European Commission - Demand
European Commission
Enterprise & Industry Directorate-General
Work Package 2 – Final Report
Innovation Demand-Side Monitoring System
December 19 th , 2014
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Table of Content
Definition of demand-oriented innovation policy and potential issues ........................ 6
Theoretical justifications for demand-oriented innovation policies ............................ 7
The relative effectiveness of financial incentives and survey evidence .................... 18
Complimentary infrastructure that facilitates ICT innovations ................................ 42
Diffusion of ICT innovations among firms – evidence for network externalities ......... 44
Implications and policy measures in the area of ICT adoption and diffusion .............. 46
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1.
Introduction and Analytical
Framework
1.1
Introduction
A wide and heterogeneous set of policies is labelled as “demand side innovation policy”, since the definition of the concept is still controversial both in the academic literature and among practitioners. There set of possibilities ranges from regulation to various types of innovative public procurement. As a result of this heterogeneity, there have been fewer advances toward a serious empirical assessment of the impact of policies in this field than in other fields such as labour, family, education or health. In the previous chapter on evaluation methodology we have developed a toolbox of econometric techniques and approaches – both as a methodological framework for evaluating such policies in the future and as a benchmark against which existing policies can be measured. One of the goals in this chapter is to assess existing evaluations of demand-side policies against this yardstick to compile evidence with regard to the effectiveness of these policies and eventual best practices, with a focus on the causality of policies for the desired effects. The goal is to scan both the EU and the most important competing economies for best and worst practices which can inform European policy in the future, by collecting information about evaluations of existing demand-side policy measures. In the course of this exercise, based on the empirical evidence as well as current economic theory we offer concrete suggestions on which additional demand-side policy measures may be applicable in the European context. As requested, the primary focus of this study is complementary measures. However, we will also search for evaluations of the
“conventional” demand-side measures, i.e., policies in the areas of legislation, standardization/regulation, and public procurement of innovation (including pre-commercial procurement).
Due to the fact that demand-side innovation policy is still a young policy field and there is a limited number of stringent evaluations, we have broadened our review of evaluations; in particular for the field of information measures, we have included studies and results from other policy areas, which may inform policy makers about how these measures function and their central determinants. A recurring theme in this chapter will be the importance of control-group approaches (or other counterfactual methods) to be able to infer the efficacy of a given program. Note that the conclusions from “evaluations” lacking such a setup must be treated with caution and it is, in fact, unclear what policy makers can learn from them. In addition to establishing this first step, internal validity of studies, we attempt to derive an assessment of their external validity; that is, we discuss whether and why one should expect a type of program also to work in other contexts within Europe.
In the course of our analysis, we present an important tool which allows steps towards a metaanalysis of existing evaluations of demand-oriented innovation policies. In the Appendix, we submit a table which summarizes the central aspects of the utilized sources, including the following information:
Class of policy
Country
Program objectives;
Observation period;
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Evaluation method and existence of control group
Required and utilized data
Program effect (Did the evaluation find a significantly positive/negative impact of the program on the envisaged objectives?)
In this form, we are able to structure the information collected which forms the basis of the detailed report summarizing our overall findings. The remainder of this chapter has the following structure:
First, we introduce a theoretical framework and stylized model of the innovation process, to help us delineate demand-oriented innovation policies. Based on this, we present a theoretical framework justifying government interventions and explaining the underlying functional mechanisms. On this basis, we then discuss the existing evidence with regard to different classes of demand-oriented innovation policies and derive conclusions with regard to other potential measures from this.
1.2
Theoretical Framework and Methodology
In the following, we consider the innovation process along its entire chain, with a special focus on the following steps:
1) Research and development carried out by inventors (firms and individuals) – this requires human capital, physical infrastructure and financial resources. We refer to these factors as
(innovation) inputs in the following. We assume that R&D decisions are driven by expected profits.
1
2) In addition to the financial inputs provided by the inventors themselves, external finance provided by the private or public sector may be necessary, both during the R&D phase and in the following commercialisation step.
3) Commercialisation of ideas and prototypes resulting from R&D activities to generate marketable products or services; a.
commercialisation includes, for example, the design and implementation of production of goods or processes required to deliver new services, as well as demand analysis regarding the viability of new products or services; b.
these activities may be carried out by the inventor herself (the original owner of intellectual property rights), or by others (entrepreneurs or firms). The latter requires a functioning mechanism to trade ideas as well as financing for entrepreneurial endeavours.
2
4) Market entry, production and diffusion of the product or service, a.
after successful commercialisation of the idea, the firm may begin to offer its product or service to customers (market entry), potentially incurring fixed costs, e.g., for setting up production, complying with regulatory standards and obtaining approvals; b.
finally, adoption of the new product or service by customers and the rate of diffusion are realised in the market; their speed depends on the environment and drivers discussed in WP 5, including the market setting, infrastructure and demand characteristics (from individuals, firms and government).
1 Innovation can also be motivated by, e.g., curiosity of inventors or be the result of fortunate circumstances. Government
example through direct subsidies to inventors or research carried out by publicly funded institutions such as universities.
Since these channels are less susceptible to and relevant for demand-oriented innovation policy, we disregard them in this analysis and focus on economic incentives articulated through the (market) channel of demand.
2 For more details, see section Error! Reference source not found.
below.
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The demand for innovation, i.e., customers’ willingness to pay for innovative products and services, is most clearly linked to the final stages (3 and 4) of the innovation process. Note, though, that product demand also feeds back into the innovative behaviour of inventors (which is aimed at achieving innovation rents in the market) and plays an important role in determining their investments incentives. In the literature, this is referred to as the “demand pull” on innovation. The pull effect can be stronger or weaker depending on the characteristics of the market, in particular market size. Events or policies that shift demand or the speed of diffusion should therefore also
affect the early stage incentives of inventors to provide innovation inputs. Figure 1 depicts a
stylised representation of the innovation process and indicates potential sources of market failure which can justify government intervention.
Figure 1: A stylized model of the innovation process and the most important potential market failures.
Source: ifo
In the remainder of this section, we briefly discuss the justifications for government intervention along the entire innovation chain, starting off with the classical theoretical justifications pertaining to the supply side. These measures are an important benchmark for demand-oriented measures and illuminate important issues with regard to evaluation of innovation policies. We then propose a definition of demand-oriented innovation policy and point out central issues of implementation and evaluation. The section concludes by presenting demand-side market inefficiencies which may justify policy interventions and presenting a taxonomy of demand-oriented innovation policies based on this.
1.2.1
Classical justifications for policy interventions
In general, government intervention is justified if the market outcome is inefficient and can be improved by the chosen policy. The bulk of existing research focuses on two supply-side reasons for market failures to occur in the context of innovation: (i) Positive externalities of research on other individuals and firms (Arrow 1962), which lead to inefficiently low R&D inputs, and (ii) malfunctions
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in the market for R&D funding, mainly due to asymmetric information in conjunction with the uncertainty and risk associated with R&D processes.
3
Concerning the first type of market failure, the most wide-spread policies for internalizing the positive externalities of R&D are the patent and copyright systems. These rights both grant temporary intellectual property of inventions to their creators and at the same time ensure the diffusion of the respective new insights by requiring publication. In many cases, it is only the protection granted by patents and copyrights that allows inventors to bar others from exploiting their new ideas and findings. Due to patents, inventors can profit from their inventions more easily and will therefore increase their innovation activities. Moser (2005) shows that in countries which grant intellectual property rights through patenting, industries in which other ways of protecting ideas (such as trade secrets) are unreliable, are more innovative. If the incentive of patenting is insufficient, or if there are welfare arguments against granting patent rights (if one does not want to preclude others even temporarily from making full use of newly found knowledge, for example), then public subsidies of R&D efforts can be justified. The most common mechanisms employed in practice to incentivize research by firms are tax breaks (Wilson 2009) or direct research subsidies
(e.g., David et al. 2000).
The second type of market failure is related to problems in R&D funding due to asymmetric information. Informational asymmetries can lead to malfunctioning capital markets and thereby to too low R&D investment by firms that are constrained by their cash flows (Hall 2002). Cash flow constraints are more likely to be binding in economic downturns, which can lead to a pro-cyclical development of R&D investments (Aghion et al. 2007). As a result, the effects of recessions are not just felt temporarily; they can have a substantial long-term impact on the growth-paths of economies due to R&D efforts that were failed to be undertaken. Financial constraints with regard to R&D investments are most likely to be problematic for small and medium-sized companies, as well as start-ups. Business Angels and venture capital firms are often hesitant to provide funding during early stages of the innovation process. In addition to this fact, the overall volume of these funds remains limited, a phenomenon referred to as “The early stage funding valley of death” in the literature (Wessner 2008).
4 Since there is substantial evidence that ground-breaking innovations are often carried out and commercialised by young firms (Acs and Audretsch 1990, Audretsch
1995), the lack of funding for start-ups is a serious issue. In reaction to these findings, various policy initiatives have sprung up focusing on fostering innovations of small and medium size firms
(SMEs) as well as start-ups.
1.2.2
Definition of demand-oriented innovation policy and potential issues
Demand-oriented innovation policies cover measures focusing on a different neuralgic area in the innovation chain: the commercialization and diffusion of a new technology, product or service.
5 This requires that socially beneficial, marketable inventions exist, but are rejected by buyers due to existing market imperfections and structural barriers. In principle, there are a number of options that the government can pursue to enable and enhance commercialization and diffusion of new products. In the following chapters, these are treated in detail, with a focus on assessing their
3 Generally, the risk associated with projects does not preclude private market funding (as long as it is adequately compensated through expected returns). Markets fail if one party (the inventor/entrepreneur) is systematically better informed about these risks.
4 This refers less to basic research, which relies on different channels of funding such as grants and public funds, than to the more applied steps of product development and commercialisation.
5 See also Edler (2007).
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effectiveness based on the existing state of the art with regard to their evaluation. They include public procurement, enhancing demand via subsidies or tax breaks, the improvement of consumers’ awareness and complementary skills, and information dissemination. Standard setting and regulations aiming at directing private demand are further instruments of demand-oriented innovation policy. Among these policies, it is mainly public procurement that has garnered substantial attention in the past, both in the political discourse and in the academic literature.
Since demand-oriented innovation policies typically target entire demand segments or types of products, they are generally associated with more intensive interventions compared to measures stimulating R&D investment and knowledge spill-overs (OECD 2011a). In most cases, governments have to decide which product or which technology is considered desirable from a social welfare perspective and should therefore receive support for commercialization and diffusion. This immediately raises one important caveat: An informed decision in this context requires a substantial amount of information in the hands of the political decision maker. Typically, there is no reason to assume that politicians have access to better or more reliable information than investors. Cabral et al. (2006) and Yang and Oppenheimer (2007) find that government agencies are historically quite unsuccessful at picking promising technologies and products. A classical example in this vein cited by Cowan (1990) is nuclear technology. Despite the fact that superior technology was available at the time, a large US Navy procurement contract in the 1950s was the initiator for a lasting market dominance of the inferior light-water reactor technology. Decision makers can be tempted to make use of too simple and faulty heuristics, such as preferring established firms with whom past interactions have taken place. Further, in such complex environments there is a heightened risk of interested parties and firms attempting to influence the decision process (Duranton 2011). As, for example, Aghion (2011) argues, in many situations the choice of a certain product or technology will not only be driven by innovation policy, but by an amalgamation of environmental, energy, health policy and consumer protection concerns.
This clearly also holds for regulations and mandated standards that take indirect consequences
(e.g., health, safety, environmental) of products or services into account and aim at directing demand by limiting the options of consumers – for example, regulations in Germany governing energy efficiency standards of buildings. The upside of such limitations is that the costs of information acquisition for consumers are reduced and the risk-assessment regarding their investment or purchase decision becomes simpler, though this is hard to quantify (Edler 2007).
Regulation can affect demand and market outcomes even more directly. The US Orphan Drug Act of
1983, for example, targeted rare diseases and consequently altered pharmaceutical firms’ R&D incentives in this area (Reaves 2003). Bearing the light-water reactor case in mind (Cowan 1990), it is highly doubtful whether government agencies should attempt to pick winners or establish quasistandards through public procurement or regulation without careful consideration based on reliable empirical evidence.
6
1.2.3
Theoretical justifications for demand-oriented innovation policies
Given that demand-oriented innovation policies are often associated with a substantial impact on market outcomes and in the face of the possibility of errors in decision making (e.g., picking the
“wrong” winners), a heavy burden of proof should be placed on the theoretical (and, whenever
possible, empirical) justifications for such measures. As depicted in Figure 1, we identify the
following central demand-side hindrances to adoption, diffusion and commercialization that could in
6
For a detailed discussion on the effects of regulation and standards, see Section 2.3.
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principle be addressed by government policies. The main focus lies on market failures that are
related to the innovation stage “market entry, production and diffusion” introduced in Section 1.2,
to which the points 1) through 5) below are mainly related. Point 6) applies to the
“commercialization” stage and should therefore be considered mainly a supply-side phenomenon.
1) Positive externalities of consumption and production (e.g., economies of scale)
2) Network externalities of new products
3) Market fragmentation and market structure
4) Consumer information and complementary customer skills
5) Lack of complementary infrastructure
6) Lack of required inventor skills (and malfunctioning market for ideas)
In the remainder of this section, we briefly discuss the most important of these mechanisms as well as a selection of potential policies for alleviating them and improving economic outcomes.
1.2.3.1
Positive externalities of consumption and production
7
For different reasons, we observe the empirical regularity of decreasing per unit cost of production in the total amount of output produced; on the one hand, mechanically, fixed costs of production are spread over more units, so that average costs decrease. In addition to this, learning effects in production play an important role (for a comprehensive early overview see Lieberman 1987) and may lead to market failure.
8 To understand this, it is important to note that learning effects do not just accrue to the producing firm itself (a forward-looking monopolist would internalize the resulting gains) – instead, competitors benefit from the experience gained by the technology leader, e.g., through imitation and through the direct (at industry conferences) or indirect (through personnel fluctuations) exchange of knowledge and experience. Thereby, other firms may benefit from spillovers. It is also possible that learning effects (in a wider sense) on the side of consumers benefit an entire industry. These learning externalities to other firms or to consumers are not internalized by the technology leader: An individual firm under competition will (dynamically) set its prices too high
(in the sense of failing to internalize learning spill-over effects) or, in the extreme, fail to introduce the welfare enhancing product in the first place.
The government can accelerate the movement along the learning curve by either stimulating demand for new products by reducing the effective price (for example through price subsidies or tax breaks to consumers), or it can generate additional demand through own procurement. With each of these measures, the additional demand should accelerate the decrease in unit costs. Under competition, with firms setting prices in direct relation to unit costs, this would also result in price decreases, which in turn feed back into faster diffusion. As a further issue to consider, learning effects can constitute a market entry barrier if potential competitors cannot imitate or otherwise benefit from the collected experience made by the pioneering firm.
