# **II  Absorbing Knowledge from Abroad – International Technology Transfer and Spillovers**

Close to 80 percent world R&D is carried out in the developed world. It is thus not surprising that most innovation by firms in developing countries does not entail advances in the frontier of global knowledge, but, instead, catching up to the frontier through adoption and adaptation of existing products, processes and methods which, while they are new to the developing country firm, are not new to the world, typically originating from firms and other innovators in advanced countries.

What is perhaps less well known is that acquisition of knowledge from abroad remains crucial at _all_ levels of development. Eaton and Kortum (1996) estimate that foreign sources of technology account for at least 80 percent of domestic productivity growth in most OECD countries, the only exceptions being the US and Japan. Cutting-edge innovation that advances the global frontier of knowledge would itself be difficult without access to the accumulated stock of scientific and technical knowledge worldwide, through technology transfers or knowledge spillovers of various kinds. Bottazi and Peri (2005) estimate that a 1 percent increase in US R&D leads to a 0.35 percent rise in knowledge creation (patenting) in other OECD countries within 10 years. Access to foreign knowledge in turn depends on (among other things) exposure to and interaction with international scientific, technical and research communities within firms, universities and other private and public bodies, be this through direct exchanges of information or through trade, investment and other international economic transactions.

The first part of this section draws on the World Bank’s firm-level Investment Climate Surveys to provide an overview of broadly defined innovation activity among low and middle income economies in East Asia and elsewhere. The section then looks in more detail at some of the principal channels through which countries absorb knowledge from abroad. These include through imports of products that embody new technologies, through purchasing or licensing new technology, and, lastly, through technology transfers and spillovers that might arise through exporting, especially under long term contracts as part of the global production networks of foreign multinationals, or from the local affiliates of multinational firms (foreign direct investment).

A common theme that emerges from this discussion is that, no matter which channel or - more accurately - which combination of channels is employed, the extent and quality of knowledge absorption from abroad is dependent on the absorptive or learning capacity of the domestic economy. This in turn depends on the education and training of the labor force and on the extent and quality of domestic R&D and of the domestic innovation effort more generally. Knowledge absorption from abroad needs a domestic technical capacity which can master, adapt and adjust foreign knowledge, to make it useful for local circumstances. This need arises because much of knowledge, especially at the practical level, is difficult to codify into explicit protocols, instructions or formulas. It is _tacit knowledge_ , requiring costly face to face interactions and learning processes to master. As Cohen and Levinthal (1989) point out, R&D itself has two faces: innovation and learning. Domestic R&D not only generates new knowledge but it also enhances the firm’s ability to assimilate and exploit existing knowledge. Thus developing country firms are more likely to benefit from FDI spillovers if they conduct some R&D themselves. They are more likely to selected as suppliers to sophisticated global production networks if they already possess significant in-house design, engineering and other 6