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EU Report on Innovation 2011

This document provides an introduction to a report on innovation in Europe. It discusses differing views on what innovation means and how it should be promoted. While innovation is often equated with research and development, many experts argue it is a broader concept that includes finding new ways to meet customer needs and improve productivity through new business processes. There is also debate around how to balance policies that promote new, innovative firms with supporting existing companies. The report brings together perspectives from academics and policymakers on defining and encouraging innovation in Europe.

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CENTRE FOR EUROPEAN REFORM INNOVATION How Europe can take off Edited by Simon Tilford and Philip Whyte
about the CER The Centre for European Reform is a think-tank devoted to improving the quality of the debate on the European Union. It is a forum for people with ideas from Britain and across the continent to discuss the many political, economic and social challenges facing Europe. It seeks to work with similar bodies in other European countries, North America and elsewhere in the world. The CER Innovation is pro-European but not uncritical. It regards European integration as largely beneficial but recognises that in many respects the Union does not work well. The CER therefore aims to promote new ideas for reforming the European Union. How Europe can Director: CHARLES GRANT ADVISORY BOARD take off GIULIANO AMATO.............................................................................................. Former Italian Prime Minister ANTONIO BORGES.............................................. Head, European Department, IMF and former Dean of INSEAD NICK BUTLER ......................... Visiting Fellow and Chairman of the Kings Policy Institute at Kings College, London TIM CLARK .......................................................................................... Former Senior Partner, Slaughter & May IAIN CONN ................................... Group Managing Director and Chief Executive, Refining & Marketing, BP p.l.c. TIMOTHY GARTON ASH ........................................................ Professor, European Studies, University of Oxford HEATHER GRABBE .................. Director, Open Society Institute, Brussels and Director of EU affairs, Soros Network LORD HANNAY.................................................................................... Former Ambassador to the UN & the EU LORD HASKINS .......................................................................................... Former Chairman, Northern Foods FRANÇOIS HEISBOURG................................................ Senior Adviser, Fondation pour la Recherche Stratégique SIMON HENRY......................................................................................................... CFO, Royal Dutch Shell plc WOLFGANG ISCHINGER.................................................................... Global Head, Government Affairs, Allianz LORD KERR (CHAIR) ................. Chairman, Imperial College London and Deputy Chairman, Royal Dutch Shell plc Esko Aho, Jim Attridge, Amar Bhidé, CAIO KOCH-WESER................................................................................ Vice Chairman, Deutsche Bank Group FIORELLA KOSTORIS PADOA SCHIOPPA............................................... Professor, La Sapienza University, Rome Albert Bravo Biosca, Nicholas Crafts, RICHARD LAMBERT.................................................... Former Director General, Confederation of British Industry PASCAL LAMY......................................................... Director General, WTO and Former European Commissioner Máire Geoghegan-Quinn, Malcolm DAVID MARSH.................................................................................................. Chairman, SCCO International DOMINIQUE MOÏSI................................................ Senior Adviser, Institut Français des Relations Internationales Harbour, John Kay, Helga Nowotny, JOHN MONKS.................................................... Former General Secretary, European Trade Union Confederation Andreas Schleicher, Michael Schrage CHRISTINE OCKRENT............................................................................ CEO, Audiovisuel Extérieur de la France STUART POPHAM.................................................................................. Former Senior Partner, Clifford Chance and David Willetts LORD ROBERTSON............................................. Deputy Chairman, TNK-BP and former Secretary General, NATO ROLAND RUDD......................................................................................... Chairman, Business for New Europe KORI SCHAKE............................................. Research fellow, Hoover Institution and Bradley Professor, West Point LORD SIMON .............................................................. Former Minister for Trade and Competitiveness in Europe Edited by Simon Tilford & Philip Whyte LORD TURNER ........................................ Chairman, Financial Services Authority and Climate Change Committee ANTÓNIO VITORINO...................................................................................... Former European Commissioner IGOR YURGENS..................................................... Chairman, Institute of Contemporary Development, Moscow Published by the Centre for European Reform (CER), 14 Great College Street, London, SW1P 3RX Telephone +44 20 7233 1199, Facsimile +44 20 7233 1117, info@cer.org.uk, www.cer.org.uk © CER JULY 2011 # ISBN 978 1 901229 99 8
ABOUT THE EDITORS Contents Simon Tilford is the chief economist at the Centre for European Reform. His previous CER publications include: ‘How to save the eurozone’ (October 2010); (as co-author) ‘The Lisbon scorecard X: The road to 2020’ (March 2010); (as co-author) ‘Carbon Capture and Storage: What the EU needs to do’ (February 2010); ‘The new About the editors Commission’s economic philosophy’ (February 2010); ‘Rebalancing the Chinese economy’ (November 2009). Editors’ acknowledgements Philip Whyte is a senior research fellow at the Centre for European Foreword Reform. His previous CER publications include: ‘Why Germany is not a model for the eurozone’ (October 2010); (as co-author) ‘The 1 Introduction: Why does innovation matter? 1 Lisbon scorecard X: The road to 2020’ (March 2010); (as co- by Philip Whyte author) ‘The new Commission’s economic philosophy’ (February 2 What is innovation? 9 2010); and ‘How to restore financial stability’ (January 2010). by John Kay ★ 3 Innovation and frontier research 13 EDITORS’ ACKNOWLEDGEMENTS by Helga Nowotny We are grateful to all the experts who contributed articles to this 4 New evidence on ‘creative destruction’ in Europe and the US 19 volume. We are also indebted to Charles Grant, Katinka Barysch, by Albert Bravo Biosca Hugo Brady, Stephen Tindale and Clara O’Donnell for comments on earlier drafts – and to Kate Mullineux for layout and production. 5 Improving productivity performance is not rocket science 25 by Nicholas Crafts Finally, we would like to thank Lundbeck for sponsoring the report, particularly as some of the views expressed in it do not necessarily 6 Skills, education and innovation 29 coincide with theirs. We take full responsibility for all errors and by Andreas Schleicher omissions. 7 Innovation policy in the EU: The biopharmaceutical sector 33 ★ by Jim Attridge 8 Financing the venturesome economy 37 by Amar Bhidé 9 Promoting innovation in an age of austerity: Copyright of this publication is held by the Centre for European Reform. You may not copy, reproduce, The European dimension 43 republish or circulate in any way the content from this publication except for your own personal and non- by Máire Geoghegan-Quinn commercial use. Any other use requires the prior written permission of the Centre for European Reform.
10 How the EU’s single market can promote innovation 49 by Malcolm Harbour Foreword 11 Innovation policy: A view from the British goverment 55 by David Willetts 12 Growth and innovation: The contribution of the digital single market 59 Lundbeck is delighted to support the CER’s latest publication. Innovation is the by Esko Aho lifeblood of the pharmaceutical industry. Its business model requires it to bring a new medicine to market every 10-12 years. 13 Does Europe really want to be innovative? 63 by Michael Schrage As such the pharmaceutical sector represents an excellent model to illustrate the challenges facing the European economy. From being, in the former Vice President 14 Conclusion 69 Verheugen’s words, “the pharmacy of the world” in the 1980’s, Europe is now by Simon Tilford witnessing a relative decline in investment, productivity and sales. The pharmaceutical sector is facing increasing challenges in bringing a new medicine to market. Even when these are met, we can no longer be certain of market access. This is impacting companies’ behaviour. For example, we are seeing companies exit the important area of depression. This is perhaps surprising given the high level of unmet medical need. A recent Health Council Conclusion noted that mental disorders account for the greatest share of disability-adjusted life years in the EU. The World Health Organisation estimates that mental disorders affect one in four citizens during their life time and can be found in ten per cent of the EU population during any given year. What message should policy-makers send to companies that are committed to continuing to search for new treatments in depression? As the authors of this report note, governments need to champion and reward new research, especially incremental developments, and cease rewarding old technologies. From a health perspective we need to change the way we regard illness. Rather than treating it with silo budgets, we need to look at illness holistically, treat medicine expenditure as an investment, and acknowledge that medicine can prevent expensive costs of hospitalisation, aide recovery and enable the patient to return to work rapidly and contribute to society. The report marks an important contribution to the debate. It provides some valuable insights and recommendations for policy makers and others to consider. Lundbeck welcomes the publication and looks forward to the debate that will follow. Ulf Wiinberg, CEO, Lundbeck
1 Introduction: Why does innovation matter? by Philip Whyte Innovation policy is currently very much in vogue. The European Union (EU) has made it one of the seven ‘flagship initiatives’ of its ‘2020 strategy’. And the Obama administration has placed it at the centre of its own strategy for economic recovery. Whatever innovation means, there appears to be widespread agreement on either side of the Atlantic that more of it is essential – not only to raise productivity, but also to ‘compete with China’ and meet all sorts of other challenges, from climate change to energy security and population ageing. Indeed, claims to the effect that innovation is crucial if countries and companies are to prosper in an increasingly competitive world economy have become something of a commonplace – repeated with monotonous regularity by policy- makers, commentators and businessmen in speeches, interviews and opinion columns. Yet it is not always clear what innovation actually means, or how it relates to prosperity. Some innovations, such as Facebook, may transform the way people interact, but do little to increase productivity. Others may have the potential to increase productivity, but require other things to happen before they do so. (This is the nub of ‘Solow’s paradox’ – the observation by the US Nobel laureate, Robert Solow, that the information technology revolution in the early 1990s was everywhere to be seen except in the productivity numbers.) Other innovations still may be positively harmful to prosperity. Those who extol the virtues of innovation often forget that one of the most consistently creative sectors of the economy is the financial sector – the relentless ingenuity of which
2 Innovation: How Europe can take off Introduction 3 recently contributed to the most spectacular destruction of wealth in a laboratory, or of a pioneer applying the latest technology to in human history. developing new goods and services. For John Kay, an academic and columnist, both are misleading images of what innovation entails. It In short, what innovation is, how it influences productivity, and what should not be conflated with R&D (because numerous innovative policy should do to encourage it are less straightforward issues than firms, like budget airlines, have no R&D budget to speak of). Nor is often assumed. The aim of this report is to explore these questions should innovation be confused with novelty. The distinction between by bringing together the thoughts of leading experts in the field. It innovation and novelty is captured by the difference between Apple should come as no surprise that they often reach different conclusions (an innovative firm that is adept at finding new and commercially on what innovation means and how it should be promoted. successful ways of using existing technology) and Sir Clive Sinclair Nevertheless, most of the authors appear to agree on two things. The (an endearing eccentric who invented things that no-one wanted). first is that there is much more to innovation than what goes on in The essence of innovation, Kay concludes, is finding new ways of research and development (R&D) laboratories. The second is that meeting customer needs. innovation is a multi-dimensional and increasingly ‘democratic’ process involving entrepreneurs and scientists, consumers and The President of the European Research Council, Helga Nowotny, producers. Innovation is as much about finding new ways of using or accepts that innovation is a complex, multi-layered process which delivering existing goods and services as about producing new ones. involves much besides the output of research laboratories. Even so, she argues that basic (or ‘frontier’) research remains vital. Even if Perhaps the most striking difference among contributors to the advances in science do not always increase general prosperity, they volume is that between academics (or think-tankers) on the one are often significant drivers of it. It was basic research, she points out, hand, and policy-makers on the other. The former point out that which drove the information technology revolution. Besides, in many Schumpeter’s famous description of innovation as a process of areas of research, the boundaries between basic and applied science ‘creative destruction’ has two components that are inextricably are blurring. Scientific curiosity continues to drive basic research, but intertwined. One cannot embrace creation (that is, the emergence of researchers increasingly work in inter-disciplinary environments in innovative young firms) without accepting destruction (letting which the search for commercial applications is actively pursued uncompetitive incumbents go to the wall). Yet policy-makers, (hence the term ‘frontier research’). Most European countries, she particularly in Europe, want to have their cake and eat it: they want argues, need to become better at commercialising ideas. innovation, but without the accompanying economic dislocation and social disruption. This largely explains the difference in policies Nowotny broadly agrees with Kay’s definition of innovation as prescribed. Whereas academics tend to emphasise the need for finding new ways of meeting (and creating) consumer needs. The lowering barriers to entry, politicians are more inclined to advocate way she sees it, however, innovation is heavily influenced by policies that are supported by incumbents. scientists and researchers, whereas for Kay it is driven mainly by entrepreneurs. Albert Bravo Biosca of the National Endowment for Science, Technology and the Arts (NESTA), strongly agrees that What is innovation? innovation is about more than research and that entrepreneurs For many people, the word ‘innovation’ is likely to conjure the have a central role to play. But he points out that it involves more image of a scientist in a white coat conducting cutting edge research than launching new products and services. If one of its purposes is
4 Innovation: How Europe can take off Introduction 5 to raise productivity, then innovation should be more broadly The claim that innovation is becoming more multi-faceted and understood to include the new ways that businesses come up with consequently less elitist (or more democratic) is also advanced by to make the best use of technology. Placing a computer on every Amar Bhidé of Tufts University. Failing to recognise this trend, he desk will not necessarily raise productivity if businesses do not goes on to argue, can often result in pointless or wasteful initiatives. change working practices. For example, encouraging more people to become scientists and engineers will not increase a country’s prosperity if the result is a dearth of managers who understand how working practices within How should innovation be promoted? their organisations should be changed to make the best use of new Nicholas Crafts of Warwick University strongly agrees with Biosca technologies. The same goes for policies designed to improve on what policy-makers should do to support innovation and funding conditions for young firms. Too much attention is arguably productivity: they should embrace creative destruction by devoted to developing the venture capital (VC) industry. VC has its encouraging the growth of innovative young firms and, where place. However, since most firms will never actually need VC necessary, accepting the demise of stodgier incumbents. As Biosca funding, democratic innovation requires a diversified financial notes, a lower ‘churn’ of firms suggests there is less creative system to fund it. destruction in Europe than in the US. Crafts suggests that the two most important things EU policy-makers can do to narrow the Jim Attridge of Imperial College London argues that it would be transatlantic productivity gap would be to ease employment law wrong to ignore the importance of R&D and highlights how (making it easier for companies to reorganise themselves to make disadvantageous Europe’s business environment is becoming to better use of information technology) and to enforce competition innovation in the pharmaceutical sector. Firms in the pharmaceutical policy. Crafts suggests these are preferable policies to increasing sector face three costly phases: a research phase, when they compete spending on R&D, pursuing sector-specific industrial policies, or to patent discoveries; an even costlier development stage, when expanding numbers in higher education. drugs are subject to clinical trials; and a diffusion phase, where firms must persuade clinicians and health bodies to adopt their new Andreas Schleicher of the OECD takes a slightly different view. For treatments. But across Europe, the economics no longer stack up. him, skills form the cornerstone of innovative societies. They spur Faced with governments that enforce low prices and restrict patient innovation by generating new ideas, and by facilitating the adoption access to innovative treatments, R&D in the sector is becoming of existing technologies. Since innovation is not confined to R&D increasingly unprofitable. If this situation is not reversed, labs, a modern economy requires an ever broader participation in pharmaceuticals companies will continue to withdraw from R&D the innovation process – encompassing producers and workers, but activity in Europe. also consumer and public-sector bodies. The bad news for Europe is that skills are unequally distributed, and that too many people do Promoting innovation in Europe not even have the most basic competences to participate in an innovation-driven economy. Moreover, producing the right mix of What sort of echo do the views expressed in the academic world skills is getting harder, because labour markets are becoming more find in policy-making circles? The European Commissioner for complex and dynamic: workers have to upgrade their skills more Research, Innovation and Science, Máire Geoghegan-Quinn, argues regularly than in the past to adapt to changing work patterns. that promoting innovation is more necessary and more difficult in
6 Innovation: How Europe can take off Introduction 7 an age of fiscal austerity – more necessary because increased sector contracts are awarded to small and medium-sized enterprises productivity is key to ensuring debt sustainability, and more under the UK’s Small Business Research Initiative (SBRI), and that difficult because fiscal consolidation is often sought by cutting similar steps be taken at EU level before the next Framework public investment in education, infrastructure and R&D. The Programme for R&D (FP8) comes into force. Commissioner makes the case for a “strategic and integrated” approach to innovation, in which national governments, the For Esko Aho, a former prime minister of Finland and a current European Commission and the private sector work closely together. member of the executive board at Nokia, one of the most important Key elements would include the completion of the European things that the EU can do to promote innovation is to extend the Research Area, the adoption of a common EU patent, and the single market. The EU’s four traditional freedoms of movement (for development of an EU-wide regime for VC. goods, services, people and capital) now need to be complemented by a fifth – for digital services and content. The absence of such a Malcolm Harbour, a member of the European Parliament for the market, Aho argues, is a serious lacuna which hampers both British Conservative Party, agrees with much of the European innovation and productivity – not just in the information technology Commission’s thinking. The best thing the EU can do to promote sector, but also across the economy more generally. Removing the innovation, he suggests, is to deepen the single market. National barriers that hamper the emergence of a single European digital jealousies and protectionist habits must be set aside so that the best market would consequently bring numerous benefits. Not only brains move to the best projects. The Services Directive must be would it help to spawn new solutions to the various challenges properly implemented. The Commission should adopt an (social, demographic and environmental) that the region faces, but ‘innovation test’ to ensure that EU policies do not deter R&D. it would also support economic growth. Standards should be harmonised so that common EU standards become global ones. Governments should ensure that public Do Europeans want to be more innovative? procurement acts as a catalyst for the growth of innovative firms by providing ‘lead markets’ for new technologies. And more should be The penultimate article, by Michael Schrage of the Massachusetts done to increase spending on R&D, notably by improving the Institute of Technology, throws cold water on European policy- infrastructure for its funding. makers by asking whether they are serious when they proclaim their ambition to make their countries more innovative. Innovation, he A national perspective on what governments can (or should) do to points out, is a disruptive process with risks and costs attached. It promote innovation is provided by David Willetts, Britain’s minister makes no sense to celebrate the upside of innovation while trying to for universities and science. Willetts agrees with the proposition resist the downside. Yet this is exactly what politicians across Europe that most European economies are experiencing diminishing returns do. They say they want to encourage the growth of innovative from labour inputs and investment in capital and must therefore companies. Yet they spend their lives resisting the demise of staid increasingly rely on innovation for future economic growth. incumbents because they fear the social and political costs of painful Interestingly, given his party’s longstanding commitment to a smaller adjustments in labour markets. The debate Europe must have, it state, he recognises that governments can actively support follows, is not about the role of entrepreneurs or new technologies. innovation – notably as a big purchaser of goods and services. For It is about Europe’s ability to tolerate – and manage – the example, the government wants to make sure that more public disruptions which innovation inevitably provokes.
8 Innovation: How Europe can take off The concluding article, by Simon Tilford of the Centre for European 2 What is innovation? Reform, shares some of these concerns. Policy-makers, he argues, think of innovation too narrowly. And their fear of economic by John Kay dislocation often encourages them to advocate policies that have only a limited impact on productivity. Governments that want to promote innovation, he argues, should focus mainly on two areas. The first is delivering an education system that equips people with the ability to generate ideas, commercialise them and absorb them Apple is the most innovative consumer products company of the last into working practices. The second is to promote competition and decade. It has redefined how people listen to music, blindsiding both markets, so that young, innovative firms can emerge to challenge music publishers and established electronics manufacturers. And it incumbents. Tilford wonders, however, whether the political climate has reinvented the telephone. Yet Apple’s achievement is not the in Europe is conducive to such policies. Since the financial crisis, result of its technology. The gizmos in the gadgets are much the same traditional European suspicions of competition and markets have as the gizmos in the gadgets of other companies. Apple’s success lies become more entrenched. in deploying existing technology in ways that meet consumers’ needs and in attracting buyers through coolly designed devices that do not Philip Whyte is a senior research fellow at the Centre for European require you to be a computer geek to use them. Reform. Understanding the needs of customers is what distinguishes innovation from novelty. Quirky inventors have a place in the affections of everyone who enjoyed physics or chemistry at school. But the quartz watches and home computers that Sir Clive Sinclair championed in the UK were quickly overtaken by better products from other businesses, and his C5 electric vehicle was not wanted by anyone. Pioneers of innovation are routinely pushed aside by competitors whose skills are in the marketplace rather than the laboratory. The invention of the body scanner won a deserved Nobel Prize for EMI’s Geoffrey Houndsfield, but almost destroyed the company. The market for scanners is now shared by Siemens and GE. My favourite innovative company is Easyjet. There is nothing technologically advanced about what it does. Indeed, there is nothing that it does that some other airline is not doing. Yet Easyjet catalysed fundamental change in the sleepy European airline industry. Innovation is about finding new ways of meeting
10 Innovation: How Europe can take off What is innovation? 11 consumers’ needs, often including needs they did not know they had. Michael Dell, who was barely in it. But IBM did not know the Sometimes such ideas come from a laboratory scientist but, more future of the industry. If it had known, it would – sensibly – have often, the innovation that changes the business landscape comes tried to prevent it. The interests of the industry and of consumers from the imagination of a Henry Ford or Walt Disney, Steve Jobs or were not only different from those of the dominant business: they Stelios Haji-Ioannou. were diametrically opposed. For years research and development scorecards have dutifully If a decade later you had wondered what government could do to recorded how much pharmaceuticals companies spend on the promote Britain’s civil aviation industry, you would have asked search for new drugs and the expenditure of governments on British Airways – and perhaps its main rival, British Caledonian. The defence electronics. But most of the spending that promotes government tried to promote competition through liberal policies innovation does not take place in science departments. The that particularly favoured Caledonian. All irrelevant, of course – financial services industry may have been Britain’s most innovative Caledonian would disappear and the people who controlled the industry in the past two decades – perhaps too innovative, for future were Michael O’Leary and Stelios Haji-Ioannou. But as many tastes – but practically none of the expenditure behind that business minister, you would have had no reason to give them the innovation comes under “R&D” rubric. And the same is true of time of day. Companies such as Easyjet see opportunities that others innovation in retailing, media and a host of other innovative have missed. Most of these opportunities do not actually exist and industries. Most innovation is the product of entrepreneurs, not the innovations fail. But only a few such entrepreneurs have to be people in white coats. right to change the face of business. So what should government do to promote innovation? Understand Confusion between the interests of an industry and the interests of that support for innovation is not the same as support for R&D, still existing companies pervades last year’s Digital Britain policy less the activities that established firms in industry regard as document and the legislation that followed. An admirable desire to innovative. We despise geeks – but we are also intimidated by them, promote Britain’s creative industries is translated into a wish list for and they retain a powerful influence on our thinking. Outside many corporate lobbyists, hired by large companies and trade university cities around the world there are biotechnology estates associations. Who else could they be hired by? There are few established by governments that believe high technology is the key certainties about how these creative industries will evolve. But one to a competitive future. The funds that governments provide to such is that if an industry is to advance, much – perhaps all – support innovation are all too often appropriated by large innovation will come from businesses that do not yet exist. Their companies that are better at forming committees to pontificate about founders may not even have imagined the activities that will one what the global village will want in the future than they are at day make them celebrities. assessing what their customers want today. The primary role of government in promoting innovation is the If you were in a government department pondering the future of the promotion of markets. The objective of promoting innovation computer industry in the 1970s, you would naturally have turned to should not be to reward grandees with knighthoods, favours and IBM for thoughtful experts and presentations. You would not have positions on committees: it should be to encourage a new generation consulted Bill Gates or Steve Jobs, who were barely out of school, or of people such as Gates, Dell and Jobs, Haji-Ioannou and O’Leary.
