Sei sulla pagina 1di 163
FINAL REPORT D RIVING FACTORS AND CHALLENGES FOR EU INDUSTRY AND THE ROLE OF R&D

FINAL REPORT

DRIVING FACTORS AND CHALLENGES FOR EU INDUSTRY AND THE ROLE OF R&D AND INNOVATION

Framework Service Contract

150083-2005-02-BE

Version 08.01.2007

Acknowledgements

Acknowledgements This draft report has been produced by the following ETEPS AISBL team: Dr. Carlos Montalvo

This draft report has been produced by the following ETEPS AISBL team:

Dr. Carlos Montalvo (team manager and report overall editor), Dr. Orietta Marsilli BSc Joost Hoogendorn Drs. Geert Jansen

Ir. Maurits Butter

TNO,

The Netherlands

Prof. Marco Vivarelli

Catholic University of Milan

Italy

Prof. Jordi Molas-Gallart

INGENIO, University of Valencia

Spain

Dr. Puay Tang

SPRU, University of Sussex

United Kingdom

Dr. Anette Braun

VDI

Germany

TNO, SPRU, Catholic University of Milan and VDI were responsible of providing inputs to task one. TNO, SPRU, INGENIO-University of Valencia and Catholic University of Milan, were re- sponsible of providing inputs to task two. In task three Catholic University of Milan provided a quantitative analysis to rank sectors of economic activities that facilitated the selection of three strategic sectors for Europe. TNO, SPRU and INGENIO-University of Valencia conducted the analysis in the sectors selected and explored the role of R&D and innovation.

The IPTS provided timely and constructive comments in the chapters that compose this draft re- port (Dr. Hector Hernández, Dr. Cristiano Cagnin, Dr. Fabiana Scapolo, Dr. Pietro Moncada, and Prof. Ron Johnston).

The responsibility of compiling and editing the report rested on TNO s Innovation Policy Group. The report has benefited from comments and revisions conducted by the following experts: Dr. Andrew Dearing (European Industrial Research Management Association), Ass. Prof. Dr. Enrico Pennings (Erasmus University Rotterdam), Dr. John van den Elst (Philips Applied Technologies), and Prof. Dr. Knut Blind (Fraunhofer Institute for Systems and Innovation Research).

Dr. Carlos Montalvo (team manager and report overall editor) TNO-IPG, Delft 08.01.2007

This report should be cited as:

Montalvo, C., P. Tang, J. Mollas-Gallart, M. Vivarelli, O. Marsilli, J. Hoogendorn, J. Leijten, M.

Butter, G. Jansen and A. Braun (2006). Driving factors and challenges for EU industry and the role of R&D and innovation, Brussels: European Techno-Economic Policy Support Network (ETEPS AISBL).

Formatted: Spanish

(Spain-Modern Sort)

(ETEPS AISBL). Formatted: Spanish (Spain-Modern Sort) Framework Service Contract 150083-2005-02-BE Driving

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

Page 2 of 163

Document Change Record

Document Change Record Issue Version Comments Date Change Affected Pages Release Framework Service Contract
Issue Version Comments Date Change Affected Pages Release
Issue
Version
Comments
Date
Change
Affected Pages
Release

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

Table of Contents Table of Contents 4 Background 8 Rationale of this study 9 Objectives

Table of Contents

Table of Contents

4

Background

8

Rationale of this study

9

Objectives and Methodology

9

Objectives Methodology and overall approach

9

9

TASK ONE:

11

Main driving factors that will shape the market in the world over the next 15

 

years

11

 

I. Introduction

11

II.

Demand side

12

 

2.1 Global challenges

12

2.2 Consumption trends

18

III. Supply side

23

3.2

Globalization

26

3.3.

Supply of new inventions: new research paradigms

28

3.4.

Supply of new economic multipliers: innovation waves

31

IV. Institutional side

35

4.1.

Increasing globalization in a context of innovation and rationalization

35

4.2

Intellectual property rights

35

4.3.

International outsourcing and the labour markets

38

4.4.

The role of organizational change

39

4.5.

Conclusion

40

V.

Emerging economies

41

5.1

India

41

5.1.1

Social Drivers

42

5.1.1.1. Demography

42

5.1.1.2. Life expectancy

42

5.1.1.3. Education: Improved literacy rate and the wide use of English

42

5.1.2

Economic Drivers

43

5.1.2.1.

Global IT boom and the foreign demand for outsourcing

43

5.1.3

Institutional Drivers

45

5.1.3.1. Central level

45

5.1.3.2. State level

45

5.1.3.3. Deregulation and privatization of industry

46

5.1.3.4. Trade Liberalization; Globalization

47

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

5.2. China 49

5.2. China

49

5.2.1.

Social drivers

49

5.2.1.1.

Reforming the Educational System

49

5.2.2. Economic drivers

51

5.2.3. Institutional drivers

52

5.2.3.1. Liberalization

53

5.2.3.2. Privatization and deregulation

54

5.2.3.3. R&D Expenditures and Developing Research Capabilities

55

5.2.3.4. Laws

57

5.2.3.5. Decentralization

58

5.2.3.6. Financial

58

5.3

Conclusion

59

TASK TWO

60

World markets trends: Implications for European Industry

Competitiveness

60

I. Introduction

60

1.1 Competitive process focus

60

1.2 Note on Methodology

61

II. Structural, organizational and sectoral composition

63

2.1

Introduction

63

Industry structure

63

Industry dynamics

63

Sectoral distribution

64

2.2 Demographic change

64

2.3 Supply side

65

2.3.1 Globalization

65

2.3.2 The service economy

65

2.3.3 The entrepreneurial economy

2.3.3 The entrepreneurial economy

66

2.3.4 Open Innovation

66

2.3.5 Supply of new inventions: new research paradigms

67

2.4

Institutional side

67

2.4.1 Intellectual property rights

67

2.4.2 Organizational change

68

III. Research, technological development and related requirements

69

3.1 Introduction

3.2 Climate change, environmental degradation and over-exploitation of natural resources69

69

3.3 Ageing population and changing health care concerns

70

3.4 Changing diets and healthier food

71

3.5 Increased demand for transport services

72

3.6 Epidemics and pandemics

73

3.7 Terrorism and pervasive insecurity

73

IV. Human resources, skills, labour market conditions

75

4.1 Globalization and technological change employment impact

75

4.2 Employment and new technologies

76

4.3 Innovation, globalization and skills: challenges and possible solutions

77

3.4 Skill bias and increasing wage inequality

78

3.5 Innovation, organizational change and human resources management

79

V. Localization of economic activities

81

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

5.1 Introduction 81 5.2 Population ageing in Europe 82 5.3 Energy 83 5.4 Mobility and

5.1 Introduction

81

5.2 Population ageing in Europe

82

5.3 Energy

83

5.4 Mobility and trade

84

5.5 Off-shoring, trade and environment

84

5.6 Knowledge infrastructures and innovation science

85

5.7 Emerging economies

85

VI. Investment attractiveness

86

6.1

Introduction

86

6.1.1

Determinants of investment

87

6.2 Pull factors: Social and economic environment

88

6.3 Pull factors: Institutional structures, practices and policies

89

6.3.1 Institutional structures and practices

89

6.3.2 Policies and regulations

90

6.4

The push factors: policies of the investing country

91

VII. Summary

92

Conclusions and policy implications

97

1. Introduction

97

2. Patterns of drivers and challenges for European competitiveness

97

3. Policy implications - The role of R&D and Innovation policy

101

References

104

Annexes

116

Annex 1. Task three - Strategic Industrial Sectors for the EU

116

A1.1. Health Sector

Telemedicine

117

A1.1.1 Introduction

117

Telemedicine technologies

117

Telemedicine services

118

A1.1.2. Main drivers affecting the sector

119

Ageing 119 Increasing demand

119

Cost savings

120

Obstacles 120 A1.1.3. Market trends

122

Sector composition

122

Service economy

122

Institutional and organizational change matters

123

A1.1.4. The role of R&D and innovation

125

A1.2 Transport sector: Aeronautics

126

A1.2.1 Introduction

126

A1.2.2 Main drivers affecting the sector

127

Globalization

127

The environment

127

Security

128

A1.2.3 Market trends

128

Sector composition

128

Service economy

129

A1.2.4 Institutional matters, organizational change and research priorities

131

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

A1.2.4. The role of R&D and innovation

A1.2.4. The role of R&D and innovation 132 A1.3 Environmental sector 133 A1.3.1. Introduction A1.3.2. Environmental

132

A1.3 Environmental sector

133

A1.3.1. Introduction A1.3.2. Environmental technologies A1.3.3. Market trends Sector composition A1.3.4. Main drivers affecting the sector

 

133

134

135

135

136

A1.3.5. Institutional matters, organizational change and research priorities Industrial classification of the environmental sector

matters, organizational change and research priorities Industrial classification of the environmental sector 137 138

137

138

Competition in the markets or

for the markets

 

138

How clean is clean enough? A1.3.6. The role of R&D and innovation

138

139

Annex 2 Method to explore and screen challenges and drivers

141

Conceptual method to screen foresight studies Organization of information gathered

141

142

Annex 3 Summary of global drivers

   

144

Table A3.1. Demand side - Overview of global challenges Table A3.2. Demand side - Summary of global consumption trends Annex A3.3 Demand side - Summary of consumption trends in European Union Annex A3.4 Supply Side: Changes in industrial organization Annex A3.5 Supply side: Overview of paradigm shifts Annex A3.6 Supply side: Overview of innovation waves Annex 3.7 Summary Institutional Side: Key Future Drivers Annex A3.8 Summary of China s Drivers for Growth Annex A3.9 Summary of India s Drivers for Growth

144

145

146

147

148

149

150

151

152

Annex 4. Sectors ranking on production, employment and exports

154

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

Background According to industrial economist theorists what determines and structures global industrial or- ganization in

Background

According to industrial economist theorists what determines and structures global industrial or- ganization in the last three decades resume to few large forces that have their own internal dy- namics:

- New technologies that enable the relocation and control of distant industrial operations (in- cluding R&D) and the creation of new markets for mass and customized mass production;

- Flexibilization of labour and regulation (fiscal, product, safety, health, etc.);

- Deregulation of capital flows so that specific industrial operations can be considered as cost/profit centres, thus facilitating foreign direct investment and fast relocation (or re- assignment) of industrial activities.

These three global drivers have led to changes in global patterns of industrial production and posed great challenges for industries and countries with a low proportion of their domestic capital engaged in the international production of goods and services. For those economies whose firms are able to operate at the global level, these drivers have enabled not only to benefit from global efficiencies but also to profit from rapid innovation and fast changing markets. So currently, na- tions (in some instances trade blocks) compete in several fronts not only to conquer new interna- tional markets for final and intermediate goods but also to retain critical industrial sectors that work as multipliers of their national economies.

It is clear that next to the above-mentioned generic drivers the nature and growth of markets (and this includes the level of regulations and restrictions) is a very important factor behind changing global patterns of industrial production. By way of a so far hypothetical example it could be ar- gued that until the internet bust of 2001 the most interesting markets in the world seemed to be in the US and Europe. Until then a major factor that seemed to govern global patterns of production was the costs of labour. The impact was considerable, but somehow the logic of the process was clear to everybody. But since the internet bust another factors seems to come into play, e.g. the fast growth of markets such as those in China and India. This poses a series of new challenges of which the outcomes for the global pattern of industrial production are largely unknown. It could be argued (but also this line of argumentation needs confirmation) that in general production fol- lows markets. And it could also be true for many good reasons to be found in the literature about interactions between R&D and production that R&D simply follows production.

Now it is well understood by policy makers in leading and competitive nations that the level of investment on knowledge infrastructures, R&D and innovation is strongly related to the current and future competitiveness of their industries. It is also well known that the creation of competitive edge is a long process of knowledge and skills accumulation at the societal level. Given the fact that economic resources are limited, the investments on innovation and R&D must be targeted in strategic areas that appear to promise to function as economic multipliers of economic activities. In the case of the EU, industry faces the challenge of not only remaining competitive in traditional sectors but to be the forerunner in new markets where the race and competition is done for the markets and not in the markets. Here R&D and technological innovation play a central role. But is solely raising the level of R&D, innovation and creativity sustainable? The inevitable ´hit-parade´ kind of markets and market structures that result (very few dominant successes) may very well meet explicit and implicit resistance as the number of failures is simply too large. Here there is a counter tendency as well: most industrial products are nowadays surrounded by and array of ser- vices without which they cannot function. This leads to pressures for industry to align with many partners (potentially contradicting the dominant neo-liberal market policies) in some sort of joint market strategies.

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

There are indications that the European industry is struggling with these challenges. Visions and policies

There are indications that the European industry is struggling with these challenges. Visions and policies at the national and at the EU level will most likely be an important factor in determining future outcomes.

Rationale of this study

This study is part of the JRC-IPTS activities to support the EU Policies concerned with industrial and technology strategies. EU policies have to address major challenges that are posed to the European industry. Issues such like productivity growth, international competition, knowledge management, reallocation of resources and structural changes. It is widely recognized that tech- nological progress can make a key contribution to deal with those challenges and thus there is the need to generate policies that are aimed at fostering the EU innovation and technological ca- pabilities.

In this context it is of fundamental importance to estimate the current and future policies needed raised by these challenges. However, the analysis of such issues is difficult due to the intrinsic uncertainty of the many factors involved and their complex effects. Therefore, it is necessary to conduct a comprehensive forward looking analysis to explore the future evolution of markets for goods and services. Such an analysis has to consider the internal and external dimensions, the interaction of supply structures and demand factors, including issues such as the influence of emerging economies, new technologies, scarce resources and demographic aspects.

This study will contribute to the identification of the key factors that will shape the development of scenarios to examine the evolution of markets in the next five years. This will be done in a follow up activity that will be conducted by the IPTS. 1 These key factors will include insights on possible challenges ahead in terms of globalization, localization of activities, infrastructure, technological know-how, human resources, knowledge generation, R&D and innovation. The idea behind the project is to exploit further available expertise at the JRC-IPTS, incorporating a forward looking dimension to generate a holistic picture that embeds all relevant aspects of the future of industry. The approach will also enable synergies between JRC-IPTS activities and allow the comparison of expectations on the future with current observed trends.

Objectives and Methodology

Objectives

This study will serve as a preliminary study for a more ample research that aims to draw the out- look of the EU industry in the long-term. In particular this study aim to fulfil two objectives:

To identify and analyse the main socio-economic and institutional driving forces that are likely to shape the markets in the world up to the year 2020.In particular this study aim to fulfil two objectives: To trace the links between these driving

To trace the links between these driving forces and the likely evolution of the European industry and the challenges that the EU economy will face in the future.to shape the markets in the world up to the year 2020. Methodology and overall approach

Methodology and overall approach

The analysis of the drivers and challenges that the European industry will face in the medium term implies the capacity to link determinants of competitiveness and competitive performance. Both aspects of competitiveness have been widely studied at the level of products, services, in-

1 Markets of intermediate goods and services.

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

dustrial sector, nations and regions. Despite this there is still no comprehensive theoretical frame- work

dustrial sector, nations and regions. Despite this there is still no comprehensive theoretical frame- work to analyse competitiveness. The state of the art in the field still resembles the story of the elephant and the blind man. The study is especially ambitious as it aims to link trends at the global level down to European and the sector levels.

The approach to the completion of the study is following. The study was based primarily on desk research and analysis. It builds on existing studies and has an exploratory nature. Specifically, the study build upon a review of the relevant literature of the past five years and on reports of past and current activities of the JRC-IPTS that deal with the future of manufacturing (e.g., Fut- Man and ManVis) and other studies that contribute insights on the performance and future of the EU industry (e.g., EU Industrial R&D investment scoreboard). The research conducted by the research team will be complemented with insights provided by a number of experts in different areas of enquiry relevant to this study (i.e., economics of technical change, industrial economics, international economics and prospective technology studies).

This will be done by requesting two types of inputs from leading scientific experts (for industry experts see point five below). The first refers to request references of the most updated and rele- vant literature in their field of expertise. The second concerns the review of the draft final report of this study and production of a short written report consisting of comments and suggestions to im- prove the final draft report. The same experts will be invited to attend a one day workshop to comment on the report findings. The analysis conducted will be mostly qualitative but comple- mented with quantitative information where available and appropriate.

