Contracting and Sector Choice for Municipal Services Production:
A Transaction Cost Approach
Abstract
Transaction costs in local service contracting are shaped not only by the
characteristics of goods and services, but also by political and
administrative uncertainty. Turnover in executive leadership can affect the
ability of local government to negotiate contracts, make credible
commitments to suppliers, and faithfully uphold and enforce contracts once
they are in force. We predict that when such transaction costs are high,
contracting out becomes less likely. We find that both manager turnover
and certain service types significantly reduce the likelihood of service
contracting, particularly with private for-profit providers.
Contracting and Sector Choice for Municipal Services Production:
A Transaction Cost Approach
Whether organizations should contract out for products and services or produce them
internally (i.e., the make or buy decision) has intrigued scholars of public agencies and private
firms for decades. Since Coase (1937), the leading explanations for vertical integration in
private firms emphasize the role of transaction costs -- the costs incurred in negotiating,
monitoring, and enforcing a transaction, contract or agreement. This framework has been
expanded by new institutional economists who view the organization of transactions within
firms (rather than relying on the open market) as contingent upon the relative costs of internal
and external transactions (Williamson 1975, 1985; Klein, Crawford and Alchian 1978;
Grossman and Hart 1978). If the cost of negotiating and enforcing contracts between firms is
high, firms have an incentive to organize production so that they will directly supply services and
products themselves, rather than seek out external suppliers.
This paper argues that governments, like firms, desire efficient production (as well as
political, electorally-oriented objectives).
Production efficiencies in government can, however,
be lost when transaction costs are high, just as they can in private firms. We further believe that
service contracting and the sector to which contracts are assigned can be linked to two sources of
transaction costs: the characteristics of goods, and the characteristics of political systems that
produce uncertainty. Our empirical analysis estimates city contractor choices with a model that
includes information on patterns of executive turnover in government and the types of services
that are provided. Based on the findings of this analysis, we conclude transaction costs limit the
gains to be achieved in contracting out services, particularly to private agents.
Certain classes of goods entail considerable monitoring and measurement costs that make
contracting with private agents problematic. In addition, uncertainty resulting from
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administrative turnover reduces the ability of a local government to negotiate contracts, make
credible commitments to suppliers, and enforce contracts. The first section of this paper
presents an overview of the role of transaction costs in the organization of production, with
specific application to the service activities of local government.
The impact that leadership
turnover within government may have on transaction costs is particularly stressed. The second
section discusses how certain types of goods and services may be particularly vulnerable to
opportunistic behavior when those activities are contracted out to external delivery agents.
The
third section identifies how problems resulting from transaction costs are affected by the sector
(i.e., public, non-profit, or private profit-seeking) of the organization that is chosen to supply the
service. The fourth section presents empirical analyses of service delivery choices made by
American cities.
Transaction Costs, Service Production, and Turnover
Some political scientists have used transaction cost arguments to account for
governmental decisions to contract out service responsibilities to external organizations. For
example, Robert Stein (1990) applied Oliver Williamson's (1975) transaction costs argument to
choices of municipal service delivery alternatives. Williamson contended that firms seek vertical
integration in order to control specific assets that could be lost if external suppliers reneged on a
contractual agreement or interpreted a contractual provision in a fashion adverse to the interests
of the firm. This argument implies that these sorts of hold-up problems and non-cooperative
behaviors can be more easily handled within vertically integrated firms than between
contractually-obligated firms. However, reneging occurs inside firms as well as among them.
The more important issue is whether mechanisms of internal governance are preferred over the
monitoring of a written contract (backed up by courts) in addressing this problem. Each
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alternative involves some transaction costs, but Williamson presumes those costs are much
greater when inter-firm relationships are involved.
A different school of thought (often linked to the economics departments of the
University of Washington and Washington University in St. Louis) contends that transaction
costs are most significant when the attributes of a good cannot be readily defined and measured.
This may hinder monitoring and enforcement of contracts through the courts. In such instances,
direct production and distribution within firms may be advantageous, primarily since it may be
easier to write directives, gauge compliance, and adjust instructions within organizations rather
than to re-negotiate and carry out new contractual provisions between separate organizations. It
could also be easier to generate trust among individuals within a single organization (through
repeated interactions and intertwined interests) than to develop such commitment between
members of different organizational entities involved in arms-length deals (see Barzel, 1982;
Cheung, 1983; North, 1990).
While these kinds of transaction cost arguments have been applied frequently by
economists in the field of industrial organization in their attempts to understand vertical
integration, franchising, and long-term contracting, they have not as often been used to account
for the organization of service production in government agencies. Some such research has been
done in the study of municipal contracting decisions. In applying transaction cost explanations
to these decisions, extant research has focused primarily on the characteristics of goods that may
indicate potential transaction costs (Ferris and Graddy, 1986; 1988; Stein 1990, 1993; Brown and
Potoski, 2003).
