Thread by @Jabaluck

The modern economic case for public provision is not about public goods or market failures or externalities. It is about what can and can't be achieved by contracting.

The classic reference is Shleifer's 1998 JEP article:

Shleifer's important and influential point is that externalities don't provide a case for public provision if contracts are complete and enforceable.

If factories emit too much sulfur dioxide, tax them. If grocery stores won't locate in areas with poor people, subsidize them to do so (if there is an externality). If UPS won't deliver mail to a valid address in Alaska, write a law with harsh penalties unless they do.

The benefit (and as we'll see, the Achilles heel) of private ownership is that the private sector has stronger incentives for innovation. USPS won't raise $100 billion to build an army of drones to do 1 hour delivery -- or at least, not before Amazon shows them how!

This means that if:
a) You can write and enforce contracts to get exactly what you want (a big if!)
b) Innovation is potentially important (almost always)
You generally want to defer to private provision.

What then is the case for public provision? The problem of non-contractible deterioration in quality (I'll explain!). Imagine there are two ways of making sidewalks, the expensive way and the cheap way, and only the expensive way yields durability.

If the government has no way of monitoring or contracting on which method is used and they offer to pay a private firm to do the job, the private firm will want to increase profits by doing the cheap way.

Now, Shleifer points out -- not so fast! -- the private firm might be disciplined by choice and reputation. They want to do a good job to get future government contracts. So if you can tell if the sidewalk is durable eventually, maybe private contracting still works here.

What's a case where private contracting is particularly unsuitable? Private prisons are (arguably) an example. Who is willing to work in a private prison for very low wages given their qualifications? Probably sadists.

Can the government easily write a contract that says, "Don't hire sadists as guards"? They certainly write very lengthy contracts for private prisons, but this is hard to monitor and contract on.

So you have a setting where there are major concerns about non-contractible deterioration in quality (which is really a private firm "innovating" to lower costs), you have no discipline coming from reputation or choice -- a recipe for bad outcomes from privatization.

What about something like healthcare? Well, it's complicated! Obviously there are huge potential gains from quality innovation in healthcare -- let's roll out AI decision-support faster! The benefits of private firms could be very large.

Is there concern about non-contractible deterioration in quality? Absolutely! e.g. an insurer tries to keep patients out of the hospital to save money and ends up killing them more.

Are these concerns fully addressed by markets and reputation? To some degree, but not entirely, because patients can't fully tell which insurance plans, hospitals and doctors are good.

So where does that leave the case for public provision? Firstly, we need to consider separately each piece of the healthcare system (insurers, doctors, hospitals).

Then, the above considerations suggest that an optimally regulated private system could be incredibly good if you could solve the above problems (provide people with better info about quality?), but that is a big if!

Not every case is so ambiguous. Think of something like private garbage collection. Here, there are certainly some concerns about stuff that's hard to contract on, but the big stuff (cost/frequency of pickup) is contractible.

So my inclination would be that we should probably contract out with private firms to do garbage collection unless there is clear empirical evidence of a problem.

Another reason for public provision (notable in the military) is if the govt. needs to change its mind fast, so contracting is difficult because contracts take time to revise. Or alternatively, if the govt. fears expropriation (e.g. Wagner in Russia).

Finally, avid readers of this Twitter feed might note that the case for govt. intervention (i.e. the First Welfare Theorem) differs from the case for govt. *provision* (reviewed above). Externalities do provide a rationale for government *intervention*.

tldr;

The case for public provision is not about public goods and externalities! It is about contracting; private provision -> innovation, and if you can write a good contract, that innovation will help rather than hurt!