Government Outsourcing: Public Contracting with Private Monopoly

Abstract

The article studies the impact of the government budget constraint on the regulation of natural monopolies in adverse selection contexts. The government maximises total surplus but incurs some cost of public funds a la Laffont and Tirole (1993). Government outsourcing is proposed as an alternative to regulation in which firms freely enter the market and choose their prices and output levels. However government can contract ex post with the private firms. This ex post contracting set-up allows more flexibility than regulation where governments commit to both investment and operation cash-flows. This is especially relevant in case of high technological uncertainties.