Several types of goods have proven difficult to contract. For example, redistributive
goods such as health and human services have outcomes that are difficult to measure and are
often retained in-house (Ferris and Graddy, 1986). Clingermayer and Feiock (1997) also found
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that regulatory services were less likely to be contracted out than non-regulatory functions.
Municipal services providing collective and common property goods also make use of the kind
of specific capital assets that create transaction cost problems (Stein, 1990). While Williamson
(1985) suggested that asset specificity should be expected to result in vertical integration, Stein
found that municipalities directly provided common property goods, but used a diverse array of
service arrangements including contracting to provide toll and private goods.
Contracting has also been linked to the existence of a stable administrative environment
for city relations with external actors. When political or administrative upheaval results in
uncertainty, it reduces the ability of a municipality to negotiate contracts, make credible
commitments to suppliers, and faithfully uphold and enforce contracts once they are in force
(Clingermayer and Feiock, 2001). Uncertainty regarding a local government’s expectations and
the credibility of their commitments can make doing business with governments risky (McManus
1991). This uncertainty is bound to increase with greater levels of executive turnover. In
addition, officials coming into office during the life of a contract may not be satisfied with some
aspects of the agreement and may demand some re-negotiation. Centralized organizations
generally extend broad powers to executives to intervene in lower-level decisions (Milgrom and
Roberts, 1990). Since intervention increases uncertainty for external actors, turnover of city
managers should lead to higher uncertainty in contractual relationships.
Local government officials may not be willing to enter into agreements for lengthy
periods that would lock them into a particular mode of service delivery and specify explicit
quantities of service, quality characteristics, or distributive criteria. More open-ended and
flexible contracts which would enable governments to modify service provisions are possible,
but they impose transaction costs upon suppliers. To compensate for increased risk, suppliers
could demand substantial premia for accepting these possible interventions. If so, the cost
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savings that contracting out is said to provide would quickly evaporate (Sappington and Stiglitz,
1987). Under these conditions contracting may be less likely.
Two problems stand out in the literature on transaction costs and municipal contracting.
First, although administrative turnover and the characteristics of goods have both been linked to
transaction costs problems in contracting, they have not been examined together in any
systematic way. Second, empirical work has typically neglected decisions of which sector to
rely on to supply of contracted services. Contracting with private firms is fundamentally
different from external delivery using other units of government or non-profit organizations
because the incentive for opportunistic behavior is usually much higher when private, profitseeking firms are involved.
Private firms are assumed to be residual claimants that retain
whatever revenue in excess of service costs are provided by a contract.
This may offer
incentives for efficiency, but it may also motivate firms to cut corners in various ways, including
limiting access to services or allowing costly service quality to decline. Units of government or
non-profit organizations that contract with governments to provide services receive no profits to
distribute to their members. Some slack or excess resources may be retained by such
organizations, but this should not provide the same “high-powered incentives” to act
opportunistically (see Frant, 1996).
Taxonomies of Goods and Services
While there are numerous ways by which governmental activities can be classified,
several typologies have been specifically linked to service delivery choices. These include
classification of goods and services based on criteria such as the distinction between regulatory
and non-regulatory goods, excludability and jointness of consumption (Ostrom and Ostrom,
1977), and net benefit/cost to the median taxpayer (Peterson 1981).
5
The distinction between regulatory and non-regulatory actions services is common to
policy studies. Beginning with Lowi (1967) public policy analysis has often differentiated
regulatory policy from other policies.
Regulatory programs tend to be labor-intensive services
intended to mitigate particular externality problems. Because regulatory activities are easier to
define than many non-regulatory activities, lower measurement costs can result. Nevertheless,
because regulatory services can employ governmental coercion, they often impose substantial
administrative or compliance costs on particular firms or individuals. Regulatory costs are
concentrated while the benefits are diffused over many constituents. For this reason they often
generate conflict and pose high bargaining costs (Wilson, 1980). Important exceptions to this
general pattern are economic regulatory policies that concentrate benefits rather than costs.
Clingermayer and Feiock (1997) found regulatory services were less likely to be contracted out
by local governments than non-regulatory services. The conflictual nature of regulatory policies
may particularly militate against the involvement of non-profit organizations in service delivery
(Clingermayer and Feiock, 1997).
A second typology focuses on the extent to which difficulty of exclusion or simultaneous
use results in externalities (Ostrom and Ostrom, 1977). Those goods that are excludable and
which do not involve jointness of supply are often called “private goods” and can generally be
provided in private markets. Nevertheless, governments may be called upon to provide such
goods when the distributive impact of market allocations is not politically satisfactory.
When exclusion is costly or difficult and jointness of supply is present, services have the
characteristics of public or collective goods.
Here a strong case for government involvement
can be made to guarantee adequate provision. Some goods permit exclusion but allow joint
supply. These “toll” goods may be provided by either private or public markets. Goods that are
“common pool resources” involve jointness of supply but do not allow easy exclusion. These
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resources may exist in nature or by human contrivance, but some monitoring by a governmental
or other organization must be in place to prevent excessive exploitation of the resource. Stein
(1993) argues that the delivery of collective goods will be dominated by direct municipal
delivery. We also expect that private goods that are provided by government will be produced in
house because of the potential for opportunistic behavior in their delivery.
