When Transparency Makes Corruption Worse: Cartels in Public Procurement

Yesterday Matthew commended the work of Mihály Fazekas, István János Tóth, and their colleagues to those concerned with corruption in public procurement.  I second that recommendation.  In their July 2013, slyly-named “Corruption Manual for Beginners”, the authors describe better than anyone yet how a government buyer can connive to steer a contract to a particular seller — from skewing the contract specifications so that only the favored firm can meet them, to failing to notify others about the procurement, to disqualifying on specious grounds firms that submit bids lower than the favored firm’s bid.

Yet despite the value of the contribution, the authors have not (yet) provided a similarly penetrating analysis of another form of public procurement corruption: that which results not from a conspiracy between a government buyer and one seller but that between the buyer and a group of sellers organized into an industry cartel.  Judging from the results of investigations in settings as different as the American states, the Netherlands, the Philippines, Nepal, France, Columbia, Uganda, Slovakia, and India, this type of corruption maybe be at least as common as the single seller form.  Costly too.  More than half the time, the price a buyer pays in a cartelized market is 25 percent or more higher than what it would have been had there been no collusion among the sellers.

The distinction between these two types of collusion–one involving a single favored seller, the other involving a cartel of sellers–is important, because the appropriate policy response is quite different. When the procurement process is corrupted by a cartel, the standard prescription for combating corruption–transparency–is not only ineffective but self-defeating. 

Cartels are the result of secret, usually illegal agreements specifying who among the members will win which contract at what price.  Adherence to the agreement depends upon each member voluntarily observing it, but cartel members are constantly tempted to deviate from the agreement if they can do so without being found out by the other members.  One of the best ways for cartels to prevent such cheating (which could ultimately result in the collapse of the cartel) is to require each member to disclose to the others the contracts on which it bids and the terms and prices it is offering.  Members can thus immediately identify and sanction “cheats.” This method is, as the leading student of cartels observed many years ago, “the ideal instrument” for keeping the cartel intact.

It is also mandated by most if not all public procurement laws.  To prevent a procurement official from awarding a contract to any but the lowest bidder, most public procurement laws require that all offers received in response to a tender be opened in public and, in recent years, posted on a public website as well.  This is an effective response to corruption resulting from a conspiracy between a government purchaser and a single firm. But where corruption takes the form of a cartel, the public opening of bids makes the maintenance of the cartel easy.

Tackling cartel corruption thus requires something besides introducing ever greater transparency into the procurement process. Fortunately, recognition of cartel corruption is growing as is innovative thinking on how to defeat it.  The OECD has been in the lead, issuing a series of reports on it, and other contributions are beginning to appear.  A Dutch scholar has just published a book on the issue and Messrs. Fazekas, Tóth and colleagues have research on it underway.  In future posts I will review this work and its implications for procurement reform.

4 thoughts on “When Transparency Makes Corruption Worse: Cartels in Public Procurement

  1. Rick, thank you for this very interesting post. The counterintuitive relationship between transparency and cartel corruption really offers food for thought.

    I may be treading on questions that you’re planning to cover in future posts, but it seems to me that the right answer might be selective transparency. Perhaps the exact terms of a contract should be withheld (the exact dollar amounts, et cetera), while more general information should be released — including disclosures most relevant to corruption, such as any disclosed conflicts of interest.

    I could also see this affecting different kinds of contracts and cartels differently. For example, many contracts are not for highly substitutable services, like building a fence or managing a parking lot. Especially with the fast-growing professional services procurement (everything from technological development to management consulting services), cost alone might become less of the sole arbiter in determining the winner of any given contract. Rather, winners might be chosen based on reputation, expertise, scale, customer service, or other factors. In these cases, transparency might be less valuable to a cartel because there’s already a higher level of subjectivity in the analysis — leading to greater difficulty, I would imagine, in enforcing cartel agreements.

    I look forward to your future posts on this topic.

    • I should note that when I mentioned disclosing those contract terms and deliberations “most relevant to corruption,” I meant especially single-seller corruption — which is most effectively targeted by transparency.