In order to achieve these objectives, four tasks were conducted:

Task 1: Identification of the main drivers affecting the shape of future markets over the next 15 years; Task 2: Analysis of the implications of the insights gained in task 1 for the EU industry, in particular for its competitiveness; Task 3: Identification of industrial sectors of strategic interest for the EU and those particularly affected by the outcomes of tasks 1 and 2. Task 4: Organization of a one day expert workshop with the aim of constructively criticizing and validating the results of this research.

Each of three first tasks has a brief methodological discussion. The overall structure of the re- port is simple it consist of four parts. The first part corresponds to task one. It provides a set of definitions and trends on global challenges and drivers. At this point no conclusion or ranking of importance is given concerning the global drivers identified. The second part develops task two. It looks into a number of themes that define the competitiveness of a region or a country and makes an attempt of make a qualitative impact assessment of potential effects of global trends in the future competitiveness of European industry. Part three presents some conclusions and lessons learned from tasks one and two and from an analysis conducted in three sectors the analysis on lead markets in presented in Annex one).

the analysis on lead markets in presented in Annex one). Framework Service Contract 150083-2005-02-BE Driving

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

TASK ONE: Main driving factors that will shape the market in the world over the

TASK ONE:

Main driving factors that will shape the market in the world over the next 15 years

I. Introduction

World production and consumption systems and associated institutions are more than ever be- fore is a state of rapid flux, in which science and technology (S&T) play an important role, some- what similar to ancient oracles and magic spells. In the face of new regional and global trends the European economy must expect to face great challenges. In particular, its industry characterized by medium-advanced technologies (e.g., automotive, steel, textile and clothing, footwear, etc.) faces both threats and opportunities with the entry of new players in global production systems, and the emergence of new markets. The aim of this exploratory and qualitative study, based on desk research, is to map the factors that are likely to shape the world market over the next 15 years. In this report on global trends, likely drivers have been classified into three broad catego- ries that provide the structure for this report: demand, supply and institutional settings.

In section II we look at the demand side; international competition has brought better and cheaper products, and many sectors that are characterized by consumers are becoming more aware of consumer behaviour (i.e. their products must meet tight quality standards). Levels of consumption are likely to be affected by the degree of trust in the economy (individual and re- gional), lifestyle patterns, demographic developments, environmental awareness, etc. We con- ceptualize the demand side as producing issues that will need to be resolved by the supply and institutional sides. This section describes global challenges and consumption trends identified in the literature as highly relevant.

In section III, we describe the major transformations that have occurred on the supply side. We look at five major trends: the increasing role of knowledge as a source of economic value; the growing openness of the market system; the rising importance of networks and the interactions they promote; new scientific and technological paradigm shifts; and underpinned by the fourth transformation, emerging areas of economic activity and new business models. In section IV we

examine the institutional side; the frameworks within which industry operates could be affected by regulation, trade relations, labour, financial aspects, intellectual property rights (IPR) regimes, etc. Several trends can be identified, such as the increasing conflict between global markets and re- gional economies; the relocation of industrial activities including research and development (R&D), shift in foreign direct investment (FDI) to emerging markets, the growing importance of IPR, organizational changes and spill-overs and changes in labour markets and the race to the

bottom .

emerging economies, China and India. This section explores social, economic and institutional developments that will determine their full effect in global markets. Annex I describes the meth- odological approach followed to explore and organize the barriers and drivers identified in recent literature (2000 to 2006). In addition it provides how the research team conceptualized the sys- tem demand-supply-institutions and the level of aggregation utilized. Following the format pre- sented in Annex I, Annex II provides an overview of the trends and drivers which will be analysed further in task two.

2

Section V looks at developments that are already affect global markets, in two crucial

2 The race to the bottom refers to the efforts that some countries are taking to attract FDI (e.g., wage minimization, tax exemptions, decreased regulation, diminishing labour-union power, etc.)

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

II. Demand side

II. Demand side

This section looks at those trends where solutions are needed via the provision of services, and new social and institutional infrastructures from the supply and institutional sides. It examines global challenges in general and consumption trends in particular.

2.1 Global challenges

Global challenges are major cross-border issues that affect the whole of society . They are prob- lematic and their resolution requires careful discussion, appropriate measures and observation over several years. Necessarily, global challenges are on the international political agenda, and require collaboration between countries. Current examples of global challenges are ageing popu- lations, global warming, terrorism, and epidemics and pandemics. Because of such aspects as overpopulation, migration, and environmental degradation, most nations have recognized their own limited capacities to respond effectively to these challenges. This has had an important con- sequence: the internationalization of certain tasks such as peace keeping or, to a more limited extent, protection of the environment. This has resulted in both a closer integration of nations into the international community and a closer interdependence of nations. Due to their nature, global challenges are identified by international oriented organizations such as the United Nations (UN), G7/G8, OESO, OECD and the European Union (EU). For example, the UN has defined eight Mil- lennium Development goals [UN, 2005):

Eradicate extreme poverty and hunger;has defined eight Mil- lennium Development goals [UN, 2005): Achieve universal primary education; Promote gender equality

Achieve universal primary education;goals [UN, 2005): Eradicate extreme poverty and hunger; Promote gender equality and empower women; Reduce child

Promote gender equality and empower women;poverty and hunger; Achieve universal primary education; Reduce child mortality; Improve maternal health; Combat

Reduce child mortality;education; Promote gender equality and empower women; Improve maternal health; Combat HIV/AIDS, malaria and other

Improve maternal health;gender equality and empower women; Reduce child mortality; Combat HIV/AIDS, malaria and other diseases; Ensure

Combat HIV/AIDS, malaria and other diseases;women; Reduce child mortality; Improve maternal health; Ensure environmental sustainability; Develop a global

Ensure environmental sustainability;health; Combat HIV/AIDS, malaria and other diseases; Develop a global partnership for development. The G7/G8

Develop a global partnership for development.and other diseases; Ensure environmental sustainability; The G7/G8 agenda and the European framework programmes were

The G7/G8 agenda and the European framework programmes were designed to solve a wide variety of these global challenges, while organizations such as Greenpeace, OESO and OECD focus on specific global challenges. On an underlying level, societal developments are often ana- lysed from the perspective of demography, economy, and social, technological, ecological and political domains. Identifying global challenges has generally been frequent, but no generally agreed list of priorities exists. The literature identifies: ageing populations, climate change, envi- ronmental degradation, epidemics and pandemics, global shifts in economic power, increasing pressure on health care, over-exploitation of natural resources, overpopulation, pervasive global- ization, social equality, sustained economic growth, terrorism and pervasive insecurity as some of the most immediate priorities. Table A1 in annex 2 provides an overview of identified global chal- lenges and a short description.

2.1.1 Ageing population

Over the last century, the life expectancy of humans in Western society has increased as a result of better health care. According to UNDESA (2002) the older population is growing faster than the total population in practically all regions of the world and the gap in growth rates is increasing. In the period 1950-1955, the global average annual rate of increase in the number of persons aged 60 years or over was only slightly higher than the rate for the total population (both around 1.8%). It is an established fact that the EU population is having fewer children and is getting older. There will be a large increase in older people when the1950s baby boomers reach old age . This in- crease will start around 2011 and reach a maximum around 2103. This trend is expected to in-

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

crease the prevalence of health impairments and chronic illnesses, which will affect mobility and the

crease the prevalence of health impairments and chronic illnesses, which will affect mobility and the physical maintenance of social relationships (ERA-AGE 2006). 3

AA BB
AA
BB

Figure 1 World trends in population ageing

A) Average annual growth rate of total population and population aged 60 or over: world, 1950-2050 B) Population aged 60 or over: world and development regions, 1950-2050

Source: UNDESA 2002

2.1.2 Climate change

According to the Intergovernmental Panel on Climate Change (IPCC) of the United Nations, the threat of climate change will have major environmental, social and economic consequences for the planet. During the last century, the average surface temperature of the earth rose by around 0.6°C. In its Third Assessment Report, published in 2001, the IPCC projects that global average surface temperatures will rise by a further 1.4 to 5.8°C by the end of this century (IPCC, 2001). This increase in the global temperature is likely to have serious consequences for humanity and other life forms and will result in a rise in sea levels of between 9 and 88 cm by the end of this century, which will endanger coastal areas and small islands, and increase the frequency and severity of extreme weather conditions. 4

2.1.3 Epidemics and pandemics

A pandemic is the worst type of epidemic: a disease that spreads around the globe. Avian influ- enza is the term used to describe influenza viruses that primarily affect birds. On rare occasions, these bird viruses can infect other species, including humans. A human influenza pandemic oc- curs when a new subtype emerges that has not previously circulated in humans and against which the human immune system has no defences and for which no vaccine is immediately avail- able. H5N1 is a strain of avian influenza with pandemic potential, since it could adapt into a strain that is contagious among humans. Influenza pandemics are rare, but recurring events. There were three pandemics in the 20 th century: Spanish flu in 1918, Asian flu in 1957, and Hong Kong flue in 1968. The 1918 pandemic killed an estimated 40 50 million people worldwide. It

3 Relation to innovation: the elderly are expected to become one of the most frequent users of self-care and e-health ser- vices at home. This will be contingent on the availability of mobile phones and computer access at home (see ERA-AGE 2006; Braun et al, 2003b; Gavigan et al., 2003).

4 The EU is at the forefront of international efforts to combat climate change and has played a key role in the development of the two major treaties addressing the issue, the UN Framework Convention on Climate Change and its Kyoto Protocol. See http://europa.eu.int/comm/environment/climat/docs.htm

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

was exceptional and is considered one of the deadliest disease events in human history. The

was exceptional and is considered one of the deadliest disease events in human history. The cur- rent H5N1 strain first infected humans in Hong Kong in 1997, resulting in 18 cases, including six deaths. Since mid-2003, this virus has caused the largest and most severe outbreaks in poultry on record. In December 2003, infections in people exposed to sick birds were identified. Since then, more than 138 people have been infected, half of whom died. This is not a pandemic, but it raises concerns among health experts that a new pandemic is becoming a closer reality. Once a fully contagious virus emerges, its global spread is considered inevitable. Through measures such as border closures and travel restrictions, it is possible to delay the arrival of the virus, but not to cannot stop it completely. Therefore, as far as a human pandemic is concerned, all coun- tries are at risk (EU COM, 2006; FAO, 2005) .

2.1.4 Global shifts in economic power

In the last 25 years, major emerging market economies have generally experienced substantially higher growth rates than the G-7/8 members. Five emerging market economies now rank among the ten largest economies in the world, measured by gross domestic product (GDP) at current exchange rates: China is the fourth largest economy in the world. Brazil, Mexico, India, and South Korea are already major economic forces. If higher economic growth continues in large, middle- income economies, and demographic trends proceed as anticipated, the structure and dynamics of the global economy will become increasingly multi-polar. Goldman Sachs projects that by 2050, the non-Western G-20 market economies emerging from the developing world may repre- sent as much as 70% of the G-20 economies total GDP, a huge rise from the 17% level of today (O Niel and Hormats, 2004; OECD, 2004; Colin et al, 2004).

(O Niel and Hormats, 2004; OECD, 2004; Colin et al, 2004). Figure 2 Expected shift in
(O Niel and Hormats, 2004; OECD, 2004; Colin et al, 2004). Figure 2 Expected shift in
(O Niel and Hormats, 2004; OECD, 2004; Colin et al, 2004). Figure 2 Expected shift in

Figure 2 Expected shift in GDPs between 2003-2050 (GDP in US bn$)

Source: O Niel and Hormats, (2004)

2.1.5 Increasing pressure on health care

It is acknowledged that, in the future, EU healthcare systems will be under pressure from a series of factors inducing a general restructuring process. Specific issues that will increase the pressure on healthcare are:

sustainability of systems; 5 5

tele-care and e-health; 6 6

cyber-security (identity, privacy and security); 7 7

5 Sustainability is defined in this report as 'development that meets the needs of the present generation without compro- mising the ability of future generations to meet their own needs . Sustainability issues have been discussed and analysed in-depth, see, for instance, Life styles, Future Technologies and Sustainable Development (ISBN 3-929118-05-X)

http://www.seniorwatch.de/swa/frame.html 7 These have been discussed and analysed in-depth, see for instance, some IPTS (socio-economic) impact studies http://cybersecurity.jrc.es, and the IPTS Report Special Issue: Vol. 57 September 2001

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

Population ageing, its effect on healthcare systems and cost/benefit aspects; 8 Challenges and opportunities from

Population ageing, its effect on healthcare systems and cost/benefit aspects; 8 8

Challenges and opportunities from EU enlargement. 9 9

The challenge is to identify policy opportunities that arise from this dynamic, and to identify areas with significant potential for policy action.

2.1.6. Over-exploitation of natural resources

Natural resources are vital to the survival and development of the human population. In the case of renewable resources (fish stocks, fresh water, rainforests, etc.), renewal is conditioned by their scale and rate of exploitation. Current exploitation trends in many cases are surpassing the earth's capability to renew them. Fresh water, forests and harvested products are renewable, provided that exploitation does not exceed their regeneration. In the case of non-renewable re- sources such as fossil fuels and metal ores, although many effects of overexploitation are felt locally, the growing interdependence of nations, and international trade in raw materials make their demand and sustainable management a global issue. In recent years, the depletion of natu- ral resource capital and attempts to move to more sustainable development have been a major focus of the development agencies. There is particular concern about the rainforest regions, which hold most of the earth's natural biodiversity - irreplaceable genetic natural capital (EEA, 2003). Despite 34 years of campaigning, and policy and regulatory efforts, the environmental damage generated by over-exploitation of resources continues (IISD, 2005).

2.1.7 Population growth

Overpopulation (resulting from higher birth rates and improved infant mortality, declining mortality rates, increasing life expectancy) occurs when the population density is so great as to actually cause reduced quality of life, environmental degradation, and long-term shortage of essential goods and services. The UN estimates that as the 21st century begins, more than a billion people lack basic needs. Nearly 60% of the 4.8 billion people in developing countries have no basic sani- tation (UNPD, 2003). Almost a third lack access to clean water. A quarter has no adequate hous- ing, and a fifth go without modern health services. According to the UN, population increases have slowed or even stopped in Europe, North America, and Japan. Nevertheless, global popula- tion continues to rise at a rate of roughly 78 million people per year. Most of the growth is taking place in sub-Saharan Africa and parts of South and Western Asia (see Table II.1 below). Not co- incidentally, these same places are afflicted by deforestation and other unsustainable exploitation of natural resources (UNPD, 2003).

8 These have been discussed and analysed in-depth in European Commission (2001), Communication from the Com- mission to the Council, the European Parliament, the Economic and Social Committee and the Committee of the Regions on The future of healthcare and care for the elderly: guaranteeing accessibility, quality and financial viability , COM (2001) 723 final, European Commission, Brussels. European Commission (2000), Communication from the Commission to the Council, the European Parliament, the Economic and Social Committee and the Committee of the Regions on the Health

Strategy of the European Community , COM(2000)285 final, European Commission, Brussels.
9

These have been discussed and analysed in-depth, see for instance, http://enlargement.jrc.es, and http://europa.eu.int/comm/ enlargement.

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

Table 1. Projection of world population growth.

Table 1. Projection of world population growth . Source: United Nations Population Division (2003) From UNPD
Table 1. Projection of world population growth . Source: United Nations Population Division (2003) From UNPD

Source: United Nations Population Division (2003)

From UNPD (2003) projects presented in Table 1 it can be suggested that the world population will pass the 7 billion mark in 2013; the 8 billion mark in 2028; the 9 billion mark in 2054 and sta- bilize at just above 10 billion after 2200. The most recent increase of 1 billion occurred in only 12 years.

2.1.8. Pervasive globalization

Globalization has become the buzzword of the new millennium. It is viewed as the cause of as well as the panacea for many of the world's problems. The debate over related global challenges is manifested in the international approaches to threats such as avian flu, the September 11th attacks, and the consequences of the Human Genome Project, and the management of the In- ternational Space Station. Globalization will be driven by rapid and largely unrestricted flows of information, ideas, cultural values, capital goods and services and people. This will increase both global economic growth and global challenges, defined by the increasing acceleration, complex- ity, and globalization, which increase the need for global, long-term perspectives. This global challenge will be further discussed in section 4 (NIC 2004).

