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 may reduce the payoff to frontier innovation and shift the composition of innovation toward existing products. Linking firm-level innovation surveys to public contract award records, we find that a one-standard-deviation increase in sector procurement exposure is associated with a 0.70 percentage-point lower probability of market-novel product introduction and a 1.3 percentage-point higher share of revenue from existing products. 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 9.77 basis points per year and delivers a welfare gain of 1.47 percent of permanent consumption.

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

Draft and slides available upon request.