private non-profit, for-profit and governmental sectors and how public policy should behave
toward them.
The object of our study is represented by the non-profit sector in European Union (EU)
member states acting as provider of education, health and social services. In our opinion, for a
long time the private non-profit sector has been considered as a marginal sector and, as a result,
studied less than the public and market sectors. Indeed, it likely to exist scope for important
spillover among non-profit, for-profit and governmental sectors. Thus, further research on the
existence of such effects, particularly in the provision of welfare services, is very welcome. We
often refer to the non-profit sector as set of organizations acting into the sphere of education,
health and social services. We focus on these three welfare industries not only because they share
the typical characteristics of a public good but also because these three industries are the most
important non-profit fields of activity. To define the non-profit organizations we follow Salamon
et alt. (2000, p. 2-5), consequently, we focus on organizations that are a) private; b) not profit-
distributing; c) self-governing; and d) voluntary. “Group of institutions that includes entities like
hospitals, schools, universities, social clubs, professional organizations, day care centres,
environmental groups, sports clubs, job training centres, human rights organizations, and many
more know variously as the non-profit, nongovernmental, voluntary, civil society, or third sector”
(Salamon, Sokolowski, Anheier, 2000, p. 12). The subject of our study focuses on the provision
of public (or quasi-public) welfare services. In more economic terms we will refer to the market,
state and non-profit sector theories in order to develop a conceptual framework.
The goal of this study is twofold. First, to detect the potential factors affecting the relative size
of the non-profit sector among the EU countries. Secondarily, to add new evidence on the
relationships existing between non-profit and public providers of welfare services in EU member
states. We are interested in whether the non-profit sector and the public sectors are “partners” or
“competitors” in the provision of welfare services, and, whether such relationships holds for
every EU member state included in the sample.
The statistic-econometric methods applied for measuring the interdependences between
variables are conducted using cluster techniques and simple and multiple linear regression
equations, which have been previously specified under the ASO project SK 05/06 BA-018
“Research team creation with the view of project cooperation between scientific research
18
institutions from Slovakia, Austria, Romania and Bulgaria” under the supervision of Prof. Ing.
Maria Uramova PhD.
2. ACTUAL SITUATION OF THE PROBLEM SOLUTION AT HOME AND
ABROAD
This chapter defines the main theoretical framework that will assist us to understand the
concept of efficiency. Then, it examines the conditions that justify the intervention of public and
private non-profit organizations in the economic and social affaires for achieving a Pareto-
efficient solution. Our main concern is to explain the role of such organizations in providing
welfare (public) goods and services. Although we use the terms public and collective goods and
services as interchangeable, for the purpose of this study, we exactingly refer to (public or
collective) welfare services as the total output of the educational, health and social care
industries. Public organizations produce a wide range of welfare goods and services that private
firms are often unable or unwilling to produce. “In some cases, public production coexists with
the private one” (Weisbrod, 1998, pp. 123). Although is not easy to settle when a good should or
should not be provided by the public sector, according to Varian (1998, pp. 554), taking into
consideration the model of the perfectly competitive market, we can observe some situations in
which the conditions necessary to achieve the market Pareto-efficiency are not fulfilled. For
instance, it is generally accepted that “the private provision of public goods will be Pareto
inefficient” (Stiglitz, 1988, pp. 322). As a result, too little of some public goods and services will
be produced and unsatisfied demand will exist. Empirically, however, there are numerous cases
where public goods and services are privately provided. Alongside the literature on market
theory, in this chapter, we also refer to the literature on government theory (see Wolf, 1998;
Musgrave, 1959). “The traditional explanation for why governments exist is to provide public
goods and services to enhance the economic and social welfare of citizens” (Muller, 2006, p.
456). Otherwise known as collective goods, “public goods are those goods and services that are
provided wholly through the political process” (Brown and Jackson, 1992, p. 57). According to
Pollitt and Harrison (1994, p. 350), public goods and services are indispensable to the social,
economic and political health of every liberal democratic state. They “engage the government in
securing a just and equitable distribution of resources” (McNutt, 1996, p. 589). Anyway, it is
observed that voluntary contributions to the provision of public goods and services are made in
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large groups. Does this represent a form of inefficiency? Private provision is to some extent a
means of correcting the inefficiencies caused by public provision of a fixed quantity of goods and
services in the absence of price adjustment or charging of individualized (Lindahl) prices. For
example, if the fixed quantity of the publicly provided public goods and the price charged do not
maximize an individual’s utility then that individual will wish to obtain the public goods through
voluntary actions. Next to the market failure, we also refer to the government failure theory.
