INDUSTRIAL POLICY AND INNOVATION: RETHINKING INNOVATION POLICY IN AN INCREASINGLY INTERDEPENDENT GLOBAL ECONOMY

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1 INDUSTRIAL POLICY AND INNOVATION: RETHINKING INNOVATION POLICY IN AN INCREASINGLY INTERDEPENDENT GLOBAL ECONOMY Carl J. Dahlman Georgetown University Presentation at International Seminar: Industrial Policy for the 21rst Century May 10-11, 2012 Rio de Janeiro Brazil

2 Structure of the Presentation 1. Argument in a Nutshell 2. Definition of Industrial Policy 3. Rationale and Focus for Industrial Policy 4. Critiques 5. Sectoral vs. Functional Approaches 6. New Global Context 7. From Industrial Policy to Innovation Policy 8. The National Innovation System 9. The Global Innovation System 10. Innovation Policies for the New Context Data Annex

3 1. Argument in a Nutshell There is a renewed interest in industrial policy because the global context has changed. The focus has changed from traditional protection of industrial sectors to innovation policy This is complicated because innovation system is now global Objective is now how to maximize benefits from this new system Easier for follower or catch up policies than for frontier so countries should fully exploit catch-up But countries should also develop research capability for frontier work, but take advantage of global networks

4 2. Definition of Industrial Policy There are many definitions Core of the definitions is attempt by government to intervene through various ways to promote a specific industry or sector or to change the structure of production in a way that is expected to offer better growth prospects for the country Originally applied quite narrowly to industrial sectors Now more generally applied to any economic sector, including services and even agriculture (such as to promote high value agricultural products) Also is generally applied in the context of favoring domestic versus foreign industries

5 3. Rationale and Focus of Industrial Policy Rationale: Market Failures Externalities Lumpiness (scale) Capital market failure Coordination Failures Focus Developing specific industrial sectors such as: Steel Shipbuilding Automobile Semi-conductors

6 4. Critiques Government Failure Government not likely to be able to second guess market But easier for government to do when it was in catch-up mode with more advanced countries Much more difficult to do when at frontier Government Capture By very groups it was trying to promote General problem of corruption Generally argued that industrial policies has failed in most countries because of lack of capability to plan and especially to implement, but also because of capture and corruption However, some countries seem to have implemented industrial policy successful Japan partially under MITI in 60 s-80 s Korea, Taiwan, Singapore, to some extent Malaysia China

7 5. Sectoral vs. Functional Approaches Targeting of specific industries and providing them assistance through Tariff and non-tariff barriers to imports Financial incentives such as subsidized loans Fiscal incentive such as tax holidays, duty free access to inputs Grants including low cost or free land Procurement preferences Equity or even full ownership as state owned enterprises Coordination of investments for specific industries Functional or horizontal intervention Strengthening financial system and facilitating access to credit Strengthening education and training Subsidizing R&D Improving physical infrastructure, energy, and information and communication technologies

8 6. New Global Context More interdependent world Share of imports and exports in World GDP increased from 40 % in 1990 to 63% in 2007 Reduction in transport and communication costs Greater globalization of knowledge Major structural break as result of 2008/2009 economic crisis Developed economies hardest hit, slow recovery Emerging and developing countries less affected, growing faster Greater competition from new entrants China Other Asian countries Changing economic power Decline of U.S. and Europe Rise of BRICs Awareness there is something new under the sun: global CO2 emissions constraint

9 IMF Global Growth (quarterly change from prior year) Source: 9/2011 WEO, p.7.

10 Major Shifts in Economic Size: Share of World GDP in PPP (IMF data and Projections) U.S EU China Source: IMF DataMapper 4/39/2012 France Brazil Germany Japan Russia India

11 China s Exports Surpassed US in 2006 and Germany in % Share of Total Global Merchandise Exports % 10.00% China 8.00% India Germany Japan 6.00% France Italy United Kingdom 4.00% United States 2.00% 0.00% cjd % of Global total

12 7. From Industrial Policy to Innovation Policy Governments have realized that Countries are more dependent on international markets and globalization Some countries have been effective at using industrial policy. But there are also more global rules now which do not allow some of the traditional industrial policy instruments Industry (and manufacturing) are shrinking share of GDP, services are a rising share The have also realized that competitiveness depends more on technological change and innovation than just on basic factor conditions Therefore there is now more focus on innovation policy rather than just industrial policy

13 Free Market/Innovation/Industrial Policy

14 Structure of Output by Income and Region 2000 vs WDI 2012 p. 221

15 Broad Definition of Innovation Innovation is a concrete application of knowledge as opposed to invention which is the first conception of something new. Innovation can be a new product, a new process, a new service, or new way of organizing production and distribution of goods and services. Four main types of innovation can be distinguished. Frontier innovation in the first application of the innovation in the world. Radical innovation refers to a major change in the technology. Incremental innovation refers to small changes that improve the innovation. Often incremental changes can be cumulative and can greatly improve the performance of the product or service over time. Most innovation is incremental. Catch-up innovation in the first application in a specific country of an innovation that already exists elsewhere in the world. This is particularly relevant for developing countries because by definition they are behind the world frontier. In addition much knowledge already exists beyond their frontiers and it is generally easier, less risky, and less costly to acquire it from elsewhere than to develop it independently again. Recombinant innovation is an innovation that does not imply new knowledge, but is based on combining existing knowledge in different ways. Inclusive innovation is innovation that focusses on goods and services for the poor: it can be high tech or low tech, new or recombinant.

