Globalization, Markets forTechnology and the Relevance ofInnovation Policies in Developing
Economies

ATPS SPECIAL SERIES NO. 2

Globalization, Markets forTechnology and the Relevance ofInnovation Policies in Developing
Economies

Dr. Sunil Mani
United Nations University/Institute for New Technologies
6211 TC Maastricht
The Netherlands
E-mail: Mani@intech.unu.edu
Fax: +31-43-3506399
Tel: +31-43-3506331

January 2001

Published by the African Technology Policy Studies Network,
P.O. Box 10081, 00100 General Post Office, Nairobi Kenya© 2001 African Technology Policy Studies Network
Designed by Magayu K. Magayu,
School of Journalism, University of Nairobi,
P.O. Box 30197 Nairobi, Kenya.
ISBN 9966-916-39-3

Contents
Abstract
Introduction
Globalization of Technology-The Three Definitions................................................. 1
Markets for Technology ............................................................................................ 11
Evidence of Technology Spillovers from FDI .......................................................... 15
Innovation Policies -Their Relevance and Components ........................................ 18
Conclusions ................................................................................................................. 31
References ................................................................................................................... 32

Abstract
Three different connotations of the term "globalization of technology" are discussed.
These definitions are then applied to actual data and the phenomenon is thus measured.
The measurements point to two opposing schools: one that believes that there isincreasing evidence or globalization of technology and another one that believes that
there is very little evidence of globalization. The debate on globalization thus brings to
the fore the concept of markets for technology. Available empirical evidence shows that
this market has become less competitive over time. Implied in this argument is therelevance of innovation policies, defined as instruments and institutions that encourage
the local development of technology and the adaptation of imported technologies. The
paper concludes by discussing the specific ingredients of such a policy.
Key words: globalization of technology; developing countries; markets for technology;
innovation policy; spillover effects, foreign direct investment; research scientists andengineers; tax benefits for R&D
JEL Classification: O31; O38

Introduction
Despite the frequent discussion of the term globalization of technology, the term lacks
precision. Different commentators use it to mean different things. Interest in thisphenomenon stems from the fact that if there is increasing globalization of technology, it
would mean that the markets for technology are becoming very competitive, which inturn should increase the accessibility of countries and firm to state-of-the-art
technologies through essentially arms-length transactions. The basic purpose of thispaper is to examine whether this proposition is actually true. To achieve this objective
the paper begins by spelling out the connotation of the term "globalization oftechnology". This is followed by its measurement in empirical terms. An allied
hypothesis is that if there is indeed globalization of technology—meaning thereby large–
scale availability and accessibility of technology—then the markets for technology are
becoming more competitive now than ever before. Based essentially on standard
indicators we demonstrate that the markets for technologies are actually becoming lesscompetitive or more imperfect. The implications of this for most developing countries isvery easy to appreciate, as most of them are mere assemblers of technologies that are
products of the developed countries. Irrespective of whether countries are assemblers or
generators of new technologies, they require a set of innovation policies that would aid
them to do so and it is necessary to spell out the components of these policies.
In keeping with these objectives, the paper is structured into three sections. The firstsection maps out the various connotations of the term globalization of technology. The
second section delineates the concept of a market for technology and analyses whether
this market is becoming competitive or not. In the light of the arguments presented inthese above two sections, the third section makes a case for innovation policies thatgovernments may put in place to encourage not only local development of technology
but also the adaptation of imported technologies to local conditions.

Globalization of Technology-The Three Definitions
Archibugi and Michie (1995, 1997) identified three separate processes that are generally
subsumed under the catch-all expression “globalization of technology”. According tothem the term has three connotations:•International exploitation of national technological capabilities;•
International technology alliances; and•Globalization of innovation across countries•
Each of the three categories has its own manifestation and has indicators that canmeasure it in empirical terms (Table 1).
It is thus clear that globalization of technology can therefore entail, one or all of thefollowing:• The global exploitation of technologies through patents and licenses.
• The global sourcing of research and development (R&D) through alliances and joint
ventures with foreign companies or universities.
• The global production of R&D through overseas subsidiaries.
Of the three, it is only the last two that can strictly be termed globalization of technology.
I now present the empirical evidence on those two.

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ATPS SPECIAL SERIES NO. 2

Table 1: The Three Definitions of Globalization of Technology
Category
1. International
exploitation of national
technologicalcapabilities

•
•
•
•

2. International
technology alliances(collaboration acrossborders among bothpublic and businessinstitutions to
exchange and develop
know-how)
3. Generation of
Innovation acrossmore than one country•

Manifestation
Domestic enterprises
Exports of hightechnology products
Relocation of
production abroad
Exports ofdisembodied
technology through themedium of licensing
agreements between
foreign and domestic
firms
Firms expand their
non-equity agreements
to share costs and risks
of industrial R&D• MNCs establish their
R&D units abroad

Indicator• International
trade in high techproducts• Quantum of FDI
inflows andoutflows• Number oflicensingagreements•

Number and form ofscientific andtechnical agreements
as given by the
MERIT-CATI
database on strategic
technology
partnering

Degree of R&D
financed fromabroad• Patenting activities of
MNCs attributable toresearch in foreign
locations•International Technology Alliances
Industrial firms increasingly have sought global research partnerships as a means ofstrengthening their core competencies and expanding into technology fields considered
critical for maintaining market share.7 Technological complementarity and reduction of
7This section is based on the data contained in the data set known as MERIT-CAT. The MERITCATI database contains more that 10,000 inter-firm cooperative agreements involving thousands ofdifferent parent companies. In the CATI database, only agreements that contain arrangements fortransferring technology or joint research are collected. These counts are restricted to strategic
technology alliances, such as joint ventures for which R&D or technology sharing is a major
objective, research corporations, joint R&D pacts, and minority holdings coupled with researchcontracts. CATI is a literature-based database; its key sources are newspapers, journal articles,
books, and specialized journals that report on business events. CATI’s main drawbacks andlimitations are that (1) data are limited to activities publicized by the firm, (2) agreements involving
small firms and certain technology fields are likely to be underrepresented, (3) reports in the popular

