The unattainable efficiency - interpreting apparent inconsistencies in outsourcing

and privatization

Abstract

Cost-containment coupled with a multidimensional constraint on quantity, quality and equity

encourages policies promoting efficiency in the production of public services. Managing the

boundaries of direct production and of public ownership have been two of the most popular

policies for designing public services since the diffusion of New Public Management (NPM)

theories. However the impact of outsourcing and privatization on efficiency is not clear and

policymakers seem to follow chaotic strategies. In this paper we try to shed new light on the

relationship between outsourcing, privatization and public expenditure and give an

interpretation to the apparently inconsistent behavior of policymakers. Using data from the

Italian National Health Service we map Regions according to their choices about the

outsourcing/privatization mix, both from a static and a dynamic point of view. We explain our

results using Transaction Costs Economics, Incrementalist theory, Punctuated Equilibria and

Garbage Cans.

Keywords: Privatization, Health Care, Quantitative

Over the last few decades, the necessity of reducing the gap between available financial

resources and public expenditure has become one of the most discussed issues in the public

sector, and increasing attention has been given to strategies for controlling input costs with a

multi-dimensional constraint on the output (Buchanan, Cappelleri, & Ohsfeklt, 1991; Burke &

Goddard, 1990; Hodges, 1997; Murray, Erridge, & Rimmer, 2012). Consequently, efficiency

has become an important objective for public organizations. The debate has thus far been

articulated over the following two main logical levels: i) the root question about the definition

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of what are (and should be) the boundaries of public services (Hefetz & Warner, 2012; Kettl,

2006; Levin & Tadelis, 2010; Mailly, 1986) and ii) second-order concerns about how to

efficiently organize and control service provisions and financing once the boundaries have

been decided. Instances of contributions that are classified into this second category are

generally focused on one specific domain of public services, such as transportation (Zullo,

2008), services delivered by municipalities (Anessi-Pessina & Steccolini, 2005; Kettl, 2006;

Levin & Tadelis, 2010) and, perhaps more than any other, healthcare (Armeni, 2011;

Buchanan, Cappelleri, & Ohsfeklt, 1991; Mapelli & Lucioni, 2003; Vernon, 2002).

Scholars have studied these questions using three main research approaches: positivistic,

interpretive and descriptive. Studies adopting a positivistic perspective aim at identifying a

causal relationship between policies, strategies and some variables of system performance

(Ashenfelier & Card, 1985; Brekke, Holmas, & Straume, 2011; Ferrario & Zanardi, 2011).

The methods generally include econometric analyses or economic modeling. Studies applying

a more interpretive approach try to explain, using qualitative methods, either the success or

the negative unpredicted outcome of public cost-containment actions (Anessi-Pessina &

Steccolini, 2005; Bloching, Stock, & Scheel, 2008; Chalkley & Malcomson, 1998; Enthoven,

2004; Ferrè, Cuccurullo, & Lega, 2012; Murray, Erridge, & Rimmer, 2012). Finally, a

relevant number of studies have focused on the description and analysis of public policies,

with the objective of critically assessing their potential, using previous evidence or policy

impact analyses from a mixed positive/normative perspective (Anessi-Pessina, Cantù, &

Jommi, 2004; Battaglio Jr. & Ledvinka, 2009; Boyne, 1998; Burke & Goddard, 1990).

In this paper, we take a mixed positivistic-interpretive approach and apply it to the case of the

Italian National Health Service (INHS) to investigate to what extent cost-containment policies

at the Regional level gain effectiveness from make-or-buy decisions and from managing

public-private boundaries. We argue that these two types of decisions are not coincident but

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rather are complementary in effectiveness; however, the transition to a more efficient

configuration is not as straightforward as economic analysis would suggest. Building on

incrementalist theory (Lindblom, 1959; Lindblom, 1979), punctuated equilibria (Breunig &

Koski, 2012) and previous empirical research, we show that the road to efficiency, defined on

the basis of the potential level of affordable savings given the status quo, is inherently

implausible. Therefore, we address the illusion of economic efficiency. In such a scenario,

Regions seem to change strategy without following a clear pattern. In fact, attaining the

potential maximum efficiency would require changes to a rigid institutional framework

(Regional healthcare model) that, once modified, would suggest a different optimal allocation

of make-or-buy decisions and a different boundary between the public and the private.

We contribute to the debate on the effectiveness of cost-containment policies by showing that

the reason for the existing lack of clear-cut results in favor of either make-or-buy or public-

private decisions lies in the illusion of efficiency, i.e., the mistake of believing that a potential

optimal efficiency is affordable. In doing so, we undertake an empirical efficiency study by

comparing organizational configurations in the Italian healthcare sector and with a simulation

exercise that explains the apparently inconsistent Regional policies over time. Moreover, we

open the question about the nature of this (apparently) infinite process: is it a long way toward

a perpetually changing target through an iterative learning process, consistent with

incrementalism, or is it a random process with erratic new targets, consistent with a garbage-

can-like disjunction of problems and solutions (Cohen, March, & Olsen, 1972)?

