How to manage the economic trade-offs of public procurement policies in developing economies

The views expressed in the Let’s Talk Development blog are solely those of the author(s).
 

Government procurement—the process in which public entities buy goods and services from private companies—represents between 5% and 20% of a country’s GDP, depending on the country. Public procurement policies allow governments to strategically support certain firms and sectors, for example, small businesses or eco-friendly products. In using public procurement systems, policymakers must navigate a trade-off: Procuring from targeted firms can alleviate economic distortions, but it can also result in higher costs if more expensive suppliers are chosen. Success depends on the specific context and the productivity differences between the targeted firms and other suppliers, highlighting the importance of careful evaluations of potential impacts.
 

The Rise of Procurement Policies

Low- and middle-income countries (LMICs) have been expanding procurement-related policies in recent years. According to data from Global Trade Alert, the number of new procurement policies announced in these countries jumped from just four in 2008 to 77 in 2024. Procurement policies more than tripled from 1.1% of all economic policy announcements to 3.4% during the same period. By 2024, around 30 LMICs countries had announced procurement-related policies. 

What Are These Policies Actually About?

When governments decide who gets their purchases, they are often trying to achieve broader economic or social goals. Some of the main types of procurement policies are:

• "Buy Local" Policies: These policies impose local- or domestic-content restrictions on government spending. More than 34 countries have announced at least one of these policies between 2009 and 2024 (for example, Kazakhstan, Uganda, Brazil, China, India).
• "Buy Small" Policies: These policies aim to help small businesses by reserving a portion of government contracts for them or giving them preferential treatment in the bidding process. For example, Indonesia requires government agencies to spend at least 95% of their budget on SMEs (firms with 100 or fewer employees). Similar policies exist in Peru, India, and the Dominican Republic, among other countries.
• "Buy Green" Policies: As climate concerns grow, many governments are using procurement to support environmental goals. In Europe, for instance, the European Commission emphasizes the importance of  “procuring goods, services, and works with a reduced environmental impact throughout their life cycle.”  In the Netherlands, factors like energy consumption, recycled content, and eco-friendly packaging now influence contract awards.
   

The Economic Trade-Off

When governments use procurement to achieve these broader goals, they face a fundamental trade-off:

• Benefits: Directing business to certain firms (small, local, or green) can help those businesses overcome constraints and potentially improve the overall economy. This would be true if winning government contracts helps firms increase their sales and employment, and this effect persists beyond the contract period.
• Costs: These targeted firms might not be the most efficient or lowest-cost suppliers at the time of the purchase. This means the government ends up paying more for the same goods and services, which increases the cost of providing public services.
   

Does Research Support These Policies?

The evidence is mixed and still developing. At the firm level, there is strong evidence that government contracts boost performance. Studies from Brazil, South Korea, Uganda, and Kenya all show that winning government business leads to higher sales and employment that last beyond the contract duration. There's also evidence that these contracts help firms overcome financial constraints and increase their borrowing capacity, as shown in studies from Spain and Portugal. When it comes to green procurement, some recent research shows securing environmentally friendly contracts improves firms' environmental and economic performance and encourages R&D investment in greener technologies.

Research quantifying the tradeoff mentioned above and the resulting broader economic impact of procurement policies is still limited. In a recent paper, for the particular case of Spain, my co-authors and I find that targeting procurement toward small firms would significantly increase private sector output, but also substantially increase government costs.
 

Which Industries Are Most Affected?

Procurement policies, and specifically “buy local” policies, tend to target specific industries. When looking at policies worldwide, iron and steel-related sectors are the most affected. Other commonly targeted sectors include:

• Measuring instruments and appliances
• General construction services
• Pharmaceutical products
• Civil engineering works
• Motor vehicles and parts
• Medical equipment
   

The Bottom Line

Government procurement is a powerful economic tool being used more frequently to address economic challenges. Procurement policies can help targeted firms and potentially address market failures, but their effectiveness depends on the specific context: the size of the economic distortion being addressed, the productivity gap between targeted and non-targeted firms, and many other factors. Understanding these costs and the necessary trade-offs has become increasingly important for businesses, policymakers, and citizens alike.

Our initial research suggests that governments could opt for more traditional tools, such as taxes and subsidies (e.g., credit subsidies for financially constrained firms), but more analysis is needed to evaluate the effectiveness of these alternative instruments compared to procurement policies, as well as to understand the additional trade-offs they may create.