Determinants of Technological Progress: Recent Trends and...

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Determinants of TechnologicalProgress: Recent Trends andProspects

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As discussed in the previous chapter, the paceat which technologies spread between andwithin countries has picked up. As a result,most developing countries are narrowing thetechnological divide that separates them fromhigh-income countries. Nevertheless, the tech-nology gap remains large; for many, includingseveral low-income countries, it is wideningrather than closing, in part because of theslowness with which technologies spreadwithin countries. For virtually all developingcountries, the domestic pace of technologicalprogress is determined mainly by the speedwith which already existing technologies areadopted, adapted, and successfully applieddomestically, and done so throughout theeconomy, not just in the main cities.

This chapter explores some of the majordeterminants of this kind of within-countrydiffusion of technology. It adopts an analyti-cal framework that distinguishes between thefactors that dictate the extent to which aneconomy is exposed to external technologieson the one hand and the efficiency with whichit absorbs them on the other hand. Among themost important channels through which low-and middle-income countries are exposed toforeign technologies are trade; foreign directinvestment (FDI); and contacts with highlyskilled diaspora members (nationals workingabroad) and with other information net-works, including those of academia and themedia. Maintaining an open environment tosuch flows is critical for accessing technology

at least cost. However, no matter how com-pellingly useful a technology may be, theprocess by which it spreads within a countrycan be lengthy.

The speed with which a country absorbsand adopts technology depends on many fac-tors, including the extent to which a countryhas a technologically literate workforce and ahighly skilled elite; promotes an investmentclimate that encourages investment and per-mits the creation and expansion of firmsusing higher-technology processes; permitsaccess to capital; and has adequate public sec-tor institutions to promote the diffusion ofcritical technologies where private demand ormarket forces are inadequate.

The process of technology absorption is alsosubject to virtuous circles. Scale economiesin technologically sophisticated sectors and inlearning by doing tend to make the acquisitionof technology a nonlinear process, character-ized initially by slow penetration until somethreshold is reached, followed by a period ofrapid acceleration, and finally by a period ofslower diffusion as saturation is achieved. Asa consequence, while gaps in technologicalachievement create opportunities for acceler-ated growth and convergence in laggingeconomies, they can also lead to divergence ifthe conditions for technology adoption inlagging countries are insufficient. Many tech-nologies operate synergistically to reinforcethe demand for each other and the effective-ness and capacity of supply.

Although the process of technological dif-fusion has a clear logic, the process is by nomeans mechanical. It occurs through interac-tions among individuals, entrepreneurs, firms,and governments. The role of government isboth direct, as a supplier of many technologi-cal services, and indirect. In particular, theefficiency with which firms can diffuse tech-nology within the domestic economy dependson the overall political and economic context,the level and distribution of human capital,the quality of the macroeconomic environ-ment, and the rules and regulations governingthe conduct of business, all of which are heav-ily influenced by governments.

This chapter discusses the principal chan-nels through which developing countries areexposed to advanced technology, analyzes themain determinants of domestic absorptivecapacity, and indicates likely future trends intechnological diffusion. The following sixmain messages emerge from this analysis.

The principal channels by whichdeveloping countries are exposed toexternal technology—which includetrade, FDI, and a highly skilled dias-pora—have increased substantially overthe past several decades. The share ofimported high-tech products in grossdomestic product (GDP) has risen bymore than half in both low- and middle-income regions since the mid-1990s,that of imports of capital goods by 37percent, that of imports of intermediategoods by 26 percent, and that of FDI in-flows by sixfold since the 1980s. Finally,the size and sophistication of global di-asporas has increased markedly, alongwith substantial improvements in thetechnology by which migrants can trans-mit their know-how and interact withtheir home economies.

The ability to absorb foreign technol-ogy, which depends on domestic policiesand institutions, has also improved inmany developing countries. Reflectingrising school enrollment, literacy rates inlow-income countries have increased

from less than 50 percent in 1990 tomore than 62 percent, and among youththey now exceed 74 percent. In addition,the macroeconomic, governance, and in-vestment climate that innovative firmsand entrepreneurs need to operate is im-proving. More countries are operatingin a context of close to stable prices (me-dian inflation in low-income countriesdeclined from 9.2 to 4.2 percent be-tween 1990 and 2006) and flexible ex-change rate regimes, while governmentfinances are better balanced.

Technological diffusion amongmiddle-income countries has benefitedfrom the reorientation of global produc-tion processes. Advances in communica-tions and transport technology havegiven rise to the growth of global pro-duction networks, facilitating increasedtrade and technological advances inmany developing countries, particularlymiddle-income developing countries.Until recently, low wages and a solid, iflow, level of basic technological literacyhave been sufficient to capture a signifi-cant role in global networks in manycountries. As wages rise, however, thesecountries will need to make substantialadditional investments in human capitalto maintain their share of global produc-tion and continue the technological con-vergence of the past few years. They willalso need to adopt a more proactive ap-proach to developing local competenciesand to using research and development(R&D) and outreach programs to bol-ster the diffusion process.

For low-income countries, poor tech-nological adaptive capacity and limiteddissemination of often simple technolo-gies to the countryside are severely con-straining technological progress. Despiteprogress in basic technological literacy,extremely low levels of income, weakgovernance structures, and, in somecases, ongoing conflict continue tostymie the ability of low-income, and

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especially Sub-Saharan African, coun-tries to obtain and absorb new tech-nologies. Nevertheless, the potential fortechnological progress through thegreater dissemination of relatively sim-ple technologies is huge.

The absence or low quality of somebasic technologies that governments his-torically provide hinders technologicaldiffusion by the private sector. Thesebasic technologies often represent essen-tial complementary technologies whoseabsence can prevent the successful adop-tion of a new-to-the-market technology.

The relatively rapid disseminationof new communications technologiesthroughout the developing world, in-cluding in low-income countries, offersa ray of hope. These potentially trans-formational technologies are enabling,often for the first time, the kinds ofarm’s-length transactions that may becritical to firm development and thespread of technology in these countries.New technologies are frequently intro-duced and promoted by members ofnational diasporas, both directly throughnetworks and indirectly through invest-ments financed from remittances.

The rest of this chapter is devoted toexploring how developing countries absorbexternal technology. The next section presentsan analytical framework for technologicalprogress. This is followed by a discussion ofhow trade, FDI, and migration expose coun-tries to new technologies and can promote in-ternal diffusion of those technologies. The sec-tion also discusses trends in these flows andthe potential magnitude of associated techno-logical progress and how this may havechanged over time. The chapter then turns toan analysis of the domestic factors that facili-tate the absorption of new technologies. Thissection first examines how government poli-cies, and the business environment in general,facilitate the creation and expansion of innova-tive firms. It then looks at how levels of humancapital—from literacy rates to R&D capacity—

affect countries’ ability to absorb technologyfrom abroad. The chapter concludes with aspeculative view of the prospects for technolog-ical progress and some policy messages.

Drivers of technologicalprogress: A framework

The process by which countries adopt,adapt, and absorb external technologies is

complicated. The overall framework followedin this chapter (depicted in figure 3.1) draws onprevious work done at the World Bank, in par-ticular, the 1998 World Development Reporton the knowledge economy (World Bank 1998)and several regional and country-specific policyanalyses of technology and technological com-petencies. In addition, it relies upon the acade-mic literature on technology diffusion, includ-ing an excellent review article by Keller (2004);several articles by Coe and Helpman concern-ing the role of FDI; case studies of the processof technology diffusion by Chandra andKolavalli (2006); empirical work on the tech-nological influence of imports by Lumenga-Neso, Olarreaga, and Schiff (2005); and thediscussion by Rodrik (2004) on the impact ofmarket failures on innovation incentives.

Exposure to external flows interacts with domestic capacity to diffusetechnologyFor the purposes of analytical simplicity, theframework presents technological progressin developing countries as a process wherebyan economy is exposed to higher-technologybusiness processes, products, and servicesthrough foreign trade; FDI; and contacts withits diaspora and other communication chan-nels, including academic and international or-ganizations (the large arrows at the top of thefigure). Exposure to new ideas and techniquesis, however, not sufficient to ensure techno-logical progress on the ground. The extent towhich these flows are translated into techno-logical progress depends on the technical ab-sorptive capacity of the economy (representedby the ringed drum). This in turn depends on

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the extent to which the business and macro-economic climate fosters an environment inwhich firms—the main mechanism for tech-nological diffusion within a country—are ableto form, grow, and expand. Absorptive capac-ity also depends on the levels of basic techno-logical literacy and advanced skills found inthe country, which together dictate the coun-try’s capacity to implement technologies onthe one hand and to do the research necessaryto understand, implement, and adjust im-ported technologies on the other hand. Alsoimportant are government actions designed tohelp overcome market failures that mightlimit the financing of innovative activity, plusactions that focus technology policy on adapt-ing and adopting those existing technologiesfor which there is a market and for which ad-equate domestic competencies exist. Criticalhere are outreach and dissemination policies,

which need to serve as a two-way conduit,both informing the population about techno-logical solutions and providing feedback toproviders concerning the usability of and de-mand for proposed solutions. Taken together,these factors act as filters (the rings in thedrum) that dictate how much of the potentialtechnological flow is actually absorbeddomestically.

The overall process is, of course, morecomplicated, with both technological flowsand technological adaptive capacity influenc-ing each other. For example, internationaltrade is perhaps the most important vector forthe transmission of technology, but the extentof a country’s openness to trade depends sig-nificantly on the amount of FDI that has oc-curred, the existence of a vibrant and techno-logically literate diaspora, and the domesticbusiness climate. Similarly, the quantity of FDI


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Returns toscale

Spillovereffects

Pro-active policies

Finance of innovative firms

Basic technological literacy

Governance and the business climate

Source: World Bank.

Figure 3.1 Domestic absorptive capacity both conditions and attracts external flows

Technological frontier

Domestic technological achievement

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Policies to - create competencies - build infrastructure - foster an innovation- friendly business climate

and its overall effectiveness depends on thequality and technological literacy of the laborforce.

Increasing returns and spillover effectscan magnify these effects . . .Both domestic and external determinants oftechnological transfer are affected to varyingdegrees by increasing returns to scale andspillover effects that can magnify the absorp-tive impact of these flows. Access to foreignmarkets may allow domestic firms to grow andexploit economies of scale associated withsome technologies, raising the overall wealthand technological sophistication of an econ-omy. Meanwhile, the technological spilloversthat can be expected from FDI, includingdemonstration effects and the transfer of busi-ness process and human capital to domesticfirms through employee turnover, are likely tobe greater the more qualified is the labor force.Both FDI and trade can contribute to clustereffects and networking externalities that in-crease the potential for spillovers and to tech-nological diffusion from individual sectors andfirms to the rest of the economy. Alternatively,economies of scale and agglomeration effectsmay prevent entry by new firms in some mar-kets, cutting off otherwise promising opportu-nities for technological learning. In addition,imitators may limit entrepreneurs’ ability tocapture the returns to new-to-the-marketinnovations, thereby reducing incentives fortechnological progress.

. . . but a lack of financing can stymieinnovation Affordability issues can influence both the sizeof initial inflows and a country’s technologicalabsorptive capacity. Even if profitable invest-ments in technology are available and the do-mestic environment encourages the absorptionof new technologies, low incomes may makenew technologies unaffordable to individualsand firms in developing countries. At the ex-treme, individuals near subsistence levels maybe unwilling to risk adopting a new-to-the-market technique, may be unable to generate

adequate savings to invest in a new technol-ogy, or may lack the collateral required to bor-row. Thus poverty is a major cause, as well asa result, of low levels of technology.

Affordability is also an issue at the macrolevel. Low incomes constrain government fi-nance, limiting the government’s capacity toput into place both the level of physical infra-structure and the investments necessary todevelop a level of domestic human capitalcapable of supporting and exploiting evensimple technologies.

Policy should not impede innovative firmsFinally, firms, entrepreneurship, and govern-ment action that actively supports the diffu-sion of economically relevant and profitabletechnologies are the grassroots mechanisms bywhich technologies diffuse within countries.Firms must be able, and entrepreneurs permit-ted, to profit from the exploitation of new-to-the-market-technologies if those technologiesand products are to diffuse. This means thatpolicy must be welcoming of such profits andthat both R&D and dissemination efforts notonly need to focus on creating or adaptingproducts and ideas (domestic or foreign) tothe local market, but also must give priority toassisting firms to exploit them.

External transmission channels

This section presents data and describes re-cent trends concerning the external chan-

nels through which developing countries areexposed to foreign technologies. Where rele-vant, it also draws on the literature to com-ment on how specific elements in a country’stechnological absorptive capacity (discussed inmore detail later in this chapter) interact withthese external flows to determine the extent towhich these channels translate into technolog-ical achievement.

TradeTrade is one of the most important mechanismsby which embodied technological knowledge(in the form of both capital and intermediate


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goods and services) is transferred across coun-tries. Imports of technologically sophisticatedgoods help developing countries raise the qual-ity of their own products and the efficiencywith which they are produced. Countries canalso absorb new technology by exporting tocustomers who implicitly or explicitly provideguidance in meeting the specifications requiredfor access to global markets. For developingcountries with low R&D intensity, trade open-ness and exposure to foreign competitionprovide powerful inducements to adopt moreadvanced technology in both exporting andimport-competing firms and are likely to pro-duce large technology spillovers and produc-tivity gains (Schiff and Wang 2006a).

However, the extent to which exposure toforeign technologies is reflected in the exportand import patterns of individual countriesdepends on, among other things, the absorp-tive capacity of individual countries. As Soub-botina (2006) discusses, countries with rela-tively weak domestic scientific capacities tendto follow a more passive approach to technol-ogy absorption that is characterized by limitedefforts to leverage the technology imported byforeign firms operating on their soil. For thesecountries, most technology transfers takeplace either through imports of high-techgoods, or perhaps through an apparentlyhigh-tech export sector that is, in reality, dom-inated by assembly operations associated withelevated imports of high-tech goods. Wheresophisticated domestic capacities coexist witha significant degree of basic technological lit-eracy in the population, technology diffusionis enhanced and, in general, the technologicalcontent of exports is higher.

Following Soubbotina (2006) classifica-tions, “traditionalist slow learners,” such asBangladesh and Burkina Faso, which have lowlevels of technological competency and tech-nological literacy, tend to rely to a large extenton imports of machinery and equipment.Other countries, such as Malaysia, Mexico,and the Philippines, appear to follow a “pas-sive FDI-dependent” learning style. For thesecountries, the share of high- and medium-tech

goods in their manufactured exports is higherthan these goods’ share in manufacturingvalue added, reflecting the dependence oftheir high-tech exports on imports of techno-logically sophisticated components and therelatively low technological complexity ofdomestic manufacturing operations. By con-trast, “active FDI-dependent” countries, suchas Chile and Hungary, strike a better balancebetween the share of high-tech goods and ser-vices in overall exports and domestic valueadded, reflecting greater domestic technologi-cal competencies. For the Russian Federationand some of the other countries that belongedto the former Soviet Union, a strong techno-logical base and relatively low import sharesof high-tech goods reflect their more advancedlearning style, which places greater emphasison domestically developed technologies.Nevertheless, these technologies mainly feedinto products that serve the local market,because both high costs and quality concernskeep these sectors from being internationallycompetitive.

The potential for technology transferthrough imports has risenImports improve domestic technology becauseembodied technology both allows firms to em-ploy more efficient production processes andaffords the possibility that firms can copymore advanced products and processes. At thesame time, competition from technologicallysuperior imports may boost domestic produc-tivity.1 Developing countries that have a largeshare of imports from high-income countrieswith large R&D expenditures have signifi-cantly higher productivity than developingcountries that import from advanced coun-tries with lower R&D expenditures (Coe,Helpman, and Hoffmaister 1997).2 There alsois evidence for a positive relationship betweenaccess to imported intermediate goods andperformance (Handoussa, Nishimizu, andPage 1986). More recent literature highlightsthe indirect benefits for developing countriesfrom North–North trade in R&D. The ex-change of high-tech goods and services among


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high-income economies contributes to an in-crease in the global stock of knowledge andeventually becomes available to developingcountries through North–South trade. Finally,technology diffusion, like trade, tends to be re-gional, with the largest transfers coming fromnatural trading partners, for example, Jordanbenefits more from the European Union andMexico benefits from Canada and the UnitedStates (Schiff and Wang 2006b).

However, the extent to which importedtechnology boosts the sophistication of do-mestic technological activity either directly orindirectly through spillovers depends on thequality of a country’s technological absorptivecapacity. Thus while using an imported capitalgood can lift the technological content of ac-tivity in a country, to the extent that importerspay competitive prices for the technology,there may be no net gain to the country (Eatonand Kortum 2001). Moreover, the businessclimate may be too weak or the technologicalliteracy of the local labor force may be toolow to successfully adapt the machinery tolocal conditions (Dahlman, Ross-Larson, andWestphal 1987; Rosenberg 1976). As a result,the country may not realize the potential pro-ductivity improvements available from im-ported technology (Pack 2006).

Developing countries’ high-tech importshave increasedTo the extent that a developing country canmake use of or imitate sophisticated goods, itslevel of technological achievement should in-crease in line with the quality and technologicalsophistication of imported goods. Since the mid-1990s, the share of imported high-tech productsinGDPhas increasedbymore than50 percent inlow-income countries and by 70 percent in mid-dle-income countries (table 3.1).3 Among devel-oping regions, East Asia and the Pacific hasthe highest share of high-tech imports in GDP(8.4 percent), with the highest share being forMalaysia (37 percent) and the Philippines(18 percent), but Europe and Central Asia hasexperienced the largest increase, reflecting thetransition of many of the region’s countries tomarket economies and their improved access tohigh-tech products following the relaxation ofCold War export restrictions. Among regionsdominated by middle-income countries, high-tech imports represent 3.8 percent of GDP inLatin America and the Caribbean and 3.6 per-centofGDPintheMiddleEastandNorthAfrica,less than in Sub-Saharan Africa (4.5 percent).

Low-income countries have also improvedtheir exposure to high-technology embeddedin foreign products. After hovering around


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Table 3.1 Trade in technology goods has increased in developing countries

Share of high-tech exports Imports of high-tech goods Imports of capital goods in world high-tech exports

1994–96 2002–04 % change 1994–96 2002–04 % change 1994–96 2002–04 % change

(% of GDP) (% of GDP) (% of GDP)

RegionsEast Asia and the Pacific 5.9 8.4 42 11.6 12.8 10 9.9 19.0 93Europe and Central Asia 3.2 7.2 125 7.1 14.7 107 1.0 2.7 163Latin America

and the Caribbean 2.4 3.8 61 5.4 7.2 32 2.1 3.4 61Middle East and North Africa 2.5 3.6 44 6.3 8.9 42 0.1 0.2 29South Asia 1.4 2.1 53 3.1 3.8 22 0.2 0.3 58Sub-Saharan Africa 3.2 4.5 39 9.3 10.5 14 0.1 0.1 4

Income groupsHigh-income countries 3.4 4.7 38 5.5 7.0 27 86.5 74.3 �14Upper-middle-income countries 4.2 7.2 71 8.7 13.1 51 6.6 9.6 47Lower-middle-income countries 3.2 5.4 70 6.9 9.2 33 6.7 15.7 137Low-income countries 1.8 2.7 53 4.9 5.7 17 0.3 0.4 53

Source: World Bank calculations using Centre d’Etudes Prospectives et d’Informations Internationales’ database, Banque Analytiquede Commerce International.

