WIR05 focuses on the internationalization of research and development (R&D) by TNCs. This is not a new phenomenon. When expanding internationally, firms have always needed to adapt technologies locally to sell successfully in host countries. In many cases, some internationalization of R&D has been necessary to accomplish this. However, it was traditionally the case that R&D was reserved for the home countries of the TNCs. By contrast, now a number of new features are emerging in the internationalization process. In particular, for the first time, TNCs are setting up R&D facilities outside developed countries that go beyond adaptation for local markets; increasingly, in some developing and South-East European and CIS countries, TNCs’ R&D is targeting global markets and is integrated into the core innovation efforts of TNCs.

Innovative activity is essential for economic growth and development. Moreover, sustainable economic development requires more than simply “opening up” and waiting for new technologies to flow in. It demands continuous technological effort by domestic enterprises, along with supportive government policies. With the increasing knowledgeintensity of production, the need to develop technological capabilities is growing. Greater openness to trade and capital flows does not reduce the imperative of local technological effort. On the contrary, liberalization, and the open market environment associated with it, have made it necessary for firms — be they large or small, in developed or developing countries — to acquire the technological and innovative capabilities needed to become or stay competitive.

Global R&D expenditure has grown rapidly over the past decade to reach some $677 billion in 2002. It is highly concentrated. The top ten countries by such expenditure, led by the United States, account for more than four-fifths of the world total. Only two developing countries (China and the Republic of Korea) feature among the top ten. However, the share of developed countries fell from 97% in 1991 to 91% in 2002, while that of developing Asia rose from 2% to 6%. Similarly, there has been a rise in innovation outputs (as measured by the number of patents issued). For example, between the two time periods of 1991-1993 and 2001-2003, the share of foreign patent applications from developing countries, South-East Europe and the CIS to the United States Patent and Trademark Office, jumped from 7% to 17%.

The share of host developing countries in the global R&D systems of TNCs is rising, but unevenly. Only a few economies have attracted the bulk of the R&D activity. Developing Asia is the most dynamic recipient. In the case of R&D expenditures by majority-owned foreign affiliates of United States TNCs, for example, the share of developing Asia soared from 3% in 1994 to 10% in 2002. The increase was particularly noticeable for China, Singapore, Hong Kong (China) and Malaysia. In the foreign R&D activities of Swedish TNCs the share of countries outside the Triad more than doubled, from 2.5% in 1995 to 7% in 2003. Survey findings and other data for Germany and Japan support the growing importance of developing countries and some economies in transition as locations for TNCs’ R&D.

The R&D conducted in different locations varies considerably by region and economy. For example, in 2002, three-quarters of the R&D of United States majority-owned foreign affiliates in developing Asia were related to computers and electronic products, while in India over threequarters of their R&D expenditure went into services (notably related to software development). In Brazil and Mexico, chemicals and transport equipment together accounted for over half of all R&D by United States foreign affiliates.

The need to adapt products and processes to key host-country markets has always been an important motive for TNCs to internationalize R&D. The need to tap into knowledge centres abroad to source new technologies, recruit the best skills and monitor the activities of competitors is also well known in the literature. However, the recent surge of R&D by TNCs in selected developing host economies also reflects the quest for cost reduction and for accessing expanding pools of talent in these locations. It can be seen as a logical next step in the globalization of TNC production networks. It also resembles the international restructuring that has taken place in export-oriented manufacturing and ICT-based services through which TNCs seek to improve their competitiveness by exploiting the strengths of different locations.

The creation of knowledge is a driver of economic growth, but no single country can produce all the knowledge needed to stay competitive and to grow in a sustained manner. Countries are therefore eager to connect with international networks of innovation. Outward and inward FDI in R&D are two ways of doing so. R&D internationalization opens up new opportunities for developing countries to access technology, build highvalue-added products and services, develop new skills and foster a culture of innovation through spillovers to local firms and institutions. FDI in R&D can help countries strengthen their innovation systems and upgrade industrially and technologically, enabling them to perform more demanding functions, handle more advanced equipment and make more complex products.

Enterprises are the principal agents of innovation. However, they do not innovate and learn in isolation, but in interaction with competitors, suppliers and clients, with public research institutions, universities and other knowledge-creating bodies like standards and metrology institutes. The nature of these interactions, in turn, is shaped by the surrounding institutional framework. The complex web within which innovation occurs is commonly referred to as the “national innovation system”. Its strength can be influenced by government intervention.

Policy-making at the national level also has to consider developments in international investment agreements at various levels. Many international agreements give special attention to investment in R&D activities. Key issues relate to the entry and establishment of R&D-related FDI, the treatment of R&D performance requirements (whether by restricting or explicitly permitting them), incentives encouraging investment in R&D activities, and the movement of key personnel.