Regulation of Privatized Public Service Systems

Abstract

We study a service system where the job of providing a public service is delegated to a private firm subject to government regulation, or run in a public-private partnership (PPP). Customers are heterogeneous in service valuation and sensitive to price and delay. The firm's goal is to maximize profit, whereas the government aims to maximize social welfare. We consider two practically motivated regulation instruments, i.e., price and wait time, and two types of interaction between the firm and government, i.e., Stackelberg regulation (as in a one-shot interaction when the government has commitment power) and Nash regulation (as in repeated interactions when the government's commitment power is absent). We find that the efficiency of a regulation instrument depends on the government's commitment power: while wait time regulation is more efficient than price regulation in Nash regulation, the relationship is reversed in Stackelberg regulation. Somewhat surprisingly, under Nash regulation, when the market size is large enough, price regulation backfires in that social welfare is lower than under no regulation at all, thus leading to a lose-lose situation from the perspective of both the firm and the government compared with complete privatization. By contrast, under Stackelberg regulation, price regulation can achieve a Pareto improvement for the firm, customers, and government over wait time regulation. Furthermore, PPP outperforms complete privatization (in terms of maximizing welfare), thereby avoiding the possible backfire of price regulation. Using practical examples of toll tunnels and outpatient clinics in Hong Kong, we show numerically that in some instances, PPP outperforms all the regulation schemes even when the government takes only a small share in the project.

Keywords: regulation, public-private partnership, service system, queueing economics