Innovation for Growth – i4g

Policy Brief N° 1

Innovating out of the crisis: Designing a new European Annual

Growth Strategy1

Luc Soete

The Annual Growth Survey (AGS 2012) needs radical structural reforms in analogy with the three

headlines of the Europe 2020 strategy

Smart growth requires smart public policy by:

A stronger cooperation in R&D with third countries and a stronger focus on the deployment of ICT

based technologies due to the internationalisation of knowledge;

A shift from the Barcelona target to a new 3% knowledge investment policy target consisting of a 2%

higher education and 1% public R&D effort.

Safeguarding public knowledge investments from any fiscal consolidation measures;

Limiting R&D tax credits across all EU MS to 0,1% of GDP to avoid "net welfare losses" as well as a

"beggar-thy-neighbour" effect

Sustainable growth – influencing the direction of technological change by:

Establishing a European policy commitment to "green technologies"

Enhancing both public and private research investments and technology transfers and redressing the

protection of intellectual property rights for those technologies.

Making the EU a global leader by “Innovation Partnerships” for green technologies by priority

inclusion of China and the other BRIC+ countries.

Safeguarding social cohesion in a Euro-crisis by:

Leveraging structural funds to boost local innovation and efficiency gains in the public sector:

Smart public specialization leading into a new phase of economic integration of public services in the

EU.

Pilots for new innovative procurement of debt stricken countries, regions or municipalities in Greece,

Portugal, Spain or Italy by new North-South European Private-Public Partnerships aimed at reducing

public electricity expenses and based on new creative financing solutions.

Granting EC structural funds as a form of regional RSFF by shifting the purely grant nature of structural

funds to a loan facility.

1 These comments are based on a number of previous presentations including expert group reports for the EC and for the ERAB, with amongst others Andrea Bonaccorsi, Dominique Foray, Anne Glover and Jan van den Biesen. I’m particularly grateful to comments from I4G members. The views and opinions expressed here are, however, my own.

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Abstract

As in other cases, a crisis brings diagnostic clarity. From this perspective the current crisis points to

the need to re-address the Lisbon strategy in a more radical fashion than proposed in the Europe

2020 strategy. The Europe 2020 strategy addressed the right issues: achieving in Europe over the

present decade a process of smart, sustainable and inclusive growth. However, today it provides

poor insights into how such a process could be achieved over the next years: witness the Annual

Growth Strategy 2012.

In this paper three areas are discussed where the strategy needs urgently to be revamped.

First and following the strategy’s emphasis on smart growth, a plea is made for a much more explicit

quantitative commitment to public knowledge investment. It has been too easy for European MS to

propose a knowledge investment target – the 2002 Barcelona 3% R&D target – which put the efforts

of knowledge investment primarily with the private sector: the economic sector which given the

internal European and external global market pressures it is subject to, is the least in need to be

incentivized by policy designed investment targets. A commitment to public knowledge investment

by contrast is particularly needed today because the 3% fiscal deficit target within the growth and

stability pact does not pay any attention to the quality of government outlays. Tow concrete

proposals are made: In short, smart growth requires smart public policy.

Second, shifting the emphasis on sustainability as the new direction for European research and

innovation growth cannot be based on the old paradigm of extracting international “monopoly

rents” out of the new sustainable eco-innovations and eco-services, European firms might produce.

Building competitiveness on sustainability requires a different growth model. One in which the

benefits are domestically translated in a European more qualitative “green” growth path and one

based on a more globally open, research and innovation policy based on global “innovation

partnerships”.

Third, the aim of achieving inclusive growth is directly challenged by the sovereign debt crisis. There

is a need to rethink the way structural funds can be used to help peripheral and cohesion regions to

unleash their own indigenous growth potential. The notion of smart specialization needs to be

broadened here to include more explicitly the public sector, what has been called smart public

specialization.

Introduction

The hypothesis I would like to put forward here is that the current European crisis is illustrative of a

broader failure to integrate across Europe some of the core “real” production factors behind

economic growth.

With the Single Market, and broadly in line with the origins of the Economic Commission for

Coal and Steel, the basis of European integration was the common economic aim of reducing

barriers to trade and in particular getting access to energy (coal) and capital, considered in

the 50’s and 60’s of the last Century as strategic production factors. At the same, consumers

benefited from cheaper prices and from enlarged product choices. The large Single Market

became the economic foundation for the European Union, laying the basis of reaping the

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economic scale advantages of the growing size of the EU. At the same time, the various

enlargement waves provided the EU with more or less continuous, new catching-up growth

opportunities, increasing its overall growth and productivity performance.

