what services need to be performed to carryout American foreign policy a task now assigned to the State De-partment Suppose that the State Department were to be privat-ized and a set of policies toward different countries specied inthe contract In this case when the government wants to changeits policy toward a country (say because Russia renounces com-munism) it would have to persuade the private contractor tochange what it does In this renegotiation the government pre-sumably would have to pay the private contractor more than itwould pay an employee who is totally replaceable when few exante investments are involved In-house provision in this case offew investments and enormous ex post holdup opportunitiesseems clearly superior

A skeptic can respond to this analysis by suggesting that per-haps ex ante the government should auction off the foreign pol-icy contract for a vast amount of money with an understandingthat it is going to be regularly held up ex post What is wrongwith this arrangement In our theory we have assumed that Mis wealthy enough to pay up front for the right to own F whenprivate ownership is optimal However in some cases such as


the conduct of foreign policy M may not be wealthy enough Thiscreates a further argument for public ownership when M rsquos expost hold-up power vastly exceeds the amount he can raise exante for the contract If M cannot compensate G in advance forall the future holdups when G changes the contract then the ex-traction of surplus from G by M is socially wasteful Hence thegovernment may wish to own F simply to avoid having to compen-sate M when it changes its mind at date 116 This logic conrmsthe conclusion that foreign policy should be conducted by govern-ment bureaucrats

C Schools

An important example that goes outside of our basic modelis the provision of schooling For schools the damage to qualityfrom cost cutting b(e) may be large but innovation is probablyimportant and the incentives of publicly employed teachers es-pecially when they are protected by unions are weak Our propo-sitions therefore do not give a clear answer as to which ar-rangement is superior The key aspect of schools however is thepotential for ex post competition In voucher arrangements com-bined with school choice the government pays for each childrsquoseducation but children and parents select schools We conjecturethat the case for such private arrangements is extremely strongSchool choice would force private schools to compete for studentsby providing higher quality since schools cannot compete in pricewhen students pay with vouchers This competition should sig-nicantly reduce the incentive to cut quality while cutting costsas well as increase the incentive to innovate quality Indeed theavailable evidence suggests that competition between schools isassociated with a higher quality of education Hoxby 1994

Critics of vouchers and school choice often point to a particu-lar aspect of quality that they believe would fall as a result ofprivatization namely reduction of access of some students togood education Specically critics fear that sorting of studentsby ability would increase as a result of such arrangements whichthey regard as socially undesirable Such sorting can take two


16 This argument is developed further in Trinh 1996 One may ask why Mcould not borrow against the receipts from his future hold-up opportunities Theanswer is that a bank may be unwilling to lend to M since there is nothing tostop M from ldquoholding uprdquo the bank by refusing to hold up the government Thatis having received his loan M can threaten not to hold up the government at date1 and use this threat to renegotiate downward his repayment to the bank Hartand Moore 1994 Anticipating this the bank will refuse to lend to M

forms First good private schools paid with vouchers would selectthe best students leaving the not-as-good students to not-as-goodschools Second private schools would avoid expensive-to-educate children altogether who would then get stuck in residualgovernment programs Critics charge that such outcomes are lesssocially desirable than those involving less sorting Some schooldistricts have tried to solve these sorting problems contractu-ally by for example using courts to allocate students to privateschools that wish to be paid with vouchers Moe 1995 Whethercontracts can successfully address the concerns of the critics ofschool choice and whether these concerns are actually justiedfrom the social welfare viewpoint are questions requiring fur-ther inquiry

D Health Care

In the case of health care as with education the governmentwants to pay for the services of at least some consumers andneeds to design a good arrangement for doing so One aspect ofthis design is whether hospitals should be private or public Inthe analysis of optimal ownership there are some similarities be-tween schools and hospitals as well as some differences To be-gin in health care as in education gains from innovation areenormous but so is the damage to quality from cost cuttingMoreover the distributional aspect of quality is extremely impor-tant in both services namely the danger that expensive-to-treatconsumers would be denied care if the government pays less thanit costs to treat them

One further similarity is that ex post competition betweenhospitalsmdashletting patients choose their hospitalmdashcan play a rolein health care Such competition generally strengthens the casefor privatization However a crucial difference is the limited abil-ity of consumers to assess the quality of health care they receiveConsumers often cannot tell whether hospitals have failed to pro-vide care to save costs and hence would not so readily changesuppliers in response to poor quality For this reason the combi-nation of private ownership and competition would not be nearlyso effective in health care as in education making the case forsome government ownership stronger

