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MISSION-ORIENTED PUBLIC ORGANIZATIONS FOR KNOWLEDGE CREATION

PAOLO CASTELNOVO MASSIMO FLORIO

Working Paper 9/2019

OCTOBER 2019

FRANCESCO GUALA

Working Paper n. 2011-18

SETTEMBRE 2011

ARE PREFERENCES FOR REAL?

CHOICE THEORY, FOLK PSYCHOLOGY,

AND THE HARD CASE FOR COMMONSENSIBLE REALISM

FRANCESCO GUALA

Working Paper n. 2011-18

SETTEMBRE 2011

!

!

Mission'oriented!Public!Organizations!for!Knowledge!Creation!!

Paolo Castelnovo* and Massimo Florio*

Abstract The purpose of this paper is to investigate and discuss the role played by the state in enhancing technological progress, creating knowledge and fostering radical innovation. This catalyst function may take place in different ways. Specifically, we focus on three channels: (a) R&D of traditional state-owned or state-invested enterprises; (b) funding of organizations such as public agencies, research universities and large research infrastructures (e.g. CERN, NASA, etc.); (c) indirect intervention through public procurement for innovation. We critically review existing contributions, summarize their main findings and discuss the benefits and costs entailed by these policies. We claim that research, development, and innovation should be supported by governments not simply to pursue generic growth objectives but also to meet societal challenges like energy transition, sustainable mobility, the digital society, the demographic transition and climate change. Mission-oriented organizations can be powerful tools for achieving the technological breakthroughs needed to tackle these challenges. Keywords: Innovation, R&D, State-Owned Enterprises, Mission-oriented organizations, societal challenges. Jel Codes: H10, I28, L32, O2, O3. *Università degli Studi di Milano, Via Conservatorio 7

1. Introduction

A crucial message arising from modern endogenous growth theory is this: the long-term growth rate of an economy depends on policy measures that support research, development, and innovation (RDI), along with human capital formation and institutional capacity building (see, inter alia, the seminal works by Arrow, 1962; Romer, 1990; Aghion & Howitt 1992; and Acemoglu, 2009). Building on this message, an increasingly influential strand of the economic literature emphasizes the role played by the state in directly enhancing scientific and technological progress and fostering radical innovation (see Fuchs, 2010; Block & Keller 2011). Furthermore, neo-Schumpeterian economics places great emphasis on technological innovation as the major force propelling economic dynamics (see Hanusch & Pyka, 2007) and assigns to the public sector the role of providing support for uncertain innovation activities (Acs, 2006). According to the National Innovation System (NIS) theory (see Lundvall, 1992; Nelson, 1993; Patel & Pavitt, 1994), the technology-based economic development of a nation crucially depends on interaction among innovation actors, including enterprises, universities and government research institutes. Government should play the role of coordinator among these knowledge producers, promoting strong linkages and trust among them (Chung, 2002). In this chapter, we ask two questions: In general, which are the most effective forms of public intervention to support RDI? Should governments promote RDI through mission-oriented public organizations? Our claim is that a new form of public enterprise, combining features of knowledge-based state-owned enterprises (SOEs) and large-scale public research infrastructures with budgetary and governance autonomy, may effectively play the role of government agent to implement mission-oriented innovation policies. The renewed interest in public intervention in RDI stems from the assumption that states can do something that companies usually cannot do, as proposed by researchers such as Mazzucato (2013). who suggests that the state is not only a regulator but also entrepreneurial, taking risks and investing to produce knowledge. This stance departs from Porter’s well-established view. According to Porter (2008), while governments should have a role as catalyst and challenger in promoting innovation, this role is inherently partial and should be limited to creating an environment where companies can gain competitive advantage. The milestones of Porter’s theory may be summarized as follows. Governments should: (1) enforce strict product safety and environmental regulation in order to stimulate domestic demand by putting pressure on companies to improve quality and upgrade technology; (2) stimulate early demand for advanced products; (3) focus on specialized factor creation; (4) encourage local competition by limiting direct cooperation and enforcing anti-trust regulations; and (5) support the rate of substantial investment in industry through tax incentives for long-term capital gains restricted to new investments in corporate equity.

