Public procurement auction: Why transparency and measurability of the promised quality is necessary

Public procurement process is plagued by lack of transparency leading to corruption and loss of utility of the general public.

Public authorities from around the world depend on auctions for acquiring required goods and services and handing out contracts for construction projects. According to the World Bank’s  Global Procurement Database, public procurement accounts for 13 to 20 percent of the global Gross Domestic Product (GDP) and accounts for 9.5 trillion US dollars. Such a humongous share of public procurement in GDP verifies that public procurement constitutes a significant portion of total economic activities in many countries which necessitates the study of these types of auctions.

The auction theory provides a necessary framework for the study of such types of auctions. However, the benchmark model focuses particularly on the price submitted by the bidders and makes assumption of homogeneity in terms of the quality of the bidders. The traditional auction theory of standard procurement auctions regards to cost as the sole determinant for the allocation of procurement contracts. The structure of the auction is analogous to that of a first-price sealed bid auction wherein the bidder who bids the lowest price wins and gets the contract for the price s/he bid. However, in several auctions, particularly on public procurement auctions, the buyer also equally cares about various attributes, mainly the quality of the product, services or the infrastructure being constructed.

Lack of a transparent procurement process and difficulty in measurement of quality leads to corruption. If the procurement process is transparent and quality is quantifiable, measurable and differentiable, it helps minimize corruption.

But in public procurement auctions, the citizens who are the actual buyers are not involved in the auction process. There is a public entity acting on behalf of the citizenry. In an ideal scenario, the representative of the government acting on behalf of the electorate aims to maximize the utility of the electorate from any procurement process. But due to the lack of transparency and pervasiveness of corruption in the procurement process, especially in an underdeveloped world, the utility function of public authority tends to be different from the electorate’s utility function.

Is corruption possible if the procurement process is transparent and quality is quantifiable, measurable and differentiable?

The public procurement process is plagued by a lack of transparency leading to corruption and loss of utility to the general public. But what happens if the procurement process is transparent and if the quality which bidders promise in their bids is measurable and can be differentiated? In such a situation, getting involved in corruption or bribing the auctioneer acting on behalf of the public is not profitable for the bidders.

Let us take an example where there are two bidders. Suppose bidder A can provide a higher quality of work incurring the same cost as that of bidder B or s/he can provide the same quality of work at lower cost than bidder B. If bidders play their optimal strategy, ex-post bidder A is the winner.

If bidder B is involved in corruption or bribing the public auctioneer, s/he must give up a part of his/her payoff, conditional upon winning. However, because the auction process is transparent and quality is measurable and can be differentiated, bidder B loses and gets a payoff of zero. Hence, there is no incentive for bidder B to bribe the public auctioneer.

Given the transparency of the auction process and measurability of the quality promised by the bidders, bidder A will win regardless of whether s/he bribes the public auctioneer or not. Bribing would only reduce his/her payoff and therefore s/he has no incentive to bribe the public auctioneer.

What happens when the procurement process is non-transparent?

The lack of a transparent procurement process and difficulty in the measurement of quality leads to corruption. Moreover, when a bidder has been given the contract to conduct public work, then the quality of the work which the other bidders would have provided had they been awarded the contract, cannot be known. This creates a ground for corruption.

Given that the public authority has total control over the scoring rule of quality, the bidder must agree to the demand of the public authority. Otherwise, the scoring rule would be set in such a way that the other bidder wins and the bidder that has actually won ends up getting a payoff of zero. Hence, the winning bidder becomes ready to give up a part of the price which s/he receives as a bribe to the public authority. However, generally, the loss of payoff resulting from bribing the public authority is recovered through a reduction in the quality of the work which the bidder provides. Since the quality of the public works is compromised and it is positively related to the welfare of the electorate/citizens, there is a loss in the welfare of the citizens.