Perhaps because of all these concerns about private provi-sion most countries have responded to the need to provide healthcare to all their people through government provision TheUnited States has been different in relying on both private and


public hospitals with the latter taking care primarily of indigentpatients Historically private hospitals have been paid on a cost-plus basismdashan approach that our model does not accommodate(since we assume that costs are nonveriable) but which unsur-prisingly has proved extremely expensive More recently theform of compensating providers has shifted to xed fees for ser-vices a contract very similar to that analyzed in our model Notsurprisingly these contracts have increased concerns about qual-ity deterioration particularly in the so-called Health Mainte-nance Organizations An analysis of health care would require asignicant generalization of our model especially since verica-tion of costs and cost-plus contracts have played an essential rolein paying for this service

E Police and Armed Forces

Consider nally some basic services provided by the govern-ment that nobody seriously thinks of privatizing the police andthe armed forces Our framework helps to explain why these ser-vices should not be privatized

If the police or armed forces were privatized the owners ofthe resulting private companies would have enormous powerPart of this power would stem from the direct ownership of weap-ons that are currently in public hands The owners could use thispower to hold up the government and society For example sup-pose as an extreme case that nuclear weapons were sold off to aprivate company and an (incomplete) contract was written withthe company as to how these weapons should be used in the eventthat the country is threatened with attack The concern is obvi-ously that the private company would wriggle out of the incom-plete contract and either threaten to withhold the weapons in theevent of an emergency to extract a huge side-payment fromthe government or even threaten to use the weapons against thecountry itself unless it receives such a side-payment

We stress that keeping the nuclear stockpilesmdashor armedforcesmdashpublic does not eliminate the possibility of attemptedholdup A general who is a state employee could use his access tonuclear weapons to attempt to hold up society After all coupsand rebellions by the armed forces do sometimes occur Howeverthere is a difference between the private and public cases If nu-clear weapons or the armed forces are publicly controlled thegovernment can take early action to prevent a potential holdupIf it suspects that an errant general is engaged in treason it can


re the general In contrast in the private case the governmentwould have to wait until a clear breach of contract occurred thismight be too late

VI CONCLUSION

We have examined the conditions that determine the relativeefciency of in-house provision versus outside contracting of gov-ernment services Our theoretical arguments suggest that thecase for in-house provision is generally stronger when non-contractible cost reductions have large deleterious effects onquality when quality innovations are unimportant and whencorruption in government procurement is a severe problem Incontrast the case for privatization is stronger when quality-reducing cost reductions can be controlled through contract orcompetition when quality innovations are important and whenpatronage and powerful unions are a severe problem inside thegovernment

We then applied this analysis to several government activi-ties using the available evidence on the importance of vari-ous factors We concluded that the case for in-house provision isvery strong in such services as the conduct of foreign policy andmaintenance of police and armed forces but can also be madereasonably persuasively for prisons In contrast the case for pri-vatization is strong in such activities as garbage collection andweapons production but can also be made reasonably persua-sively for schools In some other services such as provision ofhealth care an analysis of the efciency of alternative arrange-ments is a great deal more complicated and requires a much moredetailed model of competition contracts and regulation than wecould provide in this paper We defer such analysis to futurework

HARVARD UNIVERSITY

HARVARD UNIVERSITY

UNIVERSITY OF CHICAGO

REFERENCES

American Correctional Association (ACA) Standards for Adult Correctional Insti-tutions 3d Edition (Laurel MD ACA 1990)

American Federation of State County and Municipal Employees (AFSCME) DoesCrime Pay An Examination of Prisons for Prot (Washington DC AFS-CME 1985)


Becker Gary S ldquoA Theory of Competition among Pressure Groups for PoliticalInuencerdquo Quarterly Journal of Economics XCIX (1983) 371ndash400

DiIulio John J Jr ldquoPrivate Prisonsrdquo unpublished discussion paper May 1987Domberger Simon Christine Hall and Eric Li ldquoThe Determinants of Price and

Quality in Competitively Tendered Contractsrdquo Economic Journal CV(1995) 1454ndash70

