Content uploaded by Simon J. Evenett
Author content
All content in this area was uploaded by Simon J. Evenett on May 01, 2015
Content may be subject to copyright.
1
May 15, 2002
Paper prepared for the World Bank conference “Informing the Doha
Process: New Trade Research for Developing Economies,” Cairo, Egypt.
The WTO Government Procurement Agreement:
An Assessment of Current Research and Options for Reform
Simon J. Evenett1
The World Trade Institute and CEPR
Abstract:
Although most industrial countries are members of the World Trade
Organization’s Government Procurement Agreement (GPA), few developing
economies have joined this plurilateral agreement. This outcome reflects the
perceived costs of complying with the agreement, as well as concerns that the
GPA has gone about tackling non-transparency and formal discrimination in
the wrong order. At present the latter is banned, and the GPA’s provisions on
the former are weak. This allows discrimination to enter by the back door as
officials can favour certain suppliers by manipulating the regulations on which
firms are eligible to bid for a contract; the specifications of the product to be
bought by the government; and how non-price factors, such as perceived
quality and reputation, are to be taken into account when awarding contracts.
Tackling non-transparency is not straightforward. Worse still, recent research
suggests that reforming the GPA to enhance transparency may lead to little
payoff in terms of market access which, after all, is the currency of the realm in
WTO negotiations. If future research sustains the latter finding, then this may
cast doubt on whether much progress can be expected on reforming
procurement practices under the auspices of the multilateral trading system.
1 Director of Economic Research, World Trade Institute, Hallerstrasse 6, 3012 Bern,
Switzerland. Email address: simon.evenett@worldtradeinstitute.ch. I thank, without implicating,
Sue Arrowsmith, Bernard Hoekman and Aaditya Mattoo for numerous stimulating discussions
on procurement discrimination during the last five years. This paper is a non-technical
assessment of the latest policy-relevant research on government procurement from an
international trade perspective.
2
Table of contents:
Introduction 3
Procurement policies in an era of reform 5
The World Trade Organisation’s Government Procurement
Agreement 9
Targets and instruments in procurement policy 14
Economic analyses of procurement discrimination in markets 25
Recent extensions: entry and corruption 32
Economic analyses of procurement discrimination in auctions 38
Preliminary assessment of the GPA and options for reform in the
light of the foregoing economic analyses 43
Potential directions for future research 46
References 50
3
1. Introduction
Many of the public services that are at the forefront of developing
economies’ attempts to fight poverty involve state bodies—whether central
government, local government, government boards, or state-run industries—
most of which purchase substantial quantities of goods and services from the
private sector. The terms upon which the state conducts business with private
firms has thus attained greater importance in development policymaking,
especially given the large and growing demands on governments in developing
economies and the scarce resources available to meet them.
The greater scrutiny of procurement policies at the national level is
complemented by discussions on these matters in international fora, most
notably at the World Trade Organisation but also at the Organisation for
Economic Cooperation and Development. Governments increasingly see
overseas state procurement budgets as potential markets for their exporters,
and the Uruguay Round of multilateral trade negotiations resulted in the
signing of a plurilateral agreement on government procurement practices, the
so-called Government Procurement Agreement (GPA). For a variety of
reasons explored below, few developing economies have decided to join the
GPA, yet several industrial countries appear keen to expand the membership
of this agreement during the Doha round. A key question is whether
membership of the current or reformed GPA is in the interests of developing
economies, and the purpose of this paper is to review the extant economic
4
literature on the effects of procurement discrimination and the likely benefits to
developing economies of further multilateral rule making in this area. Although
research in this area is too embryonic to come to a definitive conclusion,
several themes are beginning to emerge.
To preview the arguments made later in this paper, the first point to take
away is that governments have many objectives for procurement policy and,
more importantly, that there are a large number of ways in which discrimination
in procurement can be implemented. This suggests that any attempt to ban
one type of discrimination is likely to result in another type of discrimination
being employed. The second point is that some types of discrimination are far
less transparent than others. Thirdly, simulations of procurement auctions
suggest that the less transparent forms of discrimination tend to raise
procurement costs more. Unfortunately, the current GPA only bans the more
overt forms of discrimination. One way forward would be to strengthen the
transparency provisions in the GPA and, so as to make this reform politically
palatable, allow nations to discriminate in an overt manner using observable
price preferences. Bounds on these price preferences could be set, and
eventually negotiated down over time.
An optimistic assessment might conclude that some overt discrimination
is a reasonable price to pay for the reduction in uncertainty and corruption
caused by improvements in transparency. However, recent research suggests
that the market access benefits—to developing and industrial countries alike—
of measures to eliminate or reduce non-transparency are smaller than
5
previously thought. If future research sustains this finding, then it may well call
into question what progress can be expected on procurement reform in the
WTO where the exchange of market access concession is the principal
motivation for negotiations in the first place.
This paper is organised as follows. Having situated changes in
procurement policies within the broader context of economic reform we briefly
summarise the current GPA and the recent discussions on procurement in the
Working Group on Transparency in Government Procurement Practices, that
was established after the WTO Ministerial Meeting in Singapore. We then
review the reasons why governments engage in procurement discrimination
and how they go about it. Then the principal economic research findings on
the effects of procurement discrimination are described and a preliminary
assessment of the current GPA is made with various options for reform
discussed. Finally, we discuss future lines of economic research that have the
greatest bearing on developing economies’ interests.
2. Procurement policies in an era of economic reform
The growth of total spending by central and local governments was one
of the most profound economic changes of the twentieth century (Tanzi and
Schuknecht, 2000). Although a large portion of that growth was devoted to
higher transfer payments, governments of all types spent considerable sums
on goods and services produced by the private sector. In addition, state-
6
owned industries procured substantial quantities of inputs from private firms.
As a consequence, through its purchases the state has had considerable
influence over the allocation of resources in market-based economies.
Throughout much of the post-World War II era a nation’s local and
central governments were supplied by firms located inside the nation’s borders.
Discrimination against foreign suppliers was rife. Two justifications were
offered for this discrimination. First, the prevailing Keynesian macroeconomic
orthodoxy emphasized that the increase in national income caused by a rise in
government expenditures was greater the smaller was the share of each dollar
spent on goods produced abroad (imports). Governments could reduce this
share – or what economists call the marginal propensity to import – by refusing
to buy goods from abroad. And so procurement discrimination became
associated with the noble goal of macroeconomic management. The second
rationale for pervasive discrimination against foreign supplies is far less
glorious – nationalism or outright protectionism2. Often it was claimed that “our
money” should be spent on “our goods” to secure “jobs at home.”
Consequently, government procurement was excluded from the original
General Agreement on Tariffs and Trade. Indeed, it was not until the
completion of the Tokyo Round of multilateral trade negotiations that an
agreement on disciplines for government procurement practices was
introduced into the world trading system.
During the Uruguay Round of multilateral trade negotiations, the
agreement of government procurement was strengthened. Three factors
7
underlie this shift towards greater acceptance of international rules on national
procurement practices. First, since the mid-1970s government budgets have
come under increased pressure, especially in industrial nations. Spending on
welfare states, health, education, and pensions have increased considerably.
Governments are then faced with the following unpleasant choices: raising
taxes or cutting non-welfare spending. Since the former was became
increasingly unpopular in many developing and industrial countries, greater
emphasis has been placed on the latter. And one means to reduce non-welfare
spending has been to stimulate competition between those firms that bid for
government contracts—and allowing foreign suppliers to bid for these contracts
helps accomplish this goal. Greater pressure on public budgets, therefore, has
been conducive to procurement reform.
