Demand-pull and environmental innovations: Estimating the effects of innovative public procurement

By Claudia Ghisetti

Demand-pull and environmental innovations: Estimating the effects of innovative public procurement

It is difficult to identify the right amount of resources for the market to invest in knowledge creation. This creates the space for market or even broader systemic failures. The market may fail to provide adequate levels of research and development (R&D) investments because of the limited appropriability of such activities and the intrinsic uncertainty that characterises any innovation project. This condition may lead to sub-optimal supply of knowledge and, as a consequence, to overall social losses, unless properly designed policies for science, technology and innovation are adopted.

Within this framework, a broad research effort has aimed to understand the role of specific policies to stimulate innovation. Most of it has been focused on the role of R&D subsidies to counterbalance such under-investment and to stimulate firm’s innovative activities, as well as on R&D subsidies’ negative side-effects, experienced when they crowd out private investments. Only recently has there been a turn towards demand-oriented innovation policies, in particular on public procurement, to stimulate innovation, and very few (though robust) empirical analyses have been focused on understanding the effects of public procurement on innovative activities as an alternative or complementary policy instrument. In parallel, a new and fast-growing research field has emerged about a peculiar typology of innovation, that of environmental innovations, whose investigation requires a more systemic lens than ‘standard’ innovations. As these environmental innovations are of importance for both the policy and the business realm and have the potential to lead to win-win solutions whereby competitiveness and environmental sustainability are combined, it is relevant to investigate whether or not governmental demand can play a role and foster their development and diffusion.

Governmental support to innovative activities through public procurement (PP)

The role of governmental demand in shaping the direction and speed of technological change has been recognised as crucial in the economics of innovation literature: an analysis of seven industries in the USA (semiconductors, commercial aircraft, computers, agriculture, pharmaceuticals, motor vehicles, residential and construction) dating back to 1982 confirmed the pivotal role of public policies in guiding technical progress. Governmental support to innovative activities through public procurement (PP) is seen as a fundamental driver for the uptake of crucial technologies, as happened in the case of general-purpose technologies, which were driven by defence-related procurement in the USA. Those technologies – mainly steam engines, electric motors and semiconductors – in turn played the role of enabling technologies that fostered widespread technical progress and eventually led to economic growth. PP is recognised as a successful stimulus for innovation when certain conditions are met: (i) when it expresses a clear and consistent set of needs to be addressed by the innovative effort in a clear contract specification; (ii) when quality is placed at the centre of the tender, rather than merely price; (iii) when it provides an assured market for early products with uncertain commercial possibilities; and (iv) when it forces contractors to share information and encourages the entry of new competitors so that it stimulates technology diffusion.

Only recently there has been an increasing tendency to reconsider the role of demand-oriented policies in European innovation policies and a discussion has emerged on the role of innovation policies to support ‘Grand Challenges’ in terms of societal and economic goals. Those challenges relate to the fields of health, pharmaceuticals, energy, environment, transport and logistics, security, and digital content. Among the array of demand-side policy instruments, PP helps to reduce the risks linked to innovation investments with unknown demand, very low expected market size or uncertain development, all of which discourage firms from bearing the costs of innovation.

Green Public Procurement provides a stimulus for innovation

In line with this trend, the European Commission has chosen to set a non-binding target of 50% of public tendering to be compliant with its sustainability requirements by 2010, in order to favour improvements in the environmental, energy and social performance of products and services and the development of a Green Public Procurement (GPP) initiative. This initiative outlines common criteria to be followed and the need to increase information on the benefits and life cycle costs of environmentally friendly products. The strategy has been explicitly linked not only to the creation of market opportunity for existing green small and medium-sized enterprises (SMEs) but also to a stimulus for innovation and diversification in traditional sectors via the increase in demand for green(er) products and services. In principle, the strategy should stimulate a critical mass of demand for greener goods and services which otherwise would be difficult to get onto the market, as European public authorities are consumers for an amount of EUR 2 trillion per year (16% of the EU’s gross domestic product (GDP)).

