Politicians have frequently argued that the government should favour UK firms in defence procurement contracts when they are in competition with foreign firms. The typical reasoning behind this argument is that if a UK firm loses a contract, then this will be a signal to potential foreign purchasers of the UK product that it is of low quality.
But new research by David Collie and Morten Hviid, published in the latest issue of the Economic Journal, shows that favouring UK firms does not improve their chances of winning a contract. Instead, it increases the cost to the government since the firms will set higher prices. Hence, Collie and Hviid conclude, defence procurement decisions should be delegated to an independent agency that is free of political interference and only concerned about value for money.
Potential purchasers of defence products often have incomplete information about the quality of new products. For this reason, the Ministry of Defence will often evaluate competing products before making procurement decisions. Then, the Ministry''s decision about which product to buy will send a signal to potential purchasers in the rest of the world about the quality of the product. If it decides not to ''buy British'', then potential purchasers in the rest of the world may conclude that the product is of low quality. As a result, some politicians have argued that the MoD should favour UK firms so as to avoid sending this adverse signal.
One example of this occurred in 1996, when the Ministry of Defence was considering procuring ambulances for the Army from Land Rover or Steyr Daimler Puch of Austria. It was argued that awarding the contract to Steyr Daimler Puch would prejudice export orders worth millions of pounds for Land Rover. Another example concerned a choice between bids from BAe and a French consortium to deliver a battlefield communications system in 1998. Then Secretary of State for Trade and Industry Peter Mandelson urged the MoD to take account of broader issues then value for money, such as the impact on British jobs and the possibility of lucrative exports. Collie and Hviid evaluate the argument for favouring UK firms using an analytical approach in which the procurement decision is a signal of quality to potential purchasers in the rest of the world. They show that if the UK government favours the UK firm, then this will lead the UK firm to increase its price. As a result of the UK firm setting a higher price, the chances of the UK firm winning the procurement contract are unchanged and there is no effect on export sales. Therefore, the only effect of favouring the UK firm is to increase the price that the government pays for the product if the UK firm wins the contract.
To avoid such an outcome, the researchers suggest that the government should delegate procurement decisions to an independent agency that is only concerned about value for money. Like giving independence to the Bank of England, this would allow decisions to be made free from political interference.
Although the research report focuses solely on defence procurement, the argument applies to all procurement decisions where policy-makers – national, regional or local government – may want to favour a local firm.
''International Procurement as a Signal of Export Quality'' by David Collie and Morten Hviid is published in the April 2001 issue of the Economic Journal. Collie is at Cardiff University; Hviid is at the University of East Anglia.