The Applied Research and Communications Fund (ARC Fund), a private non-profit organisation based in Sofia, has published a report tracking the innovative performance and potential of the Bulgarian economy. The report, entitled 'Innovation.bg: Measuring the innovation potential of the Bulgarian economy', aims to assist the efforts of Bulgaria's public and private sector for a successful move to an innovation-driven economy. The report focuses on a number of specific national economic, political and institutional conditions, identifying several challenges that must be overcome to develop a 'modern' innovation system. Despite significant economic growth since the late 1990s, economic indicators show that Bulgaria still lags significantly behind the average EU-25 level. However, the country's homogeneous, labour- and material-intensive products and low costs are considered to be driving factors behind its recent competitiveness. While the report recognises innovation as an important tool for improving the competitiveness of Bulgaria's industries and overall economy in the long run, it finds that investment in the components that make up the innovation process, namely science and technology, has been limited. The report finds that Bulgaria's share of innovative enterprises is approximately one-quarter of the EU-25 average. Of the companies found to be innovative, the report notes that this activity is based primarily on the acquisition of new machinery and equipment, while marketing, staff training and research and development (R&D) investment remain secondary. This behaviour, says the report, reflects the relatively early stage of market and innovation development in the Bulgarian economy, characterised by the manufacture of inexpensive products with low levels of differentiation. The industries with the highest accumulation of foreign direct investment are shown to have a larger share of innovative companies. In order to make full use of foreign investment, the report points to the need for domestic enterprises to better absorb foreign innovation and knowledge, as well as attract further foreign investment with higher R&D content. Bulgaria's overall R&D expenditure over the past ten years has remained approximately one-quarter the average EU-15 level as a percentage of Bulgaria's GDP. Businesses' contribution to R&D, the report finds, remains less than half that of the state, which is exactly the opposite situation to that in the leading innovation economies of Europe. Worst hit by this deficit is the R&D system dealing with applied and experimental research and development, which the report notes are of particular importance to innovation in contemporary market economies. To rectify the situation, the report recommends, in the short to medium-term, bringing the State and private contributions to R&D expenditure to parity, while increasing the percentage of GDP spent on R&D to 1.5 per cent. In the longer term, Bulgaria should aim to raise R&D expenditure to 3 per cent of GDP, in line with the EU goal. For greater investment, the report underlines the need for a sound R&D infrastructure, which should be taken-up by the public sector for the successful integration of the Bulgarian innovation system into the European Economic Area. Bulgarian R&D organisations and innovative enterprises should participate in the specialised programmes of EU and NATO. In order to maintain their competitive advantages, the report recommends that companies create special R&D departments to develop higher value added products with high knowledge content. Another crucial determinant of the long-term development of the Bulgarian innovation system is the quality and quantity of the available human capital. The ability of the Bulgarian economy to absorb, use and adapt new knowledge, as well as to introduce outside innovation, the report argues, is determined by the quality of secondary and higher education and the system of life-long learning. Again here, the report describes problems at all levels of the country's education system, but points to indications that universities have already started responding more adequately to market demands. This is especially true for technological majors, in particular in relation to IT training. The report suggests that policy makers should strengthen efforts to multiply such emerging positive trends, and devote more time to increasing the quality requirements at the exit of the education system. Careers in science (PhD) and employment in R&D also define the internal potential of the economy to generate innovation, according to the report. However, statistics for 2002 show that R&D employment per thousand inhabitants in Bulgaria was below the level of the ten new EU member states. In fact, this figure is even lower in the private sector, and if it was not for the public sector to compensate overall R&D, unemployment would have increased, says the report. While State subsidised over-employment in R&D, inherited from the past, has contributed to preserving part of the country's scientific potential during the years of transition, the report notes that the imbalance between public and private sector R&D employment is inefficient and unsustainable in the long-run. Careful dismantling of state subsidised employment in the sector, it argues, is an important step towards improving the market efficiency of the science and education system. Other factors determining the development of an innovation-driven economy include implementing business networks structured around specific innovation and technology clusters, rather than broad market relations; developing modern information communications technologies (ICT) infrastructure; ensuring the most effective links between public and private institutions dealing with innovation; and the promotion of entrepreneurship among the Bulgarian population. The report concludes by arguing that for innovation to thrive in Bulgaria, these realities need to be addressed within the national innovation policy.