Innovation and Technology Absorption for Growth Forum Closing Remarks

1. Innovation and Technology Absorption for Growth Forum Closing Remarks Fernando Montes-Negret, World BankSector DirectorPrivate and Financial Sector Development DepartmentEurope and Central Asia Region, The World Bank Knowledge Economy Forum V, Prague, March 2006

2. Innovation and Absorption “Under capitalism, innovative activity - which in other types of economy is fortuitous and optional - becomes mandatory, a life and death matter for the firm.” *W.Baumol, The Free-Market Innovation Machine ‘The ability of a firm to recognize the value of new, external information, assimilate it, and apply it to commercial ends is critical to its innovative capabilities. We label this capability a firm’s absorptive capacity and suggest that it is largely a function of firm’s level of prior related knowledge.” *Cohen and Levinthal, 1990, Absorptive Capacity: A new perspective on Learning and Innovation.

3. Closing Remarks: Outline • Global Pressures on the ECA Region • Major Supply Shock: China and India; EU Accession & commodity prices shock (energy) • Role of Government in Fostering Innovation: Enabling Environment and Proactive Interventions • Coordination Failures and Economic Incentives Regime • Cooperation, Competition & Intellectual Property Rights • Intervention in Innovation Markets • Technology Transfer and Absorption • Human Capital Development • Reforming HEIs and R&D Institutes, Reversing Brain Drain • Setting up the necessary Information Infrastructure • Lessons Learned

4. Global Pressures Faced by ECA Region • Increasing globalization and new global players: • Competing effectively in an enlarged EU market • Mobile FDI bypasses restrictive national policies • Increasing labor mobility, but with relatively high unemployment and slow growth (w/exceptions) • China and India: new global players climbing rapidly the value chain, raising both new challenges and opportunities. Is ECA prepared? • Limited Choices: Source of (not so) cheap labor? Or Source of (Market & Inside-Oriented) Innovations?  DevelopingDynamic Comparative Advantages, more flexible organizations & Niches

5. Diagnostics • Growth is largely driven by technological change and innovation (TFP) and not by factor accumulation. But successful innovation does not guarantee faster growth. • Competitive pressures main source of innovation. • Most revolutionary innovations come from upstarts & incremental innovations from large, established cos. • Social returns of R&D exceed private returns => Under investment in innovation => Need for smart government intervention.

6. Policy Instruments • Proactive and market friendly public policies • Government intervention to foster innovation: • R&D: A binding constraint to growth? Maybe. • R&D necessary but not sufficient condition. • Successful cases available (e.g. Fundacion Chile) • Alsorisks of wasting public scarce resources. • Design of incentive-compatible financial instruments.

7. Under competitive pressure the new Wealth of Nations depends on … …their ability to learn …their ability to deliver (reforms) …their ability to adapt (to new challenges) …their ability to attract (capital, knowledge, human ressources) …their ability to sell (on domestic and foreign markets) © kgretschmann

8. Other Factors Affecting Innovation • Dealing with local and global spillovers • Size matters! • Importance of General Purpose Technologies as engines for growth  Developing Absorptive Capacity • Protection of IPRs  Importance of technology trading and technology transfers • IPRs  Granting temporary market power in exchange for ex-ante investments  Watch competition policy

9. Risks • Inability to satisfy rising expectations, while wasting scarce public funds  Brain drain • Danger of creating dual economies (high & low productivity sectors, youth unemployment, worsening personal & regional income distribution) • Inability to adapt fast enough to change Institutional rigidities, rigid labor markets & unresponsive HEIs • Large transition costs & dislocations  Political and institutional constraints to implement policies • Difficulty in compensating losers • Demographic factors  Rapid aging of population

10. India: Driving Forces for Change • Historical coincidences (path-dependent) • Structural and systemic factors: • Human resources • Institutional networks (clusters) • Diaspora (non-resident Indians) and market linkages • Government support (or non-interference) • Towards a Knowledge Economy • Spreading the base • From services to manufacturing & new ventures in high-tech areas • Establishing Competitiveness • In several sectors have gone through one cycle of industrial reform and restructuring, Automotive, auto components, & Pharma • Measures of Competitiveness • Innovation is now the challenge • Patenting activity • New product launches Patwardhan

11. India: Key Policy Issues • Government as a customer (Procurement) • Making public-private partnership work • Leveraging and using publicly funded RDIs • Effective national innovation system requires coherent synergy amongst different elements • Focus on interface structures, mechanisms and organizations (coordination and sequencing) Patwardhan

