Europe�s growth performance has been the subject of increasing

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					     Assessing innovation capacity: fitting strategy, indicators and
                    policy to the right framework
                                   Prof. Dr. Reinhilde Veugelers,
                              DG ECFIN / Katholieke Universiteit Leuven




                               Paper prepared for the Conference
                       Advancing Knowledge and the Knowledge Economy

                       National Academies, Washington 10-11 January 2005


                                                  January 2005


                                               Very preliminary
                                              Please do not quote


                         This paper does not reflect the view of EC-DGECFIN



                                                     Abstract
Growth performance has been the subject of increasing scrutiny over recent years, a problem that Europe has
addressed very aggressively. The much debated analysis of the contribution to overall productivity growth from
ICT production and use, indicates the EU’s difficulty in re-orientating its economy towards the newer, higher
productivity, growth sectors such as ICT. At the same time, it raises the broader issue of whether the EU is
insufficiently capable of creating and exploiting new technologies in general. For this, analysis must go beyond
research inputs to include the capacity to link public and private knowledge creators and creators and users of
knowledge. Sufficient ‘demand pull’ is needed for innovation to reward successful innovators, which requires
sophisticated lead users willing to pay for innovations, effective intellectual property rights (IPR) schemes, a
favorable macro-economic environment, well functioning financial markets, vigorous competition in output
markets, and flexible product and labour markets. Hence, tackling the deficient EU innovative capacity requires
a broad systemic policy framework.
These challenges the EU is facing has motivated it to develop the “Lisbon strategy”. The strategy involves a
broad set of structural reforms to encourage employment and productivity growth to become a supremely
competitive knowledge-based economy by 2010. It also entails a set of targets and indicators that can be
continuously monitored to assess progress on these reforms. A broad systemic framework goes well beyond
targeting R&D budgets but unfortunately includes many factors difficult to document with statistical indicators.
We evaluate the assumptions behind the Lisbon strategy, i.e. the choice of policy priorities and structural
reforms. We analyse the set of indicators chosen to evaluate progress. Are these the right indicators for
informing improvement in innovative capacity? What are the interactions and complementarities between the
various reforms and indicators? We also consider the need to monitor and evaluate the indicators – and whether
this should be done individually or at a systemic level, at aggregate or sectoral levels, at EU, national or regional
level.




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1. INTRODUCTION

Europe’s growth performance has been the subject of increasing scrutiny over recent years,
most notably in the context of the Lisbon process and its efforts to encourage governments to
introduce employment and productivity enhancing reforms. This reform agenda is all the
more pressing given that the EU’s underlying growth rate has been trending downwards since
the second half of the 1990’s.The medium to long term outlook points to a continuation of
these trends. While many EU countries are understandably preoccupied with extricating their
economies from the relatively prolonged short run downturn, many of the solutions to this
slow growth problem require in fact a longer term policy perspective. A sustainable medium-
term recovery process demands action on a wide structural reform agenda aimed at effectively
addressing the EU’s fundamental growth challenges, presently posed by the accelerating pace
of technological change, globalisation and ageing populations.

The much debated analysis of the contribution to overall productivity growth from ICT
production and use, indicates the EU’s difficulty in re-orientating its economy towards the
newer, higher productivity, growth sectors such as ICT. At the same time, it raises the
broader issue of whether the EU is insufficiently capable of creating and exploiting new
technologies in general. Tackling the deficient EU innovative capacity requires a broad
systemic policy framework that goes well beyond targeting R&D budgets but unfortunately
includes many factors difficult to document with statistical indicators. We evaluate the actual
policy strategy developed to tackle the EU’s growth challenge, namely the Lisbon strategy.
More particularly we examine the choice of policy priorities and structural reforms for
tackling the deficiencies in the innovative capacity. In addition, we analyse the set of
indicators chosen to evaluate progress.      Are these the right indicators for informing
improvement in innovative capacity? What are the interactions and complementarities
between the various reforms and indicators? We also consider the need to monitor and
evaluate the indicators – and whether this should be done at aggregate or sectoral levels, at
EU, national or regional level.


2. ASSESSING THE PROBLEM: THE EU’S RELATIVE PRODUCTIVITY PERFORMANCE

Enhancing productivity growth is fundamental to realising the Lisbon ambition of making
Europe the most competitive, knowledge based, economy in the world by 2010. It is also
fundamental to sustain and possibly increase future living standards in a context of an ageing
population, an accelerating pace of technological change and continued globalisation. Yet,
productivity growth is the result of the interplay of a host of factors. Policy makers can only
influence some of them and often only in an indirect way. The present section focuses on the
nature and source of the deterioration in the EU’s productivity growth performance relative to
that in the US since the mid-1990’s. It will serve the discussion in later sections on the policy
approach to be adopted in order to remedy this situation. More particularly, this section will
address the following questions:

   o Firstly, in explaining recent EU-US divergences in productivity trends, to what extent
     is the EU’s relatively poor performance linked with its particular industrial structure
     and its difficulty in re-orientating its economy towards the newer, higher productivity,
     growth sectors such as ICT ?


                                               2
   o Secondly, what is the contribution of ICT towards explaining the productivity trends,
     not only as a high-tech, high-productivity-growth sector, but also in its role as a
     General Purpose Technology increasing the productivity growth in other sectors?

   o Thirdly, the analysis focuses on the specific role to be played by the production and
     absorption of new technologies in any overall strategy.


2.1. An industry level breakdown of labour productivity trends : Where are the EU’s
      problems coming from ?

Graph 1 zeros in on the sectoral productivity growth structure of the EU and US economies :

      The EU has been doing reasonably well compared with the US in a wide range of
       manufacturing and service industries over the second half of the 1990’s. However the
       problem for the EU is that most of these industries, not being the high-growth sectors,
       are not making big contributions to overall productivity growth or do not have a large
       enough share of EU output to alter the EU’s overall productivity performance. In
       addition, for most of these industries not only are productivity growth rates low but
       they have been declining over the course of the 1990’s.
      Regarding manufacturing, two sectors dominate the overall productivity patterns,
       namely semiconductors and office machinery. These are the two industries where the
       US is clearly ahead, with semiconductors contributing 5 times more to US
       productivity growth compared to the equivalent gains for the EU and with office
       machinery contributing more than twice as much.
      The US is dominant in the private services industries category. Of the service
       industries which individually contributed significantly to overall productivity growth,
       the US is dominant in the financial services area, and wholesale and retail trade. Only,
       in communications, the EU holds the advantage.
      For the EU, the productivity improvements which have been achieved in a number of
       the network industries took place when liberalisation efforts were most evident. The
       size of these industries is, however, not large enough to alter the overall EU picture in
       any significant way.
      Finally, regarding the primary industries and public services, the striking feature is the
       vastly different performance of the EU and the US in health, education and social
       services where the US experienced large negative contributions compared with a
       positive / broadly unchanged position for the EU. Obviously, measurement problems
       could blur the picture here.

Graph 1 : Contributions of the 56 Industries to Overall Labour Productivity Growth in the US +
                  EU15 (1996-2000) (Source: ECFIN (2004), Annual Review)




                                               3
                                        -0.2%
                                                -0.1%
                                                        0.0%
                                                               0.1%
                                                                      0.2%
                                                                             0.3%
                                                                                    0.4%
                                                                                                              0.5%
                                                                                                                     0.6%

                      Semiconductors
                     Office Machinery
                                Clothing
                              Chemicals
                     Rubber & Plastics
                                 Textiles
                        Motor Vehicles
                               Furniture
                           Basic Metals
                      Air & Spacecraft
                           Pulp & Paper
                         Metal Products
                            Instruments
                    Railroad Equipment
                         Insulated Wire
                         Ships & Boats
                                 Leather
                                                                                           Manufacturing




                   Telecom Equipment
                      Mineral Products
                     Oil & Nuclear Fuel
                  Printing & Publishing
                          Radio and TV
             Wood & Wood Products




    USA
                  Electrical Machinery
              Mechanical Engineering
                 Scientific Instruments
             Food, Drinks & Tobacco
                      Wholesale Trade




4
                            Retail Trade
                 Real Estate Activities
              Aux.Financial Services
                    Financial Services
                      Communications
                 Renting of Machinery
                          Air Transport
                Insurance & Pensions
    EU15




             Aux.Transport Activities
            Research & Development
                        Land Transport
                      Water Transport
                   Legal & Advertising
                                                                                           Private Services




                   Computer Services
              Electricity, Gas & Water
            Other Business Activities
               Motor Sales & Repairs
                           Construction
                 Hotels & Restaurants
                             Agriculture
             Public Admin & Defence
                                  Fishing
                               Forestry
                    Mining & Quarrying
           Social & Personal Services
                                                                                        Rest of
                                                                                       Economy




                 Health & Social Work
                              Education
2.2. The contribution of ICT to EU-US growth differentials

One of the most popular explanations for the diverging productivity fortunes of the EU and
the US has been the relative exposure of both areas to ICT.

