Journal of Theoretical Politics

http://jtp.sagepub.com A Spatial Model of Competitive Bidding for Government Grants: Why Efficiency Gains Are Limited
Hugh Ward and Peter John Journal of Theoretical Politics 2008; 20; 47 DOI: 10.1177/0951629807084039 The online version of this article can be found at: http://jtp.sagepub.com/cgi/content/abstract/20/1/47

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Journal of Theoretical Politics 20(1): 4766 DOI: 10.1177/0951629807084039 http://jtp.sagepub.com

Copyright 2008 Sage Publications Los Angeles, London, New Delhi and Singapore

A SPATIAL MODEL OF COMPETITIVE BIDDING FOR GOVERNMENT GRANTS: WHY EFFICIENCY GAINS ARE LIMITED
Hugh Ward and Peter John

ABSTRACT With a view to improving public sector efciency many governments now make public sector bodies competitively bid for funding. We model the bidding process as a game of spatial competition. Using Monte Carlo simulations we show that in efcient equilibria many bidding groups will not be under competitive pressure. The model suggests that this is because their ideal projects are inherently valuable for the funding agency and other groups cannot match this without departing so far from their ideal that they would rather not be successful. We test the hypothesis that competition will be limited largely to groups whose preferred projects are of medium quality on data from the UK Single Regeneration Budget. Using resubmitted bids to track the impact of competition, we nd evidence consistent with this hypothesis. KEY WORDS . competition . bidding . public sector . grants

In this article we develop a model of competitive bidding for public funding of projects. In such bidding tournaments (Lane, 2001) or challenge programmes (Foley, 1999) an agency funds the best set of projects from a larger pool of bids, constrained by a xed budget. Our aim is to understand the degree to which competition pushes bidders to improve the quality of their projects. This question is signicant because bidding tournaments have become commonplace at national and at international levels. For instance, the Single Regeneration Budget (SRB) was introduced by the Conservative government in the UK in 1994 to generate competition between projects for urban regeneration, partly following precedents set by competitive US Federal Department of Housing and Urban Development programmes. Another example is bidding under the Montreal Protocol to the Multilateral Fund through the World Bank to fund projects to reduce the production and use of ozone-depleting substances in developing and transition economies. Bidding tournaments are an important component of the New Public Management reforms, introduced in many countries in an attempt to increase efciency by introducing market or market-like forces into the public sector (Walsh, 1994;

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Boyne, 1998; Robinson, 2000; Lane, 2001). For instance, since the early 1980s, central government in the UK has compelled ministries and local authorities to put out to competitive tender more and more functions that were once carried out in-house (Boyne, 1998: 10310). In the 1990s, central government developed the Private Finance Initiative (PFI) and the similar Public Private Partnerships (PPP), whereby private consortia provide capital funding for public projects. In New Zealand in the 1990s such measures were worked up into the method of contract budgeting, where the executive decides on what outputs it requires and quasi-independent government agencies, the private sector, or publicprivate partnerships competitively tender for contracts (Robinson, 2000). There have been extensive measures to encourage competition for school places, such as the Danish voucher system (Anderson and Serritzlew, 2007). On common sense grounds there may be signicant efciency gains when competitive bidding is introduced, because the monopoly of bureaucracies is broken (cf. Boyne, 1998: 1067) and because the executive as the sole or main purchaser can drive hard bargains (cf. Robinson, 2000: 86), although the transaction costs of forging contractual relationships may be high (Foley, 1999; Lane, 2001: 35). But there is an absence of theoretical models from which hypotheses can be derived about bidding tournaments. First thoughts might be to treat them as some sort of auction and to try to borrow or adapt a model from the vast literature (Milgrom, 2004; Menezes and Monteiro, 2005). An instance of such adaptation is to model lobbying as an all-pay auction in which the prize goes to the lobby making the biggest bid, with all other bids forfeit (e.g. Baye, Kovenock and De Vries, 1993; cf. Grossman and Helpman, 2002). Also standard auction theory can be applied to bidding to carry out a public sector contract (Rothkopf and Harstad, 1994). However, bidding tournaments are not like the auctions dealt with by economic theory. While groups that fail to get funding do waste their efforts in bid preparation and lobbying, the analogy with the all-pay auction breaks down because competition may force those who do get funding to pay an additional price: carrying through a project which is not what they exactly wanted to do. As far as we know auction theory does not deal with situations where the number of prizes depends on a budget constraint and the bids made, and is endogenous to the game-equilibrium, not determined in advance. Our contribution is to develop the rst model specically tailored to understanding bidding tournaments. Our claim is that gains from competition are limited, though not necessarily negligible, because competition does not impinge much on bidders whose preferences happen to be similar to those of the funding agency. We use Monte Carlo simulations to show that in equilibria derived from formal results many bidders are not under competitive pressure. We know little empirically about efciency gains from bidding tournaments. While some nd signicant gains from competitive tendering for public contracts, there are questions about the degree to which results generalize, whether quality of output has been maintained when production costs are cut, and

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whether cost-cuts are maintained once contractors have established a quasimonopoly position (Walsh, 1994: 22249; Boyne, 1998: 14752 and 16267; Lane, 2001: 423). Apparently large reductions in unit costs of the order of 20% (Boyne, 1998: 13546, Domberger and Jensen, 1997) divert attention from transaction and other social costs, such as unemployment, and poverty among low-paid workers (Lane, 2001: 423). PFIs and PPPs have generated claims for efciency savings, but evidence for actual gains is limited (IPPR, 2001). Competitive bidding to carry out particular functions within the public sector may be seen as part of the phenomenon of quasi-markets (Bartlett and Le Grand, 1993), where similar mixed results have been found (Anderson and Serritzlew, 2007). The evidence discussed so far may tell us little about bidding tournaments, because they do not involve tendering for a single well-dened contract. Doubts have been expressed about efciency gains from bidding tournaments (Foley, 1999; Taylor, Turok, and Hastings, 2001; John, Ward and Dowding, 2004; John and Ward, 2005), but the number of studies is small. We provide additional evidence by re-analysing data from the SRB programme.

