[pic] | COMMISSION OF THE EUROPEAN COMMUNITIES |

Brussels, 21.12.2007

SEC(2007) 1730

COMMISSION STAFF WORKING DOCUMENT

Annex II to theCOMMUNICATION FORM THE COMMISSION TO THE COUNCIL, THE EUROPEAN PARLIAMENT, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF THE REGIONS

A lead market initiative for Europe

Explanatory Paper on the European Lead Market Approach:

Methodology and Rationale {COM(2007) 860 final SEC(2007) 1729}

COMMISSION STAFF WORKING DOCUMENT

Annex II to theCOMMUNICATION FORM THE COMMISSION TO THE COUNCIL, THE EUROPEAN PARLIAMENT, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF THE REGIONS

A lead market initiative for Europe

Explanatory Paper on the European Lead Market Approach:

Methodology and Rationale

SUMMARY

Europe’s competitiveness and ability to face global competition is hampered by a relative under-performance in innovation. Becoming an economic zone that could generate much more “lead markets” would bring a series of substantial economic advantages for the economy as a whole and for the citizens.

The present paper constitutes firstly an assessment confirming the above statement. Based on examples of successful lead markets, on the result of discussions with stakeholders and on the input from economic analysis, the paper indicates the positive impacts to be expected and analyses to which extend and in which form public intervention can best be conducive to such positive outcomes.

It notably details the potential economic advantages of the Lead Market Initiative (LMI) for Europe. Facilitating the growth of lead markets is an approach to bridge the gap between the generation of new technologies and the market success of innovations. The gains from closing the gap could include more rapid returns on investments and thus greater incentives for expanding private investment in R&D; location advantages for R&D and production facilities; higher productivity, increased exports, ultimately leading to higher levels of growth and employment. Given the areas identified, the approach would also generate substantial environmental and societal benefits.

This paper also recognises the well substantiated analysis that “lead markets” with a sustainable potential can not be artificially created but only facilitated by offering best possible conditions for transforming ideas into new products and services and therefore substantiate the policy choices made by the Commission in its LMI. Coordination of targeted policy measures that serve several policy objectives (health, environment, energy etc.) in a horizontal way could better foster innovation in specific areas, while avoiding creating burdens on innovative businesses and other organisations.

Finally, this paper complements the LMI communication in explaining the methodology that has been followed to identify some potential lead markets and to avoid possible negative side effects. Based on a set of prudent assumptions, the volume of each of these markets may double or triple over the period 2006-2020, for a total market value exceeding 300 billions euros and a total 3 million persons employed in 2020. Ten to fifty per cent of that growth might be attributed to the fact of being a lead market[1]. Applying a conservative average of 20% to these emerging markets[2] would attribute more than 60 billions euros of additional market volume (and close to half a million new jobs) to the lead market effect and related policy measures for Europe only.[3]

TABLE OF CONTENTS

1. Consultation of interested parties 7

2. Problem definition 8

2.1. Overall situation 8

2.2. Detailed analysis 9

2.3. Summary 12

3. Main components of the economic definition of lead markets 12

4. The economic rationale for a lead market policy initiative 16

4.1. The economic advantages for Europe of encouraging the emergence of more lead markets 17

4.1.1. Quantitative advantages 17

4.1.2. Better Adaptation to structural change 17

4.1.3. Substantial benefits for the citizens and the society 18

4.2. Public intervention can contribute to the emergence of lead markets 21

4.2.1. Favourable horizontal market conditions 21

4.2.2. Market failures 22

4.2.3. Other specific policy measures 23

5. Features of a lead market initiative 25

5.1. Main features 25

5.2. Does the LMI approach take account of lessons learned from previous initiatives? 27

6. Summary of main economic benefits of the LMI in six identified emerging markets 29

6.1. Overall market prospects and impact of the LMI and related policy activities 30

6.1.1. Market and employment perspectives 30

6.1.2. Potential impact of the LMI and related policies an the first set of identified emerging markets 32

6.1.3. Summary 32

6.2. Detailed market prospects 33

7. Governance, monitoring and evaluation 35

8. Conclusions 36

9. List of annexes 37

Appendix 1 - Methodology followed to identify the six emerging markets 38

1 Pre-identification 39

2 Identification process itself 39

3 Result of the identification process – Definition and validation of the proposed lead markets 41

Appendix 2 - The policy tool box in support of lead markets 43

1 The lead market initiative and regulation 43

2 The lead market initiative and standardisation, labelling and certification 44

3 The lead market initiative and public procurement 46

4 The lead market initiative and intellectual property protection 47

5 The lead market initiative and finance 48

6 The lead market initiative must be based on effective communication and on open competitive markets 48

7 Implementing the lead market initiative: action plans 49

Appendix 3 - Summary of main findings and recommended actions for each illustrative case 50

Appendix 4 - References 74

Introduction

The January 2006 Report of the Group chaired by Mr Aho on "Creating an Innovative Europe"[4] recommended the development of innovation-friendly markets in a more targeted way by creating conditions to facilitate the translation of technological and non-technological innovation into commercial products and services. The report calls for simultaneous and synchronous efforts at all levels and includes the recommendation to take steps to encourage ‘lead markets’.

The Commission’s Communication “Putting knowledge into practice: A broad-based innovation strategy for the EU”[5] , defines a more integrated and coherent approach in support of innovation. An initiative for innovative “Lead Markets” is announced as part of this strategy.

The Council subsequently invited the Commission to present such a Lead Market Initiative (LMI) in 2007, based on a broad stakeholder consultation and targeting in particular markets with high economic and societal value[6]. The European Parliament (EP) welcomed in its report[7] the Commission's proposal to launch a LMI, aimed at facilitating the marketing of new innovative products and services in areas where the EU can become the world leader.

The Communication on the European Lead Market Initiative (LMI) presents this new instrument of the Innovation Policy. Its main message is that the available policy tools need to be better coordinated and timed to facilitate the emergence of lead markets in Europe and that such an effort, if adequately focussed and following an in-depth analysis, can bring substantial advantages for Europe’s competitiveness.

The objective of the LMI is to develop a new approach, in addition to the horizontal innovation policy, to foster and accelerate the transformation of ideas into new products and services in Europe, with the ambition to promote in this way internationally successful innovation. This approach aims at facilitating demand-side potential of promising new innovative technologies or business models resulting in the early adoption of new business solutions in Europe. It is intended to create a virtuous circle of growing demand, reducing costs by economies of scale, rapid product and production improvements and a new cycle of innovation that will fuel further demand and a spinout into the global market. In other words, the aim is to trigger the positive effects of a lead market, as observed for instance in the case of the GSM standard for mobile telephony, CDs or ADSL .

The Community actions of the LMI would be implemented within the existing financial and human resource provisions by drawing on available resources and combining them in an optimal, mutually reinforcing manner. It thus does not generate any needs for extra Community funds or staff.

The LMI also comprises policy packages targeting six identified market areas with a possibility to expand to additional areas in the medium term. First five ambitious action plans have already been developed and the packages are tailored to the conditions and problems of each of these areas.

The individual measures contained in the different action plans will be assessed according to the relevant impact assessment rules and will be subject to the relevant normal decision-making procedures.

The present paper therefore:

- describes the consultation process of interested parties;

- aims at demonstrating the overall potential for economic, social and environmental benefits that justify the administrative efforts needed to launch and implement the LMI and its specific initiatives;

- analyses the economic nature of lead markets in order to assess the main features of the LMI in order to avoiding risks of negative impact;

- assess the relevance of the objective of the LMI in respect of the economic theory and of the current economic situation of Europe and how it can be best achieved;

- identifies very significant market prospects for the first set of identified emerging markets, that confirm the high potential impact of the LMI implemented first in these domains.

The economic content builds, to a large extend, on the Commission Staff Working Document accompanying the 2006 Competitiveness Report[8] as well as on input from the industry during the stakeholders’ consultations.

Consultation of interested parties

The LMI builds upon various broad public consultations, as well as on continuous feedback received from Member States on innovation policy aspects in both formal and informal settings.

A first Europe INNOVA Thematic Workshop on "Lead Markets and Innovation" (June 29th and 30th, 2006, Munich, Germany) explored the concept of Lead Markets. The participants generally supported that concept. In particular, the role of the public sector was seen as instrumental in lifting obstacles to market development and as a facilitator for aggregating demand. Public procurement, standardisation and regulation were identified as suitable instruments to this end. Further consultations of the Europe INNOVA community were conducted in cooperation with the Europe INNOVA Innovation Panels that confirmed a generally strong interest in a possible policy initiative. However different opinions were expressed on the ideal “policy mix”. For example, regulation is seen as a vital issue which can have mixed effects in lead markets, but can lead to success as in the case of mobile telephony. Another point raised was that industry engagement will be especially important in some sectors, such as in the greening of industries[9].

The European Technology Platforms (ETP) were in parallel consulted on the opportunities and conditions for a Lead Market approach in the potential market areas in which the outcome of the implementation of a strategic research agenda might be likely to introduce significant product or service innovations. In particular, the ETPs on textile, chemicals and construction signalled strong support for a LMI, which was taken into account when identifying areas for the LMI.[10]

In preparation of the individual roadmaps of the specific lead market initiatives, extensive consultations with relevant stakeholders were carried out by the Commission’s Services. These consultations addressed issues such as the application of the Lead Market approach to specific areas, the economic and societal implications and the concrete actions to be considered for implementation. The consultations involved industry stakeholders, representatives of relevant national ministries and user groups. A detailed description of these stakeholder consultations can be found in the thematic preparatory documents to the Lead Market Initiative93.

