Transaction Costs and Institutional Explanations for Government Service Production Decisions

Governments not only choose which services to deliver to citizens, but they also choose how to deliver those services. Governments can produce services themselves or through a variety of external production mechanisms, including contracting with other governments, private firms, and nonprofits. In this article, we apply a transaction cost framework complemented with institutional and market theories to examine governments’ service production decisions. Our analyses of a 1997 International City/County Management Association survey shows how governments choose service production mechanisms to manage the transaction costs inherent in delivering different types of services. Perhaps the central decision that governments make is choosing which services to deliver to citizens. However, governments also decide how to deliver these services. Traditionally governments have internally produced services—that is, they have made the services themselves, with their own workers, offices, equipment, and so on. Over the last several decades the means through which governments can deliver services has expanded to include vouchers, franchises, and nontax incentives, to name a few policy tools (Stein 1990; Salamon 2002). In particular, governments have increasingly relied on external actors to produce services through contracting and other third-party arrangements (Warner and Hedbon 2001). Given the array of production possibilities available to governments, why do governments select the service production mechanisms that they do? We use a transaction costs framework to argue that governments select production mechanisms in part to minimize risks associated with delivering services under alternative institutional arrangements. These risks derive from the type of service being produced, the nature of the service marketplace, and goal incongruence between the government and the vendor. We further complement our basic transaction costs framework by arguing that institutional pressures in governments’ operating environments reinforce these purposive decisions about service production mechanisms. In this article we examine how municipal and county governments choose to produce services across five service production mechanisms—internal production, joint contracting, complete contracts with other governments, complete contracts with private firms, and