Donahue John Prisons for Prot Public Justice Private Interests (WashingtonDC Economic Policy Institute 1988)

mdashmdash The Privatization Decision Public Ends Private Means (New York BasicBooks 1989)

Grossman Sanford J and Oliver D Hart ldquoThe Costs and Benets of OwnershipA Theory of Vertical and Lateral Integrationrdquo Journal of Political EconomyXCIV (1986) 691ndash719

Hart Oliver Firms Contracts and Financial Structure (Oxford Oxford Univer-sity Press 1995)

Hart Oliver and John Moore ldquoProperty Rights and the Nature of the FirmrdquoJournal of Political Economy XCVIII (1990) 1119ndash58

Hart Oliver and John Moore ldquoA Theory of Debt Based on the Inalienability ofHuman Capitalrdquo Quarterly Journal of Economics CIX (1994) 841ndash80

Holmstrom Bengt and Paul Milgrom ldquoMulti-Task Principal-Agent Analyses In-centive Contracts Asset Ownership and Job Designrdquo Journal of Law Eco-nomics and Organization VII (1991) 24ndash52

Holmstrom Bengt and Paul Milgrom ldquoThe Firm as an Incentive Systemrdquo Ameri-can Economic Review LXXXIV (1994) 972ndash91

Hoxby Caroline ldquoDoes Competition among Public Schools Benet Students andTaxpayersrdquo NBER Working Paper No 4979 December 1994 revised 1997

Klein B R Crawford and A Alchian ldquoVertical Integration Appropriable Rentsand the Competitive Contracting Processrdquo Journal of Law and EconomicsXXI (1978) 297ndash326

Laffont Jean-Jacques and Jean Tirole A Theory of Incentives in Regulation andProcurement (Cambridge MIT Press 1993)

Logan Charles H Private Prisons Cons and Pros (New York Oxford UniversityPress 1990)

mdashmdash ldquoWell Kept Comparing Quality of Connement in Private and Public Pris-onsrdquo Journal of Criminal Law and Criminology LXXXIII (1992) 577ndash613

Lopez-de-Silanes Florencio Andrei Shleifer and Robert W Vishny ldquoPrivatizationin the United Statesrdquo Rand Journal of Economics (1997) Autumn

Metropolitan Government of Nashville and Davidson County ldquoDesign Construc-tion and Management Service Contract between CCA and Metropolitan Gov-ernment of Nashville and Davidson Countyrdquo 1990

Moe Terry ed Private Vouchers (Stanford CA Hoover Institution Press 1995)The New Republic March 4 1996 p 9The New York Times ldquoIn Corrections Business Shrewdness Paysrdquo July 23

1995 p 1mdashmdash ldquoPrivate Tennessee Prison is Praised in State Studiesrdquo September 19 1995

p 7The New York Times Magazine ldquoThe Toughest Job in America is Getting Tougherrdquo

November 26 1995Savas Emanuel Privatizing the Public Sector How to Shrink Government (Chat-

ham NJ Chatham House Publishing 1982)mdashmdash Privatization The Key to Better Government (Chatham NJ Chatham House

Publishing 1987)Schmidt Klaus ldquoThe Costs and Benets of Privatization An Incomplete Con-

tracts Approachrdquo Journal of Law Economics and Organization XII (1996)1ndash24

Shapiro Carl and Robert Willig ldquoEconomic Rationales for the Scope of Privatiza-tionrdquo in Ezra N Suleiman and John Waterbury eds The Political Economyof Private Sector Reform and Privatization (Boulder CO Westview Press1990)

Shichor David Punishment for Prot (Thousand Oaks Sage Publications 1995)Shleifer Andrei and Robert W Vishny ldquoCorruptionrdquo Quarterly Journal of Eco-

nomics CVIII (1993) 599ndash618Shleifer Andrei and Robert W Vishny ldquoPoliticians and Firmsrdquo Quarterly Journal

of Economics CIX (1994) 995ndash1025


State of Tennessee ldquoComparative Evaluation of Privately-Managed CCA Prisonand State-Managed Prototypical Prisonsrdquo February 1 1995

Stigler George ldquoThe Economic Theory of Regulationrdquo Bell Journal of EconomicsII (1971) 3ndash21

