The efficiency of public sector outsourcing contracts: A literature review

Melbourne Institute Working Paper No. 29/04

Date: October 2004


Paul H. Jensen
Robin E. Stonecash


Outsourcing the provision of traditionally publicly-provided services has become commonplace in most industrialized nations. Despite its prevalence, there still is no consensus in the academic literature on the magnitude (and determinants) of expected cost savings to the government, nor the sources of those savings. After articulating the differences between outsourcing and privatization, this article considers the arguments for (and against) outsourcing and then examines the empirical evidence pertaining to whether any observed savings occur and whether they persist over time. In addition, we examine the existing evidence for the “redistribution hypothesis” and the “quality-shading hypothesis”, which critics have used to argue that outsourcing may result in lower government expenditure, but it does so by lowering wages and conditions for employees and lower quality services. Finally, we consider the impact of contract design on outsourcing outcomes. While the nature of the risk-incentive trade-off is well-known in the contract theory literature, some new empirical work has explored the application of this framework to outsourcing in order to understand the impact of the risk premium on outsourcing outcomes.

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