With respect to labour mobility, migration did play a less significant role in the economic

integration process. In some countries, such as the UK, immigrants from new member states

provided a major impulse to economic growth in the late 90’s, but the effect faded away as

the catching up growth of new members states started to run into domestic labour shortages

resulting from their own even more rapidly ageing population trend.

The factor and admittedly the most important input factor behind economic growth, where

the least progress was made at the level of European integration was knowledge in its

different forms. National policies with respect to research and development (R&D), patents

and licensing; with respect to attracting foreign direct investment; with respect to telecoms,

Internet and more broadly the use of ICT; all remained first and foremost governed by each

national member states’ policies and concerns.

o In R&D, EU policies focused on the 5 to 10% or so of funding the EC was entitled to

distribute through its own research policies.

o The structural cohesion funds which the EC grants to so-called cohesion and

peripheral regions in the Union, became in their execution the sole prerogative of

national and/or regional governments. The Commission’s role was limited to control

and accounting.

o ICT where the advantages of a single market would be most obvious in terms of

productivity gains in both manufacturing and services, and in terms of the creation of

new product and services with the whole of the EU as home market, became trapped

in different national liberalisation processes and the creation of national regulators.

The EC is now aiming for a digital single union in 2015: a good 20 years after the

emergence of Internet and mobile communication. From a technologically leading

position in mobiles in the 90’s, the EU has now become a laggard.

The result has been that, contrary to the Lisbon growth strategy, neither technology nor innovation,

social cohesion or ICT played at the European level a significant role in enhancing European growth.

National policies and national and regional prerogatives remained by and large dominant.

As in other cases, a crisis brings diagnostic clarity. From this perspective the current crisis points to

the need to re-address the Lisbon strategy in a more radical fashion than originally proposed in the

Europe 2020 strategy. The Europe 2020 strategy addressed undoubtedly the right issues: achieving in

Europe over the present decade a process of smart, sustainable and inclusive growth. Today,

however, it provides poor insights into how such a process could be achieved over the next years:

witness the Annual Growth Strategy 2012. In this short paper I will address the three: smart,

sustainable and inclusive growth areas where the strategy needs urgently to be revamped.

First and following the strategy’s emphasis on smart growth, I’ll plead for a much more explicit

quantitative commitment to public knowledge investment. It has been too easy for European MS to

propose a knowledge investment target – the 2002 Barcelona 3% R&D target – which put the efforts

of knowledge investment primarily with the private sector: the economic sector which given the

continuous European and global market pressures it is subject to, is the least in need to be

incentivized by policy designed investment targets. A commitment to public knowledge investment

by contrast is particularly needed today because the 3% fiscal deficit target within the growth and

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stability pact does not pay any attention to the quality of government outlays. In short, smart growth

requires smart public policy.

Second, shifting the emphasis on sustainability as the new direction for European research and

innovation growth cannot be based on the old paradigm of extracting international “monopoly

rents” out of new sustainable eco-innovations and eco-services, European firms might produce.

Building competitiveness on sustainability requires a different growth model. One in which the

benefits are domestically translated in a European more qualitative “green” growth path and in

which Europe is becoming globally a technologically leading, best practice region in the world with

respect to the transition towards sustainable development. Such a position requires a different, more

globally open, research and innovation policy based on global “innovation partnerships”.

Third, the aim of achieving inclusive growth is today probably most directly challenged by the

sovereign debt crisis in many peripheral euro-zone countries. There is a need here to fundamentally

rethink the way structural funds can be used to help peripheral and cohesion regions to unleash their

own indigenous growth potential. The notion of smart specialization needs to be broadened here to

include more explicitly the public sector, what I call here smart public specialization.

Most public sectors, whether regional or national are directly or indirectly essential for long term

growth and in particular for the knowledge based economy the Europe 2020 strategy is aiming at.