As section 2.1 has demonstrated, a primary source of US productivity acceleration in the
1990s has been the increasing share of ICT production in the US, combined with
extraordinary gains in productivity. However, given the General Purpose Technology
characteristics of ICT, one should also see productivity gains from using that technology,
further sustaining the ICT effect on aggregate productivity. In fact, both the ICT producing
manufacturing and intensive ICT-using private services categories are causing the 1996-2000
divergences in EU-US productivity growth rates. It is precisely in these two areas of the
economy where the EU fares most poorly relative to the US either in terms of the size of the
respective industries (i.e. small shares of overall EU output) or having relatively low
productivity growth rates.

       Table 1 : Breakdown into ICT categories (ICT producing + Intensive ICT-Using)
                 Hourly Labour Productivity        Value Added Share         Contribution to Total Change
                   (Average % Change)                                       in Hourly Labour Productivity
                1991-1995       1996-2000       1991-1995     1996-2000    1991-1995        1996-2000
                              1(a) ICT-Producing Manufacturing Industries
EU                 (9.6)           (17.1)          0.02          0.01        (0.2)              (0.2)
US                (16.4)           (26.0)          0.03          0.03        (0.4)              (0.7)
                           1(b) Intensive ICT-Using Manufacturing Industries
EU                (2.6)             (2.0)          0.07          0.06        (0.2)              (0.1)
US                (-0.6)            (1.4)          0.06          0.05        (0.0)              (0.1)
                                  2(a) ICT-Producing Service Industries
EU                 (4.8)            (6.8)          0.03          0.03        (0.2)              (0.2)
US                 (2.4)            (0.8)          0.03          0.04        (0.1)              (0.0)
                               2(b) Intensive ICT-Using Service Industries
EU                 (1.8)            (2.1)          0.20          0.21        (0.4)              (0.4)
US                 (1.6)            (5.3)          0.23          0.25        (0.4)              (1.3)
SOURCE : ECFIN, ANNUAL REVIEW 2004.



Beyond the diffusion of ICT in the narrow sense (ICT capital deepening), the EU has not been
able to reap the same benefits as the US in terms of TFP gains in the ICT using sectors (ICT
diffusion in the broader sense). It must be emphasised that the most important gains occur in
a narrow segment of the economy and here especially in service sectors (RT, WT, FS) where
productivity is difficult to measure. 1In ICT using manufacturing, the relative TFP gains in the
US are much smaller.

The fact that TFP accelerations in ICT using service industries are not observed in the EU
could be –beyond measurement issues- either due to adjustment costs (EU is in an earlier
stage of the transition) or it could be the result of institutional constraints in specific industries
(e.g. land use regulations in wholesale and retail trade, less entry of new establishments)


1 There is still a controversy on the size of the contribution coming from ICT using industries, with Gordon
remaining sceptical whilst Stiroh / van Ark are more optimistic. Attempts to disentangle production and
investment effects using different methodologies, different levels of aggregation and different datasets arrive at
rather different results.



                                                        5
which prevents firms to reap the full benefits of the new technology in EU countries. It is
important to keep in mind, however, in terms of the ongoing acceleration in ICT usage (or
diffusion of ICT in a narrow sense in both WT and RT i.e. the actual purchases of ICT
investment goods and services by these industries), there is no big difference between the EU
and the US. It is the TFP gains in these two industries where the more important difference
appears to be located (ECFIN, Annual Review 2004)).


2.3. The importance of knowledge production and diffusion
The analysis of the contribution to overall productivity growth from ICT production /
ICT use in the previous section, has indicated a more general theme, namely the
importance to the EU’s future productivity performance of an ongoing process of
industrial restructuring aimed at boosting the production and absorption of new, more
knowledge based, technologies.

An important question to examine is the extent to which the example of ICT is an isolated
case or is likely to be replicated in other high-growth, high-tech industries. If this is a
credible risk then the key question is whether the EU has specific problems in relation to its
innovation infrastructure (in terms of the resources devoted, rates of return, industry focus)
and whether the US has specific features / framework conditions which make it more likely to
be the locus for the future breakthroughs in technology. 2The wider issue is why is it that the
US seems to be better in creating and exploiting new (general purpose) technologies in
general ? This requires broadening the discussion beyond ICT to consider why the US seems
to have a better innovation capacity than the EU.

In overall terms when one assesses the evidence in relation to the manufacturing sector, it is
fair to conclude that the overall R&D infrastructure of the US seems to dominate that of the
EU’s. Not only does the US display a higher R&D intensity overall, it also has a larger
weight of is production concentrated in R&D intensive sectors and it realizes a better growth
performance in R&D sectors. Hence, differences in innovative capacity are a prime candidate
to explain the EU-US differences in productivity growth performances, particularly in high-
tech manufacturing industries

      Table 2 : Comparison of EU-US differences in R&D spending and Productivity Growth
                                           (US=1)

                                                                  EU-US Gap in VA                   EU-US Gap in
                                  EU-US Gap in R&D                 (Specialization)            Productivity Growth Rates
                                      Spending


                               1991-1995 1996-1999 1991-1995                  1996-2000       1991-1995       1996-2000




2   This is a pertinent question if one accepts the contention of Gordon (2004), amongst others, that the US’s lead
      in ICT is not an isolated case. The US holds a comparative or absolute advantage also in other general
      purpose technologies, like its initial leadership in the electricity industry and in its exploitation of the
      internal combustion engine (Gordon 2004)).



                                                         6
    Total High              0.686         0.621        0.825          0.826         0.48            0.41
    Technology
   Manufacturing


         (ICT)              0.552         0.411         0.45          0.42          0.23            0.27

      (Non-ICT)             0.783         0.813         0.98          1.01          1.15            2.81

                             (Source: DG ECFIN, 2004 Annual Review)



Within high-technology industries, we have to make a distinction between ICT and non-ICT
high-tech sectors. As discussed in section 2, the US is more specialized in ICT industries as
compared to other high-tech sectors and it has a higher productivity growth in these sectors.
This higher productivity growth can be related to a higher spending in total on R&D; and
getting a higher leverage out of its R&D investments. For non-ICT high-tech sectors, the
picture is less devastating for the EU, particularly in the second part of the nineties. There is
no difference in specialization in these industries, nor a productivity disadvantage. The gap in
total expenditures on R&D is also smaller than in total. Unfortunately, these sectors, often
being only medium to high-tech, have far less scope for productivity growth than the ICT
industries.

The main conclusion is that while there are examples of good performance, in particular
sectors and particular Member States, overall the EU innovation environment remains weak
in a number of key ‘input’ indicators; But in addition to much larger investments in R&D
both by the public and the private sector (i.e. the basic innovation infrastructure), there are
also other characteristics of the US innovation system which explain its ability to focus on the
high productivity growth areas and to gain a higher rate of return from its knowledge
investments. What are these factors that determine an economy’s “national innovation
capacity” defined as the ability of a nation to not only produce new ideas but also to
commercialize a flow of innovative technologies over the longer term?


