RESEARCH PROJECT NATIONAL INNOVATION SYSTEMS of BRICS COUNTRIES IDRC Center File: 104227-001

RESEARCH PROJECT

NATIONAL INNOVATION SYSTEMS OF BRICS COUNTRIES (IDRC CENTER FILE 104227-001)

FINAL TECHNICAL REPORT

SEPTEMBER 2007 TO OCTOBER 2010

RedeSist - Economics Institute, Federal University of Rio de Janeiro, Brazil

Globelics

http://brics.redesist.ie.ufrj.brhttp://brics.redesist.ie.ufrj.br FINAL TECHNICAL REPORT SEPTEMBER 2007 TO OCTOBER 2010

RESEARCH PROJECT NATIONAL INNOVATION SYSTEMS OF BRICS COUNTRIES IDRC Center File: 104227-001

Country/Region: Brazil, Russia, India, China and South Africa (BRICS)

Research institutions: Economics Institute, Federal University of Rio de Janeiro, Brazil Center of Development Studies, Trivadrum, Kerala, India Tshwane University of Technology, Pretoria, South Africa Tsinghua University, Beijing, China Higher School of Economics, Moscow, Russia

Information on Research Institutions: Annex 1

Research Team Coordinators: José Eduardo Cassiolato – Brazil K.J. Joseph – India Rasigan Maharajh – South Africa Liu Xielin – China Leonid Gokhberg – Russia

Names of Researcher/Members of Research Team: Annex 2

Keywords: innovation, national innovation system, BRICS.

Date: October 15th, 2010

Report prepared by: Maria Clara Couto Soares (project manager)

Report reviewed by: José Eduardo Cassiolato (project coordinator)

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br Summary

1. Synthesis...... 4

2. Research problem and project objectives:...... 5

3. Methodology...... 7

4. Project Activities...... 10

4.1 Research Related Activities ...... 10

4.2 Project Management Activities...... 11

5. Project Outputs and Dissemination: ...... 12

5.1 Research...... 12

5.2 Capacity building ...... 14

5.3 Policy influence...... 15

6. Main Project Findings ...... 16

ANNEX 1...... 29

ANNEX 2...... 31

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br Final Technical Report

Project: National Innovation Systems of BRICS Countries

1. Synthesis

The world is experiencing significant transformations in its geopolitical and economic constitution. The processes of transformation have accelerated over the last decades. A significant part of the growth potential of the world economy nowadays and for the coming decades resides mostly in some fast developing countries. Brazil, Russia, India, China and South Africa (BRICS) have displayed such potential for dynamic change. In a historic rupture with past patterns of development, the BRICS counties are now playing a major role in alleviating the current global crisis whilst revealing new and alternative progressive paradigms.

Much beyond the emphasis given by international agencies to the identification of investment possibilities in the BRICS production structures or to the prospects presented by their consumer markets, our perspective in analyzing BRICS along this project was inspired by their significant development opportunities, as well as their several common characteristics and challenges, and the learning potential they offer for other developing countries. Identifying and analysing these opportunities and challenges will help to uncover alternative pathways towards fulfilling their socio-political-economic development potential within the constraints of sustainability.

The central focus of the project is the national innovation system (NIS) of the five BRICS. The emphasis on the study of innovation systems of BRICS results from the recognition that understanding the particular dynamics which connects the knowledge base with innovation and economic performance in each of the five BRICS countries is, today, a precondition for better appreciating the direction that the world economy will be following (Lundvall, 2009).

Besides analysing the broad characteristics and dynamics of the NIS in Brazil, Russia, India, China and South Africa, five key components of their innovation systems were studied in greater detail throughout the project. Analyses on the role played by the State, the financing, the direct investment and the small and medium enterprises were provided, besides approaching a particularly relevant – though still not extensively studied – aspect of the BRICS: the challenge of inequality and its interrelations with the national systems of innovation (NSIs) of these countries.

The research endeavour of the project has gathered universities and research centres from all the BRICS, as well as policymakers invited to discuss the outcomes. The research development and the comparative analysis of its results intended to bring to light the challenges and

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br opportunities of BRICS’ national innovation systems from the points of view of these same countries. Part of the effort undertaken was addressed to the construction of a shared methodology aimed at advancing the comprehension of the specificities of innovation systems in each country. This was done, in view of the need for improvements in the analytical framework used for the analysis of the national innovation systems located in countries outside the restrict sphere of developed countries.

Special attention was paid to the political implications. However, instead of searching for generalizable policy recommendations, it was sought to identify and analyze bottlenecks that are common to the BRICS, their complementarities and competition areas, as well as other aspects of major importance for supporting decision makers and that are able to incite reflection about the subject of innovation and development in other less developed countries.

It is worth to mention that the research consolidated along this project is rooted in a larger research effort on BRICS national innovation systems being developed in the sphere of the Global Research Network for Learning, Innovation and Competence Building Systems- Globelics (www.globelics.org) and the Research Network on Local Production and Innovation Systems-RedeSist, at the Economic Institute of the Federal University of Rio de Janeiro (www.redesist.ie.ufrj.br). Globelics is an international academic network which uses the concept of innovation systems (IS) as an analytical tool aimed at the comprehension of the driving forces that push economic development. It aims to advance the use of IS perspective on a world basis. Established in 2002 and inspired by renowned scholars from the field of economics of innovation as Christopher Freeman (1987) and Bengt-Äke Lundvall (1992), the Globelics network has, among others, the purpose of encouraging knowledge exchange between less developed countries, thus fostering mutual learning across innovation research groups in Latin America, Africa and Asia. With this, it is sought to strengthen an original and more autonomous approach to understanding the development processes in developing countries.

The project objectives, activities, outcomes and outputs are detailed in the following topics.

2. Research problem and project objectives:

As previously mentioned, the main focus of the project is the national innovation system (NIS) of BRICS. The notion of innovation system has in its centre the production, S&T and education sub-systems; but includes also the financial subsystem, the investment patterns, the legal and political frameworks as well as other spheres connected to the national and international, contexts where knowledge are generated, used and diffused. In this effort it was necessary to develop conceptual and methodological frameworks capable of depicting their different private, public and governmental dimensions and that allow the comparison of the NIS of the five countries, pointing out convergences, divergences and synergies. Another priority issue was policy implications resulting from the research findings.

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br The main objectives of the project were: § To stimulate interactions and the exchange of experiences between researchers and policy-makers interested in innovation in BRICS aiming at creating capabilities and finding joint workable solutions; § To characterize the structure of BRICS´ national innovation systems, their recent evolution and perspectives; § To compare the five countries innovation systems, identifying differences and similarities, common bottlenecks and complementarities; § To develop and use concepts and information capable of representing the Innovation Systems of BRICS; § To discuss policy implications and put forward policy recommendations, extracting lessons that can be useful not only for these countries but also for other developing countries. Its specific objectives were: § To increase the interaction of innovation researchers and government officers of BRICS through meetings and other forms of articulation (seminars, web page, etc). § To increase the knowledge about the NISs of BRICS through o the development of adequate concepts and methodologies; o the analysis of selected BRICS innovation systems –sectoral and horizontal themes that affect innovation in these countries; § To increase the capability both of researchers – in special graduate students - and government officers of BRICS through research on innovation systems, discussions, innovation panels and other forms of articulation; § To diffuse the knowledge generated through the publication of a book, setting up a web page and participation in meetings and panels.

The basic rationale for the project and the research problems hasn´t changed since the beginning of the project. The emergence of the international crisis in 2008 just reinforced the relevance of BRICS countries and the importance of better understanding their NIS dynamic. The same can be stated for the general and specific objectives of the project that remained the same. It can be said that the overall project objectives were met. Project dissemination surpassed the goals defined at the beginning of the project as it will be detailed in the following topics.

However, some adjustments were needed especially regarding project rescheduling and budget reallocation. As a consequence both budget reallocations and project termination date

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br postponement were submitted for IDRC appreciation and have been approved subsequently. Details on these changes were provided by the previous technical reports.

3. Methodology

Figure 1 below is a schematic attempt to show the NIS framework in the two main approaches - the narrow and the broad. Methodologically, the project uses the broad understanding of the NIS framework. It includes the larger set of institutions affecting the innovation system (such as macro-economic implicit policies for innovation, the financial system as well as the cultural and historical processes that underlie it) and shaping competence building in the economy (such as education, training, industrial relations and labour market dynamics).

A broader and systemic understanding of the innovation process is instrumental to avoid an overemphasis on R&D, encouraging policy-makers to take a far-reaching perspective on the opportunities for learning and innovation. Emphasis is put on interactions and on the role of historical processes - which account for differences in socio-economic capabilities and for different development trajectories and institutional evolution - creating systems of innovation with very specific local features and dynamics.

Figure 1 - The broad, narrow and very narrow versions of the national system of innovation approach

Geo-Political, Social, Political, Economic, Cultural & Local Context Wide

Narrow Very Narrow Subsystem Subsystem Production/Innovation Demand Capacity-Building, (segmented) Research & Technology Services

Subsystem Policy, Promotion, Representation & Financing

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br It is precisely the production-centred approach to NSI which, in our view, makes it relevant for understanding it in the context of developing countries. Therefore, it was used for the analysis of the BRICS’ innovation systems.

The country studies followed a four dimensional analytical scheme, providing information and examination of: the production; the capacity-building sub-system (including the education, research and technology infrastructure); the policies, representation & financing subsystem; the role of demand (including income distribution, structure of consumption, social organization, social demand - basic infra-structure, health, education). The following points were addressed: a. Production and Innovation Sub-system

· Analysis of the recent evolution of each country’s productive system in terms of participation of economic sectors, of capital origin, of firms’ size and spatial distribution and its impacts on the national productive structure, focusing on the characteristics of the production and innovation systems in the manufacturing, services and agro-industrial sectors; · Information for the analysis of the impacts on the patterns of technological learning and innovative capability building resulting from the broad intra-regional and intra-sectoral heterogeneity of BRICS economies; · Information gathering about the ways the labour market both affects and is affected by the characteristics of the NSI, by sketching the features of formal and informal employment in the country. b. Sub-system of Capabilities Building, Research and Technological Services

· Preliminary verification of the characteristics of each country’s educational system; · Information gathering the modes of interaction developed between the postgraduate and research programs and the productive sector ; · Information gathering on human resources training and capabilities building developed; · Preliminary analysis of the S&T infrastructure in each country; c. Sub-system of Policies, Funding and Regulation · Data gathering and preliminary analysis on the interaction between implicit (macroeconomic) and explicit (of science, technology and innovation) policies · Characterization of the main programs and policies of S, T & I implemented in recent years, verifying the major outcomes reached by such programs; 8

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br · Preliminary survey and analysis of financing tools addressed to innovation, seeking to underline the evolution of outlays in the scope of the main programs, as well as the main outcomes and weaknesses of such programs; d. The role of the demand in the BRICS Innovation Systems

· Preliminary analysis of the effects of the pattern of income distribution on the structure of the national innovation system; · Preliminary examination of the potential interaction between innovation systems and welfare systems, using the healthcare innovation system as object of analysis.

In addition to the country studies focusing on the National Innovation Systems, five specific themes were selected to be analyzed in greater detail:

§ Innovation, finance and funding in the national system of innovation § Transnational corporations and the national system of innovation § The role of State and innovation policy § The role of SMEs in the national system of innovation § Innovation and inequality in the BRICS

The definition of the focus given in each one of these themes was established by Terms of Reference (TORs). The methodology also incorporated the broad concept of National System of Innovation besides the main specific issues relevant for each subject. All consultants were oriented to follow the main guidelines defined by TORs, in order to assure methodological coherence as well as to allow comparative analysis developed further on.

Six comparative studies were written sharing pre-defined methodologies. The first focused on the National Innovation Systems of BRICS countries and the five others addressed each one of the specific themes mentioned above.

The 36 research reports developed by the project - including 5 NIS, 25 thematic and 6 comparative - are available at BRICS-IDRC web page http://brics.redesist.ie.ufrj.br/proj_idrc/.

It is worth mentioning that project methodology also considered the exchange of experiences between researchers and policy-makers interested on innovation in BRICS countries. It aimed at creating capabilities and finding joint workable solutions, as well as discussing policy implications and policy recommendations that could be useful not only for BRICS countries but also for other developing countries. As will be detailed in a topic ahead, the project team organized international seminars and innovation panels addressing this goal.

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br Finally, besides international seminars and innovation panels the methodology regarding project outputs dissemination included the publication of a book and the creation of a webpage (http://brics.redesist.ie.ufrj.br/proj_idrc/) with project information.

4. Project Activities

Many activities were developed along the project. They will be briefly described in the next two sub-topics.

4.1 Research Related Activities

One of the basic goals of Globelics is to advance the use of the IS perspective on a world basis. A BRICS comparison is an essential part of this endeavor since it brings important methodological and empirical challenges. Therefore, this project was designed to link research efforts among the 5 BRICS countries. For this purpose partnership with research institutions in India, South Africa, China, Brazil and Russia was a key constituent part of the project.

The research institutions involved in the project are: the Economics Institute, Federal University of Rio de Janeiro, Brazil; the Center of Development Studies, Trivadrum, Kerala, India; the Tshwane University of Technology, Pretoria, South Africa; the Tsinghua University, Beijing, China; and the Higher School of Economics, Moscow, Russia. A coordinator was named in each one of these institutions not only to assume the responsibility for the project implementation at national level, but also to compose a coordinating committee for the project. One IDRC representative was also invited to integrate the coordinating committee.

Five coordinating meetings took place along the project covering a broad agenda. They discussed among others the analytical framework of NIS reports, the selection of thematic studies, the schedule and organization of international seminars and innovation panels, the participation in international conferences and the organization of panels focusing on the dissemination of BRICS project, as well as the guidelines for the books’ publication.

The elaboration of the terms of reference (TOR) for NIS country studies and for the five thematic country studies was an import milestone of the Project. The TOR proposals were discussed by project research team during the international seminar of South Africa allowing TORs’ improvement and consensus. All TORs are available at http://brics.redesist.ie.ufrj.br/.

Another important project milestone was the discussion of the preliminary versions of the research reports. The reports were presented and discussed during the International BRICS Seminars of Trivandrum (India) and Rio de Janeiro (Brazil) contributing to raise comments and suggestions to the authors. Besides research project team, seminars participation included academics, post graduate students, governmental representatives, policy makers and business institutions. All power point presentations are available at http://brics.redesist.ie.ufrj.br/. 10

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br In November, 2009 a workshop was organized in Rio de Janeiro aiming to advance on the basic analytical framework for the comparative reports together with proceedings for books publishing. An ‘editing group’ was settled by BRICS project to work on the books manuscripts.

The project scope included the edition of just one book to disseminate the overall findings of the BRICS project. However, as the project produced very interesting contributions connected to the thematic studies there was a convergent view that it would be interesting to find alternatives to allow the publication of 5 books – one for each theme. The IDRC representative – Ms Veena Ravichandran - advised the group on the possibilities and procedures to be taken in order to ask for supplementary funds to cover additional publication costs.

In April, 2010 IDRC approved supplementary funds for the edition of the additional books to be published in a co-edition joining IDRC and a private publisher. The IDRC publisher division will be working with BRICS’ project editing group to facilitate the co-publication agreement and will be responsible for publishing the e-book edition, including for free access from IDRC's website. 4.2 Project Management Activities

In the beginning of BRICS project implementation, the Regional Controller for Latin America and the Caribbean of the IDRC-Canada had a meeting in Rio de Janeiro with FUJB and BRICS project coordination team in Brazil (RedeSist/IE/UFRJ). Focusing on IDRC financial and administrative procedures, the meeting was very helpful to clarify some doubts and to build a constructive mutual confidence approach.

FUJB and RedeSist/IE/UFRJ structured the administrative and budget control procedures to allow BRICS project implementation. Both were responsible for all basic administrative and financial activities during BRICS project implementation, including the contracting of consultant services, managing project funds in Brazil and New York and periodically reporting to IDRC.

Significant efforts were developed during the first semester of project implementation in order to fulfill IDRC requirements regarding country clearance approval for research partnerships in China and India. Different dealings were tried, but the process took too long and the project got delayed for about six months. Country clearance is not a common requirement from international development agencies or foundations. As the procedures are not simple, vary from country to country and the time taken is not short, it would be extremely helpful if IDRC could provide granted institutions with clearer guidelines on how to obtain clearance approval in the specific countries covered by their projects.

In addition to the standard management activities, it’s worth mentioning the activities developed to guarantee a successful organization of the events aiming the dissemination of project results, including travel logistics, invitations, infrastructure, etc.

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br Several national and international events were organized throughout the project. As will be detailed ahead 3 International Seminars (South Africa, India and Brazil), 4 Innovation Panels (India, Brazil, South Africa and China) and panels prepared at different international forums took place aiming at debating and disseminating project findings with focus on policy makers, academics, post-graduate students and business sector.

5. Project Outputs and Dissemination:

5.1 Research

BRICS project has fostered research efforts connecting universities and research centres in Brazil, Russia, India, China and South Africa. More than 40 researchers from the five countries are directly involved in the project, besides PhD and M.Sc. students as well as interns, which are both giving support and being skilled in each one of the five countries. This is an important output of BRICS project combining knowledge building and networking.

As a result we have produced 36 research papers, both focusing on the national system of innovation in BRICS countries as well as detailing specific dimensions of the NISs. The research outputs of the BRICS Project gather among others:

Ø Five National Innovation Systems reports analyzing the cases of Brazil, Russia, India, China and Russia Ø One Comparative Report of NIS in BRICS countries Ø Five Reports analyzing the Financing, Funding and experiences in the NIS of BRICS countries Ø Five Reports analyzing the TNCs in the NIS of BRICS countries Ø Five Reports analyzing the SMEs in the NIS of BRICS countries Ø Five Reports analyzing the Role of the State in the NIS of BRICS countries Ø Five Reports analyzing the Inequality and the NIS of BRICS countries Ø Five Comparative reports each one addressing one thematic study

All reports are available at http://brics.redesist.ie.ufrj.br/proj_idrc/

Recognizing the important contributions gathered by the research papers, the decision to publish 5 books putting together the main findings of BRICS project was followed by the structuring of a BRICS project editing group. This group reviewed all the aforementioned reports, identified main gaps and worked together with the authors to make the necessary changes/adding. Afterwards, the group prepared the 5 book manuscripts following the standards of renowned publishers. The idea is to have a co-edition between IDRC and a private publisher of the following books:

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br 1. BRICS and Development Challenges: Inequality and National Innovation Systems - Edited by Maria Clara Couto Soares, Mario Scerri and Rasigan Maharajh 2. The State and the National System of Innovation: a Comparative Analysis of the BRICS Economies – Edited by Mario Scerri and Helena Lastres 3. BRICS National Innovation Systems: the Promise of Small and Medium Enterprise – Edited by Ana Arroio and Mario Scerri 4. The Financing of Innovation in BRICS – Edited by Michael Kahn and Luiz Martins TNCs and the National System of Innovation in BRICS – Edited by José Cassiolato, Graziela Zucoloto, Liu Xielin and Abrol Dinesh

Finally, it’s worth mentioning that other book chapters, journal and magazine articles, as well as conference papers resulted from BRICS project research activities.

Dissemination Events:

Four main dissemination modalities were put in place. First, the organization of International Seminars gathering researchers, students, policy makers, as well as academic, government and business representatives. The organization of Innovation Panels was the second modality, which focused on the dissemination and discussion of research findings and outputs at national level with policy makers and other local society representatives. Third, the organization of panels focusing on BRICS innovation systems and development issues during international conferences. The events in some cases counted with the sponsorship of other national and/or international institutions, besides the support of IDRC. Finally, a webpage was developed to disseminate the BRICS project (http://brics.redesist.ie.ufrj.br/proj_idrc/index.php). The webpage gathers information about project partners and sponsors, main activities, research outputs and research team. All events, power point presentations, research reports and related information are available to download after registration.

It follows a brief description of the events organized by BRICS Project:

Brazil (2007) – The International Seminar “Ten years of Local Innovative and Productive Systems”, commemorative of ten years of RedeSist creation, was organized from 26th to 28th November 2007, Rio de Janeiro. Taking advantage of this opportunity, two panels were organized focusing on the BRICS Project: “National Systems of Innovation and Development” and “Measuring Innovation: systemic indicators for the BRICS countries”. The event had the participation of Luiz Antonio Elias (Executive Secretary of the Ministry of Science and Technology), Luis Fernandes (President of the Brazilian Innovation Agency-FINEP), Luciano Coutinho (President of Brazilian Development Bank-BNDES), among other government representatives.

South Africa (2008) - The International Seminar ‘National Innovation Systems of BRICS Countries’ took place in Stellenboch, South Africa, from July 28 to 29th. The seminar counted with the participation of BRICS research team, as well as foreign and local invited participants. NIS draft reports were presented as well as the thematic TOR proposals. Comments and 13

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br suggestions emerged from the debates. This workshop put together almost all BRICS project researchers, helping to build new dialogue chains among country teams. The final session had the speech of Prof Ben Turok from the African National Congress.

Mexico (2008) - In spite of not being a specific project activity, Globelics seminar was an opportunity to disseminate preliminary findings of BRICS project. The workshop session on ‘BRICSM national innovation systems and transnational corporations’ was organized by B.A. Lundvall. BRICS project coordinators from South Africa, Russia, Brazil and India presented their contributions based on the research reports of National Innovation Systems.

India (2009) - The International Seminar and India Innovation Panel ‘Innovation under Globalization: The BRICS Experience’ took place in Trivandrum, India. The meeting happened from November 18th to 21st and included Plenary and Technical Sessions. The plenary sessions addressed two key issues: ‘Global Financial Crisis and Innovation in BRICS’ and ‘BRICS for an Innovative South’. The technical sessions focused on the five thematic issues covered by the project. The seminar was closed by the speech of Dr Shashi Tharoor, the Ministry for External Affairs, Government of India.

Brazil (2009) - The International Seminar and Brazil Innovation Panel “Innovation, Development and the Global Crisis: The BRICS Experience” took place in Rio de Janeiro, from 16 to 17th November, 2009. The event presented and debated the major findings of BRICS project with Brazilian government’s representatives, policy makers, business institutions as well as academics and pos graduate students.

China (2009) – The Innovation Panel “BRICS, Innovation, Globalization and China's Industrial Upgrading”, discussed regional innovation capabilities and the present and future status of BRICS’s innovation system in China. It also addressed the relationship between FDI and BRICS’s innovation capability, and China's industrial upgrading and innovation after the financial crisis. The Innovation Panel took place in Beijing, December 26, 2009. It had the participation of the Ministry of Science and Technology and the General Director of Department of Policy and Regulation of China, among other government representatives.

South Africa (2010) - The Innovation Panel in South Africa took place in Pretoria, January 29, 2010. It disseminated the findings of the South African component of the BRICS project to a wider South African audience, including academics, government agencies concerned with various aspects of the national system of innovation, NGOs, independent research and international organizations.

5.2 Capacity building

José Bonifácio Universtity Foundation- FUJB has a large experience with management of resources from governmental, private and non governmental national institutions. However the condition is not the same regarding international funding. BRICS project has contributed to the

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br strengthening of FUJB’s capability to deal with international donations and provided an opportunity for the development of new staff capabilities.

Also, BRICS project allowed a better understanding of the challenges and opportunities of building an international research network that gathers countries of four different continents. Finding ways to go beyond differences in language, culture, work dynamics, academic approaches among other elements was also an important capacity building component of the project.

Training activities were developed both within research country teams and between them. In all BRICS countries research work included undergraduate and postgraduate students helping to build new capabilities on BRICS and National Innovation System research area. Interns, master and doctorate students took part in different research activities, such as database organization, preparation and discussion of BRICS reports, as well as in the organization of project dissemination events. All international seminars and national innovation panels counted with the collaboration and participation of undergraduate and post graduate students linked to the host project partner/institution.

The dissemination events also contributed for the knowledge of the academic and business representatives who had the opportunity to share the debates. The same applies for the policy makers and governmental representatives that followed up the events. The list of seminars and innovation panels’ participants is available at BRICS project webpage.

Finally, in some BRICS countries teaching activities of project researchers includes BRICS subject both during regular classes as well as trough seminars and other university forums.

5.3 Policy influence

As already mentioned particular attention was given by BRICS project to policy implications. One of the main objectives of the project was to stimulate interactions and the exchange of experiences between researchers and policy-makers interested in innovation in BRICS aiming at creating capabilities and finding joint workable solutions. The interaction of innovation researchers and government officers was stimulated through the organization of the aforementioned International Seminars and National Innovation Panels, the last ones specifically addressed to diffuse the policy analysis and recommendations developed by the project. The debates during these events contributed to generate inputs as well as to discuss policy implications and put forward new policy recommendations, extracting lessons that can be useful not only for these countries but also for other developing countries.

The five books to be published consolidate the knowledge developed along BRICS project making it available to interested public including policy makers, donor and multilateral institutions, among others.

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br According to the specific contexts of each country, the goal of bringing high level government representatives to take part of the events and even to co-sponsor BRICS project initiatives was a significant achievement of the project. For instance, the Brazilian Development Bank has hosted the BRICS Innovation Panel in Rio de Janeiro. Its president, as well as the Brazilian Secretary of Science and Technology and the president of the Brazilian Innovation Agency took part of the event. The same happened at other project events such as the Innovation Panel in India, which had the participation of the Ministry of External Affairs, and the Innovation Panel in China that was chaired by their Ministry of Science and Technology.

Therefore, we could say that the contribution of BRICS project has gone beyond the improved knowledge on BRICS’ National Innovation Systems or a mere academic contribution. It also released important tools and recommendations for advising policy making that may influence national policies.

6. Main Project Findings

The analysis of the National Innovation Systems of BRICS countries was developed along the first year of the project. A summary of the country reports together with a comparative analysis is available in Annex 3. The following paragraphs highlight some general findings.

The present condition of the national innovation systems of BRICS countries is strongly influenced by their historical evolution. With the exception of Russia and China, colonization plays an important role in explaining their current scientific and technological capabilities. In the case of Brazil and South Africa such influence was more dramatic as they are, in practice, constructions of colonization.

In Brazil, the Portuguese not only forbade the setting up of all production activities that could be either performed in Portugal or subjected to exchange with Portuguese commercial partners, but also impeded the establishment of any academic or research institution in its colonies. All training in law, medicine or technical areas of Brazilians up to 1808 should necessarily be made in Portuguese institutions. Even after that, and for more than a century, internal scientific and technological were restricted to activities such as medicine, law, agricultural research and health and hygiene.

As for South Africa, although it is considered the cradle of humanity, its development trajectory was totally influenced by an aggressive colonization that started in 1652 by the Dutch East India Company that exploited the abundance of natural resources. It was only in 1961, that the country was officially decolonized from Britain but one may argue that its National System of Innovation only began to take shape after the end of the apartheid regime in 1994.

India suffered through colonization in a different way. India had a well developed scientific and technological heritage, the most advanced production system in textiles and clothing, etc.

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br However, the British colonization hampered Indian technological and industrial development by relegating her to the status of a raw material supplier and by forcing an educational system, which focused only on production of clerks and administrators. All of this contributed at least to slow down Indian scientific and technological development.

China was never colonized and was already a proto industrialized country in the XIII century. For centuries China has been a nation, characterized by a strong central power and governed as a political unity. Arguably, some of the most important inventions of mankind such as paper, the compass, gunpowder, ceramics and printing were Chinese.

Russia, as a nation, has also has a long history. The Russian Empire became a world power for the first time only under the Romanov dynasty and Peter I the Great. In the XVIII century the Russian Academy of Sciences and Arts was set up and a system of professional schools and academies in engineering, medicine, navigation, military science etc. and the Moscow State University were also created.

Given such historical differences the recent developments of the NSI in these countries present several similarities and important disparities that should be taken into account in a comparative exercise. In fact, all these countries have tried to implement strategies to enhance the domestic capacity for innovation. These strategies, however, have been implemented differently, taking into account the cultural and historical heritage of each country. China and India have had greater freedom to define and implement their policies and strategies for STI than South Africa, which emerged from the apartheid regime in 1994 with its economy in difficulty. Russia, on the other hand, was able to adopt a more independent strategy only after the arrival of the Putin government by 2000. South Africa still suffers from the profound divisions that occurred in the country during the apartheid period and the dualism of its science and technology is only now beginning to diminish. China and Russia have strong central governments, while India has to cope with a significant number of sub-national entities in the execution of policy and South Africa has to live with more than a dozen different nationalities, each with its own language.

All four countries have enormous regional disparities and all suffer from a perverse distribution of income. These characteristics have a significant and differentiated impact on the domestic innovation systems that cannot be minimized in a comparative analysis.

At the same time there are important specific differences. In general terms, the strong position of Russia in terms of higher education is very important. This capacity is not just quantitative – in 2006 more than 72% of the school age population was matriculated in higher education (Table 1) – but also qualitative, especially in the areas of mathematics and physics. The earlier levels of specialization and training – such as those in defence and the petroleum and gas complex should also be noted. Russia has faced significant challenges in its institutional plan, particularly with regard to the transformations necessary to make use of the more than 4000 research institutes inherited from the Soviet period.

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Countries 1990 2000 2006 Var (%) 1990-2006 Brazil 11.2 16.2 25.48 127.50 China 3.0 12.7 21.58 619.33 India 6.1 10.6 11.85 94.26 Russia 52.1 62.8 72.28 38.73 South Africa 13.2 14.6 15.41 16.74 World 16.0 23.9 23.69 48.06 Source: UNESCO

In the Indian case, there was a significant improvement in qualitative terms in its educational and scientific infrastructure and also serious attempt to increase the foundations of the system throughout the 1990s. Even so, only 10.7% of the school-age population was able to enroll in institutions of higher learning in 2000 and 11.85% in 2006, the lowest percentage among BRICS (Table 2).

South Africa has been working to achieve a significant increase in quality higher education but R&D and innovation activities remain relatively weak with limited scientific training. Training programs with technological content is confined to the areas of mining and agro-industrial sectors (namely the production of wine).

Once again it is China that is presenting the most impressive results, especially because the creation of scientific and technological training is one of the principal aspects of the Chinese strategy of development. China significantly increased the number of enrolments in higher education (especially in the areas of engineering) growing from 3% of the school age population in 1990 to 13% in 2000 and 21.5% in 2006, with an astonishing rate of growth of 619% in the period. At the same time, the strategy is concentrated on sending a significant number of Chinese students to study abroad (approximately 150,000 in recent years). The Chinese share of scientific publications increased from 2.05% in 1995 to 6.52% in 2004.

Despite the difficulty in finding reliable indicators, it can be said that these countries are passing through a period characterized by a sharp increase in R&D activities. Based on data from UNESCO, Table 2 shows that, between 2000 and 2008, R&D expenditure in these countries increased from US$ 88.4 billion to US$ 191.8 billion in 2004, equivalent to an increase of 70.6% over the period. R&D spending in China led this growth, increasing by 113% in that period, rising from US$ 45 billion (0.9% of GDP) to US$ 122 billion (1.3% of GDP). In all other BRICS, however, the increase in absolute terms has not been matched by an increase in relative terms, as the relation between R&D expenditure and GDP practically did not changed during this period.

When the agents responsible for making investments in R&D are taken into account, (Table 3), it can be seen that the government’s share of total R&D expenditure is particularly high in 18

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In all other countries (China, Russia, Brazil and South Africa) the share of government expenditure is relatively low, fluctuating around 21% and 26%, in 2004. However, there are some important differences in these four BRICS. In the case of China, where 68% of total R&D expenditure is performed by firms, one should remind that state-owned companies still constitute the core of the Chinese entrepreneurial sector. In Russia, the large percentage share of the entrepreneurial sector R&D expenditure (68%) reflects the intense efforts of the process of re-conversion of the manufacturing structure. In the other two BRICS, what stands out is the excessive relative participation of higher education institutions which accounted in case of Brazil for 38% of total R&D expenditure and in the case of South Africa for 21% in 2004.

Table 2: BRICS - R&D Expenditure – 2000-2008. US$ billion PPP and % of GDP

Country 2000 2001 2002 2003 2004 2008

Brazil 12,573 0.94% 13,584 13,408 0.91% 13,344 0.88% 13,558 0.83% 17,762 0.82% China 44,894 0.90% 52,435 65,515 1.07% 77,899 1.13% 95,498 1.23% 122,706 1.33% India 20,177 0.77% 18,378 18,933 0.73% 19,663 0.71% 21,189 0.69% 22,575 NA Russia 10,760 1.05% 12,983 14,655 1.25% 16,517 1.28% 16,360 1.15% 24,127 1.07% South Africa NA NA 2,978 NA 0.80% 3,607 0.86% 4,176 0.92% 4,462 NA BRICS 88,406 100,360 112,512 131,031 150,782 191,632 TOTAL 705,114 752,735 776,115 827,279 896,066 NA % BRICS 12.5 13.3 14.5 15.8 16.8 NA Source: UNESCO and OECD

Table 3: BRICS - R &D Expenditure 2004-2007 – Total, Percent of GDP and Distribution by Sector (2004) Gross domestic expenditure on R&D GERD by sector of performance (%) - 2004 Country (GERD) as a % of GDP Business Higher 2004 2007 Government Private non-profit enterprise education Brazil 0.91 0.91 40.2% 21.3% 38.4% 0.1% China 1.34 1.43 68.3% 21.8% 9.9% ... India 0.61 0.69 19.8% 75.3% 4.9% . Russia 1.07 1.08 68.0% 26.1% 5.8% 0.2% South Africa 0.87 0.92 56.3% 20.9% 21.1% 1.7% Source: UNESCO and OECD

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br Although these figures should be considered with caution, giving the problems with STI statistics above mentioned, they nevertheless confirm some patterns that are qualitatively assessed by the different country papers of this book. In fact they illustrate a general picture of the national system of innovation of these countries which has been affected – positively and negatively by explicit and implicit STI policies.

Although policies directed to science and technology have been implemented in both the developed and developing world in a systematic way only since the end of the second world war of the 20th Century, governments of different countries have been designing policy mechanisms that influenced their scientific and technological development for a long time. BRICS are no exception to such rule, particularly the oldest civilizations. The Chinese inventions of the ancient world above mentioned and its evolution to become a proto- industrialized country already in the 12th century were possible only with a strong government that supported technological development extensively. This is also true of India which had metallurgical technological capabilities more than 500 years before the industrial revolution and Russia where Peter the great set up the Russian Academy of Sciences and Arts in the early 18th century together with a system of professional schools and academies in different technical area.

But it was only after the end of the Second World War in the middle of the XX century that governments began to perceive the importance of directing the scientific and technological development. One effect of the war was a generalized perception about the importance of technology and that governments should organize scientific and technological activities. But, as pointed out in the Brooks Report (OECD 1971) up to the early 1960s STI policies were mostly of the science push type, governed by a strong conviction that scientific development would necessarily lead to social and economic development. After that - and supported by a series of empirical studies on sources of innovation - the core of STI policies shifted significantly. The objectives moved towards fostering STI activities towards attaining national strategic achievements. In the developing world, at least up to the late 1970s, organizing scientific and technological activities and controlling foreign technology that accompanied foreign direct investment were the basic objectives of STI policies

The crisis of the 1980s put the STI policies in the backyard of the policy agenda in the developing world. As part of what has been called a 'counter-revolution in development theory and policy' (Toye 1987) a radical neo-liberal program in which “development practically disappears as a specific question (remaining) only as the welfare achieved by the elimination of obstacles to market functioning” (Arocena and Sutz 2005, p. 16) was introduced in the developing world. As this program stated the supremacy of the markets prices that even if market failures existed, imperfect markets were better than imperfect states, policy intervention was limited to the implementation of those mechanisms that did not interfere with market functioning.

Obviously this reflected in the STI policy and it was only after the liberal program started to face problems in the late 1990s that old science and technology policies began to be renovated 20

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br under the new label of the national innovation system approach. In fact, beginning at the end of the 1980s, STI policies started to target more explicitly technological innovation. In a period of huge influence of foreign policy experts, their internal policy formulation process introduced the “innovation” theme at the core of policies, but with a distorted vision based on emerging conceptual models of OECD countries. In fact the “national innovation system” version that inspired policies was the narrow one that attempted to emulate what was perceived as the benchmark of the new economy – Silicon Valley and similar U.S. experiences. Implicitly, policies were informed by the ‘mode 2’ knowledge production (Gibbons et al 1994) which advocated an entrepreneurial role for modern universities. The general constitution of STI policies was to manage instruments and mechanisms that could foster innovativeness in the economy, concentrating on providing infrastructure (external economies) and on stimulating technological entrepreneurship. According to Gibbons et al, the role of science in achieving national goals should be oriented towards “the single question of how to hitch the scientific enterprise to industrial innovation and competitiveness”.

It was under such framework that BRICS policies to STI evolved in the last 20 years. In the reports to the BRICS project one will find that in one way or another BRICS pursued these policy lines, but in different ways. In particular BRICS connected in a different way, explicit STI policy mechanisms of such type to other policies not geared directly to STI but which have a significant impact on innovation outcomes

India was one of the few developing countries to formulate an explicit policy for science and technology immediately after the end of the Second World War. In fact, the pursuit of technological self-reliance was given a central role in its development strategy after independence. This resulted in substantial public investment in scientific education and R & D infrastructure and involved the establishment of public enterprises for the production of inputs like steel, oil and gas, petrochemicals, power, fertilizer and equipment and machine tools needed for the production of capital goods and the creation of mission oriented scientific and technological agencies and R&D institutions for the development of technological capabilities needed for the production of atomic energy, space, clean coal, glass & ceramics, processed foods, pharmaceuticals, agro-chemicals. India accomplished self sufficiency in food production and the establishment of a diversified industrial sector. This first phase led also to substantial achievements in areas such as atomic energy and space.

After 1980 India’s main axis of STI policy continued to be a strong emphasis on some strategic areas such as atomic energy, defense and space and civilian R&D priorities continue to be neglected (Abrol 2005). In 1983, however, a change in STI policy was proposed by the Technology Policy Statement (TPS), de 1983, which set up, as main priorities, both internal technological development and absorption of foreign technology. After that at least eight major policy documents were issued by the government of India with the aim of organizing the STI policy. One striking difference of the Indian policy is that it never adopted the emphasis on innovation and the National Innovation System approach. Its legislation and policy mechanisms continue to target the scientific and technological infrastructure and the technological

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High quality research public institutions also characterize India’s NSI. In particular, those research institutions linked to defense have played a major role and haven been one of the cornerstones of the STI policy. Worth pointing out is the role of the Defense Research and Development Organization, to which some authors credit the success of India in the area of software (Kumar 2000). In India, even after liberalization the government spending on R&D continued to be crucial and more significant than private spending. But few concentrate the bulk of government support: the strategic areas of defense, space and nuclear energy1 receive 64% of the expenditure in science and technology of the central government, while agricultural research comes after with approximately 10% (Basant 2000).

Another specific point regarding India is that the opening up of its economy since the 1980s has been highly selective and a combination of active policies and strong regulation facilitated the emergence of large domestic entrepreneurial groups and technological learning. Some of these groups became multinational conglomerates such as the Tata group, several pharmaceuticals firms (Cipla, Ranbaxy, Dr Reddys) and steel groups (Mittal). A well-known recent case of technological and production success is the US$ 2000 automobile (the Nano) developed by the Tata Group which was called by the Economist magazine (2007, p. 30) an “example of the smart but ascetic engineering that can produce an impressive car” for such a price. Tata expects to sell at least 300,000 of them in 2009-2010 only in India (The Economist 2009). Also, a more liberal approach towards foreign investment was introduced in India, even if there are several areas such as telecommunications and energy where foreign participation is still regulated. In the case of Russia, it is true that the period that immediately followed the collapse of the Soviet Union represented a significant downgrade of previous accumulated capabilities. The first half of the 1990s was a period that Gokhberg (2003) characterized as one of “market romanticism in science and technology policy, driven by vain hopes of reformers for quick and automatic transfer (of responsibilities) to the market economy”. During this period the Russian scientific and technological system almost collapsed as a dramatic decrease in government funding (from 1991 to 1992 alone (it fell from 1.85% to 0.67 of GDP) meant a significant reduction of human resources and a liquidation of a large number of scientific organizations. According to the chapter on Russian STI policy in this book the consequences of this crisis have not been overcome by the end of the 2000s.

STI policy started to change in the early 2000s. A first noticeable trend was a remarkable increase in, government R&D funding that in 2003-2004 federal budget grew by 14.2%, and in 2004-2005 by 51.1%. Although initially using mostly traditional instruments – national programs – STI policy started to be formulated in that period in a significantly more interventionist manner. First, the policy began to target areas and sectors: priority scientific and technological areas and critical technologies were chosen. More important big-scale

1 These figures are under-estimated as, for reasons of national security, a large part of government expenditure in this area is not published.. 22

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Such change is associated is to the rise of the new government in 1999, which at its inauguration points out the need for State intervention in regulating economic forces in order to achieve strategic objectives including reestablishment Russian geo-political influences using internal natural and technological resources. (Putin, 1999).

In the new policy agenda, there is an explicitly mention to the need for pursuing a strategy that emphasizes the “progress in the high technologies and science-intensive commodities” (Putin, 1999). Among the main policy actions public procurement for advanced technologies and science-intensive production, support for the production of technology intensive goods for export, support for processing industries geared to internal demand and, finally using novel instruments for stimulating energy, oil and gas industries were singled out.

Besides a radical transformation of the industrial structure in the oil industry – with an increasing control by the State - State corporations were set up in areas of state interests and priorities. The best example, perhaps, of such radical change was the setting up of the Russian Corporation for Nanotechnology (Rosnanotech) in 2007 to address the challenges associated with the rapid development of nanoscale technologies. Rosnanotech is one of seven Russian state corporations, enjoys direct budgetary support, has a special status, being out of control from regulating bodies and its director is appointed by the Russian President only.

China, is without doubt the most significant and complex case of recent STI policies among BRICS. A major difference is that explicit technological policies were accompanied by and are in fact an important part of a sophisticated industrial policy since 1989, characterized by huge state intervention geared towards industrialization with emphasis in what is termed in China as the “pillar industries”, the high tech sectors, intensives in capital and technology. This intervention combined the selective attraction of TNCs (most of them required to perform R&D activities inside China as part of a permission to produce there) and changes in the industrial structure in almost all sectors of activity which not only privileged locally controlled ventures but also retained State control of several important firms.

In the 1989 reform, science was given strong priority as improvement of scientific and technological infrastructure was targeted and universities became major actors of the Chinese National Innovation System. Through a series of policy programs several universities were targeted to become world leading universities and, by 2010 China will probably produce more PhDs in science and technology areas than the United States. Universities were also targeted to strengthen research capabilities with the 973 program (Basic Research program), perhaps the most important of the Chinese STI policy, launched in 1997 with the aim of strengthening the role of government in science that targets areas such as energy, information technology, health and materials.

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br The upgrading in university capabilities was associated with programs that addressed high tech entrepreneurship, particularly the Torch Program launched in 1988. Conceived basically as a follow-up of the 863 Program (High Technology Development Plan) it aimed at the diffusion of the technologies emerging from the research carried out as part of the Plan (Baark, 2001). The success story was that new high-tech ventures were set up and were able to grow, as the program was associated to other institutional changes that basically allowed universities and research institutes (including the Chinese Academy of Sciences) to keep control of these hi-tech firms. It provided the basis for the upsurge of a locally controlled high-tech sector that keeps being important in the Chinese national system of innovation.

High-tech zones have been also promoted and linked to these two programs, universities were also given permission to set up and control firms in high-tech areas which explains the setting up of important firms that became leading actors in their sectors such as Lenovo. The immediate result is that the share of the value-added of high-tech goods in GDP jumped from 2.12% in 1998 to 4.44 % in 2004.

Finally worth mentioning is the change of direction of the Chinese STI policy in 2006. Perceiving the limits in pursuing a technological strategy directed to export goods to western advanced economies. The new 2006 plan addressed two key issues: the environment and innovations towards the needs of the domestic market. Perhaps worried with an over exposition to the global market the policy aims at stimulating firms and other actors of the innovation system to develop innovations more appropriate to the specificities of the large Chinese market. It contemplates the setting up of priorities for indigenous innovation products in public procurement and some price advantages in public procurement for these products. More recently, in the middle of the crisis, China economic-stimulus package provides approximately US$ 200 billion to eco-friendly projects (34% of the total).2

Brazil and South Africa followed more or less the same pattern, as their development trajectory have been marked by the same type of integration in the world economy subjected to abundance of natural resources within their borders. In both cases, but more marked in the case of South Africa, mineral resources play a key role. In Brazil, although some institutional efforts were introduced in the 1950s with the setting up of the National Research Council, it was only in the late 1960s that an explicit policy for science and technology began to take off. Nevertheless this policy concentrated in organizing a post-graduation and research system primarily at public universities. But these policies were much influenced by a broader import substitution industrialization policy which only in a small number of cases addressed internal technological capability building. In fact, the Brazilian production subsystems with high internal technological development are precisely those where the technological policy has been the core of the industrial policy: petroleum and gas, aeronautics, bio-fuels, most of the agroindustrial subsystems, some industrial inputs (raw-materials) such as mineral ores, and paper

2 This figure is from The Economist (2009b) which is based on a report published by HSBC, ranking 17 countries by the green elements of their stimulus package. Just for a comparison, according to the study, India is investing nothing of its $13.7 billion stimulus plan for such ventures and Japan allocated just 2.6% (US$ 12 billion). 24

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There was a specific institutionalization that proved to be crucial both for industrialization and technological development. Perhaps one of the main reasons for the successes of the Brazilian industrialization process was the setting up of the National Bank for Economic and Social Development (BNDES) in the 1950s. When expectations about a possible Marshall Plan for Latin America subsided, the internal reaction was to create a financial institution to deal with problems of long run investment. BNDES, that today is twice as large as the World Bank, although not caring specifically about technological development, has had an important role on the institutionalization of science and technology in Brazil. It was there that in the 1960s the first program directed towards scientific and technological development was created. Afterwards, a specific government agency to deal with science and technology - Finep - was created, still in the 1960s. In the 1970s another crucial institutional development occurred with the setting up in 1973 of the Brazilian Agricultural Research Corporation (EMBRAPA) with the aim of providing feasible solutions for sustainable development of the Brazilian agriculture through knowledge and technology generation and transfer. EMBRAPA consists of a set of agricultural research and services units scattered in different parts of the country. Today it comprises 41 units: services (such as the units for technological information, technology transfer, instrumentation, etc.) product research units (such as the units for soy, fruits, etc.) research on basic themes units (such as genetic resources and biotechnology) and research units specialized on the different Brazilian eco-regions (such as the units specialized in the cerrado, semi-arid, tropical forest, etc.). In 2007, EMBRAPA set up a research unit for satellite monitoring that concentrates on research and development of territorial management systems. In its labs researchers work on geographical information systems, electronic networks, processing of satellite images for remote sensors and data obtained at local level. The technologies and information by this unit have been crucial for the development and implementation of production strategies that are specific to different areas of Brazil and for different plots in each farm. Arguably the technological success of the Brazilian agriculture is due to EMBRAPA.

After the crisis of the 1980s and 1990s, STI policies went back to the Brazilian policy agenda which, similarly to what happened in other countries concentrated on three main pillars: stimulus to technological development and innovation in the firms; upgrading the technological infrastructure; and incentives to the setting up of new technology based firms (spin offs from university research). For the implementation of such agenda the Brazilian Ministry of Science and technology created 12 sectoral Funds for Supporting Scientific and Technological Development, which essentially attempt to finance partnership projects between universities and firms, and projects aiming at recovering and expanding the scientific and technological infrastructure of research institutions and universities. Also, together with traditional mechanisms such as fiscal incentives to R&D, Brazil introduced an “Innovation Law” inspired by French legislation in the early 2000 with the objective of stimulating the transfer of

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In the case of South Africa only with the elimination of the apartheid regime one can speak of a national policy for science and technology. Before that period, programs for human formation and research only existed for the white minority and one of the main policy challenges of the new democratic post-apartheid regime was to include all South Africans in its teaching and research system. After the end of the Apartheid regime science and technology policies were gradually and systematically changed using the NSI approach with the support of foreign donors and policy experts. The chapter on South Africa of this book points out that as a consequence, the policy that was adopted afterwards did not adequately take into account the historical and contextual conditions of South Africa as a latecomer society and that is why it did not show any perceivable results as far as innovation is concerned.

In one way or another both Brazil and South Africa set up a wide variety of policy programs and funding mechanisms for innovation that focus primarily on scientific and technological institutions and joint R&D projects between universities and firms. Regarding the support for firms´ innovations, mechanisms contemplate traditional, low effectiveness, fiscal incentives and loans towards R&D.3 However, in both cases on e could argue that important upgrading in the infrastructure has been obtained and that in some subsystems the results have been positive.

During the second year of the project the five thematic studies were undertaken. The main findings of these studies are being compiled in five books, which are briefly presented below.

The first one is an aspect of the NSI that is normally absent from the discussion: the relation between innovation and inequality. The objectives of the book ‘BRICS and Development Challenges: Inequality and National Innovation Systems ’were to trace the trends in interpersonal and inter-regional inequality within BRICS in an evolutionary perspective and to analyze the co-evolution of inequality and innovation system to highlight how the various elements of innovation and production system and inequality mutually reinforce. The book is driven to improving our understanding of this issue. Inequality concept is considered in its multi-dimensional character, embracing a phenomenon that goes beyond the mere income dimension and is manifested through forms increasingly complex, including, among others, assets, access to basic services, infrastructure, knowledge, as well as race, gender, ethnic and geographic dimensions. The book adopts the broad approach of national system of innovation to analyze the relations between BRICS innovation systems and inequality, departing from a co-evolutionary view. As shown along the book, innovation can affect inequalities in different ways and through distinct trails that are influenced by national conditions, and shaped by public policy interventions. Although innovation does not constitute the main factor of influence on

3 The effectiveness of such incentives for inducing firms to invest in innovation activities has been hotly debated. In a synthesis of such debate an extensive policy evaluation of Australian policy for innovation concluded that “ firms should be barely receptive to subsidies directed at R&D alone, any more than people buying cars would respond to a reasonable subsidy on the tyres (Productivity Commission 2007, 35). 26

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The second book ‘The State and the National System of Innovation: a Comparative Analysis of the BRICS Economies’aims at exploring the relationship between the state and the National System of Innovation in BRICS. An evolutionary approach has been adopted in order to capture the nature of the state in the respective countries and thus understand the historical and ideological basis for its role in the evolution of the NSI in the five countries. As a background, it is argued that debates on the role of the state in the development process, especially since the eighties, have often focused on the apparent dichotomy between market driven and state driven development. This is a rather wasteful diversion, since it should be accepted as a starting premise that the state is essential to the structural transformation that is required for development.

The third book aims at analysing the contribution of SMEs in the national system of innovation. The objective of the book ‘BRICS National Innovation Systems: The Promise of Small and Medium Enterprise’is to explore three main research goals. In the first place, to provide an overview of the main characteristics of micro, small and medium firms in the Brazilian, Russian, Indian, Chinese and South African National System of Innovation as a basis to examine the contribution of SMEs to the economy of each country.. A second goal is to bring to the forefront crucial issues in the discussion of industrial and technological policies for small firms; including the recent evolution and future trends of policies and instruments, their applicability and coordination, as well as a discussion of the macro-economic, legal and regulatory environment. A final research objective is to draw out initiatives to promote innovation in SMEs that address common bottlenecks in BRICS countries and that can contribute to policy design and implementation by these and other countries.

The fourth book deals with finance and funding in the national system of innovation The objective was to analyze institutional character and support instrument for the innovation financing process in BRICS, focusing on the institutional structure and innovation policy. This book “The Financing of Innovation in BRICS” offers a contribution to understanding the varied approaches to the financing of innovation. It draws on the experience of five diverse countries each of which has undergone dramatic structural adjustment in the last two to three decades. The experience of the BRICS countries presents a unique set of case studies of the transition from largely closed centrally-planned and state driven economic and science policy to a more open and market-led situation. The contributing authors examine the varying approaches to the provision of support to the full range of activities that contribute to innovation ranging from scholarship support to doctoral students, to R&D tax incentives and the provision of seed capital.The significance of financing to investments in innovation has been pointed out as an important structural bottleneck that was yet to be solved by the private financial institutions. If, 27

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br on the one hand, the internationalization, deregulation and globalization of financial markets signalizing the possibility of resources at lower costs, on the other, the characteristics of investments in innovation such as the long term for development, the uncertainty and the risk, point to the need of setting national institutional arrangements.

Finally, the fifth book discusses the relationship between transnational corporations and the national system of innovation of BRICS countries. In the book “TNCs and the National System of Innovation of BRICS” the thesis of technological globalization is taken with some caution, refuting the idea that R&D activities would be inexorably internationalized. In fact, technological innovative activities in TNCs have been transformed, in relation with the financialization of TNCs, as evidenced by the rise of their intangible assets (which includes R&D, patents, and trademarks) and a reorientation of R&D expenditures towards non-scientific activities and very downstream development. The book presents a detailed presentation of the relation of the position and evolution of TNC in the country. Subsequently there is a discussion on the local factors affecting innovation by TNCs and local firms in the country. Government policy towards TNCs has been important but as the Chinese experience shows, access to local buoyant markets has also been vital. Other issues discussed refer to how does government protect local companies from competition of TNCs. Spillovers of TNCs to local BRICS enterprises have also been analysed and the immediate conclusion is that there is hardly any convincing evidence regarding either the existence or non existence of spillovers. An in-depth analysis of outward FDI has also been conducted.

A synthesis of these books is available in Annex 4.

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br ANNEX 1

Coordinating Institutions of BRICS Project

RedeSist is an interdisciplinary research network focusing on Local Production and Innovation Systems. It was set up in 1997 at the Economics Institute of the Federal University of Rio de Janeiro (IE-UFRJ), Brazil. RedeSist´s main research interest is the analysis and comprehension of the new requirements and forms of industrial and technological development, as well as the role, objectives, and instruments of technological and industrial policies. Since it was established in 1997 RedeSist has developed a methodology applied to analyze Local Production and Innovation Systems (LIPSs). This methodology has been successfully used in more than 70 LIPSs empirical studies in different parts in Brazil in the areas of manufacturing, agriculture, services and creative and cultural industries. RedeSist comprises about 28 universities and research centers in different parts of Brazil and has more than 100 Senior Researchers, PhD and MSc Students associated. Redesist has already established connections with more than 20 research centers and 6 international agencies abroad and is an integral part of Globelics, the international research network on the Economics of Learning, Innovation and Capacity Building Systems. Since 1997, Redesist research projects have been supported by several Science and Technology and other Development agencies in Brazil including CNPq, BNDES, Finep, Sebrae and Banco do Nordeste.

Center for Development Studies; Trivandrum, Índia: The Center research approach is influenced by diverse considerations, being the main ones: the researchers flexibility to works in areas of their own interest and the priority of the economic theory application in current problems. Although the maintenance and the development of a national perspective, the Center concentrates efforts also in the understanding of the specific economic problems of the state of Kerala. Finally, the Center values the collaboration of others social scientists, scientific and technological institutions and development agencies aiming at contributing to the interaction between diverse types of researchers. Basically, throughout the last years, the researchers haven being divided in three great thematic areas of research. The first examines the correlation between population and economic development, particularly considering quality of life and social identities, as the gender and the social position. This area has developed projects linking gender and poverty or social welfare. The second analyzes the primary productive sector and emphasizes the management of natural resources, as water and land. The third thematic area is about economic liberalization and focuses itself in industry, trade and technology. The biggest efforts re related to the productive growth, the nature of the foreign direct investment and the national technological behavior, the trade reforms (its external performances and its impacts in specify industries) and the economic theoretical models. Some studies on industrial clusters and regional industrial development already have been produced. Other works had searched to correlate these trade reforms the regional integration. Finally, a series of studies on technology and innovation have been developed.

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br Institute for Economic Research on Innovation (IERI) at Tshwane University of Technology; Pretoria, South Africa: IERI was recently inaugurated with the support of the Ministry of Science and Technology of South Africa IERI is located at the Faculty of Economic Sciences, Tshwane University and specializes on analyses of innovation systems, science and technology policies and local economic development. The work of the institution is structured in provincial, regional and national levels inside South Africa, but it extends to other African countries. The institute provides space for debates on alternative economic policies and social and political development, by its approximation with the evolutionary economic school and participation in the program of Science and Technology of New Partnerships for the Development of Africa (NePAD). The research program of the institute is structured in three subjects of empirical research: capacity building, development of capabilities and knowledge dissemination. IERI considers that capacity building is the basic component for transforming underdevelopment left by the apartheid regime. IERE also has partnerships with other education companies, academic institutions, research institutions and not-governmental organizations.

Research Center for Technological Innovation at Tsinghua University; Beijing, China: The Center of Technological Research in Innovation was considered one of the key research centers of China in 2004. The research interests of the institute includes technology transfer strategies and innovation transition, primary resources allocation, scientific parks strategy, innovation and technology integration, regional development, S&T policies, competitive dynamics, technological management policy, statistical control processes, R&D generation, new products creation and development, copyright administration and corporative governance. Moreover, the university develops a partnership with the International Technology Transfer Center (ITTC). The center helps the Chinese companies to find international technologies and partners. The center also offers services that allow the introduction and popularization of technologies and products in the Chinese industry and market. Besides that, the ITTC invests in mature technologies and products in the international market that still present great potential in the domestic market of China. The center also stimulates the academic research about technological transfer around of the world.

Higher School of Economics; Moscow, Russia: The Higher School of Economics (HSE) develops research and teaching activities in areas such as economic theory, the history of economic studies, institutional economics, macroeconomics, the mathematical and instrumental methods of the economy, psychology, law, sociology, public administration, computer science and political studies. The HSE has 11 institutions for research and teaching to accomplishment such activities: the Institute of Research and Macroeconomic Forecast; the Institute of Studies on Enterprise and Market, that focus only microeconomic questions; the Institute of Social Policies, that study the participation of the state in the market; Institute of Prices and Regulation of Monopolies; the Institute of Educational Policies, that is responsible for the modernization of the education system; the Economic Center of Environmental and Natural Resources; the Center of Corporative Governance; the Center of Studies in Labor Market; the Institute of Information Development, that develops the available systems of communication,

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br information and statistics in the HSE; the Institute of Public Administration and Local Management; e, finally, the Institute of Statistics Research and Knowledge Economy.

ANNEX 2

BRICS PROJECT RESEARCH TEAM

Name Institution Role

BRAZILIAN TEAM José Eduardo Cassiolato Economics Institute, Federal Coordinator University of Rio de Janeiro Maria Clara Couto Soares Economics Institute, Federal Project Manager University of Rio de Janeiro & Researcher Luiz Martins de Melo Economics Institute, Federal Researcher University of Rio de Janeiro Fabio Stalivieri Economics Institute, Federal Researcher University of Rio de Janeiro Marina Szapiro Economics Institute, Federal Researcher University of Rio de Janeiro Gabriela Podcameni Economics Institute, Federal Researcher University of Rio de Janeiro Fabiano Geremia Economics Institute, Federal Researcher University of Rio de Janeiro José Luiz Gordon Economics Institute, Federal Researcher University of Rio de Janeiro Helena Maria Martins Brazilian Development Bank- Researcher Lastres BNDES Priscila Koeller Brazilian Institute of Geography and Researcher Statistics-IBGE Graziela Zucoloto Brazilian Institute of Applied Researcher Economic Research-IPEA Ana Carolina Arroio Federation of Industries of Rio de Researcher Janeiro-FIRJAN Márcia Siqueira Rapini Federation of Industries of Minas Researcher Gerais-IEL/FIEMIG Rosileia Milagres Dom Cabral Foundation Researcher Carlos Gadelha Oswaldo Cruz Foundation - Fiocruz Researcher José Maldonado Oswaldo Cruz Foundation - Fiocruz Researcher Mariano Laplane Economics Institute, University of Researcher Campinas, Brazil Fernando Sarti Economics Institute, University of Researcher Campinas, Brazil 31

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br Celio Hiratuka Economics Institute, University of Researcher Campinas, Brazil Léa Velho Economics Institute, University of Researcher Campinas, Brazil André Furtado Economics Institute, University of Researcher Campinas, Brazil Hildete Pereira de Melo Fluminense Federal University Researcher Jorge Britto Fluminense Federal University Researcher Marco Antonio Vargas Rural Federal University of Rio de Researcher Janeiro

RUSSIAN TEAM Alexander Sokolov Higher School of Economics, Coordinator Moscow Tatiana Kuznetsova Higher School of Economics, Researcher Moscow Leonid Gohkberg Higher School of Economics, Researcher Moscow Natalia Gorodnikova Higher School of Economics, Researcher Moscow Stanislav Zaichenko Higher School of Economics, Researcher Moscow Pavel Rudnik Higher School of Economics, Researcher Moscow

INDIA TEAM K. J. Joseph Centre for Development Studies, Coordinator Trivandrum Sunil Mani Centre for Development Studies, Researcher Trivandrum D. K. Abrol National Institute of Science, Researcher Technology and Development Studies Mahesh Sarma Centre for Development Studies, Researcher Trivandrum Keshab Das Gujarat Institute of Development Researcher Research Vinoj Abraham Centre for Development Studies, Researcher Trivandrum Lakhwinder Singh Punjabi University Researcher Venni Venkata Krishna Asia Research Institute, National Researcher University of Singapore

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br CHINA TEAM

Xielin Liu Graduate University of Chinese Coordinator Academy of Sciences Lv Ping Graduate University of Chinese Researcher Academy of Sciences Jian Gao School of Economics and Researcher Management, Tsinghua University Li Yanhua Graduate University of Chinese Researcher Academy of Sciences Yuan Cheng Graduate University of Chinese Researcher Academy of Sciences Han Shucheng Graduate University of Chinese Researcher Academy of Sciences Chen Ao Graduate University of Chinese Researcher Academy of Sciences Fei Teng School of Economics and Researcher Management, Tsinghua University

SOUTH AFRICA TEAM Maharajh Rasigan Tshwane University of Technology, Coordinator Pretoria Mario Scerri Institute for Economic Research and Vice-Coordinator Innovation-IERI Ximena Gonzalez-Nunez Trade and Industrial Policy Director Strategies-TIPS Michael Kahn Research and Innovation Associates Researcher

Lindile Ndabeni Institute for Economic Research and Researcher Innovation-IERI Thomas Pogue Institute for Economic Research and Researcher Innovation-IERI Mbofholowo Tsedu Trade and Industrial Policy Researcher Strategies-TIPS Lucienne Abrahams Learning, Information, Networking, Researcher Knowledge Centre, University of the Witwatersrand Myriam Velia Trade and Industrial Policy Researcher Strategies-TIPS Glen Robbins Trade and Industrial Policy Researcher Strategies-TIPS Helena Barnard Gordon Institute of Business Science Researcher Glenda Kruss Human Science Research Council, Researcher 33

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br Cape Town Dave Kaplan University of Cape Town Researcher Mike Morris University of Cape Town Researcher

Av. Pasteur 250 – Sala 104 e 107 - Urca - Rio de Janeiro/RJ - CEP 22290-240 Tel 55-21-3873.5279 / 5278 - Fax 55-21-2541 8148 Site : www.redesist.ie.ufrj.br ANNEX 3

BRICS Project

Comparative and Summary Report on BRICS National Innovation Systems

RedeSist - Economics Institute, Federal University of Rio de Janeiro, Brazil

Globelics The BRICS Project is a comparison between the National Innovation Systems of Brazil, Russia, India, China and South Africa. It is a project conducted by the Global Research Network for Learning, Innovation and Competence Building Systems – Globelics (see www.globelics.org) and RedeSist – the Research Network on Local Productive and Innovative Systems – at the Economics Institute of the Federal University of Rio de Janeiro Brazil. Conceptually, the project is structured around the Systems of Innovation framework. The central focus of the study is the national innovation system (NIS) of the five BRICS. The notion of innovation system has in its centre the industrial, S&T and education sub-systems; but includes also the legal and political frameworks, investment and financial sub-system, as well as other spheres relating to the national and international contexts where knowledge is generated, used and diffused. The objective is to characterize and compare the NIS of the five countries pointing out convergences, divergences, and synergies, as well as identifying current and potential connections. Particular attention will be given to policy implications. Therefore, the project aims at involving, not only researchers, but also policy-makers working in national and international agencies. Specifically the project aims at: (a) stimulating interactions and the exchange of experiences between researchers and policy-makers interested in innovation in BRICS aiming at creating capabilities and finding joint workable solutions; (b) characterizing the structure of BRICS´ national innovation systems, their recent evolution and perspectives; (c) comparing the five countries innovation systems, identifying differences and similarities, common bottlenecks and complementarities; (d) developing and using concepts and information capable of representing the Innovation Systems of BRICS; (e) discussing policy implications and put forward policy recommendations, extracting lessons that can be useful not only for these countries but also for other developing countries. The project is coordinated by José Cassiolato (RedeSist) and Bengt-Aake Lundvall (Aalborg University Denmark). Country coordinators are: in Brazil, José Cassiolato, RedeSist, IE/UFRJ; in India, K.E. Joseph , Centre for Development Studies, Trivandrum; in South Africa, Rasigan Maharajh, Tshwane University of Technology; in China, Liu Xielin, Graduate University of Chinese Academy of Sciences and in Russia, Leonid Gohkberg, Higher School of Economics, Moscow.

1 I. INTRODUCTION:

Conceptually, the BRICS project is structured within the National Systems of Innovation and the Development frameworks. Characterizing and comparing the BRICS´ NSIs is a challenging enterprise. The first methodological challenge was the development of a common structure capable of capturing their specific characteristics and, at the same time, appropriate for comparison. These are countries with huge dimensions and resources, large populations, wide income disparities (and hence wide disparities in capabilities), regional imbalances, with parts of their systems developed and others relatively underdeveloped. In addition, most of them have experienced huge transitions in their political, economic and social structures as analyzed by the BRICS NSIs country studies. The summaries of these studies are presented in the topics following this introduction. One of the most fruitful thinking developed in advanced countries in the last 30 years came from a resurrection and updating of earlier thinking that emphasized the role of innovation as an engine of economic growth and the long-run cyclical character of technical change. A seminal paper by Christopher Freeman (1982) pointed out the importance that Smith, Marx and Schumpeter attached to innovation (p.1) and accentuated its systemic and national character (p.18). He also stressed the crucial role of government policies to cope with the uncertainties associated with the upsurge of a new techno-economic paradigm and the very limited circumstances under which free trade could promote economic development. Since it was formulated in the 1980s, the system of innovation (SI) approach has been increasingly used in different parts of world to analyze processes of acquisition, use and diffusion of innovations and to guide policy recommendations. Particularly relevant in the SI perspective is that since the beginning of the 1970s, the innovation concept has been widened, to be understood as a systemic, non-linear process rather than an isolated fact. Emphasis was given to its interactive character and to the importance of (and complementarities between) incremental and radical, technical and organizational innovations and their different and simultaneous sources. A corollary of this argument is the context specific and localized character of innovation and knowledge. This understanding of innovation as a socially determined process is on opposition to the idea of a supposed techno-globalism and implies, for instance, that acquisition of technology abroad is not a substitute for local efforts. On the contrary, one needs a lot of knowledge to be able to interpret information, select, buy (or copy), transform and internalize technology. Systems of innovation, defined as a set of different institutions that contribute to the development of the innovation and learning capacity of a country, region, economic sector or locality, comprises a series of elements and relations that relate production, assimilation, use and diffusion of knowledge. In other words, innovative performance depends not only on firms and R&D organizations performance but also on how they interact, among them and other agents, as well as all the other forms by which they acquire, use and diffuse knowledge. Innovation capacity derives, therefore, from the confluence of social, political, institutional, and cultural specific factors and from the environment in which economic agents operate. Different development trajectories contribute to shape systems of innovation with quite diverse characteristics requiring specific policy support

2 It is this understanding of the systemic nature of innovation that allows for two crucial dimensions of the SI approach to be explicitly discussed: the emphasis on historical and national trajectories and the importance of taking into account the productive, financial, social, institutional and political contexts, as well as micro, meso and macro spheres (Freeman, 2003; Lastres, Cassiolato & Maciel 2003). Although all of these contexts are relevant for a discussion about development, two in particular should be singled out that are pertinent to this project. One is the financial context, recognized by Schumpeter (1912) in his Theory of Economic Development. For him entrepreneurs, to become the driving force in a process of innovation, they must be able to convince banks to provide the credit to finance innovation. In this sense, any discussion about innovation systems has to include the financial dimension.1 The other is the idea that space matters, that analyzing systems of innovation should be done at the national (Freeman 1982 and Lundvall 1988) and local levels (Cassiolato, Lastres & Maciel 2003). The national character of SI was introduced by Christopher Freeman (1982, 1987) and Bengt- Ake Lundvall (1988) and has been widely used as an analytical tool and as a framework for policy analysis in both developed and underdeveloped countries. As a result, research and policy activities explicitly focusing on SI can be found in most countries and a rapidly growing number of studies of specific NSI have been produced. Although some authors tend to focus on the NSI in a narrow sense, with an emphasis on research and development - R&D - efforts and science and technology organizations, a broader understanding of NSI (Freeman, 1987; Lundvall, 1985) is more appropriate. This approach takes into account not only the role of firms, education and research organizations and STI policies, but includes government policies as a whole, financing organizations, and other actors and elements that influence the acquisition, use and diffusion of innovations. In this case emphasis is also put on the role of historical processes - which account for differences in socio-economic capabilities and for different development trajectories and institutional evolution - creating SI with very specific local features and dynamics. As a result, a national character of SI is justified. Figure 1, is an attempt to show both the narrow and the broad perspectives on NSI. The broad perspective includes different, connecting subsystems that are influenced by various contexts: geopolitical, institutional, macroeconomic, social, cultural and so on. First there is a production and innovation sub-system which contemplates the structure of economic activities, their sectoral distribution, degree of informality and spatial and size distribution, the level and quality of employment, the type and quality of innovative effort. Second there is a sub-system of science and technology which includes education (basic, technical, undergraduate and postgraduate), research, training and other elements of the scientific and technological infrastructure such as information, metrology, consulting, intellectual property. Third, there is a policy, promotion, financing, representation and regulation sub-system that encompasses the different forms of public and private policies both explicitly geared towards innovation or implicit, i.e., those that although not necessarily geared towards it, affect strategies for innovation. Finally, there is the role of demand, which most of the times is surprisingly absent most analyses of SI. This dimension includes pattern of income distribution, structure of consumption, social organization and social demand (basic infra-structure, health, education).

1 See for instance Mytelka and Farinelli 2003; Freeman, 2003; Chesnais & Sauviat, 2003 3 Figure 1- The Narrow and the Broad Perspectives on NSI

Geo-political, institutional, macroeconomic, social and cultural context

Broad Narrow Science & Technology Production & Innovation Subsystem Subsystem Demand

Policy, promotion, Financing, Representation & Regulation

Source: adapted from Cassiolato & Lastres 2008

This portrayal of the national innovation system framework is a corollary of an understanding that,

• innovation capacity derives from the confluence of economic, social, political, institutional and cultural specific factors and from the environment in which they operate, implying the need for an analytical framework broader than that offered by traditional economics (Freeman, 1982, 1987; Lundvall, 1985); • the number of firms or organizations such as teaching, training and research institutes is far less important than the habits and practices of such actors with respect to learning, linkage formation and investment. These shape the nature and extensiveness of their interactions and their propensity to innovate (Mytelka, 2000, Johnson & Lundvall, 2003); • main elements of knowledge are embodied in minds and bodies of agents or embedded in routines of firms and in relationships between firms and organizations. Therefore, they are localized and not easily transferred from one place/context to another, for it is something more than information and includes tacit elements (Lundvall, 1985); • the focus on interactive learning and on the localized nature of the generation, assimilation and diffusion of innovation is in opposition to the idea of a supposed techno-globalism. The understanding of innovation as a context specific process implies that the acquisition of foreign technology abroad is not a substitute for local efforts (Cassiolato & Lastres, 1999); • national framework matters, as development trajectories contribute to shape specific systems

4 of innovation. The diversity of NSIs is a product of different combinations of their main features that characterize their micro, meso and macroeconomic levels, as well as the articulations among these levels (Freeman, 1987; Lastres, 1994).

From the specific point of view of less developed countries (LDCs) the usefulness of the SI approach resides precisely in the facts that (i) its central building blocks allow for their socio- economic and political specificities to be taken into account and (ii) it does not ignore the power relations in discussing innovation and knowledge accumulation. As this project argues, these features are particularly relevant in the analysis of BRICS´ innovation systems. As the analysis of economic phenomena also takes into consideration their social, political and historical complexity, policy prescriptions are based on the assumption that the process of development is influenced by and reflects the particular environment of each country, rather than to recommendations based on the reality of advanced countries. A number of development studies followed these ideas, arguing that technical change plays a central role in explaining the evolution of capitalism and in determining the historical process through which hierarchies of regions and countries are formed. Furtado (1961), for instance, established an express relation between economic development and technological change pointing out that the growth of an economy was based on the accumulation of knowledge and understood development within a systemic, historically determined, view. Although original these contributions have a close correspondence with Myrdal’s (1958) proposition that (i) contexts and institutions matter; (ii) positive and negative feedbacks have cumulative causation; (iii) cycles may be virtuous or vicious and with Hirschman’s (1958) point that interdependencies among different activities are important. The need to address paradigmatic changes and the problems and options deriving from the upsurge of the information technologies led to the upsurge in Latin America in the 1980s of a series of interconnected work from the innovation perspective. Building on Furtado’s work on changes associated with the industrial revolution (Furtado, 1958), authors like Herrera (1975) and Perez (1983) analyzed the opportunities and challenges associated to the introduction of these radical changes in the region. It was only then that the innovation and development literature started to integrate the empirically validated knowledge about learning inside firms with the contributions stemming from the work of Freeman, Perez, Herrera and others on new technologies, changes of techno-economic paradigm and systems of innovation. What gave special impetus on this direction was the empirical work focusing on technological capability building as part of a broader national innovation system. The role of government policies in orienting the speed and direction of technological changes was also highlighted (Freeman and Perez, 1988). Development processes are characterized by deep changes at the economical and social structure taking place from (technological and/or productive) discontinuities that cause and are caused by productive, social, political and institutional structure of each nation. Development is also seen as a systemic process, given the unequal world capitalism development. The recognition of national specificities of these processes is also fundamental. We could find the same stress on the national character of development processes by List (1856) and on the NSI idea of Freeman (1982) and Lundvall (1988) 5 in Furtado’s (1961) discussion about the transformation of national economies where their structural complexity is manifested on a diversity of social and economic forms. For Furtado, it is in this transformation that resides the essence of development: structural changes “in the internal relations of the economic and social system” (p. 103) that is triggered by capital accumulation and technological innovations. The emphasis on diversity, and the recognition 5 that (a) both theory and policy recommendations are highly context dependent, (b) the economy is firmly embedded in society and (c) knowledge and technology are context-specific, conform some general identities. Furtado (1961) established a direct relation between economic development and technological innovation pointing out that the growth of an advanced economy was based on the accumulation of new scientific knowledge and on the application of such knowledge to solve practical problems. The Industrial Revolution set into motion a process of radical changes based on technical progress that lasts till now and that is at the roots of how the world economy is conformed. In essence, those changes: (i) rendered endogenous the causal factors related to growth into the economic system; (ii) made possible a closer articulation between capital formation and the experimental science. Such articulation has turned to be one of the most fundamental characteristics of modern civilization. As pointed out by Furtado (1961), the beginning of such process took place at the countries that were able to industrialize and create technical progress first, and the quick accumulation made possible in the development of this process became the basic engine of the capitalist system. For this reason, there is a close interdependency between the evolution of the technology in the industrialized countries and the historical conditions on what such development was made possible. As the behavior of the economic variables rely on parameters that are defined and evolve into a specific historical context - it is quite difficult to isolate the study of economic phenomena from its historical frame of reference (Furtado 2002). This assertion is more significant when analyzing economic, social and technological systems that are different from each other, as in the underdeveloped economies. In this context, underdevelopment may not, and should not, be considered as an anomaly or simply a backward state. Underdevelopment may be identified as a functioning pattern and specific evolution of some economies. Social and economical peripheral structure determines a specific manner under which structural change occur (industrialization during the 1950s and 1960s) and technical progress is introduced. Hence different outcomes from those happened in developed countries are to be expected (Furtado, 1961; Rodriguez, 2001). The neo-schumpeterian perspective also argues that economic development is considered as a systemic phenomenon, generated and sustained not only by inter-firms relations, but most significant by a complex inter-institutional network relations. Innovation is eminently a social process. Therefore, development – resulted form the introduction and diffusion of new technologies – may be considered as the outcome of cumulative trajectories historically built-up according to institutional specificities and specialization patterns inherent to a determined country, region or sector. Each country follows its own development trajectory according to its specificities and possibilities, depending fundamentally on their hierarchical and power position into the world capitalist system. The more distant underdeveloped countries are from the technological frontier the larger will be the barriers to an innovative insertion in the new technological paradigm. More serious than technological asymmetries are knowledge and learning asymmetries, with the implication that access, understand, absorb, dominate, use and diffuse knowledge turns to be impossible. However, even when the access to new technologies becomes possible, most of the times they are not adequate to the reality of underdeveloped countries and/or these countries do not have a pool of sufficient knowledge to make an adequate use of them. This occurs because the learning process depends on the existence of innovative and productive capabilities that not always are available. On this aspect, Arocena and Sutz (2003) argue that there are clearly learning divides between North and South that are perhaps the main problem of underdevelopment nowadays.

6 Departing from this theoretical framework, the BRICS project attempted to build up the understanding of the national systems of innovation of BRICS countries by refining and applying the broad analytical structure. Therefore, the NSIs studies presented subsequently used this analytical framework to guide their research efforts. Besides this introduction and the summary of the BRICS country studies, this report ends up presenting a comparative analysis of Brazil, Russia, India, China and South Africa national innovation systems.

7 II. SUMMARY OF BRICS NATIONAL INNOVATION SYSTEMS REPORTS

DESCRIPTION AND DYNAMICS OF THE BRAZILIAN INNOVATION SYSTEM

José E Cassiolato Maria Gabriela Podcameni Maria Clara Couto Soares Marina Szapiro Priscila Koeller Fábio Stalivieri Fabiano Geremia

1. Introduction

The analysis of the Brazilian National System of innovation departs methodologically from the broad understanding of the NSI framework. As it is known, the concept of NSI may follow two different approaches: the narrow and the broad. Some authors tend to focus on the innovation system in the narrow sense. In this vision, the NIS concept is a follow up to earlier analyses of national science systems and national technology policies. The key issue is then to map indicators of national specialization and performance regarding innovation, research and development - R&D - and science and technology - S&T. The policy issues raised are typically related almost exclusively to explicit S&T policy focusing on R&D and interactions between the scientific and technological infrastructure, on the one hand, and the productive sector, on the other. The analysis may include markets for knowledge – intellectual property rights and the venture capital aspects of financial markets, but hardly the broader set of institutions affecting the innovation system (such as macro-economic implicit policies for innovation) and shaping competence building in the economy (such as education). Although it brings important information regarding the national system of innovation, the narrow version provides only an incomplete account of its structure and evolution. The broad approach is inclusive, incorporating the narrow dimension and going beyond it. A broader and systemic understanding of the innovation process avoids an overemphasis on R&D, encouraging policy-makers to take a far-reaching perspective of the opportunities for learning and innovation. Emphasis is put on interactions and on the role of historical processes - which account for differences in socio-economic capabilities and for different development trajectories and institutional evolution - creating systems of innovation with very specific local features and dynamics. It is precisely such production-centered approach to NSI which, in our view, makes it relevant for understanding it in the context of developing countries and it is in this way that it will be used for a brief analysis of the Brazilian innovation system during the last few decades. This is the approach used in the BRICS project and in this paper. It includes the production and the innovation

8 subsystem; the capacity-building sub-system, such as education and technology infrastructure; the policies, representation and financing subsystem; and the role of demand. We start with some brief historical notes. Brazil is a direct product of the European expansion of the late 15th century. Since the first arrival of Portuguese colonizers in 1500 up to the early 19th century it was ruled directly by the Portuguese crown, as a colony. During these first three centuries Brazil was characterized by some specific facts that influenced significantly the scientific and technological capabilities of this country. The Portuguese exploitation in most cases acted against the development of local capabilities as the crown not only forbade the setting up of all production activities that could be either performed in Portugal or subject to exchange with Portuguese commercial partners, but also prevented the establishment of any academic or research institution in its colonies. From an institutional point of view, it was only when the Portuguese crown, evading French threats of invasion, moved to Brazil in 1808 that the Portuguese Regent signed a bill allowing for the first Medical School to be organized. While the Portuguese Regent ruled from Brazil, attempts were made to organize some experimental research. Brazil become independent in 1822 and would be a monarchy until 1889, with no major changes at the beginning, as some efforts to increase local production were aborted by a different type of colonization by the British. The predominantly commercial class that controlled political power during the Monarchy was not interested in joining the industrial revolution and the country remained specialized in agricultural commodities like sugar cane and coffee. The elite could be qualified abroad and more than 20 bills proposing the creation of a Brazilian university were rejected by parliament. It was only in the second half of the 19th century that things started to change, as the monarchy and slavery gradually collapsed. The first undergraduate school of engineering was set up in 1874. Technical centers in natural sciences, agricultural research and health and hygiene were also established. But these technical training and research centers in the areas of health and agriculture were only created insofar as they were instrumental to guarantee the economic specialization of Brazil. As the Brazilian economy was anchored in the production of two basic crops for export (coffee and sugar cane) there was a need to control agricultural plagues and to improve planting and harvesting methods. As there was hardly any manufacturing industry, there was almost no need for scientific and technological knowledge. During the 1920’s, universities started to be created. The São Paulo state, that lost in 1932 an internal war to separate from the union, decided to bring in modernization and created the first complete university of Brazil. The establishment of the University of São Paulo was perceived as an important step in this direction. High level teaching and research in areas such as physics, biology and chemistry were accomplished with the “importation” of senior European researchers running from nazi Germany and fascist Italy. The São Paulo project ignited similar efforts at the Federal level. The importance of the unspoiled biomes in Brazil is very high in a period of the world history when a preoccupation with sustainable development is high in the geo-political and economic agenda. Only recently recognition of the importance of knowledge possessed by local indigenous communications started to be recognized and is gradually entering into the science and technology agenda. Given this historical drawbacks, a full institutionalization of the system only unfolded after the second world war, as Brazil engaged in an industrialization process. The Brazilian NIS evolved from 1950s to 1970s as the country was changed from traditional supplier of raw materials and

9 some crops such as coffee to an economy based on manufacturing industry. But the system is profoundly marked by the specific social and political conditions of the country. In particular its perverse income distribution and regional and personal inequalities mark significantly the system. Social demands referring to basic infra-structure, health and education create specific problems and the heterogeneity of demand require different types and levels of capabilities and technologies. The role of the demand in the Brazilian NIS will be presented in item 2, including the effects of the distorted pattern of income distribution on the structure of the innovation system. Item 3 will discuss the production and innovation Sub-system. Item 4 will discuss the sub-system of capabilities building, research and technological services. Finally, item 5 will focus on the subsystem of policies, funding and regulation.

2. Sub-System Demand - Inequality and Heterogeneity in Brazil: Connections with the National System of Innovation

Brazil ranks at the 11th position among the world’s largest economies. Although this could hardly characterize a poor country, in 2005 there were 55.4 million poor and 20.6 million indigent people, respectively 30.7% and 11.4% of the Brazilian population. This huge contrast reveals a country where poverty is neither rooted in absolute nor in relative scarcity of resources, but is the result of a deeply unfair society. A specific methodological approach is needed for dealing with underdeveloped countries. In the Brazilian case, considering the issues of poverty and inequality and their social, political and economic implications becomes fundamental not only for apprehending the magnitude of existing challenges, but also, and specially, for the formulation of appropriate public policies. Such policies should not be restricted only to social ones, but rather should comprise the set of policies that both affect and are affected, either directly or indirectly, by the prevailing status of structural inequality. Such heritage of social injustice, which hinders the access of a significant part of the population to minimal conditions of dignity and citizenship, brings on the additional challenge of pursuing development strategies that get to combine economic growth and social inclusion. In this context, the discussion of a national system of innovation (NSI) should be articulated to this specific dimension of the Brazilian underdevelopment. Especially because one of the fundamental aspects for understanding the particularities of and the obstacles posed to our NIS is related to the huge disparities of income distribution and of consumption patterns observed in Brazil, which shape a deep and complex social heterogeneity. This heterogeneity is reflected in every sector of activity, including the productive sector and the technological and scientific dimensions.

2.1 Poverty and Inequality in Brazil – Patterns and Trends

2.1.1 Its Multidimensional, Heterogeneous and Concentrated Nature

The GINI index – 0.57 in 2005 – reveals how deep income inequality in Brazil is. This index puts the country, just as the GDP, in the eleventh position in the world ranking, but now amongst the most unequal countries. The 20% poorest Brazilian people hold only 2.8% of the national income, whereas the 20% richest ones appropriate 61.1% of this income. Besides being unfair and polarized, the structure of income distribution in the country also affects the intermediary segments that present percentages of participation in the income very lower than those observed in countries with more homogeneous social structures.

10 Moreover, between 1980 and 2005, the participation of labor income in the national income decreased 11%, falling from 50% to 39%. The growing process of financialization of Brazilian wealth, in course since 1981, is the main factor explaining this sharp inflection in the functional distribution of income that favors returns on property. Furthermore, irrespectively of income magnitude, factors such as the enormous regional heterogeneity, ethnic and racial differences, gender issues, asymmetries regarding occupation, and distinct opportunities for social and economic inclusion constitute important forms of reproduction and perpetuation of inequalities. In terms of regional inequalities, the Northern and Northeastern regions of the country deeply contrast with South and Southeast. When we analyze ethnic/racial asymmetries, data also reveal a worrying disparity. In 2006, white people comprised 49.7% of the Brazilian population; mixed race people represented 42.65% of it, and Afro-Brazilians, 6.9%. However, in the same year, 78.1% out of all people aged over 25, which had at least 15 years of formal education, were white; only 6.5% of these people were of mixed race and 3.3% were black people. As for the distribution of households’ monthly per capita income of working people aged over 10, according to skin color/ race, reveals that among the poorest 10% the white represented 26.1% and non white comprised the 73.2%. Conversely, among the richest 1% of the population, only 12.4% are non white and 85.7% are white. The average monthly income of white people in 2006 was nearly twice the average income of non white people. Regarding gender inequalities, although educational asymmetries that are characteristic of several underdeveloped countries are not present in Brazil, disparity of wages still persists between men and women in the workforce, despite having decreased in the latter 10 years. Considering people aged 10 and over, the average monthly earnings of men in 2006 was 80.8% higher than women’s, a quite significant difference, although much lower than that of 140.4% observed ten years before. In terms of workforce distribution, working women are concentrated in less organized economic activities, are more susceptible to informal hiring conditions, face a higher chance of unemployment and also represent a significant force enrolled in non paid work, which emphasizes the precarious nature of women’s occupations. It is worth recalling that in 2006 women represented almost half of Brazilian working population (43.7%). Finally, there are two aspects worth emphasizing. The first one is that, in spite of the amplitude of poverty and privation in Brazil, these problems are strongly concentrated. It is in the regions North and Northeast, in the rural areas and in the small towns that one can find the main deficiencies: low schooling, low access to infrastructure services supply, low access to manufactured durable goods, and prevalence of low-quality dwellings. Secondly, despite its apparent homogeneity, poverty hides very distinct social circumstances and is an outcome both from the reproduction of obsolete forms of productive integration and from anachronistic institutions, which occur particularly in the rural world.

2.1.2 The Structural Character

High poverty levels and strong inequality of income distribution do not constitute recent facts in the Brazilian society. In fact, inequality has been established in the country as a historical legacy since colonization. The Brazilian original social matrix, determined by concentration of land and of political power, as well as by external dependency, imposed its trace to the whole process of historical constitution and evolution of the nation. Coalitions constituted in Brazil by distinct economic and political powers of each social class, particularly those of landowners and capitalists in relation to urban waged workers and the rural mass, are the outstanding mark of Brazilian

11 capitalism. The force of these distributive coalitions lies in the inertial and iniquitous distributive pattern observed in Brazil. Therefore, a remarkable characteristic of inequality in Brazil is the persistence of income and wealth concentration throughout the various periods, political regimes and patterns of development undergone by the country, in spite of the significant structural changes realized. From colonization to the present, wealth has been quite iniquitously shared among the population. In spite of the great economic progress reached by the country, particularly between 1930 and 1980, Brazil failed to accomplish social development and thus was unable to deal with the problems related to wealth concentration and social exclusion. Not even public goods were universalized so that to offer equal opportunities for education, health, housing and transport services to the population. Thus, in the distinct stages since the beginning of colonization in 1500, there is no account of substantial change in the distributive profile of the country. However, such recognition should not obscure the understanding of the different processes that determined the persistence of the unequal distributive profile. The accurate understanding of these processes is fundamental to avoid both simplistic diagnosis and the reinforcement of political propositions limited to focused social policies.

2.1.3 Its Evolution since Post-War

According to the Latin American structuralism approach, structural economic dimensions are crucial determinants of income inequality. Corroborating such perspective, in the present work the analysis of power relations and of the evolution of economic growth in Brazilian society plays a central role for understanding variations in both income distribution and poverty. A central aspect of the post-war period in Brazil, the industrialization process via imports substitution characterized a long lasting period of high economic growth which lasted until late 1970s accompanied by deep structural changes. Changes that transformed the country from a primary exporting economy to a complex industrial economy, placed among the world’s largest economies. Nevertheless, for lacking structural reforms, among which the agrarian reform, the industrialization process has been unable to modernize the outdated agriculture at the same rhythm and, thus, has exacerbated differences in productivity and income between countryside and cities. Accordingly, although a decrease was observed in absolute poverty, the personal income distribution became more concentrated. The great unbalance between the low-productive agriculture and the modern industry of relatively high productivity allows one to understand the context of “growth with concentration”. In spite of the accelerated industrialization promoted by the State, that allowed an ascendant occupational mobility, expanded the modern waged employment and unionization, broadened the medium strata and reduced absolute poverty, it was unable to fully absorb the huge manpower contingent that moved from rural poor areas, especially in the Northeastern region, towards urban outskirts. Such great availability of labor force, created by urban explosion, by low productivity of the food agriculture and by the relations regarding land ownership, exerted a depressive impact on the base of urban wages and allowed for the loss of almost a half in the real value of the minimum wage during the period 1960-80. At the beginning of the 1980’s, the cycle of growth with structural changes was interrupted. Characterized by the external debt crisis, this period was marked by great turbulences – high and increasing inflation, unemployment, labor market disorganization, drop down in both minimum

12 wage and wages in general, growth of employment in the services sector to the detriment of industrial jobs, among others. As an outcome, the 1980 decade brought on an aggravation of the already high levels of income concentration, and the Gini coefficient reached 0.636 in 1989. The slowdown in the 80’s aborted the possibility of a less exclusionary via; high inflation was the main mechanism of income concentration. With the end of inflation, there was a significant reduction in poverty, but low economic growth and the reduction of formal jobs, especially industrial ones, prevented long-lasting positive effects. Commercial and financial opening, privatizations, as well as changes in the economic and social structures resulting from them, have consolidated a new distributive coalition in the years 1990 in Brazil. Constituted by the new financial groups, by the foreign capital attracted by privatizations and by industrial and agribusiness exporters, this coalition has consolidated a model of macroeconomic policy guided by orthodox fiscal policies, high interests rates, increasing debt, and by external insertion subordinated to financial flows of the balance of payments. Such policy ended up by introducing a serious distributive conflict between the payments of financial obligations regarding the debt (which benefited a new stratum of rent seekers) and the social expenditures aimed at income transference, thus affecting not only the minimum wage as also the investments in education, health, housing and sanitation. Following more than two decades of low growth, Brazil entered the 21st century under increasing fragmentation of the productive structure, low productivity of exports, low investment levels, technological backwardness, increasing infra-structure deficiencies and increasing financialization of the economy. This picture, having aggravated both unemployment rates and the precariousness of the labor market (broadening of informality and of non remunerated work), brought on non traditional forms of inequality and social exclusion. In this context, exclusion begins manifesting not only among the social segments traditionally disadvantaged, as also in social strata that were previously socially integrated. These new pariahs, mostly belonging to the urban areas of the Southern and Central regions, comprise a not insignificant part of the working class, subject to kinds of contracts and modes of integration characterized by fragility and instability – segments that have been deprived of better conditions of work and that see themselves threatened by underemployment, long-lasting unemployment and greater age vulnerability. Among them are included even some segments of better schooling levels, whose individual and collective skills are neither developed nor used in view of lacking opportunities. This scenario determined a period still more harmful than that of the years marked by strong industrial growth in terms of distributive. The macroeconomic regime, focused on the strict defense of new financial groups, stopped any strategy for effective income distribution. More recently, indicators reveal the reduction of both the absolute poverty and the Gini index in Brazil. Resuming economic growth, gradual recovering of real value of the minimum wage, the growth of formal employment in the lower strata of the occupational pyramid, the decrease in disparity between wages in rural and urban areas and the relative reduction in prices of the set of products of basic maintenance have all been contributing to it. The income transfer programs, with focused character, have also contributed to the reduction of extreme poverty. However, with regard to distributive policies, in view of the persistence of a series of structural factors, among which the old (and renewed) structures of power that survived and perpetuate inequalities, it is not possible to claim that a steady and sustainable movement towards reduction of disparities is in course in the country.

13 2.2. Inequality, Heterogeneity and the National System of Innovation

The inequality pattern above analyzed strongly affects the consumption patterns and the demand structure of Brazilian economy. The drastic disparity between purchasing power of the rich and the poor segments of the society (not mentioning those practically excluded from the consumption market), as well as the strongly concentrated character of poverty in regional (North and Northeast) and sectorial (rural / small towns) terms, as previously mentioned, contribute to a extremely heterogeneous pattern of demand in Brazil. The different consumption pattern of families according to income groups are not restricted to the quantitative aspect; they rather are expressed also qualitatively. That means, besides consuming goods and services in lower quantities, poorer families tend to acquire products and services of lower quality (and price), which are compatible with their diminished power of purchase. This heterogeneity of demand tends to determine a productive pattern far less homogeneous than that of countries with less unequal income distribution. A facet of such heterogeneity of Brazilian productive structure may be observed, for instance, in the coexistence of distinct productive systems of quite distinct technological base within a same sector and frequently within a same industrial plant directed to different markets in terms of income. Therefore, a same manufacturing unit may present a technologically modern line of production, aimed at manufacturing products directed to the higher income groups of the population, along with another production line, of low technological complexity, aimed at supplying the demand of the low income population. The existence of a low income consumer market in the country allows for the survival of production activities of very low productivity based on spurious competitive advantages such as low paid work which is enabled by the enclaves of poverty existing in the country. Concomitantly to these low productivity activities, others are observed, which are aimed at supplying the consumption market comprised by the country’s rich socio-economic elite that adopts consumption patterns similar to those of developed countries. The productive structure aimed at supplying the demand of this segment of high purchasing power is characterized by greater dynamism, by producing goods containing greater value added and by the use of capital-intensive techniques, generally based upon imported technologies. As a consequence, a high heterogeneity of the productive structure is observed in the country, being directed to demand patterns quite distinct, which adopt also different technological patterns. To such productive heterogeneity, different patterns of technological capabilities, information and knowledge needs and, especially, forms of technical and economic insertion in the respective innovation systems are associated. Therefore, one observes the coexistence of complex and articulated innovation systems with productive and innovative systems characterized by little dynamism. Under this perspective, the National system of innovation in Brazil is permeated by structural characteristics of a peripheral and highly unequal and heterogeneous country. Its institutional conformation has served the current pattern of accumulation, both reflecting and contributing to reproduce actual inequalities.