1. The Model In this section we state the assumptions of our model.

1) If a group makes a bid, it must propose a single project to the funding agency at the same time as all other bids are placed. 2) Bid characteristics are reduced to a single bid score, s0 , that reects how far the bid is away from the funding agencys ideal point, and the level of funding demanded, y. 3) For any bid (s, y) is known with certainty by the funding agency.

A portfolio of bids is some subset of a set of bids. A portfolio is feasible if the total funding demanded is less than or equal to the agency budget, G > 0. No bid can be added to a maximal portfolio without breaking the funding limit. The agency tries to nd the maximal portfolio of bids which has the minimum summed score, a version of the 01 knapsack problems (Martello and Toth, 1990).1 Algorithms giving exact solutions are computationally complex (Martello and Toth, 1990: 1377) and analytically difcult in our context. Approximate solutions for n > 2, where n is the number of bids, generally rely on calculating the value ratio x0 = s0 =y0 . (Here low values of x0 mean the bid is of better value.) One method is called the greedy algorithm. Suppose for the moment that no two bids have the same x-score. Order the bids according to
1. So called because they are analogous to lling a knapsack up to a weight limit so that the subset of all the items taken has the highest possible usefulness on the hike (Dantzig, 1957).

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their value x0a , x0b ; . . . ; x0n1 , x0n , where x0a is the bid with the best value. Then for the agency:
4) i) Start with x0a ; if y0a G, funds this bid; else do not fund it; ii) if the amount of funding left after stage 1 is G1; repeat stage 1 with x0b replacing x0a and G1 replacing G; iii) repeat the second stage until there are no more bids to consider or there is no more remaining funding.

Taking bids in value-for-money order until no more can be taken without breaching the budget constraint is relatively efcient if the value of the marginal item considered but left out is small compared to the total value of those chosen (Martello and Toth, 1990: 28), which ought to apply where funds demanded are small compared to the overall budget. Set the baseline payoff for a group that makes no bid at 0. There are bid payoffs enjoyed if a bid is made and succeeds in getting funding and process payoffs from the act of making a bid, whether or not the bid succeeds. Process payoffs derive from: satisfying local electors that you are trying to bring home the pork; the process of bid construction, itself, helping build community relations; useful experience for future bidding (Ward, 1997). Specically:
5) For group i the process payoff associated with any bid made is the same, and greater than 0.

Groups know what project they ideally want to carry out, its characteristics and the funding they would like to deliver those characteristics. Not only can they get too little funding for their ideal project, but they can also get too much. For one thing they ultimately have to account for the efcient use of public money. Their ideal bid has a certain score on the agencys metric. Our assumption about group preferences is that moving in any given direction away from their ideal point is s/y space they get a lower payoff, if their bid is funded. It is easier to work with groups induced preferences in x/y space. Points in s/y space correspond one-to-one with points in x/y space, so a group has a derived ideal point in x/y space, say (xi , yi for the i-th group.2 Group is bid payoff if their bid succeeds and obtains funding is given by an ordinal utility function ui (x, y). Set the notional bid payoff from a bid that receives no funding at zero. Then:
6) ui (x, y) is a continuous, strictly decreasing, function of the distance between (x, y) and (xi ; yi ) on the Euclidean metric, such that ui xi , yi ) > 0.

2. Consider (s0 , y0 ) and (s00 , y00 ) in s/y space mapping into (s0 =y0 , y0 ) and (s00 =y00 , y00 ) in x/y space. They are only the same point if y0 = y00 , hence if s0 = s00 .

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Thus groups indifference curves are circles centred on their ideal points in x/y space.3 For bids close enough to their ideal point groups would prefer to get funded rather than not; but for bids too far away from what they ideally want to do they would rather not succeed as the price of delivering on the bid is too high. The set of bids such that group i is just indifferent between the bid succeeding and failing have a bid payoff of zero and are all located on some circle of radius ri centred on (xi , yi . Assume:
7) For any two groups i and j, ri = rj = r; r > 0; 8) ui (x, 0) < 0 for any x0 ;. 9) For any group i, ui (0, y0 ) < 0

which implies r < xi for all i.

10) The utility functions for bid payoffs and process payoffs of each bidding group are common knowledge among the groups and the funding agency.

First to prevent ambiguity assume that:

11) For any two groups i, j xi 6 xj so that groups can be completely ranked in ascending order of the ideal points on the x-dimension and correspondingly numbered 1, 2, . . . n.

Then:
12) If two or more groups put in bids with the same x-value, the funding agency considers them in the same order that the groups are numbered, starting with the bid from the group with the lowest number.

Thus faced with bids of equal value, the agency rst funds the bid coming from the group that ideally in the absence of competition would like to put in the better value bid. Given competition improves bids, if anything, an agency breaking ties this way allocates funds rst to the group that stands to gain most, as the funds go to the group whose ideal bid is closer to its actual bid. We refer to assumption 12 together with assumption 4 as sequential funding. Then:
13) Sequential funding is common knowledge among bidding groups.