2.1.9. Social equality

Social equality is the process of dealing with the balance between economic growth, environ- mental impact and social problems such as poverty and social exclusion, the education and skills gaps, poor or no access to information, and personal factors such as age, gender or disability. The EU's enlargement on 1 May 2004 has exacerbated these disparities; populations in the ten new member states have on average lower income levels and lower ICT penetration rates. Ac- cording to Commission figures, the income, rural, educational and age gaps are greater in the ten new member states than in the former EU-15 (SPVI, 2001; EU COM-DG ESA, 2006).

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

2.1.10. Sustained economic growth

2.1.10. Sustained economic growth The Asian tigers, reduction in trade barriers, increased technological possibilities,

The Asian tigers, reduction in trade barriers, increased technological possibilities, demand for low cost products, increased oil price are all examples of trends and drivers that put pressure on the economic growth of the industry. Although some sectors such as pharmaceuticals and construc- tion, are experiencing continuous growth, other sectors are under economic pressure due to in- creasing competitiveness and government regulation. The industry related to process technology can be characterized as susceptible to this increase in economic competition. Profit margins are under pressure, but innovation is needed to increase quality and address other market demands. The projection for the world economy is to maintain the trend that began in 2005. In 2007 eco- nomic growth will be relatively more pronounced in developing countries (5.5%) than in OECD (2.7%) and the Euro zone (2%). It is expected that East Asian and Pacific countries will have the highest growth rate (7,4%) and that Sub-Saharan countries will recover and surpass the rate of growth of the Latin American countries. Here, again the effect of China and India is noticeable as they account for almost 1% of total growth in real GDP in developing countries (World Bank,

2006)

Table 2 Projected economic growth in the world

Real GDP growth e

 

2003

2004e

2005f

2006f

2007f

World

 

2,5

3,8

3,2

3,2

3,3

 

Memo item: World (PPP weights) f

 

3,9

5,0

4,4

4,3

4,4

High income

 

1,8

3,1

2,5

2,5

2,7

 

OECD Countries

1,8

3,0

2,4

2,5

2,7

Euro Area

0,7

1,7

1,1

1,4

2,0

Japan

1,4

2,6

2,3

1,8

1,7

United States

2,7

4,2

3,5

3,5

3,6

Non-OECD countries

3,7

6,3

4,3

4,2

4,0

 

Developing countries

 

5,5

6,8

5,9

5,7

5,5

 

East Asia and Pacific

8,1

8,3

7,8

7,6

7,4

Europe and Central Asia

6,1

7,2

5,3

5,2

5,0

Latin America and Caribbean

2,1

5,8

4,5

3,9

3,6

Middle East and N. Africa

5,2

4,9

4,8

5,4

5,2

South Asia

7,9

6,8

6,9

6,4

6,3

Sub-Saharan Africa

3,6

4,5

4,6

4,7

4,5

Memorandum items

 

2003

2004e

2005f

2006f

2007f

 

Developing countries

 
 

excluding transition countries

5,3

6,8

6,1

5,8

5,6

excluding China and India

4,1

6,0

4,9

4,7

4,6

Note: PPP = purchasing power parity; e = estimate; f= forecast.

a. Canada, France, Germany, Italy, Japan, the UK, and the United States.

b. In local currency, aggregated using 1995 GDP Weights.

c. Simple average of Dubai, Brent and West Texas Intermediate.

d. Unit value index of manufactured exports from major economies, expressed in USD.

e. GDP in 1995 constant dollars;1995 prices and market exchange rates.

f. GDP mesaured at 1995 PPP weights.

Source: World Bank 2006.

Turning to the Euro zone, after several years of stagnation, GDP growth is expected to increase from 1.4% in 2006 to 2.4% in 2007. According to the EU Commission (2006b) growth has been hampered by structural rigidities, and member state economies have been deteriorating in recent years. Confidence in the Euro zone has suffered as a result of the management of public fi-

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

nances in France and Germany. Added to this are the large public deficits in GDP

nances in France and Germany. Added to this are the large public deficits in GDP ratios and high debts of over 100% in Hungary, Italy and Greece. All these aspects are challenging the enforce- ment of the EU's recently reformed Stability and Growth Pact. Economic activity is set to grow by 1.5% in 2006 to 2.1% and to accelerate further to 2.4% in 2007 (EU COM 2005).

2.1.11. Terrorism and pervasive insecurity

In response to the September 11 attacks, political leaders from Europe, North America, Asia, and the Middle East have placed the phenomenon of terrorism within the context of a global struggle against systems of government perceived by those accused of using terrorist tactics as harmful to their interests. Differing social philosophies, religions, globalization, sustainability issues (e.g. poverty, access to natural resources) can lead to tensions between and within societies. Non- state organizations such as Al-Qaeda are increasingly performing terrorist actions intended to coerce or to intimidate governments or societies, in the pursuit of goals that are generally politi- cal, religious, or ideological. This forms a threat to economy and society and leads to the need for mechanisms to counteract terrorism, the organization of defence and mechanisms to deal with cultural differences. Related themes include the detection of terrorist hazards and the reduction of terrorist threats to industrial complexes (European Commission, 2002).

2.2 Consumption trends

Consumption trends are directly related to income and growth levels. As population and eco- nomic growth have steadily risen over the last three decades, levels of consumption have also increased. In this section we look at key global consumption trends that are clearly linked to in- come and population levels. Income and population trends are depicted in Figure 3. Key con- sumption indicators according to UNEP-DTIE (2004) are energy, materials usage and waste, wa- ter, mobility, urban concentration and food.

2.2.1 Energy

Energy consumption levels are directly related to economic development, population size, final goods consump- tion, transportation intensity, and the provision of basic and more sophisti- cated services and to environmental impacts (see Figure 3). The dominant sources of energy are petroleum and electricity, and demand for them has grown steadily over the years. Accord- ing to UNDESA (2006) the level of con- sumption worldwide has doubled since the mid 1970s, a trend that mirrors GDP growth. Several challenges are

100 100

200 200

300 300

350 350

Electricity production Electricity production GDP GDP Industrial value added Industrial value added Energy use
Electricity production
Electricity production
GDP
GDP
Industrial value added
Industrial value added
Energy use
Energy use
CO2 emissions
CO2 emissions
Population
Population
SO2 emissions
SO2 emissions
Population Population SO2 emissions SO2 emissions 1971 19711971 1980 19801980 1990 19901990 2002 20022002

1971

19711971

1980

19801980

1990

19901990

2002

20022002

Figure 3. Growth in economy, energy and emissions

Source: UNDESA 2006

associated with the current trends in consumption. The most important are: limited availability of fossil fuels in the long term; environ-

mental degradation arising from exploration, extraction, refining and usage of petroleum deriva- tives; effects on economic growth of high oil and derivates prices. Use of renewable energy has increased from 2.2% to 4.1% of total energy consumption (10,723 million tonnes of oil equivalent world consumption in 2003). If demand for oil crude continues to rise, oil prices are likely to in- crease from their current levels. Figure 4 below shows the evolution of oil and natural gas prices over the last 30 years.

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

Dollars per 1000 cubic feet (gas)

Dollars per 1000 cubic feet (gas)

per 1000 cubic feet (gas) Dollars per 1000 cubic feet (gas) 100 100 100 90 90
100 100 100 90 90 90 80 80 80 Oil price (constant) Oil price (constant)
100
100
100
90
90
90
80
80
80
Oil price (constant)
Oil price (constant)
Oil price (constant)
70
70
70
60
60
60
50
50
50
Oil price (current)
Oil price (current)
Oil price (current)
40
40
40
30
30
30
20
20
20
10
10
10
Gas price (constant)
Gas price (constant)
Gas price (constant)
0
0
0
Dollars per barrel (oil)
Dollars per barrel (oil)
Dollars per barrel (oil)

1976

1976

1980

1980

1985

1985

1990

1990

1995

1995

2000

2000

2005

2005

12

12

12

10

10

10

8

8

8

6

6

6

4

4

4

2

2

2

0

0

0

Figure 4. Crude oil and natural gas prices 1976-2005

Source: UNDESA 2005

2.2.2 Materials usage and waste

In 1972 the Roma Club published The Limits of Growth, which speculated about the collapse of

global resources (Meadows et al., 1972). Since then although there have been many discoveries

contradicting much of the study - global consumption of

the most important raw materials has continued to increase rapidly. There is only one earth, thus there are inevitably limits to the current rates of growth. There was little information found on world trends in raw materials usage and solid waste disposal. The information that does exist re- fers to specific types of materials or combination of a few types of materials and refers to solid waste disposal globally. Nevertheless, in the last 20 years there has been a considerable in- crease in the use of resources. This is demonstrated by the levels of energy (Figure 3) and the levels of water used globally (Figure 5). We adopted a throughput perspective to show trends in solid waste disposal in the EU.

of new reserves of many raw materials

disposal in the EU. of new reserves of many raw materials According to the European Environmental

According to the European Environmental Agency (2005), one of the targets set in the 5th Environmental Action Programme was to reduce the generation of municipal waste per capita per year to the average 1985 EU level of 300kg, by the year 2000 and to main- tain it at that level. Figure 4 indicates that this target was far from being reached in 2003. The average amount of municipal waste generated per capita per year in many western European countries has reached more than 500kg. Municipal waste generation rates in central and Eastern Europe are lower than in west- ern European countries and generation is decreasing slightly. According to the OECD Observer (2004) the US processes 2 kg of municipal waste per person per day, the Europeans 1.1 kg; for OECD countries the total is over half a tonne per person per year, only 16% of which is recycled. Six per cent goes for composting, the rest is put in landfill or is incinerated (OECD,

2004b).

.

Figure 4 Municipal waste generation in western European (WE) and central and eastern Euro-

pean (CEE) countries. Source: European Environmental Agency 2005

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

2.2.3 Water

2.2.3 Water Water is an element that enables not only life itself, but determines the location

Water is an element that enables not only life itself, but determines the location of human settle- ments, and economic and social development. Figure 5 illustrates that trends in water consump- tion drastically increased after 1950, the extreme being found among the Asian countries.

1950, the extreme being found among the Asian countries. Figure 5. Global trends in water consumption

Figure 5. Global trends in water consumption 1900-2025

Source: Igor A. Shiklomanov, SHI (State Hydrological Institute, St. Petersburg), and UNESCO, Paris, 1999; World Re- sources 2000-2001: People and Ecosystems: the Fraying Web of Life, WRI, Washington DC, 2000; Paul Harrison and Fred Pearce, AAAS Atlas of Population 2001, AAAS, University of California Press, Berkeley.

The latest diagnosis by UNEP (2006) of the state of waters in the globe indicates that there are great challenges to be faced by 2020. A summary of the trends identified is presented in Box 1 below.

Box 1. Effects of water consumption trends and associated socio-economic impacts

In more than half of the regions/sub-systems considered in UNEP (2006) the overall envi- ronmental and socio-economic impacts of freshwater shortages were found to be moderate or severe;Acute freshwater shortages

Acute freshwater shortages(2006) the overall envi- ronmental and socio-economic impacts of freshwater shortages were found to be moderate

Conflicts over water resourcesto be moderate or severe; Acute freshwater shortages Degradation of grazing lands Impacts of the modification

Degradation of grazing landsAcute freshwater shortages Conflicts over water resources Impacts of the modification of stream flow caused by

Impacts of the modification of stream flow caused by dams or river diversions were more widespread and severe than those caused by pollution of existing supplies or changes in the water table;Displacement of people

Displacement of peoplewere more widespread and severe than those caused by pollution of existing supplies or changes in

Impacts on coastal fisheriesor changes in the water table; Displacement of people Increase in infectious diseases Increased vulnerability to

Increase in infectious diseasesDisplacement of people Impacts on coastal fisheries Increased vulnerability to flooding Water for irrigation is

Increased vulnerability to floodingImpacts on coastal fisheries Increase in infectious diseases Water for irrigation is causing the most severe

Water for irrigation is causing the most severe environmental and socio-economic impacts;Increased water-related diseases

Increased water-related diseasesWater for irrigation is causing the most severe environmental and socio-economic impacts;

Interruptions in water supplysocio-economic impacts; Increased water-related diseases Over extraction of aquifers is becoming severe in many areas

Over extraction of aquifers is becoming severe in many areas that depend heavily on irri- gated agriculture or are densely populated;Lack of potable water

Lack of potable waterof aquifers is becoming severe in many areas that depend heavily on irri- gated agriculture or

Loss of cropsor are densely populated; Lack of potable water The extraction of fossil water from deep aquifers

The extraction of fossil water from deep aquifers is unsustainable as they will not be refilled on human time scales. Knowledge of aquifers is insufficient and further studies are needed in order to comprehensively assess trans-boundary aquifers;Loss of farmland and infrastructure

Loss of farmland and infrastructureof aquifers is insufficient and further studies are needed in order to comprehensively assess trans-boundary aquifers;

Loss of fisheriesaquifers; Loss of farmland and infrastructure Loss of traditional livelihoods Loss of traditional sites

Loss of traditional livelihoodsLoss of farmland and infrastructure Loss of fisheries Loss of traditional sites Land-use changes, including

Loss of traditional sitesLoss of fisheries Loss of traditional livelihoods Land-use changes, including deforestation and the

Land-use changes, including deforestation and the cultivation of wetlands, affect the water budget, thus causing floods or droughts in many regions;Political disputes

Political disputesdeforestation and the cultivation of wetlands, affect the water budget, thus causing floods or droughts in

Reduced agricultural outputfloods or droughts in many regions; Political disputes   Reduced availability of fish Reducedproductivityof

 

Reduced availability of fish 

Reducedproductivityof farmlandagricultural output   Reduced availability of fish Agricultural land is becoming too saline to support

Agricultural land is becoming too saline to support important crops, the salinity of aquifers is too high for human use, and saline waters encroach further up rivers during dry seasons.Upstream/downstream conflicts

Upstream/downstream conflictsthe salinity of aquifers is too high for human use, and saline waters encroach further up

Source: UNEP (2006)

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

2.2.4 Mobility

2.2.4 Mobility Economic growth, technological possibilities and globalization have led to increased mobility. However,

Economic growth, technological possibilities and globalization have led to increased mobility. However, transport is one of the most prominent environmental pollutants, leading to health prob- lems, congestion, environmental impact and delays. This has consequences for spatial planning, technology, design of infrastructure, modality (OECD, 2002). Related themes are reductions in emissions and waste from transport. With rising oil prices and the demand-supply problems re- lated to oil, the transport sector is searching for alternative sources of energy (ERTRAC, 2004). Transport is the fastest growing source of greenhouse gas emissions, which are contributing to global climate change (OECD, 2002; WBCSD, 2005). In the industrialized countries the emis- sions arising from international aviation have grown twice as fast as overall transport emissions (UNDESA, 2006).

2.2.5 Urban concentration and consumption

According to UN-Habitat, in 1950, one-third of the world s peoples lived in cities. Just 50 years later, this proportion has risen to one-half and will continue to grow to two-thirds, or six billion people, by 2050. In terms of population densities, spatial distribution, economic activity and social attitudes, the world has become urbanized. Cities have always been the focal points for invest- ment, commerce, production and consumption. Urban concentration brings many challenges at the global level including cities are magnets for immigrants seeking a better life. The problems that result from these profound economic and demographic trends include urban poverty and the growth of slums that now envelope nearly one billion persons worldwide (UN-Habitat, 2005). In addition, cities have evolved into a highly subsidized habitat system compared to natural habitats. Such a concentration of population brings challenges not only in terms of the necessary inputs, but also in terms of the waste generated (UNEP, 2005).

but also in terms of the waste generated (UNEP, 2005). Figure 6 Concentration of human settlements

Figure 6 Concentration of human settlements

Source: UNHabitat, 2005

2.2.6 Food

There are two main global challenges related to food: lack of it and overeating. According to the most recent estimates of the UN s Food and Agriculture Organization (FAO), there are 852 million undernourished people in the world. Chronic hunger, malnutrition and related diseases cause the deaths of 25,000 people every day, with children accounting for more than 70% of these deaths (UN-WPF, 2004). In addition, according to the World Health Organization (WHO), currently there are more than 1 billion adults that are overweight - and at least 300 million that are clinically obese. Obesity levels range from below 5% in China, Japan and certain African nations, to over

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

75% in urban Samoa. But even in countries with currently low levels of obesity, rates

75% in urban Samoa. But even in countries with currently low levels of obesity, rates are almost

20% in some cities. Obesity accounts for 2-6% of total health care costs in several of the devel- oped countries; some estimates put the figure as high as 7%. The true costs are undoubtedly

much greater as not all obesity-related conditions included in these calculations (WHO, 2003).

such as diabetes and coronary diseases - are

(WHO, 2003). such as diabetes and coronary diseases - are Framework Service Contract 150083-2005-02-BE Driving

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

III. Supply side

III. Supply side

This section outlines ongoing trends in the organization of production in the industrial system and in the multipliers of economic activities arising from the S&T infrastructures that are influencing what will be on offer in global markets over the next 15 years. Some fundamental changes are highlighted in this section. In terms of the organization of production increasing the role of knowl- edge is an important source of economic value. The generation of new knowledge, through inno- vation, has become the key driver of competitive advantage at firm and country level. In the new knowledge economy, 10 public organizations supporting innovation (S&T policies) and a variety of public and private organizations producing and diffusing new knowledge in the industrial system have assumed a key role (entrepreneurial firms, entrepreneurial universities, innovation factories, etc.). A second transformation is the increasing openness of the system, in several dimensions. Markets have become more open to international competition and to globalization of production and distribution of products, services and knowledge. Firms themselves have become more open, increasingly outsourcing activities, widening their supply chains, and relying on collabora- tions with external parties for R&D, innovation and production. A third transformation concerns the increasing importance of networks. Industrial firms increasingly see themselves as network organizations whose competitive advantage depends more on their ability to interact in order to connect technologies, people and organizations, than on a their own R&D investment. A fourth transformation, concerns new scientific and technological paradigms shifts, which include ad- vanced biomedical sciences, cognitive sciences, molecular biology, etc. Underpinned by this there are whole new areas of economic activity and business models, such as cleaner environ- mental processes, effect-based security operations, effective health care, smart housing, sus- tainable agriculture, etc.