14 2.3 Inequality as an Obstacle to Innovation and Development

2.3.1 Restrictions to Endogenization and to the Diffusion of Technological Advancement

Latin-American structuralism literature demonstrates that the technical change (innovation and technological diffusion) plays a key role in explaining the evolution of capitalism and in identifying the historical process through which hierarchies are constituted between countries and regions. According to Cassiolato and Lastres (2008), evolutionist and structuralism approaches converge “on the argument that those nations that were able to obtain a better position in the ‘innovative race’ tend to be more dynamic and competitive than others, reaching better social and economic performance, and consequently, more geo-political power. Thereupon, division lines had been established between those that are capable to promote or directly participate in the innovative and development process and those kept out” (p.19). These asymmetries have major consequences insofar developed countries concentrate the advancements of technological frontiers, specializing in the production and distribution of sophisticated goods and services, whereas the other countries specialize in those goods and services of low productivity. Such ‘dualization’ of the capitalist system, where a group of countries which commands technological development coexists with a vast and heterogeneous periphery, marginal to the system, determines the basis for unequal growth, for iniquity in distribution of the fruits of technical progress, and for income concentration in the global scale. It, therefore, implicates the generation of quite distinct conditions for development and for incorporation of technological progress, which end up boosting a trend of intensification of the gap between countries. From this analysis, derives the view by the Latin-American structuralism school that the break with the specialization pattern based on production and exports of primary products could only happen by means of the incorporation by least developed countries of advancements attained by industrialization. In other words, structural changes of the production factors (capital and labour force) from low productivity sectors to the ones characterized by high productivity were identified as a necessary precondition to a virtuous development pattern. And industry at that time was the main axis of productivity increasing. Nevertheless, some authors of structuralism Latin-American tradition add to the external obstacle above mentioned other hindrances of internal nature which restrict the possibilities for development in peripheral countries and among which inequality plays a key role. The technological determinant in peripheral countries as Brazil is associated to the degree of diversification of the demand by socio-economic elite, which tend to follow the consumption pattern of the core countries. According to Furtado, the technological determinant in peripheral countries as Brazil is associated to the degree of diversification of the demand by socio-economic elite, which tend to follow the consumption pattern of the core countries. Although representing a quite small proportion of Brazilian population, this elite holds a high purchasing power and capacity for consolidating its consumption pattern in the internal market, thus generating either through

15 restrictions of the balance of payments or through market opportunities incentives to the domestic productive sector for internalizing the production of luxury goods for consumption in the country. This process allows, on the one hand, for a relative update and sophistication of the domestic industrial park, by means of a process of imports substitution. On the other hand, the internalization of these productive activities is made predominantly with base on imported technology and, given existing restrictions of scale and scope, tends to incentive a process of imports of capital goods, presenting a low concatenating effect on the economy. Thus, consumption patterns of high income class reflect on the structure of what Furtado (1968) called polarization ‘modernization-marginalization’, which is characteristic of underdevelopment. The ‘modernization’ process initiates with internationalization of the production of luxury goods in the country, local industries being stimulated by the adoption and constant update of consumption patterns disseminated by developed countries. The industrialization process, in this perspective, takes the form of a permanent effort for adaptation of the domestic productive system to the sophisticated pattern of demand created by the elites, with practically no links to the productive forces and to pre-existent technological capacity, and so constantly renewing the bonds of dependency. The “marginalization’ pole arises with the use in these industries of capital-intensive techniques without correspondence with the actual accumulation level of the society and with low employment generation. Additionally, in view of the difficulties for accompanying the core countries’ rhythm of technological progress, domestic production, as already mentioned, is often accompanied of imports of technology and capital goods, generating productivity gains with raises in unemployment, what contributes for reproducing structural inequality. The concept of ‘technological inappropriateness’ developed by the structuralism school seeks to characterize the persistent blockade to endogenous technological development that is generated by this polarization modernization-marginalization. In the core countries pressure by social movements plays a major role in the inclusion of workers in the share of the fruits of technological progress, generating positive effects on the guidance of the technological path, insofar the growing demand allows for economies of scale and scope, products diversification and productivity increments. Conversely, the industrialization process in Brazil brings with it renewed forms of structural unemployment, given the organizational fragility of social forces. Also limited is the capacity of these forces to pressure the State to adopt universalizing social policies. Thus, the fruits of the productivity gains end up being appropriated by a limited part of the population and the internal market (mass consumption) stay restricted, hindering the impulse to development and the possibilities of technical progress. The polarization modernization-marginalization, therefore, characterizes a specific pattern of development, in which the vicious cycle of underdevelopment recurrently reproduces itself. Because of it, the implementation of developmental policies in Brazil in the post-war period, in spite of having leveraged the construction of a complex industrial structure, was unable to overcome the structural traits of underdevelopment, as evidenced by both the persistence of a deep heterogeneity in its multiple dimensions (social, productive etc.) and the subordinated and dependent technological pattern. In short, the concentrative pattern of income distribution in Brazil impacts the demand structure through a sharp disparity of consumption patterns, which in its turn boosts a great heterogeneity of the production structure. The productive systems aimed at supplying the demand of the richest strata of population tend to stimulate as much the adoption of technology intensive systems as the dependence on imported capital goods, reinforcing structural unemployment and social

16 heterogeneity, besides representing hindrances to a greater productive efficiency and technological autonomy. A development strategy aiming to break with this vicious cycle requires major structural reforms, among which the designing of new institutional arrangements able to break with inequality and with the polarity modernization-marginalization. The State, in this context, has a core importance in the adoption of active policies that enable to counteract the concentrative and excluding trend and to dismantle the archaic structures of underdevelopment. Given the core importance of innovation, learning and building capabilities for the contemporary development process, another major element in the structure of these new institutional arrangements is related to the connections between problems arisen from income concentration and the technological issue. The implementation of active policies aimed at strengthening the endogenous technological capacity and the national system of innovation, in connection with the objective of social inclusion, constitutes, in this context, a fundamental part of this arrangement.

2.3.2 Technological Progress and Development: The Role of the National System of Innovation

The literature on innovation systems and the theoretical works of the Latin-American structuralism school converge in the sense of ascribing a central role to technology in the development process. Both approaches emphasize that structural changes triggered by technical progress (innovation) comprise the main determinant of development. According to these perspectives, institutional, organizational, technological and productive changes constitute relevant outcomes of the innovative process; this latter understood as a core element for a long-term development. The structuralism school advises, as already highlighted, that the dynamic of innovative and productive local systems depend upon both the kind of international insertion and the historical national specificities (social, cultural etc.), and also points the restrictions existing in the least developed countries which derive of their peripheral condition. That is, given the subordinate role of technical progress that characterizes these countries, it suggests that the assimilation, adaptation and creation of new techniques should occupy a priority position in any development plan. It further remarks the center role of the State and of governmental policies in guiding speed and direction of technological changes, so that to allow for innovation processes that conform to national needs and specificities. These elements bring us back to the reflection on the Brazilian process of development, particularly on the dimension related to the process of incorporation of technological progress in the country. Worthy of attention in the Brazilian development process is the fact that, despite the already mentioned strong obstacles to the endogenization of technological progress, there were some exceptions. That is, in some specific productive systems, among which agro-industry, aeronautics and petroleum, the country was able to build a remarkable international competitiveness, supported by dynamic comparative advantages. These exceptions allow devising strategies able to overcome some of the indicated limitations. These exceptions resulted from active State policies, which provided for structuring sectorial innovation systems developed through a long process of capabilities building and interaction between research institutes, universities and the economic and productive sector. With basis on

17 systematic and persistent efforts, excellence centers holding sophisticated innovative capabilities were developed in some areas, keeping strong interaction with the productive sector. However, due to the localized nature of this process of technological assimilation, among other reasons, such virtuous pattern of institutional interaction did not suffice for impressing on the economy as a whole a development dynamic based on the strengthening of the innovative capacity of the country. Furtado calls attention to some key points that should be taken into consideration for overcoming actual limitations, among which the need of re-orienting technological progress and the creation of an efficient system of production based on a relative technological autonomy. Furthermore, he explains that technology in its own is not capable of creating the conditions to overcome underdevelopment, putting emphasis on heterogeneity and social inequality as structural problems of major relevance. In this sense, he suggests that is necessary “to make productive activities grow in a broad sense, that is, stimulate productive activities which not always aim profit, but that are essential for attaining the social goals” (2004, p.3). He highlights, in this aspect, how important is the selection of techniques aimed at social objectives. According to Albuquerque (2007a), overcoming this vicious cycle of limited technological update and continuous structural underdevelopment involves not only quantitative factors (such as the growth of existing institutions), but especially qualitative aspects. Among these latter, he emphasizes the need for clearing the deeply rooted institutional structure that serves the dominant sectors and social classes perpetuating inequalities. The author compares this institutional structure to the ‘lock-in’ phenomenon brought by evolutionist tradition. He further remarks that the existing institutions of the innovation system have served the current pattern of development, but do not necessarily would comprise the basis of a new development pattern which provides for social inclusion. In this perspective, he points out that in Brazil the inclusive development depends upon breaking this ‘lock-in’ and suggests that the challenge to be faced implies not only the improvement of democracy in the country, as also the identification of a pattern of technological development which allow for escaping the structural polarity modernization-marginalization. A first consideration on this proposition concerns the premise that the emphasis must be on broad innovation policies, based on a systemic approach of a National system of innovation. The proposed hypothesis suggests that the interactive construction of both innovation systems and systems which meet the priorities of social development may contribute to reduce the “modernization-marginalization” polarization, thus leading to a less unequal pattern of technological development which would be more consistent with a national project of long term development. However, we will first proceed a brief account of the recent policies aimed at reducing poverty in Brazil.

2.4 Recent Policies for Reducing Poverty in Brazil

In the Brazilian trajectory of social policy during the last decades it is possible to recognize two opposite movements. The first one aims at structuring the institutional, financial and protection bases typical to the Welfare State. This movement has its origins in the social struggles for democratization of the country and has its apex in the Federal Constitution of 1988. The second movement gains impetus as from 1990, with the cycle of liberal and conservative reforms, and is based on the thesis of Minimal State. This perspective ascribes a predominant role to assets unequal distribution (especially educational) and to public policies distortion for explaining the causes of persistent poverty and high income concentration in Brazil, irrespectively of the country’s production and social structures. It minimizes the importance of economic growth and its impacts

18 on employment and labor income as relevant factors for reducing both poverty and inequality. It criticizes the recovery of minimum wage real value as an unnecessary and retrogressive measure and advocates the flexibilization of labor legislation as a way for facing unemployment. It considers too high the Brazilian public expenditure and disapproves universalizing social policies on the grounds of threatening the stability of public accounts and reproducing privileges, thus favoring richer ones. Once the emphasis of this perspective is put essentially on the supply side, it produces microeconomic guidelines addressed to a better operation of market incentives. Under this approach, the main issue for the public policy consists of the betterment of social expenditures allocation, through the efficient focalization on the target public (limited to families living below the poverty line). Besides these compensatory policies of income transfer, it proposes to further schooling levels, to promote agrarian regulation and to provide micro-credit as forms for reducing inequality in assets distribution. This perspective, strongly stimulated by multilateral bodies such as the World Bank, has been predominant in the design of public policies for facing poverty in Brazil since the end of the eighties. Although an effective strategy for reducing poverty in Brazil cannot be done without emergency policies of income transfer able to free marginalized segments of the population from extreme poverty, making this axis the main strategy for facing social poverty in Brazil is ignoring the structural aspects of poverty and misery in the country. It is not possible to reduce poverty by means of focused policies in a country where more than 40% out of the population are poor or indigent people – nothing less than 76 million people. It is not a surprise that the outcomes of these policies have been insignificant, as one can observe from the poverty and indigence indicators of the country in the last decades. Bringing back the lessons from the Latin American Structuralism tradition, the fight against poverty and inequality must give priority as much to social reform as to the demand structure and the adoption of systemic policies designed to foster the economic dynamism. This tradition understands that the lack of growth deteriorates the labor market, restricts both tax collection and resources for social policies, besides devaluating educational capability due to missing opportunities. Once the relation between wages of qualified and non qualified workers is affected by the value of the wage paid at the base of occupational hierarchy, without the expansion of modern employment and in the absence of changes in the structure of occupations, the contingent of underemployed and underpaid would hardly be reduced and equally difficult would be changing the context of social exclusion. For so doing, a favorable evolution of effective demand along with both diversification of production structure and technological modernization is essential. Even without directly impacting functional income distribution, the expansion of the average real income and the creation of employment in regular activities tend to reduce the poverty levels and to improve the personal income distribution. Therefore, the State intervention on macroeconomic variables able to stimulate global demand and foster growth (such as interest rates, exchange, and investment rates) is deemed fundamental for its impacts on either the creation of employment or the reduction of poverty and inequality. However, it must be emphasizes that growth, in spite of being a necessary condition for assuring any path to a sustainable reduction of inequalities, does not suffice to overcome the current situation, on the grounds of the recurrent creation of misery enclaves. Additionally, as previously remarked, poverty is also a state of ‘disempowerment’, of deprivation of capabilities of access and of opportunities, and thus cannot be faced only through the provision of resources.

19 These are the grounds for the need of articulating economic development and social inclusion. Emergency policies, in this perspective, must be embedded in a set of structuring policies. Targeting development with income re-distribution, the structuring policies are fundamental for providing the required amplitude and sustainability for the process of poverty reduction, aiming at not only guaranteeing the survival of those socially excluded, as also assuring their citizenship and rights, among which the right to work and to a decent payment. Such diagnosis, which is shared by the present study, certainly points to a distinct design of policies aimed at meeting a more distributive justice. In order to accomplish development with income and wealth distribution and social inclusion, many challenges must be faced. As previously mentioned, besides changing the iniquitous combination that has characterized the main macroeconomic variables in the country; promoting diversification of the productive structure and technological modernization; and facing the structural deficiencies in the field of the Welfare State (by means of universalizing social policies), it is necessary to defy the archaic powerful structures which persisted historically and which are the fundamental pillars of inequalities reproduction. For so doing, it is indispensable to include the issues of democracy strengthening and social control on the State in the agenda of development. Without changes in the relations of power that have historically produced and perpetuated inequality, it will not be possible to break the spiral of impoverishment and exclusion prevailing in the Brazilian society. Making room for social participation in the debate and design of public policies may contribute to break the corporative, patrimonial, clientelista and authoritarian logic of Brazilian State, which favors the private appropriation of public resources. The National system of innovation should assume a relevant role, constituting a central element of systemic policies aiming at simultaneously boosting economic dynamism and social inclusion. In the next section, based on the evolutionist view of National system of innovations, we aim at:

· Exploring the hypothesis of interactive development of innovation systems and systems which meet the priorities of the social development as an alternative for building a least unequal pattern of technological development, more consistent with a national project for long term development; · Analyzing the capacity of interaction between the innovation systems and the welfare systems, with a focus on the health innovation system.

2.5 Opportunities for a Virtuous Interaction Between Innovation and Inclusive Development

2.5.1 National System of Innovation in Brazil and the Reproduction of Inequalities

The evolutionary approach highlights the importance of geography and history in the development and in the design of the national system of innovations. It emphasizes the complexity of both processes and the importance of local actors that structure the distinct institutional arrangements and technological paths. It also stresses the significance of national policies for the construction and development of national system of innovations. Worth mentioning in this perspective is that the dynamics of the innovation system in Brazil is connected to the polarization modernization-marginalization that historically characterizes the Brazilian development process, upon which the institutions comprising the national system of innovation have worked for the pattern of accumulation in process.

20 So that if, on the one hand, polarization affects the national system of innovation restricting the endogenization of technological progress and limiting the capacity of acquisition, use and diffusion of innovations in the country, on the other hand, the current dynamics of the Brazilian innovation system contributes to the reproduction and perpetuation of the vicious cycle of inequality. The asymmetries of the national system of innovation can be observed in their different dimensions. In the following chapters, we will see how iniquities happen in a set of subsystems of the national system of innovation, both reflecting and contributing to reproduce a dynamic of polarization and inequality in the country. A clear example is the infra-structure of science and technology, which is characterized by strong asymmetries. Perhaps the most evident of them being the disparity in the access to quality education (in its diverse levels) depending on the income group one belongs to. The limitations faced by the poorest people to access a quality public education restrict their opportunities in the labor market, reinforcing iniquity. On the other hand, the low quality of education provided to the great majority of the population has a negative impact on the internal capacities for learning and incorporating, disseminated and generating innovations. It also limits the development of important sources of diversity of social agents and institutions jeopardizing the national system of innovation. Another example is the spatial concentration of centers of excellence and of technological services, which similarly reflects and reinforces socio-regional inequality. An equal pattern can be observed by the strong concentration of investments in innovation in the large companies, in the regions South and Southeast, and involving a very small segment of the workforce in the country. The other pole comprises micro and small enterprises, cooperatives of production, family farmers, and forest dwellers, among others, especially those located in regions North-Northeast, with major participation of poor people, a precarious insertion in the labor world, and which tend to stay marginalized if not excluded from the necessary support to the innovation process. Therefore, considering that the current dynamic of innovation system in Brazil contributes to the reproduction of inequality, a major question is placed: What pattern of technological development should be sought in order to break with this perverse dynamic and to escape continuous reproduction of polarization? And, in this sense, what structure of national system of innovation should be pursued?

2.5.2 The Necessary Articulation Between Innovation Policies and Social Policies

The hypothesis of this work suggests that the configuration of a technological development pattern which escapes such polarization must, necessarily, include its own articulation with policies that promote social inclusion. The interactive development of both innovation systems and systems that meet the priorities of social development can be an alternative for attaining this objective (Sutz & Arocena, 2006; Cassiolato, Soares & Lastres, 2008). In this perspective, the national system of innovation must be devised deeming social inclusion as a key variable. It is important to emphasize that the integration of the segments of Brazilian population, socially excluded or precariously included, to appropriate conditions of consumption, concurrently to the search for the improvement of the social services infra-structure (sanitation, health, housing etc.), may represent a great challenge to innovation policies. This is because the incorporation of these segments means expanding the demand for goods and services, with effects of inducing investment and innovation.

21 Concurrently, the expansion and improvement of public services in the areas of education, health and other services integrating the Welfare State would reduce inequalities, provide better life conditions to the population and contribute to improve internal capacities of learning and acquisition, use, adaptation, diffusion and generation of innovations in the country. Better qualification and ascending mobility of workers, sophistication of labor division, productivity gains, and expansion of domestic market among other positive feedbacks for the technological change and for social inclusion, are also usual outcomes of universalizing social policies. On this purpose, social policies, besides addressing social needs, should help to enhance capacities to do new things, to integrate new technologies into everyday life, and to solve problems by making the most extensive use of knowledge. As Hirschman pointed out, underdevelopment is a result not only of weak capabilities but, even more, of the sub-utilization of existing capabilities. Social policy demands for innovation could be an instrument to overcome the lack of sustained, inward oriented, knowledge demand coming from production that characterizes underdeveloped countries, opening opportunities to put available capabilities to work for development purposes. In this sense, socially oriented innovations could foster the social utility of scientific and technological knowledge locally available that are currently underutilized. Palliative interventions designed to and focused on extreme poverty situations that lack a broader systemic approach usually fails to be sustainable in the medium and long term. If the ultimate goal is social inclusion, the approach cannot be restricted to focalized solutions for alleviating poverty or other specific deficits. Improvements due to innovation should also generate a broader dynamic process of societal change, including the generation of local learning processes and capabilities for problem resolution. Consistently, the national system of innovation could contribute to the implementation of these social welfare policies, among other ways by means of ‘mission oriented projects’ so that to redirect technological progress toward specific objectives that allow for complying actual institutionality with new demands resulting from social reform. On this purpose, however, deliberate efforts for policies aiming at the articulation between innovative activities and social development are necessary, insofar the traditional mechanisms of market tend to disregard innovation in these areas. However, precisely because socially oriented innovation should be integrated in the broader scope of development trajectories, policies aiming to mobilize the processes of knowledge generation and use are embedded in complexity and cannot be considered de-linked from social, political and economic powers. The constitution of interaction between innovation systems and systems that meet social priorities shall be fruit of both institutional construction and long term structural reforms, which result from political decisions and articulations between State, market and society. As a result, it has its viability conditioned to the strengthening of democratic processes in the country and to the capacity for dealing with the potential conflicts that will necessarily arise. To sum up, the interaction between welfare systems and innovation systems can generate extremely positive synergies in terms of growth, efficiency and equity, thus constituting a significant link in a proactive strategy for development with social inclusion; a strategy in which the State must play a core role. However, strategic changes are needed to put STI on behalf of social needs. Beyond the usual target of increasing international competitiveness and promoting economic growth, innovation policies should put focus on the resolution of social pressing problems and interconnected development issues, making room for the development of productive specialization in important areas, the building of new product lines and business opportunities, fostering local

22 level innovative dynamic, etc besides contributing to improving life conditions and the capabilities of the poor. The Brazilian health system, given its social scope, its capacity for configuring a pattern of specialization of scientific capability building and its privileged locus among public policies in the country, will be taken as emblematic case for the analysis of the above mentioned potential for interaction between innovation systems and welfare systems.

2.5.3 Health System: Opportunity to Simultaneous Construction of Innovation and Welfare Systems

Health concomitantly comprises an essential component and a big challenge to the implementation of development policies. In Brazil, health requirements of population constitute a social demand in constant expansion, conforming a dynamic long term horizon for both agents and activities sectors. Innovation capacity is a crucial factor for the dynamic of production in health within a structural and long term perspective, insofar health is characterized as an area of high technological intensity. In developed countries, the activities of R&D in health are, along with the military sector, among those that receive the major public effort for producing knowledge. In these countries, systemic conditions of competitiveness were created, which congregate infra-structure of advanced science and technology, industrial sectors and highly innovative enterprises, and a significant action by the State that connects the health system with the innovation system. In Brazil we find a dichotomic picture: on the one hand, the country follows the international pattern of promotion of scientific activity on health by governmental agencies; on the other hand, the outcomes of this policy have been quite limited from the technological perspective. The observed structural blockades are connected to the fragility of the national production system and, particularly, of domestic firms. These blockades are expressed in the specialization of local production in activities of least technological content and in the increasing dependency on imports. It is worth mentioning that in Brazil all the firms which comprise the health complex have lost international competitiveness along the 1990 decade. As a result, a broadening of the commercial deficit is observed, coming from a level of US$ 700 million in the end of the eighties to a level over US$ 3 billion in the early 2000. A major factor affecting such involution is the broadening of the knowledge and innovation gaps in this area, especially caused by the adoption of commercial liberalization policies in that period. This situation reveals to be critical in a country like Brazil, not only for reflecting the economic vulnerability in key sectors of the new technological paradigms, as also for exposing the vulnerability of a strategic social policy. Thus, the articulation between health policies and innovation policies must be regarded now as a fundamental objective of public policies. An active public action in this area is justified, since the health complex holds high economic relevance and potential for innovation; the Brazilian government has an increasing and broad action in the health field; increasing dependency on imports puts this social policy in a vulnerable situation; and there is a possibility of articulation of the national base of knowledge with national strategies for public health. The proposal of articulation of the industrial and technological policy with the health social policy announced in 2004 (and expanded in 2008) by the Brazilian government, and the particular emphasis put on the health industry seems to be a valuable opportunity for chasing this goal. Even taking into account the unavoidable tensions between the goals of each of these policies, there is currently in Brazil a privileged room for promoting the articulation between them.

23 2.5.4 The Example of the Pharmaceutical Industry

The pharmaceutical industry, which has a significant weight within the health complex, holds a remarkable relevance for a development strategy aimed at forming a technological pattern linked to inclusive social policies. Internationally, the pharmaceutical industry represents a nearly US$ 500 billion market, 85% out of it corresponding to USA, European Union and Japan, a share that contrasts with the 80% world population living in the least developed countries. This industry comprises a differentiated oligopoly, with high entry barriers, especially regarding marketing and investments in R&D. It presents intensive innovative dynamic, with focus on product innovation. Is characterized by strong relationship with the State, in which the State intervention determines the industry dynamic from the views of activities regulation, of promotion to scientific and technological development and use of purchasing power. The reason is that, besides non traditional forms of competition prevailing in this industry, regulation and financing modes significantly affect its performance. In Brazil, the pharmaceutical industry is dominated by multinational companies, which control about 70% of the market. Such companies carry out in the country just those activities involving least technological content – manufacturing, marketing and distribution of medication – performing abroad most pharmacological and R&D activities. The Brazilian industrial complex shows a high production capacity, although restricted to final products, with low performance in the production of pharmaceuticals, therefore strongly depending upon imports. Since the commercial liberalization of the nineties, such dependency has intensified - the pharmaceutical segment currently accounts for about 60% of the country’s health related commercial deficit. Although counting on a consolidated and qualified scientific infra-structure, with relatively stable public investments, this industry in Brazil still presents an immature innovative potential. The technological effort of the Brazilian pharmaceutical industry (R&D expenditures / total value of industrial production) was only 0.93%, against 10.03% of OECD countries. It is not surprising that in a recent study on the Brazilian industrial structure, the pharmaceutical industry was ranked as medium technological intensity, in contrast to the mark of high intensity in technology of this industry in the international ambit. Among hindrances to innovation in Brazil, one can mention the weak connection between scientific, industrial and health policies. As a result, one may observe a low level of technological development, restricted to a few private companies and some public organizations. In spite of the weak productive, commercial and technological performance of this industry in the country, a number of positive factors contribute to the adoption of active public policies in this field:

§ Brazil has an attractive national market (9th in the world and the greatest in Latin America); § The significant weight of the public sector demand, that qualifies the State for intervening through active purchasing policies connected to innovation strategies; § The existence of vast network of public laboratories (at federal, state and municipal levels), which production already helps to reduce supply for some medications and thus to reduce costs of public health programs; § Increasing participation of domestic firms in the market in the last years, resulting from the governmental policy for the development of generic medications; § Availability of techno-scientific infra-structure, as well as qualified human resources in the health area;

24 § Recent priority established by the government to public policies aimed at strengthening the pharmacological sector.

Therefore, there are structural bases for a development and innovation strategy in this industry. However, it requires a new form of intervention by public policies for the pharmaceutical industry, based on a systemic approach and which provide a greater synergy between industrial, technological and health policies. It must be stressed that the role of the State in demanding, regulating and financing is strategic for strengthening this industry, as demonstrated by international experiences. Public policies goals must converge to improve quality of both products and processes, to promote technological innovation in the pharmaceutical industry, to foster internalization of production stages of higher technological intensity, to reduce the commercial deficit in the health sector, to expand and qualify job posts, to allow coverage expansion and reduction in prices of medications available to population, and to develop alternatives for facing neglected diseases that prevail in the country, among other actions. An area of particular interest in this perspective is the provision of antiretroviral medications (ARVs). Since the establishment by the Brazilian government of free access to such medications, in the late eighties, through the National Program on Sexually Transmitted Diseases and Aids (NP), the demand for ARVs in the country became essentially public. Given the raise in the number of patients under treatment and the update of recommended therapy, public resources aimed at the acquisition of ARVs jumped from R$14 million to R$986 million between 1996 and 2005, foreseeing to reach R$1.3 billion in 2008 Such growth intensifies worries about the sustainability of the NP. The patented ARVs account for a significant part of the public expenditures: about 80% out of them in 2005 was directed to imports of these drugs. As for the domestic pharmaceutical manufacturers, they focus on the production of generic medicines, public laboratories being the main producers of ARVs procured by the NP. However, in value, the participation of foreign products represents 72.8% against mere 19.6% produced by the public laboratories. Participation of private domestic manufacturers is still small. Thus, the domestic capacity for producing generic ARVs in the country is regarded as critical for the sustainability of the program aimed at universalizing the access to antiretroviral medications. Once, in a general manner, Brazil counts now on both production capacity and academic competence for producing ARVs, active principle and medication, it constitutes a window of opportunity for structuring a standard of specialization of the domestic scientific and productive capability, which would contribute to diversify the productive structure and technological modernization in the country, concurrently allowing the continuity of the population free access to these medications. This opportunity, and so many other existing in Brazil, offers the possibility for adopting what Freeman (1996) called ‘projects oriented by mission’, taking matters related to health as reference. This emphasis on the health system may play a fundamental role in the concurrent designing of innovation systems and welfare systems, insofar the health innovation systems lie on the intersection of these two institutional arrangements. To sum up, here we claim that the health innovation system may play a strategic role in the configuration of a pattern of technological development able to escape the polarity modernization- marginalization which keeps us in the trap of underdevelopment. However, for accomplishing it, new forms of public policies are required, which act providing a better connection among the

25 industrial, commercial, technological and public health policies, and are based on strategies of social inclusion.

3. Production and Innovation Subsystem in Brazil

The analysis carried out in this chapter aims at investigating the dimensions related to the Brazilian production structure and the sectoral distribution of these activities, as well as the characteristics associated to the innovative processes, the distribution of these activities in terms of both the size of the establishments and geographic regions, and also some characteristics of formal and informal employment. The joint analysis of these issues provides a broad view of the characteristics of the productive and innovative subsystem, allowing for identifying some of the trends which orient the relations between the production structure and the other subsystems comprising the Brazilian Innovation System.

3.1.1 Recent Characterization of the Brazilian Production Structure

As previously stated, the Brazilian production structure has recently undergone deep changes which intensively affected the structural characteristics of the national manufacturing industry, also generating impacts on activities related to the services and agricultural sectors. A debate is in course in literature on whether Brazil has experienced since the 1990s a process of deindustrialization, or changes in both structure and participation of the various sector in the composition of industry. Our objective here is just identifying and analyzing changes in structure of industry, services and agriculture. The first general observation that can be made refers to the significant raise in participation of sectors intensive in natural resources in the industrial structure vis-à-vis other categories, by intensity of factor, particularly those intensive in technology. This movement starts in the second half of the 1990s and intensifies in the recent period leading to a specialization of the industry in sectors intensive in natural resources. In 1996, the five main industrial sectors accounted for more than a half (51.8%) of the industrial output value generated by the whole industry. However, in 2006 more than a half of the industrial production (50.3%) is concentrated in only four sectors, three of them directly associated to processing of natural resources. The major gain of participation in the period was that of coke manufacturing and petroleum refining, elaboration of nuclear fuels and production of alcohol, the sector which more than doubled its weight in industry (from 7.0% in 1996 to 16.5% in 2006), due to both the increase of national production and the raise of petroleum prices. On the other hand, the sectors that are clearly intensive in technology and science – manufacturing of office machines and computer equipment, and manufacturing of other equipment for transport, which includes the aeronautics industry – keep a very small weight in the production structure of Brazilian industry, 0.6% and 1.9%, respectively, in 2006. A general evaluation indicates that the scene of transformations in the production structure of industry is worrying insofar the industry is increasingly more specialized in the production of commodities, whereas relevant sectors, form the technological point of view, which had already a relatively low weight in the middle 1990s, remain with a negligible participation. By analyzing the exporting trend for selected agricultural activities,it is observed that the cultures related to exporter agribusiness experienced a significant raise of harvested area in the period ranging from the beginning of the 1980 decade to 2006. Soy increased its harvested area of approximately 150%,

26 jumping from nearly 8 million hectares to 22 million. Sugar cane had its harvested area increased of 135% in the same period, rising from nearly 2.5 million hectares to more than 6 million hectares. In contrast, its is observed that cultures related to domestic consumption, as for instance wheat crops, remained virtually constant along the years under analysis. This fact reflects, on the one hand, the exporter bias of Brazilian agribusiness, specialized in the production of export commodities. On the other hand, the greater participation of the agribusiness sector in Industrial Output Value (IOV) and by extension in Brazilian GDP also reflects the development of strong productive and innovative capabilities in the sector. Another point worth highlighting refers to the intense raise in IOV participation of the activities related to “manufacturing of petroleum products”. In the period in question a raise of about 250% in participation of this activity in the Brazilian IOV is observed. Such growth is more intense from the beginning of 200 on and reflects significant advances in the processes of petroleum exploration and subsequent processing. We note that such advances result from efforts directed to the improvement of productive and innovative capabilities made by the Brazilian state oil company, Petróleo Brasileiro S.A. (PETROBRAS). It is worth noting that this productive activity holds strong links, both forward and backward, within the productive chain. Its high growth has impelled other sectors of economic activity, as the naval industry, the most emblematic example. Until the beginning of 2000, the Brazilian naval industry was about to disappear, the few remaining shipyards engaged in building fishing boats and yachts. Production in this sector was developed at a low scale, what had negative impacts on competitiveness. Along with the growth of petroleum industry, Brazilian naval sector reemerged, having their demand guaranteed by Petrobras purchases. The argument is strengthened by the steady growth of national production of oil, which in the middle of 2007 led the country to reach self-sufficiency in the production of this input. Again, we emphasize that production growth cannot be dissociated of the efforts developed by Petrobras, once the national reserves are sited in off shore deep waters where the available technologies were not efficient. Thus, the company has developed its own technology for exploration, becoming a world leader in this kind of petroleum prospecting. We also observe a steady growth in production of other kinds of energy inputs, such as natural gas and alcohol. This fact reveals another recent trend of Brazilian production structure that refers to a greater participation of energy industry in its composition. In contrast, it is observed that sectors more intensive in Technologies associated to the paradigm of ICTs are reducing their relative participation in the value of industrial output in Brazil. We note that all sectors depicted in the chart exhibit a marked decrease, excepting for the activities related to “manufacturing of telecommunications and radio equipment and devices and television and radio transmitters” that present certain stability. As already noted, these activities present a strong bias to imports; the companies established in the country which operate in this sector usually behave as assemblers of equipment and devices.

3.1.2 Brazilian Foreign Trade

3.1.2.1 Brazilian Trade Balance

The Brazilian trade balance presented a relative equilibrium during the last two decades. The negative fluctuations presented are due, in a general manner, to the macroeconomic policy adopted and to the development strategies applied by the Brazilian State. Nevertheless, what is worth emphasizing is the significant growth of exports and Brazilian imports in the current decade. In 2007, Brazilian exports and imports reached, respectively, US$160.6 billion and US$120.6 billion, 27 with a balance of US$40.0 billion. These values are approximately three times higher than the results attained in 2002. Such dynamism is clearly related to the global expansion of commodities and to the well known “China effect”. It must be emphasized, however, the recent trend observed, since 2006 and 2007, of an exports increment lower than the extraordinary growth reached in the period of 2002-2004, accompanied of an increase more than proportional of imports. It is possible to note that the Brazilian exportations are basically products of lesser value and the imports refer to products that have a higher technological content. As a result, the country is surplus in sectors that have a lower technological content and deficit in products with the greater technological content. In light of this feature there is an expertise of the staff of Brazilian foreign trade in terms of products imported and exported. Products related to the health complex also present a similar fragility. Notwithstanding its growth during the last decade, in absolute terms, the trade balance of health products is highly negative. This production system is remarkably characterized by products with greater technological content and, thus, with greater value added, as for instance, medicines, vaccines and products of both mechanical and electronic basis as equipments, medical and surgical instruments and supplies. However, it is observed that the participation of these products in the Brazilian exports is quite reduced. Even in case of exporting these goods, we note that the technological intensity of exported products is comparatively lower. In the health complex, the deficit related to pharmacological products is the one deserving most concern, once the strategy for restructuring the national industry, implemented in the beginning of the 1990s, promoted a significant denationalization of pharmaceutical industry. Finally, it is worth emphasizing that Brazil keeps the strategy of importing even products with old patents – previous to the 1970 decade and, therefore, of low technological content. That is, the high imports of products of low technological content evidence the prevalence of marketing strategies of foreign companies to the detriment of the national interests. Another relevant point to highlight is the increase of foreign trade in the energy sector, impelled by the greater use of alternative sources as biodiesel and ethanol, in addition to other natural sources as charcoal. In the energy productive system, the efforts developed in the country towards building capabilities for producing alternative sources of energy, in this case biodiesel and ethanol have generated good outcomes, which resulted even in the enhancement of innovative capabilities in the segment, making Brazil one of the main world producers of energy sources alternative to oil. However, we note that the trade balance in energy segment is still negative, although this result is due to imports of machines and equipment for expanding the energy structure of the country. The technological efforts have been concentrated on improving conditions of supply for downward productive chain, to the detriment of machinery and equipment industry. The production of goods related to agribusiness also presented a high growth in the foreign trade, resulting, on the one hand, from the growth of demand for goods in the foreign market, and on the other hand, from the internal strengthening of the innovative system. In this case, we observe a movement similar to that of the energy system, related to the development of high capabilities which allowed for significant upgrading of innovative performance. The increment of capabilities in the agribusiness is closely related to the construction of the agricultural research system, led by Embrapa. Added to it is the growth of the world demand for agro-industrial goods and the critical phytosanitary problems occurred in major exporter and consumer markets, which furthered Brazilian foreign trade in this segment, allowing for the opening of new markets.

28 Regarding imports, the absolute values are impressive. In the beginning of the 1990 decade, imports amounted approximately US$18 billion. Yet, in the first half of this decade, they grew at an annual rate of about 18%, mainly furthered by the mechanical segment which was chained to the imports by the automotive industry. In the second half of this same decade, imports growth was rather slow: in average, 2% per year. Such drop in imports was driven by the broad investments made by the automotive industry which gradually inverted the flow of foreign trade in Brazil. Nevertheless, in the beginning of years 2000, the imports coefficient raises again, jumping from US$55 million in 2000 to US$120 million in 2007.. In addition, the energy production system had incentives to import machinery and equipment as a strategy for expanding investments. Thus, imports of reactors and components for building and improving the Brazilian energy structure. The imports of fossil energy, in view of the above mentioned, did not grow, in absolute terms, at the same rates. The conjoint analysis of Brazilian foreign trade reflects the trend to specialization in the composition of Brazilian foreign trade. It is possible to divide the two latter decades into three distinct periods. In the first one (1989/1995), we observe that exports of goods related to the health production system attained a growth much higher than the average, a fact that is similar to what occurred with agribusiness. In this period, we also observe a steady expansion in imports of goods related to mechanics, effect of the imports of capital goods. Therefore, in this first period we may already observe some signs of productive specialization in agribusiness and commodities, to the detriment of activities with greater value added. The high growth of imports was linked, then, to the process of commercial liberalization, associated to exchange rates appreciation. The adopted strategy for production development has, fundamentally, led the country to reach successive negative balances in foreign trade, with an average growth of about 18.27% in imports vis-à-vis the 6.73% in exports. In the second period, comprised between 1995 and 2001, a strong drop in the average annual growth of imports (to 1.8%) is observed, although with a rather higher raise in the productive systems related to the health and electronics complexes. In the case of the basic inputs and mechanical production systems, the low growth rates of the economy are more relevant for explaining the drop of import rates, once most of the composition of these imports refers to investments in capital goods. With regard to exports (which grew in average 2.37% in the period), we observe a sharper raise in goods related to the mechanics and electronics systems. However, it is worth emphasizing that these exports are predominantly directed to the Latin-American market, therefore, with a lesser technological content. The third period (2001/2007) is characterized by a movement of exchange rates appreciation (from 2004 on). However, diversely from previous periods, as much imports as exports reveal to be less susceptible to that movement. Even in face of such appreciation, imports rose at relatively reduced rates (13.78% per year), the analyzed segments presenting movements very close to the average. As for the exports, they grew in average 20% per year, with the segments of energy, agribusiness and basic inputs growing at rates slightly higher than the average. This last period led the country to register consecutive positive balances in the foreign trade, raising reserve currency and providing some calmness regarding foreign debt. The next section will present evolution of the foreign direct investment in Brazil.

3.1.2.2 Evolution of Foreign Direct Investment in Brazil

29 The flow of FDI for Brazil had two moments of significant increase: first in the 1970’s and subsequently in the 1990’s. In the first period, it represented around 5% of the world investments, with significant acceleration in the second half of the decade, and contributed to the consolidation of process of Brazilian industrialization. The oil crises in the seventies, associated with internal macroeconomic fragilities, promoted an accentuated escape of the flow of foreign capitals. The effects of this moment were extended to the 1980’s and to first half of the 1990’s, when the flow of foreign investments in Brazil started recovering. This second wave was strongly related to a patrimonial change, as many state-owned companies were privatized and there was an expressive growth of FDI in the banking system. It was also observed an expressive increase of Brazilian’s passive external, but without increasing the production capacity, and it was not successful in motivating innovative process in the subsystems. In the beginning of the years 2000 the relative flow of foreign investments declined, staying around 2% of the world investments.

3.2 Innovation Processes in Brazil:

3.2.1 Critical Analysis Regarding Innovative Processes in Brazil

It is observed that, from 2000 to 2003, the industry’s average innovation rate raised from 31.52% in 2000 to 34.41% in 2005. These rates are inferior to the rates presented by most of the countries of OECD. However, it is worth emphasizing that in the major part of the firms innovations consist in the introduction of products and processes that are new just for the firms, once they exist in the market and in the sector of operation. Taking this characteristic into account, one may observe that the innovation rate in Brazil is even lower. In contrast, we must highlight that the referred average innovation rate does not take into account the high heterogeneity of Brazilian industry; neither considers the different weights held by the industrial sectors within the production structure of the country. A strong discrepancy is observed among sectorial innovation rates, which reach high values in some production segments. In the activities related to information technology equipment, for instance, the average innovation rate is close to 70%. Regarding the innovative efforts developed by the Brazilian firms, we note that they are considerably reduced. In 2003, the proportion of income spent in innovative activities is even lesser (approximately 2.4%). This decline of innovative efforts refers to the implementation of defensive strategies by firms in a moment when the country underwent economic troubles, that is, in the face of difficulties firms choose reducing their expenditures with innovation, trying to keep their competitiveness by means of costs reduction. The analysis of the kind of innovative expenditure made by firms shows that they concentrate their strategies on acquiring machinery and equipment and, to a lesser extent, on carrying out R&D activities. Furthermore, efforts related to training and qualification of human resources (HR) are very low and much inferior in comparison to most of the developed countries. Regarding cooperative strategies implemented by innovative enterprises, it is possible to suggest a strong fluctuation of the rate of cooperation during the studied period, with a sharp decline in 2003, due to the strong economic retraction. Nevertheless, even when the cooperation rate attained its highest index (11%) in 2000, the level of cooperation of Brazilian enterprises is still considered low in comparison to international patterns. In brief, the analysis of data of Brazilian innovation survey (PINTEC) demonstrates that the innovation rate in Brazil is low and concentrated in disseminating innovations. Innovative efforts refer to the acquisition of machinery and equipment, and R&D activities are scarce. Strategies

30 aimed for human resources training and capabilities building are also incipient, as well as the cooperative actions developed by innovative enterprises. However, bias created by the survey must be taken into account. Pintec only captures the movements relative to the extractive and manufacturing industries, not comprising activities related to the services sector and to agroindustry. It is aggravated by the fact that both sectors excluded present high participation in the composition of Brazilian GDP and take specific characteristics regarding their respective innovative processes. Therefore, analyzing the characteristics of the Brazilian innovative processes with basis only in PINTEC is neglecting the relevance and the innovativeness of these subsystems. In other words, is creating a bias that overestimates the innovative efforts related to the manufacturing industry to the detriment of the innovative efforts made by the productive activities of the services and agricultural sectors. It is worth mentioning that empirical studies demonstrate that the production subsystems in the sectors of services and agroindustry are highly innovative and carry out significant learning efforts for improving technological capabilities. Therefore, for a better understanding of the Brazilian innovative production system, it is necessary to analyze the dynamics assumed by innovative processes in the sphere of the activities related to agribusiness and services sectors.

3.2.2 Innovative Processes in the Brazilian Agribusiness Sector

The agribusiness sector developed strong productive and innovative capabilities due to the coordinated efforts of the various areas, as much technical as political and productive ones. Such capabilities were developed by encompassing Brazilian geographical specificities, by allowing agroindustrial exploration of virtually the whole national territory. The Brazilian agroindustrial production subsystem presented an expressive growth during the last years and a relevant part of this vigor is associated to the progressive expansion in exports of food, inputs for the production of renewable energy and inputs of agricultural production. The agricultural and agroindustrial dynamism is strongly connected to the integration of the production systems. This growth and modernization was possible because of a greater systemic integration between economic agents, especially suppliers of machines and equipment and of inputs and fertilizers, with research institutes and with agricultural productive units. In the last years a significant raise of interrelations has occurred between Brazilian agribusiness and suppliers of specialized and science-based technologies. The universities and public research centers, are the main responsible by the development of genetic researches, as well as for the development of scientific researches. Created in 1973, Embrapa coordinates the Brazilian System of Agricultural Research. It funded essentially by the government, and we may observe that investments have declined in the last years, following the profile of investments of the current Brazilian government. However, a valuable source for financing innovative activities consists in the regime of royalties. Embrapa’s position as licensor and producer of new cultures has assured an important network of contractual partners, including private foundations, small and medium enterprises and seed producers. Research involves the use of improved seeds that seek to enhance the “precociousness”, as well as the resistance to plagues and diseases, through adaptations to different climates and regions of the country. Agroindustrial activities, furthermore, create positive spillovers which disseminate the innovative dynamism to other productive segments, such as chemicals and agrarian machines.

3.2.3 Innovative Processes in the Service Sector

31 Two facts are noteworthy regarding the service subsystem: first, it has a significant weight in the Brazilian economy. Second, it disseminates innovations, providing for synergies and spillovers all along the national production structure. In this regard, the sector of software development is emblematic. In the context of an economy increasingly “based on knowledge”, the importance of software production comes not only from its role as an instrument that enables the incorporation of knowledge in products, services and systems, but also from its intrinsic importance for the diffusion of information and communication technologies. The software sector plays a fundamental role in processes of learning and development of capabilities both within a firm and between firms, creating significant productivity gains in industry (involving aspects related to industrial automation, production control, purchasing, inventory, logistics and others) and in the service sector (particularly in the segments of financial services, education, public services and transports, among others). It is worth highlighting that, in the beginning of this decade (2001), software production activities in Brazil equated the seventh major world market in terms of domestic sales, which reached approximately US$ 7.7 billion. All along this trajectory, expressive investments were made in accumulating productive and technological competencies and in developing inter-industrial connections. It allowed the formation of both a specialized labor force and an expressive infrastructure, thus creating important stimulus to the emergence and consolidation of new businesses in the sector. The service subsystem also accounts for the diffusion of knowledge to several other production subsystems. As emphasized in the first section of this chapter, the subsystems of activities related to energy registered a significant raise in their participation in IOV. This fact reflects the high productive and innovative capacities developed in these activities. Oil extraction and manufacturing respond for most of this enhancement. The major enterprise in this sector in the country is undoubtedly PETROBRAS, which accounts for most part of the production. and plays a role of boosting, dynamizing and stimulating innovation within several of its service providers. In the particular case of manufacturing industry, we observe that it presents relative low innovation rates, which are concentrated on dissemination of innovations. Its innovative efforts are also reduced and refer principally to acquisition of machinery and equipment, with reduced activities of R&D. Equally reduced in this sector are the efforts related to training and capabilities building of HR, as well as the implemented cooperative strategies. Nevertheless, these data should be analyzed with reservations, once they represent the average of the national industry, which, as already claimed, presents a high degree of inter-industrial and intra-sectoral heterogeneity. In this sense, the next section aims indeed at demonstrating the strong Brazilian heterogeneity referred to along this chapter.

3.3 Heterogeneity of the Production Structure

3.3.1 Specifics Regarding the Size of Establishments

The Brazilian productive and innovative structure shows a broad heterogeneity, particularly characterized by regional, institutional and political asymmetries. The huge geographical extension of Brazil intensifies the emergence of heterogeneities, once the spatial concentration of production systems reveals high developed segments coexisting with backward structures and with several limitations. Furthermore, the Brazilian production system is comprised by an expressive number of

32 micro and small enterprises (MSEs), with very distinct competitive, technical and institutional specificities. In view of the high number of MSEs, the formulation of new institutional designs and of policies that promote knowledge flows in these enterprises presents particular relevance for the Brazilian scenario. MSEs contribute with 36.2% of the total formal employment in the country and to 10.3% of the total wages in the Brazilian economy. The micro and small enterprises have been increasingly recognized as motors of growth and employment. In a general manner, MSEs concentrate in activities of low technological intensity and intensive use of labor force of low qualification; they operate predominantly in traditional industries such as food and beverage, footwear, textile and furniture. Although the outstanding relevance of MSEs, they face huge challenges in the short term, not only for surviving and maintaining their activities, as also in terms of conceiving ways for enhancing their competitiveness and their chances of economic survival, through an ecologically and socially sustainable way. These challenges are generally faced individually by firms, once the productive and spatial contexts where small firms are inserted make difficult the technological cooperation. In view of this, the presence of micro and small enterprises within production systems with greater technological content is reduced. Large-sized enterprises have better possibilities for maintaining own laboratories of R&D, playing a relevant role in the governance of the Brazilian productive and innovative system. Therefore, the production segments comprising enterprises of greater relative size tend to be more dynamic regarding activities of research and development. Indeed, among the main characteristics of these economic activities there is the demand of heavy investments with long-term maturation and, therefore, the insertion of small enterprises in these segments occurs only sporadically, generally as a result of localized efforts. Bankruptcy among MSEs is quite large: 49.9% of MSEs end their operations within two years of starting and 59.9% within four years. Another important asymmetric characteristic found in the national production system and, particularly, among the MSEs, is the high and increasing informality that characterizes the Brazilian economy. There are approximately 20 million informal small businesses, involving about 60 million people, operating in Brazil and which proliferate primarily as a result of economic recession and of the high unemployment rate of the last decades. The high degree of informality prevents the access to official financing sources. However, it is quite plausible that a significant contingent of micro and small enterprises (both formal and informal) do develop creative solutions in the face of problems and difficulties, although these solutions do not comprise the official statistics of Brazilian innovation. Finally, it is recognized that during the 1990 decade Brazil made significant institutional investments for promoting MSEs. However, the initiatives focused on the enterprises were, often, insufficient, uncoordinated and marked by overlap and discontinuity. And, more importantly, the objectives of promoting the small enterprise shocked with the macroeconomic policy goals. Moreover, the main beneficiaries of the public financial support for innovation continue to be the large companies. Notwithstanding the official statistics do not representing adequately the reality of MSEs, and in spite of the deficiencies of the policies adopted in the last decades aiming to promote and support MSEs, such policies must become the focus of permanent actions by governments and new institutional designs must be created for promoting local productive arrangements and for supporting MSEs. Such actions might reduce the institutional and regional heterogeneity of the national innovation system, mitigating the limitations to the competitive insertion of MSEs.

33 3.3.2 Regional Specificities

The strong regional heterogeneities of the Brazilian production system must be incorporated to the study of this system as a way for weighting the findings arising from Pintec data. As aforementioned, Pintec presents statistics through the averages of indicators. Due to the strong disparities (including regional), the average of innovation rates is quite distant from the reality of the Brazilian regions. This section is purposed to demonstrate the strong regional heterogeneity, in order to support the argument just presented. The Southeastern and Southern regions and part of the Center-Western regions comprise about 26% of the national territory and concentrate 63% of the country’s population. The combined gross domestic product of regions South and Southeast represent approximately 75% of the national gross product and about 80% of exports. The economic history of Brazilian regions is directly associated to the history of industrialization and to the formation on the domestic consumption market. The socio-economic unbalances can be evidenced through the ascertainment that the population of regions North and Northeast present the worst indicators, those regions showing the highest proportion of population leaning on agriculture (above all subsistence agriculture) and the lowest percentages of people occupied in industry, besides presenting the lowest levels of formal education. The spatial dynamics of Brazilian production structure determines unequal development, because the strength of the national economy is characterized by the hegemony of the State of Sao Paulo and its surroundings. The concentrated nature of Brazilian industry may be expressed through the following figures: 4.5% out of all municipalities hold 70% of working people and more than 85% of the value of industrial manufacturing. The distribution of both industrial chains and processes of development of science and technology reproduces and can increase regional disparities, mainly because of the cumulative nature of the new processes associated to the scientific and technological revolution, which are at greater or lesser extent related to the density of the industrial fabric and to the history of social indicators. Recently, elements related to fiscal war between states and to wage disparities in the country, sought to promote investments flows in all regions resulting some spatial changes in the production structure. Another attempt to strengthen the Brazilian innovation system was made through the state decentralization of part of the investments in science and technology. Nevertheless, there remains still profound regional disparity in this allocation of resources, once the Southeastern region expends approximately 74% of the resources spent with S&T in the country and, if including region South, this proportion raises to 88% of expenditures. It is also observed that these two regions allocate 72% of Master degrees and 80% of Doctor Degrees conferred in the country, what reflects decisively on several indicators, especially regarding the Brazilian scientific production. Furthermore, from the innovation point of view, the regional disparities are still more expressive. More than 50% of innovative enterprises are located in the Southeastern region. Above all, the analyzed socio-economic indicators reveal that the inequalities found have widened since the beginning of the 1990 decade, notably in the educational system, making difficult for regions Northeast, North and Center-West to advance towards a more dynamic national innovation system. The geographical distribution of enterprises and of formal employment is concentrated in regions South and Southeast of the country. The heterogeneity of the Brazilian production structure is part of an historical process in which the productive dynamics developed from the expansion of the primary activities existing in these regions.

34 3.4 The Brazilian Labor Market and its Influence on the National Innovation System

This section presents the composition of the Brazilian labor market distributed among the distinct economic activities that comprise the national production system. The higher administration represented by the occupational bond of the managers of the national production structure comprises 5.37% of employed personnel. The economic activity related to the “financial” production structure holds approximately 60% of employees connected to activities of planning and managing the structure of provided services. This trend can be also observed in productive activities of information and communication technology and health. Occupations related to higher administration invariably require a higher schooling degree, in view of the characteristics and specificities of activities carried out. In this perspective, the Brazilian higher education system is extremely important in training the human resources for these activities. In view of this, the occupational group related to the education of human resources holds strong correlation with the groups which require greater schooling levels, including the relation with itself, as educator of educators. The qualification of human resources is more intensively related to the activities of services production – the service production system demands human resources with higher educational levels. In general, universities and technical schools classify within this subsystem, although the education of human resources is recognized as influencing all other production segments. The other production subsystems which hold employment links with educators of human resources are basically centers for vocational training, such as the “S” system, which represents an important part of these bonds. Furthermore, consultant firms that provide services of administrative and technical training are also considered as human resources educators. The occupational groups related to technical administration and to production techniques share very similar professional characteristics. The basic difference is that the first group is characterized by the technical professional management, comprising job posts of directors, of production managers or, autonomous professionals working as consultants. These professionals are characterized by the high degree of formal education and work predominantly in the service sector. This ascertainment allows perceiving that the productive and innovative structure of the Brazilian segment of service present better furnished possibilities of development and consolidation, based on the development of more virtuous learning processes and on a labor force with higher capacity. In their turn, the professionals related to production techniques work directly in the production and, at a great extent, have strong informal education, acquired through processes of learning by doing. The production technicians are present preferably in knowledge intensive activities as electronics, health and information and communication technology. Similarly to technical administrators, the production technicians work primarily in the service segment, which comprise approximately 3 million employees, reinforcing the hypothesis of a dynamic movement in the segment due to the high capacity of the labor force. The professionals linked to activities of basic science have small participation in employments generated in the production structure. In occupations related to basic science, participation is inferior to 1% of total employment, with a single emphasis on activities related to nanotechnology, novel materials and defense. In absolute terms, professionals linked to basic science totalize nearly 13.000 employments (scientists). It is important to observe also that, in crossing data, we note that the number of professionals related to the science subsystem who perform activities of basic science is very small, showing a discontinuity between the education of human resources in areas related to basic science and the absorption of these human resources by the national production structure.

35 Although applied sciences give emphasis to professionals connected to engineering, these professionals work basically as autonomous firms. This element can be considered a fragility in the Brazilian productive and innovative system, once only enterprises of larger sizes maintain professionals related to engineering activities in their roll of professionals. However, it is noted that exists a relatively significant number of these professionals working in the national production structure, particularly in more dynamic production segments like information and communication technology, sciences and energy. The work of these professionals represents an important part of the dynamic of innovation in product and, principally in production process. This element can explain part of the differences between the innovation rates of Brazilian production system. The production assistance personnel is constituted by workers directly associated to the production of goods and services. In general, these workers hold low levels of formal schooling, their technical knowledge being acquired basically through processes of learning by doing. This occupation is directly related to the degree of labor force utilization of each production structure. The service production system has greater participation in this segment, being strongly affected by commercial services. It is also observed that production segments with greater technological content use a significantly smaller part of production assistance personnel, with emphasis to financial services, information and communication technology and sciences. On the other hand, systems with lesser technological content use a contingent significantly greater of these personnel. It is noted, as well, that structural changes occurred along the 1990s in the Brazilian economy reflect on the performance of the labor market. As of the beginning of the commercial and financial liberalization, the production system has changed quickly and significantly, reflecting the efforts of technological capacity building developed by the country. The major increment of competition, both domestic and external, has impelled firms to incorporate technological and organizational innovations, resulting in the raise in demand for more qualified workers. This phenomenon tends to be intensified in the medium and long terms. It is in this context that the structural conditions in the labor market must be analyzed, for building the technical and scientific capabilities able to keep competitiveness in the international ambit. The central idea demonstrates that the low innovative dynamism by some production systems is reinforced by structural deficiencies of the labor market. With respect to workers´ school levels, it is possible to observe that the agribusiness production structure presented a significant raise in the rate of job posts of higher schooling levels. This fact is closely related to the efforts of Research and Development carried out by this production system, once the implementation of innovation requires a better level of formal schooling. In contrast, the growth rate of employment of lower schooling levels was significantly lower. This fact strengthens the evidence that the Brazilian production structure is becoming intensively specialized in services. Moreover, services show an important innovative dynamics. The agribusiness productive an innovative system presented the greater average employment growth. Manufacturing industry showed the lowest figures, although it should be carefully analyzed – in this period occurred transference, through subcontracting movements, of diverse production processes. The oil industry, notably through PETROBRAS, and agribusiness presented the highest growth rates. In the service production system, it was the health segment that presented the highest growth rates. Nevertheless, given the emergence of information and communication technologies, telecommunications services and the industry of electronic equipment presented an insignificant growth.

4. Subsystem of Creation of Capabilities, Research and Technology Services

36 In the present context, distinguished by rapid changes of markets, of technology and organizational forms, the ability to generate and absorb innovations has been considered increasingly essential to the effective competitiveness of an economic agent. Therefore, it becomes essential to analyze the subsystem of Creation of Capabilities, Research and Technology Services which comprises all institutions that somehow contribute to the process of building the capabilities of the workforce.

4.1 Basic Education

The learning process is directly associated to the knowledge accumulated and it defines the possible spectrum of generation and assimilation of new knowledge and technical advancement . In view of the cumulative nature of the learning process, basic education, provided in the early years of life, constitutes a major pillar in the process of capabilities building. The strengthening of NIS is, then, closely related to the development of a quality education system. In 2006, 42.2 million, out of the 55.9 million Brazilians officially enrolled in the distinct modalities of Basic Education, are attending Elementary and Secondary Schools, the remaining being divided into Pre-School (7 million) and other minor categories. From the quantitative view, private education in Brazil seems to have a complementary role with respect to the public system, with 17% of the establishments and 13% of students. Qualitatively the private schools are in general better than the public ones. The results of students’ proficiency in Portuguese Language and Mathematics of the SAEB (Basic Education Evaluation System) test are quite below those desirable. Although private school being considered as superior, the high costs of private education limits the access - only 10% of students are enrolled in private schools at primary education and 12% of them at secondary education . Such duality in the quality of education (public versus private) incites social inequality in the country, once different opportunities are offered to different segments of the population, with consequent distinct possibilities to access higher education. Figures reveal that Brazil presents a relatively slow and constant process of expansion of the basic education system. However, the high and increasing abandonment rate has significantly reduced the primary education completion rate. Not surprisingly, it happens to the most detriment of poor children. Brazil is among the countries with highest illiteracy rates in Latin America, with 11% in 2005. With respect to functional illiteracy, this number raises to 23.5%. It is possible to identify a great disparity between rural and urban illiteracy rates, the former much larger than the latter. Also remarkable is the great regional disparity of the Brazilian basic education system. Indicators related to infra-structure of primary education schools network, also reveal worrying regional disparities. These features associated to primary education end up affecting secondary education and a delay is perceived in youth entry to secondary school. The enrollment rate of students aged 15 to 17 was of 81.7%. However, only 44.4% was attending secondary education in 2005. It is possible, too, to relate these data to unfavorable socioeconomic factors which constitute a serious hindrance to human capital accumulation. In addition, 140 municipalities do not offer full and regular secondary education, the most critical situation occurring in relation to Youth and Adult Education nonexistent in more than half Brazilian municipalities. In brief, by means of the analysis of indicators above described, it is possible to infer that the quality of public education in the country, in virtually all its dimensions, is dreadful.

37 The fact that students remain in the system beyond the age foreseen and beyond the time required to completion of primary education, associated to high abandonment rates, increases the costs of education per student and reduces the amount of resources available for improving the quality of education and of the schools system.

4.1.2. Education Investment – The Supply Side

The Brazilian public investment in Education has fluctuated, since 2000, around 4.5% of the GDP. Higher education is favored in terms of resources, to the detriment of primary education. Brazil is, in relative terms, one of the countries in the world with highest investments per student in public higher education.

4.2 Higher Education and the Relationship Enterprise-University

The precarious and heterogeneous conditions of basic education spill to higher education. Studies on innovation have systematically pointed to the importance of latter to technological innovation. Amid all benefits generated by the higher education system to the innovation process, the training of human resources seems to be the most important Universities are key institutional agents in the national and regional innovation systems, whose role is usually associated to the education of qualified human resources, as a source of fundamental knowledge and knowledge relevant to the modern knowledge based economy. However, the functions performed by universities in the NIS are usually directed to education and research. The functions of human resources training and of advanced research by universities have been pointed as relevant for the countries catching-up, insofar they expand the absorption capacity and the development of national industry. Furthermore, the development of the education system would have opened a new channel for diffusion of technical and scientific knowledge, by the occupation of graduates in either industry or universities and similar institutions abroad. It is important to emphasize that the interaction university- enterprise consists of an important institutional sub-group of the broad system of knowledge exchange, being peculiar to each country and dependent on the national infrastructure of Science and Technology (S&T). Firms must develop technological competences which allow for the effective absorption of knowledge in universities. For understanding the current system of Brazilian higher education and its implications for NIS, it is worth briefly analyzing the historical process of its creation and development. Brazil was the last country in Latin America to develop a higher education system. Brazilian universities have existed for less than 100 years. During the military dictatorship (1964-1985) several legal acts were created aiming to provide a legal framework for the higher education system, modernize it and improve its quality by enhancing its flexibility and efficiency in training human resources for the development of the country. The rise in the number of students between 1960 and 2004 has been substantial, although much lesser than that desirable. The number of students experienced a raise in absolute terms in the last ten years, but the proportion of youth aged between 18 and 24 remains unchanged (10%). Ambitious goals for the expansion of higher education are described in the National Plan for Education (2001), which forecasts 30% of the population attending higher education by 2010. Yet, this proportion is still lower than that of the OECD countries where such rate reaches significant

38 60%. Noteworthy is the strong expansion of private institutions, especially as of the 1990’s. Contrarily to the primary and secondary education, higher education is marked by superiority, in quantitative terms, of the private education over the public. The Brazilian higher education system is marked by the presence of strong heterogeneities. Firstly, one may perceive some elitism regarding the access to higher education, enrollment corresponding to mere 10% of population aged between 18 and 24. This can be deemed as an extension of social exclusion that occurs along primary and secondary education, where just a small elite has access to quality education and, thus, get to guarantee access to higher education. Furthermore, the regional distribution of these institutions is strongly unequal: 49% of universities and other higher education institutions are located in the Southeastern region. In addition, the Brazilian higher education system is also marked by a sharp racial inequality. In 2005, nearly 75% of students in higher education institutions declared being of “white race”, against 5% declared “black” or afro-Brazilian and 20% of mixed and other races. The distinct schooling of white, black and mixed race people also have an impact on the labor market. White working people had, in 2004, an average of 8.4 years of study and earned an average monthly income of 3.8 minimum wages. Conversely, black and mixed race working population, in that same year, presented an average of 6.2 years of study and 2 minimum wages of monthly remuneration.

4.3 Graduate Education System

In the 1960’s, Brazil decided to invest in training researchers, counting on the public universities as the main institutional basis of this goal. Along the 1970’s around 800 new Masters and Doctorate courses were created and, in the beginning of the nineties, the number of courses reached a little more than one thousand, comprising all knowledge areas. The number of masters and doctors increased as well. It is possible to affirm that the number of qualified doctors a year in Brazil is very significant, even in international terms, and continues to grow at rates accelerated. However, if the goal is leveling with OECD countries, we are far from reaching it: these countries produce, in average, one doctor for each 5.000 inhabitants, while Brazil produces one doctor for each 28.000 inhabitants.

4.3.1 - Analysis of the Number of Doctors Formally Employed By Area of Expertise

Educational institutions were responsible for the employment of 65.96% of all doctors. Certainly, these institutions also conduct research and development activities in addition to training qualified human resources for all other sectors of the economy, but its weight seems to be disproportionately high. In the USA, this rate reaches only 47%, and one out of three doctors work in private companies.This is an indication of the relatively low participation of the productive sector in the R & D and innovation effort. NGO’s and trade unions are responsible for a relatively large share of employed doctors. The non-absorption of PhDs by the Brazilian enterprises probably inhibits those who, under different conditions of the labor market for researchers, could be interested in taking a doctoral education in engineering. Thus, in terms of participation of knowledge areas in the composition of the stock of new researchers, it is reasonable to claim that the dynamic processes of relations between the scientific and technological sectors have not been fully established in Brazil. One of the evidences that this system is serving only for reproducing itself lies in the methods for evaluating graduate education, which in spite of using multiple criteria ascribe a greater weight

39 to scientific publications produced by professors and students to the detriment of alternative activities. At this point, it is worth analyzing the causes for the low interaction of the graduate education system with the Brazilian productive structure. One explanation is related to the late creation of higher education institutions, associated to the historical process of Brazilian industrialization, which demands on the scientific infra-structure remained limited and scarcely challenging until at least the end 1980 decade, and constituted hindrances to the consolidation of the NIS. A second reason is that, during the period of imports substitution, the protected market did not require the development of innovations, and the most common collaboration activities of universities occurred with public companies which belonged to technologically advanced sectors, and with some private companies of the agro-exporter sector. Other problems include communication difficulties, bureaucracy, inadequacy of research personnel, inadequate financing, socio-cultural factors and cultural differences between university and industry in terms of R&D activities related to long term versus short term perspectives.

4.4 Research Institutes

The historical roots of the pattern of interaction between universities/ research institutions and enterprises in Brazil are characterized by only localized “interaction points” that become successful cases of relationship between research institutes/universities and some firms. The observed “interaction pattern” is very limited and insufficient for impressing to the economy a dynamics of economic growth based on the strengthening of innovative capabilities. In spite of all difficulties identified along the development process of research institutions, there are some historical examples of articulation between economy and the formation of education and research institutions that allow for arguing that the successful cases identified are based on a long term construction, characterized by systematic and persisting efforts. These include agrarian sciences and forest engineering; mining, materials engineering and metallurgy; and aeronautics engineering.

4.5 Technological Parks

Retrospectively, the origin of the concept of technological parks dates back to the beginning of the 1960s, through the well known spontaneous experiences of spatial agglomeration and technological success of Silicon Valley. The success of these initial American experiences has, decisively, contributed for the construction of the concept of tech parks and their evolution as a mechanism for integrating universities and industry. The establishment of these first tech parks in developed countries, during the 1970s and more effectively during the 1980s, occurred in a period marked by the lack of economic and industrial vitality (economic crises, unemployment and post-industrial economic scenario). Parks came to this context as a political and institutional answer, linked to experiences and industrial revitalization policy. However, these experiences and policies were implemented on the basis of the prevalent linear model of innovation: transfer of knowledge produced. In Brazil, the definition of tech parks focuses on the concept of a planned scientific and technological industrial productive complex, incorporating also services, besides the traditional functions of parks such as the strengthening of the university-industry linkages. As a result, the Brazilian parks tend to be planned in a delimited loci, in which there is space for housing firms of

40 all dimensions and appropriate infrastructure for “businesses” they intend to house: universities, research institutions, incubates. With respect to the lack of performance indicators that may validate the several tech parks impacts, it is consensual the existence of implicit methodological difficulties in the evaluation procedures. The movement of tech parks in Brazil is quite recent, having started its first projects at the beginning of this decade. Brazilian technological parks have some clear characteristics. It’s young, but it has made its way into the political agenda. As there is no international model of tech park, there is no Brazilian model either, with diverse experiences. The main stakeholders and their objectives remain unchangeable over time, and in most cases there is no adherence between projects of parks and the local reality. In general, it has been identified the lack of parks’ performance indicators able of validating the diverse impacts that emerge from their implementation. Also, projects lack financial engineering strategies.

4.6 Vocational Education and Training

Although the technical education system presents an increasing enrollment rate, it is yet little developed and insufficient for meeting the industrial demand. The number of students at technical schools still represents less than 7.5% of the total number of students attending the secondary level in the country. One of the main reasons of the scarcity of qualified workforce in Brazil is the disparity between current supply of technical courses and the demand by the sectors that grow more intensively, as services and some industrial segments such us mining, sugarcane (sugar and alcohol). Undoubtedly, Brazil lacks a vocational education public system to meet the industrial needs. The inadequate supply of vocational education and training implicates hindrances to industrial development and consequently to the growth of the country, besides reducing the chances for inclusion of low income youth. The technical education, which is a vocational training that holds status of a undergraduate course, also consists in a problem regarding its expansion. A form for expanding the preparation of technologists in the public network is creating partnerships, mainly some that meet the regional demands. The vocational education system in Brazil is made up by public and private establishments, with increasing predominance of the latter. The private vocational system is fundamentally comprises by the so called “S System”, a group of 12 institutions which financial resources come from social obligations incident on the payroll of the enterprises in each category and are aimed at financing activities of vocational capabilities building and improve worker’s quality of life. In fact, it is a public resource administered by the private sector, with the objective of meeting the demands of the productive sector. The “S System” does not hide the deficiencies in the qualification of workforce in Brazil. Complaints on the part of the enterprises about the deficit of technicians for filling the supply of job posts are recurrent. Additionally to shortage of technical courses for training the workforce, enterprises are characterized as little proactive on issues related to training and capacity- building human resources (HR).

4.7 Metrology

The development of metrology, standardization, and quality certification in the perspective of organizing the scientific and technological basis of a country is essential for the development of

41 technological innovation and, as such, represents a strategic aspect of the NIS. This section analyzes the Brazilian metrology and the measures adopted by the National Institute of Metrology, Regulation and Industrial Quality (INMETRO), whose aim is to improve the mechanisms that allow expanding productive and innovative capabilities of Brazilian enterprises. Metrology is closely connected to science and technology (S&T) and also requires substantial investments in research and development (R&D). The character of public good inherent to the investments required in the various fields of metrology imposes major challenges to the role of the State in what respects the provision of a solid metrological and laboratory basis. Metrology and the process of technical standardization must be deemed as a powerful tool for strengthening industrial competitiveness and innovativeness, once both affect the processes of generation and diffusion of technological innovations and, lastly, the competitiveness. One must also pay attention to the fact that within a context of decreasing tariffs, room is opened to more subtle instruments of protection such as “technical barriers”, derived of technical specifications more restrictive than the necessary. As for Brazil, it is observed that the first institute of metrology (Instituto Nacional de Pesos e Medidas - INPM) was created only in 1961, without an expressive investment in the scientific area. Attempts for fulfilling this void have only been made as of 1973, with the creation of INMETRO. However, it was only from the beginning of the 21st century that a greater intensity of formal investments in R&D started comprising the routines of this Institute. Inmetro had historically a strong action in more traditional fields of metrology: with a consolidated role in the Brazilian laboratory structure, but with little intervention in the development of reference standards in areas of national interest. In this perspective, the central role of public policies is once more emphasized when considering the State’s role in metrology and technical standardization. Therefore, the development of specific researches on this matter becomes essential, under the proposed designation of “Economics of Standardization”, given its strategic and broad character, with influences on industrial innovativeness and competitiveness, considering the different sectors of a given economy. Only thus it will be possible to undertake a prospective attitude, designing opportune strategies, avoiding the perpetuation of hindrances to the technological advancement that promotes economic growth and development.

5. Sub-System of Policies, Representation & Financing

At least since the 1970s, there has been, in Latin-America, a perception that decisions and strategies regarding industrial and technological investment are strongly influenced by both the macroeconomic context and by the policies that have an effect on it. That period was characterized by a global structural crisis and even among advanced countries, there was a perception that the macroeconomic environment and microeconomic decisions were deeply interconnected. Interesting enough, during the financial globalization that followed suit, such linkages gradually disappeared from the policy agenda in most parts of the world. Under the broad perspective of NSI of the BRICS project we depart from the view that the effort for understanding the dynamic of industrial and technological development and for proposing suitable policies for its mobilization must take into account and intervene on the determining factors of the macroeconomic, political and institutional and financial contexts that are specific to each country. In developing countries the macroeconomic policy comprises an “implicit policy” which, depending on its objectives and instruments, may hinder, and even cancel, explicit policies aimed at the industrial and innovative development of the country. In developing countries, this need for caring about the macroeconomic

42 context in what regards private decisions related to production and innovation is still more pressing. Indeed, in countries marked by macroeconomic instability, the specific characteristics of the macroeconomic regimes overlap and determine microeconomic decisions, tending to configure specific patterns of financing and corporative governance, of trade, competition and technical change. The key variables of the economy (interest rate, exchange rate, inflation rate, etc) shape and determine microeconomic decisions insofar they affect capital costs and conditions the strategic options of private agents. Similarly, microeconomic decisions set patterns at various levels that affect and determine the very macroeconomic regime from which they derive. There is, therefore, a double and reinforced interaction between micro and macroeconomic levels. This section of the report will, then, discuss implicit and explicit policies aimed at technological development and innovation in Brazil. We will analyze the influence of implicit policy (macroeconomic) on the potential effects of explicit policy (industrial and innovation) for supporting the national system of innovation in Brazil, from the decade of 1990 on, and the impacts of each of them on microeconomic evolution and performance.

5.1 The Implicit Policy

5.1.1 From Post-War to the 1980 Decade

As opposed to most developed countries, Brazil evolved, since its colonial period until the middle 20th century, as an economy specialized in some basic commodities such as coffee and sugar cane. From the perspective of the productive system, the role of the implicit policy was only of assuring this pattern of specialization, without creating conditions for the country to reap the benefits of the second industrial revolution. Since the end of the World War II this has changed significantly, when, similarly to other developing countries, Brazil implemented an extensive policy program of import substitution, allowing the country to, within 30 years, implement a wide, complex and diversified extractive and manufacturer industry. In item 3 we saw that, from the mid 1960s to the beginning of the 1980’s (when the oil shock and the crisis of external debt reached the country), Brazil experienced an intensive growth process: an average growth of 9% per year, only exceeded by Korea and Singapore. In spite of using a set of traditional protection instruments, and even if it had strong sectorial component, only in a small number of cases industrial policies included internal technological capabilities building as one of their main pillars. This characteristic of the Brazilian policy had an important impact on the evolution of Brazilian industrial structure and innovative capacity. Most of Brazilian productive subsystems with high internal technological development are precisely those where the technological policy has been the core of the policy of production development, such as oil and gas and aeronautics. Then, the decision to create state-owned enterprises in some sectors represented, in fact, implicit technological policies insofar as these firms gradually built their own R&D labs. But there was another specific institutionalization that proved to be crucial both for industrialization and technological development: the setting up of the National Bank for Economic and Social Development (BNDES) in the 1950s. When expectations about a possible Marshall Plan for Latin America subsided, the internal reaction was to create a financial institution to deal with problems of long run investment. BNDES, that today is twice as large as the World Bank, although not caring specifically about technological development, has had an important role on the

43 institutionalization of S&T in Brazil. Afterwards, an specific government agency to deal with S&T – Finep - was created, still in the 1960s. Brazil has benefited from the high international liquidity which prevailed in the global economy in the period from the end of the sixties until 1973, when the first oil shock took place. However, from 1974 on, despite significant changes in the international scenery, the government persisted in a strategy of economic growth based on a growing external debt as the recycling of petrodollars brought liquidity to the international market. At the beginning of the 1980s, when the country started to face the effects of both the second oil shock and the rise of interest rates in the international financial market, the process of industrial development planning that characterized the previous decades was abandoned. The structure of financial and fiscal incentives was dismantled and reduced, and the industrial sector suffered the impacts of the process of macroeconomic adjustment required for the adaptation to the new external restrictions. The deterioration of the external current account, the need to control public accounts and the declining in conditions of financing of state companies have blocked Brazilian industrial development and broken off the trajectory observed in previous decades. As a result, policy efforts during the 1980s were directed to the control of public budget and inflation, sided with attempts to improve the trade balance through export growth. Throughout the 1980s the Brazilian economy evolved under extremely high inflation rates: in 1988 it was near 400% per year, and rose up to 2000%, in 1990. The chaotic inflation, the increasing budget deficits and the general instability implied the abandonment of any technology strategy.

5.1.2 The Macroeconomic Policy of the 1990s: Commercial Opening and Monetary Stability

The 1990 decade was characterized by a radical change in terms of macroeconomic policy in Brazil with the adoption of the Washington Consensus. Trade liberalization, deregulation and privatization became key-words in Brazil at the beginning of that decade. In the early nineties inflation escalated. Trade liberalization, besides being part of a neoliberal ideology that invaded Latin America in the 1990s, aimed at using imports as a policy tool to control inflation. However, such strategy was not effective and inflation rates reached nearly 1500% in 1991, growing to 2700% in 1993. One of the major impacts of trade liberalization was the promotion of what became known as “defensive adjustment” of Brazilian firms. In view of the rapid process of trade liberalization and the vertiginous growth of imports, firms were forced to drastically reduce costs. The strategy for reducing costs was implemented mainly through the reduction in job posts, through imports of inputs, outsourcing activities and reducing long run technological activities. Although this strategy was often successful, many firms simply disappeared. In 1994 a successful plan - the Real Plan (Plano Real) – was introduced to fight inflation. Initially the plan was based on both an exchange rate anchor (with an overvalued exchange rate) and high interest rates. The macroeconomic policy for monetary stabilization, along with the deregulation and privatization of state companies started to be seen by the government as necessary and sufficient conditions for the industrial and economic development. It is important to emphasize that, from 1995 to 2002, there was an abandonment of industrial policies, as suggested by the Washington Consensus. In this period, only specific measure to cope with difficulties of some sectors with high political clout were implemented. The main objective of these policies was counterbalancing the impacts of the macroeconomic policy which caused a

44 chaotic upsurge in imports of several manufactured products and hampered a more balanced external insertion of the Brazilian economy. One of the major problems deriving from a macroeconomic policy based on overvalued exchange rates, which lasted during almost all 1990 decade, was the deterioration of the external current account. In order to guarantee drawing foreign currencies and keeping exchange rates within the set range, the Brazilian government had to keep interest rates at a considerably high level. This was how government guaranteed the entry of foreign capital, which came to Brazil due to the difference between interest rates in Brazil and the rest of the world, particularly the USA. In order to sterilize capital inflows, the government issued public debt securities which, given high domestic interest rates, promoted the growth of the public debt. One of the results of this process was a low rate of GDP growth and a growing unemployment rate. However, the main purpose of this policy (keeping control on inflation rates) was attained, evidencing thus that fight to inflation constituted the priority of the government, a policy to which every other was subordinated. In view of both the unsustainable external situation of the country and crises faced by the emerging countries in the second half of the 1990 decade (characterized by speculative attacks to local currencies), the Brazilian government was forced to change its exchange rate policy. In 1999 the government modified its exchange rate policy to a floating exchange rate regime. It allowed the reduction of interest rates in the economy, but caused the decrease of foreign reserves.

5.1.3 The Macroeconomic Policy of the Late 1990 Decade and Years 2000: Lula’s Government and the end of the Exchange Rate Anchor

The flexible exchange rate regime has enabled the flotation of the national currency according to the degree of external liquidity. In moments of excess international liquidity, the Real stays overvalued and, in moments of external or domestic turbulence, the national currency suffers sudden devaluations. The fluctuation in value of the Real in relation to the USA dollar has profound impacts on both imports and exports, and exerts a negative influence on the result of explicit policies on innovation directed to the national system of innovation. Since 2007, the exchange rate has been below R$2.00 per dollar, unanimously considered as leading to an overvaluation of the Real regarding to the North-American currency. The net effect is obviously a rise of imports and a discouragement of exports. This impact of the devaluated exchange rate on the trade balance has not been worse only because of the high international prices obtained by the commodities exported by Brazil, what somehow counterbalances the devaluated exchange rate. The fulfillment of inflation goals is the great priority of the government and the main instrument for keeping inflation goals is the interest rate. Pursuing the control of inflation rates, since 1994 the last Brazilian governments have kept interest rates at high levels. It is worth remarking that the maintenance of high interest rates since the implementation of the Real Plan, in 1994, was connected to the need of attracting foreign capital for enabling an overvalued exchange rate which until 1999 constituted the main anchor of the stabilization policy. The high interest rate serves as a lure for short-term and speculative capital inflows. Brazil has been distinguished by exhibiting the worldwide highest real interest rates. In the period 2005 – 2007, the improvement in performance of the economy led to a slow and gradual reduction of interest rates, taking the country out from this dubious first position. However, the emergence of inflationary pressures with both internal (increase in purchasing power of a good part of the low income population) and external (the USA crisis and rise in food and oil prices) led the

45 monetary authorities to seek, one more time, the strategy of raising interest rates, which is now at 12.25% per year. The decision of raising the SELIC was taken precisely as a consequence of the observed inflationary pressures. The high real interest rate and an overvalued exchange rate have had a negative impact on the economy, discouraging productive investments in the real economy and presenting a direct impact on its growth. Moreover, the use of high interest rate as the only mechanism for fighting inflation has been quite polemical and highly criticized by several segments of the economy, particularly those related to production. The net result of using a flexible exchange rate and high interest rates was an insignificant growth of GDP per capita between 1995 and 2002: 0.8% per year. Such policy sustained a valuation of the real at the expense of real interest rates of 20% a year, which yielded a rise of the net public debt/GDP, from 30% in 1994 to 51% in 2002. In the same period, there was also a significant accumulation of current account deficits reaching US$ 186 billion. From 2003 on, pushed by the growth of the world economy which was headed by the Chinese economy, exports increased in average 22% per year (2003-2007), a significant jump in comparison to the former period, total external debt / exports decreased from 350% to 120%, the reserves amount exceeded the external public debt and the growth rate of per capita GDP reaches 2.4% per year. Although undergoing a favorable external situation, Brazil has not significantly advanced its participation in global trade. The rise experienced in the period 2003-2007 has just taken the country to the same level it held in 1980-1984: 1.2% of the world trade. Moreover, in spite also of the improvement observed in several indicators, the country still relies upon the two instruments – overvaluation of the exchange rate and high interest rates – for anchoring all economic policy for fighting inflation. It is worth emphasizing that given the upsurge of the world market of commodities Brazil acquired in the last years, an impressive improvement in the external front through the accumulation of foreign reserves. This started in 2005 and by June 2008, foreign reserves reached US$ 200 billion. As a consequence of this improvement in the external situation, in May 2008 the government announced the creation of a Sovereign Fund of Brazil (FSB) that would be initially constituted with US$13 billion. These resources should be used primarily to buy US dollars, absorbing an eventual surplus of the strong currency in the local market, or either for investing in public debt securities and in bonds of BNDES, with returns of 6.5% per year.

5.2 Science, Technology and Innovation Policy

5.2.1 Brief Background – From the Fifties to the 1980s

The Brazilian National System of Innovation has changed significantly between 1950 and 1970, when the country was converted from a traditional supplier of raw-materials into an economy based on manufacturing industry. In this context, significant initiatives of Science and Technology were adopted in the sphere of the federal government, aiming at organizing S&T. The late 1940s and the 1950s was a rich period regarding the provision of government institutions to coordinate and execute S&T policies. Among such initiatives, stand out the setting up of CNPq – National Council of Scientific and Technological Development – and Capes – Committee for Improvement of Tertiary Level (Post Grad) Personnel – both created for organizing and financing research and graduate studies. Also

46 remarkable is the creation of some sectorial R&D institutions by the federal government, in strategic areas. For the first time, institutions established were not restricted to biomedical and agricultural areas. From the point of view of S&T development, it was only in the late 1960s that Brazil started again to include the issue of scientific and technological development in its policy agenda, as part of a series of policy measures that deeply transformed the Federal Government (such as the setting up of a Central Bank). Brazil implemented a strategy that consisted primarily of really providing a good S&T infrastructure. The first serious attempt to mobilize financial resources for scientific and technological development in Brazil was made at the National Development Bank – BNDE - in 1964 when FUNTEC (National Techno-scientific Fund) was created. The basic aim of FUNTEC was to provide financial resources for up-grading the scientific-technological infrastructure. This was to be achieved primarily through the establishment of joint graduate courses and research programs in (not exclusively, but almost entirely) public universities and research institutes. The second important institutional change in S&T in Brazil was the creation of FINEP (Agency for Financing Studies and Projects) in 1969 as a separate agency of the Ministry of Planning. FINEP, which could be roughly characterized as a development bank for science and technology, started operating mainly in financing feasibility studies, but in 1971 had its functions greatly expanded. A new fund, FNDCT (National Fund for Scientific and Technological Development), was created using federal budget resources with the aim of fostering scientific and technological capabilities. A mention should be made to the transformation of the old National Research Council (CNPq) into an institution responsible for the coordination of all scientific and technological activities at federal level in 1973. These can be broadly described as comprising, first, a statement of the main points of the strategy for S&T, as envisaged by the federal government and, secondly, a brief description of the projects and programs of the institutions subordinated to the central government. As regards technological development, the main political message was the need for increasing the absorption of technology from abroad and the capacity for self-reliance, particularly of Brazilian enterprises. There is no explicit mechanism proposed in each plan regarding how to achieve these goals apart from the budgets of state institutions and enterprises and FINEP's financing programs. Perhaps the most significant institutional innovation of the period was the setting up in 1973 of the Brazilian Agricultural Research Corporation (EMBRAPA) aiming to provide feasible solutions for sustainable development of Brazilian agriculture through knowledge and technology generation and transfer. In short, one may conclude that in this period some important institutional development took place that would have significant positive impact in the long run. From the point of view of technological development at firm level, policies did not show a remarkable success but the roots for successes in the agro-industry (especially thorough the work of EMBRAPA), airspace, oil (where Brazil is the world leader in technology for deep water extraction), telecommunications, energy were established. In all these sectors the State decided to have control of production, instead of letting the private sector to take the lead. The debt crisis of the 1980’s impacted the entire private sector as well as the large State enterprises holding dollar denominated debts in the offshore euro market. From the point of view of the productive structure and its degree of competitiveness, potential problems that would affect the Brazilian economy - insufficient technological development, low level of specialization and low degree of integration with the international economy - were already detected in the early 1980s.

47 Obviously, this crisis period (and the consequent short run stabilization measures) had a significant impact on government S&T expenditures. The three main sources of funding for public science and technology institutions were allocated in 1985 only 40 per cent of the amount they received in 1979. To counteract the budgetary crisis, in 1984 the Brazilian Government began the negotiation of a Loan Agreement with the World Bank. The project supported specific knowledge fields but, also, addressed some general deficiencies of the National system of innovation, such as metrology, basic industrial technology, information science, chemical reagents and research consumables. However, the World Bank loan was not sufficient to restore the funding at the level of the 1970s. Another important institutional development was the setting up of a new Ministry of Science and Technology as part of the new democratic government of 1985. The Ministry introduced, for the first time the issue of innovation in the policy agenda.

5.2.2 Characterization of the Main Programs and Policies of S,T&I and Guidelines Officially Adopted in the 1990 and 2000 Decades

5.2.2.1 Federal Government

On the backdrop of the macroeconomic policy, two distinct periods of Innovation Policies stand out within the period of 1990 and 2006, in the ambit of the federal government: in the first one (1990 – 1998), the Innovation Policy was configured with basis on the Industrial Policy. In the second period (1999 – 2006), the innovation policy is characterized by a discourse advocating innovation and the first movements towards recovering the capacity of the federal government to foster and financing innovation.

1990-1998

The innovation policy of the 1990 decade is marked by a turning point in the industrial – and technological – policy direction in the ambit of the federal government. This inflection has been directed to the liberalization of the market and towards the incentive to foreign investment, both as elements able to dynamize Brazilian industry and technology, hence undertaking a ‘radical neoliberal policy agenda’. They privileged a supposedly more neutral character trough the use of mechanisms said “horizontal”, which would not discriminate against sectors and enterprises in the spirit of a market economy. Instruments were created being justified with basis on the core idea that the process of trade liberalization would induce firms to pursue innovation, as part of a process to survive in the domestic market, at a first moment, and to improve their international competitiveness at a second stage. The guidelines were to increase the efficiency of production and commercialization of goods and services. These guidelines were based on processes of modernization and technological capabilities improvement in the search for international standards of quality. The strategies then adopted can be summed up within two groups: the first one characterized by the elimination/ reduction of both tariff and non-tariff protection mechanisms; the second group aimed specifically to the modernization of the productive sector, providing for the establishment of mechanisms for coordination, support and financing for restructuring the industry and technological infra-structure, for the incentive to specialization of production and planned exposure of Brazilian industry to the international competitiveness. The former was quickly implemented, while the latter has been restricted. These guidelines were implemented through two main programs: the Program of Support for

48 Improving Technological Capabilities of the Industry (PACTI), that proposed the expansion of public resources for science and technology granting fiscal incentives; and the Brazilian Program of Quality and Productivity (PBQP), which was structured in sub-programs aimed at objectives such as the development of human resources and new methodologies of management. In this period, two other programs were implemented by the MCT (Ministry of Science and Technology), conforming to the logic proposed by the policy: the Program on Technological Management for Competitiveness (PGTec), aimed at developing competences in technology management; and OMEGA, aimed at stimulating the development of cooperative research projects involving education and research institutions, as well as firms. In 1993, programs granting fiscal incentives for improvement of technological capability of industrial and agricultural enterprises: the Program of Industry Technological Development (PDTI), and the Program of Agriculture Technological Development (PDTA). In the scope of these programs, the enterprises which developed projects for building capabilities in technology and the enterprises which, on the grounds of law, invested in R&D for technology of software development although this was not its main objective could apply for fiscal incentives. The PDTIs and the PDTAs applies were presented to the Ministry of Science and Technology which was responsible for implementing the fiscal incentives. For the implementation of PDTs and PDTAs, Law no. 8661/93 provided for the firms to associate with universities, research institutions and other firms, as well. At the end of this period, following various criticisms regarding the failure of this policy, the Sectorial Chambers assumed as their new task the analysis of the structural conditions of these sectors according to a vision of medium and long terms. However, the measures of medium and long terms proposed by these Chambers either were not implemented, or had their implementation ceased due to the economic instability. In 1994, the year of implementation of the Plan for economic stabilization, all concerns of the economic policy was focused on this plan, and no measure has beed established that was related to the innovation policy. The period 1995-1998 was characterized by the maintenance and intensification of the industrial policy guidelines that was valid in the former period (1990-1994), promoting competitiveness through the establishment of horizontal policies. In 1995, the government announces its Industrial, Techological and Foreign Trade Policy which targeted trade liberalization and economic stabilization, also opposing the policies of imports substitution. Indeed, as the economic authorities of the Treasury Department was opposed to the idea of an industrial policy, government actions in this period were limited to the existing PBQP and PACTI, and to isolated actions addressed to small and medium enterprises. This opposing position culminated in the reduction, in 1997, of fiscal incentives for R&D, and in the refrainment from implementing PADCT III, the third phase of PADCT which was under negotiation and had been formally signed in 1997.

Period 1999-2006

The guidelines and objectives of the policy on innovation designed for the period 1999-2006 configure a picture quite similar to that announced in the previous period (1995 – 1998), when the horizontal policies were advocated as the most appropriate to a policy on innovation. Emphasis given to the perspective of market failure that guided the State action, especially regarding the need of establishing partnerships between firms and the scientific and technological institutions.

49 According to this perspective, the lack of interaction between scientific and technological institutions and the firms would prevent the successful implementation of a scientific infrastructure in the country from resulting innovations in the productive sector. In addition, the characteristics of the innovative process that involves high risk, high costs and long periods of maturation would justify the State intervention. The conception of the policy was marked by this view, and aimed the structuring of mechanisms and instruments that allow to foster interaction between universities and the productive sector and to reduce costs and risks for stimulating investment by the productive sector in innovative processes. The initiatives of innovation policies have been practically restricted to actions of the Ministry of Science and Technology (MCT), although in the beginning of 1999 there have been positive signs by the Ministry of Development, Industry and Foreign Trade (MDIC). In this year, the Department of Industrial Policy of MDIC formulated a detailed plan of the Policy for Industry, Technology and Foreign Trade. Then, the strong impact of trade liberalization, the process for currency stabilization and other reforms on the various sectors of the economy, and the difficulties they imposed to the adjustment of most of these sectors was already recognized. Reduced growth rates and growing deficits of the trade balance of the country were pointed out as major problems, which resulted in decrease of national participation in the production of many sectors, in closing down many businesses and even in disappearance of productive segments. It was also identified that the most affected business segments was those of small and medium sizes. Hence, the proposed actions of that policy aiming to revert such picture had the following objectives: to raise the rate of growth of both production and employment; to cancel the trade balance debt; to increase investments and to intensify the rhythm of technological innovations (Lemos, 1999). As a consequence, MDIC started, in 2000, the creation of Competitiveness Forums, which had the purpose of improving the industrial competitiveness of the main productive chains of the country in the world market. The forums were associations which saught to take the opportunities tha surrouded the productive chains, be them either related to employment snd income generation, regional productive development, technological capabilities building focused on productivity, quality and innovation, or related to the increment of exports and reduction of imports. Managed by the Department of Production Development (SDP), subordinated to MDIC, this program composed “Brasil Classe Mundial” a program part of “Avança Brasil – PPA 2000/03”. Its objective was making room for the dialogue between the productive sector, the government and the National Congress, aiming to promote the debate, search for a consensus and the establishment of challenging actions and goals for the solution of problems and for taking the opportunities presented by productive chains. Despite all this, in fact the greatest changes from the view of science, technology and innovation has occurred after some measures adopted in the ambit of the Ministry of Science and Technology (MCT). The innovation policy was structured with basis on three main pillars: stimulus to technological development and innovation in the firms; stimulus to the creation of technological infrastructure; and stimulus to the emergence of the businesses based on technology. For enabling the implementation of this policy, MCT has created the Funds of Support to Scientific and Technological Development, designated sectorial funds, and aimed at recovering the capacity to foster/ finance R&D and innovation. Between 1999 and 2002, 12 sectorial funds were created, directed, respectively, to financing projects in partnership between universities and enterprises for generating innovations, and for recovering and expanding the scientific and technological infrastructure of research institutions and universities. Restructuring the funding capacity of MCT allowed for the implementation (or the start of

50 implementation) of the policy’s three pillars. Thus, regarding the stimulus to technological development and innovation in the firms, the core purpose was the implementation of instruments to both foster and finance innovation projects of firms and scientific and technological institutions, with basis on the establishment of non-reimbursable financing lines and of reimbursable funding, as well as through the stimulus to integration of researchers, masters and doctors in the firms. The period of 2003-2006 begins, from the perspective of the innovation policy, after the recognition [by the government] of the need for adopting an explicit industrial policy that should incorporate elements related to innovation. The government, then, sets up the Science, Technology and Innovation National Policy and the Industrial, Technological and Foreign Trade Policy, both founded on the promotion of and encouragement to innovation within firms. The Science, Technology and Innovation National Policy was coordinated and implemented by the Ministry of Science and Technology and its objectives stayed unchanged since the former government (1999-2002). Concurrently, the guidelines of the Industrial, Technological and Foreign Trade Policy (PITCE) were published in November of 2003, and officially issues by the Ministry of Development, Industry and Foreign Trade in March of 2004. Technological innovation was one of the core elements of this policy and, in the perspective of disseminating the discourse pro-innovation through various ministries, these guidelines were jointly formulated by several departments of the federal government. In spite of the explicit recognition of the need for a policy on innovation, the government has implemented it policies with basis on the ideas and mechanisms created during the former government, with emphasis on the sectorial funds as one of the main sources of resources and as a model for implementation of such policies. In addition to the sectorial funds, two legislative acts were issued: the Law on Innovation, established in 2004, and the so called Lei do Bem, established in 2005; both these laws aimed at fostering innovation with basis on either fiscal incentives or the creation of funding mechanisms or interest rates equalization.

5.2.3 Modes of Planned (or not) Coordination/ Articulation Between Adopted Programs and Policies

In the first period analyzed (1990 – 1998) the innovation policy did not established mechanisms for coordination or articulation of actions, once the “market” would be in charge of promoting such coordination and the required articulations. The mechanisms of fiscal incentives created in that period were configured so that it would be on the firms the initiative to apply for them before the competent governmental bodies. The actions directed to smaller firms were virtually restricted to the Ministry of Science and Technology, particularly to Finep – the agency provider of funds for projects and research. Regarding the second period of analysis (1999-2006), it is observed that the guidelines and implementation of the Innovation Policy occurred, especially, by means of fiscal incentives, which continued to be managed according to the practices of the former period – the initiative for accessing benefits was incumbent upon the firms – and by means of the implementation of sectorial funds, looking for establishing a new mode of coordination through the creation of Directing Committees of Sectorial Funds composed by representatives of government, academic sector and productive sector. Also noteworthy is the fact that for competing for resources made available through public calls for proposals, projects should necessarily involve partnership between universities and companies.

51 The fact is that the creation of Directing Committees did not suffice to promote the coordination of the sectorial funds, or to establish strategic guidelines for the implementation of all funds (actually, the composition and functions assumed by the committees showed to be quite heterogeneous). Furthermore, for the period 2003-2006, the Industrial, Technological and Foreign Trade Policy and the Science, Technology and Innovation National Policy presented clear failures of coordination and problems of overlapping objectives and actions. Although the main source of resources being the sectorial funds and its mode of implementation remaining unchanged regarding the previous period (1999-2002), it was not possible to promote, through the Directing Committees, the coordination and articulation of these two policies aimed at fostering innovation. Trying to solve the problem of disconnection between projects approved (and funded) by the Sectorial Funds Directing Committees and the strategic guidelines set up by the federal government for the Science, Technology and Innovation National Policy and for PITCE, the Ministry of Science and Technology created, in 2005, the Coordinating Committee of Sectorial Funds, setting cross actions. These cross actions, which became to be administered in the ambit of this Coordination Committee, are funded through 50% of resources from the sectorial funds, as from the established separation of resources of these funds. Finally, regarding to the form of implementation of sectorial funds, based on public calls for proposals and on application for financing of projects in partnership with scientific and technological institutions, two main problems are remarkable: the first, also related to fiscal incentives, refers to the fact that the initiative for accessing resources of the funds relies on the institutions, involving the notion that the ‘market’ would establish the necessary articulations; the second problems, regards the fact that other forms of articulation are ignored, as well as other relevant agents for the development of the innovative process, omitting the systemic logic of this process.

5.2.4 Main Outcomes and Problems of Adopted Policies of Science, Technology and Innovation

The analysis of the innovation policy’s outcomes must take into account the macroeconomic policy adopted in the period between 1994 and 2006: restrictive fiscal and monetary policies, mainly oriented by the model of inflation goals. The State intervention has been straightly related to the prevailing policy; that is, in periods when economic authorities were opposed to policies towards innovation, ‘discouraging’ measures were adopted. In those periods when such authorities were favorable to innovation policies, the State’s role was only stimulating this process by means of conceding fiscal incentives and opening specific financing to innovation, since the policy was identified with ‘market failures’. Hence, along the 1990 decade, Brazilian government implemented a number of policy mechanisms aiming at stimulating the business sector to expand its expenditures with R&D and thus to raise the innovation rates of the country. This policy can be briefed within two main mechanisms: fiscal incentives to innovation; and stimulus to interaction between universities and the productive sector. The implementation of these mechanisms occurred diversely along the period under analysis (1990-2006): at a first stage (1990- 2006), fiscal incentives to R&D were implemented; and, in the second stage (1999-2006), in addition to these incentives, some mechanisms of public funding for innovation were introduced aiming to stimulate the formation of partnerships between firms and universities.

