Minnesota contractor here.
We actually have a hybrid system here. State law says the state does electrical inspections unless a local government gets permission to do their own. Working in the Twin Cities metro area, I frequently deal with both systems. Minneapolis, for example, is under state jurisdiction, while St. Paul has their own inspectors. State inspectors are all contract inspectors. All the city inspectors I've dealt with have been city employees.
As for the conflict of interest problem, state law has that covered. If you work as an inspector on behalf of an AHJ, you are automatically barred from having anything else to do with the electrical industry. That means you can't be a contractor or work for one, nor can you own any interest in one. You also can't work for the supply houses. State law requires every AHJ inspector to be licensed as either a journeyman or a master electrician (all electrical licenses are state licenses).
State permits are pretty cheap; only one city I've worked in has had a lower minimum fee. State minimum is $20, with an additional $20/inspection. My guess is that the inspectors get a percentage, but the only way they can make money is if they do their inspections fast. That has been my experience with state contract inspectors. Whenever I meet them in person, they usually seem like they are behind schedule and have no time to waste. They often just take a quick glance at my work and run off to their next stop.
City inspectors tend to be more thorough, in my experience, but not always.
Both systems have their pros and cons. The inspectors I've dealt with have generally been pretty sharp on the code and haven't gigged me for imaginary violations. I also haven't run into any corruption.