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Choice and Competition in Public Service Provision
We are grateful to participants in the Economic Theory Workshop at Nuffield College for helpful comments on an early presentation of these ideas.
Timothy Besley LSE and CIFAR
James M. Malcomson University of Oxford
In spite of a range of policy initiatives in sectors such as education, healthcare and security services, whether choice and competition is valuable
remains contested territory. This paper puts forward a canonical model for framing the issues where a monopoly incumbent faces potential competition from
an entrant. A novel feature of the framework is studying how competition plays out for different objectives of providers -- for-profit or not-for-profit
-- in the presence of unobserved quality dimensions. We show why entry is less likely with a not-for-proft
incumbent. If consumers are well-informed, competition is welfare enhancing in a wide range of cases provided the incumbent, if not-for-profit, retains
its not-for-profit objective. But we also illustrate cases when it may not be. We discuss when policy-makers should encourage and discourage entry. Our
model also gives an insight into why initiatives are frequently opposed by incumbent providers even if the latter have not-for-profit objectives.
Keywords: Choice, Competition, Public Service
JEL codes: H11, H44, L21, L31. \thispagestyle {empty}
Introduction
\setcounter {page}{1} Pressures on government finances
the world over have spurred calls for cost saving in the provision of public services. Yet whether there are benefits from opening up to external competitors
in the provision of public services remains a controversial topic. The logic for allowing competition is superficially compelling;
if there are potential providers who know how to produce more cheaply than incumbent public sector providers, then it would make sense for
public services to harness these benefits. Suspicion about the value of competition comes from the fact that public services are typically provided by incumbents
whose goals are not-for-profit while many entrants could be standard private firms that are interested in making profits. And there are good reasons, such
as the difficulty of specifying quality, externalities, equity concerns and minimum service obligations which underpin why most public services are not
left to the market in the first place. The aim of this paper is to provide a canonical model of choice and competition in public services
that takes account of the strategic interactions between providers. There are four key features of the approach. First, there is a set of mobile consumers
who are willing to exercise choice. Second, potential service providers differ in their costs, with some having an intrinsic cost advantage. Third, there
are dimensions to quality affecting consumer benefits that consumers are not in a position to assess before choosing a provider. Fourth, some providers
have not-for-profit motives which may or may not be at variance with consumer preferences. We begin with a single incumbent provider. In
many applications, this would be a public provider. However, it also fits the scenario where there is a local
not-for-profit hospital operating in a distinct locality as in Gaynor et al (2015). We are interested first
in the impact of expanding choice by opening up provision of the service to competition where the entrant receives the same regulated price for the service
as the incumbent. Choice in such cases may be exercised directly as when a consumer chooses a school or a hospital. It may, however, be exercised indirectly
by an intermediary such as a doctor choosing on behalf of a patient. We suppose that the incumbent remains active in the provision of services alongside
any private sector competitor. We show how the objectives of the providers -- for-profit or not-for-profit -- affect the case for
choice and competition. Under a wide range of reasonable conditions, competition is welfare enhancing provided consumers are well-informed and the incumbent,
if not-for-profit, retains its not-for-profit objective. But less entry can be expected when the incumbent is a not-for-profit provider than when it is
a for-profit provider. The paper also explores the factors that determine whether policy makers will wish to create a level playing
field for incumbents and entrants. We show that there can be grounds for either encouraging or discouraging entry through the pricing of the service. In
general, we find a presumption against a level playing field and explore the factors
that shape this decision optimally. The model that we develop shows why opposition to competition can be expected from incumbents,
particular provider interests, whose monopoly rents (whether earned as profit or having control over decisions) are threatened. It is important that such
insiders are not therefore decisive in determining policy even when they pursue non-profit objectives.
The Model
Set-up
A not-for-profit provider's objective is a weighted sum of consumer and provider preferences, i.e.
A not-for-profit provider must also respect the profit constraint
First consider the values of that maximize ( ) subject
to the profit constraint ( ).
The Value of Not-for-profit Provision
We note the following:
The consumer utility provided by a monopoly not-for-profit incumbent, , is increasing in and and decreasing in . This proposition says that .
Implications
The utility of the flexible consumers is
This case sees the paternalism of the incumbent completely undone by entry as far as flexible consumers are concerned
because they get their maximal utility given the cost efficiency of the providers. The essential point is that Bertrand competition leaves no scope for
providers to indulge their own preferences over those of flexible consumers. agsm
PK ڵ1 plots/PK ڵ1 tex/PK qH =6 6 tex/main.aux\relax
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\begin{document}
\title{\textbf{Choice and Competition in Public Service Provision}\protect\footnote{
We are grateful to participants in the Economic Theory Workshop at Nuffield College for helpful comments on an early presentation of these ideas. }}
\author{Timothy Besley~~\\\relax LSE and CIFAR
\and James M. Malcomson~~\\\relax University of Oxford}
\maketitle
\begin{abstract}In spite of a range of policy initiatives in sectors such as education, healthcare and security services, whether choice and competition is valuable
remains contested territory. This paper puts forward a canonical model for framing the issues where a monopoly incumbent faces potential competition from
an entrant. A novel feature of the framework is studying how competition plays out for different objectives of providers -- for-profit or not-for-profit
-- in the presence of unobserved quality dimensions.~We show why entry is less likely with a not-for-proft
incumbent. If consumers are well-informed, competition is welfare enhancing in a wide range of cases provided the incumbent, if not-for-profit, retains
its not-for-profit objective. But we also illustrate cases when it may not be. We discuss when policy-makers should encourage and discourage entry. Our
model also gives an insight into why initiatives are frequently opposed by incumbent providers even if the latter have not-for-profit objectives. ~~\\\relax \textit{Keywords: }Choice, Competition, Public Service ~~\\\relax
\textit{JEL codes: }H11, H44, L21, L31.
