Regulation of Privatized Public Service Systems

Abstract

To address financial shortage for public service provision, a government may delegate service provision to a private firm subject to regulation in service price or wait time, or jointly finance, own, and run a service system with the firm. However, the conflict between the government's and firm's objective may lead such public-private partnership to low efficiency or even unappealing consequences. Exploring the interaction between the government and firm under different scenarios thus help identify and understand which scheme can be the best for service provision. We model the service system as an unobservable M/M/1 queue. The interaction between the government and firm under regulation is modeled as a game. We consider two practically motivated regulation instruments, i.e., price and wait time, and two types of interaction, i.e., sequential move (when the government has commitment power) and simultaneous move (when the government's commitment power is absent). The scenario under joint venture is modeled as an optimization problem whose objective is a mix of profit maximization and social welfare creation. While wait time regulation is more efficient than price regulation when the government lacks commitment power, the relationship is reversed when having commitment power. Somewhat surprisingly, price regulation without commitment power may backfire. Furthermore, joint venture outperforms complete privatization (in terms of maximizing welfare), thereby avoiding the possible backfire of price regulation. In some instances, joint venture outperforms all regulation schemes even when the government takes only a small share in the project. Our work uncovers that the government's commitment power plays a critical role in choosing the regulation instrument. Joint venture can be an efficient method to deliver public service, especially when the private system is very congested.

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