Innovation Union Competitiveness papers Issue 2013/1

Internationalisationof business investments in R&D

EUR 25195 EN

Research and Innovation

EUROPEAN COMMISSIONDirectorate-General for Research and InnovationDirectorate C — Research and InnovationUnit C.6 — Economic analysis and indicators

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European CommissionB-1049 Brussels

EUROPEAN COMMISSION

Directorate-General for Research and Innovation2012 EUR 25195 EN

Internationalisation of business investments in R&D and analysis of their

economic impact

Authors of the study

Bernhard Dachs, Franziska Kampik, Thomas Scherngell, Georg Zahradnik AIT Austrian Institute of Technology

Doris Hanzl-Weiss, Gabor Hunya, Neil Foster, Sandra Leitner, Robert Stehrer, Waltraut Urban The Vienna Institute for International Economic Studies - wiiw

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Luxembourg: Publications Office of the European Union, 2012

ISBN 978-92-79-22836-0ISSN 1831-9424doi 10.2777/60978

© European Union, 2012Reproduction is authorised provided the source is acknowledged.

Images cover: earth, © #2520287, 2011. Source: Shutterstock.com; bottom globe, © PaulPaladin #11389806, 2012. Source: Fotolia.com

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Foreword

Things have changed. Contrary to what happened during previous serious economic and financial crises, R&D investment has been protected by businesses during the past few years, thus illustrating that such investment is now perceived as a crucial ingredient in the development of firms. It cannot be cut without endangering the development or even the survival of many companies, especially in the context of increased global competition. Firms have indeed maintained, on average, their investment in R&D during the crisis in 2008-2010. Furthermore, according to a recent survey commissioned by the European Commission, top EU businesses expect their investments in R&D to grow by an average of 4% annually over 2012 to 2014.Clearly, there is no future for firms' global competitiveness without investments in R&D.

This, combined with the observation that firms increasingly perform R&D activities outside their home countries, shows how important it is for Europe to continue attracting business investment in R&D from all over the world. This study is encouraging in that respect. It concludes that the rising degree of internationalisation in business R&D benefits the EU's Member States and strengthens their capabilities in science and technology.

The findings of this study are important for informing policy choices at a time when encouraging new sources of growth in Europe is a priority. The creation of the Innovation Union, which will further make Europe the place in which to invest in research and innovation, is obviously the right strategy. This calls for increasing efforts at EU and national levels to realise the Innovation Union as a key component of the Europe 2020 strategy.

Pierre Vigier

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Main findings

Firms increasingly perform research and development (R&D) at locations outside their home countries. We refer to this development as the internationalisation of business R&D. The internationalisation of R&D has become an important trend that shapes the national innovation systems of all European Union (EU) and OECD countries. Foreign-owned firms already account for 20% to 25% of total business R&D in France, Germany and Spain; between 30% and 50% in Canada, Hungary, Portugal, the Slovak Republic, Sweden and the United Kingdom (UK); and more than 50% in Austria, Belgium, the Czech Republic, Malta and Ireland. The project “Internationalisation of business investments in R&D and analysis of their economic impact” has been launched by the Directorate General for Research and Innovation of the European Commission (Economic Analysis Unit) to examine this phenomenon in detail. This study is part of a set of projects providing key information for policy making in the perspective of contributing to growth in Europe through innovation policies.

The results indicate that EU member countries are active players in the internationalisation of business R&D. The internationalisation of business R&D has strengthened intra-EU integration and the exchange of knowledge between EU countries. Around half of all R&D expenditure of foreign-owned firms in the EU can be assigned to firms from other EU member states.

There is also evidence that the EU is an attractive R&D location for firms from outside the EU . Non-EU firms, in particular firms from the United States of America (US), have continuously increased R&D expenditure in the EU since the 1990s. Further, multinationals from India, China, Brazil or other emerging economies are just about to make first steps into the EU as a location for their R&D activities. Strengths of the EU as a location for R&D include developed markets with a sophisticated demand (‘lead markets’), its pool of skilled labour, a stable economic framework, and excellence in academic and business R&D.