The paper is structured as follows: in the first section, we present our theory, and we also

introduce the research context of the INHS. In the methods session, we present the statistical

model and the interpretive structure of our analysis. The results and discussion section draws

on empirical evidence and our simulation to explain the puzzle of Regional strategies.

Incrementalist theory and the concept of punctuated equilibria are used to support our thesis

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about the unattainable nature of efficiency. The concluding remarks highlight drawbacks and

future directions for research.

THEORY AND HYPOTHESES

Efficiency in public service production and delivery is of paramount importance for New

Public Management (NPM)1. According to Lynn (1998), the diffusion of NPM has brought

some constructive legacies, where a prominent role is given to “a stronger emphasis on

performance-motivated administration and inclusion in the administrative canon of

performance-oriented institutional arrangements, structural forms and managerial doctrines

fitted to particular contexts” (Lynn Jr., 1998). Performance is a multidimensional concept.

This concept is particularly evident in the public sector, where the prevalent performance

dimension of private companies – profit – is inherently inappropriate. Because of this

inappropriateness, a broader approach to performance identification and measurement is

preferred (Holzer & Yang, 2004; Newcomer, 2007; Nicholson Crotty, Theobald, & Nicholson

Crotty, 2006; Pollitt, 2006).

Since the late ‘70s, NPM and the tightening of budgets have gained advocacy in developed

countries. Therefore, cost-containment has become one of the most relevant and urgent issues.

Downward pressure on costs implies that there is modification of the objective function of

policymakers in terms of efficiency, with constraint on other performance dimensions (e.g.,

quality and equity).

1 NPM is one of the most debated set of cultural elements and managerial tools. It has been widely criticized because of its lack of adherence to the core peculiarities of public management (Riccucci, 2001).

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In this paper, we focus on outsourcing (make-or-buy) and privatization, two efficiency-

improvement policies that can be taken as an example of quasi-markets introduced under

NPM influence. We chose the case of the Italian Healthcare Service for the possibility of

disentangling these two policies, which are generally viewed as coincident (David & Chiang,

2009; Guerrero, Mossé, & Rogers, 2009), because INHS has interesting variability in the mix

of these policies both across Regions and over time.

Outsourcing and efficiency

In the presence of minimum quality constraints, a decline in spending implies an

improvement in efficiency (Boyne, 1998). Spending, in turn, can be controlled with make-or-

buy decisions concerning the separation of two or more activities in a production process with

the objective of exploiting specialization economies (buy) (Levin & Tadelis, 2010) or

reducing transaction costs (make) (Williamson, 1973; Williamson, 1979).

Williamson argued that markets and bureaucracies are two alternative opportunities for

organizing the production structure. In his view, the market is the most efficient

organizational form unless the transactions costs in the market are higher than the transactions

costs incurred by operating within a bureaucracy. The activities are, therefore, allocated to the

most appropriate executor and are defined according to the efficient boundary between

hierarchy and market. Under this perspective, outsourcing in the public sector has often been

associated with the decision for privatization.

However, in some cases, these two have been considered as separate choices, particularly

when: i) the hidden costs of competition in terms of an inefficient market structure or high

prices are manifest and ii) the level of market failures in the sector (e.g., education or

healthcare) is considered to be inappropriate for leaving the production to private actors only

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(Borgonovi, Fattore, & Longo, 2012). Under such circumstances, some studies have reported

that contracting out to other public agencies2 appears to be largely a substitute for in-house

provision rather than an analogue of privatization (Levin & Tadelis, 2010). Therefore, even in

the absence of privatization, any change in the level of outsourcing in the public sector

produces a variation in the following two categories of costs: transaction costs and

organizational costs. Based on this premise, we expect that the direction of the impact of

outsourcing on spending varies according to the sum of the transaction costs (and specular

benefits of direct control) and the organizational costs (deriving from the management of

complexity).

However, the interplay between these two categories of costs may depend upon the initial

condition as both contracts and organizations have fixed institutional costs3. At different

levels of outsourcing, the decision to expand or reduce the organizational boundaries may

have different impacts on spending, suggesting a non-linear relationship between make-or-

buy and public spending. In a study focused on motor bus services (Zullo, 2008), outsourcing

has revealed a weak curvilinear association with the total cost, suggesting that the most cost-

efficient agencies either fully contract out or provide full in-house service. Therefore, we

expect that given the importance of the fixed costs of moving from the extremes, intermediate

configurations are the more costly, identifying an inverted U-shaped relationship between

outsourcing and spending.

2The diffusion of NPM-style reforms have often produced the disintegration of vertically integrated bureaucracies substituted with arm’s length executive agencies.3 For example, if the initial condition is a pure market configuration, then insourcing back some activities may entail substantial fixed costs for acquiring production factors that may overrun the savings in the transaction costs. Similarly, from a pure bureaucracy configuration, outsourcing-related costs may include relevant transaction costs for beginning to interact with other institutional actors.

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In those INHS Regions where outsourcing is set at an intermediate level, the sum of the

transaction costs and organizational costs is high, suggesting an opportunity for reducing

public expenditure via make-or-buy.

Hypothesis 1. In the absence of privatization, outsourcing has an inverted U-shaped

relationship with public expenditure.