The third local government service typology addressed here is Paul Peterson’s (1981)
classification of services as developmental, allocational, and redistributive based on whether the
median taxpayer’s benefits cost ratio resulting from provision of a service is positive
(developmental), negative (redistributional) or roughly zero (allocational). Peterson argued that
local governments compete for residents and investment in order to maintain their tax bases and
gain sufficient revenue to sustain government operations. In order to attract investment, local
governments make use of development services to lure new investment or to expand existing
investments in the community. These include provision of physical infrastructure and facilities
as well as services that direct benefits to business and high income taxpayers. Peterson claimed
that development is made in a relatively closed process with little public involvement.
Governments must also carry out basic police power functions, as well as provide basic
services that do not necessarily have substantial redistributive consequences. These services,
including police, fire, and street maintenance, Peterson classifies as “allocational” policies.
Peterson argues that cities rarely undertake “redistributive programs because they might drive
away new investment, or encourage mobile existing investment to migrate to areas with less
antagonistic business climates. Local government aversion to redistribution may encourage
indirect provision of these services. This occurs because redistributive services are
controversial, “it is expected that municipal governments that choose to provide their citizens
private redistributive goods, such as health, hospital, and welfare services, will choose a non-
7
direct service mode to fulfill this responsibility” (Stein, 1993: 77). Extending Peterson’s
argument, we predict developmental services will be provided in-house rather than be outsourced
because they are politically more popular with local politicians than redistributive services.
Allocational services fall between the extremes of the other two categories, but if they are
contracted out we expect them to be provided by non-profit organizations because of the greater
heterogeneity of preferences for these services. Thus, Peterson’s classification provides a rank
ordering of local government preferences to provide particular types of services.
There has been considerable recent interest in what factors account for turnover among
city managers and CAOs (DeSantis, Glass, and Newell, 1992; DeHoog and Whitaker, 1990;
Whitaker and DeHoog, 1990; Feiock and Stream, 1998; Feiock, et al., 2001). Executive
turnover has transaction cost implications for exchanges between city governments and external
actors because uncertainty resulting from turnover in leadership positions affects the ability of
local officials to negotiate contracts, make credible commitments and faithfully uphold and
enforce contracts or agreements with suppliers, contractors, or intermediaries. Contractual
exchange is only likely if both parties to the exchange (the municipality and an external actor
such as a firm, a non-profit organization or another government) consider the arrangement to be
in their interest. Exchange is less likely if either side believes that the terms of the contract or
agreement may not be honored. This suspicion may prevent service contracting that otherwise
would be mutually advantageous.
Transaction Costs and Sector Choice
Transaction costs problems can be troublesome for cities pursuing any kind of external
service delivery, but the problems may be less great when service responsibility is given to nonprofits. This occurs because nonprofits are less likely to operate under specific contracts and
8
monitoring is not solely dependent on government officials. Profit-seeking enterprises are
typically more capital intensive than governments or non-profits, and therefore have greater sunk
costs. Non-profits generally have less in the way of capital assets and are generally involved in
complimentary service activities in addition to those funded by government. Oversight of
nonprofits is not carried out exclusively by government, but instead is a responsibility of boards
of directors, donors, and volunteers as well as government. Therefore, we expect leadership
turnover to have a greater impact on contracting with for- profit than nonprofit organizations.
Methodology
To examine impacts of executive turnover and the characteristics of goods upon service
contracting and contractor choices, we use of ICMA’s Profile of Alternative Service Delivery
Approaches for 1988 and 1992. These two data sets are drawn from responses to survey
questions from city officials regarding whether the respondent’s municipality provides particular
services and, if so, how the specific services are delivered.
The analysis covers all
municipalities with populations of 25,000 or more in 1985 that were included in each of the two
surveys (N=234). These data were supplemented with information from various editions of the
Municipal Yearbook and County and City Data Books.
Prior research used ICMA’s 1988 survey to investigated city governments’ decisions to
use external service delivery (Clingermayer and Feiock, 1997). The 1992 data were instead used
to examine contractor choices for two reasons. First, the effects of city conditions and leadership
turnover would not occur simultaneous to the contracting decisions, so it was necessary to
incorporate a lag between the independent and dependent variables. Second, the 1992 survey
differentiates between delivery by private for-profit and nonprofit organizations, but the other
ICMA surveys did not.
9
The probabilities a city would contract with other governments, non-profit organizations,
or for-profit firms, as alternatives to in-house production were estimated with multinomial logit .
Fifty-three services reported in both the 1988 and 1992 surveys were examined. There was
greater variation in contractor choices for supplying these services than for most other services
included in the surveys. Data for each of these services were pooled by city. Thus our unit of
analysis is service/city. Sets of indicators were then constructed to distinguish the effect of
service types on contractor choice.
