2007/6 Research & Review

Multinationalization of R&D and Innovation Systems

ITO Banri
Visiting Scholar, RIETI
Research Fellow, Japan Society for the Promotion of Science

Cross-border research and development (R&D) activities have significantly increased in recent years in the wake of rising overseas private-sector investment. In this article, I would like to discuss my view on the potential policy implications of the internationalization of R&D on national innovation systems, referring to some of the research findings I presented at the International Workshop on Empirical Studies of Trade, FDI and Firm in East Asia on March 16 and 17, 2007. The workshop was organized by RIETI and attended by 30 economists from Japan and abroad (Program Chair: Ryuhei Wakasugi, Research Counselor, RIETI, and Professor, Institute of Economic Research, Kyoto University).

Internationalization of R&D activities

In recent years, multinational corporations have been rapidly expanding R&D activities outside their home countries. Among Organisation for Economic Cooperation and Development (OECD) member countries, local subsidiaries of multinationals accounted for an average of 16% of private-sector R&D expenditures in 2004. Japanese companies are no exception, with an increasing number of their overseas subsidiaries investing in R&D in their host countries. According to the Survey of Overseas Business Activities conducted by the Ministry of Economy, Trade and Industry (METI), Japanese manufacturers' overseas R&D expenditures more than doubled from ¥205.7 billion in fiscal 1996 (April 1996-March 1997) to ¥421 billion in fiscal 2004. Overseas R&D by private-sector companies can generally be classified into two types based on its objective. First, there are cases in which companies engage in overseas R&D for the purpose of adapting their products to local needs. This type of R&D is driven from the need to support local production units so as to adapt to the local market environment, including market regulation and consumer preferences, when launching operations abroad. The other type of R&D is aimed at creating new technical knowledge by absorbing superior technical knowledge and other R&D resources in host countries. The first type is called "support R&D" because it supports production units, whereas the second, for creating new technical knowledge and returning those benefits to the headquarters, is called "sourcing R&D." Of these, the latter has been markedly increasing and this expansion of R&D functions is thought to be a factor behind the ongoing increase in multinationals' R&D expenditures.

Shift in type of R&D and underlying factors

Let's look at overseas R&D trends with a focus on overseas subsidiaries of Japanese companies. The table below examines overseas subsidiaries that report R&D expenditures, dividing them into two groups: those with a local research institute and those without. More specifically, it shows the number of subsidiaries and the total sum of R&D expenditures for each of these groups. Due to data constraints, the comparison can be made only between fiscal 1995 and fiscal 1998. Still, we can see that the number of subsidiaries operating a local research institute increased rapidly and the total R&D expenditures by those subsidiaries nearly doubled during the three years.

Table: R&D activities by Japanese companies' overseas subsidiaries in 1995 and 1998

The Survey on Research Activities of Private Businesses conducted by the Ministry of Education, Culture, Sports, Science and Technology (MEXT) cited reasons why companies chose to set up research institutes overseas. Many noted that the presence of a local research institute enables them to secure with relative ease capable human resources and to quickly access high-quality research by local universities and public agencies, in addition to the facilitation of support R&D. It can be inferred that by establishing R&D bases abroad, companies add sourcing R&D functions to conventional support R&D functions. Therefore, the recent and notable rise in overseas R&D is seen to be accompanied by the expansion of R&D functions centered on support R&D to those that include sourcing R&D functions.

So, what factors determine this type of overseas R&D? Using the same data shown in the above table, Professor Ryuhei Wakasugi of the Institute of Economic Research at Kyoto University and I conducted joint research (Ito and Wakasugi, 2007), in which we examined the decision-making mechanism for overseas R&D by focusing on market and company-specific factors. We found that the increased number of Japanese companies' R&D bases overseas between 1995 and 1998 was particularly sharp in countries that have an extensive accumulation of technical knowledge. Also, companies' decisions to set up R&D bases in a host country were found to have a significant positive correlation with the number of researchers available and the degree of intellectual property protection provided in that country.1 More importantly, it became clear that these factors have a greater impact on sourcing R&D aimed at accessing superior technical knowledge and R&D resources in a host country than on conventional support R&D. These findings show that the multinationalization of R&D depends significantly on the R&D potential and market system of the targeted country, and that these factors are particularly important in selecting the location of sourcing R&D bases, the number of which is on the rise.

Implications to innovation policy

The multinationalization of R&D may possibly affect the formation of national innovation systems. In general, knowledge creation generates spillover effects. Those engaged in knowledge creation receive spillover from R&D undertaken by others, thereby raising the productivity of their own R&D. Spillover effects generated by foreign multinationals' R&D have been empirically shown to spread to domestic companies and increase their productivity. Using Japanese data, Todo (2006) showed that R&D stock of foreign companies has a positive impact on the productivity of domestic companies, and this impact is greater than that from domestic companies. Given the presence of such spillover effects, it is important to improve the quality of human resources, the level of their technical knowledge, and the degree of intellectual property protection so as to create an "innovation-friendly" environment, as shown by the aforementioned series of studies. Or, arguably, there is room to consider policy for more straightforwardly encouraging foreign multinationals' R&D investment. Notably, Australia is alone among OECD member countries in offering incentives for foreign direct investment in R&D.2 Japan is the lowest among OECD member countries in the level of foreign companies' R&D expenditures measured as a percentage of total private-sector R&D expenditures. However, by further opening its innovation systems to the rest of the world, it may be possible to accelerate domestic companies' innovation. Other countries' policy initiatives for R&D internationalization need to be reviewed and further evidence needs to be gathered on the impact of multinationals' R&D on domestic industries.

>> Original text in Japanese

  1. Wakasugi and Ito (2007) also found that greater protection of intellectual property not only increases R&D at local subsidiaries but also accelerates intra-company technology transfer from the headquarters to the subsidiaries.
  2. This is based on the OECD survey of 13 member countries in 2005 (OECD, 2006). Under the Strategic Investment Coordination (SIC) program, Investment Australia, a government agency promoting inward investment, has offered investment incentives to nine projects since 1997.

Ito, B. and R. Wakasugi, 2007, "What factors determine the mode of overseas R&D by multinationals? Empirical evidence," Research Policy 36, pp. 1275-1287.

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

Todo, Y., 2006, "Knowledge spillovers from foreign direct investment in R&D: Evidence from Japanese firm-level data," Journal of Asian Economics, 17(6), pp. 996-1013.

Wakasugi, R. and B. Ito, 2007, " The effects of stronger intellectual property rights on technology transfer: Evidence from Japanese firm-level data," Journal of Technology Transfer, forthcoming.

October 4, 2007

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