Public Procurement, the Nature of Innovation, and Growth: Firm-Level Evidence from Germany

German firms invest in R&D, yet fewer introduce products new to the market. Public procurement may contribute to the pattern: contracts that reward specification-compliant delivery over frontier novelty reduce the payoff to frontier innovation and redirect innovative effort toward incremental product lines. In the data, a one-standard-deviation increase in procurement exposure is associated with a 0.20 percentage-point decline in market-novel product introduction and a 0.38 percentage-point increase in existing-product revenue. Whether such composition shifts slow growth depends on general-equilibrium forces. We build and estimate a quality-ladder endogenous-growth model incorporating this mechanism. Redirecting procurement funds to an R&D tax credit raises growth by 12 basis points per year and delivers a welfare gain of 3.2 percent of permanent consumption.

JEL codes: D22, H57, O31, O38, O41.