MARKETS FOR TECHNOLOGY AND THE RELEVANCE OF INNOVATION POLICIES IN DEVELOPING ECONOMIES

3

the innovation period are primary catalysts for entering into a core technology alliance;
market entry and production-related factors are more relevant in technologically lessadvanced or mature markets. Though difficult to define in very precise terms, there is
widespread consensus that: (a) strategic alliances are not primarily direct investments but
not arm’s-length relationships either and; (b) the notion of alliances assumes theexistence of distinctive or relatively independent agents. Their growth of alliances wasvery fast during the 1980s but involved predominantly companies from the US, Western
Europe and Japan (Freeman and Hagedoorn, 1994). These new forms of agreements are
not replacing but actually complementing and expanding traditional foreign direct
investment (FDI). According to Hagedoorn (1996), a large share of the population ofstrategic technology partnerships is still of an intraregional or domestic nature. Although
this share has declined over the past decades, from an average of about 50% for most of
the 1980s to somewhat higher than 40% during the early 1990s, it is still the single
largest group of alliances. Only during a few years has the share of international, interTriadic alliances been higher than the domestic and regional alliances. During the mostrecent years there has been a growth of alliances with companies from the newly
industrialized companies (NICs), in particular from Korea, Taiwan, Singapore and HongKong. For the decade since 1986, growth in core technology alliances has been
continuous though irregular. Of the roughly 2,500 information technology alliances
formed during this period, the largest number has been among U.S. companies andbetween European and US firms. Among the 1,100 strategic biotechnology alliances,
US–European interregional partnerships have been more prevalent than any other,
especially during the mid-1990s. In fact, by 1996 almost 60% of all biotechnology
collaborations were interregional. The opposite was true of partnerships focusing on
information technology, for which intraregional alliances were created twice as often as
interregional partnerships in 1996.
Two major conclusions emerge from these studies as far as the developing countries
are concerned. First of all, the share of developing countries in such strategic technology
partnerships2 is very low (about 4% during the period 1980–1989 according to Freeman
and Hagedoorn, 1994. In the period between 1989 and 1992 there were some slightincreases (Hagedoorn, 1996), but these were confined to the four East Asian tiger
economies of South Korea, Taiwan, Singapore and Hong Kong and as such were notwidespread. The second aspect is that if one decomposes these strategic technology
partnerships (between the developed and the developing countries) into four categories
according to their mode of cooperation, such as joint ventures, joint R&D, minority
investments and others such as R&D contracts, etc., over two-thirds of the partnerships
are in the form of traditional joint ventures. The share of joint R&D agreements does notpress are likely to be incomplete, and (4) it probably reflects a bias because it draws primarily fromEnglish-language materials. CATI information should therefore be viewed as indicative and notcomprehensive.
2
Freeman and Hagedoorn (1994) defines strategic technology partnership as those inter firm agreements forwhich joint R&D and/or other innovative activities are part of the agreement and that can reasonably
be assumed to affect the long-term product market positioning of at least one partner
3
However the major reasons for these partnership is to be seen in the availability of highly skilled personnel
to the TNC. Given the fact these linkages are very recent, it is a bit too early to measure its
spillovers to the country at large.

4

ATPS SPECIAL SERIES NO. 2

make up more than 14% most of which are once again concentrated in the tiger
economies of East Asia. However, among the non East Asian developing countries, India
is an important exception as it features some examples of government research institutes
attracting research contracts from multinational corporations (MNCs) UNCTAD,
1999b)3. Thus, based on this indicator, it is safe to conclude that that there is very little
empirical evidence of any globalization of technology as far as the majority of thedeveloping countries are concerned.

Generation of Innovation Across More than One Country
Of the three definitions given earlier, this is the most prominent connotation of the term
globalization of technology. Studies analyzing the internationalization of corporate R&D
are largely based on two sets of measures:
R&D Expenditures and employees: The Organization for Economic Cooperation
and Development (OECD, 1999a) has recently brought together evidence fromnational surveys on the shares of domestic business funded R&D performed byforeign firms, and of R&D funded by domestically owned firms that is performed
outside their home country.
• Patent statistics: Several researchers (Patel and Pavitt, 1998) have used thismethodology, which allows the inventor’s address as given in each published patent
to stand as a proxy measure for the geographical location of R&D activities.
There are, as well, two sets of empirical evidence: one that states that globalization is on
the increase and the other that finds very little evidence for globalization. These are
analysed in turn.
•Globalization of Innovation is on the Increase: Empirical
Evidence
Much of the of the evidence on increases in globalization is to be found in two different
studies by the OECD.4 These studies have used three separate indicators to measureglobalization:• Share of foreign affiliates in domestic manufacturing R&D• Share of domestic industrial R&D financed from foreign sources• Cross-border ownership of innovations

Share of Foreign Affiliates in Domestic Manufacturing R&D
Although R&D in many countries is less internationalized than production, there havebeen significant increases in certain countries (namely, the United States, France,
Sweden and the United Kingdom) in the past 15 years. The share of foreign affiliates in
R&D varies widely across countries, ranging from less than 2% in manufacturingindustry in Japan to 68% in Ireland. The differences among countries reflect primarily
the contribution of foreign affiliates to industrial activity in those countries. Thus theshare of foreign affiliates in manufacturing production is high in Ireland and low inJapan. Similar data on developing countries are extremely hard to come by.

4

See OECD (1999 a and b).

5

MARKETS FOR TECHNOLOGY AND THE RELEVANCE OF INNOVATION POLICIES IN DEVELOPING ECONOMIES

Table 2: Share of Foreign Affiliates in Manufacturing R&D in OECD Countries

CanadaUnited States
Australia
Japan
Czech Republic
FinlandFranceGermany
GreeceIreland
Italy
Netherlands
PolandSpain
SwedenTurkeyUnited Kingdom

1985
44.2
5.9
46.4
1.0
10.1
9.2
63.1
46.4
8.2
18.0

1996
40.3
12.0
37.6
1.3
30.9
11.5
21.0
14.5
10.1
68.0
23.1
18.0
13.9
42.7
18.7
16.1
39.5

Source: OECD (1999b), p.162

Share of Domestic Industrial R&D Financed from Foreign Sources
With the exception of Japan, the seven largest R&D performing countries have all seen a
considerable rise in the percentage of R&D expenditures financed from foreign sources
since 1981. There are of course problems with respect to the estimation of foreign
contribution, as not even all the OECD countries keep track of this particular statistic ona systematic basis.

Cross-border Ownership of Innovations
Cross-border ownership of patents reflects the inventive activity of foreign affiliates of
MNCs. On average, 8% of inventions made in any OECD country were owned by aforeign resident in the mid-1990s, against 6% in the mid- 1980s. For almost all countries,
both ownership of invention abroad and foreign control of domestic inventions haveincreased.
Ownership of inventions made abroad is high in small open countries such as the
Netherlands and Switzerland. These two countries and the United States are the largest
owners of patents covering foreign inventions; however, because of the size of theUnited States, the share of foreign inventions is just above the OECD average. Japan and
Korea are much less internationalized in this respect.
All the foregoing evidence refers only to the OECD countries. However even forthese developed countries, I present below the contrary evidence.

6

ATPS SPECIAL SERIES NO. 2

Globalization of Innovation is not on the Increase: Empirical
Evidence
I hold the view that what is happening in terms of R&D centres moving abroad is a
developed country phenomenon and as such it does not affect the majority of thedeveloping countries. This inference is based on an analysis of the evidence presented ina number of recent studies, particularly two studies by US government agencies and theone by Patel and Pavitt (1998).

The US Government Studies
The US government has been particularly worried about its firms establishing R&D
centres abroad. This worry stems from two pertinent but unrelated facts: First is a feelingamong some analysts that the American innovation system could "hollow out". In
particular, developing countries (like Korea and India) are making important investments
in high-technology sectors. This feeling has forced some analysts to raise the following
questions: (a) What stops these developing countries from becoming new Japans? (b) Is
technology transfer between countries accelerating? (c) Is the technological superiorityof the developed world more precarious than in the past? Second is a feeling among the
US policy makers that US MNCs, while taking advantage of various fiscal incentives for
R&D extended to them by the federal government, are actually locating their R&D
outfits abroad. This feeling has prompted the US government to commission two
separate studies on the globalization of industrial R&D by the US MNCs. The first one isthrough the now defunct Office of Technology Assessment (OTA, 1994) and the second
is through the Council on Foreign Relations (1998). I consider the evidence presented on
the issue by both these studies, beginning with the one by OTA.

