Innovation Systems and European Integration

Exploitable results

- Development of Skills in Assessment of Intangible Investments Should be encouraged: In The Green Paper on Innovation of The Commission (Dec. 1995), actions to promote innovation financing were proposed at both a national and a Community level. For example, it was suggested that the banks should establish partnerships with expert bodies in appraising innovation projects, i.e. expanding the banks' competence in relation to innovation financing. Related to this, the OECD (Gonenc, 1996, p.4) points to a dual development between an increase in technological, operational, and marketing uncertainties in innovation projects on the one hand, and increased requirements for sophisticated skills and techniques in screening, selection and management of R&D and innovation projects on the other hand. This issue will be even more important in the future because the importance of intangible assets in production over the past few years has increased and should be expected to do so in the future. Current experiments to include knowledge assets in established accounting procedures should therefore be encouraged. - Radical Changes are Necessary to Change the Existing Venture Capital Market: In Europe today, almost all countries try to boost their venture capital markets, recognising that a lack of equity for innovation is a major constraint to innovation in small- and medium-sized firms. This study indicates, however, that existing venture funds are unlikely to shift to financing small, technology based firms. Too high fixed costs; lock-in with respect to competencies etc. are some of the reasons. In itself this leads to the policy conclusion that the intention to boost the venture capital industry must either involve institutional reform-new funds-or involve very strong incentives/measures to redirect existing venture funds towards new, technology-based, small firms. In our view, it could, however, be seen in connection with a second suggestion which has to do with informal venture capital. - In Europe informal venture capital should be put on the agenda as a major policy issue for promoting financing of innovation: There are several arguments for this suggestion. As far as the empirical evidence goes, informal venture capital is more directed towards small, early stage investments. Informal venture capital also tends to be geographically widespread whereas formal venture funds are concentrated in certain geographical areas. Further, formal venture capital has to a large extent shifted its focus from early-stage, high-tech (and high-risk) investments; this type of financing is often a gateway to other types of financing-bank financing, government support programmes, and other equity investments. The hands-on character of the investment often provides the firm with an upgrading of competencies, especially with respect to management skills. Initiatives supporting the functioning of the informal venture capital market are unlikely to suffer from dead-weight effects. The cost per job created easily compares with that of other initiatives. Displacement effects, the redirection of activity from equivalent or otherwise economically beneficial activities, is likely to be low (there are, of course, also drawbacks). It was pointed out that, at least in the U.S, there may be complementarity between informal investors and formal venture capital firms. Whether such complementary relationships exist elsewhere than in the United States is, however, uncertain. But if they do, the policy implications are immense. The most obvious implication is that current attempts to boost formal venture capital markets in Europe-now seen in many countries-may seem successful in the short run. But long-term efficiency is accomplished only if dual initiatives are taken to promote both the informal and the formal venture capital industry and in particular the interplay between informal and formal investments. In fact, coupling formal venture funds with informal investors could be a method to redirect some of the formal venture funds towards "classic" venture investments. The advantage would be that private investors may contribute substantially to management expertise and partly to monitoring, thus reducing fixed costs for the formal venture capital firm. Policy formulation and research should go hand in hand on this issue. One of the things to explore is the specific way informal venture capital markets could be developed in accordance with the specific national or regional context. Business angel networks and other policy options are sensitive to such national and regional contexts. - Financial Organisations Should Be Involved in Network Policies: A number of policies throughout Europe have focused upon initiatives to establish or enhance networking between private firms and organisations specialised as consultants on technological development and diffusion. Also, at the EU level these policies have attained interest. It has generally not been the case, however, that financial organisations have had a formal role in these networking policies. It should be considered if and in what way financial organisations - including EU funding sources like the European Investment Fund-could contribute. Obvious benefits are improved knowledge of the markets and possible synergies with other firms and financial organisations (one financial organisation may be the gateway to other financial organisations or markets). Involvement of financial organisations in different types of network policies may thus alleviate some of the problems of assessing and trusting not only the technology in question, but also especially the persons and firms involved.

