Knowledge for Growth: Role and Dynamics of Corporate R&D

First European Conference

Seville / Spain, 8th-9th of October 2007

An Analysis of R&D Spillover,

Productivity, and Growth Effects in
the EU

Ali Bayar*, Frederic Dramais*, Amela Hubic*,

Jeoffrey Malek-Mansour*, Cristina Mohora*, Masudi Opese*, Hector Pollitt**

* EcoMod & Universite Libre de Bruxelles

** Cambridge Econometrics

We gratefully acknowledge the financial support of the European Commission DG JRC

Institute for Prospective Technological Studies (IPTS) under the contract 150343 – 2005 –
F1SC – BE.

Correspondence:
Ali Bayar, Universite Libre de Bruxelles – Avenue F. Roosevelt, 50 CP 140
B-1050 Brussels – Belgium
Email : Ali.Bayar@ecomod.net
1 Introduction

One of the key elements of the Lisbon strategy is the target of raising R&D spending to 3%
of GDP by 2010 for the Union. This is quite understandable given the central role of R&D
investments in driving productivity growth and fostering competitiveness in a global world
where knowledge and innovation are critical factors for the advanced economies.

Investigating the relations between industrial R&D efforts and economic performance in the
Member States in terms of competitiveness, growth and employment is of course a difficult
and complex task. Given the complex and dynamic interactions within economies, R&D
expenditures can be expected to have long-lasting and broad impacts not only on the targeted
industries but also on other branches, as well as on the capital and labour markets. In order to
gauge these effects, we use a variety of approaches and three models:

• QUEST, the macroeconometric model developed by the Econometric Modelling Unit

of DG ECFIN;
• GreenMod, the dynamic general equilibrium model developed by the EcoMod team
at the Free University of Brussels;
• E3ME, a large-scale Energy-Environment-Economy (E3) econometric model
developed by an international team including Cambridge Econometrics and which
covers 42 industries and 27 European countries.
All three models have been used in parallel with common policy shocks which take into
account baseline projections from the Quest model.
In addition to the growth and productivity impacts of R&D investment in the EU, we also
examine the spillover effects.

2 The Impact of R&D on Productivity Growth

Domestic R&D can be performed domestically by the private (business) sector, domestically
by the public sector, or abroad. All three kinds of R&D are likely to impact domestic
productivity, however measured. If domestic and foreign R&D impact domestic productivity
through obviously different channels, we also make a separate case for publicly funded
domestic business R&D, since some authors predict a dramatically different impact according
to the source of funding.

2.1 Methodological Issues

To gauge the economic impact of R&D investment on firms’ performances, two main broad
approaches have been pursued. Some authors regress change in firms’ market value on R&D
investment (see e.g. Hall and Oriani, 2004) while other contributions are more directly
interested in the impact of R&D intensity on productivity. This note focuses on the second
approach.

2
Within this second approach, various methodologies have been used. We now briefly expose
the theoretical foundations for these methodologies and define some concepts that are
relevant for the interpretation of the results we report in the present survey. We voluntarily
omit any time or unit subscript since these methods have been used at various aggregation
levels and for time-series, panel and cross-sectional datasets.

2.1.1 The Elasticity of Output and TFP With Respect to R&D

To start with, consider a typical Cobb-Douglas CRS production function

Y = TFP Lα K(1-α) ,
P P P P (1)

where Y is output (or value added), L is labour input, K is physical capital, and α is the share
of wages in income (or in value added), and TFP is Total Factor Productivity. On the basis of
Equation (1), TFP can be estimated either in levels (Equation (2a)) or in growth rate
(Equation (2b)):

ln TFP = Y – α ln L – (1-α) ln K (2a)

Δ ln TFP = Δ Y – α Δ ln L – (1-α) Δ ln K (2b)

Following among others Guellec and van Pottelsberghe de la Potterie (2004), TFP itself can
be modelled as a function of R&D stock (S), a deterministic component (A), which may
include a trend in a dynamic setting, and some stochastic element (η), as shown in Equation
(3):

TFP = A Sβ η (3)

Equation (3) can be conveniently rephrased as an econometric relationship linking TFP to the
R&D stock, given in (4a)

ln TFP = ln A + β ln S + ε (4a)

Or, as in (4b), in growth rates:

Δ ln TFP = Δ ln A + β Δ ln S + ν (4b)

How are we to interpret the coefficient β ?

1. Formally speaking, it is the net elasticity of TFP with respect to the R&D stock. It indicates
the percentage by which TFP level increase if the level S increases by 1%. Alternatively, by
the same token, it indicates the percentage increase in the TFP growth rate if the net rate of
R&D accumulation increases by 1% (that is, not the R&D expenses but the net increase in the
stock, taking its depreciation into account).

2. Interestingly, β also measures the elasticity of output (or added value) with respect to S. To
see this, merge Equation (1) with Equation (3) and take logarithms of both sides:

ln Y = ln A + α ln L + (1- α) ln K + β ln S + ε (5)

This is a natural consequence of the fact that Y has a unitary elasticity with respect to TFP.
3
2.1.2 The Rate of Return on R&D

According to Equation (5), the coefficient β can be interpreted as:

β = dln Y / dln S = [ dY / dS ] [S / Y] (6)

Plugging this expression into (4a) yields, for small variations of S:

d ln TFP = Δ ln A + β d ln S + ν
= Δ ln A + [ dY / dS ] [S / Y] [ dS / S ] + ν
= Δ ln A + [ dY / dS ] [ dS / Y ] + ν

Define ρ = dY / dS as the net rate of return on R&D. That is, if the R&D stock increases by 1
Euro, output will rise by ρ euros. With this definition in hand, we get the following estimable
equation:

Δ ln TFP = Δ ln A + ρ [ Δ S / Y ] + ν (7)

The link between β and ρ is thus:

β=ρ[S/Y] (8)

2.1.3 How to Measure the R&D Capital Stock S?

It is common to have figures not about S but only about gross R&D investments, i.e. R&D
expenses, let R. The question is: how can we use the available information on R to get figures
about S or ΔS ? Most authors use the perpetual inventory method. The law of motion for the
R&D stock writes:

S(t) = R(t-1) + [1 – δ] S(t-1) (10)

Where δ denotes the depreciation rate of S and t indexes the time periods. In period 1, we
have:

S(1) = R(0) + [1 – δ] S(0) = R(0) + [1 – δ] R(-1) + [1 – δ]2 R(-2) + ....

P
P

If R grows at constant rate g, it is easy to show that this latter expression converges to:

S(1) = R(1) / [ g + δ ] (10)

Hall and Mairesse (1995) suggest to use δ = 0.15 in their baseline and propose an “extreme”
version with δ = 0.25. In the same line, van Pottelsberghe (1998) also estimated the value of δ
to be about 20%. Finally, many authors do not use a depreciation rate which amounts to
setting δ = 0.

4
2.1.4 Caveats and Problems

There are some caveats that are worth mentioning here before we start reviewing the
empirical results.

First, as stated by Griliches (1988),

− There are difficulties in correctly measuring the quantity and the quality of labour
services
− There are difficulties in correctly measuring the physical capital stock and its
utilisation rate.

Second TFP estimation method is conditional upon the hypotheses of constant returns to
scale and of perfect competition.

Another problem that has attracted much attention is the withdrawal of double counting: both
L and K have an R&D component. However, according to some authors, the bias becomes
negligible when growth rates, instead of levels, are considered in the regressions (see Hall
and Mairesse (1995) for results at firm level and van Pottelsberghe (1998) for results at sector
level).

There is also a problem regarding the aggregation level. Because knowledge capital bears
externalities (it is not completely appropriable), its social return is higher than its private
return. Hence, as demonstrated by Griliches (1991), the coefficient β will be higher at more
aggregate levels. Hence, firm-level results cannot be translated at face value to industry-level
or to country level.

Another type of externality that might affect results is international spillovers. These may
arise through reverse engineering, imitation, trade, FDI,... Lichtenberg (1993) shows that the
presence of such spillovers will typically lower the expected estimate of β. We will come
back to the problem of inter-industry and international spillovers below.

2.2 The Direct Impact of R&D Investments

2.2.1 Domestic R&D Investments in the Business Sector

2.2.1.1 General Results

In this Section, we review some of the main results regarding the direct impact of R&D
investments in the business sector. That is, we are interested in the magnitude of the response
(β or ρ) of a given industry’s TFP or output with respect to R&D investments in the same
sector.