The second factor has been the widespread privatisation of state-owned
enterprises. Without governments standing behind them, these enterprises
know that poor management decisions will not be ‘bailed out’ by the state—
leading to what economists refer to as a ‘hardening of the budget constraint’.
In addition, the owners of the newly privatised firms know that their profits will
not be entirely appropriated by the state. These two changes provide the
privatised firm with an incentive to lower costs, including the expenditures on
goods and services bought from other firms. Since most state-owned firms
procured (like their governments) from domestic firms, privatisation is likely to
increase the opportunities for foreign supplies that sell high-quality
2 For other political economy rationales for reform see Hoekman (1998).
8
competitively-priced goods and services. As privatisation continues in the
future, this will reinforce the opportunities for cross-border procurement.
The third factor conducive to procurement reform is often referred to as
‘export politics.’ Domestic firms eye profitable opportunities in supplying
foreign governments and press their own government to negotiate ‘access’ to
those overseas procurement markets. In industries where there are strong
economies of scale – that is, average costs which fall as production levels
increase – firms have an incentive to increase sales at home or abroad.
Although one government could begin bilateral negotiations with another
government to open the latter’s procurement market, the most prevalent path
to reform has been for nations in the same region to simultaneously increase
the access to their procurement markets to firms from the same region.
Reciprocity is at the core of such agreements to liberalize together, as
contracts lost by domestic firms to foreign suppliers are compensated for by an
increase in the contracts won in neighbouring countries. The export gains can
be balanced against the loss in sales to domestic firms – or so the theory
underlying this approach to trade negotiation goes. Such a regional approach
to procurement reform has advanced furthest in the European Union, and this
experience had considerable influence in shaping the Government
Procurement Agreement negotiated during the Uruguay Round.
9
3. The World Trade Organization’s Government Procurement Agreement
The WTO’s Government Procurement Agreement entered into force on
January 1, 1996. At present the agreement has twenty six members (Austria,
Belgium, Canada, Denmark, the European Communities, Finland, France,
Germany, Greece, Hong Kong (China), Iceland, Ireland, Israel, Italy, Japan,
Korea, Liechtenstein, Luxembourg, Netherlands, Norway, Portugal, Singapore,
Spain, Sweden, Switzerland, the United Kingdom, and the United States), and
twenty three economies hold observer status. Furthermore, Bulgaria, Estonia,
the Kyrgyz Republic, Latvia, Panama, and Taiwan (China) are negotiating
accession to the agreement. China became a member of the GPA when she
accedes to the WTO. In sum, the membership of the GPA comprises mainly of
industrial nations and many developing nations have chosen not to accept this
agreement’s disciplines and reporting requirements.
According to the WTO (2000):
The GPA establishes an agreed framework of rights and obligations
among its Parties with respect to their national laws, regulations,
procedures and practices in the area of government procurement. The
cornerstone of the rules in the Agreement is non-discrimination. In
respect of the procurement covered by the Agreement, governments
Parties to the Agreement are required to give the products, services and
suppliers of any other Party to the Agreement treatment “no less
favourable” than that they give to their domestic products, services and
suppliers and not to discriminate among goods, services and suppliers
of other Parties (Article III:1). Furthermore, each Party is required to
ensure that its entities do not treat a locally-established supplier less
10
favourably than another locally-established supplier on the basis of
degree of foreign affiliation or ownership and do not discriminate against
a locally-established supplier on the basis of country of production of the
good or service being supplied (Article III:2) In order to ensure that the
basic principle of non-discrimination is followed and that access to
procurement is available to foreign products, services and suppliers, the
Agreement lays heavy emphasis on procedures for providing
transparency of laws, regulations, procedures and practices regarding
government procurement.
The annexes of the GPA outline, for each member, which government
authorities (central government, sub-central governments, and other state
bodies such as utilities) and which purchases of goods and services are
potentially covered by the disciplines of the GPA. Even then, only those
transactions which exceed certain threshold levels are actually covered by the
GPA. Although a common threshold of SDR 130,000 was established for
central government utilities purchases of goods and non-construction services,
these thresholds tend be much higher for construction projects and purchases
by non-central government entities.
The treatment of goods and services in the GPA differs in one important
respect. All goods purchases are subject to GPA disciplines unless a nation
secured exemptions during the agreement’s negotiation (or during subsequent
accession to the agreement.) In contrast, only those services which a nation
lists in the Annexes to the agreement are covered by the GPA’s disciplines.
Nevertheless, the WTO suggests that the scope of government procurement
covered by the current GPA is approximately $300 billion, which is ten times
11
the estimated coverage of the agreement of government procurement
negotiated during the Tokyo Round.
As the quotation above made clear non-discrimination is at the core of
the GPA. However, unlike many other WTO agreements, many members
have conditioned their own commitments on the market access offered by
other members of the GPA. This has effectively meant negotiating a raft of
bilateral obligations on reciprocal access to procurement markets, and deflects
from the well-established principle that nations grant unconditionally the same
access to all members of a WTO agreement. To the extent that such
reciprocity actually prolongs discrimination against foreign supplies, then the
benefits of enhanced competition to supply domestic procurement contracts
will be reduced. Finally, the GPA’s requirement that foreign bidders are treated
no less favourably than domestic bidders (a discipline called ‘national
treatment’ in the jargon of international trade experts) effectively bans price
preferences against overseas bidders located in nations which are members of
this agreement.
The GPA has two other important features: measures to improve
transparency in the procurement process and enforcement provisions. The
agreement contains measures on the use of selected and invited tendering, the
nature of technical specifications listed in a tender, and the criteria used to
make procurement awards. The article on technical specifications, Article VI,
contains a number of loopholes as it only enjoins nations from creating
“unnecessary” obstacles to trade. Furthermore, the agreement notes that
12
specification should “where appropriate” relate to performance, rather than to
the manner in which a good or service is designed, produced, or marketed.
The GPA preserves some discretion on the part of procuring entities
when it comes to deciding which bidder to award the contract to. Contracts
must be awarded to the supplier that is deemed capable of undertaking the
contract and satisfies one of the following two requirements: (i) the supplier
made the lowest bid or (ii) the supplier best meets the evaluation criteria laid
out in the original tender. Essentially, this latter requirement prohibits a
procuring entity from refusing to award a contract to a supplier on grounds that
were not specified in the tender. Of course, the effectiveness of this
requirement depends critically on how broad are the evaluation criteria in the
tender.
On the subject of transparency two other provisions of the GPA are
worth noting. First, the GPA allows a government to refuse to award a contract
on “public interest” grounds that, alas, are not defined. Second, once a
contract award has been made the procuring entity does not have to provide
an explanation to those bidders who did not win the contract. The latter is only
required when a member government intervenes on behalf of a bidding firm
under the GPA’s enforcement procedures.
The enforcement provisions of the GPA are particularly interesting.
Recognizing that aggrieved bidders want to have rapid redress, perhaps even
reversing an ongoing procurement process, the GPA mandates that members
establish impartial domestic arbitration procedures capable of making swift
13
decisions. Furthermore, complainants are allowed to invoke the provisions of
this WTO agreement in making their case in a domestic arbitration procedure.
In addition to these domestic procedures, members are allowed to bring cases
before the WTO dispute settlement body, especially if it is found that a
domestic arbitration procedure has misinterpreted the GPA. Of course, the
effectiveness of this domestic dimension to enforcing an international trade
agreement depends crucially on the manner in which national adjudication is
carried out. There will inevitably be differences in such procedure across
nations and, perhaps more worryingly, differences in the ability of adjudicators
to resist pressures to favor domestic suppliers.
