Financing Innovation

First published 2014 in India
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Contents

List of Abbreviations

List of Figures

List of Tables

Foreword

The role of financing to support company strategies to introduce new products and processes in the economy has long been recognised as key. More than a hundred years ago, Joseph Schumpeter pointed out the crucial function of banks in stimulating economic growth and innovation, as well as identifying and financing new investments in production. He also emphasised the differences between countries due to the organisation of their banking and credit systems. Especially for small firms and other organisations that could not benefit from previous profits, credit was singled out as a starting point to introduce an innovation. In the third chapter of his 1911 book, The Theory of Economic Development, Schumpeter pointed out that credit works as a command for the economic system to accommodate the entrepreneurs’ goals, and so development could flow. Later on, with the ‘capitalism of trusts’, innovation was fundamentally connected to large-scale firms and their initiatives. The power of these firms to accumulate reserves and to directly access capital markets changed their need for credit. Nevertheless, in his work Business Cycles (1939), he once again qualified the relation between credit and innovation, as he pointed out that such a relationship is essential for the capitalist machine to work properly.

In the 1970s and 1980s, among others, Chris Freeman addressed this issue when he analysed the Japanese National System of Innovation (NSI) in the post-war period. There, he stressed the systemic nature of innovation, the strong connections between banks, production systems and large conglomerates (keiretsus). These elements, together with the building of financing competence capable of fostering new industrial and technological capacities, were depicted as the main reason Japan was able to significantly advance in technology and innovation activities. Two related dimensions of the NSI approach are of paramount value to explain how production and innovation capabilities are acquired, used and further developed: the emphasis on historical and national trajectories, and the importance of taking into account the productive, financial, social, institutional and political contexts, as well as micro, meso and macro spheres. Another of his longest-standing arguments refers to the strategic role of government policies, especially in times of ruptures and crises, in mobilising and reorienting national production and innovation systems.

In Latin America, the so-called structuralist literature also dealt with the issue of innovation and technical progress. One of its most influential contributions relates to the argument that the main factor behind ‘the passive behavior of local firms towards technological development’ was related to the overall geopolitical and macroeconomic context, which in fact obstructed their potentially more active strategies and greatly contributed to limiting the scope for explicit science, technology and innovation (ST&I) policies. Comparing of firms’ behaviour and their innovation trajectories in different countries has reinforced the argument that, indeed, the specific characteristics of national macroeconomic systems contain and condition the microeconomic decisions that form the standards of financing, corporate governance, international trade, competition and technical change. Actually, one of the pitfalls of most neo-classical Walrasian economic models is that macroeconomic solutions are reduced to the sum of microeconomic decisions. There is no room in this model for contextualisation or for considering the influence of malign and benign macroeconomic scenarios. For instance, it does not take into account monetary, fiscal and credit policies, nor the action (and autonomy) of central banking institutions, and, therefore, cannot account for specific relationships between the interest rate, the exchange rate, the expected inflation level and the fiscal environment.

Innovative activities are dependent upon investment strategies as a whole by firms. Innovation portfolios are positively influenced by macroeconomic stability that favour long-run investments and are negatively influenced by policies that increase uncertainty and instability, and that favour financial speculation. Therefore, it is essential to recognise that key macro variables and other macroeconomic conditions enclose and shape the space both for microeconomic decisions and for implementing policies that foster production and innovation development.

The recognition of the importance of innovation activities has led governments in different parts of the world to establish policies to guide and stimulate the productive sector. Among them, those that target funding and financing have received special attention. Main efforts have been directed at stimulating organisations to (i) incorporate and use new knowledge, aiming at increasing the quality and the value added to goods and services, as well as to (ii) endogenise and enroot these processes.

Within this context, the Brazil, Russia, India, China, and South Africa (BRICS) countries’ policies are growing even more relevant as it becomes clear that they constitute a large share of the most dynamic parts of the world economy. In the beginning of this century, around two-thirds of the world gross domestic product (GDP) was concentrated in advanced economies, and in 10 years their share decreased to around 50 per cent. Indeed, the global crisis and the recession in developed economies reinforced a mismatch in the pace of growth in the least developed countries. Growth in the world economy over the last decade has relied heavily on the prominence of emerging countries. As a result, recent decades have witnessed a shrinking distance between developed and developing nations. Investment, production and consumption are gradually moving to the developing world. Within such a scenario, a dispute has also arisen for larger portions of international trade, heating up foreign competition. Preserving national autonomy and the possibility of continued growth requires a new look at the interface between macroeconomic, industrial, commercial and innovation policies. It is, therefore, important to assess the real stamina, characteristics and sustainability of this process. To examine the capacity to orient and support industrial and technological strengths is at the core of such a task.

This is precisely the central objective of this book, which provides a map of institutions and instruments and an analysis of experiences in fostering and financing innovation in BRICS. It singles out significant differences between these countries that are inherent to their historic evolution, and the specificities of their financial systems along with other parts of their NSI. In all cases, however, one will find that governments are strongly inducing innovation in the productive sector through sophisticated financial mechanisms. The chapters of the book also point out that the efficacy in using these instruments varies substantially, as BRICS countries have not only undergone major political, institutional and economic transformations, but are also inserted in specific geopolitical contexts. Moreover, they have a singular macroeconomic environment, as well as a pattern of industrial structure and specialisation, while pursuing different policy targets.

The BRICS countries’ experiences in financing innovation have other points in common. First, departing from the understanding that innovation is a systemic process — involving firms along the production chain and the diverse organisations that affect it — successful policies have targeted the whole set of organisations instead of concentrating on a single individual firm or project. Given the territorial dimension of the BRICS countries, this has also meant fostering articulation and mobilisation of national, regional and local systems for production and innovation. Second, policies for financing innovation have been influenced by complementary policies, in particular those that constitute ‘implicit’ innovation policies, such as the macroeconomic policies, trade policies, etc. The chapters discuss the degree of integration of innovation policy and other policies. Also particularly vital in the analysis is the assessment of the level of autonomy and endogeneity of the innovation policy and its relationship with the development policy, their convergence or dissonance, and the degree of differentiation between the two.

Official government banks have played a crucial role in all five countries. It is important to note the efforts of these banks in providing compensative and decisive stimulus to the national economies during the international crisis, helping to soften its effects in most countries. Regarding the financing of innovation, in the case of China, the analysis covers the performance of the Industrial and Commercial Bank of China, the Bank of China, the China Eximbank, and especially the China Development Bank (CDB). To a lesser extent, this is also the case for India and Brazil. In the long run, governmental action and public financing have been decisive in promoting essential changes in their social and economic systems. In India, the post-independence period was marked by a perspective of planned development and the building up of a wide range of financial institutions to mobilise savings and channel investment to meet the priorities of the development plans. Ranging from the Industrial Finance Corporation of India (IFCI), the Industrial Development Bank of India (IDBI), a subsidiary of the Reserve Bank of India, to the Industrial Credit and Investment Corporation of India (ICICI), a complex set-up was erected to meet the long-term financing requirements. Transformations in the post-liberalisation period include the mobilisation of a broad array of institutions and support programmes under the leadership of the Department of Science and Technology and the National Innovation Foundation.

In Brazil, two federal government organisations are at the core of innovation promotion policies. The Studies and Projects Finance Organisation (FINEP) is specifically dedicated to fostering innovation. The Brazilian Development Bank (BNDES), in its turn, led the way in promoting science and technology institution (STI) activities in the 1960s and 1970s and is taking up this task again. The BNDES has also been a major financier of national industry and infrastructure throughout the Brazilian industrialisation processes and plays a key role in industrial and STI policy. A new pattern of systemic and cooperative initiatives between the two institutions has characterised its activities since 2005.

Likewise, in Russia the government is the main funding source for innovative activities, establishing programmes earmarked for specific strategic goals. On a broader perspective, the challenge is to diversify the Russian economy and transform the country’s high scientific capacities into technological and industrial development. The Bank for Development and Foreign Economic Affairs (Vnesheconombank, VEB) plays an important function in directing resources towards these long-term goals.

South Africa conciliates public institutions with the private banking system to finance industry, in general, and innovation, in particular. When it comes to high-risk and long-term initiatives, public institutions such as the Innovation Fund and the state-owned Industrial Development Corporation are depicted as the main players. The Development Bank of Southern Africa (DBSA) takes a stance that explicitly goes beyond the scope of a specific country, recognising the importance of integrated social and economic development in the Southern African regions.

This plurinational perspective based on the specific challenges and opportunities in developing countries is at the basis of the proposition of the BRICS Development Bank. This could provide an alternative that is capable of financing basic and future infrastructure, as well as other development needs in the BRICS economies and their neigh-bouring countries. Furthermore, it will soften the impact of fluctuations in the international financial system. As a matter of fact, the BRICS Summits have contributed to strengthening relations among the development banks in the five countries. During the BRICS 5th Summit, held in Durban, South Africa, in March 2013, two agreements were drawn up. Besides the BNDES, the signatory institutions included the Vnesheconombank, the Export-Import Bank of India, the CDB and the DBSA. The BRICS Multilateral Cooperation and Co-financing Agreement for Sustainable Development seeks to establish the basis for coordination and an exchange of information between the development institutions in the five countries, aimed at building partnerships, and improving mechanisms for sustainable development. According to the interests and the rules within each development institution, agreements may be signed to finance projects connected to sustainability. Examples include projects that foster the sustainable use of biodiversity, ecosystems and the regeneration of natural resources; as well as those aimed at developing, disseminating and transferring inclusive and sustainable technology; mitigating and adapting climate change; fostering renewable energy and energy efficiency; and other sustainable development infrastructure projects. The BRICS Multilateral Agreement on Co-financing for Infrastructure in Africa is mostly aimed at facilitating bilateral pacts between development banks in the bloc in order to provide support to develop infrastructure in the African continent.

A development bank anchored in developing countries can become a catalyst for change and provide opportunities for new development partnerships, giving emphasis to the innovations and other opportunities entailed in pursuing more adequate paths towards inclusive and sustainable development. It could provide essential assistance to developing countries and emerging countries as they undertake new and more sustainable infrastructure investment for growth and poverty reduction. It also represents an important opportunity to put into practice modern financial instruments and new sources of funding, such as sovereign wealth funds and public pension funds, as well as adequate forms of risk management, and innovative and cost-effective approaches. The new bank can make a major contribution to the health of the global economy by facilitating the transition to new poles of growth and demand, helping to rebalance global savings and investments, and channelling excess liquidity to productive use. It may become not only a driver for sustainable development in the developing countries, but also the engine for change from which all in the developed and developing world alike will benefit. It is worth noting that, within the scope of growing South–South cooperation, this constitutes an additional initiative, which reaffirms the importance in envisaging and financing new inclusive, sustainable and appropriate development trajectories and models. Fostering and articulating knowledge basis, efforts and capabilities can be instrumental for this purpose.

This book offers pioneering and fundamental contributions for this process and related discussion by focusing on one of its central issues: accumulated know-how on financing scientific, technological and innovation activities in the BRICS.

Enjoy reading these rich and promising experiences.

Luciano Coutinho
President
Banco Nacional de Desenvolvimento Econômico e Social

References

Schumpeter, Joseph, 1911 (1936). The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest and the Business Cycle. Trans. Redvers Opie. Cambridge, Massachusetts: Harvard University Press.

———, 1939. Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process. New York, Toronto, London: McGraw-Hill Book Company.

Preface

This volume is the result of a collaborative effort of several people and institutions. The contributions presented here consolidate the findings of the project ‘Comparative Study of the National Innovation Systems of BRICS’ sponsored by the International Development Research Centre (IDRC). The project is rooted in a larger research effort on BRICS national innovation systems (NISs) being developed in the sphere of the Global Research Network for Learning, Innovation and Competence Building Systems — Globelics. The Globelics initiative on BRICS brings together universities and other research institutions from Brazil, Russia, India, China, and South Africa. It seeks to strengthen an original and less dependent thought, more appropriate to understanding development processes in less developed countries.

First and foremost, we would like to thank Professor Bengt-Åke Lundvall, the coordinator of Globelics, who supported and promoted the BRICS project from the outset in 2003 and organised the First International Workshop of the BRICS Project in Aalborg, Denmark, in 2006. Without his leadership and enthusiasm the project could not have taken off.

We owe special thanks to project researchers and coordinators for their engagement in project activities and accessibility which helped overcome difficulties that naturally emerge from the geographical and cultural diversity of BRICS. We are also very grateful to the ones who provided the necessary administrative and secretarial support allowing the good performance of the project, especially Luiza Martins, Fabiane da Costa Morais, Tatiane da Costa Morais, and Eliane Alves who helped in editing activities and whose support was crucial for formatting book manuscripts and organising tables and figures. Max dos Santos provided the technical information technology (IT) support for the research network.

The core ideas analysed in this book were discussed at international seminars organised in Brazil (2007), South Africa (2008), India (2009), and Brazil (2009) under the auspices of the BRICS Project, gathering scholars, academics, policy makers, businessmen, and civil society representatives. Our understanding of this complex theme has evolved considerably thanks to constructive criticism from the seminar participants. We are grateful to them as well as to all other people not named here who also helped in the implementation of the project.

None of this work would have been possible without financial support. The support given by the IDRC was essential for the completion of this project and we are very obliged to them and their staff for their support. We would especially like to thank Richards Isnor, Federico Buroni, Gustavo Crespi, Veena Ravichandran, and Clara Saavedra. We are also grateful to Bill Carman, IDRC Publisher, for the technical assistance provided in the preparatory work that led to this publication.

Supplementary grants were received from various agencies of the Brazilian Ministry of Science and Technology, especially the Studies and Projects Finance Organization (FINEP) and the National Council for Scientific and Technological Development (CNPq). In particular, we would like to thank the General Secretary of the Ministry of Science and Technology, Dr Luiz Antonio Elias, and the President of FINEP, Luis Fernandes, who have given enthusiastic support to the BRICS project since its inception.

Introduction

BRICS National Systems of Innovation

José E. Cassiolato and Maria Clara Couto Soares

Preamble

The world is experiencing significant transformations in its geopolitical and economic constitution. The processes of transformation have accelerated over the last decades. A significant part of the growth potential of the world economy nowadays and for the coming decades resides in some fast-developing countries. Brazil, Russia, India, China, and South Africa (BRICS) have displayed such potential for dynamic change. In a historic rupture with past patterns of development, the BRICS countries are now playing a major role in alleviating the current global crisis whilst revealing new and alternative progressive paradigms.

Much beyond the emphasis given by international agencies to the identification of investment possibilities in the BRICS production structures or to the prospects presented by their consumer markets, our perspective in analysing the BRICS countries is inspired by their significant development opportunities, as well as their several common characteristics and challenges, and the learning potential they offer for other developing countries. Identifying and analysing these opportunities and challenges will help to uncover alternative pathways towards fulfilling their socio-political-economic development potential within the constraints of sustainability.

The central focus of this book series is the National System of Innovation (NSI) of the five BRICS countries. Each book deals with a key component of the innovation system, providing the reader with access to analyses on the role played by the state, the financing, direct investment and the small and medium enterprises (SMEs), besides approaching a particularly relevant — though still not extensively studied — aspect of the BRICS economies: the challenge of inequality and its interrelations with the NSIs of these countries.

The research endeavour that generated the publication of this book series has gathered universities and research centres from all the BRICS countries, as well as policy makers invited to discuss the outcomes. The research development and the comparative analysis of its results are intended to bring to light the challenges and opportunities of the BRICS countries’ national innovation systems from the points of view of these same countries. Part of the effort undertaken was addressed to the construction of a shared methodology aimed at advancing the comprehension of the specificities of innovation systems in each country. This was done in view of the need for improvements in the analytical framework used for the analysis of the national innovation systems located in countries outside the restricted sphere of developed countries. Special attention was paid to the political implications. However, instead of searching for generalisable policy recommendations, it was sought to identify and analyse bottlenecks that are common to the BRICS economies, their complementarities and competition areas, as well as other aspects of major importance for supporting decision makers and that are able to incite reflection about the subject of innovation and development in other less developed countries.

It is worth mentioning that the research consolidated in this publication is rooted in a larger research effort on BRICS national innovation systems being developed in the spheres of Globelics¹ and the Research Network on Local Productive and Innovative Systems (RedeSist) at the Economic Institute of the Federal University of Rio de Janeiro.² Globelics is an international academic network which uses the concept of innovation systems (IS) as an analytical tool aimed at the comprehension of the driving forces that push economic development. It aims to advance the use of the IS perspective on a world basis. Established in 2002 and inspired by renowned scholars from the field of economics of innovation such as Christopher Freeman (1987) and Bengt-Åke Lundvall (1992), the Globelics network has, among others, the purpose of encouraging knowledge exchange between less developed countries (LDCs), thus fostering mutual learning across innovation research groups in Latin America, Africa and Asia. With this, it is sought to strengthen an original and more autonomous approach to understanding the development processes in developing countries. On the other hand, the focus put by the Globelics network on the study of innovation systems of BRICS results from the recognition that understanding the particular dynamics which connects the knowledge base with innovation and economic performance in each of the five BRICS countries is, today, a precondition for better appreciating the direction that the world economy will be following (Lundvall 2009). It is within such analytical field that the contribution offered by this book series is inserted.

In the following sections we (a) present the broad conceptual approach of NSI used as the guiding analytical framework for the research gathered under this book series; (b) characterise the increasing importance of the BRICS countries in the global scenario; and (c) introduce the five-book collection on NSIs in the BRICS countries.

NSI and Development — A Broad Perspective

One of the most fruitful ways of thinking developed in advanced countries in the last 30 years came from a resurrection and updating of earlier thinking that emphasised the role of innovation as an engine of economic growth and the long-run cyclical character of technical change. A seminal paper by Christopher Freeman (1982) pointed out the importance that Smith, Marx and Schumpeter attached to innovation (ibid.: 1) and accentuated its systemic and national character (ibid.: 18). Freeman also stressed the crucial role of government policies to cope with the uncertainties associated with the upsurge of a new techno-economic paradigm and the very limited circumstances under which free trade could promote economic development. Since it was formulated in the 1980s, the system of innovation (SI) approach has been increasingly used in different parts of the world to analyse processes of acquisition, use and diffusion of innovations, and to guide policy recommendations.³

Particularly relevant in the SI perspective is that since the beginning of the 1970s, the innovation concept has been widened to be understood as a systemic, non-linear process rather than an isolated fact. Emphasis was given to its interactive character and to the importance of (and complementarities between) incremental and radical, technical and organisational innovations and their different and simultaneous sources. A corollary of this argument is the context-specific and localised character of innovation and knowledge. This understanding of innovation as a socially determined process is in opposition to the idea of a supposed techno-globalism and implies, for instance, that acquisition of technology abroad is not a substitute for local efforts. On the contrary, one needs a lot of knowledge to be able to interpret information, select, buy (or copy), transform, and internalise technology.

Systems of innovation, defined as a set of different institutions that contribute to the development of the innovation and learning capacity of a country, region, economic sector, or locality, comprise a series of elements and relations that relate production, assimilation, use, and diffusion of knowledge. In other words, innovative performance depends not only on firms and research and development (R&D) organisations’ performance but also on how they interact, among themselves and with other agents, as well as all the other forms by which they acquire, use and diffuse knowledge. Innovation capacity derives, therefore, from the confluence of social, political, institutional, and culture-specific factors and from the environment in which economic agents operate. Different development trajectories contribute to shape systems of innovation with quite diverse characteristics requiring specific policy support.

It is this understanding of the systemic nature of innovation that allows for two crucial dimensions of the SI approach to be explicitly discussed: the emphasis on historical and national trajectories and the importance of taking into account the productive, financial, social, institutional, and political contexts, as well as micro, meso and macro spheres (Freeman 2003; Lastres et al. 2003). Although all of these contexts are relevant for a discussion about development, two in particular should be singled out that are pertinent to this study. One is the financial context, recognised by Schumpeter (1982 [1912]) in his TheTheory of Economic Development. For him, entrepreneurs, to become the driving force in a process of innovation, must be able to convince banks to provide the credit to finance innovation. In this sense, any discussion about innovation systems has to include the financial dimension.⁴ The other is the idea that space matters, that the analysis of systems of innovation should be done at the national (Freeman 1982; Lundvall 1988) and local levels (Cassiolato et al. 2003).

The national character of SI was introduced by Christopher Freeman (1982, 1987) and Bengt-Åke Lundvall (1988) and has been widely used as an analytical tool and as a framework for policy analysis in both developed and underdeveloped countries. As a result, research and policy activities explicitly focusing on SI can be found in most countries and a rapidly growing number of studies of specific NSIs have been produced. Although some authors tend to focus on the NSI in a narrow sense, with an emphasis on R&D efforts and science and technology (S&T) organisations, a broader understanding of NSI (Freeman 1987; Lundvall 1988) is more appropriate. This approach takes into account not only the role of firms, education and research organisations and science and technology institution (STI) policies, but includes government policies as a whole, financing organisations, and other actors and elements that influence the acquisition, use and diffusion of innovations. In this case emphasis is also put on the role of historical processes — which account for differences in socioeconomic capabilities and for different development trajectories and institutional evolution — creating SI with very specific local features and dynamics. As a result, a national character of SI is justified.

Figure 1 is an attempt to show both the narrow and the broad perspectives on NSI. The broad perspective includes different, connecting sub-systems that are influenced by various contexts: geopolitical, institutional, macroeconomic, social, cultural, and so on. First, there is a production and innovation sub-system which contemplates the structure of economic activities, their sectoral distribution, degree of informality and spatial and size distribution, the level and quality of employment, the type and quality of innovative effort. Second, there is a sub-system of science and technology which includes education (basic, technical, undergraduate, and postgraduate), research, training, and other elements of the scientific and technological infrastructure such as information, metrology, consulting, and intellectual property. Third, there is a policy, promotion, financing, representation, and regulation sub-system that encompasses the different forms of public and private policies both explicitly geared towards innovation or implicitly, that is, those that although not necessarily geared towards it, affect strategies for innovation. Finally, there is the role of demand, which most of the time is surprisingly absent from most analyses of SI. This dimension includes patterns of income distribution, structure of consumption, social organisation and social demand (basic infrastructure, health, education).

Figure 1: The Narrow and Broad Perspectives on NSI

Source: Adapted from Cassiolato and Lastres (2008).

This portrayal of the national innovation system framework is a corollary of an understanding that

• innovation capacity derives from the confluence of economic, social, political, institutional, and culture-specific factors and from the environment in which they operate, implying the need for an analytical framework broader than that offered by traditional economics (Freeman 1982, 1987; Lundvall 1988);

• the number of firms or organisations such as teaching, training and research institutes is far less important than the habits and practices of such actors with respect to learning, linkage formation and investment. These shape the nature and extensiveness of their interactions and their propensity to innovate (Mytelka 2000; Johnson and Lundvall 2003);

• main elements of knowledge are embodied in minds and bodies of agents or embedded in routines of firms and in relationships between firms and organisations. Therefore, they are localised and not easily transferred from one place/context to another, for knowledge is something more than information and includes tacit elements (Lundvall 1988);

• the focus on interactive learning and on the localised nature of the generation, assimilation and diffusion of innovation implies that the acquisition of foreign technology abroad is not a substitute for local efforts (Cassiolato and Lastres 1999);

• national framework matters, as development trajectories contribute to shape specific systems of innovation. The diversity of NSIs is a product of different combinations of their main features that characterise their micro, meso and macroeconomic levels, as well as the articulations among these levels (Freeman 1987; Lastres 1994).

From the specific point of view of LDCs the usefulness of the SI approach resides precisely in the facts that (a) its central building blocks allow for their socio-economic and political specificities to be taken into account and (b) it does not ignore the power relations in discussing innovation and knowledge accumulation. As this book argues, these features are particularly relevant in the analysis of the BRICS countries’ innovation systems. As the analysis of economic phenomena also takes into consideration their social, political and historical complexity, policy prescriptions are based on the assumption that the process of development is influenced by and reflects the particular environment of each country, rather than on recommendations derived from the reality of advanced countries. A number of development studies followed these ideas, arguing that technical change plays a central role in explaining the evolution of capitalism and in determining the historical process through which hierarchies of regions and countries are formed. Furtado (1961), for instance, established an express relation between economic development and technological change pointing out that the growth of an economy was based on the accumulation of knowledge, and understood development within a systemic, historically determined, view. Although original, these contributions have a close correspondence with Myrdal’s (1968) proposition that: (a) contexts and institutions matter; (b) positive and negative feedbacks have cumulative causation; (c) cycles may be virtuous or vicious, and with Hirschman’s (1958) point that interdependencies among different activities are important.

The need to address paradigmatic changes and the problems and options deriving from the upsurge of information technologies led to the outbreak in Latin America in the 1980s of a series of interconnected work from the innovation perspective. Building on Furtado’s work on changes associated with the industrial revolution, authors like Herrera (1975) and Perez (1983) analysed the opportunities and challenges associated with the introduction of these radical changes in the region. It was only then that the innovation and development literature started to integrate the empirically validated knowledge about learning inside firms with the contributions stemming from the work of Freeman, Perez, Herrera, and others on new technologies, changes of techno-economic paradigms and systems of innovation. What gave special impetus to this direction was the empirical work focusing on technological capability building as part of a broader national innovation system. The role of government policies in orienting the speed and direction of technological changes was also highlighted (Freeman and Perez 1988).

Development processes are characterised by deep changes in the economic and social structure taking place from (technological and/or productive) discontinuities that cause and are caused by the productive, social, political, and institutional structure of each nation. Development is also seen as a systemic process, given the unequal capitalism development in the world. The recognition of national specificities of these processes is also fundamental. We found the same stress on the national character of development processes in List’s work (1841), and on the NSI idea of Freeman (1982) and Lundvall (1988) in Furtado’s (1961) discussion about the transformation of national economies where their structural complexity is manifested in a diversity of social and economic forms. For Furtado, it is in this transformation that the essence of development resides: structural changes ‘in the internal relations of the economic and social system’ (ibid.: 103) that are triggered by capital accumulation and technological innovations. The emphasis on diversity, and the recognition that: (a) both theory and policy recommendations are highly context dependent, (b) the economy is firmly embedded in society, and (c) knowledge and technology are context-specific, conform some general identities.

Furtado (1961) established a direct relation between economic development and technological innovation pointing out that the growth of an advanced economy was based on the accumulation of new scientific knowledge and on the application of such knowledge to solve practical problems. The Industrial Revolution set into motion a process of radical changes based on technical progress that has lasted till now and that is at the root of how the world economy is conformed. In essence, those changes: (a) rendered endogenous the causal factors related to growth into the economic system; (b) made possible a closer articulation between capital formation and experimental science. Such articulation has become one of the most fundamental characteristics of modern civilisation. As pointed out by Furtado (ibid.), the beginning of such a process took place in the countries that were able to industrialise and create technical progress first, and the quick accumulation made possible in the development of this process became the basic engine of the capitalist system. For this reason, there is a close interdependency between the evolution of the technology in the industrialised countries and the historical conditions on the basis of which such development was made possible. As the behaviour of the economic variables relies on parameters that are defined and evolve into a specific historical context, it is quite difficult to isolate the study of economic phenomena from its historical frame of reference (Furtado 2002). This assertion is more significant when analysing economic, social and technological systems that are different from each other, as in the underdeveloped economies. In this context, underdevelopment may not, and should not, be considered as an anomaly or simply a backward state. Underdevelopment may be identified as a functioning pattern and specific evolution of some economies. Social and economical peripheral structure determines a specific manner under which structural change occurs (industrialisation during the 1950s and 1960s) and technical progress is introduced. Hence different outcomes from those in developed countries are to be expected (Furtado 1961; Rodríguez 2001).

The neo-Schumpeterian perspective also argues that economic development is considered a systemic phenomenon, generated and sustained not only by inter-firm relations, but most significantly by a complex inter-institutional network of relations. Innovation is eminently a social process. Therefore, development — resulting from the introduction and diffusion of new technologies — may be considered as the outcome of cumulative trajectories historically built up according to institutional specificities and specialisation patterns inherent to a determined country, region or sector. Each country follows its own development trajectory according to its specificities and possibilities, depending fundamentally on their hierarchical and power position in the world capitalist system. The more distant underdeveloped countries are from the technological frontier, the larger will be the barriers to an innovative insertion in the new technological paradigm. More serious than technological asymmetries are knowledge and learning asymmetries, with the implication that access, understanding, absorption, domination, use and diffusion of knowledge become impossible. However, even when the access to new technologies becomes possible, most of the time they are not adequate for the reality of underdeveloped countries and/or these countries do not have a pool of sufficient knowledge to make an adequate use of them. This occurs because the learning process depends on the existence of innovative and productive capabilities that are not always available. On this aspect, Arocena and Sutz (2003) argue that there are clearly learning divides between North and South that are perhaps the main problem of underdevelopment nowadays.

The Increasing Relevance of the BRICS Countries

The BRICS denomination was originally used to connect the dynamic emerging economies of Brazil, Russia, India, China, and South Africa as continental countries bearing a strategic position in the continents of the Americas, Europe, Asia, and Africa. The BRICS are also joined by their large geographical and demographic dimensions. Collectively, they were home to 42.2 per cent of the world population as of 2010 representing nothing less than 2.9 billion people. In addition, the five countries account for approximately 30 per cent of the earth’s surface, holding significant reserves of natural resources such as energy and mineral resources, water and fertile lands. As well, BRICS countries have 24.3 per cent of world biodiversity; Brazil alone embracing 9.3 per cent of the total (GEF 2008).

Moreover, it is the recent performance of these economies and their macroeconomic indicators that make them more and more the focus of surveillance and analysis. In fact, the BRICS countries display a growing economic importance. In 2000, the five countries accounted for 17.1 per cent of the world Gross Domestic Product (GDP) in public–private partnership (PPP). Their share increased to 25.7 per cent in 2010, with China and India accounting for 13.6 per cent and 5.5 per cent respectively, followed by Russia (3 per cent), Brazil (2.9 per cent) and South Africa (0.7 per cent) (IMF 2011).

The participation of the BRICS countries in world GDP is expected to rise sharply in the years to come. The impact of the financial crisis and global recession on developed world economy over the last three years has only lent support to this expectation, beyond attracting attention to the BRICS economies’ capacity to remain immune or quickly recover from the crisis. Large domestic markets, proactive investment policies, monetary and tax policies with anti-cyclic capacity, presence of major public banks, and high level of reserves are elements increasingly recognised as having helped at least some BRICS economies to be less affected by the crisis.

While growth slowed in all major regions, China and India continued to grow rapidly in 2009 and 2010 (Table 1). In other BRICS countries the crisis rebounded fast. In Brazil, the GDP fell 0.2 per cent in 2009, but the economy surpassed pre-crisis growth rates in 2010 (7.5 per cent). South Africa showed a GDP decrease by 1.8 per cent in 2009 and had a 2.8 per cent increase in 2010. In Russia, heavily dependent on commodities like oil and gas, the economy has been hit more severely by the global crisis. It experienced shrinking of almost 8 per cent in 2009 but the GDP growth recovered to 3.7 per cent in 2010, beating the developed economies’ growth rates. Prospects for 2015 show the five economies representing 29.5 per cent of the world economy.

