MANAGING FEDERAL

INFORMATION RESOURCES

SECOND ANNUAL REPORT

UNDER THE

PAPERWORK REDUCTION ACT OF 1980

OFFICE OF MANAGEMENT AND BUDGET

APRIL 1983

INCENTIVES FOR

EFFICIENT INFORMATION

RESOURCES MANAGEMENT

A Supplemental Report to

Managing Federal Information Resources,

Second Annual Report to Congress

under the Paperwork Reduction Act of 1980

Office of Information and

Regulatory Affairs

Office of Management and Budget

October 1983

INCENTIVES FOR

EFFICIENT INFORMATION

RESOURCES 14ANAGEMENT

CHAPTER ONE INTRODUCTION

CHAPTER TWO PRICING INFORMATION PRODUCTS

Cost Recovery Principles

User Fee Strategies (in part)

CHAPTER THREE PLANNING AND MANAGING INFORMATION

TECHNOLOGY

Telecommunications Planning:

Incentives for Efficient

Decisions

Managing Information Technology

CHAPTER FOUR IMPLEMENTING IMPROVED MANAGEMENT

INCENTIVES

APPENDIX A A DECISION RULE FOR IMPROVING

MANAGEMENT INCENTIVES

The following is an extract from Chapter 1, part of Chapter 2 and the remainder of the report.

CHAPTER I

INTRODUCTION

The Federal government is the largest producer, consumer, and regulator of information in American society. Aside from financial transfers and national defense, the provision of information to and from the government is the most important relationship between the private and public sectors.

Because of government's pervasive role, the management of information is a dominating and perennial problem to government itself. Information is a tool for managing the government's activities. It is also a commodity with economic value in the marketplace. It has societal value in providing citizens with knowledge of their society. Government policies can speed or impede the growth of information technology and thus help or hinder governmental functions as well as the burgeoning information industry. (National Commission on Libraries and Information Science, 1982)

The Paperwork Reduction Act of 1980 requires the Office of Management and Budget (OMB), together with senior officials in Federal agencies, to assume a unified responsibility for management of information resources. OMB discharges its statutory responsibilities under the Act in ways described in its annual report to Congress (office of Management and Budget, 1983). In addition, OMB has focused attention particularly on the role that incentives might play in management of information resources. This supplemental report examines the use of incentives in planning and managing information technology.

Management incentives are important for planning the allocation of common-user resources as, for example, centralized computer facilities. When many agencies of government or many subunits within agencies utilize information resources in common, principles must be developed which will ensure efficient resource usage. In the typical governmental setting, the policy principles are developed by senior management on the basis of a "priority user" scheme and administered from the top down. The perspective presented in this report describes bottom-up incentive mechanisms which constrain agencies to take into account the opportunity costs that their actions and choices impose on other agencies. These mechanisms encourage agencies to assess how their behavior has immediate impact upon their resources.

Examples of decisions to which management incentives mechanisms might be applied include:

Decisions on whether to acquire dedicated telecommunications facilities to be shared by numerous Federal agencies or permit each agency to pursue its own strategy.

Decisions on the configuration of information processing support services that would serve numerous end users within an agency; this is an intra-agency variant of the government-wide telecommunications decisions cited above.

informed resource allocation decisions must provide for appropriate recovery of costs of information. Chapter 2 discusses pricing of government information products and services and the recovery of costs through application of user fees to computer based information resources. Chapter 3 describes incentive mechanisms in more detail and considers how their introduction could lead to more efficient planning and management of information technology. Chapter 4 indicates some steps to be taken toward implementation of improved management incentives.

8 (a portyion of page 8 and 9 in Chapter 2 is included here)

Public Goods Pricing Strategies. In developing pricing strategies for information programs, the Federal government is relying largely on traditional pricing and cost recovery strategies to allocate information resources efficiently and fairly. However, there are obvious constraints in many instances where these traditional strategies are ineffective. These constraints include problems of "market failure" such as monopoly, the arrangement of property rights, and "public goods" or "common input" problems. Chapter 4 of the first annual report briefly explored these problems, suggesting that, where such constraints unduly inhibit efficient operation of the market, one might turn to nontraditional pricing strategies.

The nontraditional strategies represent an attempt to ot,)erationalize the basic benefits received principle of public finance. That principle, described in relation to technical services by Trumble and Gould (1983), would allocate the costs of governmentally produced information services in relation to benefits received. Therefore, the costs to be allocated to identifiable beneficiaries would include not only the costs of preparing the information for public release but also the public good costs of generating the information.

