The term policy mix is generally taken to refer to the balance of and interactions among policies. It can refer to the different policy goals pursued by government or the different rationales for policy intervention, but it refers more commonly to the mix of instruments used in pursuit of a particular policy goal, in this case, the promotion of business R&D and innovation. This is the perspective adopted in this policy profile.

Firms are major drivers of innovation but tend to underinvest in R&D. They engage in R&D to differentiate themselves from competitors, to be more successful in business and to increase profits. However, the costs and uncertainty of R&D, the time required to obtain returns on investment, and the possibility that competitors can capture knowledge spillovers – owing to the non-rival and non-excludable nature of R&D – often reduce their incentives to undertake R&D. The funding of innovative entrepreneurship raises further issues, addressed in the policy profile on Financing innovative entrepreneurship.

R&D tax incentives aim to encourage firms to perform R&D by reducing its costs. Compared with direct subsidies, R&D tax incentives allow firms to decide the nature and orientation of their R&D activities, on the assumption that the business sector is best placed to identify research areas that lead to business outcomes. R&D tax incentives are market-friendly instruments that are by nature more neutral than direct support instruments. In addition, direct subsidies under World Trade Organization (and European Commission) rules are subject to ceilings (50% of upstream R&D, 25% of downstream R&D) that do not apply to indirect support, provided the tax relief remains non- discretionary and applies evenly across firms and sectors.

Access to financing is crucial for creating and growing an innovative business, in particular at the seed and early stages. The main sources of finance for start-ups are: the founder’s own funds (plus money from friends and family), bank loans, equity capital (including from business angels and venture capitalists) and government support. It is well documented that young innovative businesses find it difficult to obtain financing. For instance, surveys show that innovative small and medium-sized enterprises (SMEs) in the euro area consider access to finance one of their most pressing problems in the wake of the sovereign debt crisis of 2011 (EC, 2011). The difficulties arise from the high risk of entrepreneurial activities and from information asymmetries between investors and entrepreneurs. New ventures also have capital and human resource constraints, insufficient collateral and lack of a track record. The quality of an innovators’ business plan and their overall readiness for investment often play a determining role in their ability to secure funding.

The process of business entry and exit as well as post-entry firm growth enhance productivity and drive economic growth. New enterprises exert competitive pressure on incumbents and improve resource allocation by forcing less efficient firms out of the market, a process which Schumpeter called creative destruction. This process is especially important during a post-recession phase, as business creation can help renew productivity growth and job creation (OECD, 2010; Criscuolo et al., 2014). New start-ups can exploit knowledge that is not used or is underused by existing companies and draw on existing knowledge to enter new or established markets (Acs et al., 2009). This is especially true in knowledge-intensive sectors.

Industrial policy has many meanings, not all of them specific to manufacturing industry. A broad definition is any type of intervention or government policy that attempts to improve the business environment or to alter the structure of economic activity toward sectors, technologies or tasks that are expected to offer better prospects for economic growth or societal welfare than would occur in the absence of such intervention (Warwick, 2013).

Demand-side innovation policy is often understood as a set of public measures to increase public and private demand for innovations, to improve conditions for their uptake or to improve the articulation of demand in order to spur innovation and facilitate diffusion (Edler, 2007). It usually aims at lowering barriers to the market introduction and diffusion of innovations.