Why large companies became the new drivers of innovation and what to do about it?

Who drives innovation in emerging markets? In Turkey, for many years, our focus has been on startups and SMEs. They are thought to be more agile than large companies and multinationals. Public funds to support innovation are directed to SMEs and startups, both they are regarded as cradles for innovation and because they suffer more from capital market imperfections to finance their innovative activities.

Recent evidence opposes the innovative magic of startups and SMEs. According to the GE Innovation Barometer 2018, the business community increasingly thinks that the driver of innovation is multinationals and large companies, not startups and SMEs. Below figure shows the sharp transformation of attitudes from 2014 to 2018, which is more pronounced for Turkey (top panel).

Figure 1 — Who is the main driver for innovation in your country?

Turkey

Source: GE Innovation Barometer

Global

Source: GE Innovation Barometer

Why multinationals and large companies are increasingly more perceived as drivers of innovation? One reason, in my opinion, is the shift in industries in which innovative activity is highly concentrated in: With the fourth industrial revolution, innovation shifted to industrial domain including manufacturing, finance, energy, health, etc — which are dominated by large firms — from consumer domain including social media, e-commerce. In the latter category of industries, startups of the last decade such as Facebook and Amazon are already the largest multinationals globally.

Figure 2 — Technology Diffusion

Source: IMF World Economic Outlook 2018

The recent World Economic Outlook by the International Monetary Fund (Chapter 4) provides a conceptual framework for the new role of multinationals as the driver of innovation in emerging economies. Innovation in an emerging market is impacted by both domestic R&D as well as the use of global R&D. Global R&D is used through knowledge flows supported by foreign direct investment, trade and migration. In turn, innovation leads to more productivity.

According to IMF analysis, one percent increase in global R&D weighted by knowledge flows is associated with one third of one percent increase in emerging market innovation.The measurements are based on patent citations, which is imperfect (not all innovation is patentable nor is optimal to patent) but is the only data availabe to make cross-country comparisons of innovation. The same patenting data also reveal that emerging market firms that participate into global value chains (i.e. become suppliers of multinationals) as a result innovate more.

Figure 3 — Contribution of Foreign Knowledge to Labor Productivity Growth

Source: IMF World Economic Outlook 2018

A more critical impact of knowledge flows is on productivity — which is the most important determinant of long-run economic growth. According to the IMF analysis in Figure 3, the impact of Foreign R&D in the labor productivity of emerging economies explains a larger portion of productivity growth in emerging economies than Domestic R&D.This is a critical finding, especially given the productivity growth has slowed down in the last decade globally.

International knowledge flows explain a significant portion of increase in innovation and productivity in emerging markets. Multinational companies are the most critical platforms through which these knowledge flows happen. They increasingly build platforms to foster knowledge linkages to emerging markets. One reason for this is the the secular decline in the innovation at the frontier at advanced economies, due to, as Robert Gordon puts forward, increasing complexity of really novel ideas.

One example is GE’s global innovation network. GE opened 8 innovation centers in countries like China, South Africa and the United Arab Emirates. One of these innovation centers is in Istanbul. Turkey hosts innovation centers of other industrial multinationals including Dupont, 3M, Cisco and BASF, as well as best-practices of global innovation programs of multinationals including Citibank, Allianz in services industries. These innovation centers and programs develop innovation collaborations with companies (large, SME, startup) in Turkey. This is a win-win relationship for both the multinational and the hosting country. I have elaborated more on the two-year story of GE Istanbul Innovation Center in a prior blog post.

As discussed above, cross-country evidence shows that international knowledge links to foreign R&D have equally large –and sometimes larger — impact on innovation and productivity as the local R&D. These links also enable local SMEs and startups to reach to global markets. Multinationals are increasingly becoming the primary platform to enable the international knowledge links. This is why they are increasingly regarded as primary drivers of innovation, both in Turkey and globally. Yet, the Government of Turkey’s innovation support strategy is still primarily centered around supporting the local R&D activities. The localization strategy, which is increasingly getting important, is also centered around activities, not linkages.

Network may of patent collaborations (2010–12)

The above figure is a map of patent collaborations in the ICT industry. Turkey appears as a point far from the dense core of international collaborative innovation and not linked to any clusters. Collaborations between multinational and large firms on one hand and startups and SMEs on the other is the way out of this loneliness. Networks will dominate the fourth industrial revolution. As such, they should become the core of our innovation strategies and policies.

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