3.1 Innovation as source of competitive advantage

etc. 3.1 Innovation as source of competitive advantage In a 1999 article entitled Industry gets religional

In a 1999 article entitled Industry gets religional , the Economist highlighted that innovation has become the industrial religion of the late 20th century . Governments depend on policies support- ing innovation to enhance competitiveness and economic growth. Firms seek to introduce new products and new processes in order to enhance their competitive advantage and increase mar- ket share. Innovation is perceived by corporate organizations as well as by policy makers as the key source of economic performance. In the OECD countries a transition towards a knowledge economy has been under way. High-tech industries account for a growing share of value added in the OECD countries (OECD, 2004). Companies and countries will increasingly rely on the creation, diffusion and exploitation of knowledge, including scientific and technological knowl- edge.

Knowledge intensive sectors are becoming more important to national economies and to interna- tional trade. These sectors account for an increasing share of the value added and the exports in the economy. In addition, the most intensive R&D sectors are those that have experienced the highest growth rates in the 1990s: office, accounting and computing machinery; pharmaceuticals; and aircraft and spacecraft (OECD, 2004).

3.1.1 Increasing government support for science, technology and innovation

Governments have been devoting increasing attention to science, technology and innovation (STI) as the sources of economic growth and societal wealth. In the OECD countries, several governments have increased public expenditure in R&D, often by setting explicit targets in terms

10 Terms such as the knowledge economy or the learning economy are now commonly used to indicate the increasing role of knowledge, alongside labour and capital, as an input to economic processes. The OECD defines knowledge-based economies as economies which are directly based on the production, distribution, and use of knowledge and information (OECD 1996, p. 7)

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

of R&D intensity or ranking among OECD countries In particular, public expenditure on R&D has

of R&D intensity or ranking among OECD countries In particular, public expenditure on R&D has increased in areas of growing technological opportunity, such as information and communication technology (ICT), biotechnologies and nanotechnologies (OECD, 2004). The increased commit- ment of governments to STI is reflected in the increased funding for R&D in the higher education (HE) sector and, to a lesser extent, in the increased spending by government laboratories. This latter mainly goes on defence. The traditional gap between R&D performed by the HE sector and by government laboratories has become broader, indicating a shift in government R&D spending from defence to more general knowledge-creation (OECD, 2004).

3.1.2. Increasing reliance on collaboration and

2004). 3.1.2. Increasing reliance on collaboration and Open Innovation Firms are expected to collaborate more and

Open Innovation

Firms are expected to collaborate more and exploit external sources of innovation in order to en- hance their internal capabilities and to cope with uncertain economic conditions (OECD, 2004). A new model of Open Innovation has emerged in contrast to the old Closed Innovation model in which innovations are generated mainly from within the R&D laboratories of firms, operating in close cooperation with other firms. The Open Innovation model states that technological break- throughs often require the contribution of a broad and diverse range of sources of ideas and technologies. As a consequence firms need to be more open towards the external environment and to engage in close cooperation with other companies, universities and research institutes (Chesbrough, 2003). Leading firms distinguished by their technological breakthroughs have em- braced the Open Innovation model as a key driver of their corporate strategy (Philips Research Press Release, April, 2004). In this new environment, networks linking organizations and people have become increasingly important for the identification and realization of new ideas. Some companies have almost entirely replaced traditional R&D activities with recombinant activities by bringing together different technologies from a broad and diverse range of external sources. The best known example is Procter & Gamble, which adopted an explicit strategy of Connect and Develop in place of the traditional strategy of Research and Develop (Dodgson et al. 2005). The new model has led to a more distributed approach to innovation in the industry.

a more distributed approach to innovation in the industry. 3.1.3. Increasing importance of Entrepreneurship The
a more distributed approach to innovation in the industry. 3.1.3. Increasing importance of Entrepreneurship The

3.1.3. Increasing importance of

Entrepreneurship

The identification, evaluation and exploitation of opportunities for new businesses are increas- ingly recognized as being very important for economic growth and job creation. Audretsch and Thurik (2000) pointed out that the OECD countries have moved away from a managed econ- omy towards an entrepreneurial economy and that this shift demands new policy approaches. This change, they argue, is the main manifestation of the shift that is occurring in the sources of competitive advantage from labour and capital to knowledge-based economic activities, which marks the emergence of The New Economy. The managed economy as characterized by Chan-

dler (1990) is based on the exploitation by corporate organizations of scale and scope econo- mies. The entrepreneurial economy is characterized by a process of identification and exploita- tion of new opportunities by new and small firms, often with potential for rapid growth. In the en- trepreneurial economy innovation is the main source of competitive advantage (Audretsch and

Thurik, 2000). Among entrepreneurial firms, fast-growing enterprises or gazelles the policy agenda, as a key driver of innovation and economic growth (EC, 2004).

a key driver of innovation and economic growth (EC, 2004). 11 have entered 3.1.4. Growing role
a key driver of innovation and economic growth (EC, 2004). 11 have entered 3.1.4. Growing role

11

have entered

3.1.4. Growing role of the service sector

The distribution of industrial activities across sectors has changed over time as the service sector has assumed increasing importance in both industrial production and R&D. The OECD s Science, Technology and Industry Outlook (2004) reports that in most OECD countries, the share of mar- ket services in total value added has increased from 35-45% in 1980 to 45-55% in 2001. In addi-

11 The term gazelles was originally used to label the young and small firms that grow at least 20% a year over a four-year period (Birch, 1979).

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

tion, innovation has become more important in the service sector. Service firms are generally re-

tion, innovation has become more important in the service sector. Service firms are generally re- garded as less innovative than manufacturing firms; partly because innovations in services are more difficult to measure than in manufacturing. However, more recent evidence based on the Community Innovation Survey (CIS) shows that this difference is minor. 12 Indeed, some areas of the service sector, like business and financial services, are more innovative than the average in manufacturing firms (OECD, 2004). In particular, a distinction has been made between traditional services and Knowledge-Intensive Business Services (KIBS). KIBS are services that rely heavily on professional knowledge and their typical main clients are other businesses. By providing knowledge and information inputs to other businesses, they are seen as playing a major role in diffusing innovation across the economy (Metcalfe and Miles, 1999). Examples of KIBS are com- puter-related services, software consultancy, data processing, R&D consultancy, architectural and engineering consultancy, technical testing and analysis, legal services, etc.

3.1.5. Interdependence of services and manufacturing

The boundary between services and manufacturing activities has blurred because of ongoing transformations of business activities along the value-chain. Upstream in the value-chain, produc- tion is becoming more service intensive, as the amount of service activities that are embodied into the manufacturing processes has increased in recent years (OECD, 2005). In a study based on input-output data for the OECD countries, Pilat and Wölfl (2005) observe that in the mid 1990s, services accounted directly or indirectly for about 22% of manufacturing production. At the same time, transformations have taken place downstream in the value chain. Manufacturing firms have differentiated their market offering into services that provide greater potential for value crea- tion. This is part of a more general trend that sees firms developing new business models: firms have changed the way they carry out transactions and position themselves along the value chain with the purpose of generating revenues. 13 These transformations have implications for industrial innovation and economic growth. For example by coupling manufacturing and services, and add- ing service components to their more traditional products, firms have created new opportunities for growth in saturated markets (Pilat and Wölfl 2005). In other sectors, new forms of organization of production activities, that involve the provision of high-value integrated solutions , have emerged (Davies, 2004). They consist of innovative combinations of products and services that are tailored to each customer's needs, and that require firms to develop new capabilities in ser- vice provision, and in the design and integration of complex systems (Davies, 2004).

3.1.6. Increasing reliance on human resources for science and technology

The increasing emphasis on technological innovation and knowledge intensive activities de- mands a skilled labour force of scientists and engineers. From 1995 to 2000, employment in hu- man resources for science & technology (HRST) has grown twice as fast as total employment, while in several countries the number of science and engineering graduates has declined (OECD, 2004). There is therefore a general concern that in the future a limited and highly unpredictable domestic supply of HRST will set constraints on the potential for economic growth in the OECD countries. This trend will be partly offset by the fact that tertiary enrolment of science and engi-

12 According to the results of the third CIS (CIS-3), the percentage of firms that reported being innovative in the service sector varies from more than 55% in Germany to about 25% in Spain. In most of the surveyed countries, the percentage of innovative firms in the total number of respondents is lower for service firms than for manufacturing firms. The largest gap, observed in Belgium, Denmark and the Netherlands, is about 20 percentage points difference. In addition, the per- centage of innovators varies considerably across service sectors. It is the highest in business services (60%) and in fi- nancial intermediation (50%) and reached values that are above the average percentage of innovators in manufacturing, which is equal to slightly less than 50% (OECD, 2004).

13 E-business is a typical example of a new business model that has emerged with the advent of the Internet (Amit and Zott, 2001). Chesbrough and Rosenbloom (2002) give a definition of a business model that put emphasis on the Interde- pendence between technological change and economic value creation. In this sense, a business model is a coherent framework that takes technological characteristics and potentials as inputs, and converts them through customers and markets into economic outputs (Chesbrough and Rosenbloom, 2002, p. 530).

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

neering students has increased in some countries, implying a greater future supply of HRST if

neering students has increased in some countries, implying a greater future supply of HRST if those students graduate. In addition, international mobility, especially of PhD students, from non- OECD countries has supplemented domestic availability of HRST in the OECD countries (OECD, 2004). Accessing and retaining skilled labour is increasingly important for companies who want to build their internal resources and capabilities.

3.2 Globalization

The phenomenon of globalization is revealed by the sharp increase observed in recent years in a number of indicators, such as measures of international trade (import and export), FDI (inflows and outflows) and integration. Globalization involves numerous aspects (Audretsch and Thurik, 2000). It has been characterized by increasing competition from low-cost high skilled labour in China (in manufacturing) and in India (in services). The potential role of emerging economies is discussed further below. At the same time, the ICT revolution has reduced the cost of relocating standardized economic activities from high-wage to low-wage countries. Not only have production activities assumed a global dimension, but, also, STI activities are becoming global. This trend is manifest in the increasing share of R&D expenditure that is performed in non-OECD countries, for example the overall share of R&D expenditure in China, Israel, and Russia has significantly increased in recent years (OECD, 2004). This issue and the increasing importance of local prox- imity and regional clusters are discussed further in Section 5.

As far as R&D and innovation are concerned, while increasing globalization has initially affected production and trade of manufacturing goods, it has progressively involved tradeable services, technology transfer and the location of innovative activities, including R&D laboratories, basic and applied research, prototyping, commercialization and marketing of innovation (see ILO, 2001; Cimoli and Katz, 2003). For example, US affiliates in China have increased their ratio of R&D spending to value added from 1% in 1994 to 9.2% in 2000 (source: US Bureau of Economic Analysis, Survey of US Direct Investment Abroad, Washington DC).

Thus, the scope of catching-up by emerging economies is now extending to R&D and knowl- edge intensive activities. Table 3 shows that the main emerging economies are rapidly catching- up with the developed ones in terms of local technological capabilities (measured by numbers of R&D workers).

Table 3: the incidence of R&D

Researchers in R&D (per million people) 1996

Researchers in R&D (per million people)2000

Rate of growth 1996-2000

USA

3,881

4,526

9.7%

Brazil

-

324

-

Mexico

215

259

20.5%

European Monetary Union

2,175

2,479

13.98%

Russian Federation

3,804

3,479

-8.5%

Japan

4,909

5,104

4%

China

450

550

22.2%

Hong Kong (China)

1,042

1,159

11.23%

India

157

120 (1998)

-

Source: World Bank, World Development Indicators 2005.

The intensity of R&D expenditure financed by industry has seen a decline in recent years in the OECD countries, but with some regional differences. The slowdown in industry funded R&D has been driven mainly by declining industrial R&D expenditure in North America after a period of growth in the 1990s, although it continued to grow in Asia-Pacific and Europe (OECD, 2004). The slowdown in industry R&D expenditure recently observed in the US is expected to continue in the

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

near term. Recent surveys indicate that US firms are more often planning to reduce their

near term. Recent surveys indicate that US firms are more often planning to reduce their R&D spending than to increase it, while European firms, although generally keen to increase R&D spending, claim that most expenditure would likely be channelled outside the EU. Longer term trends are unpredictable and are conditional on changes in the economic environment (OECD,

2004).

3.2.1. The emergence of markets for technology

Another trend identifiable in the economic organization of innovation is the increasing specializa- tion and division of labour among firms in the innovation process (Arora, Fosfuri, Gambardella, 2001). The process of specialization in innovation has seen some firms focus on creative activi- ties. These are generally new and small firms that have the skills and mindsets needed to create new products (especially radically new products), which established firms are less likely to have. However, established and large firms are more likely to be specialized in development activities, which demand large investment, and in the commercialization of innovation, which requires com- plementary assets (in marketing, manufacturing, distribution, etc.) (Gans and Stern, 2003). New technologies are not brought to the product market directly from the entrepreneurial firms that developed them; but they are traded in the market for ideas through licensing or collaboration agreements with established firms. The emergence of the market for technology has seen the creation of internet based market places for technology that facilitate the exchange and trade of intellectual assets. A new typology of innovative firms has emerged that has been labelled inno- vation factories that specialize in the design of new products and services, which are manufac- tured and offered to customers by other firms (Hargadon and Sutton, 2000). These are product development companies that mostly work on an innovate for fee basis and whose customers are firms from a broad range of different industries.

3.2.3 More sophisticated use of customers as sources of innovation

Von Hippel (2005) argues that the innovation is being democratised in recent years and that the innovation system has been radically transformed from a manufacturer-centred system to a user- centred system. Users of products and services, both from industry and from the final consumer sector, are increasingly available to carry out innovations themselves. This is a further develop- ment of the process of customization of production and innovation, which goes beyond a recogni- tion of the importance to the firm of understanding users needs in the development of new prod- ucts and services. It assigns a central role to users as the direct sources of innovation. Users are best able to identify their own needs, and develop new products and services that respond to those needs; they can design exactly what they want as they have a market of one (Von Hippel 2005). In contrast, users needs can only be partially captured and represented by manufacturer firms, because of the sticky nature of knowledge that make those needs difficult to communicate, and because manufacturers have much larger markets. Individual users are willing to share their innovations within a user community, in which participants can benefit from the innovations de- veloped by others (Von Hippel 2005).

the innovations de- veloped by others (Von Hippel 2005). 3.2.4 Rise of innovation technologies (IvT) Dodgson,
the innovations de- veloped by others (Von Hippel 2005). 3.2.4 Rise of innovation technologies (IvT) Dodgson,

3.2.4 Rise of innovation technologies (IvT)

Dodgson, Gann, and Salter (2005) argue that a profound transformation has taken place in the innovation process. They propose that a new category of technology, which they call innovation technologies (IvT) has emerged. The application of new technologies (e.g. ICT) to support the process of innovation has led to greater efficiency in research, design and engineering proc- esses. New technologies, such as visualization, simulation and modelling, system analysis, 3D prototyping, are increasingly being applied to support the research, design and development (RD&D) of new products and processes. One of the consequences of the application these new technologies is the increased codification of knowledge. In some cases, such as chemicals, they

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

have radically transformed the approach to problem solving. They have modified the way compa- nies

have radically transformed the approach to problem solving. They have modified the way compa- nies manage industrial innovation, and their organizational structure and capabilities.