Thomas Charles W Private Adult Correctional Facility Census (Gainesville Cen-ter for Studies in Criminology and Law 1995)

Tirole Jean ldquoThe Internal Organization of Governmentrdquo Oxford Economic Pa-pers XLVI (1994) 1ndash29

Trinh Cong Minh ldquoThree Essays on the Economics of Governancerdquo PhD thesisHarvard University 1996

United States Immigration and Naturalization Service The Elizabeth NJ Con-tract Detention Facility Operated by ESMOR Inc Interim Report July 201995

Vickers John and George Yarrow Privatization An Economic Analysis (Cam-bridge MA MIT Press 1988)

Webb Sidney and Beatrice Webb English Prisons Under Local Government(Camden CT Archon Books 1963 reprint of 1922 edition)

Williamson O The Economic Institutions of Capitalism (New York Free Press1985)

Wilson James Q Bureaucracy What Government Agencies Do and Why They DoIt (New York Basic Books 1989)


that may throw light on the cost and quality of service under al-ternative provision modes

The perspective we adopt is that of incomplete contractsGrossman and Hart 1986 Hart and Moore 1990 Hart 1995Suppose that a public-spirited politician chooses between havinga service delivered by a public agency and contracting it out Inthe rst case the politician hires public employees and givesthem employment contracts specifying what they need to do Inthe second case the politician signs a contract with a private sup-plier who in turn contracts with his (or her) employees If thepolitician can sign a complete or comprehensive contract (witheither employees or a contractor) he can achieve the same out-come in each case From the traditional incentive viewpoint mo-tivating the contractors and the public employees presents thesame problem to the politician even in the presence of moral haz-ard and adverse selection To understand the costs and bene-ts of contracting out we need to consider a situation wherecontracts are incomplete and where residual rights of control inuncontracted for circumstances are important in determiningagentsrsquo incentives

The assumption of contractual incompleteness is not hard tomotivate once it is recognized that the quality of service the gov-ernment wants often cannot be fully specied Indeed critics ofprivatization often argue that private contractors would cut qual-ity in the process of cutting costs because contracts do not ade-quately guard against this possibility Critics of private schoolsfear that such schools even if paid for by the government (egthrough vouchers) would nd ways to reject expensive-to-educate children who have learning or behavioral problemswithout violating the letter of their contracts Critics also worrythat private schools would replace expensive teachers withcheaper teachersrsquo aides thereby jeopardizing the quality of edu-cation In the discussion of public versus private health care thepervasive concern is that private hospitals would nd ways tosave money by shirking on the quality of care or rejecting theextremely sick and expensive-to-treat patients In the case ofprisons concern that private providers hire unqualied guardsto save costs thereby undermining safety and security of prison-ers is a key objection to privatization Our model tries to explainboth why private contracting is generally cheaper and why insome cases it may deliver a higher while in others a lower qual-ity level than in-house provision by the government

Many discussions of privatization lump together the issue of













II THE MODEL

A Basic Assumptions



















B B b e i + (= -0 ( ) )b

C C c e = -0 ( )








C e i C c e e i + + + + = -0 ( )








B Default Payoffs





FIGURE I






C The First-Best


(1) max + + e i

b e c e i e i

[ ( ) ( ) ( ) ]- - -b


(2) + 1- cent cent =b e c e( ) ( )

(3) 1cent =b ( )i





(4) + U B P i b eG = - -0 0 1 2 ( ) ( )b

(5) + 12 + U P C i c e e iM = - - -0 0 b( ) ( )



(6) max 12 + e i

i c e e i


(7) 1cent =c eM( )

(8) 12 1cent =b ( )iM









(10) + (1 2) + + (U B P b e c e iG = - - -0 0 l b( ) ( ) )

(11) + 2 + + U P C b e c e i e iM = - - - -0 0 l b( ) ( ) ( )


(12) max 2 + + e i

b e c e i e i

[ ( ) ( ) ( ) ]l b- - -



(14) 2 1l bcent =( )i









(16) + + ( +

+ (


- -


i e i

G M

G G G G G M M

M M M

( ) ( ) ) ( ) ( ) )

bb



A Main Results








FIGURE II




PROPOSITION 3







PROPOSITION 4











B Competition


























A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES
























































II THE MODEL

A Basic Assumptions



















B B b e i + (= -0 ( ) )b

C C c e = -0 ( )