1.2.3.2
Network externalities of new products
Network effects arise when the value of a product increases with the number of its users (Liebowitz and Margolis 1995). The focus of both policy makers and academics on network effects (and the
7 In this theoretical subsection, we deal only with externalities that are most closely linked to demand-side innovation policies. Clearly, other externalities (e.g., environmental or health benefits) can be linked to these policies, and are often drivers in the political decision making process from which they arise. We do not include them in the discussion at this point, because they justify state intervention in general, nut just via demand-side innovation mechanisms.
8 Note that learning effects and associated economies of scale are also used to justify protectionist measures such as tariffs; see, e.g. Greenwald and Stiglitz (2006). Aghion (2011) points out that the infant industry argument still is lacking in empirical validation.
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related theory of two-sided markets) has intensified in the last decades, as these effects are considered to be a prevalent characteristic of many high-tech products (Katz and Shapiro 1985).
Katz and Shapiro (1994) distinguish between direct (e.g., the more individuals have an emailaddress, the more valuable the e-mail service is to each of them) and indirect network effects.
Indirect network effects are a result of additional market interactions – e.g., the Android platform for apps becoming more attractive to programmers as the number of owners of Android devices increases.
Network effects are closely associated with the concept of path dependency, which can be explained using a very simple model: Consider a new gadget which exhibits network externalities. Assume that a certain subgroup of the consumer population, so called early adopters, derives utility both from owning this new gadget itself, u ea
, plus an additional utility component depending on the network, which depends on the total number of users N, u n
(N).
The remaining consumer population does not derive a high utility from owning the new gadget, they only receive the utility u n from using it in the network. Note that if u ea
>p , i.e., the early adopters’ utility from ownership is higher than the price, this subgroup will buy the gadget in any case. The remaining consumers, on the other hand, will only purchase the gadget if u n
(N)>p , i.e., if the network utility exceeds the price, which requires that enough other consumers have purchased the gadget.
Therefore, a (potentially inferior) technology may remain dominant, because alternative better technologies cannot achieve the required critical size of consumer base to become more attractive to a wide range of consumers than the incumbent technology. Analogously, new technologies may never become viable if the initial user base of early adopters is too small. According to Cabral et al.
(2006), Edler and Georghiou (2007) and other theoretical studies in this field, governments can help to overcome these issues by purchasing large numbers of units of the new product to achieve the necessary critical mass, or by subsidizing early purchasers and users. However, given the lack of empirical evidence Liebowitz and Margolis (2005) conclude: „Since the empirical support for this theory is so weak, it appears at best to be premature and at worst simply wrong to use this theory as the basis for policy decisions.” A further potential remedy could be policies that aim at increasing the share of early adopters in the population, e.g. through information campaigns and education measures.
1.2.3.3
Market fragmentation and market structure
So-called market fragmentation is a further theoretical justification for demand-oriented policy interventions (see Edler and Georghiou 2007, Edquist and Hommen 2000). In fragmented markets, firms have insufficient incentives to undertake product development and modifications of products
(or information campaigns), because the number of consumers they are likely to reach is too small
(Edquist and Hommen 2000). Analogously, if multiple firms are competing and there are positive externalities attached to information campaigns, for example, then such welfare-enhancing measures may not be carried out and there is room for government intervention as a result.
Also, market structure can affect the rate of technology diffusion and investment into innovation in other ways. This includes the level of horizontal competition between firms (see e.g., Reinganum
1981; and the classical inverted U-shape argument by Aghion et al. 2002) as well as the vertical structure of industries. With regard to the effects of (horizontal) competition on innovation, the appropriate government measures primarily involve antitrust-policy. But, more recently, the focus of research has shifted to the role of vertical procurement structures and complementary inputs on innovation investments and adoption. Koenen and Ruhmer (2013) show that with complementary upstream inputs settings may arise, in which the ownership of patents may actually be detrimental
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for upstream technology leaders. Therefore, in cases in which strong complementarities between upstream inputs exist, other measures to foster innovative behaviour than patents – such as prizes – should be implemented; the recent announcement by the electric vehicle producer Tesla that it will not enforce one of its central patents serves as a case in point.
1.2.3.4
Consumer information and complementary customer skills
Adoption of new technologies can be hampered, if potential customers lack necessary or complementary skills to use new products (e.g., so called “Level-3-Users” in the terminology of
Rankine 1995). User competency is of particular importance for so-called General Purpose
Technologies (GPT), such as computers and the internet. In addition to exhibiting network effects, as discussed above, these technologies and related products and services are of little or no use to consumers who lack the required ICT skills (for more details on GPTs see Helpman 1998). As one of the central GPTs of our time, the Internet has triggered many subsequent innovations in other fields, which raises the question whether the government should promote user competencies in modern information and communication technologies (ICT) through educational measures.
Evaluations of educational measures in different countries show that students can under some circumstances become more competent in ICT usage when they use computers in school (for an overview see Malamud and Pop-Eleches 2011). These competency gains in ICT may be associated with a competency loss in other skills, though. The findings suggest that measures to improve user competencies for the application of new technologies can generally be effective, but possible unintended side effects have to be taken into account (Edquist and Hommen, 2000).
The lack of user competencies may be a result of market fragmentation (discussed in the previous
Section): Lundvall (1988) and Olerup (2001) argue that the lack of competencies is a result of restricted communication and interaction between the supply and demand side in fragmented markets, which blocks collective learning of users and producers. In such a situation the state could become active as a (frequently well-informed and demanding) customer or a “lead user”. Von Hippel
(1986, S. 791) describes lead users – though without direct reference to the state – as follows:
„Lead users are users whose present strong needs will become general in a marketplace months or years in the future. Since lead users are familiar with conditions which lie in the future for most others, they can serve as a need-forecasting laboratory for marketing research. Moreover, since lead users often attempt to fill the need they experience, they can provide new product concept and design data as well.” The role of the state as a lead user is classically exemplified through the case of the airbag in the literature, see in particular Hemenway (1989), who argues that public procurement cracked the resistance of auto manufacturers to the airbag and caused a change in the entire industry. Whether a causal relationship actually exists, however, cannot be stated with certainty.
Analogously to the lack of competencies, if consumers are unaware of a new technology or are uninformed regarding its uses (or risks), individual firms may not have an incentive to provide the required information due to external effects (or even conflicts of interest). In this case, the government can step in by providing information, e.g. through information campaigns or labelling on products. Public procurement can also function as an informative signal for consumers. The successful public use of technologies or products can signal important information about cost and utility (Cowan 1995). This increases the knowledge of private buyers in regard to the technology so that they can possibly make better decisions on whether the purchase of the particular product is worthwhile. However, the signalling effect of public procurement depends on the extent to which
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knowledge of the use of the new technology is disseminated to the general public. If this cannot be sufficiently achieved, signalling effects cannot be expected for private buyers (Cowan 1995).
9
Overall, public demand could help to overcome lack of coordination by reducing the market risk for producers, while additionally enabling the realization of economies of scale and learning effects
(Edler and Georghiou 2007, Geroski 1990).
10
In particular, this argument applies for early phases of development of an industry, wherein products are not yet standardized, since standardization (and accompanying regulations) can have similar effects.
1.2.3.5
Lack of complementary infrastructure
As discussed in the previous section, lacking complementary consumer skills may negatively affect the value of (classes of) products, while due to externalities individual firms lack the incentive to provide remedies for this. An analogous and perhaps even more straightforward case can be made for complementary infrastructure. To give two examples: 1) For purely electric vehicles to be useful for the wider public will require an expensive charging infrastructure – competing manufacturers of electric vehicles may each lack the incentives for investment. 2) Many advanced ICT services (such as cloud computing) require advanced broadband infrastructure to be useful to customers – the providers of these services, though, individually do not have an incentive to invest in the broadband network. In such cases, governments must play a central role.
1.2.3.6
Lack of required inventor skills (and malfunctioning market for ideas)
As introduced above, the commercialisation phase is at the interface between the supply side of innovations, i.e. research and development, and the demand for products. It is in this phase that the results of research processes are transformed into marketable products and services. We briefly point out an additional potential market failure pertaining to commercialisation, even though it is mostly attributed to the supply-side and corresponding measures. Inventors can either commercialise their invention themselves, which requires specific skills that may be quite different from those that are useful for researchers, or transfer the technology to someone else. If there was a perfect market for ideas,
11
due to skill mismatches most inventors would probably not commercialise their inventions themselves. However, there are several reasons why the market for ideas is imperfect (Spulber 2011). For example, it is often difficult or very costly to obtain protection of intellectual property rights and to enforce them. Another problem is that the true quality of the idea is often difficult to convey to potential buyers, which can lead to adverse selection. Therefore inventors have to invest into costly signals, like expert opinions. Although the market for ideas is imperfect, many inventions are nevertheless transferred and typically acquired by entrepreneurs. Schumpeter (1934) was one of the first to carefully distinguish the inventor from the entrepreneur. In his words, the entrepreneur contributes mainly “will and action” and receives an “entrepreneurial profit” (Schumpeter, p. 134). The key point is that he does not necessarily contribute the invention itself. The entrepreneurial profit must therefore be distinguished from the gains that arise from selling intellectual property. Government policies can aim at either reducing the skill mismatch by training inventors’ entrepreneurial skills, or they can improve the functioning of the market for ideas, e.g., by improving the options to enforce intellectual property rights.
9 This is most likely an issue for public procurement in the military sector which typically is subject to confidentiality restrictions.
10 Furthermore, demand by public institutions can compose a considerable and for the firm crucial fraction of the total earnings of the industry in these early stages of development (Dalpé 1994, Faucher and Fitzgibbons 1993, Malerba 1985).
11 Note that with “market of ideas” we are generally referring to an abstract market in which knowledge, ideas, technology and intellectual property are traded. There are also a number of explicit market platforms, like www.patentauction.com, where inventors can sell their ideas to entrepreneurs.
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In the following section, we introduce different classes of demand-oriented innovation policies and
present existing empirical evidence. Figure 2 below provides a brief overview.
Figure 2: Overview of Types of Demand-Oriented Innovation Policies
Public Procurement refers to public sector purchases of non-existing (R&D is required) or already commercialised products (no further R&D is required), typically with innovationrelated criteria in tender specifications. The government itself exerts demand for innovations.
Measures that directly affect private demand are financial incentives to consumers, such as tax breaks or price subsidies for certain desirable (from the viewpoint of the government) innovations.
Regulations and standards have an indirect effect on demand for innovation. Regulations help in promoting certain socially desirable criteria and establish consumer trust, thereby accelerating the diffusion of innovations. This is most relevant with regards to regulations protecting consumer health and the environment.
Complementary measures support other demand-side innovation policies. Leading examples of this are information or awareness measures (e.g. in the form of direct training or large campaigns), where consumers are informed about the existing state of the art of new technologies. We also discuss industry agreements, i.e., standards to which the industry pledges to adhere without being mandated by law. Such standards help achieving a critical mass for new technologies, thereby promoting the commercialization of certain innovations. Other measures are investments into complementary infrastructure and technologies, which we discuss in the context of ICT, demand articulation to overcome information gaps between consumers and suppliers, or the government support of user innovation (through, for example, the modification of IPR regulation)
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2.
Evidence on Policies and
Recommendations
In the remainder of this chapter, we scrutinize the existing empirical evidence on demand-oriented innovation policies, to derive policy recommendations and best practices. Prior to immersion into the empirical studies, it is important to briefly focus on what we are able to learn from this type of evidence. The basic standard for any evaluation study must be that it is internally valid: This requires correct and diligent collection and analysis of the necessary data, as well as utilization of the appropriate methods to ensure identification of causal effects of a given policy (if they exist). An immediate implication of this is that the results of a single study are only valid for precisely the environment that it was conducted in – a given set of drivers, addressees, etc. It can also not be used to assess the hypothetical effects of potential alterations to the setup of the policy.
12
The external validity of evaluations, i.e., the question what can be learned for the application of policies in a different context, depends, on the one hand, on the similarity of the surrounding environmental variables and drivers; these are the focus of WP5. In addition to this, if the effectiveness of a policy can be shown for a wider set of environments (e.g., multiple time-periods, different sizes of countries, etc.), this strengthens the external validity of the results.
For the existing evidence, focus on the following policy fields (see Figure 2 for an overview with
brief descriptions): Public procurement, price subsidies and tax breaks, regulations and standards as well as complementary measures. Among the complementary measures, we study information and awareness campaigns, the promotion of skills and finally we discuss the nexus of skills and complementary infrastructure using the example of the most important current general purpose technology, ICT.
2.1
Innovation Procurement
It is clear from the theoretical framework that there are multiple channels through which public demand for and procurement of innovative products can spur innovation. Therefore, a number of countries have been employing procurement measures, including the UK, Germany, the
Netherlands, the United States, China and Japan. Innovative procurement strategies also feature in the EU “Horizon 2020” Framework Program as a tool to foster innovation. The complexity of these programs (and the fact that they tend to pursue many different aims) make these programs difficult to evaluate; therefore, there is no overwhelming evidence on their efficacy despite their importance and relatively wide usage (for a very recent overview, see e.g. Warwick and Nolan, 2014).
In classifying actual evaluation studies that have been carried out, it makes sense to distinguish between two types of government procurement:
1) Pre-commercial procurement; this mainly concerns services ranging from R&D to prototyping, as no associated marketable final services and products are yet available. This type of procurement is closely related to R&D subsidies and is therefore on the boundary to supply-side innovation measures.
12 A branch of empirical industrial organization, “structural” estimation, attempts to analyse the effects of counterfactual
(“what if”) scenarios by using behavioural predictions of market participants based on structure derived from (mostly game theoretical) equilibrium models.
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2) Procurement of (innovative) goods and services that are in principle commercially purchasable.
Innovative procurement is not the main focus of this study; therefore we only briefly address and summarize the most important findings on the topic in the following.
2.1.1
Pre-commercial procurement
To better understand potential pitfalls in the evaluation of policies, it is helpful to consider one of the most prominent existing programs that is originally meant to alleviate malfunctions of the market for R&D finance. The US Small Business Innovation Research (SBIR) program was initiated through the 1982 Small Business Innovation Act and has been regularly renewed in the meantime.
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The terms of the program require government agencies under certain conditions to allocate contracts worth a certain share of their procurement budget to SMEs. Currently, eleven government agencies are participating in the SBIR program (Link and Scott 2012a), mainly focused on the areas of health, security, environment and energy. SMEs can submit research proposals in these fields and request SBIR funding. Proposals can either take the form of a feasibility study (Phase I, up to
150,000 USD) or the development of a prototype (Phase II, up to 1,000,000 USD). The next important step, commercialization of the resulting new product, is realized with (private or public) funds outside the SBIR Program. Some government agencies, such as the Department of Defence, utilize the SBIR Program for the procurement of innovative products resulting from SBIR-funded
R&D activities. According to Wessner (2008), 51% of the firms awarded Phase II funds respond that their most important customer is in the private sector; among the public sector customers, the most important ones are the Department of Defence and NASA, with a share of 44%.