3.2.5 The experience economy

Traditionally firms are considered as and see themselves as suppliers of manufactured goods and services. Goods and services are more and more becoming commodities that, with the ad- vent of mass customization, can be tailored to the specific requirements of customers and yet be produced on a large scale. Pine and Gilmore (1999) argue that because of the process of com- moditization, the value of economic activity has to be found in the offering of experience. The process of shifting the economic offering downstream in the value chain (what Pine and Gilmore call the progression of economic value ), which has for a time moved from the making of goods to the provision of services , has now reached a new phase, the staging of the experience . In this definition, the experience should not be considered a subset of services and is more than entertainment. While services can be customized, experiences are personal. They provide con- sumers with offerings, to which a feeling or sensation (rather than a benefit) is attached, and which will be remembered for a long time. Indeed, consumers are active participants who are di- rectly involved in the staging (rather than the provision) of the economic offering. They are guests rather than users or clients. The emergence of the experience economy and of consumers that are more concerned with experiences and creative content, have transformed the process of new product development. Branding and advertising have assumed a greater relevance and become closely connected with new product development.

and become closely connected with new product development. 3.3. Supply of new inventions: new research paradigms

3.3. Supply of new inventions: new research paradigms 14

Research revolves around the creation of scientific knowledge and the translation to new ena- bling technologies. Scientific knowledge generation (science) aims at creating an awareness and understanding of facts, truths or information gained, in the form of experience or learning (a pos- teriori), or through introspection (a priori). The conversion from science to technology is aimed at the development of tools, machines, materials and processes to help solve human problems. Ac- cording to the Frascati Manual (OECD, 2002) a distinction must be made between basic re- search, strategic research and applied research). Basic research focuses on expanding knowl- edge about fundamental processes related to the production processes in the firm. Strategic re- search has industrial relevance, but no immediate specific application.

The development of S&T (research) takes place in the Research Arena. The Research Arena consists of the academic community, Research and Technology Organizations (RTOs), and, be- ing an ingredient in R&D, also takes place in (high-tech) companies. The upper aggregate level of Research paradigm shifts , constitutes long-term shifts in global research philosophies. Research paradigm shifts include scientific paradigm shifts (Kuhn, 1962) and technological paradigm shifts (Dosi, 1982). These changes initiate radical, system changing science and technologies within a

timeframe of 30-50 years. They are sometimes referred to as the scientific or technological trajec- tory (Dosi, 1982). They are often natural trajectories of technical progress: once a path has been selected and established, the direction taken is towards the problem solving activity (Nelson,

1977). Along the trajectory, new global research communities are created

disciplinary research paradigms will emerge. An example is the shift from more traditional bio- technology, which focuses on the use of bacteria as means of production/products, to molecular

15

and new (cross)-

14

Whether what is described in sections III.3 and III.4 should be considered purely a global driver of industrial markets is unclear. It can also be considered as part of the response of Science and Technology Infrastructures (the role of R&D and Innovation) to emerging global issues (comment from the project leader).

to emerging global issues (comment from the project leader). 1 5 A research community can be

15 A research community can be defined as: Large international groups of researchers that share common scientific inter- ests, but are not institutionally linked. Researchers will have shared mental model and heuristics on a conceptual level, but will be unaware of individual members.

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

biotechnology, which uses these insights at the molecular level for production/products. Biotech- nology is an

biotechnology, which uses these insights at the molecular level for production/products. Biotech- nology is an example of a generic technology or research discipline. Unlike a research paradigm shift, a discipline does not necessarily develop. Research paradigm shifts will affect society and economy on a systemic level, opening up a wide range of new applications. New industrial sec- tors can be created or current sectors transformed. Research paradigm shifts can be defined as:

Long term changes in research philosophy, which constitute cross disciplinary shifts in global research communities, and even new research communities.

The literature provides some lists of enabling or emerging science and technologies. Perez (1986) talks about the new technologies ; new energy sources, new materials and biotechnology. Recent research focuses on converging technologies: nanotechnology, biotechnology, ICT and cognitive sciences (e.g. IPTS, 2005) These technologies converge, thereby creating new inter- disciplinary research themes. In a recent publication, the UN identified the so-called platform technologies: 16 ICTs, biotechnologies, nanotechnology, and low cost materials (UN, 2005). Most of the research focuses on identifying the most promising sciences and technologies, referring to them as frontier or key science and technologies. Here, we attempt to identify all relevant scien- tific and technological paradigm shifts on the broad societal level.

ICT, biotechnology and nanotechnology, although frequently used terms, their meaning may be problematic. These are umbrella concepts that have much overlap and little focus. For example, there is overlap between nanotechnology and biotechnology. The field of genetic engineering could almost be seen as a part of nanotechnology. As a result, these concepts are more like re- search disciplines than advances in science and technology. Therefore in this report we try to identify their real meanings.

3.3.1. Advanced medical sciences

Important technologies such as biotechnology, nanotechnology, ICT and material sciences have been successfully introduced into healthcare products with one major aim: to improve healthcare delivery. Despite increased interest in cost-benefit assessment techniques, the pace of introduc- tion of new technologies is very slow, and there will be a significant increase in the number of new technologies available in the coming decade (Institute for the Future, 2003a). These devel- opments in the new technologies highlight a number of opportunities for the future such as ge- nomics, new prosthetics techniques and the use of new biomaterials, that will dramatically im- prove life conditions. Telecoms will permit remote monitoring of patients from a centralized facil- ity. Integration of ICT, medical imaging and robotics will allow remote delivery of healthcare, im- age processing, virtual reality, storage analysis and interpretation, robot-assisted surgery, image- guided surgery and conform radiotherapy. The development of medical decision support systems will be an essential complement to evidence-based medicine, providing information, analysis or options to assist in diagnostic, therapeutic and prescription decisions (Braun et al., 2003).

3.3.2. Advanced process technology

Ultimately the goal of advanced process technology is to develop a process pathway or a series of reactions that converts relatively abundant, but poorly differentiated raw materials and feed- stock into desirable products for society, at the lowest possible cost (American Chemical Society, 2001). Major research paradigms that are having a great influence on new scientific insights and enabling technologies in this field are developments in materials science, new theoretical knowl- edge on materials and processes, cognitive science and developments in ICT. Related emerging and driving developments in this field include theoretical modelling of materials and processes, advanced catalysis, novel reactor concepts, advanced separation, novel solvents and alternative

16 The UN nominates them as platform technologies as their benefits are suggested as being available to poor countries that often lack adequate infrastructure (electricity, transport, telecoms).

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

media, functional coatings, advanced sensors, ubiquitous networks and computational intelli- gence (Butter et al, 2006).

media, functional coatings, advanced sensors, ubiquitous networks and computational intelli- gence (Butter et al, 2006).

3.3.3. Cognitive sciences

The field of cognitive science consists of an interdisciplinary study of the structures of the human mind. These structures include the sensory/perceptual apparatus, such as vision, audition, olfac- tion; internal mental processes such as language, thinking, reasoning and problem solving; motor control and the organization of skilled behaviour such as speech and musical performance; memory; consciousness; attention; and many other aspects of the mind. All of these subfields are clearly intertwined. The disciplines involved include psychology, biology, neuroscience, philoso- phy, anthropology, linguistics, sociology, and computer science. Cognitive science has great po- tential for applications in the medical and psychiatric realm, for sensory and motor prostheses, for normal, remedial, and compensatory education, for cognitive, communicative, and decision- making tools. The impact on individual, social, and cultural practices and self-understanding, with implications for the political, economic, and ethical realms, cannot be underestimated. Finally, the stimulation that cognitive science brings to its core contributing disciplines, and to the general advancement of scientific and cultural ideas, is considerable (Andler, 2005).

3.3.4. Intelligent mechatronics

Intelligent mechatronics refers to a new generation of robotics, that can be very small in size, and have the capacity to learn (performing still simple operations). Intelligent mechatronics is centred on mechanics, electronics and computing whose combination makes possible the generation of simpler, more economical, reliable and versatile systems. This hybrid world between ICT and mechanical systems has been stimulated by advanced developments in ICT. New developments in micro/nano manufacturing, embedded systems, advanced sensors and biomechanics, con- nected to better control systems and system modelling are providing the motivation for increasing the intelligence in mechatronics, and further developing the miniaturization of mechanical sys- tems. The great benefit of these technological developments lies in being able to manipulate re- motely (or intervene) in situations where this was previously not possible. For example, use of mechatronics to conduct chirurgic operations within the human body by introducing micro-robots. Similar applications can be found in defence equipment, submarines and equipment for use in hazardous environments.

3.3.5. Molecular biotechnology

Molecular biotechnology is a collection of technologies able to manipulate the structure and func- tion of biological systems on a molecular scale into forms not found in nature. The discovery of the sequencing of the human genome at the end of 2000 heralded a revolutionary new scientific age. The availability of the complete human gene map opens up enormous possibilities still re- quiring the pooling of research efforts on a very large scale. The development of genomics (study of all the genes in a living organism) enables the genetic manipulation of molecules or transgenic organisms, which can completely change the ability to customize therapies based on individual genomics; prevent, diagnose, and treat all types of diseases rather than relying on rescue ther- apy; and provide breakthroughs in agricultural production and food safety (Anton et al., 2001).

3.3.6. Nano-engineering

Nanotechnology deals with the manipulation of atoms or molecules to produce materials, elec- tronics, devices and new technologies. It involves nano-scale construction, atom by atom and molecule by molecule, of new devices with extraordinary properties. The principle underlying nanotechnology is simple: instead of reducing matter to arrive at the smallest possible particle,

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

the smallest possible particle is extracted from matter. For thousands of years, humans have ex-

the smallest possible particle is extracted from matter. For thousands of years, humans have ex- tracted materials from the ground, modified, heated, subjected them to pressure, assembled them, etc. All these procedures use a great deal of energy and, at the same time, generate a great deal of waste. Current industrial production is based on this manufacturing principle. How- ever, nanotechnology uses the individual atoms directly and, through their manipulation and through the application of assembly processes, groups of atoms are formed that can be used to manufacture nano-materials or nano-machines. Nanotechnologies, inasmuch as they are a driver of economic competitiveness, represent not only a major technical and industrial challenge, but also an immense intellectual, cultural and educational challenge (Anton et al., 2001).

3.3.7. New energy technologies

Energy technology is important at both European and national levels. Based on the develop- ments in oil prices, and the threat of climate change, this research paradigm is increasing in im- portance. New technologies in the field of e.g. renewable energy (solar energy, biomass conver- sion), fuel cells, energy storage, catalysis, high power electricity systems are creating momentum for the development of new transport engines, domestic energy systems, centralized energy gen- eration, etc.

3.3.8. Novel materials

Materials are widely used in our society. Packaging of food to providing the information carrier for computer hard disks, all these functions are enabled by various materials, with various character- istics. Materials can be considered the enabler for many technological innovations. Materials technology is a very broad domain that covers many subjects and materials technologies such as processing techniques, analytical techniques, materials design, and cost/benefit tradeoffs in in- dustrial production of materials. In general, materials technology concentrates on the develop- ment of certain materials with specific properties such as low weight, high strength, and efficient biodegradability (Foresight Programme, 2000). Important drivers for these novel materials are pharmaceutics, food conservation, nanotechnology, micro system technology, sustainable energy and transport and space technology.

3.3.9. Ubiquitous computing

As a result of the advances in electronics that produced computers and new telecommunication systems, our economy has changed dramatically. Ubiquitous computing describes a state in which computer-based devices become so cheap, seamlessly interoperable and easy to use that they will find application across a broad swathe of everyday activities. The implications of these changes for policies on technology, employment and competitiveness will be profound (Institute for the Future, 2003b). Examples of research themes are artificial intelligence, advanced comput- ing, human interfaces, ubiquitous networks, telematics, digitization and intelligent electronic de- vices.

3.4. Supply of new economic multipliers: innovation waves

Innovation waves represent societal aims or major technological trends in specific domains, in- volving a number of industries, delivering a massive wave of innovative developments in a bid to achieve particular goals and take advantage of technological potential. Innovation waves can create or transform whole sectors. The societal aims can be sustainability or safety, while techno- logical opportunities include ICT or nanotechnology. Basic societal functions can be addressed by specific sectors, such as transport, health care, agriculture, energy and food. Innovation waves have an impact on large parts of the international economy and require trans-national

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

networks of organizations for their diffusion. Similar to Kondratiev waves, innovation waves, can extend for

networks of organizations for their diffusion. Similar to Kondratiev waves, innovation waves, can extend for 50 to 60 years.

Lists of major developments within industry are scarce. Schumpeter took up the ideas of Nikolai Kondratiev, hypothesizing the existence of very long-run macroeconomic and price cycles, origi- nally estimated to last 50-54 years. According to innovation studies, the Kondratiev waves arise from the bunching of basic innovations that launch technological revolutions, which, in turn, cre- ate leading industrial or commercial sectors. Most theorists agree with the Schumpeter-Freeman- Perez techno-economic paradigm shifts; so far five waves since the industrial revolution, and sixth to come (Freeman, 1997):

1. The Industrial Revolution (1770s to 1840s)

2. The Age of Steam and Railways (1830s to 1890s)

3. The Age of Steel, Electricity and Heavy Engineering (1880s and 1940s)

4. The Age of Oil, the Automobile and Mass Production (1930s 1980s)

5. The Age of Information and Telecommunications (1970s to

)

The even numbered Kondratiev waves represent applications of the core technological break- throughs established in the preceding odd numbered Kondratievs. Therefore, the sixth, currently being debated, is expected to be the knowledge based economy in a globalized world, but there is as yet no consensus. Kondratiev waves focus on the most prominent innovation, which intro- duces completely new sectors. In general, innovation studies mainly focus on technological de- velopment, innovation and diffusion in a few leading and fast-growing sectors. After all, these ma- jor technological paradigms along with their fast-growing sectors drive economic growth. How- ever, innovation is not confined to only a few key sectors forging ahead and driving the economy (Bruland and Mowery, 2005). In the Netherlands, for example, the government has nominated some sectors as transition themes: sustainable agriculture, sustainable energy and sustainable mobility.

Those identified in the literature include: economic and environmental industrial processes; ef- fects-based security operations; efficient and effective healthcare; high tech product manufactur- ing; Information economy; Network economy; new business concepts; refocusing government and citizenship (new governance concepts); safe and healthy food; smart consumer goods; smart housing; sustainable agriculture; sustainable building and constructions; sustainable energy; sustainable regions, cities, and rural areas and sustainable transport. Annex 3.2.3 provides an overview and short description of innovation waves. A brief description of each trend is given be- low.

3.4.1. Economic and environmental industrial processes

This trend focuses on industrial processes, such as chemical and food processing. New conver- sion concepts, separation methods, modelling, advanced use sensors for monitoring and control have led to efficiency improvements, and waste reductions. Reaction and process design (or in- dustrial process technology) refers to the design and development of new processes - the fastest, cheapest, cleanest etc. It includes the development, scale-up and design of chemical manufactur- ing facilities (National Institute of Standards and Technology, 1998).

3.4.2. Effect based security operations

Within the military objectives have changed (Joggaby, 2005a). Historically, warfare was focused on territorial conquest, attrition and annihilation of another country. Nowadays, terrorism and na- tional security are more important than the threat of a war. Currently, destruction is the means rather than the end of conflict, and the focus is on the effectiveness of security operations. These so called effects-based operations are a technology-enabled force employment concept, which

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

subordinates destruction to achieving only desired physical and psychological effects (Joggaby, 2005b). The focus on

subordinates destruction to achieving only desired physical and psychological effects (Joggaby, 2005b). The focus on desired effects and the actions required to achieve them, implies a thor- oughly considered, planned, executed, and assessed security operation. Unwanted side effects from the application of specific security means are avoided as much as possible at all levels of conflict.

