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Innovating a recovery

Andrew Wyckoff, OECD Directorate for Science, Technology and Industry

©Faber

A jolt of innovation can be a powerful antidote to recession. But innovation risks being hit hard by the economic crisis as the capital to finance research and develop new products grows scarce. The economic fallout could be serious, since innovation is a key driver of growth.

As financial markets collapsed last autumn and economies around the world plunged into recession, many venture capitalists started putting their wallets back in their pockets to wait out the crisis. Instead of funding startups, they are sparing capital to help firms in their portfolio survive.

The numbers are cause for concern. US venture investments started declining in early 2008. And in the first quarter of 2009, they plunged 60% compared with the same period a year earlier. In Europe, venture investments declined 40% in the first quarter, and in China, by 58%, according to Dow Jones Venture Source.

At many companies, funding for research and development (R&D) is also squeezed by the recession. Those struggling to remain profitable are forced to put risky, long-term R&D projects on hold or curb spending-since R&D tends to be financed from cash flow. Corporate reports for the fourth quarter of 2008 in many cases already show a decline or slower growth in R&D spending. And forecasts for 2009 confirm the trend. A recent survey by McKinsey of almost 500 large businesses worldwide shows 34% expect to spend less on R&D in 2009.

And even though some stronger companies reported taking advantage of the recession to outspend weaker rivals and gain competitive edge, available data show that even quarterly R&D expenditures of top information technology firms are dropping in many sub-sectors, notably semiconductors, which were down 14% in the first quarter over a year earlier. Whereas Internet and software firms still have rising year-onyear R&D spending in the first quarter of 2009, growth is down.

Why should a contraction in R&D or venture capital outlays matter more than any other nose-dives in this crisis? The answer is simple: this is not your parents' recession.

Productivity gains and GDP growth are strongly linked to new technologies and investment in a wide range of intellectual assets. The advent of personal computers, the world wide web and its offspring, broadband communications networks, all play a key role driving efficiency gains, new business models and new firm creation.

R&D is a powerful driver of innovation, but it's not the only one. Globalisation has changed the way economies transform knowledge into market value-the definition of innovation. That process now takes place increasingly outside the lab. New approaches to design, marketing and organisations are powerful drivers of growth. Companies can enhance efficiency by investing in new technology, but to reap greater gains they need to take advantage of technology by investing in new skills and approaches too.

In our knowledge-based world, investment in these "intangible assets" has become as important as that in traditional plant and equipment, accounting for 5% to 12% of GDP in many OECD countries.

Skills, networks and trading knowledge are vital to competing efficiently in today's economy where information travels in real time. Companies increasingly collaborate to reduce the cost and risk of bringing new ideas to market by tapping expertise around the globe. How can countries improve their ability to innovate? The OECD Innovation Strategy offers a way. With a final report due in 2010, the strategy is being designed to help governments devise policies that keep pace with change.

The goal is to unleash greater innovation across all economic sectors, including services, which now average 70% of GDP in OECD countries. The Internet, for example, has become a platform for new business models, especially in marketing, retail sales and distribution. German automaker BMW used mobile-phone messages to reach a younger crowd of potential buyers for a new model it was launching in 2004, inviting them to signups on BMW's website for pre-launch test drives. The experiment worked, sparking responses from 150,000 potential customers-and sales of the new model took off when it was launched.

A more well-known example is online auction house eBay, which began life on a personal computer 14 years ago, and which today is an $8.5 billion company and a virtual market-place for millions of people.

Such examples are multiplying, but countries have still barely begun to tap the transformative power of innovation across all industries, the consumer landscape and even government itself. To accelerate that process, the OECD Innovation Strategy is developing a coherent policy approach, with guidelines and principles to help governments reap benefits across the entire economy.

The strategy will also help governments wield innovation to tackle challenges such as climate change, healthcare and food shortages more effectively. The economic crisis has prompted the creation of huge stimulus plans. By investing part of these packages in innovation and collaborating internationally, policymakers also have a rare opportunity to accelerate scientific breakthroughs and innovative solutions that can benefit the entire planet. On the environment, governments around the world are already setting aside billions of dollars of these funds to help drive a "green" recovery. Their aim is to provide incentives for the development, uptake and diffusion of innovations in energy, buildings and transport that will lower energy use and carbon emissions.

Innovation is a powerful force for development, too. Take the Bhoomi Project in the Indian state of Karnataka, which computerised 20 million rural land records of 6.7 million farmers, improving the availability of information on land rights and land use practices.

The initiative allowed bankers to provide crop loans much faster. Land disputes are declining, encouraging farmers to invest in their property. The success of the Bhoomi Project has prompted India's government to launch a similar programme to cover the entire nation.

Several countries have demonstrated the powerful impact of increased spending on the entire innovation ecosystem during a downturn. Finland emerged from a severe recession in the early 1990s with a strong communications technology industry, a more highly-skilled workforce and new economic muscle.

A key part of the Finnish plan was nearly doubling public investment in R&D from 1991-1995, which helped staunch the downturn in business R&D. Equally important were higher outlays for education and worker training. By 1995, Finland's GDP growth had rebounded to 5%. "Innovation is a high-risk business. We need the ability to take real risks," said Esko Aho, executive vice-president of Finland's world-leading mobile phone maker, Nokia, at a recent OECD conference in Denmark. Mr Aho was also the prime minister that led Finland out of that 1990s recession.

Innovation can do more than prime the growth pump. Combined with good crisis management, it can also accelerate structural change. Korea is an example. As the Asian financial crisis of the late 1990s buffeted Korean firms, triggering mass layoffs, the Korean government developed policies to seed new small and mediumsized technology companies. Like Finland, Korea offset the decline in corporate R&D spending with a strong increase in public R&D and education. It also created a law in 1998 to promote venture capital firms, which was a key to developing privatesector funding for innovation. By 2001, the number of venture firms had grown to over 11,000-up from 100 on the eve of the crisis.

For economies around the world, a good dose of innovation can deliver a double win: a sustainable recovery and progress on social goals. But innovation is a complex and dynamic game and to succeed in the long run, countries will need to make innovation a central pillar of government policy and equip citizens everywhere to participate and harness knowledge for solutions. The OECD Innovation Strategy will be there to help.

For more on the OECD Innovation Strategy, contact Gail.Edmondson@oecd.org, who contributed to this article.

References

"Innovation: A stocktaking of existing OECD work" at http://www.oecd.org/dataoecd/14/32/42095821.pdf

"Fostering Entrepreneurship for Innovation" at http://www.oecd.org/dataoecd/11/41/41978441.pdf

OECD Observer (2008), "Koreans online", No 268, June

For further information, see www.oecd.org/innovation

©OECD Observer No. 273, June 2009