Day3 ND Innovation Policy

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Drs. Norman DytianquinTeaching Fellow

University of Maastricht

Innovation Policy

This project is funded by the European Union 1N. Dytianquin

UPM EU ACTIVE WEEK 21-25 Nov 2011Business


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AGENDA

ECONOMICS OF INNOVATION POLICY

Solow growth model

Endogenous or New growth theory

Schumpeterian Growth theory

Evolutionary Growth theory

EU INNOVATION POLICY

Goals

Evolution

EU Innovation Scoreboard

Community Innovation Survey National systems of innovation


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ECONOMICS OF INNOVATION POLICY

Three strands in the theory ofinnovation

Solow or neoclassical growth theory Endogenous or New growth theory Schumpeterian

Evolutionary theory


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ECONOMICS OF INNOVATION POLICY-2

Solow growth model: Y = AK L

where Y is output, K and L are capital and labor inputs,respectively, A is a parameter representing technology, and and are the respective output elasticities of K and L

In the model, constant returns to scale is assumed, hence+ =1, so to prevent diminishing returns from occurring the A

parameter shifts the production function outward.

However, Solow assumed this technology as manna from

heaven or available for all countries to exploit.

Given access to this free technology, then there is aconvergence phenomenon where countries starting at lowinitial per capita GDPs will grow faster and catch-up withindustrial countries.


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Solow-Swan Growth Model

Developed independently by Robert Solow (1924- ) and Trevor Swan(1918-1989) although model is more popularly known as Solow modelor neoclassical growth model.

Designed to show how growth in capital stock, growth in labor force,and advances in technology interact and affect a nations total output

Shown in the production function of Cobb-Douglas formY = (AL) K1-

Where A represents technological progress, K is capital stock and L is labor,and the superscripts and 1- indicate the output elasticities of capitaland labor respectively.

If we solve for growth rates:

g(Y) = g(A) + *g(L) + (1-)*g(K)

This is known as growth accounting. Growth can come from either growth ofinputs of K and L (accumulation) or technological progress (assimilation)


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Model basically shows:

Model is expressed in per capita terms, thus:Y/L = A f (K/L) or per capita output is

determined by capital per worker. Y/L isdenoted as y and K/L as k.

Model assumes diminishing returns to capitalas denoted by slope of production functiony=f(k)

Capital per worker is determined by 3 variables

Investment (savings) per worker

Population growth (denoted by n),increasing population decreases the levelof capital per worker, k.

Depreciation (denoted by d). Capital stockdeclines as it depreciates



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If all parameters (savings rate (s),population growth (n), depreciation rate(d), output per worker (y) and capital perworker are all growing at same constantrate, how then can growth be sustainedin the long run?

Only through upward shift of theproduction function y=f(k) curve madepossible through technological progress.

Technological progress shifts productionfunction upward so output per worker

increases.

But where does this technology comefrom? To Solow, technology is mannafrom heaven or exogenous

y0

k0 k

A

0

Y* = Af(k)y*

y = Af(k)

k*

B

(n+d+ )ks

y0

k0 k

A

0

Y* = Af(k)y*

y = Af(k)

k*

B

(n+d+ )ks

y0

k0 k

A

0

Y* = Af(k)y*

y = Af(k)

k*

B

(n+d+ )ks

y0

k0 k

A

0

Y* = Af(k)y*

y = Af(k)

k*

B

(n+d+ )ks(n+d+ )ksWITH EXOGENOUS TECHNOLOGICAL CHANGE


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Thus in the steady state output per worker grows at the rate of thetechnological progress.

Thus with the introduction of technological progress, it is possible for aneconomy to experience sustained growth in per capita income (output) atrate of the technological progress. Thus, the farther an economy is from its

steady state value, the faster it grows given access to same technology.

The model predicts that given access to this free technology, poorcountries will catch up to the richer countries (absolute convergence) withend result of having same per capita GDPs

However growth rates have not been faster in developing countries than

in developed countries. Empirical evidence show tendency for countries having similar

characteristics to have convergence of their average incomes (conditionalconvergence).


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Based on unrealistic assumptions

Full employment

Substitutability of capital and labor (not complementarity)

Diminishing returns to capital Homogeneity of capital (as opposed to embodied in assets

and hence lumpy) and labor

Exogenous technological progress



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NEW GROWTH THEORIES

Endogenous or New Growth Theory

Neoclassical growth model is not clear as to who produces andshoulders the cost of technology. If technology were mannafrom heaven, it assumes a public good character. Which means

it is obtainable at zero costs.