The SBIR program is an excellent example to demonstrate potential pitfalls of innovation policy interventions, because it has been carefully evaluated using modern micro-econometric methods. It is also a useful example to illustrate how similar interventions on the demand-side should be evaluated. Lerner (1999) uses a matching approach, showing that only for few select firms participation in SBIR led to positive effects on long-term employment growth. To further understand the employment effects of SBIR funding, Wallsten (2000) uses an instrumental variable (IV) approach to take into account that funds are not allocated randomly within SBIR, due to the insight that more innovative firms are more likely to receive funding. With this IV-approach he finds no significant employment effects through SBIR funding.
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The even more troublesome finding of
Wallsten is that SBIR may also be unsuccessful with regard to increasing total research funding, due to crowding out of private funding for innovation through public funds. His statistical results imply that every dollar of funding through SBIR led to a reduction of private R&D expenditures by the same amount. Firms applied for (and received) public funds for projects which they would have likely implemented with private funding in any case, thereby realizing rents due to lower cost of capital. Note that this issue of crowding out or deadweight is highly relevant for demand-side
innovation policies such as price-subsidies for innovative products (see also Section 2.2 below).
A large-scale evaluation study carried out by the National Research Council found positive effects of the SBIR program on knowledge generation and dissemination, cooperation between universities
13 In Europe, SBIR-type programs were implemented in the Netherlands (Dutch Ministry of Economic
Affairs, Agriculture and Innovation 2011) and the United Kingdom (Mazzucato 2011).
14 It is important to bear in mind, though, that job creation is not an explicit aim of the SBIR program; however, more innovative firms are expected to be more successful at creating jobs. Therefore job creation can be considered as a reasonable proxy for the success of innovation policies.
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and firms, entrepreneurial activity and firm growth, among other things (Wessner 2008). The study relies on extensive surveys carried out among the about 11,000 recipients of Phase II funds granted by government agencies between 1992 and 2001. The study is a perfect example both for the merits and for the limitations of a pure survey-based approach to evaluation addressed only to recipients. On the one hand, it grants important insights into the functioning and mechanisms of the
SBIR program. On the other hand, since it only covers the perspective of those firms that did receive funding, due to the completely lacking counterfactual (what would have happened without
SBIR funds) no causal inference about the effects and effectiveness of the SBIR program can be derived from this study (see also Link and Scott 2012a,b).
In the meantime, SBIR-type programs have also been implemented in Great Britain, the Netherlands,
Japan and Korea. Using matching procedures for grants awarded between 2004 and 2006, Inoue and Yamaguchi (2014) show that for firms awarded a contract, there is neither a significant effect on sales nor on employment. They do find a positive and significant effect on the patent output of
SBIR firms. Bound and Puttick (2010) study the UK SBIR program; their interviews with participating firms and universities indicate that the program was successful in improving government services and closing the innovation funding gap. Due to the lack of a control group and based on the evidence provided for the US SBIR above, caution with regard to this type of program appears to be warranted. To identify causal effects of pre-commercial procurement policies, a control-group-type study is essential.
2.1.2
Procurement of innovation
Similar conceptual issues plague the procurement of marketable innovative products and services.
From the view of the evaluator, it is generally close to impossible to identify a group of firms that is identical to awardees of government contracts except for the incidence of public procurement; one needs to be aware of the fact that the most successful bidders may also be more productive or innovative (or better connected). In Aschhoff and Sofka (2008), the authors try to address this issue through a matching procedure within a cross-sectional survey for German firms. They observe a binary variable, i.e., whether a firm had won a public procurement tender between 2000 and
2002, and match such firms to other companies for whom this does not hold, but which are very similar according to different characteristics. The variable of interest studied is the share of turnover with new products. They find that firms who have won public procurement contracts display significantly higher shares of turnover with innovative products, which indicates a positive effect of public procurement. An advantage of their measure is the relative ease of data-collection
(cross sectional survey data); but note the disadvantage of their approach that results could be due to unobserved heterogeneity unaddressed by the matching procedure.
A more recent, important study by Guerzoni and Raiteri (2013) also uses survey data to analyse the effects of public procurement (and R&D subsidies) on firms’ R&D expenditures for the EU, Norway and Switzerland. The independent variables of interest in their study are again binary: A dummy for government procurement and a second dummy for R&D subsidies received. Again, the control group is constructed through matching procedures in a cross-section using survey data, with the same advantages and potential drawbacks as above. They find positive and significant effects of public procurement on firm R&D investment; interestingly, there is an additional stronger positive and significant effect if public procurement is combined with R&D subsidies.
Slavtchev and Wiederhold (2011) use an instrumental variable approach to attempt to disentangle the causal effect of public procurement on the private R&D expenditures and R&D employees in US firms between 1999 and 2007. Their method requires micro-level panel-data, which is substantially
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more difficult to collect. Their results are slightly more nuanced than the above: They find that public procurement has positive and significant effects for technology-intensive industries, only.
Further, they show that explicit government contracting for R&D services only has employment effects in these industries, while private R&D expenditures are only driven by general (non R&D services) procurement.
An earlier important study by Lichtenberg (1988) reveals a different cautionary result. Using an instrumental variable approach and panel data for US firms between 1979 and 1984, he attempts to differentiate between different procedures for awarding public procurement contracts to firms.
The results are sobering. Taking crowding out of private investment into account, Lichtenberg finds that procurement contracts that were awarded without competitive tenders had a significant and negative effect on firms’ R&D expenditures. The results for competitively awarded contracts (which is currently the internationally accepted standard for government procurement) was slightly ambiguous, similar to the results of Slavtchev and Wiederhold (2011): R&D service contracts actually had no significant effect on firms’ R&D expenditures, which indicates crowding out. Only competitively awarded non-R&D contracts actually significantly increased firms’ spending on research and development.
2.1.3
Implications
In the area of public procurement, crowding out of private R&D efforts and funding through public sponsorship of R&D is a critical issue. As a result, case study type approaches (of which there are many, see the table in the Appendix) without a control group, in which R&D expenditures are simply tallied, can lead to particularly misleading results. Overall, the existing results indicate that there are innovation-enhancing effects of public procurement, in particular when the government purchases technology-intensive products and services. Moreover, the insight that competitive tenders should be the standard form of organizing procurement has fortunately become common knowledge in the past decades. Where more research is still required is to distinguish different forms that competitive tenders may take, e.g. with regard to the criteria of ranking submissions.
It also noteworthy that the issue of crowding out appears to be more pertinent in the context of the procurement of R&D services; here, different studies (at very different times, both in the late 1980s and in the past decade) demonstrate that government procurement has no significant positive effect on firms’ own research efforts. This finding can and should be reflected by the procurementpractice of governments whenever possible. For example, procurement strategies could attempt to switch from the (short-term) purchasing of R&D-services to announcing longer-term government requirement schedules for innovative goods. In this way, dynamic incentives for firms to develop their production and service capabilities in order to meet the scheduled future demand could be generated. Clearly, though, there are limitations to this strategy due to uncertainty regarding future technological developments – both regarding to future technological needs as well as realistic performance levels for technologies.
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Figure 3: Overview of implications of evaluations of innovation procurement
Innovation Procurement:
Innovation procurement can be effective in fostering innovation o
Causal evidence for selected countries from different time periods o Evidence stronger for innovative goods than for services
Procurement design matters – non-competitive tenders counterproductive
Evidence on pre commercial procurement (in particular SBIR-type programmes) indicates that crowding out of private investment is an important issue, that is often overlooked
Caveat: o Relative small number of studies
There is a pressing need for better (causal) evaluation of these frequently used instruments
2.2
Subsidies and Tax-Incentives
Next, we focus on financial incentives to consumers and businesses to spur their demand for specific innovations. The economic rationale is that market failures can slow down or prevent the diffusion of innovations beyond a certain threshold. One solution for this is lowering the effective purchase price of the innovation. Especially in cases when technologies are associated with large upfront costs and their benefits are spread over a long time horizon, consumers might be reluctant to adopt the technology (e.g., due to uncertainty and bounded rationality). As discussed in the theoretical framework above, technologies with steep learning curves are also prone to suffer from high initial prices that hamper their diffusion.
There are generally two ways in which the effective purchase price of a new technology can be lowered by policy makers. The first option is a direct purchase subsidy for a product. Subsidies can take obvious and immediate forms, such as cash grants or vouchers, or they can take less obvious and more long-run forms, such as loan guarantees or interest-free loans. The second option is to provide consumers and firms with tax incentives. For consumers, they can take the form of tax waivers or tax deductions, for businesses, they can also take the form of tax deferrals or accelerated depreciation allowances. The choice of instruments usually depends on the stage in the innovation life cycle, the distribution of costs and gains over time, and the desired time frame for considered incentive.
Tax incentives and price subsidies are quite popular among policy makers, consumers and businesses (e.g. Linares & Labandeira, 2010). Their effect is thought to be more predictable than the effect of other innovation policies, as long as the price elasticity for the innovative product can be estimated. There are also a number of theoretical arguments why positive financial incentives are reasonable solutions to specific problems regarding diffusion of innovations. For example, prospect theory predicts that consumers prefer to avoid losses now over receiving potential gains in the future (Kahneman and Tversky, 1979). For many new technologies, there is a relatively high upfront cost that consumers have to pay for receiving uncertain gains in the future. A good example is the distribution of costs and gains in the case of solar panels. Although they might lead to future savings in energy costs, consumers have to engage in relatively high upfront investments; if prospect theory holds, they might choose to save the money instead. Here, price subsidies or interest-free loans can overcome the problem and further lead to a faster movement of solar panel producers along the learning curve.
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Of course, there are also disadvantages to tax incentives and price subsidies. With regard to efficiency considerations, they are more expensive for the state than other policies, like labelling or regulation. Beyond this, they are also associated with a potential drawback for politicians enacting the policy (from a public choice perspective): They are less specific than supply-side subsidies as to which companies or specific technologies they target. Given the choice, politicians may prefer a measure from which the domestic industry is more likely to benefit to a greater degree. For example, tax incentives for electric vehicles (EV), in addition to the effects on air quality and fossil energy consumption, might not only lead to higher demand for national brands, but might benefit innovations from other countries. Norway is a case in point: It exempts EVs from all major taxes
(e.g. sales tax and annual road tax), which has let the Tesla Model S and the Nissan Leaf become the most sold cars in Norway by the end of 2013. Although both cars are frontrunners in EV technology, neither of the two models is built in Norway.
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This type of reasoning may contribute to the decision of other countries, like Germany, to choose to subsidize R&D for EVs from domestic car manufacturers. A third issue of tax incentives and price subsidies is that it is difficult to determine if the diffusion of a new technology will become self-sustainable after providing initial incentives.
Especially in the case of new technologies that are environmentally beneficial, there are many cases in which price subsidies became permanent instead of remaining a temporary policy to boost the diffusion (Cantono & Silverberg, 2009). As for most subsidies, it is hard to determine ex ante if price subsidies or tax incentives will lead to a dependence of the market on state money or whether they can help the market achieve a self-sustainable equilibrium.
The high costs, the chance that subsidies will end up at foreign companies and the difficulty to predict if the diffusion of the technology will ever become self-sustainable leads to a rather narrow application field for tax incentives and price subsidies. The majority of such policies targets environmentally friendly innovations, whose diffusion is associated with positive externalities, in particular reduction of carbon emissions. Another field with additional positive externalities is health innovations. In certain areas, network effects may take the role of classical positive externalities in justifying demand subsidies. This especially holds for ICT innovations.
The following sections first discuss studies that provide evidence on the comparative effectiveness of tax incentives and price subsidies. Then we provide a short survey of consumer oriented policies and studies related to environmentally friendly innovations. After an overview of environmentally related policies for businesses, this section concludes with other fields in which subsidies play a role and finally, policy implications.
2.2.1
The relative effectiveness of financial incentives and survey evidence
Before analysing studies of specific programs that involve tax incentives or price subsidies, it is useful to consider comparative studies that can shed some light on the question of relative effectiveness. An early study that compares the effect of price changes to the effect of regulatory standards is Greene (1990). Using a structural model, he estimates the effect of mandatory fuel efficiency standards in the U.S. and finds that they were more than twice as important for the promotion of fuel efficiency innovations compared to changes in the fuel price. Although the effects can hardly be interpreted causally and the changes in oil price correspond to a negative hypothetical tax rather than a positive tax incentive, the difference between the two policy instruments is still
15 Note that from a global efficiency standpoint as well as regarding the policy goals of emissions and fuel usage reduction, this outcome could well be optimal. What the example also shows, though, is that this policy design might be problematic regarding the objective to foster domestic innovation and investment through increased domestic demand.
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remarkable. Similarly, Newell, Jaffe & Stavins (1999) study how energy prices and regulation affected technological advances in energy efficiency of air conditioners and gas water heaters in the
U.S. The authors find that both changes in energy prices and changes in energy efficiency regulation had an effect on the direction of product innovation towards more efficient appliances.
The responsiveness of the innovations to energy prices and regulation increased when mandatory labelling was introduced.
Among the more recent comparative studies, Johnstone, Haščič & Popp (2009) investigate how different policy instruments related to environmentally friendly innovations affect patent counts across 25 countries over the period 1978-2003. The authors analyse six types of policies: subsidies for R&D, tariff incentives, voluntary programs, obligations and quotas, tradable certificates, investment incentives and tax incentives. The overall finding is that the policy instruments had a significant influence on patents in the area of environmentally friendly innovations. However, they find large heterogeneities when it comes to the effect of different policy instruments on different industries. For example, feed-in tariffs are found to be effective to spur innovation in the solar energy sector, while certificates are the instrument of choice for fostering wind energy.
Peters et al. (2012) focus on the question of how supply side and demand side innovation policies interact across countries. This question is of high relevance as one of the major critiques of demand side tax incentives and price subsidies is that they might favour foreign industries more than they favour innovations in domestic industries (e.g. Brunnermeier and Cohen 2003). Therefore, Peters et al. analyse the photovoltaic sector in 15 OECD countries. In most of these countries, the adoption of photovoltaic units is in some way incentivized through preferential tax treatment, subsidized loans or price guarantees. The authors argue that these demand side policies are best captured by the annual photovoltaic capacity additions. Supply side policies are measured by public funding for
R&D in the photovoltaic sector. Peters et al. find that domestic demand side policies (mostly consisting of tax incentives and subsidized loans) lead to an equally large increase in domestic innovative activities (measured by patent counts) as foreign demand side policies in the same industry. For supply side policies, these spill-overs cannot be observed to the same extent.
Therefore, the authors call for better international coordination of demand side policies such as tax incentives.