52 Period 1990-1998

The outcomes of the policies of Science, Technology and Innovation were not satisfactory, even though the government has included the support to science and technology as one of the main elements of this policy. Indeed, due to the fiscal crisis, the policy was virtually limited to the liberalization of international market. The two main programs implemented, PBQP and PACTI, seem to have reached their expected results. The analyses on PBQP, whose main objective was promoting the increment of firms’ productivity, do not attribute directly to this program the productivity gains obtained by the Brazilian economy in the period of 1992 to 1994. The grounds are that the advancements were in good part due to a “favorable climate” globally created around productivity of firms, convergence towards the needs of productive systems and, particularly in the Brazilian case, to the process of spontaneous adjustment by firms for surviving in an environment of increasing exposure to the international economy. PACTI, whose set goal was a raise of expenditures with S&T, from 0.5% to 1.3% of GDP in 1994, aiming at stimulating the creation of an innovative environment, also did not reach its goal. In spite of this latter being considered shy in comparison to world data, it revealed to unattainable, in face of the prevailing economic policy and of the period of high monetary instability. For encouraging private companies to increase expenditures with Research and Development (R&D), PACTI provided for fiscal incentives and granting of credit by federal agencies of technological development, mainly the Studies and Projects Financing Agency – Finep. Another instrument suggested by PACTI was the purchasing power of the State for inducing technological activities on the part of the national companies. In spite of these efforts, the program failed basically for the lack of significant incentives. The analysis of the period 1990-1994 allow to infer that just the processes of trade liberalization had unplanned effects on the firms, inducing modernization and increasing productivity of some sectors; producing changes in the productive structure and affecting the microeconomic behavior of agents. However, these effects on the productive structure were not positive, for they include: change in the capital origin of innovative Brazilian companies (which were acquired by foreign companies); significant reduction in production of equipment and machinery in Brazil, with consequent raise in imports of capital goods; adoption of modernization strategies based on the substitution of equipment and machinery reducing the need for human resources, nevertheless without the adoption of innovation strategies; reduction (elimination) of integration between multinational companies and supplier firms, due to the adoption of outsourcing strategies. Therefore, the policy outcome was the concentration in segments and sector of lesser value added. It is worth noting that, in view of the highly unstable and weakened macroeconomic environment before the escalate inflation of years 1990 to 1994 (as seen in section 1.2), all explicit policies aimed at industrial and technological development was jeopardized and had limited impacts.

Period 1999-2006

The analysis of the innovation policy adopted in the period reveals a policy based on the existence of ‘market failures’ which was to justify a distinct intervention by the State. This assumption led to a mistaken diagnosis about Brazilian reality which, combined to the lack of

53 planning, budget and coordination between policies, and to the fact of policies being inspired on those designed and implemented by developed countries, resulted in the formulation of policies, programs and actions insufficient and ineffective, which benefited a limited number of firms in spite of the discourse of ‘horizontality’. Nevertheless, it did not affect the strategic decision by firms, once, as we will show further on, the firms which search for the available mechanisms would possibly invest in R&D independently of the existence of this policy, given their need for maintaining a competitive position in the market. Without clearly defined goals and with its main mechanisms being implemented by initiative of the beneficiary, the impacts of the policy on the strategy of the agents seem not to be significant, especially regarding innovation. As shown by IBGE’s survey on Technological Innovation, the innovation rates for manufacturing firms appear practically invariable along the periods 2001-2003 (33.3%) and 2003-2005 (33.4%). Similarly, the adopted policy was unable to influence the investment rates in the period, which stayed low (between 15% and 16% of GDP, according to IBGE). As a consequence, the productive structure did not present significant variations if compared to the former period, with the movements for acquisition of Brazilian companies by foreign companies aggravated by the privatization policy instituted by the federal government and mainly focused, in this period, on the services sector (non-tradeables). The innovation policy should be based on a national development strategy and its structure should be based on the notion that decisions by firms regarding technology and innovation are significantly dependent of the existence of such strategy. The innovation policy adopted in many countries is still concentrated on traditional models, focusing their actions on the strengths of the system, instead of concentrate action on new elements and new fronts of growth. Concomitantly to this point, it is remarkable that the whole logic surrounding innovation policy instruments and implementation in the period of 1994 – 2006 disregarded the systemic vision of the innovative process. The new policies for industrial and technological development must be considered with reference to the new knowledge on innovative process. The analysis of instruments and implementation of the innovation policy has always been focused on scientific and technological institutions and on the enterprises, at most, on the articulation and interaction between these two agents of the innovative process. Thus, other fundamental institutions for the innovative process have been excluded from this logic, and even the governmental institutions which take part in this policy were not considered. Furthermore, the required process of coordination and interaction that must be established between the institutions did not occur. Finally, despite these evidences, in 2007 we can only observe the continuity of this policy, which is still based on the incentive to R&D within firms and stimulus to the establishment of partnerships between universities and enterprises, by means of concession of fiscal incentives and financing for projects of R&D. This policy is based on those instruments created in previous years: tax incentives, sectorial funds, economic subventions and interest rates equalization. Still worth mentioning are the impacts of the implicit policy which, in the period immediately following the adoption of Plano Real (from 1995 to 1999), in spite of the great accomplishment of controlling inflation, kept interest rates at levels extremely high, besides keeping an overvalued exchange rate, what jeopardized the Brazilian industrial and technological development. From 1999 on, the need for meeting the inflation goals set up by the Central Bank has determined the establishment of interest rates, generally high if compared to international parameters, in detriment to the decisions on investment by the business system. The new process of appreciation of the exchange rates, initiated in 2006 (due to both internal and external factors) has also conditioned decisions and actions by the microeconomic agents and influenced the potential

54 impacts of explicit policies.

5.3 Financing Innovation

5.3.1. Main Instruments to Promote Innovation Adopted in the Decades of 1990 and 2000

The main instruments form promoting innovation adopted in the decades of 1990 and 2000 have been tax incentives to R&D, sectorial funds, economic subventions and the equalization of interest rates. The incumbents of implementing such instruments were the Ministry of Science and Technology and its operating agencies, the National Council for Scientific and Technological Development (CNPq) and Studies and Projects Financing Agency – Finep.

5.3.2. Main Problems and Results Obtained from the Implementation of Instruments for Financing and Fostering Innovation

The major ‘outcome’ from the implementation of instruments for financing and fostering innovation has been the recognition of the relevance of the issue ‘innovation’ as an object of economic policy making in the ambit of the federal government. However, besides this ‘outcome’, very little can be added regarding results properly speaking, especially regarding the capacity to change the strategies of microeconomic agents. The literature confirms that, in spite of being largely used in most of the world’s countries (with the noteworthy exception of United Kingdom), the detailed analysis on the eficacy of such incentives suggests that they constitute, at most, a secondary element of support in public promotion of innovation. At the end of the 1990’s, some mechanisms began to be implemented aiming at promoting the relations between the productive sector and the research infrastructure, particularly as of the institution of sectorial funds. The creation of these funds held the merit of substantially enhancing the capacity for funding the S&T system. However, the instruments available in the scope of MCT and its agencies for application of the new resources are bound to rules and practices that make difficult to promote the synergy between S&T system and productive sector. As it seems, the mechanisms and instruments made available for promoting innovation are still directed to the strengthening of the research infrastructure of the country Such mechanisms seem to be based on the linear vision about innovation (which suggests the existence of a technology “supply” in the research institutions to be absorbed by a “demand” existing in the productive sector); the programs do not consider that firms, when interacting with the R&D infrastructure must have a strong basis and develop internal capabilities for R&D activities. Such capability building is a necessary condition for the establishment of cooperation and must be one of the main axes of governmental programs and actions. Furthermore, this vision does not take into account the changes happened in the scope of the Evolutionist School, where the innovation process is understood as a systemic process that is not restricted to the enterprise, although this latter is to be the locus of innovation, or to the enterprises and universities. In the broad vision of the national system of innovation, the innovative process involves, in addition to the production sector (subsystem production / innovation) and to the scientific and technological infrastructure (subsystem of capabilities building, research and technological services), other agents such as the government and professional and business organizations (subsystem of representation, public policies, promotion and financing) and

55 consumers (subsystem of demand), as well as the context in which it is inserted configured by the geopolitics and by the social, political, economic, cultural and local contexts.

5.4 Regulation

5.4.1 Sectorial Regulation

The restructuring process of infrastructure sectors in Brazil followed the trend initiated in developed countries and, in some cases, was inspired on the models for sectors’ reorganization in those countries. According to this trend, the governments of the periods 1995-1998 and 1999-2002 implemented a set of constitutional reforms with the objective of restructuring the infrastructure sectors and put an end to state monopolies. The restructuring processes involved the liberalization of these sectors to the private capital, the privatization of state monopolies and the creation of sectorial regulatory agencies. In the cases of the telecommunications, energy and channeled gas sectors, the monopolies have been extinguished and the companies privatized; and, in the case of the oil sector, Petrobras monopoly was just made less rigid. In what respects to the regulatory agencies, a set of sectorial regulatory agencies was instituted aiming at the organization and regulation of the following sectors: energy, oil and gas, telecommunications and terrestrial transport. The restructuring process of infrastructure sectors assumed distinct forms. Agencies were in general created a little before privatization or even after the beginning of the privatization process. The processes of liberalization and privatization of infrastructure sectors have been speeded up and headed by interests of the World Bank, and that these are the grounds why regulatory agencies ended up becoming the “bad copies” of institutions that, in their origin, aimed at introducing important elements of political, technical and administrative rationality in the state processes of economic regulation. Unlike Brazil, where the objective of the restructuring process of infrastructure sector was reducing the State’s capacity of intervention on the economy, in the case of USA, the main goal of reforms was strengthening the state action against the private firms which had become excessively strong. In a general manner, regulatory agencies instituted in Brazil were characterized by a great diversity and heterogeneity in their legal frameworks. Moreover, along the latter years, the precariousness of instruments of the regulatory agencies became evident, as well as the risks of capture by agents of the market and the difficulties for controlling both agents and regulated services. In some cases, these difficulties are related to the lack of financial resources by the agencies. The initial resources of the agencies for sectorial regulation are very different from that effectively received by the agency for its expenditures. Along their existence, regulatory agencies have been passing through processes of reformulation of their role and their institutional organization and, in some cases, the regulatory frameworks are being reviewed because of either technological changes or changes in the competition processes. During the periods of 1995 to 1980 and 1999 to 2002, the role and the function of regulatory agencies was, among others, to develop and formulate policies for the regulated sectors. However, there was no legal provision allowing agencies to absorb the activities of policy making; such absorption happened for omission and disorganization of the incumbent ministries. In view of the lack of human resources, the lack of technical capability and the omission of the ministries, the regulatory agencies started not only to regulate and control the respective sector, as also to formulate public policies.

56 The beginning of the government in the period 2003-2006 is marked by a criticism to the range of the roles performed by the regulatory agencies. The main focus of criticisms made by this government to the agencies was related to the granted power for formulating and implementing sectorial policies. As of 2003 this situation has been modified and the government changes its orientation in the sense that the ministries responsible for each sector should take back their role of sectorial policy makers. This orientation originated a broad debate in what respects to the division of attributions between regulatory agencies and ministries, and resulted an effective change in the process of formulation and implementation of policies which started to count on the active participation of the competent ministries. The definition of the roles of ministries and agencies is still being formed.

5.4.2 Regulation of Intellectual Property

An interactive relation between the technical-economic paradigm and the institutional organization of the society is observed. For each historical period there is a corresponding particular form of interaction, from which emerges an also specific modality of appropriation of the gains resulting from technological innovation. The technological paradigm characteristic of the learning and knowledge economy, especially the development of technologies of information and communication and biotechnologies, has brought the consolidation of more restrictive and sophisticated mechanisms of appropriation, which institutionally had their bases defined by the Agreement on Intellectual Property (TRIPS) signed at the Uruguay Round of GATT, in 1995. Having patents as an outstanding instrument, the current regime of intellectual property imposes hindrances to the previously exiting conditions for the formulation of appropriate legislations, articulated to the needs of the process of building national system of innovations, particularly relevant for countries as Brazil. Nevertheless, TRIPS left a certain margin of freedom for each country to define its understanding of the general requirements of the Agreement and to consolidate them into a national legislation. This opens some breaches for less developed countries to explore the “gray” areas of the agreement and include flexibilities in their national legislations. In Brazil, intense debates have marked the issue of intellectual property during the nineties. The liberalizing view prevailed in that period and the option fell on the stream that offered less resistance, surrendering, thus, to the pressures by holders of intellectual property from developed countries and to threats of bilateral commercial retaliation. Therefore, the regulation of TRIPS, was made in haste and disregarded some mechanisms allowed by TRIPS that could bring benefits to the country’s technological development. Hence, in spite of having until year 2000 for adopting a national legislation in conformity with the agreement, and until 2005 for conceding patents for products that were nor included in the system of intellectual property of the country (among which, medicines), the Brazilian law on intellectual property was approved as soon as in 1996. The country wasted, thus, the transition period of 10 years for adapting the productive sectors and those of science and technology to the new context. In addition, Brazil has instituted instruments that exceeded requirements of TRIPS, such as the mechanism of “pipeline”, and concurrently failed to include the mechanism of parallel imports allowed in the agreement. The results of these changes in the Brazilian regime for protection to patents do not confirmed expectations and arguments of their advocates. The available national statistic on patents for the period 1995-2006 show a relatively low number of concessions of new patents to both residents and non-residents (demonstrating decrease in dynamism in the innovation process), a significant raise of

57 requests for privilege of invention by foreigners (and insignificant for residents), besides the low increment of requests for patents and and inventions deposited abroad by Brazilian residents. The evaluation conducted by Elias (2004) on the results of the use of intellectual property as a stimulus to technological development and to the innovative capability of Brazilian pharmaceutical industry, reveals outcomes equally unfavorable: in spite of the changes in the regime, the tendency of national enterprises to register patents remained low and the pattern of reduced technological development performed locally by subsidiaries of multinational companies also remained unchanged. As for the contracts for technology transfer, the study demonstrates that only the category of brand use (which does nor imply knowledge acquisition) has been relevant. However, if on the one hand the change in the regime of appropriation did not bring the announced benefits, on the other it has been posing restrictions to the implementation of policies that are necessary for strengthening the national system of innovation. The system of innovation in health, taken as an example in the present study, is a relevant case , where patents have put hindrances to the development of the national pharmaceutical industry, with strong repercussions on public health. Among others reasons, because of the raise of costs and of the volume in imports of antiretroviral medicines protected by patents, which have been threatening the policy of universal access to medicines of the National Program on STDs/Aids. Consequently, it is necessary to review the emphasis given to interests of the advanced countries by the government in the nineties, looking for constituting a system of patents that fit to the specificities and needs of the Brazilian innovation system, aiming at a new balance between incentive to endogenous innovation and the full use of new knowledge and innovations internationally available. Albuquerque (2007) suggests three fundamental elements for pursuing this objective. First of all, the search for arrangements more favorable to the dissemination of technologies in the country and to the creation of incentives for protecting adaptations and incremental innovations, crucial elements for the process of catching up. Secondly, the legislation of patents must be compensated by a simultaneous development of an anti-trust legislation, able to restrict the power of monopoly assured by patents. Thirdly, administrative structures and enforcement institutions must be organized so that to enable a qualified intervention in processes of international negotiations. With this latter objective, the author emphasizes the necessary articulation between state bodies responsible for the concession of patents; state bodies of regulation of economic activity and antitrust policies; and Brazilian negotiators at international forums. These elements may help to compensate difficulties introduced by the pattern of protection to intellectual property prevailing in the international ambit. However, they must be complementary to efforts for the constitution of internal capacity for technological absorption, the basis for building a national system of innovation, and also must be inserted in a strategy for development consistent with the national specificities and priorities, among which the search for inclusion of the groups currently excluded from the exercise of fundamental rights and citizenship.

5.4.3 Environment Regulation

It’s usually argued that environmental regulation decreases the competitiveness of national products with respect to countries with such regulation. This perspective is associated to the idea that polluting would be unavoidable if it is to assure industrial growth and economic development, and this reasoning was implicit during the whole industrialization process. The strategy of growth associated to industrialization through imports substitution ended up benefiting sectors that are

58 emission intensive for, although Brazil has advanced in the consolidation of a diversified industrial basis, such advancement has been supported on the indirect use of natural resources (energy and cheap raw-materials). In the last 30 years, there has been a strong expansion of industries of great polluting potential – particularly in the complexes metallurgical and chemical/ petrochemical – without the required control for treatment of these emissions, suggesting a relative specialization in sectors potentially “dirty”. Brazil still bases its development on traditional commodities (raw materials of natural origin) and industrialized products characterized by high intensity of energy consumption and other natural resources (thus, tending to be more “dirty”). Several studies reveal that the main incentive to industries for investing in environment is the legal requirements. This evidence reinforces the importance of implementation and consolidation of environmental regulation, for inducing environmental investments by the firms. The central question is to identify how the environmental regulation currently affects competitiveness of firms. The Brazilian environmental policies have not succeeded in the sense of allowing firms to improve their competitive performance and concomitantly to reduce their environmental impact. Firms that change their production on the grounds of environmental regulations did not increase their probability to enhance economic performance. Firms which spontaneously performed environmental innovation got to develop capabilities that yielded a positive relation with competitive performance. This result further reinforces the thesis that the environmental policies in Brazil did not incorporate efficiently the aspects related to competitiveness of firms. The environmental policy in Brazil has used instruments of command and control (CC). These are characterized by direct regulation on the locals that emit pollutants and determine that all firms reach the same level of pollution irrespectively of costs involved. Once the firm reaches a particular standard required, the Brazilian environmental regulation discourage the search for new environmental technologies, reducing the possibilities of technological advancements related to the environmental matter. It may be observed, also, high costs of the policy of command and control, which requires a continuous inspection on the part of the regulatory bodies.

59 2RUSSIA’S INNOVATION SYSTEM IN TRANSITION -BRICS NATIONAL INNOVATION SYSTEMS

Gokhberg, L.;Gorodnikova, N.; Kuznetsova, T.; Sagieva, G.; Sokolov, A.; Zaichenko, S.

1. Geo-Political, Social, Political, Economic, Cultural & Local Contexts

1.1. Geo-political context

The Russian Federation is the largest country in the world. Russia has the world's greatest reserves of mineral and energy resources, the largest forest more than one-third of the world’s fresh lake water. Russia has access to three oceans. Only 13% of surface is suitable for farming. Russia’s climate and soils are mostly not favourable for agriculture and industrial activities. That’s why the population, the 9th largest in the world, is concentrated in several regions leaving large areas almost unpopulated. Large area of the country and population distribution imbalance cause considerable difficulties in development of infrastructure and governing system. On the other hand, Russia has 16 neighbouring states with border length of more than 60 thousand km. It determines extensive economic, trade, financial, cultural, and scientific relationships. Seas considerably extend trade linkages: with a coastline of over 37000 kilometers along three oceans. Today the most important feature of the Russia’s geopolitics is energy carriers production and distribution. The Russian Federation has the largest known natural gas reserve, along with the second largest coal reserves, the world's second largest oil producer and the eighth largest oil reserves. It is the world biggest natural gas producer and also the biggest exporter with 24.0% of global natural gas export (International Energy Agency, 2006). The state-controlled Gazprom and Rosneft companies consolidate the major part of natural gas and oil resources in the country, consumed domestically and exported: in 2006 Russia supplied over 25% of Europe's oil and over 40% of its gas.

1.2. History matters

Russia has a long history but the Russian Empire became a world power for the fist time only under the Romanov dynasty and Peter I the Great, who ruled from 1682 to 1725. In 1724, Peter founded the Russian Academy of Sciences and Arts – the first official entity in Russia performing R&D on the regular basis. In 1755 the Moscow State University (the first university in Russia) was founded. Catherine II (Catherine the Great), who ruled from 1762 to 1796, continued the efforts to establish Russia as one of the Great Powers of Europe. Industrialization wasn’t possible before

2 Higher School of Economics Institute for Statistical Studies and Economics of Knowledge –Draft country report 18, Myasnitskaya str., 101000, Moscow, Russia Tel.: (7-495) 621 28 73 Fax: (7-495) 625 03 67

60 Alexander II (1855–1881), who enacted significant reforms, including the abolition of serfdom in 1861. Alexander II also carried out significant reforms in science and education. However, many socio-economic conflicts were aggravated during Alexander III’s reign and under his son, Nicholas II. It was the period of the revolutionary socialist movement beginning. The failure of the Tsar's military forces in the initially-popular Russo-Japanese War, and the event known as "Bloody Sunday" (suppression of workers’ peaceful demonstration), ignited the first Russian Revolution in 1905, which was dismantled but led to some political reforms. In 1914 Russia entered World War I. Although the army was far from defeat in 1916, the already-existing public distrust of the regime was deepened by the rising costs of war, casualties (Russia suffered the highest number of both military and civilian deaths of the Entente Powers). This set the basis to the October Revolution, led by Vladimir Ulyanov (Lenin), overthrew the Government and created the world’s first Communist state. Following the October Revolution, a civil war broke out between the new regime and the Socialist Revolutionaries. The Treaty of Brest-Litovsk concluded the World War I for Russia. It lost its Ukrainian, Polish and Baltic territories, and Finland by signing the treaty. By the end of the Civil War, some 20 million had died and the Russian economy and infrastructure were completely devastated. Following victory in the Civil War, the Russian SFSR together with three other Soviet republics formed the Soviet Union on December 30, 1922. The Russian Soviet Federative Socialist Republic dominated the Soviet Union for its entire 74-year history; the USSR was often referred to as "Russia" and its people as "Russians." Russia was the largest republic of the USSR and contributed over half the population of the Soviet Union. After Lenin's death in 1924, Joseph Stalin took power. He launched a centralized command economic system, rapid industrialization processes and collectivization of agriculture. During a short period the Soviet Union was transformed from an agrarian society to a powerful industrial economy. However millions of Soviet people died as a consequence of Stalin’s harsh policies. The basic elements of the Soviet R&D system were set up after 1917. The political objectives of accelerated development of R&D to serve military requirements and the industrialization of the economy led to strengthening existing research institutes and establishing new ones. Universities responded to political directives aimed at tailoring higher education for the masses and the training of "proletarian specialists," particularly engineers. Universities, where the most prominent Russian scientists carried out both training and research, now became almost exclusively training centers with relatively little R&D activity. Thus, contrary to the pattern of R&D growth taking place in Western universities and industrial enterprises during the interwar period, Soviet R&D was increasingly concentrated in research institutes of the Academy of Sciences and of the industrial ministries. The overall growth of the sector was unmistakable. From 1922 to 1940 employment in the Science and Scientific Services sector increased more than ten times, and its share in total employment increased from 0.6 percent to 1.1 percent. Intensive investment was made in R&D facilities and equipment, and it became possible to carry out research in the most important areas of science and technology. On June 22, 1941, the Soviet Union entered the Second World War. The Soviet economy and infrastructure suffered massive devastation after the war, but the Soviet Union emerged as an acknowledged superpower: the Red Army occupied Eastern Europe after the war, including the eastern half of Germany; Stalin installed communist governments in these satellite states. During World War II the Soviet R&D system demonstrated its ability to mobilize R&D for the production and improvement of weapons. The defense R&D complex was formed during World

61 War II and accelerated the growth of total R&D. By 1950, employment in the “Science and Scientific Services” sector was 82% higher than in 1940. Becoming the world's second nuclear weapons power, the USSR established the Warsaw Pact alliance and marched into the Cold War. After Stalin's death, the subsequent Russian leader Nikita Khrushchev denounced Stalin’s regime and eased his repressive policies. It was a period remembered for some victories in the space race – the first artificial satellite and the first cosmonaut – and for the “Caribbean crisis”, the peak of the Cold War. The next period of the Soviet history was characterised by slow economic stagnation under Leonid Brezhnev leadership. In 1985 the first Soviet president Mikhail Gorbachev announced a new course of development. His new policies were based on “glasnost” (openness) principle and “perestroika” (restructuring) reforms. These policies did not prevent the collapse of the Soviet economy and the eventual dissolution of the USSR into 15 independent republics, in 1991, under Boris Yeltsin, who became the Russian president. In the 1950s, 1960s, and 1970s the R&D sector continued to expand; by 1990 R&D personnel exceeded 2.8 million. The expansion of R&D was largely in employment rather than in equipment and facilities, but the applied R&D organizations remained separated from production. About half of the R&D effort was for military purposes. The 1980s, however, was a decade in which the Soviet R&D sector lost much of its dynamics, and the indicators of R&D inputs and outputs showed decline due to the inefficiency of the centrally planned Soviet R&D and to the economic slowdown. The transition to a new regime, which started officially in 1991, caused a major crisis, including a 50% decline in GDP from 1990 and 1995. Millions people were plunged into poverty. Russia took up the responsibility for settling the USSR's external debts, even though its population made up just half of the population of the USSR at the time of its dissolution. The long depression was coupled with social decay. Social services collapsed and the birth rate plummeted while the death rate considerably increased. One more disaster happened in 1993 when a constitutional crisis resulted in the worst civil strife in Moscow since the October Revolution. And in 1994 the first Chechen war started. All these shocks developed into deep socio-economic crisis. In the late 1990s high budget deficits and the 1997 Asian Financial Crisis caused the financial crisis of 1998 and resulted in further GDP decline. It was the last economic shock in Russia till nowadays. In the R&D and education spheres these trends resulted in a major downsizing accompanied by a fall of the prestige of R&D and education careers (caused in part by the decline in real wages, especially when compared with the business sector). In public opinion surveys, the prestige of scientific activity was considered fairly low among persons with higher education, especially those under 40. High oil prices and initially weak currency followed by increasing domestic demand, consumption and investments helped the economy to grow for nine years, gradually increasing the quality of life. Therefore the period from 1999 to present time may be considered as time of stability and socio-economic recovery.

1.3. Social, Political & Economic context

The contemporary socio-economic situation in Russia is rather contradictory. In 2007 Russian GDP (PPP) was at the same level as in the UK or France. Russia ranked third after China and India among the BRICS countries by GDP PPP, and it had the leading position by GDP PPP per capita in 2005. HDI is also at “high” group.

62 At the same time some key social indicators remain low. More than 13% of population stays below the poverty level; average pension is below the subsistence wage; the sickness rate is more than 76%; the life expectancy accounts for 66.6 years – about 10 years shorter than the overall figure in the European Union. Slow but positive dynamics of these indicators gives grounds for optimism. The Russian Federation is a diverse, multi-ethnic society, homeland to as many as 160 different ethnic groups. Though Russia's population is comparatively large, the population density is low because of the country's enormous area. Population is densest in European Russia, near the Ural Mountains, and in the southwest Siberia. At the same time in Russia exist huge areas almost with no population. 73% of the population lives in urban areas. Russia's population peaked in 1991 at 148.689 million. It was more than 6 million higher than in 2007. The number of deaths was greater than the number of births. The primary causes of Russia's population decrease are a high death rate and low birth rate. While Russia's birth-rate is comparable to that of other European countries, its population declines at much greater rate due to a substantially higher death rate compared3. The health issue is regarded to be the basic element of the current demographic problems in Russia. Although the Russian Constitution guarantees free, universal health care for all citizens, free health care is actually restricted due to very poor quality and local registration regime. Russia has more physicians, hospitals, and health staff than almost any other country in the world on a per capita basis, since the collapse of the Soviet Union the health of the Russian population has declined considerably as a result of social, economic, and lifestyle changes. As of 2007, the average life expectancy in Russia is 61.5 years for males and 73.9 years for females. The biggest factor contributing to this relatively low life expectancy for males is a high mortality rate among working- age males from preventable causes (e.g., alcohol poisoning, stress, smoking, traffic accidents, and violent crimes). Mortality among Russian men rose by 60% since 1991, four to five times higher than in Europe. In an effort to stem Russia’s demographic crisis, the government is implementing a number of programs designed to increase the birth rate and attract more migrants to alleviate the problem. The government has doubled monthly child support payments and offered a one-time payment of about US$10,000 to women who had a second child since 2007. In 2007, Russia saw the highest birth rate since the collapse of the USSR. The economic situation improvement is an important factor for solving the demographic problem. Since the turn of the century, rising oil prices, increased foreign investment, higher domestic consumption and greater political stability have bolstered economic growth in Russia. In 1998-2007 the average annual growth rate accounted for 7%. In 2007, Russia's GDP was the 7th largest in the world, with GDP growing 8.1% from the previous year. Russia has the world's largest natural gas reserves, the second largest coal reserves and the eighth largest oil reserves. It is the world's leading natural gas exporter and the second leading oil exporter. Since 2003, however, exports of natural resources started decreasing in economic importance as the internal market strengthened considerably. Despite higher energy prices, oil and gas only contribute to 5.7% of Russia's GDP. Russia also stays ahead of most other resource-rich countries in its economic development, with a long tradition of education, science, and industry. The country has more higher education graduates than any other country in Europe.

3 However, the Russian health ministry predicts that by 2011, the death rate will equal the birth rate due to increases in fertility and decline in mortality. 63 A simplified tax code adopted in 2001 reduced the tax burden on people and SMEs, and considerably increased state revenue. This is the second most attractive personal tax system for single managers in the world after the United Arab Emirates. Oil export earnings have allowed Russia to increase its foreign, the third largest reserves in the world. The foreign debt was also reduced. The economic development of the country though is unbalanced geographically. The Moscow region contributes a disproportionately high amount of the country's GDP. The rest of Russia, (especially Siberia), stays significantly behind. Over the last five years, poverty has declined steadily and the middle class has continued to expand. Russia has also improved its international financial position since the 1998 financial crisis.

1.4. Cultural aspects

Historically, the dominating position in Russia is occupied by the culture of Russian language and Russian nationality; this is partly because Russians constitute the vast majority of the population in the country, and partly because many times in the History of Russia the cultures of other nationalities were suppressed through russification. Ethnic Russians have predominantly followed the Russian Orthodox Church. Even under Soviet mandatory atheism, over one-third of the country's people remained religious. Cultural policies in the USSR were mixed, as some aimed at creating an unified Soviet culture while others tried to preserve national cultures. Arts were characterised by the rise and domination of the government-imposed style of Socialist realism. During the Brezhnev era, a distinctive period of Soviet culture developed. It was characterized by conformist public life and intense focus on personal life. In the late Soviet Union popular culture was significantly influenced by American popular culture.

1.5. Regional & local characteristics

Russia is divided into several types and levels of subdivisions from autonomous Federal subjects to dependent sub national entities of various names. Russia is a federation which consists of 83 subjects, with different levels of autonomy, which are grouped into federal districts. These are a level of administration for the convenience of the federal government of the Russian Federation. Russia is also divided into twelve economic regions. This division into economic regions is different from the division into federal districts – the former is done solely for economic and statistical purposes, while the latter is totally administrative. The regional disparities in Russia are evident with a simple comparison between the Moscow city and the Far Eastern Federal District (the largest federal district with area of 6215900 km2): Moscow is 1.6-fold greater in population, 3-fold – in income per capita, 4-fold – in GRP and 6-fold – in number of enterprises. Actually Moscow with population of 10383 thousand people is an atypical region of the country, covering 1/5 of the total GRP and 1/4 of the total enterprises. The same trend can be seen in sphere of innovation. However in this distribution Moscow is not leading but is still comparable with other federal districts.

64 2. Sub-System: Production & Innovation

2.1. Structure of economic activities

Today the most important challenge for the Russian industrial system is adaptation of its economic proportions for requirements of internal and external markets. Industrial sector is also the first element of the “Triple Helix”, joining industrial, academia and governmental communities. Economic activities related with high technology tend to be the key driver of growth in knowledge- based economy. Since 1999 almost all production activities in Russia performed growth. However the rates of growth are different depending on type of activity. The highest rates are typical for mining and quarrying (annual growth rate 6%) and especially oil and gas mining (6.5% annual growth). This growth is stimulated by high export capabilities. Inside the manufacturing activities group the highest growth rates can be seen in the high-tech cluster (including manufacturing of aircraft and spacecraft). In 2000-2006 share or high-tech manufacturing output almost doubled. Medium low-tech activities perform the highest share of output: steadily around 30% in the past years. This group includes refined petroleum and nuclear fuel. Outside the medium low-tech activities about 23% of output comes from mining and quarrying. In this group of activities 89% refers to energy producing materials. Compared to EU economies, Russia performs relatively low share in the national manufacturing system.

2.2. Sectoral distribution

The Russian economy is still commodity-driven. Payments from the fuel and energy sector in the form of customs duties and taxes accounted for nearly half of the federal budget's revenues. The large majority of Russia's exports are made up by raw materials and fertilizers, although exports as a whole accounted for only 8.7% of the GDP in 2007, compared to 20% in 2000. The primary sector of the Russian Economy forms 13% of GDP (14.8% of the gross national value added) and is mostly represented by the oil and gas mining and agriculture. The oil and gas industry of Russia is one of the largest in the world. It amounts to 10.2% of gross value added. Russia has the largest reserve, and is the largest exporter, of natural gas; the second largest coal reserves, and the eighth largest reserve, and is the second largest exporter, of oil, but it’s also a great consumer. The Russian oil industry is in need of tremendous investment, although the currently high oil prices mean that there are resources available for financing the upgrades needed. The share of Russia's agriculture in GDP has remained below 6% since, much lower than the average for the other countries of the Commonwealth of Independent States (17% on average for the 12 CIS countries). The share of agricultural employment is relatively high at 16% of the total number of employed, but this is also substantially lower than in other CIS countries (around 40% on average). The disproportion between the share of agriculture in GDP and its share in employment suggests that the productivity of labour in Russia's agriculture is below the average in the economy. The secondary sector, composed mainly by manufacturing and construction, contributes 24.2% of GDP (27.4% of the gross value added). Four main activities accounting for 67.3% of all manufacture are coke and refined petroleum products (17.8% of the total manufacture product value), metallurgy (19%) machinery including manufacture of electric and non-electric machines, automobile industry etc (15.5%) and food and beverages (15%).

65 The tertiary sector represented by services is about 51% of GDP (or 57.8% of the gross national value added) – trade alone responds for 34%. Education services amount only about 6.8% of the total services value. Investment is a basic factor of the innovation-driven growth. Foreign investment in Russia is very low, specially because of an underdeveloped stock market. The first rise since 1990 was in 1999. The next significant growth phase started in 2003 and lasted till 2006. During the last decade portfolio investment share remained low (about 1-2%) and the nominal value did not change regardless the total growth in investment. In 2006 the situation changed dramatically with 6-fold increase of the portfolio investment share. It is also important to discuss the ICT, one of the most dynamic sectors of the Russian economy. Russian software exports have risen from just $120 million in 2000 to $1.5 billion in 2006. Since 2000 the IT market grew about 40% a year. Today Russia covers about 3% of the offshore software development market and is the third leading country (after India and China) among software exporters.

2.3. Spatial distribution

As mentioned above, Russia has great regional disparities. Under the USSR, regional development policies can be determined as “equality-targeted”. Regions were regarded as specialised industrial and the main political objective was to ensure an equal development of the national industrial economy. This equality was based on promotion of less developed clusters and slowing down more developed ones (which were called “economic donors”). But the post-Soviet regional challenges were determined by new factors: - new geopolitical space after the USSR breakdown; - transition from the planning economic system to the market economy; - opening of the national economy towards the world markets; - new mechanisms of budgetary and administrative interaction between the center and the regions; - changes in regional division; - “new urbanism” – transition from industry-targeted urban development towards socially- oriented one. According to experts, the equality-targeted policies became outdated and inefficient. The new regional development concept is based on the “polarized growth” principle. The main idea is that human and financial resources should be concentrated in the most developed areas (centers of growth) instead of being redistributed between depressed regions. The new economy and innovation should spread from these centers of growth to the rest of regions in the future. The polarized regional growth model however presupposes several “locomotion region” types: - Innovation-based growth zones, with world-level R&D and education, are the places where innovation begins. - Transfer zones: technology transfer from the innovation-based growth zones or abroad based on high investment and advanced industrial infrastructure.

66 - World cities: highly developed urban zones specialized in quartering of multinationals; they are centers of business and administration. At the same time “the rest of the country” is also represented by different type of regions: - Security zones: potentially dangerous regions (e.g., due to conflicts) where any tensions may cause severe consequences for the whole country. - Extractive zones: source of natural resources for the national economy, highly specialized, lacking in infrastructure. Particularly vulnerable to shocks. - Depressive industrial zones: characterised by outdated infrastructure and technical base, low human resources level, isolation from the markets, population drain. - Primary industrialisation zones: perform social, economic and ethnic isolation staying behind in terms of health, education, infrastructure and urbanisation. Nowadays official regional policies are aimed at creation and development of locomotion regions, first of all innovation and transfer zones. This typology is rather relative concerning that any region has its strengths and weaknesses. At the same time there is no any actual “locomotion-type” region in Russia by now but relatively successful regions. However, today official regional policies are aimed at creation and development of locomotion regions, first of all innovation and transfer zones. One of these activities is known as the Special economic zones project described in the section on policies below.

2.4. Employment

In 1999-2000 employment market climate in Russia was mostly favourable, as both employment and real wages grew. This growth of the main indicators was influenced mostly by demographically-based increase of labour force in 1999-2006, not limited to the formal sector due to overregulation, but supported instead by the informal sector. Labour productivity growth can be noticed in all industries, but the highest rate is in mining and quarrying, which is also characterised by the highest nominal labour productivity level. Apart from mining and quarrying high productivity growth rates are performed by medium low technology manufacturing activities (4-fold growth). The lowest labour productivity as well as the lowest productivity growth is typical for the Russian high-tech sector. Labour productivity in the Russian high-tech sector is relatively low not only in comparison with other activities but also compared to other countries.

2.5. Size

The Russian economy in the late 1980s was dominated by large and medium-sized industrial enterprises with more than 200 employees, achieving 95% of industrial workforce and production. Virtually all this was state-owned. By the end of 1993, more than 85% of Russian small enterprises and more than 82 thousand Russian state enterprises, or about one-third of the total, had been privatized. The 1992 mass privatization programme divided enterprises into three categories: small enterprises (to be sold by competitive bidding or lease buy-out), large enterprises (to be converted to joint stock companies first, and then privatized through the mass privatization programme), and

67 medium enterprises (which could use either method). Some enterprises, such as most public utilities and firms in the defence sector, were exempted from this round of privatization. Today it is important to understand the role and potential of innovation activity in different types of enterprises by scale. In 2006 only about 7% of organisations performing innovation were small businesses. At the same time, the highest expenditure on innovation is performed by larger enterprises. Average annual expenditure on innovation for an enterprise with size of 10000 and more employers performing innovation is about $62.6 million PPP. But for organisations sized less than 50 this value accounts for $2.7 million PPP.

2.6. Informality

Lack of interaction between the knowledge infrastructure and the firms is the most important factor slowing down the process of learning and building competence. Informal mechanisms supporting this interaction could boost the Russian NSI development. The informal economy in Russia is far from innovation-based competitiveness building. The contemporary Russian shadow economy has its grounds from the Soviet planning system where it was a sort of substitute for entrepreneurship activities (impossible in that period). After the USSR breakdown, official institutions of economy were extremely inefficient. The created in the framework of the planning system which did not exist anymore, but at the same time they were not adjusted for the market economy operation. The early 1990s were the period when the shadow economy replaced many non-vital official mechanisms. However one should distinguish criminal and non-legal components inside the shadow economy. The criminal economy appeared as a challenge for inefficient economic, legislative and security systems. The main motivation of the criminal actors was super profit based on legal and security uncertainty. There were two main criminal powers for that period: traditional criminal groups (racket, drug dealers, “problem solving” groups, gangsters etc) and authority-criminals (officials and oligarchs using their power for criminal activities, especially economic crimes). The non-legal component of the shadow economy was not oriented towards crime but it was aimed at survival in economic environment where official mechanisms did not work. This economy was outlaws just because there were no proper regulations by the moment. The non-legal sector was represented by SMEs “gray economy” and informal transactions of self-employed actors. The contemporary Russian shadow economy has its grounds from the Soviet planning system where it was a sort of substitute for entrepreneurship activities (impossible in that period). Directors of some state enterprises can be discussed as an example of Soviet shadow entrepreneurs in the 1980s. They could not be proprietors of their enterprises but had broad credentials as well as strong informal ties with local administrations, suppliers, intermediaries etc (Popov and Tarasov, 2005). Soviet shadow economy had its exact functions related to improving or balancing of the planning economy weaknessesNowadays the shadow sector is not so large as in the early 1990s but the remaining shadow mechanisms consolidate their positions on all economic and administrative levels. Corruption perceptions is a reliable indicator of this trend. Compared to other BRICS countries Russia performs the worst corruption estimates. In 2003, it had 145th position among 180 countries by the corruption index far behind India, Brazil, China and South Africa. Innovation activity should be a natural mechanism for competitiveness building. But today the Russian economy includes much more efficient mechanisms of competition: corruption, administrative power, etc. These mechanisms give results immediately, in contrast to innovation

68 aimed at long-term perspective. Therefore high level of uncertainty in the economy makes innovation activity even more unattractive compared to the shadow economy tools.

2.7. Innovative effort

Innovation activity is the main the driving force of growth in the framework of knowledge economy. Russian industry could not overcome the shock of the middle 1990s and continues stagnating in terms of innovation activity. The percentage of innovative activities fall from almost 20% in 1993 to an average of 5% during the second half of the nineties, and stabilizing on an average of 10%since then. The problem is not only in the innovation activity but also in its efficiency. In Russia the difference between relative inputs and outputs of innovation accounts for about 6 points that makes 3-fold effect, while in other countries these figures are much higher: from 20.6 points (10-fold effect) in Greece to 54.4 points (15-fold effect). Different economic activities in Russia perform high variety in level of innovation activity. E.g. in coke and petrol industry more than 31% of enterprises perform innovation. High share of innovating organisations can be seen also in production of electrical and electronic equipment and instrument s (26.8%), transport equipment (23.8%) and chemicals production (23.5%). Therefore activities related to petrol extraction and to high-tech are characterised by higher weight of innovative enterprises. However competitive knowledge economy can grow only under condition of broad innovation spreading including such activities as agriculture, food, textile etc. Probably one of the key reasons for low innovation efficiency in Russia is the fact that Russian managers underestimate capabilities of innovation activity. Analysis shows that innovators are oriented more towards local markets and less – towards external ones. At the same time they are interested more in increasing production capacities than in cost reduction. A simple comparison can show advantages of innovation activity: innovative enterprises are just 9.4% of the total number of firms, but they perform about a half of total sales and investment. They are also more competitive on the national markets as well as on the European ones.

3. Sub-System: Capacity-building, Research & Technological Services

3.1. Education (basic, technical & graduation)

There are 7 levels of education in Russia. All they are comparable with the International Standard Classification of Education – ISCED (UNESCO, 2006). i - Preschool education (equivalent of ISCED 0 – Pre-primary education) ii- Primary general education (equivalent of ISCED 1 – Primary education) is the first full- sense stage of compulsory education in Russia (1-4 grades). A successful completion of this level is sufficient to acknowledge that the primary general education (the primary school) has been attained. iii - basic general education (equivalent of ISCED 2 – Lower secondary education) – is the second part of compulsory education (grades 5-9). Its successful completion coincides with the completion of compulsory education at general education institutions and is sufficient for acknowledging that the basic general education has been attained. There also exists a stage of complete secondary general education (10-11(12) grades at general education institutions). The

69 lower vocational education is included in this level irrespective of whether or not the students have received a certificate of secondary (complete) general education. This stage is an equivalent of ISCED 3 – Upper secondary education. After these grades, citizens can continue their learning by two ways: secondary vocational education (ISCED 5B – Tertiary-type B education) and higher education (ISCED 5A – Tertiary- type A education). The second one provides possibility of obtaining postgraduate education (ISCED 6 – Advanced research programmes). The Russian education system was originally inherited from the Soviet Union without any significant changes. Education was free at all levels in the Soviet system, which explains the high number of Russians that hold 6-year degrees (20%). After the collapse of the USSR, the system could not be funded anymore, and private education spread. Russia’s enrolment in basic and secondary education is comparatively not high. In 2005 it accounted for 778 students per 10000 population. It is 1.6-fold lower than in Australia and 2-fold lower than in the UK. The difference between basic general and secondary education enrolment in Russia shows a certain demographic decline. Performance of the basic education can be illustrated by PISA survey, which place Russia at middle-lower positions. A higher education institution (HEI) is defined as an organisation providing higher professional education in accordance with the state accreditation4. Today, the country has 1304 HEIs – roughly half of them are governmental institutions. After obtaining a Certificate of Complete Secondary Education a student can enter a University or an Institute (College). A student can choose a program of higher education with duration of four to six years. There are three different degrees that are conferred by Russian universities: The first degree is the Bakalavr (Bachelor) degree. Bakalvr's programs last for at least 4 years of full-time university-level study. Holders of the Bakalavr degree are admitted to enter the Specialist Diploma and Magistr's (Master's) degree programs. The Magistr's (Master's) degree is awarded after successful completion of two years' full-time study. Although secondary vocational education is also enough to obtain a blue-collar job, enrolment rate at this level is 2.7-fold lower than in higher education – which seems to be an international trend. At the same time Russia is one of the leading countries by secondary vocational and higher education enrolment per 10000 population. Teaching staff capabilities are decreasing as professors concentrate on teaching instead of academic activities: the share of professors performing R&D decreased from 32% to 17%. At the same time, education staff is becoming older: the average age of the teaching staff in HEIs is also approaching 60-years value. Average monthly salary in the higher education sector during the period of 1995-2005 accounted for 63-65% of the national economy average level. Low salaries are a result of the lack of funding in the higher education sector. In Russia this funding is about 3.7 thousand $ PPP per student, which is 3-5 times lower than in some OECD countries. It is also possible to notice that Russia presents very low R&D activity in HEIs compared to other countries. Low salaries and lack of funding as well as poor motivation and formalism of teachers make the higher education system in Russia less and less competitive. In 2006 only 13% of

4 There exist three types of HEIs: universities (multidisciplinary HEIs performing education programmes and research in multiple domains of knowledge), academies (focused on particular areas, such as agriculture, health, arts etc), and “institutes” (HEI providing education services in certain narrow areas). 70 the population mentioned the science and higher education institutions as a key driver of the national economic growth, whereas for instance 39% put natural resources in this category. A professor’s career was regarded as prestigious only by 8%. On the other hand there exists a strong opinion that universities and university networks need to be developed. 79% of the respondents said that state support of universities should be considerably increased. 36% believe that promotion of the higher education sector and its integration with other spheres of social life should be one of the official priorities.

3.2. Post-graduation

After Specialist's or Master's degree, a student may enter a university or a scientific institute to achieve postgraduate education. This degree is roughly equivalent to the Ph.D. in the United States. After that, a student may go on to reach a doctor of sciences degree – usually after ten years, and most new doctors are at least 40 years old. A candidate may hold the position of assistant professor, or associate professor in universities and of researcher or senior researcher in scientific institutes. Doctor of sciences can hold position of full professor or head of laboratory. Despite considerable higher education enrolment rates, post-graduate enrolment is not so intensive in Russia. It accounts only to 10 students per 10000 population or 2% of higher education enrolment. The postgraduate and doctoral courses distribution shows that HEIs are much more involved in postgraduate and doctoral programmes than research institutes. This difference is a result of traditional gap between these two groups of institutions in Russia: research institutes are mostly not specialised in education activities. There also exists a difference between total graduation and graduation with a dissertation defended: in HEIs successful defense is more probable (this fact can be related with difference in quality of dissertations).

3.3. R & D

The primary focus of the Russian NIS is R&D, not innovation, as it’s biased towards legally independent researches separated from both education and industry. Taken together with specialized design organizations they account for 69.9% of the total population of R&D-performing units and contribute with 85% and 83% of R&D personnel and expenditure, respectively. The shares of HEIs and industrial enterprises among other R&D institutions are as low as 12% and 7%, respectively. It is explained by an increasing number of research institutes (until 2002), as large institutions were dismantled into smaller ones after the collapse of the USSR. Another important factor affecting the Russian NIS is a still existing wide research front inherited from the former USSR, established under the conditions of long-term political and economic autarky. Accordingly, the Soviet S&T sector incorporated practically all research orientations. For the development of new scientific areas the government used to multiply the number of R&D units. However, this system emphasised the areas that met primarily the requirements of the military and considerations of political prestige as well as needs of heavy industry. Though R&D funding flows in Russia have increased twofold in real terms during 1995-2006, being expressed as a percentage to GDP it is still at low 1.07% (1.05% in 2000). At the same time the output indicators continue to decline. For the number of scientific articles published in SCI journals, Russia moved to the eleventh place (2.4% of the world total) from the seventh line in 1995

71 and the third one occupied by USSR in 1980. Exports of technology are still low when compared to developed countries. The ratio of public and private investments in R&D gives a clear picture of the Russian national S&T system. One can then define two groups. In the first group (including Russia), governments play dominant role in funding R&D5 – this is also the case in middle-income European. The second group comprises countries where the S&T sphere is funded predominantly by the business enterprise sector. On average, in the OECD countries private companies' share in R&D funding amounts to 60%. Russian higher education institutions traditionally play a small role in this picture when compared to developed economies, being focused on the provision of education and training rather than research. In 2006 only 38% of HEIs performed R&D and only 4% of GERD refer to HEIs. The isolation of Russian universities from science may respond to population demand for university degrees without any research orientation. R&D human resources were also affected by transition shocks. Today 1.4% of employed population in Russia is involved in R&D (a half of them, 0.7%, are researchers), a high figure for international standards. However, there was an overall decline of R&D personnel by 58% during 1990-2006, especially in higher education. 25.6% of the employed have university degrees, again a high level for international standards, but R&D expenditure-to-personnel ratio is considerably low – just 21.0 thousand USD (2005). Average monthly salary of R&D personnel in Russia accounts for 774.4 $ PPP. It is a bit higher than average salary in the economy (101.9%), but still not attractive for young specialists. Yet another barrier to the integration of research and education is the legal impediment of reallocation of budgetary funding and property between education and R&D purposes. Nevertheless, the Russian higher education sector has maintained a considerable potential for R&D and innovation. Currently, HEIs provide one-third of principally new technologies created in the country, although R&D expenditure in this sector does not reach 5% of the national total. Furthermore, 29.3% of this funding comes to HEIs from the private sector. Some leading Russian universities perform R&D and educational activities at equal scales. It is also noticeable that the average proportion between R&D and education relative annual expenditure is 37.1: 26.7 thousand RUR.

3.4. Training & Capacity-building

One of the most important factors of the human resources efficiency is capability to adapt quickly to changes on the labour markets, especially in a globalizing learning economy in which rapid learning is essential. Professional education does not stop at graduation but continues during the whole life. Lifelong learning (LLL) encompasses all purposeful learning activities, whether formal or informal, undertaken on an ongoing basis with the aim of improving knowledge, skills and competence. As in other countries, formal professional education is the less popular form of LLL: in 2006 only 4.5% of population aged 25-64 chose this form. Non-formal options, e.g. MBA’s and refresher courses, are faster, more flexible and therefore more popular: its share is nearly twice higher than the formal education. In other countries, this gap is even wider and more spread than in Russia. On the other hand, Russia has high

5 This is also the case in some middle-income European countries (Portugal, Greece, Hungary, Bulgaria, Lithuania, Poland) and Latin American countries (Brazil, Mexico, Argentina). 72 average education hours (90 hours a year, against an average of 66 in the EU). The structure of non- formal education and training if biased towards refresher courses, vocational courses and regular training events – options that upgrade current qualification without breaking current professional activities. Training in English as a foreign language is common, while there is almost zero share of training for the unemployed. The most typical places of non-formal training are specialised centers, office and HEIs. It should be notice that the main reason for non-formal education in Russia is promotion at the current job (even if job diversification would be demanded in an innovation economy), since employers usually pay the fees for courses that will improve the current skills of employees. Non-formal education is not linked to a particular institutional origin and includes activities such as self-learning on the internet and TV/radio educational broadcasts.

3.5. Metrology and S&T information

The most important challenge for the Russian S&T metrology is the creation of internationally compatible S&T statistics system at the national level, a task that was unachievable under the centralized Soviet system. With the disintegration of the USSR, a new S&T agency was set and took an active role in the search for a new public policy against the background of lacking comprehensive, modern, internationally compatible, and regular information. For the first time main principles for the projected system of R&D/S&T statistics were formulated, including international comparability. Four requirements should be met: 1) user needs, 2) requirements of the market economy, 3) peculiarities of the national innovation system and 4) international standards. The new National R&D Survey is based on Frascati standards, covering all R&D- performing units in the country and includes series starting from 1994. It uses 5 general statistical classifications (sectors of performance, Russian Classification of Economic Activities harmonised with ISIC/NACE, regional classification, official types of institutions, and types of ownership). The data scope is allocated by three dimensions: R&D personnel, R&D expenditure and stock of R&D fixed assets. The human resources of S&T (HRST) in Russian statistics are characterised, first of all, by head-count and by full-time equivalent (FTE). The head-count indicators include data by occupation, qualification, field of S&T, gender, age and flows. The FTE data is represented by full- time R&D personnel in head-counts and part-time R&D personnel (by occupation) in head-counts and man-days. Total FTE is calculated as sum of full-time R&D personnel and FTE of part-time R&D personnel. Innovation surveys are provided in Russia since 1994. These annual mandatory surveys are compatible with international standards (OECD / Eurostat Oslo Manual, EU CIS). Innovating enterprises are defined as ones performing participation in innovative activities (during the period under review) in form of: R&D, acquisition of embodied technology, industrial design, among others.

3.6. Intellectual Property

About 37.7 thousand patent applications have been filed in Russia in 2006, including 27.9 thousand by domestic and 9.8 thousand by foreign applicants. Patent applications by foreigners (mostly citizens of OECD countries) kept a steady growth, while those by Russians have been more erratic. As to patent applications for inventions filed by domestic and foreign applicants that

73 mention Russia, the country holds the 24th place in this rating. Its share is about 124 thousand patent applications, which is not large for international standards. Insignificant distribution of Russian technologies abroad reflects one of the most acute problems of Russian patenting - excessive enthusiasms about «own field advantages», while designs protected by foreign registration are by far the most important ones. Firstly, this indicates low competitiveness of domestic R&D products and weak position of domestic entrepreneurs in international technology markets. The most important families6 to analyse are consolidated (e.g. the "triad") patent families (the ones which include EPO, USPTO and JPO patents, considered as top priority by all inventors). The number of "triad" patent families registered by Russian applicants varied from 52 in 1994 to 80 in 1998 and 2000. In 2001 the number of Russian patent families decreased to 61. By absolute number of patent families, Russia remained at the same level as Singapore and Taiwan. It is important that the number of patent applications (i.e. the real number of patented inventions) of patent families drops by more than fifty times. By number of patent families per 1 million capita, Russia's rating falls to the level of countries with much lower S&T potential - like Portugal and Poland. Undisputed leaders in this area are the USA, Japan and Germany - they are among the top six in both ratings. It is important that Russian applicants file tens or even hundreds times fewer ICT patent applications than applicants from developed countries. There were 2549 licensing and cession of patent contracts registered in Russia in 2004, which is very few keeping in mind that there are over 108.7 thousand valid patents for inventions in the country, 29.2 thousand utility models patents, 11.5 thousand industrial design patents, 170.6 registered trademarks and service marks. Only 2% of that number were subject to commercial deals. The above data demonstrates that the current technology market in Russia is quite small and underdeveloped. Registered contracts distribution by industries indicates that active technology transfer is taking place in engineering and machine tools manufacturing, medical industry, light and food industries, chemical and petrochemical industries. Russian technology trade in the world market shows a growth both in terms of turnover and geographical spread. Russia trades licences with 105 countries (in 1998 it was 46), including 31 OECD countries and 9 CIS countries. The total turnover grew by 12 times and in 2004 has reached $1.2 billion (in 1998 it was $100.5 million), which is still low for international standards. A specific feature of Russian technology trade is predominance of unregisterable R&D products which are much less commercially valuable. Both technology exports and imports amount mostly to engineering services, R&D products and other unpatented technologies. Considering technology payments, only R&D and other deals on provision of marketing, advertising, financial, insurance, transport etc. non-technical services show positive balance. The main Russian technology exporters are construction companies and S&T organisations. Industrial enterprises' contribution to technology exports is growing but still amounts to just 15.2%, indicating their insufficient R&D potential. Technology trade is inefficient, as R&D products are often sold abroad at too low prices, and low-level technologies are bought in, promoting Russia’s technological dependency. Geographically, the main trend in Russian technology export is reduction of the OECD countries' share (especially the US), while the CIS and third world countries show growth (particularly China and India). On the other hand, the OECD countries remain undisputed leaders in Russia's

6 All patents issued in various countries to protect the same invention are grouped in so-called "patent families". 74 technology imports, US ahead. Positive balance in Russia's technology trade with foreign countries was reached mainly in licensing deals with the CIS countries. The balance with the vast majority of the OECD countries remains negative.

4. Sub-System: Policies, Representation & Financing

4.1. Explicit policies

The role of the government in the development of an innovation system generally follows one of these paths: adopting a special law to regulate all aspects of government support to innovation activity; adopting both a special law on innovation activity and various other laws, plus amending existing legislation to regulate appropriate aspects of innovation activity; or adopting a number of special laws and amending existing legislature to regulate and provide support to various areas of innovation activity. The actual choice depends on a country’s economic development and specific legislation. None of these options is currently implemented in Russia. Existing legislation does not provide adequate legal regulation for support and development of innovation activity. There are no special laws on innovation activity in the country, and the existing provisions are fragmentary and accidental. Draft federal laws are needed to create the legal framework for government support; to create economic incentives for R&D; legal framework for application of technologies developed with federal and regional funding. These drafts define technological innovation and calculate tax bases; and regulate property rights, among many other tasks. Further legal developments are still under way to establish rules on government support and innovation activity; federal technologies transfers; government financing and risk funding in venture companies. In addition, legislation that affects the innovation indirectly should be considered (e.g., organization forms, PPPs, foundations to support R&D etc). During the years of the economic reform, S&T sector in Russia was developing in a difficult situation, by rather conflicting trends. On the one hand, government R&D funding is growing since 1999. In 2003-2004 federal budget allocations on civilian R&D grew by 14.2%, in 2004-2005 - by 51.1%. It is important that about 40% of the government funds are allocated to support basic research. Financial support of R&D through contracts, programmes and tenders also grew significantly. The number of researchers has stabilised. Salaries of R&D staff are much higher than the average wage in the economy, and gradually moving towards the average wage in manufacturing. The number of private research institutions' employees is growing (17% increase since 2000). The number of certified top-level professionals is also growing. The number of government-owned research institutions has reduced by 9% since 2000. Inventive activity also shows positive trends. In 2000-2005 the number of utility model certificates issued in Russia has grown by 1.7 times; the number of industrial design patent - by 1.5 times. It is to note that for industrial property objects this growth was achieved by Russian applicants. In recent years export of Russian technologies also shows growth (albeit mostly in engineering services). Capitalisation of R&D organisations and innovation activity of companies are growing, though not as much as we'd like them to. Innovation infrastructure is firming up. Despite certain reduction of the number of small innovation companies in 2000-2004, their output has almost doubled. On the other hand, the development of a modern innovation system is still very slow – due both to restrictions in demand and supply of R&D products. Demand for R&D products in Russia

75 still comes mainly from the government, and government budget remains the main source of R&D funding. The private sector seems uninterested and R&D funding grows slower than the main macroeconomic indicators. Private business does not show much interest in this area, so the state has to make up for its low innovation activity with government budget funding. Business enterprise sector's share of R&D funding is under one third of the overall domestic expenditures (compared with 72% in Japan and 68% in the USA). R&D funding grows slower than the main macroeconomic indicators (the latter's growth is explained by high oil and other energy resources prices). As a result, after a small increase in 2003 (to 1.29%) R&D expenditures as share of the GDP started to decline again. At the same time the system for prioritising allocation of government funds remains rather inefficient. Significant growth of government funding is noted only in the basic research area. Highly important applied research and R&D with good commercial prospects on domestic and international markets received much weaker support, as well as innovation infrastructure. Second, organizations cannot obtain adequate equipment due to lack of funding. Generally, hardware and equipment amount to 26% of R&D organisations' fixed assets; the share of hardware and equipment older than 11 years is 42%; hardware and equipment under 2 years old amount to just 3%. Average salary in the R&D sector is three - four times lower than in developed countries, which continues to provoke internal (to other sectors of the economy) and external (to foreign countries) migration of researchers, and reduces their productivity. Russia's share in the total number of publications in leading international scientific magazines (according to ISI data) is under 3%. The number of Russian publications per 1 million population is about 20-25% of the average for the OECD countries. Third, restructuring of the government R&D sector is dragging on for unreasonably long time. Most of this sector's organisations are financed out of the government budget, have limited rights and little interest in increasing their productivity. Efficiency of reforms is very much reduced by delayed practical implementation, lack of necessary legislation regulating creation and operation of new S&T institutions to match the realities of market economy. Fourth, Russian industry is dominated by obsolete technological structures, companies are not interested in modernising their production facilities and applying new technologies, which weakens demand for domestic R&D products. Fifth, Insufficient orientation of Russian R&D organisations towards innovation reduces their productivity and financial stability and hinders supply of R&D products. After fifteen years of economic reform only half of R&D organisations own registered intangible assets. Due to relatively low capitalisation, R&D organisations do not look attractive to investors and creditors. Investment risks are increased due to holes in legislation and low efficiency of law enforcement work. Sixth, the Russian innovation system’s profile does not meet modern equipments. The number of Russian innovation-active companies is by an order of magnitude lower than in countries with developed market economy. The engineering segment responsible for transferring results of applied research to the experimental stage of the innovation cycle continues to get weaker. Only in very few industries companies show high innovation activity - office equipment and computers, medical equipment, hardware for radio, TV and communications, cars, ships, aircraft and spacecraft, electrical engineering, oil products. Lastly, the innovation system shows low potential for self-development and self- organization. The still-present misbalance in its structure hinders transfer and commercialisation of R&D products and technologies. For example, the number of registered contracts transferring rights to use inventions (licensing or cession of patents) amounts to just 5-6% of the number of annually registered patents. Despite emergence of new objects of innovation infrastructure, their total number

76 (especially small and medium innovation enterprises) does not meet requirements of modern innovation economy. The proposal to give those enterprises property which becomes available after optimisation of the network of R&D organisations was never approved. This situation is worsened by the weak and inadequate economic management mechanisms, including an existing legislation that does not fully encourage innovation activity and business. Existing legislation (tax, customs, financial) does not fully encourage innovation activity of businesses. As a result there appear obstacles hindering efficient interaction between R&D, innovation and production. R&D and innovation activity are also poorly organised on the regional and federal district levels. Mechanisms for setting up private and government sector partnerships are practically non-existent. Solving the main problems in the R&D and innovation sphere requires serious resources and significant time. Today Russia in principle could afford it because the economic situation has noticeably improved and the country moved to one of the top places in terms of the level of investments. Putting off dealing with the above problems is fraught not just with conserving the current situation, but could lead to degradation of the basic elements of innovation cycle, irreversible technological lag and complete loss of the country's prestige as a leading R&D nation. The contemporary economic potential of the Russian economy is high enough to launch the NSI reforms and complete the transition of the S&T and innovation sector. By now the main directions of such reforms are the following: restructuring government and S&T institutions vis-à- vis new economy markets; S&T budgetary funding reforms; building an efficient system of national priorities setting; establishing of efficient legal framework for S&T and innovation; implementing comprehensive tax incentives for R&D and innovation; and building a competitive innovation infrastructure for S&T and innovation. It is also extremely important that all the official actions are balanced with other and co-ordinated as a single system. Speeding up reorganisation of national S&T complex' institutional structure was one of the key objectives of the Russian government during the recent years. Current government initiatives to improve S&T institutional structure are concentrated on two key interconnected directions: introduction of new organisational forms for public R&D institutions; and modernisation of the State academies of science. One huge problem concerns the predominance of government-owned budget-funded institutions in the S&T sector, making the country quite different from other industrially developed countries. These institutions do not have the rights and responsibilities needed for adequate economic behaviour, leading to inefficient use of public funds. As of 2006, the policy designed to deal with this problem is the substitution of the government-owned organizations into new autonomous institutions, the AIs. The key point is to increase the government R&D sector productivity. Opposite to the government institutions, the new structures will not be funded through fixed budgets; rather, they'll receive funding from investors. Accordingly, they will have more freedom in deciding how to spend resources. The transition to the new model, however, is far from complete, and the AIs are just a first step, vulnerable to critics – e.g., its economic activity is still limited. State academies are a traditional organization form and play a relevant role, being engage both in basic and applied research, and experimental development. They still lack a legal status and need to be modernized. The most unusual feature of state academies' legal status is its "mixed" nature, which combines elements of government institution, public association and some other forms (e.g. corporation and alliance). Also, academies are “holdings” that “own” non-profit organizations, which causes property conflicts – Russian law forbids such holdings, and academies are exceptions. Last but not least, academies operate as government institutions, even if formally

77 they cannot be self-governing institutions. This "mix" of various organisational, legal and administrative forms has no analogues in the world. There is a huge mismatch between investment - at least 80% of all public funds allocated for basic research go via academies of science7 - and economic results, among other problems. Some modernization programs are under way, but face great resistance.

4.2. Implicit policies

The development of S&T, with focus on its innovative orientation, should be based on an efficient regulation system – including funding and a system of taxes and subsidies. However, Russian innovation policy is being shaped in incomplete legal framework. Inconsistency of legal reforms, lack of continuity of legal provisions brought about the situation when many of the previous norms of tax legislation that have proved their efficiency did not find a place in the new Tax Code. VAT. After introduction of the Tax Code in 2000-2001, tax breaks for hardware imported into Russia for R&D purposes and for periodic scientific publications were cancelled. Only technological equipment, components and spare parts for them are tax-exempted as investment in organisations' authorised capital, plus publications received by state libraries and museums as part of international book exchange. To set up mechanisms for indirect motivation of R&D and innovation activity, some amendments can be proposed, such as VAT breaks for small innovation firms and individual entrepreneurs; and VAT exempts for all R&D. Individual income tax. In order to ensure that the income of scientists remain stable, which would increase their well-being and increase Russia’s intellectual potential, there are two ways: exempt some kinds of individual's income from income tax; and to introduce income deductions to reduce taxpayer's total revenue. Profit tax for organisations. The current state of laws on taxation of organisations is unsatisfactory from the point of view of supporting R&D and innovation activity. It would be reasonable to introduce preferential taxation of profits received by organizations from innovation activity; by banks from crediting start-up innovation companies; and insurance companies for insuring entrepreneurial risks of companies engaged in innovation activity. Also, gratuitous transfers of funds for R&D (target funding) in the form of grants received from foreign and international organisations should be exempt from taxes – currently, this is the case only for some listed institutions. Another possible step is to exempt small innovation enterprises from all taxation for the first two years after creation. As was already noted, R&D expenditures are included in taxpayers' total expenditures for two or three years (depending on results). It is reasonable to include these costs in total expenditures for 12 months, regardless of actual R&D results. It would also make sense to remove all limitations on interest for promissory notes for credits received to finance R&D, which reduce profit tax base. Unified social tax. This tax is paid by entities that make payments to individuals, mainly by organisations and individual entrepreneurs. Standard tax rate is 26%. Various special rates are used to tax agricultural producers, organisations engaged in popular arts and crafts, small native communities in the far north who live off traditional industries, individual entrepreneurs and advocates. To encourage R&D activity, it should be useful to apply a special rate of 14% to unified

7 Just the property controlled by the RAS is estimated at over 68 billion roubles. Its 2005 budget was over 20 billion roubles. This is a lot for Russia. 78 social tax paid by R&D organisations. Property tax on organisations. In 2003, during the reform of tax legislation, the majority of R&D organisations have lost their property tax breaks. Currently, only properties of public research centers or academies of science are exempt from tax. To encourage R&D activity by organisations, it would be reasonable to exempt from tax their property used to conduct R&D and experimental work. It would also make sense to exempt machines, equipment etc. received by these organisations for testing and experimental purposes, or given to them for free in the course of carrying on the R&D contracts. Land tax. According to tax laws, R&D organisations owned by academies of science were exempted from land tax on the land occupied by buildings used for their R&D. However, this tax break was cancelled as of January 1, 2006. It should be amended and restored to apply to all land owned by all R&D organisations and used for R&D purposes. Simplified taxation. Simplified taxation is used by small enterprises. The maximum revenues that allow organisation to use simplified taxation, established by the current legislation, do not allow applying this taxation regime to venture companies set up specifically for innovation activity. In order to make creation of venture companies and investing in their operations more attractive, they should be allowed to choose which taxation system they'd use. Also, it would make sense to amend the law in such a way that R&D expenditures and the costs of patenting R&D products could be included in the list of expenditures subject to simplified taxation.

4.3. Regulation

Science and technology policies in developed countries have undergone considerable changes over the past 30 years. Although initially their role consisted mainly in funding basic research as a way of supporting knowledge generation, providing the research facilities and creating instruments for supporting research organizations and public S&T and innovation programs, their new objectives have expanded to such goals as achieving greater research efficiency and more intensive transfer of knowledge by means of establishing networks involving research and business. Thus the main goal of the S&T and innovation policies is shifting toward the creation of an efficient national innovation system (NIS) covering the entire sector of generation, transfer and application of knowledge. While the scope of scientific research is expanding from year to year, really high research standards are unattainable without highly qualified specialists and sophisticated research equipment. In these circumstances even the wealthiest nations cannot support simultaneous research in every field of science. This state of things forces governments to form a system of priorities for scientific and technological development and to create instruments for selecting such priorities and the mechanisms of their implementation. The process of establishing S&T priorities is closely linked to the existing NIS goals and structure. Depending on the country-specific conditions, the advanced industrial nations use such mechanisms as critical or key technologies, long-term technology foresight, links between major national priorities and the S&T potential, etc. In Russia the efforts to select S&T priorities were first launched at federal level in the middle of the 1990-ies, and have since been undertaken on a regular basis. National S&T priorities are formulated in two lists: of priority S&T areas and critical technologies.

79 Priority areas set the general trends of the country’s S&T development. They represent the S&T areas capable of providing new technologies and facilities that contribute to the development of Russia’s economy and social sphere. These priorities are specified in the List of Critical Technologies of the Russian Federation, which serves as a background for making decisions on concentrating public resources in the most important areas of science, technologies and innovation and on implementing the available S&T potential. Most of critical technologies can be employed in different spheres of the national economy and have the greatest capacity for innovation, development of competitive products and services and for enhancing national security. The first list of S&T priorities of the Russian Federation was created in the middle of the 1990-ies. In 1996, Government Commission on Scientific and Technological Policies approved a list of eight Priority Areas for Scientific and Technological Development. In 1999 this list was submitted to a large-scale examination by more than 1000 leading Russian experts. Their analysis revealed that Russia had largely slipped from the forefront of many applied research areas, the weakest aspect being the poor state of the national innovation system and a low demand for research outcomes in the national economy. Russia still maintained strong positions in some areas of basic research and applications that were relevant for the defense sector, such as space research, nuclear power engineering, etc., as well as in some applied research that had no serious market prospects (for instance, pipelines for transporting coal suspension) or were country-specific to Russia (e. g., open-pit uranium mining). Russian science was unfortunately much weaker in the rapidly developing areas with the greatest demand for research outcomes (information technologies, telecommunication, biotechnologies, etc.). The expert analysis awakened the awareness of an urgent need to reconsider the system of S&T priorities, concentrating on a small number of “breakthrough” directions. In 2000-2001 new lists of nine S&T priority areas and 52 critical technologies were developed. The purpose of their formulation consisted in reducing the number of priority areas, so as to concentrate resources in the most important fields of innovation. In the spring of 2002, the situation in Russia’s S&T sphere was discussed at a joint meeting of the Security Council and the Presidium of the State Council for Science and Advanced technologies under the President of the Russian Federation. Following the discussion, Russian President approved Basic Policies of the Russian Federation in the Sphere of Scientific and Technological Development for the Period Ending 2010 and Further Prospects. This document has become an important element of Russia’s social and economic development strategy, with its goals of innovation-based economic development, creation of an effective national innovation system and making science and technology one of Russia’s greatest priorities. Simultaneously, the Russian President approved the new priorities of science and technologies, thus boosting their status. Implementation of the Basic Policies implies that all decisions relating to the support of science, allocation of budget funds and targeted stimulation of research and innovation should be founded on the defined S&T priorities. The document called for a regular review of S&T priorities based on the goals set in the Concept and Programs of Russia’s medium and long term social and economic development, while the priorities and critical technologies should be lined up to form so- called technological corridors leading from research to developing and manufacturing competitive products. It should be remarked, however, that while formally the number of critical technologies was cut (from 70 to 52); the task of concentrating resources in the most important research areas was not really accomplished. The reason lay in a lack of strictly defined criteria for the procedures of

80 selecting and formulating priorities. This led to the set of priorities being left open to the pressure of lobbyists representing sectoral ministries and academies of sciences, resulting in its actual expansion despite formal reduction. Some of the critical technologies covered greater areas than before (“Prospecting, extraction, refinement and pipeline transportation of oil and gas”, “Coal mining and procession”, “Transportation and shipbuilding for winning control of and extracting resources from the Ocean”, “Procession and renovation of forest resources”, etc.). On the other hand, some very sector-specific areas were also included into the list (“Rapid construction and transformation of housing”, “Technologies for deep procession of domestically produced materials in the light industry”, “Technologically compatible modules for small-scale metallurgical facilities”, etc.). As a result, while the list of critical technologies had undergone considerable changes, it became useless since practically any research program could be presented as falling under one or another of the critical technologies and thus declared a priority. The chosen priorities were implemented via traditional instruments – national S&T and innovation programs. At the same time there was used a new approach – big-scale innovation projects partly funded by the government. The work to select and implement major innovation projects of national importance has grown into an important innovation initiative and become a real step towards building partnerships between science and the economy, the government and the private sector, major industries and small innovative business. A dozen projects have been selected for implementation. Open tenders for government contracts for their implementation in 2003-2006 have been held. Only those organizations were eligible which had relevant R&D experience and capacities of attracting more than 50% of the necessary funds from non-budget sources and strong increasing on this basis the output of science-intensive products and respectively generating more tax revenues. Real innovation clusters and large-scale facilities for manufacturing competitive products for the domestic and foreign markets were expected to emerge in Russia upon completion of these projects. As noted above, the S&T priorities and critical technologies approved in 2002 represented research areas that were too broad to become real targets for selecting technologies for priority government support and for private investment, and Russia’s Ministry of Education and Science organized work to revise and correct these lists in 2003—2004. The revision of S&T priorities was carried out during a period of sustained economic growth and great improvement of the state government system. According to international experience, long-term sustainable development is achievable only as a result of high entrepreneurial and innovation activities both in production and service sectors, diversification of production and greater share of sophisticated and hi-tech products. Thus concentrating resources in the areas where Russia’s competitive advantages can be implemented helps faster introduction of innovation based on latest research outcomes and technologies, which at present is a key factor that determines the competitiveness of the national economy. This is particularly important for Russia because of its present strong dependence on the international markets of fuel and mineral resources. One of the main objectives in revising the priorities was to create an information and analysis background for defining budgeting priorities and forming the Federal S&T Program “Research and Development in Priority Areas of Science and Technology,” as well as for other federal and sectoral goal-oriented programs, eventually resulting in greater efficiency of public funds invested into S&T. Given Russia’s new economic development model, with its goal of faster GDP growth, greater increase of competitive capacity of the national economy and its diversification based on high technologies, the revision of priorities had a practical purpose, in that the newly formulated

81 lists of priorities and critical technologies were to be correlated with industry’s needs so that they could serve as a basis for managerial decisions on intensification of innovation activities, practical implementation of the existing research capacities and concentration of public R&D funding in the most important S&T areas. Some of the objectives of the revision were to develop criteria for evaluating technologies; analyze components of existing critical technologies; identify research areas within critical technologies with the greatest potential for developing such products; create revised lists of priorities; evaluate the innovation capacity of critical technologies; and develop proposals concerning practical implementation of selected S&T priorities. In revising the priorities, the best international and domestic practices of selecting and implementing scientific and technological priorities were taken into account, including such projects as the national critical technologies in the United States, key technologies in France, long- term technology foresight in Japan, the British Foresight program, Germany’s FUTUR and some others. The first working definition used to redefine priorities was ‘priority areas of S&T development’: areas with potential for making a major contribution towards national security and faster economic growth. The second one was ‘critical technologies’: sets of technological solutions that create potential for further development of various technological areas. Critical technologies were selected based on the 10-year horizon (up to 2015) of their practical use, with a particular focus on those nearest to a practical implementation stage. The main objectives of Russia’s Social and Economic Development Program for the medium term consist in overcoming factors hindering GDP growth and ending the present dependence on the fuel and raw materials as the mainstays of the national economy. Two main criteria were used for correcting the lists of priorities and critical technologies: contribution to accelerating GDS growth and enhancing competitiveness of the Russian economy; and capacity for enhancing Russia’s national security. The latter was assessed based on overcoming dependence on imports of particularly important goods and technologies; and competitive capacity compared to their foreign equivalents of domestic technologies for reducing technogenic catastrophe risks. The prospective contribution to GDP growth and enhancement of competitiveness was assessed based on competitiveness in domestic and foreign markets; capacity of ecisting and prospective markets for products embodying critical technologies; and prospective rates of sales in domestic and foreign markets8. In selecting critical technologies for the civil sector it was decided to restrict their number to a minimum due to the need for concentrating resources. Thus it will be possible to provide sufficient budget funding for each of the critical technologies through the federal S&T program “Research and Development in Priority Science and Technology Areas.” Each critical technology was to be accompanied with a set of measures for obtaining research outcomes and their further implementation. Evaluation of the priorities was organized as series of surveys and expert panels with participation of all interested government agencies, leading Russian scholars and experts from relevant companies. At the initial stage, a preliminary poll was held concerning each proposed priority, with questionnaires submitted to experts in order to gather information on the most important prospective innovation products and services, as well as technologies that might have crucial role in their development.

8 Other auxiliary criteria were used, as can be found in the original paper. 82 Each expert was asked to name at least 10-12 important innovation products (services) that could be produced in Russia on the basis of domestic S&T developments in the nearest decade and that would meet the following criteria: competitiveness, demand on domestic and foreign markets; considerable contribution to GDP growth; and overcoming the dependence on imports of vital products and technologies that are or may be prevented from being sold to Russia by some governments. The experts were also asked to describe the main features of each of the products and identify technologies that need to be developed for their creation. The information on the products thus obtained was systematized and offered to expert panels for discussions that were held concerning each priority. During the expert panel discussions, the original set of products was reviewed and major innovation product groups were identified, which, according to the experts, could have the greatest effect on GDP growth in the immediate future, and on which government funding should be focused. As a result of expert panel discussions, there was formed a set of the most important innovation products (services) that can be produced in Russia in the next 10 years. As a rule, the sets encompassed approximately 20-30 product groups in each priority area. This was a reference points for a revision of the existing critical technologies and proposing amendments. To this end, the experts were asked to estimate the degree to which old critical technologies are involved in creating important innovation products. Thus, the expert panel debates resulted in the formation of new, preliminary lists of priorities, critical technologies and major innovation products. In order to identify the most promising critical technologies, an additional experts survey was held with the object of providing a comprehensive evaluation of the preliminary set of innovation products that resulted from expert panel discussions. For each innovation product the following issues were assessed: projected annual volume of sales (in Russia and abroad), competitive capacity (on domestic and foreign markets), possible date of launching it into production, the ownership of technologies required for production, availability of production facilities, etc. Furthermore, the experts identified several Russian organizations that possess technologies required for launching the production of major innovation products and provided other information (i. e. barriers, measures to be taken before production can start, availability of qualified human resources, etc.). In assessing products in the area of ecology and rational nature utilization, the questionnaires were slightly modified. Thus, instead of evaluating sales volumes, the experts were asked to evaluate prospective annual ecological effect (prevented damage to ecology less environmental protection costs). While responding to this questionnaire, the experts were again asked to review the formulation of critical technologies as proposed by expert panels, amending innovation product sets if necessary. The experts’ responses were pooled and later used to assess various aspects of major innovation product markets and the innovation capacity of critical technologies. The innovation capacity of critical technologies was assessed based on how many of the major innovation product groups were created with its help, the total capacity of the product markets and the competitive potential of such products. The documents that resulted from this process are a draft of revised list of priority areas of S&T development; a draft of revised list of critical technologies; and a description of the main features of critical technologies. In the course of the final stage of the process ministry officials and experts reduced and considerably modified the earlier approved list of priority S&T areas. The new list included eight priorities: 1. Information and telecommunications systems

83 2. Nanosystems industry and materials 3. Living systems 4. Rational nature utilization 5. Power engineering and energy saving 6. Transport, aviation and space systems 7. Safety and terrorism counteraction 8. Prospective armaments, military and special equipment The first six of the above areas correspond to the current international technological development priorities. They possess the greatest innovation development potential that is defining the formation of new global markets. This is particularly true for information technologies, nanosystems industry and new materials and living systems. The two latter priorities on the revised list relate to national security. The number of civil priorities was radically reduced. Sectoral priorities, such as “Manufacturing technologies” and “New transportation technologies” were taken off the list. Safety and terrorism counteraction was included for the first time on the advice of many agencies because of its vital importance. The significance of various aspects of safety during the production of goods and services was raised in the course of the discussion of various critical technologies in most of the priority areas. Just as the list of priorities, the list of critical technologies also underwent major changes. Compared to the current list, their number was reduced from 52 to 33. The list had become more focused both in number of technologies and in their substance. Thus, as a result of the multistage discussion process, new lists of S&T priorities and critical technologies were created, containing technologies that would make it possible to achieve average growth rate and competitive capacity in certain groups of high-tech products that would be far ahead of average GDP growth rates, and to create S&T outcome for a broad range of innovations in different economic and social sectors. Critical technologies are also instrumental in providing national defense and technological safety. The President of the Russian Federation approved both lists in May 2006. Another outcome of the process was the drafting of sets of major innovation products and services, which, according to experts, can be created with the help of domestic technological developments in the next 5-10 years. The sets included only products capable of making the greatest contribution into GDP growth owing to their high competitive potential on domestic and foreign markets and large production volumes. In information and telecommunication systems priority will be given to technologies for creating intelligent management systems for complex objects and navigation systems, technologies for transmitting, processing and protecting information, technologies for software development and technologies for computation systems. In nanosystems industry and materials the most important breakthroughs can be expected in the sphere of nanotechnologies and technologies for mechatronics and microsystem equipment development; technologies for creating crystals; developing and processing materials with special qualities, composite and ceramic materials, polymers and elastomers. In living systems, technological development is going to be defined by cell technologies, R&D in stem cells and bioengineering and biosensor technologies. In rational nature utilization, the main areas of technological development will result from more sophisticated technologies for environmental monitoring and forecasting together with the introduction of technologies for ecologically safe mining and oil and gas extraction, as well as for

84 processing and utilizing technogenic substances and wastes and decreasing the risks and minimizing the consequences of natural and technogenic catastrophes In power engineering and energy saving, the most important areas are hydrogen power research, broad-scale introduction of various renewable energy sources and power generation from organic fuels. Experts pointed out that the area of information and telecommunications systems has the greatest innovation capacity. According to some estimates, the export of software amounted to approximately US$ 400 billion as early as 2000, mostly accounted by offshore programming services. The area with the next greatest possible production volumes is power engineering and energy saving, where Russian companies are capable of achieving sales volumes of US$ 3-4 billion, with several dozen million dollars’ worth of exports. In nanosystems and materials, the greatest export growth rates can be expected in the product groups such as: fibers, ceramic, non-organic composite materials and technologies; carbon- based materials and technologies; new-generation materials for fuel element; new types of electrode materials; new generation of materials for pipeline and maritime transportation; radiation-resistant metal and ceramic materials, glasses for nuclear and aerospace equipment; materials for security devices. In biotechnologies, experts noted that the following products and services have great export potential: molecular biological microchip diagnostics of the most wide-spread human diseases and contagious disease agents and their metabolism products; genetically engineered micro-organisms for the production of biologically active compounds, environment remediation, and soil and mineral enrichment. In rational nature use the highest economic effect can be expected from hydrometeorological support of various sectors of the economy. Although there are many technoparks in Russia, only some of them have official licenses. Policies in this sphere have problems and many factors hinder their development: among others, lack of premises convenient for the technopark purposes; insufficient consulting and marketing support for residents. Some of the main trends of state policy are technopark industrial zone development; business incubators support within technoparks; technopark start-ups financial support; support for technology commercialisation at universities, research institutes, and industrial enterprises in partnership with technoparks; balance between defence and civil technology transfer; and providing conversion and commercialisation mechanisms for defence ‘dual-purpose’ technologies. Some measures in this direction include the provision of federal lands for technoparks on a competitive basis; infrastructure direct investments by federal executive bodies; and the creation of favourable conditions for technoparks investment. Applications for new technopark set- ups or existing ones expansion shall be selected on a competitive basis. Small enterprises support funding can be used for regional business incubators development by allocation corresponding federal budget funds to the subjects of the Russian Federation. Another important policies sphere is “science cities” or “technopolises”, large up-to-date research and industrial complex, including HEIs, research institutions, as well as residential area provided with cultural and recreation infrastructure. The science cities concept is to concentrate the scientific potential in advanced and pioneer fields, using favourable environment for creative R&D activities. Mostly researches and their families populate them, that rely heavily on federal funding and faced a difficult period with the end of the USSR. However, as of 1998, a new federal law provided new survival strategies. Nowadays, there are about 70 cities, that concentrate about 40% of national S&T potential. Science cities are supposed to attract considerable foreign investment as

85 venture business centers and areas of science, education and technologies integration. Today more than 70% of science cities have innovation-oriented higher education institutions. It should be noted that the services provided by technoparks, innovation-technology centres, small-business incubators, and innovation-industrial complexes are almost completely overlapping. When it became clear that Russian high-tech sector is unable to collect enough investment the state intervention concept appeared in form of the Russian venture company. The role of the Russian venture company is to promote venture investment and financial support for S&T all over the country. After the venture fund complete formation (i.e., filling with monetary funds), the fund management company can start investment activities. The resources for the Russian Venture Company capitalisation will be allocated from the Investment Fund of the Russian Federation - up to 5 billion roubles in 2006 and 10 billion in 2007. Further steps for promotion of innovation were made in the framework of the special economic zones project. Special economic areas are the Russian Federation territories defined by the government, where special regime of entrepreneurial activity is applied. Special economic areas are created to promote high-technology industries. There are two types: industry and manufacturing special economic areas; and technology and innovation special economic areas.

4.4. Promotion

Wide and comprehensive integration between R&D and education activities is one of the key features of modern innovation economy. Today traditional mechanisms and forms of these two sectors’ interaction for several decades considerably define integration between science and education in Russia. At the early 1990s education and R&D integration activities had risen as a survival strategy for both in times of funding reduction. However, this integration was often unlawful according to R&D and education legislation. Legal uncertainty has increased over the years and is still an issue, as attempts to establish a legal framework are far from successful, and legal integration has not yet been achieved.

4.5. Financing

In the transition period, the ratio between government spending in S&T and GDP fell from 1.85% to 0.67. Despite noticeable increase of civilian R&D funding out of the federal budget, these expenditures are still below both the 1991 and the USSR levels. Accounting problems make it difficult to separate civilian and non-civilian expenditures, as funding for defense R&D was scattered under different entries. Basic research remains priority area of civilian R&D government budget funding since 1991, having reached up to 60% of total expenditure. It’s mostly supported through state academies of science, which depend almost solely on the federal budget. To ensure high level of basic research and concentrate the R&D on areas with the highest potential in achieving the national objectives, the development of a long-term basic research plan began in 2006 and covers the period up to 2025. Funding is allocated mostly through ministries and government agencies and is used to provide financial support to government-owned R&D organisations and to implement target federal

86 programmes (TFP) and departmental programmes9. However, a large proportion of budget funds available to S&T organizations is not made conditional on results and encourages simulation of work. Funds to support programmes are allocated by tender. Most of the "programme" funds are allocated to civilian R&D organisations through the "Priority areas R&D". However, in 2002-2004 its share of total civilian R&D funding did not exceed 5%. The Russian government intends to steadily increase the amount of budget funds allocated through target programmes, to extend the range of programme application and targeting budget planning techniques and reduce the non-programme expenditures. Large-scale projects will be a main target. Resources managed by Russian state budgetary foundations are also allocated by tender – the main one being the Russian Foundation for Basic Research Currently (RFBR), with around 70% of all resources. Its tasks include establishing contact with international organizations to raise funds and sign cooperation agreements. Government R&D expenditures in Russia should be restructured in the next years. However, moving in that direction is difficult due to the large size of the public R&D sector, the remaining disproportions in the economy, insufficient coordination between the S&T policy, economic and other components of government policy. The main point of the years-long debates on the government R&D policy and the claims the scientific community makes to authorities is the need for large-scale budgetary R&D funding increase. The quest for efficient mechanisms for the government to support R&D is relevant all over the world, and the solution found by the Russian government in the current situation is based on more efficient budgetary resources allocation together with institutional reforms in R&D and innovations area. This took place within the new budgeting process, with new classification and accounting systems, valid as of 2004, which determined mid-term performance plans for the management of public funds. R&D allocations are divided now into basic and applied research expenditures, which in turn are broken down into sections. Budgets do perform some functions they are supposed to, but not all of them. The economic function (as financial plan to support sectors of the economy) and the management function (as procedure to agree objectives, structure, techniques and mechanisms for managing financial flows, monitoring and evaluation of results) are carried out. On the other hand, the ideological budget function (as a programme to provide financial support for R&D reforms) and the function as strategies and sets of measures to mobilise and allocate financial resources) are not in place yet. In the situation when the state remains the largest R&D "sponsor", the following tasks become particularly important: restructuring the government sector of R&D; abandoning dispersion of funds between numerous organisations and areas; financial mechanisms streamlining. Direct government support should be brought to a minimum, aimed only at the most relevant priority. New R&D organizations should be fostered to match the market economy environment. Moves in these directions have started in 2005. Organizations unable to keep doing research will be liquidated; those that kept some research ability will be privatized of handed over to HEI. Credit will substitute subsidies. Target programmes and state R&D foundations should be favoured. The share of basic funding in the R&D budget – funds allocated to specific organizations and earmarked for specific

9 Federal target programmes (FTP) are plans to develop large social and economic areas proposed and implemented by government ministries. By 2006 there were 6 FTP areas in Russia: development of infrastructure, new generation, restructuring of justice, safety of human activities and environment protection, new economy, regional parity. 87 purporses - should be radically decreased. A special place in budgeting process holds streamlining the mechanisms of joint innovation programmes and projects funding. Moving on in this direction requires introduction and development of legal instruments regulating cooperative agreements in R&D sector, grant support and long-term government orders for R&D.

5. Demand

5.1. Income distribution

The problem of low demand for innovation is also determined by customer demand for new/innovative goods and services. This demand is limited by two main factors: unwillingness to purchase new/unknown goods and services and relative insolvency of potential customers. Real income of the Russian population started to grow in 2000. In 2000-2007 the annual growth rate accounted for 10-15% and for 2007 the monthly income per capita reached 794$ PPP. Inter-regional income inequality softened during this period. At the same time intra-regional income distribution remains high. During last years real wages grow at annual rate of 12-13%. The income structure by source is dominated by wages and this share continues to grow. At the same time the share of entrepreneurial activities is decreasing. The poverty rate in Russia is more than 13% while the subsistence monthly wage accounts for 244$ PPP. About 60% of poor population live in the country-side. Poverty level also correlates with the number of children in family. In families with 1-2 children poverty level accounts for more than 50% and in families with 3 children and more it exceeds 75% (85% in one-parent families). These poor groups don’t have access to new innovational products and services, to proper medical care and to professional education.

5.2. Structure of consumption

The structure of end consumption of households in Russia is naturally biased towards non- natural form goods and services consumption. This distribution is typical mostly for urban households. However there exists a significant difference between urban and rural population. Rural households perform 5.7-fold higher consumption of food products in natural form (food products created inside the household) than urban ones. At the same time their access to services is 1.7 times more limited than in case of urban households. At least 65% of the household consumption is potentially open for innovative products (food and non-food products) and up to 23% - for innovative services. However real consumption of innovative goods and services is influenced by household purchasing capacity and receptivity to innovation. According to the national survey only 7% of population is ready to purchase innovative products. Another group of 16% is not against such products but can not afford experiments with new products because of low income. It is to notice that 60% of population definitely are not willing to deal with innovation. While 16% convinced that can not afford new products now, 50% are ready to purchase them only if they are not more expensive (or just a bit more expensive) than other products. Therefore apart of 17-20% of population ignoring any innovation, other groups are ready to perform demand for innovative products if their income would allow it or if innovative products would be more economically attractive.

88 5.3. Social demand (basic infra-structure, health, education)

Ageing of population is a crucial demographic problem in Russia. The forecasts warn that Russia's 2005 population of about 143 million can fall 3-fold by 2050. A number of simple (but unpopular) measures, such as putting up the price of alcohol, implementing smoking limits or forcing people to wear seatbelts, might make a lasting difference. However programmes of larger scale are needed to solve the problem. Up to now only one programme is in progress – the National Programme of Demographical Development of Russia (National Programme of Demographical Development of Russia, 2006). But its instruments deal mainly with birth rates increase stimulation, while the main problem is high mortality. To deal with the last one two other programmes will be needed: the health reforms and quality of life reforms. Otherwise continuous ageing of population will lead to economic crisis instead of growth, due to laborforce slowdown compared to disabled population; knowledge crisis caused by teaching staff ageing; and productivity decrease caused by two above-mentioned factors. The main factor contributing to the relatively low life expectancy is high mortality among working-age males due to preventable causes such as accidents, alcohol poisoning, violent crimes, heart disease etc. Statistically the main cause of death in Russia is cardiovascular disease (about 50% or 1.1 million of all deaths). Alcohol abuse, road accidents and cancer are responsible for a quarter of all deaths. AIDS has become a concern, but the Russian Federation has demonstrated a high-level commitment in response to the epidemic. As of 2007, the average life expectancy in Russia is 61.5 years for males and 73.9 years for females. The average Russian life expectancy of 67.7 years at birth is 10.8 years shorter than the overall figure in the European Union. The turmoil in the early 1990s and the economic crisis in 1998 caused life expectancy in Russia to go down while it was steadily increasing in the rest of the world. The strongest obstacle for improving the health situation in Russia is its obsolete health system originating from the Soviet regime. The former health system was public and gratuitous, but in the framework of the market economy it could not function any more. It was changed into a mandatory health insurance, which offers limited coverage and is complemented by private insurance, affordable only for a small fraction of the population. The health system in Russia can be one of the key factors of the human capital development for the innovational economy, however it still lacks innovation itself. The second challenge is education system providing skills for the innovational economy. Despite considerable changes in professional structure of grades during last 10-15 years, it does not meet the labor-market demand. About 26% of employed population in Russia have higher school degrees and only 20-50% of HEI graduates succeed to find a job within their specialization. A solution lies with a new institutional model to be established in the Russian higher education sector. This model will be built around research universities notable for innovative state- of-the-art education programmes (the best “innovative HEIs” or “research universities”). The important function of these universities will be the integration of science and education. The Priority National Project “Education” involves specific policy actions in this direction. An important component of this project, entitled “Support Measures for Higher Education Institutions Implementing Innovative Education Programmes” is devoted to the distribution of competitive grants for the innovation development of universities (including human resource development, unique R&D and innovation projects, improvement of innovation infrastructure, acquisition of research equipment, etc.). There were 57 winners in the 2006 competition. Each of them received

89 funding in the range of 200 million – 1 billion RUR depending on the scale of projects. The average annual R&D expenditure of the grant-winners was 123.3 thousand RUR per one member of R&D and teaching staff, but the difference between minimum and maximum amounts (1.1 and 586.6 thousand RUR, respectively) was very high. It means that only a part of the winning universities really could develop a large-scale innovation activity. However it was a first government experiment towards the earmarked support of research universities as centers of excellence. The main challenge for today is to continue this practice on the regular basis. If so, it could be a powerful driver like university block-grants in the UK or Japan. Two other programmes concerning higher education deserve to be mentioned. The Unified State Examinations (USEs) aims at providing clear and efficient mechanisms for school graduation in order to grant equal opportunities for enrollees irrespective of their residence or type of school graduated. It’s still under adjustment for being too centralized but it’s become compulsory. There also exists a promising programme for developing R&D and innovation human resources in HEIs. The Federal Programme, entitled “Science and Education Human Resources for Innovational Russia” was designed for the period of 2009-2013 (President Commissions, 2006). The aim of the Programme is to provide institutional support for efficient human resource development in the S&T and innovation sphere. In order to achieve this goal, it is proposed to attract and involve young talents and highly-skilled professionals in S&T and innovation projects and to consolidate efficient and competitive scholars in the best universities and R&D institutes. In this regard, the Programme includes a number of actions and instruments: centres of excellence for science and education, a system of grants for young promising scientists and teachers, special schemes to attract young promising scientists and teachers from abroad, grants for the innovation infrastructure development, etc.

90 THE NATIONAL SYSTEM OF INNOVATION OF INDIA

K. J. Joseph

1. NSI of India

During the first half of the nineteenth century, colonial India inherited a stagnant economy with annual GDP growth rate below 2% and per capita income growth around 0.5 percent. In terms of structural characteristics, it exhibited all the characteristics of an underdeveloped economy: agriculture accounted for 85% of the workforce and the industrial sector, made up of traditional industries, employed only about 10 per cent of the labour force. Capital formation remained at an extremely low level of 6% with a domestic savings rate of 5%. The country was poorly endowed with human capital; illiteracy reached 85% of the population. The task was obvious - to transform such a traditional, backward and stagnant economy into a modern industrial economy. In the post-independence period, the process of economic transformation was sought through the centralized planning. This involved the setting up of an elaborate system of production, promotion and regulation of goods, services and knowledge. The policy regime remained intact till the end of the 1970s. This decade marked the emergence of a large number of studies highlighting the efficiency losses associated with the import substituting industrialization. The success of the East Asian countries has been cited to suggest that trade restricting and import substituting policies have failed and should be replaced by trade oriented, export promoting policies. In the early 1990s, in the context of an unprecedented crisis in the external sector, India embarked on a series of stabilization and structural adjustment policies heralding the beginning of an era of globalization that culminated in the mid 1990s with the setting of WTO and India joining as a founding member. The series of institutional interventions undertaken to influence technology, trade, industry, labour, finance, investment and others undertaken over the last 60 years has had significant bearing, either explicitly or implicitly, on the evolution of the national innovation system.

1.1. Evolution of India’s Innovation System

Any attempt to examine India’s innovation system has to take into consideration the process of the colonisation the country underwent for nearly a century and a half, and the deep impact it left on the society. While the visible processes of de-industrialisaiton is quantifiable and hence can be easily analysed, the complex relationship the country had with language, science, and developmental orientation of the coloniser, has deeper but not so visible impacts in education, research, processes and rituals that provide the glue for the system and its impact on the deliverables of an innovation system. This process has been named cultural blanketing and comments that its impact is substantial in the long term and has tremendous implications for national developmental projects initiated after decolonisation.