The economic performance of the BRICS countries has, however, varied widely during the last decades as shown in Table 1. China has maintained its position as the fastest growing economy worldwide. India has also grown significantly and regularly. Brazil has had an irregular performance, well below its potential, but showed an enhancement in the second half of the 2000s. Russia, after the severe 1990s crisis that resulted in a decline of 40 per cent in its real GDP, has recovered and South Africa has had a small improvement in its economic performance that remains below its potential.

These different performances were accompanied by significant changes in the productive structure of the five countries, which reflect dissimilar development strategies.

The competitiveness of China’s industrial sector is the main source of the country’s impressive economic growth. The share of industry in the composition of China’s GDP is unusual and growing: it was around 40 per cent in 1990 and reached 48 per cent in 2009. In contrast, in 2008, 56.1 per cent of the Chinese labour force still remained in rural areas. The relative share of the agricultural sector, which accounted for 30.2 per cent in 1980, is constantly falling, to 11 per cent of GDP in 2009. The share of services grew from 21.6 per cent in 1980 to 41 per cent in 2009.

Table 1: BRICS: Average Rates of Growth of Real GDP, 1980–2015 (percentage)

Source: UNCTAD (2010) for the period 1980–2008 and IMF (2011) for 2009–2015 data. See http://unctadstat.unctad.org/ReportFolders/reportFolders.aspx (accessed 15 March 2011).

Note: *Estimate.

Really impressive is the mounting share of China’s manufacturing sector in world manufacturing GDP (Figure 2). In 1990, it represented 3.1 per cent of global manufacturing GDP, achieving 21.2 per cent in 2009.

Figure 2: Manufacturing Sector: BRICS’ Share in World GDP, 1970–2009

Source: UNCTAD (2009). See http://unctadstat.unctad.org/ReportFolders/reportFolders.aspx (accessed 15 March 2011).

China has diversified its industrial system to a significant degree during the last 25 years and the share of technologically intensive sectors in industrial output in 2009 reached 42 per cent of the total value added by the manufacturing sector. In the other four countries this share is around 15 per cent.⁵ In addition, some major differences in the characteristics of the BRICS countries’ manufacturing sectors should be noticed.

Brazil has gone through a structural transformation since the late 1980s, with a significant reduction of the share of industry in total GDP (declining from 41.7 per cent in 1980 to 25.4 per cent in 2009) and a high growth of services (from 50 per cent to 68.5 per cent in the same period). It is worth emphasising that agricultural goods that have had an important role in the country’s trade surplus were responsible for only 6.1 per cent of GDP in 2009, showing a fall from 9.0 per cent in 1980. In Brazil, as in Russia and South Africa, the products based on natural resources and commodities have a relatively greater share of national GDP than in China and India.

Russia’s economic development is heavily dependent on energy and raw material resources. As in Brazil, the contribution of manufacturing sector to GDP in Russia has declined since the 1980s, decreasing from 44.6 per cent in 1983 to 32.9 per cent in 2009. The share of defence-related industrial complex in manufacturing is significant, together with the strong production base in non-electric machines and equipment. The oil and gas industry alone accounts for more than 10 per cent of the gross value added. The share of services in total GDP has grown in the last two decades achieving 62.4 per cent in 2009 while agriculture has decreased its participation accounting for only 4.7 per cent in 2009.

The Indian economy is essentially service-led. Skills in the manufacturing sector are relatively modest and concentrated in non-durable consumer goods and in the chemical-pharmaceutical complex. However, some manufacturing segments in the automobile complex and in certain basic industries have been developing rapidly in recent years. Since the mid-1980s, the contribution of industry to India’s GDP has been almost constant and around 26 per cent, but from 2004 to 2009 it increased to 28.3 per cent. India’s capacity in the area of services is significant, particularly those linked to information and communication technology (ICT). The share of services in GDP has grown from 39 per cent in 1980 to 54.6 per cent in 2009. Although the agricultural sector is declining in India’s GDP, it still represented 17.1 per cent in 2009 (compared to 36.8 per cent in 1980) and constitutes an important determinant of the overall economic growth.

The services sector has also been playing a more important role in the South African economy. The share of this sector in GDP was 45.4 per cent in 1980 and increased to 65.8 per cent in 2009. The development of the financial sector and the growth of tourism have contributed to this growth. Finance, real estate and business services are expanding their share with regard to government services. South Africa’s industrial sector is heavily based on natural resources, mainly steel and non-ferrous metals, with some increases in capacity occurring in non-durable consumer goods and the automobile sector. The share of industry-added value in total GDP value decreased from 48.4 per cent in 1980 to 31.4 per cent in 2009. The metal and engineering sectors dominate the manufacturing sector. Although agriculture is responsible for a small share of South Africa’s GDP (3 per cent in 2009), it still represents an important source of employment. The minerals and mining sector remains important also with respect to both employment and foreign trade.

The changes observed in the participation of BRICS countries in international trade were even more significant (Table 2). Their share in merchandise trade value more than doubled in the short period of 2000–10, exports rising from 7.5 to 16.4 per cent and imports from 6.2 to 14.9 per cent. However, the contribution of the five countries varied significantly. The most notable fact is the well-known growth of China in the merchandise trade value: its exports mounted from 3.9 per cent to 10.4 per cent of world exports reaching US$ 1.58 trillion in 2010, and imports increased from 3.4 per cent to 9.1 per cent in the same period.

Table 2: BRICS: Merchandise Trade Value (in billion of current US$) and Share in World Total, 2000–10 (percentage)

Source: UNCTAD (2010).

India also experienced a sharp increase of exports, reaching 1.46 per cent of the world total in 2010. Fostered by Chinese growth and commodities boom, the share of Brazil and Russia in world exports grew rapidly from 2000 to 2010, increasing almost four times. South Africa is the only BRICS country that still shows less than 1 per cent of world exports. On the import side, India and Russia increased their share in world imports more than fivefold. Except India and South Africa, the other BRICS countries managed to keep a surplus in their merchandise trade in 2010. In India inflows on account of invisibles have been helpful in financing the growing deficit in merchandise trade.

The BRICS economies have significantly increased their openness to international trade in the last decades. They have raised their exports and imports both in volume terms as a share of GDP, but the level of trade openness has varied quite a lot (Table 3). The greater changes occurred in China and India, particularly since the 1990s when they speeded up their international trade flows. Currently, China, South Africa and Russia are the BRICS economies with the higher levels of openness. The Brazilian economy, despite the liberalisation process in the 1990s, remains the most closed amongst the BRICS countries.

Table 3: BRICS: Foreign Trade and Share of GDP

Source: United Nations (2010b); World Bank (2011).

The bilateral trade flows between BRICS countries have been relatively restricted. However, since the first half of the 2000s there was a widespread increase of exports and imports flows between the five economies, but particularly a stronger presence of China as an important trade pole for the other four countries (Baumann 2009). In 2009, China surpassed the United States (US) as the main trade partner of Brazil and also emerged as the second main trade partner of India and Russia. The converse does not however hold, as these four economies don’t match their respective rankings insofar as they are neither the top import suppliers nor export destinations for China. China exports to Brazil, India, Russia, and South Africa at a more intense pace than it imports from them. In addition, the latter are concentrated on a few primary goods intensive in natural resources while China’s exports are much more diversified and led by manufactured goods. Therefore, despite the fact that intra-BRICS trade has increased in recent years, the flows are still restricted in size and unbalanced in terms of the different rhythms and compositions of the BRICS bilateral commercial transactions.

In the last decades, the BRICS countries have been the recipients of significant amounts of foreign direct investment (FDI). Brazil received the greatest share of FDI of all BRICS economies until the first half of the 1980s. Although China has surpassed Brazil since 1985, Brazil continued to be a major destination for FDI during the 1990s, most notably during the process of privatisation that took place during that decade. Since the 2000s Russia and India have been strengthening their relevance as FDI inflow destinations (Table 4). In 2010, the BRICS countries received 17.6 per cent of global FDI inflows. Especially since 2005, there was a sharp increase of BRICS’ FDI outflows. With the exception of South Africa, BRICS countries more than tripled their FDI outflows from 2005 to 2010, raising their participation in the world total from 3.6 per cent to 11.1 per cent in the period.

BRICS countries also followed different development strategies regarding FDI. Particularly remarkable has been the Chinese policy to attract multinational companies since the beginning of the 1990s. Inserted in a broader strategy aiming to expand its technological knowledge and later to strengthen the domestic industries and enterprises, China imposed conditions — such as the establishment of joint ventures and that R&D be carried out locally — that had to be met before the subsidiaries were to operate in China or sell in its markets. Brazil, Russia and South Africa — countries that liberalised their economies with few restrictions — got more portfolio investment, but most of the investment received by the manufacturing sector was used to buy up local companies. In China and India, where the capital account was not liberalised, FDI seems to have been concentrated in new investments in production and innovation.

Table 4: BRICS: Foreign Direct Investment, Inflows and Outflows Share in the World Totals

Source: UNCTAD (2010).

Other relevant macroeconomic indicators could be added — such as the impressive share of BRICS in international monetary reserves (about 40 per cent of the total) — but the interest in these five emerging economies goes beyond this area. Together with their expanding economic relevance, these countries are claiming a rising geopolitical influence. They have been important players in their geographic areas of influence. However, they are pushing to have an increasing voice in the international high-level decision-making institutions, particularly through reforms in the UN system and in the Bretton Woods organisations. New dialogue spaces bringing together BRICS countries, such as the IBSA (India, Brazil and South Africa), BRICS and BASIC (Brazil, South Africa, India, and China) signal concrete steps to move forward the cooperation and coordination within and amongst these countries, which intends to go further than the mere economic sphere.⁶

Their growing leverage in international relations together with other emerging countries is associated with a repositioning of the balance of power on the world stage, which was intensified by the recent world crisis. BRICS countries want to see these changes reflected in the institutions of global governance. Since their economies will probably continue to account for a sizeable portion of the increase in global GDP in the near future, it is expected over time that BRICS will exert increasing financial and political influence, even if limited by their considerable differences and constraints to form a coherent political bloc anytime soon.⁷

The increased influence of these countries took place during a period marked by intense transformations in the global society. One of these remarkable changes is the integration in the economy of a significant portion of previously marginalised segments of the BRICS population. The highly populated China and India led this process in terms of world shares, but Brazil also had an important participation (Soares and Podcameni 2014). The present and potential dimension of BRICS domestic markets as well as the policies adopted by some BRICS countries aiming to reduce their dependence on developed countries’ consumer markets has been drawing increasing attention in the last years. According to one estimate, two billion people from BRICS will join the global ‘middle class’ by 2030 (Wilson and Dragusanu 2008) representing a huge impact on the demand profile with expected reflexes on global investments as well as on innovation.

Simultaneously, several hurdles remain for the BRICS to overcome. One of them is the growing social gap caused by the unequal distribution of recent economic growth. While the percentage of the population below the poverty line has decreased over the past 30 years in most of the BRICS countries, inequality is still a major issue for these economies. In fact, the BRICS countries, except Brazil, show a trend of increasing income inequality that — particularly since the 1990s — has been following the rapid economic growth. Moreover, despite the improvements in recent years, Brazil is still among the countries with the worst distribution of income, together with South Africa that found itself in an even worse situation.⁸ In addition, India and Russia are among those with the largest percentage of the population living below the poverty line.⁹ Furthermore, beyond the income dimension, inequality has a multi-dimensional character in the BRICS countries. This challenge is exacerbated by race, gender, ethnic, and geographic dimensions and therefore demands more integrated solutions (Scerri et al. 2014).

One of the problems associated with the high poverty levels and the perverse distribution of income is the limited access to quality public services — education, health, housing and infrastructure, safety and security, etc. These problems are common to the five countries, where a significant portion of the population lacks access to essential goods and services, and demand urgent redress. This situation is reflected in poor human development indices in the BRICS countries. Other undeniable challenges faced by BRICS are unemployment, poor quality employment and increasing informality.

Another evident challenge in all five countries is the huge regional disparity in human and economic development. There is also a large gap between the rural and urban population. In general, the wealthier regions are those that are more industrialised. Practically 60 per cent of the total GDP of Brazil originates in the states of the southeast. The Chinese economic development model favours the coastal provinces, while other provinces in the interior are much less developed. In South Africa, economic activity is concentrated in Gauteng province and in the western part of Cape Town. The industrial development of Russia occurred principally around cities such as Moscow, St Petersburg, Nizhny Novgorod, and Ekaterinburg. India also shows significant inequalities between the rich regions to the south and the northern regions of the country as well as between the rural and urban populations. Therefore, regional redistribution of income and access to essential goods and services is another significant challenge that these five countries have in common (Scerri et al. 2014).

The negative environmental impact of recent growth is another huge challenge to be faced by BRICS countries. According to Carbon Dioxide Information Analysis Center–United Nations (CDIAC–UN) data for 2008, the BRICS countries are responsible for emitting 35.3 per cent of the world’s total CO₂.¹⁰ China is ranked as the world’s largest emitter, accounting for 21.9 per cent followed by the United States (17.7 per cent), India (5.4 per cent) and Russia (5.3 per cent). South Africa and Brazil are responsible for 1.4 per cent and 1.2 per cent of global emissions respectively, and occupy the 13th and 17th positions internationally. If we take the example of China, we observe that fossil-fuel CO₂ emissions in the country have more than doubled in the 2000 decade alone. Energy efficiency is a big problem in China and energy consumption per product is about 40 per cent higher than in the developed world. Other environmental problems are also critical. For instance, 40 per cent of river and 75 per cent of lake water is polluted leaving 360 million rural people without clean water. As in China, the environmental impacts in other BRICS countries are also mounting.

Other than extending the existing problems in BRICS countries, one general and common issue should be emphasised. This relates to the sustainability of its current growth trajectory. This is true in terms of growing inequality, increasing environmental impacts, as well as regional and other imbalances. However, there are some recent changes that may open better future prospects.

All the BRICS countries have an important role to play in shaping the future of the world economy, but China will probably have a more prominent role in this respect. The Chinese system of innovation has been undergoing some changes in order to address two new proclaimed goals: the building of a ‘harmonious growth’ and the development of ‘indigenous innovations’ (AeA 2007). The harmonious growth aims at reducing the growing social and environmental imbalances. China’s emerging ‘high-growth with low-carbon’ strategy has been emphasised by recent policy decisions, together with measures directed to reduce rural–urban social gaps. The indigenous innovation goal refers to the efforts to make China less reliant on foreign technology through the building of a new kind of relationship between national and foreign players in the process of developing and using new technologies.¹¹ China is pursuing these goals especially by linking innovation to domestic needs and by giving increased priority to domestic consumption.¹²

For Brazil, India, Russia, and South Africa, Chinese success may lead to strategies towards strengthening domestic technological capabilities and fostering clean technologies. Nevertheless, the differentiated role of the BRICS countries in the configuration of global power and the global economy will in some way constrain the evolution of BRICS national systems for innovation. In addition, their NSIs are highly dependent on their historical development and on how the different domestic actors interpret global developments as well as how they position themselves in the national and international economies. Yet, more flexibility for setting up new industrial and technological policies may be expected.

Introduction to Books 1–5

This book series attempts to cover five themes that are crucial to an understanding of the National System of Innovation of BRICS. The first book The Role of the State, edited by Mario Scerri (South Africa) and Helena M. M. Lastres (Brazil) aims at exploring the relationship between the state and the national systems of innovation in BRICS countries. An evolutionary approach has been adopted in order to capture the nature of the state in the respective countries and thus understand the historical and ideological basis for its role in the evolution of the NSI in the five countries. As a background, it is argued that debates on the role of the state in the development process, especially since the 1980s, have often focused on the apparent dichotomy between market-driven and state-driven development. This is a rather wasteful diversion, since it should be accepted as a starting premise that the state is essential to the structural transformation that is required for development.

The second book addresses an aspect of the NSI that is normally absent from the discussion: the relation between innovation and inequality. The objectives of the book Inequality and Development Challenges, edited by Maria Clara Couto Soares (Brazil), Mario Scerri and Rasigan Maharajh (South Africa) are to trace the trends in interpersonal and inter-regional inequality within BRICS in an evolutionary perspective and to analyse the co-evolution of inequality and the innovation system to highlight how the various elements of innovation and the production system and inequality mutually reinforce.

The book is driven to improving our understanding of this issue. The inequality concept is considered in its multi-dimensional character, embracing a phenomenon that goes beyond the mere income dimension and is manifested through forms increasingly complex, including, among others, assets, access to basic services, infrastructure, knowledge, as well as race, gender, ethnic, and geographic dimensions. The book adopts the broad approach of the national system of innovation to analyse the relations between BRICS innovation systems and inequality, departing from a co-evolutionary view.

As shown in the book chapters, innovation can affect inequalities in different ways and through distinct trails that are influenced by national conditions, and shaped by public policy interventions. Although innovation does not constitute the main factor of influence on inequality, it is suggested that distinct strategies for technological change may lead to different outcomes in distributive terms, thus either aggravating or mitigating inequality. Based on this understanding, the book corroborates the hypothesis that inequalities need to be explicitly taken into account in development strategies since the benefits of science, technology and innovation are not automatically distributed equally. Therefore, advancing the comprehension of inter-relations between innovation and inequality may be helpful to find ways to shape the national innovation systems so that they reduce rather than increase inequalities.

The third book aims at analysing the contribution of small and medium enterprises (SMEs) in the national system of innovation. The objective of the book The Promise of Small and Medium Enterprises, edited by Ana Arroio (Brazil) and Mario Scerri (South Africa) is to explore three main research goals. In the first place, to provide an overview of the main characteristics of micro, small and medium firms in the Brazilian, Russian, Indian, Chinese, and South African national systems of innovation as a basis to examine the contribution of SMEs to the economy of each country. A second goal is to bring to the forefront crucial issues in the discussion of industrial and technological policies for small firms, including the recent evolution and future trends of policies and instruments, their applicability and coordination, as well as a discussion of the macroeconomic, legal and regulatory environment. A final research objective is to draw out initiatives to promote innovation in SMEs that address common bottlenecks in BRICS countries and that can contribute to policy design and implementation by these and other countries.

The fourth book discusses the relationship between transnational corporations (TNCs) and the national system of innovation of BRICS countries. In the book Transnational Corporations and Local Innovation, edited by José E. Cassiolato (Brazil), Graziela Zucoloto (Brazil), Dinesh Abrol (India), and Liu Xielin (China), the thesis of technological globalisation is taken with some caution, refuting the idea that R&D activities would be inexorably internationalised. In fact, technological innovative activities in TNCs have been transformed, in relation with the financialisation of TNCs, as evidenced by the rise of their intangible assets (which includes R&D, patents, and trademarks) and a reorientation of R&D expenditures towards non-scientific activities and very downstream development.

The book chapters present a detailed presentation of the relation of the position and evolution of TNC in the country. Subsequently, there is a discussion on the local factors affecting innovation by TNCs and local firms in the country. Government policy towards TNCs has been important but as the Chinese experience shows, access to local buoyant markets has also been vital. Other issues discussed refer to how the government protects local companies from the competition of TNCs. Spillovers of TNCs to local BRICS enterprises have also been analysed and the immediate conclusion is that there is hardly any convincing evidence regarding either the existence or non-existence of spillovers. An in-depth analysis of outward FDI has also been conducted.

Finally, the fifth book deals with finance and funding in the national system of innovation. The objective was to analyse institutional character and support instruments for the innovation financing process in BRICS, focusing on institutional structure and innovation policy. This book, Financing Innovation, edited by Michael Kahn (South Africa), Luiz Martins de Melo and Marcelo G. Pessoa de Matos (Brazil), contributes to understanding the varied approaches to the financing of innovation. It draws on the experience of five diverse countries each of which has undergone dramatic structural adjustment in the last two to three decades. The experience of the BRICS countries presents a unique set of case studies of the transition from largely closed centrally planned and state-driven economic and science policy to a more open and market-led situation. The contributing authors examine the varying approaches to the provision of support to the full range of activities that contribute to innovation ranging from scholarship support to doctoral students, to R&D tax incentives and the provision of seed capital.

The significance of financing investments in innovation has been pointed out as an important structural bottleneck that is yet to be solved by the private financial institutions. If, on the one hand, the internationalisation, deregulation and globalisation of financial markets signals the possibility of resources at lower costs, on the other, the characteristics of investments in innovation such as the length of time needed for development, the uncertainty and the risk, point to the need of setting national institutional arrangements.

Notes

1. Available at http://www.globelics.org (accessed 3 December 2011).

2. Available at http://www.redesist.ie.ufrj.br (accessed 3 December 2011).

3. This is also true in Latin American countries, where it is being applied and understood in close connection with the basic conceptual ideas of the structuralism approach developed in the region since the 1950s under the influence of the Economic Commission for Latin America and the Caribbean (ECLAC). In fact, since the mid-1990s, the work of RedeSist — the Research Network on Local Productive and Innovative Systems — based at the Economics Institute of Rio de Janeiro, Brazil, has been using such a dual frame of reference.

4. See, for instance, Mytelka and Farinelli (2003); Freeman (2003); Chesnais and Sauviat (2003).

5. The following data on BRICS countries’ value added by sector (per cent of GDP), 1980–2009 is based on the UNCTAD Handbook of Statistics (2010).

6. The IBSA Dialogue Forum was established in June 2003 in Brasilia, Brazil.

BRIC was formally constituted in June 2009 at a summit of the four countries in Yekaterinburg, Russia. In 2011, South Africa joined the group, which changed its denomination to BRICS.

BASIC of the G4 was formed during the international climate change negotiations in December 2009 in Copenhagen, Denmark.

7. There are several economic and geopolitical factors that restrict a greater convergence of interests among BRICS countries in multilateral negotiations. The analysis of these constraints goes beyond the limited scope of this concept note, but we could cite the aforementioned relatively low degree of trade complementarities between BRICS as an important one.

8. In 2008, Gini indexes were respectively 0.54 and 0.67 according to Brazilian and South African national institutes of statistics.

9. According to World Bank statistics, the population below poverty line was 28.6 per cent in India and 30.9 per cent in Russia in the mid-2000s.

10. It is important to mention that CDIAC-UN data considers only global carbon dioxide emissions from the burning of fossil fuel, but not emissions from deforestation or other greenhouse gases, including methane.

11. The US Information Technology Office in Beijing refers to indigenous innovation as a term combining three distinct elements: yuanshi (original, or genuinely new); jicheng (integrated, or combining existing technologies in new ways); and yinjin (assimilated, or making improvements to imported technologies). See http://www.usito.org/ (accessed 8 January 2013).

12. In November 2008, China launched a US$ 584 billion anti-cyclical package. According to the HSBC report on climate change (Robins 2009) almost 40 per cent of the total package resources were allocated to ‘green’ themes. Among others, it combined the search for a lower carbon pattern with the offering of better transport conditions for lower income people placed in rural areas, fostering a niche for the development of innovations capable of attending to the specificities of this domestic market segment.

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1

The Financing of Innovation

Michael Kahn, Luiz Martins de Melo and Marcelo G. Pessoa de Matos

In general, studies based on a narrow perspective of National Systems of Innovation (NSIs) focus on the processes of interactive learning and knowledge generation within enterprises, higher education institutions, and government research institutions, as well as on the interactions amongst them that contribute to the innovation process. The issues raised are typically related to explicit science and technology (S&T) policy. In contrast, a broad approach to NSI (Freeman 1987; Lundvall 1985) incorporates a wider set of institutions. As outlined in the introduction to this publication, besides the ample context conditions, this includes also the subsystem of demand and the subsystem of policy, promotion, financing, representation and regulation.

This last subsystem is of particular relevance for this book. The role played by the state in the formulation and implementation of policies for fostering innovation, including macroeconomic policy, is highly contextual, contested and centrally important. The financial dimension plays a key role, setting incentives and constraints to innovation efforts.

In its early formulation the neo-Schumpeterian approach that informs much of the conceptual development of the NSI approach gave little emphasis to the financial perspective. Freeman (1994) in particular analysed neo-Schumpeterian research, claiming that this topic had not taken a central position. As highlighted by Levine and Zervos (1998), this is a significant gap in theory, the more so as Schumpeter, writing in the 1930s, had in fact emphasised the relevance of the banking system in economic development, underscoring the circumstances in which banks could actively encourage investments in innovation. Recent literature provides some progress in linking the financing of innovation with the financial system and in bringing in an institutional perspective of the NSI.¹ But there is still a long way ahead.

The financing of innovation has been identified as an important structural bottleneck that has yet to be solved. Coping with this challenge involves considering both the role of the state and public organisations and the role of private financial institutions. The importance of setting up national institutional arrangements is twofold. First, even if the internationalisation, deregulation and globalisation of financial markets signal the possibility of obtaining resources at lower costs, the characteristics of investments in innovation — long lead times for development, inherent uncertainty and high risk — limit the disposability of these kinds of resources (Melo 1994). The inherent characteristics of the innovation process lead banks and even markets to resist the financing of early stage innovation. This is particularly so in countries that have only recently introduced market capitalism, and where the capacity to evaluate intangible assets may not be yet well developed. And further appropriability matters may help to lower expected returns due to the difficulty of capturing profits from intangibles (Nelson 1959).

Second, considering a deliberate or implicit development strategy of a country, specific institutional set-ups may influence the areas to which resources are oriented, thus inducing or favouring specific trajectories. As stressed by Dosi (1990: 301) ‘allocative criteria and rates of allocation should plausibly affect the amount of resources which the industry devotes to the innovative search, and also the directions in which the agents search’. Thus, at least as relevant as standard market failure arguments for public support to innovation, there is a strategic dimension that connects STI policy and the financial system to a development perspective.

In analysing the relationship between the financial system and investments in innovation, it is necessary to take into account the nature of the innovation process, the competition within markets and the criteria for risk and credit analysis by financial institutions for conceding the financing. Companies may use different sources for financing their investment programmes, namely: reinvestment of retained earnings; issuance of shares; issuance of securities; and bank loans. The use of each of these sources and their relative weight in the enterprise capital structure will depend on the historical and institutional development of the relationship between the financial system and the industrial system. This process is very specific to each country and its NSI. This highlights the need to go beyond benchmarks and to understand this issue within the context of each country.

This book therefore sets out to address the gap in neo-Schumpeterian analysis by offering a contribution to understanding the varied approaches to the role of finance in innovation. It draws on the experience of the five diverse BRICS countries each of which has undergone structural adjustment in the last two to three decades. The experience of the BRICS countries presents a unique set of case studies of the transition from largely closed centrally planned and state-driven economic and science policy to a more open and market-led innovation policy. Of key importance among these case studies is the role of the state.

The contributing authors examine the varying approaches to the provision of financial support to the full array of activities that contribute to innovation, ranging from idea generation and basic research to market development and ‘human resources’. First, it is interesting to understand the varying importance of different types of instruments in each country, such as the financing of infrastructure, R&D tax incentives, grants, provision of seed capital and scholarship support to doctoral students. Second, the cases show how this relates to the diverse dimensions highlighted in the innovation system framework.

The individual country chapters are written within a broadly common framework starting with a synthesis of the problem of enterprise funding and the interface with the specific country financing systems. Next follows the discussion of the specificities of the innovation process and its financing. Consideration is then given to instruments and institutions for fomenting and financing innovation as well as the evidence from R&D and innovation surveys where such are available. The authors also discuss the impact of macroeconomic policies as well as implicit policies on financing for investments in innovation over the last two to three decades. The concluding sections summarise the role of the financial system in each innovation system with policy suggestions regarding the major future challenges.

In the chapter on Brazil, Melo and Rapini start by providing a detailed examination of the emergence of that country’s financial system. Over the last decades the evolution of the banking system was marked by a significant increase in the participation of foreign banks but with the prevailing dominance of national private banks and a relevant participation of public banks in specific areas. The Brazilian capital market experienced a timid development until the 1990s. It was after economic liberalisation and the stabilisation of inflation that the demand for stock shares increased. The changes in the legal framework favoured the entry of foreign capital. However, the growth of the capital market was concentrated in the secondary market. The limited rise in the market value and in the liquidity of the shares of private enterprises, discouraged both the demand of investors and new issues by the enterprises.

The banking credit is quite limited in the country and it is mostly addressed to short-term funding. It increased along the last decades, reaching the level of 40 per cent of GDP in 2008, but it is still considerably low by international standards. The extremely severe monetary policy implemented after the Real Plan, in 1994, also contributed to its scarcity and volatility. A high inflation regime was replaced by a regime of high interest rates and high compulsory deposits.

This brings us to the role of macroeconomic policy as an implicit STI policy. The cost of public debt provides the minimum base for the level of remuneration of private bonds. In the period from 1994 to 2007 Brazil presented the world’s highest real interest rate, thus impeding the development of a more robust private bonds market. In addition, public debt is concentrated in short-term bonds that are daily indexed to the interest rate of monetary and interbank markets. This leads the state to offer, simultaneously, liquidity, profitability and safety. Thus, issuers of private bonds have to raise profitability to compensate for liquidity and risk.

This contributes to the financing of innovative activities to be heavily based on the enterprises’ retained earnings. The participation of the financial system is almost non-existent. However, on the perspective of the firm’s investment strategy, the alternative of investing resources in the financial market with high levels of return and low risk constitutes a disincentive for investments in uncertain innovative activities.

Melo and Rapini conclude that the relation between the financial system and the industrial system did not evolve in the same way it historically happened in developed countries. Thus, within a deliberate development strategy efforts were mobilised for structuring financial mechanisms for financing investment in intangible assets.

From the 1960s Brazil built a sophisticated innovation financing system. Initially, the Brazilian Development Bank (BNDES) undertook this mission. Later, the National Fund for Scientific and Technological Development (FNDCT) was created and the Studies and Projects Finance Organisation (FINEP) was assigned with its executive-secretariat. In 1997 the creation of the sectoral funds represented not only a change in funding sources for FNDCT, but also a change in the priorities for the allocation of resources. FINEP lost almost its whole autonomy in the definition of the strategy for application of FNDCT resources through sectoral funds. Currently, each sectoral fund has a managing committee and there is a general managing committee of FNDCT, in which FINEP is minor. This leads to a poor coordination and integration of activities and hinders the pursuing of strategic goals.

The authors show that the country now counts on a complex array of instruments for financing different innovative activities. These comprise fiscal incentives, long-term credit for R&D and innovation and non-reimbursable sources, such as the economic subvention. Although limited in amplitude, venture capital (VC) initiatives have existed since the 1980s, supported by the Brazilian Innovation Agency (FINEP) and BNDES (Melo 1988 and 1994). The question then turns to the impact of these initiatives on the innovation performance of Brazilian firms. Based on data from the Brazilian innovation survey, the authors show that firms invest little in R&D and present a relatively weak innovation performance, since only one-third of firms innovate and only a fraction of these introduced innovations that are new to the market. But, at the same time, the survey suggests some improvement in the access to resources. A steadily decreasing share of firms identifies the availability and cost of resources as obstacles for innovation.

