House of Commons - Trade and Industry

Select Committee on Trade and Industry Minutes of Evidence

APPENDIX 25

Memorandum submitted by the Forum of Private Business

EXECUTIVE SUMMARY

Governments around the world procure $5.3 trillion worth of goods per year. In the UK, only 22% of government procurement contracts go to small and medium-sized businesses. Research shows that the larger the business, the more chance it has of obtaining contracts from public authorities.

Why should this be so? Do large businesses necessarily produce better products and services at cheaper prices than their smaller counterparts? No. If that were the case, the smaller businesses would not survive in private markets either.

The key issue is that governments are not commercial organisations. They do not have a profit motive or a competition motive, and therefore no incentive to behave in a way that economists would necessarily define as rational when they procure inputs to the services they produce. Their behaviour excludes a potentially large source of bids for tender. Firstly, this means that governments pay more than they need to, and taxpayer value is not maximised. Secondly, small businesses, the vehicle for the innovations that guarantee future increases in prosperity and the target for much of the investment for innovation that facilitates them, do not have access to a potentially lucrative market. Thirdly, resources are not allocated efficiently in the economy. Many stakeholders worry about the distortions that could be created if deliberate efforts are made to improve the procurement process for small businesses. In reality, large distortions already exist.

This paper lists a number of corrective actions that could be undertaken by government. However, it also points out that, without the profit motive that drives private organisations to make economically efficient decisions, there is no incentive for government departments and local authorities to unilaterally take these actions. This paper therefore recommends radical reform of procurement policies so that advocates for fair competition can work within government departments to instruct them on how to make their procurement processes fairer. A target should also be introduced, for the percentage of government contracts that go to small and medium-sized businesses. Not a ring-fenced quota that leads to contracts being given unfairly to small businesses which could not win them competitively, but a benchmark against which the success of competitive procurement policies can be measured. Furthermore, we outline the specific circumstances under which setting certain government contracts aside for small businesses actually results in greater competition and efficiency than allowing dominant large businesses to compete with them.

Finally, we recommend support for a revision of the WTO Agreement on Government Procurement. Revision, not so that we can protect our own market and unfairly favour domestic producers, but so that we can take the necessary measures to institute fair competition, and so that we can work to revise the Agreement such that small business programmes are allowed, but that national protectionism is not, for a far greater percentage of the whole global procurement space than is currently covered by the Agreement.

INTRODUCTION

Governments are not commercial organisations. They do not seek to deliver profits for their shareholders or owner-managers. Their revenue is derived from taxes. Profits are budget surpluses that are simply offset against deficits from previous or subsequent years, diverted around departments, or used to pay off government debt. Nevertheless, when they deliver their services, they inevitably buy goods or services from private organisations during the delivery process. As William G Poeton wrote in 1986, government purchases range "...from complex space vehicles to paper clips, janitorial services to cancer research. In short, the (US) Government buys just about every category of commodities and services available."[50]

However, governments cannot be compared with other commercial purchasers of goods and services.

Private companies purchasing other companies' products do so with a specific objective that the procured product be used in their own production processes in a way that will increase the price: quality ratio of their own products and give them an advantage over their competitors in a highly contested marketplace.

Governments, however, are not subjected to the same constraints.

There is no such thing as competitive government. People cannot choose to receive public services from a range of different governments in the marketplace. The only choice is at election time, yet the politicians who have to be re-elected are not the ones who make the day-to-day purchasing decisions. These are civil servants. The only other avenue of choice is residence: yet most people cannot, for practical, personal reasons, emigrate if they are dissatisfied with their government's services. Furthermore, while value for money in procurement is important, it is not likely to influence an intention to vote or emigrate.

Because of the widespread proliferation of government activity and the ever-increasing role government plays in our lives, the Government has assumed the role of dominant buyer in many industries. As a dominant buyer, while not entirely in a monopolist position, its actions significantly affect the structure of the markets in which it purchases.

The lack of competitive constraint and incentive causes Governments to make decisions that would be economically irrational from the point of view of an economic agent operating in input and output markets which were perfectly competitive both from the suppliers' and purchasers' side. As a dominant buyer, the Government's actions have the power to create significant distortions.