Service delivery sector choices were estimated with a model that included measures of
service types, racial and economic diversity, turnover in the office of manager, and
characteristics of communities and government workforces that have been linked to contacting
patterns. A city’s experience with provision of particular services and the scope of its total
service delivery, city population in 1980, and change in population between 1980 and 1986 were
also included in the model.
We created three indicators of service types based on the classifications in the literature
discussed above. The characteristics of regulatory and non-regulatory goods are expected to
create different types of transaction costs. A binary variable distinguishes regulatory (coded 1)
and non-regulatory services (coded 0). The categorization of services based on excludability and
jointness of consumption is a set of dichotomous dummy variables corresponding to private
goods, public goods, and CPR goods. Finally, Peterson’s ordinal classification of services was
coded as redistributive (0), allocational (.5), and developmental (1) (see Appendix 1).
Racial and economic homogeneity were measured by percentages of municipal
population white and living below the federal poverty line. We operationalize administrative
turnover as the number of new chief administrative officers (“managers” from this point
forward) in a city for the 1984-1990 time period reported in Municipal Yearbooks. A dummy
10
variable indicated whether or not particular services were provided in 1988 to test the
expectation that newly adopted services functions are more likely to be contracted. Contracting
out was also expected to be more popular in metropolitan areas because of the availability of
alternative service providers; therefore we include whether a city is located within a metropolitan
area (MSA). Because opposition to contracting often comes from municipal employees, we
included indicators of the number of full-time public employees (per 10,000 population), and the
percentage of the municipal workforce unionized. We expect that cities providing more services
will be more likely to contract because it promises to reduce overall service provision costs.
This prediction was tested with a service responsibility indicator that counts the number of
services provided by a city in 1987 as indicated in the Census of Government Finances
(Clingermayer and Feiock, 1997). Finally, the countywide vote for the 1992 Republican
presidential candidate measured ideological preferences of voters which may influence support
for service contracting. Population change was calculated by subtracting 1980 from 1986
population and dividing the difference by the 1980 population. We predict increased service
demands resulting from population growth make contracting more likely. Finally, we expect that
larger population cities will be more likely to contract out because culturally and economically
diverse populations will demand more services.
Findings
Two concerns were addressed before undertaking statistical analysis of contractor
choices. A first concern was whether the time period examined provides adequate variation in
manager tenure to identify the influences of turnover on contacting decisions. Examination of
turnover patterns reveals that over half (54.7%) of the municipalities in our data set had at least
one new manager during the period we examined and fourteen percent had two or more new
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managers.
A second concern was whether to estimate a single equation with all three service
classification measures, or estimate three models that examine the service classifications
separately. We chose the former strategy because we believe that the three service
classifications measure three distinct theoretical concepts. We tested this assertion by examining
interrelations among service classifications with an ordinal measure of association, the
symmetric lambda statistic2. We found virtually no relationship between the service sector
classifications, which suggests that they should be analyzed in the same model.
Multinomial Logit Analysis
In the analysis that follows we the report relative risk ratios (RRR) derived from
multinomial logit. This provides a meaningful method of comparing the propensity to contract
out a municipal service to each of the alternative service sector options3. A RRR greater than
one indicates an effect favoring a particular kind of external delivery over in-house production,
and a RRR less than one indicates decreases in the odds of external supply. For example, in
Table 2 the RRR for manager turnover on contracting with nonprofit organizations is 0.860. The
odds of contracting with nonprofits rather than providing the service in-house are multiplied by
0.860, thus each manager change between 1983 and 1990 reduced the odds of contracting out
services to a nonprofit organization 14 percent. An RRR of 1 indicates an independent variable
does not increase or decrease the likelihood of contracting out to a particular service sector.
<Table 1 About Here>
2
Because symmetric lambda is a non-directional measure of association, it requires no assumptions about the
direction of the casual relationship between two variables. We coded the Peterson variable as three dichotomous
dummy variables so that it will be in the same unit of measurement as the other two service classifications. We also
used an ordinal measure of association to test the relationship among the service classifications, and our results do
not change.
3
For the set of service delivery alternatives (s), the RRR for an alternative service delivery category (j of s) and an
independent variable (x) equals the amount by which the predicted odds favoring j over direct city provision (the
base category of s) are multiplied, per a one unit increase in x, with all other factors being equal.
12
We first examine variables other than service classification in Table 1 to identify the
influence of manager turnover on the service classifications. The first column of Table 1 reports
the likelihood of contracting out to other governments. We find that the number of public
employees and the Republican vote share in 1992 significantly discouraged service delivery by
other governments. The negative coefficients for the public labor force variables suggest that
cities with high labor costs were unlikely to employ other labor-intensive forms of service
delivery. A community was less likely to contract out with other governments the greater the
county Republican vote suggesting conservative electorates may encourage elected officials to
reduce government production as well as provision. Manager turnover had the expected negative
effect, but it was not statistically significant.