The OTA Study
Although the volume of overseas R&D by affiliates has increased substantially, it is stilla small fraction of R&D conducted by MNCs. Like the aggregate level of R&D
spending, the R&D intensity of foreign affiliates tends to be substantially lower than thatof parent groups. Much of the growth in R&D of both foreign affiliates in the UnitedStates and US affiliates abroad can be attributed to overseas acquisitions and/or joint
ventures,5 and consequently does not necessarily represent a transfer of R&D operations
from the home country to foreign markets. However, the role of FDI in launching andstimulating local R&D in developing countries is very limited. To illustrate (Figure 1), in
the case of the US MNCs, R&D by developing country affiliates came to only 8.86% of
total overseas spending, or 1% of parent company R&D in 1994. Even what existed washighly concentrated. Brazil by itself accounted for over one-quarter of affiliate R&D in
the developing world. The top four countries, with Mexico, Singapore and Taiwan
Province, accounted for 77.4%. Least developed countries had no significant R&D.

5

According to the Trade and Development Report 1999 of the UNCTAD, the Mergers andAcquisitions (M&A) in developing countries accounted for well over half the total FDI inflow in
1992-1997 and almost three quarters if China is excluded.

7

MARKETS FOR TECHNOLOGY AND THE RELEVANCE OF INNOVATION POLICIES IN DEVELOPING ECONOMIES

Further even the share of developing countries in the overseas R&D by affiliates of US
MNCs does not show an increasing trend.

10

9

8

Percentage Share

7

6

5

4

3

2

1

0
Share of Developing Countries (%)

1966

1977

1982

1989

1994

4.92

7.66

5.25

3.38

8.86

Figure 1: Share of Developing Countries in the Overseas R&D Expenditure by theAffiliates of US MNCs
(Source: OTA (1994)
Although relatively low, the rapid increase in both the magnitude and the intensity ofoverseas R&D by foreign affiliates does represent a gradual globalization of R&D. But
it is extremely difficult to assess the significance of this trend because of the lack of dataon the technological and strategic contribution of the R&D conducted by foreign
affiliates. The important analytical task is to determine whether R&D conducted byforeign affiliates contributes to the core technological activities of the parent firms, orwhether it contributes to the product and process technology used by overseas production
facilities. The study by Kuemmerle (1997) to a certain extent answers this point.
According to Kuemmerle, firms tend to adopt a global approach to R&D for one of
the two basic reasons:• Multinational firms seek a foreign R&D presence to support their overseas
manufacturing facilities or to adapt standard products to the demand in thoseregions. This arrangement is referred to as the home-base exploiting site, where
information tends to flow to the foreign laboratory from the central laboratory at
home.
•

The foreign site is established to tap knowledge from competitors and universities
around the globe. This is referred to as the home-base augmenting site and in this8

ATPS SPECIAL SERIES NO. 2case the flow of information is from the foreign laboratory to the central homelaboratory.
Kuemmerle's study of 238 foreign R&D sites showed that a majority of them (55%) wereof the home-base augmenting type.6 For developing countries to benefit from MNC
investment in overseas R&D it should be more of the of the home-base exploiting variety
as that is the only one where some spillover from such investments can occur to the hostcountry.

The Council on Foreign Relations Study.
This study is based on a case-by-case analysis of R&D globalization in several
technology-intensive industries: software, semiconductors, industrial chemicals, medical
devices and pharmaceuticals. The industries were chosen because the type of research
they perform differs along dimensions that would be expected to result in distinct
globalization patterns. The study has found that the offshore sourcing of R&D by
MNCs—through alliances and joint ventures, and offshore development of new ideas
and products through subsidiaries—has the following four characteristics:
It is occurring at a modest pace, with the majority of industrial R&D still done in thecompany’s home country.
• It varies considerably across industries in its pace, extent and nature.
• It is primarily a first world phenomenon because the developing countries, even theadvanced ones, are marginal participants in industrial research. Although on the rise,a relatively small percentage of US R&D is performed in the developing world(Table 3).
• R&D globalization has primarily benefited the US economy because the UnitedStates has remained an attractive research site for foreign MNCs.
Most studies indicate that over time and across countries the most significant reason for
conducting R&D in foreign markets is to customize products to local market conditions.
Fully integrated affiliates that conduct independent product R&D are relatively rare. Insum, R&D moves overseas much more slowly than production, sourcing and otherbusiness activities.
•

6

This finding has been confirmed by a more recent study by Dalto, Serapio and Yoshida(1999). According to them, " Motives for establishing overseas R&D facilities are manifold anddiffer among industries; technology or supply-oriented reasons have increasingly influenced thedecision of U.S. firms to locate R&D abroad (a home-base augmenting strategy). This trend isparticularly true for electronics and computer software. Even when companies initially invested
abroad for the purpose of assisting their manufacturing/sales/service facilities in a local market (ahome-base exploiting strategy), they increasingly are positioning these R&D facilities as regionalR&D bases".

9

MARKETS FOR TECHNOLOGY AND THE RELEVANCE OF INNOVATION POLICIES IN DEVELOPING ECONOMIES

Table 3: Source of Patenting of the of the Largest Firms in the World

Nationality

Percentage Share of US Percentage
Patents in 1992-96
Share
of
R&D
ExpenditureHome
AbroadAbroadJapan

2.1 (1993)
11.9 (1994)

Change inpercentageof patents
abroadsince
1980-84
-0.7
2.2

97.4
92.0

2.6
8.0

77.3

22.7

3.3

33.2

66.8

4.9

40.1

59.9

6.6

42.0

58.0

8.2

47.6

52.4

7.6

US
EuropeBelgium

Netherlands
Switzerland
UK
64.0

36.0

SwedenFrance65.4

34.6

Finland
Italy
Germany
All Firms

71.2
77.9
78.2
87.4

28.8
22.1
21.8
12.6

21.8 (1995)

-5.7
12.9

24.0(1992)
18.0( 1995)
11.0 (1997)

6.0
7.4
6.4
2.4

Source: Patel and Pavitt (1998)

The Patel and Pavitt Study
This study is based on the patenting behaviour of 359 of the world's largest firms(European = 136, American = 128 and Japanese = 95) from the Fortune 500 list. (SeeTable 3) First it shows that for an overwhelming majority of the firms R&D is still
conducted within the home country and not abroad. Only for smaller European countries
such as the Netherlands, Belgium and Switzerland does a majority of the patents
originate from research done abroad. But for these countries this has been the case for avery long time in view of the small size of their home economies and the resultant short

10

ATPS SPECIAL SERIES NO. 2

supply of skilled personnel and other key resources for conducting R&D. Second, theposition is exactly the same if one uses R&D data instead of patent data. Third, if one
considers the patent data, there was hardly any change in the patenting behaviour ofthese firms in the 1990s or the change was too small for most countries when comparedwith the 1980s. In short, this study too confirms the view that there is very little evidence
for an increase in the internationalization of corporate technology.
Finally the main conclusion that one can draw from all these studies is that although
there is some limited evidence for globalization of technology, it is restricted to theUnited States, Western Europe and Japan. At best some developing countries are inreceipt of foreign R&D centres, but the share of R&D expenditure of these foreign R&D
centres in the total industrial R&D expenditures of these countries is insignificant.
Even according to OECD (1999a), the data on patenting remind us that R&D
globalization is not entirely new. When one calculates the share of patents based on
research done by US and European firms, one sees that some industries and somecountries were already as global in the 1920s and 1930s as they are in the 1990s. British,
Dutch and Swiss companies performed a significant share of their R&D abroad during
the inter-war period—nobody called that globalization of technology at that time.

