Public procurement and its implications for government support policies, innovation and growth

Notes from a Seminar in Brussels on May 17, 2010, hosted by the Swedish Entrepreneurship Forum

Professor Pontus Braunerhjelm, Managing Director of the Swedish Entrepreneurship Forum introduced the seminar and lead the discussions on the topic “Public procurement and its implications for government support policies, innovation and growth”.

Professor Gunnar Eliasson presented his new book Advanced Public Procurement as Industrial Policy -The Aircraft Industry as a Technical University. In his book, published by Springer, professor Eliasson focuses on a case study of the development of Saab’s military aircraft, the JAS 39 Gripen system, a project that involves advanced technological innovations, a complex network of suppliers, public-private sector collaboration, and both military and commercial applications.

In his book the role for regional and national entrepreneurship capability for maximum civilian spillover effects of advanced procurement is specifically emphasized. His main key-question is:

  • What is the macroeconomic significance of the ”cloud” of technological spillovers that surrounds advanced industrial product development?

img_bryssel17maj_panelFrom left: Andreas Pyka, Bertrand Wert, Carlo Magrassi and Gunnar Eliasson.

Professor Dr. Andreas Pyka, Hohenheim University, Stuttgart, Deputy Chief Executive Carlo Magrassi, European Defence Agency (EDA), Brussels and Dr Bertrand Wert, Policy Officer Assistant, European Commission, DG Enterprise and Industry gave their comments and reflexions on professor Eliassons speech.

Professor Eliasson began his speech by stating that recent econometric studies suggest the wealthy industrial economies to be underinvesting   in privately financed R&D, compared to what is socially optimal.  This underinvestment is mirrored by large differences between measured social and private rates of return on such investments. And the critical problem is that the private generators of the total return capture too little of the value they create.

– Value creation through spillovers occurs in the form of additional economic growth. Most of it is spilled on to the consumers in the form of lower prices.

Hence, the fact that others than the private investors capture most of the value created make private investors to underinvest in industrial R&D. The industrial economies have a property rights problem associated with the intangible assets their private firms invest in.

– I have myself investigated the spillover generation around the development of the Swedish combat aircraft Gripen during the period 1982 through 2007, aggregating case study data on identified civilian spillovers from that development project.

Some of the spillovers have been captured and commercialized by the firms directly involved in Gripen development (Saab, Volvo Aero and Ericsson), others by outsider firms.

– I have found that the civilian values created around Gripen, net of opportunity costs and cumulated for the entire period, divided by the R&D investment, similarly cumulated ( the spillover multiplier) is at least 2.6. This means that the development investment has been returned to Swedish society at least 2.6 times over in the form of additional economic growth.

The case study method used tends to underestimate the spillover multiplier for the simple reason that it is difficult to identify all civilian spillovers. Econometric studies on good quality data, most of them North American, reveal even higher numbers. Differences between social and private rates of return on private R&D investments estimated in those studies also indicate spillover multipliers far above the 2.6 obtained in this study.

All advanced firms engage in joint production when developing new products. They develop a double product; the product really procured and developed and a valuable cloud of spillovers available to other firms in proportion to their ability to commercialize them.

– The main thrust of my investigation is that I have studied a privately demanded public good procured by Government, but developed by private firms that have carried most of the technical and economic risks associated with the development. Contrary to the advanced products demanded by private firms Government here acts as a double customer.

– Government is not only acting on behalf of its citizens as a substitute customer, but  should also be concerned about the economic values embodied in the cloud (spillovers), and even be willing to pay something extra for that cloud, again on behalf of its citizens. This is a rationale for using advanced Government procurement as industrial policy.

img_bryssel17maj_eliassonGunnar Eliasson

The spillover intensity furthermore is maximized the more competent (and the less political) as a customer Government, and the economic value creation out of that cloud depends positively on the entrepreneurial capabilities of the local economy.  ( So public procurement of privately demanded public goods can be designed as a potent policy machine to overcome some of the observed  underinvestment, and particularly so if the policy maker also pays attention to the quality of the product being developed and the entrepreneurial capacities of its economy. The latter should in fact be regarded as a good policy objective in itself).

