Mr. Itzhak Goldberg Lead Specialist Europe and Central Asia Region World Bank

1. KEF VI: Technology Acquisition and Knowledge Networks The Role of Government:Building Absorptive Capacity in Europe and Central AsiaApril 17, 2007 Mr. Itzhak Goldberg Lead Specialist Europe and Central Asia Region World Bank

2. Output Growth Labor Capital Human Capital Absorption Innovation Investment Climate Education Competition R&D Corporate Governance Training Corporate Governance Trade & FDI Brain circulation Financial Discipline IPR & Knowledge Brokers The Importance of Innovation and Absorption for Growth

3. Definition: Absorptive Capacity From Absorption to Innovation: New to the Firm versus New to the World Absorptive capacity: Firm’s capacity to assess the value of external knowledge and technology and make necessary investments and organizational changes to absorb and apply this in its productive activities Examples of absorption: Adopt new product, process, Upgrade old product, process; Quality certification, Technology license

4. Product v. Process Innovation • Product Innovation - development of new products representing discrete improvements over existing ones. • Process Innovation - redesign of products, services; reorganization of layouts, transport modes, management, HR • Dual economies: India’s and Israel’s islands of ICT or hi-tech in laggard conventional industry

5. Main Channels of Absorption Learning & Brain Circulation Trade & FDI IPR & Knowledge Brokers Absorption R&D

6. Channel I: Trade and Supply Networks and Foreign Direct Investment (FDI) • Imports of machinery & equipment • Knowledge spillover from exporting to R&D-rich firms/countries • FDI → “vertical spillovers” for suppliers (e.g. Lithuania), export diversification

7. Channel II: Learning and Brain Circulation • Tertiary education and training by firms → specialized skills to enable innovation • Instead of brain-drain, return migration → brain circulation → skills & entrepreneurship • India ICT example: Graduates of Public Technology Institutes (IITs) emigrated before 1990; Liberalization → return expats - key to Brain Circulation and ICT miracle

8. Channel III: Intellectual Property (IP) and Knowledge Brokers • Licensing technology → reduce absorption cost compared to “imitating around” IPR • Clearer IPR → reduce transaction costs for public-private and private-private technology transfers • Knowledge brokers → complementary transfer of tacit knowledge Eg: Israeli incubators help Russian scientist-immigrants to commercialize new ideas

9. Channel IV: Research and Development • R&D for absorption, not JUST for innovation -- the “second face” of R&D à la Cohen and Liebenthal (1990) • R&D output does not flow automatically or costlessly from developed countries to developing countries. China invests massively in R&D

10. Micro Firm-level Incentives: FDI Case study • Slovenian Aluminum firm “ Impol” bought Serbian “Seval” in 2002 • Post privatization: production increased by 3.5 times, productivity by 7.2 times and wages increased by 20% • Why? “Brownfield” FDI changes micro firm-level incentives. More tomorrow at 2 PM from my colleague Dr. Goddard.

11. Measuring Absorption in ECA • Overview of WB econometric study of absorption using BEEPS surveys of enterprises in ECA • Absorption--adopting new and improved products and manufacturing technologies-- is more likely for firms that: • Transition to export status increasing their absorption by about 33%, • Form JV with a multinational increasing their absorption by 41%

12. Market failures may justify government intervention to stimulate absorptive capacity in private sector BUT Policy design needs to account for government failures: capture, corruption,misaligned incentives AND… Role of Government – the Why?

13. Skills and Human Capital India: Early publicly financed education - critical importance Investment Climate and Governance Russia: Poor investment climate (weak competition, red tape); governance: corruption, regional government capture by business Pre-requisites for Intervention

14. The How of Government Intervention? Governments can support absorption via: • Role I: Regulatory interventions to improve the policy environment for absorption • Entry,Financial Discipline, Exit, Mobility , Barriers to FDI, Trade: Non-Tariff-Barriers, Customs, Standards, Quality Certification and IPR Enforcement • Role II: Commitment of public funds – financial and institutional instruments - next.

15. Which financial instruments? • Matching grants: preserve private risk, no crowding out • Soft loans: maturity deters risk taking • Tax holidays: no profit to offset in SMEs • Guarantees: takes away risk (Source: WB ECA Study “Public Financial Support for Commercial Innovation”)

16. Which Institutional Instruments? Institutional instruments include: • Incubators • Technology parks • Technology transfer offices Pros and cons of different options: • Privately owned/managed & subsidized • Publicly owned & managed • Publicly owned & privately managed & subsidized

17. Transition 2nd Phase Policy implications

18. Summary and KEF VI Agenda • Innovation v. absorption; Product v. Process • The 4 channels: FDI/trade, skills, IP, R&D • From Micro to Macro: Firm-level Incentives • The Why of Intervention • Pre-requisites for Intervention • The How: regulate and/or subsidize? • Financial and/or institutional instruments