EU countries benefit from R&D activities of foreign-owned firms . Their R&D expenditure helps to raise overall R&D intensity in order to increase investment in research and development to 3 % of GDP as laid down in the Europe 2020 strategy. Moreover, R&D expenditure and labour productivity of foreign-owned affiliates is positively related to labour productivity of domestic firms which may indicate spillover and competition effects.

Moreover, EU firms are also very active in R&D abroad, in particular in the US, helping them to open up new markets and expand globally. The home countries benefit from this global expansion via reverse knowledge spillovers. Based on today’s empirical evidence, it is unlikely that these overseas R&D activities are a substitution for similar domestic activities.

The internationalisation of R&D has also changed the framework for R&D policy. Today, the largest corporate performers of R&D in a country are o�en foreign multinational firms. Countries that want to attract foreign R&D should rely on a stable economic framework and on policies to strengthen the capabilities of people, firms and universities, rather than grant financial incentives to foreign-owned firms. Moreover, policy should help to raise the capabilities of foreign affiliates and domestic firms for co-operation to stimulate knowledge spillovers between the two groups.

The Final Report of this study as well as its detailed Analytical Report and 34 Country reports are available at: http://www.ec.europa.eu/research/innovation-union/index_en.cfm?pg=other-studies

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1. Which countries are attracting R&D of foreign-owned firms?

The level of internationalisation in business R&D has increased in recent years in the large majority of countries. We measure these changes by relating the R&D expenditure of foreign-owned firms in a particular country to total R&D expenditure in the business sector of the country (see Figure 1).

The level of R&D internationalisation is highest in small countries such as Austria, Belgium, the Czech Republic or Ireland. In some of these small countries, R&D expenditure of foreign-owned firms is even higher than that of domestic firms. Smaller countries exhibit also a higher degree of openness in trade or foreign direct investment. In addition, it only takes a handful of multinational firms and their R&D investments to substantially raise overall R&D expenditure in a small country.

Large and medium-sized countries, in contrast, have considerably lower levels of R&D internationalisation. In the United States, around 15% of all business R&D expenditure comes from foreign-owned firms. The share of foreign-owned firms is around 25% in Germany. Japan is considerably below the US value.

But there are also exceptions to this rule. The UK and Canada, on the one hand, have high levels of R&D internationalisation compared to other countries of similar size. The UK benefits from its role as the preferred location for the European headquarters of US, Asian and other non-European firms. Canada owes its high degree of R&D internationalisation to its strong economic ties with the US.

On the other hand, Finland, Switzerland and Denmark have surprisingly low shares of foreign-owned firms on total R&D expenditure for small countries. The reasons for this are country specific and include the amount of R&D done by domestic firms, the attractiveness of the market, but also geography and cultural factors.

Large countries tend to have a lower degree of internationalisation in relative terms; in absolute terms, however, the US, Germany, the UK, Japan and France are by far the most important host countries for R&D activities of foreign-owned firms. In 2007, foreign-owned firms in the United States spent around 30 bn EUR on R&D. The corresponding amount for Germany is 11 bn EUR, 9 bn EUR for the UK, 4.8 bn EUR for France and 4.4 bn EUR for Japan.

R&D internatio-nalisation is strongest in small countries such as Austria, Belgium, the Czech Republic, Hungary or Ireland

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There is no official number for R&D expenditure of foreign-owned firms for the whole EU. Based on the data from the member states, we estimate that R&D expenditure of foreign-owned firms in the EU amounts to more than 42.6 bn EUR in 2007. Around half of this amount can be attributed to foreign-owned firms from non-EU countries, mostly US and Swiss firms.

R&D internationalisation can also be analyzed from a home country perspective. Data on R&D activities of domestic firms abroad is scarce however. The available data suggests that US firms have the highest overseas R&D expenditure, followed by Swiss and German firms. Firms located in Switzerland spend more on R&D abroad than at home.

In a global perspective, the internatio-nalisation of business R&D is the result of relations between a small number of countries. Figure 2 illustrates these relationships for the manufacturing sector of the EU, the US, Japan, China and Switzerland. The service sector is excluded due to scarce data. The size of the pie chart for each country indicates the total amount of R&D expenditure of foreign-owned firms in this country, while the pie slices represent the R&D expenditures of foreign-owned firms from one particular country. Inter-nationalisation between two EU member states is excluded in Figure 2.