By far the greatest economic folly committed by government is single-sourcing. It is simply not economic not to seek as many tenders as possible for each and every contract, and yet, in many cases, preferred suppliers are used without the necessary competitive tendering process. Firstly, this discriminates against smaller businesses, and causes misallocation of resources in the economy. Secondly, a lack of or limited competition in the tendering process causes prices to be inefficiently high and wastes taxpayers' money.

These irrational actions have resulted in poor access to government contracts for small businesses. Small businesses currently receive less than 20% of UK Government procurement contracts. Including medium-sized businesses, this rises to 22%[51], but this is still insignificant compared to the 99.8% of businesses which are small or medium-sized. The situation for small businesses is similar in many other EU countries. In France, for example, the figure is 21%.[52]

It is official government policy in the UK that procurement tenders should be opened up to small businesses. The Supply2.gov.uk website states that "Government policy is now encouraging Public Sector bodies to open up public sector procurement to small business."[53] The creation of the Supply2.gov.uk website is the main ingredient of this policy. However, further measures are needed in order to address the imbalance.

In recommending further measures, we are always mindful of the fact that small businesses, while they do not enjoy the same economies of scale as their larger counterparts, are the vehicle for much of the innovation that guarantees future increases in our living standards. In the United States, they produce 13 to 14 times as many patents per employee as larger businesses.[54] They are the companies at which venture capital and other sources of high-risk equity for innovation are directed, and, without the ability to tap into a market that can reach up to a sixth of GDP, they are less attractive investments than they could be.

Furthermore, we do take into account the fact that mention of improving access for small businesses to government contracts invokes preconceptions of "positive discrimination" or some kind of undue favour. In fact, we are looking for procurement to be more competitive, not less. Currently, a huge field of potential suppliers—smaller businesses—is shut out from the process, meaning that Government does not always take into account all possible suppliers of goods and services and is, therefore, procuring less competitively and with less taxpayer value than it could.

GOVERNMENT BEHAVIOUR AND THE INHERENT DISCRIMINATION AGAINST SMALL BUSINESSES

As highlighted above, governments are not subject to competitive constraints in the same way that commercial purchasers of goods and services are. Therefore, their actions are not always entirely rational, or, if they are, are driven by motives other than economic ones.

Here are some examples of how government practices shut small businesses out of the procurement process:

— Single sourcing means that many contracts are not even advertised, but are simply awarded to the preferred supplier.

— Most small businesses do not know where to find public contracts.

— The bureaucracy needed to complete a tender often takes one person three working days, which is a huge cost commitment for smaller businesses, indeed probably a larger commitment in terms of average avoidable cost than for large businesses.

— Public authorities tend to bundle tenders together for convenience when they could get better value for money by breaking them up and putting them out to tender individually. For example, the contract to build the interrogation centres for the new identity card scheme was given as a whole to a large company called Mapeley. However, there is more than one centre to be built, and the contract was given for all centres. This is called bundling. If the construction of each centre had been put out to tender individually, small businesses in each locality could have competed for the building of individual centres, and, in some instances, their bids may have been cheaper or more advantageous.

— There is also inherent risk-aversity in government departments, both at a personal and collective level: "Nobody ever got sacked for hiring IBM", is a common phrase. As departments are not businesses acting under competitive constraints, they do not have to think about potential return on their investment. They simply go for the most convenient and safest option. For innovative start-ups and specialist smaller businesses, there are obviously unique problems with such behaviour. Private firms that procure products and services have to make complex value judgments when deciding between tenders. One may have the potential to deliver stunning returns, but these returns may not be certain. Does the purchaser select the riskier offer with the higher potential, or play it safe? The level of risk-aversity in the business drives the decision, a level that is itself driven by the competitive dynamics of the marketplace that the purchaser eventually supplies. However, private purchasers have the ability to make provisions for risk—bad debt provisions are used in their accounts; risky investments are hedged, and they are financed by a variety of means provided by investors: leverage finance, acquisition finance, equity finance for specific ventures. Investors vary in their risk-aversity, but risk-seeking ones may be found to finance specific, promising but risky, ventures. Governments do not have the same financial facilities; their funding is simply decided on three-year cycles by the Treasury.