Markets for Technology
Implicit in the "globalization” argument is another one, namely that markets fortechnologies exist and that with globalization the barriers to entry into this market are
being lowered, leading to increased competition among the so- called technology
suppliers. This state of affairs of increased competition is said to be beneficial todeveloping countries as they are supposed to be able not only to benefit from increased
access to, say, state-of-the-art technology but also to obtain it in terms of better terms andconditions (referred to as at arm's-length prices). But "markets for technology" is a rather
elusive concept as the product (namely technology) that is bought and sold in the market
is very often intangible. This renders any attempt to outline the contours of this market avery difficult task. Nevertheless, Arora et al. (1999 and 2000) recently attempted not
only to define it but also to provide some estimates of its physical size in value terms.
According to them, "technology transactions can take different forms, from purelicensing of well defined intellectual property, to complicated collaborative agreements
which may well include the further development of the technology, or its realizationfrom scratch". Though transactions in technology can also occur through mergers andacquisitions and through the mobility of people, the authors do not include these models
in their definition because of the extreme difficulty in measuring these components. They
estimate the value of technology transactions of all countries as follows:• The value of the transactions consists of the licensing and royalty payments, equity
purchase in technology source, and R&D funding to technology source.
• Each transaction was verified to ensure that it involved a transfer of technology.
• The firm(s) granting the technology were coded separately from the firm(s)receiving the technology.
• In case of a cross-licensing agreement, the value was split equally between thefirms.
The estimates so arrived at are presented in Table 4. In measuring the relative size of thevalue of the market for technology I take it as a percentage of the business enterprise
R&D expenditure of all the developed economies (OECD). The table brings out several
interesting details. First of all, the market for technology does not show a definite
increasing trend, but only fluctuations. In fact, there has been considerable shrinkage in12

ATPS SPECIAL SERIES NO. 2

its size and growth since the mid-1990s. This is quite compatible with the fact that
increasingly, many of the technologies are getting transacted through non-market forms:
the substantial growth of FDI during the period substantiates this point. Second, themarket for technology is actually very small even though it has showed some increases
during the early part of the last decade.7 The implications of these two results for thedeveloping countries are discussed below.
Table 4: Size of the Market for Technology, 1985-1997(1)

1985-89
1990
1991
1992
1993
1994
1995
1996
1997

Market for
RateofTechnology
Growth of the(Millions of Market (%)
Current $)
(2)
(3)

27753
24169
41410
43571
46479
51604
44469
20761
21956

-12.91
71.34
5.22
6.67
11.03
-13.83-53.31
5.76

Business
Enterprise
RelativeR&D (Millions Size of theofCurrent Market for
PPP $)
Technology(4)(5=
2/4*100)
237603250366256922254090259808292272313056
NA

10.17
16.54
16.96
18.29
19.86
15.21
6.63

Source: Arora et al. (2000) and OECD (1999c).
It is seen that non-market forms of technology transfer are on the increase. This meansthat increasingly technologies are being transferred through the intra-firm route. To
illustrate, parent companies are selling technologies more to their affiliates andconversely less to unaffiliated firms. Recent data clearly substantiates this point. Both
Korea and India have traditionally used the medium of purchasing technology throughthe market by means of licensing agreements. Of late the number of cases of licensing
agreements that are approved has come down in both of these countries while the relative
share of technical collaboration agreements involving equity participation by thecollaborator (no-market forms) is clearly on the increase in both countries.
United States is the world's largest net seller of technologies to the rest of the world(as indicated by its consistent positive technology trade balance). Increasingly, however,the share of receipts from the sale of technology by US firms to unaffiliated companies
or firms abroad has decreased (Figure 2). The figure indicates that there has been a
7

My estimates of the size of the market are slightly different from Arora et al. (1999c). They haveestimated it to be around 5% of the total non-defense R&D of the developed countries and therefore
it is clearly an underestimate. By contrast, my estimates are likely to be overestimates as the businessenterprise R&D figures are in current purchasing power parity dollars while the value of the market
for technology figures are in current US dollars. In all probability, Arora et al. might have converted
national values of technology transactions into US dollars using the official exchange rates rather
than purchasing power parity terms.

13

MARKETS FOR TECHNOLOGY AND THE RELEVANCE OF INNOVATION POLICIES IN DEVELOPING ECONOMIES

significant reduction in the rate of growth of sales of technology to unaffiliated firms
since 1994, thus confirming my earlier proposition.
In Table 5, I do a further exercise by decomposing the sale of this disembodied
technology to unaffiliated enterprises in the developing world. The exercise shows thatwhile the sale of technologies to developing countries has almost doubled (as measured
by the share of developing country sales to total sales) during the period underconsideration, this is entirely due to the sale of technologies to just two countries, Korea
and Taiwan. Net of these two, the share of developing countries has remained virtuallystagnant.

Payments in respect of Technology Sales (Millions of US $)40,00035,00030,00025,00020,00015,00010,0005,000

0Receipts

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

9,914

11,802

13,064

16,634

18,107

19,71520,323

26,71230,28932,82333,676

Affiliated

7,629

9,156

10,207

13,251

14,395

15,71815,707

20,27522,85924,71025,515

Unaffiliated

2,285

2,646

2,857

3,384

3,712

3,997

4,616

6,437

7,430

8,113

8,161

Figure 2: US sale of disembodied technology to affiliated and unaffiliatedenterprises abroad, 1987–1997
Source: National Science Board (2000).
From the foregoing analysis, the following conclusions emerge:• The so-called market for technologies is actually small and is shrinking over time.
• Much of the sale of technologies to enterprises in developing countries takes placethrough non-market forms such as FDI.
In the light of this it will be very instructive to find out whether there exists any
systematic evidence of the spillovers from FDI especially in the developing world. This
is attempted in the following section.

Table 5: US Sale of Disembodied Technologies to Developing Countries(Millions of US $)

Asia

Latin
Africa Middle Total
Total
All
America
East
Developing Developing Countr
Countries
Countries
ies
excluding
Korea andTaiwan
1987
213
64
277
222
1,678
1988
302
48
22
18
390
237
1,962
1989
351
54
24
17
446
245
2,051
1990
437
59
22
22
540
236
2,333
1991
419
85
34
25
563
281
2,434
1992
436
73
27
21
557
295
2,525
1993
532
36
33
601
289
2,820
1994
691
83
26
20
820
385
3,026
1995
914
35
35
984
297
3,513
1996
850
28
23
901
294
3,488
1997
912
69
17
40
1038
499
3,272
Source: Computed from National Science Board (2000).

