Privatization of Welfare Services: A Review of the Literature. Cost Savings


A basic tenet of economic theory is that competitive markets will result in cheaper and higher quality goods and services as consumers shop around for the best deal and suppliers work to provide the best products at the lowest cost. This theory suggests that contracting out saves money as the positive pressures of competition force organizations to find ways to work more efficiently. This is thought to hold true for competition broadly, not only for competition by for-profit corporations. In fact, for some observers, what matters most is the extent of competition rather than simply whether the public or private sector is the provider (Kettl 1993; Donahue 1989; Osborne and Gaebler 1992; Nightingale and Pindus 1997).

The empirical evidence about cost savings through contracting out social services tends to be mixed, although overall it suggests the potential for somewhat lower costs.

  • A 1993 survey, conducted by the Reason Foundation, found that cost savings were the most common reason for privatizing social services, but officials estimated that savings in this service area were lower than those in other services. About a quarter of agencies reported that their cost savings for social services were 10 percent to 20 percent, while the remaining 75 percent reported that they saved 10 percent or less (45 percent reported no cost savings). Savings in other areas were estimated at 20 percent to 40 percent. Insufficient competition in bidding for contracts was cited as one reason for the limited cost savings (Eggers and Ng 1993).
  • The 1996 GAO child support enforcement report examined the cost effectiveness of privatized services at four sites in three states--Arizona, Tennessee, and Virginia--where cost effectiveness was defined as the administrative costs of collecting one dollar. The study found that in the Arizona and Virginia sites, the privatized operations were 18 percent and 60 percent more cost effective respectively than the public operations. In Tennessee, however, one public operation was 52 percent more cost effective than its privatized counterpart, while at another site, the private and public operations were about the same (GAO 1996).
  • A 1997 survey by the Council on State Governments of state social service agencies found that 53 percent privatized more than 15 percent of their programs but that the reported cost savings were modest. Of those agencies that provided an estimate of savings, 76 percent said they saved less than 5 percent, and no agency reported saving more than 15 percent of its budget (Chi and Jasper 1998).

Some observe that cost estimates, however, often do not include the transaction costs entailed in the contracting process (Sclar 2000). Agency officials might not always include the expense of effective contract design and monitoring in survey estimates. In addition, the cost comparisons between the private and public sector should control for variables, such as the proportion of clients who are "difficult to serve" or other relevant differences (Walters 2000; Yates 1997c).

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