Public contracting Vs in-house service delivery?

Conventional wisdom would have it that private contracting is more cost-effective than government in-house activity in that they deliver services with greater quality aand at cheaper prices. I have sought to provide a more nuanced perspective on the issue here, here, and here.

In this context, a first of its kind comprehensive comparative study of the cost of in-house government delivery versus private contracting by the Project on Government Oversight (POGO) in the US reveals several interesting findings. It analyzed the total compensation paid to both federal and private sector employees, and annual billing rates for contractor employees across 35 occupational classifications covering over 550 service activities to assess the cost-effectiveness of federal service contracting. The study writes,

"The current debate over pay differentials largely relies on the theory that the government pays private sector compensation rates when it outsources services. This report proves otherwise: in fact, it shows that the government actually pays service contractors at rates far exceeding the cost of employing federal employees to perform comparable functions.

Our findings were shocking — POGO estimates the government pays billions more annually in taxpayer dollars to hire contractors than it would to hire federal employees to perform comparable services. Specifically, POGO’s study shows that the federal government approves service contract billing rates — deemed fair and reasonable — that pay contractors 1.83 times more than the government pays federal employees in total compensation, and more than 2 times the total compensation paid in the private sector for comparable services... Federal government employees were less expensive than contractors in 33 of the 35 occupational classifications POGO reviewed... Private sector compensation was lower than contractor billing rates in all 35 occupational classifications we reviewed...

We believe awarding government service contracts is nearly always more expensive than having such work performed by federal employees, even after accounting for the total cost to the government of federal employee fringe benefits and associated overhead costs."

In simple terms, this effectively negates the widespread perception that contracting out service delivery will result in considerable savings. The argument that outsourcing or contracting will automatically result in competition and resultant efficiency improvements and tax payer dollar savings is questionable, certainly the later. As the study finds out - using contractors to perform services may actually increase rather than decrease costs to the taxpayers.

And about the reasons for this failure of governments to wring out better deals from private contractors than even the private sector,

"POGO found several failures in government procurement, employment, and data systems that limit the government’s and the public’s abilities to assess and correct excessive costs resulting from insourcing or outsourcing federal services. Failures included the lack of standards for calculating cost estimates and justifying insourcing or outsourcing decisions; the lack of data related to negotiated service contract billing rates; not publishing government information about the number of actual contractor employees holding a specific occupational position under any given contract; and that there is no universal job classification system."

Cost-effectiveness consists of two parts - efficiency improvements and cost of service delivery. Though, as the study shows, contracting fails on the later, it does bring in efficiency improvements. This does mitigate the higher cost of service delivery to some extent. But even with this, the cost of contracting remains far higher, as seen from the comparative study, for similar service delivery in private sector (where the efficiency improvements are less substantial).

This cost of contracting becomes even greater in developing countries where the cost of transacting with the government is substantial and a premium gets priced into the contract cost. This apart, the inability or limitations inherent in public contracting systems comes in the way of governments getting the best possible deal. Finally, there is the issue of inherent problems of co-ordination and resultant transaction costs associated with scale that applies to contracting certain public services. All these three problems are greater in developing countries, and therefore the premiums are higher.

None of this is an endorsement of in-house serive delivery or a case against outsourcing or public contracting. My objective is two-fold. One, it is important that we rectify the skewed public perception that private service delivery is inherently more efficient and cheaper than in-house service delviery. Second, a proper recognition of these deficiencies is important to help us design and implement outsourcing contracts that are cost-effective.