Innovation, the EU Budget and Growth

John Hudson Department of Economics, University of Bath, Bath, BA2 7AY, United Kingdom. email: J.R.Hudson@bath.ac.uk.

Basic Causes of the Crisis• The euro and credit crisis is serious. But to an extent it

is not the real problem, or rather it is not the whole of the problem.

• Nor are the policy actions, the improvements in regulatory activity apart (such as Basle III), long term solutions.

• Quantitative easing is at best a short term solution, something which buys governments time.

• The loans to Greece and other countries are also short term ‘solutions’.

• The risk is quantitative easing and these other measures may form the basis for Part III of the crisis.

The problem is the ratio of government debt to GDP: Debt/GDP

• In many countries this is high, rising and on the verge of becoming out of control.

• Most governments with a high debt ratio are seeking to reduce it by acting on debt, that is by activities designed to raise revenue through higher taxes and cut spending, e.g. a reduction in benefits and public sector spending.

• But as this may result in lower GDP, it may not work.• There is another way, which to an extent the US is

following, and that is to increase GDP.

Increasing GDP

• Will lower the ratio directly, but also indirectly by increasing tax revenues (the higher is GDP the higher are tax revenues).

• But if this is done via traditional Keynesian policies of deficit spending, as in the USA, then there is the risk the debt will simply get worse.

• Hence the need to focus on supply side policies. We will look at one aspect of this, related to innovation.

Long term solutions

• Long term solutions lie in getting the economies growing and this means the EU and the UK need to produce products the world wants to buy and to do this we need innovation.

• The US takes innovation seriously, e.g. Silicon Valley. As we will see most of Europe, including the UK, pays it lip service.

Innovation

Patents per million people (2010)

Source: World Bank

Now the EU pays lip service to innovation.

“With an ageing population and strong competitive pressures from globalisation, Europe' s future economic growth and jobs will increasingly have to come from innovation in products, services and business models. This is why innovation has been placed at the heart of the Europe 2020 strategy for growth and jobs. With over thirty action points, the Innovation Union aims to improve conditions and access to finance for research and innovation in Europe, to ensure that innovative ideas can be turned into products and services that create growth and jobs.”

http://ec.europa.eu/research/innovation-union/index_en.cfm

With Key Initiatives• Promoting excellence in education and skills development• Delivering the European Research Area• Focusing EU funding instruments on Innovation Union priorities• Promoting the European Institute of Innovation and Technology (EIT) as a model of

innovation governance in Europe• Enhancing access to finance for innovative companies• Creating a single innovation market• Promoting openness and capitalising on Europe's creative potential• Spreading the benefits of innovation across the Union• Increasing social benefits• Pooling forces to achieve breakthroughs: European Innovation Partnerships• Leveraging our policies externally • Reforming research and innovation systems• Measuring Progress

And more rhetoric 10/50

• The European Union exists to deliver value added to its 500 million citizens. I believe it can be a force for economic renewal in Europe and globally. To do this, we need a budget that is innovative, attuned to the new realities of globalisation, and that responds to today's challenges and creates opportunities for tomorrow.

http://ec.europa.eu/budget/reform/

The EU Budget: Multiannual Financial Framework 2014-20, Commitments

Linked to innovation

Linked to agriculture

http://ec.europa.eu/budget/library/biblio/documents/fin_fwk1420/MFF_COM-2011-500_Part_I_en.pdf

Millions of Euros

A Budget for Europe 2020: EUROPEAN COMMISSION Brussels, 29.6.2011 COM(2011) 500 final

SMART & INCLUSIVE GROWTH 490908SUSTAINABLE GROWTH 382927NATURAL RESOURCES 188535SECURITY & CITIZENSHIP GLOBAL EUROPE 70000ADMINISTRATION 62629

But: SMART & INCLUSIVE GROWTH?

Galileo 7000nuclear safety decommissioning 700csf research and innovation 80000new competitiveness/SME 2380Single training, education youth and sport 15120Social development agenda 850Customs-fiscalis-anti fraud 840Agencies 2030Other 1868margin 4009Energy 9121Transport 21694ICT 9185Cohesion policy 336020

Only the ones highlighted in yellow are really focused on innovation. Of course all expenditure MAY impact on innovation, but it is probably only those highlighted where this is the key focus or impact

Now doubtless the actual budget will change

• But the relative emphasis on innovation, versus other priorities is perhaps less likely to change.

