The Additionality of Public Support for Innovation: Evidence for Irish Manufacturing Firms

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The Additionality of Public Support for Innovation: Evidence for Irish Manufacturing Firms

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2. Overview Economic & Policy Context Conceptual Basis Data source & research methods Discussion of Findings Key conclusions & policy implications

3. Regional & Policy Context Over the period considered here (1994 to 2002), Ireland and Northern Ireland experienced very different patterns of economic growth (Figure 1), suggesting marked changes in the market incentives for investing in R&D and innovation[1]. In Ireland – the Celtic Tiger – GDP grew by an average of 7.2 per cent per year from 1990 to 2000, while real GNP grew by 6.3 per cent per year, largely due to continued inward investment and re-investment in the high-tech sectors[2]. Northern Ireland, the 1990s was marked by more steady output growth of 3.2 per cent per year from 1990 to 1998, but this still compared favourably to growth rates in the UK (2.1 per cent pa) and EU (1.8 per cent pa) during the same period. (e.g. Morahan, 2002) [3]. From 2000 to 2002, the economic situation looked very different, however, with manufacturing output actually falling in Northern Ireland, while the rate of growth of output in Ireland slowed considerably (Figure 1). [1] For a detailed comparison see O’Malley and Roper, 2004. [2] GDP is conventionally used in making international comparisons. However, in the case of the Republic of Ireland GNP is generally regarded as more meaningful, since it excludes the substantial profits of foreign multinational companies that are withdrawn from the country. [3] UK and EU data from OECD Historical Statistics 1970-1999.Over the period considered here (1994 to 2002), Ireland and Northern Ireland experienced very different patterns of economic growth (Figure 1), suggesting marked changes in the market incentives for investing in R&D and innovation[1]. In Ireland – the Celtic Tiger – GDP grew by an average of 7.2 per cent per year from 1990 to 2000, while real GNP grew by 6.3 per cent per year, largely due to continued inward investment and re-investment in the high-tech sectors[2]. Northern Ireland, the 1990s was marked by more steady output growth of 3.2 per cent per year from 1990 to 1998, but this still compared favourably to growth rates in the UK (2.1 per cent pa) and EU (1.8 per cent pa) during the same period. (e.g. Morahan, 2002) [3]. From 2000 to 2002, the economic situation looked very different, however, with manufacturing output actually falling in Northern Ireland, while the rate of growth of output in Ireland slowed considerably (Figure 1).

