The pro­cure­ment gold­mine

Financial Mirror (Cyprus) - - FRONT PAGE -

Gold is rare. More than 99.9% of the Earth’s crust is com­posed of ox­ides of sil­i­con, alu­minum, cal­cium, mag­ne­sium, sodium, iron, potas­sium, ti­ta­nium, and phos­pho­rus. So, for most of hu­man his­tory, peo­ple have be­come quite ex­cited when they have dis­cov­ered gold. De­spite the se­ri­ous en­vi­ron­men­tal con­se­quences of gold min­ing, in­clud­ing mer­cury and cyanide pol­lu­tion and the dev­as­ta­tion of land­scapes, hu­man­ity has not given up the search – and seems un­likely to do so any time soon.

But there is a fig­u­ra­tive gold­mine – safer and po­ten­tially at least as lu­cra­tive as the real thing – that most coun­tries pos­sess, but few choose to ex­ploit fully: gov­ern­ment pro­cure­ment.

The po­ten­tial ad­verse con­se­quences of gov­ern­ment pro­cure­ment are well known. It can en­able com­pa­nies to charge ex­ces­sive prices for low-qual­ity goods and un­re­li­able ser­vices, while fa­cil­i­tat­ing cor­rup­tion, abuses of power, and waste.

To mit­i­gate th­ese risks, most coun­tries have im­ple­mented re­quire­ments for open bid­ding pro­cesses and strict trans­parency rules for gov­ern­ment pur­chases. In­deed, most re­cent free-trade agree­ments re­quire sig­na­to­ries to open up gov­ern­ment pro­cure­ment to one another’s firms, and the World Bank pub­lishes the names of firms barred for fraud or cor­rup­tion from bid­ding on Bank-fi­nanced projects. Coun­tries that forego open bid­ding pro­cesses end up with the kind of large-scale theft that has been doc­u­mented in Venezuela and almost cer­tainly oc­curred in Ukraine un­der de­posed Pres­i­dent Vik­tor Yanukovych.

But be­neath all of this ar­senic is gold. Most mod­ern pro­duc­tion in­volves not just the cost of do­ing things, but also the cost of fig­ur­ing out how to do them. Be­fore air­craft man­u­fac­tur­ers can pro­duce and sell a new air­plane model, they must spend bil­lions of dol­lars over a decade or more of de­vel­op­ment – costs that must later be re­couped. If they were not sure whether there would be a mar­ket for the new model, few would as­sume th­ese costs. That is where gov­ern­ment pro­cure­ment comes in.

For ex­am­ple, in 1946, the United States gov­ern­ment is­sued a con­tract for Boe­ing to de­velop the B-52. The gov­ern­ment ob­vi­ously did not want the company to de­liver more of the same; it wanted the first fast jet-pow­ered strate­gic bomber. After all, the sec­ond-best army in a war is the loser. The con­tract thus had to re­flect the risks in­her­ent in find­ing out how to de­sign and pro­duce the most ad­vanced air­craft of its time.

But the ben­e­fits of the gov­ern­ment pur­chase ex­tended beyond its spe­cific goal, when Boe­ing used the knowhow it ac­quired de­vel­op­ing the B-52 to cre­ate its com­mer­cial B-707 air­craft. Though the gov­ern­ment never pur­posely pro­moted the de­vel­op­ment of com­mer­cial air­planes, its pro­cure­ment of high-qual­ity, tech­no­log­i­cally ad­vanced mil­i­tary air­craft was es­sen­tial to the emer­gence of Amer­ica’s glob­ally dom­i­nant com­mer­cial air­craft in­dus­try.

Sim­ply put, fig­ur­ing out how to do one thing of­ten makes it eas­ier to do other things. In this way, a gov­ern­ment that is ex­act­ing about the qual­ity of its pur­chases can have a pow­er­ful im­pact on the evo­lu­tion of its coun­try’s com­par­a­tive ad­van­tage.

Is­rael’s gov­ern­ment has had a sim­i­lar im­pact through its ef­fort to man­age its limited wa­ter re­sources. Let’s say that the coun­try in­curs a cost of 100 of some unit be­cause of its wa­ter short­ages. The in­no­va­tions that the gov­ern­ment en­cour­ages, such as drip ir­ri­ga­tion or de­sali­na­tion, not only re­duce the do­mes­tic cost of such short­ages to, say, 70, but also un­der­pin an in­dus­try that, by sell­ing its wares in the most de­mand­ing mar­kets, ac­crues a global value of more than 1,000. In this sense, Is­rael’s wa­ter scarcity has made the coun­try wealth­ier than it oth­er­wise would have been.

Like­wise, Is­rael’s mil­i­tary in­vest­ments have gen­er­ated a set of so­lu­tions that, with some ex­tra ef­fort, have had use­ful – and lu­cra­tive – civil­ian ap­pli­ca­tions. This helps to ex­plain why pri­vate in­vest­ment in re­search and de­vel­op­ment con­sti­tutes a larger share of GDP in Is­rael than any­where else in the world.

The lessons from army pur­chases can be ap­plied else­where. Gov­ern­ments are in the business of procur­ing so­lu­tions to their par­tic­u­lar so­ci­ety’s most press­ing chal­lenges. Given that a coun­try’s prob­lems are rarely unique, in­no­va­tive so­lu­tions can spawn glob­ally com­pet­i­tive – even dom­i­nant – in­dus­tries. And so­lu­tions for one prob­lem may have ap­pli­ca­tions in other ar­eas.

This should serve as a model for Latin Amer­ica as it works to im­prove the qual­ity of its ed­u­ca­tional sys­tems. As it stands, the eight Latin Amer­i­can coun­tries that take the OECD’s stan­dard­ised PISA exam are among the 15 worst-per­form­ing coun­tries of the 65 that par­tic­i­pate in the pro­gramme.

In­stead of sink­ing mas­sive amounts of money into poorly per­form­ing school sys­tems, Latin Amer­i­can gov­ern­ments would un­doubt­edly be in­ter­ested in in­no­va­tive so­lu­tions, such as tablet-based text­books, that can help teach­ers pro­vide ef­fec­tive lessons, mon­i­tor their stu­dents’ progress, and iden­tify re­me­di­a­tion strate­gies. Beyond im­prov­ing their own chil­dren’s per­for­mance, such ef­forts could spawn a glob­ally com­pet­i­tive in­dus­try in state-of-the-art teach­ing tools.

Th­ese are just a few ex­am­ples of the value that can be ex­tracted from the gov­ern­ment­pro­cure­ment gold­mine. By com­mit­ting to pur­chase large amounts of high-qual­ity prod­ucts that ad­dress ma­jor na­tional chal­lenges, gov­ern­ments can en­cour­age pri­vate, pub­lic, or mixed or­gan­i­sa­tions to in­cur the fixed costs of find­ing so­lu­tions. In many cases, the ben­e­fits of those so­lu­tions will ex­tend far beyond their orig­i­nal pur­pose.

But, in pur­su­ing such a path, gov­ern­ments must re­mem­ber that min­ing is a po­ten­tially dan­ger­ous in­dus­try that must be ap­proached with care. To this end, they could be­gin by ap­ply­ing, say, 5% of their pro­cure­ment bud­gets to nur­ture ur­gently needed so­lu­tions in ar­eas with po­ten­tially large global mar­kets. After all, any­thing that is worth do­ing is worth do­ing bet­ter.

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