Public Procurement. Stéphane Saussier Sorbonne Business School IAE de Paris Class 2

Transcription

1 Public Procurement Stéphane Saussier Sorbonne Business School IAE de Paris Class 2

2 Today! Public procurement, transaction costs and incomplete contracting 2

3 Asymmetric information, contracting problems and public procurement General Equilibrium Model Arrow - Debreu (51) The introduction of Asymmetric information. The market is not anymore a central place where quantities of a specified good are exchanged. It becomes a local face to face exchange place where economic actors are able to identify themselves and to contract together. Stiglitz, Mirlees, Laffont, Tirole, Akerlof, 3

4 Issues generated by asymmetric information Asymmetric information gives rise to pervasive problems. " Adverse Selection! Definition! Illustrations # Insurance; Labor contracts; Manager-Shareholders! Impact # The case of insurance: Average cost is a function of the price! # Akerlof 1970 and the «Market for Lemons»: markets might be closed! # George Akerlof, «The Market for "Lemons" : Quality Uncertainty and the Market Mechanism», Quarterly Journal of Economics, vol. 84, no 3, 1970, p ! The specific case of public procurement: which partner to select? Which partner is efficient and which one is not? # Often investments to be made: long-term contracting # Water supply; regional transportation; urban transport; hospital; 4

5 Issues generated by asymmetric information Moral Hazard Definition Illustrations Insurance; Labor contracts - Team; Manager- Shareholders Impact The specific case of public procurement: how to give the right incentives to selected partners? Usually we need investments to be made: long-term contracting Water supply; regional transportation; urban transport 5

6 Incentive Theory s Methodology Exchange between two actors One Principal (The government) One Agent (The operator) One party is more informed than the other one (Usually the operator) One party gets the whole negotiation power (Usually the government) Third parties are supposed to be efficient without any cost (Courts) 6

7 What is the contract role? The incentive theory postulates that the contract helps To make actors reveal their information For example, bad actors will declare their type To make actors change their behavior Good ones will perform Incentive complete contracts 7

8 Assumptions underlying the result Full rationality and complexity The Principal is able to perfectly reconstruct the strategies of privately informed agents Perfect communication No bounded rationality Full control of communication channels between agents and mediators No risk of collusion Full commitment No risk of renegotiation even if this is ex post optimal Costless Enforcement Courts are benevolent and efficient 8

9 One important conclusion incentive theory has nothing to say about such things as the distribution of authority within an organization, the limits of the firm, the separation between the public and the private spheres of the economy, and more generally nothing to say about organizational forms and designs! (Malin & Martimort 2000, p ) -- Malin, Eric, et David Martimort «Transaction costs and incentive theory». Revue d économie industrielle 92(1): In order for this theory to be able to add something to those issues, incentive models should take into account various forms of transaction costs and that those forms of transaction costs lead to various contract incompletenesses which can be easily described 9

10 The CATV case as an illustration of contractual difficulties Williamson, Oliver E «Franchise bidding for natural monopolies: In general and with respect to CATV». Bell Journal of Economics 7(1):

11 Transaction costs and new institutional Economics 2009: Oliver E. Williamson "for his analysis of economic governance, especially the boundaries of the firm". 1991: Ronald H. Coase "for his discovery and clarification of the significance of transaction costs and property rights for the institutional structure and functioning of the economy". 1993: Douglass C. North "for having renewed research in economic history by applying economic theory and quantitative methods in order to explain economic and institutional change"

12 Make or buy? Transaction Cost Economics A broader picture Williamson O.E. U. of California Berkeley Starts from the 70 s Starting point: let s take Ronald Coase seriously and identify the source of transaction costs - cost of using the market Antitrust issues at the beginning A theory of the firm, contracts and vertical integration A theory that applied to both private and public contracts First case study 1976 CATV case An empirical success story 12

13 Transaction Cost Economics Williamson, Oliver E, "Markets and Hierarchies: Some Elementary Considerations," American Economic Review, vol. 63(2), pages , May. Williamson O.E. U. of California Berkeley

14 Transaction Cost Economics: basics Williamson O.E. U. of California Berkeley A set of realistic behavioral assumptions Bounded rationality Opportunism Coupled with characteristics of the transactions Complexity and/or uncertainty Small number relationships / asset specificity Generating transaction costs 14

15 Transaction Cost Economics: basics Bounded Rationality Complexity / Uncertainty Incomplete contracting Williamson O.E. U. of California Berkeley Possible Opportunism Small Numbers Relationship Need for Credible Commitments 15

16 What Are Transaction Costs? The Costs of contracting. Ink costs Ex ante Costs Negociation costs Search costs Contract costs Maladaptation costs Ex post Costs Renegociation costs Monitoring costs Breach costs 16

17 Asset specificity level is endogenous Small number relationships and asset specificity Uncertainty Lock-in effect and long-term relationships Organizational surplus Rooms for opportunism 17

18 The Hold-Up Issue "It's always been a danger, but it looms like a shadow over everything we've built here. But things have developed that will ensure security. I've just made a deal that will keep the Empire out of here forever." Lando: «But, this was not our initial agreement!» Darth Vader: «I changed the terms of the agreement. Consider yourselves happy that I did not change them more.» 18

