Innovation financing and long term investment:
the role of multilateral development banks
Prof. Anthony Bartzokas
EBRD Board Alternate Director
bartzokasa@ebrd.com
25 June 2013
Prepared for a workshop organised by the School of Slavonic and East European Studies at
UCL on “Transition Economics Meets New Structural Economics”. The views expressed
herein are those of the speaker and do not necessarily reflect the views of the EBRD.
Outline
• Innovation financing and long term investment: an innovation
studies perspective
• Post crisis challenges for transition economies
• Innovation dynamics trends
• Innovation financing and multilateral development banks
• Towards an Innovation Financing Matrix
Why innovation financing?
• The innovator is the agent of the financier (innovator's effort and the
inherent value of the project determine the financier's payoff).
• This agency relationship is subject to asymmetric information on both the
value of the innovation and the actions of the innovator.
• The bright side: Innovation have the potential to provide for a more
efficient allocation of resources. Financial innovation is associated with a
stronger relationship between a country’s growth opportunities and
actual growth, especially for industries that are more dependent on
external finance.
• The dark side: Financial innovation is associated with higher growth
volatility, higher bank fragility and higher bank losses during economic
crises. Thus, innovations have also the potential to negatively impact the
solvency of the financial system.
• Multilateral development institutions (and development banks) should
promote the beneficial effects of innovations while minimizing downside
risks
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Empirical studies on innovation financing
• Several recent studies provide evidence that Innovation has an important
positive effect on firm performance.
• This effect is mediated through financial markets. That is, the positive
impact of innovation on productivity is significantly larger in countries with
well-developed financial markets.
• Policymakers and economists generally agree that well-functioning
financial institutions and markets contribute to economic growth.
• Recent literature suggests that key channel by which financial
development could influence growth is by facilitating technological
innovations and production methods that boost productivity.
• This has important implications for growth and for medium-term
prospects in transition economies.
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Empirical studies on New Technology- Based Firms
• Young, high-potential firms are likely to play an important role in boosting
innovation.
• Young firms appear not only to be important generators of large numbers
of innovations, but also particularly important in developing radical
breakthroughs.
• A substantial body of literature suggests that spending on innovative
activities, particularly by smaller firms, is limited by capital constraints.
• These patterns reflect the fact that financial constraints appear to limit
high potential entrepreneurs.
• Economists have suggested a variety of reasons why these patterns may
hold, from their incentive schemes to their organization structure.
• The market for financing high-potential entrepreneurial firms appears far
from an efficient one.
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The rationale for innovation financing
• Given the same level of internal funds, firms with higher innovative
capability should be more likely to be constrained than firms with lower
innovative capability.
• Given the same level of innovative capability, firms with lower financial
resources should be more likely to be constrained.
• The more severe the financial constraints, as caused by negative liquidity
shocks, the less likely it is that the firm engages in innovation activities.
• The larger are the cost of external finance, the more negative is the
impact of financial constraints on the firm's innovation activities.
• Innovating firms that are financially constrained and facing conditions of
more substantial asymmetric information are likely to more strongly
respond to exogenous variation in access to external finance.
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Development trajectories and technological change
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As economies begin to mature, productivity growth is harder to achieve and
requires bigger efforts in building critical infrastructure, including “soft”
infrastructure such as information technology, research and development and the
development of human capital.
Innovation is the implementation of a new or significantly improved product,
process, a new marketing method, or a new organizational method in business
practices, workplace organization, or external relations.
Innovation is not just a new product, process, design, or form or organizing or
delivering or using a product or service that is new to the world. But one that is
new to the country, the sector or the unit using it.
This broader definition includes the search process and the mobilization of
resources for the absorption and the efficient use of technological externalities.
Innovation can arise at different points in this process, including conception,
research and development, transfer (the shift of the “technology” to the
production organization), production and deployment, or marketplace usage.
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Policy responses
 Coordinating technology acquisition decisions across firms and sectors
 Sharing risk and enabling the financing of investment in new technologies and
sectors
 Sharing risks in labour training and learning processes
 Providing targeted infrastructure to critical sectors
 Developing regulatory capacity to maintain and enhance competitiveness
The mix of policies will depend on the technologies being adopted and the preexisting strengths and weaknesses of entrepreneurs, financial institutions,
infrastructure and skills in the sector.
The critical determinant of success is likely to be governance and regulatory
capacities to maintain and enhance competitiveness through monitoring and
taking tough action when required, including the early withdrawal of support if
progress is unsatisfactory.
While most countries have tried variants of industrial and technology policies in
the past, the main cause of their differential success has often been the efficacy
with which incentives have been implemented, and the credibility with which
their withdrawal has been organized in cases of poor performance.
