It has been recognised that the same arguments that apply to the impact of competition on private sector efficiency are also relevant for public sector activity. In the case of public goods, there has to be some sort of government involvement as a free market will not ensure the provision of these goods. However, this does not necessarily mean that the public sector has to provide these good directly. A number of ways in which the public sector can ensure provision through some sort of engagement with the private sector has been developed.
The simplest firm of this is through contracting out. Under such an arrangement, the public sector issues a contract to a private firm for the supply of some good or service. Competition between firms can be encouraged through a competitive tendering service. In other words, the contract would be announced and firms invited to put in bids specifying the quality of the good or service they will provide, and at what price. The local authority will be in a position to look for efficiency in choosing the most competitive bid. One example of this is waste disposal.
More complex models of cooperation between public and private sectors have been developed, involving various kinds of Public Private Partnership. The most common partnership model is the Private Finance Initiative (PFI).
Private Finance Initiative
The PFI was launched in 1992 as a way of trying to increase the involvement of the private sector in the provision of public services. This established a partnership between the public and private sectors. The public sector specifies, perhaps in broad terms, the services that it requires, and then invites tenders from the private sector to design, build, finance and operate the scheme. In some cases, it may be that the project would be entirely free standing – for example, the government may initiate a new product such as a bridge that is taken up by a private firm who recoup their costs eventually through tolls. In some other cases, the project may be a joint venture between the private and public sectors. The public sector could get involved with such a venture to ensure wider social benefits, perhaps through reductions in traffic congestion that would not be reflected in market prices, and thus would not be fully taken into account by the private sector. In other cases, it may be that the private sector undertakes a project and sells its services to the private sector, often over a period of 25 or 30 years.
The aim of the PFI is to improve the financing of public sector projects. This is partly achieved through a competitive element in the tender process, but in addition it enables the risk of the project to be shared between the two sectors, which allows efficiency gains to be made.
The PFI has been much debated and much criticized. One effect the PFI has is to reduced the pressures on public finances by enabling greater private sector involvement on funding. It may however increase the cost of borrowing if the public sector can borrow at more favourable rates.
The tendering process can make cost savings, but may impact on the health and safety of such projects.
As PFI switches the focus from social benefit to efficiency and cost – sometimes social welfare is sacrificed on a small scale, so more efficincy and lower costs which may maximise social benefit on a larger scale.