Where it would be rational to seek as many bidders as possible for each tender and evaluate them on the basis of return on investment in a risk-neutral mindset, the Government, sometimes intentionally, through single-sourcing, and sometimes unintentionally, through the practices outlined above, restricts competition for its tenders, and then evaluates them in a risk-averse manner.

The reasons for this can be:

(b) Financial goals. Public sector organisations do not work to the same financial goals as private organisations. As highlighted above, return on investment is a key criterion for private organisations. Government departments, however, do not have an incentive to look for return on investment. Their funding is decided in three-year cycles between Comprehensive Spending Reviews, decided by the Treasury. They cannot set their own budgets, nor raise external financing for an investment project which may be costly in the short term but pays for itself in the long term, subject to risk. Therefore, short-run cost and reliability, rather than contribution to long-term productivity and competitiveness, are often the criteria used, and this weighs heavily against small, innovative businesses.

CORRECTIVE ACTIONS

The following corrective measures should be taken:

(a) The removal of the requirement for three years of accounts to be provided before a tender is granted. This requirement obviously excludes innovative start-ups which may not have existed for three years, as well as certain small businesses that have no reason to keep accounts that are audited according to the standards used by listed companies.

(b) A reduction in the paperwork and bureaucracy needed to submit a tender.

(d) An improvement in the late payment records of government departments. They act as a large disincentive. Research could also be commissioned to determine whether payment practices could be changed for small businesses. For example, the justification for the requirement for three years of accounts is that government departments must know that the tendering business has the financial capacity to deliver the project. This is often needed if the project is of long duration with payment on completion. However, if payment practices were changed such that payment could be made incrementally for work in progress, more small businesses would be able to compete.

(e) Greater transparency and abolition of single-sourcing: every government contract should be advertised publicly, not given to a preferred supplier, and tendering businesses should have access to information as to why their bid was successful or unsuccessful.

(f) A decision management process, either through decision-management software or through recognised procedures, should be implemented in order to take into account other factors than short-term cost, which might make a tender attractive to a government department.

(g) All local authorities should sign the small business concordat.

(h) The use of "smart procurement" could be examined. One example of smart procurement is a process whereby procuring authorities are less rigid in their requirements from a tender, allowing a tendering business to creatively apply whichever solutions they feel will increase the operational efficiency of the customer's business. This allows tenders to be judged against more criteria than just the one-off cost of producing specific defined services. Innovative small businesses, especially start-ups, would be better able to compete if such methods were used.

Of course, ideally these measures would be actioned by government departments unilaterally. Unfortunately, unless government is subjected to competitive constraints (which is, of course, impossible, as a country can only have one government), this is unlikely to filter through the whole government machine.

Without competitive constraint or the motive of profit, there is little incentive to act in an economically rational way. Therefore, an "artificial" incentive, and a mechanism to ensure the corrective actions outlined above, need to be inserted in order to change the behaviour of the procuring authorities and individuals.

STIMULANT FOR CORRECTIVE ACTIONS

One such incentive would be a target for the percentage of government contracts that should go to small businesses. Of course, introduction of this target should not be the sole measure put in place. In the absence of corrective measures to address the problems highlighted, it would be impossible to implement, as small businesses still could not compete fairly. Small businesses can only compete fairly if the measures above are taken. However, a target would be the incentive to implement those measures. If an individual, be it a Minister or a relevant senior civil servant, could be held accountable to the target, then annual reviews of performance against the target would provide indicators as to whether the measures were being implemented and having the desired effect.

Furthermore, if the target were set above the current level, but just below the level which small businesses would receive from an economically rational buyer, the target could, along with the corrective measures, be guaranteed to correct, rather than create, distortion, and to enhance competition by including more small bidders, rather than unfairly favouring small businesses.