1.2. S&T in the pre –independence era

91 Though India had a well developed scientific and technological heritage, the twin processes adopted by the British imperial - stunting of Indian industrial development by relegating India to the status of a raw material supplier, and development of an educational system, which focuses only on production of clerks and administrators - led to the stunting and reversal of Indian scientific growth. Research has focused on the impacts of colonization on the economic structure, but has been limited about the impact on science and technological system of India. Though preparatory elements for the emergence of modern scientific traditions existed in India, the constraints and restrictions, even blanket denial that the colonial administration practised, did not allow a robust scientific tradition to emerge. A crucial element of this control was in the multi-layered constraints that the colonial regime put in place especially in the education system. The British education system was in effect an attempt at cultural blanketing, an initiative carefully calibrated to serve colonial interests. The belief that the British gifted Science to India has to be evaluated with scepticism.

1.2.1. Indigenous initiatives in S, T&I during pre-independence

The early S&T initiatives in India, especially during the 19th century, were primarily led by explorers (geographical, botanical and zoological), whose interests converged with those of flag and trade. Thus while the scientific survey agencies did economically useful science, from the point of view of the colonizer, the British education system did provide scope for the emergence of a sporadic but still historically important nationalist initiatives. It is these ‘national’ scientists who struggled to cultivate modern science within the framework of emerging nationalism the national scientists. An organised attempt at incorporating S&T as a major tool of economic development started with the establishment of Indian Association for the Cultivation of Science, in early 1869 and subsequent establishment of various other institutions. The National Planning committee of the Indian National Congress formed in 1939 also emphasized the importance of the scientific outlook and the need for utilization of science in the solution of economic problems. The high point of increased attention to S&T was the Sarkar Committee, which promoted idea of establishing world class technical education, modelled in the lines of MIT, USA.

1.3. S&T in independent India- 1947- 2005

Independent India benefited substantially from the emergence of secular and progressive leaderships, with a positive effect of S&T. Pundit Jawaharlal Nehru, the first Prime Minster of India for nearly a decade and a half dominated the Indian policy scene. The Indian economic policy exhibited three major policy strands. The primary feature is the fiscal and monetary conservatism; a second feature is the emphasis on self-reliance; and the third is the distrust of the price mechanism and a preference for administrative solutions. The last two strands were important to the ascendancy of the role of S&T in economic development. This era (1947-64) saw an impressive build up of institutions, expressed an affirming faith in the capability of S&T to catapult a primitive, predominantly agricultural based, illiterate, nation into an advanced country, developed reasonable production capability, and failed to some extent in terms of addressing the fundamental issues such as food security and technological development. The next two decades witnessed, with respect to S&T, the continuous growth of infrastructure and the development of manpower. The last part of this period also the first unsure steps of

92 liberalization, partial movement away from controls, and openly increasing dependence on foreign collaboration. The next years saw multiple prime ministers, but a policy of increased liberalization was followed which culminated in the emergence of an Indian economy well integrated with the global economy, but at its own pace. The tone of liberalization though did not begin with the new economic policy (NEP) of 1991; the NEP was definitely a marker in terms of the decisive shift in the articulated ideological moorings of the state. The NEP, and New Industrial Policy (NIP) that came along side, articulated a new strategy in terms of building of national S&T & I capabilities. In line with the philosophy of leaving to the market, the state assumed that even investments in S,T& I capabilities would be left to market forces. Thus the first decade of this era, saw reduced investment on infrastructure, and consequently a reduction in the growth of science and technology capabilities. It was only in early 2000s, that in line with international trends in increasing investments in science, that this trend was revised, and massive investments, along with a slew of incentives came in to being to revitalize civilian S,T& I capabilities. Collectively the nearly 60 years of , and Indian S&T development saw six industrial policy statements, one technology policy, one scientific policy, two education polices, two intellectual property bills, two competition bills, and one science and technology polices. While the examination of the impact of these policies would be taken up elsewhere, we will attempt to provide a pen-picture of sectoral interventions in different sectors in the following sections.

1.3.1. S&T interventions – Prestige Science or Big Science

Indian Science and Technology policy has acquitted itself, considerably well, in the big science areas. Achievements have been considerable in terms of nuclear weapons capability, weapon systems, indigenously developed Inter continental Ballistic missile systems, GSLV capabilities, among other successes. Indian space programme was formally organized only in 1972. The space programme had well defined objectives of applying space technology to communications, meteorology, and resources management. The space programme with nearly 30 billion rupees (or 20% of total R&D expenditure so far) of cumulative investment , has performed well by vaulting India into the prestigious club of nations that could launch indigenously developed GSLVs, and is into the marketing of satellite launching facilities. The Indian defense R&D completes the prestige research triumvirate defense, space and atomic research. With an investment of over 45 billion rupees (30% of cumulative R&D expenditure) the defense establishment is the single largest consumer of R&D money. It has performed effectively in the missile systems, has launched India into the Inter-Continental Ballistic Missile Club, has developed array based radar systems, a light commercial aircraft, tanks, and ammunition, sonar systems, and the spin offs from defense research to commercial R&D and product development is slowly on the rise. Efforts in these areas have been guided by relatively coherent policies and strong administrative support, and a substantial portion of the investment came from the state. These projects are run quite independently and have had spectacular successes and occasional failures.

93 1.3.2. S&T interventions – the social sectors In contrast with the achievements in the big science, India’s performance in the social sector has been far from satisfactory. In terms of overall human development indices, India ranks a lowly 124, in the comity of nations, with nearly 350 million or one third of its population is in abject poverty, one third of the able manpower is unemployed or underemployed, not more than 45% of the population has access to clean drinking water facilities, and after five decades of independence nearly 35% of the population is illiterate. In agriculture, though the production has peaked in the last decade, there are problems to overcome. Hunger deaths continue to be a reality. The state has become the biggest hoarder of food grains. Though green revolution was touted as the best example technological diffusion in the country is clearly exhausting itself. With population projected to cross $ 1.8 billion by 2050, India needs to double its agricultural production. Since the available arable land holdings are getting smaller, the only viable alternative is increased productivity. State intervention in agriculture must shift from aimless subsidization of all inputs to massive investment in research and development and extension, rural roads, rural power and support for the development of an agro-processing industry. The state spends nearly 11% of its total R&D expenditure on agricultural research and majority of it is spending through the Indian Agricultural Research Institutes (IARI) network. Private sector in the country accounts, according to one estimate, for only 15 per cent of the total research expenditure. Health is another major sector where India has a mixed bag of results. In terms of the growth in infrastructure, the state has performed reasonably well. But in terms of providing health services India’s performance has not at all been satisfactory. There is a huge and largely unregulated private sector and a small, inefficient and insufficiently funded public sector. The paper mobilizes the national system of innovation and development framework as a conceptual tool to examine the evolution of India’s innovation system, its present status and highlight the issues to be taken up for detailed analysis. The present study intends to go beyond the narrow focus of examining the R&D and S&T institutions and organisations, informed by explicit policy pronouncement, in order to adopt a broader perspective, and attempts to argue that a broader set of institutions such as macro-economic policies, trade and investment policies, the policies relating to financial system and labour market, among others, play a significant role.

Section 1

1. Sub-System: Production and Innovation

1.1. Size of the economy

With a little more than one trillion US dollars, Indian GDP is 12th largest economy. The country is the second most populous in the world with more than a billion people. Per capita income at nominal exchange rate is estimated at US$ 1,021 keeping India still in the category of low income countries. However, when GDP is estimated at purchasing power parity, the Indian economy is the fourth largest, after the US, China, and Japan. However, GDP PPP per capita puts India only in the 132nd position among the world economies. This poor status in per capita GDP is reflected in the case of the general Human Development Index: 128th among all countries. The Indian economy had growth rates of nearly 3 to 4 percent during the first three decades of post independence growth. During the last two decades starting from the eighties, the output growth accelerated from the ‘Hindu rate of growth’ and accelerated gradually to reach at nearly 7

94 percent growth rate during the period 2001-06. Currently the economy is growing at nearly 9%, one of the world’s highest growth rate for real GNP. The observed growth dynamism has been unequally distributed across different sectors. In terms of growth rates the highest growth was observed in the service sector followed by the secondary and primary sectors.

1.2. Structure of economic activity

At the time of initiating development planning, India had a traditional agricultural economy with more than 60% of the GDP being generated from the primary sector, mainly the agricultural sector. But even during this early stage of economic development, a peculiarity of the economic structure was the presence of a relatively large services sector, accounting for nearly 30% of the GDP. The secondary sector, during that period, was in a rudimentary stage of development accounting for only about 14% of the GDP. This tertiarisation process noticed early in the developmental path of India had been on the ascension ever since, and was more pronounced during the period starting from early 1980s. The growth rate of services sector has been the highest during the period 1983 to 2004-05. On the other hand, the growth of the secondary sector has been lower, at 5 to 7%, and the growth in the primary sector had almost stagnated. The growth in the services sector had thus been crucial in kick-starting the economy from being a stagnant slow growing economy to being a fast growing one. Nowadays more than half of the GDP is in the services sector. Such a service oriented growth goes against the conventional theories of structural change put forward by Fisher (1935, 1939) and Clark (1940), wherein service sector growth is associated with the maturity of the economy and preceded by the growth of primary and secondary sectors. The unique experience of service oriented shift, bypassing the manufacturing sector in India has also questioned the Kaldorian hypothesis projecting manufacturing sector as the engine of growth, and the growth of service sector as essentially driven by intermediate services demand from the goods producing sector and final services demand by worker/consumers of the industrial/urban centres. The unconventional service oriented growth in India, without strong inter-linkages with the goods producing sector, poses a new concern on the paths of economic growth. A reason of concern has been the sources of this services growth and its sustainability. This nature of dynamism of the service sector, it has been argued, offers a fresh set of opportunities for growth of the Indian economy. The possibility of trade in services, which was considered a non-tradable economic activity till recently provides a new opportunity for India. It is all the more so, given that services sector is labour intensive. The demand for the service export is mainly in the form of labour services, Information Technology exports and Information technology enabled services. The new technological possibilities of services outsourcing in a number of services such as the legal services, medical transcription, and insurance services, all provide greater opportunities of service led growth without having to depend on the demand to arise from the inter- linkages with urban/manufacturing sector.

1.3. Regional disparities in the production structure

The acceleration in the growth of the economy however has not been uniform across regions. The initial decades of the planning era, more specifically the period till mid 1970s, witnessed a convergence in regional growth patterns leading to a considerable reduction in regional disparities. However, the surge in the growth in the early nineties also coincided with widening

95 regional disparities. The measure of interstate inequality of SDP growth rate, coefficient of variation had been 14 percent in the eighties, but almost doubled to a level of 29 percent in the nineties. The service sector oriented structural change noticed at the national level is by and large reflected at the regional level as well. By 2004-05 all major states in India had a bulk of their SDP contributed from the tertiary sector. The regional disparity in the service sector share had been the lower and declining till 2000-01. The CV in the service sector share declined from 15.5 to 12.4 between 1980-81 and 2000-01 though there has been some increase in the recent years. On the other hand the share of the primary sector was getting increasingly regionally concentrated during the period. The CV for primary sector share increased from 19 percent to 29 percent during the three decades. The regional disparity in the manufacturing sector shares had been more or less stagnant. The service sector oriented growth of the economy, however, has some notable exceptions. Bihar, one of the poorest States in the country and Punjab, the second richest state in the country has bulk of their SDP coming from the primary sector. Punjab, which had inherited an extensive irrigation system blessed by nature and extended by the colonial rulers, experimented with the ‘green revolution’, which in essence was a package of productivity enhancing seed technology, which drove the Punjab economy to become the richest among all the Indian states till recently, when it was over taken by other industrially developed states. Oriented structural change had occurred at a pre-mature stage in economic development for India. However this is not entirely true when we look at the regions within the economy. States like Tamil Nadu and Maharashtra had already acquired more than 30 percent of their SDP from the manufacturing sector by early 1980s. The share of their manufacturing sector has since then declined and their relative share of tertiary sector increased, taking them through the traditional structural change argument. Other states have shown a similar trend. Their secondary sector share in SDP had been increasing along with rise in the tertiary sector share, thus again confirming largely to the traditional structural change theories. However, the rest of the states, had a structural change similar to what was noticed at the national level, namely a shift from the primary to the service sector, bypassing the secondary sector. In fact some of the poorest states in India like still had more than one-third of third SDP coming from primary sector, at the same time these states had more than 40 percent of their SDP generated from the service sector as well, relegating the manufacturing sector to the background.

2. Structure of employment

2.1. Unemployment in India

The planners aimed at annual GDP growth of 5% during the initial five years plans. Along with an anticipated labour force growth rate of 2 percent, the unemployment could be kept under control. These expectations continued throughout the 1950s and 1960s. However, GDP growth rate lagged behind the expectations (around 3.5%) and the labour force growth exceeded (2.5 percent) leading to an increase in the rate of unemployment in the economy. The National Sample Survey Organisation (NSSO) started publishing detailed reports on the employment situation in India in 1973. This essentially opened up the issues pertaining to different and new dimensions of unemployment and underemployment and also the changing dimensions. The male open unemployment per 1000 workers in the rural economy was more or less constant during the period 1972-73 to 2004-05 at approximately 2.1 percent. The rise in the open

96 unemployment rates in this period is attributed to the large scale drought and famine that stuck most rural parts of the country in this year. As can be seen the open unemployment rate in the rural areas had been comparable to the developed economies. However, what is worrying is the fact that Current Daily Status (CDS) unemployment rates, has been much higher than the open unemployment rates, indicating the severity of disguised unemployment in the economy. The underemployment rates for rural males measured as CDS declined from a high of 7.1% to 4.6% in 1987-88, but showed an upward trend since then, to reach 8%, the highest ever recorded underemployment rates for rural males since 1972-73. Such a rising trend in underemployment is visible in case of females as well. For females the CDS unemployment relates increased from the low point of 5.6 percent in the 1998-09 to 8.7 percent in 2004-05. The rise in underemployment rates in the rural sector is associated with the widespread stagnation of the agrarian sector and the ensuing decline in rural employment opportunities. The urban open unemployment rates are substantially higher than in the rural areas, accounting for the influx of migrants in search of employment from the rural areas. The male open unemployment rates have declined from 6.1 percent in 1987-88 to 4.4 percent in 2004-05, while that of females increased to 9.1 percent. Level of education is found to be positively related to open unemployment in India. The higher the level of education, higher the level of unemployment. At levels of no literacy the unemployment rates are very low, in all categories, rural, urban male, and female. This peculiar pattern of unemployment expresses the lack of demand for skilled labour in the economy, where the general level of productive activity requires less skilled, highly labour intensive technology. The trends in the unemployment rates in the recent period from 1993-94 to 2004-05 however, shows that though the levels of demand for skilled labour is low in India , there is a rising trend in the demand for semi skilled and skilled labour in the economy. The unemployment rates among educated labour force had experienced a decline among male workers in both rural and urban areas. However educated unemployment among females tended to increase in the latter period 1999-00 to 2004-05. Thus the rising demand for skilled workers is segregated in nature, the increasing skill demand being mostly concentrated among males.

2.2. Employment: Growth and structural change

Employment growth rate in India had been very slow both in the eighties and the nineties. The total employment growth during the decade 1983 to 1993-94 was only 1.71 percent, which further declined to 1.45 percent during 1994-2000. The period 1994-2000 thus experienced a phase of ‘jobless growth’ in the economy indicating that the innovation system that facilitated growth dynamism of the economy has been inimical to the resource endowment of the economy. This decline in the employment growth during a period immediately following the dramatic policy shifts toward opening up and liberalization of the economy has attracted much academic attention and debate. The stagnation in employment growth, is arguably, a fall out of the trade liberalization and investment liberalization; and privatization of public enterprises. However, in the later period 1999-00 to 2004-05 the employment growth has shown a reversal in trend and it grew at the rate of 2.7 percent The employment growth in the rural areas had been much lower than that of the urban areas throughout the periods. Even when there is a decline in employment growth rate in the period 1994-2000 the rural urban difference in employment growth remains same. Moreover, the employment growth in the urban areas is mainly fuelled by surge in the employment growth of the female workers, especially in the recent past. The total female employment growth in the period

97 1999-00 to 2004-05 was 3.78 percent, much higher than the male employment growth. This ‘feminization of work’ is again arguably the fallout of opening up of the economy. The feminization of workforce is associated with the demand for cheap ‘disciplined’ labour, in the unorganized sectors of the economy in the wake of trade liberalization and rise of the service sector based economy , coupled with changes in the household attitudes.

2.3 Casualisation

As in most developing economies the main type of employment in India is self employment. Both in the rural and urban areas more than half of male workers are engaged in self employment. Among females also nearly half of the workers are engaged in self employment. For males the next largest share of workers are engaged in casual type of employment. Nearly a third of the total employment is engaged in casual work. Casual employment represents that of employment characterized by low and flexible wage rates, impermanence of employment and vulnerable conditions of work. The rise in casual employment in India is a worrying fact. It is possible to say that the stagnation in regular employment opportunities owing to the labour market rigidities attached with the organized employment, especially so after liberalization of the economy, had led to a situation wherein informal forms of employment , especially casual employment is on the rise.

2.4. Sectoral Distribution

The sectoral composition of workforce is such that it exhibits the persistence of nature of traditional economy within India. In rural areas more than 66 percent of the male workers were involved in primary sector activities. In the case of females this share was more than 81 percent of the total female workers. For obvious reasons the urban share of primary workers is very low, but in its place is the overwhelming presence of the service sector, rather than the manufacturing sector. Nevertheless, in the recent past there have been some changes in the sectoral composition of employment, albeit being very slow and very less. The rural share of male workers in the late 1970s was more than 80 percent, which declined in a period of nearly thirty years to 66 percent, while the share of secondary workers increased from 9 percent in 1977-78 to 15.7 percent in 2004-05. For services sector the rise was from 10.7 percent to 18.7 percent. Yet for females the inertia to move from one sector to other had been very slow. During the thirty year period, the shift from agriculture sector had been hardly 5 percent. For urban male the shift from primary sector to other sectors during this period was to the tune of 4 percent, while for females the shift had been more conspicuous , a decline of more than 10 percent. The resultant increase had been almost completely in the services sector, bypassing the secondary sector.

2.5. Employment Elasticity

One of the major contradictions of the Indian economy lies in here, in the sectoral distribution of employment and income in the country, especially after India embarked on the liberalisation project. While the rate of growth of GDP accelerated in the post-reform period compared to pre- reform period, the total employment growth decelerated during this period, which essentially was primal in naming this type of growth phenomenon as ‘jobless growth’ in India. The total

98 employment elasticity of output declined from 0.46 in the pre reform period to 0.32 in the post– reform period. During the period 1999-00 to 00-04 the elasticity was 0.42. The employment elasticity in all the sectors however did not record a decline, the exception being the secondary sector, marked by an increase in the employment elasticity from 0.51 to 0.61. The service which generally has a record of high employment elasticity in other countries has very poor employment elasticity in India, and this is in comparison to the goods producing sectors as well. The employment elasticity of service sector has never been anywhere near unity. The maximum achieved elasticity has been 0.62 during 1987-88 to 93-94. Also, during the post reform period the employment elasticity of the service sector was even less than secondary sector, which traditionally has a high capital intensity and poor labour absorption capacity. The decline in the elasticity has been entirely due to the secular decline in the growth rate of employment along with spiralling growth rate of output in this sector. Thus, this sector quite clearly shows trends in increasing labour displacing technology and capital propelling the growth of this sector.

2.6. The Informal Sector

The traditional models of theories of economic duality in developing economies had theorised the presence of an informal and formal economy, co-existing , of which the informal economy gradually disappears as the economy develops. However, the case in India has been quite contrary to expectations. Not only does India have a very large share of its economy being informal in nature, but also it’s expanding at the cost of the formal segment of the economy. Analytically, the informal economy consists of two segments, the informal sector, and the informal employment. Though they both have a large intersecting region, they are not coterminous. For instance, there could be regular workers appointed in a very small unregistered firm, or there could be contractual vulnerable type of employment in the organised sector. The National Commission for Enterprises in the Unorganised Sector had estimated the composition of employment in formal and informal forms of employment in India. OF the total employment in the agricultural sector 99 percent of the employment was in the un organised sector, and 80 percent of all employment in the non-agricultural employment was in the unorganised sector. Together they account got more than 91 percent of the total employment in the economy, consisting of 363 million workers of a total of 397 million workers. This clearly brings out the large, overwhelming informal and unorganised nature of the employment scenario in India. In terms of the formal and informal sector of the total employment more than 86 percent of the employment was in the informal sector. In the rural areas this share was to the tune of 92 percent and in the urban areas this accounted for 66 percent of the employment. Moreover, employment growth in the unorganised sector had been consistently higher than the organised sector.

2.7. Informal Employment in the Organized Sector

In 1980-81, the total number of people engaged in the organised manufacturing sector was 7.7 million. After nearly a quarter of a century, in 2002-03 it reached only 7.9million. During this period the total employment in production workers had remained more or less stagnant at 6 million. However the composition of employment changed drastically during this period. Permanent workers or direct workers, who accounted for more than 88 per cent in the early 80s were reduced to 74 percent by 2003-03, while the share of temporary workers or contract workers , whose

99 employment conditions are very similar to that of informal workers , increased from 12 percent to 26 percent during the same period. Thus there has been a process of informalisation of the formal sector going on in the formal sector s of the economy. The rise in the contractual employment in the organised sector is being attributed to the cost cutting strategies of the formal sector firms, and as a mechanism to overcome the institutional rigidities associated with the labour market to gain international competitiveness in the open economy.

Section 2

1. Sub-System: Capacity-building, Research and Technological Services

Capacity for developing and actualising national innovation processes rests on institutions, infrastructure and education. Though policy remains the glue which binds them together, inadequacy in any one of the above constituents invariably results in lopsided evolution of the innovative capabilities. This section would attempt to examine four major factors that contribute to innovation capability building. The first focus area is education, where in a detailed analysis of all the three segments namely, primary, secondary and tertiary education, as well as capability building in vocational education before during and after the actual performance of education. The SPR noted that India’s enormous resource- manpower- becomes an asset in the modern world only when trained and educated. This stand led to substantial investment in establishment of an elaborate system of education conducive for addressing not only the issue of widespread illiteracy but also the growing demand for highly skilled manpower for a growing economy.

1.1. Primary and Secondary

Given the high rate of illiteracy prevalent at the time of independence on the one hand and the imperative of skilled manpower to achieve the desired economic transformation with prime role for science and technology, the planners adopted a strategy where both primary education and higher education were promoted with an equal vigour. Increasing public investment in education (from 1.5% of GDP to over 3.7% during 1950-51 to 2003-04) and resultant built up of institutions, the literacy rate increased from 18.3 per cent in 1950-51 to 64.8 per cent in 2003-04 and India emerged as a major source of skilled manpower and fertile ground for skill intensive industries. However, a careful examination of the data till 2000-01 on enrolment for boys and girls at the primary, middle and higher secondary revels that there is much more to be achieved more so in case of girls with un acceptable gender differences. At the middle class level, the enrolment for girls is only a little over 50 per cent and for boys also the observed levels has been 68%. At the higher secondary level the total enrolment is only 33 per cent with 38% for boys and 27% for girls. Apart from the gender inequality observed at the national level, there are very high regional imbalances.

1.2. Higher and Technical Education

The importance of building an efficient and sufficiently large infrastructure need not be overemphasized when one discusses the constituents of a NSI. When it comes to educational infrastructure building, various developing countries have adapted different strategies. Some focused on achieving full literacy, then went on to develop application skills, and turned their

100 attention towards fundamental, science based research only recently. Countries like India focused on building an impressive higher education infrastructure, initially and focused on skill building and literacy only later. The basic structure of technical and higher education in India is basically a three tier one with each level producing different levels of output. The first includes the premier institutions in the country whose main objective is to produce world-class manpower. Most of these institutes are completely funded by the central government Ministry of human Resource Development. The second level of higher education institutions come under the university education systems that consists of over 300 universities are there in India. These universities offer programs of both undergraduate and post graduate degrees. The university system in India operates with teaching and research departments of universities as well as the affiliated colleges. The Sarkar Committee of 1946 highlighted the inadequacies in manpower supply and recommended the setting up of premier educational institutes in the lines of Massachusetts Institute of Technology. Following this the government established six IITs between the period 1950-1961. The location of these IITs was selected on the basis of the geographical industrial concentration and regional equity. The resources were to be raised through three important channels, Student tuition fees, own revenue of the Institute and the state support in the initial year of development. Later on two more IITs were created. Over the years IITs have grown substantially in numbers and became the most important supplier of manpower in the country. India stands third in the overall quality of engineers and scientists behind Israel and France. A large part of this can be attributed to the quality of education imparted at IITs. IITs are also considered to be one of the toughest institutions in the world to get through admissions.

1.3. Emergence of new players

Till about 1980, the growth of higher education was largely confined to arts, science and commerce wherein the government apart from supporting higher education by the establishment of universities and colleges also took financed institutions set up by the private sector grant-in-aid. In the 1980s inter alia on account of the turnaround in the economy, greater opportunities on account of opening up, there was an unprecedented increase in the demand for higher relevant to the needs of business and industry. Also, there was a growing middle class with the ability to pay for higher education. A large number of professional institutions – engineering, medicine, management, teacher education have come up in the private sector over the last 2-3 decades. Nowadays, in the professional stream, nearly 80% of all institutions and enrolments are in the private sector. Many of these private initiatives got degree granting powers either as deemed to be universities or even full- fledged private universities through the state legislatures over the last five years. During this period, private institutions proliferated, distance-education programmes gained wider acceptance, public universities and colleges started self-financing programmes, and foreign institutions started offering programmes either by themselves or in partnership with Indian institutions and the non-university sector grew rapidly.

1.4. Growth of enrolment

These initiatives have led to a substantial increase not in the number of institutions but also in the enrolment. The total number of higher education institutions increased from 516 at the time

101 of independence to nearly 18,000 in 2005-06 of which universities increased from 20 to 347. More importantly, the enrolment in higher education has increased from 0.2 per cent to 10.5% in 2005-05. While the observed increase in enrolment, mostly occurred since the 1980s, is remarkable, it compares very poorly with the OECD countries (55%).

1.5. Trends in outrun

Over the last 50 years there has been a substantial increase in the outrun of students from both degree and diploma categories of engineering education. But it needs to be noted that with increased enrolment and private participation there has been a drastic decline in the out turn especially for degree holders where it has declined from over 60 per cent in the early 1950s to 37 per cent in 2000. There is also evidence to indicate that the trend continues. The total outrun of engineers from all the institutions in India has increased substantially during the 1990s. The increase in outrun was substantial in the case of electronics and telecommunication. Substantial increase in outrun has also been witnessed by branches like mechanical and electrical engineering. Civil engineering registered only a modest growth and that their share declined from over 21% in 1990 to 12.6% in 2000. Thus there appears to be an imbalance wherein there is an intense competition between the booming IT sector, driven mostly by world demand, and other sectors for skilled manpower with likely adverse implications on the growth and competitiveness of other sectors. Despite the enrolment in higher education for the country as a whole increasing over the years, it varies widely across different states in India. These differences are not only linked to variation in government expenditure on higher education, but also to the per capita income, percentage of people below poverty line and the extent of urbanisation in different states. Generally, states with a higher enrolment in universities and colleges are those with higher ratio of urban population and a lower percentage of population below poverty line. In terms of the number of researchers and technicians engaged in R & D activities, India has merely 119 researchers, whereas Japan has 5287 and the US has 4484 researchers per million of population. Even in absolute terms, the number of researchers in India is much smaller compared to the US, China, Japan, Russia, and Germany. The National Science Foundation (NSF) shows that in the US, about 4 % of the science and engineering graduates finish their doctorates and 7 % for Europe. In India this is not even 0.4 %. India needs to substantially increase its enrolment at higher education, and this need has made its way into the political agenda.

1.6. Training and Capacity building ( Lifelong learning))

Widespread illiteracy hampers the productivity of the informal sector, despite many programs that serve this sector. India is home to more than a third of the world’s illiterate population, many of whom are part of the informal sector labour force. Currently literacy programs are active in almost all 600 districts in India. Programs to combat illiteracy have helped reduce it: in 2001–02 almost 1.5 million people received literacy training. India’s National Literacy Mission, established in 1988, is aiming for 75% national literacy by 2007. But the official literacy rate is still low at 62 percent. In India this translates into roughly 400 million illiterate people, which doesn’t account for functional illiteracy.

102 1.7. Technology import, FDI and R&D

During the early years of development planning, with relatively liberal policy towards foreign technology, there was a substantial increase in the number of foreign collaborations. To be more specific, until 1955, the number of foreign collaboration per Annum was only of the order of 35. The pace accelerated during the second Five Year Plan with an almost a threefold increase to reach a level of 104. The third Plan period and the period until mid-sixties witnessed further increase in the access to foreign technology as there has been on an average 356 agreements per annum. Thus there was an almost six fold between 1948 /1958 and 1954/1970. The FDI stock more than doubled to Rs 560 Million between 1948 and 1964. Technology related royalty payment jumped sixteen fold between 1956-57 and 1967-68. The building of industrial capacity during the early years proceeded almost totally on the basis of import technology. Yet when we consider the first policy phase as a whole, India was able to achieve considerable progress with respect to the declared objective of reducing technological dependence and building technological self-reliance viewed in terms of the achievement in respect of the capacity created for technology unpackaging in the system. There also occurred drastic reduction in the cost of technology imported during the period of restrictive regime. It was also shown that domestic R & D effort increased at an unprecedented rate while the cost of technology import increased at a much lower phase as compared to national R & D The annual average growth rate in R & D expenditure (8.34%) was at a higher rate than the corresponding increase in the direct cost of technology import (7.7) during the seventies. On the whole it has been shown that regulatory policy of the seventies did stimulate in-house R & D especially industrial R & D. Let us now examine how technology import and local R&D have behaved under the liberal regime. It is evident that the number of foreign collaborations recorded unprecedented increase during the post liberalization period. The number of collaborations during the five years beginning with 1980s was only 686 where as it increased more than threefold to reach level of 2175 during 1996-01 and the available evidence tends to suggest that the trend continues. This tend to suggest that the Indian firms strategy, in the event of increasing international competition, is to increasingly depends on foreign firms to build their competitiveness and enhance their access to foreign market. Along with an increase in the dependence on foreign technology, the nature of collaborations also changed. In the earlier period when there was a general disenchantment with foreign capital, the policy was to encourage technical collaborations. In 1960, for example, for every financial collaboration, there were 1.4 technical collaborations and by 1977 it increased to eight. But as the policy became more open towards foreign technology and capital there was steady increase in the number of financial collaborations vis-a vis the technical collaborations and that by 2001 there was only 0.1 technical collaboration for every financial collaboration. Here again there was increasing incidence of cases involving majority equity participation. Also mergers and acquisitions grew at an unprecedented rate during the 1990s, rising from US $ 3.5 million to US $ 1 billion by 2001.

1.8. R&D capacity building

1.8.1. Trends in S&T investments in India

The third issue of consideration is the nature of institutions and organisations that constitute the research and development infrastructure of the country, and their impact and relationship between higher education systems. Finally we shall also highlight trends and patterns in the R&D

103 activities and also major achievements and their limits with a view to provide a realistic picture about the development of these activities and their influence on the productive and innovative capabilities, considering the specificities adopted in the sectoral and regional scopes, and in the performance and funding of those activities. The prime indicator of S&T growth in a country is the investment it makes in S&T. Although the literature does not explicitly consider the quantum of investment, analysts do use the quantum of investment as an indicator in terms of national commitment and resources availability. Interestingly Indian investment though is impressive, the cumulative growth rate after reaching a peak during the 5th plan period (268%) is slowly showing signs of petering of, and trend becomes all the more visible as one examines the expenditure as a % of GNP. As a percentage of GNP even in absolute terms, India is way below the developed nations. But what is of concern even here is that the annual growth rate is progressively declining, though has shown a positive twist in 1998- 99. But if one examines the average spend as a percentage of GNP spread over the last two decades it consistently hovers in the 0.70-0.90 bands. And as one examines the degree share of investment, wherein the contribution of the federal source is substantial, though is progressively decreasing. The private sector share has consistently raising form a meagre 1% in 60s to a respectable 23% in 2000. This trend of increasing private sector participation is line with the international scenario; however the phase of growth of private sector participation is substantially low. This picture is contrary to the scenario in the developed world where in the private sector dominates the R&D spends, while as the state focuses on education and human capital building.

1.9. Sectoral R&D expenditure analysis

The lion’s share of R&D expenditure, almost 50%, goes towards the three epochal technological systems, and these sectors have acquitted themselves fairly well in terms of, technological competence, outputs and their role in the perceived prestige rivalry science games which nations play. But they did provide prestige by enabling India to break into, unannounced, and definitely uninvited, into the club of five, even club of four nations, in terms of nuclear, space and defense capabilities.

1.10. Innovation outputs - Direct and Indirect

Scientific publishing is a hallmark of a mature S&T producing and consuming economy. Though publishing by its very nature may not have a direct impact on economic production, the process of knowledge accumulation which publishing generates plays a major role, providing research velocity to a country. Since only aggregate data, on periodicals as a whole is available, an analysis of the nature, quality, and stature of the periodicals may be hard to achieve, but even an examination of the trends in publishing, communicates an across the board, deceleration even in the quantum of scientific periodicals, being published barring Biological sciences, which shows an increase. The reasons for such sudden deceleration are worth examining, but what is of more importance is the quantum of scientific publishing India does. Even though research publishing has shown a consistent raise, in the crucial mathematics sector it shows a substantial decline (28%). One way of explaining such a drastic decline is the increasing focus on patenting rather than publishing in the Indian scientific and technological

104 community. But in terms of world output, it is showing mixed trends with, agriculture’s contribution drastically decreasing, mathematics and engineering showing modest increases. But this quantum of output has very little meaning, since in terms of scientific citation index, India, has lost its position and is slipping down in the last two decades. Thus there is a definite danger of quality being compromised, in the mad rush for achieving quantity.

1.11. Trends and patters in FDI inflows

As expected increasing incidence of financial collaborations and increased foreign equity participation in a context of removal of the restrictions and joining bandwagon in with more ever new subsidies, there has been an unprecedented increase in the inflow of FDI into the country. During the pre-liberalization period India attracted FDI but the magnitude of FDI was less. But after the 1991 there has been a significant increase. The average annual inflow of FDI increased from $ 79 Million in the 1980 to $ 237 Million in 1990 and by 2007 the total inflow of FDI in India was to the tune of US $ 19156 Million making India the second most favoured destination after China for foreign investment. The annual growth rate of FDI in the pre-liberalisation period was at 21.9%, while in the immediate post liberalisation period the inflow was growing at the rate of more than 92%, and in the period 2000-07 it was growing at 71%. Thus with the adoption of liberalized policies there has been a marked change in the growth of FDI inflow into the country. The remarkable increase in the volume of FDI however is not matching to the size of the Gross Fixed Capital Formation of the economy. During 1999-2000 the average FDI inflow accounted only for 1.9 percent of the GFCF in the country. But after year 2000 the share of FDI in GFCF has sharply increased and reached 8.7 percent by the year 2006. This represented a rise in FDI as a share of Gross Domestic Product from the average 0.5 percent in 1990 to reach 5.7 percent of the GDP. The changes in the foreign investment policy in the Indian economy in the 1990s created substantial changes in the sectoral composition of FDI. The deregulation of many sectors, allowing 100 percent automatic approval and the change in equity cap in different sectors like telecommunication, electric generation, transmission and distribution in Power Sector have attracted FDI to these hitherto protected sectors.

1.11.1 Research and Development

While there was an increased orientation for foreign technology and capital the domestic technology generating effort did not show any marked increase but has taken a back seat. This has been true not only in case of a number of technology intensive industries like electronics, but in many other industries and hence at the national level. The R&D effort at the national level has shown a marked increased especially in the first period. But as we move to the second period, there has been steady decline in the R&D effort in terms of R&D. Expenditure at national level as proportion of GDP. The target for R&D investment set by the latest Science and Technology Policy (STP-2003) by the end of the Tenth Plan, which the current is supposed to implement, is 2% of the gross domestic product (GDP). After reaching the high point of 0.91 percent in 1987-88, there was a steady decline to reach 0.71 percent in mid 1990s. According to the statistics provided by Department of Science and Technology, it slowly

105 picked up in 1998-99 to 0.81% and stands today at around of 0.9%– still lower than the record 20 years before. It is evident that even today there is heavy concentration of central R&D expenditure in a few departments like atomic energy, defense and space. Civilian R&D priorities continued to be neglected. The annual budget on R&D relating to health, communicable disease control, nutrition and family welfare put together is only around Rs. 3500 million. The spending of Rs. 25000 million for defence R&D and Rs. 8000 million on atomic energy R&D. R&D in meteorology, an area that is critical to agriculture, irrigation, flood control, drinking water and disaster prediction is only about Rs. 1300 million. Along with increasing concentration in terms of certain departments, there has also been increasing regional concentration where in R&D activity is concentrated a select industrially advanced states. While a number of policy initiatives including fiscal concession starting with 1996- 97 to 2006-07 to encourage the investments in R&D by industry, judging from their impact it can be easily seen that significant change in the growth of private sector R&D activities is yet to occur. While there are empirical evidence to indicate that the share of private sector in industrial R&D has increased from about 41 per cent in 1985 to 61 per cent in 2003-04 R&D intensity of private sector in India is only about less than 0.1% of their turnover and has shown a declining trend since 1992- 92. Promotional efforts undertaken by the government to lure the corporate sector to participate in the development of indigenous technology have been far from effective. What is more, there is heavy concentration of R&D in selected industries. Seven industries account for about 70% of the total industrial R&D and the remaining is shared across 34 other industries. Pharmaceutical industry is the single largest R&D spender accounting for over a quarter of the R&D expenditure followed by the automotive industry.

Patenting

The Patent Act of 1970 has been considered as the most innovative initiative by the state that helped indigenous development of technology. Comprehensive and extensive, the Act was aimed at protecting the nascent domestic industry and was a role model for many developing countries. The new Patent Act abolished product patents in food, chemicals and drugs. It also reduced the life of patent from 14 to five years from the date of sealing of the patent or seven years from date of filing which ever was earlier. The act had many other features to facilitate indigenous development of technology like adoption of process instead of product patenting in the area of chemicals, powerful compulsory licensing provisions, enabling state intervention in pricing of patented products and so on. In tune with globalization and under the influence of WTO India moved towards a liberal copyright regime. While it is true that the post 1970 period witnessed a decline or stagnation in the number of patents applications and number of patents sealed in India, the mechanism of process patenting led to substantial increase in the adaptive research even by small and medium enterprises and proved especially effective for the development of industries like pharmaceuticals. More importantly, there has been an increasing incidence of patenting by Indians as is evident from the drastic decline in the ratio of patents registered by foreigners vis a vis Indians. It has also been shown that there has been a drastic increase in the number of US patents by Indians after 1990s and the observed increase has been at a higher rate than China.

106 Section 3

1. Sub-System: Policies, Representation and Financing

1.1. Science, technology and innovation since independence (1947- 2008)

Independent India, benefited, substantially by the emergence of secular and progressive leadership that undertook a host of initiatives to promote S T&I in the country. Pundit Jawaharlal Nehru, the first Prime Minster of India, who remained in office for nearly a decade and a half, dominated the Indian policy scene. Being a liberal and socialist, he believed in the paramount nature of the state, distrusted business, had an abiding concern for the poor, admired soviet style planning, which led to the establishment of Planning Commission, and to its subsequent primacy in the Indian economic development and finally he had full faith in the capability of Science and Technology as a key to development. Under Nehru, India embarked upon a journey of freedom with the avowed objectives of, growth, prosperity, economic development and equitable distribution of wealth (Nehru, 1947), by harnessing amongst others the power of S&T. To quote from SPR” the key to national prosperity, apart from the spirit of the people, lies, in the modern age, in the effective combination of three factors, technology, raw materials and capital, of which the first is perhaps the most important”.

1.2. Promotion of R&D and pursuit of technological self reliance

The Nehruvian era (1947-64) saw an impressive build up of institutions, with an affirming faith in the capability of S&T to catapult a primitive, predominantly agricultural based, illiterate, nation into an advanced country. The Science Policy Resolution of 1958, notwithstanding its emphasis on big science, underlined the need for pursuing self-reliance in technology when it stated “in industrializing a country heavy price has to be paid in importing science technology and early and large scale development of science and technology in the country could there for greatly reduced the drain on capital”. Hence the SPR aimed to “foster, promote, and sustain, by all appropriate means, the cultivation of science and scientific research in all its aspects-pure applied and educational”. The strong belief in the capability of Science and Technology to improve productivity substantially and provide employment in sufficiently large numbers so as to overcome the disadvantage of lack of ownership of means of production, thus led to the industrial policy finally favouring a rapid heavy industry led industrialization strategy. The Industrial Policy Resolution (IPR, 1948) thus explicitly states that, “meagre redistribution of existing wealth would make no difference, and a dynamic policy must therefore be directed to continuous increase in production”. Thus rapid industrialization was ensconced in the policy, and since the Indian capitalist class, was primarily of trading vintage, the state assumed role of the prime mover of industrialization, with the IPR (1948) reserving major sectors of the industry exclusively for the state, and reserving the right “to intervene whenever the progress of the private sector is unsatisfactory” which the state seldom did. The import substitution industrialization strategy, which finally emerged, focused on building large industrial assets, and the strategists believed that, such a big push strategy would compress within a short period the kind of changes that had taken over two centuries to unfold in the developed world, and it was expected that it would bring in prosperity without violently affecting any of the existing power structures.

107 The technological underpinning of an import substitution strategy adopted by a technology starved third world country was two –pronged. While dependence on imported technology and capital was accepted, the policy made it clear that, ownership and control as a rule would lie in the Indian hands, there by effectively gaining control, on the technology and its dynamics Statement of Prime Minister (1949). By restricting the entry of foreign capital, the foreign players were forced to sell technology outright or enter into collaborative arrangement with Indian players, there by leading to diffusion of technology. The outcome of such a technology strategy could be examined at the large industrial or capital goods sector, dominated by the public sector and the batch processing industries sector. In case of batch processing sector the phased manufacturing programme was the tool, which the state wielded to assimilate technology especially in the batch-processing sector. The phased manufacturing programme was the key component of the ISI strategy, This as the name suggests was a programme, where in the in a both the foreign firm, and the Indian collaborator, undertake to reduce the import content of products or systems progressively and over a period of time achieve a certain degree of technological competence. At the level of production capability, the programme was a success, and India, by mid 1960s achieved a large range of industrial and consumer goods. But the high cost of adaptations in the context of slow and growing potential markets and the prevailing xenophilia among bureaucrats, politicians and scientists, inhibited innovations and local adaptation of imported technology. Such stagnation led to high production cost of goods, and in a dynamic market, these firms and their technologies would have been outpaced be new and nimble competitors with improved technologies, and consequently, new products. The industrialists of the day, obtained pre- emptive licenses ,to prevent entry of future competitors. With their hoarded licenses, the capitalist of the day could rest assured that capacity restrictions would prevent Schumpeter’s gale of creation destruction from threatening the lucrative rental heaven that the custodial state has bestowed upon them. While the Scientific policy resolution, dutifully acknowledges that’ an early development of S&T in the country could greatly reduce the drain on capital during the early and critical stages of industrialization’ by reducing the dependency of foreign capital” since no attempt is made in the industrial policy to incorporate achieving technological competence as a critical success factor, the import content of new investment continued to be more than 60% even during the 3rd plan period. While the technology competence of the majority of Indian industry showed impressive post independence advances in sheer range of products indigenously produced, they have not been able to generate for innovation in design, manufacture, ,quality and reliability and cost reduction. In other world, they learned to innovate but not to industrialize. The failure of Indian technology policy and the dichotomy between Indian Science and Indian technology policy becomes distinct in this era. To achieve economic growth, nations need to invest in both science and technology. But the proportion of investment and the outcomes of such an investment are subject to debate. As for as the technical component of economic progress is concerned, it is obliviously not the expenditure on science that is crucial, but rather, the input of know-how in terms of new and relevant technologies. He goes on to criticize the science focus of S&T policy, and according to him technological policies, have to take into consideration, the balance between, high low and intermediate technology and arrive at an optimum ideal for a developing country like India, a tall order indeed. Rahman A (1964) compared R&D expenditure in select sectors to the number of foreign collaboration agreements by way of import of technologies and concluded that both of them are anti correlated. In the case of Japan they are more perfectly correlated. Thus here is a classic

108 example of the technology strategy, and industrial strategy, operating in blissful isolation, thereby providing validity to the criticism, that indigenous corporations are incapable of producing quality products, and domestic R&D is devoid of practical applications. Such a chorus, coupled with, the external influences, led to the replacement of import substituting industrialization with export oriented strategy with increased implication for the technology policy and consequently technology competitiveness. In case of batch processing industry, the Indian Patent act (1970) played a major role in promoting indigenous technology by way of learning by doing. The patent act was one of the corner stone’s of India’s indigenous technology development initiative. Comprehensive and extensive, the Act was aimed at protecting the nascent domestic industry, and was a role model for many developing countries. In the case of food c pharmaceuticals, pesticides and other agrochemical products, the term of patents was shortened to five years from the date of sealing the patent or seven years from date of filing which ever was earlier. The act had many interesting features, like adaptation of process instead of product patenting, reduction in the number of years of patent protection, powerful compulsory licensing provisions, enabling state intervention in pricing of patented products and so on. The mechanism of process patenting proved very effective for the development of pharmaceuticals, light engineering, industrial components and even chemical process equipment industry. Industrial policy attempted to revert back to the nationalistic mode of industrial development, albeit in a socialistic mode, reflected in the Manipulative and Restrictive Trade Practices Act (1969), compulsory industrial licensing, within a span of three years, the policy underwent a sizable shift, instead of evolving into a watch dog for enabling competition, reduce concentration of economic power, and by extension induce technology diffusion, the Act, became yet another toll- gate mechanism showering its implementers with powers to dispense favours. Having shifted from the ideological moorings, in terms of technological self- reliance, and domestic capacity building, Indian technology policy slowly veered towards foreign capital and technology. As a consequence of the shift in strategy, the nature, and direction of control of foreign capital and there by foreign technology progressively loosened. The Govt. Guidelines (July 1970) thus opened up the market space, for large firms, in sectors other than that reserved for them, if they committed to export more than 60% of their products. To achieve technological self-reliance through promoting indigenous development the government, apart from adopting a series of measures to restrict the acquisition of foreign technology, formulated a ‘comprehensive science and technology plan’ for the first time in India closely integrated with the fifth five year plan of the country. Also, there was a marked increase in the investment in the science and technology. By the end of fifth five year plan an amount of Rs. 13800 million was invested against the out lay of 18500 . This constituted an almost four fold increase in the investment in science and technology as compared to Rs. 3730 million spend in the fourth five year Plan (1969-75). What is more the outlay for R&D during the last year of the plan (1978-79) constituted 0.84 per cent of the GDP against the target of 0.95 percent. A number of specialized laboratories and institutions providing a variety of services relating to science based technologies were set up. Though the history of S&T institutions could be traced to the pre-independence period, after independence a separate Ministry of Scientific Research and Cultural Affairs under the Prime Minister was set up - an indication the high priority attached to the development of science and technology in the country. Since then an elaborate scientific and technical infrastructure has been set up over the years under CSIR, ICMR, ICAR and various government departments like Department of Atomic Energy, Department of space, Department of

109 S&T, Defense Research and Development Organization and others. As Patel (1993) observed “the maze of institutions for science and technology is an outstanding testimony to the wide spread of the scientific and technology infrastructure. India has no rival in the whole third world for the vastness of infrastructure and even many among the highly development countries could not be able to rival India in the number and the spread of the institutions” ( p 34 ) These institutions, apart from their wider contribution in the field of their specialization, became the largest source of experienced scientists/technologists for in-house R&D activities in the country. Governments in both industrially developed and developing countries have been employing tax incentives and subsidies to support private R & D investment as they are considered as an effective measure to address market failure in private firms’ R & D investment decisions by eliminating the wedge between the private and social returns to R & D investments. Government subsidies have taken different forms in different countries. In South Korea for example, (Kim 1993) finds that more than 94 per cent of industrially funded R & D in 1987 was derived from low interest R & D loans from state controlled banks and other public funds. A number of European governments have used targeted R & D subsidies to provide support for R & D in selected areas notably in microelectronics. In Germany, R & D subsidy programmes included defraying a part of the salaries of new R & D employees. Fiscal incentives offered by the state had an important role. As early as 1974, government started a scheme of recognizing the in-house R & D units of industrial firms. Such units were given easier access to imported equipments, row material and various tax concessions, For example, expenditure incurred on scientific research were 100 percent deductible from profit for the purpose of income tax calculations. The various fiscal incentives provided by the state continued in the 1980s and 1990s notwithstanding major changes in the approach of the government policy towards technology development. Apart from fiscal incentives, venture capital, provided mostly at the instance of public sector institutions such as Industrial Development Bank of India, State Industrial Development Bank of India, State Finance Corporations and the Industrial Credit and Investment Corporation of India in the initial years has also been made available. In 1988, the government of India introduced the Venture Capital Guidelines, along with a venture fund of $ 45 million provided by the World Bank. The policy provided a differential tax advantage to venture capital vis-à-vis Capital gains tax of the corporate sector. The policy also stipulated that VC funds could be provided only to new technology areas and the promoters should be relatively new to the field with inadequate funds to meet their project demands. During the period 1991-99, the Total Capital Under Management (TCUM) of Venture Capital in India had recorded a whopping annual growth rate of 232.9 percent, which was higher than most Asian economies. However only 4 percent of the venture capital industry in Asia was located in India.

1.3. Approach to foreign technology

Though the hallmark of S&T policy in India during the first three decades has been considered as technological self-reliance and indigenous development, that in turn implied limited recourse to foreign capital and technology, there has been a significant variation in the intensity with which the above objective was pursued. The policy towards foreign technology and capital was relatively liberal up to mid 1960s as is evident from the industrial policy resolution of 1948 and the statement on foreign investment made by the Prime Minister in Parliament on April 1949. The overall approach until late sixties remained liberal as foreign investment was considered to be a

110 channel of technology transfer but the effective control was expected to be with the local firms keeping in view of national interest. However the policy towards foreign technology became most stringent from the mid 1960s due to difficulties in the balance of payments. In 1966 following the recommendation of Mudhaliar Committee on foreign collaborations, the procedure for the approval of foreign investment proposal was streamlined. The Foreign Investment Board (FIB) was set up to deal with all the cases involving foreign investment of less than Rs. 20 Million and those within the 40 percent equity limit. Collaborations that exceed this limit were to be referred to the cabinet committee on foreign investment. Government also made a list of industries were foreign collaborations are considered necessary and those where in technical collaborations could be permitted. Government also set maximum ceiling for royalty payment (normally 5 per cent of sales) and duration (normally 5 years). In general foreign collaborations were severely restricted and FDI was allowed only in core industries where no alternative local technologies were available (Kumar 1987). As a result there has been a marked decline in the reliance on foreign technology as is evident from the fact that the number of foreign collaborations approved per annum during the early years of 1970s was less than half of those approved in the early 1960s. More importantly the number of cases involving foreign equity participation declined from 165 in 1961 to 27 in 1971.

1.4. Internal liberalisation (1980-1990)

During the first phase of internal liberalization, from the early eighties until 1991, the thrust was on internal competition. Policy initiatives during this period aimed at encouraging the Indian corporate sector to acquire the means of industrial upgrading through technology imports and removal of internal controls. With external liberalisation policies still on hold domestic firms were allowed to grow in size and increase their share in the Indian market. During this phase domestic firms also had relatively better protection against imports. The government was made to de-license sufficiently the industrial space, relax regulation regarding foreign collaborations and foreign exchange and dilute the controls over the expansion of Indian big business to provide them with enhanced access to the home market. The government had eased the restrictions in respect of the scope and terms of duration and payments for technology collaborations. The corporate sector was provided with a wide range of fiscal and non-fiscal. It was actively encouraged to access the publicly funded R&D institutions for the purpose of consulting them for problem solving and sponsorship of R&D. The Technology Policy Statement of 1983 aimed to step up the pace of technological change through the development of new policy instruments. The basic objective, as stated in the policy statement was the development of indigenous technology and efficient absorption and adaptation of imported technology appropriate to national priorities and resources. The policy highlighted the importance of building up human capital, providing satisfying employment to all strata of society, especially women and weaker sections of society while harnessing their tradition skills and capabilities and making them commercially competitive. Some of the initiatives under TPS (1983) included, the Program Aimed at Technological Self Reliance (PASTER)- now known as Technology development and demonstration program (TDDP). This program aims at technology adaptation by research design and development executed by the industry and overseen by the exports from Lab/university, Technology Absorption and Adaptation Scheme, National Register on Foreign Collaboration, S&T for Weaker sections, S&T for Rural Development, Science & Technology Entrepreneurship Park (1984) jointly with financial

111 institutions, state Governments and academic institutions. In addition there were added incentives for in-house R&D and technology development to industry apart from the setting up Technology Development Fund (1987), through the levy of a cess on all technology import payments. Finally A full-fledged Ministry of Science and Technology was created in 1985, with the earlier Department of Science and Technology (DST) and a new Department of Scientific and Industrial Research (DSIR) as constituents (Richardson 2002). This period also witnessed DSIR initiating the scheme of granting recognition to scientific and industrial research organizations (SIROs) in the private sector. A major innovation in explicit policies for STI pursued during this period pertains to the perusal of technology missions for the promotion of technological applications for civilian development and their diffusion in the society. Important positive outcomes obtained from these missions in terms of the technology development and diffusion in the fields of telecommunications, oilseeds and literacy. Successful creation of the rural telephone exchanges developed by CDOT, achievement of improvement in literacy targets to the extent of almost ten percent, are cited here as examples of what could be achieved through technology missions. Technology missions for societal development were however not pursued consistently by the implementing agencies involved by the government after 1991. India experienced a loss of momentum gained in respect of these missions at an early stage. The government failed in respect of the institutionalization of this very connection of S&T with development, particularly as there was a need to guard the mission orientation emerging for societal development in the S&T agencies on the one hand and in the government line departments on the other hand. Therefore, after 1991 the policymakers in these agencies were also free to shift to the projects that they believed to be far more consistent with the new goals of external liberalization.

1.5. External liberalization (since 1991)

In the second phase of reforms the thrust of policy changes was on external liberalization although it involved changes in many different aspects. Indian firms were permitted to enter into collaborations of their own choice with the foreign firms. The policy, thus became a vehicle for the foreign firms to demand financial participation from the collaborating firms in India. There has been an enhancement of both fiscal and non fiscal incentives to the corporate sector for undertaking in-house R&D with a view to encourage the enterprise sector to ‘innovate’ faster in respect of the development of new products and processes and the absorption of imported technological know- how. IPR also undergone changes to bestow an absolute monopoly to the generators of intellectual property with the aim to encourage the corporations to invest in the development of technology. Above all the corporate sector has been offered a strategic role by the government in the processes of policy-making, planning and regulation with the aim to achieve a better coordination between the S&T institutions and the Indian industry. In addition new policy initiatives were made to encourage Indian companies to invest abroad and facilitate access not only to their technology and human capital but also to their markets. During this period also there were new initiatives which aimed at promoting science technology innovation through public-private partnerships in pre-competitive R&D. They included but not limited to the setting up of Innovation foundation to promote the harnessing of traditional knowledge, New Millennium India Technology Leadership Initiative (2000) and Technology Development Board (TDB) to provide financial assistance in the form of equity, soft loans or grants. This was followed by the setting up of Technology Business Incubators (TBIs) (2001) where in grants-in-aid is provided by the Department, both on capital and recurring for a stipulated period.

112 The observed shift in policy focus, however, was built on a vibrant innovation system evolved over the years as evident, among other, from a sound infrastructure base for science and technology - research laboratories, higher educational institutions and highly skilled human resource. This, as stated in science policy statement of 2003 was built up over the years on account of the commitment towards promoting the spread of science and recognition of the key role of technology as an important element of national development. In a context wherein returns of science, technology and development were yet to reach large segments of society, the new science policy statement laid emphasis on inclusive development as is evident from its focus on enhancing livelihood security, removal of hunger and malnutrition, reduction of regional imbalances, generation of employment, by using scientific and technological capabilities along with traditional knowledge pool. Another import aspect of the new policy in tune with earlier policies is its renewed focus on human capital and emphasis on environmental protection while continued with fiscal incentives and other measures to promote R&D and innovation.

1.6. Promotional initiatives- R&D schemes and mission projects

1.6.1. Technopreneur Promotion Programme (TePP)

As a golden jubilee initiative during 1998-99, the Ministry of Science & Technology, Government of India launched a novel programme known as “Technopreneur Promotion Programme (TePP)” to tap the vast innovative potential of Indian citizens. The programme aims to support individual innovators, from informal knowledge system as well as from formal knowledge system so as to enable them to become technology-based entrepreneurs. TePP provides financial support to individual innovators to convert an original idea/invention/know-how into a working prototype/process. Under the programme, any Indian citizen having an innovative idea could aspire to become a technology-based entrepreneur technopreneur). Since its inception, the Government of India under the TePP programme has given financial support to over 115 projects. Out of these, around 50 projects have been completed and around 25 projects have been commercialized. The scheme has resulted in grant of domestic patents to more than 10 innovators and US patent to 3 innovators, besides the commercialization of the processes/gadgets.

1.6.2. Technology Development and Demonstration Programme (erstwhile PATSER)

The Technology Development and Demonstration Programme (TDDP) of DSIR aims at catalyzing and supporting activities relating to technology absorption, adaptation and demonstration including capital goods development by involving industry and R&D organizations. Under the programme, innovative technologies are up-scaled from the ‘proof of concept stage’ to ‘pilot plant/pre-commercial stage’ by the industry. The projects involve research, design, development and engineering and are executed by industry, overseen by experts from university/laboratory. DSIR has supported over 150 projects so far since inception of the scheme in 1992, when it was called PATSER. More than 65 projects have been completed and 31 companies have started paying lump sum premia /royalty. So far, more than Rs. 35 million royalty/premia have been received. About 15 patents have been filed based on projects supported under the scheme.

1.6.3. Home Grown Technology Programme (HGTP)

113 The Home Grown Technology Programme (HGTP), a mechanism of Technology Information Forecasting and Assessment Council (TIFAC) of the Department of Science & Technology, Government of India was started in 1993 following a suggestion from the Planning Commission. The HGTP was started primarily to support the Indian industry for achieving competitive strength through technological innovation. HGTP assists industries/companies for scaling up laboratory/bench scale technology to pilot or precommercial stage. The HGTP is intended for bringing about significant improvement in an existing product or process. HGTP is designed to support commercialization of technologies developed by indigenous research and development. HGTP provides soft loan (generally not exceeding 50% of the project cost) for technology development which is repayable in user friendly instalments after the completion of the project. More than 60 projects have been supported so far.

1.6.4. Science & Technology Entrepreneurship Parks (STEPs)

Science Parks help in creating an atmosphere for innovation and entrepreneurship, and promote active interaction between academic institutions and industries for sharing ideas, knowledge, experience and facilities for the development of new technologies and their rapid transfer to the end user. The major objectives of STEPs are to forge linkages among academic and R&D institutions and industry, to promote entrepreneurship among Science and Technology persons, to provide R&D support to the small-scale industry and to promote innovation based enterprises. The Science & Technology Entrepreneurship Park (STEP) programme was initiated during 1984 by Department of Science & Technology, Government of India jointly with all India financial institutions (IDBI, IFCI & ICICI), State Governments and the academic institutions. Under this initiative, DST has catalyzed setting up of 15 such STEPs in different parts of the country.

1.6.5. Technology Development Board (TDB)

Technology Development Board (TDB) was set up by Government of India on 1st September 1996 and the operation of fund was assigned to Department of Science & Technology, Government of India. The Board provides financial assistance in the form of equity, soft loans or grants. TDB’s participation in a project generally does not exceed 50 per cent of the project cost. The projects funded by the Board include sectors such as medicine and health, engineering, chemicals, agriculture and transport. Till 31st March 2005, the TDB had handled 141 projects valued at a total cost of Rs 20,438.9 million. Of the TDB’s commitment of Rs 6,629.4 million towards these projects, it has already released Rs 5,264.1 million.

1.6.6. Drug Development Programme and Pharma-ceuticals Research and Development Support Fund (PRDSF)

The Department of Science and Technology (DST) launched a Drug Development Programme during 1994-95 for promoting collaborative R&D in drugs & pharmaceuticals sector involving industries and institutions. Fifty projects have been supported under the Programme involving 22 institutions and R&D establishments and 23 industries. These projects were about development of new chemical entities, new vaccines, assay systems, drug delivery systems and herbal drugs. These projects have resulted in filing of 4 product patents and 12 process patents. The Programme has also led to setting up of eight National Facilities for R&D.

114 The Government established a Pharmaceuticals Research and Development Support Fund (PRDSF) of Rs. 1,500 million (US$35 million) in January 2004. The fund will be used for supporting Pharma R&D projects by extending soft loan with 3 per cent p.a.interest rate.

1.6.7. New Millennium India Technology Leadership Initiative (NMITLI)

The Government of India has recognized the power of innovation and had launched a new initiative during 2000 to enable Indian industry to attain a global leadership position in a few selected niche areas by leveraging innovation-centric scientific and technological developments in different disciplines. In a very short span, NMITLI has crafted more than 25 path setting technology projects involving over 50 industry partners and 150 R&D institutions with an estimated outlay of Rs 1,600 million. These projects are setting new global technological paradigms in the areas such as nano material catalysts, industrial chemicals, gene-based new targets for advanced drug delivery systems, bio-technology, bio-informatics, low cost office computers, improved liquid crystal devices and so on. The scheme is being implemented by Council of Scientific & Industrial Research (CSIR).

1.7. Policies towards FDI

An explicit policy aimed at attracting Foreign Direct Investment in India came about only after the liberalization of the economy in the early 1990s. However, this is not to put the point that the government was not aware of the importance of FDI as a catalyst of economic growth. Authors (Subrahmanian et al 1996) have identified four phases of the state attitude towards FDI. The first phase, beginning with 1948 to mid 1960s was marked by ‘Cautious welcome” as evident from the Industrial policy resolution of 1948. FDI was considered important, and foreign investors treated on par with local enterprises. But the controlling interest and ownership were to be with Indian hands. However the adverse external Balance in the 1970s made FDI as a source of foreign exchange outflow through the transfer payments by Foreign investors. Thus in the second phase (mid 1960s to late 1970s) the government became more inward looking and FDI approval was selective and regulated. The Foreign Exchange Regulation Act (FERA) was enacted in 1973, and FDI inflow was regulated through the provisions of this act. Some of the large MNCs like IBM and Coca Cola had to withdraw from Indian market due to their inability to comply with the provisions of FERA. However, by late 1970s it was realized that the high entry barriers for the foreign firms have had large negative externalities, including widening technology gap, poor competitiveness of Indian firms and the ultimate lose for the Indian consumers. Thus in the late 1970s, the third phase was began, marked by partial liberalization. Accordingly the Industrial policy of 1977 allowed foreign firms to engage in financial and technological collaboration with Indian firms and fully owned foreign firms were permitted in highly exports oriented and sophisticated technology areas. Industrial policy of 1980, among others, focused on the need for promoting competition in the domestic market, technological up gradation and modernization. The policy laid the foundation for an increasingly competitive export based investment and for encouraging foreign investment in high-technology areas. A number of policy and procedural changes were introduced in 1985 and 1986 under the leadership of Shri Rajiv Gandhi aimed at increasing efficiency, productivity, and competitiveness. The emphasis was on opening up the domestic market to increased competition and preparing the Indian industry to be internationally competitive.

115 The New Industrial policy of July 1991, marks the beginning of the fourth phase. A landmark in the history of Indian economy, the New Industrial Policy announced on July 24, 1991 marked announced major policy shifts in terms of investment liberalization, along with privatization and opening up the economy for free trade. Among other policies of liberalisation the most relevant for foreign investment was the removal of the general ceiling of 40 percent foreign equity under Foreign Exchange Regulation Act (FERA) and abolition of the Monopolies and Restrictive Trade Practices Act. The policy also called for lifting the restriction on use of foreign brand names in the local market, withdrawal of the restriction on entry into low technology consumer goods; abandonment of the phased manufacturing programme (PMP), dilution of the dividend balancing condition and export obligation; liberalisation of terms for import of technology and royalty payments’; and allowed investment up to 24 per cent in small scale units. Thus today India has a FDI policy more liberal than ever before and comparable to many other developing countries and even retail trade is being opened for FDI. The FDI policy as prevailing in the country provides for “automatic" approval in many sectors, by which foreign investors only need to notify the Reserve Bank of India (RBI) of their investments, and need not obtain government licenses or approvals. The Foreign Investment Promotion Board clears the proposals that do not confirm to the guidelines of automatic approvals. Government also encourages investment from Non Resident Indians . Investments and returns are freely repatriable, except where the approval is subject to specific conditions such as lock-in-period on original investment, dividend cap, foreign exchange neutrality, etc. as per the notified sectoral policy. The condition of dividend balancing that was applicable to FDI in 22 specified consumer goods industries stands withdrawn for dividends declared after 14th July, 2000. While the FDI policy at the national level governs the inflow of FDI into the country, the decision of the TNCs with respect to the location of their investment is guided to a great extent by the policies and practices adopted by the state governments. Thus, while the regional governments do not have an FDI policy of their own, they do have various policies with respect to industry, labour, power and other related issues that in turn have a crucial bearing on the location decision of TNCs. This is because, India has a federal system of government with clear demarcation of powers. The states deal with subjects of law & order, agriculture, sales tax, minor minerals, electricity, health, education, irrigation, water supply, minor ports, roads, etc. From time to time the states are liberalising their policy to attract investment in both private and public sector. Since many of these areas act as determinants of location of FDI, states do compete among themselves to attract FDI using these policy instruments. Some states provide special packages to foreign investors and representatives of some states visit investors’ country to give information regarding the state policy preference to foreign investors.

1.8. Policies towards industry, trade, and finance

The initiative towards promoting industrial development with emphasis on self-reliance was evident in the industrial policy resolution of 1948 and got firmed up with the Industrial Policy Resolution (IPR) of 1956. The industrialization process, however, was to be achieved through a planning process involving greater role for the state (read as public sector) and small scale sector with limited role for the market. With regard to industrial restructuring, the Indian plans were influenced by the Mahalanobis strategy, which deviated from the `textile first' strategy of industrial development followed by the successful "late-comers" like Japan in industrialization. Considering the labour surplus nature of the Indian economy and perceived advantage of small scale sector in

116 generating industrial employment a large number of industries were reserved for the small scale sector and their number grew steadily over the years from 47 in 1967 to 836 in 1989. Given the fact that the domestic private capital was in infancy and in tune with the declared objective of establishing a socialist pattern of society, the Industrial Policy Resolution (1956) reserved almost all the key industries (scheduled B) and infrastructure reserved for the public sector. Given the importance assigned to the development of capital goods industries as envisaged by Mahalanobis model to achieve self-reliant development, a number of public sector units were set up to manufacture a wide variety of basic and capital goods. Thus the underlying task implied in the Mahalanobis strategy was the development of a capital goods sector as rapidly as possible which would reduce imports and make production less dependent on foreign market. Indian planners, also laid emphasis on import substituting growth as opposed to export oriented strategy which in turn was guided by the export pessimism argument prevalent among the development economists. The fact that the planners assigned key role to the state needs to be seen not only in the context of their limited faith in the market as the memories of great depression of 1930s remained fresh but the Soviet experience with planning has been generally viewed as a great success. Thus the policy makers were influenced not only by the state of the economy and the experience of development under colonial rule but also by the state of development thinking prevalent at that time. Though the issue of land reform remained a subject only for discussion, a number of policies were evolved over the years with a view mitigate in equities at all levels especially personal and regional. Almost all the Five Year Plans a serious of programmes designed to address the welfare of weaker section. Industrial policies announced at points of times have had the number of provisions to ensure that industrial location decisions are not guided by market forces but intone with the declared objective of balanced regional development. The concerted effort by the state towards achieving an equitable growth notwithstanding, prominent committees came out with disturbing evidences with respect to achieving equitable growth. While Mahalanobis pointed towards growing inter personal inequalities, Hazari Committee revealed that the licensing system as existed in the country, inadvertently though, has been acting as instruments of promoting industrial concentration and monopoly power. Responding to the findings of the Industrial licensing Policy Inquiry Committee, government among others, appointed The Monopoly Enquiry Commission and its recommendations inter alia leading to the passing of Monopolies and Restricted Trade Policies (MRTP) Act . Apart from this the state also felt the need for protecting the industries from external competition. Following Frederic L infant industrial protection through high tariff and non-tariff barriers were the rules of the day. The policies in general, aiming at import substitution and focusing on self-reliance in remained intact until the late 70s. Success in building up a fairly diversified industrial structure under the import substitution strategy notwithstanding, there has been a marked deceleration in the rate of growth of Indian economy since the mid 1960s. To be more specific, the rate of growth of industrial value added, during 1965-75 was only of the order of 4.7 percent per annum as compared to 8 percent during 1956-65. Being a democracy, different committees were appointed to search for the reasons and come up with solutions. The Committees in general were unanimous in concluding that India has been overplaying with her controlled regime and hence called for doing away with many of the restrictions that hindered the growth of the economy. The IPR (1970) was issued with an objective to give teeth to the socio-economic and technological advancement objectives enunciated in the earlier polices. But by 1973, with the excitement over restriction of concentration of wealth waning, and a looming recession in the

117 economy, and the seemingly intractable economic mess, compounded by the Oil shock, the state made the first attempts at loosening of the resolve to move firm on the industrial policy regime, with a focus on developing indigenous technological capability. The MRTP Act was loosened, the IPR (1973) Govt. decisions was the first explicit attempt at inviting foreign participation. The statement invited foreign players to participate in industries, where production is predominantly for exports, an uncontrolled openness. This period also saw the first signs of vacillations on the efficacy of industrial licensing focusing on outputs, vis a vis productivity or technology competencies. Thus while a report on economic times (1974) suggested the Govt. setting up a working group to review the IPR in the light of new technological advances in the world, and incorporate the same into Indian economy, and stream line licenses, the same paper in (1975) quoted the Industries Minister wanting to abolish licensing altogether to improve availability of consumer goods. What failed the country was the lack of conception of a phased technological improvement programme analogous to the Phased manufacturing programme. Not only that even when credible technological competences where built, the contradicting policies of the state ensured their untimely death. To use an example, in the case of thyristorised control devices, India built up a substantial degree of expertise and the Department of Electronics (hereafter DoE) thus restricted the award of industrial licenses to those applicants using domestic technology. But when BHEL was given a go ahead for a foreign collaboration with Siemens, the DoE too had to reverse its policy, there by opening the floodgates for foreign collaboration. Thus a formulation that technology improvement also requires a phased process, which Tyabji was beyond the understanding of the state, and hence the Indian policy establishment doomed the Indian manufacturing sector willy-nilly to perpetual foreign dependence. This is a view advocated by Joseph (1997) while studying Indian electronics he opines that “ in a perverse sense the Indian policy wily nilly made the domestic firms in the private sector the trading agents of foreign firms”. This was reflected in the three major phases of import liberalizations, which India undertook, 1975 to 79, 1980- 84, and 1885- 89, and the fourth and the final phase it entered into in 1991. As the state, was buffeted by political, economic and external crisis’s like oil shock on one hand, and political crisis’s on the other hand culminating in emergency, the economic policy was subjected to violent mood swings from socialism to guarded capitalism to rural development within a span of one decade, and they definitely influenced the S& T policy too. The Statement on Industrial Policy IPS (1977) was epochal in the sense that it understood the fact that ‘ a technique of production not only generates certain incomes’ but also determines the pattern of production. It acknowledges that in terms of generation of employment, bridging of rural – urban divide, growth of rate of investment and industrial output, the polices have performed well below expectations. The policy correctly diagnoses the problem that, there was very little interaction between the agricultural and industrial sectors, which is important since’ only by a such a process of reinforcing interaction that employment can be found for large numbers of the rural population who cannot be absorbed in the agricultural sector ‘ Statement on Industrial Policy (SIP 1978) and the introduction concludes with the bombastic assertion that the new IP ‘ will here after place man at the center of the planning” (SIP 1978).The policy was also important in the sense that it gave for the first time, adequate attention to the small industries. The case of small scale industries development policy is unique in itself and the role of S&T in their development and growth is all the more quirky. IPR (1948) delineated the role of small scale industries as being particularly suited for achieving self sufficiency in consumer goods like food, clothing, and agricultural implements. With its delineation based on size and nature of work, and with the focus of Gandhians to ensure supply of consumer goods with essentially using

118 traditional technology and with no wage labour, the door to development utilizing technology was virtually closed for the sector. The new found enthusiasm of the state in promoting small scale sector is meaningless, since technologically backward, small scale can never satisfy the growing demand for goods, if the state improves efficiency and quality of the industrial sector in a systematic manner, both small and large scale industries would find their own place in an economy. Growing markets for the sector would come only if purchasing patterns are deliberately geared towards the outputs of this sector. An effective form of assistance thus would be to initiate technological change within the sector to make it produce more attractive to the consumers. But the policy, though mentioned appropriate technology, shied away from recognizing the importance of management, organization, and entrepreneurship, and totally overlooked the lack of their infusion in the small scale sector, thereby ensuring its continued dependence on reservations for survival. (EPW 1978). In terms of capital goods sector, the policy grudgingly acknowledges that certain measure of growth of existing large units is inevitable, and in the rest of the cases, the growth in size would be curtailed by various measures like, denial of expansion, reduction in finance availability, regulatory mechanisms etc and the public sector is expected to play a commanding role in ensuring supply of essential goods. An acknowledgement for the need for continuous adaptation of foreign technologies was mentioned in this statement and this resulted in the establishment of the national registry for foreign collaboration to monitor these activities. Foreign investment was restricted to only those in India’s national interest, collaborations are put under scanner, and Indian Joint Ventures abroad are frowned upon. Even in this case though the policy rightly favoured the outright purchase of foreign technologies, and their subsequent modifications for Indian conditions, it made no mention of a monitoring mechanism to ensure the same. And even before any of the policy measures could reach fructification the policy died collapsing under the weight of the inherent contradictions the initiating Government. itself. With the introduction of, the IPS (1980), which was the first SIP, which explicitly focused on Research and Development and transfer of technology domestically, and the Technology policy statement TPS (1983) whose high light is that it for the first time focuses on the nitty- grities of acquisition of technologies, India moved towards explicitly focusing on research. The statement speaks of identification of priority areas, promotion of imports, and seeking commitment from importers, in terms of absorption, adaptation and subsequent development of imported technologies. With broad-spectrum policy initiatives one would have expected an analysis of the current status of technologies in the country, and a road map for developing domestic R&D capabilities. But contrary to such expectations the policy laid the foundation for an increasingly competitive, albeit skewed, export base, and for encouraging foreign investment in high technology areas. By and large foreign collaboration agreements are rather poor instruments in raising efficiency of utilization of resources, and the absorption, assimilation of foreign technology is minimal in case of Indian firms, which spend just of half of the amount spend on technology imports in domestic R&D. The primary shift in policies during this period especially in electronics and telecommunications which announced that in order to promote high technology import and to take advantage of up gradation of high technology by foreign suppliers’ equity participation of foreign suppliers would be preferred over outright purchase of technology from aboard. More explicitly with the sectoral polices brought out during the, 1984-1989 period, India was firmly perched on the path to industrial development based on technology imports, and the general perception was, foreign control was not any more a necessary evil, but a welcome phenomenon since it would bring along with itself, technology and management skills so, crucial for the growth of the industry. The

119 mood was captured in statements like ‘the technological somnolescence of the seventies was replaced by a spate of technological collaborations and ambitious schemes of modernization’. BM (1987) after critically examining past performance of the Indian industrialization experience in terms of foreign capital and technology concluded, liberalization of economy and the strategy of import based industrialization would lead the industrial enterprise in the country, to function and develop as appendages to foreign suppliers of technology, a view echoed by Mohan ( 1989) when he states the promotion of modern technology has become a tool of neo-colonialism. The foreign exchange crisis in 1991 proved his predictions right. But to argue in the light of the above discussion that, the policy apparatus gave up building up domestic capability building in terms of technology would be far from truth. While liberalization of foreign technology took place during this place, the state also attempted to provide increased incentives to domestic technology building. The Department of Science and Technology ( currently operated by DSIR) since 1973, has been providing a registration scheme for R&D Units which provided them incentives in terms of import of equipments, and the income tax provides effectively 125% tax exemption of investment made in developing indigenous technology. The Department of Scientific and Industrial Research (DSIR) set from 1984 was explicitly seized with the responsibility of promoting industrial research, The R& D Cess Act (1986) was an attempt to promote indigenous technology and discourage imports, by way of a carrot and stick policy. The act paved the way for collection of a sum up to 5% of the total money paid for importing technology and to be utilized for the commercialization of indigenously developed technology. The money thus collected was to be deposited with IDBI for a venture capital fund to further the stated purpose. A critical assessment of the nature and direction of the money spend from a such a fund could help in assessing the outcome of Indian initiative. The setting up of Technology Information and Forecasting Assessment council (TIFAC) was also an attempt to enable and facilitate technological development. Neither the public sector, not the private sector, separately or together, did much to build up independent, self reliant technological capacity to cope with the requirements of accelerated development. The prime explanation is the absence of any pressure of effective demand for domestic technologies. The very system of technology demand in India was skewed. The public sector, obtained its technology especially on a turnkey basis from the foreign supplier, the private sector had plainly not paid any attention to R&D. The result was the series of economic reforms in the 1980s, which were initiated over the fairly strong edifice built during the import substitution phase. While the reforms involved, devaluation and removal of import barriers, the focus has been on internal liberalization with a view to make the domestic industry more competitive in structure. The new reforms measures, therefore, involved the removal of entry barriers through industrial delicensing, removal of restrictions on capacity expansion along with regularization of the excess capacities created earlier, dismantling of price controls and expansionary fiscal policies to expand the domestic demand base. While there has been acceleration in the rate of output growth, in the 1980s, the growth momentum could not be sustained as evident from the mounting fiscal and current account deficits leading to a liquidity crisis towards the end of 1990s. It was against this background that India embarked on the far-reaching economic reforms in 1991 that marked a profound change in India’s economic policies with the twin objectives of stabilization and structural adjustment. While the former dealt mainly with short term demand management through correcting fiscal, external and monetary imbalances, the latter focused on addressing the rigidities associated with the supply side of the economy by liberating it from the fetters state control and promoting an open and market friendly economy. The structural adjustment measures, aiming at enhancing efficiency, productivity

120 and competitiveness of the economy; inter alia included industrial deregulation, liberalization of foreign direct investment, trade liberalization and reforms in public sector, infrastructure and financial sector. Given the crisis that prevailed in the external sector, the initial focus has been on the external sector and later the reforms were extended to other sectors of the economy.

1.9. Reforms in the last decade

However, as 1990s approached, the macroeconomic crisis’s led to the launch of the new economic and industrial policy. An exercise in managing contradiction, this path breaking policy statement, while reaffirming the contribution made by the founding father of Indian economic policy, Nehru, made a clean break from the planning led economic policy, though the breaches began much before, the complete demolition had to wait for the 1991 policy statement. The policy abolished the industrial licensing for industries but for select sectors, thereby signalling the end of planned development of the economy and placing its trust on the market to govern the phase and direction of industrialization. It was a landmark decision to effect a complete burial of industrial licensing which in any way was diluted throughout the late 1970s and 1980s and the closure of Directorate of industrial and technical development. But in terms of conception of technology the policy was far reaching. The premise of the NIP (1991) is that hang up on self reliance in the past has resulted in foreign capital and multinationals passing India in favour of other countries and they have consequently grown and modernized themselves and hence to achieve growth India too needs to integrate itself with the world economy, while the stated objectives of foreign collaboration even with equity participation is the continuous improvement of technology, the policy lays down that foreign equity proposals need not be accompanied by foreign technology agreements. It then presumes that Indian industry has reached a certain level of general resilience, sophistication and size and therefore suggests a much more dynamic relationship between foreign and Indian firms. In terms of foreign technology collaboration the policy makes an epochal statement “Indian companies will be free to negotiate the terms of technology transfer, with their foreign counterparts, according to their own commercial judgment.” (IPS, 1991). This was the first policy in 40 years of independence, which criticized the public sector and went overboard in criticism. It almost castigated the public sector as a liability rather than an asset. So the policy promises to review the public sector philosophy, recast them in the light of changing economic scenario and get out of consumer goods and service sector. With respect to the MRTP Act, the thrust shifted from governing the size, nature and direction of investments by business houses, to the taking appropriate action in respect of monopolistic, restrictive and unfair trade practices. Technologies in all areas of production are not such that o adjustment in factor combinations for producing the same broad product range is possible. One of the very purposes of control and regulation of Indian industrialization was that to ensure the use of such means of production which will be labour intensive and capital savings. But not only the mode of industrialization which India adopted with its capital intensive plants, but also the means of control which the state adopted in terms of quantitative controls rather than qualitative control led to the failure of the stated objectives and thus the IPS (1991) had no alternative other than to lament that the despite investment in S&T Indian industry has continued lag behind MNCs and the only way to induce technology is through foreign collaboration. This coupled with the short sightedness of the Indian entrepreneur, who is protected by controlled market, led to continued dependence on foreign technology, which was officially recognized by the IPS (1991). In terms of technology, especially

121 foreign technology unfortunately the IPR (1991) seems to have prescribed a medicine worse that the cure Pranjepe (1991) In terms of promotion of domestic technology development, this era saw three major policy initiatives, the aborted technology policy statement (1993), Technology Development Board Act (1995), and the new S&T policy statement 2003. It also the evolution inauguration of three schemes, PATSER, NMTLI, and SEETOT. The technology policy (1993) was, landmark opportunity to take stock of India’s technology initiatives, coming exactly after a decade, it would have been an ideal platform to evaluate the measures of liberalization, which was undertaken throughout the 1980s in different sectors, and the a quick review of the impact of India’s economic liberalization initiated two years before and consequently evolve a set of directions. Instead policy makes no mention of, different sectoral studies initiated by DSIR, on telecom, cement, switchgear, transformer and control equipments, to examine their degree of technological competences. The policy draws no conclusions or inferences on such documents, and makes no attempt to take stock of the existing scenario. However, there is nothing actually new about this policy. It is an add- on, incremental type of effort, essentially trying to smear the cosmetic of ‘software’ and biotechnology on the old tied face of ‘rural development et al. But the other initiatives in technology development are relatively successful. The partial convertibility of the rupee on the trade account was announced in the 1992-3 budget that was subsequently broadened to full convertibility on current account by August 1994. India is cautiously moving towards the full capital account convertibility. Reforms in the trade sector included the progressive reduction in the customs tariff rates from peak rates of 150% in 1991/92 to 45% by 1997/98 to 25% in 2003/04. In January 2004 these were further brought down to 20% for non-agricultural goods. The import licensing system has been dismantled and quantitative restrictions on imports have been phased out two years ahead of schedule. India has bound over 3298 of the 4701 (i.e. 70 per cent) of her tariff lines (at 6 digit level HS classification). Of these 99 per cent of the bound lines have been bound at rates 40 per cent or lower. The applied rates are much lower than the binding rates for most of the products. The Capital Issues Control Act was repealed and the Securities and Exchange Board of India (SEBI) was set up as a watchdog for regulating the functioning of the capital market. SEBI has focused on regulatory reform of the capital market as well as on market modernization. Online trading and dematerialized trading have been introduced. Companies have been allowed to buy back their own shares subject to the regulations laid down by SEBI. In September 1992, the government announced guidelines for investments by foreign institutional investors (FIIs) in the Indian capital market. FIIs were now allowed to invest in all types of securities traded on the primary and secondary market with full repatriation benefits and without restrictions on either volume of trading or lock-in-period. In January 1993 a package of financial sector reforms was announced that included permission to new private sector banks including foreign joint ventures. The government has also established a policy regime for functioning of private non-banking finance companies (NBFCs) and agencies for rating their credit worthiness. With a progressive liberalization of FDI policy, foreign ownership of up to 100% is permitted in most of the manufacturing sectors (except for defense equipment and for items reserved for production by small scale industries). A system of automatic approval of FDI proposals fulfilling the conditions laid down has been put into effect. Dividend balancing requirements imposed on consumer goods industries have been withdrawn.

122 Along with policy measures to integrate the Indian economy with the world market, a conscious attempt was also made to intensify the economic integration with other countries in the South. This was manifested the Look East policy adopted in the early 1990s. As a result, the ASEAN-India Partnership has seen a virtual transformation from just a sectoral dialogue partnership of India with ASEAN to a Summit-level interaction within a decade viz. 1992-2002. It scaled new heights with the signing of the Framework Agreement on Comprehensive Economic Cooperation between ASEAN and India at the Bali Summit in October 2003 and FTA by 2008. Similarly, India entered into FTA with Sri Lanka and Thailand and played a key role in the formation of BIMST-EC by combining Myanmar, Thailand Bangladesh, Sri Lanka and India and SAFTA. Working with Brazil and South Africa, IBSA Forum was formed in June 2003 to promote mutual cooperation and to voice jointly the demands and concerns of the South. The leaders of the three countries formally launched IBSA at the UN General Assembly in September 2003. Since then there has been increased interaction between leaders of the three countries. Among others, there has been a meeting of the Defence Ministers in South Africa, Co-operation at WTO’s fifth ministerial at Cancun, Mexico on agricultural issues and a state visit by Brazilian President Luiz Inacio Lula da Silva to India in January 2004 wherein he highlighted the need for exploring “new trade geography” followed by the Ministerial meet in Delhi on 4-5 March 2004. The Ministerial meeting of IBSA held in March, 2004 in New Delhi, in tune with Brasilia declaration, emphasized the importance of concrete trilateral cooperation in civil aviation, infrastructure, job creation and small medium and micro enterprises, science and technology, information technology, tourism, energy, defense and social sectors covering health, education etc. The Minister’s agreed that the IBSA countries can reinforce the economic strength of each other by synergising their complementarities in area of industry, services, business and technology which in turn could create a market of 1.2 billion people 1.2 trillion dollars of GDP and foreign trade of 300 billion dollars. It was also decided that each countries could conduct studies to examine the potential for economic and commercial partnership and the ways and means for increasing trade and investment flows among the three countries.

Section 4

1. Sub System: The Demand Side

The current growth trends of the economy and rising purchasing power of Indians have evinced immense interest in the Indian market. World over, the Indian ‘middle class’ is being seen as a huge untapped market. There are even predictions that the future of the international market would depend upon the consumer behaviours in the two emerging economies of India and China. The survey conducted by National Council for Applied Economic Research (NCAER) in 2005 forecasted that the Indian middle-class will increase to 154 million (28 million households), accounting for 13 per cent of the country’s population by 2010, with one-thirds of them living in villages. The study further claimed that the overall expected growth in the demand of various consumer goods would be around 9 per cent per annum. A billion strong population, with the demographic advantage of having a majority of younger working age population, and a per capita income that is growing at the rate of around 6.2 percent is indeed great potential and bound to influence the innovation system in general and growth in particular

123 1.1. Income Levels and Distribution: Wages and Consumption

One of the worrying aspects about the growth of wages in India had been the stagnation , or even deceleration of real wages in India. Whether it is casual or regular employment, between every round of NSS there has been a secular deceleration in growth of wage rates during the period 1983 to 2004-05. For the regular workers the growth rates declined from 4.1 percent per annum during the period 1983 to 1993, to 3.9 percent during 1993 to 1999, and by 2004 the rate turned out to be negative at –0.62 percent. For the casual workers the rates had declined from 3.3 % to 3.1% to 1.9% during the same periods. The urban regular male workers and rural male casual workers, the two representative groups of Indian workers, had experienced a marginal rise in growth of wage rates during the previous period, 1993-99, but both these groups experienced decline in the later period. For the urban male regular workers it declined from 7.43 percent in 1993-99 to –4.17percent in 1999-2005, and for the rural casual male workers the growth rates declined from 3.33 to 3.19 percent. A comparison across the two decades of 1983-1993 and 1993 –2004, clearly shows that the growth of wage rates in the first period had been substantially higher than the second period in all sectors, gender and employment status, except for the rural casual male workers, which is marginally higher in the second period. However this margin petered out in the period 1999 to 2004 exhibiting a secular and pervasive decline in growth of wage rates. The most striking aspect about the regional patterns in real wage growth is that the negative growth rate (or a decline in the wage rate levels) during 1999-2004, among regular employees is almost a pan-Indian phenomenon. Barring the states of Assam, Bihar, Punjab, and Uttar Pradesh, all major states in the country experienced this negative growth in the regular wage rates. In the case of casual wage rates though the growth rate is positive among most states, a few states such as Haryana, Punjab, Rajasthan and West Bengal had shown negative growth rates. Not only that the growth of wages had stagnated during this period the degree of wage inequality among wage earners also widened during the period 1983 to 2004-05. Between 1983 and 1993 the range of the wage rates had reduced, but since 1993 the range had been widening, and by 2004 the range had reached to 1983 levels. A comparison of the values across time period brings out that at the lower spectrum (below the 5th decile) the wage inequality is declining, while at the upper spectrum (above 5th decile) the wage inequality is widening among the regular workers. The wage inequality among casual workers is considerably lower than the regular workers. There is no widening of wage inequality in the case of casual workers. Intertemporal comparison of the calculated ratios shows that between 1983 and 1993 there was some reduction in wage inequality across all deciles, and after that there has been remarkable stability in wage inequality till 2004. The distribution of wage rate increment during the period 1993-94 to 2004-05is such that the rise in wage rate is much higher among the high wage earning groups rather than the low wage earners, which accounts for the widening inequality among the regular workers during the period. Such an increasing trend in wage inequality is visible during the period 1993-99 as well. During the period 1999-04 the wage increment is confined to the 8th percentile and above, while all the deciles below experienced absolute decline in the wage rates. Thus if inequality of wage rates was widening in relative terms during the period 1993 to 1999, during the period 1999-2004 wage inequality was widening in absolute terms , with low wage earners earning less in 2004 than what they earned in 1999, while high wage earners earned higher than what they earned in 1999. For casual workers, however the incremental widening of wage inequality is very low compared to regular workers. Between the 1st and the 9th decile the increment in wage rate differs by Rs. 3.2 in

124 the period 1983-93. This difference continues in the later decade 1993-04 as well. Comparison between the periods also shows that there are no incremental changes in wage inequality among the casual workers. Poverty alleviation has been one of the most important challenge faced by the Indian policy makers. Irrespective of measurement used, there appears to be a broad agreement regarding the direction of change. Going by the head count ratio, the population under poverty line declined from about 44 per cent in 1983 to 26 percent in 1999-00 a period covered by the 55th round of National Sample Survey (NSS) survey. Notwithstanding such a reduction in the proportion of the people in poverty line, India still has about 250 million people considered as poor, a major challenge before the policy makers. Remarkable achievements with respect to poverty reduction notwithstanding, interpersonal inequality has shown an undesirable trend. Fro Fig it is evident that the period prior to liberalization, despite lower growth rate, was marked by a significant reduction in the Gini index. With the onset of liberalisation and out ward orientation there appears to have been a trend reversal which casts doubt on the sustainability of the system and that inclusive development has become the buzz word in the policy discourse and the focus of the present plan.

1.2. Social discrimination in India

The Indian society is stratified on the basis of the caste system, a hierarchical segregation of the society based on hereditary occupation. The occupational segregation, however, is attached with dignity or the lack of it , and discriminatory practices based on it. The caste system, which has been practiced at least for the past two millennia in India, is deeply entrenched into the very fabric of Indian society. Dalits who are considered to be outside the caste hierarchy are the victims of the worst forms of caste discrimination including untouchability. The Adivasis, or native tribal communities, are another social group who are subjected to extreme forms of isolation and discrimination. The Dalits or the Scheduled Castes account for 19.7 per cent of the population. Adivasis or Scheduled tribes account for about 8.5 per cent of the population of the country. Both these groups together forming nearly a third of the Indian population remain as the most backward social groups in economic and social development. The scheduled castes are mostly landless agricultural workers. Nearly 62 percent of the SCs were either having no land holding or held marginal lands. Having no land assets to hold, and at the same time restricted by the caste identity their living conditions and access to basic amenities of life is extremely poor. The scheduled tribes have experienced similar conditions of livelihood not so much due to the lack of assets, but mainly due to their vulnerable geographical location. STs are much better endowed in terms of the quantum of land they hold when compared to the SCs. However, the more worrying fact for the STs is the type and quality of land they hold. The adivasis are often subjected to land alienation, and marginalization as a result of the mainstream developmental initiatives. This has resulted in a condition wherein these segments of the population suffer from relatively much higher levels of poverty, illiteracy, mal nutrition, and general standards of living in comparison to the rest of the population. The share of poor among the STs (44 %) and SCs (32 %) were substantially higher in comparison to that of the general population (25 %) as per the NSS survey conducted in 2004-05. Similarly the level of illiteracy was to the tune of 62 percent for STs and 58 percent for the STs, while for the general category the rate of illiteracy was only 43 percent. On the other hand these deprived groups also performed very poorly in higher levels of education.

125 Though initially it was claimed that the caste system was intrinsic to the Hindu community, later studies show that caste discrimination continued to occur in other religious groups as well. As can be seen a substantial share of Buddhist (89.5%) and Sikh population (30.7%) belong to the SC category. The discriminatory practices such as denial of access to resources, employment, education and common facilities that others have, impoverishes the lives of individuals from excluded groups, which is concern not only for the sake of equity but even for the sake of efficiency. Fixed occupations essentially involve restrictions on mobility of labour and capital across caste groups, leading to an imperfect market situation and a fragmentation of economic activities (Thorat, 2007). Akerlof (1976) had argued that given the segmented and imperfect character of the labour market, the economic outcome of the caste economy is lower than posited in the model of perfectly competitive markets. Moreover, the caste stigma acts as a disincentive to respond to market signals due to the notions of pollution and purity attached to occupations.

126 CHINA’S INNOVATION SYSTEM IN TRANSITION -BRICS NATIONAL INNOVATION SYSTEMS

Xielin, Liu; Ping, Lv; Tie Pen; Tingting, Zh; Mingjue, Jian; Hongyi, Dai

1. Geo-Political, Social, Political, Economic, Cultural & Local Contexts

1.1. Geo-Political Context

The People’s Republic of China is one of the largest countries in the world and has the largest population, with more then 1.3 billion people. China has one of the world's greatest reserves of mineral and energy resources, access to two oceans and large surface water resources. The territory of the PRC contains a large variety of landscapes, including the Himalayas. Only 12.5% of surface is securable for farming and not all areas are suitable for industrial activity, causing a concentration of the population in some regions. China borders 14 nations and has extensive economic and cultural relationships with its neighbors. The country is one of the main reasons that explain Asia’s economic prosperity.

1.2. History Matters

China was one of the earliest centers of human civilization, dating back more than six millennia. It has the world's longest continuously used written language system, and is the source of many major inventions (e.g., printing and gunpowder). China’s cultural influence extended across East Asia, and it was one of the few to have developed writing independently. The first dynasty described in ancient historical records, the Xia Dynasty, dates back to 2100 BC. The first unified Chinese state – centralized government, legal code, written language, measurement and currency - took place under the Qin dynasty, in 221 BC, which is well known for beginning the construction of the Great Wall. Next came the Han Dynasty, who expanded the empire’s territory with military campaigns and established the silk road in Central Asia. The next great period of prosperity happened under the Tang Dynasty, from 618 to 907, with innovations in arts and technology. Buddhism became the predominant religion in China in this period. The last dynasty of China was the Qing, from 1644 to 1912. In the 19th century, China openned up to foreign trade and missionary activity, but was unable to resist European imperialism. It was military defeated by the British, the French and the Japanease. Following this series of defeats a reform plan for the empire to become a modern Meiji-style constitutional monarchy was drafted by the Emperor in 1898, but was opposed and stopped by the Empress, who placed the Emperor under house arrest in a coup d'état. This was the beginning of a mass civil disorder at the beginning of the 20th century. Both the emperor and the empress died suddenly and suspeciously in 1908, and the throne was inheritated by Xuantong, the empress’ nephew and last Chinese emperor. His consort, empress Longyu, signed the abdication decree as regent in 1912, ending two thousand years of imperial rule in China. On 1 January 1912, the Republic of China was established, heralding the end of the Qing Dynasty. Sun Yat-sen of the Kuomintang (the KMT or Nationalist Party) was proclaimed provisional president of the Republic – after a short period, Yuan Shikai’s, a former general who supported the revolution, was given the presidency. Upon his death, in 1916, China was politically fragmented with a powerlss national government. 127 In the 1920s, Sun Yat-Sen established a revolutionary base in south China, and set out to unite the fragmented nation. With Soviet assistance, he entered into an alliance with the fledgling Communist Party of China (CPC). After his death in 1925, Chiang Kai-shek seized control of the Kuomintang. and succeeded in bringing most of south and central China under its rule in a military campaign known as the Northern Expedition, and then turned against the CPC. This events were interrupted by long Japanese invasion (1931-1945), which changed the Chinese political and economic systems. After the surrender of Japan, China was financially drained. The continued distrust between the Nationalists and the Communists led to the resumption of the Chinese Civil War and eventually to the victory of the latter in 1949, as the Kuomintang (KMT) retreated to Taiwan. Until 1978, the People’s Republic of China was a Soviet-style centrally planned economy. Private businesses and capitalism were suppressed and technology was imported almost solely from the USSR. After the Sino-Soviet split in the 60’s, China started investing in its own nuclear weapons and in a satellite launching program, with successful outcomes. The 60’s also marked the beginning of the Cultural Revolution, from 1966 until Mao’s death a decade later. Motivated by power struggles within the Party and a fear of the Soviet Union, it led to major upheaval in the Chinese society and brought science and technology activity to a nearly-complete stop. Deng Xiaoping took over right away and began economic reforms and openness, including the de-collectivization of the countryside and decentralization of controls in the industrial sector. Special Economic Zones (SEZs) allowed foreign investment to run basically in a capitalist system. Standards of living improved significantly in the 80’s, including increases in GDP per capita, life expectany and literacy rate. This path was continued by Zemin’s administration in the 1990s, raising average annual GDP growth rate to 11.2%. China’s technological progress also spurred, including a consistent space program. Some concerns include the impact of economic growth on the environment and the fact that some sectors of society are not benefiting sufficiently from the country’s development. This issues have been addressed by President Hu Jintao and Premier Wen Jiabao. Freedom continues to expand, but political reform will continue. China has the world’s second largest research and development budget and an estimated 1.50 million R&D personels. The Chinese government continues to place heavy emphasis on research and development.