– I am not suggesting that Government should step in and subsidize such R&D investments. Practically all evidence suggests that direct subsidies are a waste of public resources, even though some politically minded economists still pursue such policy opinions. Public procurement of privately demanded public goods and services, however, are not a form of subsidies, as long as the public customer actors on behalf of its ( willing to pay)  citizens to procure public goods demanded by them. The distortive effects on the economy associated with traditional Keynesian demand policy are then minimized. We can talk about public procurement of privately demanded public goods and services as a New Demand policy, that helps overcome the underinvestment in private R&D.

The main reasons for that underinvestment, according to Eliasson, are:

1. The difference between social and private values created and that the private investor cannot capture more than a fraction of the difference. There are, however, other reasons as well.

2.  Government is not properly attending to its main task as a substitute customer for privately demanded public goods and services.

3.  A large number of infrastructural investments, furthermore, contributing to the production of privately demanded goods and services are of such a long term nature that no rational private investor find it in their interest to provide the large capital outlays needed on such a long term and highly risky basis, needed for instance in new medical technology development. Point 3 in fact may be seen as a special case of point 2.

– It may look the same, but there is a significant principal difference between the government shelling out R&D subsidies for uncommitted R&D on the one hand, and acting as a competent customer acquiring developed technologies to functional specification on the other.

The first case, said Eliasson, is that of a technical university engaging in basic research. The advanced firms, on the other hand, tend to act as technology drivers that not only develop new complex technologies but also take them up to functionally tested products that are tested in the market. In that capacity the advanced firm competes with, and compares very favourably with the traditional technical universities.)

img_bryssel17maj_kommentarFrom left: Andreas Pyka, Carlo Magrassi and Bertrand Wert

Comments and reflexions

Professor Braunerhjelm – and also others in the audience – questioned the statement that public authorities should be especially competent to procure complicated technological systems. Could the public sector really pick the winners better than the market and could they cut the losers in due time?  And don´t we see a risk of crowding out better investments with even higher spillovers?

Professor Eliasson stressed that Sweden had a very good record of successful public procurements during the period 1860 to 1920, but he admitted that this period also coincided with a period of liberal and trade reforms.

Professor Pyka claimed that the book is an example of Complexity Economics with strong time delays and interactions.  He also stressed the roll of demand as a complement to the strong supply-side dominance. He also would like to see more of political entrepreneurship and tolerance for failures. Today many interesting ideas and investments are cut off too early. There is a lack of patience often depending on budget restrictions.  Knowledge many times spill over to other sectors of the economy – not foreseen in the original plans.

Carlo Magrassi saw the problem from a more practical economic perspective. Today the EU Commission has to save money and would be very hard to convince to invest in large-scale military projects. In the past we have seen a lot of joint procurements in the defence sector – some of them successful and some failures. Magrassi finds Europe fragmented into three parts: three large industrial countries, the former Eastern Europe and a lot of quite small countries that cannot afford any large-scale investments. He also emphasized the possibility to use the model of public procurement on a much wider scale and in many other areas than defence.

Pontus Braunerhjelm emphasized the past problems to fulfil earlier large-scale EU-projects in e.g. hospitals.  Many times the resources to launch the projects are missing. Instead of supporting certain projects it could be wiser to engage in developing technologies, in the way CESAR works (To maintain the European leading edge position in the transportation as well as automation market, CESAR aims to boost cost efficiency of embedded systems development and safety and certification processes by an order of magnitude).

The third commentator Bertrand Wert made two remarks:

– There is a rigorous legal framework that limits the possibilities to procure large projects in EU.
– Any initiatives taken in order to procure new technology must be consistent with the overall EU innovation politics.

Bertrand Welt also made a couple of comments:

– Use procurements to foster innovations;
– Develop new procurement  policies;
– Increase the knowledge of the demand-side linking it to best practise;
– Establish a supply-side SME´s directorate to emphasize the importance of entrepreneurship on a regional and local level;
– Allow R&D grants to be used for procurement-purposes.

Gunnar Eliasson would like to see more of professional demand for procurement also in e.g. the health care-sector – some kind of sustainable customer developing a technological platform. He also likes to see establishing of a network exchanging best practice between, countries and regions. In Sweden for example it is forbidden to regions to cooperate (team up) to procure equipment and services within the health care-sector.

Final words from Gunnar Eliasson:

– Open up the possibilities for more of procurements;
– Increase the acceptance for failures;
– Establish more of political entrepreneurship.

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