Subsequently, a Working Group on Transparency in Government
Procurement Practices was established after the 1996 WTO Ministerial
Meeting in Singapore.3 The mandate of this Working Group was contained in
that meeting’s Ministerial Declaration and called for
“the working group to conduct a study on transparency in
government procurement practices, taking into account national
policies, and, based on this study, to develop elements for
inclusion in an appropriate agreement.”4
The Working Group produced four annual reports between 1997 and 2001. At
the 2001 WTO Ministerial Conference in Doha, Qatar, a concerted effort was
made by a number of WTO Members, including the EU and the US, to obtain
3 For an analysis of the origins of this Working Group, and its relationship to the Uruguay
Round GPA, and the likely consequences of strengthening transparency provisions in the
GPA, see Arrowsmith (1997).
14
agreement to launch negotiations on transparency in government procurement.
This was opposed by a number of developing countries, who were of the view
that the WTO should continue studying and discussing this subject with a view
to identifying good practices and determining what the benefits of multilateral
disciplines might be. In the event, it was agreed in principle to launch
negotiations on this subject at the 2003 Ministerial Conference, on the basis of
modalities that must be agreed by explicit consensus. This leaves open the
possibility that negotiations will be blocked through a veto, or, alternatively, that
WTO members will agree that the outcome of negotiations will not apply to all
members.
4. Targets and instruments in procurement policy
Tinbergen, the Nobel-prize winning macroeconomist, introduced the
distinction between a government’s targets and instruments. The former are
the objectives that the government wishes to achieve, and the latter are the
means employed in the attempt to meet those objectives. This distinction in no
way validates, or endorses, the targets chosen by the government; nor does it
imply that any given instrument has the desired effect. In our case government
procurement policies tend to have multiple targets and numerous instruments.
This reality complicates an analysis of procurement policies, and no doubt
4 See “Singapore Ministerial Declaration—Adopted on 13 December 1996,” World Trade
Organisation, document WT/MIN/96/DEC.
15
accounts for the multi-faced nature of international disciplines on the use of
such policies.
Targets
Perhaps the most common objective of procurement policies is to obtain
‘value for money’ for the government in its purchases. This straightforward
objective itself has many facets; it could mean the purchase of goods, that
meet certain quality levels, at minimum cost. Alternatively, it could mean
choosing that good with the highest quality among a set of similarly priced
goods. At a first cut this objective seems unobjectionable. However, this is to
forget that the key metric used by economists to evaluate government policies
is the effect of such policies on economic efficiency. Efficiency is attained
when the price paid for a good (service) reflects the value to society of the
resources used to produce the last unit of that good. One classic source of
inefficiency occurs when the decisions of a buyer or seller of a good affect
market prices. Now a government buyer may, through the sheer volume of its
purchases, have such clout or market power so as to induce supplies to lower
their prices in order to win government contracts. Therefore, it is important to
bear in mind that attaining the lowest possible price, or ‘value for money,’ in
government purchasing need not generate efficient economic outcomes.
Governments also use procurement policies to favour certain groups,
firms, regions, and industries. For example, such favouritism is widespread in
the United States and India where the central government favours small firms
16
who bid for contracts. More recently, South Africa has considered instituting a
scheme which will favour black entrepreneurs and firms that employ stipulated
numbers of black employees. This is part of a sweeping initiative to enhance
the economic status of the majority black population after the fall of apartheid.
Finally, purchases of military equipment have long been subject to different
rules, as nations have felt the need to maintain a broad range of military
production facilities for national defense purposes. Because these objectives
of procurement policy do not directly relate to maximizing economic efficiency,
economists refer to them as ‘non-economic’ objectives. This does imply that
these objectives are misguided or unattainable. Rather, it implies that
governments have explicitly decided to adopt measures that may well lead to
market outcomes that do not maximize economic efficiency.
Given the widespread adoption of non-economic objectives by
governments, economists have researched extensively their consequences,
especially in the area of international trade policy. The main finding of this
research has been to show that the amount of economic efficiency sacrificed to
meet a non-economic target differs considerably across instruments—and so it
makes sense to determine which instrument attains the desired goal with the
smallest reduction in economic efficiency. In so doing, economists have
argued that it is better to tackle the direct source of problem rather than take
measures that only indirectly bear on the problem.
For example, governments may want to promote the number and
production levels of small firms by awarding these firms state contracts even
17
though at least one large firm submitted a lower bid. An economic approach
might point to a different course of action: first, the government should identify
the impediments faced by small businesses and take measures that directly
remedy them. If the critical impediment to the growth of small firms is access to
financial credit, for instance, then policies should be directed towards
bolstering the supply of credit to small firms—rather than using indirect means
such as deliberately increasing the sales of small firms through government
contracts.
The arguments above are not theoretical hair-splitting—they have direct
relevance for the reform of government procurement policies. Governments
may be more inclined to eliminate a procurement scheme that favours a certain
industry if they know that other forms of state intervention can better attain this
objective. Furthermore, if the chosen form of state intervention directly tackles
the source of the favoured industry’s impaired performance, then economic
efficiency is likely to be improved also. Indded, international negotiations on
government procurement provide an excellent opportunity to revisit the
rationale and effectiveness of existing forms of favouritism in procurement.
Instruments
The manner in which governments procure goods and services can be
complex and leaves plenty of room for favouritism towards groups of suppliers.
Our main focus here is on favouritism towards domestic suppliers, or
alternatively put, discrimination against foreign suppliers. At this point it is
18
worth noting that a supplier can be foreign, and therefore the potential subject
of discrimination, in two respects: the supplier is located overseas, or the
supplier is located domestically but is partially or fully foreign owned. The latter
includes subsidiaries of multinational corporations whose headquarters are
located abroad.
Since most of the instruments for discrimination can be identified in a
description of how governments actually procure goods, we shall start there.
However, additional means of discrimination against foreign providers of
services do exist and we shall discuss them later. If a government decides not
to effectively ban outright foreign bids for a contract5, then in essence the
procurement of goods can be divided into three distinct stages: tendering,
evaluation, and challenge. At the tendering stage the government notifies a
supplier or suppliers of its desire to procure certain types of goods. The
government can specify what type of goods that it wishes to buy – including, in
principle, the manner in which those goods are produced. There three types of
tendering procedures: open, selective, and limited. In open procedures an
interested supplier, located at home or abroad, can submit a bid or, as it is
often called, a tender. Under selective procedures only those pre-qualified
firms may submit a tender. Pre-qualification is an additional step where a firm
must demonstrate that it can deliver high-quality goods in a timely fashion. As
this determination depends on the judgement of the procuring officials, some
suppliers (including foreign firms) may be at a disadvantage if they do not have
5 This can be accomplished by an outright ban on foreign bids, or by permitting foreign bids on
contracts value exceeds a certain size.
19
a track record in supplying the relevant goods. Limited tendering procedures
are the most restrictive as the procuring agency contacts individual suppliers
and invites only these suppliers to submit tenders. This is not to say that there
are no circumstances under which limited tendering is appropriate (ensuring
quick delivery in a time of national emergency is one such circumstance).
Rather, that limited tendering frustrates one of the principal objectives of
procurement reform—to stimulate competition among suppliers, which is likely
to result in lower prices for the government. Finally, if governments rely on
existing suppliers when conducting limited tendering, then new foreign and
domestic suppliers are almost certainly to be discriminated against.