1.3. Social, Political & Economic Context

The contemporary socio-economic situation in China is rather contradictory: in 2007 it reached the second largest GDP (PPP) in the world, but it had the lagging position by GDP per capita among the BRICS. Some key social indicators remain low and 10% of the population are below the poverty level; the higher education rate is far from developed countries. The population has expanded greatly as the birth rate has reduced but is still above the death rate. Population is expected to increase at a 5% rate in the next years and at a higher pace in urban areas, as the rural population is decreasing. As the government’s goal is to stabilize the population at the beginning of the 21st century, the one-child policy will be kept. Health conditions have improved: life expectancy is greater and the death rate of infants has gone down. China’s desease prevention and control system has been improved. China’s economy has spurred, but the gap between urban and rural areas has increased. The production of energy has increased 3-fold since 1978, but the main source is still coal and is usually below consumption,

128 especially due to oil. The trade balance has become positive and is increasing; however, exported goods still lack high technology. Economic growth owns to labor advantage, not to technology. To develop the economy in the long term, the first and foremost task China has to do is to improve its innovation capability

1.4. Cultural Aspects

Many ethnic groups have existed in China, although numerically the most important is the Han Chinese. From a historical perspective, Confucianism was the official philosophy throughout most of Imperial China's history. In recent years, a number of New Confucians (not to be confused with Neo-Confucianism) have advocated that democratic ideals and human rights are quite compatible with traditional Confucian "Asian values". With the rise of Western economic and military power beginning in the mid-19th century, non- Chinese systems of social and political organization gained adherents in China. The ideology of the Communist and Maoist movement beginning in the twentieth century is certainly crucial to understanding modern Chinese culture. Today, the Chinese government has accepted a great deal of traditional Chinese culture as an integral part of Chinese society.

1.5. Regional & Local Characteristics

China is divided into several types and levels of subdivisions. Basically, the administrative regions of China are divided into 3 levels: province, county and townships. China is composed of 34 administrative divisions directly under the central government: 23 provinces, and 5 autonomous regions, 4 municipalities and 2 special administrative regions. To balance the economic and social development, China has divided the 31 first level administrative regions into three large areas: Eastern Region (the largest economic area), Central Region, and Western Region.

129 2. Sub-System: Production & Innovation

2.1. Structure of Economic Activities

Today the most significance feature of Chinese economic activities is the rising of manufacturing industry, which labels "Made in China" due to the large manufacturing industry output products. The label can be seen on a huge range of goods from clothing to electronics. But another important challenge for the Chinese industrial system is that the products made in China often lack of core technology. China’s construction sector is the second sector which drives the economy strongly. It has grown substantially since the early 1980s The high-tech industry is so important that gains attention all over the country. The scale of China's high-tech industry continue to maintain high-speed growth in 2007, but the growth rate of it dropped significantly, compared with the last year.Now, China is the second largest high-tech exporting country in the world. In 2007, the gross value of China's high-tech industry output reached 5.0461 trillion yuan, the growth rate is 20.2 percent, which declined 2 percentage points compared with 2006.The contribution to the GDP of all the manufacturing’s growth is 10.7%. The added value of high-tech industries in China achieved 1.1621 trillion yuan, it increased by 15.6 percent compare with last year. China performs relatively high in Exports of high-tech share of world total, ranked as the second in 2005. And the share of high technology manufacture in the total national production value reached 20.46% in 2007. But compared to developed countries, China’s share of high technology manufacture in the total national production value is relatively low. This shows that China needs to improve continuously in the high-tech industries in order to catch up with the advanced countries.

2.2. Sectoral Distribution

The two most important sectors of the China economy have traditionally been agriculture and industry, which together employ nearly 70 percent of the labor force and produce more than 60 percent of GDP. The two sectors have differed in many respects. Technology, labor productivity, and incomes have advanced much more rapidly in industry than in agriculture. Agricultural output has been vulnerable to the effects of weather, while industry has been more directly influenced by the government. The disparities between the two sectors have combined to form an economic- cultural-social gap between the rural and urban areas, which is a major division in Chinese society. The primary sector of the Chinese Economy forms 11.7% of GDP (12.5% of the gross national value added) in 2006 and is mostly represented by agriculture. About 45 percent of China's labor force is engaged in agriculture. According to the United Nations World Food Program, in 2003, China fed 20 percent of the world's population with only 7 percent of the world's arable land. The secondary sector, composed mainly by industry (including mining, manufacturing and production and supply of electricity, gas and water) and construction, contributes 48.9% of GDP (47.5% of the gross value added) in 2006. China’s rapid industrialization requires imports of minerals, and the country hás many áreas of mining. Since the founding of the People's Republic, industrial development has been given considerable attention. Among the various industrial branches the machine-building and metallurgical industries have received the highest priority. These two areas alone now account for about 20–30 percent of the total gross value of industrial output. In these, as in most other areas of industry, however, innovation has generally suffered at the hands of a system that has rewarded increases in gross output rather than improvements in variety, sophistication and quality. China, therefore, still imports

130 significant quantities of specialized steels. China’s construction sector has grown substantially since the early 1980s. In the twenty-first century, investment in capital construction has experienced major annual increases. The tertiary sector represented by services is about 39.4% of GDP (or 40.0% of the gross national value added) in China. Its main components, contributing about half of the tertiary sector activities value added, are: Wholesale and Retail Trades (18.3%) transport, storage and post trade (14.5%), real estate transactions (11.4%) and Financial Intermediation (9.1%). China's services output ranks seventh all over the world, and high power and telecom density has ensured that it has remained on a high-growth trajectory in the long-term. However, its proportion of GDP is still low compared with the ratio in more developed countries, and the agricultural sector still employs a larger workforce. Investment is considered as a important factor of the innovation-driven growth. China's investment climate has changed dramatically with more than two decades of reform. In the early 1980s, China restricted foreign investments to export-oriented operations and required foreign investors to form joint-venture partnerships with Chinese firms.

2.3. Spatial Distribution

China's underdeveloped transportation system—combined with important differences in the availability of natural and human resources and in industrial infrastructure—has produced significant imbalances in the regional economies of China. The Eastern Region’s advantages in economy are so obvious that the same preponderant performance can be seen in sphere of innovation. Among various regions the innovative elements and performance behave very unbalanced. In fact, economic development has generally been more rapid in coastal provinces than in the interior, and there are large disparities in per capita income between regions.

2.4. Employment

In recent years, employment situation in China has been improved. The main employment indicators have changed year by year. First of all, the number of employed persons has increased at a stable rate from 73740 in 2002 to 76400 in 2006; meanwhile, the employment shares of secondary and tertiary industry have become larger, although the share of primary industry has been still the biggest (about 40-50%). Moreover, employed population from rural area has been 2-fold of that from urban districts. In addition, the average monthly real wage has improved at a faster rate than GDP per capita growth. Overall speaking, the labor productivity in high-tech industry has been higher than the average the labor productivity in manufacturing industry, but the growth rate in high-tech industry has been much lower. The average labor productivity in manufacturing industry has been growing by over 2- fold during 2002-2006; at the same time, that of high technology industry only has grown by about 60 percent. Productivity growth in high-tech industries has increased, though the growth rate differs from each other among various industries.

2.5 Size

Since 1979, the development of the private sector was allowed and it was permitted to compete with state firms in a number of service sectors, and increasingly in infrastructure operations, such as construction. Before 1998, the Chinese economy was dominated by the state owned enterprises. Over half of China's state-owned enterprises were inefficient and reporting losses. After reforms and

131 privatization, in 2005 the OECD estimated that the percentage of the private sector composition of GDP was 59.9%. Today it is important to understand the role and potential of innovation activity in different types of enterprises by scale. According to the calculation, there were 300 thousand enterprises above designated size in 2004, 32296 of which were large and medium-sized enterprises. According to the special investigation on innovation activities of China’s industrial enterprises carried out in 2004-2006, in the industrial enterprises above designated size, there were 86 thousand enterprises carrying out innovation activities, accounting for 28.8% of total. Of these 86 thousand enterprises, 2.6% were large enterprises, 19.2% were 19.2%, 78.2% were small enterprises, which reflecting the small enterprises have become a new force in innovation activities of China’s enterprises10. The innovation activities carried out by enterprises are closely linked to the scale of the enterprises. According to the survey, from the level of innovation activity, in large enterprises, enterprises having innovation activities accounted for 83.5% of total; in medium enterprises, it accounted for 55.9%; in small enterprises, 25.2%. From the level of R&D activity, in large enterprises, enterprises performing R&D activities as percent of total was 65.3%; in medium was 31.2%; and in small enterprises was 16%. From the level of R&D intensity, R&D expenditure as percentage of total sales of large enterprises was 0.97%, that of medium enterprises was 0.60% and that of small enterprises was 0.2%11. From above analysis, small enterprises accounting for most share of total enterprises above designated size having innovation activities, but the share having innovation activities of total small enterprises was quite less. In 2005, large and medium-sized enterprises accounted for 74.7% of total R&D expenditure from the enterprises, which shows that large and medium-sized enterprises still play an important role in innovation.

2.6. Informality

In the planned time, private economy was prohibited, so, there were space for some informal market such as agriculture products, undergrand market for house-using products. But since 1980s, this informal secoter began to be the formal part of the economy. But new phenomena developed in China: the corruption began as the “oil” for operating of some sector of economy, such as in construction project, housing project, etc. though the central government tried hard to control this, but correuption is still a big challenge for Chinese economy.

2.7. Innovative Effort

Compared with other countries, Chinese the inputs and outputs of innovation are poor. Different industries in China perform high variety in level of innovation activity. Most of innovation activities were concentrated on high- tech industries or medium high-tech industries. According to the special investigation on innovation activities of China’s industrial enterprises carried out in 2004-2006, intensive innovation activities are performed mainly in manufacture of medicines ( 63.8%), manufacture of measuring instrument, machinery for cultural and office work (60.9%), manufacture of special purpose machinery (46.6%), manufacture of communication, computer and other electronic equipment (46.5%) and other medium high-tech industries, while the weights of enterprises performing innovation activities in the traditional manufacturing industries and non-

10 http://www.sts.org.cn/tjbg/dzxqy/documents/2008/08111904.htm 11 http://www.sts.org.cn/tjbg/dzxqy/documents/2008/08111904.htm.

132 manufacturing industries were relatively low, i.e. the weight of manufacture of textile was 24.2%, mining 12.2% and production and distribution of electric power, gas and water 15.7%.

The innovation capability of China’s enterprises is low for China’s enterprises paying less attention to R&D activities, the relative inputs was very low compared to foreign counterparts, and most enterprises make profit on the basis of low cost such as cheap human resource, seek short-term benefits and prefer proven technologies, so they pay less attention to R&D activities to improve their innovation capability and dislike to cover the risks of innovation.

3. Sub-System: Capacity-building, Research & Technological Services

3.1. Education (Basic, Technical & Graduation)

Education system is a complex system providing human resources, knowledge and skills for the NIS. China’s education system could roughly be classified into 4 levels, namely preschool education, primary/elementary education, secondary education and higher education, which are comparable with the International Standard Classification of Education – ISCED (UNESCO, 2006). The first one, preschool education (equivalent of ISCED 0 – Pre-primary education) commonly consists of a stage of 3 years’ nursery education and a stage of 1-year preparatory education, but its successful completion does not mean that any level of education has been attained, and it is not compulsory. Primary/elementary education (equivalent of ISCED 1 – Primary education) is the first full-sense stage of compulsory education in China, both 5-year and 6-year system have existed for a long time, but now, almost all primary school is 6 years’ education. A successful completion of this level is sufficient to acknowledge that the primary/elementary education has been attained. The next stage - secondary education is somewhat more complex than that of most western countries, which has two stages: junior middle-school education (equivalent of ISCED 2 – Lower secondary education) and senior middle-school education (equivalent of ISCED 3 – Upper secondary education). The 3 years’ junior middle-school education is the second part of compulsory education, while the 3 years’ high middle-school education is not. For the high middle-school education, both general high middle-school and vocational school education (equivalent of ISCED 5B – Tertiary- type B education) exist. A successful completion of this level is sufficient to acknowledge that the secondary education has been attained. After this grade citizens can continue their learning of higher education (equivalent of ISCED 5A – Tertiary-type A education), which provides possibility of obtaining postgraduate education (ISCED 6 – Advanced research programs). Besides these levels of education, there are also students enrolled in other formal programs, such as employed people enrolled in doctoral and master's degree programs, etc. China’s enrollment in junior (equivalent of ISCED 2 – basic general education, lower secondary) and senior (equivalent of ISCED 3 – Upper secondary education) education is not high (this certainly have relation to do with the demographic structure of China). In 2004, it accounted for 788 students per 10,000 populations. The difference between junior and senior enrollment in China shows a certain demographic decline. The similar trends can be also seen in many other countries such as Russia, Mexico, Germany, etc. At the same time some countries perform a reverse proportion (e.g. Canada or Finland). Performance of the basic education in China can be illustrated by PISA survey. In 2006 China occupied 16th position of 56 by reading, 1st - by mathematics and 4th - by natural science (OECD, 2007). These are at very high positions, which mean China’s basic education system is one of the world’s best. Therefore PISA results are an exciting signal for the Chinese government and people.

133 In China, a higher education institution (refers to as HEIs hereinafter) is defined as an organization providing higher professional education in accordance with the state accreditation. There exist three types of HEIs: universities (multidisciplinary HEIs performing education programs and research in multiple domains of knowledge), academies (focused on particular areas, such as natural sciences, social sciences, agriculture etc), and “institutes” (providing education services in certain narrow areas, such as Chinese traditional medicine, music etc). Some key universities and institutes are directly under Ministry of Education or other state ministries, while the others usually under local government. In May 1998, China’s former president, Jiang-Zemin, put forward the famous “985 Program” at the 100th anniversary celebration of Peking University, which means China will develop a number of world-class universities in order to achieve modernization. By now, there are 34 universities including Tsinghua University and Peking University on the “985 Program” list. Today, the country has 1867 HEIs, of which 1591 are state-owned and 276 are private. From the discipline distribution of all HEIs, we can see that the HEIs in natural sciences & technology accounted for more than 40% of all, while the HEIs in social sciences (art, political science and law, finance & economics, language & literature) accounted for less than 20%. This implies that China put much emphasis on science & technology education in the last several decade years. In 2007, the total number of HEI students was 25.29 million (23.66 million and 1.63 million in governmental and private HEIs respectively). The scale of higher education in China is now among the biggest in the world. After obtaining a Certificate of Complete Secondary Education a student can take higher education entrance exam to enter a University or an Institute (College). There are three different degrees that are conferred by Chinese universities: The first degree is the Bachelor’s degree. Bachelor's programs regularly last for 4 years of full-time university-level study except medical students (who need 5 years). The programs include professional and special courses in Science, the Humanities and Social-economic disciplines, professional training, completion of a research paper/project. The Bachelor's degree is awarded in all fields. Some students who don’t pass the higher education entrance exam can choose to attend adult HEIs (need only 3 years) and pass the final exam for another 2 years’ study to apply for bachelor’s degree. Holders of the Bachelor’s degree are admitted to enter the Master's degree programs after passing the entrance exam, and only very small number of bachelor students who have got excellent performance during their undergraduate studies can be admitted to master’s degree program without examination. The Master's degree is awarded after successful completion of two or three years' full- time study (some of HEIs’ master program is still 3 year’s while some have transformed into 2 year’s education, depending on different HEIs and different disciplines). Students must carry out 1- year’s research including practice and prepare and defend a thesis which constitutes an original contribution. Often students have to release at least one academic paper before they can get master’s degree. Besides higher education, secondary vocational education (in China, this term consists of Regular Specialized Secondary Schools, Adult Schools, Vocational High Schools and Skilled Workers Schools) is also enough to obtain profession (for most of blue-collar jobs including technical). However, now in China, enrollment rate on this level is much lower than that of higher education. In the 1980s and 1990s, the social and economic development in China was very rapid; labor force was well in need. At that time, secondary vocational education was glorious in China. Many students would rather go to these schools than senior general schools because it is easy for them to find a job after secondary vocational education, and it is a quick way for them to obtain profession compared to higher education; the enrollment rate of secondary vocational education is high compared with senior general education and higher education. However, in the new century, the competition in labor market is more and more fierce. College students are no longer the “unusual

134 favorite person” in the society, and some of them in turn become blue-collar job hunter who was formerly the role of vocational graduates. And it becomes harder for vocational graduates to find jobs; students are no longer eager to enter secondary vocational schools. So, the enrollment rate of vocational schools decreases relative to higher education. In recent years, the higher vocational education had emerged in China and has developed very quickly in the last five years. The higher vocational education is part of 3-year short-cycle higher education. The aim of this level education is to cultivate higher technical workers. Higher vocational education colleges are now partly replacing the role of secondary vocational schools. From recent year’s statistic data, we found that the employment rate of higher vocational education colleges (especially in some hot specialty) is growing year by year and had nearly exceeded the employment rate of general college’s 4-year bachelor students. This implies that the education system has developed with social and economic development. In a long period time before liberation, China's education system had a strong feudal color, only the upper class have the right to be educated. Since PRC was founded in 1949, all Chinese people gradually got the equal chance to be educated, the reform of China's education system has also made tremendous achievements, during which the structure of China's education system continues were improved. For example, in the year 1949, the number of enrolled elementary school students, junior middle school students, senior middle school students and college students are only 24,000,000, 952,000, 315,000 and 117,000 respectively. The enrollment ratio of school-age children is only about 20%, and 80% of Chinese population is illiterate at that time. However, in the year 1977, the number of enrolled elementary school students and junior middle school students had attained historically high of 151,000,000 and 49,900,000, which is respectively 6.2 times and 52.5 times of those in 1949. The number of enrolled senior middle school students also reached about 19,000,000, which is 60 times of that in 1949. Looking back to today, the achievements is obvious: the 9-year compulsory education has basically become universal; the net enrollment ratio of school-age children in primary schools has reached 99.49%; the gross enrollment ratio of junior middle school students has reached 98%; the promotion rate of senior school graduates has reached 75.1%; the facilities conditions of primary and secondary schools are further improved, for example, their building area has reached 1,353,200,000 square meters, which are also full equipped with physical, musical, art and natural science educational instruments. By the end of 2007, there are more than 2,300 HEIs in China (including general HEIs and adult HEIs) and about 27,000,000 students ahve attended China's different kinds of higher education, and the gross enrollment rate of higher education has reached 23%. The postgraduate students enrolled have reached 1,200,000. Besides the government-owned educational system, there are also many private schools in China. In 2007, there are 95,200 private schools in China ranging from preschool education to higher eduacaiton as well as vocational school. The development of China's education system had been influenced to some extent by former Soviet Union. For example, for a long time, China's charging system had followed the "free education" system of Soviet Union. However, during the 1980s, China was transitting from planned economy to market economy, the notion of "free education" as the basic feature of socialistic education was subject to many queries. The reform of the charging system gradually implemented. The scope of education charge had gradually extended and amount of education charge had continually increased. Higher education made her farewells to free education and elementary education also transformed from gratuitous education to payed education. At present, the charging of post-graduate education had also actulized in some HEIs where different kinds of scholarships and subsidies are to compensate for tuition fees. With the development of higher education, the quality of college teachers in China has also increased. The proportion of regular HEIs teachers with doctor's degree and master's degree is continually increasing in the past decade. In 2006, teachers with doctor's degree in general HEIs had accounted for 10% of all general HEIs teachers, which indicate a rise in qualification of Chinese HEI

135 teachers. Especially in recent years, the competition between HEIs has been more and more fierce, so does the competition of talent HEI teachers. HEI teacher cadidates are required with better quality. PhD degree is a necessity but no longer insurable for a college teacher title. Besides teaching, resaerch ability has more and more brought into consideration. More and more HEI teachers perform R&D besides teaching affairs especially the teachers in HEIs with post-graudate education. In these post-education HEIs, graduate students and young teachers are the main R&D labor force. On the other hand, with the development of higher education, the age structure of college teachers is growing equitable. In 2006, all the HEI teaching staff younger than 30 years accounted for 30%. Professors and Associate professors older than 60 years only accounted for 14% and the age of most Professors and Associate professors have centralized around 30-50 years especially around 41-45. This implies the young energy of Chinese higher education compared with Russia where the young teachers (younger than 30 years) accounted only for 16% and more than half of professors were older than 60 years. In China, the average annual salary in the higher education sector is 63% higher than the national economy average level in 2006. This implies that higher education sector is relatively a high paid sector in China. Only the information, computer and software sector and the finance sector are beyond the sector of higher education in their salary level in 2006. However, the salary level of primary education and secondary education is lower than the national average level, which is the reason why State Council of China had recently promulgated some measures to increase the salary level of primary and secondary education to promote social equity. High salary level of higher education sector is partly the result of high expenditure on higher education. In 2005, the total education expenditure is 255 billion RMB, however, the expenditure on higher education per student in China is only 559 RMB (calculate according to indicators of education in China), which is much lower than developed countries such as United States, United Kingdom, France, Canada, and also is much lower than Russia which is about 3.6 thousand $ PPP in 2005. (If calculate with only general HEIs students, the expenditure on higher education per student in China is 15,364 RMB, which is still much lower than developed countries and lower than Russia). Chinese college teachers also earn money form R&D projects. The total R&D fund raised by HEIs had attained 619.67 billion RMB in 2006 and the growth rate of R&D fund maintained 20% in the last five years. However, there is an obvious inequity among college teachers in earnings from performing R&D. “Big professors” have both social resources and academic ability raising R&D fund and undertake national R&D projects thus could earn a lot from R&D project while young teachers/lectures often lead a “simple” life.

3.2. Post-Graduation

After Bachelor or Master's degree, a student may enter a university or a scientific institute to achieve postgraduate education. Students who have got master’s degree could apply for doctor’s program and usually they need to take an exam just like the higher education entrance exam and master’s degree program entrance exam. The exam includes two chief subjects, foreign language and mathematics. Only very small number of master’s degree student can be admitted to doctoral degree program without examination for their good performance and great academic potential in their master degree program. The seeker of PhD student should participate in 1.5 or 2 years’ course study, pass the quality exam, publish at least three or four scientific articles in top peer-reviewed journals, obtain important scientific results, write a thesis and defend it, the doctor of sciences degree can be awarded. The time between obtaining candidate and doctor degrees is about 3~5 years or more, and the requirements to get PhD degree are more and more stringent in China. Doctor of sciences may hold the position of

136 assistant professor in universities or researcher in scientific institutes, and some of them also enter industries. China’s postgraduate education started from 1981, and has grown very fast, and the enrollment number of post-graduate education is continuous increasing. In 2006, the total enrollment number of post-graduation students is 1,104,653, of which 208,038 are PhD students. Although generally the relative proportion of post-graduation students to undergraduate students is still low, the absolute number of post-graduate students is by no means rapidly increasing, which provide China’s social construction and development with tremendous advanced talents. Especially in some research- oriented comprehensive universities, such as Tsinghua University, Peking University, University of Science and Technology China, the proportion of graduate students has nearly surmounted undergraduate students. Besides regular HEIs, research institute is another force providing post-graduate programs in China, and Chinese Academy of Sciences (CAS) is a typical one. The Graduate University of Chinese Academy of Sciences (GUCAS) is known as the biggest post-graduate education instituts in the world. By now, GUCAS has more than 30 thousand enrolled post-graduate sutudents which accounts for more than 3% of all the post-graduate students in China. (PhD students account for more than 8% of all PhD students in China).

3.3. R & D

In recent years, China’s R&D expenditure has expanded rapidly. In 2007, the R&D expenditure amounted to 48.79 billion US dollars, which is 11.12 billion US dollars more than that of 2006. Moreover, this number has surpassed that of Britain and France for the first time, and made China rank 4th in the world in 2007 in terms of R&D expenditure. However, concerning with the R&D expenditure, the gap between China and the top three countries has remained very large, as that number in 2007 of USA, Japan and Germany respectively accounted to 343.7, 148.5, 73.8 billion US dollars. It is usually considered that high level of R&D intensity is an important guarantee of innovation capability. According to the intensity of R&D input, which is usually measured by the rate of R&D/GDP, this ratio began to improve rapidly after 1999. It accounted to 1.49% in 2007, and took the first place among developing countries. But there still exists a wide gap between the R&D intensity level of China and that of developed countries, since the ratio in most developed countries were more than 2% in 2007. R&D funding resources in China are enterprises, government and other institutions. Enterprises are the main funding resources, whose R&D funding accounted for 70.4% of the total R&D expenditure of China in 2007. The ratio of R&D funding of enterprises in most developed countries were more than 60% in 2007, and China’s R&D funding distribution is similar. In addition, enterprises are also the main R&D performer in terms of R&D activities. In 2007, R&D activities performed in enterprises spent 72.3% of the total R&D expenditure of the country. In 2007, the basic research funding in China was 2.29 billion US dollars, which increased by 0.34 US billion dollars than 2006, but the basic research funding proportion of the total R&D expenditure was only 4.70%, which only accounted to less than half of developed countries. During the past years, this proportion has been remained stably at about 5%. The number of Chinese R&D personnel has increased rapidly in recent years. It achieved 1.50 million in 2006. Moreover, the number of scientists and engineers reached 3.13 million, which increased at a rate of 11.8% than that in 2006. In addition, the amount of scientists and engineers during 10 thousand working people has increased to 39.8 in 2007.

137 Enterprises, research institutions, and universities are the main R&D performer in China. In 2007, the distribution of R&D personnel in the three sectors was: the ratio of R&D personnel in enterprises was more than 2/3 and such ratio in research institutions and universities was totally less than 1/3. The increase of the amount of R&D personnel mainly owns to the enterprises. In 2007, the number of R&D personnel in China increased by 234 thousand, among which 162 thousand came from enterprises. In the same time, the increasing rate of the number of R&D personnel in the country was 15.6%, while that in enterprises was 23.3% In terms of the R&D personnel input, enterprises had become to play the main part in China’s R&D activities. In recent years, China’s imports and exports of high-tech products have been increasing rapidly and the exports have gradually exceeded the imports. This may indicates that Chinese S&T capability has been improved. Furthermore, the high-tech industrial output has increased greatly, and the economic profits have also been improved. Thus we can see that the R&D inputs, including funds and personnel, have made the technology enhanced and brought forth great profits. But the high-tech enterprises in China are much weaker than that in advanced countries, as China’s technology still needs to be improved by learning from advanced countries and developing innovation capabilities. One of the serious challenges Chinese companies are facing is that they are still pursuing a cost advantage strategy, spend relatively little on R&D. Large and medium sized companies have continuously increased their R&D, but still remains at a low level. In 2005, R&D spending relative to sales was only about 0.76%. Secondly, a surprising fact is that many large and medium sized companies have reduced their R&D labs in those years; the reasons for these phenomena may be out of merging, joint venture and ownership transformation which made them to cut off their previous R&D labs. Thirdly, the total number of business R&D personnel has increased from 294,000 in 1995 to 883,100 in 2005, with an annual growth rate of 12.4. Its share in total R&D personnel is about 64.7%. But since 2001, the share of key scientists in business R&D personnel has been flattening at about 37.25%, with no obvious increase. It means that even now, the R&D activities of businesses are still not an attractive place for leading scientists compared to universities and GRIs (Government Research Institutions).

3.4. Intellectual Property

About 351.8 thousand patent applications have been filed in China in 2007, including 301.6 thousand by domestic and 50.2 thousand by foreign applicants. Both the number of patent applications filed by China and foreigners over the last several years shows a steady growth. The geography of foreign applicants is represented more than 100 countries. Most of the applications were filed by OECD citizens, and their share reached more than 95% in 2007. It is to note that the most active applicant countries are all OECD countries (including Japan, USA, Korea, Germany, France). At the same time, the number of applications filed in China amounts to 6.16 times of all applications filed by the OECD applicants abroad. The distribution of domestic and foreign patents granted that mention China in three types of patent (invention, utility model, design) reflects the acute problem of China - while the difference of the number of invention patenting and that of domestic invention patenting is narrowing every year, the designs and utility models still dominate the patents granted, which indicates low competitiveness of domestic R&D products. And China’s applications for patents abroad are quite lower than USA, Japan and other main dynamic countries in the global patent field. Comparison of patent statistics for various countries faces much difficulty due to specific features of patenting procedures such as verification and local legislation and so on. To make comparable analysis on patent activities, the patent applications of PCT at WIPO are considered

138 separately for their top priority in patent application. The number of PCT patent applied by Chinese applicants varied from 322 in 1998 to 5470 in 2007, the growth rate is very high. But the number of Chinese patent applications was very small compared with USA and Japan. In 2006, the value of contract deals involving licensing and cession of patents and other technology transfers in domestic technical markets reached 32.13 billion RMB with a reduction of 3.87 billion RMB compared with the figures in 2005, but the average value of the contracts increased to 2.77 million RMB by 1.1 times. Combined with the value of other type contracts including technology development, technology consultation and technology service, the value of contract deals in domestic technical market reached 181.82 billion RMB with increment of 17.2% in 2006. The number of the contract deals on electronic and information technology was 63,155 accounting for 30.7% of total contract deals and the value of these contract deals reached 66.23 billion RMB ranking first in every technology field with 36.4% of total value; the contract deals on advanced manufacturing technology was 19,222 items, and the value of these deals was 29.71 billion RMB ranking second; new energy and high-efficiency energy-saving technology, modern traffic technology achieved value of 16.22 billion RMB and 15.53 billion RMB contract deals respectively, ranking third and fourth in rating. Chinese technology trade in the world market shows growth both in terms of turnover and geographical spread. The number of countries technology imported from increased to over 60 countries and areas in 2005(in 1997 it was 15). The value of technology contracts grew from 15.9 billion USD in 1997 to 19 billion USD in 2005. Manufacturing was the main industry importing technology, and the value of technology contracts imported by it was 10.9 billion USD, occupying 57.3% of total value. And the technology was mainly imported through importing complete set of equipment, key equipment and production line, patent technology licensing and transfer, and technology consultation and service accounting for 79.59% of total value. The value of importing through complete set of equipment, key equipment and production line was most - 5.3 billion USD, reflecting most attention is paid to technologies of direct application. The exports and imports of high-tech products also reflect the technology trade of one country. China’s exports and imports of high-tech products grew by 5.68 times between 2000 and 2005, and reached 415.9 billion USD in 2005. And its percentage of imports and exports of total manufactured goods increased from 19.8% to 33.9%. From the aspect of technology types, the imports and exports of high-tech products was still centred in computers, telecommunications, and electronics. The exports and imports of products of these fields accounted for 87% of total imports and exports high- tech products, while the proportion of other high-tech such as biotechnology and material and so on which are also very important for the national development is very low. The exports of high-tech products in 2005 reached 218.24 billion USD with the growth of 32.0%. The proportion of exports in the three fields reached 92.4%, especially the proportion of exports in computer reached nearly 50% (48.04%), mainly due to substantially exporting automatic data processing equipment, monitors, printers, drivers and other products. But most of the exports were from the processing trade for imported material, accounting for 75.1% in 2005, 87.3% of which was from computers and telecommunications and reflecting the technology innovation capability of enterprises was very low. The imports of high-tech products reached 218.25 billion USD with the growth of 22.5%. The imports of high-tech products in computers, telecommunications and electronics reached 81.5% of high-tech imports, and electronics accounted for 51.0%, most of which was integrated circuits and printed circuits. The imports of integrated circuits accounted for 41.1% of total high-tech imports. The active balance of high-tech trade in 2005 was 20.54 billion USD, which was 5 times as many as that in 2004. Most of the active trade balance of high-tech trade came from computers about 70.54 billion USD and telecommunications about 46.23 billion USD. The electronics contributed to the most trade deficits about -76.40 billion USD.

139 4. Sub-System: Policies, Representation & Financing

4.1. Explicit Policies

The central government plays an important role in the development of national innovation system in China even though the market force has been an increasing countervailing force. Government agencies at different levels have control of land, large investment projects, infrastructure development, and market accesses to some strategic industrial and service sectors such as automobile industry and financial services. Besides the policy of technology importation and “market for technology”, the most important technology policy is Chinese high-tech policy. The main policy tool for high-tech industry is National High-Tech R&D Program (863 Program), launched in 1986 with the aim of tracking and catching up with the development of high technology of developed countries, both for defense and civil ends. Funding this program added up to 15 billion RMB from 2001 to 2005, and it achieved great output in terms of patent and scientific papers: the former rose from 108 in 1999 to 3106 in 2005, while the latter grew from 1629 to 9830 in the same period (only English papers considered). Besides “863 Program”, China has developed a system of national R&D programs to support innovation activities, summing over 25 billion RMB in funding. The Chinese government has adapted various important policy instruments to encourage innovation activities and promote technology transfer as well as its commercialization. One of the most important policies is to establish special enterprise zones and incubator facilities to develop high-tech industries in China, which started at the end of 1980s by following the Silicon Valley model. There are 53 high-tech development zones at the national level. The first one, ZhongGuanCun high-tech zone, was established in Beijing in 1988. The high-tech zone policy objectives include establishing infrastructure facilities; provide tax reduction for high-tech firms; create new governance models with small government to reduce costs; and establish clusters in order to promote interactions among firms. These zones expanded rapidly in the last two decades: nowadays, more than 90% of high-tech firms and incubators are located at one of them. In 2004, the total added-value of high-tech zones reached USD 66.4 billion, accounting for about 8.8% of GDP, and exports make up about 12% of total Chinese industrial exports. The first business incubator in China was established in 1987 in Wuhan. By 2005, more than 490 incubators had been created across the country. Regarding the ownership of IPR, some steps have been taken to facilitate the commercialization of R&D products. First, IPR resulting from government-funded R&D projects can be commercialized. Second, the ownership of this IPR can be transferred to the university that conducted the project, instead of being government-owned. Third, investor are entitled to royalties. As many policy tools have been used in China, one may ask the impact of them of long-term growth, specially as of 1978. Different ministries decide over S&T and innovation-related policies (ST&I): the ministry of science, the ministry of education; the ministry of commerce and the National Development and Reform Committee; and other specific agencies. The national program is one of the most important policy tools in China, not just for the reason of funding. In China, the main contractors for the government program are universities and GRIs. Besides that, other regional and industrial funds usually have their own regional projects.

4.1.1 Science Policy

In China, there is little space for curiosity-driven research. S&T was generally viewed as a practical economic activity. The share of R&D budget and human resources for basic research is increasing gradually, but it is still quite low compared with developed countries. In addition, most of

140 government funds for basic research are spent on targeted limited areas such as biology and nanotechnology with strong practical purpose. Before 1980s, the major actor for basic research was government research institutions, but since then universities have become more and more important. Two important organizations to support science at a national level are the National Science Foundation and the Basic Research Beroa. Most regions have local science foundations systems aimed at regional needs.

1. Actor for Scientific Research

Before 1980, GRIs was the main player in China’s S&T system, each with a different `mission. From 1950s to 1980s, China had established different layers of GRIs with various missions. At the national level, the most important GRI is Chinese Academy of Science (CAS), focusing mainly on basic research. There were also hundreds of industrial and regional research institutes that had specific demands. Back then, enterprises used to do no R&D. Only some large state-owned enterprises had their own R&D labs, but their work mainly focused on experimental issues. Most universities were not involved in research, or were only focuses on industry specific technology. Following the dramatic S&T system reform, most GRIs have become enterprises and universities have been given a more important role in science.

2. Policy Tools for Basic Research

The are mainly five policy tools for basic Research. The first is the National Science Foundation of China (NSFC), which plays a unique role in China’s science system. It’s the backbone of China’s science system. It operates in the form of peer-review rather than government plan and has promoted much curiosity-oriented R&D. Resources come mainly from the government budget. The second is the National Basic Science Program (“973 program”) is a national mission- oriented program for big science and transnational cooperation, launched in 1997 in order to strengthen the role of government in science. It targets areas such as energy, information and health. The Knowledge Innovation Program (KIP) was launched in 1998 and its main goal is to make CAS the world-leading research center. With this meta-project, CAS has been reorganizing itself to develop core competence against university. The Talent People Policy is also very important in promoting basic research and aims at attracting talented scientists to China, with special grants for returnees. Also important in measuring a country’s scientific output are the Publications and paper citations. Since 1990s, papers published by Chinese scholars both in English and in Chinese have been increasing rapidly. In terms of SCI, China has already been the 5th in SCI in the world. The size of R&D is increasing both in grand and human resources. Universities are expanding and China has the largest human resources for R&D in the world.

4.1.2 Technology Policy

1. Technology Import: until the 70’s, the aim of technology policy was to cover shortage of technology and strengthen China’s military force. Then China began to emphasize independent technology development due to the broken alliance with the USSR, though imported technology still played a very important role at that time, which laid down the foundation of many industries in the country. But the absorbing capability of Chinese firms is still rather poor. 2. Market for Technology: this policy became a practical technological policy in the 80’s, though the government never formally used the term due to ideological restrictions to foreign capital. The government used the big market to press foreign companies to transfer the technology to

141 local companies and to protect the local companies from international competition. This policy of “market for technology” was stopped by the entry of China into WTO. After entering into WTO, foreign wholly-owned firms became the main way for multinationals to investment in China, while joint ventures have been very controversial 3. Encouraging Multinationals to Set Up R&D center in China: the Chinese government tried to use cheap R&D human resources in order to take advantage of the new trend of globalization of R&D driven multinationals. Special policies were set to attract multinationals, but it seems that the spillover effect of FDI is very low – the R&D system of multinationals in China is essentially cloed, with no linkage to the Chinese innovative system. 4. High-Tech Zones: the purpose of high-tech zone was to establish well-functioning infrastructure to serve as a platform for innovation and interactions among university, research institutes and firms. These zones have expanded rapidly in terms of size and scope of activities and play an important role in the development of high-tech industry. 5. Special Industrial Policy: some policies were implemented to foster the development of some strategic industries, including leading innovative companies. 6. Actors of Technology Policy: since the 1980s, state-owned enterprises were given more autonomy to invest and innovate, and millions of SME were allowed to be set up be entrepreneurs. This wave of privatization and competition provided enterprises with the motivation to invest in product development and innovation on top of exploiting cost advantages or diversification. But generally, their level of R&D is still very low compared with other companies in developed countries. This is why, in China, companies introduced more incremental innovations and few radical innovations.

4.1.3 Innovation Policy

In China, the innovation policy was born to break the high barrier from R&D outputs to its commercial application. The planed economy gave GRIs and universities the freedom to do their own research without caring much about technology application. The traditional system is more close to the linear model of innovation. The market-oriented policy pressed the S&T system to operate by satisfying economic demands. Variety of innovation policies were brought forward since then. 1. Spill-Off Policy: in order to speed up the process from scientific research to commercialization, in 1980s, Chinese government began to encourage GRIs and universities to set up their own spin-offs and scientists to leave their research position to engage in commercial activities. Though the size of spin-off business has been small compared with that of Chinese industry, it was valuable to high-tech industry in China as it gave birth to a lot of domestic dynamic high tech companies. 2. Indigenous Innovation: the “National Program 2006-2020 for the Development of Science and Technology in Medium and Long-term” is the current long-term innovation policy framework in China. The most interesting element of the new plan is the declared intention to strengthen “independent” or “indigenous” innovation. The essence of this policy is to strengthen the innovation capability of domestic companies. The main ways for indigenous innovation are: original innovation based on basic research; integrative innovation and second innovation. It’s based on three factors: the economic growth of China has been dependent on foreign technology and FDI; the culture of imitation is common in the field of scientific research; and lastly, the pattern of high growth rate of the Chinese economy in the last twenty years will not be sustainable without a dramatic change for next twenty years. The government plans to increase R&D to 2.5% of GDP by 2020 and to set fiscal policy to activate innovation capability at the firm level. Also, public procurement shall set priority for innovative products.

142 The new public procurement policy shall set priority for innovative products. Also, domestic products must be favored, and purchases from foreign companies will demand them to transfer technology. A system of procurement and innovation will be established in order to let the government purchase domectic innovative products that have a large potential market. Lastly, innovative products shall have some price advantage in procurement.

4.1.4 Regional Perspectives of S&T and Innovation Policy

China, as a large country, has different regions with different cultures, geographic situations and resources. This kind of diversity is also very important for national innovation. Historically, the north-east part used to be the core industrial base of China with heavy industries and important technologies imported from Soviet Union. The diversity of innovation across the country also have owned to the decentralization of decision-making over both resources allocation and operational decisions from 1980s. One result but also a serious challenge in the R&D activities of China after decentralization is the large regional S&T disparity. Being aware of the divergence among regions and the risk that the gap will increase further, the central government launched the “go west” strategy in 2000, aiming at energizing the less developed regions through a combination of fiscal, regional, FDI- and S&T policies.

4.1.5. Discussion of Policy Implication in China

S&T and innovation policy has been a very important policy for China to become a real powerful country in the world. The traditional S&T policy has been gradually replaced by a market-based one within allowance of WTO. The following three dimensions of S&T and innovation policy-making still matters very much in China. Firstly, supply via demand. Overall and in S&T, demand policy is weak compared with supply side policy. But there is a large gap between what academy produces and what the industry needs. Secondly, domestic via global. Since China’s open to the world, FDI became a new force in Chinese innovation system, but it’s still controversial as spillovers effects are low. The protection of infant industries is still one big question. Thirdly, centralization via decentralization. The latter is an ongoing trend in China and makes innovation more diversified, but enlarges the regional gap. Lots of challenges exist in the near future. Science itself is too strongly driven by practical goals, generating short-sighted research. Firms are too weak in the system of innovation. Lastly, IPR is still a large problem.

4.2. Implicit Policies

Sustainable development of innovation economy should be based on both direct and indirect motivation. Direct motivation is usually implemented by government subsidies and government procurement. Meanwhile, indirect motivation often includes tax incentives, special treatments for property depreciation, and etc. preferential policies on tax is usually considered as a main effective and sensible stimulation for innovation. China has gradually formed a set of preferential tax policies to encourage enterprises to exerting technological innovation. These include tax reliefs for innovation activities and cost deduction for inputs in the development of new products, among other policies. The role of tax incentive policies is to promote the production, application, and knowledge inter- flow, so the effects of such policies are related to all aspects of knowledge flows. There are 8 tax preferential policies aimed at stimulating R&D investment, 12 policies for technology transfer and application, 5 for commercialization, and 3 for workers’ education and training. So the incentives for R&D activities and commercialization are somewhat in shortage. These policies are mainly used for

143 high-tech enterprises which have already developed very well, but enterprises which need to upgrade the backward technology urgently can not enjoy the preferential policies. China’s referential tax policies aim at different objects. There are 33 policies aiming at enterprises, which accounts for 33.33% of the total; and for research institutions and universities, the number is 29 and take a 29.29% share; for individuals, that is 28 and the percentage is 28.28%. Thus we can conclude that enterprises, which should take a dominant role in NIS, have not benefit enough from tax policies. China’s existing preferential tax policies for stimulating innovation has been playing an important role in enhancing scientific and technological innovation environment, guiding social capital and human capital to invest on R&D, strengthening enterprises’ technological innovation capacity, and advancing the development of high-tech industries. In recent years, innovation oriented corporation has expanded greatly, that may partly because of the preferential tax policies. However, there exist some problems on the tax issues. First of all, the focus of preferential tax policies is not very clear, because the existing tax policies are usually aimed at certain types of projects which were brought forth to apply to temporary need, and the policies can not coordinate with each other so that there is no systematic planning and orientation. At present, China’s preferential tax policies are mainly concentrate on stimulating the transformation of R&D achievements, meanwhile, the efforts exerted on the pre-, mid- R&D are relatively poor. In summary, the current preferential tax policies lack overall industry orientation. Moreover, because such tax policies often tend to give incentives to certain innovation activities, the policies are easy to change as new needs occur all the time. The lack of stability and continuity is another problem of current tax policies. These two defects may be the focus of tax policy reform so that tax preferential items can serve more efficiently to innovation activities of enterprises, research institutes, universities, and individuals.

4.3. Regulation

Before the 1980s, most of science and technology policies were just aimed to prompt the development of the science and technology, and build up the system of science and technology. The majority of science research was focused on military-related projects, which were centrally planned and appropriated by the government. The weak in-house R&D capacity of enterprises and the segregation of S&T system away from industry resulted in a limited scope and range of industrial research activities. Since the 1980s, China has reformed its system of S&T greatly. Policies have been enforced to improve its innovation capabilities, strengthen the basic research and frontier technology, and construct the efficiency linkages between industry and science. Though great achievements in science and technology have been achieved during the past 20 years, the development of science and technology has faced great challenges and difficulties, and problems also appeared during the economic development in those years. In this circumstance, Chinese government has framed the Medium and Long-term Development Plan for Science and Technology to establish key fields in national economy and social development. In China, the establishment of key fields of S&T is based on the national situations and needs, then according to the specific condition, their priorities are selected to achieve recent breakthrough. The key fields are specified in the “Guidelines on National Medium- and Long-term Program for Science and Technology Development (2006-2020)”, so the efforts to select S&T key fields were undertaken in the process of constituting the guidelines, which can be divided into two phases: the strategic research and drafting the guidelines. The strategic research was carried out after the startup of the guidelines according to the State Council’s overall deployment. The strategic research comprised of 20 topics, which can be classified into three parts: the macro-strategic research, the research on major tasks of scientific and technological development, and the research on inputs and policies environment of scientific and

144 technological development. More than 180 projects were set under these 20 topics, and over 2000 experts from industry, science and technology, and social sciences participated in this strategic research, finally the results of this research formed a general report. In the phase of strategic research, forum on strategic research with over 200 experts taking part in, named “China’s Science and Technology toward 2020 - the International Forum on National Long-term Program for Science and Technology Development” and other 300-person-scale meetings such as the startup meeting of topic research were held. In order to promote public participation in the process of constituting program, governemnt responsible for the program set up special website and column in relevant press media. From Dec. 2003 to Jan. 2004, the first intensive research was carried out for 40 days, and the comprehensive exchange with the State Council's nearly 40 departments, trade associations and more than 100 enterprises were also organized during this research; in April 2004, the second intensive research was carried out for two weeks; in May and June 2004, a two-month "There Academies" (that is, the Chinese Academy of Sciences, Chinese Academy of Engineering, Chinese Academy of Social Sciences) advisory work was carried out, the views of various departments and the regional views were investigated; On this basis, during July 13-24, 2004, the third intensive research was carried out. On the basis of strategic research, in August 2004, the draft of "Guidelines", was formally launched. Members from Ministry of Science and Technology, National Development and Reform Commission, Ministry of Finance, Defense, the General Armament Department, Chinese Academy of Sciences, Chinese Academy of Engineering and other departments and units, as well as some key universities, research institutes, large and medium-sized enterprises contributed to work out the “Guidelines”. Some experts who participated in the strategic research also contributed to the draft. The draft experienced five stages: prophase preparation, framework design, tasks compacting and policies carding, draft formation and soliciting the views, which lasted over 1 year, and has been modified 20 times. On January 6, 2005, the "Guidelines (Draft)" was delivered to Chinese Academy of Sciences, Chinese Academy of Engineering, and Chinese Academy of Social Sciences for consultation, and was submitted to the members of the leading group of this program and members of expert advisory group for comments. Meanwhile, the views of relevant departments of the State Council were solicited for several times. The research and constitute of matching policies related to the “Guidelines” was initiated at the same time with drafting the guidelines. According to the instructions of the State Council, the research and constitute was launched at the beginning of June 2005. the Ministry of Science and Technology, National Development and Reform Commission, Ministry of Finance, Ministry of Personnel, the People's Bank of China —— five leading departments and the departments related under the unified arrangement of the State Council and Program Office participated. 12 policy- maker groups were established, in which 200 experts from the 25 departments took part. With over half years’ efforts, a series of powerful, breakthrough and operational policy measures were put forward to guarantee the implementation of every tasks and fulfillment of objectives in the “Guidelines”. At the end of 2005, The State Council issued the “Guidelines on National Medium- and Long- term Program for Science and Technology Development (2006-2020)”. In the process of constituting the “Guidelines”, great attentions were paid to learn from other countries’ experience and practice; more than 10 countries’ science and technology development programs and plans were investigated with emphasis; young oversea scientists were invited to ask for advices; close join with the "Eleventh Five-Year" national economic development plan and participation of enterprises were stressed, convening over 10 forums with sectors (industries), regions and a variety of enterprise representatives taking part in, and nearly 600 business representatives directly involved in this constituting process.

145 Based on China's conditions and needs, the “Guidelines” layouts several key areas and their priorities to achieve major breakthroughs in critical technologies and enhance the capacity of scientific and technological support, in order to solve the pressing problems in economic and social development. The “Guidelines” asserts 11 key fields in the national economic and social development, and 68 priorities are selected out in the fields. The key fields refer to the industries and sectors in national economy, social development and defense security requiring development with emphasis and crucial scientific and technological support. Priorities refer to the technology groups in key fields with clear tasks and better technical basis, which require crucial development and in which recent breakthroughs can be achieved. Priorities are selected through the following principles: firstly, they are conducive to break through the bottleneck and improve the capacity of sustained economic development; secondly, they are conducive to master critical technologies and common technologies as well as enhance the industrial core competitiveness; thirdly, they are conducive to solve major public scientific and technological matters, and improve the capability of public service; fourthly, they are conducive to develop dual- use technologies and improve the capability of national security. In the energy sector, the first key field, priorities concern energy conservation for industrial production, including clean and efficient use of coal; exploration of oil and gas in complicated geological conditions; renewable energy; and security of large-scale power transmission. Priorities for water and mining resources include the optimized distribution of water resources; desalting of sea water and prospecting new reserves; and the efficient exploration of mining, maritime and oceanic resources. Environmental priorities aim at controlling pollution and recycling wastes; and protecting and restoring vulnerable ecological areas. Agriculture priorities include the exploration of seed resources, including health and disease control, and the comprehensive exploration of biological resources of agricultural and forest industries. In manufacturing, some areas that will be focused are environment-friendliness and automation of integrated industrial production and equipment; and recyclable and integrated process and equipment for iron and steel production, a relevant industry in China. The transportation sector will focus on technology to build and maintain infrastructure and new- energy automobile, as well as intelligent traffic management systems and safety support. The information industry priorities include both large applicable softwares and key technology and services for the next-generation information network. As for population and health, focus will be on birth control, prevention and control of serious diseases and epidemics and innovation of traditional Chinese medicine. Policies for urban development shall consider regional planning, energy- efficiency of buildings and information platforms of cities. Lastly, the public security sector has priorities such as precaution and rescue for major industrial accidents, food safety and monitoring of major natural calamities. The key fields and their priorities are selected to achieve the following objectives in 15 years development (2006-2020): firstly, manufacturing and information industries are expected to master a number of core technologies that have a bearing on the country's national competitiveness, with its technological level of manufacturing and information sectors reaching world class. Secondly, Agricultural science and technology sector as a whole becomes one of the most advanced in the world, so as to promote the comprehensive productive capabilities of agriculture and ensure food safety for the country, efficiently. Thirdly, There will be breakthroughs in energy exploration, energy-saving technology and clean energy technology, which may promote the structural optimization of energy, with energy consumption of major industrial products reaching or approaching world level. Fourthly, Major industries and key cities will set up a technological development mode of recycled economy, providing scientific and technological support to the building of a resource-efficient and environment-friendly society. Fifthly, remarkable improvement will be achieved in the prevention and control of major diseases and epidemics, with serious diseases

146 like AIDS and hepatitis well under control, while there will be breakthroughs in the development and manufacturing of new pharmacy and medical equipment and apparatus, with sufficient technological capabilities for industrialization. Sixthly, the development of defense technology will be able to meet the fundamental demands of self-reliant research and development of modern weapons and informationization of the Army, to provide assurance for the safeguarding of national security. The “Guidelines” select several strategic production, critical common technologies or major projects as the major special projects to concentrate the limited resources to achieve breakthroughs and leap development in the productivity driven by the zooming partial development in technology. The “Guidelines” identify the major special projects according the following principle12: the major special projects in close connection with the major needs of economic and social development can nurture the strategic industries with core independent intellectual property able to play great roles in enhancing the capability of the enterprises’ independent innovation; the major special projects highlight the critical common technologies with strong drive, which impose the overall influence on integral lifting of industry competitiveness and; the major special projects may to address the major bottlenecks of economic and social development; the major special projects reflect the development of dual-use technologies and are of strategic significance to protect national security and enhance national comprehensive strength; the major special projects accord with national conditions and national power withstand them. 16 major special projects indentified in the “Guidelines” include core electronic devices, high- end universal chips and basic software, manufacturing technologies and complete set processes of very large-scale integration, a new generation of broadband wireless mobile communication, high- end numerical control machine tools and basic manufacturing technologies, large-scale oil and gas fields and coal-bed methane development, nuclear power plants of large-scale advanced pressurized water reactor and high temperature gas cooled reactor, waters’ pollution control and counter, cultivation of new varieties of GMO, creation of major new drugs, prophylaxis and treatment of AIDS and viral hepatitis and other dread infectious diseases, large aircraft, high-resolution Earth Observation System, manned space flight and the moon exploration program and so on. The projects cover the strategic industries such as information, biological, and major pressing issues such as energy, resources and environment and people's health as well as dual-use technologies and defense technologies. In above part, the key fields and their priorities and the major special projects are introduced to reflect the blueprint of China future science and technology development. The research content of them was carried out according to the succeeding “Five-year Plan”. The 11th “Five-year Plan (2006- 2020)” is the first “Five-year Plan” after the “Guidelines” was issued. In the 11th plan, the implementation of critical technologies and mega-projects in the key fields and their priorities are identified, and the content and objectives of the major special projects are established.

4.4. Promotion

Before 1985 China adopted the former Soviet Union’s model, the S&T activities at public research institutes and production at state-owned enterprises were completely separated. In 1985, the “Resolution on the Reform of the S&T System” was enacted. The objectives of the reform were twofold: to introduce competition-based funding system and to establish a new governance system of S&T institutions in order to more efficiently commercialize R&D results. The key initial changes were to reform the funding system and to make the governance of S&T institutions more flexible. It meant that government reduced the direct funding for GRIs, and the funding of GRIs were expected to be increasingly diversified and to come from other sources than the government. While this

12 http://www.most.gov.cn/kjgh/

147 change aimed to enhance incentives for innovation and to accelerate commercialization, it imposed increased pressure on scientists and led to short-term research projects for pursuing more immediate economic returns. In the 1990s, after more than ten years of reform, there was still a great gap between the research activities of GRIs and the needs of industrial sectors. In the meantime, the government research system underwent a significant change as most of the industry-specific ministries were abolished. The new structural challenge was how to deal with the industrial GRIs, which were previously affiliated to several ministries. Toward the end of 1998, the State Council decided to transform 242 GRIs at the national level into technology-based enterprises or technology service agencies. The transformation process was led by the State Council and implemented by the respective ministries through various administrative re-constructions and regulations. This important structural change implied that the dominance of GRIs in the Chinese innovation system was changed and instead, the industrial enterprises were on the way to becoming the core of the innovation system. However, the GRIs and universities are still the key players in frontier science and technological research, and they own plenty of advanced S&T achievements supported by public funds without commercialization. In order to speed up the process from research to commercial products, the government encouraged GRIs and universities to set up their own spin-offs and encouraged scientists to leave their research position and engage in commercial activities. Though the size of the spin-off business in China has been small compared to that of Chinese industry, it was valuable for high-tech industry in China. Spin-off companies gave many scientists in the universities or GRIs good opportunities to access the market knowledge. Furthermore, a new institution called Technical Market was introduced. This new specialized market was supposed to facilitate technology transactions between suppliers and users of technology. Moreover, special economic zones were also established across China to support the development of high-tech enterprises. GRIs and universities were allowed and encouraged to set up their own spin-offs so that they could commercialize their technology and research results directly, which is very different from the technology transfer ways of GRIs and universities in other countries. In this way, GRIs and universities could be more integrated in the economic activities. Spin-off companies could also provide GRIs and universities with some financial resources, which could compensate for budget cuts from the government. Up to 2004, there were around 2400 spin-off enterprises established and generated around 80.7 billion RMB revenue (Ministry of Education, 2005). Although the number of spin-off firms in China is small compared to that of the Chinese industrial sector, it is very important for high-tech industries in China. Spin-off companies provided many scientists from GRIs and universities with opportunities to access new market opportunities. The policy to encourage spin-offs also gave birth to many successful domestic high-tech companies, such as Lenovo (from the CAS) and Beida Founder (from Peking University), which are now leading companies in the Chinese ICT industry. Most of the Chinese biotechnology companies are also spin-offs. The patents sold by universities in the science, engineering, agriculture and medicine fields increased from 532 in 2002 to 701 in 842 in 2005, and the sum increased from 220 million RMB to 294.77 million RMB. Though other policy actions are also enforced to accelerate the commercialization of the S&T achievements such as Agricultural Science and Technology Transfer Fund, problems still exists in the process. It is reported that the rate of translating research into practice is less than 20% and the real industrialized S&T achievements account for less than 5% in the whole national research institutions. According the survey, lack of mature technology meeting the market demand, lack of financial support, lack of understanding of market demand and lack of policy support are main problems in technology transfer, and in 51% of the surveyed 60 universities few people pay attention or less attention to technology transfer, with only 10% not satisfied with income distribution system of technology transfer.

148 4.5. Financing

The government appropriation for science and technology makes great contribution to implementing the national science and technology development. Starting from 1985, although the government appropriation for science and technology has risen by over 12 times - from 10.26 billion to 133.49 billion, its percentage of China’s GDP has decreased by over one third from 1.14% to 0.73%. The most decline happened between 1986 and 1988. The bottom value was reached in 1996 with 0.49%. Its share of the total government budgetary expenditure has also experienced a fall course from 5.1% to 3.9%, the bottom of which is at 3.6% in 2000. The government appropriation for S&T is classified into four types by the management category: operating funds13, special project funds for S&T14, capital construction for science research and other special funds. The mount of operating funds in 2005 is about 13 times as many as that in 1985; the mount of the special project funds for S&T in is nearly 14 times more than that in 1985; the capital construction for science research in 2005 is just about 6 times more than that in 1985, which is the lest increment in the four types. And the share of capital construction for science research has been decreasing from 18.35% to 3.31%, while the others funds have been rising from 7.22% to 16.75%. The government appropriation for S&T can be divided into two parts for the financial system: The central government appropriation for S&T and the local government for S&T. For lack of data, the following part just introduces the appropriation for S&T by central government in main programmes of S&T, then gives a brief introduction to the trend of the local government appropriation for S&T. The main programmes include Key Technologies R&D program, Basic Research Program, Conditional Construction Program on Research and Development, Environmental Construction Program on Science and Technology Industrialization. The MOST is responsible for most of programs, and cooperate with NSFC and other related departments to carry out the programs in the form of scientific research project system. The Key Technologies R&D program with the aim of encouraging key technology research has been implemented through more than 25 years. Through these years, the program has made remarkable contributions to the technical renovation and upgrading of traditional industries and the formation of new industries, and also boosted the sustainable development of our society and enhanced the national S&T strength and innovation capacity. The central government appropriation for Key technologies R&D program has increased by nearly 5 times- from 520 million RMB in1996 to 3000 million RMB in 2006. The fields of the program include agriculture and biological technology, high-tech industry, social development and others, and the agriculture and biological technology is its key field. The Basic Research Program consists of the National Natural Science Fund, National Basic Research Program of China (known as the “973 Program”), National Key Program of Basic Research (Climbing up Program between 1998 and 2000), the total funds of these programs have been increasing by nearly 2 times between 1998 and 2005: The National Natural Science Fund is the program of the most funds equal to 3.75 billion RMB in 2005; The National Basic Research Program (973 Program) of China is the most rapid increasing program, from 300 million RMB in 1998 to 1000 million in 2000——about 3.3 times; Compared with the former two programs, the amount of the National Key Program of Basic Research, which takes up a little part of the total funds, has been decreasing from 71 million RMB to 50 million RMB.

13 The administrative and operating funds allocated to the R&D institutions of government departments and scientific research institutions of higher education. 14 The new trail funds, interim trail funds, responsible scientific research grants and special funds allocated to the relevant units through the scientific project.

149 The National Natural Science Fund administered by NSFC. The funding provided by NSFC supporting mathematics, natural science, engineering science, management science and the cross- disciplines covers scientist-oriented basic research (Zhu & Gong, 2008). This system works under more on peer review rather than on government plan, gives curiosity research a space in the whole R&D research in China, and support from general project, project for young scientists. The 973 Program of China directed by the Ministry of Science and Technology are the main channels for funding basic research. The 973 Program covers task-oriented basic research including agriculture, energy, information, materials, resource environment, population, health and other key fields, In 2005, the main fields sponsored by 973 program are population and health care (17.4%), IT (12.1%), material (14.3%), agriculture (17%), energy (10.5%), resource and environment (17.4%), Cross-principle study (14.7%) and others (2.8%). The National Key Program of Basic Research holds tender in the following subjects: mathematics, physics, chemistry, astronomy, earth sciences, biological sciences, synthesis and forefront of major science and others, which also is task-oriented program. In 2005, physics, chemistry and biological sciences are the top three appropriations subjects, accounting for 74.2% of total. The Conditional Construction Program on Research is made up of four programs: State Key Laboratory Construction Program, National Engineering Research Centers, Scientific and Technical Basic Work, and Special Research Project on Social Public Welfare, aiming to adjust, enrich, and strengthen the S&T capacity of national S&T research bases of different kinds.. The funds have not increased as rapid as the Basic Research Program. State Key Laboratory Construction Program has only risen by 20%, but the figure of it would be up to 2 billion RMB in 2008; the National Engineering Research Centers has just increased by about 60% from 40 million in 1998 to 65 million in 2005. A set of programs was set to strengthen policy for environment construction, promote regional economic development, enhance technical services and exchanges, stimulate development of small and medium-sized S&T enterprises. Besides, there is a program aimed to promote high technology and catch up with the development of that of developed countries, known as the “863 Program” launched in 1986. The program is divided into two parts: for defense technology and civil technology. From 2001-2005, about 15 billion RMB were spent on civil technology. From above analysis, we know about the appropriation changes for S&T by central government. The central government plays a leading role in supporting the science and technology activities, while the local governments invest in the science and technology activities according to the central government policies, adjusting the funds to meet their development. From 1990 to 2005, both the central government and the local government appropriation have risen: The central has increased from 9.76 billion to 80.78 billion RMB by over 7 times, and the local from 4.16 to 52.71 by over 12 times. The share of local government appropriation has also grown after falling in the early years, from about 70% to nearly 60%. The rapid growth of the local government appropriation for science and technology reflects that their attention to the science and technology progress is enhanced. While the amount of the local government appropriation for S&T has been increasing, its share of local government budgetary expenditure has also increased to 2.2% in 2006, with a little increment compared to last year. In 2005, of total local government appropriation, the special project funds for S&T was 29.4 billion RMB, amount to 55.78%; the other special funds was 7.03 billion RMB with 36.5% growth compared to last year, amount to the 13.34%. The growing share of the other special funds reflect the local government carry out more and more science and technology activities according to local features and demands. Recently, the national S&T programs pull the social funds including local government appropriation into the science and technology with the pulling ratio about 1:10, especially, the policy induced programs bring more local government appropriation with the pulling ratio above 1:17.

150 The increment of government Along with the rapid increment of the government appropriation for S&T, the government has strengthened the management of the funds. To guarantee the steady increment of government appropriation for science and technology, the safeguard measures are stated in the “Science and Technology Progress Law”: the growth rate of government appropriation for science and technology should be higher than that of government revenue. According to the law the government appropriation for science and technology should be mainly used for the following items: basic conditions and infrastructure for science and technology; basic research; research on the forefront technologies of strategic importance to economic and social development; application of critican common technologies and demonstration of high and new technology industrialization; R&D on new agricultural hybrids and technologies; popularization of S&T. The law has also indentified the principles of establishing the science and technology projects through financial funds. And other matching policies related to the “Guidelines” are enforced to enhance the management of funds in different programs. The above passages introduce the financing of the government, but with the development of the national innovative system the enterprises have become the dominant actor. Its funds for S&T is increasing rapidly, from 40.25 billion RMB in 1998 to 344.02 billion RMB in 2005 - the share from 31.21% to 65.52%. The enterprises are not only the dominant funder for S&T, but also the dominant performer of R&D activities. In 2005, the enterprises’ expenditure on R&D was 167.38 billion RMB, accounting for 68.31% of total expenditure on R&D by the performer. Though China’s funds for S&T have increased rapidly in enforcing the S&T programmes and performing R&D activities and other aspects, shortage exists in the whole country and enterprises’ R&D expenditure. As for the country, the ratio between R&D expenditure and GDP (1.34% in 2005) is still low compared to other emerging industrial Asian nations. Also, R&D for basic research amounts only to 5.4% of total expenditure. As for enterprises, the ratio between R&D expenditure and sales is too low: 0,76% in 2005. There is almost no lack of basic research, even is this picture has started to change. Firms also lack government support for R&D activities, even if the country displays great state intervention in economic life. According to the “Guidelines”, the government is going to display the role of guiding the funds for S&T. The government will increase the appropriation for S&T steadily, and the appropriation is going to mainly investment into the S&T activities such as basic research, to which the market mechanism cannot distribute enough resources. And policy actions such as tax preference are going to adopt to spur enterprises’ funds for R&D activities. Through these ways, China expects the ratio of the gross R&D expenditure to GDP increase year by year, and reaches 2% in 2010, over 2.5% in 2020.

5. Demand

Customer demand for new goods and services is a main determinant of demand for innovation, but it is constrained by two main factors: (1) people’s willingness to purchase new/unknown goods and services; and (2) the number of potential customers. These two elements are affected mainly by consumption structure and income distribution which will be discussed respectively below.

5.1. Income Distribution

China, a transition country, modeled many of its institutions after Soviet ones, and therefore is closer to Russia than to other BRICS. While income per capita doubled from 2000 to 2006 in urban

151 areas, it increased 60% in rural areas, which were poorer in the first place: average income of rural population is now one-third of urban counterpart. Increasing income inequality is a concern in China. The income structure by source is still dominated by wages, although this share has decreased during the year from 2000 to 2006. In 2000, wages represented 50% of income while entrepreneurial activities 19%. In 2006, wages fell to 40%,while entrepreneurial activities represented 30% of average income. Above 60% of the Chinese people live in the countryside, with no access to innovative products. The income structure is still dominated by wages, but this fraction has gone down as the share of entrepreneurial activities increased. Because of poor income, these poor groups hardly have access to new innovational products and services.

5.2. Structure of Consumption

The structure of end consumption of households in China is biased towards food. During 2000 to 2006, the Engle coefficient of urban households has decreased a little from 39.4% to 35.8%, and that of rural households has also decreased subtly from 49.1% to 43.0%. In addition, people’s consumption on residence, recreation, education, transportation and communication accounts for a large share. However, significant differences exist between urban and rural households. Although the shares of food consumption of urban and rural population both started to decrease in recent years, rural food consumption proportion is always much larger than that of urban people. In addition, the share of consumption on recreation, education and culture articles has slightly changed and this proportion in rural area is about 2% lower than urban area. What’s more, the proportion of consumption on transportation and communication has been increasing recently, and it is a little lower in rural households. In terms of consumption on health care and personal articles, the share of rural households is increasing, while the urban people is decreasing. However, the share in country-side is still 2-3% lower than urban districts. In terms of service consumption, the share is increasing slowly, but such proportion in rural area is much lower than that of urban districts, especially the proportion of financial and insurance service consumption.

5.3. Social Demand (Basic Infra-Structure, Health, Education)

Chinese birth rate has reduced greatly from 21.06% in 1990 to 12.09% in 2006; meanwhile, the death rate has remained at 6-7%. Thus the population continues to expand, although at a decreasing rate. According to the demographic trends, Chinese population may increase at the rate of about 5% in the next few years (China Statistical Yearbook, 2007). In addition, as the development of urbanization reform, the rural population rate decreased from 63.78% in 2000 to 56.10% in 2006. The health condition has become better in recent years, and the average life expectancy is higher comparing with that of 1990, life expectancy was 66.84 years for males and 70.47 for females, these figures became 69.63 and 73.33 in 2000, and then increased to 71.96 and 74.10 in 2006. Since the reform and opening-up policy in 1978, the medical and health undertaking has greatly advanced. For example, in 2006, the death rate of infants has largely deduced to 15.3% and that of pregnant and maternal women has decreased to 0.0366 %. The medical and health condition in rural area has changed impressively. In October 2002, the central committee and state council brought forth a new rural cooperative medical system, which indicated that governments at all levels should actively guide the farmers to establish coordination mainly of serious illness. In 2008, the central authorities subsidies farmers 40 RMB per capita who

152 participated the cooperative medical system in central and western districts. Nowadays, central and western farmers have funded 100 RMB per capita per year. In order to solve the medical treatment problem of poverty-stricken population, by the end of 2007, districts which contain agricultural population has all established rural medical assistance system. In this system, the poor population can participate the rural cooperative medical system funded by the government. In urban areas, since 2000, a new model of medical and health service has gradually established which consists of hospitals and community health service institutions and guides city residents to have preventive health care in community and go to hospital for severe problems. By of the end of 2007, all prefecture-level cities have launched community-based health services. The National Community Health Center (stations) amounted to 24,000, and a total of 260,000 health and technical person has engaged in community health services. Today, more and more city residents can be provided with free public health service and low-cost basic health care services by the governments. China's disease prevention and control system has been improved. Since 2004, the national Direct Network Report system of public health emergencies of infectious diseases has been launched, 37 kinds of infectious diseases can be reported through this network. Since 1992, the number of carriers of hepatitis B virus surface antigen has decreased by 30 million. In 2007, the hepatitis B vaccine inoculation rate of children has achieved to more than 95%, which prevented hepatitis B epidemic effectively. In addition, Chinese government has also strengthened its focus on preventing and curing AIDS, tuberculosis and other major infectious diseases by increasing funding and taking comprehensive measures to handle the above-mentioned diseases. At the same time, the government has been exerting great efforts on preventing plague, cholera, severe acute respiratory syndrome, human infection of highly pathogenic avian influenza and other infectious diseases.

153 TRANSFORMING SOUTH AFRICA’S NATIONAL SYSTEM OF INNOVATION FOR ACCELERATED AND SHARED GROWTH AND DEVELOPMENT

Rasigan Maharajh, Thomas Pogue ++15

Introduction

The global community of nations applauded the peaceful transfer of political power from an ethnic minority regime to the representative of the majority of South Africa’s people on the 27th of April 1994. For the first time in hundreds of years, all citizens of the country were able to vote for their political representatives in a free and fair election based on a universal franchise for a united, non-sexist and non-racist South Africa. The accolades accompanying this celebration conferred on the occasion the sense of a miracle as the rainbow nation was proclaimed and the work of deep reconstruction and development began. An institutional apparatus essentially designed to maintain by force and legal qualification a system of production, consumption and distribution of goods and services for approximately 12.6% of the population16 would now need to meet the aspirations of a democracy of 40.4 million people17. The idealism and pragmatism with which the political miracle was engaged with by what essentially was a national liberation movement has matured over the last thirteen years. Whilst both contradictory and harmonious policy and strategy convergences have been orchestrated, the contradictions of centuries of colonialism and racial capitalism continue to permeate the current realities of South Africa. Strides in the achievement of individual development indicators do not necessarily correlate with the broader results of systemic transformation. Having celebrated its first decade of democracy and freedom in 2004, a vantage point is created to look at the reform of South Africa’s National System of Innovation (NSI). Subsequent reviews and analysis from various institutions and scholars will also be drawn together to generate this assessment of the state of the NSI. This paper attempts to portray the contemporary character of South Africa’s production, consumption and distribution system in the context of the transformation of its system of innovation. Drawing together data into time-series which straddle the era of apartheid colonialism with the new South Africa is a difficult exercise as the points of reference embedded within such perspectives tend to either mask or exaggerate the full import of a country under the dictatorship of a minority regime. From mid-1980 till the unbanning of political movements in the early-1990, South Africa lurched from consecutive national states of emergency. This essentially entailed the country even

15 Institute for Economic Research on Innovation, Faculty of Economics and Finance, Tshwane University of Technology, 159 Skinner Street, Pretoria, 0001, Tshwane, Gauteng, South Africa. 16 The estimated number of the white population as defined by the national population registration act was scrapped in 1991. In this paper the terms white and black are used as indicators of race without pejorative meaning. White refers to all ethnic groups of Caucasian descent. Black refers to the all indigenous ethnic groups together with this originating from India and those of mixed heritage, also referred to as ‘coloured’. 17 No reliable census figures were available at the time of the 1st elections. Later estimates by a restricted national statistical agency (Statistics South Africa) would be “back-casted” to generate the approximation of 40.4 million.

154 downgrading the meagre representative democracy of the ‘white’ population as it experimented with a militarised governance model unashamedly called the national state security management system. This paper comprises five parts. The first section, after this introduction, is devoted to defining the local context. Specifically we will look at the five subsections which cover geo-politics, the social, political, economic, cultural aspects of the local context. This will generate for us a local characterisation which is obtained from historical evidence. Section 2 therefore covers the structure and size of economic activities and its sectoral and spatial distribution. Section 3 is devoted to issues related to capacity-building, research and technological services. In this section we will cover the span of education, training and capacity-building (including basic, technical & graduate and post-graduate) information. Section 4 is about policies, representation and financing. It spans explicit (S&T&I, industrial, sectoral) and implicit policy domains (macroeconomic, investment, trade, etc.) whilst also commenting on the regulatory environment (sectoral, foreign trade, intellectual property, environment, innovation). Section 4 brings in the current debate on the developmental state and its relationship with the market though an outline of the Accelerated and Shared Growth Initiative for South Africa (ASGISA). The National Research and Development Strategy (NR&DS) and the Government’s Programme of Action which incorporates key programmes and projects in a planning framework will be outlined to make explicit South African government’s stance on innovation, growth and development. Section 5 is about the demand for innovation in South Africa. Here we consider the implications of the empirics of income distribution, structure of consumption, social organisation, and broad social demand (basic infrastructure, health, education).

1. Geo-Political, Social, Political, Economic, Cultural & Local Context

1.1 Geo-Political Context

In terms of its population, South Africa is a small country. In terms of its physical characteristics, while mainly arid, it holds vast biological resources. It is also one of the more strongly mineral resource endowed economies in the world. Its emergence from apartheid into the globalised world of the mid-nineties brought about two main imperatives. On the local front it had to redress the economic effects of apartheid, in terms of the distribution of income, wealth and economic power, as they impinged on the majority of the population. On the global front, the new legitimate political economy found itself as the economic powerhouse of sub-Saharan Africa, with the potential, and even the necessity to embark on an effective drive to stimulate the integration process across the region.

1.2 Social, Political and Economic Context

South Africa was colonised in 1652 by the Dutch East India Company. This ushered in a period of linking the country into the global imperial system as it occupied a strategic position on the exploitative trade route between Europe and Asia. For many years thereafter South Africa, then existing as the Cape Colony, was used as a refreshment station for passing ships. Not only did this limit European occupation to the area which is now Cape Town, but it also saw the importation of un-free labour in the form of slaves from Java. Diamonds were discovered in the interior of South Africa in 1867. This event was to initiate a process of rapid and accelerated consolidation of the colony. This would eventually cross over into the 20th Century and lay the basis for conflicts which would continue for the entire period until the last decade preceding the 21st Century. Segregation, stratification and segmentation of labour markets would continue in a racial form to become a foundational legacy inherited by the first

155 democratic government of the country in 1994. In 1994, two thirds of South Africa’s mineral rights are privately owned, with the remainder vested in the State. In 1948, the National Party, espousing a theory of Apartheid, won another all white election. This consolidated the establishment of the earlier segregationalist period and notwithstanding heroic forms of passive resistance by the majority, saw the country ‘balkanised’ into separate administrations for black and white citizens. In 1961, the country was officially decolonised from Britain and became the Republic of South Africa. This decade saw the emergence of much more brutal repression which led to the national liberation movements launching armed struggles. The main enduring structural characteristics of the political economy inherited from apartheid, which is still largely unaltered, can best be captured by the “two economies” syndrome. In this model, the first economy refers to an advanced, sophisticated economy, based on skilled labour, which is becoming more globally competitive. The second is a mainly informal, marginalised, unskilled economy, populated by the unemployed and those unemployable in the formal sector. Despite the impressive gains made in the first economy, the benefits of growth have yet to reach the second economy, and with the enormity of the challenges arising from the social transition, the second economy risks falling further behind, if there is no decisive government intervention. This model should not be too closely identified with that of enclave economies, since the interdependence of the two sectors prevents a glib compartmentalisation and would fail to capture the enduring symbiosis of the “two economies”. Rather, it indicates the enduring malaise of the South African political economy. Measures such as the Group Areas and Land Acts, the Population Registration Act, systematic job reservation, the homelands policy, controls on movement by people and the separate and significantly unequal educational schemes all fed a post-colonial developmental state which sought to merely maintain the well-being of minority of the population within an enclave of prosperity. The fragmentation, uneven and combined development which this promoted was never seen as being particularly effective, and rather quite contrary, in addressing the aspirations of the vast majority of South Africans. As repression expanded, resistance within the borders of the country increased. By the 1980’s, the South African state had effectively being transformed into a military formation and promulgated successive states of emergency as a means to curbing resistance and opposition from all sectors of the oppressed majority. With the constant and rapidly increasing impact of economic sanctions, international isolation and a decrease in domestic support, the apartheid regime began to negotiate itself out of power. The end of apartheid may therefore be seen as resulting from a combination of both endogenous and exogenous factors. The energy crisis of the early seventies accelerated the process of consolidation and expansion in the financial sectors across the world. The increasing reliance on a variety of investment opportunities transformed the nature of production in agriculture, energy, mining and industry. The service sector grew as opportunities for increasing returns shifted towards the developing countries. The sophistication of this process of integration was accompanied by the creation of currency markets wherein trader and investor sentiment became an important component of achieving value. Having a large deficit became very expensive for non-dollar economies. The increased role and engagement of creditor countries and multilateral agencies facilitated this expansion across the globe. South Africa itself was severely affected by the refusal of its key private financiers to provide any sort of debt relief or concessions. The collapse of the monolithic Warsaw Pact realised the end of the ‘cold war’. The use of non Warsaw Pact countries as surrogates in cold war conflict immediately created a lacuna. The post cold war period has seen the expansion of liberal democracies premised on multi-party political dispensations and operationalised through universal suffrage. Neither the consolidated state security system in South Africa nor the country’s predatory regional stance was capable of being supported in an era where the threat of the communist threat (sic) no longer existed.

156 The elaboration of an ideological paradigm which venerated markets and sought the withdrawal of state intervention had become the norm throughout the Anglophone world. This was an impact created and consolidated by electoral victories by conservative political parties in both the United States and the United Kingdom. Under the mutually interchangeable nomenclature of Thatcherism and Reaganism, the victory of neo-liberalism over all other alternatives precipitated the rather grandiose declaration of the end of history thesis. By the 1980’s, organisations opposed to apartheid had begun to consolidate their activities. The private sector and even formations from within the ruling political elite began to initiate talks with the national liberation movement in exile. This led to the National Party initiating a political transformation by the removal of restrictions on some anti-apartheid organisations and the release of prisoners incarcerated for political offences. Within the mass democratic movement (MDM), significant deliberation had been completed on the vision of a post-apartheid South Africa. In planning resistance, people had also begun to articulate how their futures should be organised without the features of apartheid. The main enduring structural characteristics of the political economy inherited from apartheid, which is still largely unaltered, can best be captured by the “two economies” syndrome. In this model, the first economy refers to an advanced, sophisticated economy, based on skilled labour, which is becoming more globally competitive. The second is a mainly informal, marginalised, unskilled economy, populated by the unemployed and those unemployable in the formal sector Despite the impressive gains made in the first economy, the benefits of growth have yet to reach the second economy, and with the enormity of the challenges arising from the social transition, the second economy risks falling further behind, if there is no decisive government intervention. This model should not be too closely identified with that of enclave economies, since the interdependence of the two sectors prevents a glib compartmentalisation and would fail to capture the enduring symbiosis of the “two economies”. Rather, it indicates the enduring malaise of the South African political economy, as highlighted in the “Towards a 10-Year Review (The Presidency, 2004)” document.

1.3 Cultural Context

The cultural underpinning of the South African national system of innovation has a number of characteristics which directly affect the performance of the system and its potential for evolving into a system which is a viable base for the general upliftment of the quality of life and the life prospects of its population. There are some important characteristics that can be highlighted. First, the 1913 Lands Act which expropriated approximately 90% of agricultural land from African peasantry. Second the already mention Apartheid system that was premised on the model of “separate development” along ethnic lines. In order to maintain this separated development, homelands (or ‘Bantustans’) which were paraded as independent regions, were created. In the process it also created, as a necessary adjunct, sycophantic and corrupt systems of local administration which still bedevil local development. The spatial geography of apartheid over time generated its own “truth effect” and the racial demarcation lines of the South African geography still remain relatively unchanged. As a third important characteristic of the cultural context of SA is the system of “Bantu education” implemented by the apartheid regime has relegated the majority of the population to the class of the uneducated and unskilled. This effect has not been addressed to any significant degree after the demise of apartheid. There are signs, supported by changes in the Gini coefficient, which the stratification in the South African economy is slowly moving away from race to class. This started with the ending of “white privilege” which protected jobs, housing, health care and education for the white working class, regardless of skills levels. There is, of course a long way to go before the “democratisation of poverty” erodes effectively the enduring racial divides.

157 1.4 Regional and Local Characteristics

South Africa has a current population of just over 47 million people. Its infrastructure was however designed for the main utilisation of a minority of the population. The consequence of this major historical circumstance was the continuities which define urban and rural settlements. The constitutional compromise of the negotiated settlement of the struggle against apartheid capitalism saw the establishment of nine provinces. Many functions of the national sphere of government were delegated to the Provinces. These included Agriculture, Education, and Transport etc. As has become evident in the performance of many of the national competencies, the failure around uniform application of policies, strategies, programmes and projects of government remains a result of this division. South Africa also has 285 local governments. They are established separately from the National and Provincial tiers, with the administration thereby being effectively dismembered. An attempt at consolidating a single public service is still being taken through the legislative process and had not by the beginning of 2009, become law.

2. Production & Innovation

2.1 .Structure of Economic Activities

2.1.1 Labour productivity

While there are several ways to measure productivity, labour productivity is an easily derived indicator of value-added output and labour inputs. However, labour productivity conflates the influence of various other input factors such as economies of scale, capital inputs, organisational efficiency, and technological change. Nationally, labour productivity grew linearly at a compound annual rate of 5.5% between 2001 and 2006. Despite relative stagnation until 2004, the primary sector experienced a rapid increase in labour productivity around 2005, which led to it having an average compound annual growth rate of 7.4% between 2001 and 2006. Mining appears to be the main component in the primary sector’s growth. Over the period 2001 to 2006, labour productivity in the mining sector had a compound real annual growth rate of 10.9%. This growth in mining appears to be related to the uptake of modern mechanized mining to meet the global commodities boom demand. It is also associated with the transformation of South Africa’s historically labour intensive mining practices. The secondary sector experienced relatively stagnant labour productivity growth after 2002 averaging 2.3% between 2001 and 2006. While a similar growth path was exhibited by the manufacturing sector, it grew at a real annual rate of 3.4%. Real compound annual growth in the tertiary sector in the period 2001 to 2006 was 5.1%. Wholesale and retail, 5.9%, as well as transport and communication, 5.8%, were significant contributors to this growth.

2.1.2. Unit Labour Costs

Unit labour costs (ULC) measure the average cost of labour per unit of output. ULC thereby relate the real value of output to labour costs. Changes in ULC overtime represent the difference between the change in wages and labour productivity. Trends in ULC indicate either increasing competitiveness or cost pressures in an economy. Nationally, ULC decreased at a compound average annual rate of 3.3% between 1999 and 2007. While ULC improved in all aggregate sectors, ULC in Tertiary Industries declined at an annual average of 4.1%, but ULC in Primary Industries only declined at an average annual rate of

158 1.1%. The finance, real estate and business services sector and general government services sector realized the most significant improvement in their ULC. Both sectors averages an annual five percent decline in ULC. The mining and quarrying sector and the agriculture, forestry and fishing sector recorded the lowest improvement in ULC. Between 1999 and 2007 both sectors averaged an annual one percent decline in ULC. This apparent contradiction with the labour productivity trend and indicates that the increasingly productive workers in the primary sector are relatively costly. Manufacturing ULC is a frequently citied indicator of industrial competitiveness and in this regard South Africa has demonstrated sustained improvement averaging a two and one-half percent annual decline in the period 1999-2007.

2.1.3 Knowledge and Technology Intensity18 of Manufactured Goods

Exports of technologically intensive goods are a measure of an economy’s knowledge intensity and demand. While all industries generate and/or exploit new technology and knowledge, some are more knowledge-intensive than others. Changes in the absolute and relative share of technologically intensive goods can indicate that an economy is increasing its demand for knowledge. However, global value chains may distort this indicator as more complex aspects of a production process may be located in a different country. As a result, a high share of high-technology goods in exports does not necessarily reflect knowledge intensity in domestic industrial activities. In terms of relative shares, there is evidence of a move to increasing knowledge intensity in South Africa’s manufacturing with a rise in the real value of medium-low technology exports from 22% of all exports in 2003 to 27% in 2007. Simultaneously, the share of low technology manufacturing decreased from 15% to 11% of all exports. Between 2003 and 2006, manufacturing exports as a whole grew at a compound annual growth rate of 8.6%. High-technology manufacturing grew the fastest at 16.2%, medium-low manufacturing exports also grew rapidly at 14.4%, medium- high technology export preformed well too with a real annual compound growth rate of 10%. Low technology manufacturing exports dragged aggregate manufacturing export growth down, recording negative compound annual growth of 1.6%.

2.1.4. Contribution to the Manufacturing Trade Balance

Assessment of an economy’s strengths and weaknesses in terms of technological intensity of demand should not exclude the role of imports as exported goods may depend heavily on imported components. An indicator of revealed comparative advantage, such as the measure of contribution to trade balance below, therefore facilitates a better understanding of an economy’s underlying knowledge intensity in manufacturing. The indicator of sectoral contributions to the trade balance identifies an economy’s structural strengths and weaknesses from international trade flows. As it indicates whether an industry performs relatively better or worse than the manufacturing total, regardless of whether aggregate manufacturing itself is in deficit or surplus, it can be interpreted as an indicator of revealed comparative advantage. If an industry had no comparative advantage or disadvantage, its share of the total trade balance would equal its share of total trade. The contribution to the balance of trade then is the difference between the actual and theoretical balance. A positive contribution indicates a structural surplus and a negative contribution indicates a structural deficit. This contribution is then expressed as a percentage of the total manufacturing trade. Between 2003 and 2007, South Africa had a comparative advantage in both low-technology and medium-low technology manufacturing

18 The classification of manufacturing industries according to technological and knowledge follows OECD guidelines.

159 industries. While the positive contribution made by medium-low manufacturing industries grew from 11.3% to 11.7% during the period, the contribution of low-technology industries decline steadily from 4.9% to 1.5%. While South Africa had a competitive disadvantage in both high-technology and medium-high technology manufacturing, the competitive disadvantage in high-technology industries declined from -10.1% to -6.8% between 2003 and 2007. In conjunction with the previous section’s analysis of manufacturing export dynamics there is repeated evidence that medium-low technology industries are making an increasing competitive component of South African manufacturing. Similarly, it appears that the competitiveness of high-technology industries is improving while there seems to be a shift away from low-technology manufacturing.

2.1.5. Gross Fixed Capital Investment

Business investment could lead to greater innovation as a result of the diffusion of new equipment. Gross fixed capital investment (GFCI) is therefore an indicator of knowledge inputs to an innovation system. However, only part of gross fixed capital investment contains an innovative component and the main determinant of the absorptive capacity for this component is the technological capabilities of the labour force. Gross fixed capital investment has increased from 15.6% of GDP in 1999 to 18.9% in 2006, which equates to an average annual growth rate of 2.7%. Tertiary industries accounted for the largest share of this investment: 61%. Secondary industries accounted for the second largest portion 27% followed by primary industries 12%. In terms of innovation, spillovers investment in machinery and other equipment are the most important type of gross fixed capital investment. This category averaged 7.7% of GDP between 1999 and 2006. While fluctuating somewhat, machinery and other equipment recorded an annualized average growth rate of 1% from 1999 to 2006.

2.1.6 Stock of Inward Foreign Direct Investment

Foreign direct investment (FDI) is an investment involving a long-term relationship and reflecting a lasting interest and control by an entity in one economy (foreign direct investor or parent company) in an enterprise resident in another economy. Therefore, FDI represents production towards higher value-added goods and increased production efficiency. Rather than FDI flow data, FDI stock data as percentage of GDP is used as an indicator of the rate of FDI saturation in an economy. Inward FDI stocks as a percentage of GDP decreased in the period between 1999 and 2002 from 39.2% to 22.6%, an annualised decrease of 18.3%. Since 2002, inward FDI stocks have risen steadily to 35.1% or average annual increase of 14.7%. For the period 1999 to 2006 95.3% of inward FDI stocks were in the private non-banking sector. This share dropped from 97% in 1999 to 91% in 2006. The banking sector averaged a 3.4% share from 1999 to 2006. There was a significant rise in this share from 1% in 1999 to 9% in 2006. Public corporations share of the inward FDI stock dropped to an insignificant level in 2005. Nonetheless, the sector averaged a 1.3% share in the period from 1999 to 2006.

2.1.7. Foreign Direct Investment Networks

Flows of foreign direct investment (FDI) as a percent of GDP as well as the traded share of the economy measure the relative importance of globalisation to an economy. FDI stocks can also be

160 used to identify the geographic sources and destinations of investment, which serves as an indicator of investment networks and associated knowledge flows in a system of innovation. South Africa’s foreign sector grew from 48% of GDP in 1999 to 56% of GDP in 2005. While FDI inflows to South Africa were larger than outflows from South Africa in most years the relative share of each did not differ substantially from year to year. In the period 1999 to 2005, Europe averaged a 79% share of South African FDI assets followed by North & South America with 8%; Africa 8%; Oceania 3% and with Asia 2%. Europe’s share of South Africa’s FDI assets decreased from 87% to 67& between 1999 and 2005, but assets in Africa and Asia increased. Between 1999 and 2005, Europe averaged an 87% share of South African FDI liabilities, followed by North & South America with 8%, Asia 4%, and Africa 1%. There were no substantial changes in the region’s share of South Africa’s FDI liabilities.

2.2 Sectoral Distribution

2.2.1. Sectoral Shares of Value-Added

There are differences across sectors in their demand for goods and services. Similarly, the nature and intensity of knowledge demand varies among sectors. Sectoral shares of value-added indicate the relative importance of various sectors’ knowledge demand in an economy. In addition, relative changes in sectoral shares overtime indicate shifts in demand. Nationally, the primary sector accounted for 11% of sectoral value-added between 1999 and 2006. The primary sector grew at a compound annual growth rate of 5.5% during this period. Secondary industries accounted for 24% of sectoral value-added and annualized growth of 5.2%. Similarly, the tertiary sector accounted for 65% of sectoral value added and growth of 5.8%. The relative shares of sectoral value-added did not vary much between 1999 and 2006, but there were two notable changes within the tertiary sector. Nationally, general government services decreased from 17% of total value-added to 15%. Simultaneously, finance, real estate and business services increased from 19% to 22% of aggregate value-added.

2.2.2. Manufacturing Shares of Value-Added

Manufacturing has historically been viewed as a critical component in an economy’s research system. Therefore, its structure represents an important aspect of knowledge demand. Manufacturing sub-sectors vary considerably in technological complexity, so the relative importance of each, as indicated in terms of value-added, suggests the knowledge intensity of this notable sector. Overall the current value of manufacturing output increased from R137 billion in 1999 to R212 billion in 2006. In real terms, between 1999 and 2006 output grew at a compound annual rate of 5.5%. The food, beverages and tobacco sector exhibited real annual compound growth of 6.9% between 1999 and 2006. This led to its increasing from 15% of all manufacturing value-added in 1999 to 18% in 2006. The metals, metal products, machinery and equipment sector grew at a real annual compound rate of 6.5%. Thus, the sub-sector grew from 20% of manufacturing value-added in 1999 to 22% in 2006. The furniture and other manufacturing sector grew at a real compound rate of 3.8%. As a result of this lower than average growth, its share of manufacturing value-added decreased from 10% in 1999 to 8% in 2006. The wood and paper; publishing and printing sector also grew below the average rate for manufacturing. It recorded a compound annual growth rate of 2.4% between 1999 and 2006. The textiles, clothing and leather goods sector recorded the lowest real annual compound growth rate of 0.1%.

161 2.3 Spatial Distribution

The spatial configuration of South Africa is not the organic result of growth and development. Rather, it draws heavily from apartheid spatial planning – a disjuncture exists between where people live and where economic opportunities exist. The pattern of the spatial distribution of economic activity continues along a trajectory established by the minerals-energy complex and under the broader impact of apartheid capitalism. These patterns were established through colonialism, mineral exploitation, commercial agriculture and a limited form of industrialisation. The swing to a highly service orientated economy, drawing on massive financialisation and monopolistic practises have also significantly affected the human settlements of the country. Apartheid spatial planning ensured that the people are located far from social and economic opportunities. This spatial marginalisation from economic opportunities is still a significant feature of the economy that needs to be addressed in order to reduce poverty and inequality, and ensure shared growth. The NSDP (2006) is South Africa’s first set of national spatial guidelines, which establish an overarching mechanism, which: enables a shared understanding of the national space economy and provides a principle-base approach to coordinate and guide policy implementation across government.

2.4 Employment

2.4.1 Employment Participation Rate

Employment participation indicates the proportion of an economy’s human resources that are mobilized. It thereby suggests a potential or a limit to further growth in knowledge demand. Nationally, growth in the economically active population was less than growth in the working age population. As a result, the employment participation rate declined from 59.4% in 2001 to 56.2% in 2007. This equated to an annualized decrease of 0.9%. In total, the working age population rose from 28.1 million in 2001 to 30.2 million in 2007. During that period, the economically active population increased from 16.7 million to 17 million.

2.4.2 Unemployment Rate

An important feature of an economy is its ability to supply jobs to those seeking to work. The unemployment rate can indicate a divergence between available skills and the demand for those skills in the economy. The indicator is equal to the number people who are willing and able to work but do not have jobs, the unemployed, divided by the total number of people who are willing and able to work, the economically active population. Between 2001 and 2007, the average unemployment rate was 28% nationally. Demographically, unemployment varied significantly. At the national level, the unemployment rate for men averaged 24% during this period, but the average rate for women was 32%. Significant differences were also seen across racial groups with whites having the lowest average unemployment rate, 6%, followed by Indians/Asians, 17%, Coloureds, 21%, and Africans, 33%. While unemployment rates generally declined, both women’s and the broad unemployment rate rose.

2.4.3 Employment Composition

As a developing economy there is an important distinction between the formal and informal economy. Knowledge demand is very different between these two sectors. At a very basic level the nature of innovation distinguishes these sectors. In addition the linkages with the economy’s broader

162 system of innovation vary markedly between the sectors. In the period 2001 to 2007, formal sector employment increased on average by 269,000 jobs annually. This strong growth led to formal sector employment increasing its share of total employment from 56% to 67%. Formal sector job growth grew at an annualized growth rate of 3.4%. Contrasting the growth of the formal sector, informal sector employment declined steadily in the period at an average rate of 118,000 jobs per year. Between 2001 and 2007 the informal sector’s share of total employment decreased from 24% to 17%. Informal sector employment decreased at an annualized rate of 5%. Between 2001 and 2007, total employment averaged an annual increase of 62,000 jobs. As the economically active population increased annually by 49,000, the labour absorption capacity of the economy was 126%. Domestic workers retained a relatively constant share of total employment, 7%, but the agriculture sector saw its share of total employment decrease from 13% to 9% between 2001 and 2007.

2.4.4 Employment of Tertiary-Level Graduates19

Employment of tertiary-level graduates over time is an indicator of an economy’s skill intensity. In South Africa, intermediate skills are also an important indicator of the workforce’s skill profile. There is a general trend of an increasingly skilled workforce, but this increase in skills is not just at the tertiary level as considerable relative growth was also seen in individuals whose highest level of education was at the secondary education level. From 2001 to 2006, the share of employed workers at the secondary education level rose from 60% in 2001 to 66% in 2007, while the share of employed workers at the tertiary education level rose from 15% in 2001 to 17% in 2007. That the same period, the share of employed workers with only primary education level decreased from 17% to 12%and with no formal education decreased from 7% to 5% in 2007. In relative terms, a similar pattern of increasing skill intensity was also seen with the share of tertiary level employment rising by 10% (1.6% annually) between 2001 and 2007, while the share of employees with no formal education decreased by 33% (-6.6% annually) in the same period. Also indicating an increasing skill intensity of the economy, the total number of tertiary level employees grew at a compound annual rate of 2.8% in the period between 2001 and 2007 while the total number of unemployed tertiary level employees decreased at an annualized rate of 3.2%. From 2001 to 2007, the unemployment rate of the tertiary educated workforce was 10.6% that rate was two- fifths the national average for all workers during the same period.

2.5 Size of Production System

2.5.1 Value of Production to Population Ratio

Gross domestic product (GDP) is the total value of production within a nation’s borders during a certain period. The total value of provincial production is similarly reported as gross domestic product per region (GDPR). Prices of final goods and services are used to indicate the ‘value’ of production. In order to measure an economy’s technological sophistication and its associated knowledge demand, the value of its production relative to the size of its population (GDP per capita) can be utilized.

19 The unemployment rate of tertiary graduates is derived in the same manner as that for the total population, but in this case it’s the sum of employed and unemployed tertiary graduates who form the relative workforce upon which the rate of unemployment among tertiary graduates is derived. The data for all the indicators is reported by Statistics South Africa on a bi-annual basis in their publication Labour force survey (Statistical Release P0210).

163 Nationally South Africa has had a compound annual real GDP per capita growth of 4.2% between 2000 and 2006. While value of production per capita suggests an economy’s level of technological sophistication, a sizable portion of the South African population does not participate in either the formal or informal economy. Therefore, the ratio of production to the economically active population may give a better indication of the economy’s technological complexity. However, that ratio is not used since it introduces its own bias towards the economically active population.