Mazzucato (2013) suggests, instead, a more proactive role for the state in shaping innovation policy. Mazzucato’s views have been criticized because they are apparently predicated on a simplistic analysis of the state–market relationship without an adequate discussion of the role of the state in capitalist economies (see Pradella, 2017) or because there may be government failures and not just success stories (an old critique of industrial policy in the tradition of Hayek, 1945). There are, however, counter-arguments in support of direct public intervention in the supply of RDI. First of all, knowledge creation is a cumulative process and requires patient investors. Governments, including SOEs, can act as long-term investors since they have no need for immediate returns and profits. In contrast, private companies usually invest to capture value in a short time and only in those forms of knowledge that may generate economic returns. Second, governments may act as risk takers, investing in risky areas such as breakthrough technologies and funding the most uncertain phase of research that the private sector is too risk-averse to engage in. Third, states have less stringent budget constraints than private companies, with the result that R&D in SOEs and public RDI agencies is influenced less strongly by business cycles. Finally, states do not need to create legal or informal barriers to knowledge dissemination, whereas for private firms appropriability mechanisms, such as patents, are essential to enjoying the benefits of their R&D investments. The combination of these four features of knowledge creation (long-term horizon, uncertainty, financial constraints, and externalities) leads to market failures and private sector underinvestment in R&D, as suggested particularly by Paul Romer, whose work in this area was recently (2018) acknowledged with the Nobel Memorial Prize. Therefore, market failure in R&D provision is usually adduced as a rationale for government intervention (Jamasb & Pollitt, 2011). These arguments have implications for the division of R&D roles between private companies, on the one hand, and public organizations, on the other, because of their respective primary functions, comparative advantages, capabilities, and differences in risk attitude and R&D time scale. Traditionally, universities (public or not-for-profit), SOEs, government agencies managing large research infrastructures (hereafter RIs) are clearly better suited to conducting basic or pre-competitive applied research while the private sector has more incentive to carry out market-oriented research. Indeed, in basic research, the risks of R&D investments are higher while rewards occur over the long term and have public good properties (see Jamasb & Pollitt, 2015). This is particularly true when a discovery, or the research process leading to it, creates some learning spillovers, i.e., externalities stemming from non-rivalrous and partially excludable knowledge creation (Griliches, 1979; Romer, 1990; Foray, 2004). Despite privatization and liberalization, some SOEs still play a relevant role. For example, EDF, the French government-controlled electricity company, manages nine research centres (including six outside France), with more than 2000 scientists and 130 postgraduates and ambitious projects looking into the distant future of energy. With an R&D budget of 789 million dollars in 2017, EDF is the world leader in electricity research (https://www.statista.com/statistics/740137/rd-investors-electricity-industry-globally/).

In contrast, in research on drugs, even a Big Pharma company like Pfizer admitted that it needed pre-competitive research done by government (Olson & Berger, 2011):

The basic biology, the understanding of disease, biomarkers of prognosis, and even drug responses all can be areas of precompetitive R&D [...] Pharmaceutical companies have recognized that they cannot develop a full understanding of these different facets of drug development on their own. Instead [...] they need to leverage the capabilities of many organizations, including government and academia. A few years ago, Pfizer would have considered the chemistry, the execution, and the quality of products to fall into the competitive arena, but even these areas may not be inviolate.

While, traditionally, national security considerations have dominated government funding of R&D (Pradella, 2017), Mazzucato (2017, 2018) suggests that public policies should take the form of mission-oriented innovation policies in new strategic areas, bringing together different actors and promoting collaboration across different sectors, thus creating co-investment opportunities and increasing future growth potential. These missions are different from traditional industrial policy. First, missions should be given clear and ambitious (but realistic) objectives with societal relevance that can be achieved by a portfolio of R&D projects and policy interventions. Second, they should be broad enough to involve public and private organizations, as well as civil society, and attract cross-sectoral investment. Third, they should not favour applied research over basic fundamental research but should be a new way to frame the communication between the two. Finally, a bottom-up approach targeting multiple solutions may be more effective, given the highly innovative and risky features of the research undertaken.

Moreover, Mazzucato (2013) suggests that taxation of corporate profits from innovation cannot solve issues of tax evasion and tax avoidance. She therefore proposes that a “national innovation fund” be established to collect the proceeds of royalties from government-supported R&D. She also proposes that government loans to firms to support investment in R&D be contingent on a fair return for taxpayers and that development banks own shares in knowledge-based firms. This proposal, as far as we understand it, would introduce a form of mixed ownership of innovative firms.

In this chapter, we take a more radical perspective. We propose a role for new public enterprises as agents of mission-oriented innovation policies, building on the experience of some of the existing SOEs and RIs. SOEs such as state-invested energy or telecom companies are mainly embedded in market environments, while RIs such as the European Space Agency or the European Molecular Biology Laboratory are shaped by research communities and are embedded in scientific environments. We suggest that a new generation of knowledge-based public enterprises should combine some features of these two types of public sector organizations. We do not suggest that innovation policies should not be implemented by other mechanisms as well, but our main interest, in the context of this book, is in a new type of public enterprise, defined by its public mission, by its knowledge asset base, and by its collective ownership and governance arrangements.

The structure of the chapter is as follows: Section 2 discusses types of government intervention to support RDI, drawing on the existing literature; Section 3 identifies five crucial areas of potential interest for mission-oriented innovation policies; Section 4 discusses the benefits and costs of delegating such policies to a new type of knowledge-based public enterprises; Section 5 concludes.

2. Typologies of government interventions to support RDI

State support to RDI can follow different channels:

1) support to private firms R&D, using tools such as tax incentives, grants and preferential loans;

2) R&D expenditures of some flagship SOEs;

3) funding of organizations such as public agencies, research universities, large research infrastructures, such as CERN (European Organization for Nuclear Research), ESA (European Space Agency) and EMBL (European Molecular Biology Laboratory) in Europe or NASA (National Aeronautics and Space Administration) and NIH (National Institutes of Health) in the United States;

4) indirect intervention through public procurement for innovation (PPI), which in turn can be managed through SOEs or other public organizations but mainly involves private firms.