One may think of education, mobility including public transport, public administration and in

particular tax collecting national and local authorities, utilities as well as the health and social

security services, including pensions. As in the case of the knowledge production factor, most if not

all of these sectors have remained by and large a national prerogative. Yet it is the widespread

divergence in the efficacy and efficiency of the public sector in many of the peripheral MS

countries/regions which has been one of the most damaging bottlenecks towards achieving more

rapid growth and productivity convergence and as a consequence has contributed to the current

euro and sovereign debt crisis.

1. On the need for a smart public commitment for smart growth

Achieving smart growth depends crucially on a better use of knowledge whatever its origin and

whatever its form: new product and process technologies developed in Europe as well as the

systematic re-use and new combinations of knowledge developed elsewhere, across both public and

private sectors, in manufacture, agriculture or services, and across borders. In other words, smart

growth will also have to take fully into account the rapidly growing internationalization nature of

knowledge accumulation and knowledge diffusion at the EU level and at the global level. The

globalization of knowledge includes the entry of new players in new countries in knowledge

production as well as an increase in the circulation of knowledge and the mobility of skilled people at

the international level among existing and new players. In this sense globalization refers to an

increasing multiplicity of international linkages and interconnections between various knowledge

actors: private high-tech companies, public research organizations, researchers within universities

located in different countries and regions which make up today the globalized R&D system.

It made little sense back in 2002 to introduce a 3% R&D/GDP target for European member states as

part of the 2000 Lisbon strategy whereby one asked the private sector, as opposed to the public

sector, to invest most in R&D (2% vs. 1%) without offering private firms any means to leverage such

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an effort. One could have asked the private sector for a stronger commitment towards investment in

R&D in counterpart for a credible plan for integrating further the final Single Market in products and

services. The 2% private R&D investment target missed the point in so far as:

• Companies would invest private resources in R&D only if they could consider the home market large enough to recover their 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 of the rate of return to R&D investment;

• The institutional separation between European research, leading to proof-of-concept or prototype stage, European innovation policy and European competition policy, remained a continuous source of uncertainty;

• Many services of direct relevance to innovation (financial services, telecom services, education services, social services) remained exempt from the Single market services directive and hence became at European level dominated by fragmented national regulation.

At the same time, and despite the international nature of knowledge linkages, there is evidence of a

persistence of an uneven spatial distribution of research and innovative activities, whereby research

investments appear to remain concentrated in a relatively small number of locations. The

internationalization of R&D has undoubtedly led to a reduction in the concentration of R&D and

innovative capabilities amongst countries at the world level with new players such as Brazil, China

and India entering the global research world. However, at the same time the trend towards the

physical and spatial agglomeration of research activities within countries has been further

accentuated. New emerging countries have shown a remarkable capacity in moving upstream in the

value chain, from the outsourcing of manufacturing activities to autonomous process technology

development, then to product development, design, and applied research. Together with a national

targeted technology policy, Eastern Asian countries have successfully and aggressively pursued the

goal of a rapid increase in the scientific quality of their universities, using both monetary and non-

monetary incentives as well as institutional reforms. Furthermore contrary to the US, Japan and

Europe, the economic crisis appears to have affected much less the growth performance of those

countries and in particular does not seem to have affected governments fiscal positions. Countries

with the potential to compete for global knowledge hubs in certain fields appear to be characterized

by the fact that they have pockets of academic excellence; that they have strong educational

programs; that they can fund major programs to create research infrastructures and attract leading

academic researchers; that they have already strong entrepreneurial activities that respond to

market incentives and last but not least that they can benefit from sophisticated users.

In short, it is not just the total amount of R&D investments which count today but also the way those

additional investments are “matched” by institutional reforms. It are those issues which represent a

major challenge to the increasingly multi-level governance character of European research and

innovation policies, exacerbating the classical tensions and trade-offs that European and national

policymakers have traditionally been (un)able to manage. The following list summarizes some of the

major characteristics:

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(a) Research and innovation policies are developed within a national context – in the case of the EC, a European context – while knowledge and investment flows are driven by firms’ and individuals’ motives which increasingly take place at a broader international level.

(b) In so far as the Lisbon strategy was rooted in the idea that the EU’s productivity problems were of an internal structural nature2, such European competitiveness vision became challenged by the way new pervasive technologies, such as ICT broke down the distinction between high and low tech sectors3. The new challenge appears today how to deal with increasingly fragmented global value chains and the accompanying heterogeneity of required local knowledge inputs. This requires stronger cooperation in R&D with third countries and a stronger focus on the deployment of ICT based technologies.

