Introduction

During the last two decades there has been a global trend of management reforms in the public sector and of attempting to scale down the public sector with privatisation and contracting out of public service production. Most countries have experienced fiscal pressure and imbalance, and have had the additional motivation for reform that public sector production is assumed inefficient. Government failure has substituted for market failure as the main concern. The reforms aim at overcoming the monopoly producer model and the associated agency problems in public institutions.

The analysis of productivity and costs in public service production must be based on an understanding of the decision problems of governments. We will use the principal-agent model as a framework and two aspects are important. The first concerns the principal, basically the electorate, but represented in various forms in political institutions. Collective decisions represent a challenge of preference aggregation, and characteristics of the political structure have been shown to influence the outcome. The problem is worsened in situations when public spending is separated from financing, the typical case with free or subsidised public services. The ‘common pool’ problem is discussed in the introduction by Torben Andersen and Per Molander, and the challenges of political decision-making are left out here.

This chapter addresses the second aspect: incentives for the agency, the actual provider of the services. When production is delegated to government agencies, well-known agency problems arise because of conflicting interests and limited information.