How heavy a monitoring burden do governments. Outsourcing Oversight: A Comparison of Monitoring for In-House and Contracted Services

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1 Mary K. Marvel Howard P. Marvel The Ohio State University Outsourcing Oversight: A Comparison of Monitoring for In-House and Contracted Services Essays on Service Delivery and Privatization The public sector contracting literature has long argued that outsourced services need to be and, in fact, are subject to a more elevated level of scrutiny compared to internally delivered services. Recently, the performance measurement and management literature has suggested that the twin themes of accountability and results have altered the management landscape at all levels of government. By focusing on performance monitoring, the implication is that monitoring levels for internally provided services should more closely approximate those for contracted services. The analysis provided here yields empirical comparisons of how governments monitor the same service provided in-house and contracted out. We find evidence that services provided internally by a government s own employees are indeed monitored intensively by the contracting government, with levels of monitoring nearly as high as those for services contracted out to for-profit providers. In contrast, however, we find strong evidence that performance monitoring by the contracting government does not extend to nonprofit and other governmental service providers, each of which is monitored much less intensively than when comparable services are provided internally. For such service providers, it appears that monitoring is either outsourced along with services, or simply reduced. How heavy a monitoring burden do governments bear when they contract out the provision of services? The public sector contracting literature has long claimed that when public services are outsourced, their provision needs to be and, indeed, is monitored more closely than when services are delivered directly by governments to their citizens. More recently, the performance measurement and management literature has suggested that the twin themes of accountability and results have altered the management landscape at the federal, state, and local levels. The implication of focusing on performance monitoring is that monitoring levels for internally provided services should more closely approximate those for contracted services. Thus, these two literatures yield differing expectations for the range and intensity of public sector monitoring. The contracting literature posits that increased monitoring headaches and the transaction costs (both ex ante and ex post) that they engender are the inevitable consequences of contracting out public services. The implicit assumption is that outsourced services need to be and are subject to a higher level of scrutiny compared to internally delivered services. In contrast, the performance measurement and management literature suggests that public sector managers must focus on accountability and results, irrespective of the mode of service delivery employed. Though this literature makes no explicit predictions regarding the relative monitoring effort of contracted out versus internally delivered services, one of the intended byproducts of the introduction of performance-based management is more the business-like operation of internally delivered services. This implies that monitoring vigilance for internally provided services more closely approximates that applied to contracted services. Th e analysis provided here, for the first time, yields empirical comparisons of how governments monitor the same service provided in-house and contracted out. Consistent with the contracting literature, our evidence though only tentative because of the small sample size of for-profit providers suggests that governments monitor for-profit deliverers intensively. We also found substantial performance monitoring for services that are delivered internally. The most striking result is that performance monitoring does not extend to nonprofit and other government service providers, both of which are monitored much less carefully by the contracting government than when comparable services are provided internally. Much of the vast and growing empirical literature on service contracting by governments relies on the Profile of Local Government Service Delivery Choices surveys conducted by the International City/County Management Association s (ICMA). Every five years, local government officials are queried about private service delivery, which is defined by the ICMA as Mary K. Marvel is an associate professor in the John Glenn School of Public Affairs at The Ohio State University. Her research concerns the substitution of supposedly higher-power, market-style incentives for the traditional low-power incentives typically found in the public sector. In particular, she focuses on the consequences of public sector contracting, asking whether public sector contracts resemble their private sector counterparts and whether public contracts substantially alter the monitoring and incentives that characterize direct public service provision. Howard P. Marvel is a professor of economics and law at The Ohio State University. He has been a fellow at the Hoover Institution on War, Revolution and Peace at Stanford University; the Institute for Social and Economic Research at Osaka University; and the Institute for Socio-Legal Studies at Wolfson College and Oxford University. His research interests include industrial organization, antitrust, and law and economics. He has advised the Ministry of International Trade and Industry and the Ministry of Post and Telecommunications in Japan, the Korean Economic Research Institute, U.S. antitrust agencies, and the National Association of State Attorneys General. A Comparison of Monitoring for In-House and Contracted Services 521