1.8 percent between 1994 and 2001, the aver-age share of high-tech imports in low-incomecountries’ GDP began to rise in 2002, reaching3.2 percent in 2004 (figure 3.2). Both SouthAsia and Sub-Saharan Africa have enjoyed sig-nificant increases, although the ratio of high-tech imports to GDP remains extremely low inSouth Asia, less than 3 percent of GDP. In mostcountries in Sub-Saharan Africa, the share ofimported high-tech goods fluctuates between2 and 5 percent of GDP from year to year.Mauritius and South Africa import the mosthigh-tech goods relative to the size of theireconomies, between 6 and 8 percent of GDP inany given year, while Somalia imports theleast, less than 1 percent of GDP.

Despite developing countries’ increased ex-posure to foreign technology through trade, itsdistribution across regions within countriestends to be extremely uneven, with foreigntrade concentrated in a few major cities or re-gions. For example, 70 percent of high-techtrade (both imports and exports) in China orig-inates in four regions and is highly correlatedwith R&D intensity and foreign firms (OECD

2007). As a result, the benefits of exposure totrade also tend to be unevenly distributed.

Capital goods imports have also increasedAlthough imports of high-tech goods providean indication of an economy’s exposure totechnology, this indicator does not distinguishbetween imports of technology for consump-tion and imports for production, nor does itindicate the extent to which these imports im-prove the technological content of a country’seconomic activities. Technological contentdepends importantly on the structure of theeconomy and the nature (assembly or highvalued added transformation) of the workdone with the imports (box 3.1).

Imports of capital goods, such as machineryand equipment, which enable the production ofhigher quality and more technologically sophis-ticated goods, have a less ambiguous impact ona country’s technological capacity. For coun-tries operating within the technological fron-tier, a higher share of imported capital goodsin GDP can reflect the presence of strong in-vestment activity; a process of technological


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Figure 3.2 Rising share of high-tech imports

Percent of GDP

Source: World Bank calculations using Centre d’Etudes Prospectives et d’Informations Internationales database, Banque Analytique deCommerce International.

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upgrading; and, over the longer term, arelatively sophisticated structure of produc-tion.4 As a result, relatively technologically so-phisticated middle-income countries importmore capital goods (as a share of GDP) than lesssophisticated low-income countries (table 3.1).

Overall, the share of capital goods in theGDP of developing countries has risen substan-tially over the past decade. Upper-middle-income countries saw a 51 percent increase inthe share of these goods in GDP, while lower-middle-income countries have boosted their re-liance on such goods by 33 percent. The formergroup of countries continues to have the largestshare of capital goods in GDP, about 13 per-cent, more than double the share of low-income countries. As a consequence, the gapbetween low-income countries (especially theLeast Developed Countries [UNCTAD 2007])and other developing countries has widened.Europe and Central Asia saw the biggest re-gional increase in imports of capital goods,reflecting the substantial economic recovery inthese countries following the recession that ac-companied the transition to market economies.As was the case for high-tech imports, SouthAsia has the lowest level of imports of capitalgoods and has shown little improvement,

presumably reflecting the relatively autarchicpolicies that governments in the region havefollowed until recently. By contrast, Sub-Saha-ran Africa imports substantially more capitalgoods, although the ratio of capital goods im-ports to GDP has increased less than in otherdeveloping regions since the mid-1990s, withthe exception of East Asia and the Pacific. Thestory is particularly varied in Latin America,where some countries, such as Costa Rica andMexico, increased their imports of capitalgoods following liberalization policies in theearly 1990s, while others did not. The increasein the share of capital goods in GDP was par-ticularly notable in Costa Rica, where it rosefrom about 7 percent in the mid-1990s to about18 percent in 2002–04.

Exports of technological goods have also expandedParticipation in high-tech export markets hasalso been identified as a channel through whichtechnology is diffused within developing coun-tries. Many case studies suggest that exportingfirms in developing countries benefit from im-plicit and explicit technological transfers thatoccur as a result of their interactions with for-eign buyers. Benefits accrue because foreign


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Based on a breakdown of trade flows by technol-ogy level and by production stage, Lemoine and

Ünal-Kesenci (2003) highlight the following divergentintegration paths adopted by China, India, and Turkey,which all started from a relatively similar degree ofindustrial specialization about 10 years ago:

• China has become an assembly country,strongly integrated into the international seg-mentation-of-production processes in Asia.Most of China’s imports of high-tech productsare parts and components. These high-tech im-ports are predominantly incorporated into theproduction of exports and are not used to mod-ernize domestic production capacities. Given its

Box 3.1 Technology imports: Different paths fordifferent countries

level of development, China’s exports display anoutstandingly strong high-tech content.

• India is characterized by limited participation ininternational division-of-production processesand by a low level of imports in high-tech prod-ucts. These high-tech imports are evenly distrib-uted among the different stages of productionand the different sectors, while high-tech exportsare concentrated in chemical industries.

• Turkey’s high-tech imports consist mainly of cap-ital goods and correspond to a classical form oftechnology transfer aimed at upgrading indige-nous industrial capacities. Turkey’s foreign tradeis strongly structured by its traditional comple-mentaries with Europe.

buyers may have higher quality standards thandomestic buyers. Foreign buyers may also as-sist with process improvements and provide in-formation about and experience with foreignmarkets. Moreover, the additional demandthat foreign markets provide may allow for theexploitation of economies of scale that justifymore capital-intensive production (see, for ex-ample, Hobday 1995 and Rhee, Ross-Larson,and Pursell 1984 on the effects of learning byexporting in East Asia). Technology transfersthrough exports may be most important inproduction networks with clearly articulatedsupply chains (Gereffi 1999; Hobday 1995).5

Spillovers may also be common in labor-inten-sive sectors where production processes are rel-atively simple and the relevant knowledge iswidely available in industrial countries (Enosand Park 1987; Hou and Gee 1993).

Unfortunately, these efficiency benefits fromexporting are not confirmed by econometricstudies (Keller 2004), which generally find thatthe positive relationship between exportingand productivity results largely from the self-selection of firms into the export market.6

Whatever the magnitude of spillovers fromexports and of concerns surrounding the re-export nature of some high-tech exports, theexport of technology products is neverthelessan important indicator of technologicalachievement. High-tech exports offer betterprospects for future growth than lower-techgoods because their market has been expandingmore rapidly and because they offer superiorspillover potential by transmitting skills andgeneric knowledge that can be used in other ac-tivities (Guerrieri and Milana 1998). High-techexports are also less vulnerable to easy entry bylower-wage competitors, substitution by tech-nical change, and market shifts (Lall 2001).

Although high-income countries continue todominatetheworldmarketforhigh-techgoods,7

middle-income countries have substantially in-creased their market share since the mid-1990s.Lower-middle-incomecountriesmore thandou-bled their global share of high-tech exports, in-creasing themfrom6.6percent in the mid-1990sto 15.7 percent in 2002–04 (3.4 to 5.0 percent

if China is excluded). Moreover, the share ofhigher-technology goods in the total merchan-dise exports of these countries has also been in-creasing (figure 3.3). Much of this increase re-flected the transfer of manufacturing processesfrom high-income countries to developingcountries, notably those in East Asia and the Pa-cific. China was a major beneficiary of thisprocess, increasing its global market share ofhigh-techexports fromabout3percent to11per-cent, but so too were other countries. ThePhilippines, for example, increased its marketshare from 0.9 percent to about 2.0 percent.Upper-middle-income countries made less spec-tacular progress, increasing their global marketshare from 6.5 percent to 10.5 percent, althoughsome countries, such as Costa Rica, the CzechRepublic, and Hungary, were able to increasetheir high-tech markets significantly.8 In Sub-Saharan Africa, South Africa is the largest ex-porter of high-tech products, but its share has re-mained small and stable at about 0.08 percent.

The relative performance of differentmiddle-income regions reflects different levels


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Figure 3.3 Exports of low-, medium-, andhigh-technology goods

Percent of total merchandise exports

Source: World Bank calculations using Centre d’EtudesProspectives et d’Informations Internationales database,Banque Analytique de Commerce International.

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of technological capabilities and learningstyles. Since the early 1990s, Latin Americahas almost doubled its share of high-techproducts in world markets and now has thesecond largest market share after East Asiaand the Pacific. However, in contrast with Eu-rope and Central Asia and the Middle Eastand North Africa, it has done so with rela-tively little input from imported technology(imports of high-tech and capital goods as ashare of GDP in Latin America and theCaribbean are half the rate of Europe andCentral Asia). Partly as a consequence, Europeand Central Asia has gained market share inhigh-tech goods much more quickly thanLatin America, and based on recent perfor-mance, is poised to overtake that region soon.

Low-income countries remain marginalplayers in the world market for high-techgoods, and even though their global share ofexports of medium-tech goods has doubled, be-tween the mid-1990s and 2002–04, it remainslow at 0.8 percent. The share of low-incomecountries in world exports of low-tech goodsis more substantial and has increased from3.5 percent to 5.2 percent. Among these coun-tries, Vietnam has improved its global marketshare of low-tech products from 0.2 to 0.8 per-cent, a 250 percent increase. India remains themost important exporter of low-tech productsin this income group with 2 percent of theworld market, second after China among de-veloping countries, which accounts for about17 percent of the world’s low-tech exports.

Overall exposure to foreign technologieshas increasedOverall, the increased participation of devel-oping countries in global trade has substan-tially increased their exposure to foreign tech-nologies. For middle-income countries, thisexposure and the attendant expansion of high-tech exports have likely yielded important sidebenefits that are reflected in the sustainedacceleration in developing country growthrates over the past 15 years. While the increasein trade openness has been generalized, theextent to which countries have been able to

translate that into improved export perfor-mance and an increase in the technologicalsophistication of their own exports has varied,with countries like those in Europe and CentralAsia that have relatively well-educated popula-tions and a strong institutional structure hav-ing extracted the greatest benefits. Amongother countries, notably low-income countries,weak absorptive capacity may be restrictingthe extent to which their economies have ben-efited from the increased exposure.

Foreign direct investmentLike trade, FDI can be a powerful channel forthe transmission of technology to developingcountries by financing new investment, bycommunicating information about technologyto domestic affiliates of foreign firms, andby facilitating the diffusion of technology tolocal firms.

Foreign investors bring both equipmentand know-howMeasuring the technological contribution ofFDI is particularly difficult, in part becausethe standard measure from the balance of pay-ments includes both physical (brownfield andgreenfield) investments and financial invest-ments (mergers and acquisitions). This said,FDI inflows to developing countries rose from$10 billion in 1980 to an estimated $390 bil-lion in 2007, or from 0.4 to 2.9 percent ofGDP, with the bulk of the increase occurringduring the late 1990s in response to the liber-alization of FDI policies.9 Assuming that for-eign firms employ a higher level of technologythan the average domestic firm, then this ris-ing trend will have increased the average levelof technology in these countries, as well astheir exposure to higher technologies.

FDI as a share of GDP has risen in all de-veloping regions and income groups since the1980s, but the increase has been concentratedin middle-income countries, where FDI rose toalmost 3 percent of GDP (table 3.2). East Asiaand the Pacific had the highest ratio during the1990s, but it has since declined, in part be-cause of a collapse in FDI inflows to a few


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countries affected by the East Asian financialcrisis in the late 1990s (particularly Indonesia),and in part because FDI inflows to China, al-though still high, have failed to keep pace withthe rapid growth of output. Meanwhile inLatin America and the Caribbean, efforts to in-crease trade openness resulted in a boom of FDIinflows, which reached an average of 3.5 per-cent of GDP in 2000–06. In Europe and Cen-tral Asia, FDI rose from next to nothing beforethe breakup of the Soviet bloc to 2.2 percent ofGDP in 2000–06. In the Middle East andNorth Africa and South Asia, FDI remains lowat around or less than 1 percent of GDP. Mostrecently, FDI inflows to Sub-Saharan Africahave surged, reflecting substantial investmentin oil and mineral production and a moregeneralized interest in the region stemmingfrom increased political stability, liberalizationof FDI policies over the past 15 years, andimproved growth performance.

One way that FDI boosts technologytransfer is by financing new machinery andequipment purchases. The share of FDI indeveloping countries’ fixed capital formationincreased from 2.9 percent in the 1970s to 10.7percent in this decade (table 3.3), with the in-crease in middle-income countries being morepronounced than in low-income countries.However, FDI includes mergers and acqui-sitions that may involve no additional physicalinvestment, and the share of mergers and ac-quisitions, including privatization transactions,

in total FDI has been rising. Nevertheless, theforeign component of aggregate investment indeveloping countries has likely been risingalong with the extent of technological transferthrough this channel. Moreover, the transfers inknow-how, business process technology, andmarket knowledge associated with mergers andacquisitions can occur whether or not any asso-ciated physical investment is involved, and mayeven be more important.

Foreign firms may also improve the tech-nological capacity of developing countries by


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Table 3.3 Foreign direct investment as apercent of fixed capital formation

1970s 1980s 1990s 2000s

RegionsEast Asia and

the Pacific 1.9 3.0 12.2 8.4Europe and

Central Asia 2.8 — 8.1 15.5Latin America

and the Caribbean 3.3 0.1 11.3 13.1Middle East

and North Africa 2.8 2.1 3.7 6.5South Asia 0.3 0.4 2.5 4.1Sub-Saharan Africa 3.6 2.2 9.3 18.6Income groupsLow-income countries 2.2 1.3 5.6 6.7Middle-income countries 2.9 1.9 11.0 11.3All developing

countries 2.9 1.8 10.4 10.7OECD countries 13.5 11.3 3.5 11.5

Source: World Bank 2007a.Note: — � not available; OECD � Organisation for Economic Co-operation and Development.

Table 3.2 Foreign direct investment as a percent of GDP

1970–79 1980–89 1990–99 2000–06

All developing countries 0.5 0.4 1.5 2.7

By regionEast Asia and the Pacific 0.5 0.5 2.8 2.3Europe and Central Asia 0.3 0.1 0.9 2.2Latin America and the Caribbean 0.6 0.7 1.5 3.5Middle East and North Africa 0.5 0.5 0.6 1.1South Asia 0.0 0.1 0.4 0.7Sub-Saharan Africa 0.7 0.4 1 2.5

By income groupsLow-income countries 0.3 0.2 0.8 1.1

excluding India 0.6 0.4 1.4 1.8India 0.0 0.0 0.3 0.7

Middle-income countries 0.5 0.4 1.6 2.9

Source: World Bank 2007a.

financing R&D. Multinational corporationsundertake most of their R&D activities intheir home country or in other high-incomecountries.10 Nevertheless, the role of develop-ing countries appears to be rising. R&Dspending in developing countries by majority-owned foreign affiliates of U.S. parent compa-nies increased from $0.9 billion in 1999 to$1.6 billion in 2003 (Bureau of EconomicAnalysis 2007). The contribution of multina-tionals’ R&D to total measured R&D activityin developing countries varies from more than60 percent in Hungary to less than 5 percent inIndia (figure 3.4).

FDI may generate technology spillovers In addition to its technological impact on thefirm directly touched by the investment, FDImay also affect the level of technology indomestic firms.11 Spillovers can arise whenworkers receive training or accumulate experi-ence working for multinationals and thenmove to domestic firms or set up their own en-terprise (Fosfuri, Motta, and Ronde 2001;Glass and Saggi 2002). For example, withinsix years of the beginning of FDI-led export

growth in Mauritius, 50 percent of all firmsoperating in export-processing zones were lo-cally owned, founded, managed, and staffed—in many cases by employees who had receivedon-the-job training in foreign enterprises andhad left to set up their own companies (Rhee,Katterback, and White 1990).

Already existing local firms may also ob-serve the actions of foreign firms and learnabout new products, equipment, marketingtechniques, and management practices. For ex-ample, 25 percent of the managers of Czechfirms and 15 percent of the managers of Latvianfirms report that they learned about new tech-nologies by observing foreign firms as they en-tered their industry (Javorcik and Spatareanu2005). In Morocco and Tunisia, domesticallyowned international call centers have risen inimitation of foreign firms (box 3.2).

If multinational entry leads to an increasein demand for intermediates, it may result inthe expansion of upstream domestic industries(see the experience with Zambian supermar-kets in box 3.3). Downstream industries mayalso benefit from the increased competitionand added variety of inputs created by the for-eign investment. In addition, foreign investorsmay provide advice, designs, direct produc-tion assistance, or marketing contacts to sup-pliers, which the latter can then deploy morebroadly than simply providing cheaper ormore reliable inputs to the foreigners.12

The entry of multinationals is likely to in-crease competition for the domestic firmswithin the industry, potentially forcing themto improve their efficiency and introducenew technologies or business strategies(Blomstrom, Kokko, and Zejan 2000), as inWal-Mart’s joint venture in Mexico (box 3.4).Such competition can make surviving domes-tic competitors stronger, but other domesticfirms may be driven out of business, lose mar-ket share, and experience a loss of high-skilledworkers and higher costs for intermediategoods resulting from increasing demand fromthe foreign-owned firms.13 These effects mayvary by industry depending on factors suchas the market structure before the entry of


117

Figure 3.4 Share of foreign affiliates inbusiness R&D expenditure

0

Hunga

ry

Brazil

Lithu

ania

Mex

ico (2

001)

Thaila

ndChin

a

Latvi

a

Slovak

Rep

ublic

Estonia

India

(199

9)

Argen

tina

Poland

Turk

ey (2

000)

Chile

(200

2)

10

20

30

70

50

40

60

Sources: OECD; Activity of Foreign Affiliates database.http://www.sourceoecd.org; UNCTAD 2005; Eurostat;R&D statistics.

Note: The year is 2003 unless otherwise indicated.

Percent


118

The liberalization of the Zambian distribution sec-tor allowed the inflow of foreign retail companies,

which replaced some of the traditional retail sectorwith modern supermarkets and added both upstreamand downstream benefits to the domestic economy.Consumers benefited from lower costs, while localsuppliers learned new production and marketing tech-niques that enabled them to improve the quality, effi-ciency, and revenues of their operations.

When Shoprite of South Africa first opened super-markets in Zambia, it found that the quality andquantities provided by individual local smallholderfarmers were too low and too unreliable, and there-fore imported 90 percent of its fresh produce from

Box 3.3 South African investment in Zambia’s retailsector has improved the quality of local produce andfarmers’ earnings

South Africa. Farmers’ cooperatives that benefitedfrom donor-funded technical assistance have sincemanaged to improve the quality of their products andservices, and Shoprite is now sourcing 90 to 95 percentof its fresh produce from Zambian farmers. In the caseof one cooperative, farmers’ cash income has increasedfrom $2 to $3 a month to $50 to $70 a month, andlocal access to health care and education services hasimproved. The supermarkets themselves are providinglocal farmers with technical assistance. Agricultural ex-perts from the retailer’s subsidiary visit farms, give ad-vice on crop sequencing, and provide inputs.