3.4.3. Efficient and effective health care

The medical health system is coming under increasing pressure, as a result of the ageing popula- tion, a lack of qualified personnel, better informed and more involved citizens; and increased medical treatment possibilities. Genetics and new ICT developments are converging to generate new treatments. Also new emerging diseases and the potential global spread of disease (due to increased air travel) have increased the need for a change in healthcare. Hospitals and general practitioners are under pressure to improve the efficiency and effectiveness of healthcare, leading to changes in the meso/ macro system of health care delivery (Institute for the Future, 2003a).

3.4.4. High tech product manufacturing

This trend focuses on the manufacture of products. The use of the new ICT in the manufacturing industry has resulted in high-tech manufacturing. It enables miniaturization of manufacturing processes, increased production speeds, higher quality, reduction in costs and increased cus- tomization of production (Roveda et al., 2003).

3.4.5. Information economy

The 2000 Lisbon European Council referred to the development of an information society as a fast way forward towards a competitive and dynamic knowledge-based economy, capable of sus- tainable economic growth, with more and better jobs and greater social cohesion. ICTs create new methods of production, trade and communications. This sector has become the second larg- est in the Union's economy and employs more than 2 m. people in Europe. To maximize the ef- fort in this field, both economically and socially, the future generation of technology will be more integrated into the environment and more accessible, facilitating a multitude of services and ap- plications. The ultimate aim is to introduce more user-friendly technologies in all areas of life: per- sonal security and privacy, teaching and training, access for the elderly and the disabled, tele- working, electronic commerce and administration, on-line health (e-health), intelligent transport, etc. (Prest, 2001).

3.4.6. Refocusing government, new governance concepts

Since the late 1990s the concepts of government and governance have been dramatically trans- formed. These changes have been due to increasing pressures and expectations that govern- ance should reflect modern methods of efficiency and effectiveness, and be more accountable. Furthermore, trends towards globalization, privatization and liberalization have given way to a new system of governance that is characterized by the state having less power to enforce gov- ernance schemes (Montalvo, 2006; Shylendra, 2006). Many claim that ICT could enable both efficiency and democracy to be satisfied more cheaply and easily than previously envisaged, and that the application of ICT enables government to reduce the trade-off that traditionally has ex- isted been between these two goals. New forms of governance are thus emerging, with profound consequences for the way citizenship is understood and exercised. Underlying innovation themes are e-government and deregulation (Millard, 2003).

3.4.9. Safe and healthy food

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

The primary function of food in the human diet is to provide energy and nutrients.

The primary function of food in the human diet is to provide energy and nutrients. Food also has the secondary function of giving sensory satisfaction based on its flavour, taste, colour and tex- ture. Recently, public interest in food has shifted towards safety and health, partly as a result of animal diseases and the risk that they could affect consumers. In addition certain foods have been identified as having the capacity to modulate physiological systems (immune, endocrine, nervous, circulatory and digestive). Research has also shown that a variety of food components, currently classified as non-nutrients, promote a biological activity that can modulate physiological functions in the body (Plaami et al., 2001). Related innovation themes are functional foods, eco- logical foods, food monitoring and food preservation.

3.4.10. Sustainability

Since 1987 sustainability of the developments related to current schemes of consumption and exploitation of natural resources has been questioned (Brundtland, 1987). The acknowledgement that current trends are not sustainable in the longer term suggests that technological stocks need to be radically modified. It has been argued that new technologies might bring the benefit of de- coupling economic growth from environmental degradation while at the same time becoming economic multipliers (Montalvo 2003, EU COM 2004). This assertion has found echoes in eco- nomic sectors such agriculture, construction, transport and energy. For example in agriculture, animal diseases have had a global impact on human health, making citizens more aware of ani- mal welfare and increasing interest in the topic of food quality. Simultaneously, the industrializa- tion of agriculture has had an impact on the environment. Therefore, agriculture is being pushed to achieve a more sustainable character through the application of precision farming, less toxic and more ecological production processes (Marsch, 2001). Furthermore, there is a trend towards optimizing agriculture by means of bio- and nanotechnologies.

In the case of the construction sector, houses, office blocks, bridges and other constructions are changing. Driven by demand for sustainability and customer individuality, as well as develop- ments in materials, ICT and mechatronics, innovations are being initiated in the processes and actual constructions. The design of buildings is highly computerized and will enable more partici- pation from users. New materials will allow faster and cheaper construction, and enable passive buildings where energy efficiency is optimized (Foresight Programme, 2001).

It is well recognized that the energy system, currently based on fossil fuels, must become more sustainable in the long term. These fossil fuels are slowly depleting, while demand for energy is growing; in addition fossil fuels produce environmental problems such as climate change. The innovation domain of sustainable energy includes generation, transport and use of energy in a manner that is globally reliable, safe, affordable, low-emission and efficient. The main focus is on technological development and integration of renewable sources in all aspects of energy supply (storage, distribution, use).

Finally, current transport demand and its associated technologies have a major effect on air quality (23% of total green house gas emissions) (OECD, 2002; WBCSD, 2005). This has prompted governments and technology developers to commit to developing new technologies to reduce environmental pollution create new markets for cleaner means of transport. The rhetoric on sustainable transport has gained momentum, but the market is not expected to take off until around 2020 when the technologies are mature and are complying with the more stringent regu- lations being proposed (ERTRAC, 2004). New innovations also aim at reducing manufacturing costs, increasing quality and safety, reducing environmental impacts (from both manufacturing and use) and increasing traffic efficiency (The Royal Academy of Engineering, 2005).

traffic efficiency (The Royal Academy of Engineering, 2005). Framework Service Contract 150083-2005-02-BE Driving

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

IV. Institutional side

IV. Institutional side

%of worldexport 1980

Expectedaveragean- nual GDPgrowth(%)

GDP(annual average

2004 Tradebalance%

%of worldexport

1990 %of worldexport

(annual average

%of FDI inflows

2004 %of FDI inflows

GDPgrowth(%)

GDPgrowth(%)

(1980-2000)

(2000-2004)

1985-1995)

2006-2010

2000-2004)

4.1. Increasing globalization in a context of innovation and rationalization

Since the 1980s, the world economy has become increasingly connected and integrated; lower transport costs and the diffusion of ICTs have enabled a reduction in the concept of distance , and, in addition, gross trade, FDI, capital flows and technology transfer have risen significantly. These trends should accelerate in the coming decades.

While increased globalization can be considered to be a widespread phenomenon, some indica- tors show that present and future trends are characterized by unbalanced globalization (see Stiglitz, 2002; ILO, 2004). In particular, trade and FDI are mostly concentrated on the developed world; emerging economies such as China and India are rapidly taking-off; other parts of the world are either stagnating (Latin America, with some national exceptions) or even declining in terms of world trade (Sub-Saharan Africa, with the exception of South Africa). According to the recent and expected trends in economic growth (see Table 4), these tendencies will be confirmed in the near future.

Table 4: Global trends in trade FDI, GDP growth

USA

11.10

11.26

9.12

24.18

14.80

-3.87

91

10.6

3.2

Brazil

0.99

0.90

1.07

0.96

2.80

0.80

52

9.2

3.7

Mexico

0.88

1.16

2.11

2.48

2.56

-1.92

69

6.5

4.2

European

38.48

43.23

37.45

35.20

16.00

1.71*

56*

5.2*

2.1*

Union (15)

Russian

Fed-

-

-

2.02

0.70

1.80

13.69

9

26.6

4.8

eration

(1995-

2000)

Japan

6.41

8.23

6.30

0.35

1.20

1.24

70

5.5

1.9

China

0.89

1.78

6.39

6.42

9.35

2.64

536

39.4

7.0

Hong Kong

0.97

2.35

2.89

2.24

5.25

5.99

189

14.2

4.8

India

1.42

0.51

0.80

0.25

0.82

-0.69

200

27.1

5.5

* = European Monetary Union Sources:

% of world export

% of FDI inflows - UNCTAD, World Investment Report 2005; Trade balance % GDP and GDP growth: World Development Indicators - World Bank 2005. Expected GDP Growth: International Financial Statistics January 2005 and projections after 2004 are from Global Insight (formerly DRI-WEFA).

UNCTAD, Handbook of Statistics 2005;

As Table 4 shows, in the last two decades the main emerging economies have taken substantial world market shares from the developed nations, while China (including Hong Kong) has recently become the main recipient of world FDI. Taking into account the spectacular past and present GDP growth of the developing economies (especially China and India) and expected short term trends , it is very likely that further globalization will bring about a further concentration of trade and activities in a selected group of emerging economies.

4.2 Intellectual property rights

With regard to future trends in the globalization of innovative activity, IPR will play an important role. On the one hand, patents and IPR are institutional devices to make inventions and/or inno- vations appropriable, and to avoid free riding and under-provision of innovation activity at the

riding and under-provision of innovation activity at the Framework Service Contract 150083-2005-02-BE Driving
riding and under-provision of innovation activity at the Framework Service Contract 150083-2005-02-BE Driving

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

level of the firm, sector, national and international system. On the other hand, open science

level of the firm, sector, national and international system. On the other hand, open science and

open innovation (for example the open source software

OSS movement; see Hertel et al.,

2003) are increasingly diffusing throughout the world. In the coming decades there would appear

to be two main global drivers:

1)

The trade-off between open science (to make scientific results and inventions publicly available) and protected/patented commercial applications (see Dasgupta and David, 1994; Murray and Stern, 2005). Finding the right balance between appropriability and dif- fusion - in terms of legislation and private/public incentives - will be one of the major chal- lenges in the next few decades.

2)

The increasing diffusion of IPR and patenting in the emerging economies, and their in- creasing role in dedicated international organizations such as WIPO and WTO (see Alik- han, 2000). As Table IV.3 shows, patenting activity in the emerging economies is boom- ing and this is a clear signal of an increasing protection of IPR in those economies.

Table 5: Number of patent applications

Resident type

Patent applications

1996

Patent applications

Rate of growth

2002 1996-2002

USA

Brazil

Mexico

European

Monetary Union

Russian

Federation

Japan

China

Hong Kong

(China)

India

Non residents

Residents

Non residents

Residents

Non residents

Residents

Non residents

Residents

Non residents

Residents

Non residents

Residents

Non residents

Residents

Non residents

Residents

111,536

111,883

29,451

2,655

30,305

389

838,660

99,022

28,149

18,138

60,390

340,861

41,016

11,698

2,059

41

Non residents

6,632

Residents

1,660

183,398

198,339

95,225

6,521

94,116

627

2,448,271

129,155

96,315

24,049

115,411

371,495

140,910

40,346

9,018

112

91,704

220

64%

77%

233%

146%

211%

61%

192%

30%

242%

33%

91%

9%

244%

245%

338%

173%

1,282%

-87%

Source: World Bank, World Development Indicators 2005.

Finally, an important feature of current trends in globalization concerns the shift from a national to a regional, international and technological competition. In general, increased global competition is moving from tangible to intangible goods and services, while the actors involved are increasingly regions rather than nations.

Indeed, in a context of increasing globalization, the geographic concentration of populations, ex- ternal and network externalities and agglomeration economies is making regions rather than na- tions the main actors in global competition and the main drivers of economic growth (see Lundvall

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

et al ., 2002). This trend will continue probably for another 20 years, although it

et al., 2002). This trend will continue probably for another 20 years, although it might be partially countered by a filtering out of activities away from the more congested areas in developed coun- try cities.

As Table 6 shows, innovation activities such as patents are even more geographically concen- trated than the levels and rates of change in GDP. In fact, innovation is particularly affected by agglomeration economies, locally bounded spillovers and the regional institutional framework. Accordingly, scholars are increasingly discussing the crucial role of regional innovation systems, together with the more traditional concept of national innovation systems (see Breschi and Lis- soni, 2001).

Table 6: Geographic concentration in key OECD countries *

GDP

GDP

GROWTH

PATENTS

SKILLS

(TERTIARY EDU-

CATION)

AUSTRALIA

35%

37%

79%

70%

CANADA

41%

43%

44%

69%

FRANCE

38%

45%

52%

36%

GERMANY

35%

43%

46%

24%

ITALY

39%

43%

54%

18%

JAPAN

42%

82%

83%

37%

KOREA

43%

57%

73%

31%

MEXICO

40%

39%

n.a.

62%

TURKEY

55%

63%

n.a

58%

UK

37%

57%

46%

33%

USA

39%

44%

65%

57%

*(weights of the 10% of the regions within a country, year 2001) Source: OECD, Regions at a Glance 2005.

Concerning the process of globalization and the easier communication enabled by the diffusion of ICT, and geographical proximity, a distinction needs to be made between information, which con- sists of codified data that can be easily stored and retrieved, and knowledge, which includes tacit knowledge, know-how, and skills that can be transmitted only through learning and experience. While the process of globalization has been fostered by falling costs in the transmission of codi- fied data through ICT, tacit knowledge that is embedded in people and organizations requires companies to locate their activities in proximity to the sources of knowledge. Geographic prox- imity thus becomes essential to gain access to knowledge of markets, even more important in a global economy where a broad range of idiosyncratic regional markets exists (Geyer et al 2003).

Proximity also allows firms to gain access to new technological knowledge in the form of spill- overs from other companies or public institutions (Audretsch and Thurik, 2000). New technologi- cal knowledge is not fully appropriable by its producers; new knowledge spills over and creates benefits at no additional cost (or minimum cost) to organizations other than the knowledge crea- tors. Knowledge spillovers often occur through employee mobility or informal communica- tion/exchanges within a community of researchers from companies, universities and public re- search institutes. Knowledge spillovers among individuals and organizations that carry out re- search in related areas are regarded as a key source of technological breakthroughs (the case of semiconductors and Silicon Valley is most often cited in this respect). These spillovers are diffi- cult to diffuse across space and tend to be localized within geographical clusters (Audretsch and Thurik, 2000). These factors have implications for firms decision making processes in relation to their innovative activities. The decisions of companies to invest in R&D and then where to locate these R&D activities are shaped by the proximity to other company activities and to technology poles and incubators, which provide access to specialized R&D knowledge and results (Euro- pean Commission, 2005).

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

4.3. International outsourcing and the labour markets According to the Heckscher-Ohlin theorem, rich, developed countries

4.3. International outsourcing and the labour markets

According to the Heckscher-Ohlin theorem, rich, developed countries should outsource

both trade specialization and FDI

tries where unskilled labour is cheaper. Although this has been happening, the emerging econo- mies are increasingly catching-up in terms of education, skills and technological absorptive ca- pacity (see Ghose, 2003; Lall, 2004).

through

labour intensive and unskilled activities to developing coun-

intensive and unskilled activities to developing coun- As mentioned above, international outsourcing also involves

As mentioned above, international outsourcing also involves higher value added activities and international competition is no longer North-South/knowledge intensive-labour intensive goods, but is much more comprehensive and intra- rather than inter-industry. This trend will increase appreciably in the next two decades (see ILO, 2005).

Accordingly, the international division of labour between firms and within transnational corpora- tions is more complex than it was only ten or 15 years ago, with new industrialized countries and emerging economies deeply involved in R&D, ICT diffusion, and the development of new prod- ucts and services (see Wood, 2001; ILO, 2001).

These changes are obviously challenging the labour markets of the developed world. In particu- lar, increasing globalization, international outsourcing and technological/organizational changes are challenging European labour markets in terms of employment levels, skill-bias, sectoral mo- bility and regulatory frameworks. As can be seen from Table 7 the main developed countries have shown a remarkable increase in the percentage of skilled labour (see also OECD, 1996,

1998).

Table 7. White-collar workers in manufacturing employment in the G-7 countries

Canada 1981-1991//1996-2000

France 1982-1990//1990-1999

Germany 1980*-1990*//1999-2002

Italy 1981-1991//1997-2002

Japan 1980-1990//1997**-2003**

UK 1981-1991//1991-1999

US 1983-1993//1998-2001

0 5 10 15 20 25 30 35 40 45
0
5
10
15
20
25
30
35
40
45

Notes and sources:

Shares (percentage values) Blue indicates the first period. For each country, the two pairs of bars refer to the initial and final year of the two periods reported on the left. The source of data reported in the first period is OECD (1998), for the second period Piva et al., 2005. Data are not comparable between countries, while within countries the two pairs of values are comparable . * data for Germany refer to West Germany for the 1980-1990 period and to the whole of Germany for the 1999-2002 pe- riod; the inclusion of East Germany contributes to reducing the skill incidence in manufacturing employment. ** 1997-2003 data for Japan also include the construction sector, which explains the reduction in skill incidence in the last period with respect to the previous one

Globalization of economic activities and outsourcing are without doubt responsible for the trends towards up skilling in the workforces of developed countries. The main reactions to these trends in terms of labour markets have been increasing wage and income dispersion in most of the de- veloped countries (see Freeman, 1995; Feenstra, 2000; Cornia, 2004 and Table 8) and decreas- ing protection of workers (see OECD, 1994; CEPR, 1995). Indeed, it is more than a decade since

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

wage moderation and labour market flexibility were considered as necessary adjustments to in- creased competition

wage moderation and labour market flexibility were considered as necessary adjustments to in- creased competition resulting from globalization and the diffusion of technological progress.

