Privatizing Services in Local Government: An Empirical Assessment of Efficiency and Institutional Explantations

Abstract

ABSTRACT Privatization of local government services by contracting out to private firms has grown in recent years. This study explored the influence of cost efficiency and institutional norms on managers' decisions to privatize services. Transaction cost theory provided a framework for testing the role of efficiency, whereas institutional theory provided a framework for testing the role of institutional norms. Based on a study of 9 services in 88 local governments, the results show that efficiency is a better predictor of the decision to privatize than institutional norms. However, institutional norms are significant predictors of the decision to privatize when the public uses a service; they are not significant predictors when local government uses a service. INTRODUCTION The New Federalism policies of the 1980s redefined relationships between federal and local governments, including less national funding and a greater emphasis on local resources to meet the local needs (Johnson and Heilman, 1987). During this time, the number of services privatized (that is, contracted out)1 in local governments increased sharply (Bailey, 1987). Many studies to date cite potential gains in efficiency to explain the rise in privatization. However, as Ward (1992:497) notes, [E]conomic factors alone are insufficient. As a result, scholars in public administration have generally viewed the political context of governments as supplemental to economic factors (for example, Kolderie, 1986; Morgan and England, 1988; Fitch, 1988; Ward, 1992). In addition to having a political context, local governments operate mainly within an institutional environment. In an institutional environment, organizations conform to implicit or explicit rules and requirements that determine structure and processes. Rewards and legitimacy provide a basis for utilizing acceptable structures rather than evaluation of organizations' output in a competitive market (Scott, 1992). When local government privatize, they change their structures. Services formerly provided within local government are now provided by a contractor using a market-based contract as the structural alternative. Thus, privatization shifts a service from an institutional environment to a market environment. Two theoretical perspectives on organizations can inform the study of privatization as a decision to change structure. One perspective, cost economics, focuses on transactions in a competitive market and proposes that managers choose cost-minimizing structures (Williamson, 1975; Armour and Teece, 1978). The second perspective, institutional theory, proposes that managers adopt institutionally acceptable structures that reflect socially constructed norms of rationality and legitimacy rather than the quantity and quality of output (Meyer and Rowan, 1977; DiMaggio and Powell, 1983; Scott, 1992). This study examines public managers' privatization decision using cost theory to answer the following question: Did increases in privatization seek efficient structures or institutionally acceptable structures (or both)? EFFICIENCY AND THE DECISION TO PRIVATIZE Public managers focus on efficient ways to provide services when they carefully compare the and benefits of providing a service in-house with the and benefits of contracting for the service. A cost analysis first assumes that the sum of all direct production is equal for privatized and non-privatized services. It then focuses on the incurred in the exchange between parties involved in providing the service. These transaction costs are the of negotiating, monitoring, and enforcing the provision of a good or service (Williamson, 1975). Maximum efficiency means that one way of providing a service has lower than all others. Williamson (1981) describes as the economic counterpart of friction in a physical system. …