POLICY IMPLICATIONS

Challenges and opportunities in the internationalisation of business research and development

The internationalisation of business R&D has increased very rapidly over the past decade, a trend that is likely to continue. Policy makers now face a more global R&D landscape with growing strengths in emerging economies and growing technological specialisation in various parts of the world. R&D activities of MNEs abroad have become more important and are driving this process.

Internationalisation of business research involves both challenges and opportunities. It is generally acknowledged that internationalisation of R&D yields net global benefits. It creates better conditions for excellent research, avoids fragmentation, minimises R&D duplication and generates more public and private R&D funding. To benefit from the internationalisation of business research and more generally of science and technology, (national) governments have formulated strategic objectives (CREST Working Group,⁶ 2007):

• To increase the quality and absorption capacity of domestic S&T through international co-operation, with the explicit aim of supporting “excellence”, including attracting the best scientists and major high-technology companies, securing access to foreign knowledge, increasing the international orientation of stakeholders, raising the visibility of the national innovation system on the world stage, strengthening collaboration between world-leading research institutes in frontier research areas and mobilising the potential of expatriate researchers.

• To gain access to new markets and to increase the competitiveness of the country’s innovation system. Partner countries are selected on the basis of the economy’s future potential growth, their potential as business

6. The Committee for Scientific and Technical Research (CREST) is an advisory committee to the European Council and the European Commission on subjects relating to scientific and technical research and in particular, on the co-ordination of national R&D policies.

and/or scientific partner and the market for domestic MNEs. Partner countries may also be chosen on the basis of political factors and broader foreign policy considerations.

• To engage in solving global problems (e.g. Millennium Development Goals), which cannot be tackled efficiently by individual countries, through co-ordination with European policies and programmes and support and development of S&T systems in developing countries.

• To improve human resources by encouraging immigration of knowledge workers, avoiding brain drain, stimulating brain circulation and diminishing administrative burdens.

At the same time there are concerns about the international distribution of benefits in the short run and the associated structural adjustment costs.

The main policy concerns arising from the accelerated internationalisation of R&D differ depending on a country’s current position in global R&D and competitiveness:

• In most OECD member countries, which are home to leading R&D- intensive MNEs, a key concern is the possible erosion of home-based R&D due to offshoring and outsourcing abroad. The fear is reduced capacity to absorb knowledge and technologies developed abroad, decreased downstream business activity and less national influence on businesses’ decision making. It is stronger in smaller countries, which may have neither sufficient domestic sources of the specific skills they require nor the advanced users needed to test major inventions (Patel and Pavitt, 1999).

• Smaller countries also face the challenge of achieving critical mass for their research efforts and avoiding possible duplication with other countries. The European Research Area aims at co-ordination of national and regional research activities, programmes and policies of the various (smaller) countries.

• In catching-up economies that attract R&D-intensive FDI, the main concern is that foreign-owned R&D facilities may not contribute enough to the development of domestic innovation capabilities while absorbing a disproportionate share of the best human resources.

• Most of the less developed countries but some OECD countries as well fear being marginalised by the globalisation of R&D.

• In most countries increasing international mobility of human resources raises concerns about possible brain drain.

• In all countries the internationalisation of public research institutions challenges usual rules and practices regarding the location of publicly supported activities at a time when taxpayers want to see more tangible benefits from research funding.

Until recently, OECD countries had not addressed the task of developing an integrated strategy for harnessing the benefits of the globalisation of R&D, while internationalisation of R&D was central to the catching-up strategy of most emerging economies (OECD, 2006a). R&D policy has in fact traditionally been largely national, often supporting the development of critical knowledge bases and technologies or particular national specialisa- tions. The new forms of internationalisation of R&D, which are based on global sourcing and integration of complex knowledge bases, challenge national approaches. A key policy problem is therefore how to bring essentially national measures and instruments into line with companies’

globalised knowledge strategies. When innovation networks span national boundaries, how should national innovation systems relate to the global division of labour in knowledge production?

In order to gain insight into how OECD countries are tackling the increasing internationalisation of R&D, the OECD conducted in 2005 a policy survey of relevant practices in OECD countries. The information collected in 13 member countries showed that policies have largely been ad hoc and aimed at specific problems, such as lack of inward investment, lack of mobility of human resources, and too much mobility, i.e. brain drain.