Privatization and efficiency

Privatization is the other decisional dimension for macro-organizing public services4. The

motivation for privatization is rooted in the intended benefits of competition as a mediator for

efficiency5. For example, Pendleton (1999) examined whether privatization and exposure to

product market competition (in local transportation) leads to changes in labor management

and industrial relations, leading to relatively higher levels of efficiency (Pendleton, 1999).

However, competition is not granted by the presence of some private actor in the production

system. For example, competition was not recognized as widely diffused in U.S. healthcare,

even though more than half of the care provision is privately managed and financed. Notably,

health care systems seem to be characterized by status/quality competition (Ferlie, 2007)

rather than by price or public/private competition. Levin and Tadelis (2010) found that

privatization had a significant impact in improving efficiency only if the conditions exist for a

4 In the particular case of the INHS, the configuration where the public sector does not contract out excludes the presence of private providers of care as emerging entrants (model 3, Figure 2).5On this point, it should be noted that the theoretical motivation for privatization is generally not explicitly mentioned in privatization reports. Hodges (1997) shows that the promotion of competition is rarely stated as an objective of a privatization, and where it is, it can lead to difficulties in drawing objective audit conclusions (Hodges, 1997). Prager (1994) suggests that contracting out of government services to private actors “will neither reduce government outlays nor increase government efficiency unless the decision makes economic sense. For example, a government authority may decide that downsizing is a political, not financial or economic, imperative, or outsourcing may serve as a threat to weaken the power of an entrenched bureaucracy or labor union” (Prager, 1994).

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competitive market to emerge (Levin & Tadelis, 2010)6. With a specific focus on healthcare,

hospital private ownership is not necessarily associated with a higher efficiency than public

ownership (Tiemann, Schreyögg, & Busse, 2012)7. Building on that premise, we argue that

privatization needs some additional conditions to enable its potential benefits. Enthoven

(2004) argued that market forces should be made strong enough to deliver efficient healthcare

systems (Enthoven, 2004), suggesting that privatization is more beneficial when the share of

the outsourced market is substantial. We hypothesize that privatization negatively moderates

the inverted U-shaped relationship between outsourcing and expenditure. In the case of INHS,

Regions might be attracted by privatization only if this decision is coupled with a substantial

level of outsourcing. In other words, privatization at low levels of outsourcing is not

beneficial, consistent with Enthoven (2004), but it leads to relatively higher savings when

used as a complement of outsourcing.

Hypothesis 2. Privatization negatively moderates the impact of outsourcing on public

expenditure (negative interaction term).

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Insert figure 1 about here

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The unattainable efficiency puzzle in the context of NHSs

According to our theoretical model, we would expect Regions to adopt extreme

configurations rather than intermediate ones. However, empirical data (cfr. Figure 3) show

strong evidence in support of mixed outsourcing and privatization levels, with smooth

6 Factors impeding competition are, for instance, problems in monitoring performance or the need for flexibility.7This evidence is consistent with findings in other domains of public services, like transportation (Zullo, 2008).

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transitions over time. Therefore, the question arises of why Regions choose and maintain

(theoretically) inefficient models.

Two possible explanations can be envisaged. 1) Regions incorrectly choose their mix between

outsourcing and privatization or 2) reasons other than efficiency lead the choice of the mix

and determine the speed of adjustment. The first explanation relies on the assumption that the

appropriate model is either a fully public and in-house service or, alternatively, a fully private

and outsourced one. Neither of the two possibilities is applicable to the INHS. Accepting the

former case would imply rejecting NPM totally and excluding important stakeholders of the

NHS (e.g., private hospitals). Accepting the latter case would contradict the foundations of a

universalistic health system, requiring a dramatic institutional and political change. We

therefore believe that the second explanation is appropriate and that efficiency, even if

theoretically affordable, is an illusion in practice. To support this thesis we build on two

arguments. First, given that the initial choice is an intermediate one, we show that the

adjustments suggested by hypotheses 1 and 2 are smooth, and second, as a consequence,

efficiency-improvement strategies can be time-inconsistent or ambiguous.

The choice of the initial configuration

NHSs are characterized by the direct provision of services. However, they may decide to

outsource the management of some production processes to other providers (public, private or

public-private mixed entities), thus generating incentives to specialization in each outsourced

phase. In recent years, the necessity of reducing production costs has pushed universal

healthcare systems to reconsider the possibility of moving organizational boundaries by

exploiting specialization economies and inducing competition (by privatization) under both a

rationality8 constraint and a quality constraint9. Burke and Goddard (1990), building on 8 i.e., the savings from outsourcing are greater than the new transaction costs.9 In Italy, minimum granted services (LEA, Livelli Essenziali di Assistenza) are defined and listed.

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Transaction Costs Economics, justified the appropriateness of an intermediate level of

outsourcing. In particular, they verified the occurrence of five conditions10 that justify the

failure of a pure-market configuration of transactions in the British NHS. As these conditions

were highly dependent upon the peculiarity of the sector rather than of the country, their

conclusions can be fairly generalized to the Italian case11.

