Flexibility In Government Procurement Needed For Developing Countries

By Riaz K. Tayob

A recently published journal article considered whether it is advisable for developing countries to use public or government procurement for development and whether developing countries should join the World Trade Organization Government Procurement Agreement (GPA). The paper concludes that if public procurement for innovation is to be seen as part of their industrial-policy portfolio, accession to the GPA would not help, and advises against it.

Following the mid-October World Trade Organisation meeting of its Government Procurement Committee, a deal on an updated plurilateral agreement appears likely by year’s end, among both developed and developing countries, though further revisions are being considered to address remaining differences.

The reality of the global economic crisis seems not to have affected the rationale for trade liberalisation in general, and for government procurement in particular. Given the paucity of standard textbook or neoclassical economics to explain the crisis (including the crisis on the Millennium Development Goals in most developing countries), there ought to be more analysis that grapples with the evidence and the relevance of the theories that underpin liberalisation.

One such approach included in a recently published journal article considered whether it is advisable for developing countries to use public or government procurement for development and whether developing countries should join the World Trade Organization (WTO) Government Procurement Agreement (GPA). The paper concludes that if public procurement for innovation (PPfI) is to be seen as part of their industrial-policy portfolio, accession to the GPA would not help, and advises against it.

And public procurement as part of industrial policy has a lot more to offer developing countries than is generally demonstrated in the typical studies undertaken, it finds. It does, however, mean that developing countries would first have to develop more robust innovation policy skills and competences, which may be lacking, and they should not directly transfer the respective policies from the developed world.

The article “Public Procurement as an Industrial Policy Tool: An Option for Developing Countries?” by Prof. Rainer Kattel and Veiko Lember appears in the Fall 2010 issue of the Journal of Public Procurement. It surveys the key arguments for and against joining the GPA, and argues that government procurement should not be seen only as an indirect support measure for development, but as a direct vehicle for promoting innovation and industries, and thus growth and development.

WTO Government Procurement Agreement

Only about 40 countries have joined the WTO GPA (a plurilateral agreement) including from the developing world Hong Kong (China), South Korea and Singapore and through the European Union, ten Eastern European countries. The GPA requires that signatories apply the principles of openness, transparency and non-discrimination (most-favoured nation treatment and national treatment) to national public procurement laws. The agreement applies above certain thresholds, for those sectors included in the positive or negative list annexed to the agreement, with exceptions allowed for “high national interests” or military products.

Government procurement, which constitutes more than 10 percent of the national economy in most countries, is perceived as one the main barriers to free trade. Discriminatory government procurement, according to the (neoclassical) theory of comparative advantage, makes states worse off in the long run because it leads to inefficient allocation of resources and limits the benefits of free trade: access to other markets, increased competition, job creation and budgetary savings.

Schools of Thought & Their Implications

In the literature, Kattel and Lember identify that the key difference between scholars from the different schools and the policy prescriptions they recommend relates to the understanding of the nature of technological development and its impact on companies and economies. The evolutionary school argues that technological development is mostly path-dependent while neoclassical arguments assume that technology is freely available to all, competitors and countries alike. Neoclassical economists set out to rectify market failures that prevent the dissemination of technologies and skills. For evolutionary economists, entrepreneurs seek technological innovation in order to create market failures, where technological development is anything but linear and technology is anything but freely available.

The paper favours the perspective of procurement from the evolutionary economics over that of neoclassical economics, because the former has a deeper understanding of technological change which is key to “catching up”.

WTO Debate: for Trade or Economic Development?

The article states that the current debate on WTO and government procurement has been mostly about the relationship between trade and procurement and not so much about public procurement and economic development as such. The WTO approach assumes that liberal trade rules and maximum competition will eventually lead to sustainable economic growth both in developed and developing countries.

According to the article, using public procurement for developmental goals, in particular innovation (PPfI – public procurement for innovation), is seen in the literature as a demand-side policy measure through which governments can generate new markets for companies in order to develop new technological capabilities and solutions. However, the paper distinguishes PPfI from government purchases of “off-the shelf” products, procurement for innovation involves procurement that needs additional research and development work and thereby influences the innovative capacity of providers.