The figure reveals the outstanding importance of the relationship between the US and the EU. R&D expenditure of US firms in the EU and of EU firms in the US taken together account for 2/3 of R&D

Figure 1: R&D expenditure of foreign-owned firms (inward R&D expenditure) as share of total business R&D expenditure, 2003 and 2007

Note: No 2003 data for Malta, Israel, Netherlands, Switzerland and Denmark; * 2008 instead of 2007; ** 2006 instead of 2007; *** 2004 instead of 2003Source: OECD, Eurostat, national statistical offices, own calculations

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expenditure of foreign-owned firms in manufacturing world-wide (The EU is considered as one entity, and intra-EU relationships - for example, R&D of German firms in France - are not taken into account). The US is also the largest investing country in the majority of the EU member states. EU firms account for more than 65% of the total manufacturing R&D expenditure of foreign-owned firms in the US, or more than 90% once other European countries which are not members of the EU (mainly Switzerland and Norway) are added.

In recent years, China has emerged as a new location for R&D of foreign-owned firms. However, Chinese data is incomplete and plagued by some methodological issues which render a comparison with data from OECD countries difficult. We included the R&D

expenditure of wholly foreign-owned companies in China in Figure 2, which is 2.4 bn EUR for the year 2007. A breakdown of this amount into different countries of origins is not available.

From an European perspective, R&D internationalisation within Europe is shaped by i) the role of Germany as the most important home country, and by ii) strong relationships between neighbouring countries. Figure 3 illustrates this integration with bilateral data on R&D expenditure of foreign-owned firms. The thickness of the lines between countries A and B corresponds to the sum of R&D expenditure of firms from country A in country B and vice versa. The node size of each country corresponds to the sum of R&D expenditure of foreign-owned firms in the country.

Figure 2: Overseas business R&D expenditure in manufacturing between the EU, the US, Japan, China and Switzerland, 2007, mio Euro.

Reading note: Firms from the EU have spent 774 mio EUR on R&D in Switzerland in 2007; Swiss firms have spend 2,470 mio EUR on R&D in the EU in 2007.Swiss data include also the service sector; data for China is estimated based on national sources and US and Japanese outward dataSource: OECD, Eurostat, national statistical offices, own calculations

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The United States is the largest investing country in the majority of the EU member states

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The resulting map of R&D internationalisation in Europe is uneven and its patterns are shaped by geography and size to a considerable degree. Germany is the central hub in this network and shows strong interactions with its direct neighbours Netherlands, Switzerland and Austria. The UK shows particular high interaction intensity with Sweden and France, Spain shows the strongest connections with France and Belgium. Finland appears to have a diverse set of partner countries but in terms of absolute size the interactions are comparably low. EU-12 member states are mostly connected to EU-15 countries; connections between

the EU-12 countries are weak. This is the result of the small size of most of these countries and a lack of multinational companies originating from these countries.

The internationalisation of R&D has led to a strong integration of business R&D within Europe. EU countries, as can be seen in Figure 4, account for the largest share of R&D expenditure of foreign-owned firms in almost all European countries. Moreover, the EU is the largest investor in Japan and the US. Figure 4 also confirms that the inter-nationalisation of R&D, through

Figure 3: Relationships between European countries measured by R&D expenditure of foreign-owned firms, 2007

Note: Node size corresponds to the sum of R&D expenditure of foreign-owned firms in a country. The thickness of the lines between countries A and B correspond to the sum of R&D expenditure of firms from country A in country B and vice versa.No data available for Italy and GreeceSource: OECD, Eurostat, national statistical offices, own calculations

Within Europe, Germany is the

central hub in R&D internationalisation with strong linkages

to its neighbours

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becoming more global, still has a strong regional character.

Intra-EU R&D internationalisation (foreign-owned firms from one EU country doing R&D in another EU country) amounts to around 19 bn EUR in 2007. This is almost half of the total R&D expenditure of foreign-owned firms in EU countries (42.6 bn EUR). Thus, the

internationalisation of business R&D also contributes to the completion of the European Research Area. Despite strong ties between neighbouring countries, there are no cohesive sub-groups in the network – groups of countries which are strongly connected with each other, but have only weak links to the rest of Europe.