• The EU justifies its focus on agriculture by saying (i) its getting less, (ii) it has largely replaced national governments with respect to agricultural spending. In effect it is saying it has only a minor role in terms of innovation, which hopefully national governments are fulfilling.

• Notwithstanding that, can the focus on agriculture and other priorities at the expense of innovation be justified at a time of crisis in Europe’s history?

Innovation

• We now turn our focus to innovation, understanding the process of innovation, the barriers to innovation and how policies cn stimulate innovation.

• Initially, the linear model of innovation was dominant. This saw innovation proceed sequentially from basic research, to bringing that research into a form suitable for a new product/service, to marketing etc.

The Linear Model of Innovation

Newer, interactive models of innovation

• However, in the past decade a new understanding of the nature of the innovation process has emerged, which emphasizes feedbacks, interactions, and networks (Freeman and Louca, 2001) and stresses the systemic and interactive character of innovation (Todtling and Trippl, 2005).

• The innovation systems approach argues that innovation should be seen as an evolutionary, non-linear and interactive process, requiring intensive communication and collaboration within companies and between firms and organisations such as universities, financial institutions and government agencies.

• Thus innovation does not/should not start with basic research in isolation from the potential for the innovation. There is interaction all along the chain.

Interaction as for example in the triple helix

• This change of view has also had an impact on perceptions of policy away from the traditional firm oriented perspective, towards inter-organisational arrangements (innovation systems, networks and clusters), i.e. a move towards a more system-centred approach of innovation policy (Nauwelaers and Wintjes, 2003).

• This does not mean that focusing on R&D and on the technological aspects of innovation is the wrong policy, but that it needs to be complemented with the organisational, financial, skill and commercial aspects of innovation.

• An influential perspective has been that of the triple helix model which emphasises networking, interaction and co-operation between university, industry and government (Etzkowitz and Leydesdorff, 2000).

Barriers to Innovation

• The phase between (basic) research and successful innovation is known as the Valley of Death, reflecting the fact that many products which enter the valley do not successfully exit.

• Finance is a constraining factor in both generating knowledge and bridging the gap between R&D and bringing the product to the market.

• For many firms finance comes from their own resources or the family.

• SMEs and new entrepreneurs with no track record face particular problems in securing bank finance.

Barriers to Innovation 20/50

• Corruption • The ability of the state and market institutions to reliably

and impartially enforce the rule of law and the rules of trade.

• Trust is also critical. Successful innovation often requires the engagement of a chain of agents, e.g. from farmer to the market sometimes via food processors. Successful co-operation requires trust

• More generally, there are many attitudes, customs and cultures around the world which do not facilitate innovation.

• The strong impact of social ties and networks and hierarchy which dominates many cultures does not facilitate the rise of the entrepreneur from across society.

Facilitators of innovation

Anything which facilitates knowledge transfer:Universities?FDI?Trade?

An example: The Pharmaceutical industry

• Similar to the valley of death, we have the translation gap. Translation relates to the transfer of basic biomedical research into clinical interventions that provide a direct benefit to human health. It correlates with the design and engineering stage of the linear model.

• The time-lag between filing a basic patent on a compound and its commercialization as a drug is long at about 11–12 years and only a small fraction of all synthesized compounds finally enter the market (Sternitzke, 2010). The average cost of taking a drug from concept to market is estimated to be in excess of $1 billion and only 20% of approved drugs make more money than their associated R&D cost (Khanna, 2012).

• Even making it to market is not the end of the problems, with dangerous side effects emerging for some drugs after several years of sales.

• This has led to increasingly stringent regulatory approval guidelines, making an already slow system (Tralau-Stewart, et al., 2009) even slower.

• These risks, together with the long time lags, make venture capital funding difficult to obtain, particularly for the early stages of translation research.

The growing role of the universities

• Partly because of these problems, the pharma industry is tending to close down its own research facilities and turn to collaborating universities, often even at the basic research stage, and increasingly with respect to translational research.

• This is happening in other industries as well and is reflective of newer models of innovation which stress collaboration and linkages between industry, state agencies and institutions such as universities.

Both sides gain?

• Industry gains access to high quality research expertise, and perhaps quite cheaply.

• And universities? They both gain access to badly needed financial resources. But also they prove their worth to society, they prove they have an impact on an economy and hence justify public funds subsidising their research.

But are the universities getting a good return on their research?

• Universities and their funders have received over $200m from the drug Humira which is used to treat arthritis.

• This uses patented technology derived from research at the MRC Laboratory of Molecular Biology in Cambridge and The Scripps Research Institute in California.

Now $200 million is a lot, but….