Besides studies that empirically compare the effectiveness of tax credits and price subsidies with other policy instruments, there are a number of literature reviews and meta-studies that compare the results of empirical papers on different policy instruments. For example, Kemp (2000) surveys the literature on technology and environmental policy with a focus on their effects on innovations.
He finds few examples of policies that target environmentally friendly technologies and effectively stimulate innovation. The explanation offered is that policy instruments need to be fine-tuned to the technical capabilities and social preferences and attitudes in a country in order to effectively “tip the balance” towards self-sustainable technological change. In order to achieve this goal, the author suggests that environmental policies should more explicitly focus on their effects on technological change and innovation.
Jaffe, Newell & Stavins, (2002, 2005) provide an overview of both the theory and the empirics of environmental and innovation economics, with a special focus on their intersection. They criticize the often ideological or political debates about policies being a “win-win” for both the environment and innovation. Instead, they call for a more detailed examination of the effectiveness of the policies and institutions in question. The authors conclude that policies with a command-and-control regulatory approach are often less effective than more market oriented policies.
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Gillingham, Newell & Palmer (2004) compare the literature on environmental innovation policies with regards to standards, information and awareness programs, and financial incentives. Appliance standards are generally found to be effective and to yield positive net benefits. For financial incentives, the authors draw a more mixed picture of the empirical evidence. They stress that the specific design is key to determine the efficacy and cost-effectiveness of these policies. Overall, the authors state that their survey reveals a “striking lack of independent ex post analyses” of these kinds of policy instruments.
A more recent literature survey on the topic is Vollebergh (2007). One important observation is that for many policy evaluations it is hard to interpret the results as causal effects. He also concludes that most instruments seem to influence the technological path to some degree, but that a direct comparison of different policy instruments is often difficult. Vollebergh stresses that timing and commitment by the regulator are important for the effectiveness of a policy, but that too little is known about these two factors.
Kemp & Pontoglio (2011) examine the literature on innovation effects of environmental policies in theoretical, empirical, survey based and case studies. One of their five major findings is that for the effectiveness of a policy instrument, the design of the instrument can be more important than the choice of the instrument. They conclude that there is no single best instrument to foster the adoption of environmentally friendly innovations.
The most recent literature overview on the topic is Edler (2013). As part of a larger compendium on different innovation policies, the study concludes that financial incentives are not generally more effective than other policy instruments. Policies related to environmentally friendly technologies, however, are usually shown to have a positive impact on adoption. The author argues that R&D subsidies are often more effective than tax incentives and price subsidies when the outcome is patents instead of adoption. Edler warns that demand side financial incentives can create a technological lock-in instead of encouraging more radical innovations. He also points out that it is difficult to determine the optimal amount of incentives, since incentives that are too high will lead to large windfall gains and incentives that are too small will not be able to foster the diffusion enough to become self-sustainable.
To summarize the findings of comparative and meta-studies, two problems seem to be detrimental in the context of subsidies and tax incentives compared to other policies: the (deadweight) rents accruing to consumers and firms that would have adopted the innovation in any case, and the problem (from a public choice policy-maker perspective, not from a welfare perspective), that financial incentives for the adoption of innovations can benefit foreign instead of domestic technology providers. In order to minimize these two issues and thereby increase the political feasibility and efficiency of such programs, design details of each policy can play an important role.
In order to better understand which details matter the most, we will turn to specific national policies in the following sections.
2.2.2
Environmental incentives for consumers
Probably the most widely studied financial incentive policies are the so-called utility-based demandside management (DSM) programs in the U.S. designed to foster the adoption of energy saving innovations. Originally, DSM was meant to reduce and even out the energy consumption of consumers and thereby ease the load management of utility providers. One important way in which these goals were achieved was to provide financial incentives, for example rebates, for consumers who purchased energy efficient equipment. Although the rebate programs worked in terms of
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fostering adoption (e.g. Nadel and Geller, 1996), it soon became evident that a lot of deadweight rents were accumulating (e.g. Gehring, 2002).
A number of early studies on the cost-efficiency of tax incentives raised doubts that these programs are effective policy instruments. Dubin and Henson (1988) examine the distributional consequences of the U.S. Federal Energy Tax Act of 1978. They do not find a measurable incentive effect and suggest that the tax credits were ineffectively targeted to households who would have invested into the new technology anyway. Similarly, Walsh (1989) finds that energy tax credits have not led to higher investments into residential energy conservation. The author suggests that possible explanations are too small tax credits, too much bureaucracy needed in order to claim the credits and too little knowledge about the program. Walsh concludes that tax credits should be combined with other programs, such as awareness and information campaigns.
One of the early studies with a convincing strategy to identify the causal effect of tax policies on innovative residential conservation investments is Hassett and Metcalf (1995). Hasset and Metcalf are the first to use panel data at the household level in fixed-effects estimations to investigate the effect of these policies. The authors find that tax credits do indeed lead to more investments into new conservation technologies, like furnace burners. However, the authors stress that they cannot make any claims about the deadweight loss of these policies. After all, many tax credits are likely to go to consumers who planned to invest into new conservation technologies and for these consumers the tax credits are a windfall.
In Europe, many countries adopted policies similar to the DSM programs in the U.S. However, the financial incentives were usually not administered by the utility companies but by the state. In the
UK, for example, the Energy Conservation Programme (SEP) and the Homes Insulation Scheme
(HIS) started in 1978 and ran until 1990. Shorrock (1999) uses data from market research surveys to estimate that every one million GBP in grants to consumers raised annual acquisitions of loft insulation by about 1 percent. The author also estimates that when the grants reach a level of 100 million GBP, more than 300 000 consumers would have received deadweight rents from the programs.
France introduced a tax credit system in 2005 that was designed to stimulate investments into energy efficient household retrofits like insulation. Nauleau (2014) uses survey data from households and finds that during the first two years the policy had no effect. The author suggests that this was mainly due to inertia associated with investment decisions and the complexity of the tax credit program. For the years 3 to 5 after introduction of the scheme, Nauleau finds significant positive effects, which again decrease and become insignificant afterwards. Remarkably, the estimated share of deadweight rents varies a lot over time and reaches 85 percent in one year.
In Germany, there are several grant programs and soft-loans aimed at fostering investments into energy efficient home retrofits. In 2009, these subsidies added up to more than EUR 5.3 billion
(Groesche, Schmidt, and Vance, 2013). Although the programs are perceived to be effective,
Groesche, Schmidt and Vance (2013) estimate that up to 90 percent of all adopters would have invested without the program. The authors argue that the share of deadweight rents could be decreased by increasing the maximum size of every grant. However, this method would lead to a substantial increase in the total volume and costs of the programs.
Canada has introduced several policies that subsidize energy saving home retrofits. The most recent program is called EcoENERGY Retrofit and provides a financial support to homeowners, SMEs, public institutions and industrial facilities. Additionally, there are tax credit programs like the Home
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Renovation Tax Credit that offer incentives by providing non-refundable tax credits. Using data from the EcoENERGY program, Rivers, Saberian & Shiell (2013) analyse price subsidies for natural gas furnaces that range between 300-790 CAD per furnace. In some regions, local subsidies increase the total rebates to up to 1130 CAD per furnace. Although the authors find a positive effect of the subsidies on adoption, they estimate that 77 percent of all expenditures from the EcoENRGY program accrue as deadweight rents. This means that out of four dollars spent, only one dollar actually changed the adoption plans of consumers.
Some Canadian local governments and utility companies also offer financial incentives for the purchase of energy efficient appliances. For example, the government of Saskatchewan provides sales tax exemptions for energy efficient appliances with the Energy Star label. The Ontario Power
Authority and several Canadian utilities provide price subsidies in the form of mail-in vouchers for refrigerators that are especially energy efficient. But besides the issue of deadweight rents, these policies have an additional problem. Young (2008) finds that 30 percent of Canadian households have a secondary refrigerator, often called “beer fridge”. A large portion of these secondary refrigerators were the former primary refrigerators. The price subsidies for energy efficient refrigerators foster the adoption of new refrigerators, but many consumers are likely to keep the old fridge as a “beer fridge”. This means that while the demand for energy saving innovations might be stimulated, the policy goal of reducing energy consumption may be considerably hampered.
For Italy, Alberini, Bigano and Boeri (2013) analyse a policy that allows homeowners to deduct up to
55 percent of their investments into energy efficient renovations from their income tax. These renovations can include a more efficient heating system, windows with modern insulations or solar panels to be used for heating water. Using a research approach comparable to an event study, the authors find that the policy led to an increase in window replacements by up to 40 percent. For heating systems, the policy was less effective. The authors find large effect heterogeneities across regions and suggest that they are due to differences in the climate.
In South America and Asia, there are generally less evaluations on policies that provide financial incentives to consumers aimed at fostering the diffusion of environmentally friendly innovations.
Boomhower and Davis (2014) study an appliance replacement program in Mexico and use a regression discontinuity design to identify the causal effect of the program. The authors find that a larger rebate leads to more participation in the program. However, the elasticities found in the study imply that a relatively modest increase in participation would require an extremely expensive rebate.
Tax incentives and price subsidies are also used in several countries to stimulate the adoption of electric and hybrid-electric vehicles. Diamond (2009) investigates how rebates, tax credits and tax deductions affected the diffusion of hybrid-electric vehicles in the U.S. Since the amounts of tax credits and price subsidies vary across states and changed over time, he is able to both panel and cross-sectional variation. Compared to other factors, like petrol prices, the income of buyers or the average miles travelled, he finds that the financial incentives had relatively little impact. Among the financial incentives, he finds that upfront payments (e.g. waivers) are considerably more effective than delayed tax credits and benefits that are spread over time. Diamond also speculates that dealers factor the financial incentives into their pricing structure and thereby capture a considerable portion of the incentives as windfall gains.
In a case study on Chinese and Taiwanese policies that target the diffusion of electric bikes, Yang
(2010) concludes that subsidies alone are not sufficient to achieve wide-spread adoption. While in
China, many cities enforced regulations that restrict the use of standard motorcycles, Taiwan
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followed a different approach and provided financial incentives for the adoption of electric scooters.
The Taiwanese Environmental Protection Administration (TEPA) started in 1998 to offer price subsidies for consumers that amounted to nearly half of the retail price of electric scooters. Thanks to the price subsidies, the costs of electric scooters were comparable to gasoline scooters.
Nevertheless, TEPA admitted in 2002 that their policy has failed in establishing a self-sustainable demand for electric scooters. In China, on the other hand, the local regulation led to an explosive growth in electric bikes.
2.2.3
Environmental incentives for businesses
Firms also contribute to the demand for environmentally friendly innovations; consequently financial incentives for adoption are not only offered to consumers, but also to companies. The range of policy instruments that target companies is actually wider, because complex tax regulations including depreciation rules and other corporate taxation incentives are added to the set of policy instruments targeting consumers. In fact, tax rules concerned with environmentally friendly technologies are so complex that KPMG compiles a regular Green Tax Index that summarizes the relevant taxation rules for 21 countries and ranks them according to their generosity.
According to KPMG’s Green Tax Index (2013), the US, South Korea, China, India and the UK are the leading countries in using tax incentives to foster the adoption of environmentally friendly technologies. The US tops the ranking due to its extensive program of green tax incentives for energy efficiency and renewable energy. Unfortunately, the number of tax incentives is too large to describe every incentive in detail. A few examples from the leading countries in the Green Tax Index illustrate the diversity of tax incentives: South Korea offers a tax credit of 10 percent of expenditures on water conservation, treatment or recycling equipment. In China, there is a VAT exemption for enterprises that produce building materials that contain at least 30 percent recycled industrial waste. India offers accelerated depreciation of up to 80 percent for a wide range of environmentally friendly assets, like solar power generating systems, wind turbines or biogas plants. In the most cases, no evaluation of the effectiveness and cost-efficiency of these tax incentives has been carried out. However, general problems that are known from consumer policies, most importantly the problem of deadweight rents, also exist with tax incentives for companies; they are most likely even exacerbated by the higher incidence of professional assistance regarding tax-optimization.
An important question associated with the adoption of new technologies is whether firms really invest into every technology that has a positive net present value (NPV), as predicted by classic investment theory. Since the NPV only takes the discount rate that should depend on other projects with a similar risk profile into account, firm characteristics should not play a role in the investment decision. DeCanio & Watkins (1998) analyse the characteristics of firms which take part in the U.S.
Green Lights program. The program is voluntary and entails that participating firms upgrade their lighting to be more energy efficient if the investment into the new lightning passes a profitability test. The authors find that there is a strong self-selection of firms into the program with better performing firms being more likely to select into the program and invest into the profitable new technology that helps them save energy costs. This result is not only interesting from a theoretic perspective, but also shows that empirical studies that do not take selection into account are likely to suffer from bias.
Although it is difficult to test the effectiveness of real-world policies in the laboratory, Aalbers et al.
(2009) conduct an interesting experiment with professional managers as subjects. They confront
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the subjects with an inter-temporal decision problem in which a new technology can either be searched for and adopted or ignored. The choices between technologies differ in their upfront cost as well as in the benefits they might yield in later periods. The authors find that the introduction of a subsidy is highly effective in altering the decision regarding technology adoption. Surprisingly, even if the subsidy is very small and in fact too small to make the technology profitable, managers will adopt subsidized technologies more often. This behavioural result is of particular interest for policy makers, as it shows that price subsidies can change adoption behaviour, even if they do not fundamentally change the profitability of a new technology.
2.2.4
Other fields
Although tax incentives and price subsidies are mostly used in the environmental context, there are a couple of notable policy examples from other fields. For example, Lay (1993) is one of the first to describe a policy that was designed to encourage the adoption of ICT in firms through subsidies. The
German Manufacturing Technology Program (“Programm Fertigungstechnik”) in the 1980s and early 1990s covered 40 percent (up to 300,000 DM) of a company’s investment into Computer
Integrated Manufacturing (CIM). The author analyses more than 800 firms that received subsidies and concludes that the policy has “succeeded” along several dimensions. However, the results of the study are purely descriptive and robust conclusions with regards to causal effects cannot be drawn. Wengel, Lay and Dreher (1995) analyse the effect of subsidies for the adoption of computeraided design (CAD) software in Germany. The authors find that subsidies led to a 300 percent increase in the number of CAD users within four years. Again, this result cannot be interpreted causally and the early studies in this field have little sensitivity towards potential problems of selfselection and deadweight rents. It is therefore possible that a potentially large share of the subsidies were windfall gains for the adopting firms.
Tax incentives and price subsidies in the field of ICT remain popular, but are unfortunately rarely evaluated. Warda (2005, 2010) provides an overview of ICT related financial incentives for businesses in Canada and other countries. A short overview of these policies is presented in Section
2.5, where we focus on the nexus between ICT skills and infrastructure.