3. WHAT DETERMINES A NATION’S INNOVATION CAPACITY?

Since Solow’s (1956) model of economic growth, an increasing emphasis has been placed on
technical progress as a means for raising growth. However, already Solow stressed that far
more needed to be known about the incentives that affect technology and technical change,
and how it varied across time and between countries. Subsequent models have attempted to
examine these influences through endogenizing technical progress (eg Aghion and Howitt
(1992); Grossman and Helpman (1991); Jones (1995)). R&D can affect TFP growth since it
produces innovations from which the expected flow of future profits creates an incentive for
innovators to undertake further R&D activity. What these later models share in common is
the mutually reinforcing relationship between the quantity of resources devoted to creating
new ideas, say skilled researchers (Romer 1990), and the existing R&D ‘stock’ of ideas from
which the researchers can draw upon to further their research work. In order to increase the
‘supply’ of ideas, strengthening the research base either in the public or private sector is
therefore an important task for policy.




                                                  7
But beyond the research inputs from the public and the private sector, the capacity to link
private and public knowledge creators as well as linking the creators and users of knowledge
is important to improve the diffusion of know-how. The premise that the performance of an
economy in terms of innovation and productivity is not only the result of public and private
investments in tangibles and intangibles by individual elements in the system, but is also
strongly influenced by the character and intensity of the interactions between the elements of
the system, is strongly advocated in the literature on “National Innovation Systems”
(Freeman 1987; Lundvall 1992; Nelson 1993). In this view, innovation and technological
development depend increasingly on the ability to utilise new knowledge produced elsewhere
and to combine this with knowledge already available in the economy. The capacity to absorb
new knowledge, to transfer and diffuse knowledge, and the ability to learn by interaction are
crucial success factors in innovation which David & Foray (1995) a.o. term the "knowledge
distribution power" of the innovation system.
Using the insights from macro, micro and systems models, applied economic theorists (e.g.,
Furman, Porter & Stern 2002) have synthesized what determines an economy’s “national
innovation capacity” defined as the ability of a nation to not only produce new ideas, but also
to commercialize a flow of innovative technologies over the longer term (see Box 1). From
this perspective a range of factors are deemed to be important for effective innovation effort.
A sufficiently developed ‘supply’ side of R&D (as reflected in the amount of R&D carried
out or the number of skilled researchers) is a necessary but insufficient condition for
successful innovation. Broader framework conditions are important as well, including a
sufficient ‘demand’ for innovation to reward successful innovators.              This requires
sophisticated lead users willing to pay for innovations, effective intellectual property rights
(IPR) schemes, a favourable macro-economic environment and effective competition in
output markets, and especially market entry and exit processes. 3

But perhaps the most critical element in the framework is the interconnectedness of the agents
in the system, linking the common innovation infrastructure to specific technology clusters.
Through networking among firms, researchers and governments, the supply of new ideas
diffuses through the economy. This requires a.o. good industry-science links and well
functioning capital and labour markets, such that the human and financial capital inputs get
allocated to their most efficient applications.

               Box 1: National Innovation Capacity: An integrative framework

        Common Innovation Infrastructure: cross-cutting institutions, resources and policies
           o Existing Stock of Technological Know-how
           o Supporting Basic Research and Higher Education
           o Overall Science and Technology Policy


3 According to Baumol (2004), innovations in the US come from two distinct sources, firstly from the activities
of large firms and secondly from the efforts of independent inventors and their entrepreneurial partners. Baumol
asserts that the active presence of both groups enhances the overall innovation process since their activities are
complementary, with the independent inventors / entrepreneurs specialising in breakthrough innovations and
with the R&D departments of the larger firms enhancing these breakthroughs and adding to their overall
usefulness. Jovanovic & Rousseau (2003) link the ICT’s arrival as a GPT to higher firm entry and exit rates,
with the young, smaller firms doing better relative to old incumbent firms, indicating the importance of flexible
product markets for the diffusion of new technologies.




                                                        8
       Technology/Cluster Specific Conditions:
           o Technology specific know-how : specialized R&D personnel
           o Incentives for innovation : lead users, appropriation (IPR) and output market
               competition: (local) rivalry, openness
           o Presence of related/supporting industries (clusters)
       Quality of Links bt clusters & common factors
            Industry-Science Relationships
            Efficient labour & capital markets

Source: On the basis of Furman et al (2002)


In the National Innovation Capacity perspective, country differences with respect to
innovation and growth might reflect not just different endowments in terms of labour, capital
and the stock of knowledge, but also the varying degrees of the “knowledge distribution
power” or the efficiency of the innovation system. Overall, this perspective warns against
looking at statistical indicators individually to assess the performance of a National
Innovation Capacity. Rather, a systemic approach should be taken to understand the
relationships between STI and socio-economic development. The problem with this approach,
however, is to approximate empirically the institutional framework and the “knowledge
distribution power” of nations. What is available at present are only pieces of statistical
evidence showing the importance of interactions, such as the availability of venture-backed
financing, cooperation in R&D among firms and between science and industry, (international)
co-patenting, the number of researchers employed by business,… (see for example, Furman
et al. (2002), EPC (2002)).

These framework features, although more difficult to document with statistical indicators,
need however to be taken into account when we want to understand the relative overall
effectiveness of the US versus the EU innovative system, if not quantitatively, than at least
qualitatively. The EPC (2002), from combining fieldwork evidence and an analysis of
statistical indicators, concludes that ‘market pull conditions’ and knowledge networks are key
areas of EU weakness. The EU generates a great deal of knowledge in its universities and
research institutes and produces large numbers of skilled personnel. But often it does not
exploit this knowledge and expertise for social and economic needs (the ‘European paradox’).
The study shows that general framework conditions appear to be vital. Above all a highly
competitive environment is essential. Gordon (2004) identifies a better connectedness in the
US of science and industry with an openly competitive system of private and public
universities and government subsidies to universities through peer-reviewed research grants,
which result in a higher quality of the research base. Other important framework conditions
present in the US are the advantage of a large, unified market unencumbered by differences in
language, customs and standards; a clearer and stronger US Intellectual Property Rights
system; more flexible financial markets, making available venture capital finance to
innovating firms; and more flexible labour markets, affecting both internal migration and the
international immigration of highly skilled people.

The overarching policy implication from all this is a call for improving the framework
conditions, requiring a ‘systemic’ approach. This means not only having the right competition
rules in place, but creating an environment in which smaller more nimble firms are able to
grow extremely quickly and challenge less innovative incumbents to improve their
performance. In addition, countries need to ensure that there are healthy fiscal and regulatory


                                              9
environments that promote innovation, a political environment which is encouraging of
enterprise and scientific education, well-functioning capital markets, a well defined public-
sector/private-sector interface, and an excellent education and scientific infrastructure. This
requires unprecedented levels of cooperation among policy makers, both in terms of action at
the EU level, and sharing good practice and understanding at the national level. It requires
developing an EU innovation system where knowledge flows connect and network all
member states.




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4. THE POLICY REACTION:    THE LISBON AGENDA: A “SYSTEMIC APPROACH” ?




At the European Council of March 2000 in Lisbon, the EU launched a ten-year long
comprehensive set of integrated structural reforms geared towards the general objective of
becoming “the most dynamic and competitive knowledge-based economy in the world
capable of sustainable economic growth with more and better jobs and greater social
cohesion” as well as “an increasing respect for the environment”. With the adoption of the
strategy of Lisbon as it became known, the European leaders acknowledged the need for
profound reforms in the EU in view of the challenges of ageing, enlargement and
globalisation. EU Heads of State and Government were well aware that such policy
endeavour could only be effectively undertaken by a concerted approach involving all
Member States and involving many policy areas.

The scope of the Lisbon strategy has been wide from the outset, not only in terms of
objectives (sustainable economic growth, more and better jobs, greater social cohesion,
environment), but also in terms of the policy tools to be used. The Lisbon European Council
conclusions make reference to the need to apply an appropriate macro-economic policy mix,
to modernise the European social model, to invest in people and combat social exclusion; to
improve R&D and ICT policies, to stimulate competitiveness and innovation, and to
complete the Internal Market.