The first condition is bounded rationality, an issue that becomes increasingly important with

the growth of complexity in activities and technological advancements in healthcare. The

second one is opportunistic behavior: even if it “has not traditionally been dominant in

healthcare [as] there has been an emphasis on ethical behavior and moral commitment”

(Burke & Goddard, 1990), most actors involved in the resource allocation process had

reported experiencing opportunistic behaviors. Third, transactions are restricted in frequency

because of the limited number of contracting parties. This characteristic is highly desirable in

healthcare as strong standardization requirements are necessary to ensure equity within the

system. However, this comes at the costs of facing a greater bargaining power and

discretionality in the final choice12. Fourth, complexity is inherent to medical activity and, by

extension, to the whole NHS. This requires a leading actor who is accountable for

performance of the whole system. Finally, healthcare is also characterized by a significant

presence of idiosyncratic investments (staff, education, equipment) that are made in a quasi

10 Based on Williamson (1973, 1975, 1979, 1985), they refer to the conditions under which the market is likely to be a less efficient allocator of resources. The first two are behavioral conditions; bounded rationality and opportunism. The remaining three relate to (i) a low frequency of transactions; (ii) high complexity and uncertainty surrounding transactions and (iii) a high degree of enduring idiosyncratic investments.11 Note that Rehnberg’s (1990) study of the organization of the Swedish health care system concludes that the degree of asset specificity and of uncertainty are poor predictors of the degree of externalization. Based on Transaction Costs Economics, he initially predicted that the production of asset-specific and uncertain service would be internalized, while the production of standardized services would be externalized. In fact, an integration pattern was found in which not only asset-specific transactions were internalized, but so were the transactions of standardized services offered by a large number of sellers.12 This is also in light of uncertainty about demographic, epidemiological and technological patterns and outcomes of care.

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monopsonistic market, requiring ad-hoc governance systems that are different from those of a

pure market (Williamson, 1979). All of these elements lead to the prediction that market is

not the most efficient organizational form for Health Systems. We therefore expect

intermediate levels of outsourcing and privatization to be the initial configuration, which may

differ across Regions depending upon the strength and the manner in which these conditions

appear and interact together.

Following hypotheses 1 and 2, at intermediate levels of outsourcing and privatization, the

opportunity exists to improve efficiency through mix adjustments. However, adjustments in

complex systems are not a straightforward process.

The smoothness of change

So far, we have relied substantially on Transaction Costs Economics in explaining why

Regions choose inefficient initial organizational configurations. To explain the smooth

dynamic of change, we also consider a sociological argument. Transaction Costs Economics

is often criticized by organizational sociologists because it operates with an under-socialized

conception of human actions (Ferlie, 2007). Thus, the governance structure and contracting

rather than social relationships are the driving forces for decisions. In other words, new

institutional economics ignores the proposition that behaviors are embedded in social

relationships (Granovetter, 1985). Embedded relationships make social actors interdependent;

therefore, any status quo shows more rigidities than do the ones we expect in an under-

socialized world. Adding the social perspective to our analysis allows us to explain the

gradual evolutionary pattern of make-or-buy and privatization in Regional Health Services

(RHSs). At any point in time, the potentially efficient configuration is not immediately

reachable because it would require a dramatic change in the institutional and relational

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framework. Therefore, small changes rather than dramatic ones are expected in RHSs. This is

also consistent with Lindblom’s incrementalist theory of decisions in public management.

Ambiguity and time-inconsistency

According to hypotheses 1 and 2, it is likely that given the initial condition, a dominant

strategy may not exist. This happens, for example, when a Region is near the maximum point

of the outsourcing-expenditure curve. Under such a condition, either an increase or a decrease

in outsourcing may induce efficiency. Moreover, in the real world, the final impact of a policy

is subject to uncertainty. Finally, even if a more convenient strategy is identifiable, it may

carry costs other than the current production-related ones, such as the costs associated with

changing the institutional framework. For example, insourcing back some activities

determines the necessity of remodeling the supply structure by building new public hospitals

and establishing relationships with additional suppliers. The above-mentioned points suggest

that efficiency-improving strategies are potentially ambiguous.

In addition, smooth strategies may be time-inconsistent, which means that the objective

configuration changes with the process of approaching it. A smooth process generates a

repositioning of the initial condition at every point in time. As a consequence, new efficiency-

improving strategies may emerge that are not necessarily consistent with the process followed

up to that point. Time-inconsistency may also derive from institutional and political factors.

The former are, for example, the costs of downsizing the level of fixed production factors or

of building a new set of agreements with other counterparties. Political factors, instead, are

related to the need to increase the consensus in specific phases of political cycles.

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From the above, we can conclude that i) both privatizing and modifying outsourcing levels

can be considered to be available policies for improving efficiency, ii) as mechanisms

explaining improvements are different, these two choices can be considered separate, iii)

Regions may start from different intermediate configurations, iv) the modification of

decisions about privatization and outsourcing levels are embedded in preexisting social

relationships/structures, making change characterized by inertia and v) efficiency improving

strategies may be ambiguous and time-inconsistent.

Therefore:

Proposition 1. Regions choose intermediate levels of outsourcing and privatization, but with

different mixes.