We consider pure-strategy equilibria in a one-round bidding game.4

3. This can be shown to be consistent with the fundamental assumption about group preferences in s/y space that things must get worse for the group along any line starting at its ideal point. 4. Repeat bidding could lead to collusion to get higher payoffs, for instance by taking it in turns to put in serious bids (cf. Pesendorfer, 2000).

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2. Limits on Competition Say a group g is under competitive pressure in equilibrium @ if its bid obtains funding and x0g < xg or x0g = xg and y0g < yg; i.e. g makes a successful bid of higher value to the agency than it would ideally like or pares costs on its ideal project. If the set of pure-strategy equilibria in our model is non-empty, it typically contains innumerable equilibria. For reasons we will amplify below, we focus on the subset of pure-strategy equilibria such that there is no alternative equilibrium that is better for at least one bidder and no worse for any bidder, i.e. on equilibria that are Pareto-efcient relative to group interests, or efcient equilibria for short. We show that, given a mild restriction on available resources is satised, in efcient pure-strategy equilibria groups that ideally want to carry out projects that are high quality as far as the agency is concerned are not subject to competitive pressure. Hypothetically allocate funding sequentially to the ideal projects of groups according to their index numbers until for the c-th group it is not possible to fund that groups ideal bid. Then: THEOREM 1: So long as G > y1; @ is not among the subset of efcient pure strategy if there exists some group g, such that xg < xc r, which is under competitive pressure. (Proof in the Appendix.) Discussion We now use an example to illustrate some general features of equilibria in the model and to help convey the intuition behind Theorem 1. In the example shown in Figure 1 the total budget is enough to cover the ideal project of groups 1 and 2 (G > y1 + y2 but it is not enough to cover group 3s ideal project as well (y3 > G y1 y2 . So the critical group identied in Theorem 1 is group 3; and Theorem 1 asserts that group 1 cannot be under pressure in an efcient equilibrium, because x1 < x , where x = x3 r. One equilibrium is {(x1 , y1 , (x*, y2 , (x*, G y1 }. Here group 1 proposes its ideal project but group 2 comes under competitive pressure from group 3. In this equilibrium group 3 does not get funded: although it proposes a bid with the same value to the agency as group 2, under sequential funding group 2s bid is funded rst, because it is nearer what it ideally wants to do than 3s bid. It is still worth group 3 making a token bid that is not funded because it gets a positive process payoff from doing so. (Because of the positive process payoff, it is a general feature of equilibria that all groups bid.) Group 2 cannot successfully make a bid to the right of x* and nearer its ideal bid: if it does so, 3s bid will be funded and there will be no funds left over. In equilibrium if a group comes under competitive pressure it is because some other group locates at the same value of x and bids for an amount that would leave the group under pressure worse off if it moved to the

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y G

i y3

y2 y1

G y1 y2

x x1 x2 x3 x

Figure 1. An Illustration of Theorem 1

right. What if group 3 located somewhere to the right in the interval (x*, x2 ], say at x# , and still asked for G y1 ? Holding group 1s position xed, group 2 would now also locate at x and ask for y2 . But this cannot be an equilibrium: if 3 relocated to the left of x, it would get the funding. One can imagine a bidding war between groups 2 and 3: starting from any position to the right of x*, group 3 would sequentially relocate putting 2 under more and more competitive pressure until the conguration under discussion is reached. Notice that if group 1s bid is (x1 , y1 and group 2s bid is (x*, y2 , it would not pay group 3 to locate even further to the left than x*: although its bid might succeed in getting funding if it did not ask for too much, the bid payoff would be negative, because the project is outside the circle of radius r around 3s ideal point that contains projects with bid payoffs greater than or equal to zero. Relative to bidding groups preferences, the equilibrium under discussion so far is an efcient one: in no alternative equilibrium does 3 get funded; and in no alternative equilibrium can 1 and 2 more closely approach their ideal bids. However, there are innitely many other equilibria; and in some of them even group 1 comes under competitive pressure. For instance it is not difcult to see that there is an equilibrium at {(x1 , y1 , (x1 , y2 , (x1 , G)}, as long as x1 > x2 r. In this equilibrium group 3 also makes a token bid and gets no funding. While groups 1 and 2 both get funded under sequential funding, 3s bid locks them into carrying out projects that are less than ideal. However, this equilibrium is no better for group 3 and is worse for groups 1 and 2 than the efcient

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equilibrium discussed in the last paragraph; so the fact that group 1 is under competitive pressure does not contradict Theorem 1. The proof of Theorem 1 essentially just comprises two steps: i) if a group like 1 to which the theorem applies is under competitive pressure, it is because a group like 3 is pushing it to the left of its ideal bid; ii) but if a group like 1 is locked into a position to the left of its ideal in some equilibrium, continuity guarantees we can always construct another equilibrium where it is only 0 to the left of its ideal point, 0 < , and this equilibrium leaves no group worse off and group 1, at least, better off. A group enjoys a rent from putting in a successful bid if its bid payoff is strictly positive. Theorem 1 identies a set of bidders that not only continue to enjoy rents but whose rents are maximal. Thus bidding tournaments do not achieve a socially efcient allocation of resources even if the funding agency represents the social interest and bidders do not engage in competition that is inefcient relative to their own interests. Although efcient equilibria relative to group interests might plausibly be a focal point for a common conjecture, it is relevant to ask whether something approaching efciency could be attained in actual bidding. As suggested when discussing the efcient equilibrium above, such equilibria can be reached through a t^ attonement process whereby groups sequentially adjust their bids under incomplete information about others preferences. If groups initially bid at-or-near their ideal point, adjustment would gradually drive groups towards the funding agencys conceptions of higher value, because it would not pay to offer more than a minute increment in value above the other group. In this circumstance it is plausible that the equilibrium arrived at would be efcient. Another motivation for only considering efcient equibria is that the funding agencys hand might tremble in an inefcient equilibrium, funding token bidder 2 instead of 1 by mistake. For instance it might mistake what the two bidders ideal projects were. In this case 2 would be cursed with the need to carry out a project that was worse than not getting funding at all. To avoid even a tiny possibility of such an outcome 2 would not make bids having a strictly negative bid payoff; so equilibria could be expected to be efcient. Let C be the set of groups such that for each member g xg < xc r. The following corollary is an immediate consequence of Theorem 1: COROLLARY 1: No group j such that j C and yj r > G yg g C is under competitive pressure in Pareto efcient equilibrium @, so long as G > y1 . This is because there is not enough left over from G to give them a positive bid payoff once groups in C have had their bids funded, so they make token bids. Consider a group, j, to which Corollary 1 applies. It is possible that js token bid would not correspond to its ideal point. However we can invoke two arguments that suggest that it will do so. First, as already suggested, the possibility of trembles by the funding agency make it implausible that token bids