In sum, Brazil built an extremely sophisticated financial system, able to do financial operations of high complexity. But, such technical capability derived from the need for agility for investing cash balances of enterprises under a regime of high inflation; and later for taking advantage of the regime of high interest rates. These capabilities helped little for improving the articulation of the financial system with the NSI. The main problem is the lack of long-term financing, which is offered only by public financial institutions. The big effort for amplifying and diversifying those resources tends to facilitate the access and lower costs. But, there is a poor coordination of activities among these public institutions, which impedes the integration of instruments and a strategic orientation of innovation policy. The more so as preferential procurement by the state is limited by law. Therefore, Melo and Rapini highlight the need for a systemic policy for industrial innovation that connects the state’s purchasing power, matches demand with supply, and the necessary financial instruments. In this way it may be possible to reduce the negative impacts of implicit policies and, concomitantly, reduce uncertainty and the costs of investments in innovation.

Gorodnikova’s chapter takes us to the evolving innovation system of Russia. It focuses on the transition from central planning to the market economy, tracing the period from that of Glasnost (1985–91) through to the present. The Glasnost period saw rapid increases in Gross Expenditures on R&D (GERD), but as a consequence of the economic shock therapy of the early 1990s there was a severe contraction of state-financed R&D.

Indeed the Soviet and post-Soviet economy was largely determined by the military-industrial complex’s potential and by mining, metallurgy and heavy engineering industries. Accordingly, the industrial sector had always prevailed in the R&D sphere (later on to be replaced by the enterprise sector) — i.e., industrial research institutes and bureaus oriented towards the demand of specific industries. Under central planning the government allocated budget to R&D while Business Expenditures on R&D (BERD) was negligible. These deep institutional patterns persist into the present so that weak innovative orientation continues because of a mismatch between the focus of R&D, institutional structures and organisational mechanisms of the science sector on the one hand, and the needs of the economy on the other. Additional shortcomings include the separation of applied science from enterprises, since research institutes and design bureaus were oriented towards encouraging research, not innovation. The imbalance added to the low technological level of industry. Another weakness of the planned economy (and of the transitional economic mechanism) is the dissemination of innovations. Even when the country was a leader in developing major innovations, it lagged behind in terms of implementation, as for example, in the steel-making and process technologies.

Gorodnikova identifies serious hurdles for Russian innovation since the innovation system remains unbalanced and its major components operate in isolation from one other. Currently the S&T sector is not a growth factor for the national economy; rather, the whole economy of post-Soviet Russia is a factor of decline for the S&T sector. In the long run it can lead to irreversible degradation both of R&D capacity and high-technology industries; accordingly, fast modernisation of the national innovation system is a top priority. This will be no small task since, among the BRICS, Russia is unique in the collapse of GERD across the transition; in constant terms GERD has now attained half the pre-1991 level. Another unique feature of the Russian system is the small amount of research in the university sector, though this is explained by the unique character of the Academy sector that includes degree-awarding institutions.

As to innovation in the business sector, the evidence of innovation surveys going back to the early 1990s is that less than 10 per cent of Russian firms declare themselves to be engaged in technological innovation. These observations must be qualified in that there are size effects: large Russian firms innovate slightly below the European Union (EU) average. But medium-sized and small firms hardly innovate at all. This constitutes one of the main observations of the chapter: ‘due to the generally weak small business support infrastructure, these companies cannot yet contribute to an overall increase of innovation activity.’ There is an insufficient level of small business development in the Russian economy. Malaise persists so much so that the overall efficiency of Russian industrial companies’ innovation activities is low with the return on investment dropping from 5.5 to 4.4 roubles per rouble spent on technological innovations. At 1.2 per cent of sales the innovation expenditure may be insufficient to exert the leverage required to boost productivity of capital.

The federal budget remains the main funding source for Russian R&D, with one component linked to payroll size and the second being programme specific — the Federal Goal-oriented Programmes (FGP) of which there are 52 at present. Nonetheless, severe budget constraints persist with many FGP budgets not allocated in full.

But as the author explains, more diverse sources of funds are now available ranging from private foundations, and Non-governmental Organisations (NGOs) across to public–private partnerships. In particular there are the ‘mega’ projects announced in May 2002. Twelve mega projects were selected; each to receive US$ 20 million for two years — the intention was to peg state involvement at no more than 50 per cent but in practice this limit was often exceeded. In 2006 responsibility for the mega projects was split between two ministries: Education and Science, and Industry and Power Generation. In spite of this potential for management confusion the project experience was found to be more positive than negative.

This much is clear: Foreign Direct Investment (FDI) remains a small component of innovation financing, and bank credit is hard to come by in the difficult financial environment of today’s Russia. This is why the Russian Venture Company is so important. When it became clear that the high-technology sector was unable to attract private capital, state intervention became inevitable. Consistent with the ongoing active role of the state in the emergent market economy is Gorodnikova’s suggestion for policy: ‘to radically change the underlying ideology of government and public sector procurement (that) must be seen not just as means to deal with specific issues but as an important tool of industrial and innovation policy.’

Turning next to the case of India, we find Sunil Mani’s econo-metric study of the impact of R&D tax incentives in that country. While noting the importance of research grants and VC, it is the operations of the tax incentive that intrigue Mani. Having traced the introduction of various market type reforms he notes that most academic studies of these have been descriptive catalogues that fall short of studying effectiveness. This to Mani is problematic given the recent estimates by the Ministry of Finance that the amount of corporate tax foregone as a result of R&D tax incentives has been increasing at a rate of 2.4 per cent per annum.

A range of input- and output-based tax incentives are available for domestic R&D, be this intramural or extramural. There are eight forms of input support, the most common being the 150 per cent deduction on intra-mural R&D expenditure that has operated since 1998. The other input deductions include capital expenditure write downs, reduced tariffs and duties. Mani notes that the existing literature (Hall and Van Reenen 2000; Mohnen 2007) on the effectiveness of R&D tax incentives is restricted to the core Organisation for Economic Cooperation and Development (OECD) countries, a situation that in part arises because of a lack of data for emerging economies, as well as the sheer difficulty of accessing such data where it exists.

In the case of India it turns out that the pharmaceutical industry, being the most R&D intensive, is the major beneficiary of the incentive, which in itself is not surprising. This incentive has the effect of lowering the industry tax rate to around 14 per cent compared with automotive (medium technology) at 26 per cent. Even so, his general finding is that the tax incentive does not have any influence on the level of R&D, except possibly in chemicals. This result follows from the fact that the incentives do not apply to the full R&D expenditure of firms but are selective. As he notes:

[F]or tax incentive to be effective in raising R&D expenditures it must form a significant portion of R&D investments by an enterprise . . . this result corroborates the results of innovation surveys in Brazil and South Africa where innovating firms did not access fiscal incentives for innovation as an important instrument for financing their respective innovation efforts.

He argues that markets, the volume of domestic sale, and in some cases exports are the factors leading to investment in R&D.

Mani’s conclusion may come as a surprise to advocates of input-style R&D tax incentives: ‘Allowing firms to become larger and through that process of growth enabling them to become larger investors in R&D may be a better policy than providing them directly with subsidies.’

The next chapter takes us to the Peoples’ Republic of China that from the 1950s followed the central planning model of the Soviet Union in shaping its innovation system. At that time the state-owned enterprises (SOEs) were expected to use R&D conducted in the public research institutes (PRIs). The abrupt emergence of state capitalism in 1978 saw the privatisation of many PRIs, and the opening up of the country to FDI through the establishment of plants and research centres. Jian Gao and Xielin Liu trace these developments pointing out the fundamental shifts in law pertaining to innovation policy initiated under the leadership of Deng Xiaopin (the ‘South Talk’ of 1992). In 1993, the ‘Technology Progress Law’ targeted S&T development as one of most important elements of China’s economic development. The 1996 Technology Transfer Law encouraged the science sector to transfer its technology, by setting rules for technology market transactions. Further change came in 1998 with the ‘State Development through Promoting Science Technology and Education’ policy and in 1999 with intellectual property rights (IPR) legislation. Outputs of scientific and innovative activity have soared with China now ranked fifth for ISI publications and effecting more than 250,000 invention patent filings annually.

The central thrust is the role of innovation in promoting economic growth and the strong political support that this notion has enjoyed since the 1980s, when modern institutions such as technology parks and incubators were introduced. The authors suggest that the NSI comprises four subsystems: the knowledge innovation system (research institutes and research-oriented universities), technology innovation system (companies), knowledge distribution system (higher education and professional training) and knowledge application system (interaction between research institutes and companies). While the first three refer to the role of different organisations, the fourth ‘system’ highlights the pivotal challenge for shifting from a centrally planned to a more market-oriented innovation system.

In addition, the characteristics of the NSI show strong regional dimensions — the further west one moves, the stronger the role of PRIs and universities. Foreign R&D centres account for anything up to 30 per cent of China’s BERD, and these tend to be located in the east. Reference is also made to China’s innovation survey that shows the strong role played by machinery, equipment and software imports as drivers of innovation. This points to a strong external influence on innovation activity and can also be interpreted as part of the learning process based on the incorporation and improvement upon foreign technology.

Regarding the financing of innovation, the first resource was government support in terms of technology programmes and innovation funds. The second and main source is bank loan finance. Although representing only 10 per cent of that investment in 1988, their share increased to 70 per cent by 1991 (Gu 1999). The authors show that despite the fact that banks did not have the capability or access to critical information to assess risk at this initial stage, they relied on a project’s designation as a recipient of the Torch Programme support for policy guidance. The third type of financing source was introduced in 1985 and is based on VC and capital markets. Of vital importance to the growth of new institutional forms was the establishment of Technology Zones in Shenzhen and Wuhan from the mid-1980s that was then extended with the founding of the Beijing Experimental Zone, the first national-level high and new technology industry development zone. These zones act as an institutional interface between new ventures and the broader socio-economic system (Gu 1999).

A key institutional innovation was the establishment in 1986 of the Technology Venture Investment Corporation, formed by the State Science and Technology Commission and the Ministry of Finance, to replicate the dynamism of Silicon Valley and Route 128 in the US. It was managed and operated like an SOE; but was really a central government agency with the mandate to support national technology venture policy objectives, rather than a profit-oriented private enterprise.

At the same time central government has taken a more indirect approach and allowed the system to develop from below and has made progress towards aligning the legal and financial systems. Local governments have responded to the incentives and opportunities to foster new technology-based ventures in their regions and allowed firms greater autonomy, including setting salary levels.

Jian Gao and Xielin Liu point to the emergence of VC firms at central government level, among the universities, and especially in the private sector. This diverse set includes wholly foreign-owned VC firms. The picture that emerges is that there are diverse forms of innovation systems in China, and it might well serve to investigate these as uniquely regional, evolving forms. Data is presented to show the stellar growth of China’s infrastructure and output — best illustrated in the statistic that the number of high-technology firms increased twenty fold over two decades.

In conclusion, the authors note that while encouraging free market forms the state retains a strongly ‘paternalistic’ stance on the economy. This may explain why VC firms do not display the same flexibility and nimbleness as their foreign counterparts. At the same time they express concern that the state has invested less in high-risk basic research than the more highly developed OECD countries, and this may be expected to change as confidence grows.

The final chapter provides the South African case. In a sense that economy has maintained its essential character for the longest period, spanning at least a century. Arguing from a sociological viewpoint Kahn shows that the South African economy, even before the 1910 political consolidation of the country, has been dominated by its minerals–energy complex (Fine and Rustomjee 1997), and that this persists to the present. Political, class, group and economic struggles continue to pivot on the fulcrum of the relationship between the state, capital, political class, labour and society.

It has been shown that modern financial capital has very deep roots in South Africa extending back to the diamond exploitation of the last quarter of the 19th century. The unique nature of the gold miner-alisation required massive capital investment as well as huge sources of labour and these aspects continue to underpin the character of the economy to this day. The country has long functioned as a market economy, open to international capital flows, even during the sanctions years since global demand for strategic minerals had to be met. For its part, the state from the 1920s established the infrastructure for heavy industry: electricity, water, forestry, iron and steel, and communications. The consequence was a large public sector alongside a set of monopolistic mining houses with diversified interests. While South African transnational corporations traded globally since the early days of mining capital, the ‘apartheid constructed crisis’ eventually drove the economy downwards into negative growth. Then followed the political transition to democracy. But unlike Russia, its NSI survived the transition largely intact, albeit with lack of direction. Industry, faced with the challenge of globalisation underwent considerable expansion abroad to the extent that foreign sales now make up close to 50 per cent of leading company revenues.

The financing of innovation activity occurs in a local financial market that is among the most advanced in the world, standing in third rank on the Global Competitiveness Index. The evidence of innovation surveys is that companies rate themselves as highly innovative even though this is mainly incremental and oriented towards process and organisational changes. Inventors and innovators can turn to a range of sources of funds that assess the prospects for a return on investment with varying degrees of expertise.

Kahn suggests that the modernising agenda is expressed through a new ‘constructed crisis’ that unfolds alongside the contested distributive role of the state. Four binding constraints arise from the country’s history: foreign-exchange volatility and controls, risk aversion and anti-competitive behaviour. All four of these involve financial decisions though the first, other than the underlying financial provision, refers to the specifics around human resource development. Indeed, there is a deep-seated failure to set a realistic agenda for basic education and to grapple with the hard choices around vocational and academic education. These binding constraints are evident in the paradoxes that the constructed crisis drives. According to the 2010 Global Competitiveness Report the country leads the world in auditing and reporting standards but is among the worst for the efficiency of health and primary education, being ranked 129th of 134 countries.

The main source of funds for company innovation is cash; in the absence of cash a well-established company can still leverage bank loans since the bank can value the assets of the firm as collateral. This implies that where fixed assets or a sound trading record cannot be identified loan finance will not be forthcoming. In practice, firms younger than three years will find it extremely difficult to access bank finance and will have to resort to self-financing.

Angel investors are virtually absent and there remain concerns relating to tax and exchange control regulations that may impact on the risk management strategies of local fund managers. Overall, there appears to be a very slim connection between industry and the state insofar as funding and sources of innovation information are concerned. This means that the question of effectiveness cannot be addressed by looking at the funding instruments. It is rather a question of the way that firms grow and deploy their financial, physical, human and intellectual capital, in spite of the state.

The state has shown willingness to take the greatest risk in very early stage development through the agency of the Innovation Fund, Biotechnology Regional Innovation Centres, the state-owned Industrial Development Corporation, and through support for technology development in the public utilities and defence-aerospace. The financing gap is between very early stage development and commercial start-up so that prospective entrepreneurs experience difficulty in raising capital.

A range of direct and indirect incentives are in place. Indications are that the enhanced 2007 R&D Tax Incentive has been framed too rigidly so that take-up has been very limited, favouring a few well-organised and well-established R&D performers. A second problem area is the plethora of direct incentives, most of which are not subject to independent impact assessment.

To stem the capital flight and rent-seeking behaviours in the sanctions era strict foreign exchange controls were enforced for five decades. This regime included the definition of a patent as ‘capital’ whose disposal was, until April 2011, subject to exchange control regulations. It is too soon to tell if this change will alter firm behaviour positively. The new law on intellectual property deriving from publicly funded research adds further complexity to the ownership of patent rights with further impact on the cost of doing business.

South Africa’s structural adjustment programme was designed to lure FDI but this has not happened in depth save for the few examples given in the chapter. Indeed, if cheap energy was the draw card, that has now turned out to be a knave. Repatriation of capital is no longer a negative for FDI: the main negatives are the cost of labour, security and uncertainties with regard to property rights. Again these are not issues to do with the financing of innovation.

It is argued that the binding constraints will remain unless government shifts gear towards more pragmatic solutions. But that may be to ask the impossible of politics.

Kahn concludes by citing Aghion, Braun and Fedderke (2006), who argue that South African manufactured goods are uncompetitive by price. If this is indeed the case then why would firms report high commitment to innovation? One would expect to find low reported levels of innovation but instead we see the contrary. Firms appear to be prepared to take the risk, and fund that risk from internal sources. Firms do not read economic journals.

So what have we learnt about innovation financing? It will be evident that there is considerable heterogeneity in the approach of the country authors. This arises from the unique history of each country’s economy, and the stance adopted by the writer — informed by their own viewpoint, interests and data availability. Fundamentally there are different formulations of what is understood by the concept of ‘National Innovation System’. And there is the fact that the neo-Schumpeterian school has devoted little attention to financing the NIS.

That being said there is also commonalty among the five BRICS countries in that since the Second World War the state has played a strong role in their economic development path. This commonalty does not fit into a neat box labelled ‘central planning’ but might be characterised as an approach to managing the commanding heights of the economy both directly and through a range of regulatory actions. One could, for example, compare and contrast the former SOEs of Brazil and South Africa, the family businesses of India and South Africa (and Brazil) and the new players, China and the Russian resource giants.

Some recurrent features of these five unique experiences appear: the role of the state; the importance of institutional coordination; the influence of macroeconomic background conditions; the questioning of the efficacy of fiscal incentives, the contributions of multinational corporation (MNC) (domestic and foreign) R&D and innovation requirements; the central role of human resource availability and mobility; the risks associated with seed and VC provision, and the tensions between local and export market-led innovation strategies. Some of them deserve closer consideration.

First, we find the central role the state plays within the NSI. Although the countries portrayed in this book come from a long history of direct governmental interference in the economy, this is not a specific feature of these countries. Rather these five cases illustrate the importance of the state in any country for: (i) ensuring supportive framework conditions; (ii) providing that kind of support which is not compatible with private financial organisations’ logic; and (iii) guiding efforts within a strategic perspective related to a development strategy. All chapters emphasise the importance of the framework conditions and of the state provision of financing. There is an important role for private financial organisations to play but the characteristics of innovative projects will always limit its scope. Even in the case of South Africa, where private bank loans are in the front stage, we find relevant bottlenecks for small-and medium-scale enterprises (SMEs) and new enterprises to access those resources. Further, considering that technological evolution is not neutral, but conditioned by priorities and strategies of incumbents, socio-cultural characteristics of each society, opportunities and so forth, the state has a pivotal role for directing resources to specific areas. Thus, we find a close articulation of innovation policy with the countries’ development strategy in China and in India. The other countries face greater hurdles for setting this strategic guidance. The study on South Africa suggests this to be less relevant.

This brings us to another central issue. The ability to shape instruments and programmes and to guide initiatives in a coherent strategic direction is conditioned by the level of institutional coordination. This is a special hurdle in the case of the Brazilian institutional framework. The Russian case also stresses the challenges for coordination among different ministries. On the other extreme, the special characteristics of the Chinese political and economic system enable a close coordination, even ‘stimulating’ national banks to offer huge sums of loans for innovation projects. The absence of this strategic guidance leads to the claim by the authors of the Brazilian and Russian chapters for public procurement to play a greater role.

In India and South Africa on the other hand (both strongly coloured by British commercial practice, and home to many large family businesses) the arguments are perhaps more free market oriented. Kahn points to the long history of anti-competitive behaviour in South Africa, with the underlying tensions between race, class and capital providing the energy to drive the balance one way or another. China’s vast size, varied implementation of policy, and considerable space now for individual entrepreneurs imply that generalisations (including the preceding) are risky. But the description of China’s rapid march to entrepreneurial freedom suggests a single mindedness on the part of political leadership that is less evident in Brazil, India, South Africa and Russia.

Another important dimension is the macroeconomic ambience and policy. The level of basic interest rate, the exchange rate and the structure of public debt function as implicit STI policy. The capacity and the extent to which private banking and stock market may contribute to innovation financing are influenced by these factors. For example, in all countries we find the problem of marshalling support from the capital markets. But this is especially true in countries with less favourable macroeconomic conditions or instability.

The study on India sheds light on an issue which is recurrent for any country: the effectiveness of fiscal incentives for promoting novel innovation efforts. The findings converge with data from innovation surveys from South Africa and Brazil. In fact, the bulk of resources are used by large enterprises which would have invested in innovative activities anyway. It is questionable how far subsidising R&D of big pharmaceutical companies constitutes the best use for scarce public resources. Thus, it’s not only about the amount of disbursements but also about what kind of strategic orientation is behind the public support to innovation. In articulation to supply side policies, demand side initiatives are imperative.

As we said before, the systems of innovation literature has not yet paid the necessary attention to the link between the innovation system and the financial system. Financing investments in innovation constitutes an important structural bottleneck that not been solved. The characteristics of investments in innovation such as long lead times for development, inherent uncertainty and high risk, point to the need for setting national institutional arrangements, the more so in the present financial turmoil, a turmoil in part owing to financial innovation itself. The creation of such alternative innovation financing instruments implies governmental actions in analysing the relation between the financial system and investments in innovation.

This has clearly not been a neo-Schumpeterian issue. At this point, it will be necessary to resort to concepts derived from Keynes’ works, who formulated the concept of liquidity preference — or of money as an asset — as a central reference for the process of investment.

Regrettably, lenders, in their quest for profit, have ignored the fundamentals of intelligent lending policy. The development of increasingly complex financial derivatives, and the difficulty in quantifying their ‘real’ value took the finance industries of the advanced economies into new territory.

It is schadenfreude indeed for countries such as Brazil to find themselves in a stronger financial position than before, precisely because they have followed a more interventionist stance. In fact, the five BRICS countries have weathered the storm rather better than most, partly because of the continuing commodities super-cycle, but also because of a different macroeconomic stance.

As we have noted, the chapters are heterogeneous in theoretical and methodological terms. Some of the preceding points have been taken into account by the authors, and others not.

So, the analysis recognises the dynamics of the economic system and the pervasive uncertainty that is inherent to investment in innovation. This signifies the importance of institutions for the dynamics of the economic system, which cannot be reduced to the market.

Finally, considering all the chapters in a comparative perspective additional research questions may be posed:

• What is the nature of firms’ financing and the interface between the financial system structure and industrial financing?

• How does implicit innovation policy shape entrepreneurial investments in innovative activities?

• How do the domestic financial regimes affect the ability of the BRICS transnational corporations to trade in global markets?

Note

1 Freeman and Perez (1988) argued that the five long waves of capitalism are marked by the co-evolution of financial institutions and technological institutions. As capital needs evolve together with technological changes there is a push for changes in the organisational structures of firms and for financial innovations. Zysman (1983, 1986) and Nelson (1993) discuss the influence of different types of financial systems and broader institutional arrangements on innovation and sectoral dynamic. Christensen (1992) analyses the role financial institutions play in national innovation systems and the mutual knowledge build-up upon repeated interactions. More recently, Mayer (2002) and Chesnais and Sauviat (2003) discuss VC market and find that its evolution is closely linked with the institutional set-up of the North American system of innovation.

References

Aghion, P. and P. Howitt, 2005. ‘Appropriate Growth Policy: A Unifying Framework’, The 2005 Joseph Schumpeter Lecture, delivered to the 20th Annual Congress of the European Economic Association, Amsterdam, 25 August.

Aghion, P., M. Braun and J. Fedderke, 2006. ‘Competition and Productivity Growth in South Africa’, Working Paper #132, Harvard University Center for International Development, Cambridge.

Chesnais, F. and C. Sauviat, 2003. ‘The Financing of Innovation-related Investment in the Contemporary Global Finance-dominated Accumulation Regime’, in J. E. Cassiolato, H. M. M. Lastres and M. L. Maciel (eds), Systems of Innovation and Development: Evidence from Brazil. Cheltenham: Edward Elgar, 61–118.

Christensen, J., 1992. ‘The Role of Finance in National Systems of Innovation’, in L. B. Lundvall (ed.), National Systems of Innovation: Towards a Theory of Innovation and Interactive Learning. London: Frances Pinter, 151–72.

Dosi, G., 1990. ‘Finance, Innovation, and Industrial Change’, Journal of Economic Behavior and Organization, 13(3): 299–319.

Fine, B. and Z. Rustomjee, 1997. The Political Economy of South Africa. From Minerals Energy Complex to Industrialization. Johannesburg: Witwatersrand University Press.

Freeman, C., 1987. Technology Policy and Economic Performance: Lessons from Japan. London: Frances Pinter.

Freeman, C. and C. Perez, 1988. ‘Structural Crisis of Adjustment: Business Cycles and Investment Behaviour’, In G. Dosi, C. Freeman, G. Silverberg and L. Soete (eds), Technical Change and Economic Theory. London: Pinter, 38–66.

———, 1994. ‘The Economics of Technical Change’, Cambridge Journal of Economics, 18(5): 463–518.

Gershenkron, A., 1962. Economic Backwardness in Historical Perspective. Cambridge, Massachusetts: The Belknap Press of Harvard University Press.

Gu, S., 1999. China’s Industrial Technology: Market Reform and Organizational Change. London: Routledge.

Hall, B. and J. Van Reenen, 2000. ‘How Effective are Fiscal Incentives for R&D? A Review of the Evidence’, Research Policy, 29(4–5), April: 449–69.

Klynveld Peat Marwick Goerdeler (KPMG) and South African Venture Capital and Private Equity Association (SAVCA), 2009. Venture Capital and Private Equity Performance Survey of South Africa for the Calendar Year 2008. Johannesburg: KPMG and SA Venture Capital Association.

Levine, R. and S. Zervos, 1998. ‘Stock Markets, Banks, and Economic Growth’, The American Economic Review, 88(3): 537–58.

Lundvall, B.-Å., 1985. Product Innovation and User-Producer Interaction. Aalborg: Aalborg University Press.

Mayer, C., 2002. ‘The Financing and Governance of New Technologies’, paper prepared for the UN University/EU DG Research Conference on Financial Systems, Corporate Investment in Innovation and Venture Capital in Brussels on 7–8 November 2002.

Melo, L. M. ‘O Financiamento ao Desenvolvimento Científico e Tecnológico: a experiência da Finep — 1967 a 1988’. Unpulished M.Sc. dissertation, Universidade Federal do Rio de Janeiro, 1988.

———, 1996. ‘Sistema Nacional de Inovação (SNI): Uma Proposta de Abordagem Teórica’, Texto para Discussão, n. 357, Institute of Economics/Universidade Federal do Rio de Janeiro, , Rio de Janeiro, April.

———, 1994. ‘O Financiamento da Inovação Industrial’. Unpulished Ph.D. dissertation, Universidade Federal do Rio de Janeiro.

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Mohnen, Pierre, 2007. ‘R&D Tax Incentives: Issue and Evidence’, Presentation Slides, Design and Evaluation of Innovation Policy Programme (DEIP), 22 October, Maastricht: UNU-MERIT.

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Nelson, E. R. (ed.), 1993. National Innovation Systems: A Comparative Analysis. Oxford: Oxford University Press.

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Schumpeter, J. A., 1982. A Teoria do Desenvolvimento Econômico. São Paulo: Abril Cultural.

Studart, R., 1993. ‘Financial Repression and Economic Development: Towards a Post Keynesian Alternative’, Review of Political Economy, 5(3): 277–98.

Zysman, J., 1983. Governments, Markets, and Growth: Financial Systems and the Politics of Industrial Growth. Oxford: Martin Robertson.

———, 1986. ‘Financial Systems and Technological Innovation’, paper presented at the Conference on Innovation Diffusion, Veneza, 17–21 March.

2

Innovation, Finance and Funding in the National System of Innovation

The Brazilian Case

Luiz Martins de Melo and Márcia Siqueira Rapini

Studies about National Systems of Innovation (NSIs) are focused on the processes of interactive learning and knowledge generation within enterprises and institutions of human resources training and scientific research, as well as on how these organisations interact for constituting the innovation process. It is evident that a key factor which may either help or hinder this interaction is the role played by the state in the formulation and implementation of policies for fostering innovation and, indirectly, of macroeconomic policies.

The neo-Schumpeterian approach, responsible for the creation and dissemination of the concept of NSI, gave no emphasis to the financial perspective in its researches. Freeman (1994) analysed the roll of neo-Schumpeterian research, claiming that this topic had not taken a central position in such roll. As highlighted by Levine and Zervos (1998), there is a significant gap in that theory, since Schumpeter (1982), himself, already emphasised the relevance of the bank system in economic development, underlining the circumstances in which the banks could actively encourage investments in innovation.

The significance of financing to investments in innovation has been pointed out as an important structural bottleneck that was yet to be solved by private financial institutions. If, on the one hand, the inter-nationalisation, deregulation and globalisation of financial markets signal the possibility to access resources at lower costs, on the other, the characteristics of investments in innovation such as long-term development, the uncertainty and the risk, point to the need of setting national institutional arrangements (Melo 1994).

The creation of alternative innovation financing instruments implies governmental actions (Corder and Salles-Filho 2006).

In analysing the relation between the financial system and investments in innovation, it is necessary to take into account the nature of the innovation process, the competition within markets and the criteria for risk and credit analysis by financial institutions for conceding the financing. As emphasised by Dosi (1990: 301):

In a very general sense, innovation concerns processes of learning and discovery about new products, new production processes and new forms of economic organization, about which, ex ante, economic actors often possess only rather unstructured beliefs on some unexploited opportunities, and which, ex post, are generally checked and selected, in product markets. However, in addition, and complementary to product market competition, innovative efforts are shaped and selected also by rates and criteria by which financial markets and financial institutions (private and public), such as stock markets and banks, allocate to business enterprises. Irrespectively of whether resources are attributed to firms or individual projects, allocative criteria and rates of allocation should plausibly affect the amount of resources which the industry devotes to the innovative search, and also the directions in which the agents search.

Such characteristics of the innovation process lead banks and even markets to resist financing innovation, particularly in countries where capitalism appeared late, which have not yet built financial systems able to properly evaluate intangible assets.

For carrying out an analysis of the problem of financing innovation, particularly in Brazil — one of the more developed countries of late capitalism — it is necessary to take into account some particular matters. The first one is the composition of investment in innovation within macroeconomic regimes of both high inflation rates and high interest rates. The second is the impact of the regime of imports liberalisation and the flexible regime of exchanges on the technology of enterprises. Third, one must examine why the discussions on relations between policies aimed at fomenting investment in innovation and the macroeconomic policies — the problem of implicit and explicit technological policies — were abandoned since the middle 1980s and only reemerged in the beginning of the 21st century (Erber 1999). These questions conduct an analysis of innovation investments as a constitutive part of the firm’s investment strategy and how this strategy is affected by the macroeconomic, technological and industrial policies. It raises the problem of the valuation of the firm’s assets and of its financing. This has clearly not been a neo-Schumpeterian issue. At this point, it will be necessary to resort to concepts derived from Keynes’ works (1936), who formulated the concept of liquidity preference — or of money as an asset — as a central reference for the process of investment.

The analysis to be developed is based on neo-Schumpeterian theoretical assumptions such as distinct characteristics of innovation projects, technological heterogeneity of economic sectors and the role of the NSI.

Besides this introduction, the chapter is organised into seven sections. The second section provides a historical overview of the structuring of the Brazilian financial system. The third presents a synthesis of the problem of the enterprises’ funding and the interface between financing systems’ structure and the financing for investment in Brazil. The fourth section summarises the specificities of the innovation process and its financing in the Brazilian case, presenting existing instruments and institutions. The fifth presents recent evidences from the Brazilian Innovation Survey (PINTEC). The sixth section presents the impacts of macroeconomic policies, the implicit policies on financing for investments in innovation in Brazil in the 1980s and 1990s. The seventh aims at summarising the role of the financial system in the Brazilian Innovation System, based on what was analysed in previous sections. The concluding remarks summarise the chapter and indicate the major future challenges for the system of financing investments in innovation.

