the innovation paradox · 2021. 4. 23. · xavier cirera and william f. maloney financed by....

OVERVIEW

The Innovation Paradox

Developing-Country Capabilities and the Unrealized Promise of Technological Catch-Up

Xavier Cirera and William F. Maloney

Financed by

OVERVIEW

The Innovation ParadoxDeveloping-Country Capabilities

and the Unrealized Promise of Technological Catch-Up

Xavier Cirera and William F. Maloney

Financed by

This booklet is an overview of The Innovation Paradox: Developing-Country Capabilities and the Unrealized Promise of Technological Catch-Up. doi: 10.1596/978-1-4648-1160-9. A PDF of the final, full-length book, is available at https://openknowledge.worldbank.org/handle/10986/28341/, and print copies can be ordered at http://Amazon.com. Please use the final version of the book for citation, reproduction, and adapta-tion purposes.

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iii

Contents

Foreword .........................................................................................................................v

Acknowledgments ..................................................................................................... vii

The Innovation Paradox ...............................................................................................1

The Nature of Innovation in Developing Countries ....................................2

Explaining the Innovation Policy Paradox: The Importance of Complementarities .................................................................................2

The Innovation Policy Dilemma ...................................................................9

References .....................................................................................................15

v

Foreword

Productivity growth is critical for accelerating development. Poverty around the

globe cannot fall unless poorer countries raise their per capita incomes. Some of this

income growth will come from investing in better physical and human capital.

However, we know that a significant share of income growth derives from productiv-

ity growth, and specifically from innovations that render physical and human capital

more productive.

Understanding how innovations arise and are adopted and which policies can sup-

port them is important for development policy design. It is even more important

given the new wave of digitalization and automation that is rapidly altering econo-

mies around the world. One of the key findings of the research presented here is that

the observed low level of technological adoption in developing countries is a rational

response of firms to a range of conditions they face: barriers to accumulating physical

and human capital, low firm capabilities, and weak government capacity. Unlocking

the enormous growth potential of moving countries closer to the technological fron-

tier thus is not as simple as, say, providing additional incentives for research and

development. Moving countries closer to the frontier will require far-reaching policy

changes that tackle multiple constraints to technological adoption.

The research presented here is part of a longer research project on productivity led

by the Chief Economist’s Office of the World Bank’s Equitable Growth, Finance, and

Institutions Vice Presidency. We are confident that researchers and development

practitioners alike will highly value the new findings on innovation patterns and the

directions for development policies this report contains.

Jan Walliser

Vice President

Equitable Growth, Finance, and Institutions

World Bank Group

vii

Acknowledgments

This report was written by Xavier Cirera (Senior Economist, World Bank’s Trade

and Competitiveness Global Practice) and William F. Maloney (Chief Economist,

World Bank’s Equitable Growth, Finance, and Institutions [EFI] cluster). The authors

thank Jan Walliser (Vice President, EFI), Anabel González (Senior Director, Trade

and Competitiveness Global Practice), and Klaus Tilmes (Director, Trade and

Competitiveness Global Practice) for their support, as well as Esperanza Lasagabaster,

Paulo Correa, and Ganesh Rasagam, successive managers in the Innovation and

Entrepreneurship unit of the World Bank.

The work builds on a combination of analytical work by the authors and inputs from

a series of background papers whose research was carried out under the umbrella of the

project and related to earlier initiatives. The authors specifically thank Patricio Aroca

(Universidad Adolfo Ibáñez, Chile), Mariano Bosch (Inter-American Development

Bank), Edwin Goñi (Inter-American Development Bank), Carlos Molina Guerra

(University of Chicago), Albert Link (University of North Carolina), Vladimir López-

Bassols (Independent Consultant), Asier Mariscal (Carlos III University), Andres

Rodriguez-Clare (University of California, Berkeley), Leonard Sabetti (CERDI,

Université d’Auvergne), Mauricio Sarrias (Catholic University of the North, Chile), John

Scott (Dartmouth University), and Felipe Valencia (Bonn University) for their contribu-

tions, as well as Oscar Calvo-González, Leonardo Iacovone, Daniel Lederman, David

McKenzie, Silvia Muzi, Mariana Pereira-López, and Daria Taglioni at the World Bank.