4. Innovation Policy Interventionist Policy for R&D and Innovation “Without state support and incentives the degree of investment in technology will be less than is desirable from the point of view of national economic development” (Culliton 1992 p. 55). EU Objective 1 status ? capability dev, infrastructure, R&D Innovation Support Programmes – focus on indigenously-owned firms Our study period was also marked by significant changes in R&D and innovation policy in both Northern Ireland and Ireland, although in both areas the innovation policy regime remained strongly interventionist, justified in terms of broadly defined economic development objectives[1]. In Ireland, for example, the landmark Culliton Report of 1992, argued that “without state support and incentives the degree of investment in technology will be less than is desirable from the point of view of national economic development” (Culliton 1992 p. 55). Essentially similar policy rationales were evident in Northern Ireland, with both government reports (e.g. IRTU, 1992) and academic studies (e.g. Harris and Trainor, 1995) reflecting low levels of R&D and innovation and the perceived need for public intervention. EU Objective 1 status – which benefited both Ireland and Northern Ireland throughout most of the period considered here - was also an important influence in the support regime for innovation in both areas. In Ireland, for example, the Operational Programme for Industrial Development, 1989-93 provided funding for capability development, while the subsequent 1994-99 Operational Programme had a specific sub-programme for research and development[2]. In Northern Ireland too, EU funding was an important component of public support for R&D and innovation, directly funding infrastructure projects as well as providing co-funding for a number of regional innovation support programmes. Developments in R&D and innovation support later in the 1990s continued the focus on developing innovation capability in indigenously-owned firms. In Ireland, the RTDI scheme was launched in 1997, for example, with wide ranging objectives one of which was to introduce firms to R&D and innovation for the first time[4]. A similar emphasis has also characterised policy priorities in innovation support in Northern Ireland, with a focus on encouraging firms to engage in R&D and innovation for the first time. The Compete programme, for example, which provides support for near-market innovation ‘has always attracted significant interest from companies engaging in R&D for the first time and 54 per cent of … applications to the programme were first time users’ (Invest NI, 2003, p. 4). [1] Although see Lenihan, Hart and Roper (2005) on the ambiguity of objectives of much Irish industrial policy and consequent difficulties in ex post evaluation. [2] Cogan and McDevitt (2000: 11) describe EU involvement in R&D in Ireland as having been of ‘critical importance’ to Irish S&T policy. They describe three benefits of the EU involvement. Firstly, they cite the organisational and institutional learning it engendered. They state, rather philosophically, that Ireland missed out on the industrial revolution and somehow expected to catch up with other nations by using imported innovation and without building up a domestic innovation and R&D capability. Secondly, the EU structural funds brought with it a disciplined evaluation of policy, something which was missing from policy prior to this. Thirdly, rather than concentrating on research that had little bearing on Irish industry, the Structural Funds were geared towards stimulating a self-sustaining capacity for innovation. [3] See, for example, Roper (1998) on Compete and Roper (2001) for a more detailed overview of the innovation support regime in Northern Ireland. [4] Following some institutional changes in 1998, the RTI scheme was implemented through Enterprise Ireland, the agency specifically charged with developing the capacity of indigenous Irish firms.Our study period was also marked by significant changes in R&D and innovation policy in both Northern Ireland and Ireland, although in both areas the innovation policy regime remained strongly interventionist, justified in terms of broadly defined economic development objectives[1]. In Ireland, for example, the landmark Culliton Report of 1992, argued that “without state support and incentives the degree of investment in technology will be less than is desirable from the point of view of national economic development” (Culliton 1992 p. 55). Essentially similar policy rationales were evident in Northern Ireland, with both government reports (e.g. IRTU, 1992) and academic studies (e.g. Harris and Trainor, 1995) reflecting low levels of R&D and innovation and the perceived need for public intervention. EU Objective 1 status – which benefited both Ireland and Northern Ireland throughout most of the period considered here - was also an important influence in the support regime for innovation in both areas. In Ireland, for example, the Operational Programme for Industrial Development, 1989-93 provided funding for capability development, while the subsequent 1994-99 Operational Programme had a specific sub-programme for research and development[2]. In Northern Ireland too, EU funding was an important component of public support for R&D and innovation, directly funding infrastructure projects as well as providing co-funding for a number of regional innovation support programmes. Developments in R&D and innovation support later in the 1990s continued the focus on developing innovation capability in indigenously-owned firms. In Ireland, the RTDI scheme was launched in 1997, for example, with wide ranging objectives one of which was to introduce firms to R&D and innovation for the first time[4]. A similar emphasis has also characterised policy priorities in innovation support in Northern Ireland, with a focus on encouraging firms to engage in R&D and innovation for the first time. The Compete programme, for example, which provides support for near-market innovation ‘has always attracted significant interest from companies engaging in R&D for the first time and 54 per cent of … applications to the programme were first time users’ (Invest NI, 2003, p. 4).

