Adjustment without Reform
5.3 Innovation Policies for Economic Growth
Technological change is considered the primary source of growth in almost all studies in the literature of economic growth. Analyses have shown that technolog-ical progress contributes between 70 and 90 percent to GDP growth per capita in industrialized countries. The process of technological progress in turn consists of the introduction and diffusion of innovations.
Recovery of innovation activity and economic growth in Russia requires a more comprehensive stabilization policy than the one currently in force. A switch to a reliable and growth-oriented macroeconomic policy is necessary but not a sufficient condition for promoting innovation activity. With a decline in investments and R&D expenditures by a factor of four, with the collapse of production of consumer durables that embody advanced technology, and with the brain drain from R&D-intensive industries, special measures are required for innovation. The government must use well-known instruments of industrial and S&T policy that include the following:
Increased government financing of R&D.
State procurement of innovative products.
Restructuring programs supported by a mix of private and public financing.
Formation of development institutions providing long-term credits for invest-ment projects.
Tariff and nontariff regulations on foreign trade, particularly for domestic innovations.
Elimination of the tax on profits used for investment and R&D expenditures.
Promotion of cooperation among production enterprises, financial organiza-tions, and R&D institutions.
Legal protection for intellectual property.
Creation of an efficient information infrastructure including a network of con-sulting companies.
In its efforts to promote R&D the state should not substitute for the market but rather help enterprises to adjust to market competition. For instance, state purchases
of new products is most important at the earliest phases of their introduction to bring down unit costs. This policy is actively used in virtually all industrialized countries. The objective of state programs is to support the initial phases in the life cycle of new products to create favorable conditions for the restructuring of production facilities. Private funding should be involved in financing innovations, for experience in other nations has shown the efficiency of mixed financing and risk sharing by the state and private organizations. Government guarantees for financing high-risk projects may also promote innovation.
Public policy is needed to improve the infrastructure and financial conditions so that small enterprises can focus on developing innovation. In spite of the role of large firms, companies owned by individuals risking their own capital remain an important force in a market economy. Small firms have been the source of many radical innovations.
Also important in financing basic research and promoting applied R&D are state subsidies and tax breaks, as well as other services whose usefulness is char-acterized by important externalities (for example, communications, transportation, information, engineering, and other business services). Any taxation scheme must recognize that the possibility of high profits provides incentives to innovate. It is necessary to gradually shift to a new taxation system that transfers a major taxation burden from current revenues to accumulated wealth. Along with the existing in-vestment tax credit it would be worthwhile to introduce a tax credit for R&D. The undeveloped market relations and the necessity to overcome the structural dispro-portions in Russia make it necessary to have special tax exemptions differentiated by industries during the transition period. As the economic situation stabilizes and the government budget condition improves, the use of tax concessions can become more limited.
An information infrastructure is also needed to provide the country’s research centers and enterprises with state-of-the-art means of telecommunications and data banks incorporated into the global information networks. This program can be developed using domestic satellite communications in the way that other global networks of commercial and scientific and technical information have been created.
Under conditions of galloping inflation and a deep slump in investment activ-ity, the formation of long-term lending institutions becomes important. Provision of special credit lines by the government through commercial banks or through the creation of special financial institutions is important in promoting innovation.
Reliance on commercial banks, however, requires complicated controls to be effec-tive. Financing from commercial banks is very inflationary in the Russian context.
The use of special institutions is more in accord with world practice. Examples include the World Bank, the European Bank for Reconstruction and Develop-ment, the Japanese Bank of DevelopDevelop-ment, and Brazil’s Bank of Reconstruction and
Development. Significant experience with project financing has been accumulated which can guide new Russian institutions.
World experience suggests various methods for the mobilization of domestic savings to support investment activity. In Russia, household savings have decreased in real value because of hyperinflation. This problem could be solved with a special program of personal savings that includes indexation of personal savings in savings banks.
The objective of state promotion of innovation and investment activity is to stimulate but not substitute for private activity. It is widely accepted that pri-vate activity largely depends on industrial organization and the industrial-financial structure of the economy. Large corporations closely connected with banks form an important base for industrial organization under conditions of a modern mar-ket economy. Controlling a major part of industrial production, such financial and industrial groups ensure stable industrial growth and are the foundation of the economic power in industrialized market economies. Financial and industrial groups can play a significant role in securing economic growth under the turbu-lent conditions in the Russian economy. Relying on their own sources of capital accumulation, these groups of interdependent industrial enterprise, banking, and trade organizations can finance innovation in key industries. The concentration of resources in financial and industrial groups ensured the rapid economic growth in the postwar Japan and West Germany and from the mid-1960s in Korea and other countries where the conditions of transition to the market were similar to those now present in Russia. This is the reason why one of the key objectives of the national industrial policy should be to promote the formation of independent financial and industrial organizations. This is particularly a necessary precondition for successful restructuring and conversion of the defense industry.
For the first time in decades enterprises are once again interested in promoting and implementing innovation activities. They now know that their products’ com-petitiveness is linked to the technological level of production. Therefore, the stage is set for an innovation-promotion policy that will lead to growth in productivity.