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Europe and Belarus: the same problems in financing innovations?

The paper highlights common traits in public sector strategies to support innovations in the European Union and Belarus. A selection bias towards “safe bet” innovation projects is diagnosed and remedial action put forward. The latter may be lotteries, auctions, crowdfunding platforms and indirect support measures that leave the definition of the nature of the innovation projects but also the risk largely with the performing entity while assuring diversity in the projects selected.

by Hannes Leo
Co-founder of cbased, a venture that combines crowdsourcing, software development and research and consultancy services.

November 14th, 2012

In July I participated in an innovation policy workshop in Minsk. I was puzzled by one of the problems we discussed: The Belarusian Innovation Fund was facing increasing competition from banks in financing innovation projects. How come? Are bank different in Belarus? Not really. Its rather the philosophy of public interventions that is peculiar in this context: Belarusians do not speculate with public money - not even if they finance innovations. Consequently they have to find very predictable innovation projects to actively promote innovation and that is exactly were they start competing with banks.

Globally, banks leave the tricky business of selecting the most promising innovation projects to a bunch of private investors - venture capitalists (VC) - which know the rules of the game and are able to squeeze out sufficient returns to take on the associated risks. Unfortunately, venture capitalists cater only for the needs of a minority of innovative companies. In many countries - most particularly in Europe - the remaining lack of innovation finance (and the lack of venture capital too) is tackled by public institutions or agencies thereof.

One might argue that the decision rules in Belarus and of VCs are the opposite poles of a risk continuum but that each of their resulting strategies make sense if taken in isolation: Why should public servants (or the juries they nominate) be able to gamble with public money. The realities of the public sector are far from the realities of innovators which makes the public sector both reluctant to buy and to finance risky innovation projects. As a consequence, it is fair to assume that the public sector develops innovation support strategies that are in line with the general mentality and framework conditions of this sector. Here are two recent and illustrative observations:

  • A prominent and well run Nordic innovation support institution stated in an innovation policy workshop in Brussels that they have been struggling with the concept of service innovation for about 10 years. This institutions has been working hard to bring the fuzzy developments and concepts of service innovation in line with their traditional stronghold in supporting technological innovations, state aid rules, etc. Fascinating to hypothise that the Nordic facebooks, googles, and pinterests would have knocked on its doors asking for support only to learn that the support agency is trying to come to grips with service innovation and may consider financing them at a later point in time. Being a VC and having the same troubles would have resulted in missing the hottest deals of the last decade. In both cases quite some start-ups would have gone down the gutter because potential financiers were still contemplating the validity of their business cases.
  • The GPrix project - which studied support measures for SMEs in traditional industries in seven European countries - concluded that the programs did have a zero or even slightly negative effect on the innovation of SME participants. The reason for this was not the schemes or instruments as such but the selection procedures. Programme managers picked already innovative companies that continued to be innovative but did not increase their efforts because of the support they received. A random selection of firms would have generated positive returns of these programs. Consequently, a more inclusive selection procedure would have improved the effectiveness of the programmes (see GPrix Deliverable 3.3: Recommendations, Appendix, http://www.gprix.eu). 

These arguments are obviously far from being an evaluation of the entire European innovation support landscape. They rather hint at a fundamental problem associated with the public sector as the main source of innovation support in Europe: the asymmetry in incentives between those taking decisions on the support of projects and those actually carrying out the projects and taking most of the risks. While topics and instruments vary, the selection procedures often reflect the values of the public sector rather than those required for successfully managing a portfolio of innovations. This also holds for the agencies operating at arms length. Both have developed a taste for innovation projects submitted by competent innovators where the results are predictable. The problem is that these innovators would have innovated anyway and take the public subsidy without changing their innovation paths. A selection that would have favoured less orthodox or less sophisticated innovators would increase the returns but decrease the predictability of (individual) results. Of course there are still many success stories that make it into the headlines - a veil of silence is cast over failures. Given the lack of control groups, nobody can prove otherwise anyway (see also GPrix Deliverable 3.3: Recommendations, Appendix, http://www.gprix.eu). 

There are several possible ways to deal with a risk averse selection of projects. The first - and this has been an on-going trend in Europe but maybe for different reasons - is to increase indirect support thus leaving the decision with the enterprise while making sure that support is only given for specific activities (e.g. R&D or/and innovation expenditures). The second would be to experiment with alternative forms of allocating money: auctions and particularly lotteries are viable alternatives to increase heterogeneity of projects and thus increase the returns to public support. The third alternative are crowdfunding platforms that support innovations with a lot of consumer appeal - another subset of the innovation universe. These "alternative" selection procedures reduce the role of "public mind-set" in the selection of projects and empower those that bear the risks of innovation projects (innovators and venture financiers). If your are somebody who is involved in the public support of innovations and this advice seems unfounded, you may consider allocating a small share of the total resources to test and evaluate alternative selection procedures - the results may be surprising. More innovations on the side of innovation support institutions would be most welcome anyway.

The stabilisation of public support for R&D and innovation activities after the financial crisis at more or less pre-crisis level was a clear indication that Europe is willing to invest in innovations to rekindle growth. The allocation of resources to programmes and projects may have had just the opposite effect and may have prolonged the innovation freeze in Europe because of risk averse project choices. In this sense Europe is closer to Belarus than one would expect. Putting all the blame on selection procedures for innovation projects - an area where we all would like to trust in these highly specialized institutions and programme managers - is certainly not warranted but hints at a more general issue in Europe: the fate of innovations is not only decided when applying for public funding. Most decisions and selections were taken well before this step. In Europe we should consequently encourage a greater variety of innovative projects, approaches and persons at all levels by reducing selection processes. Likewise we should cultivate less respect for the vested interests of established sectors and institutions.

Demanding more variation and less selection in a European setting that already praises its big inherited diversity may be somewhat surprising. Diversity is seen as a pool of working solutions to problems we all share. This interpretation comes with a grain of salt: Stressing the value of diversity may help to conserve whatever peculiarities have developed in Europe over time rather than finding a common solution for European problems. Consequently, it may in practice produce just the opposite behaviour of what is claimed: oppressing experimentation and change and producing more of the same instead. Diversity should be seen as the result of something living and evolving and not of something that has to stay as it is. A more up to date definition of diversity and more emphasis on experimentation might not only help to better support innovations but might also be beneficial for society and individuals. This is also something to be considered by Belarus.

Please discuss these arguments with me on http://www.cbased.com/en/consultation/190. The discussion will be open until the 7th of December. I am looking forward to your comments!