Public Risk Capital Funding: additionality vs duplication Presentation by Charles Edquist CIRCLE, Lund University, Sweden at 5th European Conferance on Corporate R&D and Innovation. Industrial Research and Innovation: Evidence for Policy. Joint Research Centre Institute for Prospective Technological Studies of the European Commission Seville October 1-2, 2015 http://charlesedquist.com 1
Intro-trailer: Activities in Innovation Systems: 1. R&D 2. Education and training 3. Formation of new product markets 4. Articulation of quality requirements 5. Creation and changing organizations 6. Interactive learning 7. Creating and changing institutions 8. Incubation 9. Financing of innovation processes 10. Consultancy services TOGETHER THESE ACTIVITIES DEFINE AN INNOVATION SYSTEM THE SYSTEMIC VIEW HAS REPLACED THE LINEAR VIEW IN INNOVATION RESEARCH BUT NOT IN INNOVATION POLICY! 2
Rationales for policy intervention Two conditions must be fulfilled for public intervention to be motivated in a market economy: (1) Private actors must fail to achieve the objectives formulated; i.e. a problem must exist. The problems may concern the future. (2) Public actors must have the ability to solve or mitigate the problem. 3
Condition (1): What is a problem Condition (1) actually specifies what additonality is. In relation to what private organizations do, public action must: be supplementary! not duplicate! not replace! not compete with! not crowd out! The additionality condition is certainly not always fulfilled! 4
Condition (2): What is ability Resources and competence for policy design and implemention are required. Can be built up over time, i.e. be created. If not ability, the problem is unsolvable. 5
Financing of innovations Is crucial for turning knowledge into commercially successful innovations and to facilitate their diffusion Is an important activity in innovation systems Come primarily from private actors: from firms themselves (internal), stock exchanges, venture capital funds/firms, banks, individuals (business angels) However, private risk capital providers are reluctant to invest in early stages because of uncertainty and high risk. 6
Public risk capital funding In many countries public organizations also provide risk financing, e.g in the form of seed capital. Such public activities may/should be a component in a holistic innovation policy Public funding should be made available when additionality is at hand, i.e. when there is a valley of death This is, of course, the reason why the public risk capital funds are created to start with. It should be established exactly where (stages, sectors) there is a shortage of privat risk capital 7
The Swedish case: the situation (1) 17-18 billion SEK (2 billion Euros) have been allocated for public risk financing of innovations 3-5 billions have not been used for the purpose at all, but invested on the stock exchange. The rest has been invested mainly in late stages where public capital is not needed. 8
The Swedish case: the situation (2) The risk capital funds are often required to and/or inclined to make investments together with private risk capital providers - on equal terms. The public organizations are often required to show a profit by their statutes (decided by the government). These resources would have been sufficient to support 17 000 18 000 innovative projects or firms in early stages with 1 million SEK (100 000 Euros) each. 9
The Swedish case: a mess (3) There is inefficiency There is duplication There is crowding out The public risk capital provision is NOT market supplementing The co-investment condition draws public capital to late stages rather than drawing private capital to early stages Additionality and market supplementing is not at hand SOMETHING HAS TO BE DONE! 10
Possible solutions (1) One option is continued co-investments between private and public investors On equal terms? On unequal terms: lower returns for public agencies? The co-investments between public and private investors have to be done on conditions that actually give the private investors an incentive to invest in early stages the public investors must draw private investors into earlier stages. Which should be the character of such conditions? The devil is in the details They should avoid subsidies of private investments in late stages = How to assure additionality? 11
Why lower returns on public capital? It is not policy if the conditions and mechanisms are the same as for private investors. The public directly gets back 60 percent in the form of taxes. If a multiplier works, jobs and growth are created with more public income/return. 12
Possible solutions (2) Another option is that public risk captial funds invest by themselves, in the seed capital stages In principle: Yes Implications Do public organizations really have the competence to select among investment opportunities? A portfolio approach can be used, however. 13
Possible solutions (3) Label the financing public funding of research as long as possible. Provide public grants instead of risk financing. Provide public loans instead of risk financing. But then no large returns to public investors, even if extreme success. 14
An innovation policy drive in Sweden The Prime Minister created (2015) a National Innovation Council wtih himself as the Chairman = Highest priority! He appointed a Minister of enterprise and Innovation. He appointed a minister responsible for public procurement including innovation procurement. *This has already created a new separate public agency for procurement support in operation from September 2015. To support innovation-related procurement will be an important task for the agency. A National Procurement Strategy, where innovation will be important, will aldo be created. The system of public risk capital provision is being reformed see further! 15