The second column examines the propensity to contract out services to nonprofit
organizations versus in-house production. The public employee and the Republican vote share
variables had the same effect as on contracting with other governments. Market attributes also
influenced the chance of contracting out to nonprofit organizations. An increase in the
percentage of the population that is white increased the likelihood of contracting out to nonprofit
organizations. However, as the proportion of residents below the poverty line increased, so did
the chance that cities would contract out to nonprofit organizations. Economies of scale
arguments might account for this finding because cities with lower income residents typically
have more nonprofit organizations, resulting in greater competition among the nonprofit service
providers. Increased competition should lower the costs of contracting out to nonprofit
organizations (citation withheld).
Manager turnover had a large and significant effect on contracting out to nonprofit
organizations. Each turnover of city managers reduced the likelihood of contracting out to
nonprofit organizations fourteen percent. Finally, larger cities were more likely to contract out
13
services to nonprofits than smaller cities. Larger cities might be more likely to contract out
services because of demands for services created by more heterogeneous populations.
Perhaps the most interesting results are the column 3 estimates for contracting with
profit-seeking firms. Cities located in metropolitan areas were more likely to contract out
services to profit-seeking firms (21.0 percent more likely) than cities not located in metropolitan
areas. This again is consistent with our economies of scale argument that metropolitan areas
offer more alternatives in service provider options. Table 1 also reports strong evidence that
manager turnover discouraged service delivery via profit seeking firms. Each turnover of
managers reduced the odds of contracting out to profit seeking firms by 11.7 percent. This effect
supports our proposition that executive turnover increases the transaction costs of negotiating
agreements, and affects the ability of local governments to make credible commitments to
alternative service providers. The more services a city provides, the more likely it is to contract
out to profit seeking firms, reinforcing the argument that cities use contracting to reduce overall
costs of operations, which are greater in full service municipalities. The measures of public
employees and racial homogeneity have the same effect on out-sourcing to profit seeking firms
as they do for contracting to nonprofit organizations.
The results reported in Table 1 confirm the importance of manager turnover on
contracting out in general, and extend this finding to explain the choice of the sector with which
cities contract.
While turnover discourages all forms on contracting out, the impact is greatest
for nonprofit and profit seeking organizations. This is also evident in tables of predicted values
reported in the next section. These findings confirm the usefulness of transaction cost based
explanations for political decision-making (Stein, 1990). We now extend this approach by
examining the influence of policy types on contracting and sector choice.
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The regulatory non-regulatory distinction has important consequences. The regulatory
service variable is significant for the other government and the nonprofit providers. The RRR
below one (0.451) for the nonprofit sector suggests that local governments favor in-house
production of regulatory services over contracting out to nonprofits. However, the RRR above
one (1.25) for the other government sector indicates local governments frequently contract out
regulatory services to other levels of government. As discussed above, these differences may
result because regulatory policies address value conflicts that tend to concentrate costs or
benefits on some small segment of the economy (Lowi, 1967). Nonprofit organizations that
provide regulatory services may be interested in producing the services because of their stake in
one side of the value conflict. In this context, transaction costs result from the risks of
delegation of coercive authority to a group that advocates one side of a policy with inherent
value conflict (Ferris and Graddy, 1986).
The impact of private goods on contracting choices is statistically significant, and the
RRR is below one for all of the service supplier options (other government 0.702, nonprofit
0.095, and for-profit 0.309). This strongly supports the proposition that local governments prefer
to produce private goods in-house rather than contracting them out. We attribute this effect to
transaction costs created by the need of local governments to monitor the provision of private
goods, which offer easily obtained slack resources to opportunistic external providers. The
public goods variable is significant for all three service provider options, and RRRs for that
variable are all below one (other government 0.645, nonprofit 0.470, and for-profit 0.479). Once
again, this implies local governments prefer to provide public goods in-house. This may result
because the provision of public goods require sunk costs (e.g. purchasing a snow plow or traffic
signals) combined with information asymmetries and monitoring costs.
15
The RRR for the CPR goods category is significant for all service provider options, but
the direction of its effect changes between service provider options. The RRR is large for the
nonprofit sector (2.543), but less than one for the other two service sectors (other government
0.643, and for-profit 0.545). Local governments prefer to contract out CPR goods to nonprofits,
but would prefer to provide CPR goods in-house rather than contract them out to the other
service sectors. Relatively small or geographically concentrated groups consume most CPR
goods. As a result, there is a core constituency to provide the political support and to encourage
local officials to contract CPR goods to locally based nonprofit organizations (citation
withheld). The motivation for the core group support is a desire for the service delivery agent to
be responsive to their preferences. The same locally based interests would most likely oppose
contracting out to other governments or profit seeking firms that may be less responsive to their
preferences than a local non-profit that is already involved in the management of the good.
Finally, the Peterson classification is significant and its RRRs across the three service
provider options are all well below one (other government 0.202, nonprofit 0.380, and for-profit
0.515)4. This suggest that developmental services are more likely to be provided in-house, and
redistributive services are more likely to be contracted out, consistent with Stein’s (1993)
argument. Allocational services are likely to be contracted out to profit-seeking firms.