2 comprising for-profit firms, non-profit organizations, and private industries (ICMA 2002, 1). Officials are asked about activities undertaken to ensure success in implementing private service delivery, obstacles to adopting private service delivery, and techniques used to evaluate systematically the performance of contractors. These data often are used as evidence of the relative costliness of the service-delivery options falling under the rubric of privatization. But a government need only confront the issue of contracting out if it has decided to consider bypassing the most common form of service provision providing services directly. The ICMA surveys provide no information about monitoring advantages and disadvantages of direct service provision compared to contracting out. Yet governments that deliver services themselves need to take steps to promote the success of the implementation of those services. They face obstacles not unlike those faced by contractors, and accordingly, they need to determine how to monitor and evaluate those services. Thus, the ICMA survey, which questions respondents only about monitoring efforts associated with private service delivery, can tell only half the story. Even for private service delivery, the ICMA survey offers respondents a simple yes/no choice for a series of oversight methods and does not link this monitoring to particular programs or modes of service delivery. Surveys also constitute the bulk of the data on the utilization of performance measurement, which is, in the words of one commentator, all the rage in the public sector ( Perrin 1999, 367 ). Melkers and Willoughby (1998) found widespread use of resultsbased budgeting among the states. In 1997, a Governmental Accounting Standards Board and National Academy of Public Administration survey reported that more than 40 percent of responding municipalities used performance measures in some of their programs. A survey by Poister and Streib (1999) found similar utilization results. These surveys do not differentiate, however, between the utilization of performance measures for internally delivered and contracted services. Nor do they consider the frequency with which monitoring activities are undertaken. Our analysis expands the methods of service delivery under consideration to include direct delivery in addition to the external options addressed by the ICMA. We seek to ascertain detailed information about the use of oversight methods for each mode of delivery. We surveyed 231 local government officials in Ohio about their service-delivery practices for a service that can be provided in a variety of ways primarily or partly by their own employees; through contracts or agreements with other governments; or through private, for-profit, or nonprofit entities. We included questions about the type and frequency of monitoring across the range of service-delivery options. We focus here on only one of the many service categories contained in the ICMA questionnaire, programs for the elderly. Survey responses indicate that the primary method employed to deliver these services varies considerably across governments. Nearly 30 percent rely primarily on their own employees, and more than half use contracting with some other entity as the primary delivery mode (see table 1). Although the contracting literature often treats monitoring as one of the major obstacles to contracting out, the performance measurement and management literature suggests that equivalent activities undertaken for internally provided services should be considered as well. Our respondents reported that they engage in extensive monitoring efforts when they provide services directly. When a government contracts out the provision of these services to another government or to a nonprofit entity, it tends to report less monitoring effort compared to contracts with for-profit firms or to internal service provision. Thus, at least for these services, it appears that governments contract out not in spite of the additional monitoring burdens they incur, but to avoid significant monitoring effort. The Contracting Literature Th e contracting literature displays broad agreement that monitoring and transaction costs are weighted heavily in the decision about whether to contract out. Monitoring costs are thought to constitute a significant part of the contracting budget. Though definitive monitoring costs per contract are often unknown or Table 1 Service Delivery Modes, Programs for the Elderly By Contract With Exclusively by Employees Partly by Employees Other Government For-Profit Entity Nonprofit Entity 522 Public Administration Review May June 2007 Percentage of governments employing mode * Comparable percentages, ICMA Survey Mode most relied upon Number Percentage * Percentages do not add to 100 because some governments employ multiple modes.

3 elusive, many scholars use Pack s (1989) figure of 20 percent of the contracting budget as an estimate. Hefetz and Warner (2004) found that monitoring, along with principal agent problems, to be the most important factors in contracting decisions. In fact, they conclude that difficulties with contract specification and monitoring were factors driving the decision to bring the contract back in-house (173). Donahue (1989), in his examination of contracting, argues that successful performance contracting requires good measures of performance measures that he argues are scarce for all but the simplest of public sector services. The implication is that measurement issues can undermine contracting success. In a similar vein, Behn and Kant warn, Performance contracting can be a perilous undertaking. Particularly when contracting for social services, both the government agency and the vendor are committing themselves to accomplish something they might not be able to do (1999, 472). They further observe that the emphasis on performance in the contracting relationship means that [n]ow the primary responsibility of both (contracting agency and vendor) is to produce the specified result. Portz, Reidy, and Rochefort (1999) identify the new tasks that confront managers when contemplating contracting out performance specifications must be written, and a system of monitoring and evaluation must he put in place. Warner and Hebdon sound the same theme regarding the difficulty in specifying the results for complex services: Privatization may be more effective for services that are easy to monitor and for which many alternative providers exist (2001, 137). Sclar (2000) weighs in on complexity, asking, Why did things not turn out as well as the privatization advocates predicted? For one thing, tasks that make up the bulk of public services are often more