Is public procurement fit for reaching sustainability goals? A law and economics approach to green public procurement

1. Transaction costs

It is clear that pursuing environmental impact through public procurement has a cost effect. For the purposes of this paper, these costs are divided into direct costs and indirect costs. The former consist of impacts on contract prices and transaction costs for both the contracting authority and the bidders participating in the contract award. Indirect costs such as the cost of reduced competition and effects on private consumer market behaviour are discussed later.

Using green requirements, award criteria, life-cycle costing and performance clauses renders procurement documents and procedures more complex and increases the need for external advisors both at the drafting stage and at the bid evaluation and verification stage. ⁵¹ Costs and efforts are considerable in the case of life-cycle assessments if developed for the purposes of a single contract. ⁵² GPP is often associated with increased complexity in contract award, due to the higher technical and documentation requirements. ⁵³ Further, and on a more general level, adding complexity to award procedures can have a negative effect on competition and sometimes encourage procurement litigation ⁵⁴ and have a positive correlation with delays and higher costs. ⁵⁵

A survey from 2006 conducted among purchasers demonstrated that procurement experts are poorly equipped to enforce sustainability. ⁵⁶ The increased expertise requirements for applying green criteria in public procurement has been one of the drivers of recently introduced EU Commission’s public buyer professionalization recommendation ⁵⁷ and competency framework ProcurComp^EU. ProcurComp^EU identifies 30 key competences of public procurement professionals and aims to support public procurement as a strategic function that channels public funds for sustainable growth. ⁵⁸ Other EU initiatives can also be viewed as an attempt to reduce transactions costs and to boost the legal certainty of GPP. These include among others the common EU GPP criteria for certain product and services categories that the EU Commission has developed since 2008. ⁵⁹ Further, the attempts to create a general life-cycle costing methodology and model are aimed at reducing the administrative burden and costs for all parties and increasing legal certainty of the complex model, although so far the progress is seen as being too slow. ⁶⁰

2. Contract price

Using GPP criteria may increase contract prices. It is clear that environmental protection does not come without a cost. Thus, it is a general assumption among contracting authorities that green products and services cost more than conventional alternatives. ⁶¹ GPP is not necessarily more expensive by default, if considering the whole lifecycle of the product or service, but the price variation as well as the frequency of using GPP depends on the product and service category. ⁶² However, to the author’s knowledge, there is no extensive empirical research on the GPP’s price impact across different product and service categories, although recent research indicates that public authorities indeed pay a price premium for GPP. ⁶³

Sustainability efforts are not free of charge. On the other hand, in the case of public procurement, price cannot be irrelevant either. Public procurements are financed by taxpayers’ money for the common good and these funds should be used in a responsible and effective way. Therefore it can be argued that the requirement on public sector accountability sets some limits on the costs of GPP. In research literature it is often submitted that, by combining environmental aspects, price and quality, the best value for taxpayers’ money can be gained. ⁶⁴ So far there has not been discussion on what can be perceived as an acceptable price premium from the perspective of accountable use of public funds.

Moreover, in order to reach the ideal best value for money by using GPP, there should be some certainty as to the investment’s positive impact on the environment. Unfortunately the evaluation of GPP’s environmental effects is difficult due to the lack of public statistics, lack of controlled experimentations of purchases on alternative criteria and uncertainties of different calculation models. ⁶⁵ Examples from Sweden suggest that GPP can be considerably more expensive than the conventional alternative. Empirical research on Swedish data revealed that an organic food basket was 65.6% more expensive. ⁶⁶ The price premium can in some cases be much more than that. Another example from Sweden revealed that a carbon neutral pre-school building cost 5–7 times more than a conventional one. ⁶⁷

Nonetheless, it is important to point out that there are also a lot of GPP criteria that do not necessarily increase contract pricing, such as measures for the circular economy that do not add requirements as such, but rather aim to extend the lifespan of a product (availability of spare parts, maintenance and education on proper use as well as recycling) or increased use of leasing and hiring of products. ⁶⁸

Alhola et al. submit that using ambitious GPP criteria gives suppliers a signal that can be translated into innovations, but this requires understanding of the current status and potential of the market and its technological development. ⁶⁹ This approach is adopted also within the Finnish National Procurement Strategy, which sets an objective that 10% of all procurements were to be innovative. ⁷⁰ Markets tend to respond if there are business opportunities, but there is a risk that the cost of such product or service can skyrocket when economic operators transfer the expenses of the innovation development to public buyers. ⁷¹ Thus, procuring green niche innovations also requires an understanding of the expenses of innovation development as well as of its impact potential. Moreover, if the main purpose is to support investments or R&D for novel green technologies, direct funding possibilities through an innovation fund or different state aid instruments could be considered as an alternative. ⁷²

