Competitive Contracting for More
Effective & Efficient Government

25 March 1996 . Number 5

Congresssional Testimony by Wendell Cox
before the
Subcommittee on Civil Service, Committee on Government Reform and Oversight
United States House of Representatives
April 5, 1995

Background on Competition

In recent decades there has been increasing concern about the cost of government, and at every level of government, there have been serious budget difficulties. The problem is not fundamentally a revenue problem --- it is a cost problem. Government revenues have risen substantially --- and so have the unit costs of government

In the private sector, people and commercial enterprises succeed by paying no more than necessary for what they buy. Businesses pay the market rate --- it pays no more than necessary --- for labor, supplies and capital. The competitive market works to minimize factor costs. In government, however, the situation is different. While government uses the competitive market to obtain various goods and services, the competitive market is not applied to the factors of public service production. The result is higher than necessary costs. And government costs that are higher than necessary is government waste.

The problem is lack of competition. Government costs are determined in a non-competitive environment. As Nobel Laureate economist Frederik Hayek put it,

The market price cannot be known until there is competition.

And government has a special obligation to exercise stewardship over the resources it compels from people. This is not so in other sectors of the economy. People are not forced to purchase specific goods and services in the market. They are able to exercise personal choice. No such choice exists with respect to taxation. Government's financial obligation to the people, is spend each (dollar) to the best effect. Individuals do that, day after day. So do companies. They succeed, more or less, because they face choices as consumers and competition as producers. The minimum duty of a state should be to replicate such choice and competition in its own affairs, so that the billions it raises in taxes achieve the high-sounding aims it sets for itself.

The public purpose (or objective), then, of government spending is to provide for government services at a cost that is no higher than necessary. The imperative to spend no more than necessary is intensified by the federal budget deficit, which threatens the living standards of future generations.

Around the world, governments are using competitive contracting to apply market forces to government services, and with overwhelmingly positive results.

The Excess Cost of Government Employment

However, before providing an overview of competitive contracting, it is appropriate to review an important root cause of higher than necessary government services costs --- excessive public employee compensation. Government employee compensation is the largest component of state and local government budgets --- representing 60 percent of operating costs.

ALEC's America's Protected Class series shows that, while private employee compensation has stagnated, government employee compensation has risen steadily.

Average state and local government compensation increased 16.0 percent from 1980 to 1991 (inflation adjusted) --- $4.78 for each $1.00 received by the average private sector workers. State and local government employees are now paid, on average, 10.3 percent more than private employees.

The average federal civilian workers has received $4.56 for each $1.00 in compensation increase for the average private sector worker between 1980 and 1991. Federal civilian employees are now paid, on average, 45 percent more than private employees.

Federal workers are compensated, on average, at least 30 percent more than above state and local government workers. If federal employees were compensated at the same average rate as state government employees nearly $25 billion would be saved annually.

Inside the beltway, there is the perception that federal workers are less well paid than private sector employees doing similar work. This is based upon federal surveys that are frankly incomplete, misleading and outrageous in their results. The federal surveys are limited to wages --- as if the more expensive federal fringe benefits has no value --- as if the extra paid time off has no value --- as if superior federal security has not value.

American Legislative Exchange Council research indicates that, where federal government and private employee wages start out equal, inherent federal employment advantages create 50 percent greater value over a career for government employees. This amounts to a nearly $600,000 advantage for government workers who start at the same rate of pay as private workers.

And then there is productivity. The lack of competitive incentives allows government staffs to become larger than necessary. ALEC has identified substantial variation in productivity among state governments.
ALEC estimates that, when all advantages of government employment are considered, including sub-market productivity, it is possible that government employment costs exceed market rates by nearly 75 percent.

In the competitive market, customers determine employee compensation: Private companies do not have the freedom to artificially raise employee compensation. In the private sector, the prices that customers are willing to pay for goods and services constrain how much will be available for employee compensation, investment and distribution of earnings to stockholders (including employee pension plans). A company that raises employee compensation above levels that customers are willing to pay will lose market share and eventually close, taking with it the jobs of employees and the investment of owners.

Competitive Contracting

The realization that government employee compensation often exceeds market rates has lead to an increasing use of competitive contracting.

Competitive contracting is the provision of a public service through a competitively awarded contract. It has been used for decades by private and public organizations to ensure that goods and services of a defined quantity and quality are produced for the lowest possible cost.

