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Major differences in the benefits of contracting out

New research shows that it is primarily average size municipalities that reap the effects when public services are contracting out. It’s time to adopt a more nuanced and context-specific approach.
Ole Helby Petersen
Ole Helby Petersen.

Ever since names like Reagan, Thatcher and Schlüter defined the political trends, contracting out and competitive tendering have been a hot political topic, with strong forces pulling the public towards sending an increasing number of tasks out to tender.

This tendency continues today, based on a rationale that private actors can generate increased growth, more effective solutions and ensure a healthier financial balance than if the public sector were to perform all the tasks themselves.

"It's essentially about how to get the most from the tax revenue. That is the basic question: Can private suppliers help make things cheaper and better, or not?” explains Ole Helby Petersen, professor (MSO) at the Department of Social Sciences and Business.

As a head of research for the research project EffektDoku, he and his colleagues from RUC, Aarhus University, Aalborg University, Copenhagen Business School, the University of Copenhagen and the Danish Centre of Applied Social Science have evaluated the outcomes of contracting out and competitive tendering, and the results are not exactly as one might have expected, he explains.

Roads with potholes as the litmus test

Part of Ole Helby Petersen's research in this field has focused on road maintenance, a field that is suitable to use as a benchmark for wider trends, because all municipalities have roads that need to be maintained and because the task of doing so is not significantly influenced by local factors. Road maintenance is therefore an excellent test of the effects of contracting out, a test that represents a combined annual cost of around DKK 5 billion for the municipalities.

At the same time, we can see that in recent years, there has been an increase in the level of competitive tendering in the municipalities where is was previously low, while those who previously had a high level have maintained the high level, so that most municipalities now have a comparatively high level of contracting out in this area.

The average municipality has the best effect

Although research shows that there is generally a beneficial effect from contracting out, there are some interesting and unexpected findings, explains Ole Helby Petersen:

"Overall, we find that contracting out is associated with lower costs in the area of road maintenance, even when we control for the quality of the roads, i.e. how good a condition the roads are in."

The big 'but' appears when we look at the size of the municipalities and the cost savings achieved.

It is primarily the municipalities with a population in the region of the average Danish municipality, i.e. about 55,000 people, who benefit from contracting out, while the effect is significantly less in both the smaller and the larger municipalities.

This is important knowledge, because many people consider contracting out to be a solution that can be used widely across the country, without taking account of the differences between the municipalities, explains Ole Helby Petersen:

"There are two things that are important when we talk about the size of municipalities: Large municipalities may have more in-house expertise to solve specialized tasks than the small municipalities, so that they can efficiently deliver the services themselves. Conversely, tasks in the small municipalities may be less attractive for the market to bid for. This may be due to the fact that contracts have a limited financial size, meaning that the business case for contracting out is less obvious”, he explains.

Goodbye to standard solutions

These new insights challenge what Ole Helby Petersen refers to as a "one size fits-all" approach to tackling municipal services, i.e. the idea that contracting out is equally effective in all the municipalities around the country.

"We tend to talk about reforms in the public sector as a broad and uniform phenomenon, but it often becomes too broad and undifferentiated. Because if the specific effects that are achieved out there where citizens encounter the service and the tax funds are spent are not the same, it suggests a need for solutions that are better adapted to local conditions”, he believes.

From a political perspective, a solution could be to leave decisions in this area to the discretion of the individual municipalities, instead of setting out inflexible targets and frameworks for the municipalities to meet:

"The broader implication is that some benefits could be achieved by allowing local governments to decide a little more. This could achieve a more efficient performance of the tasks, adapted to local conditions and circumstances. The compulsory competitive tendering regime established in the past did not take account of these differences between the municipalities, and there is an obvious risk that such regulations will become too generalized a way of managing these processes and will not always produce the desired effects” explains Ole Helby Petersen.

Ole Helby Petersen and Kurt Houlberg's research results were published in the international “Journal of Strategic Contracting and Negotiation” in January 2017.

Ole Helby Petersen is a professor (MSO) at the Department of Social Sciences and Business and head of the Centre for Research in Public-Private Interaction (Center for forskning i Offentlig-Privat Samspil (COPS)). He teaches at e.g. Public Administration in the subjects Practical Statistics and Public Economy and Regulation, and on International Public Policy and Administration (IPAP).