• By August 2009 Humira was being used in 80 countries in the treatment of 370,000 patients, and estimated to be the world’s top-earning pharmaceutical product with projected sales of $10billion by 2016 for the US firm Abbott Laboratories.

• Indeed in April 2012 its sales in the previous year were reported as $2.3billion.

• Thus the license income as a proportion of sales was relatively small.

A general problem

• This is reflective of the fact that universities, everywhere, not just in the UK, are getting a relatively small return on their research.

• They tend to be restricted by not having sufficient expertise or resources to protect their intellectual property rights (IPRs), nor do they have the financial expertise to deal with industry on an equal footing.

Even more of a problem• But there is another problem with this example.

The multinational exploiting this research is American, not British and not even European.

• This is an extreme, but not isolated, example. Much of Europe’s research is not benefitting the EU.

• And many academics would see no problem with this. Research is meant to be freely available to all.

Many funders of university research, such as the research councils

• are behaving within the linear model, funding research on its scientific merits, without considering how it will be used and who will use it.

• That is right for some types of ‘blue skies’ research.• But for other research, more thought needs to be

given as to the likely impact on he economy, how that impact will be achieved and even with which private sector partners.

•

But there are signs that research is beginning to be used as a tool of industrial policy.

• The French government have funded an initiative to create six world poles of excellence bringing together French firms and publicly funded research centres in a bid to to keep France in the forefront of pharmaceutical innovation and production.

• The EU’s Innovative Medicines Initiative for Basic and Translational Research IMI supports collaborative research projects and builds networks of industrial and academic experts in Europe, aiming to build a more collaborative ecosystem for pharmaceutical research and development. It is a joint undertaking between the European Union and the European Federation of Pharmaceutical Industries and Associations (EFPIA). Although this does include non-EU firms with a base in the EU who are members of EFPIA.

• Even in the US, where there has been a traditionally reliance on market forces, publicly funded research is beginning to be seen as a way of boosting the economy.

Dangers• Firstly it clashes with the academic’s traditional focus on knowledge

as widely and freely as possible, and risks taking the focus away from high quality research publications.

• Secondly it involves, directly or indirectly, public money underwriting the commercial success of some firms and not others.

• Thirdly, it risks the multinationals ‘capturing’ the academic, limiting their traditional role of being able to critically evaluate everyone. In the case of the pharma industry, for example, there is the risk that only favourable outcomes to drug trials will be reported in the journals.

Minor Innovation• Innovation is not just about major new

products and services. • Innovation can also feature ‘new to market’

products and services. That is taking innovation developed elsewhere, in another country perhaps or another town or industry, and developing it in a new context.

• This involves knowledge diffusion • Once more the entrepreneur plays a pivotal

role.

Knowledge Diffusion 34/50

• A key barrier to knowledge diffusion is distance. • Within a country, innovation and knowledge tends to

be first diffused in large towns and cities and then becomes diffused to other areas (OECD, 2010).

• Thus stimulating innovation in a small country is in most cases a two stage process.

• First it needs to be targeted at the large cities, where it will be most successful with ready acceptance. Secondly, it then needs to be diffused to the rest of the country.

Barriers to Knowledge Diffusion and Absorption of new Technology.

• Lack of technical expertise and skills – and with the increasing sophistication of technology this problem will get worse not better.

• Finance• Intellectual property rights (IPRs – e.g. patents) raise

the cost of acquiring technology.

Universities have a role to play, even in the diffusion of existing knowledge

• But in many smaller countries they are often not effective in this.

Not enough resources Not a focus on research Disconnected from firms in their own

countries

• FDI – again in general does not facilitate knowledge diffusion as much as it could..

Empirical Work

• The variable we will analyse is for firms. It is coded one if they answer yes to the question:

• “Do you use technology licensed from a foreign-owned company”

• It is therefor very specific and relates to the absorption of technology, rather than new technology developed by the firm or in the firm’s country.

• It is obtained from the World Bank’s enterprise survey of firms across developing and transition countries.

The Data shows large variations within Slovakia

Bratislava Middle East West TotalSlovakia Slovakia Slovakia

No 34 46 78 87 245Yes 7 11 5 7 30% Yes 17.07 19.30 6.02 7.45 10.91Total 41 57 83 94 275

To an extent these differences reflect differences such as whether the firm is foreign owned, exports abroad, etc. But only to an extent.

Probit regression

Below there follows the results of a probit regression on:• firm specific variables such as the age of the firm, whether foreign owned, etc.•Regional variables relating to what other firms in a firm’s region, e.g. the proportion of other firms in the region who use email to communicate to clients.•Industry & sector variables.