It is worth noting that these possible forms of government intervention to support R&D activities are not mutually exclusive but may coexist. Actually, according to NIS theory, enterprises, universities and government research institutes are components of a collective system of knowledge creation (with government playing the crucial role of coordinator), and the innovative performance of a country depends on the interactions among them. Such linkages can take the form of joint research, staff exchanges, cross-patenting, purchase of equipment and a variety of other channels (OECD, 2017b).

The first form of intervention, subsidies to private firms, is beyond the scope of this chapter. For more information and analysis, readers may refer to the work of Liechtenberg (1990), Busom (2000), Trajtenberg (2002), and Gorg and Strobl (2007), among others. Subsidy policies aim to shift the goal of private organizations from profit to public goods production. This is costly and often found to be inefficient because of major principal–agent issues. Therefore our interest is in public organizations and PPI. We initially review some of the literature, then discuss the benefits and costs of each intervention type, and finally suggest a possible new approach.

2.1 State-owned enterprises

A well-established strand of economics literature suggests that SOEs are inefficient compared to private firms. Traditional arguments about SOEs’ inefficiency mainly rely on two criticisms. The “agency view” asserts that SOEs are characterized by poor monitoring and low-powered incentives (Jensen & Meckling, 1976; Holmstrom & Milgrom, 1994; Scott & Falcone, 1998). According to the “political view,” public firms may have a distorted objective function: on the one hand, they may pursue politicians’ individual goals (Shleifer & Vishny, 1993, 1994), thus targeting short-term political gains rather than the long-term shareholder value. Alternatively, they may seek social goals, such as correcting market failures and taking social welfare into account (Atkinson & Stiglitz, 1980) or pursuing employment objectives (Shleifer, 1998). More recent research challenges these traditional views, focusing specifically on the SOE’s innovative capacity. According to Belloc (2014), contrary to conventional wisdom, SOEs'

inefficiency is not due to state ownership per se but is likely related to other conditions, such as institutions, culture, legislation and degree of political competition. Therefore specific measures aimed at increasing managers' commitment to long-term investment plans and reducing political interference should be more beneficial for long-term technological progress than company privatization. The role of SOEs in promoting economic development is discussed from a theoretical perspective by Tonurist and Karo (2016), who argue that SOEs can be seen as instruments of innovation policy, operating both as independent innovation actors and as potential coordinating change agents within broader innovation systems. One important advantage of SOEs as instruments of innovation is that they can make it possible to overcome many of the conventional challenges of innovation policy and its implementation, from policy coordination and implementation to innovation funding. The authors conclude that SOEs have the potential to act as instruments to foster a more proactive and targeted role for the state in innovation. However, given the legacies of SOE rationales and governance over the last decades, their rediscovery as innovation policy tools requires some challenging policy reforms. At the macro level of economic and innovation policy, it is necessary to change the policy orientation of SOEs towards R&D and networking within the innovation system. At the micro level of SOE governance, it is essential to change internal managerial practices, incentives, and performance orientation. Thus it cannot be taken for granted that any SOE can be an effective and efficient actor in RDI. But what does the empirical evidence tell us about the SOE’ role in knowledge creation? Econometric studies comparing SOEs’ and private firms’ innovation capacity mainly rely on two alternative approaches: (1) making a direct comparison between the R&D expenditure and innovation outcomes of SOEs and those of private companies operating at the same time in a given market; (2) examining the outcomes of privatization reforms and, specifically, of the transition from state ownership to private ownership. Most of the existing research focuses on network industries, especially in the electricity sector, given the pervasive process of liberalization and privatization that has affected these industries in recent years. Overall, the evidence suggests that SOEs outperform private enterprises in terms of R&D investment and innovation outcomes (usually proxied by the number of patents filed). One of the first studies that uncovered the declining trend in energy R&D investment induced by the deregulation of the energy sector in advanced industrialized nations was that of Dooley (1997). More recently, Sterlacchini (2012) showed that the processes of liberalization and privatization led to a sharp decline in R&D investment by major electric utilities worldwide. This phenomenon was mainly attributable to private or newly privatized companies, while those that remained under public control did not reduce their R&D expenditure. Based on this finding, the author suggested that radical policy measures such as an R&D obligation for regulated private electric utilities, an extension of public ownership, or the introduction of public-private partnerships should be taken into consideration for the purpose of supporting RDI in the electricity industry.

Additional evidence of the R&D expenditure decline that followed the restructuring of the electricity industry in developed countries is provided by Kim et al. (2012) and Erdogdu (2013).In their studies of the impact of the liberalization process on the innovative capacity of the UK electricity industry, Jamasb and Pollitt (2008, 2011, 2015) found consistent results. Analyzing patenting activities from the 1970s to 2005–2006, Jamasb and Pollitt (2008, 2011) provided evidence that liberalization reforms resulted in a reduction of both public and private R&D investment in the UK electricity companies in the years following the completion of the liberalization process. This led to a drop in patenting by the successor companies created out of the restructuring process. In contrast, the electricity-related patents in non-nuclear and renewable technologies increased in the post-liberalization period thanks to strategic subsidies and to the increased commercialization of the sector. In addition, R&D productivity and innovative output per unit of input seemed to have improved. Despite this, the authors warned that a lasting decline in R&D might have negative long-term consequences for the continued improvement in sector efficiency – an improvement made possible by radical technological progress and innovation. More recently, however, R&D expenditures made a significant recovery thanks to an improved institutional framework and innovation policies (Jamasb & Pollitt, 2015).