The typology of Lisbon reforms and objectives in Scheme 1 permits to better appreciate the
scope of the Lisbon strategy and to assess the economic consequences of reforms undertaken
(Source: EC-ECFIN (2005)). The Lisbon reforms have been classified into five categories:
product and capital market reforms; investments in the knowledge-based economy; labour
market reforms; social policy reforms; and environmental reforms. The Lisbon objectives are
classified in five categories as well: greater competitiveness; creation of a dynamic
knowledge-based economy; increased employment; better jobs and greater social cohesion;
and environmental sustainability.




                                            11
Scheme 1: Typology to Lisbon reforms

Macroeconomic framework conditions                                                                  LISBON REFORMS

 Product and capital market            Investments in knowledge-         Labour market reforms               Social policy reforms         Environmental policy reforms
          reforms                            based economy

1.   Improve the functioning of   1.     Invest in education and    1.     Improve incentives to        1.   Modernisation of social       1.   Improve understanding of
     the Internal Market for             training                          participate and remain in         protection systems                 environmental problems
     goods and services                                                    the labour market

2.   Improve the business         2.     Invest in R&D and          2.     Improve matching             2.   Improve working               2.   Increase use of cost-benefit
     environment                         innovation                        between human resources           conditions and skill levels        analysis
                                                                           and vacancies

3.   Promote EU financial         3.     Encourage production and   3.     Increase labour market                                          3.   Increase use of market-
     integration                         use of ICT                        flexibility                                                          based instruments

                                                                                    
Increased competition and         Increased innovative capacity     Improved use and allocation of      Reduction in the risk of social    Less costly, more effective
efficiency                                                          human resources                     exclusion and creation of better   environmental policies
                                                                                                        jobs

                                                                                    
       COMPETITIVENESS                      DYNAMIC KBE                       MORE JOBS                  BETTER JOBS AND GREATER           ENVIRONMENTAL
                                                                                                               SOCIAL COHESION             SUSTAINABILITY

                                         PRODUCTIVITY GROWTH AND EMPLOYMENT CREATION

                                                                          STANDARD OF LIVING

        Economic sustainability                                                                 LISBON OBJECTIVES




                                                                                   12
The classification of reforms and objectives in Scheme 1 suggests a number of economic
links between structural reforms and performance in terms of achieving the Lisbon
objectives. It clearly illustrates that the Lisbon strategy embodies the idea that to yield
maximum synergies from structural reforms, they are best implemented in a comprehensive
and co-ordinated way. As the previous sections have documented, tackling the deficiencies
in the innovative capacity, requires a systemic policy perspective. Investment and innovation
benefit from a more competitive and entrepreneurial environment, fostered by structural
reforms on product, capital and labour markets that improve the transfer of resources from
low-productivity to higher productivity use. Therefore, beyond stimulating the research
inputs from the public and the private sector, it is important that other structural reforms are
part of the Lisbon agenda. With well functioning product markets, firms will have incentives
to innovate and new firms, embodying new ideas can flow into the market. Furthermore,
new business opportunities can only be taken advantage of if appropriately educated and
skilled workers can be hired under the right conditions. This requires flexible labour markets
providing innovators access to researchers and skilled human capital. Similarly, well
functioning risk capital markets assure innovators access to financial capital to finance their
risky projects. Especially high-tech start-ups, often an important source of breakthrough
innovations, need open product markets with low entry barriers, access to capital, especially
early stage financing of high risk ventures, and they also need flexible labour markets, esp
researchers mobility between science and industry.



5. IMPLEMENTING THE STRATEGY: NEED FOR INDICATORS

One of the challenges to implement the Lisbon Strategy is to get the Member States involved.
Since the structural reforms touch upon sensitive areas of national competence, the EU
member states need to be incentivated to act on the reforms and to coordinate their policies.
This is implemented through the “open method of coordination” which involves inter alia:
         Agreements of targets with timetables
         Use of indicators and benchmarks
         Periodic evaluation of progress made.

The wide scope of the Lisbon strategy made it necessary to focus and identify a restricted well
defined set of targets and policy measures necessary to achieve the objectives, and at the same
time, a corresponding restricted set of indicators to monitor progress on the targets.

5.1. Defining the targets and policy measures

In the summer of 2004, the EPC4 attempted to compile a definitive list of targets and policy
measures of the Lisbon strategy under six areas: economic performance; employment;
education, innovation and research; economic reform; social cohesion; and
environment/sustainable development. With respect to research and innovation, a key
element of the Lisbon strategy has been to speed up the transition towards a knowledge-
driven economy under the umbrella of a European Knowledge Area (EKA). Action has been
shaped around a range of initiatives from e-Europe and the creation of a European Research

4  Economic Policy Committee (2004), “Mid-term review of the Lisbon strategy: Progress Report by the
Economic Policy Committee”, Annex B. The list presented by the EPC is largely based on information provided
in the Commission Staff Working Paper in support of the 2003 Spring Report.



                                                    13
Area to promoting innovation and establishing common objectives at EU level for national
education policies. For Innovation and Research, the following box summarizes the targets
and policy measures with respect to the EKA (see Annex I for the full list on all areas).


Research
 Network national and joint research programmes on a voluntary basis around freely chosen
  objectives
 Improve the environment for private research investment, R&D partnerships and high-technology
  start ups
 Develop an open method of co-ordination for national research policies
 Roll out a world class research communications infrastructure
 Remove obstacles to the mobility of researchers, attract and retain high-quality research talent in
  Europe
 Introduce a cost-effective Community Patent
 Harness new and frontier technologies, notably biotechnology and environmental technologies
  (Stockholm)
 Full implementation of the e-Europe Action Plan by 2005

Information Society
 All teachers to have training in digital skills by 2003
 Ensure access to widespread, world class communications infrastructure and ensure significant
   reduction in the cost of using the Internet (local loop unbundling)
 Create conditions for e-commerce to flourish
 Prevent info exclusion
 Stimulate e-Government
 Support take up of 3G mobile communications and introduction of Internet Protocol version 6

Education
 Achieve a substantial increase in per capita spending on human resources
 Promoting lifelong learning
 Adapt skills base better to needs of knowledge society
 Better recognition of qualifications
 Promote learning of EU languages and introduce a European dimension to education
 Promote school twinning via Internet


This has been translated into specific and measurable targets for the European Knowledge Area:

   Increase R&D spending with the aim of approaching 3% of GDP by 2010.
   The proportion financed by business should rise to two thirds of that total by 2010.
   100% of schools to be connected to the internet by 2002
   100% of teachers to have training in digital skills by 2003
   Internet penetration in households should reach 30% by 2002
   Basic governmental services should be 100% online by 2002

See Annex III for all major measurable targets of the Lisbon Strategy.

5.2 Indicators

(a) Structural Indicators



                                                   14
To monitor the progress on the targets of the Lisbon strategy, the Commission and the
Council agreed on a list of 14 structural indicators. Member States’ performances on these
indicators is continuously being assessed.

        GDP per capita
        Labour productivity per person employed
        Employment rate
        Employment rate of females
        Employment rate of older workers
        Educational attainment (20-24)
        R&D expenditures (% of GDP)
        Business Investment (as % of GDP)
        Comparative price levels
        At-risk-of poverty rate
        Long-term unemployment rate
        Dispersion of regional employment rates
        Greenhouse gas emissions
        Energy intensity of the economy
        Volume of transport.

For the European Knowledge Area, R&D expenditures as a % of GDP, with a target of 3% is the main
indicator. But beyond this main indicator there are other (secondary) structural indicators of the EKA
identified.

