KEF VI: Technology Acquisition and Knowledge Networks The Role of Government: Building Absorptive Capacity in Europe and Central Asia April 17, 2007 Mr. Itzhak Goldberg Lead Specialist Europe and Central Asia Region World Bank

2 The Importance of Innovation and Absorption for Growth Output Growth Labor Capital Human Capital Absorption Innovation Investment Climate Trade & FDI Education Training Competition Corporate Governance Financial Discipline IPR & Knowledge Brokers Corporate Governance R&D Brain circulation

3 Definition: Absorptive Capacity From Absorption to Innovation: New to the Firm versus New to the World Absorptive capacity: Firms capacity to assess the value of external knowledge and technology and make necessary investments and organizational changes to absorb and apply this in its productive activities Examples of absorption: Adopt new product, process, Upgrade old product, process; Quality certification, Technology license

4 Product v. Process Innovation Product Innovation - development of new products representing discrete improvements over existing ones. Process Innovation - redesign of products, services; reorganization of layouts, transport modes, management, HR Dual economies: Indias and Israels islands of ICT or hi-tech in laggard conventional industry

5 Main Channels of Absorption Trade & FDI Trade & FDI R&D Learning & Brain Circulation Learning & Brain Circulation IPR & Knowledge Brokers IPR & Knowledge Brokers Absorption

6 Imports of machinery & equipment Knowledge spillover from exporting to R&D-rich firms/countries FDI vertical spillovers for suppliers (e.g. Lithuania), export diversification Channel I: Trade and Supply Networks and Foreign Direct Investment (FDI)

7 Tertiary education and training by firms specialized skills to enable innovation Instead of brain-drain, return migration brain circulation skills & entrepreneurship India ICT example: Graduates of Public Technology Institutes (IITs) emigrated before 1990; Liberalization return expats - key to Brain Circulation and ICT miracle Channel II: Learning and Brain Circulation

8 Licensing technology reduce absorption cost compared to imitating around IPR Clearer IPR reduce transaction costs for public-private and private-private technology transfers Knowledge brokers complementary transfer of tacit knowledge Eg: Israeli incubators help Russian scientist-immigrants to commercialize new ideas Channel III: Intellectual Property (IP) and Knowledge Brokers

9 R&D for absorption, not JUST for innovation -- the second face of R&D à la Cohen and Liebenthal (1990) R&D output does not flow automatically or costlessly from developed countries to developing countries. China invests massively in R&D Channel IV: Research and Development

10 Micro Firm-level Incentives: FDI Case study –Slovenian Aluminum firm Impol bought Serbian Seval in 2002 –Post privatization: production increased by 3.5 times, productivity by 7.2 times and wages increased by 20% –Why? Brownfield FDI changes micro firm- level incentives. More tomorrow at 2 PM from my colleague Dr. Goddard.

11 Measuring Absorption in ECA Overview of WB econometric study of absorption using BEEPS surveys of enterprises in ECA Absorption--adopting new and improved products and manufacturing technologies-- is more likely for firms that: –Transition to export status increasing their absorption by about 33%, –Form JV with a multinational increasing their absorption by 41%

12 Market failures may justify government intervention to stimulate absorptive capacity in private sector BUT Policy design needs to account for government failures: capture, corruption, misaligned incentives AND… Role of Government – the Why?

13 Skills and Human Capital –India: Early publicly financed education - critical importance Investment Climate and Governance –Russia: Poor investment climate (weak competition, red tape); governance: corruption, regional government capture by business Pre-requisites for Intervention

14 The How of Government Intervention? Governments can support absorption via: 1.Role I: Regulatory interventions to improve the policy environment for absorption –Entry, Financial Discipline, Exit, Mobility, Barriers to FDI, Trade: Non-Tariff-Barriers, Customs, Standards, Quality Certification and IPR Enforcement 2.Role II: Commitment of public funds – financial and institutional instruments - next.

15 Which financial instruments? Matching grants: preserve private risk, no crowding out Soft loans: maturity deters risk taking Tax holidays: no profit to offset in SMEs Guarantees: takes away risk (Source: WB ECA Study Public Financial Support for Commercial Innovation)

16 Which Institutional Instruments? Institutional instruments include: Incubators Technology parks Technology transfer offices Pros and cons of different options: 1.Privately owned/managed & subsidized 2.Publicly owned & managed 3.Publicly owned & privately managed & subsidized

17 Transition 2 nd Phase Policy implications

18 Summary and KEF VI Agenda Innovation v. absorption; Product v. Process The 4 channels: FDI/trade, skills, IP, R&D From Micro to Macro: Firm-level Incentives The Why of Intervention Pre-requisites for Intervention The How: regulate and/or subsidize? Financial and/or institutional instruments