(c) Within Europe the drive towards excellence in research has undoubtedly benefited from Europe’s internal regional cultural diversity and autonomy. At the same time though the drive towards excellence demands ultimately that no consideration is given to maintaining such diversity in terms e.g. of the country or region of origin of the researcher. For countries and regions that are in need of qualified human capital for their own catching up effort and which are in no position to match the working conditions and real income levels of richer countries or regions, this represents a major problem.

(d) The crisis is likely to further exacerbate some of the structural problems the globalization and spatial agglomeration of research raise with respect to Europe. Compared to other regions in the world, the remaining fragmentation of European national markets e.g. in high-tech services, is likely to increase the uncertainty surrounding the expected rate of return to R&D investments in Europe, and represents ultimately an impediment to an increase of private investment in R&D in Europe.

From this perspective, there is a need for a stronger and more outspoken public commitment to

knowledge investments in the years to come from EU Member States4. Such a commitment should

address not just research but all components of knowledge investments including e.g. higher

education and lifelong learning, as well as the deployment of ICT-based innovations and applications

in services5. While public commitment and financial efforts can in this context be translated into clear

targets, such as the 2010 Barcelona 1% public R&D funding target or the 2% higher education target6,

business investment should rather be considered as the result of such efforts: ultimately the

reflection of the success of a persistent public effort that makes the country or region attractive (and

visible) to/for private knowledge investment.

The first proposal is therefore to advance a new 3% knowledge investment policy target consisting of

a 2% higher education and 1% public R&D effort. Such a new target has three policy advantages over

the previous Barcelona 3% target.

First, it focuses directly on what governments and policy makers are directly responsible for. The

knowledge investment target is directly under the control of governments, whether in terms of

funding or setting funding rules such as in the case of tuition fees with respect to higher education. It

2 In short: the EU was lagging behind in R&D because of the failure to strongly develop high-tech sectors and knowledge-

intensive services. 3 See Snower, D.J., AJG Brown, and C. Merkel (2009). 4 See http://ec.europa.eu/research/era/pdf/community_research_policy_role.pdf 5 While US and European firms are more or less similar in R&D intensity “within sectors”, they are not similar in the service sector. In services European firms appear particularly R&D adverse. 6 In the latter case based on public or private contributions.

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is a target for which governments and policy makers in MS can hence be held both responsible and

accountable for.

Figure 1: Higher education and public knowledge investments as a % of GDP

Second, and as illustrated in Figure 3, in political terms the target offers credibility. All countries are

being challenged to either find their own public resources to increase such knowledge investments,

or alternatively to call upon private resources to invest in individual’s future human capital. By

leaving the latter to the individual choices of MS, the target also provides sufficient political freedom

to MS to decide how they intend to try to achieve the target by 2020.

Third, the target is realistic even under the severe fiscal consolidation conditions MS with large

sovereign debts problems are confronted with today, because it offers also scope for lowering the

public funding part of higher education in favor of e.g. raising more the private funding part through

e.g. tuition fees.

From this perspective, my first proposal would consist of separating out of Member States’ national

budgets, public investments in higher education, research and innovation from all other public

expenditures. Such public knowledge investments should be safeguarded from any fiscal

consolidation measures. They represent a long term investment which shouldn’t be put into jeopardy

by the sovereign debt crisis. At the same time, MS would be held fully accountable for achieving such

3% target by 2020. The growth in private R&D investment as a % of GDP should be viewed as the

outcome of the policy: public R&D and higher education investment attracting increased private

domestic or foreign investment assured about the long term national public commitment towards

research and higher education.

A second proposal focuses on the effectiveness of R&D support policies. Many European countries

have stimulated private R&D investments through R&D tax credit systems such as in France, The

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Netherlands, the UK and Belgium7. By contrast, countries such as Finland and Germany have rejected

such tax systems, and prefer to focus on R&D subsidies. The economic literature suggests that in

particular volume based R&D tax deduction systems result often in a 'net welfare loss' due to the

'dead weight losses' involved. An additional problem is the “beggar-thy-neighbor” aspect of such

nationally implemented systems within the EU, and in particular cross border regions with individual

countries trying to offset the tax credit offered in the neighboring countries through increasing their

own national R&D tax credit8. Particularly in a period of fiscal consolidation, the question must be

raised to what extent MS should refrain from watering down tax revenues, particularly in view of the

size of the dead weight losses involved.