Figure 4: R&D expenditure of foreign-owned firms: share of EU countries as country of origin (2007)

Notes: Malta and Switzerland 2008; Ireland 2005, Canada 2003; only manufacturing included in Belgium, Canada, France, Germany, Ireland, Japan, Norway and the United States of AmericaSource: OECD, Eurostat, national statistical offices, own calculations

0% - 30% 30% - 50% 50% - 65% 65% - 80% 80% - 100%

Integration between EU member states in terms of business R&D is strong

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2. The sectoral perspective

The internationalisation of R&D is to a considerable degree sector-specific. A high sectoral R&D intensity is a necessary precondition for the internationalisation of R&D. Hence, in most countries, R&D expenditure of foreign-owned firms concentrates on R&D intensive, high technology or medium-high technology sectors (see Figure 5). Moreover, some sectors offer better preconditions for a decentralized organisation of R&D, because their knowledge base is less cumulative, allows an easy exchange of knowledge, or because there are only few size advantages in R&D which would favour a centralisation.

These factors help to understand why the internationalisation of R&D predominantly takes place in pharmaceuticals, machinery and equipment, electrical and optical equipment (including computers, communication equipment, and instruments), motor vehicles and other transport equipment including the aerospace sector. Each of these sectors accounts for between 5.2 bn EUR (machinery and equipment) and 16.4 bn EUR (pharmaceuticals) of R&D expenditure of foreign-owned firms worldwide in 2007. The highest degree of internationalisation is found in pharmaceuticals, where 30% of total R&D expenditure in the US and Europe comes from foreign-owned firms, followed by motor

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Note: * 1999 (Greece), 2001 (Canada, Netherlands), 2005 (Ireland) and 2008 (Malta, Switzerland) instead of 2007; Due to data constraints in the services sector, we only consider five industries: four manufacturing industries and total non-manufacturing (including KIS and LKIS but also all other non-manufacturing sectors). Source: OECD, Eurostat, national statistical offices, own calculations

The majority of R&D expenditure of

foreign-owend firms is concentrated in a

few industries

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vehicles and other transport equipment. The only relevant non-manufacturing sector is business services, which is important in Israel, Estonia or the UK in particular. In most of these sectors, the US attracts the largest amount of R&D of foreign-owned firms, followed by Germany.

The lowest degrees of internatio-nalisation of R&D are found in low- and medium-low technology sectors such as textiles and clothing, wood, paper, rubber and plastics, or basic metals and metal products. An exception is the food and drink industry, which shows high levels of R&D internationalisation due to a number of multinationals with widely decentralized R&D networks. Though data is scarce, the existing evidence suggests that service industries tend to be characterised by lower levels of R&D internationalisation compared to manufacturing industries.

3. Who are the new players in the Internationalisation of R&D?

There is evidence that Asian countries, in particular China, India, Singapore, Taiwan, or Malaysia are emerging as new players in the internationalisation of R&D, both as host countries and as home countries for internationally active firms. Data availability and quality for these countries, however, is poor compared to the EU member states.

The most reliable source to analyse the emergence of new players in R&D internationalisation is data on overseas R&D expenditure of US firms. This data also allows some conclusions on the attractiveness of the EU vis a vis emerging economies as a location for R&D.

Figure 6 above displays overseas R&D expenditure of US firms in mio USD between 1994 and 2008. We included the EU, Japan, other OECD countries (including Australia, Canada, Korea,

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Figure 6: Overseas R&D expenditure of US firms, 1994-2008, mio USD.Source: OECD based on US outward data by the US Bureau of Economic Analysis, own calculations

The importance of emerging economies as locations for overseas R&D is growing fast

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Israel, Mexico or New Zealand), non-OECD Asia (including China, India, Taiwan, Singapore, or Malaysia), and the rest of the world (including Africa and South America).

