How do cartels work? Dealmaking at Lebanon’s Council for Development and Reconstruction

/Mounir Mahmalat,Wassim Maktabi- Policy Initiative/

While power-sharing arrangements are powerful tools to appease conflict, they come at a price. To make powerful elites stop their guns, they must gain larger economic and political benefits from an arrangement than from continuing violent conflict. Elites thereby tend to capture valuable functions of the state as spoils of truce and divert profits from these functions in the form of rents to their own benefit.

Lebanon’s infrastructure procurement is a prominent point in case. In the absence of extractable natural resources, elites had to identify other valuable resources to distribute. Government contracts to build bridges, highways, and (unused) wastewater treatment plants appeared to be a lucrative way to profit from a power-sharing arrangement in a country that needed extensive reconstruction after a long civil war. With billions of dollars provided by foreign donors and creditors, political elites wouldn’t even have to tap their own resource pool. They would only need to ensure that resources remain within their realm of influence. Companies with close and trusted board members or CEOs would receive contracts that they would not win otherwise, that would be more costly than they should be, or would exhibit excessive provisions for overspending, allowing politicians to receive kickback payments or other forms of support. 

Thus far, the story is public knowledge. However, procurement might be one of the most standardized and best-controlled functions of a state. In Lebanon, the Council for Development and Reconstruction (CDR) – an autonomous public agency founded in 1977 with the objective of directing postwar reconstruction efforts –is responsible for the largest part of infrastructure procurement. With its (formerly) well-paid engineers and technocrats, CDR handles a complex tendering, implementation, and supervision process closely scrutinized internally as well as externally by donors and creditors. Bids are evaluated in a transparent assessment procedure, while supervision takes place with the help of the best firms in the region. From what is generally a well-functioning institution that has handled hundreds of complex projects in a politically volatile environment, surprisingly little hard evidence of corruption has emerged beyond anecdotes.

How, then, do elites succeed in generating rents from an institution such as CDR?

A recent study by The Policy Initiative, supported by the Konrad Adenauer Foundation in Beirut, sheds light on how rent generation works. For this study, we identified the political connections of all firms involved in any of CDR’s 394 infrastructure procurement contracts between 2008 and 2018 through interviews with key informants and by systematically analyzing media sources. While this includes the contractors that are responsible for executing a project on behalf of CDR, we focus on design and supervision consultants. Responsible for specifying the parameters of a project, writing the terms of references, evaluating bids and being the CDR’s “eyes on the ground,” consultants are the “masters of the game” and do “everything but management” on behalf of CDR, to use the words of politicians and engineers we interviewed for this study.

We find that design consultants serve as the lynchpins of the cartel. We show that only those contracts are overpriced or overspent that have been designed by a consultant that is politically connected. However, not all political connections matter. Contracts get inflated and costs overrun only when the firms involved are connected to the small group of politicians that control the CDR’s board (either board members or the small group of politicians who have nominated the board). Certainly, other contracts can still be affected by some form of corruption, but not in a systematic manner.

These details provide important hints about how rent generation works, namely via organized networks, or cartels. Design consultants reduce what can be labeled as searching costs – that is, the effort and risks elites have to take to find suitable partners for a corrupt deal.

This is crucial as not everybody can be trusted and defections from a cartel can have unpredictable consequences for all other players. With instructions from elites, designers know which firm should win a bid and can “tailor” tender documents, exclude other bidders, or facilitate the exchange of information among bidders to let them know the “correct” prices to submit. This exchange of information, however, only works with equally connected contractors that CDR board members and political elites can trust.

But why shouldn’t unconnected firms be able to break the dominance of connected consultants with lower prices or higher qualifications? The trick here is that elites kept the circle of firms eligible to bid small. For many tenders, the contracts for designers were not open to competition. Only selected designers were invited to bid under the pretext of facilitating the administration and making sure that the most qualified designer win the contract. While the principle is useful and common practice in other countries, the board of CDR abused this discretionary power. By making sure that contracts are designed by a small group of connected and trusted consultants, elites retained influence over crucial project parameters.

The quality argument, then, falls apart when investigating which contracts are more likely to be overspent and have larger cost overruns. While individual level corruption on a project level is certainly common in Lebanon as in any other country, contracts are generally not more likely to be overspent. Only a subset of contracts is more likely to be overspent and has larger cost overruns, namely those that are designed by a politically-connected design consultant. In a world absent of cartels, “better” firms should not be expected to deliver lower quality project designs that require excessive variation orders or claims. 

Lebanon’s political elites are certainly powerful actors. But maintaining such networks to undermine a task as differentiated as infrastructure procurement is extremely complex and all but trivial to keep undetected. How can such cartels sustain for decades and survive Lebanon’s ubiquitous political turmoil?

The answer lies in the long-time horizons of both CDR’s board members and their political protégés. All actors knew that they would remain in their positions of power when time comes to honor commitments and “make up” for favors. Not only have elites in their roles of party leaders stayed in power unabated over the period of our investigation, but the CDR’s board too has remained almost unchanged since 2006 until very recently. In 2009, the government of Fouad Siniora issued a decree that extended the mandate of the board members at the time “until the nomination of a new board,” thus invalidating the CDR’s establishment decree stating that board members should be changed every five years. Long-time horizons provided the facilitating condition based on which deals could be honored in deferred reciprocity. Elites leveraged their control over the institution to ensure that risks and concessions taken by one firm today would be “made up” tomorrow.

The costs incurred by this scheme were significant. We estimate that contracts have been overpriced by about 34% whenever a connected designer-contractor pair was at work. Over the period from 2008 to 2018, this resulted in excess costs of contracts of roughly $160 million – and this doesn’t even include cost overruns which evade estimations. 

So, what can be done? Lebanon’s dilapidated infrastructure must be overhauled if the country was to emerge from the current crises. As an experienced investment agency, CDR will have to play a central role in this regard. Without addressing the operations of cartels, however, plans like the 2018 Capital Investment Plan will provide ample opportunities for elites to collude and for millions to be squandered.

The World Bank exemplifies how risks of collusion can be minimized. For instance, the World Bank required CDR to forego lists of eligible bidders and to open up competition among all firms willing to bid, thereby significantly increasing searching costs for elites. According to our estimates, contracts funded by the World Bank were not systematically affected by overpricing. 

This example provides clues for what can be done. First, the dominant status of a small group of connected consultants and contractors should be broken by increasing competition among firms. The new procurement law, elaborated with technical support of the World Bank, the Institute des Finances Basil Fuleihan and others, provides a crucial step forward in this regard as it limits or abrogates the use of such lists and distributes the responsibilities for procurement contracts among a wider set of institutions. And second, CDR’s board must be augmented to its originally intended size and go back to a rotation scheme. No group of technocrats, no matter how well-intentioned and qualified, can withstand the sustained grip of political influence for too long.

https://www.thepolicyinitiative.org/article/details/194/how-do-cartels-work-dealmaking-at-lebanon%E2%80%99s-council-for-development-and-reconstruction?lang=en&src=init

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