The first policy implications derive from the findings that major differences among technologies exist in the dynamics of transition. These differences are closely related to the main characteristics of technologies or sectors. In certain technologies or sectors, the type of knowledge base and the specific conditions of opportunity, appropriability, and cumulativeness of innovation (the so-called "technological regime") led to a major role played by large firms diversifying into new technologies. In other technologies, new firms and new innovators represented the driving force of change. Thus policies of support for a rapid transition should take into account these differences. In the first case, policies targeted to support the large established firms in their transition process may be inappropriate because they may run into antitrust and competition problems. Policies of human capital formation or standard setting, however, could be appropriate. On the contrary, in the case of transition with a major role played by new firms, policies that support entry may be appropriate. In this case, however, it has been shown by ISE research that a top policy priority should be to help new innovators to overcome key obstacles after innovative entry has occurred. These obstacles take place during the first years after entry has occurred and are related to problems concerning assets that are complementary to technology and innovation (such as financing, human capital, and management). Second, the other policy implications derive from the findings of an interaction between technology specific factors ("technological regimes", rather invariant across countries for a specific technology) and national innovation systems (similar for all technologies in a specific country). Here, policy has to assess the specific role of the institutional setting and the national innovation system in the modification of the patterns of sectoral innovative activities (in terms of relevance of new innovators, large established firms, and so on) along the way most adapt and tuned to the specific technological regime. When policy-makers try to modify the patterns of sectoral innovative activities, they need to periodically asses the specific roles of the institutional settings and the national innovations system so that, over time, they adapt and stay tuned to the developments in the different technological regimes. Third, the existence of strong relationships between technological innovation and industrial dynamics suggests that policies which aim at affecting the birth and mortality rates of firms should take into account the role of technology and innovation in firms' survival. Whenever governments aim to increase the entry rates within a given industry (or to enhance small firms survival probabilities), the best policy target is not gross entry rates (which is always very high), but net entry rates (which depend upon new entrants survival probabilities in the short run). Since such probabilities are critically affected by firms capabilities of developing technologies up to a viable level, a top policy priority should be to help new innovators (e.g. firms which enter the market and soon register a patent) to overcome major obstacles when they try to build upon their initial innovation. Fourth, some implications also refer to innovation and diffusion policies for SMEs. These policies should recognise that firms are highly heterogeneous, with only a few ones being likely to survive in the medium and long run, as a consequence of their different technological bases and skills. This implies a high degree of heterogeneity in firms responsiveness to innovation and diffusion policies. Therefore generalist policies (i.e. policies which aim at increasing the degree of innovativeness or the adoption of new technologies by all firms in a country, region, or industry by means of non-selective mechanisms for financing innovation efforts or providing technical assistance) may end up channelling a large amount of resources towards firms, which would be doomed to fail anyway. Selective policies (i.e. policies which target a small number of beneficiaries) would on the contrary face the problem of selecting a priori the most promising firms (i.e. firms with the better technological capabilities or the most promising growth and survival probabilities). This task, however, would require an advanced level of competence, which rarely can be found in any policy body. Thus, a trade-off between the two kinds of policies can be envisaged. It is very difficult to find ex-ante an effective solution to this trade-off. The variables that the policy-maker should consider include the specific features of the technologies or sectors mostly affected by these policies, the amount of available resources, the age and entry dates of the SMEs, and the competencies of the policy bodies. Fifth, whenever resource scarcity necessitates a choice between policies aimed at large established innovators -the core- and policies aimed at new innovators - the fringe-, this choice has to consider the specificities of the technology. In fact, the findings of this sub-project have shown that the relative contribution of core and fringe firms to innovation differs widely from technology to technology. If the policy objective is the overall growth of national expertise in a given technology, then the type of firms to support is closely related to the specific features of that technology. On the contrary if the policy objective is to support a specific type of firm (either large established firms -the core- or new entrants -the fringe-) then specific technologies have to be selected. These technologies are the ones where either the importance of the core is great or the survival probabilities of the fringe firms are high. However, the papers also found that all countries which develop a major international strength in a given technology host a relatively large core of innovators. The opposite happens in countries which are weak in a technology. This observation suggests that technologically weak countries should focus their efforts on building up and consolidating a core of innovators. At the same time however, our research shows that technological and industrial dynamics is to a large extent irreversible: the growth of a core of innovators depends crucially upon the date on which firms started developing competencies in a technology. They show the relevance of policy for the development of a strong technological base (and the growth of two core firms such as Ericsson and Nokia) in the mobile telephone industry in Sweden and Finland. At the same time, though, they show how these efforts occurred very early in the history of the industry, this being a key of their success. Thus a major policy question is related to the way technologically weak countries should develop their core of innovators in specific technologies. This process being long and cumulative, timing and the amount of resources devoted to this goal are very important. This may be quite difficult for latecomers and small countries. Sixth, policies aiming to support new innovators - the fringe - should take also into account the specific relationship between large and small firms in different technologies and different countries. Following the above discussion about the interaction between sectoral specificities (cross-countries sectoral invariances due to technological regimes) and national specificities (due to national systems of innovation), this relationship may differ from country to country as a consequence of the characteristics of the industrial structure, the competitiveness of large firms and the institutional setting. For example, given the fact that new innovators are very important in biotechnology, the relationship between new innovators and large firms is quite different in the United States and in Europe, and the policy implications have to take these differences into account. Moreover, in many cases small innovators do not exit the market because of failure, but because they are acquired by large core innovators. In many cases this is a sign of success. This suggests then that being absorbed by the core innovators may be one of the main long run objectives of a SME. This observation adds further support to selective policies rather than to generalist policies. Selective policies are better equipped to identify the causes of disappearance of individual firms and to take them into account when their purpose is to support small firms survival. Seventh, a final suggestion refers to policy and policy capabilities. The policymakers choices and actions to support or direct firms' efforts is characterised by trial-and-error and by success and failure. No public body holds a "superior" knowledge, which may channel firms innovation strategies in the right direction. False starts and dead ends are common. This implies both the need to evaluate policy results in the long run, and the need to pursue more technological options at once.