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associated with strictly negative bid payoffs would be observed, which means the token bids of such groups would not be too far from their ideal points. Second, as already discussed, equilibrium may be reached through sequential adjustment starting with groups ideal bids. If so j will be clear to such a group from early on that it cannot complete, for initial bids disclose which groups are potentially competitive. Why would j bother to change the value of its bid when it knows that this is futile? Given the above, we would not expect competition to impact either on the set of groups with ideal projects that the funding agency likes to which Theorem 1 applies or to groups to which corollary 1 applies: both can be expected to tender their ideal projects. It is among middle-range groups to which neither Theorem 1 nor corollary 1 applies that competition will push them to put in high value bids. Hence: Hypothesis: Competition will do most to improve the value of bids among groups with ideal projects that are mid-range in value.

3. Monte Carlo Simulations If Theorem 1 applied only to a small subset of groups given empirically reasonable values of parameters, it would do little to alter our thinking about whether bidding tournaments are a signicant innovation. However, we show that if the ideal funding of each group is of a lower order of magnitude than the total budget and groups cannot be pushed too far away from their ideal project without leaving them with something they would rather not carry out, Theorem 1 will apply to a considerable proportion of groups. The basis of our simulations are x-values of ideal points, assumed to be independent draws from a distribution. The y-values of each ideal point are assumed to not be conditional on x-values and are also independent of each other. Bids are drawn from probability distribution over the x/y space. We repeat the experiment 1000 times with 30 groups. For each draw the proportion of groups to which Theorem 1 applies can be calculated. The experiment is repeated 1000 times and, according to the basic Monte Carlo principle, the average proportions are estimates of the expected proportions given the assumed distributions. We report an estimate of average proportion of groups to which Theorem 1 applies and an estimate of average proportion of groups to which Corollary 1 applies. What matters in Theorem 1 is not G per se but the proportion of ideal bids that can be funded, and this parameter must be varied. A distribution of ideal points over the bidding space must be assumed. The one chosen approximates a uniform distribution over the unit square. (The exact assumption will be stated shortly.) Thus on average groups ideal funding level would be around 0.5 units. What proportion of its ideal budget for its ideal project could a group

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lose without being forced into something it would rather not carry out? Twenty percent seems a liberal estimate. Given an average ideal budget of around 0.5, this implies a value of r of around 0.1. The conclusions are somewhat sensitive to the assumption about r, with lower values of r corresponding to less competition. Results are also presented for r = 0.05. The assumption in the model is that ideal points cannot be within distance r from the axes, measured both vertically and horizontally. Thus the actual distribution used in the simulation was uniform over the square such that the x and y values of ideal points both belonged to the interval (r, 1]. For r = 0.1 the average ideal funding level would then be 0.55 and the average proportion of ideal bids that could be fully funded is G/ (0.55 * n), or around 1.8 * G/n. Results are shown in Table 1. As a larger proportion of ideal bids can be funded, the simulations suggest that Theorem 1 applies to a greater and greater proportion of groups. The sum of columns 2 and 3 can be thought of as a lower limit on the proportion of groups not subject to competition or making token bids. (Theorem 1 does not say other groups will be under competitive pressure.) This total is soon dominated by groups covered by Theorem 1. When r = 0.05, the lower limit is close to the proportion whose ideal bids could be expected to be funded. When r = 0.1, it is about 0.15 less. In summary the simulations suggest that if about a half of ideal bids could be funded, the proportion of groups not subject to competition is surprisingly high: at least a third of groups will get funding for their ideal project and at most a sixth will have to improve the quality of their proposals to get funding.

4. Empirical Evidence on competition in the SRB Process In this section we attempt to test our hypothesis about the limited impact of competition using a unique dataset on a series of bidding rounds for English urban policy funds, the Single Regeneration Budget (SRB), which contains detailed information on the bidders and the bid documents for both successful and unsuccessful bidders. Although there has always been an element of competition for urban funds (Ball, 1995), there was a break in UK urban policy in the early 1990s when the Conservatives moved decisively away from allocation according to measures of spending need towards competitive bidding by local partnerships, usually led by local authorities (Oatley, 1998; Foley, 1999; Stewart, 1994; Taylor, Turok, and Hastings, 2001). In 1994 the government unied existing urban regeneration funds into the SRB. The overall budget was around 1.4bn in 1994/5. The administering government Ofces for the Regions each had a separate budget. The programme was continued under Labour, with a fourth round in 1997/8 (DETR, 1997). The SRB bidding process provided opportunities for sequential adjustment under incomplete information. Because most bids were led by ofcials from

