How to fix the EU’s R&D statistics

The latest Eurostat data shows Europe is not delivering on the Lisbon target of boosting R&D spending to 3 per cent of R&D. So what is to be done to reverse this situation, spoke to Bruno van Pottelsberghe, senior fellow at Bruegel, a Brussels-based think tank, and professor at ULB-ECARES.

Most member states in the EU have reduced public spending on R&D over the past decade, even though they claim to support ambitious EU-wide goals such as the target of three per cent of gross domestic product for public and private sector R&D spending by 2010, says van Pottelsberghe in his paper, “Europe's R&D: Missing the Wrong Targets.”

The European Commission’s benchmarking of member states’ R&D intensity against the headline three percent figure is questionable because such comparisons fail to take into account the effect of industrial specialisation in different countries. National economies focused on agriculture, tourism or financial services need to spend less on R&D than ones with developed IT, biotech or pharmaceutical sectors.

But this factor alone cannot explain why hi-tech Sweden outspends other countries by such a wide margin, both in terms of public and private sector R&D intensity. The reason is Sweden's superior academic research environment, demonstrating how government spending on academic research acts as a magnet for industry-funded research.

Finland too, has had this insight, and other countries should follow their example by investing more in their universities, instead of spending money on public research projects that have little spin-off effect on the private sector.

As the Science|Business article on the Lisbon targets (No progress on Lisbon target as R&D stays put at 1.84 per cent of GDP) shows, the intensity of R&D spending across EU member states varies considerably. While Finland and Sweden sailed past the three percent Lisbon target, Denmark, Austria and Germany are at around 2.5 per cent and France is just above 2 per cent.

However, the vast majority of countries have an R&D intensity of well below 2 per cent, fluctuating between 0.5 per cent and 2 per cent of GDP, with a median of 1.2 per cent. While such a broad range of intensities is also observed within the US, median R&D intensity is much higher than in Europe.

And the best European performer, Sweden, has an R&D intensity which is less than half that of the top US performer, New Mexico. Seven US states have an R&D intensity higher than 4 per cent, against none for the EU.

Trends in the R&D-to-GDP ratio provide an interesting insight into how active countries have been in actually devoting one percent of their GDP to funding public (higher education, laboratories) or business-channelled (subsidies and procurement) research activities. The only countries that are close to the one percent target are Sweden, Austria and Finland.

Second, despite the Lisbon agenda, a large number of countries have actually reduced their government funding of R&D as a percentage of GDP. The aggregate EU27 government-funded R&D intensity fell between the mid 1990s and 2005. Interestingly, a drop also occurred in the US and Japan over the same period. But while this was largely compensated for by a more than proportional increase in business-funded R&D, this was not the case for the EU27.

How can Europe stimulate business R&D? 

So the burning question is: How can Europe stimulate business R&D? The key driver of course is the expected return on the investment. What would improve this expected return?

Beside fashionable R&D tax credit or direct subsidy policies designed to reduce the cost of carrying out R&D, two specific policy areas deserve particular attention in Europe.

The first is an integrated market for innovation. Larger markets would logically result in a higher expected return on investment in R&D. The market size hypothesis may explain why the US has an above-average R&D intensity (larger than its industrial structure would suggest). The US benefits from a huge and homogeneous market, with one main language and one regulation.

In Europe, sending a product from Amsterdam for sale in Brussels is still considered an ‘export’, whereas in the US a product made in New York and sold in Los Angeles is labelled ‘distribution’. There is a large body of evidence on how lack of European integration hobbles investment.

Another ingredient for growth is missing

An additional key growth ingredient is still missing: an EU-wide financing infrastructure for emerging companies. This is emblematic of the lack of market integration in the way the innovation system works in Europe.

The European patent system, and hence the European market for technology, is highly fragmented. The dismal story has been rehearsed many times: once a patent has been granted by the European Patent Office, it must be validated, translated, monitored and enforced in all relevant national patent offices. A European patent costs about 11 times more than a US Patent, and 14 times more than Japanese patent.

The failure to create an EU patent places a heavy burden on the shoulders of European innovators and entrepreneurs at the very beginning of the innovation process - a clear comparative disadvantage for Europe.

Another way to increase private R&D spending is to encourage more and better academic research. Market size may explain US performance with regard to R&D intensity, but it does not explain the performance of Sweden. The explanation here is probably linked to the relatively very high level of spending on academic research, which is the highest as a percentage of GDP in the whole OECD area.

This acts as stimulus for business R&D as universities generate new ideas which are then transferred to the private sector. The transformation of these ideas into products or processes requires further applied research activity and development. Not surprisingly, the four countries with the highest academic R&D intensities are also the four countries with the highest business R&D intensities.

Given that effective technology transfer systems are put in place, academic research is probably the most effective source of new ideas, which in turn induce further research in the business sector.

In this respect, the European Research Council (ERC), which provides merit-based fundamental research grants, is a recent positive example of what the EU can achieve.

Not only does academic research feed ideas to the market, but it also attracts more funding from the business sector and promotes the setting up of scientific clusters. For example, in the UK, universities with a high scientific output attract significantly more local and foreign research laboratories to their neighbourhoods.

This is important because gaining a technological edge is the main driving force behind foreign business R&D investment, be it in the US, in Europe, or elsewhere. In fact, large firms nowadays increasingly invest in emerging markets, which provide a high quality labour force at much lower cost than in Europe.

The important role played by academic research as provider of ideas to the business sector and as a driver of foreign R&D expenditure implies a need for relatively more resources to be devoted to higher education research activities.

A recent Bruegel Policy Brief on European universities underlines that Europe invests too little in higher education and that “European universities suffer from poor governance, insufficient autonomy and often perverse incentives.”

In addition to remedying these three failings, governments should also provide more funding for universities’ research activities. The alternative for Europe will be to lose related business research, and ultimately to lose business.