2.2.5
Implications
A central problem with regard to tax incentives and subsidies is deadweight rents. Ex-post, it is often impossible to determine which program participants would have adopted a technology without the financial incentives.
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A better understanding is of direct and immediate importance for the quality of policy decision making in the future, and therefore closely dependent on the quality of evaluations. One possibility to get a better understanding of the problem is to conduct a survey with program participants and ask them if they would have purchased the product if there has not been any tax incentive or price subsidy.
17 If these static deadweight rents are taken into account, the effective policy costs per adopter can rise significantly. Using a more elaborate control group approach by creating several clusters of similar consumers, Malm (1996) finds that nearly 89 percent of adopters within a program that subsidized energy efficient heating systems would have adopted the system anyway. In the light of these numbers, policy makers have to be very sensitive
16 Note that this is not a static problem. The important question is not only if a participant would have adopted the technology at the time of the program, but if the participant would have adopted the technology at any point in time.
17 For example, Joskow and Marron (1992) analyse data from 10 U.S. utility companies on the effectiveness of their DSM programs that are designed to encourage users to adopt energy saving technologies. Out of the 10 utilities, only 3 used expost evaluations to estimate the extent of deadweight rents.
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concerning the topic of deadweight rents to adopters when implementing tax incentives or price subsidies.
Given that there are many policies, but only few evaluations that can identify a true causal effect on the adoption of specific technologies, it is difficult to derive general policy conclusions. However, tax incentives and price subsidies have been shown to stimulate demand in many instances. at The existing evidence indicates that this policy could be more costly compared to other demand side innovation policies such as standards and labels. Therefore, these policies are mainly applied in policy fields that simultaneously address other market failures. Most prominently, they are applied for stimulating the demand for environmentally friendly innovations. Further note that the costeffectiveness of these types of policies are empirically hard to determine; it appears that often the true costs are underestimated.
Figure 4: Overview of implications of evaluations of subsidies and tax incentives
Subsidies and tax incentives:
Substantial evidence that subsidies and tax incentives are effective in stimulating demand for innovative products o Evidence from a rather wide range of countries and measures
Instruments require awareness/information on the side of potential beneficiaries; this indicates potential complementarities with information/awareness campaigns
Recent studies and academic literature focus on deadweight rents associated with subsidies/tax incentives, which makes them appear relatively expensive compared to other measures
Caveats: o
Final incidence (who benefits?) of financial incentives can be difficult to predict
2.3
Regulation
Governments may promote innovations by directing private demand through regulation. Regulation refers to the set of policies with which the government oversees market activity and the behaviour of private actors in the economy. Traditionally, the literature has been concerned with the effect of regulation on the supply of innovation. It mostly states a trade-off between regulation and innovation (see e.g. Aghion and Griffith, 2005) since stricter regulation decreases competition and therefore reduces companies’ pressure to innovate in order to stay in the market. In recent years, increasingly also positive effects of regulation on innovation are recognized in that it may positively affect private demand for new goods. These “successful” measures typically aim at regulating consumer health and safety, worker safety as well as protecting the environment.
Regulation can affect innovations through two channels. First, it exerts a direct effect on producers, in that they are forced to change products of production processes in order to comply with legislation. We consider this a more supply-side effect of regulation. Second, regulation may speed up the diffusion process since customers (private as well as business) place higher trust in innovations, if they know that new products must meet certain requirements. We consider this a demand-side effect of regulation. In practice, it is very hard to disentangle these two effects of regulation in empirical analyses and to isolate the pure demand-side effect. Conclusive empirical evidence of the effect that regulation has on the supply of innovation or on demand for innovation is scarce, and mostly concentrated on the health sector as well as on measures for protecting the environment.
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The OECD distinguishes between three generic types of regulation, economic, institutional and social. Economic regulation comprises competition policies, price regulation, market entry regulations, the regulation of natural monopolies as well as public utilities (Blind, 2012). Out of these, price ceiling regulations have an obvious effect on consumers. They will increase demand for a given product according to price elasticities.
18
The reduction of entry barriers for foreign firms, in turn may increase the potential market of newly entered foreign firms, thereby increasing the potential market size and therefore demand for new products. Institutional regulation describes the legal environment. In this context, especially liability rules can be named as one measure that influences consumer acceptance of new products, thus leading to faster diffusion of innovations.
Finally, social regulation which aims at reducing negative externalities to consumers (such as health or environmental regulations) can be perhaps considered the most important category for influencing demand for innovations.
Following Edler (2006), we can also distinguish between regulations that affect the relationship between producers and customers, and regulations aiming at producers’ not directly consumerrelated conduct. The first type, i.e. regulations that affect the relationship between producers and customers, may affect demand for new products by providing transparency and information to consumers, thereby reducing information asymmetries. This may generate trust in the regulated new products, thereby speeding up the diffusion process. Examples for this are labelling requirements, product type approval procedures or other mandatory safety standards. The second type of regulation aims to internalize negative external effects that producers may generate in the course of production (mostly concerning the environment and worker safety). As a result, producers may be forced to develop new products in order to comply with regulation or to adopt new technologies or production processes.
2.3.1
Consumer health regulation
Health regulations are clearly of special importance in the pharmaceutical sector. In the following, we focus on the context of price regulation and product admission. In the European Union, regulation concerning the admission of new pharmaceutical products to the market underlies directives 2001/83/EC and EC regulation 726/2004. Regulation here aims at ensuring safety, quality and medicinal efficacy of new (and existing) drugs. The legislation regarding admission procedures has been largely harmonized across Europe, the USA and Japan.
In the context of the USA, several studies have evaluated the effects of amendments to the Federal
Food, Drug and Cosmetics Act (FDCA) on pharmaceutical firms’ subsequent innovation. According to the FCDA, new drugs must undergo certain safety tests, and subsequently undergo an approval process with the government. Until 1962, efficacy was no requirement for the admission of new drugs. This changed with the Kefauver-Harris-Drug Amendment in 1962, which required adequate proof of efficacy in response to the Contergan scandal. Peltzman (1973) analyses the effects of the amendment and concludes that the compliance costs for pharmaceutical companies have led to a considerable reduction in drug innovation. Moreover, he claims that the welfare loss from foregone
“good” innovations exceeds the surplus from reduced “ineffective” drugs. However, he attributes all changes in drug innovation during the period 1964 to 1970 to the FDA amendment, an assumption which seems far too drastic. Grabowski and Vernon (1977) similarly find that the introduction of an efficacy requirement led to a decline in new drugs in the US market. In addition, the relative market position of multinational firms was strengthened as they were better able to deal with stricter regulation, a finding that is backed up by Thomas (1990). In a similar vein, Grabowski et al. (1978)
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attributes about half of the productivity decline in the US pharmaceutical sector to the Kefauver-
Harris-Drug Amendment. In 1976, a further amendment requires medical devices to be included in the regulation in addition to drugs. Hauptman and Roberts (1987) find that the 1976 FDA regulation poses a significant constraint to biomedical firms. The effect is stronger for more elaborate devices and for more regulated products. However, the authors report only weak correlations between regulation and firms’ financial performance measured in terms of sales, as well as employment size.
More recently, there are still considerable differences in price regulation of new drugs across countries, even within the EU. EU member states can freely choose their pharmaceutical pricing and reimbursement policies, as long as they comply with the Transparency Directive for pharmaceuticals
(Toumi et al., 2013). Therefore, price regulation varies greatly within the EU which leads to substantial price differentials in patent markets (as well as off-patent markets). In Germany for instance, highly innovative, patented drugs do not underlie price regulations (Federal Ministry of
Health, 2014). Other countries, such as France, use an external pricing reference system (i.e. prices in an international comparison as a benchmark for regulation) to obtain regulated prices. Vernon
(2002, 2005) analyses the effects that price regulation has on firms’ R&D expenditures. The pharmaceutical market in the USA traditionally underlies only few price regulations. The author therefore considers changes in price regulations abroad, since many US firms export to such price regulated markets. Vernon finds that firms that export in the relevant markets spend less on R&D if the regulated price decreases (i.e. there is stricter price regulation), since their expected returns on
R&D decrease.
The studies presented so far in this section suggest a trade-off between regulation intensity and innovation incentives. But several caveats apply. First, the studies that consider the effect of (any type of) regulation on the number of drug innovations cannot distinguish between “good” and “bad” drug innovations. If bad innovations are reduced and the good ones remain in the market, reduction of innovation would be a good outcome. Second, most studies cover relatively short time spans, which allow for no inference on the long term effects that might considerably differ from the short- and midterm. In addition, despite offering interesting insights, none of these findings qualifies as a causal effect, due to the lack of adequate control groups in the statistical analysis.
Considering the demand side, price regulation results in lower consumer prices for new drugs, which should speed up the take-up rates of such innovations. However, this still needs to be verified as the studies by Vernon (2002, 2005) do not measure the demand side effect.
2.3.2
Regulation to increase environmental efficiency
Another important category of regulations are environmental regulations. The literature generally agrees on regulations being a particularly important determinant of environmental innovation (see, e.g. Rennings and Rammer, 2011). This is because environmental innovation differs from “regular” innovation in that its primary aim is to reduce negative externalities of firms’ activities. This may generate higher costs for the producers and does not necessarily lead to higher profits, which may apply to both new products as well as new production processes. According to the Oslo Manual
(OECD, 2005) environmental- or eco-innovations reduce the environmental impact of goods and services during the production phase or during utilization.
One large program for improving the energy efficiency of products during their entire life cycle is the EU’s Ecodesign Directive, a framework directive, which aims at improving the environmental performance of energy-related-products. Binding requirements apply to different product groups on
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a case by case basis.
19
This comprises products which use, generate or transfer energy as well as products that do not directly use energy but can contribute to saving energy (such as windows or insulation material in construction). These products account for a large share of the consumption of energy in the EU (European Commission, 2012). The Ecodesign Directive may thus affect demand for innovation twofold: First, the harmonization of environmental requirements reduces entry barriers and thus enlarges the potential market for each firm in the EU. Second, it generates consumer trust and - combined with the labelling – reduces information asymmetries. Braungardt et al (2014) provide some evidence on the Ecodesign Directive’s innovation incentives. Measuring innovation as the number of approved requests from R&D funding from the European Investment
Bank, they find that funding requests coincide with the regulation between 2001 and 2012, especially in the white goods and tyre sector. However, the number of observations is too small to conduct statistical analysis. As a second measure they investigate the number of patents and find that firms already had the technical ability to fulfil the requirements, but had no incentive to bring them to market without regulation. They moreover conclude from case study evidence that
Ecodesign mostly impacts the speed of diffusion of high-efficiency technologies and that it hardly influences innovation in earlier R&D stages.
Another government program that is often named in this context is the Top Runner program in
Japan. In 1998, Japan introduced the program to improve the energy efficiency of final products in the household and transportation sectors and to improve the competitiveness of Japanese firms by forcing the diffusion of eco-innovations (see e.g. Kimura, 2010). Under the Energy Conservation
Law, the most efficient product is chosen as a mandatory energy standard and serves as industry benchmark. Firms have to catch up with the standard within 5 to 7 years in order to avoid penalties.
Thereby, not every single product has to fulfil the standard, but on average their products must comply. In 2009, the program comprised 21 products, including home appliances, office equipment and vehicles. The energy standards are combined with a labelling system to provide consumers with information about whether products are according to the standard (Hamamoto, 2011). Regarding the effect on innovation, there exists some qualitative evidence (Kimura, 2010) that the program accelerated manufacturers’ development activities for more fuel efficient vehicles. Overall, the program reportedly improved energy efficiency rates between 16 and 80%, depending on the product group. A study by Hamamoto (2011) shows that, combined with the labelling system, the
Top Runner Program led to an increase in firms’ R&D expenditures by around 10 percent. In addition, he finds that motor vehicle producers responded rather to exhaust gas regulation – that was introduced in Japan in 2000 in order to restrict pollution from diesel-powered vehicles – rather than the energy efficiency regulation.
In 1991, Porter suggested that environmental regulations have a positive effect on firm performance as they stimulate environmental innovation in regulated industries faster than elsewhere. Adopting the regulation can cause a firm to produce at higher prices than in the absence of regulation. However, it gives the firm a competitive advantage 20 over its foreign competitors in international markets that adopt the regulation at a later point in time. Note that the EU’s Lead-
Market Initiative is based on a similar logic. Several studies have investigated this hypothesis empirically and compared to other policies considered in this study, evaluations of environmental
19
Under the Ecodesign Directive, standards can in some cases also be met through voluntary industry agreements as outlined in Section Error! Reference source not found.
.
20 Competitive advantage in our context refers to a firm’s ability to be ready-to-serve a newly regulated foreign market, whereas the foreign firms still adjust to the regulation. Moreover, the firm may have realized some learning effects which would allow it to produce the new technology at lower prices than foreign firms.
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regulations are numerous (see the literature table in the Appendix). The literature is ambiguous, though, about whether regulation increases environmental innovation. The effects of regulation very much depend on factors such as institutional and general market characteristics and vary by type of regulation (e.g. price regulation, standard setting, etc.).
Recent evaluations often find that other factors besides regulatory enforcement – such as market demand, regional innovation conditions or energy prices play a larger (or at least equally important) role in environmental innovation (see, e.g. Brunnermeier and Cohen, 1996; Doran and Ryan, 2012;
Ju et al., 2013). Lee et al. (2007), for instance, test Porter’s claim and make use of a series of amendments to the US Clean Air Act and the Motor Vehicle Safety Act between 1967 and 1976 where car manufacturers were obliged to reduce harmful emissions by 90 percent. The authors make use of these regulatory changes to investigate their impact on innovative activity, measured by successful patents. They find no evidence that a stricter emission regulation spurred environmental innovations in the car industry.
Rennings and Rammer (2011) try to investigate whether environmental innovation triggered by regulation is as successful as innovation that was triggered by market demand and technological developments. They analyse whether regulation-driven innovation increases firm success, measured as sales, which is a more immediate indicator for demand than the number of innovations. Using a dataset on German firms for the years 2000 until 2002, they find that product and process innovation driven by environmental regulation generate similar success in terms of sales as other
(non-regulation induced) innovations. However, this result differs by type of environmental regulation. Regulations on sustainable mobility generate higher sales, regulations on water management are associated with lower sales. Moreover, higher profit margins can be observed for firms with innovations triggered by regulations on recycling and waste management as well as on resource efficiency.
Popp et al. (2007) looks into the reduction of the use of chlorine in the US pulp industry, initiated by regulatory pressure and changing consumer demand during the 1980s and 90s. The authors find evidence for considerable process innovation before the regulation took place. Producers adopted low-chlorine production in response to changes in consumer demand. However, the authors emphasize the role of government regulation in fostering wide adoption of the environmentally friendly production process as not all firms applied the innovations voluntarily.