As noticed by e.g. van Pottelsberghe (1998), there have been a considerable number of
studies on that topic. These studies are, however, virtually impossible to compare because
they differ with respect to key dimensions such as the aggregation level (firm, industry,
country), the econometric specification, the data source, the measurement of R&D, the
measurement of productivity, the period of investigation... Nadiri (1993) presents a full-scale
5
survey of such econometric studies. As we have just explained, there appears to be a great
deal of variability in the results. Nearly all studies surveyed conclude that R&D does matter
for productivity growth. In spite of the large variance in the measured elasticities and returns,
we can summarize the results as follows:

ƒ At firm level, the elasticities ( β ) tend to lie around the [10%-30%] range whereas the
rates of returns ( ρ ) concentrate in the [20%-30%] range
ƒ At industry level, the elasticities ( β ) turn around the [8%-30%] range whereas the
rates of returns ( ρ ) are mostly in the [20%-40%] range

Table 1 contains a sample of the results reported by Nadiri (1993). Specifically, we focus on
the USA and on European countries (Nadiri also reports results for Canada, Japan,...). The
figures in the “Return” column are those obtained variants of Equation (7), whereas the
“Elasticity” column pertains to results based on Equations (4a) or (4b).

6
Table 1. Sample of Studies Surveyed by Nadiri (1993)**
STUDIES AT THE FIRM LEVEL STUDIES AT THE INDUSTRY LEVEL
Country Study Return Elasticity Country Study Return Elasticity

USA Minasian (1969) 54% USA Terleckyj (1974) 0% to 29%

Griliches (1980) 27% Link (1978) 19%
Mansfield (1980) 28% Griliches (1980) 0% to 42%
Nadiri-Bitros (1980) 26% Nadiri (1980a)* 6% to 10%
Shankerman (1981) 24% to 73% Nadiri (1980b) 8% to 19%
Griliches-Mairesse (1983) 19% Sveikauskas (1981) 7% to 25%
Clark-Griliches (1984) 18% to 20% Sherer (1982,1984) 29% to 43%
Griliches-Mairesse (1984) 30% Griliches-Lichtenberg (1984a) 3% to 5%
Griliches (1986) 33% to 39% Griliches-Lichtenberg (1984b) 21% to 76%
Griliches-Mairesse (1986) 25% to 41% Mohnen et al. (1986) 11%
Jaffe (1986) 25% Wolff-Nadiri (1987) 11% to 19%
Shankerman-Nadiri (1986) 10% to 15% Bernstein-Nadiri (1988) 10% to 27%
Bernstein-Nadiri (1989) 7% to 20% Patel-Soete (1988)* 6%
Griliches-Mairesse (1990) 27% to 41% Nadiri-Prucha (1990) 24%
Lichtenberg-Siegel (1991) 13% Bernstein-Nadiri (1991) 15% to 28%
France Griliches-Mairesse (1983) 31% France Patel-Soete (1988)* 13%
Cuneo-Mairesse (1984) 55%
Mairesse-Cuneo (1985) 9% to 26%
Germany (W) Bardy (1974) 92% to 97% Germany (W) Mohnen et al. (1986) 13%
Patel-Soete (1988)* 21%
UK Mohnen et al. (1986) 11%
Patel-Soete (1988)* 7%
Sterlaccini (1988) 12% to 20%
Source: Adapted from Nadiri (1993). For the references, see the original paper.
U U

*: Total economy
**: Figures are in % of %, i.e. 20% means that a 1% increase in R&D yields a 0.20% increase in TFP growth.

7
An obvious response to these “homogeneity” problems is to use a large cross section with a
homogenous methodology. A significant advance in this respect is provided by Lichtenberg
(1993). He builds on Mankiw, Romer and Weil (1992) to construct a structural model from
which the value of β can be inferred. Equations are estimated on the basis of a very large
sample of countries (between 38 and 53 according to the various specifications). The
elasticity of GDP with respect to privately funded R&D stock is consistently found to be
about 7%.

Coe and Helpman (1995) go one step further and consider panel data instead of a large cross-
section. Their sample comprises 21 OECD countries plus Israel, over the period 1970-1990.
Though their primary focus is on international R&D spillovers, they also provide evidence on
domestic R&D elasticities, using a variant of Equation (4a) and cointegration techniques. For
their complete sample, they report average elasticities between 6% and 10%, much in line
with the findings reported by Griliches (1988) or Lichtenberg (1993). However, focusing
upon G7 countries yields much larger elasticities, with order of magnitude about 23%. It
should be noted that these elasticities are computed with respect with one-year lagged R&D.

In the same vein, Park (1995) considers 10 OECD countries, accounting for roughly 95% of
global R&D (by the time he wrote his paper), over the period 1970-1987. Though his focus is
upon the differentiated impact of private R&D, public R&D and foreign R&D, he also
measures the output elasticity of private R&D alone. He reports a coefficient of about 11%.

Guellec and van Pottelsberghe (2001, 2004) are also concerned with the differentiated impact
of private, public and foreign R&D. They consider a sample of 16 OECD countries over the
period 1980-1998 and regress TFP growth on the various types of R&D stocks using an
error-correction model. They report that the domestic business R&D stock has a long-run
elasticity of 13%.

To conclude this Section, we summarize some of the elasticity (β) results reviewed so far and
complement them with a sample (limited to total economy or private sector results) of those
reported by Cameron (1998). This is done in Table 2.

8
Table 2. Main Elasticity Results – Domestic Business R&D

Country Authors Elasticity

USA Patel-Soete (1988) 0.06

Nadiri (1980) 0.06 to 0.10

JAPAN Patel-Soete (1988) 0.37

FRANCE Patel-Soete (1988) 0.13

GERMANY (W) Patel-Soete (1988) 0.21

UK Patel-Soete (1988) 0.07

G7 Coe-Helpman (1995) 0.23

OECD Guellec-van Pottelsberghe (2004) 0.13

Park (1995) 0.11

VARIOUS Coe-Helpman (1995) 0.07

Lichtenberg (1993) 0.07

As to the rate of return on R&D ( ρ ), an influential investigation is provided by Hall and

Mairesse (1995). They estimate equations in the spirit of (7) using a sample of 97
manufacturing firms over the period 1980-1987. They consider both net investment in R&D
(i.e. ΔS / Y as in Equation (7)) and gross investment in R&D ( i.e. R&D expenses). They also
consider first- and long- differences (i.e. over 7 years), and various ways to compute the
R&D capital stock. We summarize their main findings in Table 3.

9
Table 3. Rates of Return on R&D in Hall and Mairesse (1995)

Gross Net

First difference [22% - 27%] [26% - 34%]

Long difference [6% - 11%] [12% - 21%]

As the authors notice, the difference between gross and net rates of return is surprisingly low.
Also, the coefficients on long difference estimates are very low and in general not significant.

2.2.1.2 Sector-Specific Aspects and Stability Issues

Hall (1993) asks whether the R&D – TFP relationship is stable across time and sectors (and
both). To check these hypotheses, she investigates data concerning 1,600 US businesses over
the period 1964-1990 and estimates an equation similar to (4a). Her main results are
summarized in Table 4. For the global sample, equations are estimated in levels (pool), long
differences (4 years) or first differences. The preferred estimator is the long-differences and it
is the one used for the industry-level analysis. The unweighted estimator treats all firms in a
given sector the same way whereas in the weighted estimator, they receive an importance that
is proportional to their share in the sector’s employment. It appears that there have been
substantial differences, both across periods and across industries.

Specifically, as far as dynamics is concerned, it appears that the elasticity has first decreased,
to reach a minimum, say, in the early 80s and that it re-increased again in the subsequent
periods. Similar conclusions are obtained by Guellec and van Pottelsberghe (2001, 2004): on
the basis of a sample covering the period 1980-1998, these authors conclude that the
elasticity of TFP with respect to business R&D has been growing over time since the early
80s, which “confirms the impression (...) that R&D is an increasingly important activity for
firms in the knowledge-based economy...” (Guellec and van Pottelsberghe (2004, p. 366)).
However, the elasticity with respect to public R&D has decreased over the same period.