\end{abstract}
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\section{Introduction}
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Pressures on government finances
the world over have spurred calls for cost saving in the provision of public services. Yet whether there are benefits from opening up to external competitors
in the provision of public services remains a controversial topic.
The logic for allowing competition is superficially compelling;
if there are potential providers who know how to produce more cheaply than incumbent public sector providers, then it would make sense~for
public services to harness these benefits. Suspicion about the value of competition comes from the fact that public services are typically provided by incumbents
whose goals are not-for-profit while many entrants could be standard private firms that are interested in making profits. And there are good reasons, such
as the difficulty of specifying quality, externalities, equity concerns and minimum service obligations which underpin why most public services are not
left to the market in the first place.
The aim of this paper is to provide a canonical model of choice and competition in public services
that takes account of the strategic interactions between providers. There are four key features of the approach. First, there is a set of mobile consumers
who are willing to exercise choice. Second, potential service providers differ in their costs, with some having an intrinsic cost advantage. Third, there
are dimensions to quality affecting consumer benefits that consumers are not in a position to assess before choosing a provider. Fourth, some providers
have not-for-profit motives which may or may not be at variance with consumer preferences.
We begin with a single incumbent provider.~In
many applications, this would be a public provider.~However, it also fits the scenario where there is a local
not-for-profit hospital operating in a distinct locality as in Gaynor et al (2015).~We are interested first
in the impact of expanding choice by opening up provision of the service to competition where the entrant receives the same regulated price for the service
as the incumbent. Choice in such cases may be exercised directly as when a consumer chooses a school or a hospital. It may, however, be exercised indirectly
by an intermediary such as a doctor choosing on behalf of a patient. We suppose that the incumbent remains active in the provision of services alongside
any private sector competitor.
We show how the objectives of the providers -- for-profit or not-for-profit -- affect the case for
choice and competition. Under a wide range of reasonable conditions, competition is welfare enhancing provided consumers are well-informed and the incumbent,
if not-for-profit, retains its not-for-profit objective. But less entry can be expected when the incumbent is a not-for-profit provider than when it is
a for-profit provider.
The paper also explores the factors that determine whether policy makers will wish to create a level playing
field for incumbents and entrants. We show that there can be grounds for either encouraging or discouraging entry through the pricing of the service.~In
general, we find a presumption \emph{against}~a level playing field and explore the factors
that shape this decision optimally.
The model that we develop shows why opposition to competition can be expected from incumbents,
particular provider interests, whose monopoly rents (whether earned as profit or having control over decisions) are threatened. It is important that such
insiders are not therefore decisive in determining policy even when they pursue non-profit objectives.
\section{The Model}
\label{S: model}
\paragraph{Set-up}
A not-for-profit provider's objective is a weighted sum of consumer and provider preferences, i.e.
\begin{equation}[\lambda (\beta Q +q) +(1 -\lambda ) (Q +q -\tau p_{i})]x_{i} =[\alpha Q +q -( 1 -\lambda )\tau p_{i}]x_{i} , \label{NP}
\end{equation} A not-for-profit provider must also respect the profit constraint
\begin{equation}\left \{p_{i} -\left [c \left (Q\right ) +c \left (q\right )\right ]/\theta _{i}\right \} x_{i} \geq 0. \label{zero profit condition}
\end{equation} First consider the values of $\left \{Q ,q\right \}$ that maximize ( \ref{NP}) subject
to the profit constraint ( \ref{zero profit condition}).~
\paragraph{The Value of Not-for-profit Provision}
We note the following:
\begin{proposition}The consumer utility provided by a monopoly not-for-profit incumbent, $U^{ \ast } \left (\alpha ,\theta _{I} ,p_{I}\right )$, is increasing in $\theta _{I}$ and $p_{I}$ and decreasing in $\alpha $.
\end{proposition}
This proposition says that .
\section{Implications}
\label{S: implications}
The utility of the flexible consumers is
\begin{equation*}2 c^{ -1}
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>U^{ \ast } \left (\alpha _{I} ,\theta _{I} ,p\right ) ,\;\ \text{for}\ \ \alpha _{I} >1.
\end{equation*} This case sees the paternalism of the incumbent completely undone by entry as far as flexible consumers are concerned
because they get their maximal utility given the cost efficiency of the providers. The essential point is that Bertrand competition leaves no scope for
providers to indulge their own preferences over those of flexible consumers.
\bibliographystyle{}
\bibliography{contract,evolanth,games,health,labour,micro,other}
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