Indeed, it is often difficult to state clearly the limits of government intervention. Government
intervention in the economy is not free of charges and has its own costs relating to bureaucracy,
administration, malfunction and ineffectiveness, which can be greater than those of an inefficient
market. The public sector is frequently asked to perform tasks, which in complex, uncertain and
rapidly changing environments are impossible to achieve. In this chapter, we will see that
government failure is just a real phenomenon as market failure. In fact, following Cullis and
Jones (1992, pp. 361-374) in current democratic states, where a simple majority-voting rule does
apply, government can perform his allocative role only when a majority of voters supports the
production of a particular public good or services. By contrast, when such a majority does not
exist, considerable unmet demand for public goods and services may consequently persist. In
such situations, unsatisfied individuals will turn to the assistance of a third sector for the
provision of the public goods and services, which they cannot obtain through the market and the
state. Next to these theoretical implications, we also recall some specific non-profit theories
useful to explain which factors influence the size and structure of this sector and the relationship
existing between the public and private non-profit sectors across industries and countries. This
last step is justified by the assumption that at the present time the economic activity is undertaken
by different types of organizations. “Private, non-profit and public sectors are strongly
interdependent among them” (Kuvikova, 2004, pp. 17-18) and “a growing number of
governments see the non-profit organizations as strategically important subjects between
governmental and market organizations” (Salamon, Sokolowski and Anheier, 2000, p. 17). In
reality, next to the potential sources of conflict, there are also important elements of potential
interdependence and partnership among sectors. For the purpose of our study, in the field of the
non-profit sector, we will preliminarily refer to the most well-known theoretical perspective that
has been developed by Weisbrod (1988), who explains the existence of non-profit organizations
from a classical economic theory viewpoint. Known as the “heterogeneity theory”, this
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framework combines the natural shortcomings of both market and government in providing
public goods and services. According to this theory, the non-profit sector intervenes in the
economy to meet the unsatisfied demand for public goods and services remaining as a
consequence of failures of both the market and the state. The need for non-profit provisions
would decline to the extent that the government provides a larger quantity of public services.
However, the rivalry relationship between public and private non-profit providers of welfare
services is not the sole way to analyse the linkages between the two sectors. Salamon and
Anheier (1998) have formulated an alternative method of analysis, known as the
“interdependence theory”. According to this theory, a close cooperative relationship can be
forged between the non-profit sector and the state in addressing public problems. What would be
desirable in this chapter is to better define the limits of state intervention and to describe more
clearly the rationale of governmental and non-profit organizations in a modern mixed economy.
2.1. Market Failure Theory
Market failure referees to those situations in which the conditions necessary to achieve the
market-efficient solution fail to exist. “There will be a tendency for it to produce too much of
some goods and an insufficient amount of others” (Schotter, 1996, p. 470).
Sources that prevent market to achieve an efficient outcome include:
1. Existence of Public Goods;
2. Existence of Externalities;
3. Imperfect Competition (e.g. Natural Monopoly);
4. Asymmetric Information;
5. Uncertainty;
6. Inability to maximize the utility;
7. Existence of incomplete market.
“Given the presence of such a market failure, one possible role for government would be to
intervene in the economy and correct the market failure” (Mas-Colell et alt., 2001, p. 432).
Anyway, if markets were perfect and if there were no coordination problems among economic
actors, then there would not be reason for government intervention in the economic affairs or, at
21
least, the government’s role would be limited to redistribute income in a just and fair way and to
implement legislation.
2.1.1. Public goods and services
We will focus only on the first source of market failure that arises from the existence of “pure”
public goods. In the rest of the discussion in this chapter, we will refer to public goods and
services as the global outcome of government activities. Next to the institutional and more
general definition of the public good aiming to stress the nature of the provider and their social
utility (see: Muller, 2006; Brown and Jackson, 1992; McNutt, 1996), here we want to focus on
their economic definition.