2.5.2 Traded Share of Economy

The traded share of an economy is an indicator of an economy’s openness and the associated knowledge demand from domestic firms who may face a relatively larger force to innovate in a more open economic environment. In the period 1999 to 2006, South Africa saw a steady increase in its traded share of the economy. During this period, the traded share of the economy grew at a compound annual rate of 3.8%. While Rand appreciation appears to be correlated to the increase in the traded share of the economy, exchange rate fluctuations primarily appear to enhance or inhibit the overall upward trend.

2.6 The Informal Economy

The informal economic sector in South Africa has been the focus of much political interest but received relatively scarce attention from the research community. Whilst definitional matters have generally conspired to keep the true extent and nature of this sector mainly in the realm of anecdote, some empirical data is now becoming available. This confirms the picture of the informal sector as mainly comprising enterprises in food, retail and hospitality sectors. The increased activity in the construction sector has also seen the increased use of day-workers for routine labour-intensive tasks. According to the 2006 Labour Force Survey, the following features of the informal sector as a whole may be distinguished. The overwhelming majority of enterprises are not formally registered through Companies and Intellectual Property Registration Office as a Company or Corporation. They are also not registered with the South African Revenue Service to pay neither Income Tax nor Value Added Taxes. While 12.4% of informal employees had access to paid leave, over 90% of these enterprises did not also pay contributions to the Unemployment Insurance Fund, Medical Aid or towards Retirement benefits. Nearly two thirds of enterprises in the informal sector work on flexible time schedules with a mean average working week exceeding the statutory allocation by 5 hours. With a standard deviation of 20.32, it is apparent that variation around actual hours worked may be extremely high. Confirming this level of exploitation, the survey found that 73.8% of informal employees were not willing to work longer hours. Nearly 41% of informal enterprises were conducted from the owner’s house or farm, while 24.1% were of no fixed location, and the third largest share being in other people’s houses. Over half of these enterprises had only one worker, while a third comprised 2-4 workers. Interestingly, 1.7% of informal enterprises employed more than 50 workers. Only 20% of informal employees had written contracts while 28.5% had permanent jobs. This is contrasted against the majority of workers being temporary or casual. Nearly 42% of these workers had only been in their jobs for up to 1 year, whilst 3.7% had been so employed for over 20 years. The overwhelming majority were not unionised and were directly supervised in the performance of their tasks.

2.7 Innovative Effort

164 2.7.1 Innovation Expenditures20

R&D expenditure is but one measure of knowledge inputs to an innovation system. A broader measure is innovation expenditures. Innovation expenditure includes R&D expenditures as well as expenditures to access embodied knowledge in equipment and other external knowledge. Enterprise expenditure on innovation is an important indicator of an innovation systems knowledge inputs. Nationally, enterprise innovation expenditures totalled R27.8 billion in 2004 with the biggest share of enterprise expenditures on innovation was acquisition of equipment: 65%, followed by in-house R&D expenditures: 20%, outsourced R&D expenditures: 8% and acquisition of other external knowledge 7%.

2.7.2 Occurrence of Innovations

Innovations are an important indicator of knowledge outputs from a system of innovation. Enterprises reporting innovations activities can be distinguished according to four categories within the OECD Oslo Manual methodology: product innovations - a good or service significantly improved or new in functional characteristics; process innovations – implementation of a new or significantly improved production or delivery method; marketing innovations - implementation of a new marketing method; and organisational innovations – implementation of a new organisational method in the firm’s business practices, workplace organisation or external relations. A majority of enterprises, 51.7%, reported that they had innovation activities during the period from 2002 to 2004. Nationally, among firms reporting organisational and/or marketing innovations 54% reported changes to the organisation of work, 53% reported implementing better knowledge management systems, 36% reported implementing design or packaging changes, 27% reported changing external relations with other firms and institutions, and 23% reported changing sales or distribution methods. In the industrial sector, among firms with organisational and/or marketing innovations, 48% reported implementing better knowledge management systems, 36% reported changes to the organisation of work, 31% reported implementing design or packaging changes, 19% reported changing sales or distribution methods, and 14% reported changing external relations with other firms and institutions. In the service sector, among enterprise with organisational and/or marketing innovations, 70% reported changes to the organisation of work, 56% reported implementing better knowledge management systems, 41% reported implementing design or packaging changes, 39% reported changing external relations with other firms and institutions, and 26% reported changing sales or distribution methods.

2.7.3 Impact of Innovations

An innovation by definition is original to some extent. However, the impact of an innovation may vary considerably as a result of a wide variety of internal and external factors. Enterprises reporting innovations activities can be distinguished according to four categories within the OECD Oslo Manual methodology: product innovations - a good or service significantly improved or new in functional characteristics; process innovations – implementation of a new or significantly improved production or delivery method; marketing innovations - implementation of a new marketing method; and organisational innovations – implementation of a new organisational method in the firm’s business practices, workplace organisation or external relations.

20 This innovation expenditure data is compiled using an OECD methodology from their Oslo Manual. The data is collected by the Centre for Science, Technology and innovation indicators (Cestii), which is part of the Human Science Research Council, for the Department of Science and Technology.

165 Among firms reporting innovations, improved quality of their product or service ranked as the most important outcome of innovation with 45% of these enterprises reporting it as an important outcome. Increasing product or service range was the next most important outcome: 33% followed by extending market share 23% and meeting regulatory requirements 21%. Nationally, the turnover of firms reporting product innovations totalled R674 billion. The national turnover can also be divided between the service sector, 59%, and the industrial sector: 41%. Product innovations new to the firm accounted for 12% of reported turnover and with product innovations new to the market accounting for a further 10%. This impact of product innovations was higher in the industrial sector where product innovation new to the firm accounted for 15% of that sector’s turnover and product innovations new to the market accounting a further 13%.

3. Capacity Building, Research & Technical Services

3.1 Basic and Technical Education System

3.1.1 Human Resources in Society

The educational composition of an economy’s population is an indicator of its human resource mobilisation. While tertiary qualifications are particularly important for knowledge intensive jobs, general abilities within the population such as literacy rates are significant in the environment of a transforming and developing economy like South Africa has. The highest level of education in the working age population (individuals between 15 and 65 years of age) is calculated as the ratio of the population in each of the four education level cohorts by the total working age population that reported their education level. In total, the proportion of the working age population with tertiary or secondary education has grown in the period between 2001 and 2007. Simultaneously, the percentage of the population with either no formal education or just primary education has declined. Nationally, ten percent of the population over 20 years of age had tertiary level education. As a proportion of the total population, these individuals increased at compound annual rate of 1.2% between 2002 and 2006. The literacy rate declined at an annualized rate of 0.5% between 2002 and 2006. Nonetheless, during this period 89% of the total population was literate. The performance of South African students relative to other countries in Africa has also declined over the period. It is worth comparing these indicators with those on innovation. The stark contrast may well provide an empirical validation of the “two economies” proposition.

3.1.2 Education System Inputs

Learner’s participation in the basic education system indicates an economy’s mobilization of its human capital resources. School participation is an important component of the basic education system. In addition, FET and ABET institutions are also important sources of basic education provision. Enrolments in various public basic educational institutions are used as indicators of education supply. Nationally, the number of learners in the school system declined by 1% between 2000 and 2005. The number of learners at ABET institutions also decreased, dropping by 9% from 2000 to 2005. Enrolments in further education and training (FET) institutions increased significantly as a result of the sectoral education and training programmes. Between 2000 and 2005, FET enrolments rose by 39%. Nationally, there were 12 million school learners on average during the 2000 to 2005 period. ABET learners averaged 264,000 nationally between 2002 and 2005. FET enrolments averaged 355,000 nationally from 2000 to 2005.

166 3.1.3 Education System Outputs

New graduates indicate the potential within an economy to absorb, transform, and diffuse knowledge. The senior certificate exam (SCE) indicates competency at a basic educational level. Learners completing subject tests in areas like biology, math and physical sciences are indicators of future skills in science and technology. SCE graduates are used as indicators of basic education output. Nationally, the number of learners writing the SCE dropped between 2000 and 2003, nonetheless the number of learners writing the SCE increased from 490,000 in 2000 to 510,000 in 2005. On average 304,000 learners passed their SCE between 2000 and 2005, equating to a growth of 23%. On average 65% of those who wrote their CSE passed. The pass rate rose from 58% in 2000 to 68% in 2005. The percentage of those writing SCE and receiving distinctions increased from 1% to 2% and averaged 8,500 learners per year. The number passing the biology subject test rose from 213,000 in 2000 to 226,000 in 2005. The pass rate on the biology test was 69% in this period. The percentage of those writing the biology test who received a higher grade was 14% or an average of 43,000 learners per year. The number passing the mathematics subject test rose from 128,000 in 2000 to 169,000 in 2005. The pass rate on the mathematics test was 53% in this period. The percentage of those writing the mathematics test who received a higher grade was 8% or an average of 22,000 learners per year. The number passing the physical sciences subject test rose from 112,000 in 2000 to 129,000 in 2005. The pass rate on the physical sciences test was 73% in this period. The percentage of those writing the physical sciences test who received a higher grade was 16% or an average of 26,000 learners per year.

3.1.4 Education Resources

The educators assigned to teach learners is an indicator of the relative quality of the education received by learners. In addition, changes in the ratio indicate mobilization of resources to development or under development of a knowledge intensive economy. Enrolments as a ratio of educators across public educational institutions are used as indicators of education resources Nationally, between 1999 and 2005 the school learners to educator ratio averaged 33. This ratio decreased by 5% from 34 learners per educator in 1999 to 32 learners per educator in 2005. The national ratio of ABET learners per educator was 19 between 2001 and 2005. Nationally, between 2000 and 2005 there were 52 FET learners per educator. This ratio increased by 53% from 39 FET learners per educator in 2000 to 59 FET learners per educator in 2005. The national ratio of HEI learners to educators averaged 47 between 2001 and 2005, which was a 7% rise from 45 in 2001 to 48 in 2005.

3.2 Higher Education System

3.2.1 Higher Education System Inputs

Higher education institutions’ (HEI) enrolments are an important indicator of the intensity of knowledge mobilization in an economy. HEI enrolments can be distinguished by contact and distant enrolments. Enrolments in public higher educational institutions are used as indicators of higher education supply. In recent years there appears to be an increasing number of private higher education institutions offering both contact and distant education, but data on these institutions is not readily available. Nationally, HEI enrolments increased 6% from 665,000 in 2001 to 738,000 in 2005. During this period, there was average of 708,000 total HEI learner enrolments. Contact HEI enrolments grew by 16% nationally between 2001 and 2005. On average there were 440,000 enrolments rising

167 from 379,000 in 2001 to 483,000 in 2005. Nationally, distance HEI enrolments decreased by 6% from 286,000 in 2001 to 255,000 in 2005. In the period, there were 268,000 distance HEI enrolments annually.

3.2.2 Higher Education System Output

New graduates indicate the potential within an economy to absorb, transform, and diffuse knowledge. HEI graduates are indicators of highly skilled workers. Graduates from public higher educational institutions are used as indicators of higher education output. Nationally, the number of undergraduate degrees awarded annually increased by 25% from 70,000 in 2001 to 88,000 in 2005. The number of postgraduate degrees increased by 29% between 2001 and 2005. Nationally, Master degrees granted increased from 6,242 in 2001 to 8,018 in 2005 for an annualised increase of 6.3%. Doctorates increased at an annualised rate of 9.8% in South Africa from 802 in 2001 to 1,189 in 2005.

3.2.3 Foreign Student Population in Higher Education

International students in higher education institutions (HEIs) are an indicator of the attractiveness of an innovation system. South Africa has since 1994 developed a large foreign student body that contains a large number of other Africans. This measure also reflects an important source of human resources and the strength of the public research sector. In the period between 2000 and 2006, the foreign student population increased by at an annual average rate of 8.5% from 31,349 to 52,270 students. During the same period, the number of foreign graduates has increased at an annual average rate of 15.6% from 3,993 graduates in 1999 to 10,189 in 2006. Nationally, foreign students as a percentage of total enrolments have risen from 5.6% in 2000 to 7.1% in 2006. However, since 2003 the level of foreign students in total enrolments has stabilized around the seven percent level. Nationally, 70.5% of enrolled foreign students were from the Southern African Development Community (SADC) region in the period between 1999 and 2006. Another 14.2% were from other African nations. Of the 15.3% of foreign students from outside Africa, 49% were from Europe, 29% from Asia, 18% were from North America, just over 2% were from South America and just under 2% were Australia and Oceania.

3.3. Research and Development System

3.3.1 Trends in Domestic R&D Expenditure21

R&D expenditures are an indicator of a country’s R&D effort. “R&D effort” is only one formal type of input to an innovation system among a range of formal and informal inputs. Nonetheless, R&D effort is a popular measure of an economy’s knowledge inputs and the overall

21 This R&D data is compiled using an OECD methodology from their Frascati Manual. The data is collected by the Centre for Science, Technology and innovation indicators (Cestii), which is part of the Human Science Research Council, for the Department of Science and Technology. In order to report relative efforts, GERD is expressed as a percentage of GDP and GDPR. This GDP and GDPR data is reported by Statistics South Africa on a quarterly basis in their publication Gross Domestic Product (Statistical Release P0441).

168 strength of its innovation system. Gross domestic expenditure on R&D (GERD) is the main aggregate measure of a nation’s domestic R&D-related expenditure for a given year. Nationally, R&D intensity has risen from 0.73% of GDP in 2001 to 0.92% in 2005. In constant 2000 terms, GERD rose at compound annual growth rate of 10.3% between 2001 and 2005, from R7.1 billion in 2001 to R11 billion in 2005.

3.3.2. R&D Financing and Performance22

R&D effort is categorised among five sectors who undertake the R&D activities: business enterprise, government, higher education, not-for-profit institutions, and science councils. In addition to the five sectors performing R&D, four sectors can be identified as financing R&D effort: business enterprise, government, foreign, and other South African sources. R&D effort is broken down by sector financing and sector performing in-line with the OECD Frascati Manual methodology. Nationally, the business enterprise sector financed the largest share of R&D effort, 50%, between 2001 and 2005. The government sector averaged the next largest share: 30%, followed by the foreign sector: 12% and the other South African sources sector: 8%. Significant variability in these sectors financing of R&D effort makes discerning clear trends in financing difficult. Nationally, the Business enterprise sector preformed 56% of R&D effort from 2001 to 2005. This rose from 54% in 2001 to 58% in 2005. The higher education sector averaged a 22% share, but this decreased from 25% in 2001 to 19% in 2005. The science council sector averaged a 17% share, followed by the government sector: 4% and the not-for-profit sector: 2%.

3.3.3. R&D by Type of Expenditure

R&D effort as indicated by R&D expenditures can be classified according to type of research, research field and social economic objective. There are three types of research reported: experimental development; applied research; and basic research. Research fields contain two high- level divisions: natural science, technology, and engineering; and social sciences and humanities. There are five aggregate social economic objectives: defence; economic development; society; environment; and advancement of knowledge. R&D expenditures are categorised by type of research, research field and social economic objective in the OECD Frascati Manual methodology. Nationally, experimental development significantly increased its share of research expenditures, rising from 33% of expenditures in 2001 to 46% in 2005. Basic research has seen its share of expenditures decrease by 9% in the same period from 27% to 18%. Applied research lost a 4% share from 40% to 36%. Nationally, 88% of R&D expenditures were on natural science, technology, and engineering. Economic development was reported as the primary social economic objective among 58% of R&D expenditures. The ‘environment’ was the least reported social economic objective of R&D expenditures: 5%. Society was the second most significant objective of R&D expenditures and accounted for 19% of expenditures. Defence accounted for a 7% share of expenditure objectives nationally. Advancement of knowledge had an 11% share nationally.

3.3.4 Public R&D Expenditures

22 In order to report relative contributions of each financing sector their respective shares of GERD are expressed as a percentage of GDP. This GDP data is reported by Statistics South Africa on a quarterly basis in their publication Gross Domestic Product (Statistical Release P0441).

169 Public expenditures on R&D are not limited to direct government R&D payments. In a broad sense public R&D expenditures include all non-business enterprise R&D expenditures. Public R&D expenditures are taken as the difference between total R&D expenditures (GERD) and business enterprise expenditures on R&D (BERD). Sectoral R&D expenditures (financing) are differentiated in the OECD Frascati Manual methodology. Nationally, public R&D expenditures averaged 0.36% of GDP in 2001, 2003, 2004 and 2005. Public R&D expenditures increased from 0.34% of GDP in 2001 to 0.38% in 2005. That increase is equal to a compound annual growth rate of 3%.

3.3.5 Business R&D Expenditures

Business enterprise R&D (BERD) accounts for the largest share of R&D expenditures nationally as well as being a lead sector performing R&D. BERD expenditures include R&D undertaken in the business sector by firms and institutions whose primary activity is producing goods and services for sale to the general public at an economically significant price. Classification of BERD expenditures is detailed in the OECD Frascati Manual methodology. Nationally, BERD expenditures averaged 0.52% of value added in industry in 2001, 2003, 2004 and 2005. BERD expenditures increased from 0.43% of value added in industry in 2001 to 0.6% in 2005. That increase is equal to an annual average growth rate of 8%. Nationally, the sectoral composition of BERD expenditures changed significantly between 2001 and 2004. Secondary industries averaged a 54% share of BERD expenditures in 2001, 2003, and 2004. However, this share rose from 50% in 2001 to 58% in 2003 and then dropped slightly to 55% in 2004. Tertiary industries saw a sustained increase in their share of BERD expenditures with an increase from 24% in 2001 to 36% in 2004. Primary industries saw a significant reduction in their share of BERD from 26% in 2001 to 9% in 2004.

3.3.6 Trends in R&D Personnel

R&D effort is also measured by the number of people who work on R&D activities. Research and development personnel include all persons employed directly in R&D activities and therefore cover technicians and support staff in addition to researchers. Headcount data23 is used as an indicator of R&D personnel despite some personnel only working on R&D activities part-time. Nationally, R&D personnel grew by 14,500 from 32,500 in 2001 to 47,000 in 2004. That equalled an average annual growth rate of 12%. In terms of R&D personnel as a ratio of total employment, the number of R&D personnel increased from 2.8 per thousand employees in 2001 to 4 per thousand in 2004. The composition of these R&D personnel was relatively stable with 58% being researchers, 18% technicians and 24% other R&D personnel.

3.3.7 Trends in Researchers

Researchers are a subcomponent of R&D personnel, but are critical part of the R&D system. They are defined as professionals engaged in the conception and creation of new knowledge, products, processes, methods and systems as well as being directly involved in the management of projects. Researchers are part of research and development personnel. Again headcount data is used as an indicator of researchers despite some researchers only working on R&D activities part-time.

23 Data on headcounts complies with the OECD Frascati Manual methodology. To measure the relative size of R&D personnel they are expressed as a percentage of total employment nationally and provincially.

170 Nationally, researchers grew by 8,250 from 19,400 in 2001 to 27,650 in 2004. That equalled an average annual growth rate of 12%. In terms of researchers as a ratio of total employment, the number of researchers increased from 1.7 per thousand employees in 2001 to 2.3 per thousand in 2004. The gender of researchers changed marginally from 36% female in 2001 to 37% in 2004.

3.4 Training and Capacity Building System

The training and capacity building system has been built around a common National Qualifications Framework (NQF). The NQF traces its origins back to the labour movement of the early 1970s where black workers saw training as a means to achieve their demands for better wages. From the seventies to the nineties, South Africa witnessed a strong demand for change in education. Student’s protests spread through nation and by the 1980s the entire education system had been discredited and rejected. Non-governmental education sector resistance resulted eventually in the formation of the National Education Policy Initiative (NEPI) based on the principles of non- racism, non-sexism, democracy and redress, and the need for a non-racial unitary system of education and training. During the nineties, a number of institutions, agreements, working groups were created as an effort to build a capacity system accessible to the people. The NQF was one of the many institutions created for this proposes and is a framework that established the boundaries for construction of a qualifications and accreditation system, which sought to certify learning outcomes from a variety of providers both formal and informal. It represents a national effort at integrating education and training into a unified structure of recognised qualifications and is therefore a framework of qualifications which serves as a record of learners achievements. These records of learner achievement are then formerly registered to enable national recognition of acquired skills and knowledge, thereby ensuring an integrated system that encourages life-long learning. The agency through which these achievements are registered is the South African Qualifications Authority (SAQA), whose tasks include overseeing the development of the NQF, by formulating and publishing policies and criteria for the registration of bodies responsible for establishing education and training standards or qualifications; and overseeing the implementation of the NQF by ensuring the registration, accreditation and assignment of functions to the bodies referred to above. It must also take steps to ensure that provisions for accreditation are complied with and where appropriate, that registered standards and qualifications are internationally comparable. Sector Education and Training Authorities (SETA's) will be responsible for disbursement of the training levies payable by all employers. These levies will be collected by the South African Revenue Service via the Department of Labour, and are to be disbursed through a management system motivated by skills requirement assessment and monitoring. Thus SETA's will ensure that the skill requirements of the sector are identified and that the adequate and appropriate skills are readily available. The SETA would contribute to the improvement of sector skills through achieving a more favourable balance between demand and supply, and would ensure that education and training is provided subject to validation and quality assurance; meets agreed standards within a national framework; ensures that new entrants to the labour market are adequately trained, and; acknowledges and enhances the skills of the current work force. The Joint Initiative on Priority Skills Acquisition (JIPSA) was a high-level task team that attempted identify urgent skills needs24 and was established to advice on government on how they

24 Professional skills in engineering, science, finance and management, as well as technical and artisan skills were specifically targeted.

171 can be met. This programme responded to the acknowledgement by government that the single greatest impediment to its public infrastructure programmes - as well as private investment programmes - remained the country's shortage of skills. The Accelerated and Shared Growth Initiative for South Africa (ASGISA) had also identified the shortage of skilled labour as one of the six constraints to its goal of boosting economic growth to 6%. The other five are exchange rate volatility, infrastructure backlogs, and limits on investment opportunities, the regulatory environment, and deficiencies in state organisation, capacity and leadership. JIPSA identified several interventions in need of urgent attention, such as mentoring programmes and overseas placement of trainees to fast-track their development. In 2008, JIPSA was rolled into the National Human Resource Development Strategy.

3.4.1 Participation in Lifelong Learning

Lifelong learning is an important component of a knowledge intensive society. It encompasses a range of education and training programmes beyond an individual’s original qualifications. Participation in lifelong learning therefore indicates a society’s mobilization of knowledge resources towards iterative learning. An indicator of National participation in lifelong learning is the number of individuals 25 years or older who report themselves undertaking some formal education or training programme. Society’s intensity in lifelong learning participation is then indicated by the ratio of those individuals by the total population 25 years or older. In the period between 2002 and 2005, South Africa’s population 25 years or older participation in lifelong learning increased at a compound annual rate of 2.8%. On average 1.9% of all individuals 25 years or older participated in lifelong learning. Universities and technikons were the most frequently used institution for lifelong learning. From 2002 to 2005, the share of lifelong learners undertaking studies at universities or technikons rose from 59.2% to 64.2%. In fact, all of the growth seen in lifelong learning by the 25 years or older population occurred within universities and technikons. Colleges, adult basic education and training (ABET), and other institutions all saw absolute and relative decreases in learner enrolments.

3.5 Metrology

The CSIR was mandated to maintain primary scientific standards of physical quantities for South Africa and compare those standards with other national standards to ensure measurement equivalence with the global community. This function was entrusted to the National Metrology Laboratory, a unit in the CSIR, until April 2007. The National Metrology Institute of South Africa (NMISA) was established through the Measurement Units and Measurement Standards Act (Act 18 of 2006). This act transferred all responsibilities for the maintenance, traceability and dissemination of national standards from the CSIR National Metrology Laboratory (CSIR NML) to NMISA. The other agency in this field is the South African Bureau of Standards (SABS). SABS is the national institution for the promotion and maintenance of standardization and quality in connection with commodities and the rendering of services and publishes national standards that it prepares through a consensus process in technical committees, provides information on national standards of all countries as well as international standards. SABS also tests and certifies products and services to standards; develops technical regulations (compulsory specifications) based on national standards, monitors and enforces compliance with such technical regulation; monitors and enforces legal metrology legislation; promotes design excellence and provides training on aspects of standardisation.

172 3.6 Intellectual Property

3.6.1 Patents

Patent indicators are popular measures of innovation performance. Patenting provides a long- term measure of an innovation systems knowledge outputs. Applicants/recipients resident in South Africa are counted as South African patents. Because patents tend to be disproportionately focused on the home market, comparison across three major patent office’s internationally facilitates identification of context specific changes in patents from more systemic changes. The three patent office’s used in-line with the OECD triadic patent categorisation are: the European Patent Office (EPO), the Japanese Patent Office (JPO) and the United States Patent and Trademark Office (USPTO). Data on domestic patenting is provided by the Companies and intellectual property registration office (CIPRO). The other patent office data is reported by the World Intellectual Property Organisation (WIPO). Patent convention treaties (PCT) were a patent granted in one treaty country is recognised in another are an increasingly important means for inventors to register their patents in other countries. This international trend is also reflected in South Africa. In 1999, 46% of South Africa’s patents granted in the EPO were PCT but by 2006 86% of South African patents granted were PCT. That equals an annualised increase of 9.2%. Similarly, 17% of South Africa’s patents granted in the USPTO were PCT in 1999, but by 2006 52% of South African patents granted were PCT. That is an annualised increase of 15.8%. South African patent applications in both the EPO and the JPO increased substantially after 2003 even if this increase was from a relatively low base. Similar if less substantial rises were also seen in South African applications to the USPTO and CIPRO. South African patents granted annually in the JPO declined marginally from 1999 to 2006. USPTO grants to South Africans remained largely unchanged in the period, but EPO grants increased at an annual average rate of 8.3%.

4. Policies, Representation & Financing

The debate about the future economy of South Africa was sharply differentiated along two positions. On the one hand, there were those who argued that the scale and scope of industry would need to expand and through its growth increasingly incorporate those people historically disadvantaged. This trickledown effect, it was argued, would eventually eradicate the distortions of apartheid and ensure sustainability without further constrictions. In this case, the state would need to relegate itself to maintaining public order and withdraw from direct intervention in the economy through the privatising of state enterprises. In contrast and opposition was the view that redistribution should be seen as an objective in itself. The pursuit of this would then generate the expansion from the historically privileged minority to the vast majority of South Africans. In this scenario it was proposed that redistribution would be the catalyst to growth and that the products of this growth would be redistributed to meet basic demands. In this case, the state would boost demand by redirecting incomes to the poor who would then increase their consumptive demands. The follow through would be an increase in domestic output and hence create the requisite conditions of growth. The political transition in South Africa became a public process when the then state president, FW de Klerk, formally announced the lifting of restrictions on banned organisations and began a selective release of its long imprisoned leaders. It was undoubtedly envisaged by him and his party that these interventions would usher in a period wherein South Africa would experience a negotiated transfer of power from a minority regime to a majority democracy over a long and protracted period

173 of transition. The first stage of this process would have seen the establishment of a transitional authority which would frame a constitution and thereby lay the basis for a universally franchised election for a government of national unity. The actual evolution of the transition did not proceed as planned as the political reality revealed a series of apartheid state sponsored and linked processes of destabilisation and an inept right-wing attempt at a coup. The Convention for a Democratic South Africa (CODESA) did however provide a forum through which representatives of the various constituencies began to negotiate the future of South Africa’s democracy. This provided the space for deeper constituency based developments to flourish. The returning exiled component of the national liberation movement was able to consolidate its base and integrate its cadres into a single formation. The mass democratic movement was therefore seen as an emergent de facto government-in-waiting. The cadres of the MDM who were deployed from a diversity of civil society organisations and the ranks of the military wing of the national liberation movements began to increasingly influence the individual sectoral deliberations about post apartheid South Africa. The country began to establish a variety of forums which sought to negotiate particular sectoral policies. As the period until 1990 was still tumultuous, very little movement was possible through a dialogue between belligerents. Rather, the discourse was engaged in through the proxy of non- governmental organisations and academic institutions who were directly affiliated to the mass democratic movement or the direct machinery of the apartheid state and its agencies.

4.1.Explicit Innovation Policies

By early 1990, there had already emerged an Interim Science and Technology Group with the now legal ANC. By October of that year, this Group produced a ‘draft position paper on science and technology policy’. This document was a combination of a critique of the existing system and proposals on the reform of the system. In a related process, the education sector had begun an extensive country wide investigation of the entire system of human resource development. This was conducted as a project of the national education coordinating committee. The aim was to generate information that could feed into deliberations on policy selection and influence the course of policy research. With respect to economic policy, the formation of the Macro-economic Research Group (MERG) by the African National Congress in 1991 was critical in gathering those sympathetic to the growth through redistribution thesis. The MERG report published in 1993 argued for a radical restructuring of the economy mainly through labour market interventions in education and training and skills development while simultaneously raising wages. Its report outlined a coherent programme of state intervention with high levels of regulation, taxation and competitiveness oversight. The MERG report also argued for the creation of tripartite supervisory boards for large companies. The progressive journal: Transformation, suggested that a symposium on the “role of research in transforming South Africa” be organised. This journal played an important role in the anti- apartheid struggle as a medium for debate on economic policy options and in expanding the critique of Apartheid strategies. It also had an organising role in the formation of the Economic Trends Group, which was aligned to a significant component of the MDM, the Congress of South African Trade Unions (Cosatu). The symposium occurred at the beginning of 1992 and is seen as providing the momentum for the creation of an external “Mission on Science and Technology Policy for a Democratic South Africa.” This would later be funded by the International Development Research Centre through its wider support programme in aid of facilitating the transition period in South Africa. Hence, the Science and Technology Policy Transition Project were begun. Similarly, Cosatu and the University

174 of Cape Town jointly sponsored a Technology and Reconstruction colloquium in 1991. This proved another significant event in the policy interregnum. While the debate within the MDM largely revolved around the nexus of economic policy, there was already a growing dissatisfaction within and amongst the apartheid-linked institutions and agencies. These had also begun a process of seeking change from within the constraints of their origination and establishment. The Human Sciences Research Council organised a ‘symposium on science policy and research management’ in August of 1991. These occasions assisted with the further elaboration on the policy transition necessary for the science and technology sector. The IDRC-sponsored Mission on Science and Technology Policy for a Democratic South Africa was a major milestone in the evolution of the policy trajectory. It was organised as an ‘external examination’ formatted along a methodology utilised by the Organisation for Economic Cooperation and Development (OECD). The Mission was led by James Mullin, the former chair of the OECD Committee on Science and Technology. He would continue to play an important and influential role in the transition and beyond. The Mission had three stages. In the first stage the ‘buy-in’ and support of the heads of the existing science and technology institutions was sought. This was achieved with participation and the commissioning of a series of background papers. The second stage comprised a process of engagement through workshops and interviews, wherein Civil society together with both public and private sectors were targeted. This allowed for open debate and mutual learning amongst different sectoral participants. The third component of the Mission was designated by OECD lexicon as the ‘confrontational’ stage. In this period, two discrete though interconnected meetings took place: gathering of organisations aligned with the MDM and a meeting attended by government and business representatives. Following these meetings, the Mission completed a report “Towards a Science and Technology Policy for a Democratic South Africa” which was published in mid-1993. The published Mission Report provided both an initial appraisal of the Science, Engineering and Technology Institutions (SETI’s) in South Africa and introduced contemporary global innovations in policy terminology and vocabulary into the country. A concurrent follow-up on the Mission was the establishment of the Science and Technology Initiative (STI). This took the form of a Working Group which included representatives from both the MDM and the existing science and technology system. The co-chairs of the STI were Jayendra Naidoo of Cosatu and Brian Clark of the Council for Scientific and Industrial Research. The Working Group comprised representatives from the ANC, Cosatu, the Committee of University Principals, the Human Sciences Research Council and the Science Advisory Council. The STI institutionalised the policy negotiating process and identified six priority issues which would guide future deliberations. These priority issues were: Information on the science and technology system; transparency and influence of the existing decision-making and advice- formulating process; a future science and technology system and its decision-making process; enabling research establishments to respond to major issues; human resources development and governance. While these developments within the domain of the NSI were emerging, the negotiation over the transfer from political power of the National Party to a democratically elected government was proceeding through CODESA. This process had deepened with preparations for a constituent assembly, the transitional executive authority and the drawing up of the bill of rights. The draft post- apartheid constitution was published shortly after the release of the Mission report. It is estimated that by 1994 there were over 250 multi-stakeholder negotiating forums active in the country. This extensive engagement between stakeholders on reforming individual sectors liberated space for intensive policy research and formulation by stakeholders. The ANC, which was the leading constituent of the MDM, had already established and activated a research coordinating desk The science and technology group was able to draft policy proposals which were tabled as draft

175 resolutions at the consecutive national and policy conferences of the ANC. These draft resolutions were debated by the rank and file membership and recommendations forwarded for discussion and ratification at the national conferences. The ANC deliberations had begun to coalesce around an emerging programme focussed on reconstruction and development as the key features of the post-apartheid dispensation. The reconstruction and development programme (RDP) went through at least six draft versions prior to final adoption by the MDM. It would thereafter become the primary policy platform of the ANC for the 1994 elections. A series of consultations between the ANC, the National Party and the Inkatha Freedom Party (IFP) helped avert a potentially catastrophic situation in the country. The political posturing which precipitated this crisis was sharply contrasted to the open and constructive engagement between stakeholders on reforming individual sectors. The STI had continued its work and held its fifth plenary a month after the 1st democratic election in South Africa’s history. The ANC won a significant majority in the election and consistent with the inclusive ethos of the transition period inaugurated a government of national unity (GNU). The GNU adopted as its policy framework the RDP which by then had been issued as green and white papers. A single portfolio position was created in the first democratic cabinet for arts, culture, science and technology (DACST) and bestowed upon a member of a minority partner in the GNU, Ben Ngubane of the IFP. The immediate challenge of the newly formed GNU was to rapidly establish and enact new policies which would simultaneously seek to redress the inherited legacies from apartheid whilst also building a sustainable future for the country. There was also the need to ensure that the value of the numerous multi-stakeholder negotiating forums was not lost. Momentum had been generated through these processes and significant advances had already been achieved in re-conceptualising the post-apartheid form of state and governance strategies. Both the new Minister and deputy Minister for Arts, Culture, Science and Technology were supportive of the STI and the proposals it was generating through its commissioned reports. It was proposed that the STI be reconstituted as a vehicle for consultation between the ministry and the science and technology community and that it be re-named the National Science and Technology Forum (NSTF) in 1994. A member of the STI was also appointed as Director General of the DACST, Roger Jardine. With guidelines established by the RDP, DACST utilised the STI outputs to formulate its initial policy agenda. The IDRC supported this period by sponsoring the secretariat function in establishing the new policy programme in the form of the Science and Technology Policy Transition Project. This was at various times coordinated by Dave Kaplan, Rasigan Maharajh and Rajen Govender. The Science and Technology Policy Transition Project assembled together an international team of experts in the field of science and technology policy. This group augmented a local team who were appointed by the Ministry and who utilised an iterative methodology to draft a green paper. The Green Paper on Science and Technology advanced the reports of the NSTF, the ANC Policy resolutions and the RDP. It was circulated for comment to the community of science and technology stakeholders and role-players. This ensured that a vibrant form of debate and engagement was created. The Green Paper suggested that the model of a transition in the mode of knowledge generation had been affected at a global level. This drew upon the research of Michael Gibbons who famously described a qualitative shift from the singular discipline based forms of research to a more dynamic multi-disciplinary and problem-orientated system. This was defined as a transition from mode one to mode two research practices. The global discourse had also experienced a shift from earlier notions of a republic of science to the more pragmatic and integrated description of a system of innovation. Across Europe similar dissatisfaction with the neo-classical disregard for the role of technological change in economic development had seen the rise of new institutional economics centred on the work of the Stanford

176 economist, Paul Roemer. The Green Paper was able to draw attention to and focus this emerging body of literature for the national debates. The Green Paper also compiled a domestic situational analysis based on the finding of the Mission and the STI-commissioned research papers. Combining both a philosophical and a pragmatic approach to redefining a contested domain ensured that the Green Paper transcends narrow sectoral interests and that of established role-players. It also posed a series of questions regarding both the orientation and the objectives of the future democratic science and technology regimen. A request for comments was issued and a new drafting team was appointed by the Ministry. A Ministers Committee on Science and Technology was established as a sub-committee of Cabinet. The chair of this body was the then Deputy President, Thabo Mbeki and the committee in essence reflected a proto-form of current cabinet cluster structures. This ministerial team was linked to a committee of Directors General from each of the represented ministries. This body would play an important role in guiding the policy process and establishing the synergies proposed as a key requisite for the transition from a narrow science and technology policy perspective to the wider national system of innovation approach as advanced in the White Paper. The White Paper Drafting Team was supported by a group of critical readers who responded to a series of draft chapters. The draft White Paper was also circulated for comment to role-players and a structured form of interaction saw the refining of the individual chapters based on comment and feedback. The Portfolio Committee also contributed to the process as did the NSTF through a series of public hearings and presentations. The “Growth, Employment and Redistribution” (GEAR) strategy employed in 1996 by government was premised on the need to stabilise the macro-economic environment in the country. GEAR was positioned as an integrated strategy which spanned the multiple sectors of government. It sought to establish macroeconomic stability as the basis for enabling a sustainable platform for accelerating the rate of economic growth, and therefore social development. GEAR was supposed to introduce greater predictability and certainty into the economic policy and fiscal architecture and planning environment, mainly through maintaining fiscal discipline, reducing government debt and the implementation of the Medium Term Expenditure Framework. By 1999, government had ensured that the fundamental stabilising mechanisms in terms of macroeconomic policies were embedded in practice and institutionally. It was upon this platform of stability that government assumed an expansionary stance whereby the constraints to growth would be redressed and the benefits of development more widely shared. It also pursued greater levels of integration and coordination within, across and between the different layers of government. The White Paper on Science and Technology (WPS&T) was adopted by the South African Cabinet in 1996. It was aligned to the Reconstruction and Development Programme of the first democratic government elected in 1994. As a policy domain with considerable potential to contribute to the growth and development of the country, the WPS&T was premised on a view of the future where all South Africans could enjoy an improved and sustainable quality of life, while participating in a competitive economy by means of satisfying employment and thereby, share in a democratic culture. The desired future contemplated by the WPS&T is consistent with the aims of the South African Constitution. The WPS&T suggested that the creative use and efficient management of innovation was imperative in order to achieve such a vision statement. This notion was translated by the WPS&T into the following three goals: the establishment of an efficient, well co-ordinated and integrated system of technological and social innovation; the development of a culture within which the advancement of knowledge is valued as an important component of national development and improved support for all kinds of innovation which is fundamental to sustainable economic growth, employment creation, equity through redress and social development.

177 The achievement of these three goals stimulated the WPS&T to adopt a systemic approach towards restructuring the country’s scientific and technological resources. The WPS&T therefore introduced the concept of a National System of Innovation (NSI) as an organising framework defined as “a network of institutions in the public and private sectors whose activities and actions initiate, import, modify and diffuse new technologies.” Within the framework of the NSI, the objectives of the WPS&T were articulated as: promoting innovation and employment creation; enhancing quality of life; developing human resources; working towards environmental sustainability; promoting an information society and generation of knowledge. The framework established by the WPS&T sought to ensure that South Africa had a set of institutions, organisations and policies that would give effect to the various objectives and functions of the NSI. In order to assess the size, scale and scope of the agencies and institutions inherited the post-apartheid Government also proceeded with three further research exercises in support of the WPS&T. These were the following: national Research and Technology Foresight; National Science and Technology Audit; and Science, Engineering and Technology Institutional (SETI) Reviews. The results of these inquiries provided the basis for the continued processes of restructuring and transformation of publicly funded research and development institutions. They also provided some baseline data on capacities and competencies inherited from the apartheid regime while simultaneously providing a methodology for determining trends and trajectories in a variety of science and technology domains. According to the WPS&T, government had the responsibility to establish laws and regulations, to allocate public resources according to defined priorities, and to initiate and implement programmes related to these functions. It saw Research and Technology Foresight and Audit exercises as examples of the functional deployment of the latter’s key competency. Another structural change which was suggested by the White Paper found support in the SETI Reviews. This provision recognised that the separate funding agencies for natural sciences, engineering, humanities and social sciences should be amalgamated into a single function. This saw legislation being introduced which would merge the Centre for Science Development with the Foundation for Research Development to form the National Research Foundation (NRF). The SETI Reviews also offered views on the governance and missions of the various performing agencies. They also confirmed that performance according to well defined criteria would offer the system greater stability and the capacity for long term planning. Again, this was aligned with the Medium-Term Expenditure Framework (MTEF) and the Performance and Financial Management Act (PFMA) which were mechanisms of the National Treasury. With the need for Monitoring and Evaluation established as a form of good governance and transparency, DACST established a set of Key Performance Indicators for Science, Engineering and Technology Institutions. Agencies receiving public money for conducting science and technology activities were expected to measure their performance according to the criteria established as an aid to the decisions regarding the allocation of those public resources. A top-slicing of agency grants saw the creation of a fund which operated on a competitive basis and sought to increase collaboration between the various agencies. These challenge awards were set up with the objective of addressing significant national priorities and imperatives. This would later evolve into the Innovation Fund. Having achieved macro-economic stability through GEAR, the second post-apartheid government began a process of deepening and widening its efforts in transforming South Africa. Attention now shifted to levers which could unlock higher growth rates and also spread the public

178 good benefits of state interventions. The Microeconomic Reform Strategy (MRS) was announced in 2000 and articulated a medium- to long-term vision for South Africa. An expanded definition of NSI was adopted which was based on global empirical and theoretical developments. From 2002, the NSI has been recognised as “a system of interacting private and public firms (either large or small), universities and government agencies aiming at the production of science and technology within national borders. Interaction among these units may be technical, commercial, legal, social and financial, inasmuch as the goal of interaction is the development, protection, financing or regulation of new science and technology to enhance the quality of life and sustainable economic growth”. The National Research and Development Strategy (NR&DS) was accepted by Cabinet in 2002 as the basis for further development of the NSI and to address key challenges to the development of the system’s robustness and effectiveness. DACST was also restructured into two stand-alone departments. The Department of Science and Technology (DST), with a dedicated bureaucracy and full Ministry was established. DST would retain custodianship over the NSI and become the implementation vehicle for governments NR&DS. The NR&DS is structured on an evidence-based indicator system of monitoring and evaluation. At a high level of aggregation it is based on a dynamic interaction of policies, strategies, plans, institutions, utilities and functionalities. The NR&DS, in accordance with the constitutionally determined role of the South African state as a key motive force in social development, is focussed on improving the quality of life of all its citizens. It qualifies this by emphasising that the creation of wealth in modern economies is increasingly dependent on innovation, research and development. It therefore proposes that South Africa must grow its investment in this domain and strategically target resources to meet its objectives. The high-level goals of the NR&DS are articulated as the improvement of the quality of life and wealth creation. These objectives are served by three key processes: business performance, technical progress which incorporates innovation and improvement, and effective and growing science, engineering and technology human capital. Sustaining these intermediate processes and objectives are the fundamental activities related to the acquisition, generation and application of knowledge, namely: imported know-how, current R&D capacity and future R&D capacity. The NR&DS is aimed at solving the following identified and quantified problems: low investment in R&D; strategic vulnerability of economy; loss of missions; weak human resources base and “Frozen” demographics; declining private sector R&D; inadequate intellectual property framework and fragmented governance. The three operational objectives for the implementation of the NR&DS are achieving mastery of technological change in our economy and society (Innovation); increasing investment in South Africa’s Science base (Human Capital and Transformation) and strengthening the government S&T system (Alignment and Delivery). DST also established strategic interventions in the fields of Biotechnology, Advanced Manufacturing, Information and Communications Technologies, and Nanotechnology. The 10 Year Plan of DST aims to stimulate the country’s research community to engage in multidisciplinary approaches which transcend narrow and traditional disciplinary boundaries, develop new tools, techniques and teaching materials to better solve contemporary problems and position the country at the frontier of the knowledge enterprise. There are six components of the 10 Year Plan. The first is a specific human capital development plan for the human and social dynamics priority area which is informed by the overall Science, Engineering, and Technology Human Capital Development Strategy. Second, an integrated and consolidated programme for reducing the ‘knowledge chasm’ between research and action and to build the SSH-policy interface. Third, the need to build large-scale integrative flagship human and social dynamics research programmes that can mobilize the research community. Fourth, The need for South Africa to identify opportunities for co-operation and alignment with continental and global efforts. Fifth, the introduction of a

179 monitoring framework to support planning and reflection on the contribution of the Human and Social Dynamics Grand Challenge to development and service delivery goals. At last, support enhanced information dissemination, exchange and collaboration within the research community as well as between the research community, policy and decision-makers, and society. To implement these six components, the DST has devised five Grand Challenges. First, the “Farmer to Pharma” value chain to strengthen the bio-economy – over the next decade South Africa must become a world leader in biotechnology and the pharmaceuticals, based on the nation’s indigenous resources and expanding knowledge base. Second, Space Science and Technology – South Africa should become a key contributor to global space science and technology, with a National Space Agency, a growing satellite industry, and a range of innovations in space sciences, earth observation, communications , navigation and engineering. Third, Energy Security – the race is on for safe, clean, affordable and reliable energy supply, and South Africa must meet its medium- term energy supply requirements while innovating for the long term in clean coal technologies, nuclear energy, renewable energy and the promise of the “hydrogen economy”. Fourth, Global Climate Change Science with a focus on climate change – South Africa’s geographic position enables us to play a leading role in climate change science. Fifth, Human and Social Dynamics – as a leading voice among developing countries, South Africa should contribute to a greater global understanding of shifting social dynamics, and the role of science in stimulating growth and development.

4.2 Implicit Innovation Policies

While the explicit policy formation, strategy and planning of the system of innovation largely rests under the custodianship of DST, numerous other domains impact on the generation and distribution of innovation in South Africa. Due to ‘systems thinking’ providing the broad theoretical underpinnings for DST, all other sectoral determinations may be considered implicit innovation policies. As this paper cannot consider them all, the following domains are selected as mainly representative of their character and features. By way of introducing these it is important to provide a stylised periodisation of efforts at reforming the country’s political economy. While Fiscal Policy, especially under the regime of Growth, Employment & Redistribution model saw government spending shrink as it reduced the inherited apartheid debt, it also ushered in conservative Monetary Policy which was aimed exclusively on Inflation Targeting as a mechanism to establish price stability. In terms of Competition Policy, much effort was spent in the period leading to 2000, building the institutional capabilities of the executing arms of the policy. The Competition Commission is a statutory body empowered to investigate, control and evaluate restrictive business practices, abuse of dominant positions and mergers in order to achieve equity and efficiency in the South African economy. The Competition Policy Guidelines were aimed at supporting both the macro-economic (national economic management) strategy and microeconomic restructuring (promoting more efficient firms and industries). They argued that such an approach required consistency across the various fields associated with competition policy, particularly trade and industrial policies, state asset restructuring, and approaches to empowering emerging entrepreneurs. The fourth area of implicit innovation policy is often referred to as Industrial Strategy. As in Competition Policy, the main actor in this domain is the Department of Trade and Industry. It established a framework for Industrial Policy but couched this in the language of Micro-economic Reform. The objects of this effort was to ensure: Geographic spread of social and productive investment; integrated manufacturing economy capable of high degrees of value added; extensive ICT and logistics system capable of speed and flexibility; high degree of knowledge and technology capacity; greater diversity of enterprise types and sizes; skilled, informed and adaptable citizens and an efficient, strong and responsive state structure.

180 4.3 Innovation Regulation

Governance of the public component of the NSI is primarily a central government competency; provincial governments contribute to the systems only through the relatively minor portfolios of primary and secondary education and local industrial development. At central government level, South Africa follows a system whereby various government departments, with the exception of the DST, assume responsibility for different areas of S&T and for specific institutions. The DST is also responsible for specific institutions (the Council for Scientific and Industrial Research, the National Research Foundation and the Human Sciences Research Council), but has a cross-cutting and steering function for areas such as S&T liaison across departmental line functions and sectors; large-scale, broad-scope new S&T platforms and challenges; and system-wide oversight functions, including establishing and maintaining a common governance framework, priority setting, and performance and budgetary monitoring systems. The mandates of the DST and the Department of Education include responsibility for creating and overseeing the implementation and funding of S&T policy and instruments – the DST primarily with regard to R&D institutions and programmes and the Department of Education with regard to the training of high-level human resources and the support of university research. Support of university research takes place through two mechanisms, namely a postgraduate component in the subsidy formula and an R&D publication subsidy. The work of these departments overlaps in two respects. Firstly, the funding and political accountability of the National Research Foundation, which supports a considerable amount of research within HEIs, are the responsibility of the DST. Secondly, the DST has since 2005 also had an oversight function for several basic research programmes within the NSI, particularly in the HEIs and PRIs. The DST and the Department of Education are supported and advised by two Ministerial statutory bodies (NACI and the Council on Higher Education respectively). Each of these departments would generally consult relevant stakeholders, directly and/or indirectly, before finalising new policy initiatives. DST is the main author of national STI priorities to the extent that it has been given a cross- cutting and steering function within the system. In this regard, it is guided by the framework established by the National Research and Development Strategy, international developments and inputs received from various role-players in the system.

4.4 Innovation Promotion

The promotion of Innovation is largely seen as a DST activity. Whilst it maintains some competences in the larger Public Understanding of Science and Technology domain, it acts though an agency called the South African Agency for Science and Technology Advancement (SAASTA) that is mandated to advance public awareness, appreciation and engagement of science, engineering and technology in South Africa. (SAASTA) is to advance public awareness, appreciation and engagement of science, engineering and technology in South Africa. SAASTA was formerly known as the Foundation for Education, Science and Technology (FEST). The organisation changed it's name after being incorporated into the NRF in December 2002. It derives its core funding via the NRF from the DST. The NRF itself is a science council and as such is a non-profit entity. SAASTA’s activities include: building the quantity and quality of mathematics and science outputs at school level (developing SET human capital); raising the general interest in, engagement and appreciation of the public (and especially poorer communities) for the benefit of science (strengthening the SET culture) and communicating science to the South African citizenry (bringing science and scientists closer to civil society).

181 5. Innovation Demand

5.1 Income Distribution

As a product of Apartheid Colonialism which was a form of Racial Capitalism, South Africa inherited massive inequalities which organised and segmented according to Race, Class and Gender lines. The regime post-apartheid has successfully managed to break these continuities through a variety of legal instruments and incentives. Notwithstanding, the removal of formal barriers to especially black people and women, the country remains scarred by an iniquitous distribution pattern in terms of incomes. Whilst maintaining a per capita level which places it firmly in the middle- income group of countries of the world, the actual spread of incomes maintains and reproduces underdevelopment. In terms of geography, South Africa remains blighted by the common rural/urban divide. These are magnified and filtered through the lenses of race, as areas historically designated for black people exhibit the highest levels of deprivation and the worst results of underdevelopment.

5.1.1 Income Inequality

Income distribution is a popular indicator of inequality in an economy. While this is a limited indicator since it does not include social security or other public resources enjoyed that benefit an individual or a house hold, it is a relatively tractable indicator that is useful in international comparisons because it does not depend on estimates of social welfare benefits. Income inequality represented by the Lorenz curves for 1995, 2000, and 2005 has decreased recently among the poorest third of South African households, but inequality has risen among remaining two-thirds of households. Income inequality as indicated by the Gini coefficient has increased in South Africa since 1995 and it has accelerated since 2000, increasing from 0.543 to 0.587 in 2005. It is however interesting to note that while income inequality within racial groups has increased, that between racial groups has decreased.

5.2 Structure of Consumption

5.2.1 Natural Resource Endowments

Natural resource endowments are important determinants of an innovation systems structure. An indicator of an innovation system’s development can be the extent to which natural resources are extracted or protected. The systematic reporting on natural resources is an area needing increasing attention in an increasingly interdependent world. Energy intensity of value added is an indicator of resource demand and associated knowledge intensity. South Africa has considerable minerals reserves of international significance. Platinum group metals (PGMs) reserves for instance account for 88% of identified resources internationally. In 2006, South Africa produced 77% of all PGMs internationally. The biodiversity intactness index (BII) indicates that approximately four-fifths of South Africa’s ‘pre-colonial biodiversity remains intact. Plantation forestry is an important resource to South Africa’s internationally competitive wood, paper and pulp industry. Significantly, a vast majority of South Africa’s forestry resources are certified as being sustainably grown by the international Forestry Stewardship Council (FSC). Transformation in the forestry industry is creating significant challenges and ensuring plantation

182 forests continue to play an important role in the industry’s competitiveness while simultaneously playing a greater role in economic development is a critical challenge for the future. South Africa has demonstrated a sustained increase in its improvement of energy efficiency. Between 1999 and 2001 an average of 200 watt were used for every rand of value-added produced. In this period energy needs per constant rand of value added decreased by 3.1% annually.

5.2.2 Information and Communication Technologies Availability

Information and communication technologies (ICT) are important means to enable knowledge growth and development. Telephones are a basic ICT, facilitating knowledge and information transfers in a society. The indicator is taken as the ratio of the number of households reporting to have a cellular of fixed-line telephone to the total number of households. Households’ access to telephones has increased at a compound annual rate of 11.5% in the period from 2002 to 2006. The percentage of households with access to a telephone has risen from 44% in 2002 to 70% in 2005.

5.3 Social Organisation

5.3.1 Age Distribution of the Population

The age distribution of the population allows one to compare the number of young people entering the work-force and the elderly leaving. If we assume that youth are generally more willing to purchase innovative products and services, the age distribution of the population indicates demand for innovations. Similarly, the age distribution may indicate the population’s willingness to learn new technologies. Nationally, over half, 52%, of the population is less than 25 years of age. This population’s relative share has declined from 55% in 2001. The share of the population between 25 and 54 has grown from 35% of the total population in 2001 to 37% in 2006. The population over 54 years of age also rose from 9% of the total population in 2001 to 11% in 2007. The share of the population less than 15 years of age has decreased at an annualized rate of one percent between 2001 and 2007. In contrast, the proportion of the population over 64 years of age increased at a compound annual rate of 2.5% during the same period.

5.3.2. Social Cohesion

A socially inclusive society, with low rates of income inequality and poverty and high education could support innovation by increasing the purchasing power of the population, increasing the pool of individuals with capital and education to invest in risk taking innovative projects, and increasing the pool of skilled, educated and committed workers. In addition, social cohesion is an indicator of social capital that can support collaboration in innovation. Measurement of social cohesion is a rapidly developing area. One critical element is public engagement. An indicator for public engagement is voter participation. Another element in the measurement of social cohesion is community and volunteer work. Other important elements of social cohesion include the intensity of involvement in community activities, inter-personal trust, and informal social networking. Between 2002 and 2007, there were just over a million people annually undertaking volunteer work in South Africa. These volunteers grew at a compound annual rate of 10%. As a percent of the working age population, individuals undertaking volunteer work have increased from 3% in 2002 to 5% in 2007.

183 In terms of participation in voting, the percentage of registered voters actually voting declined slightly between the 1999 and 2004 national elections, but remained nearly constant between the 2000 and 2006 local elections.

5.3.3 Entrepreneurship25

Because creation of new businesses and closure of failing business are a potential source of economic dynamism entry, exit and turnover of firms are important indicators of entrepreneurships in an economy. Change in the composition of firms measures an economy’s ability to expand and transform the boundaries of economic activity to meet changing needs. In 2006, the birth rate of enterprises in South Africa was 8% of the total number of enterprises. This rate is similar to that reported in OECD nations like Finland and France. The annual number of enterprises registered increased steadily from 1999 to 2005 before dropping sharply in 2006. In the period 1999 to 2006, the majority of newly registered enterprises were close corporations: 77%, followed by private companies: 21% and non-profits 1%.

5.3.4 Innovation Networks

Innovation surveys provide an important source of information about the structure of knowledge flows in an innovation system as well as major facilitators and barriers to the efficient flow of knowledge. Among enterprises reporting innovation activities, the most frequently sighted source of innovation was from within the firm itself, 51%. This source was reported by 70% of firms in the industrial sector, but only 35% in the service sector. Internal collaboration was the next most sighted source 20% followed by other enterprises 6%. In terms of information sources identified as being important for innovation, internal information was the most frequently cited source, 49%. Customers 35% followed by suppliers 24% and competitors 13% were other information sources identified as being important. Market domination was identified by 26% of all firms as an important factor hindering innovation. It was followed by lack of internal funds 25%, innovation costs 20%, lack of qualified personnel 17% and lack of external finance 15%. Nationally, customers were identified as the most frequent collaborative partner in an innovative activity 38%.

5.3.5 International Flows of Human Resources

International flows of human resources are another important indicator of knowledge flows in a system of innovation. The composition of student enrolments is an indicator of provincial and national mobility networks. There has been a significant increase in nationals from other SADC countries as well as rise in the number of Asians and North Americans in South African public HEI.

5.4 Social Demand

5.4.1 Poverty and Inequality in Household Characteristics

Poverty is an important determinant of an innovation systems structure. An indicator of an innovation system’s development can be the extent to which poverty exists in an economy and the

25 Entry, exit and turnover of firms are primary measures of entrepreneurship.

184 groups most severely impacted by it. Simultaneously poverty is an indicator of human capital availability and hence of the growth and development potential of the national system of innovation. Medical aid coverage varied considerably across racial groups. While on average 66% of White households had medical aid coverage in the period between 2002 and 2006, only 8% of African households had medical aid coverage. “Household” amenities varied considerably across the provinces while on average 92% of households had access to water on site or in the dwellings in Gauteng only 39% of households on average in the Eastern Cape had the same. Notably, there is a constant rise seen across all the provinces and nationally. Access to electricity as a primary source of lighting was similarly skewed among our three provinces, with 76% of households nationally reporting electricity as a primary energy source for lighting in the period between 2002 and 2006. Infant mortality increased during the period 1999 to 2005 at a compound annual rate of 7.7%. Child malnutrition decreased steadily from 31% of households reporting a child went hungry in the last twelve months in 2002 to only 16% reporting as much in 2006.

185 III. CONCLUSION

The aim of this Project was to make a detailed description of the National Innovation System of Brazil, Russia, India, China and South Africa. Instead of focusing on a narrow view of the NIS, it searched to understand all the actors that influence innovation. Each country has unique features that one must take into account in order to understand the processes that lead t o new standards. At the same time, common patterns arise in the most different settings. National Innovation Systems are the result of all these different forces. Historic backgrounds differ significantly among the BRICS. China is an ancient civilization and is used to innovation: some of the main inventions of all time came from there. From a historical point of view, it was isolated from the Western world most of the time. Meanwhile, Russia is a European country in the sense that its population came from the same Indo-European branch of mankind; however, its history oscillates between being near or far from Europe. India is another example of a country whose roots date back at least to 6th century BCE, but developed a peculiar culture. Brazil and South Africa are examples of typical European colonization overseas as of the 16th century. Nevertheless, these countries have outstanding similarities. All of them were quite underdeveloped still in the 19th century; all of them were left behind the first waves of industrialization and were in a weak position before European countries. All of them underwent deep transformations in the 20th century and their modern political designs are quite recent. Modern China was born in 1949, with the Communist Revolution. As for Chinese economy, the tale began even later: it has spurred only since 1978. While in China the communist government was able to develop a strong and regulated capitalist economy, in Russia the change was must more disruptive, as both the economy and the political regime fell apart and adopted a capitalist economy and a Western-like government in 1991. This was no easier than the transformation of South Africa: the new political regime established in the 1990’s decade overcame apartheid, a system that had left most of the population without any representation due solely to skin color. Although less troublesome, the transformations that resulted in the modern Brazilian democracy are also quite recent. The country was under a military dictatorship until 1985, as most of Latin-America during the Cold Was: right-wing coup d’états supported by the United States took place all over the continent to prevent the development of communism. The present Constitution was promulgated in 1988 and the first president elected after the dictatorship took office in 1990. India is the only country that can tell a somewhat longer contemporary government: the Republic was set in 1947, in the aftermath of World War II, as a pacifist resistance to British rule was able to gain independence. In brief, some of the fundamental contemporary institutions of the BRICS – including their governments - are very recent. Their very ability to choose their own institutions, without explicit intervention from developed countries, is very recent. Accordingly, the roads toward socio-economic development are new in the BRICS; none dates back to more than a few decades. All these countries have to deal with a heavy heritage of social distortions. Whether in a large and populous country such as China, or in a smaller one such as South Africa, all the BRICS were endowed with great natural resources. Success depends only on how they will design their institutions – specially the National Systems of Innovation and all its subsystems. In the Brazilian case, considering the issues of poverty and inequality and their social, political and economic implications becomes fundamental not only for apprehending the magnitude of existing challenges, but also, and specially, for the formulation of appropriate public policies. The discussion of a national system of innovation (NSI) should be articulated to this specific dimension of the Brazilian underdevelopment. Especially because one of the fundamental aspects for understanding the particularities of and the obstacles posed to our NIS is related to the huge disparities of income distribution and of consumption patterns observed in Brazil, which shape a

186 deep and complex social heterogeneity. This heterogeneity is reflected in every sector of activity, including the productive sector and the technological and scientific dimensions. There were two aspects emphasized related to Brazilian demand subsystem. The first one is that, in spite of the amplitude of poverty and privation in Brazil, these problems are strongly concentrated. It is in the regions North and Northeast, in the rural areas and in the small towns that one can find the main deficiencies: low schooling, low access to infrastructure services supply, low access to manufactured durable goods, and prevalence of low-quality dwellings. Secondly, despite its apparent homogeneity, poverty hides very distinct social circumstances and is an outcome both from the reproduction of obsolete forms of productive integration and from anachronistic institutions, which occur particularly in the rural world. Under this perspective, as it was argued, the National system of innovation in Brazil is permeated by structural characteristics of a peripheral and highly unequal and heterogeneous country. Its institutional conformation has served the current pattern of accumulation, both reflecting and contributing to reproduce actual inequalities. In short, the concentrative pattern of income distribution in Brazil impacts the demand structure through a sharp disparity of consumption patterns, which in its turn boosts a great heterogeneity of the production structure. The productive systems aimed at supplying the demand of the richest strata of population tend to stimulate as much the adoption of technology intensive systems as the dependence on imported capital goods, reinforcing structural unemployment and social heterogeneity, besides representing hindrances to a greater productive efficiency and technological autonomy. A development strategy aiming to break with this vicious cycle requires major structural reforms, among which the designing of new institutional arrangements able to break with inequality and with the polarity modernization-marginalization. The State, in this context, has a core importance in the adoption of active policies that enable to counteract the concentrative and excluding trend and to dismantle the archaic structures of underdevelopment. The dimensions related to the Brazilian production structure and the sectoral distribution of these activities, as well as the characteristics associated to the innovative processes and also some characteristics of formal and informal employment were analyzed. The joint analysis of these issues provided a broad view of the characteristics of the productive and innovative subsystem. As it was seen, Brazil presents a relatively slow and constant process of expansion of the basic education system. However, the high and increasing abandonment rate has significantly reduced the primary education completion rate. Not surprisingly, it happens to the most detriment of poor children. The precarious and heterogeneous conditions of basic education spilled to higher education. The historical roots of the pattern of interaction between universities/ research institutions and enterprises in Brazil are characterized by only localized “interaction points” that become successful cases of relationship between research institutes/universities and some firms. The observed “interaction pattern” is very limited and insufficient for impressing to the economy a dynamics of economic growth based on the strengthening of innovative capabilities. Although the technical education system presents an increasing enrolment rate, it is yet little developed and insufficient for meeting the industrial demand. At least, but not least, Brazilian`s implicit and explicit policy was described. The 1990 decade was characterized by a radical change in terms of macroeconomic policy in Brazil with the adoption of the Washington Consensus. Trade liberalization, deregulation and privatization became keywords in Brazil at the beginning of that decade. In the early nineties inflation escalated. Trade liberalization, besides being part of a neoliberal ideology that invaded Latin America in the 1990s, aimed at using imports as a policy tool to control inflation. One of the major impacts of trade liberalization was the promotion of what became known as “defensive adjustment” of Brazilian firms. In view of the rapid process of trade liberalization and the vertiginous growth of imports,

187 firms were forced to drastically reduce costs. The strategy for reducing costs was implemented mainly through the reduction in job posts, through imports of inputs, outsourcing activities and reducing long run technological activities. Although this strategy was often successful, many firms simply disappeared. The analysis of the innovation policy’s outcomes must take into account the macroeconomic policy adopted in the period between 1994 and 2006: restrictive fiscal and monetary policies, mainly oriented by the model of inflation goals. Russian SNI was analyzed in sequence. As it was seen, the Russian economy is still commodity-driven. Payments from the fuel and energy sector in the form of customs duties and taxes accounted for nearly half of the federal budget's revenues. The large majority of Russia's exports are made up by raw materials and fertilizers, although exports as a whole accounted for only 8.7% of the GDP in 2007, compared to 20% in 2000. The primary sector of the Russian Economy forms 13% of GDP (14.8% of the gross national value added) and is mostly represented by the oil and gas mining and agriculture. The oil and gas industry of Russia is one of the largest in the world. It amounts to 10.2% of gross value added. Russia has the largest reserve, and is the largest exporter, of natural gas; the second largest coal reserves, and the eighth largest reserve, and is the second largest exporter, of oil, but it’s also a great consumer. The Russian oil industry is in need of tremendous investment, although the currently high oil prices mean that there are resources available for financing the upgrades needed. As mentioned, the lack of interaction between the knowledge infrastructure and the firms was mentioned as the most important factor slowing down the process of learning and building competence. Informal mechanisms supporting this interaction could boost the Russian NSI development. The informal economy in Russia is far from innovation-based competitiveness building. The contemporary Russian shadow economy has its grounds from the Soviet planning system where it was a sort of substitute for entrepreneurship activities (impossible in that period). Education was free at all levels in the Soviet system, which explains the high number of Russians that hold 6-year degrees (20%). After the collapse of the USSR, the system could not be funded anymore, and private education spread. Russia’s enrolment in basic and secondary education is comparatively not high. It was also mentioned that Russia presents very low R&D activity in HEIs compared to other countries. Low salaries and lack of funding as well as poor motivation and formalism of teachers were pointed as the causes of poor competitiveness of the higher education system in Russia. Despite considerable higher education enrolment rates, post-graduate enrolment is not so intensive in Russia. Non-formal options, e.g. MBA’s and refresher courses, are faster, more flexible and therefore more popular: its share is nearly twice higher than the formal education. In other countries, this gap is even wider and more spread than in Russia. On the other hand, Russia has high average education hours (90 hours a year, against an average of 66 in the EU). The structure of non- formal education and training if biased towards refresher courses, vocational courses and regular training events – options that upgrade current qualification without breaking current professional activities. With the disintegration of the USSR, the most important challenge for the Russian S&T metrology is the creation of internationally compatible S&T statistics system at the national level, a task that was unachievable under the centralized Soviet system. As it was argued, the current technology market in Russia is quite small and underdeveloped. It was also argued that technology trade in Russia is inefficient, as R&D products are often sold abroad at too low prices, and low-level technologies are bought in, promoting Russia’s technological dependency. Geographically, the main trend in Russian technology export is reduction of the OECD countries' share (especially the US), while the CIS and third world countries show growth (particularly China and India). On the other hand, the OECD countries remain undisputed leaders in Russia's technology imports, US ahead. Positive balance in Russia's technology trade with

188 foreign countries was reached mainly in licensing deals with the CIS countries. The balance with the vast majority of the OECD countries remains negative. As shown, the role of the government in the development of an innovation system generally follows one of these paths: adopting a special law to regulate all aspects of government support to innovation activity; adopting both a special law on innovation activity and various other laws, plus amending existing legislation to regulate appropriate aspects of innovation activity; or adopting a number of special laws and amending existing legislature to regulate and provide support to various areas of innovation activity. The actual choice depends on a country’s economic development and specific legislation. None of these options is currently implemented in Russia. Existing legislation does not provide adequate legal regulation for support and development of innovation activity. There are no special laws on innovation activity in the country, and the existing provisions are fragmentary and accidental. During the years of the economic reform, S&T sector in Russia was developing in a difficult situation, by rather conflicting trends and existing legislation (tax, customs, financial) does not fully encourage innovation activity of businesses. As a result there appear obstacles hindering efficient interaction between R&D, innovation and production. R&D and innovation activity are also poorly organised on the regional and federal district levels. Mechanisms for setting up private and government sector partnerships are practically non-existent. So, in order to solve the main problems in the R&D and innovation sphere it is required serious resources and significant time. Today Russia in principle could afford it because the economic situation has noticeably improved and the country moved to one of the top places in terms of the level of investments. As outlined, putting off dealing with the above problems is fraught not just with conserving the current situation, but could lead to degradation of the basic elements of innovation cycle, irreversible technological lag and complete loss of the country's prestige as a leading R&D nation. As outlined, the contemporary economic potential of the Russian economy is high enough to launch the NSI reforms and complete the transition of the S&T and innovation sector. By now the main directions of such reforms are the following: restructuring government and S&T institutions vis-à-vis new economy markets; S&T budgetary funding reforms; building an efficient system of national priorities setting; establishing of efficient legal framework for S&T and innovation; implementing comprehensive tax incentives for R&D and innovation; and building a competitive innovation infrastructure for S&T and innovation. It is also extremely important that all the official actions are balanced with other and co-ordinated as a single system. In relation to the demand subsystem, the problem of low demand for innovation is also determined by customer demand for new/innovative goods and services. This demand is limited by two main factors: unwillingness to purchase new/unknown goods and services and relative insolvency of potential customers. The structure of end consumption of households in Russia is naturally biased towards non- natural form goods and services consumption. This distribution is typical mostly for urban households. However there exists a significant difference between urban and rural population. Rural households perform 5.7-fold higher consumption of food products in natural form (food products created inside the household) than urban ones. At the same time their access to services is 1.7 times more limited than in case of urban households. As argued, a solution lies with a new institutional model to be established in the Russian higher education sector. This model will be built around research universities notable for innovative state-of-the-art education programmes (the best “innovative HEIs” or “research universities”). The important function of these universities will be the integration of science and education.

189 The main characteristics of Indian SNI were also outline throughout this report. It was shown that, at the time of initiating development planning, India had a traditional agricultural economy with more than 60% of the GDP being generated from the primary sector, mainly the agricultural sector. But even during this early stage of economic development, a peculiarity of the economic structure was the presence of a relatively large services sector, accounting for nearly 30% of the GDP. The secondary sector, during that period, was in a rudimentary stage of development accounting for only about 14% of the GDP. This tertiarisation process noticed early in the developmental path of India had been on the ascension ever since, and was more pronounced during the period starting from early 1980s. The growth rate of services sector has been the highest during the period 1983 to 2004- 05. On the other hand, the growth of the secondary sector has been lower, at 5 to 7%, and the growth in the primary sector had almost stagnated. The growth in the services sector had thus been crucial in kick-starting the economy from being a stagnant slow growing economy to being a fast growing one. Nowadays more than half of the GDP is in the services sector. However, as shown, the acceleration in the growth of the economy however has not been uniform across regions. It was also mentioned that the level of education is found to be positively related to open unemployment in India. The higher level of education, higher the level of unemployment. At levels of no literacy the unemployment rates are very low, in all categories, rural, urban male, and female. This peculiar pattern of unemployment expresses the lack of demand for skilled labour in the economy, where the general level of productive activity requires less skilled, highly labour intensive technology. As in most developing economies the main type of employment in India is self employment. Both in the rural and urban areas more than half of male workers are engaged in self employment. Among females also nearly half of the workers are engaged in self employment. For males the next largest share of workers are engaged in casual type of employment. Nearly a third of the total employment is engaged in casual work. Casual employment represents that of employment characterized by low and flexible wage rates, impermanence of employment and vulnerable conditions of work. The rise in casual employment in India is a worrying fact. It is possible to say that the stagnation in regular employment opportunities owing to the labour market rigidities attached with the organized employment, especially so after liberalization of the economy, had led to a situation wherein informal forms of employment , especially casual employment is on the rise. One of the most important features of Indian SNI is it`s educational system. Given the high rate of illiteracy prevalent at the time of independence on the one hand and the imperative of skilled manpower to achieve the desired economic transformation with prime role for science and technology, the planners adopted a strategy where both primary education and higher education were promoted with an equal vigour. Increasing public investment in education (from 1.5% of GDP to over 3.7% during 1950-51 to 2003-04) and resultant built up of institutions, the literacy rate increased from 18.3 per cent in 1950- 51 to 64.8 per cent in 2003-04 and India emerged as a major source of skilled manpower and fertile ground for skill intensive industries. This report also emphasised that India has witnessed an unprecedented increase in the inflow of FDI into the country. During the pre-liberalization period India attracted FDI but the magnitude of FDI was less. But after the 199, there has been a significant increase, making India the second most favoured destination after China for foreign investment. The remarkable increase in the volume of FDI however is not matching to the size of the Gross Fixed Capital Formation of the economy. During 1999-2000 the average FDI inflow accounted only for 1.9 percent of the GFCF in the country. But after year 2000 the share of FDI in GFCF has sharply increased and reached 8.7 percent by the year 2006. This represented a rise in FDI as a share of Gross Domestic Product from the average 0.5 percent in 1990 to reach 5.7 percent of the GDP.

190 The changes in the foreign investment policy in the Indian economy in the 1990s created substantial changes in the sectoral composition of FDI. The deregulation of many sectors, allowing 100 percent automatic approval and the change in equity cap in different sectors like telecommunication, electric generation, transmission and distribution in Power Sector have attracted FDI to these hitherto protected sectors. It was also shown that during the first phase of internal liberalization, from the early eighties until 1991, the thrust was on internal competition. Policy initiatives during this period aimed at encouraging the Indian corporate sector to acquire the means of industrial upgrading through technology imports and removal of internal controls. With external liberalisation policies still on hold domestic firms were allowed to grow in size and increase their share in the Indian market. During this phase domestic firms also had relatively better protection against imports. The government was made to de-license sufficiently the industrial space, relax regulation regarding foreign collaborations and foreign exchange and dilute the controls over the expansion of Indian big business to provide them with enhanced access to the home market. The government had eased the restrictions in respect of the scope and terms of duration and payments for technology collaborations. The corporate sector was provided with a wide range of fiscal and non-fiscal. It was actively encouraged to access the publicly funded R&D institutions for the purpose of consulting them for problem solving and sponsorship of R&D. In the second phase of Indian reforms the thrust of policy changes was on external liberalization although it involved changes in many different aspects. Indian firms were permitted to enter into collaborations of their own choice with the foreign firms. The policy thus became a vehicle for the foreign firms to demand financial participation from the collaborating firms in India. There has been an enhancement of both fiscal and non fiscal incentives to the corporate sector for undertaking in-house R&D with a view to encourage the enterprise sector to ‘innovate’ faster in respect of the development of new products and processes and the absorption of imported technological know-how. The current growth trends of the economy and rising purchasing power of Indians have evinced immense interest in the Indian market. World over, the Indian ‘middle class’ is being seen as a huge untapped market. A billion strong population, with the demographic advantage of having a majority of younger working age population, and a per capita income that is growing at the rate of around 6.2 percent is indeed great potential and bound to influence the innovation system in general and growth in particular One of the worrying aspects about wages in India has been the stagnation, or even deceleration of real wages in India. Whether it is casual or regular employment, between every round of NSS there has been a secular deceleration in growth of wage rates during the period 1983 to 2004-05. A comparison across the two decades of 1983-1993 and 1993 –2004, clearly shows that the growth of wage rates in the first period had been substantially higher than the second period in all sectors, gender and employment status, except for the rural casual male workers, which is marginally higher in the second period. However this margin petered out in the period 1999 to 2004 exhibiting a secular and pervasive decline in growth of wage rates. At last, Poverty alleviation has been one of the most important challenges faced by the Indian policy makers. Irrespective of measurement used, there appears to be a broad agreement regarding the direction of change. Notwithstanding such a reduction in the proportion of the people in poverty line, India still has about 250 million people considered as poor, a major challenge before the policy makers. China SNI was also deeply analyzed. As shown, the rise of manufacturing industries is the cornerstone of the Chinese economy. However, the industrial system often lacks core technology. The construction sector is the second most important, and the high-tech industry keeps a fast pace –

191 China is the second largest high-tech exporting country in the world, although the share of high-tech production in GDP is still low when compared to developed countries. Traditionally, the two most important sectors have been agriculture and industry, with 70% of the working population and 60% of GDP. The latter has grown more rapidly, being directly influenced by the government, and the disparities between them have built a huge gap between the rural and urban areas. The tertiary sector has achieved almost 40% of GDP, but it’s still lower than in developed countries. There are significant regional disparities in the Chinese economy. The Eastern region is ahead, which determines its role also in innovation. Economic development has generally been more rapid in coastal provinces than in the interior, and there are large disparities in per capita income between regions. The employment situation has improved. Both employment and real wages have grown, and the employment shares of secondary and tertiary industry have become larger, although the share of primary industry has been still the largest (above 40%). It was also shown that the share of private sector in GDP reached 59.9% in 2005, as informal business became part of the formal economy after 1979. However, corruption also increased. Compared to other countries, Chinese the inputs and outputs of innovation are poor. Most innovation activities are concentrated in high-tech or medium high-tech industries. Chinese educational system was also analyzed. China’s enrolment rates in junior and senior education are not high. The difference between junior them shows some demographic decline, a trend observed in many other countries. As for quality, the PISA survey of 2006 placed China in very high positions: basic education system is one of the best in the world. The country has 1867 higher education institutions; 1591 are state-owned and 276 are private. Natural sciences & technology accounted for more than 40% of all institutions: China has focused on science & technology education. Besides higher education, secondary vocational education is also enough to obtain a profession. In recent years, higher vocational education has also developed very quickly. As mentioned, in a long period time before liberation, China's education system had a strong feudal colour: only the upper class had the right to be educated. Since PRC was founded in 1949, all Chinese people gradually got the equal chance to be educated. The average annual salary in the higher education sector is 63% higher than the national economy average level in 2006. High salary level of higher education sector is partly the result of high expenditure on higher education. China’s postgraduate education started in 1981 and has grown very quickly. PhD students account for more than 8% of all PhD students in China. It was also possible to notice that China’s R&D expenditure has expanded rapidly, making China rank 4th in the world in terms of R&D expenditure. However, the gap between China and the top three countries (USA, Japan and Germany) is still very large. In ratio between R&D expenditures and GDP was 1.49% in 2007, below developed countries. Enterprises are the main funding resources, accounting for 70.4% of the total R&D expenditure of China. In addition, enterprises are also the main R&D performer in terms of R&D activities. One of the serious challenges Chinese companies are facing is that they are still pursuing a cost advantage strategy, spend relatively little on R&D. Both the number of patent applications filed by China and foreigners over the last several years shows a steady growth. Most of the foreign applications were filed by OECD citizens.

It was emphasised that the central government plays an important role in the development of national innovation system in China even though the market force has been an increasing countervailing force. Government agencies at different levels have control of land, large investment projects, infrastructure development, and market accesses to some strategic industrial and service sectors such as automobile industry and financial services.

192 The Chinese government has adapted various important policy instruments to encourage innovation activities and promote technology transfer as well as its commercialization. One of the most important policies is to establish special enterprise zones and incubator facilities to develop high-tech industries in China, which started at the end of 1980s by following the Silicon Valley model. Different ministries decide over S&T and innovation-related policies (ST&I): the ministry of science, the ministry of education; the ministry of commerce and the National Development and Reform Committee; and other specific agencies. China has gradually formed a set of preferential tax policies to encourage enterprises to exerting technological innovation. These include tax reliefs for innovation activities and cost deduction for inputs in the development of new products, among other policies. The role of tax incentive policies is to promote the production, application, and knowledge inter-flow, so the effects of such policies are related to all aspects of knowledge flows. China’s existing preferential tax policies for stimulating innovation has been playing an important role in enhancing scientific and technological innovation environment, guiding social capital and human capital to invest on R&D, strengthening enterprises’ technological innovation capacity, and advancing the development of high-tech industries. In recent years, innovation oriented corporation has expanded greatly, that may partly because of the preferential tax policies. In China, the establishment of key fields of S&T is based on the national situations and needs, then according to the specific condition, their priorities are selected to achieve recent breakthrough. The key fields are specified in the “Guidelines on National Medium- and Long-term Program for Science and Technology Development (2006-2020)”, so the efforts to select S&T key fields were undertaken in the process of constituting the guidelines. The key fields refer to the industries and sectors in national economy, social development and defence security requiring development with emphasis and crucial scientific and technological support. Before 1985, China adopted the former Soviet Union’s model; the S&T activities at public research institutes and production at state-owned enterprises were completely separated. In 1985, the “Resolution on the Reform of the S&T System” was enacted. The objectives were to introduce competition-based funding system and to establish a new governance system of S&T institutions in order to more efficiently commercialize R&D results. The key initial changes were to reform the funding system and to make the governance of S&T institutions more flexible. As a result, the number of patents showed steady growth. The government appropriation for science and technology makes great contribution to implementing the national science and technology development. Starting from 1985, although the government appropriation for science and technology has risen by over 12 times - from 10.26 billion to 133.49 billion, its percentage of China’s GDP has decreased by over one third from 1.14% to 0.73%. The bottom value was reached in 1996 with 0.49%. Its share of the total government budgetary expenditure has also experienced a fall course from 5.1% to 3.9%, the bottom of which is at 3.6% in 2000. On the other hand, local governments followed increase their role in S&T financing. When it comes to income distribution, China, a transition country modeled after Soviet institutions, is therefore closer to Russia than to other BRICS. While income per capita doubled from 2000 to 2006 in urban areas, it increased 60% in rural areas, which were poorer in the first place: average income of rural population is now one-third of urban counterpart. Increasing income inequality is a concern in China. The income structure by source is still dominated by wages, although this share has decreased during the year from 2000 (50%) to 2006 (40%). The structure of end consumption of households in China is biased towards food, although this picture is softening as the economy grows. People’s consumption on residence, recreation,

193 education, transportation and communication accounts for a large share. However, significant differences exist between urban and rural households. In terms of service consumption, the share is increasing slowly, but such proportion in rural area is much lower than that of urban districts, especially the proportion of financial and insurance service consumption. Chinese birth rate has reduced greatly between 1990 and 2006; meanwhile, the death rate has remained steady. Thus population continues to expand, but at a decreasing rate, with a lower demand for basic services (health, education). According to the demographic trends, Chinese population may increase at the rate of about 5% in the next few years. In addition, as the development of urbanization reform, the rural population rate decreased from 63.78% in 2000 to 56.10% in 2006. The health condition has become better in recent years, and the average life expectancy reached to 71.96 (males) and 74.10 (females) in 2006. At last, but not least, South Africa was analyzed. It was emphasised that labour productivity grew linearly at a compound annual rate of 5.5% between 2001 and 2006. The primary sector experienced a rapid increase in labour productivity around 2005, with annual growth rate of 7.4% between 2001 and 2006. Mining app modern mechanized mining to meet the global commodities boom demand and to the transformation of South Africa’s historically labour intensive mining practices. The secondary ears to be the main component in the primary sector’s growth, related to the uptake of sector experienced relatively stagnant labour productivity growth after 2002. In terms of relative shares, there is evidence of a move to increasing knowledge intensity in South Africa’s manufacturing with a rise in the real value of medium-low technology exports from 22% of all exports in 2003 to 27% in 2007. Simultaneously, the share of low technology manufacturing decreased from 15% to 11% of all exports. Between 2003 and 2007, South Africa had a comparative advantage in both low-technology and medium-low technology manufacturing industries. While South Africa had a competitive disadvantage in both high-technology and medium-high technology manufacturing, the competitive disadvantage in high-technology industries between 2003 and 2007. Gross fixed capital investment (an indicator of knowledge inputs to an innovation system) has increased from 15.6% of GDP in 1999 to 18.9% in 2006, an average annual growth rate of 2.7%. Tertiary industries accounted for the largest share of this investment: 61%. South Africa’s foreign sector grew from 48% of GDP in 1999 to 56% of GDP in 2005. While FDI inflows to South Africa were larger than outflows from South Africa in most years the relative share of each did not differ substantially from year to year. In the period 1999 to 2005, Europe averaged a 79% share of South African FDI assets. Nationally, the primary sector accounted for 11% of sectoral value-added between 1999 and 2006. The primary sector grew at a compound annual growth rate of 5.5% during this period. The pattern of the spatial distribution of economic activity continues along a trajectory established by the minerals-energy complex and under the broader impact of apartheid capitalism. These patterns were established through colonialism, mineral exploitation, commercial agriculture and a limited form of industrialisation. Apartheid spatial planning ensured that the people are located far from social and economic opportunities. Growth in the economically active population was less than growth in the working age population. As a result, the employment participation rate declined from 59.4% in 2001 to 56.2% in 2007. This equated to an annualized decrease of 0.9%. Between 2001 and 2007, the average unemployment rate was 28% nationally. Demographically, unemployment varied significantly. At the national level, the unemployment rate for men averaged 24% during this period, but the average rate for women was 32%. Significant differences were also seen across racial groups with whites having the lowest average unemployment rate, 6%, followed by Indians/Asians, 17%, Coloureds, 21%, and Africans, 33%. While unemployment rates generally declined, both women’s and the broad unemployment rate rose.

194 South Africa has had a compound annual real GDP per capita growth of 4.2% between 2000 and 2006. While value of production per capita suggests an economy’s level of technological sophistication, a sizable portion of the South African population does not participate in either the formal or informal economy. In the period 1999 to 2006, South Africa saw a steady increase in its traded share of the economy. During this period, the traded share of the economy grew at a compound annual rate of 3.8%. The informal sector comprises mainly enterprises in food, retail and hospitality sectors. The increased activity in the construction sector has also seen the increased use of day-workers for routine labour-intensive tasks. Enterprise innovation expenditures totalled R27.8 billion in 2004 with the biggest share of enterprise expenditures on innovation was acquisition of equipment, followed by in-house R&D expenditures and outsourced R&D expenditures. A majority of enterprises reported that they had innovation activities during the period from 2002 to 2004. South Africa educational system was also analysed. It was shown that the literacy rate declined at an annualized rate of 0.5% between 2002 and 2006. Nonetheless, during this period 89% of the total population was literate. The performance of South African students relative to other countries in Africa has also declined over the period. Higher Education Institutions enrolments increased 6% from 2001 to 2005. The number of undergraduate degrees awarded annually increased by 25% from 70,000 in 2001 to 88,000 in 2005. The number of postgraduate degrees increased by 29% between 2001 and 2005. It was also shown that R&D intensity has risen from 0.73% of GDP in 2001 to 0.92% in 2005. In constant 2000 terms, Gross Domestic Expenditures on R&D (GERD) rose at compound annual growth rate of 10.3% between 2001 and 2005, from R7.1 billion in 2001 to R11 billion in 2005. Public R&D expenditures averaged 0.36% of GDP between 2001 and 2005. Public R&D expenditures increased from 0.34% of GDP in 2001 to 0.38% in 2005. That increase is equal to a compound annual growth rate of 3%. Nationally, Business enterprise R&D (BERD) expenditures averaged 0.52% of value added in industry in the same period. R&D personnel grew from 32,500 in 2001 to 47,000 in 2004 at an average annual growth rate of 12%. In terms of R&D personnel as a ratio of total employment, the number of R&D personnel increased from 2.8 per thousand employees in 2001 to 4 per thousand in 2004. The composition of these R&D personnel was relatively stable with 58% being researchers, 18% technicians and 24% other R&D personnel. Researchers grew from 19,400 in 2001 to 27,650 in 2004, at an average annual growth rate of 12%. In terms of researchers as a ratio of total employment, the number of researchers increased from 1.7 per thousand employees in 2001 to 2.3 per thousand in 2004. The gender of researchers changed marginally from 36% female in 2001 to 37% in 2004. With respect to economic policy, the formation of the Macro-economic Research Group (MERG) by the African National Congress in 1991 was critical in gathering those sympathetic to the growth through redistribution thesis: it argued for a radical restructuring of the economy mainly through labour market interventions in education and training while simultaneously raising wages. It’s coherent programme of state intervention with high levels of regulation, taxation and competitiveness oversight. The Science and Technology Initiative (STI) was established and institutionalised the policy negotiating process and identified six priority issues which would guide future deliberations: Information on the science and technology system; transparency and influence of the existing decision-making and advice-formulating process; a future science and technology system and its decision-making process; enabling research establishments to respond to major issues; human resources development and governance. The STI made its way into the new democratic government, after 1994. The NSI of South Africa has been recognised as a system of interacting private and public firms (either large or small), universities and government agencies aiming at the production of

195 science and technology within national borders. Interaction among these units may be technical, commercial, legal, social and financial, inasmuch as the goal of interaction is the development, protection, financing or regulation of new science and technology to enhance the quality of life and sustainable economic growth. As for implicit policies, while Fiscal Policy, especially under the regime of Growth, Employment & Redistribution model saw government spending shrink as it reduced the inherited apartheid debt, it also ushered in conservative Monetary Policy which was aimed exclusively on Inflation Targeting. In terms of Competition Policy, the guidelines were aimed at supporting both the macro-economic (national economic management) strategy and microeconomic restructuring (promoting more efficient firms and industries). The fourth area of implicit innovation policy is often referred to as Industrial Strategy. It established a framework for Industrial Policy but couched this in the language of Micro-economic Reform. As for the regulation of innovation, governance of the public component of the NSI is primarily a central government competency; provincial governments contribute to the systems only through the relatively minor portfolios of primary and secondary education and local industrial development. When it comes to the relation between demand and innovation, South Africa inherited massive inequalities, which are organised and segmented according to Race, Class and Gender lines. Notwithstanding the removal of formal barriers to especially black people and women, the country remains scarred by an iniquitous distribution pattern in terms of incomes. In terms of geography, South Africa remains blighted by the common rural/urban divide. In terms of natural resources, South Africa has considerable minerals reserves of international significance, as well as plantation forestry that give competitive wood, paper and pulp industry. Energy efficiency has increased. Poverty is an important determinant of an innovation systems structure. All indicators concerning poverty varied considerably across racial groups and show that only white people have reasonable access to basic services. This racial pattern has also a geographic version, as regions where the white are nearly absent have the poorest coverage.

196 ANNEX 4 BRICS Project

Comparative Report on the State and the National System of Innovation in BRICS

Mario Scerri and Helena Lastres October, 2010

Globelics The BRICS Project is a comparison between the National Innovation Systems of Brazil, Russia, India, China and South Africa. It is a project conducted by the Global Research Network for Learning, Innovation and Competence Building Systems – Globelics (see www.globelics.org) and RedeSist – the Research Network on Local Productive and Innovative Systems – at the Economics Institute of the Federal University of Rio de Janeiro Brazil. Conceptually, the project is structured around the Systems of Innovation framework. The central focus of the study is the national innovation system (NIS) of the five BRICS. The notion of innovation system has in its centre the industrial, S&T and education sub-systems; but includes also the legal and political frameworks, investment and financial sub-system, as well as other spheres relating to the national and international contexts where knowledge is generated, used and diffused. The objective is to characterize and compare the NIS of the five countries pointing out convergences, divergences, and synergies, as well as identifying current and potential connections. Particular attention will be given to policy implications. Therefore, the project aims at involving, not only researchers, but also policy-makers working in national and international agencies. Specifically the project aims at: (a) stimulating interactions and the exchange of experiences between researchers and policy- makers interested in innovation in BRICS aiming at creating capabilities and finding joint workable solutions; (b) characterizing the structure of BRICS´ national innovation systems, their recent evolution and perspectives; (c) comparing the five countries innovation systems, identifying differences and similarities, common bottlenecks and complementarities; (d) developing and using concepts and information capable of representing the Innovation Systems of BRICS; (e) discussing policy implications and put forward policy recommendations, extracting lessons that can be useful not only for these countries but also for other developing countries.

The project is coordinated by José Cassiolato (RedeSist) and Bengt-Aake Lundvall (Aalborg University Denmark). Country coordinators are: in Brazil, José Cassiolato, RedeSist, IE/UFRJ; in India, K.E. Joseph , Centre for Development Studies, Trivandrum; in South Africa, Rasigan Maharajh, Tshwane University of Technology; in China, Liu Xielin, Graduate University of Chinese Academy of Sciences and in Russia, Leonid Gohkberg, Higher School of Economics, Moscow.

2 THE STATE AND THE NATIONAL SYSTEM OF INNOVATION: A COMPARATIVE ANALYSIS OF THE BRICS ECONOMIES

Mario Scerri and Helena M. M. Lastres

This report provides a comparative analysis of the relationship between the state and the national systems of innovation of Brazil, Russia, India, China and South Africa (BRICS) and this report seeks to address four issues which we see as germane to this study. The first, and conceptually the most challenging, one deals with the rationale for the examination of the role of the state in the development of national systems of innovation as a legitimate object of analysis. We hope to show that the whole discussion of the placement of the state in systems of innovation discourse is by the very nature of the topic quite complex and hopefully rich. The second issue concerns the particular varieties of the national systems of innovation concept which have been adopted in the individual country reports. Although these five studies generally fall within a broad definition of national systems of innovation which goes considerably beyond the sphere of science and technology, there are nonetheless differences of emphasis in the application of this concept to individual cases. The third section provides a brief, and hopefully succinct, comparative treatment of the five country cases. Finally, it would be apposite to outline the basis of future research in the area, arguing for the BRICS grouping as possibly laying the foundation for a new discursive formation in studies on national systems of innovation. There are several cogent reasons for the analysis of the relationship between the state and the national system of innovation. Primary among these is the fact that if the fabric of national systems of innovation is an institutional web, it is the Weberian (Mannheim, 1947) state with its monopoly on violence and legitimate coercion which sets the foundation of rules and regulations, explicitly as sets of legislation, from which the institutional web emerges. It is this foundation of rules and regulations which shapes the evolution of the various institutional sub-systems which constitute the national system of innovation. On this basis, it is therefore legitimate to claim for the nation state the theoretical position of the defining agent of the national system of innovation. The rationale for the assignment of this primacy to the state in the study of national systems of innovation stems at least as strongly from the development of thought in the area of the economics of innovation as it does from empirical observation of the role played by governments in the development of systems of innovation. A part of this report will indeed examine this relationship as an object of analysis before delving into a more detailed discussion of the individual country studies in this report. We must however at the outset introduce a sense of misgiving about the very wording of the title of this report, an articulation which was inescapable but which opens up the discourse in this area to what we feel is a mistaken dichotomy between an entity labelled the state and another named the national system of innovation. This is a dichotomy which is all pervasive in economics, whatever the ideological stance towards the state, and which pervades a wide range of development approaches. Whether the role of the state is seen to be circumscribed solely by the need to address the presence of public goods and externalities, as in neoclassical economics, or as formed as the agency of the capitalist mode of production, as in most Marxist literature, or as a Foucauldian account of power exercised through governmentality and biopolitics, or as the possible launch pad of development as in most of

3 development literature, the implicit underlying assumption is that of an organic separation of the body politic from the body economic.1 This dichotomy has run throughout most of the economic literature on innovation, as it has through mainstream economics, but this was not a necessary outcome of the body of economic theory which came to be loosely defined under the rubric of innovation. This theoretical objection to the separation of the state and the economy echoes a similar disquiet in state theory at the separation of theories of the state from social theory.2 The systemic approach to innovation and to the economy in general, which has been adopted in the heterodox economic literature on innovation, contains the basis for a novel integrated study of innovation systems which has to be understood by looking at the various dimensions of the economic systems. This perception allows crucial dimensions of the system of innovation approach to be explicitly discussed: the emphasis on historical and national trajectories and the importance of taking into account the production, financial, social, institutional and political contexts, as well as micro, meso and macro spheres3. There are numerous reasons why innovation theory has yet to provide an alternative general theory of economics, not the least of which is its relatively short history combined with the overwhelming hegemony of neoclassical economic theory. In addition, and as argued by a number of authors, a new framework of thought capable of orienting the analyses of development problems related to knowledge, innovation and learning is also fundamental.4 In this line it could be argued that the attention the performance of BRICS has attracted in the beginning of the millennium - given not only their share of the world product and trade, their reserves of natural resources and of financial capital, the size of their domestic markets, but also their various challenges - can contribute to reinvigorate the interest in development issues and in the comprehension of how knowledge is acquired and diffused, thus enlarging theoretical contributions and the options for policy prescriptions. In addition, the huge task of reducing regional imbalances in countries of continental dimensions makes tackling regional and social development as a core priority of the policy agenda. There are also opportunities for the development of new policy models that foster sustainable and coordinated development at national, regional and local levels. For the organisations that design and implement policies, the pressure for the elaboration and use of concepts, indicators and models that help to reduce the imbalances, instead of reinforcing them, and that associate economic and social development within a long-term perspective become extremely relevant. This reinforces the need to develop new ways of looking at development issues. Policies emerging from this approach would include players, as well as production and innovation activities with different dynamics and paths, varying from the most intensive in terms of knowledge to those that use indigenous and traditional knowledge, as well as with different sizes and functions, deriving from the primary, secondary and tertiary sectors, operating locally, nationally or internationally. In other words what is required is the development of new and broader forms of knowledge capable of contemplating the reality of all sorts of economies and societies. The theoretical base of this approach enables a fuller understanding of developing countries with the complexity of their

1 One important exception is the work of the so-called Latin-American Structuralist School. See for instance Furtado, 1964. 2 “Theorizing the state is further complicated because, despite recurrent tendencies to reify it as standing outside and above society, there can be no adequate theory of the state without a theory of society.” (Jessop, 2008: 1). 3 For details see Freeman, 2003; Lastres, Cassiolato and Maciel, 2003; Lundvall, 2006. 4 See, for instance, Arocena and Sutz (2003).