Source: Mattoo and Payton 2007.

Leading call center companies from France andSpain have paved the way for domestically

owned and export-oriented call centers in Moroccoand Tunisia. Although call centers existed inMorocco and Tunisia before the first European callcenters outsourced operations to the region in theearly 2000s, domestically owned firms served thelocal market and provided only basic telecommuni-cations services. Only after Atento (a Spanish-ownedsubsidiary) set up a call center in Morocco andTeleperformance (a French-owned firm) settled inTunisia to serve clients in Europe did local entrepre-neurs jump into the European market.

This transition was not without problems. Locallyowned call centers lack the international name

Box 3.2 European call centers in the Maghreb have inspired local entrepreneurs and prompted aspecialization in high-value-added services

recognition of large foreign-owned firms and havehad difficulty obtaining contracts from foreigncompanies. In addition, most of them are small, witha maximum of 100 to 200 employees, compared withmore than 2,000 positions at some foreign-owned callcenters.

Interestingly, many domestically owned firms,such as Outsourcia in Morocco, have chosen todifferentiate themselves by targeting higher valueadded services. High turnover rates have also helpeddomestically owned firms to hire experienced agentswho were trained in the foreign call centers.

Source: World Bank forthcoming.

foreign multinationals, the R&D intensity ofthe products, and the links between foreignfirms and domestic firms in upstream anddownstream sectors.14

Outsourcing decisions, domestic policies,and absorptive capacity all affect spilloversEvidence indicates that spillovers to local sup-pliers are not uniform across countries oracross industries within a country.15 Multi-nationals may choose not to source inputs lo-cally because of concerns about the quality oflocal inputs or the time required to developrelationships with local suppliers or becauseof centralized sourcing arrangements that mayprovide volume discounts or access to cus-tomized inputs (UNCTAD 2001). In hostcountries with underdeveloped upstream sec-tors or in cases of FDI with very specializedinput needs, the scope for spillovers to up-stream sectors may be limited. Policies mayalso reduce the potential for spillovers. For ex-ample, in a highly protected market, foreignplants may operate at an inefficiently smallscale (Moran 2007). Requirements that for-eign firms enter into joint ventures with localcompanies may discourage use of the most ad-vanced technology to avoid leakage to poten-tial competitors (Beamish 1988).

The level of spillovers also depends on thedomestic absorptive capacity. For example,other advanced countries tend to gain fromtechnology spillovers from the activities ofsubsidiaries of U.S. multinationals, while poorcountries do not (Xu 2000). Firms using ad-vanced technology in low-income countriesfail to achieve the same level of productivity asfirms in industrial countries (Acemoglu andZilibotti 2001) or the same kinds of spilloversas in middle-income countries, in part becausethe gap between the quality and human capi-tal of the domestic workforce and that forwhich the equipment was originally designedis too large (Borensztein, de Gregorio, and Lee1998). In general, spillovers may be morecommon when the difference in technologicallevels between the foreign multinational andthe domestic economy is not too large.

As discussed earlier, the extent to which acountry benefits from spillovers to the rest ofthe economy also depends on the country’spolicy stance on basic technological literacyand more advanced skills and on promotionof the adoption and diffusion of technologieswithin the economy. For example, some coun-tries such as Mexico and the Philippines havebenefited relatively little from FDI spilloversbecause FDI inflows, although abundant, have


119

The Aurerra–Wal-Mart joint venture, which cre-ated Walmex, followed Mexico’s reduction in

tariffs and liberalization of FDI in the late 1980s. Byexercising its bargaining power, Walmex squeezedprofit margins among the major soaps, detergent,and surfactants suppliers, offering them higher vol-umes in return.

Local firms that were not efficient enough to meetWalmex’s terms lost market share, and many failed.Those that survived grew and became more efficientand innovative. The quality and efficiency of theiroverall operations benefited from their interactionswith both their client (Wal-Mart) and with foreign-

Box 3.4 Wal-Mart’s entry in Mexico boosted theMexican soaps, detergents, and surfactants industry

owned suppliers, with many firms adopting techniquesand products first introduced into the market by theirmultinational competitors.

As a result of these spillovers and labor shedding,the surfactants sector rapidly improved its value addedper worker. The newly found competitiveness and ex-posure to the requirements of Walmex and other for-eign retailers on the domestic market has allowed theMexican surfactants sector to expand its exports andmarket share in the United States, targeting the Latinocommunity in which their brands are known.

Source: Javorcik, Keller, and Tybout 2006.

been oriented toward exploiting low wagesand have not built many links to the domesticeconomy. In contrast, countries like Singaporehave actively sought to maximize the technol-ogy spillovers from FDI by investing in thedomestic skills and competencies necessary tosupport high-skill and high value added indus-tries and by welcoming and promoting FDI insuch sectors (Lall 2003).

Spillovers might be highly concentrated in certain regions within a countryGeographic proximity also determines theextent of technological spillovers observed.The closer a local firm is to a foreign-ownedfirm, the more frequently will the firms’ em-ployees interact with each other, increasing thelikelihood that employees (and their acquiredknowledge) will move between the two firms.The spatial aspect is also important for verti-cal spillovers between foreign-owned firmsand their local suppliers, which are often lo-cated close to each other (Jaffe 1989).

The existence of such cluster effects mayexplain why FDI tends to be geographicallyconcentrated within a country mainly aroundlarge cities or coastal states. In Russia, for ex-ample, more than two-thirds of the FDI stockin 2000 was in Moscow and three surround-ing regions (Broadman and Recanatini 2005).Similarly, almost half of FDI flows in India goto the Mumbai and Delhi areas (Reserve Bankof India 2007), while in China, almost 90 per-cent of FDI flows go to the western coastal re-gion (Kui-Yin and Lin 2007). This said, be-cause of data limitations and conceptualproblems, econometric support for the notionthat such clusters generate important technol-ogy spillovers is limited (Lipsey and Sjohom2005), with some studies supporting their ex-istence (see Girma and Wakelin 2001 for theelectronics sector in the United Kingdom) andothers not (see Aitken and Harrison 1999 forVenezuela and Sjoholm 1998 for Indonesia).

Developing countries also purchase foreignhigh-tech firmsOutward FDI, that is, the purchase of foreignfirms by domestically owned ones, and the

licensing of technologies are two other, moredirect mechanisms by which developing coun-tries acquire foreign technologies and researchexpertise.

Over the past 20 years, firms domiciled indeveloping countries have increasingly turnedto foreign acquisitions as a means of expandingtheir market share and gaining control overtechnology. Cross-border mergers and acquisi-tions by multinational corporations located indeveloping countries increased from $400 mil-lion in 1987 (less than 1 percent of globalmerger and acquisition transactions) to almost$100 billion in 2006 (almost 9 percent of globalmerger and acquisition transactions) (WorldBank 2007a). Although technology may not bethe primary motivator in many of these pur-chases, technology transfer is associated withnearly all of them in the form of control overpatents and knowledge of manufacturingprocesses, marketing, and business process ex-pertise. Table 3.4 summarizes some of the moretechnologically important recent acquisitionsof high-tech firms by developing country firms.

Developing country firms may seek to ac-quire a brand or a marketing or distribution net-work. Examples include the Thai Union FrozenCompany’s purchase of the Chicken of the Seabrand; the South African Brewery’s purchase ofMiller Brewing (a major U.S. beer maker); andMalaysian Berjaya’s purchase of Taiga, thelargest Canadian distributor of building materi-als. Developing country firms may also purchaseforeign firms to acquire R&D capacity. For ex-ample, the Chinese company Shanghai Automo-tive Industry Corporation bought Sangyong ofthe Republic of Korea to enhance its R&Dcapabilities in sport utility vehicles. Accessingforeign technology also takes the form of estab-lishing R&D centers in developed countries. Forexample, Huawei Technologies and ZTECorporation, both Chinese companies, haveestablished R&D centers in Sweden.

Developing countries can also licenseforeign technologiesDeveloping countries can also gain access totechnology through licensing, which typically


120

involves the purchase of production or distri-bution rights for a product and the underlyingtechnical information and know-how for pro-ducing it. As measured by the payment of in-ternational royalties and fees in countries’balance of payments, licensing fees paid by de-veloping countries increased from $7 billion in1999 to $22 billion in 2006, about a fivefoldincrease when expressed as a percentage ofdeveloping country GDP.16 The increase wassharpest for oil- and mineral-exporting coun-tries, reflecting higher prices for oil andcontracts that often expressed these fees as apercentage of revenues or profits. Nevertheless,licensing fees paid by other developing coun-tries also tripled, and for both low- and middle-income countries these fees represented a largershare of overall GDP than they did for oil- andmineral-exporting countries (figure 3.5).

Licensing can be used as a substitute forFDI. Uncertainty about the policy environ-ment may lead multinationals to sell technol-ogy rather than to exploit the technologythrough foreign investment (domestic firmsmay have more information or may be betterplaced than foreigners to deal with a poor pol-icy environment). Evidence suggests that bothFDI and licensing respond to an adequate busi-ness environment, and factors such as patentprotection may shift incentives for investorsfrom FDI toward licensing (Maskus 2002).Where protection of intellectual property

rights is weak, multinationals may be less will-ing to license technology for fear of it beingcopied by domestic firms. Alternatively, theymay only be willing to license out-of-datetechnologies (Maskus 2000). Data on U.S.multinationals show that the likelihood ofentering into licensing agreements increases asdeveloping countries increase their protectionof intellectual property rights (Antras, Desai,and Foley 2007).

Some countries have pursued a licensing-based strategy of technology acquisition in the


121

Table 3.4 Selected purchases of high-tech firms by companies in developing countries,early 2000s

Acquiring company Country of acquirer Year Acquired firm Country of acquired Industry

Netcare South Africa 2006 General Health Care United Kingdom HealthTata Tea India 2006 Tetley United Kingdom Tea Videocon Industries Ltd. India 2006 Daewoo Electronics Korea, Rep. of ElectronicsChalkis China 2005 Le Cabanon France Food processingEssel Propack India 2005 Telcon Packing United Kingdom Tube packingWipro India 2005 New Logic Austria SemiconductorsOrascom Egypt, Arab Rep. of 2005 Wind Italy TelecommunicationsLenovo China 2004 IBM United States PC manufacturingTCL China 2004 Alcatel France TelecommunicationsRanbaxy India 2004 RPG France PharmaceuticalsBOW Technology Group China 2003 Hynix Korea, Rep. of PC manufacturingPKN Orlen Poland 2002 BP (500 petrol stations) United Kingdom Downstream oil

Source: World Bank 2007a.

Figure 3.5 Licensing payments have risensharply

0Oil andmineral

exporters

Other Oil andmineral

exporters

Others

1990–04

1995–99

2000–06

0.05

0.25

Percent of GDP

0.15

0.10

0.20

Sources: Balance of Payments Database (IMF) and WorldDevelopment Indicators.

Middle-income countries Low-income countries

belief that domestic firms will be able to up-grade their own technological capacities byworking with licensed technology. For exam-ple, in the 1950s and 1960s, Japan kept itseconomy relatively closed to FDI to encouragemultinationals that wished to gain from thegrowing Japanese market to license technol-ogy to domestic firms (Pack and Saggi 1997).China has also encouraged joint ventures, asopposed to FDI, to maximize technologytransfers to local firms. This strategy is likelyto work only if the country has sufficient mar-ket power. Moreover, such discriminatorypolicies run the risk of resulting in the transferof substandard technologies (Hoekman andJavorcik 2006). In contrast, several LatinAmerican countries discouraged the licensingof technology from abroad because of con-cerns about unfair pricing and competitionwith local technologies, a strategy that re-tarded or skewed technological developmentin that region (Pack and Saggi 1997).

The bulk of international royalties and feesstems from intrafirm transfers. In part, thismay reflect a preference by multinationalfirms to transfer more advanced technologiesonly to wholly owned subsidiaries rather thanto partially owned affiliates and to enter mar-kets through wholly owned subsidiaries ratherthan through joint ventures (Javorcik 2006;Mansfield and Romeo 1980). However, it mayalso mean that these fees are being used as amechanism for repatriating profits, perhapsfor tax reasons. As a result, the level of royal-ties and fees may not be a market-based re-flection of the value of technology purchasedby the local subsidiary (Robbins 2006).

Partly because of intrafirm payments and ofthe close relationship between licensing andFDI, economists have had difficulty in evaluat-ing the impact of licensing on technologytransfer. Nevertheless, a few case studies havedocumented its benefits. Brazil and Koreaachieved considerable success in absorbingnew technologies through licensing (Correa2003), and licensing agreements were animportant factor for the success of flori-culture in Kenya, maize in India, and the

electronics sector in Taiwan, China (Chandraand Kolavalli 2006). The latter study alsohighlights that even though licensing may en-able rapid acquisition of product and processknow-how, it also requires a significant level oflocal technological capability to put thelicensed technology to work.

International migrationAlong with trade and FDI, international mi-grants are another important channel for thetransmission of technology and knowledge.From the perspective of developing countries,however, the direction of technology transfercan be both outward (as migrants take awayscarce skills) or inward (through contacts withthe diaspora).

The direction and scale of technology flowsthat result from international migration areless clear than for FDI and trade. On the onehand, the brain drain associated with bettereducated citizens of developing countriesworking in high-income countries is a seriousproblem for many developing countries. Onthe other hand, the contribution that these in-dividuals would have made had they stayedhome is uncertain given the lack of opportuni-ties in some countries. Moreover, developingcountries can benefit from the immigration,albeit often temporary, of managers and engi-neers that often accompanies FDI; the returnof well-educated developing country emi-grants; and the contacts with a technologicallysophisticated diaspora.

High rates of skilled out-migration imply anet transfer of human capital and scarce re-sources (in the form of the cost of educatingthese workers) from low- to high-incomecountries (UNCTAD 2007; World Bank2006a). For some countries, the brain drainrepresents a significant problem: emigrationrates of highly educated individuals can ex-ceed 60 percent in some small countries (fig-ure 3.6), and since 1990, the highly educateddiaspora of developing countries has doubledin size.17 However, the share of developingcountry tertiary-educated individuals livingabroad remained stable and relatively low,


122

ranging from 5 to 13 percent depending on theregion (figure 3.6), because the number ofsuch individuals also doubled.

The emigration of professionals who makea direct contribution to production, such asengineers, may result in reduced rates of do-mestic innovation and technology adoption(Kapur and McHale 2005a). Emigration ratesfor scientists, engineers, and members of themedical profession tend to be higher than forthe general university-educated population.For example, in India, the emigration rate for

those with a tertiary education is 4 percent,but the rate for graduates of the elite IndianInstitutes of Technology ranged from 20 to30 percent in the 1980s and 1990s (Docquierand Marfouk 2004; Khadria 2004).

More moderate migration rates may be ben-eficial, especially when domestic opportunitiesare limited, because of technological transfersfrom the diaspora and because most migrationis not a one-way flow. For example, a majorityof foreign students from many developingcountries who earn their doctorates in theUnited States return home (figure 3.7), bring-ing with them a great deal of technological andmarket knowledge that represents an impor-tant technological transfer in favor of the de-veloping country.

The share of recent doctoral graduates fromdeveloping countries who remain in the hostcountry varies significantly across countries oforigin. In part, these cross-national differencesreflect differences in opportunity costs. Thelikelihood that a student remains in the UnitedStates after graduation falls as average percapita incomes in the home country rise. How-ever, even at a given income level, the length ofstay varies significantly across countries, withfewer graduates returning home to countriessuch as Argentina, China, India, and theIslamic Republic of Iran than would be ex-pected based on income alone. Other factorsexplaining high retention rates include thequality of living conditions and research facili-ties in high-income countries, as well as thedensity of research networks and the size of thepreexisting diaspora. Factors favoring a returninclude proximity to family, cultural affinities,and emigrants’ desire to contribute to techno-logical progress in their native country.18

The diaspora is a major source of skillsand capital Repeated waves of emigration have led to thecreation of vibrant diasporas that possesscutting-edge technology, capital, and profes-sional contacts. For example, developingcountries accounted for three-quarters (ap-proximately 2.5 million) of the 3.3 million


123

% of tertiary-educated individuals in OECD countries, 2000

Source: World Bank staff calculations based on Docquierand Marfouk 2004.

Note: OECD = Organisation for Economic Co-operation andDevelopment.

St. Kitts and Nevis

Antigua and Barbuda

Cape Verde

Grenada

Tonga

Trinidad and Tobago

Suriname

Jamaica

Guyana

Haiti

0 605040302010 70 80 100

90

86

83

82

78

74

72

71

69

67

90

Figure 3.6 The brain drain is a severeproblem in a number of small countries

% of low-, medium-, and high-skilled individuals living inOECD countries, 2000

0

10

14

4

6

12

8

2

Low skilled

Medium skilled

East A

sia

and

the

Pacific

Europ

e an

d

Centra

l Asia

Latin

Am

erica

and

the

Caribb

ean

Midd

le Eas

t

and

North

Afri

ca

South

Asia

Sub-S

ahar

an

Africa

High skilled

immigrant scientists and engineers living in theUnited States in 2003.19 Moreover, becauseout-migration rates are higher for high-skilledindividuals than for low-skilled individuals, onaverage, the diaspora is much more skilledthan the home-country population and repre-sents an important concentration of expertise(figure 3.8). Notwithstanding the size of thediaspora, relatively little rigorous empiricalresearch exists on whether and to what extentit influences technology adoption and creationin emigrants’ home countries.20 The primaryevidence of diaspora contributions to knowl-edge transfers comes in the form of case stud-ies. At a minimum, the technical, market, andmarketing knowledge of national diasporas isa huge potential technological resource.21

Returning migrants can be a major sourceof entrepreneurship, technology, marketingknowledge, and investment capital (Brinker-hoff 2006a, 2006b; Kapur 2001).22 Migrantsreturning to Egypt tend to have higher levels ofhuman capital than nonmigrants and are likelyto be more entrepreneurial the longer they

work abroad (McCormick and Wahba 2003;Wahba 2007). Returning migrants and mem-bers of national diasporas who are still abroad


124

Figure 3.7 Share of Ph.D. students still living in the United States five years after graduation

Percent No. of graduates, 1996

0

20

40

100

80

60

Percent

0

20

40

100

80

60

9.56.0 6.5 7.0 7.5 8.0 8.5 9.0

ChinaIn

dia

Argen

tina

Iran

Turk

ey

Egypt

, Ara

b Rep

. of

South

Afri

caPer

u

Taiw

an, C

hina

Colom

bia

Mex

icoChil

e

Brazil

Korea

, Rep

. of

Indo

nesia

0

400

800

1,200

1,600

Stay back rate(left scale)

Number graduating in1996 (right scale)

Log of per capita gross national income in 2001

INDCHN

IDN

IRN

EGY

TUR

PERCOL

ZAF

BRA

ARG

CHL MEX

KOR

a. Share of foreign Ph.D. graduates who remain inthe United States for five or more years

b. Higher home-country incomes are associated withlower retention rates

Source: World Bank calculations based on Finn 2003.