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Table 1. Monte Carlo Simulations (a) Bids are drawn from the uniform distribution on the set such that x , y [0.1 , 1]. Repetitions of the experiment 1000. Number of groups, n = 30, r = 0.1.
G (expected proportion of ideal bids that can be funded 1:8G=30) 1 (0.06) 3 (0.18) 5 (0.3) 7 (0.42) 9 (0.54) 11 (0.66) 13 (0.78) 15 (0.9) 17 (1.02) Estimate of average proportion of groups to which Theorem 1 applies 0.011 0.041 0.141 0.267 0.388 0.510 0.631 0.749 0.831 Estimate of average proportion of groups to which Corollary 1 applies 0.013 0.010 0.010 0.008 0.005 0.003 0.002 0.001 0.000

Sum of column 2 and column 3 0.024 0.051 0.151 0.275 0.393 0.513 0.633 0.750 0.831

(b) Bids are drawn from the uniform distribution on the set such that x , y [0.05, 1]. Repetitions of the experiment 1000. Number of groups, n = 30, r = 0.05.
G (expected proportion of ideal bids that can be funded 1:9 G=30) 1 (0.06) 3 (0.19) 5 (0.32) 7 (0.44) 9 (0.57) 11 (0.70) 13 (0.82) 15 (0.95) 17 (1.08) Estimate of average proportion of groups to which Theorem 1 applies 0.006 0.099 0.218 0.343 0.473 0.602 0.725 0.838 0.899 Estimate of average proportion of groups to which Corollary 1 applies 0.060 0.055 0.046 0.035 0.029 0.019 0.011 0.003 0.001

Sum of column 2 and column 3 0.066 0.154 0.264 0.378 0.502 0.621 0.736 0.841 0.900

different local-government units who met quite regularly, including at pre-briefings on annual rounds of the SRB, groups had considerable knowledge of what others wanted to do. These meetings also gave ofcials from Government Ofces of the Regions information about groups ideal projects. In the rst annual round groups put in outline bids, then some were invited to put in modied bids. Although this was subsequently dropped, there was still considerable interaction between groups and ofcials, whereby bids were further rened. Knowing the quality of bids currently in the frame, ofcials had incentives to pass on this information, to provoke bid improvement. Their role may have been

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analogous to that of the Walrasian auctioneer, spreading information about the current conguration of bids until equilibrium was reached. We coded the bid documents on various indicators of bid quality for almost all the bids submitted over four rounds from 1994/5 to 1997/8. We developed a composite index of bid quality, index, derived by standardizing and adding individual indicators. We could not directly observe what groups ideal bids were, nor did we have drafts of bid documents which would have enabled us directly to observe competition at work within a given round. We showed that round-byround improvements in index largely occurred at or below the median, not at the high-quality end of the distribution (John, Ward and Dowding, 2004; John and Ward, 2005). Assuming it took more than one round for competition to have its full effects, this is consistent with the idea that competition has less effect among bidders with high-quality ideal projects. Here we adopt a different empirical strategy. First, we now focus on bid value, not bid quality as in our previous work. Our measure of this is value = index/srbtot, where srbtot is the total SRB funding asked for. (Note bigger scores on value suggest higher value bids.) Theory suggests that under sequential funding bids will not get funded unless value is greater than some cut-off point. The amount of funding a bid obtained from the SRB process is total. If value is greater than the cut-off, total should be an increasing function of how much grant was requested, srbotot. The overall observed success rate of bids was around 54%. So we constructed a variable h46value that took on the value 0 if the value index was less than the 46th percentile point of the distribution by value and was equal to srbtot otherwise. Because many bids were not successful and total is censored below at zero, we used Tobit Regression. We controlled for the size of the regional budget in the round, rbudget, and the number of bids in the region/round, nobids. As shown in Table 2, h46value powerfully predicts the amount of funding bids received, which suggests that value is a reasonable proxy for what the funding agency was looking for. Second, we considered the impact of competition on bids that were resubmitted. The advantage of this is that for resubmitted bids we had a measure of how the value of that particular bid changed between rounds, whereas our previous method did not track the effects of competition on particular bids. We identied 43 bids that were resubmitted in subsequent rounds. This coding was based on the criteria that the aims of the bid and the main members of the bidding group were the same, identication being aided by comparing bid titles.5
5. We exclude a bid submitted in the rst and second rounds, entitled Safe in Tesside a very large, high-leverage outlier in models for the value of resubmitted bids. The very large increase in funding asked for between the rst and second rounds, from 63,000 to 1,743,000, suggests that a different and far more ambitious law-and-order-related project was resubmitted. If a dummy variable for this bid is included in the model, results are substantively the same as those reported.

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Table 2. Tobit Regression for Total Funding Obtained

Total h46value Nobids Rbudget Constant obs. Note. Absolute value of t statistics in parentheses signicant at 10%; signicant at 5%; signicant at 1% log likelihood = 6703.92 prob > 2 = 686.64 .633 (30.69) 47.6 (5.87) .00785 (2.82) 1048 (3.20) 1194

