Dr Alejandro Riaño, from City's Department of Economics, unpicks the Labour Party’s plan to award more public contracts to British companies
The Labour Party has unveiled “make, sell and buy more in Britain” as its post-Brexit vision for the UK. As set out by shadow chancellor Rachel Reeves, one of the key proposals is to use public procurement more strategically to award a greater number of public contracts to British companies. As she put it, we should be “rethinking how we support our businesses”. Unfortunately, it’s not going to work.
The UK spent £290 billion on public procurement in 2020. At about 14% of GDP, this is only likely to keep growing as a result of the government’s response to the COVID-19 pandemic. So why not do as Labour says and ensure that more of it goes to British firms?
First, this is not a new idea. Tilting the playing field in the process by which governments purchase goods and services from the private sector to discriminate against foreign goods, companies, workers and investors is known as a “behind-the-border barrier” – or more plainly “murky protectionism”.
The US has for example introduced numerous “buy American” laws over the years, going back as far as 1933. Notably Barack Obama’s American Recovery and Reinvestment Act of 2009 required steel and iron purchasing to be from US producers. This was a watered-down version of what was originally a wider initiative, which was scaled back because American companies feared retaliation from other countries.
Even without retaliation, taxpayers are likely to end up footing the bill with such a procurement plan, and economic activity shifts towards domestic producers who otherwise would not be competitive enough to win the contract. This inefficiency potentially has knock-on effects for healthier domestic players, say by reducing the number of people looking for jobs or by driving up demand for factory units and therefore increasing rents. In the case of the Obama initiative, one piece of research later suggested it did little to help the American steel industry, anyway.
As for the question of other countries retaliating, it’s akin to the famous prisoner’s dilemma where two bank robbers have been arrested and have to decide whether to testify to their crimes to the police without knowing what the other will do. If both say nothing, they can both only be convicted on a lesser charge with the lightest sentence. If one testifies and the other stays silent, the first can potentially walk free while the second faces a maximum sentence. But if they both testify, they both face a middling sentence.
In the present case, the UK and a given trading partner are both better off if they don’t introduce nationalist procurement rules. However, if the UK does and the second country does not, the second country will be worse off than if they both introduce such rules. In other words, following Labour policy will probably lead to retaliation from other countries.
But the problems do not stop here. The UK is a signatory to the World Trade Organization (WTO)‘s Agreement on Government Procurement, which guarantees that suppliers based in countries that are parties to the agreement are not discriminated against.
And beyond WTO rules, the trend is towards deep free-trade agreements that introduce more detailed rules on procurement. For example, the Brexit agreement between the UK and EU guarantees mutual access to each other’s procurement markets in certain areas, such as hospitality, property and education services. More broadly, the UK has notified 39 free-trade agreements to the WTO since 2020, with more agreements on the way. This may well mean that the scope to award more contracts to British firms will be curtailed.
At the same time, potential gains for British companies are likely to be small because a strong home bias already exists in public procurement. The UK procured only 13% of its total £1.3 billion of spending from international suppliers in 2019-20, compared with 12% the year before.
One of the most celebrated tenets of trade policy is the principle of targeting. Roughly speaking, it states that the most effective policy to correct a market failure is one that acts most directly on it. If the policy’s ultimate objective is to create jobs and improve the dynamism of British businesses, there are more direct ways to achieve this. The apparent corruption in some of the UK’s COVID procurement contracts for PPE (personal protective equipment), for example, would be a good place to start.