The specification of the goods also introduces the potential for
discrimination. For example, a government might require that the goods be
produced in firms that adhere to certain health and safety standards for
workers. As these regulations differ across countries foreign suppliers may
find their costs rise to meet another nation’s standards, reducing their ability to
effectively compete in a tendering process. Even if a foreign firm already
meets those standards, there may well be costly verification procedures which
too reduce the effective competition from foreign bidders. Our discussion on
tendering procedures has, therefore, identified two forms of discrimination
against foreign suppliers – discrimination that directly or indirectly reduces the
number of bidders and discrimination that increases the costs of foreign
bidders. We shall refer to these as ‘entry’ and ‘cost’ discrimination
respectively.
20
The evaluation of tenders is the next critical stage in the procurement
process. As firms rarely bid to supply identical goods, the procuring official will
have to assess not only the price of the tender but also a whole series of non-
price factors—such as the quality of the good, the quality of after-sales service,
the reliability of the supplier, and alike. Many of these factors are hard to
quantify and some subjective judgements are inevitable. However, such
judgement is to be distinguished from explicit discrimination against certain
groups of suppliers. Governments may employ price preferences to inflate the
bids of disfavoured suppliers. For example, a ten percent price preference
against foreign suppliers implies that their actual bids will be inflated by ten per
cent before being compared to bids by domestic suppliers. This puts foreign
firms at a disadvantage as raising a bid typically reduces the probability of
winning a government contract.
There is one caveat to the presumption that a lower bid increases the
chances of securing a state contract, and that is when a bid is too low to be
commercially viable. At first this may seem implausible, however, it is
important to remember that firms often supply a good well after the contract is
awarded. If a firm is building a bridge for a government and the firm runs out of
money (because its bid was below the cost of producing the bridge), then the
government is in something of a bind. Does the government begin the
procurement process afresh, or is it cheaper to pay the existing contractor
additional sums to complete the bridge? Here the supplier is being ‘bailed out’
by the government and the latter finds the bridge cost more (possibly much
21
more) than intended. Furthermore, the possibility that a supplier may be
subsequently ‘bailed out’ affects the prices that each firm bids in the first place.
And, if domestic firms are more likely to be bailed out than foreign firms, this
confers an advantage on domestic bidders for state contracts6. Procuring
officials should check to ensure that tenders with exceptionally low bids have
the capacity, and the incentive, to complete any contract that is awarded to
them.
The role of intangible factors—that are part of the decision as to which
firm to award a contract to—can undoubtedly cause controversy. Firms that do
not win the contract may feel that they were discriminated against, that the
evaluation was conducted unfairly or incorrectly, or that irrelevant factors were
taken into account. Consequently, many governments have established
procedures that enable firms to challenge the decisions of procuring officials.
The specific details of these procedures determine, in large part, their effect of
the tendering and award steps of the procurement process. If aggrieved
parties can only recover the cost of preparing the bid and the cost of mounting
a challenge, then a firm will be disinclined to object to a procurement decision,
unless there is the expectation that similar tenders will be issued in the future
and that the challenge will alter the subsequent behaviour of procuring officials.
(Of course, the firm might also be concerned about retaliation by these officials
in future tenders.) In contrast, if the challenge procedure offers the potential to
win substantial damages this may well reduce inappropriate behaviour by
procuring officials. This beneficial effect must be seen beside the costs of
6 This argument is developed at length in Mattoo (1997).
22
frivolous challenges, and the increased bureaucratic measures that officials will
take in order to reduce the likelihood of successful challenges by initially
unsuccessful bidders. Finally, to the extent that foreign firms believe that they
are unlikely to receive a fair and objective hearing from a domestic challenge
procedure, then another form of discrimination is introduced into a nation’s
procurement system. This increases the likelihood that the entry-based, cost-
based, and price-based discrimination identified earlier will occur, again
reducing the benefits that accrue to governments from competition between
potential suppliers.
Services
Up until now our discussion has focused on purchases of goods, with
the implicit assumption that a foreign firm can supply a domestic government
contract through the export of a good. This mode of supply is, in the parlance
of trade experts, called the ‘cross-border movement of goods.’ When
discussing the procurement of services three other modes of supply are of
importance, each of which reflects the fact that many services can only be
delivered when the supplier is close by, or proximate to, the purchaser. The
first of these three modes of supply is referred to as establishing ‘commercial
presence.’ Here a foreign firm sets up a subsidiary, or forms a joint venture
with a domestic firm, within the borders of the ‘home’ nation. Once established
this subsidiary or joint venture can attempt to bid for the ‘home’ government’s
service contracts. The ability to establish presence, and therefore to bid for
23
government contracts, is highly contingent on government policies towards
foreign direct investments, joint ventures, and foreign mergers and acquisitions
of domestic firms. Strict rules on foreign takeovers of domestic firms are likely
to reduce this method of establishing presence and, therefore, will alter the
nature and extent of tendering for government service contracts.
The other two modes of supply relate to the movement of people across
national boundaries. To effectively supply some services, such as accounting,
auditing, consulting, and legal services, may only require the temporary
movement of personnel. Other services, such as recurring maintenance and
perhaps nursing, may require longer term or even permanent migration of
workers, especially if there is insufficient expertise in the domestic labour force.
In both cases the ability of a foreign firm to contest the domestic service
market—irrespective of whether the buyer is a government or not—depends
critically on the nation’s policies towards work visas and migration.
This discussion implies that a government that wants to reap the full
benefits of competition between potential service suppliers cannot confine
themselves to implementing a transparent and non-discriminatory government
procurement regime. As services can be supplied through four modes of
supply (cross border-movement for tradeable services-and the additional three
modes described above), policies towards each mode of supply can affect the
intensity of competition in the services market. It should be noted that foreign
firms do have some choice over which mode of supply to use. For this reason,
some have argued that a nation may not need to open all modes of supply in
24
order to derive the benefits from foreign competition. While there may be
some validity to this argument in certain situations, in general just because a
foreign firm has access to at least one mode of supply does not imply that the
permitted mode(s) are the lowest cost mode(s) of supply. Furthermore, as the
costs of each mode of supply are likely to vary across industries and over time,
there is little reason to suppose that opening any one mode of supply in
general (such as permitting foreign direct investments) will maximize the
benefits to governments of foreign competition for procurement contracts.
Corruption and collusion
Given that firms (domestic and foreign) want to secure lucrative
government contracts, and that officials may be motivated as much by
personal self-interest as by promoting the public interest, it should come as no
surprise that corruption and collusion are a feature of government
procurement. Firms may decide to reduce the competition for contracts by
agreeing (or ‘rigging’) the prices they submit to the government. The intention
is for each firm to take its turn in winning a government contract, and this
clearly requires repeated tendering by the state which in effect holds out the
prospect of future contracts for all those engaged in collusion. Of course, firms
could attempt to bribe or induce government officials to view their tenders more
favourably, and such corruption has been extensively researched (see
Bardhan, 1997, and Rose-Ackerman, 1999, for recent surveys.)
25
Without preventing a full fledged analysis of corruption, for our purposes
it is important to recognize that procurement rules–-whether national or
domestic—should be designed with the possibility of corruption in mind. As we
have already seen there is considerable scope for discretion on the part of
procuring officials, and much can be done to force those officials to make their
decisions in an open fashion. Likewise, ‘carrots and sticks’ can be offered to
officials to induce them not to take bribes. However, an important question
which we will discuss later, is how effective can any reform to procurement
practices be when corruption is present.
5. Economic analyses of procurement discrimination in markets
In recent years the forms of procurement discrimination identified in the
last section has received greater attention from researchers. As usual
economists distinguish between two sets of research questions: what is the
effect of a government policy on market outcomes? And what is the effect on
national welfare, which aggregates the benefits that purchasers (including the
government) and suppliers derive from market exchange? Most of the
scholarly attempts to answer there questions have focused on the effects of
procurement discrimination in a single market or auction. However, it is
important to realize that international trade research stresses actions in one
market can have knock-on effects in other markets, an approach which
emphasizes so-called “general equilibrium” effects.
