Innovation is the heartbeat of OECD economies. Without it firms cannot introduce new products, services and processes. They find it hard, if not impossible, to gain market share, reduce costs or increase profits. In effect, if the pulse of innovation is missing, firms quite simply die.
In the past, larger firms and corporations may have had the muscle to insulate themselves from change, holding off innovation and living off successful product lines for many years. But in today's globally competitive environment, no firm, large or small, can survive without innovating. In all sectors of the economy, firms need innovation to grow and to stay ahead in the market. It helps producers to satisfy diverse and fast changing consumer demands, and enables improvements in health, communications and the quality of life generally. In other words, innovation is the driving force of progress.
Innovation is costly. In 1996 OECD business expenditure on research and development (R&D) topped US$300 billion. Large manufacturing and service firms such as Ford, Siemens, IBM and Microsoft spend billions of dollars a year on R&D. And R&D expenditure is only part of the total cost of innovation. In manufacturing, R&D amounts to between a third and half of all business expenditure on innovation. But in services, R&D is often less than a third of the total cost of innovation. Large complementary investments in equipment, training, licences, marketing and organisational change are needed to make innovation work.
The innovation process has changed markedly over the past years. Firms innovate more rapidly, due to globalisation, stronger competition, the growing impact of information and communications technology, and the high pace of scientific and technological change. This is leading to more effective business R&D, but is squeezing out private investment in long-term applied research. Surveys for the United States suggest that firms' average R&D cycle has fallen from 18 months in 1993 to only 10 months in 1998.
The paradox of innovation is that while it is driven by competition, it can not flourish without co-operation, sometimes even between competing firms. The costs, complexity and risks of innovation are high and no firm, no matter how large, can find all the knowledge and information it needs in-house or even within the boundaries of its own country.
The development of a new pharmaceutical drug may cost hundreds of millions of dollars, and only some of the drugs under development will ever reach the market. To share risks and costs, to access new knowledge, and to ensure that innovation responds to consumer needs, firms join in networks, alliances and clusters. They work with universities and research institutes, with clients and regulatory agencies, and even with competitors. Many of these networks and alliances, in areas such as cars, airlines, telecommunications and retailing, now have a global character.
Where governments come in
While firms drive innovation, they depend on government to perform three core tasks. The first is to invest in basic scientific research, which is essential as the foundation for new ideas, methods and products. Major advances in scientific research are the source of many of the breakthroughs in information technology, like the Internet, and in biotechnology, including genetic engineering. The long gestation period, high cost and uncertainty involved are among the key difficulties firms face in generating any worthwhile financial returns from basic science. The onus would appear to be on governments to continue supporting such vital long-term research. All OECD countries re-cognise this, and several, including Japan, Korea and the United Kingdom, have recently increased their support for basic scientific research.
The second task for government is to lay the right conditions for business innovation. That includes a stable macroeconomic environment with properly functioning financial, labour and goods markets, and a regulatory set-up that promotes competition and innovation. It means helping people to acquire the education and skills needed to adapt to a higher pace of technological progress. It also means protecting intellectual property rights in a manner that both encourages innovation and the diffusion of new technology throughout the economy.
Government's third task is to help improve the innovation system itself. Innovation no longer depends only on how firms, universities, research institutes and regulators perform, but on how they work together. Institutional and organisational rigidities can stifle innovation and deliberate government policy is needed to break such strictures down. Obstacles that prevent co-operation and networking have therefore to be reduced and collaboration between universities, public research institutions and business promoted.
In many OECD countries, university researchers do not have the right incentives to engage in research that has potential commercial applications or to co-operate with the business sector.
The United States was among the first countries to recognise the need to unblock this. Since the passage of the Bayh-Dole Act in 1980, US universities have been allowed to patent the results of federally-funded research. Previously, patents would be assigned to the federal government. In Japan, recent legal changes also assign publicly-funded researchers half of the patent rights for their inventions. These are regulatory improvements that stimulate innovation and strengthen the link between scientific research and the innovation process. Other bottlenecks require action too, such as rules that prevent university researchers from working with the business sector or regulations that unduly inhibit co-operation between firms themselves. Access to venture capital appears to be another problem in need of government attention. In short, the barriers to innovation are several and a detailed analysis of the functioning of a national innovation system is often needed to identify the possible policy responses in each individual country.
A new responsibility
Many countries are now aware of the growing importance of innovation and knowledge. But in a number of OECD countries reform efforts to reflect that awareness remain piecemeal. They could look at the case of the booming economy of the United States, which already has the type of business climate where innovation can flourish (see article on the US economy). They would also do well to learn from countries like France, Mexico, Japan, Korea, Finland and Austria, which have taken comprehensive policy initiatives to strengthen their innovation systems. Measures to ease access to venture capital and to enhance the commercialisation of public-funded research are major elements in these initiatives.
Clearly innovation does matter. And learning from each other is important too. One reason is that innovation has to be shared for it to thrive. Equally importantly, governments have a new and responsible role, which is to build the coherent policies needed for innovation to flourish and the knowledge-based economy to grow and prosper.
Managing National Innovation Systems, OECD, 1999.
OECD Policy Brief: Fostering Scientific and Technological Progress, 1999.
Boosting Innovation: The Cluster Approach, OECD, 1999.
Technology, Productivity and Job Creation: Best Policy Practices, OECD, 1998.
The Knowledge-based Economy: A Set of Facts and Figures, OECD, 1999.
©OECD Observer No 217/218, Summer 1999