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Policy Incentives for the Creation of Knowledge: Methods and Evidence

Final Report Summary - PICK-ME (Policy Incentives for the Creation of Knowledge: Methods and Evidence)

Executive Summary:
The project Policy Incentives for the Creation of Knowledge: Methods and Evidence (PICK-ME) aims at assessing the impact of market demand and public procurement on the patterns of knowledge creation across different regions and sectors.

The research activity moved from the appreciation of the inherent complexity of socio-economic interactions which underlie the generation and exploitation of new technological knowledge. In this perspective, basic steps in the analysis of demand driven innovation dynamics involve the identification of the main issues and gaps in the economic literature, and the elaboration of a comprehensive model drawing upon appreciative theorizing.

In view of the variety of phenomena under scrutiny, the PICK-ME project relied on different methods of analysis so as to ascertain the impact of demand on: i) the rate and direction of technological change; ii) the evolutionary dynamics of knowledge intensive sectors; iii) mobility of workers and skill matching in local contexts; iv) sectoral patterns of innovation. The empirical investigation has focused on different units of analysis, ranging from micro-level studies focusing on firms to regional and country level analyses.

The results of the analysis provide sound evidence about the effects of demand, both in terms of public procurement and in terms of market transactions, on the dynamics of knowledge generation, diffusion and exploitation. However, the key finding concerns the so-called competent demand pull hypothesis. The micro-founded framework is thus crucial to explain the competent demand pull hypothesis.
Demand will actually pull the generation and adoption of new technological solutions only if and when the customers are sufficiently creative and their demand is consequently competent. But even if competent, demand alone is inactive, unless accompanied by insightful user-producer interactions. Thanks to such interactions, the access to external knowledge and to knowledge externalities is assured. Finally, the implementation of external knowledge and its combination with the internal stock readily available is the most important consequence of the interaction with the competent users.
Actually, most of the empirical works carried out within the PICK-ME project has shown that path-dependency plays a crucial role in shaping the performances of individual agents as well as of sectors and regions. In this perspective, the construction of comparative technological advantages to rejuvenate development trajectories, cannot neglect the effects of dynamic irreversibility and the related economies of scale. Learning dynamics and the accumulation of competences over time set evident constraints to the technological opportunities that individuals can profitably exploit in their innovation efforts.

In this perspective, public and private demand can exert an effective impact on innovation insofar as policymakers and economic agents target new activities and new technologies that show some degree of relatedness with the core competences that individuals and regions have accumulated in their past history. The stimulation of innovation efforts directed towards the implementation of radically new technological trajectories appears to be more risky in that they need for the development of new competences and new complementary assets, both tangible and intangible. The complexity of innovation dynamics is augmented when discontinuities in the local patterns of development are at stake.

• Key recommendations stemming from the PICK-ME project are the following:

Policy should not support declining industries that take a peripheral position in the industrial portfolio of a region. Such support is not a smart policy from a relatedness perspective because these industries already have a high probability of exiting the region. Yet, an intervention might be justified when a related industry is confronted with a (temporary) demand fall, resulting in serious damage to the dynamics of other local industries to which it is technologically related. Policy intervention might be needed to avoid such a cascade effect which might erode the whole underlying capability base.
• Policy should aim at diversification, with the objective of broadening and renewing the industrial structure of regions by making them branch into new related activities. This is achieved by encouraging and enabling crossovers between related industries that can provide complementary assets. One-size-fits-all approach should be avoided. Instead, tailor-made strategies that capitalize on region-specific assets that are linked to technologically related industries are recommended.
• Public demand and procurement should be ‘competent’ as such able to stir the interactive competence of qualified users and producers
• Collaborative research networks should be promoted, with a focus on research cooperation between related partners within the same region or located in different regions. The latter underlines the importance of establishing linkages with partners outside the region to get access to external knowledge, in particular related knowledge.
• Companies should be encouraged to recruiting workforce from different and yet related industries, since recruitment is likely to engender good performances and increase labor productivity. Related to this policy makers should discourage workers from changing jobs within the same industry because moving across skill-related industries seems to be more beneficial.
• Institutional bottlenecks (laws, rules) that prevent companies from connecting and exchanging labour across industries should be removed to encourage inter-industry labour mobility. In this direction, local policy makers should be encouraged to pursue policies which attract industries that could boost mobility across (related) industries.
• Policymakers should aim to encourage foreign enterprises to engage in innovation activities and effectively diffuse these innovations. In a demand driven context, this implies:
o Upgrading human capital in line with demand and linking higher education programs to industries and specializations for which demand exists.
o Undertaking a mapping out of the skills required by both domestic and foreign firms and well as improving cooperation between firms and other institutions.
o Investing in public Research and Development in order to encourage existing subsidiaries to engage in high value added activities, while building domestic capabilities to take advantage of the uncompensated benefits associated with them.
o Fostering long term research projects in key areas in order to generates outputs (e.g. patents or academic publications) that may act as relevant inputs for research establishments by MNEs and domestic firms.
o Investing in particular sectors with the aim of developing specific innovations to meet the needs of the economic actors, both foreign and domestic, operating in these industrial contexts.
o Putting in place an adequate system of incentives to favor the emergence of cooperation: this can be done by embedding the MNE’s subsidiary into the local innovation system by introducing its role as potential partner rather than competitor.