The authors are especially grateful to Nick Bloom (Stanford University), Renata

Lemos (World Bank), Rafaella Sadun (Harvard Business School), John Van Reenen

(Massachusetts Institute of Technology), and Daniela Scur (Oxford University) for

their support with the World Management Survey and for ongoing discussions on

managerial practices. The authors acknowledge invaluable comments from José Miguel

Benavente (Inter-American Development Bank), Laura Chioda (EFI, World Bank),

Charles Edquist (Centre for Innovation, Research, and Competence in the Learning

Economy, Sweden), Keun Lee (Seoul National University), Bengt-Åke Lundvall

(Aalborg University, Denmark), Juan Rogers (Georgia Technological University), and

Luis Servén (Development Research Group, World Bank) for their work on the national

innovation system.

viii Acknowledgments

The policy chapters partially draw from the work on innovation policy by the

World Bank Trade and Competitiveness Global Practice and the Innovation and

Entrepreneurship unit in particular, as well as from various other innovation policy

activities at the World Bank, with specific inputs from Anwar Aridi, Jaime Frias, Justin

Hill, Natasha Kapil, and Juan Rogers (Georgia Technological University). The report also

benefited from the work on the Public Expenditure Reviews in Science, Technology, and

Innovation that was piloted in Colombia and later implemented in Chile and Ukraine.

The research on management and technology extension systems benefited from

work by the World Bank and the government of Colombia developing their techno-

logical program. The authors thank Paula Toro and Rafael Puyana (Departamento

Nacional de Planeacion, Colombia), Martha Lucia Perlaza, and the team at the National

Productivity Center (Cali, Colombia), as well as Eduardo Bitrán (Production

Development Corporation–CORFO, Chile) and Xavier Duran (University of the

Andes, Colombia), for extended conversations on the topic. In Asia, the authors bene-

fited from interviews with Junichiro Mimaki and Junko Motozawa (Small and Medium

Enterprise Agency, METI), Akihiro Takagi and Takenori Nasu (Japanese International

Cooperation Agency), and Kenji Fujita (Japanese Productivity Center). In Singapore,

the authors thank Audrey Lok and Mohamed Sirajuddin Jaleel (SPRING), and Guan

Wei Lee (Research and Enterprise Division, Ministry of Trade and Industry).

For their careful review of the entire document, the authors thank Martin Bell

(SPRU, University of Sussex), Nick Bloom (Stanford University), Paulo Correa (World

Bank), Paulo Figueiredo (FGV, Brazil), David McKenzie (World Bank), Carlo Pietrobelli

(UN-MERIT), Sudhir Shetty (World Bank), John Sutton (London School of

Economics), and Mary Hallward-Driemeier and Denis Medvedev at the World Bank.

The report also benefited from comments from World Bank colleagues Ali Abukumail,

Maja Andjelkovic, James Brumby (Director, Governance Global Practice), César

Calderón, Ana Cusolito, Mark Dutz, John Gabriel Goddard, Naoto Kanehira, Smita

Kuriakose, John Panzer (Director, Macro and Fiscal Management Global Practice),

Samuel Pienknagura, Jean-Louis Racine, Mariam Semeda, Siddharth Sharma, Michael

Wong, and Michael Woolcock.

The authors also thank Diletta Doretti and Susana Rey, as well as Bill Shaw and Nora

Mara, who edited the report. Rumit Pancholi, Susan Graham, and Patricia Katayama

provided production and acquisitions support.

Finally, the authors thank the following for financial support: the European Union;

the African, Caribbean, and Pacific Group of States Secretariat; and the governments of

Austria, Norway, and Switzerland, through the Competitive Industries and Innovation

Program trust fund.

1

The Innovation Paradox

Innovation—the invention of new ideas, and the introduction of new products, technolo-

gies, business processes, and ideas in the market—is central to the rise of advanced econo-

mies. It drives the process of creative destruction as new, productive firms enter the

market and old, unproductive ones exit (Schumpeter 1942), underlies modern growth

theory, and is the critical ingredient in historical accounts of how countries achieve pros-

perity. Its importance is captured by the classic metaphor of The Unbound Prometheus

(Landes 1969), referring to the Greek god who released the power of fire to humankind.

Yet in developing countries, Prometheus remains bound. Despite the vast potential

returns, developing countries encourage far less innovation, measured along a variety

of dimensions, than advanced countries. Firms and governments appear to be leaving

billions of dollars on the table in forgone productivity growth. This is the innovation

paradox.

The standard policy advice to resolve this paradox—to move into areas of produc-

tion thought to be more growth friendly—misses the critical point that countries

that are unable to innovate and be competitive in their current industries are unlikely

to do so in new industries.

Moreover, discussions about

innovation policy often omit

the question of who actually

implements it. The role public

servants, ministries, and agen-

cies play in ensuring or undermining the effectiveness of policy instruments is rarely

considered. This public sector role is a key element in most developing countries with

little implementation capacity.

Three factors help explain developing countries’ innovation paradox:

1. The critical complements to investments in innovation that are needed to

achieve high potential returns are missing.

2. The key firm capabilities—managerial and organizational practices—required

to pursue innovation and take it to market successfully are weak.

3. Government capabilities for implementing effective innovation policies are also

weak and limited.

