One of the reasons why countries promote inward FDI is to link up to the global technology and innovation networks led by global firms. In terms of creating new technology and diffusing it internationally, transnational corporations (TNCs) are the world leaders. They account for the bulk of world business expenditures on research and development (R&D).
For example, six TNCs (Ford, Pfizer, DaimlerChrysler, Siemens, Toyota and General Motors) spent more than $5bn on R&D in 2003. By comparison, only Brazil, China, South Korea and Taiwan had larger R&D expenditures among developing economies. TNCs dominate new patent registrations and often lead innovation in management and organisation.
As highlighted in the World Investment Report 2005, corporate strategies in this field are changing rapidly. Not only is more R&D being conducted outside the home country, but also TNCs are bringing selected emerging market economies into their R&D networks (see TABLE 1 download file).
The number of developing countries in the R&D systems of TNCs is rising, but unevenly. Developing Asia is the most dynamic host. In the case of R&D expenditures by majority-owned foreign affiliates of US TNCs, the share of developing Asia soared from 3% in 1994 to 10% in 2002. The increase was particularly noticeable for China, Singapore, Hong Kong and Malaysia.
This new internationalisation of R&D is both expected and unexpected. It is expected for two reasons. First, as TNCs increase their production in developing countries, some R&D is bound to follow. Second, like other services, R&D is fragmenting, with different activities being performed in different locations, depending on the advantages of each location.
Yet, it is unexpected because R&D is a service activity with skill, knowledge and support needs that are traditionally met only in developed countries with strong national innovation systems. Moreover, R&D has traditionally been considered one of the least fragmentable economic activities because it involves knowledge that is strategic to firms, and often requires dense knowledge exchange between users and producers within localised clusters. So why is it happening?
Companies have long needed a foreign R&D presence to adapt products and processes to local markets (in both developed and developing countries), or to tap into leading centres of technological excellence (notably in developed countries). The recent surge in R&D being carried out by TNCs in selected developing host economies is unlike earlier patterns. For the first time, developing countries are attracting R&D that is aimed at supporting not only local sales, but also global operations. The process is driven by a complex interaction of push and pull factors.
On the push side, intense competition is forcing companies to innovate more, while keeping their costs down. A combination of increasing complexity of R&D work, rising costs and an insufficient number of certain engineering and scientific manpower in industrialised countries is compelling firms to explore new sources of low-cost and highly qualified researchers.
On the pull side are a greatly improved availability of scientific and engineering skills at competitive costs, the continuing globalisation of manufacturing activities and fast growth in some key emerging markets.
The expanding pool of talent in selected developing countries and economies in transition is particularly important, especially for companies that fail to find a sufficient number of skilled human resources in their home countries.
The global supply of skilled workers has increased rapidly thanks to a dramatic rise in the number of students enrolled in higher education outside the developed world (see figure 1).
FIG1: SHARES OF GLOBAL TECHNIKAL TERTIARY ENROLMENTS (%)
Note: Transition economies here comprise south-east Europe and the Commonwealth of Independent States as well as the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia and Slovenia.
At the turn of the century, China, India and Russia together accounted for almost a third of all tertiary technical students in the world. In addition, more scientists and engineers working abroad are returning to China and India to perform R&D work for foreign affiliates or local firms.
In Bangalore, for example, about 35,000 non-resident Indians have lately returned with training and work experience from the US. Reflecting the growing competition for the best brains, both developed and developing countries are adopting new measures to attract foreign skills.
R&D internationalisation is also facilitated by improvements in information and communication technologies, new research techniques that allow greater fragmentation of R&D and greater awareness of research capabilities available worldwide.
Improvements in host-country investment climates have also contributed. Important policy developments relate, for example, to intellectual property rights (IPR) protection, reform of public research activities, infrastructure development, and investment promotion efforts specifically targeting R&D-related FDI and R&D incentives.
The globalisation of R&D is still in its infancy but the current trend towards internationalisation is set to gain momentum. The competitive pressure on firms is likely to remain intense, so the need to innovate is unlikely to disappear – on the contrary.
