Government Outsourcing: Contracting with Natural Monopoly (original) (raw)

This paper studies the effect of soft-budget constraints in a pure adverse selection model of monopoly regulation. We consider a government maximizing total surplus but incurring some cost of public funds à la Laffont Tirole (1993). We propose a regulatory setup in which firms are free to enter natural monopoly markets and to choose their price and output levels as in the laisser-faire. In addition, the government proposes ex-post contracts to the private firms. We show that this regulatory setup allows governments to avoid refunding money-loosing firms and that welfare is larger than under traditional regulation where governments commits to both investment and operation cash-flows.