The attempt to change micro-level “learned organisational capabilities” for innovation and technological change via public policy is what classical industrial policy used to be about up to the rise of the Washington Consensus policies and WTO agreements, citing Harvard Business School Prof. A. D. Chandler.¹

For public procurement, classical industrial policy represents what is called soft procurement practices, as in the case of East Asian post-World War II industrial policy. These nations started with a clear idea of what kind of products were wanted and the kind of technological capabilities and know-how that was needed to achieve these products. Governments set deadlines and quality standards to ensure continued improvement and productivity increases. Simultaneously, most policy measures kept competitive pressures alive through sunset clauses or similar measures. “Thus, through the successive industrial policy measures from one product to the next (from radios and light bulbs in the 1950s to computers and chips in the 1990s), East Asian industrial policy can be seen as a prolonged process of public procurement activity,” the authors state.

Today, however, many heterodox economists argue that the WTO rules substantially restrict the availability of such practices to developing countries. The article notes that while policy space has become much narrower for industrial policy under the WTO, it shows why it is still important for developing countries to use the still-available policy options. This would allow for the needed policy learning to take place through experimentation and is less open to rent-seeking and capture by interest groups.

Rationale for Not Acceding to the GPA

The paper discusses four categories of objections by developing countries to joining the GPA: political (like patronage, job losses unpalatable), technical (meeting requirements for statistics), secondary policy-related (social, policy, promoting minorities), and economic (developmental).

On economic reasons, the paper cites a study that claims that “in the last 25 years, a small literature has developed focusing on the effects of international discrimination in procurement. Much of this literature considers procurement discrimination in perfectly competitive markets and, in partial equilibrium settings, typically finds no efficiency rationale for discrimination.” Other writers state that under these premises the implementation of secondary policies such as industrial policy measures can be justified only in case of severe market failures. And even in case of severe market failures, these measures (e.g., infant industry protection) are considered to be mostly ineffective due to expected policy failures, the article notes.

The authors, however, state that these arguments ignore the recent development experience of the East Asian countries as well as the historic lessons from the now developed countries. Most importantly, these treatments fail to differentiate between discriminatory procurement and public procurement aiming at promoting innovation.

Situating the current debate on WTO and government procurement, it states the debate has been mostly about the relationship between trade and procurement and not so much about public procurement and economic development as such, assuming that liberal trade rules and maximum competition will lead to sustainable economic growth in all countries. But it is not competition per se that is important, the paper argues, citing University of Birmingham Economics Professor A. Singh, but whether and to what extent it is capable of supporting economic development. A maximum level of competition may not be the best solution for developing countries and, instead, a more strategic policy view could be used that mixes competition with cooperation.

Direct public procurement for innovation represents one possibility that can be used to affect the technology life cycle, promote clusters and innovation systems, and thereby increase urban, regional and national competitiveness, the authors argue. The role of the public sector could be seen as a facilitator of innovation processes especially in the fluid phase of technology development because both social and economic benefits for the region and/or nation state might follow.

Include the Demand Side

Concretely, the authors suggest several ways that public agencies can support innovations through procurement: The creation of new markets for products and systems that go beyond the state-of-the-art; the creation of demand “pull” by expressing its needs to the industry in functional or performance terms; the provision of a testing ground for innovative products; the provision of the potential of using public procurement to encourage innovation by providing a “lead market” for new technologies/solutions.

Compared to the (traditional) supply-side innovation policy measures, the public sector can use PPfI to act as a demanding first buyer by absorbing risks for socially/ecologically demanded products (where significant financial development risks prevail) and by promoting learning (where procurement introduces strong elements of learning and upgrading into public intervention processes). The government can also be the demander, bear higher entry costs, create critical mass, signal the market and link innovation to production – and not just increase internal capacities of producers.

In contrast to supply-side measures such as R&D subsidies, public procurement for innovations leads not only to technological capacities but also to increased production capacities for innovations. In addition to direct technological or product innovations, quality and other standards (e.g., ecological) set by public agencies also play a key role and in this way, PPfI conceptually differs from discriminatory “off-the-shelf” public procurement.

