Public procurements face the classic problem of any principal-agent framework. Discretion that utilises the informational advantage of agents leads to efficient decision-making. But it also comes at the cost of abuse of the discretion by agents. Getting the trade-off right and allowing the right level of discretion is a big challenge. In bureaucracies where the risk aversion is high, it is generally the case that bureaucrats err on the side of limiting discretion.
This manifests egregiously in the form of the unqualified preference for least price auctions/tenders which, as I have blogged here and here in the context of decision paralysis within the Indian bureaucracy, leads to sub-optimal outcomes.
Francesco Decarolis, Raymond Fisman, Paolo Pinotti, and Silvia Vannutelli have an excellent paper which does an empirical examination of this problem using the example of infrastructure procurements in Italy and establishes several important insights. While most of these are widely known, it's perhaps the first time it has been established using rigorous evidence.
The authors use a unique and rich database on over 200,000 procurement tenders in Italy during the 2000-16 period covering civic buildings, and roads, bridges and highways. The database has information on whether firms that participated and won the tenders were under investigation for corruption and whether the administering officials were similarly being investigated for corruption charges. The size of the database allows the authors to examine several dimensions of contracting and discretion and come up with very robust results.
They compare two broad categories of tenders, based on awarding process (open auction and negotiations) and selection criterion (lowest price or scoring rule). The so-called scoring rule (or quality based) auctions also involve (potentially subjective) non-price criteria in selecting a winner. On the firm characteristics based on corruption allegations and the level of discretion in the tenders, they find,
We begin by examining the types of auctions that are most often won by investigated firms. We show that two auction arrangements are significantly more likely to lead to a contract being awarded to an investigated firm: first, so-called scoring rule auctions, which involve (potentially subjective) non-price criteria in selecting a winner, are 1 percentage point (6 percent) more likely to be won by investigated firms, relative to first-price (non- discretionary) auctions. Auctions that use “negotiated” procedures in which procurement officials invite bidders (rather than allow for open bidding) are no more likely to be won by firms investigated for corruption, relative to open auctions. However, when we look at the subset of negotiated auctions in which officials fail to invite the requisite number of bidders (which we take to be an indication of abuse of discretion), we find a 1.9 percentage point (11 percent) higher probability of an investigated winner. While more at risk of selecting investigated firms, we also find that scoring rule auctions are associated with lower cost overruns and higher award prices, while negotiated procedures are associated with lower delays and higher award prices... we interpret these features as an indication of improved contract execution.
They also looked at whether the choice of discretion is affected by whether the auction was administered by or associated with an individual flagged as suspected of corruption. They examined whether individual procurement officials prone to corruption and areas where suspected corruption is present (proxied by municipalities with at least one official accused of corruption) are more likely to select discretionary (corruptible) tenders.
Our results show effects that go in opposite directions: public officials suspected of corruption are 2.9 percentage points more likely to use one of the two discretionary auction types we flag for concern (discretionary criteria or discretionary procedures with too few invited participants). By contrast, discretionary auctions are 1.9 percentage points less common in “corruption-suspected” municipalities.
Their summary is important,
In our context, greater discretion allows for more efficient implementation of government projects by well-informed and well-intentioned procurement officials, which must be traded off against the higher prob- ability of leakage by corrupt officials. If the choice of auction design is one of the primary means of oversight by a (non-corrupt) central monitor, then less discretion will be allowed in locales where the probability of corruption is higher. When possible, however, corrupt officials deploy discretion, to the benefit of corrupt firms.
They also look at two methods often used to contain corruption, rotation of procurement officers and tighter limits on subcontracting (seen as the main channel for funnelling public money into bribes and kickbacks), both of which also come with efficiency costs. They find that both these are more commonly used in "corruption-suspected" municipalities.
The implied effect of suspected corruption on turnover is very large, with a 22 percent (6.82 percentage points) lower fraction of contracts managed by an average official in “corrupt” versus “non-corrupt” municipalities (and a nearly identical effect on the value of the con- tracts managed)... Indeed, we show a series of results indicating that firms investigated for corruption sub- contract more often and – conditional on subcontracting – they are more than 60 percent more likely to delegate subcontracts to other investigated firms and to award a larger share of all subcontracts to investigated firms. But subcontracting is also a tool for the efficient allocation of job tasks, especially for more complex projects. When inspecting regional procurement regulations on subcontracting rules, we find that regions in which corruption is less of a concern are more apt to loosen regulations on subcontracting, whereas regions where corruption is more of a concern implement tighter subcontracting rules.
They also show that government systems tend to err on the side of caution and impose excessively strict constraints on discretion by lower officials. They examined the consequence of a mid-2000s reform which loosened regulations governing negotiated tenders.
Whereas such contracts could only be deployed for relatively small projects (under €300,000) in the early 2000s, by 2011 the limit had been raised to €1,000,000. This change, motivated by the government’s desire to stimulate the economy by reducing the procedural times to award public contracts, led to a massive increase in the share of auctions held via negotiated procedures, from 10 percent in 2006, to 60 percent by 2012. Yet the vast majority of these were conducted with the legally required number of bidders, and hence the loosening of rules had at most a very small effect on the fraction of contracts awarded to firms under investigation for corruption. And in locations in which officials might have exploited discretion, their use was relatively limited. Indeed, calculations based on our estimates imply a 0.05 percent increase in investigated winners overall between the periods before and after the increase of the threshold for using negotiated procedures. This appears to be a small cost when compared to improvements in contracting quality from discretion, such as a 14 percent reduction in delays.
This points to the scope for allowing greater discretion in procurements which is likely to be net welfare enhancing.
The paper assumes significance in light of the Government of India considering amendments to the General Financial Rules (GFR), 2017 to shift away from the lowest-price auctions towards more quality (or scoring rule) based tenders. The paper offers a ringing endorsement for any such move.
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