Research and Development: Germany's 3% target not enough
By Michael Hennigan, Finfacts founder and editor
Apr 24, 2014 - 4:26 AM

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As a research location, Germany has made significant progress over the last few years. The share of R&D expenditure in GDP probably just missed the EU's 3% target in 2012. Despite this positive trend, further efforts are necessary to maintain Germany's competitive position, according to Deutsche Bank economists.

Thomas F. Dapp and Sebastian Koch say that at 2.5% back in 2000, Germany's R&D spending in relation to GDP, also referred to as "research intensity", already exceeded the European average. In the years that followed, however, it more or less stagnated. There was no pronounced increase until 2008, when above all the public sector and universities markedly boosted their R&D budgets. According to Eurostat, research intensity in Germany reached 2.89% in 2011.

In a European comparison, Germany thus maintained a top ranking. Research intensity was higher only in Denmark (2.98%), Finland (3.8%) and Sweden (3.39%) in 2011. The EU average stood at just over 2% and so it was still one percentage point below target. Germany also outstripped the US (2.67%).

Dapp and Koch say that despite the recent positive trend Germany must not tire in its efforts. Two major economies - - Japan and South Korea - - still enjoy a substantial lead. In 2010 - - more recent data are not yet available - - they spent 3.25% and 3.74% of GDP on R&D, respectively. At the same time, research capacities are being built up particularly in the emerging markets such as the BRICs (Brazil, Russia, India and China), albeit from a low level. This catching-up process is being led by China, which in absolute numbers is already the second largest research location behind the US, though an international comparison is proving to be difficult in light of differences in statistical definitions, for instance regarding the quantity and quality of patents. If high-wage Germany wants to keep or even improve its position as technological heavyweight among its international competitors, it needs not only to continue to raise expenditure on research and development but also address problems in other areas. After all, the economists say that research intensity is only one of many indicators of a country's innovative capacity. Therefore an analysis of Germany's strengths and weaknesses may be helpful.

Germany  benefits from the business sector's active participation in the financing of R&D at both universities and other research facilities.  In 2011 companies contributed 14% of total R&D expenditure at universities and 9% at other research facilities. By comparison, the OECD averages came to no more than 6% and 4%, respectively. Despite these close funding ties, the share of companies cooperating with universities and other research outfits in the field of innovation is lower than in the EU as a whole, according to the Stifterverband für die Deutsche Wissenschaft (the business community's innovation agency for the German science system). Hence, the economists say that suitable conditions should be put in place to ensure that businesses can take recourse to specific knowledge accumulated by these scientific facilities to an even stronger degree than so far. One example would be to better reconcile incentive structures in academic and corporate research. After all, more intensive cooperation would benefit the companies in the form of knowledge spill-over.

Dapp and Koch say that one of the weaknesses of Germany as a research location is the fact that R&D expenditure is heavily concentrated on a small number of sectors. The lion's share goes to manufacturing, whose research intensity in turn is determined by a few sectors only. Traditionally, there is a strong focus on the automotive sector. In 2011, it accounted for one-third of total corporate spending on in-house R&D. At 12.8% and 9.6%, respectively, electrical and mechanical engineering were other research-intensive industries, as well pharmaceuticals (8%). Overall, German companies tend to have a strong R&D focus on high-value technologies whose share of R&D spending in turnover amounts to between 3 and 9% on an annual average - according to the definition given by Germany's Commission of Experts for Research and Innovation (EFI).

In the cutting-edge technology sector, the situation is quite different, with more than 9% of turnover being spent on R&D. In this regard, the German economy is in a relatively weak position. According to calculations by the expert commission, only 2.5% of total value added was attributable to cutting-edge technologies in 2011. In Japan (3.3%) and South Korea (7.3%) this share was considerably higher, even though the two countries are also well positioned in the high-value technology sector. The structure of the German economy, with its weaknesses in cutting-edge and strengths in high-value technologies, is a major determinant of the country's attractiveness as an R&D location. Both domestic and foreign companies are increasingly relocating their cutting-edge R&D activities abroad. At the same time, new research capacities are being created in Germany, mostly by the automotive industry.

This specialisation makes perfect sense as it enables German businesses to focus on their strengths and make use of comparative advantages which set them apart from their international competitors. Cutting-edge goods and services such as information and communication technologies (ICT) that are considered key technologies, however, are of special and cross-sectoral significance for potential growth. With weak domestic R&D activities and minor value added in the cutting-edge segment, the positive momentum created by these technologies for the German economy as a whole could suffer.

Dapp and Koch say that in order to foster research in high-tech sectors such as biotechnology, pharmaceuticals or ICT, conditions should be improved for, among other things, new business startups. These include early-stage funding through easier access to venture capital for start-ups. In its coalition agreement, the German government explicitly announced its intention to make Germany a more attractive location for international venture capital investment. It remains to be seen whether it can do justice to this plan, as announced, by means of specific regulation. Another key factor could be tax incentives for R&D, as are already in place in many OECD countries. In addition, networking is required between leading foreign cutting-edge companies and German partners from both the business and science communities in order to promote the diffusion of knowledge to domestic sectors.

"In spite of all these measures geared to meet Germany's demands as a research location, we must not lose sight of the aim of creating a strong European research area. It cannot possibly be in the interest of Germany's business sector to curb economic momentum in the EU and its medium-term growth potential by cutting R&D expenditure, as is currently the case in connection with national austerity programmes. Instead it should be borne in mind that the EU must not fall behind the US and Asia in the cutting-edge segment. This implies, however, that R&D expertise in crisis-ridden countries be maintained and promoted. It may therefore make sense to make available EU R&D funding especially in places where in light of large public-sector deficits long-term underinvestment looms," the economists conclude.

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