Government Procurement Policies and International Trade: Economic Considerations

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Government Procurement Policies and International
Trade Economic Considerations

• Simon J. Evenett
• www.evenett.com

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Contents and summary of this presentation

• Motivation and Preliminaries.
• Factors influencing national procurement reform.
• Size of national procurement markets.
• Economic analysis of procurement policy in
  markets.
• Economic analysis of procurement policy in
  auctions.
• Is there a logic for international collective
  action on public procurement policy?
• Empirical analysis of the effects of procurement
  provisions in trade agreements.
• Summary and implications for policymaking.
• This presentation is accompanied by teaching
  materials circulated earlier.

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Motivation and Preliminaries
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Why should trade experts know about procurement
policy?

• National procurement policies have many
  objectives and some of them result in measures
  that affect market access.
• Discrimination against foreign firms is thought
  to be rife in many nations procurement policies.
• Procurement policies are one of few tools left to
  governments to shape national industries.
• Procurement is sensitive because of links to
  corruption, governance, and the funding of
  national political parties.
• Some trade agreements include provisions on
  public procurement
• The wisdom of doing so is debated.
• No multilateral agreement as of yet on
  procurement.

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National procurement policies can cause
controversy in trade circles
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Analysis of policies Tinbergens approach

• Identify the targets and instruments of a
  policy.
• General rule assign a single instrument to each
  targetthe instrument that has the least (ideally
  no) adverse knock-on effects for other policy
  goals.
• Example government goal is for a given industry
  to meet a certain production target.
• Why would a per-unit production subsidy be
  preferable to a tariff?
• What metric can be used to establish a ranking of
  policy measures?
• Why do rankings matter?
• Dont forget these points as this discussion goes
  forward.

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The many targets of national procurement policy

• Value for money
• Minimising procurement costs
• Is there a tension between efficiency and
  procurement cost?
• Macroeconomic management.
• National security.
• Redistributive goals.
• Industrial and regional development.
• Promote SMEs.
• Support state-owned enterprises.
• Governance-related targets.

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The principal instruments of national procurement
policy

• Procedures to identify, specify, and announce
  goods to be purchased by the state.
• Procedures to determine which suppliers are
  eligible to bid for state contracts.
• Tendering procedures open, restrictive, and
  selective.
• Evaluation and award procedures.
• Bid-challenge procedures.
• Can you identify ways in which discrimination
  against classes of bidding firms can enter into
  these five instruments?

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Additional considerations on procurement policy
in developing countries

• Presence of budgetary aid.
• Tied aid implications for spending patterns.
• HIPIC initiative commitments made by recipient
  governments with respect to expenditure policy.
• Resource constraints and implications for
  implementation of certain procurement policy
  measures.
• Size of national procurement markets (more on
  this later.)

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The forms of discrimination in national
procurement policy

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Lack of transparency creeps in many ways in
procurement policy
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Summary on national procurement policies

• There are many many objectives for national
  procurement policy.
• What questions does this raise?
• Procurement regimes are complexcertainly a lot
  more complex that tariffs and quotas.
• Opens the possibility for outright discrimination
  and lack of transparency in national procurement
  policy.
• What are the immediate implications for
  procurement reform initiatives, including those
  involving trade agreements?
• The answers to these questions give an indication
  of the challenges to come in devising procurement
  disciplines in trade agreements.

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Factors influencing national procurement reform
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Principles of Good Procurement Policy

• What?
• Efficiency (value for money)
• Equality of opportunity to compete for state
  contracts (non-discrimination)
• Transparency (control corruption and ensure
  accountability).
• Encouraging investments and partnerships
  (public-private partnerships, etc).
• Espoused by whom?
• Leading development agencies.
• Embodied in UNCITRAL too.