        Spending on human resources (public expenditure on education)
        GERD (Gross domestic expenditure on R&D)
        GERD (Gross domestic expenditure on R&D) by source of funds
        Level of Internet access – households /enterprises
        Science and technology graduates – total/females/males
        Patents – EPO/USPTO
        Venture capital investments – early stage/expansion & replacement *
        ICT expenditure – IT/Telecommunications expenditure *


(b) Innovation Indicators

Beyond the structural indicators which cover all Lisbon areas, the Lisbon European Council
also requested for the area of innovation and R&D, the development of the European
Innovation Scoreboard (EIS) by DG Enterprise5. It focuses on high-tech innovation and
provides indicators for tracking the EU’s progress towards the Lisbon goal. The 2003 EIS
contains 19 main indicators, selected to summarize the main drivers and outputs of
innovation. These indicators are divided into four groups: Human resources for innovation (5
indicators); the Creation of new knowledge (4 indicators); the Transmission and application
of knowledge (3 indicators); and Innovation finance, output and markets (7 indicators). The
EIS mainly uses Eurostat data, covering 32 countries. Six of the 19 indicators are drawn from
the EU Structural Indicators.
         1. Human resources

5 In addition, in the framework of enterprise and industrial policy, there is the complementary Enterprise Policy
Scoreboard. Several indicators in both scoreboards are identical,




                                                       15
       1.1 S&E graduates (‰ of 20 - 29 years age class)
       1.2 Population with tertiary education (% of 25 - 64 years age class)
       1.3 Participation in life-long learning (% of 25 - 64 years age class)
       1.4 Employment in medium-high and high-tech manufacturing (% of total workforce)
       1.5 Employment in high-tech services (% of total workforce)


       2. Knowledge creation
       2.1 Public R&D expenditures (GERD - BERD) (% of GDP)
       2.2 Business expenditures on R&D (BERD) (% of GDP)
       2.3.1 EPO high-tech patent applications (per million population)
       2.3.2 USPTO high-tech patent applications (per million population)
       2.4.1 EPO patent applications (per million population)
       2.4.2 USPTO patents granted (per million population)

       3. Transmission and application of knowledge
       3.1 SMEs innovating in-house (% of manufacturing SMEs and % of services SMEs)
       3.2 SMEs involved in innovation co-operation (% of manuf. and services SMEs)
       3.3 Innovation expenditures (% of all turnover in manufacturing and services)

       4. Innovation finance, output and markets
       4.1 Share of high-tech venture capital investment
       4.2 Share of early stage venture capital in GDP
       4.3.1 SMEs sales of 'new to market' products (% of all turnover in manufacturing and
       services SMEs)
       4.3.2 SME sales of 'new to the firm but not new to the market' products (% of all
       turnover in manufacturing and services SMEs)
       4.4 Internet access/use
       4.5 ICT expenditures (% of GDP)
       4.6 Share of manufacturing value-added in high-tech sectors
       4.7 Volatility-rates of SMEs (% of manufacturing and services SMEs)

(c) Research Indicators

The European Research Area initiative (ERA) aimed to create a single market for research,
achieving more coherence between research policies conducted throughout Europe, in order
to reinforce their overall impact. This necessitates a better knowledge of those policies and the
identification of good practices, as well as the establishment of collective learning processes
across Europe. To this aim, DG Research was entrusted with a mission to produce a set of
indicators and a methodology for benchmarking research policies in the Member States. A
set of 20 indicators was proposed to help monitor and report on progress towards the ERA.
Most of the indicators are already used in other Commission publications. Eight indicators
are also used in the European Innovation Scoreboard. (Source: DG RESEARCH, Investing
in research: an action plan for Europe).

Investment
        Share of gross domestic expenditures on R&D (GERD) in GDP
        GERD as a % of GDP by source of fund


                                               16
          Share of business enterprise expenditures on R&D (BERD) in GERD
          Share of BERD financed by government
          Share of SMEs in BERD financed by government
          R&D intensity (R&D expenditures as % of GDP) across industries in
           manufacturing
          R&D intensity (R&D expenditures as % of GDP) in some high-tech sectors

Human Resources
   Share of total tertiary education expenditure in GDP
   Share of researchers (RSEs) in population
   Share of R&D personnel in labour force by institutional sector
   R&D expenditures by RSE by institutional sector
   Number of yearly new S&T PhD in 25-34 population
   Breakdown of employed HRST according to native country

Innovation potential
    Number of patents with EPO and USPTO
    Number of High-Tech patents at EPO and USPTO per capita

Business Innovation
    Share of seed& start-up venture capital in GDP
    Share of seed& start-up in venture capital for all sectors and for high-tech sectors
    Expenditure on innovation in turnover of manufacturing industry
    SMEs innovating inhouse (% of manufacturing SMEs)
    Innovative co-operating SMES (% of manufacturing SMEs)

Competitiveness
   Technology Balance of Payments per capita
   High-tech products imports and exports per capita




                                              17
6. EVALUATING PERFORMANCE ON THE SELECTED INDICATORS

Presently at mid-term, the Lisbon strategy is under review (Kok report (2004)). It is clear that
the objectives are far from being achieved. Halfway to 2010 the overall picture is very mixed
and much needs to be done in order to prevent Lisbon from becoming a synonym for missed
objectives and failed promises. Annex III provides a mid-term assessment of the main
targets identified in the Lisbon strategy.

Over the last four years, the overall growth performance of the European economy has been
disappointing. In fact, after having peaked in the mid-1990’s at around 97% of US levels, EU
labour productivity per hour is projected to deteriorate to around 88% in 2005, which is close
to its relative level in the early 1980s. This post 1995 deterioration in relative productivity
levels reflects a sharp decline in EU productivity growth rates relative to those of the US over
the period in question. Net job creation largely slowed down considerably in recent years and
the risk is apparent that the 2010 target of 70 % employment rate will not be reached. The
same applies to the target of 50 % for older workers. However, despite disappointments
Lisbon is not a picture of unrelieved gloom. There has been significant progress in
employment between the mid-1990s and 2003. European governments have introduced
measures that cumulatively have attempted to remove obstacles to the employment of low-
paid workers, stepped up their active labour market polices, and permitted the growth of
temporary employment and employment by females and older workers (DG ECFIN (2005)).

One of the most disappointing aspects of the Lisbon strategy to date is however the
performance on R & D. On the R & D target, only two countries (Finland, Sweden) currently
have R & D spending exceeding 3 % of GDP; in these same two countries business is
achieving the goal of spending the equivalent of 2 % of GDP on R & D. The rest are behind
on both scores. Progress in providing every teacher with digital training is very disappointing.
On a positive note, Member States have progressed in the spread of ICT and Internet use in
schools, universities, administration and trade. Household Internet penetration, for example,
has risen rapidly, with 12 Member States meeting the targets.

The little progress that has been made on R&D is all the more remarkable taking into account
that the Lisbon European Council rightly recognised that Europe’s future economic
development would depend on its ability to create and grow high value, innovative and
research-based sectors. One of the preconditions for any increase in European productivity
growth is to increase R & D spending.

However, the knowledge society is a larger concept than just an increased commitment to
R&D expenditures. Further zooming in on innovation and R&D, Table 3 provides a look at a
selected combination of indicators from the Innovation Indicators discussed supra for the
EU15 relative to the US and Japan (see Annex IV for an assessment of all 2003 European
Innovation Indicators for all Member States).

As Table 3 indicates, Europe lags behind the US and Japan on several indicators. Although
S&T graduates show no gap, both Japan and the US have significantly more working
population with tertiary education. Both government-, but especially business- expenditures
on R&D are considerably lower within Europe. Moreover, growth rates differentials reveal a
similar trend, suggesting a further widening of this gap in the near future. Also with respect to




                                               18
invested venture capital, within Europe, the amounts of resources available (divided by GDP)
are clearly lower.

This difference in the level of S&T ‘inputs’ between the EU and the US is accompanied by
lower levels of technological output. Both the US and Japan outperform Europe in terms of
technological performance as measured by the number of patents per million inhabitants; this
‘gap’ being even more pronounced for high tech patents. Similarly, in terms of the share of
added value within manufacturing industries, especially the difference with the US is striking;
while high tech sectors account for about a quarter of (manufacturing) added value in the US,
in Europe this is only 14%.


