Privatization and Corruption

Privatization of services that were formerly provided by governmental agencies has been an important issue for both local and national governments. The purpose of this paper is to examine the issue of privatization in the context of the provision of a public good such as street cleaning and refuse collection, which can be contracted out or provided in-house. Since these services require relatively low technology and both outputs and inputs are readily observable, one would think "privatization" by contracting out is a straightforward proposition. History shows otherwise. Our analysis is motivated by a study of the New York City experience in the 19th Century. Throughout most of the century, street cleaning and refuse collection were contracted out. Yet, the contract system was a total failure. The failure of the system occurred even though various safeguards to ensure contractors' performance were in place. The private contract system was effectively undermined by corruption. Toward the end of the century, the contract system was abandoned and the municipal government took over the provision of services. In this paper, we develop a framework for analysis that focuses on corruption on the part of players when a public good can be either outsourced or provided in-house. Two variations of the rotten apple theory are modeled, one in which player-type is exogenously determined and another in which players choose their type (actions). We identify conditions under which private contracting is more costly than municipal provision of the public good