Production Costs, Transaction Costs, and Local Government Contractor Choice

Local governments that choose to externally produce a service can contract with other governments, for‐profit firms, or nonprofit organizations. This contractor choice is modeled as one in which the local government decision maker minimizes service delivery costs, both production and transaction costs, subject to political and fiscal constraints. The model is estimated using data on three frequently contracted health services obtained from a national survey of local government service delivery arrangements. The empirical analysis reveals the importance of both production and transaction costs, as well as the choice set of available suppliers, to contractor choice.