Endogenous or new growth theory introduces monopoly powerand spillover effects (positive externalities) as means ofappropriating technology.

We have Romer and Lucas models which show how technology

creates positive spillovers. Romer introduced R&D thatproduces innovation while Lucas introduced human capital(education, skills) that produces knowledge.


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NEW GROWTH THEORY

Thus the new models emphasize the importance of

1Y A K x

a b a+ -=

investments in human capital (Lucas model) and

1Y A K H h

a a b-=

investments in R&D or knowledge (Romer model)

H is investments in human capital (education and training) which increases the

average human capital (h) and this creates a positive spillover in the workforce.

Represents knowledge (experience, learning by doing) which generates positive

externalities. In a later model he develops, represents intermediate goods which

embody blueprints or investments in R&D by the research sector,


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Cricticisms of new growth theory are:

The new growth theory remains dependent on some of the

traditional neoclassical assumptions that are inappropriate for

developing countries

The empirical studies of the predictive value of endogenous

growth theories show limited results. Most empirical results

are used to test the neoclassical growth theory rather than

endogenous growth theory itself.

NEW GROWTH THEORY


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SCHUMPETERIAN GROWTH

Joseph Schumpeter (1883-1950) saw

innovative entry by entrepreneurs as

the force that sustained long-term

economic growth

Introduced the concept ofcreative

destruction where competition for

monopoly profits leads to technological

progress old technologies are

replaced by new ones
http://en.wikipedia.org/wiki/Image:1schumpeter.jpg


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Types of innovation creating creative destruction

New markets or products

New equipment

New sources of labor and raw materials

New methods of organization and management

New methods of transportation and communication

New methods of marketing and advertising

New methods of inventory management

New financial instruments



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Schumpeter linked growth theory with theory of business

cycles.

When economy reaches a stationary state, the

entrepreneur disturbs this equilibrium by creating a newinnovation which is the cause of economic development.

Tying this up with Kondratieff cycles (50 years) or long

waves, a whole new invention or innovation changes

entire economic and productive structure.



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Like Marx, Schumpeter believed in the demise ofcapitalism. But unlike Marx who believes socialism willreplace capitalism, Schumpeter thought that capitalismwould crumble because of

Obsolescence of the entrepreneurial function:

innovation becomes routinized so entrepreneurs lose their function inthe economy

Destruction of political strata:

Big business will destroys small and medium sized firms and weakenposition of the industrial bourgeosie

Destruction of institutional frameworkGovernments play larger role in the economy so that institutions thatmake markets work will be replaced by state planning, governmentcontrol, nationalization of industries, welfare state, etc.

SCHUMPETER AND DEMISE OF CAPITALISM


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1910The age of oil, automobile, air travel, petrochemicals and mass production

1971The age of information technology, knowledge and global telecommunications

Carlota Perez: A GREAT SURGE OF TECHNOLOGY EVERY HALF CENTURY

1771The Industrial Revolution in England

1830The age of railways, coal and the steam engine

1875The age of steel, electricity and transcontinental communications

20??The Age of biotechnology, nanotechnology and bioelectronics?


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NETWORK OF TECHNOLOGY SYSTEMS


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EVOLUTIONARY THEORY

Starts from Schumpeters ideas that growth emanatesfrom innovation or technological change

But adds on Darwinian theory of evolution where we findprinciple of natural selection (survival of the fittest)

Describes firms as displaying three principles

Search and selection (of routines and decision rules by the firm) Hereditary mechanism (organizational competence, knowhow,

skills are passed on to next generations through codification,imitation, take-overs, labor mobility or piracy)

Generation of variety or novelty (firms differentiate themselvesfrom competitors through product and process innovations)


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Evolutionary theory differs from other theories in following respects:

Multiplicity and uncertainty of outcomes could lead to disequilibrium

and/or multiple equilibria. In mainstream theory, the growth path was

linear.

Likelihood of inefficiency Path dependency (differences in initial conditions determine long-run

outcomes)

Possibility of lock-in solutions (inferior technology can be dominant:

economy can be locked into using an inferior technology, e.g.,

QWERTY keyboard) Evolutionary models were introduced by Nelson and Winter, Dosi et al.,

Silverberg-Verspagen, etc.

EVOLUTIONARY THEORY


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EVOLUTIONARY THEORY


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EVOLUTIONARY THEORY


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Growth path is characterized by instability or chaos as shown in thefollowing possibilities.