4 ecosystems, biodiversity and mainly their social communities - including those pluriethnical and multicultural – and their own forms of interaction with nature and culture. There is one fundamental tenet which provides the initial departure of the approach adopted here from economic orthodoxy. Theories and concepts are not ideologically neutral and they are, often implicitly, value-laden. They derive from and reflect specific conditions and points of view. Most available concepts and theories are still limited to few economic activities, actors and regions and were elaborated mainly within developed economies contexts. This makes a number of activities, actors and regions invisible to both theoretical and analytical lenses. This invisibility is implicit in the exclusion of these agents and dimensions from the policy agenda. This exclusion highlights the importance of fostering the capacity to develop and use contextualized concepts, indicators and analytical and policy models capable of addressing the challenges and opportunities of each context given their geopolitical, institutional, scientific, technological, economic, financial, social, cultural and environmental dimensions. The development of this capacity should simultaneously enable the association and articulation of these dimensions in an inclusive way. Of course this is not an easy task. The main challenges involved still relate to the difficulty to work with new concepts, particularly those aiming at capturing and evaluating the creation, use and diffusion of innovation and production capabilities in situations of high levels of inequality and informality. However, as knowledge results from interactive learning processes and pragmatic use has an important learning dimension, we also expect that the analysis of the BRICS innovation systems will bring new light not only about these five countries, but also about this concept, contributing to its further development. Another reason why innovation theory has yet to provide an alternative general theory of economics is the wide span of the definitions of national systems of innovation. These can range from a narrow focus on a network of formal science and technology institutions, at one end, to an incorporation of the whole spectrum of formal and informal institutions which come together in partially planned, but mostly unplanned, networks to provide the setting for innovation. Innovation itself may even be defined in its broadest sense to cover any alteration in economic relationships which is seen to be preferable to what is displaced. Within such an approach to the understanding of the evolution and performance of economic systems there is a theoretical scope for the elimination of this false dichotomy between the state and the economy. This scope is allowed by the assumption of specificity and the role of history in determining the shape of innovation systems. The propensity to generalise about any group of agents, be it the state, the private sector, civil society, organised labour, etc., is significantly reduced in an approach which holds contextual specificities to significant non-trivial determinants of shape and performance of systems of innovation. Of course, one could argue that an excessive reliance on specificity as the source of understanding of particular systems also holds the danger that each specific national system of innovation as an object of study is treated sui generis, bearing little or no relationship whether of similarity or of categorical difference with the studies of other systems. This would obviously eliminate the legitimacy of comparative analysis and eventually of theory. However, except for extreme approaches of this type, the introduction of specificity into analysis does provide the theoretical space for reconceptualising the nature of the concept of the state in relation to that of the national system of innovation. On the other hand, and in line with the argument developed above, it could be argued that all knowledge is contextual. It could also be claimed that the novel understanding of innovation as a systemic social, political and economic process not only

5 requires advances in theory, but also implies in the need to develop a whole new set of categories and indicators to analyse and compare experiences. Since the introduction of the term, the definition of the national system of innovation5 concept has varied considerably with often radically different implications for analysis and for policy. Generally, definitions of the national system of innovation differ on the basis of two elements of the underlying concept. The first is the definition of innovation. This may range from frontier and radical technological innovations at one end to one which includes any alteration in economic activity which represents a real or perceived “better practice” within a specific context at the other. There is obviously room for a large range of variations in between these two extremes. The other element is the definition and choice of institutions which may be considered as part of the national system of innovation. The inclusion of formal institutions would range from those strictly concerned with the promotion of science and technology at one extreme to all those institutions that govern all aspects of the economy at the other. These two elements are often interrelated where an increasingly broad definition of innovation implies a widening inclusion of institutions which are considered pertinent to the national system of innovation and to innovation policy. We should not see the possible variations of the definition of the national system of innovation as lying across a continuum. At some point the degree of exclusion/inclusion that is adopted results in two fundamentally different concepts, with radically different implications for policy. As the definition of the national system of innovation tends towards the system of science and technology, we admit the possibility of the non-existence of the national system of innovation and the imperative to create one in the interest of promoting economic growth and development. If, on the other hand, the definition tends towards the all inclusive one, the national system of innovation exists whether planned or not, simply by virtue of the binding legal identity of the sovereign state. In this case the possibility of the non- existence of the national system of innovation arises only where the state is under threat due to foreign aggression or civil war. Within the broad definition, the role of policy is not to create but to shape the evolution of the national system of innovation along a path that is more appropriate to the sustainable improvement of the quality of life of the general public. Within the broader definition of the national system of innovation, state policies outside the ambits of science and technology policy may still be seen by the analyst as innovation policies. Thus trade, industrial, labour, education and basic services policies may become a legitimate object of the analysis of the relationship between state and the national system of innovation, even if such policies are not explicitly defined as innovation related by their designers.

5 “ .. the network of institutions in the public and private sectors whose activities and interactions initiate, import, modify and diffuse new technologies.” (Freeman, 1987) “ .. the elements and relationships which interact in the production, diffusion and use of new, and economically useful, knowledge ... and are either located within or rooted inside the borders of a nation state.” (Lundvall, 1992) “... a set of institutions whose interactions determine the innovative performance ... of national firms.” (Nelson, 1993) “ .. the national institutions, their incentive structures and their competencies, that determine the rate and direction of technological learning (or the volume and composition of change generating activities) in a country.” (Patel and Pavitt, 1994) “.. that set of distinct institutions which jointly and individually contribute to the development and diffusion of new technologies and which provides the framework within which governments form and implement policies to influence the innovation process. As such it is a system of interconnected institutions to create, store and transfer the knowledge, skills and artefacts which define new technologies.” (Metcalfe, 1995)

6 Figure 1, represents an attempt to summarize the narrow and the broad perspectives on the national system of innovation. The broad perspective includes the different interrelated subsystems that are influenced by the geopolitical, institutional, macroeconomic, social, cultural context. In the centre of the system is the production and innovation subsystem that incorporates the structure of economic activities, with their sectoral spatial and size distribution, degree of informality, level and quality of employment, type and quality of production and innovation capabilities. Secondly there is the subsystem of science and technology that includes education (basic, technical, undergraduate and postgraduate), research, training, technological services, information, metrology, intellectual property, etc.. Thirdly, there is the policy, promotion, financing, representation and regulation sub-system that encompasses the different forms of public and private policies both explicitly geared towards innovation or implicit, i.e., those that although not necessarily geared towards it, affect strategies for innovation. Finally, there is the role of demand that reflects patterns of education and of income distribution, structure of consumption, social organization and so on.

Figure 1- The Narrow and the Broad Perspectives on NSI

Geo-political, institutional, macroeconomic, social and cultural Broad Narrow Science & Technology Production & Subsystem Innovation Demand Subsystem

Policy, promotion, Financing, Representation & Regulation

Source: Cassiolato and Lastres, 2009

It is also important to bear in mind that the question of whether or not to create a national system of innovation becomes less legitimate as we move from the narrow to the broad definition of the concept. It is more relevant to subsystems but the broader context and the web of informal institutions which comprise the system exist regardless the nature and extent of planning. More relevant is the discussion of what type of national system of innovation to shape through planning and policy and it is here that, in some cases, policy choice is contaminated by the observation of the structure and dynamics of a specific context. Resulting knowledge is

7 formed (and deformed) by this experience. When applied to a different environment this knowledge ends up frequently inducing the reproduction of behaviours and other elements that, while possibly working well in a specific system, prove to be inappropriate for the local conditions and potentialities of another. The main point here is that context matters both in terms of understanding and promoting innovation. History and specific territorial conditions are essential to explain how production and innovation capabilities are acquired, used and further developed. Analytical models, taxonomies and policy prescriptions that disregard these parameters put their usefulness seriously in risk (Lastres and Cassiolato, 2005). In other words, ‘general history (social, political and cultural) economic history and industrial history are not only indispensable, but really the most important contributors to the understanding of our problem. All other materials and methods statistical and theoretical are only subservient to them and worthless without them’ (Schumpeter, 1939 and Freeman, 1982). In a similar line Lundvall (2006) has argued that to develop a general theory of innovation systems that abstracts from time and space would undermine the utility of the concept both as an analytical tool and as a policy tool. One main conclusion here is that by adding new knowledge derived from the observation of new innovation dynamics and contexts, this report can represent a significant analytical and theoretical contribution with even more fundamental policy implications. In spite of the width of the range of possible variations in the definition of the national system of innovation concept, the central role of the state in the formation of the national system of innovation is always prominent. Even so, however, the various possible combinations that these options offer open up the possibility of variation in the assessment of the role of the state in the development of the national system of innovation. There is also a strong possibility of a divergence between the analyst’s definition of the national system of innovation and its definition by the state. This adds yet another dimension to the analysis of the relationship between the state and the various conceptualisations of the national system of innovation. For the purposes of this study, the broader definition of the national system of innovation is adopted. This definition, which goes beyond the analysis of activities that directly determine technological innovation, captures the overall economic framework which sets the context for innovation. Furthermore, the definition of the economic framework itself is expanded beyond the normal ambit of economic orthodoxy to include all aspects of human capital formation as economic strategy variables. This broad approach is particularly relevant to developing economies where fundamental changes in the underlying institutional infrastructure often form the national development policy strategy framework. Theoretically, the system of innovation approach with its focus on institutions, formal and informal, provides the broader context within which development economics should properly be based. In this case we have a strong possibility of a convergence between science, technology and innovation (STI) policy and development policy, especially if the broader definition of innovation as any novel and superior manner (relative to a specified context) of reallocating resources is adopted. The other two areas of convergence between development economics and innovation theory are the issues of regional disparities and income distribution. In the case of the former, the study of sub-national systems of innovation may enable us to understand the process of regional convergence. In the case of income distribution, we have implications for the process of human capital formation which lies at the core of the evolution of the national system of innovation. Given that the basic assumption of development economics is that of the fundamental inadequacy of economic structures to attain specified development and

8 growth objectives. Consequently, development policy should be designed to engineer the radical structural transformation of the economy in pursuit of the goal. From this perspective, broadly articulated national system of innovation theory in its focus on the institutional foundations of economies provides a comprehensive framework for a coherent approach to development policy. Even if we accept this argument, we still need to ask about the role played by the state, however defined, in the study of the evolution of systems of innovation. After all, it is widely acknowledged that it is firms which produce, diffuse, adopt, adapt and even deploy, innovation. Firms, however, normally tend to act within a context, determined by market structures, established practices and routines. They rarely, except in the most exceptional of cases, act consciously and in a coordinated manner to alter the context in which they operate. This context is, to varying degrees, the product of the “extra-market” policies, rules and regulations laid down by the state, by regional (supra-national) bodies and global protocols. Again, it is in the context of developing economies where there is a recognised need for structural transformation that the role of the state in the development of the national system of innovation becomes paramount. This role should generally be more pronounced than in the case of mature, developed industrial economies where we should be able to assume (at least prior to the current global financial crisis) the underlying institutional framework to be stable, under healthy public regulation and appropriate for growth, stability and international competitiveness. We can therefore comfortably say that, at least at the national level, the state is fundamental in the shaping of the development path of the national system of innovation, however that is defined. It is the state which usually lays down the formal institutional underpinning of economic activity, including innovation. The broader the definition of the system of innovation and the further it departs from a science and technology system, the more pervasive and complex is the role of the state. In a fundamental sense we can say that the state is ever present in the articulation and enforcement of the “rules of the game” which govern the way in which innovation occurs, the roles of the various agents who interact in the production of innovation, as well as the effects which emanate from innovations of various forms. The rules of the game introduced by the state often tend to be explicit but they can also be implicit in, for example, unspecified tender grant and procurement policies, labour market practices, environmental considerations, macroeconomic policies, etc.6 Explicit rules, established through laws and declared practices thus also eventually permeate down to the layer of amorphous sets of routines and practices which are probably a stronger long term determinant of behaviour than explicit rules. Even the most minimal state imaginable, within an extreme form of neoliberal ideology, still sets the “rules of the game”, by virtue of its absence. The definition of the national system of innovation adopted in this report is generally broad enough to, at least implicitly, allow for some resolution of the fallacious separation of the state and the system of innovation, or even of the economy. This definition extends significantly beyond the system of science and technology to incorporate a wide gamut of institutions, formal and informal, which affect all aspects of innovation. This certainly covers most functions of the modern state, ranging from those specifically concerned with science and technology, to broader

6 The literature on technology and development has stressed that economic conditions, in general, and macroeconomic policies, in particular, are important elements shaping microeconomic behaviour and dynamics as far as innovation and technology are concerned. It has been also argued that these so-called implicit policies can assume greater importance than specific technology policies in terms of orienting firms’ strategies (Herrera, 1975).

9 concerns of economic policy, to those areas of state involvement which are often assigned to “social policy” but which directly affect various aspects of human capital formation. In this sense the “state” which is considered in relation to the innovation system covers almost the entirety of the state and its sphere of governmentality. The inclusiveness of this approach is certainly firmly within the essence of the systems of innovation approach which highlights the specificities of the institutional interactions within particular systems as crucial to their analysis. It is here that the nature of particular states and their evolution over time has to be brought in as part of the core of the approach adopted in this report. The introduction of history then opens up to a rich and highly diverse treatment of the five national systems of innovation which form the object of this body of analysis. The common structure of the country studies on the one hand belies rich variety of the form of the state within and without the national systems which they shaped and which in turn shaped them. On the other hand, without a common structure it would have been extremely difficult to come out with a coherent analytical framework for the analysis of this complex relationship within these very different contexts. This commonality may actually bring to the fore the specificity of these five studies which have been brought together in this report. The case studies of the five national systems of innovation presented are, by virtue of the core nature of the state within a context of structural transformation, closely concerned with policy, with its intentionality, its consequences, intended or otherwise, and with the various political, economic and historical determinants of policy. In this regard we need to discuss the relationship between innovation policy and other spheres of policy which lie within the specifically delineated terrain of state power. Again, this relationship depends critically on the definition of the national system of innovation which is adopted since the extent of the domain of innovation policy is positively correlated with the breadth of the definition of the national system of innovation. The various studies presented here allude to the degree of integration of policies but again this treatment holds nuances regarding whether we are talking about integration between innovation policy and other policies (macroeconomic, investment, trade, labour and social policies, to name the immediately obvious) and integration within a definition of innovation policy increasingly broadened to incorporate at the limit all other policy spheres. The significance of these nuances depends both on the analyst’s theoretical base and on the official explicit or implicit formulation of innovation policy by the principals of the state. In the specific case of the five systems examined here, all of which are undergoing a rapid process of structural transformation, it is important to assess the relationship between innovation policy and development policy, its convergence or dissonance, and even more fundamentally the degree of differentiation between the two. The conceptual foundation of this report thus requires that historical analysis permeates all of the case studies and that specific periodisations are adopted in every case. This periodisation is applied both to the evolution of the role of the state and to the history of the political economy of each country. Again, the degree of convergence of the two areas, the extent to which the evolutionary path of the political economy was affected by the changing role of the state and the degree of convergence, and even possibly the identification, if the two evolutionary paths differ in each case. This, we feel, makes for a particularly rich comparative analysis of these five very distinct innovation systems. Certainly, the historical and structural differences of the five economies which are the subject of this report are deep enough to raise the question of the rationale for their grouping

10 within the same body of work. This rationale is loosely based on a number of factors whose peculiar heterogeneity may itself prove to be a valid reason for this grouping of case studies. The immediately obvious rationale is that all five countries have had histories where the very nature of the state has been challenged and altered, often violently, and in the process has radically altered the very foundations of the national system of innovation. Secondly, there is the placement of these five economies on the global political economy topography. Each one of them, in its own right is particularly influential within a region and by consequence its fortunes carry implications at a global level. India and China are now rightly seen as the two emerging economic giants which, in spite of their significant structural differences, are destined to alter dramatically the very foundations of the world economic order. The sheer size of the Brazilian economy and the diversity of its base place it at the epicentre of the Latin American development thrust and indeed at the forefront of the sustained countervailing centre of development economics over the past four odd decades. The Russian system of innovation emerging as it has from the total repudiation of the Soviet system of innovation constitutes the most dramatic experiment of the radical destruction of the foundations of one of the two most powerful systems of innovation until the late nineties. South Africa is not only unique in its emergence from a particular legislated form of racial capitalism but its national system of innovation stands as possibly the regional economic catalyst for the development leap of sub-Saharan Africa. It is also worth pointing out that in three of these cases an important dimension was the influence of colonialism in the formation of the nation states and their very birth. These diverse histories also affect the placement of the respective analyses contained in this report within the broad definition of the national system of innovation especially when it comes to the focus on specific policy areas. Several correspondences exist among the innovation systems analysed in this volume. In terms of ruptures and continuities, South Africa and Russia both went through a sudden and radical transformation of their political systems, with the demise of apartheid and the dissolution of the Soviet Union at around the same time. The effects of those political transformations on the respective national systems of innovation, however, may from a normative perspective be seen as diametrically opposite. In the case of South Africa there is a growing body of literature which sees no significant structural rupture with the previous system of innovation accompanying the radical change in the legal basis of the state. This continuity in the evolution of the national system of innovation is now widely seen as one of the main obstacles to the transformation of the South African political economy to an effective, as distinct from the legal, democracy. In the case of Russia, the opposite is often claimed to be true, that the change in the political order brought in too radical a rupture with the previous system of innovation with the rapid emergence of an extreme form of predatory capitalism. The abruptness of this rupture poses one of the major obstacles to the development of a viable national system of innovation. The evolution of the Chinese and the Russian systems of innovation stand in stark contrast in terms of the ruptures and continuities engendered by the respective changes in their ideological underpinning. Other correspondences exist. Thus India and China are both seen as the emerging economic world powers, through a combination of the size of their economies and liberalisation of their economic policies. The twentieth century histories of these two systems, and the radically different structures which emerged from those histories, again lay the basis for a comparison of the implications of policy and ideology for the evolution of national systems of innovation.

11 The thematic organisation of this and accompanying reports in this series is aimed at providing a comparative analysis across the five national systems of innovation and in that light there is a loosely defined common structure across the five country studies. Each chapter looks at the nature of the state within the specific national system of innovation and presents an overview of the evolutionary path which led to the current relation between the state and the economic system?. In the process of this depiction, ruptures and continuities are identified and the relevant period of analysis delineated. From this general overview of the evolution of the state, each chapter then focuses on the evolution of institutions and policy frameworks directly concerned with innovation policy, with a particular reference to the relationship between innovation policy and broader economic policy. This analysis requires that the specificities of the particular national system of innovation with its particular national, regional and local production and innovation structures are examined. In the process, the main constraints on the viability of the systems of innovation, in terms of their capacity for reproduction, growth and evolution, are identified. “Reproduction is essential for the survival of a system, while (steady state) growth implies that the current shape of a specific system of innovation is well suited to its broader environment. There are various measures that may be used to estimate these two dynamic processes, depending of the breadth of the definition of systems of innovation. They may range from those pertaining specifically to systems of science, technology and innovation to those which reflect the wider political economy. The evolution of systems takes two forms. The first is essentially reactive in the sense that the mutation of the system responds to a changing environment. To use the biological analogy, this type of evolution is Darwinian. The other type, drawing on a Lamarckian analogy, is a conscious mutation, based on feedback effects, which alters the environment within which the system is set; it is initiative rather than reactive.” (Scerri, 2009: 37) The country studies follow with a description of explicit and implicit state policy on science, technology and innovation, with a classification of such policies into supply-push and demand-pull categories. Explicit policies are defined as those which directly affect innovative activity, specifically related to technological innovations and the deployment of innovation in production. Implicit policies are those which affect sectors which appear peripheral to innovation but which nonetheless form the institutional context within which innovation occurs and which governs its impact on the overall economy. As mentioned earlier, the particular structures of the five cases determine the specific emphasis on the choice of the relevant policy sets in each case. Thus in the case of India, a mixed economy from its post-colonial inception, with the outward expansion after the liberalisation of the economy of the early nineties with a recent reversal of the brain and skills drain, the chosen focus is on STI and industrial policies. In the case of Russia – one of the two former main superpowers (militarily, politically, economic, scientific) – the rapid deterioration of the innovation base with the disintegration of the USSR and COMECON has created probably the most dramatic transformation of a national system of innovation in recent history. In the Russian case, with a heritage of a broad human capital base the main innovation strategy is to restore and retool the scientific base to attain international competitiveness and the focus of that chapter is on the re-orientation of STI policy to achieve that goal. China’s opening up to its particular variety of capitalism is creating a novel model of export-oriented industrial growth which is built on a rapid and radical transformation of its national system of innovation and its policy focus is broad as it seeks to leverage the sheer size of the economy for a development leap

12 in the new world order. Brazil, since the beginning of the 2000s, has struggled to recover its capacity to implement and articulate economic and STI policies, after 15 years of liberalisation that has both impoverished the capacity to design and implement policies and resulted in the destruction of industrial and technological capabilities in sectors such as information and telecommunications and auto-parts. In the case of South Africa, the impact of the apartheid legacy is most evident in its systematically impoverished human capital base and the main focus of the South African chapter is on the extent to which post-apartheid economic policy and innovation policy have been congruent and suited for development. Within this policy framework, the national integration of the innovation system is assessed in terms of the forms of the relationships and interactions of policy between the national and sub-national levels of government. This analysis seeks to identify coordination mechanisms and impediments to coherent coordination mechanisms among the various levels. One particular area of concern in the assessment of the viability of systems of innovation is the development of human capital (or human capabilities). As the definition of the national system of innovation broadens away from that of a system of science and technology, so does that of the relevant human capital base. The centrality assigned to this particular component of the system of innovation rests on the core role which technological capabilities play in the evolution of systems. The long term investment and appropriability characteristics of human capital development have a particular relevance to the role of the state in shaping the evolutionary path of the system of innovation. Policies in this area, especially when we adopt a broad definition of the constituents of human capital, could be enhanced if they advanced from the traditional supply-push and demand-pull approach to an effective systemic approach. Finally each chapter ends with an assessment of the effects of state policy on the respective national system of innovation. Given the complex nature of the relationship between the state and the national system of innovation, this can only be, at best, a tentative assessment taking some specific policy targets as the reference point. On the basis of this assessment a brief listing of recommendations for the future of state policy in this regard is provided. At this relatively initial stage of the research on the role of the state and the national system of innovation, as reported in this report, we have five independent country studies for each of the BRICS countries. This constitutes the first assessment of this topic for the five cases but it is as yet only a stage towards a full comparative analysis of the theme across the five systems. At this stage the outlines of such a comparative analysis can only be sketched in this introductory chapter through a summation of the main findings for each national system of innovation. This will hopefully lay the basis for an eventual fully fletched comparison of the various dimensions of the country studies presented here. At a global level, innovation policy, as distinct from science and technology policy, and the national system of innovation policy framework only entered into the lexicon of national policy makers in the early nineties and the history of innovation surveys date from that period. Thus, in this sense, innovation policy set within the national system of innovation theoretical framework is generally young. In this report we consider a different measure of age, that of the current form of the national system of innovation itself, while taking into account those global and regional changes which define the context within which the global economy evolves. In the assessment of the age of a specific form of the system of innovation we have to identify ruptures in its evolution and we have to judge the extent to which a particular rupture represents such a dramatic break that a entirely new phase emerges. The most obvious cause of such radical

13 ruptures is an overthrowing of an established political order which brings about a new legal definition of the nation state within which the national system of innovation is located. Other, less radical ruptures originate from a paradigmatic change in the ideological base of the political system. Such assessments are obviously inevitably highly contestable but the very fact that they are so makes them a rich ground for research. In terms of this measure of age, therefore the present form of the Indian system of innovation dates from its independence in 1947. In Brazil it could be said that the only real rupture was colonisation, which started in 1500. All subsequent transformations – the independence in 1822 and the inauguration of the republic in 1889 – could be characterized as Lampedusian changes. The ruptures in the case of Brazil and also of China are relatively “softer” since they do not entail the radical politico-legal redefinition of the nation state base of the system of innovation. In the case of China, the progressive shifts in economic policy since the late seventies, culminating in the relatively recent massive emergence on the global markets, dramatic as it may have been, still occurred within the context of a generally stable politico-legal structure. Russia and South Africa possibly constitute the youngest systems whose current structure and form dates from the radical political change of the early nineties. In the case of Russia the dismantling of the communist state also resulted in the fragmentation of the USSR and of its wider political economic domain within the COMECON region. The total redefinition, not only of the governance system but of the political and geographic terrain of the nation state certainly resulted in the emergence of a new national system of innovation. In the case of South Africa the rift was marked by the demise of apartheid and the creation of the first South African democratic state; there is however a strong sense of reservation, expressed in the chapter on South Africa, about the degree to which the political rupture was accompanied by an equivalent shift in the evolutionary path of the system of innovation. However, and as stressed above, one cannot never ignore the time span of history and the very fact that the old forms of these systems’ inheritance leaves profound marks in the shape of the subsequent new forms of systems. The country studies of South Africa and Russia serve as exemplary cases in this sense. They both identify problems that have their origin in the old forms of national systems of innovation as main challenges to the development of the current new forms of their systems. The periodisation discussed in the five country studies also provides the reader with another dimension of age, that of innovation policy. The chapter on Brazil identifies three main enduring deficiencies of innovation policy. All three, the excessive focus on technological innovations, the exclusive targeting of the partnership between enterprises and science and technology institutions as the vehicle for innovation and the adoption of the linear model of innovation as the informing vision for innovation policy. It is worth pointing the aim of consolidating the Brazilian system of innovation, as well as of linking STI, industrial, social and other policies as main objectives of the policy discourse adopted since 2007, even if it is not yet possible to perceive any effective systemic vision put into practice. In the case of the Russian system of innovation the turmoil of the breakdown of the USSR and the initial swing to a laissez faire capitalism retarded the adoption of innovation policy in pace with other industrial countries. The adoption of a comprehensive innovation policy and its integration with other economic policies only started in the mid-2000s. The chapter on Russia identifies a number of current obstacles to the implementation of an effective innovation policy. Generally, these obstacles are due to the relegation of innovation policy as secondary to broader economic policy currently dealing with the impact of the global financial crisis. This has set back the integration of innovation policy into the broader development policy framework. Specifically, the single most

14 significant obstacle to the development of the national system of innovation is identified as the low demand for innovation by private sector enterprises, itself perhaps a testimonial to the effects of the unplanned transition to a market economy from the central planning model of the USSR. In the case of India the overall policy of self reliance adopted since independence until the liberalisation move in the early nineties pushed supply-side explicit science and technology policies but the absorption of innovation was also considered to be retarded by a demand side failure. Innovation policies are still fragmented and persistent low R&D ratios and low rate of human capital development still pose significant obstacles to the development of the Indian system of innovation. In the three decades since the political shift in the late seventies, China, starting from a low innovation base has seen progressive shifts transferring science and technology functions from state institutions to enterprises, deepening the indigenous innovation base and moving innovation progressively from cost-reducing to product innovations. The identified constraints to the development of a viable national system of innovation are mainly due to the ongoing process of transition to a market oriented economy within the context of a single party socialist governance structure. The main constraints are the lack of integration of the science and technology sector with other sections of the economy and a low human capital base. In the case of post-apartheid South Africa, the first innovation policy articulation was explicitly based on the national system of innovation theoretical framework. However, the overall neoliberal macroeconomic planning framework which was simultaneously implemented has prevented the integration of innovation policy with other economic policies. As such, therefore, there is still an absence of a comprehensive innovation policy. The failure to address the crippling human capital deficit inherited from apartheid is probably the single most significant impediment to the attainment of a viable system of innovation in South Africa. Though there is now recognition of this policy failure and a determination to address it in a comprehensive approach, it is still too recent a shift to enable a proper assessment of the significance in practice of this shift. The policy recommendations which are provided in each case flow directly from the respective assessments of the major fault lines in each national system of innovation. It is interesting to note the similarities in the recommended policy measures among these disparate political economies which still exhibit a striking number of common features in their national systems of innovation. Finally, we need to come back to the initial issue of the theoretical validity of the study of the national systems of innovation of the BRICS economies. We will have to interrogate the degree to which this study constitutes, along with the other reports in this series, the basis for the emergence of a new discursive formation7 which may provide the scope for an ensuing and expanding distinct field of enquiry. This interrogation will have to proceed in a cascade from

7 Variava (1989, Ch 2) describes the conditions for a discursive formation as follows: … a discourse can be seen as a system of possibility which allows statements to be made which will either be true or false. This makes possible a field of knowledge. The rules of discourse … provide the preconditions for the formation of statements. Foucault formulates four hypotheses in terms of which he attempts to identify and to isolate a discursive formation: · a discursive formation is identifiable if the statements in it refer to the same object; · a discursive formation has a regular 'style', a common way in which statements are made; · a discursive formation is identifiable if the concepts in the statements have a constancy; · a discursive formation exists if all the statements support a common theme, or what Foucault calls in his later books a 'strategy', a common institutional or political pattern.

15 general theory to specific application. The general theory in this case is that which underlies the concept of the national system of innovation. We can start from the assumption that this body of work already constitutes an established discursive formation which now offers the possibility for the emergence of an alternative theory of economics. The next level will be to enquire whether the grouping of the BRICS national systems of innovation constitutes an identifiable and uniquely distinct space for the development of the possibility for distinct body of emerging knowledge. This possibility stems from the combination of three factors – the commonalities in the characteristics of the BRICS systems of innovation, the commonalities of the presence of the BRICS economies in the global economy and their ability to form a new significant economic power bloc of the “south”, the conditions for the possibility that the commonalities among the BRICS systems of innovation constitute a new empirical, but more importantly a theoretical, specificity in national system of innovation theory. The last condition is possibly the most crucial one, given the basis for the inductive origin of the bulk of innovation theory as we know it. Unlike neoclassical economics, innovation theory, starting from the massive case studies project initiated by the Science Policy Research Unit (SPRU) at Sussex University, and its particular articulation as national system of innovation theory is decidedly evidence based theorising. It emerged from a growing sense of disquiet at the failure to explain the residual in growth accounting and gradually grew as its own discursive formation from the growing body of observations in the field. There is consequently always the possibility that a new body of empirical evidence may alter theory and in the process provide the basis for the emergence of a new discursive formation. In a rapidly changing global political economy, the conglomeration of the BRICS systems of innovation as an area of study may well prove to be a case which goes beyond a simple application of an existing body of theory to new empirical terrain. It may affect how we conceive of the theory of innovation systems and open up to new theoretical explorations. We hope that this report, and the others in this series, will provide a step in that direction.

16 References

Arocena, R. & Sutz, J. 2003. ‘Knowledge, Innovation and Learning: Systems and Policies in the North and in the South’, in J.E. Cassiolato, H.M.M. Lastres & M.L. Maciel Systems of Innovation and Development — Evidence from Brazil. Cheltenham, UK: Edward Elgar. Cassiolato, J.E., Lastres, H.M.M., Mytelka, L. & Lundvall, B.A. 2005. Systems of innovation and development: an introduction. Mimeo, Economics Institute, Federal University of Rio de Janeiro. Cassiolato, J.E., Guimarães, V., Peixoto F. & Lastres, H.M.M. 2005. Innovation Systems and Development: what can we learn from the Latin American experience?, paper presented at the 3rd Globelics Conference, Pretoria, South Africa. Chesnais, F. & Sauviat, C. 2003. ‘The financing of innovation-related investment in the contemporary global finance-dominated accumulation regime’, in J.E. Cassiolato, H.M.M. Lastres & M.L. Maciel Systems of Innovation and Development — Evidence from Brazil. Cheltenham, UK: Edward Elgar. Freeman, C. 2003 ‘A hard landing for the “new economy”? Information technology and the United States national system of innovation’ in J.E. Cassiolato, H.M.M. Lastres & M.L. Maciel Systems of Innovation and Development — Evidence from Brazil. Cheltenham, UK: Edward Elgar. Freeman, C. 1987. Technology and Economic Performance: Lessons from Japan. (UK: Pinter). Freeman, C. 1982. ‘Technological infrastructure and international competitiveness’, draft paper submitted to the OECD ad hoc group on science, technology and competitiveness, Paris: OCDE. Furtado, C. 1964. Development and Underdevelopment, Los Angeles: University of California Press Furtado, C. 1958. ‘Capital Formation and Economic Development’ in A.N. Agarwala & S.P. Singh (Eds), The Economics of Underdevelopment, Oxford: Oxford University Press. Herrera, A. 1975. ‘Los Determinantes Sociales de la Politica Cientifica en America Latina’, in J. Sábato (Ed.) El pensamento Latinoamericano en ciencia-tecnologia-desarrollo- dependencia. Buenos Aires: Paidos. Jessop. B. 2008. State Power: A Strategic-Relational Approach. (UK: Polity Press) Lastres, H.M.M. & Cassiolato, J.E. 2005. ‘Innovation systems and local productive arrangements: new strategies to promote the generation, acquisition and diffusion of knowledge’, Innovation: Management, Policy & Practice, 7 (2), 172-187. Lastres, H.M.M., Cassiolato, J.E. & Maciel, M.L. 2003. ‘Systems of innovation for development in the knowledge era: an introduction’, in J.E. Cassiolato, H.M.M. Lastres & M.L. Maciel Systems of Innovation and Development — Evidence from Brazil. Edward Elgar. Cheltenham, UK. Northampton, MA, USA. Lundvall, B-Å. 2006. National innovation system: analytical policy device and policy learning tool. Mimeo. Department of Business Studies, Aalborg University, Aalborg, Denmark. Lundvall, B-Å. (ed). 1992. National Innovation Systems: Towards a Theory of Innovation and Interactive Learning. (UK: Pinter). Mannheim, K. (ed). 1947. From Max Weber: Essays in Sociology. (UK: Keegan Paul). Metcalfe, S. (1995) “The Economic Foundations of Technology Policy: Equilibrium and Evolutionary Perspectives”, in P. Stoneman (ed), Handbook of the Economics of

17 Innovation and Technological Change. (UK: Blackwell Publishers). Nelson, R. (ed). 1993. National Innovation Systems: A Comparative Analysis. (UK: Oxford University Press). Patel, P. and Pavitt, K. 1994. “The Nature and Economic Importance of National Innovation Systems,” STI Review, No. 14. (France: OECD). Scerri, M. 2009. The Evolution of the South African System of Innovation since 1916. (UK: Cambridge Scholars Publishing). Variava, R. 1989. The Deployment of Racism in South Africa. PhD dissertation. (UK: Cambridge University).

18 ANNEX 5 BRICS Project

Comparative Report on Innovation Systems and Inequality in the BRICS

Mario Scerri, Maria Clara Couto Soares and Rasigan Maharajh October, 2010

Globelics 2

The BRICS Project is a comparison between the National Innovation Systems of Brazil, Russia, India, China and South Africa. It is a project conducted by the Global Research Network for Learning, Innovation and Competence Building Systems – Globelics (see www.globelics.org) and RedeSist – the Research Network on Local Productive and Innovative Systems – at the Economics Institute of the Federal University of Rio de Janeiro Brazil. Conceptually, the project is structured around the Systems of Innovation framework. The central focus of the study is the national innovation system (NIS) of the five BRICS. The notion of innovation system has in its centre the industrial, S&T and education sub-systems; but includes also the legal and political frameworks, investment and financial sub-system, as well as other spheres relating to the national and international contexts where knowledge is generated, used and diffused. The objective is to characterize and compare the NIS of the five countries pointing out convergences, divergences, and synergies, as well as identifying current and potential connections. Particular attention will be given to policy implications. Therefore, the project aims at involving, not only researchers, but also policy-makers working in national and international agencies. Specifically the project aims at: (a) stimulating interactions and the exchange of experiences between researchers and policy-makers interested in innovation in BRICS aiming at creating capabilities and finding joint workable solutions; (b) characterizing the structure of BRICS´ national innovation systems, their recent evolution and perspectives; (c) comparing the five countries innovation systems, identifying differences and similarities, common bottlenecks and complementarities; (d) developing and using concepts and information capable of representing the Innovation Systems of BRICS; (e) discussing policy implications and put forward policy recommendations, extracting lessons that can be useful not only for these countries but also for other developing countries.

INNOVATION SYSTEMS AND INEQUALITY IN THE BRICS

Mario Scerri, Maria Clara Couto Soares and Rasigan Maharajh

The relevance of science, technology and innovation for promoting economic growth is increasingly recognized nowadays. However, the analysis of the distributive effects of innovation, production, distribution and consumption circuits is still relatively new and the complex links between the inequality, innovation systems and development still remain largely unexplored. The analysis of economic systems through an innovation systems lens opens up the theoretical space for the analysis of the co- evolution of economic systems and society and of the multiplex causalities of the various interlinked sub-systems. The understanding of the dynamic inter-relations between innovation systems and inequality constitutes a formidable challenge given its complexity and interdisciplinary character. However, despite the magnitude of the task, a better understanding of the relationship between innovation systems and inequality allows for the evaluation of different options for configuring technological and institutional change and for opening up the possibility for policies that may promote development alternatives towards greater equality and social cohesion. This book is driven by the imperative, for both the academic and for the policy designer, to improve our understanding of this issue. The book adopts the broad version of the national systems of innovation approach to analyse the relations between the innovation systems of the BRICS (Brazil, Russia, India, China and South Africa) countries and inequality, proceeding from a co-evolutionary perspective. The early works on the systems of innovation approach to the analysis of economic dynamics date back to the 1980s (Freeman, 1982; Freeman and Lundvall, 1988). Since then the SI approach has been increasingly used to analyse processes of acquisition, use and diffusion of innovations besides orienting policy recommendations in both developed and less developed countries. The initial attempts to present a countervailing theory to the neoclassical orthodoxy were based on a narrow approach to the analysis of innovation systems, with a specific focus on research and development and on organisations directly connected to science and technology. While the narrow approach is still adopted in innovation system literature, the eventual broadening of the understanding of innovation systems and the convergence of the innovation systems approach with the Latin American structuralist approach to development economics (see Cassiolato and Lastres, 2008) has brought in a greater analytical and normative capacity to the analysis of national systems of innovation. This broader approach incorporates governmental policies as whole, social institutions, financing organizations and all other agents and elements that affect the acquisition, use and dissemination of innovations. This approach also includes informal institutions, as established routines and practices which, through processes of socialisation and internalisation, govern social/economic interactions. It is this broad perspective which is particularly important to the subject addressed by the book, since it allows a better understanding on how innovation process takes place and how it is linked with local specificities and distributional issues (see Cassiolato, Soares and Lastres, 2008). 4

An important contribution of the broad approach to the analysis of innovation systems is the recognition of the importance of the socio-economic and political context in which the system is embedded, due to its influence on the configuration of the capabilities of organizations, regions and countries for developing, disseminating and using innovations. In this approach, innovation is considered as deeply dependent on the local specificities of social, political and economic relations, being therefore directly affected by both history and the particular institutional context of countries or regions where it occurs. Therefore innovation and learning reflect the combination of prevailing institutions and the socio-economic structures. The extension of the definition of institutions to include formal institutions not directly connected to science and technology and even further to informal institutions as established forms of routines, practices and interpersonal relations allows for an integrated approach to the analysis of the sources of enduring patterns of inequalities of various forms. Before we proceed further, however, we need to expand on the rationale for the inclusion of the question of inequality in this series of studies of the various aspects of national systems of innovation in the BRICS countries. This is a legitimate query since in some respects the problem of inequality is substantively different from the other issues addressed in this series. The relationships between the national system of innovation and the state, finance, the small and medium enterprise sector, and transnational corporations and foreign direct investment are immediately apparent and self evident as relationships between formal institutions. The phenomenon of inequality, in terms of its root causes and effects, is usually seen to belong more to the area of social, rather than economic, studies, even though the degrees of inequality are usually estimated using economic measures. Marxist analysis is, of course, the one main exception to this rather generalised statement, given its direct focus on the economic sources of class divisions and inequality and the innovation systems approach is in its way similar to a refined Marxist approach in its consideration of the totality of the phenomenon and its multidimensional relationship with the economy. This is enabled by the extension of the definition the economy under this approach beyond the neoclassical reductionist version and by its erosion of the misleading distinction between the “economic” and the “social” spheres. The detrimental effects of inequality are usually seen in terms of their impact on social stability and on the value system of the democratic ideal. We therefore need to see why the issue of inequality, measured in various ways, should be included as a legitimate component of this series of studies on the various aspects of the BRICS’ systems of innovation. One reason for this inclusion is that in this group of countries high levels of inequality have been and/or are becoming a seriously worrying outcome of the development process. This concern is, of course, a global one and as such its inclusion in the analysis of these specific systems of innovation brings in a degree of congruence between innovation studies and those of the global political economy. The basic assumption is that the nature of the specific systems of innovation, and their evolutionary paths, has a non-trivial effect on the manifestation of significant levels of inequality in its various dimensions. From this perspective these five studies seek to understand the history of inequality and the manner in which it has been affected by economic policies in general and by industrial, trade and innovation policy in particular. At the same time these studies reflect on the effects of inequality, in its specific manifestations on the evolutionary paths of the respective national systems of innovation of the five economies. At the outset, we must also try to pin down a definition of inequality. Broadly speaking inequality can be defined as referring to opportunity and as to outcomes. The 5 two aspects are of course strongly related but not identical. Opportunity here refers to what we may call the “life chances” of individuals and groups, whose determinants include a myriad of factors both economic, political and social. Opportunity is difficult to measure except through usually far from adequate proxy variables, including income, wealth, the various facets of human capitali, and access to the means for self improvement. Broadly defined, human capital can be seen as an enabler of personal life choice options. From this perspective we can avoid an economic reductionist assessment of inequality by contextualising measurements of human capital within a context of political and social constraints. Outcomes, on the other hand are more easily measured, usually in terms of income, wealth and consumption patterns. While the two aspects of inequality are not identical, the endurance of a specific pattern of inequality of outcomes over time would tend to entrench corresponding patterns of inequality of opportunity. The concept of inequality is considered in its multi-dimensional character, embracing a phenomenon that goes beyond the mere income dimension and is manifested through increasingly complex forms, including, among others, assets, access to basic services, infrastructure, and knowledge, as well as race, gender, ethnic and geographic dimensions. The different forms of inequality, whether class, gender, ethnicity or geographic, has distinct implications on the effects of inequality and on the required counteracting policies. These forms often intersect, as with, for example, a correlation between race and class or the relationship between ethnicity and geographical setting, to create new configurations of the manifestation and the root causes of inequality. There are therefore two aspects to the definition of inequality. The first is its expression in class, gender, ethnicity and geographical forms, as discussed above. The second dimension to the definition concerns its manifestation in terms of income, wealth, education, health, etc., which determine both the quality of life and life opportunities. The focus on inequality in terms of opportunity and prospects highlights the structural nature of inequality which establishes it as an institution within the web which makes up the national system of innovation. The types of inequality which are considered in this book, and the relative emphasis placed on them, obviously differ across the five studies and are quite specific in terms of their underlying structures and histories. In the case of the two national systems of innovation which emerged from planned economies into some variety of capitalism, the main focus of the respective studies is on class and geographical inequalities. This focus is most pronounced in the case of China, whereas in the Russian study gender inequality is also included. The Russian study also identifies families with children as being particularly disadvantaged since the demise of the Soviet Union with the consequence of a recognised disincentive to have and raise children. In the case of India, inequality measures refer to religious groupings, as well as class and region. The Brazilian study also includes ethnicity, in terms of racial classification, alongside class and region. The history of South Africa obviously dictates that the conjuncture of race and class be considered in the assessment of the institution of inequality, along with region and gender. The choice of the types of inequality which have been considered in the respective country studies also carries implications for the complexity of the problematic posed by the proposed co-evolution of innovation and inequality. The wider the range of the types of inequality which are considered as relevant for a particular system, the greater is the potential for inter-relations and causalities among the various types and sources of inequality. This tends to render both the phenomenon of inequality and the possibilities for its solution through policy more complex. The treatment of specific inequalities in these five studies is obviously not exhaustive, both in terms of inclusion and of emphasis. It represents, rather, a context 6 specific ranking of the types of inequality in terms of their relevance in the co-evolution between innovation and inequality. The idea of co-evolution between innovation and inequality offered by Cozzens and Kaplinsky (2008) is a welcome contribution to the understanding of this complex relationship. They suggest that ‘innovation and inequality co-evolve, with innovation sometimes reflecting and reinforcing inequalities and sometimes undermining them’. The causal relations between innovation and inequality can also run in the opposite direction with high degrees of endemic inequality shaping the evolution of national systems of innovation. Here we can find the source of mutual self-reinforcing mechanisms between innovation and inequality which over time entrench and deepen the structural inequality of incomes, wealth and, more crucially, the life chances of different sections of populations. This forms the basis for a path dependent vicious circle of innovation deepening inequality which further determines an evolution of the system of innovation which adjusts for the economic constraints posed by acute inequality, primarily in terms of the type and spread of human capabilities and learning capacities. This path dependency, especially given long historical reinforcement, would almost inevitably require state intervention to break this vicious cycle. Fundamentally, the basis for the co-evolution between innovation and inequality is the fact that the foundations of inequality form one of the informal institutions of national systems of innovation. The treatment of inequality, and its basis, as an institution is premised on the assumption that the inequalities which we consider exhibit a degree of duration over time. They must arise from established practices and relationships which endure, are structural and are subject to analysis stemming from an established theoretical basis. In this sense both the sources of inequality and the specific type of inequality itself can be considered as informal institutions. From this perspective therefore we can proceed to explore the factors which tend to reproduce inequality and it is only on this basis that we can eventually derive corrective policy recommendations. The study of the sources and effects of inequality thus becomes an integral part of the analysis of systems of innovation. Several theoretical approaches can be brought into the investigation of inequality as one of the institutional components of a national system of innovation and given the political economy basis of the study of systems of innovation these approaches almost necessarily tend to be contentious. Thus class inequalities are obviously subject to Marxist analysis while racial and ethnic inequalities would merit approaches to identity politics and the analysis of ethnic conflict, with gender inequality requiring the application of gender economics. Regional inequalities would probably best be approached from a more traditional development economics basis. These various approaches must not be seen as compartmentalised since the various forms which inequality can take are often conflated in a singular, contextually specific, local manifestation. Thus, for example, a roughly theoretically integrated approach is required to analyse the effects of globalisation on the shape and changes in inequalities of various forms within the context of specific national systems of innovation as well as the more commonly studied effects on the inequalities between national systems of innovation. In this way a more complex assessment of the systemic effects of the modern manifestation of globalisation can be brought to bear on to an issue which has come to occupy a prominent place in the analysis of the development of the global political economy. The potency of this institution of inequality in terms of its specific manifestation differs dramatically across systems and again this is one of the examples where specificity matters crucially. In the case of South Africa, for example, it is impossible to understand the national system of innovation without an understanding of apartheid, a 7 unique example of entrenched inequality arising from a system of legislated racial discrimination which affected almost all aspects of life. The uniqueness of this case among the BRICS systems of innovation is that until relatively recently racial discrimination in South African was a formal institution. Inequality in India, on the other hand, rises from a political economic context which has, since independence, been deeply democratic and has outlawed discrimination on the basis of caste, religion, ethnicity or gender. The enduring inequality in India is a deeply rooted informal institution and it is perhaps this very informality which makes it so difficult to eradicate simply through legislation. Inequality and poverty have defined Brazil’s and South Africa’s political economy historically and continue to be a worrying reality despite the recent improvements in Brazilian case. The trend of increasing inequality in both China and India wherein the ‘Gini has overtaken the growth rates’ has attracted the attention of number of scholars. Thus, as highlighted in this book, inequality is a peculiar trait of these countries comprising a key factor for understanding both the configuration and the dynamic of the national innovation systems of BRICS. We are of course fully aware that the referred trends are not confined to the BRICS economies. Inequality is shown to have increased in the global economy at an unprecedented rate over the last three decades, a period when knowledge intensity in the production process and international trade dramatically increased. This validation of the logic of the Prebisch-Singer theorem (see Singer, 1950 and Prebisch, 1950) of the deteriorating terms of trade between developed and developing economies and the perverse effect of the neoclassical factor price equalisation theorem on the globalisation of class divisions should come as no surprise. On the one hand the increasing prominence of knowledge intensity as a determinant of international competitiveness tends to increase the inequality between national systems of innovation. On the other, the accelerating rate with which knowledge and the access to knowledge has come to create competitive advantage at the interpersonal level has increasingly sharpened inequalities within national systems of innovation. It seems, therefore that national systems of innovation can thrive even in the presence of large and enduring structural inequalities. This then is the conundrum which faces both the analyst and the politician. The drive to reduce inequality and eradicate poverty can obviously stem from a principled ethical stance entrenched in a variety of political agendas and ideologies. This however, is not always sufficient to bring about the necessary structural changes, especially in the face of the ubiquitous allure of the neoliberal “trickle down” theory of the welfare effects of free markets. It has to be clearly demonstrated that significant enduring inequalities within any national system of innovation ultimately severely restrict its development and compromise its long term viability. The immediately obvious argument for this proposition is premised on the deleterious effects of sustained inequalities on the development of broad based human capital and human capabilities and the severe constraints which they impose on internal systems of consumption. The former effect imposes supply side restrictions on innovation, while the latter imposes constraints on the demand side of the innovation system. Beyond these effects there is also the other, more generic implication of sustained significant inequalities for the long term political and social stability of the political economy of the national system of innovation. Innovations, whether as technology or institutional change, can spur economic growth and engender the structural transformation of an economy. But the operation of systems of innovation and capacity building might either improve or exacerbate inequality. While a positive correlation is frequently observed between advances in 8 science, technology and innovation and the deepening of socioeconomic gapsii, this is not a necessary outcome. Indeed, this study is partially driven by the hope that a better understanding of the relationships which determine this apparently common correlation, or even causality, may eventually enable to design policy which would directly address this particular deleterious effect of innovation. The relevant question here is whether an innovation system can be separated from the logic and accumulated trajectory of its political economy. This aspiration is particularly relevant to highly unequal developing economies where fostering innovation usually increases inequalities and “the trend toward higher inequality is probably stronger in a global knowledge-based and innovation-driven economy ... (with) ...people with greater capabilities, power, and social capital ... (being)... better situated to innovate, to take profit from innovations, and to learn by innovating” (Sutz and Arocena 2006, p.7). As shown in all the chapters in this book, innovation can affect inequalities in different ways and through distinct trails which are influenced by national conditions and shaped by public policy interventions. Although innovation does not constitute the main factor of influence on inequality, it is suggested that distinct strategies for technological change may lead to different outcomes in distributive terms, thus either aggravating or mitigating inequality. Based on this understanding, the book corroborates the hypothesis that inequalities need to be taken explicitly into account in development strategies since the benefits of science, technology and innovation cannot be assumed to be automatically distributed equally. Therefore, advancing the comprehension of inter-relations between innovation and inequality may be helpful to find ways to shape the evolution of national innovation systems so that they reduce rather than increase inequalities. It is here that we need to make a distinction between innovation and systems of innovation. The relationship between innovations, especially technological innovations, and inequality, can perhaps be traced through the factor biases of innovations and their effects on existing distributions of income, wealth and economic and political power. A comprehensive deconstructive analysis of these relationships, however, can only be adequately assessed from within the theoretical context of the national system of innovation, defined broadly enough to incorporate most aspects of the political economy and extending considerably beyond the orthodox definition of the economic sphere. It is only within this context that the intimate relationship between innovation and issues of inequality and the attendant one of poverty can be thoroughly explored in their various multidirectional sets of causalities. The systems of innovation approach also allows for a proper dynamic analysis of the shifts of these various interlocked relationships over time, affected by, and affecting, the various interlocking political economies within which they are set. Given the fact that the analysis of the relationship between systems of innovation and inequality has a relatively short history, this book is not rooted in a body of concepts already sufficiently developed and able to provide a solid basis for guidance to the research. The reflection on the subject in this book is built on the experience of the BRICS. The terms of reference of this study are not confined to contributing to a better understanding of the relations between inequality and national innovation systems in these countries; they are also driven by a recognised urgent need to support a programme of political action aimed at the promotion of development from a perspective focused on social inclusion. This is a case where praxis, based on sound theory and empirical investigation, is urgently called for. Thus, beyond the analytical view the book aims to stimulate discussion of the implications of the analysis for public policies in BRICS and may also inspire policy makers in other countries interested in the topic. 9

The following five chapters present the BRICS case studies and each chapter shares a loosely common structure so as to facilitate cross system comparisons. The overall objectives of each chapter are twofold. The first is to trace the trends in interpersonal and inter-regional inequality within economies from an evolutionary perspective. The relevant period of analysis obviously differs, depending on the specific histories of individual countries, but in general it covers the past seventy years. The second is to analyse the co-evolution of inequality and innovation system in order to provide some understanding of the mutually reinforcing relationship between on the one hand and the various elements of innovation and production system and inequality, on the other. Each chapter starts with the characterization of poverty and inequality patterns in the country concerned, tracing the trends in interpersonal, inter-regional as well as in other forms of inequality (race, class, gender, ethnicity, geographic locality and others as appropriate for the country) within the economy over the last few decades, from an evolutionary perspective on the political economy in question. In the analysis of the grounding of the patterns of inequality, the individual chapters attempt to place the observed trends against the historical, political and cultural background of inequality. The analysis of the co-evolution of inequality and innovation system follows this section. The attempt here is to analyse how (and whether) the various elements of the national innovation system and inequality mutually reinforce each other. To this effect, each chapter examines how the policies and institutions of the national systems of innovation and production co-evolve with inequality at personal and regional levels. This enquiry also empirically highlights how these policies and institutions have reinforced greater structural heterogeneity, the informalisation of employment along with widening of productivity in a context of unequal access to education, health, knowledge infrastructure (e.g. access to mobile networks, the internet, etc.), financial infrastructure, R&D infrastructure and other relevant elements of the national systems of innovation. Within the context of the evolution of the policy framework, the shift away from public sector orientation to private sector domination, with unequal access to global production network, market driven trade and investment, etc., within the context of rapidly accelerating globalisation will be examined. Thus the co-evolution of national systems of innovation and inequality will be examined within the changing context of the national systems of innovation and production. The main indicators of inequality which are used in this book cover both inequalities of opportunity and those of the more immediate conditions of life. The former set of measures includes access to health and education, access to knowledge infrastructure and access to financial infrastructure. In this regard the chapters also pay specific attention to regional disparities in competence building institutions and production. These measures provide some indication of the entrenchment of the institutions of inequality. The more immediate measures of inequality which are used include wages, the assessment of inter-sectoral wages/productivity differential and their bearing on inequality, and the patterns of employment, specifically with respect to the formal/casual divide. The final section of each of the country chapters identifies some salient features of the relationships between the shape of the specific national systems of innovation and specific prevalent forms of inequality which require the attention of policy-makers and also draws out a brief list of recommendations for future policy. The BRICS systems of innovation exhibit high degrees of inequality of different forms. The origins of the current patterns and rates of inequality are quite diverse. Thus, for example, South Africa emerges from a state of legalised racial discrimination which, in terms of biopolitics, represents an extreme example of the governance of 10 every aspect of racial divisiveness, from job and residential allocation, the right to engage in business, the right to education, and the freedom to associate, including the area of sexual relations. The Brazilian original social matrix, determined by the concentration of land and of political power, as well as by external dependency, imposed its imprint on the entire process of historical constitution and evolution of Brazilian nation. Throughout different political regimes, the strength of political coalitions particularly those of landowners and capitalists in relation to urban waged workers and the rural mass, underpinned the inertial and iniquitous distributive patterns observed in Brazil. Both Russia and China were formed by variations of the egalitarian ideal of communism but both have seen worrying rate of inequality arising over the last two decades. In the case of Russia, the collapse of the Soviet Union and the sudden plunge into an extreme laissez faire form of capitalism during the nineties had a devastating effect on income and wealth distribution. In the case of China, the accelerated evolution of the political economy into a distinctly Chinese form of capitalism has also brought in a hitherto unprecedented incidence of inequality in its wake. India, a constitutional parliamentary democracy since its independence, has addressed endemic inequality consistently through policy over the past six decades; the fact that inequality in its various forms still remains such a serious concern is indicative of the ubiquitous and pernicious nature of the informal institutions which underlie endemic inequality. The nature of the co-evolution of the national system of innovation and inequality is obviously different for the five economies given their historical specificities. The general conclusion, however, is that in the absence of appropriate policy measures, the evolution of national systems of innovation within the post- eighties context of market liberalisation tends to reproduce, reinforce and even intensify structural inequalities. This is as should be expected since the alteration of the structural context within which private corporations operate does not fall within the role of those corporations. It is rather, the role of the state to alter the structure within which the private sector functions. Thus in the case of Russia and China, the two economies which, following their very specific paths, have emerged from a totally planned economy into some variety of capitalism we see an almost inevitable increase in inequality. In the case of Russia the dismantling of the soviet welfare system and its inadequate substitution in the transition to a capitalist system of innovation has been the main cause of the relationship between inequality and the particular evolution of the national system of innovation. In the case of China, this co-evolution related to the shift to a highly specific variety of capitalism has also increased inequality, not so much in terms of class stratification as geographically, between rural and urban populations. In the case of China, while absolute poverty levels are being reduced, inequality is still increasing. In the case of India, the initial stage in the evolution of the national system of innovation, from independence until the early eighties, was state led on the basis of import substitution and inward industrialisation and, with a strong redistributive component, was accompanied by falling levels of inequality. In the second phase of the evolution of the innovation system within a more market driven policy environment the nature of the co-evolution between the system of innovation and inequality has altered, with increasing inequality as, for example, employment grows at a significantly slower rate than output. In the case of South Africa the stimulation and promotion of innovation by the state has largely proceeded without an effective programme for the incorporation of the majority of the population in to the formal, skills intensive sectors of the economy. As a consequence, we see a positive relationship between the direction of the evolution of the national system of innovation and inequality. The co- 11 evolutionary aspect of these relationships is highlighted in the chapter on Brazil, which indicates that while the structure of the innovation system, and its development, does little to alleviate inequality, the structure of inequality has also restricted the absorption of technology and the development of an indigenous technological base. In all five cases, therefore, the indication seems to be quite clear that the set of strong and multidirectional causalities in the co-evolution between innovation systems and inequality can only be addressed adequately by state policy. In the absence of public explicitly designed to alter the nature of this co-evolution, the logic of the development of a capitalist system of innovation almost inevitably has negative distributional effects across the system. This is why it is useful to view inequality, in its various related forms, as an institution within the broader institutional web which makes up the national system of innovation. This perspective should enhance the design of appropriate policy measures aimed at aligning the progression on the system of innovation with the reduction of inequality. This need has become even more pronounced since the global alteration in policy environments since the eighties. Finally, we need to accept that the studies presented in this book constitute an initial step in a longer term research programme which this topic merits. The complexity of this area of research and its strong and increasing relevance not only to individual national systems of innovation but to the global system certainly requires a more thorough and exhaustive analysis of the co-evolution of inequalities and systems of innovation for each of the BRICS economies as separate works. The comparative analyses presented in this book raise a number of questions which still need to be explored. In the first place the bulk of the studies focus on the effects of particular evolution paths of national systems of innovation on inequality, defined in a number of ways. However, as already discussed briefly, causality also works in the opposite direction with endemic inequality determining the evolutionary path of systems of innovation, through, for example, the human capital implications for choice of technology and industrial structure. This is due to the fact that in the BRICS systems of innovations, entrenched inequality is a strong non-trivial component of the informal institutional underpinning of these national systems of innovation. The effects of this institution in its various specific manifestations on the nature of the national system of innovation still have to be assessed in detail in future research. The importance of considering this specific institution of the BRICS systems of innovation emerges from the studies in this book which clearly indicate that it is still an important defining institution in the system of innovation. From this position we may tentatively propose that one of the watersheds in the evolution of the innovation systems of the BRICS systems of innovation will occur when the specific institutions of inequality cease to be a significant identifier of these systems. Another area which, while addressed in the various chapters, also merits further exploration is the effect of rapid globalisation on inequality, not merely in terms of current measures but also with regards to the altering of the parameters of inequality. It is now common knowledge that the modern process of globalisation tends to erode the national specificity of systems of innovation and the simultaneous effect which is relevant to considerations of inequality is the degree to which the introduction of access to globalised means of production deepens the intra-national gaps in the conditions of life and in life chances. Finally, a fundamental question about the nature of inequality still needs to be addressed and this has to do with the relationships among the various types of inequality. At this stage we are still largely in the process of measuring different forms of inequality and locating them within a specific national system of innovation. 12

Congruence in measurements often indicates some strong correlations among various forms of inequality but we still need to grapple with the issue of causality, especially from a historical perspective, in order to understand the root causes of the multifaceted complexity of inequality and the nature of its embedment within national systems of innovation to the point of becoming an integral part of the institutional framework of these systems. It is particularly in this area that the future development of this research project could fruitfully co-opt other disciplines than economics in order to provide the kind of inter-disciplinary methodology required for the thorough investigation of this problematic. There is in these five studies, to various degrees, already a hint of an interdisciplinary approach. Certainly history has been firmly brought in, in each case. Ideological shifts have also been alluded to in some of the studies, although again the space constraint prohibits the development of the rich analysis which this aspect opens up. It is hoped that this book has started a new debate with the convergence of two areas of interest – the co-evolution of systems of innovation and inequality with the consideration of the BRICS economies as a specific and distinct field of application. The project has also proceeded in the conviction that the study of inequality through the perspective of the systems of innovation approach not only enriches our understanding of this particular aspect of economic dynamics but also provides the theoretical foundation for policy formulations which are more appropriate for addressing the problems of structural inequalities. All of these studies identify some sort of trade-off between equity and growth with some countries experiencing a stronger correlation between growing inequality and the development of their national system of innovation. The one system where this “perverse” correlation is least pronounced is India, due to the fact that the first stage of the evolution of its system of innovation, from independence to the early eighties, was guided by a policy framework explicitly designed to reduce poverty and inequality. This starting base has served to mitigate the effects of the market liberalisation drive which followed. What is evident is that the link between growth and inequality has to be broken through revisiting the foundations of the systems of innovations which we have studied. This need is captured by the statement at the end of the chapter on China that “we need a new philosophy of development and innovation” if we hope to break this link. 13

NOTES

i Sen (1999: 296), among others, cautions against the possible pitfalls in the adoption of the concept of human capital when he points out that “human beings are not merely the means of production, but also the end of the exercise”. Sen also states that “(w)e must go beyond the notion of human capital, after acknowledging its relevance and reach. The broadening that is needed is additional and inclusive, rather than, in any sense, an alternative to the ‘human capital’ perspective”. However, a broad enough definition of human capital and an emphasis on the fundamental distinction of human from other forms of capital should enable the appropriate deployment of this potentially powerful analytical construct within a systems of innovation approach, while subverting its appropriation by neoclassical and neoliberal economics. One of the benefits of this deployment would be the erosion of the distinction between the economic and the social spheres and the dangerously misleading separation of the means and the ends of development policy. ii As pointed out by some authors: “when the issue of inequality ... (is) ... investigated, we often find that diffusion of innovations widens the socioeconomic gap between the higher and the lower status segments of a system” (Rogers 1995, p. 125).

References Cassiolato, J. and Lastres H. (2008) Discussing Innovation and Development: Converging Points between the Latin American School and the Innovation System Perspective? ; GLOBELICS Working Paper Series, No. 08-02. Cassiolato, J., Soares, M. C. and Lastres, H. M. M. (2008) Innovation in Unequal Societies: How can it contribute to improve equality? Seminario Internacional Ciencia, Tecnología, Innovación e Inclusión Social, UNESCO, Montevideo, May 2008. Freeman, C. (1982) The Economics of Industrial Innovation, 2nd ed. (USA: MIT Press). ______. and Lundvall, B.-Å. (eds.) 1988. Small Countries Facing the Technological Revolution. (London: Pinter). Lundvall, B.-Å. (ed.). (1992) National Systems of Innovation. Towards a Theory of Innovation and Interactive Learning. (London: Pinter). Prebisch, R. (1950) The Economic development of Latin America and its Principal Problems. (USA: ECLA, UN Department of Economic Affairs). Rogers, E M (1995) Diffusion of Innovations, Fourth edition, Free Press, New York. Sen, A. (1999) Development as Freedom. (US: Anchor Books). Singer, H. (1950) “The Distribution of Gains between Investing and Borrowing Countries”, American Economic Review. Sutz J. and Arocena, R. (2006), Integrating Innovation Policies with Social Policies: A Strategy to Embed Science and Technology into Development Process; IDRC Strategic Commissioned Paper, April. ANNEX 6 BRICS Project

Comparative Report on FDI and National Systems of Innovation in BRICS

José Eduardo Cassiolato October, 2010

2 FDI AND NATIONAL SYSTEMS OF INNOVATION: LESSONS FROM THE EXPERIENCE OF BRICS José Eduardo Cassiolato

1. Introduction

Foreign Direct Investment is an important facet of the globalization process. In the mid 2000s, FDI stock corresponds to approximately 20% of world GDP. In 1982 FDI flows amounted US$ 58 billion and in 2007 about US$ 2 trillion. These flows are not homogeneously distributed around the nations and important changes have been observed in the last 20 years. Up to the early 1990s, approximately 95% of FDI originated in the developed world (USA, western Europe and Japan) and were directed to the same region (around 85% of total In the last few such situation radically changed: in 200, 68.7% of FDI flows went to developing countries and approximately 16% of world FDI originated in these countries. There have been other important new trends regarding FDI in the last 20 years. First, rates of FDI growth since the early 1980s have been more than twice the rate of world investment (using GFCF as a proxy of investment) which signals the increasing importance of TNCs in the world economy. Second, a significant share of such FDI is via mergers and acquisitions (US$ 112 billion in 1990 and US$ 1,031 billion in 2007), showing that a large part of new FDI does not generate new production capacity but rather is linked to a process of capital concentration and is part and parcel of a financial dominated accumulation regime. Transnational Corporations (TNCs), main drivers of world FDI, have intensified their relevance. In the beginning of 1990s there were 37 thousands of TNCs, followed by 175 thousands subsidiaries; in 2007, these amounts achieved 79 thousands and 790 thousands, respectively. The international trade between subsidiaries and parent companies represents, nowadays, 60% of world trade. TNCs also dominate most part of private R&D and of advanced technology available in the world. Product originated by TNCs were estimated to be around 5% of the world’s total product in 1982 and reached 11.4% in 2007. Such figures demonstrate a significant increase on the degree of internationalization of the world economy and on the importance of TNCs. Although present in the world economy for a long time, TNCs became particularly important after the end of II World War. In the 1950s and 1960s, US TNCs were dominant drivers of the internationalization of capital. The following decades were marked by the increasing presence of European and Japanese TNCs. In the last few years, another trend has been noticed: the emergence of developing countries’ TNCs. But the changes observed in the last 20 years have been qualitatively more more profound and are part of large economic and political transformations. The influence of large TNCs in technology and innovation is even more compelling. According to information released by the European Commission, the top 2000 companies (1000 EU and 1000 non-EU) invested €372 billion in R&D in 2006/7, which corresponds to approximately 80% of global business expenditure on R&D. (Industrial Research and Innovation, 2008). In the case of the US it is estimated that US

3 TNCs are responsible for approximately 74% of total R&D by the nation´s private sector. Approximately 80% of the 700 TNCs that most invest in R&D are originated from five countries: USA, Japan, Germany, United Kingdom and France. Their technological activities seem to be strongly concentrated on parent companies. R&D expenditures of US TNCs’ affiliates correspond to around 17% of US TNC’s parent companies’ expenditures (2007), and most part are directed to other developed nations. In spite of this intensive productive and especially technological concentration, some researchers argue in favor of a tendency of technological internationalization to developing countries, which has benefited from the partnership between foreign enterprises and local institutions and, most, from the increasing of TNCs’ R&D activities. In fact, the growing importance of TNCs in the recent globalization process has renewed an old debate. Several advocates of the liberal globalization have stressed that attracting TNCs to developing countries may allow access to technologies of advanced countries. By facilitating the entry and stimulating investments of these enterprises, developing nations would benefit from technological innovations brought by them and, consequently increase productivity and improve the quality of their products. For these authors, not only the use and the acquisition of new technologies would be incorporated by subsidiaries, but also the generation in these countries would be stimulated. Through their affiliates, these companies would be increasingly performing R&D activities out of their home countries, and, as a result, they would start creating new products and processes locally. In this process, called “globalization/internationalization of technology”, subsidiaries would not only be responsible for an increasing share of R&D investments of TNCs, but, among all affiliates those in developing countries would be representing a more significant role. An Unctad report (2005) has attempted to demonstrate the existence of a process of internationalization of R&D by transnational enterprises, and declared that an increasing part of these activities has been performed outside the home country of parent companies. Others although not presenting substantial data to demonstrate it, claim that as the technological function of the big companies – in particular the research and development activities – is planned and conducted on a global scale there is an increasing participation of the subsidiaries companies in the global technology effort of TNCs. This book addresses the role of TNCs in the national system of innovation of BRICS countries and this introduction attempts to discuss the main issues that we think are relevant. It adopts the broad version of the national systems of innovation approach and in this book the thesis of technological globalization is taken with more caution, refuting the idea that R&D activities would be inexorably internationalized. In particular, it considers that the complexity involved in innovative activities, like R&D, limits the occurrence of technological globalization automatically and without significant costs, and argues that knowledge-intensive activities still tend to be concentrated in home countries.

2 FDI in BRICS: evolution and related national policies FDI has presented a strong tendency of increase in BRICS countries in the 2000s, boosted by national favorable policies toward FDI. Figure 1 illustrates the trends in FDI inflows to the BRIC members during the last decade. Over such period China had the highest inflows among all BRIC members. At the peak of its FDI inflows China

4 recorded about US$60 billion. This occurred in 2000 and again in 2008. Over the entire period Brazil was the second highest FDI recipient. This country also displayed less volatility in inflows than China. Its lowest FDI inflows were in 2003 at about US$ 10 billion. Russia, on the other hand, shown robust growth in the second half of the decade. Russia started from a low base of about US$3 billion prior to a peak of about US$52 billion in 2007. South Africa is at the bottom of the list of BRIC countries with less than US$10 billion between 1998 and 2007. A breakdown of average FDI inflows again confirms that Brazil has displayed the least FDI inflows fluctuations. Figure 1 - FDI Inflows to BRICS countries, 1998 to 2007 - US$ billion

FDI Inflows 70

30 US$ Billion 20

0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Brazil China India Russia South Africa

Source: Calculated using data from UNCTAD.

In the mid 1990s, deep structural change in the Brazilian economy propelled a FDI boom – the third in its history. The central government played a key role for attracting FDI, basically through the approval of constitutional amendments that terminated public monopoly in sectors such as telecommunications and oil and gas and removed earlier distinction between Brazilian firms of national and of international capital. This recent FDI by TNCs in Brazil mostly targeted the services sector, particularly the privatized infrastructure sector (telecommunications and electricity). Also it concentrated in operations of mergers and acquisitions of local firms. The share of TNC subsidiaries on overall sales of the 18 most important production chains jumped from 36% in 1996 to 52% in 2000. In the last years (2007, 2008), FDI flow was strongly directed to the primary sector - oil and natural gas extraction and, specially, metallic minerals extraction. In Russia, the expansion of international TNCs to the country is encouraged by its government which pursues a policy aimed at providing favourable investment climate and development of investment infrastructure. In order to attract FDI in Russia, the government implements a set of specific measures, as the Foreign Investment Advisory Council (FIAC), which main objective is to create attractive investment climate in Russia, and the federal Law "On Investment Activities in the Form of Capital Investments in the RF”, to provides guaranties of equal rights, protection of interests and property to all investors regardless of their ownership. As a consequence of these incentives, in the recent

5 years TNCs have been rapidly increasing their presence in the Russian economy – the FDI flow went from US$ to US$ 93 billion in 2001 to US$ 881 billion in 2008. However, many Russian economists believe that liberalisation of external economic activity was implemented without taking into account domestic economic realities. Foreign TNCs are generally not ready for large-scale investments in modernisation of major Russian production facilities whose equipment is mostly obsolete. In India, since the decade of nineties 1990s the policymakers have viewed the FDI inflows to be a major source of scare capital, which is capable of contributing to capital formation, output and employment and providing access to technology, managerial skills and markets. Consequently, FDI has became an important form of external financing for India. After stagnating for a few years at around US $ 2.5 billion, FDI inflows rose again to a level of about $ 4.3 billion in 2003, reached nearly US $ 17 billion in 2006-07 and and $ 35.3 billion in 2008-09. These include a large number of cases of foreign firms acquiring wholly Indian ones. Policymakers in India have made a shift away from the focus on merely attracting a higher quantity of FDI to targeting a higher quality of FDI (UNCTAD, 2005). From the mid nineties onwards policymakers in India even targeted to attract FDI for activities such as research and development (R&D), design, technical support centre, education and training, etc. FDI in sectors designated as high technology is receiving preferential treatment in terms of access to infrastructure, tax incentives and subsidies. The latest policy of FDI promotion practices, as in Brazil, the principle of no discrimination against foreign firms. China is a dominant player amongst the BRICS group in terms of its FDI outflows. In China, on the early stage of reform and opening-up, due to policy restrictions, joint venture and cooperation ventures were the main forms of foreign investment in China. But with improvement of China’s investment environment, an increasing number of foreign investments have taken the form of solely foreign-funded enterprises. After the middle of 1990’s, manufacturing TNCs began to invest in capital-intensive or technology-intensive areas, and start to emphasize the strategically position of subsidiary companies in China in the global business integration. However, much of China’s exports in high-technology fields still represent shipments of final-stage assembly of electronic products based on components that are produced in developed countries. The South African economy is nowadays highly favourable to foreign investors, though few national documents currently contain specific references to FDI. At the international level, the country has committed to the majority of international and/or multilateral agreements relevant to ensure the protection of foreign direct investors and of their intellectual property. Generally, no discrimination is applied against foreign investors except in the banking sector. Besides its favourable TNC context, the country also offers a wide range of incentives to both domestic and foreign direct investors. Nevertheless, South Africa is still a small FDI recipient, and this inflow appears to be volatile – all the African continent only absorbed 0.7% of world FDI outflows, most from developed countries. Sectorialy, FDI has been concentrated in the primary sector, notably mining. The country is particularly attractive in this regard, given the large stocks of mineral resources and the variety of mineral resources on its territory.

3 - R&D and innovation activities: the role of TNCs In general, all the studies recognize the influence of TNCs on their economies and the efforts made by their governments in recent decades to stimulate FDI flows. But conclude

6 that, although some exceptions, the contribution to innovation’s development has been very limited. Brazilian’s innovation survey (PINTEC) sectoral analysis revealed that, with few exceptions, R&D/net sales ratio of large local firms (with more than 500 employees) tends to be higher than the proportion of large TNC subsidiaries; and also that R&D expenditures over total innovation expenditures of locally – owned large firms are bigger than those of TNC subsidiaries. The authors conclude that the innovative performance of large domestic enterprises is stronger than the subsidiaries. Comparing the performance of 150 TNCs in Brazilian’s affiliates and in the rest of the world (including parent companies), it is also possible to observe that average technological efforts (R&D/sales) in Brazil was 0.7%, while in the world it was 5.0% in 2005. This data suggests the technolgical performance of subsidiaries are comparatively still low. Besides its limited performance, R&D activities of TNCs in Brazil are very concentrated: almost half (48.6%) of large subsidiaries’ R&D is performed by firms of the auto industry alone. In Russia, nowadays the creation of R&D organisations with TNC participation, except in very few cases, does not bring to the country any outstanding results in development and promotion of advanced technologies or products. Foreign-owned companies are considered even less innovative than Russian ones. However, a relevant level of innovation activity has been shown by companies jointly owned by Russian and foreign capital, which have been twice as innovative as other types of companies. The main aspect of local expenditures which does affect TNCs' innovation activities in Russia is low salaries of highly skilled professionals. Despite the fact that in 2001-2007 salaries of R&D personnel across all R&D sectors have increased, they still remain extremely low – which makes conducting research and development in Russia attractive. Foreign firms also reveal a lower R&D intensity compared to domestic firms in India. The post-liberalisation period has been characterized by the establishment of centers working exclusively on the objective of global R&D. This trend has spread to the fields of software engineering, chip design bio-informatics and agro-biotechnology. Recently, there has been a significant increase in the number of FDI projects through US companies for design, R&D and technical support activities for the development of global products. Indian’s subsidiaries do not focus on technology absorption. Their focus is largely on the customisation of their parents’ technology for the local market. Analysis of the patterns of collaborations and patent ownership indicates that TNCs are establishing a highly unequal division of labour with the national S&T system of India. TNCs are using the foreign affiliates for the products under development for global markets. TNCs are actively using the instrument of ownership of intellectual property rights to prevent the spillovers from being captured by the domestic entrepreneurs. So far there have been very few spinoffs from the foreign R&D centres. In general MNCs use collaboration for later-stage work to avoid possible infringements. Further, major software firms such as Infosys, Wipro, TCS are under contractual obligations to transfer the ownership of intellectual property created in the host organization. At present, China has become an important R&D base for TNCs, specially due to growing pool of skilled engineers and technicians, to facilitate the reduction of research expenditure and Chinese government’s pressure. In spite of enhancement of this process, the share of China is small compared to TNCs global R&D investment. Although supportive R&D was still the mainstream of foreign R&D activities in China, many TNCs have transferred their innovative R&D facilities to China. Wholly owned affiliates are the main ownership mode of Foreign R&D centers. Foreign R&D organizations established by transnational firms are highly concentrated in the information and communication technology (ICT) industries (including software, telecommunication, semiconductors and

7 other IT products) but equipment and components, biotechnology and drugs as well as automotive industries also attract a significant amount of this investment. Beijing and Shanghai are the preferred locations, but more recently Guangdong, Jiangsu and Tianjin have appeared on the map of foreign R&D investors. In South Africa, 48% of subsidiaries of foreign firms performing R&D reported collaborating with other local firms. Healthcare and aerospace deserve attention in this topic - aerospace has been developed through large defense budget acquisitions in South Africa and a long history of telemetry (Kahn, 2007). R&D is concentrated in two main South African provinces: Gauteng, which incorporates Johannesburg and adjacent Pretoria, has province with 14%.

4 - Spillover X crowding out effects on domestic enterprises Analysing the effects of TNCs on domestic enterprises of BRICS countries, the studies shows that vertical productivity spillovers have been present in some countries and sectorial contexts, but it has been harder to find horizontal productivity spillovers or technological spillovers. Some crowd out effects also have been found in specific situations. The Brazilian’s studies concluded for the occurrence of vertical spillovers; positive horizontal effects only when locally-owned firms already acquired higher levels of innovative capabilities. Market seeking strategies by TNCs, particularly when combined with high levels of effective protection, have a negative impact in locally-owned firms including those with higher levels of relative efficiency . In Russia, foreign TNCs have established training centres to ensure Russian personnel's skills match the required level, and transfer knowledge necessary to use or implement specific technological solutions. Practically all IT companies support training programmes to promote corporate standards for business solutions. A good example is cooperation between the Higher School of Economic and TNCs dealing with information technology. In India, when the Indian locations are required to be closely integrated through the establishment of affiliates MNC ownership and affiliation is seen to be gaining importance in a sector like automobile and auto components. In the case of information technology services sector, a similar trend is growing. According to NASSCOM, offshore operations of global IT majors accounted for 10-15 per cent of IT services and BPO exports and captive BPO units account for 50 per cent of BPO exports. MNC- owned captive units are scaling up their operations quite steadily with the headcount forecast to grow by at least 30 per cent this year. In India, the contribution of foreign firms to the activities connected with the processes of upgrading of national system of innovation (NSI) were found to be insignificant. The main gainers have been MNEs and their affiliates which have better access to technology and other intangible assets. In the case of domestic firms those who have adopted a strategy of relying on non-equity route for technology imports against royalty payments are alone reported to have done well. The other domestic firms that have no networking or non-equity strategic alliances have not done well. Further, that in the case of domestic firms only when their technology and productivity gap was small in relation to MNEs they have done well under liberalization. Analysis shows that the gains made by the domestic firms in sectors as pharmaceuticals and automobiles cannot be attributed to the third generation policies of promotion of FDI and innovation. On the contrary, domestic firms could extract better results from the systems of innovation because the government chose to delay external liberalization in these sectors.

8 However, analysis suggests that it is possible, with the use of appropriate obligations and restrictions, to develop the connections of domestic STI space with the emerging global system of S&T and innovation in a favourable way. Domestic firms and national level S&T organizations would need to step on to the paths of pro-active learning to harness the spillovers and linkages for the benefit of indigenous innovation. But in actual scenario, indigenous R&D undertaken to assimilate foreign technology and exploit technology spillovers still did not improve in a significant way. Chinese’s analysis reveal that foreign investment has failed to promote an effective improvement in local companies’ innovation abilities. Due to the lack of apparent technology spillover from TNCs to local businesses, the role of TNCs remains controversial in the country. Researchers have found that there are positive productivity spillovers from foreign firms to their local suppliers in upstream sectors but, when it comes to the effect on domestic innovative technological development, the study proved not so optimistic, with insufficient spillover effects. Once more, this result was not exclusively caused by the TNCs’ strategies: it is also attributed to the poor absorption abilities of local firms and industrial structure of the country. In South Africa there has been a very mixed experience with the role of TNCs in domestic companies. In many sectors, as iron and steel, telecommunications, pharmaceuticals, transport equipment and consumer goods, TNCs have been said to abuse a position to the detriment of competitors or consumers, crowding out local development. However, some positive impacts can be seen in the automotive sector, as productivity gains from domestic firms through linkages with TNCs. 5 - Domestic TNCS of BRICS countries BRICS countries also benefit from FDI’s enhancement in the world. Their enterprises has presented a relevant degree of internationalization in recent years, improving their importance in world economy. Outward FDI of Brazilian enterprises presented an important growth in recent period, achieving US$ 18.6 billions between 2006 and 2008. (Eclac, 2008). Many companies have increased their investments abroad to diversify the risk associated with operations in the domestic market. Essentially, the main driver of such expansion has been market access (Marcopolo, Embraer). Some firms have also invested abroad seeking access to natural resources (Petrobras, Vale), while others have sought to avoid trade barriers or to improve the logistics infrastructure for their exports (Gerdau, CUTRALE). (Unctad, 2004). The internationalization of Brazilian large firms got momentum after BNDES, the Brazilian National Socio-economic Development Bank, began to provide specific supporting mechanisms. In particular BNDES assessed financing schemes abroad and re-directed them to potential Brazilian TNCs under very favorable conditions with very long repayment periods and very low spreads. In the last two years BNDES increased substantially its role as it started to use its investment arm, BNDESPar (which stands for BNDES Participations) to become a shareholder of these firms. Russia was the 15th largest foreign direct investor in 2005, according to UNCTAD. Its outward FDI increased strongly in the 2000s, from US$ 58 billions in 2001 to 664 billion US$ in 2008. In some extent this phenomenon can be attributed to the emergence of Russian TNCs in fuel and energy sector that took place over recent years. Significant FDI also has been made by Russian telecommunications companies. These internationalization movement was strongly propitiate by the State - about 30% of

9 Russian TNCs' accumulated foreign assets are goverment’s owned. Nevertheless, in recent years most of outward FDI has been boosted by private companies. In India, since early nineties the firms have been induced to expand their multinational operations in a big way . The motives for investing abroad is not only of market seeking types but have expanded to include access to strategic assets and skills overseas, enhancing non price segment of global competitiveness through establishing trade-supporting infrastructure, and circumventing the effects of emerging trading blocs on a regional basis by gaining insider status. Indian multinationals draw their ownership advantages from their accumulated production experience, cost effectiveness of their production processes and other adaptations to imported technologies made with their technological effort, and sometimes with their ability to differentiate product. Since the onset of latest phase of external liberalization the dynamics of the processes of learning, competence building and innovation making is now getting increasinly grounded in the OFDI based multinational operations of Indian firms. However, analysis of the emerging patterns of alliances, acquisitions and collaborations being entered into by the Indian multinationals is quite clear that through the OFDI based relationships not many resources could be leveraged by them from the acquisitions and strategic alliances for the upgrading of national processes of technological accumulation. In terms of the role of external and internal networking taking place the relationships being forged for the benefit of upgrading of the learning, competence building and innovation making the efforts of Indian multinationals are not able to add the capabilities of development of new products. There exists little encouragement from the OFDI based operations for the development of products and systems needed for facing the challenges of socio- technical transitions to be undertaken by the country. The national system of innovation is thus experiencing a liability in the form of distortion in the goals of innovation making at all levels including in public sector research organizations. China’s outflows reached $16 billion in 2006, the 6th largest FDI stock in the developing world. Most part of this overseas expansion involves investment in other developing and transition economies, which are the main destinations of Chinese TNCs. The first generation of Chinese TNCs was mainly drived by large State-owned enterprises. The the second generation, which emerged after the early 1990s, has diverse ownership structures, including private ownership and foreign participation, and has been presented in competitive manufacturing industries, in particular those related to electronics and information and communication technologies (ICT). Hong Kong (China) was usually the first stop along the path of the internationalization since the first-generation, and it remains the major location for their “overseas” operations.The main activities attracting Chinese investments are business activities, trade and natural resources. In recent years, FDI in manufacturing and mining has grown especially fast, accounting for 60% of total Chinese FDI outflows in 2005. Because of lack of core technology, many Chinese firms mainly compete by low value-added products. FDI outflow from South Africa reached more than US$ 3 billion in 2007. FDI outflows started to accelerate between 1997 and 1998 - given South Africa’s democratic dispensation installed in 1994, and the opening up of markets after the dismantling of apartheid, its companies were afforded the opportunity to invest in economies previously closed to them for political reasons. Most TNCs from South Africa can be categorized into five key categories: mining and energy; transport (aviation and road transport); retail; telecommunications and financial services. In the industrial sectors, minerals and energy TNCs dominate, including former state enterprise, Sasol

10 (petrochemicals and chemical products), and the many mining giants. Although spread globally, the core of South African TNC investments are concentrated in Africa.

6 - Implications for innovation policy

In this section, we compare the conclusions drawn from the analysis of studies undertaken in respect of the experience of BRICS group of countries with the results of past investigations undertaken into the impact of policies of FDI promotion that the late industrializing countries followed to catch up with the developed capitalist world. During the pre-globalization phase the obligations and restrictions placed by the governments in respect of access to market, local content and exports played an important role in persuading the foreign investors to contribute to the processes of innovation making, technological transformation and structural change in late industrializing countries. Although to a lesser extent the importance of this factor is also confirmed by the experience of BRICS countries, the achievements of Indian success in pharmaceuticals and Chinese success in telecommunications and electronics shows that governments of these countries still required a policy space to advance the processes of technological accumulation at home.

Innovation making for the process of technological upgrading is still contingent on active efforts being made for technological accumulation by domestic firms and improving the national systems of innovation through the enhancement of investment in human resource development, strengthening of the linkages of national level S&T institutions with domestic firms, protection of the innovation making processes by maintaining the openings in the institution of intellectual property rights (IPRs) for indigenous innovation and home market protection. However, today the policy regimes in developing countries are certainly characterized by the mixes that offer more advantage to the multinational enterprises (MNEs) as compared to the domestic firms. Analysis shows that the balance of advantages being offered has varied and is not the same in all the emerging economies. Achievements and limitations of the technological upgrading process are now much more dependent on the degree of discipline shown by the domestic enterprises and the success of a country in the implementation and coordination of policies of creation of national S&T capacity, development of effective demand for indigenous innovation and home market protection.

Studies reported in this book on the experience of upgrading of the systems of innovation in the BRICS countries during the last two to three decades also confirm that the channel of foreign direct investment (FDI) was not a major international source of knowledge and technology transfer for at least the sectors that have ultimately proved to be somewhat dynamic in respect of innovation making and allowed their own domestic firms to compete with TNCs in a successful manner in the developed countries markets. Analysis shows that the main burden of competence building had to be largely borne by the national level S&T institutions. There is also confirmation that the catching up process had to be also carried out mostly through the investment of domestic enterprises. Achievements and limitations of the catching up process depended on the degree of success of a country in the coordinated implementation of policies of creation of national S&T capacity, development of effective demand for indigenous innovation and home market protection. Investigations into the experience of BRICS countries also

11 point out that the governments had to make their domestic enterprises to submit to a policy of conditional access to foreign sources of knowledge and technology and to bring the required discipline to recipient firms for the development of national absorptive capacity.

However, studies also confirm that there is now a greater influence of the third generation policy regime of FDI promotion in the BRICS countries. This policy regime allows a very different set of policy mixes that give total freedom to foreign investors to establish their operations in the domestic space. Foreign investors are allowed to use the national economic and technological space without being subjected to any kind of restrictions and obligations. While the balance of advantages being offered to the TNCs is certainly not the same in all the countries, definitely the new policy mixes offer greater access to national knowledge base and markets. Today in many countries foreign subsidiaries receive almost the same treatment as what the domestic enterprises got in earlier times from the policymakers. Arguably, it has been suggested that changes in the system of governance of the global economy may have influenced the policies of FDI promotion in this new direction. Earlier catching-up paths are believed to be no more open to the countries on account of the new regime of trade and development as enshrined in the rules of the World Trade Organization (WTO). In many sectors consequently the efforts of domestic enterprises for the building of national capabilities have also not been seen as much critical by the governments over the last one decade.

Policymakers have chosen to encourage domestic firms and the S&T organizations to actively participate in the global production and innovation networks (GPINs). Focus has been on encouraging domestic firms and S&T organizations to establish close linkages with foreign firms that choose host locations for the reason of seeking the supply of cheap talent and advanced skills. Recently as factor seeking investments originating from the TNCs of US and Europe have moved into knowledge intensive activities in a big way, this tendency has been consciously allowed to grow in the emerging economies through the new policy mixes of FDI promotion and supportive innovation policy measures. Even the policies promoting outward FDI from the BRICS countries also aim to tap the possibilities that can arise from the outward FDI in respect of the reverse flows from the host economies to foreign subsidiaries.

Studies reported in this book also cover the results arising out of the policies promoting outward FDI in the BRICS group of countries. While only a small amount of outward FDI is being undertaken with the aim to tap the possibilities that arise from the outward FDI due to the reverse flows from the host economies to TNCs, it seems that the multinationals of BRICS countries have not been able to realize the impact of reverse flows from the host locations through even these investments. Since the implications from investing abroad by TNCs of the BRICS countries are embedded in firms’ strategies as well as in policies of states that have problems in their systems of innovations at both corporate and national level, the gains and liabilities being accumulated in host economies must be kept in view.

Experience of the BRICS countries is yet to confirm the emergence of too many spinoffs from the factor seeking investments of those TNCs from Europe and United States. It appears that finance required for the new start ups and spin offs is still not available in most of the BRICS countries. Private equity (PE) and venture capital (VC) firms are not interested to support the processes of innovation making by such firms. Even in the case of outward foreign direct investment (OFDI), the reverse flows from

12 the countries of Europe and United States to the economies of BRICS group have not been possible because the emerging economies’ multinationals are apparently still resource short and overstretched and in very few cases their existing established strategies allowed them to tap into the national systems of host locations for the benefit of innovation making and technological capability building at home. Most tie ups and investments are directed towards the objectives of taking over of the production facilities and establishing the marketing and distribution networks. Processes of competition faced by TNCs arising out of the BRICS countries are capable of overstretching and draining them of resources. Consequently there are also now many examples of takeover of these new BRICS TNCs by TNCs originating from developed countries.

Although the implications of this experience are slowly making an impact on the options of policy makers of BRICS countries, but it is also apparent that they are not yet ready to move to the policy regime in which the innovation policy would be utilized in a non-neutral manner and positively discriminate the measures of innovation policy in favour of indigenous innovation. It seems that the logic of achievement of higher growth rates is still driving the national states of these countries to practice more of the same pathways of greater integration with the emerging global economy. There is an uncertainty in respect of the path that they should take to grow in the near future. There is a lack of clarity regarding the costs and benefits of taking to the new pathways for growth. Consequently competition in respect of both, inward as well as outward FDI is still rising in the case of BRICS countries. Most of them measure now the level of success in competition by the amount of FDI their respective governments are able to attract in respect of knowledge intensive activities. In most of the BRICS countries governments are now in competition to attract FDI for activities such as research and development (R&D), design, development and testing, technical support centre, education and training, etc. FDI in sectors designated as high technology is receiving preferential treatment in terms of access to infrastructure, tax incentives and subsidies in these countries. Governments have become liberal in their approach with regards to encouraging FDI in the sectors connected with information technology, software development, biotechnology, pharmaceuticals and so on.

The thrust of new policy mixes includes the introduction of measures providing for a) stronger protection of intellectual property, preferential access to infrastructure, both technological & physical, through the formation of special economic zones (SEZs), b) supply of cheaper R&D services from publicly funded S&T institutions, c) availability of cheaper talent for scientific and engineering work, d) development of educational institutions that are capable of offering well trained professionals who are fully familiar with international management and accounting practices, e) easy access to domestic market, f) elimination of export and technology transfer obligations, g) removal of controls over monopolies and restrictive business practices, h) dilution of environmental controls and so on.

Being aware that TNCs can offer new production facilities, managerial practices and also technology transfer to host countries, it is necessary that in the new context policymakers have to formulate the policy mixes of FDI promotion and innovation policy measures to succeed in the process of building national capabilities. After the experience of the global financial crisis certainly there is again even a renewal of interest in dealing with the implications of financial liberalization for the domestic economies in both developed and developing countries. In the emerging economies

13 policymakers are engaged in rethinking the policies that were responsible for the transmission of the impacts of global crisis into their economies. In this context the role of private equity and venture capital is also required to be reconstituted if we are keeping in view the specific experiences of transmission of the impacts through the instruments of finance on innovation in the emerging economies. Solutions to the problem of how the governments must constitute the mix of policies of FDI promotion and innovation policy measures need to be evolved keeping in view that the systems of innovation can have varying mitigation and transformational capacities due to the existence of their systemic connections with the pathways of growth chosen during the period of last two decades.

Since the new measures under implementation also belong to the sphere of innovation policy, in the recent period scholars of innovation have also become quite active to study the impact of the policy changes for FDI promotion on the national systems of innovation. In the field of innovation studies, focus is back on the study of contribution of foreign direct investment (FDI) to the processes of technological change and innovation making. Policy challenges that developing countries face in respect of monitoring and evaluation of the impact of interventions being put in place by governments to deal with the interplay between innovation policy and FDI promotion have recently come under investigation suggest that the challenge of present times requires a different approach than policies focused on the ‘quantity’ of FDI inflows, a shift from a mindset that prioritizes attraction of greenfield investments towards one where the focus is on ‘subsidiary development’ and a focus on changes in the policy mix and in the approach to performance measurement.

To the contrary studies reported in this volume show that domestic enterprises and efforts of national level S&T institutions seem to matter more in the sectors that have proven to be dynamic in terms of innovation making. Experience of the implementation of the third generation policies of FDI promotion and innovation making is clear that the pathways of growth constituted during the period of liberalization were by themselves certainly insufficient for the introduction of major innovations. By shaping the institutions and incentives in the same direction for market and non-market actors the narrowly defined pathways of growth were instrumental in not allowing their processes of competence building and innovation making to go beyond the activities of outsourcing of services and manufactures and exports to regulated markets in select product segments. Demand side signals for the activities of innovation of both non- market and market actors were not helpful for the efforts to be undertaken for the benefit of indigenous innovation. In such a situation the NSI of BRICS countries have been shown to be getting harnessed less for major innovation of indigenous kind and far more by S&T asset seeking and outsourcing markets related FDI for minor innovations. It is apparent that policy coordination would need to appropriately focus on the management of the interplay of global push and domestic pull factors. Policymakers need to keep in mind that foreign capital is collectively in better position to forge a new international division of labour in which FDI is their most important instrument for the incorporation of domestic private capital and publicly funded S&T infrastructure. It cannot be ruled out that in the absence of suitable policy coordination domestically developed expertise may get used far more for the development of global networks of production and innovation for the benefit of world market. Alliance building and interactions of domestic and foreign firms need regular monitoring with the aim of not only undertaking programmes and policies to take benefit of the possible realization of spillover, linkage, competition and demonstration effects but also to prevent and

14 minimize the liabilities and distortions being experienced by the systems of innovation in the presence of greater FDI. In terms of the onus of directing FDI and guiding domestic firms and national level S&T structures to leverage the local factors for the development of appropriate kind of relationships the government must bear the responsibility of formulating the relevant elements of policy coordination in respect of technology transition management and development of systems of innovation. Policy coordination is required in respect of especially those policies that shape the management of the dynamics of emerging networks, the nature of specialization, the development and implementation of appropriate technologies, and the development of long or short term relationships of domestic firms and national level S&T organizations. As far as the area of innovation policy is concerned, policy coordination would need to target especially the areas of policy interventions capable of providing opportunities to the national level S&T organizations, the young start ups and the domestic firms to harness the spillovers, competition and demonstration effects at home itself for the benefit of indigenous innovation. It is clear that the fundamental political arrangements which structure a country's domestic institutions and international linkages in the policy regime under implementation are what ultimately determine a country's propensity to undertake indigenous innovation. FDI cannot play the role of network organizer with the aim of benefiting the processes of competence building and innovations needed by the local productive structures. Policy coordination should be taking care of the changes to be made with regard to the direction and promotion of foreign direct investment. Policy space exists in abundance in respect of the determination of policies of investment, competition, procurement, demand articulation, R&D subsidies and standards making. The government has to determine the goals of development of national system of innovation. The host government must take responsibility, put the politics in command and undertake the policy coordination. In order to meet the challenge of development of the pathways of growth for undertaking inclusive development the government can get the relevant domestic actors to initiate and develop innovation making programmes for the benefit of self-reliant development. Since the pathways of growth accompanying the new policy of FDI promotion have to bear a significant part of the responsibility for the institutions and capabilities of NSI to evolve in a myopic way during the period of liberalization, foreign subsidiary development cannot be the aim of the third generation policies of FDI promotion and innovation making. Specific aims of the government of any latecomer country in respect of the policy coordination have to flow from the developmental needs of the people and the upgrading requirements arising out of the need to alleviate the constraints facing the national system of innovation with regard to the management of technology transitions. Analysis shows that domestic market is still the main attraction for foreign firms.

15 ANNEX 7 BRICS Project

Comparative Report on the Financing of Innovation

Michel Kahn and Luiz Martins October, 2010

2 THE FINANCING OF INNOVATION Michael Kahn and Luiz Martins

In the main the study of National Innovation Systems (NSI) focuses on the processes of interactive learning and knowledge generation within enterprises, higher education institutions, and government research institutions, as well as on the interactions amongst them that contribute to the innovation process. The role played by the State in the formulation and implementation of policies for fostering innovation, including macroeconomic policy, is highly contextual, contested and centrally important.

In its early formulation the Neo-Schumpeterian approach that informs much of the conceptual development of the NSI approach gave little emphasis to the financial perspective. Freeman (1994) in particular analyzed Neo-Schumpeterian research, claiming that this topic had not taken a central position. As highlighted by Levine and Zervos (1998), this is a significant gap in theory, the more so as Schumpeter, writing in the 1930s, had in fact emphasized the relevance of the banking system in economic development, underscoring the circumstances in which banks could actively encourage investments in innovation.

This book therefore sets out to address this gap by offering a contribution to understanding the varied approaches to the role of finance in innovation. It draws on the experience of the five diverse BRICS countries each of which has undergone structural adjustment in the last two to three decades. The experience of the BRICS countries presents a unique set of case studies of the transition from largely closed centrally- planned and state driven economic and science policy to a more open and market-led innovation policy. Of key importance among these case studies is the role of the state.

