Upgrading technology in Central and Eastern European economies

Central and Eastern Europe in a comparative perspective

As a means of comparing technology upgrading on an international level, it is interesting to measure CEE countries against BRIC countries in terms of production, R&D, and technology capability. Figure 1 distinguishes between Central Europe (Estonia, Poland, Czech Republic, Hungary, and Slovenia), Eastern Europe (Romania and Bulgaria), and the BRIC countries, as well as the other EU region—EU South (Greece, Cyprus, Malta, Portugal, Spain, and Italy). The figure compares these regions to the EU North (the remaining EU12 developed economies) and finds substantial differences. These gaps are largest in terms of technology capability, where CEE ranks between 10% and 20% of the capacity of EU North, between 20% and 60% in terms of R&D capability and between 40% and 60% in terms of production capability.

When compared to the BRIC region, Central Europe ranks higher when it comes to the level of development of their production and R&D capability, and is ahead of three out of four BRIC countries (except China) in terms of technology capability. On the other hand, Eastern Europe trails behind the BRIC range in all three types of technology upgrading. Central Europe’s high position in production capability is due to its strong integration into European industrial networks, particularly the German-Austrian industrial system [3].

Technology upgrading: Perspective on growth

Identifying the drivers of productivity or total factor productivity is often an uncertain or controversial endeavor. In this article, the issue is approached through the prism of technology upgrading. Technology upgrading denotes substantial changes in a country’s specialization and knowledge base, which increase its capacity to use and generate technology as a cumulative capability [4]. Technology upgrading is depicted through the improved ability of a firm or an economy “to move to more profitable and/or technologically sophisticated capital and skill-intensive economic niches” [4], pp. 51−52. In a nutshell, technology upgrading is “a shift to higher value-added products and production stages through increasing specialization” [5]. (See also [2].)

It is usually assumed that R&D drives growth, which drives innovation, which, in turn, further drives growth. However, this model of technology upgrading is not typical for middle-income economies. In these economies, the mode of innovation is most often located in “downstream” activities related to production capability. This refers to the capability to produce at global standards of quality at a given standard technology. Improving production capabilities is about improvements in process engineering, quality improvements, and management practices. Instead of innovating based on R&D, these economies are much more likely to innovate based on incremental innovation, cost-oriented process innovations, and technology adoption. These are demand-driven innovations, rather than supply or R&D-driven ones. Technology upgrading in these economies, which includes the majority of CEE countries, is about improving management practices before moving to process engineering improvements [6].

Similarly, it is conventionally assumed that innovation takes places in a linear sequence, in which R&D leads to innovation that leads to productivity (referred to as the R>D>I sequence). However, the evidence on technology upgrading in economies that operate behind the technology frontier suggests that technology upgrading does not occur this way; rather, it very often follows an inverse sequence, which starts from production capability and moves toward innovation and R&D, similar to an inverse product life cycle (Figure 2).

The linear R&D-driven model of technology upgrading captures only a part of the spectrum of technology upgrading activities in CEE. An alternative is a two-way model, where growth is based not only on the traditional R>D>I sequence, but also on a sequence in which production capability induces engineering that leads to development and finally results in innovation (PC>E>D>I sequence). In fact, due to the strong focus on production processes rather than research innovation in CEE economies, this latter process is a much more important driver of productivity growth, as compared to the R&D push focused R>D>I model.

R&D, innovation, and technology upgrading in Central and Eastern Europe: Evidence

The effective use of imported technology: Key to current technology upgrading

CEE economies are small open economies whose technology accumulation is largely driven by the import of new equipment and foreign knowledge in the form of licenses, know-how, and production capabilities. Technology transfer activities are major drivers of innovation in the region, along with non-R&D-based innovation activities (e.g. quality and engineering improvements). Innovation activities are about adoption and adaptation of imported technology and inputs [9]. In other words, R&D in CEE includes not only direct or own R&D, but also technology and R&D that is embodied in imported inputs and capital goods. For example, Figure 4 shows that the main difference between the UK and Bulgaria and the Czech Republic is due to each country’s own R&D, and not R&D embodied in imported inputs and capital goods. In fact, R&D intensity embodied in imported capital goods and inputs in Bulgaria and the Czech Republic is similar to the UK; i.e. Bulgaria imports equally sophisticated equipment and inputs as does the UK. So, the key for Bulgarian firms is how to generate value-added using similarly sophisticated equipment and inputs as in the UK, but without the same levels of domestically generated R&D. In other words, how can they achieve global standards of productivity by assimilating and adopting foreign technology in the absence of their own R&D [9]? This challenge calls for improving absorptive capacity through better management practices and vocational training, as well as gradual orientation of local private and public R&D toward effective adaptation of foreign technology and R&D.

