The make vs. buy decision of the union government

by Aneesha Chitgupi and Susan Thomas.

Introduction

Like every organisation, the government faces the question of make vs. buy in carrying out its functions. Should it recruit people, and take on management responsibilities of directly making goods/services? Should it enter into contracts with private persons who already specialise in this production? Each choice has a different cost when using public funds. Managers in government face a Markup in State Production, which is the inefficiency of the state in direct production, and the state has to deal with a Markup in State Contracting, which is its inefficiency when contracting for procurement (Kelkar and Shah, 2022).

This question needs to be set in some basic facts. How large are the magnitudes of make vs. buy in the Indian state? Over the years, is there a bias towards producing goods/services in-house? Is there a process of growing maturation where the buy ratio is going up, or have the spate of difficulties in government contracting of the recent decade led to a certain retreat from buy in favour of make? In this article, we collect evidence for the union government, to offer some answers to these questions.

Methodology and data constraints

We use the methodology in Sharma and Thomas (2021) to estimate what the Union Government spends on procurement in a year. This uses the annual statement of accounts (Accounts at a glance) published by Controller General of Accounts (CGA). The books of accounts of government follows cash based system, recording only cash transactions (as opposed to accrual based system where transactions are recorded upon becoming payable).

The calculation of what was spent on procurement uses the expenditure under various ``object heads''. This is only feasible from 2015-16 onwards, when the CGA started disclosing expenditure under object heads in their annual reports. In the work presented here, we undertake this measurement from 2015-16 upto 2019-20. We ensure comparability by converting nominal values to real using the CPI.

Our calculations differ from the methodology employed by Sharma and Thomas (2021) on three counts:

1. We only report the procurement expenditure of the Union Government, which includes only the expenditure under its ministries. We do not include expenditure in Central Public Sector Enterprises (CPSEs), which accounted for 3.5x the procurement of the entire Union Government.
2. We calculate procurement expenditure for the Railways Ministry using a combination of its annual reports and the capital expenditure reported in the CGA annual reports for the Ministry.
3. We include only those items that can be unambiguously classified as procurement for the Union Government.

Results

Figure 1 shows the real actual spending of the Union Government for 2015-16 to 2019-20. The fraction of procurement spending has been quite stable at around 17-18 percent of the total expenditure. The remaining 82-83 percent of budget each year is spent on salaries and pensions and payments in the form of Grants-in-Aid, which are about 20-25 percent of the budget each year.

 

Figure 1: Union Government spending, with fraction of total procurement, inflation adjusted, 2015-2019

Figure 2: Union Government procurement expenditure, with fractions of capital and revenue, inflation adjusted, 2015-2019

 

 

 

Source for both figures: Annual statement of accounts by CGA, Annual report of the Indian Railways, and authors' calculation.

While the share of procurement within total expenditure has been stable, there is a small shift in the composition of Union Government procurement. In Figure 2, we see that share of capital in total procurement increased from 53.7 percent to 57.5 percent between 2015-16 to 2019-20.

Table 1: Changes in share of total and procurement expenditure of Union Government as GDP (in %), 2015-2019

	Total expenditure	Procurement expenditure	Capital procurement
	/ GDP	/ GDP	/ GDP
2015-16	14.36	2.42	1.30
2016-17	14.37	2.50	1.38
2017-18	13.92	2.37	1.31
2018-19	13.55	2.40	1.39
2019-20	14.23	2.39	1.37

Source: Annual statement of accounts by CGA, annual reports of Indian Railways and authors' calculation.

How have these changed as a share of overall GDP? Table 1 shows that these fractions tend to be stable, whether it is the total spending by govt, or the spending on procurement or on capital procurement spending. There are some changes during 2017-18. This is likely a result of lack of maneuverability to reduce revenue expenditure, and an emphasis on items such as subsidies (RBI, 2020).

Discussion

Government contracting is a critical part of state capacity that influences how the government chooses between make or buy in providing public goods. Given the more intractable problems faced by the Indian state in its attempts at recruiting people and producing internally, the possibility of contracting out to private firms is appealing. In the best examples, capabilities in public procurement have fostered innovation. But, this requires state capacity in government contracting. The evidence in India points to weak capacity in government contracting. Whether it is high levels of public litigation at courts (Mehta and Thomas, 2022; Damle et al, 2021), increasing levels of delayed payments at PSEs to vendors (Manivannan and Zaveri-Shah, 2019) and delays in project completion (Burman and Manivannan, 2022). Private parties are increasingly withdrawing from contracting with state (Mehta and Uday, 2021). This hampers purchase by the state as there is an inferior landscape of potential sellers.

A strategy of procurement reform could potentially put the Indian state on a path to higher capacity. The foundations of the field, of procurement reforms, lies in establishing basic facts:

1. How large are the magnitudes of make vs. buy in the Indian state? About 17% of the expenses of the union government work through buy, the remainder work through make.

2. Is the buy ratio something that is stable or does it fluctuate from year to year? The buy ratio is remarkably stable; it changes very little from year to year.

3. Is there a process of growing maturation where the buy ratio is going up? Or alternatively, have the spate of difficulties in government contracting of the recent decade led to a certain retreat from buy in favour of make? The buy ratio is highly stable; it shows no time trend. What has changed is a small shift towards a increasing spending for capital procurement.

This shows that, in real terms, the allocation between the make vs. buy choice of the union government has remained the same. But there has been a rise in the share of capital procurement spending. This tends to involve spending in projects with longer maturity, with greater risks to the project during the contract implementation and management phase being the underlying driver for procurement failure. Bottlenecks to resolving problems in this stage of procurement will become an important area to focus on as the government reforms public procurement rules and processes.

References

Vijay Kelkar and Ajay Shah. In service of the republic: The art and science of public policy. Second edition, 2022, forthcoming.

Pavithra Manivannan and Bhargavi Zaveri. How large is the payment delays problem in Indian public procurement?. The Leap Blog. 22 March 2021.

Charmi Mehta and Susan Thomas. Identifying roadblocks in highway contracting: lessons from NHAI litigation. The Leap Blog. 13 July 2022.

Devendra Damle, Karan Gulati, Anjali Sharma and Bhargavi Zaveri. Litigation in public contract: some estimates from court data. The Leap Blog. 26 May 2021.

Pavithra Manivannan and Bhargavi Zaveri. How large is the payment delays problem in Indian public procurement?. The Leap Blog. 29 March 2022.

Perun. Defence economics, and the U.S. production advantage, YouTube, 31 July 2022.

Charmi Mehta and Diya Uday. How competitive is bidding in infrastructure public procurement? A study of road and water projects in five Indian states. The Leap Blog. 22 March 2021.

Anirudh Burman and Pavithra Manivannan. Timeliness in government contracting: Evidence from the country's largest metro-rail network. The Leap Blog. 12 August 2022.

Anjali Sharma and Susan Thomas. The footprint of union government procurement in India. XKDR Working Paper 10, November 2021.

Aneesha Chitgupi is a Research Fellow at XKDR Forum, and Susan Thomas is a Researcher at XKDR Forum. We thank Abhishek Gorsi for excellent research assistance, Josh Felman, Sudha Krishnan, Anjali Sharma and Ajay Shah for their inputs and comments.