12 Innovation: How Europe can take off Promoting innovation means making it easy for new entrants to 3 Innovation and frontier research develop new products and business processes, not subsidising existing research and development. by Helga Nowotny John Kay is a visiting professor at the London School of Economics and a columnist for the Financial Times. There has always been an inherent tension between the demands of policy-makers for practical innovation, seen as the undisputed motor of productivity and hence economic growth, and the deeply-rooted interests of scientists in curiosity-driven research. Some of my academic colleagues fear that, by stressing ‘innovation’, politicians focus on incremental technological advancement only. As a result, the pivotal role of basic research remains largely unacknowledged. Politicians, on the other hand, feel that researchers are often uninterested in confronting today’s pressing problems, preferring to remain ensconced in their labs. The US has been more successful than Europe at resolving this tension between the research community and policy-makers. European scientists seem to want to wish away the tension, while the policy-makers, maybe even more naïvely, believe that commercially- applicable knowledge can be commissioned top-down. Innovation is a collective bet on our future. We have to get this right. With its rapidly ageing population Europe has to compensate for its falling birth rate by becoming more innovative. The contradictory perspectives of scientists and policy-makers are shaped by their differing time horizons. For politicians, the battle to ‘win the future’ means that results must be obtained immediately. For their part, scientists know from long experience that it is impossible to predict research outcomes, and that even when the outcomes are known, it may still take years to fully realise their benefits. What is innovation? We can broadly define innovation as the successful economic application of an idea. It results from enhancing
14 Innovation: How Europe can take off Innovation and frontier research 15 the way something is produced or from introducing new products. The process of innovation depends on many variables: the specific It can also involve new ways of organisation and modes of financing. field of scientific knowledge and technological know-how; national As a result, it is difficult to identify the processes through which and EU-level institutional contexts; regulatory frameworks that innovation actually happens. Moreover, innovation does not always seek to ban state-aid while encouraging governments to use public have to be a technology. In the ‘real’ world, social innovations may procurement to stimulate demand for new technologies; be just as important. The more technological innovation we want, intellectual property rights which may help as well as hinder the the more social innovation we need. burst of activities in novel areas; and, crucially, geographic location. Innovation ecosystems tend to emerge in certain places Nobody doubts its importance for economic growth and societal and not in others. Excellence (and the opportunities it provides) development, but the results of innovation cannot be foreseen and attracts excellence. Finally, there is the elusive, yet vital success remains unpredictable. Innovation describes a very complex, Schumpeterian human element of leadership. If we were to make non-linear process on various levels. It is therefore misleading to progress in understanding and coping with all these elements, we think of innovation merely as a chain starting with an idea and could make a giant step forward in what I call the ending in its profitable application. Such a ‘linear model’ of institutionalisation of innovation. knowledge production fails to capture the nature of research or how firms operate. Sometimes, the successful commercial What does this mean for basic research? Firstly, we cannot draw a development of a new technology triggers basic research by opening concrete link between specific scientific insights and increases in up new ways of tackling a problem. Sometimes research conducted productivity. But there is no doubt that investment in basic research in a lab turns out to be tremendously productive and useful for other contributes significantly to the processes that lead to innovation purposes outside the lab. and productivity. For example, it was basic research that underpinned the breakthroughs in ICT, biotechnology and Innovation should therefore be understood as a multi-layered nanotechnology that have driven such pervasive economic and process. First, there is the interaction of individuals, firms, societal changes over the last 30 years. Basic or investigator-driven organisations and governments. Second, invention and innovation research generates the scientific insights that lead to the development are both continuous and discontinuous processes. Many important of new technologies and markets. innovations are continuous in the sense that subsequent improvements in a product may be vastly more important than the Secondly, the European Research Council, an EU funding body set initial idea. This is what ‘incremental innovation’ is all about. But up to support investigator-driven frontier research, was wise to there is also a discontinuous, deeply disruptive form of innovation. change the term basic or fundamental research to frontier research. Had we continued to improve candles we would never have This was not only semantic. It indicates a change in the way developed electricity. And had we continued to improve the research is conducted and its very nature. In many areas of frontier production of electricity, we would never have come up with the research, the boundaries between basic and applied science have laser. Such ‘radical innovation’ has enormous repercussions for the become blurred. While frontier research continues to be driven by structure of our economies and their growth potential. Radical scientific curiosity, researchers are often working in an innovation is almost entirely due to new scientific insights, interdisciplinary context and increasingly with potential discoveries and technologies made in basic research. applications in mind.
16 Innovation: How Europe can take off Innovation and frontier research 17 Thirdly, past experience shows that governments are poor at picking changes in productivity. Such paradigm shifts are driven by winners. The once so popular discourse on National Innovation curiosity-driven scientific enquiry. However, Europe also needs to Systems based on the idea of nationally centralised innovation is get much better at commercialising or diffusing new insights. Closer rapidly giving way to a debate about ‘open innovation’. Again, with links between scientists on the one hand and policy-makers and a more distributed, diverse and hybrid innovation ecosystem businesses on the other would help. But we also need to make sure emerging, public and private actors will continue to mix; and that the national and EU-level institutional contexts are conducive markets and research will move closer to each other. Moreover, the to innovation. Policy-makers need to strike the right balance ideas of collective property rights and open access have begun to between the rights of developers of intellectual property and the challenge the more orthodox views of intellectual property rights. need to disperse new technologies. Firms must face strong market incentives to commercialise technologies and/or to reorganise in Crucial questions remain. How do we manage the inherent tension order to make the best use of them. This is Europe’s sputnik between the political impatience for practical results and the moment. Europe cannot afford to fail to develop more favourable insistence of scientists that in frontier research the outcome is innovation ecosystems if it is to meet its mounting economic and impossible to predict? How do we foster innovation across a wide social challenges. spectrum of possibilities and cope with the inherent uncertainty and risks that scientists face when working at the frontier between what Helga Nowotny is director of the European Research Council. is known and yet unknown? And how do we contribute to the establishment of the European Research Area? Rather than trying to suppress the inherent tension between the interests of policy-makers and scientists, we need to acknowledge it openly. If we want to foster innovation, we need to boost frontier research. That does not mean pouring money indiscriminatingly into basic research. Although frontier research is inherently uncertain, that does not mean everything can be left to chance. It is vital that scientific excellence is the sole criteria for the funding of frontier research. This will inevitably mean that funds continue to be concentrated in leading institutions. This is as it should be, but excellence does not equal exclusivity. We should do everything to nourish existing innovation ecosystems, and enable new ones to emerge. The process of innovation is a complex and unpredictable one: we cannot pick winners. However, we do know that basic or frontier research is an indispensable element of this process. Perfecting existing technologies is important, but it will not lead to step-
4 New evidence on ‘creative destruction’ in Europe and the US by Albert Bravo Biosca Europe faces major challenges recovering from the recession. The immediate ones are to avert a full blown sovereign debt crisis, consolidate the nascent recovery and create jobs. But in the longer term more fundamental changes are needed. The European economy has structural weaknesses that preceded the financial crisis. So a return to ‘business as usual’ is not an option. Improved productivity is essential if European economies are to thrive in the next decade: European businesses are less productive on average than their US counterparts, and the gap had been widening for over a decade before the recession took hold. Closing this gap requires a more innovative and dynamic economy. For much of the second half of the twentieth century, European countries could grow by accumulating capital and imitating others’ inventions. Now we need to foster innovation to drive productivity growth. This is also the most appropriate response to increasing competition from emerging markets. And it is the only sustainable route if firms and countries are to move up the value chain. Innovation needs experimentation in the real world, going beyond the R&D lab. Innovation is about putting new ideas into practice. Trying a new business model, exploiting a new technology or launching a new product often requires a firm to expand its current capabilities (for example, by setting up a new plant or hiring a new marketing team). However, since innovation is uncertain and market selection harsh, too many companies prefer an ostensibly safer ‘wait
20 Innovation: How Europe can take off New evidence on ‘creative destruction’ in Europe & the US 21 and see’ approach to riskier experimentation, particularly if failure has long vexed European policy-makers. But the new database is too costly. In the long term, such conservatism could be far riskier. shows that this is only part of a wider picture: While experimentation is necessary, it is not enough. Companies ★ European countries have a lower share of high-growth firms must build on their innovations. This means growing and replacing than the US. But they also have fewer medium-growth firms less successful firms, and forcing competitors either to improve their and fewer shrinking firms. At the same time, Europe has a performance or to shrink and exit the market altogether. This much larger share of ‘static’ firms, that is, firms that neither creative destruction is what ultimately drives productivity growth. expand nor contract over time. Are European economies up to the challenge? The evidence is not ★ The fastest growing half of firms grow faster in the US than in encouraging. Both Europe and the US have highly successful the average European country, while the bottom half shrink companies, but the European ones are generally much older. A study faster. Thus, the gap between successful and unsuccessful firms by Bruegel, a Brussels-based think-tank, shows that only 2 per cent is larger in the US than in Europe. of the European companies in the world’s largest 500 firms by market capitalisation were founded after 1975, compared with 14 ★ There is a strong negative correlation between the growth rate per cent in the US. of firms at the top and the bottom of the growth distribution. In other words, the faster successful companies grow, the faster This is not just about differences in rates of entrepreneurship. unsuccessful companies in the same industry shrink. Researchers at the OECD and the World Bank have shown that the main differences between the US and Europe lie in the rate at ★ The average high-growth firm multiplies its workforce by 2.5 which new firms grow rather than the number of new firms. US over three years. Therefore, despite their small share (3-6 per start-ups grow much faster in their early years than their cent of firms), high-growth firms account for a disproportionate European counterparts. share of job creation (between a third and half of all jobs created by surviving firms with ten or more employees). To shed further light on the dynamism of Europe’s business landscape, the Danish Ministry of Economic and Business Affairs ★ A less dynamic business growth distribution, with a larger and Britain’s National Endowment for Science, Technology and the share of ‘static’ firms as in Europe, is associated with lower Arts (NESTA), with support from the International Consortium for productivity growth. Importantly, both a higher share of Entrepreneurship, collaborated with researchers and statistical growing and shrinking firms are correlated with higher agencies in 11 countries across three continents to collect new and productivity growth, which is consistent with a faster comparable data on business growth. The resulting database, which reallocation of resources (both labour and capital) towards draws on individual records for six million businesses, provides successful innovators. useful lessons for policy-makers. Europe’s less dynamic businesses – both in terms of growth and The dearth of European equivalents to Google or Microsoft – contraction – should be a concern. We are not good enough at innovative start-ups that grow quickly to dominate their markets – creating an environment where firms experiment with new projects,
22 Innovation: How Europe can take off New evidence on ‘creative destruction’ in Europe & the US 23 scaling them up when successful while being able to backtrack and Current attempts to create an EU-wide corporate tax system (the shrink when unsuccessful. As a result, innovation in Europe suffers. common consolidated corporate tax base), a single European patent (the EU patent) and a single legal form for SMEs (the European This has implications for European policy-makers. The debate on Private Company – ‘SPE’) suggest a potentially valuable third way. high-growth firms often considers them in isolation. But policies A new ‘28th regime’, sitting alongside the 27 national regimes targeted solely at high-growth businesses, such as improving the without replacing them, could give firms the option to operate under climate for venture capital, are not enough to address the lack of the same set of simplified rules and procedures across the EU, while dynamism that hampers Europe’s productivity. They need to be still preserving the rights of member-states over specific issues such combined with deeper structural reforms that remove not just as tax rates. Other benefits would follow. For instance, it would barriers to entry, but also barriers to growth and contraction, such make it easier for firms from different countries to work together, as improving product and labour market regulation and tackling create a less fragmented market for business services providers, and access to finance. Some European countries are more advanced facilitate the development of Europe-wide financial intermediaries. than others in this respect, so governments have much to learn from their experiences. Achieving a more innovative Europe requires action in multiple areas. Removing barriers to make it easier for innovative businesses Finally, Europe needs an ambitious push to reduce its market with high-growth potential to experiment and expand across Europe fragmentation. While the single market has made it easier to sell is crucial. European policy-makers must make it happen. After all, goods across borders, the liberalisation of the market for services has the sooner we start addressing our long-term growth challenge, the been too slow. And even with planned reforms, differences in easier it will be to navigate today’s uncertainties. regulation between member states will still make it difficult for companies, particularly SMEs, to operate across borders. Albert Bravo Biosca is senior economist at NESTA and author of ‘Growth Dynamics’, a report on which this essay is based. To read The European Union represents a potential market of half a the full report, visit www.nesta.org.uk. billion customers, the third largest after China and India, and has a combined GDP larger than that of any country in the world. But a firm wishing to set up establishments across the 27 EU member-states would still be subject to 27 different legal regimes, with different registration requirements, labour regulations, intellectual property systems, tax rules, commercial law, judicial traditions and bankruptcy proceedings, among others. While dealing with 27 different jurisdictions may be merely an annoyance for large multinationals (to the benefit of their armies of advisers), it can be an insurmountable challenge for innovative smaller firms willing to grow (in fact, some ambitious entrepreneurs simply choose to relocate to the US altogether to avoid the hassle).
5 Improving productivity performance is not rocket science by Nicholas Crafts From the mid-1990s to the eve of the global financial crisis, European productivity performance was disappointing. The rate of labour productivity growth in the EU-15 averaged 1.5 per cent per year, compared with 2.1 per cent in the US. Around this European average, there were, of course, large national variations, with labour productivity growing by 3.5 per cent a year in Ireland, but by just 0.4 per cent in Italy. The fact remains, however, that in ten European countries labour productivity grew by less than 2 per cent a year. For the first time since World War II, much of Europe has been falling further behind the US, rather than catching up. European politicians often respond to these figures by stressing the importance of promoting a dynamic, knowledge-driven economy. The task, they argue, is to achieve faster economic growth by prioritising a stronger research and development effort and expanding higher education. Accordingly, they are often tempted to launch initiatives to encourage the rebalancing of economies towards high value-added, new-technology growth sectors through selective industrial policies. These approaches to the productivity agenda are seen as modern and proactive and often get a good press. It is certainly reasonable for governments to support research activities, including those in universities. There are divergences between private and social returns, so there is a traditional market- failure justification for such policies. More generally, government has an important role in underpinning productivity performance
26 Innovation: How Europe can take off Improving productivity performance is not rocket science 27 through ‘horizontal’ industrial policies. Policies which raise the rate produce ICT equipment, but how to make best use of it. And this of return to private investment and innovation – notably by raising consideration has been influenced more by regulations than by the quality of state education or improving the provision of shortfalls in human capital or domestic R&D spending. transport infrastructure – can have a favourable impact on the long- Employment protection legislation, for example, can make it hard run rate of productivity growth. and expensive for businesses to reorganise themselves to make best use of the ICT they have invested in. Similarly, restrictions on However, there is usually no good case for ‘selective’ industrial retailing create barriers to entry and slow down the exit of less policies which subsidise favoured businesses or sectors. Economic efficient firms. theory tells us that such policies will generally be skewed not only to advancing producer interests at the expense of consumers, but also Consider the case of distribution. It is a large sector across Europe, to supporting declining industries which have the most to gain from typically employing as many people as manufacturing. And it lobbying. Economic history from the 1930s through to the 1970s happens to account for a sizeable share of the widening transatlantic and beyond bears out these predictions and shows that such policies productivity gap after the mid-1990s (when labour productivity were a dismal failure in terms of improving growth performance. growth in this sector fell from 1.7 per cent to 1.3 per cent per year in the EU, but rose from 2 per cent to 6.5 per cent in the US). The It is also important to put the role of domestic R&D in true US’s strong productivity performance was based on the entry and perspective. Recent research has confirmed that investment in exit of retail establishments – in other words, creative destruction. ‘intangible capital’ has a significant impact on productivity growth. Retailing has become a big user of new technology, especially ICT. However, intangible capital includes much more than just But since it carries out very little R&D, it would never be the focus conventional R&D. Typically, about two-thirds of intangible capital of a so-called ‘growth strategy’. In short, the example of the is made up of other components such as computerised information, distribution sector underlines the importance of competition policy design, and economic competencies – items which are generally not (rather than industrial policy) and of technology diffusion (rather good candidates for subsidy on market-failure grounds. Recent than R&D) for innovation and productivity growth. research suggests that investment in ‘innovative property’ (a broader concept than traditional R&D) accounted for only about 10 per cent There is compelling evidence that competition promotes productivity of the productivity growth difference between Europe and the US growth. Yet competition is generally weaker in the EU than in the after the mid-1990s. US. Competition works through its positive impact on management quality, by creating pressure to invest and innovate or lose market The two most important things that EU countries can do to raise share, and by ensuring that productive resources are reallocated to productivity is to encourage the rapid diffusion of new technologies, better uses. It is therefore disappointing to note that regulations and to facilitate creative destruction. For the typical European which inhibit competition and the rapid take-up of new technologies country, at least 90 per cent of the R&D that contributes to its are still prevalent in many European economies. Moreover, the productivity growth is conducted abroad. It is therefore the effective impact of the single market programme on productivity has been transfer and assimilation of this knowledge that is required. impaired because its implementation by many member-states has Information and communications technology (ICT) is an excellent been half-hearted. The symptoms of inadequate competition are example: for most countries, the big issue has not been whether to relatively high price-cost mark-ups, as well as lower market shares
28 Innovation: How Europe can take off of high-productivity firms in the EU compared with the US. Rather 6 Skills, education and innovation than reverting to industrial policy, strengthening competition policy is much the better way to go. by Andreas Schleicher The message must be that an effective policy to promote innovation is not just, or even mainly, about stimulating R&D and giving subsidies to hi-tech sectors. It is mainly about the decidedly unglamorous, even thankless, task of putting in place a framework Skills have never been as central to the prosperity of nations and that encourages the efficient diffusion of new technology and ensures individuals as they are today. Skills spur innovation by generating the exit of the inefficient and outmoded. Both literally and new knowledge, and facilitating the adoption and adaptation of figuratively, it is not about rocket science. The economics is quite existing technologies and ideas. In so doing, they contribute to straightforward; the problem is the politics. Implementing an productivity (and hence economic growth). They also play a key role appropriate policy will provide fewer photo opportunities for in countering earnings inequality. politicians, and may in any case lose rather than win votes. Because innovation is not confined to corporate R&D laboratories, Nicholas Crafts is director of the Research Centre on Competitive a modern economy requires broad participation in the innovation Advantage in the Global Economy (CAGE) at the University of process – among users, suppliers, workers and consumers, and in the Warwick. public, private and non-profit sectors alike. It is worrying, therefore, that skills are highly unevenly distributed across Europe, and that substantial numbers of people still do not even reach the minimum levels of basic skills. While some countries have managed to improve their skills base in recent years, others have stagnated or even declined – this at a time when the economic and social costs associated with low skills have been rising. Matching the supply of relevant skills to the demand for them is never straightforward. Skills mismatches can occur when a worker would be more productive in another job, or when there is a general surplus or shortage of specific skills. And they can result from any number of factors. Employers may be ineffective at signalling their needs; education and training systems may be unresponsive to changes in demand for certain skills; and skills can atrophy or be lost altogether – either because they are not developed or sustained through education and training, or because they are not used (commonly as a result of unemployment).
30 Innovation: How Europe can take off Skills, education and innovation 31 What does all this mean for policy? The foundation for building a skills Female educational achievement has increased significantly and, for pool remains the acquisition of what can be called ‘cognitive foundation the younger cohorts, it has now overtaken that of men. But while skills’ – in plain language, basic literacy and numeracy. Both are key female participation in the labour force has increased, the gender tools for continued learning, and for developing more advanced and gap remains substantial: on average, only about 60 per cent of specific types of human capital. If countries are to avoid wasting talent women in OECD countries are employed or looking for work, from the outset, they must ensure access to education for all – not just compared with 80 per cent of men. to reach the right level of basic education, but also to make it possible to upgrade and extend skills during the course of a person’s lifetime. Lifelong learning will require the development of new funding models. Investment in learning needs to be cost and tax-efficient for However, making the optimal use of existing skills and preventing individuals and their employers. For those out of work, funding the erosion of skills through lack of use is just as important as needs to be accessible to support and incentivise learning. producing the right skills in the first place. As job and occupational Governments should encourage, via the tax system and regulation, mobility increases, and the shelf-life of domain-specific knowledge the development of new financial instruments that allow learners to declines, individuals must upgrade their skills more regularly than in access opportunities when they need them most. For learning the past. With demand for skills growing and changing over time, beyond universal education, education and training systems need to traditional education and training systems that select individuals find ways to share the costs among government, employers and and assign them to particular streams are increasingly out of date. students based on the respective benefits obtained. Governments need to improve skills across the population as a whole; ensure that vocational training focuses on more than Policies must become less piecemeal than they have often been in the immediate employability (notably by developing transferable skills past. Large gains can be achieved by co-ordinating efforts at all that facilitate occupational mobility); and make sure that skills are levels and by investing tight public budgets more effectively and developed through lifelong learning (which may require new ways of efficiently. To this end, governments must build new relationships ‘bringing learning to the learner’). with learners, providers, businesses, social investors and innovators. Governments must also develop more targeted policies to support Andreas Schleicher is head of the Indicators and Analysis Division, groups that are currently marginalised in the labour market. School Education Directorate, OECD. drop-outs represent one group at risk. Key policy actions for this group must include early interventions to support young people at risk of leaving the education system without a recognised qualification, as well as measures to assist young people in finding jobs. Other groups at risk include immigrants and minorities. The integration of such communities into the labour market remains a major challenge in many EU countries. Despite welcome change in recent years, women still represent the largest under-utilised pool of human capital in OECD countries.