The Recent Structure of the Brazilian Financial System

In the 1950s, with the advancement of the industrialisation process, it was necessary to create the Brazilian Development Bank (BNDES) in 1952, for solving the problem of long-term funding. BNDES resources stemmed from an additional tax on the revenue tax and from technical reserves of insurance and capitalisation companies. It also counted on the resources raised in foreign currency arising from international agencies.

In the 1950s and 1960s, other governmental banks with regional scope were also created, such as, in the federal sphere, the Northeast Bank (1952) and the Amazon Bank (1996); regional development banks, such as the Farther South Development Bank (1962); and state development banks such as the Minas Gerais Developmente Bank (1962). This group of institutions formed a relatively articulated system of financial institutions able to implement public sector credit policy (Cavalcante 2002). On the other hand, the private banks were not able to follow the industrial and commercial growth, keeping their essentially regional and family-dominated character, and a limited range of services (Barker 1990).

Besides the development banks, there were the large, state-owned, commercial banks, such as Brazil Bank (Banco do Brasil) and the Federal Savings Bank (CEF). This latter is a bank which, in addition to the typical services of a commercial bank, operates as a saving bank, particularly of small savers.

Following the 1964 military coup, several institutional reforms were made in the financial system. The perception of the government was that the financial system was hampering the process of economic growth. It was considered inadequate for financing the consumption of durable goods, the needs of working capital by firms and the new stage of modernisation of Brazilian economy. The ‘Law of Usury’ (from 1933) established a limit of 12 per cent for the interest rates. Thus, short-term transactions became the pattern, especially in periods of high inflation rates.

The financial reforms carried out were inspired by the North American model which had a financial system segmented in conformity to the Glass-Steagall Act of June 1933. The Law of Bank Reform (Lei 4595/64) established the model of specialised institutions and was responsible for the creation of the Central Bank and the Securities and Exchange Commission of Brazil (CVM). Law 4357/64 introduced the concept of ‘monetary correction’. Law 4728/65, the Law of Capital Market, regulated the activities of stock exchanges, created fiscal incentives for the issue and acquisition of stock shares and debentures and defined the functions of investment banks (Puga 1999).

The scope of operation for institutions in the financial system became defined as follows: (a) commercial banks, responsible by short-term deposits and loans; (b) investment banks, responsible for the promotion of the capital market, in order to finance private investment; (c) institutions of saving and loans, responsible for financing the housing system; (d) companies of credit, funding and investment, responsible for credit to consumers; (e) stockbrokers and dealers in charge of supporting the development of the stock exchanges. Long-term credit would be granted mainly by BNDES with resources of the Unemployment and Retirement Guarantee Fund (FGTS), the Social Integration Programme (PIS) and Programa de Formação do Patrimônio do Servidor Público (PASEP).¹

During the reform, the Central Bank of Brazil (BACEN) was created. Another relevant change was the creation of the National Housing System in 1964, when a specific fund aimed at financing housing was created through the establishment of the National Housing Bank (BNH).

The reform of 1964, however, did not lead to a significant change in the structure of the financial system. It was unable to develop a market of long-term funding for private banks of investment, so that industrial investment was limited to public credit, through BNDES actions. On the other hand, it met one appeal by the business sector that was the expansion of credit aimed at consumption.

According to Hermann (2003), the failure of this reform points to three major factors: (1) fails in the diagnosis of the financial problem, which attributed the difficulties of long-term funding to insufficiency of domestic saving; (2) the persistence of the inflationary process; (3) failures in financial policy management, which in several occasions relaxed the valid legislation and ended up allowing financial conglomeration.

The failure in the establishment of investment banks, which were to constitute the fundamental piece for consolidation of the securities market, was attributed to the impossibility of developing long-term financial assets in economies undergoing chronic inflation. Other authors attributed the failing to the refusal of banking capital to participate in activities involving greater risks (Cruz 1994).

Moreover, as of 1967 an intensive process of bank concentration had begun. The number of private commercial banks dropped from 188 in 1968, to 72 in 1974. Between 1967 and 1976, the share of the five major banks in total volume of deposits in the financial system increased from 20.9 per cent to 34.2 per cent. Concurrently to banking concentration, a movement of financial centralisation was also observed, with the emergence of large financial conglomerates headed by commercial banks.

In the 1980s, the financial system presented a consolidated standing. However, the chronic macroeconomic instability sharpened the difficulties regarding long-term funding.² The restrictions of the public financing system, in their turn, created profitable short-term opportunities for the banking system. From 1985 onwards, ‘holdings’ started to be constituted from the conglomerates formed in the 1970s. The incorporation of non-financial enterprises was part of the strategy for equities’ defense.

In 1988, another reform of the banking system was carried out. On this occasion, BACEN authorised the creation of multiple banks, which combined commercial and financial banking portfolios (Securities Commission Regulation number 1529). As stressed by Hermann (2003) the reform represented nothing but the institutionalisation of a structure already in force in the Brazilian banking system, which were banks already operating as multiple banks.

The Real Plan, implemented as of 1994, led to a reorientation of the financial system insofar as, with the end of inflation, financial institutions lost a significant part of inflationary revenue. Between 1990 and 1993, inflationary revenue as a percentage of Gross Domestic Product (GDP) reached 4 per cent. In 1994 it reduced to 2 per cent and in 1995 to 0.1 per cent. Inflationary revenue as a percentage of production imputed to the banking system, which was 87.3 per cent in 1993, reduced to 49.5 per cent in 1994 and to 1.6 per cent in 1995 (Corraza 2000).

The reduction of inflationary revenue and the growing entry of foreign banks since 1996 led to an increase in competition and to the restructuring of the Brazilian financial system. The financial system restructuration was fostered by the government, which created the Program for Restructuring and Strengthening of the Financial System (PROER) in 1995, and the Program of Incentive to the Reduction of State Institutions in Banking Activities (PROES) in 1997.

PROER aimed at providing resources, through BACEN, so that solid financial institutions acquired the financial control of banks undergoing difficulties. PROES, in its turn, aimed at promoting the recovering of state banks, restricted to three options: privatisation, liquidation or being converted to a development agency. The main outcome from PROER and PROES was the concentration of the Brazilian financial system. The reduction in the number of commercial and multiple purpose banks may be seen in Table 2.1.

Table 2.1: Financial Institutions and Other Institutions Authorised by Central Bank of Brazil, in Operation, 1994 and 2001

Source: BACEN (2002).

Another change observed in the Brazilian financial system was the growing entry of foreign institutions in the 1990s. Between June 1995 and December 1998 the number of foreign banks increased from 37 to 52. Domestic banks with foreign control jumped from 20 to 36. The participation of foreign banks in total number of commercial and multiple banks increased from 15.4 per cent to 25.6 per cent (Puga 1999). In addition to the entry of new institutions, an expansion of existing institutions by the acquisition of domestic banks was observed.

The growing presence of foreign banks may be seen in Table 2.2, which presents the market share for the banking system. The market share of banks with foreign control increased gradually, passing from 8.4 per cent in 1993 to a maximum of 29.9 per cent in 2001.

With the reduction in the participation of state-owned banks, there was an increase in credit operations carried out by private banks. In 1996, state-owned banks accounted for approximately 60 per cent of credit operations, dropping to 32 per cent in 2006.

In its turn, the participation of private banks in credit operations increased more than 60 per cent, jumping from about 42 per cent in 1996 to 68 per cent in 2006 (Table 2.3).

The participation of state-owned banks in the total credit operations decreased in the post-Real Plan period due to both privatisation and liquidation of some of these institutions, eminently federated state-owned banks, and cleaning up of balance sheets, especially by excluding the ‘rotten’ real estate credits from assets of CEF in the first half of 2001. According to Pinheiro (2006: 34), the state-owned banking segment operates as follows:

• They rather lend to the public sector and to the real estate segment, although both these currently account for a small part of their operations;

• They account for most part (about 60 per cent) of rural credit;

• They hold a minor share of the credit to individuals, in spite of having also significantly expanded these operations as of 1999;

• They account for approximately 40 per cent of the credit to industry and to other services, rivalling national private banks in importance, and 23 per cent of the bank financing to commerce, a segment where national and foreign private banks have greater participation.

Table 2.2: Banking System‘s Market Share in Brazil (Total Assets), 1993–2004 (percentage)

Source: BACEN (1993–2004).

Note: *Includes state saving banks, but excludes the Federal Savings Bank and the Bank of Brazil.

Table 2.3: Evolution of Financial Institutions’ Share in Credit Operations, 1996–2006

Source: IPEA (2009).

It is important to note that the privatisation of federal and regional state-owned banks, acquired principally by foreign banks, did not change the structural conditions of the banking system operation. Both long-term and short-term credits to productive activities remained scarce. In the regime of high interest rates and restrictive monetary policy (high compulsory reserves), credit remained scarce and competitive advantages of foreign banks were not very relevant.

Brazilian banking institutions, which were adapted for operating under conditions of high inflation rates, had an automated banking system precisely for avoiding inflationary losses and for daily investment in public bonds through the ‘over-night’ system. This situation remained the same under the Real Plan, a regime of high interest rates and exchange rate appreciation.

Therefore, the Brazilian banks, in the beginning of the 21st century, started to buy foreign banks. The foreign banks that stayed in the Brazilian market started to operate exactly as the Brazilian banks, thus frustrating hopes of those who believed that the trend to short-term operations was a characteristic of Brazilian banking institutions.

The capital market in Brazil, after the 1964 reform, did not develop as expected. According to Bastos et al. (2000) this was the result of the lack of rules, of institutions and of demands by firms. The funding needs of the enterprises were restricted and were supplied with own resources (retained earnings) and with governmental and commercial credit, such as those provided by BNDES.

Many initiatives were introduced for promoting the development of the capital market. One example was the creation of the Funds 157 (Act no. 157) which allowed tax payers to choose using from 2 per cent to 4 per cent of the due income tax for the acquisition of quotas from open capital companies. In 1976, a new ‘Law of Public Corporations’ (Law no. 6404) granted the right to enterprises to issue and trade up to two-thirds of preferential shares without voting rights. In this same year, a second Law of Capital Market (Law no. 6385) was established, creating the Commission of Securities and Stock (CVM) and setting general provisions on the securities and stock market. Such efforts, however, were unable to foster the development of the capital market, which presented only some sporadic surges of growth.

In the 1980s, the Brazilian stock market presented a weak performance; the market value of Brazilian enterprises practically stagnated between 1985 and 1992. A period of greater dynamism was observed following the Cruzado Plan, when the decrease of inflation rates impacted favourably on the expectations of agents, who increased the demand for stock shares (Prates 1999).

In the 1990s, with the economic liberalisation, the main change occurred in the legal framework aimed at relaxing the entry of foreign capital in the Brazilian market. The possibility of accessing the Brazilian market was conceded to foreign investors by means of either foreign institutional investors (pension funds, insurance companies, foreign financial institutions, investment funds constituted in foreign countries, etc.) or acquisition of quotas of investment funds (Prates 1999).

In 1991, Privatization Funds–Foreign Capital were created, aimed at the acquisition of securities in enterprises in the process of privatisation, and of privatisation money. In 1993, the Fixed Income Funds–Foreign Capital were created, allowing foreign investors to opt for investing in fixed income securities. In 1996, two new alternatives were opened to the participation of foreign capital in funds constituted in the country: the Fund of Investment in Emerging Enterprises and the Fund of Real Estate Investment (Studart and Hermann 2001).

With these changes, a growth in the number of pension funds in the country was observed. Between 1985 and 1997, the pension funds increased from 256 to 339. The investments of the funds grew from US$ 17 billion (2 per cent of GDP) to US$ 78 billion (11.5 per cent of GDP). Between 1992 and 1997, the number of enterprises listed in the stock exchange increased 12 per cent, whereas their market value increased 464 per cent in the same period. However, the growth of the capital market was concentrated in the secondary market (Studart 2000).

According to the summary by Prates (1999: 54):

the degree of concentration of business at Bovespa did not reduce in the 1990 decade, once the foreign investors bought, essentially, stock shares from state owned enterprises, anticipating appreciation following privatization. The financial liberalization, therefore, did not result in rise of the market value nor in liquidity of the stock shares of private enterprises, what discouraged both the demand of investors and new issues by the enterprises. Thus, a vicious circle was created, once the little volume of primary issues implied reduction of the relative participation of these firms in the secondary market, which contributed to the concentration of trading on more liquid assets.

In 2000, the diagnosis was that the Brazilian capital market presented restrictions which impeded its development, namely: (1) the Brazilian tax structure did not encourage operations with variable income; (2) restrictions that the CVM, as a public body, faced for hiring and adequately remunerating qualified staff for carrying out and reinforcing the control of the market; (3) large stock of existing preferential shares (Bastos et al., 2000). In this perspective, in 2001 the new Law of Public Corporations (Law 10303/01) was sanctioned, changing the legislation of 1976. This law sought to reduce conflicts arising from distinct interests of managers and shareholders, particularly the minor ones.

In December of 2000, BOVESPA installed the New Market and Different Levels of Corporate Governance (Levels 1 and 2) aiming at providing a trading environment that boosted the interest of the investor and appreciation of the firms. The enterprises shall be committed to adopt additional practices of corporate governance, aiming at reducing the risk for the investor (BOVESPA 2009). According to Boletim Informativo (Newsletter) of April 2009, there were 99 companies listed in the New Market (22.9 per cent out of the total number of enterprises), which accounted for R$ 659,000 million of capitalisation (18 per cent of the total).

According to a recent report by FUNDAP (2008), the Brazilian capital market presents, since 2005, a major expansion in the increase of funds by Brazilian enterprises. In 2006 share issuing reached R$ 14.4 billion, corresponding to a growth of 225 per cent in relation to 2005. In 2007, primary (initial public offering [IPO]) and secondary issuances totaled R$ 33.1 billion. In 2007, there were 682 public companies, a growth of nearly 10 per cent in relation to 2005. Nevertheless, as highlighted by Sant’Anna (2008), the issuance of shares in the market is still restricted to a small group of sectors.

Firms Funding and Interface between the Financial System Structure and Industrial Financing

It is important to note that a firm may resort to distinct sources for financing its investment programmes. These sources may be classified as follows: (1) reinvestment of retained earnings (self-financing); (2) shares issue (raising funds either from shareholders or from public); (3) issue of securities (direct financing mechanisms); (4) banking loans (indirect financing mechanisms).

The use of each one of these sources and their relative participation in enterprises equity capital structure will depend on the historical and institutional development of the relation between financial and industrial systems.

Innovation constitutes an intangible asset characterised by high unpredictability, high costs and long-term development. The difference between the funding of an intangible asset and of a tangible one is that, in case of the latter, the asset itself serves as collateral to the lender. It reduces the uncertainty for the creditor regarding debt repayment. It is a guarantee against default. Even incurring transactions costs, the financial operation becomes linked between asset and liability.

In the case of innovation, there are no assets to guarantee the loan. Therefore, in order to finance it, the financial system must create instruments for the evaluation of intangible assets that will necessarily involve future expectations on earnings and the willingness of investors to become illiquid and with their operations detached regarding assets and liabilities.

Retained earnings is the major funding source of enterprises. This is one of the few consensus points in the literature on the issue. Being so, a decisive question will be the influence of macroeconomic policy on the funding strategy of firms: to reinvest internally or to invest in the financial market.

In the case of micro and small enterprises (MSEs), the funding presents yet other specificities. Since these enterprises will hardly have resources for their self-financing, the availability of external financing is crucial, especially for the quickly growing sectors (Arthur 1996). According to Britto, Vargas and Cassiolato (2001), regarding micro, small and medium enterprises, it is necessary to identify to what extent the aims and interests of the parts involved in the process of financing are conflicting or complementary. While these enterprises search financing at the lowest costs as possible and under friendly conditions adapted to the needs of their initiative, the financial sector tends to pass forward the specific costs of operations.

It must also be assumed that enterprises have the alternative to invest their resources in the financial market, instead of reinvesting them in the firm. Therefore, all investment decisions are decisions on constituting a portfolio of assets and of appreciating them. That is, depending on the conditionalities of economic policy (implicit innovation policy) and on the capacity of NIS, these investments may be directed either to enhancing the firms’ capabilities in production and innovation or to the financial market.

The comparison between some indicators helps to understand the distance separating the Brazilian financial system from other financial systems with respect to production financing.

The banking credit, mostly addressed to short-term funding, is quite restricted. In the beginning of the 1990s it reached at most 15 per cent of GDP. In 2006, it reached 31 per cent of GDP and, in 2008, the level of 40 per cent of GDP. These are levels are too low if compared to the international ones. In Eastern Asia and the Pacific region this rate was 72 per cent and in the Middle East and Northern Africa it reached 43 per cent. Yet, the Brazilian rate is similar to the average of 28 per cent observed in Latin American economies during the 1990s (Puga 2006). Another characteristic of the Brazilian credit system was its high volatility due to macroeconomic shocks of foreign nature.

The extremely severe monetary policy implemented after the Real Plan, in July 1994, also contributed to its scarcity and volatility. A high inflation regime was replaced by a regime of high interest rates and high compulsory deposits.

In Brazil, as aforementioned, the long-term direct funding mechanisms have been little developed. In 2007, the stock of these assets (most of them comprised debentures) was equivalent to only 2.6 per cent of GDP, while the international average was 10.8 per cent of the GDP (Sant’Anna and Cruz 2008). This sample can be much biased by size and intensity of developed countries’ capital markets. Although even in comparison with developing countries, we observe that the Brazilian position is very weak. South Korea which for many years had a practically state-owned credit market, already presents an indicator 10 times higher than the Brazilian (ibid.).

BNDES, between 2001 and 2007, was responsible for 20 per cent of resources used for investment by industrial and infrastructure enterprises. The participation of other sources in financing of enterprises is much more unstable. The funds raised externally got to represent 30 per cent of invested sources, although on average its participation remained at 16 per cent between 2001 and 2007. Following this, worth noting are the issuances of debentures (10 per cent) and of shares (3 per cent). Generally, the increase in importance of these sources is associated with large scope operations. Thus this does not reflect on the average behaviour of enterprises (Puga 2008).

In the Inter-American Development Bank (IDB) (2007) we find an analysis of the relation between public and private debts in Latin America. The main argument raised in this study is that the cost of public debt provides the minimum base for remuneration and terms of private bond because it establishes a reference pattern to the demand for these bonds. The market of public bonds provides a basic infrastructure for the private bonds market. The evidence points to the fact that it is not the size of public debt that hinders the development of the private bonds market. There are countries such as South Korea, Thailand and Malaysia with extensive public debts and yet well-developed corporate bonds markets, whereas others such as Brazil and Venezuela have a relatively large public debt and a small and poorly developed market of corporate bonds.

As public bonds work as references for the issuance of corporate debts, the interest rate paid by the Treasury (SELIC) represents the basic price, which added with the respective margin of risk will provide the minimum financial cost of enterprises in issuing debentures. The greater the interest rate, the lesser is the incentive to enterprises for using own issuances as a way for raising funds, because of the impacts on their costs of capital.

Among the countries with higher interest rates, China has the most developed market of corporate debt, with 3 per cent of GDP. Brazil was the country which in the period from 1994 to 2007 presented the highest real interest rate, thus impeding the development of a more robust private bonds market.

The structure and term of public debt also play a significant role in the restriction to the enhancement of the capital market. Brazilian public debt is concentrated in short-term bonds, daily indexed to the interest rate of monetary and interbank markets, SELIC. This composition makes the Brazilian public debt practically unique in the world.

These operations, agreed upon between the Central Bank and banks, assure the technical reserves of banks automatic remuneration at an interest rate that also affects public debt bonds. This indexation, an inheritance of the times of high inflation rates in the former regime, has been retained by the monetary policy of high interest rates.

The Brazilian financial system still enjoys the safety assured by the Central Bank through these operations, hindering the development of a true interbank market. There is, indeed, a negative relation between the composition of the public debt, expressed by the quotas indexed at fluctuating interest rates, and the size of the market of private fixed income bonds. To this we must add the term of public debt as an aggravating factor for the low development of the private bonds market. This combination of short-term debt indexed to a fluctuating rate makes the state offer, simultaneously, liquidity, profitability and safety. Thus, issuers of private bonds have to raise profitability for compensating liquidity and risk. Under such conditions, the chances for an issuer enterprise to attract investors to a fixed-income, long-term bond, at a suitable cost, are limited, since the buyer may always opt for a public bond with large liquidity and for a short term. For this reason, large Brazilian investors, such as pension funds and investment funds, concentrate most of their portfolios in federal public bonds.

This analysis has revealed the poor development of the capital market and of banking credit for financing long-term investments. Regarding financing of intangible assets, such as innovation, the participation of the financial system was almost non-existent. It only remained for firms to use self-financing. However, the macroeconomic context where these investment options occurred was not attractive for investment in innovation.

The need for creating specific — public — institutions, the outcome of a strategic action by the Brazilian state, showed that the relation between the financial system and the industrial system did not evolve in the same way it historically happened in developed countries (Miranda and Tavares 1999).

As a consequence of this evaluation, BNDES was created at the beginning of the 1950s, aimed fundamentally at financing of tangible assets, investment in infrastructure and both creation and expansion of production capacity in national enterprises. It is known that the financing of investment in tangible assets — machines, equipment and facilities — also includes a proportion of intangible investment, incorporated in the tangible assets (Melo 1994; OECD 1996). Therefore, there is quite a close relation between tangible and intangible investments.

In the mid-1960s, the need for structuring financial mechanisms for financing investment in intangible assets was identified. Initially, BNDES undertook this mission. Later, it became clear that the logics of financing were distinct. Then, the National Fund for Scientific and Technological Development (FNDCT) and the Brazilian Studies and Projects Finance Organization (FINEP) was assigned with its executive-secretariat.

Financing of Innovation in Brazil

The institutions for funding and supporting scientific and technological development in Brazil began to be created in the 1950s. The National Council for Scientific and Technological Development (CNPq) and the Commission on Qualification of Graduated Human Resources (CAPES) were both created in 1951 for building human resources capabilities in research and for financing projects of scientific research. Later, as aforementioned, FNDCT was created for financing initiatives for building enterprises’ productive and technological capacities.

The analysis of the evolution of the sources of funds for innovation financing in Brazil is heavily based on Melo (2009). This study shows that the financing of innovation had two different periods. The first one, from 1967 to 1997, comprises the period of constitution of FNDCT and its financing through ordinary budget allocation. The second begins with the enactment of the new legislation on sectorial funds as a new source of funds for FNDCT, and continues to be in force up to now.

The creation of sectorial funds represented not only a change in funding sources for FNDCT, as also a change in the priorities defined for allocation of its resources through its Executive Secretariat, FINEP — another kind of institutional articulation between FINEP and FNDCT. These are the institutional reasons that grounded the periodisation of the analysis.

The first important difference between the two periods resides in the macroeconomic context. The major change happened in international policy during the 1980s, with the hegemony of neo-liberal thought directing the economic policies towards greater trade liberalisation, and liberalisation of the account of capital of the balance of payments, flexible foreign currency exchange rates, fiscal adjustments and control of inflation. Most of these policies were opposed to the dominant policy of economic development that dominated the first period, characterised by what has been called the imports substitution model. In Brazil, these policies began to be adopted during the Collor government and were kept by the following governments, particularly the guidelines of macroeconomic policy.

Obviously, those differences led to a change in the priorities for application and in the sources of funds from FNDCT and FINEP. In the first period there was an explicit concern in the document of the National Technological Development Support Program (ADTEN) about the support to national enterprises (Brazilian capital–owned enterprises), as well as about a greater coordination between the application of FNDCT and FINEP resources, particularly because of the fact of FINEP being practically the leader of the operational strategy of them both. The source of funds of FNDCT was, in its major part, the fiscal budget. FNDCT was a fund of free application; it transferred resources to FINEP for it to finance enterprises and, in some periods, it was complemented by external financings (Melo 2009).²

The evolution of the source of funds is shown in Table 2.4, which presents data on the evolution of resources aimed at the financing of innovation by FNDCT and FINEP, in the period from 1967 to 1997.³ The resources of FNDCT refer to financing of scientific development in research institutions, comprising non-reimbursable finances. The resources of FINEP refer to funding for investment in innovation within enterprises, being reimbursable. The third line (FINEP + FNDCT) represents the sum of resources, the total amount of financing for the whole process of innovation.

In the second period, the exclusivity for enterprises of national capital was withdrawn. FINEP lost almost its whole autonomy in the definition of the strategy for application of FNDCT resources through sectorial funds. Currently, each sectorial fund has a managing committee and there is a general managing committee of FNDCT, in which FINEP is minor. The strategy is much more in the hands of Ministério de Ciência e Tecnologia (MCT) than in those of FINEP. Table 2.5 shows the evolution of the source to funds to financing innovation in this period.

Sectoral funds may be decisive to finance innovation since the barrier of the restrictive monetary and fiscal policy is overcome with cessation of resources allocation to contingency reserves, and, thus, allows for a greater financial availability for financing innovation. FNDCT’s resources have increasingly been captured as contingency reserves, as can be seen in Table 2.6. There are currently more resources allocated to contingency reserves than those allocated to FNDCT for financing innovation and science and technology (S&T) infrastructure. This is a major contradiction between the macroeconomic policy and the industrial and STI policy, since the objectives are incompatible.

Table 2.4: Evolution of FINEP and FNDCT Outlays, 1967–97 (in million of constant US$, December 2006)

Source: FINEP (1967–97).

Table 2.5: Financial Evolution of FINEP and FNDCT, 1998–2006 (in million of constant US$, December 2006)

Source: FINEP (1998–2006).

Table 2.6: Financial Evolution of FNDCT, 1998–2006 (in million of constant US$, December 2006)

Sources: FINEP (1998–2006) and MCTI (1998–2006). Authors’ own elaboration.

In Table 2.7 the average funding granted by FINEP and FNDCT in the two studied periods is presented. The first period shows an average amount of non-reimbursable funding by FNDCT and of reimbursables by FINEP that was higher than those of the second period.

Instruments for financing innovation

Fiscal incentives granted to Brazilian enterprises date back to the beginning of the 1990s and underwent a number of modifications all along this period. Most of the times, these changes were reflexes from fiscal limitations of the Brazilian state (Pacheco 2007).

Table 2.7: Comparison between the Average Disbursements by FNDCT and FINEP in the Two Periods

Source: FINEP (1967–97; 1998–2006). Authors’ own elaboration.

There are two modalities of non-reimbursable resources to innovative activities in Brazil. The first one is the concession of resources for scholarships and grants to research institutions and universities for developing projects in partnership, services and consultancies related to solutions of technological problems in enterprises and to development of new products and processes. The second and more recent modality is the economic subvention granted directly to enterprises.

The economic subvention for enterprises was established on the basis of Law no. 10332 of 2001. Law no. 10973, of 2004, provided for the concession of financial resources, as economic subvention, to national enterprises which aimed at the development of innovative products or processes, under the requirement of approval of the project by a granter institution. Law no. 11196/05, in its turn, institutes another form of subvention — the concession of resources for enterprises located in Brazil to hire researchers who should engage in innovative activities. The subvention could reach up to 60 per cent of the total remuneration of Masters or Ph.D. researchers.

Box 2.1 summarises the instruments for financing innovation in Brazil and Table 2.8, the value and number of firms/project approved in each programme.

Venture capital

The activities directed to venture capital (VC) in Brazil started in the 1970s, but did not continue. According to Gorgulho (1997) the expansion of VC in Brazil was restricted by the economic context (instabilities, high interest rates in the market of governmental bonds, difficulties for long-term planning) and by the lack of regulatory and fiscal mechanisms for fostering such activity. The companies were only institutionalised in 1986 and the Mutual Funds for Investment in Emerging Enterprises (MFIEE) were regulated by CVM in 1994 (Instruction no. 209).

Box 2.1: Instruments for Financing Innovation in Brazil

Source: MCTI (1991 – 2009), FINEP (1991 – 2009), BNDES (1991 – 2009).

Note: The sectors are: (1) ‘mobilisers in strategic areas’ (defense, health, ICT, nuclear energy and nanotechnology) the rate is 4.25 per cent; (2) ‘for conciliating and expanding leadership’ (iron and steel, petroleum, natural gas, bio-ethanol, cellulose and aeronautics complex) the rate is 4.75 per cent; (3) ‘for strengthening competitiveness’ (capital goods, automotive, textile, footwear and agro-industry) the rate is 5.25 per cent. Projects that do not fit to any of the Productive Development Policy (PDP) lines pay a variable long-term interest rate (TJLP) rate plus 5 per cent per year.

Table 2.8: Value and Number of Firms Covered by Each Programme

Source: MCTI (1997–2009), FINEP (1997–2009).

In 2003, the 391 CVM Administrative Act fostered VC funds formation with the creation of Private Equity Funds (FIP). The FIP are aimed to investments in either public or private companies which have little liquidity, with effective participation of the Fund in the enterprise’s administration and in dissemination of management and control best practices (De Paula et al., 2003). The participation may happen through the acquisition of stock shares, debentures and other bonds and securities convertible to stock. In 2008, there were 171 FIPs operating in Brazil.

Venture Capital at FINEP

In 2000 FINEP created the INOVAR Program, a set of activities aimed to build innovative capabilities in SMEs which wanted to take part in risky investments programmes. INOVAR currently comprises the following activities:

• Venture Forum FINEP: a permanent agenda of business rounds, where participant entrepreneurs have the opportunity to present their business plans to investors such as managers of VC funds, corporate investors, ‘angels’, investment banks, among others.

• Brazil Forum for IPO: an agreement of technical cooperation between FINEP and BOVESPA to IPO from technology-based enterprises in the new market. There is an annual meeting which offers a broad exposition of the enterprises to representatives of security and stock brokers, investment banks, managers of investment funds and pension funds.

• INOVAR Funds Incubator: aims at fostering the creation and capitalisation of VC funds, by attracting potential investors to emerging technology-based enterprises, especially institutional investors. Between 2001 and 2007, FINEP contri-buted with resources to 11 funds which have committed equity capital amounting to US$ 240 million.

• INOVAR Seed Program: provide support to start-up enterprises. The Program Fundo Inovar Semente has the objective of capitalising funds, preferably local ones, for investment by innovative MSEs with a turnover of up to US$ 1.2 thousand. In 2007, the first investment in Fundo HorizonTI was approved, a fund directed to information technology sector resources of up to R$ 8 million.

• Brazil Forum for Innovation: has the objective of attracting institutions of higher education and/or research for carrying out projects of technological innovation whose outcomes have potential application in the market, operating in the phases of pre-incubation, incubation and technology transfer of the innovative cycle.

• Business Prospecting and Development Network: has the purpose of developing a joint effort for identification and support to new opportunities of investment, to enhance technology enterprises creation with potential for increasing the VC in the future. Besides prospecting start-up enterprises, Inovar Network supports the development of business plans and provides consultancy services for technology-based enterprises and funds managers.