Market demand has generally been established as the most important factor in firms’ decisions to engage in environmental innovation. Doran & Ryan (2012) and Horbach et al. (2011) e.g. find strongly positive effects of demand for eco-friendly products on firm’s decisions to engage in environmental innovation. Note that the positive and significant coefficient might partially contain the effect of regulation (in addition to preferences that consumers would have developed anyway) but the studies mentioned here do not allow to clearly isolate the effect.
A study on the Australian oil and gas industry by Ford et al. (2014) postulates that firms often go beyond the regulatory requirements and exceed compliance. They explain this with the concept of
“social license”, or a certain level of acceptance or approval by the relevant community. Therefore, this concept describes consumer demand as resulting from a socially acceptable norm, where increased consumer awareness as well as the proliferation of pressure groups that can exert influence on firms towards more environmentally friendly production processes and products beyond the traditional governmental roles. It is thus also demand-pull which ultimately causes environmental innovation.
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Newell and Jaffe (1999) stress the importance of the relative price of energy for eco-innovation.
They analyse US energy-consuming durable goods between 1958 and 1993, during which time energy prices vary considerably due to several energy shocks. The authors additionally estimate the effect of mandated efficiency standards
21
on energy efficiency. They make use of the National
Appliance Energy Conservation Act that mandated minimum energy efficiency standards for room air conditioners and gas water heaters in 1990 and for central air conditioners in 1992. They find that energy prices as well as standards are important determinants of eco-innovation. The authors cannot fully ensure that they can isolate the effect of energy efficiency standards. It may well be that the estimated effect captures a combined effect of several standardization efforts that occurred around the same time.
For China, Ju et al., (2013) find that regulation plays a minor role in environmental innovation.
Instead, general regional innovation conditions such as innovation input, export pressure and educational expenditure shares affected environmental innovation to a much larger extent.
In addition to studies that analyse single environmental regulation policies, some authors (Norberg-
Bohm, 2000; Frondel, 2007; Arimura, 2007) have stressed the importance of general policy stringency in environmental matters. They found this a more potent driver of environmental innovation than single policy instruments, which may signify the importance of preferences of society in general.
The heterogeneous findings on the effect of regulation on innovation can be found in other contexts beyond environmental regulation. Amable et al. (2010), e.g. test the existence of a relationship between product market regulation and innovation conditional on the proximity to the technological frontier using industry data for a sample of OECD countries between 1979 and 2003. They find that product market regulation may have a hindering impact on the number of patents, but the effect becomes positive as an industry moves closer to the technological frontier. Bassanini and Ernst
(2002) also argue that the sign and magnitude of the effect of job protection regulation crucially depend on specific characteristics of each industry. These findings echo the differential effects of public procurement on innovation, which were positive for high-tech sectors but neutral otherwise
(see Section Error! Reference source not found.
).
2.3.3
Implications
The empirical studies investigating the impact of regulation on innovation present a rather heterogeneous picture along multiple dimensions. The effect of a regulation on innovation crucially depends on the setting and is among others determined by the type of regulation, the industry and the time frame. All the evaluation studies presented in this section have in common, that the indirect effect of regulation on demand for innovations cannot be isolated from other effects.
Consider a study that finds that a firm increased (or decreased) innovative activities (in the form of e.g. R&D expenditure, patents) or the speed of adoption (measured for instance as market shares or sales). This study typically cannot state whether this change in innovation or diffusion is due to a change in the consumer preferences (the demand side) or because producers must simply comply with certain rules (a supply-side effect) because they occur at the same time. Isolating the demandside effect of regulations would ideally require an experimental setting in which consumer’s reactions to regulated products are tested.
21 We consider mandated standards a subset of regulations, as opposed to voluntary standards that are treated separately in
Section Error! Reference source not found.
.
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Also, often regulations do not occur on their own, but are accompanied by labelling requirements or awareness campaigns, as in the case of the Ecodesign Directive that is combined with the voluntary
EU Ecolabel or the Top Runner Program Program which is connected to a labelling system (Chapter
2.4.2 treats labels separately). In such cases, where different policies occur together, the effect of the single measures cannot be distinguished.
Concluding, it can be mentioned, that a general advantage of regulations and mandated standards is their relative cost efficiency for policy makers compared to measures such as tax incentives, price
subsidies or awareness campaigns (cf. Section 2.2). Even though there are costs involved for policy
makers in obtaining relevant information on the best regulatory praxis, the majority of the burden should lie with the regulated firms who have to adjust production processes and products. However, it is not possible to draw conclusions on the overall efficiency of the single measures.
Figure 5: Overview of implications of evaluations of regulations
Regulations:
Overall, limited causal evidence for effectiveness of regulations
Regulations/mandatory standards relatively inexpensive (policy makers’ perspective)
Indications of complementarity with labelling and other awareness measures
Caveat: o Hard to empirically disentangle demand/supply side effects of regulation
Potential drawbacks: o
Regulation can also discourage innovators (theory and empirics) o Risk of wrong incentives - no full information on all available technologies
Specifics: Consumer health
Robust evidence, that consumer health regulations - in the form of stricter approval procedures or price ceilings - decreased firms’ innovative activities
Caveats: o Strong focus of studies on the US o Lack of information on quality of innovations o no long-term effects considered
Specifics: Environmental regulation
Robust evidence that environmental regulation creates incentives to innovate
Strong importantce of (changes in) consumer preferences (independent of regulation)
Caveats: o
Few OECD countries studied o Few sound empirical studies, often qualitative evidence o Likely to mostly affect speed of diffusion, not earlier stages of development
2.4
Complementary Measures
After having discussed the “classical” demand-oriented policies (procurement, price subsidies and regulation), we now turn to complementary demand-oriented measures, in particular measures advancing information regarding and awareness of new technologies (information campaigns and labelling) as well as the promotion of required complementary skills. In many circumstances, these measures are implemented to augment (or “complement”) other policies, which makes it difficult to
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assess their independent effects. This chapter then closes with a focus on skills and infrastructure, which are complementary requirements for many innovative products, and resulting policy implications using the example of ICT.
There are various reasons how lack of information and awareness on the side of potential consumers and users can adversely affect the diffusion of new technologies: Lack of information can lead consumers to distrust innovations; imperfect knowledge and awareness may entail that the expected utility from a new product or service is substantially underestimated, resulting in a too low willingness to pay; missing complementary skills on the side of customers will have the same effect, which can be exacerbated by the lack of organizational skills and human capital in a corporate setting. Note that there is so far very little robust empirical research on the effects of information and awareness campaigns with regard to technology adoption. Therefore, in the following, we will also address findings from neighbouring fields such as health and nutrition awareness that can be considered relevant for consumer behaviour and information uptake in general.
2.4.1
Information and awareness campaigns
Information campaigns aim at familiarizing consumers with new technologies, therefore potentially generating additional demand, purely by providing information. They are closely related to informational advertising.
22 Some campaigns may attempt to more directly influence consumer behaviour through a combination of information complementing other measures discussed in the previous sections. For example, economic or behavioural incentives such as the eco-point system in
Japan offers information as well as points for buying energy-efficient products that can be redeemed for other goods and services.
An important setting for information campaigns concerns energy efficiency advisory for private homes.
23
As noted above in Section 2.2.2, the effectiveness of price subsidies for energy efficient
home refurbishing was most likely impaired by lack of consumer knowledge. While the studies in that section focused mainly on lacking awareness with regard to subsidies, two German studies focus on the provision of information regarding the technological and efficiency benefits of different options for refitting homes. Duscha et al. (2013) conducted a survey among private households in
Germany to investigate the effect of informing consumers about energy saving possibilities and the implementation of energy efficiency measures. The advice mainly concerned general information regarding renewable energy and more energy efficient solutions for homes. The authors claim a significant positive impact of advice on the households’ investment decisions regarding energyefficient systems, with an extremely high share of interviewees indicating concrete plans for investing in their homes energy efficiency after receiving advice (>50%), mostly to renew and modernize the heating system (which according to the authors is the most promising investment for saving energy). Similar results are found by Duscha (2011), who evaluated advice regarding the replacement of windows and retrofitting isolation to homes. Both studies unfortunately lack a control group and may be subject to sample selection.
For control-group type settings, we turn to the subject of health and nutrition. In 1990, the
Nutrition Labeling and Education Act was launched in the USA. It required food manufacturers to provide more easily and readily accessible detailed nutrition information on the packaging of their products. Moorman (1996) examined the influence on consumer activities, using a longitudinal
22 Government may play an important role in this context if, e.g., due to fragmentation of markets an informative ad campaign is beneficial for society but not profitable for any given (group of) firm(s).
23
separately since one policy targets consumption decisions (this section) and the other policy targets investment decisions.
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quasi-experimental design with over 1000 consumers and 20 product categories. There were significant effects observable regarding the consumers’ understanding of nutritional information, with some important caveats: Most strikingly, there is no conclusive finding with regard to alterations in consumption behaviour. Further, consumer learning partially depended on measures of consumer motivation and scepticism – only the more interested consumers actually became more informed. One of the results therefore was that the information gap regarding the nutrition content of unhealthy food groups widened among consumers. These interactions between information campaigns and consumers’ original attitudes could have wider-reaching consequences, which we will revisit in the section on implications below.
One of the shortcomings of Moorman (1996) – the lacking effect of information campaigns on consumer behaviour – is addressed in another nutrition setting for an Australian information campaign on the importance of eating fruit and vegetables: The Western Australian Health
Department Go for 2&5 social marketing campaign was carried out from 2002-2005 and evaluated by Pollard (2007), using independent randomized before-and-after telephone surveys focused on adults in the Perth metropolitan area (therefore, it has to rely on self-reported answers). The marketing strategy of the campaign included mass-media advertising, public relations events, a website and community activities and was purely informative in the sense that no economic incentives were offered. The awareness campaign appears to have reached the target audience; the self-reported fruit and vegetable consumption increased significantly after the campaign by 0.8 in the mean number of servings of fruit and vegetable per day. Unfortunately, there is no information regarding the longer-term effects of this particular intervention available.
It is specifically the long-term effects of information campaigns that are the central focus of the more recent evaluations of anti-smoking campaigns. In 1964, the Surgeon General initiated the first wave of major sustained anti-smoking campaigns. It famously was found to have induced an immediate 5 percent decrease in 1964 cigarette consumption in the USA (Warner, 1977). This finding, significant reductions in cigarette consumption, has been confirmed by recent studies, such as the work of Liu and Tan (2009).They examined the effectiveness of the California Tobacco
Control Media Campaign, one of the USA’s longest running anti-smoking programs, and showed empirically how the awareness of health risks has changed the smoking behaviour of adults and adolescents in the short as well as in the long run. For their investigation they construct a pseudo panel with repeated cross sections and use an instrumental variable approach to confirm causality.
They find that the anti-smoking campaign significantly reduces the prevalence of smoking and also has long-term effects in smoking reduction, both due to higher incidences of quitting among adults and by successfully deterring take-up by adolescents. In a complementary approach, the
Department of Public Health and Policy at the London School of Hygiene and Tropical Medicine investigated the cost-effectiveness of anti-smoking campaigns in different population groups.
Thorogood (2002) finds that campaigns targeted at groups with high smoking prevalence due to lower awareness of medical risks, in this case identified as the Turkish speaking population in
London, may be more cost effective.
2.4.2
Labelling
Beyond nutritional information, simple labels are often employed as easy-to-understand signals of certain product characteristics in different contexts, perhaps most importantly environmental sustainability. Here, eco-labelling programs, such as Green Seal, Scientific Certification Systems,
Energy Guide, Energy Star, and Green-e certify energy-efficient appliances and renewable electricity. Green Seal is an environment organization, which certificates products and services. The
Green Seal assessment is based on performance, health, and sustainability criteria. Started in 1984,
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the Scientific Certification Systems is an independent agency which labels for food safety and quality issues. The Energy Guide, passed by the US energy Policy and Conservation Act in 1975, provides consumers with information about the energy consumption and energy efficiency of several groups of products, including refrigerators, freezers, televisions, water heaters and window air conditioners. The label shows the key features and displays operating costs with comparison to similar models. Energy Star, created in 1992 by the Environmental Protection Agency and the
Department of Energy aims at reducing air pollution and climate change by promoting the use of energy efficient products. The Green-e is a seal-of-approval label that certificates energy efficiency, which means that the power marketed by firms is gained from renewable energy sources. While
Energy Guide and Energy Star are government-run programs, the rest are private initiatives.
Banerjee and Solomon (2003) carry out a meta-analysis to determine the effectiveness of energyefficiency labels. Overall they find that government programs such as Energy Star were significantly more successful than those programs without government involvement considered in their data. For energy labelling, their research shows that private programs have an almost insignificant effect on the consumers. In this context it therefore appears that government support is a crucial aspect for determining a program’s credibility and long-term viability.
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With regard to the details of implementation, they find that simple logos and labels generally affected consumer behaviour more than complex information labels. The authors conclude that a properly designed labelling program can be a significant stimulus for market transformation toward environmentally preferable products. In the context of the US, government involvement, simplicity and label clarity were indicators for effectiveness of labelling programs. They also find that labelling is more successful in altering consumer behaviour when combined with economic incentives for consumers.
In 1997, the OECD’s Joint Working Party on Trade and Environment examined selected eco-labels and investigated short-term and long-term impacts on consumer behaviour and the environment.
The study found that the impact of eco-labelling is directly linked to the country’s environmental awareness and the demand for eco-products. The significance of the effect is difficult to evaluate, because eco-labelling is only one of many factors which can influence the market penetration of products. One of the better-evaluated eco-labels is the “Nordic Swan”, an environmental label that was introduced in Denmark in 1989. This label aims at affecting consumer brand choice and thus increasing the market shares of companies with green technologies or environmentally friendly products. In an econometric study, Bjorner et al. (2004) attempt to quantify the effect of the Nordic
Swan on consumers’ brand choices of toilet paper, paper towels and detergents. The study comprises data from a detailed Danish consumer panel, including information from 1596 Danish households from 1997 to 2001 and employs a mixed-logit discrete choice approach. The authors find that the environmental label has had a significant effect on the choice of different household products, with the marginal willingness to pay component for certified environmentally friendly brands ranging from 13% to 18% of the price. Relatedly, the US Dolphin Protection Consumer
Information Act was approved in 1990, enforcing a dolphin safe standard and corresponding labelling in the United States. Teisl et al. (2002) used time-series data on the expenditures for canned tuna and its substitutes and estimated a set of conditional demand functions for these goods. The study concludes that consumers respond to eco labels and that the implementation of dolphin-safe labelling affected consumer behaviour and significantly increased the market share of canned tuna. The introduction of this eco-labelling program even provided an incentive to produce
24
effects depends on the characteristics of the market and country in question. While for certain countries government can bequeath characteristics such as trustworthiness, impartiality and expertise, this does not necessarily have to hold for others.
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in a more environmentally friendly fashion, especially the harvesting techniques of fishermen changed.
