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Competition for-the-market

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This presentation by Elisabetta Iossa. Professor of Economics at "Tor Vergata" University of Rome, was made during the discussion “Competition for-the-market” held at the 18th meeting of the OECD Global Forum on Competition on 6 December 2019. More papers and presentations on the topic can be found at oe.cd/cmkt.

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Competition for-the-market

  1. 1. Competition for the market: Tackling the incumbency advantage (Advocacy) O.E.C.D. Global Competition Forum, Paris 5, 6 December 2019 Elisabetta Iossa Professor of Economics, Department of Economics and Finance, University of Rome Tor Vergata, Rome 00133, Italy; and GREEN-Bocconi. Email: Elisabetta.Iossa@uniroma2.it Full Paper on OECD website: http://www.oecd.org/daf/competition/competition-for-the-market.htm
  2. 2. Economic Theory Two useful insights: • Competition for the market may be suitable when market/lot may be more efficiently served by a single firm, the quality of the service is verifiable, and therefore it can be contracted upon, and there are opportunity for cost reduction and innovation (Hart, Shleifer and Vishny, 1997). • Bundling design, building and operation, PPPs, may be desirable when there are strong positive externalities between building and operation, as then bundling induces the contractor to build better infrastructures to reduce operational and maintenance costs (Hart 2003, Bennett and Iossa 2006, Martimort and Pouyet 2008).  If level playing field, bidding for the contract results in best Cost, Quality offer. 2
  3. 3. Worrying signs • Lack of effective competition often observed at tender stage (problems at contract implementation stage not discussed here). • Public procurement in Europe, btw 2006- 2016: • Number of public tenders with only one bid has grown from 17% to 30% • Average number of offers per tender fallen from 5 to 3 (EC 2017). • Evidence of public contracts repeatedly won by incumbent (German rail, Weiergraeber and Wolf, 2018 and others) • SMEs win only 45 % of value of public contracts above EU thresholds, well below their weight in the economy (in 2015: firms with less than 250 persons represented 99 % of all enterprises in the EU), which may be a sign of increasing concentration in public procurement markets 3
  4. 4. Main issues • Factors limiting effectiveness of competition: • Badly designed tenders and contracts that discourage participation • Bid rigging, corruption • Barriers to entry (sunk costs; ownership/access to essential assets or information) • Incumbency advantage (technological, informational or linked to existing rights) • Vertical integration with monopolistic provider abusing power across value chain • Agency problem with Public Buyers: • Short termism and political interference • Lobbying and regulatory capture • Competence of public buyers (Saussier and Tirole, 2015; Decarolis et al., 2019) • Defensive Administration 4
  5. 5. What to do • Redesigning the law to reduce discretion of public authorities? Not sufficient and can be harmful (Coviello, Guglielmo and Spagnolo, 2018). Also, we should incentivize unsolicited proposals not defensive administration. • Artinger and Gigerenzer (2018): 950 public managers in Germany reported that about 25% of the ten most important decisions taken in the previous year are motivated by defensive choices. • Strengthen competence (use buyer certification systems) and empower public authorities, with ex post accountability and involvement of independent authorities (centralizing procurement, using benchmarking, ex-post valuations, best practices, standardized contracts and tenders) • Yes, but not enough. • Better prepare the market for competition so to tackle incumbency advantage to avoid monopolization and lock in 5
  6. 6. Incumbency advantage: Evidence • Construction industry: Incumbent’s bidding behaviour reflects theoretical predictions (De Silva et al. 2003) • Structural model of German short-haul railway passenger services 1995–2011: DB’s incumbent advantage linked to information about future ticket revenues (Weiergraeber and Wolf, 2018) • Hong Kong driving schools case: incumbency advantage stemming from ownership of existing rights (see HKCC contribution) and thus possibility of “monopolization” (as predicted: Rey, Salant, 2019) • South Africa Negotiated bus services: “there has not been meaningful entry in the subsidized bus sector for many years and this contributed to the lack of innovation in the sector”. Unduly long contracts in coal industry entrenching incumbent coal suppliers and foreclosing market to SMEs (see CC South Africa contribution). 6
