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Ways for the Government to Promote Technical Innovation with the Help of Market Mechanism

Jul 28,2015

By Lv Wei, Department of Techno-Economic Research of DRC

Research Report No 136, 2014 (Total 4635)

The 18th CPC National Congress put forward the innovation-driven development strategy. Transformation from element and investment-driven development to innovation-driven development is the transformation of development motivation in nature and it urgently requires changes related to economic systems and mechanism and governance modes. The 3rd Plenary Session of the 18th CPC Central Committee proposed "perfecting the market-oriented mechanism for technical innovation and giving play to the guiding role of market in R&D direction, route selection, element price and allocation of various innovation elements". In the market economy, the government can work on market mechanisms via policy and regulations to guide social resources into innovation.

I. Combining Government Policies with Market Mechanisms to Channel Social Resources to Innovation

Here are some cases about how the government of market economy countries influencing the market mechanism via policy and regulations to promote industrial technical innovation.

Case 1: Relaxing price control in targeted fields and reducing and exempting taxes to promote technical progress in shale gas exploration and development in the United States

At the end of the world oil crisis in the 1970s, the US government kept the domestic natural gas price under control, crippling the initiative of natural gas producers in exploring new mining areas and causing the output to plunge. In order to address the imbalanced natural gas supply and demand and ease oil supply shortage, the US government promulgated several laws and policies to encourage the development of unconventional natural gas. For instance, it promulgated the Natural Gas Policy Act in1978 to abolish the control over natural gas price and consequently the market-based pricing mechanism was gradually shaped. In 1980, it enacted the Crude Oil Windfall Profit Tax Act to initiate long-term tax reduction and exemption for unconventional energy development and the unconventional gas drilled from 1980 to 1992 could enjoy tax reduction or exemption equivalent to USD3 per barrel oil. Later, the government expanded the scope of tax reduction and exemption for unconventional energy through several rounds of legislation and maintained the similar tax policy for alternative energy. The policies improved the market competitiveness of unconventional natural gas, boosted the initiative of US energy enterprises in developing the gas, drove enterprises to make continuous innovation in key technologies and processes and reduced the development cost. After long-term efforts, breakthrough was made in technologies of shale gas exploration and development. Since 2003, shale gas output of the United States has kept rising by over 60% annually on average and reached 86.7 billion cubic meters in 2009. More than 60 companies are now engaged in shale gas development, including some magnates such as Shell and ExxonMobil and a large number of independent small and medium-sized enterprises.1

Case 2: Adopting policies including feed-in tariff and degressive fixed feed-in tariff to encourage PV power generation and promote PV technological advancement in Germany

In 1991, Germany passed the Electricity Feed Law, clarifying the three principles for PV power generation: compulsive grid connection, complete purchase and fixed feed-in tariff. It was regulated in the Renewable Energy Sources Act issued in January 2000 that power grid companies shall purchase PV generated power entirely for a term of 20 years. Solar power suppliers enjoy a fixed feed-in tariff throughout the term. Feed-in tariff of power generated by newly built PV stations decreases by 5% year by year and the difference between solar feed-in tariff and the average tariff is shared by consumers of the entire power grid. The original feed-in tariff of PV power generation was DEM0.99/kWh, which was four to five times the average feed-in tariff at that time. The policy not only addressed the grid connection problem troubling power generation with renewable energy, but also ensured stable and reasonable investment return for PV power generation investors during different periods of time.

In 2004 and 2008, respectively, the German government amended and supplemented the Renewable Energy Sources Act. It lowered the feed-in tariff for PV power generation, increased the annual tariff decrease margin, adopted different tariffs for different forms of solar power generation and encouraged consumers to develop distributed generation. In 2008, the solar feed-in tariff in Germany dropped to EUR0.33-0.43/kWh. 2It not only maintained the stimulus to the German PV market, but also promoted manufacturers of PV power generation equipment to keep improving technologies and reducing generation cost. The construction cost of PV power stations in Germany dropped from EUR5/kW in 2006 to USD1/kW in 2012.3

Case 3: Regularly adjusting emission standards to promote progress in energy conservation and emission reduction of the auto industry in Europe

EU countries adopt the same exhaust emission standard for cars in order to restrict environment pollution caused by car exhaust emission. The standards in Europe were updated almost every four years and EURO Ⅰ emission standards, EURO Ⅱ, EURO Ⅲ, EURO Ⅳ and EURO Ⅴ were put into effect in 1992, 1996, 2000, 2005 and 2009 respectively. In February 2014, EU passed another act, requiring average carbon dioxide emission for 95% of the new cars sold within EU below 95g/km. Since EU regularly raises the emission standards for cars, auto companies have to make massive investment in technological progress, reduce pollution and cost by improving car structure and performance and explore new energy cars in order to win in the competition.

Case 4: Formulating standards and timetable for technical upgrading to promote technology application and industrial development of digital television in the United States

To promote the development of the information superhighway, in 1992, the Clinton administration regarded digital television with rosy market prospect as an important part of the telecom industry in the United States. First, it passed the Telecommunications Act of 1996 and identified the timetable for establishing and implementing digital television standards. Federal Communications Commission (FCC) was responsible for making related plans, publicizing the timetable of replacing the analog TV system with digital TV system, funding plans and projects on channel installation and allocation, formulating preferential policies for TV stations, manufacturers and users, offering related parties a period of time to prepare for the technical conversion and launch the pilot programs in public broadcasting stations. To this end, the federal government formulated supportive policies such as relaxing access control, granting financial support and developing the TV content industry to restrict monopoly, promote competition and dissolve market risks for system conversion. The measures greatly drove forward the development of digital TV in the United States. 4Digital TV ground broadcasting (DTV) was first used in November 1998 and by June 2009, the United States had closed transmission of all analog television signals and converted them all into digital television signals.5

II. Inspirations and Suggestions

The above cases show that it's not true that the government can do nothing to allow the market to play its role in allocation of innovation resources; instead, it can guide allocation by adjusting the benefit mechanism through making rules and regulations and policies. For example, in environmental protection, energy safety and some other fields under strong external influence, the market mechanism won't automatically drive innovation. The government tends to make rules and regulations and policies to internalize the external cost and benefit before the market plays its guiding role to channel more social sources towards innovation.

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1Zhang Yuchi. Taxation Incentive Policies on Unconventional Natural Gas ——Experience and Inspirations of the United States. Lin Boqiang. Inspirations of US Experience to Shale Gas Development in China. www.chinavalue.net. August 5, 2011.

2Subsidy Policies of Germany on the Solar Photovoltaic Industry. www.solar001.com. November 25, 2012.

3Speech entitled "Experience and Policy of Germany in Photovoltaic Power Generation" given by Martin Schpe, Director of Department of Energy, International Environmental Affairs and Renewable Energy with the Federal Ministry for the Environment, Nature Conservation and Nuclear Safety in the "2013 PV Summit". guangfu.bjx.com.cn.

4Zhao Ming. Digital Television Development in the United States and its Inspirations. www.people.com.cn. April 11, 2007.

5US Accelerates Making of Next-generation Digital TV Standards and China Gets Engaged in Competition. tech.sina.com.cn. October 21, 2013.