Problem definition

Overall situation

Europe misses considerable growth and job opportunities if the current innovation gap isn’t reduced more quickly.

The EU as a whole, and most of the EU countries[11], still lag significantly behind the top innovation performers in the world, such as the US and Japan[12]. There is no single explanation for this innovation gap. Frequently mentioned reasons refer to an underinvestment in R&D and the lack of market dynamics, including venture capital, regulatory barriers and a shortage of skilled workers in Europe.

Policy initiatives have responded to this challenge using, broadly speaking, two approaches: Firstly, by aiming at increasing R&D investment, and secondly by encouraging and facilitating the uptake of new ideas and their transformation into marketable products and services, especially by SMEs. So far, less attention has been paid to improve market conditions and to facilitate the realisation of the demand potential for innovative market solutions.

The first approach has dominated the European policy debate for some years. With impetus from the Lisbon strategy (2000), the Barcelona 3 % objective (2002) for more investment in research in Europe and the renewed Lisbon strategy (2005), R&D is increasingly considered to be a key contributing factor to economic growth and welfare. Meanwhile, almost all Member States have set targets for R&D investment. If these targets are met, the EU would reach an R&D level of 2.6 % of GDP in 2010 (up from 1.9 % in 2005)[13].

A number of Member States have significantly boosted their public investment in R&D in the past decade. EU-25 R&D expenditure grew by 2.7 % per year between 2001 and 2004 in nominal terms[14]. In 2005, 1.84 % of GDP was spent on R&D in EU-27, compared with 2.67 % in the USA and 3.17 % in Japan. If the current trend would continue, by 2010 Europe's R&D intensity will have declined to its mid-nineties level of less than 1.80 % of GDP[15].

Two thirds of the total investment in R&D of 3% of GDP should come from the private sector, according to the Barcelona goal. Yet the gap in business R&D expenditure of the Union relative to the USA and Japan continues to be higher than in public R&D expenditure[16].

Higher R&D spending, notably by companies, is in many cases a necessary, though not a sufficient condition for more innovation. What matters ultimately in this respect, is turning scientific discoveries and new ideas into new products and smart processes that create wealth and new job opportunities. More innovation-friendly market framework conditions are deemed to be necessary in Europe to reduce the time-to-market of new goods and services, thus better valorising R&D investments and creating a necessary incentive for business to invest in research and innovation. Public and private investment in R&D will only pay off, if firms can translate innovation inputs into innovation outputs and if they have sufficient market prospects to decide to make the necessary investment to achieve this goal. Without strengthening innovation dynamics, R&D investments and support to entrepreneurship activity may not be well valorised, hence diminishing the efficiency of the whole public effort in favour of a transition towards a European knowledge economy.

Innovation efficiency is the ability of firms to translate innovation inputs into innovation outputs. An indication of this ability is given by the ratio between the European Innovation Scoreboard (EIS) composite indices for inputs (education, investment in innovation, etc) and outputs (firm turnover coming from new products, employment in high tech sectors, patents, etc)[17]. A major issue is therefore to increase this ratio while at the same time creating the market conditions that will make it easier for firms to adapt to this new paradigm. The development of lead markets could be instrumental to address that.

Detailed analysis

Some countries (e.g. Germany, Finland and Italy) perform better on outputs than on inputs, suggesting that they are more efficient at transforming inputs into outputs than other countries (e.g. Belgium, Poland and Portugal), that have made relatively large investments but do not show yet a comparative performance on outputs. It should of course be taken into account that innovation is a long-term process and the progression of the output performance of the latter countries could improve in the coming years, as a result of ongoing investment in inputs.

On the demand-side, the openness to new products and services of a country’s population might be one explanation for the fact that some countries perform relatively better on outputs and other countries on inputs.

While Europe plays a leading role in terms of its science and the provision of science and technology graduates[18], it seems less successful in converting science-based findings into commercially valuable innovations. For example, in relation to its population, Europe generates fewer patents with high economic value than the US or Japan. In 2003 the EU-27[19] had 34 so-called Triadic patents per million population versus 68 for the US and 106 for Japan.[20] The US also has a higher share of patent applications at the European Patent Office (27 %) than the EU has at the US Patent Office (16 %). In key areas such as biotechnology and information and communications technologies, Europe also lags behind in its share of patents. In biotechnology, EU-25 accounts for only 27 % of high-value “triadic” patents, compared with 55 % for the US. In ICT the shares are 25 % for the EU versus 37 % for the US[21].

The Community Innovation Survey of R&D Trends 2005[22] identifies market demand for new products and services as the most important factor influencing the level of private investment in R&D and innovation. The inventor and the early user are generally young innovating companies, who need to stay ahead of the competition. Such companies have to meet the high initial cost for placing products on the market and they run the risk of working with a technology that may not be fully developed.

Another issue is that existing market dynamics may not provide the right feeding ground for the emergence and growth of fast growing SMEs . In the re-vitalisation of Europe’s markets, fast-growing SMEs play a key role. Even if the macro economic conditions have become more favourable, there is a risk that growth could not be sustained or would not generate sufficient jobs, unless enough new world class companies are created. The relative inability of the majority of European SMEs to grow rapidly may be a major handicap to growth in Europe[23].

These high-growth SMEs, so-called “gazelles”, contribute to wealth through the creation of new business and jobs. These companies are said to provide high returns for investors, promote regional development, generate satisfaction for managers and employees, and make a significant contribution to job creation. Several empirical studies confirm the importance of high-growth firms for job creation. In the United Kingdom, 4 % of new start-up survivors were responsible for 50 % of jobs created by all new firms 10 years later. In the U.S., 3 % of the fastest growing firms generated over 70 % of the new jobs created by new firms between 1992 and 1996.

The first Global Entrepreneurship Monitor (GEM) report[24] on “high-expectation entrepreneurship” showed that high-aspiration entrepreneurs representing less than 10 % of the population of nascent and new entrepreneurs were responsible for up to 80 % of total expected job creation by all entrepreneurs. In addition, and contrary to popular perception, only around one-third of gazelles are ‘high-tech’ companies[25]. Fast-growing firms whose success comes from innovative approaches to marketing, organisation or distribution can be found across a wide range of activities, e.g. retail, services and manufacturing[26].

A recent OECD study using firm level data reveals that while firms' turnover is similar in Europe and the US, their post entry performance differs markedly[27]. Firms in the US are smaller than EU firms when they enter the market but, if they survive, they grow much faster and reach higher average sizes in terms of employment. The indicators of sales of products and services which are new-to-firms halved their performance from 2000 to 2004 and reached a worryingly low average level for EU-25[28]. The risk of not supporting these firms may be that the EU’s economic recovery will slow down or not fully exploit opportunities, e.g. of lead markets, in terms of growth and job creation.

The CIS 17 also highlights that having a broad-based innovation strategy at EU or National levels increases significantly the efficiency of the innovation policy. A consensus is therefore emerging that a coherent and consistent policy approach requiring coordination across the different policy areas and policy levels (EU and Member States). The need for increased interactions and better coherence between innovation-related policies , both at the Member State and European levels, has therefore been stressed in the Lisbon Strategy[29]. The Commission’s Communication on ‘Putting knowledge into practice: A broad-based innovation strategy for the EU’, the report of the Aho Group 4 and the BEPA Report on ‘EU competitiveness and industrial location’[30] further support this new integrated approach. For example, the Commission’s broad-based innovation strategy aims to improve the framework conditions for innovation by combining supply factors, such as research, workforce skills and access to finance, with measures strengthening the demand side.

Innovation has also been a central theme of the informal Competitiveness Council discussions during the Finnish EU Presidency in July 2006 with a focus on demand as a driver of innovation .[31] Similarly, the discussions during the Portuguese EU Presidency in July 2007 focussed on a sustainable industrial policy with the objective to ‘speed-up innovation and develop lead markets for low carbon and energy and resource efficient technologies, products and services’, naming low energy housing, energy efficiency in industry, low carbon emitting power generation, renewable raw materials and low emission cars as potential examples for lead markets.[32]

Summary

The weak innovation activity – i.e. decrease in new product innovation in 2000-2004 – and, more general, the lack of private investment in RDI, is very likely related to inadequate market conditions, insufficient market demand for innovative products and services and the lack of prospect for young innovative firms. Addressing this in a determined and focussed way might therefore contribute effectively to creating growth and jobs.

Main components of the economic definition of lead markets

The analysis of the development of lead markets has received a great deal of attention from companies, scientists and policy makers. Lead markets may connect the development of new technologies, skills and knowledge with market success of innovations and lead markets could produce significant competitive benefits for a region or country. Lead markets could be a way of establishing a “virtuous cycle” that supports the market up-take and increases the interest in investment in a particular market and thus results in higher investment in R&D, skills and innovation.