Between 2001 and 2008 FINEP landed resources in 22 funds which have committed capital amounting to US$ 1.23 billion. The Finep contribution amounted to US$ 134,000 (this represents a leverage of US$ 4.05). These funds are 13 of VC, three of private equity (PE) and six of seed funds, of which 12 are operating, nine are in capitation phase and one has already closed.

This timid position seems to disregard the change that occurred in the position of the capital market in Brazil (Melo 2009). Since 2005, there was a significant search for financing via the capital market. Such movement by enterprises represented a positive change in their investment expectations, which signalled a better confidence in returns of these investments. It reinforces the perception that a less restrictive monetary policy, which would make interest rates lower and exchange rates higher, would lead Brazilian enterprises to a more dynamic investment strategy and, possibly, would lead to improvements in the generation of innovations.

Venture Capital at BNDES

The Program for Capitalization of Technology-based Enterprises (CONTEC) was created in 1991, directed to technology-based SMEs. The programme supports technology-based enterprises with net turnover lower than US$ 15 million. The investments in enterprises can be made by means of subscription of convertible stock shares or debentures without the requirement of real guarantees. Since its creation, more than 700 firms were evaluated, and investments were made in 44 enterprises of several sectors totalling US$ 100 million. Twelve disinvestments were already accomplished and nine enterprises were transferred to co-management funds (Fingerl 2007).

The Fund for Start-up Enterprises (FINEE), of BNDESPAR was created in 1995, based on a perceived need to enable the capitalisation of SMEs during their process of growth. The initial equity foreseen for FINEE/BNDESPAR was of US$ 25 million and investments could happen through direct stock holding, subscription bonus and convertible debentures, without real guarantees. The maximum contribution to enterprises is US$ 4 million, and the value cannot exceed 30 per cent of the firm’s equity capital.

In 2008, a new Program of Investment Funds was created, with a budget of US$ 0.75 billion. The programme has the purpose of investing in quotas of up to 10 funds, eight of them being funds of PE and two others funds of VC. BNDESPAR will have a maximum participation of 20 per cent of equity capital in FIP and of up to 25 per cent in VC funds. The programme aims at enhancing the capitalisation of enterprise of different sizes and encouraging VC culture.

In 2008, BNDES participated in 31 investment funds (seven at contracting stage), which amounted to an equity capital of about US$ 3.7 billion. Since the beginning of its activities through the funds, BNDES allowed indirect investments in more than 110 enterprises (www.bndes.gov.br, accessed 1 April 2010).

The Program for Creation of Technology (CRIATEC), an investment fund in seed capital, was approved by BNDES in 2006. It is a partnership between MCTI, FINEP and BNDES, and has the support of SEBRAE, ANPROTEC and some state institutions. The programme consists of a Restrict Mutual Investment Fund aimed at the capitalisation of innovative MSEs in their start-up stage. The programme is focused on TI, biotechnology, new materials, precision mechanical, nanotechnology and agribusiness sectors. CRIATEC will hold a budget of R$ 80 million and is expected to capitalise up to 60 innovative MSEs with an average investment between US$ 250 thousand and US$ 500 thousand.

To promote access to CRIATEC’s resources to enterprises all over the country, in 2008, seven regional managers in Ceará, Minas Gerais, Pernambuco, Pará, Rio de Janeiro, Santa Catarina and São Paulo were selected. At the end of 2008, Criatec had 11 firms, an average investment per firm of US$ 717,000 accounting to the amount of US$ 7.6 billion.

Synthesis of the instruments for financing innovation

Box 2.2 presents a synthesis of the instruments aimed at fostering and financing innovation in Brazil according to distinct stages of innovation process. The different stages of the innovation process require distinct kinds of resources and support modalities. For instance, in conception and in both basic and applied research stages, resources as scholarships granted to masters or doctorate researchers and financing resources can be used.

In spite of the existence of various supporting lines and recent efforts on the part of FINEP and BNDES to create new lines of promotion and financing, some stages of the innovation process still count on few resources alternatives, as is the case of the final stages of production, commercialisation and market development.

The Innovation Activity and Its Financing

The Innovation Survey, PINTEC, applied by the Brazilian Institute of Geography and Statistics (IBGE 2010), gathers information on innovative activities carried out by the Brazilian manufacturing enterprises.⁴ The survey was structured based on the conception of innovation as an interactive process, comprising interdependence between various agents, and the institutional and economic environment in which they are inserted. PINTEC is already in its fourth edition, which presents data regarding the strategies adopted by enterprises between 2006 and 2008, and incorporates the services sector (telecommunications, information technology and R&D). The other surveys were developed in the periods of 1998–2000 and 2001–3. This section is based on these PINTEC surveys (IBGE 2007). The relevance of adopting strategies aimed at the introduction of innovations for enterprises’ growth and operation is illustrated through recent information available on the website of IBGE. Innovative manufacturing enterprises account for 38.1 per cent of the total number of enterprises. Innovative enterprises from selected services sectors correspond to 46.2 per cent of all enterprises. Brazil, generally, and its manufacturing enterprises specifically, is particularised by extremely low levels of outlays in R&D. Hence, it is not surprising that outcomes from innovation efforts in Brazil are weak. IBGE (2010) data allow for ascertaining that among the nearly 107,000 enterprises covered only near 41,000 (less than two-fifths) introduced some kind of innovation during the period of three years between 2006 and 2008. Out of these firms, more than 32,000 must be deemed as simply imitative firms. They declare having introduced innovations of product or process that are new to enterprise, but not to the market where they operate. That is, only a fraction of the Brazilian enterprises were able to introduce ‘actual’ innovations.

Box 2.2: Federal Programmes of Financial Support in Innovative Process Stages

Source: Adapted from Mani (2001). Authors’ own elaboration.

The low intensity of R&D expenditures on the part of the Brazilian private sector is illustrated by data from this survey. They represented only 0.54 per cent of GDP, whereas in most developed countries this percentage reached 2 per cent. Only a small part of Brazilian enterprise can be deemed as innovators.

Data also reveal a high participation of outlays with acquisition of tangible assets (mainly machinery and equipment) in total expenditures with innovation in Brazil (nearly 45 per cent). On the other hand, the expenditures with internal R&D activities, intangible assets, are lower: 28 per cent of the total. That is, the most investment in innovation by Brazilian enterprises is directed to the acquisition of machinery and equipment.

From the technological point of view, some of the main characteristics of Brazilian industry revealed by IBGE (2007) are:

• The use of foreign technology during the process of imports substitution was not, excepting for a few cases, accompanied by an internal technological effort further than adaptation of such technologies to local conditions and few technological improvements.

• There is a small number of enterprises with formal R&D activities.

• Even among these enterprises, R&D expenditures tend to concentrate on payroll; consequently, R&D efforts, with few exceptions, are limited to incremental improvements of process and product, thus not introducing more radical innovations.

• The reduced effort of R&D results in enterprises having a limited and partial knowledge of their own production processes.

• The technical links external to firms are very faint; this is the case both for the links among enterprises and between enterprises and universities and research institutions.

• The possibility of the establishment of technical relations between enterprises is hindered by the excessive technological heterogeneity of the industry.

Such technological deficiencies do not represent a significant hindrance to economic growth during the process of imports substitution. In more recent times, however, they constitute an important bottleneck. Thus, Brazil in general and manufacturing enterprises in particular are characterised by extremely low levels of expenditures with innovation.

The enterprises of foreign equity capital innovate more than national ones, taking the domestic market as a reference. It does not necessarily imply their own efforts of technological capability building. The higher rates may reflect a strategy for internalisation of new products or processes to Brazil, although developed in a foreign country.

The scarcity of appropriate sources of financing and their high costs appear as risk factors of greater relative weight to domestic enterprises than to foreign ones; a result that is consistent with the restricted access of national enterprises to the external sources, as presented in Section 2.

Cooperation with universities has low relevance. The strongest relations of cooperation are those established with clients and suppliers.

The larger Brazilian-owned enterprises (>500 employees) showed a cooperation effort near to that of multinational companies present in the Brazilian economy and three times greater than those of smaller sizes.

Brazil has been dropping in the world ranking of the United States Patent and Trademark Office (USPTO), supplanted by other emerging countries in the last three decades. In the period 2005–7, Malaysia, China and India presented a great technological dynamism in the areas of electronics and software, with record growth rates. India, which only got to overcome Brazil in the USPTO since the past 10 years, doubled the number of patents in this area regarding the previous three years’ period, reaching 44 per cent of the total, with 620 new patents, while Brazil remained on a low level of 11 per cent, with 32 registers. In electronics, China and India obtained, in this period, respectively 4.7 and 2.2 times more patents than Brazil in the same period (MCT 2008). Another interesting data is that, between 2001 and 2008, universities were responsible for most of them. They filed 1,359 requests at the National Industrial Property Institute (INPI), and the enterprises filed 933.

Table 2.9 presents the problems pointed out by innovative firms. The percentages refer to the number of innovative enterprises that ascribed high importance to problems and hindrances, in relation to the total number of innovative enterprises in each period. The main barriers to innovation in the four analysed periods did not change, although there is a reduction in the degree of importance attributed by firms to these obstacles.

The most recurrent obstacles are: excessive economic risks, high costs of innovation and shortage of appropriate sources of financing. Therefore, the main obstacles identified are rather linked to the economic field than to aspects of technical and information character and/or internal to enterprises.

These data certainly reflect the various instruments and mechanisms of financing and promotion of innovation which have been created since 2000 and described in the previous section. Such instruments, besides providing a variety of financial resources for innovation (reimbursable and non-reimbursable ones) are helping to reduce the innovation costs. Nevertheless, the macroeconomic and market conditions still remain the main hurdles pointed out by enterprises for innovating.

Table 2.10 presents total outlays in innovative activities and in R&D, as well as financing sources used by Brazilian manufacturing enterprises in the four periods covered by PINTEC. It is worth highlighting that information regarding expenditures with innovation activities and R&D refers only to the last year covered by each edition of the survey.

Between 2000 and 2008, a raise is observed in expenditures with internal R&D activities in comparison to total expenditures in innovation activities. This proportion, which was 16.7 per cent in 2000, changed to 21.7 per cent in 2003, to 25.2 per cent in 2005 and reached 28.1 per cent in 2008. The other innovation activities comprise: acquisition of external knowledge, acquisition of software, acquisition of machinery and equipment, trainings, activities aimed at the introduction of technological innovations in the market, at industrial projects and technical innovations. An increase in average expenditures with R&D by enterprises is also observed.

Table 2.9: Innovative Enterprises that Attributed ‘High’ Importance to Factor as Obstacle to Innovation (percentage)

Source: IBGE (2000, 2003, 2005 and 2008).

Note: (1) Not available.

Table 2.10: Financing Sources of Innovation Activities, Brazil, 2000, 2003, 2005 and 2008 (percentage)

Source: Own elaboration. Original values in national currency based on IBGE (2000, 2003, 2005 and 2008). Average exchange rate for each year based on data from BACEN (Brazilian Central Bank).

As can be seen in Table 2.10, a great part of R&D activities is financed with the firms’ own resources. In the three first editions of the survey, the percentage of R&D activities that was financed with resources from third parties remained almost stable around the 11 per cent level. But there was a considerable increase in this share in the last edition, where the results point to a participation of external sources of 24 per cent. The last edition of the survey also revealed a considerable increase in the share of governmental sources among resources from third parties for financing R&D (representing nearly 80 per cent of them). On the other hand, the participation of resources of third parties in financing of other innovation activities was more significant in the first survey (35 per cent in 2000) than in the subsequent ones. Once more we find the same picture with a considerable increase in public resources share among third parts resources for other innovative activities (64 per cent). The big picture reveals a greater participation of private third part financing to other innovation activities than to activities of R&D. It results certainly from the fact that other innovative activities involve fewer risks than R&D activities.

Table 2.11 presents the percentage of expenditures with internal R&D activities on the total expenditure in innovative activities according to the number of a firm’s employees. The data suggest that only in the case of the biggest enterprises (more than 500 employees), there was a relevant change in the relative importance of investment in R&D as opposed to other innovative activities. The share of internal R&D expenditures on total innovation expenditures grew from 20 per cent in 2000 to almost 37 per cent in 2008. For the enterprises of other sizes these figures are oscillating. For all years, the major part of resources has been directed to the acquisition of machinery and equipments. In 2000, the outlays in this activity were higher than 50 per cent of the total; in 2003 this figure was 50 per cent, in 2005 it was 43 per cent and in 2008 nearly 45 per cent.

Table 2.11: Expenses with Internal R&D Activities Over Total Expenses in Innovative Activities, by Firm Size, Brazil, 2000, 2003, 2005, and 2008 (percentage)

Source: IBGE (2000, 2003, 2005 and 2008).

In terms of firm size, it is possible to observe that, in 2000 and 2003, the large enterprises (more than 500 employees) were the ones which used the most resources from third parties for accomplishing R&D activities (Table 2.12). Furthermore, whereas in 2000 there was a major participation of governmental third party resources, in 2003 the main participation was of private third party resources. In 2005 and in 2008, the small (from 30 to 49 employees) and medium enterprises (from 250 to 499 employees) were those which presented the major proportion of resources of third parties in financing R&D activities (being respectively 21 per cent and 22 per cent for 2005 and 44 per cent and 50 per cent for 2008). The other innovative activities, in their turn, count on a greater part of resources from third parties. In 2003, the major participation of public resources in other innovative activities was in small enterprises, whereas in 2005 it was in medium enterprises. In 2008 there is an increase in the share of public resources for all firm sizes.

STI Implicit Policy and Its Influence on Entrepreneurial Investments in Innovative Activities

In this section, we will start from the impact of the implementation of the Real Plan, which determines both the pattern of macroeconomic policy still prevailing and the main implicit industrial policy that Brazil has had: privatisation. The Real Plan followed the basic method used to put an end to most of the great inflations of the 20th century: recovery of confidence in the national currency through the guarantee of its external value. The anchor was the stabilisation of the nominal exchange rate, guaranteed by financing in foreign currency and, more recently, by a reserve amount able to discourage speculation against the exchange rate.

Table 2.12: Sources of Financing Innovative Activities by Firm Size, Brazil, 2000, 2003, 2005 and 2008

Source: IBGE (2000, 2003, 2005 and 2008).

It was possible, thanks to the deflation of securities and real estate wealth observed since the end of 1989 in the global market. The American recession, which lasted until middle of 1992, and the burst of the Japanese speculative bubble were factors which required great attention from the monetary policies. The purpose was to overcome current unbalances in the financial position of companies, banks and families affected by the collapse of the exuberating burst of assets valuation that followed the redemptive intervention of 1987 (Belluzzo 2009).

The liberalisation of foreign commercial and capital flows dates back to the beginning of the 1990s. The Collor government announced an image, and the society bought it, of a modernising plan, adopting the Washington Consensus. Modernising, here, means opening markets and capital flows without any safeguard, for an economic system which operated with strict controls of both capitals and imports. Furthermore, the Brazilian economy underwent a serious recessive period which, in addition to the recession of the American economy, undermined the performance of national enterprises. It resulted in the transfer of control of several national enterprises which had been established at the time of the regime of import substitution, to foreign capital. These enterprises were, in their majority, the best qualified and those which used to make some kind of innovative effort along with the modernisation of production.

When there is a greater freedom for capital flows, a financial market is created which is much more agile and strong in both speculation and arbitrage, involving many kinds of financial innovations. In this global market, which incorporates both the commercial and the financial, the exchange rate becomes a financial asset whose price is instantly adjusted, irrespective of the conditions of the commercial market. This is the reason why a divergence may occur between the commercial exchange rate, which accelerates economic growth and employment, and the global exchange rate. This latter obeys the interests of financial speculation and arbitrage, depending upon the profits it offers to the agents (Netto 2008).

Who, then, directs this financial movement and, therefore, the global supply? It is the expectations arising on the evolution of the economy and of the exchange rate itself, besides the differences between the real internal and external interest rates. The capital flow that either valuates or devaluates the exchange rate depends, obviously, on the differences of return that one dollar may obtain in the foreign financial market and, with the same risk, in the Brazilian financial market. In 2008, our efficient Stock Exchange of Sao Paulo State (BOVESPA) provided the foreign investor a return rate in dollars of the order of 5.5 per cent per month, as against the less than 2 per cent per year in the US (ibid.).

The exchange rate anchor of the Real Plan started with US $1.00 (one dollar) corresponding to R$ 0.83 (83 cents). The appreciation of the real between 1995 and 1998 caused a deficit in the current account of US$ 106 billion. Between 1999 and 2002 we accumulated more than 81 billion dollars in deficits in the current account. The exporting sector only recovered in 2003. Exports have grown at 3.2 per cent per year between 1995 and 1998, and at 8 per cent between 1999 and 2002. The surprising results of 2003 and 2004 were an outcome of the exchange rate devaluation of 2002, of the abundant supply of international credit and of the huge growth of world exports. Between 2002 and 2008, our exports grew 22 per cent per year. This was a consequence of the rise in prices and quantities of agricultural and mineral products, which generate less employment than the manufacturing industry and services (Netto 2008). For financing this deficit, the interest rate should be quite high (see Figure 2.1) and, thus, it produced the very low 2.6 per cent per year average rate of GDP growth. The gross formation of fixed capital has been very low for the same reasons above mentioned.

This implies that, in this economy, the economic incentive is directed to the production of commodities, products that in general have lower technological intensity, with low elasticity of income and of international demand. The domestic opening to foreign trade implies the existence of a strong demand for imports of products with greater technological content. Therefore, there is a structural trend towards deficits in the current account.

The process of liberalisation of productive, commercial and financial flows of the Brazilian economy with other countries culminated with the privatisations in the sectors of raw materials, energy and telecommunications. This measure has modernised consumption in the Brazilian economy, but broke apart the domestic production chains and the efforts for technological capabilities building developed in the previous decades, during the period of imports substitution.

Such movement of liberalisation and privatisation led to a reduction in the mechanisms for protection of the national enterprises and to less intervention by the state, raising the risks of their investments. The monetary policy, which benefited rentiers to the detriment of productive sectors, strengthened the formation of defensive expectations on the part of the national enterprises. Finally, the NSI, unstructured on the grounds of lacking an explicit policy for industrial innovation, remained at very low operational level. In fact, it must be highlighted that, in this period, the integration between the implicit policies, monetary and fiscal, and the industrial innovation policy, the privatisation, was conducted in the opposite direction of the strengthening of national innovative enterprises. In this institutional context, national enterprises deepened the trend to invest in modernisation.

Figure 2.1: SELIC Rate, 1996–2008

Source: BACEN (1996–2008).

It is worth highlighting that privatisation in Brazil transferred assets from the state productive sector corresponding to 15 per cent of the GDP mainly to international monopolistic groups. This has been the major implicit industrial policy carried out in Brazilian history, with deep future impact on the balance of payments as shown by the data on payments of dividends, interests, royalties and profit transfers in 2008. The deficit in the current account amounted to US$ 28.3 billion in 2008, a figure that corresponds to 1.78 per cent of the GDP. In absolute terms, the negative result is the highest since 1998 and closes a period of five years of surpluses, occurred between 2003 and 2007. In the comparison with GDP, however, the deficit is not so high. In the historical average, the deficit in the current account was of 1.75 per cent of GDP between 1947 and 2008. The last negative result had been in 2002, with 1.51 per cent of GDP; in 2001, it was 4.19 per cent of GDP. The current accounts underwent a relatively quick change. In 2007, a surplus had been registered, with US$ 1.551 billion, or 0.12 per cent of GDP. From 2007 to 2008, therefore, there was a variance of US$ 29.851 billion. Little more than half of it (51.2 per cent) is due to the drop in trade surplus, which changed from US$ 40.032 billion to US$ 24.746 billion from one year to the next. The second most important factor (which responds for 38.3 per cent of the change) was the growth in transfers of profits and dividends that increased from US$ 22.435 billion in 2007 to US$ 33.875 billion in 2008. The drop in trade balance is explained by the increment of 43 per cent in imports, which were pulled by the increase of domestic demand and by the appreciation of the exchange rate. Exports increased 23 per cent from one year to the next. The growth in transfers of profits and dividends is due to three main factors. First, the appreciation of the exchange rate observed until September of 2008, which made profits become higher when converted into foreign currency. Second, the good results obtained by the enterprises, until the crisis reach the country. Third, the branches established in Brazil sent more resources in order to cover losses of the headquarters in other countries, especially in the automotive and financial segments (Ribeiro 2009). All this exposes the extreme volatility of the external sector of the Brazilian economy, with strong impacts in the formation of business sector expectations on the future of the productive investment.

In 2004, the government launched the PITCE. However, it kept the same framework of the implicit policies, the mix of appreciated exchange rate and high interest rates. The tendency since 2008 was for Brazil to start having current account surpluses and accumulate foreign currency reserves.

In 2008, a new industrial policy was launched — the PDP. The short interval between PITCE and the launch of PDP shows that the Brazilian government remains divided between liberals and developmentalists. The short interval between them exposes the absence of a long-term strategy. Without even expecting a minimum period for evaluating PITCE, PDP was launched. What can the enterprises expect about stability with such erratic behaviour of the government and a macroeconomic policy? Defensive expectations can hardly be altered. The world economic crisis which suddenly appeared in the second half of 2008 was a new hard shock on them.

The positive aspect of the last years was the cessation of the privatisation process, which allowed Brazil to enter its most important investment cycle since the end of the ‘economic miracle’ of the 1970s. Under the lead of Petrobras and Eletrobras, for instance, the country started again to expand public investments which, supported by state banks, incited the private sector to expand production and employment. However, the success of an industrial policy relies on the pertinence of its internal coherence, on the adequacy between strategy and the organisation of the means for reaching the determined objectives, which affords it essence. It depends on the compatibility and convergence with the macroeconomic policy, which affords the dynamism derived from positive expectations of returns of investments. And, lastly but not less important, on its institutions, which allow the prevalence of a state of trust, the basis for improvement and adaptation before the several situations of economic changes that arise intermittently.

What can be noted from the previous analysis is that Brazil is not yet fully released from the rentism subsided by significantly high real interest rates. The mistakes of the macroeconomic policies involve not only the most recent stage of appreciation of exchange rates, but principally the persistence of the logic of the fictitious valuation of wealth over the investment in production and innovation.

The Role of the Financial System in the National System of Innovation

The importance of funding for investment in innovation has been deemed as a significant structural bottleneck still not solved by private financial institutions. If, on the one hand, the internationalisation, deregulation and globalisation of the financial markets signal the possibility of resources at lower costs, on the other, the characteristics of investment in innovation, such as long term of maturation, uncertainty and risk, suggest the need of existence of domestic institutional arrangements (Melo 1994). In his work on Japan’s NIS, Freeman (1987) claimed that any NIS must be prepared for operating in a way to meet requirements of innovation in four areas: the intervention of the state through public policy, the way enterprises design their strategies of R&D, the impact of education on human resources formation and training of technicians, researchers and other workers, and social innovations related to human resources formation and the conglomerated structure, the enterprises internal organisation and the relations between them, which comprise the industrial structure prevalent in a particular moment in each country.

Including or excluding institutions in a concept is a task that involves historical analysis and theoretical considerations, since at distinct historical periods, different parts of the economic system, or different interfaces between subsystems, may play the most important role in the innovation process. However, there is no investment without financing, as already emphasised in this work. In this sense, Melo (1996) sought support in post-Keynesian concepts, developed by Minsky (1982) and Studart (1993), for adding a fifth characteristic to the previous four defined earlier: the institutional organisation and the structure of the financial sector.

In order for NIS to operate with efficacy, it is fundamental that the previous establishment of an institutional environment of innovation policy take into account the three factors that comprise it. System means that subsystems of the innovation system must operate in a coordinated and compatible way, in order to generate a positive effect on enterprises and, then, induce them to increase investments. For doing so, it is crucial that a public policy on innovation be in place, incorporating the national dimension as priority.

In the discussion of this specific issue, financing and NIS, some authors have already made some relevant analysis. Zysman (1983 and 1986) discussed the impacts of different kinds of financial systems — dominated either by credit or by capital market — on the dynamics of innovations and industrial sectors. Zysman (1983) systematised a typology of financial systems according to distinct links, the institutionality between banks, industry and finances based on the study of several countries. In the capital market–based system, stocks and debentures are the predominant sources of long-term funding for enterprises. In this system, the key function of bank loans is for short-term purposes (finance). The entry and exit of distinct financial operations are relatively simple processes (even more in the presence of elaborate secondary markets). This model would, then, put banks, enterprises and the government at distinct spheres, which would risk meeting as autonomous partners in exchanges. The special characteristics of investments in innovation led to the development of specific financial institutions, which interact with the financial markets. An example is the financing via VC for technology-based enterprises (electronics, information technology, telecommunications, biotechnology) in US and the constitution of a specific market for negotiating stock shares of these enterprises, National Association of Securities Dealers Automated Quotations (NASDAQ).

In the credit-based financial system, the capital market is under-developed and enterprises strongly rely on credit to obtain further financing. The absence of adequate mechanisms for financing investments makes enterprises rapidly increase their indebtedness in order to follow development. The credit-based financial system is, therefore, extremely vulnerable to changes in credit conditions in growth periods. If the interest rate increases, it causes an increase in firms’ financial expenses. The latter will try to adjust by cutting other expenditures. This will start up a vicious cycle of financial reactions which may cause financial instability and drag the economy into recession.

Mayer (2002) questions the so-called financial pre-conditions to the development of a high-technology sector. He criticises the almost unanimous response that these pre-conditions involve the existence of an active sector of VC connected to a capital market able to provide much liquidity. It can be said that Mayer (2002) and Chesnais and Sauviat (2005) line up in their conclusions, even if they are based on distinct theoretical assumptions. Venture capital, as a system for financing innovation, is an innovation adequate to US, but which other countries have difficulties imitating.

The financial systems that intend to positively influence the innovation process must, first of all, confer a major importance to firms’ long-term performance. Second, they must acquire the knowledge of firms and retain the competence for assessing firms’ intangible assets. The Brazilian financial system does not meet any of these requirements.

The close relationship between enterprises and financial institutions allows for better knowledge on the part of these latter on enterprises’ strategy, their management and their sources of competitiveness. Conversely, short-term firms’ evaluation by financial institutions, based on conventional instruments of financial and economic analysis, is completely inadequate for this task. Innovation is an asset constituted by uncertainty, long period of time until producing results, continuous investment in intangible factors, and it is carried out without any precise idea about future market demand. The conventional criteria of economic-financial analysis assess these factors negatively, since they only take into account results already obtained and not the changing processes within enterprise for implementing its innovation strategy.

If the conventional criteria are uncritically applied, they will result in sub-investment in innovation, privileging those activities closer to the market and characterised by lesser uncertainty. In spite of this, the use of such inadequate financial instruments is a consequence, not the cause of theoretical models and myopic institutional structure, biased towards the short term.

A Schumpeterian and Keynesian approach emphasises the role of institutions and conventions for relieving uncertainties of the decision-making process in monetary economies.

Brazil built an extremely sophisticated financial system, able to perform financial operations of high complexity. However, as aforementioned, such technical capability of the financial system derived, first, from the need of agility for financial application of cash balances of the enterprises under a regime of high inflation. Later, this technical capability was used to take advantage of the regime of high interest rates. That is, this technical capability showed to be practically ineffective for improving the articulation with NIS and the financing to innovation.

It was not for lacking financial instruments. In this aspect Brazil has been quite creative. At the end of the 1970s and beginning of the 1980s, VC enterprises already existed, supported by FINEP and BNDES (Melo 1988 and 1994). BNDES already had a portfolio of direct investments of participation in the equity capital of enterprises listed at the Stock Exchange. FINEP already operated directly the investment in innovative enterprises via VC (Melo 1988).

However, the extremely high economic volatility that followed the Mexico moratorium in 1982 has practically paralysed all these initiatives. Only after the implementation of the Real Plan were they were systematically resumed. More recently, the sectorial funds expanded this range of instruments.

The main deficiency in the relation between the financial system and the NIS is that it does not get to provide long-term financing. Even when the instruments for this do exist, they are limited to the public financial institutions. In addition, among these latter there is poor coordination and integration of activities; and, within them, there is no strategic guidance for integrating these instruments.

Understanding this process as a systemic one means to claim that existing financial instruments must operate in an integrated way. Today, in Brazil, there are three instruments for this task: equalisation of interest rates, VC and subvention. The disconnected use of such instruments leads to a fragmented and non-systemic policy.

Such institutional disarticulation reflects with more intensity on the absence of a policy based on state purchase. Brazilian legislation, Law no. 8666/93, in practice impedes any criterion for purchasing by public power, if not by lower price or lower tariff. Preference for national enterprises has been incorporated in the 2010 revision of the law, but it only offers a margin for price divergence. Technical and quality criteria are subordinated to lower price criteria.

Therefore, in order to meet the requirements of a systemic, integrated operation, directed to national innovative enterprises in NIS, it is necessary to have a policy for industrial innovation which can combine the state’s purchasing power, demand with supply, financial instruments. Only thus will it be possible to reduce the negative impacts of implicit policies and, concomitantly, reduce uncertainty and the costs of investments in innovation.

Conclusions and Policy Suggestions for Required Changes Aimed at Improving Innovation Financing in the Country

The Brazilian industrialisation process, led by multinationals and by the state, which pulled, in its expansion, complementary and subordinate investments by national capital in the industrial, agro-industrial and civil construction sectors, exhausted in the 1908s. This depletion left exposed all the contradictions which comprise the framework of structural heterogeneity of Brazilian capitalism, constituted by several asymmetries, two out of which concern directly to the present work. The first one, the financial asymmetry, exposes the lack of interaction between banks and the national manufacturing enterprises, as well as the humble dimension of these latter in international terms, with the few exceptions of PETROBRAS, Vale do Rio Doce and EMBRAER. It is worth noting that all these either were or still are state companies. The existence of large international groups, leaders in the more dynamic markets, makes them independent and disconnected from the Brazilian financial institutions, whose capital is predominantly national. At the same time, the large national groups stay, in general, closed, avoiding opening their capital for concerns of losing control on their enterprises. The disconnection between the banking system and the large industrial capital, blocks the conglomeration of the firms by failing to make the articulation between the financial and the productive circuits, impeding the national groups to overcome their financial fragility.

The Brazilian state, in spite of being the owner of the largest banks of the country, cannot operate actively for articulating the financial and the productive systems, and promoting the process of conglomeration and monopolisation of the capital, since it would involve a broad process of statisation of the economy. Thus, their role is passive, through mechanisms of long-term credit and with partial results.

The financial asymmetry is responsible for the inexistence of large private national groups, of international magnitude, with financial capacity and capability to productive conglomeration, able to face competition at the international market in equal conditions as the large groups from developed countries and even from other emerging countries such as South Korea and China.

The second, the technological asymmetry, results from the problems of international insertion subordinated to the Brazilian economy. The first is the lack of leadership by Brazilian enterprises in the dynamic sectors, which prevents the complete internalisation of industrial innovation, causing a rupture between the capacity for generating knowledge, forming human resources for R&D and the effective introduction in the productive innovation system. The issue is not solved, therefore, only with the increase in resources for innovation. They are important and necessary, but do not solve the central question — the separation of R&D produced outside the country by multinational companies, leaders in the dynamic sectors, and introduced in the country without the need for an internal effort of innovation.