Proposition 2. Regional strategies may change over time as predicted by hypotheses 1 and 2,

but they rarely experience dramatic changes that would require a strong revision of the

preexistent relationships between social public and private actors.

Proposition 3. Regional strategies may not follow consistent patterns over time due to the

ambiguity and time-inconsistency of optimal strategies.

As predicted by proposition 1, we expect to find a distribution of choices that could be

classified and interpreted on the basis of the prevalent presence of attributes, according to

Figure 2:

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Insert figure 2 about here

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METHODS

We first proceed by testing hypotheses 1 and 2, and then we compare the predictions from our

simulations with the real evolution of outsourcing and privatization in some of the Regions,

interpreting apparent inconsistencies in the light of propositions 1 through 3. We combine,

therefore, methods of quantitative statistical analysis with qualitative interpretive analysis.

Statistical analysis

The Italian NHS represents an excellent setting for studying outsourcing and privatization. In

2001, the Italian government approved legislation13 that recognized the 21 Italian Regional

Health Services as accountable for healthcare expenditure on an annual budget allocation and

gave them substantial autonomy in the definition of policies for attaining a sustainable level

of efficiency14. At the beginning of the decentralization/regionalization process, Italian

Regions showed very different starting points in terms of the urgency of turnaround and the

solutions already in place. Therefore, there is substantial variation both over time and across

Regions (cfr Figure 3).

To test our hypotheses, we use the public account data of the Local Health Authorities

(LHAs) in the 21 Italian Regions over a period of 8 years (2002-2009)15. Our dependent 13 L. 405/2001.14 For example, in accordance to national thresholds, RHSs can independently increase / decrease the level of resources devoted to healthcare varying the level of regional taxes and co-payments for services directly paid by service users to regional governments.15 We excluded year 2001 because the decentralization law was approved in November.

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variable is the natural logarithm of the per capita public healthcare expenditure16. Health

expenditure is measured as the total regional health expenditure for each year. Outsourcing is

measured as the proportion of hospital beds that are non-directly managed by LHAs (i.e.,

managed by public hospital enterprises cfr. Lo Scalzo, Donatini, Orzella, Profili & Maresso,

2009) and privatization is measured as the proportion of beds that are owned by private

hospitals for which a contract has been signed with the Region or the LHA (according to the

institutional setting). Controls include the level of regional healthcare deficit for every year,

the presence of a healthcare turnaround plan and the local government party affiliation,

together with the regional fixed effects and specific dummy variables for 200517. We identify

the effect with a linear panel regression model with regional fixed effects.

The variable definitions and sources are summarized in Table 1.

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Insert table 1 about here

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In the second part our empirical analysis, we interpret the evolution of regional choices

considering the interplay of two explanatory forces: the first one is the opportunity for

improving efficiency (simulation exercise in our statistical analysis), and the second one is

represented by the consequences of the smoothness of change (cfr. supra), such as ambiguity

and time-inconsistency.

RESULTS AND DISCUSSION

16 We used the logarithmic transformation for interpreting model coefficients as percent variations.17 In 2005, an important innovation in the categorization of hospital bed ownership occurred. In particular, hospital beds of public research-hospitals (IRCCS) were counted together with public hospital beds, while they were previously excluded.

15

As noted above, the case of the Italian RHSs shows sufficient variability with respect to the

attributes depicted in Figure 2; thus, we expect to find at least 1 Region per sector in the

matrix. In particular, we were able to position the 21 RHSs in the matrix based on two main

dimensions: the proportion of hospital beds managed by private entities and reimbursed by

the RHS (model of privatization) and the proportion of hospital beds managed by public and

private entities other than the Local Health Authorities (model of outsourcing). Figure 3

shows the positioning of the Regions in an outsourcing/privatization matrix in the observed

period, following the dimensions presented in Figure 2.

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Insert figure 3 about here

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According to our classification, Regions appear to be predominantly public service-based

with low levels of outsourcing (model 1 in Figure 2), but just one Region (Valle d’Aosta)

shows a complete direct provision of services by the LHA and, as a consequence, no presence

of private providers. This is consistent with our theoretical argument about the choice of

intermediate rather than extreme configurations. Lazio and Campania present a rather high

level of privatization, even with substantial variability across time (model 4 in Figure 2), as

do Lombardia and Calabria (not in Figure 3). Two Regions are consistent with model 2 in

Figure 2, i.e., outsourcing within the public sector.

Statistical analysis

Table 2 presents the correlations among the variables.

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Insert table 2 about here

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We estimated four models using linear panel data analysis (Region/year) with regional fixed

effects (Table 3). We centered our explanatory variables over the regional means across the

observed time period to reduce multicollinearity issues, and we estimated robust standard

errors to account for possible heteroscedasticity. In model 1, only control variables are

included. They explain 28.7% of the within-group variability. It is interesting to note that

Regions with turnaround plans show a higher level of health expenditure. Left-affiliated

governments tend to generate a 0.7% higher per capita expenditure, but the effect is not

significant in models 3 and 4. In model 2, we added the 2005 dummy variable, which is not

significant. Our explanatory variables are included in models 3 and 4. In model 3, we only

look at the direct effects, while the outsourcing squared and the interaction terms are added in

model 4. In model 4, we also excluded the 2005 dummy variable, which was not significant in

model 3. As the R-squared is substantially higher in model 4 (35.3%), we use this model to

test our hypotheses.