The market-led approach could therefore constitute a particularly strong incentive for more private investments for research and innovation. This investment of the private sector would in turn promote its competitiveness. Moreover, the open innovation model supported by the LMI would favour the development of young innovative firms, facilitate the involvement of a broader scope of stakeholders and ultimately contribute to the development of highly competitive clusters that will sustain over time the competitive advantage provided by the lead market.

The first issue for a sound policy approach of lead markets is therefore to build on a clear definition of this concept, reflecting the current economic knowledge and observations. This should allow for a better identification of emerging markets that might become lead markets, as well as of the conditions favourable to their emergence

A lead market is the market of a product or service in a given geographical area, where the diffusion process of an internationally successful innovation (technological or non-technological) first took off and is sustained and expanded through a wide range of different services[33].

While the concept of lead markets implies that an innovation has gained the affection of a whole market, denoted by a high or rapidly increasingly penetration rate, the other concepts (such as innovating lead users, pilot or launch customers for innovations, pioneer companies) focus on the actors that are the first to generate, adopt or use a particular innovation.8 The economic literature highlight that these other concepts, while able to provide advantages to an individual firm, generally do not foster the same level of macro-economic advantage to the National or continental level concerned. Therefore, the lead market concept is more suitable for a public policy in order to maximise the positive externalities derived from the development of such markets.

This definition should therefore not be confused with various other meanings for the term that appear in the literature. For instance, most importantly, a ‘lead market’ is not necessarily the country or market where the innovation was first developed, or even used for the first time.8 To elaborate, the economic definition that has been used for the Commission’s policy purposes is based on the following four key notions. [34]

Notion 1: “take off” (or “potential of the market”)

This is clearly different from the “first to invent” or “first to use”. A lead market implies economy of scale and ability to respond to the need of a large number of users. This is needed to derive a competitive advantage on an international scale and to create a sustainable international path.

Notion 2: “needs”

Technology is an important element but not systematic. The identification of needs is even more important. Fast-growing firms, whose success comes from innovative approaches to marketing, organisation or distribution, can be found across a wide range of activities (for example, distribution systems using internet developed new business models; productions and sales of customized products have developed at large scale; new design of the distribution chain have led to huge and lasting advantages for lead enterprises).

A particularly important condition for the successful development of a lead market is to meet the demand, rather than to try to create the market. Policies and regulation could strengthen the orientation of firms to meet the demand in the lead market area. Public procurement should be geared towards enabling local authorities to use criteria that encourage innovative approaches (use of life-cycle assessment for determining the advantage of a product, avoiding lock-in due to procurement processes, assessing risk, etc.) rather than to policies that aim at pushing specific technologies, products or services into the market. Inappropriate use of public procurement could actually be detrimental to the development of lead markets over the medium term if a technology-push approach is adopted that favours solutions that are not suitable for large scale demand or that are incompatible to broader market developments. For example, cases where the role of the US military as a crucial launch customer for new technologies led to civilian applications are relatively scarce. Thus, while there are several well known cases of government R&D procurements that have successfully spun off into widespread market developments (e.g. the Internet, GPS, Alzheimer treatments), procurement of R&D and or new technologies should be based upon user needs and open ended innovation processes.[35]

Notion 3: “internationally successful innovation ”

If other countries do not follow using the same innovation design, or technological trajectory, few exports may result, and ultimately the inward-looking development of the home market could be lagging behind and miss opportunities. One example is the success and subsequent decline of the commercial online service Minitel in France. Although the service was adopted earlier and more widely than the Internet in France, it lost the struggle to become the globally dominant design of a network protocol to the latter (see Figure 1 below). Another example is the effect that the success of the fax machine in Japan had on the rivalling telex system in Germany (see Figure 2 below).

The examples indicate that early adoption of a new technology by the market does not suffice as a competitive advantage. The openness to market trends thus appears to be an additional necessary condition for international competitiveness. This also implies that a country that lags behind scientifically but which domestic market is more willing to adopt new technology can not only catch up but also get ahead of the innovator.8 Thus, it is not necessarily the inventions but the ability to turn inventions into commercially successful products, which determine international technology gaps. Consequently, lead markets must not necessarily be the most innovative markets[36].

Figure 1: Minitel and Internet penetration rates in France, the US and Germany |

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Source: ITU, Beise (2001). |

Figure 2: The success of the fax and the demise of telex in Germany

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Source: Estimations by Beise & Gemünden (2004) based on Scherer (1992), Yoffie (1997), ITU

Notion 4: “Open and competitive markets ”

A European-wide lead market can reach the scale and competitiveness necessary to compete successfully world-wide only in open, competitive Internal Markets. The lead market approach builds on the legal framework related to the Internal Market and does not provide a rationale for derogations from this legal framework, e.g., in to the fields of competition, State Aid or public procurement. The size of the EU market (500 million people and 10,817[37] billion € GDP) will be a sufficient marketing springboard for a large number of products and services.

The Internal Market has contributed significantly to stimulate innovation. Market integration has a twofold impact on the incentives to innovate. Greater market size could increase profits and allows for more thinly spreading out of the costs of innovation over a larger volume of sales[38]. Secondly, firms that operate in a more integrated market are exposed to higher competition, so have stronger incentives to innovate in order to retain their market positions and stay ahead of their competitors[39]. Evidence however suggests that EU companies do not fully exploit the opportunities given by the Internal Market – about 60 % of the innovative companies tend to launch their new products on national markets while only 25 % achieve this in other Member States[40].

In order to improve our understanding of the economic obstacles preventing markets from functioning well, the Commission will conduct monitoring of product markets and sectors within the framework of the ongoing Internal Market Review. Information assembled this way will contribute to a better governance of Single Market policies. In the context of the LMI, the results of more systematic market monitoring exercises within the framework of a revised policy approach towards Internal Market could be seen as an important input to the identification of additional lead market areas in the future, by providing, inter alia , information on the market-based and policy-related causes of market malfunctioning in terms of innovation.

Notion 5: “Open innovation and clusters”

There are microeconomic decisive advantages to an open and cluster approach. For instance, both locally-owned and local affiliates of multinational firms may contribute to the creation of a lead market. On the one hand, an indigenous R&D capacity is essential to be able to master and assimilate innovative solutions and to exploit them to economic and societal advantage. On the other hand, some firms were not initially leaders in the respective technology but acquired the technological knowledge from abroad and a close interaction between market and production ensures a substantial manufacturing of several generations of products (cellular phones in the Nordic countries, cameras in Japan, computers in the US, wind energy in Denmark). Internationalisation is also good in terms of social welfare. Based on superior productivity or market intelligence, international competitiveness is often sustainable over time with a high degree of competition and lower prices for users. A cluster approach enables the pooling of resources needed to achieve the required degree of organisation and competencies as well as the amalgamation of innovators and users necessary to anticipate future trends of demand.

In lead markets that are characterised by a high degree of trans-disciplinarity and complex value chains, a trans-national cluster approach that links different disciplines and actors and facilitates cooperation may support the development of these lead markets

Therefore policies supporting the excellence and openness of clusters would contribute most efficiently to the success of a LM approach if on one hand they facilitate the ability of the European industrial structure to respond quickly to multidisciplinary challenges linked to the development and marketing of innovative products incorporating technologies and knowledge from diverse disciplines and sectors, and they also diminish the barriers between regional and national clusters, in order to facilitate transnational cooperation to attain a world-wide competitive scale, in particular in sectors related to the future lead markets.

THE ECONOMIC RATIONALE FOR A LEAD MARKET POLICY INITIATIVE

Well recognised object of the economic analysis, lead markets have only recently be analysed as a possible policy tool. Their place in innovation policy both at the EU level 4 and in some Member States (e.g. in Germany[41]) has however started to be recognised. The European mid-term review of industrial policy[42] concluded in that respect that a lead market initiative could contribute to effectively improve the competitive environment for business.

In the Commission Staff Working Document accompanying the 2006 Competitiveness Report, an extensive review was presented of the lead market concept, the potential role of public policy in the development of lead markets, the set of policy instruments and the problems arising from policy interventions. The present lead market approach as an additional and effective tool for innovation policy is largely based on this review.

The rationale is foremost based on two reasons, which are widely recognised by economists:

- favouring the emergence of a larger number of lead markets would entail a series of substantial economic advantages for Europe, well beyond the concerned sectors;

- public role can be effective in pursuing such a goal, provided it avoids certain factors of risks.

The economic advantages for Europe of encouraging the emergence of more lead markets

The identified economic advantages can be grouped in three categories:

Quantitative advantages

More lead markets will produce more growth and jobs, notably more qualified jobs. This would result of the combination of three components:

- Positive impact on GDP, due to faster market growth and a substantial rise of export where firms may profit from productivity gains that can be realised earlier than in other countries and therefore may become major players in the world market[43];

- More added value through increased innovative and knowledge content in the markets concerned, with a positive impact on qualified jobs. Incidentally, the approach contributes to bridge the gap between the generation of new technologies and market success of innovations notably by identifying factors that would make innovation policies, in particular market regulation, more anticipatory of global trends

- Better response to globalisation: the lead market can provide a certain protection from low-cost competition; since lead markets regularly keep larger manufacturing capacities at home in order to guarantee superior quality and allow for quick responses to varying local markets trends;

Better Adaptation to structural change

Not only more lead markets would provide quantitative advantages, but this would also constitute a structural gain for Europe, in terms of capacity to adapt over time to structural changes. Here again, three main components can be highlighted:

Prospect of gaining a sustainable advantage over several generations of products and innovation steps or even technologies (e.g. cellular phones in the Nordic countries, cameras in Japan, computers in the US, wind energy in Denmark)[44] due to the earlier adoption of an innovation, higher market share and market dynamics (i.e. virtuous cycle) that may enable to sustain the lead market ‘premium’ over some time. This creates confidence in the future and entails large cluster development linked to these markets.