Observations 29318; Wald statistic 3090.8

If the t statistic > 1.96, we are 95% certain the variable is significant, is having an impact

If the t statistic> 2.57, we are 99% certain

The positive sign on email, standards and group firms indicate that as the proportion of firms in the region with email connection, an international standard or are part of a group increases, then so does the probability of licensing for ALL firms in the region.

The negative sign on foreign firms indicates the opposite: as the proportion of foreign owned firms increases, then the probability of licensing declines for other firms in the region. That is important.

Regional Variables Coefficientt statisticTransport -0.23321 2.06Transport squared 0.057452 1.56Email 0.362801 2.44Standards 0.658775 3.07Foreign firms -0.80324 3.26Group firms 0.452787 2.09

41/50

Firm variablesExports 0.009127 5.61Exports squared -9.9E-05 6.9Log Firm age -0.03578 2.56Small -0.55095 18.07Medium -0.27341 10.72Rural -0.077 1.49Small town -0.0109 0.29Foreign 0.527291 17.66Group 0.258047 9.4Partnership -0.07998 1.36Private Ltd 0.06133 1.74Public Ltd 0.200804 4

The greater a firm’s focus on exports, the more likely they are to license foreign owned technology.

Older firms, and small, and medium sized firms are less likely to license foreign owned technology.

Foreign firms and firms who are part of a group are more likely to license foreign owned technology.

Industry/SectorTextiles -0.04377 0.96Leather -0.22314 1.21Food 0.067758 1.97Metals 0.082614 2.11Electronics 0.316226 4.46Chemicals 0.259384 6.41Wood -0.04886 0.61Plastic 0.095547 2.16Auto 0.045992 0.36Otherman 0.085047 2.2Retail 0.21546 2.46Hotels 0.034455 0.17Otherser 0.154048 1.81Construction 0.309642 2.95

Large differences between industries.

Conclusions

• The EU, and to an extent much of the rest of the world, got into the current situation through ineffective regulation, a stability and growth pact which was not observed, and a desire for a high standard of living, possibly higher than countries could afford.

• Underlying these problems was an unwillingness to face and deal with realities.

• That unwillingness is still with us, as the Eurozone struggles to retain in its membership countries who cannot compete and as all countries move to replace taxes and borrowing with the ‘printing of money’.

The EU and its member countries need to:

• But in the end there are no magic cures. If the EU is to prosper, whether it is the Europe we have today or a changed EU, possibly with fewer members, and possibly differing degrees of membership, then it has to pay its way in the world.

• Critical to this is innovation. The EU and its countries need to develop products other countries, and indeed its own citizens, want to buy.

• This means both large scale ‘blockbuster innovation’ and innovation of the ‘new to market form’.

Policies

• To help with the financing of innovations across the Valley of Death.

• Provide the infrastructure (today Internet and transport) to facilitate innovation.

• To help small and medium sized enterprises bring in innovation new to market.

• To reduce bureaucracy (within reason) which harms entrepreneurs.

• To bring industry, universities, other research centres and government agencies together as in the model of the triple helix.

• View research as a tool of industrial policy, whilst preserving universities independence and integrity.

However

• On the basis of past performance I have doubts as to whether the EU, including individual countries such as the UK, can implement the changes needed.

Universities

• Need to both focus on traditional activities of knowledge generation, in many cases knowledge free to all.

• Whilst fulfilling their responsibilities to society by helping develop research into innovation.

• That means developing greater links with industry and focusing not just on their basic research, but ensuring that research has impact.

• They also need to ensure they get a greater return from their IPRs.

Slovakia

• Needs to do all the above, but in particular should be concerned with the innovation gap between (i) Bratislava and Middle Slovakia and (ii) East and West Slovakia.

• The lack of original innovative active as reflected by patents should also be a matter of concern.

• Slovakia’s recent prosperity has been built on FDI. That is not a long term guarantee of prosperity.

• One way forward, as with other countries, is to give more emphasis to exploiting the research potential of the universities.

Post Script

• The economic crisis is not the only, and perhaps not even the most important, problem facing us.

• There is also climate change.• We saw earlier the very small amount the EU

was allocating to climate change research.• But if there is a solution to this problem, it lies

in part with innovation.

• Both new ways of generating energy and new ways of using it.

• And here too there may be a link with economic growth as the world gradually switches on to low carbon technologies, potentially developed in Europe.