How can the government support innovation in the electricity sector? Public R&D expenditure may be necessary in light of the “uncertainty of innovation.” Jamasb and Pollitt (2015) provide some important policy recommendations. First of all, a combination of private and public actions on expenditure and in institutional support is required. In particular, support mechanisms for R&D are needed. Moreover, public resources should be used to encourage private R&D, not simply through R&D subsidies but also through promotion of collaborative research. This is especially true in regulated natural monopoly networks. However, the main purpose of government intervention should be to support basic research, an area with a higher incidence of R&D market failures. At the same time, long-term policy stability and regulatory commitment are two crucial factors in boosting energy research capacity.

Recent evidence indicates that SOEs may innovate even more intensively and with more originality than their private peers. Lazzarini et al. (2016), examine a sample of over 900 private and State-owned multinationals. Using matching techniques to control for firm characteristics, they were able to show that SOEs invent more intensively (i.e. file more patents) than private firms. In addition, looking at the number of patents filed that did not cite any previously patented work, they concluded that SOEs’ inventions were more pioneering. On the other hand, patents filed by SOEs were less frequently cited in subsequent patents, suggesting that their inventions were less impactful. Institutional and industry features have a role in enhancing SOEs’ innovative performance. A strong institutional environment in the home country, such as improved checks and balances against governmental intervention, increases the likelihood that SOEs will gain invention intensity, originality and impact. Sector characteristics matter too: SOEs operating in high innovation industries are more likely to benefit from their patient capital orientation, with positive effects on innovation outcomes. Similarly, Clò, Florio and Rentocchini (2018) compare privately owned and state-owned telecom enterprises in terms of innovative capability, measured by the number of patents filed, in order to

determine whether the relationship between ownership and innovation varies depending on the quality of institutions. They take into account both internal characteristics (i.e. ownership) and external characteristics (i.e. absence of corruption, government effectiveness, rule of law), as well as their interactions, and they investigate how these characteristics can affect firms’ propensity to innovate. The empirical analysis carried out suggests that SOEs with direct public control in countries with high institutional quality achieve a better patenting performance than private firms. This finding is in line with previous results on the total factor productivity of telecom SOEs (Castelnovo et al., 2018) and of electricity distribution utilities (Borghi et al., 2016).

The importance of the institutional framework and industry characteristics is confirmed by Kou et al. (2017), who examined Chinese listed firms and found a heterogeneous effect of state ownership on patent applications, depending on the sector and the specific economic, institutional and political context of the region considered.

While the empirical literature summarized above focuses on SOEs defined in the usual way as corporations owned or invested by governments, another mechanism for public intervention is through public organizations such as research universities, RIs and public agencies that may, in turn, collaborate with both private firms and SOEs.

2.2 Public research organizations: universities, RIs and agencies

Among public organizations, universities (either public or not-for-profit) have traditionally played a major role in carrying out RDI. Nowadays, universities remain at the centre of the system of knowledge creation, as proved by their massive contribution to scientific research output, measured by the number of academic papers published in a given country. The growing participation of other sectors such as hospitals, industries and governments laboratories is largely explained by the fact that these actors produce a large proportion of their papers in collaboration with universities (see Godin & Gingras, 2000; Foray 2004). In particular, collaboration between universities and industry is a vehicle to enhance innovation through knowledge exchange and has a crucial role in supporting firms’ R&D. Companies tend to encourage universities to contribute to their R&D programs since this is a more flexible and convenient way of carrying out research than having their own research infrastructures. Through this form of collaboration, they can indirectly transfer part of their costs to the state, which is often the main source of funding for universities, including private ones (see Slaughter & Leslie, 1997). Nonetheless, it has been shown that publicly funded basic research carried out in universities, rather than being simply a substitute for private R&D, stimulates and enhances private companies’ research investments (Nelson & Rosenberg, 1994). Veugelers and Cassiman (2005) investigated the factors prompting firms to undertake R&D cooperation with universities. They confirmed that cooperation with academic institutions complemented firms’ own R&D efforts and that cost sharing was their main objective. Cooperation between universities and private firms to promote technical and economic development generates significant benefits for both companies and society as a whole. This is because of major spillovers from university research to commercial innovation, measured by

corporate patents (see Jaffe, 1989). In the absence of university research, a consistent share (from 9 to 15 percent) of companies’ products and processes in the US could not have been developed without a substantial delay (Mansfield et al. 1991; Mansfield, 1998). University and public research patents might, in certain cases, be more impactful (they receive more citations) and be disseminated more rapidly than corporate ones (Bacchiocchi & Montobbio, 2009)1. In addition, academic research has positive side-effects on business startups (Bania et al., 1993) and on the number of high-technology innovations (Anselin et al., 1997). Moreover, the closer firms are located to major academic research centres, the greater the benefits enjoyed (Mansfield & Lee, 1996).

