Innovation, Performance and Policy in the Norwegian Defence Industry

Micro-drones from the Norwegian company Prox Dynamics are now to be used in Afghanistan.  Photo by Prox.

A research project funded by the Research Council of Norway FORFI programme investigates innovation patterns and performance of companies in the Norwegian defence industry, and how these are shaped and supported by innovation and defence industrial policies.

By Fulvio Castellacci, Professor, Norwegian Institute of International Affairs (NUPI) and TIK Centre, University of Oslo

The INNDEF project

The INNDEF project builds upon a collaboration between the Norwegian research institutes NUPI, NIFU and FFI over the period 2010-2013.

The project, which will be completed during the spring 2013, carries out an investigation of the Norwegian defence industry, with a special focus on the innovativeness and economic performance of the companies operating in this market, and how these are shaped by innovation policy support, on the one hand, and defence industrial policy, on the other.

Innovation and performance of defence companies

The starting point of the project is the remarkable economic performance that Norwegian defence companies have recently experienced. In particular, Norwegian export of defence products has quadrupled over the last ten years. What can explain this notable performance, and to what extent is it related to innovation capabilities and public policy support?

The first paper of this project [1] carries out an empirical analysis of the factors explaining the export performance of Norwegian defence firms.

The analysis makes use of two complementary methodologies: the first is based on quantitative firm-level data analysis for the whole population of defence companies in Norway, whereas the second is based on qualitative case study research on the three most important defence export products (weapon stations, ammunition, electronics).

The empirical results highlight the importance of four major success factors for Norwegian exporting firms: (1) the participation in public offset agreements; (2) the ability to focus on their set of core competencies; (3) their R&D activities and interactions with the public S&T system; (4) demand opportunities and, relatedly, user-producer interactions.

Defense-civilian spillovers

While export performance is an important dimension of corporate performance – and a key objective of innovation policy makers – another relevant dimension that has so far received limited attention refers to so-called dual use and defence-civilian spillovers.

Due to the close interaction between defence and civilian production, particularly in technologically advanced products and markets, innovative activities in the defence industry are likely to spill over and benefit technological activities in civilian sectors.

The second study of this project [2] carries out an empirical analysis of this neglected dimension. The work makes use of an extensive dataset of Norwegian patent inventions and citations, and analyses the factors that are related to, and may contribute to increase further, knowledge exchanges between military and civilian productions.

The study, still in progress, indicates that patents that are created by firms with high technological capabilities are more likely to benefit innovative activities in civilian sectors. This would imply that R&D policy support targeted at Norwegian defence firms will also turn out to benefit, at least to some extent, the innovativeness and competitiveness of civilian sectors.

EU liberalization and the changing policy regime

Given the remarkable performance of the Norwegian defence industry, and its relevance in terms of national security and defence policy objectives, should Norwegian public authorities continue to provide active innovation policy support to the private companies operating in this industry?

This is the question investigated in the second part of the project. Answering this question requires an analysis of two important facts and recent developments.

Policy support

First, Norwegian defence companies have so far received active policy support, primarily from two different public sources: the Norwegian Ministry of Defence and Innovation Norway.

It is important to study to what extent the approach and instruments adopted by these public organizations are compatible and complementary to each other, or whether a higher degree of coordination among them could be achieved in the future.

EU Directive

Secondly, a new EU Directive (Defense and Security Procurement Directive 2009/81/EC) intends to liberalize the European defense market, in the attempt to increase international trade across European countries, and make the defence market more open, transparent and competitive than it has been the case so far.

The future scenario of market liberalization presents new opportunities and challenges for defence companies. It is then vital for national and EU public authorities to understand how private firms are responding to the liberalization scenario.

Simulation model

The third project paper [3] presents a stylized model of the European defence industry that tries to address these issues. It is an agent-based simulation model resembling some of the key characteristics of the defence sector, and studying how firms in this market are responding to the opportunities provided by a higher degree of openness and liberalization in the future.

The simulation analysis points out that European defence firms, in a dynamic perspective, will progressively become more efficient, less dependent on public procurement and innovation policy support, and more prone to knowledge sharing and inter-firm collaborations.

This firm-level dynamics will on average lead to an increase in the industry’s export performance.

Innovation vs. defence policy

The fourth study [4] makes use of this model to undertake an analysis of the trade-off between innovation and defence industrial policy in Norway. We calibrate our agent-based simulation model to resemble some of the characteristics of the Norwegian defence industry, and to build up different policy scenarios that might realize during the implementation of the new EU Directive in Norway.

The exercise points to two main results.

(1) It finds that a pure scenario where national authorities focus on, and provide support exclusively for international competitiveness or national defence and security objectives, is more Pareto efficient than a corresponding mixed strategy where policy makers simultaneously pursue both international competitiveness and defence and security objectives.

(2) Under the conditions of the new EU liberalization regime, a stronger and more visible trade-off will emerge between international competitiveness and national defence and security objectives. Policy makers will have to choose which to prioritize, and set a clear agenda focusing on one of the two objectives.

Company response to changing policies

Finally, the fifth and conclusive paper of the project [5] investigates how the defense companies are responding to the changing policy regime changes by carrying out a set of interviews with a selected sample of some of the most important defense contractors in Norway and Sweden.

The paper points out two main results.

(1) The defense companies believe that the liberalization of the European defense market will at best be partial and fear that the new regulations might end up favoring the larger nations (e.g. Germany, UK, France) at the expense of the smaller countries (e.g. Norway and Sweden).

(2) The companies’ skepticism and response to the Directive vary according to the defense industrial policy regime they are part of and their position in the defense industrial value-chain.

These empirical results provide relevant indications for Norwegian and EU public authorities: despite the importance of the new EU Directive, its potential benefits will only be realized if private firms will effectively expect and perceive that a full and well-coordinated implementation process is in place.

Conclusions and final workshop

The INNDEF project is currently in its concluding phase, and is organizing a final workshop on “Innovation, Performance and Policy in the Norwegian Defence Industry”, where the five studies produced by the project will be presented in further details and discussed by Norwegian and international experts in the field. The workshop will take place at NUPI (Oslo) on 21^st March 2013 (9.30 am – 3.30 pm). Participation is open, and registration can be done through NUPI website.

Fulvio Castellacci (Foto:NUPI)

Fulvio Castellacci is Head of Department and Senior Research Fellow at the research institute  NUPI.

See also the FORFI-programme of the Research Council of Norway

References

[1] Castellacci, F. and Fevolden, A. (2012): “Capable companies or changing markets? Explaining the export performance of firms in the Norwegian defence industry”, NUPI Working Paper no. 795 [Link].

[2] Castellacci, F., Enger, S. and Maurseth, P. B. (2013): “Do defence products create knowledge spillovers to civilian sectors? Empirical evidence for Norway”, presentation at the final workshop of the INNDEF project, NUPI, 21 March 2013.

[3] Blom, M., Castellacci, F. and Fevolden, A. (2011): “Defence firms facing liberalization: Innovation and export in an agent-based model of the defence industry”, NUPI Working Paper no. 793 [Link].

[4] Blom, M., Castellacci, F. and Fevolden, A. (2012): “The trade-off between Innovation and Defence Industrial Policy: A Simulation Model Analysis of the Norwegian Defence Industry”, Technological Forecasting and Social Change, in press. [Link]

[5] Castellacci, F. Fevolden, A. and Lundmark, M. (2013): “How are Defense Companies Responding to EU Defense and Security Market Liberalization? A Comparative Study of Norway and Sweden”, NUPI Working Paper 2013, forthcoming.