12. Lessons from India’s IT Sector • Excellence in industrial age was not prerequisite for success in knowledge age – Leapfrogging an option • Success in one part of knowledge economy drove development and success in other parts • Creating right environment for a new industry was easier than dismantling / rebuilding for existing industries – overcoming vested interests • Government’s supportive measures enabled growth (but otherwise the government stayed out of the picture) • First-generation entrepreneurs, often not from traditional business background • Importance of role models • This is perhaps a lasting benefit of the dot-com boom & bust Patwardhan

13. China: A Strategic Approach to Reform… • Reform strategy • Gradual reform with flexibilities; • Experiments, feedback, and expansion; • Creating incentive regime for R&D organizations to serve economic development: from public institutions to businesses; • Competition mechanisms and declining budget for RDIs; • Learning from abroad. • Changing roles • Initial focus on diffusion and application • As China developed, knowledge generation becomes increasingly important. Xue

14. China: A Strategic Approach to Reform… • Initial international competitive reform pressures: • For Chinese industrial sectors to upgrade; • The emergency of knowledge economy; • Reforming of the national innovation system (consolidation of research institutes from 120 to 80) • Reform and decentralization of HEI management • dramatic increase in university enrollment (from 6.4 million in 1998 to 12.1 in 2001). • WTO accession • Current internal pressures (environment, regional disparities, urban-rural) stimulate further reform Xue

15. China: A Strategic Approach to Reform • Practical, rather than ideological or orthodoxy; • Debates 1978, 1992, current debates • Political stability and policy consistency; • Policy changes in magnitude but not in major directions; • Gradual reform with determination: • e.g. changing the status of public research institutes • Creating a learning cycle: opening up and reform: • Opening up => new ideas and new forces to push for reform => more reform create more rooms for opening up; • Never under estimate the positive externality generated by opening up. Xue

16. Economic Incentives Regime • Innovation is a complex activity that needs sophisticated institutional settings and incentives for various actors (IPR, financing, international trade and FDI, market structure). • An important element of the national innovation system is competition policy and the interplay between competition and innovation. • Schumpeter argued monopolists are the most vigorous innovators, new research (Baumol) argues that competition (or its threat) might be a stronger incentive for innovative activity. Incumbent firms likely to be routine innovators, new market entrants as revolutionary innovators. Willig, Gretschmann

17. ©Intellectual Property Rights • Markets for knowledge are subject to failure: IPR as a Market-based solution… ...caution ! Risk of holding back technological progress. • The objectives of an IPR regime are stimulation of investment in innovation; knowledge diffusion and creation; and the creation of markets for knowledge. • Relationship between patent rights and per capita GNP seems to imply that as countries grow richer, the need for protecting IPR also grows. • IPR regimes need to be embedded into policy systems for innovation, competition and development, and not as stand alone policies. ©Maskus, Finger, Dezhina

18. Intellectual Property Rights ® Maskus, Finger, Dezhina

19. The Role of the Government in Supporting Innovation and Technology Absorption • Market failures in the creation of knowledge (information asymmetries, partial appropriability) result in less than socially optimal investment in innovation. • Innovation as a continuum, with creation of new products at the technology frontier and absorption of existing technologies further down the line – both need investments in R&D (public and private). • Principles for government intervention in innovation markets: • Neutrality of Intervention (incentives) • Attention to the Institutional Environment • Additionality of funds. Trajtenberg, Goldberg

20. The Role of the Government in Supporting Innovation and Technology Absorption • Financial instruments: • Matching grants, mini-grants, venture capital; • Tax incentives, procurement preferences; • Non-financial instruments: • Incubators, business support services, technology parks, etc. • Government interventions should take institutional setting into account and address problem areas. Trajtenberg, Goldberg

21. The Role of the Government in Supporting Innovation and Technology Absorption Trajtenberg, Goldberg

22. EU: Avoiding Coordination Failure (Lisbon 2) Spill over effects (across borders) R&D Interdependence (No independent decision making) Complementarities Product market reforms( EC) Coordination (structural reform) Labormarket reforms (Nat) • Learning (from each other) • Cross-country comparisons • Benchmarking Gretschmann

23. Technology Transfer through FDI • Research shows that economies generally benefit from FDI, regardless of determinants. Stability, competition, infrastructure are critical to attract FDI but investment and incentive policies do not work. *MGI • FDI benefits arise from increased competition, product and process imitation, new management approaches and backward and forward linkages. But adoption of new technologies, processes, etc. is not free of cost. Countries have to invest in their absorptive capacity to benefit. Remes, Klusacek, Broseta, Cordua

24. 300 250 200 150 100 50 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 Technology Transfer through FDI… • FDI Inflows have increased exponentially since the early 90s. Inflows, US$ billion Remes, Klusacek, Broseta, Cordua

