Tuesday 11.24.15

Situating the State within Innovation: the German Example

When we think of innovation on a national scale – the US as a nation of innovators or entrepreneurs, for instance – we tend to use metaphors of genetics. “Innovation is in their blood,” we say, or “entrepreneurship is in their DNA.” We speak of “start-up nations”, invoking the metaphors of biological nationhood in which citizens are united by shared circumstances of birth or, somewhat more modestly, a shared innate outlook. What is obscured by these metaphors is the extent to which deliberate public policy facilitates, engenders, supports, and substantially creates this innovation.

Throughout its history, Germany has been an economic outlier. Most recently, Germany weathered the 2008 downturn, leading the EU in employment and exports. German products (particularly high-end manufacturing) have long been synonymous with quality in the minds of global consumers. This singular economic performance is not particularly novel, however. Though Germany’s industrialization in the late 19th century was late in comparison to its European peers, it came to rival (and in some cases surpass) its neighbors in exceptionally short order. Competition among pre-unification German states drove funding for university research labs, and in the 1870s, German firms created the first in-house research laboratories. Though German economic innovation has at times faltered – efforts in the ‘90s to import American-style approaches to innovation in biotech and software were disappointing – Germany has had success playing to its strengths; namely, export of high-value and technologically complex manufacturing.

As such an outlier, Germany is lauded as a nation of innovators in the same mythical terms I discussed above. It would behoove us to peel back the layers of myth and interrogate the structural and political roots of this performance, particularly if we want to assess the replicability of Gernany’s innovation climate. What, then, are the enablers of Germany’s success in innovation?

• Firm size as an enabler of vocational training: In Germany, small and medium enterprises predominate, targeting high-end markets and often under family ownership. While the size of a firm may not make it more or less innovative per se, there is an indirect impact on innovation on a national scale. These firms are not large enough to have large, in-house research capabilities yet spend a larger share of revenues on R&D than larger firms. This historically has supported a strong technical apprenticeship system, diffused throughout Germany, that myriad small and medium sized firms can participate in.

• Strong state financing: Germany has not blanched from financing R&D, even in times of fiscal constraint. There is broad recognition that R&D entails certain externalities, making it extremely valuable to a national economy but not always immediately profit-maximizing for individual firms. Germany has stepped in to support and subsidize research efforts that may be too risky for individual enterprises.

• Direct involvement of public R&D institutions: Subsidies are not always enough to bridge the R&D gap. The Fraunhofer Institute was created in 1949 to internalize research that was too applied for direct public expenditure but too risky for private capital. The institute blends public support through competitive grants with contract research for firms, the latter making up the majority of the institute’s revenue. Over the past four decades, Fraunhofer has become a remarkable storehouse of scientific and technical knowledge that is easily mobilized across disciplinary bounds and that can be spun off into its own enterprises.

Though other factors like the labor market structure and the availability of private finance for startups and private R&D also have an impact, I would argue that the combination of firm size, state financing, and public research institutions are at the heart of German innovation.

Each of these factors is uniquely challenging to replicate. Small firms have created an environment in which the German vocational system has thrived, which in turn has lowered the costs of training and research for these firms. But it’s difficult to tease out which came first, and in any case, it is difficult for any country to dictate firm sizes or create extensive vocational systems ex nihilo. State financing for R&D is challenging to execute. Subsidies alone have not been shown to be particularly effective at incentivizing research; rather, a complex ecosystem of programs is necessary. While the Fraunhofer model is intuitive and inspiring, its replicability in other countries (particularly developing countries) is plagued by brain drain, in which turnover at the institution is so high as to retard its growth.

Nevertheless, I would suggest that the last enabler – public R&D institutions like Fraunhofer – is one of the most promising avenues for donor intervention in developing economic innovation. Public R&D institutions strike an important balance among measurable impact, brandability, and scale, making them attractive and accessible options for discrete programs and piloting. The problem of institutional brain drain, while not trivial, has a long history of public and private sector experimentation and experience in a variety of contexts and scales.

While it is tempting to believe that innovation cultures can be replicated or, even more perniciously, to indulge in the fatalistic belief that certain nations are inherently more innovative, it may be more instructive to look at institutions that, although less “sexy”, are more productive levers for public policy.

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