16 8. The National System of Innovation Narrow Innovation System Universities Researchers Universities R&D labs Public R&D labs Firms and firm R&D labs Regional Innovation Systems (RIS) Science Parks and Industrial Clusters Networks among the above and between them and foreign correlates Angel, venture capital and early stage finance for technology start-ups Technology infrastructure (MSTQ, norms and standards) Government policies aimed explicitly at the narrow innovation system (R&D funding and subsidies, IPR, etc.) Broader Context of Innovation System (Enabling Environment) Market size, sophistication, and growth Economic and firm structure Trade policy and domestic competition People & labor force, and their level of education & skills The education and skills development systems Entrepreneurship and risk taking culture, and quality of life Financial system including banking and equity markets Investment climate-macro conditions, ease of operating a business Infrastructure including especially ICT infrastructure Quality of life Government policy that affects factor and market conditions, economic and firm structure, infrastructure, and how all these interact in the enabling environment

17 copyright cjd 9. The Global Innovation System

18 The World of R&D 2011

19 Ten Largest Tertiary Student Populations 2009 (Thousands) Country Number of Students Percentage of World China 29, US 19, India 14, Russia 9, Brazil 6, Indonesia 4, Japan 3, Iran 3, South Korea 3, Ukraine 2, World total 168, Source: UNESCO Global Education Digest 2011, pp

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23 Science and Engineering Journal Articles by Region/Country Source: U.S. SEI 2012

24 Main Stages and Agents of Innovation Cycle There are many intermediary steps between research and innovation. These are not always linear and sequential because often the idea for an innovation may come from consumers, or from the experience acquired in production and delivery of goods and services. Also, innovation can occur without any formal R&D such as many innovations which consist of new ways or organizing production or distribution of products and services There are also many agents involved in the innovation cycle: governments, private firms (including finance and venture capita, universities, NGOs, individual)

25 Main Agents and Stages of Innovation Cycle Innovation cycle/ Main Agents Government SOEs Research Development Engineering & Scale- Up Government Research Institutes Government funding of university and private sector research (mostly basic) Important performers of own research, and some funding by universities and others Government Research Institutes Government funding of private sector development Development work for own technologies Government Research Institutes Some government funding of scale up by private sector Scale up of own technologies Production and Commercialization Some support of private firms mostly in military area, but mostly through SOEs May be important producers of goods and services, especially in developing countries Dissemination and Use Work of own ministries through use of new technologies plus explicit dissemination efforts by ministries Through own growth, licensing and strategic alliances Private Firms Main performers and funders of all research in world Main agents in development Individuals Inventors Very little development work by individual inventors Grassroots innovators Universities NGOs Main agents in scaling up Very little scale-up by individual inventors Main agents in production Through licensing of technology to productive enterprises or own startups Non-formal if any Non-formal if any Very rarely Usually limited to own use Important performers of Some development Little scale up University Spin offs R&D, particularly basic work Licensing of research technologies to productive sectors Funding Research (mostly by Foundations) Not very common, though some do produce Through own growth, licensing or other strategic alliances Ultimate users of innovations Very little dissemination Key agents in dissemination of knowledge: teaching, papers, conferences, consulting Dissemination of appropriate technologies, through advocacy, demonstrating projects, finance

26 Key Functional Inputs into Innovation Cycle Innovation. value chain Research Development Engineering & Scale-Up Production & Commercialization Dissemination & Use Main Type of Factor Inputs Key Knowledge and Information Scientific and Technical knowledge Scientific and technical knowledge Mostly engineering knowledge Knowledge of how to start or expand a business Information on market Knowledge of how to run a business Information on market Key Human Capital Research Scientists and Engineers Research Scientists and Engineers Engineers Entrepreneurs and Managers Managers Key Financing Main financing for research own resources of firms, universities, or individuals, supplemented by government grants or angel capital Angel capital and some early stage finance mostly by government Some venture capital once there is proof of concept Venture capital for start-ups Bank finance or equity markets for already established firms Normal finance through operation of financial sector

27 Transnational Companies are the Key Global Innovation Agent They account for more than 60% of all R&D in world Less of basic research Most of the development and commercialization They account for 2/3rds of world trade Half is intra firm trade between affiliates Other half is with third parties They account for more than 27% of global value added Underestimate because does not include backward and forward linkages They control global supply and distribution chains They are scouring globe seeking talent and markets, and competing based on innovation, scale and speed. Therefore they are key agent that needs to be taken into account in developing effective knowledge strategies They have become global corporations, losing allegiance to home countries in pursuit of profits Countries need to find productive way to engage with them to leverage their technological capabilities TNCs also need to be enlisted in efforts to provide innovations relevant for the poor, as well as to address global public goods, particularly global warming