                  Table 3 : Selection of Main EIS Indicators – A Triad Comparison

                                                               EU15          US            JPN
1. S&E Graduates                                               11.3          10.2
2. Work Pop with 3th Educ                                      21.5          37.2          33.8
3. Public R&D expenditures (GERD-BERD) (% of                   0.69          0.76          0.81
   GDP)
4. Business expenditures on R&D (%of GDP)                       1.30          2.04         2.28
5. Early stage venture capital in GDP                          0.037         0.218
1. EPO patent applications (per million population)            161.1         169.8         174.7
2. USPTO patent applications (per million population)           80.1         322.5         265.2
3. EPO high-tech patent application (per million                31.6          57.0          44.9
   population)
4. Share of high-tech sectors in manufacturing value            14.1         23.0          18.7
   added
5. ICT expenditures (%GDP)                                      7.0           8.2           9.0
Source: European Commission (2004), "2003 Innovation Scoreboard," Commission Staff Working Paper. EC,
Brussels.

Broadly speaking, a picture emerges from the indicators where the EU continues to lag behind
on the level of technological performance and related –technology intensive – economical
activity. All this confirms the analysis of the deficiency of the EU’s innovative and growth
capacity underlying the rationale for the Lisbon strategy, as discussed in sections 2 & 3.
Hence, the conclusion seems unescapable that Lisbon as yet has failed to deliver wrt
improving the EU’s innovative capacity.


7. CONCLUSIONS: EVALUATING THE POLICY PROCESS

7.1. Lisbon as a systemic approach?
At mid-term it is clear that the Lisbon strategy has not delivered what was expected,
particularly with respect to the knowledge economy. While the worldwide and particularly
European macroeconomic climate may have contributed to this situation, the slow pace of
policy reforms and of their implementation by the Member States has held back economic
growth.

Is the Lisbon strategy too ambitious? The answer of most mid-term reviewers is no, on the
contrary. Even if every target were to be hit on schedule, Europe would not be on safe



                                                  19
ground. Structural reforms are even more important with the challenges of globalisation,
ageing and enlargement.

Is Lisbon the wrong strategy? The economic literature on the impact of Lisbon-type reform
ranges wide and is not easy to summarise (see DGECFIN 2005). Nevertheless, a clear
impression emerges that Lisbon-type reforms have substantial positive economic effects and
are what is needed to get the EU growth performance on track again.

Is Lisbon too broad ? A broad agenda is necessary to exploit the existing complementarities
between reforms undertaken simultaneously in different domains. A ‘systemic’ approach
builds on complementarities among reforms: in order to reach maximum effectiveness
measures in one reform domain need to be accompanied by flanking measures in another
domain. Measures that increase the level of competition in product markets, for example,
often lead to economic restructuring implying job losses in some sectors and employment
creation in others. Well functioning labour markets and sufficient social support would tend to
facilitate such a transition. Similarly, a full exploitation of the potential benefits of EU
financial integration would require an efficient competition regime, increased transparency of
financial information and macro-stability. Hence, in view of the complementarities, Lisbon
should be broad, ie cover multiple policy areas.

Lisbon not only needs to cover multiple policy areas, Lisbon is also a strategy that is best
pursued collectively by all Member States if maximum benefits are to be reaped. In order to
ensure these benefits, Member States must take their responsibility and take ownership of the
process.

The problem is, however, that the Lisbon strategy has become too broad to be understood as
an interconnected truly ‘systemic’ endeavor. Lisbon is a collection of policy initiatives, rather
than a truly integrated view. A major deficiency of the Lisbon strategy is the governance of
the policy process, with a lack of peer pressure at the level of the Member States and poor
communication about the benefits to all actors involved.

This is why the mid-term reviewers have called for more focus (Kok report (2004)). For
Europe to increase its living standards, it needs to focus on employment and productivity
growth. But in line with the systemic approach, this needs to be done through a wide range of
reform policies as well as a wider macroeconomic framework as supportive as possible of
growth. No single action will deliver higher growth. Rather, a series of interconnected
initiatives and structural changes are needed. In line with a “systemic perspective”, the Kok
report calls for action across five areas of policy:
         • the knowledge society: increasing Europe’s attractiveness for researchers
         and scientists, making R & D a top priority and promoting the use of information and
         communication technologies (ICTs);
         • the internal market: completion of the internal market for the free movement of
         goods and capital, and urgent action to create a single market for services;
         • the business climate: reducing the total administrative burden; improving the
         quality of legislation; facilitating the rapid start-up of new enterprises; and creating an
         environment more supportive to businesses;
         • the labour market: rapid delivery on the recommendations of the European
         Employment Taskforce; developing strategies for lifelong leaning and active ageing;
         and underpinning partnerships for growth and employment;



                                                20
       • environmental sustainability: spreading eco-innovations and building leadership in
       eco-industry; pursuing policies which lead to long-term and sustained improvements
       in productivity through eco-efficiency.

This plan of action clearly carries as a priority for growth, progress on the knowledge
society;

At the same time, the mid-term reviewers have called for an improvement in the governance
of the Lisbon process. An ambitious and broad reform agenda needs a clear narrative, in
order to be able to communicate effectively about the need for it. So that everybody knows
why it is being done and can see the validity of the need to implement sometimes painful
reforms. The task is to convince Europe’s leaders and public intellectually of Lisbon’s case;


7.2. Evaluating the indicators and targets for improving the Innovative capacity

Are the set of indicators chosen to evaluate progress, the right indicators for informing
improvement towards the Lisbon objectives? The set of indicators -both the structural
indicators, and those specific for research and innovation- although being restricted by data
availability, clearly look like being inspired by the specific weaknesses of the EU innovative
capacity and the ‘systems’ approach towards improving this capacity.

Although R&D spending is a central structural indicator, it fits into a set of other structural
indicators allowing integration with labour, capital, and product market reforms. The targets
in other areas are key to improving the innovative capacity. For instance assessing the ease of
entry of new firms and their survival is important to have new ideas coming to market. For
this, targets like the Risk Capital Action Plan, lowering the cost of doing business, further
opening up of markets, are important to assess. But also targets like livelong learning, and the
reduction of barriers to labour mobility between Member States, will improve the human
capital resources necessary for implementing innovation strategies. Even sustainable
development targets, when directed towards green technology development, could be
developed into a EU strength.


Are we measuring the right indicators for informing improvements in innovative capacity?
The systemic view seems to have been underlying the selection of research & innovation
indicators. A key message from a systemic approach is that the effectiveness of innovation
systems depends on the balanced combination of creative capacity, diffusion capacity and
absorption capacity. It is well recognized that human and social capital are the necessary oil
in the system: in a knowledge-based economy, they represent the most important resource;
The structural indicators and Lisbon targets selected for the European Knowledge Area,
beyond R&D expenditures, reflect the importance of a highly educated labour force as central
in EU’s creative but also distributive capacity. It also reflects the specific importance of ICT
in the EU’s growth agenda as a General Purpose Technology and recognizes the importance
of financing for innovation.

The area of indicators that is least represented is Scientific Performance and Industry Science
Links. Especially the lack of Industry Science Link Indicators is disturbing since this is one
of the particular deficiencies of the EU innovative capacity (cf European Paradox). What we
are missing in the set of main indicators are those on Industry-Science Links, such as for



                                              21
instance, cooperation between firms and research institutes, co-patenting & co-publishing,
researcher mobility between industry and science, private research funding of basic research,
patenting by universities and public research institutes, spin-offs…This is partly due to a lack
of systematic data on this, but clearly more could be done here (Gault (2005)).

