A Quota by Any Other Name:The Cost of Affirmative Action Programs In the Construction of DIA IP-6-1994 (May 1994

) Author: Charles King After months of delay and massive cost overruns, Denver International Airport (DIA) has found its opening indefinitely postponed. One of the most important reasons for the delay has been the affirmative action policies imposed on firms in construction of DIA. But for those affirmative action policies, Denver International might well have opened 'on time and under budget.' This Issue Paper details the massive costs which have been inflicted on the people of Denver, and the city's reputation, through policies of racial discrimination. At least for the delays since March 1994, the primary cause has been problems in making the automated baggage handling system work. While the baggage system was built by BAE Automated Systems, Inc., the BAE company was not chosen to operate and maintain the system. The 'OM' contract to run the baggage system was awarded to a different company which, however diligent its efforts, did not have the enormous learning curve advantage of having built the baggage system. According to Denver's construction chief at DIA, 'The worst decision that was made in the last six months was the decision not to give BAE the OM contract.' And why was the company that built the baggage system not given the contract to operate and maintain it 'The city was concerned that BAE wouldn't hire enough local minority subcontractors,' reports the Denver Post. (1) Apparently the Webb administration found that BAE would not hire 'enough'minorities, even though, according to BAE, the company had pledged to hire 36% minority workers and 11% minority subcontractors.(2) Although BAE was eventually hired as a subcontractor, the firm's contribution was obviously less than if BAE had been the prime OM contractor. Because of the numerous problems with the operation of the baggage system, the airport (and ultimately the traveling public) must pay about half a million

dollars a day on bond interest payments despite the lack of any revenue from DIA. Some airports shops are teetering near bankruptcy, as the DIA delays make it impossible for the shops to generate enough revenue to pay back the shops' start-up loans. (And to the extent that the Denver government assists those shops, the losses are simply transferred to Denverites.) The DIA delays have also resulted in a lowering of the bond ratings to junk or near-junk status by national rating agencies, thereby raising the interest rates that Denver (and ultimately the traveling public) will pay in future airport bond sales. No-one knows exactly how many tens of millions of dollars have been lost as a result of the Webb administration's decision to reject BAE as the baggage system operator because, apparently, BAE pledged merely to fulfill, and not exceed, the Webb/Pena racial quotas at the airport. Significant as the baggage system fiasco costs are, they are only one part of the gigantic waste of public funds caused by the Webb/Pena racial quotas. This study provides a conceptual framework for measuring the costs of affirmative action, some estimates of these costs in construction of DIA, and some policy implications. WHEN DOES AN AFFIRMATIVE ACTION 'GOAL' BECOME A QUOTA Some persons claim that no quotas were imposed at DIA because the affirmative action 'goals' are voluntary. It is true that affirmative action programs at the federal, state, and local level are stated in terms of 'goals' in contracting work to minority owned enterprises (MBEs) and female owned enterprises (WBEs). If contracts are awarded to MBEs and WBEs only when they submit low bids, then there are no quotas, and no additional construction costs incurred. But, if contractors who fail to meet affirmative action 'goals' in their bids are not awarded contracts, then the goals become quotas. When contracts are set aside for MBEs and WBEs even when these firms are not low bidders the costs of construction are increased by these set asides. The argument that affirmative action 'goals' for contracts at DIA are voluntary