26
General equilibrium analyses
The first effect of government procurement discrimination that we shall
consider is on the level of demand for different goods. Suppose a government
decides to no longer buy a good from abroad. This will raise the relative price
of that good (the price of that good compared to other goods) because the
additional resources that favoured domestic firms need to use, in order to
satisfy the government’s higher demand for their products, must be lured away
from other productive resources. Immediately, then a procurement ban will
affect the payments to factors of production, such as land, labour, and capital.
The factor of production who gains (loses) from the imposition of this
procurement ban is the one which is used most (least) intensively in the
production of the good that the government is now buying solely from domestic
firms. For example, if the amount of capital used per worker to produce one
unit of steel is greater than one unit of textiles, then increased government
demand for domestically–produced steel will raise the demand for capital more
than the demand for labour, with predictable consequences for the payments
to capital owners and workers. The first knock-on effect of procurement
discrimination in the domestic goods market is in the labour and capital
markets.
The second knock-on effect is on the quantity of exports and imports.
There are two mechanisms at work here: one which works through relative
prices and one that works in industries where higher output levels translate into
27
higher productivity levels. To consider the first mechanism, let us return to the
steel and textile example of the last paragraph. The imposition of a
procurement ban on foreign steel raised the relative price of steel. Now, if the
nation was already exporting steel before the procurement ban, then the ban’s
imposition will raise the relative price of steel to all purchasers -- including
foreigners -- who will then buy less domestically-produced steel. In other
words, the procurement ban would lead to a fall in domestic exports. On the
other hand, if the nation was importing steel before the ban was imposed, then
the increased relative price of steel that results from the imposition of the ban
would reduce the total (government plus private sector) domestic demand, and
therefore, the imports of steel. In both situations trade flows decrease as a
result of the procurement ban.7 More importantly, both situations rely on the
world price of steel (relative to textiles) being affected by a nation’s
procurement ban. Not many nations are likely to have such clout over the
world price of even a few goods. In contrast, the next mechanism works when
a nation’s procurement ban has no effect on world prices.
Suppose that labour productivity (output per worker) and capital
productivity (output per machine) rise when a firm’s production level increases.
Taking our steel and textile example again, let us consider what happens when
government stops buying purchases of foreign steel, and when the ban has no
effect on world prices. The government switches any demand for foreign steel
to domestic steel producers, whose immediate response is to increase output.
7 Both cases are based on the reasonable assumption that the demand for steel falls as its
relative price increases.
28
Such increases in output also raise productivity, so lowering the amount of
labour and capital used to produce additional units of output. This increases
the incentive for domestic steel production to expand exports too, since the
higher productivity results in lower incremental costs of supplying any market—
including the export market. In sum, an expansion in domestic demand for
steel has increased exports as well as domestic steel sales. Now, it should be
borne in mind that in firms where labour and capital productivity falls as output
rises (perhaps because firms find it more and more difficult to organize larger
and large production runs), the opposite effect will occur. That is, procurement
bans at home will reduce exports abroad. As this argument raises clear,
everything turns on the effect of output on productivity levels, which depends
on the firm’s technological and managerial capabilities.
Partial equilibrium analyses
The first influential analyses of procurement discrimination examined the
effects on outcomes in a single market. The essential feature of these
analyses is that there are two sources of supply (domestic and foreign) and
two sources of domestic demand (the government and consumer). The
principal finding, which may seem a little counterintuitive at first, is that a
procurement ban on foreign purchases by the government will affect output
levels, imports, and prices only if government demand exceeded domestic
supply at the moment the ban was imposed. An example will make this a little
clearer: Suppose that in the market for cars before the procurement ban was
29
imposed, government demand was 60, private sector demand was 40, the
domestic private sector supplied 45 cars, and 55 cars were imported. Initially,
then the government must have imported at least 15 (60-45) cars. So at the
prices that prevailed before the ban was imposed, government demand
exceeded domestic supply. In this case, when the ban is imposed the price of
cars paid by the government must increase to encourage domestic supply to
expand to meet government demand. At this higher price government demand
equals domestic supply at, say, 52 cars. In which case, government demand
has fallen by 8 cars, domestic production has risen by 7 cars, and imports have
fallen by at least 15 cars.
Now effect on the domestic consumer depends critically on whether the
initial pre-ban price was determined by world prices or by domestic market
forces. If the world price determined the pre-ban price, then the domestic
consumers are unaffected by the procurement ban. After all, domestic
consumers do not need to pay the higher post-ban price charged to domestic
government, as they can buy all the cars they want on world markets at the
world price. In contrast, if foreign producers customize their cars to the
domestic market, the procurement ban leaves foreign producers with at least
15 cars which they used to sell to the domestic government but can no longer.
Since these cars were customized for a specific market (say they have
steering wheels on the left hand side), then the possibility of selling these cars
on the world market is remote. The foreign car suppliers are left with little
choice but to offer additional cars to domestics consumer are at lower prices.
30
In this case, domestic consumer actually gain from a government ban on
purchases from foreign cars—as the ban creates a temporary surplus of
foreign goods which lowers the price paid by domestic consumers.
The arguments in the last two paragraphs considered the case when the
government demand for cars (60 in this case) exceeded domestic private
sector supply (45) at the time the procurement ban was imposed. Now,
suppose that government demand were less than or equal to domestic private
sector supply, then the imposition of a procurement ban would have absolutely
no effect on imports, output, or national welfare. To see this, let us change the
preceding example in only one respect—assume now that before the ban is
imposed government demand is 45 cars and domestic private sector supply is
60 cars. (Everything else in the example is as before.) In this case, the ban
would merely reshuffle demand between foreign supplies and the domestic
producers of cars. To see why, suppose originally the government bought 5
cars from abroad then those 5 cars must now be supplied by domestic firms,
which in turn would have 5 fewer cars to supply the domestic consumers.
However, foreign firms have exactly 5 unsold cars which they can now supply
to domestic consumers, making up any apparent shortfall on the supply side.
Therefore, when government demand is relatively small, and procurement ban
merely reshuffles sales between domestic and foreign firms, with no effect on
overall imports, output, or prices. This striking result was first pointed out in
Baldwin and Richardson (1972), and suggests that there are circumstances
under which procurement discrimination has no effect on market outcomes.
31
Unfortunately, the clear-cut nature of these predictions only provides us
with a test of whether the future imposition of a procurement ban will affect
market outcomes. A procurement ban on a good by a nation’s government will
only affect market outcomes if the level of government demand before the ban
exceeds domestic private sector supply. This test, however, tells us little about
whether an existing procurement ban restricts market access to foreign firms.
Certainly, other things being equal, if government demand after the ban is less
than domestic private sector supply then we know the argument in the last
paragraph applies and that the ban has had no effect on market outcomes,
including imports. However, if observed government purchases equals the
quantity supplied by the domestic private sector after the ban was imposed,
then we do not know if the ban has distorted market outcomes. This is because
this equality could have prevailed before the ban, and in that case the
imposition of the ban would have had no effect on imports. Thus, this simple
test does not always provide a reliable guide about the market-access reducing
effect of an existing procurement ban.
In sum, this framework is useful as it implies that procurement
discrimination effectively segments the domestic market into a market to
supply domestic government and a market to supply the domestic consumers.
The domestic government forgoes the benefits of foreign competition, and may
pay a higher price and purchase less—if its demand was relatively large
(compared to domestic supply) to start with. Domestic producers can gain (if
they have to coaxed into supply more with higher prices) and the effect on
32
domestic consumers depends on whether domestic prices were initially set by
world prices or domestic market forces.