The linear coefficient for outsourcing is positive and significant, while the squared term’s

coefficient is negative and significant. Within our sample, we found evidence for both the

increasing and decreasing part of the relationship, supporting hypothesis 1. Hypothesis 2

predicted a negative interaction term. In model 4, the coefficient is negative and significant,

consistent with hypothesis 2.

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Insert table 3 about here

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Privatization shows also a significant and positive direct effect on expenditures. At small

levels of outsourcing, privatization is therefore likely to increase transaction costs more than it

is to generate savings. However, the negative impact of privatization on efficiency is then

gradually reduced with higher propensities to outsource. The overall effect on public

expenditure turns out to be negative after a certain level.

Interpretation of the actual dynamic

We now compare the suggestions based on simulations from model 4 with the actual dynamic

in three Regions: Piemonte, Sicilia and Lazio, which are instances of the models of public

production, public outsourcing and privatization, respectively (cfr. Figure 2).

Piemonte Region

From the starting point in 2002, there were different strategies for reducing public

expenditure. According to the simulation in Figure 4.a, the most effective ones suggest to

increase both outsourcing and privatization (long-dashed line; +50% privatization) or to have

a dramatic reduction in the presence of private actors coupled with a reduction in the

outsourcing level (dotted line, 0% privatization). In this case, ambiguity is evident, and no

clear-cut suggestion emerges from the simulation. Looking at the actual dynamic, the regional

government has increased both the levels of privatization and outsourcing from 2002 to 2003,

but the opposite strategy has been followed from 2003 to 2005. In the 2006-2009 period, the

Region increased both outsourcing and privatization again. Taken individually, both strategies

were consistent with the indications from the simulation exercise. However, we find evidence

of smooth change, with rather small yearly variations in the mix. As we discussed in the

theory section, time-inconsistency is one of the consequences of smoothness of change.

Moreover, time-inconsistency may also derive from institutional and political factors. In this

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case, the right government was replaced in April 2005 by the left-wing coalition. The sharp

reduction of privatization in 2004-2005 may be interpreted as a choice to build an electoral

consensus by expanding the boundaries of public service18. The new left-party government

has resumed the outsourcing policy without giving excessive space to privatization. It is likely

that after observing more political cycles, the pattern of evolution could show recursive

dynamics. If this is true, then the potential levels of efficiency might never be reached because

the smoothness of change, the institutional rigidities and the length of political cycles do not

favor a long-term strategy.

Sicilia Region

In 2002, Sicilia Region showed higher levels of outsourcing as compared to Piemonte but

lower levels of privatization. The suggestions coming from the simulation exercise, even if

still subject to ambiguity, show a relatively sharper reduction in public expenditure when

privatization and outsourcing are both increased (long dashed line; +50% privatization) with

respect to decreasing levels of outsourcing and the exclusion of private providers (dotted line,

0% privatization). Coherent with the suggested strategy, the Region increased the level of

privatization by 14.5% from 2002 to 2003, creating the conditions for a greater effectiveness

of the outsourcing policy, and from 2006 to 2009, it favored the increase of outsourcing via

privatization. During these four years, the Region followed a balanced increase in its

outsourcing and privatization levels even though the following sharp changes occurred: the

adoption of a turnaround plan because of a high Regional healthcare deficit (2007) and the

election of a new government with the appointment of the right-wing party (2008). This

evolution pattern reaffirms the validity of the smoothness of change in complex and highly

institutionalized settings.

18 Note that this choice is traditionally considered proper for the left coalition, and the fact that it was the right party that made it can be a signal of consensus-building behavior.

19

Lazio Region

In Regions such as Lazio, which shows a high level of privatization and a high-intermediate

level of outsourcing, reducing the presence of private hospitals could be detrimental in terms

of the productive efficiency according to hypothesis 2, which would suggest a further increase

in outsourcing. Looking at the simulation, from the starting point in 2002 (the intersection of

the curves), a better level of efficiency could be achieved by either increasing or decreasing

outsourcing. In the former case, an increase in privatization is also suggested. Looking at the

policy adopted by the regional government, it seems that during the first four years (2002-

2004), the strategy suggested by the simulation was chosen, but then a reduction in the mix of

outsourcing and privatization was set during the government election campaign (2005-2006).

Insourcing back some activities again suggests a trigging intervention to promote the pre-

electoral consensus. The new left-wing party revamped a sharp expansion toward

privatization (2007) and an increase in outsourcing (2008-2009). The dynamic process of the

reconfiguration of the outsourcing and privatization levels generally operate as two separate

choices, with regional governments experiencing small but continuous modifications in the

levels of outsourcing.