is not supported by the data. The appendix to this study compiles evidence on the two affirmative action programs administered at DIA by the Denver Mayor's Office of Contract Compliance in 1992. The federal government implemented an affirmative action program in the award of both construction and professional services contracts. The federal program makes no distinction between MBEs and WBEs, but rather lumps the two together into a disadvantaged business enterprise (DBE) program. Of the 16 federal government contracts awarded under this program none were significantly below the 'goals' for DBEs, and a number of contracts significantly exceeded those 'goals.' The City of Denver also administered an affirmative action program in the award of contracts to both MBE and WBE enterprises. Of the 21 city contracts only 3 were below the 'goals' for total MBEs and WBEs, while the majority of contracts exceeded those goals. WHAT WAS THE COST OF SET ASIDES IN CONSTRUCTING DIA Estimates of the cost of set asides varies considerably. At least seven bids were rejected by the Pena/Webb administrations because the low bidder did not meet the 'goals' for subcontracting to minority firms. Those contracts were then set aside to higher cost bidders who met the affirmative action 'goals.' When the city awarded those seven contracts to higher bidders who met affirmative action 'goals,' the increase in construction costs was $3 million.(3) When prime contractors at DIA set aside subcontracts for MBEs and WBEs that were not low bidders, their costs also increased. The firm awarded the prime contract for designing and constructing the computerized baggage system subcontracted $40 million to MBEs and WBEs. The firm stated that if it had not been required to set aside subcontracts for MBE and WBE firms it would have done the work itself at a savings of $6 million.(4) This estimate for construction of the baggage system suggests that set asides increased cost by 15% of the value of work subcontracted. Estimates of the cost of set asides by engineers and prime contractors at DIA vary between 2% and 12% of contract

dollars.(5) Studies of other public works construction projects suggest that the cost of set asides in constructing DIA is probably at the upper end of these estimates. In a previous Issue Paper the author reported estimates of the cost of set asides by the Associated General Contractors of California of 9% to 14% of the value of public works construction contracts in the San Francisco area.(6) A recent study of all federally funded construction projects estimates that about $10 billion of federal contract monies was channeled into these set asides.(7) The premium for awarding federal contracts to MBEs and WBEs is not supposed to exceed 10%, but for some contracts the premium was as high as 25%. That study concluded that 10% (or $1 billion) is probably a conservative estimate of the cost of set asides in all federally funded construction projects. A total of $118 million in contracts was set aside for MBEs and WBEs at DIA in 1992. If we apply the 10% figure to this figure, the estimated cost of set asides at DIA was $11.8 million in 1992. Reports on affirmative action programs at DIA for 1993 and 1994 will soon be available which should provide a basis for estimating the cost of set asides in those years as well. WHAT WAS THE COMPLIANCE COST OF AFFIRMATIVE ACTION PROGRAMS IN THE CONSTRUCTION OF DIA The cost of set asides is only the tip of the iceberg in estimating the cost of affirmative action programs in public works construction projects such as DIA. All firms at DIA incurred labor and capital costs to remain in compliance with affirmative action regulations, and recent studies provide a basis for estimating these compliance costs. Research by the Center for the Study of American Business at Washington University estimates that for every dollar spent on regulatory enforcement, about 20 dollars is spent for compliance costs in the private sector.(8) Compliance with federal affirmative action regulations increased federal contractors' costs by an average 6.5%. In 1991, $211 billion was spent by the

federal government on contracts with non-government entities. The additional cost to private sector firms to comply with federal affirmative action regulations in the award of these contracts is estimated at about $13 billion. The total contract dollars for construction of DIA is now estimated at $3.2 billion, although that figure will surely be higher as a result of the delays in completing construction. If we apply the 6.5% figure to the estimated cost of construction of $3.2 billion, compliance costs for these firms is estimated at $208 million. WHAT WAS THE COST OF ADMINISTERING AFFIRMATIVE ACTION PROGRAMS IN CONSTRUCTING DIA Costs are also incurred in the public sector to administer the affirmative action programs. Of the total $425 million spent by the federal government for civil rights oversight in 1991, about $303 million was allocated for enforcement of affirmative action laws affecting the private sector.(9) In addition to federal dollars, state and local monies are also spent to enforce affirmative action regulations. The Denver Mayor's Office of Contract Compliance, which administers these affirmative action programs, had a budget of $540,000 last year. It is clear that a significant amount of federal and local dollars were spent in administering affirmative action programs in the construction of DIA. So far, more than 200 minority firms have been awarded contracts at DIA, and another 14 firms have been denied contracts because they did not meet affirmative action requirements. Of the latter firms denied contracts at DIA, three firms appealed the ruling, with two rulings upheld and one still under appeal.(10) Significant costs were incurred in the litigation of these affirmative action rulings. Indeed a cottage industry has emerged for economists and lawyers engaged in attempting to prove the existence of discrimination in the award of public works construction projects and in litigation over which firms should

