Social Heterogeneity and Optimal Mix between Public and Private Provision of Public goods

With a framework of incomplete contract, this paper shows that for provision of public goods such as Medicare and education, pure privatization can’t promote competition. On the contrary, the co-existence of public and private provision can enhance de facto competition. Two competitive effects are identified. When consumers are heterogeneous, the co-existence of public and private ownership gives consumers freedom to choose from different ownership, improving allocation efficiency (Tiebout effect). While consumers are homogeneous, the co-existence can promote yardstick competition, squeezing out information rents from both ownerships, improving production efficiency (benchmarking effect). In either case, the co-existence dominates unique ownership. The paper ends up with some implications for China’s Medicare and education reforms.