28 Role of Government in Innovation Cycle Setting up an enabling innovation environment Policies Institutions Infrastructure Overcoming market failure Non rivalrous, non excludable Lack of risk finance Information asymmetry Coordination problems But watch out for government failure Inefficiency Capture Corruption

29 9. Innovation Policies for New Context Key is how to tap into and benefit from the global innovation system To do this need: Dynamic entrepreneurial firms Good general education plus high level human capital Research capability (research universities, government labs, firm research labs) A supportive enabling environment In short, a strong national innovation system But need to avoid focusing too narrowly on upstream R&D and neglecting the downstream parts of engineering and scale up, production and commercialization, and dissemination. There is also need and potential in developing and applying green technologies

30 Key Points for Developing Countries -1 Need to be very good at tapping global knowledge through all its forms Trade, technology, licensing, FDI, participation in global value chains Foreign education and training, participation in trade fairs Global research networks, accessing technical publications and data bases Copying and reverse engineering Need to build up domestic capability This requires not just education in general but entrepreneurship and business management, as well as science and engineering Also requires institutions and mechanisms to provide re-skilling and up-skilling to keep up with new technology and business needs

31 Key Points for Developing Countries -2 Catch-up strategies are easier than pushing back the global frontier so must exploit these opportunities However developing countries also have to develop capability to do some frontier work Need to get in on potentially new and exciting technologies that may be key to new technological revolutions Should explore some areas of nanotechnology and biotechnology by joining global research networks in these areas How much to invest and in what areas depends on countries capabilities and ambitions Need to put explicit effort in getting from research to actual use and diffusion Knowledge is sticky so there is need to build up technology clusters because of agglomeration economies and the importance of tacit knowledge transfers through personal contacts However, these clusters need to be networked internationally as well as nationally

32 Framework of Insead s Global Innovation Index

33 Insead s Global Innovation Rankings

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35 ITIF Global Innovation Policy Index Rankings 2012

36 Brazil SWOT Analysis Strengths Natural resources Young demographic Size Government stability Large energy resources with new pre-sal discoveries Social cohesion Benign climate Good neighborhood Good political leadership on macro since Cardozo Positive actor in global governance Opportunities Invest petroleum windfalls wisely (education, R&D, infrastructure, social safety nets) More investment in poverty reduction and social infrastructure Develop technology for deep oil extraction Develop green technologies Promote regional integration and south-south trade Be more proactive in international diplomacy Weaknesses Education Still high inequality Legacy of protectionist policies Resurgence of heavy handed industrial policy Bloated and expensive government Lots of red tape and regulation Corruption Poor infrastructure Low R&D especially by private sector Overvalued currency Weakness in competing with Chinese manufactures Threats Risk of Dutch disease Risk of breakdown of social cohesion if cannot provide full employment Risk of spread of drug economy Risk of distortion in infrastructure investment to games, not best economic use Environmental risk with unsustainable agriculture, deforestation, and global warming China slowdown or crash will hurt Brazil's commodity exports

37 Changing Relative Shares of Merchandise Exports Brazil vs. China 2000 vs Total Merchandise Exports (US billions) Brazil China ,578.2 Percentage Breakdown ( SITC) 0+1 Food, beverages& tobacco Materials and vegetable & animal oils Mineral fuels Chemicals and related products Manufactured goods classified by materials Machinery and transport equipment Miscellaneous manufactures Not elsewhere classified

38 Implications for Brazil Brazil is still a small player in the global innovation system Brazil needs to increase its innovation potential Two components Tapping into global knowledge networks Strengthening domestic innovation potential Improve the investment climate Invest natural resource windfalls in education, especially tertiary education and research universities, and STEM R&D infrastructure Avoid appreciation of exchange rate Strengthen diversification of economy Leverage the attractiveness of its domestic market Leverage its global position as green economy

39 THANK YOU! Carl J. Dahlman

40 Total R&D and Percentages by MNCs & other Firms vs. Government and Others Total $982 Percentage Top 1000 MNCs Next 1000 MNCs Smaller MNCs and other companies Government, non-profits, other [Memo: top 20 MNCs] [$128.5] [13.1] Soured: Jaruzelski and Dehoff (2008)

41 Tertiary Students Studying Outside of Home Country 2009 Number of Students As Percentage of Domestic Enrolments As Percentage of World Total Brazil 26, China 510, India 195, World Total 3,369,242 Source: UNESCO Global Education Digest 2011, pp

42 Academic Ranking of Universities 2011

43 Academic Ranking of Universities 2011

44 Exports of High Technology Products by Region/Country (U.S billions)

45 Exports of Commercial Knowledge Intensive Services By Region/Country U.S. Billions

46 Public Stimulus Funding for Clean Energy and Technologies by Selected Region/Country (U.S. Billions)

47 Financial New Investment in Clean Energy and Technologies (U.S. Billion) Source: U.S. SEI 2012