Allocational services include basic city services many municipalities contract out, such as
emergency medical services, public parking facilities, etc.
Analysis of Predicted Values
To ease interpretation of the transaction cost measures, we calculated predicted values of
Y (propensity to contract out a service) that are conditional on some chosen value of the
4
Estimates with the Peterson categories operationailized with a set of dummy variables yielded similar results.
16
explanatory variable(s) of interest (see King, et al., 2000). The three tables of predicted values
are compared among the classification categories to show how the characteristics of the services
influence service contracting and across each classification category to illustrates how manager
turnover impacts contracting out of municipal services.
<Table 2-4 about here>
Table 2 reports the greatest change in the predicted values between regulatory and nonregulatory services occur in the nonprofit sector. The predicted value for the nonprofit sector
provider of a non-regulatory service when there are three new managers is (3.60); this value
decreases to (0.80) for the provision of a regulatory service. The predicted values change in the
opposite direction when comparing the provision of non-regulatory (9.60), and regulatory
(11.60) services by profit-seeking firms. Local governments prefer to contract out regulatory
services to profit-seeking firms than to nonprofit organizations. Local governments may contract
out regulatory services to profit-seeking firms because transaction costs of monitoring are less
than for non-regulatory services. Thus, local governments may be more willing to contract out
regulatory services to profit seeking firms. Comparing the predicted values across provider
options reveals administrative turnover decreases the likelihood of local governments contracting
regulatory and non-regulatory services. Predicted values for in-house and other government
provision of regulatory services and non-regulatory services increase with the number of new
managers while provision by nonprofits and for-profits, for both regulatory and non-regulatory
services decrease with manager turnover.
Table 3 reports the greatest variation in predicted values for Ostoms’s CPR goods
category. Nearly forty-five percent of CPR goods are provided by nonprofit organizations, other
governments, or for-profit firms. There is less variation in the private goods, 73.5 percent of all
private goods are provided in house. The vast majority of public goods are also provided in
17
house (70.3%). Comparing predicted values across the classification categories demonstrates
manager turnover impacts the ability of local governments to contract out services. In the case
of private goods, turnover reduces contracting out with nonprofits and profit-seeking firms, but
increases the likelihood of contracting out to other governments. As predicted, turnover
increases in-house provision and decreases contracting out of public goods and CPR goods. The
predicted values for in-house and other government providers increase as turnover increases and
out-sourcing to nonprofits and for-profits decreases as turnover increases.
The results support our extension of Peterson’s (1981) argument that developmental
services are likely to be provided in-house and that redistributive services are provided by
alternative methods because of their varying levels of political support and higher decisionmaking costs. Three-quarters of all developmental services (78.40%) are provided in-house
regardless of the level of turnover. Barely half of all redistributive services (50.80%) are
provided in house compared to the two-thirds (66.50%) of allocational services, lending
credibility to Stein’s (1993) assertion that municipalities engage in indirect provision
(contracting out) of redistributive services to avoid the political and financial costs of providing
these services in house. Strong support for the influence of turnover is found within each service
classification. The changes across the predicted values for the redistributive, allocational, and
developmental service classifications show that turnover decreases the chance of contracting out
with external supplies.
Discussion
The transaction cost approach provides a conceptual link between economic and political
explanations for contracting and also helps us understand the choice of the sector of the external
service delivery agent. Extant research suggested that local contracting decisions are affected
18
by transactions cost problems resulting from both administrative uncertainty and the
characteristics of goods. Nonetheless, prior to this analysis the effects of service types and
turnover have not been studied jointly. Executive turnover and the characteristics of goods and
services affect uncertainty in exchange and credibility of commitments. Our findings suggest
administrative turnover can make contracting with private, profit-seeking providers expensive or
risky. This kind of privatization failure can be characterized as "contract failure"(citation
withheld). If privatization failure seems likely, in-house service delivery may be the best
strategy for local governments. The same factors also could make particular types of external
delivery, such as contracting with governmental or not-for-profit organizations, a less risky
option than contracting with profit-seeking firms.
Private and public goods appear unlikely to be out-sourced to any kind of alternative
service provider. This may be because the transaction costs of monitoring the distributional
consequences of external production of private and public goods provision are high. Even
though for-profit firms, non-profits, and other governments may efficiently produce these goods,
the costs of mitigating possible opportunistic behavior of external suppliers make it less likely
cities will contract these kinds of services. In addition, local leaders may not wish to contract
out some services because doing would limit their ability to claim credit for service benefits that
are popular among local constituencies.
We confirm that characteristics of services affect whether or not local governments
contract out. For example, regulatory services are unlikely to be contracted out to nonprofit
organizations. Some localities may be unwilling to contract out these services because of the
risks of delegating coercive authority (Ferris and Graddy, 1986). Further, private goods and
public goods may not be contracted out because of the costs to monitor distributional aspects of
service delivery and prevent opportunistic behavior. Local governments contract out
19
redistributive services, and provide developmental services in-house in response to their different
decision-making costs.