EVOLUTIONARY THEORY


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Nelson and Winter model

EVOLUTIONARY THEORY


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Economics of Positive Externalities

Innovation creates positive externalities such that social marginal benefitsexceed private marginal benefits. With externality, Q1 is produced where

PMC=PMB. Q2 would have been produced (PMC=SMB) if externality is paid

for.To internalize the positive externality, there is a need to SUBSIDIZE the

activity producing the positive externality according to Pigou.


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EU Innovation Policy

Economics of innovation policy

Goals of innovation policy

Evolution of EU innovation policy

EU Innovation Scoreboard and major findings

Community Innovation Survey

National systems of innovation


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GOALS OF EU INNOVATION POLICY

To strengthen innovation capacity ofEuropean firms

To enhance effectiveness and coherence ofexisting innovation and technology transferinstruments

To promote rapid diffusion of new technologies

To disseminate knowledge concerninginnovation processes


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EVOLUTION OF EU INNOVATION POLICY

EU innovation policy combines overall analysisprovided by a Communication entitled Innovation in a

Knowledge-Driven Economy in 2000 and the annuallypublished European Innovation Scoreboard which is

based on results of the Community Innovation Surveys

Earlier in 1995, Green Paper identified Europeanparadox of strong research performance but weakinnovation. This called for:

Large scale production for successful exploitation of innovation

Large-scale consumption to build scale economies

Clusters and industrial districts to generate high innovation rates

Tolerance of high degree of social and economic upheaval

Individualism as motivator of innovation


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Includes innovation performance of EU-27 + Croatia, Turkey, Iceland,Norway, Switzerland, USA, Japan, Australia, Canada and israel

Innovation indicators expanded into 25 and arranged into 5 dimensions:

Innovation drivers

Knowledge creation

Innovation & entrepreneurship

Applications

Intellectual property

EU Innovation Scoreboard

EU innovation scoreboard provides overview of relative national

innovation performances

In 2005, EIS is based on 20 indicators which are then combined into a

Summary Innovation Index. This was expanded to 25 indicators in 2006.


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EU Innovation Scoreboard 2009 (2)

Innovation Leaders

Denmark, Finland, Germany, Sweden, Switzerland, UK

Innovation Followers Austria, Belgium, Cyprus, Estonia, France, Iceland, Ireland, Luxembourg,

Netherlands, Slovenia

Moderate Innovators

Czech Republic, Greece, Hungary, Italy, Lithuania, Malta, Norway, Poland,Portugal, Slovakia, Spain

Catching-up

Bulgaria, Croatia, Latvia, Romania, Serbia, Turkey

Note: In 2009, non-EU countries included in 2007 and 2008 EIS were excluded .These are Australia, Israel, USA, Canada, Japan.

Candidate countries were also included aside from EU-27.

Major Findings of EIS 20091. Country clusters according to innovation performance


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Colour coding matches the

groups of countries

identified in Section 3.1:

green are the Innovation

leaders, yellow are theInnovation followers,

orange are the Moderate

innovators, blue are the

Catching-up countries.

Average annual growth

rates as calculated over a

five-year period. The

dotted lines show EU27performance and growth.

Figure 3: Convergence in innovation performance
http://www.proinno-europe.eu/page/31-innovation-performancehttp://www.proinno-europe.eu/page/31-innovation-performance


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2. EU innovation gap with USA and Japan

Figure 10 shows that the innovation performance of the US and Japan is well

above that of the EU27. The EU27-US gap has dropped significantlyup until

2007, but in the last 3 years the relative progress of the EU27 has slowed down.

The EU27-Japan gap has remained stable between 2005 and 2009 although

the gap has decreased up until 2008 but has increased again in 2009.


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2. EU innovation gapwith USA and Japan

USA ahead in 11 out of 15

indicators

EU ahead in

S&E graduates employment in medium &

high-tech manufacturing

Community trademarks

knowledge-intensive services

Narrowing gap in

tertiary education public R&D expenditures

broadband subscriber

business R&D expenditures

Venture capital

Widening gap in

patents

Figure 11: EU27-US Comparison


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Japan ahead in 12 out of 14

indicators

enablers

firm activities

outputs

EU ahead only in

Community trademarks

KIS employment

KIS exports

Narrowing gap in

S&E graduates

tertiary education broadband penetration

Public R&D expenditures

Widening gap in

Business R&D spending

PCT patents

Figure 12: EU27-Japan Comparison


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Strong and stable lead to Brazil Declining lead to China

Strong but slowly declining lead to India Stable lead to Russia

Innovation comparison with the BRIC


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3. Growth performance

The analysis of the EU27 growth rate in

innovation performance shows an averageannual growth rate of 1.8% over a five

year period. This improvement is

particularly due to Human resources

(2.3%), Finance and support (6.5%) and

Throughputs (3.8%) where the EU27 has

progressed most compared to 2005

(Figure 8). In Economic effects (0.9%)improvement has been small and in Firm

investments (-0.4%), Linkages &

entrepreneurship (-0.6%) and Innovators

(-1.3%) improvement has worsened.