For a systematic review of university–industry collaboration, see Ankrah and AL-Tabbaa (2015), who provide an exhaustive taxonomy of its economic, institutional and social benefits for both sides. However, they also warn about the possible drawbacks of this cooperation: the threats to research autonomy and integrity inherent in companies’ quest for commercial gain and the abandonment of long-term, basic research in favour of results-oriented, short-term, applied research.

The positive impact of university research on innovation has positive repercussions on economic growth, as shown by Bergman (1990), Martin (1998), Martin and Tang (2007), and others. In particular, the different channels and mechanisms through which publicly funded research can enhance economic growth were identified by Salter and Martin (2001), who highlighted the increase in the supply of information, new instrumentation and methodologies, skilled graduates, professional networks, technological problem solving and creation of new firms.

Although universities play a prominent role in carrying out scientific research, they may have some limits as mission-oriented organizations. First of all, they are not designed to carry out public missions, the scope of which may be too broad and the objectives too specific for organizations with an educational role. After all, universities have their own missions and have to contend with a complex balance of power among research communities represented by different departments. Moreover, owing to their typically small size, diseconomies of scale would be likely to arise.

Other actors that could be involved in the implementation of public missions are large RIs. The term “RI” refers to facilities that are typically funded with public resources and the aim of which is to bring about scientific and technological advances in a specific field. As far as the impact on innovation and economic development is concerned, theoretical arguments similar to those previously made for universities may be applied to large RIs and public agencies, which could be considered as types of scientific public enterprises. However, the socio-economic impact of these organizations has only recently been investigated from an empirical perspective. Six main benefits to society accruing from large RIs can be identified, beyond the non-use value of scientific knowledge per se (see Florio et. al, 2016; Florio & Sirtori, 2016; Florio, 2019): (1) knowledge outputs, such as publications; (2) human capital formation, such as the impact on PhD students; (3) public outreach and cultural impact on the general public; (4) services provided to !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!1!University!patents!receive!more!citations!in!the!US,!but!!there!is!no!evidence!of!higher!rates!in!Europe!and!Japan.!

third parties such as patients and consumers of spin-off goods; (5) technological spillovers; (6) externalities arising from free software and access to databases. Among these benefits, industrial knowledge spillovers are one of the most important and most extensively investigated sources of scientific progress and economic development (see Salter & Martin, 2001). Existing research on the economic repercussions of large RI procurement has drawn mainly on surveys of suppliers, focusing in particular on industrial knowledge spillovers. The evidence is available mainly for basic physics and aerospace RIs such as CERN (e.g. Schmied, 1977;!Bianchi-Streit et al., 1984; Autio et al., 2004; Autio, 2014), ESA!(e.g.!Cohendet, 1997; Schmied, 1982), and NASA (e.g. Hertzfeld, 2002). Florio et al. (2018) updated the survey methodology with a Bayesian network analysis of the outcomes of being a CERN supplier for over 650 firms. They investigated the determinants of suppliers’ sales, profits and development activities and found that collaborative relations between CERN and its suppliers improved the suppliers’ economic performance and increased positive spillovers along the supply chain. In a recent study, Castelnovo et al. (2018) were the first to apply an econometric approach to investigating the impact of CERN procurement on supplier companies through an analysis of company balance-sheet data. Their results show that becoming a CERN supplier has a positive impact on a company’s R&D efforts, innovative capacity (proxied by the number of patents filed), productivity and economic performance (measured by revenues and profitability). High-tech companies are the main beneficiaries, while the impact on low-tech is smaller and often statistically insignificant. See also Nielsen and Anelli (2016) for CERN spinoff technologies and Unnervik (2009) on risk taking. Studies on space programs such as those of NASA and ESA confirm the role played by these organizations in generating significant economic returns. NASA R&D spending was found to have positive social returns on the US economy through new product development, cost reduction, and productivity gains (see, for example, Evans, 1976; Mathematical Inc., 1975; Mathech Inc., 1977). More recent studies based on surveys of firms that were able to transform NASA R&D investments into marketable goods and services revealed positive effects on the national economy in terms of value added and showed that NASA acted as a lever for investment (see Hertzfeld, 2002). Bezdek and Wendling (1992) highlighted the positive impact on industry sales, estimating a 2.1 multiplier effect of NASA procurement on the US economy.

Similar findings have come from studies investigating the economic impact of ESA. This case analysis was based on direct interviews with contracting firms. The findings suggest that, on average, every euro paid by ESA to the industry resulted in an indirect economic benefit through ESA contracting firms that was three times higher (see B.E.T.A.2, 1980, 1988, 1996; Cohendet, 1997). Schmied (1982) tried to quantify the surplus generated by ESA through interviews with supplier companies and calculated a utility expenditure ratio of about 1.5. More recently, the Danish Agency for Science (2008) surveyed Danish companies involved in the ESA supply chain and

!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!2!Bureau d’Économie Théorique et Appliquée [Office of theoretical and applied economics] of the University of Strasbourg.!

found that, for every one million euros of Danish contributions to ESA, a total turnover of 4.5 million euros was generated.