However more holistic approaches are emerging in some countries (see Box 3.1). According to a recent questionnaire among EU member states and associated countries, close to half indicated that they have implemented or are implementing a comprehensive national strategy on internationalisation of S&T policies (CREST Working Group, 2007).

However, many countries stressed that many forms of international S&T co-operation were the result of individual contacts and initiatives between researchers, companies and research organisations, in the absence of any supporting government strategy. In some countries, often quite recently, this bottom-up process has been complemented by a more strategic central government top-down process.

Box 3.1. Ireland: an integrative approach

In contrast to other European countries, Ireland’s rapid economic development has been strongly based on industrial policy and substantial investments in innovation measures.

Business expenditure on R&D remains low, and 80% is accounted for by foreign-owned MNEs. Ireland is commonly regarded as a success in terms of inward investment owing to its proactive stance. Headed by the Industrial Development Authority (IDA), it has gained an international reputation for its emphasis on policy independence, continuity and consistency (Tekes, 2004).

With regard to the decision-making framework, grant concessions were initially tied to well-defined objectives (employment, R&D), and repayment was required if an MNE failed to comply. Additionally, policy implementation was always on a project-company basis, and explicit sectoral targeting was a defining policy feature. In fact, MNEs were not attracted to sectors in which Ireland traditionally had an advantage but to high-technology industries; FDI therefore had a tangible impact on Irish industry, as it motivated a structural shift in sectoral and regional terms. As a result, there was significant growth in FDI inflows over the last decade, with the greatest part for greenfield investment or expansions rather than mergers and acquisitions (Molero and Alvarez, 2004; Tavares, 2004).

From the end of the 1990s, in order to attract new investments, Ireland has adopted a bold and expensive set of instruments, upgrading the physical infrastructure of universities and making massive investments in strategic research in biotechnology and ICT. The Science Foundation Ireland (SFI), an agency of the industry ministry, offers very large grants to foreign-based researchers willing to move to Ireland and establish research groups, as well as smaller grants, open to nationals as well as researchers abroad. Other incentives include inward mobility schemes for individual researchers and those with key skills, and reduced fees for non-EU postgraduate students. Furthermore, there is an innovation support programme aimed especially at strengthening the capabilities of Irish plants, and corporation taxes are still low (Tavares, 2004; Tekes, 2004).

The next section looks at policies relating to the internationalisation of R&D through FDI. It examines the costs and benefits of FDI in R&D and existing policies and policy views regarding attractiveness and connectedness. The following section highlights existing policy views and reflects on policy from a broader innovation perspective and considers three main areas through which the internationalisation of S&T occurs: the internationalisation of research through technology collaborations; international mobility of researchers; and international exploitation of research. The discussion is based on the information collected in the OECD questionnaire (2005) and the CREST questionnaire (2007).

Policies relating to the internationalisation of R&D by MNEs

Inward FDI in R&D

Attracting FDI in general and FDI in R&D in particular has traditionally been high on the policy agenda of many countries, as inward flows of R&D are believed to provide net benefits for the host country (Table 3.1). The acquisition of modern technology may generate important spillovers for the host country economy which result in more and better competition, the upgrading of domestic innovative capacity, increased R&D employment, better training, support to education and formation, and reverse brain drain effects. However, these spillover effects do not appear automatically. In order to maximise the positive effects, countries that receive FDI have to strengthen agglomeration effects in domestic clusters and increase the local economy’s absorptive capacity. Inward FDI may also have negative effects, such as the loss of control over domestic innovative capacity, with potential impacts on the technological competitiveness of domestic firms. Many empirical studies find that foreign presence lowers the average dispersion of a sector’s productivity, with less productive firms exiting the market (see OECD and Belgian Science Policy, 2005).

