Why Latin America invests so little in innovation

In 2018 alone, Amazon, Alphabet, Intel, Microsoft and Apple invested approximately $65 billion in research and development (R&D), a sum that is three times NASA's annual budget of around $20 billion.

Entrepreneurship - and the ability to do so through multi-billion dollar investments in new lines of business - goes a long way towards explaining why the United States is the world's largest R&D spender. But above all, it is evidence that private companies have a greater role than ever in fostering innovation and technological and scientific breakthroughs. In fact, approximately 75% of R&D investment in the US comes from the private sector.

If we look down to Latin America, we can see some green shoots in a field full of shadows and greys. The emergence of technology-based Latin American unicorns reflects that the region is in a sweet spot in terms of entrepreneurship, and that societies and economies are ready to consume certain innovations. But in the region's business park, cases such as Rappi, Mercado Libre or Globant remain atypical, and companies that are not very productive and innovative continue to predominate.

Currently, Latin American countries invest an average of 0.8% of their GDP in R&D, in contrast to 2.8% in the US, 2.5% in the European Union and 2.2% in China. Furthermore, only 8% of Latin American companies invest in R&D. These figures provide a better explanation for the low competitiveness of the region's economies, most of which are made up of MSMEs that do not manage to grow as fast as their peers in the more advanced economies, nor do they manage to generate quality employment or implement technologies that add value.

This situation is closely related to one of Latin America's chronic problems: low productivity. The region is still characterised by too much concentration of production in large, resource-intensive firms and too little competition. The vast majority of the rest of the companies do not have sufficient innovative capacity and, therefore, are not taking advantage of the opportunities of digital transformation or introducing innovative processes in their operations. 

It is a kind of vicious circle. Small companies are small partly because they do not invest in R&D, but at the same time they do not invest because they do not have sufficient resources. To complete the picture, governments often do not provide the necessary incentives for this to happen and sufficient investment for such activities is not forthcoming.

"Innovation will always happen, it is something permanent that happens in all societies. The big difference is in the speed, and this is determined by how much is invested in it. Because of the lack of innovation in Latin America, the competitiveness gap is getting bigger and bigger," says Juan Carlos Elorza, Director of Productivity at CAF. 

According to Elorza, the role of companies has to play a leading role in driving innovation, and governments should promote frameworks that guarantee legality and encourage companies to innovate, for example, through measures such as tax discounts or support for the incorporation of skilled labour. 

"First and foremost, more private investment is needed compared to OECD countries. Moreover, as we mentioned in our report on Latin America's economic outlook, for 1% of GDP invested in R&D, the number of patents is 7 times higher in OECD countries than in Latin America," says Sebastián Nieto Parra, head of Latin America at the OECD Development Centre.

This raises an obvious question: how to incentivise the private sector to invest more in R&D?

For a consistent answer we would need more space than is contained in this article, but as an OECD study indicates, there are several factors that determine the degree of innovation in a country, as well as measures to encourage it from both the public and private perspectives.

The most traditional ones include incentives for companies to invest in innovation, legal environments that facilitate the creation and growth of new companies, the development of financial markets and venture capital that guarantee the financing of companies, the opening up of trade and the reduction of tariff barriers. 

One of the current trends that is generating more innovation is entrepreneurship, probably as a consequence of the media cases coming out of Silicon Valley based mainly on a radical pro-innovation culture. The fact that companies led by young graduates (and undergraduates) changed the world thanks to technological disruption and generated multi-million dollar revenues is evidence that entrepreneurial ecosystems are an important part of the gears of innovation.

"Companies that receive venture capital tend to have higher levels of innovation and higher returns than others, and they also tend to generate more jobs and grow faster. That is why it is so important for countries in the region to create competitive innovation and entrepreneurship ecosystems, because this will attract more investment and generate a virtuous circle," Elorza says.  

Latin America is not yet in a position to compete with innovative ecosystems such as those in the US or China. But technological change and digital transformation are forcing companies in the region to be more dynamic and access international markets not only to improve their turnover, but also to generate and integrate the knowledge and skills needed to prevent the innovation gap from widening.

Robert Valls, Senior Communications Executive at CAF.

Visiones del Desarrollo is a section promoted by CAF -development bank of Latin America- that analyses the main development issues in the region. The articles it contains are published simultaneously in the main Latin American media.