The process of reforming state risk capital provision Various analysts pointed to the problem (2014). Issue raised in first meeting in the Innovation Council (Feb 2015) The Min of Enterprise and Innovation appointed an investigator immediately The investigator got three months for analysis and proposal (June 2015) Issue discussed again in the Council (Aug 2015) 16
Remaining problems The investigating could not inlcude a detailed mapping of where (stages, sectors, etc) there is a shortage of private risk capital. The main proposal is (still) that public and private risk investors shall invest together (fond-in-fond solution). The specific conditions must be clarified! We do not know the size of the subsidy needed to make private investors invest in stages that they spontaneously do not invest in. 17
How much lower returns? The current Swedish proposal is that the public funds shall not loose value in real terms which is also a return requirement. The return on private capital may be 5-7 percent. Is a subsidy of that size enough? Maybe a larger subsidy is needed to draw private capital to earlier stages what do, then, the EU state support rules say? 18
The continuing process The proposal has been widely sent out for comments. When an acceptable strategy has been designed, it will be sent to the Parliament for discussion and decision. Theis might happen during 2015, i.e. the process would have taken one year 19
The Swedish Innovation Council It is not a Science and Technology Policy Council or a Research and Innovation Policy Council There is another Council in Sweden for Research (chaired by the Minister of Research) This is an attempt to escape the linear model! The Councils in all other countries are linear, i.e. dominated by research (and there are many). 20
A holistic innovation policy Defined as a policy that explicitly integrates all public actions that influence or may influence innovation processes (for example by addressing all the ten activities in a coordinated manner). Takes all determinants of innovation into account (ten activities). It requires a very broad view of innovation systems, including all the determinants of innovation processes. It must include demand-side innovation policy instruments, such as innovation procurement 21
But policy is still linear! Innovation researchers have abandoned the linear view since decades. But innovation policies in practially all countries are still linear. Indicated by: the dominance of the expression science and technology policy and/or research and innovation policies That the provision of R&D results is the most important innovation policy instrument Innovation policy is far behind innovation research 22
WHY is innovation policy (still) linear? Policy-makers and policy analystswho come to innovation research conferences have also completely abandoned the linear view. Conclusion: The division line is within the policy realm! Governance matters! Community: policy-makers (adm/bureaucrats) and elected politicians Perhaps the dividing line is between these two categories? (Elected politicians take final decisions.) And: different views in finance ministries and other ministries? Or between ministries of research and ministries of Industries? Also: the R&D people are much better organized than the innovation people. 23
Next logical step: It should be that the Swedish govenment presents an innovation bill to parliament (which has never happened in any country. It would mean a consolidation of innovation policy as an independent policy area (just like research policy, and separate from research policy). I made a specific such proposal in an article in the largest Swedish newspaper 3 months ago. 24
References Edquist, C. (2014). Striving towards a Holistic Innovation Policy in European countries But linearity still prevails! STI Policy Review, 5(2), 1-19. Edquist, C. Innovation-related Public Procurement to Solve Societal Problems and Satisfy Human Needs, written for the Globelics Conference, Havana, Cuba 23-25 September 2015. Published as CIRCLE Working Paper, August 2015. Edquist, C. Systems of Innovation: Perspectives and Challenges, in Fagerberg, J., Mowery, D., and Nelson, R. (eds.) Oxford Handbook of Innovation, Oxford University Press, Oxford, November 2005, pp. 181-208. Edquist, C., 2011. Design of innovation policy through diagnostic analysis: identification of systemic problems (or failures), Industrial and corporate change no 20/6, pp. 1725-1753. Edquist, C., Hommen, L., and Tsipouri, L. J. (Eds.). Public technology procurement and innovation, Vol. 16, Kluwer Academic Publishers, Boston/Dordrecht/London, 2000, 311 pp. Edquist, C., and Zabala-Iturriagagoitia, J.M., Public Procurement for Innovation as mission-oriented innovation policy, Research Policy, 41 (10), December 2012, http://dx.doi.org/10.1016/j.respol.2012.04.022. Edquist, C and Zabala-Iturriagagoitia, J.M. Pre-Commercial Procurement: a demand or supply policy instrument in relation to innovation?, R&D Management, 2014. Edquist, C. Offentlig Upphandling och Innovation (Public Procurement and Innovation in Swedish), Report written for the Swedish Competition Agency, September 2014. Edquist, C., Vonortas, N. and Zabala, J-M (2014) Introduction in Edquist, C., Vonortas, N., Zabala, J-M., and Edler J. (eds) Public Procurement for Innovation, Edward Elgar Publishing Ltd, (forthcoming, 2014) Publications are available at: http://charlesedquist.com 25