Issues in implementing the benefits received principle include: how much do particular concentrated users of the services benefit in relation to more general users from whom cost recovery may be inefficient because of the prohibitive costs of charging, transacting, and policing the use of the good? Are the costs of policing and transacting among the concentrated beneficiaries so high as to prohibit application of the benefits received principle?

Conventional views on the answers to these questions have begun to change as the result of recent work in the application of public goods theory. Out of this theory has emerged new mechanisms which permit application of the benefits principle in ways that significantly reduce costs of policing and transacting among beneficiaries while obtaining accurate information about benefits received (Clarke, 1971, 1980).

These mechanisms may permit the government and the private sector to move beyond traditional user fees in pricing public goods. This would allow providers, public or private, to rely on alternative approaches for making decisions on the allocation of scarce Federal resources in cases where the products are so public in nature that user fees are not appropriate. These new developments are considered in the next chapter in the context of common-user decision problems within the Federal government.

CHAPTER THREE

PLANNING AND MANAGING INFORMATION TECHNOLOGY

Common-user projects represent an area in which incentive approaches can lead to more efficient decisions. In particular, proposals for improving the Federal Telecommunications System (FTS) provide illustration as to how incentives might be used in addressing some of the telecommunications planning and financing problems facing the government.

Telecommunications Planning: Incentives for Efficient Decisions. Recent proposals for financing the costs of telecommunications systems would give government planners such as GSA additional flexibility in deciding what system improvements to make and in recovering the associated costs from user agencies. However, this financing approach may exacerbate problems of obtaining more efficient acquisition decisions because they fail to effectively link user preferences for different configurations of a common-user telecommunications system with the costs individual users will be required to pay. Instead, these proposals would simply expand the funding available to finance any changes in the Federal telecommunications system that a central agency decides will best serve the collective needs of all the users. Member agencies have already expressed their dissatisfaction with this approach in criticizing the current administration of the FTS.

- Agencies complain that they have had no effective voice in selecting existing FTS services and facilities. And, they are not confident that existing procedures for determining agency needs and requirements will lead to efficient acquisition decisions in the future.

- Changes in technology and the emergence of a more competitive market in the telecommunications industry have led many agencies to question whether there are any advantages to the common-user systems now in place. in particular, agencies are skeptical that they can realize substantial scale economies through common-user networks. This skepticism has increased with the elimination of bulk discount transmission tariffs such as Telepak. While there may be some scale economies achievable with shared telecommunications systems, these economies may be fully realized at relatively low traffic volumes.

- Agencies have also been increasingly resistant to standardized service offerings that limit their flexibility, particularly in the absence of substantial cost savings. Moreover, agencies are aware that important technological changes will continue to reduce costs, perhaps dramatically. Agencies fear that long term commitments will deny them future cost savings and flexibility.

Although GSA believes that it can adapt to the new technological and competitive environment within the current common-user structure, there are a number of difficult problems in relying on the current decision making approach to meet the diverse communication needs of a wide variety of user agencies. For example, there may be substantial differences in agency requirements in terms of usage, size of network, signal quality, privacy, and resistance of the system to degradation. A centralized decision process must collect information from each of the agencies on the advantages of a set of technically complex alternatives and, ultimately, select a configuration that best meets requirements across Federal agencies--that is, a configuration that strikes the best balance between low-cost service and other desirable attributes of a telecommunications system.

In addition to considering the requirements of government users, it may also be desirable to consider some of the broader (social/private) aspects of alternative configurations. For example, differences in the acquisition of equipment or services under different alternatives may foster--or limit--competition in the telecommunications industry. or, a configuration that improves physical robustness may have the commercially desirable effect (for private vendors) of improving system reliability or the quality of service. These "external" effects of government acquisition decisions also need to be considered. Again though, it is difficult to develop and organize information in a way that permits an effective centralized decision.

These acquisition decisions also require an assignment of project costs among the various participants. it is difficult, though, for a centralized decision maker to obtain accurate information permitting equitable decisions on the distribution of likely benefits from a joint project. In this situation, the assignment of cost shares becomes somewhat of an arbitrary exercise, often relying on a simple rule--for example, allocating project costs on the basis of equal shares or usage. These simple schemes for allocating project costs can, in turn, distort incentives in both the use of the system and in reported preferences for the acquisition of future generations of equipment. As a result, the information available to a centralized decision process may contain a bias that contributes to inefficient decisions on the acquisition of Federal telecommunications services.

