the role of competition in bureaucracy benito arruÑada arrunada arrunada pompeu fabra university
TRANSCRIPT
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The Role of Competition in Bureaucracy
Benito ARRUÑADAhttp://www.econ.upf.es/~arrunada
Pompeu Fabra University
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Introduction:Organizational divisionalization
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Possibilities and problems
▪ Divisions without objective evaluation ♦ Expense center—budgets (bureaucracy)
▪ Divisions with objective evaluation♦ Cost center
• Quality suffers
• Too little/much quantity, with increasing / decreasing costs
♦ Revenue center: excessive quantity♦ Profit center
• Transfer pricing: congruency versus motivation
♦ Investment center: • Be careful with ROI Use residual profits
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Key issue
Moving away from bureaucracy (expense centers) to “internal markets”
or, at least, introducing market incentives in bureaucracies
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Family doctors are being asked to get a grip on hospital spending. It is a tough battle
“The National Health Service: The power game”, The Economist, March 3, 2007, pp. 33-34.
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Three Parts
▪ I. The economics of bureaucracy
▪ II. Learning from old services
▪ III. Taking stock
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Part IThe economics of bureaucracy
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Expense centers
▪ Given a budget, provide vague set of services♦ In firms: accounting, personnel, planning departments♦ Ministries, universities, Government, NHS, etc.
▪ Problems: grow to large & inefficient b/c:♦ Users not pay demand until U’ = 0♦ Providers “build empires”
• to consume, career, prestige, hire friends, etc.
♦ Budget office badly informed on users’ value and providers’ costs: • E.g., spend annual budget fully to avoid hinting of slack
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Internal Demand
Cost
Marginal Cost
Average Cost
Quantity
Tendency
Optimal budget
Discretionary expense center with increasing
cost function
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The equilibria of a bureaucracy: Niskanen’s model
▪ Maximize budget for two demand functions, D1(Q) and D2(Q) subject to total utility >= budget
D (Q)2
D (Q)1
j
s
o
D, C
k
Q
g
i
hl
a 2
f
(óptimo)Q* 1a / b
Q = 2(a -s)÷(b+t)1 1 Q = a /b22
a1
2(a -s)÷(b+t)2
C (Q) = s + tQmg
mg
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Production under competition, monopoly and bureaucracy
Competition
Monopoly Bureaucracy
Internal Demand
Marginal Cost
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Budget battles, cuts, freezes
▪ Budget office does not know where to cut
▪ Gaming with budget office: e.g., closing service to crucial, sensitive clients
▪ Root causes subsist recidivism
▪ Even “zero-base” budgeting not much better than usual “incremental” budgeting
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Radical solution: incentives, even aiming for an “internal market”
▪ Users: prices (partial, total) and/or opportunity cost through freedom of choice (among expenses, internal providers, external providers)
▪ Providers: pay for performance, even profit sharing; and freedom to organize provision
▪ Budget office: upgraded to market designer and manager, big expense center itself
▪ Hope-for effects♦ Users reveal information better control of budget♦ Providers organize efficiently♦ Users guide resource allocation, closures efficiency
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How markets work
▪ Real markets rely on property rights, which automatically♦ Evaluate performance♦ Reward owners♦ Reallocate resources
▪ Artificial markets need a planner to♦ Allocate decision rights♦ Design and implement evaluation systems♦ Reward decision makers who are not owners
(agency)
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The market planner’s tasks ▪ Designing the market
♦ Allocate decision rights♦ Design and implement evaluation systems♦ Reward decision makers who are not owners
(agency)
▪ Avoiding market failure♦ Externalities: More than in real markets?♦ Locus of uncertainty
▪ Tolerating market decisions♦ If we are reluctant to close private firms, are we
willing to accept the market’s verdict on public services?
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Jensen’s “locus of uncertainty” problem
▪ Matching supply and demand to avoid parties’ freedom causing surplus capacity
▪ Factors: ♦ Expense composition affects consumption
predictability♦ Computers help real time budgeting♦ Capacity to speedy re-contracting of recourses ♦ Flexibility for internal reallocation of recourses
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Discussion
▪ The Lenin-Lange paradox♦ Does it make sense to nationalize an industry (e.g.
healthcare) to later create an internal market?• Only as a stepping stone for privatization?
▪ If the internal market is a planner’s fantasy, what should be done with public services?
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Part IILearning from old services
Judiciary
Registers
Schools
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Judiciary
▪ Users pay fee for service
▪ Judges paid fixed salary quality
▪ Judicial clerks paid salary plus share of fees speed, quantity
▪ Mutual control of judges & clerks
▪ Planners:♦ Suppressed variable compensation of clerks in the 1950s♦ Suppressed fees in 1986
▪ Increasing judicial congestion productivity bonus for judges quality disregarded, mostly ineffective
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Registries
▪ Users free to choose notaries, pay fees▪ Mutual control
♦ Notaries with closed number, franchisees, local competition♦ Registrars with closed number, franchisees, territorial
monopoly
▪ Vertical control♦ Counsels (Letrados) with inspection & appeal functions, paid
fixed salary + substantial deferred compensation
▪ Planners♦ Suppressed counsels♦ Wanted to introduce free choice of registrars♦ Ended up mandating maximum delays
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Schools
▪ Basis for internal market in place: private and public schools, money following users
▪ When demography down, demand switched towards private schools
▪ 17 Planners decided against the market:♦ Constraints on users’ choice ♦ Constraints on private schools growth
▪ Private schools’ dropping to public standards
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Part IIITaking stock
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Salient features of old services
▪ Automatic management: ♦ Opposing incentives: fixed vs variable for controller / controlled
▪ Partial but strong incentives♦ Judges & Letrados: quality important long term careers,
deferred compensation♦ Secretaries: pushing papers, variable compensation ♦ Notaries: Franchises cost containment♦ Registrars: intermediate:
• quality & externalities important monopoly
• Franchises cost containment
♦ Notaries & Registrars: property rights: e.g., employers
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Contrast with internal markets
▪ Plenty of management in designing & running the system
▪ Comprehensive incentive system, trying to cover many dimensions of performance, ideally measured with profit or even ROI proxies
▪ Weak incentives♦ Incomplete decision rights♦ Small variable compensation as % of total♦ Profits or savings not individually appropriated but
invested in unit
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Tentative conclusions
▪ Internal markets♦ Costly to implement♦ Produce little value:
• Weak incentives
• market decisions are rejected
▪ Options for public services♦ Real markets, perhaps with public financing♦ Bureaucracy
• With automatic management elements: e.g., public hospitals run by fixed salary, deferred compensation managers and pay for performance doctors
• With minimalist planning units