Overall, ‘green’ PP is a (procurement) procedure that leads to the purchase of ‘greener’ products, whose impact on the environment throughout their whole life cycle is lower than comparable products or solutions. This provides a stimulus for innovation and creates a minimum critical mass for sustainable goods and services, thus helping to overcome the problem of under-investments in innovation due to the uncertain demand. In reality, this non-binding target has not been reached, as mutually reinforcing obstacles are hindering those organisations that should launch and promote ‘green’ tenders from doing so.

Innovative PP (IPP) is an important demand-side policy instrument

The focus of the current study is not on ‘green’ PP, usually referred to as an environmental policy tool, but rather on innovative PP, a category that has recently received attention and is increasingly seen as a crucial instrument for innovation policy. Regular PP occurs when a public institution buys already existing products or services for which no R&D is involved, and supplier selection depends on readily available information about price, quantity and performance, given the existence of standardised markets. Innovative PP (IPP) occurs whenever public institutions invest in products or services that have not yet been developed but could be developed within a reasonable timeframe, and that can help satisfy human needs or solve societal problems; thus, IPP explicitly stimulates an innovative effort. The latter case of procurement (IPP) is the main object of the current study. Public procurement for innovation has been acknowledged as an important demand-side policy instrument, as it has ‘the potential to improve delivery of public policy and services, often generating improved innovative dynamics and benefits from the associated spill-overs’, but, at the same time, ‘it has been neglected or downplayed for many years’, probably because of the stringent competition rules adopted in Europe.

The rationale for using PP to stimulate innovation is threefold: (i) IPP is a major part of local demand and this affects decisions by multinational enterprises (MNEs) about where to locate and the dynamics of innovation in countries; (ii) IPP can help overcome market (information asymmetries) and system (poor interaction) failures relating to innovative products; and (iii) purchasing innovative solutions contributes to improving public infrastructure and services. Intelligent and tailored intermediation services may, however, be needed to make this instrument more effective in connecting supply and demand. Predicting longer term societal needs and trends in emerging technologies can also make this instrument more effective. Overall, IPP is an important source of innovation because it counteracts market and systemic innovation failures, which otherwise would lead to under-investment in innovative activity.

Recently it has been argued that PP can be useful to support public research to facilitate advances at the technological frontier and also to meet the EU 2020 targets of socio-economic and environmental sustainability. The uptake of climate-friendly technologies may be influenced by public policies, since the transition to more sustainable production requires the invention, adoption and diffusion of radical and, consequently, riskier innovations, and high levels of investment, which are unlikely to be sustainable by the private sector on its own. Alternative-energy technologies are potentially deployed to replace already existing technologies and, initially, may be less reliable and/or more costly, and require public support for their early-stage deployment. As IPP reduces the investment risks inherent in radical innovations with uncertain markets and demand, and it can create niches for the emergence of early-stage environmental technologies, it can be a valuable instrument to encourage their early adoption and to allow their easier diffusion. Overall, there is agreement that governmental intervention is needed to favour the adoption and diffusion of environmental innovation (EI) and that IPP might be well positioned to be a valuable policy instrument to this end. However, there is still no empirical confirmation that IPP effectively stimulates EI.

 

This is an excerpt of the journal article: Demand-pull and environmental innovations: Estimating the effects of innovative public procurement, by Claudia Ghisetti. Published: December 2017 in Technol Forecast Soc Change; 125: 178–187; DOI: 10.1016/j.techfore.2017.07.020 under a Creative Commons Attribution License (CC BY 4.0). 

Claudia Ghisetti
Research Fellow

Claudia Ghisetti currently works as a researcher for the Joint Research Centre (JRC) of the European Commission. She holds a PhD in European Law and Economics (University of Bologna) and she has been visiting researcher at GREDEG-CNRS and at the Centre for European Economic Research (ZEW) in Mannheim. Her expertise is in micro-economics empirical analysis in the fields of economics of innovation and environmental economics.