5. Ireland: Support for R&D and Innovation

6. Northern Ireland: Support for R&D and Innovation

7. R&D and Innovation Grant Support €m pa Changes in the innovation support regimes of Ireland and Northern Ireland, and their increasing focus on developing innovation capacity in indigenously-owned firms, were also reflected in changes in the overall levels of government investment in R&D and innovation support. In Ireland, government support for R&D and innovation activity grew steadily through the 1990s from €5 m pa to around € 30 m pa (Figure 2), while that in Northern Ireland remained relatively stable at an annual overall level of around €25 m pa. Nb… NI from c. 1996 to 2001 although support for Near Market remained relatively stable, support for pre-competitive R&D reduced markedly. ROI – focus always on Near MarketChanges in the innovation support regimes of Ireland and Northern Ireland, and their increasing focus on developing innovation capacity in indigenously-owned firms, were also reflected in changes in the overall levels of government investment in R&D and innovation support. In Ireland, government support for R&D and innovation activity grew steadily through the 1990s from €5 m pa to around € 30 m pa (Figure 2), while that in Northern Ireland remained relatively stable at an annual overall level of around €25 m pa. Nb… NI from c. 1996 to 2001 although support for Near Market remained relatively stable, support for pre-competitive R&D reduced markedly. ROI – focus always on Near Market

8. Implications for Research Differences in economic & policy environments Ireland & NI Targeting of Assistance Policy focus on indigenously-owned firms Policy focus on stimulating non-innovators to innovate - 1st Timers This changing economic and policy context has important implications for our assessment of the effectiveness of innovation support measures. First, spatial differences in the economic and policy context in Ireland and Northern Ireland suggest the potential importance of allowing for location in our modelling strategy. Second, the priority given to supporting innovation in particular groups of firms, e.g. those engaging in R&D or innovation for the first time, is likely to introduce a potential bias into OLS estimates of the ATE suggesting the value of an instrumental variables approach (e.g. Madalla, 1983; Wooldridge, 2002). This is therefore explicitly allowed for in our modelling approach. Third, the focus of innovation support policy in Ireland and Northern Ireland on indigenously-owned firms suggests this group may be of particular interest in assessing policy additionality. This changing economic and policy context has important implications for our assessment of the effectiveness of innovation support measures. First, spatial differences in the economic and policy context in Ireland and Northern Ireland suggest the potential importance of allowing for location in our modelling strategy. Second, the priority given to supporting innovation in particular groups of firms, e.g. those engaging in R&D or innovation for the first time, is likely to introduce a potential bias into OLS estimates of the ATE suggesting the value of an instrumental variables approach (e.g. Madalla, 1983; Wooldridge, 2002). This is therefore explicitly allowed for in our modelling approach. Third, the focus of innovation support policy in Ireland and Northern Ireland on indigenously-owned firms suggests this group may be of particular interest in assessing policy additionality.

9. Rationale for Interventionist policy Additionality & effect on business performance (Griliches 1995; Mamuneas and Nadiri 1996) Reduce the cost of building up knowledge stocks (Trajtenberg 2000), enhancing business performance (Klette and Johansen 1998), ability to conduct future research (Mansfield and Switzer 1984, Luukkonen 2000) Development in Human Resources and innovation activity (Freel 2005) Absorptive capacity (Veugelers and Cassiman 1999, Cassiman and Veugelers 2002) Reputational or ‘halo’ effects (Powell 1998) R&D cost savings through collaborative R&D (Irwin and Klenow 1996) For policy makers – key issue is the extent to which public support leads to ADDITIONAL innovation & it is questionable the extent to which a single measure of additionality can capture the range of possible impacts – e.g.public support may encourage firms to commence innovation OR to increase the amount of innovation that they undertake. For policy makers – key issue is the extent to which public support leads to ADDITIONAL innovation & it is questionable the extent to which a single measure of additionality can capture the range of possible impacts – e.g.public support may encourage firms to commence innovation OR to increase the amount of innovation that they undertake.