The figure conveys two messages. In relative terms, the rise of Asian countries as R&D locations for US firms has led to a shift in the distribution of US overseas R&D expenditure. The share of the EU on US overseas R&D expenditure has decreased from around 75% in 1994 to around 60% in 2008, with corresponding increases for Asian countries and non-European OECD member states. It is also remarkable that

most of this decrease occurred in the second half of the 1990s: the share of the EU on US overseas R&D expenditure has remained relatively stable since the early 2000s.

In absolute terms, however, R&D expenditure increases at each location, and overseas R&D expenditure of US firms in the EU more than doubled between 1994 and 2008. The development in the last years prior to 2008 shows no indication that US firms would increase their R&D efforts in Asia at the expense of locations in the EU, indicating that the internationalisation of R&D is not a zero-sum game.

But China and India are not only host countries for R&D activities of foreign-owned firms. A small number of Chinese and Indian firms have already set up R&D activities in Europe and the US. Some of these activities are not yet fully reflected by the currently available data. Future research should therefore focus on the R&D activities of these firms in Europe and the US, their motives and strategies.

4. What drives the internatio-nalisation of business R&D?

The motives of firms to locate R&D activities abroad are manifold and complex, partly determined and driven by very specific conditions in both host and home countries. As such, the size of the host economy is a major driver of R&D expenditure of foreign-owned affiliates. Larger markets which promise superior market potentials and sales prospects are conducive to R&D efforts of foreign affiliates since the costs of R&D can easier and faster be recovered and profits quickly materialise.

R&D efforts of foreign affiliates also tend to be higher if they face lower cultural barriers in their host countries. Stronger cultural ties between home and host countries ease communication and

11

the exchange of information and knowledge between foreign-owned firms and local organisations, improve their market knowledge and understanding of customer preferences and demand and facilitate their access to informal networks in their host countries. Similarly, geographic proximity is an important driver of R&D expenditure of foreign affiliates. Foreign affiliates located in neighbouring countries spend signi-ficantly more on R&D than foreign affiliates located farther away.

Moreover, a pivotal role is also attributable to the quality and size of a skilled workforce which is crucial in any successful research endeavours. Specifically, a large pool of skilled labour in the host country is conducive to R&D activities of foreign affiliates while a shortage of a skilled labour force in the home country tends to foster the relocation of innovative activities to other parts of the world with more

conducive and superior human capital stocks.

In contrast, distance between the host and the home country is obstructive to R&D expenditure of foreign affiliates. Typically, foreign-owned firms have to shoulder additional costs when penetrating foreign markets: the costs of co-ordinating geographically dispersed R&D activities, the costs of transferring knowledge over distance, or a loss of economies of scale and scope when R&D becomes more decentralised. And since additional costs increase with distance, R&D expenditure is higher in foreign affiliates located closer to the home country.

Case study evidence moreover points to the importance of sector-specific drivers, such as the rising cost of R&D that leads to mergers and acquisitions, long-term specialisation patterns in various industries, the need to do R&D close to customers to learn from them, and the

Location decisions for R&D are driven by market size, availability of skilled personnel, and geographical and cultural proximity

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various roles of policy as a driver for trans-national co-operation in business R&D in Europe. In general, the most important principle is non-discrimination of domestic and foreign-owned firms.In some sectors, such as aerospace, however, policy has actively promoted internationalisation by creating trans-European conglomerates.

It is also important to recognize that R&D internationalisation is the result of the activities of a very small group of large, R&D intensive, multinational firms. The activities of only a handful of MNE affiliates can explain aggregate patterns of R&D internationalisation in small countries in particular.

5. How does the internatio-nalisation of R&D affect the host countries?

Host countries can benefit considerably from the presence of foreign-owned firms. A first, direct effect is that foreign-owned firms may help to increase aggregate R&D expenditure in a short time. Moreover, there is also a positive relationship between R&D expenditure of foreign affiliates and labour productivity of domestic firms which may indicate that domestic firms become increasingly more productive due to knowledge spillovers emanating from innovative foreign-owned firms.

In addition, there is evidence of performance and size effects on domestic firms. Specifically, labour productivity as well as employment of foreign-owned and domestic firms is positively related which may point to the presence of strong competition effects between domestic and foreign-owned firms which render domestic firms larger and more productive.

