Service Outsourcing and Government Fiscal Conditions: Do Market Competition, Bureaucrat Support, and Management Capacity Matter?

Published date01 August 2024
AuthorWenchi Wei,Xin Chen
Date01 August 2024
Subject MatterArticles
Service Outsourcing and Government
Fiscal Conditions: Do Market
Competition, Bureaucrat Support,
and Management Capacity Matter?
Wenchi Wei
and Xin Chen
Scholars have long regarded government f‌iscal stress as a crucial factor driving public service outsourcing; however, further
investigation is still needed to determine whether service outsourcing in turn helps governments improve f‌iscal conditions.
Public choice theory suggests that outsourcing services can lead to eff‌iciency improvement and cost savings. Nevertheless,
transaction costs theory implies that the costs associated with service outsourcing may offset or even outweigh its potential
benef‌its. Moreover, the extent of transaction costs depends on contextual factors such as market competition, bureaucrat
support, and government management capacity. Empirically, we employ an instrumental variable estimation approach to exam-
ine the impact of service outsourcing on the budget balances and debt levels of U.S. municipalities. We f‌ind that service out-
sourcing improves government f‌iscal conditions, with contextual factors playing an important role in moderating this effect.
Additionally, outsourcing services to different types of contractors has varying implications for government f‌iscal conditions.
public service outsourcing, f‌iscal conditions, instrumental variable estimation
Outsourcing public services to external entities constitutes an
essential alternative approach to public production and has
been one of the dominant themes addressed by public adminis-
tration and management scholars over recent decades (Boyne,
1998a, 1998b; Brown & Potoski, 2003a; Elkomy et al.,
2019). Advocates for service outsourcing have widely pro-
claimed its potential benef‌its in terms of eff‌iciency improvement
and cost savings (Bryson et al., 2014; Mohr et al., 2010; Rho,
2013). However, the presumed benef‌its of public service out-
sourcing rely largely on prerequisitessuchasvendorcompeti-
tion, government contract management capacity, and absence
of opportunistic behaviors by bureaucrats (Feiock & Jang,
2009; Girth et al., 2012; Hefetz & Warner, 2012; Johnston &
Girth, 2012). The lack of these prerequisites generally incurs
high transaction costs in the process of service contracting
(Petersen et al., 2018). Moreover, critics of public service out-
sourcing commonly contend that the gains in eff‌iciency
improvement and cost savings should be balanced against the
losses such as heightened inequality and diminished account-
ability (Kettl, 2011).
There is much extant evidence regarding the conse-
quences of service outsourcing, which are mostly related to
cost savings and service performance (e.g., Bauer &
Johnston, 2020; Boyne, 1998a; Brudney et al., 2005;
Dahlström et al., 2018; Elkomy et al., 2019). However,
most existing empirical studies that focus on the value of
service outsourcing in terms of cost savings fail to account
for the transaction costs that are associated with contracting,
such as increased spending on bid coordination, contract
management, and performance monitoring and evaluation.
As noted by Petersen et al. (2018, p. 147), the general
lack of measurement of transaction costs in the vast majority
of studies clearly makes a comparison of the full costs of
public and contracted out service provision diff‌icult.A
lack of awareness of the potential transaction costs poses a
challenge to the accurate assessment of the real costs that
are associated with service outsourcing, as well as its
impact on government f‌iscal conditions. An important contri-
bution of this research is its theoretical analysis and empirical
testing on how contextual factors, such as market competi-
tion, bureaucrat support, and management capacity, shape
School of Public Policy and Management, Tsinghua University, Beijing, China
Center for Chinese Public Administration Research, School of Government,
Sun Yat-SenUniversity, Guangzhou, China
Corresponding Author:
Xin Chen, Center for Chinese Public Administration Research, School of
Government, Sun Yat-Sen University, C209A North College Building,
Guangzhou 510275, China. Email:
American Review of Public Administration
2024, Vol. 54(6) 568589
© The Author(s) 2024
Article reuse guidelines:
DOI: 10.1177/02750740241232678
transaction costs in service contracting, which in turn moder-
ate the impact of service outsourcing on government f‌iscal
conditions. Notably, previous studies have taken into
account similar contextual factors when examining service
outsourcing, but they primarily focus on how such factors
inf‌luence contracting decisions (Brown & Potoski, 2003a,
2003b; Hefetz & Warner, 2004, 2012). This study shows
that these contextual factors not only shape the decisions
regarding service outsourcing but also affect the conse-
quences of contracting public services.