complex than privatization advocates maintain, and the complexity translates into extra costs to administer the contracting process, monitor work and evaluate performance. These can outweigh savings from lower production costs. Van Slyke (2003) concurs, noting that contracting often leads to additional public management costs. Brown and Potoski, building on Prager s (1994) admonition regarding the difficulty of measuring activities whose outcomes are not readily identifiable, conclude that [u]nder these circumstances, the contracting government is exposed to the risk of unseen vendor non-performance or negligence (2003, 277). Their research adds nuance to conclusions about contracting, demonstrating that the nature of the With the increasing prominence of the performance measurement/management orientation, it is interesting that monitoring/transaction costs have been of interest only if a private contractor provides the service but not if it is furnished by a government agency. service, the contract partner, and the competitiveness of the environment each contribute to the magnitude of a government s investment in monitoring and attendant transaction costs. Th e contracting literature, as noted, relies primarily, although not exclusively, on the ICMA survey (see, e.g., Van Slyke 2003 and Romzek and Johnston 2005 for analyses of contracting using non-icma data). The ICMA survey asks respondents to enumerate obstacles to adopting private sector service delivery but ignores any impact these obstacles might have on public sector service delivery. It catalogs the evaluation techniques used for private sector service delivery but not for public sector service delivery. This literature shines a spotlight on the monitoring of alternative service delivery even as similar activities associated with internally provided services remain out of sight. With the increasing prominence of the performance measurement and management orientation, it is interesting that monitoring and transaction costs are of interest only if a private contractor provides the service but not if it is furnished by a government agency. Sclar (2000) is correct to point out that the privatization debate typically ignores transaction costs. The proponents of performance measurement and management would agree. The omission of this perspective results in a failure to account for both the internal monitoring and transaction costs and the external monitoring costs to which Sclar refers. Does the answer to the mystery of the missing monitoring and transaction costs in the contracting literature lie in hierarchy? Is there something inherent in the pyramidal-configured organization that renders that cost calculation moot? Klaas, McClendon, and Gainey appear to agree, arguing that all parties involved share membership in the hierarchy and the potential to benefit over the long term from cooperation,... [and thus] adjustments across multiple parties is more easily accomplished (1999, 114). Bernstein and Raphaelson (1998) concur that the direct provision of services by a government agency replaces monitoring with direct supervision of employees. Miller (1992) identifies an advantage of hierarchies over markets, in that the former can more readily inculcate common knowledge and cooperative work norms. This advantage provides an explanation for the supposed absence of monitoring activity for internal service provision workers and supervisors with consistent objectives work in tandem, as opposed to governments that contract out with service providers with differing goals. But he sounds the first of two cautionary notes about internal service provision and A Comparison of Monitoring for In-House and Contracted Services 523

4 the monitoring and transaction costs accompanying service delivery within hierarchies. Miller s first concern deals with the ubiquitous principal agent issues. As Evans and Grossman note, It is strange that the transaction cost literature assumes that the mere act of integration transforms selfish humans into selfless ones whose only goal is their company s welfare. Common ownership, unfortunately, eradicates neither indolence nor dishonesty (1983, 121). Miller argues that it is to be expected that hierarchies only rarely and briefly achieve anything that may be regarded as a full resolution of the problems of information asymmetry, team production externalities, and market power (1992, 237) that bedevil service provision. Brehm and Gates (1997) concur that adverse selection and moral hazard shift the power relationship in a supervisor subordinate relationship from the former to the latter. They add that a supervisor s influence is further constrained by time, information, resources, civil service rules, subordinate preferences, the repertoire of responses available to subordinates, and the means by which subordinates learn rules. They argue that supervisors have limited abilities to influence subordinate behavior even under the best of circumstances. So it seems that the implicit assumption in the contracting literature that monitoring is less necessary if a service is delivered internally rather than contracted out is open to question. The relative power balance between superior and subordinate in favor of the latter means, in many cases, that implementation will not be easy or automatic if it is done internally. The identification of monitoring activities and the costs that accompany them is important for an accurate comparison of contracted versus internally provided government services. The second caveat regarding internal provision and transaction costs is rooted in the accountability and performance measurement and management movement. Increasingly, governments have been called upon to document effectiveness. Hatry (1999) traces interest in performance measurement to the 1960s. Widespread interest in performance measurement has been ignited at all levels of government. More and more governments, either because of external pressure to demonstrate results or a desire to highlight accomplishments and improve internal processes, have invested in metrics that track outputs and, to a lesser extent, outcomes. The Performance Measurement and Management Literature As the literature on performance measurement and management is voluminous, only a sample will be reviewed