Friday, May 9, 2008

Inefficiencies in government procurement

I am firmly convinced that we are wrong in believing that in general, inefficiency and wastage in government procurement is more the result of conciously driven rent-seeking actions than incidental corruption arising out of the incentive structure created by the procurement bureaucracy. While it is undoubtedly true that there is no dearth of active and conciously corrupt actions, the inefficiency and wastage generated by bureaucratic red tape provides more than ample incentives to sustain a massive rent-seeking economy.

There is an excellent CEPR paper by Oriana Bandiera, Andrea Prat, and Tommaso Valletti, Government spending in Italy - inefficiency vs. corruption, which seeks to clear some of the widely held misconceptions about corruption and inefficiency in government.

The authors use a dataset of procurement prices paid by Italian public bodies to disentangle the effect of active waste (overpricing that benefits the decision-maker directly, like bribing) and passive waste (overpricing due to sheer inefficiency). They find that passive waste, and not corruption-led active waste, accounts for 83% of the total estimated waste.

They find that some public bodies appear to pay systematically more than others for the same type of goods, with the central administration paying on average 22% than health authorities and universities (local government is in between). The differences appear to be due to passive waste rather than active waste, suggesting that sheer inefficiency is an important component of government waste.

The typical procurement policies of Government agencies are cast in stone and this inflexibility makes them economically inefficient. The lack of flexibility means that the procuring agencies cannot factor for local conditions and requirements. All the procurement parameters - specifications of the items, technical and financial qualifications of bidders, bid process management and bid finalization conditions - are laid out in the form of guidelines and frozen. This becomes a major handicap given the large variety and choice now available, disaggregated nature of the market, difficulty (and even desirability) in standardizing specifications of materials to be procured, and role of informal practices like sub-contracting, ring-formation etc.

The main objective of these guidelines is to standardize procurement rules, so as to eliminate the role of human discretion and the attendant possibilities of corruption and nepotism. This rigidity in the rules means that any deviation from these procedures - even when it would very obviously benefit the Government financially or when the specifications need to be modified to optimally suit local requirements - renders the officials vulnerable to disciplinary action.

The incentive structure is therefore clearly established. In most cases, the guidelines specifically prohibits economically efficient alternative price discovery arrangements like post-bid negotiations between say, the lowest two bidders, on the grounds that it opens up the door for corrupt practices. In other cases, the guidelines specifically fix quarterly quantities of different materials to be procured, leaving the local offices with no discretion to change them to suit varying local requirements. Therefore we end up having scarcity of certain materials and abundance of others.

Even those officials genuinely interested in reducing inefficiency and procuring the right kind and quantity of materials, and at the least cost, are disincentivized from using their subjetive discretion. The procurement process is thereby reduced to a set of guidelines to be applied mechanistically, without any application of mind with regard to local requirements and econommic efficiency.

The findings of the study that the wastage is maximum with central government procurement is understandable. Centralized procurement guidelines try to formulate a single set of rules for the entire country, which are invariably oblivious to local requirements and conditions.

The results are - procurement at higher prices than local market rates, delays, sub-optimal and inefficient inventory management, materials not suiting local requirements etc. In any case, with the bidders having internalized the processes, the inevitable corruption associated with bureaucracy remains. Further, with limited attention generally paid to the quality of the procured materials, the major source of rent-seeking and inefficiency lies in the quality.

There is therefore a risk that policy measures aimed at reducing corruption, like additional administrative hurdles or external controls, may increase passive waste. At the risk of sounding cliched, we end up being "penny wise and pound foolish". I am inclined to the arguement that procurement process should be more flexible, giving greater discretion to the local officials, while being unwaveringly strict on the quality of materials procured.

Yes, this will lower the control exercised by the central bureaucracy and increase the discretion of local officials, with all its perceived deficiencies (though I am again strongly inclined to believe that it will be no worse). But on the positive side, the procurement process will surely become more efficient, less wasteful, cheaper prices, better inventory management, superior quality, and thereby better value for money.

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