Are we being stupid? – Part 2: Strategic Foresight

In part 1 we have established that growth in the West relies on innovation and technology much more than growth in developing countries. We are the ones at the technology frontier, so if we want to grow, we need to be more innovative. In this blog I’ll mainly cover government policies regarding R&D and higher education, focusing a lot on expenditure (1). If you’re interested in broader measures, you could start here, with the Innovation Union Scoreboard 2014.

For those of you who like the big numbers, let me introduce you to GERD. GERD is the Gross Domestic Expenditure on R&D, which includes expenditure by business enterprises, governments and foreigners. In 2010 GERD stood at 245 673 million in absolute terms in the EU-27. Given that this does not really tell us much, GERD is normally calculated relative to GDP. Between 2000 and 2010 the ratio has roughly been flat at around 1.80-2% of GDP. This means that internationally the EU-27 figures are below those in other countries: Japan (3.45%), US (2.80%).2 There are also substantial differences within the EU. The highest expenditures in 2010 were reported from (how could it be different) Finland (3.87 %), Sweden (3.42 %) and Denmark (3.06 %).

The main reason for these differences within and outside of the EU are not the government’s R&D or higher education expenditure, but the differences in the innovative activities of the business sector. In the EU R&D expenditure within the business sector was 1.23% of GDP, while it was 2.70% in Japan and 2% in the US.(2) Put differently, in the EU (in 2009) the division of R&D expenditure between businesses/ governments/ foreigners was 55%/35%/10% while in Japan and the US businesses accounted for 80% and 70%, respectively. Within Europe, the Scandinavian countries but also Austria and Germany, have higher business expenditures than other European countries. In Bulgaria, Poland, Romania, Slovakia, for instance, the majority of the funding came from the government (Source: Eurostat )

So, it seems that the big numbers suggest that right now where Europe lags behind is R&D expenditure undertaken by businesses and not government expenditure. Ultimately, though, the fact that Europe lags behind is still on the European governments as they are responsible for creating an environment which provides the incentives for businesses to invest and innovate. Part of this environment is to ensure that we have the skilled employees and research and technology innovative businesses look for. In addition, a comparison of current data tells us very little about where we are headed in the long-run. What does a more qualitative approach tell us about R&D and the business environment in Europe?

As pointed out in a recent financial times article, just nine out of the world’s top 100 high tech companies have their headquarters in Europe. If Europe loses the most innovative companies, knowledge and technology clusters suffer and these are one of the main engines for innovation and growth. A report suggests a variety of reasons for why the Europe is falling behind: a shortage of skilled engineers, fragmented markets and a lack of strategic foresight.“ Similarly, a report of the European Commission states that we are underinvesting in knowledge. It advocates the idea of an „Innovation Union“ and, here it comes, point 1 on the agenda is:

In times of fiscal constraints, the EU and Member States need to continue to invest in education, R&D, innovation and ICTs. Such investments should where possible not only be protected from budget cuts, but should be stepped up.“

However, has anybody pitched that to governments? Because right now it looks like the European Commission is the one organization that cares. The EU member states seem to be doing… whatever. In 2010, in the aftermath of the financial crisis, the UK government’s proposal to heavily cut funding for sciences received a strong reaction from the science community. In the end, the cuts were postponed, but in real terms, the science budget is still shrinking  and cuts are still looming with every new budget discussion. In Austria we are all only too familiar with the regular bickering about university funding  and the most recent culmination of political idiocy: the fusion of the ministry for science with the ministry for economics.  How very surprising that one of the three departments with the main cuts in the subsequent budget had to be made in the RESORT science in the eonomics department (funnily enough, the second affected department was infrastructure, which is also an essential factor for growth and development).

I am sure, those of you who are familiar with other European countries will find similar trends in many other countries. I’m not saying that no European government is doing its job right. Both GERD and the Innovation Scoreboard highlight that there are strong differences within Europe with Scandinavia and the German speaking countries leading most rankings. But, overall, when I look into the media, I feel like the majority of European governments are taking the Commission’s Horizon 2020 project not as seriously as they should. To hear what I think good policies with “strategic foresight” look like, you’ll have to wait until the last blog of this series.


1Yes, expenditure does not necessarily translate into outcomes. Nevertheless I think in many cases funding cuts in these areas are a good indicator of the priorities of governments. Anyway, this blog entry includes a lot of links you can follow and read up on. 

2China, for instance, is one of the developing countries with the highest GERD ratio to GDP. It has already surpassed a number of European countries.   