6. Recent extensions: entry and corruption
Entry
The framework described in the last section has been extended recently
in two directions. First, the implications for firms entry have been considered by
Evenett and Hoekman (2000a). They noted that, in the case where
procurement discrimination raised the price paid by the government, domestic
firms expanded output and saw their profits rise. As is usual in a market
economy, profits act as a signal to entrepreneurs who are deciding which
industry to set up production in. New “domestic” firms want to enter this
protected industry—and if they do, then the number of firms who can supply
the domestic government increases, and the price paid by the government will
tend to fall until the incentive to enter this market (higher profits) has gone.
Indeed, the principal consequence of allowing free entry into the market is that
the price paid by the government may now fall down to the world price—
eliminating any price wedge between that paid by consumers and that paid by
the government.
Whether entry occurs depends on the prevalence of natural–and policy-
induced barriers—to entry. Entry by domestic entrepreneurs may be frustrated
by rules, regulations, and licensing. Entry by foreign entrepreneurs, who could
33
set up production facilities in the nation with the procurement ban, depends
upon a slew of policies towards foreign direct investments. Therefore, the long
term consequences of a procurement ban are determined in part by domestic
competition policies and restrictions on foreign direct investments. The greater
the entry the smaller the difference between the prices paid by the domestic
government and the domestic consumer, and the smaller the distortion to
government consumption decisions. However, if the new entrants have long
run costs of production than exceed those of overseas producers, then the
elimination of the procurement ban will still improve market access-- that is, if
domestic suppliers cannot take steps to lower production costs in the face of
increased foreign competition.
Corruption
The second extension is to consider the effects of corruption and bribery
on the benefits of procurement liberalization. It has been widely acknowledged
that corrupt government officials can solicit payments from actual and potential
potential suppliers of goods and services to the public sector. Naturally, the
nature and extent of corrupt practices differ across the world, and it is
impossible to give a comprehensive account of corruption in the space
available here. Instead, we focus on two distinct lines of argument developed
in Evenett and Hoekman (2000b, 2002). The earlier of these two papers
considered the impact on procurement and procurement reform when a corrupt
government official took bribes in a transparent fashion. The second paper
34
considers the case when a corrupt official shifts government expenditures
towards goods where the procurement process is relatively more non-
transparent, which in turn facilitates the collection of bribes.
The first paper proceeds from the assumption that a procurement official
cares about two factors: the quantity of goods that his government agency
buys (which is associated with size of his agency and the prestige of the
agency), and the benefit he derives from spending any income he receives as
bribes from the firms which supply his government agency. Now suppose that
these firms can also sell in the world market at a price of $1. This means that
these firms’ revenues from supplying the government, net of bribes paid to the
official, can never fall bellow $1, otherwise the firms would concentrate on
supplying the world market. The official has to decide what bribe $b (per unit of
good sold to the government) has to be paid by the firms. Competition among
the firms ensures that they charge the government $(1+b). In making his
choice the official knows that a lower bribe will increase the quantity that his
agency purchases, which increase his welfare, but may reduce his total income
from graft. The official will choose that bribe level which equates the
incremental benefits of the former to the incremental benefits of the latter.
Under quite standard assumptions on the official’s preferences, this will result
in positive bribes being set. (A bribe of $0 would, of course, result in no income
from bribery.) Now our corrupt official does not, in this set up, really care
whether a domestic or foreign firm pays the bribe, so long as the bribe is paid.
35
Therefore, it is perfectly possible for a corrupt official to buy some goods from
abroad.
As we have just seen bribery raises the price paid by the government and
reduces the quantity purchased. How much that quantity is reduced also
determines whether or not the subsequent imposition of a procurement ban
has any effect. The following example underlines this point. Suppose that the
government only decides to buy 5 units of a good when the official is corrupt.
Before the procurement ban is imposed those 5 units were supplied by both
domestic and foreign firms. If the domestic industry supplies more than 5 units
to all buyers when bribery occurs then, just as Baldwin and Richardson found,
a procurement ban merely reshuffles demand between domestic and foreign
suppliers. This is because the domestic firms need not change their
production plans in order to meet all of the government’s demand.
Furthermore, the greater is the reduction in government demand due to
bribery, the higher the likelihood that are procurement ban has no effect.
However, if the domestic firms initially supply less than 5 units, then the
imposition of the procurement ban will result in government demand exceeding
these firms’ pre-ban output. To meet the governments’ demand the domestic
firms have to expand output and can only be induced to do so if the price
(charged to the government) rises. Just like the Baldwin and Richardson
model, procurement bans can distort market outcomes. However, in this
model the greater the effect of bribery on government demand, the less likely is
a subsequent procurement ban to distort prices, outputs, and market access.
36
Thinking in terms of procurement reforms these arguments imply that nations
are less likely to benefit from removal of a procurement ban when their officials
are corrupt. In this case, bribery undermines the benefits of procurement
liberalization. (Notice that the argument developed above did not need to
invoke non-transparency in order to come to the this finding.)
In a later paper Evenett and Hoekman (2002) introduced an additional
realistic wrinkle: that the procurement processes for differentiated products
tend to allow for more discretion by procurement officials—potentially
presenting opportunities for corrupt officials to collect bribes. As we have seen
earlier, WTO members have become increasingly concerned about the effects
of non-transparency in government procurement practices and the goal of this
paper was to see what the implications for market access would be of
eliminating non-transparent procurement procedures. The first step in Evenett
and Hoekman’s argument was to appeal to the following finding, which is
supported by a growing body of empirical literature on the nature and effects of
corruption in procurement settings, namely,
“that corrupt officials deliberately expand expenditures on goods and
projects—such as aircraft and construction—which are highly
differentiated and for which there are few, if any, comparable reference
prices in world markets. Recent econometric analysis supports the
contention that governments which are perceived to be more corrupt
spend more on military procurement and on arms imports. Put simply,
officials with an interest in rent collection are likely to employ non-
37
transparent procurement regimes to expand government spending on
those items where the opportunities for self-enrichment are greatest
(page 11).”
This finding suggests that the composition of government spending is shifted
towards goods and services that have relatively less transparent procurement
processes. In addition, Evenett and Hoekman pointed to separate evidence
which suggests that small and medium enterprises are less willing to bid for
government contracts if they have to bribe government officials. In economic
terms, to the extent that non-transparent procurement procedures reflect the
desire to collect bribes by corrupt government officials, then the willingness of
firms to supply the government’s needs here is smaller than it would otherwise
be.
These two stylised facts were used to analyse the effects of introducing
a WTO agreement that eliminated non-transparency in procurement
procedures. Evenett and Hoekman argued that such an agreement would shift
government demand away from more differentiated towards more
homogenous goods, and would increase the number of firms willing to bid to
supply differentiated products. In most of the cases analysed in their paper,
Evenett and Hoekman found that the demand for imported differentiated
products would fall—suggesting that eliminating transparency need not raise
foreign market access in total. It would be very interesting to see if subsequent
research comes to a similar conclusion as it would call into question the value
(from a market access perspective) of negotiating additional disciplines on
38
transparency in government procurement at the WTO. This is not to say that
enhanced transparency would not have other development-friendly effects.
7. Economic analyses of procurement discrimination in auctions
In the analyses of procurement discrimination in markets outlined in the
last two sections, the discrimination never resulted in a fall in the market price
paid by the government—underlying the presumption that zero discrimination
maximizes both government purchases and the benefits derived from scarce
government resources. However, many government purchases are transacted
not through markets, but with suppliers bidding for a contract. Each firm
typically bids a price to complete the contract given what it thinks other firms
are bidding. And if price were the only consideration, the government would
choose the bid with the lowest price. Economists have developed theories of
auctions to examine such bidding behaviour, and here we discuss what these
theories imply about the desirability of discriminating against one class of
bidders (in our case, foreign bidders).
