1. 1 Centre for Development Studies/Federal University of Rio de Janeiro International Seminar on Innovation and Development under Globalization: BRICS Experience Trivandrum, 19-21 August 2009 INNOVATION, FINANCE AND FUNDING IN THE NATIONAL SYSTEM OF INNOVATION: The Brazilian Case Session 2: Financing of Innovation Luiz Martins de Melo – IE/UFRJ

2. 2 Questions: Why have Brazilian-owned firms performed so badly in innovation? Why have they chosen the way of modernization rather than innovation? Brazilian System of Innovation since the late sixties has set up a wide range of financial instruments to support R&D: Scholarships to post-graduate students in Brazil and abroad Financial support to scientific and technological infrastructure Funding of scientific research Subsidized loans Fiscal Incentives Explicit Industrial and Technology Policies >>>>> Innovation Policy And a very comprehensive network of organizations, federal and state, and institutions bounded for supporting innovation. Introduction

3. 3 It is worth pointing out that traditional technology policy instruments such as reimbursable credit and fiscal incentives (i.e. “explicit” technology policy instruments) reduce the cost of technology projects but have a limited bearing on the risk of such projects. Therefore such instruments are more effective for the least uncertain projects than for RD projects. For the latter, the most important instruments are those which reduce the uncertainty of the project (see below). To the extent that such uncertainty derives from “systemic risk”, macro economic policies become dominant – i.e. “implicit” policies are more important than “explicit” cost-reducing policies.

4. 4 But, If we figure out that a National System of Innovation is a network of institutions and organizations which must work together, in a compatible way, coordinated by a public policy, implicit or explicit ( macroeconnomic policies), we begin to understand the reason for such a poor innovation performance. Working with Freeman´s (1987) concept of National Innovation System: ► the role of state intervention: macroeconomic policies and innovation policy ► the role of domestic company’s innovation strategy in relation to MNCs and imported technology ► the role of education and training and related social innovations ► the conglomerate structure of industry ► the role of the financial system in supporting the investment in innovation activities

5. 5 What has been the performance of the Brazilian Innovation System? At least very heterogeneous. Depending on the period more friendly to or more hostile to innovation. “Nationhood matters and has a pervasive influence. In all the study cases, a distinctive national character pervades the firms, the educational system, the law, the politics, and the government, all of which have been shaped by a shared historical experience and culture.” Nelson, R. R., (ed.)1992, National Systems of Innovation: a retrospective on a study, Industrial and Corporate Change. Vol.1, no.2347-374. In periods where nationhood mattered the performance was better, because there was coherence between the aims and the means. For instance, privatization was sold as a solution for a new telecommucations industry, plenty of innovative firms in the chain supply. What happened has only been modernization. Is it important? Yes, better than nothing. But, we have witnessed a systematic destruction of technological and scientific skills in this industry, which had been built in the former period, when the indsutry was state-owned.

6. 6 Though a necessary condition, the system feature of the Brazilian National Innovation System has not been very systemic. ► Poor compatibility between macroeconomic and innovation policies ► Lack of coordination and integration among its institutions and organizations ► Overwhelming representation of scientific interests ► Strong trend towards the fragmentation of resources in the absence of coordinated and integrated action “However, the rate of technical change in any country and the effectiveness of companies in world competition in international trade in goods and services, does not depend simply on the scale of their research and development and other technical activities. It depends upon the way in which the available resources are managed and organised, both at the enterprise and at the national level. The national system of innovation may enable a country with rather limited resources, nevertheless, to make very rapid progress through appropriate combinations of imported technology and local adaptation and development. On the other hand, weakness in the national system of innovation may lead to more abundant resources being squandered by the pursuit of inappropriate objectives or the use of infective methods.” Freeman, C., 1987, Technology Policy and Economic Performance, London, Pinter Publishers.

7. 7 The main source of funding that has been used by Brazilian firms is retained profits. This is not a novelty. It is a worldwide feature, The Barzilian characterisitc is the low proportion of bank credit as a source of finance and funding for investment (gross capital formation) Among the resources of others - stocks, bonds and loans - the loans out of the BNDES. On average, the Bank accounted for about 20% of resources used to finance business investment and industrial infrastructure. The shares of other sources in financing companies are much more unstable. The external funding came to represent 30% of investment sources, although, on average, its share has fallen by 16%, between 2001 and 2007. Then there are the entries of debentures - 10% and shares - 3%. In general, increasing the importance of these sources is associated with major operations in ports, does not reflect the behavior of the median- ment companies.