Targets distort the market when they are introduced into already perfectly functioning and competitive markets. However, such a description is not apt for the UK public procurement space. We have listed above several examples of market failure, such as imperfect information, and irrational behaviour and non-optimisation on the side of the consumer (government). This results from the dominant position of government as a buyer and its lack of competitive constraint in its output markets. The proliferation of government activity and the ever-expanding size of the state have created a dominant buyer, whose actions have the power to distort the market because of its dominance. Furthermore, this is a buyer that does not operate in any competitive market as a supplier. It is not subject to competitive constraints that would rationalise its economic behaviour. Therefore, its economically irrational behaviour creates market failure and misallocation of resources—or what we would commonly call distortion.

A target would not correct this. Corrective measures as outlined above would. A target would force government departments to implement those measures.

The target that we advocate should not be a ring-fenced quota. It should not, under any circumstances, lead to small businesses being granted contracts that they could not obtain competitively. Indeed, if a quota did lead to this situation, the UK would be in breach of EU law.[59] The target should be a benchmark target against which actual performance can be measured and relevant individuals and authorities held accountable.

A second means of enforcement of the necessary changes would be a system of advocates, which may or may not be modelled on those working under the auspices of the Small Business Administration (SBA) in the United States, working with government departments to force them to put out tenders for competition and make them more accessible for small businesses.

The experience from the US shows that, in just the two years after President Reagan signed into force the Small Business and Federal Procurement Competition Enhancement Act of 30 October 1984, savings of $201m[60] had been achieved, just in the Department of Defence, through releasing to open tender defence contracts that would previously have been secretively given to large, established, reputable companies for convenience. This reflects the increased competition for each tender, which was only made possible through the SBA's work in forcing departments to break the contracts out so that they were competitively tendered and accessible for smaller businesses.

The $201 million can be taken as the quantification of the reduction in market distortion achieved by the SBA's Breakout for Competition Programme. Indeed, one might add that President Reagan, given his record, would not have passed such an Act unless it acted to reduce market distortions and enhance competition, as is implied in the name of the Act. It is proof that deliberately improving access for smaller businesses opens a new field of potential bidders, therefore creating greater competition for tenders, reducing distortion and saving taxpayers' money.

A further measure in use was the system of set-asides. Set-asides do not mean unfair advantages, as Poeton points out: "The use of the phrase `set-asides' immediately creates a feeling of privilege to the UK mind. It took the team some time to fully understand that in reality it is a `set aside for competition' programme."[61]

Set-asides are used for certain classes of procurement and they dictate that only small businesses may bid for them. This does seem, at face value, to restrict competition. However, such set-asides are only implemented where the presence of a large business as a bidder deters small businesses from submitting a tender themselves, when, for example, the small business may be economically dependent on the larger business. Where such discouragement occurs, there is market failure, as the large business is obviously dominant enough to bring about exclusionary abuse against the small business. Therefore, the set-aside is a measure to reduce market failure. The evidence of the United States' experience shows that cost savings to the taxpayer of 40% can be achieved[62] because the number of bids received for each tender is greater under small business set-asides than when competition is open to large businesses as well.[63]

Whilst we would not recommend wholesale copying of this policy into the United Kingdom, we do believe that its use should be permitted, under specific circumstances which can be identified through appropriate economic research procedures: namely, where the market failure, in the form of exclusionary abuse outlined above, can be proven.

LEARNING FROM BEST PRACTICE—PROCUREMENT FROM SMALL BUSINESSES IN THE UNITED STATES

It is fair to say that the system in the United States is imperfect and has worked, at many points in history, far better than it does now. For this reason, any recommendation to model our own policies on the American experience is often treated with trepidation. Whilst we would not advocate simply lifting and copying the system from the United States, we do believe there are significant advantages to the American system that could form the basis of a British model. However, it is worth explaining in depth which points to take on board and which features have caused the current imperfections in the American system.

The genesis of efforts to improve small businesses' access to public procurement contracts in the United States came during World War Two, when Congress was concerned that taxpayer dollars used for defence procurement may not be being spent effectively. The concern was that the federal Government was not maximising its use of funds and that the war effort may, therefore, be being compromised. A programme was initiated to grant Certificates of Competency (COCs) to small businesses to enable them to bid for tenders from the Department of Defence (DOD). As Clark and Moutray point out: "The Certificate of Competency (COC) had its beginning during World War Two as part of the Small Business Mobilization Act of 1942. This legislation established, among other things, the War Production Board, with authority to review and certify the competency of a small business to perform a specific Government contract."[64]

The dual utility of the programme is effectively summed up by the same authors. "The purpose of the program is to ensure that small businesses, especially those newly entering the federal marketplace, receive a fair share of government contracts. This, in turn, helps the Government to supplement and diversify its sources of supplies and services."[65]

Small businesses benefit because they receive fair access to a significant market. The Government, and taxpayers, benefit because there is greater competition, as a whole new source of tenders is opened up. The economy benefits through greater efficiency and allocation of resources.

