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Entrepreneurship, Innovation and Development

Otto Toivanen

At least since the 1950s it has been recognized that innovation is central to economic growth. It has also been well understood that innovations both generate and rely on externalities. These twin facts, together with market failures most often thought to arise in financing of innovation, serve as the basic justification for public sector actions which nowadays are jointly labelled innovation and research policies. In practice R&D subsidies is one of the most important tools of innovation policy — and the one that has theoretical justifications in the endogenous growth literature.

For a country such as Finland, amongst the top in terms of the World Competitiveness Index, R&D and innovation is important. It has been estimated by others that Finnish growth without ‘the success information and communication technologies (ICT) manufacturing’ would have been 0.9 percentage points lower during 1990–2004. In terms of innovation, the country does well, considering for instance that it produces some 30 to 40 per cent more scientific publications per inhabitant than for example Norway, a country of similar characteristics. Finland, together with Israel and some of the Asian Tigers, also belongs to the small group of countries that have been able to significantly improve their innovative output as measured by US patents.

It is often asked what lessons developing and emerging economies can learn from Finland’s experience? This article provides a brief review of the Finnish innovation environment and discusses the implementation of Finnish R&D subsidy policy in a developing country context, with special emphasis on entrepreneurship.

The Finnish innovation policy environment

Finnish government employs several agencies to conduct innovation policy. The most important ones are depicted in Figure 1.

The Academy of Finland is the main source of government funding for basic research, but it nowadays also funds applied research. The government runs a number of research institutes. Of these, the most important one is VTT, the technical research institute. The Finnish Foundation for Innovation’s (FFI) objective is to help individuals and small and medium sized enterprises (SME) in protecting their intellectual property. The regional dimension is taken care of through 15 TE-centres. These are regional government offices whose task is to provide business support services, consultation and advice, as well as finance to SMEs. Finnvera is a state-owned financing company whose main tasks are to promote entrepreneurship, development of SMEs, internationalization and exports of firms, and government regional policy. Only a comparatively small part of Finnvera’s activities fall under innovation policy. Finnish Industry Investment and Sitra are the venture capital funds of the government, although the latter has lately greatly reduced its activities in this field. Finnpro is the responsible organization for providing business support services for the internationalization of firms.

Finally the National Technology Agency of Finland (Tekes) is the main organization of Finnish innovation policy. Tekes provides funding (e.g. it is the sole source of R&D subsidies), expert advice and promotion of national and international networking.

Tekes’ decision-making is constrained by rules that dictate that the maximum subsidy is 50 per cent of incurred costs (60 per cent for medium sized and 70 per cent for small enterprises). In case of cooperation, these funding limits may be exceeded. Besides firms’ R&D projects, Tekes funds feasibility studies and university research.

Tekes receives some 3000 applications per year, half of which are for business sector R&D projects, two-thirds of which are accepted. Tekes grants around 300 million euros in subsidies and loans to companies. In 2007, Tekes funded 695 microenterprise projects with a total of 69 million euros; 408 small enterprise projects with a total of 73 million euros; 152 medium sized enterprise projects with a total of 19 million euros, and 295 projects by large firms with 123 million euros. Tekes takes unsolicited applications, but also runs special programmes. The latter are usually designed in close cooperation with the industry.

Tekes has three funding instruments: grants (subsidies), low interest loans and capital loans. Low interest loans not only have a low interest rate, but are also soft: if the firm can demonstrate that the R&D project failed, the payment may be waived in part or completely. Capital loans are a Finnish speciality: They are included in fixed assets in the balance sheet and can be paid off only when unrestricted shareholders’ equity is positive and the debtor cannot give collateral.

R&D subsidies and entrepreneurship

Tekes is not the main Finnish policy tool to foster entrepreneurship (that is Finnvera). Hence R&D subsidies are not directly aimed at promoting entrepreneurship in Finland. However, Tekes does have policies directly aimed at start-ups and hence, fledgling entrepreneurs. Tekes divides its special funding for young innovative companies into three stages: pre-stage funding, first stage funding and second stage funding.

There are a number of obstacles that hinder the use of R&D subsidies in promotion of entrepreneurship. One is that subsidies in most countries are paid ex post against receipts. If (new) entrepreneurs are credit constrained, this type of funding may be of little help. Second, (though fast), the speed at which the decisionmaking progresses in Tekes may be too slow for an entrepreneur. This sounds trivial, but is not so at all; and may be hard to rectify. The reason for the former is that an entrepreneur may indeed need to move fast in order to, for instance, secure funding for R&D. The reason for the latter is that the essence of R&D subsidies is that they are tailor-made for each application. This is the greatest asset of R&D subsidies in comparison to R&D tax credits and almost by definition leads to an application process that may be too slow, especially for small firms.

While a potential obstacle, the fact that R&D subsidies are tailored is also their biggest asset in terms of promoting entrepreneurship. If one is able (e.g. the legislation does not rule out the possibility) to explicitly target the support to certain types of firms, it may be possible to increase their likelihood of applying.