10. Focus of this paper - Project-level Additionality … the decision of a firm either to abandon, go ahead with, or modify an innovation investment decision in light of the availability of public support. Extensive Additionality Incremental Additionality Radical Additionality A Priori – where the population of firms comprises a mix of those undertaking no innovation, those undertaking incremental innovation and those undertaking radical innovation, public support for innovation should have positive extensive, incremental and radical additionality effects. Paper – conceptual framework developed further – Marginal Revenue of Innovation and the Marginal Investment Cost of Innovation Extensive – probability that a firm introduced new or improved products over previous 3 years Incremental – porportion of new & improved products in firms sales Radical – proportion of new products in firms sales. Quality of the innovation produced, q. - this is examined as a continuous variable from 0 – no product change, to 1 new to the world product innovation. Increases in q then represent moves up the quality ladder as firms seek to improve the quality, complexity or sophistication of their innovation outputs. Expectation that improvements in product quality will command a market premium – therefore MRI increases as quality increases. In assessing MCI – 2 elements of this – fixed capital cost of innovation + a variable element which is an increasing function of innovation quality. MIC>MRI – no innovation – costs outweigh benefit MIC=MRI for some 0<q<1 – this is the break-even point with minimum investment cost MIC=MRI at q=1, - this is where the firm would optimally engage in new to the world innovation. Public support for innovation is typically offered as a proportion, say s, of total innovation cost. This will reduce the firm’s cost of achieving any given level of innovation quality to MIC=(1-s)h(q) and create the potential for additionality Where the firm is not innovating, public support – if sufficiently large to overcome the gap between MIC and MRI will encourage the firm to engage in innovation, moving to q1 - extensive additionality, encouraging the firm to undertake the innovation project when it would not otherwise have done so. NB.. in this scenario. First, the larger the grant offered the higher will be the achieved innovation quality, assuming additionality. Second, there is little possibility of deadweight in this scenario – i.e. the firm will not receive public support unless it is demonstrably engaging in innovation. more common - innovation active firm with innovation quality q0 - additionality outcomes depend strongly on the way in which the firm uses any public support for innovation. For example, on the positive side, if public support allows the firm to raise total investment in the project to MIC1 in Figure 4b, the potential exists for the firm achieve higher levels of innovation quality and unit revenues. Here, q1 would represent full (incremental) additionality and levels of innovation quality between q0 and q1 would represent partial (incremental) additionality. Radical additionality may also result here where the subsidy is sufficiently large to allow q1=1. Less positively, the firm might opt to use public support to reduce its own investment in innovation while maintaining innovation quality at q0. In this scenario, the effective innovation cost to the firm is MIC2 and, at q0, the firm is making additional revenue per unit of s.h(q), the average unit value of the public support (Figure 4b). This is a situation of deadweight as the public support is simply being used by the firm as a subsidy to its existing activities. In the situation described in Figure 3b therefore it is difficult a priori to predict the additionality profile which will result from public support for innovation: positive incremental additionality or radical additionality may result if firms can be encouraged to increase their investment in innovation; deadweight may result, however, if firms are either unwilling or unable to increase their innovation investment. Finally, in the situation where a firm is engaged in radical innovation (i.e. q=1) prior to receiving public support for innovation (Figure 3c), there is no scope for positive incremental or radical additionality. There is, however, scope for deadweight if public support for innovation allows the firm to maintain its level of radical innovation with lower private investment (e.g. MRI1 in Figure 4c). Paper – conceptual framework developed further – Marginal Revenue of Innovation and the Marginal Investment Cost of Innovation Extensive – probability that a firm introduced new or improved products over previous 3 years Incremental – porportion of new & improved products in firms sales Radical – proportion of new products in firms sales. Quality of the innovation produced, q. - this is examined as a continuous variable from 0 – no product change, to 1 new to the world product innovation. Increases in q then represent moves up the quality ladder as firms seek to improve the quality, complexity or sophistication of their innovation outputs. Expectation that improvements in product quality will command a market premium – therefore MRI increases as quality increases. In assessing MCI – 2 elements of this – fixed capital cost of innovation + a variable element which is an increasing function of innovation quality. MIC>MRI – no innovation – costs outweigh benefit MIC=MRI for some 0<q<1 – this is the break-even point with minimum investment cost MIC=MRI at q=1, - this is where the firm would optimally engage in new to the world innovation. Public support for innovation is typically offered as a proportion, say s, of total innovation cost. This will reduce the firm’s cost of achieving any given level of innovation quality to MIC=(1-s)h(q) and create the potential for additionality Where the firm is not innovating, public support – if sufficiently large to overcome the gap between MIC and MRI will encourage the firm to engage in innovation, moving to q1 - extensive additionality, encouraging the firm to undertake the innovation project when it would not otherwise have done so. NB.. in this scenario. First, the larger the grant offered the higher will be the achieved innovation quality, assuming additionality. Second, there is little possibility of deadweight in this scenario – i.e. the firm will not receive public support unless it is demonstrably engaging in innovation. more common - innovation active firm with innovation quality q0 - additionality outcomes depend strongly on the way in which the firm uses any public support for innovation. For example, on the positive side, if public support allows the firm to raise total investment in the project to MIC1 in Figure 4b, the potential exists for the firm achieve higher levels of innovation quality and unit revenues. Here, q1 would represent full (incremental) additionality and levels of innovation quality between q0 and q1 would represent partial (incremental) additionality. Radical additionality may also result here where the subsidy is sufficiently large to allow q1=1. Less positively, the firm might opt to use public support to reduce its own investment in innovation while maintaining innovation quality at q0. In this scenario, the effective innovation cost to the firm is MIC2 and, at q0, the firm is making additional revenue per unit of s.h(q), the average unit value of the public support (Figure 4b). This is a situation of deadweight as the public support is simply being used by the firm as a subsidy to its existing activities. In the situation described in Figure 3b therefore it is difficult a priori to predict the additionality profile which will result from public support for innovation: positive incremental additionality or radical additionality may result if firms can be encouraged to increase their investment in innovation; deadweight may result, however, if firms are either unwilling or unable to increase their innovation investment. Finally, in the situation where a firm is engaged in radical innovation (i.e. q=1) prior to receiving public support for innovation (Figure 3c), there is no scope for positive incremental or radical additionality. There is, however, scope for deadweight if public support for innovation allows the firm to maintain its level of radical innovation with lower private investment (e.g. MRI1 in Figure 4c).

