Keith Hartley

Transaction costs, relational contracting and public private partnerships: a case study of UK defence

Abstract This paper is concerned with the economics of public private partnerships (PPPs)/private finance initiative (PFIs) and in particular the role of transaction costs and the importance of trust in relational contracting. The discussion is illustrated by reference to the UK defence sector. The paper begins by discussing the nature of PPPs/PFIs before moving on to consider how the economics of contracting literature can shed light on their strengths and weaknesses. The transaction cost literature is reviewed alongside a resource-based perspective of procurement decisions. The concepts of trust and reputation are then considered in the context of minimising procurement transaction costs. The theoretical framework developed is then applied and illustrated through a case study of UK defence contracting, in an attempt to assess whether the use of PPPs will necessarily lead to improved economic efficiency. The case study highlights both the scope of PPPs/PFIs and their potential transaction costs in defence procurement, with the normal perils in terms of contracting given information asymmetry, asset specificity and the resulting scope for opportunistic behaviour.

The economics of partnership sourcing versus adversarial competition: a critique

Abstract In the strategic procurement management literature two general forms of purchasing arrangement feature—‘partnership sourcing’ and ‘competition’. Usually partnership sourcing is said to be superior because it leads to long-term collaboration based on trust between buyer and supplier. One product is a reduction of the supplier base with firms perhaps relying on a single source of supply or a small number of preferred suppliers. The paper reconsiders procurement methods in terms of a continuum using the economics of transaction costs. The paper then illustrates the economic issues discussed by considering procurement in the defence sector. Defence is taken as an example of public procurement with experience and opportunities for competition, partnership sourcing and long-term buyer-supplier relationships. The paper concludes that the case for partnership sourcing over competition is not clear cut.

The future of european defence policy: an economic perspective

European defence policy has been dominated by politics. This paper shows how economic principles can be used to derive guidelines for the formulation of European defence policy. The inefficiencies of the EUs existing defence arrangements are identified. It is shown that there is scope for efficiency improvements in the EUs Armed Forces and its defence industries.

The Economics of Defence Spending: An International Survey

United States defence expenditure trends and analysis, R.Looney and S.Mehay the political economy of military effort in the WTO, D.Nelson defence spending in the United Kingdom, R.Smith defence spending in France - the price of independence, C.Schmidt, L.Pilandon and J.Aben West German demand for defence spending, D.Fritz-Assmus and K.Zimmerman Swedish military expenditures and armed neutrality, J.Murdoch and T.Sandler defence spending in Israel, A.Mintz, M.Ward and S.Bichler military security and the economy - defence expenditure in India and Pakistan, S.Deger and S.Sen military expenditures in Argentina, Chile and Peru, T.Scheetz Japanese defence spending, S.Niioka.

The Economics of military outsourcing

UK defence policy is facing major financial pressures. Defence budgets hav been falling in real terms and only recently received a small real terms increas This budget has to fund a major new equipment programme involving th acquisition of Typhoon, A400M airlifters, missiles, warships, submarines and aircraft carriers. New equipment is costly and costs are rising in real terms, typically by about 10 per cent per annum, which is greater than the increase i the defence budget. An all-volunteer force is also costly to recruit, train an retain, since military personnel require salaries which are higher than in the civilian sector to persuade them to accept the disadvantages of the military employment contract (e.g. discipline; unsocial hours and conditions; and risk of injury and death). The funding pressures mean that UK defence policy cannot avoid the nee for difficult choices: something has to go and the question is what goes? The are four broad policy options, namely, ‘equal misery’ or another major defe review or higher defence spending or increased efficiency. Typically, gover ments prefer the ‘easy’ options of equal misery (e.g. delays in the new equip ment programme; reduced training) and increased efficiency. Militar outsourcing provides opportunities for efficiency savings. It is not the onl option for efficiency improvements. Others include purchasing equipme more cheaply from overseas, especially high technology equipment which costly to develop and where the UK requires only small quantities (e.g nuclear-powered submarines); and opening-up all UK defence contracts competition (i.e. warships where there remains a commitment to build al Royal Navy warships in the UK).

