innovation for development and the role of...

INNOVATION FOR DEVELOPMENT AND THE ROLE OF GOVERNMENTA Perspective from the East Asia and Pacifi c Region

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INNOVATION FOR DEVELOPMENT AND THE ROLE OF GOVERNMENTA Perspective from the East Asia and Pacifi c Region

Edited byQimiao FanKouqing LiDouglas Zhihua ZengYang DongRunzhong Peng

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©2009 The International Bank for Reconstruction and Development/The World Bank1818 H Street, NWWashington, DC 20433Telephone: 202-473-1000Internet: www.worldbank.orgE-mail: feedback

All rights reserved

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This volume is a product of the staff of the International Bank for Reconstruction and Development/The World Bank. The fi ndings, interpretations, and conclusions expressed in this volume do not necessarily refl ect the views of the Executive Directors of The World Bank or the governments they represent.

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Cover photo Chinese stock exchange image: © Wu Hong/epa/CorbisCover design Edelman Design Communications

ISBN: 978-0-8213-7672-0eISBN: 978-0-8213-7673-7DOI: 10.1596/978-0-8213-7672-0

Library of Congress Cataloging-in-Publication Data Innovation for development and the role of government : a perspective from the East Asia and Pacifi c region / edited by Qimiao Fan . . . [et al.]. p. cm. Based on proceedings of the Innovation for Development Forum held in Shanghai, China, on Sept. 21–22, 2006. Includes bibliographical references and index. ISBN 978-0-8213-7672-0 — ISBN 978-0-8213-7673-7 (electronic) 1. Economic development—Technological innovations. 2. Technological innovations—Government policy. 3. Finance—Technological innovations. 4. Competition—Government policy. 5. China—Economic policy. 6. Technological innovations—Government policy—China. I. Fan, Qimiao. II. Alternative Fuels Data Center (National Renewable Energy Laboratory) III. Title. HD82.I3417 2006 338.9—dc22

2008037351

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v

Contents

Foreword ix

Preface xiii

Acknowledgments xv

Contributors xvii

Abbreviations xix

Introduction and Summary 1Qimiao Fan and Douglas Zhihua Zeng

Opening Address 7Jun Wang

Keynote Address 11Frannie Leautier

PART I INNOVATION, COMPETITIVENESS, AND DEVELOPMENT

1. Innovation, Competitiveness, and Economic Development 17Qimiao Fan, Yang Dong, and Douglas Zhihua Zeng

PART II INNOVATION AND FINANCIAL DEVELOPMENT

2. Financial Innovation and Economic Performance 53Shahid Yusuf

3. China’s Financial Sector Policies 71Vivek Arora

4. The Innovation and Development of China’s Bond Market 91Huaipeng Mu

5. Innovation and the Financial Sector: Role of the Asia-Pacifi c 103 Economic Cooperation

Kenneth Waller

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vi Contents

PART III INNOVATION AND GOVERNMENT POLICIES IN CHINA

6. Overview of China’s Enterprise Innovation: 121Progress, Challenges, and Policy Recommendations

Chen Jia

7. China’s Fiscal Policies for Innovation 149Shahid Yusuf, Shuilin Wang, and Kaoru Nabeshima

8. China’s Tax Policies for Promoting Innovation 181Yaobin Shi

Index 195

BOXES

1.1 The U.S. Automobile Industry: Competition Drives Innovation 201.2 Best Practices for Effi cient Technology Diffusion Programs 301.3 Establishment of Industrial Clusters: Silicon Valley 321.4 The Republic of Korea: The Role of Government in a National

Innovation System 361.5 Creating an IP Culture in Singapore: Using Proactive Policies 391.6 Investing in Human Resources and R&D: Recent Policy

Development in Some OECD Countries 401.7 The Republic of Korea: Promoting R&D and Innovation 411.8 Fiscal and Financial Policies: The Case of TEKES in Finland 421.9 The TEFT Technology: Attachés as Brokers 441.10 Ingredients for the Success of Bangalore as an Innovative Cluster 453.1 International Experience with Corporate Bond Market

Development 835.1 Technology in the Banking Sector 1065.2 The Rationale behind APEC’s Focus on Good Governance,

Supervision, and Regulation 1105.3 Background to APEC: Members, Pillars, and Objectives 1125.4 ABAC Support for the Implementation of Basel II and Developments

in Banking and Supervision in the Asia-Pacifi c Region, 2006 1155.5 APEC Support to Corporate Bond Market Development, 2007 1168.1 Examples of Tax-Based Innovation Policies in China 187

