Demand-side innovation Policies

1. Demand-side innovation Policies Mario CERVANTES Country Studies and Outlook Division Science and Technology Policy Division OECD

2. Relevance (1) Demand-side policies have raised a lot of interest Since Aho report in 2006 - explicit policy statements on importance of demand-side innovation (e.g. European Commission, Finland, Japan and the UK but also China, Brazil) Current debates • Context of fiscal consolidation = use demand-side policies to leverage innovation without new programme spending • Urgent need to stimulate innovation to meet strong societal demands in key sectors (e.g. health, environment, energy) • concerns at international level over « techno-protectionism » (i.e. procurement of R&D not covered by WTO rules or EU Procurement Directives, trade conflicts over standards and procurement)

3. Relevance (2) Other trends explaining interest in demand-side policies: • Adoption of a broader-based approach to innovation policy (considering full scope of the innovation cycle/innovation system) • Globalisation puts pressure to accelerate innovation (ICTs and global value chains speed up the feedback between supply and demand; more demanding users) • Some OECD countries face a persistent « innovation paradox »: high or rising R&D, but low rates of innovation, low TFP

4. Traditionalgovernment support to the demand-sidelimited • Economic growth ascribed to increases in supply factors (land, capital, labour, etc) • Endogenous growth model and focus on innovation ascribe a greater role to demand : more innovation increases demand for innovation • Nature of market failures on the demand-side less prone to direct government action, often resolved by: • Macroeconomic policies to sustain demand/income growth • Good framework conditions (e.g competition policy and removal of barriers to firm entry and exit) • Getting prices “right” (IPRs, tax, subsidies) • Use of mission-oriented procurement of R&D limited to societal demands (e.g. public procurement in defence, health, transport sector)

5. Demand for innovation in context Societal Challenge Users Open Innovation Regulations Standards Socio- Cultural Legal

6. More “targeted” demand-side policies • Have three main objectives (Edler 2007): • Increase demand for innovation • Improve the conditions for the uptake of innovations • Improve the articulation of demand (e.g. Sweden combining demand for energy efficient products with –industry and consumers) Source: OECD based on Georghiou, 2007.

7. « Targeted » Demand-side policies and instruments Take several forms: 1. Innovation-friendly regulation (e.g. Orphan Drug regulation; US, 2010 HITECH Act for EHRs) 2. Public procurement of innovation 3. Innovation-spurring standards (e.g. GSM, ADSL) 4. Lead market initiatives 5. Pricing schemes /taxes and subsidies 6. User-driven and consumer-oriented schemes

8. General findings (1) • Sector specificity of innovations and innovation dynamics requires a sectoral approach (e.g. pharmaceutical, chemicals = technology push; ICT, automotive more platform based) • Scale: is needed for reaching critical mass, reducing costs and increasing market uptake (e.g. teaming with other regions/countries for procurement) • Diverse policy instruments; need to choose appropriate policy mix meeting policy goals (e.g. prices, pre-commercial public procurement and regulation could favour more radical innovation; regular public procurement perhaps more incremental innovation)

9. General findings (2) • Need for evidence on the area targeted (metrics) (e.g. size of public procurement); need for evaluation of public interventions • Systemic nature of these policies implies co-ordination between industry and (across) government and other stakeholders (e.g. UK biometrics standardisation, wide-ranging consultation, but, it takes time and has cost) • Key role played by the public sector; need to provide incentives for buy-in by public administrations and to foster “cultural change”. Networks can help: e.g. networks of public procurers EU

10. Public procurement of innovation Considerable policy interest (esp. to support innovative SMEs). Some challenges: • Diverse nature of public goods services • Fragmentation of demand and co-ordination costs • Lack of measures of public procurement (est. 16% of GDP in EU) • Risk aversion and weak capacity/skills of public sector • Risk of protectionism and capture by big players (usual suspects) Good practice: • Networks of public procurers (learning platforms/expertise) • Prevent discrimination against SMEs (e.g. Korea, France) • Funding instruments to provide incentives (e.g. Finland)

11. Procurement of Innovation • Finland – TEKES funding instrument • Germany – High Tech Strategy and Interministerial agreement • EU - Discussion of new instrument to co-finance procurement for innovation • Korea – sectoral approach in ICT procurement and recently green growth • UK: Guidelines for Procurement(DIUS/OGC) Innovation Procurement Plan (for each Department) • United States: • the Small Business Act, Small Business Innovation Research Program.(SBIR) and its smaller sister Small Business Technology Transfer Program (STTR) earmarked towards promotion of business–university interface; CRADAs

12. TEKES approach in Public Procurement for innovation Procurer Risk due to failure, public accountability Tekes funding instrument for innovative public procurement to cut down the risk Innovative product or service Risk due to uncertain nature of new product/service Supplier