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Cost-benefit analysis of improving transparency

• Costs Establishing, operating, and enforcing
  clear rules requires resources.
• Benefit 1 Improving transparency reduces
  uncertainty for potential bidders (both domestic
  and foreign) that encourages them to compete for
  government contracts and lowers prices paid by
  state.
• Research shows SMEs are especially responsive to
  reductions in uncertainty.

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Cost-benefit analysis of improving transparency

• Benefit 2 Clearer procedures mean that firms
  need to spend less time and money being sure they
  have complied with specified bidding
  requirements. So, existing bidders have lower
  costs.
• In sum
• No one denies improving transparency involves
  outlaysbut the benefits include a broader set of
  suppliers and lower prices paid by the state.
• More bidders for state contracts, lower bidding
  costs, and lower prices paid by the state.

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Importance of competitive tendering

• A strong finding of research on public
  procurement practices is that increasing the
  number of bidders substantially reduces the price
  paid by the stateespecially when initially 5 or
  fewer firms bid.
• If value for money is the objective, then the
  participation of the largest number of qualified
  bidders should be encouraged.
• Open competitive bidding places no a priori
  restrictions on who can bidunlike other
  tendering processes.

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Small improvements in procurement policy would
have large aid-equivalent payoffs
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Different epochs in procurement policy and their
rationales

• Immediate post-WWII closed national procurement
  markets
• Keynesian demand management (reduce marginal
  propensity to import).
• Activist industrial policies and ISI policies in
  developing countries.
• Outright protectionism and nationalism.
• Later movement towards reform liberalisation
  (albeit slowly).
• Budget squeezes from the 1970s in rich countries.
• Widespread privatisation of state-owned
  enterprises.
• Export politics and reciprocal trade reform.

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Factors said to impede procurement reform in
developing countries

• Source Hunja (2003).
• Deep vested interests and lack of political will
  to overcome them.
• Paucity of technical knowledge and capacity.
• Complexity of the substantive issues involved.
• Relationship between procurement reform and
  across-the-board governance reform.
• Role of IT and computerisation.
• Necessity of support of highest political leaders.

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Size of national procurement markets
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What goods and services do states buy?

• Goods major item is office machines telecom
  equipment transport equipment.
• Services construction leasing maintenance
  health education.
• 70 of GDP, large share of total public demand.
• Distinction becoming blurredgovernment
  outsourcingso part of what is wages potential
  procurement.
• Share of services imports ltlt goods.
• Technology that makes services tradable e.g.,
  call centers diagnostics BPO.

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Determinants of size of national procurement
markets

• Underlying societal preferences that manifest
  themselves in
• Constitutional structure.
• Role and size of the state.
• Share of public sector enterprises in GNP.
• Extent of tied aid.
• Government propensity to buy
• Services.
• Defence expenditure.

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Estimates of total size

• 2004 Contestable market in OECD some US 1.8
  trillion (Excludes military and wages)
• EU estimates 10-15 of GDP or 1 to 1.5
  trillion
• 10 of this sourced from another country, i.e.,
  imported
• But another 30 involves FDI indirect
  cross-border trade
• US /- 700 billion.
• 25-35 of spending is by central governments
• Non-OECD assume /- 5 GDP 400 billion
• NB underestimateoften procurement is higher
  share of total expenditure in developing
  countries (30-40)
• Is all this available for competition? No.
• Thresholds, de jure or de facto Policies
  Politics

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Govt outlays, of GDP(excluding wages and
defence)
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Non-OECD procurement markets exceeding US5
billion in 1998.
Source OECD (2002a).
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Economic analysis of procurement policy in markets
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Introductory notes

• Analysis of discriminatory procurement policy
  started by Baldwin and Richardson (1972).
• Considered a partial equilibrium perfectly
  competitive market where
• a government buys a homogenous good that is
  traded on world markets and
• importantly, consumers can buy the same good as
  well
• no tariffs or transportation costs (free trade
  assumption).
• Baldwin and Richardson showed that used certain
  circumstances there would be no effect of banning
  foreign firms from supplying the government.
• What are the implications for trade policy of
  this finding?