Another concern relating to the costs of GPP is the lack of transparency and data on the environmental price premiums. Contracting authorities are often unaware of the actual price tag of the GPP criteria they have applied. This is mainly due to two reasons. First, in the event, where GPP criteria are used as mandatory requirements, only companies fulfilling such requirements can submit a bid. Thus, the market price of a conventional alternative remains unknown as well the potential savings that could have been realized through enhanced competition. ⁷³ Second, if GPP criteria are used as contract award criteria, the transparency of its effects on contract prices is subject to the contracting authority’s expertise and the scoring model used. Bid evaluation models that are based on points and relative comparison to scores of other submitted bids, rather than choosing a winner on the basis absolute monetary values, are seen to compromise GPP’s cost transparency and to result in unequal and false outcomes from the perspective of choosing the ‘most economically advantageous tender’. ⁷⁴

3. Indirect costs: competition and consumer markets

Sometimes, as discussed above, even the direct costs of GPP can be hard to detect. However, the impact of GPP on transaction costs and contract price is easier to measure than the potential cost effects that they may generate on the markets. One of the European Commission’s major concerns in public procurement relates to the functioning of the markets and the level of competition. ⁷⁵ GPP likely has an effect on competition. ⁷⁶ Mandatory requirements such as eco-labels or certain production standards limit the pool of potential tenderers. On the other hand, even the use of non-mandatory GPP criteria can disincentivize conventional economic operators from participating due to the lower likelihood of winning the contract. Sanchez-Graells is one of the few legal scholars that currently call for further promotion of the principle of competition, even in the sustainability context of public procurement. He stresses that public procurement’s role in supporting economic development, including socially responsible and sustainable growth, is conditional on its ability to promote the maximum degree of competition and being open to market-led innovation. ⁷⁷ His views align well with the law and economics tradition discussed earlier: in market-based regimes, regulation’s effectiveness is conditional upon the economic incentives of market operators. Similar concerns relating to competition have been presented in the context of social public procurement by Trybus, who submits that ‘social objectives are nevertheless important considerations which governments and legislators must not neglect. However, there are many alternative and better suited instruments to promote social considerations – inter alia criminal law, labour law, tax law, or State aids (subsidies)…’. ⁷⁸

Assessing markets’ reactions to GPP criteria is difficult. The rationale behind GPP assumes that markets will respond to the use of GPP and sustainable development follows. ⁷⁹ As participation in public contract awards is voluntary for economic operators, it is likely that the use of GPP will reduce competition as conventional product suppliers refrain from bidding. ⁸⁰ Further, if applications of GPP criteria are random and approaches adopted by different contracting authorities vary, the incentive factor often associated with GPP can be diminished. Thus, standardized, unified approaches such as general EU GPP criteria and sectoral legislation could be viewed as more direct and appealing ways to pursue sustainability goals. ⁸¹

The potential negative effects of GPP on competition are particularly problematic in the light of current concerns relating to already existing low level of competition in public procurement. According to the Commission, the competitive process on which public procurement relies to achieve best value for money is either not present or it is losing intensity. Between 2006 and 2016, the number of contract awards with only one bid has grown from 17% to 30%. The average number of offers per tender fell from five to three in the same period. ⁸² The trend is similar across Nordic countries: the level of competition in Finland is overall very low, with the median number of bidders being only two, ⁸³ and similar results have been reported for Sweden. ⁸⁴ In a recent research report on competition in Swedish public procurement, Halonen and Tukiainen submit that the complexity of procurements and bidding costs (combined with the uncertainty of winning) are among the top reasons for not bidding in public contract awards. ⁸⁵ Our finding are important, as competition is crucial for the functioning of the whole public procurement regime and its ability to produce value for money. ⁸⁶ Increased competition generates also savings: increasing competition by one bidder is associated with a 5–10% decrease in procurement costs. ⁸⁷

Public authorities are on the one hand encouraged to promote ambitious green innovations through public procurement, but also on the other hand to concentrate their purchases on green alternatives, when such products or services are available. In the latter case, the focus is not so much on expediting green transformation as on leading by example and reducing the emissions of a single contracting authority. It has also been suggested that concentrating public purchases on green products will lower the price of sustainable alternatives and improve their availability for others, ⁸⁸ and encourage others to be more concerned about the environment. ⁸⁹ However, economic substitution policy sheds doubt on such conclusions. It proposes that amendments in public sector purchasing policies may also lead to changes in private consumer consumption. If the public sector is concentrating its purchases on green products, the producers of conventional products need to attract customers elsewhere, if they wish to stay in the business without green investments. ⁹⁰ Private consumption is not led by purchasing strategies and it is susceptible to changes in the event of price reductions. In other words, if the price gap between green and conventional products increases, private consumers that previously bought green products may adapt and start consuming conventional options. ⁹¹ Thus, GPP can lead to significant price reductions of conventional products and subsequently result in increased demand from private consumers. Substitution policy is supported in different economic studies demonstrating that increased consumption of green products risks inflicting a counterproductive effect among private consumers and compromising the positive environmental effects of GPP. ⁹² Therefore, it is submitted that potential substitution behaviour of private consumers should be closely monitored in the future and in particular if current proposals on the imposition of green purchase obligations on contracting authorities and making the current EU GPP criteria mandatory become a reality.