7 Innovation policy in the EU: The biopharmaceutical sector by Jim Attridge The pharmaceutical industry creates many positive spill-overs. Aside from the development of treatments for crippling, painful and life threatening conditions, wider social and economic benefits flow from having healthier populations and high quality employment. For years now the industry has been consolidating its research and development (R&D) spending in fewer places and on a reduced number of diseases. There is less R&D money around and more competition for it. Europe is losing out to the US and increasingly to fast-developing economies such as China and India. This is because the EU and member-state governments are failing to strike the right balance between the need to contain rising healthcare costs and the need to provide pharmaceuticals firms with sufficient incentives to develop new innovative medicines in Europe. Innovation in the pharmaceutical sector epitomises what Schumpeter called routine innovation. The research component of R&D investment is much like many other sectors, involving laboratory- based studies by academic and industry-based scientists and a competitive race to patent inventions. But the second stage – the development phase – is exceptionally long and expensive; it is dominated by clinical trials, which test the efficacy and safety of treatments against stringent criteria. The third phase of the innovation process – the often overlooked diffusion phase – requires innovators to persuade conservative clinicians and financially- pressed health bodies to adopt their new treatments. Once a product enters the market, the firm responsible for its development benefits
34 Innovation: How Europe can take off Innovation policy in the EU: The biopharmaceutical sector 35 from only around ten years of market exclusivity before it faces should militate against the need for further regulations to limit the competition from cheaper generic versions of the drug. prices of new patented treatments or to cut the prices of those already on sale in EU countries. Governments need to recognise The discovery of a new way to treat a disease results in the filing of that after decades of ‘cut and cut again’ cost saving measures, numerous patents by many competing academic and industrial Europe’s R&D-based pharmaceuticals industry is wilting. This is organisations across the world. Companies with the necessary largely the result of a failure to recognise the impact that cost resources then have to decide whether to risk embarking on a ten containment by governments has had on the attractiveness of year development programme – costing around US$1bn – to Europe as a location for pharmaceuticals R&D. The threat emanates translate the invention into a commercially viable product, which not only from the US – where European pharmaceuticals firms are stands a good chance of being approved by the various regulators. doing an increasing share of their bioscience R&D – but increasingly Early market access benefits both patients and the innovator seeking from China and India, whose fast-growing markets make them a return on their investment. formidable rivals for R&D investment. However, the full therapeutic potential of a new treatment may only There have been some positive EU initiatives to increase the rewards be realised following many more years of additional investment in for investing in innovation. The EU’s ‘orphan drug concept’, clinical trials and associated product development. This highlights introduced in 2001, has encouraged R&D into treatments for the crucial distinction between the primary research, which leads to numerous rare diseases. This has been achieved by fast-tracking the initial invention, and the incremental development of that regulatory approval for the medicines and extending the period of treatment over many years. This distinction is at the heart of a time that firms benefit from patent protection. However, patient access vigorous debate over how and where to invest public research funds to the new treatments varies greatly across EU member-states, with and how EU governments should determine access to treatments and some countries severely restricting access to them on cost grounds. The the prices paid for them. Public health insurance schemes are the Innovative Medicines Initiative, a joint public-private collaboration dominant funders of prescription medicines in the EU. Burgeoning between the European Commission and the pharmaceuticals industry, demand for treatments combined with weak public finances means aims to both promote a wider science base through funding research that these organisations are under huge pressure to cut costs. Over projects and through initiatives to streamline development processes. many years this has spawned a plethora of national regulations for Whilst such initiatives are undoubtedly helpful, their scale and effect the pharmaceutical sector, the main thrust of which has been to are unlikely to offset the much greater impact of ever tighter price enforce low prices and restrict patient access to innovative controls and regulatory changes. treatments. This, in turn, has reduced the amount of revenue accruing to a firm over the life-time of an innovative new treatment, The lack of a holistic approach encompassing all three of the and undermined the attractiveness of Europe as a location for innovation phases – research, development and diffusion – has led to pharmaceutical R&D. poor policy towards the pharmaceuticals industry. A key EU policy shift in recent years has been to reduce the amount of money firms Over the next three years the patents on a large number of high receive for what are considered minor or incremental advances in value drugs will expire, reducing companies’ revenues and providing treatments; the aim being to concentrate R&D investment in areas substantial savings for both public and private health systems. This likely to produce major new medicines. Despite the obvious appeal
36 Innovation: How Europe can take off of such policies, they are incompatible with the inherent nature of 8 Financing the venturesome the innovation process. All the evidence suggests that reducing the amount of money pharmaceuticals firms receive for incremental economy innovation will accelerate the withdrawal of R&D activity from by Amar Bhidé ever more areas of disease. This trend is well illustrated by the current crisis in the development of new antibiotics. Declining R&D investment into antibiotics means that there are now few new products to treat resistant organisms, such as c.difficile or MRSA. Over the coming decade further ‘innovation deserts’ will emerge, and the capabilities and infrastructure necessary to respond quickly A relatively small number of individuals and organisations is often and effectively to new diseases will be much diminished. credited with advancing the scientific and technological frontier (and hence with sustaining the well-being of all). In reality, however, To prevent this, the EU and member-state governments need to re- this common yet elitist conception of innovation misrepresents its think policies on two fronts: nature and role. Widespread prosperity and rewarding work depend on the creativity and enterprise of many individuals, rather ★ The European Commission needs to focus less on maximising than a few. Innovation is a multiplayer game, not a professional the short-term interests of consumers and do more to sport in which a few highly talented and well paid athletes put on champion the pharmaceuticals industry as a strategic EU asset a show for the rest of us. Narrow conceptions of innovation are in a global context. damaging in a modern economy because they often prompt pointless and wasteful initiatives. ★ EU member-states need to integrate better their national strategies for healthcare – balancing the need for affordable Inclusive innovation treatment with the need for a thriving pharmaceuticals industry. Better integrated models will need to acknowledge that Europe In earlier times, new artefacts were often developed by a small faces intensifying competition for internationally mobile number of inventors and sold to a few wealthy buyers. Alexander bioscience and biopharmaceutical activities. Graham Bell, for example, invented the telephone with one assistant. Likewise, automobile pioneers were one- or two-man Jim Attridge is research fellow at Imperial College London. shows – Karl Benz and Gottlieb Daimler in Germany, Armand Peugeot in France, and the Duryea brothers in the US. Early car buyers were rich hobbyists. These days, innovation is far more inclusive. Innumerable entrepreneurs, venture capitalists, executives of large companies, researchers at universities and commercial and state-sponsored laboratories, programmers and members of standard-setting institutions as well as politicians have played their part in turning the
38 Innovation: How Europe can take off Financing the vernturesome economy 39 Internet into a revolutionary medium of communication. Steve Jobs, primary bottleneck. We should always remember that the most often portrayed as a brilliant solitary inventor, relies on tens of important innovations are often the organisational changes needed thousands of individuals working at Apple and its network of to make use of new technologies. suppliers. And, unlike the early buyers of automobiles, millions of regular consumers scoop up products such Apple’s iPad and Official preference for particular technologies conflicts with the Microsoft’s Kinect. principle of encouraging the many to draw on their unique imaginations and experiences. Faced with the same general The many kinds of ideas and know-how needed for the opportunity, different innovators will often come up with very development and widespread use of new products and services different solutions – and no one can predict whose will work best. favours such ‘inclusive innovation’. Consider the microprocessor, So, for example, the problem of global warming is best confronted which is at the heart of so many modern gadgets. The necessary with numerous independent approaches, from more efficient solar know-how ranges from high-level general principles (the laws of cells to carbon capture and storage, safer nuclear power, better solid state physics, mid-level technologies including circuit designs insulation of homes, and fewer cars. and chip layouts, and so on) to ground level problem-solving (like tweaking conditions in a specific semiconductor fabrication plant At the same time, official indifference will not do either: to maximise the quality and yield of the microprocessors technological advances often require an increase in the role of produced). The development of these multiple levels is best government. The growth of the automobile industry, for example, entrusted to many individuals and organisations with specialised required the building and maintenance of roads, the formulation and knowledge and skills. enforcement of driving rules, a system of vehicle safety inspections, and controls on vehicle emissions. Rather than lead or ignore In general, therefore, the development of new technical know-how technological advances, governments should provide broad but is not enough. A new ‘diskless’ computer, for instance, will generate ‘oblique’ support, as John Kay would put it. The ups and downs of value only if it is effectively marketed by producers and properly the US financial system illustrate the importance of a sensible deployed by users – all of which requires marketing and indirect government role. organisational innovations. Innovation also requires venturesome consumers. The use of a new product or service is not a passive act: Funding innovation each time we buy a new computer we take a chance that it will be worth the money and effort. Financing innovation often brings to mind professional venture capitalists (VCs) who invest in high-tech start-ups. But it is often forgotten that VCs fund less than one half of one per cent of annual Policy implications US business start-ups. Most small businesses are not suited for VC Policies to advance cutting edge science and technologies that derive funding and never develop revolutionary products, yet still play a from an elitist view of innovation often do more harm than good by crucial role in the innovation game. Innumerable small outfits – diverting resources away from other activities. Encouraging more including retailers and customisers of off-the-shelf software – people to become engineers and scientists instead of managers will worked hand-in-hand with enterprises such as Apple, Microsoft and exacerbate the problem if the development of technology is not the Intel to put a computer in virtually every home and office in the US
40 Innovation: How Europe can take off Financing the vernturesome economy 41 and Europe. And small businesses usually cannot thrive without The rules that sustained sound but not stagnant lending steadily bank loans because they cannot raise much equity capital. unravelled after the 1970s. Policies that favoured light touch banking regulation and arm’s length markets fostered the growth of Venturesome consumption also hinges on credit. Henry Ford’s an unregulated and uninsured depository system. They also genius would have counted for little without millions lining up to encouraged lenders to rely on backward-looking statistical models buy the Model T. And even though revolutionary manufacturing that paid little heed to the specific circumstances and prospects of methods made cars much more affordable, few buyers had sufficient borrowers, instead of case-by-case forward-looking judgments. savings. By 1926, two-thirds of all cars sold in the US were purchased on credit. Today, consumer lending underpins the The growth of such ‘robotic lending’ was hailed as an advance akin explosive growth of smart-phones. to Henry Ford’s assembly line. Among other things, it sharply reduced the costs of extending credit, especially to poorer home By and large, sensible bankers will not make medium or long-term buyers. Lending to consumers with limited immediate means loans to businesses or consumers if they are worried about the certainly helps create mass markets for new products. But it can only stability of their own deposits: the risk of unexpected withdrawals be sustained if lenders select individuals who are likely to repay their (or ‘runs’) encourages banks to stick with well-secured and short loans. Skimping on due diligence and showering all comers with term loans. In fact, until the passage of the Banking Acts in 1933 credit does more harm than good. Moreover, not all credit decisions and 1935 that created a comprehensive system of deposit insurance, can be easily mechanised. Small business lending for instance is US banks did not lend to consumers. The buy-now-pay-later plans harder to mass-produce than housing loans. This no doubt explains of the 1920s that helped create a mass-market for cars, radios and why, as housing credit surged before the 2008 crash, banks neglected vacuum cleaners were promoted by consumer loan companies and the small business borrowers that make a larger contribution to the other such non-bank finance companies. It was deposit insurance long-run growth of innovative economies. Worse, after the crash that permitted banks to offer longer term loans to businesses and to banks withdrew credit from sound businesses. finance the consumer boom that followed World War Two. Several measures such as fiscal stimuli and quantitative easing have Prudent lending requires careful, case-by-case judgment. A since been deployed to get developed economies moving again. But borrower’s credit history certainly merits consideration, but in a growth cannot be sustained without innovation, as many realise. A pervasively dynamic economy, ‘past performance is no guide to the clearer and broader appreciation of how the structure and future’. In addition, the time and expense required for careful orientation of modern finance undermines innovation in its broad judgments about what is likely to happen can encourage bankers to sense is a necessary first step. cut corners. Deposit insurance only increases the temptation by removing the fear of bank runs. For many years, tough regulatory Amar Bhidé is Thomas Schmidheiny professor at the Fletcher School oversight of loans and lending practices effectively checked the of Law and Diplomacy, Tufts University. imprudence that deposit insurance alone might have encouraged. Even as bank lending in the US grew by over 9 per cent a year in the 1950s and 60s, the largest number of banks that failed in any given year was just seven.
9 Promoting innovation in an age of austerity: The European dimension by Máire Geoghegan-Quinn As Europe emerges from the global financial crisis, member-states must press ahead with consolidating their public finances and transforming their economies to tap new sources of growth. Several challenges must be tackled simultaneously: restoring fiscal sustainability, tackling the long-term financial problems associated with an ageing population, and preparing for increased competition from emerging economies. Ever since the crisis broke out, the European Union has therefore taken a holistic approach: it has sought to address short-term challenges, while also taking action geared towards the medium- to longer-term. In its Europe 2020 strategy, the European Commission set out how to achieve high levels of future growth. Raising productivity through innovation is one of the key ingredients of the Union’s response to the crisis. This is why innovation has been put at the heart of the Europe 2020 strategy. The so-called ‘Innovation Union’, which the Commission presented in October 2010 as one of its seven ‘flagship initiatives’ under the Europe 2020 strategy, charts the course for the years ahead. Europe has no shortage of potential. It has some of the world’s most successful and innovative economies. There is a long tradition of inventions, many of which have changed the world and improved our quality of life. The political systems of the EU are based on the rule of law and stable democratic institutions. The EU has the largest single market in the world and a majority of its
44 Innovation: How Europe can take off Promoting innovation in an age of austerity: The European dimension 45 members now share a common currency. Last but not least, our framework. The aim will be to bring together the different people, our common values and our cultural diversity and creativity instruments into a common strategic framework to focus on areas are sources of great strength. with the highest EU added value, and to provide seamless support for innovations from research to market application. Europe’s competitive strength must derive from higher productivity, from improving our skills and from producing high quality products What Europe lacks compared to key trading partners such as the and services, which compensate for higher wages and costs of US, Japan, South Korea and China is a strategic and integrated production. Europe must regain a first-mover advantage and approach to innovation – that is, one in which innovation strengthen its share of global markets. In short, our future prosperity objectives guide policies in relevant areas such as education, depends on the quality of the European labour force and on skills, labour, product and services markets, and in infrastructure Europe’s ability to drive innovation in a range of different areas. and regional development. Only a handful of member-states pursue such a strategic approach, which is steered at the highest All member-states are currently working to reduce their budget political level. deficits and to keep public debt levels under control. While this process is necessary, it is critical that budget cuts be implemented in Innovation does not happen in a vacuum. There are essential a way that supports sources of future growth. Smart fiscal conditions that need to be fulfilled for innovation to flourish. What consolidation involves protecting investments in areas such as the leading countries and regions have in common – whether it is in education and skills, research and innovation, high-speed internet, ICT, renewable energy or healthcare – is an integrated, well- and other information and communication technologies on which functioning innovation ecosystem, where government policy works our future growth will depend. hand-in-hand with the private sector. Several member-states have recognised the need to turn the crisis National governments have a key role to play, notably by providing into an opportunity. Some countries, like Germany and France, have excellent education, equipping people with the skills needed to opted to increase their public investments in education, research thrive in a knowledge-based society, and supporting and innovation despite cuts to their overall budgets. Other countries, entrepreneurship and risk-taking. There are several world-class such as the UK and Spain, have decided to keep their research and universities in the European Union, but Europe’s ambition should innovation budgets stable, against a background of deep cuts be to have many more, to promote networking and to ensure that elsewhere. These are examples of ‘smart’ fiscal consolidation. Other many more young people can gain experience in setting up and member-states should, as far as possible, follow suit. running their own businesses. The positive effects of (increased) investment in growth-enhancing Alongside policies at national level, there is much that can be done areas must be further reinforced by undertaking targeted structural at European level to improve the overall framework conditions: reforms, notably of research and innovation systems. More than ever, fiscal pressures require us to maximise the quality – and the ★ The completion of the European Research Area (ERA) by 2014 leverage effect – of public-sector funding. These principles will be will create major opportunities for closer cross-border co- applied to EU research and innovation funding in the next financial operation between researchers, educational institutes, research
46 Innovation: How Europe can take off Promoting innovation in an age of austerity: The European dimension 47 centres and industry that are not currently being exploited the Framework Programme as leverage to secure comparable because of obstacles in the single market. The finalisation of the access abroad – and adopt a common EU front where needed ERA will produce mutually beneficial spill-overs between to protect our interests. member-states’ investments in the fields of research, innovation and science. Máire Geoghegan-Quinn is the European Commissioner for Research, Innovation and Science. ★ An EU-wide venture capital scheme must be put in place and the conditions for an EU-wide ‘knowledge market’ need to be established. Such a market will not only facilitate the better exploitation of knowledge but also give rise to important new sources of revenue that can be re-invested into research and innovation. ★ A common EU patent would provide a major boost to innovation in all parts of Europe – notably by reducing the costs of getting new products to the marketplace (particularly for SMEs). ★ Interoperable standards must be encouraged to ensure that research reaches the marketplace more rapidly and to reinforce Europe’s global reach. ★ EU, national and regional authorities, as well as the various stakeholders (such as researchers, industry, consumers and users), should work closely together through the system of European Innovation Partnerships. This will help speed up breakthroughs, reduce the fragmentation (and resulting duplication) of effort, cut costs and facilitate ideas being turned into commercial successes. ★ International co-operation is critical if the EU is to benefit from the best scientific and research capacities available globally. The EU is already one of the most open markets in the world. Our Research Framework Programme, for example, is accessible to many third countries. But other countries should not be allowed to innovate at the EU’s expense. We should use
10 How the EU’s single market can promote innovation by Malcolm Harbour The Commissioner for Research, Innovation and Science, Máire Geoghegan-Quinn, is giving strong leadership on ways to make the EU a more innovative economy. Her comprehensive initiative, the Innovation Union, rightly focuses on all the factors that have led to Europe’s under-performance, as revealed by a whole range of independent benchmarks. This essay examines how single market policies can contribute to the Innovation Union. The European Parliament’s internal market and consumer protection committee is fully behind this initiative and is working closely with other parliamentary committees to give this project the support it deserves. Encouraging researcher mobility and knowledge transfer Benchmarking data shows that high quality research in the EU too often fails to be translated into innovative products and services. Notwithstanding large investments in a succession of EU research programmes, EU academic research and technology transfer policies remain fragmented. Healthy competition is one thing, but universities need to co-operate too. There needs to be a shift away from entertaining national intellectual rivalries, towards embracing each other’s experience and knowledge. Improved employment and career prospects for researchers must also be part of the EU’s strategy to fight the ‘brain drain’ to the US and, increasingly, to China, Japan, and South Korea.
50 Innovation: How Europe can take off How the EU’s single market can promote innovation 51 Despite repeated political commitments and numerous Commission Standards in the EU must also continue to be harmonised. The EU initiatives to create more favourable conditions, the free movement has a structural advantage in setting international standards by of researchers across the EU continues to be hampered by all manner virtue of its dominant voting rights in the International of obstacles. Fostering greater cross-border mobility must therefore Standardisation Organisation. It should capitalise on this advantage. be a priority. We need to build on successes in the field of mutual The Commission’s forthcoming initiative to extend standardisation recognition of qualifications and break down remaining barriers. to services is particularly welcome. Improved broadband Better salaries, allied to transferable pensions and other benefits, connections and the increased use of radio spectrum will enable would encourage the best brains to move to the best projects. It is more commerce to be conducted swiftly across national borders, and good that new plans for pension portability feature prominently in will boost the sharing of information as well as collaboration the Innovation Union strategy and that the implementation plan has between geographically separated businesses and universities. been picked up in the proposed Single Market Act. Finally, intellectual property protection is a crucial element in stimulating research investment. Agreement has finally been reached on an EU wide patent, which will cut the cost and complexity of Making EU policy more innovation friendly patent protection. Just as the Commission has accepted the importance of an ‘SME test’ to make sure that its proposals take smaller enterprises into Exploiting lead markets and innovative procurement consideration, we need to establish an ‘innovation test’ to ensure that new policies do not hamper research and development through Around 17 per cent of EU GDP is accounted for by public unnecessary bureaucracy. We must eliminate undue costs of doing procurement. This spending must be harnessed to encourage the business, and create a truly business-enabling EU regulatory development and diffusion of new technologies. The Commission’s framework. This will release more funds in business for innovation Innovation Union plans rightly highlight the importance of public and support the development of better products and services. procurement generally, and pre-commercial procurement in particular, as a catalyst for the growth of innovative companies. Employed The Services Directive has removed a number of constraints on correctly, public procurement should generate ‘lead’ markets for new cross-border trade and the right of establishment, making it easier technologies, for example in the environmental and healthcare sectors. for businesses to set up operations in other member-states. But there is still a long way to go. Governments must ensure that EU rules on public procurement should help contracting they liberalise services in all the areas concerned, as there are still authorities obtain the best value for money for quality public some laggards. In addition, the directive must be publicised more services. But they should also create new opportunities for effectively because businesses have been slow in exploiting the businesses. Procedures need to be further clarified as the opportunities it has created. Innovative companies should make procurement landscape evolves, in particular for new forms of full use of these new freedoms by expanding their business in procurement including shared services, public-private ventures, other member-states. The single market must also now ‘go pre-commercial procurement, and e-procurement. Following digital’. The full potential of the Internet must be released and the pressure from the European Parliament, the Commission has Commission must offer an ambitious approach to breaking down launched a consultation bringing forwards a wide-ranging review the barriers to e-commerce. of the EU’s rules. Modernisation and the take up of e-procurement
52 Innovation: How Europe can take off How the EU’s single market can promote innovation 53 will significantly contribute to improving the delivery of public economy. Despite the single market’s remarkable achievements, it is services, particularly in ICT, transport and environmental services. still rich with untapped opportunities. This is why the Commission adopted in late 2010 the so-called Single Market Act – a series of proposals to deepen market integration in the EU. It is now essential Funding research and innovation that member-states push on with adopting the measures outlined in In many EU countries, spending on R&D is comparatively low. To the Act. If they take up the challenge, then the EU 2020 programme rectify this problem, new sources of funding need to be found. could be the key that unlocks Europe’s economic recovery. If they do not, it will be another lost opportunity. The EU is well-placed to direct funding programmes, such as regional and rural development funds, to encourage innovation. Malcolm Harbour is a Conservative Member of the European There are many good examples within individual countries of Parliament. incubators and ‘seed corn’ finance for high-growth SMEs. However, more systematic exchanges of best practice and better networks between regions might help to improve outcomes. In addition to selective public funding, it is important to boost capital availability from private sector sources. Pan-European venture capital instruments would create a more effective funding environment for high-growth and innovative SMEs. The Commission should take this important work forward with the European Investment Bank, the European Investment Fund, and expert bodies in the member- states. At EU level, crucial instruments that have already been adopted, such as the Strategic Energy Technology Plan (SET), remain under-funded. This problem must be addressed. One of the Commission’s most promising new proposals is for pan- EU Small Business Innovation Research (SBIR) programmes to underpin innovative procurement. SBIR should identify technology- oriented public sector challenges and fund R&D projects to develop new solutions to both old and emerging problems. This should now be rolled out as a priority. Delivering on EU 2020 The EU 2020 programme recognises that the single market is one of the most important policy tools for the recovery of the European
11 Innovation policy: A view from the British government by David Willetts The UK’s coalition government aims to support sustainable economic growth and deliver better public services. The means to those ends – new knowledge, new technologies, smarter ways of working – can all be described as innovative. Later this year, the British government will publish an innovation strategy detailing how we will target support and spending to have the greatest impact on growth and attract private sector investment. The document will set out how we will make the UK a more attractive location for R&D and technology start-ups. It will also encompass how we will promote innovation in and through the public sector, and make the country’s innovation infrastructure (including the Design Council, National Measurement System and Intellectual Property Office) more efficient and responsive. This approach is informed by the latest evidence. NESTA’s ‘Innovation Index’ (January 2011) showed that innovation has accounted for 63 per cent of labour productivity growth in the UK since 2000. More significantly, it revealed that private sector investment in innovation helped to reduce the negative impact on productivity at the beginning of the recent recession. We must increase and broaden these investments in the coming years. Ahead of the strategy, the government has already signalled its intent. In particular, it cast a vote of confidence in science and research by maintaining and protecting its budget in cash terms. For the first time higher education research funding in England has
56 Innovation: How Europe can take off Innovation policy: A view from the British government 57 been included within the protected funds, providing greater stability plausible figure given that, in the US, SMEs generate 60 to 80 per and certainty to academics. cent of net new jobs annually; employ 30 per cent of high-tech scientists, engineers, and computer workers; and produce 13 to 14 We have also made it clear that the Technology Strategy Board times more patents per employee than large firms. (TSB) will become the prime channel through which we will incentivise business-led technology innovation, including the future We will therefore improve the effectiveness of SBRI in the UK. In allocation of R&D grants for small businesses. Allied to a stronger addition, we want to realise an equivalent scheme within the EU. TSB will be two networks focused on developing critical mass and Successive rounds of EU Framework Programmes (FPs) have sought helping firms to exploit new and emerging technologies: an elite to increase SME participation in Europe, in recognition of their group of technology and innovation centres, backed by over £200 contribution to economic growth. It is vital to make further million of new investment; and local coaching for growth, linking progress on this before the Eighth Framework Programme (FP8) small and medium-sized enterprises (SMEs) with high-growth enters into force, by allocating some FP funding to an SBRI-type potential to sources of capital and other professional services. scheme which fosters product development and commercial exploitation of technology. Most SMEs simply lack the resources to In terms of the potential of governments to drive innovation participate in international research-based projects. through their own purchasing power, the evidence is just as compelling. As the Commission stated in its communication on Numerous studies have shown the need for improved innovation Innovation Union (October 2010): “Public procurement accounts performance in Europe. The US and Japan continue to outperform for some 17 per cent of the EU’s GDP. It represents an important the EU, while China is rapidly closing the gap. Meanwhile, analysis market, particularly in areas such as health, transport and energy. by the OECD suggests that developed economies must increasingly So, Europe has an enormous and overlooked opportunity to spur rely on innovation for future growth as their population levels innovation using procurement.” The UK public sector has, for stagnate (or decline), and they experience diminishing returns from example, been spending around £220 billion annually. It must labour inputs and investment in capital. become a more willing and reliable customer of innovative goods and services. The UK government therefore welcomes the decision of the European Council, on February 4th 2011, to pursue a range of Through the UK’s Small Business Research Initiative (SBRI), more proposals designed to smooth the passage of innovative products to than £35 million worth of public sector contracts have gone to the marketplace. Easier access to finance for SMEs; faster, SMEs – including micro-businesses, the firms that find it hardest to interoperable standard setting; more affordable intellectual property seize such opportunities. But this record bears no comparison to the rights; joint public procurement and EU-wide measures to support equivalent scheme in the United States, the SBIR. The US scheme venture capital investment: these are all essential for economic issues $2 billion worth of contracts annually. Since its inception growth and competitiveness. almost 30 years ago, it has helped to develop more than $21 billion worth of research and over 45,000 patents. The US Innovation David Willetts is Britain’s minister for universities and science. Development Institute estimates that SBIR delivers a multiplier of between five and seven in terms of economic benefit accrued – a
12 Growth and innovation: The contribution of the digital single market by Esko Aho Europe aspires to remain a global powerhouse with its own values and social model. Sadly, there is a large gap between the rhetoric of its political leaders and the reality of its economic and industrial potential. The global financial crisis has cruelly exposed the EU’s weaknesses and vulnerabilities. A more sustainable foundation for the future must include a more stable financial system, allied to stronger public finances. However, while necessary, such measures are not sufficient to put Europe back on track. The most critical issue is how to create the potential for future growth. There is much that Europeans can do to boost innovation and productivity. Perhaps one of the most important is to encourage the transition to a ‘digital society’ by extending the EU’s single market to digital services and content. The underlying aim should not be the creation of a digital society for its own sake. It should be to ensure that digital products, services and solutions reshape all aspects of our economy and society – from the way that energy is managed in homes and offices, to the way that goods are transported and culture is consumed. The key to this transition will be political will. The political obstacles to carrying out the necessary pro-growth changes are very real. But the alternative – of low growth or none – will hurt Europe far more in the long run.