FIGURES

1.1 Inverted U–Shaped Relationship between Competition and Innovation 19

1.2 Number of Patents Granted by the U.S. Patent and Trademark Offi ce, 2006 22

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Contents vii

1.3 Number of Researchers in Research and Development, 2004 251.4 Countries’ R&D Expenditures as a Percentage of GDP, 2004 261.5 Sources of Early-Stage Technological Development Funding

in the United States 271.6 Correlation between Innovation and Income Level, 2007 361.7 R&D Expenditure as a Share of GDP, 1980–2004 393.1 Relationship of Financial Deepening and Development, 1970–2000 733.2 Investment as a Share of GDP, Selected Countries, 2000–05 743.3 Stock Market Capitalization as a Share of GDP, 2005 773.4 Source of Outside Funds as a Share of Total Funds Raised,

Nonfi nancial Corporations, 2005 783.5 Corporate Bonds in Selected Countries: Outstanding Stock, 2006 793.6 Sources of Financing as a Share of Total Urban Fixed-Asset

Investment, 2007 806.1 Patent Applications Filed by Chinese Enterprises, 2000 and 2005 1246.2 Total Output Values of China’s High-Tech Industries, 1995–2004 1277.1 R&D Expenditures of Selected Multinational Corporations and

Economies, 2002 1567.2 Locations of R&D Investments by Multinational Corporations, 2004 1577.3 Prospective R&D Locations Considered Most Attractive, 2005–09 158

TABLES

1.1 Global Comparison of Knowledge Economy Indexes Using Four Pillars: Top 15 Countries 24

1.2 Ranking of Innovation and Competitiveness, 2006–07 342.1 Ranking of the Top 50 Worldwide Centers of Commerce, 2007 645.1 Key Aspects of the Financial Sector Enabled by Technology

and Innovation 1055.2 Financing Technology and Innovation: Some Characteristics of

Innovation and Financial System Responses 1076.1 Share of Technology-Based Industries in the Manufacturing Sector,

1998 and 2003 1236.2 Changes in the Export Composition of China’s Products, 1990–2005 1237.1 Various Types of Fiscal Incentives, Selected European Countries 1597.2 China’s R&D Expenditures and Shares in Relation to GDP 1647.3 Distribution of Funding on R&D, 2002–06 1657.4 Distribution of R&D Expenditure, 2002–06 1657A.1 Patent Applications Filed with and Granted by the State Intellectual

Property Offi ce, 1995–2004 1767A.2 Patent Applications Filed by and Granted to Chinese Residents

in the U.S. Patent and Trademark Offi ce, FY 2001–FY 2005 1777A.3 Publications Catalogued in Refereed Scientifi c Journals, 1998–2003 1777A.4 China’s Increasing High-Tech Exports, 1995–2003 177

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Introduction and Summary

Qimiao Fan and Douglas Zhihua Zeng

In today’s highly globalized economy, innovation has become the key driver for growth and competitiveness. The capability to innovate and

to bring innovation successfully to market will be a crucial determinant of the global competitiveness of nations over the coming decades. An inno-vation system consists of the network of institutions, rules, and procedures that infl uences the ways a country acquires, creates, disseminates, and uses knowledge. The actors in the innovation system include universities, public and private research centers, enterprises, consulting fi rms, policy think tanks, policy makers, and others. The innovation performance of a country largely depends on how these actors relate to each other as ele-ments of a broader system.

The concept of innovation encompasses not only technological inno-vation, that is, diffusion of new products and services of a technological nature into the economy, but equally includes nontechnological forms of innovation, such as organizational or institutional innovations. The latter may include the introduction of new management or marketing strategies, adoption of new policies or creation of a new service (or nontechnological product), and improved approaches to internal and external communica-tions and positioning. Innovation is important not only for the production sectors, where technologies play a crucial role, but also for the service sec-tors, such as fi nance and public services.

This book is the result of a joint forum on “Innovation for Development” held by the World Bank and the China-based Asia-Pacifi c Finance and Development Center (AFDC) in Shanghai in September 2006. The book

1

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2 Qimiao Fan and Douglas Zhihua Zeng

examines the relationship between innovation, competitiveness, and eco-nomic growth; the role of innovation in fi nancial sector development; and specifi c government policies for innovation in China.

The authors of book chapters are mostly policy practitioners and inter-national experts on technology innovation or fi nancial sector innovation. The book is intended to provide useful analysis on innovation and its de-termining role for growth and competitiveness and practical policy op-tions for policy makers in the Asia-Pacifi c Economic Cooperation (APEC) countries/economies, especially those in China.

