Presentation to Statistical and Social
Inquiry Society of Ireland, 1st Nov 2012.
Effects of R&D Spending on Innovation by
by Irish and Foreign-owned Businesses
Justin Doran, Declan Jordan
& Eoin O’Leary,
School of Economics,
University College Cork

Introduction
 This paper estimates the private returns to four different kinds of
R&D spending on probability of Irish and foreign-owned businesses
engaging in product, process and organizational innovation.
 By providing econometric analysis of the Community Innovation
Survey: 2004 to 2006 for a sample of nearly 2,000 businesses, it
contributes to the debate on Irish innovation policy.
 Begins by profiling policy stance, then positions paper in context of
recent literature on Irish innovation, leading to the formulation of
model.
 Then presents descriptive statistics and regression results
 Finally, we will look at the policy implications of this work.
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Irish Policy Context
 Important policies that delivered ‘Celtic Tiger’
 12.5% corporation tax
 Targeting high-technology foreign-owned sectors
 Objective was ‘industrialization by invitation’ with objective being
that multi-nationals would ‘embed’ in Irish economy.
 Policy a success if need for IDA pipeline lessened over time.
 Little evidence of agglomeration economies (O’Leary, 2007, Van
Egeraat, 2006).
 Reputation and demonstration effects may be important (Barry et
al , 2003).
 After 1990s, high cost led to policy of ‘Innovation by Invitation’ –
strong emphasis on increasing R&D spend to 3% of GDP.
 Continued reliance on IDA pipeline – even more important in current
crisis!!
 Given long-standing importance of foreign-owned businesses, it is
important to compare them to Irish-owned.

Irish Policy on R&D
 In Building Ireland’s Smart Economy our government stated that
“Ireland has already laid the foundations of the ideas economy by investing heavily
in education, skills training and R&D under the National Development Plan [2007-
2013], which includes delivery of the Strategy for Science, Technology and
Innovation involving major investments in basic research through the PRTLI, SFI
and other funding programmes. €8.2 billion has been committed to research,
technological development and innovation [under the National Development Plan
2007-2013]. Business expenditure on R&D is targeted to grow to about €3.8 billion
per annum by 2013”.
(Department of the Taoiseach, 2008:60)
 Policy shift towards funding R&D by businesses and HEI’s initiated
during the late 1990s.
 Agencies have devoted significant shares of their budgets to
science and technology.
IDA Ireland spending on S&T increased since 2004 to reach 67% in 2010.
EI spending share increased before 2004 and declined since, to reach 36% in
2010.
SFI founded in 2000 and spend €170 million annually.
4

Irish Policy on R&D (ctd)
Business +5.3% pa
Source: CSO, BERD Releases

Irish Policy on R&D (ctd)
 Incentives for BERD
 12.5% corporation tax attractive to all business.
 R&D is a cost centre – why would foreign businesses locate it
here?
 25% R&D tax credit, grants etc help to eliminate disincentive.
 Range of additional supports for Indigenous industry
 R&D Funds; Competence Centres; Applied Research Enhancement.
 Business Incentives linked to HERD
 Investment in science may be attractive to industry
 Collaboration with HEI’s through matched funding initiatives.
 Tax exemptions for all business on patents/licences sourced in
European Economic Area
 Range of additional supports for Indigenous industry working
with HEIs
 Innovation Vouchers; Innovation Partnerships; Technology Transfer; Spin-
outs etc
6

Recent Evidence on Irish Business
Innovation
 Innovation policy criticized for
 science-push focus through role of HEI’s
 focus on high-technology sectors
 Evidence that external interaction with HEIs might have limited effect
(Jordan and O’Leary, 2005, 2008 & 2011 – 184 High-tech)
 Availability of broad-based CIS facilitates more detailed analysis
 Are Some Businesses More Likely to Innovate than Others?
 Businesses in 5 sectors (including high-tech) are equally likely
 Foreign-owned businesses more likely
 ‘Dichotomous knowledge sourcing’ – high-tech businesses more likely to source
knowledge from universities.
 What is Role of External Knowledge for Innovation and Productivity?
 Theory is that interactive learning crucial for innovation performance
 External interaction affects decision to innovate but not the exploitation of
innovation for productivity gains within the business
 Therefore, important to drill deeper into R&D activity in Irish businesses
(Doran and O’Leary, 2011 – Irish CIS).

Private Returns to R&D Spending
 Returns to R&D may be private or social (Roper et al, 2003, 2004) –
only concentrating here on the former.
 R&D linked to absorptive capacity – increased ability to identify,
assimilate and exploit knowledge for innovation (Cohen and
Levinthal, 1989).
 Research confirms R&D expenditure has consistently strong
positive effects on probability and intensity of innovation (eg Crepon
et al, 1998; Roper et al 2008, Doran and O’Leary, 2011).
 Klette and Griliches (1990) propose that R&D spending exhibits
positive but diminishing returns – as products become more
sophisticated the costs per efficiency unit increases.
 Therefore, going to test whether private returns to R&D spending
are positive and diminishing?