-------------------------------------

Insert Figure 4 about here

-------------------------------------

We can conclude that Regions have shown that efficiency-improving strategies are identified

and smoothly implemented but are changed before their completion, generating non-linear

patterns of evolution. A general interpretation of these patterns is to be made in the light of

the fundamental question about the existence of steady-states. Are there (sooner or later)

reachable efficient configurations? Or, instead, is this instability moving between waves of

20

insourcing and outsourcing perpetually, with no long-lasting matching between problems and

solutions?

Arguments in support of the first interpretation may be built upon incrementalism and by

using the concept of punctuated equilibria19. Adopting this theoretical lens, efficiency is in

principle obtainable in the long run, but the path is not short or linear, and the excessive

amount of time may be perceived as a signal of impossibility. It is still possible that in some

cases a Region is not able to make decisions that would require a drastic change in the model,

for example because of institutional and social rigidities. This is the case, for example, in

Sicilia Region. Instead, if punctuated equilibria exist, it is possible that time-inconsistency

emerges to a greater extent. This is the case, for example, in Lombardia Region, where the

privatization-only process occurred between 1997 and 2001 and was coupled in the 2001-

2003 period with a dramatic increase in outsourcing. In the following years, and notably since

2005, the strategy has been changed every year, without showing an identifiable pattern. In

fact, in 2005, some of the activities outsourced to other public institutions were insourced

back, while the remainder were privatized. In 2006, both outsourcing and privatization were

reduced. In 2007, there was a substantial downsizing of privatization, and in 2008-2009,

outsourcing and privatization were again increased. A useful framework for interpreting this

evolution is the garbage can model. Indeed, at least two of the typical conditions that favor the

emergence of garbage cans are met: in our case, both the technology is unclear (there is no

clear rule to reach efficiency, if we reject the incrementalist view), and preferences are

problematic to the extent that beyond the objective of efficiency, quality constraints and other

relevant dimensions of performance do not allow for the identification of a univariate

objective function. Fluid participation, the third basic property of systems where garbage can

19 Punctuated equilibria in social theory is a method of understanding change in complex social systems, particularly how policy change and the development of conflicts seem to progress in extended periods of stasis, punctuated by sudden shifts with radical change.

21

emerge, is not very applicable at such a macro context, but it is still observable, extending the

analysis to the whole network of stakeholders instead of focusing only on the appointed

policymaker. According to this view, no efficiency is obtainable by definition of the dynamics

because regional strategies for improving efficiency will be inherently chaotic, highly

unpredictable and ineffective in the long run.

CONCLUDING REMARKS

Adopting different theoretical interpretive approaches, we have shown that efficiency,

intended as a final steady-state, is an illusion. Some drawbacks should, however, be noted.

The choice of disentangling outsourcing and privatization is theoretically intriguing but quite

new, and there was little possibility of identifying an empirical setting with available data

where the two choices were not coincident. Consequently, we made some simplifying

assumptions in the definition of our variables. In the case of the INHS, public outsourcing is

not conceptually homogeneous across Regions. In particular, quasi-market systems differ

considerably in the degree of separation (institutional and financial) between hospitals directly

managed by LHAs and public hospital enterprises. Therefore, our measure is a potentially

biased proxy of public outsourcing and should be taken with care when discussing normative

implications. However, the focus of this paper is not the identification of an optimal policy,

but rather the interpretation of public choices that deviate from a theoretically efficiency-

improving consistent strategy. Another possible concern is the generalizability of the results.

The health sector shows significant peculiarities with respect to both the content and the

country. However it can be considered a relevant case for i) the possibility of disentangling

privatization and outsourcing and ii) for the substantial weight of public healthcare

expenditure on total government expenditure (15% on average in European countries and

21% in the U.S. in 201020). Our study sheds new light on the gap between the normative

20 Source: OASI Report, 2012.

22

implications derived from comparative statics exercises, based on statistical analyses, and the

actual, apparently unsystematic, dynamic of public policies.

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27

Tables and Figures

Figure 1: Theoretical model

OUTSOURCING

PRIVATIZATION

PUBLIC EXPENDITURE

-U

-

Figure 2: Models of privatizing and outsourcing

Public ownership Private ownership

MakeModel 1: Public Production Model 3: n.a. in NHS

Buy

Model 2: Public Outsourcing

(separation of production

activities and service design

within the public sector)

Model 4: Privatization

28

Figure 3: 2002-2009 range of Regional choices of outsourcing and privatization

Piemonte

Trento

Veneto

Friuli VG

Toscana

Umbria

Marche

Lazio

Molise

Campania

PugliaBasilicata

Sicilia

Sardegna

0

0.5

1

1.5

2

2.5

3

3.5

0 0.2 0.4 0.6 0.8 1 1.2

Public ownership Private ownership

Buy

Mak

e

Buy

Mak

e

Public ownership Private ownership

Notes:- The intersection of axes is arbitrary and has only descriptive value;- Yearly observations have been connected with a smooth line to facilitate the

identification of Regions;- In this Figure, we do not report years. Even if we lose the direction of change, we are

interested in mapping the overall range of Regional variation of the outsourcing and privatization mix. The dynamic perspective will be analyzed in the results and discussion section.

- Some Regions (e.g., Lombardia) are not reported for scale reasons.