Instilling structural change by offering opportunities to numerous high-growth start-ups and intra- and inter-sectoral dynamics as a result of innovations diffusing to other markets, as well as through the development of an entrepreneurial culture and changing societal attitudes towards innovations;

Inducing a virtuous investment cycle by stimulating investment by local firms as well as by attracting foreign direct investment and stimulating further investment in R&D and high-skilled knowledge (workers) as a result of rising market revenues[45].

Substantial benefits for the citizens and the society

Last but not least, public intervention to favour the emergence of lead markets could bring substantial benefits in terms of welfare. The following positive impacts have been identified by the theory and the stakeholders:

- positive impact in terms of employment and wealth as a result of the economic changes and growth;

- positive impact in terms of welfare as a result of more innovation made available sooner at reasonable pricing and responding better to users’ needs and resulting of a high degree of competition;

- even more importantly, health and environmental advances through a wider application of technological innovations incorporating social preoccupations (the impact of most of the themes identified by the LMI are particularly illustrative in this respect);

- To a certain extend, global challenges might be more effectively tackled, by what the economic theory calls a transfer advantage: some countries successful in terms of lead markets, are characterised by their ability to influence or increase the incentives in other countries to adopt the same innovation. This can be instrumental in adopting earlier in a greater number of countries standards protective of the environment, or even in replacing obsolete products.

These lead markets advantages can be derived from the frequently observed pattern of the international diffusion of an innovation by countries (see Figure 3). The country where an internationally successful innovation first took off and is sustained and expanded is called a lead market; those that follow are lag markets. The time lag between the usually S-shaped curves of this lead-lag pattern illustrates the obvious potential benefits of being the lead market, in terms of growth, employment and wealth.

Figure 3: An international diffusion pattern of an innovation design |

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Source: ZEW, e.g. Beise & Gemünden (2004). |

It should be stressed though that lag markets have often opted for a different, competing innovation design before the lead market, but later switched to the lead market design. As illustrated in Figures 1 and 2, the demise of Minitel in France and telex in Germany and the switch to competing designs as their own nation-specific designs are such examples. Therefore, importance has been placed far more on anticipatory demand (than on idiosyncratic innovation), which means that a country or market adopts a new technology early, which no other country finds worth adopting[46].

The following Figures 4 and 5 depict empirical evidence of this lead-lag market pattern in the diffusion of the Internet and the employment of robots in Japan, respectively. Comparing both figures also highlights that the gap between lead markets and lag markets can be of different magnitude.

Figure 4: Diffusion of Internet in selected countries |

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Source: ITU. |

Figure 5: International adoption of robots in manufacturing |

[pic] |

Source: IfR, OECD. |

Further empirical examples of this lead-lag pattern of international diffusion of new technologies, for instance, are the classic rise of Japan as the steel-making nation following the adoption of the oxygen steel making process (Maddala and Knight 1967; Poznanski 1983; Lynn 1982; Papajohn 1991)8, the leading PC usage of the United States with a prevailing IBM-Microsoft-Intel specification[47], and the success of Europe’s GSM standard for digital cellular mobile telecommunication.

Quantifying ex-ante these three groups of advantages is difficult because the diffusion time lag can vary widely as can the added value in market volume. For instance, the advantages of the lead market over the lag market appear to be much stronger in the case of the adoption of robots in manufacturing (Figure 5) than for the diffusion of the Internet (Figures 4). However, even in cases where the gap between lead and lag market appear to be small, the benefits are still likely to be substantial as the advantages accumulate due to the sustainability of the lead-lag market pattern for some time.

Even in bad case scenario, where economic benefits cannot be reaped to the extent hoped, wider benefits for the economy and for the citizens may still be expected due to an increased responsiveness to emerging changes and consequent advances, e.g. in environmental and health aspects, as analysed in the second and third groups of economic advantages that have just been described. This alone should already justify the extra efforts needed for the policy coordination.

Public intervention can contribute to the emergence of lead markets

Favourable horizontal market conditions

Besides descriptive studies on the diffusion of globally successful innovations, the afore-mentioned Commission Staff Working Document accompanying the 2006 Competitiveness Report 8 also outlines further strands of literature that have analysed and tried to explain lead markets. These strands highlight some key general policy orientations that are favourable to the emergence of lead markets:

- Promotion of innovation and entrepreneurship in education and information of the consumer, which both make innovation more likely to be widely accepted

Statistical analyses of the international diffusion of innovations from a marketing perspective (e.g. Tellis, Stremersch and Yin, 2003) highlight the importance of ‘the willingness of countries to adopt an innovation’ with a focus on economic wealth and cultural dimensions as explanatory variables. Lehrer and Schlegelmilch (2006), highlight in this respect the role of markets that are able for cultural reasons to demand the highest performance.

- Ensure a lively competition climate and possibility of using alternative designs (hence the risks to choose standards depending on a single technology)

A high degree of competition raises the chances of local innovations becoming successful abroad as well (Nelson 1993; Porter 1990). In a country with a monopolistic producer or user, fewer alternative designs (or only one) are offered than in a country where several companies, including from abroad, compete. Competitive markets are, therefore, more likely to discover latent needs and innovation designs preferred by consumers.

- Promotion of innovation systems and support to clusters and cluster cooperation that favour open innovation and user-driven innovation models

Co-operation has become increasingly necessary in order to cope with the rising complexity and multi-disciplinary nature of innovations and competencies needed to develop their applications in lead markets. Enright (1995), for instance, calls in this respect for an optimal mix of collaboration and competition. The role of local interaction between customers and innovators within ‘national systems of innovation’ is also emphasised by various studies (e.g. Lundvall, 1988; Fagerberg, 1992; Nelson, 1993).

Market failures

The most common rationale for public intervention is based upon the traditional market failure argument. Under-investment in R&D, for instance, occurs due to the public good character of knowledge (Nelson, 1959), positive externalities of new technologies due to knowledge spillovers (Arrow, 1962) and information asymmetries in financial markets that may lead to credit rationing for research projects. (Stiglitz and Weiss 1981; Goodacre and Tonks 1995)[48].

In essence, since the economic benefits of the lead markets for Europe will be maximised if the markets correspond to the conditions that are identified as favouring the emergence of lead markets, market failures need to be addressed in addition to favourable horizontal market conditions such as high competition in open Internal Markets.

Indeed, the benefits of innovation for society and for groups of enterprises in the long term are higher than the sum of benefits of individual firms due to the incomplete appropriation of innovation knowledge by companies. This gap between the societal benefits and the individual return on possible outcomes is even greater in the short term. As a matter of fact, the preference of firms for short term results limits also their investment in domains, whose development is difficult to quantify precisely. As a result, the level of investment of firms as well as their involvement in various lead-market related activities (such as participation in advanced clustering activities, or in the collective design and setting of open and interoperable standards) will be sub-optimal from the common welfare point of view. This justifies public intervention for instance to support clusters[49] or platforms to enhance cooperation between public and private stakeholders in the identification of the regulatory obstacles to market development.

However, if markets in new technology are indeed often burdened by information asymmetries and uncertainty, these problems affect all countries and generally do not explain the fact why certain markets emerge as lead markets and others don’t. Market failure considerations do not therefore entirely explain the phenomenon. Conversely, , policies that aim at making markets conducive to innovation, such as the LMI, to meet societal goals of economic, social and environmental nature through the a support to the emergence of lead markets need to go beyond addressing market failures to encompass other specific policy measures.

The need to address market failure in recycling

Areas such as the recycling of plastics and composite materials experience much greater difficulties for an economic perspective[50]. Plastics correspond to 40 million tonnes per annum in the EU, of which less than 39% is recovered in EU 15 (where recovery means incineration with energy recovery or recycling)[51]. In addition, the amounts of plastics going to landfill increased by 21% in the period 1990 to 2002. There are technical difficulties with the processing of plastic waste streams. This is because of the large range of different types of plastics available, most of which cannot be mixed if they are to produce high quality recycled material. Manufacturers in principle allow recyclates to be used in most components, provided that the specific quality requirements are met. The fact that dismantled plastics components are currently only available on a very small scale is because dismantling, sorting and logistics costs outweigh the possible returns. In comparison to metals such as steel, the situation can be regarded as a market failure . Furthermore, the plastics markets for both virgin and recycled materials are part of a global market, and subject to much greater volatility than markets for many other recycled materials. Plastics recycling and markets are heavily impacted by the export of plastics to the Pacific Rim. Thus there are many good reasons to focus a lead market activity on plastics in particular .

Other specific policy measures

In addition to addressing market failures, policies should also remedy to the possible unfavourable or sufficiently supportive market environment from a competitiveness point of view (regulatory and standardisation environment).