  7. 7. Tackling incumbency advantage (1) • Make Competition Assessment prior to opening up market/ tendering. • Reduce sunk costs, carefully choosing ownership of essential assets (trains, buses, depots etc.) • Create level playing field on information. • For net cost contracts (where demand risk is transferred to contractor), provide demand information to potential bidders. • If do not have it, consider gross cost contracts which do not transfer demand risk to the contractor as they can reduce the incumbency advantage stemming from knowledge of past demand information. 7
  8. 8. Tackling incumbency advantage (2) • Coordinate tendering for the same service in different cities, or for similar services across cities. • Tendering timing (synchronous vs staggered) affects likelihood that competition will be preserved or there will be instead monopolization. • When monopolization expected, synchronous tendering is preferable, as it strengthens pressure entrants exercise on incumbent. When instead other firms remain active, staggered tendering maximizes competitive pressure that comes from these other firms and therefore may be more conducive to future competition (Iossa, Rey and Waterson, 2018) • Staggered tendering leads to Monopolization when economies of scope (Cabral, 2017) • Iossa, Marx, Loerscher, rey (2019): synchronized tendering facilitates bid rigging. 8
  9. 9. Tackling incumbency advantage (3) • Fight Defensive administration (helping administrations!) with standardized tenders and contracts and diffusion of best practices: HKCC: «Preference for straightforward well-established and hard to legally challenge approaches which often prioritize income to Government» • Change perspective: Award criterion not based on short term subsidy minimization or premium maximization, but also with view of preserving competition • Divide contracts into lots, awarding initially different lots to different firms, (dual sourcing) to enhance competitive pressure over time, even if not cost minimizing 9
  10. 10. Tackling incumbency advantage (3) • Incentivize participation of SMEs and new entrants by: • Shorter and more frequent contracts (albeit they may facilitate bid rigging). • Bidding credit and quotas to SMEs/entrants to maintain long-term competition. • Services that are ancillary, e.g. porter services, parking, or catering services, should be unbundled from the core contract and tendered separately. 10
  11. 11. References (more in the paper) Bennett John and Elisabetta Iossa (2006). “Building and Managing Facilities for Public Services,” Journal of Public Economics, 90 (10-11): 2143-2160. Cabral, Luis (2017), “Staggered Contracts, Market Power, and Welfare,” Mimeo, Columbia University. Coviello Decio, Guglielmo Andrea and Giancarlo Spagnolo, (2018), “The Effect of Discretion on Procurement Performance,” Management Science, 715–738. Decarolis, Francesco, Giuffrida Leonardo, Iossa Elisabetta, Mollisi Vincenzo and Giancarlo Spagnolo (2017) “Bureaucratic Competence and Procurement Outcomes”. Previous title: Buyer Quality and Procurement Outcomes: Evidence From the US”. NBER Discussion Paper 24201. De Silva, Dakshina G. and Dunne, Timothy and Kosmopoulou, Georgia, An Empirical Analysis of Entrant and Incumbent Bidding in Road Construction Auctions. Journal of Industrial Economics, 51, pp. 295-316,. European Commission (2017), “Making Public Procurement work in and for Europe,” Communication from the Commission to the European Parliament, The Council, The European Economic and Social Committee and The Committee of the Regions. Strasbourg, 3.10.2017. COM(2017) 572 final. Hart, O. , Shleifer, A. and Vishny, R. W. (1997), “The Proper Scope Of Government: Theory And An Application To Prisons,’ Quarterly Journal of Economics, 112: 1119-58. Hart, Oliver. (2003), ‘Incomplete Contracts and Public Ownership: Remarks and an Application to Public-Private Partnerships,’ Economic Journal, 113: 69-76. Iossa, Elisabetta and Mike Waterson (2019) “Maintaining Dynamic Competition in Procurement: The Case of London Bus Tendering”. Transport Policy, Vol. 75: 141-149. (VQR: A) Iossa, Elisabetta, Loertscherz Simon Marx Leslie M. and Patrick Rey (2019), “Collusion via Market Allocation,” Mimeo. Iossa, Elisabetta, Rey Patrick and Mike Waterson (2018), “Organizing Competition for the Market,” C.E.P.R. Discussion Paper 13461. Martimort David and Jerome Pouyet (2008), “To build or not to build: Normative and positive theories of public–private partnerships,” International Journal of Industrial Organization, 26: 393-411. OECD. (2009), Guidelines on Fighting Bid Rigging in Public Procurement, O.E.C.D. Paris. OECD (2019), Competition for the market. Background note prepared by the Secretariat. O.E.C.D., Paris. 11

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