1. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt The Trade-off between Innovation and Defence Industrial Policy: Results of a study of the Norwegian Defence Industry Fulvio Castellacci (NUPI) FORFI Programme Seminar 29 October 2012

2. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt The INNDEF Project Title: «Innovation and Defence Industrial Policy: Creating a Common Strategy for Institutions with Different Goals and Approaches to Policy-making» Project duration: October 2010 – February 2013 Funding: NFR-FORFI Programme

3. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt Project team Norwegian Institute of International Affairs (NUPI): Fulvio Castellacci, Per Botolf Maurseth, Martin Blom Norwegian Defence Research Establishment (FFI): Kari Tvetbråten NIFU: Arne Fevolden

4. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt Scientific output Four articles submitted for publication in international journals This presentation will focus on one of these papers This choice is due to this paper’s relevance for the innovation policy debate for the present seminar and its possible future extensions

5. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt The Norwegian defence industry Two distinct types of firms: Large system integrators vs. smaller specialized suppliers High innovativeness (high investments in R&D) Strong export performance: Norwegian defence export is booming (+181% in the last decade) Active public support (to promote innovation and export performance, but also the companies’ military capabilities)

6. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt The current policy regime (1) Different objectives: Innovation policy aims at strengthening Norwegian companies’ innovative capabilities, and hence their economic performance (competitiveness objective) Defence industrial policy aims at strengthening Norwegian companies’ technological expertise and products that are useful in a military context (national security objective)

7. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt The current policy regime (2) Different focus and target groups: Innovation policy for defence companies typically focuses on SMEs and specialized suppliers (to foster their growth and internationalization) Defence industrial policy is instead primarily targeted at the largest dominant firms in the industry (Kongsberg, Nammo, Thales Norway)

8. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt The current policy regime (3) Different policy instruments and supporting institutions: Innovation policy is in line with the instruments used in other sectors (e.g. R&D incentives). Innovation Norway is an important institution for SMEs in the defence sector Defence industrial policy makes use of other more general instruments such as public procurement and offset agreements regulating trade. The Ministry of Defence is the key institution here.

9. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt The future regime: EU liberalization of the defence market The new EU Directive (2009/81/EC): The European Union’s Defence and Security Procurement Directive It intends to introduce a higher degree of liberalization in the EU defence market European countries (including Norway) will implement this new Directive from 2012 onwards

10. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt Questions Is there a trade-off (or contrast) between innovation and defence industrial policy in the current regime? How will the process of EU liberalization affect this in the future? How could the Norwegian defence policy regime be revised to make it more effective?

11. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt An agent-based model of the defence industry Objective: A model to study how defence firms adjust their strategies to respond to possible changes in the policy regime ABM model: a computer model that simulates the behaviour of a population of firms, their interactions, and the aggregate outcomes Key idea: Heterogenous firms compete in the market by producing new products. Over time, they may adjust their performance by means of (1) publicly-funded R&D, (2) private R&D, or (3) external learning through inter-firm collaborations

12. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt The model flowchart

13. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt Summary and overview of the model Three distinct groups of firms: (1) successful innovators that qualify for public funding; (2) successful innovators that do not meet the crietria for public support; (3) unsuccessful performers, which will either do private R&D or imitation (cooperation) Two different mechanisms drive the model dynamics: (1) cumulativeness through public support; (2) catching up through firms’own innovation and imitation strategies

14. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt Simulation of policy scenarios Current scenario: SMEs receive innovation policy support, and larger companies receive defence industrial support from the MoD Alternative 1: Firms only receive innovation policy support (focus on the competitiveness objective) Alternative 2: Firms only receive defence industrial support from the MoD (focus on the national security objective)

15. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt Results (1) In the present regime (protected domestic market): Alternative scenario 2 (in which firms only receive defence industrial support from the MoD) leads to a better performance than the current mixed scenario Why? Larger companies contribute to both the competitiveness objective (e.g. export) and the national security objective (e.g. military capability building). It is then more efficient to concentrate all public support on the largest defence enterprises

16. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt Results (2) In the future regime (liberalized EU market): A visible trade-off will emerge between alternative scenarios 1 and 2 (competitiveness versus national security objectives) Why? Innovation policy support targeted to Norwegian SMEs will become more crucial in the future to sustain their competitiveness in the European market – while defence industrial policies will still be crucial for national security reasons It is a political matter to decide which scenario should be followed

17. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt Summary Policy interventions in the defence industry are characterized by a trade-off between two contrasting objectives It is not efficient to allocate public support to pursue both objectives simultaneously: it is better to focus on the national security objective (and provide support only to the largest firms) It is crucial to achieve a good coordination among different relevant institutions in this field (e.g. INN & MoD) and a clear agenda of the political priorities to be pursued by the Government

18. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt Future extensions (1) «Trade-offs» between different policy objectives are not only present in the defence industry, but can arguably be found in other sectors and/or fields of public policy This is therefore a topic that necessitates further elaboration and extensions in the future

19. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt Future extensions (2) Example 1: Other industries characterized by a contrast between the competitiveness objective and another social objective (e.g. environmental protection, health) Example 2: The trade-off between R&D policy and regional cohesion policies (the former fosters aggregate growth, whereas the latter intends to avoid regional disparities)

20. Norwegian Institute of International Affairs Norsk Utenrikspolitisk Institutt Thanks! Contact details: Fulvio Castellacci Professor, Head of Department, Department of International Economics, Norwegian Institute of International Affairs (NUPI) E-mail address: fc@nupi.no