To avoid these problems, the Federal government should begin developing new procedures that will improve the efficiency of government acquisition decisions while promoting other broad national goals.

Incentives for Efficient Decisions: A Demand Revealing Approach

In order to promote more efficient decisions in case-s involving common costs, the Federal government should consider the use of incentive mechanisms that would motivate each party to reveal its preferences for alternative system configurations. This information could permit a more efficient set of decisions in designing a Federal telecommunications system. This report will outline the use of a "demand revealing" mechanism as one possible approach to eliciting accurate information on the advantages of alternative configurations.

The basic elements and attributes of the demand revealing approach have been outlined in the economics literature over the last decade (See Appendix to this report). This approach is designed to obtain accurate information and making efficient resource decisions in areas where markets do not function--for example, the provision of public goods. In essence, the demand revealing approach requires that parties report their expected net benefits--in effect, a bid--for each of the available alternatives. Accurate reporting is assured by imposing a penalty on any party whose reported response affects the group decision to undertake the selected option. Because of the way this penalty is structured, the demand revealing approach is not subject to strategic misrepresentation by individual parties in reporting their expected gains under the available alternatives. Why this is true is discussed below.

A Formal Statement of a Demand Revealing-Approach. Under the demand revealing mechanism, parties are asked to report their expected net benefits for each of the available alternatives. The collective choice rule requires that the alternative with the largest reported net benefits for the group as a whole be selected as the preferred alternative. Thus, the reported net benefits for each of the parties are summed for each alternative and the alternative with the largest net benefits is selected.

A penalty will be levied on selected parties if their bid (reported net benefits) for the selected alternative affects the outcome. That is, a penalty is assessed for a participant if, in the absence of the reported bid for that participant, the remainder of the group would have selected some other alternative under the collective choice rule. The penalty for each party affecting the outcome is the difference between the net benefits for the selected option and the option preferred by the remaining participants, as calculated in the absence of a bid from that party. The Appendix to this report provides a formal mathematical statement of the rule and the calculation of the penalty. The Appendix also provides an example to illustrate the operation of the demand revealing mechanism.

Parties preferring an option other than the selected alternative would not be required to pay a penalty. In addition, parties preferring the selected alternative over the remaining options would not be required to pay a penalty if their bid would not affect the outcome. As a matter of actual practice, the number of participants incurring a charge and the size of the penalty are likely to be small--particularly, in cases where there are a large number of participants.

There are some additional requirements:

1. There can be no reimbursement of any penalties levied on the participants. The prospect of reimbursement could distort the incentive to report accurately the expected benefits under the available alternatives.

2. There can be no coalitions. As in the case of other types of decision mechanisms, the formation of coalitions can distort incentives to report accurate information and result in an incorrect decision.

While the mechanism motivates truth-telling behavior, it does have certain operational shortcomings. For example, 1) it is not immune from influence by coalitions--a flaw shared with all other decisionmaking arrangements--and 2) the penalties are unrelated to additional charges in excess of fully allocated costs.

The existence of a penalty for "successful" bids may dampen agency enthusiasm for this kind of an approach. There are ways of addressing this problem; for example, rebating the expected value of the penalties before beginning the process in order to ensure that participants are, on average, better off as a result of using this approach.

The efficiency gains, though, from the improved decision making provided by a demand revealing approach are likely to more than offset the wastage from these shortcomings. As a result, the existence of operational shortcomings per se is less important than the effectiveness of its operation relative to other alternatives. For this reason, the inherent shortcomings of existing arrangements for

governmentwide telecommunications planning should be recognized.

Incentives for Efficient Regulation. These shortcomings also apply to telecommunications planning and regulations affecting private sector decisions. These regulatory decisions might involve changes in the quality or type of service provided by private telecommunications systems in order to promote broader public objectives. The incentives approach described in this chapter could be used to ensure that an inefficient regulatory requirement is not imposed on the private sector.

The process would be essentially the same as that outlined above. The cost shares would be assigned according to the estimated benefits of alternative project configurations (including the possibility of not undertaking the project at all). Both private parties and Federal agencies would respond with estimates of their expected net benefits under each alternative and, on the basis of these responses, the alternative with the largest net benefits would be selected. Reliance on a demand revealing mechanism would assure that parties report accurately the expected net benefits of each alternative. This information could then be used to determine whether the regulatory requirements should be adopted.