Note: Country mnemonics follow ISO standards.

Source: Docquier and Marfouk 2004.

Figure 3.8 High-skilled emigrantsare disproportionately representedin the diaspora

Percent of emigrants, 2000

0

40

60

10

20

50

30

East A

sia

and

the

Pacific

Europ

e an

d

Centra

l Asia

Latin

Am

erica

and

the

Caribb

ean

Midd

le Eas

t and

North

Afri

ca

South

Asia

Sub-S

ahar

an

Africa

Medium skilled

High skilled

have made major contributions to technologi-cal progress in their home countries (box 3.5).

The diaspora also contributes to technologytransfers and adoption by strengthening tradeand investment linkages. The high-skilled dias-pora of countries such as India has contributedto the growth of the information technologysector, outsourcing (Kapur and McHale 2005b;Pandey and others 2006), and FDI in theirhome countries. The flow of outward FDI fromthe United States is strongly correlated with thestock of migrants from the origin country.23

Nearly half of the $41 billion in FDI that Chinareceived in 2000 may have originated from itsdiaspora abroad (Wei 2004). Similarly, 60 per-cent of the increase in bilateral trade in differ-entiated products within Southeast Asia may beattributable to ethnic Chinese networks (Rauchand Trindade 2002).24 Moreover, technologyappears to diffuse more efficiently through

culturally and nationally linked groups, andshared ethnicity appears to counteract the kindof home bias effects that underpin the geo-graphic network or the cluster effects that givehigh-density R&D zones an innovation advan-tage (Agrawal, Kapur, and McHale 2004).

Diaspora networks and returnees helppromote technology adoptionThe diaspora’s political engagement in homecountries can also improve local technologicalabsorptive capacity, both through return andby exercising pressure on home country politi-cians from afar. Many leaders of developingcountries were educated abroad and returnedto strengthen political institutions in their coun-tries of origin (Easterly and Nyarko 2005). Inaddition, migrants have often played a valuablerole in the transfer of market-based institutions,such as venture capital, entrepreneurship, and


125

An émigré from Bangladesh working in the finan-cial sector in the United States returned to help

create the Grameen Phone network and make mobilephones available to poor people in remote villages(Sullivan 2007). Through its successful Village PhoneProgram, the network has provided business oppor-tunities to some 260,000 Village Phone operators,mostly poor rural women. Grameen Phone now has15 million customers, more than 10 times the maxi-mum potential client base initially estimated byBangladesh Telecom.

In India, Sam Pitroda, a global entrepreneur who divides his time between India and the United States,founded the Center for Development of Telematics,which developed rural automatic telephone exchangesand introduced shared public call offices all over the country, thus expanding access to cheap and reli-able domestic and international calling. The rela-tively low-cost telephone exchanges are designed tooperate without air conditioning and require signifi-cantly less maintenance than conventional ex-changes. The technology has been exported to sev-eral other developing countries.

Box 3.5 Technological transfers through the diasporaand return migrants: Some examples

Bata Shoes of the Czech Republic is an early exam-ple of technology diffusion through migration and re-turn. Faced with the threat of bankruptcy at his smallshoemaking business in the early 1900s, the founderof the company, Tomas G. Bata Sr. went to the UnitedStates in 1904 to learn more efficient mass productionmethods. Bata returned to the Czech Republic toapply these production techniques. He eventuallyexpanded production to several other countries, in-cluding India, Poland, and the former Yugoslavia, andbecame the world’s leading footwear maker by the1930s. Faced with nationalization in 1945, thefounder’s son moved his family and the company’sheadquarters to Canada, returning to the Czech Re-public once again in 1989 with a further transfer oftechnology and business know-how acquired over theintervening years. Since then, the Bata company hascontinued to spread technology. It has opened stores inCroatia, Poland, Russia, and Slovenia, as well as aproduction facility in China, and is modernizing itsBatanagar factory complex in India.

Source: http://www.bata.com; Factiva; Telenor press releases.

corporate transparency, to their countries oforigin.25 Overseas Taiwanese engineers andreturnees, for example, worked closely withpolicy makers to establish a successful venturecapital industry. This has provided local entre-preneurs with an alternative source of finance,which has helped them overcome the constraintposed by the reluctance of state-owned finan-cial institutions to lend to high-risk entrepre-neurial activities in the technology sector(Kuznetsov 2007).

Expatriate knowledge networks have beencreated to foster regular contacts; transfers ofskills; and opportunities for business with re-searchers, scientists, and entrepreneurs in thecountry of origin. Brown (2000) identified 41such networks for 30 different countries.These networks tend to be rich depositories oftalent with high concentrations of memberswith advanced degrees, many earned in thehost countries.26 Colombia’s Red Caldas net-work, set up with government assistance in1991, was one of the first diaspora networksthat succeeded in promoting collaborative re-search between domestic scientists and Colom-bian researchers abroad through workshopsand symposiums, joint research programs, vis-iting researchers, scientific events, publica-tions, and research and training opportunities(Chaparro, Jaramillo, and Quintero 2006).Less formal networks played an important rolein the transition of the Republic of Korea andTaiwan (China) from developing to high-income economies.27 Some diaspora networkshave failed, principally because they were tooambitious, particularly in cases where the pol-icy and institutional environment in the homecountry were not supportive.28 Research sug-gests that the most successful models startsmall to build up trust and credibility beforeattempting to sponsor a major research projector cooperative agenda (Kuznetsov 2006).

Remittances can promote technologydiffusion by making investments more affordableRemittances to developing countries havegrown steadily in recent years, reaching $207

billion in 2006, and are now are larger thanFDI and equity inflows in many countries, es-pecially small, low-income countries. Remit-tances can support the diffusion of technologyby reducing the credit constraints of receivinghouseholds and encouraging investment andentrepreneurship (Fajnzylber and López 2007;Puri and Ritzema 1999; Woodruff andZenteno 2007; World Bank 2006a). A surveyof self-employed workers and small firms inMexico found that remittances were responsi-ble for one-fifth of the capital invested in mi-croenterprises in urban Mexico (Woodruffand Zenteno 2001). In the Philippines, house-holds work more hours in self-employmentand become more likely to start relativelycapital-intensive household enterprises in re-sponse to an exogenous increase in remit-tances (Yang 2006).

Remittance flows have also contributedto the extension of banking services (oftenby using innovative technologies), includingmicrofinance, to previously unserved, oftenrural, sectors. This has improved the accessof households and firms to financial services(box 2.8; Gupta, Pattillo, and Waugh 2007),and their ability to purchase and invest intechnology. For example, remittance rev-enues may have helped Ghana’s ApexLinkand Mongolia’s Xac banks to expand theirnetworks and services (Isern, Donges, andSmith 2006). Cell phone money transfers,such as G-cash and Smart Padala in thePhilippines, and card-based remittances arebecoming prevalent in a number of countries,including Mozambique, South Africa, andthe United Arab Emirates, and are likely toexpand to other countries in the comingyears (Helms 2006; Jordan 2006). Remit-tances have also helped domestic banksfoster links with banks in high-incomecountries. In turn, such links have fosteredtechnology transfers as banks in high-incomecountries have helped local partners to up-grade their systems to comply with the anti-money-laundering, antiterrorism, and know-your-customer regulations in developedcountries.


126

A summary index of trends in theexposure of developing countries to external technologyThe preceding paragraphs have argued that de-veloping countries gain access to foreign tech-nology through trade, FDI, and the diasporaand that these links have been increasing overtime. This section reports on the results of aneffort to summarize these trends by applyingprincipal components analysis to five data se-ries covering trade and FDI following the samebasic methodology as used in chapter 2 to cre-ate the index of technological achievement.29

The index shows that the relationship be-tween income levels and exposure to externaltechnology is relatively weak across countries.Even though the average exposure is higheras one moves from low-income to upper-middle-income developing countries, substan-tial variation is apparent across countries. Thisvariation partly reflects issues of country size(smaller countries tend to be more open thanlarger countries), but it also stems from varyingdegrees of specialization among countries.

The index also shows that many countrieshave increased their exposure to tech-nology during the 1990s (figure 3.9). Of thedeveloping countries for which data are avail-able, 17 experienced a reduction in exposureto foreign technologies over the 1990s and 70saw their exposure rise. The average percent-age increase was highest in low-income andin upper-middle-income countries, with the in-crease among lower-middle-income countriesactually being below that observed amonghigh-income countries. These average resultsreflect a mix of strong increases in excess of100 percent in a number of countries and lessspectacular increases in others.

Much of the variation is attributable tostrong increases in the degree of opennessamong the transition economies. The averageimprovement in the index of exposure to for-eign technology for the countries of Europe andCentral Asia was 80 percent. Excluding thesecountries from the sample lowers the averageincrease in middle-income countries signifi-

cantly, resulting in a clear negative relationshipbetween the observed increase in exposure toforeign technologies and incomes (table 3.5).This is particularly encouraging for low-income countries, as the gains from such expo-sure tend to be nonlinear and enduring(Lumenga-Neso, Olarreaga, and Schiff 2005).For middle-income countries and South Asia,however, this result suggests that many coun-tries (notably those in South Asia) may bemissing out on the potential benefits to beachieved from increased openness.

Nurturing technologicaladaptive capacity

Openness to trade, FDI, and internationalcommunication through the diaspora,

other networks, and various media all serve toexpose a country to technologies and applica-tions of technologies that may not have beenexploited domestically. Exposure does not,however, guarantee that these new technolo-gies will spread and grow within the domesticeconomy. Too often technologically sophisti-cated processes or products are limited to a fewmajor centers or foreign-owned enclaves. Howfar these technologies diffuse within a countryis determined by its technological adaptive ca-pacity, that is, the quality of its labor force andthe business environment (including access tofinance) in which firms operate and are able(or unable) to start up, expand, and reap the fi-nancial rewards of their new-to-the-market in-novations. In the following sections we explorerecent trends in technological adaptive capac-ity among developing countries and the rolesfirms, governments, and individuals play increating and supporting that capacity.

Governance and the businessclimateA stable and predictable economic environ-ment reduces the risk that returns to invest-ments in technology and innovative businessactivities will be lost to conflict or widely vari-able inflation and exchange rates. A stableregulatory environment that facilitates theconduct of business by enforcing property


127

rights, by limiting corruption, and by not im-posing onerous requirements that make thecreation or expansion of firms or theiradoption of new technologies unnecessarilydifficult also contributes to an economy’s tech-nological adaptive capacity.

Political and macroeconomic stabilityhave improved countries’ ability to exploit technologyOver the past 15 years, the number of coun-tries involved in international or domestic


128

Figure 3.9 Most developing countries have increased their exposure to external technology

Index

Source: World Bank.

0High-income

countriesUpper-middle-income

countriesLower-middle-income

countriesLow-income

countries

0.05

0.25

0.20

0.15

0.10

Exposure to external technology

Percent change in index

�100High-income

countriesUpper-middle-income

countriesLower-middle-income

countriesLow-income

countries

0

150

200

�50

100

50

Changes in exposure (2000s versus 1990s)

conflict, as measured by the InternationalCrisis Behavior Project, has declined signifi-cantly (figure 3.10). The decline has been mostpronounced in Sub-Saharan Africa, where thetotal number of countries in conflict declinedfrom a peak of 10 in 1998 to only 2 in 2004.Among its many benefits, the cessation ofconflict can provide an environment that ismore conducive to both private and publicsector investments in technology. For example,12 years after the end of hostilities, the gov-ernment of Rwanda launched an ambitious

program of technological capacity building(Watkins and Verma 2007).

Improved macroeconomic stability andgrowth in developing countries has also con-tributed to an environment that is morefriendly toward technological investment.30

High and variable inflation and high exchangerate volatility increase the risk involved ininvestments in technology and increase thereturns to financial manipulation relative to

investment. High government deficits and debtalso increase uncertainty, especially whencombined with a rigid exchange rate regime, acombination that increases the likelihood of anabrupt revaluation that would further cloudexpected future returns. The median inflationrate in developing countries fell from 19 per-cent in the early 1990s to 4 to 6 percent duringthe first half of this decade, exchange ratevolatility is down, and government deficitshave declined across the board and are nowbelow 3 percent of GDP in every developingregion except South Asia. Moreover, the accel-eration of per capita income growth over thepast 15 years, which has been most markedover the past 6 years, has improved the overallaffordability of technology (table 3.6).

A weak business environment and poorgovernance can impair technologicalprogressRegulatory restrictions that impair the econ-omy’s flexibility may limit the absorption oftechnology. Restrictions on labor mobility andrules that constrain firms’ ability to reallocateworkers within the firm can be importantbarriers to the adoption of new technologies(Parente and Prescott 1994). For example,


129

Table 3.5 Increases in exposure to externaltechnologies index, 1990s to 2000s

(excluding Europe All countries and Central Asia)

Regions (percent change)East Asia and the Pacific 13.4Europe and Central Asia 83.7Latin America and the

Caribbean 33.4Middle-East and North Africa 37.8South Asia 13.7Sub-Saharan Africa 33.4

Income groupsHigh-income countries 27.7 27.7Upper-middle-income countries 45.1 24.4Lower-middle-income countries 36.2 31.7Low-income countries 33.5 33.5

Source: World Bank.Note: Values are unweighted averages of country-specificchanges.

Figure 3.10 Number of countries in conflict worldwide

Source: International Crisis Behavior database. http://www.cidcn.umd.edu.icb.

0

1960

10

30

35

Number of countries

5

25

20

15

1965

1970

1975

1980

1985

1990

1995

2000

2005

High-income countries Upper-middle-income countries Lower-middle-income countries Low-income countries


130

Table 3.6 Macroeconomic stability has improved in developing countries

Median inflation ratea Real effective exchange rate volatilityb

1990–94 2002–06 Difference 1990–94 2002–06 Difference

World 11.1 3.6 �7.5 3.7 1.4 2.3High-income countries 3.4 2.1 �1.3 1.6 0.8 0.8Upper-middle-income countries 19.2 4.5 �14.7 2.8 1.4 1.4Lower-middle-income countries 16.3 4.7 �11.6 6.5 1.2 5.3Low-income countries 9.2 4.0 �5.2 3.9 2.0 1.9Developing countries 18.8 4.2 �14.5 4.5 1.5 3.0

East Asia and the Pacific 7.1 3.4 �3.7 1.3 1.2 0.1Europe and Central Asia 326.8 4.3 �322.5 10.6 1.2 9.4Latin America and the Caribbean 17.1 5.5 �11.6 2.9 1.3 1.6Middle East and North Africa 8.9 3.7 �5.2 1.9 1.2 0.7South Asia 9.8 5.4 �4.4 1.4 1.1 0.3Sub-Saharan Africa 9.2 4.6 �4.6 3.9 2.1 1.8

General government balancec General government debtd

1990–94 2002–06 Difference 1990–94 2002–06 Difference

World �5.0 �1.5 3.5 62.6 64.1 1.5High-income countries �4.3 0.8 5.1 58.7 55.6 �3.0Upper-middle-income countries, excluding ECA �2.3 �2.1 0.2 55.1 74.5 19.4Lower-middle-income countries, excluding ECA �3.8 �2.9 0.9 64.3 57.5 �6.8Low-income countries, excluding ECA �5.4 �1.9 3.5 97.9 106.5 8.7Developing countries, excluding ECA �4.1 �2.2 1.9 73.3 78.7 5.4

East Asia and the Pacific �2.0 �2.1 �0.1 45.6 57.0 11.4Europe and Central Asia �9.4 �1.9 7.5 38.9 37.2 �1.7Latin America and the Caribbean �2.2 �2.8 �0.6 67.5 69.7 2.2Middle East and North Africa �6.6 �2.8 3.9 71.6 71.3 �0.3South Asia �7.7 �6.1 1.5 78.2 76.3 �1.9Sub-Saharan Africa �5.3 �1.4 3.9 88.6 97.6 8.9

GDP per capita growthe

1985–94 1995–2006 Difference

World 1.8 2.5 0.7High-income countries 2.1 2.5 0.4Upper-middle-income countries, excluding ECA 2.9 2.1 �0.8Lower-middle-income countries, excluding ECA 1.1 2.1 1.0Low-income countries, excluding ECA �0.5 1.6 2.1Developing countries, excluding ECA 2.0 2.0 0.0

East Asia and the Pacific 3.7 2.5 �1.1Europe and Central Asia �2.4 4.9 7.3Latin America and the Caribbean 2.1 1.7 �0.5Middle East and North Africa 3.2 2.1 �1.1South Asia 2.6 3.3 0.7Sub-Saharan Africa 0.6 2.6 2.0

Source: DataStream, International Monetary Fund, JP Morgan, World Bank.Note: ECA � Europe and Central Asia.

a. Calculated as the mean over each indicated period of the median monthly (year over year) Consumer price index infla-tion rates of the countries in each grouping.

b. Calculated as the period average of the absolute value of the month-over-month percent change of the real effective ex-change rate of countries in each grouping.

c. Calculated as the period average of the simple mean across countries of the central government budget deficit as re-ported by the International Monetary Fund.

d. Calculated as the period average of the simple mean across countries of the government debt as reported to the WorldBank (for low- and middle-income countries and as per the IMF for high-income countries).

e. Calculated as the period average of the simple mean across countries of the growth in GDP per capita.

stringent labor market regulations in Brazilundermine productivity and technical effi-ciency (World Bank 2005), and the removal oflabor market regulations that result in invol-untary overstaffing would increase labor pro-ductivity by 7 percent in India (World Bank2004b). Similarly, restrictions on firm exit andentry can impede technological progress bypropping up inefficient firms and limiting theexpansion and creation of innovative firms.31

Rules and regulations governing firm start-up can be particularly important, because theyhave the potential to prevent a new technol-ogy or new-to-the-market product or processfrom seeing the light of day. The World Bank’sindicators on doing business suggest substan-tial room for improvement in most developingregions. On average, an entrepreneur seekingto begin a new business must undertake morethan 9 separate procedures, which can take al-most 50 days to complete (table 3.7). Amonghigh-income countries that belong to theOrganisation for Economic Co-operation andDevelopment (OECD), the equivalent figuresare 6 procedures and 17 days. Moreover, indeveloping countries the associated fees areparticularly onerous given income levels, con-suming more than an amount equivalent to1.5 years worth of per capita income for a per-son living in South Asia, compared with5 days worth of the per capita income of


131

Table 3.7 The regulatory burden is heavier in developing countries than in the OECD

Procedures Duration Cost Minimum capital requirements

(number) (days) (% of GNI per capita) (% of GNI per capita)East Asia and the Pacific 8.2 46 43 60Europe and Central Asia 9.4 32 14 54Latin America and the Caribbean 10.2 73 48 18Middle East and North Africa 10.3 41 75 745South Asia 7.9 62 163 1Sub-Saharan Africa 11.1 33 47 210Developing-country average 9.5 47.8 65 181OECD countries 6.2 16.6 5 36

Memo:Ratio of developing-country

average to OECD average 1.5 2.9 12.2 5.0

Source: World Bank; Doing Business. http://www.doingbusiness.orgNotes: Procedures required to register a firm, average time spent during each procedure, offical cost of each procedure, andminimum capital required as a percent of income per capita; GNI � gross national income.

someone in an OECD country. Minimumcapital requirements are also high comparedwith income and likely limit the size of formalsmall and medium enterprise sectors, particu-larly in the Middle East and North Africa andin Sub-Saharan Africa, where they representmore than two years of average earnings.

