1 Panel: Innovation Policies for Developing Countries – more of the same? Manuel Trajtenberg Tel Aviv University, NBER, CEPR June 2005

2 The Rationale for Government Support of R&D and Innovation R&D KKKK TFP Growth Social returns >> private, market failures Government intervention (e.g. subsidize R&D) Historically also “demonstration effects” from success of military R&D in WWII, cold war; raising hopes in medicine (post-antibiotics).

3 Government Support to R&D – cont. Government support in developed countries to: –Basic research, higher education –Defense-related R&D –Health Care/Medical R&D Also widespread support to commercial, civilian R&D, menu of policies : –Tax incentives –Grants, conditional loans –Incentives for tech transfer –Jump-start VCs

4 The emerging view: R&D/Innovation policy as panacea The Lisbon agenda: 3% R&D/GDP, the “K economy” Race in emerging economies to develop innovation policies, set up Gov support to R&D (e.g. eastern Europe, Central Asia, India, etc) Presumed success stories turned into “role models”: Israel, Finland, Taiwan, Bangalore. Bandwagon effect in riding the globalization R&D wave; rush to attract and set up Venture Capital funds all over. Is all this really relevant for development? Constructive skepticism…

5 Sobering questions about R&D Policy for Developing Countries Global R&D, K TFP R&D KKKK Growth Why not free ride? Why not free ride? Is the inflow really larger than the outflow? Is the inflow really larger than the outflow? What exactly do we mean by “absorptive capacity?” What exactly do we mean by “absorptive capacity?” Need not only formal R&D, but host of other factors to get useful  K Need not only formal R&D, but host of other factors to get useful  K What sort of innovations impact TFP? What sort of innovations impact TFP? Are these the same in DCs and in LDCs? Are these the same in DCs and in LDCs? Is “growth”  “development” in this context?

6 R&D Policy: The case of Israel Background (1970’s): Israel had little resources, but highly skilled manpower, scientific and tech prowess – how to mobilize them for growth? Government Strategic Decision: Jump-start and breed a “science-based” sector by providing broad financial support, and making up for market failures. Hallmark of policies: “Neutrality”: respond to market demand/signals, do not “pick winners.” Dynamic/Innovative: create new and varied support programs according to evolving needs Mobility of personnel in and out of Gov. programs; not “self-perpetuating”

7 Main R&D-Support Programs in Israel Matching grants to commercial R&D projects: criteria: innovativeness, tech and commercial feasibility, risk, spillovers; paybacks if success; some strings attached. “Magnet” Program for support of generic, pre- competitive R&D consortia: corporations + academia; longer term, higher support. Examples: Nano Functional Materials, Streaming Media Messaging, Digital Printing. Technological “Incubators” Program: from innovative ideas to start-ups : “Yozma” Program: Jump-started the Venture Capital Industry – success, hence discontinued

8 Some indicators of R&D performance in Israel: ICT production grew 4.6 times (16% per year); share of GDP grew from 5% to 14% Exports grew 6.2 times (to $ 15 billion), 1/3 of total exports The ICT sector contributed 30% of the growth of GDP. 2 nd largest VC market after the US US Patents per capita: fourth (after US, Japan, Taiwan) Major innovations: ICQ, disk-on-key, cardiac stents, camera/pill for gastro imaging, shopping.com, etc. Finding of additionality: every additional dollar of R&D support => 1.4 dollars of R&D performed (but caution…) 2004: R&D/GDP= 4.6% (world highest, but…), ~ 4,000 high tech companies.

9 And yet, sustained growth elusive… Wide disparity between fast growing High Tech sector and the rest of the economy; stagnant productivity of non-tradable, non-ICT sectors – a “dual economy”. Rising socio-economic inequality: concern in itself, and narrowing future pool of human capital.

