Insight | May 11, 2016

Can Economics Fix Public Procurement?

By Raj Sharma

This article originally appeared in the Governing Institute’s VOICES column, which seeks out practitioners and observers whose perspective and insight add to the public conversation about state and local government. The original article is copyrighted to Governing.

There is plenty of consensus that government procurement needs a lot of fixing. But do we know the magnitude of the impact when government purchasing doesn’t work? Or what to do about it?

Governments at all levels spend almost $2 trillion in the United States and $8 trillion globally. How those funds are used, though, is perhaps more important than how much money is spent. Governments spend money to deal with some of our most critical challenges — from education to health care to national security to infrastructure and waste management — and provide many services that affect us every day. When not done right, we all feel the impact.

So what can be done to fix government purchasing? Let’s not start with another round of the stale and tiresome dialogue around “procurement reform.” Typically developed by legislators with little understanding of the systemic or operational issues surrounding purchasing, stabs at procurement reform seldom help, instead creating yet more conflicting rules that our government buyers and suppliers must navigate.

If we are to give our governments and citizens a better system that allows us to obtain best value and tap the best, most innovative suppliers, we must step back and ask ourselves, “What is our end goal?” And, perhaps more importantly, “Are we trying to solve the right problem?”

I believe the issues and answers become clearer if we take off our procurement hats and instead look at the public-sector market through the lens of economics and how “perfect” markets supposedly operate.

Outside of economic theory, of course, there is no such thing as a perfect market. Furthermore, there is no homogenous “public-sector market.” Rather, there are many different sub-markets (IT services, for example, or defense systems), each with its own distinct characteristics.

Nonetheless, viewing the public-sector market through the lens of economic theory allows us to diagnose potential issues that undermine the ability of buyers (governments) and sellers (vendors) to work together effectively in search of the best solutions at the lowest total cost – which is not necessarily the same as price.

Let’s start with information and knowledge symmetry. Market theory holds that in most efficient markets, knowledge and information is freely available to all participants. In public-sector markets, however, significant amounts of information asymmetry exist: Sellers often have more information and knowledge about the buyers than the buyers do about the sellers. Government buyers often lack in-depth market knowledge or cost understanding of suppliers, a critical barrier to effective negotiations and deal structure. The goal should be to equalize the playing field by arming government with more information and knowledge about supplier industry trends while driving more collaboration with suppliers so they are able to meet government needs.

Another efficient market characteristic is low barriers to entry. In perfect markets, participants can enter or exit a market easily. In the public-sector market, that is hardly the case. With its complex rules and regulatory requirements, the public sector sets up many significant barriers to entry for new suppliers, and even for suppliers who already operate in the market. Many capable suppliers refuse to work with government. Meanwhile, incumbent suppliers just respond to long, complex RFPs knowing that “checking the box” is more important than questioning any requirement that may perpetuate inefficiencies.

The optimal flow of resources must also be examined. While resources (in this case, government contracts for goods or services) should go to the best providers, in public-sector markets those who know how to play the game typically win. Unclear performance or accountability metrics mean that contract options are exercised without real scrutiny on outcomes delivered. Meanwhile, the best providers for a given need often cannot, or refuse to, compete. Hence, resources flow to potentially suboptimal solutions.

I don’t believe that any perfect market exists. Within public-sector markets, things are even more difficult given the externalities that exist, such as political interference or mandated procurement preferences such as those for small businesses. But if we are ever going to deliver on the promise of best value and the best solutions for our citizens, understanding how our markets work in the real world is a good place to start.