25. Technology Absorption • Innovation is critical for firms of all sizes and technology intensity. • SMEs struggle to internalize R&D – outsourcing an option. • Local government support • Learning & adapting technologies proven abroad • Public endowment, private incentives, clear exit strategy • Fundacion Chile • Adequate upgrading of skills and tax benefits • Honeywell, Skoda, Technology Centre AS CR • Importance of Learning from mistakes and developing home grown solutions to promote innovation, technology absorption and encourage start-ups • TTGV Turkey Remes, Klusacek, Broseta, Cordua

26. Higher Education Reform… • “Mass higher education is forcing universities to become more diverse, more global and much more competitive. A more market-oriented system of higher education can do much better than state-dominated model.”*The Economist • HEIs cannot - and will not - reform alone… competition and more comprehensive reform required. Universities will need to be more flexible, change oriented and responsive to needs of individuals and economic interests (good example is MMU in Malaysia, discussed in the Forum, with its technopreneurship program) • Tuition fees politically difficult, but means to increase access and quality of tertiary education. Magrath, Crawley, Kolar, Tam, Paces

27. Higher Education for Innovation Examples of necessary flexibility: • Acts modeled on Bayh-Dole being adopted to facilitate commercialization of university research conducted in partnership with private sector and TTO (Technology Transfer Office). • Science Foundation Ireland key component in this strategy • Located in enterprise ministry, not education ministry • Foster academic-industry collaboration • Target industries; biotechnology and ICT • Competitive funding decisions, emphasize quality, international reviewers. Flexible funding tools Magrath, Crawley, Kolar, Tam, Paces

28. R&D for Innovation • Universities are taking on a new role, as entrepreneurs and direct contributors to economic development (engaging in in partnerships with industry, establishing spin-off companies and patenting research results). • Incentives structures within universities must also be changed to ensure that they contribute to their new role as entrepreneurs and direct contributors to economic development. • The Way Forward… • Enabling Environment/IP • Performance Based Funding • Entrepreneurship & Researcher Training • Technology Transfer Offices • Public Private Partnerships Holm-Nielsen, Lindqvist, Janecek, Campbell

29. From Brain Drain to Brain Gain • Migration: a complex social and economic phenomenon. • Migration of the highly educated: • a significant loss to countries, but could result in potential gains • Deterrence of migration not an option. Rethinking options. • Recent research has shown that migration of highly skilled people can also have positive effects: • Incentives to get educated • Benefiting from diaspora • Returning of migrants with new skills • Remittances • Options: Attract Skilled Migrants / Finance Education Abroad • Fresh Talent Scotland, ImigraCzech vs. Bolashak Kazakhstan Caglar, McDonald, Andrasova, Roman

30. Lessons learned • Most growth is created by innovation and technology change rather than factor accumulation. This has implications both for employment creation and standards of living. • The world is moving fast (China, India), with our without the participation of ECA countries. To benefit from globalization and economic flows, ECA countries have to become more competitive and innovative. • There is a rationale for government support for private sector R&D efforts, but also a danger that resources will be wasted. Therefore support instruments have to be carefully designed.

31. Lessons learned • Governments should also work on designing a conducive national innovation system, where the right economic incentives and a friendly business environment play a major role – within those, competitive pressures should take priority given new research results on the interplay between competition, innovation and growth. • The analysis of China and India’s experience with technological upgrading is important to understand what worked and what didn’t in these countries and what could be replicated in ECA countries. • Another key aspect of the national innovation system is education – specifically higher education. There is a clear trend towards new or reformed models of higher education, making universities more flexible and responsive to societal needs as well as increasing the links with the private sector.

32. Lessons learned • Universities are being asked to play a new role as an active economic actor (technology transfer, patenting, partnership with industries, spin-off companies, etc.). This will clearly need new structures and incentive schemes. • A major source of technological upgrading has been the absorption of foreign technologies (FDI, trade, etc.). Absorption of foreign technologies is not free of cost and certain policies may be detrimental to economic flows and technology absorption (e.g. local content requirement). • Countries are following different paths to increase technology absorption (Chile, Romania, Czech Republic, Spain), but they all are very specific attempts at increasing the absorptive capacity of the economy.

33. Lessons learned • Another hot topic is the issue of brain drain/ brain gain. It looks like there is very little countries can do to prevent people from moving. Win-win strategies would be to actively try to offer more opportunities at home and to increase links with the diaspora. • Intellectual property rights is one instrument countries can use to encourage knowledge creation and innovation. Current support instruments seem to be appropriate to incentivate innovation in ECA countries, although some tailoring to local characteristics would be necessary. • Caution ! Too stringent IPR regimes can hamper competition. • While protecting inventors is important, well functioning technology markets are key for technology diffusion.