The contributing authors examine the varying approaches to the provision of financial support to the full range of activities that contribute to innovation, ranging from financing of infrastructure, R&D tax incentives, grants, provision of seed capital and scholarship support to doctoral students.

The role of finance for innovation has been identified as an important structural bottleneck that has yet to be solved by private financial institutions. On the one hand, the internationalization, deregulation and globalization of financial markets signals the possibility of obtaining resources at lower costs. On the other the risk characteristics of investments in innovation point to the need for setting national institutional arrangements (Melo, 1994).

In analyzing the relationship between the financial system and investments in innovation, it is necessary to take into account the nature of the innovation process, the competition within markets and the criteria for risk and credit analysis by financial institutions for conceding the financing (Dosi, 1990).

The inherent characteristics of the innovation process lead banks and even markets to resist the financing of early stage innovation. This is particularly so in countries that

3 have only recently introduced market capitalism, and where the capacity to evaluate intangible assets may be inadequate.

The individual country chapters are written within a broadly common framework starting with a synthesis of the problem of enterprise funding and the interface with the specific country financing systems. Then follows discussion of the specificities of the innovation process and its financing. Consideration is then given to instruments and institutions for fomenting and financing innovation as well as the evidence from R&D and Innovation Surveys where such are available. The authors also discuss the impact of macroeconomic policies as well as implicit policies on financing for investments in innovation over the last two to three decades. The concluding sections summarize the role of the financial system in each innovation system with policy suggestions regarding the major future challenges for the system of financing innovation.

Citing Schumpeter (1982), Gerschenkron (1962), Minsky (1982) and Mowery (1992) Melo and Rapini present the case of Brazil starting with a comparative analysis of the relationship between financial capital and firms in France, the United States, Germany and Japan. A key issue is the supply of short term credit by the banks based on their expectations regarding economic growth. The authors contend that financing of short term investment is not conditioned by the level of saving but is provided principally by the bank system through the creation of money. The financial instruments created for the accomplishment of this task depend on the institutional context and on the structure of the financial system.

In the Brazilian case banks are not merely re-allocators of pre-existing resources (savings). They are key participants in the process of wealth creation and accumulation. Long term financing depends on the existence and adequacy operation of primary financial markets - for the new issues – and of secondary financial markets (or stock exchanges) for dealing with existing bonds.

In less developed countries, financial mechanisms aimed at financing investments are generally absent. Thus, growth will only be possible if part of the short-term credit taken by the firms may be paid with new short-term credit until the investment gets to develop and start producing the cash flow required for repaying its debts. These continuing negotiations and re-contracting of long-term investment contracts with short- term funding conditions raise financial fragility, of both creditors as debtors.

In the analysis of Brazil Melo and Rapini provide detailed analysis of the emergence of that country’s state banks. Melo (1996) earlier built on the post-Keynesian concepts developed by Minsky (1982) and Studart (1993), in adding a fifth characteristic to the four innovation system characteristics defined by Freeman (1987). This is the institutional organization and structure of the financial sector. Later, Freeman and Perez (1988) argued that the co-evolution between financial and technological institutions have constituted one of the key characteristics of five long waves of capitalism, for pressing for changes in the organizational structures of firms and for financial innovations in reply to needs for working capital which evolved along with technological changes. Rosenberg (1990) highlighted that basic research is a kind of long term investment of high uncertainty and its financing must be structured in order to meet this requirement. However, when it obtains results, the greatest returns are appropriated by private enterprises, with social returns in the form of spillovers.

4 From the 1970s Brazil built a sophisticated financial system, so that by the 1980s, venture capital enterprises already existed, supported by the Brazilian Innovation Agency (FINEP) innovation fund and by state bank Brazilian Development Bank (BNDES) (Melo, 1988 and 1994). However the 1982 Mexico debt moratorium paralyzed these initiatives until the implementation of the Real Plan. More recently, the Sectoral Funds expanded the range of financing instruments.

But a lack of institutional coordination persists the more so as preferential procurement by the state is constitutionally limited. Therefore, in order to meet the requirements of systemic support for innovative enterprises, it is necessary to have a policy for industrial innovation connects the State’s purchasing power, matches demand with supply, and the necessary financial instruments. In this way it may be possible to reduce the negative impacts of implicit policies and, concomitantly, reduce uncertainty and the costs of investments in innovation.

The second Chapter takes us to the Peoples’ Republic of China that from the 1950s followed the central planning of the Soviet Union in shaping its innovation system. At that time the state-owned enterprises (SOEs) were expected to use R&D conducted in the public research institutes (PRIs). The abrupt emergence of state capitalism in 1978 saw the privatization of many PRIs, and the opening of the country to FDI through the establishment of plant and research centres. Jian Gao and Fei Teng trace these developments pointing out the fundamental shifts in law pertaining to innovation policy under the successive leadership of Deng Xiaopin (South Talk , 1992) the 1993 “Technology Progress Law, ” and 1996 “Technology Transfer Law.” Further change came in 1998 with the “State Development through Promoting Science Technology and Education” policy announced at the 15th Congress of the Chinese Communist Party. Outputs of scientific and innovative activity have soared with China now ranked 5th for ISI publications and effecting more than 250 000 invention patent filings annually.

The central thrust is the role of innovation in promoting economic growth and the strong political support that this notion has enjoyed since the 1980s when modern instituions such as technology parks and incubators were introduced. The authors suggest that the national system of innovation comprises four sub systems: the knowledge innovation system (KIS), technology innovation system (TIS), knowledge distribution system (KDS) and knowledge application system (KAS).

In addition the characteristics of the NSI show strong regional dimensions – the further West one moves the stronger the role of PRIs. Foreign R&D centres account for anything up to 30% of China’s BERD, and these tend to be located in the East. Reference is also made to China’s innovation survey that shows the strong role played by machinery, equipment and software imports as drivers of innovation. This points to a strong external influence on innovation activity.

Regarding the financing of innovation, the first resource is government support in terms of technology programs and innovation funds. The second and main source is bank loan finance, while the third from 1985 is venture capital and capital markets. Of vital importance to the growth of new institutional forms was the establishment of Technology Zones in Shenzhen and Wuhan from the mid-1980s that was then extended with the founding of the Beijing Experimental Zone, the first national-level high- and

5 new technology industry development zone. These zones act as an institutional interface between new ventures and the broader socio-economic system (Gu, 1999).

A key institutional innovation was the establishment in 1986 of the Technology Venture Investment Corporation, formed by the State Science and Technology Commission and the Ministry of Finance, to replicate the dynamism of Silicon Valley and Route 128 in the US. It was managed and operated like an SOE; but was really a central government agency with the mandate to support national technology venture policy objectives, rather than a profit-oriented private enterprise.

At the same time central government has taken a more indirect approach and allowed the system to develop from below and has made progress towards aligning the legal and financial systems. Local government has responded to the incentives and opportunities to foster new technology-based ventures in their regions and allow firms greater autonomy, including setting salary levels.

Jian Gao and Fei Teng point to the emergence of Venture Capital (VC) firms at central government level, among the universities, and especially in the private sector. This diverse set includes wholly foreign-owned VC firms. The picture that emerges is that there are diverse forms of innovation systems in China, and it might well serve to investigate these as uniquely regional, evolving forms. Data is presented to show the stellar growth of China’s infrastructure and outputs – best illustrated in the statistic that the number of high-technology firms increased twenty fold over two decades. In concluding the authors note that while encouraging free market forms the State retains a strongly ‘paternalistic’ stance on the economy. This may explain why VC firms do not display the same flexibility and nimbleness as their foreign counterparts. At the same time they express concern that the State has invested less in high risk basic research than the more highly developed United States and European Union and Japan, and this may be expected to change as confidence grows.

Turning next to the case of Índia, we find Sunil Mani’s econometric study of the impact of R&D tax incentives in that country. While noting the importance of research grants and venture capital, it is the operations of the tax incentive that intrigue Mani. Having traced the introduction of various market type reforms he notes that most academic studies of these have been descriptive catalogues that fall short of studying effectiveness. This to Mani is problematic given the recent estimates by the Ministry of Finance that the amount of corporate tax foregone consequent R&D tax incentives has been increasing at a rate of 2.4 per cent per annum.

A range of tax incentives input and output based are available for domestic R&D, be this intramural or extramural. There are eight forms of input support, the most common being the 150% deduction on intra-mural R&D expenditure that hás operated since 1998. The other input deductions include capital expenditure write downs, reduced tariffs and duties. Mani notes that the existing literature (Hall and Van Reenen, 2000 and Mohnen, 2007) on the effectiveness of R&D tax incentives is restricted to the core Organization for Economic Cooperation and Development (OECD) countries, a situation that in part arsies because of a lack of data for emerging economies, as well as the sheer difficulty of accessing such data where it exists.

6 In the case of India it turns out that the pharmaceutical industry, being the most R&D intensive is the major beneficiary of the incentive, which in itself is not surprising. This incentive hás the effect of lowering the industry tax rate to around 14% compared with automotive (médium technology) at 26%. Even so his general finding is that the tax incentive does not have any influence on the level of R&D, except possibly in chemicals. This result follows from the fact that the incentives do not apply to the full R&D expenditure of firms but are selective. As he notes: ‘for tax incentive to be effective in raising R&D expenditures it must form a significant portion of R&D investments by an enterprise ... this result corroborates the results of innovation surveys in Brazil and South Africa where innovating firms did not access government funds for innovation as an important instrument for financing their respective innovation efforts.’ He argues that markets, the volume of domestic sale in some cases exports are the factors leading to investment in R&D.

Mani’s conclusion may come as a surprise to those advocates of input style R&D tax incentives” ‘Allowing firms to become larger and through that process of growth enabling them to become larger investors in R&D may be a better policy than providing them directly with subsidies.’

The evolving innovation system of Russia, as covered in the Chapter of Gorodnikova involves the transition from central planning to the market economy, and is traced from the period of Glasnost (1985-1991) through to the present. The Glasnost period saw rapid rises in Gross Expenditures on R&D (GERD), but as a consequence of the economic shock therapy of the early 1990s there was a severe contraction of state financed R&D.

Indeed the Soviet and post-Soviet economy was largely determined by the military- industrial complex’s potential and by mining, metallurgy and heavy engineering industries. Accordingly, the industrial sector had always prevailed in the R&D sphere (later on to be replaced by the enterprise sector) – i.e. industrial research institutes and bureaus oriented towards the demand of specific industries. Under central planning government allocated budget to R&D while Business Expenditures on R&D (BERD) was negligible. These deep institutional patterns persist into the present so that weak innovative orientation continues because of mismatch between the focus of R&D, institutional structures and organisational mechanisms of the science sector on the one hand, and the needs of the economy on the other. Additional shortcomings include separation of applied science from enterprises since research institutes and design bureaus were oriented towards encouraging research, not innovation. The imbalance added to the low technological level of industry. Another weakness of the planned economy (and of the transitional economic mechanism) is dissemination of innovations. Even when the country was a leader in developing major innovations, it lagged behind in terms of implementation as for examples in steel making and process technologies.

Gorodnikova identifies serious defects for Russian innovation since the innovation system remains unbalanced and its major components operate in isolation from one other. Currently the S&T sector is not a growth factor for the national economy; rather, the whole economy of post-Soviet Russia is a factor of decline for the S&T sector. In the long run it can lead to irreversible degradation both of R&D capacity and high- technology industries; accordingly, fast modernisation of the national innovation system is a top priority. This will be no small task since among the BRICS Russia is unique in

7 the collapse of GERD across the transition: in constant terms GERD has now attained half the pre-1991 level. Another unique feature of the Russian system is the small amount of research in the university sector, though this is explained by the unique character of the Academy sector that includes degree awarding institutions.

As to innovation in the business sector, the evidence of innovation surveys going back to the early 1990s is that less than 10% of Russian firms declare themselves to be engaged in technological innovation. These observations must be qualified in that there are size effects: large Russian firms innovate slightly below the European Union (EU) average. But medium sized and small firms hardly innovate at all. This constitutes one of the main observations of the chapter: ‘due to the generally weak small business support infrastructure, these companies cannot yet contribute to an overall increase of innovation activity.’ There is an insufficient level of small business development in the Russian economy. A malaise persists so much so that the overall efficiency of Russian industrial companies’ innovation activities is low with the return on investment dropping from 5.5 to 4.4 roubles per rouble spent on technological innovations. At 1.2% of sales the expenditure of innovation may be insufficient to exert the leverage required to boost productivity of capital.

The federal budget remains the main funding source for Russian R&D, with one component linked to payroll size and the second being programme specific – the Federal Goal-oriented Programs (FGP) of which there are 52 at present. Nonetheless severe budget constraints persist with many FGP budgets not allocated in full.

But as the author explains more diverse sources of funds are now available ranging from private foundations, and Non Government Organizations (NGOs) across to public- private partnerships. In particular are the ‘mega’ projects announced in May, 2002. 12 mega-projects were selected; each to receive $20 million for two years – the intention was to peg state involvement at no more than 50% but in practice this limit was often exceeded. In 2006 responsibility for the mega projects was split between two Ministries: Education and Science, and Industry and Power Generation. In spite of this potential for management confusion the project experience was found to be more positive than negative.

This much is clear: Foreign Direct Investment (FDI) remains a small component of innovation financing, and bank credit is hard to come by in the difficult financial environment of today’s Russia. This is why the Russian Venture Company is so important. When it became clear that the high-technology sector was unable to attract private capital, state intervention became inevitable. Consistent with the ongoing interventionist role of the state in the emergent market economy is Gorodnikova’s suggestion for policy: ‘… to radically change the underlying ideology of government and public sector procurement (that) must be seen not just as means to deal with specific issues but as an important tool of industrial and innovation policy.’

The final chapter provides the South African case. In a sense that economy has maintained its essential character for the longest period, spanning at least a century. Arguing from a sociological viewpoint Kahn argues that the South African economy, even before the 1910 political consolidation of the country has been dominated by its minerals-energy complex (Fine and Rustomjee, 1997), and that this persists to the

8 present. Political, class, group, and economic struggles continue to pivot on the fulcrum of the relationship between the state, capital, political class, labour and society.

It is shown that modern financial capital has very deep roots in South Africa extending back to the diamond exploitation of the last quarter of the 19th century. The unique nature of the gold mineralization required massive capital investment as well as huge sources of labour and these aspects continue to underpin the character of the economy to this day. The country has long functioned as a market economy, open to international capital flows, even during the sanctions years since global demand for strategic minerals had to be met. For its part the State from the 1920s established the infrastructure for heavy industry: electricity, water, forestry, iron and steel, and communications. The consequence was a large public sector alongside a set of monopolistic mining houses with diversified interests. While South African trans-national corporations traded globally since the early days of mining capital the ‘apartheid constructed crisis’ eventually drove the economy downwards into negative growth. Then followed the political transition to democracy. But unlike Russia the NSI survived the transition largely intact albeit with lack of direction. Industry on the other hand underwent considerable expansion abroad to the extent that foreign sales often now make up 50 percent of leading company revenues.

The financing of innovation activity occurs in a local financial market that is among the most advanced in the world. Inventors and innovators can turn to a range of sources that assess the prospects for a return on investment with varying degrees of expertise. The evidence of innovation surveys is that companies rate themselves as highly innovative even though this is mainly incremental and oriented toward process and organizational changes.

Kahn suggests that the modernizing agenda is expressed through a new ‘constructed crisis’ that unfolds alongside the contested distributive role of the state. Four binding constraints arise from the country’s history: foreign-exchange volatility and controls, risk aversion and anti-competitive behaviors. All four of these involve financial decisions though the first, other than the underlying financial provision, refers to the specifics around human resource development. Indeed there is a deep-seated failure to set a realistic agenda for basic education and to grapple with the hard choices around vocational and academic education. These binding constraints are evident in the paradoxes that the constructed crisis drives. According to the 2010 Global Competitiveness Report the country leads the world in auditing and reporting standards but is among the worst for school efficiency.

The main source of funds for company innovation is from cash; these may be used to leverage bank loans since the bank can value the assets of the firm as collateral. This implies that where fixed assets cannot be identified such (high risk) loan finance will not be forthcoming. In practice firms younger than three years will find it extremely difficult to access bank finance and will have to resort to self-financing.

Angel investors are found to be virtually absent and there remain concerns relating to tax and exchange control regulations that may impact impacts on risk strategies of local Fund Managers. Overall there appears to be a very slim connection between industry and the state insofar as funding and sources of innovation information are concerned means that the question of effectiveness cannot be addressed by looking at the funding

9 instruments. It is rather a question of the way that firms grow and deploy their financial, physical, human and intellectual capital, in spite of the state, not because of its interventions.

The state does tend to take the greatest risk in very early stage development through the agency of the Innovation Fund, Biotechnology Regional Innovation Centres, the state- owned Industrial Development Corporation, and through support for technology development in the public utilities and defence-aerospace. The financing gap is between very early stage development and commercial start-up so that prospective entrepreneurs experience difficulty in raising capital.

Then follows a discussion of the various incentives both direct and indirect. Early indications are that the R&D Tax Incentive has been framed too rigidly so that take up has been very limited, favouring a few well-organized and well-established R&D performers. A second problem area is the plethora of direct incentives, most of which are not subject to independent impact assessment.

But there are others barriers to innovation. The mini-budget of September 2009 further relaxed foreign exchange controls perhaps with the intention of weakening the Rand and thereby compensating for Dutch Disease. But this had but a short-term effect and the exchange rate stands close to 7.0 to the US Dollar that prices domestic labour out of competition with Central and Eastern Europe and South and Eastern Asia.

This techno-nationalism echoes with what prevailed in the sanctions era. To stem the capital flight and rent-seeking behaviours strict foreign exchange controls have been enforced for five decades. This regime includes the definition of a patent as ‘capital’ whose disposal is subject to exchange control regulations. The new law on intellectual property deriving from publicly funded research adds further complexity to the ownership of patent rights with further impact on the cost of doing business.

The structural adjustment programme was designed to lure FDI but this has not happened in depth save for the few examples given in the paper. Indeed if cheap energy was the draw card that has turned out to be a knave. Repatriation of capital is no longer a negative for FDI: the main negatives are the cost of labour, security and uncertainties with regard to property rights. Again these are not issues to do with the financing of innovation. Policy needs to reconsider the prescriptions in the new patent act with regard to the disposal of IP to designated parties – surely a disincentive and anticompetitive too.

It is argued that the binding constraints will remain unless government shifts gear toward more pragmatic solutions. But that may be to ask the impossible of politics.

Kahn concludes by citing Aghion, Braun and Fedderke (2006) who argue that South African manufactured goods are uncompetitive by price. If this is indeed the case then why would firms report high commitment to innovation? One would expect to find low reported levels of innovation but instead find the contrary. Firms appear to be prepared to take the risk, and fund that risk from internal sources. Firms do not read economic journals.

10 So what have we learnt about innovation financing? It will be evident that there is considerable heterogeneity in the approach of the country authors. This arises from the unique history of each country’s unique economy, and the stance adopted by the writer – informed by their own viewpoint, interests, skills and data availability. Fundamentally there are different formulations of what is understood by the concept ‘National Innovation System.’ And there is the fact that the neo-Schumpeterian school has devoted little attention to financing of the National System of Innovation.

That being said there is also commonalty among the five BRICS countries in that since the 2nd World War the state has played a strong role in their economic development path. This commonalty does not fit into a neat box labeled ‘central planning’ but might be characterized as an approach to managing the commanding heights of the economy both directly and through a range of regulatory actions. One could for example compare and contrast the former state owned enterprises of Brazil and South Africa, the family businesses of India and South Africa (and Brazil) and the new players of China and the Russian resource giants. This rich area of study must await a different publication. All face the problem of marshalling support from the capital markets. This rich area of inquiry must await another project, another book perhaps.

Some common features of these five unique experiences appear: the role of the state in ensuring supportive framework conditions; the contributions of multi-national corporation (domestic and foreign) R&D and innovation requirements; the central role of human resource availability and mobility; the risks associated with seed and venture capital provision, and the tensions between local and export market-led innovation strategies. This brings the central role of the financial system into focus. It is necessarily treated differentially and it is to the differences that we now turn.

The Brazilian chapter is written from the perspective of economic history and of the economics of innovation. It provides a discussion of policy matches and mismatches over time. While it stops short of a deeper analysis of the relation between the NIS and the legal framework Melo and Rapini conclude by arguing for two thrusts: ensuring that platform technologies are widely developed and disseminated and using public finance, as collateral to lubricate private bank loans. As they note: “Developing countries, characterized by scarcity of capital, particularly for long term investments, cannot count solely on the action of private businessmen or on the invisible hand of the market in the search for a sustainable economic development.”

The chapter about Russia provides a more comprehensive analysis of the change occured in the institutional environment from the financing of innovation in the former USSR to the present. In India and South Africa on the other hand (both strongly coloured by British commercial practice, and home to many large family businesses) the arguments are perhaps more market oriented. Mani suggests that R&D tax incentives are not the way to go and that corporates should be left to get on with what they know best to do. Kahn points to the long history of anti-competitive behaviours in South Africa, with the underlying tensions between race, class and capital providing the energy to drive the balance in one way or another.

This brings one to China, that is presents the most varied challenge to the analyst. Like India, China may be many countries in one. Its vast size, varied implementation of policy, and considerable space now for individual entrepreneurs and imply that

11 generalizations (including the preceding) are risky. The description of China’s rapid march to entrepreurial freedom suggests a single mindedness on the part of political leadership that is less evident in Brazil, India and South Africa. Russia may remain the enigma.

Much of the literature on systems of innovation is focused on the processes of interactive learning and knowledge generation within enterprises and institutions of human resources training and scientific research, as well as on how these organizations interact in constituting the innovation process. It is evident that a key factor which may either help or hinder this interaction is the role played by the State in the formulation and implementation of policies for fostering innovation and, indirectly, of macroeconomic policies.

The significance of financing investments in innovation has been pointed out as an important structural bottleneck that not been solved by the private sector financial institutions. On the one hand, the internationalization, deregulation and globalization of financial markets signals the possibility of obtaining resources at lower costs. On the other hand, the characteristics of investments in innovation such as long lead times for development, inherent uncertainty and high risk, point to the need for setting national institutional arrangements.

The creation of such alternative innovation financing instruments implies governmental actions In analyzing the relation between the financial system and investments in innovation. To this end it is necessary to take into account the nature of the innovation process, the competition within markets and the criteria for risk and credit analysis by financial institutions for granting finance. Such characteristics of the innovation process lead banks and even markets to resist financing innovation, particularly in countries of late capitalist inception, which did not build financial systems able to evaluate intangible assets.

To analyze the problem of financing innovation, one must take some particular issues into account. The first is the composition of investment in innovation within macroeconomic regimes of high inflation and high interest rates. The second is the impact of regimes of import liberalization including exchange rates on the technology of enterprises. Third, to examine why the discussions on relations between policies aimed at fomenting investment in innovation and the macroeconomic policies – the problem of implicit and explicit technological policies – were abandoned since the middle 1980s only to re-emerge in the beginning of the 21st century.

These questions lead to the analysis of innovation investments as a key part of the firm’s investment strategy and of how this strategy is affected by macroeconomic, technological and industrial policies.

This has clearly not been a Neo-Schumpeterian issue. At this point, it will be necessary to resort to concepts derived from Keynes’ works, who formulated the concept of liquidity preference – or of money as an asset – as a central reference for the process of investment.

12 As we have noted the chapters are heterogeneous in theoretical and methodological terms. Some of the above points have been taken into account by the authors, and others not.

So, the analysis recognizes the dynamics of the economic system, and the absence of a natural trend towards equilibrium, in the pervasive uncertainty that is inherent to the process of investment. This signifies the importance of institutions for the dynamics of the economic system, which cannot be reduced to the market. Enterprises are central to the innovation process.

Finally, considering all the chapters in a comparative perspective additional research questions may be posed:

o What is the nature of firms’ financing and the interface between the financial system structure and industrial financing? o How does implicit innovation policy shape entrepreneurial investments in innovative activities? o How do the domestic financial regimes affect the ability of the BRICS transnational corporations to trade in global markets?

13 References

Aghion, P., M. Braun and J. Fedderke. 2006. “Competition and Productivity Growth in South Africa.” Harvard University Center for International Development Working Paper #132.

Aghion, P. and P. Howitt, Appropriate Growth Policy: A Unifying Framework. The 2005 Joseph Schumpeter Lecture, delivered to the 20th Annual Congress of the European Economic Association, Amsterdam, August 25, 2005.

Dosi, G. Finance, innovation, and industrial change, Journal of Economic Behavior and Organization, v.13, p.299-329, 1990.

Fine, B and Z Rustomjee 1997. The political economy of South Africa. From Minerals energy complex to industrialization. Witwatersrand University Press, Johannesburg.

Freeman, C. Technology Policy and Economic Performance: Lessons from Japan. London: Frances Pinter, 1987.

______. The Economics of Technical Change. Cambridge Journal of Economics, v.18 n. 5, p.463-518,1994.

______; Perez, C. Structural crisis of adjustment: business cycles and investmente behaviour. IN: Dosi, G., Freeman, C.; Silverberg, G.; Soete, L. (eds.) Technical Change and Economic Theory. London: Pinter, p.38-66, 1988.

Gershenkron, A. Economic Backwardness in Historical Perspective. Cambridge, Massachusetts: The Belknap Press of Havard University Press, 1962. Gu, S. 1999 , China's Industrial Technology: Market Reform and Organizational Change, London: Routledge, 1999.

Hall, B. and Van Reenen, J, How effective are fiscal incentives for R&D? A review of the evidence, Research Policy, Volume 29, Issues 4-5, April 2000, pp. 449-469, 2000.

KPMG/SAVCA, Venture Capital and Private Equity Performance Survey of South Africa for the calendar year 2008. Johannesburg: KPMG and SA Venture Capital Association, 2009.

Melo, L. M. O Financiamento ao Desenvolvimento Científico e Tecnológico: a experiência da Finep - 1967 a 1988. Dissertação de Mestrado, Rio de Janeiro: Instituto de Economia da UFRJ, 1988.

____ O Financiamento da Inovação Industrial. Tese de Doutorado, Rio de Janeiro: Instituto de Economia da UFRJ, 1994.

____ Sistema Nacional de Inovação (SNI): Uma Proposta de Abordagem Teórica. Texto para Discussão IE/UFRJ, n. 357, abril, 1996.

Minsky, H. P. “The financial-instability hypothesis: capitalist processes and the

14 behaviour of the economy”. In: Kindleberger, C.P. and Lafargue J. P. Financial Crises. Cambridge: Cambridge University Press, 1982.

Mohnen, Pierre, ‘R&D Tax Incentives: Issue and Evidence’, Presentation Slides, Design and Evaluation of Innovation Policy Programme (DEIP), October 22, Maastricht: UNU-MERIT, 2007.

Mowery, D. C., Finance and corporate evolution in five industrial economies, 1900-1950, Industrial and Corporate Change, vol.1, no.1, 1-36, 1992.

Rosenberg, N. Why do firms do basic research (with their own money)? Research Policy v. 19, p.165 – 174, 1990.

Schumpeter, J. A. A Teoria do Desenvolvimento Econômico. São Paulo: Abril Cultural, 1982.

Studart, R. Financial Repression and Economic Development: Towards a Post Keynesian Alternative, Review of Political Economy , 5(3), pp. 277-298, 1993.

15 ANNEX 8 BRICS Project

Comparative Report on the Role of Small and Medium Enterprise in the National Innovation System of BRICS

Ana Arroio and Mario Scerri October, 2010

Conceptually, the project is structured around the Systems of Innovation framework. The central focus of the study is the national innovation system (NIS) of the five BRICS. The notion of innovation system has in its centre the industrial, S&T and education sub-systems; but includes also the legal and political frameworks, investment and financial sub-system, as well as other spheres relating to the national and international contexts where knowledge is generated, used and diffused. The objective is to characterize and compare the NIS of the five countries pointing out convergences, divergences, and synergies, as well as identifying current and potential connections. Particular attention will be given to policy implications. Therefore, the project aims at involving, not only researchers, but also policy-makers working in national and international agencies.

Specifically the project aims at:

(a) stimulating interactions and the exchange of experiences between researchers and policy- makers interested in innovation in BRICS aiming at creating capabilities and finding joint workable solutions;

(b) characterizing the structure of BRICS´ national innovation systems, their recent evolution and perspectives;

(c) comparing the five countries innovation systems, identifying differences and similarities, common bottlenecks and complementarities;

(d) developing and using concepts and information capable of representing the Innovation Systems of BRICS;

(e) discussing policy implications and put forward policy recommendations, extracting lessons that can be useful not only for these countries but also for other developing countries.

2 THE ROLE OF SMALL AND MEDIUM ENTERPRISE IN THE NATIONAL INNOVATION SYSTEM OF BRICS

Ana Arroio and Mario Scerri

In view of the lack of economic theories whose application is viable in the case of underdeveloped structures, I believe that priority should be given, when educating an economist, to verse him in the techniques that train him to observe economic reality in a systematic manner. To know how to methodically observe the real world ... is more important than a refined knowledge of the most subtle scholastic models. Celso Furtado, “The graduation of the economist in an underdeveloped nation”, 1961.

The formula 'Two and two make five' is not without its attractions. Fyodor Dostoevsky, Notes From the Underground, 1864

The case for taking a broad and many-sided approach to development has become clearer … these issues relate closely to the need for balancing the role of the government - and of other political and social institutions – with the functioning of markets. Amartya Sen, Development as Freedom, 1999.

Men and women must receive equal pay for equal work in production. Genuine equality between the sexes can only be realized in the process of the socialist transformation of society as a whole. Mao Zedong, Introductory note to "Women Have Gone to the Labour Front", 1955.

Science and technology have no class nature; capitalists make them serve capitalism, and socialist countries make them serve socialism. Deng XiaoPing, Realize the Four Modernizations and Never Seek Hegemony, 1978.

The case against the emergence of a strong black business class within the present system is that the economic legacy of colonial capitalism, rooted internally, remains in place. Although the forced aspect of the system has gone, it remains extremely difficult to transform this system, and the economic and social dualism of the past remains structurally intact. Ben Turok, The challenge of managing capitalism, 2005.

3 Summary

1 - Small Fish in a big pond – SME and innovation in BRICS countries 2 - The importance of the System of Innovation framework for SME policy and varieties of the concept in BRICS 3 - Setting the Stage: The role of SMEs in BRICS 4 - Comparative treatment of the five country cases 4.1 Definitions and basic statistics 4.2 SME policies and innovation policies 4.3 Innovation data 4.4 Financing 4.5 Innovation financing 4.6 Innovation systems - key actors and their interactions 5 - Policy recommendations and foundations for future research References

4 1 – Small fish in a big pond – SME and innovation in BRICS countries

It is not by a slip that an inverted popular quotation was permitted to intrude into the title of this section. The analogy is useful because it brings to mind an image of numerous, dispersed and heterogeneous ‘small fish’ swimming confusedly in an oversized, inadequate and dangerous ‘pond’ and this corresponds to the experience faced by the millions of micro and small firms spread throughout the developing world. It illustrates an often confusing and challenging reality. Nonetheless, understanding and working with this reality is essential as small firms are central to capitalist development: they are thought to have the capacity to change the world both through the generation of critical income and also through their role in the Schumpeterian cyclical ‘waves’ that are the key drivers of innovation, thus furnishing the potential for great social and economic transformation. Buffeted by strong currents, these firms struggle to survive in a highly challenging, mostly adverse, global scenario. The pond appears to be getting bigger and bigger; however, in many cases this apparently larger potential is an illusion, or available to the very few, and in other instances, the fish are becoming noticeably smaller. The analogy highlights the urgency of a new approach to understanding the opportunities and challenges to the sustainable development of small and medium firms; an urgency that is heightened by the crisis and conflicts that characterize the globally competitive accumulation regime. The aim of this book is to address some of the challenges to the sustained growth of small firms looking at the development alternatives that are evolving in the BRICS countries. This book on the Role of SME in the National Innovation System of BRICS countries is driven by three main research goals. In the first place, to provide an overview of the main characteristics of Small and Medium firms in the Brazilian, Russian, Indian, Chinese and South African National System of Innovation as a basis to examine the role and contribution of these firms to the economy of each country. The themes and questions addressed in each one of the five individual country chapters seek to draw out the links between SMEs and the NSI, providing empirical observations on innovation indicators, financing mechanisms for innovation, the gender implications of SME ownership and innovation, and the contribution of science parks, incubators, universities and research institutes. A second goal is to bring to the forefront crucial issues in the discussion of industrial and technological policies for small firms; including the recent evolution and future trends of policies and instruments, their applicability and coordination, as well as a discussion of the macroeconomic, legal and the regulatory environment. The fundamental research question that guides the analyses is: how can policies best be designed to enable the social and economic inclusion of complex, numerous, dispersed and heterogeneous SME firms? These firms are, in many cases, important depositories of traditional local based knowledge; how then, can policies harness the potential of the localized nature of the generation, assimilation and diffusion of innovations to strengthen and sustain their own development? What are the implications and lessons for BRICS and other developing countries? The third and final research objective is to draw out initiatives to promote innovation in SMEs that address common bottlenecks in BRICS countries and that can contribute to policy design and implementation by these and other countries. Identifying and analyzing key development

5 opportunities may help to uncover development alternatives to help Small and Medium Firms in both developed and underdeveloped countries fulfill their potential. This book uses a broad National Systems of Innovation approach as a theoretical framework. According to this perspective, the effectiveness of policies for the promotion of SMEs depends on a wide-range set of factors that include the historic specificity of each country and the existing macro-economic and social contexts, business and institutional environment and related policies. Besides drawing out the importance of the National System of Innovation concept for an analysis of SME policies, this introductory chapter offers an analysis of the varieties of the NSI concept that have been adopted by the BRICS to deal with the policy challenges of strengthening Small and Medium firms. Section 3 provides a general picture of the environment for SMEs, pointing out their relative importance and strength in BRICS, and this is followed by a discussion that highlights relevant dimensions of the individual realities of the five country cases that are dealt with in more detail in the country chapters. The final section draws out the policy implications and foundations for future research in this area.

2 - The importance of the System of Innovation framework for SME policy and varieties of the concept in BRICS

Systems of innovation, understood as a set of differing institutions that contribute to the development of the learning and innovation capacity of a country, region, economic sector or locality, and that comprise a series of elements and relations that link together the production, assimilation, use and diffusion of knowledge, have been defined, studied and adopted as an important analytical tool and framework to guide analysis in both developed and underdeveloped countries (Cassiolato and Lastres, 2009, Freeman, 1982, Lundvall, 1988). The framework takes into account the specific social, economic and political realities of each country, the local or tacit nature of knowledge and innovation and also the power relations in discussing innovation and knowledge accumulation. The relevance of the NSI framework for BRICS has been extensively discussed in Cassiolato and Lastres, 2009.

It is argued here that the National System of Innovation concept can be usefully employed to focus on the processes of interaction, cooperation, learning and development of capabilities in Small and Medium firms. The concept enables taking into account the micro, meso and macro economic dimensions that are central to innovation efforts and allows focusing on issues and dimensions that are not usually considered including the productive, financial, social, institutional and political spheres. Most importantly for the innovation system of BRICS’ countries and SMES, the NSI approach provides lenses that can be used to examine learning processes, historical and cultural trajectories, social, regional, gender and other inequalities.

While National Systems of Innovation researchers concur that national and local conditions may lead to completely different paths and that there is not only one solution and policy prescription but rather a myriad of alternatives, it is nonetheless possible to draw several lessons from the experiences presented in this book. Importantly the adoption of a common theoretical framework allows research to draw back, analyze the bigger picture and draw lessons which can be of value to the broader discussion on the role of innovation in socio-economic development. Varieties of the National System of Innovation concept in BRICS

6 Reflecting an international move towards recognising the need to develop a systemic approach to the promotion of innovation and competitiveness of firms and individual agents, polices have more clearly focused on clusters of firms (Freeman, 1987; Piore and Sabel, 1984; Storper, 1995). In particular, policies to promote technological and industrial development increasingly recognise that the agglomeration of enterprises and the best use of the collective advantages generated by their interactions, and also by their interactions with the surrounding environment, can effectively contribute to the strengthening of their chances of survival and growth, and represent an effective source for sustainable competitive advantages (Cassiolato, Lastres and Maciel 2003). This approach suggest that collective learning processes, co-operation and the dynamics of groups of firms are fundamental to meet the challenges of economic, social, technological and knowledge asymmetries. Gradually, existing programmes have begun to provide support to groups of small firms, employing varying conceptual definitions and terminologies, such as firm networks; technological parks; incubators, co-operative projects; clusters; productive, regional, sectorial or export zones, among others (Porter, 1998; Piore and Sabel, 198, Storper, 1997). A unique experience in public policy to foster collective regional entrepreneurship and SME innovation is the Local Productive Systems – LPS approach examined by Arroio in her chapter on Brazil. This concept is grounded in the National System Innovation perspective to guide economic, industrial and social policies that seek to strengthen the interactions among SMEs and to promote learning and innovative capabilities. Local Productive Systems represent a practical unit of analysis and investigation that goes well beyond traditional views based on individual organizations (enterprise) or economic sectors, comprising both the territorial dimension and economic activities. This perspective brings to the fore the heterogeneous agents (enterprise and R&D organizations, education, training, financial agents, etc.) and related activities that are necessarily comprised in any productive system. The approach highlights the conditions under which local learning, the accumulation of productive and innovation capabilities and effective use of these capacities occur. For developing countries this is absolutely vital. Although other BRICS countries haven’t articulated SME policy-making to such a conceptually structured National System of Innovation approach, the need to bridge the gap between the challenges of globalization, development and innovation-based competitiveness, has meant that all countries have to some extent found a response in the systems of innovation approach. In South Africa, the systems of innovation framework has been used to organize public resources in research, development science and technology since 1996 when the publication of the White Paper on Science and Technology established the parameters and orientation of the reframed national system of innovation. The South African policy framework is particularly relevant for analysis of strategies to strengthen SMEs considering that in the post-apartheid policy framework, these firms are perceived to occupy a central role in the achievement of social (poverty alleviation), economic (employment creation, growth), and political (black economic empowerment) objectives. China also adopts an explicit National System of Innovation approach, and the evolution of that countries’ approach to scientific and technological policy-making described by Yuan Cheng and Jian Gao illustrates key milestones in the development stages associated with strengthening the innovation system. In the current phase, beginning from 1998, the country has focused on enhancing the innovation capabilities of domestic enterprises, including the technological

7 capabilities of SMEs. Both the India and Russia country studies provide a detailed description and analysis of legislation and policy instruments to support SMEs, giving a comprehensive overview of the role of SMEs in the country’s system of innovation. In the India report the focus is on the huge policy challenges inherent in an innovation system torn between highly competitive SMEs that display technological capacity and vibrancy on one hand, and the profusion of tiny, small sector firms, often grouped in what has been termed ‘poverty clusters’, on the other hand. They show that increased competition from the world market has led to increasing concentration of SMEs in more advanced regions, thus aggravating rather than mitigating regional inequities. The Russia report examines the consequences of immersion in the global economy without an adequate legal and institutional framework to shield the development of small and medium enterprise. In both these countries policy-making in general, and for SMEs in particular, is not couched explicitly in a NSI perspective. Almost all of the country reports highlight the need for more detailed analysis using both a regional and a sectoral innovation systems perspective. The authors in this book make it clear that it is important to tailor the NSI concept to study in more focused detail the regional and sectoral specificities that may lead to improved policy-making for a broader spectrum of SMEs. This is because regional level specific mechanisms for supporting small and medium-size entrepreneurship are considered crucial to their sustainable development. The Brazilian experience that looks at Local Productive Systems can bring important insights for such studies, and these are drawn out in the final section in this Introduction.

3 – Setting the Stage: The role of SMEs in BRICS This section brings to the fore central aspects of the social and economic context, in addition to the business environment, that are essential to analyze small and medium enterprise development and that are summarized in Tables 1 and 2. The data reveal that SMEs play an important role in BRICS economies, representing in most cases over 90% of total firms. Although studies show that these firms are less important in terms of wage generation, as salaries are significantly larger in bigger firms, SMEs provide a much needed cushion to absorb the labor force contingent, particularly in China and India, and also to buffer high unemployment rates, reaching 23% in South Africa. Table 1 – SME in BRICS countries –Social and Economic Context (2007) SMEs Labor force Unemployment GDP growth Interest Rates Inflation (million units / %)* (million) (% labor force) (2000-2007) (Short-term) ** Brazil 5.37 / 99 97.7 8.9 3.3 17.85 3.6 Russia 4 / 97 75.8 6.1 6.6 10.00 9.0 South Africa 2.5 17.4 23.0 4.3 11.00 7.1 Upper middle- … 378 8.7 4.3 … … income group India 26 447.7 5.0 7.8 6.00 6.4 China 42 / 99.6 785.7 4.0 10.3 3.33 4.8 Lower middle- … 1,662 5,7 8.0 … … income group

8 *SME data compiled from information in individual Country Chapters in this book. Other sources are IMF, Inter- agency Group on Economics and Financial Statistics and World Bank, Development Economics Data Group and Investment Climate Department of the Financial and Private Sector Development Vice Presidency …indicates data not available. **annual % change in CPI. These firms must deal with a highly challenging financial and business environment. Although all BRICS have experienced positive GDP growth in the new millennium, short-term interest rates are high in most countries, and very high in Brazil at 18%; this is compounded by the fact that official credit-lines for SMEs are in most cases, practically non-existent, and even when formally in place, very difficult to access. In terms of inflation, the scenario in most countries has improved significantly from the late 1980s and early 1990s, when extremely high inflation rates were feeding the financial economy rather than the ‘real economy’. Nonetheless, existing rates of over 5% in most cases, may prove too steep for the survival of many SMEs. The business environment is equally challenging. Opening a formal business enterprise in Brazil is not for those that are in a hurry, as this could take as long as 152 business days. The tax rate is high in all countries and absorbs a significant percentage of profits, reaching 71% in India. Russia is the champion in terms of new business density and, together with South Africa, is one of the countries that requires the smallest number of procedures to start a business, and likewise these two countries can boast of the smallest interval to start a business. The last column in Table 2, on ‘Firms using banks to finance investments’ is probably significantly overstated when it comes to SME investment financing. It is reproduced here to illustrate, albeit skewedly, the very low access rates to formal credit, as low as 10% in China and Russia and no higher than 24% for all BRICS countries. In the developed world, banks enjoy financing up to 44% of firm’s investments in Germany. Data for the USA, the United Kingdom and other OCDE countries is not available in the World Bank database. Table 2 – SME in BRICS countries – Business Environment (2007)

Time to start a Procedures to start Total tax rate New business Firms using banks to business (days) business (number) (% of profit) density* finance investments (% firms ) Brazil 152 18 69.4 4.1 22.9 Russia 29 8 48.7 4.9 10.2 South Africa 22 6 34.2 1.4 24.2 Upper middle- 53 9 45.8 3.9 … income group India 30 13 71.5 0.0 19.4 China 40 14 79.9 ... 9.8 Lower middle- 35 9 42.9 1.0 … income group World Bank, Development Economics Data Group and Investment Climate Department of the Financial and Private Sector Development Vice Presidency …indicates data not available*new registration per working age population. These countries have several aspects in common that may have a profound impact on how policies for SME are conceived, developed and implemented. These include demographic and social aspects, such as the high degrees of inequality in the distribution of income; their large, or extremely large, population densities, and associated challenges in the provision of essential goods and services, including water, food, energy, sanitation, education and health. Additional development challenges such as relatively large unemployment figures, the significant gap between the rural and urban populations, the immense regional disparities in human and

9 economic development and perverse regional income distribution patterns are common themes that justify focused attention on policies for SMEs. As regards economic and productive structures, BRICS have in common the importance of agricultural and extractive activities as well as the transformation of mineral and energy resources. The magnitude of their agro-industry and the rich biodiversity are noteworthy and may offer important windows of opportunities for SME policies. The trends and directions of SME policies will also be to a large extent dictated by the different strategies for development that have been adopted in BRICS and their various degrees and forms of integration into the world economy. Thus in Russia, specialization in petroleum, the gas complex and other natural resources associated with the strength and impact of the 4000 research institutes inherited from the Soviet era, has led to strong policies within specific industrial clusters, as discussed in Sokolov and Rudnik’s chapter. The opportunities and challenges associated with the various development strategies are drawn out in individual country chapters. BRICS have faced intense political and economic transformation processes in the last decades. They have dealt in diverse manners with the impacts of liberalization, deregulation and financial instability. The significant increase in their participation in international trade, fostered by the Chinese and commodity booms, has led to specific vulnerabilities in SMEs dedicated to the export sector or that are attempting a more nuanced insertion in global production chains, as addressed particularly in the China and India analysis of the role of SMEs in national innovation systems. Russia and South Africa have also faced great political changes and the strategic role assigned to SMEs in bringing about radical political and economic change is exceptionally highlighted in the South Africa case. Likewise, the Brazilian chapter brings to the fore the importance of national policies to orient, regulate and support SME growth. As mentioned previously, this chapter provides an important conceptual contribution: it presents the Local Productive System approach that provides a policy framework that seeks to foster sustainable and coordinated development at national, regional and local levels. Because it is not geared solely towards integration into the global economy, it is a promising policy model to face the huge task of evening out regional imbalances in countries of continental dimensions.

4- Comparative treatment of the five country cases

4.1 Definitions and basic statistics

There are various challenges to carrying out cross-country empirical comparisons of BRICS. The paucity of existing data on SME and the varying definitions used for Small and Medium firm categorization is one of the first difficulties.1The term SME is used to describe a diverse range of highly heterogeneous business activities that differ in size, sector, ownership structure, the

1 The main focus of the study is on Small and Medium Enterprise - SME; however, given their significance, most Country Reports also include analysis on micro firms. In this Introduction the terms SME, MSME, SMME, and Small Scale Industry or Small Sector Businesses, in the Indian case, are used.

10 market that is served and the technology that is used. Most importantly, variations occur considering the nature of the productive and institutional relationships they are embedded in and their legal status. Although SME definitions vary from country to country, some of the commonly used criteria include number of employees, total net assets, sales and investment level. Brazil and China’s National survey systems, for example, consider employee figures for specific industrial sectors, including manufacturing, construction and other categories such as commerce or services, while other countries’ indicators comprise broad criteria based on employee numbers, rather than associated with specific industrial sectors. All five countries also categorize SMEs according to revenues from sales of goods but here again, the limits vary considerably. Keshab Das and K.J. Joseph provide an interesting discussion on the evolution of the definition of SME in India, showing that the adoption of criteria for the definition and classification of firm size allows policy makers to draw out particularities that are considered relevant; in the Indian case, employment and the usage of power until the 1960, when the criteria was dropped and firms were defined in terms of investment in plant and machinery. In India these businesses are categorized as ‘small scale industry’ highlighting the fact that varying terminologies are used in different contexts. The definitions and criteria that are adopted allow policy-makers to highlight specific themes according to local interests, and also enables firms within the established limits to enjoy the benefits and incentives offered in legislation providing differential treatment to SME. Because countries use different criteria for defining SMEs it is impossible to generate valid direct comparisons. Nonetheless, it is possible to draw some broad comparative insights. Not surprisingly, most authors represented here stressed the role of SMEs as the backbone of their national economies. In Brazil and China, for example, 99% of total firms are SMEs and they contribute heavily to employment generation and to GDP growth, reaching almost 60% in China. As pointed out by Yuan Cheng and Jian Gao, these firms make a tremendous contribution to national economic development. In Russia, Sokolov and Rudnik observe that although the country has yet to complete the process of downsizing conglomerates inherited from the USSR era, small and medium business have steadily increased production volumes and employment and are becoming mainstays of the national economy. In India, although MSMEs have achieved relatively high growth in terms of number of units, investment, output, employment and exports, production growth has not kept pace with employment or number of units. The strategy for enhancing the competitiveness of Indian small firms has linked output growth to increased capital intensity of production, and it is highly likely that a few relatively larger units have emerged as competitive by being able to invest in expensive plant and machinery. This strategy has not been able to enhance either employment or number of units, a pressing issue for large developing countries. As regards exports, China and India present a striking contrast to the other countries. In the Asian countries these businesses are responsible for a significant volume of exports, 68% for China and 40% for India. This is in marked contrast to the relatively low figures reached in South Africa and Brazil, where around 2% SMEs export and Russia, where only 7% of small companies have consumers outside the country. These businesses remain central to domestic economies as engines to promote internal markets.

11 It is in the chapter on South Africa that the relevance of policies to promote these businesses as a vehicle for economic growth, wealth distribution and social transformation comes sharply into focus. Ndabeni’s study shows that in over three hundred years of colonialism and over fifty years of apartheid capitalism, there was little scope for any policy framework to promote MSME. Industrial and business policies were in line with racial discrimination: blacks were meant to provide labour for the white business establishments; it was as crude as that. This led to the creation of two disconnected and parallel economies, what is termed in South Africa as the ‘first economy and second economy’. As in other countries, a vast majority of the firms in the second economy are informal and ‘survivalist’; they exist at the barest levels of survival. In Brazil it is estimated that the number of informal businesses is at least four times larger than the number of MSMEs that have been legalised, involving around 60 million individuals. In India, 99.5 per cent of over 4.4 million small enterprises belong to the micro category and these are largely part of the ubiquitous informal sector. As Arroio observes, these firms face limited availability of financial, human, technical, technological and management resources and have very weak capability and bargaining power when it comes to dealing with actors in their external environment. The authors in this book highlight the many difficulties faced by businesses in the ‘second economy’ in their external environment, in addition to the internal organizational challenges detailed above. Ndabeni, for example, points out that they have to compete with more sophisticated and well-organized counterparts in the formal sector. Sokolov and Rudnik discuss one of the most perverse aspects of the informal or ‘shadow economy’, as it is known in Russia, where ‘shadow’ firms push legal companies out of the market since the former can sell their products and services at more competitive prices. SMEs have to either accept the ‘shadowy’ rules of the game or quit the market. This is an important challenge that requires creative policies, such as the introduction in Moscow of registries of ‘honest small businesses’ that receive breaks and preferences, including reduced rent. Taking steps to ensure that the rights and lawful interests of small and medium-size businesses are not breached and to deal with private and public corruption and criminalization of activities, thus reducing the substantial uncertainties and risks faced by small businesses, are very important policy challenges.

The small size and heterogeneity of firms, coupled with high levels of informality in the production and labour processes, has implications for the nature of innovative activity in this sector. A different approach is required to help these ‘small fish’ survive, grow and contribute to more dynamic regional and national systems of innovation.

4.2 SME policies and innovation policies Considering that the BRICS countries have had to deal with the long-lasting and insidious economic, social and psychological legacies of colonialism in the case of South Africa, India and Brazil, and concentrated state ownership of the means of production, in the case of China and Russia, one of the most surprising factors to emerge from the analysis is how fast and far policies to strengthen SME, and also policies to promote small business innovation, have advanced in the BRICS countries. Until the 1970s, policies had traditionally focused almost exclusively on the

12 promotion of large domestic State Owned Enterprises or in creating an environment that was favorable to the productive structure of large firms, both national and foreign, through monetary, fiscal and labor policies, among others. With the notable exception of India, where the National Planning Committee of 1938-41 had already accorded significance to small scale firms in India’s industrial development, the formulation and implementation of policies for the promotion of SMEs is very recent, beginning from the 1970s, in Brazil and China, from the 1980s in the case of Russia, and as late as the 1990s in South Africa. In most cases, initiatives in support of the universe of small businesses were a small item on the government agenda and the focus was mainly on social welfare, that is, redressing unemployment. Early policy-making sought to establish the institutional structure and legal framework for the treatment of small enterprise. As can be expected from countries this diverse, institutional design and the legal framework vary considerably. Brazil, India and South Africa, for example, implemented relatively centralized institutional structures to address SME related topics. India created the Ministry of MSME as early as 1954, while Brazil developed a sophisticated and extensive system to provide business assistance to SME, the Brazilian Micro and Small Business Support Service, SEBRAE. In South Africa, the Department of Trade and Industry (DTI) is the policy coordinating body for SME development and promotion while the offices of Small Enterprise Development Agency (SEDA), focus on the delivery of SMME services at the local level. In Russia, a wide range of organizations have been set up to support innovation and entrepreneurship in small and medium businesses, including the Russian Foundation for Technological Development (RFTR); the Foundation for Assistance to Small Innovative Enterprises; the Russian Venture Company; the Russian Corporation of Nanotechnologies (Rusnano); and regional venture funds. Although in most BRICS there is one institution responsible for overall policy coordination, SME promotion is a shared competency cutting across a range of policy areas and government departments. As regards legislation, common themes focusing on the differentiated treatment of SMEs that emerge in the BRICS countries include administrative, taxation, social security and welfare, labour, credit and entrepreneurial development strategies. Legislation to create an enabling framework focuses on tax exemptions, simplified accounting rules for tax calculations, differential taxation and other financial incentives, facilitating access to finance and specific credit lines. Regulation also seeks to reduce constraints and simplify bureaucratic procedures; in addition to creating structures that facilitate or provide access to information, advice and access to affordable physical infrastructure; including training for entrepreneurship skills, management and export-oriented services. The importance of improving SME business skills is noted by all authors in this book. These entrepreneurs generally lack business skills which in turn constrain their ability to take advantage of business opportunities; the lack of relevant skills also constrains creativity, limits innovations and leads to entrapment in low quality, unsustainable, product and service offerings. Cheng and Gao observe that the shortage of talent is one of the biggest problems faced by SMEs and highlight the fact that these firms must deal with the simultaneous occurrence of the phenomena of shortage of talent and brain drain. Many SMEs are family business and these tend to have weak management abilities that are not usually grounded in modern scientific management ideas. Even the more competitive SMEs may find it difficult to attract and retain talent, because they cannot implement effective incentives or mobilize the enthusiasm and creative talent needed to

13 remain competitive. SMEs thus become trapped in a vicious cycle where it is extremely difficult to upgrade management and technological innovation capacities, making it impossible to achieve economies of scale and compete with larger companies with more access to capital, technologies and information. The other side of the coin is the lack of relevant professional skills in the institutions designed to support SME entrepreneurs. This is a serious issue that tends to becomes more acute with insufficient resources and weak management and technical skills. Thus, although there exists in most countries an extensive arsenal of tools to support small enterprises, the absence of skilled, modern-thinking professionals, means that conditions are less than favorable. Policy initiatives are often poorly integrated and badly tuned to the needs of innovative science-and-production small companies. In addition, the lack of clarity about the roles and responsibilities of staff in different levels of the public sector makes their efforts uncoordinated and less effective. This makes it almost impossible to undertake thorough and regular monitoring and evaluation of evolving support processes, leading to inefficient use of limited resources. There is thus a double challenge in improving staff qualifications for dealing with SME and also improving the integration of the surrounding network of actors that are relevant in SME promotion and innovation efforts. This is where the National System of Innovation perspective can have a deep impact, because according to this perspective technological innovation is not an isolated instance and the surrounding environment and network of actors and institutions must be taken into account. From 2000, legislation in most countries has focused more sharply on facilitating SME access to technologies and the development of technological capabilities. A case in point is China’s ST&I system, which although undergoing a series of stages since the reform and opening up in 1977, only succeeded in implementing an SME Promotion Law in 2003. Although late relative to the other BRIC countries, this legislation has a clear cut focus on technological innovation, in addition to measures for financial support; entrepreneurial support, market development, social services and building an appropriate legal environment. This finds echo in the Russian Federation, where it was only in 2007 that more sophisticated legislation for the treatment of SMEs was implemented. Tracing the historical roots of SMEs development in Russia, Sokolov and Rudnik provide a picture of a country undergoing profound economic and social transformation and the impact of political upheavals on SMEs. Evolving from the cooperative movement of 1985-1991 and from the 1991 law ‘On General Principles of Entrepreneurial Activities of the USSR Citizens’ that established the basis for private property ownership and laid the basic provisions for the functioning of a market economy and the entrepreneurial environment in the USSR, SMEs have trod an unequal and uncertain path. On the one hand, government support was mainly directed towards large SOEs undergoing privatization and on the other hand, the environment enabled small and medium business ‘parasitism’, that is super-profitable brokerage, contributing to criminalization and deterioration of the market's psychological climate. In Russia, some very tough social, legal, economic and psychological learning has been going on since legitimization of private enterprise in the early 1990s. The 2007 legislation seeks to ensure the rights and lawful interests of small and medium-size businesses. As Sokolov and Rudnik point out, although the legislation is in place and significant institution- building has resulted from the turbulence of the past two decades; there is still a long way to go.

14 In Brazil, the legislation and the institutional structure to support SME was introduced in the 1990s. However, in this period government activity was mainly focused on macroeconomic structural adjustment policies, in detriment of industrial and technological policies, and this strongly contributed to increase the difficulties in the implementation of initiatives to promote small firms. The framework for dealing with SMEs in a more comprehensive manner has evolved in more recent years, mainly through the Local Productive System approach, as examined in Arroio’s chapter on Brazil.

Fostering demand and the role of government procurement Creating demand for small enterprise products and services in addition to legislation that lays down special conditions for their increased participation as suppliers (contractors) of products and services in government acquisitions are key themes that have recently begun to be explored in country-specific legislation and that may include the design of specific procurement policies. Government procurement can be successfully tied into technological development and capacity building strategies and this is an important theme for SME promotion that has only recently begun to achieve recognition through specific legislation. For Ndabeni, the crucial problem is that a majority of SME entrepreneurs depend entirely on local markets which are often overtraded, suggesting that isolation of the business enterprise from large markets is at the core of the lack of demand problem. In addition to improving regional inequalities, policies should seek to provide efficient programs to promote small enterprises marketing and export so that entrepreneurs can diversify products, identify niche markets for high value products and expand. Some authors suggest that the lack of demand for SME products could be addressed through policies that seek to promote integration into relevant value chains, particularly through increasing large enterprises demand for innovative products supplied by SMEs. However, bearing in mind Das and Joseph’s alerts on the pitfalls of ‘global integration’ and that there is nothing inevitable about small firms being connected with global commodity chains, any such policy should be carried out with eyes wide open. Most interestingly for developing countries, Sokolov and Rudnik point out that there is significant room for improvement in procedures for placing government orders as a tool to promote the demand for SME products. Procurement could also be part of a broader strategy to promote cooperation and networking between small, medium and large businesses. In particular, promoting linkages between SMEs, including strengthening inter-enterprise cooperation among SMEs and fostering networks of sectoral associations that represent collective interests could be very beneficial. The role of Business Associations in the promotion of SMEs and innovation should not be underestimated. In Russia, there has been an interesting participation of businesses’ representatives and non-profit organisations in the development and implementation of the national policy to support SMEs; they provide expert assessment of draft federal, regional and local legislation regulating this sphere. In India there have been efforts by industry associations to associate with commercial banks and financial institutions to provide collateral security to entrepreneurs and in China, Productivity Promotion Centers, scientific and technical service organizations that support small and medium size enterprises, have grown significantly. In Brazil, in addition to SEBRAE, the National Confederation of Industries provides a forum for

15 discussion of industrial interests and various services for micro and small businesses. These bridging institutions are crucial in the system of innovation that supports SMEs, they represent important loci for the discussion of public policies and could be an important bridging channel to discusses and implement mechanisms to facilitate public procurement of SME products and services. Gender in SME development Ndabeni’s observation that “the marginalization of women’s enterprises in the general economy tends to mirror the marginalization of women in society” says it all; in BRICS countries, as in many other developing countries, women are a majority of the population and they tend to dominate the micro enterprises of the SME economy. However, their production is concentrated in a relatively narrow range of activities, characterized by low technological density and few fixed assets, with intense use of unqualified labour, developing activities in traditional industries, such as livestock, food and beverage production, clothing and footwear manufacture. These enterprises operate on the fringes of the major economic sectors and enjoy very low profits and rent. In India, Das and Joseph’s study hones in on the 3.5 million, mostly female workers in the garment industry, that despite topping the list of export goods from the SME sector in India, operate in poor working conditions, exploitative labor markets that frequently pay less than minimum wages, no legal provisions for worker production and industrial safety, and outdated machinery. The systematic subversion of workers’ legitimate rights and social security is an issue that has been carefully avoided by firms and institutions involved in the governance of Global Value Chains, excepting for a “nagging insistence” for even greater freedom in labor regulations. Policy-makers and institutions in South Africa and Brazil are beginning to recognize and address the gender issue explicitly. These countries have begun to implement policies that recognize the role of gender equality, not only as a fundamental human right, but also as essential to poverty reduction, reducing racial inequalities, improved living standards, and sustainable economic growth. Brazil established the Special Secretariat of Policies for Women in 2003 and South Africa has established the Technology for Women in Business (TWIB) an exciting program that focuses on technology promotion activities, identifying the technological needs of women entrepreneurs and fostering linkages between women’s enterprises and technology service providers, among other services. Gender inclusive policy designs in BRICS countries are timid and fall short of meeting the pressing requirements and specific obstacles faced by business women. Given their social and economic relevance, it is essential to create alternative forms of incentive and that public policy be purposefully designed to promote an enabling environment for women entrepreneurs. Placing the gender issue within a broader development policy that includes not only access to credit, markets, information, the development of business and other capabilities, but most importantly also seeks to enable their engagement in policy dialogue and political empowerment, may have a significant impact on their status, transforming power relations and positions within society. Likewise, the almost complete absence of information and lack of policy instruments for family businesses in the BRICS suggests a very important gap in research, analysis and policy-making

16 that requires urgent attention. A significant proportion of SMEs are family businesses and more knowledge is needed to design policy instruments tuned to the specific vulnerabilities and challenges of this type of business. The studies show that since the 1950s BRICS countries have focused, with varying degrees of success, on the policies and the institutional build-up to strengthen domestic industries. During the 1990s and into the new millennium, there have been major efforts at institution building, legislation and regulation for SMEs, BRICS have designed and to varying extents successfully implemented policies to promote SMEs; more recently policies have begun to tune into a Systems of Innovation approach. The country reports or chapters in this book show that, in addition to social and economic constraints, the major challenge to successful policy implementation is linked to the weak articulation among the diverse initiatives and agencies in charge of policy execution, leading to fragmentation and dispersal of policy initiatives. Another serious challenge is that funds allocated from federal budgets to programs for small business support may in reality be almost insignificant and that many programs are not as fully financed as initially planned. In some cases, funds that were small to begin with get dispersed among myriad competing initiatives. The authors argue that use of the policy framework provided by the national systems of innovation perspective, particularly focused on the regional or local level of production, although requiring unprecedented efforts to develop a collective and systemic approach, could redress many of the challenges associated with the large geographic spread and sectors of SMEs, women and family enterprises. 4.3 Innovation data

It is essential to point out from the outset that existing concepts and methodologies for studying innovation in developing countries’ SMEs are inadequate, leaving out and thus rendering invisible a wide array of factors, indicators and processes that are crucial to broad based innovation in SMEs; importantly, these gaps may lead to skewed policy-making. The use of narrow concepts to focus on innovation, including the emphasis on R&D, for example, has meant that those other highly relevant aspects of the innovation process, such as design and computer programming; management; business, administrative and production activities; teaching and other activities needed to innovate are left out. Equally worrying is the inability to incorporate, comprehend and deal with the high levels of informality in the SME sector. In BRICS countries, where informality prevails and informal cooperative practices and agreements are a part of the historically established socio-cultural context, this limitation is particularly important. The ‘invisibility’ of actors, regions and activities has prevented their inclusion in policy agendas, reinforcing inequalities.

The relatively large expense of carrying out innovation surveys and the inadequacy of the indicators used to shed light on innovation in developing countries has meant that Russia and Brazil are the only countries reporting innovation data following the Community Innovation Survey model used by EUROSTAT. Both countries report that large industrial firms enjoyed the largest share of innovation activities and that they are also the main beneficiaries of public financial support for innovation. Despite this support, in Brazil as in Europe (CIS, 2004), economic factors are perceived as the main barrier to innovation, regardless of firm size. Other

17 barriers to innovation considered very high in Brazil include lack of qualified personnel; lack of information and lack of interaction with other firms or institutions. As regards cooperation, SMEs involvement in joint R&D projects has declined in Brazil, with only 2% small firms reporting cooperative practices in 2003, down from 11% in 2000. In Russia, the number of joint R&D projects involving SMEs increased in 2006, after a significant drop in 2005. Interestingly, the number of enterprises engaged in joint R&D projects was lower than the number of projects they implemented; meaning that on average one enterprise participated in more than one R&D project. Sokolov and Rudnik observe a strong positive relationship between firm size and collaboration in all economic sectors, leading to the conclusion that larger firms may function as crucial nodes in interactive networks. Unfortunately the data does not enable mapping and analysis that would highlight the informal cooperative practices between arrangements of MSME. This would bring to light truly dynamic networks between ‘invisible’ suppliers, clients or consumers in addition to links with education, financial and other institutions. This gap is once again bought to the forefront in the India chapter where research shows lack of co-ordination between the private and the public sector in terms of research investment and overall poor levels of integration between the different agents engaged in innovation. Das and Joseph observe that the share of small-scale sector investment in R&D comes to 4% and this compares very poorly when considered in terms of their contribution to output, employment or export earnings. It is apparent that a methodology and accompanying indicators that seek to illuminate SMEs contributions to broad innovation in BRICS countries, rather than exclusively focused on R&D strictu sensu, would provide more robust data and innovation indicators, greatly contributing to policy-making. A key indicator for innovation in SMEs is technology transfer, and the data for Russia show that the number of companies selling new technologies was significantly lower than the number of companies which purchased technologies (buyers). This suggests that transferring new technologies to the SME sector for subsequent development and commercialization is a more common practice in Russia than development of new technologies in SMEs for subsequent transfer and ‘replication’ in large enterprises. This finding probably reflects the experience of most developing countries, however only China reports specific arrangements, through the 2007 Torch Plan, to create special funds to facilitate technology transfer between universities, research institutes and firms. The discussion of innovation data in the country reports suggests that it is important to develop and use concepts and parameters that enable analysis of ‘invisible’ local innovation in order to foster their inclusion in policy agendas. There is ample room to improve policies and financing to enhance the innovation efforts of SMEs, however it is important that policy initiatives be based on innovation indicators that are developed taking into account and that prioritize the realities and requirements of the firms and contexts they are targeting.

4.4 Financing Improving access to financing and innovation financing for SMEs is the holy grail of economic

18 policy for these firms. The studies in this book will show that since the mid-1990s in most countries, many credit lines traditionally available in the portfolio of public banks and development agencies for financing production, floating capital, equipment, exports and technological capability building, have been available, at least in thesis, for use by small firms. However, several obstacles have contributed to the overwhelming failure of financing programs directed towards small enterprise. The first is the traditional and immense difficulties felt by small firms in adapting to existing rules, considering that the structure of credit instruments was conceived to meet the requirements of large firms. A second obstacle refers to the conflict between the commercial and political logics inherent in the activities developed by banks. Even though it is increasingly being demanded that development banks invest public resources to finance SME, these banks, due to specific traits and to the context in which they are embedded, have many difficulties in dealing with small firms. In South Africa, the Khula Enterprise Finance scheme has the mandate to improve SMMEs access to finance through the provision of wholesale finance or guarantees to retail financial intermediaries which in turn finance SMMEs. Both micro credit and larger loans are available and Khula provides a Credit Guarantee Scheme that offers alternative security to entrepreneurs wishing to acquire or expand their business through a bank loan but not in a position to provide the necessary security or collateral. However, many implementation problems have been faced and these are similar to the obstacles found in other BRICS, including the lack of technical skills and knowledge by commercial bank to lend to the SMME sector, the lengthy and cumbersome loan procedures that discourage small borrowers and new start- ups, the inexperience of Retail Finance Intermediaries, inadequate capacity building before and after loan implementation and disbursement, the failure to scrutinize lending methodologies and importantly, an emphasis on ‘international best practice’ rather than developing a focus that would enable improved results tailored to local conditions. On the small firm side, many SMMEs lack the skills and the business experience required to develop and submit business plans, and they may also lack awareness of financial institutions’ services and products, including competing finance charges. As Ndabeni correctly observes, there is a need for increased transparency in the banking sector, including banks reporting on their SMME lending. Most importantly he also suggests that effective SMME promotion requires a supportive human resource base fostering business and economic literacy and the importance of bringing in non-financial institutions in the broader provision of finance. These institutions can strengthen business efforts through entrepreneurship skills improvement and they may also have knowledge of local economic conditions which can impact on the success of individual projects. In South Africa, only two thirds of projects submitted by SMEs are approved; in India the proportion of credit to the sector as a percentage of net bank credit has been on the decline since 1997 and reached a low of 8% percent in 2007. Financial agents show a clear preference in dealing with credit lines that favor larger businesses. In China and Russia access to funding for small businesses is also very limited and the government support system is poorly tuned for bridging the gap small companies’ face when they try to get bank loans, in Cheng and Gao’s own words. There is a strong bias against small loan portfolios’ and it is deeply ironic that in countries where SMEs comprise over 90% of the total number of firms, they receive such a tiny slice of the financing pie.

19 In chapter 4, Cheng and Gao go further into the discussion of the complexity of financing SME. Despite strong GDP and industrial production growth (8.6% and 16.1% respectively, February 2010), insufficient funds and difficulties in accessing credit or ‘the financing channel problem’ as aptly named, also besiege Chinese SMEs. These firms lack adequate capital accumulation and have poor access to venture capital and to more traditional financing channels. They rely mainly on internal accumulation and bank loans. In the financial system, small and medium-sized commercial banks, despite possessing advantages in terms of lower transaction costs, more efficient monitoring, shorter management chains, more operating flexibility and higher adaptability, possess significantly smaller sources of funds when compared to the four major state-owned banks, and their network and settlement system is also far less sophisticated, so they have great difficulties in supporting small and medium enterprises. The development of regional small capital markets services specifically for small and medium-sized enterprises lags far behind as does the development of entrepreneur and venture capital. Sokolov and Rudnik agree that it is important to take into account specific features of micro- finance activities; paying particular attention to the development of private micro-financial organizations, credit cooperatives and cooperative banks that could provide services to start-up entrepreneurs and clients that are traditionally unattractive to banks, particularly in regions where regular banks are poorly represented. They also focus on the many problems surrounding tax legislation, including the fact that tax laws and regulations are imprecise and that small enterprise have limited access to preferential taxation regimes. Of course, while this is important, simplification of tax laws will only benefit SMEs that operate in the formal economy. In Brazil, the policy approach prioritising the collective treatment of SMEs from 2003 has led to the development of an interesting array of instruments to improve access to credit. The main public and private banking institutions participate in the Working Group on Local Productive Systems and have implemented specific credit lines to finance LPS. These institutions have increasingly recognised that the focus on the financing of small firms in LPS represents better opportunities and less risk. This experience, although by no means sufficient to meet all demands for financing, has interesting lessons for other developing countries seeking to promote these firms and particularly the collective treatment of firms. As Ndabeni concludes, the institutional environment of traditional financial institutions is unfriendly to many SMEs and the majority of these entrepreneurs rely on their personal savings and other informal lending outlets. This persistent financial vulnerability poses insurmountable problems for the landless, the poor, and women and is a serious obstacle to socio-economic development and sustained competitiveness. As highlighted by various authors, the creation of cluster banks, or other financial arrangements, embedded within local systems of innovation and that target collective agents is a promising way forward.

4.5 Innovation Financing Interesting advances regarding SME innovation financing were reported. Innovation Funds, Equity financing and venture capital are the most commonly used to promote technological development and these are fully explored in the country reports. Innovation Funds

20 Relatively strong Innovation Funds, endowed with substantial financial resources, have been implemented in Brazil, Russia and China. In Brazil, the 16 ‘Technological Sector Funds’, created at the end of the 1990s to salvage Science, Technology and Innovation financing in the aftermath of neo-liberal globalization and privatization of strategic R&D companies, discussed in Arroio’s chapter, has proved an interesting initiative to strengthen innovation financing. These funds are also used to promote innovation in small firms, mainly those that are located in Local Productive Systems, incubators, and science and technology parks. In 2006, around US$ 20 million were made available for non-reimbursable financing for R&D in micro and small enterprise. In Russia, the S&T Programme administered by the Federal Agency for Science and Innovations, Rosnauka, may provide up to 90% of funding for research. There is private sector participation; 64% of the budget for the S&T Programme ‘Commercialisation of Technology’ comes from non-public sources. In China, the Ministry of Science and Technology’s Innovation Fund also established at the end of the 1990s, has supported over 13000 projects. The Fund has achieved noteworthy results and the data shows a large increase in demand (applications) for funding. As regards equity financing, in China, since 2004 small and medium-sized firms have been allowed to list on the Shenzhen Stock Exchange, and this has had a positive impact on the capital structure of small and medium-sized enterprises; equity financing has also helped reduce the overall financing costs of SMEs. High expectations accompanied the launch, in 2009, of the Growth Enterprise Market - GEM, the Nasdaq-style second board market for start-ups, as it is hoped that the GEM will address the financing problems of small and medium-sized enterprises in the mid-and late-stage of venture. Cheng and Gao’s chapter explores the interesting concept of ‘over-the-counter securities trading system, or the third board market,’ an experience in the multi-level stock market system, that enables firms located in technology parks to more easily graduate to the SME Shenzhen board or to the Shanghai Stock Exchange. Venture Capital Venture capital has become the panacea of SME innovation financing and its role in promoting the innovation economy has been much extolled. Studies have shown however, that there are specific socio-economic and institutional aspects that must be satisfied for a successful venture capital industry to flourish. These include high mobility and regular flow of talented people, a very large supply of investment funds and highly liquid public equity markets to permit exit in good conditions (Chesnais and Sauviat, 2003). In most Developing Countries these conditions do not exist and governments have been busy attempting to create an environment that is propitious to the take-off of a venture capital sector. As can been in the country reports in this book, all of the attempts are government led and have been successful only in a narrow sense. Russia, for example, is optimistic as regards to venture capital financing and appears to be the BRICS country with the largest number of VC initiatives, perhaps as a result of World Bank involvement in restructuring of the economy in the 1990s. In the late 2000, various Funds were initiated and these are detailed in Sokolov and Rudnik’s chapter. The authors believe that the establishment of national venture funds with public participation is the first step to launch a successful venture industry; it is hoped that a convincing set of success stories will trigger a private sector chain reaction for the market's further development. China strongly believes in the potential of integrating incubators and venture capital investors. This is considered a positive trend enabling accelerated firm growth because venture capital

21 institutions established in incubators and parks will have better conditions to make the right investment decisions, reduce decision-making delays and decision-making mistakes as a result of information asymmetries, hopefully promoting the growth of start-ups. The authors in this book highlight challenges to the establishment of a venture capital market, including lack of projects in the regions where funds operate; the small size of some of the first- order funds; problems with attracting private capital and the inadequate skills, qualifications and experience of managing companies’ personnel. As in China and Russia, in Brazil, South Africa and India the venture capital market is also the result of state-supported operations rather than a spin-off of the private sector’s wealth and risk taking. Various initiatives for venture capital promotion have been implemented, but so far the results have been relatively meager. It does not appear that the existing venture capital system takes into account specific requirement of SMEs and the socio-economic contexts in developing countries, rather there are clear attempts at forcing reality to adapt to this tool. Most importantly, not all fields of economic and industrial activity are consistent with venture capital practices, making it an instrument with rather limited reach; it has the potential to benefit only a very small segment of the SME universe in Developing Countries.

4.6 Innovation systems - key actors and their interactions Local Productive Systems As regards the collective treatment of SMEs, perhaps the most innovative conceptual and policy- making approach is provided by the ‘Local Productive System’ – LPS, perspective adopted in Brazil since 2004. LPS refers to any productive agglomeration involving economic, political and social agents localized in the same area, performing related economic activities and presenting consistent articulation, interaction, co-operation and learning processes. The advantages of focusing on groups of agents that interact to produce goods or services; and of implementing policies that stimulate these agents and their surrounding social and economic environment, go beyond economies of scale and include the potential to benefit from other important synergies. As discussed in Arroio’s chapter, this approach has provided the framework to ground new forms of support and specific legislation to promote innovation in LPS. Important lessons have been gained from the Brazilian experience in implementing polices based on this collective approach. Firstly, that it is essential to adopt a broad conception of innovation, starting from the point of view of the economic, social or political agent, or of the collective actors in the Local Productive System, that are implementing the innovation. A related observation is that LPS do not comprise an end per se, in the sense, for example, of counting them and attempting to increase their total number. Indeed, the use of narrow concepts and mapping of innovation and LPS in Brazil has tended to reveal only cases in the most advanced parts of the country, the less structured cases with intense participation of SMEs and with high levels of informality - that may also require both research attention and policy support – have been left aside. Secondly, the focus on the collectivity means going beyond the frontiers of individual enterprise as units of analysis and intervention. From this point of view, it is essential to focus on agents, enterprise and other organizations as a body. The advantage of adopting this approach, and

22 perhaps also the largest challenge to successful policy implementation, resides precisely in the collective treatment of agents, that is, the design and implementation of policies geared to a body of agents rather than individual firms. Research in this vein argues that the very success of development policies hinges on the focus on the collectivity. This task requires additional and unprecedented efforts, as well as requiring a systemic view for the construction of new frameworks, that also comprise inter-related issues including access to credit, taxation, regulation and legislation. It is essential to develop partnerships to think out collective solutions to specific problems and the means to best exploit growth potential. This involves institutional learning and the design of new frameworks and policy instruments; it is not enough to augment and make available financial, technological and management resources. Rather it is essential to enable institutional learning to deal with (i) groups of enterprise and, more precisely, groups of actors that are frequently at odds and resistant to articulation and cooperation amongst themselves; (ii) micro and small enterprise that may have difficulty in identifying and expressing their needs; (iii) segments that are not usually contemplated by such policies, particularly those that are excluded from formal economic activities. Of the work presented in this book, the greatest emphasis on territorial and regional imbalances is that of Arroio, Ndabeni, Das and Joseph. They are particularly concerned with the deep structural and regional inequalities that must be faced to overcome constrains to social-economic development. They argue that access to support services must be comparable in urban and rural areas and detail specific mechanisms for supporting small and medium-size entrepreneurship, including the dissemination of regional experience in supporting SMEs, improving their access to financial and credit resources and extending the network of regional business-incubators. They stress the potential contribution of analysis that adopt a local, sectoral and regional systems of innovation approach to SME analysis, as this could provide helpful insights and enable sub- sectoral policy-making and interventions with a greater leverage than would otherwise be possible. South Africa’s policy regarding clustering is also pertinent, focusing as it does on two levels, the sectoral and the spatial to overcome the various inequality legacies of apartheid through the redistribution of economic activities and infrastructure. At the spatial level initiatives are linked to regional systems of innovation, while the sectoral focus deals with improving the performance and competitiveness of specific sectors. However, here SMMEs are seen as beneficiaries of multiple effects of clustering rather than primary beneficiaries of the clustering policy. This is in contrast to the Local Productive System perspective that places SMEs at the heart of policy initiatives. Keshab Das and K.J. Joseph also highlight the role of small firms to regional long-term competitiveness, and as important agents to help build locally rooted and diversified industrial capabilities. In India, as in other BRICS countries, the distribution of industries is highly skewed regionally and this imbalance has been accentuated with globalization. In their words: “as investment decisions got governed by the market test of profitability rather than social objectives even in the small scale sector, their operations got confined to the developed regions.” As a result, most of the poorer states in India have fared badly since the opening up of the economy. Their analysis emphasizes the importance of strengthening regional innovation systems and the interaction between various agents to facilitate the growth of industries.

23 In India, policy initiatives to strengthen clusters are being implemented by a diverse set of agencies, including central government ministries, state governments, international agencies and other specialized institutions with diverse agenda and support instruments. The authors of the India report draw attention to the fact that the diverse sets of actors involved in policy-making and the limited interaction and coordination between them may lead to duplication of efforts and other inefficiencies. In addition, there appears to be limited understanding of the need for a conceptual framework to consider policies that link innovation, the regional or spatial dimension and SME development. The Brazil, South Africa and India country reports strongly emphasize the importance of policies that focus on the local or territorial dimension for the emergence of a vibrant system of innovation and production. They alert to the dangers of ‘invisible exclusion’ and of policies that favor the ‘winners’ or the more structured SMEs, and suggest that partnerships are essential to think out collective solutions and develop policies that are articulated with local realities. Technological and science parks, and business incubators The promotion of technology and science parks gained momentum in the 1990s and there is a shared understanding of the importance of industrial, technological and science parks, and business incubators to enhance the innovation capability of SMEs as they provide critical technical, logistical and operational support for these businesses. Cheng and Gao summarize the main contributions of incubators to SMEs, observing that they promote overall learning and network effects through system of innovation synergies, they help to reduce start-ups costs and provide assistance to obtain financial resources, particularly helping to reduce investment risk as investors can use incubator generated information to make more accurate investment decisions, and finally they enable cultivation of the innovation and entrepreneurial spirit, particularly learning how to take risks and overcome difficulties. As Ndabeni points out, the more advanced parks and incubators will provide a critical platform for the implementation of new business ideas. They may also provide a vast array of essential services and facilities, including flexible office leases; site security and access control; parking; digital communications system; management advisory and mentoring services; assistance in accessing technical expertise, venture capital or finance; and improved market visibility. Ideally industrial and science parks will bring together the firms producing final goods and their suppliers and contractors, and it is important that they possess adequate infrastructure, real estate, trained managers and preferably trained staff to support start-up entrepreneurs. Russian policy-making has a particularly strong and positive focus on the linkages between universities, higher-education institutes and support to SMEs, with a relatively broad system of industrial parks (about 85 throughout the country), business incubators and Technological Innovation Centers (around 40 nationwide). It is interesting that many of these industrial parks were created on the basis of state research centres, in academic towns, science towns and formerly ‘closed’ settlements. There has been consistent and evolving legislation to support these initiatives. A particularly interesting initiative is the Technological Innovation Centres that are linked into an integrated network and that provide opportunities for flexible cooperation between the Centres and innovative companies from various parts of the country. Russia has also promoted

24 regional science parks, with regional and local authorities playing a major role in setting them up. Likewise, the eight Technikon’s or technology stations spread throughout South African focus on a wide variety of industrial sectors and provide technology transfer and facilitate feedback of SMME problems into teaching, learning and research. As regards technology incubation, the GODISA programme, comprise a Pilot Innovation Support Centre, a Pilot Technology Demonstration Centre and several Technology Incubators that provide support to key hi-tech and industrial sectors. The first internationally accredited science park in Africa is the Innovation Hub that focuses on high-technology entrepreneurs and start-up companies in ICT, biosciences, electronics, advanced materials and manufacturing. The chapter on China provides thorough data on the performance of incubated SMEs, showing that by the end of 2007 there were 614 science and technology enterprise incubators in the country, ranking second in the world after the United States. These had produced a total of 23,394 graduated businesses. The most sharply focused and apparently highly effective policy mechanism to associate SMEs and innovation is found in China’s 56 national-level ‘high-tech zones’ that emphasize individual innovation, enterprises and institutions. Their achievements in the promotion of high-tech industrialization, institutional innovation, the transformation of production and optimization of the economic structure, the attraction of the talents and the provision of entrepreneurial environment best illustrate what Cheng and Gao mean when discussing “the road of high-tech industrialization with Chinese characteristics”. Of the total 48,472 high-tech enterprises in 2007, 52% are SME and new products sales accounted for 27% of total sales revenue. However, not all is rosy in the “road to hi-tech industrialization” as shown by Das and Joseph in their discussion of the impacts of market liberalization and the "small-scale led growth" strategy adopted in India. The strategy, which was in tune with the objectives of regional dispersal of economic activities, utilization of local skills, materials and capital, broadening of entrepreneurial base, reserved production for SMEs in a number of high tech industries. In 1976, out of the 81 units licensed for the manufacture of TV receivers, 71 units were in the small-scale sector; today, of the over 3500 firms in India’s electronics industry more than 2900 units are in the small scale sector. However, since the opening of the economy in 1991, policies have favored those few units in certain subsectors which have a global market presence and have left out massive number of smaller units where the average capital investment is low and also face low global market demand for their products. Even for those SME that have ‘successfully’ integrated into global value chains or global production networks, there are serious issues regarding their participation that must be faced. All too frequently anchor or leading firms engage in what has been termed ‘rent-poor’ activities, whereby, typically, labor-intensive and low value-adding tasks are subcontracted to SMEs in poorer countries, particularly in modern, labor-intensive subsectors. Opportunities to participate in non-labor or high-tech stages are practically non-existent in highly asymmetrical business ‘partnerships’. These are essentially exploitative business relationship, where mostly the participating enterprises do not have complete information regarding production processes and where it is almost impossible to achieve functional upgrading. The authors argue that in terms of knowledge spillover, technological capacity building and moving up in value chains, SMEs have gained precious little.

25 India, however, is moving forward with a series of new policy measures that apparently recognize the dynamic role that can be played by MSMEs, most notably the 2006 MSMED Act, that seeks to enhance competitiveness and increase links with multiple stakeholders. The analysis of this legislation shows, however, that the emphasis is on selected product groups that have potential for global competitiveness, primarily favoring the well-off subsectors and within those the larger, more competitive ones. Enterprises in non-metropolitan regions are neglected. Once again, the analysis returns to the central point of bringing research attention and policy support to the less structured cases with intense participation of SMEs and with high levels of informality. Importantly, the MSMED Act identifies the category of ‘medium’ enterprises as a vital section in the manufacturing stream. The number of existing Medium Enterprise in most BRICS countries is small and inadequate, and in some countries it is actually declining, in Russia, for example, the number of MEs in 2007 decreased compared to 2005. This leaves an important gap in productive structures and the lack of policies to promote small enterprise scale-up has implications for sustainable growth and competitiveness. Most of the Country reports suggest that overall the collaborative efforts between government, research institutions, universities and firms is encouraging. The proliferation of S&T parks and business incubators in BRICS is witness to the relatively successful policy efforts aimed at small, high-tech firms and the recognized importance of knowledge sharing and technology transfer between universities and SMMEs. There remains a major lesson to learn from the Chinese strategy of the state playing a vital role in creating a dynamic business environment (including building physical and economic infrastructure) for networking between manufacturers and traders who are otherwise disadvantaged by distance and limited local market. Likewise, there are important policy lessons to be gained from collective approaches that seek to incorporate the many ‘invisible’ small firms as an integral component of national development strategies. Manufacturing Growth Poles The China and Russia chapters are the ones that best explore the various dimensions of their manufacturing clusters as they impact on SME innovation and strategies for sustainable economic growth. The Chapter on China provides robust data on the economic and development characteristics of the Pearl River Delta and Yangtze River Delta, the ‘double triangle’ or ‘the world’s factory’, as the two most dynamic production bases in the world are called. A close look at total economic output, investment in fixed assets exports, living standards and the difficulties faced during the financial crisis begun in 2009, offers a panoramic view of these ‘super-export’ manufacturing clusters, that in 2008 reached a combined value of 710,37 billion U.S. dollars in total exports. The analysis highlights the pattern of interaction between industrialization, urbanization, information and internationalization, stressing the important aggregation effects and the industrial chains between major cities in the regions. The advantages of the Yangtze River Delta region in terms of high-quality human resource and scientific infra-structure density have proved very beneficial to the absorbing and introduction of foreign advanced technology, to the transformation of traditional industries and to the development of new industries. The authors observe that in the Pearl River Delta the direction of investment has progressively changed from

26 manufacturing to service industries, international finance, insurance, logistics, advertising and other industries. This glossy picture is only one side of the coin. The other side, touched upon by Cheng and Gao and also highlighted by Das and Joseph in their analysis of the performance of the Indian small scale sector in the electronic industry, is the potential trap for small firms caught in the operational, strategic and economic reality of global production value chains. Cheng and Gao observe that in China, although the proportion of technology and capital-intensive industries has increased, they are trapped in the low-end of the value chain because the design and production of high value-added segments, including core technologies, marketing, design and management is centralized at headquarters, local firms can only engage in processing, assembly and other low-tech segments, local independent innovation capability is weak, profits are relatively thin and there is limited production driven by local economy. Small firms and their employees suffer many difficulties due to this production pattern, difficulties that have been exacerbated with the 2009 financial crisis. From 2008, the price of electricity, water and coal have risen, but increases in production cost cannot be made up by raising product prices because most of these enterprises are extremely price sensitive, a large price increase may lead to the loss of many customers. Insufficiency of funds has become an urgent problem. Even before the financial crisis applying for a bank loan was very difficult; with the crisis banks have increased the price of credit for SMEs and many SMEs have defaulted and face bankruptcy. As in most BRICS countries, the cost of borrowing is unbearable to SMEs. Finally, with the increased educational levels being achieved by young rural workers, labour rights are becoming an important issue. The low-cost ‘rural workers economy’ that has fed the dynamism of the ‘Double Triangle’ area is not expected to subsist for long. The authors conclude that the competitiveness of the ‘World Factory’ region has been mainly built on the basis of low-cost, reflected in price advantages and that the lack of innovation ability and technological innovation in the leading industrial clusters is the crucial bottleneck that China faces during its current development phase. Sokolov and Rudnik provide an in-depth analysis of the major Russian industrial clusters, the wood-processing cluster in the Archangelsk Timber Products Region, the agrifood cluster in Krasnodar District, the chemical cluster in Perm District, and clusters in the Tatarstan Republic and Tomsk Region. In all of these, there is a relatively high participation of SME’s; and the analysis draws out the role and challenges to small and medium enterprises. In the Archangelsk Timber Products Region, for example, their participation is about 20% and these are mostly concentrated in the end-product sector (wooden furniture) and maintenance of the fleet of machinery and equipment. In the Krasnodar agrifood cluster, SMEs represent almost 50% of the enterprises in the cluster, these include processing companies, small food packaging firms, farms and SMEs in retail and catering. A noteworthy aspect is the high degree of cooperation between participants in this cluster; however, this is the exception not the rule in most industrial clusters, as discussed in the analysis of other Russian clusters and also in the Chapter on India. The strategic role of government support and active industrial policies to promote SMEs is drawn out in the subsequent analysis of Russian clusters. Perm District, with one of the most diverse and developed cluster portfolios in Russia, including leading clusters in strategic areas such as chemical, oil and gas production, power generation, engineering, aircraft engines and

27 power machine building, accumulated by the end of 2005, 10.6 thousand small enterprises, employing 89.4 thousand people. The participation of SMEs is over 30%. Additionally, small enterprises play an important role in the cluster's development since they make the most advanced and innovative products. Likewise, in the Tatarstan Republic the government has consistently pursued an active industrial policy, providing leasing and loan programmes with simplified procedures and preferential terms, free access to fairs and exhibitions, free or preferential terms for training and certification programmes, direct funding of specific projects enabling SMEs to replace equipment, launch new business initiatives, and other support. The regional economy is steadily growing, and the total number of small enterprises by the end of 2005 was 18.6 thousand, with a workforce of 146.5 thousand people. The final industrial cluster discussed, located in the Tomsk Region, also enjoys energetic government policies to support entrepreneurship. Although a large share of the industrial output is generated by a few large companies, such as Gasprom, SMEs comprise almost 50% of the regional economy and revenues generated by mining industries are used to diversify the region's economy promoting mostly high-tech SMEs. Tomsk is a major inter-regional education centre for the whole of Western Siberia and this is reflected in the competitiveness of companies in high-tech sectors including automatic control systems; telecommunication equipment; digital images and sound enhancing software; medical equipment and others. The Russian industrial clusters face difficulties that are peculiar to their own productive structures and the specific sectors and activities in which they are embedded, such as the environmental problems faced by the Archangelsk Timber Products Cluster, including depletion of forests; lack of clear federal and regional forest and environment policy; and the growing costs of transporting timber from forests to consumers. But they also share common challenges, not only with other clusters in Russia, but also broadening the base to consider other BRICS clusters. The most pressing shared challenges include lack of funding or difficulties in accessing existing credit lines; obsolete infrastructure; lack of skilled labour; inefficient tax administration; high administrative barriers; competition from manufacturers who use low-quality raw materials and competition from ‘shadow firms’. In addition, many of the clusters suffer from insufficiently developed engineering components and machinery manufacture; they typically have a comparatively low share of processing industries, making half-finished products for export and using low potential technologies. Perhaps the most important weakness pointed out by the authors is the “distinct separation of the enterprises from each other, there is a lack of interaction and links between them. Companies of the Tomsk ICT cluster practically don't compete with each other, but they don't have any motivation for networking and cooperation either.” The analysis of the role of SMEs in the manufacturing growth poles or industrial clusters of China and Russia points to the importance of policies that seek to enhance innovative density and diversity. The role of a Systems of Innovation perspective, particularly one that seeks to strengthen cooperative practices among the network of local and other relevant actors, is particularly significant. This understanding is crucial to address the challenges of upgrading these clusters from labor-intensive manufacturing clusters to innovative industrial clusters, thus improving both the competitiveness of SMEs located in the clusters and their domestic and international competitive advantages. 5) Policy recommendations and foundations for future research in the area

28 The five case studies in this book showcase important advances in our understanding of the role of SMEs in the National Systems of Innovation of BRICS. As summarized in Table 3 and discussed in the previous sections, these countries have pursued specific strategies to enhance SME’s growth, their chances of survival and the support institutions that provide business, technological and other development services. Innovation policies have targeted the promotion of agglomerations of firms, incubators and science and technology parks. There appears, however, to be a sharp distinction between policies that target high-tech innovative SMEs and those policies that aim to support the ‘survivalist SME economy’. As shown in column 2 ‘SME innovation Policy’, the focus of these policies is on innovative firms, and these are usually not articulated with broader SME development policies, including finance, family businesses and gender related policies. With the exception of Brazil, that has sought to implement policies using a Local Productive System approach, most SME policies and support mechanisms remain focused on single, High-tech, firms. Table 3 – SME Policies in BRICS SME SME Innovation Main support Innovation SME gender Policies Policy instituion* Finance policies Brazil ü Local Productive SEBRAE Innovation Funds ü Arrangements Russia ü University& industrial Rosnauka Innovation Funds - parks; innovation centres; industrial growth poles India ü MSMED Act, 2006; Ministry of - - clusters MSME China ü High Tech Zones; Productivity Innovation Funds - Incubators; S&T Parks, Promotion industrial growth poles Center South Africa ü SDI, clusters, SEDA Khula Enterprise ü Technology Stations Finance *In BRICS, SMEs are supported by a myriad of federal, state and local institutions. This column draws out the main institution responsible for technical, training and other non-financial support services. Many public initiatives to promote micro, small and medium enterprise have been justified based on arguments considering the reduction of economic, regional and social disparities. However, despite significant investment in the institutional framework to foster MSEs, initiatives focusing on single firms have been in many cases, inadequate, indiscriminate, uncoordinated and they have suffered from superposition and lack of continuity. Most importantly, small firm promotion objectives have frequently collided with macro-economic policy goals, budget constraints and, as illustrated in the case of India, with policy goals that seek primarily to enhance growth of SME output, capital intensity and their chances of participation in global production chains. The heart of policies for SME and industrial development lies in the financial dimension, specifically as it relates to SME access to credit and the mechanisms for financing SME innovation. The overwhelming failure of the current funding paradigm, structured to meet the demands of larger firms, is discussed in each one of the country chapters, but few strategies are presented to deal with this challenge. There is a belief that Innovation Funds and Venture Capital may provide the ‘magic bullet’ to boost the innovation system. However, as argued convincingly

29 in the NSI literature, these mechanisms depend on socio-economic specificities that are not usually present in BRICS and reproducing them may have limited impacts and uncertain costs. A more systemic and localized approach is needed. Particularly, the weak results so far in improving SME’s participation in the finance pie suggest that the design of new instruments requires a systematic effort to invert the logic of traditional resource offerings, created and offered in the belief that there exists a corresponding demand for these resources. A policy that prioritises small firms requires, in contrast, initiatives that strengthen the interaction between firms, financial and technological agents, in order to simultaneously strengthen various capabilities. An obvious point here is that policies have to be developed taking into account the specific requirement of the firms and contexts they are targeting, and not the other way round, that is forcing reality to adapt to them. It is therefore necessary to modify the prevailing culture in the environment where policies are formulated and operationalised, with a view to effectively changing the promotion and funding paradigm in order to tailor it to the MSE profile. It is important to bear in mind that the attempt to transform small enterprises into one collective agent, capable of filling in the mould designed for large firms, is only one of the factors that justify the support given to Local Systems, clusters and other agglomerations. The advantages go well beyond so-called economies of scale considering the opportunity to promote other important synergies, including processes of interaction, cooperation, learning and development of capabilities. The largest challenge to successful policy implementation resides precisely in the collective treatment of agents. As shown in the Brazilian experience, to create and make available the capabilities required to understand and translate the demands of SME and local agents is essential to developing partnerships that are prepared to think out collective solutions to specific problems and the means to best exploit growth potential. These themes and issues make it necessary to establish governance systems that include the multiple social actors that are most strongly affected and that are usually excluded from such systems. New intervention mechanisms should be found and traditional mechanism improved, particularly through the improvement of the articulation between local, state level and federal institutions. This task requires additional and unprecedented efforts, as well as requiring a systemic view for the construction of new frameworks, that also comprise inter-related issues including taxation, regulation and legislation. A better understanding of the role of SMEs in the national systems of innovation is critical to the overall transformation of the sector as well as to an improved innovation policy environment. Because it works with the opportunities, diversity and specificities of different territories the Local Productive Systems approach represents a powerful analytic and normative instrument to study and tackle regional imbalances and to foster development of local SMEs. The approach could also be usefully employed to study empirical and analytical issues that are not addressed in this book. Questions regarding innovation, development and strategies for environmental sustainability as well as implications of environmental policies adopted by other countries on SME competitiveness, for example, are hardly mentioned in the chapters of this book. International and domestic environmental legislation can represent a significant burden for SMEs and government support mechanisms may provide essential information on technological solutions, funding possibilities and others. Considering the impact of BRICS SMEs on the

30 environment and the pressing international demands for compliance to ever-increasing environmental standards, this is an area that merits greater research attention. Studies will also need to explore to a much larger extent the cooperative practices between small firms and other actors that are important in their environment. This relates not only to conspicuous, formalized cooperation mechanisms that are usually traced in formal innovation studies but also the more hidden and subtle links that are ‘invisible’. Thus, it is important to use a broad definition of innovation to encompass the less structured cases with intense participation of SMEs and with high levels of informality. This approach may render visible a wider array of actors, regions and activities thus justifying their inclusion in policy agendas. The discussion offered by the different authors in this book represents an important contribution to studies of innovation, SME and development. We hope that the discussion can stimulate further development of conceptual frameworks and analytical perspectives capable of dealing with the realities, challenges and opportunities of BRICS development and that enable the design of increasingly socially inclusive policy approaches.

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