Why Procurement Matters: The economic value of fixing the way government buys

CCI recently published, Buying Ideas, a report on the public procurement of innovation. Reactions to the report have been mostly gratifying – a lot of folks out there are convinced of the need for change in how the public sector buys, and appreciate the input.

One of Canada’s preeminent newspaper columnists, however, was not happy. And that’s ok. You can’t please everyone. But I do think it’s worth discussing why this report is more than just “caterwauling for cash” or a plea for “government lolly” (delightful phrases, by the way – he’s still got it!).

Let’s leave aside some of the obvious first objections here(e.g. is the way the system currently works delivering good results for Canadians?) and get at the heart of this. Why isn’t reforming procurement to buy innovation just old-fashioned corporate welfare with a new coat of paint?

Let’s start from first principles. Public spending should aim, first and foremost, to create public benefit. That’s why we pay taxes. When governments spend it, we should expect a public benefit, and we should expect to get our money’s worth.

What makes innovators such a special group of people that they warrant any kind of public support? The idea here is that technological progress is basically a public good — and that’s over and above whatever private good firms generate for themselves through research and innovation. But companies have a really hard time capturing the full benefits of their R&D — because after somebody does the hard work of inventing a new and better technology, inevitably lots of other people come along and copy it. This is basically why most countries subsidize research and development; if governments didn’t step in, the conventional economics literature tells us that the private sector would do less R&D than would be best for Canadians.

So far, so good. But why should government purchasing enter the equation at all? Shouldn’t some tax incentives be enough to generate spillovers and minimize any distortions?

In theory, maybe that would be the case, if the market were perfectly competitive and stable. But innovation-driven markets generally aren’t anything like that. From a competition standpoint, they usually end up with superstar firms that leverage IP and (increasingly) data assets to dominate and suppress competition as they scale globally. And of course, by their very nature, innovation-driven firms are often creating and iterating on novel technologies, so the marketplace is never stable for long.

Let’s take a look at a couple real world examples of how procurement has been a driver in both technological progress and industrial development.

The first is Silicon Valley, the heartland of technological venture capitalism. As Mariana Mazzucato (The Entrepreneurial State) and Chris Miller (Chip War) trace in their respective books, aggressive procurement from the American Department of Defence was absolutely critical in launching the semiconductor industry. Purchase orders from the Air Force sped the nascent industry through its first generations, using public purpose (here, global military dominance) to get to the point where broad commercial applications for computing became screamingly obvious. An R&D tax credit simply would not have been able to substitute for a sustained program of pre-commercial procurement of a novel technology with a public use.

Another example of procurement spurring the adoption of new tech is telecommunications. If you were making a list of the most important countries for telecommunications equipment production, China (Huawei), Sweden(Ericsson) and Finland (Nokia) is a somewhat unlikely group of global power-players. Why do two relatively small Nordic economies sit in a club where even the US lost its membership?

The answer, if you’ve been paying attention, probably won’t surprise you – public procurement! Both countries’ public telecom authorities invested early in digital switching technologies to connect their respective citizens, helping Nokia and Ericsson get to a point of considerable sophistication. Sweden and Finland were also aligned in propagating the GSM standard, which was adopted across Europe, and helped those companies get an early beachhead into the broader European market. Both of them went on to use their technological and standardization successes to become global giants, driving lots of follow-on innovation and new value chains in their home markets.

Somebody might scoff at the idea that procurement is a “traditional engine of entrepreneurial dynamism and inventiveness,” but there are enough significant examples to think that there is actually something to the idea.

Procurement of innovation has a strong track record of de-risking promising technologies and getting them to a point where much broader adoption is possible and companies can go bananas with wider commercial applications and generate lots of benefits and further innovations.

Like everything else in life, and indeed with the procurement system as it currently exists, things can go wrong. But to insist that looking at the public sector as a driver of innovation is naked corporate welfare or a dead-end bound to result in failure reflects a failure to absorb some pretty obvious historical lessons and the realities of the economics of innovation.

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