Lead market models suggest that policy-makers can indeed improve upon the factor that renders a local market a lead market. In addition to the general policy-mix aimed at encouraging innovation (see section 4.2.1), demand-orientated policy instruments seem to offer solutions for attempting to induce innovation, their diffusion and even a fast-following approach.

The objective of providing a more conducive environment for innovation and market development is already a justification in itself, especially since the focus of the LMI is on a more integrative co-ordination of mutually interdependent policy measures that do not require additional funding. Nevertheless, the possible substantial advantage that being a lead market holds for businesses, citizens and the environment is the core incentive for following this approach.

The section 4.1 has clearly outlined the potential strong economic advantages of lead markets, especially through its accelerated growth and increase in market volume and factor of structural change.

However, there are also limitations and potential risks of lead market oriented policies. Direct government interventions might improve a certain attribute of local demand but such interventions are at the same time prone to negatively affect other factors that constitute a lead market. A particular attention to the following risks seems needed in the implementation phase of the LMI:

- If government intervention in the standardisation process in product markets is premature, the lead market potential is weakened as the selection of a particular innovation design or a technology by the government or other non-competitive agencies is normally a poor replacement for a competitive market solution.

- The same risk applies if public procurement or public support programs support an idiosyncratic innovation design that is not able to counter the competitive strength of the competing innovation design in the lead market, but keeps the domestic market away from the coming global standard, since domestic and foreign suppliers would respond to the specified design, even though it stands no chances on the world market.

- Public procurement as an instrument to generate early demand for innovations often also focuses too much on achieving quality criteria for new technologies (e.g. for military, space or health missions) that can lead to quality characteristics above the market and socially optimal levels, i.e. restricting cost-effectiveness and thus acceptance by private customers, effectively preventing the innovations to constitute a lead market.

- Strong support by a national government to promote the adoption of technologies can restrict exportability of innovations if national legislation and regulation tend to focus only on domestic needs and the local environmental context.

Avoiding these risks doesn’t imply to have a zero policy change option. For instance, having an anticipatory approach of demand in standardisation or regulation, means to identify technology trends and new categories of products and services, that might need to enlarge or modify the scope for standardisation or regulation and address several issues related to interoperability, not only within a single market segment, but between various categories of products in previously unrelated markets. All these changes in approach can be achieved without pre-empting technology choices. Similarly, the fact to favour the search for innovative solutions in public procurement can be done in an open and transparent manner, based on a dialogue with the civil society and better information of various stakeholders. This can be very efficient in revealing the advantages of new solutions and therefore favour the quicker attainment of a critical mass for an emerging market, but can be done with a view to avoids the risks identified above.

On the basis of an extended discussion of these limitations, the Commission Staff Working Document accompanying the European Competitiveness Report 2006 has identified a number of success factors that lead market oriented policy should take into account 8:

- Incorporate foreign market needs and preferences of customers from abroad;

- Transfer domestic market preferences abroad;

- Lower the cost of production to a level that is sufficient to make an innovation attractive in other countries;

- Be neutral with regard to the choice of technology, i.e. the policy should allow for competition between competing innovations;

- Shift the country to the forefront of a global demand trend;

- Be compatible with policies designed to support the innovation process, i.e. policies to protect intellectual property, correct for knowledge spill-over’s, or combat credit market imperfections.

Features of a lead market initiative

Main features

The principal characteristic of a lead market policy approach is tighter co-ordination in synergy and time between policy measures which act on the demand-side factors . This concentration of different efforts makes it possible to resolve interdependencies between various demand-side factors and thus lead to better outcomes. The aggregate impact in terms of the economic, social and environmental benefits is therefore likely to be higher than the sum of the impact of the individual actions. Various stakeholders have pointed out their general expectation that improved policy coordination would yield unprecedented benefits. In addition to coordinating a mix of policies aimed at encouraging innovation, the measures available to a lead market initiative are such that they supplement and reinforce synergistically the more supply-side oriented measures, notably the research policy. Features of an approach to innovation policy for lead markets:

An approach to innovation policy for lead markets should be applied notably to areas where coherent and coordinated policy-making by relevant public authorities can speed up market development, without interfering with competitive forces.

The key features of an approach to innovation policy for lead markets are as follows:

- It offers a policy framework for the prospective, concerted and focused application of relevant policy instruments, with the objective to help to bring new technologies and ideas faster to the market;

- To this end, a set of coordinated actions will have to be implemented in a consistent manner, all aiming at lifting obstacles that hinder the development of new markets or at providing incentives for their more rapid emergence. The mix of the actions will be determined by the scope of the market, by the legal basis of the policy instruments and by the public organisations that can implement them (i.e. EU, national, regional, local level and various regulatory organisations).

The lead market approach supplements the Union’s industrial policy focus on creating conducive conditions for innovation by removing obstacles specific to new, emerging market areas in Europe that provide innovative solutions to societal needs, including concern for the environment, by a proactive, anticipatory and timely policy.

It does so by ensuring a more integrative co-ordination of mutually interdependent policy measures , which has nothing to do with directly creating new markets or technologies (“picking winners”). Instead, the objective is rather to develop and to test a policy concept that can be supportive to this end. The main added value of such an approach to innovation policy for lead markets would be to improve the efficiency of existing policy instruments and their impact on innovation. The present approach aims at applying the concept of concerted policy action in a short-medium term timeframe to a number of specific areas where, as a result, a strong impact on innovation can be expected. The present selection of the first six markets is in no way exclusive and the approach could be applied to further candidate lead markets.

The Aho Report pointed out that ‘many elements for lead markets are already in place, including relatively high incomes and a willingness to purchase higher quality goods’, yet that the following key steps need to be further taken to encourage the emergence of lead markets: 4

- Provide a harmonised regulatory environment across the EU favourable to innovation and based on early anticipation of needs. The LMI calls indeed for an anticipatory approach that sufficiently takes into account new technological and market developments[52].This would be more effective if such an approach is developed in close cooperation with the Member States, in the same way as the “Action programme for reducing administrative burdens in the EU” outlines how the Commission intends to work with Member States to cut administrative burdens on businesses by a quarter by 2012[53].

- Use standards-setting powers to demand high-technical performance levels and reach agreement on new standards quickly and efficiently. Here again, the LMI calls for a more result oriented standardisation process that supports the market take up of new business solutions more effectively[54].

- Use public procurement to drive demand for innovative goods[55], while at the same time improving the level of public services; and

- Foster a cultural shift which celebrates innovation and a desire to possess innovative goods and experience innovative services; such that Europe develops as a natural home for innovators[56]. In this respect, education and skills could constitute in the future an additional element to a LM approach, with recommendations on how to adapt education and skills, taking into account the needs of the specific lead market The Commission identified the key competences necessary for living and working in a modern innovation-oriented society[57]. The Member States’ education systems are instrumental in ensuring that there will be an adequate supply of key skills to support innovation.

In addition to the elements identified above, other elements identified by the stakeholders’ consultations include:

- Business and innovation support services, training and communication: Launch of specific actions to develop European platforms that foster the further implementation of innovation policy for specific lead markets, by bringing together knowledge transfer, incubation and access to finance in support of innovative SMEs that contribute to the creation of new markets in strategic areas.

- Financial support and incentives: Recommendations for improving access to finance, taking into account the needs of policy development for lead markets in specific areas. A wide range of initiatives provide and stimulate access to finance in R&D and innovation; e.g. the Framework Programmes, Competitiveness and Innovation Programme, the JEREMIE Initiative, Cohesion programmes and numerous national, regional and local initiatives[58].

The issue in the case of the LMI is to identify more precisely how such policies can be effectively coordinated for specific areas and how far they address clearly identified challenges in these markets. Each specific lead market calls for a particular mix of policy instruments and actors , thus raising the problem of consistency in terms of policy priorities and timing. The main challenge will be to define and implement the different policy agendas in a way that synergies can be expected.

This concern is reflected in the methodology used to identify appropriate market areas. The European Commission undertook intensive stakeholder consultations to identify a consistent set of criteria for the identification of the market areas. These consultations drew, in particular, on the very large industrial and thematic coverage of more than thirty industry-led European Technology Platforms (ETP)[59] and on the eight Europe INNOVA Panels[60] and led to the establishment of the criteria referred to in chapter 2.2 of the Communication:

- Demand pull instead of technology push:

- Broad market segment:

- Strategic societal and economic interest:

- Added value of prospective, concerted and targeted, but flexible policy instruments:

- No "picking of the winners"

These criteria were completed by an assessment of the feasibility of launching a lead market initiative in these various sectors in terms of availability of information, ongoing work in the Commission and its administrative capacity. Further detail on the identification process are provided in appendix 1 to the present document.

The appendix 2 analyses the questions about challenges and policy responses, based on the responses to questionnaires to stakeholders and on the analysis by the various services of the Commission involved in these policies.

Does the LMI approach take account of lessons learned from previous initiatives?

The lead market approach builds on and incorporates elements of previously established initiatives by R&D policy and by innovation policy in Europe. Generally, four types of policy to support R&D and innovation have been applied with greater and lesser degrees of success in the past.