Project Context and Objectives:
The ongoing global economic crisis has seriously affected the performances of both developed and lagging behind countries, raising huge challenges to reach the target of increasing growth and competitiveness. In this direction, a shared view emerged according to which a well articulated innovation policy represents a necessary condition for countries to undertake a sustained growth path. However, the bulk of innovation and technology policies has mainly been designed by relying on a supply side perspective, which implicitly assumed the creation of technological knowledge as an outcome of a process in which knowledge already available, stemming from past R&D activities, and R&D personnel represent the main inputs. The demand-side has instead long been neglected in innovation policy, as policymakers, academics and the business community have mostly emphasized the benefits of supply side strategies.
The main purpose of the project is to analyse the role played by demand in the generation and exploitation of innovation, and eventually in fostering productivity growth, at a theoretical and especially at an empirical level. In addition the project will also consider the linkages among the different institutional actors (research infrastructure, business community, policymakers) as well as the sectoral and the geographical dimensions in which these processes take place. This will be done in order to give scientific support to demand-oriented innovation policies and to identify best practices for national and regional innovation systems.

In particular, in the course of the project, the research activity will aim at:
- developing new databases and elaborate new indicators for analyzing and assessing the impact of demand-driven innovation policies at different government levels;
- analysing the influence that demand may have on the generation of knowledge, both from a quantitative and a qualitative viewpoint, as well as on the evolution of education and research systems and on the location choices of skilled work force and of multi-national corporations;
- investigating the interplay between demand-driven knowledge activities and the dynamics of both pure and pecuniary knowledge externalities, and how these affect local performances in Europe and the diffusion of knowledge;
- assessing the relationship between the evolution of demand and the dynamics of knowledge-base in knowledge intensive sectors, with a particular emphasis also on development and the organization of innovative activities;
- extracting policy guidelines for public administrations practitioners in order to support them in the future design and implementation of innovation strategies at different levels;
- diffusing the project results to policy makers at European, national and regional level, to promote the efficiency of future policies for the support of innovation activities and regional economic development.

Project Results:
The PICK-ME project has achieved all the Scientific & Technological target objectives established at begin of the activities.

The general objective of the project is to analyse the role played by demand in the generation and exploitation of technological knowledge, introduction of technological and organizational innovation, and in fostering productivity growth, at a theoretical and especially at an empirical level.

In particular the PICK-ME research activity has been driven by a number of specific objectives that are indicated in what follows.

- To develop new databases and elaborate new indicators for analyzing and assessing the impact of demand-driven innovation policies at different government levels;

The PICK-ME project has generated a new dataset based on survey of inventors of EPO patents localized in 3 main European regions: Catalunia, East and West Midlands and Piedmont. Access to the data is open to researchers willing to use them for statistical and economic research.

