If private contracting, managed competition and outsourcing was the silver bullet that saved taxpayer dollars, we would not be facing a trillion dollar federal budget deficit today. The allegations of waste, fraud and abuse by private contractors in Iraq continue to add up. And the city of San Diego is borrowing from the same rule-books of the federal privatization game.

The jury on taxpayer savings from private contracting is still out. For every case study that shows cost savings, there are others that show disastrous results.

Columbia University Professor Dr. Elliott Sclar says in his award winning book (“You Don’t Always Get What you Pay for,” Page 155):

The bottom line is that public contracting continues to be a cumbersome and expensive instrument for the delivery of public service.

So why is it so expensive to contract out?

In his essay “Nature of the Firm,” Nobel laureate Ronald Coase attempted to explain why firms exist? The question he was grappling with, was that if the external market worked efficiently, then there was no need for firms to exist. We would not need organizations, just a bundle of contracts.

The answer Coase proposed, shook the entire establishment of classical economic theory, and gave a new direction to it in new institutional economics (Coase, 1937, Economica, pg. 390):

The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price mechanism. The most obvious cost of organizing production through the price mechanism is that of discovering what the relevant prices are.

Coase had stumbled upon one of the most significant limitations of using the market: the cost of accessing the market itself. New institutional economics labels these as transaction costs.

So let us re-examine the elephant of public contracting. What are the transaction costs involved in private contractors providing public goods? The activity-based costing system commissioned by the city does not account for some of these costs.

Transaction costs in the mayor’s proposed managed competition process include:

  • Search and information costs: There will be four highly paid staff and myriad of consultants in the Mayor’s Office trying to figure out whether there is a market for some of the services, and whether you can protect the public interest by privatizing.
  • Contracting process cost: We will need teams of city staffers and of course private consultants to write the RFP, evaluate the bids, and make presentations.
  • Transition Costs: Recruiting, hiring, licenses and certifications for private contractors, background checks and security clearances, procuring equipment and minimizing disruption to services for 6 months during transition.
  • Monitoring and supervision costs: This will need an army of supervisors, or self-supervision (Iraq-style). Or we could have supervisors to supervise over the contractor supervisors. Then, we need auditors, including year-round quality assurance program. Most empirical evidence about public contracting suggests that this is where the most problems occur.


These transaction costs need to be included in our evaluation of our $1.4 billion “Supplies and Services” budget, or soon we will have a white elephant on our hands: charming, but very expensive.

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