Looking back at the history of industrial and innovation policies, approaches fell mainly into the following categories:

- governments could support technologies in which governments have a strong interest or may play a role as a procurer, yet the risks of such approaches are high. The cases where public authorities been successful in fostering the emergence of new markets are rather special and relatively few in number, even if some are very important. In general, therefore, pro-innovation procurement should be based on open approaches that reduce the risk that public money is wasted on technologies that are not accepted in the market;

- governments could use subsidies to support the transfer of basic to applied research (by companies) and to promote the take-up of new goods and services, for example in the case of HDTV[61];

- variations on technology roadmaps and action plans have been used for more than two decades as a tool for providing frameworks for a more conscious integration of all aspects of technology into market development. In 1994, the so-called Bangemann report[62] and its accompanying action plan[63] on ‘Europe and the global information society’ proposed “ten applications to launch the information society” and measures to “stimulate markets so that they can rapidly attain critical mass”;

- governments could try to "pick winners" in commercial applied R & D.

The analysis of the outcome of these approaches help to identify the reasons for success or failure. An important lesson is that primarily top-down, centrally planned and technology-focused approaches to innovation policy are seldom effective.

A more market-oriented view of innovation embraces the dual efforts of channelling public funding to support more effective industrial and public-sector R&D, of addressing weaknesses in the innovation system, for example by measures to remove barriers to innovation[64]. The 3 % Action Plan and the Commission's Communication “More Research and Innovation” of October 2005, were amongst others, important milestones in this respect.[65][66]

Earlier efforts have attempted to improve efficiency and impact of innovation policy instruments on competitiveness and growth. In the past, innovation policy has confined itself to the identification of promising market perspectives offered by technologies and to the definition of supporting policy measures to foster market breakthroughs of innovative solutions. The novelty of the approach to innovation policy for lead markets is:

- first, how these different instruments shall now be coordinated and

- second, how to instil a new culture in the public administration at all levels on better integrating in the different functions (regulation, support, procurement, etc.) the goal to promote innovation.

Therefore, the challenge ahead is to practically implement such roadmaps in a strategic manner and not to lose sight or momentum over time.

Summary of main economic benefits of the LMI in six identified emerging markets

Based on the economic analysis presented in the previous part 4 and in particular the section 4.1, it is clear that the actions suggested in the specific thematic Lead Market Initiatives, that follows the policy options described in part 5, will facilitate growth and strengthen demand in Europe.

The concrete quantitative impacts of the LMI on the GDP and on employment are difficult to calculate, given the large range of imponderability, externalities and intricate interaction of various factors, on which the development of these market segments depends. The present part constitutes therefore only a tentative to illustrate what could be, under certain assumptions, such a quantitative impact.

Taking into account these uncertainties, the choice has been made to systematically retain very prudent assumptions:

- The likely advantage in terms of exports that would result of a successful development of several lead markets is not integrated in the data of market development. Therefore the positive quantitative prospects for the market development tend to be minimised;

- When faced with several market development forecasts, we usually retained the lowest[67], also minimising the figures given for the prospects for the market development;

- In terms of impact on employment, we based our assumptions on a very high increase in labour productivity in these markets[68]. The resulting figures on the likely positive impact on employment are therefore also significantly minimised both because the market development estimate is very prudent, and because of these hypothesis on productivity forecast;

- Finally, among various hypothesis on the likely impact of the specific market segment becoming a lead market on market prospects, we retained here again a low hypothesis of 20%[69] of gain in market development, i.e. one third below the average gain of well document previous experiences.

In spite of this prudent approach, as outlined below, the conclusion is that the LMI and related policy initiatives have a significant economic potential, if successful.

Overall market prospects and impact of the LMI and related policy activities

This section addresses two questions: first, the evaluation of overall market development and, secondly, the evaluation of overall impact of the LMI and related policies.

Market and employment perspectives

As regards to the first issue, the detailed analysis of market developments in section 6.2 below gives a scattered view, because values are given for different geographical markets and timings. Therefore, the following tables were prepared to provide a consolidated and comparable overview of the expected development of market growth and jobs for the first six identified potential lead markets, including the additional advantages related to their "lead market" position

As the available data set was based on forecasts of different sources and for different time frames, expected volume growth and jobs had to be computed by applying some prudent assumptions and methodologies.[70] Hence, these forecasts figures may at least provide a succinct indicative picture of the potential of the identified emerging markets. The figures are based on very cautious assumptions and do not reflect in particular the additional export potential that could be generated by a lead market position and which is very difficult to estimate in a reliable way.

On this basis the volume of the products and services in these emerging markets in the EU (see Table 1) is expected to rise by between 50% in eHealth and recycling, and a nearly doubling in protective textiles, to a triple increase or more in bio-based products, renewable energy and sustainable construction by 2020. Overall, the total market volume for all these six areas is expected to rise from 121 billion in 2006 to 304 billion Euro in 2020, representing an increase of 182 billion Euro .

Following the expectations of growth in these six markets, an increase in employment of more than a million jobs in the EU is anticipated (see Table 2). The increases range from a moderate rise of around 7-10% in recycling and protective textiles, and an around 50% increase in eHealth and sustainable construction, to a doubling and tripling in renewable energy and bio-based products respectively. Overall, total employment in the six markets may grow from 1,875 million in 2006 to 3,007 million in 2020, representing a job rise of 1,132 million . More details on the growth expectations can be found in appendix 3.

Table 1 : Expected market growth of the identified emerging market areas (2006-2020)

Market areas [71] | Volume of the new markets products/ services in the EU in 2006 [million Euro] | Volume of the new markets products/ services in the EU in 2020 [million Euro] | Growth in volume resulting from market development and policy initiatives, 2006-2020 [million Euro] | Growth share attributed to the Lead Market Initiative and related policies in 2020 [million Euro][72],[73] | Cumulated growth share attributed to Lead Market Initiative and related policies, 2006-2020 [million Euro][74] |

eHealth | 21000 | 30000 | 9000 | 1800 | 12600 |

Bio-based Products | 19000 | 57000 | 38000 | 7600 | 53200 |

Protective Textiles | 8800 | 15200 | 6400 | 1280 | 8960 |

Sustainable Construction | 24000 | 87000 | 63000 | 12600 | 88200 |

Recycling | 24000 | 36000 | 12000 | 2400 | 16800 |

Renewable Energy | 25000 | 79000 | 54000 | 38000 | 266000 |

TOTAL (six areas) | 121800 | 304200 | 182400 | 63680 | 445760 |

Table 2 : Expected job creation in the identified emerging market areas (2006-2020)

Market areas 71 | Jobs dependent on the new products/services in the EU in 2006 [thousand jobs] | Jobs dependent on the new products/services in the EU in 2020 [thousand jobs] | Growth in jobs resulting from market development and policy initiatives, 2006-2020 [thousand jobs] | Growth in jobs attributed to the Lead Market Initiative and related policies, 2006-2020 [thousand jobs]72, [75] |

eHealth | 250 | 360 | 110 | 22 |

Bio-based Products | 120 | 380 | 260 | 52 |

Protective Textiles | 205 | 228 | 23 | 5 |

Sustainable Construction | 500 | 870 | 370 | 74 |

Recycling | 500 | 535 | 35 | 7 |

Renewable Energy | 300 | 634 | 334 | 304 |

TOTAL (6 areas) | 1875 | 3007 | 1132 | 464 |

Potential impact of the LMI and related policies an the first set of identified emerging markets

The second issue is the estimation of the potential quantitative impact of the LMI and of related policy initiatives. Not only is it difficult to estimate overall policy impact, but it is also very hard to differentiate between the impacts of different policy measures. Policies are often interlinked and influence each other. Thus, they have indirect impacts upon the objectives and success of related policies. For instance, the success of the LMI for the market area of renewable energies can obviously not be assessed without taking into account the expected intense policy initiatives to reduce greenhouse gasses (GHG).

The analysis in this paper however suggests that obtaining a lead market position without the type of coordinated action that is proposed in the LMI will be very difficult and that on average the benefits for Europe of the development of these emerging markets would be substantially lower. Indeed, the fact that in the majority of the cases, major recent lead markets have been developed in the USA or in Japan, even when Europe had strong scientific and industrial positions in the related domains, is largely explained by the difference between markets and policies, which are more homogeneous in large national markets (in the USA and in Japan) than in the EU. Therefore, an initiative to tackle this comparative disadvantage is crucial to create a balanced competitive situation for our industry in Europe. The estimates below attempt to give an indication of the importance of obtaining a lead market position and hence can be considered to put a quantitative value upon the effect of the proposed policy efforts. For the reasons indicated above, such a quantitative value must of course be considered with caution. This is why, as already mentioned, it is based on conservative assumptions and can be seen as only indicative. The calculations are made explicit in the 4 th and 5 th columns of the two previous tables.

Based upon the past experience of lead markets, a ten to fifty per cent of growth might be attributed to the fact of being a lead market. Applying a conservative average of 20% to these emerging markets[76] would attribute more than 63 billions Euros of additional market volume and 464,000 new jobs in 2020 to the lead market effect and related policy measures for Europe only.

The cumulative effect is obviously much higher. The cumulated value of the annual increase in market volume that may be attributed to the LMI and related policies is expected to be in the excess of 445 billions Euro over the period 2007-2020 . Similarly, the cumulative effect of an annually higher amount of employment in terms of hours worked would also build up further wealth.