Eberle and Reuter (2003) study the effects of the Blue Angel label, which is a German certification for products that have environmentally friendly aspects, and found that this label has played an important role in shaping the development of the production processes of various products, by encouraging producers to take the environmental impacts of their product into account. Also, it has directly inspired the emergence of other eco-labels. Research on other eco-labelling programs, such as the New Zealand Environmental Choice label and the Japanese Eco-Mark, also provide empirical evidence that the labels can provide an incentive to produce greener products, because companies experienced increased sales of their certified products (see the collected evidence in the main table in the Appendix). To our knowledge, a control-group type study of producer effects of eco-labels has not yet been undertaken, probably in large parts due to data availability issues.
Similar to the “Beer-Fridge”, eco labels may also have unintended negative effects on consumer behaviour. The study on the New-Zealand’s Environmental Choice label (OECD, 1997) indicates that purchasing more green products can lead to increased overall consumption, because consumers think that they already have done something good for the environment.
2.4.2.1
Implications
The empirical evidence shows that information campaigns and labelling can affect consumer behaviour in desirable ways both in the short- and in the long-run. The magnitude of these effects, with around 15% of the price of household goods is economically significant. The findings also show, though, that both the effectiveness of these measures as well as their actual effects may strongly depend on both the societal context (the fact that government involvement had a positive impact on energy labelling in the US prior to 2003 must not necessarily hold true today) as well as preferences
(Bjorner et al., 2004, conclude that the boost to the willingness to pay through the Nordic Swan label was to a large part an expression of the consumers’ altruism; therefore one has to be very careful to transfer the magnitude of these findings to other contexts). Thorogood (2002) shows that in the context of information campaigns, there may be decreasing marginal benefits; therefore it may be most cost-effective to target less informed over better informed groups in the population
(though additional robust empirical evidence is required to corroborate this finding). The final implication is perhaps the most far-reaching, though it also requires the most additional scrutiny, since our understanding of this issue is extremely shaky:
The findings of Moorman (1996), Bjorner et al. (2004) and Banerjee and Solomon (2003) indicate that the overall attitude of groups or the society as a whole can influence both consumer (and firm) behaviour as well as the efficacy of the complementary measures discussed in this section. This finding should apply more generally and in particular to diffusion and adoption of new technologies.
In fact, there are active discussions taking place throughout Europe currently with regard to the different societies’ openness toward innovation and new technologies. Perhaps the most prominent current initiative is the German Economic Ministry’s initiative for more openness toward innovation in the population.
25
The interaction between societal attitudes and policy measures is currently still a complete black box and desperately requires attention from empirical researchers and policymakers. With our current knowledge, though, it is impossible to give well-founded recommendations about how to approach the issue of trying to assess and perhaps even influence societal attitudes towards technology and innovation; this could involve a plethora of approaches starting with
25 The BMWi “Initiative zur Technologieaufgeschlossenheit“, http://www.bmwi.de/DE/Themen/Technologie/rahmenbedingungen,did=583088.html
.
see e.g.,
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science education for children and including measures to make better use of the experience and expertise of senior citizens. In the final section of this chapter on the Importance of ICT, we will at least cover some related issues with regard to a particular technology.
2.4.3
Promotion of skills
As discussed above, lack of complementary skills to make optimal use of new technology can negatively affect consumers’ and firms’ willingness to pay for innovative products and services.
These issues can be substantial impediments to the diffusion of innovations. Therefore, the promotion of complementary skills among consumers and firms are potentially important policies to enhance the diffusion of innovation. In the following, we consider the effects of skills and advice on process innovation in manufacturing and agriculture
26
and show examples in which the government plays an important role, which can be considered as a benchmark for similar policy measures and initiatives.
2.4.3.1
Aiding the Diffusion of Process-Innovations (Manufacturing
Extension)
Small and medium-sized companies often find themselves unable to adopt modern technologies and business practices due to the lack of specialists with the necessary expertise within their organizations. The solution to employ expensive temporary specialists such as commercial consulting firms is too expensive in most cases. Due to these setup-costs, the adoption rate for process innovations among SMEs can be too low, potentially seriously hampering productivity growth and competitiveness. In the US, the Manufacturing Extension Partnership (MEP), which was administered by the National Institute of Standards and Technology (NIST),
27
attempts to alleviate this problem by assisting smaller US-based SMEs in identifying and adopting innovative processes and providing information and advice. Examples for this include helping a plant install a CAD/CAM system or switching to production processes generating less waste, but also offering strategic advice and consulting. An issue in evaluating this type of program is that causal effects are difficult to identify, because they are extremely hard to separate from productivity contributions from other sources, such as own research or shocks to human capital. Jarmin (1999) attempts to measure the impact of MEP programs using panel data and controlling for both observed and unobserved characteristics of treated and non-treated firms. The results are quite striking: According to the regression results, treated firms enjoyed productivity growth that was between 3.4 and 16 percent higher than non-treated firms, with a two-stage approach trying to take the selection effect into account. A previous study by Oldsman (1996) focuses on a more specific sub-program, the
Technology Extension Service for New York State. The study also uses a control-group design comparing treated to non-treated companies. The results suggest that the program has had a positive impact on companies with regard to costs and productivity, as well. Despite the fact that
MEPs can also choose to refer firms to private service providers, and despite the quantifiable evidence regarding the success of these programs, there have been discussions regarding the political influence and rigidity of the program (see Shapira, 2001).
Since 1976, the US Industrial Assessment Centers (IAC) program 28 has been offering free industrial assessments to small and medium-sized manufacturers, specializing on technical issues such as energy efficiency. The program operates as an extension service through 26 participating
26 As noted above, these are very much akin to the information campaigns noted above, except for the fact that they concern investment decisions by firms instead of private consumption choices.
27
28
See also: http://www.nist.gov/mep/about.cfm
See also: http://energy.gov/eere/amo/industrial-assessment-centers-iacs
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universities, whereby teams of engineering students and faculty help manufacturers identify opportunities to conserve energy, reduce waste, and improve productivity. The program’s provided assessment follows a standardized process. After performing a pre-assessment (e.g. reviewing energy bills, interviews, visiting plants), the IAC teams provide a report with opportunities to increase energy efficiency. Ca. 6-9 months later, the teams contact plant management by phone to get an overview of the implemented projects. Anderson and Newell (2004) evaluate the IAC program, which has generated an unusually extensive set of data, so a fixed-effects model controlling for unobserved differences in firms’ propensities to adopt technology could be estimated. The Database used has a record of over 70,000 individual projects going back to 1981, covering nearly all geographic regions and manufacturing industries. The results show that 53% of the programs' recommended projects were adopted, half of them covered energy saving issues, the other half cost savings. Generally, the adoption rates are higher for projects with shorter payback periods, lower implementation costs and greater annual energy savings.
2.4.3.2
Diffusion of Process Innovations in the Agricultural Sector
In 1979, lupins, a potential replacement for soya, were reintroduced into Western Australian farming, concomitant with a major extension program. Lupins are an innovation that is highly profitable and compatible with farming in Western Australia. Using a multivariate regression analysis, Marsh et al. (2004) attempt to measure the impact of the extension program on innovation adoption. The results suggest that both public and private extension activities influenced farmer uptake of lupins, particularly by moving the start of the diffusion curve forward. Benin (2011) assesses the National Agricultural Advisory Services (NAADS) program of Uganda, which started in
2001, regarding its rate of return using data from two rounds of surveys conducted in 2004 und
2007. The direct and indirect impact of the program is estimated at 37–95% and 27–55% increase in per capita agricultural gross revenue between 2004 and 2007 for households participating directly and indirectly in the program, respectively, compared to a non-participating control group. The rate of return on the program’s expenditures is estimated at 8–49%. Training of village groups and farmer forums at the local level has further strengthened local institutional capacities.
2.4.4
Voluntary agreements
The final group of complementary measures we consider is are voluntary agreements.
29 They can be defined as agreements between the regulator and firms within an industry to facilitate voluntary action with a determined goal (Storey et al., 1997; Rezessy et al., 2005; Metz et al, 2007).
Voluntary agreements vary a lot with respect to their goals, their legal commitment and enforcement mechanisms, their associated regulatory or fiscal threats, and the incentives that they provide for participating firms. The reason why they are often used as complementary tools in addition to other regulatory strategies is that they can go beyond regulatory requirements and at the same time foster the dialogue between the regulator and the industry. While the former can reduce the need for further regulation, the latter can improve the effectiveness of the regulation in place.
Storey et al. (1997) distinguish four major types of voluntary agreements: target-based, performance-based, co-operative R&D, and monitoring agreements. Target-based voluntary agreements usually consist of negotiated targets that all participants have to meet. Often, the regulator will threaten to impose regulatory measures if the negotiated targets are not met.
Performance-based voluntary agreements are less often negotiated to pre-empt regulation.
29 Other frequently used names for voluntary agreements or similar concepts are: industry covenants, negotiated agreements, self-regulation, and codes of conduct.
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Participating firms either set performance goals themselves or the goals are set by all participants as a group. The primary incentives to meet the performance goals are self-interest and credibility.
Co-operative R&D is an agreement type that is more focused on developing and sharing knowledge that will bring the industry closer to a specific goal. There are sometimes separate voluntary agreements that only have the monitoring or reporting of other agreements or regulatory measures as their subject. A good example is the U.S. Energy Policy Act (EPAct) of 1992 Section 1605(b) programme, a voluntary effort for reporting achievements in reducing greenhouse gas emissions.
Voluntary agreements began to proliferate in the 1990s when countries in the European Union as well as the US began to use them as a policy instrument to attain environmental and energy goals
(Rezessy, 2005). The industry often prefers voluntary agreements over regulation because firms can have a more active role in designing the details of voluntary agreements and the enforcement is often less strict than for other types of regulation (Bertoldi, 1999). The advantage from the perspective of policy makers is faster enactment than alternative measures, without having to pass legislative burdens. From a theoretical perspective, the potential cost-effectiveness and flexibility of voluntary agreements is intriguing, although collaborations between market participants can raise antitrust issues.
The most prominent example of a voluntary agreement in the EU is probably the Green Lights program that was launched by the European Commission in 2000 and committed 734 “partners” from different industries to save energy by replacing conventional lighting with energy saving lighting. A similar programme has been adopted in the U.S. and many other countries.
Unfortunately, only a small number of voluntary agreements has been empirically evaluated. One reason for the lack of empirical evidence is that voluntary agreements are often combined with other measures, which makes it hard to isolate effects that can be causally attributed to voluntary agreements. Another reason is that the objectives of voluntary agreements are not always easily quantifiable. Their voluntary nature often makes it impossible to identify a clear causal effect, due to self selection into programmes. With these caveats in mind, we want to present a few examples of voluntary commitments that have been evaluated.
Standards by the International Organization for Standardization (ISO) are also often described as voluntary agreements. A good example is the ISO 14001 standard which requires all complying firms to formulate and implement an action plan for environmental management and to establish internal governance for environmental issues. Participating firms can either audit themselves and declare compliance or receive an external audit. Potoski and Prakash (2005) analyse 3,700 firms in the U.S. and estimate a selection model in order to at least partially account for selection of firms into adopting the standard. The authors find that firms which adopted ISO 14001 have better compliance records than firms which have not adopted the standard. Tole and Koop (2013) use panel data from 1992-2007 on 99 copper mines around the world. Estimating a random effects model, the author finds no evidence that complying with ISO 14001 is associated with higher costs or lower efficiency for the mines. This contradicts findings from case studies that highlight the administrative burdens and costs that are associated with ISO 14001 compliance. Sugiyama and
Imura (1999) analyse several so-called Voluntary Action Plans (VAP) in Japan and criticize that the targets set in these agreements are often not ambitious enough, that only the largest firms have incentives to comply and smaller firms free-ride on the pre-empted regulation and that there are too little sanctions when firms do not comply.
The role of the government or regulator in voluntary agreements can take many different forms.
For example, the 22/50 program in the U.S. was the first voluntary program launched by the
Environmental Protection Agency (EPA) with the goal to reduce the release of 17 toxic chemicals.
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All chemicals where already under regulation by the agency, but instead of reducing the maximum allowable quantities, EPA rather chose to offer participation in a voluntary agreement to reduce the released quantities. Innes and Sam (2008) analyse 165 firms that participated in the program and
160 firms that did not participate in the program. The authors find that participation is rewarded by relaxed regulatory scrutiny and that the anticipation of this reward is likely to spur firms into participation. This example shows that besides helping with the design of a voluntary agreement (or designing the agreement), regulators can offer implicit and explicit incentives for firms to participate and for participating firms.
Figure 6: Overview of implications of evaluations of complementary measures
Labelling and information and awareness campaigns:
Effectiveness of these measures on consumer awareness and information could be causally shown
(including field experiments) for different countries and periods of time; but: o
Mostly for other policy fields (e.g., health and nutrition) o Mostly short-term effects o Less established whether consumer behaviour is significantly affected.
Measures are relatively inexpensive and can enhance the effectiveness of, e.g., subsidies or regulations.
New field that is less well-understood: Measures targeting the attitude towards innovation, technology, etc.
Promotion of skills
Evidence for the effectiveness of these measures in the areas of manufacturing and agriculture o Studies focus mainly on the US and on developing countries
2.5
Complementary Skills and Infrastructure:
The case of ICT
As outlined in Section 1.2, two types of complementarities can substantially affect the rate of
adoption and diffusion of new technologies: Complementary (consumer) skills and complementary technological infrastructure. In both cases, market participants do not internalize the external effects and underinvestment can occur. In this concluding section, we explore these issues using the example of Information and Communication Technology (ICT).
Today, ICT plays an important role for innovations in almost all sectors and markets. Due to their wide use, their ongoing fast-paced development, and their application throughout most economic sectors, they can be best described as "General Purpose Technologies" (Bresnahan and
Trajtenberg, 1995). These kinds of technologies also enable complimentary innovations in other industries. For this reason, it is worthwhile to consider ICT innovations in greater detail and to explore how demand side policies can promote their diffusion. After a short outline of policy measures in both markets, this section provides an overview of existing policies and recommendations regarding other fields to which these policies could be extended.
The adoption of many ICT innovations, for example e-health products, requires that consumers have the necessary skills to use these products. Even the best telemonitoring device will not be bought if consumers lack the necessary skills for its application, or if consumers are sceptical towards the
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new device or application. By promoting complimentary ICT skills, the state is able to foster the demand for ICT related innovations and perhaps also shape consumers’ attitude towards these technologies. The second central complementarity is ICT related infrastructure. Many ICT innovations require fixed or mobile broadband Internet infrastructure. In the case of e-health innovations, consumers without broadband access will not buy a telemonitoring device because it is all but useless to them. By facilitating the roll-out of the required infrastructure, the demand for innovative solutions that rely on this infrastructure (and thereby the incentive to innovate) can be increased. Another dimension of demand for ICT innovations is the business-to-business (B2B) market. Since many ICT innovations are based on networks and interconnectivity, it is important to realize that many firms promote the diffusion of ICT-related innovations by requiring their business partners to implement compatible (i.e., in most cases the same) new technology – either by developing compatible applications or purchasing compatible solutions.