13. Innovation-friendly regulation • From a conceptual and empirical perspective, the relationship between regulation and innovation is ambivalent • But some evidence that regulation, especially social regulations, can be a very powerful tool to foster demand for innovation • But use of regulation is challenging (effects and timing are difficult to determine ex ante) and economic consequences are far-reaching • Industry-specific intelligence is needed • Co-ordination between regulators and different stakeholders Good practice: • Excellent market/sector knowledge (through stakeholder involvement) • Regulatory system using foresight to anticipate technological developments

14. Clear policy signals can spur demand for innovation Source: OECD (2010), The Invention and Transfer of Environmental Technologies

15. Environmental regulations or taxes on pollution are the main driver of environmental innovations Source: OECD (2011), Science, Technology and Industry Scoreboard

16. Innovation promoting standards • Standards provide significant economic benefit (annual contribution of GBP 2.5 billion in UK); they promote interoperability and diffusion of information • Developing international standards helps expand markets, esp. for emerging technologies • Standardization is voluntary process • Many successful platforms are based on Open standards • In fast changing areas, Dynamic standards may be more appropriate • But government role in standards setting also comes at a cost (budget and govt. co-ordination costs) Good practice: Although mainly industry-led, but government has role in: • Coordinating the process • Setting standards for government demand (e.g. health, security) • Making a case for standardisation in government

17. Lead Markets for Innovation • Lead markets: ““Innovation taken up one market eventually spread and adopted in other market” (EC) • Bridge the gap between innovation generation and market success • Increases rate of return; attracts further R&D – virtuous cycle of growth and jobs But • Identifying the “right” market for the technology/innovation is tricky • Timing and scale of public intervention (long lead time is a risk) • Choosing and co-ordinating the policy mix for LM • Picking winners or losers (Risk of technology lock-in) Good practice: • Focus on removing barriers in sector (e.g. construction sector, screening national building regulations) • Broad-based approach – don’t target specific technologies (techno neutrality) or products

18. Pricing and innovation • Market based mechanism (in contrast to command and control regulation) • Widely applied in environmental and energy where there are large externalities to correct market failures (e.g. carbon pricing, feed-in tariffs for renewable) • But also used to sustain social goals in public goods (e.g. water, medicines) • Positive effects to promote innovation compared to regulations (firms retain margin of manoeuvre) • But • Pricing mainly induces incremental innovation • Time and inertia are key constraints • Pricing does not, alone, address technology lock-in Good practice: • Pricing policies work best to meet social demands and to correct market failures (e.g. externalities) in private markets • Need for complementary policies, e.g. research, support for technology diffusion

19. Pricing NOx Tax in Sweden • Swedish NOx tax Patents increased; emission intensities declined; Marginal Abatement Costs fell • Swiss VOC tax Firms were quite innovative and found many solutions involving changes in organisational and production practices that did not result in patenting of technologies • UK Climate Change Levy Firms that agreed to a voluntary emission-reduction agreement received a 80% reduction on carbon tax = > innovated less • OECD (2010) Taxation, Innovation and the Environment

20. User-driven innovation User-driven innovation programmes (e.g. Denmark) • Uncovering user needs does not necessarily lead to innovation • Innovation from users takes time • Requires involvement of top management in firms Good practice: • Enhance access to government data, including public research data (e.g. Australia, US, UK ) • Develop ICT infrastructure to enable users

21. Challenges to demand-side policies • Definition of Public procurement for Innovation tends to restrictive • PP4 Innovation can be at odds with competition policy (e.g. WTO GPA rule) and favour large players. • Standards-setting might lock-in inferior know-how. • Problems in Timing of demand policy intervention in the innovation cycle – too early or too late • Evaluation of demand-side policies • Lead-Markets initiatives might be neutarlised by larger market and techno-economic forces. • Important links in the value chain might lie largely in other jurisdictions (i.e. countries, or regions with legislative powers) - global open innovation

22. Open issues • Linking supply and demand by focusing on “societal challenges” • Demand-side policies to foster new innovation or to foster diffusion? • Evaluation metrics and impact methodologies for the demand-side • Adopting a value-chain-approach to innovation policy that links supply and demand

23. Conclusions • Innovation Policies on the supply and demand-side need to become better integrated = systemic approach • Timing of policy interventions is important • Industrial sector, market conditions and maturity of technology matter • Importance of technology neutrality through performance, standards etc. • Evaluation of demand-side measures needed

24. Difference in impacts of supply and demand-side policy instruments Relative impacts of policy on patent activity Public R&D The histogram shows empirical estimates of elasticities, evaluated at sample means, and normalized in terms of the effect of “public R&D spending” (R&D=1.0). Bars shown without fill represent estimates that are not statistically significant at the 5% level. Forthcoming in OECD (2011) Invention and Transfer of Environmental Technologies

25. What next? • Next steps in 2011-2012: • Best practices for linking supply and demand-side policies for green growth

26. Government R&D budgets for energy and the environment, 2010 As a percentage of the total government R&D budget GBAORD for energy and environment programmes (Millions USD PPP) Source: OECD, Research and Development Database 2011, May.

27. Thank you for your attention! Mario.cervantes@oecd.org www.oecd.org/sti/innovation/demandside