New York City Pays a Steep Price for Failing to Guard a Guardian

This past Monday, April 28, U.S. federal trial court judge George B. Daniels sentenced three persons at the center of a corrupt scheme that cost New York City some $600 million to 20 years each in prison.  Despite the massive loss and the large number of firms and individuals that participated, the scheme was quite simple.  Its simplicity, and the vulnerability of a government as large and sophisticated as that of New York City to it, is a stark reminder of how critical contract administration — one of the more prosaic-sounding responsibilities of government — is to controlling corruption.

The New York scam arose from a $63 million contract to modernize its payroll system. Software contracts, like construction contracts, can take months if not years to perform and may need to be modified as the contractor runs into issues not anticipated when the contract was drafted.  More computer code than initially foreseen may be required to capture the way employees in some departments record their hours; a road may have to be re-routed because the ground along the original route turns out to be unstable.  But it may also be that more code isn’t needed or that the original routing of the road is fine.  Instead, it may simply be that the contractor is looking for a way to squeeze more money out of government.

To deal with this concern, governments typically rely on expert professionals to evaluate a contractor’s requests for change orders. Often these professionals also decide whether the completed project meets contract specifications.  They thus serve as guardians of project quality and integrity.  What happened in New York was simple: the guards deserted their post, conspiring with the contractor to bilk the city of out hundreds of millions of dollars. Where the city erred was its failure to heed the famous question attributed to the Roman satirist Juvenal:  Who guards the guardians?

Heeding that question and coming up with a satisfactory answer are, of course, two different things.  What can a government do to avoid the sort of collusion that cost New York City so much money?

A first answer is to hire a second guardian to guard the first, a solution the European Union adopted in a road construction project it financed in Tanzania; it retained an engineer to check up on the work of the engineer the government had employed to monitor construction.  But as commentators since Juvenal’s time have observed, this can lead to infinite regress: What guarantee is there that the second guardian will not be drawn into the corrupt scheme?  And the third?

An answer suggested by the World Bank is to enlist civil society as the second guardian. The purpose of all government contracts is to further citizen welfare — through better roads, a more efficient payroll system, and so forth.  Who better to watch over the execution of a contract than its beneficiaries?  The problem is that civil society groups may not have the technical expertise to judge whether, for example, more software coding is needed or the road must be re-routed.  That need for technical expertise, after all, is why New York City (and other governments) rely on professional monitors in the first place.

Beyond searching for the ideal guardian, there are other ways to reduce the risks of corruption in contract administration, from tinkering with the guardians’ incentives to reduce the risk they will leave their posts to restructuring contracts so as to give contractors stronger incentives to complete the job honestly.  These and other areas are the subject of discussion and experimentation by some practitioners and a few in the academic community. What is surprising is that contract administration is not accorded higher priority by the anticorruption community when, as the New York City case demonstrates, the failure to pay attention to it can be so costly.

4 thoughts on “New York City Pays a Steep Price for Failing to Guard a Guardian

  1. Rick,

    While I basically agree with what you say in this post, I wonder how confident you are that the NYC government does not accord sufficiently high priority to contract administration. A governance failure — even a very big one — does not by itself establish that the city wasn’t taking optimal precautions (though it certainly suggests the need for a careful assessment of whether this is the case). And as you yourself have pointed out on other occasions, there’s a countervailing concern about layering on so many safeguards to prevent corruption, conflict of interest, etc., that in the end it becomes very difficult to get anything done efficiently. (This is especially so given that measures to control fraud and conflict-of-interest can accumulate over time, with new measures added after each scandal — such that even if every individual measure looks sensible and cost-justified, in the aggregate they impose efficiency costs that outweigh their anticorruption benefits.)

    To be clear, I’m not saying that I actually think the attention given to public contract oversight in NYC or elsewhere is optimal. I really have no idea. But I wondered if you could elaborate a bit on the basis for your claim that contract administration currently does not get sufficient attention.

    • Matthew,
      Thanks for poking me to elaborate on what I meant in the initial post when I said contract administration wasn’t receiving sufficient attention.