An innovation system perspective on economic policy implies, roughly, that policies should emphasise dynamic efficiency rather than static efficiency and explicitly try to improve the performance of the relevant systems of innovation. The performance of a system of innovation reflects how the system functions as an environment for the evolution of economically useful knowledge-how it produces, distributes, and utilises such knowledge. It reflects technical, organisational, and institutional learning, which are the main sources of innovation. There are close connections between the performance of the different national systems of innovation and the European system of innovation. Since a European system of innovation still only exists rather selectively and in the narrow sense of the term, it may be premature to evaluate its performance. It should also be noted in this connection that an improvement in the performance of the European system of innovation primarily becomes evident through the improved innovation performance of the firms in the individual member countries and thus as improvements in the performance of national systems of innovation. Innovation policy is here defined as those parts of economic policy that are concerned with improving the performance of systems of innovation. There are at least two characteristics of innovation policy to be taken into account. First, innovation policy should be regarded as a process of policy learning. Continued weak macro-economic performance in many countries in combination with theoretical doubts about the efficiency of fiscal policy and new types of institutional restrictions on the policy options in Europe increasingly force innovation policies onto the agenda of economic policy. Gradually, and in interaction, the theories, practices, and institutions of innovation policy develop and become a permanent and natural part of economic policy. Second, there is also unintended policy in connection to innovation. Policy decisions in the fields of labour markets, education, social security, income distribution, etc., as well as traditional fiscal and monetary stabilisation policies strongly-but in the form of unplanned side effects-influence the production and diffusion of new knowledge in the economy. The implication is that the policy-makers should be more aware of the important indirect effects their policies may have on innovation and that inter-ministerial co-ordination is necessary in connection to innovation policy. In the report, five types of innovation policies are identified: 1. Policies to develop and strengthen the knowledge infrastructure. 2. Policies to develop some basic, formal as well as informal, institutions that affect interactive learning. 3. Policies to create specific organisations that support innovation activities. Policy types 1-3 can be termed framework condition policies. They work indirectly by contributing to a better environment for processes of learning and innovation. 4. Policies directly and selectively supporting the development of science and technology (RTD policy). 5. Public technology procurement policy. These policies are sensible from a systems of innovation perspective. They all potentially support different kinds of learning processes. However, they could be targeted much more directly at interactive learning than is the case today. Procurement policies could be used more systematically to shape patterns of user-producer interaction. Government support of R&D could be connected to organisational as well as technical learning and, especially, to the interactions between organisational and technical change. The knowledge infrastructure and intellectual property rights could be developed to support research and development co-operation, etc. Today, the policy mix still puts too much weight on R&D subsidies and the idea of supporting nodal points and strategic patterns of interaction within systems of innovation does not yet seem to have been understood by policy-makers. Furthermore, all these types of policy could be systematically monitored from a policy learning perspective and they could be better co-ordinated and sometimes integrated with education policy, labour market policy, employment policy, etc. In addition to these five types of established innovation policy, there are two yet unexplored innovation policy areas, which follow from the innovation systems perspective. First, innovating firms interact with each other in complicated and changing networks of users and producers, of sources of labour skills, finance, knowledge and so on. It is an important task for innovation policy to identify and support important interconnections and nodal points in these networks. Second, innovation policy should pay attention to the learning and innovation capability of firms. This implies giving organisational and management aspects increased attention. Further, it implies that policies to promote innovativeness of firms should be combined with policies, which develop human resources and support changes in work content and the upgrading of skills and competencies of employees. Innovation policy-makers should recognise that what is required are often combinations of technical, organisational, and sometimes, institutional innovation. The policy implications above apply to national systems of innovation. What are the possibilities for an innovation policy learning process at the European level? What are the prospects for the five types of innovation policy? - Policies to develop and strengthen the knowledge infrastructure can be fruitfully developed much further on the European level than is the case today. - Policies to develop some basic institutions which affect interactive learning have been pursued for some time. Development and harmonisation of intellectual property rights, for example, are feasible fields for Community action. - Policies to create specific organisations that support innovation activities take longer time to develop. There is more scepticism and resistance in different member countries to these kinds of somewhat more visible policy instruments. To build a completely new organisation will always raise questions about its necessity as well as its physical localisation. - Policies directly supporting the development of science and technology (RTD) will probably continue to expand. However, the existence of underlying system diversity poses important challenges for RTD policy at the European level; diversity implies that policy actions will have widely different effects according to the nature of innovation systems and production structures at national and regional levels. The pursuit of policy programmes in this field leads to such strong inter-European informal network building that it will seem more and more natural to finance increasing amounts of R&D support over the community budget. The informal network building is