Evidence of Technology Spillovers from FDI
It is argued that when firms establish affiliates abroad and become multinational, they
are distinguished from the already established firms in the host country by two factors:• They bring with them some amount of proprietary technology that constitutes theirfirm-specific advantage and allows them to compete successfully with local firms
who have superior knowledge of local markets, consumer preferences and businesspractices.
• The entry of the MNC affiliate disturbs the existing equilibrium in the market andforces local firms to take action to protect their market shares and profits.
Both these factors are likely to cause various types of spillovers that lead to productivity
increases in local firms. There are three types of spillovers:• Perhaps the simplest example of a spillover is the case where a local firm improves
its productivity by copying some technology used by MNC affiliates operating in
the local market.
• A second kind occurs if the entry of an affiliate leads to more severe competition in
the host economy, so that local firms are forced to use existing technology andresources more efficiently.
• A third type of spillover effect takes place if the competition forces local firms tosearch for new and more efficient technologies, as the entry of a foreign affiliate
may demonstrate the existence and profitability of new products and processes, andencourage local firms to adopt some of them. These diffusion processes may evenbe repeated every time innovations are transferred.
A detailed survey of the various studies is provided in Blomstrom and Kokko (1997). To
examine how the development of technology and productivity in individual local firms isrelated to the presence of foreign MNCs in the local market, a study would requiredetailed micro data, both qualitative and quantitative. The study would have to cover
several years, as spillovers are not instantaneous. It should also indicate a large numberof firms and industries, so that inter industry spillovers could be observed, and so that it
would be possible to reach statistically significant conclusions. According to Blomstrom
and Kokko, however no comprehensive analysis of this character has ever been made,16

ATPS SPECIAL SERIES NO. 2

essentially because of the extreme data requirements. Additional empirical evidence on
spillovers must therefor be drawn from two other sources.
First, in addition to the few case studies focusing directly on spillovers, there are large
numbers of case studies discussing other aspects of FDI in different countries andindustries; these studies often contain valuable “circumstantial evidence” of spillovers.
For instance, many analyses of the linkages between MNCs and their local suppliers andsubcontractors have documented learning and technology transfers that may make up abasis for productivity spillovers or market access spillovers. These studies seldom reveal
whether the MNCs are able to extract all the benefits that the new technologies orinformation generate among their supplier firms, so there is no clear proof of spillovers,
but it is reasonable to assume that spillovers are positively related to the extent oflinkages There are also studies of demonstration effects, technology diffusion and labour
training in foreign MNCs.
Second, there are a few statistical studies examining the relationship between aforeign presence in a host country industry and the productivity (or productivity growth)of the locally owned share of the industry or of individual locally owned firms. Thesestudies typically estimate production functions for locally owned firms, and include theforeign share of the industry as one of the explanatory variables. They then test whether
foreign presence has a significant positive impact on local productivity (or productivity
growth) once other firm and industry characteristics have been accounted for. Although
the data used in these analyses are often limited to few variables, aggregated to industry
level rather than plant level, and in several cases of a cross-section rather than time series
or panel character, they do provide some important evidence on the presence and patternof spillover effects.
In short, the evidence on positive spillovers from FDI, from anywhere in thedeveloping world, is not easy to come by. However, two developing countries, Singapore
and Malaysia, have benefited from FDI. But Mani (2000) shows that Singapore has
actually engineered spillovers from FDI by putting in place a host of target-oriented
innovation and industrial policies such as the Local Industry Upgrading Programme”. 8
Consequent to this, there has been a significant spurt in the number of local small andmedium enterprises and of late the ratio of R&D expenditure of local firms to foreign
firms is greater than unity in a number of manufacturing industries such as precision andtransportation engineering and service industries as a whole. In the case of Malaysia thepicture is entirely different. FDI has played an important role in this transformation andthe spectacular expansion and structural changes in the composition of manufactured
exports. Manufacturing is dominated by a few industries, notably the electrical andelectronic industries, making the economy vulnerable to changes in world demand forthe products involved. The most important industry is electrical machinery, appliancesand parts. This industry, in which foreign affiliates are prominent, is characterized byhigh import intensity and limited technology transfers and backward linkages. The shareof value added is relatively low and has even declined over the years from 28% of gross
output in 1981 to 22% in 1992. A survey of 18 of the largest foreign affiliates in the8Under the Local Industries Upgrading Programme (LIUP), the government encourages MNCs to“adopt” a group of small and medium enterprises (SMEs) and transfer technology and skills to them.
The government pays the salary of a full-time procurement expert to work for specified periods withthe adopted firms and help them upgrade their production and management capabilities to thestandards required. In this way the state engineers positive spillovers from FDI to the local small andmedium sector.

MARKETS FOR TECHNOLOGY AND THE RELEVANCE OF INNOVATION POLICIES IN DEVELOPING ECONOMIES

17

industry carried out in 1995 showed that the value of imported materials and components
accounted for 78% of their total inputs (UNCTAD, 1999a). However there areencouraging signs of foreign affiliates forging backward linkages and there areindications of technological deepening and upgrading. A principal constraint is theshortage of skilled personnel and of substantial investments in R&D. and this is thechallenge facing the policy makers in that country.
My analysis thus far brings to the fore the following propositions with respect totechnology development in developing countries. First, globalization of technology has
affected developing countries only in an insignificant manner. The process does notaffect the majority of the developing countries at all. Second, the markets for technology
are shrinking and appear to be not very competitive. Increasingly, moreover, muchtechnology is being transferred to the developing countries through non-market forms
like FDI. The evidence on positive technology spillovers from FDI to local firms is very
limited, but some countries have been successful in engineering it through ingenious
policies. This raises some questions about the continued relevance of governments’innovation policies designed to give their national firms an advantage. This forms thefocus of the next section.

Innovation Policies – Their Relevance andComponents
It is essential, at the very outset, to define what I mean by innovation policies. I define
these as those efforts by governments, that encourage the accumulation, diffusion andcommercial use of new products, processes and services by firms.9 The basic rationale
behind public innovation policies is to combat private under-investment in R&D.
Following Leyden and Link (1992), the scope of public innovation policies can bedivided into two: First is the creation and maintenance of a legal environment conducive
to private sector investment in innovative activities. This is created by legal measuresthat enhance the power to appropriate the fruits of R&D. Patents and the relaxation of
antitrust activity are the primary means by which the government creates such a
conducive environment. The second category comprises the provision of sufficient
stimuli to overcome the natural inclination of private agents to consider only their private
benefits when choosing the level of innovative activity in which to engage. This takes avariety of forms, ranging from government grants and contracts to targeted tax
incentives. Public innovation policies vary significantly across countries10 according to
the nature of their development. Table 6 summarizes the main components of thesepolicies.

9This definition is very similar to the one by Dodgson (1999)10

According to World Bank (1998), public innovation policies should consist of: (a) Governments
encouraging research either directly through public R&D or indirectly through incentives for private
R&D. Direct government R&D includes that financed at universities, government research institutes,
science parks and research-oriented graduate schools. Indirect support for R&D includes preferential
finance, tax concessions, matching grants, and the promotion of national R&D projects. (b)Governments developing core strengths in basic science and technology, as that is not only necessary
to maintain access to the global pool of knowledge but also to adapt that knowledge to local use.