- To analyse the influence that demand may have on the introduction of technological innovations, both from a quantitative and a qualitative viewpoint, including such key issues as the evolution of education and research systems and the location choices of skilled work force and of multinational corporations;

These issues have been the specific focus of research carried out within the context of Work Package 6. The empirical analyses show that labor mobility affects firm performance and regional development, but the impact depends on the industries from which new employees are recruited and the life cycle stage an industry is in. Overall, a positive effect of labor mobility between related and unrelated industries is found in these studies. Related labor mobility has a positive effect on plant productivity growth, plant survival in young industries, plant employment growth in mature industries, and regional productivity growth. Labor recruitment from unrelated industries increased plant survival and employment growth and lessened regional unemployment growth, while it had no effect on plant productivity growth and regional employment growth.

A particular attention has been devoted to the mobility of skilled workers. The role of graduate and skilled migration is indeed at the root of the policy agenda at the national, European, and international level. The empirical findings provide relevant insights on the determinants of the mobility of skilled individuals, in particular recent graduates, and on the relevance of skilled mobility as a key channel of knowledge transmission.

This analysis assesses the skill-development trajectories of recent university graduates by looking at migration as key mechanism to achieving an education-job match. The role of migration in helping the achievement of such a match was identified at two different career points: approximately within the first year and the fourth year after graduation. Migration can be a skill-sorting mechanism, but only to the extent to which it allows graduates to achieve their first matched job. Inter-regional migration appears to be crucial to achieve an education-job match at the beginning of employee's career. Important sub-regional differences are at stake: late migration, for those in the virtuous trajectory, was negatively related to an education-job match, unless the destination was London.

- To investigate the interplay between demand-driven knowledge activities and the dynamics of both pure and pecuniary knowledge externalities, and how these affect local performances in Europe and the diffusion of knowledge;

The analysis of knowledge externalities span across the different WPs in which the project is articulated.

The conceptual and analytical framework underlying the PICK-ME research activities rests upon the concept of ‘competent demand’. According to this hypothesis, demand can pull the introduction and adoption of new superior technologies only if and when it is “competent” (i.e. devised by creative customers). Moreover, it has to be accompanied by qualified user-producer interactions that make the necessary access to external knowledge possible and allow its effective use as an input into the recombinant generation of technological knowledge. The effects of demand-pull will be negligible, in terms of total factor productivity, when firms cannot access external knowledge, but rather rely upon flexible inputs, both capital and labor, that make it possible to adjust quickly to the demand levels moving on the existing map of isoquants in equilibrium conditions.

This framework leads to focus attention on the types of knowledge interactions that link each sector to the others. An important implication is that the users involved in the system experience productivity increases that are directly related to the innovative activity of the rest of the system. The contribution of the system to the actual levels of technological advancement of each agent consists in the spillovers of pecuniary knowledge externalities entering the recombinant generation of technological knowledge and enabling the introduction of technological innovations. The appreciation of the powerful effects of learning by using in the adoption process complements the well-known effect of learning by doing and makes it possible to appreciate both the upstream and downstream linkages as important vectors of pecuniary knowledge externalities.

Within such a systemic perspective, workers mobility is also a source of external effects. Empirical results show that the mobility of knowledgeable individuals impacts a firm’s innovative performance. The effect on those firms exploiting more extensively external sources offered some support for the role of externalities linked to the spatial clustering of different sources of knowledge in specific spatial contexts. Mobility has been increasingly seen as a primary channel through which knowledge spills over space, since knowledge itself tends to travel along with the people who master it. In a demand for innovation framework, powerful policy implications are linked to this claim. Moreover, a strong intensity of intra-regional labor flows between skill-related industries impacted positively on regional productivity growth.

Another interesting area in which the interaction between demand and innovation may generate effective knowledge externalities concerns the activity of multi-national corporations (MNCs). In this context, the results of the research suggest that domestic firms’ absorptive capacities play a key role in facilitating the exploitation of the potential positive externalities arising from MNCs and in encouraging foreign enterprises to engage in cooperative dynamics. The effect of MNCs’ investments is particularly pronounced for domestic firms showing a significant engagement with its regional and national market, which, in turn, is the locus in which different mechanisms of knowledge transfer from foreign to domestic firms operate. In addition, firms that are already part of a multinational group are less affected by the positive externalities coming from other MNCs. These economic actors have reasonably fewer incentives to engage in patterns of cooperation since they already have access to the infrastructure channeling the diffusion of global knowledge.

