5. Reforming the system.

NATIONAL INNOVATION SYSTEM

An essential tool to moving beyond the present approach to private sector development is the National Innovation System (NIS. A National Innovation System is the set of government and private sector policies and incentives that generate much of a country's research and technological innovation. A successful NIS would seek to improve private sector investment in research and development, labor skills and education, and encourage collaboration between businesses and research institutions. (55)

Chile has succeeded in introducing new technologies, engaging in technology transfers, improving the business environment, and improving company strategy and operation. However, it remains behind similar-income countries in East Asia and Eastern Europea in investment climate and innovation frameworks. In addition to attracting more foreign technology, these countries have invested in public and private research and developmemt, and encouraged collaboration between scientific institutions and local firms. (56)

In contrast, Chile does not have a formally declared and accepted technology innovation policy. Nor does it have a mechanism to coordinate activities in science, innovation, and technology. The lack of a central authority to coordinate the innovation and technology efforts and provide a strategic framework with unifying principles leads to a loose ad hoc coordination. It would be far more effective if there were a forum for exchange, a shared diagnostic and a strategic framework to insure the efficient use of resources, minimize mixed signals to potential product users, and maximize new business applications.

In addition, Chile is a leader in some areas of scientific research, but not in business applications that may result from the research. The Chilean scientific community garners well-deserved international respect, and is moving toward a leadership position in research among industrializing countries. However, this substantial progress has not yet matched the country's aspirations. The table below shows the strengths and weaknesses of the Chilean NIS.

Three factors limit the Chilean National Innovation System: (1) low levels of education in reading and mathematics, (2) a very small investment rate in applied technology, and (3) an even lower commitment from private firms. The low quality of education is reflected in low comprehension reading levels and knowledge of mathematics, compared to countries with similar GDP levels. In addition, given its impact on the transition to an innovation economy, a more worrisome aspect is the very low level of resources dedicated to technological innovation--only 0.7 percent of GDP. This is far below the 2 percent average in OECD countries. In Chile, the private sector only contributes 25 percent of the total amount applied to basic research. This translates into a very low investment in applied research or transfer activities; if increased, these investments could lead to improved firm performance. (57)

However, innovation for its own sake is not the answer--business applications are what matter. Given the importance that exports have in the national economy, Chilean firms are well aware that businesses compete in the global economy. But if firms do not integrate technological innovation into their business plans, the public sector's efforts to create an intensive knowledge-based economy will be ineffective. Moreover, because of the lack of concrete applications or relevance, the resources assigned to science and technology may not produce the desired results. Innovative technologies with business applications promise much more for the modern economy.

To that end, the National Commission of Science and Technology (CONICYT) and the Presidential Scientific Advisory Commission are responsible for formulating and overseeing Chile's strategy for scientific and technological development. In addition, the Presidential Commission on the Development of New Information and Communication Technologies and the Biotechnology Development Commission have sought to provide an integrated and macro level approach to innovation. As a result, Chile has developed myriad policies, programs and policy instruments for research and innovation. To make the strategy more effective, representatives of the beneficiaries-research institutions, universities and private firms--should be involved in the design and implementation of this strategy. The government would benefit from devising an overall strategy and coordinating its initiatives in these areas, by aligning managerial responsibilities with accountability for results, and introducing consistent budgeting and monitoring process. Further, it will be important to identify clearly the institution that will lead these exercises and provide monitoring and periodic reports. (58)

In addition, the World Bank-sponsored Science for the Knowledge Economy Project (IBRD 71720) had two development objectives, which should place Chile on the path to a knowledge-based economy. First, the project sought to establish a strong and coherent policy framework, promoting high-quality and relevant science and technology activities and by supporting international linkages and linkages between the public and private sector. Second, the project sought to improve the stock of human capital in the Chilean science and technology sector. The project pursued these objectives through three components: (i) improving Chile's science, technology and innovation system; (ii) strengthening Chile's science base; and (iii) enhancing public-private linkages. The project closed in March 2007. The World Bank is developing a follow-up innovation project with public- and private-sector partners.