The second concrete proposal consists of limiting R&D tax credits across all EU MS to a maximum

percentage of GDP, e.g. 0.1%. The extent to which the EU, compared to the US, might as a result

become even less attractive to private firms’ R&D investment is something which should be the

subject of discussion in the transatlantic dialogue between the US and the EU.

2. Sustainable growth – influencing the direction of technological change

A green economy will require a major private sector commitment to create more efficient green

technology options. Yet, private sector investment is, apart from the current financial uncertainties,

unlikely to be forthcoming as long as there is no clear and full commitment to setting an effective

price on Green House Gas (GHG) emissions: setting tight caps that will not be loosened by the

issuance of additional emissions permits to alleviate industrial "distress".

The current danger is that the public debt crisis leads to an "inadequate-effort level equilibrium trap"

as exemplified by the case of carbon-capture technologies. Because current costs of carbon-capture

pilot operations are too high to make it believable that firms facing CO² emissions limits would adopt

these methods, many countries (in particular those with coal deposits) resist tight caps on CO²

emissions: in the absence of affordable carbon capture they would be the first to lose access to that

source of energy, and profits, respectively.

As a result the necessary private investment in R&D (required to create the expectation that those

caps would turn out to be tolerable) is not forthcoming. So measures that enhance the effectiveness

of both public and private research investments and technology transfers in a broad array of “green

technologies” are in urgent need. However, in line with the arguments about the need for a new,

credible 3% knowledge investment target, publicly funded R&D is here too essential in sharing the

risks of developing such new technologies. Only through such publicly funded R&D will the private

sector be forthcoming in exploring further the opportunity to build on these technologies through

less risky, applied R&D. It is often forgotten in the debate surrounding green technologies that such

sort of exploratory research is particularly uncertain. Yet, at the same time R&D diversification is

essential so as to ensure that other alternative, potentially promising technology options are either

in the pipeline or can be quickly scaled up if so required. To make a broad R&D portfolio strategy

7 It general these were volume based tax systems meaning that it is the total volume of a company's R&D costs which define the amount of tax deduction This stands in contrast with the US and Japan, where tax deduction is more 'increment-based': it is the extra amount of R&D spending, on top of normal spending, that defines the tax benefit. 8 At the moment, e.g. the Dutch R&D tax credit system has been enlarged so that it is likely to represent nearly up to 0.25% of GDP, a figure still well below the French figure of 0.29%.

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work, a European policy commitment to an array of “green technologies” is needed accompanied by

facilitating knowledge-sharing, adaptation, trial and error and up-scaling of different eco-innovations.

This raises of course many regulatory issues: for instance, with respect to intellectual property. The

idea that companies in Europe would be able, as in the traditional competitiveness view, to extract

through current intellectual property regime schemes monopoly rents out of their eco-innovations,

ignores the fact that it is the speedy diffusion of such green technologies which is at the centre of the

current global climate change debate. As David et al. have argued: “This implies a critical rethinking

of ways to mitigate the inhibiting effects upon R&D of excessive protection of intellectual property

rights. Targeted domains for research exemptions, liability approaches to IPR infringement and

competition policy adjustments to permit efficient pooling of patent, copyright and database rights,

all come under this heading.” (David, Huang, Soete and van Zon, 2009).

These arguments point to the need to broaden research and innovation on “green” or “sustainable

growth” to include at a much earlier state of the design of the growth strategy the rest of the world.

Quite strikingly, China has recently embarked on focused investments in a range of GHG emissions-

reducing technologies – from nuclear power plants to wind-turbines and low-cost carbon-capture

and sequestration techniques. China is opening a path permitting eventually greater exploitation of

its abundant coal resources without further degrading its own environment. More strikingly still is

the recent report of the International Energy Agency that these efforts have yielded such rapid

advances that China could be in the forefront of the world’s green technology movement by 2020,

providing methods that would permit carbon capture at commercially affordable costs in other

similarly endowed regions, including the US.

It leads me to a third proposal: in the area of green growth, the EU should (again) become the trusted

world leader both in words and actions in the creation and diffusion of green technologies in relation

to the rest of the world. By leading is not meant extracting monopoly rents out of such technologies

and innovations but rather being a global research and innovation partner leader. In this sense the

concept of “Innovation Partnerships”, as proposed in the Innovation Union flagship, is right on target.