The first finding is that outright bans on foreign bids unsurprisingly
reduce the competition faced by each domestic bidder, who in turn all submit
higher bids. The government then finds itself choosing from a range of higher
bids, and the overall cost of the contract rises. This finding establishes a
strong presumption against forms of discrimination that exclude foreign
bidders, and evidence from simulated auctions in McAfee and McMillan (1989)
39
suggests that restricting the number of bidders considerably increases
procurement costs.
The second finding is that any measure that increases the cost of one
group of bidders results in that group raising their bids (or possibly not bidding
at all). The other bidders face less competition and so raise their bids too.
Again the government will see its procurement costs rise. Suppose that a
government decided that foreign firms would, from now on, have to incur costs
to verify that they met certain domestic health and safety standards.
Furthermore, assume that even though domestic firms faced the same
requirements the latter are enforced less rigorously on home firms. This
asymmetric enforcement would effectively discriminate against potential
foreign bidders by raising their costs. This would result in higher bids by all
firms – domestic and foreign – and higher procurement costs. In simulations of
auctions Deltas and Evenett (1997) found that such “cost” discrimination
against foreign firms can raise procurement costs significantly. However,
comparing their findings with McAfee and McMillan’s simulations, the outright
prohibition on foreign bidding raises the expected procurement outlays more
than cost discrimination.
The third finding differs from the first two in that one form of
discrimination–using price preferences–can actually lower procurement costs.
McAfee and McMillan (1989) demonstrated this result in an analysis of optimal
procurement auctions. The significance of this result is that it undermines the
presumption that a cost-minimizing procurement official would always choose
40
not to discriminate against any bidder, domestic or foreign. To understand the
intuition underlying McAfee and McMillan’s result it is important to bear in mind
two points. First, in most analyses of auctions, if one supplier raises his bid
then other suppliers have an incentive to raise their bids too. (Here there is no
need to lower your bid if another supplier is raising his bid, and therefore,
increasing the probability that you are going to win the contract.) The second
point relates to how price preferences work. A price preference is only used to
inflate the actual bids of foreign suppliers when comparing domestic and
foreign bids. If a foreign supplier’s inflated bid is still the lowest, then the
government awards the contract to that foreign supplier, but only pays that
supplier their actual bid. For example, suppose there is a 10% price
preference on foreign bids. If a foreign supplier bids $10 for a contract, then
for the purpose of comparison with domestic bids the domestic government
treats the foreign supplier as if he had bid $11. Now if $11 is the lowest
amount that any supplier bids, then the contract is awarded to the foreign
supplier and the latter is only paid $10 (his actual pre-inflated bid).
McAfee and McMillan’s insight was to show that foreign firms choose
their bids knowing that a price preference will be used to inflate their bids.
Foreign firms respond to high price preferences by lowering their actual bids,
but not by enough so that their inflated bid falls. What is more, foreign firms
accept a larger reduction in their profit margins as price preferences become
more stringent. The inflated bids of the foreign firms reduce how much
competition domestic firms effectively face. Since the price preferences raise
41
the foreign firms’ (inflated) bids, then domestic firms respond by raising their
actual bids and, therefore, their profit margins. The effect of higher price
preferences on procurement costs is ambiguous, but if the probability of a
foreign firm bidding the lowest is high, then raising prices preferences might
actually reduce procurement costs because the actual amount paid by the
government to any successful foreign bidder has gone down. In particular,
McAfee and McMillan show that if the foreign firms have on average lower
costs than domestic firms, then an increase in price preferences from zero will
always reduce procurement costs because the probability of a foreign firm still
winning the contract is so high.
The domestic firms approve of raising price preferences, because it
expands their profit margins if they win the contract, and so long as they do not
increase their bids too much, the probability of their winning the contract
increases too. In sum, McAfee and McMillan show that it is possible with
certain price preferences to lower the government’s procurement costs and to
raise the expected profits of the domestic firms. (They also show that if the
government is prepared to trade off higher procurement costs against higher
domestic profits, then the government should always impose price
preferences. It is always possible to find a price preference that increases
domestic firm’s profits more than such preferences raise procurement costs.)
But how much of a reduction in procurement costs can be accomplished
by using price preferences? Both McAfee and McMillan (1989) and Deltas and
Evenett (1997) found in simulations of auctions that the cost reductions were
42
very small (often less than 1%). Worse still, Deltas and Evenett found that if
the government accidentally chose the wrong rate of price preference then
these cost reductions would quickly become cost increases–-even for small
errors. This is particularly important as policy makers do not typically have
access to all the relevant information (including the actual probability
distributions of the costs of the domestic and foreign firms) to choose the
optimal price preference. And even if they did, political factors would probably
“encourage” policymakers to choose a higher-than-optimal price preference
which benefits domestic firms. Indeed, Deltas and Evenett’s simulations imply
considerable gains in the expected profitability of domestic firms result from
even quite modest (5-10%) price preferences. Overall, even though McAfee
and McMillan (1989) demonstrated in theory that it is possible to reduce
procurement costs by imposing price preferences, in practice the reductions
are very small and given the realities of policy making will almost certainly
never be realized. This form of procurement discrimination is bad policy too.
One final point is that, comparing across simulations of procurement
auctions, these three forms of procurement discrimination in auctions can be
clearly ranked in terms of their adverse consequences for procurement costs.
Price discrimination tends to have the least adverse effect, followed by cost
discrimination, which in turn is less distortionary than outright bans on bids
from foreign suppliers. Given these findings, it is unfortunate that the current
WTO Government Procurement Agreement takes the strongest measures
43
against price preferences and imposes much weaker disciplines on the other
two forms of procurement discrimination.
8. Preliminary assessment of the GPA and options for reform in light of the
foregoing economic analyses.
Even though this assessment will be critical of selected aspects of the
GPA, it should not be forgotten that this plurilateral agreement has expanded
considerably the disciplines on public procurement procedures. We can
expect, with a reasonably high degree of confidence, that membership of this
agreement translates into lower procurement costs, allowing members to
spread stretched government budgets across a wider range of activities.
Nevertheless, the agreement falls short of its potential for two reasons. First,
discrimination has only been tackled partially. Second, the benefits of
membership of this agreement are highly contingent on the extent of bribery
and corruption in an economy. We discuss each of these in turn.
The provisions in the GPA allowing for conditional non-discrimination
need to be rethought. Commitments to open procurement markets should be
made unconditionally to all members of the GPA, or even better, to all
members of the WTO. Removing conditionality would expand the number of
foreign suppliers who are treated similarly to domestic suppliers, encouraging
competition, and lowering procurement costs.
44
The more important concern about the GPA’s disciplines on
discrimination is that they ban price preferences, which tend to be the least
(economically) costly and relatively transparent form of procurement
discrimination. At the same time, the provisions on cost or entry discrimination,
which are far more opaque, are weaker. An alternative would be to tighten up
on the latter, and channel any protectionist tendencies towards observable
price preferences, whose levels can then subsequently be negotiated down
over time. In addition, one could modify the selective procedures to allow firms
who have not pre-qualified to bid, but to do so with a fixed price preference
applied against them. Apart from this price preference, such firms’ bids would
be treated identically to those firms who pre-qualified. The advantage of this
provision in that it caps the costs of the pre-qualification process.