MARKETS FOR TECHNOLOGY AND THE RELEVANCE OF INNOVATION POLICIES IN DEVELOPING ECONOMIES

Table 6: Components of Innovation Policies
Type of Measure
Relationship with the Financial Measures
Market• Subsidizing
exchange of R&D
Public provision of goods
personnel between
and services
public and private
sectors

Modification of market
incentives

•
•

•

•

Support of the
improvement of market
mechanism•Tax incentives for
R&D
Direct funding
through grants, soft
loans, loan
guarantees for
R&D projects;
Promotion ofnational R&D
projects;
Joint cooperative
R&D projects
betweengovernment and theprivate sector
Creation or
improvement ofspecialized
financial market
mechanisms (e.g.,
venture capital)

19

Non-Financial
Measures• Policies aimed at
diffusion oftechnology• Human resources
development
policy• University andgovernment
R&D• Industrial
standards• Public
procurement• particularly in
defence• The IPR regime• Industrial andtrade policies

Source: Mani (2001).
Of the various policies it has been the financial measures and among them the tax
incentives that have attracted much attention and analysis. Tax incentives possess anumber of attributes that are palatable to policy makers during a phase of economic
liberalization. The main popularity of the tax incentive system arises from the fact that it

20

ATPS SPECIAL SERIES NO. 2

interferes less with the market mechanism. So it is not surprising that public innovation
policies have become equated, very narrowly, with tax incentives and other financial
measures. However, in current discussions—and these too in the context of developing
countries—some of the non-financial measures are equally important. Among them wefocus our attention on two: human resources and industrial standards. This is because, as
mentioned before, innovation policies will have to undergo significant changes according
to the potential technological capability of a country. For instance, developing countries
can no longer be considered as a homogenous bunch especially in terms of theirtechnological capability. Some developing countries (such as the east Asian and some
Latin American countries) are creators of technology, while others (such as all thecountries in sub-Saharan Africa and some countries in South Asia, Latin America andthe Middle East) are mere assemblers of technology imported from elsewhere.11 I denotethe former group as Type 1 and the latter as Type 2. For the Type 1 countries, I argue
that the financial measures are more important and effective, while for the Type 2 groupof technology assemblers it is the non-financial measures that must precede or mustreceive more emphasis than the financial measures. So I begin with the non-financial
measures. It must be mentioned, however, that the basic objective of all innovation
policies is to increase the supply of technologies to local firms. Yet it is now well known
that merely increasing the supply of technologies need not necessarily lead to positive ordesirable outcomes for the economy as a whole. This is because increases in supply must
be matched by increases in the demand for technology (Kim, 1997). Most developing
countries are characterised by low levels of demand for technologies consequent to thehigh barriers to entry (both domestic and foreign as well) and therefore domestic firms
have little or no real incentive to effect technological improvements: the Indianpassenger car market is a good example of this point. The technological development of
successful east Asian countries such as Korea (Kim, 1997) has shown that innovation
policies must be backed by trade and industrial policies that increases the demand forinnovations.

Non-Financial Measures
Policies on Human Resources Development
In my view, this is the most important measure to stimulate domestic technology
development. The importance of the availability of a steady stream of highly trained
personnel hardly needs to be emphasized. All successful countries including the recent
success stories from East Asia had successful policies for increasing both the quality andthe quantity of technically trained personnel (Lall, 1998). Most developing countries,
however, treat policies on human resource development separately from public
innovation policies. Unless there is a critical mass of technically trained personnel, noamount of fiscal incentives can spur innovations. There are two separate but related
statistics which capture this state of affairs: (a) the density of tertiary students (Table 7),
and the availability of this affects the second one, (b) the density of research scientists
and engineers (RSE) (Table 8). In fact as can be seen in Table 8 there is a very strong
11

More rigorous criteria for arriving at a taxonomy of developing countries ARE attempted in Mani
(2000). I use two measures of "revealed technological capability", namely (a) the number of patents
received in the US and (b) the share of high technology exports in a country's manufactured exports
in classifying developing countries into Type 1 and Type 2 countries.

MARKETS FOR TECHNOLOGY AND THE RELEVANCE OF INNOVATION POLICIES IN DEVELOPING ECONOMIES

21

positive correlation between the RSE and the research intensity: the zero-ordercorrelation coefficient between the two works out to (+) 0.88. Moreover, the number ofstudents enrolled at the tertiary level in science and engineering subjects does not workout to more than 15 to 20% in most developing countries. A third point, which is usuallyforgotten, is that it is not merely the supply of technically trained personnel that matters.
There has to be a match between the requirements of industry and the output of thehigher education system. Failure to recognize this can result in losing important markets.
For instance, the number of students in IT related subjects are extremely low in mostdeveloping countries12 with some notable exceptions.
Table 7: Density of Tertiary Students (Per 10, 000 Inhabitants)
Brazil China Korea Malaysia Singapore India Tanzania Uganda Zambia Nigeria
1980 1,158 166 1,698
419
963
515
22
45
128
229
1985 no328 3,568
595
1,474
582
22
69
181
352
data
1990 1,082 331 3,946
680
1,846
582
26
107
212 no data
1991 1,077 313 4,071
753
1,956
no
28
126 no data no data
data
1992 1,042 313 4,375
856
2,080
no
29
124 no data no data
data
1993 1,067 377 4,420
886
2,273
no
33
135 no data 410
data
1994 1,092 437 4,637
973
2,328
538
36
150
238 no data
1995 no461 4,950 1,048
2,527
610
43
160 no data no data
data
1996 1,424 473 5,605 no data
2,730
638
48
179 no data no data
1997 no488 6,106 no data no datano57
no data no data no data
data
data
Source: Human Capacity Development Center (2000)

Industrial Standards
Most developing countries pay scant attention to the issue of industrial standards. But
this is going to be an important consideration if they want to emerge as manufacturers
and exporters of manufactured products especially to the western markets. Industrial
standards are an integral component of public innovation policies (Ergas, 1987). They
confer at least two major benefits. The first comprises of what may be termed as direct
benefits and the second indirect benefits. These are discussed, albeit briefly, below.

12

There is a shortage of IT related technicians even in advanced countries such as the United States andGermany, but these countries have the luxury of allowing in-migration of these personnel.

22

ATPS SPECIAL SERIES NO. 2

Table 8: Density of Research Scientists and Research Intensity(per 1 million labour force)
Year
CountryUSA
UK
Germany
Korea
Singapore
Malaysia
India
China
BrazilSouth Africa
Nigeria
Uganda

1993
1996
1995
1996
1995
1996
1994
1996
1995
1993
1987
1997

Researchers per 1
Million Labour
force
3676
2448
2831
2193
2318
93
149
454
168
1031
15
21

Research Intensity(R&D/GNP*100)
2.63
1.95
2.41
2.82
1.13
0.24
0.73
0.66
0.84
0.70
0.09
-

Source: UNESCO (1999)
The immediate impact of standardization is to reduce transaction costs by providing
clearly specified interface requirements for products. It can thus lower barriers to market
entry and speed up competition and hence demand for new technologies. In other words,
though it is a supply-side measure, it has the potential of stimulating demand fortechnological improvements as well. Further, it fulfills a quality certification function,
which is especially important for industrial components. In terms of indirect benefits the
preparation of new standards and the ongoing review of existing ones provides animportant forum for the exchange of technical information both within each industry andwithin its users and suppliers. Ergas (1987) thus argues that It can also function as ameans of placing ongoing pressure on firms to upgrade their products, while providingthem with the technical information required to do so.
Finally, under the Technical Barriers to Trade (TBT) Agreement, which was part of
the WTO Treaty signed in 1994, all the signatory governments are obliged to give
preference to international standards as a basis for their technical regulations. In
addition, the TBT Agreement encourages national and regional standards developers todefer to international standards in their activities. The motivation for this agreement is
the long-term goal of free trade across the world. If trading partners adhered to identical,
or equivalent, standards, then the costly problem of satisfying arbitrary technicalrequirements peculiar to nations or regions would be reduced substantially.
For a credible presence in international markets, certification under ISO 9000
standards has become increasingly important for manufacturing and service sector units