It should be enlarged though to include now China and the other BRIC+ countries (as e.g. in case of

NER 300 and Carbon Capture Schemes and/or energy renewables) as a question of priority.

Let me conclude from the policy brief with Paul David already quoted above, published two years

ago: “In a certain sense the international financial crisis and the looming crisis of climate change have

brought to the forefront an understanding that the realistic solution to a truly global sustainable

development strategy is not simply to provide the world’s investors with global financial access.

Having access to the fruits of expanded public and private investments in science and technology at

the global level, is no less and probably more critical in the long run. What makes the “climate crisis”

a unique green growth opportunity, if a perilous one, is that citizens in Europe, the US or Japan, are

crucially dependent in their sustainable future on the speed of (green) knowledge diffusion

throughout the rest of the world as well as in their own countries.” (David, Huang, Soete and van

Zon, 2009).

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3. Safeguarding social cohesion in a euro-crisis

In several policy papers (Barca, 2009), including some of the ERAB recommendations, it has been

proposed to make the provision of European structural funds – the main financial tool of European

social cohesion policy – conditional upon the development of local, smart and open specialization

strategies. I will not elaborate here on these possibilities. They will be addressed by other I4G

members such as Andrea Bonaccorsi, Dominique Foray and Lena Tsipouri in other I4G policy briefs.

Let me add here the reflection that the role of structural funds in enhancing growth could well in

some areas receive a major impetus through new financial engineering methods. Shifting the purely

grant nature of these funds into a more combined loan facility whereby the interest revenues of the

loan would be reinvested in the cohesion region, could create new financial “rolling fund” structures

for European structural funds. At the same time this might remove the policy discussions surrounding

the use of such funds out of the traditional “aid” mind set framework which raises increasingly

questions9 about the intrinsic limited effectiveness of such cohesion “grants” and the growing

dependency of peripheral regions on such funds. An interesting notion here might be to grant EC

structural funds as a form of regional Risk-Sharing Financial Facility (RSFF) in collaboration with the

EIB. The success of the EIB in running with the support of DG Research (FP7) the RSFF, a debt-

financed financing instrument to support private and public investment in research, development

and demonstration as well as innovation across Europe, is of course no guarantee for success to

apply such systems in social cohesion policies. But 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 a more explicit way the growth and competitiveness potential of cohesion support.

The urgency in addressing this issue has of course become exacerbated by the euro-zone crisis in the

peripheral MS confronted with large public debts, a collapse in private investment, rising

unemployment and economic contraction. Effectively, there is today only a limited window of

opportunity to address the competitiveness gaps across EU countries and regions using structural

funds.

From this perspective the key sector which has up to now been most ignored in economic integration

in Europe, and which in my view should have played a much more central role in European growth is

the public sector. The budgetary austerity in the euro zone, but also the privatization of many utilities

as well as the easiness by which public investments could be delayed or simply scrapped over the last

twenty years has led to a steady decline in public investment projects despite the increasingly crucial

contribution in many countries of European structural funds10.

From this perspective, a central problem is that the old 3% Maastricht criteria of public deficit does

not take into account the quality of public expenditures. There is of course a huge difference

between public expenditures devoted to consumption activities and public expenditures devoted to

9 Witness the huge inefficiencies in the spending of European structural funds in many European countries. See the

research done by the Bureau of Investigative Journalism and the FT on Europe’s hidden billions – tracking the European Structural funds, at http://www.thebureauinvestigates.com/category/projects/europes-hidden-billions/ 10 The ERAB recommendation on this matter read:“Make (part of) EU co-funding in the context of the Structural Funds conditional to procurement of innovative technologies and R&D, also as a means of gearing cohesion policy more towards stimulating R&D and innovation.”

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public investment. One of the most robust results from modern growth theory is the strong positive

impact of public investments in e.g. physical infrastructure and above all intangibles such as

education and R&D boosting overall productivity growth. Yet and as highlighted in the picture below,

Eurozone countries have been cutting significantly public investment, more than any other spending

item.

Figure 2: Public investments as a % of GDP

Source: Updated from De Grauwe, P. “Eurobonds: a crucial step towards political union and an

engine for growth”, mimeo, March 201111.