The Small Business Act was created in 1953, to ensure fair treatment of small businesses as well as ensuring that they received a fair proportion of government contracts. Again, the focus was on maximising small business interests in order to enhance competition, as Congress stated:

The Small Business Act was enhanced through the Small Business Federal Procurement Competition Enhancement of 1984, after a pilot project of 1980 that had pointed to the efficacy of breakouts, saving $7.3 million through 294 breakouts at four Air Force Logistics Centres.[67] The Act assigned a Small Business Administration (SBA) Breakout Procurement Centre Representative to all major procurement centres and required federal procurement regulations to be subject to public consultation.[68] In the same year, the Competition in Contracting Act limited non-competitive procurement methods and instituted an advocate for competition in each executive agency.[69] In 1985, the Department of Defence Authorization Act designated an advocate for competition to the Department, and established guidelines on the use of qualified bidder lists, which small businesses believed had been used to discourage new firm participation in the tendering process.[70]

Following the signing into law of these Acts by President Reagan, significant cost savings were achieved as outlined above, as new sources of bids were opened up.

Even before the 1984 Act and the savings identified in 1986, the Small Business Act of 1953 had been effective in increasing small business' share of the federal market to 30%.[71]

These policies, which are both competitive and SME-friendly, and produced visible results both for SMEs and for the taxpayer, are those on which we would like to see a UK reform modelled.

However, there are also downsides to the American system. The Buy American Act of 1933, which "mandates preference for the purchase of domestically produced goods over foreign goods in US Government procurement"[72], is not a policy that we advocate replicating, as it is protectionist and anti-competitive.

Furthermore, the access of smaller businesses to federal contracts appears to have gone into decline from the 1990s, as Clark and Moutray point out that 22.6% and 23.6% of government contracts went to small businesses in fiscal years 2002 and 2003 respectively.[73]

However, the explanations for this are offered quite clearly by Clark and Moutray, and their figures are a clear vindication of the theories highlighted above regarding competitive procurement.

As Clark and Moutray point out[74], the Federal Acquisition Streamlining Act of 1994 authorised multiple-award contracts—leading to a 19% jump in the number of bundled contracts—and allowed for purchases of items below $2,500 without competitive quotations. The National Defence Authorisation Act of 1994 created a new category of transactions authorised for the Department of Defence other than those that had to be competitively tendered. The Clinger-Cohen Act of 1996 authorised credit card use for purchases up to $2,500, and the Administrative Dispute Resolution Act of 1996 limited the number of places where small businesses could file a claim.

All of these Acts impacted negatively on the ability of small businesses to fairly compete for government contracts, as evidenced by the low proportion of government contracts won by small businesses in 2002 and 2003 compared with, for example, 1984. In short, bundling and less competitive tendering had unfavourable effects on small businesses. This corroborates our view that the less competitive the tendering, the more difficult life is for small businesses. This was predicted, at the time of these reforms, by Donald L. Campbell.[75]

Conversely, however, the Small Business Reauthorization Act of 1997 actually increased the target for the percentage of Government contracts that should be awarded to small businesses, from 20% to 23%. The target was increased at the same time as the ability of small businesses to compete fairly was compromised. There is anecdotal evidence that the target has, during recent years, caused market distortions, as federal authorities have tried to award small businesses a fair share that they cannot fairly obtain. However, the reforms of the 1990s are the reason that they cannot fairly obtain that proportion. If the effect of those reforms were neutralised, small businesses could compete fairly and the target would not be causing any distortion, but acting as a regulator of fair behaviour.