The Model
 We estimate a series of innovation production functions
using probit models
IOi = α 0 + β j R & Dij + λ j R & D + φ k Z ik + ε i
2
ij
 Three types of Innovation output and four types of R&D
spending are considered.
 We use two equivalent approaches to assess differences
in the determinants of innovation performance between
Irish and Foreign-owned:
 Interaction Terms - Interact Coefficients by ownership type
 Likelihood Ratio Tests - Split regressions by ownership type
 Both reveal significant differences.
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Descriptive Statistics from the Irish CIS 2004-06
Irish-Owned Foreign-Owned
Variable Standard Standard
Mean Mean
Deviation Deviation
Innovation
Product Innovator (1/0) 32.31% n.a. 53.25% n.a.
Process Innovator (1/0) 30.13% n.a. 46.35% n.a.
Organisational Innovator (1/0) 40.42% n.a. 56.41% n.a.
R&D Activity (€ per worker)
Intramural R&D € 1,370 € 7,634 € 4,881 € 20,582
Acquisition of Capital for Innovation € 1,719 € 13,030 € 8,621 € 60,900
Extramural R&D € 108 € 1,480 € 981 € 9,338
Acquisition for External Knowledge € 134 € 1,731 € 4,366 € 54,112
Sectors
High Technology Manufacturing 8.86% n.a. 28.99% n.a.
All Other Manufacturing 32.38% n.a. 22.88% n.a.
Wholesale, Transport, Storage &
39.33% n.a. 21.89% n.a.
Communication
Financial Intermediation 6.13% n.a. 14.99% n.a.
Computer, Architecture & Engineering
13.29% n.a. 11.24% n.a.
Services
Employment 86 524 232 564
Number of Observations 1,467 507
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What is the effect of R&D Spending on
the Probability of Innovation?
Product Process Organizational
Irish* Foreign Irish* Foreign Irish* Foreign
Intramural – +0.0723 +0.0250 +0.0148 Not +0.0144 Not
significant significant
‘creative work
by business’
Acquisition of +0.0163 +0.0163 +0.0242 +0.0050 +0.0342 +0.0037
Capital for
Innovation
Extramural – Not Not +0.1057 Not +0.1217 Not
significant significant significant significant
‘creative work
by others’
Purchase or Not +0.2055 Not Not Not Not
significant significant significant significant significant
licence of
Patents, know-
how etc
Note * These coefficients are the marginal effects from the interaction model. The Irish-owned coefficients are added
to the foreign-owned coefficients from Table 4 of the paper.

Are there Diminishing Returns?
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Implications for Policymakers
 For intramural spending Irish-owned businesses nearly three times
more likely than foreign-owned to introduce new products, despite
per worker spending being 4 times less.
 Results imply that Irish-owned businesses superior at directing creative effort to
new products and also new processes and organizational improvements
 Irish-owned businesses incentivized to channel intramural R&D to innovation
performance.
 Foreign businesses also incentivized to minimize corporate tax bill.
 Are Irish businesses superior at converting new products into increased
productivity/employment?
 Irish-owned businesses also enjoy positive return from extramural
spending but only for process and organizational innovation
 May reflect tendency of these smaller businesses to rely on outside sources of
knowledge
 More research needed to see whether these sources are in Irish innovation
system.
 In particular, it would be interesting to investigate whether Innovation Vouchers
have had a positive effect on innovation performance.

Implications for Policymakers (ctd)
 Foreign-owned businesses enjoy very high and increasing returns
to product innovation for purchase or licence of patents, know-
how.
 They spend 33 times more per worker on this form of R&D and get a very high
return
 They experience limited returns from other types of R&D spending
 Tax incentives from purchase of patents in European Economic Area seem to
be important.
 Foreign-owned businesses have greater resources to purchase patents and
better placed to identify opportunities for commercialization
 Policymakers interested in whether these returns are related to collaboration
with Irish HEI’s?
 Cross-tabulation between purchase of patents and HEI collaboration suggests
that this more likely with Irish HEI’s
 Product innovating foreign-owned businesses that collaborate with Irish HEI’s spend €1,002 per
worker on purchase of patents (compared to €30 in rest of Europe and zero outside Europe).
 However, given that average spend is €4,366, foreign-owned businesses not involved in product
innovation spend considerable amounts on the purchase of patents (eg pharmaceutical
businesses).
 Further research required to investigate whether interaction between HEI
collaboration in different locations and the purchase of patents are related to
the probability of innovation. 14

Implications for Policymakers (ctd)
 Overall, fundamental difference in the innovation activities of Irish
and foreign-owned businesses
 Further evidence of dichotomous innovation systems.
 Policy may need to be more differentiated in its supports
 For example, challenge for Irish-owned businesses may be to convert
innovation performance into increased employment
 Private returns are generally positive but diminishing at the margin.
 Continuing focus on R&D appear to have limited effects at the margin.
 Other factors such as human capital and external interaction working
in tandem with R&D spending may deliver positive and increasing
returns?
 This paper has not addressed the social returns to Irish taxpayer
of R&D spending.
 Are those benefiting from R&D spending by Irish-based businesses
themselves likely to be based in same city/county/region/country?
 More research required on the inter-relationship between R&D
spending and external networking.
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Implications for Policymakers (ctd)
 Benefits from up-skilling of Irish workforce may be very
important
 This paper has controlled for business’s perceptions on the ‘lack
human capital’ – poor measure
 Need better measures, such as % of workforce with different levels of
education, but also levels of ‘on-the-job’ training.
 It is only by doing research, using econometric and case
study techniques, will we be able to answer the key policy
question:
 Are the ratios of private and social benefits to Ireland relative to the
costs worthwhile compared to alternative kinds of government
intervention?
Questions Welcome
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