Table 8: Income inequality in the G7 countries (Gini index)

 

Gini Index

Gini Index

Gini Index

mid-1980s

mid-1990s

2000

Canada

28.7

28.3

30.1

France

27.6

27.8

27.3

Germany

-

28.3

27.7

Italy

30.6

34.8

34.7

Japan

27.8

29.5

31.4

United Kingdom

28.6

31.2

32.6

United States

33.8

36.1

35.7

Source: OECD, OECD Factbook 2006: Economic, Environmental and Social Statistics

However, in the last two decades the occupations that have been negatively affected by these drivers have mainly been unskilled jobs in traditional manufacturing sectors as a result of more outsourcing of unskilled activities to the developing world.

In the coming decades, given the trends described above, most categories of workers with the exception of specialists and workers employed in sheltered sectors such as non tradeable public and private sectors will be affected. In this context, the risk of a rush to the bottom (lower wages and lower labour protection) between the developed and developing world is increasing and spreading around the different economic sectors and occupations.

4.4. The role of organizational change

Together with increasing globalization and outsourcing of economic activities, another big revolu- tion is underway in both the developed and developing countries: lean production (see Piva et al., 2005).

17

Decentralization and delayering; collective working in teams and quality circles; multi-tasking workers and job rotation are increasingly common features of national and transnational firms corporate governance (see Brynjolfsson and Hitt, 2000; Hitt and Brynjolfsson, 2002). In the next two decades we can forecast a deepening of new organizational practices in the developed coun- tries and an extensive diffusion of these same practices in the developing world.

This means that R&D alone will be insufficient to pursue productivity gains and international com- petitiveness. A vast theoretical and empirical literature is showing how the European productivity slowdown and the so-called Solow paradox (Solow, 1987) is due to the lack of organizational changes necessary to make new technologies profitable. In other words, technological and or- ganizational changes are strictly complementary and super-additive, thus productivity gains can only be obtained through their simultaneous adoption.

In addition, there is a third aspect, which concerns skills and human resource management (HRM). Innovation, re-organization and skills constitute what is referred to as the productivity tri- angle (see Caroli, 2001), able to sustain competitiveness and to face the challenges from the emerging economies.

In terms of policy prescriptions, this argument suggests that innovation policies should be cou- pled with re-organizational strategies and HRM at the level of firms. Indeed, the lack of comple-

17 First introduced in Japan, lean production is the organizational model based on just in time, total quality management and flattening hierarchy as efficient ways to match new technologies and obtain the required flexibility both in process and product innovation (see Womack et al., 1990), The Machine that Changed the World, Macmillan, London).

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

mentary manpower strategies increases the likelihood of redundancy among those workers that may be particularly

mentary manpower strategies increases the likelihood of redundancy among those workers that may be particularly exposed to the threats of globalization and skill-biased organizational and technological changes. Hence, policy makers should support holistic strategies at the level of the firm (on-the-job training aimed at transferring updated capabilities to workers), and promote edu- cation and off-the-job training.

The literature suggests that ICTs and other pervasive general-purpose technologies (GPTs) are applicable across a wide range of functions and tasks (see Bresnahan and Trajtenberg, 1995; Freeman and Louçã, 2001) and so workers are better off with a general rather than vocational education, because their skills are in this case less likely to be rendered obsolete by globalization and technological progress (see Bresnahan (1999) and Bresnahan et al. (2002), Maurin and Thesmar, 2004).

4.5. Conclusion

As the above sections have shown, the interaction between globalization, technological progress and organizational change proves to be knowledge-biased for all levels of the workforce. As far as labour markets in the developed world are concerned, global competition and outsourcing would seem to imply either an increase in unemployment or an increase in income inequality and labour market deregulation (see Section 2). A possible alternative to these trends might be achieved through greater competitiveness derived from innovation and increased productivity. In particular, economic policy should encourage product innovation in high-tech sectors and in those sectors characterized by higher income and demand elasticities (such as ICT services; see Freeman and Soete, 1994; Torrisi, 1998; Vivarelli, 1995, 2006).

At the same time, technological and organizational change are imposing increasing demands on knowledge-based workers and combining the three angles of innovation, organization and HRM (see Section 3) seems the only way to efficiently compete with emerging economies in the long- run (as opposed to short-term responses such as decreasing wages, increasing wage dispersion and increased labour flexibility, see Section 2). In this framework, the concept of a learning soci- ety (see Lundvall, 1992; Lundvall and Johnson, 1994; Lundvall et al., 2002) should shape the evolution of economic and education policies. 18

the evolution of economic and education policies. 1 8 To sum up, the only feasible alternative
the evolution of economic and education policies. 1 8 To sum up, the only feasible alternative

To sum up, the only feasible alternative to the race to the bottom strategy to face the competi- tion from emerging economies appears to be an efficient combination of technological and organ- izational innovation with adequate education and training policies,. both at the national and re- gional level.

policies,. both at the national and re- gional level. 1 8 A learning society is a

18 A learning society is a socio-economic system able to match the challenges posed by the diffusion of the ICTs in terms of supply of skills, education and life-long training (see Lundvall, 2001).

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

V. Emerging economies

V. Emerging economies

The majority of children s toys carry the label Made in China.

70% of the world s toy production (Shenkar 2005). In 1843, Daniel Webster, US Secretary of State in the John Tyler administration wrote that the great and well-known amount of imports of the production of China into the United States are not likely to be diminished (Shenkar 2005, p. 72) 19 . Prescient words. Currently, China is taking on the world and the world seems to have little choice but to deal with this reality so long as China continues its dizzying pace of economic de- velopment. Like India and Russia, it is an arriviste power.

In January-February 2006 at the Davos World Economic Forum, discussions on China figured

prominently. But it was India that seemed to be everywhere, an India that was intent on brand- ing itself as an attractive destination for foreign investment, as an emerging manufacturing hub and as a credible partner for world business. In an effort to showcase its strengths and opportuni-

ties in front of world business and the political elite, Indian business and government leaders had committed some two years of effort, and more than $4 m,, to an elaborate marketing and PR

campaign

(Knowledge@Wharton, 2006; Wolf, 2006). China, on the other hand, was relatively invisible in terms of its public relations efforts.

This section addresses the key drivers for economic progress in India and China, these being the two countries that occupy centre stage among the Emergent Economies. They have become the focus of global attention because India is on the growth turnpike (Kelkar 2004) and China is

funny looking tiger (Economist 1996), and have experienced the fastest growing economies in the last 20 years.

Since the opening of China to foreign investment in the mid 1980s, and its embarkation on eco- nomic reforms, China has taken the lead over India. Its economic growth has averaged just under 10% per year; India s, despite it active program of reforms in 1991,was about 6% per year for the same period (Wolf, 2006),. It is however, important to note that the economic-political environ- ments of these two countries are distinctly different. China in many ways is still shackled to com- munism, whereas India is the world s largest democracy. Therefore, to contrast and compare re- cent economic performance in India and China is to portray the two countries in some zero-sum game, that is, to ask which of the two countries is going to lose the contest. Rather than sur- mising whether India will outpace China, it is more constructive to examine the drivers of each country s economic growth.

It is on this premise this next part of the report investigates the impressive performance of India and China.

a

the impressive performance of India and China. a China is responsible for some India Everywhere to
the impressive performance of India and China. a China is responsible for some India Everywhere to

China is responsible for some

of India and China. a China is responsible for some India Everywhere to ensure that the
of India and China. a China is responsible for some India Everywhere to ensure that the

India Everywhere

to ensure that the India story receive attention at this summit

ensure that the India story receive attention at this summit 5.1 India India embarked on an
ensure that the India story receive attention at this summit 5.1 India India embarked on an
ensure that the India story receive attention at this summit 5.1 India India embarked on an
ensure that the India story receive attention at this summit 5.1 India India embarked on an
ensure that the India story receive attention at this summit 5.1 India India embarked on an
ensure that the India story receive attention at this summit 5.1 India India embarked on an
ensure that the India story receive attention at this summit 5.1 India India embarked on an

5.1 India

India embarked on an ambitious reform programme following the country s balance of payments crisis in 1991. There was a marked willingness to begin an effective shedding of its hitherto dirig- isme economy and to introduce industrial and trade liberalization, and financial deregulation. Policies conducive to privatization and FDI were introduced, along with improvements to India s regulatory systems. These reforms helped to accelerate the country s hitherto dismal rate of growth, once described as Hindu when referring to its low rates of growth in the three decades after its independence from Great Britain in 1947. These reforms built upon the reforms of the 1980s, about which much has already been written (Desai 1999), but these reforms were fledg- ling compared to the 1990s measures.

reforms were fledg- ling compared to the 1990s measures. India s real GDP growth accelerated in
reforms were fledg- ling compared to the 1990s measures. India s real GDP growth accelerated in

India s real GDP growth accelerated in 2003/2004 to its highest level in over a decade. At 8.2%, real GDP growth was double that recorded in 2002/2003, when India suffered its worst drought for over 15 years. This remarkable stellar recovery in activity was spearheaded by agriculture

19 Citing From instructions by Daniel Webster to Caleb Cushing, his emissary to China, whose mission resulted in the Treaty of Wanghia, signed on July 3, 1844. 'Annals of American History.'

on July 3, 1844. 'Annals of American History.' Framework Service Contract 150083-2005-02-BE Driving

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

where growth reached 9.1% in 1996. Industry grew by 6.7% and services grew by 8.7%

where growth reached 9.1% in 1996. Industry grew by 6.7% and services grew by 8.7% (IMF

2005).

The drivers for India s growth are categorized as (1) social; (2) economic; and (3) institutional.

5.1.1 Social Drivers

Social drivers, unlike economic or structural reforms, do not usually feature largely as factors for economic growth. But the social dimension helps to underpin or sustain growth and thus needs to be considered alongside other drivers of economic growth. Economic development results from the interaction of growth opportunities with the right fundamentals or pre-existing capabilities (Kochhar et. al, 2006). These fundamentals are diverse and include human capital. Of course the sheer population size of a country is not a necessary condition for economic growth, but it could be a sufficient condition that works in conjunction with other drivers, for a country to develop and grow.

5.1.1.1. Demography

Much has been written about the greying of the world s population, which has given rise to a near universal pensions crisis. India is not exempt, but is in a better demographic situation than China, which also has a huge population. An average of 13 m. people are expected to enter the Indian labour force every year for the next four decades (Kochhar et al., 2006, IMF 2005). Fore- casts of the number of Indian men and women over 60 years old in 2025 are 11.8 and 13.1%,

respectively. In China, the figures are: men

the median age for India is forecast to be 33 years in 2025. For China, this is 39. Significantly, the dependency ratio of the Indian population (the ratio of those above and below standard working age to those of working age) is 16.2 and 20.5 for men and women, respectively; for China, this is 28.4 and 30.8 (Concepcion, 2000; Kelkar 2004). These comparative data signal that India will

have a larger and younger labour force

invariably is required for sustainable economic growth.

16.8 and women 19.8%, respectively. Furthermore,

a demographic dividend (Kelkar 2004, p. 20), which

5.1.1.2. Life expectancy

Associated with their demography is life expectancy in India, which has increased from 55 to 63 years. The infant mortality rate has dropped from 109 to 70 per thousand live births (Fischer, 2002). This trend helps to sustain India s demographic advantage in providing human capital and a viable work force, at least over the next 20 years.

5.1.1.3. Education: Improved literacy rate and the wide use of English

India s literacy has risen from 45 to 68% for men and from 20 to 45% for women (Fischer 2002). With more investment in higher education and professional training, such as engineering, com- puter science and software programming, and biochemistry, this high level of human capital will continue to underpin India s economic growth. The IT explosion has apparently increased the attractions of higher education. There is anecdotal evidence about the demand for English lan- guage schools in backward states, such as Bihar and the agricultural hinterland of Punjab. This demand is based on the belief that a command of the English language provides a gateway to better employment opportunities largely because the use of English is widely acknowledged to be an important factor in engaging with the worldwide economic community and using the Internet. English is the language of international business and its use lowers transaction costs in interact- ing with the global economy. The ability to communicate effectively with the global economy, among other factors, provides opportunities for job creation. Other observers have provided sys- tematic evidence from Mumbai on how the increased returns from education are bringing about an increased enrolment of women in schools and upsetting the traditional caste system (Munshi and Rosenzweig, 2003). However, because its population is so huge, India s population will con- tinue to have generally low levels of education.

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

India s remarkable growth in the last decade or so has been mainly due to

India s remarkable growth in the last decade or so has been mainly due to its stock of highly edu- cated human capital. Incomes will likely rise with continued economic growth and this in turn may provide a disincentive for labour emigration, a pattern that India experienced in the 1970s (partly because of the stagnant state of the Indian economy referred to above). The more high skilled labour that remains within India, the greater the spillover benefits to the Indian economy (Rodrik and Subramaniam, 2004a, p. 8; 2004b; Kochhar et al. 2006). Retention and skills training re- mains a priority for the Indian Government.

training re- mains a priority for the Indian Government. 5.1.2 Economic Drivers Much has been written
training re- mains a priority for the Indian Government. 5.1.2 Economic Drivers Much has been written

5.1.2 Economic Drivers

Much has been written about the effective package of reforms that India undertook in the 1990s, following the 1991 exchange crisis, which saw India s shift toward neoliberal, pro-business and pro-market economic reform. Yet much has also been written on the greater significance of In- dia s progress from the reforms undertaken in the 1980s (Desai, 1999; Kochhar 2004). Arguably, if the starting level is low, any progress from that level will be impressive. However, it is not the purpose here to engage in this debate; it is accepted that the reforms undertaken in the mid- to late 1980s paved the way for India s accelerated growth. The point that should be emphasized is that growth is arguably unsustainable in the absence of ongoing economic and institutional meas- ures directed at overall economic growth. In other words, reforms must be systematic, if not sys- temic see Table 9.

This section on economic drivers focuses mainly on the global IT outsourcing trend that helped to drive India s economic growth and whose international trade has been boosted by this global de- mand for IT-related services. Services, in particular in the IT sector as the following discussion will show, continue to remain a central feature of India s growth and international trade.

Table 9 India: Composition of GDP (Per Cent)

1980

1990

2000

Agriculture

38.6

31.3

24.9

Industry

24.2

27.6

26.9

Manufacturing

16.3

17.2

15.8

Services

37.2

41.1

48.2

Source: World Bank, Basic Indicators, as adapted from Panagariya, 2004, p. 35.

5.1.2.1. Global IT boom and the foreign demand for outsourcing

The growth of services picked up sharply in the 1980s but accelerated in the 1990s, at an aver-

age rate of 7.5% per annum (Panagariya 2004; Kelkar 2004; Kocchar 2005). Its growth outpaced that of industry. Today, India is a byword for the provision of IT-enabled and professional ser- vices, such as software programming, software engineering, business process outsourcing, fi-

nancial services, health services and call centres etc

from high volume production of low-end services such as accounting and payroll management to services that require highly specialized and high wage staff, such as research and development. For example, research laboratories set up in India by foreign companies have filed for more than 1,000 patents with the US Patent and Trademark Office (Kelkar 2004).

Business services, communication, IT-services banking and hotels and restaurants were mainly responsible for the acceleration in services growth. Business services grew the fastest, with growth averaging nearly 20% in the 1990s. However, it must be noted that business services was growing from a very low base (IMF 2005). As pointed out above, the growth in services was pro- pelled by foreign demand, although domestic demand has also grown. The impact of domestic demand, however, is less outstanding than the effect of increased foreign demand. For instance,

Export-oriented services production ranges

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

the export market registered an average growth rate of 42% and the domestic market 16%

the export market registered an average growth rate of 42% and the domestic market 16% (IMF 2005) between 1998-2003.