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Procurement ban government demand less than
domestic supply
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Procurement ban government demand exceeds
domestic supply
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The effect on long-run equilibrium outcomes of a
procurement ban
Key 0 no change from initial pre-ban long run
equilibrium Decline Increase.
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Price preferences government demand less than
supply
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Price preferences government demand exceeds
supply (case 1)
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Price preferences government demand exceeds
supply (case 2)
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The effect of price preferences on short run and
long run equilibrium outcomes
Key 0 no change from the initial long run
equilibrium without price preferences
Decline Increase.
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Nontradables a ban on purchases from
foreign-owned firms when demand is less than
domestic supply
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Nontradables a ban on purchases from
foreign-owned firms when demand exceeds domestic
supply
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The effect on long-run equilibrium outcomes of a
procurement ban on foreign-supplied non-tradeables
Key 0 no change from initial pre-ban long run
equilibrium Decline Increase.
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Impact of greater transparency demand effects
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Impact of greater transparency supply effects
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Summary of main findings (1)

• Impact of procurement discrimination (and reform)
  depend on
• relative size of demand.
• barriers to entry and exit (including policies
  towards foreign investment).
• Distinction between short and long run effects.
• Conditional nature of effects complicates policy
  recommendations.
• Unlike tariff cutting there is no reason to
  expect that it will lead to simultaneous
  improvements in market access and national
  welfare.

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Summary of main findings (2)

• Improving transparency in procurement policies
  can have an ambiguous effect on market access.
• Export interests may be less interested in
  supporting this reform.
• Implications for propensity to bring dispute
  settlement cases on transparency matters.
• Relationship of findings to the debate in the WTO
  between 1996 and 2004 on the merits of
  multilateral rules on the transparency of
  government procurement.
• Caveats to this analysis.

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Economic analysis of procurement policy in
auctions
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Theoretical analyses and simulations of price
preferences in auctions

• There are few analyses of these matters.
• Recall auctions are analysed using game theory
  tools that take into account the strategic
  interaction between bidders.
• Each bidders bid depends in principle on others
  choices.
• Models are complicated and are normally simulated
  to establish findings for given parameters.
• In what follows we will discuss
• McAfee and McMillan (1989).
• Deltas and Evenett (1997).
• As will become clear there is an analogy to the
  literature on strategic trade policy and the
  monopoly tariff finding.

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McAfee and McMillan (1989)

• Consider an optimal auction where there a finite
  number of bidders.
• Each bidder knows their own marginal cost of
  supply, but not that of any other bidder.
• Each bidder knows the distribution from which it
  can assume the other bidders costs are
  independently drawn.
• There are two types of firm home and foreign.
  Each type has its own different cost
  distribution.
• Generates an asymmetric auction.
• The government purchasing the good knows about
  the asymmetry too.

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McAfee and McMillan (2)

• The government decides to buy one (or more) unit
  of the good. Sets up an auction.
• Consider the case where the home firm and foreign
  firms cost distributions are the same except
  that the mean of the latter is lower than for the
  former.
• They show that if the government wants to
  minimise the expected cost it will pay then it
  will discriminate against the foreign firms using
  a price preference policy.
• What logic underlies this finding?
• Why is it similar to what you have learned about
  the monopoly power and the strategic trade
  policy case for protectionism?

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McAfee and McMillan (3)

• The authors caution the reader It should be
  stressed that our argument is purely normative.
  It does not explain the existence of price
  preference policies their existence is more
  likely to be due to the political power of
  certain interest groupsprocurement preferences
  have unexpected, and sometimes beneficial, side
  effects.
• Discriminatory preferences are not as costly as
  they appearthe zero preference is not the
  appropriate benchmark for evaluating the effects
  of these preferences.
• What is meant by this last remark?