There are problems, however, in adapting a demand revealing process to a joint decision involving both Federal agencies and private parties because of the peculiarities of the Federal revenue collection process. Legislative authorization would clearly be required in order to permit the Federal government to collect any penalties associated with a demand revealing mechanism.

Managing Information Technology

In addition to Federal regulation affecting the private sectort the Federal government establishes standards for government purchase of communications and computer equipment.

Information Processing Standards. The Paperwork Reduction Act specifically requires the development of a program for (1) enforcing Federal information processing standards, and (2) revitalizing the standards development program in the National Bureau of Standards (NBS). OMB's first annual report to Congress noted that a demand based incentives approach could be used to select efficient information processing standards.

In the past, regulatory approaches have often failed to reveal what standards will satisfy a large number of common users of computer technology within the government as well as the suppliers of technology outside the government. A demand based procedure could point to new requirements or changes in existing requirements that would increase net benefits in terms of common user savings. At a minimum, an enforcement program should confront agency decision makers with the opportunity costs to other potential common users when making acquisitions that depart from existing standards.

An incentive approach can be illustrated with a standard established by NBS in 1979 when OMB had just begun to require cost-benefit support for the setting of standards. In the case of the Input-Output Standard, NBS estimated approximately $55 million in acquisition cost savings to Federal agencies over a decade if the standard were adopted. However, the cost-benefit estimates were hotly contested by numerous suppliers who charged that the benefit estimates were unsupported; that potential

innovation would be stifled; and that the cost impacts on the private sector had not been taken into account. A number of vendors pressed suit against the government not to impose the standard, but the government position was upheld.

This example can now be examined to suggest how an incentives approach would lead to more efficient regulatory outcomes for both government users of computer technology and private vendors. Assume that the NBS commenced to put a price tag estimating common user savings on existing or proposed information processing standards. The initial price tag could be based on benefit estimates similar to those made in the case of the input-output standard. Federal agencies that make acquisitions departing from these standards would incur a penalty measured by the "opportunity cost" to other agencies. Initially, this cost could be NBS's estimate of the share of common user savings sacrificed as a result of the individual acquisition.

This enforcement approach would effectively "balance" the desirability of common user savings within the Federal government against the desirability of encouraging flexibility and industry innovation. It could also allow agencies to weigh penalty payments against possible discounts from suppliers who might incur favorable cost conditions for efficiently "violating" a particular information processing standard.

Using a demand revealing approach, individual agencies might be motivated to provide more accurate information on the benefits to them of alternative standards. Consider a situation where several agencies become convinced of the need for changes in information processing standards that impede introduction of a new technology. A demand revealing approach would permit agencies to petition for appropriate modifications in standards, accompanied by an expression of their willingness to pay for the modification. If the amount they are willing to pay exceeded the benefits to the remaining agencies as calculated by NBS, the standards would be modified and penalties would be incurred according to the demand revealing procedures described above.

Information Support Services. Federal agencies have a variety of common-user input decision problems that are similar to those faced by private firms. The problems involve decisions both on the level of iput to provide, for example, computer support services and on the rate of use of the input (e.g., how to allocate computer time among users).

Queuing Problems: For example, in simple operations research applications of demand revealing pricing structures, the basic objective is to motivate users of a computer facility to reveal their benefits for access to the facility so as to minimize overall system costs and the value of collective delay time to

all other users. Effective implementation is made possible by allowing a system administrator to set "priority prices" based on expected delay time and penalty payments analogous to those described in thi-s chapter would be collected.

This suggested application to the solution of queuing problems (i.e., computer facility usage, allocation of airport usage) is particularly useful in that it demonstrates how the basic demand revealing mechanism can be modified to reduce administrative and decision making costs both for the central administrator and the users of the facility. (See references in the Appendix.)

This modified incentive approach to solving queuing problems would still generate revenues in excess of fully allocated costs. In order to properly evaluate such a system, we must consider not only its administrative feasibility and costs, but also what constraints might prevent agency managers from using a more efficient pricing approach. Among other constraints, OMB's own Circular No. 121 instructs agency managers to seek full cost recovery, and might be interpreted as prohibiting the generation of a small budgetary surplus (in excess of fully allocated costs) within an individual agency or bureau.