thus an important effect of formally coordinated European research co-operation. - Technology procurement policy is a less obvious community activity in the sense that European policy-makers probably will stick to rule-making and leave the actual procurements to member countries. By co-ordinating some very expensive procurement programmes at the European level, it may, however, be possible to avoid some unnecessary duplication of research activities. This concerns primarily technology procurement as opposed to off-the-shelf procurement. All five kinds of community innovation policy discussed here will affect the member countries unevenly. This is a consequence of persistent differences between countries in terms of income levels, institutional set-ups, and specialisation patterns. Given the lack of convergence between European countries in these respects, it is impossible to design a European innovation policy, which is neutral in the sense that it does not favour some countries more than others. There is thus a risk of violating the principle of cohesion. Finally, the report raises the question of different main directions in the process of policy learning. Which are the alternative visions and strategies that can be pursued in the development of a European innovation policy? Is building systems of innovation an option? In that case, should the policy support particular selected national innovation systems or should it try to support all of them? Or should the efforts be concentrated on building European systems of innovation, maybe concentrated to particular aspects of it and maybe coordinated with particular national systems of innovation to form a kind of system of systems or a co-ordinated system of innovation? Questions like these follow naturally from the systems of innovation approach. To formulate policy aims in relation to national and European systems of innovation raises all the difficulties inherent in the idea of planning for innovation. There is no such thing as an optimal system of innovation (and even less an optimal system of systems). The best one can do is to, step by step, develop common infrastructures and institutions: for example, co-ordinate R&D and education and training; strengthen different communication channels; increase the production and distribution of information; help build networks; take initiatives to establish institutions for discussion and exchange of information and ideas between different actors in the process of innovation (entrepreneurs, labour market organisations, researchers, policy-makers, venture capital organisations). Such an approach might be called indicative planning in a European system of innovation, i.e. building and using information and interaction infrastructures and institutions, and is thus to be considered as a necessary part of a process of innovation policy learning.

Growth: On the basis of the analysis presented in the paper on growth, only fairly general policy implications can be drawn since the paper is primarily theoretical. Cautious interpretation is called for. The Systems of Innovations approach seeks to identify the sources and determinants of innovation. So far this approach has not had much to say about how innovations translate into economic growth; it is more a theory of innovation than a theory of growth. The so-called new growth theory, on the other hand, has only a primitive and biased way of treating technical and organisational innovation. A complete growth theory should include a sub theory of the sources and processes of innovation as well as one of how innovation induces growth. This is simply because innovation is the most important source of productivity growth. Therefore, the systems of innovation approach may be seen as a complement rather than a substitute vis-a-vis new growth theory. Formal growth models have always been built without giving much thought to the institutional framework of the economy. Endogenous institutional change is much more difficult to model than endogenous technical change and this has induced a bias and flaw into production function centred formal growth theory. The main contribution from the systems of innovation approach to growth theory lies in its emphasis on the importance of institutions and institutional change and especially in the focus on interactions between institutional, organisational, and technical change as the basic source of growth. Therefore, the main policy implications are that the most important thing is to get the institutions right in a policy of stimulating growth. Designing and implementing changes which continuously support technical and organisational learning and innovation is the same thing as a more or less permanent process of institutional learning. With this as a guide-post, it is crucial to study in detail the role of various specific institutions - like laws, norms, rules and routines - for innovation, and thereby for growth. Institutional framework conditions are crucial. For policy-makers, who try to stimulate growth by supporting innovations, the focus should be on designing and implementing institutional changes that continuously support technical and organisational learning and innovation, i.e. they should try to implement a more or less permanent process of institutional learning. Employment: The implications of the scientific findings for government policy with regard to innovations and employment can be summarised in the following points. - Employment policies need to reflect the differences between those sectors highly concentrated on process innovations and those highly concentrated on product innovations. If a country (time period, firm, or region) is characterised mainly by process innovations (technological or organisational), the tendency is for employment to decrease. If product innovations dominate, there is an opposite tendency of increasing employment. - A reallocation of resources from process to product innovation will generally have positive employment effects. An example is policy that identifies and strengthens those manufacturing and service sectors where product innovation dominates over process innovation, namely those with a high R&D (knowledge) intensity. Such a policy would support structural change in the economy in the direction of new sectors. (On the whole, these sectors are characterised by higher productivity and higher productivity growth, and therefore can carry higher wages and profits. They are also characterised by more rapid market growth than are other products.) Such a policy of structural change would increase employment in the long run. - However, technological and organisational process innovations should not be stopped or hindered in any firm, region, or country. While employment problems can be solved by decreasing productivity in the short term, in the longer run such a policy would have devastating consequences. Productivity