Moreover, rapid technological change requires sizeable numbers of research staff with a range of specialisations, which in turn necessitates an R&D presence where such pools of researchers are available. This will increasingly be in emerging markets.
Ageing populations in many industrialised countries may accentuate existing shortages of certain skills, with accompanying rising costs, forcing TNCs to look elsewhere for talent. At the same time, developing countries that take part in the internationalisation of R&D should progressively enhance their own ability to conduct more R&D and more sophisticated R&D.
In an UNCTAD survey of the 300 largest R&D spenders, about 69% of the respondents stated that the share of foreign R&D was set to increase; only 2% indicated the opposite and the remaining 29% thought the level of internationalisation would remain unchanged (see figure 2).
FIG2: PROSPECTS OF TNCS LOCATING R&D ABROAD 2005-9
Source:UNCTAD survey of top R&D spenders
The momentum appears to be particularly strong among companies based in Japan and South Korea, which, until recently, have not been internationalising their R&D to any large extent. For example, nine out of 10 Japanese companies participating in the UNCTAD survey plan to increase their foreign R&D, while 61% of European firms state similar intentions.
A further shift in terms of R&D locations towards some developing and transition economies is also envisaged (figure 3). China is the destination most often cited by the world’s top R&D spenders for future R&D expansion, followed by the US. In third place is India, another significant newcomer location for R&D. Russia was also among the top 10 target locations.
Other developing economies identified as candidates for further R&D by some respondents included South Korea, Singapore, Taiwan, Thailand and Vietnam. Conversely, very few respondents indicated any plans to expand R&D to Latin America or Africa.
The success of some Asian economies in terms of attracting the R&D work of TNCs is no coincidence. In many of them, the starting point has been a long-term vision of how to move the economy towards higher-value-added and knowledge-based activities. In many instances, targeted government policies have aimed to strengthen the national innovation system and facilitate knowledge inflows. Such policies have included:
- active promotion of imports of technology, know-how, manpower and capital from abroad;
- strategic investment in human resources to support technological upgrading in the private sector, typically with a strong focus on science and engineering;
- continuous improvement of education systems;
- development of science parks, public R&D labs and incubators that help promote innovation by both foreign and local firms;
- use of performance requirements and/or incentives as part of an overall strategy to attract FDI in targeted activities; and
- strategic implementation of IPR protection.
The active government policies to benefit from R&D internationalisation are also reflected in the work of investment promotion agencies (IPAs). A survey of 84 national IPAs found that more than half of them actively promote FDI in R&D (see table 2). By sub-region, the highest percentage was noted for IPAs in Asia and Oceania. Conversely only a minority of IPAs in Africa actively target R&D-related FDI, and only 11% of the Latin American agencies in the survey do so. For the world as a whole, this recent trend of R&D internationalisation should help to speed up the innovation process and facilitate more cross-border flows of knowledge and technology. The fact that some emerging economies are now perceived as attractive locations even for highly complex R&D (such as chip design) shows that it is possible for latecomer countries to develop the capabilities needed to connect with global R&D networks. It opens the door for the transfer not only of technology created elsewhere, but also of the technology creation process itself. That means new opportunities for firms and institutions in developing countries to engage in learning processes. New career paths for skilled engineers and scientists should help to mitigate the risk of brain drain.
How should governments respond to this latest feature of globalisation? Governments in developed countries may be tempted to put up barriers to prevent high-value R&D investment from leaving their shores. This is a temptation to resist because it risks, among others, damaging the competitiveness of their own firms that are global players. Instead, they should consider ways to improve the performance of their innovation systems. This may involve shifting into higher-level R&D activities, fostering world-class centres of excellence and helping displaced research staff to find new employment.
Countries that remain at best only loosely connected to the global R&D networks need a blend of realism and optimism. Few may have immediate prospects of attracting R&D from TNCs but, as part of longer-term efforts, they could learn from others by investing strategically in education and fostering an institutional environment that is supportive of innovation and R&D. The international community should support these efforts.
Torbjörn Fredriksson is a senior economist at UNCTAD.