In considering possible revisions of OMB's own regulations and circulars as well as fostering innovative ways of relying on market competition and appropriate pricing structures, OMB is also looking at the overall organization and delivery of support services within an Federal agencies. Illustrative of OMB~s approach are initiatives for the reshaping of information processing support services in agency "information resource centers."

Information Resource Centers: In OMB"s view, the "microprocessing revolution" has created a new planning environment in which the Federal government may be increasingly less able to rely on the traditional planning and regulatory approaches that it has used to seek economy and efficiency in the acquisition of major information systems. Under the traditional approach, OMB has sought efficiency in the acquisition of hardware in a manner similar to the acquisition of telecommunications assets. Just as the telecommunications planning problem is being reviewed, OMB believes that Congress and the executive branch may need to reconsider the traditional approaches to the acquisition of information processing facilities and services.

In this new planning environment, information policy may be increasingly "coordinated" at the agency or bureau level. Coordination could be accompanied by the use of accounting and pricing methodologies that will stimulate efficiency in the acquisition of information processing services.

The current monopoly environment and internal pricing procedures that are utilized in most agencies to support agency programs must be carefully scrutinized. The central facility managers may lack incentive to seek an efficient allocation of resources since they sometimes have a captive audience. Likewise, the program managers may lack incentive, or leverage where the incentive may exist, to ensure that information processing resources are efficiently allocated when they cannot seek alternative sources of supply.

As technological developments proceed, OMB expects the current institutional tensions will be exacerbated with an increasing likelihood that individual program managers will pursue a "go it alone" approach while the facility manager will become more like an agency GSA that must compete with alternative sources of supply, or else serve as a "broker" in helping program managers evaluate such sources. In this context, the use of market type incentives to make basic decisions on the acquisition and configuration of the central support service should be considered. This support function is defined as an information center (IC) which is a portion of the information system (IS) that supports end users within the firm or organization.

The Institute for Computer Sciences and Technology (ICST) at NBS has been evaluating business experience with this concept, asking how it would fit into the current department/bureau information management structure. The ICST efforts include consideration of current institutional problems in diverse agencies and bureaus and development of specific guidance on how the IC concept can be successfully implemented in the current institutional climate. ICST is also defining the products, technical assistance and supporting services that are necessary to establish and operate an IC in a Federal agency.

In addition, both OMB and ICST are concerned with the appropriate regulations and incentive structures that will bring about efficient IC configurations. For example, interest is focused on ways of ensuring the efficient application of information processing standards which are jointly the responsibility of NBS/ICST and OMB under Section 3505(3)(C) of P.L. 96-511. In addition, an incentives approach of the kind described in this chapter could be used to make decisions on what configuration of support services will best serve the needs of agency users.

Regulatory Information Systems: Finally, another kind of application of the incentive procedure described in this report is to the design of regulatory information systems. For example, the Federal government is planning a major multi-billion dollar replacement for the existing air traffic control system. Decisions concerning the configuration of this system might rely on cost-benefit information generated by the affected users through demand revealing procedures.

Demand revealing procedures could also be utilized by self-regulatory organizations (SRO's) that are established by the Federal government but are given wide latitude in determining the rules and procedures governing affected industry participants. A growing number of SRO's are being established in the financial, securities, communications, and commodity trading areas. The recent literature has suggested that the demand revealing procedure might be used in choosing industrywide accounting and reporting standards. As observed in last year's report, a related area of potential near term application might be decisions on how to configure automated reporting systems so as to meet industry needs efficiently as well as needs of Federal and State regulatory authorities.

CHAPTER FOUR

IMPLEMENTING IMPROVED MANAGEMENT INCENTIVES

With respect to pricing of information products, OMB is currently reviewing Circular No. A-25 with the viewpoint of setting user charges, to the extent practicable, at market based prices. Implementation of a market based pricing policy may well require legislative changes on an agency-by-agency basis.

In addition, OMB will encourage agencies and Federal research organizations to experiment with the implementation of improved incentives for managing information technology. A four step approach to implementation is envisioned which is presented here for the case of a demand based information technology acquisition:

1. Initial analysis of the costs and benefits of implementing the approach;

2. initial modeling and simulation;

3. A small scale experiment; and

4. A wider implementation.

These steps, explained in more detail below, would be designed to give those involved in succeeding steps insight into practical problems of implementation prior to wider scale application. in addition, the initial evaluation of costs and benefits would be successively modified on the basis of information derived from steps 2 and 3.