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McAfee and McMillan (4)

• Second finding Irrespective of any international
  differences in the bidders cost distributions,
  if the government values domestic firms expected
  profits as well as expected procurement costs,
  then the government will discriminate against the
  foreign bidders using price preferences.
• This is the classic profit shifting argument
  found in many models with imperfect competition
  between firms.
• How would you interpret this finding?

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Simulating the effects of discrimination in
auctions

• McAfee and McMillan conduct a large number of
  simulations of the effects of discrimination in
  their optimal auction. Their simulations
  demonstrate that
• The maximum reduction in expected cost that
  discrimination can bring about is 2.5.
• Very small errors in the computation of price
  preferences can eliminate all of the benefits of
  this form of discriminationand errors can
  readily raise expected procurement costs.
• Evenett and Deltas (1997) simulate the effects of
  raising price preferences in first price sealed
  bid auctions with only one domestic bidder and
  one foreign biddera setting where the
  profit-shifting motive should be strongest.

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Simulating the effects of discrimination in
auctions (2)

• Evenett and Deltas (1997) found that increasing
  price preferences
• yielded at most a 2.5 reduction in expected
  profits.
• resulted in substantial effects on the bids
  submitted by both firms
• raised the expected profits of domestic bidders a
  lotbut not the expected probability of the
  domestic bidder winning.
• errors in choosing the optimal price preferences
  very soon generate increases in expected
  procurement costs.
• Interpretation Price preference policies
  generate the same political economy dilemmas that
  confront tariffs concentrated benefits and
  diffuse costs.

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Comparing price preferences to other forms of
discriminatory measures

• Governments use measures other than price
  preferences to discriminate against foreign firms
  in auctions including
• import content restrictions/domestic content
  requirements.
• stronger de facto regulation of national
  regulations for foreign firms.
• restrictions on ability to bid through a variety
  of selective or limited tendering procedures.
• First two of the above measures raises the costs
  of the foreign firm or bidder last measure
  affects their ability to contest the auction in
  the first place.
• Can a ranking of the impact of these policies on
  expected procurement costs be established?

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Comparing price preferences to other forms of
discriminatory measures (2)

• Deltas and Evenett (1997) show in their
  simulations that measures to raise the costs of
  foreign bidders cause the latter to raise their
  bids, in so doing raising both expected
  procurement costs (somewhat) and the expected
  profits of the domestic bidder (a lot).
• McAfee and McMillan (1989) show that increasing
  the number of foreign (or domestic for that
  matter) bidders from two to four reduce expected
  procurement costs by a lot.
• Contestability of procurement matters.
• Simulations suggest the following ranking of
  policy measures in terms of increasing effects on
  expected costs price preferences, cost
  increasing measures/discrimination, and selected
  or limited tendering.

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Cost over-runs

• Occur when the actual cost of a projects
  implementation exceed its contracted or planned
  cost.
• Much energy is spent by procurement officials to
  avoid this outcome, still
• If cost over-runs by domestic firms are more
  likely to be bailed out by the domestic
  government, then domestic firms are provided with
  an incentive to lower their bids when seeking the
  state contract.
• Problem arises because a government may not be
  able to commit to a symmetric policy towards
  bail-outs, including potentially a policy of no
  bail-outs.
• See Mattoo (1997) for further discussion.

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Summary of policy implications

• Although departures from free trade can be
  theoretically justified, the use of price
  preferences does not seem to deliver much in
  terms of expected cost reductions.
• Worse, no government will have the information to
  choose price preferences optimally and there are
  big costs to making mistakes.
• Free trade (zero price preferences) then may
  still be a useful rule of thumb.
• The impact of price preferences on domestic
  bidder expected profitability strongly suggests
  that interest group considerations are likely to
  be very important in determining procurement
  policy.
• A clear ranking of the harm done by different
  procurement policies can be established could
  guide trade negotiators.