C e i C c e e i + + + + = -0 ( )








B Default Payoffs





FIGURE I






C The First-Best


(1) max + + e i

b e c e i e i

[ ( ) ( ) ( ) ]- - -b


(2) + 1- cent cent =b e c e( ) ( )

(3) 1cent =b ( )i





(4) + U B P i b eG = - -0 0 1 2 ( ) ( )b

(5) + 12 + U P C i c e e iM = - - -0 0 b( ) ( )



(6) max 12 + e i

i c e e i


(7) 1cent =c eM( )

(8) 12 1cent =b ( )iM









(10) + (1 2) + + (U B P b e c e iG = - - -0 0 l b( ) ( ) )

(11) + 2 + + U P C b e c e i e iM = - - - -0 0 l b( ) ( ) ( )


(12) max 2 + + e i

b e c e i e i

[ ( ) ( ) ( ) ]l b- - -



(14) 2 1l bcent =( )i









(16) + + ( +

+ (


- -


i e i

G M

G G G G G M M

M M M

( ) ( ) ) ( ) ( ) )

bb



A Main Results








FIGURE II




PROPOSITION 3







PROPOSITION 4











B Competition


























A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES

























































B B b e i + (= -0 ( ) )b

C C c e = -0 ( )








C e i C c e e i + + + + = -0 ( )








B Default Payoffs





FIGURE I






C The First-Best


(1) max + + e i

b e c e i e i

[ ( ) ( ) ( ) ]- - -b


(2) + 1- cent cent =b e c e( ) ( )

(3) 1cent =b ( )i





(4) + U B P i b eG = - -0 0 1 2 ( ) ( )b

(5) + 12 + U P C i c e e iM = - - -0 0 b( ) ( )



(6) max 12 + e i

i c e e i


(7) 1cent =c eM( )

(8) 12 1cent =b ( )iM









(10) + (1 2) + + (U B P b e c e iG = - - -0 0 l b( ) ( ) )

(11) + 2 + + U P C b e c e i e iM = - - - -0 0 l b( ) ( ) ( )


(12) max 2 + + e i

b e c e i e i

[ ( ) ( ) ( ) ]l b- - -



(14) 2 1l bcent =( )i









(16) + + ( +

+ (


- -


i e i

G M

G G G G G M M

M M M

( ) ( ) ) ( ) ( ) )

bb



A Main Results








FIGURE II




PROPOSITION 3







PROPOSITION 4











B Competition


























A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES
















































C e i C c e e i + + + + = -0 ( )








B Default Payoffs





FIGURE I






C The First-Best


(1) max + + e i

b e c e i e i

[ ( ) ( ) ( ) ]- - -b


(2) + 1- cent cent =b e c e( ) ( )

(3) 1cent =b ( )i





(4) + U B P i b eG = - -0 0 1 2 ( ) ( )b

(5) + 12 + U P C i c e e iM = - - -0 0 b( ) ( )



(6) max 12 + e i

i c e e i


(7) 1cent =c eM( )

(8) 12 1cent =b ( )iM









(10) + (1 2) + + (U B P b e c e iG = - - -0 0 l b( ) ( ) )

(11) + 2 + + U P C b e c e i e iM = - - - -0 0 l b( ) ( ) ( )


(12) max 2 + + e i

b e c e i e i

[ ( ) ( ) ( ) ]l b- - -



(14) 2 1l bcent =( )i









(16) + + ( +

+ (


- -


i e i

G M

G G G G G M M

M M M

( ) ( ) ) ( ) ( ) )

bb



A Main Results








FIGURE II




PROPOSITION 3







PROPOSITION 4











B Competition


























A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES














































B Default Payoffs





FIGURE I






C The First-Best


(1) max + + e i

b e c e i e i

[ ( ) ( ) ( ) ]- - -b


(2) + 1- cent cent =b e c e( ) ( )

(3) 1cent =b ( )i





(4) + U B P i b eG = - -0 0 1 2 ( ) ( )b

(5) + 12 + U P C i c e e iM = - - -0 0 b( ) ( )



(6) max 12 + e i

i c e e i


(7) 1cent =c eM( )

(8) 12 1cent =b ( )iM









(10) + (1 2) + + (U B P b e c e iG = - - -0 0 l b( ) ( ) )