In making an initial cost and benefit evaluation of a demand based system different types of information technology acquisition could be chosen for study:

A small intra-agency telecommunications or ADP common user system; or

A wider scale interagency acquisition such as the FTS.

The purpose of such an evaluation would be to determine order of magnitude estimates of potential savings and efficiencies from a demand based acquisition. Such a calculation would also serve to help make concrete the details of actual implementation.

Second, a small scale model and/or simulation game may be created based on a concrete acquisition problem. Such a model would serve to make implementation details even more concrete and would test a particular implementation scheme for performance under

uncertainty. A game would be even more useful by providing a

measure of performance when strongly held preferences are

present. The game would also assist in determining what decision

aids may be needed to gain acceptance of the procedure by users.

The third step would be to conduct an actual field experiment. One illustrative possibility lies in the area of Federal agency decisions on the acquisition of telecommunications systems. Current proposals to modernize the telecommunications system for Federal agencies in the Washington, D.C. area provide a specific example. in 1981, the Washington Telecommunications Interagency Committee (WTIC) was formed by GSA to recommend specific steps for modernizing the Washington, D.C. area telecommunications system. In June 1982, the Committee issued a report describing the general configuration for a modernized system and outlining an acquisition strategy for obtaining such a system. This provides an opportunity to illustrate the way in which an experiment using the demand revealing approach might be structured.

A Demand Revealing Experiment. The experiment could be undertaken in tandem with initial planning of alternative system specifications with an eye toward evaluating whether a decision mechanism based on demand revealing principles would generate results superior to the current approach. The WTIC report, for example, described a preferred system configuration and in general terms suggested that, of several transitional funding mechanisms considered, a direct appropriation might be an advantageous way of proceeding with the modernization of the system. However, this approach may fail to elicit accurate preference information for determining the efficient configuration for a modernized system. A demand revealing approach would be designed to remedy this deficiency, ensuring that final decisions on the system configuration would maximize net benefits to agency users.

Under a demand revealing approach:

GSA would coordinate preferred options submitted by various agencies and provide alternative system specifications, accompanied by estimates of the total multi-year costs associated with these alternatives. Each agency would then be assigned cost shares for each alternative based on estimates of the benefits to the agency.

Agencies would then register their preferences for the recommended option or alternatives. The alternative yielding the largest net reported benefits would be selected.

If as a result any agency's reported net benefit changes the outcome that would have resulted in the absence of the agency's vote, then a penalty would be

determined according to the procedures described in the Appendix.

Specific procedures for assessing the penalty and

-he decision procedure to the budgetary

tailoring AL. process also have to be specified.

Experimental Evaluation. There are two objectives of an experimental evaluation: (1) establishing a workable decision process using a demand based mechanism, and (2) comparing the operating of this process with alternative processes. Criteria that should be considered in evaluating alternative approaches include economic efficiency, administrative simplicity, and compatibility with budgetary procedures. Explicit attention should also be given to the problems with the current decisionmaking process so that an evaluation considers all relevant costs of alternative processes. These costs include departures from economic efficiency, arising from either the absence of information or group manipulation of the available information, as well as the administrative costs of the decision process.

An experimental evaluation could be made as the initial step in a field test. This evaluation would simulate or model the behavior of agency decisionmakers to determine the likelihood of group manipulation and what decision aids might be needed to help participants communicate more accurate preference information.

A simulation would also assist in evaluating the possible costs and benefits of revised decisionmaking and administrative procedures. In a 1978 analysis of the Public Broadcasting System where a related incentive mechanism was experimentally evaluated, it was learned that decisionmaking costs are typically quite substantial. About 5 percent of the total costs of programs was devoted simply to operating the allocational institution.

With government telecommunications expenditures by Federal civilian agencies currently exceeding $7 billion annually, decisionmaking costs are also substantial. Any significant changes in decision procedures might involve cost impacts that must be compared with the probable benefits from improvements in the efficiency of decisionmaking.

In addition to the type of interagency decision illustrated above, other candidates for experimental evaluation might include:

1. An intra-agency telecommunications acquisition, particularly one where the agency must make common user choices among a variety of enhanced (e.g., voice-data) as opposed to basic services;

2. The allocation of computer time among "priority users" within a small agency or bureau; or

3. Decisions on the configuration of central agency support services as part of the acquisition of an information processing system.