Another criticism is the highly aggregate level of the indicators. Underlying any aggregate
innovation indicator, is the structural make up of the economy, which differs greatly between
EU countries. Such structural differences can have an important role in explaining some of the
differences in innovation performance. The main reason is that there is a great deal of
diversity amongst industrial sectors in terms of innovation process, innovation inputs and
outputs. First, technological opportunities differ across sectors with ICT as a prime example
of the high growth sector with huge opportunities for technological advance. Another major
difference across sectors is the size of the innovating unit, which is typically large in certain
industries such as Chemicals, Motor vehicles, and Aircraft, and small in Machinery,
Instruments and Software. Moreover the objectives of innovation are different amongst
sectors. In Pharmaceuticals and Machinery sectors the main aim is to introduce product
innovations, in the Iron and Steel industry the major objective of innovative activity is to
come up with process innovations, and in the Motor vehicles industry both are important.
There is a great deal of diversity amongst the sources of innovation. In Agriculture and
Traditional Manufacturing industries (such as Textiles, Wood and Paper) suppliers are
important source of innovative ideas, in Instruments, Machinery and Software, users play this
role. In-house R&D laboratories are important in the Chemicals industry and many parts of
the Electronics industry. In Pharmaceuticals a major source of innovative ideas is basic
research. This implies that there will be major differences across sectors in many of the
indicators used in the EIS, for example those based on R&D, patenting, SMEs and innovation
expenditures. Since the systemic approach operates at the specific technology or sectoral
level, this implies that indicators should be traced at technology/sectoral level. The single
most important constraint is the lack of data at the sector level for some key variables.
Nevertheless, the main conclusion from an exploratory analysis of the EIS indicators at
sectoral level is that there is a great deal to be gained by analysing innovation performance
across sectors 6

Another area of over-aggregation is the geographical dimension. Regional level data are of
value for two reasons. First, innovation policies are often developed and implemented at the
regional level, in addition to national and EU level policies. Regional indicators can help
inform these policies. Second, many innovative activities are strongly localized into clusters
of innovative firms, sometimes in close co-operation with public institutions such as research
institutes and universities. The effective design and implementation of cluster policies
therefore depend on identifying both highly innovative regions and less innovative regions
that might have future potential. Some regions may need diffusion-oriented policies that focus
on the adoption rather than the creation of new technology, while others, with high-level



6 For the restricted set of indicators that are available at sectoral level, the results show that a country with a high
ranking in high technology industries is also likely to have a high ranking in medium-high, medium-low, and
low technology industries. Thus Finland is ranked 2nd amongst the EU countries in high technology and 1st in
medium-low technology industries. The countries that have above average performance in all four sectors are the
Netherlands, Finland, Sweden, Germany, and Belgium. The countries that lag behind most EU countries in all
four sectors are Greece, Spain and Portugal. France, UK, Ireland, Italy show heterogeneous performances across
the different industries. Source: DG Enterprise, 2003 European Innovation Scoreboard:Technical Paper No 4
Sectoral Innovation scoreboards.


                                                          22
knowledge creation activities, might be best served with policies focusing on spin-offs and
high-tech clusters creation. 7

Beyond the selection of indicators and the level at which they should be evaluated, there is
also the issue of the systemic approach to evaluating the indicators. Since multiple
dimensions need to be measured for innovation capacity, multiple indicators need to be
developed and assessed simultaneously. The recognition of the need to measure multiple
dimensions has led to an emerging call for composite indicators (Grupp & Magee (2004)).
Also the EU had advocated the use of composite indicators. The EIS 2003 for instance,
contains 2 such composite indicators as well as the 3% Action Plan. However the use and
implementation of composite indicators are currently merely seen as a way of summarizing
different indicators, rather than as reflecting the need for a systemic evaluation of indicators.
This is clear since mostly the weighing of indicators is statistical rather then guided by a clear
conceptual model.


7.3. Implications for STI policies?


Enhancing horizontal policy coordination: STI policies should not be designed in isolation
from each other (research policies, innovation and education policies) and in close interaction
with other policy areas (financial markets, labour markets, product markets, macro-economic
stability, environmental policies). Increasing the efficiency of STI policies implies improving
the policy arena in terms of co-ordination among various policy makers. Close co-operation
among decision-making instances or even integration should be explored to guide
prioritisation processes and to better exploit synergies.

Enhancing vertical policy coordination: The natural tendency for R&D resources to
concentrate geographically should be reflected in a regional policy design, but this should be
accompanied by coordination of policies among regional, national and international policy
makers. The Lisbon strategy and the ERA should not be thought of as a harmonization
process: innovative and productive structures’ differ across countries and regions. A
decentralized policy approach implies more possibilities of adaptation to local specific needs
in order to better align the various complementary local actors. Flexibility of policy measures
is needed at the various administrative levels, especially between national and regional levels.
Nevertheless, coordination among the various policy levels is important. Nation-based RTD
policy can be more effective if part of a European policy design. The progressive opening of
national programs, cross-fertilization measures and international mobilization of human
resources need to be promoted. The idea is to facilitate co-operation and to boost diffusion
and uptake of knowledge by increasing the efficiency of the resources used.


7 One of the expansions of the 2002 EIS was the development of a Regional Innovation Scoreboard (RIS). The
2002 RIS was limited to those indicators from the EIS for which regional data were available and to a static
comparison only. RIS uses regional data for 13 innovation indicators plus per capita GDP at the regional level
for the EU member states. The available regional innovation indicators provide good coverage of the innovation
categories Human resources (4 indicators), Knowledge creation (4 indicators) and Transmission and application
of knowledge (4 indicators). The coverage of Innovation finance, output and markets is limited to only one
indicator. Hence, due to data limitations, the regional indicators are better at identifying strong innovative
regions than regions with future potential, or regions that require diffusion-oriented policies.




                                                     23
Improving the management of the policy framework. Well-developed skills and
competencies are needed within the policy world itself. Inventiveness and creativity in policy
building will be enhanced if policy makers can access experiences of other countries,
provided these are presented in their context and evaluated properly. Benchmarking exercises
involving policy makers, should be conceived as “learning-by-interacting” exercises rather
than “diffusion of best practices”.
STI policies need to be supported by monitoring and evaluation (scientific, external)
practices, which then feed back into the policy process.
Involving stakeholders in policy-making is necessary. Policy design processes that are
inclusive (i.e. associate stakeholders to the decision-making process) are more suited to the
challenges of a systemic approach to the Lisbon strategy, because they take better into
account all the elements of the system and the relationships between them. This emphasizes
the importance of an appropriate governance system for policy.




                                             24
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                                            25
Annex I:        List of Lisbon targets and reforms
Economic Performance

The Lisbon strategy does not set particular targets for economic performance. However, a sound
economy is a precondition for achieving the objectives of the strategy. That is why particular emphasis
has been placed on the Stability and Growth Pact and on structural reforms intended to raise the
growth and employment potential of the Union.

The Lisbon approach implies:
 That if the Lisbon measures are implemented against a sound macroeconomic background an
  average growth rate of around 3% per year should be a realistic prospect
 Member States’ budgets close to balance or in surplus over the medium term, ensuring the long-
  term sustainability of public finances
 Redirecting public expenditure towards increasing the relative importance of capital accumulation
  (physical and human) and supporting R&D, innovation and IT


Employment (more and better jobs)

Lisbon has set an overall target of bringing the Union back towards full employment. This means for
the Union:
 An overall employment rate of 70% in 2010 (67% in 2005)
 A female employment rate of 60% in 2010 (57% in 2005)
 An employment rate for older workers (55-64) in 2010 of 50%
 An increase by 2010 of five years in the average age at which people stop working
 Availability of childcare by 2010 for 90% of children (3 years+) and 33% of under 3s

As well as action at EU level to:
 Remove barriers to mobility between and within Member States (e.g. recognition of qualifications,
   pension portability, better provision of information, etc.)
 Improve quality in work, in particular the working environment and health and safety

For Member States:
 Reduction of tax burden on low-wage earners
 Make work pay within tax and benefit systems
 National labour institutions and collective bargaining to take account of relationship between wage
   developments and labour market conditions in order to bring wage developments in line with
   productivity
 Review employment contract regulations in order to strike a proper balance between flexibility and
   security
 Remove disincentives for female participation in workforce, promote active ageing and reduce
   early retirement incentives for individuals and companies
 Reduce the informal economy




                                                  26
Education, Innovation and Research (European Knowledge Area)

Under the umbrella of a European knowledge area, a key element of the Lisbon strategy has been to
speed up the transition towards a knowledge-driven economy. Action has been shaped around a range
of initiatives from e-Europe and the creation of a European Research Area to promoting innovation
and establishing common objectives at EU level for national education policies. This has been
translated into targets such as:
 Increase R&D spending with the aim of approaching 3% of GDP by 2010. The proportion financed
   by business should rise to two thirds of that total (target set at Barcelona)
 100% of schools to be connected to the internet by 2002 (target set at Lisbon)