Public purchasing in the European Union: some evidence from contract awards

Explains that the public sector is a major buyer of goods and services. In the mid‐1980s discriminatory (buy national) public purchasing was identified as one of the barriers to the completion of the Single European Market. Studies suggested that a more liberal public purchasing regime would bring significant economic benefits with increased competition for contracts reducing public sector procurement costs and facilitating the creation of a more competitive European industrial base. These ideas led to a series of European Union procurement directives designed to prohibit preferential public purchasing. Uses data on contract awards from 1993 to investigate the extent to which public purchasing still discriminates in favour of domestic firms. This evidence casts doubts on the true extent of openness in EU public procurement markets.

COLLABORATION AND EUROPEAN DEFENCE INDUSTRIAL POLICY

Traditionally, the EU has protected its national defence industries (through Article 296). There are now policy initiatives to create a European defence equipment market (EDEM) and a European defence technology and industrial base (EDTIB). This article assesses these policy initiatives. It considers the EU as an inefficient defence market and also considers the opportunities for creating an efficient defence industrial policy. Collaboration has been a distinctive feature of European defence industrial policy and a case study of the Typhoon is presented and assessed. Finally, criteria for assessing the strengths and weaknesses of the EDTIB are presented.

Defence Industrial Policy in a Military Alliance

Much of the alliance literature has focused on the collective defence benefits and burden-sharing. This article considers the potential for developing a defence industrial policy in a military alliance. Previous proposals from the literature are reviewed, especially proposals for economic specialization based on comparative advantage applied to both armed forces and defence industries in a military alliance. European Union (EU) defence policy is outlined, including its armaments agencies (OCCAR and the European Defence Agency), and inefficiencies in EU defence markets are identified. Economic theory offers some policy guidelines for an efficient defence industrial policy in a military alliance, including gains from trade and competition, from learning and scale economies, and from reducing the duplication of costly R&D. These economic principles are applied to the EU and are also applicable to NATO. Evidence of efficiency gains from trade and from economies of scale and learning is reviewed and applied to various scenarios for the creation of a Single European Market for defence equipment. The scenarios include a liberalized competitive market, a centralized EU procurement agency and a ‘twin-track’ model. Estimates are presented of the cost savings from these scenarios. However, proposals for an efficient defence industrial policy will be opposed by the potential losers who will prefer alternative industrial policies involving international collaboration and offsets. Among these alternatives, collaboration is assessed as a distinctive European policy. The inefficiencies of collaboration are reviewed, including its impact on development and production costs and on delays in delivery. Consideration is given to the research issues to be addressed by an economic evaluation of European collaborative projects. The article concludes by stressing the inefficiencies of current procurement policies in the EU and NATO and the potential cost savings from the adoption of a more efficient defence industrial policy within an alliance.

The Arms Industry, Procurement and Industrial Policies

Weapons programs are criticized for cost overruns, delays in delivery and failure to meet their operational requirements. Critics focus on the power and influence of the military-industrial-political complex. This chapter addresses these controversial areas involving arms industries, alternative procurement policies and industrial policy. Arms industries are defined and statistics are presented on the worlds arms industries. They can be analyzed as economically strategic industries where both R&D and production quantities are important and lead to decreasing cost industries reflecting economies of scale and learning. A structure-conduct-performance approach is applied. Market conduct is assessed including defense R&D and the role of the military-industrial-political complex. Market performance is reviewed by assessing contract performance, firm productivity and profitability and exports. Governments are central to understanding arms markets and weapons procurement raises both theory and policy issues. There are principal-agent problems and issues of adverse selection, moral hazard, risk sharing and bilateral monopoly. Various types of contract are available, each with different efficiency incentives. Governments can also use their buying power to determine the size, structure and performance of a nations defense industrial base (DIB). The benefits and costs of a national DIB are assessed and three policy issues and challenges are reviewed. These are the role of competition in arms procurement, its extension to military outsourcing and the profitability of non-competitive contracts. Alternative industrial policies are a further aspect of procurement policy. Guidelines for a defense industrial policy in a military alliance are outlined together with an assessment of European collaborative programs. The Chapter concludes by speculating on the future of the defense firm and proposing an agenda for future research in the field.

Industrial policies in the defense sector

Voluntary military alliances, such as NATO, are often criticized for failing to exploit the opportunities for equipment standardization and free trade. However, nationalism means that governments adopt a variety of industrial policies for purchasing defense equipment, leading to departures from the competitive free trade model. Different procurement policies offer varying combinations of military and national economic benefits. Work sharing can be achieved through international collaboration, licensed production and offsets. Policies designed to improve efficiency in equipment procurement also affect the military production function. Job losses associated with the closure of military bases and defense plants raise issues of conversion.