here. The cohesive body of work supporting performance measurement and management authored by Harry Hatry of the Urban Institute constitutes an excellent overview of the literature. He has been instrumental in providing guidance on the rationale, construction, and implementation of performance measurement and management systems ( Hatry 1978, 1999; Hatry and Fisk 1971 ). Osborne and Gaebler (1992), Holzer and Callahan (1998), Mintzberg (1996), Wholey (1983, 1997), Wholey and Hatry (1992), Newcomer (1997), Melkers and Willoughby (2005), and Grizzle (1987) have been important contributors as well. The plus side of investments in performance measurement and management highlighted in their work increased productivity, enhanced customer satisfaction, and greater accountability have been incorporated as part of the New Public Management. The Government Performance and Results Act and its progeny, the federal Program Assessment Rating Tool, demonstrate the power of performance proponents. These measures have become part of the lexicon in federal agencies. State and local governments have been adopters as well. The ICMA, through its Comparative Performance Measurement Consortium, founded in 1994, established a working group among cities and counties to promote performance measurement and management and to provide benchmarks. Governing magazine and the Maxwell School at Syracuse University assign grades to states based on their use of performance measures. Patricia Ingraham of the Maxwell School has argued persuasively that performance is a siren for modern government and justly so (2005, 391). Cautionary notes have been sounded about the emphasis on performance measurement and management. Ingraham identifies three necessary conditions for performance success: capacity, appropriate metrics, and leadership (2005, 391). She notes, however, that these conditions are not always present and that there is slippage between adoption and implementation of results-based systems. Perrin provides a thoughtful critique of the flaws and limitations of performance indicators but argues that they can play an important role in monitoring and asking questions (1999, 375). Both bodies of literature provide valuable insight and guidance about the nature of public sector service delivery, the options available to managers, and a partial understanding of their strengths and weaknesses. Both because of principal agent issues and calls for accountability, there is reason to suspect that the degree of internal monitoring has been growing and may be underestimated by the contracting literature. As a result, the cost comparisons between internal and external service delivery could be incorrect. Setting internal monitoring costs to zero while calculating only those for contracted deliverers artificially skews the results. The performance measurement and management literature assumes and sometimes documents the adoption and utilization 524 Public Administration Review May June 2007

5 of measurement systems. It fails, however, to differentiate utilization across service-delivery modes. We attempt to inventory service-delivery practices for a more complete array of monitoring options with an eye toward the longer-term objective of identifying the monitoring and transaction costs for each of them. In the short term, this research answers Ingraham s (2005) call (attributed to David Walker and the Government Accountability Office) to begin to consider both contract and noncontract provision in discussions of government performance. Methods and Data To investigate these issues, we designed a survey instrument that followed the ICMA survey in obtaining information on the monitoring methods employed for the provision of several types of services but expanded the ICMA s inquiries to obtain information about how each type of service provision was monitored. The ICMA asked governments to describe their monitoring efforts generally for contracted services. We added an inquiry to determine how monitoring was carried out when the service in question was provided directly. Moreover, the ICMA s query discussed government monitoring efforts in general terms, as opposed to the efforts tied to a particular service-delivery mechanism. This approach assumes that monitoring of external service delivery is independent of the external delivery method employed. We asked for a report of monitoring efforts linked to the corresponding delivery mechanism. The results we report here contradict the ICMA assumption. We mailed 231 surveys, primarily to members of the Ohio City Managers Association. A total of 137 surveys were returned, yielding a 59 percent response rate. This compares favorably to the response rates of 32 percent for the 1997 ICMA survey and 24 percent for the 2002 ICMA survey. A comparison of the respondents and nonrespondents indicates that the former represented locations that were larger (in terms of population), better educated, and richer. Only one of the variables (per capita income) revealed a statistically significant difference between the two groups. None of the other income, population, government revenue, or expenditure variables was statistically significant. A majority of respondents provided services for the elderly, 78.8 percent ( N = 108). Not surprisingly, the locales providing these services had significantly larger populations, as well as more government revenues and expenditures compared to survey respondents who did not provide these services. Service providers had a better-educated and higher-income citizenry, but those differences were not statistically significant. As noted in the introduction, we asked governments about the frequency and importance of monitoring activities for all these service-delivery options, as well as the collective bargaining status of the delivery option most relied on and the degree of competition in the service environment. Table 1 provides the distribution of service-delivery options employed by governments that provided programs for the elderly. Because governments can use multiple methods to deliver these services, we asked which of the delivery methods each government most relied on. Table 1 also summarizes responses to this question. Using the most relied on responses, we divided respondents into groups according to whether they most