Although we cannot directly test our hypothesis we can test the related claim that resubmitted bids will show the greatest improvements in value if they were mid-range on value the rst time they were submitted: i) if the bid was of high value at time t, it could be expected to be competitive at time t + 1 without much improvement, conditional on a similar competitive environment in the next round; ii) if it was mid-range in value at t, it could be expected to face the strongest competition at time t + 1, requiring a bigger improvement to be competitive; iii) nally if it was low value at time t, the likelihood is it would not be competitive at time t + 1, so it would not be worth putting much extra effort in. Notice that our expectations about resubmitted bids follow if groups carry expectations over to the next round that parallel our hypothesis; so although our test is indirect, it seems appropriate, given the fact that we could not observe the process of competition within a round. Valuenext is the value of the resubmitted version of a bid, measured only for bids subject to the selection lter of being resubmitted. We hypothesise an inverted U-shaped relationship between this variable and value, which we tested for by including value and its square, valuesq as explanatory variables. To control for the competitive environment in the round the bid was resubmitted in which we included the average value of bids at t + 1, avaluenext, the budget of the region the bid was submitted to at t + 1, rbudgetnext, and the number of bids in the region concerned at t + 1, nobidsnext. To allow for the selection effect due to the fact only some bids were resubmitted we estimated a Heckman selection model. We examined a number of possible inuences on whether a bid was re-submitted, the most powerful of which proved to be shortfall, the difference between the amount of SRB funding that was asked for at time t, srbtot, and the amount the bid obtained, total. We tested for regional effects, based on interviews that suggested that some regions were more helpful than others when

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Table 3. Heckman Selection Model for the Value of Resubmitted Bids

(1) Selection Equation Valuesq avaluenext rbudgetnext shortfall East Constant .0000312 (3.47) .438 (2.07) 1.94 (24.19) obs. 1191 (1) Valuenext 5.14 (5.36) .244 (2.48) 3.26e-08 (2.73)

.0315 (3.80) uncensored obs. 43

Note: z statistics in parentheses signicant at 10%; signicant at 5%; signicant at 1% log likelihood = 25.05 rho = 0.91 prob > 2 = .023

bidding groups wanted to resubmit; and we found that the dummy variable for the Eastern Region, east, was signicant in selection models. In Table 3 the rst column contains the selection component of the Heckman model and the second the explanatory component. In column 2, valuesq has a highly signicant negative coefcient. When we added value to the model, its coefcient was nowhere near signicant. As the mean of value is .0163, the evidence is for a signicant inverted U-shaped relationship between value and valuenext centred at zero, near the mean of value. That is, bids of mid-range value at time t had the highest value when resubmitted at time t + 1. The competition variables behaved as expected, except that nobidsnext was insignicant and was dropped. The value of rho is 0.91, and the chi-square test indicates rho is signicantly different from 0, justifying the idea that it was important to allow for selection to avoid biased estimates. 5. Conclusion This article has developed a model to understand how an agency allocates a budget to a group of bidders and how these bidders strategies evolve. The main engine of our approach is that, given a list of bids is presented to the funding agency before it makes a choice, the agency uses a relatively efcient algorithm to pack its knapsack. Given this assumption, the theoretical results and

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simulations suggest that competition will be conned to groups whose ideal projects are neither too near what the funding agency wants nor too far away. Competition is at the margin, when much of the budget has already been allocated to groups with good ideal projects. Our simulations suggest that relatively high proportions of groups will get funding for their ideal projects. We test our model on a unique dataset of urban policy bids, where the results suggest that the SRB process did little to induce groups already inclined to provide high value to do any better. This is in line with theoretical expectations and supports the view that there are limits on gains to be made from introducing competition for grants, especially as transaction costs are often high and it cannot be guaranteed that the funding agency will act in the public interest. This is not to say that competition will fail to induce greater efciency among groups inclined to produce lower-quality projects. These ndings have implications for those wishing to develop specic models of public sector competition, for students of public administration seeking to understand the operation of such competitive processes, and for policy-makers themselves who wish to introduce competitive bidding schemes.

Appendix LEMMA 1: if @ is a pure strategy equilibrium, x0i xi for each group i whose bid is funded. Suppose to the contrary that for some group x0i > xi . As funding is sequential 0 for x00 i [xi , xi ), i would be able to make a bid which would receive at least as 0 much funding as its bid under @, given other groups strategies. As x00 i is nearer xi 0 given it receives the same funding or more, it is strictly better than xi , which contradicts the assumption that @ is an equilibrium. Hypothetically allocate funding sequentially to the ideal bids of groups according to their index numbers until for the c-th group it is not possible to fund that groups ideal bid. C + is the set of groups with x-ideal points xc . C is the set of groups whose with x-ideal points xc . LEMMA 2: if xg < xc r, g cannot be under competitive pressure in any purestrategy equilibrium @ in which no member of C + puts in a bid with a lower x-value than xc r. At most all members of C /g put in bids with lower x-values than xg in the equilibrium. Suppose they all did so. Given the x-values of their bids, as they could also get their ideal funding level under sequential, if their bids are part of equilibrium @ each must ask for its ideal amount. But this means that gs bid must be its ideal point: as no member of C + locates to gs left and all members