As substantial as our finding is regarding the implications of service characteristics, our
results regarding executive turnover are even more compelling. Administrative uncertainty was
predicted to reduce contracting out to profit-seeking firms for which high power incentives
operate, which is generally what we find. The RRR for the manager turnover variable is
consistently well below one. This result indicates that cities are much less likely to contract out
services when their administrative environments are unstable.
The application of transaction costs approaches to service contracting point to the
importance of institutions, political contexts, and administrative change for understanding the
efficiency of the various policy choices confronting local governments.
The framework
provided here for examining sector choices for service contracting might also be utilized to guide
empirical inquiry of other local government policy such as debt management and economic
development incentives that involve exchange and contractual commitments between
governments and private actors.
20
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24
Table: 1 Multinomial Logit Estimates of Contractor Choice a
Variable
Provided in 1988
Percent White
Below Poverty
Manager Turnover
SMSA
Service Responsibility
Public Unionization
Public Employees
1992 Republican Vote
Population Change
1980 Population
Regulatory Service
Private Good
Public Good
CPR Good
Peterson Classification
Other
Government
(n=1342)
RRR
Z
1.002
0.199
(0.013)b
0.998
-0.371
(0.002)
1.010
1.511
(0.007)
0.956
-0.979
(0.043)
0.947
-0.985
(0.051)
1.002
0.699
(0.003)
0.993
-1.485
(0.004)
0.999** -3.884
(.00039)
0.977** -5.227
(0.004)
1.439
0.944
(0.555)
0.960
-1.120
(0.034)
1.253** 2.697
(0.105)
0.702** -4.001
(0.061)
0.645** -5.097
(0.0554)
0.643* -1.920
(0.147)
0.202** -14.85
(0.021)
Nonprofit
Provider
(n=460)
RRR
Z
0.978
-0.944
(0.022)
1.017**
3.522
(0.005)
1.044**
4.290
(0.010)
0.860*
-1.953
(0.066)
0.956
-0.504
(0.084)
0.998
-0.187
(0.006)
0.999
-0.078
(0.007)
0.999**
-2.523
(.00055)
0.983*
-2.251
(0.007)
0.780
-0.381
(0.508)
1.092*
1.612
(0.060)
0.451**
-4.168
(0.077)
0.095**
-12.31
(0.018)
0.470**
-6.449
(0.055)
2.543**
4.281
(0.554)
0.380**
-5.979
(0.061)
------------------------------------------------------Number of Observations
9070
Log Likelihood Function
-8207.23
Chi-Square
926.98
* significant at 0.10 level with a two tailed test
** significant at 0.05 level with a two tailed test
a
The toll good variable dropped due to collinearity.
b Numbers
in parentheses are standard errors.
25
For-Profit
Provider
(n=1250)
RRR
Z
0.977
-1.577
(0.014)
1.00*
1.808
(0.003)
0.997
-0.331
(0.007)
0.883** -2.585
(0.042)
1.210**
3.322
(0.069)
1.008**
2.103
(0.004)
1.001
0.371
(0.004)
0.999** -2.668
(.000031)
0.997
-0.457
(0.004)
2.219**
2.037
(0.868)
1.135**
3.716
(0.038)
1.089
1.023
(0.091)
0.309** -12.94
(0.028)
0.479** -9.368
(0.037)
0.545** -2.380
(0.138)
0.515** -6.253
(0.0546)
Table: 2 Predicted Values for Regulatory and Non-Regulatory Servicesa
Non-Regulatory Service
Service Sector Choice
In House
Other Government
Nonprofit
For-Profit
Number of New City Managers Between 1988 and 1992
Zero
One
Two
Three
68.00
71.30
74.40
73.50
12.90
12.30
12.70
13.30
3.50
3.20
2.50
3.60
15.60
13.20
10.40
9.60
Regulatory Service
Service Sector Choice
In House
Other Government
Nonprofit
For-Profit
aAll
Number of New City Managers Between 1988 and 1992
Zero
One
Two
Three
66.70
65.60
72.60
72.50
16.90
17.90
14.90
15.10
1.80
1.90
2.50
0.80
14.60
14.60
10.00
11.60
other independent variables are set at their means.
26
Table: 3 Predicted Values for Private, Public and CPR Goodsa
Private Good
Service Sector Choice
In House
Other Government
Nonprofit
For-Profit
Number of New City Managers Between 1988 and 1992
Zero
One
Two
Three
73.50
75.90
76.70
78.10
14.80
13.40
13.90
14.50
1.00
1.00
0.70
0.70
10.70
9.70
8.70
6.70
Public Good
Service Sector Choice
In House
Other Government
Nonprofit
For-Profit
Number of New City Managers Between 1988 and 1992
Zero
One
Two
Three
70.30
72.80
72.00
72.90
11.30
11.50
11.90
12.10
4.70
4.50
4.40
4.00
13.70
11.20
11.70
11.00
CPR Good
Service Sector Choice
In House
Other Government
Nonprofit
For-Profit
a Ostrom’s
Number of New City Managers Between 1988 and 1992
Zero
One
Two
Three
54.30
57.30
60.20
63.50
10.20
12.00
11.30
9.10
21.50
19.70
17.10
17.80
14.00
11.00
11.40
9.60
service categories set at zero, and all other independent variables are set at their means.