relied on internal service delivery, defined as delivering services exclusively or partly with their own employees or, alternatively, whether they contracted with an outside entity. Comparing demographic and government characteristics between these groups yielded no significant or even meaningful differences. One environmental variable did differ between these groups. We asked whether the government in question competed with no, few, or many potential providers of programs for the elderly. Of the 50 governments who relied on their employees, 70 percent reported few or many competitors, as opposed to none. For the remaining 58 governments, the percentage was 96.6 percent, and these two proportions were significantly different. Our goal is not to explain why some governments rely heavily on internal service delivery, whereas others are more inclined to look to outsiders. This is fortunate, given the considerable similarities between the two groups. For the one variable that appears to matter, competition, we could not determine whether a government was more likely to rely on internal service owing to an absence of potential providers, or alternatively, whether that absence of alternatives was a consequence of not looking outside. In any event, the effect of potential providers on monitoring efforts is controlled for in the analysis that follows. Results Given our interest in assessing differences in monitoring activity across methods of service delivery, we asked respondents to indicate the frequency with which they engaged in a series of 10 monitoring activities. We interpret our frequency categories as summarizing a continuous, latent variable measuring the frequency and likely intensity of monitoring efforts. We divided our monitoring measures into four categories to reflect where the activities fit in the delivery process. These include activities undertaken to control the services provided by specifying their characteristics, process monitoring occurring as services are provided, attempts to measure service outcomes, A Comparison of Monitoring for In-House and Contracted Services 525

6 and efforts to use the results of monitoring to sharpen provider incentives. Even a cursory look at the data suggests that internal service provision is far from devoid of monitoring. As least some monitoring activity was reported by more than 90 percent of respondents who provided programs for the elderly exclusively or partly with their own employees for seven of our 10 monitoring activities. The two activities that ranked lowest in terms of utilization were monitoring-based incentives namely, rewarding strong performance and sanctioning poor performance with some utilization reported by 59 percent and 57 percent of internal provision respondents, respectively. Our data permit us to go beyond a dichotomous characterization of the presence or absence of monitoring methods (up-front, process, ex post, and monitoring-based incentives) to report the intensity of monitoring efforts. The average effort for each monitoring method across five service-delivery modes is reported in table 2. Governments delivering services to the elderly using their own employees, exclusively or partly, engaged in more monitoring than governments that contracted with other governments or nonprofits to deliver the same services. Only monitoring of forprofit service providers exceeded internal monitoring, and although mean monitoring of for-profit firms was higher, the differences were not significant, perhaps because of the small number of governments choosing to contract with for-profit providers. Our data further allow us to conduct a multivariate analysis to explore how such efforts vary across methods of service delivery in order to determine whether performance measurement has increased the surveillance of internally provided services to achieve parity with that of contracted services. Accordingly, we computed ordered probit estimates of the determinants of monitoring effort. Specifically, we estimated a relationship that may be expressed in the form of the equation Y * = X + Z + where Y * is the (latent) frequency of the monitoring activity in question; X is a vector of dummy variables taking the value of 1 for service provision by other governments, private firms, and nonprofit entities, respectively; and Z includes demographic and governmental variables, a measure of the competitive environment for service provision, as well as a dummy variable for the presence of a collective bargaining agreement covering service delivery. Th e estimates of this equation include a collective bargaining variable as a measure of the ability of a government to utilize the results of monitoring to influence service delivery. We expected that, when present, collective bargaining would reduce the value of monitoring and thus would reduce monitoring efficacy. The collective bargaining variable was assigned according to the response provided for the method most relied on, with 0 indicating the absence of an agreement and 1 indicating that an agreement was present. A small number of don t know responses were dropped from the data set. Collective bargaining agreements, common across all forms of government-provided service delivery, had the expected effect. Where present, an agreement was associated with lower monitoring effort, with the Table 2 Average Monitoring Effort by Service-Delivery Mode Service-Delivery Mode Monitoring Method Exclusively by Employees Partly by Employees Other Government For-Profit Entity Nonprofit Entity Average, All Modes Up-front monitoring Setting/changing service ** 2.75 Specifications/work plans Setting/changing performance targets Process monitoring Assessing compliance with specifications/ ** 2.88 work plans Financial audits Monitoring consumer/client complaints ** 2.60 Verifying services were provided Ex post monitoring Measuring results of services ** Measuring citizen satisfaction with services ** Monitoring-based incentives Rewarding strong performance * 1.24*** 2.57** Sanctioning poor performance * 1.19*** 2.57*** Average, all methods Public Administration Review May June 2007 Notes: Asterisks indicate that the mean in question is significantly different from that for Exclusively by Own Employees at the 10 percent (*), 5 percent (**) or 1 percent (***) level.