growth is the main source of increased material welfare, and competitiveness (of the firm, region or country) depends on productivity growth. Those that attempt to avoid process innovations will end up lagging behind, with deteriorated prospects for gaining material welfare. - Any policy that gives priority to employment generation over productivity growth by preventing process innovation will fail, partly because competition normally requires that potential increases in labour productivity be exploited in the long run. - Policies for increased employment shouldceteris paribussupport more capital-saving types of organisational process innovations rather than more labour-saving ones. As Europe seems to have become locked into a technological trajectory or growth pattern that is predominantly labour-saving, the employment intensity of growth is relatively low. For this reason, a policy supporting structural change in the direction of more R&D-intensive and less process innovation oriented sectors is called for more in Europe than in the United States and Japan. The present European trajectory will lead to increasing competition with Eastern Europe and advanced developing countries. This trend has continued for at least two decades without being corrected by market forces. There is thus a strong justification for considering policy intervention. Government policy in this field should be thought of as a matter of emphasis between supporting process innovations and supporting product innovations. More specifically, policy can attempt to dissolve situations of lock-in into sectors dominated by process innovations and to facilitate (or support) structural change in the direction of sectors where product innovations dominate. Stimulating R&D-intensive and less process-oriented industrial sectors is important. Stimulating service sectors with a high level of product innovation and those with relations to innovative manufacturing sectors is also important. Governments faced with an economy with an employment problem should consider these options.

Most of the innovation policy instruments available refer to the supply side of technological change, such as R&D subsidies, the improvement of the technological infrastructure, or the encouragement of innovation networks. However, developing demand-side policy instruments is equally relevant for European and for national innovation systems. Examples of such instruments are public technology procurement, laws, regulations, standards, and related institutions, which help to shape the demand for technological solutions. Two main dimensions of EU policy - and national government policy - regarding public procurement and its effects on public technology procurement conducted at the level of individual member states can be identified: - The first of these dimensions concerns the regulatory aspect of policy - i.e. the creation of rules governing public procurement, including public technology procurement. Here a relevant question is how the new EU procurement regulations affect the role of national agencies involved in technology procurement. - The second dimension concerns the strategic aspect of policy-i.e. the actual practical use of public technology procurement as an instrument of innovation policy. The research conducted by the ISE sub-project on public technology procurement as a policy instrument provides the basis for developing a critical perspective on current EU policy regarding public technology procurement. The theoretical and research literature reviewed, together with the analysis of the case studies, indicates that successful examples of developmental public procurement aimed at achieving important technological innovations typically build on and bring to fruition longer-term innovation trajectories involving close collaboration and interactive learning between users and producers. To establish such trajectories, a number of important preconditions must be met, through a variety of policy instruments. Market regulation, competition policy, industrial policy, and the mandates of public agencies must combine to produce a competitive environment providing strong incentives for both public agencies, as users, and private firms, as producers, to invest in the development of new technologies. Through policies supporting scientific research and technological development, poles of competence have to be brought into existence in economic sectors of major importance. Further, through the sectoral organization of firms and public agencies that can function in relation to industry as focal organisations, frameworks for learning have to be established that will allow for the development of balance and complementarily between user and producer competence in the new technologies. We can relate the findings and conclusions from the ISE case studies on public technology procurement to the current EU policies on public procurement by referring to the two dimensions of policy that were introduced and explained at an earlier point in this discussion. The first of these dimensions was identified as the regulatory aspect of policy. This concerns the rules governing public procurement, including public technology procurement. The second dimension was identified as the strategic aspect of policy. This involves the use of public technology procurement as an instrument of innovation policy. The findings of the project indicate that innovative public technology procurement relies on institutional and organisational arrangements that allow for close relationships and interactive learning between public agencies and their suppliers. Interactive learning is fundamental to innovation in the context of public technology procurement. Some clear policy implications follow from this basic and centrally important finding. Most concern the regulatory dimension of policy, but there are also some related considerations about the strategic dimension. With respect to the regulatory dimension of policy, the main lesson to be drawn from the findings of the ISE sub-project on Public Technology Procurement is clear. The rules and laws designed-by national governments and the European Commission - to govern the relations between procurers and suppliers must allow for close interactive learning between them. They must certainly not be confined to arms-length market relationships. This has radical implications with regard to existing regulation at the European level, which currently does not recognise the need for such interaction, except in a negative way. EU procurement rules have, it is true, allowed for the continuation of user producer interaction in public goods markets through certain special tendering procedures, allowable exemptions from the regular procurement rules, and a flexible regime of enforcement. This has been done, however, without an explicit policy rationale-only the implicit understanding