Sir James Mirrlees, Asymmetric Information, Dodgy Cars and Government Procurement Problems

Professor Sir James Mirrlees died last week at the age of 82.

That may not grab your attention, but as well as being a very distinguished Scottish economist, a Nobel Prize winner no less, his work should be known and understood by every procurement professional.

His work that won the big prize was in the field of “information asymmetry”, about making transactions with imperfect knowledge, but he was also influential in other fields including tax policy and investment in developing countries. But those issues around what happens when one party in a transaction – usually the buyer or the seller – knows more about what is being sold than the other, is critical for the world of procurement too.

Mirrlees applied this particularly to taxation in his Nobel-winning work, where the government knows less about the behaviour and motivation of the people it is taxing than they do. But many of the principles apply elsewhere. In a consumer example, it explains why buying a second-hand car is so stressful and risky. The seller always knows far more about the vehicle, how it has been looked after and how reliable it has been, than the buyer.

In the B2B world, it highlights the importance of understanding as well as possible what we are buying, particularly expensive and “one-off” type purchases, whether it is a major piece of capital equipment or a significant consulting or IT integration services contract. In these cases, the seller starts from a position of understanding what we might buy much better than we do as buyers, which means the transaction is imperfect and there is a danger that we get ripped off (putting it in non-Nobel prize-winning language!).

But it’s interesting to note that we have seen recent examples where arguably the asymmetry has worked in the other direction. The problems we have seen in major UK public sector contracts have in some cases been driven by the seller not understanding well enough what they were committing to in the contract. We can think of the recent NHS Primary Care back-office services contract, where Capita’s MD admitted that they didn’t really understand what they were taking on.

Or consider the case of Serco and the asylum seekers contract we reported on here. Now in these cases we might argue that the public sector buyer didn’t understand things much better, but any asymmetry probably applied in the buyer's favour in that they did know a little more than the poor old service provider.

And in cases like these, the result is often unsatisfactory for everyone. The supplier loses money, and often struggles with service too, or both parties end up in an acrimonious re-negotiation of the contract. Indeed, another Nobel winning economist, George Kerlof demonstrated that it is even possible in cases of extreme asymmetry for a market to "decay to the point of nonexistence". Might we be getting close to that point for major outsourced service contracts in government, I wonder?

But back to the main point – procurement needs to be aware of the dangers of information asymmetry and take steps to minimise it when it is working against the buyer. And do read more about Sir James – starting from very humble beginnings, his was a life well-lived, he did very useful work in the developing world, was apparently a “thoroughly nice man”, and has left his mark on the world in a very positive manner.

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