10
Table 4. Sample Results From Hall (1993)

Global 64 - 90 64-70 71-80 81-85 85-90

Pool 3.2% 4.3% 3.0% 2.4% 4.0%

Long diff. 2.6% 10.1% 0.6% 0.9% 5.3%
1st Diff 1.7% 17.5% 2.1% -1.1% 3.6%

Unweighted 64 - 90 64-70 71-80 81-85 85-90

Chemicals -1.5% 7.5% -1.4% -8.3% 4.8%

Pharma. 10.2% -26.2% 15.0% 9.0% 9.7%
Electrical -2.9% 0.7% -2.7% -0.1% -6.2%
Computers 6.8% -13.2% 7.3% 4.9% 8.9%
Machinery 1.0% 6.6% 1.1% -0.4% 1.3%
Others 0.5% 50.0% -0.5% -2.0% 4.6%
Total 2.6% 11.1% 0.7% 1.1% 5.1%

Weighted 64 - 90 64-70 71-80 81-85 85-90

Chemicals 0.8% 4.0% 6.3% -11.6% 11.1%

Pharma. 11.4% 3.0% 14.6% 17.7% 4.2%
Electrical -3.6% -2.8% 5.2% -9.0% -8.2%
Computers 7.9% 4.2% 20.7% -1.0% -1.2%
Machinery 4.4% 16.0% 1.4% 10.8% -5.0%
Others 0.1% 64.8% 0.2% -4.4% 1.4%
Total 3.8% 19.8% 3.7% 2.3% 3.3%

Source: Adapted from Hall (1993)

As far as elasticities are concerned, noticeable differences are also apparent in Table 4. A
systematic attempt to capture differences in elasticities at sector level is provided by Cameron
(2000). He makes use of a panel of nineteen UK manufacturing industries over the period
1972-1992. The elasticity is computed with respect to the ratio of industry-funded Business
Enterprise R&D to physical capital, i.e. S/K. Their reported elasticities are thus not directly
comparable to the β’s and ρ’s we have mentioned up to this point. The industry elasticities
computed by Cameron are revealed in the column “Cameron” in Table 5. To make these
figures comparable to our earlier β’s, we have put total manufacturing elasticity at 0.15 (a
consensual figure for β), and aligned the sector-level elasticities to that benchmark. Results
are revealed in the “Comparison” column.

11
Table 5. Sector - Level Results in Cameron (2000)

Cameron Comparison

Total Manufacturing 0.24 0.15

Food, drink, tobacco 0.23 0.14

Textiles and clothing 0.30 0.19
Timber and furniture 0.22 0.14
Paper and printing 0.36 0.23
Minerals 0.22 0.14
Chemicals nes 0.12 0.07
Pharmaceuticals 0.29 0.18
Rubbers and plastics 0.37 0.23
Iron and steel 0.34 0.21
Non-ferrous metals 0.25 0.16
Metal goods nes 0.20 0.13
Machinery 0.13 0.08
Computing 0.29 0.18
Other electricals 0.24 0.15
Electronics 0.17 0.11
Motor vehicles 0.24 0.15
Aerospace 0.25 0.16
Instruments 0.27 0.17
Other manufacturing 0.15 0.10

Source: Cameron (2000) and author’s computations

Interestingly, Cameron investigates into the source of these differences using a battery of
industry-level indicators. TFP elasticity increases with the (K/L) ratio and with the propensity
to use intermediate goods from technology-intensive industries. It also increases with the
intensity of competition against imports. On the contrary, the elasticity is inversely related to
the (S/K) ratio.

2.2.2 Domestic Government R&D

Governments have various ways to perform R&D. First, they may perform R&D directly,
through universities and other public laboratories. These research programmes may be basic
(fundamental), or applied. Besides, governments may also fund some of the R&D performed
in the business sector, either through grants or through procurements (in the defence sector,
e.g.).

As stated above, some authors also try and assess whether government-funded R&D
performs as efficiently as “pure” business R&D. In his 1993 survey, Nadiri observed that
“almost all of the available studies suggest that rates of return on privately financed R&D
are much higher than those on publicly financed R&D” and that “...the rates of returns on
publicly financed R&D are often insignificant or negative”.

Lichtenberg (1993) provides an early attempt to shed more light on the issue. Specifically, on
the basis of a cross-country study using a large number of countries (see above), his results
“decisively reject the hypothesis that the rate of return to government-funded R&D is equal to

12
the rate of return to privately-funded R&D”. The estimated coefficient on government-funded
R&D is most often not significant. It even happens that it is significantly negative. To explain
U U

such results, the author argues that public R&D is often devoted to topics at best imperfectly
measured in national accounts, such as fighting pollution, improving health conditions,
ensuring national security (defence),...

Park (1995) also distinguishes between publicly and privately funded R&D. When they are
included separately, the productivity (output per hour worked) elasticity of public research is
weaker than the productivity elasticity of private research (0.08 vs. 0.11), and both
coefficients are significant. When both publicly and privately funded research are considered
jointly, the coefficient on public research becomes insignificant and the elasticity to private
research jumps to between 18% and 23% according to specifications.

Guellec and van Pottelsberghe (2004) go one step further in the analysis of the impact of
government R&D. One of their main advances is to disaggregate the share of government
funding according to its socioeconomic objective. They consider an error-correction model in
the spirit of (4a), which they estimate on a sample of 16 OECD countries over the period
1980-1998. They first confirm that, from a global point of view, the share of government
funding has a negative impact on business R&D elasticity. However, this effect appears to be
mostly, if not only, due to the part of defence-related expenses. Public funding with a civilian
objective appears to have a weakly positive impact. To explain these results, the authors
invoke an appropriation effect: the contractor of a defence contract will not be the final owner
of the technological output. They also investigate the elasticity of public R&D performed in
government laboratories and laboratories, for which they report a TFP elasticity of 17%. That
is, the long-term impact of public R&D seems higher than its business counterpart (for which
the same authors report an elasticity around 13%). The proposed explanation is that public
R&D focuses more on basic research, which has a wider scope for externalities.

A naturally related question of interest is about the link between public and private R&D
investment. Do public R&D investments stimulate their business counterparts? Guellec and
van Pottelsberghe (2003) investigate the possible link between both sources of R&D. At a
theoretical level, governmental R&D investment policies may be hindered by 3 factors:

ƒ Crowding out of private spending by public spending

ƒ Displacement of private funding (the government finances investments that would have
occurred anyway)
ƒ Inefficient resource allocation by the government

To gauge the interaction between public and private R&D investments, the authors consider a
database covering 17 OECD countries over the period 1981-1996. They conclude that “...both
fiscal incentives and direct funding stimulate business-funded R&D, whereas research
performed by the government appears to have a crowding out effect and the research
performed by the higher education sector has no impact”.

13
2.3 The Indirect Impact of R&D

R&D activities, as is well-known, generate externalities: other firms, industries, or countries

may benefit from research activities performed in a particular place. Specifically, Griliches
(1979) distinguishes two kinds of spillovers:

ƒ Rent spillovers, that arise because the prices of intermediates do not completely reflect
quality improvements ( a commonly cited example of such spillovers is computers:
though their power and quality have continuously been increasing all along the past 20
years, their prices have at best remained constant).
ƒ Knowledge spillovers, that arise because of the imperfect appropriability of knowledge:
poor patent protection, reverse engineering,... are pervasive phenomena that contribute
to the diffusion of knowledge.

Such spillovers may arise across industries within a given country, across countries within a
given industry, and across countries and industries.

To measure the magnitude of these spillovers, it is common practice to build, for a reference
unit i (a country or an industry within a country), a stock of spillover knowledge as a
weighted average of R&D stocks in other comparable units. To fix ideas, if S*(i) is the stock P
P

of spillovers pertaining to unit i, and S(i) denotes the R&D stock in unit j, we have in general:

S*(i) = Σj ω(i,j) S(j)

P
P
B B (i ≠ j)

Where ω(i,j) is the weight of industry/country j for industry/country i. The idea is then to
measure the elasticity of TFP(i) with respect to S*(i), using standard (cross-section, panel,
P
P

cointegration,...) regression techniques.

2.3.1 Domestic Inter - Industry Spillovers

Regarding inter – industry spillovers, van Pottelsberghe (1998) considers a sample

comprising 22 industries for each of the G7 countries over the period 1980-1990. Dropping
time indices and fixed-effects coefficients (grouped in the term G), he estimates an equation
whose form is similar to

Δ TFP(i,k) = G + ρR [ ΔS(i,k) / Y(i,k) ] + ρS [ ΔS*(i,k) / Y(i,k) ] + ε(i,k)

B B B B

Where Y denotes value added, ρR is the rate of return on own R&D, and ρS is the rate of
B B B B

return on external R&D. The authors considers various weighting schemes ω(i,j) that allow
him to disentangle four types of spillovers: input-related rents spillovers, patents-related rents
spillovers and knowledge spillovers. Results show that the impact of both direct and indirect
R&D varies greatly across countries:
1
ƒ Three countries enjoy significant input-related rent spillovers : Germany (1163%), TP PT

France (3209%) and Italy (8247%)

2
ƒ Patent-related rents spillovers are significant in the USA (562%), Germany (1128%),
TP PT

France (1854%), Japan (345%) and The UK (472%)

1
TP PT Results obtained using a weighting scheme based on input-output matrices.
2
TP PT Results obtained using a weighting scheme based on US technology flows matrices

14
 3
ƒ Knowledge spillovers are significant in Canada (232%), Germany (224%), and Italy
TP PT

(461%)

2.3.2 International Spillovers

As explained in the Introduction, R&D generated abroad may have a non-negligible impact
on domestic productivity. Among the authors that investigate the issue, Coe and Helpman
(1995) arise as a seminal reference. They posit that technology spills over across countries
through the channel of trade flows and present evidence consistent with that hypothesis.
Specifically, using a panel of OECD countries between 1970 and 1990 (see above), they
regress TFP on both the domestic and the foreign R&D stock. The foreign R&D stock is
computed as a weighted average of foreign R&D stocks, where weights are proportional to
the shares of the various partner countries in the domestic country’s imports. If the coefficient
on foreign R&D is constrained to remain constant across countries, the authors report a figure
about 0.29 for the long-term elasticity. However, interacting the coefficient on foreign R&D
with the ratio of imports to GDP leads to the conclusion that the elasticity to foreign R&D is
not constant across countries. In Table 6, we have selected some of results, focusing on
European countries. The entries show, for each country, the sensitivity (elasticity) of its
domestic TFP with respect to world R&D (including his own) and with respect to foreign
R&D. By construction, figures represent net elasticities. As could be expected intuitively,
smaller and more open countries are in general more sensitive to foreign R&D.