that these are necessary accommodations of national and sectoral interests. Hence, for the benefit of innovation, the regulations should be changed. In a positive way, the regulations should be changed to encourage, stimulate, and spur interaction between procurers and suppliers in fields where public technology procurement is appropriate. More direct EU action in public technology procurement could have two objectives. In the first place, it could help in co-ordinating and catalysing (well or weakly articulated) national actions. A decided EU action in this sense could have the benefit of avoiding duplication of efforts undertaken at national levels, as discussed earlier (i.e., the 15 train systems). A second role for direct EU involvement in this area could be to complement the actions already undertaken under the EU innovation policy strategy. EU innovation policy has been criticised on several occasions for being too supply side -oriented. The introduction of EU-wide technology procurement tenders would certainly stimulate technology development in some concrete technological areas with large potential for European industry as a whole. Needless to say, the role of a hypothetical EU agency for that purpose should be based on the idea of working as a catalyst, with a strategy combining development-oriented and adaptation-oriented tenders, and encouraging cross- European co-operation among firms as a requisite for obtaining the contract.

The following policy implications can be drawn from the analysis in this subproject: - During the development of the two science-based areas analysed the science base of the fields broadened in the sense that more scientific disciplines became involved. To support this development, broad, open and flexible policy instruments seem to be adequate. In addition, this observation raises the general question of the relation between policy instruments supporting linking and networking activities and policy instruments supporting fundamental research activities. The challenge is to design the optimum ratio between these two types of instruments for the respective science/technology area. - The statistical data point to strong interrelations between the different phases of the innovation process leading to different patterns of development in the two cases. In particular, the interrelation between the characteristics and possibilities offered by the technology at a certain stage of development and market requirements and demand seems to be an important factor in shaping science/technology development. This points to a dilemma of potential policy interventions: On the one hand, policy instruments supporting a broad approach towards the technological areas of interest seem to be useful. On the other hand, such a broad support and approach might conceal the discussed feedback mechanisms. This leads to the more general question of significance, timing, and interrelation between the following elements: creation of variation, selection of best-suited options, and shift towards exploitation. Questions of variations and selection in particular are able to influence the innovation process. On the one hand, very strict selection processes can lead to a lack of progress and innovation while too weak selection can lead to inefficiency because of too much experimentation. In terms of policy implications, this indicated the need of having a mix of instruments available which allows these systems' elements to be tackled in an optimum way. A crucial issue in this context is the question of direct intervention versus setting frame conditions. It should be pointed out that this discussion does not necessarily mean that intervention (direct or indirect) is the only option. No intervention may turn out to be the best option in certain cases. Similar problems are relevant within large pharmaceutical companies. During the process of drug development, the focus of activities has to switch at a certain point from more exploratory research activities to concentrated testing and developing of a particular drug candidate. A key success factor for pharmaceutical companies is to find the optimum balance between these two types of activities. Therefore, selection mechanisms are of paramount importance. - During the development of the science-based technologies considered here, there is a significant overlap, not only between different research stages but also between different stages of the process as a whole. Policy instruments are needed which target different phases of the whole process. Since quite often there is a rather clear division of responsibilities among policy-makers, the question of interrelation and co-ordination between the different policy responsibilities is important. In addition, within a certain responsibility different types of instruments may be needed, leading again to the question of co-ordination and interrelation between the policy actors responsible for the different types of instruments. - With respect to the question of national versus European policies at least two issues need further discussion: -- The results point to the significance of international interdisciplinary networks. This brings up the question of whether it is possible to identify a type of "division of labour" between national policies and European policies, in the sense that national policies are more deeply rooted in supporting disciplinary research while European policies tend to support interdisciplinary activities more intensively. This would indicate the importance of the role of European policies for the development of science-based and interdisciplinary technologies. -- On the other hand the international design of policies could also become a certain impeding factor for innovativeness. The argument is as follows: if the original source for innovative ideas is linked mainly to individual players, then the need to form international R&D consortia could lead to a certain levelling out of individual innovative forces. - Interpersonal links and social networks play an important role in initiating and sustaining interdisciplinary co-operations. The question is whether and how policies could support the formation of such social networks. Direct approaches seem to be very difficult since they require a profound knowledge of "know-what", "know-why" and "know-who" which is hardly accessible from outside the research community. Indirect approaches like providing for a for dialogues between the actors or supporting mobility and exchange of researchers might be easier to follow. - There seem to be inherent and pronounced differences in the patterns of development of science-based and interdisciplinary technologies. This points to the notion that it would be very difficult to define best practice policies for science-based technologies. - As an impeding factor for interdisciplinary research networks, the disciplinary-oriented career schemes in public organisations in general and in universities in particular have been identified in some of the analysed countries. Therefore in those cases, integrating interdisciplinary components into academic career schemes is an important policy issue. - Public procurement seems to be a difficult policy instrument in interdisciplinary and science-based technologies. At least the two cases studied here indicate that both the technologies per se and the organisational context, in which innovations take place, are extremely complex. Under these conditions, public procurement instruments must be able to draw on a strong expertise in the technologies under consideration and their organisational contexts, which might be a difficult challenge.