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of C-/g bid for their ideal level of funding, gs ideal bid will be funded under sequential funding. If only some members of C-/g put in bids with lower xvalues than xg , the argument still holds as gs ideal bid will be funded before the funding constraint bites under sequential funding. LEMMA 3: let f be the lowest-indexed group under competitive pressure in a pure-strategy equilibrium @. Let fs equilibrium bid be (x0f , y0f ). Then x0f < xf , so long as G > y1 . Suppose this were not the case. Then as f is under competitive pressure and x0f xf in equilibrium (Lemma 1), it must be the case that x0f = xf and y0f < yf . Suppose f = 1. Under sequential funding 1s bid is the rst to be considered, even if other groups locate at x1 , and 1 will get the amount it asks for so long as this is feasible. By assumption G > y1 . If 1 asks for y01 < y1, @ cannot be an equilibrium, then. So either x01 < x1 , or 1 is not the rst group under competitive pressure. Suppose the latter is the case. F is the set of groups with bids less than x0f in @. This set is non-empty as 1 is not the rst group under competitive pressure. In @ each group in F makes its ideal bid and gets funding, as none is under competitive pressure. Now suppose that x0f = xf , and f is only under competitive pressure because y0f < yf . Again this cannot be the case. Under sequential funding the rst bid considered for funding among the bids at xf will be f s, even if more than one bid is made at this x-value. It must be the case that F f C- because xf < xc and for each member of F , say g, xg < xf . Therefore the amount already allocated to members of F plus yf must be less than or equal to G, since G is large enough to fund all the ideal bids of members of C . Hence if x0f = xf and y0f < yf , fs bid cannot be a best response and @ is not an equilibrium: f could ask for yf and get it under sequential funding. THEOREM 1: @ is not among the subset of pure strategy equilibria that is Pareto efcient if there exists some group g such that xg < xc r which is under competitive pressure, so long as G > y1 . If f is under competitive pressure in @ the set of groups, F , such that their bids have the same x-value as fs must be non-empty, or else f could put in a bid for the same amount but a higher x-value, nearer its ideal point, get the bid funded and obtain a higher bid payoff (Lemma 2). Divide F into subsets F 1; F 2 containing groups putting in token bids and groups putting in funded bids with ideal points at higher x-values than x0f . (Recall that groups never put in funded bids with higher x-values than their ideal point in equilibrium, by Lemma 1.) Let the next bid(s) to the right of x0f in @ be located at x0f + . Now consider an alternative set of strategies @0 which differs from those in @ only in that f and the members of F 1 and F 2 put in bids for the same amount as under @ but this time at x0f + ,

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> 0; x0f + < x0f + . For small-enough , we show that @0 is an equilibrium if @ is an equilibrium. F is the set of groups with bids less than x0f in @. By construction they bid their ideal points in @ and @0 and these bids get funded under sequential funding, so they cannot strictly increase their payoffs by switching strategy in @0 . F + is the set of groups with bids with x-values greater than x0f in @. We need only consider whether members of F + would get a higher payoff for some bid on the interval [x0f , x0f + ] rather than in their assumed position in @0 : given the strategies of the other groups, for any position outside this interval their payoff, contingent on the amount of funds asked for, is exactly the same as in @, because funding is sequential and the rank order of bids on the x-dimension is the same; and groups in F + cannot strictly increase their payoff by moving to any such position in equilibrium @. First consider any group j in the set F + C +. By Lemma 3 x0f < xf , xf < xc r, and xj xc ; so can be chosen such that x0f + < xj r. Thus for small enough the most that j can make by relocating in the interval [x0f , x0f + ] is the payoff associated with a token bid, for any bid there that obtained funding would have a negative bid payoff. Group js payoff in @0 is the same as their payoff in @: as x0f + < x0f + and funding is sequential, the same amount is divided among the members of F + in @0 as in @; and as their bids are the same, so must their payoffs be the same. As @ is assumed to be an equilibrium, no group can get less than its payoff from a token bid with zero bid payoff, because they can guarantee this amount by making a token bid. Thus no j in the set F + C + can strictly increase its payoff by relocating in the interval [xf 0 , xf 0 + ], so long as is small enough, because it would receive a maximum of its bid payoff, which is less than or equal to its current payoff. Next consider any group in the set F + C : The payoff of each such group, say j, is the same in both @ and @0 . By assumption group j is making the same bid in each case. As x0f + < x0f + and x0j x0f + and each group is asking for the same amount in both @ and @0 , the amount that has yet to be allocated when js bid is considered under sequential funding is the same in both cases; so js payoff is the same. We show that the funding j asks for in @ must be yj the level that corresponds to its ideal bid. By denition of the set C , yj Gj C that is, each member of C can be funded up to its ideal level of bidding, so long as no other bid is funded rst under sequential bidding made by groups outside C and no member of the set C asks for more than its ideal level of funding. Any group in the set F + C + that makes a bid with an x-value lower than xc r, that might be considered before js bid, must be making a token bid that gets no funding, otherwise its bid payoff would be negative. Conditional on the x-value of its bid, the level of funding that maximizes a groups payoff is always that corresponding to its ideal bid. Thus no member of C that is considered for

