Social Heterogeneity and Optimal Mix between Publi

1SocialHeterogeneityandOptimalMixbetweenPublicandPrivateProvisionofPublicgoods*YongqinWANGHaiboXUAbstract:Withaframeworkofincompletecontract,thispapershowsthatforprovisionofpublicgoodssuchasMedicareandeducation,pureprivatizationcan’tpromotecompetition.Onthecontrary,theco-existenceofpublicandprivateprovisioncanenhancedefactocompetition.Twocompetitiveeffectsareidentified.Whenconsumersareheterogeneous,theco-existenceofpublicandprivateownershipgivesconsumersfreedomtochoosefromdifferentownership,improvingallocationefficiency(Tiebouteffect).Whileconsumersarehomogeneous,theco-existencecanpromoteyardstickcompetition,squeezingoutinformationrentsfrombothownerships,improvingproductionefficiency(benchmarkingeffect).Ineithercase,theco-existencedominatesuniqueownership.ThepaperendsupwithsomeimplicationsforChina’sMedicareandeducationreforms.Keywords:socialheterogeneitypublicgoodsoptimalmixJELclassification：H410，L330，L3901.IntroductionTheproperboundarybetweengovernmentandmarketmakesforthecenterpieceineconomics.Generalconsensusamongeconomistsiseasilyachievedonpurecompetitiveprivategoodsbeingprovidedbymarket.However,ineconomictheoryorinreal-worldpolicymaking,thereismoreconflictthanconcordwhenitcomestotheprovisionofpublicgoods,especiallythesupplyof“soft”publicgoodsorpublicservicessuchasMedicareandeducation.Partlybecauseofthelackofgeneralguidingtheories,wecanseevariousinstitutionalarrangements,whichcorrespondtodifferentsocialmodelssuchastheScandinavianmodel,Germanmodel,Americanmodel,etc.InrecentyearswehaveobservedthatintheprovisionofsuchpublicgoodsasMedicareandeducation,countrieswithvariedsocialmodelsarealldissatisfiedwiththestatusquoandeagertomakenecessarychanges1.PublicserviceslikeeducationandMedicarehavethefollowingspecialproperties:First,unlikesearchgoods,thequalityofexperiencegoodsisnotknownexante.Theirqualitycanonlybeknownexpost.Second,theprovisionofsuchpublicservicesentailscomplexexpertisethatcannotbejudgedorverifiedbyconsumersorathirdparty.Theoretically,serviceisatypicalmoralhazard(hiddenaction)variable;thequalityofserviceismostlydeterminedbyserviceproviders’behaviorandistosomeextentindependentofprice.Inthiscasepriceisnotasufficientstatisticandhencecannotgivefullinformationonquality:highpricedoesnotnecessarilymeanhighqualityandinsomecaseshighpriceandpoorqualitycoexist.Forthesepublicservices,simplyprivatizationmaynotachievetheproductionefficiencyandallocationefficiency.TakingintoaccountthefactthateducationandMedicarehavesubstantialinfluenceonhumancapital,economicdevelopment,incomedistributionandsocialwelfare,thereformsinthesesectorsundoubtedlybecomethemostimportantandintricatepartofsocialreforms.Bothmarketandgovernmentfailuresoftenoccurintransitionor*ChinaCenterforEconomicStudies,FudanUniversity,emails:[e-mail],[e-mail],ZhaoChen,MingLu,Yew-KwangNgandTeagueSavitchforvaluablecomments.Theusualdisclaimersapply.1Relevantarticlescanbefoundinvariousissuesoftheeconomistinrecentyears.2developingeconomiesduetoimperfectinformationandinstitutions,makingpublicservicesectorsevenworse.ReformsintheeducationandMedicaresectorshavenotyetbeencompletedinChina.UnderChina’sdecentralizationreform,yardstickcompetitionamongsameleveljurisdictionsbasedonGDPgrowthrateprovidesenoughincentiveforlocalgovernmentstostarttheprocessofprivatization,whichsolvestheissueofreformsintheareaofcompetitiveprivategoods.Inaddition,localgovernmentsareactiveininfrastructuredevelopmenttoattractmoreinvestment.Although“hard”publicgoodslikeinfrastructurearewellinplace,provisionsfor“soft”publicservicessuchaseducationandMedicarestillleavesmuchtobedesired(Wangetal.,2006).Consideringthatthesepublicservicesectorsplayasignificantpartinthedevelopmentofhumancapitalandsocialwelfare,whethertheirreformsaresuccessfulornot,willdeterminethedestinyofoveralleconomicreformsofChina.Thereformsinthesesectorsposesomechallengingquestionsforeconomists.Thefirstquestionis,sincepublicgoodscanbeprovidedeitherbygovernmentorbyprivateenterprises,whatarethedifferencesintheincentivestructuresandperformancesbetweenthesetwoownerships?Thesecondis,ifthetwoownershipscoexist,whataretheinteractionsbetweenthem?Relatedtothesecondquestion,thethirdquestionaskswhatistherelationshipbetweenownershipandcompetition?Doesprivatizationpromotecompetition?Orfurther,onwhatconditionsdoescompetitionfunctionwellinthesesectors?ThestartingpointforanytheoryofprivatizationisthebenchmarkresultofpropertyrightirrelevancebySappingtonandStiglitz(1987):Giventhatthegovernmentisbenevolentandunrestrictedincontracting,propertyrightsareirrelevantevenifthereisinformationasymmetry.Sotoexaminethethreequestionsabovementioned,onemustrelaxtheassumptions,eithertheassumptionofcompletecontractorbenevolentgovernmentorboth.Onthebasisofincompletecontracttheory,Hart,etal.(1997)andGlaeserandShleifer(1998)addressedthefirstquestion.Hart,etal.(1997)arguesthateffortinthemanagementcanimproveefficiencyintwodimensions:costandquality.However,attemptstolowercostwillfurtherjeopardizequality.Managersofstate-ownedfirmshaveonl