2.3 Public procurement for innovation

The two broad forms of RDI support outlined above are both related to direct government interventions and ownership of organizations. Another relevant role for government is to stimulate innovation through public procurement for innovation (PPI). PPI can be managed either directly by the state or by public entities (e.g. RIs) and SOEs, thereby encompassing and exploiting the alternative tools of intervention previously analyzed. PPI occurs when a public agency places an order that entails the development of new products and services, requiring the supplier company to undertake R&D and innovation activities (see Edquist & Hommen, 2000; Edquist et al., 2015). Through PPI, public entities therefore act as launch customers for innovative goods or services that do not exist yet or are not available on a large scale. Acting as first buyers, governments and public organizations enlarge the size of the market and create new segments. Although states are not directly involved in companies’ innovation processes in this scenario, they can foster technical change and support the development of crucial technologies by ordering new high-tech products and thus enhancing companies’ R&D investments and innovation capabilities. For this reason, PPI may act as an important demand-side innovation policy (see e.g. Edquist et al., 2105; Edquist & Zabala-Iturriagagoitia, 2012; Aschhoff & Sofka, 2009; Martin & Tang, 2007). This is particularly true in cases where the development of sophisticated products is required (Salter & Martin, 2001) and in economic fields characterized by high risk that cannot be borne entirely by the private sector (Mazzucato, 2016). Empirical analysis showed that PPI has a positive effect on firms’ R&D investment and expenditure in innovative activities, with demand-pull effects that are even greater than those of other private contracts and R&D subsidies and tax credits (see Litchtenberg, 1990; Guerzoni & Raiteri, 2015). Moreover, it has been shown to be a possible complement or even an alternative to supply-side policies (Edler & Georghiou, 2007).

In many countries, including the US, Italy and France, relevant examples of PPI are found in the military sector, while in other European countries PPI mainly takes place through “mission-oriented” public organizations. A prominent example of PPI in the military sector is the procurement approach of the Defense Advanced Research Projects Agency (DARPA), the US Department of Defense body responsible for making pivotal investments in breakthrough projects for the development of new technologies for national security and military use. It was created in 1958 and since then, collaborating with academic, industry and government partners, it has designed and carried out R&D projects to expand the frontiers of technology and science. In so doing, DARPA has often gone beyond immediate US military requirements. For example, DARPA-funded projects spawned emerging technologies that significantly influenced many non-military fields, such as computer networking and IT technologies, laying the foundations for the modern

Internet. For an analysis of the most important features of the “DARPA model,” see Bonvillian and Van Atta (2011).

The same approach has been recently followed by the Advanced Research Projects Agency-Energy (ARPA-E), which adopted key DARPA features to offer a new institutional innovation framework for meeting advanced energy technology challenges. Modeled on DARPA, ARPA-E was created to fund high-risk/high-reward research that might not otherwise be pursued because of a relatively high risk of failure and to contribute to projects involving government laboratories, private industry and universities (Bonvillian & Van Atta, 2011).

As highlighted by Mazzucato (2016), PPI may even take place in fields and in contexts that are generally believed to be in the hands of the private sector. The development of Silicon Valley has been investigated by researchers such as Wonglimpiyarat (2006), who focused on the specific factors contributing to the success of the Valley and on the role played by US government programs in financing early-stage innovations. Indeed, a key factor in the success of Silicon Valley was the availability of financial resources to support entrepreneurial growth.

3. The need for missions and mission-oriented organizations to face global challenges

RDI should be supported by governments not simply to pursue generic growth objectives but also to meet societal challenges. In order to clarify our perspective, we will briefly discuss five broad missions for which a new form of public enterprise may play the role of change agent on behalf of governments: energy transition, sustainable mobility, digital communication, health and climate change. Our proposal is to create public mission-oriented organizations that are linked to such societal challenges, where the best research in the world is centred, and where technology transfer to private and public companies is actively promoted.

3.1 Energy transition

The energy transition from hydrocarbons and nuclear fuels to alternative energy sources (see. Welsch, 2017; Solomon & Krishna, 2011; Fouquet & Pearson, 2012; Araujo, 2014) is one of humanity’s main challenges. Despite major efforts by Denmark and a few other European governments to promote renewable energies such as solar and wind (see Meyer, 2004; Parajuli, 2012), there are still unsolved technological and scientific issues, with renewable power still not costing much less, or costing even more, than power from fossil fuels (see IRENA, 2017). Working with an international coalition of partners, the EU is currently funding ITER, a very expensive research project on nuclear fusion. The EU and several national governments support a number of other smaller-scale projects, but something more ambitious would be needed, such as a new organization with an ambitious research agenda covering the whole spectrum of R&D options in the fields of generation, distribution, decarbonization and energy efficiency. These cannot be seen as separate RDI sectors.

The research needed for a complete transition to a sustainable model should be undertaken by a public entity that would not be paralyzed by the awareness that, if the electricity transition is successful, electricity prices may plummet along with the profits of conventional utilities. The new organization’s mission should not be related to a single project but to a broader goal: generate a

knowledge leap that would definitively close the fossil era, nuclear fission, copper networks and energy waste – the legacy of the 20th century energy paradigm.