According to Samuelson (1954, p. 388), a public good is such a good which consumption from
each individual does not subtract from any other individual’s consumption. Another useful
definition describes the public good “as a good provided in the same amount to all involved
individuals although each individual could value it in a different manner” (Varian, 1998, p. 556).
From these definitions clearly appear two main economic features of a public good: non-rivalry
in consumption and non-excludability. Public good is non-rival in consumption because one
individual can consume the good without limiting the availability of the same good for another
individual. For example, one consumer can breathe clean air or walk in an uncrowded park
(street, bridge, railway compartment) without limiting the consumption of others. The non-rival
goods are not necessarily non-excludable. In the case of a park, for instance, can be applied an
entrance fee which make it perfectly excludable. Moreover, Apagar and Brown (1987, pp. 187-
189) argue that the non-rivalry characteristic of the public goods is strictly due to their
indivisibility. How to divide the park among individuals that pay for entrance? By contrast, with
private (rival) good joint consumption is not possible without reducing the availability of good
for another individual. For example, a bottle of mineral water or clothes. In other words, a good
can be defined as non-rival when the marginal cost of adding another individual to consume the
good is zero (MC = 0). In perfectly competitive markets, the efficient solution requires price
equals marginal cost (p = MC). Consequently, for such a good, also, the price, would be zero (p =
0). Revenues will not cover costs and private profit maximizing producers will not provide such a
good. Normally, the private provision of a good would imply charging a positive price (p > 0).
22
This will discourage not only producers but also consumers and, as a result, the output will not be
Pareto efficient. The market fails because unable to allocate efficiently such a good. The
government should intervene in order to correct such inefficiency. Although, the government
provides a large share of public goods and services, this does not necessarily mean public
production. Indeed, the government could subcontract the production of such goods and services
to a private producer. Amartya (1982, pp. 788-790) defines this process as a common feature of
the policy of privatization or denationalization.
Like non-rivalry, non-excludability is another characteristic of most public goods and services.
For many public goods, exclusion is either technically unfeasible or expensive to apply; examples
include national defense, street lighting and clean air. In each example, benefits go to all
individuals living in the same area, irrespective of whether or not they contribute to the cost of
production. If a country is provided with defense service, it is extremely difficult to exclude
anyone who lives within that country from being defended. A pacifist living within the country is
defended whether he likes it or not. He could be able to reject the services of defense only by
moving to another undefended country. Thus, most pure public goods are non-excludable and
non-rejectable. Anyway, “the non-excludability does not imply necessarily non-rivalness in
consumption” (Cullis and Jones, 1996, p. 60), like for example, in the case of common property
resources. By contrast, with private good and service exclusion is feasible. In that case, the set of
property rights defines the ownership of the good. The individual who possesses the property
right has the sole claim to enjoy the benefits of the good and, therefore, can exclude others from
doing so. “Exclusion occurs when a producer is able to limit individuals from consuming a good”
(Bonin and Bonin, 1998, p. 101). In fact, if firms could not exclude from consumption those who
do not paid for a good, they could not continue to remain in the market.
The differences between pure private goods and pure public goods can also be summarized as
follow:
For a pure public good:
(2.1)
GG
i
Each of the i individuals has at his disposal for consumption the total amount of the public good
(G). The public good is indivisible over the set of individuals.
For a pure private good:
23
ƒ
n
1i
XX
i
(2.2)
The total amount of private good (X) is the sum of the amounts consumed by each of the i
individuals (X
i
). The private good is perfectly divisible among individuals.
Table 1: Taxonomy of goods.
EXCLUDABLE NON-EXCLUDABLE
RIVAL
Pure Private Goods
1. Exclusion costs are low
2. Produced by private firms
3. Distributed via markets
4. Financed by revenues from sales
Ex: Food, Clothes
Mixed Goods
1
1. Goods whose benefits are collectively
consumed but subject to congestion
2. Produced by private or public sector
3. Distributed via markets or public budget
4. Financed by fees for the right to use the
good or by tax revenues
Ex: Common Property Resources, Public
swimming pool or park (crowded)
NON-
RIVAL
Mixed Goods
2
1. Private goods with externalities
2. Produced by private firms
3.Distributed via markets
4. Financed by revenue from sales,
public subsidies or tax exemptions
Ex: Schools, Health Services,
Codified TV
Pure Public Goods
1. High exclusion costs
2. Produced by government or by private
firms under sub-contract
3. Distributed via public budget
4. Financed by tax revenues
Ex: National Defense, Street Lighting,
Law and Information
Source: Adapted from Brown and Jackson, 1992, p. 42.