This would therefore constitute the basis for a sustainable wealth effect that might induce several positive effects in terms of balance in budget and social expenses and in terms of overall business activity in Europe.

Summary

The forecasts in this part 7 clearly show the potential for these emerging markets in terms of growth, jobs and consequent wealth. They also show that an important part of the calculated benefits will only be reaped by those home markets that gain a lead market position and therefore demonstrate the value of the Lead Market Initiative.

The sum up the LMI and related policies are likely to have a very high positive impact in terms of:

- Growth and employment on the identified emerging markets;

- Overall growth in Europe based on a wealth effect, with therefore an impact beyond these markets;

- Europe’s competitiveness in these markets;

- Europe’s overall competitiveness by favouring structural change and generating a virtual circle of investment in the knowledge economy;

- Contribution to health and environment protection, as a result of the themes of the identified markets.

While this section has highlighted in quantitative terms the overall benefits in terms of growth and jobs for the potential lead markets and for a successful lead market initiative, the following section (see also appendix 3) provides a brief overview of the potential of the individual markets and details some of the assumptions and market prospects that have been used to establish the overview summarized in tables 1 and 2.

Detailed market prospects

According to a recent study[77] the 2006 volume of markets for bio-based products might more than triple until 2020 to an estimated 250 billion Euro globally, which could result in a similar increase in jobs (380,000). As of 2005, bio-based products already accounted for 7% of global sales and around 77 billion Euro in value within the chemical sector. The EU industry accounted for approximately 30% of this value. In addition, the increasing use of bioplastics that are usually better biodegradable (starch-based) than conventional plastic, for instance, could provide Greenhouse Gas (GHG) savings in the EU in 2020 of 9-27 million tons of CO2.

eHealth can help to deliver better care for less money within citizen-centred health delivery systems. It can thus alleviate the cost pressure on the largely public budgets for health. Without significant reforms, including the better use of eHealth, health expenditure is expected to increase from 9% of GDP at present to around 16% by 2020. In the area of eHealth a forecast expects an increase of 43% by 2020 bringing the total volume of the market to 30 billion Euro from currently 21 billion in 2006 within the EU-15.[78] If this materialises, there would be 360,000 jobs in Europe in this sector.

The economic relevance of the EU-27 construction market is undeniable with 10% of GDP (1305 billion €) and 7.3% of the total workforce (13.2 million persons). About one third of this GDP (for the new construction and renovation of buildings and civil engineering on-site) is attributable to construction materials and building products. [79]Buildings account for the largest share of the total EU final energy consumption (42%) and produces about 35% of all greenhouse emissions. The residential sector represents 46% of the total EU production, the non-residential sector 31% and civil engineering 23%[80]. The building sector is characterised by a long service life of several decades or even more, a slow replacement rate of the building stock (about 1% per year) and a much lower rate for building demolition (about 20 times less than new construction)[81]. This means that interventions on the existing buildings such as insulation works, double glazing, acoustic developments, etc. will have immediate effects on climate change, indoor air quality, re-use/recycling and other sustainability issues like safety and accessibility. New construction already incorporates more recent technical solutions and therefore will affect sustainability issues on the long term. In addition to the overall promising economic outlook of the construction sector in the next 2-3 years, initiatives linked to the sustainable development agenda provide good growth prospects for this market. Export opportunities may also arise in countries such as India and China where the global construction spending growth is actually more than 8% per year.[82]

Protective textiles comprise clothing and other textile-based systems whose main function is to protect the users from hazards and dangers in the conditions in which they operate. These products are needed in hazardous professional environments, civil and military emergency interventions or in hospitals and manufacturing environments that require insulation from bacterial and viral contamination, with a share of public procurement in some fields close to 100%. The current size of the personal protective equipment products (PPE) market segment in the EU is estimated at 9.5-10 billion Euro, when service operations related to PPE are included (8 billion Euro without)[83]. Around 200,000 jobs are directly or indirectly related to the PPE products and services. The fast growth forecasted in certain parts of the world suggests that EU exports of PPE could grow by about 50% over the next 5-10 years and nearly doubling their value by 2020.

Recycling is a broad and diverse area which addresses concerns of waste reduction and of consumption of natural resources. The market segment encompasses products and services related to the recycling process and products using the recycled material, so-called recyclates. The waste management and recycling sector in the EU has a turnover of over 24 billion Euro, and provides more than 500,000 jobs in over 60,000 companies in the EU, 69% of which are small (28% medium)[84].

A significant part of materials available on the market today are already recycled. For example 45% of steel comes from recycled steel; 43% of glass comes from recycled glass and more than 50% of paper comes from recycled sources. At the same time, demand for raw materials is increasing rapidly worldwide with corresponding price increases. For instance, it is estimated that the world aluminium consumption will grow by 30,4 % (annual average rate of 5,1 %) between 2004 and 2010. This means that the demand for recycling and the resulting secondary raw materials is also increasing, depending on different material classes.

Different materials have different recycling properties and thus different economic factors relating to them. The potential energy savings of recycling compared to primary production can vary for different materials, for example up to 95% for Aluminium; up to 74% for Steel; up to 64% for paper and up to 80% for plastics. From these figures it is clear that recycling helps reduce energy consumption and thus reduce costs of production.

There are clear signs of increasing demand and price for raw materials and markets are increasingly affected by global players: US, Russia, China, India and South America. Recycling is therefore an area of growing strategic importance, as it reduces dependency on raw material prices. Thus is further supported by the fact that international trade in recycled materials is on the increase. In 1995 international trade in recycled material was estimated to be 2 million tonnes; by 1999 this had increased to 4.5 Million tonnes. Figures also show that 5.8% of EU exports to the rest of the world were waste management goods, in the period 1994-2004. An important figure is that the EU has roughly a 50% share of the world market in the waste and recycling industries and that this sector is expected to grow in turnover at the rate of 3% in the period 2005-2020[85].

Renewable energy refers to energy that can be derived from regenerative resources like wind, sun, biomass and hydro and is transformed into electricity, heating/cooling or transport fuels (biofuels). Currently, the European renewable energy sector has an annual € 25 billion turnover and provides jobs to around 300.000 people while meeting approximately 8.5% of Europe's energy needs[86]. Assuming that policies for renewable energies are implemented, projections for wind power, for instance, forecast a growth from 12,000 to 18,000 installed wind power in Germany (50% growth) and from nearly 5,000 to 12,000 in the USA (150% growth) between 2002 and 2010[87].

GOVERNANCE, MONITORING AND EVALUATION

It is clear from the analysis developed in the present paper that the added value of the LMI in its coordination nature will notably depend on the interaction with stakeholders and on its anticipatory approach. This implies that the monitoring of the actions may yield valuable lessons that enable policy makers to refine the approach and adapt the actions plans over the period. The Commission’s Communication on the LMI foresees various monitoring, evaluation and feed-back mechanisms.

The effectiveness of the implementation of the policy measures of each action plan will depend on the ability and commitment to coordinate the different actions of in the LMI in a mutually supportive manner. Operational interfaces (networking) should be developed between ongoing legislative activities that affect the implementation of these action plans. Proposals for organisational arrangements may include a well-defined mandate[88]; a clear notion of the scope, duration and the level of participation of the relevant Commission’s Services in each specific action plan. Thematic inter-departmental task forces of the Commission’s Services for each action plan may be instrumental to this end.

These task forces could also provide input to the Commission’s Annual Legislative and Work Programme (CLWP), to the reporting on the progress of the Community Lisbon Programme and budget planning for relevant funding instruments (predominantly FP7 and CIP).

The overall development of the lead market initiatives may be reported to the Competitiveness Council Commissioners Group (CCCG), the Enterprise Policy Group and to the Competitiveness Council.

There may be opportunities in the CIP to fund networking activities of stakeholders (policy makers, finance, standards, clusters and industry) in the themes of the emerging markets, building on ongoing Europe INNOVA activities. Under the PRO INNO Europe umbrella, a network could be established that brings together regional and national policymakers with the aim of facilitating trans-national cooperation in areas of common interest[89]. In the context of Cohesion Policy, the Commission initiative "Regions for Economic Change"[90] implemented through the 2007-2013 INTERREG IVC and URBACT II programmes, focuses especially on networking between regions and stakeholders in various thematic networks of relevance to lead market areas.

CONCLUSIONS

This explanatory paper outlines a strong consensual support of stakeholders for a lead market policy initiative.

It outlines also a solid theoretical economic rationale for such a policy initiative, which may explain this consensus.

Lessons from the past indicate that such type of initiative isn’t exempt of risks. The analysis provided here as well as the governance and monitoring aspects which are envisaged aim at avoiding to repeat such mistakes. The methodology that has been followed to identify emerging markets, to elaborate the policy tool box and to enumerate the recommended conditions favourable to its adequate implementation, all take into account such lessons and try to avoid the identified risks.

Economic gains to be expected appear to have a huge potential. The quantitative evaluation of these gains is an extremely difficult exercise that must be taken with caution. Nevertheless, based on prudent assumptions for the first set of six identified emerging markets, more than 60 billions euros of additional market volume and close to half a million new jobs could be attributed to the lead market effect and related policy measures for Europe only. The markets concerned might represent in total more than 300 billions euros and 3 million jobs in 2020.