Technology integration and technology upgrading in CEE

CEE countries are specialized in the low value-added yielding assembly stage of the global production chain. By contrast, EU North firms are typically located higher up the value chain and tend to benefit more in terms of output, employment, and labor productivity growth from intense vertical specialization. Evidence shows that the effect of vertical integration in CEE is mixed, so long as countries remain in the lower end of the value-added assembly stages of the global value chain [10]. This situation hinders the effectiveness of focusing on upstream R&D activities and programs. These upstream targets are designed to generate new products and employment through a kind of “trickle down” process, but if there is no solid foundation of applied production knowledge from and to which to trickle down, then investment in cutting edge R&D excellence is much less relevant [7]. On the other hand, technology upgrading and innovation closely related to production capability in manufacturing and services are key areas of modernization for CEE, due to the region’s heavy focus on these segments of the value chain.

The literature shows that economies that have successfully caught up to the most developed ones such as Korea and Taiwan have cultivated an interaction between their own technology efforts and the R&D that is embodied within foreign technology imports. As CEE economies are currently situated behind the technology frontier, their firms are reliant on foreign knowledge. Hence, their technology efforts are, by necessity, focused on how to assimilate and adopt foreign technology. Thus, the underlying path of their technology upgrading is not the R>D>I sequence, but rather relies on the interaction of their own R&D with knowledge embodied in imported equipment and inputs [9].

The stylized path of how countries undergo technology upgrading includes four distinct stages, each of which is characterized by transitions in how technology is created, imported, and adapted [9]. This upgrading path is relevant for CEE countries, as most of them are currently struggling to pass through the final two stages. In the initial stage of the technology upgrading process overall R&D intensity is low. For countries at this stage, their own R&D and the sophistication of imported technologies are at comparatively low levels. In stage 2 there is an increase in the sophistication levels of imported equipment and inputs, know-how, and licenses. In stage 3 the economy further increases levels of own R&D and the sophistication of imported knowledge. Further upgrading requires the coupling of imported knowledge with domestic knowledge generation through increased R&D intensity within both business and public sectors. Finally, in stage 4 domestic knowledge generation becomes the dominant component. As R&D intensity increases, the relative importance of knowledge embodied in imported inputs and equipment decreases as the country approaches the world technology frontier. The key challenge in this context for CEE countries is how they will couple their own knowledge generation activities with absorption and adaptation of foreign knowledge (i.e. transition from stage 3 into stage 4). This process is not automatic and linear; one can distinguish thresholds in terms of production, R&D and technology capabilities, which require transformative innovation policy appropriate to each specific stage.

Copying policies despite different conditions

Innovation policy in CEE implicitly and mistakenly assumes that R&D is the major driver of technology upgrading in the region. This approach reflects “the best practices” of the EU North countries, rather than the technological positions and constraints of the CEE region. Research on the innovation policy mixes in the EU28 region has shown that despite relatively large differences between countries in terms of technological and economic development, their policy mixes are pretty homogenous [11].

According to the technology upgrading perspective, countries at different innovation levels require different policy mixes that reflect their specific technology challenges. However, technological differences between countries are just one of many factors that influence the composition of policy mixes, many of which have to do with path dependencies, policy trends, and perceptions of best practices [11]. The commercialization of academic research or science–industry collaborations make up the most frequent innovation-focused policy measures; by contrast, much less attention is given to supporting firms’ adoption of imported technology and knowledge. This feature is equally strong in other transition economies outside the EU [6].

Before opting for one or another policy instrument, policymakers should be certain that they understand their country’s specific circumstances and challenges. For CEE, policy should shift toward drivers of technology upgrading, which are located in downstream activities, and couple them with global sourcing and value chain-oriented policies; for example, supplier development, establishing technology centers by foreign firms linked to domestic suppliers, or technical cooperation agreements between local and foreign firms. CEE countries are unlikely to attract significant supply-driven R&D in the business sector because there are few locations in CEE with the relevant science and technology infrastructure [12]. As such, it would be more effective to foster demand-driven R&D, i.e. R&D that is associated with the implementation of improved products and processes, which are produced or assembled in CEE. However, this type of policy requires critical mass of specialized skills, technology-based small- and medium-size enterprises and international funding, which, in turn, require inflows of foreign direct investment (FDI) complemented by local investments in technology and firm-specific infrastructures. The challenge for CEE countries is thus: how can they attract technology-oriented FDI and exploit it to leverage local investment in R&D, especially in downstream areas [7]?

Meeting this challenge requires a transition from prioritizing and attracting FDI toward a focus on the functional, product, and process upgrading of FDI-based subsidiaries. A good example of this policy was provided by CzechInvest, the Czech Republic’s investment promotion agency, who recognized the need to shift from FDI investments focused on manufacturing and blue-collar jobs toward new sectors. CzechInvest identified this transition as a “shift from quantity to quality” [7]. This type of policy initiative requires closer links between FDI and industry and innovation policies. The tendency in CEE has been to focus on FDI inflows at the expense of the R>D>I content of FDI; in other words, the primary policy aim has been to generate employment rather than to induce technological upgrading of the economy. However, this approach only offers a temporary easing of the problem, since it merely addresses cost competitiveness, without resolving the issue of technology competiveness [7]. The smart specialization strategies driven by EU structural fund programs represent unique opportunities for integrating FDI or supplier development and innovation policy.