60 Growth and innovation: The contribution of the digital single market 61 Economic strategy: It is about execution subsequent liberalisation of the telecoms sector (pursuant to the The EU is often better at designing medium-term strategies than at single market programme). implementing them. The Lisbon Strategy, which was adopted by the EU in 2000, is a case in point. Although it was in many ways an Europeans should aim to repeat this success story. Without the excellent programme, it failed because of poor implementation. The digital single market (and the clusters to which it can give rise), we EU has now launched a successor programme, known as EU 2020. risk being squeezed between the content-driven innovation of the US Its ambition is to make the EU more productive, knowledge-driven and the manufacturing capabilities of Asia. The four freedoms based and greener. These are all excellent aims. But why should EU 2020 on the single market programme have been key building blocks of succeed where the Lisbon Strategy failed? Europe’s competitiveness. It is now time to add a new one by implementing a ‘fifth freedom’ – the free movement of digital The region’s economic experience over the past decade suggests that content. The EU should harmonise fragmented regulations and EU leaders were right to set out an economic strategy based on remove barriers to buying, selling and interacting online in the EU, information and know-how. Their failing was that they did not as it has done for the sale of most products. EU measures should implement the strategy assiduously enough. Basing our future on target not only physical goods and digital content, but also the world-class know-how, creativity and technological innovations is intellectual property that is the fruit of our creativity. Our aim the only way Europeans will maintain an economic leadership role should be to ensure that the world’s leading online content and meet some of the key challenges that they face: supporting distributors are European. growth, jobs and environmental sustainability, managing demographic change, and so on. This is why completing the EU’s A more integrated digital market would bring a whole host of digital single market is so critical – not only for the ICT sector itself, benefits. Not only would it help to spur new solutions to many of but for other industries too. the social, demographic and environmental problems that Europeans now face. But it would also support growth, create new jobs and generate much-needed tax revenues. The economic fruits of Why deepening the single market is critical a more integrated digital market would be huge. The European The EU’s single market gives companies access to a much larger, Policy Centre, a Brussels-based think tank, estimates that removing integrated market than they would otherwise enjoy. One of the obstacles to the free flow of digital content could lead to incremental advantages of such a market is that it gives European entrepreneurs EU GDP growth of S500 billion – or 4 per cent – over ten years. the opportunity to grow to scale in the same way that their counterparts from the US already can. Europe has already seen the Who will lead the revolution? positive effects that an integrated regional market can have on its own firms. European companies such as Nokia, Ericsson, Alcatel, The digital revolution is underway. Major trading partners such as Siemens, Vodafone and Telefonica have played leading roles in the the US, China, India, Japan, South Korea and Brazil are revolution in mobile technology – in the process, creating millions of transforming their economies and their societies to reap the benefits. high quality, well-paid jobs across Europe. The rise of Europe’s Europe must take urgent steps if it is not to lag behind. As prime telecoms cluster during the course of the 1990s was closely minister of Finland in the early 1990s, I witnessed at close quarter associated with the adoption of the GSM standard in 1987 and the how economic crisis can be followed by growth and technology-
62 Innovation: How Europe can take off induced economic transformation. It is now time for Europe to 13 Does Europe really want to be build the framework for a new phase of post-recessionary growth through investment and pan-European co-operation. For that we innovative? need a digital single market to ensure that Europe is the birthplace by Michael Schrage of globally successful economic firms and clusters. Esko Aho is a member of the executive board of Nokia. He is a former prime minister of Finland. Innovation enjoys a remarkably good press. The mind’s ingenuity. The power of a new idea. Opportunities for profit. A chance to change the world. And so on. Innovation reeks of the same sort of ‘political correctness’ – or should I say ‘economic correctness’? – that ‘multiculturalism’ once enjoyed. That should be warning enough. The immaturity, trendiness and ahistorical quality of Europe’s discussions on innovation policy are dangerously disingenuous. If ‘innovation’ is the answer, then what – exactly – is the question? Just a few short years ago objective observers from the media to ECB spokesmen insisted that Europe’s financial services firms were remarkably innovative. Certainly, the numbers said so. High- powered maths, software-driven securitisation and digital network distribution produced dizzying arrays of novel financial instruments. CMOs, CDOs and CDSs constituted some of the most ingeniously high-tech products ever devised by the best-educated minds from many the world’s finest universities. Just to be safe, elegant algorithms and Monte-Carlo-tested ‘risk models’ gave quantitative assurance that these clever innovations could not misbehave too badly. Over a trillion euros of annihilated wealth and one global financial crisis later, the world knows better. ‘Too clever by half’ and ‘too big to fail’ have given new meaning to Schumpeter’s romantic aphorism on innovation: creative destruction. Policy-makers take note. Schumpeter deserves to be taken more seriously. The empirical reality is that ‘innovation’ isn’t a
64 Innovation: How Europe can take off Does Europe really want to be innovative? 65 euphemism for economic growth but a dynamic that comes with And what is the secret ingredient making this economic growth risks and costs attached. Ignore the received wisdom and possible? Let us call it ‘innovation.’ (We could call it ‘free trade’ – accompanying agitprop. Inherently, innovation is neither a societal but that is another essay.) Innovation adds a full 0.5 percentage nor an economic ‘good.’ point to GDP and a percentage point to the rate of unemployment. That is the benefit – and the cost – of an innovation policy. That is Just as they desire public spending without deficits, politicians and the thought experiment. technocrats want innovation’s benefits without its costs. This is well- illustrated not just by innovation-enabled financial crises but by the How many French, German, Spanish, British, Dutch, Italian or persistent economic underperformance of Spanish wind-farms and Greek politicians would leap at the offer? How many eurocrats other eco-greenery innovation. would declare this a healthy exchange? Who would publicly argue that the benefits of a rise in GDP clearly outweigh this unfortunate Somehow, techno-subsidies never quite generate the growth that cost in unemployment? has been promised. There is a ‘Concorde-like’ quality of undeniable technical cleverness without measurable private sector success. Clarifying economic assumptions, trade-offs and aspirations is an important obligation of serious policy-makers. Voters should know While policy-makers extol innovation’s importance, realpolitik whether their technocrats value generating economic growth over suggests that, more often than not, they actually celebrate the preserving jobs. Taxpayers deserve to know whether ‘innovation’ importance of new jobs and rising incomes. Innovation is a code excuses speculative subsidies to unproven technologies. People word not for invention, novelty and productivity but for the should know whether their public servants believe they can higher employment and pay packets it purportedly generates. consistently outperform their private sector counterparts in Innovation is creative destruction where the destruction is identifying cost-beneficial innovation opportunities. In democratic pronounced silently. societies, ‘innovation’ should not be a semantic shield concealing policy-makers’ real priorities. Is this characterisation unfair? Perhaps. But consider this thought- experiment: the typical European technocrat or politician is This thought experiment illustrates arguably the biggest single offered an innovative deal to boost their nation’s economic misunderstanding around innovation policy: innovation is not an growth. With a snap of their fingers, they can procure a 0.5 end, but a means. Only ideologues cherish innovation for percentage point increase in their country’s GDP. All they have to innovation’s sake. But innovation for the sake of innovation is no do is accept, in exchange, a 1 percentage point rise in their more meaningful an economic policy than quantitative easing for the country’s rate of unemployment. sake of quantitative easing. Economic purpose must underlie economic policy. Innovation is the means to what economic ends? In other words, to increase GDP from 3 to 3.5 per cent – which More jobs? Better jobs? Greater productivity? Environmental would be tremendous – they would have to raise their country’s sustainability? Subsidising innovators? unemployment level from, say, 8 to 9 per cent. Newspaper headlines and economic analyses would read: "GDP rises but unemployment What real-world economic trade-offs does innovation make still climbs." politically palatable? If state-sanctioned innovation initiatives
66 Innovation: How Europe can take off Does Europe really want to be innovative? 67 eradicate more jobs over three years than they create in ten, other innovation’s impact cannot be reliably predicted – even with forms of measurable economic benefit had better accrue. Innovation literally hundreds of billions of euros at stake – should inspire policies facilitating the demise of tens of thousands of medium-wage caution, even from policy-makers who desire greater dynamism in jobs in the hope of creating hundreds of thousands of minimum their economies. wage jobs surely suggest a ‘revealed preference’ of policy-makers. So do innovation policies converting industries filled with tens of The most important thing that policy-makers can and should do is thousands of middle-class jobs into ones with thousands of high- to force a larger argument around what kinds of economies paying jobs. enterprises and wider society desire. The point is not to caricature innovation’s destructively creative – or Do they want the ‘top down’ diktats of policy innovations designed creatively destructive – economic implications but to mock the by the centre? Or are they prepared to deal with the inevitable pretensions of policy-makers who think they understand what they disruptions caused by bottom-up innovators like Ryanair, Facebook are doing. and Google? Is entrepreneurship a value that should be cherished in an economy? Or do the competitive discontinuities they threaten Ambitious technocratic plans promoting innovation may have a mean that the precautionary principle should rule? miserable track record, but that apparently does not deter policy- makers from believing they have successfully learned from their It may seem dissatisfying to draft a policy essay about innovation predecessors’ mistakes. Surely this generation of European that portrays it as too rude and unruly to craft meaningful policies technocrats are significantly smarter and wiser than the last. around. But, again, to steal from John Kay: “The primary role of government in promoting innovation is the promotion of markets.” Even putting aside perennially exhaustive and exhausting debates about ‘industrial policy,’ history suggests that innovation has This is an undeniably important insight and I agree with it perverse and unpredictable impacts on national incomes and wholeheartedly. But, respectfully, he begs the larger question: What employment. If we take Schumpeter – or even Keynes – seriously, it markets are we seeking to promote? is painfully clear that innovation-as-economic-policy does not lend itself to the sort of ‘rational planning’ methodologies and analyses so Precisely because innovation is a means to an end, the debate Europe beloved of technocratic elites. must have has little to do with the cleverness of individual entrepreneurs and the promise of new technologies. It has to do with So what should policy-makers do? The answer is not nothing or as the willingness of societies – and their economies – to accept that little as possible. To the contrary, policy-makers and technocrats innovation means, yes, creative destruction of jobs, livelihoods, have an enormous influence – but it should not be in their traditional established institutions and economic security. This is in exchange and typical role of budgeting, planning and regulation. for what history indicates are increased standards of living, quality of life and more choices for more people. As John Kay rightly observes, innovation is not R&D – and vice versa. The argument that more R&D funding invariably assures While the past is always prologue, it is not guarantor of the future. more innovation is prima facie ridiculous. Similarly, the fact that The simple reality is that focusing on innovation distracts from the
68 Innovation: How Europe can take off economic issues that truly matter. Europe does not have an 14 Conclusion innovation problem, but a ‘what kind of growing economy do we want to have?’ problem. by Simon Tilford Michael Schrage is a research fellow at the Massachusetts Institute of Technology’s Sloan School of Management. Innovation is widely held to be a ‘good thing’. Most of the contributors to this report agree that innovation accounts for a rising share of productivity growth in advanced economies; and that Europe is not as innovative as it needs to be. Productivity growth across much of the EU has been terribly weak for around 20 years – not just compared with past performance, but also in comparison with the US. However, politicians often think of innovation too narrowly, and advocate policies which promise to have only a limited impact on innovation and productivity growth. This is unsurprising. Innovation is a messier and more destructive process than is commonly understood. It holds out the promise of higher living standards, but often at the cost of existing jobs, livelihoods, established institutions and economic security. Politicians usually place considerable emphasis on research and development (R&D) and patents as measures of innovation, and on high technology being the key to a country’s ‘competitive future’. This emphasis, which is based on the belief that there is a strong link between domestic R&D and productivity growth, leads them to believe that innovation and productivity are best promoted by policies aimed at boosting R&D spending. As a result, the EU and most member-states continue to use R&D spending and the levels of patents filed as indicators of their economies’ capacity for innovation. Such assumptions often encourage policy-makers to advocate active industrial and research policies. They focus on fostering a strategic approach to innovation, where ‘government policy works hand in hand with the private sector’. Much emphasis is placed on strategies
70 Innovation: How Europe can take off Conclusion 71 to bring firms, governments and universities closer together, on These points have obvious implications for policy. Governments policies that will make better use of Europe’s research capabilities by should place greater emphasis on competition policy than on encouraging pan-European research networks, and on pushing industrial policy and concentrate on encouraging technology ahead with an EU patent. Policy-makers believe such policies are diffusion rather than supporting R&D. The most important thing synonymous with support for innovation. If economies are to that governments can do to encourage innovation is to promote flourish economically, they must boost their R&D spending. markets, and to make it easier for new entrants to challenge incumbents. This requires structural reforms that remove not only However, as a number of the expert contributors to this report barriers to entry, but also barriers to the growth and contraction of convincingly argue, strategies which focus solely on R&D-intensive firms, such as restrictive product and labour regulation and sectors can be misdirected and wasteful. An obsession with financial systems that fail to make capital available to dynamic meeting targets for R&D spending, they point out, leads policy- new firms. Public support for primary research is also important. makers to pay insufficient attention to other forms of innovation But for the main part, the process of innovation is so complex and which do not involve R&D spending, but which are the main uncertain that it is pointless, and almost certainly counter- source of productivity growth. And they bolster their argument productive, to try and second-guess it. By working with existing with two key points. businesses, governments risk subsidising existing R&D or supporting declining industries. First, there is extensive research showing that only a small part of the productivity growth difference between Europe and the US is However, government’s role should extend beyond the promotion of down to different levels of R&D investment. Moreover, in a typical markets; it also has a big contribution to make as the provider of European country at least 90 per cent of the R&D that actually crucial public goods. The quality of state education, in particular, contributes to productivity growth is conducted abroad. It is the can have a favourable impact on an economy’s capacity for diffusion of technology, rather than its generation, which is the innovation and hence on the rate of productivity growth. Skills play crucial driver of productivity. The most important innovations, in a crucial role in spurring the generation of new ideas and other words, are often the organisational changes needed to make knowledge. But it is perhaps at the more prosaic level of technology use of technology. diffusion where they have the most important impact: they facilitate the adoption and adaptation of existing technologies, ideas and Second, many of the most important future innovations will be working practices. And it is the pace of technology diffusion, made by companies that do not yet exist. Innovation results from combined with differing levels of commitment to competition, that new entrants with innovative new models and/or products replacing explains variations in productivity across the EU. existing, less successful, ones. This process of ‘creative destruction’ is what drives productivity growth. The disappointing rate of Why are policy-makers attracted to policies that often have a poor productivity growth across much of Europe reflects a relatively record of boosting innovation, while underplaying the contribution static industrial structure: too few firms grow rapidly, or are of competition policy? The answer is that actively encouraging the allowed to shrink or disappear. In many EU countries, resources exit of inefficient firms – and embracing more rapid changes in (labour and capital) need to be reallocated more quickly towards industrial structure – is politically unpalatable. And this is the crux successful innovators. of the problem. Innovation is a destructive and unpredictable
72 Innovation: How Europe can take off process. European electorates want the benefits of innovation – cheaper, better products – but not the disruption and the insecurity that come with it. As the report’s concluding author, Michael publications Schrage, writes, European politicians talk a lot about innovation, but are not prepared to come clean about what is necessary to # Germany’s brief moment in the sun increase it. Essay by Simon Tilford (June 2011) # Thorium: How to save Europe’s nuclear revival Could Europe yet embrace the kind of creative destruction needed to Policy brief by Stephen Tindale (June 2011) drive innovation and productivity growth? The evidence suggests # The EU and Russia: All smiles and no action? not. Several of the authors in this report argue convincingly for a Policy brief by Katinka Barysch (April 2011) deepening of the EU’s single market. But many member-state # Surviving austerity: The case for a new approach to EU military collaboration governments show little enthusiasm for this. The crisis-hit members Report by Tomas Valasek (April 2011) of the eurozone are implementing far-reaching reforms of their # Europe’s parliament: Reform or perish? labour and product markets in return for financial support. But Essay by Denis MacShane (April 2011) there is little sign of comparable action elsewhere in the currency # A new neighbourhood policy for the EU union, or indeed across the EU more generally. The belief that Policy brief by Charles Grant (March 2011) creative destruction is the driver of innovation has always been weak in Europe. But it has been further undermined by the financial # A chance for further CAP reform Policy brief by Christopher Haskins (February 2011) crisis, which has done much to discredit market-led reforms. If anything, EU governments are now more wedded to defending # Delivering energy savings and efficiency Policy brief by Stephen Tindale (January 2011) national champions and more wary of competition than they were prior to the crisis. For most, placing their countries’ ‘competitive’ # Beyond the European Parliament: Rethinking the EU’s democratic legitimacy future in the hands of such unpredictable forces is an article of faith Essay by Anand Menon and John Peet (December 2010) too far. # Turkey and the EU: Can stalemate be avoided? Policy brief by Katinka Barysch (December 2010) Simon Tilford is chief economist at the Centre for European Reform. # Ukraine turns away from democracy and the EU Policy brief by Tomas Valasek (November 2010) ★ # Why Germany is not a model for the eurozone Essay by Philip Whyte (October 2010) # Turkish politics and the fading magic of EU enlargement Policy brief by Sinan Ülgen (September 2010) # How should Europe respond to sovereign investors in its defence sector? Policy brief by Clara Marina O’Donnell (September 2010) # How to save the euro Essay by Simon Tilford (September 2010) Available from the Centre for European Reform (CER), 14 Great College Street, London, SW1P 3RX Telephone +44 20 7233 1199, Facsimile +44 20 7233 1117, kate@cer.org.uk, www.cer.org.uk COVER IMAGE: CORBIS
CENTRE FOR EUROPEAN REFORM INNOVATION How Europe can take off Edited by Simon Tilford and Philip Whyte Every EU government supports innovation, believing that it will help Europe to meet the numerous economic, social and environmental challenges that it faces. But innovation is a vague concept and there is disagreement on what policies best promote it. The articles in this report discuss what innovation entails and what policy-makers can do to encourage it. There is general agreement that innovation is a broader and more ‘democratic’ process than what goes on in companies’ research and development laboratories. More controversially, however, some authors believe that an innovative society requires ‘creative destruction’, and that Europe has failed to accept the social and economic dislocations that a more innovative economy must entail. ISBN 978 1 901229 99 8 # £10/G16

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EU Report on Innovation 2011

  • 1.