Ensuring timely and efficient exit by failedbusinesses also promotes technologicalprogress by freeing unemployed and underem-ployed capital and workers for more efficientuses. Developing countries, on average, requiremuch more time to resolve insolvencies (rang-ing from 2.7 years for East Asia and the Pacificto 5.0 years for South Asia) than OECD coun-tries (which require an average of 1.3 years). Inaddition, the amount recovered averages lessthan 30 cents on the dollar in all developing re-gions (and only 20 cents in South Asia and17 cents in Sub-Saharan Africa), compared with74 cents on the dollar in OECD countries.32

The quality of regulation, including its en-forcement, and of the business legal environ-ment are critical determinants of the capacityof new and innovative firms to grow and ex-pand. For example, the ability of such firmsto finance their initial operations or conductarms-length operations, both of which arecrucial for technologically advanced compa-nies that require a large customer base toexploit economies of scale, depend on the

system’s ability to enforce contracts, establishproperty rights, and enforce court decisions ina timely and cost-effective manner.

Although the number of procedures re-quired to enforce a court decision in the caseof a contract dispute in developing countries issignificantly higher than in OECD countries,the time taken to reach a decision is not toomuch greater (with the notable exception ofSouth Asia), generally less than 25 days, com-pared with 13 days in OECD countries (figure3.11). However, the time required to enforcelegal decisions approaches two years in four ofsix regions. This seriously affects firms’ (andconsumers’) ability to effect arms-length trans-actions with confidence, and is therefore animportant inhibitor to the growth of techno-logically sophisticated firms.

Corruption can also prevent entrepreneursfrom making investments in technology andexpanding their businesses in a manner thathelps extend the penetration of technologiesinto the economy, while increasing the relativereturn to activities aimed at influencing policymakers. Moreover, better governance is also

associated with improvements in processtechnology, particularly in the delivery of gov-ernment and regulated services. For example,Kaufmann, Kraay, and Mastruzzi (2007)estimate that an improvement of one standarddeviation in the summary governance indica-tor is associated, in the long term, with a two-thirds reduction in infant mortality and atripling of incomes.

Surveys suggest that developing countrieslag behind high-income countries on a widerange of governance indicators (figure 3.12).For example, government effectiveness andregulatory quality are typically considered tobe at half of OECD levels, with indicators forcorruption, rule of law, and voice and ac-countability being even lower.

These aggregate results hide a certainamount of variation across countries andregions (figure 3.13). Governance in theCaribbean and in Eastern Europe and theBaltic countries appears to be much stronger(more than 70 percent of the OECD level)than in the rest of the developing world, whilecountries in the former Soviet Union and Sub-Saharan Africa have the lowest ratings, only 34and 28 percent of OECD levels, respectively.

In contrast to other indicators of perfor-mance, such as inflation and openness, there islittle evidence that developing countries have


132

Figure 3.11 Efficiency of contractenforcement

Number of procedures Days

0

OECD

East A

sia a

nd

the

Pacific

Europ

e an

d

Centra

l Asia

Sub-S

ahar

an

Africa

South

Asia

Latin

Am

erica

and

the

Caribb

ean

Midd

le Eas

t and

North

Afri

ca

5

15

20

45 1,200

10

35

25

30

401,000

800

600

400

200

0

Procedures (left axis) Time (right axis)

Sources: World Bank; Doing Business.http://www.doingbusiness.org.

Figure 3.12 Developing countrygovernance scores relative to OECDaverage

Source: Kaufmann, Kraay, and Mastruzzi 2007.

605550

Index, OECD � 100

4540

Voice andaccountability

Regulatoryquality

Political stability

Control ofcorruption

Rule of law

Governmenteffectiveness

markedly improved their governance over thepast decade. Despite individual country im-provements and marked gains in the regula-tory environment in Europe and Central Asia,on average, the quality of governance aroundthe world has not improved much over thepast decade (see the World Bank’s GovernanceMatters series). For each country that hasdone well, one has experienced deteriorationin its governance indicators. Two countriesthat have experienced notable deteriorationare Belarus and the República Bolivariana deVenezuela. Many countries have not experi-enced any significant change in either direc-tion. On the positive side, the GovernanceMatters series shows that where countries arecommitted to reform, improvements cantake place relatively quickly. For example,during the relatively brief period of 2002–06,Kenya, Liberia, and Ukraine made significantadvances in voice and accountability, whileAlgeria and Angola made substantial progressin political stability. Thus the potential existsfor a rapid, substantial improvement in the

quality of governance in many developingcountries, an improvement that would en-courage technological progress.

Basic technological literacyWhile the policy environment is critical to theabsorption of technology, technologicalprogress also requires a literate workforce.The process by which external technologiesare absorbed, adapted, and integrated into aneconomy is not a mechanical one, but one thatdepends on the quality, quantity, and distribu-tion of human capital, that is, on the techno-logical competencies and the health of thepeople that use and implement the technology.For this reason, efforts to increase the techno-logical competency, knowledge, and under-standing of populations, firms, and govern-ments lie at the heart of the World Bank’stechnology agenda. Especially among poorcountries and in rural areas, existing deficits interms of basic skills are a binding obstacle totechnological progress and income growth.

Low incomes and poor health impair skillformation for technological progressLow income and poor health are perhapsamong the most basic constraints to techno-logical progress. Even if profitable investmentsin technology are available, inadequate incomelimits the ability to generate resources forinvestment. At the level of the economy, lowincome is both a cause and an effect of low lev-els of human capital, limited funds allocated toresearch, thin financial markets, often poorgovernance, and sometimes violence andmacroeconomic instability, all of which limitthe ability to absorb technological innovations.

Recent developments in relation to incomelevels are heartening. Growth rates of GDPper capita have picked up throughout thedeveloping world over the past 15 years(figure 3.14). The number of people living inabsolute poverty has declined by more than250 million, and their share in the populationof the developing world is expected to fallfrom 18 percent in 2004 to around 11 percentby 2015 (chapter 1).


133

Figure 3.13 Regional averages of sixgovernance indicators

Sources: World Bank; Doing Business.http://www.doingbusiness.org.

10080

Share of OECD averagePercentile rank (1–100)

6040200

Latin America

Middle East andNorth Africa

South Asia

Sub-SaharanAfrica

FormerSoviet Union

Eastern Europeand Balticcountries

OECD

East Asia

Developing-country average

Caribbean

Similarly, welcome developments havetaken place in basic health. Life expectancy atbirth has reached 70 years in middle-incomecountries and continues to converge to still-rising high-income country levels (figure 3.15).Among low-income countries, life expectancyis also converging with high-income countries.Excluding Sub-Saharan Africa, where life ex-pectancy has been declining because of HIV/AIDS, life expectancy in low-income countriesincreased from 59 years in 1990 to 64 years in2005, suggesting that in much of the world,poor health should be decreasing as a factorimpeding technological progress.

In Sub-Saharan Africa, the combination ofincomes that are still extremely low and theravages of HIV/AIDS are more problematic.The failure to control HIV/AIDS is itself anexample of poor dissemination of technologyand problems of affordability, as both theknow-how to limit the spread of the diseaseand to control its health effects are wellknown, even though implementation strate-gies are controversial and tend to be countryspecific. Some countries, such as Uganda, havesucceeded in reducing HIV infection rates.Other countries in western Africa have suc-ceeded in limiting its spread. Still others, no-tably Botswana, are doing better at treatingthose infected than in preventing new infec-tion. In too many countries, however, theepidemic continues to grow more or lessuncontrolled, with widespread societal conse-quences (World Bank 2007b). Estimates sug-gest that in Burkina Faso, Rwanda, andUganda, HIV/AIDS is likely to increase thepercentage of people living in extreme povertyby as much as 6 percentage points between2000 and 2015 (UNDP 2003). In Kenya,HIV/AIDS may reduce GDP per adult by 11percent by 2040 compared with what it wouldhave been in the absence of HIV/AIDS (Bell,Bruhns, and Gersbach 2006). In addition tothe incalculable human costs implied, contin-ued high death rates in the adult populationwill have further negative implications for theability of these countries to acquire and toapply technology, both because the experienceand technological competencies of the adultsexpected to die will be lost and because theeducational attainment and literacy of theirchildren and dependents will be impaired(Bell, Devarajan, and Gersbach 2004).

Illiteracy is declining, but still blockscountries’ ability to absorb newtechnologiesThe level of human capital is a major determi-nant of an economy’s ability to adapt and ab-sorb both sophisticated and even more basictechnologies.33 In both high-income (Eatonand Kortum 1996) and developing countries


134

Figure 3.15 Except in Sub-Saharan Africa,life expectancy is improving

40

50

South Asia

Sub-Saharan Africa

Low-incomecountries



Upper-middle-incomecountries

80

1960

Life expectancy at birth (years)

60

70

Source: World Development Indicators.

1965

1970

1975

1980

1985

1990

1995

2000

2005

Figure 3.14 Per capita incomes haveaccelerated in recent years

�2

0

2

3

5

6

Low-incomecountries

Average growth in annual per capita incomes

4

1

�1

Source: World Bank.

Middle-incomecountries

Sub-SaharanAfrica

2001–06

1990s

1980s

1970s

1960s

(Caselli and Coleman 2001), the extent towhich a given technology is used within acountry depends importantly on the educa-tional attainment of the population, both be-cause such skills help individuals learn how tomake effective use of a new-to-the-firm or farmtechnique, and because they increase the likeli-hood that firms will learn of new innovationsbeyond the scope of their local communities.

Although the gap between the educationalattainment of individuals living in developingcountries and those in high-income countriesremains wide, it is closing, both in termsof the most basic indicators (literacy and

primary school completion rates) and moresophisticated indicators, such as tertiary edu-cation enrollment rates (table 3.8). Over thepast 15 years, literacy rates have increasedthroughout the developing world, with thebiggest increases recorded among low-incomecountries, particularly in South Asia. Reportedliteracy rates in Europe and Central Asia rivalthose in high-income countries, while in EastAsia and the Pacific and Latin America andthe Caribbean, literacy rates are at or close to90 percent. Elsewhere literacy lags consider-ably, with only 73 percent of the population inthe Middle East and North Africa being able to


135

Table 3.8 Educational attainment indicators

Adult literacy rate Female literacy rate Expected years of schooling

1990–2005 2005a 1990–2005 2005a 2001–05 2005

(% of population (% of female(% point aged 15 (% point population aged (years of

Regions change) and older) change) 15 and older) (% change) schooling)East Asia and the Pacific 10.7 91 14.9 87 1.9 11.2Europe and Central Asia 1.3 97 1.8 96 0.8 12.7Latin America and the Caribbean 2.3 90 2.6 89 0.5 13.1Middle East and North Africa 14.7 73 16.5 63 2.1 11.7South Asia 11.6 58 12.8 46 4.0 9.7Sub-Saharan Africa 5.1 59 5.2 50 3.5 8.0

Income groupsWorld 6.0 82 7.3 77 2.0 10.9High income 0.3 99 0.3 98 0.4 15.8Upper middle income 0.8 93 1.9 92 0.5 13.3Lower middle income 9.2 89 12.0 85 2.0 11.5Low income 9.3 61 10.1 50 3.5 9.0

Primary completion rate Secondary completion rate Tertiary completion rate

1991–2005 2005 1990–2000 2000 1990–2000 2000

(% of population

(% point (% of relevant (% point (% of population (% point aged 15Regions change) age group) change) aged 15 and older) change) and older)East Asia and the Pacific �1.7 97.7 1.5 13.7 0.8 2.5Europe and Central Asia 2.2 94.9 0.1 13.5 1.6 5.5Latin America and the Caribbean 16.9 98.5 1.1 8.7 1.2 4.9Middle East and North Africa 13.7 90.7 2.1 10.0 1.4 3.4South Asia 18.1 83.5 0.5 7.0 0.5 2.0Sub-Saharan Africa 11.5 60.8 0.5 2.3 0.4 1.0

Income groupsWorld n.a. 87.6 0.4 11.9 1.0 4.9High income n.a. 97.4 �0.7 18.6 2.9 13.3Upper middle-income 10.3 98.5 0.7 12.4 1.4 4.9Lower middle-income 2.7 96.6 1.4 12.4 0.9 2.9Low income 17.0 75.9 0.5 6.1 0.4 1.8

Source: World Development Indicators.a. Actual reference year varies by country.

read and write and about 60 percent in SouthAsia and in Sub-Saharan Africa. Moreover,there are concerns about the comparability ofthese data, as some low-income countries re-portedly define literacy as the ability to readand write one’s own name.

Divergence in the literacy rates for womenexplain much of the disparity. For example, inSouth Asia fewer than half of women age 15and older are literate. Women in the MiddleEast and North Africa and Sub-Saharan Africafare somewhat better, with literacy rates of63 and 50 percent, respectively. Althoughthe technological consequences of such wide-spread illiteracy are difficult to quantify, illiter-ate mothers are much less successful in assist-ing their children to learn (Behrman and others1999), have much more difficulty in absorbingnew techniques and instructions that are trans-mitted in written form, and are likely to be lesseffective workers than their better educatedpeers. Indeed, female illiteracy and the result-ing relative ignorance of best practices in childrearing may be a major causal factor in poorchild health care and poor female labor forceoutcomes (Rosenzweig and Wolpin 1994).

Rising primary school completion ratesshould drive further improvements in adult literacyThe rise in literacy rates is due in no small partto increased and longer participation in for-mal education. Primary school completionrates approach 100 percent in about half ofthe developing regions and have increasedsubstantially among poorer regions, notablySouth Asia and Sub-Saharan Africa. Althoughreflective of the average literacy in the geo-graphical region, these numbers hide impor-tant variations across countries. Thus the lowscore for South Asia reflects mainly low liter-acy in India, and it masks the fact that some95 percent of Sri Lankan youth can read andwrite. Similarly, China’s relatively high liter-acy rates and its large weight in East Asiaaggregate mask the less than 90 percent liter-acy rates of less populous countries such asCambodia and the Lao People’s Democratic

Republic. In particular, the gap betweenschool completion rates for girls and boys hasnarrowed significantly. Partly as a conse-quence, youth literacy rates are much higherthan adult literacy rates in South Asia andSub-Saharan Africa, which over time shouldbe reflected in better literacy scores for womenand improved transmission of knowledge andtechnology to future generations (table 3.9).

Of course, progress in providing effectivebasic education is a necessary precursor ofmore formal secondary and tertiary educa-tion. Nevertheless, the more advanced techni-cal and problem-solving skills that are taughtat the basic level can significantly increase stu-dents’ capacity to learn to work with, adapt,and maintain more technologically advancedgoods. Indeed, the main obstacle to deepeningthe use of a given technique or process in acountry is frequently a lack of sufficient num-bers of individuals trained to maintain andinstall systems. For example, in Rwanda ashortage of plumbers and sheet metal workershas been identified as a principal factor con-straining the deployment of the simple kindof rain-harvesting technologies that havesucceeded in increasing the supply of sani-tary drinking water in neighboring countries


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Table 3.9 Relatively high youth literacyrates

Youth literacy rate

1990–2005 2005a

(% of(% point population

Regions change) age 15–24)East Asia and the Pacific 3.43 98Europe and Central Asia 1.67 99Latin America and the Caribbean 2.29 96Middle East and North Africa 12.23 88South Asia 13.72 73Sub-Saharan Africa 5.42 70

Income groupsWorld 4.16 88High-income countries 0.23 99Upper-middle-income countries 1.82 98Lower-middle-income countries 3.68 96Low-income countries 10.41 73

Source: World Bank; World Development Indicators.a. Actual reference year varies by country.

(Watkins and Verma 2007). While nearly 19per-cent of the population completes secondaryschool in high-income countries, secondaryschool attainment rates range between 10 and14 percent in East Asia and the Pacific, Europeand Central Asia, and the Middle East andNorth Africa, but are below 9 percent in LatinAmerica and the Caribbean, South Asia, andSub-Saharan Africa (table 3.8). Between 1990and 2000, secondary completion rates morethan doubled in the Middle East and NorthAfrica, East Asia and the Pacific, and LatinAmerica and the Caribbean, but remain low. Incontrast, improvements have been much lessmarked in South Asia and Sub-Saharan Africa,and no appreciable gain was apparent in Eu-rope and Central Asia. By income grouping, thestrongest gain in the secondary completion rateis reported by the lower-middle-income coun-tries with an increase of 1.4 percentage pointsduring 1990–2000, compared with half asmuch or less of an improvement among otherincome groupings.

This same general pattern is observed fortertiary-level students. In East Asia and thePacific, South Asia, and Sub-Saharan Africa,2.5 percent or less of the population aged15 years or older has completed tertiary edu-cation. Europe and Central Asia and LatinAmerica and the Caribbean have almost doublethe number of tertiary-level graduates, whilethe Middle East and North Africa falls in be-tween these two groups of regions (table 3.8).The share of secondary graduates who go onto tertiary studies is relatively high in LatinAmerica and the Caribbean, 60 percent, com-pared with 70 percent in high-income coun-tries. However, the share of university students following a scientific as opposed to asocial science curriculum is relatively low(Maloney 2006). Elsewhere, the ratio is 42 per-cent or lower, with only 18 percent of sec-ondary graduates going on to the tertiary levelin East Asia and the Pacific.

This performance in educational attainmentacross levels of schooling is largely consistentwith patterns of public expenditures dedicatedto education. For example, public expenditures

on education among lower-middle-incomecountries averaged about 3.3 percent ofGDP during the 1970s and 1980s and roseto a fairly steady 4.3 percent during 1990through 2000 (figure 3.16). Among low-income countries, the share of public outlaysrose by about half a percentage point to anaverage of 3.3 percent of GDP during1990–2000, up from an average of 2.9 percentduring 1980 through 1985. These sharescompare with government expenditures oneducation of close to 5.3 percent of GDP inhigh-income countries, down from a peak ofjust over 5.6 percent during the mid-1970s.34

While educational attainment rates and ex-penditure data are available for a fairly widenumber of countries, the data are silent on thequality of the education (or knowledge) re-ceived, and it is the quality of education thatdetermines the effectiveness with which indi-viduals can absorb and exploit technology.Here significant concerns have been raised,particularly for poorer countries where thequality of educators and limited resources sapthe value of time spent in school. This suggeststhat the education deficits in developing re-gions could be larger than indicated by na-tional indicators, which, in turn, implies thatthe expansion of knowledge attained (and thecapacity to adopt and adapt technological


137

Figure 3.16 Educational expenditures haverisen in some regions

Public expenditures as a percent of GDP

Sources: UNESCO Institute of Statistics; World Bank.