The opening address by Vice Minister Jun Wang emphasizes the im-portance of innovation to economic development using as an example China’s rising demand for natural resources. He points out that the speed of China’s economic growth has far outpaced this demand because China has constantly pushed ahead with technological and institutional inno-vations and reforms. However, given its vast population and scarcity of natural resources, China’s future economic development will face far greater pressures. How to promote sustainable development through in-novation is a huge challenge for the Chinese government. To cope with this challenge, the government of China is ready to introduce four major measures: (1) proactively offer guidance and support to promote indig-enous innovation; (2) gradually establish a technology innovation system with enterprises as the cornerstone, the market as the guide, and industry, academia, and research institutions fully integrated; (3) provide more sup-port to small and medium enterprises (SMEs); and (4) ensure better pro-tection of intellectual property rights (IPR). In the end, he hopes that the Asia-Pacifi c region will share experiences with innovation, learn from one another, and make concerted efforts to promote this region’s economic prosperity.

The keynote address by the former World Bank Vice President Frannie Leautier defi nes innovation as consisting of (1) new products, (2) new processes, (3) ways to penetrate new markets, (4) new supply sources or distribution methods, and (5) new industries. In addition to these fi ve categories, the use of new management practices and organization struc-tures, the development and retention of skilled personnel, and new ways of securing fi nancial resources and managing interface with government and other external agencies are also forms of innovation. She acknowledg-es that innovation is a complex and multifaceted phenomenon and that there are many factors that infl uence a country’s innovation performance; therefore, there is an important role for the public sector to play, particu-


Introduction and Summary 3

3

larly governments, in fostering innovation. However, innovation policies and ambitions have to be adapted to the levels of development and the institutional capacity of a country. She hopes that the forum will become a regular venue for South-South learning in the Asia-Pacifi c region.

The main contents of the book are divided into three parts. Part I, on innovation, competitiveness, and development, provides in one chapter a brief overview of the key determinants of innovation, the importance of innovation to competitiveness and development, and the role of govern-ment in fostering and promoting innovation. The key factors covered in chapter 1 include competition and market structure, IPR protection, qual-ity and availability of human resources, investment in research and de-velopment (R&D), fi nancing of innovation, technology diffusion systems, and the presence of industrial clusters. The chapter describes how govern-ments can create an enabling environment for innovation by improving business climate, establishing well-balanced IPR systems, investing in hu-man capital, enhancing the R&D infrastructure to attract private invest-ment, encouraging the establishment of industrial clusters, and providing direct funding for basic research and developing a competitive fi nancial market.

Part II of the book, which includes chapters 2 through 5, examines the relationship between innovation and fi nancial development, and the im-portance of fi nancial innovation for overall economic performance. Beyond generic analysis, this part also presents the cases of China and the APEC. In chapter 2, the fi rst of two sections briefl y synthesizes the contribution of key fi nancial innovations and examines the role of information and com-munication technology (ICT) in accelerating the pace of innovation; the second section comments on the status of fi nancial changes in China, the speed at which new fi nancial instruments are being introduced into the Chinese fi nancial system, and the areas where catch-up will have fruit-ful consequences. Four points that are covered in this chapter are worth noting. First, the fi nancial system in the leading industrial countries is an unusually prolifi c source of innovations, and these are now spreading rapidly to industrializing countries. Second, as a result of the ICT revolu-tion, the productivity of the fi nancial sector has risen rapidly over the past decade. Third, fi nancial innovations, which help to cut down transaction costs, promote liquidity, and better serve the requirements of borrowers and lenders, are making a signifi cant difference to allocative effi ciency and total factor productivity. Fourth, despite the great progress, China has yet to exploit the full potential of fi nancial innovation.



Chapter 3 discusses China’s experience with fi nancial sector devel-opment and some of the challenges ahead in the context of international experiences. China has made signifi cant progress in fi nancial reforms in recent years; however, the fi nancial system still favors large state-owned enterprises over smaller fi rms and private enterprises, and there is still much to be done to complete bank reforms and to further develop capital markets that can play a larger role in the fi nancial system. A more devel-oped fi nancial system, with competition among banks, sound institutions, and developed capital markets, can help to allocate scarce resources effi -ciently, ensuring that they are used in the most productive way.

Chapter 4 provides an overview of product innovation and institution building in China’s bond market over the past two years. The innovations of bond products in China include the securities companies’ short-term fi nancing bills, the subordinated bonds and ordinary fi nancing bonds is-sued by commercial banks, credit asset securitization, the hybrid capital bonds, and the nonfi nancial corporations’ short-term fi nancing bills. There are also great innovations in trading instruments and fi nancial derivatives in the bond market. The major innovations in institution building include the establishment of the management mechanism for issuance of short-term fi nancing bills, more stringent information disclosure requirements, and the introduction of the bond rating system. Driven by product in-novation and institution building, China’s bond market has been grow-ing very rapidly in recent years; however, the development of corporate bonds still lags behind. Citing experiences of China’s bond market in the past years, this chapter concludes that innovation is the driving force for the development of the bond market, which will contribute signifi cantly to expanding the scale of corporate direct fi nancing.