For the future, and to encourage wider scale implementation, OMB is consulting with agencies and research organizations within the government who have already supported a variety of basic research studies in this area. OMB now believes that a program of applied research and experimental evaluation with demand based procedures can significantly improve the coordination of Federal information policies.

APPENDIX

A DECISION RULE FOR

IMPROVING MANAGEMENT INCENTIvrS

The operation of the decision rule described in Chapter 3 can be illustrated, as follows. Suppose there are two alternatives under consideration, say, Option A and Option B. Each of the parties reports the expected net benefits under the alternatives. The net benefit of Option A for the group of N participants is

given by: (Note the mathematics did not reproduce in the scanned document.

__________________________________________________________

where S iA is the net benefit reported by the ith party under Option A

In turn, the net benefit of option B is given by:

StIB

Under the collective choice rule, Option A is selected if:

and conversely, Option B is selected if:

F. A < E A

If the sum of the net benefits for the two options are equal, i - e - , there is a tie, then, one of the options is selected at .-andcm.

A penalty will be assessed on any party whose reported net

benefits affects the final outcome. Thus, if for the group as a

whole Option A is selected (i.e., ZA > Z a) , the jL- party

affects the final outcome if in the absence of a bid from the

jLh party, Option B would have been selected under the collective

choice rule. (In cases where there is a tie, all parties

preferring the winning option over the other options must pay a

penalty.) That is, the jL- party would be assessed a penalty

if:

Sj 1; < SjB

The size of the penalty for the 'th

]- party is given by:

S (2: Sj

A - j B -

This decision rule yields accurate information because the reward

st'ructure for individual parties with a demand revealing

mechanism is independent of the party's response. As a result,

the party will be best off by reporting accurately the likely net benefits under the several available alternatives. In effect, the party can accept a decision or he can change the decision to a specified alternative by making a sacrifice equal to the net costs of undertaking an alternative to the option collectively preferred by the remaining parties.

The following example illustrates the applicaton of the decision rule and the operation of this approach to elicit accurate statements from each party about the net benefits of each alternative.

Suppose that two alternatives are under consideration, Option A and Option B. Option A--in this case, taking no action--involves no costs and no benefits for the participants. Option B is an alternative joint project with estimated costs of $10 million. If the project is undertaken, the project costs are to be shared equally by the five parties. Suppose the reported net benefits are, as follows:

Option A Option B Penaltv

Party 1 0 1.0 -0.5

Party 2 0 0 0

Party 3 0 -0.5 0

Party 4 0 1.0 -0.5

Party 5 0 -1.0 0

Under the collective choice rule, Option B would be selected--the net benefits of Option B ($0.5 million) are greater than the net benefits of doing nothing (Option A). The group as a whole is better off, then, under Option B. Rowever, if either Party 1 or Party 4 had abstained from "voting," the remaining members of the group would have preferred Option A. Because their "votes" swing the outcome, both Parties 1 and 4 are subject to penalties under the demand revealing process. The penalty for each of these parties is the collective cost to the remaining participants of foregoing Option A. For Party 1, then, the penalty is given by:

5 5 t

sip zsi, - ~ S!" I= 0. S, M,11,0A

A izz

____________________________________________________________

Note that even after paying this penalty, Party 1 is better off with the selection of Option B. Second, the penalty paid by Party 1 is independent of its own "vote." Thus, the structure of this mechanism does not provide any incentive for strategic behavior by individual parties. As long as the net benefits reported by Party 1 are greater than $0.5 million--the "bid" required to shift the group choice from Option A to Option B under the collective choice rule--the penalty is independent of the amount of the "bid." There is no advantage, then, to Party 1 in terms of a reduction in its penalty of mis-stating its net benefits.

In fact, under the demand revealing approach, there is an incentive to report correctly the net benefits of each alternative. If Party 1 incorrectly reports that its net benefits are less than $0.5 million, the group choice shifts to Option A. Although Party 1 would no longer be subject to a penalty charge, it would have been better off--given actual net benefits of $1.0 million under Option B--with the selection of option B (even with the penalty). On the other hand, suppose Party 5 sought to shift the group selection to Option A by incorrectly reporting a net benefit with Option B of a negative $2.0 million instead of actual net benefits of a negative $1.0 million). By successfully shifting the group choice to Option A, Part 5 would incur a penalty of $1.5 million and would actually be worse off than would have been the case with the selection of Option B.