The second key contribution of this study pertains to
research methodology. Due to a lack of valid evidence, it is
challenging to establish a reliable causal relationship
between service outsourcing and government f‌iscal condi-
tions (Bel & Fageda, 2017). Given the challenge of disentan-
gling whether f‌iscal conditions drive contracting decisions or
are affected by the decision to contract out, the provision of
causal evidence between service outsourcing and govern-
ment f‌iscal conditions is invaluable. To address potential
endogeneity problems arising from omitted variable bias or
reverse causation, we conduct instrumental variable estima-
tion (IVE) in the empirical analysis. Our IVE results show
that service outsourcing has a positive effect on the f‌iscal
conditions of U.S. municipalities and, moreover, the contex-
tual factors examined in this study serve as important moder-
ators of this effect. Additionally, outsourcing services to
different types of contractors has varying implications for
government f‌iscal conditions.
The second section of this article brief‌ly introduces the lit-
erature on the antecedents and consequences of public
service outsourcing. The third section presents the theoretical
analyses and hypotheses. The fourth section presents the esti-
mation strategy, which is followed by the empirical results
offered in the f‌ifth section. The last section concludes with
the empirical f‌indings and discusses the potential limitations
of the study and the opportunities for future research.
Literature Review
The literature on public service outsourcing primarily focuses
on its antecedents and consequences. Regarding the former,
early studies mostly examine how cost savings, political
inf‌luence, and f‌iscal pressure can shape local government
outsourcing decisions (e.g., Alonso & Andrews, 2020;
Ferris & Graddy, 1986; Florestano & Gordon, 1980;
Morgan et al., 1988). Later empirical studies widely
employ an economic-political-f‌iscal framework for theoreti-
cal analysis and empirical tests. Bel and Fageda (2007,
2017) systemically review this body of literature and summa-
rize three broad groups of explanatory factors in local out-
sourcing decision making, including f‌iscal stress (such as
local tax burdens, budget def‌icits, and outstanding debt), eco-
nomic eff‌iciency (such as the urban status of localities, asset
specif‌icities, contract management diff‌iculty, and market
competition), and political processes and ideological
attitudes (such as local institutions, pressure from interest
groups, and the ideological attitudes of both citizens and gov-
ernment off‌icials).
Regarding the consequences of contracting out public ser-
vices, a considerable amount of scholarly attention has been
paid to the effects of service outsourcing on public sector
employees, service performance, and governmentscost
savings (e.g., Buerger & Harris, 2021; Jang & Eger, 2019;
Lee & Lee, 2020; Lee et al., 2019; Yusuf & OConnell,
2014). First, scholars f‌ind that contracting out public services
not only leads to increasing reliance on inexperienced, short-
term, and less educated public employees but also negatively
affects public employeesworking conditions, salaries, and
job satisfaction (Fernandez et al., 2007; Rho, 2013;
Vrangbæk et al., 2015; Yang & Kassekert, 2010). Second,
with regard to the effect of outsourcing on service perfor-
mance, many previous studies employ citizen satisfaction
as an indicator of service quality, f‌inding that contracting
out services exerts either a negative or nonsignif‌icant effect
on citizen satisfaction (Dahlström et al., 2018; Elkomy
et al., 2019; Prager, 1994; Thompson, 2011). Some previous
studies directly examine the effect of outsourcing on service
performance outcomes, obtaining mixed empirical f‌indings.
For instance, Rho (2013) f‌inds that contracting helps
improve studentstest scores in Texas school districts.
However, Bauer and Johnston (2020) f‌ind that contracting
out the management of detention facilities to private corpora-
tions leads to worse conf‌inement conditions. Moreover,
Elkomy et al. (2019) focus on 130 National Health Service
trusts in the UK and f‌ind that contracting out cleaning ser-
vices reduces the level of cleanliness and causes more
hospital-acquired infections.
Third, a plethora of previous studies have specif‌ically
addressed the potential benef‌its of service outsourcing for
cost savings (e.g., Alonso et al., 2015; Boyne, 1998a;
Petersen et al., 2018). Scholars compare the costs of in-house
productionand those of contractingout for a variety of services,
generally resulting in mixed or inconsistent f‌indings (e.g., Bel
et al., 2010; Elkomy et al., 2019; Petersen et al., 2018;
Thompson, 2011). Boyne (1998a) reviews more than 20
studies assessing the consequences of service contracting,
f‌inding that the outsourcing of public services generally leads
to lower expenditures and higher eff‌iciency. However, a
recent comprehensive review by Petersen et al. (2018) shows
that the magnitude of cost-saving effects ranges from a reduc-
tion of 45% to an increase of 18.3%.
As mentioned above, previous studies on the conse-
quences of public service outsourcing are generally limited
by a failure to account for and empirically test the contextual
factors that may modify the results of service outsourcing and
a lack of appropriate attention given to endogeneity problems
in empirical estimations. This present research contributes to
the literature by applying IVE to examine the effect of service
outsourcing on government f‌iscal conditions and how several
key contextual factors can moderate this effect.
Wei and Chen 569

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