This leads me to two additional concrete proposals:

a) It is again not so much a question of the sheer volume of public investment, but of the quality of

public investment. What I would propose here is to allow the best performing MS’ public services to

take the lead in a new phase of economic integration in the EU: that of public services. As a result the

performance of the public sector in Europe, still responsible for the largest part of GDP, will receive a

major boost in efficacy and efficiency. We all know the typical European joke of the Brussels dinner

organized by an Italian, prepared by a Briton and with a German giving the after dinner speech. But

the ideal picture also exists of course. There is no reason why not to exploit much more fully across

Europe the diversity in different member states, even regions, of the quality and efficiency of public

service delivery. Hence the proposal for a process of smart public specialization.

Think of the Dutch tax-paying office taking on the responsibility for earning tax revenues in Greece,

Italy or even Belgium. Or using the approach of Belgium’s social security bank12 to manage social

11 http://ec.europa.eu/economy_finance/publications/publication734_en.pdf

1991

1992

1993

Source: European Commission, AMECO databank

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security payments in every member state. Every MS does have some segment of its public sector

which is “best practice” in the efficacy of its activities or the quality of its service delivery. The notion

of “smart specialization” as developed by Foray, 2009 and David, Foray and Hall, 2009) should not be

limited to the private sector. Actually smart public specialization would, and as a particularly

welcome side-effect, increase the understanding amongst MS of the intricacies of the differences in

regulation, habits, cultures as they have historically grown over hundreds of years amongst the

different European countries. Doing so it would form a better intellectual base for further European

integration than the material consumer gains in the case of the Single Market.

The approach would not consist of a centralized but rather of a decentralized approach, leaving the

public services in each country under national and local jurisprudence and responsibility, but reaping

through “best practice” comparisons, efficiency scale advantages in e.g. back office treatment of

data, speediness and reliability of the service, user friendliness, etc. All this is likely to result in a

significant impact on productivity growth in countries with low productivity levels, as the private

sector in those countries will also benefit from the more efficient public sector. At the same time,

mutual trust in MS’ national public sector capabilities, culture and ethics will receive a boost.

European diversity will again have a positive connotation across the EU. Tax revenues in some of the

Southern MS will increase substantially as tax evasion and large parts of the over-sized black market

economy will become integrated into the formal national economy.

At the same time, the European Commission could provide underlying technocratic support for such

reforms which again would benefit from the variety of institutions within different European

countries. The ECB as a centralized European bank with national banks in each MS is often used as

the example, but other decentralized institutional reforms can also be explored13. In short, the result

is a pragmatic approach to member states reform whereby subsidiarity and additionality are key

concepts in providing legitimacy to newly created European, decentralized institutions with locations

in different MS.

b) The second concrete proposal under this heading addresses directly the rather provocative title of

this paper. The large sovereign debt in some of the peripheral European countries should be viewed

as potential pilot cases, killer application cases for triggering innovation in public procurement with

the help of the private sector.

Let me give a concrete example dealing with public lighting based on the ERAB proposal written

jointly with Anne Glover and Jan van den Biesen and presented at the Innovation Convention in

December 2011.

About 19% of the electricity generated globally is used for lighting purposes and around 70% of all

existing lighting equipment is energy inefficient by today’s standards. Lighting, and in particular

public lighting is a pure case of “low hanging fruit” innovation. New technologies such as LEDs can

provide energy savings of up to 80%. Furthermore, additional energy savings can easily be realized

such as lower costs for air conditioning, as LED-based lighting produces less heat; savings in high

12 The so-called “Kruispuntbank Sociale Zekerheid” (KSZ) is an electronic network between Belgian institutions of social security and the state register. It is considered as a government “best practice” case. 13 For example in the area of collecting statistical evidence, one could imagine that Eurostat would become gradually transformed into a fully decentralized organization exploiting at EU level each MS’ comparative advantage in one particular statistic.

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voltage grid capacity; and lower maintenance costs for lighting systems – state-of-the-art light

sources have a hassle-free lifetime of more than twenty years, as opposed to three years for many of

those currently installed.