Innovation policy in developing countries is more challenging and complex than in advanced countries because the market failures and missing complementarities are likely to be more acute.

2 The Innovation Paradox

This volume analyzes these factors, with the goal of contributing to more coherent and

effective policy making in developing countries to unleash the power of innovation.

The analysis draws on two important traditions, the neoclassical and the national

innovation system (NIS) literature, highlighting the common ground between them.

The Nature of Innovation in Developing Countries

New data allowed us to generate stylized facts about the nature of investments in inno-

vation that firms have undertaken at various stages in the development process. Firms

report innovating at all income levels and in all sectors. In developing countries, how-

ever, these investments often consist of marginal improvements in process or products,

rather than significant technology adoption or new product imitation. They very rarely

involve frontier research. Further, as a country’s per capita income rises, so too do its

investments in a wide range of inputs related to innovation, such as use of technology

licenses, purchase of equipment, and research and development (R&D), as well as

investment in outputs, such as patents or products new to the national or international

market (see figures O.1 and O.2).

These firm-level data reveal the innovation paradox: the coexistence of low levels of

innovation-related investment in developing countries with the dramatically high

returns that should accompany the adoption of more productive technology (techno-

logical adoption) and the catch-up of developing countries (Schumpeterian catch-up) to

the levels of productivity of advanced countries (the productivity frontier). What

explains this weaker effort in adopting technology, much less in introducing new prod-

ucts and services?

Explaining the Innovation Policy Paradox: The Importance of Complementarities

The increase in the use of the wide variety of inputs needed for the innovation process,

as well as physical and human capital, as countries develop (as shown in figures O.1 and

O.2), suggests a high degree of complementarity among the different factors necessary

for innovation. This co-movement also helps explain the innovation paradox. If a firm

(or country) invests in innovation but cannot also import the necessary technology,

contract or hire trained workers and engineers, or draw on new organizational tech-

niques, the returns to that investment will be low. That is, while it is true that the poten-

tial gains from Schumpeterian catch-up increase with distance from the frontier, the

availability of the factors of production necessary to realize them decreases.

Figure O.3 confirms the essential role of complementarities in realizing these

returns. The returns from investment in R&D initially do rise as predicted with coun-

tries’ increasing distance from the frontier. However, the lack of complementary factors

eventually becomes a binding constraint, causing the returns to innovation to decline,

and possibly even become negative, as shown by the inverted U-shape.

The Innovation Paradox 3

Source: World Bank innovation study team, using Enterprise Survey data (www.enterprisesurveys.org).

FIGURE O.1 As Countries Develop, Firms Introduce More Sophisticated New Products and Purchase More Licenses to Use Technology

DRC

GHA

KEN

NAMNGA

SSD

SDN

TZA

UGA

ZMBBGD

IND

NPL

PAK ALB

ARM

AZE

BLR

BIH

BGR

HRVCZE

EST

GEO

HUN

KAZ

KSV

KGZLVA

LTU

MKD

MDA

MNG

MNE

POLROM

RUS

SRB

SVK

SVNTJK

TUR

UKR

UZBEGY

ISR

JOR

LBN

MAR

TUNWBG

YEM

0

0.1

0.2

0.3

0.4

Shar

e of

firm

s

6 7 8 9 10 11

Log(GDP per capita)

Product innovation−new to national/internationalTechnology license

Countries with product innovationCountries with technology licenses

FIGURE O.2 As Countries Converge to the Productivity Frontier, R&D Intensity Rises

0

1

2

3

4

5

4.5 5.5 6.5 7.5 8.5 9.5 10.5 11.5

R&D/

GDP

(%)

Log (GDP per capita) in constant US$

a. Country level

(Figure continues on the following page.)


This insight has two key implications for innovation policy. First, the concept of the

national innovation system (NIS) must be expanded, as illustrated in figure O.4.

The policy maker’s concep-

tion of the NIS must go

beyond the usual institutions

and policies designed to offset

standard innovation-related

market failures (as indicated

in the left-hand side of figure).

The scope of the NIS must include broader complementary factors and supporting

institutions (as in the middle of the figure).