30
2.5.1
ICT skills and their relationship to innovations
Innovations in ICT typically require complementary skills on the consumer side. The degree to which
ICT skills are existent among the population is an important indicator explaining the adoption of ICT innovations. Since ICTs are General Purpose Technologies, their adoption does not only lead to further innovations in the ICT sector, but also to complimentary innovations in other industries. For example, a population with high ICT skills usually also has a high penetration of PCs. This will most likely also lead to a high penetration of similar innovations, like the smartphone. More importantly, however, it will be the basis of complimentary innovations in industries like health, mobility, energy and education.
The relationship between ICT skills and the diffusion of ICT innovations is theoretically well established. However, until recently it was difficult to obtain a cross-country measure of ICT skills and to empirically verify the link between skills and innovation in an international setting. The
Programme for the International Assessment of Adult Competencies (PIAAC) is the first to provide consistent cross-country data on ICT skills among the entire population. Developed by the OECD and collected between August 2011 and March 2012, PIAAC provides internationally comparable data about skills of the adult populations in 24 countries, representing almost 75 percent of the GDP worldwide. PIAAC is designed to measure key cognitive and workplace skills of individuals. It comprises skills in three domains: literacy, numeracy, and problem solving in technology-rich environments. Problem-solving in technology-rich environments closely corresponds to a person’s
ICT skills. Specifically, the domain is defined as the ability to use digital technology, communication tools and networks to acquire and evaluate information, communicate with others and perform practical tasks. Since participation in the problem-solving domain was optional, a few countries, namely Cyprus, France, Italy, and Spain, did not participate in this domain.
ICT skills in PIAAC are measures on a 500-point scale. Looking at respondents between 20 and 39
years of age (Figure 7), we observe that Finland achieves the highest average ICT score (308), and
Poland the lowest (280).
30
path-dependencies.
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Figure 7: PIAAC ICT Skills by Country
Notes: ICT skills of persons between 20 and 39 years of age. Data source: PIAAC.
There is a clear relationship between ICT skills, as they are measured in PIAAC, and the adoption of
ICT technologies. For example, Figure 8 shows the correlation between the average ICT skills in a
country and the percentage of the population using the Internet. Of course, this is not implying that
Internet penetration is a causal result of the average ICT skills. But it does indicate that ICT skills are a closely associated with Internet use. The more ICT skills people have, the more they tend to use the Internet, which feeds back into ICT skill accumulation.
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Figure 8: The relationship between ICT Skills and Internet penetration
Japan
Finland
Sweden
Belgium
Czech Republic
Canada
United Kingdom
Poland
60 70 80
Internet users (in percent)
90 100
Notes: Average PIAAC ICT skills of persons between 20 and 39 years of age on the y-axis (standard deviation of countries’ PIAAC scores is about 7.7 points; differences between countries and the slope of the regression are both highly significant). Percentage of internet users in 2012 according to the database of the International Telecommunication Union on the x-axis.
2.5.2
Complimentary infrastructure that facilitates ICT innovations
ICT innovations often rely on pre-existing infrastructure. Most importantly, it has been shown that the infrastructure for broadband Internet is important for economic growth (Röller and Waverman,
2001; Czernich et al., 2011). One reason for this importance is its effect on productivity and innovation within firms (see, for example, Bertschek et al., 2011; Polder, 2009). If the necessary infrastructure is lacking, there is no possibility for firms to adopt ICT innovations that are based on this infrastructure. On the other hand, network providers are hesitant to invest into networks as long as they do not know the demand for innovations based on the infrastructure. Just like in the case of skills, the diffusion of ICT innovations relies on the existence of infrastructure, but the infrastructure is also likely to improve with an increasing diffusion of ICT innovations (due to an increase in demand). This may justify market interventions by policy makers. Policies that foster ICT infrastructure can at least partially be considered demand-oriented measures, since the infrastructure is a prerequisite for the development of demand for advanced ICT solutions.
ICT skills and infrastructure are important complements for ICT innovations. Further, improvements to ICT infrastructure increase the likelihood of consumers’ applying and improving their ICT skills.
Unfortunately, the reverse (i.e., a positive effect of ICT skills on the incentive for network providers to invest in infrastructure) is less likely to hold: There is little room for differentiation which leads to
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tough price competition among network providers – many of the rents from high-intensity broadband usage accrue to the content suppliers instead of the network providers. The relationship
between ICT infrastructure and skills is depicted in Figure 9. The x-axis shows the average
advertised broadband speed in 2012 according to OECD statistics, which we use as a proxy for consumers’ actual broadband speed. The cross-country correlation between ICT skills as measured by PIACC and the ICT infrastructure measure is high, which indicates a positive relationship between infrastructure and skills.
Figure 9: The relationship between ICT Skills and advertised bandwidth
Finland
Japan
Sweden
Denmark
Norway
Netherlands
Belgium
Germany
Korea
Czech Republic
Canada
United Kingdom
Estonia
United States
Poland
0 50000 100000
Average advertised bandwidth (in Mbit/s)
150000
Notes: Average PIAAC ICT skills of persons between 20 and 39 years of age on the y-axis. Average advertised download speeds from the OECD Communication Outlook 2013 on the x-axis.
Governments around the world have acknowledged this relationship and are actively involved in fostering ICT infrastructure. Broadband infrastructure in rural areas has been at the centre of public debates, which – besides ensuring equivalent living conditions – is believed to make regions more competitive and to create employment by increasing the potential for innovation.
31
Besides directly handing out subsidies and credits for infrastructure deployment, governments can also change regulation of the private sector in order to create investment incentives. For a long time, incumbents in telecommunication markets used to face little to virtually no infrastructure-based competition due to prohibitively high costs of network replication. Opening the network via a strict regulation scheme was therefore necessary to allow for competition to develop. Incumbents in most countries now face increasing infrastructure-based competition. This has fuelled a debate, which is
31 The focus of most OECD countries today is on expanding ICT infrastructure to so-called white spots, which are predominantly rural municipalities that would remain underprovided if left to market forces. In an effort to promote broadband Internet as a source of growth in Germany, a total of €587 million from European, national, and federal state funding has been made available for German municipalities between 2011 and 2013 to close these white spots (Goldmedia,
2013). Other European countries have engaged in similar or even larger programs.
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as of yet inconclusive, among regulators how incentives can be designed to ensure future investment and innovation in network infrastructure. The previous discussion indicates that externalities with regard to the provision of ICT infrastructures exist, therefore it appears very likely that governments will have to continue to play an active role in infrastructure investments in the future.
2.5.3
Diffusion of ICT innovations among firms – evidence for network externalities
For firms, ICT innovations can fundamentally change operations by increasing productivity and enabling other product innovations (Bresnahan and Trajtenberg, 1995; Spiezia, 2011). Due to their nature, communication and coordination among and within firms plays a predominant role: ICT innovations can facilitate coordination and collaboration within firms and among business partners
(Gretton et al., 2004). Better coordination along the value chain can foster new innovations or their diffusion. Also the collection of data can be facilitated, since ICT innovations allow large amounts of data to be stored and processed. Furthermore, geographic limitations are reduced as ICT allows sourcing from a wider set of suppliers, selling to a larger market and connecting with more business partners (Forman et al., 2014; Koellinger, 2005).
Various studies find that ICT enables innovation by capturing, organizing, and processing knowledge, all of which is important in the innovation process. Early studies on ICT investment focus on the role of ICT in organizational innovation and conclude that the successful implementation of
ICT is tied to organizational change. That is, firms need to engage in organizational “co-innovations” to fully capture the benefits of ICT (see, e.g., Brynjolfsson and Hitt, 2000). Examples of organizational change include flatter hierarchies in firms due to improved communication channels, resulting in the reorganization of responsibilities.
Although most industries use ICT innovations to some degree, there is little consistent evidence on which industries benefit the most. A couple of studies show that ICT innovations are especially important for the service sector. For example, Hempell et al. (2006) find that ICT capital increased productivity in German and Dutch firms in the service sector. Polder et al. (2009) stress the importance of ICT in all sectors of the economy, but find that ICT investment plays a rather limited role in manufacturing. A survey among firms in the Madrid metropolitan area finds that benefits of
ICT are most prevalent in the IT and services sector (Gago and Rubalcaba, 2007).
In order to better understand the diffusion of ICT innovations, we can study unique data from the
2012 wave of the ifo Innovation Survey, which aims at mapping innovative activity in Germany and has been conducted annually since 1979 among manufacturing firms (for a detailed description, see
Penzkofer, 2004). Firms indicated whether they invested in new ICT equipment during the preceding two years. In 2012, this was the case for 58 percent of the responding firms. Then, firms are asked what motivated them to invest in ICT innovations. Most respondents indicated that ICT investments were initiated by agents within the firm, namely the internal IT department and management (44 and 36 percent, respectively). Fewer respondents indicated that external partners had contributed to the decision to invest in ICT, most importantly external consultants (15 percent) and customers (11 percent), with suppliers and other business partners each considered relevant by between 4 and 5 percent of respondents (see the Figure below).
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Figure 10: Internal and external catalysts for investments in ICT
IT-department
Management
External consultant
Customer
Other business partners
Supplier
0% 10% 20% 30% 40% 50%
Source: Own representation based on Ifo Innovation Survey 2012.
The survey indicates that the distinction between internal and external initiators for ICT investments is relevant for a firm’s innovation behaviour. In the Ifo Innovation Survey, firms are asked whether they completed a product innovation during the preceding year. In 2012, 44 percent of the firms did. This variable captures an informal and direct measure of innovative output at the firm level, and thus reflects an actual benefit to the economy as opposed to started innovation activities that have not (yet) resulted in a market introduction. We consider this innovation measure preferable to alternative measures such as patent counts or R&D expenditures: patents capture only a fraction of all innovations; R&D may not necessarily lead to innovations (for an overview of different innovation measures and their characteristics, see Hagedoorn and Cloodt, 2003).
Figure 11 shows the percentage of firms that recently completed a product innovation. Among
those firms that invested into ICT due motivation by customers, suppliers, external consultants or other business partners, the share of innovators is 52.9 percent. Firms that did not receive an enticement for ICT investment from external sources have a more than 10 percentage points and strongly significantly lower share of innovators. Of course, this descriptive evidence does not imply a causal effect of ICT diffusion among firms on product innovations, but the correlation is striking.
Considering the network externalities which are inherent in many ICT-applications, one explanation for this could be that ICT investments are more valuable (also with regard to innovation) to firms
that employ them to interact with external entities. As discussed in Section 1.2.3, network
externalities can be a justification for government involvement to enhance and foster the diffusion of technologies.
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Figure 11: Firms’ likelihood of product innovation
55%
50%
45%
40%
52,9%
35%
30%
External motivation for ICT investment
40,7%
No external motivation for ICT investment
Source: Own representation based on Ifo Innovation Survey Ifo Institute 2012.
2.5.4
Implications and policy measures in the area of ICT adoption and diffusion
As the previous sections have argued, there is evidence for externalities both in ICT skills and infrastructure. Beyond anecdotal evidence and theoretical arguments, there are also indications for network effects. Government involvement in the area of ICT infrastructure and skills may therefore be justified. Applying our taxonomy to ICT, these efforts could include the following measures:
1.
ICT education, consulting and skill training (cf. Section 2.5.1).
2.
Public investment into ICT infrastructure or incentives for firms to invest (cf. Section 2.5.2)
3.
Public procurement of innovative ICT products and services (cf. Section 2.1)
4.
Financial incentives for firms to invest in innovative ICT products (cf. Section 2.2)
5.
Regulation and mandated standards, e.g., to increase trust in IT safety (cf. Section 2.3)
6.
(Complementary) awareness campaigns, e.g. in the area of IT safety (cf. Section 2.4.1)
Clearly, policy initiatives have been undertaken in the past that aim at facilitating the adoption of
ICT innovations. Unfortunately, these initiatives have not yet been reliably evaluated to our knowledge. To demonstrate the extent of the differences in the approach between countries, in closing, we provide a very short overview of the existing price subsidies and tax incentives that aim at fostering ICT adoption.
A very recent EU policy that is still in its pilot phase is the ICT Innovation Vouchers Scheme (see
Köpman 2014). The aim of the initiative is to increase the adoption of ICT services among SMEs in order to enhance their competitiveness and growth prospects. Implicitly, the initiative also aims at making these companies more innovative. The program is meant to be adopted by regional authorities that can then offer vouchers of up to € 10,000 in value. SMEs can exchange these vouchers for ICT services from private companies, universities and other accredited service providers. Ideally, companies will use the services to build a business website, online shop, or IT tools that improve their internal processes. This kind of ICT innovation is often the basis for firms to come up with other innovative products or services. Until today, the program is only adopted in two
Spanish regions, but is planned to roll out to other regions throughout 2014.
Besides price subsidies like the ICT Innovation Vouchers Scheme, there are several other policies that have been applied to foster the adoption of ICT innovations. Most importantly, tax credits and
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tax incentives for ICT investments are used in a number of countries. Warda (2005, 2010) provides a good overview of tax credits and tax incentives in 19 countries. Japan, for example, has one of the most generous tax systems with regards to ICT investments. Firms that invest in ICT can choose between a 10 percent credit on corporate tax or a special depreciation rate amounting to 50 percent of the acquisition cost. Spain also offers a 10 percent tax credit, but only to small firms.
Korea favours small firms with tax credits for ICT investment of up to 7 percent. Canada does not offer direct tax credits, but a generous depreciation (capital cost allowance) of 55 percent for computer equipment and 30 percent for broadband and Internet equipment. Between 2009 and
2011, Canadian businesses were even able to deduct computer equipment up to 100 percent. China has special tax incentives for firms that are export-oriented. These firms can use depreciation rates for ICT equipment of up to 90 percent. The US had temporary tax incentives of up to 50 percent due to provisions of the Economic Stimulus Act and the Economic Recovery and Reinvestment Act.
However, these provisions ended in 2009. Similarly, the UK also had a temporary tax incentive program specifically targeted at ICT investments.
Unfortunately, we do not know very well how effective price subsidies and tax incentives really are in encouraging the adoption of ICT innovations. Our insights from financial incentives in other economic fields suggest that deadweight rents may make this approach very costly. It seems, however, that except for Spain, EU countries are cautious with regard to the tax treatment of ICT investments. Going forward, carrying out reliable econometric evaluations of such policies, particularly in the area of the general purpose technology ICT, should be a prerogative. This issue is all the more urgent, as governments across the world are undertaking strong and costly efforts in this regard already, with some countries choosing to be far more assertive than others.
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