qualify as minority firms.(11) WHAT WERE THE SOCIAL COSTS OF AFFIRMATIVE ACTION PROGRAMS IN THE CONSTRUCTION OF DIA Society incurs costs over and above the cost to individual firms in complying with affirmative action regulations. These social costs are difficult to quantify, but this does not mean that social costs are any less 'real' than those estimated above. Social costs are incurred due to delays in completion of construction of the airport. These costs are incurred not only by construction firms, but also by airlines, concessionaires, and passengers. The City of Denver has floated $3 billion in bonds to finance the construction of the airport. In the absence of delays those funds would be available in either the public or private sector rather than being tied up in airport construction. The City of Denver must spend $18.8 million per month in interest payments on the bonds sold to finance airport construction. With no definite date set for the opening of DIA, it is highly probable that these interest costs alone will cumulate to over $100 million. There are also opportunity costs of resources allocated by individual firms in complying with affirmative action regulations. Labor and capital resources allocated by individual firms to affirmative action could have been allocated to more productive uses. To the extent that affirmative action programs result in lower efficiency and productivity of these resources, affirmative action quotas diminish social welfare. There are social costs due to fraud and corruption in the design and implementation of the affirmative action programs. Non-MBEs and WBEs set up dummy corporations to qualify for set asides. In some cases the dummy corporations with minority ownership did nothing more than take some percentage of contract dollars without doing any work under the contract. In other cases firms changed their organizational structure to include a minority when in fact ownership and control remained in the hands of the nonminority

agents. The extent of this fraud and corruption in the construction of DIA remains to be determined, but a preliminary surveys suggest that it was substantial.(12) It is important to emphasize that fraud and corruption are bound to occur as a result of the arbitrary way in which affirmative action programs are designed and implemented. The arbitrary nature of the 'goals' established for DIA contracts is readily apparent from the data in the appendix of this paper. The range of 'goals' set for minority contracting is rather consistent at 10% for MBEs, and 5% for WBEs. The actual set asides consistently equaled or exceeded these 'goals' with few exceptions. A survey of the nature of these contracts reveals a wide range of different kinds of construction contracts, including paving, lighting, sound, landscaping, and a wide range of professional service contracts including architecture, environmental, fire fighting etc.. The probability that the availability of minority firms in these diverse industries would conform to the uniform 'goals' for minority contracting at DIA must be very low. Therefore it should not be surprising to find many firms engaging in fraud designed to meet these 'goals' for minority contracting. Finally, there are social costs due to the disincentive effects of affirmative action programs in the construction industry. Affirmative action programs impose a particular burden on minority firms in the construction industry that are able to compete based upon their efficiency as revealed in low bids for construction projects. If these minority firms are excluded from public works contracts because of fraud and corruption in the design and implementation of affirmative action programs, those programs have perverse effects on the minority firms they are designed to help. Further, legitimate minority firms are stigmatized to the extent that fraud and corruption are associated with all minority firms, making it more difficult for them to compete in both the private and the public sector. Legitimate minority firms are stigmatized to the extent that the firm's legitimately-won contracts may be seen as the result of political favoritism or fraud. The stigma that a firm

won a contract because of its race or gender, rather than the quality of its work, makes it more difficult for the qualified firm to compete in the private sector. It is often argued that despite these problems affirmative action programs give some minority firms an opportunity to compete in an industry which discriminates against them. However, this argument is not supported in recent studies of discrimination in the construction industry.(13) Nor is it clear that affirmative action programs have resulted in an increase in the competitiveness of minority firms in the construction industry.(14) A SOLUTION During the late 19th century, big-city political bosses would hand out public funds on the basis of ethnicity, giving a certain percentage of government contracts to the Irish, a certain percentage to the Italians, and so forth. Progressive reformers combatted discrimination and fraud in public works by requiring that contracts be awarded to low bidders. The low-bid rule enabled all firms, including minority owned firms, to compete for contracts based upon quality and price. But in late 20th century Denver, the city is governed like late 19th century Chicago, as politicians hand out hundreds of millions of public dollars on the basis of what favored group the recipient belongs to, rather than the basis of merit. To add insult to injury, the administrators of Denver's modern spoils system wrap themselves in a sanctimonious mantle of 'fairness.' The impact of a pork-barrel quota system such as the one at DIA has been to reduce competition and enable special interests to transfer wealth through the public sector. Much of the burden of these wealth transfers falls on the least advantaged members of the society. Colorado's taxpayers and contractors could use some genuine fairness, and the best way to get fairness is through re-instituting the Progressive-era reform of the lowest bidder system. Awarding public works contracts to the lowest qualified bidder is the only way to ensure true equality. The lowest bidder rule enables all firms, including minority owned firms, to compete for the award of