23

MARKETS FOR TECHNOLOGY AND THE RELEVANCE OF INNOVATION POLICIES IN DEVELOPING ECONOMIES

the world over .13 ISO 9000 (first published in 1987 and revised in 1994) is primarily
concerned with quality management. The definition of quality in ISO 9000 refers to all
those features of a product or a service that are required by the customer. Though theshare of developing countries in the ISO 9000 certification has shown increases, there isconsiderable concentration of it within the east Asian countries (the traditional Asiantigers plus China, Malaysia, Indonesia, Thailand and Philippines). In fact, the number of
ISO 9000 certifications secured by firms in developing countries excluding the east
Asian ones has actually increased very slowly and their share in the total also continues
to be small (Figure 3). The ISO is currently working on a year 2000 version of thequality systems standards. It is very important that firms in the developing countries
prepare themselves for the effective implementation of these and in this task thegovernments of these countries (thorough their institutions on national standards) havean important role to play.
250000

Number of ISO 9000 Certification

200000150000100000

50000

0
1993

1994

1995

1996

1997

Jan-93Jun-94

Dec-95

Dec-96

Dec-97Developed Countries

26414

66197

118081144919191655Developing Countries

1402

4167

9272

17785

34694

Developing Countries Excluding East Asia

884

2136

3794

6624

10208

Total World

27816

70364

127353162704226349Figure 3: Trends in ISO-9000 certification world-wide, 1987–1997
Source: Mani (2001).
In addition to process or management standards covered by the ISO certification, there
are at least three other types of standards: (a) test and measurement standards; (b)product standards; and (c) documentation standards. Firms in developing countries arevery often unaware of the plethora of standards that are available. The only way in which
13

ISO is the international organisation for standardization. It is composed of standards institutes fromboth the developed and developing countries. ISO develops voluntary technical standards, which add
value to all types of business operations. Among other things, it facilitates international trade.

24

ATPS SPECIAL SERIES NO. 2

they can keep themselves abreast of the latest developments is through governmental
standards implementing agencies. This is an area that just cannot be left to the private
sector institutions in these countries.

Financial Measures
Tax Incentives
The fiscal measures to promote innovation have assumed much importance in current
discussions on innovation policies. Among the fiscal incentives, the most important andwidely used instrument is tax incentives. A recent survey by the OECD (1996) has forthe first time quantified in an exhaustive manner the entire gamut of public support to
manufacturing R&D by the major public players in national R&D systems of the OECD
countries. R&D contracts form the most important component, but it has been nearlystagnating. The direct support to R&D is the next important segment and it has been
growing at a rate of nearly 9% per annum: the decline in 1993 is perhaps due to reporting
gaps. All the three (namely research grants, tax concessions and loan guarantees) put
together (research grants, tax incentives and loan guarantees) account for as much as
15% (approximately) of the total industrial R&D budget of the region.
Since direct support to R&D is the one that is relevant for our discussion I now
present the details on it. Within the direct support to R&D the share of tax incentives hasgone down significantly while that of direct grants has actually increased (Table 9). Thisshows that in the free market economies, direct grants for specific projects in the private
sector are becoming very popular despite the fact that grants may interfere with themarket mechanism.

Table 9: Direct Support to R&D in Developed Economies(Percentage Share)
Financing
Instrument
Research
GrantsTax
Concessions
Loan
Guarantees
Mixed
Unclassified

1989

1990

1991

1992

1993

42.5

45.6

45.6

53.5

58.5

35.4

31.4

31.10

19.80

19.80

1.2

1.3

1.70

4.6

0.9

20.4
0.50

21.0
0.70

20.5
1.36

20.8
1.40

19.1
1.70

Source: Mani (2001)
Among the direct support mechanisms, grants appear to be the most dominant form. In
some countries like Israel, for instance, the entire support from government to industry isin the form of direct grants (Mani and Harison, 2000) Moreover, this mode of support

25

MARKETS FOR TECHNOLOGY AND THE RELEVANCE OF INNOVATION POLICIES IN DEVELOPING ECONOMIES

has also increased its share rather significantly. Tax concessions, while the second mostimportant, have eroded their share by nearly one-half. This disenchantment as it werewith tax concessions warrants a closer look, in particular:• The specific forms they have taken in various countries; and• The empirical evidence on their efficacy as a tool for stimulating investments in
R&D by private sector firms.

Nature of Tax Subsidies Across Countries
This is based on a survey of tax treatment of R&D expenditure across 20 developed anddeveloping countries.14 The following stylized facts emerge:• The majority of the countries covered in the sample allow almost the entire revenue
and capital expenditure on R&D to be deducted from the taxable income during ayear.
• In some 10% of the countries an amount even greater than what is spent is allowed
to be deducted.
• Much of the revenue expenditure deduction is admissible in the first year itself,while much of the capital expenditure deductions is admissible in the first five
years.

Nature of Tax Subsidies Across Developing Economies
Among the over 100 or so countries typically referred to as developing, only a handful(approximately 10 or so) have production enterprises that invest in industrial R&D.
These countries are either in Asia (specifically in East Asia) or in Latin America. All thedeveloping countries that report sizeable industrial R&D expenditures have some form oftax treatment for R&D, though only Korea and Taiwan among them offer tax credits.
Singapore, too, offers some additional tax benefits (Table 10).

Table 10: R&D Tax Treatment across Developing Economies
Country

BrazilIndia

14

Definition of
R&D forTax
treatment
R&D incomputerindustry
Scientific
Research or
Know-how

R&D
Depreciation
Rate(%)

R&D Capital
Depreciation
Rate(%)Tax Credit
Rate(%)

100

100

none

100

100 except land

none

These countries include 13 developed countries (Australia, Belgium, Canada, France, Germany,
Ireland, Italy, Japan, Netherlands, Spain and Switzerland, UK and USA) and 6 developing countries(Brazil, China, Hong Kong, Korea, Singapore, South Africa and Taiwan).

26

ATPS SPECIAL SERIES NO. 2

Korea

MexicoExperimental 100
and researchexpenditure-

Singapore Either inhouse R&D
or R&D
contracted
out toapprovedorganisations
excludingsocialscience,qualitycontrol,
software
ScientificSouth
research,
Africadevelopmentoftechnology
Usual
Taiwan
Malaysia

Systematicor intensive
study
undertakenin the fieldof science
andtechnology
with theobject ofusing theresults of thestudy for the
production
or
improvementof materials,
devices,

18-20
depreciation;
5-6 for buildings

103-year SL
20-yearbuildings

none100; and incertain cases
200 onapplication to
the Economic
Development
Board

Depreciation as
usual

none

100 % forrevenue
expenditure

25

none

Depreciation as
usual
Depreciation as
usual

15
20
none

100

100
1. Double
deductions
on revenue
expenditureforapproved
projects
2. Double
deduction
on cashcontributio
n toapproved
research
institutes
3. Double
deductions
on25

MARKETS FOR TECHNOLOGY AND THE RELEVANCE OF INNOVATION POLICIES IN DEVELOPING ECONOMIES

products,
produce orprocesses.