11. Data Source & Methods Innovation (knowledge) production function I = Innovation output X vector of plant level control variables knowledge sourcing Market position Resource base Z binary treatment variable Instrumental variables approach Innovation production function – relating knowledge inputs to knowledge outputs. I = innovatio output X is a vector of plant level control variables Z is a binary treatment variable taking value 1 if the firm received public support for innovation and 0 otherwise. The size, sign and significance of the coefficient on the treatment term will give an indication of the adiditonality of public support. See page 10 – knowledge sourcing – R&D emp as % total emp supply chain and non-supply chain links – intensity scores Market position – size variable & its square production activity dummy variables Resource3s – part of group externally owned R&D carried out elsewhere in group. labour - % degree/ no qualifications capital investment relative to turnover. Innovation production function – relating knowledge inputs to knowledge outputs. I = innovatio output X is a vector of plant level control variables Z is a binary treatment variable taking value 1 if the firm received public support for innovation and 0 otherwise. The size, sign and significance of the coefficient on the treatment term will give an indication of the adiditonality of public support. See page 10 – knowledge sourcing – R&D emp as % total emp supply chain and non-supply chain links – intensity scores Market position – size variable & its square production activity dummy variables Resource3s – part of group externally owned R&D carried out elsewhere in group. labour - % degree/ no qualifications capital investment relative to turnover.

12. Irish Innovation Panel (IIP) 1991 – 2002 (analysis based on ‘94 to ‘02) 4 period postal survey Manufacturing plants >=10employees Avg response 34.5% c. 56% plants product innovators 12% sales new products 25% sales new and improved products c. 25% plants received public support for product dev.