Thus, the NSI undergoes a congenital defect, the weak economic and technological competence of Brazilian enterprises that should be their central and strongest element.

The central problem that must be considered by the innovation policy is not the support to sectors, but technologies that are pervasive to all sectors and firms, such as information technology, biotechnology and nanotechnology. These technologies have a pervasive effect in the economy as a whole, permeating the networks constituted between the enterprises for sharing and using knowledge in production. Thus, the question is how to set a national scale which would allow for the use of these technologies by the national enterprises. Thence the importance of purchasing power of the state, as used by the Petrobras system until now and, formerly, in the constitution of Embraer, now privatised, but with ‘golden share’ of Brazilian state.

We can imply, specifically from the analysis on the relation between the financial system and the financing to innovation, the following:

i) the need for strengthening the entrepreneurial capacity of large Brazilian groups, by creating mechanisms for approach to private banks. A possible alternative for the advancement of this approach would be the use of assets of public banks and financial institutions, as a securitisation of operations between private banks and national enterprises, aiming at their productive conglomeration.

ii) organising for emerging enterprises, with direct participation of public financial institutions, especially the National Bank of Social and Economic Development and the Finance Agency of Studies and Projects, a system of VC exempting them from the responsibility of collaterals, because they do not have these, and enhancing their financial capacity. On this point, it is worth noting a crucial problem that concerns the entrepreneurial competence of these entrepreneurs and innovators, who have no experience of organisation and man-agement of firms.

iii) financing of innovation must aim, principally, at reducing the technological heterogeneity of enterprises, of their production chains and of local production arrangements, aiming at enhancing the use of generic technologies.

iv) an area where the government has intervened in a timid manner, in order to develop the financial system, is that of institutional investors, pension funds, insurance funds and programmes of social security. Such a segment is able to provide and to mobilise high amounts of stable and large-scale resources, which must be channeled to long-term financing, constituting funding for financial institutions.

Developing countries, characterised by scarcity of capital, particularly for long-term investments, cannot count solely on the action of private businessmen or on the invisible hand of the market in the search for a sustainable economic development. The institutional infrastructure built by the state represents, unequivocally, a positive externality for the private enterprises.

The intervention and participation, in the period of startup of industrialisation, were fundamental in the face of the scarcity of capital and of the natural resistance by private entrepreneurs to adventure in high-risk and low-return investments. In the new historical phase of development of countries of recent industrialisation, the support of the public power becomes, once more, essential for promoting the national technological capacity and for providing better stability to the private enterprise.

In brief, the increase in resources for the financial allocation, participation, equalisation, subvention and guarantee of credit and liquidity, with the respective reduction and elimination in resources allocated to contingency reserves, is important. FINEP will need to build its capacity for operating all forms of participation in the risk of innovative enterprises. Now, it is almost exclusively limited to the participation in funds of VC for startup technology-based enterprises. It is an indirect form, perhaps less risky, but that is not compatible with the strategic institutional role that a public financial institution may play in the creation of these enterprises and in sharing the risks of investment in innovation.

Finally, the integrated and articulated operation of NIS relies upon the definition of an innovation policy that faces the problems of articulation between institutions that comprise it, that integrates its subsystems and, thus, reduces the uncertainty inherent to contradictions between implicit and explicit innovation policies, building a trustful institutional environment for investors.

Notes

1. In this period, the strategies of the Banks may be summed up as follows: (a) increased participation of public bonds (short term) in the asset; (b) relative shrinking of credit operations; (c) heavy investments in information technology aiming at reducing operational costs of banking services; and (d) outward diversification — towards non-banking sectors (Hermann 2003: 8).

2. In 1984, the Brazilian government signed a contract with the World Bank for the Program in Support to Scientific and Technological Development (PADCT). The funding of this programme would be comprised by a loan from the World Bank and a counterpart from the FNDCT. The impact of this programme’s resources was very low and did not reach the 5 per cent of total resources managed by FINEP. Its major mark was the new model for managing its resources and applications, through the advisory committees, that would become the basis for the managerial model of the Sectoral Funds (Bastos 2003 and Milanez 2007).

3. The information on FNDCT and FINEP in the tables and graphs was retrieved from FINEP’s budget area. The author thanks the kindness of the researchers André Amaral de Araújo, Marilena Ferraz Andrade and Jose Antonio Bustamante in attending to the data requests for this work. The responsibility for the analyses and concepts emitted based on this information is exclusive to the author.

4. The survey comprises: (a) expenditures with innovative activities; (b) sources of financing innovation expenditures; (c) impact of innovations in enterprises’ performance; (d) sources of information used; (e) cooperative arrangements used; (f) role of governmental incentives; (g) obstacles to innovation activities.

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———, 1996. ‘Sistema Nacional de Inovação (SNI): Uma Proposta de Abordagem Teórica’, Texto para Discussão. Institute of Economics/Universidade Federal do Rio de Janeiro, n. 357, April.

———, 2003. ‘Inovação, Financiamento e Sistemas Locais de Produção’, Anais do First Globelics Conference: Innovation Systems and Development Strategies for the Third Millenium, Rio de Janeiro.

Melo, L. M., 2009. ‘Financiamento à Inovação no Brasil: análise da aplicação dos recursos do Fundo Nacional de Desenvolvimento Científico e Tecnológico (FNDCT) e da Financiadora de Estudos e Projetos (FINEP) de 1967 a 2006’, Revista Brasileira de Inovação, 8(1): 87–120.

Milanez, A. Y., 2007. ’Os Fundos Setoriais São Instituições Adequadas para Promover o Desenvolvimento Industrial do Brasil?’ Revista do BNDES, 14(27): 123–40.

Ministério da Ciência e Tecnologia (MCT), 2008. Relatório Anual da Utilização dos Incentivos Fiscais — ano base 2007. Brasília: Ministério da Ciência e Tecnologia.

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3

The Russian Federation

Natalia Gorodnikova

The increasing role of innovations in the economy, the changing speed, trends and mechanisms of innovation activities are major factors causing radical shifts in the economies of developed (and of many developing) countries. These include increased investments in education and science in technological and organisational innovations; faster development of high-tech industries accompanied by overall increase of traditional industries’ technological level; and the emergence of new industries.

Certain specific features of innovation activities — such as uncertain and delayed results, mismatch between overall social and specific individual effects, between information available to researchers, innovators, potential investors and consumers; high investment risks; and particular requirements regarding workforce skills and management quality increase the role of the innovative ‘component’ of public administration. The scale of and the mechanisms for providing government support to Research and Development (R&D) and innovation in countries change along with the country’s development, shifting priorities and even changing political fashion. At the same time the high ‘average’ level of such support and the wide range of relevant tools define the paradigm of modern innovation policy in countries with a developed market economy.

The main attributes of this paradigm include:

• Orientation towards long-term technological priorities identified taking into account global trends and internal socio-economic objectives connected with sustainable development, increased competitiveness and national security;

• Pursuit of optimal balance between direct government funding and targeted support of R&D and innovation activities;

• Encouraging innovative development in the broad economic context, including creation of favourable conditions, promoting innovative behaviour of all economic players. Particular attention is paid to increasing efficiency of public institutions and government agencies responsible for development and implementation of efficient models and mechanisms, customised regulation techniques and tools;

• Building up effort aimed at development of new efficient tools and mechanisms of public–private sector partnership (PPP). Facilitating and supporting such alliances, the governments sends ‘innovative development signals’ to business, helps to implement company innovation strategies and major innovative projects (co-investment, infrastructure building, promoting transfer of technology and R&D results), and at the same time increase returns on their own investments;

• Growing interest in research-intensive services and non-technological innovations (i.e. organisational, management, marketing, consumer innovations), largely defined by the recognised crucial role of information and communications technologies.

During the last 10–15 years virtually all industrially developed and newly industrialised countries including China have set their R&D and innovation goals through strategic programme documents. This in itself serves as a motivation for R&D and innovation activities, in both the public and private sectors.

Two major trends profoundly affect the long-term prospects of innovative development — and, accordingly, development of innovation strategies. The first is globalisation and global competition which speeds up introduction of new technologies and products to the markets and forces companies and entire countries to boost their innovation activities. The emergence of new global players in the international science and technology (S&T) ‘space’ also increasingly affects innovation activities. International technology transfer, transnational corporations, labour mobility and other factors play an increasingly important role. At the same time proposed solutions for global problems are also becoming more innovative (e.g. cures for various diseases, power generation, climate change, etc.).

The second trend is increasingly more complex innovations whose interdisciplinary, cross-sector nature demands more and more substantial — and more risky — investments. Most companies already cannot afford to carry on innovation activities on their own — funding all the relevant research, obtaining market-related information, etc. The challenge is to join forces, attract outside knowledge without losing independence and harming one’s own interests.

Emphasis is now being placed on open innovations which ensure not just quick recovery of R&D and innovation activity expenditures but also the involvement of talented people with diverse skills (the increasing need for the latter is another sign of the current times). The ability to adapt quickly, use knowledge acquired from external sources in a flexible way, becomes the key to successful innovation and making profits out of in-house generated knowledge (Chesbrough 2003).

The need to adapt innovation policy to the complex, spatially distributed, changing nature of innovations directly affects such policy areas and tools as taxation; support for human and social capital development; regulation of labour and investment markets; conducting R&D; promotion of best practices in corporate strategy development, finance and management. Recent Russian government policy papers on strategy development connected with switching the economy to an innovation-based model clearly demonstrate that the government has a serious, firm agenda. At the same time the exact motivation of the innovation-driven scenario, values of certain target indicators, the list of policy areas and specific measures to be taken to implement those policies with minimum social costs, may be questioned. An illustration of that is the debate on the draft ‘Concept for long-term socio-economic development of the Russian Federation’, and the long-term forecast of the Russian Federation S&T development until 2025, which is taking place in various government agencies and in the expert community. The authors and critics of these documents agree about one thing: their implementation would require truly unprecedented efforts by the government, to support and coordinate all participants of innovation activities and achieve significant progress in reforming the National Innovation System (NIS) to substantially improve its basic parameters and increase efficiency of innovation policy.

Recent Development of the Financial System’s Structure and Its Role in Financing the Production Sector

The contemporary system of S&T and innovation funding in Russia should be regarded as an outcome of the transition from the Soviet centralised model to the market economy. Therefore two stages must be specified: the Soviet ‘context’ period of 1985–91 and the transition stage of the 1990s. Over 1985–99 and especially during the second half of the period, one socio-economic or political crisis followed another; it was a very hard time for the science sector as well as for the whole economy. Government support to the R&D sphere was reduced greatly. Research organisations were forced to spend most of their time looking for other sources of funding, trying to adapt to a radically new environment. It became much harder to survive, to find partners, to keep skilled personnel. During the last years before the collapse of the USSR (the late 1980s) R&D expenditures funded from the government and other sources grew steadily. Over 1985–89 their total amount increased from 3.7 to 4.7 per cent of the GDP (USSR Goskomstat 1990: 290).

In a situation of rapidly deteriorating macroeconomic conditions made worse by a series of political crises, all players engaged in S&T processes (from government agencies to individual enterprises and organisations) became unable to finance their R&D on the previous years’ level. Accordingly, the amount of internal R&D expenditures started to drop sharply; over 1989–95 it decreased by 3.8 times in constant prices (HSE 2005; 55). In the situation of radical market reforms the science sector was seriously affected by high inflation, greatly reduced government support and low demand by industries and enterprises and by lack of consistent national S&T and innovation policy (at least at the beginning of the period in question).

The development of the Soviet and post-Soviet economy was largely determined by the military–industrial complex’s potential and by mining, metallurgy and heavy engineering industries. Accordingly, the industrial sector had always prevailed in the R&D sphere (later on to be replaced by the enterprise sector), i.e. industrial research institutes and designed bureaus oriented towards the demand by specific industries. However, while market-based mechanisms were actively implemented in the economy (during 1989–95), the sector’s R&D expenditures have reduced fivefold, from 8,498.6 to 1,702.8 million roubles in 1989 prices. At the same time the sector’s share in the total internal R&D expenditures has dropped from 80 to 68.5 per cent (HSE 2005: 114). Until 1992 the public sector share (mainly represented by state academic institutes) never exceeded 17 per cent, about five times lower than the industrial (enterprise) sectors. In the course of winding up industrial R&D activities, the public sector’s share of expenditures started to grow. One of the reasons was the political clout of the state academies of science (especially the Russian Academy of Science) that actively lobbied their vested interests. Second, in post-Soviet Russia a full-fledged corporate (private) segment of the R&D sector never developed. Another unusual feature is the weak R&D divisions of higher education institutes and universities. Their R&D work (unlike R&D conducted by research institutes) was not included in the centralised planning and funding system. These projects were financed mainly through contracts with industrial enterprises and research organisations. Before the collapse of the USSR the higher education sector’s science accounted for just 7 per cent of the total internal R&D expenditures. By the end of the 1990s this figure dropped even further, to 4.8 per cent — an almost marginal amount for a developed country. Thus the increased role of the public sector wasn’t due to the quality of its R&D products but, rather, to the weakness of other segments of the science sphere.

The period of the country’s R&D system transformation was characterised not just by financial cutbacks but also by shifts in the funding structure. In the planned economy the whole R&D system functioned in the environment of centralised accumulation and allocation of financial resources via the government budget (whose share in the total amount of funds allocated for R&D purposes until 1991 never went below 91 per cent). Financial support for R&D work provided by enterprises out of their own funds was insignificant. It should be noted that the centralised R&D funding system survived almost until the mid-1990s. The main barriers to development of alternative funding sources during that period were macroeconomic problems: failed expectations of the research community who believed that the reforms started in the country would encourage demand for innovations, which in turn would increase investments into R&D. However, industrial enterprises were affected by the overall recession no less heavily than the R&D organisations. Detailed statistics on funding sources (which have become available since 1994) demonstrate total dominance of the government budget whose share of the country’s internal R&D expenditures reached 61 per cent; the enterprise sector provided less than 20 per cent while organisations’ own funds accounted for just over 10 per cent (HSE 2005: 117–18).

A distinctive feature of the Soviet (and later on the Russian) science is its weak innovative orientation. Market failures in the innovation field can be explained not only (and not so much) by the economic recession of the 1990s as by mismatch between the subject areas of the R&D, institutional structures and organisational mechanisms of the science sector on the one hand, and the needs of the economy on the other. Even in the situation of investment growth at the turn of the 21st century there wasn’t any significant inflow of funds into the R&D sector.

Separation of applied science from enterprises and departmental barriers resulted in a gap between R&D and innovation activities. The economic mechanism on the basis of which research institutes and design bureaus used to function was oriented primarily towards encouraging research, not innovation. The misbalance between them resulted in a radical decline of productivity and quality of research, in low technological level of the Russian industry and other sectors of the economy, poor state of production equipment and ultimately, low competitiveness of Russian products.

Another weakness of the planned economy (and of the transitional economic mechanism) is dissemination of innovations. Even when the country was a leader in developing major innovations, it lagged behind in terms of implementing them; examples include steel making and processing technologies. The reverse side of this phenomenon is (often) unjustified adoption of imported technologies when efficient domestic alternatives were available. Accordingly, instead of integration into global innovation processes the country became stuck with the ‘catching up’ paradigm of S&T development. Low prices for domestic technologies (compared with imported ones), more favourable prospects for internal cooperation (as opposed to international) on the one hand, and tough competition on international markets, enterprises’ lack of funds and experience necessary to promote Russian R&D products abroad and patent them in foreign countries on the other, resulted in a certain isolation of the Russian domestic technology market.

After the socio-economic transformations of the early 1990s, the Russian NIS remains unbalanced; its major components — such as the S&T sphere, enterprises and innovation infrastructure — exist in isolation from each other. In the situation of vague economic prospects, the industrial sector’s strategy is not oriented towards innovation development and application of Russian R&D results. Russia will not be able to sustain its R&D potential if it doesn’t maintain close links with the national economy, while the economy won’t become competitive if it doesn’t rely on R&D. Currently the S&T sector is not a growth factor for the national economy; rather, the whole economy of post-Soviet Russia (and unbalanced R&D and innovation funding mechanisms in particular) is a factor of decline in the S&T sector. In the long run it can lead to irreversible degradation both of the R&D sphere and the high-technology industries; accordingly, fast modernisation of the NIS becomes top priority for creating the ‘new economy’.

Considerable growth of R&D expenditure (measured at constant prices) started only in 2006. In 2007, the gross expenditure on R&D (GERD) at current prices amounted to RUB 371.1 billion (Figure 3.1).

At comparable prices, these costs reached 76.3 per cent of the 1991 level but remained almost twice lower than in 1990. The breakdown of expenditures by source of funding and by sector of performance has changed little since the early 1990s. Due to many years of insufficient funding, absence of modern funding and motivation mechanisms, Russia did not manage to catch up with the world leaders neither in terms of volume nor comparable cost indicators (Table 3.1).

One of the key indicators of S&T development is the share of R&D expenditure in the GDP. In Russia this indicator grew over the period of 1995–2003 from 0.85 per cent to 1.28 per cent; in 2004 it again decreased to the level of 1.07 per cent, which remained until 2006, and started growing again in 2007. In line with targets of the S&T and Innovation Strategy of the Russian Federation for the period until 2015 (Ministry of Education and Science of the Russian Federation 2006) this key indicator should have grown much faster: in 2006 to 1.51 per cent and in 2007 to 1.62 per cent of GDP. However, its actual value proved to be considerably lower than the targets (Table 3.2), which in turn must have influenced other indicators mentioned in the document.

The analysis of R&D expenditure distribution by sector shows that the largest — like in other countries — was the business sector. The share of public sector in overall expenditure fluctuated in the past years from 24.3 to 29.1 per cent — the top value was reached in 2007. This is quite different from the Organisation for Economic Cooperation and Development (OECD) countries (on average 11.4 per cent in 2006) and the EU-27 (13.8 per cent).

The breakdown of Russian R&D expenditure by sector has changed little during the period 1995–2007. The greatest share (64–70 per cent) is concentrated in the business sector, with a little more than a quarter of the total being spent in the public sector. The main difference between Russia and other developed countries is the role of the public sector and higher education sector. The share of the Russian public sector in R&D expenditure is twice as high, while the share of higher education sector is nearly three times lower than the OECD average. The state budget has been the key funding source for Russia’s S&T sphere. In 2007, the state budget covered 62.6 per cent of all R&D expenditure. The system of public S&T funding has been heavily dominated by the federal budget.¹ In the course of previous years preserving (and in some years even increasing) the government budget’s share of R&D expenditure has been more or less necessary. This reflects not only the priority of S&T development objectives set by the government but also the low share of other S&T funding sources, especially the businesses. In 2007, the share of non-public expenditure in the total volume of internal S&T costs amounted to 37.4 per cent — less than the figure set in the S&T and Innovation Strategy. The funds allocated to universities (almost all of which are earmarked for educational purposes) are little used for R&D purposes (in 2007, they constituted only 0.2 per cent of total R&D expenditure).

Figure 3.1: Gross Domestic Expenditure on R&D

Source: HSE (2005, 2009b). Original data: Institute for Statistical Studies and Economics of Knowledge (ISSEK). Available at http://issek.hse.ru/en/dep_scieninnovat (accessed 3 June 2010).

Table 3.1: Gross Domestic Expenditure on R&D (million current PPP US$)

Source: HSE (2005, 2009b). Original data: Institute for Statistical Studies and Economics of Knowledge (ISSEK). Available at http://issek.hse.

Table 3.2: GERD as a Percentage of GDP

Source: HSE (2005, 2009b). Original data: Institute for Statistical Studies and Economics of Knowledge (ISSEK). Available at http://issek.hse.ru/en/dep_scieninnovat (accessed 3 June 2010).

In 1995–2007, the GERD financed from government sources grew 2.3 times (at constant prices). At current prices their volume reached RUB 232.4 billion — twice as much as the funds provided by the business sector which in 2007 grew to RUB 109.3 billion (29.4 per cent of the total expenditure).² The ratio of public/private investment in the S&T sphere describes the core element of the national S&T system and its place among other countries.

The civil R&D budget appropriations are another key indicator of S&T funding. Their total volume in Russia in 2008 amounted to RUB 162.1 billion at current prices (Table 3.3). In 2007 this indicator amounted to RUB 132.7 billion, which at constant prices is 2.4 times lower than in 1991. The consequences of reduced budgetary support to S&T in 1991–96 in the situation of rapidly growing inflation and the economic crisis of 1998 explain the lack of effect from the later budget increase. The 3.1 times increase of budgetary appropriations from 1998 to 2007 (at constant prices) only allowed the attainment of the 1993 level, when the level of appropriations was 60 per cent less than in 1991. Civil R&D federal budget appropriations as a share of the GDP show similar dynamics: in 1991–98 they decreased from 0.96 per cent to 0.24 per cent and then grew to 0.40 per cent not even reaching the 1994 level.

Table 3.3: Indicators of Innovation Activities of Industrial Enterprises: Federal Budget Appropriations on Civil Science and Technology

Source: HSE (2009a). Original data: Institute for Statistical Studies and Economics of Knowledge (ISSEK). Available at http://issek.hse.ru/en/dep_scieninnovat (accessed 3 June 2010).

Figure 3.2: Federal Budget Appropriations on Civil Science and Technology (million roubles, before 1998 — billion roubles)

Source: HSE (2005, 2009b). Original data: Institute for Statistical Studies and Economics of Knowledge (ISSEK). Available at http://issek.hse.ru/en/dep_scieninnovat (accessed 3 June 2010).

In 2007, the share of non-public funds in the total volume of GERD amounted to 37.4 per cent — less than the figure set in the S&T and Innovation Strategy. The share of foreign fund sources shows rather shaky dynamics: in 1995–2007 this value varied between 4.6–16.9 per cent, in 2007 it was 7.2 per cent.

It should be noted that the Russian R&D expenditure structure provides specific data not just on higher education institutions but industrial enterprises as well. Unlike most foreign countries where universities and industrial companies play a leading role in S&T development, in Russia these organisations are less important in this area. For example, the number of industrial enterprises performing R&D activities in 2007 was 265, or just 6.7 per cent of the total (they employed 7.1 per cent of R&D personnel). Industrial enterprises’ share in GERD is comparable with these figures — only 6.8 per cent (RUB 25.3 billion at current prices). Note that the breakdown of industrial enterprises’ R&D expenditure by funding source is different from the overall picture. Just under 50 per cent of the total costs are covered by public funds (coming from government budgets of all levels); slightly more than 25 per cent of expenditures were covered by enterprises’ own funds; and the rest came from business enterprise sector organisations (11 per cent), public sector organisations (4 per cent), non-budget foundations (2.8 per cent), higher education institutions (0.2 per cent) and foreign organisations (6.8 per cent).

Innovation Activities in Russia and their Funding

Current trends of innovation activities in Russia do not fully match expectations in line with the creation of innovation-based economy, achieving dynamic sustainable growth, increased competitiveness of products and higher quality of life. So far there are no grounds for talking about technological breakthroughs in industry or active implementation of R&D results. Businesses’ demand for and interest in innovations, especially technological ones, remains low. Furthermore, the latest data suggests there is stagnation in this area (Table 3.4).

So far innovations have had little real effect on the economy. On the other hand, the macroeconomic situation and the institutional framework are hindering enterprises’ innovation activities. Their level is low in all industries and sectors of the economy — industrial production including small businesses and services, and for all types of innovations — technological, organisational, marketing. The crises of the late 1980s–early 1990s led to a significant drop of innovation activities’ level, from 60–70 per cent to 5–6 per cent in the post-reform years. Growth of this figure coincided with the growth of macroeconomic indicators.³ The peak was achieved in 2000 due to the short-term import substitution boom following the financial crisis of 1998. Then the indicator’s dynamics stabilised at 9–11 per cent. In 2007 2,485 industrial enterprises performed development and implementation of technological innovations, or 9.4 per cent of their total number — not an impressive figure compared with the EU members including Eastern European countries. The closest to Russia in this respect are Latvia (17 per cent) and Bulgaria (18 per cent). Germany, Ireland and the Czech Republic show much higher figures: 73 per cent, 61 per cent and 41 per cent, respectively.

Table 3.4: Main Indicators of Innovation Activities of Industrial Enterprises

Source: HSE (2009a). Original data: Institute for Statistical Studies and Economics of Knowledge (ISSEK). Available at http://issek.hse.ru/en/dep_scieninnovat (accessed 3 June 2010).

To analyse the current situation let’s take a look at the factors affecting enterprisers’ demand for innovations and their success in implementing innovations. The analysis shows that the highest demand for innovations demonstrates large, economically sound enterprises with sufficient financial, labour and intellectual resources. Note that the bigger the companies in a group, the higher share of innovators the group shows. Half of the Russian industrial enterprises engaged in technological innovations employ more than 500 workers.

But it’s not just about size. High-tech companies with not especially large output — or especially high level of investments — demonstrate impressive results. Their innovation activities are above 30.4 per cent, which is close to the European average.⁴ In this case important factors include highly developed R&D potential, skilled workforce, highly efficient innovation expenditures, orientation towards international markets, various forms of government support. Unfortunately, due to their limited output these companies’ activities so far have little effect on the overall innovation activities indicators for the Russian economy. In medium-technology industries the level of innovation activities is 1.5–2.5 times lower; in low-tech industries it’s five times lower.

Small enterprises play an important role in development of innovation activities — due to their willingness to take initiative, flexibility and ability to adapt to changing environments quickly. In the situation of growing diversification and customisation of production, small companies show better results in developing and producing small-lot innovative products. In Russia, due to the generally weak small business support infrastructure, these companies cannot yet contribute to the overall increase of the innovation activities’ level. The current situation is largely caused by insufficient level of small business development in the Russian economy generally.

The share of small enterprises engaged in technological innovations in 1999–2005 remained under 1.6 per cent; in 2007 it increased to 4.3 per cent (see Table 3.5).

Small firms lack the required financial resources, adequate R&D potential, skilled personnel needed to implement even modest innovative projects, much less radical innovations — or the time necessary to introduce new technological processes and wait until they pay enough to cover the costs. Normally they need comprehensive support (financial, intellectual, information) by the government, large parent enterprises or external investors. In developed countries the tune for innovation activities is usually set by large companies, while small enterprises are commonly used as testing grounds to try innovations out. In Russia the inertia of large and medium enterprises, their lack of enthusiasm for implementing innovative solutions, cast their shadow on innovation activities of small firms as well. The statistical ‘leap’ of 2007 in small companies’ innovation activities was probably due to the different sample of the surveyed enterprises in this group. That would also explain the mismatch between the actual and planned in the Science and Innovation Strategy increase of the number of small enterprises: in 2007 this figure amounted to just 39. Apparently, util-ising innovative potential of small enterprises requires serious effort by government agencies.

Non-technological innovations (i.e., organisational and marketing ones) are playing an increasingly important role in increasing production efficiency and boosting innovation activities. However, that kind of innovation hasn’t yet taken its proper place in the Russian practice: the overall level of innovation activities (calculated taking into account all types of innovations) in 2007 amounted to just 10.8 per cent — only slightly higher than the figure for technological innovations.

Organisational innovations include introduction of advanced corporate management techniques as a recognised factor contributing to increased competitiveness; development of new and improvement of existing mechanisms and forms for organising production and labour. Normally such techniques and methods involve development of more advanced corporate strategies — entry into new markets, mergers and acquisitions, adoption of international management and product certification standards. Since 2006, the share of organisations which implemented organisational innovations in the reporting year is used as an indicator for measuring these types of innovation activities, calculated in line with international statistical standards. In 2007 in Russia this figure was at 3.5 per cent.

Table 3.5: Innovation Activities of Small Industrial Enterprises

Source: HSE (2009a). Original data: Institute for Statistical Studies and Economics of Knowledge (ISSEK). Available at http://issek.hse.ru/en/dep_scieninnovat (accessed 3 June 2010).

Success of innovative projects largely depends on how clearly company management sees the market situation — market potential, trends, competition, efficient advertising techniques, etc. Accordingly, marketing innovations are being actively developed around the world, aimed at adapting products and services to the clients’ needs to increase production and sales. In Russia the role of marketing in corporate management has been ignored for quite a long time. This, combined with lack of skilled personnel, is hindering the innovation process even further. In 2007, 656 Russian industrial organisations were engaged in marketing innovations (2.5 per cent). In high-tech industries this figure was three times higher. Today Russian companies are beginning to realise the importance not just of specific marketing tools and techniques but of implementing them as a wholesome integrated business management concept.

In the overall national economy the effect of innovation activities is not especially apparent. In 2007 large- and medium-size enterprises produced 916.1 billion roubles’ worth of innovative products; their share of the total amount of industrial products’ sales remained under 5.5 per cent. Small enterprises manufactured 12.6 billion roubles’ worth of innovative products, or 2 per cent of all shipped industrial products. Despite the fact that appropriate overall figures for the whole industrial production show certain growth (3.3 per cent in 1996, 3.7 per cent in 1999), it’s certainly a very small contribution which doesn’t have any appreciable effect on production development, competitiveness and export potential. According to calculations, in the EU countries the total share of innovative products was in excess of 60 per cent, and in some industries even higher.

The ratio of total sales by innovative and non-innovative companies in Russia is 48.2 and 51.8 per cent. Compared with the EU domestic innovative enterprises are ahead only of Bulgaria (39.7 per cent); their figure is twice lower than that of Germany’s which is the leader at 91.3 per cent. Thus, despite all efforts the overall efficiency of Russian industrial companies’ innovation activities remains low. This is confirmed by dynamics of innovative products’ output: in 1995–2007 the absolute figure increased only by 77 per cent while innovation-related expenditures during the same period grew more than twice. Accordingly, the return on investment (ROI) dropped from 5.5 to 4.4 roubles per rouble spent on technological innovations.

Low efficiency of innovation activities significantly weakens competitiveness of Russian producers on international markets. Most of their export is made by products which haven’t been subjected to technological change. Export of innovative products (services) in 2007 was estimated at 276.3 billion roubles; despite significant growth in the last two years, the share of such products (services) in the total export of industrial enterprises amounted to just 7.9 per cent (see Table 3.6).

The actual value of this indicator exceeded the target figure set in the strategy. The discrepancy is due to increased exports of high-level medium-technology industries, primarily chemicals (21.6 per cent against 16.2 per cent in 2006), and mining (except fuel and energy resources) (6 per cent).

The domestic market demonstrates a decline of interest in innovative products, caused among other factors by growing inflation, growing internal commodity prices and highly competitive foreign-made analogues. The share of innovative products and services in the total domestic sales amounted to 3.8 per cent — almost 1.5 times less than in 2005. Companies’ demand for innovations is largely determined by the availability of resources. The level of investments in innovations usually is not adequate to the objective of switching the economy to the new development model. Insufficient funding slows down implementation of efficient projects, which lowers the overall innovation activity level even further. The quality of innovations deteriorates too; opportunities to innovate on an ongoing basis are not provided. Implementing radical full-cycle innovations — from performing specialised R&D to manufacturing fundamentally new products — becomes increasingly more expensive, so enterprises are less and less able to afford it.