    CENTRE FOR EUROPEANREFORM INNOVATION How Europe can take off Edited by Simon Tilford and Philip Whyte
  • 2.
    about the CER TheCentre for European Reform is a think-tank devoted to improving the quality of the debate on the European Union. It is a forum for people with ideas from Britain and across the continent to discuss the many political, economic and social challenges facing Europe. It seeks to work with similar bodies in other European countries, North America and elsewhere in the world. The CER Innovation is pro-European but not uncritical. It regards European integration as largely beneficial but recognises that in many respects the Union does not work well. The CER therefore aims to promote new ideas for reforming the European Union. How Europe can Director: CHARLES GRANT ADVISORY BOARD take off GIULIANO AMATO.............................................................................................. Former Italian Prime Minister ANTONIO BORGES.............................................. Head, European Department, IMF and former Dean of INSEAD NICK BUTLER ......................... Visiting Fellow and Chairman of the Kings Policy Institute at Kings College, London TIM CLARK .......................................................................................... Former Senior Partner, Slaughter & May IAIN CONN ................................... Group Managing Director and Chief Executive, Refining & Marketing, BP p.l.c. TIMOTHY GARTON ASH ........................................................ Professor, European Studies, University of Oxford HEATHER GRABBE .................. Director, Open Society Institute, Brussels and Director of EU affairs, Soros Network LORD HANNAY.................................................................................... Former Ambassador to the UN & the EU LORD HASKINS .......................................................................................... Former Chairman, Northern Foods FRANÇOIS HEISBOURG................................................ Senior Adviser, Fondation pour la Recherche Stratégique SIMON HENRY......................................................................................................... CFO, Royal Dutch Shell plc WOLFGANG ISCHINGER.................................................................... Global Head, Government Affairs, Allianz LORD KERR (CHAIR) ................. Chairman, Imperial College London and Deputy Chairman, Royal Dutch Shell plc Esko Aho, Jim Attridge, Amar Bhidé, CAIO KOCH-WESER................................................................................ Vice Chairman, Deutsche Bank Group FIORELLA KOSTORIS PADOA SCHIOPPA............................................... Professor, La Sapienza University, Rome Albert Bravo Biosca, Nicholas Crafts, RICHARD LAMBERT.................................................... Former Director General, Confederation of British Industry PASCAL LAMY......................................................... Director General, WTO and Former European Commissioner Máire Geoghegan-Quinn, Malcolm DAVID MARSH.................................................................................................. Chairman, SCCO International DOMINIQUE MOÏSI................................................ Senior Adviser, Institut Français des Relations Internationales Harbour, John Kay, Helga Nowotny, JOHN MONKS.................................................... Former General Secretary, European Trade Union Confederation Andreas Schleicher, Michael Schrage CHRISTINE OCKRENT............................................................................ CEO, Audiovisuel Extérieur de la France STUART POPHAM.................................................................................. Former Senior Partner, Clifford Chance and David Willetts LORD ROBERTSON............................................. Deputy Chairman, TNK-BP and former Secretary General, NATO ROLAND RUDD......................................................................................... Chairman, Business for New Europe KORI SCHAKE............................................. Research fellow, Hoover Institution and Bradley Professor, West Point LORD SIMON .............................................................. Former Minister for Trade and Competitiveness in Europe Edited by Simon Tilford & Philip Whyte LORD TURNER ........................................ Chairman, Financial Services Authority and Climate Change Committee ANTÓNIO VITORINO...................................................................................... Former European Commissioner IGOR YURGENS..................................................... Chairman, Institute of Contemporary Development, Moscow Published by the Centre for European Reform (CER), 14 Great College Street, London, SW1P 3RX Telephone +44 20 7233 1199, Facsimile +44 20 7233 1117, [email protected], www.cer.org.uk © CER JULY 2011 # ISBN 978 1 901229 99 8
  • 3.
    ABOUT THE EDITORS Contents Simon Tilford is the chief economist at the Centre for European Reform. His previous CER publications include: ‘How to save the eurozone’ (October 2010); (as co-author) ‘The Lisbon scorecard X: The road to 2020’ (March 2010); (as co-author) ‘Carbon Capture and Storage: What the EU needs to do’ (February 2010); ‘The new About the editors Commission’s economic philosophy’ (February 2010); ‘Rebalancing the Chinese economy’ (November 2009). Editors’ acknowledgements Philip Whyte is a senior research fellow at the Centre for European Foreword Reform. His previous CER publications include: ‘Why Germany is not a model for the eurozone’ (October 2010); (as co-author) ‘The 1 Introduction: Why does innovation matter? 1 Lisbon scorecard X: The road to 2020’ (March 2010); (as co- by Philip Whyte author) ‘The new Commission’s economic philosophy’ (February 2 What is innovation? 9 2010); and ‘How to restore financial stability’ (January 2010). by John Kay ★ 3 Innovation and frontier research 13 EDITORS’ ACKNOWLEDGEMENTS by Helga Nowotny We are grateful to all the experts who contributed articles to this 4 New evidence on ‘creative destruction’ in Europe and the US 19 volume. We are also indebted to Charles Grant, Katinka Barysch, by Albert Bravo Biosca Hugo Brady, Stephen Tindale and Clara O’Donnell for comments on earlier drafts – and to Kate Mullineux for layout and production. 5 Improving productivity performance is not rocket science 25 by Nicholas Crafts Finally, we would like to thank Lundbeck for sponsoring the report, particularly as some of the views expressed in it do not necessarily 6 Skills, education and innovation 29 coincide with theirs. We take full responsibility for all errors and by Andreas Schleicher omissions. 7 Innovation policy in the EU: The biopharmaceutical sector 33 ★ by Jim Attridge 8 Financing the venturesome economy 37 by Amar Bhidé 9 Promoting innovation in an age of austerity: Copyright of this publication is held by the Centre for European Reform. You may not copy, reproduce, The European dimension 43 republish or circulate in any way the content from this publication except for your own personal and non- by Máire Geoghegan-Quinn commercial use. Any other use requires the prior written permission of the Centre for European Reform.
  • 4.
    10 How theEU’s single market can promote innovation 49 by Malcolm Harbour Foreword 11 Innovation policy: A view from the British goverment 55 by David Willetts 12 Growth and innovation: The contribution of the digital single market 59 Lundbeck is delighted to support the CER’s latest publication. Innovation is the by Esko Aho lifeblood of the pharmaceutical industry. Its business model requires it to bring a new medicine to market every 10-12 years. 13 Does Europe really want to be innovative? 63 by Michael Schrage As such the pharmaceutical sector represents an excellent model to illustrate the challenges facing the European economy. From being, in the former Vice President 14 Conclusion 69 Verheugen’s words, “the pharmacy of the world” in the 1980’s, Europe is now by Simon Tilford witnessing a relative decline in investment, productivity and sales. The pharmaceutical sector is facing increasing challenges in bringing a new medicine to market. Even when these are met, we can no longer be certain of market access. This is impacting companies’ behaviour. For example, we are seeing companies exit the important area of depression. This is perhaps surprising given the high level of unmet medical need. A recent Health Council Conclusion noted that mental disorders account for the greatest share of disability-adjusted life years in the EU. The World Health Organisation estimates that mental disorders affect one in four citizens during their life time and can be found in ten per cent of the EU population during any given year. What message should policy-makers send to companies that are committed to continuing to search for new treatments in depression? As the authors of this report note, governments need to champion and reward new research, especially incremental developments, and cease rewarding old technologies. From a health perspective we need to change the way we regard illness. Rather than treating it with silo budgets, we need to look at illness holistically, treat medicine expenditure as an investment, and acknowledge that medicine can prevent expensive costs of hospitalisation, aide recovery and enable the patient to return to work rapidly and contribute to society. The report marks an important contribution to the debate. It provides some valuable insights and recommendations for policy makers and others to consider. Lundbeck welcomes the publication and looks forward to the debate that will follow. Ulf Wiinberg, CEO, Lundbeck
  • 5.
    1 Introduction: Why does innovation matter? by Philip Whyte Innovation policy is currently very much in vogue. The European Union (EU) has made it one of the seven ‘flagship initiatives’ of its ‘2020 strategy’. And the Obama administration has placed it at the centre of its own strategy for economic recovery. Whatever innovation means, there appears to be widespread agreement on either side of the Atlantic that more of it is essential – not only to raise productivity, but also to ‘compete with China’ and meet all sorts of other challenges, from climate change to energy security and population ageing. Indeed, claims to the effect that innovation is crucial if countries and companies are to prosper in an increasingly competitive world economy have become something of a commonplace – repeated with monotonous regularity by policy- makers, commentators and businessmen in speeches, interviews and opinion columns. Yet it is not always clear what innovation actually means, or how it relates to prosperity. Some innovations, such as Facebook, may transform the way people interact, but do little to increase productivity. Others may have the potential to increase productivity, but require other things to happen before they do so. (This is the nub of ‘Solow’s paradox’ – the observation by the US Nobel laureate, Robert Solow, that the information technology revolution in the early 1990s was everywhere to be seen except in the productivity numbers.) Other innovations still may be positively harmful to prosperity. Those who extol the virtues of innovation often forget that one of the most consistently creative sectors of the economy is the financial sector – the relentless ingenuity of which
  • 6.
    2 Innovation: How Europe can take off Introduction 3 recently contributed to the most spectacular destruction of wealth in a laboratory, or of a pioneer applying the latest technology to in human history. developing new goods and services. For John Kay, an academic and columnist, both are misleading images of what innovation entails. It In short, what innovation is, how it influences productivity, and what should not be conflated with R&D (because numerous innovative policy should do to encourage it are less straightforward issues than firms, like budget airlines, have no R&D budget to speak of). Nor is often assumed. The aim of this report is to explore these questions should innovation be confused with novelty. The distinction between by bringing together the thoughts of leading experts in the field. It innovation and novelty is captured by the difference between Apple should come as no surprise that they often reach different conclusions (an innovative firm that is adept at finding new and commercially on what innovation means and how it should be promoted. successful ways of using existing technology) and Sir Clive Sinclair Nevertheless, most of the authors appear to agree on two things. The (an endearing eccentric who invented things that no-one wanted). first is that there is much more to innovation than what goes on in The essence of innovation, Kay concludes, is finding new ways of research and development (R&D) laboratories. The second is that meeting customer needs. innovation is a multi-dimensional and increasingly ‘democratic’ process involving entrepreneurs and scientists, consumers and The President of the European Research Council, Helga Nowotny, producers. Innovation is as much about finding new ways of using or accepts that innovation is a complex, multi-layered process which delivering existing goods and services as about producing new ones. involves much besides the output of research laboratories. Even so, she argues that basic (or ‘frontier’) research remains vital. Even if Perhaps the most striking difference among contributors to the advances in science do not always increase general prosperity, they volume is that between academics (or think-tankers) on the one are often significant drivers of it. It was basic research, she points out, hand, and policy-makers on the other. The former point out that which drove the information technology revolution. Besides, in many Schumpeter’s famous description of innovation as a process of areas of research, the boundaries between basic and applied science ‘creative destruction’ has two components that are inextricably are blurring. Scientific curiosity continues to drive basic research, but intertwined. One cannot embrace creation (that is, the emergence of researchers increasingly work in inter-disciplinary environments in innovative young firms) without accepting destruction (letting which the search for commercial applications is actively pursued uncompetitive incumbents go to the wall). Yet policy-makers, (hence the term ‘frontier research’). Most European countries, she particularly in Europe, want to have their cake and eat it: they want argues, need to become better at commercialising ideas. innovation, but without the accompanying economic dislocation and social disruption. This largely explains the difference in policies Nowotny broadly agrees with Kay’s definition of innovation as prescribed. Whereas academics tend to emphasise the need for finding new ways of meeting (and creating) consumer needs. The lowering barriers to entry, politicians are more inclined to advocate way she sees it, however, innovation is heavily influenced by policies that are supported by incumbents. scientists and researchers, whereas for Kay it is driven mainly by entrepreneurs. Albert Bravo Biosca of the National Endowment for Science, Technology and the Arts (NESTA), strongly agrees that What is innovation? innovation is about more than research and that entrepreneurs For many people, the word ‘innovation’ is likely to conjure the have a central role to play. But he points out that it involves more image of a scientist in a white coat conducting cutting edge research than launching new products and services. If one of its purposes is
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    4 Innovation: How Europe can take off Introduction 5 to raise productivity, then innovation should be more broadly The claim that innovation is becoming more multi-faceted and understood to include the new ways that businesses come up with consequently less elitist (or more democratic) is also advanced by to make the best use of technology. Placing a computer on every Amar Bhidé of Tufts University. Failing to recognise this trend, he desk will not necessarily raise productivity if businesses do not goes on to argue, can often result in pointless or wasteful initiatives. change working practices. For example, encouraging more people to become scientists and engineers will not increase a country’s prosperity if the result is a dearth of managers who understand how working practices within How should innovation be promoted? their organisations should be changed to make the best use of new Nicholas Crafts of Warwick University strongly agrees with Biosca technologies. The same goes for policies designed to improve on what policy-makers should do to support innovation and funding conditions for young firms. Too much attention is arguably productivity: they should embrace creative destruction by devoted to developing the venture capital (VC) industry. VC has its encouraging the growth of innovative young firms and, where place. However, since most firms will never actually need VC necessary, accepting the demise of stodgier incumbents. As Biosca funding, democratic innovation requires a diversified financial notes, a lower ‘churn’ of firms suggests there is less creative system to fund it. destruction in Europe than in the US. Crafts suggests that the two most important things EU policy-makers can do to narrow the Jim Attridge of Imperial College London argues that it would be transatlantic productivity gap would be to ease employment law wrong to ignore the importance of R&D and highlights how (making it easier for companies to reorganise themselves to make disadvantageous Europe’s business environment is becoming to better use of information technology) and to enforce competition innovation in the pharmaceutical sector. Firms in the pharmaceutical policy. Crafts suggests these are preferable policies to increasing sector face three costly phases: a research phase, when they compete spending on R&D, pursuing sector-specific industrial policies, or to patent discoveries; an even costlier development stage, when expanding numbers in higher education. drugs are subject to clinical trials; and a diffusion phase, where firms must persuade clinicians and health bodies to adopt their new Andreas Schleicher of the OECD takes a slightly different view. For treatments. But across Europe, the economics no longer stack up. him, skills form the cornerstone of innovative societies. They spur Faced with governments that enforce low prices and restrict patient innovation by generating new ideas, and by facilitating the adoption access to innovative treatments, R&D in the sector is becoming of existing technologies. Since innovation is not confined to R&D increasingly unprofitable. If this situation is not reversed, labs, a modern economy requires an ever broader participation in pharmaceuticals companies will continue to withdraw from R&D the innovation process – encompassing producers and workers, but activity in Europe. also consumer and public-sector bodies. The bad news for Europe is that skills are unequally distributed, and that too many people do Promoting innovation in Europe not even have the most basic competences to participate in an innovation-driven economy. Moreover, producing the right mix of What sort of echo do the views expressed in the academic world skills is getting harder, because labour markets are becoming more find in policy-making circles? The European Commissioner for complex and dynamic: workers have to upgrade their skills more Research, Innovation and Science, Máire Geoghegan-Quinn, argues regularly than in the past to adapt to changing work patterns. that promoting innovation is more necessary and more difficult in
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    6 Innovation: How Europe can take off Introduction 7 an age of fiscal austerity – more necessary because increased sector contracts are awarded to small and medium-sized enterprises productivity is key to ensuring debt sustainability, and more under the UK’s Small Business Research Initiative (SBRI), and that difficult because fiscal consolidation is often sought by cutting similar steps be taken at EU level before the next Framework public investment in education, infrastructure and R&D. The Programme for R&D (FP8) comes into force. Commissioner makes the case for a “strategic and integrated” approach to innovation, in which national governments, the For Esko Aho, a former prime minister of Finland and a current European Commission and the private sector work closely together. member of the executive board at Nokia, one of the most important Key elements would include the completion of the European things that the EU can do to promote innovation is to extend the Research Area, the adoption of a common EU patent, and the single market. The EU’s four traditional freedoms of movement (for development of an EU-wide regime for VC. goods, services, people and capital) now need to be complemented by a fifth – for digital services and content. The absence of such a Malcolm Harbour, a member of the European Parliament for the market, Aho argues, is a serious lacuna which hampers both British Conservative Party, agrees with much of the European innovation and productivity – not just in the information technology Commission’s thinking. The best thing the EU can do to promote sector, but also across the economy more generally. Removing the innovation, he suggests, is to deepen the single market. National barriers that hamper the emergence of a single European digital jealousies and protectionist habits must be set aside so that the best market would consequently bring numerous benefits. Not only brains move to the best projects. The Services Directive must be would it help to spawn new solutions to the various challenges properly implemented. The Commission should adopt an (social, demographic and environmental) that the region faces, but ‘innovation test’ to ensure that EU policies do not deter R&D. it would also support economic growth. Standards should be harmonised so that common EU standards become global ones. Governments should ensure that public Do Europeans want to be more innovative? procurement acts as a catalyst for the growth of innovative firms by providing ‘lead markets’ for new technologies. And more should be The penultimate article, by Michael Schrage of the Massachusetts done to increase spending on R&D, notably by improving the Institute of Technology, throws cold water on European policy- infrastructure for its funding. makers by asking whether they are serious when they proclaim their ambition to make their countries more innovative. Innovation, he A national perspective on what governments can (or should) do to points out, is a disruptive process with risks and costs attached. It promote innovation is provided by David Willetts, Britain’s minister makes no sense to celebrate the upside of innovation while trying to for universities and science. Willetts agrees with the proposition resist the downside. Yet this is exactly what politicians across Europe that most European economies are experiencing diminishing returns do. They say they want to encourage the growth of innovative from labour inputs and investment in capital and must therefore companies. Yet they spend their lives resisting the demise of staid increasingly rely on innovation for future economic growth. incumbents because they fear the social and political costs of painful Interestingly, given his party’s longstanding commitment to a smaller adjustments in labour markets. The debate Europe must have, it state, he recognises that governments can actively support follows, is not about the role of entrepreneurs or new technologies. innovation – notably as a big purchaser of goods and services. For It is about Europe’s ability to tolerate – and manage – the example, the government wants to make sure that more public disruptions which innovation inevitably provokes.
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    8 Innovation: How Europe can take off The concluding article, by Simon Tilford of the Centre for European 2 What is innovation? Reform, shares some of these concerns. Policy-makers, he argues, think of innovation too narrowly. And their fear of economic by John Kay dislocation often encourages them to advocate policies that have only a limited impact on productivity. Governments that want to promote innovation, he argues, should focus mainly on two areas. The first is delivering an education system that equips people with the ability to generate ideas, commercialise them and absorb them Apple is the most innovative consumer products company of the last into working practices. The second is to promote competition and decade. It has redefined how people listen to music, blindsiding both markets, so that young, innovative firms can emerge to challenge music publishers and established electronics manufacturers. And it incumbents. Tilford wonders, however, whether the political climate has reinvented the telephone. Yet Apple’s achievement is not the in Europe is conducive to such policies. Since the financial crisis, result of its technology. The gizmos in the gadgets are much the same traditional European suspicions of competition and markets have as the gizmos in the gadgets of other companies. Apple’s success lies become more entrenched. in deploying existing technology in ways that meet consumers’ needs and in attracting buyers through coolly designed devices that do not Philip Whyte is a senior research fellow at the Centre for European require you to be a computer geek to use them. Reform. Understanding the needs of customers is what distinguishes innovation from novelty. Quirky inventors have a place in the affections of everyone who enjoyed physics or chemistry at school. But the quartz watches and home computers that Sir Clive Sinclair championed in the UK were quickly overtaken by better products from other businesses, and his C5 electric vehicle was not wanted by anyone. Pioneers of innovation are routinely pushed aside by competitors whose skills are in the marketplace rather than the laboratory. The invention of the body scanner won a deserved Nobel Prize for EMI’s Geoffrey Houndsfield, but almost destroyed the company. The market for scanners is now shared by Siemens and GE. My favourite innovative company is Easyjet. There is nothing technologically advanced about what it does. Indeed, there is nothing that it does that some other airline is not doing. Yet Easyjet catalysed fundamental change in the sleepy European airline industry. Innovation is about finding new ways of meeting
  • 10.
    10 Innovation: How Europe can take off What is innovation? 11 consumers’ needs, often including needs they did not know they had. Michael Dell, who was barely in it. But IBM did not know the Sometimes such ideas come from a laboratory scientist but, more future of the industry. If it had known, it would – sensibly – have often, the innovation that changes the business landscape comes tried to prevent it. The interests of the industry and of consumers from the imagination of a Henry Ford or Walt Disney, Steve Jobs or were not only different from those of the dominant business: they Stelios Haji-Ioannou. were diametrically opposed. For years research and development scorecards have dutifully If a decade later you had wondered what government could do to recorded how much pharmaceuticals companies spend on the promote Britain’s civil aviation industry, you would have asked search for new drugs and the expenditure of governments on British Airways – and perhaps its main rival, British Caledonian. The defence electronics. But most of the spending that promotes government tried to promote competition through liberal policies innovation does not take place in science departments. The that particularly favoured Caledonian. All irrelevant, of course – financial services industry may have been Britain’s most innovative Caledonian would disappear and the people who controlled the industry in the past two decades – perhaps too innovative, for future were Michael O’Leary and Stelios Haji-Ioannou. But as many tastes – but practically none of the expenditure behind that business minister, you would have had no reason to give them the innovation comes under “R&D” rubric. And the same is true of time of day. Companies such as Easyjet see opportunities that others innovation in retailing, media and a host of other innovative have missed. Most of these opportunities do not actually exist and industries. Most innovation is the product of entrepreneurs, not the innovations fail. But only a few such entrepreneurs have to be people in white coats. right to change the face of business. So what should government do to promote innovation? Understand Confusion between the interests of an industry and the interests of that support for innovation is not the same as support for R&D, still existing companies pervades last year’s Digital Britain policy less the activities that established firms in industry regard as document and the legislation that followed. An admirable desire to innovative. We despise geeks – but we are also intimidated by them, promote Britain’s creative industries is translated into a wish list for and they retain a powerful influence on our thinking. Outside many corporate lobbyists, hired by large companies and trade university cities around the world there are biotechnology estates associations. Who else could they be hired by? There are few established by governments that believe high technology is the key certainties about how these creative industries will evolve. But one to a competitive future. The funds that governments provide to such is that if an industry is to advance, much – perhaps all – support innovation are all too often appropriated by large innovation will come from businesses that do not yet exist. Their companies that are better at forming committees to pontificate about founders may not even have imagined the activities that will one what the global village will want in the future than they are at day make them celebrities. assessing what their customers want today. The primary role of government in promoting innovation is the If you were in a government department pondering the future of the promotion of markets. The objective of promoting innovation computer industry in the 1970s, you would naturally have turned to should not be to reward grandees with knighthoods, favours and IBM for thoughtful experts and presentations. You would not have positions on committees: it should be to encourage a new generation consulted Bill Gates or Steve Jobs, who were barely out of school, or of people such as Gates, Dell and Jobs, Haji-Ioannou and O’Leary.
