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EBRD Transition Report 2014 – Potential for knowledge-based growth

TRANSITION REPORT 2014 Innovation in Transition

Potential for knowledge-based growth

Stages of innovation development

Transition countries differ significantly in terms of their rates of innovation and the ways in which firms acquire or create the know-how that they need. The analysis in Chapter 3 demonstrates that both firm-specific factors (such as a firm’s age, size and ownership) and country-specific factors (such as the business environment) influence innovation. The importance of these factors varies depending on a country’s position relative to the global technological frontier – in other words, whether a country is in a pre-catching-up phase, a catching-up phase or a post-catching-up phase.2

The way in which firms acquire the knowledge that underpins innovation tends to differ across these stages of development. As Chapter 1 shows, countries can be grouped together in four broad categories in terms of the main ways in which knowledge is obtained: (i) “low innovation” countries (where few companies spend money on buying or producing knowledge); (ii) “buy” countries (where firms predominantly buy technology, and relatively few firms engage in in-house R&D); (iii) “make and buy” countries (where firms are more active in terms of in-house R&D, relative to the purchasing or licensing of patents and know-how); and (iv) “make” countries (where firms are even more active in terms of in-house R&D).

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In general, analysis suggests that in countries with very low levels of development (in other words, countries in the pre-catching-up phase) the take-up of new technology is often still slow (or absent entirely). This is partly because insufficient human capital severely constrains technological progress. As economies develop and move into the catching-up phase, the pace of such take-up starts to vary greatly, even across countries that are at similar levels of development.3 One explanation for this heterogeneity in take-up rates is differences in countries’ access to (typically foreign) technology, particularly information and communication technology (ICT).

The openness of a country’s economy to foreign direct investment (FDI) and other forms of international cooperation are the key channels that determine the extent to which a country that is catching up with the technological frontier is able to tap the global pool of existing technologies.4 In particular, attracting FDI helps countries to effectively absorb such technologies. For instance, the Spanish-based firm Grupo Industrial Roquet is investing, in cooperation with the EBRD, in the production of standard hydraulic cylinders for agricultural and construction machinery in Romania. The use of modern technology – particularly as regards welding techniques and other modern production facilities – was essential to obtaining the approval of major international clients such as Kubota, Caterpillar and John Deere.

This absorptive capacity also depends on many other factors. Among these are: (i) the availability of technologically literate workers (reflecting both the quality of education and the effectiveness of on-the-job training programmes); (ii) good management skills; (iii) incentives for firms to use higher-technology processes; (iv) access to capital; and (v) the existence of adequate public-sector institutions which will support the take-up of critical technologies where market forces prove to be insufficient.5

As countries develop further and move closer to the technological frontier, another factor explaining the heterogeneity of the take-up of technology comes into play. This factor is the capacity of countries to create their own knowledge as they move from the “buy” group to the “make and buy” group.6 The adoption of technology and its modification to suit local circumstances tend to be more effective when domestic firms have R&D programmes.

At higher levels of development (as countries move to the “make” group), a country’s own R&D can increasingly start to generate new processes and products, particularly in areas where the country has developed advanced capabilities. In this post-catching-up phase, countries require cutting edge know-how, supported by both public and private R&D and good links between the two. Incentives for investment in R&D and innovation, which should already have been put in place, now become crucial. This requires access to markets where there is strong demand for new products, as well as effective intellectual property rights, tailored finance and access to specific skills.

Conditions for knowledge-based growth

These prerequisites for knowledge-based growth can be grouped together under broader business environment conditions (or framework conditions). Such conditions affect the operations and decisions of all firms in the economy, particularly firms that innovate. Some conditions affect specific aspects of firms’ capacity to innovate. Business environment conditions include the quality of institutions (in other words, the legal and administrative framework that underpins interaction between individuals, firms and governments), macroeconomic stability and the functioning of product, labour and financial markets. (The importance of these factors as drivers of innovation is discussed in Chapter 3.)

Taking into account differences in levels of development, the conditions influencing innovative capacity can be divided into those affecting access to foreign technology, those affecting firms’ capacity to adopt and fully understand existing technologies, and those affecting the ability to create knowledge.7

For instance, access to technology depends on a country’s economic openness, the availability and use of ICT infrastructure and the extent to which FDI facilitates the transfer of technology. Absorptive capacity is underpinned by the quality of secondary and undergraduate education, the effectiveness of on-the-job training and the extent of any “brain drain”. Creative capacity depends crucially on: (i) the quality of postgraduate education; (ii) the availability of highly qualified scientists and engineers; (iii) flexible product and labour markets; (iv) the quality of scientific research institutions; (v) effective cooperation between science and industry in the field of research; (vi) the protection of intellectual property; and (vii) the availability of venture capital.


