Policies to promote R&D

Accumulation of knowledge is continuously becoming more important as driver of economic growth and increased standards of living. Yet our understanding of the determinants of knowledge accumulation and the complicated processes by which knowledge is diffused, turned into innovation and enhances economic growth is incomplete. Another reservation is that the statistical data in this area is more uncertain than normal. Thus, the available indicators of the generation of knowledge and of inputs into knowledge production such as R&D expenditures are imperfect.

Knowledge is fundamentally a public good. This means that everybody can access and apply knowledge without limiting the ability of others to apply the same knowledge. With the progress made in information technologies and the expansion of the Internet, knowledge can now be accessed world wide easier and faster than ever.

Knowledge is to a large extent generated by the R&D activities of the private and public sectors. Expenditure on R&D in the European Union are only two-thirds of the expenditure in the USA and Japan, when measured relative to GDP. The European Union also has a deficit in terms of R&D indicators such as the number of scientists, patents and innovations. Efforts must be made to correct this deficit.

Table 1. R&D expenditure and patent applications.

R&D expenditure Year Per cent of


Private share of R&D

Resident patent applications per 10,000 inhabitants, 1996 Austria 1998 1.6 ≈ 50 2.33 Belgium 1998 1.6 ≈ 65 0.88 Denmark 1998 2.0 60 2.53 Finland 1998 2.9 61 4.32 France 1997 2.2 60 2.25 Germany 1998 2.3 ≈ 65 5.25 Greece 1997 0.5 23 0.39 Ireland 1997 1.5 74 2.22 Italy 1998 1.1 ≈ 55 1.24 Luxembourg - - - 2.14 Netherlands 1996 2.1 54 1.59 Portugal 1998 0.7 < 330.09 Spain 1998 0.9 ≈ 50 0.59 Sweden 1997 3.9 75 4.72 United Kingdom 1997 1.9 65 3.10 EU 1998 1.81) 552) 2.62 USA 1998 2.81) 652) 4.03 Japan 1998 2.91) 702) 26.94 1) Commission estimate. 2) 1995.

Source: European Commission, Policies for Promoting Research and Development, 2000, and OECD, Main Science and Technology Indicators.

Two other observations are important, however. First, R&D expenditure varies greatly among the Member States. Countries like Sweden and Finland spend relatively more on R&D than both the USA and Japan, and they may be a useful benchmark for other Member States. Second, public expenditure on R&D is almost the same in Europe, the USA and Japan, implying that the European deficit is primarily to be found in the private sector.

Based on the second observation, the backlog of R&D in the European Union should not primarily be solved by increases in public research, although this would indeed be appropriate in a few Member States. Governments should focus on measures that facilitate and support private R&D and increase the market orientation of public R&D. Creating the framework conditions for private investments in R&D is vital. These include the funding of basic research, the creation of centres of excellence, and the dissemination of information in particular between public and private research centres.

Ensuring a sufficient supply of human capital, in particular within sciences and engineering,is a crucial precondition for the success of policies to promote R&D. In a broader context, the availability of appropriate and abundant human skills is also necessary if increases in knowledge are going to be exploited efficiently in the production of goods and services. As the stock of knowledge increases, research will tend to be more specialised as each researcher can only master a relatively small area. There is therefore a risk of public research becoming too fragmented. Efforts must be made so that public research is cohesive in order to achieve the desired level of excellence. Promoting research networks at the national, European and global level is one possibility. Another is to establish research centres in specific areas and of a size that exceeds the critical mass for undertaking research at the frontier. To strengthen the focus on areas of commercial value, initiatives aimed at enforcing the intellectual property rights of public research results, for instance through patents, may be considered. Yet care should be taken in striking the right balance. Giving public researchers a share of proceeds from licensing will undoubtedly increase the awareness of the commercial use of public research. But it may also divert public resources into research that should properly be undertaken by private enterprises, and away from basic research of a more general public value, which ought to be the primary target.

The public sector also has a role to play in encouraging entrepreneurship and start-ups of new R&D intensive businesses. Including entrepreneurship and business economics in the curriculum of institutions of higher learning to encourage graduating students to set up their own business may have positive effects. In particular, it may be possible to achieve a direct spin- off in the form of new enterprises based on the work of research students. In a similar vein, public research institutions can aid start-ups by giving them access to research and testing facilities on favourable terms.

Diffusion of knowledge accumulated within public research institutions must also be given a high priority. Otherwise it cannot be used by industry to the benefit of consumers at large. There is a range of means to achieve this. Formal and informal co-operation between public and private researchers based on comparative advantages; the establishment of science parks conducive to co-operation among public and clusters of private enterprises; leave-schemes enabling public researchers to be employed in private enterprises for shorter periods of time are just a few examples.

Developments in product and capital markets also have an important influence on private sector R&D. The benefits of R&D come only over a longer time period, while the costs are paid up-front. Therefore, the availability of capital is crucial for all R&D activities. This may be a significant barrier for SMEs, in particular new business, as they may have more difficulties to finance their activities through own savings. Establishing the right conditions for venture or risk capital markets is therefore important. Venture capital is particularly important, because it also provides new firms with important managerial skills.

Competitive product markets are important, because they provide incentives for enterprises to strive for product and process innovation. In addition, free access to global markets enables enterprises to reap the full benefits of having made a new innovative product. Thus, making entry into business simple and reducing barriers to international trade will increase the incentives of private enterprises to engage in R&D activities. These incentives can be further enhanced if intellectual property rights are secured. The public sector can contribute by making the enforcement of legislation covering intellectual property rights effective.

All of the above measures are aimed at either increasing the supply of R&D resources available to private enterprises or establishing well-functioning markets for knowledge including an efficient diffusion and transfer of knowledge obtained through public R&D activities. In other words, they emphasise the need for strengthening the framework conditions for private sector R&D.

There may be a case for supplementing these measures by more direct support for R&D activities in the private sector, in particular for SMEs. If private enterprises are not able to appropriate all the benefits from their R&D efforts, they will devote too few resources to R&D. Thus, the social benefits of R&D can be larger than the private benefits. This externality could in principle justify direct public support for R&D, thereby reducing the costs to private enterprises.

However, the size of the spillover from the R&D of one enterprise to other enterprises will vary greatly. One R&D project may be of no use to other enterprises, while another can be exploited by many enterprises. Identifying a priori projects with large spillover effects is not an easy task. Consequently, governments will often have to rely on general schemes for direct support to private R&D. Since general schemes will also provide support for R&D projects that would be undertaken anyway, they will involve a substantial dead-weight loss. This problem may be enlarged as companies will have an incentive to reclassify activities as R&D. If the insufficient level of R&D is predominantly due to constraints on the supply side, promoting private R&D can cause a misallocation of scarce resources. For example, scientists and engineers may be moved into R&D activities, even if the return to their work might be higher in other parts of the productive process.

While direct support for private R&D may be clearly justified on theoretical grounds, the way in which support schemes are implemented in practice must be carefully considered to avoid creating new distortions that could be larger than the initial market failure.

In document Economic Policy Committee Annual Report on Structural Reforms 2000 Report addressed to the Council and the Commission 13 March 2000 (Page 46-49)