More importantly, beyond the direct economic gains in these markets, the analysis points out at credible and highly significant potential gains in Europe’s overall competitiveness by favouring structural change and generating a virtual circle of investment in the knowledge economy as well as to a significant contribution to health and environment protection , as a result of the themes of the identified market areas.

List of annexes

1. Methodology followed to identify the six emerging markets

2. The policy tool box in support of Lead markets

3. Economic potential of each of the identified markets

4. References

5. Appendix 1 - Methodology followed to identify the six emerging markets

The set of criteria used to assess the market areas refers mainly to the economic and societal impact, the European industry potential and the potential of innovation policy instruments to have a decisive impact on the growth of the emerging market areas. A significant outcome of the action plans in each market area should be expected in the time horizon of the Lisbon strategy.

For the identification of suitable lead market areas, an approach at the European level does not exist. An appropriate identification process was therefore developed, that is described at some length below. Figure 1 illustrates the logical sequence of the process in a simplified way, as the real process would be more interactive, involving possibly several loops or iterations among the steps.

Figure 1: Main steps to identify lead market areas

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1 PRE-IDENTIFICATION

The pre-identification process was totally open, with no a priori restriction of the number of markets to be retained for a more in-depth screening. In line with the Council’s conclusion, broad stakeholder consultations were instrumental to the identification of suitable candidate areas.

Stakeholder consultations played indeed a crucial role throughout the preparation of the initiative, including at this very early stage. Industry experts were consulted on the appropriateness of a lead market approach and the choice of the criteria to verify their relevance to the lead market approach[91]. The Europe INNOVA Innovation Panels and the European Technology Platforms (ETPs) were invited specifically to respond to a survey on the potential of lead markets according to the criteria[92].

The text of the Council conclusions and of the Commission’s Communication on the broad-based innovation strategy that listed some possible domains, were widely distributed, in order to raise awareness. This notably concerned markets related to areas such as low carbon technologies, eco-innovation, e-health, intelligent transport systems, digital content, energy efficiency, bioenergy/biotechnology, nano-technology, satellite navigation and earth observation, security, ICT and marine technologies, including mineral resources, intelligent near-zero energy building, well-being and culture, ageing population-related markets, climate change-related markets, new concepts for markets in the automobile sector, textile.

The information collected was discussed by experts throughout the services and whenever needed through further external consultations. The main reasons for not retaining potential areas for a lead market initiative were:

- Absence of clear evidence of the existence of a sufficient potential market;

- That might emerge is a rather short time;

- That were based on clear signals from the market (demand-driven approach);

- The technology was too far from being mature and that the risk of “picking winners” and more precisely to be wrong in making such choices was too high;

- The nature of the problems encountered and respect of the subsidiarity principle.

Priority was also given to markets where the actions were supposed to give the most added-value. Finally six different domains were considered as more suitable candidates, which were retained for a final, more detailed screening.

2 IDENTIFICATION PROCESS ITSELF

Following the pre-identification phase, for each candidate lead market area, the European Commission constituted a task force. Each task force analysed the information collected for the criteria, elaborated a roadmap for an action plan and conducted the stakeholder consultations in its market area[93].

The outcome of the analysis of the information and the assessment of the actions proposed to implement the lead market approach were extensively discussed with a variety of industry associations. The consultation process involved also stakeholders other than industry representatives: representatives from relevant ministries were consulted as well as user associations. The lead market concept, the analytical information and the policy recommendations were thus scrutinised in a series of meetings arranged in a very short period of time, which in itself is a testimony of the high interest stakeholders have in the initiative.

Stakeholders’ appreciation of the proposed market areas and policy measures showed a great satisfaction with the approach proposed. The co-ordination of policy measures from various policy domains in a prospective, coordinated and strategic approach with a synchronised list of actions was considered to provide a very high value-added.

Decisive in the process are the criteria used. They can be grouped into two classes:

6. the potential or interest of the market area in view of the objectives;

7. the effectiveness of the policy toolbox to support the market areas to become lead markets.

The criteria are set out in some detail below.

8. The interest of identified areas for Europe

Public policy in support of emerging innovative markets should be geared towards market areas with high societal and economic interest. The conditions for enterprises located in the Union to respond to the policy initiative effectively need also to be assessed.

Areas could turn around major concerns of citizens: environment, security and health (this is of course not limitative). These are policy domains in which the case for public interest is long recognised. All of them are affected by structural changes due to demography, climate change, new security threats and economic restructuring.

The criteria to assess the interest of the market areas for Europe are:

- Specification of the emerging market and the extent of customer needs , both private and public, that would be satisfied, and how this could lead to the development of new products and services with a global perspective.

- The potential of technologies under development and of new combinations of existing technologies for the creation of world class markets.

- The basis for the EU to capitalise on investments in such technologies and their applications to develop world class markets, notably in terms of existing or nascent industrial strengths in Europe that could develop the new markets.

- Evidence of the commitment of industrial and service sectors to contribute to the success of the initiative in the proposed domain, following stakeholders’ consultations.

- The potential of policies to favour the emergence of lead markets

Market areas in which no decisive obstacles can be observed or where the obstacles can be overcome by the policies already in place are inappropriate lead market areas, because they would not provide any added value in developing a lead market approach. The analysis of the criteria has therefore to establish the presence of obstacles with a considerable delaying effect on the emergence of markets and to show that Community innovation policy instruments can overcome these obstacles.

The second category of criteria related to this assessment comprises:

9. Existence or lack of regulation of markets of products and services , which currently, or in the foreseeable future, will impede the development and market take-up in Europe of new products and services in the considered markets.

10. With regard to product standardisation , standardisation issues that would need to be addressed in a timely way to foster the development and market take-up in Europe of new products and services.

11. With respect to intellectual property protection , the presence of IPR issues specific to the area, which presently, or in the future will impede the faster development of the emerging market.

12. With respect to public procurement , the extent to which opportunities for the public sector, acting as a launching customer, to foster the development and market take-up of new products and services through a more proactive and innovation-oriented approach to public procurement.

13. The presence of obstacles to sufficient mobilisation of finances (bank, EIB Group, VC) which are specific to support the development of the new world class market to which public measures can contribute to alleviate.

This list of possible policies is not limitative. If the detailed analysis of a case demonstrates the contribution of another policy tool, such an instrument isn’t a priori excluded.

3 RESULT OF THE IDENTIFICATION PROCESS – DEFINITION AND VALIDATION OF THE PROPOSED LEAD MARKETS

One of the defining results of this preparatory phase was the necessity to retain rather broad definitions of the lead market areas. Systemic interdependencies across technologies used in a broad range of markets for the products and services concerned and interdependencies between policy impacts let expect that the value-added of creating synergies between policies would be the greatest in such broadly defined market areas. This lesson is reflected in the definitions retained for the different markets which are proposed, which were validated by stakeholders.

As regards the screening of criteria, the prevalence of demand-side factors and corresponding innovation policy instruments might in the future be complemented by the more quantitative approach being developed at present in the context of the Internal Market review.

In conclusion, based on an in-depth and objective analysis, by applying the criteria set out above, six candidate lead markets were identified as good illustrative cases for the lead market approach and validated by stakeholders:

- eHealth

- Sustainable Construction

- Technical textiles for intelligent personal protective clothing and equipment

- Bio-based products

- Recycling

- Renewable energy

For each of the initial lead market areas, appendix 3 gives a summary of the definition of the market areas, of the reasons why they meet the two categories of criteria (economic and policy-related) and of the key elements of the action plan needed to support the emergence of such markets.

The areas retained for the approach do not express any political or strategic preference or importance over other market areas or involved industrial sectors. No preferential treatment or fresh money would be allocated to them. The only advantage they enjoy is of operational nature: a tighter policy co-ordination than is available up to now. And even in this respect, they represent a 1st batch of market areas on which to learn lessons for a tighter policy co-ordination ahead of its generalised application. Other areas, for which such a policy approach would be considered useful, could therefore follow.

The identification of such areas in the future could broadly follow the two- stage approach applied in the 1st round of LMI. The analysis complementing the stakeholders' consultations could be further extended to examine in more detail the determinants of innovation take-off and to assess whether the underlying problems are due to market or policy failures. This could be done for example by looking at the market characteristics in terms of structure (number of players, entry/exit conditions, costs structure, characteristics of demand and commercial characteristics), conduct (strategic patenting, use of standards, characteristics of innovation activity, asymmetric information, etc.) and performance (prices, employment, etc.). Afterwards, a more in-depth analysis of the market and policy failures identified in the previous step could follow. As the determinants of innovation take-off are related to the individual decisions of suppliers to disseminate innovation on the one hand, and of the demanders to purchase and adopt new technologies on the other hand, it would be important to have a closer look at (i) the benefits from the innovation; (ii) costs of adoption (acquisition, complementary investments and learning); (iii) market size and its growth potential (e.g. sales forecast), industry environment and market structure; and (iv) network effects.

The absence of specific "exceptional" or "preferential" treatment for the identified lead market areas underlines the full respect of and complementarities to the legislative framework by any action that would be proposed.

Appendix 2 - The policy tool box in support of lead markets

A lead market approach also needs to establish how the policy instruments can be best designed, used and coordinated to favour the