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The growth in innovation performance hasbeen calculated for each country and for

the EU27 as a block using data over a five-

year period

The average growth rates for the 4

country groups show that there is

between group convergence with theInnovation followers growing at a faster

rate than the Innovation leaders, the

Moderate innovators growing faster than

the Innovation followers and the

Catching-up countries growing at a faster

rate than the Moderate innovators. The

overall process of catching up, where

countries with below average

performance have faster growth rates

than those with above average

performance, can also be observed at the

level of most individual countries.


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Within the individual indicators, the EU27 is

showing relative strengths n Youth

education, Public R&D expenditures,

Broadband access, IT expenditures,

Knowledge-intensive services employment,Medium-high and high-tech manufacturing

exports, Knowledge-intensive services

exports and Sales of new-to-market

products .

The EU27 is showing relative weaknessesin S&E and SSH doctorate degrees, Life-

long learning, Innovative SMEs

collaborating with others, Technology

Balance of Payments flows and Resource

efficiency innovators.


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In 1960s-1980s, individual member states mostly Scandinaviancountries, France, Germany, Netherlands undertook separateinnovation surveys

In 1992, Oslo Manual harmonized national methodologies andstandardized data collection on innovation activities of EU firms.

Eurostat developed a standard questionnaire that allows forinternational comparability. Questionnaire came to be known as CIS and contains inquiries about

types of innovation done by firms reasons for innovating sources of information for innovation

impact of innovation on firm performance obstacles to innovation expenditures on innovation government incentives and effectiveness in affecting innovation

Community Innovation Survey


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Community Innovation Survey (2)


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C S


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C i I i S (20)


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C i I i S (21)


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C it I ti S (23)


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C it I ti S (24)


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N ti l S t f I ti


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National Systems of Innovation

What is the national systems of innovation?Network of institutions in the public and private sectors whose activitiesand interactions initiate, import, modify and diffuse new technologies(Freeman, 1987)

Elements and relationships which interact in the production, diffusionand use of new and economically useful knowledge (Lundvall, 1992)

Set of institutions whose interactions determine the innovativeperformance of national firms (Nelson & Rosenberg, 1993)

Constituted by the institutions and economic structures affecting therate and direction of technological change in society (Edquist & Lundvall,1993)

National institutions, their incentive structures and their competences

that determine the rate and direction of technological learning (Patel &Pavitt, 1994)

Set of distinct institutions which jointly and individually contribute to thedevelopment and diffusion of new technologies and provides theframework within which governments form and implement policies toinfluence the innovation process (Metcalfe, 1995)

N ti l S t f I ti (2)


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National Systems of Innovation (2)

National S stems of Inno ation (3)


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National Systems of Innovation (3)

EU Institute of Innovation and Technology (EIT)


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In 2008, the European Institute of Innovation and Technology (EIT) will be launched. It is the

first European initiative to integrate fully the three sides of the "Knowledge Triangle" (Higher

Education, Research, Business-Innovation) and will seek to stand out as a world-class

innovation-orientated reference model

Based on partnerships known as Knowledge and Innovation Communities (KICs) highly

integrated public-private networks of universities, research organisations and businessesthe EIT's activities will be coordinated by a Governing Board (to be appointed end June 2008

along with possible headquarters) ensuring its strategic management

The mandate of the EIT are:

Serving EUs strategic priorities (7-year Strategic Innovation Agendas: first Agenda to be

submitted in 2011)

Connecting EU business and research (commercialize research findings)

Providing higher education (MAs and PhDs with EIT label and innovation partnerships)

Setting up incremental development path (phased introduction of KICs: slection fo first

KICs by end 2009)

Leverage for business (integrated knowledge transfer and networking)

EU Institute of Innovation and Technology (EIT)

Sample Innovation Survey Questionnaire from Malaysia


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p y Q y

MYEULINK


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MYEULINK

Thank you.

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