Research
 Network national and joint research programmes on a voluntary basis around freely chosen
  objectives
 Improve the environment for private research investment, R&D partnerships and high-technology
  start ups
 Develop an open method of co-ordination for national research policies
 Roll out a world class research communications infrastructure
 Remove obstacles to the mobility of researchers, attract and retain high-quality research talent in
  Europe
 Introduce a cost-effective Community Patent
 Harness new and frontier technologies, notably biotechnology and environmental technologies
  (Stockholm)
 Full implementation of the e-Europe Action Plan by 2005

Information Society
 All teachers to have training in digital skills by 2003
 Ensure access to widespread, world class communications infrastructure and ensure significant
   reduction in the cost of using the Internet (local loop unbundling)
 Create conditions for e-commerce to flourish
 Prevent info exclusion
 Stimulate e-Government
 Support take up of 3G mobile communications and introduction of Internet Protocol version 6

Education
 Achieve a substantial increase in per capita spending on human resources
 Promoting lifelong learning
 Adapt skills base better to needs of knowledge society
 Better recognition of qualifications
 Promote learning of EU languages and introduce a European dimension to education
 Promote school twinning via Internet




                                                 27
Economic Reform

The Lisbon strategy has identified a wide range of structural economic reforms, often translated into
requests for the adoption of specific legislative proposals by a given deadline. The following specific
targets have been set:
 Ensure full implementation of the Risk Capital Action Plan by 2003 and the Financial Services
   Action Plan by 2005 (target set at Lisbon)
 Increase the percentage of Internal Market directives transposed into national law to 98.5% (target
   set at Stockholm)
 Increase the percentage of Internal Market directives, which are more than two years overdue,
   transposed into national law to 100% (target set at Barcelona)
 Ensure the opening of energy markets for business customers in 2004 and subsequently for
   domestic users (target set at Barcelona)
 Ensure cross-border energy transmission capacity equivalent to at least 10% of installed production
   capacity by 2005 (target set at Barcelona)
 Achieve a single European sky by 2004 (target set at Barcelona)

In addition, the Lisbon strategy calls for economic reforms to:
 Increase the supply of venture capital (including via EIB/EIF support)
 Further opening of market for postal services, railway and port services, and agreement on rules for
   public service contracts in transport
 Increase the openness of public procurement
 Complete the internal market for services
 Lower the costs of doing business and reduce red tape
 Introduce an improved impact assessment system for Community proposals
 Continue downward trend in state aid as a percentage of GDP and redirect aid towards horizontal
   objectives
 Promote a competitive business environment by eliminating harmful tax competition for businesses
 Promote quality public services

Social Cohesion (Social Policy Agenda)

The approach to improving cohesion, particularly social cohesion, is strongly focused on
implementing the European Social Policy Agenda launched in Nice, but it also recognises the
importance of basic education and training as a stepping stone to the labour markets. Targets for the
Union include:
 Halving by 2010 the number of early school leavers who do not continue with further education
 Efforts to reduce by 2010 the numbers of people living at risk of poverty by setting appropriate
  national targets in the 2003 National Action Plans
 Stimulating the take up of lifelong learning

In addition, other policies should contribute to:
 Strengthening equal opportunities for the disabled,
 Promoting gender equality, a good working environment and involve of the social partners in
   managing change
 Promote corporate social responsibility
 Adapting pension and healthcare / long-term care systems to an ageing population with twin
   objectives of ensuring quality and financial sustainability




                                                  28
Environment/Sustainable Development

The Göteborg European Council agreed on a sustainable development strategy that underpins the
whole of the Lisbon strategy and adds to it an environmental strand. Importance is attached to how
decisions are taken and prepared, and to “getting prices right” in order to provide consumers and
producers with better incentives to make the right choices for their activities. Four specific priorities
were identified in Göteborg which translate in targets such as:
Climate change
 Reduction in greenhouse gas emissions (i.e. Kyoto targets) with visible progress by 2005
 Progress towards an indicative target for 2010 of 22% for electricity generated from renewable
   sources
 Set national indicative targets consistent with the reference value of 5.75% for the use of bio-fuels
   by 2010 for transport purposes
Sustainable transport
 Decoupling GDP and transport growth, in particular by a shift from road to other modes of
   transport
 Tackling rising traffic volumes and congestion, noise and pollution
 Encourage use of environmentally friendly transport (shift from road) and give priority to investing
   in environmentally friendly infrastructure
Public health
 Respond to citizen’s concerns about safety and quality of food, use of chemicals, infectious
   diseases and antibiotic resistance
Resource management
 Decoupling resource use and generation of waste from growth




                                                   29
Annex III: The main Lisbon targets (Oct. 2004)
Progress of Member States on the MeasurableTargets of the Lisbon Strategy 1

                                                                                              EU-15:                EU-25:
                                                            Target     Reference    EU 15                 EU 25
       Lisbon Strategy                    Target                                              target                target
                                                             year       year 2     average               average
                                                                                             achieved              achieved
        Employment
   Overall employment rate                 67%               2005        2003      64.4%        7        62.90%        8
   Overall employment rate                 70%               2010        2003      64.40%       4        62.90%        4
   Female employment rate                  57%               2005        2003      56.00%       9        55.10%       14
   Female employment rate                  60%               2010        2003      56.00%       7        55.10%        8
Employment rate for workers
                                           50%               2010        2003      41.70%       4        40.20%        6
       aged 55-64

 Increase in average effective       by 5 years to EU
                                                             2010      2001-2002    60.8        0         60.4         0
        retirement age                  average 65

 Available childcare for pre-
                                           90%               2010        2004      81.30%       4         n.a.       n.a.
 school children over three
    Available childcare for
                                           33%               2010        2004      24.50%       2         n.a.       n.a.
     children under three
   Research, Innovation,
  Information and Society
     R&D spending/GDP                      3%                2010        2003      1.99%        2        1.93%         2
Business participation in R&D
                                            2/3              2010        2003      55.90%       3         n.a.         3
          spending
   All schools with internet
                                          100%               2002        2002      93.00%       1         n.a.       n.a.
          connection
All teachers to have training in
                                          100%               2003        2002      56.80%       0         n.a.       n.a.
         digital skills
    Internet penetration in
                                           30%               2002        2004      40.00%      11         n.a.        11
          households
 eGovernment: basic services
                                          100%               2002        2002      56.80%       0         n.a.       n.a.
          online
     Economic Reform
Transposition rate of internal
                                         98.50%              2002        2004      97.80%       5        92.90%      n.a.
     market directives

     2 years time limit for
   transposition of internal           0 directives          2002        2004       n.a.        4         n.a.       n.a.
       market directives

 Open electricity markets for
                                          100%               2004        2003      75.90%       7        59.40%        7
    business customers
Open gas markets for business
                                          100%               2004        2003      82.30%       6        63.30%        6
         customers

     Cross-border energy
transmission capacity relative
                                           10%               2005        2003       n.a.       11         n.a.        19
    to installed production
            capacity

       Social Cohesion
 Reduce the number of early
                                         by 50%              2010      2000-2003   -6.70%       0         n.a.       n.a.
      school-leavers
 Environment/Sustainable
      Development

                                                                                             3 respect             10 respect
 Visible progress at reducing      Reach EU average of                   2002,
                                                           2008-2012               97.10%    national     n.a.      national
  greenhouse gas emissions         92% of the 1990 level               1990=100
                                                                                              targets                targets




                                                               30
  Contribution of electricity
                                 Reach EU-15 average                                              0 respect            0 respect
  produced from renewable
                                  of 22% and EU-25           2010          2002          13.60%   national    12.70%   national
   energy sources to gross
                                   average of 21%                                                  targets              targets
   electricity consumption


n.a.= not available
1- October 2004 data
2-if data not available for reference year, earlier data has been taken for some Member States




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