8. 8

9. 9 The initial pattern of financing innovation in Brazil: 1967-1997 The pattern in force from the late 1960s until 1997 was based upon fiscal and monetary budget resources, which were directly allocated to the FNDCT and operated by FINEP for application in innovation projects. In addition to this the resources also formed a constituent counterpart of external loans that were acquired from international organizations. Those resources complemented the budgetary resources, especially, from the Inter-American Development Bank – IDB, the World Bank - IBRD, and increased capital for FINEP. A primary and crucial matter for innovation financing programs, concerns interaction with the capital markets. It is important to emphasize that although the basic task of the financial system has evolved and no longer strictly finances project investments, financial support exists for the creation, growth and consolidation of firms. This is particularly applied to domestic firms, which are responsible for lower foreign dependency and for not aggravating the balance of service accounts: royalties, dividends, profit remittance, and licensing technology among others.

10. 10 As aforementioned this is of decisive matter in order to understand the creation of FNDCT in 1969 at a time when the National Bank for Economic and Social Development (BNDES) operated a financing fund for scientific and technological development. However, this fund was managed by an institution whose culture was, and still is up to this day, predominantly dominated by financing tangible assets, machines, equipment and facilities, aimed at increasing production capacity and the national infrastructure. In this instance the assets that were financed served as collateral for the loan. Another very different task is financing innovation, which is basically an intangible asset. There weren’t any resources or specialized institutions, being private or public, for its execution. FNDCT was established by Law- decree 719, on 31st July 1969, and ratified by Law 8.172, on 18th January 1991. The resources that make up FNDCT were defined as budgetary, resources proceeding from fiscal incentives, loans and donations.

11. 11 The Research and Projects Financing (FINEP) that already existed as an agency directed toward supporting pre-investment projects (consultative engineering) became the FNDCT executive secretary by Decree 68.748, of 15th July 1971. This attribution demonstrates that since the start of the institutional confirmation of the national innovation system, there has been a concern that the finance of innovation would encompass much broader activities than just R&D. Financial support was included for technology and science, in other words, for innovation. This relationship was strengthened with the creation of a program for Technological Development Support for National companies (ADTEN), through the Exposition of Motives – E. M. Nº 252 of 31 August 1976 from the Minister of the Planning to the President of the Republic. It can be said that this is the first document of innovation finance policy in Brazil which points out to the needs of differentiating the financing of intangible investment from tangible ones.

12. 12 Disbursements of FINEP and FNDCT from 1967 to 1997 in Constant Millions US$ /Dec/2006

13. 13 Financing Innovation through Sectoral Funds since 1998. The depreciation crisis of the Real in 1998/1999 exhausted the old pattern of innovation financing activities, which had been invigorated since the beginning of the 1970s. This crisis changed the main objective of the macroeconomic ongoing policies. The adoption of the inflation target policies along with strong fiscal adjustments (increasing primary surplus) and highly restrictive monetary policies (very high nominal and real interest rates) led to a fast reduction of inflation but keeping a low growth rate. The solution found to substitute fiscal restriction was the creation of tax contributions, taking advantage of the legal precedent opened with the approval of the Provisory Contribution on Financial Movement - CPMF – and its linkage to the health areaI n 1997 the first fund to establish resources for the S&T area emerged from the payment of a percentage of oil royalties. After that the Ministry of Science and Technology - MCT initiated studies to elaborate upon proposals to be sent to the National Congress for the constitution of other sectoral funds.

14. 14 The sectoral funds were formulated to be an alternative to financing an increase of investment in innovation for national companies and, at the same time, to face the deterioration of the infrastructure of scientific and technological research institutions. Even though the legislator at the time tried to take all precautions against the demands of the primary surplus policies, concerning the operational budget the political power of the Ministry of Treasury always prevailed. The legislation also specified general guidelines for the operation of sectoral funds: ►modernize and extend S&T infrastructure; ► promote greater synergy between universities, research institutions and the productive sector; ► create new incentives to private investments in S&T; ► stimulate the generation of knowledge and innovations that contribute to the solution of the most relevant national problems; ► stimulate the articulation between science and technological development through the reduction of regional inequalities and the interaction between university and companies.

15. 15 The model of management conceived for the Sectoral Funds is based on the existence of managing committees, one for each Fund. Each managing committee is chaired by a representative of the MCT and integrated by representatives from related ministries, agencies, from the academic and enterprise sectors and from FINEP and National Counsel of Scientific and Technological Development – CNPq. The managing committees have the legal prerogative to define the guidelines, actions and plans of investments of the Fund, once the previously presented guidelines are respected. The lack of a general managing committee led to the creation, in 2004, of the Coordination Committee of Sectoral Funds, with the objective of integrating their actions. The Committee is formed by the presidents of the Managing Committees, of FINEP and CNPq, and it is chaired by the Minister of Science and Technology.

