The Economics and Politics of Contracting out with the Private Sector: Evidence from the US Transit Industry

Abstract

The paper studies contracting practices in the US transit industry. It employs the methods of transaction cost economics and public choice theory to develop an empirical model of bus contracting in the US transit industry. The empirical results shed light on why transit services in the US remain largely public, despite many attempts to introduce competition by contracting out services to the private sector. The results show that the decision by transit agencies to contract out with the private sector is constrained by the transaction costs of contracting and the institutional and subsidy arrangements that govern the transit industry in the US. Services that require idiosyncratic investments to provide large densities of passengers are less likely to be contracted out than those services that are provided using standard, small vehicles. Similarly, increases in federal subsidies and dedicated subsidies are found to discourage contracting out with the private sector. On the other hand, increases in state and local subsidies, other things being equal, encourage contracting. Agencies that have high labor costs –– indicating strong labor unions –– are less likely to contract out. In light of these findings, the paper concludes that piecemeal contracting out of services is not likely to increase the role of the private sector in the provision of public transit services. Structures of subsidies and federal arrangements creates intertwined incentives that discourage contracting by transit agencies, thus foiling the attempts to increase efficiencies by establishing competition for transit markets.