Long-term Research and Innovation Policies for Sustainable Growth

Luc Soete

UNU-MERIT

Regions for Economic Change – Building Sustainable Growth, 20-21 May 2010, Brussels

Outline Cohesion Policy’s Contribution to Smart Growth from the perspective of a Knowledge

and Innovation based economy. Focus, as the title suggests, will be on long term research and innovation policies. These are essential for smart growth, but also for sustainable growth and for inclusive growth.

Structure will follow the three focal points of the EU2020 strategy discussion but keeping the private and public debt crisi(e)s as new background: Smart growth and the issue of long-term funding of research and innovation –

the rate of technical change – and the respective roles of private and regional, national and European public funds;

Sustainable growth and the (re-)discovery of the importance of the direction of technical change – at different levels, local/regional, national/European, global level our societies are confronted with major societal challenges;

Inclusive growth limited here to the issue of the regional impact of knowledge accumulation and innovation opportunities: an increasingly spiky as opposed to flat world?

1. Conditions for long term smart growth Investing in R&D and innovation: from Barcelona to EU 2020 and back… Barcelona target: asking the private sector for more investment in R&D without

offering a credible plan for integrating, or at least harmonizing, the remaining parts of the Single Market, was missing the point. Some basic economics: Companies invest private resources in R&D only if they consider the final market

large enough to recover the investment; Having national markets fragmented by regulation, language, and entry

processes, implies an increase in the marginal costs of the overall “time-to-market” decision, leading to a reduction in the rate of return to research investment;

The institutional separation between European research, European innovation policy and European competition policy, was an additional source of uncertainty.

For Barcelona to succeed there should have been a milestone strategy for the integration of Europe’s final product and services markets of most relevance to knowledge investments. While the services directive is now finally in operation, it doesn’t represent, nor correspond to a single innovation market.

The financial private and public debt crises raise dramatically the stakes: a new financial framework for funding research in Europe is urgently needed.

Proposal for a new 3% knowledge investment target Given the fiscal pressures on Member States’ budgets in the years to come, it is

crucial to stress today the particular role and responsibility of European governments towards a long term public commitment in support of research and innovation. Broaden the discussion on fiscal control to include the quality of MS’ budgets. The systemic aspects of knowledge are similar to those in finance, but are long term.

Proposal for a new 3% (of GDP) knowledge investment target, but one which focuses on what governments are directly responsible for.

Direct funding of public research at national, regional or European level; (In-)direct support for private funding of research: tax credits, public-private collaboration, researchers’

mobility schemes; European support programmes: FPs, ERC, JTI’s and other forms of co-operative research support; Higher education investment whether in terms of direct public funding or in terms of setting funding rules

such as height of the tuition fees. Such a new 3% target offers credibility: MS are challenged to either find public

resources to increase knowledge investments; alternatively to call upon private individual resources to invest in individuals’ higher education.

Private knowledge investments should not be used as national policy targets, rather they are outcome variables. If used as national policy targets they are more likely to lead to beggar-thy-neighbour policies attempting to attract such private investments in one country/region at the expense of another.

A target for all Member States

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Government-f inanced R&D Tertiary education - publicly funded Tertiary education - privatly funded

New public-private risk-sharing funding schemes Since 2007, the EIB with the support of DG Research (FPs) has been running a Risk-

Sharing Financial Facility: a debt-financed financing instrument to support private and public investment in research, development and demonstration as well as innovation across Europe.

The RSFF is managed by the EIB (standard rules, regulation and procedures), and aims at adding value in areas where the financial market cannot provide the required funding while EIB can leverage private funds.

The amounts of support are significant: the contribution of EIB and EC is euro 2 billion, providing loan finance and/or guarantees in the order of euro 10 billion to eligible RDI investments for the period 2007-2013.

The RSFF provides an interesting innovative approach to public-private partnerships in risk-sharing within the present private and public debt crisis situation: Creates positive feedbacks in markets at a difficult time for companies; Combines budgetary European FP7 resources with loan resources creating at the same time a new

revolving funding basis for research and innovation.

2. Achieving sustainable smart growth The focus in knowledge and innovation policy, has been since Lisbon on increasing

the “rate” of technical change. More research, more innovation is good for you. On what should be left open to markets and to the interest of researchers. Policy makers seem to have forgotten about the direction of technical change. Again some basis economics: remember the first, seminal NBER book on research and innovation published in 1962 on The Rate and Direction of inventive Activity.

Sustainable development belongs to the category of major societal problems that cannot be solved in a reasonable time without a strong coordinated input requiring both technological and non-technological innovation, and at times, advances in scientific understanding.

The central issue is at the opposite end of the previous one. Can resources, not just research but also procurement and other investments, be shifted across different national/European stakeholders to more productive “societal use” to influence not only the rate but also the direction of technical change and innovation?

Societal Challenges are not grand rather they raise grand policy challenges: how to achieve compatibility between top-down initiatives and a more bottom-up, market-driven resource allocation logic that allows for multiple decentralized experiments.

Existing technologies: is it easy to be green? Using currently available technologies to control emissions could appear at first sight to be the

most sensible thing to do. However, doing so would fix the energy consumption characteristics of that machinery and equipment at a level dictated by the present state of technology, whereas much energy conversion machinery, like a coal-fired or gas-fired power plant, has a technical lifetime of three decades or more.