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Is there a logic for international
collectiveaction on procurement policy?
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Rationales for international collective action

• Market access based arguments traditional
  reciprocity.
• How does the political economy of reciprocal
  procurement reform differ from that of tariffs?
• Unilateral reform in both will probably garner
  less support than reciprocal reform.
• Different conditioning variables (demand side,
  barriers to entry and exit, FDI policy).
• Same potential for substitutability between
  discriminatory instruments.
• Need to combine transparency reform with market
  access measures to preserve the original
  bargain.

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Rationales for international collective action (2)

• What is the political economy of international
  collective action on transparency in procurement
  practices?
• Recall such reform may cause more of domestic and
  foreign firms to bid.
• Domestic exporters may support these measures if
  other barriers do not entirely block their access
  to foreign markets.
• Points to the value of combining transparency and
  market access provisions in a multilateral
  initiative.
• Casts the Doha Ministerial mandate on government
  procurement in a poor light could be valuable
  (is half a loaf better than no loaf?) but more
  expansive mandates are better.

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Empirical analysis of the effects of procurement
provisions in trade agreements
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Evenett/Shingal analysis of Japans UR GPA
membership

• Japans economy stagnated throughout the 1990s.
• How effective has the URs Agreement of
  Government Procurement been?
• Metrics
• Improved resource allocation/welfare.
• Improved market access.
• Preserved market access under pressure.
• Using Japanese submissions to the WTO procurement
  patterns in late 1980s were compared with those
  in late 1990s.

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Finding 1 Snap shot of 1998-9

• Annual reported procurement 36 bn SDRs
• 65.9 below GPA-specified thresholds.
• 25.0 above thresholds and not subject to limited
  tenderingmeasure of market size available to
  foreign competition.
• Contracts awarded to foreigners
• 1.39 services.
• 13.41 goods.

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Finding 2 More below threshold contracts 1997 to
1999

• Percentage of contracts above threshold and not
  using limited tendering
• 1997 26.6.
• 1999 24.4.
• Is this peanuts? Not in dollar terms.
• Amounts to 0.8bn SDRsor over a billion US
  dollars.

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Finding 3 Fewer contracts are awarded to
foreigners

• Proportion of contracts awarded to foreigners (by
  number)
• 1990-1 26.
• 1998-9 24.
• Proportion of contracts that are available for
  international competition
• 1990-1 91.
• 1998-9 86.

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Finding 4 Market access would have been 25
larger

• Reported foreign contracts 1998-9 769m.
• Additional contracts in absence of
• Falling share of above threshold contracts
  131.6m
• Falling probability of foreigners winning a
  contract 61.1m
• Total reduction 192.7m.
• 25 of reported foreign contracts.

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Econometric analysis

• Observe the following two dependent variables in
  19 sectors for 7 years
• Proportion sourced from abroad.
• Proportion of contracts not using limited
  tendering.
• Years 1990-3 1997-2000.
• What factors determine these dependent variables
  and is there a break post UR?
• Answer having controlled for other determinants,
  there is a statistically significant reduction in
  the share of procurement sourced abroad.
• Possible explanations for this finding.

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Evenett (1998) study of eliminating procurement
biases in APEC

• Studied likely impact on bilateral trade volumes
  of eliminating the following two distortions
  created by discriminatory procurement policy
• Reduced demand for foreign produced goods.
• Increases demand for domestic goods and so
  reduces goods available to export.
• Results
• Only first channel is statistically significant.
• The expansion in trade volumes from eliminating
  discrimination is higher in the nations where the
  ratio of state demand to private sector demand
  for tradeables is higher.

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Summary and implications for policymaking
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Main findings

• The very fact that there are many types of
  procurement policy objectives and instruments
  complicates matters.
• Effects of procurement reform are contingent on
  other policies and state actions.
• Effects of a single procurement reform are
  typically contingent on the other procurement
  policies a government employs.
• Both of these points imply that
• The political economy of procurement reform may
  differ from that of tariffs.
• There is a stronger case for trade initiatives
  that include more disciplines on procurement
  policies rather than less.