13. Findings – Average Treatment Effects (ATEs) Indigenous – effects are universally positive but more strongly significant in Northern Ireland than Ireland – i.e. the effects of additionality were generationally stronger for extensive, incremental and radical in Northern Ireland than in irlean dover the period 3 possible explanations – Catch-up / consistence of support / level of support First, general levels of innovation activity in the population of firms were generally lower in Northern Ireland than Ireland over the sample period (Annex 1). This means that a larger proportion of firms in Northern Ireland were engaged in either no innovation or incremental innovation than in Ireland, increasing the potential for extensive, incremental or radical additionality among these firms. It also means that fewer firms in Northern Ireland were engaged in radical innovation, limiting the potential for further additionality. Both effects would tend to increase levels of policy additionality in Northern Ireland relative to those in Ireland. Second - potential explanations relate more directly to the consistency and level of public support for innovation in Ireland and Northern Ireland (Figure 2). In general terms levels of public support in Northern Ireland were more consistent than those in Ireland, creating perhaps a more stable planning environment in which firms were able to develop innovation projects. Possibly more important, however, Third - per employee basis public support for innovation in Northern Ireland (€225 per employee per annum) was more than double that in Ireland (€105 per employee per annum) over the 1994-2001 period[1]. [1] Average annual grant expenditure in Northern Ireland over the 1994-2001 period was €22.6m compared to an average of €28.31 in Ireland. Employment in Ireland in 2001 was 268,000 and in Northern Ireland was 100,186. Sources: Figure 1, Department of Trade, Enterprise and Investment, Belfast; Central Statistical Office, Dublin. Indigenously owned – smaller, more traditional sectors and less innovativen - key focus of policy – In reality – lower poprotion of indigenous firms received support for innovation esp in Northern Ireland… 19.7% indigenous to 27.5% externally owned Extensive additionality – positive and significant ATE – i.e. desired policy effect in increasing % of firms innovating Indigenous – effects are universally positive but more strongly significant in Northern Ireland than Ireland – i.e. the effects of additionality were generationally stronger for extensive, incremental and radical in Northern Ireland than in irlean dover the period 3 possible explanations – Catch-up / consistence of support / level of support First, general levels of innovation activity in the population of firms were generally lower in Northern Ireland than Ireland over the sample period (Annex 1). This means that a larger proportion of firms in Northern Ireland were engaged in either no innovation or incremental innovation than in Ireland, increasing the potential for extensive, incremental or radical additionality among these firms. It also means that fewer firms in Northern Ireland were engaged in radical innovation, limiting the potential for further additionality. Both effects would tend to increase levels of policy additionality in Northern Ireland relative to those in Ireland. Second - potential explanations relate more directly to the consistency and level of public support for innovation in Ireland and Northern Ireland (Figure 2). In general terms levels of public support in Northern Ireland were more consistent than those in Ireland, creating perhaps a more stable planning environment in which firms were able to develop innovation projects. Possibly more important, however, Third - per employee basis public support for innovation in Northern Ireland (€225 per employee per annum) was more than double that in Ireland (€105 per employee per annum) over the 1994-2001 period[1].

14. Plant-level variables All Firms Internal R&D Supply Chain Knowledge Linkages Skill Levels Capital Intensity Production activity Less important Scale, Ownership, Plant Vintage Indigenous FIrms Internal R&D Supply-chain Knowledge linkages Skill Levels Production activity Less important Scale, Vintage, Multi-plant group Internal R&D important – re… knowledge creation and absorptive capacity Internal R&D important – re… knowledge creation and absorptive capacity

15. Policy Implications Positive effect of public support for product development Extensive, incremental & radical additionality effects 1 Grant assistance is effective either in isolation or as part of a package of innovation support measures Other factors In house R&D and supply chain knowledge linkages Initiatives to strengthen internal R&D ? innovation and absorptive capacity 3 Initiatives to support knowledge linkages likely to also encourage innovation Organisational Context, skill base & capital investment 4 Measures to support skill development ? effectiveness of innovation through knowledge absorption & commercial exploitation

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