Costs and Benefits of Affirmative Action in California Government Contracting - Executive Summary

Abstract

Government purchases of goods and services represent approximately 10 percent of the U.S. economy, and policy is commonly used to direct some of those purchases toward specific groups. Bid preferences in procurement auctions, which allow firms from an identifiable group an advantage in bidding against unfavored firms, and subcontractor participation goals that require participation of minority and women owned subcontractors, are two tools commonly used to achieve a particular allocation.The first chapter of the thesis considers the effects of bid preferences on procurement costs, firm competition, and economic efficiency. While economic efficiency is expected to fall as a result of bid preferences, government procurement costs may either increase or decrease depending on the competitive response of favored and un-favored firms. Using data from California auctions for road construction contracts, where small businesses receive a five percent bid preference in auctions for projects using only state funds and no preferential treatment on projects using federal aid, I show that procurement costs are 3.5 percent higher on auctions using preferences.This increase cannot be explained by the bidding behavior of firms. Large firms bid 1.4 percent lower on auctions using bid preferences, while the lowest cost small firms increase their bid on preference auctions by 1.4 percent. The higher procurement cost in preference auctions is instead attributed to reduced participation by lower cost large firms.Structural estimates of latent firm costs are then used to evaluate how efficiency and the division of surplus between firms and the government is impacted by the use of preferences. Firm profits are 9.8 percent lower on preference auctions, implying significant losses in economic efficiency. The efficiency loss associated with changing some auction winners from large firms to small firms is estimated to represent 0.7 percent of overall procurement costs; however, including the adverse effect of preferences on the participation of large firms increases the estimated efficiency loss to 6.5 percent.The second chapter uses California's Proposition 209, which prohibited the consideration of race or gender in state-funded contracts, to investigate the effect of disadvantaged business enterprise subcontractor participation goals on the winning bids for highway construction contracts. After Proposition 209, the winning bid on state funded contracts fell by 4-6 percent relative to federally funded projects, for which preferences still applied. The savings are not explained by compositional changes in bid winners or changes in the number and quality of bidders. The subcontractor goals are found to distort the contractor's make-versus-buy decision, which may explain some of the decline.