Discretion and Favoritism in Public Procurement

Abstract This paper investigates the consequences of bureaucratic discretion in public procurement. I exploit a Hungarian policy reform, which allows a “high-discretion” procedure below a certain contract value. At the threshold, I document large discontinuities both in procurement outcomes and in the density of contract values, which indicates that buyers manipulate contract values to avoid auctions. I combine the reform and a structural model to find that discretion increases prices and results in the selection of less productive contractors. I also show that high discretion benefits firms with connections to the party of the central government. I use the structural model to document that public buyers are willing to sacrifice more contract value to increase their discretion if more connected firms are operating in the market. I also use the model to simulate the effects of counterfactual procurement thresholds on different procurement outcomes.