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Foreign Bidders Going Once, Going Twice... Protection in Government Procurement Auctions

Matthew T. Coley (Florida International University)
Ronald B. Davies (University College Dublin)

IIIS Discussion Paper No. 441

Until recently, government procurement bidding processes have generally favored domestic firms by awarding the contract to a domestic firm even if a foreign firm tenders a lower bid, so long as the difference between the two is sufficiently small. This has been replaced by an agreement abolishing this practice. However, the presence of other trade barriers, such as tariffs, can continue to disadvantage foreign firms. We analyze the bidding strategies in such a game and show that when domestic profits are valued, tariffs will be used to discriminate against foreign firms. Furthermore, we find that optimal tariffs can be more protectionist than the optimal price preference, resulting in lower expected domestic welfare and total surplus.

Non-technical summary:
Until recently, government procurement bidding processes have generally favored domestic firms by awarding the contract to a domestic firm even if a foreign firm tenders a lower bid, so long as the difference between the two is sufficiently small. This has been replaced by the Government Procurement Agreement, which abolishes this practice. However, the presence of other trade barriers, such as tariffs, can continue to disadvantage foreign firms. We analyze the bidding strategies in such a game considering two types of protection, a specific tariff and an ad valorem tariff. We show that in either case, when domestic profits are valued, tariffs will be used to discriminate against foreign firms. Furthermore, we find that optimal tariffs can be more protectionist than the optimal price preference, resulting in lower expected domestic welfare and total surplus than under the price preference (which itself is inefficient relative to free trade). Between the two tariffs, the ad valorem tariff is marginally more efficient than the specific tariff because its burden is smaller for low-cost foreign firms, enhancing the awarding of the contract to low-cost firms. These results lend support to concerns that the Government Procurement Agreement may force countries to use second-best methods of discriminating against foreign firms, in contrast to the agreements intent.

JEL classification: F13, H57, F12
Keywords: Government Procurement; Tariffs; Price Preference

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Last updated 28 August 2014 by IIIS (Email).