The two reports in this sub-project. Systems Approaches to Innovation: Overview and Policy Issues and Public Policy and Industrial Dynamics: an Evolutionary Perspective have closely related approaches to exploring the scope, foundations, and objectives of public policy. Within orthodox theory, policy is based on problems in achieving an optimal (static) allocation of resources. These papers adopt a more dynamic approach based on the problems involved in a more detailed and realistic approach to learning in firms and industries; they therefore seek to identify problems or failures which might arise in the dynamics of learning, especially where such learning is interactive in character and where path dependence produces problems in adaptation and flexibility. Here, we outline the basic approaches of the two reports in turn. Systems Approaches to Innovation: Overview and Policy Issues This paper addresses two broad policy questions, namely: - The rationale for policy action: What is the underlying justification for policy intervention, and do these justifications throw any light on the general scope, objectives, and methods of policy? - Policy capabilities: In a systems context, what competences, skills, and resources do policy-makers need, and to what extent do these differ from current views? Rationales for policy action: The report argues that four types of failure can emerge in systems contexts. These are: - Failures in infrastructural provision and investment. Two types of interaction between firms and infrastructures are important within innovation systems: first, with physical infrastructures usually related to energy and communications; second, with science-technology infrastructures such as universities and publicly-supported technical institutes. The paper argues that infrastructural support is an important but neglected issue at the present time. - Transition failures and lock-in failures. Dynamic learning processes imply that from time to time there are more or less major discontinuous changes in relevant scientific and technical knowledge bases. The phenomenon of lock-in implies major adaptational problems for firms, industries or even whole economies. The paper argues that an important role for policy lies in identifying such shifts and facilitating adaptation by firms and industries when they occur; this is particularly important at the present time when major shifts in generic knowledge bases are occurring. - Institutional failures. System approaches place considerable emphasis on institutional and regulatory frameworks as promoters or obstacles to innovation. For example, the operation of the market for corporate control changes the time horizons of firms, with important implications for their abilities to invest in the intangible assets, which are central to innovation capabilities. The report argues that such frameworks ought to play a more central role in general innovation policy. - Policy capabilities The report argues that adopting an approach to policy based on systems concepts and more nuanced understanding of the diversity of learning places considerable new demands on the knowledge that is required for policy itself, both in terms of policy formation and policy implementation. The relevant knowledge affects at least the following areas: - The assessment of system specificities, where policy-makers require a more detailed grasp have scientific, technological, and organizational specialisations. - The understanding of relevant knowledge bases, where policy-makers need a closer understanding of the direct and indirect knowledge inputs to industries. - The assessment of system dynamics, particularly those related to discontinuous changes or shifts in technological paradigms. - System co-ordination within the policy field itself, particularly between policy arenas that are at present rather uncoordinated (such as links between macro-economic or financial policy, and the dynamics of the innovation system). Public Policy and Industrial Dynamics: an Evolutionary Perspective The report focuses on the main evolutionary traps, trade-offs, and failures. From the evolutionary literature, the following principal problems are identified: - Learning failures. Firms may not be able to learn rapidly and effectively. - Lock-in traps. Industries may be locked into existing technologies and may be unable to jump to the new technologies. - Exploration-exploitation trade-offs. Some industries may be characterised by much exploration and experimentation and too little exploitation of what has been discovered. Others may be characterised by much exploitation, modifications, and incremental innovations and too little exploration and experimentation. - Variety-selection trade-offs. Industries may be characterised by much variety generation with weak selection processes or by tough selection with little variety generation. Tough selection may rapidly kill off variety, experimentation, and competition and lead the system into a one-view situation. Weak selection processes, on the other hand, may allow the persistency of too much experimentation and too many inefficient firms, thus blocking the exploitation of technologies. - Appropriability traps. Too stringent appropriability may greatly limit the diffusion of advanced technological knowledge and eventually block the development of differentiated technological capabilities within an industry. - Complementarities failures. The appropriate dynamic complementarities required for successful and sustained innovative activities may not be present within an industry or an innovation system. If they are present, they may not be connected, so that the positive effects from complementarities may not take place. In addition, the report emphasises that public intervention also may face problems. The government may not have the capability to carry on its tasks; it may misrepresent the specificity of the environment; and it may not have the long-term vision needed in the development of technologies or industries: it may lack the co-ordination abilities needed to organise and connect complementarities within a system of innovation.