Another potential benefit of R&D subsidies is that the government may use them to generate externalities. The Finnish government (Tekes) does just this by requiring that a large firm has to cooperate with SMEs in order to be eligible for government R&D support. This may allow small firms and entrepreneurs to access information that would not be available to them otherwise.

Finally, subsidies may act as a signal to private financiers. This can be the case if the government agency is good at finding out the type of the applicant – type here meaning ‘good’ (positive expected profits) or ‘bad’ (negative).

R&D subsidies and entrepreneurship in a developing country

The Finnish policy described and discussed above is tailored to Finnish needs, and therefore reflects the fact that Finland is a developed economy. One may therefore wonder how much of the Finnish experience can be of use in a developing country context. As there is to my knowledge no research on such issues, what follows should be viewed as speculative.

A key characteristic of the Finnish innovation policy system has been that it has been quite predictable. It is clear that for any system to take root, information about it and its workings needs to spread among potential applicants. This may still be a problem in Finland; Tekes exists since a quarter of a century, is well known and receives a lot of media attention, but still only a relatively small proportion of Finnish companies apply for funding from Tekes. At any rate, however, it would seem that a key characteristic to copy into a developing country is the long term nature of the institutional arrangement.

A prerequisite of being able to administer an R&D subsidy program is that the required human capital exists. One may copy institutional arrangements, but the institutions need to be manned by competent personnel. A key is to be able to recruit capable reviewers. Unless one succeeds in this, there is no hope of being able to reap the benefits that the system might otherwise offer.

A further ‘capability requirement’, a necessary condition, is that there is demand for such policy instruments. This most likely necessitates long-term investments in the education sector, from bottom upwards. It is fair to state that a key feature of Finnish innovation policy is a determined effort to increase the education levels of the population, and especially, investment in engineering education. This is reflected e.g. in the fact that some 80 per cent of Finns who obtain a US patent and trademark office (USPTO) patent are engineers by training.

A caveat that must be inserted here is that while the above public sector intervention is motivated by the possibility of the public sector being the focal point, the same argument may also carry a danger. If the government sector is successful in becoming the focal point of R&D support, this may paralyze private sector efforts. In practice, it could be that, for instance, private venture capital markets are not born if the government crowds them out. So far there is no evidence of this taking place anywhere in general or in Finland in particular, but this is certainly an issue discussed by Finnish researchers regarding the Finnish R&D funding mechanisms.

While the message from the above analysis may be bleak, there is some evidence that public support to private R&D (also) works in developing countries. Hall and Maffioli (2008) analyse the effects of Technology Development Funds in Argentina, Brazil, Chile, and Panama, and find encouragingly large positive effects on R&D investments, but less encouragingly, little impact on patents, new product introduction, or productivity. One should also note that most of the countries studied by Hall and Maffioli differ from many developing countries, particularly low-income countries, in that they have a long history of investing (in relative terms) in higher education and research.

Concluding Remarks

A lesson from small developed and R&D intensive countries (such as Finland and Israel) is that entrepreneurship that is innovation-linked can be fostered. A prerequisite for this is that the educational system harnesses individuals with the requisite skills; then and only then can active government policies towards entrepreneurship have the wished for consequences. Finland and Israel offer a contrast in this respect, as, at least as an approximation, the former is dominated by large companies in terms of innovation, the latter by small businesses. Small countries can overcome the deficit of size by determined efforts especially in higher education.

Entrepreneurship, especially in connection to innovation, seems to hold the promise of economic prosperity and growth. Some Finnish policy characteristics – such as tying support to large companies – to a requirement that they cooperate with small companies, may indeed by ones that are worth copying in a developing country environment. Others, such as relying entirely or mostly on R&D subsidies, may be less promising. As so often, the devil is in the details.

About the author

Professor Otto Toivanen is the director of Helsinki Center of Economic Research. Before this he was a professor at Helsinki School of Economics, and has been a visiting scholar at MIT and University of California, Berkeley. His research interests include industrial organization and economics of innovation. He has consulted for the Finnish government and the EU Commission on innovation policy.

Further reading:

This article is based on the author’s presentation to the UNU-WIDER and UNU-MERIT workshop on Innovation and Entrepreneurship in Economic Development, held in Maastricht, The Netherlands between 30-31 October 2008.
RP2009/48   Innovation Policy, Entrepreneurship, and Development: A Finnish View.
Otto Toivanen

See also:
Georghiu, L., K. Smith, O. Toivanen, and P. Ylä-Anttila (2003). ‘Evaluation of the Finnish Innovation Support System’, Finnish Ministry of Trade and Industry Publications 5/2003. Helsinki: Finnish Ministry of Trade and Industry.

Hall, B., and A. Maffioli (2008). ‘Evaluating the Impact of Technology Development Funds in Emerging Economics: Evidence from Latin-America. European Journal of Development Research, 20: 172–98.

WIDER Angle newsletter, October 2009
ISSN 1238-9544

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