1970 1975 1980 1985 1990 1995 20002.0

3.0

4.0

6.0

5.5

5.0

2.5

3.5

4.5


Low-incomecountries



knowledge) is not necessarily rising in accor-dance with higher educational attainment.The availability of international test scoresacross countries is very limited outside ofhigh-incomes countries, but some data under-score these concerns. For example, in a num-ber of middle-income countries, the majorityof primary school students fail to meet OECDliteracy standards. In Sub-Saharan Africa, de-spite enrollment rates of close to 100 percent,in some countries fewer than half of grade sixstudents are deemed literate (figure 3.17).Although based primarily on data from high-income countries, research suggests thatteacher quality is a key determinant of differ-ences in student outcomes (Hanushek andWoessmann 2007).

Financing innovative firmsSo far, the discussion has described how the pol-icy environment and human capital can pro-mote technology diffusion. At the same time,and as indicated in chapter 2, affordability, bothat the level of the firm and of the consumer, canbe a major impediment to the diffusion of tech-nology within a country. In this regard, the suc-cess with which an economy’s financial systemsucceeds in channeling resources (savings)

toward their most productive use (investments)is an important determinant of its technologicaladaptive capacity.

Limited financial intermediation restrictstechnology diffusion Neither the banking system, nor equity mar-kets, nor private sector bond markets in devel-oping countries have channeled savings intothe private sector to the same extent as theyhave in high-income countries (table 3.10). Asa result, the arm’s-length channels throughwhich private savings can be directed towardinnovative firms are limited. While banks inhigh-income countries play a significant role inrelaying private savings to investors (private-sector debt is equivalent to some 50 percent ofGDP in high-income countries), this kind of in-termediation occurs at about half that level inmiddle-income countries and almost not at allin low-income countries. On a more encourag-ing note, the run-up in international investors’appetite for risk has increased market capital-ization in developing countries by significantmargins since 2000 (with the exception of EastAsia, where valuations declined). Valuationratios are now much closer to those observedin high-income countries.


138

Figure 3.17 Many developing country students fail to meet literacy standards

Source: World Bank 2007d.

0

20

10

100

Percent Percent

50

40

30

80

70

60

90

Turkey Argentina Colombia Morocco

Fourth grade reading performance on OECD test Sixth grade reading performance on South Africanregional test

0

20

10

100

50

40

30

80

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60

90

South Africa Uganda Namibia Malawi

Percent ever enrolled Percent enrolled and achieved minimal literacy

Barriers to the finance of high-riskactivities severely impede the spread of technology Although weak intermediation is a generalproblem in developing countries, the problemfor innovative firms or companies seeking toemploy an untested new-to-the-market tech-nique or product is more severe. Innovationcan involve high risk, and traditional sourcesof capital—banks, stock exchanges, andbond markets—often lack the technical exper-tise to evaluate innovative investments. Thusin the absence of demonstrated cash flowsor enforceable collateral, innovative firms or

entrepreneurs are less likely to obtain financ-ing than experienced entrepreneurs operatingwith proven techniques. Coupled with thinmarkets, this translates into higher capitalcosts for innovative firms in developing coun-tries than for those in high-income countries, afact that is reflected in lower R&D intensities(Lederman and Maloney 2006) and a reducedlikelihood that their financing needs are met.35

Innovative firms in developing countriesare also less likely to have access to equityfinancing than do their counterparts in high-income countries because of strict listingrequirements imposed by the regulators of


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Table 3.10 Weak financial intermediation hinders technology in developing countries

% change % change 1990 2000 2005 2005/1990 1990 2000 2005 2005/1990

Financial system deposits Stock market capitalization

(% GDP) (% GDP)RegionsEast Asia and the Pacific 40.9 41.7 45.6 11.5 38.7 44.1 51.3 32.5Europe and Central Asia 23.8 22.8 31.2 31.0 8.5 13.8 19.7 130.8Latin America and

the Caribbean 31.1 39.9 39.8 28.1 11.7 28.2 46.4 298.3Middle East and

North Africa 46.5 47.4 59.8 28.7 16.0 26.1 63.8 298.3South Asia 22.5 33.3 43.7 94.0 6.7 13.4 26.1 290.0Sub-Saharan Africa 18.5 19.9 24.4 31.4 31.0 27.0 34.9 12.4

Income groupsHigh-income countries 76.0 87.0 91.4 20.4 45.1 105.0 112.2 148.7Upper-middle-income countries 34.3 43.6 45.2 31.8 37.7 36.5 50.2 33.4Lower-middle-income countries 36.0 34.3 39.4 9.7 13.4 20.4 34.3 156.7Low-income countries 16.7 17.4 21.8 30.7 7.6 10.8 22.3 194.7

Private-sector credit Private-sector debt

(% GDP) (% GDP)RegionsEast Asia and the Pacific 30.3 36.7 44.9 48.2 — 37.5 31.0 ..Europe and Central Asia 22.3 18.2 27.9 25.3 — 12.7 12.2 .Latin America and

the Caribbean 28.6 40.6 32.1 12.3 — 27.2 23.3 ..Middle East and

North Africa 35.3 40.5 46.1 30.7 — — — ..South Asia 16.2 21.6 34.1 110.4 — 1.9 4.0 ..Sub-Saharan Africa 17.4 16.3 18.2 4.4 — 20.1 30.2 ..

Income groupsHigh-income countries 81.1 94.2 108.2 33.3 — 47.9 50.0 ..Upper-middle-income countries 32.8 42.5 40.5 23.6 — 27.5 26.1 ..Lower-middle-income countries 27.3 29.3 31.9 16.7 — 27.7 23.4 ..Low-income countries 14.9 13.4 16.4 9.7 — 1.9 4.0 ..

Source: Beck, Demirgüç-Kunt, and Levine 2000. Financial Structure Dataset updated March 20, 2007. For Private Sector Debt the source is World Bank, Financial Sector Development Indicators. http://www.financial-indicators.org (February 2007).Note: — � not available; .. � undefined.

emerging-market exchanges36 (Pfeil 2000).Less stringently regulated, so-called new mar-kets, modeled after the NASDAQ in the UnitedStates, have been developed to fill the void.Many of these markets help investors by pro-viding some, albeit less rigorous, due diligenceof listed firms and by offering risk-poolingservices (offerings of bundled shares that reduceinvestors’ exposure to any one firm). Such cap-ital pool companies allow listing firms to accessequity finance in amounts that are too large forangel investors to provide, but are too small forinstitutional investors. However, the fullpromise of such markets has yet to be felt, inpart because many of them have been obliged tomaintain relatively strict listing requirements toattract foreign investors (Yoo 2007).

Increasingly, venture capitalists and “busi-ness angels” are playing a role in financingnew technologically sophisticated firms indeveloping economies.37 These investors tendto have more technological know-how thando traditional lenders and to be better able tojudge the potential profitability of new ven-tures. Often the transfer of business and mar-keting expertise is as important as the infusionof capital in determining the difference be-tween success and failure for young firms(Avnimelech and Teubal 2004; Mayer 2003).Even though empirical evidence is still scarce,this activity appears to be translating intoincreased innovation (Pfeil 2000). Western-based venture capitalists are increasingly be-coming involved in markets in Asia (Chinaand India), Eastern Europe (notably the CzechRepublic, Hungary, and Russia), and SouthAfrica. Notwithstanding this increased activ-ity, Nastas (2007) reports that only 1 in 200small and medium enterprises in emergingmarkets is likely to secure venture capital fi-nancing, and the ratio is undoubtedly lowerfor firms in less-developed countries.

Supporting innovative firms with R&D and outreachWhile the process of technological advanceoccurs fundamentally at the firm level,the government, along with international

and national organizations, includingnongovernmental ones, can play a role in pro-moting the dissemination of knowledgewithin the domestic economy. In addition tothe formal education system, less formalcontinuing education—notably, outreach pro-grams and R&D programs that focus onadapting technologies to local conditions—have a central role to play.

R&D efforts to adapt existing technologyto local conditions are expandingDomestic R&D capacity is critical indetermining an economy’s capacity both togenerate new technologies and to absorb tech-nologies from abroad. Foreign technologiesfrequently need to be modified so that they aresuitable for domestic circumstances. For ex-ample, equipment and processes may need tobe adapted to differences in the quality of in-puts and in the relative abundance of laborand capital, and a stock of researchers is oftennecessary to understand and evaluate ad-vanced technology (Cohen and Levinthal1989). Building up R&D capacity facilitatesthe imitation and adaption of foreign tech-nologies and improves the extent to which pos-itive spillovers from FDI and trade accrue tothe rest of the economy (Fagerberg 1988; Ki-noshita 2000). Moreover, countries tend to ac-quire technology more readily when domesticfirms have R&D programs and when publicresearch laboratories and universities have rel-atively close ties to industry (Maskus 2000).

Available data indicate that most develop-ing regions have been increasing their R&Dexpenditures relative to GDP (table 3.11).38

East Asia and the Pacific has experienced aparticularly rapid rate of increase in R&D ex-penditures and also has the highest level ofsuch expenditures among those regions forwhich data are available. In contrast withother regions, in Latin America and theCaribbean, both the number of researchersand expenditures on R&D have been fallingor stagnant, reflecting both a reorientation ofpolicy away from university-led R&D (Mal-oney 2006) and tighter fiscal policies.


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While developing countries spend less onR&D than high-income countries, the gap isnot extreme. Relative to GDP, low-incomecountries spend about one-third as much onR&D than high-income countries. One issuewith the data is that the coverage of commer-cial R&D expenditures is poor in manydeveloping countries, so the figures largely re-flect R&D expenditures by the public sectorand universities. As firms in many developingcountries probably focus on adapting foreigntechnology to local conditions, a significantportion of this important activity may there-fore not be captured.

Firm-level R&D is most effective in promoting technological progress All R&D can contribute to an economy’s ca-pacity to create, adapt, and adopt technology.Nevertheless, because of the fundamental rolethat firms play in diffusing technologythrough the economy, the most productiveR&D tends to be that conducted by firms orby public or university laboratories workingactively with the private sector. Across devel-oping countries, the share of R&D conductedby firms (as opposed to government oruniversity laboratories) is highest in East Asiaand the Pacific, where it rivals the share in


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Table 3.11 R&D intensities have increased

R&D expenditure Researchers in R&D

1997–2002 2002 1997–2002 2002

Regions (% point change) (% of GDP) (% change) (per million people)East Asia and the Pacific 0.45 1.06 4.4 545.3Europe and Central Asia 0.06 0.88 –1.4 2008.7Latin America and the Caribbean 0.01 0.57 — —Middle East and North Africa — — — —South Asia 0.13 0.77 — —Sub-Saharan Africa — — — —

Income groupsWorld 0.12 2.18 — —High-income countries 0.12 2.43 2.6 3750.0Upper-middle-income countries 0.09 0.71 — —Lower-middle-income countries 0.46 1.01 3.9 499.9Low-income countries 0.18 0.80 — —

Source: World Development Indicators.Note:* Interpolation applied where appropriate; — � not available.

Table 3.12 Private-public sector R&D

Sector of performance Sector of funding

Higher HigherR&D spending Business Government education Business Government education

(% GDP) (share of total) (share of total)World 2.28High-income countries 2.45 63 13 27 49 34 2.1Developing countries 0.83 — —

East Asia and the Pacific 1.44 62 22 14 54 35 2.3Europe and Central Asia 0.94 43 29 20 38 54 0.5Latin America and

the Caribbean 0.56 29 27 33 33 37 27Middle East and North Africa — — — — — — —South Asia 0.73 — — — — — —Sub-Saharan Africa — — — — — — —

Source: Gill and Karas 2007.Note: — � not available.

high-income countries (table 3.12). Note,however, that in China, despite rapid techno-logical progress, the efficiency of R&D spend-ing is relatively low and the impact of R&D isimpaired because of poor linkages among gov-ernment R&D institutes, businesses, and uni-versities (Zeng and Wang 2007). In Europeand Central Asia and in Latin America and theCaribbean, academia and the government areresponsible for a much higher share of R&D.Moreover, in the latter region coordinationbetween R&D carried out by government in-stitutions and private firms has been poor,reducing the impact of R&D on productivitygrowth (de Ferranti and others 2003).

Research on OECD countries suggests thatthe more R&D is conducted at the firm level,the higher the rate of return to public and aca-demic R&D, presumably because having R&Dexpertise close to the firm increases the likeli-hood of successful adaptation of a technologycreated in government, academic, or even for-eign laboratories (Guellec and Pottelsberge dela Potterie 2004). Maloney (2006) concludesthat state-funded R&D that is too academicand/or too disconnected from the private sec-tor is less effective at promoting technologicalprogress than firm-conducted R&D or state-supported R&D that has a strong connectionto business needs. Indeed, the relatively highshare of private sector R&D in East Asia andSouth Asia may have contributed to the morerapid technological progress in those regionsthan in Latin America and the Caribbean andEurope and Central Asia.

Outreach plays a critical role in bringingtechnology to the broader populationToo often the overall effectiveness of R&Dundertaken by government and specialized re-search institutes is reduced because such orga-nizations are divorced from their eventualclients and their incentives are poorly alignedwith the ultimate dissemination of their inven-tions and adaptations.39 Especially in poorcountries plagued by illiteracy and weak com-munication networks, technology outreachprograms can play a critical role in increasing

the diffusion of often simple but importanttechnologies. Agricultural outreach programswere instrumental to the green revolution,even though it took much longer than initiallyexpected for those programs to bear fruit(World Bank 1998). Difficulties encounteredin other efforts to disseminate technologyinclude a lack of skilled personnel to staffthe outreach program and the need to earn thetrust of the local population. Here challengesinclude minimizing the risks people run intrying a new technology, listening to their ex-periences, and adapting techniques as a conse-quence (World Bank 2007d). Enhancing therole of farmers in agricultural outreach pro-grams and relying more on cooperation be-tween government and the private sector—inthose areas where private benefits fromtechnology transfer can be substantial—mayimprove both the impact and financial sus-tainability of outreach efforts.

Direct government policies topromote technologyInnovation requires entrepreneurs: peoplewho are willing to take risks to invest in un-certain projects and who have the organiza-tional skills required to bring new products tothe market. Given the high risks involved, thereturns to successful entrepreneurship mustbe high, but the returns to investment in newtechnology in developing countries can be lim-ited, because potential profits may be reducedby imitation, because of a lack of coordinationbetween firms that produce complementaryinputs, or because economies of scale and ag-glomeration generate threshold effects thatprevent firms from breaking into mature mar-kets (box 3.6).

Government policy can play a central rolein helping firms overcome market failuresThe difficulties that these externalities pose forfirms in certain sectors and those seeking toadopt a new-to-market (or even new-to-the-firm) technology imply that specificgovernment interventions may be necessary toencourage investment in technology.


142

Governments in developing countries have un-dertaken a host of direct interventions inproductive activities to provide demonstrationeffects, encourage innovation that otherwisewould not occur because imitators reap thelion’s share of benefits, resolve coordinationfailures, and move an industry toward efficient

technologies that it would not otherwise adoptbecause of capital market imperfections. Thesesteps have included the following:

• Providing support for industry-specificresearch. For example, Malaysiafunded industry-specific R&D, provided


143

The nonpatentability of new-to-the-market prod-ucts and processes. The vast majority of innova-

tion that occurs in developing countries involves theadaptation of already discovered techniques andproducts to the domestic market, and such innova-tion is not patentable. Lack of patent protectionfacilitates imitation, which may speed diffusion, butreduces the returns to the individual or firm intro-ducing the technique or product to the domesticmarket. As a result, private entrepreneurs under-invest in easily reproduced techniques, even thoughthey could have large social benefits.

Coordination failures limit investment in technol-ogy. Some technologies rely on the availability ofcomplementary inputs. Coordination failures canarise when new industries exhibit scale economiesand some of the inputs require geographical proxim-ity. For example, producing cut flowers for exportrequires an adequate electrical grid, irrigation, logis-tics and transport networks, quarantine and otherpublic health measures, and resources devoted tomarketing the country as a dependable supplier(Rodrik 2004). However, these services have highfixed costs and will not be supplied unless demand issufficient, creating a vicious circle where demand isnot forthcoming because of the lack of supply. Themarket for training is another example of potentialcoordination failure, as workers will demand train-ing only if a demand for trained workers exists, butin the absence of training there is no demand(Rodriguez-Clare 2005). Perhaps reflecting suchfactors, in almost all the successful case studies ofinnovation reported in Chandra (2006), governmentplayed an important role by providing infrastructure,marketing, or training support.

Threshold effects caused by economies of scale inmany manufacturing sectors prevent entry by firmsinto global markets or the introduction of a new

Box 3.6 Principal market failures impedingtechnological progress in developing countries

process in a small market dominated by a preexisting,large-scale competitor. Economies generated fromlearning by doing and the productivity boosts gener-ated by the accumulation of small innovations arerelated impediments that imply that start-ups mustendure an initial period of relatively high costs, whichin the absence of adequate intermediation, may pre-vent them from accumulating sufficient experience orscale to attain adequate levels of profitability. For ex-ample, Arrow (1962) cites evidence that productivityin the production of airframes is a decreasing functionof the total number of airframes of the same type pro-duced previously.

Knowledge spillovers tend to be geographicallybounded within a region where the new economicknowledge is created (Audretsch and Feldman 2004).Audretsch and Feldman (1996) find that the propen-sity of innovative activity to cluster geographicallytends to be greater in industries where new economicknowledge plays a more important role as has oc-curred in, for example, Silicon Valley and Bangalore.Studies also find that access to venture capital in theUnited States is heavily skewed by region (Sorensonand Stuart 2001).

Agglomeration effects, whereby firms benefit fromthe knowledge and human resource spillovers arisingfrom the geographical proximity of firms in the samearea of business, may also prevent developing econ-omy firms from breaking into established markets(Glaeser and others 1992). The absence of such effectsrepresents an important barrier to development inSub-Saharan Africa and in more remote areas ofChina and India, where lack of physical proximityboth raises trading costs and minimizes the potentialfor benefits from interactions with more rapidlygrowing areas.

Source: World Bank.

financing, built infrastructure, and of-fered tax incentives to encourage theprocessing of palm oil (Chandra andKolavalli 2006).40 Governments havealso encouraged innovation by improvingnetworking among enterprises, universi-ties, and government research institutes(Goldman and Ergas 1997). For example,government-funded technology parks inTaiwan, China, encouraged research byproviding high-quality facilities and byfacilitating interactions among scientists.Many governments finance agriculturalresearch and support farmers’ efforts toexploit new technologies.

• Providing direct subsidies for specificproducts. The government started thefirst commercial-scale salmon farming

operation in Chile to demonstrate itsfeasibility (Rodrik 2004). Korea andJapan provided fiscal subsidies to create“national champions” in key sectors(Hoekman, Maskus, and Saggi 2005).Similarly, the Brazilian aircraft andbiofuel sectors (box 3.7), the Indianpharmaceuticals sector, and the SouthAfrican automobile industry were devel-oped using tax incentives, regulatorypolicies that encouraged domestic com-petition, science and technology support,and collaboration with foreign firms(UNCTAD 2003).