The second implication is that innovation cannot be supply driven; there must be

demand from firms that have the capabilities to innovate. On this demand side—the

firm and its decisions to innovate (shown on the right-hand side of figure O.4)—policy

makers must be concerned with the incentives for firms to accumulate the necessary

physical, human, and knowledge capital. Thus, policy makers must consider the overall

macroeconomic and competitive contexts, the trade regime, and the barriers to the

accumulation of all of these types of capital, such as credit markets, entry and exit bar-

riers, the business and regulatory climate, or the strength of the rule of law. Hence, in

Sources: World Bank innovation study team elaborations. For panel a, data are from Orbis (UNESCO). For panel b, data are from the World Bank Enterprise Survey (www.enterprisesurveys.org).Note: In panel b, the distance to the frontier is calculated as the difference between the firms’ log of sales per worker and the 95th percentile labor productivity in the sector for the entire dataset. Values for extreme sales per worker are excluded. The line represents smoothing linear fit. GDP = gross domestic product; R&D = research and development; UNESCO = United Nations Educational, Scientific, and Cultural Organization.

b. Firm level

0

5

10

15

Log

R&D

per w

orke

r (co

nsta

nt U

S$)

−13 −11 −9 −7 −5 −3 −1

Distance to frontier

FIGURE O.2 As Countries Converge to the Productivity Frontier, R&D Intensity Rises (continued)

What looks like an innovation problem, such as a low rate of investment in research and development, may not be one, but rather reflect barriers to accumulating other factors, including physical and human capital.


addition to the elements generally focused in the NIS (highlighted by the blue triangles

in figure O.4), developing country innovation policy must address the failures or

underdevelopment of a wider range of markets to realize the potential returns from

catch-up (indicated by the green triangles). The innovation agenda is, therefore, much

broader and more complex in these countries.

This complexity of the NIS has strong implications for conventional measures of

benchmarking innovation performance—such as comparing raw levels of gross

domestic expenditures on R&D across countries—since they are likely to be misleading

if they do not consider the existing stock of other complementary factors. A low level

of R&D may indicate unresolved problems in innovation per se, but may just as likely

reflect constraints in the accumulation of other factors. That is, low-income developing

countries that have weak education systems, or have capital markets or import restric-

tions that make it difficult to invest in physical capital, will not have high returns to

R&D or innovation more generally, and hence should not be targeting advanced-

country levels of R&D. Nonetheless, they may benefit from international scientific

training, international collaborative projects, and links among universities that can

transfer knowledge to domestic firms and universities.

Source: Goñi and Maloney 2017.Note: The figure uses quinquennials of cross-country data from 1960 to 2010 to estimate the rate of return to research and develop-ment (R&D) across the development process: 0.0 on the x axis is the frontier, and moving left represents progressively more distance from the frontier.

FIGURE O.3 For Countries That Are Far from the Technological Frontier, the Returns to R&D Increase Until a Point Where the Lack of Complementary Factors Depresses Them

ARG(

1966

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2006

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BRA(

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BRA(

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CAN(

1966

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0)

CAN(

2006

–201

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CHE(

1986

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CHE(

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CHL(

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CHL(

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CHN(

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COL(

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2006

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CRI(1

976–

1980

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CRI(2

006–

2010

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CYP(

1981

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5)

CYP(

2006

–201

0)

CZE(

1996

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0)

CZE(

2006

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DEU(

1976

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DEU(

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DNK(

1976

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ECU(

1971

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2006

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EGY(

2006

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ESP(

1966

–197

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ESP(

2006

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GBR(

1976

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GBR(

2006

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GRC(

1966

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GRC(

2006

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GTM

(197

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GTM

(200

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HKG(

1996

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IRL(

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ISL(

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JPN(

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JPN(

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KEN(

1966

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KOR(

1966

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2006

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2006

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LUX(

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–2.0 –1.5 –1.0 –0.5 0.0

6

Sour

ce: M

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017.

FIG

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Managerial Practices as a Key Input for Innovation

In order to innovate, firms need to acquire a range of capabilities, without which they

cannot manage innovation projects effectively, as an extensive literature in the NIS

tradition points out. The acquisition of these capabilities—specifically, managerial and

organizational practices—is fundamental to the process of upgrading both productiv-

ity and quality (see Teece and Pisano 1994—and, more in the mainstream, Sutton 2012,

Sutton and Trefler 2016, and Hallak 2006, among others). Accounts of the East Asian

“miracles” place primary emphasis on the accelerated process of learning and raising

the capabilities for innovation of firms, rather than on the particular sectors they were

in (see Kim 1997; Hobday 2000; Dodgson 2000; Lee 2013).

The recent introduction of the World Management Survey (WMS), initiated by

Bloom and Van Reenen (2007, 2010), has permitted a quantum leap in the comparative

quantitative analysis of management practices and their implications for productivity

and innovation. Firms in developing countries are indeed lagging in a wide range of

skills/abilities that are critical to the Schumpeterian catch-up process (figure O.5).

Average scores in monitoring,

employment of just-in-time

processes, internal feedback

mechanisms, long-run plan-

ning and goal stretching, and

human resource policies in low- and middle-income countries are well below those of

advanced economies. Firms that lack the capabilities required to respond to market

conditions, identify new technological opportunities, develop a plan to exploit them,

and then cultivate the necessary human resources will find it difficult to innovate and

respond to government incentives to do so.