Table 3.1. Benefits and costs of FDI in R&D

On host country – inward FDI On home country - outward FDI

Positive impact

• Increased local technical capability

• Potential knowledge and economic spillovers

• Job creation

• Contribution to human resource development (training, education)

• Tap into other sources of expertise

• Reverse technology transfer

• Enhance access to foreign markets

• Economic benefits if the results are exploited at home

Negative impact

• Foreign control over domestic R&D resources

• Crowding out (R&D, labour market)

• Loss of economic benefit if results are exploited elsewhere

• Loss of jobs

• Loss of technical capability; technology leakage

• Hollowing out of industry

• Loss of economic benefits if results are exploited locally

Source: Adapted from Sheehan (2004) and UNCTAD (2005).

Information collected in the 2005 OECD survey showed that while incentives to attract FDI in general are quite common, specific incentives for FDI in R&D are relatively uncommon. Only Australia, through its Invest Australia Strategic Investment Co-ordination, reported offering direct financial support for FDI in R&D. This is in line with theoretical and empirical findings showing that R&D investment abroad by MNEs is largely driven by fundamental economic factors (market size, tax rates, labour market conditions, etc.), the political environment (stability and an appropriate public infrastructure) and the country’s scientific and technological specialisation and capabilities.

The CREST questionnaire also made clear that policies to attract FDI in R&D still seem to be part of more general policies to attract R&D. Countries that actively encourage FDI in R&D implement one or a mixture of the following instruments: promotion of national strengths abroad; cluster policies to attract FDI in R&D; administrative support; provision of infrastructure; active recruitment; direct financial support; and fiscal incentives.

An important determinant of a country’s attractiveness is the quality and specialisation of the domestic knowledge base. Hence, all measures to improve an economy’s scientific and technological capabilities will also increase the country’s attractiveness for R&D investment by MNEs. In this context, the most important measures relate to human resource development, intellectual property protection, a first-class knowledge infrastructure, excellent universities and research organisations, and co-operative partners in the business enterprise sector. Some countries have introduced financial support for the internationalisation of public institutes and universities.

According to a recent report on the internationalisation of R&D by the Dutch Advisory Council on Science and Technology (2007), efforts to attract FDI should be directed towards key areas on the basis of a package of R&D-related policies. A niche strategy should be applied to well-defined areas in which the strengths of the business world and research institutions converge. However, one may ask whether a niche strategy (i.e. specialisation and concentration) is also appropriate for larger countries which can take a more general approach to attracting R&D because of their broader knowledge base.

Policies to attract R&D might lead countries to engage in harmful competition for MNEs’ “footloose” R&D investment. It would be undesirable for countries to try to attract as much foreign R&D as possible, while trying to prevent domestic firms from increasing their R&D investments abroad.

Such measures might include discrimination against firms that offshore activities, for example by withdrawing public support or discouraging such firms in other ways; offensive measures could include competition to attract

R&D-intensive FDI based on taxes and financial support. Such measures could invite retaliation and create the potential for a destructive series of “tit for tat” actions and reactions that would diminish the effectiveness of the global innovation system (Mowery, 1998).

Within the EU, the recently introduced new state aid regime should help avoid such harmful competition. Its aim is to reduce state aid gradually while refocusing it on activities with the most sustainable impact on competitiveness, jobs and growth, such as research and development.

Previous rules already provided wide possibilities for member states to support R&D through state aid. However, the Commission reviewed these rules in 2006 in order to better reflect Community policy priorities such as promoting cross-border research co-operation, public-private research partner- ships, dissemination of research results, and major research projects of common European interest. This will help create a more research- and innovation-friendly business environment.

Choosing a location for R&D-intensive FDI is also increasingly influenced by other structural policies e.g. education, labour market, social security, etc. While their effect so far has mainly been indirect, some countries are now paying more attention to their relation to R&D and fine-tuning these policies in consequence.

Outward FDI in R&D

A key question regarding FDI in R&D is how to benefit not only from attracting and retaining R&D, but also from encouraging firms to engage in global innovation networks and capture economic benefits from global innovation activities (i.e. outward FDI). MNEs benefit from establishing subsidiaries in foreign centres of excellence by drawing on their stock of technical knowledge and by learning from innovations of local firms (see Table 3.1). Smaller firms may benefit from greater involvement in global networks and significantly expand their innovative capabilities. In analysing UK firms that had located R&D facilities in the United States, Griffith et al.