these contracts based on their quality and efficiency. In the award of construction contracts, such as those at DIA this would mean: 1)no race/ gender barriers; 2) no race/gender preferences; 3)no race/gender subcontracting quotas; and 4) no race/gender set asides. Endnotes
Mark Eddy, 'BAE Operating Exclusion Blasted,' Denver Post, May 1, 1994. Eddy, ibid. Denver Post Feb. 6, 1994, p.A22. Op. Cit. Denver Post, Feb. 6, 1994, p.22A. Denver Post, Feb. 6, 1994 p.A22. Barry W. Poulson, 'Stop Cooking the Books on Set Asides: How Statistical Disparity Misleads and Multiple Regression Excels For Assessing Discrimination in Public Works Contracting,' Independence Issue Paper 7-93, Feb. 15, 1993, p.5. Peter Brimelow and Leslie Spencer, 'When Quotas Replace Merit, Everybody Suffers,' Forbes, Feb. 15, 1993, p.96. Op. Cit. 'When Quotas Replace Merit, Everybody Suffers,'p.90. Op. Cit. 'When Quotas Replace Merit, Everybody Suffers,'p.90. Denver Post, Feb 6, 1994, p.22a. One estimate is that $13 million of taxpayer dollars has already been spent for these disparity studies, with another $14 million contracted. Op. Cit. Brimelow and Spencer, 'When Quotas Replace Merit,' p. 96. Litigation of affirmative action decisions also turns out to be an expensive proposition for taxpayers. Op. Cit. Poulson, 'Stop Cooking the Books on Set Aside Programs.' Twelve firms that were qualified by the city as MBE or WBE firms eligible for contracts at DIA were rejected for similar designation by the state government. These twelve firms received $29 million in contracts at DIA. Denver Post, Feb. 6, 1994, pp.A1 and A22. Studies of affirmative action programs in

other cities suggest the extent of such fraud and corruption. A recent disparity study for San Jose California showed that of 33 trucking firms available for contracting with the city, only one firm was white male owned, 20 were MBEs, and 12 were WBEs. Barry W. Poulson, 'Preliminary Thoughts on Questions Regarding the MBE/WBE Disparity Study for the City of San Jose,' mimeo, Oct. 6, 1993. Op. Cit. Poulson, 'Stop Cooking the Books.' Over the past eight years since the City of San Francisco has enforced affirmative action quotas in awarding public works construction subcontracts, the share of MBE/WBE participation in such contracts declined to less than 10 percent. Over the same period the San Francisco Unified School District awarded construction contracts strictly on the basis of low bidder. The share of those contract dollars awarded to MBE/WBE firms increased to the highest levels in the U.S.: 71%. Poulson, 'Stop Cooking the Books on Set Asides.' Copyright 1994 - Independence Institute INDEPENDENCE INSTITUTE is a nonprofit, nonpartisan Colorado think tank. It is governed by a statewide board of trustees and holds a 501(c)(3) tax exemption from the IRS. Its public policy focuses on economic growth, education reform, local government effectiveness, equal opportunity, and the environment. PERMISSION TO REPRINT this paper in whole or in part is hereby granted, provided full credit is given to the Independence Institute DAVID B. KOPEL is Research Director of the Independence Institute, and editor of the Issue Paper series. TOM TANCREDO is President of the Institute. BARRY POULSON is a Senior Fellow in Economic Policy with the Independence Institute, and a Professor of Economics at the University of Colorado at Boulder. Views expressed in this Issue Paper are the author's alone.

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