Overall expenditures on technological innovations during 1995–2007 show positive trends: their volume (at constant prices) has doubled (see Table 3.7). Note that growth was performed both in high-tech and low-tech industries. At the same time the absolute amount of these investments was just 207.5 billion roubles — almost two times less than R&D expenditure. This is an indirect evidence of insufficient use of national S&T potential for development of the real sector of the economy.

Table 3.6: Sales of Innovative Products of Industrial Enterprises

Source: HSE (2009a). Original data: Institute for Statistical Studies and Economics of Knowledge (ISSEK). Available at http://issek.hse.ru/en/dep_scieninnovat (accessed 3 June 2010).

Table 3.7: Expenditure on Technological Innovation of Industrial Enterprises

Source: HSE (2009a). Original data: Institute for Statistical Studies and Economics of Knowledge (ISSEK). Available at http://issek.hse.ru/en/dep_scieninnovat (accessed 3 June 2010).

The level of investments in technological innovations is not comparable with the economy’s needs for modernisation of capital assets and increasing the range of new competitive products. The rate of such investments (their share in the total industrial output) in 2007 was no higher than 1.2 per cent. Note that since 2002 when this indicator had reached its peak (1.8 per cent compared with 0.9 per cent in 1995) it steadily dropped lagging behind the growth rate of industrial production in the country. The gap with developed countries is also growing: only Malta, Spain, Portugal, Norway and Bulgaria show even lower values (0.9–1.4 per cent). In France this indicator reaches 3.4 per cent, in Germany 4.6 per cent, in Sweden 5.6 per cent, in Baltic countries 1.8–2.8 per cent.

This stagnation in the innovation sphere is largely due to insufficient attention the government pays to implementation of innovations in the real economy (sluggishness and inconsistency of institutional reforms, lack of integrated approach to indirect motivation, insufficient financial support). Despite the wide variety of funding mechanisms and forms, enterprises’ own funds still remain the main source: 87 per cent in 1995 and 79.6 per cent in 2007. Share of credits and loans in 2005–7 dropped from 17.5 to 13.7 per cent; note that only 4 per cent of all credits and loans have been provided on preferential terms. This is explained both by the banks’ lack of confidence in proposed innovative projects and by the overall problems with the banking system — insufficient credit resources, inability to offer syndicated credit services, high interest rates, short terms of loans, and limited range of breaks and incentives offered to clients.

Combined public funding covers just 4 per cent of total expenditures on innovations. More than 50 per cent of the federal budget funds are channelled into high-tech industries, which increase the rate of their innovation expenditures. Three-quarters of funds provided out of regional and local budgets go into low-level medium-technology industries, mostly metallurgy. Other funding sources (non-budgetary foundations, foreign investors, venture funds) amount to 0.04–0.3 per cent of the total. Foreign investments (0.6 billion roubles) mostly go into food production (47.6 per cent) and manufacturing of cars, trailers and semitrailers (31.2 per cent of the total). Venture investments into innovation projects by large and medium enterprises in 2007 amounted to 76.2 million roubles (0.04 per cent of the total expenditures on technological innovations), and were made only in one sector — non-metal mineral products.

A breakdown of expenditures by type of innovation activity reveals a serious misbalance against investments in knowledge and human capital. Most of the funds are spent on acquisition of machinery and equipment (57.5 per cent). Then (with manifold gap) come expenditures on R&D (17.3 per cent) and industrial designs (7 per cent). Expenditures on acquiring patent licenses (0.8 per cent), staff training and retraining (0.5 per cent), marketing research (0.3 per cent) also can hardly be considered sufficient. On top of that, during the recent years there was a steady trend to increase investments in machinery and equipment (by 3.3 times in constant prices in 1995–2007), and reduce R&D expenditure.

International comparison reveals quite different proportions between types of innovation activities. In most of the economically developed European countries R&D expenditure are 1.5–2 times (or even more) higher than investments in machinery and equipment. For example, in France this ratio is 9:1, in Denmark and Norway 5:1. In some Eastern European countries — like in Russia — it has shifted towards machinery and equipment expenditures: in Bulgaria (8 and 89 per cent), Slovenia (10 and 89 per cent), Poland (10 and 86 per cent).

Innovation activities in the EU countries are performed on a different, more advanced technological basis. Enterprises strive to increase the novelty level of innovations and their competitiveness, so they invest in R&D — which is mostly conducted in-house. On the other hand, in Russia innovation activities primarily amount to the modernisation of active capital assets. This situation has an overall negative effect on the whole innovation process, leading to degradation of industrial S&T potential, poorer quality and low novelty of innovative products and services. Enterprises are losing the ability to innovate and, accordingly, are becoming less competitive in the markets of new high-tech products.

Survey of Existing Funding Mechanisms and Tools

Sustainable development of S&T and innovation activities can be achieved through creation of efficient funding tools regulated by a system of coordinated legislation. Quite a number of different funding mechanisms can be used, including budget appropriations, credits and loans, targeted funding, public, private or joint investments in R&D and innovative projects. The following section describes the most important Russian funding instruments.

The federal budget is the main funding source for Russian R&D, and remained such during the whole post-Soviet period. Regardless of the absolute budget appropriations, the share of budget funding remains more or less constant — at about 60 per cent of GERD.

By law public budget funds can only be used to finance services provided in the interest of the whole society or to support public structures and organisations created for the same purposes. There are two forms of budget funding of R&D: basic funding (funds are allocated as a specific budget article) and grants. Baseline funding is provided to specific R&D organisations based on the number of their staff and last year’s level of expenditures. R&D expenditure amounts to at least 95 per cent of total public expenditures on S&T; the remaining 3–5 per cent of GERD are invested in capital assets.

Programme funding can be tender-based or allocated to specific organisations to implement specific projects. Such funds are provided through government programmes of various levels. Usually the programme mechanism is used to finance projects aimed at solving specific (mostly major) S&T problems (e.g. in airspace industry, nuclear physics and aircraft construction).

An important tool for dealing with priority national objectives — and a mechanism for public funding of R&D — are the Federal Goal-oriented Programmes (FGP). In the 1990s the number of FGPs was exceedingly large: between 96 and 155 such programmes were financed out of the government budget. As a result, the burden on the budget became too much and, accordingly, budget money — albeit allocated routinely — was not actually paid. The problem was made even worse by equally frequent failures to receive funds due from other, non-budgetary sources. The first victims of this lack of funds were R&D projects. The introduction (in 1996) of officially approved lists of priority S&T areas and crucial technologies had practically no effect on existing approaches to composing S&T sections of FGPs. All it actually amounted to was identifying such priority areas in S&T sections of existing FGPs.

Due to all of these reasons, R&D provided for in FGPs was only loosely related to the programmes’ goals and objectives. Some FGPs supported R&D projects whose contribution to the programmes’ ultimate goals was far from obvious. In 2004, the framework of FGPs was radically reconsidered; the total number of these programmes was significantly reduced, and by 2005 only 54 FGPs were funded out of the government budget. This restructuring was continued in 2006. Currently, 52 FGPs are being implemented. Essentially, FGPs are being merged together into larger programmes. This initiative was proposed by the Ministry for Economic Development, which suggested reducing the number of FGPs while increasing their share of budget appropriations and more closely monitoring how the money was spent. Thus it was recognised that targeted funding was more efficient than basic budget funding, so increasing its share should also increase returns on public investments.

In 2005, R&D funding was provided through 33 FGPs; in 2006 the number of FGPs was 23 (accordingly, innovative projects were financed through 21 and 29 FGPs). Despite the reduction of FGPs with S&T components, the amount of federal budget appropriations to finance them has increased in 2006. However, some of the programmes were seriously underfinanced. For example, FGP ‘Electronic Russia’ received only 20 per cent of the approved funds, while FGP ‘Development of Unified General Education Information Environment in 2001–2005’ received 52 per cent of the allocated money.

Grant funding is tender-based; grants are provided to support the best projects and the most productive research teams. Grants are allocated through the system of public foundations: the Russian Basic Research Foundation (RBRF), the Russian Foundation for Humanities (RFH), and the Russian Foundation for Assistance to Small Innovative Enterprises (FASIE). These foundations receive a (specified by legislation) percentage of total budget appropriations to finance civil research. The percentage hasn’t been changed in about 10 years, which is an evidence of stagnation of this funding mechanism. Research foundations finance small basic research projects which usually have unpredictable results.

The FASIE is a good subject for evaluation of commercial R&D projects. This foundation was established by the RF government regulation no. 65 of 3 February 1994 as a public non-profit organisation. In effect, FASIE is a public research institution that has the mandate to:

• Implement government policy to develop and support small innovative enterprises (SIE);

• Provide direct financial, information and other support to SIE pursuing projects to develop and manufacture new research-intensive products and technologies based on own intellectual property;

• Create and develop infrastructure to support small innovative entrepreneurship.

The foundation conducts ongoing monitoring of SIE in the country, analyses the situation, prepares reports about the state of affairs and its own activities for the general public and the RF government, and makes relevant suggestions. The foundation’s analytical materials are in public domain, divided into three categories: innovation activities, intellectual property and venture financing. The foundation also holds regular tenders to finance applied research projects within the framework of its own programmes.

The foundations mentioned here have many functions and responsibilities in the areas of R&D, S&T and innovation activities. FASIE, the Russian Foundation for Technological Development (RFTD) and industrial non-budgetary foundations for funding R&D established by federal executive authorities and commercial organisations support a whole host of projects to promote innovation activities and commercialisation of technologies. FASIE provides financial support to SIE that pursue projects to develop and manufacture new research-intensive products and technologies based on their own intellectual property (the main tender organised by the foundation); supports innovative projects during their early stages (START programme); and helps to set up SIE to apply own R&D results. Four hundred and thirty SIE were established in 2004 through this programme. The TEMP programme helps SIE to enter licensing agreements for intellectual property owned by state R&D organisations. RFTD provides support to research organisations and innovative enterprises at all stages of the applied research — prototype to pilot production cycle.

The bulk of government budget allocations to R&D organisations come in the form of basic funding. This is provided through the system of ministries and departments administering research and higher education institutions. The other two forms of budget funding account for about 30 per cent of the total budget appropriations. Programme funding reached its peak in 2000 at 24.9 per cent, and then its share started to decline. However by 2007, when the new budgeting principles were adopted, the programmes’ share of funding was radically increased.

Private Financing Mechanisms

The law ‘On Science and State S&T Policy’ allows other public, private and international foundations to support R&D and/or S&T activities. One such foundation is the Innovation Support Foundation created in 2002 by the Bashkortostan Cabinet of Ministers as a non-profit organisation. The law also provides for the establishment of non-budgetary industrial and inter-industry foundations not registered as legal entities, to finance R&D. Such foundations can be created by federal executive agencies or commercial organisations.

One of the first such foundations was the non-budgetary RFTD of the Russian Federation Ministry of Science, Higher Education and Technology Policy, created in 1992. The foundation was financed through voluntary contributions by government ministries, departments, concerns, corporations and associations that could contribute 25 per cent of their own non-budgetary funds earmarked for financing R&D and development of new research-intensive products. The sources of these funds, in turn, were payments by enterprises at the rate of 1.5 per cent of their product costs.

The PPP mechanism for R&D funding was first tried by the Russian government in 2002. It was decided that the priority was to support major innovative projects of national importance (so-called mega-projects) — large-scale innovative projects implemented by teams comprising representatives of R&D and industrial organisations. According to ‘Main Areas of the RF Government Investment Policy in Science and Technology Sphere’ (Government of the Russian Federation 2002), major innovative projects are based on world-level R&D results obtained through conducting research in priority areas, and allow the establishment of large-scale high-technology production of research-intensive competitive products, financed by non-public funds. This initiative was based on the idea that by supporting major innovative projects the state takes financial risks and thus encourages development of high-tech business. The projects were supposed to deal with key aspects of increasing competitiveness, such as cost reduction through resource-saving. Among other matters project participants were obliged to guarantee that revenues from sales of the new products would be at least five times higher than the amount of funding provided by the government.

The first tender for major innovative projects was announced in May 2002. Twelve mega-projects were selected; each was to receive US$ 20 million for two years — an impressive sum for the R&D and innovation sphere. Public funds were supposed to amount to no more than half of each project’s total budget, with the rest being provided by interested investors. However, in reality two-thirds of the projects received more than 50 per cent of their funds from the government budget.

One of the main selection criteria for the projects was that scientific interests should coincide with those of the business: the selection board included not just officials and scientists but representatives of major corporations. This was supposed to ensure that only commercially attractive projects would be selected.

After the administrative reform and introduction of new budget classification, the mega-project costs Article was divided equally between two ministries which to a certain extent became successors to the former Ministry of Industry and Science: the Ministry of Education and Science and Ministry of Industry and Power Generation. The division across two ministries disrupted coordination of this work since it was no longer possible to manage it as a single programme.

By the beginning of 2006 two of the mega-projects had reached investment-worthy level and were sent for evaluation to the Ministry of Economic Development and Trade. Total government funding allocated to the mega-projects by then amounted to 2.56 billion roubles, plus more than 2.77 billion roubles of non-public money. Potential sales of the innovative products in 2006 were estimated at 5 billion roubles.

Obviously, the plan that revenues should amount to five times public investment did not happen. The board that selected mega-projects for funding was unable to resist lobbying, and the adopted funding scheme created certain problems that arose when volume and types of R&D were being agreed. Government funds are allocated to research or higher education institutions — partners of industrial enterprises. On the other hand, commercialisation of the generated R&D results is the responsibility of the enterprise. In reality it turned out that such a scheme made it rather hard to match the interests of the business and the R&D potential (or interests) of the research institution. Apparently, even innovation-oriented enterprises see cooperation with state-owned research institutions as an additional risk factor.

But there was a positive outcome — during implementation of some of the mega-projects management and monitoring functions were outsourced, and this approach brought good results. External management was allowed to monitor the activities in a more neutral way and quickly react when there was need to make necessary adjustments. It should be noted that the PPP mechanism can be used only in certain situations, since such partnerships are not specifically provided for in the legal framework. Russian laws (including the federal law ‘On Science and State S&T Policy’) made no mention of cooperative agreements to conduct R&D.

In international practice, public funding provided for applied research via PPPs is often allocated on the basis of priority areas of S&T. Projects selected for funding always must have a high social potential. When the mega-projects were selected in Russia, their subject areas and social importance didn’t play a particularly important role.

Since one of the major selection criteria was significant growth of product sales within a short period of time, in some cases projects were selected for funding though they were aimed at dealing with small technical problems not on the mega-project level at all — exactly because they guaranteed rapid growth of sales. When new mega-projects are selected it would make sense to shift the accent to supporting basic technologies. Also, in the course of mega-projects’ implementation the possibility to provide public funding for R&D not to research institutions but to private enterprises should be considered, on condition they contract state-owned research and higher education institutes to perform the relevant R&D. This might help to balance the private sector’s demand for and the public R&D sector’s supply of R&D products. As long as public sector research organ-isations are largely oriented towards public funding, their interest in PPPs will not be high. But if the customer role is taken from the state and given to private business, it would contribute to ‘soft’ adjustment of the state R&D sector to the needs of the market economy.

There are more than 40 venture funds in Russia, investing in innovative projects; however, only about 1 per cent of all venture funding is spent directly on development of high technologies. Most of the projects supported by venture funds include research or early-stage development that explains the low level of subsequent commercialisation. The Venture Innovation Fund (VIF) established with government participation in 2000 did not manage to expand due to financial and legal barriers and lack of motivation for investing in high-risk projects. At the end of 2006, a new ‘fund of funds’ was created, the Russian Venture Company.⁵ It is supposed to concentrate on encouraging venture investments in and providing financial support to the high-tech sector of the economy. The company was registered as a 100 per cent state-owned corporation; the authorised capital was provided out of the federal budget.

Since 2005, the Russian Ministry for Economic Development supports tender-based creation of regional venture funds and closed unit funds with participation of regional authorities. Currently the regional governments that have won the first stage of the tender for federal budget subsidies have completed registration of the so-called ‘intermediary’ funds who — jointly with private investors — will establish venture funds on a 50/50 financial basis.

Another Russian venture funding institution is the Russian Venture Fair, an annual event where dozens of companies selected from a large number of candidates present their projects to investors and consulting firms. Russian Venture Fair is one of the mechanisms for attracting investments into the innovation sector. Russian Venture Fair’s objectives include encouraging financial institution interest in promising small innovative high-tech enterprises; assisting company owners and managers in their dealings with venture investors; and helping participating companies in securing external capital for their growth and development. The fairs include various events such as conferences, workshops, presentations, round tables and briefings on the practical experience of venture funding in Russia, development of the Russian venture industry and switching the Russian industry to an innovation-based development model. Participants include innovative companies with an annual turnover between US$ 50,000 and US$ 8 million and investment needs between US$ 100,000 and US$ 10 million.

Investment credit is also used in a somewhat different form than in industrially developed countries. The international practice of providing investment credits (debt financing) is based on average-term loans (three to seven years) with LIBOR interest rates (2–4 per cent). The rate may be adjusted depending on the actual circumstances. Russian financial organisations see the above terms and conditions rather like long-term ones. Standard terms for providing investment credits in Russia are for one to five years.

Russian banks define investment credits as participation (in the form of providing a loan) in an investment project for the period of no longer than one year. Loans are secured by all assets of the borrower including revenues generated in the course of the project. For loans provided for the period up to three years the interest rate is usually over 15 per cent a year, in hard currency. The actual rates are calculated depending on the term of the loan, estimated risks of the project, quality and liquidity of the security. The rate may also directly depend on the amount of money in covered letter accounts or the company’s circulating assets (the higher the amount, the lower the rate). Creditors also demand that all project-related operations must be transparent, though they promise not to interfere with the project management.

Credit organisations do not see themselves as venture capitalists investing in R&D and innovations. Creditors do not take any risks associated with the projects; still, that kind of scheme is available for funding innovative projects.

Orientation towards the borrower in such cases implies that their assets and reputation must match the creditor’s requirements. Lack of financial transparency and the ambiguous taxation rules have a negative effect on companies’ dealings with investors, especially foreign ones. Attracting all possible funding sources to finance innovative technology projects would require improved financial accounting, preferably in line with international standards.

Financial organisations may consider yet another project funding scheme — project financing. Pay-off and returns on investment are received out of profits generated through sales of products/services created in the course of the project. The main difference between project financing and investment credits is that in the former case the project serves as the primary loan security. Calculating interest rates and the repayment schedule of the loan, creditors pay particular attention to expected project returns. The term ‘project financing’ is understood differently in various countries. For example, in the OECD countries project financing means providing investment resources to companies when money for servicing the loan is taken out of the company’s regular cash flow while ‘access to the company’s assets’ serves as loan security.

Project characteristics, participants, partners and guarantors, and the distribution of associated risks become particularly important considerations if the project financing scheme is used. The level of project-related risks defines potential investors’ willingness to provide funding. Accordingly, in the case of innovative projects the project financing scheme has certain limitations. Unlike venture capital (VC) that can be attracted at any stage of S&T activities, creditors who consider project financing will not take that high a risk since the money invested in the project will be repaid only if the project is successfully completed.

Indirect Financing Mechanisms

Tax legislation is a very powerful tool for encouraging R&D and innovations. In Russia, after a relatively favourable period for organisations acting in this sphere, approval of Part 2 of the Russian Federation Tax Code has significantly increased the tax burden they bear. Specifically, reversal of the law on value-added tax eliminated VAT breaks for imported machinery and equipment intended for R&D, and for patent and licensing operations involving industrial property. Negative effects of these developments on R&D activities, including cooperation with foreign partners (and international organisations, foundations, etc.) became immediately apparent. We now examine the Russian system for indirect encouragement of R&D and innovation activities.

Sustainable development of the S&T complex and strengthening its innovative orientation should be based on an efficient regulation system, including direct funding and indirect motivation. Indirect motivation techniques include tax breaks, discounts, and special procedures for property depreciation. International experience suggests that a sensible taxation system may serve as a very efficient incentive to develop an innovation-based economy.

Currently Russian innovation policy is being shaped in an incomplete legal framework for R&D and innovation activities. Taxation law does not include provisions for an efficient system of tax breaks and benefits, similar to those existing in advanced economies countries.

Inconsistency of legal reforms, and lack of continuity of legal provisions have brought about the situation when many of the previous taxation rules that have proved their efficiency did not find a place in the new Russian Federation Tax Code. That, in turn, caused problems hindering the growth of innovation activity and efficient use of the country’s intellectual and economic potential.

According to the current tax code, R&D expenditures are subtracted from revenues when the tax base is calculated, which encourages organisations to make them. At the same time tax legislation in effect discourages participation of R&D organisations in the practical implementation of knowledge and technologies they generate and develop, or organisations funding R&D and innovation projects.

After introduction of the Russian Federation Tax Code in 2000–2001, tax breaks for hardware imported into Russia for R&D purposes and for periodic scientific publications were cancelled. Only technological equipment, components and spare parts for them are tax-exempt as investment in organisations’ authorised capital, as also publications received by state libraries and museums as part of international book exchange. Since 2002, sales of periodic publications as well as their editing, publishing and printing are subject to VAT. The tax code no longer has provision for preferential taxation of patent and licensing operations connected with industrial property.

Accordingly, to set up mechanisms for indirect motivation of R&D and innovation activity the following amendments to the Russian Federation Tax Code are proposed:

1. VAT breaks should be extended to cover SIE and individual entrepreneurs engaged in R&D and innovation activity, regardless of their revenues.

2. The following operations should be exempted from VAT:

• R&D;

• Sale of scientific and training printed materials, periodic publications of scientific and educational nature, and relevant services.

3. In article 150 of the Russian Federation Tax Code, the importation of technological equipment, components and spare parts and import of printed materials of scientific and educational nature should be exempted from VAT.

4. Patent and licensing operations (except brokerage) connected with industrial property (excluding trademarks and service marks) should be exempted from VAT.

An important condition for the development of Russian R&D and increasing the efficiency of government policy aimed at increasing and preserving Russia’s intellectual potential is the improvement of the well-being of scientists and ensuring their income remains stable in an unstable market economy. One way to achieve this is to exempt certain kinds of personal income from income tax. Another way is to introduce income deductions to reduce taxpayer’s total taxable revenue.

Since researchers often bear no significant R&D costs, it seems that in Russia it would be more efficient to put the accent on tax benefits for appropriate groups of people. Accordingly, the following amendments to the Russian Federation Tax Code to exempt individuals’ income from taxation could be implemented:

1. Income earned through R&D contracts with individuals named as contractors;

2. Income earned through licensing contracts transferring exclusive right to use industrial property objects;

3. Income received from employer as fee for creation of industrial property;

4. Fees for scientific, educational and training publications;

5. Income earned through all grants, including the ones made available to public and private R&D support foundations.

The use of tax incentives to promote R&D and innovation plays an important role in the development of the S&T sector. However, the current state of laws on taxation of organisations is unsatisfactory from the point of view of supporting R&D and innovation activity. To improve the situation in the near future, it would be reasonable to make the following changes to the Tax Code, to introduce preferential taxation of profits of:

1. Organisations through innovation activities;

2. Banks through crediting start-up innovation companies;

3. Insurance companies through insuring entrepreneurial risks of companies engaged in innovation activities.

Gratuitous transfers of funds for R&D (target funding) in the form of grants received from foreign and international organisations not included in a special list are also subjected to profit tax.

The list of foreign and international organisations that are allowed to make such grants tax-free should be abandoned, and all grants provided by foreign and international organisations should be exempt from taxation. Another possible step is to exempt small innovation enterprises from all taxation for the first two years of their operations. The list of foundations included in the Tax Code whose target funding is not considered as profits, is unreasonably short. The Tax Code does not take into account specific features of expenditures made in the course of R&D and innovation activity, and does not consider as direct expenditures certain significant costs such as expenditures on special equipment for R&D, expenditures to buy or use new kinds of hardware and materials, etc. Reducing tax base by writing off these expenditures involves serious discussions with tax authorities, which is a lengthy and arduous process with no guaranteed results.

Taxpayers’ expenditures in the form of donations cannot currently be written of the profit tax base. However, to encourage provision of R&D resources as gifts such contributions should not be taxed.

As already noted, R&D expenditures are included in taxpayers’ total expenditures for two or three years (depending on results). It is reasonable to include these costs in total expenditures for one year, regardless of actual R&D results.

It would also make sense to remove all limitations on interest for promissory notes for credits received to finance R&D, which reduce the profit tax base.

Unified social tax is paid by legal entities that make payments to individuals, mainly by organisations and individual entrepreneurs. The standard tax rate is 26 per cent. Various special rates are used to tax agricultural producers, organisations engaged in popular arts and crafts, small native communities in the far north who live off traditional industries, individual entrepreneurs and advocates. To encourage R&D activity, it would be useful to apply a special rate of 14 per cent to the unified social tax paid by R&D organisations.

In 2003, during the reform of tax legislation, the majority of R&D organisations lost their property tax breaks. Currently the property of state-owned research centres and state academies of science are exempt from tax. To encourage R&D activity by these organisations, it would be reasonable to exempt from tax their property used to conduct R&D. It would also make sense to exempt machinery, equipment, etc. received by these organisations for testing and experimental purposes, or given to them for free according to R&D contracts.

According to tax law, R&D organisations owned by academies of science were exempted from land tax on the land occupied by buildings used for R&D. However, this tax break was cancelled as of 1 January 2006. This should be reversed to apply to all land owned by all R&D organisations and used for R&D purposes.

Simplified taxation rules apply to small enterprises. The maximum revenues that allow an organisation to use simplified taxation rules established by the current legislation do not apply to venture companies set up specifically for innovation activities. In order to foster the creation of venture companies and make investment in their operations more attractive, they should be allowed to opt for the taxation system they prefer. It would make sense to amend the law in such a way that R&D expenditures and the costs of patenting R&D products could be included in the list of expenditures subject to simplified taxation.

In 2006, another tax break for intellectual property was added: taxpayer’s expenditures on R&D for the creation of new or improved products, including expenditures connected with inventions; payments made to the Russian Technological Development Foundation and other industrial and inter-industry foundations for financing R&D registered according to provisions of the law ‘On Science and State S&T Policy’ (Council of the Federation 1996), were counted as ‘other expenditures’ for two years (for research that generated positive results) or for three years (for research that didn’t generate positive results).

Also, depreciation costs included the original cost of depreciated intangible assets calculated as actual expenditures to acquire (create) them and turn them into a usable state, except VAT and excise duty. The cost of intangible assets created by the organisation was defined as actual expenditures in their creation (manufacturing), including personnel costs, outsourcing and contracting costs, patent duties, and excluding taxes paid in the course of these expenditures.

Intangible assets to be included in depreciation costs (concerning the subject in question) comprised (exclusive rights to) intellectual property acquired (created) by the taxpayer, utilised for production of products (provision of services) or for managerial purposes of the organisation for a long period of time (in excess of 12 months). To include an intangible asset, it should have the potential to generate economic benefits (profits) to the taxpayer; the taxpayer also must have valid documents confirming existence of the intangible asset and/or their exclusive rights to intellectual property (such as patents, certificates, other titles of protection, and the cessation (acquisition) contracts for patents or trademarks. In particular, intangible assets included the following:

1. Exclusive rights of patent holder to invention, industrial design, utility model;

2. Exclusive rights of author or other right holder to use computer software or database;

3. Exclusive rights of author or other right holder to use integrated circuit topology;

4. Exclusive rights to trademark, service mark, products’ place of origin and brand name;

5. Exclusive rights of patent holder to selective achievements;

6. Possession of know-how, secret formula or process, information about industrial, commercial or scientific experiment.

Intangible assets do not include the following:

1. R&D and technological activities which did not generate positive results;

2. Intellectual or business abilities of organisation’s personnel, their skills and competences.

The Tax Code also allowed the use of intellectual property rights as a contribution to the authorised capital of corporations that was in the interest of S&T products developers.

A whole set of legislations is currently being discussed in Russia, in particular, bills on preferential taxation of R&D and S&T activities. Some of these laws were passed in 2006–7 and became valid in 2008. Specifically, these concern the reduction of the period for which R&D expenditures (reduced tax base) can be included in the ‘other costs’ category to one year, and exemption from VAT of all organ-isations engaged in R&D, regardless of their sources of funding. The transfer of exclusive rights to inventions, utility models, industrial designs, computer software, databases, integrated circuit topologies, know-how (and licensing all of these types of intellectual property) are now tax-exempt.

The overall effect of this legislation will depend on the actual amount of proposed breaks and benefits (taking into account the organisational sensitivity threshold to tax reduction), as well as on their organisational culture (producers — consumers of R&D results and new technologies; R&D and educational organisations — their funding sources; innovators — investors in innovation activities, staff training and so on).

Specific S&T and Innovation Policies and their Effects on Entrepreneurial Investments in Innovation Activities

Russian laws provide for various forms of financial support to S&T and innovation activities, which are used with varying efficiency and frequency. Currently the state mostly finances R&D and innovation activities directly, including the Federal Goal-oriented Programmes (FGPs). The FGPs’ ‘R&D in priority areas for development of Russian S&T complex in 2007–2012’ sets the goal of development and application of S&T potential, while its objectives include the development of efficient innovation infrastructure, promotion of small R&D organisations and their integration into the system of S&T cooperation.

As of 2003, the federal budget had a new targeted article: Funding of scientific support to major innovative projects of national significance. This article is used to finance R&D connected with major promising innovation activities. The state’s ultimate goal in supporting such projects is the creation of innovation clusters and the large-scale production of research-intensive products; increasing the competitiveness of Russian manufacturers on internal and international markets; and encouraging entrepreneurial initiative, partnership between science and industry, public and private sectors, large and small businesses.

The Role of the Financial System in the National Innovation System

Like other developed countries, the main source of innovation investments in Russia is the organisations’ own funds, which is natural for a market economy. For internal R&D expenditures the share of industrial enterprises’ funds amounts to about 30 per cent; in the case of technological innovations this figure rises to 86 per cent. However, this high (compared to other countries) value in Russia is explained not so much by market economy ‘laws’ or abundance of company capital as by the unavailability (due to various reasons) of other funding sources that should be present in a developed market economy. We now consider these barriers.

Foreign sources play a minor role in funding R&D and innovation activities. Compared with the 1990s figures, their share has dropped from 7 per cent to 2.3 per cent of GERD.

The credit and the loan market for investing in innovation activities and innovative projects is limited. Access to credit is possible but only for companies with an established business reputation and serious assets that can be used as securities. The cost of credit (in most cases provided only for a short term) is quite high.

Apart from subsidies and credits, funds for innovative projects can be attracted by increasing the authorised share capital of the organisation that holds the main responsibility for the project. Increasing the authorised capital (or capital stock) is an attractive option because it doesn’t involve the burdens of assuming credit-related obligations. The price (dividends on additionally issued shares, etc.) can be adjusted according to the financial situation. Shareholders may decide to reinvest the profits into further development of production. However, using this funding source one should take into account the interests of the new shareholders, their influence on the project implementation and the possibility that they may assume a certain degree of control.

