CLOSUP Conferences

Privatization: Issues of State and Local Public Infrastructure

Ann Arbor, November 22, 2002

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Privatization and Fiscal Health

James R. Hines, Jr., University of Michigan and NBER

Abstract
This paper evaluates the effect of fiscal health on the extent to which governments provides services using private contractors rather than in-house production. Data on the behavior of U.S. counties and municipalities in 1987 and 1992 indicate that jurisdictions with fiscal difficulties - as revealed by low bond ratings - are the least likely to use private contractors to provide services. Having a Moody's bond rating that starts with "B" (as opposed to a better rating that starts with "A") is associated with a two percent lower (e.g., 19 percent rather than 21 percent) likelihood of providing services using private contractors. This pattern is inconsistent with a simple capital-cost explanation of service provision, since higher borrowing costs (associated with low bond ratings) should encourage cost-conscious governments to use private contractors rather than in-house service provision. This evidence instead suggests that governments that are unable or unwilling to maintain strong fiscal positions also are disinclined to privatize their service provision, which is consistent with theories of political patronage as sources of public sector employment.