27

payments
for the useof theservices of
R&D
centres

Source: Mani (2001)

Effectiveness of R&D Tax Subsidies
There are two key aspects to evaluating the effectiveness of the R&D tax subsidies. One
relates to the efficacy of tax subsidies in general as a policy tool for spurring increased
research spending. The other aspect concerns how effective the research anddevelopment tax credit in particular has been in stimulating increased R&D spending,and at what cost in forgone federal tax revenues. These issues are analysed in turn.
Direct government funding is apt to be more efficient than tax incentives when thepolicy is to enlarge the stock of basic knowledge available to domestic firms: direct
funding would likely raise total spending on basic research by more than the amountspent by the government, whereas one unit of tax incentives would likely yieldsignificantly less than one unit of additional spending on basic research because of its
relatively large spillover effects. But if the policy aim is to boost a country’s rate ofcommercialization of new products, processes or services, then a tax incentive has someadvantages over direct funding. Success in commercialization hinges on a soundunderstanding of the market, and tax incentives have the advantage of leaving thedecisions of which projects to fund in the hands of private firms rather than government
agencies. Even with the tax subsidies, firms will still be putting up most of the money for
projects they pursue, which ensures that they, not taxpayers, will bear most of the risks
of failure. By contrast, direct funding of commercial R&D could foster a misallocation of
resources among major sectors of the economy.
In addition, tax incentives involve less interference in the market and thus allow
private sector decision makers to retain autonomy in devising their R&D strategies in
response to market signals. It is further opined that tax incentives are easier to administerand are less discretionary than direct project subsidies which are often granted on a caseby-case basis. Project grants are also less predictable as they are subject to yearly budget
allocations.
Tax incentives also have a number of limitations. The most important ones are: The
R&D tax subsidies tend to operate as entitlement: all firms that qualify may claim it. In
addition, a credit is easy to abuse by classifying routine research expenses as innovative
ones. Tax incentives are blunt instruments: a tax incentive like a credit cannot be targeted
at R&D projects with large spillover effects, unlike direct funding programmes. The
propensity to relabel routine expenditures such as quality control and testing as R&D
expenditure and then claim tax incentives is also very high, especially in the developing
country context.

Empirical Evidence on the Efficacy of Tax Incentives

28

ATPS SPECIAL SERIES NO. 2

There are two methodologies for empirically testing this proposition. Most or all thestudies are based on the Research and Experimentation Tax Credit of the United States:• The first technique uses the simple survey method of essentially questioning senior
R&D managers about their response to changes in the tax incentive system.
• The second technique uses econometric techniques to estimate the price elasticity of
R&D—the percentage increase in R&D induced by a percentage fall in its cost.

Venture Capital
Another fiscal instrument, which is increasingly gaining currency, is venture capitalfunds. Venture capital is an equity form of investment in a technology-based firm at its
early stage of development. In addition to providing much-needed risk capital, theventure capitalist also renders a fair amount of value added support to the investee. Thus
in a sense the venture capital institutions, theoretically speaking, are a solution tofinancial barriers to innovations in both developed and developing countries. This point
is further elaborated in Mani (1997). It is interesting to note that even in many OECD
countries, governments have implemented their own programmes to mobilize venture
capital in support of small, innovative firms. Direct measures refer to specific publicly
funded schemes, which increase the supply of venture capital financing.
The diverse forms of public policy instruments aimed at stimulating the supply of
venture capital in OECD countries can be grouped into three main categories: (1) direct
supply of venture capital to venture capital funds or small firms; (2) financial incentives
to investing in venture capital funds or small firms; and (3) investor regulations
determining the types of investors in venture capital. By contrast, most developing
countries do not have any policies for addressing the financial barriers to innovation.
Even the developing countries such as India that have sizeable venture capitalinstitutions, do not see these institutions as a real solution to the financial barrier toinnovations (Mani, 1997).
There is thus a case for incorporating the supply of risk capital as part of public
innovation policies. An important point to be noted, however, is that the idea of theventure capital funds is not freely transferable to most developing countries as some of
the requisite institutions, such as a vibrant secondary equity market (which would
provide a means of exiting for the venture capitalist), are virtually absent in thesecountries. If the absence of these secondary equity markets is the result of structural
weaknesses in the domestic capital markets, then one needs policies to remedy thislacuna before even attempting to establish venture capital institutions.

A Proposed Innovation Policy Framework
I now conclude my discussion of innovation policies by drawing up a hypotheticalsequencing of the various components of innovation policy, especially in the context ofthe majority of the developing countries, which fall in the Type 2 group of assemblers ofimported technologies. The sequence is outlined in Figure 4. The first and foremost
component is a policy on improving both the quality and the quantity of the humanresource, which then leads to the creation of a pool of techno-entrepreneurs. Time again
it has been demonstrated that fiscal benefits can lead to meaningful results only in cases
where there is an adequate and appropriately skilled workforce. To achieve this, theMARKETS FOR TECHNOLOGY AND THE RELEVANCE OF INNOVATION POLICIES IN DEVELOPING ECONOMIES

29

state will have to tone up its entire education system—primary, secondary and tertiary—and in some cases allowance will have to be made for the importation of skilled persons
from abroad in areas where such shortages are badly felt. This last is of course apolitically sensitive issue and can be used only as a short-term measure. Once the state
has created a critical mass of technically trained personnel, they then must be encouraged
with financial measures to establish small and medium enterprises. The success of theresearch grant system in Israel (Mani and Harison, 2000) and the significant increase in
the number of technology-based small and medium enterprises, as well as the increased
investments in R&D in Singapore (Mani, 2000) is an eloquent testimony to this line ofreasoning.

Innovation Policy

30

ATPS SPECIAL SERIES NO. 2

Policies
engineerinforsgpillovers
FDI;
from
•
Policiesgoverning theimport ofdisembodie
technology
ddabroad.
•i
Policies for
Indigenizing
imported technologies
and local developmentof simple technologies(incremental
innovations)

Policies for Improving the
Quality and Quantity of Human
Resource••••
Leads to Creation ofTechnoEntrepreneurs

Toning up primary andsecondary education
Improving the quality oftertiary education andespecially science andengineering
Vocationalizing education
by establishing polytechnics
Even allowing the
migration of skilled
personnel in selected areas
Where severe shortages arefelt subject to politicalfeasibility

Various Fiscal
Incentives:•••

Research grants
Tax Incentives
State sponsoredventure capital

Policies for Encouraging Smalland Medium Enterprises Basedon Local Capital

Figure 4: Hypothetical Sequencing of Innovation Policy in a Typical Developing
Country belonging to Type 2

Conclusions
It is seen that globalization of innovation is a process restricted, by and large, to the firstworld. Moreover the market for technologies appears to grow smaller and smaller while
non-market forms such as FDI are on the increase. The empirical evidence that there arepositive spillovers to domestic firms from FDI is scanty and exists only under certain
conditions. However, the example of Singapore shows that spillovers can be engineered
through imaginative industrial and innovation policies. Given this state of affairs, it isimperative that developing countries, especially those that who continue to be assemblersof borrowed technologies, must put in place a set of innovation policies to hasten theprocess of domestic technology development. Central to such a policy framework is thesystematic improvement of both the quality and the quantity of technical skill
endowments of the domestic human resource.

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