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    12 Innovation: How Europe can take off Promoting innovation means making it easy for new entrants to 3 Innovation and frontier research develop new products and business processes, not subsidising existing research and development. by Helga Nowotny John Kay is a visiting professor at the London School of Economics and a columnist for the Financial Times. There has always been an inherent tension between the demands of policy-makers for practical innovation, seen as the undisputed motor of productivity and hence economic growth, and the deeply-rooted interests of scientists in curiosity-driven research. Some of my academic colleagues fear that, by stressing ‘innovation’, politicians focus on incremental technological advancement only. As a result, the pivotal role of basic research remains largely unacknowledged. Politicians, on the other hand, feel that researchers are often uninterested in confronting today’s pressing problems, preferring to remain ensconced in their labs. The US has been more successful than Europe at resolving this tension between the research community and policy-makers. European scientists seem to want to wish away the tension, while the policy-makers, maybe even more naïvely, believe that commercially- applicable knowledge can be commissioned top-down. Innovation is a collective bet on our future. We have to get this right. With its rapidly ageing population Europe has to compensate for its falling birth rate by becoming more innovative. The contradictory perspectives of scientists and policy-makers are shaped by their differing time horizons. For politicians, the battle to ‘win the future’ means that results must be obtained immediately. For their part, scientists know from long experience that it is impossible to predict research outcomes, and that even when the outcomes are known, it may still take years to fully realise their benefits. What is innovation? We can broadly define innovation as the successful economic application of an idea. It results from enhancing
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    14 Innovation: How Europe can take off Innovation and frontier research 15 the way something is produced or from introducing new products. The process of innovation depends on many variables: the specific It can also involve new ways of organisation and modes of financing. field of scientific knowledge and technological know-how; national As a result, it is difficult to identify the processes through which and EU-level institutional contexts; regulatory frameworks that innovation actually happens. Moreover, innovation does not always seek to ban state-aid while encouraging governments to use public have to be a technology. In the ‘real’ world, social innovations may procurement to stimulate demand for new technologies; be just as important. The more technological innovation we want, intellectual property rights which may help as well as hinder the the more social innovation we need. burst of activities in novel areas; and, crucially, geographic location. Innovation ecosystems tend to emerge in certain places Nobody doubts its importance for economic growth and societal and not in others. Excellence (and the opportunities it provides) development, but the results of innovation cannot be foreseen and attracts excellence. Finally, there is the elusive, yet vital success remains unpredictable. Innovation describes a very complex, Schumpeterian human element of leadership. If we were to make non-linear process on various levels. It is therefore misleading to progress in understanding and coping with all these elements, we think of innovation merely as a chain starting with an idea and could make a giant step forward in what I call the ending in its profitable application. Such a ‘linear model’ of institutionalisation of innovation. knowledge production fails to capture the nature of research or how firms operate. Sometimes, the successful commercial What does this mean for basic research? Firstly, we cannot draw a development of a new technology triggers basic research by opening concrete link between specific scientific insights and increases in up new ways of tackling a problem. Sometimes research conducted productivity. But there is no doubt that investment in basic research in a lab turns out to be tremendously productive and useful for other contributes significantly to the processes that lead to innovation purposes outside the lab. and productivity. For example, it was basic research that underpinned the breakthroughs in ICT, biotechnology and Innovation should therefore be understood as a multi-layered nanotechnology that have driven such pervasive economic and process. First, there is the interaction of individuals, firms, societal changes over the last 30 years. Basic or investigator-driven organisations and governments. Second, invention and innovation research generates the scientific insights that lead to the development are both continuous and discontinuous processes. Many important of new technologies and markets. innovations are continuous in the sense that subsequent improvements in a product may be vastly more important than the Secondly, the European Research Council, an EU funding body set initial idea. This is what ‘incremental innovation’ is all about. But up to support investigator-driven frontier research, was wise to there is also a discontinuous, deeply disruptive form of innovation. change the term basic or fundamental research to frontier research. Had we continued to improve candles we would never have This was not only semantic. It indicates a change in the way developed electricity. And had we continued to improve the research is conducted and its very nature. In many areas of frontier production of electricity, we would never have come up with the research, the boundaries between basic and applied science have laser. Such ‘radical innovation’ has enormous repercussions for the become blurred. While frontier research continues to be driven by structure of our economies and their growth potential. Radical scientific curiosity, researchers are often working in an innovation is almost entirely due to new scientific insights, interdisciplinary context and increasingly with potential discoveries and technologies made in basic research. applications in mind.
  • 13.
    16 Innovation: How Europe can take off Innovation and frontier research 17 Thirdly, past experience shows that governments are poor at picking changes in productivity. Such paradigm shifts are driven by winners. The once so popular discourse on National Innovation curiosity-driven scientific enquiry. However, Europe also needs to Systems based on the idea of nationally centralised innovation is get much better at commercialising or diffusing new insights. Closer rapidly giving way to a debate about ‘open innovation’. Again, with links between scientists on the one hand and policy-makers and a more distributed, diverse and hybrid innovation ecosystem businesses on the other would help. But we also need to make sure emerging, public and private actors will continue to mix; and that the national and EU-level institutional contexts are conducive markets and research will move closer to each other. Moreover, the to innovation. Policy-makers need to strike the right balance ideas of collective property rights and open access have begun to between the rights of developers of intellectual property and the challenge the more orthodox views of intellectual property rights. need to disperse new technologies. Firms must face strong market incentives to commercialise technologies and/or to reorganise in Crucial questions remain. How do we manage the inherent tension order to make the best use of them. This is Europe’s sputnik between the political impatience for practical results and the moment. Europe cannot afford to fail to develop more favourable insistence of scientists that in frontier research the outcome is innovation ecosystems if it is to meet its mounting economic and impossible to predict? How do we foster innovation across a wide social challenges. spectrum of possibilities and cope with the inherent uncertainty and risks that scientists face when working at the frontier between what Helga Nowotny is director of the European Research Council. is known and yet unknown? And how do we contribute to the establishment of the European Research Area? Rather than trying to suppress the inherent tension between the interests of policy-makers and scientists, we need to acknowledge it openly. If we want to foster innovation, we need to boost frontier research. That does not mean pouring money indiscriminatingly into basic research. Although frontier research is inherently uncertain, that does not mean everything can be left to chance. It is vital that scientific excellence is the sole criteria for the funding of frontier research. This will inevitably mean that funds continue to be concentrated in leading institutions. This is as it should be, but excellence does not equal exclusivity. We should do everything to nourish existing innovation ecosystems, and enable new ones to emerge. The process of innovation is a complex and unpredictable one: we cannot pick winners. However, we do know that basic or frontier research is an indispensable element of this process. Perfecting existing technologies is important, but it will not lead to step-
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    4 New evidenceon ‘creative destruction’ in Europe and the US by Albert Bravo Biosca Europe faces major challenges recovering from the recession. The immediate ones are to avert a full blown sovereign debt crisis, consolidate the nascent recovery and create jobs. But in the longer term more fundamental changes are needed. The European economy has structural weaknesses that preceded the financial crisis. So a return to ‘business as usual’ is not an option. Improved productivity is essential if European economies are to thrive in the next decade: European businesses are less productive on average than their US counterparts, and the gap had been widening for over a decade before the recession took hold. Closing this gap requires a more innovative and dynamic economy. For much of the second half of the twentieth century, European countries could grow by accumulating capital and imitating others’ inventions. Now we need to foster innovation to drive productivity growth. This is also the most appropriate response to increasing competition from emerging markets. And it is the only sustainable route if firms and countries are to move up the value chain. Innovation needs experimentation in the real world, going beyond the R&D lab. Innovation is about putting new ideas into practice. Trying a new business model, exploiting a new technology or launching a new product often requires a firm to expand its current capabilities (for example, by setting up a new plant or hiring a new marketing team). However, since innovation is uncertain and market selection harsh, too many companies prefer an ostensibly safer ‘wait
  • 15.
    20 Innovation: How Europe can take off New evidence on ‘creative destruction’ in Europe & the US 21 and see’ approach to riskier experimentation, particularly if failure has long vexed European policy-makers. But the new database is too costly. In the long term, such conservatism could be far riskier. shows that this is only part of a wider picture: While experimentation is necessary, it is not enough. Companies ★ European countries have a lower share of high-growth firms must build on their innovations. This means growing and replacing than the US. But they also have fewer medium-growth firms less successful firms, and forcing competitors either to improve their and fewer shrinking firms. At the same time, Europe has a performance or to shrink and exit the market altogether. This much larger share of ‘static’ firms, that is, firms that neither creative destruction is what ultimately drives productivity growth. expand nor contract over time. Are European economies up to the challenge? The evidence is not ★ The fastest growing half of firms grow faster in the US than in encouraging. Both Europe and the US have highly successful the average European country, while the bottom half shrink companies, but the European ones are generally much older. A study faster. Thus, the gap between successful and unsuccessful firms by Bruegel, a Brussels-based think-tank, shows that only 2 per cent is larger in the US than in Europe. of the European companies in the world’s largest 500 firms by market capitalisation were founded after 1975, compared with 14 ★ There is a strong negative correlation between the growth rate per cent in the US. of firms at the top and the bottom of the growth distribution. In other words, the faster successful companies grow, the faster This is not just about differences in rates of entrepreneurship. unsuccessful companies in the same industry shrink. Researchers at the OECD and the World Bank have shown that the main differences between the US and Europe lie in the rate at ★ The average high-growth firm multiplies its workforce by 2.5 which new firms grow rather than the number of new firms. US over three years. Therefore, despite their small share (3-6 per start-ups grow much faster in their early years than their cent of firms), high-growth firms account for a disproportionate European counterparts. share of job creation (between a third and half of all jobs created by surviving firms with ten or more employees). To shed further light on the dynamism of Europe’s business landscape, the Danish Ministry of Economic and Business Affairs ★ A less dynamic business growth distribution, with a larger and Britain’s National Endowment for Science, Technology and the share of ‘static’ firms as in Europe, is associated with lower Arts (NESTA), with support from the International Consortium for productivity growth. Importantly, both a higher share of Entrepreneurship, collaborated with researchers and statistical growing and shrinking firms are correlated with higher agencies in 11 countries across three continents to collect new and productivity growth, which is consistent with a faster comparable data on business growth. The resulting database, which reallocation of resources (both labour and capital) towards draws on individual records for six million businesses, provides successful innovators. useful lessons for policy-makers. Europe’s less dynamic businesses – both in terms of growth and The dearth of European equivalents to Google or Microsoft – contraction – should be a concern. We are not good enough at innovative start-ups that grow quickly to dominate their markets – creating an environment where firms experiment with new projects,
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    22 Innovation: How Europe can take off New evidence on ‘creative destruction’ in Europe & the US 23 scaling them up when successful while being able to backtrack and Current attempts to create an EU-wide corporate tax system (the shrink when unsuccessful. As a result, innovation in Europe suffers. common consolidated corporate tax base), a single European patent (the EU patent) and a single legal form for SMEs (the European This has implications for European policy-makers. The debate on Private Company – ‘SPE’) suggest a potentially valuable third way. high-growth firms often considers them in isolation. But policies A new ‘28th regime’, sitting alongside the 27 national regimes targeted solely at high-growth businesses, such as improving the without replacing them, could give firms the option to operate under climate for venture capital, are not enough to address the lack of the same set of simplified rules and procedures across the EU, while dynamism that hampers Europe’s productivity. They need to be still preserving the rights of member-states over specific issues such combined with deeper structural reforms that remove not just as tax rates. Other benefits would follow. For instance, it would barriers to entry, but also barriers to growth and contraction, such make it easier for firms from different countries to work together, as improving product and labour market regulation and tackling create a less fragmented market for business services providers, and access to finance. Some European countries are more advanced facilitate the development of Europe-wide financial intermediaries. than others in this respect, so governments have much to learn from their experiences. Achieving a more innovative Europe requires action in multiple areas. Removing barriers to make it easier for innovative businesses Finally, Europe needs an ambitious push to reduce its market with high-growth potential to experiment and expand across Europe fragmentation. While the single market has made it easier to sell is crucial. European policy-makers must make it happen. After all, goods across borders, the liberalisation of the market for services has the sooner we start addressing our long-term growth challenge, the been too slow. And even with planned reforms, differences in easier it will be to navigate today’s uncertainties. regulation between member states will still make it difficult for companies, particularly SMEs, to operate across borders. Albert Bravo Biosca is senior economist at NESTA and author of ‘Growth Dynamics’, a report on which this essay is based. To read The European Union represents a potential market of half a the full report, visit www.nesta.org.uk. billion customers, the third largest after China and India, and has a combined GDP larger than that of any country in the world. But a firm wishing to set up establishments across the 27 EU member-states would still be subject to 27 different legal regimes, with different registration requirements, labour regulations, intellectual property systems, tax rules, commercial law, judicial traditions and bankruptcy proceedings, among others. While dealing with 27 different jurisdictions may be merely an annoyance for large multinationals (to the benefit of their armies of advisers), it can be an insurmountable challenge for innovative smaller firms willing to grow (in fact, some ambitious entrepreneurs simply choose to relocate to the US altogether to avoid the hassle).
  • 17.
    5 Improving productivity performance is not rocket science by Nicholas Crafts From the mid-1990s to the eve of the global financial crisis, European productivity performance was disappointing. The rate of labour productivity growth in the EU-15 averaged 1.5 per cent per year, compared with 2.1 per cent in the US. Around this European average, there were, of course, large national variations, with labour productivity growing by 3.5 per cent a year in Ireland, but by just 0.4 per cent in Italy. The fact remains, however, that in ten European countries labour productivity grew by less than 2 per cent a year. For the first time since World War II, much of Europe has been falling further behind the US, rather than catching up. European politicians often respond to these figures by stressing the importance of promoting a dynamic, knowledge-driven economy. The task, they argue, is to achieve faster economic growth by prioritising a stronger research and development effort and expanding higher education. Accordingly, they are often tempted to launch initiatives to encourage the rebalancing of economies towards high value-added, new-technology growth sectors through selective industrial policies. These approaches to the productivity agenda are seen as modern and proactive and often get a good press. It is certainly reasonable for governments to support research activities, including those in universities. There are divergences between private and social returns, so there is a traditional market- failure justification for such policies. More generally, government has an important role in underpinning productivity performance
  • 18.
    26 Innovation: How Europe can take off Improving productivity performance is not rocket science 27 through ‘horizontal’ industrial policies. Policies which raise the rate produce ICT equipment, but how to make best use of it. And this of return to private investment and innovation – notably by raising consideration has been influenced more by regulations than by the quality of state education or improving the provision of shortfalls in human capital or domestic R&D spending. transport infrastructure – can have a favourable impact on the long- Employment protection legislation, for example, can make it hard run rate of productivity growth. and expensive for businesses to reorganise themselves to make best use of the ICT they have invested in. Similarly, restrictions on However, there is usually no good case for ‘selective’ industrial retailing create barriers to entry and slow down the exit of less policies which subsidise favoured businesses or sectors. Economic efficient firms. theory tells us that such policies will generally be skewed not only to advancing producer interests at the expense of consumers, but also Consider the case of distribution. It is a large sector across Europe, to supporting declining industries which have the most to gain from typically employing as many people as manufacturing. And it lobbying. Economic history from the 1930s through to the 1970s happens to account for a sizeable share of the widening transatlantic and beyond bears out these predictions and shows that such policies productivity gap after the mid-1990s (when labour productivity were a dismal failure in terms of improving growth performance. growth in this sector fell from 1.7 per cent to 1.3 per cent per year in the EU, but rose from 2 per cent to 6.5 per cent in the US). The It is also important to put the role of domestic R&D in true US’s strong productivity performance was based on the entry and perspective. Recent research has confirmed that investment in exit of retail establishments – in other words, creative destruction. ‘intangible capital’ has a significant impact on productivity growth. Retailing has become a big user of new technology, especially ICT. However, intangible capital includes much more than just But since it carries out very little R&D, it would never be the focus conventional R&D. Typically, about two-thirds of intangible capital of a so-called ‘growth strategy’. In short, the example of the is made up of other components such as computerised information, distribution sector underlines the importance of competition policy design, and economic competencies – items which are generally not (rather than industrial policy) and of technology diffusion (rather good candidates for subsidy on market-failure grounds. Recent than R&D) for innovation and productivity growth. research suggests that investment in ‘innovative property’ (a broader concept than traditional R&D) accounted for only about 10 per cent There is compelling evidence that competition promotes productivity of the productivity growth difference between Europe and the US growth. Yet competition is generally weaker in the EU than in the after the mid-1990s. US. Competition works through its positive impact on management quality, by creating pressure to invest and innovate or lose market The two most important things that EU countries can do to raise share, and by ensuring that productive resources are reallocated to productivity is to encourage the rapid diffusion of new technologies, better uses. It is therefore disappointing to note that regulations and to facilitate creative destruction. For the typical European which inhibit competition and the rapid take-up of new technologies country, at least 90 per cent of the R&D that contributes to its are still prevalent in many European economies. Moreover, the productivity growth is conducted abroad. It is therefore the effective impact of the single market programme on productivity has been transfer and assimilation of this knowledge that is required. impaired because its implementation by many member-states has Information and communications technology (ICT) is an excellent been half-hearted. The symptoms of inadequate competition are example: for most countries, the big issue has not been whether to relatively high price-cost mark-ups, as well as lower market shares
  • 19.
    28 Innovation: How Europe can take off of high-productivity firms in the EU compared with the US. Rather 6 Skills, education and innovation than reverting to industrial policy, strengthening competition policy is much the better way to go. by Andreas Schleicher The message must be that an effective policy to promote innovation is not just, or even mainly, about stimulating R&D and giving subsidies to hi-tech sectors. It is mainly about the decidedly unglamorous, even thankless, task of putting in place a framework Skills have never been as central to the prosperity of nations and that encourages the efficient diffusion of new technology and ensures individuals as they are today. Skills spur innovation by generating the exit of the inefficient and outmoded. Both literally and new knowledge, and facilitating the adoption and adaptation of figuratively, it is not about rocket science. The economics is quite existing technologies and ideas. In so doing, they contribute to straightforward; the problem is the politics. Implementing an productivity (and hence economic growth). They also play a key role appropriate policy will provide fewer photo opportunities for in countering earnings inequality. politicians, and may in any case lose rather than win votes. Because innovation is not confined to corporate R&D laboratories, Nicholas Crafts is director of the Research Centre on Competitive a modern economy requires broad participation in the innovation Advantage in the Global Economy (CAGE) at the University of process – among users, suppliers, workers and consumers, and in the Warwick. public, private and non-profit sectors alike. It is worrying, therefore, that skills are highly unevenly distributed across Europe, and that substantial numbers of people still do not even reach the minimum levels of basic skills. While some countries have managed to improve their skills base in recent years, others have stagnated or even declined – this at a time when the economic and social costs associated with low skills have been rising. Matching the supply of relevant skills to the demand for them is never straightforward. Skills mismatches can occur when a worker would be more productive in another job, or when there is a general surplus or shortage of specific skills. And they can result from any number of factors. Employers may be ineffective at signalling their needs; education and training systems may be unresponsive to changes in demand for certain skills; and skills can atrophy or be lost altogether – either because they are not developed or sustained through education and training, or because they are not used (commonly as a result of unemployment).
  • 20.
    30 Innovation: How Europe can take off Skills, education and innovation 31 What does all this mean for policy? The foundation for building a skills Female educational achievement has increased significantly and, for pool remains the acquisition of what can be called ‘cognitive foundation the younger cohorts, it has now overtaken that of men. But while skills’ – in plain language, basic literacy and numeracy. Both are key female participation in the labour force has increased, the gender tools for continued learning, and for developing more advanced and gap remains substantial: on average, only about 60 per cent of specific types of human capital. If countries are to avoid wasting talent women in OECD countries are employed or looking for work, from the outset, they must ensure access to education for all – not just compared with 80 per cent of men. to reach the right level of basic education, but also to make it possible to upgrade and extend skills during the course of a person’s lifetime. Lifelong learning will require the development of new funding models. Investment in learning needs to be cost and tax-efficient for However, making the optimal use of existing skills and preventing individuals and their employers. For those out of work, funding the erosion of skills through lack of use is just as important as needs to be accessible to support and incentivise learning. producing the right skills in the first place. As job and occupational Governments should encourage, via the tax system and regulation, mobility increases, and the shelf-life of domain-specific knowledge the development of new financial instruments that allow learners to declines, individuals must upgrade their skills more regularly than in access opportunities when they need them most. For learning the past. With demand for skills growing and changing over time, beyond universal education, education and training systems need to traditional education and training systems that select individuals find ways to share the costs among government, employers and and assign them to particular streams are increasingly out of date. students based on the respective benefits obtained. Governments need to improve skills across the population as a whole; ensure that vocational training focuses on more than Policies must become less piecemeal than they have often been in the immediate employability (notably by developing transferable skills past. Large gains can be achieved by co-ordinating efforts at all that facilitate occupational mobility); and make sure that skills are levels and by investing tight public budgets more effectively and developed through lifelong learning (which may require new ways of efficiently. To this end, governments must build new relationships ‘bringing learning to the learner’). with learners, providers, businesses, social investors and innovators. Governments must also develop more targeted policies to support Andreas Schleicher is head of the Indicators and Analysis Division, groups that are currently marginalised in the labour market. School Education Directorate, OECD. drop-outs represent one group at risk. Key policy actions for this group must include early interventions to support young people at risk of leaving the education system without a recognised qualification, as well as measures to assist young people in finding jobs. Other groups at risk include immigrants and minorities. The integration of such communities into the labour market remains a major challenge in many EU countries. Despite welcome change in recent years, women still represent the largest under-utilised pool of human capital in OECD countries.
  • 21.
    7 Innovation policyin the EU: The biopharmaceutical sector by Jim Attridge The pharmaceutical industry creates many positive spill-overs. Aside from the development of treatments for crippling, painful and life threatening conditions, wider social and economic benefits flow from having healthier populations and high quality employment. For years now the industry has been consolidating its research and development (R&D) spending in fewer places and on a reduced number of diseases. There is less R&D money around and more competition for it. Europe is losing out to the US and increasingly to fast-developing economies such as China and India. This is because the EU and member-state governments are failing to strike the right balance between the need to contain rising healthcare costs and the need to provide pharmaceuticals firms with sufficient incentives to develop new innovative medicines in Europe. Innovation in the pharmaceutical sector epitomises what Schumpeter called routine innovation. The research component of R&D investment is much like many other sectors, involving laboratory- based studies by academic and industry-based scientists and a competitive race to patent inventions. But the second stage – the development phase – is exceptionally long and expensive; it is dominated by clinical trials, which test the efficacy and safety of treatments against stringent criteria. The third phase of the innovation process – the often overlooked diffusion phase – requires innovators to persuade conservative clinicians and financially- pressed health bodies to adopt their new treatments. Once a product enters the market, the firm responsible for its development benefits
  • 22.