- To assess the relationship between the evolution of demand and the dynamics of knowledge base in knowledge intensive sectors, with a particular emphasis on development and the organization of innovative activities;

These issues have been covered mainly in WP 5 and WP 7. WP5 provides empirical analyses of knowledge intensive sectors like pharmaceuticals, electronics, telecommunications and biology. The research elaborated upon the mechanisms through which agents use the different knowledge inputs so as to create new knowledge. The creation of new knowledge is represented as the outcome of a recombination process across different bits of available knowledge. Recombination stems from search activities locally conducted in the technology and geographical space. The variety and relatedness across the different combinable bits of available knowledge, as well as across the different sectors featuring the local mix of industries may be conceived as good proxy allowing for characterizing the evolutionary phase of regional knowledge-intensive sectors. If new knowledge stems from the recombination of different bits of existing technologies, its structure may be represented as a network the nodes of which are the technologies distributed in the knowledge space, while linkages stand for their actual combination. Such an approach will allows us to identify a number of properties of the knowledge base which mirror the localness degree of the search activity reflected in its structure. A way to do this relies on the use of the information contained in patent documents, and in particular the one about the technological classes are assigned to.

For each of these sectors, we will analyze the mechanisms by means of which knowledge is created and used, we compare them, and identify commonalities and differences. Statistical techniques will draw upon the co-occurrence of different technological classes within the same patent document. In particular a number of properties will be identified, namely (i) variety (related and unrelated), (ii) coherence, and (iii) cognitive distance, which can describe the evolution of the internal structure of the knowledge base in each sector. The use of an evolutionary framework also renders possible the relationship between changes in knowledge structure and the dynamics of industries lifecycles. Further, we used network analysis techniques for different and yet complementary purposes. First, we will focus again on the co-occurrence of technological classes within the same patent document, so as to gain a description of the structure of knowledge based on network properties like density, centrality, clusters and the like. The long-run analysis so conducted will provide insights about the emergent properties of knowledge structures.

In WP 7 a number of sector-specific analyses have been conducted, spanning from wind energy to nanotechnologies. The insights provided by these case studies enrich our understanding on the opportunity and the complexity involved in the diffusion of new technology. Let us begin with a concise appreciation of the fact that the nature of the innovation process has changed over the last two decades. Three of those changes deserve closer attention. The first is that products, services and processes have progressively drawn on wider ranges of knowledge bases. This phenomenon is ascribed to the search for both cost reductions and differentiation as well as to increased availability of specialized components. The second type of change is the growing tendency of products, services and processes to be used in symbiotic fashion. The resulting trajectory is one in which products that were originally conceived as meeting different needs co-exist in a systemic context of use, and therefore are exposed to the potential benefits, but also to the huge drawbacks, of interoperability – or lack of thereof. The last important characteristic concerns the type of knowledge that best enables and facilitates innovation in such a fast-changing scenario.

This set of case studies provide a synthesis of these conceptual inputs and call for a reconsideration of the tools and of the criteria by which innovation is approached, both conceptually and empirically. In dynamic environments characterized by recurrent changes, the internal capabilities of individual firms hardly suffice. It is also clear that strategies for the governance of knowledge are critical for survival. To this end firms deepen specialization and establish connections to access and contribute to collective knowledge. New knowledge is facilitated by complementarities, rather than substitutability, between internal and external knowledge: the greater the scale of collaboration, the more intense the internal know-how that is necessary to retrieve, command and recombine external capabilities.

Potential Impact:

The main socio-economic impact that a research project like PICK-ME may have concerns the shaping of policy measures aiming at fostering knowledge generation and exploitation.

An economy-wide understanding of the innovation system and its drivers is crucial to identify effective consensual innovation policies. We predict a two-stage process in which experts from all parts of society meet to engage in understanding and mapping the ecosystem, and only after reaching consensual agreement on how the system works (and why perhaps it does not), debate how policy interventions can be most effective. By attaining a deep understanding of national innovation ecosystems, and by studying those of other nations, we believe that European innovation policies will be more innovative, more effective in their national impact, and more integrative in their Europe-wide design.

Policy can play an active role in enabling and activating knowledge transfer mechanisms through which related industries can connect at the regional scale. This can be realized through entrepreneurship policies that focus explicitly on experienced entrepreneurs from related industries.