27
Table: 4 Predicted Values for Redistributive and Allocational Servicesa
Redistributive Service
Service Sector Choice
In House
Other Government
Nonprofit
For-Profit
Number of New City Managers Between 1988 and 1992
Zero
One
Two
Three
50.80
55.10
55.80
60.60
27.90
25.50
26.30
23.70
5.10
3.90
4.30
4.30
16.20
15.50
13.60
11.40
Allocational Service
Service Sector Choice
In House
Other Government
Nonprofit
For-Profit
Number of New City Managers Between 1988 and 1992
Zero
One
Two
Three
66.50
69.80
69.00
73.00
16.10
12.70
14.10
14.10
3.40
4.00
3.40
3.00
14.00
13.50
13.50
9.90
Developmental Service
Service Sector Choice
In House
Other Government
Nonprofit
For-Profit
a
Number of New City Managers Between 1988 and 1992
Zero
One
Two
Three
78.40
78.10
78.50
82.90
6.00
7.90
7.40
7.60
2.90
3.00
1.90
1.30
12.70
11.00
12.20
8.20
All other independent variables are set at their means.
28
Service Category
Residential Solid Waste
Commercial Solid Waste
Solid Waste Disposal
Street Repair
Street/Parking Lot Cleaning
Snow Plowing
Traffic Signal-Install/Maintenance
Parking Meter Maintenance
Tree Trim/Plants In Public Areas
Maintain/Administer Cemeteries
Inspection Code Enforcement
Operate Parking Lots/Garages
Operate Bust Transits System
Crime Prevention/Patrol
Policy/Fire Communications
Fire Prevention/Suppression
Emergency Medical Service
Ambulance Service
Traffic Control/Parking Enforce
Vehicle Towing & Storage
Sanitary Inspection
Insect/Rodent Control
Animal Control
Operation of Animal Shelters
Operation of Day Care Facilities
Child Welfare Programs
Programs for the Elderly
Operation/Manage Hospital
Public Health Programs
Drug/Alcohol Treatment Programs
Mental Health Programs/Centers
Prison/Jails
Operate Homeless Shelters
Operate/Maintain Recreation Area
Parks Landscaping/Maintenance
Operate Convention Center
Operate Culture/Arts Programs
Operate Library
Operate Museums
Buildings/Grounds Maintenance
Building Security
Payroll
Tax Bill Processing
Tax Assessing
Data Processing
Collect Delinquent Taxes
Title Records/Plat Map Maintain
Legal Services
Secretarial Services
Personnel Services
Public Relations/Public Info
Operate Paratransit System
Operate Airports
Appendix A
Classification of Services
Regulatory
Ostrom
Peterson
REGULATORY
REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
REGULATORY
NON-REGULATORY
NON-REGULATORY
REGULATORY
NON-REGULATORY
REGULATORY
REGULATORY
REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
NON-REGULATORY
29
TOLL
TOLL
TOLL
PUBLIC
PUBLIC
PUBLIC
PUBLIC
PRIVATE
PRIVATE
PRIVATE
PUBLIC
PRIVATE
TOLL
PUBLIC
PRIVATE
PUBLIC
CPR
CPR
PUBLIC
PRIVATE
PUBLIC
PUBLIC
PUBLIC
TOLL
PRIVATE
TOLL
TOLL
CPR
PUBLIC
TOLL
TOLL
CPR
CPR
CPR
CPR
PRIVATE
TOLL
TOLL
TOLL
CPR
TOLL
PRIVATE
PRIVATE
PRIVATE
PRIVATE
PRIVATE
PRIVATE
PRIVATE
PRIVATE
PRIVATE
PUBLIC
TOLL
TOLL
ALLOCATIONAL
DEVELOPMENTAL
ALLOCATIONAL
DEVELOPMENTAL
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
DEVELOPMENTAL
REDISTRIBUTIVE
DEVELOPMENTAL
DEVELOPMENTAL
REDISTRIBUTIVE
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
DEVELOPMENTAL
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
REDISTRIBUTIVE
REDISTRIBUTIVE
REDISTRIBUTIVE
REDISTRIBUTIVE
REDISTRIBUTIVE
REDISTRIBUTIVE
REDISTRIBUTIVE
ALLOCATIONAL
REDISTRIBUTIVE
DEVELOPMENTAL
DEVELOPMENTAL
DEVELOPMENTAL
DEVELOPMENTAL
DEVELOPMENTAL
DEVELOPMENTAL
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
ALLOCATIONAL
REDISTRIBUTIVE
ALLOCATIONAL
ALLOCATIONAL
DEVELOPMENTAL
REDISTRIBUTIVE
DEVELOPMENTAL