Contracting with nonprofits for economic development: A transaction cost explanation

Nonprofits play a leading role in community development, including the provision of economic development services. Despite their involvement, few studies have examined why some cities contract with nonprofits to facilitate economic development. This study investigates how transaction costs, affected by factors such as governance structure, preference diversity, market structure, and fiscal stress, shape a city’s decisions to rely on nonprofits. Using probit regression, the study finds that an increase in the number of nonprofit economic development organizations within a city increases the likelihood of nonprofit selection, while municipal fiscal stress decreases that likelihood. It also finds that the impacts of preference diversity, measured by income inequality and racial-ethnic diversity, are mixed, with income inequality increasing and racial-ethnic diversity decreasing the likelihood of nonprofit participation. The findings elucidate the dynamics of government-nonprofit relations, highlighting how community characteristics influence local governments’ contracting decisions.