The main impediment to the introduction of such “low hanging fruit” innovations in lighting is a

financial one, affecting both public procurement and household decisions, and have to do with the

fact that decisions regarding capital expenditure are not based on a total cost of ownership

approach, but on a cost of initial investment approach. Thus whereas the overall financial

investments needed to achieve the energy savings in lighting are relatively modest, the initial

expenditure will tend to be much higher than the expenditure on traditional, electricity-guzzling

lighting systems. And while we all know that over the whole lifecycle of the product (the initial capital

expenditure plus electricity consumption plus maintenance), it is financially much wiser to buy a 5

euro energy efficient light bulb than to buy its 1 euro incandescent counterpart, many of us will buy

incandescent bulbs. The same holds true at the institutional level; worse, it will even be more so in

the case of many of the debt stricken municipalities, regions and countries in the Southern euro-zone

area.

Those debt stricken countries, regions or municipalities in Greece, Portugal, Spain or Italy, should

become pilots for new innovative procurement aimed at reducing public electricity expenses and

based on new creative financing solutions. One could talk here about new North-South European

Private-Public Partnerships. Furthermore, with the help of the European Investment Bank using

available structural funds, it should be relatively straightforward to eliminate the current ‘lowest

initial cost’ bias from the public sector’s procurement equation in those countries/regions.

In short, there is a lot to be gained by focusing on the way innovation and knowledge investments as

process of cost-saving and quality improvement can rebuild the basis for catching-up growth in

public sectors which appear to have been isolated in many MS from “creative destruction” in the old

Schumpeterian definition. Europe with its widespread diversity represents from this perspective a

unique experimental ground for such innovation.

Conclusions

Going back to the Europe 2020 strategy highlights three central entry points for the EU to “innovate

out of the crisis”:

First the importance of investments in research and innovation, both public and private – the “rate”

of technical change – an old European (Lisbon) concern which needs though to be reassessed within

a European fiscal consolidation framework. Two concrete proposals are offered here. Smart growth

requires today more than ever a smart public commitment.

Second, the importance of the “direction” of technical change: the challenge of sustainable growth.

Such direction depends again first and foremost on public policy: not just on setting out clear,

consistent rules and regulations across MS in an internal European domestic pro-growth direction

but also the need for new global “Innovation partnerships”.

Third, the regional impact of research and innovation policies in Europe within the context of a

sovereign debt crisis concentration in a number of peripheral countries. How to leverage structural

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funds to boost local innovation and efficiency gains in the public sector? Again a number of concrete

proposals are made.

As has been illustrated all three areas call for a number of more radical structural reforms in policy

making than those presented under the AGS 2012. They do so not just from the perspective of the

lack of the effectiveness of some of the AGS proposals – something not the subject of the analysis

presented here – but from the perspective of the timeliness of introducing today in a moment of

crisis more radical reform in the multi-level (European, national regional) governance of research and

innovation policy as well as from the perspective of opportunities for innovative solutions to the

current fiscal consolidation framework.

Over the last twenty to thirty years, most research and innovation policies have sought to promote

the supply of innovations. In Europe, the rationale for this could be easily understood from the

perspective of the need for institutional reform in Europe on the supply side of R&D and Innovation.

European research policy offered, in the spirit of the Lisbon agenda, scope for such institutional

reform, searching for opportunities for better coordination between Community and Member States’

research policies. One may think in particular of the creation, over the last decade of new European

concepts and institutions such as the ERA, the ERC and the EIT. The gradual transformation of

Europe’s research system on the supply side has actually been impressive: there is today a clear

tendency towards further integration of MS’ national research policies in a European framework

through e.g. the concept of the “joint programming” of research. The conceptual idea was, and still

is, that such supply-side institutional reforms would feed, and be driven by, broader Single Market

achievements. Demand didn’t really enter the picture, except for concerns with respect to the

possible emergence in European high-tech sectors of market dominance and as a result a possible

lack of competition.

With the integration of innovation under the heading of the Commissioner for research, innovation

and science, there is, however, a clear policy shift in the recognition of the need for effective supply-

demand matching in research and for the particular role of demand-driven innovation for growth,

welfare and well-being. This role needs to be made much more explicit in periods of crisis.

Despite the concerns about Europe’s future integration process as expressed here, these are exciting

times. Times for stronger policy emphasis on knowledge investments in sectors which we seem to

have forgotten in the past such as the public sector which in the current sovereign debt crisis period

might well offer new opportunities to address the lack of growth convergence within Europe and the

euro-zone area in particular.

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References & Bibliography

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