The public agency seeks competitive bids to provide a particular public service. The public agency establishes quality and quantity specifications. The competitive market responds to the invitation of the public agency, and one or more producer is selected to provide a specific service for a period of time. The public sector retains policy control over the service, while the competitive market produces the service under public scrutiny.

There are five basic steps in the process:

1. The public agency seeks competitive proposals to deliver a specific quality and quantity of service for a defined period of time.

2. The public agency may submit its own cost proposal, capturing all attributable costs, and subject to the same terms and conditions that apply to private proposals.

3. A contract is awarded to the lowest responsible and responsive public or private proposer who demonstrates an ability to provide the same quality and quantity of public service at a cost lower than that of the public agency.

4. Contractors, public or private, that fail to provide the service as specified are financially penalized or replaced.

5. New competitive proposals are sought in sufficient time to award a new contract for service commencing at the expiration of the contract. New competitive proposals are sought regardless of whether the incumbent contractor is a private company or the public agency itself.

Competitive contracting does not necessarily result in private operation of public services. It merely requires that the public service be provided according to the specifications of the public agency for the lowest possible cost. Competitive contracting removes the present bias toward in-house public service provision and replaces it with a results oriented approach in which the lowest cost qualifying proposer, public or private, operates the service.

Competitive contracting reduces public costs in three ways:

1. Lower costs through provision of service at no more than the competitive rate (the "going" rate). Cost savings of 15 to 50 percent are frequent, with occasional savings of up to 75 percent. Touche Ross reports cost savings in 98 percent of cases.

2. Lower direct public service costs as public agencies improve their cost performance in response to the competitive environment. Competitive contracting not only results in lower costs for the public services competitively contracted, it also induces improved internal public cost performance. This "ripple effect" has been identified in various public services, including solid waste collection, public transit, fire protection, and other services. Public employee unions have negotiated competitive wage and benefit packages in response to competitive contracting.

3. Lower net costs as a result of tax revenues paid by private contractors on the public services they operate.

There are two fundamental principles of competitive contracting of public services:

1. The public agency should retain full policy control, determining which services are purchased, establishing quality and safety standards, administering contracts, and monitoring service performance.

2. The public agency should foster a competitive market. The maintenance of a competitive market is crucial to the success of competitive contracting. Private monopoly should not be tolerated any more than public monopoly. Fostering a competitive market requires:

a. Wide participation and full disclosure of information, so that all potential interested proposers have sufficient information to submit a proposal if they desire.

b. Limitation of contract duration (usually no more than five years including renewal options).

c. Limitation of contract size, so that smaller companies have an opportunity to participate.

d. Cost control through a requirement for fixed price proposals, and pro hibition of price negotiation after contract execution.

e. No public agency specification of labor arrangements except compliance with applicable state and federal law.

f. The public agency should compete in the process under the same terms as the private proposers and should include all attributable costs.

Competitive contracting saves money not because the private sector is superior to the public sector; competitive contracting saves money because competition induces lower costs than monopoly. Services provided by private contractors are no less public than the same services that are provided by public agencies themselves, because the public agency remains in complete control.

At the state level, more than 100 services have been competitively contacted. But even so, there remains substantial opportunity to increase competitive contracting and reduce the costs of government.

Unfortunately, the federal government itself sometimes puts barriers in the way of state and local governments that seek to implement more cost effective service delivery mechanisms. A particularly egregious example is the special labor mandates in the Federal Transit Act (Section 13c). The US Department of Labor has repeatedly withheld federal grants pending the capitulation of transit agencies to union demands. The perniciousness of these labor provisions is illustrated by the six year severance payment obligation for transit employees dismissed because of efficiency measures. This mandate has been used to prohibit competitively contracted transit service and unsubsidized transit services. This has retarded transit job creation. Particularly onerous is the fact that minority entrepreneurs have been systematically denied the opportunity to initiate services and that residents in low income communities have been denied the improved mobility that such services would have provided. all as a result of this egregious federal mandate.


The administrative mechanisms for controlling the costs of government have failed, and are beyond repair. The answer is not better administrative systems, it is direct application of market forces, especially through competitive contracting. All governments, state, local and federal need to be brought to the market.

The transition of government to the market will be, in many ways, as difficult as the transition from statist monopoly economies to market economies in eastern Europe and the former Soviet Union. But the transition from costly monopolistic government service provision to competitive service provision is necessary.

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