Therefore, it can be fairly calculated that any distortions that have occurred in recent years as a result of the 23% target have in fact been due to the fact that the target was acting alone. When the procurement system was altered it became unfavourabe to small businesses and to competition, attempts to enforce small businesses' fair share through the use of a target alone resulted in limited success, success that was achieved at the price of distorting the market.

However, the fact that federal authorities have, in recent years, missed or only narrowly met the percentage target for procurement from small businesses has forced a review of the 1990s reforms and a new round of initiatives to allow small businesses to compete: Clark and Moutray point out:

The failure to meet or to significantly exceed the target acted as an indicator to policymakers that procurement policies were not as competitive—as open to small businesses as well as large—as they should be. This has led to corrective actions such as tightening up on bundling and reduction of bureaucracy, the results of which cannot yet be judged due to economic and data collection time lags, but which should result in more competitive procurement and greater access for small businesses. If there were no target against which small businesses' share could be benchmarked, there would have been no signal that the reforms of the 1990s had been harmful.

We believe that the American experiences of the 1980s through to the present corroborate our view that specific measures to maximise openness and competition are needed to improve the access of small businesses to government contracts, but that these can only be policed through benchmarking against a target, where the failure to reach the target acts as an alarm bell to sensible policymakers that such policies may not be being pursued or implemented in the best possible way.

While the 1990s and 2000s provide a valuable lesson in the usefulness of the target as an enforcer of procurement policies which are both friendly to small businesses and pro-competitive, the actual policies enacted in the United States through the Acts of 1942, 1953, 1984 and 1985 that we believe could form the basis of a reform in the UK are:

— Break-out for competition programmes

— Set-aside for small business competition programmes, where appropriate on grounds of fair competition

— Limiting of non-competitive tendering

— Public consultation of procurement regulations

— Guidelines on use of qualified bidder lists

— Appointment of an advocate for competition in each procuring authority

— Advocacy of the above by an equivalent Small Business Administration, whose advocates should work inside each procuring authority

INTERNATIONAL FRAMEWORK

There are two major international agreements governing government procurement practice, to which the UK is subscribed. At EU level, there is Directive 2004/18/EC. At WTO level is the Agreement on Government Procurement (AGP), to which the UK is a party as an EU member state.

EU Directive 2004/18/EC does not need to be, could not and should not be renegotiated. As mentioned above, it forbids the granting of any kind of special favours to a tendering business that could not win a contract competitively. This is implied to include favours on grounds of home nationality—it is a piece of internal market legislation[77]. However, as we have extensively pointed out in this paper, we believe that greater, not lesser, open competition is needed and do not look for special favours of any kind.

EU Directive 2004/18/EC also contains certain specific provisions which could be helpful to small businesses, but have simply yet to be implemented in the UK. For example, it stipulates that unsuccessful tenderers must be able to know the reasons why their tender failed[78], it instructs procuring authorities to act in a transparent way[79], provides for competition by regulating the use of restricted procedures,[80] and instructs procuring authorities to advertise the value of contracts they wish to issue.[81] The Directive, indeed, provides a certain legal framework that may be helpful in enforcing some of the measures we outline.

The Directive could probably not be renegotiated even if this were worthwhile, as the negotiations were extensive and were only concluded three years ago, as per the date of the Directive. The Directive does not rule out any of the corrective measures we outline, nor does it rule out the enforcers of those corrective measures that we recommend: the advocates or the target.

The AGP was concluded in the General Agreement on Tariffs and Trade (GATT) in 1979 and re-concluded at the inception of the World Trade Organisation in 1994. It was one of four agreements annexed to the agreement establishing the WTO, and came into effect in 1996.

The AGP is a plurilateral agreement for which signatories must designate which procuring entities and types of procurement are covered.[82] Specific signatories have made specific classes of procurement or procurement policies exempt from their participation in the agreement. As the Canadian Department for Foreign Affairs and International Trade sets out, the USA has exempted its small business set-asides and Canada has exempted procurement by sub-federal governmental authorities.[83] Japan and South Korea also enjoy specific opt-outs.

The main purpose of the agreement is summarised by the WTO as follows:

It essentially rules out national protectionism from the selection of contractors on a global level, in the same way as Directive 2004/18/EC does so on an intra-EU level. This goal is one with which we fundamentally agree.

