Working Paper Series
No 750:
Privatization of Credence Goods: Theory and an Application to Residential Youth Care
Erik Lindqvist ()
Abstract: A wide range of services provided by the public sector are
credence goods, i.e., services for which the producer has private
information whether a certain treatment is needed or not. This paper
studies how ownership affects the incentives for producers to reveal such
information to public procurers. I develop a model where procurers buy a
more extensive treatment in case quality is high. Private firms have strong
incentives to reduce cost and must be given rents in order not to shirk on
non-contractible quality. The existence of rents makes private firms try to
induce demand for unnecessary treatments. Public sector managers have no
incentive to cut cost, implying that optimal contracts don't entail rents
unless quality is very important. Public sector managers instead use their
informational advantage to avoid unpleasant tasks. Empirical evidence from
residential care for teenagers with behavioral problems supports the
model's predictions. Private ownership prolongs the duration of treatment
by more than a year, doubling total cost. Unlike private facilities, public
facilities are much more likely to initiate treatment breakdowns for
teenagers that are particularly burdensome to treat.
Keywords: Privatization; Public Sector Contracting; Credence Goods; Incomplete Contracts; Contracting Out; Residential Youth Care; Juvenile Delinquency; (follow links to similar papers)
JEL-Codes: H11; H40; L32; L33; (follow links to similar papers)
48 pages, June 4, 2008, Revised September 23, 2008
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