Privatization of Welfare Services: A Review of the Literature. Guaranteeing Competition


While proponents of privatization argue that service improvements and cost efficiencies will arise, in large part through the incentives inherent in a competitive market, Sclar (2000) and others point out that the market in which government contracting takes place might not realize this ideal, for a number of reasons. One factor that frequently contributes to an imperfect market for social service privatization is a limited number of qualified providers. Because of the specialized nature of social service delivery--which, in many cases, requires well-trained professionals and imposes significant start-up costs--the pool of capable contractors might be quite small. In these situations, bidders have reduced incentives to minimize costs and operate more efficiently (Sclar 2000; GAO 1997b; Cohen and Eimicke 2001b). A desire for continuity in service provision can also hinder switching among potential service providers, further restricting the choices available to public agencies (Kettl 1993). One tool for encouraging providers to enter a market is government grants for "capacity building" within these organizations. Another possibility is to offer payment terms that help cover the costs of contractor expansion, such as the purchase of facilities or the hiring of new staff (Cohen and Eimicke 2001b). Both these approaches to increasing competition, however, reduce any potential cost savings from privatization, at least in the short run.

Lack of complete information--about the actual costs of providing services or the abilities of contractors--might erode the benefits of a competitive market. A government agency awarding a contract cannot make the most favorable decision, in terms of price and quality, without such knowledge (Sclar 2000). The result may be poor services for clients at a cost above what the agency would pay if it provided the services directly. This type of market failure is especially problematic in the context of social services, where quality service provision is both highly important and difficult to confirm (Blank 1999).

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