However, in the laudable aim of seeking to encourage international competition, the Agreement has also possibly ruled out certain of the specific measures that we have outlined that could improve small businesses' access to government contracts.

Article 7 states: "Each Party shall ensure that the tendering procedures of its entities are applied in a non-discriminatory manner."[85] Again, while we agree with the noble aim of this clause, we anticipate a degree of legal uncertainty with regard to the use of small business set-asides. In the cases where small business set-asides are needed, it is because the presence of a large business in the tendering process discriminates against a disproportionate number of small businesses, as described above. Therefore, a small business set-aside is a measure to reduce discrimination, as we outlined.

However, is this the interpretation the WTO would use, when large businesses are excluded from certain contracts? We believe that this article should be redrafted simply to say "in a manner that ensures that tenders are competed for in the most competitive way possible", as this would allow set-asides when they are necessary to improve competition. The same legal uncertainty does not apply to EU Directive 2004/18/EC, as its non-discrimination applies to the "Awarding of Contracts', which implies the selection of a tender from the bids received, not the actual conditions for participation in the tendering process.

It is also doubtful whether a target for the percentage of government contracts to be given to SMEs, would be in accordance with the Article 7.

Article 8 states: "...any conditions for participating in tendering procedures shall be limited to those which are essential to ensure the firm's capability to fulfil the contract in question."[86] Here, small business set-asides stipulate that a business must be small in order to compete for a contract, yet this is not related to the business' ability to fulfil the contract, it is related only to the need to ensure maximum competition. This clause would need to be redrafted to say "any conditions for participating in tendering procedures shall be limited to those which are essential to ensure the firm's capability to fulfil the contract in question or to ensure effective competition in the tendering process."

Article 10 states: "entities shall, for each intended procurement, invite tenders from the maximum number of domestic suppliers and suppliers of other Parties, consistent with the efficient operation of the procurement system."[87] There exists the potential for legal uncertainty here with regard to the use of set-asides. We believe they should only be used where they are proven to produce a higher number of bids. However, would the WTO conclude that the exclusion of larger businesses is contrary to the invitation of the "maximum number of suppliers"? We believe that this clause would need redrafting to exclude the duty to "invite" tenders, saying instead "...entities shall, for each intended procurement, provide for efficient competition by ensuring the maximum number of bids is received." Again, as we believe set-asides should only be used where they increase the number of bids, this would allow us the legal flexibility. EU Directive 2004/18/EC[88] does allow, as we pointed out above, for restricted procedures under certain regulated conditions—namely that at least three bids must be solicited. We do not see this as a problem because, we repeat, set-asides should only be used where they increase the number of bids.

Article 13 states: "The entity shall make the award to the tenderer who has been determined to be fully capable of undertaking the contract and whose tender... is either the lowest tender or the tender which in terms of the specific evaluation criteria set forth in the notices or tender documentation is determined to be the most advantageous."[89] While we agree with the aim of this clause, the phrase "in terms of the specific evaluation criteria set forth in the notices or tender documentation" makes it more difficult for small firms to win contracts by producing innovative offers that provide benefits outside of the specific scope of the contract, and indeed for procuring authorities to be open-ended in the requirements they stipulate. Therefore, this clause would need to be redrafted to remove the words in bold, giving procuring authorities more flexibility.

There is currently a window open until March 2007 for the tabling of a revised AGP.

The UK cannot negotiate for itself in the WTO, as trade is an EU competence at "first-pillar", i.e. supranational, Community level. Therefore, we believe that the UK should actively engage in the EU to reach an agreement that a revised AGP proposal should be tabled, encapsulating the above suggestions, and that the EU should push for these changes in the WTO. If the changes cannot be made, an opt-out should be sought to exempt smart procurements, and, if necessary, break-outs and set-asides, from the agreement, or indeed to exempt certain classes of procurement from the whole agreement if this is easier to operate.

However, we do not believe that the thrust of the AGP is wrong. Non-discrimination on grounds of nationality is imperative to the evolution of comparative advantage through international trade. We would not want any of our proposed measures to conflict with this principle, and do not believe that there is any reason why they should. Even if we were to opt out from the agreement, we should still award contracts without discrimination on the grounds of nationality.