Table 6. International R&D Spillover Effects in Coe and Helpman (1995) – Selected
Results

Elasticity of TFP with respect to

World R&D Foreign R&D

Austria 19.2% 11.4%

Belgium 33.7% 26.0%
Denmark 16.9% 9.2%
Finland 15.2% 7.5%
France 30.1% 6.7%
Germany (W) 31.1% 7.7%
Greece 17.2% 9.4%
Ireland 24.3% 16.5%
Italy 29.2% 5.8%
Netherlands 23.6% 15.8%
Portugal 21.0% 13.2%
Spain 14.1% 6.3%
Sweden 17.1% 9.3%
UK 31.5% 8.1%
Source: Adapted from Coe and Helpman (1995)

Lichtenberg and van Pottelsberghe (1998) argue that the weighting scheme proposed by Coe
and Helpman (1995) may introduce an aggregation bias and propose an alternative weighting
scheme that is theoretically less biased. They conclude that it is not openness (i.e. the ratio of
imports to GDP, as in Coe and Helpman) per se that matters for the elasticity but rather the
composition of imports: the more a country imports from R&D intensive countries, the higher
its elasticity to foreign R&D.

3
TP PT Cfr. Regression 6 in Table 5.6, p. 177.

15
Guellec and van Pottelsberghe (2001) perform the same kind of analysis using this
alternative, theoretically less biased, weighting scheme and report a long-run elasticity of
domestic R&D with respect to the foreign capital stock of 0.45.

Park (1995) distinguishes between spillovers into production and spillovers into research. In
the former case, foreign R&D is an input into the domestic production function, whereas in
the latter case, the influence is indirect and works through the domestic R&D accumulation
rate. When investigating spillovers into production, it is found that, although the productivity
elasticity to foreign R&D is higher than to domestic R&D (0.17-0.18 vs. 0.04-0.08), the rate
of return of foreign R&D is lower than to domestic R&D (0.05 vs. 0.44): a 1$ increase in
foreign R&D raises domestic output per hour by 0.05$ whereas the same 1$ invested in
domestic R&D would raise domestic output per hour by 0.44$.

Finally, van Pottelsberghe de la Potterie and Lichtenberg (2001) perform the same kind of
analysis but focus on FDI, instead of trade, as transmission mechanism for R&D spillovers.
They consider 13 industrialized countries over the period 1970-1990. Outward FDI (i.e. made
by partner countries in the domestic economy) arises as a significant transmission channel
whereas the coefficients for inward FDI (i.e. made by domestic firms abroad) remain
insignificant. The elasticity with respect to outward FDI – weighted foreign R&D ranges
between 4% and 7%, whereas the elasticity with respect to the imports – weighted foreign
R&D ranges between 7% and 15%. Both elasticities are significant

2.4 Conclusions

Having gone through some of the most widely cited references in the econometric literature
about the impact of R&D on growth, we can draw the following conclusions:

ƒ Domestic business R&D has an output elasticity that varies approximately between
10% and 30%. This elasticity is not constant over time: after having reached a
minimum in the early 80s, it has continuously been rising since then. It is not constant
across industries either. Finally, the lower the share of public funding, the higher the
elasticity. This is mainly because of defence investments.

ƒ The elasticity with respect to foreign R&D appears to be quite high. It depends,
moreover, positively on the openness to imports and to the outward FDI intensity. It is
affected by the composition of imports: the larger the share of R&D-intensive countries
in imports, the higher the elasticity. To fix ideas, the elasticity should range between
0.3 and 0.5.

16
3 R&D Spillover Effects

3.1 Data
The data used in the following analysis have been drawn from the E3ME model database.
Data for each variable (gross value-added GVA, employment and R&D spending) are in the
form of annual time series, covering the period 1990-2004 for the EU-15 and 1993-2004 for
the ten countries that joined the EU in 2004. As the E3ME database only covers European
countries, it is not possible to assess the effects of R&D in the rest of the world.

The bilateral trade data, used to form weights of indicators of activity between countries, are
for a single year, with data points for each sector, country of origin and country of
destination. The geographical distance matrix was calculated as an inverse of the relative
distances between each country (ie closer countries have larger weights).

The main data sources for the E3ME database are the OECD (Stan) and Eurostat. R&D data
come from the OECD’s ANBERD database and Eurostat. Where necessary these have been
supplemented with data from national statistical agencies and more aggregate data from the
AMECO database and the World Bank.

Following the approach used in other analyses in the project, average labour productivity
(ALP) is used as a proxy for TFP.

R&D is defined as industrial R&D spending, converted to millions of euros at constant 2000-
based prices. In the sectoral analysis it is disaggregated to 42 industrial sectors.

Labour productivity is defined as gross value added (GVA) at factor cost in millions of euros
at 2000 prices divided by employment, defined as a headcount of the sum of full-time, part-
time and self-employed jobs. A more accurate measure could be obtained by including a
measure of average hours worked in the equation (this approach has been used in the
modelling where levels rather than changes are more important) but for the purpose of this
analysis it would be an unnecessary complication, particularly given that accurate detailed
sectoral hours-worked data are often not available.

The bilateral trade and distance matrices are used to determine the relative importance of the
relationships between each EU country and to form weights between investing and receiving
countries.

3.2 Methodology

3.2.1 The Basic Specification

The basic specification of the model used is shown in Equation 11. Productivity is a function
of R&D in the same country (RD) and R&D external to the same country (XRD, ie the
possible spillover effect). Both types of R&D are expressed as rates in relation to
employment (ie RD is R&D spending divided by employment). Lagged terms are included
for both R&D terms, although due to the relatively short time series, it was decided to restrict
the equations to include only single-year lags.

17
PROD = F ( RD, RD ( −1), XRD , XRD (−1)) (11)

All the equations were estimated using a standard Error-Correction Methodology (ECM),
with a specification of long and short-term relationships. The short-term relationship
includes the lagged dependent variable. The final chosen model is determined using the
Akaike Information Criterion (AIC) with insignificant variables removed. This is identical to
the methods used to estimate parameter coefficients in the E3ME model and is described in
4
more detail in the model manual .

A similar regression is then run, without the external R&D spillover terms. Results from the
two sets of regressions are then compared. If there is no significant difference between the
two sets of results, then it can be said that there are no R&D spillover effects. Initially a
regression was attempted for each country and the results were analysed on a country-by-
country basis. This was then expanded to look at individual sectors.

3.2.2 Choosing the Exact Model

Three different definitions of external R&D were examined for the EU-15, with the one
showing the best fit chosen for the final analysis of all EU-25 countries.

The first and simplest method defined external R&D as the sum of R&D in the rest of the
EU-15. This makes no geographical assumptions; so, for example in Ireland, R&D spending
in the UK and Greece would be given the same weighting despite the fact that the UK is
much closer to Ireland and a much more important trading partner.

The second method weighted R&D spending using an inverse distance matrix; so closer
countries have a higher weighting. In the third method, weights derived from bilateral trade
data were used to sum external R&D. This was the most complex of the three methods as the
weights varied by sector. However, it gives some indication of cross-border competition and
collaboration that may affect productivity. It should be noted that this is not a sensible way to
measure external effects in non-traded sectors; so these were weighted using the distance
matrix.

Finally, each method was tried with and without the lagged external R&D terms, to see if
they improved the accuracy of the model. Table 7 shows the adjusted R-squared values for
each country, achieved using each set of variables. The values are for the long-run part of the
equation (the levels relationship) and are therefore higher than would normally be expected,
but for the purpose of comparing between models this is adequate and, given that we are
interested in the long-run relationships, probably more appropriate.

