Inflation is ganging up with long-standing problems in our contracting and procurement systems to stifle construction, innovation and ultimately our economic future.
While the Reserve Bank fights inflation, the government must lead reform in procurement practices, with the aim of ensuring that more potential contractors can bid for major projects. Indeed, this period of exceptional difficulty for project contracting should be the motivation for addressing inefficiencies in contracting that have damped construction activity for too long.
High inflation is not merely making life uncomfortable for people generally. It is also shifting investment dynamics, potentially damaging economic performance and competitiveness. The 40 percent surge in construction costs since the onset of the Covid-19 pandemic has dire implications for public and private sector investment. It threatens our infrastructure projects and thereby robs us of productivity gains and economic growth.
The problem is acute in northern Australia, where construction costs have always been high and in the past few years have risen even faster than in the rest of the country.
Inflation that outstrips growth in public finances diminishes the government’s ability to fund crucial infrastructure projects. Meanwhile, private industry, wary of somewhat unpredictable cost rises, must set higher elevated return thresholds, leading it to shy away from investment.
This not only slows or prevents construction of facilities but also stifles economic growth. If infrastructure isn’t built, industries that need it won’t expand.
This relatively recent inflation problem is overlayed on the stifling effect of long-standing contracting practices and procurement systems.
Consider the example of government contracts. Often, governments engage architects and engineers to create detailed project designs then, in the tender phase, require contractors to warrant the buildability of the designs. This unreasonably gives bidders only a few weeks to evaluate a year’s worth of design work.
The result? Many bidders inflate their prices to account for the uncertain risks; other companies simply choose not to bid. The result is less competition, which, in turn, drives prices higher, adding to inflation.
Prerequisites imposed on contractors can also diminish competition. For instance, mandating unusually high levels of professional indemnity insurance may deter smaller subcontractors from participating in a project, again leading to fewer bids and higher costs. Punitive liquidated damages clauses further add to the financial burden and, again, compels bidders either to raise their pricing or withdraw from the tender process.
The loss of competition has another effect: firms under less market pressure are less likely to innovate. And absence of small firms from projects is particularly damaging, because they are the greatest source of innovation.
The complexities of the US Department of Defense’s contracting approach add yet another layer to this challenge. By favouring US firms and imposing compliance requirements that align with American requirements for lodging bonds to guarantee work they effectively shut many Australian companies out of lucrative opportunities. This not only limits the competitive field but also constricts the available talent pool, ultimately compromising the quality and efficiency of public works.
Yet there is an opportunity here. The extraordinary additional stress on the major-projects sector created by high inflation should create the motivation for us to now reassess and refine contracting practices. A strong effort from the federal government to understand and mitigate the hidden costs associated with specific contractual clauses could revitalise competition, help mitigate immediate inflation and create permanent efficiencies.
Moreover, by fostering an environment where a diverse range of contractors can compete, we may very well stimulate innovation.
We need decisive leadership from policymakers. The Australian government must actively engage industry stakeholders in a dialogue about these issues, prioritising transparency and flexibility in contracting practices. This means re-evaluating the criteria that determine bidder’s eligibility for projects and making necessary adjustments to ensure that more companies—especially smaller, innovative firms—can be involved.
Moreover, procurement processes should be streamlined to reduce the burdensome requirements that deter participation. By creating a more inclusive framework, we can not only enhance competition but also better position Australia for long-term economic growth.