This paper estimates the private returns to four different kinds of R&D spending on the probability of Irish and foreign-owned businesses engaging in product, process and organizational innovation. By providing econometric analysis of nearly 2000 businesses in the Community Innovation Survey: 2004 to 2006, it makes an important contribution to our understanding of the effects of Irish innovation policy, which has incentivized businesses to spend on R&D in Ireland. The main findings are that Irish-owned businesses are significantly more likely than foreign-owned to introduce new products as a result of creative R&D work undertaken. Foreign-owned businesses, which spend nearly 6 times more per worker on R&D than Irish-owned, enjoy very high returns mostly from the purchase or licence of patents. This reflects a fundamental difference in the innovation activities of these businesses, which is critical for policymakers’ understanding of the Irish innovation system.

1. 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

2. 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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3. 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.

4. 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.
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5. Irish Policy on R&D (ctd)
Business +5.3% pa
Source: CSO, BERD Releases

6. 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
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7. 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).

8. 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?

9. 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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10. 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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11. 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.

12. Are there Diminishing Returns?
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13. 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.

14. 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

15. 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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16. 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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