This report offers a novel empirical analysis that confirms the importance of

advanced managerial and organizational practices for innovation, both directly and

by facilitating investments related to innovation. Even after controlling for the usual

innovation inputs such as R&D, managerial and organizational practices are impor-

tant predictors of innovation and productivity across countries, firm size, and coun-

try income levels. Not only do they help explain the lower returns to R&D found in

lower-income countries, but they also facilitate R&D and enhance its effectiveness. In

sum, accumulating these managerial capabilities is of paramount importance for

innovation policy, especially in countries and firms that are distant from the techno-

logical frontier.

What Drives Managerial Capabilities?

These findings beg the question of why managerial capabilities are so weak in develop-

ing countries. Figure O.6 shows that for four developing countries representative of

A key missing factor concerns firm capabilities, ranging from basic managerial skills to engineering capacity.


their respective regions (East Asia, Latin America, South Asia, and Eastern Europe)

their firms’ scores are lower than scores for firms in the frontier country (the United

States) across the entire distribution. This implies that moving the average toward the

frontier requires not only the exit of badly run firms, but also upgrading the managerial

capabilities of the best firms.

Several factors have been identified as affecting managerial quality (Bloom and Van

Reenen 2007, 2010; Maloney and Sarrias 2017). More educated managers tend to be

better managers. Limits on product market competition enable inefficient firms to sur-

vive by failing to provide adequate incentives for firms to upgrade. Firms with diffuse

ownership tend to be among the best, whereas government-owned companies and

family-owned firms are weaker. The ubiquity of family-owned firms in developing

countries is partly due to a weak rule of law, which triggers mistrust in delegating man-

agement to professional managers. Openness to trade provides incentives to upgrade

and presents exposure to new ideas. Imports can increase access to technology and its

embedded know-how, and exporting enables firms to learn about more sophisticated

and contested markets. Similarly, exposure to better-managed multinational enter-

prises (MNEs) and participation in global value chains (GVCs) offer important oppor-

tunity for knowledge spillovers, although weak firm capabilities often impede

participation in GVCs and learning.

Source: World Management Survey 2015.Note: The figure shows the management scores for the 15,454 interviews across the countries in the World Management Survey. Management is scored on a 1-to-5 basis for 18 questions. Country scores reflect the average across all firms in each country. Gross domestic product (GDP) data are on a purchasing power parity (PPP) basis for 2013, as reported in the International Monetary Fund’s World Economic Outlook. Smaller and larger firms in China, Mozambique, and Nigeria have been stratified to balance the sampling frame.

FIGURE O.5 Managerial Practices Lag in Developing Countries

ARGBRA

CHL

COL

MEX

NIC

FRA

DEU

GRC

IRL

ITAPOL

PRTESP

SWE

GBR

CHN

IND

JPN

SGP

TUR

AUSNZL

CAN

USA

ETH GHA

KEN

MOZ

MMR

NGA

TZAZMB

2.0

2.5

3.0

3.5M

anag

emen

t sco

res

7 8 9 10 11

Log of 10-year average GDP based on PPP per capita (current international $, billion)

Latin America AsiaEurope Oceania North America Africa


The Innovation Policy Dilemma

The need for innovation policy in developing countries to address deficiencies or fail-

ures in a larger range of complementary factors and institutions that are required to

promote innovation gives rise

to the innovation policy

dilemma. As the complexity of

innovation policy increases

with distance from the fron-

tier, government capabilities

to design, implement, and coordinate the appropriate combination and policy

instruments—the policy mix—weakens. These limitations/constraints on government

capabilities offer another key to resolving the innovation paradox.

Governments themselves must develop their own capabilities for innovation policy

making across four pivotal dimensions:

1. Policy design demands the ability to identify market failures, design the

appropriate policies to redress them, and establish clear metrics for success.

Many failed experiments in developing countries result from naively

importing institutional models and best practices from advanced economies

FIGURE O.6 The Management of Developing Countries’ Firms Trails That of US (Frontier) Firms across the Distribution

Source: World Bank Innovation study team elaborations, based on World Management Survey 2015.Note: The figure shows kernel density estimates.

0

0.2

0.4

0.6

0.8

Prob

abilit

y de

nsity

1 2 3 4 5

Firm average management score

United States China Brazil India Poland

Weak capabilities on the government side compound the difficulties involved in building private sector capacity and constructing a functional national innovation system.


that may not address the true failures or be politically viable. Many agencies,

such as public research institutions, lack a clearly defined mission and

incentives that would align them with identified clients and goals and shield

them from capture.

2. Efficacy of implementation rests on strong public management practices, as

well as processes for evaluating, adapting, and modifying or terminating

policies when needed.