In a situation of ongoing technical change, committing investment resources to produce output now essentially entails foregoing producing those same units of output with even more efficient equipment in the future. Investment in current technologies entails the loss of the option to invest in superior future ones.

The result is a tendency to postpone investment not just because of a lack of trust, as in the present economic crisis, but even in good times for perfectly respectable reasons. From a long-term point of view, postponing investment may have its merits.

Publicly funded R&D will be necessary to share the risks of developing the technologies: this would provide the private sector with the opportunity to build on these technologies through less risky, applied R&D. At the same time R&D diversification will be essential so as to ensure that other potential technology options would either be in the pipeline, or could be scaled up if so required.  

Two central research/innovation trajectories The scale and complexity of the scientific and technological efforts require that measures that

enhance the effectiveness of both public and private research investments and technology transfers in a wide array of “green technologies”, facilitating also knowledge-sharing, adaptation and diffusion of innovations.

Two major trajectories of research and innovation can be thought off. One focusing on reductions in the energy/ecological footprint of high income consumers ( the vertical arrow in the figure below) One focusing on increasing development in an energy/ecological sustainable fashion (the horizontal arrow in the figure below)

Such a vast research and innovation program also entails a critical rethinking of ways to mitigate the inhibiting effects on exploratory research and cumulative incremental technology development that arise from the intellectual property rights regime. Targeted domains for research exemptions, defined fields in which a liability approach to IPR infringement replaces the existing property rights approach, and competition policy adjustments to permit efficient pooling of patent, copyright and database rights, are likely to be needed.

A smart, green economy is therefore less likely to lead to the sort of technology-based competitiveness monopoly rents and advantages typical of other major technological breakthroughs. Citizens in Europe, the US, or Japan, are ultimately dependent in their sustainable future on the speed of (green) knowledge diffusion in both their countries as well as those in the rest of the world..

The global sustainability smart research challenge

3. On inclusive social cohesion smart growth At the geographical level, the crisis is likely to increase the gap between front runners

and laggards in knowledge investments by exacerbating the different existing capacities of countries and regions to respond. The crisis challenges directly both the limited degrees of freedom offered to laggard countries being part of the euro-zone (Greece, Portugal, Spain, Ireland) and regional cohesion policies, and in particular the role of research and innovation in those policies.

At the same time, the search for excellence in research and innovation is also challenging social cohesion policies in Europe. The European Research Area is likely to become more spiky and less flat. At the same time, income inequality in Europe is already higher than in the US and other large countries in the world.

At the organizational level, the crisis leads to a further increase in the off-shoring and outsourcing of private R&D: a more rapid relocation of certain parts of R&D, in particular development, to cheaper locations with good access to S&E within and particularly also outside the EU.

Yet. the open innovation paradigm offers also new opportunities for local public-private collaboration and for young innovative SMEs.

Income spread across regions

The need for new regional smart knowledge policies There is now a limited window of opportuntiy – three years – to address the

competitiveness gaps across EU MS (and regions) particularly of those countries within the euro-zone confronted with large public deficits. Adressing those competitiveness gaps will need to recognize the under-exploited opportunities for smart, local knowledge specialisation as opposed to aiming for the Barcelona targets.

However, prevailing institutional conditions in partly fragmented European markets raise formidable barriers which have limited the overall success of this process so far. There is a need for an EU-wide scheme that strengthens links between high regional performers in research, innovation and entrepreneurship, and promote the evolution of regional specialization based on growth of young innovative firms.

Smart knowledge specialisation is in need of smart research and innovation polciy governance. Research quality assessment is heavily dependent on scale: the European scale is the logical scale for most publicly funded research activities, for reducing costs in selecting and evaluating research proposals and for enabling high quality research specialization; Europe’s regional scope represents the long tail of European opportunities for growth specialisation based on diversity.

A formidable challenge for Europe, given the wide diversity in income levels across regions but the growing converging aspirations of European youngsters.

Need to revisit cohesion policy

A couple of proposals: Allocate a greater proportion of structural funds to the development of applied

research and innovation capacity. In particular, make the provision of structural funds conditional upon the development of local, smart and open specialisation strategies.

Develop a regional Risk-Sharing Financial Facility (RSFF) in collaboration with the EIB.

The notion of RSFF can be expanded in different directions: e.g. RSFF is currently being expanded into risky climate change projects: carbon capture storage and innovation renewal technology projects. In this case the EIB will be combining grant funding (coming out of the monetization of CO2 allowances: some 300 million of the NEReserve will be sold for cash on secondary markets) with its own loan provision system under RSFF.

A similar scheme could be set up in relation to structural funds, increasing dramatically the leverage on local public and private funding . Furthermore the EIB expertise in selecting projects is likely to have a crucial additional feature on the economic impact of structural funds.

Start by allocating currently non–used cohesion funds to such a regional RSFF, increasing gradually the volume amount of RSFF. By linking European structural grant funds with an EIB debt-loan facility, one will add a specific economic prioritization – the capacity of generating in the long term an income revenue stream -- in the submitted projects for structural funds bringing to the forefront in more explicit way the growth and competitiveness potential of such cohesion support.