4. Environmental impact

The size of the public procurement market and consequently the purchasing power of the public sector has been viewed to support GPP’s role as an effective policy instrument. ⁹³ There is a worldwide trend to use public procurement as a tool for environmental policy. ⁹⁴

Regardless of the size of the market, there are challenges in achieving sustainable goals through public procurement, which have been demonstrated in economics research both at the level of theory and empirical findings. Public procurement rules and practice have developed over the past decades to a regime of multiple objectives. The purpose is no longer only to ensure transparency and the effective use of public funds or receiving value for money for contracting authorities and users of public services. Instead, public procurement has transformed into an instrument for promoting societal change.

Recently, legal scholars have called for mandatory GPP elements to be included to public procurement rules. ⁹⁵ Such approach can be justified through the interpretation of EU law and policies, but multiobjective public procurement appears problematic from the perspective of the economic ‘Tinberger rule’. The Tinberger rule, developed in 1952, also known as the rule of thumb, is a mathematic rule according to which each policy objective should be targeted with a specific instrument. ⁹⁶ In case multiple objectives are subject to the same instrument, their efficiency is compromised. Recently, the Tinberger rule has been applied in economic research on GPP and as a result GPP was not considered as an effective environmental policy instrument. ⁹⁷

GPP’s effectiveness is subject to its ability to lead polluting firms to invest in less polluting technologies or products. In order to achieve environmental impact, it is necessary, according to Lundberg and Marklund, that the requirements go beyond the market’s current environmental standard. ⁹⁸ So far GPP’s ability to drive such green transformation has been considered limited, but instead it has focused on buying already green products. Also there seems to be ambiguity regarding which environmental targets the use of certain GPP criteria aims for. ⁹⁹

The growing importance of GPP has also increased research literature on topics related thereto, but most of these have concentrated on the policy and regulation or practices and uptake views. Research literature that draws an optimistic and positive views on the environmental impact of GPP are usually based on case studies, literature reviews or some qualitative interviews, ¹⁰⁰ whereas economic theories and quantitative empirical research have provided a more reserved view. Research on GPP’s effectiveness is nonetheless still very limited and especially more empirical research is needed. ¹⁰¹ The limited amount of empirical research can be in part due to the lack of common eProcurement systems, lack of detailed bid level data or due to the limited access to such data, but situation is improving through better access and AI. ¹⁰² Lundberg et al. studied the effectiveness of GPP criteria in cleaning service contracts. The research was based on a vast Swedish bid level dataset. The research concluded that GPP criteria are often non-binding and do not create incentives for bidders to drive a green transformation. Green criteria also had a weak effect on supplier’s environmental performance. ¹⁰³ In California, results from the construction sector suggest that a large-enough buyer can drive some change to speed up green building standards in the private sector. ¹⁰⁴ Similar, more encouraging results were found by Lindström et al. regarding GPP’s ability to drive conversion of farmland into organic production. In the latter, the positive correlation between purchasing strategies and conversion of farmland was mostly due to the unified approach adopted by all Swedish municipalities. ¹⁰⁵ Based on these two, more promising examples of GPP’s ability drive green transformation in the markets, it can be argued that if GPP is to be used as a policy tool, public buyers’ purchasing power should be harnessed towards a common EU or national set of GPP criteria applied by all contracting authorities and designed for the specific industry in order to send a clear signal to market operators instead of random, heterogenous and at times conflicting ad hoc criteria applied by different contracting authorities. This would be beneficial also from the perspective of minimizing transactions costs for both parties. Nonetheless, such systematic approach also has its disadvantages and risks relating to the substitution of private consumption as discussed above. Sectoral legislation that would set a higher, industry-wide environmental standard for all suppliers, and not only those supplying the public sector, would be the most effective way forward because it would not leave room for demand substitution. On the other hand, substitution risks depend on the private consumption share of the relevant market. In limited private consumption markets, for instance within healthcare in countries with state-funded provision, substitution risks would be significantly lower than for cleaning products for instance.