3. Coherence of policy across the NIS requires the ability to have an overview of

the overall system and effectively coordinate across ministries and agencies. In

developing countries, policy is often balkanized by ministry or administrative

level, and there is little alignment between the stated goals of policies and actual

budgets and impact.

4. Policy consistency and predictability require systems that cultivate

innovation policies and institutions over time, overcoming fluctuations in

the political economy and guaranteeing a predictable environment for long-

term investments in innovation. Instead, there is often only partial high-level

political commitment, and policy is subject to weak backing and frequent

reversals.

None of these capabilities is easy to generate or maintain.

Supporting the “Capabilities Escalator”

The final step in addressing the innovation policy dilemma requires choosing the

appropriate policy mix in the context of scarce government capabilities. The report

offers a heuristic framework,

the “capabilities escalator”

(see figure O.7). Policies to

support firm upgrading are

sequenced in keeping with

the level of capabilities of the

private sector, policy makers, and institutions, and ratchet up through progressively

higher stages of sophistication:

1. Stage 1 primarily supports production and management capabilities in

incipient NISs.

2. Stage 2 increases the focus on supporting technology adoption and imitation

capabilities in maturing NISs.

3. Stage 3 expands the support to invention and technology-generation

capabilities in more mature NISs.

Given the wide variation in the innovation potential of firms found at all develop-

ment stages, the framework is not meant to be deterministic. For example, many

A gradual process—the capabilities escalator—is needed to accumulate the necessary instruments, institutions, and capabilities for firms and the government to promote innovation.


advanced countries—such as Italy, Japan, Singapore, and the United States—have

invested and continue to invest heavily and profitably in the first stage of the escalator.

Rather, the capabilities escalator provides guidance on where to prioritize and allocate

existing public resources. Evidence from India, Italy, and the United States, among

others, suggests that programs supporting managerial upgrading can yield high

returns and increase tax revenue by multiples of the cost of the program. For instance,

textile firms in India that received consulting services almost doubled the share of

management practices they adopt and enjoyed a rise in productivity of more than

10 percent after one year (Bloom et al. 2003) (see figure O.8).

Figure O.9 depicts the three stages of the capabilities escalator and presents the

implications for the policy mix. The important message of the figure is that the policy

mix is cumulative. As firms move up the capabilities escalator, the policy mix also

advances from less sophisticated instruments to more sophisticated ones.

The first stage starts by building basic managerial and organizational capabilities

through management extension. It provides incentives for collaboration among firms,

such as through vouchers for innovation. It also focuses on developing key comple-

mentary factors, such as science, technology, engineering, and mathematics (STEM)

skills and early-stage infrastructure. More important, it makes sure that there is an

enabling environment for firms to invest in innovation.

The second stage focuses on strengthening technological capabilities via tech-

nological extension or technology centers. It provides direct and indirect support to

R&D projects, while continuing to strengthen existing complementary factors and

FIGURE O.7 Meeting Innovation Policy Needs: The Capabilities Escalator

Note: NIS = national innovation system; NQI = national quality infrastructure; R&D = research and development; STEM = science, technology, engineering, and mathematics.

STAGE 1Incipient NIS

STAGE 2Maturing NIS

STAGE 3Mature NIS

Leve

l of d

evel

opm

ent

• Pursue long-term R&D and technological programs• Minimize innovation gap between leaders and laggards• Collaborative innovation projects

• Build managerial and organizational capabilities• Start collaborative projects• Start developing STEM skills and engineering• Build basic infrastructure—NQI and incubation• Eliminate barriers to physical, human, and knowledge capital

• Build technological capabilities• Incentivize R&D projects• Link industry and academia• Improve the quality of research, innovation, and export infrastructure


FIGURE O.8 Management Extension Improved Management Practices in India

Source: Bloom et al. 2013.

–10

20

30

40

50

60

–8

Perc

enta

ge o

f 38

man

agem

ent p

ract

ices

–6 –4 –2 0 2 4 6 8 10 12 14 16 18 20 22 24

No. of months after the start of the diagnostic phase

Treatment plants Control plants Rest of the industry around Mumbai

FIGURE O.9 The Capabilities Escalator: The Policy Mix Evolves from Less to More Sophistication

STAGE 1

STAGE 2

STAGE 3

Instrument accumulation

ImprovingBusiness environment/

Competition

Long-term R&D programsDirect and indirect support to R&DCollaborative innovation projects

Precommercial procurement

Technology extension and technology centersR&D grants

Grants to industry/university collaborationAccelerators and other infrastructureUpgrading and export quality support

Management extensionVouchers to collaboration

STEM skillsNQI infrastructure

Incubation

Note: NQI = national quality infrastructure; R&D = research and development; STEM = science, technology, engineering, and mathematics.


infrastructure for innovation. It is important to highlight that the institutions appro-

priate to this stage take decades to build. Although capability building remains the

priority, laying the groundwork for an advanced science and technology capability

must also begin at this stage.

