Going for growth

Alain de Serres, OECD

All OECD governments recognise the importance of encouraging innovation. After all, most of the rise in material standards of living since the industrial revolution has been the consequence of innovations, be they new or improved products and services or new and improved ways of producing them.

Unlike most other forms of investment, innovation is not something that can safely be solely left to market forces. Several factors reduce incentives for private firms to invest in innovation, precluding private investments from reaching socially optimal levels. The outcomes of innovation efforts are highly uncertain, especially in their early stages, making firms reluctant to invest sufficiently in research and development. In addition, firms face great difficulty in appropriating the economic benefits of their investments in innovation, while preventing their competitors from doing so.

To overcome these market failures and encourage innovation, a number of policy instruments can be put in place, including financial support for private R&D projects and funding for research in public institutions. Also, patent laws and other legally enforceable measures provide innovators with time-limited, exclusive rights over the exploitation of their innovation.

The innovation gaps widen

As shown in the second annual OECD report, “Going for Growth 2006”, most governments have made use of such instruments and yet comparable measures of innovation efforts show a wide dispersion across countries. The most common indicator, the total amount of R&D spending as a percentage of GDP (R&D intensity), varies from over 3 per cent in leading countries to less than half a per cent in lagging countries. And most of the variations actually come from R&D performed in the (private) business sector. Furthermore, the gap in business R&D between leading and lagging countries has, if anything, widened further since the early 1990s with the Nordic countries and Japan pulling further ahead.

Countries that have a relatively high R&D intensity include the Nordics, the United States, Japan, Korea and Switzerland, while low intensity is found in southern European countries, Central and Eastern European economies and Mexico. Even though the bottom end of the scale includes mostly lower-income countries, the relationship between R&D intensity and income levels is not so clear cut. For instance, English-speaking countries other than the United States do not rank particularly high on this measure, despite their overall good economic performance since the mid-1990s.  

Such diversity in efforts to innovate can be only partly explained by differences in public support for R&D performed in the business sector. In fact, countries use different mixes of tax incentives and direct subsidies for private R&D, but the effectiveness of individual instruments, which is highly contingent on their design and implementation, appears to vary significantly across OECD countries. For example, countries with the most generous tax incentive systems tend to be those with the lowest levels of business R&D intensity, such as Spain, Mexico, Portugal and Canada, suggesting the need for a careful evaluation of such programmes.

Governance makes a difference

Likewise, most countries invest vast amount of resources in public research, which to a large extent might not be undertaken by private firms given the lack of clear commercial benefits. However, the effectiveness of public R&D in fostering private R&D and overall innovation performance depends on the strength of industry–science linkages and the governance of public research organisations. Accordingly, innovation policy has more recently focused on improving institutional structures for funding and steering public research as well as on facilitating the transfer of knowledge and technology between the public and private sectors.

The importance of these measures notwithstanding, innovation effort and performance are influenced by a wide spectrum of policies, the purpose of which usually goes beyond innovation performance objectives. For instance, good basic education is fundamental both for the conception and the implementation of innovation. Catching-up countries will close the technological gap faster if their workforce has sufficiently broad skills to absorb and adapt new technology. Strengthening the compulsory school system is thus a priority in countries such as Greece, Portugal and Turkey.

Education, education, education

Creating and implementing innovation, however, requires above all a highly trained workforce with skills in science and technology. Indeed, all leading countries in R&D investment benefit from a well-trained labour force, with high graduation rates from tertiary education. Although the same is generally true for most Continental European countries, they nevertheless need to strengthen tertiary education in order to raise the contribution of universities to innovation. In most cases, this entails granting universities and other public research organisations more autonomy, as well as fostering competition for research funding.  

The type of market environment in which firms operate is also an important determinant of R&D spending. The OECD research indicates that strong competition provides powerful incentives to companies to invest in innovation -- if only to stay ahead of competitors -- as long as firms can reap the benefits from commercially interesting innovations via patents or other forms of intellectual property rights.

Most OECD countries have made substantial progress in reducing competition-restraining regulation in product markets, in particular in network industries that can impact on the diffusion of technology (for example, telecommunications). Even so, a number of countries, notably in Central and Eastern Europe, need to reduce the administrative burden on firm creation, while efforts at the EU level to remove remaining cross-border barriers in goods and especially services should be vigorously pursued to ensure that the benefits of market liberalisation are fully reaped.

Well-functioning financial markets are also important to support strong innovation efforts. Sufficient availability of risk capital is necessary to fund risky R&D investment, and high taxes on capital gains in some OECD countries may hinder the development of a vibrant venture capital market. Similarly, restricting the extent to which institutional investors can own shares in non-listed or high-risk companies, even when at levels consistent with prudential standards, may have the same effect.

Alain de Serres is a senior economist at the Organisation for Economic Co-operation and Development, a forum of 30 member countries working together to address the economic, social and environmental challenges of globalisation