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Title: Government Procurement Policies and International Trade: Economic Considerations


1
Government Procurement Policies and International
Trade Economic Considerations
  • Simon J. Evenett
  • www.evenett.com

2
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.

3
Motivation and Preliminaries
4
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.

5
National procurement policies can cause
controversy in trade circles
6
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.

7
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.

8
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?

9
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.)

10
The forms of discrimination in national
procurement policy
  • .
  • .
  • .
  • .
  • .

11
Lack of transparency creeps in many ways in
procurement policy
12
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.

13
Factors influencing national procurement reform
14
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.

15
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.

16
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.

17
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.

18
Small improvements in procurement policy would
have large aid-equivalent payoffs
19
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.

20
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21
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22
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.

23
Size of national procurement markets
24
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.

25
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.

26
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

27
Govt outlays, of GDP(excluding wages and
defence)
28
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29
Non-OECD procurement markets exceeding US5
billion in 1998.
Source OECD (2002a).
30
Economic analysis of procurement policy in markets
31
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?

32
Procurement ban government demand less than
domestic supply
33
Procurement ban government demand exceeds
domestic supply
34
The effect on long-run equilibrium outcomes of a
procurement ban
Key 0 no change from initial pre-ban long run
equilibrium Decline Increase.
35
Price preferences government demand less than
supply
36
Price preferences government demand exceeds
supply (case 1)
37
Price preferences government demand exceeds
supply (case 2)
38
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.
39
Nontradables a ban on purchases from
foreign-owned firms when demand is less than
domestic supply
40
Nontradables a ban on purchases from
foreign-owned firms when demand exceeds domestic
supply
41
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.
42
Impact of greater transparency demand effects
43
Impact of greater transparency supply effects
44
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.

45
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.

46
Economic analysis of procurement policy in
auctions
47
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.

48
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.

49
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?

50
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?

51
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?

52
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.

53
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.

54
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?

55
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.

56
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.

57
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.

58
Is there a logic for international
collectiveaction on procurement policy?
59
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.

60
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.

61
Empirical analysis of the effects of procurement
provisions in trade agreements
62
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.

63
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.

64
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.

65
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.

66
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.

67
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.

68
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.

69
Summary and implications for policymaking
70
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.
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