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Public Sector Procurement: Lump-Sum Payments or Optimal Contracts?

In a Dynamic setting, we compare procurement schemes in the form of a lump-sum payment with an optimal information-revealing menu of contracts without commitment. We find that lump-sum contracts generate two benefits. First, they always provide optimal levels of effort. Second, they 'tie the hands' of the producer, and avoid the ratchet effect. These benefits must be weighted against the costs of higher rent in the second period. For a low discount factor such costs dominate, but for a high discount rate, when the ratchet effect becomes acute, the welfare gap becomes small and lump-sum payments may even welfare-dominate an optimal menu.