• Imposing more dirigiste policies. Somecountries, particularly in East Asia, haveguided production decisions throughinitially high import tariffs, export


144

Brazil launched its National Alcohol Program in1975 to reduce its dependence on crude oil im-

ports and to guarantee the profitability of the sugarindustry by allowing excess sugar production to beconverted into alcohol (ethanol) in special distillerieslocated near sugar mills.

Government support for the initiative has been ex-tensive. Initially it was supported by legislation thatmandated that 24 percent of fuel sold for automobilesmust be in the form of ethanol. This requirement wascomplemented by sponsored research into the produc-tion of, and eventually the subsidization of sales of,cars that ran entirely on ethanol. Moreover, govern-ment credit guarantees and low-interest loans to con-struct the refineries amounted to some 29 percent ofthe overall investment cost of these ventures. At thesame time, the state oil company, Petrobras, wasrequired to make infrastructure investments inethanol distribution and to keep the cost of ethanol toconsumers significantly cheaper than the cost of gaso-line. Overall, the government spent $12.3 billion onthe National Alcohol Program during 1975–98.

During periods of high oil prices the program hasbeen relatively successful, with ethanol-powered carsrepresenting 90 percent of sales between 1983 and

Box 3.7 Government sponsored innovation:Brazilian biofuels

1988. However, as oil prices fell, the technology be-came less attractive and the costs of supporting the in-dustry rose. At the same time, world sugar prices roseand sugar growers shifted their cane to the productionof sugar for export instead of ethanol for the domesticmarket. Ethanol shortages developed and ethanol-powered car sales dropped. As a result, the govern-ment gradually rescinded the program’s incentives andsubsidies, although it still mandated that all gasolinecontain roughly 20 percent ethanol, citing environ-mental benefits to justify the mandate.

The flex-fuel car engine, which was able to run onany combination of ethanol and gasoline, was intro-duced in 2002 and, along with the surge in crude oilprices, led to a revival of ethanol in Brazil. With therecent rise in oil prices, ethanol-based cars are onceagain competitive, and ethanol produced from Brazil-ian sugar can be produced for less than the equivalentquantity of gasoline. Other developing countries areincreasingly interested in adopting the Brazilian tech-nology to reduce their energy dependence and also tosupport their sugar sectors.

Source: Coelho and Goldemberg 2004; World Bank 1994; XavierMarcos 2007.

subsidies, government influence over theallocation of production, and directedcredit programs. The extent to which suchpolicies were necessary to these countries’success has generated some controversy(Hernandez 2004), and the forms ofintervention in high-growth East Asianeconomies were by no means identical.For example, Korea (box 3.8) favored tar-iff protection and constraints on FDI tomaximize technology transfer; Singaporeencouraged FDI; and Hong Kong, China,practiced laissez-faire policies. Neverthe-less, some observers doubt that such in-terventions were pervasive in many of themost successful East Asian economies.

But government efforts at promotingtechnological champions have often failedNotwithstanding the wide range of supportpolicies that governments have tried and theexistence of many apparent success stories,such policies have often been spectacular fail-ures. Even among the examples cited, it is notclear that all should be considered successes.For example, the Brazilian aircraft maker

Embraer did not become commercially suc-cessful until it was privatized. More generally,the import-substitution policies followed bymany countries in Latin America and Africaand India’s inward-focused policies severelyhampered economic and technological devel-opment. To take two of the countless exam-ples, first, rather than promoting the develop-ment of a technologically sophisticated exportindustry, the tariffs, price harmonization, andimport licensing programs imposed in Côted’Ivoire diminished incentives for efficiency inits textile industry, making it internationallyuncompetitive. Second, Brazil’s attempts topromote its domestic personal computer sec-tor by banning imports and FDI, awarding li-censes for production, providing fiscal incen-tives, and establishing a public research centerresulted in an inefficient industry, high domes-tic prices, and lagging technology (WorldBank 1998).

Two important issues distinguish industrialpolicies in the successful East Asian countrieswith those in many other countries. First, incontrast to Latin America, where subsidieswere often provided free of performance


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GDP per capita in Korea increased from $150 in1960 to $16,000 in 2005, with GDP growing

particularly rapidly during the 1980s and early1990s as technological progress accelerated. Althoughan outcome of many factors, Korea’s technologicallyintensive growth spurt had a strong public policyelement. Government-funded research institutes, in-cluding the Korea Science and Engineering Founda-tion in the 1970s, recognized the need to enhance co-operative research between universities and industry(80 percent of the nation’s research capability wasuniversity based in the 1970s). The government cre-ated research centers located within corporations tosupply industry with high-tech research capabilityand industry dictated the focus and area of research.

Box 3.8 A successful government program oftechnological development and innovation financing in the Republic of Korea

With time, industry realized that domestically-developed technology could be internationally compet-itive and began investing heavily. As a result, Koreanindustry transformed itself from a low-tech, labor-intensive exporter to one of the world's leading high-tech producers. Private sector expenditures on R&Dhave increased rapidly since 1990—almost doublingover the past decade—and are now the main source ofR&D financing. Nanotechnology, informationtechnology, and biotechnology are the main axes ofthe government’s focus on R&D at the generationstage.

Source: World Bank.

criteria, East Asian countries conditionedsubsidies on performance (often export per-formance), essentially relying on externalcompetition to discipline the market.41 Sec-ond, East Asian countries maintained high-quality bureaucracies that for the most partavoided capture by industrial interests, therebymaintaining a balance between knowledgeand involvement in productive activities andstate autonomy. In Latin America, industrial-ists often captured bureaucracies, while inmany Sub-Saharan African countries, the in-terests of industrialists or corrupt officialsdominated government interventions.

Imitation opportunities may boosttechnological diffusion, but have costsThe possibility of adopting technologiesalready elaborated in more technologicallyadvanced economies represents a fundamentaladvantage of less-advanced developingeconomies and is the basis for much of theirR&D and outreach activity. Indeed, many de-veloping countries with relatively advancedlevels of technological achievement (Brazil,China, India, the Republic of Korea, Mexico,and Malaysia), as well as Japan, initially usedan explicit policy of copying foreign technolo-gies. While this strategy proved successful to apoint, eventually the successes that theseeconomies had in the markets of their higher-technology competitors meant that thesecompetitor countries became increasinglyunwilling to share technology with them.

A substantial literature attempts to grapplewith the trade-off between the impact ofweaker intellectual property regimes and thepotential for increased technological diffusionin a host country and with the impacts thatsuch regimes might have on foreign partners’willingness to undertake FDI and licensingagreements. Although the theoretical litera-ture emphasizes the importance of intellectualproperty regimes (Lai 1998; Taylor 1994), theempirical evidence is ambiguous overall.

Some studies find no relationship betweenthe level of intellectual property rights andFDI or licensing (Primo Braga and Fink 2000;

Branstetter, Fisman, and Foley 2005; Maskusand Konan 1994). Other studies show a posi-tive effect of strong intellectual propertyregimes on FDI both in influencing locationdecisions by multinational corporations andin inducing foreign firms to invest in produc-tion rather than in distribution activities(Javorcik 2004; Lee and Mansfield 1996;Mansfield 1994; Maskus 1998).42 Some evi-dence suggests that while a stronger intellec-tual property rights regime is associated witha rise in flows of knowledge to affiliates and ininward FDI toward middle-income and largedeveloping countries, this is not the case forpoor countries (Fink 2005; Hoekman,Maskus, and Saggi 2005; Smith 2001).

Overall, the impact of intellectual propertyrights on FDI depends on the nature of thesector. Intellectual property rights appear tohave little impact on investment in lower-technology goods, such as textiles and ap-parel; services sectors, such as distribution andhotels; or in sectors where the sophisticationof the technology itself or the cost of produc-tion already serves as an effective barrier toentry. Indeed, the increased ease with whichsome products such as pharmaceuticals, chemi-cals, food additives, and software are reproduced


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Figure 3.18 Levels of intellectual propertyprotection

Index

Source: World Bank calculations based on individual countrydata provided by Walter Park, American University.

Note: A higher score on the index indicates strongerintellectual property rights.

1970 1975 1980 1985 1990 1995 2000 20051

2

3

4

5


Low-incomecountries



may explain the rising interest in establishing in-tellectual property rights (Maskus 2000).

Perhaps reflecting such considerations, ageneral trend toward strengthening the legalprotection afforded by intellectual propertyrights has been apparent since the latter half ofthe 1980s (figure 3.18). Among developingcountries, the legal basis for such rights hasprogressed most in upper-middle-incomecountries, where levels of protection now ex-ceed the levels in high-income countries in themid-1990s. Progress in lower-middle-incomeand low-income countries has been lessmarked, reaching about the same level as inhigh-income countries in the 1990s and 1970srespectively (note, however, that the index infigure 3.18 refers to the protection offered instatutes, not in practice).

Governments can also promotetechnological progress in their ownoperations . . .In many developing countries the governmentaccounts for a significant share of productiveactivities. Using technology to increase the pro-ductivity of government operations can helpraise the efficiency of the economy as a wholeby improving health and education services(see chapter 2 and the foregoing discussion ofhuman capital); enhancing the effectivenessand reducing the costs of publicly-providedpower, telecommunications, and water andsanitation; providing approaches to regulationand tax administration that are less burden-some to firms; and demonstrating the feasibil-ity of new technology that firms can copy. Onearea where dramatic efficiency gains are possi-ble is greater use of technology in governmentprocurement. Countries that have imple-mented Internet-based procurement systemsinclude Brazil (including in some local govern-ments), Chile, Mexico, and the Philippines.43

Implementing e-procurement systems may re-quire changes in laws and policies governinggovernment operations (for example, ensuringthat government agencies can contract withforeign firms that can provide such systems.Although procurement is often a focus of

corruption and is frequently biased in favor oflocal products (most developing countries pro-vide preferential treatment to local suppliers ingovernment procurement [Kohr 2007]), theuse of advanced communications and informa-tion technologies can raise the transparencyand efficiency of government procurementand can ensure greater competition, therebycontributing to an overall improvement in thequality of government services.

More broadly, the integration of informa-tion and communications technology toolshas tremendous potential for improving accessto government information, increasing publicparticipation in government decision making,and making government services more readilyavailable to the public (World Bank Informa-tion for Development Program and Center forDemocracy and Technology 2002). In addi-tion to enhancing government efficiency, suchimprovements can help reduce costs and im-prove services to private sector firms, therebyincreasing the potential for technologicalprogress. While many industrial countrieshave used the Internet to improve local accessto information and services, its potential re-mains largely unexploited in many developingcountries. Nevertheless, some developingcountries are implementing e-government sys-tems that are as or more sophisticated thanthose used in some high-income countries(United Nations 2003). Also, the use ofelectronic systems has helped improve the effi-ciency of customs services in many countries.

A survey of case studies in developingcountries outlines some initial steps in use ofthe Internet to improve tax administrationand general services and to enhance the trans-parency and efficiency of government opera-tions (Ndou 2004). The survey underlines theimportance for the success of e-governmentinitiatives of appropriate stocktaking of thecurrent state of telecommunications networks;of raising awareness of the potential for, in-formation and communications technologybeginning with relatively small projects to testfeasibility; of stimulating collaboration amonggovernment departments; and of making


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substantial investments in equipment and soft-ware, human capital, and appropriate organi-zational changes. Other important issues perti-nent to implementing e-government systemsinclude its coverage (comprehensive, nationalefforts may be appropriate for small countries,but may be too complex and difficult in largecountries); the ability of the enabling environ-ment to support e-government initiatives, forinstance, adequate infrastructure, an appro-priate legal framework, political commitment,and public involvement; and the availability ofstrong project management skills (Bhatnagarand Deane 2002).

. . . and encourage improved technologythrough product standardsGovernments can play a key role in boostingtechnological progress by defining and pro-moting standards for products made by pri-vate firms and by facilitating quality controlto help firms comply with standards. Goodstandards support technological progress byincreasing consistency and ensuring minimumproduct performance; facilitating the connec-tion of components in complex systems bystandardizing the interfaces between differentparts of the system; offering buyers a greaterchoice of suppliers at lower risk and lowercost and the prospect of faster and morereliable system development; and offeringmanufacturers and vendors easier entry tomarkets, economies of scale, and lower prod-uct liability risks (Yokota and Weiland 2004).The transmission of information about stan-dards can be an extremely useful channel fortechnology transfer. Implementing well-definedstandards, including testing and sanctions fornoncompliance, can be critical in maintaininga country’s reputation for quality, which is im-portant for establishing and maintaining ac-cess to global markets.

The value of a country’s reputation, the ben-efits of coordination, and the protection ofhealth and safety underline the government’srole in promoting and enforcing standards,even in competitive product markets, but thegovernment’s specific role will depend on the

product and the market structure involved.Standards may be defined by private firms withdominant market shares or agreed on througha collaborative process negotiated within thecontext of professional organizations. Theymay also be imposed by government regula-tion, or they may derive from some combina-tion of collaboration and imposition. Partici-pation in international organizations can helpdeveloping countries understand and influ-ence international standards. The Interna-tional Organization for Standardization, with132 developing country members, is a forumfor agreement on technical specifications for avariety of products.44

Coherent policies and committedgovernment leadership are critical fortechnological progress No single blueprint for technological progressexists, but most success stories have involvedstrong central leadership to ensure a consis-tent and effective policy framework that sup-ports the development and commercializationof innovations. Technological progress islargely implemented by private firms. How-ever, progress at the firm level requires gov-ernment support, elements of which includethe following: an appropriate incentivesframework, including overall political andeconomic stability and government trans-parency, along with specific technology poli-cies such as protection of intellectual propertyrights; investments in human capital, includ-ing general education and technical trainingwhere firms underinvest in training because ofthe potential mobility of trained staff; supportfor R&D of new-to-the-market technologiesbecause of difficulties in appropriating the fullbenefits from such efforts; and, where appro-priate, government interventions to overcomemarket failures involving coordination,threshold effects, and agglomeration effects(box 3.6). Most technological success stories,including Germany in the 19th century, Japanbefore and after World War II, the EastAsian miracle countries, Chile, Ireland, andIsrael have involved strong national leadership


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and a coherent strategy for promotingtechnology.

An overall index of technologicalabsorptive capacityFigure 3.19 summarizes countries’ level oftechnological absorptive capacity andchanges over the past 10 years. The overallindex was generated following the samemethodology used to construct the index oftechnological achievement discussed in chapter2 and the index of exposure to external tech-nologies discussed earlier in this chapter. Aswas the case for technological achievement, a

two-step procedure was followed. The firststep was to estimate a separate summaryindex of the quality of the macroeconomicenvironment, financial market intermedia-tion, human capital, and governance. Thetechnical annex to chapter 2 describesthe estimation process used and the results ofthe principal components analysis in moredetail than provided here and table A2.2summarizes the individual indicators thatwent into the index.

The most important determinants of theoverall index are the governance variables(with a 37 percent weight), followed byhuman capital variables (with a 25 percent


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Figure 3.19 Level of and recent changes in technological absorptive capacity

Technological absorptive capacity

Source: World Bank.

0

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weight), and financial intermediation (with a27 percent weight), followed by the macro-economic environment (with an 11 percentweight).

Compared with the technological achieve-ment index, technological absorptive capacityis more clearly correlated with income, withless of an overlap across countries in differentincome groups. This probably results from thecomplex causal relationship that may exist be-tween technological absorptive capacity, tech-nology, and income, in which technology is afunction of technological absorptive capacityand affordability, income is a function of tech-nology, and affordability is a function of in-come, with income being both an indirectcause and an effect of technological absorptivecapacity.

Reflecting the complexity of the institu-tions that generate technological absorptivecapacity and the difficulties of reformingsome of the measures included in the index(see technical annex to chapter 2), progresshas been more limited than was the case fortechnological achievement (where the indexincreased by 160 percent for low-incomecountries). Relatively few countries improvedtheir overall score for absorptive capacity bymore than 10 percent between 1990 and2000 (the strongest negative score in low-income countries was recorded by Zimbabweand reflects mainly the deterioration inmacroeconomic and governance conditionsthere in recent years). Moreover, in contrastto technological achievement, there is littlesign of catch-up. Developing countries areimproving their technological absorptive ca-pacity at about the same rate as high-incomecountries.45

The relatively weak improvements in ab-sorptive capacity notwithstanding, the relativestrength of the technological improvement ob-served to date might be comforting. At thesame time, the relatively weak increases in tech-nological achievement in Latin America andthe Caribbean and in the Middle East andNorth Africa may reflect that technologicalprogress (and TFP growth) in those countries

has reached the limits that can be achievedfrom relatively easy adoption and imitation ofexisting technologies given current levels of ab-sorptive capacity and that further improvementmay require substantial enhancement of ab-sorptive capacity.

Conclusion

Technology diffusion in developing coun-tries depends both on access to foreign

technology (through trade, FDI, internationalmigration, and other networks) and on theability to absorb technology (as determined bythe quality of government policy and institu-tions, the stock of human capital, the efforts atR&D, and the financial system). One implica-tion of the analysis and data presented in thepreceding two chapters is that prospects forfurther technological progress in low- andmiddle-income countries are good. Over thepast 15 years, the main international channelsthrough which technology is transferred haveincreased. Developing countries’ imports ofhigh-tech goods and of capital goods haverisen relative to GDP, and their share in globalhigh-tech export markets has increased. In-flows of FDI have increased sixfold relative todeveloping countries’ output, and opportuni-ties to purchase technology have risen alongwith FDI outflows.

Simultaneously, the absorptive capacity ofdeveloping countries has been increasing, al-beit more slowly. Youth literacy rates are asmuch as 15 percentage points higher than forthe adult population. As a result, the basictechnical literacy of the population has beenincreasing, and it should continue to do so formany decades. The macroeconomic instabilitythat plagued developing countries during the1970s and 1980s has declined, and the busi-ness climate has improved, although not byas much or as uniformly as one might havehoped. Technological achievement shouldcontinue to rise over the medium term as longas these trends continue and assuming thereare no major disruptions to global trade andfinancial systems.


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Of particular note is the speed with whichcommunications technologies are evolvingand diffusing in the developing world. Only27 years after the introduction of cell phonetechnology, mobile phones are being used invirtually every country, and penetration ratesare rising rapidly. Moreover, the range of eco-nomic activities that were once heavily depen-dent on infrastructure and that are now beingconducted using mobile phone technology isimpressive and growing daily. Already mobilephones are bringing banking, remittances, andarm’s-length financial transactions to regionsof the world that until recently were unserved.Given the pace at which things are changing,most developing countries should continueto see a rise in their ability to communicateand process information over the next fewdecades, which should help speed the diffu-sion of other technologies as well.

For middle-income countries, the relativelyrapid technological progress of the past fewyears and the improvements in both opennessand technological adaptive capability suggestthat their level of technological sophisticationshould continue to converge with that of higher-income countries. However, even the most ad-vanced of the middle-income countries will beunable to benefit fully from the new technolo-gies that are expected to become both techni-cally and economically viable over the nextseveral years because of inadequacies in theirinfrastructure (unreliable power or communi-cations systems), insufficient technical literacy,or the absence of a critical mass of scientists andengineers necessary to exploit the technology(box 3.9). For some countries, the relative slow-ness with which technological absorptivecapacity has been advancing could slow thepace of convergence as missing competenciesbecome an increasingly binding constraint onthe absorption of additional technologies.