The activation of knowledge transfer mechanisms is also achieved through a labor market policy that focuses on mobility across industries, with an emphasis on mobility between related industries, because this leads to the formation of knowledge networks and the transfer of skills between industries that provide complementary resources.

Policy can also focus on establishing collaborative research networks with a focus on research collaboration between related partners within the same region or located in different regions.

A number of specific frameworks can be devised in which the PICK-ME project provides useful inputs to the policy making process. In particular our research suggests that policy measures should be designed to:

- Stimulate labor mobility across related industries through information provision and the removal of institutional bottlenecks.
- Attract valuable individuals with distinctive skills that are linked to local demand conditions. This evidence advocates the design of policy options that are aimed at tackling structural weaknesses, especially in peripheral regions, to favor retaining these valuable resources, while strengthening local capabilities to take advantage of their skills and competencies. The upgrading of local capabilities in the light of existing specializations is a crucial step towards better economic performance.

- Attract knowledgeable individuals from an enrichment of the local knowledge-based needs to be complemented by capacity building strategies.

- Target local firms, with the aim of increasing their capability to absorb and exploit external sources of information, through effective linkages with other co-located actors.

- create incentives (e.g. tax exemptions) for large multi-national firms to locate in the periphery and by working towards increasing the industrial variety in peripheral regions, especially in the tertiary and quaternary sectors.

- Provide older individuals with the proper tools for retraining and career change (e.g. especially in the scientific and engineering fields) in order to increase their chances for reintegration into the labor market.

- Upgrade human capital in line with demand, linking higher education programs to industries and specializations for which demand exists. This implies mapping the skills required by both domestic and foreign firms and well as improving collaboration between firms and other institutions. Universities, in particular, should be encouraged to work with specific MNCs, providing both on the job training for existing employees and dedicated training for prospective employees.

- Invest in public R&D to encourage existing subsidiaries to engage in high value-added activities, while building domestic capabilities to take advantage of the uncompensated benefits associated with them. In a demand-driven perspective, this implies fostering long-term research projects in key areas to generate outputs (e.g. patents or academic publications) that may act as relevant inputs for research establishments of MNCs or domestic firms. It also entails investing in specific sectors with the aim of developing innovations to meet the needs of the economic actors, both foreign and domestic, operating in these industrial contexts.

- Focus on enhancing the likelihood of cooperation with MNCs by matching the characteristics of recipient sectors. Traditional demand-driven initiatives that exploit the incentives for attracting MNCs without attempting to maximize linkages with the domestic economy are likely to result in a net negative sum game. Heterogeneity across domestic firms in terms of market strategies shows that the likelihood of interaction with foreign actors may be also hampered by deliberated choices.

- Implement standards specifically targeted at raising the quality of the local industry and local firms (e.g. especially in production and hardware development). High quality standardization will enable local firms to better compete with foreign firms (e.g. non-MNCs located outside Israel) in supplying MNCs sophisticated goods and services, thus raising demand for local innovation. Standardization is also an efficient tool in increasing the possibilities to exploit technological opportunities on a broader basis and in developing interface capabilities.

- Expand current government incentives for the support of existing and new MNC subsidiaries and R&D centers (e.g. via grants and tax incentives). Emphasis should be placed on diversifying the activity of MNCs (e.g. moving from R&D to manufacturing).

- Expand government-initiated R&D incentives aimed at fostering collaboration between MNCs, local companies, and the academia. R&D incentive programs help share some of the risks inherent to all R&D activities through attractive financing, the creation of unique partnerships between industry and academic institutions, and the facilitation of international cooperation. These programs help firms to actively pursue R&D and, thus, develop, produce, and market a wide-range of cutting-edge products that compete successfully in world markets. These types of collaborations are beneficial both for MNCs and for local firms due to the externalities and knowledge spillovers that they promote.

- Provide targeted support for local firms dealing with technological domains that could provide complementary support (e.g. in terms of goods and services) to the activity of foreign R&D centers and MNC subsidiaries.

- Promote long-term investment in technological education, which is vital for the survival and fortification of the high-technology industry.

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Coordinator: Cristiano Antonelli