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Public Disclosure Authorized IGNITING INNOVATION Public Disclosure Authorized Rethinking the Role of Government in Emerging Europe Public Disclosure Authorized and Central Asia Itzhak Goldberg John Gabriel Goddard Smita Kuriakose Public Disclosure Authorized Jean-Louis Racine This report is part of a series undertaken by the Europe and Central Asia Region of the World Bank. Earlier reports have investigated poverty, jobs, trade, migration, demography, and productivity growth. The series covers the following countries: Albania Lithuania Armenia Macedonia, FYR Azerbaijan Moldova Belarus Montenegro Bosnia and Herzegovina Poland Bulgaria Romania Croatia Russian Federation Czech Republic Serbia Estonia Slovak Republic Georgia Slovenia Hungary Tajikistan Kazakhstan Turkey Kosovo Turkmenistan Kyrgyz Republic Ukraine Latvia Uzbekistan IGNITING INNOVATION IGNITING INNOVATION Rethinking the Role of Government in Emerging Europe and Central Asia Itzhak Goldberg John Gabriel Goddard Smita Kuriakose Jean-Louis Racine Europe and Central Asia Region ©2011 The International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org All rights reserved 1 2 3 4 14 13 12 11 This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The findings, interpretations, and conclusions expressed in this volume do not neces- sarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judge- ment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Rights and Permissions The material in this publication is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. The International Bank for Reconstruction and Development / The World Bank encourages dissemination of its work and will normally grant permis- sion to reproduce portions of the work promptly. For permission to photocopy or reprint any part of this work, please send a request with complete infor- mation to the Copyright Clearance Center Inc., 222 Rosewood Drive, Danvers, MA 01923, USA; tele- phone: 978-750-8400; fax: 978-750-4470; Internet: www.copyright.com. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: [email protected]. ISBN: 978-0-8213-8740-5 e-ISBN: 978-0-8213-8741-2 DOI: 10.1596/978-0-8213-8740-5 Cover illustration & design: Romain Falloux Cover image of Sputnik-1: NASA/Asif A. Siddiqi Library of Congress Cataloging-in-Publication Data Igniting innovation : rethinking the role of government in emerging Europe and Central Asia / Itzhak Goldberg ... [et al.]. p. cm. Includes bibliographical references. ISBN 978-0-8213-8740-5 (alk. paper) ISBN 978-0-8213-8741-2 (e-ISBN) 1. Research, Industrial—Economic aspects. 2. Endowment of research—Europe. 3. Endowment of research—Asia. 4. Government spending policy. I. Goldberg, Itzhak. HC79.R4I38 2011 338’.064094—dc23 2011024386 Contents Foreword ix Acknowledgments xiii Contributors xv Abbreviations xvii Overview 1 Why innovation matters 4 Acquiring technology from abroad 9 Connecting research to firms 12 Restructuring options for RDIs 14 Bringing innovations to market 14 1. Why innovation matters—and what the government should do about it 19 The rationale for innovation 26 Coping with spillovers 28 Coping with unequal information and the “funding gap” 30 Why the government should play a role 33 2. Acquiring technology from abroad—leveraging the resources of foreign investors and inventors 39 Cross-border knowledge flows 42 Acquiring foreign technology 54 How well do ECA firms absorb knowledge? 62 Case study: The role of FDI in helping Serbia acquire technology 69 v vi Contents 3. Connecting research to firms—options for reforming the public RDIs 81 Incomplete restructuring of RDIs 83 RDIs outside ECA 85 A snapshot of RDIs in ECA 91 Government funding and governance 100 A roster of obstacles 106 A proposed RDI reform strategy 110 Options for restructuring RDIs 112 Options for public funding to support RDI reforms 115 Case Study: Finland’s shift to a knowledge-based economy: The Role of TEKES 118 4. Bringing innovations to market—boosting private incentives through public instruments 123 Basic principles of instrument design 125 Basic types of instruments 131 Financial instruments for ECA 135 Institutional support instruments 144 Monitoring and evaluation 148 Conclusion 151 Case study: How Israel has promoted innovation in recent decades 152 References 157 Boxes 1 Demystifying innovation and absorption 5 2 Poland at a crossroads: Expanding from technology absorption to broader meanings of innovation 6 1.1 Defining innovation and absorption 21 2.1 A snapshot of coinvention in Poland 53 3.1 Restructuring of RDIs faces important legacy challenges 109 4.1 Catalyzing private sector innovation in Turkey through an improved institutional environment and financial instruments 127 4.2 Using grants and loans for innovation support in Croatia 132 4.3 Do matching grants for industrial R&D help the Israeli economy? 