Conditions for innovation

Thus, as countries develop, the relevant conditions need to evolve in order to support knowledge-based growth. Having better access to technology without an educated workforce that is capable of effectively absorbing such technology will make it difficult for countries to progress to the “buy” stage of knowledge acquisition. Countries that become successful at absorbing technology and seek to create knowledge will need to improve the availability of specific skills. They will also need to strengthen links between public scientific institutions and the private sector.8

Policies that help to improve these conditions must evolve accordingly, depending on the extent to which conditions supporting knowledge-based growth are already in place. Where countries are still in the early stages of technological development, policies should focus on fulfilling the conditions for access to and absorption of technology.

In these circumstances, a policy mix that focuses solely on strengthening creative capacity (for instance, through increases in venture capital or grants fostering cooperation between industry and science) may yield only limited results. At the same time, these factors cannot be completely ignored, as elements such as cooperation between industry and science and the quality of scientific research institutions take a long time to improve.


Assessment of prerequisites

A simple framework comprising six sets of conditions for knowledge-based growth (the quality of institutions, the macroeconomic environment, the functioning of markets, access to technology, absorptive capacity and creative capacity) is used below to provide a brief assessment of the conditions for innovation in individual countries in the transition region.

Assessment in these areas is based on the relevant global competitiveness indicators. Data on these indicators are provided not only for the transition countries, but also for a number of advanced economies (in other words, countries operating at the technological frontier) and emerging market comparators.9 The scores reflect the establishment of various regulations (such as laws protecting intellectual property or requirements that need to be fulfilled in order to start a new company) and their implementation, as well as expert assessments of the quality of economic institutions and firms’ capacity to access and absorb technology.

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The largest gap between the transition countries and the advanced economies relates to the capacity to create knowledge (see Chart 5.1a). While transition countries score relatively well on the availability of scientists and engineers (thanks to the emphasis placed on science and technology in the days of centrally planned economies), they lag behind when it comes to the quality of scientific research institutions and the availability of venture capital.

The gap between transition and advanced economies in terms of their absorptive capacity and access to technology is smaller, but still substantial, driven primarily by the lower availability and use of ICT in transition countries. This is also the area where differences within the transition region are the largest. This suggests that countries in the region tend not to fully exploit the potential of ICT when fostering innovation-based growth. A lower use of ICT often reflects insufficiently dynamic product and labour markets, as well as inadequate university systems.10

Transition countries perform somewhat better when it comes to broad business environment conditions such as the functioning of markets, although the gap in terms of the quality of institutions is sizeable.

Differences relative to other emerging markets (such as Brazil, Chile, China, India and South Africa) are smaller (see Chart 5.1b). However, the transition region is not in the lead on any aspect. Indeed, it trails all of those comparators when it comes to the capacity to create knowledge (where Chile scores highest).

Within the transition region, countries differ substantially in terms of the conditions for innovation. As expected, countries in the “make and buy” group tend to score higher than the “buy” and “low innovation” countries on all aspects (see Chart 5.2). In turn, the “buy” countries score higher than the “low innovation” countries on all aspects (with the exception of the quality of institutions, where differences are generally smaller).

These broad trends mask substantial heterogeneity within each group. For instance, Hungary, Poland and Turkey score highest among the countries in the “buy” group, signalling greater potential for knowledge-based growth. However, all of these countries have areas where they underperform. Hungary scores relatively poorly on the quality of institutions. Poland does badly on education and Turkey underperforms when it comes to labour market efficiency and the use of ICT.

Countries in the “low innovation” category have made substantial improvements since 2007, particularly in terms of the quality of institutions, access to technology and absorptive capacity. In these areas they have closed all or most of the gap relative to countries in the “buy” category. However, they continue to be held back by insufficient competition in their product markets, as well as their relatively inefficient labour and financial markets.

Regardless of these differences, the fact that countries that are more highly developed score better on all conditions for innovation suggests that they need to be looked at as a whole. Estonia, the transition country with the highest score in terms of the conditions for innovation, illustrates the importance of such a systemic approach to innovation (see Box 5.1).

CHART 5.1

Source: World Economic Forum (2013) and authors’ calculations.
Note: The scores for each indicator range from 1 to 7, where 1 corresponds to the worst possible outcome and 7 corresponds to the best possible outcome. Scores for “macroeconomic stability” are not shown, given the extraordinary circumstances affecting this broad framework condition in the review period. Data are not available for Belarus, Kosovo, Tajikistan, Turkmenistan or Uzbekistan. Figures for the transition region are unweighted cross-country averages.

CHART 5.2

Source: World Economic Forum (2013) and authors’ calculations.
Note: Transition countries are grouped together on the basis of the methodology presented in Chapter 1. (See Chapter 1 for a list of the countries in each category.) The scores for each indicator range from 1 to 7, where 1 corresponds to the worst possible outcome and 7 corresponds to the best possible outcome. Scores for “macroeconomic stability” are not shown, given the extraordinary circumstances affecting this broad framework condition in the review period. Data are not available for Belarus, Kosovo, Tajikistan, Turkmenistan or Uzbekistan. Figures are unweighted cross-country averages.