Towards a National Innovation System

Indian industry must see R&D as its way of building a future based on proprietary technology

Over 30 years ago, three economists — Chris Freeman in the UK, Bengt-Ake Lundvall in Sweden and Richard Nelson in the US — began talking of National Innovation Systems. It helped that they represented different countries and approached innovation from an international and comparative perspective, greatly enhancing our understanding of what makes an effective ecosystem. Innovation largely happens at firms, so they began there. Firm capacity is affected by both what they do themselves and the institutions around them. The trade regime can foster production for the world or an inward-looking mindset. The education system provides skilled (or not!) labour, engineers and researchers. Publicly funded research can enhance science; where it is done affects how it connects with industry. Public policy can provide incentives for investing in R&D, either directly or through patents. The culture of entrepreneurship affects investment in different kinds of capabilities. And broader cultural factors influence how entrepreneurs define “good”.

Let us also start with firms: Indian industry must see research & development (R&D) as its way of building a future based on proprietary technology. We must increase in-house R&D from 0.3 per cent of gross domestic product (GDP) to match the world’s (and China’s) level of 1.5 per cent. Why does Indian industry lag so far behind the world in in-house investment? Where do the opportunities lie? The top 2,500 firms investing in R&D worldwide account for around 90 per cent of all industrial R&D, and the top 10 sectors account for close to 80 per cent. India has no firms in the top 2,500 in five of these 10 sectors, and just one firm each in two more. Within some sectors, we are much less R&D-intensive: Our software firms, large by world standards of profitability, are small in R&D, investing around 1 per cent of turnover on average, against a world average of 12 per cent (and a Chinese average of 10 per cent). And we are simply missing any giant investors in R&D.  The world’s 26th-largest investor in R&D, Bosch, invests more than all Indian firms combined. Where could our big R&D investors come from?

In “R&D: India’s Missing Giants” (Business Standard, March 23, 2023), I looked at our most successful firms. Our 10 most profitable non-financial firms are in software (TCS and Infosys), oil refining (ONGC, Reliance and Indian Oil), metals (Tata Steel and JSW), and other industries (NTPC, Reliance Jio and ITC). Among them, they made a profit of $44 billion last year. They invested under $1 billion, or about 2 per cent of profit, in R&D. Contrast China: Its most profitable non-financial firms are in software, oil refining, beverages, mining, and construction. Among them, they made a profit of $106 billion last year and invested $31 billion in R&D — 29 per cent of profit. The top 10 in the US, Japan and Germany invest, respectively, 37, 43 and 55 per cent of profit in R&D. 

So, for Indian industry to get much more serious about R&D, we must be present in more technology-intensive sectors, invest closer to the world average within the sectors where we are already present, and see the emergence of some giant investors in R&D among our most profitable firms. The wide availability of technical talent in India means we can use this key resource to build long-term success — if we choose to.

This discussion has placed industry at the centre of our national innovation system. I would indeed propose that any vibrant national innovation system begins with firm competitiveness. That is why India’s attempts to build technical capability through heavy investments in public R&D well ahead of most developing countries in the 1950s, 60s and 70s came to nought. There is much we can learn from the experience of the most successful economic development stories of the last 70 years — Japan, South Korea, Taiwan, Singapore, and China. Each followed a particular sequence in building innovation capacity. Firms first entered export markets as original equipment manufacturers (OEMs) supplying to foreign brands. This ensured world-scale capacity and was by definition internationally competitive.  These industries were usually labour-intensive and low-technology — garments, footwear, food processing. The next step was a move up the value chain to more technology-intensive sectors — consumer durables, electronic assembly, automobiles and parts, and chemical intermediates. As firms entered these sectors, they also started to invest in in-house R&D to sustain competitiveness in the long run. A later move to higher-technology sectors — semiconductors, pharmaceuticals, computers — went with increasing investments in in-house R&D. The growth of industrial R&D demanded more sophisticated research talent. Whether by design or happy accident, all five East Asian governments responded by growing their investments in publicly funded R&D and, crucially, followed the successful example of the West in locating this public research in the higher education system. The net effect was that this public research was fruitful, not because it was of much value in itself, but because excellent researchers got trained in the education system as a by-product.  These researchers became the core of the increasingly sophisticated in-house R&D departments of local firms. This sequence of a competitive industry followed by deepening technical sophistication followed by in-house R&D followed by public research is my reading of the economic history of these countries. I’ve painted it broad-brush, drawing on what another pioneering economist of innovation, Keith Pavitt, argued some decades ago — albeit with the nuance of a good academic.

Now consider India. Only after our 1991 liberalisation was competitiveness forced on Indian industry, placing it on the first step of the innovation sequence. The next step hasn’t happened in any broad sense. As we saw earlier, Indian industry has been content with low R&D spending of 0.3 per cent of GDP, compared with the world’s 1.5 per cent. But some sectors have moved ahead. Among the 10 key technology-intensive sectors that dominate global industrial R&D, India has some presence in two — pharmaceuticals and automobiles. The pharmaceutical industry may have no presence in the league table of our most profitable firms, but it dominates the league table of our top R&D investors. With 41 of the top 100 R&D spenders, pharmaceuticals accounts for 34 per cent of all Indian industrial R&D. At 10 per cent of sales, R&D intensity is lower than the world’s 16 per cent, but this ratio is decent relative to every other sector. Our best chance of building a world-class innovative industry is in pharmaceuticals. What must we do to get there? What must industry do? And what call does this place on the wider innovation ecosystem — on public research, R&D incentives, and a regulatory system that supports innovation? That will be Part-II of this article.

The writer is co-chairman, Forbes Marshall, past president, CII, chairman of the Centre for Technology Innovation and Economic Research, and Ananta Aspen Centre. His book, The Struggle and the Promise, was recently published by HarperCollins