German innovation

OECD Observer

“Today every invention is received with a cry of triumph which soon turns into a cry of fear.” Bertolt Brecht’s much quoted comment would probably capture the mood of today’s German venture capitalists, who, if recent spending trends are a sign, may only just be recovering from the fright of the new economy’s collapse in 2000-2001.

Before then, venture capitalists (or business angels) eagerly sought out good ideas, even wild ones, to finance, often to the tune of many millions. There were new economy successes, but also many failures. The price has been a sharp fall in venture capital spending, which Germany badly wants to see reversed.

Globalisation means that to remain competitive OECD economies must stay ahead of the game when it comes to new ideas and products. Germany’s economy reflects this need more than many, so much so that the government even declared 2004 the “year of innovation”. The world’s third largest economy has built much of its industrial might on maintaining high value-added in engineering and heavy industries. Today, Germany spends about 2.5% of GDP on research and development (private and public R&D), which is high by international standards. According to a paper by Kerstin Röhling, and Thomas Multhaup from the Federal Ministry of Economics and Labour, published in the latest OECD SME and Entrepreneurship Outlook, the German government’s aim is to raise R&D expenditure to 3% of GDP by 2010.

Some 85% of all R&D expenditure in Germany is channelled into the country’s powerhouse automotive, chemical and machine tooling industries. However, Germany also boasts strong investment in advanced sectors like information technology, biotechnology and nanotechnology. The authors point out that the integration of “high-tech” into “medium-tech” products has already boosted innovation performance in manufacturing.

The trouble is that for innovation to remain vigorous, more investment has to flow to small and medium-sized enterprises too, for without these, as the authors stress, the innovation process cannot function. Indeed, it is the legendary Mittelstand, a formidable network of SMEs, including many family firms, that lies behind Germany’s leading position in the world market for everything from machine tools to laser systems. But the challenge lies in luring back venture capital, whose decline, particularly for company startups, has been dramatic in Germany. Early-phase investments (seed and startup) in 2003 were below 1998 levels. True, there was a recovery in overall venture capital in 2004, but most of this was for the expansion stage. Only 22 companies received seed financing, fewer than in 2003 or even 1996, and far below the 388 that received it in 2000.

This sorry situation called for a new support structure, opening up new financing sources for R&D-based start-ups. The federal government has modified the instruments of venture capital promotion, and has set up a new joint venture capital fund for newly created innovative companies, to be invested in partnership with private investors. According to the authors, the government also intends to create a seed fund for R&D-based start-ups, mainly for young entrepreneurs with total capital requirements of up to €600,000.

Meanwhile, several regional pilot funds for venture capital have been established, led by KfW SME Bank, which was born out of a merger of federal support banks, Kreditanstalt für Wiederaufbau (KfW) and Deutsche Ausgleichsbank. It is too early to say if last year’s rise in venture capital is part of a new trend. As the authors warn, keeping up innovation requires action in all policy areas, particularly education, but also areas like taxation, where reforms to relieve the burden on small firms is under way. This conclusion is echoed by the latest OECD Economic Outlook, which stresses that for Germany to achieve durable growth, the government must push on with deep reforms. Young entrepreneurs, as well as venture capitalists, will be watching closely. Rory J. Clarke

References

Röhling, Kerstin and Multhaup, Thomas (2005), “Innovative SMEs in Germany”, in OECD SME and Entrepreneurship Outlook, Paris.

OECD (2005), Economic Outlook No 77, June, Paris. Both titles available at www.sourceoecd.org

©OECD Observer No 250, July 2005




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