7 largest impact recorded for the monitoring-based incentive variables. Table 3 reports the coefficients and statistical significance of the effects of contracting out on each of our 10 measures of monitoring frequency. We record only the results for delivery method (the independent variable of central importance for our analysis) because, apart from collective bargaining, the remaining control variables in our analysis rarely yielded significant effects. Inspection of the results in table 3 does indicate, however, that the delivery mechanism matters a great deal for monitoring effort. For-profit firms were typically monitored somewhat more intensively compared to internal provision, but the effects were not often significant. The limited significance of the coefficients is not surprising given the small number of governments choosing to deliver programs for the elderly through for-profit entities. The small number of governments that employed for-profit delivery is consistent with the view that the difficulties of measuring service outputs discourage contracting with such firms, but it is nonetheless clear that such difficulties do not impede extensive contracting out by other methods. The only significant results were obtained for processmonitoring activities, a result that mirrors a previous finding ( Marvel and Marvel 2003 ) that, compared to private sector contracts, public sector contracts are oriented more toward process than outcome. The most striking aspect of the results in table 3 is the lower use of monitoring by the contracting government when services were provided by either another government or a nonprofit agency. Because these types of contractors are much more common for programs for the elderly than is the use of for-profit contractors (see table 1 ), contracting out, on balance, was associated with a reduction of monitoring effort by the contracting government. This finding could be attributable to differences among governments in their choice of which services to provide under the ICMA heading we employed, programs for the elderly. It could be argued that governments might contract out easy-to-monitor services to for-profit firms, coupling their contracts with intensive monitoring. The mirror image of this argument is that particularly difficult-tomonitor services would be contracted to nonprofits or other governments, which would be monitored significantly less than when services are provided internally. Thus, if governments differ substantially in the services they provide for the elderly, it is possible that our respondents were reporting monitoring practices that differ systematically across services. If so, our findings indicate that contracting with nonprofits or other governments occurs when there is little hope of monitoring an interesting and surprising outcome. To the extent that governments provide similar bundles of services for the elderly, the differences in monitoring that we observed arise from a lower perceived need to Table 3 Determinants of the Frequency of Monitoring Effort by Service-Delivery Mode Effect Relative to Service Delivery Exclusively by In-House Employees (Statistical Significance in Parentheses) Monitoring Method Partly by Employees Other Government For-Profit Entity Nonprofit Entity Up-front monitoring Setting/changing service specs/work plans (0.06)* (0.80) (0.58) (0.001)*** Setting/changing performance targets (0.73) (0.52) (0.84) (0.08)* Process monitoring Assessing compliance with specs/work plans (0.76) (0.64) (0.09)* (0.05)* Financial audits (0.08)* (0.84) (0.22) (0.02)** Monitoring consumer/client complaints (0.37) (0.19) (0.64) (0.04)** Verifying services were provided (0.39) (0.85) (0.21) (0.51) Ex post monitoring Measuring results of services (0.68) (0.06)* (0.97) (0.13) Measuring citizen satisfaction with services (0.79) (0.02)** (0.73) (0.09)* Monitoring-based incentives Rewarding strong performance (0.50) (0.003)*** (0.77) (0.003)*** Sanctioning poor performance (0.43) (0.004)*** (0.31) (0.07)* Notes: Effects are measures of the change in probability of monitoring relative to base method, delivery exclusively by the government s own employees. The estimates include independent variables that control for the presence of a collective bargaining agreement covering service delivery, as well as differences across communities in population, education, government expenditures per capita, and the competitive environment for programs for the elderly. *** indicates effect significantly different from zero at the one percent level. ** indicates effect significantly different from zero at the five percent level. * indicates effect significantly different from zero at the 10-percent level of confidence. A Comparison of Monitoring for In-House and Contracted Services 527

