How does competition promote innovation?

competitiveness : The market alone is not always able to produce innovations

This year, Germany was named the most innovative country in the world for the second time in a row in the Global Competitiveness Report by the World Economic Forum. With research spending a good three percent of GDP, Germany is ahead of major competitors such as the USA, France and Great Britain. Only Japan and smaller countries such as South Korea, Israel, Switzerland and Austria invest relatively more in research and development.

This is good news for the German economy, but no reason to sit back complacent. There are obvious deficits and major challenges for securing the innovative capacity of the German and European economies. These include weaknesses in data and network-based business areas, in artificial intelligence and cloud computing, in drive technologies for vehicles and in genetic engineering. In order to meet these challenges, both state support and state intervention are required, because the market and private companies alone are not always able to produce sufficient innovations.

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But how must a far-sighted innovation and technology policy be designed today? As a rule, some so-called horizontal policy measures are undisputed. Funding for basic research in universities and state institutions is generally welcomed. On the other hand, the recently decided introduction of tax incentives for research and development (R&D) expenditure in Germany is more controversial.

In many countries where this type of promotion has been practiced for a long time, it has only had a limited effect on promoting innovation. In Germany it was focused on small and medium-sized companies that make little contribution to economic R&D investments. It is therefore questionable whether this form of unspecific funding really brings new impulses for innovation, especially in the important high-tech sectors.

As part of the German high-tech strategy, money is also invested in specific projects with a technological focus in this country. This “mission-oriented” strategy, which is one of the so-called vertical industrial policy measures, directs research funding to projects that contribute to solving problems for societal challenges such as climate change, demographic change, or digital change.

The state and companies shy away from investment risks

It is essential that the state and private companies take technological and financial innovation risks. A new element of priority setting in this type of technology policy is the newly founded “Agency for the Promotion of Leap Innovations”. This is based on role models from abroad, namely the successful US agencies DARPA and ARPA-E.

But innovation policy is more than just funding for research. Further investment in knowledge-based capital is also required. In addition to R&D, this also includes software and databases, the development and organization of companies as well as training and further education for employees. Our analyzes show that these investments increase productivity and growth.

Promotion of risk projects

One starting point can be the promotion of high-risk innovation projects that involve simultaneous investments in different types of knowledge capital. The promotion of cooperation projects, networks and clusters is particularly suitable for supporting the formation of knowledge capital in companies in the broadest sense. The same applies to investments along the entire value chain. The existing funding projects for digitization in small and medium-sized companies and for continuing education should also be expanded and dovetailed.

However, all of these efforts should not obscure the fact that no European country can act successfully on its own. Europe will increasingly need broad partnerships that will allow it to achieve the level of R&D that competing US and Asian corporations and government agencies can handle.

Europe must stick together

There are already good approaches with the so-called “Important Projects of Common European Interest” (IPCEI / Important Projects of Common European Interest). These are projects that encourage Member States to direct their public research and innovation spending towards large, joint projects for breakthrough technologies that go beyond the state of the art and are privately funded.

Last year, for example, the EU Commission approved state aid totaling 1.75 billion euros for a joint project by France, Germany, Italy and Great Britain in the field of microelectronics. The microelectronics cluster in Saxony, where Bosch is building one of the most modern chip factories in the world, will benefit from this. As recently as December, the EU Commission approved 3.2 billion euros for a pan-European IPCEI initiative for battery cell production. From Germany, BMW, BASF and Varta are involved.

No room for isolation

It is expedient that within the framework of IPCEI regulations have also been adapted which, under competition law, could stand in the way of cooperation between companies and financial support from the state. A modern competition and economic policy thus represents an essential basis for a successful innovation policy, in which there is no room for isolation or the promotion of market power. Research shows that promoting innovation is most effective in those sectors in which there is healthy competition.

And this must ultimately be the goal of any innovation policy. In summary, German and European competitiveness could be maintained as follows: state funding and priorities paired with a coordinated European approach so that innovations can achieve the correct scaling. One should not focus exclusively on promoting R&D, but also on strengthening knowledge-based capital and supporting entire new value chains. After all, politics must focus on free, competitive markets, because only fair and lively competition promotes innovation.

All three authors work in the Companies and Markets department at the German Institute for Economic Research (DIW) in Berlin. Tomaso Duso is the head of the department, Heike Belitz and Alexander Schiersch are research assistants.

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