Chapter 5 discusses the key aspects of the fi nance sector that have been enabled by the introduction of innovation and technology, including ef-fi ciency, risk management, liquidity, pricing, regulation, and supervision. The advances in fi nance, in turn, have enabled and encouraged investment in technology and innovation in other sectors across an economy. This effect can be attributed to strengthened capabilities in risk management, fi nancial modeling, product design, and proliferation of service forms. These key strengths promote technology and innovation, both at the fi rm level in real sectors and through their infl uence on specifi c markets for technology and innovation. This chapter also addresses the broader policy environment for fi nancial innovation, such as strong legal, supervisory,


Introduction and Summary 5

and regulatory regimes, and the role regional cooperation can play in har-nessing and facilitating innovation in the fi nance sector, especially in the Asia-Pacifi c region.

Part III, which consists of chapters 6 through 8, examines some specifi c government policies to promote innovation in China. Chapter 6 discusses the progress and challenges of China’s enterprise innovation, and pres-ents a set of policy recommendations. The author argues that the technol-ogy levels of China’s industries and enterprises have been increasing, but compared with the advanced countries, the innovation capacity of Chinese fi rms is still weak. This can be attributed to the lack of effi cient integration between the economic activities and science and technology, lack of ef-fective policies and institutions that enable key industries to stimulate in-digenous innovation, weak IPR protection, a performance benchmarking system that fails to emphasize indigenous innovation by fi rms, and more. To strengthen the innovation capacity among Chinese fi rms, the govern-ment needs to develop and implement innovation-oriented public policies and policy measures. Measures could include effective industrial policies to promote indigenous innovation, strengthen IPR protection, and sup-port SME innovation through special programs. In addition, technology absorption, adaptation, and commercialization capabilities could be im-proved by establishing R&D platforms for industrial and core technolo-gies, fostering science and technology talents, strengthening technology transfer mechanisms, and using direct public funds, tax-based fi scal incen-tives, and government procurement to promote indigenous innovation.

Chapter 7 explores the fi scal policy options for China. First, China’s spending on R&D has been growing rapidly in past decades, but it’s also important to raise the effi ciency of R&D through organizational changes. Second, it might be more desirable to shift emphasis from di-rect budgetary supports of R&D to R&D tax credits, leaving the deci-sion on what to do research on with fi rms. Third, experienced research managers in China are still scarce, so offering incentives to foreign companies to set up R&D facilities can be a potential means of train-ing Chinese researchers; also, offering substantial incentives to Chinese researchers abroad is an effective way to attract back overseas science and technology (S&T) talents. Fourth, it is desirable to rigorously ex-amine the gains from the multiplication of technology zones and the returns accruing from the fi scal incentives provided. Although the gov-ernment incentives provided have led to a number of state-sponsored



venture capital fi rms, the provision of capital remains subject to many administrative hurdles. Finally, because of the importance of high-quality S&T workers, fi scal support, at least for the leading universities, would be a sound investment.

Chapter 8 examines China’s tax policy options for innovation. It looks at the challenges and opportunities faced by China regarding technologi-cal innovation and advocates that the government should adopt effective tax policies to promote technological innovation. On the basis of a brief assessment of China’s current tax policy incentives, the chapter suggests some adjustments in the tax regime to encourage innovation. These in-clude reforming the existing main tax categories and enhancing the cata-lyst role of tax policies in technology innovation. Greater efforts need to be made to transform the value added tax system from production based to consumption based and to allow technology fi rms to deduct fi xed assets from taxable revenues. The existing preferential tax policies for innovation also need to be streamlined and improved to better promote fair com-petition, encourage the development of new and high-tech enterprises, strengthen the development of S&T talents, and spur the commercializa-tion of S&T results.

Generally speaking, innovation covers a large spectrum of social, eco-nomic, scientifi c and technological aspects. The eight chapters included in this book refl ect the different viewpoints on linkages between innovation and government policies and on the challenges that probably are com-monly faced by economies in the APEC region, particularly for develop-ing economies. Although this book is divided into three parts, it became clear in preparing the book that there is no single best way to sequence the chapters. The volume editors decided to follow a sequence that best illustrates the relationship between innovation and development, starting with the key conceptions about innovation, competitiveness, and devel-opment, followed by ideas on innovation and fi nancial development, and fi nally consideration of the relevant government policies in China.

Two additional considerations are worthy of note. First, the reader will fi nd some overlap among chapters. This refl ects the authors’ fi nd-ings from different approaches to and perspectives on the same or similar topics. Second, this book should be viewed as a work in progress, and the opinions expressed are entirely those of the authors and do not necessarily represent the views of the World Bank or the AFDC.


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