8 528 Public Administration Review May June 2007 monitor the same services when provided externally. But in any event, our clear finding is that monitoring intensity by the contracting government is lower for services contracted out to nonprofits and other governments than for services provided internally. This finding sharply contradicts the conventional wisdom on contracting. The finding comes from two sources. Internal service provision receives much closer attention than is customarily assumed. Contracting out does not result in new or increased attention to monitoring on the part of the contracting government. Aggregate monitoring can therefore decline when service provision is contracted out, constituting a potential advantage to the contracting government. Why might this be the case? When one government contracts for services with another, the employees of the provider and the monitoring techniques available to monitor them are unlikely to be altered in a significant manner. Responsibility for governance is transferred, but the fundamental governance problem remains. Whichever government s employees provide a service, they must be monitored, but by contracting out, the contracting government transfers that responsibility to the service deliverer. The contracting government need only check for an absence of discrimination. If its constituents are treated the same as those of its contracting partner, the monitoring responsibility for all consumers is assigned to the delivering government. As long as there exist economies of scale in monitoring, contracting out actually streamlines monitoring by requiring that it only be done once by the government that performs that service. A similar process may be at work for nonprofit providers. A for-profit service provider must be monitored by each of the governments with which it contracts, for they could all simultaneously find that the for-profit provider shirks on service provision. This sort of shirking is perhaps less of a problem (or believed to be less of a problem) when services are provided by a nonprofit whose goals are perceived to be aligned with those of its contracting governments. This explanation would lead one to conclude that goal congruence is greater between a government agency and a nonprofit than between a government agency and its own employees. The renewed emphasis on performance measurement and management, though yielding forecasts of increased monitoring vigilance for internal service When one government contracts for services with another, the employees of the provider and the monitoring techniques available to monitor them are unlikely to be altered in a significant manner. Responsibility for the governance problem is transferred, but the fundamental governance problem remains. provision, does not predict that it would surpass that of this group of subcontractors. But it is apparent, in any event, that the monitoring effort required to contract out with another government or with a nonprofit entity is far lower than either the monitoring required for contracting out to a for-profit or, more importantly, for internal service provision. Conclusions Th e decision to contract out the provision of public services is often viewed as triggering a need for increased monitoring of service provision. First, our respondents reported that they engaged in very substantial monitoring of services provided internally. This monitoring was less than that devoted to forprofit service providers, though the difference was significant in only one in 10 comparisons. The relatively small increase in monitoring when dealing with for-profit partners compared to internal service provision is a consequence of the central finding of our study, namely, that internal service provision is subject to extensive monitoring efforts. Our most striking finding, however, is that when services are contracted out either to nonprofit or other government service providers, the monitoring burden shouldered by the initiating government falls substantially. Thus, in practice, contracting out with nonprofits or other governments does not increase monitoring by the government that procures services for its citizens. Low levels of monitoring do not mean, however, that monitoring levels are chosen correctly to provide effective and efficient service provision. The quality of services provided by outsourcing as opposed to internal service provision is unknown. These results raise the very important question of the relative effectiveness of the service-delivery methods, but this is not a question that our data permit us to answer. The clarity of responses to our survey and evident commitment among respondents to monitoring internal employees offer reasons to question the conclusion that contracting out inevitably creates new measurement and monitoring burdens. The respondents to our study seem to have heeded the call to engage in performance measurement and management activities with their own employees. Because the bulk of contracting for programs for the elderly involves contracting partners who are either other governments or nonprofit entities, contracting out could actually reduce aggregate monitoring activity. Our data, however, do not permit us to measure the monitoring effort undertaken

9 by the entities with which the responsible government contracts. It is an open as to question whether reduced monitoring by a contracting government is offset by monitoring elsewhere or whether monitoring is somehow avoided in the contracting process. This is a worthy topic for future research. Hatry, Harry P The Status of Productivity Measurement in the Public Sector. Public Administration Review 38 (1): Performance Measurement: Getting Results. Washington, DC : Urban Institute Press. Hatry, Harry P., and Donald M. Fisk Improving Productivity and The conventional contracting Productivity Measurement in Contracting does not necessarily wisdom has long held that contracting out would occur far more raise monitoring vigilance. Washington, DC : National Local Government. frequently but for the additional When the contracting partner is Commission on monitoring efforts such contracts either another government or a Productivity. entail. Put succinctly, the belief is nonprofit entity, monitoring