1. Support for commercial innovation: why, how and when?
Knowledge Economy Forum V
Prague, 28 March 2006
Itzhak Goldberg
World Bank

2. Absorptive capacity—the ability to tap into the world technology
Absorption is as important as innovation, or more
Absorption channels: trade, FDI, license; role of spillovers
BUT - Absorption is not cost-free – pre-condition: capacity to learn and imitate.
Indigenous R&D and learning institutions needed to build absorptive capacity
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3. Market versus Government Failures - when is intervention right?
In the presence of the markets failures discussed by Manuel, is there a case for Government intervention in a market economy?!,
Yes! - But…
While in a well-functioning market economy, there are institutions to allow effective Government support
In transition economies, Government intervention might fail, or even cause harm, without an institutional framework conducive to intervention.
Government failures can do harm! More below.
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4. Does Support for Innovation Mean “Industrial Policy”? Not Necessarily.
Market failures are a necessary but NOT sufficient condition for government intervention. Watch for more failures…
A source of government failures: ‘picking’ of winners – industrial sectors or individual firms distorts markets. Who knows better?
Targeting (industrial policy) has not proven helpful: India’s software success.
Neutrality - key principle in instrument design – responding to market signals.
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5. Principle I: Neutral and Transparent Project Selection
Neutral and transparent selection criteria set in regulations
Funding decision is made by an independent investment committee.
International experts and civil society stakeholders in Board of Directors of innovation agency.
Technical assessments of the project proposals are based on external international peer reviews
All project proposals and decisions are made publicly available to enhance transparency.
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6. Principle II: Public - Private Risk Sharing
Risk sharing: Risk to be born by inventors/ researchers must be affordable. BUT..
Preservation of incentives: … Risk sharing needs to impose on entrepreneurs enough risk to preserve their incentives to invest resources and effort.
Commercial orientation: To have a measurable outcome, select only projects with potential commercial success, rather than only scientific interest.
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7. Financial instruments I: taxes, procurement, loans
Tax incentives - more complex, do not help start-ups with little profits, may encourage reclassification of expenditure
Procurement preferences – needs large government sponsored, commercially oriented R&D budget plus transparent procurement process
Loans – do not provide for crucial risk-reducing, repayment problematic due to uncertain cash flows at the initial stages of the innovation process
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8. Financial instruments II: Grants to enterprises or consortia
Mini-grants: Small grants designed to support the identification of commercially viable ideas as well as encourage entrepreneurship among the scientific and SME community (e.g. funds for technical assistance, business support services, etc.)
Matching grants : Matching =risk sharing; selects commercializable projects; grants to business- research consortia fosters linkages.
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9. Financial instruments III: Co-fund Private VC (3)
Grants support Early Stage, VC is needed for commercialization; VC cannot support Early Stage.
State-owned and managed VC don’t work.
Governments can “seed” VC by investing in privately managed funds. Example: Israel’s Yozma Fund.
Leveraged returns: Gov’t co-invests but takes small part of the return, e.g. U.S. SBIC, Australian Innovation Investment Fund Program
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10. Can these instruments be applied in transition countries? (1)
State Capture = business manipulating policy/rules of the game to their advantage
Mega projects Russia Government did not define priorities; selected proposals bottom-up.
Results: some mega projects result from heavy lobbying
Corruption of Investment Committees
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11. Can these instruments be applied in transition countries? (2)
Secrecy and national pride – block international peer review; publicity of decisions
Some instruments exist in ECA but w/o risk-sharing; transparency and neutrality: grants restricted to R&D Institutes; loans forgiven when project fails – punish success.
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12. Requisite Institutional Framework
Government support could be wasted without in parallel improving economic incentives, upgrading information infrastructure, and reforming education
Empirical analysis shows wide differences in economic incentives, information infrastructure, and education among ECA countries.
Some countries just might not be ready to engage in designing and implementing financial instruments; might be better advised to follow a different route to acquire and absorb knowledge.
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13. Knowledge Assessment Methodology (KAM)
KAM indicators (KEI) used to assess which countries in ECA are ready for public support of commercial innovation and to determine how they should sequence support instruments.
KAM main indicators:
Economic incentives and institutional regime
Education (tertiary in particular)
Innovation system
Information infrastructure
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14. Knowledge Assessment Methodology (KAM) – unweighted scores
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15. KAM – Bottleneck analysis
Review individual pillar indexes to identify and prioritize financial instruments targeted at specific bottlenecks
Address bottleneck before using instruments.
Example: Weak economic incentives is bottleneck for Government support even though education, innovation and ICT are high (e.g. Russia)
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16. KAM: Sequencing of Support for Innovation
Low KEI country might be better off concentrating its efforts on improving the institutional requisites for these types of financial instruments.
Some countries should invest first in the prerequisites before—or in parallel with—engaging in a public support program for innovations.
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17. Knowledge Assessment Methodology (KAM) – selected results
Eight countries have a KEI above 6.5. on a scale of 1 to 10, few above Portugal, Spain, and Greece
None of these eight countries scores less than 5 in any of the four pillars. Thus none of these pillars seem to be a binding constraint.
Ten countries score 4-6.5; some have binding constraints, e.g. Turkey in education
The rest score below 4 – improve environment first; public support - ineffective
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18. Conclusions
Private commercial innovation and knowledge absorption are key to growth.
Market failures require Government support for commercial innovation.
Yet, in ECA, Government support is prone to Government failures: capture and corruption
To protect instruments, design needs:
Neutrality in regulations; publicity
Public-private risk sharing
Civil society and international stakeholders
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19. Conclusions (continued)
Notwithstanding any protection against capture and corruption, public support is never fool proof. Need cost-benefit of above risks with social benefits, if succeeds.
Financial support instruments cannot be implemented in isolation; to be effective, they have to be supplemented by reforms in education, ICT and other support systems
In sum, KAM analysis can help Governments to decide if, how and when to use public financial instruments.
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