(11) + 2 + + U P C b e c e i e iM = - - - -0 0 l b( ) ( ) ( )


(12) max 2 + + e i

b e c e i e i

[ ( ) ( ) ( ) ]l b- - -



(14) 2 1l bcent =( )i









(16) + + ( +

+ (


- -


i e i

G M

G G G G G M M

M M M

( ) ( ) ) ( ) ( ) )

bb



A Main Results








FIGURE II




PROPOSITION 3







PROPOSITION 4











B Competition


























A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES


















































C The First-Best


(1) max + + e i

b e c e i e i

[ ( ) ( ) ( ) ]- - -b


(2) + 1- cent cent =b e c e( ) ( )

(3) 1cent =b ( )i





(4) + U B P i b eG = - -0 0 1 2 ( ) ( )b

(5) + 12 + U P C i c e e iM = - - -0 0 b( ) ( )



(6) max 12 + e i

i c e e i


(7) 1cent =c eM( )

(8) 12 1cent =b ( )iM









(10) + (1 2) + + (U B P b e c e iG = - - -0 0 l b( ) ( ) )

(11) + 2 + + U P C b e c e i e iM = - - - -0 0 l b( ) ( ) ( )


(12) max 2 + + e i

b e c e i e i

[ ( ) ( ) ( ) ]l b- - -



(14) 2 1l bcent =( )i









(16) + + ( +

+ (


- -


i e i

G M

G G G G G M M

M M M

( ) ( ) ) ( ) ( ) )

bb



A Main Results








FIGURE II




PROPOSITION 3







PROPOSITION 4











B Competition


























A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES
















































(4) + U B P i b eG = - -0 0 1 2 ( ) ( )b

(5) + 12 + U P C i c e e iM = - - -0 0 b( ) ( )



(6) max 12 + e i

i c e e i


(7) 1cent =c eM( )

(8) 12 1cent =b ( )iM









(10) + (1 2) + + (U B P b e c e iG = - - -0 0 l b( ) ( ) )

(11) + 2 + + U P C b e c e i e iM = - - - -0 0 l b( ) ( ) ( )


(12) max 2 + + e i

b e c e i e i

[ ( ) ( ) ( ) ]l b- - -



(14) 2 1l bcent =( )i









(16) + + ( +

+ (


- -


i e i

G M

G G G G G M M

M M M

( ) ( ) ) ( ) ( ) )

bb



A Main Results








FIGURE II




PROPOSITION 3







PROPOSITION 4











B Competition


























A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES
















































(10) + (1 2) + + (U B P b e c e iG = - - -0 0 l b( ) ( ) )

(11) + 2 + + U P C b e c e i e iM = - - - -0 0 l b( ) ( ) ( )


(12) max 2 + + e i

b e c e i e i

[ ( ) ( ) ( ) ]l b- - -



(14) 2 1l bcent =( )i









(16) + + ( +

+ (


- -


i e i

G M

G G G G G M M

M M M

( ) ( ) ) ( ) ( ) )

bb



A Main Results








FIGURE II




PROPOSITION 3







PROPOSITION 4











B Competition


























A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES














































(16) + + ( +

+ (


- -


i e i

G M

G G G G G M M

M M M

( ) ( ) ) ( ) ( ) )

bb



A Main Results








FIGURE II




PROPOSITION 3







PROPOSITION 4











B Competition


























A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES













































FIGURE II




PROPOSITION 3







PROPOSITION 4











B Competition


























A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES















































PROPOSITION 3







PROPOSITION 4











B Competition


























A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES















































PROPOSITION 4











B Competition


























A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES

















































B Competition


























A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES



































































A Overview





































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES













































































V OTHER ACTIVITIES







B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES















































B Foreign Policy





C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES














































C Schools






D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES














































D Health Care












VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES




















































VI CONCLUSION



HARVARD UNIVERSITY

HARVARD UNIVERSITY


REFERENCES













































THE PROPER SCOPE OF GOVERNMENT: A S R W V · 2013-02-05 · THE PROPER SCOPE OF GOVERNMENT: THEORY...

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Transcript of THE PROPER SCOPE OF GOVERNMENT: A S R W V · 2013-02-05 · THE PROPER SCOPE OF GOVERNMENT: THEORY...