4
http://www.camecon-e3memanual.com/cgi-bin/EPW_CGI

18
Table 7: Adjusted R-squared values for the different models (long-run equation)
Lagged External R&D No Lagged External R&D
Bilateral Bilateral
Weight Base Distance Trade Base Distance Trade
ALP = b0 + ALP = b0 + ALP = b0 +
b1*RD + b1*RD + b1*RD + ALP = b0 + ALP = b0 + ALP = b0 +
b2*RD(-1) + b2*RD(-1) + b2*RD(-1) + b1*RD + b1*RD + b1*RD +
b3*XRD + b3*XRD + b3*XRD + b2*RD(-1) + b2*RD(-1) + b2*RD(-1) +
Countries b4*XRD(-1) b4*XRD(-1) b4*XRD(-1) b3*XRD b3*XRD b3*XRD
Belgium 0.94 0.95 0.95 0.93 0.94 0.92
Denmark 0.94 0.97 0.93 0.94 0.97 0.93
Germany 0.72 0.96 0.95 0.74 0.84 0.80
Greece 0.93 0.96 0.89 0.92 0.94 0.90
Spain 0.69 0.69 0.73 0.69 0.72 0.74
France 0.80 0.77 0.96 0.76 0.77 0.92
Ireland 0.84 0.88 0.87 0.77 0.83 0.89
Italy 0.36 0.16 0.80 0.41 0.23 0.80
Luxembourg 0.42 0.67 0.74 0.47 0.50 0.72
Netherlands 0.88 0.86 0.82 0.87 0.85 0.83
Austria 0.95 0.97 0.89 0.92 0.96 0.90
Portugal 0.59 0.66 0.86 0.62 0.66 0.85
Finland 0.96 0.96 0.94 0.95 0.95 0.94
Sweden 0.71 0.69 0.84 0.51 0.67 0.81
UK 0.67 0.81 0.81 0.68 0.75 0.79

Although there are differences between the countries, the model with external R&D spending
weighted using bilateral trade data generally provides the best fit, with the highest adjusted
R-squared value in half of the equations (and substantially higher in some countries). So this
model was chosen for the analysis. The same model was chosen for the sectoral analysis,
although one should remember that the distance matrix is used to provide weights for the
non-traded sectors (defined as the utility sectors, Construction, Distribution, Retail and public
sectors). Perhaps surprisingly, when comparing the values in Table 7 the lagged term on
external R&D was not found to add much accuracy to the model (except in Germany) and so
was removed to keep the model as simple as possible (the adjusted R-squared was higher in
seven cases where the lagged variable was included, and eight without).

This makes the analysis of the external R&D terms slightly more straight forward. Rather
than running regressions with and without the external R&D term and then comparing results,
it is sufficient to look at the t-statistics and probabilities of the estimated coefficients for the
external R&D terms resulting from the fully-specified regression.

3.3 Results
3.3.1 Results at the National level

The initial set of regressions (which produced the numbers for the final column of Table 7)
did not include a sectoral breakdown of results. It should be noted, however, that external
R&D was still calculated by sector, using the trade weights for each individual sector (and the
distance matrix for non-traded sectors) and then total external R&D was then calculated by
summing sectoral external R&D across the sectors. External R&D was calculated using the
EU-15 countries rather than the EU-25 countries so that a time series starting in 1990 could
be used without a structural break.

19
Table 8 shows the T-probabilities of the estimated coefficients of the long-run external R&D
term being significant. A number less than 0.05 suggests significance at the 5% level and a
number less than 0.01 suggests significance at the 1% level.

Table 8: Significance of long-run

external R&D term by EU-15 country
Country T-probability
Belgium 0.547
Denmark 0.847
Germany 0.013*
Greece 0.828
Spain 0.922
France 0.202
Ireland 0.001**
Italy 0.000**
Luxembourg 0.001**
Netherlands 0.987
Austria 0.516
Portugal 0.310
Finland 0.389
Sweden 0.963
UK 0.945

Three countries (Ireland, Luxembourg and the Netherlands) have coefficients on the long-run
external R&D term that are positive and significant at the 1% level, indicated by ** in Table
8. Ireland and Luxembourg are both countries that attract inward investment although, in the
case of Ireland, much of this comes from outside the EU. Of these countries, the estimated
coefficient for Ireland is much larger than the other countries (0.67 compared to 0.38 for Italy
and 0.16 for Luxembourg). Despite having the highest domestic levels of R&D spending,
Germany also displays a significant relationship at the 5% level, although the estimated
coefficient is smaller (0.013).

3.3.2 Results at the Sectoral level

There are substantial differences in the productivity effects of R&D spending between
different sectors, and in particular between public and private R&D spending. Therefore, for
a comprehensive analysis of possible spillover effects, it is not adequate to examine only the
aggregate results. Sectoral external R&D is defined as R&D in the same sector but a
different country, using the same trade-weighted matrices for traded sectors and the distance
matrix for non-traded sectors. A set of regressions was run for each of the 42 sectors and
5
EU-15 countries, with a total of 607 separate equations estimated.

Of these equations, long-run external R&D was found to have a significant (at the 1% level)
positive effect in the long run in 36 of the sectors, and a total of 57 sectors at the 5% level.
Figure 1 presents the results in a matrix format of sector by country, with the black cells
indicating 1% significance and the grey cells indicating 5% significance. Counts of positive,
significant cells are shown for each row (sector) and column (country).

5
The missing sectors are mainly “Unallocated” and the mining sectors in countries with no domestic mining industry

20
Several sectors showed significant negative relationships. This was unexpected, but tended
to occur in sectors where productivity is determined by other factors, including the energy
sectors and, notably, the public sectors. One other sector, Other Transport Equipment, had
significant negative effects, but this sector (which includes aerospace) has volatile output
patterns and can be difficult to model.

Looking at the results by country, there are clear differences between the sectoral and
aggregate country results, highlighting the importance of the sectoral analysis. Of the three
countries that showed significant long-run productivity effects from external R&D in the
aggregate equation, two of them (Ireland and Italy) have only a small number of sectors
showing significant effects. However, closer inspection shows that the sectors that are found
to have possible spillover effects tend to be the ones associated with higher levels of R&D
spending (eg chemicals, pharmaceuticals and motor vehicles), which will carry a higher
weighting in the aggregate results.

Three countries that did not seem to have significant effects at the aggregate level (Finland,
Sweden and the UK) have more sectors where external R&D may have significant long-run
productivity effects. These often tend to be the same sectors (eg Distribution, Retail,
Communications and Insurance) but, with the exception of Communications, are not large
R&D sectors. Numbers for the UK are flattered by significant results for small energy
sectors.

Out of the 42 sectors, the one which stands out as having the greatest potential spillover
effects is Communications. External R&D was found to have a significant effect (at the 1%
level) in six of the fifteen countries, including all three Scandinavian countries.

Several other sectors also demonstrate possible spillover effects, but they are not sectors that
are associated with high levels of R&D spending. They are Non-metallic mineral products,
Distribution and Retail. Generally, spillover effects seem to be more likely in service sectors
with lower rates of R&D spending.

21
Figure 1: EU-15 sectors where the external R&D coefficient is significant
T PROBABILITY BE DK DE EL ES FR IE IT LX NL AT PT FI SW UK 1% 5%
1 Agriculture etc 0 0
2 Coal 1 0
3 Oil & Gas etc 0 1
4 Other Mining 1 0
5 Food, Drink & Tob. 1 0
6 Text., Cloth. & Leath 1 1
7 Wood & Paper 0 0
8 Printing & Publishing 0 0
9 Manuf. Fuels 0 0
10 Pharmaceuticals 0 2
11 Chemicals nes 0 2
12 Rubber & Plastics 2 1
13 Non-Met. Min. Prods. 4 1
14 Basic Metals 0 0
15 Metal Goods 0 0
16 Mech. Engineering 0 2
17 Electronics 0 1
18 Elec. Eng. & Instrum. 0 1
19 Motor Vehicles 2 1
20 Oth. Transp. Equip. 0 0
21 Manuf. nes 2 0
22 Electricity 2 0
23 Gas Supply 0 0
24 Water Supply 0 0
25 Construction 0 0
26 Distribution 4 1
27 Retailing 4 1
28 Hotels & Catering 0 0
29 Land Transport etc 0 0
30 Water Transport 0 1
31 Air Transport 1 0
32 Communications 6 0
33 Banking & Finance 1 3
34 Insurance 3 0
35 Computing Services 0 1
36 Prof. Services 1 0
37 Other Bus. Services 0 0
38 Public Admin. & Def. 0 0
39 Education 0 0
40 Health & Social Work 0 0
41 Misc. Services 0 1
42 Unallocated 0 0
Pos. & Sig, 1% level 4 1 2 0 3 0 0 1 3 2 0 1 5 8 6 36
Pos. & Sig, 5% level 4 1 3 3 4 1 2 1 6 4 1 3 7 10 7 57

Positive & Significant (1%) Negative & Significant (1%)

Positive & Significant (5%) Negative & Significant (5%)

22
3.3.3 Results at the Sectoral level for the ten New Member States (2004)

A separate set of regressions was run for the ten new member states that joined the EU in
2004. The reason for this is that the time series of reliable available data are shorter (1993-
2004 rather than 1990-2004). External R&D is defined as R&D in the same sector in other
EU-25 countries, with the same trade-weighted matrices and distance matrices used to
determine the relationships between the countries. This means that for the central European
countries, external R&D will tend to be dominated by spending in Germany.