One of the arguments of this project is that policy towards corporate governance is a key factor governing innovation and economic growth performance and deserves greater attention from policy-makers. One of the conclusions likely to emerge from this project is that there should be a more significant European level in shaping corporate governance systems and in deciding their content. Specific policy implications from the project are discussed above, in the fourth paper of this project. More generally, the policy implications are as follows. Corporate governance refers to the systems of law, regulation, and accountability that provide the institutional framework within which corporations are managed and controlled. Corporate governance is normally seen in terms of the problem of making managers responsive to shareholder interests. This project seeks to place the general issue of corporate governance into the much wider framework of economic development and growth. In the conventional framework, corporate governance is seen in terms of how to secure the interest of owners when corporations are in effect directed by professional managers; this is approached in terms of principal-agent problems, in which the market for corporate control secures the ultimate interests of owners and in which freely functioning equity markets - which place strong short-run profit objectives on managers - are a central economic mechanism and policy instrument. This project sees the problem in terms of innovation: how do corporate managers secure the powers and authority to organize firms and commit resources to learning (that is to make long-term intangible investments), and thus generate innovation-based growth? What are the long-run effects of different solutions to this question, and what are the policy implications? The approach of the project is to offer a comparative-historical analysis of economic development and international competition in the large advanced economies, in particular making a triadic comparison of Europe (meaning the United Kingdom and Germany in this case), the United States, and Japan. Against this background, it suggests two fundamental conditions that characterise the social organisation of innovation. One fundamental characteristic, which in the project is called organisational integration, is that the people involved in the process of organisational learning be willing and able to make their skills available and efforts to the pursuit of organisational goals. The other fundamental condition, which in the project is called financial commitment, is that the business enterprise has sufficient access to financial resources to sustain both the innovation process until it can generate returns and the business organisation so that it can engage in continuous innovation. The project argues that the different systems for meeting these conditions have very different long-term outcomes and play a large part in explaining different development trajectories for the countries concerned. The project suggests that this type of approach opens up the possibility for market-oriented policies that affect innovation capabilities and performance without direct intervention. However there remain strong differences between countries in terms of these systems at the present time, and harmonisation of corporate governance rules is already an issue in the EU. The main policy recommendation of this project will be that such harmonisation, which is both inevitable and desirable, should occur on the basis of conceptions of corporate governance which are founded on real, long-run innovation performance and not on the maximisation of short-run returns to stockholders. Many aspects of public policy-including especially the operation of stock markets and their impacts on mergers and acquisitions activity-over the past decade have in effect been aimed at changing systems of corporate governance. These changes, however, have not taken the organisational and innovation capabilities of companies into account. Policy-makers have not considered how policy measures aimed at improving efficiency (that is, market efficiency) might affect long-term asset building. This is a pressing problem because long-term asset accumulation is essential to develop organisational and innovation capability. From an innovation perspective, the basic criticism of the Anglo-American model of corporate governance is that it inhibits the creation of the intangible assets needed for good innovation performance. It forces managements into maximising short-term rates of return. In particular, managers do not have incentives for investing in workforce skills, R&D resources, design and engineering development and so on. These might be important in the long run, but in the short run they are current costs, which reduce current profitability. The German and Japanese systems have placed more emphasis on growth, on human capital development and on acquiring market share-short-term profitability has been seen as less important than long-term viability. The German and Japanese systems have been more focused on creating value; the Anglo- American system is more focused on extracting value from the firm. The choice between these types of corporate governance system will be a key issue for Europe in the future.

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