(2004) showed that total factor productivity (TFP) grew more in these firms than in UK firms that had not located there. This suggests a specific spillover effect from the internationalisation of R&D. Moreover, the effect was stronger for firms whose productivity gap with the United States was greatest; that is, the benefits were greater for those with the “most to learn”.

The CREST questionnaire indicated an increase in policy efforts not only to attract FDI in R&D but also to absorb spillovers created by inward and outward FDI in R&D. Policy instruments are increasingly designed to better link inward and outward FDI in R&D to the “home base” by means of

an enabling environment for spillovers and a better embedding of foreign- controlled R&D into local chains of production (Figure 3.1).

Figure 3.1. Evolution in policies towards FDI in R&D

Source: CREST Working Group (2007).

The issue of absorptive capacity (Cohen and Levintahl, 1990) is crucial in policies for inward and outward FDI in R&D since the economic performance of a country or region increasingly depends on its ability to acquire and assimilate knowledge developed elsewhere. Domestic enterprises must have a certain level of technological expertise to be able to absorb spillovers from foreign affiliates. Since these spillovers are regarded as one of the main benefits to be derived from the presence of MNEs, the domestic economy’s technological capacities also crucially affect the degree to which countries benefit from FDI in terms of technological effects (rather than the more usual benefits of employment, value added, etc.). At the same time, foreign R&D activities of MNEs may provide access to foreign technologies and therefore be a channel for transferring knowledge back to the home country. There is some empirical evidence to suggest that to benefit from technology acquired abroad by their MNEs, home countries should develop their domestic absorptive capacity and networking. In this respect, the absorptive capacities and networking of both large and small enterprises, as well as R&D institutions, need to be strengthened.

All this has become more important following the trend towards asset- augmenting and technology-sourcing internationalisation of R&D. Foreign subsidiaries increasingly try to tap into the knowledge generated in centres of excellence around the world. This has led to combined inward and outward learning and reverse and interactive technology transfer among organisational and geographic locations. Governments of net recipient countries fear that foreign-owned firms may act as “Trojan horses”, both reducing the national technology and production base and keeping their core innovative activities in their home countries. For the host economy, the

Take advantage of inward and outward FDI by embedding spillovers Attraction of

inward FDI in R&D

trend towards technology-sourcing motives for internationalising R&D would suggest more potential for diminishing than for increasing domestic innovative capacity. At the same time, it creates more scope for potential benefits since there are likely to be more technology transfers to the host location. For their part, countries that are net sources of foreign R&D investment worry that the internationalisation of R&D may erode (“hollow out”) the domestic knowledge base because foreign affiliates may export technology developed at home and because fewer R&D activities may be undertaken at home.

A recent study by the European Commission has examined the validity of fears about the internationalisation of business R&D within the EU (LTT- Tutkimus Oy, 2007). The worry is that offshoring of business R&D outside the EU may lead to a decline in European firms’ innovation capacity and in turn to sluggish development of aggregate productivity, slower economic growth and reduced employment levels. The study concluded however that these fears are not justified and that there is no reason to expect European firms to lose their competitiveness through the offshoring of R&D. In fact, both the survey results and various econometric analyses and case studies suggest that EU firms have either maintained or improved their competitiveness by engaging in global R&D operations.

Policies to encourage the internationalisation of innovation Internationalisation of research through technology collaborations

Most policy makers acknowledge that governments can play an active role in supporting technology co-operation, including between companies and public research organisations. International co-operation on R&D between companies and research institutes has traditionally been established through a bottom-up process, without direct government intervention, but policy makers increasingly recognise the strategic benefits of such co- operation and have implemented various measures accordingly. Tapping into the vast reservoir of global knowledge and accessing new markets and human resources are important motivations. Because “connectedness” is the main driver in this process, many countries are increasing their support for international co-operation.

Most countries have a range of initiatives to attract foreign firms and link domestic firms to foreign knowledge, but the range, intensity and priority of their policy measures vary widely. The measures are mostly non- monetary in nature and concentrate on administrative and managerial support, matchmaking between domestic and foreign firms willing to co-operate, provision of information services, consultancy services, etc. Several countries

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