The dramatic growth in these areas, particularly in IT-related services, is largely attributable to the nexus between the economic reforms that the country undertook to stimulate the services sector and the worldwide demand for IT and telecommunications services, coupled with the accelerating demand for IT-related services outsourcing. It must be remembered that growth in services is not unique to India; there is an extant literature explaining why services grow rapidly in mature economies. Where India, perhaps differs from this pattern is the rate of growth in its service sec- tor as a percentage of GDP. For instance, average annual growth rates in the services sector went from 6.9% during 1981-1991 to 8.1% for the period 1991-2001 (Panagariya 2004).

Certainly technological advances particularly in IT and telecommunications have played an im-

portant role. As noted above the confluence between economic reforms and the global IT boom that began in the late 1990s and continues to the present day provided opportunities for India. It would be useful to ponder what would have been the state of India s growth in the IT services sector in the absence of the worldwide demand for IT-enabled services and outsourcing. None- theless, for India the timing was opportune and the IT sector recorded the most impressive growth, at an annual rate of 28% between 1998 and 2003, and turnover estimated at US$17 bil- lion in 2003 (IMF 2005). Indian exports in these services grew at an average of 15% per year in the 1990s compared with 9% in the 1980s, and at21% in the second half of the 1990s. Cumula- tively, service exports increased four-fold in the 1990s and constituted US$25 billion in 2002

35% of total exports

In the Indian context, IT services encompasses ITS (systems integration, packaged software in- stallation and support, application outsourcing, custom application development, testing, etc), hardware development and maintenance, and ITES (call centres, payment services, human re- sources management systems, finance, business process outsourcing, etc). ITES exports grew at an average annual rate of 62% in 2001-2003. The share of ITES and ITS exports increased from 35% in 1998 to more than 60% in 2003, compared with the domestic market for ITS and ITES which decreased by 20% in 2003 (IMF 2005, Gordon and Gupta, 2004). Table 13 presents the composition of the IT sector in India.

of which about one third came from software exports (IMF 2005).

Table 13 Composition of the IT Sector in India, 1998, 2004.

1998

1998

2004

2004

Composition

US$ million

Percentage

US$ million

Percentage

IT& ITES exports

1759

35

12,200

63

IT domestic

2096

42

3780

20

Hardware domestic

1152

23

3370

17

Source: IMF 2005, p. 17

Associated with the growth in the IT sector was the changing composition and mode of IT exports over the period 1998 to 2004. In 1993-94, nearly 62% of all IT exports from India were conducted onsite (at the client s premises). By 2002-2004, off-shoring, or outsourcing by foreign customers, dominated the mode of delivery of software exports, accounting for almost 58% of total exports. For India, the growth in IT exports has been remarkable. From a global perspective, however,

India accounts for a minor share of the total global spending on ITES

It is also worth noting that while outsourcing has provided increased employment opportunities, its overall contribution to total employment remains modest. According to the Nation Association of Software and Service Companies (NASSCOM), the ITES segment provided additional em- ployment to 74,400 people in 2003-2004; the total number employed in this segment was 245,500 by March 2004. Despite the NASSCOM-McKinsey report s forecast of an additional 1 m. jobs in this segment, it still constitutes a small contribution, given that India has to generate jobs

less than 2%.

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

for about 100 m. new entrants in the next decade (IMF 2005; Gordon and Gupta

for about 100 m. new entrants in the next decade (IMF 2005; Gordon and Gupta 2004). A poten- tially dampening factor for further generation of employment in the IT sector could lie in the grow- ing furore caused by organized labour in foreign countries, such as the US, over the issue of IT outsourcing and the loss of domestic jobs. The jury is still out on the backlash and the effects of this increasingly contentious issue on India. Does the modest overall growth in employment in the Indian services sector help to underscore the need for industry and agriculture to grow rapidly? Could Europe derive any implications from this by questioning the real role of the IT sector in overall job creation?

the real role of the IT sector in overall job creation? 5.1.3 Institutional Drivers The quality
the real role of the IT sector in overall job creation? 5.1.3 Institutional Drivers The quality

5.1.3 Institutional Drivers

The quality of institutions is well recognized as contributing to successful development. High qual- ity or well-functioning institutions, among other things, lower transaction costs, provide good gov- ernance and ensure trust and credibility. The following sections discuss India s existing, reformed and new institutions. It begins with the institutional reforms at the central and levels, which are then followed by the sweeping changes of trade liberalization and privatization.

5.1.3.1. Central level

Institutions, for the purposes of this report, are defined as a set of norms, practices and proce-

dures

ganizations/regimes. For instance, democracy, the press, regulatory bodies, the bureaucracy, redistributive mechanisms, market stabilization and pro-business measures are examples of insti- tutions. Already noted above, a joint reading of the economic and institutional drivers arguably provides a better grasp of the impact of the drivers for India s growth. As the discussion on Eco- nomic Drivers above has shown, economic reform was very much a part of India s existing and new institutional landscape. Indeed, the existing institutions of democracy, the rule of law, etc, provided the bedrock on which India s development since its independence in 1947 was founded. Since then new institutions have been introduced and others, deemed incompatible with its post 1991 reform package, abandoned or reformed. Institutions reflect the past and present but they are also constituted by change.

As noted above, a key fundamental in the case of India is the presence of established institutions.

It is a democratic state, which functions under the rule of law. But this is not to say that non-

democratic states cannot grow fast; witness China. In fact, one could argue perversely that de- mocratic states can sometimes find it more problematic to institute change. However, in the case

of India, its long-standing democratic institutions have in large part contributed to its political sta-

bility, an important factor for FDI.

In the case of new regulatory bodies, India is continuing to develop supervisory and prudential

institutions to ensure proper governance in the financial sector. In a show of its commitment, In- dia has submitted to the scrutiny of Financial Sector Stability Assessment, which is a diagnostic tool that draws on the knowledge of experts from national and international institutions, led by the IMF and the World Bank (Fischer 2002). In liberalizing its insurance sector, it established an In- surance Regulatory and Development Authority. According to the World Bank s Governance in- dicators India ranks above China, in voice and accountability (Government s efforts in trans- parency) and government effectiveness (Wolf, 2006; Dahlman and Utz 2005). Another institu- tional advantage is a well-developed private sector that continues to animate business develop- ment opportunities.

rules of the game, the legislative, the judiciary and the rule of law, regulations, and or-

the judiciary and the rule of law, regulations, and or- 5.1.3.2. State level A less widely

5.1.3.2. State level

A less widely researched issue is policy decentralization reform and its effect on India s growth.

India s democracy is more representative than participatory. In recognition of this, the 73

74 th amendments to the Constitution of India, which became law in 1993, represented a major

rd

and

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

step toward decentralization. From then, it became mandatory for each state to constitute local self-government

step toward decentralization. From then, it became mandatory for each state to constitute local self-government institutions (Narayana 2005; Kelkar 2004; Kochhar 2006).

A major objective of this measure was to remedy the disadvantaged position of certain groups

(castes, women) in the state electoral and decision-making processes. To achieve this, new insti- tutions had to be developed. According to experts, the loosening of central control over economic decisions catalysed states into undertaking economic measures, including those designed to at- tract private sector investment. According to Kochhar (1996), many states economic perform- ance was closely tied to state policies and their new institutions, facilitated nonetheless by de-

regulation measures and the relaxation of protectionist controls undertaken at central level. This

of course led to stark divergences in growth rates between the states. But as Kochhar (2006)

suggests, laggard states can still reform and perhaps the precedent set by Western Europe, which offered incentives (through the European Commission) for laggard European countries to reform, can be a lesson. The external pull set reforms into motion, so much so that some of the former laggards like Ireland and Spain are now Europe s locomotives (Kochhar, 2006, p. 43).

But institutions can also inhibit progress; a refusal to dispense with institutions that are no longer relevant can thwart change. India seemingly suffers from this problem even as it creates new in- stitutions to spur the country to greater growth. For instance, dealing with its bureaucracy to set up new businesses is still considered to be difficult and time consuming. Its continuing ban on exit and retrenchment of workers remains a stumbling block to more flexible labour policies that aim

at increasing productivity and constraining costs, and privatization needs to proceed faster.

5.1.3.3. Deregulation and privatization of industry

In July 1991, the minority government of P.V. Narasimha Rao announced sweeping (by India s

standards) liberalization measures and opened up an economy that hitherto had been rather in- sular. These measures dismantled import controls, lowered customs duties, devalued the cur- rency and, with the exception of except the rail transportation and nuclear energy sectors, se- lected for security and strategic reasons, broke public sector monopolies.

The 1990s reforms saw a rapid deregulation of industry, with only five sectors requiring industrial licensing down from a list of 18 at the start of the reforms. These were retained for health and safety, and environmental reasons and included(a) arms and ammunition, military aircraft and warships, and items of defence equipment; (b) nuclear substances; (c) narcotics and psychotro- pic substances and hazardous chemicals; (d) distillation and brewing of alcoholic drinks; and (e) cigarettes/cigars and manufactured tobacco substitutes (Panagariya, 2004).

Entry restrictions on MRTP firms (firms subject to the Monopolies and Restrictive Trade Practices Act had an asset limit) were abolished, which allowed mergers, acquisition, amalgamation and takeovers to be conducted more freely. New regulations for controlling and regulating monopolis- tic, restrictive and unfair trade practices were instituted to replace entry restrictions.

Privatization was also a major theme of the reforms but has progressed only gradually. There are still 276 public sector companies at central level, which observers regard as untenable (Kelkar 2004, p. 11). However, central and state governments recognize the link between privatization and productivity and are continuing to privatize these companies, albeit at a leisurely pace. For instance, of the total of 919 state companies, 33 have been privatized and 69 have recently been shut down (Kelkar 2005, p. 11).

With regard to FDI, the previous threshold of 40% on foreign equity investment was abolished and replaced by a threshold of 51%. Since January 2006, India allows 51% foreign investment in the retail industry, thus clearing the way for companies such as Reebok and Nike to move be- yond franchise agreements in India. In eight categories, including mining services, electricity gen- eration and transmission, and construction of roads, bridges, ports, harbours and runways, the automatic approval for equity investment is now 74%. Furthermore, automatic approval for FDI of up to 100% is applied to all manufacturing activities, with certain exceptions, such as acquiring an existing Indian company and in industries where sectoral policies apply, for example, telecoms and insurance. These require special conditions. FDI in defence production significantly, is now allowed up to 26% equity, subject to licensing terms (Panagariya, 2004; IMF 2005).

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

5.1.3.4. Trade Liberalization; Globalization Trade liberalization reforms were reflected in (1) merchandise trade; and (2)

5.1.3.4. Trade Liberalization; Globalization

Trade liberalization reforms were reflected in (1) merchandise trade; and (2) services. Merchan- dise trade liberalization was undertaken mainly through tariff reform. Trade in services was liber- alized mainly through institutional reforms, which prominently allowed FDI and foreign equity in a broad range of service sectors.

5.1.3.5. Merchandize Trade Liberalization

Tariff rates rose substantially from the 1980s. Tariff revenue as a proportion of imports rose from 20% in 1980-81 to 44% in 1989-1990. In 1990-1991, the highest tariff rate was a shocking 355% and the average of all tariff rates was 113%. These tariffs thus became barriers to imports when licensing was removed (see above). As a core plank of the 1991 reforms was to liberalize the economy and to make India more business-friendly, the Indian Government was forced to lower tariffs. The tariff structure was eventually rationalized through a reduction in the number of tariff bands. The top rate fell to 85% in 1993-1994 and 50% in 1995-1996. In 2003-2004, the top rate fell to 25% (Panagariya 2004).

The July 1991 reforms abolished import licensing on most intermediate inputs and capital goods. About 30% of all tariffs, however, were made up of consumer goods and these remained subject to licensing. However in 2000 India s trading partners successfully took India to the World Trade Organization (WTO), which led it eventually on 1 April, 2001, to free all consumer goods from licensing, with a few exceptions. By 2004, India could be described as having really liberalized its trade practices, especially in the light of its past prohibitive tariff structure.

in the light of its past prohibitive tariff structure. 5.1.3.6. Liberalization of Trade in Services Liberalization
in the light of its past prohibitive tariff structure. 5.1.3.6. Liberalization of Trade in Services Liberalization

5.1.3.6. Liberalization of Trade in Services

Liberalization of merchandise trade was accompanied by liberalization of trade in services in the

1991 reforms. Service sectors were traditionally subject to Government intervention, for instance

in insurance, banking and telecommunications. In 1991, the Indian Parliament passed the Insur- ance Regulator and Development Authority Bill, established an Insurance Regulatory and Devel- opment Authority and opened the sector to private entrants and foreign investors.

The financial sector has undergone significant changes. Private banks are now permitted and FDI in these banks is also permitted, up to a limit of 74% equity. Furthermore, foreign banks may also open a specified number of branches annually. Currently, there are approximately more than 25 foreign banks with full banking licences and about 150 foreign branches are operating in India.

India s BSE and NSE stock exchanges are reputedly the third and sixth largest stock exchanges

in the world (Kelkar 2004, p. 11). Equity derivatives trading was launched in July 2000, and in

2004 had a daily turnover of US$4 bn. India s derivatives trading has been lauded as the world s

most successful launch and foreign brokers such as JP Morgan Chase are extending their pres- ence in reaction to the remarkable growth of this segment of the financial sector (Sarkar 2003). In

sum, it is plausible that stock exchanges are key to modernizing and growing the financial sector as well as being the building blocks required to improve transparency and competition. (In India, non-transparent transactions are proscribed.)

The telecommunications sector was a public monopoly until 1994. A new National Telecommuni- cations Policy in 1994 liberalized the sector, allowing the private sector to provide mobile, basic and value-added services. Foreign investors were granted entry into the sector. In 1999 the New Telecom Policy was promulgated and extended the provision of telecommunication services to include satellite services and paging. FDI in these services is, however, limited to 49%, although up to 100% of foreign investment is allowed under certain conditions for Internet service provid- ers, infrastructure providers, email and voice mail providers (Panagariya 2004; Gordon and Gupta 2003).

As a result of its telecommunications liberalization measures, India now boasts a teledensity of 7%, the target for 2005 which was achieved in 2003. The forecast of teledensity for 2006 is 17%.

Framework Service Contract 150083-2005-02-BE Driving factors and challenges for the EU industry and the role of R&D and innovation (SC06_05 R&D Innovation) Final Report

Furthermore, there are about 40 million cell phone subscribers and subscription is growing at a

Furthermore, there are about 40 million cell phone subscribers and subscription is growing at a rate of 2 m. a month (Kelkar 2004). For a country that up till the late 1980s experienced immense difficulties with telecommunications services (it was a public monopoly), this is remarkable pro- gress. Interestingly, India is the only market where CDMA and GSM, the two main mobile tech- nologies, are locked in grim competition, (Kelkar 2004, p. 7), of course to the benefit of custom- ers who are lured by attractive subscription incentives.

One hundred per cent of foreign investment is also allowed for software companies and almost all areas of electronics. Similarly, 100% of foreign investment is allowed in IT businesses set up ex- clusively for exports (Panagariya 2004). For instance, since January 2006, India has permitted 51% foreign investment in the retail industry, which cleared the way for international companies such as Reebok and Nike to move beyond franchise agreements in India.

The infrastructure sector has been opened to 100% foreign equity. The construction of roads, ports, airports, harbours can now involve 100% of foreign capital. Domestic air transport has also been significantly liberalized; foreign equity up to 40% and investment by non-resident Indians up to 100% are permitted in this sector. The rail sector remains firmly in the hands of the state.

Regarding the energy sector, FDI is allowed in the generation, transmission and distribution of electricity. Building upon the experience of liberalization of the telecommunications sector, the Government aims to do the same in the energy sector by introducing competition through the pri- vate and public sectors. But despite its intention, electricity provision remains a problem for India and even private providers continue to have to be financially rescued by Central Government. Table 10 highlights the growth of the service sector compared to the other main sectors over a period of about 50 years.

to the other main sectors over a period of about 50 years. Table 10 Sectoral Growth

Table 10 Sectoral Growth Rates 1951-2000

Sector

Average Growth (in% per annum)

 

1951-1980

1981-1990

1991-2000

Agriculture

2.1

4.4

3.1

Industry

5.3

6.8

5.8

Services

4.5

6.6

7.5