16. 16 Source: FINEP. (Own elaboration). Resources Approved through the Annual Federal Budget Law, 2002 - 2005 (current R$ thousands)

17. 17 Disbursements of FINEP and FNDCT from 1967 to 1997 in Constant Millions US$ /Dec/2006

18. 18 Seizure of FNDCT resources is being done increasingly, as a result of the contribution of these resources to the primary surplus. Currently there are more resources in reserve than those that had been placed at FNDCT disposal for financing S&T innovation and infrastructure. The strong contradiction between the macroeconomic politicies and the Industrial and Foreign Trade Policy - PITCE makes incompatibility between objectives explicit. FNDCT - Financial Evolution –- Constant US$ Millions Dec/2006 ) Source: FINEP. (Own elaboration)

19. 19 FNDCT - Financial Evolution –- Constant US$ Millions Dec/2006)

20. 20 Comparison between the Averages of Disbursements in both Periods – US$ millions Dec/2006) Source: Finep (own elaboration)

21. 21 It is important to highlight the evolution of the funds created to support innovation in the area of telecommunications. It is of remarking knowledge that this is a highly sensitive area for a technological country capability. However, it can be presumed from the numbers presented in the table below that the Ministry of Treasury does not agree. The Funds for Universalization of Telecommunications – FUST - was not applied. The Fund for Fiscalization of Telecommunications - FISTEL had 10% of its resources applied and FUNTTEL 50 %. It seems seizing is the rule, not the exception. Source: Telecom Agency and Secretary of Treasure. Own Elaboration

22. 22 The change in the stock market operation in Brazil was also important. Since 2005 an effective increase has occurred in the funding of companies through capital markets. The value of new equity issued is almost ten times that of 1996. This strengthens the perception that a less restrictive monetary policy, lowering interest rates and raising exchange rates, would have taken the Brazilian firms towards a more dynamic strategy of investment, improving investment rates and the generating of innovation.

23. 23 Fiscal Allowance According to Brazilian Law - Current US$ million dollars Source: MCT, Dahlman (2008). Nota: (a) estimated values. Own elaboration.

24. 24 1)The compatibility between macroeconomic policies and innovation policies. This can be noticed by the smaller amount of resources during the second period. 2)Modernization of financial instruments. The first period was almost entirely dominated by subsidies over credit contracts indexation, which was extremely high. This would make credit more attractive than the equity financing (venture capital). In the context of a macroeconomic regime of low inflation without indexation of asset and prices, a fall in interest rates and strengthening of the stock market, would make financing innovation investments through equity more attractive. 3) It is clearly seen that there was a bigger concern in the first period, with the Brazilian capital owned companies. It was explicitly stated that ADTEN program only supported Brazilian capital owned companies. There was also a stronger coordination between the operation of FNDCT resources and FINEP. This was achieved because FINEP practically defined the operational strategy for both, maintaining it compatible with the general goals of the innovation policy. Conclusion

25. 25 4) In the second period the discrimination in favor of Brazilian owned firms disappeared. FINEP has lost almost all of its operational autonomy in defining the strategy of resource application of the sectoral funds. Now, each sectoral fund has a managing committee and there is also a general managing committee for FNDCT, in which FINEP is a minority. The operational strategy is much more in the hands of the MCT than in the hands of FINEP. 5) However, some advances were made. The first one, showed that a change in macroeconomic policies, more favorable to economic growth, with less fiscal restriction, would lead to an increase in resource availability of sectoral funds. The second one, BNDES returning to the system which can be considered a strong source of investments in innovation as well as the INOVAR program, The changes which have occurred in the Brazilian economy in the last two years, mainly in the capital and credit markets, have been a result of a loosening, although slow and shy, in monetary policies. Such changes have pointed out to a better relationship between the financial system and the productive sector. This is crucial for innovation investments by the private sector for the fact that innovation is an asset of high uncertainty, high risk and of long term maturation.

26. 26 In this way, the differences between the two periods have resulted not only from the innovation policies, but much more from the dominant macroeconomic policy since the balance of payment crisis in 1998/1999.

27. 27 Thank You. luizmelo@fujb.ufrj.br

28. 28 Sources of financing of innovation activities by number of employees, 2000, 2003 and 2005. Fonte: PINTEC, 2000, 2003 e 2005.

29. 29 Fonte: PINTEC (2000, 2003 e 2005).

30. 30 Brazil Basic Interest Rate