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Knowledge Economy Study

ECA Knowledge Economy Study: Public Financial Support for Commercial Innovation

Lead Author: Itzhak Goldberg
March 2006
This Knowledge Economy Study aims to offer policymakers from transition economies in Europe and Central Asia (ECA) options to increase and maintain productivity and growth by creating an environment conducive to the application of knowledge in the economy via innovation and learning. The tradition of excellence in learning and basic research in the ECA region provides some basis for hope that commercial innovation can be adopted and built “on the shoulders” of the past. Translating this research foundation into economically productive commercial applications, however, remains a critical missing link in transition countries. Against that background, this study focuses on public policies for building institutions and creating an incentives framework for the support of commercial innovation.

1. Introduction

This chapter defines the basic terminology of the report, such as innovation and absorption, to lay the groundwork for evaluating the rationale, financial instruments, and institutional requisites for effective public support for commercial innovation.

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2. Economic Rationale of Support for Commercial Innovation

With the extensive development of endogenous growth theory, economists came to accept the view that innovation, spillovers, and R&D were the key factors driving self-sustained, long-term economic growth and, moreover, that these factors were generated from within the economic system, responding to economic incentives There are two main sources of market failure with respect to knowledge creation: (1) partial appropriability (due to spillovers), and (2) information asymmetries. These failures inhibit private firms from investing enough in innovation and R&D, thus depriving the economy of one of the key levers for sustained growth.

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3. Instruments to Support Commercial Innovation

This chapter will first discuss the basic principles of instrument design and how these can be applied to ECA countries. It will review the basic type of financial instruments used in OECD countries, including grants, loans, tax incentives, and procurement preferences, and discuss their applicability to ECA countries. The chapter will then describe in detail the recommended instruments for the ECA region, including R&D grants and venture capital. The effectiveness of these instruments requires that key principles be taken into account in instrument design: (i) neutrality of intervention, (ii) institutional environment and (iii) additionality of funds.

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4. ECA's Institutional Framework for Public Support of Innovation

This chapter uses the national innovation system (NIS) framework and knowledge assessment methodology developed by the World Bank Institute to assess ECA countries’ readiness to apply innovation support instruments. Using the Knowledge Economy Index and a more in-depth analysis of the different pillars of the national innovation system, it classifies ECA countries into three different groupings related to the development of their NIS, identifying and prioritizing interventions targeted at specific bottlenecks in the NIS.

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5. Conclusion

The conclusion summarizes the discussion of the rationale for public support for commercial innovation, the review of the instruments and the principles of their use and the institutional requisites for public intervention.

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