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funding before j asks for more than this amount. Thus when it is the turn of js bid to be considered j can feasibly ask for yj , and this maximizes its payoff conditional on the x-value of its bid. By making a bid in the interval [x0f , x0f + ] rather than its assumed bid in @0 , j might feasibly have access to more funding than the amount it already gets, yj , because its bid might be considered earlier under sequential funding as it would be at or to the left of those of f, and groups in F 1 and F 2. But it would not be optimal to ask for more than yj . Any such bid would be for yj , otherwise j could increase its payoff conditional on the x-value of the bid, and it would be funded for this amount under sequential funding. As @ is an equilibrium, x0j xj (Lemma 1); so by moving into the interval [x0f , x0f + ] j would be moving further away from its ideal point parallel to the x-axis and would get the same level of funding. But this means its payoff would be lower if it made this move. So if @ is an equilibrium, no group in the set member of the set F + C would have an incentive to switch strategy into the interval [x0f , x0f + ] in @0 . To show that @0 is an equilibrium it remains to prove that neither f, nor any groups in F 1 and F 2 have any incentive to change strategy. We only need consider whether it pays any such group to change its strategy under @0 by locating in the interval [x0f , x0f + since the payoffs of such groups are the same in @ and in @0 for any other move they can make and, as @ is an equilibrium, it cannot strictly increase groups payoffs to relocate outside this interval as their payoffs in @0 are greater than or equal to those in @. Group j in F 1 makes a token bid. If in equilibrium @ it cannot move further to the left to obtain more funding, by being considered earlier under sequential funding, and remain with a radius r of its ideal point, for small enough this will still hold in @0 . The feasible level of funding nearest to yj available to j in @ if it moves just to the left of x0f is the same that is obtainable in @0 on the interval [x0f , x0f + ; and if x0f is too far from js ideal measured along the x-axis for the bid to be made with a positive bid payoff just to the left of x0f , the same will be true for bids on the interval for small enough , since x0f + will still be too far from js ideal point along the x-axis. Now consider a group j in f F 2. Suppose, rst, that in equilibrium @ j gets less than yj units of funding. The next bid below those located at x0f , if any, is that of group (f 1) located at its ideal point. If j is located anywhere on the interval (xf 1 , x0f 0 ), or on the interval [0, x0f 0 ) if f = 1, the maximum feasible amount of funding it could obtain is the same under sequential funding. Suppose this was yj + > y0j . Then @ could not be an equilibrium: just to the left of x0f j could put in a bid for an amount nearer its optimal level of funding that would be nearer its ideal point. Thus on the interval (xf 1 , x0f ) the most j can obtain in funding must be y0j . Now consider @0 . So long as x0f + < x0f + , the most j can obtain on the interval [xf 00 , xf 0 + in @0 is the same as the most it can obtain on the interval it (xf 1 , x0f 0 ) in @, which is to say y0j as @ is an equilibrium. But this means that it will not pay for j to relocate on the interval [x0f , x0f + in @0 , so

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long as is small enough: by moving in this way it can only obtain the same amount of funding as from its strategy in @0 , but it moves further away from its ideal point measured along the x-dimension, so long as xj > x0f + . Group f is chosen to be the group with the lowest index number that is under competitive pressure. By Lemma 3 x0f < xf and xf xj , or else j would be the group with the lowest index number under competitive pressure; so we can chose small enough to ensure that x0f + < xj . Finally suppose that in @ j gets yj units of funding. Then in @0 j also gets yj 0 units of funding. On the interval [x00 f , xf + j might feasibly be able to obtain more than this, but it would have no incentive to do so. As x0f < xf (Lemma 3) and xf xj , for small enough , x0f + < xj . To move into the interval [x00 f, x0f + would be to move further away from its ideal point relative to the xdimension and there would be no advantage in terms of extra funding. Hence j cannot strictly increase its payoff by making such a move. We have shown that by choosing a small enough value of it is possible to ensure that @0 is an equilibrium if @ is an equilibrium. Moreover @0 is a Pareto improvement on @. Apart from f and any groups in F 2, the payoff of all groups are the same in each case. Group f and any groups in F 2 get the same level of funding but, for small enough , x0f + is nearer to their ideal point than x0f measured along the x-dimension, as x0f < xf < xj for any j F 2 (Lemma 3). Therefore it cannot be the case that any group g such that xg < xc r is under competitive pressure and @ is a Pareto optimal equilibrium, for under these assumptions it is possible to construct an alternative equilibrium no worse for any group and strictly better for at least one group. REFERENCES
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John, Peter, Hugh Ward and Keith Dowding (2004) The Bidding Game: Competitive Funding Regimes and the Political Targeting of Urban Programme Schemes, British Journal of Political Science 34: 40528. John, Peter and Hugh Ward (2005) How Competitive Is Competitive Bidding? The Case of the Single Regeneration Budget Program Journal of Public Administration Research and Theory 15: 7187. Lane, Jan-Eric (2001) From Long-term to Short-term Contracting, Public Administration 79: 2947. Martello, Silvano and Paulo Toth (1990) Knapsack Problems: Algorithms and Computer Implementations. New York: Wiley. Menezes, Flavio M. and Paulo K. Monteiro (2005) An Introduction to Auction Theory. Oxford: Oxford University Press. Milgrom, Paul R. (2004) Putting Auction Theory to Work. Cambridge: Cambridge University Press. Oatley, Nick (1998) Cities, economic competition and urban policy, in Nick Oatley (ed.), Cities, Economic Competition and Urban Policy. London: Paul Chapman. Pesendorfer, Martin (2000) A Study of Collusion in First-Price Auctions, Review of Economic Studies 67: 381411. Robinson, Marc (2000) Contract Budgeting, Public Administration 78: 7590. Rothkopf, Michael H. and Ronald M. Harstad (1994) Modelling Competitive Bidding: A Critical Essay, Management Science 40: 36484. Stewart, Murray (1994) Between Whitehall and Town Hall: The Realignment of Urban Regeneration Policy in England, Policy and Politics 22: 13346. Taylor, Peter, Ivan Turok, and Annette Hastings (2001) Competitive Bidding in Urban Regeneration: Stimulus or Disillusionment for Losers, Environment and Planning C 19: 4563. Walsh, Kieron (1994) Public Services and Market Mechanisms. Basingstoke: Macmillan. Ward, Kieron (1997) Coalitions in Urban Regeneration: A Regime Approach, Environment and Planning A 29: 14931506.

HUGH WARD teaches in the Department of Government at the University of Essex. His current research interests include international environmental politics, international conict, and social choice theory. He is co-editor of the British Journal of Political Science. E-mail hugh@essex.ac.uk. PETER JOHN holds the Hallsworth Chair of Governance and is Director of the Institute of Political and Economic Governance at the University of Manchester. His main research interests are urban politics and policy, public policy theory, social capital, and participation. E-mail Peter.John@ manchester.ac.uk.

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