1
These are goods for which property rights cannot be assigned to any single individual. Because the benefits of the
good are made equally available to all members of the group, no single individual is able to sell his property right of
good to another member of the group. Since this good is freely available, the extent to which one individual makes
use of it to pursue the maximization of his own welfare will constrain the amount of the resource available to others.
In the absence of regulated use, each individual will tend to be a “free rider”. However, if all members of a group
behave as free rider, the final outcome will be Pareto-inefficient. Surely, the market solution can be improved if
everyone cooperates or, in the absence of voluntary cooperation and market exchanges, government should intervene
providing a solution that maximizes the common interest of all members of the community.
2
These goods are non-rival in consumption till the dimensional constraint is not reached.
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Apart from the two pure categories of goods, in table 1 there are examples of goods sharing
characteristics of private and public goods (so-called mixed goods). For goods in the lower-left
corner, exclusion is possible, but they are non-rivalness in consumption. In this case, exclusion
brings inefficiency since the non-rivalness of the product implies that no additional resources
must be spent to permit additional consumption. For goods in the upper-right corner, exclusion is
impossible or very expensive, but they are rival in consumption. Because it is impossible to
exclude, many individual may attempt to over-use the good at the same time. The rivalry
characteristics of the good leads to congestion. The result is that the good or service rapidly
deteriorates and the unregulated self-interest behaviour of each single individual produces a less-
than-optimal solution for the group as a whole. Consequently, market fails and government
should intervene in order to correct such inefficiency.
Let us take into consideration two more concrete examples of market failure.
The table 2 shows the pay-off matrix of two individuals (A and B) who have free access to a
swimming pool. They can decide to go to swim according to their self-interest and over-use the
good. Act incorrectly is the individual-utility-maximizing strategy for each individual.
Alternatively, they can decide to behave correctly and in doing so maximizing the social welfare.
The latter choice is Pareto-efficient and ensures the highest level of outcome. Nevertheless,
because of the lack of cooperation between individuals and in the presence of strong incentives to
free rider behaviour, the Nash equilibrium will supply a less-than-optimum solution.
Table 2: A non-excludable, rival good: Swimming pool.
B
CORRECT NON-CORRECT
CORRECT 100, 100 0, 150
A
NON-CORRECT 150, 0 50, 50
Source: own elaboration.
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Table 3: A pure public good: TV.
B
BUYS TV DOESN’T BUY TV)
BUYS TV -50, -50 -50, 100
A
DOESN’T BUY
TV
100, -50 0, 0
Source: own elaboration.
The table 3 presents the case of two flatmates (A and B) who should decide to buy a television
to locate in the living room (commonly accessible) of their flat. In this example, each flatmate
recognizes to the television a value of 100 euro, and, the cost of television is 150 euro. We know
that the purchase of television is Pareto-efficient because the sum of the values recognized by the
flatmates is higher than the cost of television. Furthermore, none can avoid the other to watch the
television. The pay-off matrix shows that if A buys the TV, he will have a net benefit equal -50
(marginal utility minus the price). The same is true for B. However, because the TV is freely
available, one will tempt to use it for free. The solution of equilibrium with dominant strategy is
when none flatmates buy the television. Nevertheless, the Pareto-efficient solution is when one
buys the television (freely shared by both). In reality, for this kind of good, we should expect that
one individual buys the good and the other contributes in some way to it. Provided that the
contributions are determined appropriately, it is in everyone’s interests to contribute to the
provision of the good.
Those two examples show that in the absence of voluntary agreements and market exchanges,
market fails and government should intervene to produce an efficient solution. Private firms can
efficiently supply only private goods. For the other kind of goods, the private efficient provision
poses significant doubts and often requires public intervention. Indeed, public production is the
rule for the pure public goods. Once the good is produced, everybody can share the total amount
in his consumption.
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