Recapture Ignored History

The authors state that the current GPA debates (in the literature) largely ignore the positive role public procurement can have on development and growth, as evidenced by the historical practices of Japan, Korea, the US. Regarding industrial policy as soft procurement, the paper states that the core of industrial policy from Europe in the 16th century to East Asia in recent years is the targeting of certain industrial sectors for priority development. Justifications for this included economies of scale, and the resulting synergies, as the key reason for differentiating between economic activities.

The paper provides a stylised account of the East Asian policy development path, and contrasts it with the policies of Latin America. It highlights the importance of targeting specific economic activities, as East Asia did, that exhibit long-term growth potential in terms of learning curves, home-market expansion and exports, as these provide dynamic increasing returns that create possibilities for continuous upgrading. In contrast, Latin America failed to target “windows of opportunities” in different economic activities, and the need for competitive pressure was also underestimated.

Different Economic Activities and “Emulation”

Classical industrial policy assumed that economic activities were fundamentally different in their development potential: at a given point in time, some activities were subject to increasing returns to scale and accompanying synergies, while other activities were not. It relied on what Prof. E. Reinert calls emulation: successful cases of development during the 500 years of capitalism have mostly been based on unrestrained copying from other successful countries, past and present.² This toolbox includes basic principles such as infant-industry protection and the application of these principles has been based on context-specific amendments – that is emulation, not simply copying. Targeting activities with increasing returns was the essence of industrial policy.

The WTO agreements assume the opposite: all economic activities are alike, exemplified best in negotiations where developed countries argue for access to developing country markets for their high-tech and patent-based products and offer in return access for developing countries’ textiles and similar products to the markets in the North. In other words, WTO agreements assume more or less static technological capabilities and trade, and that gains come from using these capabilities.

Use Policy Flexibilities

Accordingly to WTO agreements such as the General Agreement on Trade in Services (GATS), Agreement on Trade -Related Aspects of Intellectual Property Rights (TRIPS), Agreement on Trade-Related Investment Measures (TRIMS) and a host of other multilateral and bilateral agreements regulating trade, intellectual property and investment is seen by many heterodox economists as severely limiting the policy space available for developing countries. The authors cite in this context, London School of Economics Professor Robert Wade, that these international regulations “are not about limiting companies’ options, as ‘regulation’ normally connotes; rather, they are about limiting the options of developing country governments to constrain the options of companies operating or hoping to operate within their borders.”

The authors mention that there is a particularly strong agreement among researchers that regional trade arrangements in many cases apply much more stringent IPR regulations, trade liberalisation measures and investment requirements than various WTO agreements proper.

However, the authors point out that WTO agreements leave some, partially substantial, space for policy. These include:

• the agreements leave more or less intact industrial policy ideas settled in the GATT agreement from 1947, which recognised import substitution and infant-industry protection based on increasing returns (Article XVIII, paragraph 2),
• WTO’s Article XVIII allows countries to protect themselves from competition from imports in order to restore balance of payments, and
• Articles XIX and VI allow protection from import competition also in individual industries (temporary safeguards) and against unfair trade practices (anti-dumping).

Citing Massachusetts Institute of Technology Professor of Political Economy A. Amsden, the paper states that TRIMS allows [some] local content requirements to stay in place and has been used by Brazil, Argentina, Chile, Indonesia, Mexico, Malaysia and Thailand. It cites Prof. Jerry Reichmann (Professor of Law, Duke University) who shows how countries like China, India and Brazil are using flexibilities under TRIPS for their own developmental agenda.

The paper states that the WTO allows for subsidies in three key areas: 1) R&D, 2) regional development, and 3) environmental protection. These existing flexibilities should be emphasised in developing country’s capacity building exercises (by WTO and other international and non-governmental organisations). While the policy space under WTO has become strictly defined, the policy space has not been eliminated completely. The authors argue that an important issue is what has become the focal problem under WTO: the policy capacity to develop and implement policies that are conducive to innovation and growth and fit into the WTO rulebook (emphasis added).

The Capacity Problem, Compounded

The authors also highlight the capacity problem in developing countries. It states that government procurement is notorious for constantly under-delivering for various reasons. A country may suffer from low policy and administrative capacities which is of special importance because of the more complex nature of procurement for innovation and because of the need to coordinate different vertical and horizontal policy domains.