29

Actual dynamic Simulation

Actual dynamic Simulation

Actual dynamic Simulation

Figure 4: Actual dynamic of outsourcing/privatization mix (left graph) and simulated response of public expenditure as a function of outsourcing at different levels of privatization.

4.a: Piemonte Region

0

500

1000

1500

2000

2500

3000

3500

4000

4500

-60 -50 -40 -30 -20 -10 0 10 20 30 40 50 60

Per-

capi

ta p

ublic

hea

lth e

xpen

ditu

re

outsourcing (centered)

Piemonte Region

Average priv. -50% +50% 0

20022003

200420052006

20072008

2009

1.20

1.22

1.24

1.26

1.28

1.30

1.32

1.34

1.36

1.380.30 0.32 0.34 0.36 0.38 0.40 0.42 0.44 0.46

Out

sour

cing

Privatization

Piemonte Region

4.b: Sicilia Region

0

500

1000

1500

2000

2500

3000

-60 -50 -40 -30 -20 -10 0 10 20 30 40 50 60

Per-

capi

ta p

ublic

hea

lth e

xpen

ditu

re

outsourcing (centered)

Sicilia Region

Average priv. -50% +50% 0

20022003

2004

2005

2006

2007

20082009

2.6

2.7

2.8

2.9

3

3.1

3.20.25 0.27 0.29 0.31 0.33 0.35 0.37 0.39 0.41 0.43

Out

sour

cing

Privatization

Sicilia Region

4.c: Lazio Region

0500

100015002000250030003500400045005000

-60 -50 -40 -30 -20 -10 0 10 20 30 40 50 60

Per-

capi

ta p

ublic

hea

lth e

xpen

ditu

re

outsourcing (centered)

Lazio Region

Average priv. -50% +50% 0

2002

2003

20042005

2006

2007

2008

2009

2.0

2.1

2.2

2.3

2.4

2.5

2.6

2.7

2.8

2.9

3.00.60 0.70 0.80 0.90 1.00 1.10

Out

sour

cing

Privatization

Lazio Region

30

Note: Outsourcing has different scales in the two graphs (the simulation is based on centered outsourcing). The intersection of the curves in Figure 4.b represents the starting point in 2002. The four curves represent different levels of privatization, starting from the Regional average, centered at 2002. The vertical axis reports values in the inverse order, for consistency with Figure 3.

31

Table 1: Variable definitions and sources

Measure SourceVARIABLES

Per capita healthcare expenditure (ln)

ln of per capita public healthcare expenditure

Reports of the Osservatorio sull’Aziendalizzazione della Sanità in Italia (OASI) (various years)

OutsourcingProportion of hospital beds non-directly managed by LHAs

Ministry of Health and OASI observatory

Privatization Proportion of hospital beds managed by private hospitals

Ministry of Health and OASI observatory

Turnaround plan 1 if Region i has an active turnaround plan at time j

OASI reports (various years)

LeftNumber of months in the year with a left-affiliated Regional government

Ministry of internal affairs

Deficit Per capita health deficit (€) OASI reports (various years)

year 2005 1 if year = 2005

Observations 168Number of Regions 21

Table 2: Correlation Matrix

Variables (1) (2) (3) (4) (5) (6) (7) (8)

(1) Per capita healthcare expenditure (ln) 1

(2) Outsourcing (centered) 0.15 1

(3) Outsourcing (centered)^2 -0.07 0.01 1

(4) Privatization (centered) -0.03 0.02 -0.01 1

(5) Private (centered) x Outsourcing (centered) -0.12 -0.22 0.62 -0.05 1

(6) Turnaround plan 0.31 0.00 -0.06 0.03 -0.04 1

(7) Left 0.14 0.00 -0.24 0.12 -0.16 -0.06 1

(8) Deficit 0.26 -0.03 -0.07 0.06 -0.07 0.29 0.07 1

(9) year 2005 0.19 0.08 0.03 -0.01 0.05 -0.09 0.07 0.13

32

Table 3: Estimation results

Per capita public health expenditure (ln)(1) (2) (3) (4)

VARIABLES

Outsourcing (centered) 0.0013** 0.0092**(0.0003) (0.0011)

Outsourcing (centered)^2 -0.0002**(0.0000)

Privatization (centered) 0.2691† 0.3123*(0.1523) (0.1511)

Private (centered) x Outsourcing (centered) -0.05919**(0.0053)

Turnaround plan 0.1451** 0.1481** 0.1318** 0.1262**(0.0187) (0.0191) (0.0206) (0.0206)

Left 0.0068* 0.0066* 0.0056 0.0055(0.0031) (0.0032) (0.0034) (0.0035)

Deficit 0.0001** 0.0001** 0.0001** 0.0001**(0.0000) (0.0000) (0.0000) (0.0000)

year 2005 0.0160 0.0147(0.0137) (0.0145)

Constant 7.32200** 7.3216** 7.3318** 7.3344**(0.0210) (0.0209) (0.0226) (0.0220)

Observations 168 168 168 168R-squared 0.28 0.29 0.31 0.35Number of Regions 21 21 21 21

Robust standard errors in parentheses† p < .10* p < .05**p < .01

33