For low-income countries, the prospects aremore complex. On average, among the low-income countries for which sufficient data areavailable to calculate recent increases intechnological achievement, convergence isoccurring and is doing so more quickly than in

middle-income countries. However, this find-ing reflects rapid progress in a few countriesand more modest performance in many othersthat are only maintaining their ground relativeto high-income countries.

Notwithstanding strong technologicalprogress in some cities and greater openness totechnological flows, the gap between existingcompetencies and those needed to convergewith technological progress in high-incomecountries is immense, especially in rural areas.Moreover, the pace at which absorptive ca-pacity is rising is disappointing. While somecountries have recorded significant increases,on average, developing countries are notcatching up to high-income countries, suggest-ing that the gap in their technology potentialis not closing. As a result, unless substantialsteps are taken to raise basic competenciesand invest in local networks that successfullydisseminate technologies and technologicalcompetencies, many of these countries are notexpected to be able to master anything morethan the simplest of forthcoming technologies(box 3.9).

One bright spot is the relatively rapid dif-fusion of some new technologies in low-income countries. Declining computing costsand prospects for rapid declines in the costof wireless Internet connections may en-hance the efficiency of ongoing economicactivities in low-income countries and mayenable them to leapfrog into more advancedtechnologies (Primo Braga, Daly, and Sareen2003).46 However, successful exploitation ofthese new technologies will require stepped-up investments in human capital and reformsin policy and regulation to provide an ap-propriate incentives structure for invest-ments in information and communicationstechnology.

A rigorous road map for achieving rapidtechnological progress does not exist. Never-theless, the evidence presented in this reportpoints to a number of conclusions, principles,and policy directions that appear likely to pro-mote technological progress and that may beable to guide policy makers. Exactly how


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Arecent report by the Rand Corporation (Silber-glitt and others 2006) examines some 56 emerg-

ing technologies expected to be commercially avail-able by 2020 and evaluates in detail the 16 judged tobe most important on the basis of technical feasibil-ity, marketability, and societal impact. These applica-tions include improvements in health services (tar-geted drug delivery, improved diagnostic and surgicalmethods), in access to information (rural wirelesscommunications, quantum cryptography), and in theenvironmental sustainability of products and services(improved water purification, green manufacturing,hybrid vehicles). It then examines the technical basea country requires to make effective use of each tech-nology and the likelihood that each of 80 representa-tive economies, including both high-income and de-veloping countries from every region in the world,will be able to exploit these technologies by 2020.

While many countries are expected to be able totake advantage of some of the simpler-to-use tech-nologies, a wide range of countries are not expectedto be able to do so because they lack the requiredtechnological infrastructure, because their populationis not sufficiently technically literate, or because acritical mass of scientists and engineers is not present

Box 3.9 Technology in 2020to exploit the technology (see the table). The reportfinds that most high-income countries will be able toadopt and exploit all the technologies effectively. Asecond group of countries, including China, India,Russia, and the countries of Eastern Europe, are foundto have a considerable level of scientific and techno-logical proficiency in specific applications. However,barriers to technology adaptation are likely to limittheir ability to take advantage of the most sophisti-cated network applications. A third group of middle-income countries, which consists of several LatinAmerican countries, Indonesia, South Africa, andTurkey, lacks more prerequisites and is therefore ex-pected to exploit fewer of these technologies. A finalgroup that comprises most of the world’s poorestcountries, including most of the countries of Africa,the Middle East, and Oceania, is projected to makeuse of only the simplest of the new technologies.

This analysis provides a useful snapshot of theprospects for technological progress based on currentdata. However, it does not incorporate the potential fordynamic improvements in technological progress, forexample, through the rapid dissemination of existingnew technologies, which could rapidly improve devel-oping countries’ ability to absorb new technologies.

Technological adaptive capacity may restrict the diffusion of future technologies

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much weight to give to each of these conclu-sions and how they interact depends on spe-cific country circumstances and should be thesubject of future research. These policy direc-tions include the following:

• Openness to external technologiesthrough foreign trade, FDI, diasporas,and other international networks is criti-cal for technological progress for bothlow- and middle-income countries,where most progress occurs through theadoption, adaptation, and assimilationof preexisting but new-to-the-market ornew-to-the-firm technologies.

• The capacity of firms or individuals to usea technology depends critically on thebasic technological literacy of workers andconsumers. The level of technological lit-eracy, in turn, depends on the government’scapacity to deliver a quality education tothe largest number of people possible.

• The preeminent vehicles for the dissemina-tion and diffusion of technology in a mar-ket economy are firms and entrepreneurs.Their success in doing so depends on theirability to undertake and expand new activ-ities. This requires a stable macroeconomicenvironment, together with a regulatoryenvironment that effectively enforcesproperty rights and the rule of law, doesnot excessively restrict firms’ ability to hireand fire, and does not impose excessiveregulatory or financial burdens.

• The capacity of firms or individuals totake advantage of a technology can beconstrained by affordability and by li-quidity, thereby placing a premium on theefficiency with which the financial systemintermediates between savers and bor-rowers both domestically and abroad.

• Given the existence of market failures,the government has a role to play in as-sisting firms to learn how to adapt,adopt, and market new technologies. Inaddition to focusing on R&D in new-to-the-market technologies, applied R&Dagencies need to emphasize outreach,

testing, marketing, and disseminationactivities. The huge rural–urban divide inboth technology and absorptive capacityin many developing countries underlinesthe importance of such activities to in-clusive development.

• The government can also have an impor-tant impact on economic progress by in-tegrating new technology into its ownoperations, including in the provision ofeducation, health, and publicly-providedinfrastructure; in the procurement ofgoods and services; in the provision ofinformation and in fostering public dia-logue; and in the definition of standardsfor commercial products.

• The principal challenge facing many low-income countries is not their access totechnology, but their absorptive capacity,including physical, human, and institu-tional capacity; their limited financialresources; and the extent to which theirsocial and political environments aresupportive of entrepreneurship, invest-ment, and technological progress.

These conclusions highlight the critical roleof the government in establishing the generalconditions that support rapid technologicalprogress, in helping to overcome market fail-ures that constrain innovations by firms, andin providing (and purchasing) high-qualitygoods and services. Countries that haveachieved sustained and rapid technologicalprogress have generally benefited from com-mitted national leadership that follows coher-ent development policies, although the natureof these policies—in particular, the degree ofpublic sector intervention in private markets—has varied enormously.

Notes 1. The econometric evidence is mixed. Harrison

(1994) for Côte d’Ivoire and Haddad, de Melo, andHorton (1996) for Morocco find no statistically signif-icant impact of import penetration on productivity fol-lowing trade liberalization. Nishimizu and Page (1982)for the former Yugoslavia; Tybout, de Melo, andCorbo (1991) for Chile; and Tybout and Westbrook


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(1995) for Mexico find a positive relationship betweenimport penetration and firm efficiency. Grether (1999)and van Wijnbergen and Venables (1993) for Mexico,Earle and Estrin (2001) for Russia, Falk and Dierking(1995) for Poland, Levinsohn (1993) for Turkey, andRoberts (1996) for Colombia find a positive impact ofimport penetration on either industry markups or mea-sured labor productivity.

2. Keller (1998) casts doubt on these results byshowing that the relationship also holds for randomlygenerated import shares, but Lumenga-Neso, Olarreaga,and Schiff (2005) find that imports from countries thatimport from other R&D centers are positively relatedto productivity and that these indirect spillovers are atleast as important as direct spillovers.

3. Lall (2000, 2001) identifies four categories ofproducts: resource-based products; low-tech products,which include textiles and fashion; medium-tech prod-ucts; and high-tech products. According to this classifi-cation, which is defined using SITC 3-digit rev. 2,technological products do not include agriculturalproducts, moderately processed food products, to-bacco products, minerals, construction materials, andenergy products.

4. Available data provide only a rough indication ofthe sophistication of economic activity, because ascer-taining the level of sophistication of the capital goodsimported is not possible. Also some countries may im-port relatively sophisticated capital goods for use in en-clave production (for example, oil and minerals) withlittle spillover into the rest of the economy.

5. Chandra and Kolavalli (2006) cite importantspillover effects from exporting electronics and software.

6. The contradictory evidence from case studiesand econometric studies may be due to the differentimpacts of exports across industries and countries, aswell as difficulties inherent in classifying firms (somestudies classify exporters on the basis of surveys withyes-no answers rather than measuring the volume ofexports) (Keller 2004). Also the argument for tech-nology transfers through exports refers only to someexports—namely, new products or products that haveevolved over time, and export statistics may not cap-ture such subtleties. Firms that export the same prod-uct that is not subject to significant upgrading may notbenefit from spillovers. If some firms improve theirproductivity through exports and some do not, andavailable data do not permit distinguishing betweenthese firms, measuring the extent of productivity im-provements over time may be difficult. For specific ex-amples, see Tybout and Westbrook (1996), who findthat trade liberalization in Mexico benefited exportersbecause of declines in prices of imported inputs, buthad no effect on productivity. Soderbom and Teal

(2000) find that Ghanaian firms with higher technicalefficiency become exporters. Isgut (2001) finds thatexporting firms in Colombia had higher labor produc-tivity than nonexporters three years before entering theexport market, but that afterward there is no differencein the growth of labor productivity of exporters as com-pared with nonexporters. Fafchamps, Zeufack, andEl Hamine (2002) find that in Morocco, more produc-tive firms move into exports. However, after initiatingexports they do not achieve more rapid reductions inproduction costs than nonexporters, although they dolearn to improve product design to suit foreign markets.

7. Following Lall (2001), the nomenclature used isSITC 3-digit, Rev. 2.

8. Costa Rica has emerged as a high-tech platformfor foreign investors and increased its world marketshare of high-tech products from 0.01 to 0.20 percentbetween the mid-1990s and 2002–04.

9. Between 1992 and 2003, developing countriesmade some 2,563 favorable changes to national lawsand regulations relating to FDI. The most frequentchanges concerned FDI promotion and incentives(855), sectoral restrictions (497), operational condi-tions (406), guarantees (304), and corporate regula-tions (153). During the same period, 113 developingcountries became members of the World Trade Orga-nization, which required the elimination of many re-strictions and impediments to FDI, particularly in theservices sector (World Bank 2004a).

10. The world’s largest R&D investors conductedan average of 28 percent of their R&D outside theirhome territory in 2003 (UNCTAD 2005).

11. This section builds on many studies of FDIspillovers that have identified possible channels fortechnology transfers and knowledge spilloversthrough FDI (Görg and Greenaway 2004; Görg andStrobl 2001; Javorcik 2007; Lipsey 2002; Moran2007; Saggi 2002).

12. Javorcik (2004) finds that the TFP of Lithuan-ian firms is positively correlated with the extent of po-tential contacts with multinational customers in down-stream sectors. Blalock and Gertler (forthcoming) andKugler (2006) find strong evidence that vertical supplychains were a channel for technology transfers inColombian and Indonesian manufacturing sectors.Swinnen and others (2006) show that investments byforeign companies in processing and retailing in East-ern Europe have introduced higher standards, which inturn led to significant efficiency gains by suppliers.

13. Javorcik (2007) documents the increased com-petitive pressures from foreign entry in Czech and Lat-vian firms, and the McKinsey Global Institute (2003)cites case studies where competition is a key factor indiffusing FDI-introduced innovations.


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14. Ayyagari and Kosova (2006), using Czech FDIdata for 1994 to 2000, show that spillovers vary sub-stantially across industries. Although service industriesbenefited from huge FDI spillover effects through bothhorizontal and vertical channels, manufacturing indus-tries did not show any significant positive spillover ef-fects from FDI.

15. Belderbos, Capannelli, and Fukao (2000) findthat the proportion of inputs sourced locally by Japan-ese multinationals increases with the number of yearsof operation in a given host country.

16. These data are incomplete, as only 90 of 150developing countries (on average across 1999–2006)reported royalty and license fee payments. The datamay also overstate payments for technology transfer, asdeveloping countries with mineral or oil investmentsabroad may report the payment of substantial royaltiesthat represent fees for extraction rights rather than forthe purchase of technology.

17. Between 1990 and 2000, the number of tertiary-educated emigrants from developing countries thatresided in OECD countries rose from 19.1 million to37.8 million (Docquier and Marfouk 2004).

18. Even though a majority of Argentine doctoralgraduates in the United States prefer to remain in thehost country, most respondents in a survey of high-skilled Argentine diaspora members in Europe, theUnited States, and elsewhere expressed their willing-ness and interest in helping develop science, technol-ogy, and education in their home country (Kuznetsov,Nemirovsky, and Yoguel 2006).

19. Of these technologically sophisticated émigrés,56 percent were born in Asia, with Latin America andthe Caribbean accounting for another 15 percent(Kannankutty and Burrelli 2007).

20. Agrawal, Kapur, and McHale (2007), usingpatent data, find evidence of the influence of the dias-pora in technology transfers to home countries.

21. The Mexican Ministry of Science and Technol-ogy views the presence of 1 million tertiary-educatedMexican migrants in the United States, with an esti-mated 400,000 in managerial positions, as a unique, un-explored opportunity for knowledge transfers(Kuznetsov 2006). Emigrants from China and Indiawere running almost 30 percent of Silicon Valley’s(California) technology businesses by the end of the1990s (Saxenian 2000, 2002). In addition, 25 percent ofall engineering and technology companies started in theUnited States during 1995–2005 had a foreign-born per-son as a key founder (Wadhwa and others 2007).

22. Page and Plaza (2006) argue that technologytransfer by migrants takes place through several chan-nels: (a) licensing agreements between diaspora-ownedor managed firms in host countries and firms in

sending countries, (b) knowledge spillovers when re-turning migrants assume managerial positions in theirhome country, (c) networks of diaspora researchersand scientists performing research directed at the needsof their country of origin, (d) “virtual” return throughextended visits and electronic communication in fieldssuch as medicine and engineering, and (e) return topermanent employment in the country of origin aftergaining work experience in the host country.

23. Estimates suggest that a 10 percent increase inskilled migrant stock in the United States is associatedwith a 4 percent increase in the flow of FDI (in currentdollars) to the home country (Mattoo, Özden, andNeagu 2005).

24. This result is supported by work on high-income countries that shows immigrant ties have beenimportant determinants of U.S and Canadian bilateraltrade (Gould 1994; Head and Ries 1998; Wagner,Head, and Ries 2002).

25. Kuznetsov (2007) argues that diasporas can actas global search networks by leveraging their contex-tual knowledge of their home countries’ economy andinstitutions to identify untapped resources and oppor-tunities, such as research capabilities, availability oftechnical manpower, and business-friendly local gov-ernments.

26. Among members of the Philippines Brain GainNetwork, 35 percent have a master’s degree and 23 per-cent hold a doctorate, while 49 percent of the membersof the South African Network of Skills Abroad have amaster’s degree and another 30 percent have a doctor-ate (Brown 2000).

27. The Taiwanese diaspora and returning migrantswere active conduits for technology transfers. For ex-ample, in 2000, 113 out of 289 companies at the Hin-schu Science-Based Industrial Park in Taiwan, China,were started by U.S.-educated Taiwanese (O’Neil 2003).

28. Countries with strong institutions such asChile, the Republic of Korea, and Scotland have beenable take advantage of their high-skilled diasporas,while others such as Argentina, Armenia, andColombia have not succeeded as well despite havingmany programs (Kuznetsov 2006).

29. Finding a relevant, available indicator of thesize of the diaspora to include in the index proved dif-ficult. The data series used included FDI net inflows,royalties and license fee payments, imports of high-tech goods, imports of capital goods, and imports ofintermediate goods—all as a percent of GDP. Importsof intermediate goods and net FDI inflows have thelargest weight in the calculation, accounting for morethan half the total.

30. The productivity benefits from the adoption ofnew technology are best realized in the context of low


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inflation, stable exchange rates, sustainable governmentfinances, and positive income growth (Pack 2006).

31. Liu and Tybout (1996) and Roberts and Tybout(1997) present data from Chile, Colombia, andMorocco confirming that the entry and exit of firmsmakes an important contribution to productivitygrowth.

32. Data are taken from the World Bank’s DoingBusiness Web site (http://www.doingbusiness.org).

33. See Keller (2004) for a survey of the economicliterature on this topic. Education levels are typicallyimportant in empirical studies of cross-country differ-ences in growth rates and in labor productivity (Chenand Dahlman 2004), but these studies do not deter-mine the channel through which human capital con-tributes to growth.

34. In some countries, the limited rise in public ex-penditures on education may have been balanced by in-creases in private expenditures.

35. Ayyagari, Demirgüç-Kunt, and Maksimovic(2007) find a positive correlation between financialmarket depth (proxied by credit to the private sector asa percent of GDP) and R&D intensities.

36. These requirements are generally imposed toreduce volatility in these often thin markets and tobolster investor confidence in the safety of investingin listed firms. While they enable some well-established firms to access global capital markets byproviding the exchanges with legitimacy, they excludemore speculative firms less well. Similarly, the use ofAmerican deposit receipts, which make investing inemerging-market firms easier for foreign investors, islargely restricted to large, well-established, andmainly export-oriented firms (Claessens andSchumkler 2007).

37. The OECD (2005) defines venture capital “ascapital provided by firms who invest alongside man-agement in young companies that are not quoted onthe stock market. The objective is high return from theinvestment. Value is created by the young company inpartnership with the venture capitalist’s money andprofessional expertise.” The flow of venture capitalfrom the investor to a start-up company and back canbe thought of as a cycle that runs through severalphases. The International Finance Corporation moni-tors about 90 venture capital funds active in develop-ing countries.

38. Internationally comparable data have beenavailable only since 1997.

39. See the discussion from the World BankGlobal Forum on Science, Technology, and Innovation,February 13–15, 2007, in Washington, DC. http://go.worldbank.org/DWODQ7E3E0.

40. Note that an OECD (2003) study found thatfiscal incentives to support R&D in rich countries were

not very effective on average, with success being heav-ily dependent on the design of the tax measures.

41. Such programs are more difficult to implementtoday in light of World Trade Organization restrictionson export subsidies (Rodrik 2004).

42. The intellectual property regime is only oneconsideration among many, including various localmarket and sector characteristics, that enter into multi-national corporations’ decisions on how to deploytechnology internationally (Mansfield 1994, 1995).

43. See World Resources Institute Digital Dividend(http://www.digitaldividend.org) and the WorkingGroup on E-Government in the Developing World(http://www.pacificcouncil.org/pdfs/e-gov.paper.f.pdf).

44. See http://www.iso.org.45. There is a slightly inverted U shape to the dis-

tribution of improvements in technological absorptivecapacity, with high-income countries recording a9.1 percent improvement, compared with 9.4 percentfor upper-middle-income countries, 9.8 percent forlower-middle-income countries, and 8.6 percentamong those low-income countries for which data areavailable.

46. The development of simple, low-cost computersand the spread of open-source technology has alreadyenhanced the affordability of new technologies forlow-income countries.

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