The final stage facilitates advanced technological development capabilities and

invention, while supporting the strengthening of basic innovation capabilities in lag-

gard firms. Establishing stage 3 capabilities is a long-term process, so it must be started

at the same time as efforts in the earlier stages. Nonetheless, it cannot be considered a

substitute for the policies to support stage 1 capabilities—firms need to walk before

they can run.

Table O.1 presents some illustrative combinations of instruments that could be used

at each stage.

TABLE O.1 The Policy Mix at Different Stages of the National Innovation System

Stage Illustrative policy mixStage 1: Incipient NISPrevalent in low- and lower-middle-income countries• Build managerial and organizational

practices

Focus on employing instruments that improve absorptive capacity and strengthen management and production capabilities:• Support management extension programs• Provide early-stage infrastructure and advisory services (incubators)• Foster collaboration and simple innovation projects through, for example,

vouchers and direct grants (accompanied by advisory services)• Establish standards and basic national quality infrastructure• Strengthen research quality

Stage 2: Maturing NISPrevalent in middle- and upper-middle-income countries• Focus on building innovation

capacities and accelerating technology transfer

Continue to build absorptive capacity.Support technology extension projects.Start university-industry collaboration in some clusters.Focus on research quality and STEM.• Technology extension and business advisory programs• Development of local supply chains and export programs• Grants for innovative projects to finance prototyping, testing, and

commercialization activities• Early-stage infrastructure and advisory programs (incubators), and some

accelerators• Innovation vouchers and grants

Stage 3: Mature NISPrevalent in higher-income countries• Concentrate on generating

technology and supporting capabilities.

• Focus on bringing along laggard firms.

Combine instruments to support frontier technology generation and projects that are highly R&D intensive with a variety of instruments to help SMEs ignite innovation:• Tax incentives for R&D• Grants to large, complex, long-term, and collaborative R&D projects• Procurement for innovation• Equity finance and early-stage capital• Loan guarantees accompanied by firm-level capacity building and advisory

programs• Technology extension and business advisory services• Systemic policies for innovation

Note: NIS = national innovation system; STEM = science, technology, engineering, and mathematics.


Rethinking Innovation Policies

This report explains why the low levels of innovation observed in developing countries are

not due to some irrationality on the part of firms and governments. Nor is the solution simply

providing more training or extension or promoting R&D to remedy well-known knowledge-

related market failures. Rather, policy makers in the developing world face barriers that are

orders of magnitude more challenging than those found in the advanced world. Thus, foster-

ing innovation requires a rethinking of innovation policies along three key dimensions.

First, the importance of a wide range of innovation complementarities implies that

the scope of the NIS that policy makers must pursue is much larger than in advanced

countries. It must include everything that affects the accumulation of all types of

capital—physical, human, and knowledge—and their supporting markets. What looks

like an innovation problem, such as a low rate of investment in R&D, may actually

reflect barriers to accumulating other factors, including physical and human capital.

Second, the cultivation of firm managerial and technological capabilities is critical

to encouraging a continual process of technological adaptation and quality upgrading.

This implies a rebalancing of policy priorities toward management and technology

extension instruments and

away from a focus mostly or

exclusively on promoting

R&D. Although R&D is an

important input for innova-

tion, it requires a set of capa-

bilities that are unlikely to be

met by many developing countries. Its promotion cannot be at the expense of the other,

and more fundamental, investments on the capabilities escalator.

Finally, while the complexity and problems of constructing a functional NIS and

building private sector capability are greater in developing countries, government

capabilities to manage them are weaker. Innovation policy thus needs an honest bal-

ancing of capabilities with tasks. This requires working on a selective set of issues rather

than trying to import a full set of institutions and policies from elsewhere.

Better data and better analytical frameworks are necessary as developing countries face

the dramatic and unpredictable evolution of the world economy. The rate of technologi-

cal change is accelerating. We cannot know with assurance which sectors or industries will

offer rapid routes to prosperity, or what technologies will drive them. However, Pasteur’s

counsel that “fortune favors the prepared mind” remains as vitally relevant for countries

as for people. Policy makers need to ensure that they, and their countries, are ready.

Overall, the issue of capabilities in innovation policy making and how to improve

them is one of the most pressing yet unacknowledged aspects of innovation policy in

developing countries.

Innovation policy needs an honest balancing of government capabilities with tasks. Working on a selective set of issues may be a better approach than trying to import a full set of institutions and policies from elsewhere.