The main limitations hindering the use of this scheme are high interest rates and the need to provide loan security. In a situation when credit-related risks are brought to the minimum it’s hard to expect that financial organisations would opt for other investment opportunities. That’s why in our opinion venture funding in Russia did not live up to expectations. The advantage of this approach — shareholder value — doesn’t look very attractive to most of the financial market players, compared with the significant benefits of providing low-risk loans.

Innovative projects can obtain funding if they promise to produce products (technologies) already in demand in the market. In other words, improved products and processes expected by the market. In that case the creditor is willing to accept some of the risk. So to financial institutions of a general profile, crediting innovative projects aimed at development and implementation of new products and technologies seems unreasonable.

Another way to widen funding opportunities for innovative projects is by attracting sponsors. Russian law allows state guaranties to participants of innovation activities for investment credits made available by Russian or foreign financial organisations. The state can act as a source of guaranteed investments in more important projects, where the project financing scheme is optimal from the point of view of expected project efficiency. By sharing project-related risks, the state smoothes the way for other creditors providing project financing for innovation activities.

Choosing specific funding schemes with government participation for innovative projects is a special task which involves assessment of the extent of such participation at one of the most important stages of project preparation and implementation. International experience of financing innovative projects has to be significantly adapted to Russian conditions, taking into account specific features and institutional maturity of the national economy. In particular, adoption of venture financing schemes widespread in many countries should be adjusted to Russian realities — such as lack of entrepreneurial skills among the majority of the population and lack of innovative culture among the majority of entrepreneurs; and the domination of mining industries in the economy.

Project financing schemes, all other matters being equal, can affect the amount of profits, current expenses, and returns on their own capital. Normally these characteristics improve if financing is provided as investments in capital stock of the company that implements the project. Choosing the best funding scheme for the project involves finding the best balance between high cost of credit and the cost of attracting capital — which amounts not only to profit sharing but to providing new partners access to project management. In reality, choosing one funding scheme doesn’t exclude using another as well.

International experience includes examples of mixed funding especially with venture financing when some money is invested in the capital stock while other funds are provided as investment credits. In Russian practice most schemes (even attracting VC) only start working when the innovation is ready for commercialisation. The role of the Russian Venture Company is to promote venture investment and provision of financial support for S&T activities all over the country. When it became clear that the Russian high-tech sector is unable to attract enough investment, the state intervention concept emerged. The Russian Venture Company invests in closed-end investment funds only (established under legislation and regulated by the Federal Financial Markets Service). A special management company manages each fund. The management companies compete for the right to sell the fund investment shares to the Russian Venture Company. Eight to 15 such funds are to be established, strictly in accordance with the principle ‘one company — one fund’. Of course companies may create other venture funds, but the Russian Venture Company will participate only in one of them.

After the venture fund is created (i.e. the investment money is in place), the fund management company can start investment activities (launch innovative companies in such areas as microelectronics, information, telecommunication, bio-, medical technologies, environment-friendly power generation and nanotechnologies). Each fund management company can finance from 10 to 15 innovative companies for several years. Thus the end result may add up to 15 venture funds and 150 innovative companies. The resources for the Russian Venture Company capital were to be allocated from the Russian Federation Investment Fund — up to 5 billion roubles in 2006 and 10 billion in 2007 (a total of 15 billion roubles). In any country the activity level of venture investors directly depends on efficiency and consistency of government policy. In Russia, the government does not provide full and regular support to the creation of intellectual products even at the early stages of this process, and does not develop efficient institutional infrastructure for innovation activities. Accordingly, it would seem logical to provide various motivations for private investors to take part in innovative projects at just such stages — i.e. involve them at the development, start-up and early expansion stage. This approach would be efficient not just in terms of widening the range of available funding sources but for the balanced development of the Russian venture funding business.

Despite the growing number of industrial parks and innovation technology centres in Russia, the number of SIE is not increasing. Experts believe that the main reason is the lack of infrastructure that would support such small companies at the start-up and early development stage.

To summarise, the following problems with venture funding are hindering its development in Russia:

• Government participation in venture funding schemes for high-tech companies remains unregulated by Russian legislation;

• Existing infrastructure to support venture funding remains weak and cannot perform its main function — encourage emergence of new and development of existing small innovative companies and R&D organisations;

• Insufficient participation of VC;

• Insufficient development of stock market makes it difficult to venture funds to leave the organisations they’ve financed, and also hinders re-financing;

• Development of legislation to regulate the creation and activities of venture funds goes quite slowly;

• The problem of providing support to new innovative companies at the start-up and early development stages remains unresolved.

As to research and innovation support foundations, the small size of grants determines the modest level of the projects they finance, and forces scientists to pursue insignificant, easily reachable objectives.

The foundations’ activities mostly amounted to increasing the number of programmes. Apart from supporting innovative R&D projects they also financed other programmes like the development of libraries, telecommunications, scientific book publishing, provision of machinery and equipment to R&D organisations, establishment of shared equipment and instrumentation centres, support to young researchers, innovative projects, regional tenders, etc. The foundations tried to fill various gaps in the R&D sphere, which appeared due to insufficient funding. For example, in 1997 the Russian Federation Board for Research started organising regional tenders whose winner projects were funded jointly by the foundation and the regional authorities. That was an important initiative since it provided a new mechanism to attract funding for the R&D sphere. At that time regional authorities did not provide much support to science: on average just 0.06–0.07 per cent of their budgets were allocated for these purposes. Now the situation has somewhat improved, though not much: regional authorities channel on average 0.1–0.2 per cent of their total expenditures to support science; the maximum figure is 0.7 per cent. The regional tenders held by various foundations certainly had a positive effect over regional administrations, who agreed to support R&D organisations on a parity basis.

The main problems hindering the foundations’ operations, reducing their efficiency and undermining the trust of the research community to them, include the following:

• Insufficient transparency of the foundations’ activities including project selection, lack of information about the reasons for turning down applications;

• Insufficient promotion of foundations’ activities and programmes;

• Some of the programmes have age limits for potential participants;

• Lack of feedback after implementation of the projects (no evaluation of results);

• Exceedingly complex application forms and numerous papers one must prepare and produce to apply for a grant;

• Exceedingly complex accounting and reporting system for grant recipients;

• Lack of anonymity in project selection: selection board members know applicants’ names, selection process is based on applicants’ names;

• Untimely and incomplete financing of the projects.

Certain basic regulatory, legal and institutional frameworks for PPPs are in place in Russia. Increased attention to the PPP concept at a high political level led to the development of a system enabling implementation of PPP projects. At present PPP activities are regulated by general legislation (Civil Code, Budget Code and others), federal laws on concession agreements, on free Economic Zones as well as certain specific laws and by-laws such as the law for Special Features of Governance and Disposal of Property of Railway Transport. On the whole, the regulatory and legal basis for PPPs is in its initial phase of development but is advancing rapidly. Adoption of the federal law on concession agreements in 2005 created conditions for Russia to use one of the most popular PPP forms in Western Europe, namely concessions. This law has a number of important provisions for further PPP advancement but is not sufficient in itself. Due to many unresolved issues the law still does not function properly. No concession agreements were concluded in 2005–6. In the institutional sphere, the Investment Fund of the Russian Federation, Russian Venture Company and special economic zones were created. Now companies planning large-scale investment projects have the possibility to obtain government support through a range of PPP tools at the federal and regional levels. One of the main obstacles hindering PPP development in Russia is the absence of an integrated governance system. Other major problems in this area include the following:

• Lack of an integrated approach. There’s no systematic work on developing PPP in the country which would cover legal, economic and social aspects and specific issues of the mechanism for establishing and regulating PPPs. Note that the problem here is not about one or several laws; it’s a complex, institutional problem and it must be dealt with through a systematic approach.

• Lack of a coordinating and supervising body. Currently a lot of various organisations participate in drafting PPP-related legislation: legislative bodies’ committees, ministries and federal services, research institutes, foundations, private individuals. All of them develop draft laws based on their own ideas about PPP, without any common conceptual ground.

Further development of the legal framework to increase the role of the financial system in advancement of the NIS should include drafting and passing of the following laws:

1. ‘On Government Support of Innovation Activity’. This law should define the comprehensive, cross-sector nature of innovation activity; the need for all executive authorities to take part in the encouragement and regulation of innovation activity; establish specific and targeted measures to support innovation activity. This law would not serve as a universal legal act in the innovation activities area; it is not likely that such a universal law could ever be created at all. The law would establish specific forms of government support to innovation activity, and clear instructions for federal executive agencies (both in terms of steps to be taken and the timeframes), regarding drafting and approving regulations aimed at providing appropriate support to innovation activity.

2. ‘On Government Financial Support of R&D and Innovation Activity’, to establish procedures for government funding of innovative projects; and other bills to improve other forms of government financial support of R&D and innovation activities.

3. ‘On Venture Funding’, to regulate the creation and activities of venture companies.

In addition to these, legislation that does not specifically deal with innovation activities but could promote their development, should also be improved and amended. The most important areas include the following:

• Organisational forms and legal framework for R&D and innovation activity, including legal status of academic R&D organisations, clarifying relationship with founders, R&D organisations’ property rights, etc.

• Private–public sector partnership in R&D and innovation activity;

• Foundations to provide support to R&D and innovation activity;

• Clarification of R&D concept, so that organisations engaged in innovation activity could obtain tax benefits.

To summarise, to ensure the successful development of innovation activities in Russia the existing financial rules and mechanisms must be changed. Lack of motivation to invest in high-risk innovative projects, and high interest rates for loans seriously limit the range of available sources of capital for venture funding. New financial stimuli are required such as preferential credits, and differentiated tax breaks that would take into account the activity level of investors and project initiators, the specific stage of the innovation cycle, industry-specific characteristics. The interest of potential investors could be increased by government participation in innovative projects as co-investor and/or sponsor.

Conclusions and Policy Suggestions to Improve the Financing of Innovation Activities in Russia

In the situation of the global economic crisis the Russian economy has had to deal with two problems at the same time: to minimise the negative effects of the crisis and create the potential for future post-crisis development. An innovative socially oriented economy was chosen as the model for this future post-crisis development. The appropriate goal is formulated in the Concept for Russia’s Long-term Socio-economic Development until 2020 (Ministry of Economic Development and Trade 2008).

The most important characteristics of the innovative socially oriented economy model include a high level of innovation activities by all economic actors, ongoing development and implementation of new technologies and products, a big share of high-tech sectors in the GDP and exports, and some other indicators. To build such a model, a system of measures must be implemented, aimed at encouraging investments in innovations, technological upgrade and implementation of innovative products and solutions in all sectors of economy and areas of social life. These measures must include both general system-wide steps aimed at long-term development of the NIS, and specific steps tailored to the current crisis situation. Possible ways to increase the level of industry’s innovation activities and promote technological modernisation of the economy can be grouped into three major blocks

Keeping in mind that the technological basis of Russian industrial production has been degrading for many years and its overall technological level remains low, launching technological modernisation as quickly as possible would be of key importance. During the crisis and post-crisis recovery the government should carefully select the priority areas for technological shifts and ensure flexible comprehensive support on a network basis. Potentially efficient steps include changing the orientation of government procurement, by ‘natural monopolies’, state-owned corporations and large state-controlled companies, and initiating programmes for technological modernisation of public sector organisations including health care, education, and culture. The point is to radically change the underlying ideology of government and public sector procurement. Government procurement must be seen not just as means to deal with specific issues but as an important tool of industrial and innovation policy. In particular, to contribute to technological modernisation the accent should be placed on programmes and projects whose implementation involves either procurement of high-tech products and services from Russian producers (certainly of adequate quality), or technological modernisation of specific enterprises or industries. Special attention should be paid to increasing innovation orientation of defence procurement, including conversion of dual-purpose technologies for implementation into civil sectors.

It seems that serious adjustment of the legislation regulating government procurement and related activities is in order, in particular:

• Setting priorities for technological modernisation, selecting industries where introduction of advanced technologies would have the biggest effect and which have the potential to achieve technological level on par with the most highly developed countries. Then it would make sense to concentrate effort and resources in such high-priority industries and at specific enterprises. At first glance these should include power generation, nature management, environment protection, transport and some other industries;

• Development of a technological and tax regulation system to encourage faster upgrade of enterprises’ technological basis (including introduction of resource- and energy-saving technologies);

• Development and implementation of programmes to liquidate or replace technologically obsolete production facilities. Paradoxically, this problem is more easily dealt with during a crisis, by speeding up bankruptcy procedures to liquidate companies using obsolete technologies or by including in restructuring programmes provisions on replacement of obsolete production processes;

• Targeted support (government procurement, special tariffs for ‘natural monopolies’ services, government sponsorship of loans, preferential credits) to enterprises (including small- and medium-size firms) who invest significant sums in innovation, implement technological modernisation programmes on their own initiative (especially in industries contributing to improved quality of life and environment) and conduct staff training;

• Additional support to enterprises exporting high-tech products and services, in particular by creating a system for promotion of such products in international markets, establishing specialised leasing companies with government participation, and financially supporting export of such products.

The second block of proposals includes measures aimed at improving the institutional environment and framework for innovative business through elimination of excessive administrative, legal and other obstacles, creation of advanced efficient market institutes and competitive environment, and encouraging demand for innovations by various economic players. The following steps are suggested:

• Increasing the range of tax breaks (tax vacations) for companies participating in innovation activities and technological modernisation, including new high-tech businesses; for companies conducting R&D at their own cost and acquiring technologies in the course of government-initiated programmes and projects; for financial organisations crediting innovation activities;

• Improving tax administration concerning application of existing tax breaks and preferences for R&D and innovation activities, to provide better conditions for economic actors involved in innovation activities.

Public funds should be used to finance the following:

• Funding of major innovative projects whose objectives were set taking into account business interests and the results of national technological foresight analysis. Specifically, public funds should be used to secure the successful launch of such projects;

• Introduction of grants (subsidies, compensation systems, etc.) for enterprises who develop, design and implement new innovative products;

• Introduction of targeted subventions paid out of the federal and regional budgets to organisations, implementing major innovative programmes (projects) which form regional innovation clusters;

• Support of industrial technological projects provided the bulk of their funding comes from private investors, and public funds are used exclusively to reduce financial risks;

• Promote participation of Russian enterprises and organisations in international initiatives, projects, alliances in the R&D, S&T and innovation spheres, including elimination of existing administrative, legal, customs and other barriers hindering Russia’s integration into international R&D and innovation cooperation;

• Promoting internal consumption of domestic innovative products and services including a system for providing government support to acquire expensive durable consumer goods made in Russia (e.g. subsidising credit interest rates);

• Promote development of regional innovation clusters by providing tender-based financial support to Russian regional and local authorities to fund regional (local) innovative development programmes; these funds should be used to eliminate existing ‘bottlenecks’ hindering development of regional innovation clusters to support cooperation programmes for enterprises — the members of such clusters;

• Supporting institutes which ensure continuous assistance to innovative projects from their start to conclusion (including completion of federal- and regional-level information and technological infrastructure — centres for sharing unique or expensive R&D equipment, information, analytical and business centres, foundations), to promote cooperation between research organisations, universities and industrial companies and to encourage innovative motivation (potential demand) of the population.

It would also be desirable to improve procedures for attracting public and private budget, non-budgetary and venture funds to financing innovative projects, to contribute to a radically increased supply of new technologies and innovations in Russia. This would link with obliging ‘natural monopolies’, state-owned companies, ‘backbone’ enterprises receiving government support in the course of anti-crisis programmes to develop and implement innovative strategies (innovation-based development programmes). In addition one should increase the range of forms and techniques for encouraging potential participants of PPPs established to develop and implement innovative projects (public investments in authorised capital of companies, compensate expenditures on obtaining and servicing international patents, and improve the legal basis for PPP).

To create conditions for accelerated technological development of enterprises, a set of additional tax breaks is required. The first task is to encourage acquisition and implementation of intellectual property, by giving taxpayers an option for early depreciation of intangible assets which are important for the development of S&T and innovation activities. The second objective is to reduce the tax burden on personnel costs for companies in the intellectual services sector, among other things by compensating extra tax expenditures due to cancellation of the unified social tax through insurance payments to information technology and engineering companies whose advanced development is a necessary requirement for increased level of overall innovation activities in the economy. Also, to provide additional support to companies, VAT on packaged software should be cancelled. Appropriate changes to tax laws are also needed to prevent increased tax pressure (due to cancellation of the unified social tax and introduction of insurance premium) on companies which enjoyed unified social tax breaks as residents of technology implementation zones and special economic zones.

The third task is to encourage technological modernisation of enterprises and increase the level of their innovation activities by exempting them from property tax during the first year after installation of new energy-efficient equipment. For the same purpose, the list of R&D approved by the RF government regulation of 24 December 2008 (according to which taxpayers’ expenditures on specific R&D were counted as ‘other expenditures’ at the actual amount multiplied by 1.5) should be extended, to include production technologies widely used by Russian industries. Procedures for paying land tax and property tax for state educational and R&D organisations also should be amended.

For private high-tech, medium-sized and small firms with limited own resources (especially in the crisis situation) procedures for providing public grants (subsidies) should be adopted, to finance their innovation activities in priority areas including R&D, design and development of new innovative industrial products; to compensate expenditures on engineering services and international patenting costs. Supporting the establishment of new innovative businesses should first of all include a wider range of support mechanisms for innovative companies at early stages of their operations, promoting the creation of innovative firms on the basis of leading R&D and educational institutes; providing opportunities for accelerated commercialisation of intellectual property owned by the state, created before Section 4 of the Russian Federation Civil Code became effective. To provide additional financial support to innovative companies at early stages of their development, a number of seed funds should be created, with participation of the Russian Venture Company and Rusnano. Proposals for launching the operations of Rosinfocominvest also should be prepared.

Direct support to the creation of small innovative companies on the basis of leading R&D and educational institutions, including with the participation of students and post-graduates, should be provided through new programmes administered by FASIE. Establishment of business incubators for students should also be considered — these would provide employment opportunities for young professionals in the crisis situation. These support measures might also be implemented in the framework of a small- and mediumsize entrepreneurship support programme.

Also, to extend opportunities for securing long-term funding for research-intensive projects from Vnesheconombank, procedures for regular evaluation of projects requiring funding of at least 1 billion roubles per year by the bank’s supervisory board should be developed — for projects undertaken by Russian high-tech companies in priority sectors and industries.

To increase the level of enterprises’ innovation activities, laws regulating venture funding and corporate contractual laws should be developed further. Steps should also be taken to increase efficiency of foundations operating in the R&D and S&T spheres.

Taking steps to implement the technological modernisation of the economy and increase the level of economic agents’ innovation activities involves introduction of new, tougher requirements to the R&D sector. Though its development doesn’t directly come within the scope of chapter, without an advanced and efficient R&D system one cannot expect to achieve innovative growth or long-term technological breakthroughs, increase national security and competitiveness. Whatever may be said about the specific experiences of China, Korea, Taiwan, and Singapore’s innovative development, these countries do have national R&D potential, and (judging by the internationally compatible statistical data) these potentials are quite high, which allows these countries not just to borrow R&D results and technologies but actively use their own S&T and innovation capacities.

In the context of innovation activities and technological modern-isation, three groups of problems are of particular importance. First, the slow institutional reform of the R&D sector demands immediate attention (including elimination of departmental fragmentation, lowering the barriers between science, education and the real sector, revitalising the network of research organisations). Implementation of real reforms on the principles of identifying and providing targeted support to centres of excellence, while carrying out all relevant social obligations could allow for savings especially in the large network of state R&D institutes that are funded regardless of the actual results they produce.

In effect, only one restructuring scenario for the R&D network is being considered now making the most of the research institutes’ autonomy and adopting more efficient forms of providing financial support. However, there are other opportunities which should be considered, including the following:

• Liquidation of R&D organisations which have lost their identities or show low efficiency (after obtaining a reliable independent assessment of the results they produce);

• In appropriate cases changing departmental ownership of R&D organisations, including those belonging to state academies of science — not forgetting about certain specific nationally important functions they might perform;

• Restructuring R&D organisations using all ways and forms allowed by the valid legislation (mergers, acquisitions, division, separation or transformation); extending the scope of non-profit organisations to transform R&D institutions into, e.g., state-owned autonomous non-profit organisations;

• Confiscation of surplus, unused or inappropriately used property (including land). Obviously this measure must be applied very carefully. Confiscation procedures are mentioned in valid legislation but the exact steps to be taken should be described in more detail, taking into account specific aspects of R&D, S&T and innovation activities.

Financial resources and public property saved through these steps should be channelled exclusively to advance the R&D sector, for acquisition of machinery and equipment, development of human resources (salaries, staff training and retraining), and attracting young talent (including graduates of higher education institutions). The money may also be used to set up a special national fund to invest in the development of R&D and higher professional education.

Second, cooperation between the R&D and industrial production sectors must be promoted, and state R&D organisations must have wider opportunities to participate in innovation activities. It is not just about creating small innovative companies (spin-off firms) or technology transfer centres — equally important is the creation of favourable conditions for commercialisation of intellectual property generated through use of public money, establishing and developing stable alliances between R&D organisations and businesses, participating in targeted investment foundations, and widening the range of available funding sources.

Another suggestion is to consider opportunities for improving the laws regulating the activities of FASIE — widening the scope and scale of its operations. Of particular importance is providing support to innovative entrepreneurship, specifically supporting highly skilled professionals laid off due to cutbacks, with the help of micro-financing and micro-crediting tools. This is especially relevant in the crisis situation and during the post-crisis period (and steps should be taken to get ready for it well in advance). Also, favourable conditions for other public R&D support foundations should be created, as well as for inter-industry non-budgetary foundations which finance R&D, and prototype design.

Third, a whole range of measures to support and develop human potential is of key importance, including the following:

• Development and implementation of a programme to support the internal mobility of highly skilled personnel, primarily young researchers and engineers (including training opportunities for young researchers at industrial enterprises);

• Elimination of excessive administrative barriers (e.g. limitations on joint use of property by R&D and educational organisations), hindering integration of science, higher professional education and business regardless of legal and property status of the parties;

• Creation of a business incubator network attached to higher education institutions. This activity may be funded with the money allocated in the framework of the anti-crisis programme to increase the number of master and post-graduate places. Enrolling more master and postgraduate students will result in more personnel oriented towards R&D. However, there’s no guarantee that numbers and specifics of the newly trained personnel would match the needs of the post-crisis economy. On the other hand, creation of a business incubator network would involve graduates and teachers in practical business activities — including implementation of R&D results generated at higher education institutes — with minimum costs.

More efficient planning and monitoring of public funds expenditures in the S&T sphere can be achieved by including an appendix to the federal budget, with a detailed breakdown of appropriations for civil R&D.

Major tools for implementing these measures include:

1. Setting priorities for the state innovation policy clearly understandable by business and the society, including major technology-related initiatives in priority development areas, connected with long-term national socio-economic goals.

2. Government procurement and programmes, as a tool for creating demand for innovative products and technologies.

3. Budget subsidies (grants) as a tool to encourage modernisation and increase efficiency of enterprises’ innovation activities. At the same time expenditures of this money must be closely monitored to ensure its appropriate use.

4. Tax breaks tailored to support clearly defined types of innovative behaviour, allowing efficient and low-cost (to the state and the businesses alike) implementation and administration with minimum loss of budget revenues.

5. The PPP in the innovative and technological development sphere (government participation in funding business projects aimed at development of new technologies and products, encouraging high-tech exports, increasing efficiency of existing institutions responsible for development of innovation infrastructure.

6. Introduction of obligatory requirements (administrative, technical, environmental, energy saving, etc.) to encourage innovation activities by enterprises.

The accent should be placed primarily on promotion of innovation activities of the real sector enterprises — which, combined with the steps to increase efficiency of the knowledge-generating sector and the S&T sphere, should create an integrated system for short-term national innovation policy of the Russian Federation.

Notes

1. State budget funds include budget appropriations for universities and funds of state sector organisations (including own funds). In 2007 the federal budget covered 97.2 per cent of all budget funds spent for R&D, while the regional budget share amounted only to 2.8 per cent.

2. The funds of business sector regroup the funds of extra budgetary funds and businesses (including own funds).

3. In 1999–2005 Russia was one of five countries showing the highest GDP growth rate in the world (10 per cent in 2000, 6–7 per cent in 2003–6).

4. The highest level is noted in sectors like manufacturing of radio, TV and communication equipment — 39.9 per cent; aircraft and spacecraft manufacturing — 34.3 per cent.

5. The official web page is http://www.rusventure.ru (accessed 4 May 2010).

References

Chesbrough, H., 2003. Open Innovation: The New Imperative for Creating and Profiting from Technology. Boston, MA: Harvard Business School Press.

Council of the Federation, 1996. ‘On Science and State S&T Policy’, Federal Law No. 127-FZ, 23.08.1996, Moscow (in Russian).

———, 2005a. ‘On Concession Agreements’, Federal Law No. 115-FZ, 21.07.2005, Moscow (in Russian).

———, 2005b. ‘On Special Economic Zones’, Federal Law No. 116-FZ, 22.07.2005, Moscow (in Russian).

European Commission, 2008. European Innovation Scoreboard 2007 — Comparative Analysis of Innovation Performance. Luxembourg: Office for Official Publications of the European Communities.

Government of the Russian Federation, 2002. ‘Main Areas of the RF Government Investment Policy in Science and Technology Sphere’, Statement of the Government of the Russian Federation No. 1764-R, 11.12.2002, Moscow (in Russian).

Higher School of Economics, 2005. Science in the Russian Federation. Data Book. Moscow: Higher School of Economics (in Russian).

———, 2009a. Indicators of Innovation: 2009. Data Book. Moscow: Higher School of Economics (in Russian).

———, 2009b. Science Indicators: 2009. Data Book. Moscow: Higher School of Economics (in Russian).

Ministry of Economic Development and Trade, 2008. Concept for Russia’s Long-Term Socio-Economic Development Until 2020. Approved by the Government of the Russian Federation, Moscow (in Russian).

Ministry of Education and Science of the Russian Federation, 2006. S&T and Innovation Strategy of the Russian Federation for the Period Until 2015. Approved by Inter-Departmental Commission on S&T and Innovation Policy, Moscow (in Russian).

USSR Goskomstat, 1990. The USSR National Economy in 1989: Statistical Yearbook. Moscow: Finance and Statistics, USSR Goskomstat (in Russian).

4

India

Sunil Mani

The government in India is on a major innovation drive like most governments across the developing world and especially that of China.¹ This drive can be found in several policy measures enunciated over the past 10 years or so and especially in the Science and Technology Policy of 2003, wherein it is stated that the government targets the expenditure on Science and Technology (S&T) to be about 2 per cent of Gross Domestic Product (GDP) and this is to be largely contributed by the industry through significant increases in industrial Research and Development (R&D). Industrial R&D, therefore, may have to be incentivised through the provision of a variety of fiscal incentives such as tax incentives. This thinking again reflects the worldwide move towards using non-interventionist, but market-friendly forms of increasing investments in industrial R&D, and within this scheme of things tax incentives form an important instrument.

In India, even as early as 2001, the existing tax treatment of R&D had undergone some upward revisions, but these were targeted more specifically to around eight high and medium technology–based industries. Although a few studies are available on the financing of industrial innovation, with rare exceptions, most of these have been descriptive, merely cataloguing the various schemes available for encouraging investments in industrial R&D. However, no analytical studies on the effectiveness of these incentives in the specific Indian context are available. This is significant as recent estimates by the Ministry of Finance showed that the amount of corporate tax foregone consequent to the tax treatment of R&D has been increasing at a rate of 2.4 per cent per annum over the last four fiscal years until 2007–8: in 2004–5 about 23,180 million of corporate tax revenue had been foregone as a result of the operation of this scheme, but this is expected to come down marginally to about 20,240 million in 2007–8. It has been seen that about 10 per cent of the corporate income tax has been foregone as result of various tax concessions of which one is the R&D tax incentive. In this context, the purpose of the present study is to analyse the effectiveness of a specific tax scheme that has been in operation since 2001. In very specific terms, this is accomplished by computing the elasticity of industrial R&D expenditure in India in response to a unit reduction in the cost of performing R&D. Such estimates of elasticity of R&D will be very helpful in judging whether the tax incentive for R&D is effective in stimulating proportionate investments in R&D.

This study is structured into four sections. Section 1 analyses the innovative performance of India by employing a number of conventional and new indicators. The second section surveys the various financial instruments that are available for financing of innovation. The third section measures the effectiveness of tax incentives for financing R&D expenditures. The fourth and final section sums up the main findings of the study and identifies the policy conclusions that may emanate from this exercise.

India’s Innovative Performance

India is generally referred to as an emerging knowledge superpower although her current record on this issue is rather mixed. We seek to analyse this record by employing a variety of conventional indicators as new indicators such as those emanating from innovation surveys are not available in the Indian context for the present.² Three conventional indicators are considered:

• Trends in R&D investment;

• Trends in patenting; and

• Trends in technology trade balance

To the extent possible, the analysis is conducted in a comparative fashion by taking China as the country of comparison.

Pre-reform refers to the period 1980–81 through 1990–91 and post-reform refers to the period 1991–92 through 2007–08; for the pre-reform period we study the Gross Expenditure on Research and Development (GERD) to Gross National Product (GNP) ratio, but given the fact that in India the ratio of GDP to GNP works out to unity, it does not really matter whether one takes into account the ratio of GERD to GDP or GNP. The following inferences can be drawn from Table 4.1:

Table 4.1: Trends in R&D Investment, 1980–81 through 2007–08 ( in millions)

Source: Department of Science and Technology (2006 and 2008).

(a) Both in nominal and in real terms, there has been a decline in the overall GERD; and (b) Even the GERD to GDP ratio has declined during the post-reform period. From this, one has to be very cautious in drawing any strong inferences about the innovative potential of the country. This is because much of the overall R&D (GERD) of the country is performed in the public sector in defense, space, atomic energy, health and agriculture. Industrial R&D forms only about 20 per cent of the GERD. However, the share of the industrial sector has shown a significant increase during the period.

In India much of the R&D is actually performed by the government or public sector (Table 4.2). However, the share of the business enterprises sector has shown some sharp increases. It now accounts for about 30 per cent of the R&D. The corresponding figure for China is as much as 70 per cent. The higher education sector represented by universities and research institutes accounts for only 5 per cent of total R&D performed in the country. Notwithstanding data problems, it is clear that the share of this sector has only shown some slight increases during this period.

Table 4.2: Sector-wide Performance of R&D in India, 1990–91 through 2007–08 (percentage shares)

Source: Department of Science and Technology (2006 and 2008).

Mani (2007) has shown that increasingly much of the industrial R&D is actually expended by private sector enterprises. I extend this analysis to the most recent period for which data is available (Table 4.3) and find that this is indeed the case. An important hypothesis that this data implies is that one sees a decline in the growth rate of industrial R&D when increasingly that R&D is performed by private sector enterprises. Does this mean that the private sector is experiencing Arrowian appropriability problems? This hypothesis makes the study of external financing of industrial R&D in India a relevant one. During this phase when investments in R&D are declining one sees that the government is putting in place a number of financial support measures that seek to reverse this declining trend. A study of the effectiveness of these financial measures thus assumes much significance.

Table 4.3: Growing Privatisation of Industrial R&D in India, 1985–86 to 2002–03 ( in millions at current prices)