The use of a firm’s track record in completing contacts must also be
handled with care. Ideally, that track record should include any experience in
completing similar contracts for other private sector firms and government
entities. Restricting the relevant track record to that of supplying a certain
procuring entity makes it much harder for a new bidder, which by definition has
no experience of contracting with this entity, to win future contracts and should
be avoided. In this instance, the burden should fall on the procuring entity to
demonstrate the irrelevance of a new bidder’s track record with other contracts
undertaken at home or abroad.
One of the main findings of the theoretical analyses was that bribery and
corruption narrow the circumstances under which procurement reform yields
45
benefits. This finding highlights the importance of complementing any
international agreement on procurement reform with national measures to
tackle graft. A reformed GPA might require signatories to delegate contract
award decisions to independent public servants or agencies (where possible);
to take steps to protect whistleblowers; and to create an independent auditing
or investigative office (which could be located in the legislative branch, rather
than the executive branch, of government.) This would complement tougher
penalties on graft by public officials and restrictions on the post-retirement
employment opportunities for officials. Specifically, retired officials should
probably not be employed by or advise the very firms that bid for government
contracts in the area which the official was previously responsible for. Since
the objective here is to avoid providing any firm (or firms) with an advantage,
because of its decision to hire a former official or officials, there need not be
any restrictions on such officials writing for, and speaking to, a broader
audience on procurement matters.
In terms of prioritising reform efforts this paper points to the importance
of tackling bribery and corruption—at the national level primarily—and then
discrimination. This is because the imposition of the procurement
discrimination merely reshuffles sales from foreign to domestic firms in
markets—and has no consequences for national welfare—when the quantity
demanded by the governments is initially below the domestic industry’s output.
Since bribery and corruption tend to reduce or reshuffle government demand,
graft expands the set of circumstances under which the imposition of
46
procurement discrimination has no effect on national welfare and market
access. In contrast, graft is welfare-reducing in many more, and probably all,
circumstances. In sum, tackling graft—rather than discrimination—is probably
the central goal for developing economies in procurement policy and there is
much that can be done at the national level without reference to international
agreements. Having said that, the latter may well reinforce domestic initiatives,
but its effects are probably of second order.
9. Potential directions for future research
The principal shortcoming of the existing literature is its weak empirical
foundation, especially as it relates to developing economies. (The situation in
industrial countries is only a little better, and nothing to be reassured about.)
Even at this stage we do not have a good handle on (i) the size of developing
economies’ national procurement markets that are in principle open to
international competition, (ii) the prevalence of different types of procurement
discrimination and the frequency with which foreign firms win contracts from
governments other than their own, (iii) the prevalence of the various types of
non-transparent procurement procedures, or (iv) the size of industrial country
procurement markets that could potentially be supplied by developing economy
exporters. Without these magnitudes, it is difficult to begin assessing how
serious a negotiating priority this is for developing economies.
47
Having established the key magnitudes, it would be useful to analyse national
procurement reforms to discern what changes yielded the greatest reductions
in costs or improvements in quality. For example, we would like to know if
internal measures—such as linking the compensation of procurement officials
to the cost savings they could accomplish without jeopardizing quality—
produced greater benefits than letting foreign firms bid for government
contracts or some other outward-oriented procurement reform. Here, the best
place to start might be to analyse key reforms in a few developing economies
that have made good strides in this area. Peru, for example, has implemented
a number of transparency-improving measures and it would be useful to know
what benefits have ensued and whether measures to reduce transparency
have subsequently been taken by officials. These systematic country studies
would provide a number of useful hypotheses that could then be incorporated
into a larger study of developing economy procurement practices. (An
alternative is to examine the effect of procurement reforms enacted at the
regional level, such as in the European Union, and compare them to the
benefits of national reform.)
The linkages between procurement reform and other areas of trade and
national economic reform could be explored more systematically. For instance,
to what extent does an open foreign direct investment regime and low barriers
to domestic entry erode the rents that procurement discrimination generates?
Similar questions could be asked in the service sector about the impact of
48
temporary migration of service workers and the rents that tend to accrue to
domestic unionised workers that work for state bodies. Indeed, these linkages
may well complicate the political economy of reform and it would be useful to
better understand why procurement reforms appear to happen so infrequently.
The trade-related aspects of procurement could be subject to better
quantification too. In addition to estimating the increase in market access that
results from different types of procurement reform, further thought is needed as
to how to measure compliance with any international agreement. As we have
seen, there are many dimensions along which discrimination can operate and it
may therefore be fruitless to assess compliance along a subset of dimensions.
Instead, perhaps we need to devise a summary statistic (summary statistics)
that provide evidence of discrimination or non-compliance. These measures
might well complement, or even supercede, the data currently collected by the
WTO on procurement matters. Indeed, it would be valuable to discern what
can be learned from the data that members of the GPA currently report to the
WTO. If little can be learned, then one might want to revisit the data reporting
requirements of the current plurilateral agreement.
As these comments suggest we are at a very early stage in devising a
comprehensive body of policy-relevant research for developing economies.
Some themes have emerged, but much further research is needed before we
49
can be sure that the greatest gains lie in reforms at the national, regional, or
multilateral levels.
50
References
Arrowsmith, Susan. “Towards a Multilateral Agreement on Transparency in
Government Procurement.” International and Comparative Law Quarterly 47:
793. 1997.
Baldwin, Robert, and J. David Richardson, “Government Purchasing Policies,
other NTBs, and the International Monetary Crisis.” In H. English and K. Hay,
eds. Obstacles to Trade in the Pacific Area. Ottowa, Canada: Carleton School
of International Affairs. 1972.
Bardhan, Pranab. “Corruption and Development: A Review of the Issues,”
Journal of Economic Literature, XXXV: 1320-46. 1997.
Deltas, George, and Simon J. Evenett. “Quantitative Estimates of the Effects of
Preference Policies.” In Bernard M. Hoekman and Petros C. Marroidis, eds.,
Law and Policy in Public Purchasing: The WTO Agreement on Government
Procurement. Ann Arbor, MI: University of Michigan Press. 1997.
Evenett, Simon J., and Bernard M. Hoekman. “Government Procurement and
International Trade.” Mimeo. 2000a.
Evenett, Simon J., and Bernard M. Hoekman. “Notes On The Interaction of
Corruption and Discrimination in Government Procurement.” Mimeo. 2000b.
Evenett, Simon J., and Bernard M. Hoekman. “Transparency in Government
Procurement: What Can We Expect from International Trade Agreements,”
forthcoming in Susan Arrowsmith and Martin Trybus, eds., Public Procurement:
Global Revolution II, Kluwer Law International.
51
Hoekman, Bernard M. “Using International Institutions to improve Public
Performance,” World Bank Research Observer, 13 (2): 249-69. 1998.
McAfee, R. Preston, and John McMillan. “Government Procurement and
International Trade,” Journal of International Economics, 26: 291-308. 1989.
Mattoo, Aaditya. “Economic Implications of the Government Procurement
Agreement.” In Bernard M. Hoekman and Petros C. Marroidis, eds., Law and
Policy in Public Purchasing: The WTO Agreement on Government
Procurement. Ann Arbor, MI: University of Michigan Press. 1997.
Rose-Ackerman, Susan. Corruption and Government. Cambridge, U.K.:
Cambridge University Press. 1999.
Tanzi, Vito, and Ludger Schuknecht. Public Spending in the 20th Century: A
Global Perspective. Cambridge, U.K.: Cambridge University Press. 2000.
World Trade Organization. “Overview of the Agreement on Government
Procurement.” 2000.
Downloaded from http: //www.wto-org/english/tratop_e/gproc_e/over_e.htm