The demand revealing approach is not, however, immune from the influence of coalitions. In the above illustration, for example, two parties (e.g., Party 1 and Party 4) could each agree to report inflated statements of their net benefits (e.g., $5 million in lieu of $1 million). The result would be that neither's vote individually "swings" the outcome and no penalties are incurred.

On the other hand, coalitions are risky. If one party defects, the other party would still shift the group choice, incur a penality, and be worse off that had that party correctly reported

n . A

its net benefits. The risks and difficulty of organizing coalitions increase with the number of participants and the degree to which the true aggregate net benefits of one option dominate other available options. The potential for coalitions disappears when the costs of providing a good are allocated so that net benefits to all parties are positive.

The influence of these variables and the probability of coalitions is one factor that should be considered in experimental evaluation and field testing along the lines suggested in Chapter 4. Applications, for example, that tend to exhibit the characteristics of a "positive sum game" would be favored over those which might tend to resemble "zero sum games."

The incentive features of the demand revealing and related mechanisms, including coalitions incentives, are developed more fully in the literature. See Clarke (1971, 1980) , Groves and Loeb (1975), Tideman and Tullock (1976), and Green and Laffont (1977).

Possible applications, briefly described in this report, have been developed by Dolan (1978), Ferejohn, Forsythe and Noll (1979), Johnson (1983), and Sonstelie (1981).

References

Clarke, E., Multipart Pricing of Public Goods, Public Choice, Fall 1971.

Clarke, E., Demand Revelation and the Provision of Public Goods, Ballinger Publishing Company, 1980.

Dolan R., Incentive Mechanisms for Priority Queuing Problems, Bell Journal of Economics, August 1978.

Federal Publishers Committee, Government Publications: How Much to Charge, Who Decides?, Report of the "Sales vs. Free" Task Force, September 1982.

Ferejohn, J., Forsythe, R., and Noll, R., Practical Aspects of the Construction of Decentralized Decision-Making Systems for Public Goods, C. Russell (ed.) Collective Decision-

Makinj~._.,.Applications - From Public Choice Theory, Johns Hopkins Press 1979.

Green, J. and Laffont, J. J., Incentives in Public Decisionmaking, Amsterdam-,North Holland Publishing Co., T9_79.

Groves, T. and Loeb, M., Incentives and Public inputs, Journal of Public Economics, August 1975.

Johnson S., Demand-Revealing Processes and Accounting Standard-Setting, Public Choice (forthcoming 1983).

National Commission on Libraries and Information Science, Public Sector/Private Sector Interaction in ProvidingInformation Services, 1982-.

Office of Management and Budget, Major Themes and Additional Budget Details, FY 1982.

Office of Management and Budget, Major Themes and Additional Budget Details, FY 1983.

Office of Management and Budget, Managing Federal information

Resources, First Annual Report to Congress under the

Paper Reduction Act of 1980, April 1982.

Office of Management and Budget, Managing Federal Information Resources, Second Annual Report to Congress under the Paperwork Reduction Act of 1980, April 1983.

Office of Management and Budget, Testimony on the National

Publications Act of 1980 (H.R. 5424), before the Subcommittee on Legislation and National Security, House Committee on Government Operations, June 1980.

President's Private Sector Survey on Cost Control, Report of the

User Charges Task Force, May 1983.

Sonstelie, J., Economic Incentives and Cost Revelation, Paper prepared for the Council on Environmental Quality, January 1981.

- and Portney, P., Truth or Consequences: Cost

Revelation and Regulation, Journal of Policy Analysis and

Managment, Vol. 2, No. 2, 19T3. -

Sprehe, J.T., A Federal Policy for Improving Data Access and User Services, Statistical Reporter, March 1981.

Tideman, T.N. and Tullock, G., A New and Superior Process for Making Collective Choices, Journal of Political Econ2my, December 1976.

Trumble, R., and Gould, S., User Fees for U.S. Government

Technical Services, PRA Research Report No. 83-4, National Science Foundation, March 1983.

Washington Telecommunications Interagency Committee, Improved Telecommunications for Federal Agencies in Metropolitan, Washington, D.C., Prepared for the Commissioner, Automated Data and Telecommunications Service, General Services Administration, June 1982.