Foreign presence may also have negative effects on the host countries, if R&D activities of foreign-owned firms substitute or crowd-out activities of domestic firms. Altogether, there is however no evidence of a crowding-out of R&D activity between domestic and foreign-owned firms. The analysis indicates that higher R&D intensities of domestic firms go hand in hand with higher R&D intensities of foreign-owned firms. These complementarities are stronger in the group of EU-15 countries than in EU-12

6. What are the consequences for the home countries when domestic firms are investing in R&D abroad?

The internationalisation of R&D also has implications for the home country of the multinational firm. A main benefit of overseas R&D activities by domestic multinational firms is the transfer of

Host countries can benefit in various

ways from the presence of foreign-

owned firms

13

knowledge from abroad to the home country. Various studies provide evidence for such reverse knowledge transfers. Reverse knowledge transfer may increase the overall technological capacity and strengthen the growth of the parent company.

But overseas R&D of firms may have also negative consequences for the home country when firms replace domestic R&D activities with similar activities abroad. The empirical evidence - which is however severely plagued by missing data - does not suggest such a “hollowing out” of domestic R&D.

Case study evidence even suggests that domestic and overseas R&D complement each other, because they target different markets. This is in line with other studies which point to complementarities between domestic and overseas R&D activities, at least at the aggregate level and in the long term.

7. Conclusions for Policy

The internationalisation of R&D changes the framework for R&D policy. Today, the largest corporate performers of R&D in many countries are foreign multinational firms. R&D, innovation, and subsequent production activities may take place at different locations inside and outside of a particular country, which may alter the way new technologies are transformed into growth and new jobs.

Science and technology policy has to reflect these changes. This study and similar research have shown that the internationalisation of R&D promises substantial benefitsfor home and host countries. The EU has a favourable position in the internationalisation of business R&D. Policy can help in various ways to maintain or even improve this position.

First, policy should maintain and foster research-friendly environment, increase the skills of the workforce – particularly those needed for R&D - and strengthen university research. Results from the quantitative analysis of this project and similar studies suggest that a stable economic framework and a sound science and technology policy are important attractors for R&D activities of foreign-owned firms.

Second, the results suggest that substantial spillovers between foreign-owned and domestic firms exist, raising labour productivity in the latter group. Policy needs to further stimulate these spillovers by raising the capabilities of foreign affiliates and domestic firms to co-operate and stimulating foreign affiliates to integrate into domestic innovation networks. Third, the analysis also shows that EU firms are very active in R&D outside Europe, in particular in the US. EU firms also increasingly perform R&D in emerging economies, including China and India. Our picture of these activities, however, is still incomplete, since data on this recent phenomenon is scarce. Results of this and similar studies indicate that R&D of EU firms outside Europe is beneficial for the home countries. There is no evidence that this expansion has led to a reduction of R&D activity in Europe. In contrast, Europe benefits from the global expansion, the opening up of new markets which may also contribute to growth at home, and from reverse knowledge spillovers.

These findings suggest that European policy makers should not be too worried about R&D activities of EU firms outside the EU. The question if policy should support outward internationalisation, however, requires a better understanding of causes and consequences. Therefore, further research filling existing data gaps on the potential impacts and future prospects of R&D internationalisation of EU firms is required.

R&D activities of domestic firms abroad do not ‚hollowing out‘ national R&D capacities

The European Union has a favourable position in the internationalisation of business R&D

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European Commission

EUR 25195 — Internationalisation of business investments in R&D and analysis of their economic impact

Luxembourg: Publications Office of the European Union

2012 — II, 14 pp — 17,6 x 25 cm

ISBN 978-92-79-22836-0doi 10.2777/60978

This is a study designed, commissioned and owned by the European Commission, DG Research and Innovation, Unit C6-Economic analysis and indicators. This study is part of a set of projects providing key information for policy making in the perspective of contributing to growth in Europe through innovation policies.

This publication, as well as the complete Final report of the study, the detailed Analytical Report and 34 Country reports are available at: http://www.ec.europa.eu/research/innova-tion-union/index_en.cfm?pg=other-studies

Studies and reports

KI-NB-25-195-EN

-N

doi: 10.2777/60978