Finally, Chile would benefit from the examples of some of the countries with which it competes. For example, many countries have established five and 10-year action plans to encourage technological development. These exercises include broad consultations with national and international experts and with active private-sector and university participation. They include real strategic agreements on a diagnostic and propose measures to be implemented over time. They are driven by an integrated and macro level approach to innovation, limited resources and the need to generate a minimal critical mass to obtain relevant research and development results.

Israel and Finland provide two two examples of this decision to build a national innovation system and target R&D investment. Israel began subsidizing R&D in 1968 with the establishment of the Office of the Chief Scientist in the Ministry of Trade and Labor. Industrial R&D increased by an average of 14 percent over the next 20 years. In 1985, with the adoption of the Law for the Encouragement of Industrial R&D, the sector received another boost. Matching funds of up to 50 percent for existing firms and 66 percent for start-ups "crowded in" private sector investments of 41 cents for every dollar of subsidy. Successful firms must repay 3 percent of annual sales up to the dollar-indexed value of the grant. Products must be manufactured in Israel. Know-how acquired in this way cannot be transferred to third parties. (59)

Finland established a national target of increasing R&D investment from 1.5 percent of GDP in 1983 to 2.7 percent by 2000. Tekes, the National Technology Agency, was set up in 1983 to finance applied and industrial R&D investments, especially through clusters. To strengthen coordination with the private sector, the Science and Technology Policy Council was established in 1987. Subsequently, to address the lack of a fully functioning venture capital market, Tekes began financing up to 40 percent of R&D investments in its projects. This subsidy strengthens the strategic and operational links between businesses and research institutes. (60)

Foreign Direct Investment and the Knowledge Economy

Attracting foreign direct investment (FDI) is one way to incorporate knowledge in a country's economic activities. FDI is usually composed of investment capital, management experience, product design and process advances. Chile has been very successful in attracting FDI, particularly since 1990. Its public security level, institutional transparency and well-established democracy make it an attractive choice for international investors. Chile's disadvantages include a small domestic market and the distance from key markets in North America and Europe.

Many countries have tried to compensate for specific disadvantages with generous incentives, but too many subsidies have the risk of attracting investments that are not based on a country's advantages. These investments eventually become uncompetitive in international markets. The investors stay only as long as the subsidies last and do not develop important linkages with the local economy. Incentives should be reserved for those sectors that offer a long-term prospect for competitive production, but due to industry-specific requirements would not attract sufficient FDI naturally. The most effective incentives for investments with a technology component support include training and capacity building, support for research and development, high quality infrastructure and, in general, high impact incentives that support the enterprise's business. (61)

Strong international competition to attract FDI has made it an area of growing specialization. Efforts to attract FDI can benefit from general dissemination campaigns on the country's image, but they also require face-to-face work. This is particularly true for countries that are still not on the "mental map" of the decision makers. Ireland, Sweden, Costa Rica and various Asian countries have been especially successful because they have special agencies dedicated to attracting foreign investment and have established offices in the markets in which they concentrate their promotion efforts. In addition, promotion efforts should be sustained in time, providing updated information to established contacts.

Despite such promotional efforts, the low availability of engineers and qualified technicians is a limiting factor. Foreign companies with investments in high tech sectors have been able to hire sufficient skilled personnel for the early phase of development and production. However, due to inadequate numbers of skilled technicians, firms are frequently unable to expand their activities. To overcome this obstacle, some companies have reached agreements with local universities to train professional staff. Since CORFO already has a broad menu of technology support programs, these could also be part of an attractive package of incentives to attract FDI in high tech sectors. Another option would be for the government to ease immigration restrictions to enable firms to attract skilled technicians from other countries. (62)

Technology Adoption, Adaptation and Innovation

There are three options to developing a technology-rich business environment: adoption, adaptation or innovation. The most profitable strategy for most Chilean companies is to adopt technological innovations from the large international innovation centers. This permits business applications without the enormous research and development costs incurred by inventors. This strategy is also the most profitable because it saves time and resources. (63)

As a result of research and development investments in wine production, mining, and forest products, Chile has succeeded in exploiting its comparative advantages. These sectors have sustained the export growth of the last two decades and are operating very close to the international frontier of knowledge. These sectors are also candidates for cluster development, since they link research institutions and firms to boost Chile's innovation capacity. (64) At the same time, these strategic production chains would benefit from an analysis of the technological bottlenecks, trends in international competition, and the relationships between key actors.

