Thursday, July 13, 2006

Trends in Corruption in Public Works Projects: Is the "Big Dig Disaster" an Anomaly?

Two leading Economic Historians wrote an important "long run trends" paper that is relevant for thinking about the recent Boston Big Dig construction problems. Engerman and Sokoloff examined cost over-runs in major public works projects over a long time period. To my surprise, % cost over-runs have increased over time.

I had thought that "muckraker" press would now do a better job monitoring the public sector to provide public goods more efficiently. This is an interesting case of asymmetric information. If for profit firms can sell cheap low quality cement for the project at a high price and not get caught, then the overall quality of such projects will be low. It is possible that the modern public works project is so complicated (such as the Big Dig) that the journalists cannot possibly monitor the contractors and would get roughed up if they really tried. Complexity increases monitoring costs and exacerbates the principal-agent problem.

So to return to the Big Dig, was the recent disaster just "bad luck" that took place on a high quality project or is this a classic case of shoddy government services due to fundamental contracting problems in the face of high monitoring costs?

Digging the Dirt at Public Expense: Governance in the Building of the Erie Canal and Other Public Works

Stanley Engerman, Kenneth L. Sokoloff

NBER Working Paper No. 10965
Issued in December 2004
NBER Program(s): DAE

---- Abstract -----

The Erie Canal was a mammoth public works project undertaken largely because the scope of the investment was beyond what a private firm could manage during the early 19th century. As with most public works, there were ample opportunities for public officials to realize private gains from the effort, and many did. On the whole, however, the construction of the Erie Canal (and most other major public works projects of the era) appears to have been well conceived and executed; it not only paid off more than its costs through tolls, but also generated substantial welfare improvements for the residents of the state of New York in the form of producer and consumer surplus and a wide range of positive externalities. Although there was obviously some fraud and mismanagement, the public authorities carried out the work at costs relatively close to those projected at the point of authorization. In an effort to try to place this episode in a broader perspective, we compare the ratio of actual expenditures on construction relative to the estimated costs at the time of authorization for the Erie Canal, to those for a range of other public works over American history up to the present day. It is our contention that this measure, albeit quite narrow in focus, is informative about the quality of governance of public resources. We highlight how, by this standard, the governance of public resources during the canal era stands up well in comparison with what we have seen since. Indeed, the cost overrun ratios have risen sharply over the last half-century, coinciding with both a marked increase in the relative size of the government sector as well as sustained economic growth. These patterns suggest how important it is that better measures and other means of systematically studying how the prevalence and effects of corruption vary across different contexts be developed.