5.2 Contracting-out under public and private ownership of the facility
Hart et al (1997) consider two cases: (i) the government can own the prison and employ a manager to run it, and (ii) the government can contract with a company owned by the prison manager to run the prison for a period of time. They ignore investments on the government side, but suppose that the prison manager can either invest in efficiency enhancements that improve the quality of prison services or invest in finding ways to reduce cost and quality within the letter of the contract with the government. A government employee has little incentive to engage in either activity since they will receive little or no share of the additional surplus created, but a private owner-manager has stronger incentives to do so. “The good news about this is that private ownership encourages the first, innovative, type of investment. The bad news is that private ownership also encourages the second quality-shading type of investment. The choice between public and private ownership depends on which of these effects are more important, and the extent to which the government can limit the extent to which quality-shading can occur”(Hart 2003:C71).
In a related analysis of private ownership, Lulfesmann (2007) extends this analysis by considering the importance of public-sector decision-making in the presence of a soft budget constraint as a rationale for ownership by the private sector. He argues that soft budget constraints may apply to private-sector firms operating important infrastructure facilities because of the proclivity of governments to offer bailouts to private firms to allow the continued operation of such facilities. He then demonstrates that in an incomplete contracts model where either the private-sector owner or the government renegotiate wages with the manager of the facility, once the ongoing viability of an existing technology is known, private ownership will generate the most efficient levels of investment in all states, except that where the existing technology is not viable and closure of the facility would be required if it was privately owned.