Raising the capabilities of firms to manage uncertainty, ensuring that the innova-

tion system provides necessary complementary inputs and flows of knowledge, and

strengthening government capabilities to manage a large and expanding set of chal-

lenges are all keys to resolving the innovation paradox and preparing countries for the

opportunities ahead.

References

Bloom, Nicholas, Benn Eifert, Aprajit Mahajan, David McKenzie, and John Robert. 2013. “Does Management Matter? Evidence from India.” Quarterly Journal of Economics 128 (1): 1–51.

Bloom, Nicholas, and John Van Reenen. 2007. “Measuring and Explaining Management Practices across Firms and Countries.” Quarterly Journal of Economics 122 (4): 1351–1408.

———. 2010. “Why Do Management Practices Differ across Firms and Countries?” Journal of Economic Perspectives 24 (1): 203–24.

Dodgson, Mark. 2000. “Strategic Research Partnerships: Their Role, and Some Issues of Measuring Their Extent and Outcomes—Experiences from Europe and Asia.” Paper presented to the Workshop on Strategic Research Partnerships sponsored by the National Science Foundation and convened at SRI International, Washington, DC, October 13.

Goñi, Edwin, and William F. Maloney. 2017. “Why Don’t Poor Countries Do R&D? Varying Rates of Factor Returns across the Development Process.” European Economic Review 94 (C): 126–47.

Hallak, Juan Carlos. 2006. “Product Quality and the Direction of Trade.” Journal of International Economics 68 (1): 238–65.

Hobday, Michael. 2000. “East versus Southeast Asian Innovation Systems: Comparing OEM- and TNC-Led Growth in Electronics.” In Technology, Learning, and Economic Development: Experiences of Newly Industrializing Economies, edited by Linsu Kim and Richard R. Nelson, 129–60. Cambridge, UK: Cambridge University Press.

Kim, Linsu. 1997. Imitation to Innovation: The Dynamics of Korea’s Technological Learning. Boston: Harvard Business School Press.

Landes, David S. 1969. The Unbound Prometheus: Technical Change and Industrial Development in Western Europe from 1750 to the Present. Cambridge, UK: Cambridge University Press.

Lee, Keun. 2013. Schumpeterian Analysis of Economic Catch-Up: Knowledge, Path-Creation, and the Middle-Income Trap. Cambridge, UK: Cambridge University Press.

Maloney, William F. 2017. “Revisiting the National Innovation System in Developing Countries.” World Bank, Washington, DC.

Maloney, William F., and Mauricio Sarrias. 2017. “Convergence to the Managerial Frontier.” Journal of Economic Behavior & Organization 134 (C): 284–306

Schumpeter, Joseph. 1942 (2008 edition). Capitalism, Socialism and Democracy. New York: HarperCollins.

Sutton, John. 2012. Competing in Capabilities: The Globalization Process. Oxford: Oxford University Press.

Sutton, John, and Daniel Trefler. 2016. “Capabilities, Wealth, and Trade.” Journal of Political Economy 124 (3): 826–78.

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SKU 33163

Since Schumpeter, economists have argued that vast productivity gains can be achieved by investing in innovation and technological catch-up. Yet, as this volume documents, developing- country firms and governments invest little to realize this potential, which dwarfs international aid flows. Using new data and original analytics, the authors uncover the key to this innovation paradox in the lack of complementary physical and human capital factors, particularly firm managerial capabilities, that are needed to reap the returns to innovation investments. Hence, countries need to rebalance policy away from R&D-centered initiatives—which are likely to fail in the absence of sophisticated private sector partners—and toward building firm capabilities; and they need to embrace an expanded concept of the national innovation system that incorporates a broader range of market and systemic failures. The authors offer guidance on how to navigate the resulting innovation policy dilemma: as the need to redress these additional failures increases with distance from the frontier, government capabilities to formulate and implement the policy mix become weaker.

This book is the first volume of the World Bank Productivity Project, which seeks to bring frontier thinking on the measurement and determinants of productivity to global policy makers.

“Too often we see companies and countries paying huge costs trying to invent shiny new things

and push out the technological frontier when, for a fraction of the price, they can harvest the low-

hanging fruit of processes and products already found in frontier firms. This book highlights the

critical importance of such untapped technological adoption for development and explores the

reasons countries, counterintuitively, invest so little to effect it. In particular, it brings empirical

discipline and economic rigor to the concept of learning to “walk before they run,” that is, the process

of developing firm and country capabilities, and in particular, sophisticated management practices.

If CEOs and governments followed this advice they could save themselves billions of dollars while

rapidly accelerating growth.”

Nicholas Bloom Eberle Professor of Economics, Stanford University, and Co-Director of the Productivity, Innovation and Entrepreneurship Program at the National Bureau of Economic Research

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in partnership with

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