Rent Extraction through Alternative Forms of Competition in the Provision of Paternalistic Goods

We compare the properties in terms of rent extraction of spatial competition and monopoly franchises using Dutch first price auctions, two of the most widely used tools to regulate public service provision. In a framework where the regulator can imperfectly observe costs, but the latter are not necessarily private information to each competitor, spatial competition is more effective in extracting rent if providers are very different in their productivity and if they can observe the costs of their competitors. When they are quite similar and have limited information on the competitors' characteristics, the use of a monopoly franchise through an auction mechanism should be preferred. In the latter environment, a multiple object auction allows more rent to be extracted from the provider. 1. Introduction Service provision in the public sector has experienced a substantial change through the introduction of forms of competition among providers. For essential facilities (such as energy, gas, and water), competition for and in the market, along with some forms of price regulation, is envisaged. For other local services, competition for the market and price regulation is often used.1 Production costs often become private information to the provider, a problem which the literature has long recognised [1], and for which specific solutions have been proposed [2–7]. In the recent past, policy makers have extended these reforms to the provision of health, social care, education, and other local services. Forms of competition such as spatial competition and monopoly franchises [8–13] have been implemented, but none of them has proved to be optimal. For education, the empirical evidence shows that competition does not have an impact on the cost of providing the service, but it might improve school performances [14–17]; for hospital care and nursing homes the evidence is fairly mixed [18–23]; in all these sectors cream skimming practices might arise [24]. We argue that performances depend on the specific characteristics of each service, which calls for a more accurate investigation of providers’ responses to alternative regulatory instruments in this very particular context. Services are in fact usually produced on demand (and the latter is not very elastic because they are often perceived as a primary need); they cannot be stocked or transported; and their quality is difficult to verify.2 The supply of these services is often associated with the notion of soft paternalism [25]; in other words Government thinks that individuals should use them irrespective of their