Sectoral data for the ten new member states tend to be of poorer quality than the equivalent
data for the EU-15 countries, particularly for the smaller new members where many of the
sectoral time series will contain estimated data points. In addition there were no workable
R&D data available for Malta so domestic R&D spending is discounted.

Figure 2 shows the sectoral results for each of the ten countries. A total of 408 equations
were estimated, of which 19 had parameter coefficients on the long-run external R&D term
that were significant at the 1% level and a further 19 that were significant at the 5% level.
This is a slightly lower proportion than in the EU-15 equations but, if Malta and Cyprus are
discounted, is roughly similar.

Both the aggregated and disaggregated analysis suggested that Poland, Slovakia and possibly
Latvia (see Table 9 and Figure 2) have the largest potential positive spillover effects, with
estimated parameter coefficients of 0.6 or higher, ie generally higher than the EU-15
equivalents. However, the sectoral pattern was much the same as the EU-15 countries. Apart
from Non-metallic Mineral Products, the sectors most likely to benefit from R&D spillover
effects were Distribution and Transport Services. Again, out of the R&D intensive sectors,
Communications is the only one with potential spillovers.

Very few sectors had significant negative results in the New Member States. These were
largely in business services and the public sectors in Slovakia.

Table 9: Significance of long-run

external R&D term by EU-10 country
Country T-probability
Czech Republic 0.894
Estonia 0.724
Cyprus 0.877
Latvia 0.017*
Lithuania 0.123
Hungary 0.731
Malta 0.863
Poland 0.000**
Slovenia 0.753
Slovakia 0.000**

23
Figure 2: EU-10 sectors where the external R&D coefficient is significant

T PROBABILITY CZ EN CY LV LT HU MT PL SI SK 1% 5%
1 Agriculture etc 0 0
2 Coal 0 0
3 Oil & Gas etc 0 1
4 Other Mining 2 3
5 Food, Drink & Tob. 0 2
6 Text., Cloth. & Leath 1 2
7 Wood & Paper 0 0
8 Printing & Publishing 0 0
9 Manuf. Fuels 0 0
10 Pharmaceuticals 1 1
11 Chemicals nes 0 0
12 Rubber & Plastics 1 2
13 Non-Met. Min. Prods. 2 4
14 Basic Metals 0 0
15 Metal Goods 0 0
16 Mech. Engineering 0 0
17 Electronics 0 1
18 Elec. Eng. & Instrum. 0 0
19 Motor Vehicles 0 1
20 Oth. Transp. Equip. 0 0
21 Manuf. nes 1 1
22 Electricity 0 1
23 Gas Supply 0 0
24 Water Supply 0 0
25 Construction 0 0
26 Distribution 1 2
27 Retailing 0 2
28 Hotels & Catering 2 2
29 Land Transport etc 1 3
30 Water Transport 1 1
31 Air Transport 2 3
32 Communications 2 3
33 Banking & Finance 2 3
34 Insurance 0 0
35 Computing Services 0 0
36 Prof. Services 0 0
37 Other Bus. Services 0 0
38 Public Admin. & Def. 0 0
39 Education 0 0
40 Health & Social Work 0 0
41 Misc. Services 0 0
42 Unallocated 0 0
Pos. & Sig, 1% level 3 3 0 1 0 2 0 3 4 3 19
Pos. & Sig, 5% level 4 4 1 4 3 3 0 6 5 8 38

Positive & Significant (1%)

Positive & Significant (5%)

Negative & Significant (1%)

Negative & Significant (5%)

24
3.4 Conclusions
This section attempts to determine whether there are significant long-run relationships between
R&D spending in one European country and productivity in another European country.
Regressions were set up with labour productivity (defined as GVA divided by employment)
described as a function of domestic R&D spending and R&D spending in other countries (external
R&D). Annual time-series data for GVA, employment and R&D spending were taken from the
E3ME database, disaggregated into 42 economic sectors covering the period 1990-2004. Shorter
time series (1993-2004) were used for the EU-10 New Member States.

Three different definitions of external R&D spending were considered: a simple sum across other
countries, a weighted average using a distance matrix, and a weighted average using sectoral
bilateral trade matrices. The bilateral trade matrices were found to produce the closest-fitting
equations and so were chosen. The distance matrix was used for sectors that are not traded, such as
Construction and Retail.

In the aggregated equations, three countries (Ireland, Italy and Luxembourg) had a positive and
(1%) significant coefficient on the long-run external R&D term, indicating possible long-run
spillover, effects. However, it quickly became apparent that there were large sectoral differences,
and the aggregated results were largely reflecting the significance of certain R&D-intensive sectors.

Although several individual sectors demonstrated possible spillover effects, these were not
generally R&D-intensive sectors and apart from Non-metallic Mineral Products were mainly
service sectors (Distribution, Retail and Insurance). However, one relatively R&D-intensive sector,
Communications, stood out as a sector with possible spillover effects in six of the EU-15 countries,
including all three Scandinavian countries. These patterns were also reflected in the analysis of the
EU-10 countries.

4 Model Simulations

In order to evaluate the employment and growth effects of various R&D investment objectives
within the EU, we used the three models (Quest, E3ME and GreenMod) to run several projections
under different investment targets. However, given the limited space available in this paper, below
we only provide the results regarding the Lisbon targets All three models provide very detailed
results for each EU Member States, year, variable, and sector in the case of GreenMod and
E3ME.We provide in the appendix only the aggregate simulation results for 2020.

Even if there are some major differences between the countries, Quest and GreenMod simulation
results show significant and positive impacts on growth in all the EU member states, especially in
some of the new EU members such as Latvia, Lithuania, Slovakia, and Poland. But the impact on
growth in some of the EU15 countries such as Portugal, Spain, Ireland, and Italy is also very
important.

In the Lisbon scenario, all countries aim to increase R&D spending to 3% of GDP, except for
Finland and Sweden which have small increases to 4%. This means that the largest effects should
be in countries that currently have the lowest current rates of R&D spending. Although this is not
always the case, as different countries have different reactions to increases in R&D, it is a trend in

25
the results. Ireland and Portugal have the two largest increases in productivity and some of the
smallest changes are in Finland and Sweden, where R&D spending is already relatively high.

E3ME and GreenMod results also show that the impacts on the various industries would be quite
different. Simulations show that there would be a large increase in the output of a number of
sectors, especially in the manufacturing sectors that supply raw materials to the R&D-intensive
sectors, high R&D intensive sectors such as Pharmaceuticals and Electronics expanding even
faster. This is not surprising given that they are less labour-intensive and are in a better position to
benefit from more efficient production methods. In comparison, the effects are much weaker in
service sectors. Gross output falls or stays the same in most of the energy sectors, because R&D
spending in the manufacturing sectors has the effect of increasing fuel efficiency and reducing the
demand for these sectors’ products.

The impacts on foreign trade would also be significant. The initial effect of increased R&D
spending is to reduce imports. However, this is outweighed by the effects of the overall increase in
demand so that, in most cases, imports increase as shown by E3ME and GreenMod simulation
results. In particular, imports of raw materials are needed by the R&D-intensive sectors to produce
their (usually manufactured) goods.

E3ME simulations show that, in most cases the largest increases in output, which feeds directly into
the labour productivity calculation, come through exports (Germany is an exception, where
consumer spending increases). It is, therefore, not surprising that the largest increases in
productivity tend to come from countries and sectors that are heavily export-oriented.

In general, the greatest effect of R&D spending is to increase exports, particularly to other EU
6
member states. Since previous studies have shown the effects of innovation on export volumes to
be a key driver of long-term growth, this result is not surprising. The direct effects will be partially
offset by higher export prices.

Some of the increases in exports are very large due to the relative increases in R&D spending,
particularly in Ireland, Spain and many of the New Member States. This illustrates how ambitious
some of the targets for R&D spending are.

Generally, increases in export demand follow the same pattern as the results for productivity.
However, this is not the case for all the countries. E3ME results show that the main boost to output
in Germany comes from higher household spending rather than exports. This is partly because the
R&D-intensive sectors also tend to have the highest wage rates.

