Opening up of Japan's National Innovation System to World

ITO Banri
Visiting Fellow, RIETI

On February 26, 2007, the Innovation 25 Strategy Council, a government advisory panel, put forward an interim report on long-term strategic guidelines for innovation through 2025, "Creating the Future, Challenging Unlimited Possibilities." In order for Japan to continue to boost productivity through technological innovation, the report refers to a wide range of policies, not only in the area of science and technology, such as the promotion of basic research, but also for improving the social environment, enhancing education, and fostering human resources. One point to which I wish to draw special attention is that the report, in consideration of ongoing globalization, has been written so as to urge innovation-pursuing companies and researchers to "open up to the world." Indeed, as corporate R&D activities are increasingly internationalized, the large amount of empirical research in international economics on the determinants of overseas R&D and its impact has been undertaken. I would like to give my views on the significance of open innovation systems, referring to some relevant empirical findings.

R&D internationalization and its determinants

In recent years, multinational corporations (MNCs) have become increasingly active in their R&D. Among the Organisation for Economic Co-operation and Development (OECD) member countries, R&D performed by foreign affiliates represented an average of 16% of total private-sector R&D expenditures in 2004, with the share exceeding 40% in Hungary, Ireland, the Czech Republic, the United Kingdom, and Australia (OECD, 2006a). Particularly, for countries that set an R&D expenditure target as part of their innovation strategy, expectations run high toward MNCs with a strong drive for R&D. But what are the objectives of overseas R&D activities by MNCs? And what are the determinants of cross-border R&D? It has been considered that cross-border R&D by MNCs is aimed at adapting their products to the market of the host country. This stems from the need to support production units so as to deliver products that meet the regulatory requirements, consumer preferences, and other conditions of the local market. Meanwhile, there have recently been a growing number of cases where MNCs undertake cross-border R&D aimed at generating new technological knowledge by tapping into local sources of expertise and R&D resources (Kumar, 2001; Belderbos, 2001).

What are the determinants of this increasing type of R&D? According to empirical findings to date, location decisions for R&D facilities of this type are substantially affected by the host country's R&D potential, such as its level of technological accumulation. Ito and Wakasugi (2007) examines how this emerging type of technology-sourcing R&D, aimed at accessing local sources of superior technological knowledge and R&D resources, is affected by the level of technological accumulation, the number of researchers, and the extent to which the host country has established an intellectual property rights (IPR) regime. The number of overseas research laboratories operated by Japanese MNCs was found to have increased from 300 in 1995 to 500 in 1998. The increase was particularly sharp in countries with higher levels of technological accumulation. Also, a statistically significant positive correlation is observed between R&D location decisions and the number of local researchers, as well as with the level of IPR protection provided in the host country. This indicates that newly emerging technology-sourcing R&D, as compared to conventional R&D designed to support production, more greatly affects the R&D potential of the host country. R&D internationalization has been shown to be significantly dependent on the R&D potential and relevant systems of the host country.

What are advantages of opening up innovation?

So what impacts do such R&D activities by foreign MNCs have on the domestic economy of the host country? Generally speaking, knowledge creation activities trigger situations in which one company engaged in R&D absorb positive spillovers from other companies' R&D, thereby enhancing the productivity of its own R&D. Spillover effects can be transmitted through diverse channels; these include transfer of technological knowledge through the disclosure of patented inventions, transfer and exchange of researchers, and reverse engineering - learning technology by dissembling a certain object to see its workings.

Thus, foreign companies with high-level technology and productivity also have been to seen to cause positive spillover effects on the domestic industry of the host country. Indeed, many studies have demonstrated that the presence of foreign companies positively affects the productivity of domestic companies. Furthermore, recent findings suggest that foreign companies' R&D activities, rather than production activities, are the source of such effects. For instance, using data on Japanese companies, Todo (2006) showed that R&D stock of foreign companies has positive effects on the productivity of domestic companies, and the impact of such effects is greater than that of effects derived from R&D stock of domestic companies.

So then what impacts does overseas R&D have on home countries? Using patent citations between Japanese companies in the U.S. and U.S. companies as a measurement for cross-border spillovers, Branstetter (2006) showed that Japanese direct investment in R&D increases the number of patent citations between the two sides, suggesting the presence of spillover effects of overseas R&D on both the host and home countries. As indicated by many preceding studies, however, in order to benefit from spillovers a country must have the capacity to absorb them. It should be noted that it is crucial to have the absorptive capacity to understand and exploit technological knowledge spillovers.

Globalization and innovation policies

As discussed, it has been empirically shown that the internationalization of corporate R&D have positive impacts both on host and home countries through knowledge spillovers. If such reciprocal spillover effects benefit both sides, policies designed to induce MNCs to undertake R&D and measures to assist domestic companies in conducting R&D abroad should be considered. R&D expenditures of foreign companies operating in Japan, despite having more than doubled in absolute terms between 1995 and 2003, remain the lowest among OECD countries as a share of total private-sector R&D expenditures in the country (OECD, 2006a). Preceding studies (e.g. Belderbos, 2001) have shown that Japanese companies' R&D activities abroad, compared to those of MNCs from other countries, remain at a low level. Japan also remains the lowest among the OECD countries in the degree of cross-border research collaboration, for instance, as measured by the "share of patent applications owned or co-owned by applicants whose country of residence is different from the country of residence of the inventor(s)." (OECD, 2006b).

Provided that the presence of a favorable institutional environment - quality human resources, high-level technological knowledge, an efficient IPR regime, and so forth - is a primary determinant of MNCs' R&D, it is important to improve the environment in each aspect. This would create an open innovation system within an innovation-friendly environment by incorporating various policy matters - including those concerning human resources, and the strengthening of basic research and promotion of private sector R&D - that properly responds to the needs created by globalization. As referred to in the Innovation 25 Strategy Council's interim report, Japan's insularity is partly responsible for its remaining at a low level in each of the above mentioned measurements. In this regard, Japan's innovation activities may not yet have been opened up. I will closely watch how the policy dialogue develops toward truly opening up the national innovation system of Japan, a country with high technology, to the rest of the world.

April 3, 2007

Belderbos, R., 2001. "Overseas innovations by Japanese firms: an analysis of patent and subsidiary data." Research Policy 30, 313-332.

Branstetter, L., 2006. "Is foreign direct investment a channel of knowledge spillovers?" Evidence from Japan's FDI in the United States. Journal of International Economics. 68, 325-344.

Ito, B., and R. Wakasugi, 2007. "Factors Determining the Mode of Overseas R&D by Multinationals: Empirical Evidence." RIETI Discussion Papers 07-E-004, Research Institute of Economy, Trade and Industry.

Kumar, N., 2001. "Determinants of location of overseas R&D activity of multinational enterprises: the case of US and Japanese corporations." Research Policy 30, 159-174.

OECD, 2006a. OECD Science, Technology and Industry (STI) Outlook 2006. OECD, Paris.

OECD, 2006b. Compendium of Patent Statistics 2006. OECD, Paris.

Todo, Y., 2006. "Knowledge spillovers from foreign direct investment in R&D: Evidence from Japanese firm-level data." mimeo.

April 3, 2007

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