Policy instruments
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Post-crisis challenges for Transition Economies
Baseline factors
Paradigm shift
Core drivers
(i) World economy
asymmetries
From catching up to suppressed • Income level effect
growth
• Reduction in asset values
Priorities for long term investment
• Better functioning markets
• Institutional rigidities
(ii) Banking sector
deleveraging
(iii) Economic recovery
trends
• Risk pricing vs. lower expected
From financial integration to
yields
declining access to international
capital markets
• Inefficient investment filtering
• Funding gaps
From regional convergence to
diverging recovery trajectories
• Economic activities with higher
extensive margin (expanding
markets)
Diverging adjustment driven by
differences in:
• Productivity
• Creation of new firms
• Shortage of reaching-for-yieldinvestors
• Expansion to new markets
• Sectoral composition
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Productivity and R&D expenditure
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Firm level innovation and economic growth
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Investment in machinery and equipment is the main source
of technology acquisition in transition economies
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Downsizing of R&D investment since 2007
Bulgaria
Lithuania
Latvia 0.01
Hungary 0.02
Kazakhstan
Romania
0.06
Turkey
LARGE FIRMS
0.21
0.18
0.39
0.35
0.08
0.07
0.23
0.21
0.30
0.40
0.13
0.23
0.20
Bulgaria
0.23
Lithuania
0.11
Latvia 0.03
Hungary
Kazakhstan
0.32
Romania
0.08
Turkey
0.31
MEDIUM FIRMS
0.19
Bulgaria
Lithuania
Latvia 0.03
Hungary 0.03
Kazakhstan
Romania
Turkey
SMALL FIRMS
0.00
0.08
0.35
0.13
0.05
0.34
0.19
0.17
0.26
0.20
0.14
0.35
0.14
0.10
0.09
0.22
0.20
0.33
0.33
0.31
0.21
0.10
0.25
0.20
0.30
Increase
0.40
Remained
0.50
0.60
0.70
0.80
0.90
1.00
Decrease
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14
Simple inward country penetration
(inward BERD from country X / inward BERD, 2007)
15
External financial dependence index across industries
(Bulgaria, Czech Republic, Estonia, Hungary, Latvia,
Lithuania, Poland, Romania)
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Areas of Emerging Europe Vulnerability
(all data for 2012, Relative position vs. Emerging Market
countries. Max Risk=1, Min Risk=0)
Source: BBVA Research
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Private sector credit: Emerging Europe and Asia
(annual change in credit to GDP ratio)
Source: World Bank, World Development Indicators, 2012.
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Summing up: why innovation financing in transition
economies?
1.
Kick-starting growth rarely leads to sustainable growth trajectories. Many countries started with an
impressive catching-up phase but failed to maintain a growth momentum when they faced
challenges related to productivity enhancing diversification and restructuring.
2. Since 2007-2008, transition economies are lagging behind other emerging economies, in terms of
total factor productivity growth. Thus, innovation and entrepreneurship can be important for growth.
3. Markets are likely to under-provide innovation and entrepreneurship because the social benefits are
likely to exceed the private benefits.
4. A reliable supply of reasonably-priced finance is important for entrepreneurial activity and
innovation. Information problems must be overcome to ensure this supply. But innovation also drives
financial market activity, sometimes through booms and busts. Overall, innovation, by incentivising
investment and consumption, may help economic recovery.
5. Innovation financing is by itself a market creation process. For example, a decentralised search for
investment projects, by focusing on start ups and export oriented firms creates new incentives for
innovation.
6. Macroeconomic volatility accentuates the effects of asymmetric information and other transactional
frictions on innovation investments.
7. The economic environment of slow growth and volatility is increasing the scope for efficiency driven
adjustment. Thus, endogenous growth re-balancing driven by better quality private sector
investment projects becomes a pre-condition for resilient adjustment to exogenous shocks and
economic growth.
8. Supply-push innovation policy subsidies have failed to deliver business sector innovation in transition
economies.
9. A large share of innovation financing is about investment in general purpose technologies (ICT,
knowledge economy), with strong positive spillovers across sectors.
10. The economic rationale for long term investors involvement is context/country specific and depends
on levels of technological development.
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EBRD and innovation financing
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The EBRD Knowledge Economy Initiative
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Towards an Innovation Financing Matrix
• VC
• FDI co-financing
R&D driven
innovation
• ICT Investment
• Equity funds
• Energy efficiency
• SME financing
Product and
process innovation
• Incremental firm level investment
• Low cost energy applications
• Provision of public goods
Technological
upgrading
Bottom of the
pyramid innovations
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