Also at the administrative level, there tend to be too many goals to follow in modern public procurement for the public administrators – cost savings, value-for-money, transparency, sectoral policies – which often contradict each other. This may lead to a misallocation of resources, where agency goals conflict with wider policy goals. There is a dilemma between the micro-cost effectiveness of a contract and the higher costs of R&D-based product/services in order to boost innovation.

Contrasted with Classical Industrial Policy, the WTO assumes universal rules and institutions that should be more or less precisely copied by the developing countries in order to widen markets and allow access for technological and market leaders whose activity should then lead to various spillovers and positive externalities. So while emulation assumed high levels of capacity to choose from a heterogeneous set of policy options, the WTO policy space assumes decontextualization of policymaking. The former assumes an institutional framework for policy learning; the latter in turn assumes the capacity to implement agreed-upon policies.

Citing Tallinn University of Technology Governance Professor Wolfgang Drechsler, the authors add that policy implementation and copying in the 1990s, in turn, became associated with decentralization and market-like discipline within the public sector, exemplified by New Public Management reforms; which are similar to values emphasized typically in the current procurement literature: cost effectiveness, transparency and enhanced competition.

Further, the authors state that both WTO and mainstream procurement literature assume that government failures are usually worse than market failures and thus disciplining governments should bring more return in the terms of developmental intervention. Consequently, WTO is based not only on a very different set of economic ideas and ideals, but also on substantially different views on policy capacity and how it evolves.

Both PPfI and industrial policy assume strong policy capacity, WTO regulations compound the capacity-building through shortening policy-learning cycles: implementing universal rules is more or less the full policy cycle. Experimenting with various industrial policy measures – and often failing – is one of the key elements in East Asia’s success story. But government failures are seen today in the WTO framework as the cardinal sin of development policy.

“The Washington-Consensus policy framework prevailing in WTO emphasizes, first, macro-economic competencies (e.g. inflation targeting, fiscal discipline) and, second, the need to transfer policies from the best practice toolbox of the time. Developing countries have become policy takers with the ascendance of WTO and Washington Consensus in the 1990s,” the authors said.

Consequently, the respective policies in most developing economies have been converging with the developed countries’ policies (in IPR, innovation, R&D, foreign direct investments and other fields). Yet, this convergence is accompanied by the hollowing or non-emergence of the local capacity to analyse and evaluate domestic policy issues because of the de-contextualization of policy making through the very same convergence. The authors elucidate, “While developing countries are voluntarily or involuntarily increasingly copying and transferring policies from developed countries and international organisations, their problems are usually aggravated because local capacity development is thwarted as policy experimentation is minimal.”

Conclusion: the Low Equilibrium Trap

The authors note that the issue of PPfI and developing countries under the WTO framework there are many paradoxes and contradictions. The paper summarises in a table the options open to developing countries regarding Industrial Policy, Public Procurement and their developing context. One option is the mainstream, where public procurement is used to create a level playing field, with transparency, non-discrimination and comparative advantage as goals. The general problem with this is that it may result in a low equilibrium trap. Other options include discriminatory public procurement, PPfI and soft procurement. The general problem is that the latter two require high levels of capacity, which may be a challenge in developing countries.

Riaz K. Tayob is the South African Representative of SEATINI (the Southern and East African Trade Institute), currently reading for a PhD in Technology Governance under Prof. Rainer Kattel at Tallinn University of Technology (Estonia).

1. Chandler’s books include “The Visible Hand” and “Scale and Scope” which was one of the first and major historical studies of the role of the large firm in industrial countries. Standard economics assumes, by and large, that all firms are alike. [^]
2. Reinert (Professor – Technology Governance and Development – at Tallinn University of Technology) emphasises that different economic activities have different characteristics as carriers of development, a 500 year old taxonomy that has been excluded from highly abstract Standard Textbook Economics to facilitate mathematical modelling. Elsewhere he refers to Paul Krugman’s comment on this process, “Economic theory came to follow the path of least mathematical resistance.” [^]