  2. Rick, thank you very much for this post! It looks at the highly relevant double-edged nature of transparency: one the one hand it can increase societies’ capacity to hold governments accountable, while on the other hand, it also provides data for everyone, including cartels which can use it to monitor each other. Another interesting example is Russia which is not exactly the land of open government by and large, still it has a very extensive public procurement database, with really low threshold for reporting. Colleagues working in Russia suggest that it is actually because the central government needs extensive transparency for controlling rent extraction on the local level (that is benefiting companies the centre doesn’t want to benefit). Even if the reasons are probably more complex, I think it highlights the general use of transparency for controlling groups action.
    But transparency is only effective control if it is actually used. This is why it is so disappointing that so many development agencies and governments publish so much procurement data and then don’t use it for cartel detection, controlling corruption, etc, you name it. There is a lot of work out there for us and like-minded researchers and activists to actually put data to work. Only then can we say that transparency strengthened government accountability rather than cartels.

  3. Appreciate the observations by both Eden and Mihaly.

    Eden suggests that the extent and type of transparency useful for reducing corruption will vary depending upon other factors. Very true. When the industry is highly concentrated, a rough measure of propensity for cartelization, disclosure of any information about the tender can facilitate collusion. On the other hand, when the industry is fragmented and the market thus likely to be highly competitive, disclosure of even such sensitive information as the procuring entity’s cost estimates can stimulate competition. (De Silva and colleagues, “The Impact of Public Information on Bidding in Highway Procurement Auctions,” European Economic Review 52(1): 150 – 181 (2008)). It is also correct, as Eden suggests, that the more variables that go into the decision on contract award, the harder it is for would-be colluders to reach agreement on dividing the business. Margaret Levenstein and Valerie Suslow nicely summarize the factors that contribute to a cartel’s adhesion or demise in “What Determines Cartel Success?” in the Journal of Economic Literature 44 (March 2006): 43 –95.

    When the cartel is aided, or even organized and managed, by the purchaser, factors that affect competitors’ ability to reach and then maintain agreement are irrelevant. My guess is that buyer led cartels in public procurement are far more common than appreciated. It may be for venal reasons – the procurement agency personnel take a share of the overcharge, or it may be because procurement agency personnel don’t think competition is a “fair” or “efficient” way to allocate purchases among potential suppliers. The latter is how I read some of the statements made in wake of the disclosure of a massive bid rigging cartel in the Netherlands in the early 2000s. Local government procurement staff were friends and colleagues of those in the selling firms and didn’t want to see their friends “fighting” for business among themselves.

    Mihaly’s description of how Russian central authorities keep tabs on who profits from government purchases reminds that in many countries procurement is first and foremost about divvying up the spoils and only secondarily about providing needed goods and services. In these countries it is not a question of lower-level procurement staff subverting the rules for their personal benefit. Rather, the highest levels of government are responsible for the subversion.

    I suspect that subversion by senior authorities may take different forms depending upon whether the country is aid dependent or not. In work cited in Nations in Transit Mihaly and colleagues reported that 40% of Hungarian government procurements were either awarded on the basis of sole source or else competing firms were disqualified during bid evaluation.

    I don’t think the figure is anywhere near that high in aid dependent nations. Most significant purchases – roads, buildings, other civil works, expensive equipment – are financed in whole or part by donor funds and donors require competitive bidding. Hence the charade often observed where the “winning” bidder bids the estimated price and the “losers” bid in five percent increments above it. Donors get the facade of competition but of course not the substance.

    On the failure to make use of the information about corruption produced by transparency requirements, this topic has provoked soul searching in the development community. In the 2010 IDS volume “Review of Impact and Effectiveness of Transparency and Accountability Initiatives” and the 2011 Scanteam’s “Achievements and Strategic Options: Evaluation of the Extractive Industries Transparency Initiative,” the authors analyze why transparency alone has had little effect. As they and many others acknowledge, there is little mystery here. Information without the power to use it is of little value. The question then becomes how information can be used to engage the levers of power.

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