3.2 Sustainable mobility

Mobility presents a similar case for a paradigm shift. The science and technology features of the engine that burns hydrocarbons are analogous to inefficient conventional electrical generation. However, it is still not clear what could replace the world of transportation as we know it today. The Global Mobility Report (OECD, 2017a), tracking progress towards sustainable mobility around the world, concludes that the transportation sector is far away from achieving a radical change. The traffic jams and pollution of our cities caused by motor vehicles, the congestion scenario created by lower air travel costs, and the enormous environmental problems generated by sea and land freight transportation are all serious issues that should be tackled.

The solutions will hardly come from the R&D of companies whose ultimate aim is to sell more cars, more aircraft or more ships. Providing the knowledge necessary to move out of the current mobility model is a matter of radical technological innovation (including urban technology), which should be driven not by the profit motives of transportation vehicle producers but by the social well-being that can be achieved through disruptive technologies designed to reduce the need to move goods and passengers physically. A clear example of the fact that the R&D of private companies may go in the wrong direction in terms of sustainability is their huge investment in the self-driving car, which will “combine a variety of sensors to perceive their surroundings, such as radar, computer vision, Lidar, sonar, GPS, odometers and inertial measurement units. Advanced control systems interpret sensory information to identify appropriate navigation paths, as well as obstacles and relevant signage” (https://en.wikipedia.org/wiki/Self-driving_car). This will do nothing to reduce traffic congestion or emissions. In fact, traffic flow may even increase.

3.3 Digital society

Even more evident is the maturity of a public mission that would create the technological and economic conditions to exploit the potentially zero marginal cost of processing and transmitting electronic information in all its forms (voice, data and content). The Internet economy is the result of a combination of two public projects, one originally funded in the 1960s by the US federal government (Arpanet) and the World Wide Web conceived at CERN in 1989. Telecommunication satellite technology grew out of research conducted by the US Navy in response to the Soviet Sputnik. The optical fibre is the result of independent university research in the UK and elsewhere. The development potential of fields such as quantum computers and new materials for the storage and production of digital data cannot be exaggerated. However, these technologies are currently developed only, or primarily, by ICT companies that earn profits by making users paying a price for each processed bit; with the new technologies, the cost would tend to zero.

3.4 Demographic transition

The ongoing demographic transition, which today is pessimistically defined in terms of the aging of the population, could be more optimistically related to longer life expectancy and responsible

procreation. A new demographic structure raises medical research challenges that the current model of care cannot meet. This model is based on private pharmaceutical companies and, in the United States and elsewhere, on insurance companies and other organizations seeking a financial return on their investment. Private health insurance and the pharmaceutical industry are more obstacles to than catalysts for the knowledge leap needed to discover, test and produce, for example, new anti-tumour drugs that would not cost the patient or the taxpayer the hundreds of thousands of euros new drugs cost today per year of life gained.

The National Institutes of Health, an American public organization with 27 research institutes housed in 75 buildings and laboratories, is universally regarded as a global centre of excellence in the field. It should be used as a model for the creation of a major international scientific public enterprise.

3.5 Adaptation to climate change

As suggested in the report Climate Change Risks and Adaptation (OECD, 2015), governments should incorporate the management of climate change risks in policy making if they hope to adapt successfully to a changing climate. A mission-oriented agency could play a crucial role in handling the combination of environmental and demographic risks arising from climate change, building on new scientific and technological knowledge. Despite the significant progress in predicting meteorological phenomena and monitoring the marine environment or geological risk, we are still a long way from developing scientific, technological and economic solutions to ensure pacific coexistence between the natural environment of our planet and its 7.5 billion inhabitants (as many as 10 billion projected in 2050). For example, we do not have the knowledge necessary to avoid an imminent African catastrophe – we see warnings of this catastrophe on boats full of desperate migrants in the Mediterranean Sea. The Green Revolution in India in the 1960ses (see Chakravart, 1973; Sen, 1974) showed how genetics could help address famines arising from droughts, but it also highlighted potential problems arising from the lack of a supranational public agency that could offer developing countries alternatives to the unsustainable conditions created by multinationals in the biotechnology sector.

The missions described above are no more than brief examples of potential responses to current societal challenges – challenges that could benefit from a new approach to RDI policy. The creation of public organizations able to manage these public missions would give new impetus to the European Union model of RDI policy. The model should not be based on imitation of the US paradigm, with research often based on funding by the military-industrial complex. Since knowledge is mainly a global good, it would be worth considering a truly international design of mission-oriented organizations in the form of coalitions of governmental sponsors.

4. Benefits and costs of mission-oriented public enterprises

In Section 2 we discussed three different but not mutually exclusive channels through which governments may step in to support research and innovation: state-owned enterprises, public

organizations (universities and large RIs), and public procurement for innovation. Recent evidence suggests that SOEs in advanced economies with sound institutions are not worse and may even be better than private firms in terms of innovation capacity. Public university R&D is a fundamental tool for sustaining basic research, enhancing technological progress and promoting academic-industry cooperation, and it exerts positive effects on economic growth. The high-capital intensity and the long time-horizon characterizing large RIs make these facilities an ideal learning environment and source of knowledge creation, generating positive technological spillovers on the entire economy, especially through their procurement activities. Public procurement for innovation, which may be funded and managed directly by states or, alternatively, by each of the public actors mentioned above, represents an effective demand-side innovation policy. By ordering new high-tech products, public entities can foster technical change and support the development of crucial technologies, enhancing companies’ R&D investments and innovation capabilities, enlarging the size of the market, and creating new segments. The interaction of the three channels can in principle enhance government support for RDI. For example, SOEs can also implement PPI and initiate long-term relationships with universities and research agencies.