Opt-outs would, however, be suitable, because, as well as providing the flexibility as outlined above, they would provide a rationale for a new agreement replacing the AGP, because they would make the AGP virtually obsolete. The AGP already only covers $240 billion of the $5.3 trillion that public authorities around the world spend on goods and services in a year. EU opt-outs would reduce this figure even further.[90]

Currently, the Agreement does not cover large sections of procurement by the world's largest purchaser, the United States Government. The rationale for the US opt-out of small business set-asides from the Agreement is that they are forbidden by the Agreement. The Buy American Act, as a protectionist measure, is also forbidden, but is conveniently applied to those classes of procurement, i.e. set-asides, that are exempted from the Agreement. If the Agreement were revised to allow small business set-asides, for the reasons extensively set out above, it would remove the US' rationale for exempting them from the Agreement, and the Buy American Act would also not be able to apply, so much of the extensive national protectionism that surrounds the US procurement system could be eroded.

A new agreement would, of course, be difficult and probably take many years of extensive negotiations to reach. However, an agreement which provides the flexibility to take measures to ensure SMEs' access to government contracts, while ruling out national protectionism to a far greater extent than at present, is desperately needed, and therefore the process should be initiated.

Therefore, the UK Government should support current moves in the EU for a revised Agreement to be tabled. As we have made clear, though, we do not support a watered-down Agreement or opt-out being used for purposes of national protectionism, and understand the reservations of those who believe that it would be used as such. Nevertheless, a proposal for a new agreement, or indeed for an interim opt-out while a new agreement was being negotiated, would probably be more widely supported if it were made clear that it would not be used for protectionism, especially by the relevant EU commissioners.

In negotiating in the EU, we have to be aware that there are many countries where small businesses do not experience the same problems as they do in the UK. These countries therefore see no reason to tackle the problem of small businesses' access to government contracts. However, their support is needed for the EU to table a revised WTO agreement. Given the circumstances, we must explain to them the asymmetry that a measure that can only be negotiated by the EU is necessary to make improvements in the UK.

CONCLUSION

Small businesses do undoubtedly need better access to government contracts in the UK. SMEs make up 99.8% of the businesses in the UK and yet they receive only 22% of government contracts. Procurement procedures and policies are uncompetitive and inefficient, because government is not a commercial organisation subject to competitive constraints.

A holistic reform of the procurement system is required, making government act and think more like a commercial organisation when it procures products, and building incentives in to the system.

To fully ensure the legal flexibility to implement the necessary measures, we would need the EU to table a revised Agreement on Government Procurement. The agreement should permit the necessary pro-competitive SME-friendly measures, while clamping down on national protectionism in procurement.

11 January 2007

http://eur-lex.europa.eu/LexUriServ/site/en/oj/2004/l_134/l_13420040430en01140240.pdf

http://www.dau.mil/pubs/pm/pmpdf97/campblnd.pdf

http://eur-lex.europa.eu/LexUriServ/site/en/oj/2004/l_134/l_13420040430en01140240.pdf

50 GRYLLS MP, Michael; POETON, William, and FORRESTER, Julian, Defence Procurement: A private mission to discover the efficacy of competitive purchasing methods carried out by the United States DOD (April 15-20 1985), and an opinion on its relevance to UK and some European Community Practices, 1986. Back

51 Confédération Générale des Petites et Moyennes Entreprises, SMEs' access to public procurement, October 2006. Back

52 Confédération Générale des Petites et Moyennes Entreprises, SMEs' access to public procurement, October 2006. Back

53 Supply2Gov, How To Tender, www.supply2.gov.uk/how-tender.shtml Back

54 CLARK, Major and MOUTRAY PhD, Chad, The Future of Small Businesses in the US Federal Government Marketplace, 2004, page 4. Back

55 Supply2Gov, How to Tender, www.supply2.gov.uk/how-tender.shtml Back

56 For more information on New Look and Matalan see http://www.fpb.org/YVHWzPVo5lMmUA.html Back

57 http://www.warmwell.com/03nov12pq.html Back