    34 Innovation: How Europe can take off Innovation policy in the EU: The biopharmaceutical sector 35 from only around ten years of market exclusivity before it faces should militate against the need for further regulations to limit the competition from cheaper generic versions of the drug. prices of new patented treatments or to cut the prices of those already on sale in EU countries. Governments need to recognise The discovery of a new way to treat a disease results in the filing of that after decades of ‘cut and cut again’ cost saving measures, numerous patents by many competing academic and industrial Europe’s R&D-based pharmaceuticals industry is wilting. This is organisations across the world. Companies with the necessary largely the result of a failure to recognise the impact that cost resources then have to decide whether to risk embarking on a ten containment by governments has had on the attractiveness of year development programme – costing around US$1bn – to Europe as a location for pharmaceuticals R&D. The threat emanates translate the invention into a commercially viable product, which not only from the US – where European pharmaceuticals firms are stands a good chance of being approved by the various regulators. doing an increasing share of their bioscience R&D – but increasingly Early market access benefits both patients and the innovator seeking from China and India, whose fast-growing markets make them a return on their investment. formidable rivals for R&D investment. However, the full therapeutic potential of a new treatment may only There have been some positive EU initiatives to increase the rewards be realised following many more years of additional investment in for investing in innovation. The EU’s ‘orphan drug concept’, clinical trials and associated product development. This highlights introduced in 2001, has encouraged R&D into treatments for the crucial distinction between the primary research, which leads to numerous rare diseases. This has been achieved by fast-tracking the initial invention, and the incremental development of that regulatory approval for the medicines and extending the period of treatment over many years. This distinction is at the heart of a time that firms benefit from patent protection. However, patient access vigorous debate over how and where to invest public research funds to the new treatments varies greatly across EU member-states, with and how EU governments should determine access to treatments and some countries severely restricting access to them on cost grounds. The the prices paid for them. Public health insurance schemes are the Innovative Medicines Initiative, a joint public-private collaboration dominant funders of prescription medicines in the EU. Burgeoning between the European Commission and the pharmaceuticals industry, demand for treatments combined with weak public finances means aims to both promote a wider science base through funding research that these organisations are under huge pressure to cut costs. Over projects and through initiatives to streamline development processes. many years this has spawned a plethora of national regulations for Whilst such initiatives are undoubtedly helpful, their scale and effect the pharmaceutical sector, the main thrust of which has been to are unlikely to offset the much greater impact of ever tighter price enforce low prices and restrict patient access to innovative controls and regulatory changes. treatments. This, in turn, has reduced the amount of revenue accruing to a firm over the life-time of an innovative new treatment, The lack of a holistic approach encompassing all three of the and undermined the attractiveness of Europe as a location for innovation phases – research, development and diffusion – has led to pharmaceutical R&D. poor policy towards the pharmaceuticals industry. A key EU policy shift in recent years has been to reduce the amount of money firms Over the next three years the patents on a large number of high receive for what are considered minor or incremental advances in value drugs will expire, reducing companies’ revenues and providing treatments; the aim being to concentrate R&D investment in areas substantial savings for both public and private health systems. This likely to produce major new medicines. Despite the obvious appeal
  • 23.
    36 Innovation: How Europe can take off of such policies, they are incompatible with the inherent nature of 8 Financing the venturesome the innovation process. All the evidence suggests that reducing the amount of money pharmaceuticals firms receive for incremental economy innovation will accelerate the withdrawal of R&D activity from by Amar Bhidé ever more areas of disease. This trend is well illustrated by the current crisis in the development of new antibiotics. Declining R&D investment into antibiotics means that there are now few new products to treat resistant organisms, such as c.difficile or MRSA. Over the coming decade further ‘innovation deserts’ will emerge, and the capabilities and infrastructure necessary to respond quickly A relatively small number of individuals and organisations is often and effectively to new diseases will be much diminished. credited with advancing the scientific and technological frontier (and hence with sustaining the well-being of all). In reality, however, To prevent this, the EU and member-state governments need to re- this common yet elitist conception of innovation misrepresents its think policies on two fronts: nature and role. Widespread prosperity and rewarding work depend on the creativity and enterprise of many individuals, rather ★ The European Commission needs to focus less on maximising than a few. Innovation is a multiplayer game, not a professional the short-term interests of consumers and do more to sport in which a few highly talented and well paid athletes put on champion the pharmaceuticals industry as a strategic EU asset a show for the rest of us. Narrow conceptions of innovation are in a global context. damaging in a modern economy because they often prompt pointless and wasteful initiatives. ★ EU member-states need to integrate better their national strategies for healthcare – balancing the need for affordable Inclusive innovation treatment with the need for a thriving pharmaceuticals industry. Better integrated models will need to acknowledge that Europe In earlier times, new artefacts were often developed by a small faces intensifying competition for internationally mobile number of inventors and sold to a few wealthy buyers. Alexander bioscience and biopharmaceutical activities. Graham Bell, for example, invented the telephone with one assistant. Likewise, automobile pioneers were one- or two-man Jim Attridge is research fellow at Imperial College London. shows – Karl Benz and Gottlieb Daimler in Germany, Armand Peugeot in France, and the Duryea brothers in the US. Early car buyers were rich hobbyists. These days, innovation is far more inclusive. Innumerable entrepreneurs, venture capitalists, executives of large companies, researchers at universities and commercial and state-sponsored laboratories, programmers and members of standard-setting institutions as well as politicians have played their part in turning the
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    38 Innovation: How Europe can take off Financing the vernturesome economy 39 Internet into a revolutionary medium of communication. Steve Jobs, primary bottleneck. We should always remember that the most often portrayed as a brilliant solitary inventor, relies on tens of important innovations are often the organisational changes needed thousands of individuals working at Apple and its network of to make use of new technologies. suppliers. And, unlike the early buyers of automobiles, millions of regular consumers scoop up products such Apple’s iPad and Official preference for particular technologies conflicts with the Microsoft’s Kinect. principle of encouraging the many to draw on their unique imaginations and experiences. Faced with the same general The many kinds of ideas and know-how needed for the opportunity, different innovators will often come up with very development and widespread use of new products and services different solutions – and no one can predict whose will work best. favours such ‘inclusive innovation’. Consider the microprocessor, So, for example, the problem of global warming is best confronted which is at the heart of so many modern gadgets. The necessary with numerous independent approaches, from more efficient solar know-how ranges from high-level general principles (the laws of cells to carbon capture and storage, safer nuclear power, better solid state physics, mid-level technologies including circuit designs insulation of homes, and fewer cars. and chip layouts, and so on) to ground level problem-solving (like tweaking conditions in a specific semiconductor fabrication plant At the same time, official indifference will not do either: to maximise the quality and yield of the microprocessors technological advances often require an increase in the role of produced). The development of these multiple levels is best government. The growth of the automobile industry, for example, entrusted to many individuals and organisations with specialised required the building and maintenance of roads, the formulation and knowledge and skills. enforcement of driving rules, a system of vehicle safety inspections, and controls on vehicle emissions. Rather than lead or ignore In general, therefore, the development of new technical know-how technological advances, governments should provide broad but is not enough. A new ‘diskless’ computer, for instance, will generate ‘oblique’ support, as John Kay would put it. The ups and downs of value only if it is effectively marketed by producers and properly the US financial system illustrate the importance of a sensible deployed by users – all of which requires marketing and indirect government role. organisational innovations. Innovation also requires venturesome consumers. The use of a new product or service is not a passive act: Funding innovation each time we buy a new computer we take a chance that it will be worth the money and effort. Financing innovation often brings to mind professional venture capitalists (VCs) who invest in high-tech start-ups. But it is often forgotten that VCs fund less than one half of one per cent of annual Policy implications US business start-ups. Most small businesses are not suited for VC Policies to advance cutting edge science and technologies that derive funding and never develop revolutionary products, yet still play a from an elitist view of innovation often do more harm than good by crucial role in the innovation game. Innumerable small outfits – diverting resources away from other activities. Encouraging more including retailers and customisers of off-the-shelf software – people to become engineers and scientists instead of managers will worked hand-in-hand with enterprises such as Apple, Microsoft and exacerbate the problem if the development of technology is not the Intel to put a computer in virtually every home and office in the US
  • 25.
    40 Innovation: How Europe can take off Financing the vernturesome economy 41 and Europe. And small businesses usually cannot thrive without The rules that sustained sound but not stagnant lending steadily bank loans because they cannot raise much equity capital. unravelled after the 1970s. Policies that favoured light touch banking regulation and arm’s length markets fostered the growth of Venturesome consumption also hinges on credit. Henry Ford’s an unregulated and uninsured depository system. They also genius would have counted for little without millions lining up to encouraged lenders to rely on backward-looking statistical models buy the Model T. And even though revolutionary manufacturing that paid little heed to the specific circumstances and prospects of methods made cars much more affordable, few buyers had sufficient borrowers, instead of case-by-case forward-looking judgments. savings. By 1926, two-thirds of all cars sold in the US were purchased on credit. Today, consumer lending underpins the The growth of such ‘robotic lending’ was hailed as an advance akin explosive growth of smart-phones. to Henry Ford’s assembly line. Among other things, it sharply reduced the costs of extending credit, especially to poorer home By and large, sensible bankers will not make medium or long-term buyers. Lending to consumers with limited immediate means loans to businesses or consumers if they are worried about the certainly helps create mass markets for new products. But it can only stability of their own deposits: the risk of unexpected withdrawals be sustained if lenders select individuals who are likely to repay their (or ‘runs’) encourages banks to stick with well-secured and short loans. Skimping on due diligence and showering all comers with term loans. In fact, until the passage of the Banking Acts in 1933 credit does more harm than good. Moreover, not all credit decisions and 1935 that created a comprehensive system of deposit insurance, can be easily mechanised. Small business lending for instance is US banks did not lend to consumers. The buy-now-pay-later plans harder to mass-produce than housing loans. This no doubt explains of the 1920s that helped create a mass-market for cars, radios and why, as housing credit surged before the 2008 crash, banks neglected vacuum cleaners were promoted by consumer loan companies and the small business borrowers that make a larger contribution to the other such non-bank finance companies. It was deposit insurance long-run growth of innovative economies. Worse, after the crash that permitted banks to offer longer term loans to businesses and to banks withdrew credit from sound businesses. finance the consumer boom that followed World War Two. Several measures such as fiscal stimuli and quantitative easing have Prudent lending requires careful, case-by-case judgment. A since been deployed to get developed economies moving again. But borrower’s credit history certainly merits consideration, but in a growth cannot be sustained without innovation, as many realise. A pervasively dynamic economy, ‘past performance is no guide to the clearer and broader appreciation of how the structure and future’. In addition, the time and expense required for careful orientation of modern finance undermines innovation in its broad judgments about what is likely to happen can encourage bankers to sense is a necessary first step. cut corners. Deposit insurance only increases the temptation by removing the fear of bank runs. For many years, tough regulatory Amar Bhidé is Thomas Schmidheiny professor at the Fletcher School oversight of loans and lending practices effectively checked the of Law and Diplomacy, Tufts University. imprudence that deposit insurance alone might have encouraged. Even as bank lending in the US grew by over 9 per cent a year in the 1950s and 60s, the largest number of banks that failed in any given year was just seven.
  • 26.
    9 Promoting innovationin an age of austerity: The European dimension by Máire Geoghegan-Quinn As Europe emerges from the global financial crisis, member-states must press ahead with consolidating their public finances and transforming their economies to tap new sources of growth. Several challenges must be tackled simultaneously: restoring fiscal sustainability, tackling the long-term financial problems associated with an ageing population, and preparing for increased competition from emerging economies. Ever since the crisis broke out, the European Union has therefore taken a holistic approach: it has sought to address short-term challenges, while also taking action geared towards the medium- to longer-term. In its Europe 2020 strategy, the European Commission set out how to achieve high levels of future growth. Raising productivity through innovation is one of the key ingredients of the Union’s response to the crisis. This is why innovation has been put at the heart of the Europe 2020 strategy. The so-called ‘Innovation Union’, which the Commission presented in October 2010 as one of its seven ‘flagship initiatives’ under the Europe 2020 strategy, charts the course for the years ahead. Europe has no shortage of potential. It has some of the world’s most successful and innovative economies. There is a long tradition of inventions, many of which have changed the world and improved our quality of life. The political systems of the EU are based on the rule of law and stable democratic institutions. The EU has the largest single market in the world and a majority of its
  • 27.
    44 Innovation: How Europe can take off Promoting innovation in an age of austerity: The European dimension 45 members now share a common currency. Last but not least, our framework. The aim will be to bring together the different people, our common values and our cultural diversity and creativity instruments into a common strategic framework to focus on areas are sources of great strength. with the highest EU added value, and to provide seamless support for innovations from research to market application. Europe’s competitive strength must derive from higher productivity, from improving our skills and from producing high quality products What Europe lacks compared to key trading partners such as the and services, which compensate for higher wages and costs of US, Japan, South Korea and China is a strategic and integrated production. Europe must regain a first-mover advantage and approach to innovation – that is, one in which innovation strengthen its share of global markets. In short, our future prosperity objectives guide policies in relevant areas such as education, depends on the quality of the European labour force and on skills, labour, product and services markets, and in infrastructure Europe’s ability to drive innovation in a range of different areas. and regional development. Only a handful of member-states pursue such a strategic approach, which is steered at the highest All member-states are currently working to reduce their budget political level. deficits and to keep public debt levels under control. While this process is necessary, it is critical that budget cuts be implemented in Innovation does not happen in a vacuum. There are essential a way that supports sources of future growth. Smart fiscal conditions that need to be fulfilled for innovation to flourish. What consolidation involves protecting investments in areas such as the leading countries and regions have in common – whether it is in education and skills, research and innovation, high-speed internet, ICT, renewable energy or healthcare – is an integrated, well- and other information and communication technologies on which functioning innovation ecosystem, where government policy works our future growth will depend. hand-in-hand with the private sector. Several member-states have recognised the need to turn the crisis National governments have a key role to play, notably by providing into an opportunity. Some countries, like Germany and France, have excellent education, equipping people with the skills needed to opted to increase their public investments in education, research thrive in a knowledge-based society, and supporting and innovation despite cuts to their overall budgets. Other countries, entrepreneurship and risk-taking. There are several world-class such as the UK and Spain, have decided to keep their research and universities in the European Union, but Europe’s ambition should innovation budgets stable, against a background of deep cuts be to have many more, to promote networking and to ensure that elsewhere. These are examples of ‘smart’ fiscal consolidation. Other many more young people can gain experience in setting up and member-states should, as far as possible, follow suit. running their own businesses. The positive effects of (increased) investment in growth-enhancing Alongside policies at national level, there is much that can be done areas must be further reinforced by undertaking targeted structural at European level to improve the overall framework conditions: reforms, notably of research and innovation systems. More than ever, fiscal pressures require us to maximise the quality – and the ★ The completion of the European Research Area (ERA) by 2014 leverage effect – of public-sector funding. These principles will be will create major opportunities for closer cross-border co- applied to EU research and innovation funding in the next financial operation between researchers, educational institutes, research
  • 28.
    46 Innovation: How Europe can take off Promoting innovation in an age of austerity: The European dimension 47 centres and industry that are not currently being exploited the Framework Programme as leverage to secure comparable because of obstacles in the single market. The finalisation of the access abroad – and adopt a common EU front where needed ERA will produce mutually beneficial spill-overs between to protect our interests. member-states’ investments in the fields of research, innovation and science. Máire Geoghegan-Quinn is the European Commissioner for Research, Innovation and Science. ★ An EU-wide venture capital scheme must be put in place and the conditions for an EU-wide ‘knowledge market’ need to be established. Such a market will not only facilitate the better exploitation of knowledge but also give rise to important new sources of revenue that can be re-invested into research and innovation. ★ A common EU patent would provide a major boost to innovation in all parts of Europe – notably by reducing the costs of getting new products to the marketplace (particularly for SMEs). ★ Interoperable standards must be encouraged to ensure that research reaches the marketplace more rapidly and to reinforce Europe’s global reach. ★ EU, national and regional authorities, as well as the various stakeholders (such as researchers, industry, consumers and users), should work closely together through the system of European Innovation Partnerships. This will help speed up breakthroughs, reduce the fragmentation (and resulting duplication) of effort, cut costs and facilitate ideas being turned into commercial successes. ★ International co-operation is critical if the EU is to benefit from the best scientific and research capacities available globally. The EU is already one of the most open markets in the world. Our Research Framework Programme, for example, is accessible to many third countries. But other countries should not be allowed to innovate at the EU’s expense. We should use
  • 29.
    10 How theEU’s single market can promote innovation by Malcolm Harbour The Commissioner for Research, Innovation and Science, Máire Geoghegan-Quinn, is giving strong leadership on ways to make the EU a more innovative economy. Her comprehensive initiative, the Innovation Union, rightly focuses on all the factors that have led to Europe’s under-performance, as revealed by a whole range of independent benchmarks. This essay examines how single market policies can contribute to the Innovation Union. The European Parliament’s internal market and consumer protection committee is fully behind this initiative and is working closely with other parliamentary committees to give this project the support it deserves. Encouraging researcher mobility and knowledge transfer Benchmarking data shows that high quality research in the EU too often fails to be translated into innovative products and services. Notwithstanding large investments in a succession of EU research programmes, EU academic research and technology transfer policies remain fragmented. Healthy competition is one thing, but universities need to co-operate too. There needs to be a shift away from entertaining national intellectual rivalries, towards embracing each other’s experience and knowledge. Improved employment and career prospects for researchers must also be part of the EU’s strategy to fight the ‘brain drain’ to the US and, increasingly, to China, Japan, and South Korea.
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    50 Innovation: How Europe can take off How the EU’s single market can promote innovation 51 Despite repeated political commitments and numerous Commission Standards in the EU must also continue to be harmonised. The EU initiatives to create more favourable conditions, the free movement has a structural advantage in setting international standards by of researchers across the EU continues to be hampered by all manner virtue of its dominant voting rights in the International of obstacles. Fostering greater cross-border mobility must therefore Standardisation Organisation. It should capitalise on this advantage. be a priority. We need to build on successes in the field of mutual The Commission’s forthcoming initiative to extend standardisation recognition of qualifications and break down remaining barriers. to services is particularly welcome. Improved broadband Better salaries, allied to transferable pensions and other benefits, connections and the increased use of radio spectrum will enable would encourage the best brains to move to the best projects. It is more commerce to be conducted swiftly across national borders, and good that new plans for pension portability feature prominently in will boost the sharing of information as well as collaboration the Innovation Union strategy and that the implementation plan has between geographically separated businesses and universities. been picked up in the proposed Single Market Act. Finally, intellectual property protection is a crucial element in stimulating research investment. Agreement has finally been reached on an EU wide patent, which will cut the cost and complexity of Making EU policy more innovation friendly patent protection. Just as the Commission has accepted the importance of an ‘SME test’ to make sure that its proposals take smaller enterprises into Exploiting lead markets and innovative procurement consideration, we need to establish an ‘innovation test’ to ensure that new policies do not hamper research and development through Around 17 per cent of EU GDP is accounted for by public unnecessary bureaucracy. We must eliminate undue costs of doing procurement. This spending must be harnessed to encourage the business, and create a truly business-enabling EU regulatory development and diffusion of new technologies. The Commission’s framework. This will release more funds in business for innovation Innovation Union plans rightly highlight the importance of public and support the development of better products and services. procurement generally, and pre-commercial procurement in particular, as a catalyst for the growth of innovative companies. Employed The Services Directive has removed a number of constraints on correctly, public procurement should generate ‘lead’ markets for new cross-border trade and the right of establishment, making it easier technologies, for example in the environmental and healthcare sectors. for businesses to set up operations in other member-states. But there is still a long way to go. Governments must ensure that EU rules on public procurement should help contracting they liberalise services in all the areas concerned, as there are still authorities obtain the best value for money for quality public some laggards. In addition, the directive must be publicised more services. But they should also create new opportunities for effectively because businesses have been slow in exploiting the businesses. Procedures need to be further clarified as the opportunities it has created. Innovative companies should make procurement landscape evolves, in particular for new forms of full use of these new freedoms by expanding their business in procurement including shared services, public-private ventures, other member-states. The single market must also now ‘go pre-commercial procurement, and e-procurement. Following digital’. The full potential of the Internet must be released and the pressure from the European Parliament, the Commission has Commission must offer an ambitious approach to breaking down launched a consultation bringing forwards a wide-ranging review the barriers to e-commerce. of the EU’s rules. Modernisation and the take up of e-procurement
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    52 Innovation: How Europe can take off How the EU’s single market can promote innovation 53 will significantly contribute to improving the delivery of public economy. Despite the single market’s remarkable achievements, it is services, particularly in ICT, transport and environmental services. still rich with untapped opportunities. This is why the Commission adopted in late 2010 the so-called Single Market Act – a series of proposals to deepen market integration in the EU. It is now essential Funding research and innovation that member-states push on with adopting the measures outlined in In many EU countries, spending on R&D is comparatively low. To the Act. If they take up the challenge, then the EU 2020 programme rectify this problem, new sources of funding need to be found. could be the key that unlocks Europe’s economic recovery. If they do not, it will be another lost opportunity. The EU is well-placed to direct funding programmes, such as regional and rural development funds, to encourage innovation. Malcolm Harbour is a Conservative Member of the European There are many good examples within individual countries of Parliament. incubators and ‘seed corn’ finance for high-growth SMEs. However, more systematic exchanges of best practice and better networks between regions might help to improve outcomes. In addition to selective public funding, it is important to boost capital availability from private sector sources. Pan-European venture capital instruments would create a more effective funding environment for high-growth and innovative SMEs. The Commission should take this important work forward with the European Investment Bank, the European Investment Fund, and expert bodies in the member- states. At EU level, crucial instruments that have already been adopted, such as the Strategic Energy Technology Plan (SET), remain under-funded. This problem must be addressed. One of the Commission’s most promising new proposals is for pan- EU Small Business Innovation Research (SBIR) programmes to underpin innovative procurement. SBIR should identify technology- oriented public sector challenges and fund R&D projects to develop new solutions to both old and emerging problems. This should now be rolled out as a priority. Delivering on EU 2020 The EU 2020 programme recognises that the single market is one of the most important policy tools for the recovery of the European
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    11 Innovation policy:A view from the British government by David Willetts The UK’s coalition government aims to support sustainable economic growth and deliver better public services. The means to those ends – new knowledge, new technologies, smarter ways of working – can all be described as innovative. Later this year, the British government will publish an innovation strategy detailing how we will target support and spending to have the greatest impact on growth and attract private sector investment. The document will set out how we will make the UK a more attractive location for R&D and technology start-ups. It will also encompass how we will promote innovation in and through the public sector, and make the country’s innovation infrastructure (including the Design Council, National Measurement System and Intellectual Property Office) more efficient and responsive. This approach is informed by the latest evidence. NESTA’s ‘Innovation Index’ (January 2011) showed that innovation has accounted for 63 per cent of labour productivity growth in the UK since 2000. More significantly, it revealed that private sector investment in innovation helped to reduce the negative impact on productivity at the beginning of the recent recession. We must increase and broaden these investments in the coming years. Ahead of the strategy, the government has already signalled its intent. In particular, it cast a vote of confidence in science and research by maintaining and protecting its budget in cash terms. For the first time higher education research funding in England has
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    56 Innovation: How Europe can take off Innovation policy: A view from the British government 57 been included within the protected funds, providing greater stability plausible figure given that, in the US, SMEs generate 60 to 80 per and certainty to academics. cent of net new jobs annually; employ 30 per cent of high-tech scientists, engineers, and computer workers; and produce 13 to 14 We have also made it clear that the Technology Strategy Board times more patents per employee than large firms. (TSB) will become the prime channel through which we will incentivise business-led technology innovation, including the future We will therefore improve the effectiveness of SBRI in the UK. In allocation of R&D grants for small businesses. Allied to a stronger addition, we want to realise an equivalent scheme within the EU. TSB will be two networks focused on developing critical mass and Successive rounds of EU Framework Programmes (FPs) have sought helping firms to exploit new and emerging technologies: an elite to increase SME participation in Europe, in recognition of their group of technology and innovation centres, backed by over £200 contribution to economic growth. It is vital to make further million of new investment; and local coaching for growth, linking progress on this before the Eighth Framework Programme (FP8) small and medium-sized enterprises (SMEs) with high-growth enters into force, by allocating some FP funding to an SBRI-type potential to sources of capital and other professional services. scheme which fosters product development and commercial exploitation of technology. Most SMEs simply lack the resources to In terms of the potential of governments to drive innovation participate in international research-based projects. through their own purchasing power, the evidence is just as compelling. As the Commission stated in its communication on Numerous studies have shown the need for improved innovation Innovation Union (October 2010): “Public procurement accounts performance in Europe. The US and Japan continue to outperform for some 17 per cent of the EU’s GDP. It represents an important the EU, while China is rapidly closing the gap. Meanwhile, analysis market, particularly in areas such as health, transport and energy. by the OECD suggests that developed economies must increasingly So, Europe has an enormous and overlooked opportunity to spur rely on innovation for future growth as their population levels innovation using procurement.” The UK public sector has, for stagnate (or decline), and they experience diminishing returns from example, been spending around £220 billion annually. It must labour inputs and investment in capital. become a more willing and reliable customer of innovative goods and services. The UK government therefore welcomes the decision of the European Council, on February 4th 2011, to pursue a range of Through the UK’s Small Business Research Initiative (SBRI), more proposals designed to smooth the passage of innovative products to than £35 million worth of public sector contracts have gone to the marketplace. Easier access to finance for SMEs; faster, SMEs – including micro-businesses, the firms that find it hardest to interoperable standard setting; more affordable intellectual property seize such opportunities. But this record bears no comparison to the rights; joint public procurement and EU-wide measures to support equivalent scheme in the United States, the SBIR. The US scheme venture capital investment: these are all essential for economic issues $2 billion worth of contracts annually. Since its inception growth and competitiveness. almost 30 years ago, it has helped to develop more than $21 billion worth of research and over 45,000 patents. The US Innovation David Willetts is Britain’s minister for universities and science. Development Institute estimates that SBIR delivers a multiplier of between five and seven in terms of economic benefit accrued – a
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    12 Growth andinnovation: The contribution of the digital single market by Esko Aho Europe aspires to remain a global powerhouse with its own values and social model. Sadly, there is a large gap between the rhetoric of its political leaders and the reality of its economic and industrial potential. The global financial crisis has cruelly exposed the EU’s weaknesses and vulnerabilities. A more sustainable foundation for the future must include a more stable financial system, allied to stronger public finances. However, while necessary, such measures are not sufficient to put Europe back on track. The most critical issue is how to create the potential for future growth. There is much that Europeans can do to boost innovation and productivity. Perhaps one of the most important is to encourage the transition to a ‘digital society’ by extending the EU’s single market to digital services and content. The underlying aim should not be the creation of a digital society for its own sake. It should be to ensure that digital products, services and solutions reshape all aspects of our economy and society – from the way that energy is managed in homes and offices, to the way that goods are transported and culture is consumed. The key to this transition will be political will. The political obstacles to carrying out the necessary pro-growth changes are very real. But the alternative – of low growth or none – will hurt Europe far more in the long run.