138 4.4 Armenia’s efforts at enterprise incubation 144 Contents vii Figures 1 ECA’s R&D efficiency is still low 8 2 ECA needs to boost its R&D spending 8 3 The expanding role of international coinvention in the ECA 7 10 4 A call for policy reforms and capacity building 13 1.1 ECA needs to boost its R&D spending 23 1.2 ECA’s researcher population is unevenly distributed 24 1.3 ECA’s R&D efficiency is still low 25 1.4 Corporate ventures and the government play a key role in the early stages 32 2.1 Innovation and absorption spur growth and productivity 41 2.2 ECA inventive activity on the rise 44 2.3 Hungary and the Czech Republic lead the ECA patents race 45 2.4 Russian Federation’s patent share could be even bigger given its size and scientific strength 46 2.5 EU12 losing its edge on China and India 47 2.6 The expanding role of international coinvention in the ECA 7 48 2.7 Germany dominates ECA coinventions 49 2.8 Expanding role of international coinventions in the Russian Federation 50 2.9 Revenue and employment trends pre- and post-acquisition 72 3.1 Number of annual publications per RDI staff 97 3.2 R&D and technical services to industry mostly marginal compared with public funds 98 3.3 Some ECA RDIs generate as much industry revenue as international benchmarks, but this is not the norm 99 3.4 SMEs could make greater use of RDIs 100 3.5 A bias toward a few types of funding sources 101 3.6 Too few private sector board directors 103 3.7 RDIs’ salaries not attractive enough 106 3.8 Chain of events leading to ineffective RDIs 108 3.9 Factors affecting RDI performance 108 3.10 RDI restructuring strategies 111 3.11 RDI reform decision tree 112 3.12 The less the government funding, the more market pull dominates 116 3.13 Finland’s business sector is sharply stepping up its R&D 119 3.14 Finland’s successful innovation environment 120 viii Contents Tables 2.1 Top generators of Russia-based U.S. patents 51 2.2 Openness is better: Link between international interconnectedness and technology absorption 65 3.1 A massive overhaul of RDIs in the 1990s 84 3.2 A successful strategy typically reflects market needs 88 3.3 Foreign comparator RDIs vary in size and ownership 93 3.4 Specializations of the RDIs in the ECA sample 94 3.5 Restructuring options for ECA RDIs 113 Foreword Innovation and technology absorption are now firmly recognized as one of the main sources of economic growth for emerging and advanced economies alike. That is why igniting the latent potential of the innova- tion systems in Europe and Central Asia (ECA) is seen as a possible cata- lyst for revitalizing the economies after the recent shocks of the global financial and economic crisis. More active government intervention to support innovation is being weighed as a tool to transform failing indus- tries, develop new industries, and speed up a recovery process of export- oriented industries. Even for countries lucky enough to have substantial natural resources, there is a pressing need to move up the value chain and diversify their economies to mitigate future price shocks. Is there a role for government intervention to ignite innovation in ECA? This is the central question to which this book responds. The answer is yes, but a qualified yes. Innovation activities are rife with mar- ket failures that tend to hold back private investment. Yet at the same time badly designed or badly implemented interventions can further hamper the development of an innovative and entrepreneurial culture among businesses and research communities. The new evidence mar- shaled by this book coincides with a growing academic literature that shows that interventions will lead to firm-level productivity and sustain- able growth under certain conditions—domestic competition, interna- tional trade flows, research and development (R&D) collaboration, worker mobility, foreign direct investment (FDI), and good governance and transparency in the innovation agencies. For ECA, a first step in revitalizing its economies will be absorbing global technology through trade, FDI, or licensing. But given that this process is not guaranteed or cost free, firms and countries will need to invest in developing their absorptive capacity. The good news is that ix x Foreword there is a tradition of excellence in learning and basic research in many ECA countries that provides the base for future commercial innovation.