While everybody agrees that the generation, exploitation and diffusion of knowledge have become fundamental to economic growth, innovation remains in many instances a fuzzy concept, difficult to apprehend and to measure. Even more so in Luxembourg, where the circumscribed territory, and therewith the moderate level of influence of national actors, challenge the very notion of a “national” innovation system¹. Yet a number of lessons can be drawn from experiences in Europe and elsewhere to help pave the way towards a truly knowledge-based economy.

First we should welcome the realisation that the 3% R&D investment target set out by the so-called Lisbon strategy might serve at best as an indicator for innovation, but that it certainly is not an end in itself. Indeed, although a country should invest more in R&D as it moves closer to the technological frontier, it would be naive to assume that increased R&D spending and subsidies are sufficient to foster innovation and productivity growth.

Rather, the stimulation of innovation and growth requires a coherent approach between measures aimed at stimulating directly R&D investment on one hand, and broader structural reforms and macroeconomic policies on the other hand. In his paper, “A Primer on Innovation and Growth”², Philippe Aghion discusses in more detail four such indirect ways to foster innovation and growth in maturing economies: competition and entry, efficient labour markets, financial development, and the conduct of macroeconomic policy over the business cycle. Interestingly, he finds that financial constraints – the inability of firms to pay the required fixed costs to enter new markets or introduce new production technology – may turn out to be a more important barrier to entry and innovation (for small firms) than labour market rigidities, which are often called forth as the main impediment to firms' entry, mobility and post-entry growth.

Yet the labour market matters, because innovation comes not only with its share of winners but also of losers. And while Schumpeter's insight regarding creative destruction as the engine of economic growth in capitalist economies is rediscovered and celebrated, we need to recognise its disruptive potential in terms of job losses and take appropriate action. Unfortunately, so far, this has often amounted to artificially blocking workers where they are and subsidising them, or to reverting to early retirement schemes. What we need though, are policies that will help workers reallocate from lagging to more advanced sectors, and policies aimed at compensating potential short-term losers from structural reforms.

“Mindless habitual behavior is the enemy of innovation” (Rosabeth Moss Kanter) – In other words, fostering innovation and growth also requires innovative thinking in the field of public management and social policy. The era of “one-size-fits-it-all” socio-economic policies might have survived “Fordism” here and there but it is definitely over today. We shouldn't forget that government budget choices are no different from private spending in terms of resource utilisation impact in a finite world. Public budgeting is a major resource allocation process and unless the value yielded by the chosen activity is greater than the value possible in other applications, the resource has been wasted. And given the major challenges lying ahead, logic suggests that wasteful misallocations can't be afforded much longer.

As a matter of fact, there is quite a gap between the rhetoric of a political system that preaches the knowledge society and the reality of budgetary priorities that show little shift in preparing to engage with it. Therefore, Aghion's fourth and last lesson is maybe the most important one: “structural reforms need careful agenda-setting and prioritization, based on a comparative cost-benefit analysis where the value of each reform would be measured by the ratio of its contribution to the overall growth potential of the country over the (social) cost of implementing the reform.” What we need henceforth is a shift from traditional line item budgets, which tend to produce incremental budgetary growth with no link to strategy, to performance budgets based on three principles³:

• “Outcomes”: What kind of influence does a government wish to have on the community?
• “Outputs and administered items”: How do public authorities wish to achieve such influence; and
• “Performance indicators”: How does the government and how does the community know whether the goals set are being achieved in an efficient and effective way?

What matters, therefore, is not so much to reach some kind of magic R&D investment target, but rather to embed the public allocation of resources into a strategic and coherent framework. For if you don't know where you are going, no road will take you there! And it looks like embracing the path towards a knowledge-based economy – that is, an economy directly resting on the production, distribution, and use of knowledge and information – will require more than just adapting policies randomly.

In “The Structure of Scientific Revolutions”, Thomas Kuhn argues that scientists tend to ignore research findings that might threaten the existing paradigm because during periods of normal science, the primary task of scientists is to bring the accepted theory and fact into closer agreement. The failure of Europe so far to confront the rising competition from other parts of the world, to recapture the entrepreneurial vigour and value-creation needed to sustain the European way of life substantiates, if necessary, that the paradigm shift cannot be confined to the narrow domain of R&D and innovation policy⁴. We are at the stage where enough significant anomalies have accrued to throw “normal science”, or for our purpose “business as usual”, into a state of crisis. Rather than considering this as a threat, we should welcome the opportunity to try out new ideas, perhaps ones previously discarded, which will eventually lead to the formation of a new frame of thought.

And while Luxembourg might face unique challenges due to its utmost exposure to external market forces, its “manageable” size also offers unique opportunities to develop a novel social structure that will allow preserving our values while fostering a culture which celebrates innovation. In this vein, it is time to realise that those who have a vision do not need, as commonly assumed around here, to see a doctor. Given the challenges lying ahead, it is rather a lack of vision that might prove fatal.

1. Cahier du Statec, n°97, April 2005 ↑
2. Fondation Bruegel, October 2006. ↑
3. Results-orientated budget practice in OECD countries, Aidan Rose, February 2003. ↑
4. Creating an innovative Europe, Report of the Independent Expert Group on R&D and innovation, January 2006. ↑