Public service provision with a limited budget: Service design, privatization and subsidies

Abstract

While demand for public services has been increasing over time, governments are usually short on capital to invest in public service provision, thereby resulting in low accessibility and heavy congestion in systems. To ease the pressure of public service provision, governments may invite private organizations to invest in and run public service systems, i.e., privatize the systems. Using a queueing framework, this paper studies how capital constraints at both the investment and operation stages affect the social planner’s pricing and capacity decisions for public interest maximization when a limited budget is available. Furthermore, two modes of privatization, complete privatization and privatization with regulation, are discussed. We then derive the optimal design of a family of linear contracts to improve the performance of privatization with a limited budget. Our results show that throughput subsidies are more effective than capacity subsidies. Furthermore, we identify the condition under which the social planner should privatize service provision completely or with regulation. Our findings are useful for improving the utilization efficiency of public service budgets.