19 One example! «But it is difficult to be clear and comprehensive in defining service targets. Governments tend to be nervous about providing only general performance obligations, fearing that the concessionaire will do less than they deem necessary. An example in the United Kingdom helps show why. In the competition for a buildoperate transfer (BOT) contract for a prison, granted under the country s private finance initiative, it turned out that the winning company s bid was based on a plan to house several prisoners in each cell. The government had wanted single occupancy, but had forgotten to specify this in the tender documents.» M. Klein, World Bank, Bidding for Concessions The Impact of Contract Design, /158klein.pdf 19

20 What Implications? Never choose to integrate only for production cost considerations: market always do better! Only transaction cost considerations should drive the decision If no credible commitment is possible then a more complex and costly governance structure is needed, namely vertical integration or regulation 20

21 Main proposition Franchise-bidding solution works in very specific situations BUY MAKE In complex or unpredictable environments, transaction costs are likely to be minimized by removing exchange decisions from the market context and substituting the continuous oversight that regulatory mechanisms entail (Crocker-Masten 1996). Crocker, K.J., et S.E. Masten «Regulation and administered contracts revisited: Lessons from transaction-cost economics for public utility regulation». Journal of Regulatory Economics 9(1):

22 An Empirical Success Story? Source: Macher, Jeffrey T, et Barak D Richman «Transaction Cost Economics: An Assessment of Empirical Research in the Social Sciences». Business and Politics 10(1) 22

23 To know more Levin J. & S. Tadelis Contracting for Government Services: Theory and Evidence from U.S. Cities Journal of Industrial Economics, 2010, 58(3): An empirical analysis of privatization by U.S. cities US cities / + 60 local services Main empirical findings: Services for which it is harder to write and administer performance contracts are less likely to be privatized. Complexity Hold-up sensibility The relationship is greater for larger and more urban cities. One explanation is that these cities have the resources to use in-house provision and perhaps also a more readily available pool of external providers. 23

24 Levin J. & S. Tadelis Contracting for Government Services: Theory and Evidence from U.S. Cities Journal of Industrial Economics, 2010, 58(3):

25 The cost of integration? Coming back to Coase 1937: Inside the firm, «If a workman moves from department Y to department X, he does not go because of a change in relative prices, but because he is ordered to do so» (Coase 37, The Nature of the Firm) Vertical integration is characterized by fiat and forbearance contract i.e. non negotiated authority. Cost is that inevitably, incentives fail i.e. bureaucratic costs Vertical integration is the solution of last resort Each governance structure is flawed Depending on transaction s characteristics some are less inefficient than others. 25

26 Franchise-bidding (Demsetz 1968) and transaction costs Choice of the Private Operator Contract renewal t Service specification Contract execution Competition for the field Competition for the field 26

27 Franchise-bidding s failures (1) The difficulties to put firms in «competition for the field» Price criteria does not always resume what is expected from the private operator Price criteria might be complex (price vector instead of one single price) Aggressive bids $and then quality shading (see the Nasa example!) Winners curse Collusion: ex: case of urban transport in France (2005) penalty 12M Corruption: anti-corruption law in France in 1993 Few bidders 27

28 Potential (imperfect) solutions Bids formulated in terms of a constant revenue stream Least-Present-Value-of-Revenue Auctions and Highway Franchising, (with R. Fischer and A. Galetovic), J. of Political Economy,109 (5), October 2001, $ High Traffic Construction Discounted Revenues Expected Traffic A Low Traffic Maximum length T 1 T 0 Years 28

29 Franchise-bidding s failures (2) Difficulties to enforce (incomplete) contractual agreements Disconnection between price and costs over time Penalties are difficult to apply (See the CATV Case) Non-verifiable dimensions of the contract Opportunistic behaviors might arise Efforts to evade or renegotiate the contract (Guasch, Jose- Luis Granting and Renegotiating Infrastructure Concession: Doing It Right. Washington DC, USA: The World Bank.) See next slide Underinvestment Lower level of quality than promised (but not enforceable) Absence of responsiveness to consumer s needs Connected to the demand risk, transferred or not Concession vs. PFI See next slide 29

30 Renegotiations are not specific to LDCs Source: Estache, Antonio, et Stéphane Saussier «Public-Private Partnerships and Efficiency: A Short Assessment». CESifo DICE Report 12(3):

31 Jamie Oliver 31

32 PPP s failures (3) Long term contracts and refranchising are problematic Specific Investments Long term contracts Lack of bidding parity at franchise renewal («Fundamental transformation») Water sector and urban transport in France: 90% of renewed contracts with the same firm! The solution of franchise bidding is not a free lunch. A need for regulation? For direct public management? Less incentives and more bureaucratic costs! 32

33 What to bring back? Transaction costs at the core of the analysis of public procurement procedures Incomplete contracting Ex ante problems are important. Ex post problems are even more central No complete contingent contracts Need for credible commitments in order to sustain a true partnership 33