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    60 Growth and innovation: The contribution of the digital single market 61 Economic strategy: It is about execution subsequent liberalisation of the telecoms sector (pursuant to the The EU is often better at designing medium-term strategies than at single market programme). implementing them. The Lisbon Strategy, which was adopted by the EU in 2000, is a case in point. Although it was in many ways an Europeans should aim to repeat this success story. Without the excellent programme, it failed because of poor implementation. The digital single market (and the clusters to which it can give rise), we EU has now launched a successor programme, known as EU 2020. risk being squeezed between the content-driven innovation of the US Its ambition is to make the EU more productive, knowledge-driven and the manufacturing capabilities of Asia. The four freedoms based and greener. These are all excellent aims. But why should EU 2020 on the single market programme have been key building blocks of succeed where the Lisbon Strategy failed? Europe’s competitiveness. It is now time to add a new one by implementing a ‘fifth freedom’ – the free movement of digital The region’s economic experience over the past decade suggests that content. The EU should harmonise fragmented regulations and EU leaders were right to set out an economic strategy based on remove barriers to buying, selling and interacting online in the EU, information and know-how. Their failing was that they did not as it has done for the sale of most products. EU measures should implement the strategy assiduously enough. Basing our future on target not only physical goods and digital content, but also the world-class know-how, creativity and technological innovations is intellectual property that is the fruit of our creativity. Our aim the only way Europeans will maintain an economic leadership role should be to ensure that the world’s leading online content and meet some of the key challenges that they face: supporting distributors are European. growth, jobs and environmental sustainability, managing demographic change, and so on. This is why completing the EU’s A more integrated digital market would bring a whole host of digital single market is so critical – not only for the ICT sector itself, benefits. Not only would it help to spur new solutions to many of but for other industries too. the social, demographic and environmental problems that Europeans now face. But it would also support growth, create new jobs and generate much-needed tax revenues. The economic fruits of Why deepening the single market is critical a more integrated digital market would be huge. The European The EU’s single market gives companies access to a much larger, Policy Centre, a Brussels-based think tank, estimates that removing integrated market than they would otherwise enjoy. One of the obstacles to the free flow of digital content could lead to incremental advantages of such a market is that it gives European entrepreneurs EU GDP growth of S500 billion – or 4 per cent – over ten years. the opportunity to grow to scale in the same way that their counterparts from the US already can. Europe has already seen the Who will lead the revolution? positive effects that an integrated regional market can have on its own firms. European companies such as Nokia, Ericsson, Alcatel, The digital revolution is underway. Major trading partners such as Siemens, Vodafone and Telefonica have played leading roles in the the US, China, India, Japan, South Korea and Brazil are revolution in mobile technology – in the process, creating millions of transforming their economies and their societies to reap the benefits. high quality, well-paid jobs across Europe. The rise of Europe’s Europe must take urgent steps if it is not to lag behind. As prime telecoms cluster during the course of the 1990s was closely minister of Finland in the early 1990s, I witnessed at close quarter associated with the adoption of the GSM standard in 1987 and the how economic crisis can be followed by growth and technology-
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    62 Innovation: How Europe can take off induced economic transformation. It is now time for Europe to 13 Does Europe really want to be build the framework for a new phase of post-recessionary growth through investment and pan-European co-operation. For that we innovative? need a digital single market to ensure that Europe is the birthplace by Michael Schrage of globally successful economic firms and clusters. Esko Aho is a member of the executive board of Nokia. He is a former prime minister of Finland. Innovation enjoys a remarkably good press. The mind’s ingenuity. The power of a new idea. Opportunities for profit. A chance to change the world. And so on. Innovation reeks of the same sort of ‘political correctness’ – or should I say ‘economic correctness’? – that ‘multiculturalism’ once enjoyed. That should be warning enough. The immaturity, trendiness and ahistorical quality of Europe’s discussions on innovation policy are dangerously disingenuous. If ‘innovation’ is the answer, then what – exactly – is the question? Just a few short years ago objective observers from the media to ECB spokesmen insisted that Europe’s financial services firms were remarkably innovative. Certainly, the numbers said so. High- powered maths, software-driven securitisation and digital network distribution produced dizzying arrays of novel financial instruments. CMOs, CDOs and CDSs constituted some of the most ingeniously high-tech products ever devised by the best-educated minds from many the world’s finest universities. Just to be safe, elegant algorithms and Monte-Carlo-tested ‘risk models’ gave quantitative assurance that these clever innovations could not misbehave too badly. Over a trillion euros of annihilated wealth and one global financial crisis later, the world knows better. ‘Too clever by half’ and ‘too big to fail’ have given new meaning to Schumpeter’s romantic aphorism on innovation: creative destruction. Policy-makers take note. Schumpeter deserves to be taken more seriously. The empirical reality is that ‘innovation’ isn’t a
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    64 Innovation: How Europe can take off Does Europe really want to be innovative? 65 euphemism for economic growth but a dynamic that comes with And what is the secret ingredient making this economic growth risks and costs attached. Ignore the received wisdom and possible? Let us call it ‘innovation.’ (We could call it ‘free trade’ – accompanying agitprop. Inherently, innovation is neither a societal but that is another essay.) Innovation adds a full 0.5 percentage nor an economic ‘good.’ point to GDP and a percentage point to the rate of unemployment. That is the benefit – and the cost – of an innovation policy. That is Just as they desire public spending without deficits, politicians and the thought experiment. technocrats want innovation’s benefits without its costs. This is well- illustrated not just by innovation-enabled financial crises but by the How many French, German, Spanish, British, Dutch, Italian or persistent economic underperformance of Spanish wind-farms and Greek politicians would leap at the offer? How many eurocrats other eco-greenery innovation. would declare this a healthy exchange? Who would publicly argue that the benefits of a rise in GDP clearly outweigh this unfortunate Somehow, techno-subsidies never quite generate the growth that cost in unemployment? has been promised. There is a ‘Concorde-like’ quality of undeniable technical cleverness without measurable private sector success. Clarifying economic assumptions, trade-offs and aspirations is an important obligation of serious policy-makers. Voters should know While policy-makers extol innovation’s importance, realpolitik whether their technocrats value generating economic growth over suggests that, more often than not, they actually celebrate the preserving jobs. Taxpayers deserve to know whether ‘innovation’ importance of new jobs and rising incomes. Innovation is a code excuses speculative subsidies to unproven technologies. People word not for invention, novelty and productivity but for the should know whether their public servants believe they can higher employment and pay packets it purportedly generates. consistently outperform their private sector counterparts in Innovation is creative destruction where the destruction is identifying cost-beneficial innovation opportunities. In democratic pronounced silently. societies, ‘innovation’ should not be a semantic shield concealing policy-makers’ real priorities. Is this characterisation unfair? Perhaps. But consider this thought- experiment: the typical European technocrat or politician is This thought experiment illustrates arguably the biggest single offered an innovative deal to boost their nation’s economic misunderstanding around innovation policy: innovation is not an growth. With a snap of their fingers, they can procure a 0.5 end, but a means. Only ideologues cherish innovation for percentage point increase in their country’s GDP. All they have to innovation’s sake. But innovation for the sake of innovation is no do is accept, in exchange, a 1 percentage point rise in their more meaningful an economic policy than quantitative easing for the country’s rate of unemployment. sake of quantitative easing. Economic purpose must underlie economic policy. Innovation is the means to what economic ends? In other words, to increase GDP from 3 to 3.5 per cent – which More jobs? Better jobs? Greater productivity? Environmental would be tremendous – they would have to raise their country’s sustainability? Subsidising innovators? unemployment level from, say, 8 to 9 per cent. Newspaper headlines and economic analyses would read: "GDP rises but unemployment What real-world economic trade-offs does innovation make still climbs." politically palatable? If state-sanctioned innovation initiatives
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    66 Innovation: How Europe can take off Does Europe really want to be innovative? 67 eradicate more jobs over three years than they create in ten, other innovation’s impact cannot be reliably predicted – even with forms of measurable economic benefit had better accrue. Innovation literally hundreds of billions of euros at stake – should inspire policies facilitating the demise of tens of thousands of medium-wage caution, even from policy-makers who desire greater dynamism in jobs in the hope of creating hundreds of thousands of minimum their economies. wage jobs surely suggest a ‘revealed preference’ of policy-makers. So do innovation policies converting industries filled with tens of The most important thing that policy-makers can and should do is thousands of middle-class jobs into ones with thousands of high- to force a larger argument around what kinds of economies paying jobs. enterprises and wider society desire. The point is not to caricature innovation’s destructively creative – or Do they want the ‘top down’ diktats of policy innovations designed creatively destructive – economic implications but to mock the by the centre? Or are they prepared to deal with the inevitable pretensions of policy-makers who think they understand what they disruptions caused by bottom-up innovators like Ryanair, Facebook are doing. and Google? Is entrepreneurship a value that should be cherished in an economy? Or do the competitive discontinuities they threaten Ambitious technocratic plans promoting innovation may have a mean that the precautionary principle should rule? miserable track record, but that apparently does not deter policy- makers from believing they have successfully learned from their It may seem dissatisfying to draft a policy essay about innovation predecessors’ mistakes. Surely this generation of European that portrays it as too rude and unruly to craft meaningful policies technocrats are significantly smarter and wiser than the last. around. But, again, to steal from John Kay: “The primary role of government in promoting innovation is the promotion of markets.” Even putting aside perennially exhaustive and exhausting debates about ‘industrial policy,’ history suggests that innovation has This is an undeniably important insight and I agree with it perverse and unpredictable impacts on national incomes and wholeheartedly. But, respectfully, he begs the larger question: What employment. If we take Schumpeter – or even Keynes – seriously, it markets are we seeking to promote? is painfully clear that innovation-as-economic-policy does not lend itself to the sort of ‘rational planning’ methodologies and analyses so Precisely because innovation is a means to an end, the debate Europe beloved of technocratic elites. must have has little to do with the cleverness of individual entrepreneurs and the promise of new technologies. It has to do with So what should policy-makers do? The answer is not nothing or as the willingness of societies – and their economies – to accept that little as possible. To the contrary, policy-makers and technocrats innovation means, yes, creative destruction of jobs, livelihoods, have an enormous influence – but it should not be in their traditional established institutions and economic security. This is in exchange and typical role of budgeting, planning and regulation. for what history indicates are increased standards of living, quality of life and more choices for more people. As John Kay rightly observes, innovation is not R&D – and vice versa. The argument that more R&D funding invariably assures While the past is always prologue, it is not guarantor of the future. more innovation is prima facie ridiculous. Similarly, the fact that The simple reality is that focusing on innovation distracts from the
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    68 Innovation: How Europe can take off economic issues that truly matter. Europe does not have an 14 Conclusion innovation problem, but a ‘what kind of growing economy do we want to have?’ problem. by Simon Tilford Michael Schrage is a research fellow at the Massachusetts Institute of Technology’s Sloan School of Management. Innovation is widely held to be a ‘good thing’. Most of the contributors to this report agree that innovation accounts for a rising share of productivity growth in advanced economies; and that Europe is not as innovative as it needs to be. Productivity growth across much of the EU has been terribly weak for around 20 years – not just compared with past performance, but also in comparison with the US. However, politicians often think of innovation too narrowly, and advocate policies which promise to have only a limited impact on innovation and productivity growth. This is unsurprising. Innovation is a messier and more destructive process than is commonly understood. It holds out the promise of higher living standards, but often at the cost of existing jobs, livelihoods, established institutions and economic security. Politicians usually place considerable emphasis on research and development (R&D) and patents as measures of innovation, and on high technology being the key to a country’s ‘competitive future’. This emphasis, which is based on the belief that there is a strong link between domestic R&D and productivity growth, leads them to believe that innovation and productivity are best promoted by policies aimed at boosting R&D spending. As a result, the EU and most member-states continue to use R&D spending and the levels of patents filed as indicators of their economies’ capacity for innovation. Such assumptions often encourage policy-makers to advocate active industrial and research policies. They focus on fostering a strategic approach to innovation, where ‘government policy works hand in hand with the private sector’. Much emphasis is placed on strategies
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    70 Innovation: How Europe can take off Conclusion 71 to bring firms, governments and universities closer together, on These points have obvious implications for policy. Governments policies that will make better use of Europe’s research capabilities by should place greater emphasis on competition policy than on encouraging pan-European research networks, and on pushing industrial policy and concentrate on encouraging technology ahead with an EU patent. Policy-makers believe such policies are diffusion rather than supporting R&D. The most important thing synonymous with support for innovation. If economies are to that governments can do to encourage innovation is to promote flourish economically, they must boost their R&D spending. markets, and to make it easier for new entrants to challenge incumbents. This requires structural reforms that remove not only However, as a number of the expert contributors to this report barriers to entry, but also barriers to the growth and contraction of convincingly argue, strategies which focus solely on R&D-intensive firms, such as restrictive product and labour regulation and sectors can be misdirected and wasteful. An obsession with financial systems that fail to make capital available to dynamic meeting targets for R&D spending, they point out, leads policy- new firms. Public support for primary research is also important. makers to pay insufficient attention to other forms of innovation But for the main part, the process of innovation is so complex and which do not involve R&D spending, but which are the main uncertain that it is pointless, and almost certainly counter- source of productivity growth. And they bolster their argument productive, to try and second-guess it. By working with existing with two key points. businesses, governments risk subsidising existing R&D or supporting declining industries. First, there is extensive research showing that only a small part of the productivity growth difference between Europe and the US is However, government’s role should extend beyond the promotion of down to different levels of R&D investment. Moreover, in a typical markets; it also has a big contribution to make as the provider of European country at least 90 per cent of the R&D that actually crucial public goods. The quality of state education, in particular, contributes to productivity growth is conducted abroad. It is the can have a favourable impact on an economy’s capacity for diffusion of technology, rather than its generation, which is the innovation and hence on the rate of productivity growth. Skills play crucial driver of productivity. The most important innovations, in a crucial role in spurring the generation of new ideas and other words, are often the organisational changes needed to make knowledge. But it is perhaps at the more prosaic level of technology use of technology. diffusion where they have the most important impact: they facilitate the adoption and adaptation of existing technologies, ideas and Second, many of the most important future innovations will be working practices. And it is the pace of technology diffusion, made by companies that do not yet exist. Innovation results from combined with differing levels of commitment to competition, that new entrants with innovative new models and/or products replacing explains variations in productivity across the EU. existing, less successful, ones. This process of ‘creative destruction’ is what drives productivity growth. The disappointing rate of Why are policy-makers attracted to policies that often have a poor productivity growth across much of Europe reflects a relatively record of boosting innovation, while underplaying the contribution static industrial structure: too few firms grow rapidly, or are of competition policy? The answer is that actively encouraging the allowed to shrink or disappear. In many EU countries, resources exit of inefficient firms – and embracing more rapid changes in (labour and capital) need to be reallocated more quickly towards industrial structure – is politically unpalatable. And this is the crux successful innovators. of the problem. Innovation is a destructive and unpredictable
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    72 Innovation: How Europe can take off process. European electorates want the benefits of innovation – cheaper, better products – but not the disruption and the insecurity that come with it. As the report’s concluding author, Michael publications Schrage, writes, European politicians talk a lot about innovation, but are not prepared to come clean about what is necessary to # Germany’s brief moment in the sun increase it. Essay by Simon Tilford (June 2011) # Thorium: How to save Europe’s nuclear revival Could Europe yet embrace the kind of creative destruction needed to Policy brief by Stephen Tindale (June 2011) drive innovation and productivity growth? The evidence suggests # The EU and Russia: All smiles and no action? not. Several of the authors in this report argue convincingly for a Policy brief by Katinka Barysch (April 2011) deepening of the EU’s single market. But many member-state # Surviving austerity: The case for a new approach to EU military collaboration governments show little enthusiasm for this. The crisis-hit members Report by Tomas Valasek (April 2011) of the eurozone are implementing far-reaching reforms of their # Europe’s parliament: Reform or perish? labour and product markets in return for financial support. But Essay by Denis MacShane (April 2011) there is little sign of comparable action elsewhere in the currency # A new neighbourhood policy for the EU union, or indeed across the EU more generally. The belief that Policy brief by Charles Grant (March 2011) creative destruction is the driver of innovation has always been weak in Europe. But it has been further undermined by the financial # A chance for further CAP reform Policy brief by Christopher Haskins (February 2011) crisis, which has done much to discredit market-led reforms. If anything, EU governments are now more wedded to defending # Delivering energy savings and efficiency Policy brief by Stephen Tindale (January 2011) national champions and more wary of competition than they were prior to the crisis. For most, placing their countries’ ‘competitive’ # Beyond the European Parliament: Rethinking the EU’s democratic legitimacy future in the hands of such unpredictable forces is an article of faith Essay by Anand Menon and John Peet (December 2010) too far. # Turkey and the EU: Can stalemate be avoided? Policy brief by Katinka Barysch (December 2010) Simon Tilford is chief economist at the Centre for European Reform. # Ukraine turns away from democracy and the EU Policy brief by Tomas Valasek (November 2010) ★ # Why Germany is not a model for the eurozone Essay by Philip Whyte (October 2010) # Turkish politics and the fading magic of EU enlargement Policy brief by Sinan Ülgen (September 2010) # How should Europe respond to sovereign investors in its defence sector? Policy brief by Clara Marina O’Donnell (September 2010) # How to save the euro Essay by Simon Tilford (September 2010) Available from the Centre for European Reform (CER), 14 Great College Street, London, SW1P 3RX Telephone +44 20 7233 1199, Facsimile +44 20 7233 1117, [email protected], www.cer.org.uk COVER IMAGE: CORBIS
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    CENTRE FOR EUROPEANREFORM INNOVATION How Europe can take off Edited by Simon Tilford and Philip Whyte Every EU government supports innovation, believing that it will help Europe to meet the numerous economic, social and environmental challenges that it faces. But innovation is a vague concept and there is disagreement on what policies best promote it. The articles in this report discuss what innovation entails and what policy-makers can do to encourage it. There is general agreement that innovation is a broader and more ‘democratic’ process than what goes on in companies’ research and development laboratories. More controversially, however, some authors believe that an innovative society requires ‘creative destruction’, and that Europe has failed to accept the social and economic dislocations that a more innovative economy must entail. ISBN 978 1 901229 99 8 # £10/G16