Hefetz, Amire, and Mildred that contracting increases the Warner Privatization efforts by the government monitoring burden of service and Its Reverse: Explaining contracting for services provision. Our evidence suggests the Dynamics of the that increased monitoring activities, actually decline. Government Contracting encouraged by performance measurement and management proponents, is associated with internal service provision. Contracting does not necessarily raise monitoring vigilance. When the contracting partner is another government or a nonprofit entity, monitoring efforts by the government contracting for services actually decline. Process. Journal of Public Administration Research and Theory 14 (2): Holzer, Mark, and Kathe Callahan Government at Work: Best Practices and Model Programs. Th ousand Oaks, CA : Sage Publications. International City/County Management Association (ICMA) Profile of Local Government Service Delivery Choices, References Behn, Robert D., and Peter A. Kant Strategies for Avoiding the Pitfalls of Government Contracting. Public Productivity and Management Review 22 (4): Bernstein, Richard E., and Arnold H. Raphaelson Issues in Shifts of Public Goods Production. In Restructuring State and Local Services: Ideas, Proposals, and Experiments, edited by Arnold H. Raphaelson, Westport, CT : Praeger. Brehm, John, and Scott Gates Working, Shirking, and Sabotage: Bureaucratic Response to a Democratic Public. Ann Arbor : University of Michigan Press. Brown, Trevor L., and Matthew Potoski Managing Contract Performance: A Transaction Cost Approach. Journal of Policy Analysis and Management 22 (2): Donahue, John D The Privatization Decision: Public Ends, Private Means. Ne w York : Basic Books. Evans, David S., and Sanford J. Grossman Integration. In Breaking Up Bell: Essays on Industrial Organization and Regulation, edited by David S. Evans, New York : North-Holland. Governmental Accounting Standards Board (GASB), and National Academy of Public Administration (NAPA) Report on Survey of State and Local Government Use and Reporting of Performance Measures: First Questionnaire Results.www.seagov.org/sea_gasb_project/1997_ Survey.pdf [accessed March 5, 2007]. Grizzle, Gloria Linking Performance to Funding Decisions: What Is the Budgeter s Role? Public Productivity Review 10 (3): icma.org/freedocs/asd_2002.pdf [accessed March 4, 2007] Alternative Service Delivery, : Full National Data Set E-Document. bookstore.icma.org/alternative_service_delivery_ 2_C44.cfm [accessed March 5, 2007]. Ingraham, Patricia W Performance: Promises to Keep and Miles to Go. Public Administration Review 65 (4): Klaas, Brian S., John McClendon, and Thomas W. Gainey HR Outsourcing and Its Impact: The Role of Transaction Costs. Personnel Psychology 52 (1): Marvel, Mary K., and Howard P. Marvel The Ratio of Beef Cubes to Onion (6:1) in Hungarian Goulash and Public Sector Contracting: Market- Like or Market-Lite? Policy Currents 12 (2): 2 4. Melkers, Julia, and Katherine Willoughby The State of the States: Performance-Based Budgeting Requirements in 47 out of 50. Public Administration Review 58 (1): Models of Performance-Measurement Use in Local Governments: Understanding Budgeting, Communication, and Lasting Effects. Public Administration Review 65 (2): Miller, Gary J Managerial Dilemmas: The Political Economy of Hierarchy. Ne w York : Cambridge University Press. Mintzberg, Henry Managing Government, Governing Management. Harvard Business Review 74 (3): Newcomer, Kathryn E., ed Using Performance Measurement to Improve Public and Nonprofit Programs. San Francisco : Jossey-Bass. A Comparison of Monitoring for In-House and Contracted Services 529

10 Osborne, David, and Ted Gaebler Reinventing Government: How the Entrepreneurial Spirit Is Transforming the Public Sector. Reading, MA : Addison-Wesley. Pack, Janet Rothenberg Privatization and Cost Reduction. Policy Sciences 22 (1): Perrin, Burt Effective Use and Misuse of Performance Measurement. American Journal of Evaluation 19 (3): Poister, Theodore H., and Gregory Streib Performance Measurement in Municipal Government: Assessing the State of the Practice. Public Administration Review 59 (4): Portz, John H., Matthew Reidy, and David A. Rochefort How Managed Care Is Reinventing Medicaid and Other Public Health- Care Bureaucracies. Public Administration Review 59 (5): Prager, Jonas Contracting Out Government Services: Lessons from the Private Sector. Public Administration Review 54 (2): Romzek, Barbara S., and Jocelyn M. Johnston State Social Services Contracting: Exploring the Determinants of Effective Contract Accountability. Public Administration Review 65 (4): Sclar, Elliott D You Don t Always Get What You Pay For: The Economics of Privatization. Ithaca, NY : Cornell University Press. Van Slyke, David M The Mythology of Privatization in Contracting for Social Services. Public Administration Review 63 (3): Warner, Mildred, and Robert Hebdon Local Government Restructuring: Privatization and Its Alternatives. Journal of Policy Analysis and Management 20 (2): Wholey, Joseph S Evaluation and Effective Public Management. Boston : Little, Brown Trends in Performance Management: Challenges for Evaluators. In Evaluation for the 21st Century: A Handbook, Elinor Chelimsky and William R. Shadish, Thousand Oaks, CA : Sage Publications. Wholey, Joseph S., and Harry P. Hatry The Case for Performance Monitoring. Public Administration Review 52 (6): Public Administration Review May June 2007

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