Each of these traditional channels of innovation policy has, however, some limitations. Before discussing these limitations, we should remind the reader that the other traditional mechanisms based on subsidies or tax exemptions to private firms are unlikely to provide effective and efficient incentives to managers. In terms of principal–agent relations, governments have very poor information on the R&D scope and orientation of private firms, and “paying” such firms to fulfil public missions may, in fact, do little more than provide a dividend to private investors. After all, the objective of managers of private firms is to create value in the form of income and wealth for investors, not to meet societal challenges. If the government just offers private firms taxpayer money (e.g. in the form of grants) to solve the perceived market failure of insufficient R&D (as defined by Romer, 1990) this will do nothing to shift their research agenda. The only way to force such a shift would be a special form of public procurement for innovation, where governments buy the research capacity of private firms to solve specific problems. This is the core of the R&D funding of the military-industrial complex in the US. From this perspective, such a policy would not differ from government transfers to SOEs, universities or RIs or some forms of PPI, provided that such grants were linked to missions.

However, each of these organizations has its own mission: providing services as a major state-invested utility (e.g. EDF or Deutsche Telekom), providing education and conducting independent academic research (universities); or carrying out specific scientific agendas (e.g. CERN for particle physics). While these organizations may be much more flexible than private firms in reacting to government incentives, they cannot devote themselves entirely to the kind of public missions mentioned in Section 3.

This leads us to our radical proposal to link mission-oriented innovation policies to a new type of public enterprise with the overarching goal of producing the knowledge needed to meet major societal challenges. These organizations can take different legal forms: for example, international agencies (such as the European Space Agency), consortia of SOEs, universities, RIs, and even some private enterprises (such as the management of some national laboratories in the UA by consortia of universities on behalf of the Department of Energy), or public corporations with their own portfolio of patents and income from intellectual property or from production and sales of innovative goods (such as certain types of new drugs). Space limitations prevent us from exploring the possible

architecture of such knowledge-based public enterprises. In our opinion, however, they should be based on the ethos and motivation already observable in existing major research centres such as CERN and the National Institutes for Health, where the best minds in their field work hard for their missions, without the kind of high salaries, stock options and other financial incentives observable in private corporations.

There are potential social benefits, but there may also be costs. Governments may be controlled by corrupt politicians or may simply be unable to lay the foundations of well-designed missions and organizations. Taxpayers’ money could be wasted on providing equity capital or other forms of money to inefficient organizations controlled by special interests, including certain groups of scientists. Those who are skeptical about the ability of governments to do anything better than private investors will not be convinced by an ambitious design such as the one proposed here. However, we are not entirely inventing something that is outside our experience. The Economist makes the following point:

Big-Science projects differ from companies in important ways. They are publicly financed and do not seek profits […] Yet, like companies, they must innovate furiously, make the most of limited resources and beat rivals to breakthroughs[…] Their aims are often clear-cut – find the Higgs, sequence the genome, potter around Mars – but the means to attaining them are anything but.

In other words, rival teams or individuals within teams in these organizations must be free to make their own proposals or to criticize those of others, openly discuss ideas, and challenge authority. The hierarchy must as far as possible be a “soft” one and be based on merit and consensus. This is in itself a powerful efficiency mechanism. While there are costs and risks associated with our ideas, there are also successful examples of public organizations accomplishing their missions.

5. Concluding remarks

Research and innovation are crucial factors for economic growth and generate both private and social returns. However, in order to produce knowledge leading to radical technological progress, they often require substantial and risky investments. The non-rivalrous and partially excludable nature of knowledge causes underinvestment in basic and pre-competitive R&D by private companies, which are too risk-averse to engage in activities with highly uncertain returns. This generates market failures and paves the way for government intervention. In contrast to private firms, governments may act as risk takers and make long-term investments since they face less stringent budget constraints and do not need immediate returns and profits. However, recent contributions suggest that the state’s role in promoting innovation should not be limited to fixing market failures but should aim at co-creating and co-shaping new markets. This may require to rethinking the forms of government intervention. “Missions” and mission-oriented public policies and organizations could be the new paradigm to shape government intervention.

From this perspective, the goal of RDI policy should be not only to foster economic growth but also to meet societal challenges. These include the energy transition, sustainable mobility, the digital society (digital communication and data processing), the demographic transition and climate change. Mission-oriented organizations can be powerful tools for achieving the technological breakthroughs needed to tackle these challenges successfully and solve the urgent problems they

entail. We can learn from the experience of successful SOEs, major research universities and national and international scientific agencies in order to design a new type of mission-oriented public enterprise for the 20th century.

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