As shown by the simulations with the three models, the EU10 the scale of the expansion of R&D
spending means that there are some very large impacts on macroeconomic totals, including a 55%
increase in exports from Poland and Estonia and a 25% increase in productivity in Estonia. This is
not entirely surprising given that R&D trebles in Estonia and increases more than five times in

6
Examples include:
In the UK: Greenhalgh, C., P. Taylor and R. Wilson (1994). “Innovation and Export Volumes and Prices: A Dissaggregated Study.” Oxford
Economic Papers 46: 102-134.
In the OECD: León-Ledesma, M. (2000). “R&D Spillovers and Export Performance: Evidence from the OECD
Countries.” Studies in Economics 0014, Department of Economics, University of Kent.
At a Global level: Barker, T. , Pan, H., Köhler, J., Warren, R. and Winne, S. (2006) “Decarbonizing the Global Economy with Induced Technological
Change: Scenarios to 2100 using E3MG” The Energy Journal, Endogenous Technological Change and the Economics of Atmospheric
Stabilisation Special Issue.

26
Poland, however it must be questioned whether it is appropriate to use Baseline parameters to
model changes this large. It is also noticeable that, even with very large increases in R&D
spending, labour productivity barely increases in Latvia, Lithuania and Cyprus, three countries with
low export ratios.

There is a major difference between the model simulations regarding the labour market outcones:
QUEST results are quite different than those of GreenMod and E3ME. This is due to the
differences in the modelling of the labour market in the three models, the link between productivity
growth and labour demand, as well as the sensitivity of the real wages to changes in
unemployment. In the case of Quest, the impacts on employment are fairly low, and in some cases
even negative (Denmark, Finland, Ireland, Cyprus, Lithuania, Latvia, etc), whereas GreenMod and
E3ME results show positive impacts in most countries and even quite high impacts in some cases
such as Ireland (E3ME), Poland (GreenMod), Lithuania (GreenMod), and Latvia (GreenMod).

In the QUEST simulations, there are two offsetting effects. There is a positive effect generated by a
reduction in labour taxes and there is a (long run) negative employment effect generated by the real
depreciation of the currency. This results from the fact that unemployment benefits (which are an
important part of the reservation wage in the model) are indexed to consumer prices.

It is difficult to evaluate the impact of increased R&D investments on employment. The effects of
innovation on employment may be positive or negative, depending on whether the innovation is
labour-saving or labour-creating (for example a new machine may replace low-skilled labour, but it
may also require operators). This is likely to vary by sector and, to a lesser extent, by country.

R&D spending does not have a direct effect on household spending, but any changes in incomes or
prices will. Household spending is the largest component of GDP, so any changes will impact on
overall results.

Investment (and further innovation) increases in all the scenarios, broadly in line with increases in
gross output.

27
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Council of the European Union (2006), “Contribution of the Competitiveness Council to the
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Gelauff G. & Lejour A. (2006), "Five Lisbon highlights; the economic impact of reaching
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Guellec, D. and van Pottelsberghe de la Potterie, B. (2004), “From R&D to Productivity

Growth: Do the Institutional Settings and the Source of Funds of R&D Matter?”, Oxford
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in French Manufacturing Firms”, Journal of Econometrics, 65, pp. 263-293.

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Lichtenberg (1993), “R&D Investment and International Productivity Differences”, in Siebert

H. (ed.), Economic Growth in the World Economy, Mohr, Tubingen, pp. 47-68.

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Lichtenberg and van Pottelsberghe de la Potterie, B (1998), “International R&D Spillovers: a
Comment”, European Economic Review, 42, pp. 1483-1491.

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Growth”, Quarterly Journal of Economics, 107, 407-437.

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Working Paper no 4423, August 1993.

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Practice for Surveys of Research and Experimental development – Frascati Manual 1993”,
OECD, Paris.

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497.

29
Appendix

Table A1: TFP growth projections due to the increase in R&D investment corresponding to the Lisbon targets

Germany France Italy Spain UK Belgium Luxembourg Denmark Greece Ireland NL Austria
2005 0.53% 0.43% 1.06% 1.42% 0.84% 0.79% 1.06% 1.21% 1.39% 1.70% 0.61% 1.10%
2006 0.54% 0.56% 1.63% 2.16% 1.05% 0.94% 1.23% 1.13% 3.30% 2.26% 0.82% 1.09%
2007 0.57% 0.67% 2.00% 2.54% 1.23% 1.07% 1.36% 1.04% 4.09% 2.58% 1.03% 1.08%
2008 0.59% 0.77% 2.17% 2.68% 1.34% 1.16% 1.44% 0.97% 4.19% 2.73% 1.17% 1.07%
2009 0.61% 0.84% 2.21% 2.67% 1.40% 1.21% 1.46% 0.93% 3.98% 2.74% 1.26% 1.06%
2010 0.62% 0.89% 2.17% 2.58% 1.44% 1.23% 1.46% 0.87% 3.66% 2.67% 1.31% 1.05%
2011 0.63% 0.93% 2.08% 2.46% 1.44% 1.23% 1.44% 0.83% 3.34% 2.57% 1.34% 1.03%
2012 0.56% 0.81% 1.63% 1.91% 1.20% 1.04% 1.19% 0.73% 2.47% 2.02% 1.12% 0.88%
2013 0.52% 0.71% 1.33% 1.52% 1.01% 0.88% 1.00% 0.64% 1.89% 1.59% 0.95% 0.77%
2014 0.48% 0.63% 1.11% 1.24% 0.86% 0.77% 0.86% 0.58% 1.51% 1.28% 0.82% 0.68%
2015 0.45% 0.57% 0.95% 1.04% 0.75% 0.68% 0.75% 0.53% 1.24% 1.06% 0.72% 0.61%
2016 0.43% 0.52% 0.82% 0.89% 0.66% 0.60% 0.66% 0.48% 1.04% 0.89% 0.64% 0.55%
2017 0.41% 0.48% 0.73% 0.77% 0.59% 0.55% 0.59% 0.45% 0.89% 0.76% 0.57% 0.50%
2018 0.39% 0.45% 0.65% 0.68% 0.53% 0.50% 0.54% 0.42% 0.77% 0.67% 0.52% 0.46%
2019 0.38% 0.42% 0.59% 0.61% 0.49% 0.46% 0.49% 0.40% 0.68% 0.59% 0.48% 0.43%
2020 0.37% 0.40% 0.54% 0.55% 0.45% 0.43% 0.45% 0.38% 0.61% 0.52% 0.45% 0.41%
2021 0.36% 0.38% 0.50% 0.51% 0.42% 0.41% 0.43% 0.36% 0.55% 0.47% 0.42% 0.39%
2022 0.35% 0.37% 0.47% 0.47% 0.40% 0.38% 0.40% 0.35% 0.51% 0.43% 0.40% 0.37%
2023 0.34% 0.35% 0.44% 0.44% 0.38% 0.37% 0.38% 0.34% 0.47% 0.40% 0.38% 0.36%
2024 0.34% 0.34% 0.42% 0.41% 0.36% 0.35% 0.36% 0.33% 0.44% 0.37% 0.37% 0.35%
2025 0.33% 0.34% 0.40% 0.39% 0.35% 0.34% 0.35% 0.32% 0.42% 0.35% 0.35% 0.34%

Source: Own calculations.

