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EBRD Transition Report 2014 – Use of vertical targeting and smart specialisation

TRANSITION REPORT 2014 Innovation in Transition

Use of vertical targeting and smart specialisation

Vertical innovation policies require high standards of governance to be effective, so they may not suit many of the transition economies. Broader sectoral coverage may be particularly advantageous for countries in the early stages of development. Their existing innovation capacity in any specific field is typically too weak to warrant a clear focus based on indigenous strengths. In contrast, broader support for multiple sectors may help to strengthen the general innovation capacity of countries, with strong competitive positions in specific areas being developed over time.

At the same time, the economies in the region have a long history of attempting policies aimed at specific sectors or technologies. While most of these countries do not focus their public support on a single sector, they do tend to identify a few priority areas. As with other features of innovation policy in the region, countries tend to focus on similar priority areas (see Chart 5.5). They show little variation based on their individual circumstances, the existing structure of production or their skills mix.

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All transition countries regard ICT, energy, biosciences and biotechnology as “highly important” or “important” priority areas for public innovation spending. Other sectors that are at least “somewhat important” in all countries are the environment, food, digital services and healthcare. There are also a few country-specific priorities. For instance, Kazakhstan, Turkmenistan and Ukraine pay special attention to the energy sector. Belarus and Kazakhstan place emphasis on heavy industries, building on their legacy from the Soviet era. The ICT sector, which is prioritised virtually across the board, is a particularly strong focus for at least three countries – Armenia, Azerbaijan and Egypt – with several dedicated initiatives and programmes (see Box 5.5).

Where countries decide to make active use of vertical policies providing benefits and subsidies to specific sectors or firms, a number of safeguards could help to minimise the risks associated with such policies and increase their effectiveness.

First, in order to minimise rent-seeking behaviour by firms and officials, vertical targeting of particular sectors or firms needs to be based on strict eligibility criteria.18 These criteria include the potential benefits for the broader economy and the degree of competition within the sector.

In this respect, reporting details of activities and spending carried out under innovation support programmes (as well as the beneficiaries of such initiatives) may help to strengthen the governance of these programmes. In EU member states, support for innovation generally constitutes state aid and falls under the corresponding rules governing monitoring and reporting.

Second, vertical policies need to be complemented by horizontal measures. Such measures will create better conditions for productivity growth across all sectors, for instance by improving the business environment, increasing the efficiency of product and labour markets and investing in education and professional training. Effective horizontal policies which address bottlenecks affecting innovation (such as corruption, inadequate skills among the workforce, and customs and trade regulations) help firms in all sectors, including those identified as priorities. In addition, effective horizontal policies are often a prerequisite if vertical policies are to yield positive results.

In this regard, improving access to ICT can in fact be seen as an important horizontal policy aimed at improving the productivity of firms in all sectors that actively use ICT services. At the same time, not all countries can or should aspire to becoming a major hub for the development of cutting-edge ICT, given their comparative advantages.

A country’s strengths may lie in the application of cutting-edge technology in medium or low-tech sectors, such as food or textiles. These sectors are often overlooked by innovation policies (which tend to target cutting-edge innovation in high-tech sectors), but they may deliver sizeable returns to innovation.

Third, vertical policies should make effective use of private-sector participation and co-financing. Private-sector involvement provides an independent assessment of the commercial viability of projects which are selected to receive preferential treatment and reduces risks associated with governments picking winners. Private-sector involvement can also strengthen publicly funded education and training programmes. For example, the Estonian Association of Information Technology and Telecommunications (EAITT), an industry association, plays a leading role in the development of clusters and the design of vocational and university education programmes.19

Private-sector involvement can also help countries and regions to pursue “smart specialisation”. Rather than targeting entire sectors, such as ICT or biotechnology, this approach focuses on promoting investment in particular activities that can strengthen comparative advantages in existing or new areas, rather than targets.20 One such example is precision farming – the management of farming practices using computers, satellite positioning systems and remote sensors. These determine whether crops are growing with maximum efficiency given the specific local environmental conditions and form the basis for decisions on seed rates and the application of fertilisers and agrochemicals. In food processing, ICT can be used to record a product’s every movement and the various stages of the production process using barcodes or radio-frequency identification (RFID) tags and other tracking media. Such traceability is a key risk management tool, allowing food businesses and authorities to withdraw or recall products which have been identified as unsafe. In the EU, traceability has been compulsory for all food and feed businesses since 2002.

Such smart specialisation relies on entrepreneurs identifying market opportunities and promising areas in which to specialise. The role of the government is to provide an environment that allows this process to happen and remove obstacles to the development of promising new activities.

CHART 5.5

Source: EBRD innovation policy questionnaire and authors’ calculations.
Note: This chart ranks priority areas for innovation spending in descending order according to the percentage of countries that regard them as “highly important” or “important”.