7 thoughts on “Are we being stupid? – Part 2: Strategic Foresight

  1. Awesome. I love GERD!

    Did you notice Switzerland? Their R&D expenditure per capita is 3 times the EU average (numbers from 2008, the last year for which Swiss data are available), basically all of it comes from the private sector. Switzerland is often ranked as the most innovative country in the world. It hosts a large number of top research facilities, especially in sciences and engineering. It is home to a large number of high-tech firms, mostly in pharma and biotech. It is also famous for fondue and xenophobia low corporate taxes and low marginal income taxes. Let me venture a bold hypothesis: these facts are causally related. R&D requires both the willingness to invest in high-risk projects and the availability of high-skilled labor. Low taxes on corporate income increase the former, high marginal taxes on income increase the latter.

    Perhaps the innovative performance of a country has less to do with the size of the government’s R&D budget and more with its tax policies.

    • Good point.

      Let me say first, that I actually don’t think that R&D expenditure on its own is a fantastic causal explanation for the innovativeness of a certain country. You need to put it into context with other things, i.e. tax rates, tax breaks, subsidies, bankruptcy laws, infrastructure etc. etc. But I think it is hard to argue how less money for something as important as higher education and research can be good and it shows off the priorities of the government a bit. That’s why I focused on it.

      Regarding Switzerland, yeah, you know, I almost always think of it a bit as an outlier and a country which I would call more selfish than average, if it was a human being (no offence). So, to demonstrate that your hypothesis is valid, you would need to look at other countries as well. And there are some who do well and don’t have particularly low corporate tax rates and some who do badly and do. I’m sure, somebody somewhere has written a paper on this… I like that you talk about the fact that business expenditures are really high and I actually have an alternative hypothesis where Switzerland fits in nicely. You’ll have to wait for the last blog though 😛

      Also, I don’t get that one point: high marginal tax rates increase the availability of high-skilled labour? Can you explain your channel or are we talking about correlation?

      • Oops, of course i meant LOW marginal tax rates increase the availability of high-skilled labor. The channel should be clear: incentives to accumulate human capital + incentives for smart guys to settle in Switzerland.

        As for public spending on R&D and universities: Well, it depends on whether public spending is a complement or a substitute for private spending on these things. As long as we’re talking about basic research, it’s probably a complement, but for more applied research it might well be a substitute. For a quick and dirty approach to this question you could use the GERD data to run a cross-country regression of private R&D spending on public spending and see whether the coefficient is negative (substitute) or positive (complement). Existing evidence is mixed:

  2. Hm. I don’t think marginal tax rates are really the KEY point when people decide where to live and which job to take. I know this sounds economically counterintuitive, but I’m talking as a human being here. How many people do you know, who go like “oh, yeah, I’m moving to Switzerland because of the marginal tax rates”. I’d say that they move because of the quality of the available jobs and the quality of life (and that is indirectly related to the taxes they pay on their income, but also to a variety of other things, like the absolute amount they get paid, the services the state provides, whether they like mountains 😉 etc.).

    I like your recreational econometrics exercise. Personally, I wouldn’t have guessed that they crowd each other out, because businesses and governments fund different things, which should ideally be complementary.

    • Well, whenever we say x provides an incentive for people to do y, it is always a ceteris paribus argument. Everything else equal, people have an incentive to settle where their after-tax income (duly adjusted for purchasing power and quality-of-life differences and so on) is highest. “How many people do you know who do x” cannot be a serious argument in social sciences. According to Facebook, I personally know 265 people. And thats certainly not a random sample. So any inferences drawn from that sample about the behavior of a population of millions have no scientific validity whatsoever.

      Luckily we don’t need to resort to that casual “How many people do you know?” kind of evidence when we have loads of real-world data on migration flows and tax rates to test our theories in a rigorous manner. Asking whether a theory accords with my personal experiences is just chitchat.

      • You know, while you’re obviously right in principle regarding both points, Max, I must still say that I am very unscientifically wondering if (a) certeris paribus works that well in this case (and many others) and (b) whether economics wouldn’t be a lot better off, if people sometimes used their common sense about how people behave in real life to think about issues instead of trying to conduct some half-sound econometrics on aggregate statistics under all kinds of assumptions.
        But, yeah, you’re probably right that my comment was unworthy of an economist.

  3. Been kind of disconnected in the last couple of weeks since I’m doing a (totally uneconomic) internship in Madrid, but really enjoying these posts, as well as Max’s follow-up. It always struck me that the long-term nature of (public) R&D investment makes it a prime candidate for short-term cuts – California seems to have been hit pretty hard here in the last couple of years, but I’m sure Max knows better about that. And I think it’s fair to say no one really understands Switzerland…

    In terms of business investment it would seem local bankruptcy law must pay a pretty big role. Sure, a huge chunk of private R&D comes from big companies who can stomach one or even 10 of their R&D projects going belly-up, but for small companies to be willing to take the risks involved (and producing probably some of the most innovative new stuff around), you really have to make sure they are allowed to fail without that failure being to onerous.

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