THE PROPER SCOPE OF GOVERNMENT - THEORY AND AN APPLICATION TO PRISONS

When should a government provide a service in-house, and when should i t contract out provision? We develop a model in which the provider can invest in improving the quality of service or reducing cost. If contr acts are incomplete, the private provider has a stronger incentive to engage in both quality improvement and cost reduction than a governmen t employee has. However, the private contractor's incentive to engage in cost reduction is typically too strong because he ignores the adver se effect on noncontractible quality. The model is applied to understa nding the costs and benefits of prison privatization.