10 Why? Innovate here, benefit elsewhere… 1.In spite of neutrality, support mostly product rather than process innovations that could be applied locally; hence little R&D in e.g. services, chemicals, etc. 2. Innovations made in Israel mainly for exports, some spillovers internal, but benefits (e.g. TFP growth) realized mostly abroad. no “Wal-Mart effect” in Israel

11 Innovate here, benefit elsewhere – cont. 3. R&D labs of multinationals: absorb local talent, but where do the benefits of the new K go? (e.g. Intel Israel designed the Centrino chip for laptops – so what?) 4. VC-backed star-ups: must exit, mostly by selling off to US-based corporations – again, who benefits? (very few large Israeli-based corporations) Israel: powerhouse in generating innovations, but not quite in benefiting from them. And this is a successful case!

12 Some lessons from the Israeli experience 1.Cannot have sustained growth by relying just on one fast-growing sector (ICT), while the rest of the economy stagnates: Need to encourage and channel innovativeness also to non-High Tech sectors 2. Cannot have growth while widening gap across socio- economic segments of the population: Need policies of inclusion, of reaching out to left-behind segments, of expanding the pool of human capital.

13 Casting doubts on common perceptions underlying R&D policies Associate R&D/Innovation just with “High Tech” as perceived in the developed economies; distorted view! View that, because of globalization, only one game in town: bring in MNLs R&D labs, bring in VC’s, become players in global HT markets. Not such a thing as local markets, let alone local “needs”, to be addressed with local innovation. The Internet fallacy: one universal network does not mean that everybody has equal access, benefits the same way, or needs the same tools to deal with it.

14 Innovation to accommodate heterogeneous needs, local markets Typical examples for LDCs (but many more): Health care: very different incidence of diseases; need for cheap prevention rather than high end technology, etc. In ICT: simpler software packages (not more features), less demanding on hardware, more backwards compatibility; If population spread over large, unwired areas: satellite-based broad band internet. Cars: emphasize reliability and functional flexibility (as the Ford Model T did…!)

15 Failure to innovate for local markets in low-income countries Demand: high income countries Demand: low income countries AC fixed cost: R&D P Q

16 Challenges for the design of sensible R&D policies Map heterogeneity of countries in terms of what sort of innovation/R&D required to foster their growth – not “one size fits them all” How to play the global game and yet try to channel (more of) the benefits of R&D/Innovation towards the local economy. Understand what do we mean by absorptive capacity, how to develop such capacity, etc. Sequencing of policies, given complementarities, “chicken and egg” problems

17 Importance of sequencing: some examples Matching R&D grants : Works if already large supply of S&T talent + entrepreneurial drive. But if those are scarce, and supply inelastic, then passive grants policy will be ineffective. Neutrality: Works well if available S&T skills are sufficiently general and “unbiased” relative to available complementary assets. Otherwise ineffectual. Setting up a VC industry: Works if already supply of start-ups, and binding constraints are in funding, managerial skills, international connections.

18 A specific suggestion: share R&D/innovation failures In best of cases low success rate of R&D projects (e.g. in Israeli incubators 1 in 10): inherent to nature of activity. At global scale, that means lots of replication of failed R&D routes, waste of resources. Potentially a severe problem for LDCs, since catching up and little resources. Create information pool of failed projects, but need clear set of incentives, perhaps sponsored by WB (see also disclosure of failed patent applications) Other information failures

19 Promote diffusion of ICT in LDCs by prolonging life cycle of before-last generation of products Global acceleration of innovation => extremely fast obsolescence of Knowledge, and of sophisticated, expensive equipment (see multi-billion $ fabs). Before-last generation of ICT “stuff” perfectly functional (PCs, cell phones, software), but no longer produced. Prolong operation of e.g. fabs by ~ ½ year, produce at ~ marginal cost (mostly sunk costs); secondary assured market (like generics); win win (good PR for MNLs…)

20 Call for genuinely innovative research on “Innovation and Development” Cannot just translate Arrow (1962) to Swahili… Cannot just extrapolate from experience in developed countries, cannot just borrow their tools and policies The truth is, we know very little – big payoff to economic research in this realm! This conference: a step in that direction – good job!