      The construction of roads, water treatment facilities, and other civil works in developing countries is one example I had in mind. When financed by the World Bank or the regional development banks, governments use a standard form contract developed by the International Federation of Consulting Engineers, referred to as “FIDIC” after its initials in French. (http://fidic.org/FIDIC_Logo) The FIDIC civil works contract provides that the contractor will be supervised by an engineer responsible for assuring the work is done according to specification and that requests for variations from the specs are justified.

      The engineer is “independent” in the sense that he or she (or “it” in the case of larger projects) is not simply an agent of the government. Rather, the professional judgment of the engineer may in some cases require that it side with the contractor. While it may be clear that a road must be re-routed to avoid an unforeseen problem with the soil in particular area, there may be different options for re-routing the road, some less expensive but less likely to endure than others. Government may want a cheaper option and the contractor a more expensive one.

      Traditionally, the engineer has had the final say. This may mean the engineer approves a change the government opposes, and absent litigation, the engineer’s word is final. (As an aside note the similarity of the engineer’s role to that of the civil law notary. The notary has a duty of loyalty to the transaction that trumps loyalty to either side.)

      The system works where the engineer is professional, impartial, and incorruptible but in the past two decades or so there has been growing evidence of a failure of the third condition. Whether engineers have always been corrupt or corruption is a recent development that is the result of a breakdown in professional norms, changes in the economics of the business, and the like is not clear. Whatever the case, as dissatisfaction with the engineer as project guardian has grown, the search has been on for alternative arrangements.

      One is Public-Private Partnerships, or PPPS. In a PPP the contractor’s revenues are tied to how well the project performs. An example is a toll road where, if the road is built poorly, revenues will be less, or at least should be less, than were it constructed properly. A second alternative is lump sum contracting. This can take a variety of forms, but the purpose in every case is to give the contractor an incentive to perform the contract according to the specs through conditions on the way payment is made.

      Some advocates of PPPs and lump sum contracts claim they avoid the problem of an untrustworthy project monitor altogether. This of course is nonsense because the principle-agent problem, and thus the need for a monitor, lurks behind every contract for the construction of civil works or the development of a software program. Others admit that the monitoring issue remains but say it is less of an issue than with a FIDIC or FIDIC-like contract.

      What I mean when I say contract administration has yet to receive sufficient attention is that at least I have not found a literature where the pros and cons of the different ways government can contract for works, software, and other complex goods are analyzed. An analysis that takes account of the capacity constraints of developing country governments.

      I concede that the contracting literature is enormous and that somewhere there may be a paper or papers that address these questions in ways useful to those who advise governments on these issues. If so, I have yet to find it. [I should also note at this point that I have seen the very fine article by David Rahman, “But Who Will Monitor the Monitor,” in a recent issue of the American Economic Review (102(6):2767-2797) and it is a step (or even two) away from the practical, policy-driven piece I have in mind.]

      What makes me think I have not missed it is that projections of the amount of investment that will be made in civil works in developing countries over the next decade usually have a “tr” in front of the “illions.” It might be only $1 trillion or it might be more. One would think with this kind of sum in play there would be a well developed, easy to access, literature on contract administration.

  2. I would love to see some literature that explores when certain types of second-level guardians are most effective. For instance, I’d guess that using “civil society” as a secondary guardian might be most successful in situations where not only technical expertise is less necessary to evaluate the pertinent project, but robust freedom of information laws make external oversight more feasible. I hesitate to think that “civil society” can ever be a satisfactory replacement for an internal government or project watchdog, as I imagine access to project data is both crucial to serving as an effective guardian and far less available to civil society than to a second-level guardian employed by the state or organization funding the project. But perhaps there is room for international organizations like the World Bank to write disclosure/FOIA type provisions into the agreements related to their development projects. In exchange for development aid, the recipient state institutions could be required to make publicly available a wide range of project related data that would facilitated civil society oversight.

  3. Pingback: Contract Administration: A Step-Child of Anticorruption Policy? | Anti Corruption Digest

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