30
Table A1: TFP growth due to the increase in R&D investment corresponding to the Lisbon targets

Portugal Finland Sweden Cyprus Czech Rep. Estonia Hungary Latvia Lithuania Malta Poland Slovakia Slovenia
2005 1.38% 1.49% 0.88% 2.30% 1.72% 2.45% 1.45% 2.09% 3.13% 0.11% 1.07% 0.77% 1.10%
2006 2.51% 1.29% 0.81% 5.72% 2.24% 3.55% 2.49% 5.34% 4.46% 3.61% 2.92% 2.86% 1.42%
2007 3.04% 1.17% 0.76% 6.31% 2.49% 3.94% 3.02% 6.14% 4.73% 4.98% 3.84% 3.95% 1.64%
2008 3.17% 1.09% 0.73% 5.80% 2.57% 3.99% 3.20% 5.83% 4.53% 5.04% 4.06% 4.30% 1.76%
2009 3.05% 1.03% 0.70% 5.10% 2.56% 3.87% 3.16% 5.27% 4.23% 4.61% 3.92% 4.22% 1.83%
2010 2.87% 0.97% 0.68% 4.46% 2.49% 3.64% 3.03% 4.70% 3.85% 4.07% 3.68% 3.98% 1.86%
2011 2.66% 0.93% 0.66% 3.94% 2.40% 3.38% 2.85% 4.20% 3.50% 3.59% 3.40% 3.69% 1.85%
2012 2.00% 0.83% 0.61% 2.86% 1.92% 2.63% 2.20% 3.12% 2.66% 2.55% 2.57% 2.80% 1.54%
2013 1.60% 0.72% 0.55% 2.23% 1.59% 2.14% 1.77% 2.47% 2.14% 1.93% 2.05% 2.25% 1.31%
2014 1.32% 0.64% 0.50% 1.81% 1.34% 1.79% 1.47% 2.04% 1.78% 1.53% 1.69% 1.87% 1.13%
2015 1.12% 0.57% 0.46% 1.52% 1.15% 1.52% 1.24% 1.72% 1.53% 1.25% 1.44% 1.59% 0.99%
2016 0.96% 0.52% 0.43% 1.32% 1.00% 1.32% 1.07% 1.48% 1.34% 1.06% 1.25% 1.38% 0.88%
2017 0.85% 0.48% 0.40% 1.16% 0.89% 1.15% 0.93% 1.28% 1.18% 0.92% 1.10% 1.21% 0.79%
2018 0.75% 0.44% 0.38% 1.04% 0.80% 1.02% 0.83% 1.14% 1.07% 0.82% 0.99% 1.09% 0.72%
2019 0.68% 0.41% 0.37% 0.96% 0.73% 0.93% 0.75% 1.03% 0.98% 0.74% 0.90% 0.99% 0.66%
2020 0.62% 0.39% 0.35% 0.89% 0.67% 0.85% 0.68% 0.95% 0.91% 0.68% 0.83% 0.91% 0.62%
2021 0.58% 0.37% 0.34% 0.83% 0.62% 0.79% 0.63% 0.89% 0.86% 0.62% 0.78% 0.86% 0.58%
2022 0.54% 0.36% 0.33% 0.79% 0.59% 0.74% 0.59% 0.83% 0.82% 0.58% 0.74% 0.81% 0.55%
2023 0.51% 0.34% 0.32% 0.75% 0.56% 0.71% 0.56% 0.79% 0.78% 0.55% 0.70% 0.77% 0.53%
2024 0.48% 0.33% 0.31% 0.72% 0.53% 0.68% 0.53% 0.76% 0.76% 0.52% 0.68% 0.74% 0.51%
2025 0.46% 0.32% 0.31% 0.70% 0.51% 0.65% 0.51% 0.74% 0.73% 0.50% 0.66% 0.72% 0.49%

Source: Own calculations.

31
Table A2: Quest simulation results – GDP and Employment effects in 2020 of Lisbon R&D targets
  Germany  France  Italy  Spain  UK  Austria  Belgium  Denmark  Finland  Greece  Ireland  Netherlands
GDP  9.57  10.35  17.36 21.52 13.88 11.83 13.34 9.96  13.12 27 21.35 11.49
Employment  0.21  0.87  0.21 2.52 0.25 1.02 0.98 ‐0.69  ‐0.52 2.42 ‐0.56 ‐0.44

Table A2: Quest simulation results – GDP and Employment effects in 2020 of Lisbon R&D targets (Continued)
  Portugal  Sweden  Cyprus  Czech  Estonia  Hungary  Latvia  Lithuania  Malta  Poland  Slovenia  Slovakia 
GDP  20.66  9.13  37.94  21.79 31.72 24.28 36.43 38.05  32.2 31.91 16.05 35.29
Employment  0.23  1.03  ‐1.88  ‐0.73 ‐0.53 0.22 ‐0.79 ‐0.95  ‐0.1 1.34 0.21 0.75

Table A3: GreenMod simulation results – Macroeconomic effects in real terms (% change compared to BAU) - 2020 (continued)
Macroeconomic effects in real terms (% change to the BAU) - 2020 BE CZ DK DE EE IE EL ES FR

GDP 8.60 11.13 6.79 6.88 15.81 8.87 9.61 13.47 6.06
Private consumption 5.13 7.53 4.63 4.11 7.49 5.89 7.94 9.89 4.20
Government consumption 8.42 10.72 6.73 6.69 15.94 9.54 15.18 13.97 6.31
Gross fixed investment 10.95 10.35 9.12 13.53 17.46 11.24 6.22 16.46 8.53
Exports 8.22 9.95 6.05 6.07 15.24 5.82 8.68 12.02 5.22
Imports 5.35 6.99 4.46 4.26 10.01 4.48 5.14 8.25 3.45

Table A3: GreenMod simulation results – Macroeconomic effects in real terms (% change compared to BAU) - 2020 (continued)
Macroeconomic effects in real terms (% change to the BAU) - 2020 IT LV LT LU HU MT NL AT PL

GDP 11.31 29.33 29.86 6.25 11.43 16.03 8.12 6.34 21.17
Private consumption 8.15 16.31 11.79 3.99 7.52 10.27 4.25 4.20 14.86
Government consumption 11.03 28.01 29.90 5.87 11.45 16.52 7.72 6.52 22.40
Gross fixed investment 17.36 33.14 52.76 5.51 11.59 13.04 12.76 8.39 26.63
Exports 9.52 31.91 29.96 5.73 9.95 13.40 7.18 5.79 19.82
Imports 6.70 18.91 18.85 4.01 6.91 8.71 4.73 4.12 12.83

32
Table A3: GreenMod simulation results – Macroeconomic effects in real terms (% change compared to BAU) - 2020 (continued)
Macroeconomic effects in real terms (% change to the BAU) - 2020 PT SI SK FI SE UK

GDP 14.72 10.18 21.75 8.72 5.79 9.00

Private consumption 10.39 6.66 12.51 5.75 4.01 6.78
Government consumption 15.82 9.91 20.81 8.74 5.44 8.97
Gross fixed investment 17.67 9.48 24.70 13.77 7.80 12.42
Exports 13.37 10.36 20.67 7.71 5.21 8.42
Imports 8.81 6.48 12.85 5.48 3.58 5.28

Table A4: GreenMod simulation results – Labour market effects - 2020

Labour market effects - 2020 BE CZ DK DE EE IE EL ES FR

National employment 2.87 3.22 1.82 2.72 4.76 1.89 2.97 5.13 2.30
Number of unemployed -23.44 -25.90 -23.66 -22.26 -31.55 -24.90 -17.50 -31.80 -18.51
Active population 0.72 0.80 0.72 0.67 1.02 0.77 0.51 1.03 0.55
Unemployment rate (in %) 6.23 6.10 3.26 6.33 6.98 3.13 9.85 7.49 6.81
Unemployment rate (% points difference with BAU) -1.97 -2.20 -1.04 -1.87 -3.32 -1.07 -2.15 -3.61 -1.59

Note: If not indicated otherwise all results are reported as percentage change compared to BAU.

Table A4: GreenMod simulation results – Labour market effects – 2020 (continued)
Labour market effects - 2020 IT LV LT LU HU MT NL AT PL

National employment 4.29 10.35 10.18 1.17 2.91 3.98 1.95 1.66 9.39
Number of unemployed -33.66 -49.26 -54.70 -17.03 -30.49 -33.85 -27.43 -21.73 -40.30
Active population 1.10 1.83 2.14 0.50 0.98 1.11 0.86 0.66 1.39
Unemployment rate (in %) 5.51 7.13 5.50 3.05 3.99 4.97 2.66 3.34 9.48
Unemployment rate (% points difference with BAU) -2.89 -7.17 -6.90 -0.65 -1.81 -2.63 -1.04 -0.96 -6.62

Note: If not indicated otherwise all results are reported as percentage change compared to BAU.

33
Table A4: GreenMod simulation results – Labour market effects – 2020 (continued)
Labour market effects - 2020 PT SI SK FI SE UK

National employment 3.87 2.81 8.48 3.39 1.67 2.62

Number of unemployed -43.14 -27.90 -31.44 -25.51 -20.10 -30.74
Active population 1.52 0.88 1.01 0.79 0.60 0.99
Unemployment rate (in %) 2.80 4.50 12.69 6.65 3.89 3.36
Unemployment rate (% points difference with BAU) -2.20 -1.80 -6.01 -2.35 -1.01 -1.54

Note: If not indicated otherwise all results are reported as percentage change compared to BAU.

34
Table A5: E3ME simulation – 2020
Employment Exports Imports
Belgium 2.6 12.3 8.1
Denmark 0.7 8.5 2.6
Germany 3.5 14.3 9.5
Greece 1.8 10.4 -2.7
Spain 8.3 18.9 7.5
France 1.6 12.9 3.9
Ireland 12.1 36.6 11.1
Italy 3.4 18.9 4.7
Luxembourg 1.6 18.7 15.7
Netherlands 4.6 17.1 5.3
Austria 0.9 7.4 3
Portugal 1.8 11.7 3.8
Finland 7.2 8.5 2.3
Sweden 2.2 5.1 1.2
UK 3.5 20.9 4.7
Czech Rep. 4.7 27.8 19.8
Estonia 1 56 24
Cyprus 0.7 13.8 -0.8
Latvia 0.2 12.7 2.1
Lithuania 0.3 12.1 5.9
Hungary 1.8 21.5 16
Malta 0.5 2.6 0.5
Poland 4.8 55.2 47
Slovenia 2 11.1 3.2
Slovakia -0.9 12 8.7
EU15 3.7 15.9 6
EU10 3.4 33 20.9

35