Multi Outcome Construction Policy (final report)

Literature ReviewEconomic Perspectives 11As could be expected, the theoretical literature in economics on the specific topic of theeffects of the above types of policies on construction projects is very limited. However, anumber of economic studies have developed frameworks and engage in analyses thathave some application to the issues under consideration. In the economics literature thesepapers are generally associated with applications of microeconomic concepts, especiallythose relating to what is known as principal-agent or contract theory analysis.Principal-agent analysis is an economic framework that can be applied to the contractualrelationship between a public-sector works agency and their ‘agents’ (e.g. a constructioncompany). As is typical of most microeconomic theory, this framework begins by settingout the objective functions of the two sets of players. For example, the works agency isassumed to aim for the maximum possible net social benefit from its projects, whilst theconstruction company is assumed to aim for maximum profits. Principal-agent analysisthen directs attention to the circumstances which can cause contracts to be ‘incomplete’and, as a consequence, fail to realize the maximum possible payoff, especially in terms ofnet social benefits.A particularly important aspect of this type of analysis relates to the difficultiesencountered in designing a contract that fully specifies all the required quantity andquality outcomes. As is elaborated on in the papers surveyed below, these problems cancause additional monitoring and transaction costs, encourage strategic, anti-competitivebehaviour, and, generally, result in a failure to realize potential social benefits.The work of Harvard economist Oliver Hart is highlighted in the first part of thisliterature review. He appears to be one of the few economic analysts who thus far have11 A technical version of this section is included in Section X.23