Based on a ranking of problems and opportunities, technology programs can be structured with objectives defined by the companies themselves. The programs can include collective or individual research and development projects (each with its own incentive), investments in improved research capacity, training, and technology transfer programs, among others. In addition, public technology institutes can be strengthened and reoriented to play a more central role in innovation development. Of the six public institutes with R&D programs, five focus their efforts on natural resources industries. (65) Several lack a sufficient number of high-level specialists, are in a precarious financial situation, and have few venues to transfer their findings to the private sector. To reorient the institutes to serve private sector needs, the first priority could be to focus on institutional development. The institutes might also build strategic alliances with international firms, identified through a competitive bidding process. These partners could contribute skilled personnel, innovative technology, and business applications. Encouraging these links and building long-term programs, matching grants and other incentives could be useful.

In addition, the public interest activities of some of these institutes could be combined in a single public institution concerned with natural resources issues. Given the importance of this area in the nation's business and in exports, an institution of this nature is fully justified. The new institution could assume research and development activities and participate in applied technology transfers with foreign counterparts and the private sector. This increased participation by the private sector could be accompanied by some public or academic presence to reduce the risk that the private business interests will "capture" their capacities. Fundacion Chile could serve as an example in this regard. (66)

To take on this more focused role, the public technology institutes will need to build capacity and hold on to key staff. To that end, they will need more resources. Although they can obtain an important part of their resources from competitive projects and the sale of services, they need additional resources to develop their systems and services. Otherwise, they run the risk of not being widely connected and respected. One way to implement these transfers is to establish performance contracts between the institutes and an authority that acts as a client.

STREAMLINING THE SME SUPPORT PROJECT PORTFOLIO

The original research for this study focused on the mission and capacity of the three government agencies with the largest SME support portfolios--CORFO, INDAP, and SERCOTEC. The analysis of the programs led to a proposed reform that could include 43 programs with a concentration in Agriculture and Animal Husbandry and Cross-Sectoral programs. Table 5.2 summarizes the programs. This reform allowed for more effective dissemination campaigns, and for moving the programs closer to their target markets. The programs would be demand-driven, have lower administrative costs, and avoid duplication and inter-institutional competition.

To avoid duplication, a centralized monitoring system and a review by the Ministry of Economy, responsible for the performance of the programs, would monitor the menu of programs for SMEs. This centralized review system would counteract the tendency to create programs to meet newly identified needs. It would develop and employ minimal criteria and requirements before a proposed instrument could be included in the development program portfolio. It would also permit policymakers and clients to see the entire range of programs. In a subsequent phase, this system could compile standardized information to measure the delivery costs and coverage of each program, thereby enabling timely comparative evaluations between the programs.

THE PATH TO A MORE DYNAMIC SME SECTOR

Most of the elements needed for improved SME efficiency and productivity are already in place, but without improved coordination, gains will be isolated. To build on national successes and capacity will require a clear mandate for the institution charged with improving the overall effort to improve SME performance. The required changes begin at the strategic level, with a conscious effort to create a National Innovation System with complementary policies and programs, coordinated and led by a single institution. Without improved coordination, the Government's investment in support of a more dynamic business sector will result in sporadic gains rather than a systemic change. Other important adjustments in the SME support institutions will avoid duplicating efforts and lead to demand-driven responses. This new focus will provide a more commercial approach to client support--and graduate clients out of the programs. Finally, without better scorekeeping, in the form of an integrated management information system, it will remain difficult to analyze, assess, coordinate and streamline the SME program portfolio in the future. Potential savings from improved coordination and streamlining are likely to amount to millions of dollars annually. At the same time, the impacts of improved productivity, employment and linkages to export markets will improve as the SME support portfolio is rationalized and refocused to more promising sectors and firms.