To get an idea of the economic mountain euro zone strugglers Greece and Portugal have to climb, consider this: per million inhabitants, they each filed fewer than eight applications with the European Patent Office in 2010.

Germany, with the advantages of scale that go with a population eight times bigger, lodged 335 patent applications per million residents. But the Czech Republic, of a similar size to Greece and Portugal, managed 16. Much-smaller Ireland boasted 112, according to calculations based on data on the EPO website.

Figures on research and development are a little better.

Greece spends just 0.6 percent of GDP on R&D, the same as in 1999. Portugal's R&D rose to 1.66 percent of GDP in 2009 from 0.69 percent a decade earlier but still lags the OECD average, which rose over the same period to 2.33 percent from 2.16.

Innovation matters because it is a key driver of competitiveness, allowing firms to win greater market share and feeding through into greater productivity.

Patent filings and R&D expenditure are only a rough proxy for a country's innovative capacity, but Peter Droell, head of policy development and industrial innovation at the European Commission, said there was a strikingly strong correlation between R&D spending in the European Union in the period 2004-2009 and economic growth in 2011.

Member states which invested in research and innovation have been stronger in the crisis and are exiting faster, Droell said in London last week at the launch of the conclusions of an EU project on financing innovation and growth.

As such, the figures illustrate the longer-term growth challenges confronting Greece and Portugal: whether they succeed in boosting productivity, now just 65 percent and 77 percent respectively of the European Union average, according to Rabobank, will largely determine whether they close the competitiveness gap with Germany and other stronger euro zone members.

That is the root cause of markets' scepticism about the ability of peripheral euro zone countries to grow quickly enough to sustain their huge debt loads.

DIFFICULTY KEEPING UP

Greece and Portugal are not the only innovation laggards. Worryingly, Italy and Spain both spend less than Portugal on R&D and trail Ireland badly on patent filings, at 67 and 31 per million inhabitants respectively.

True, some experts argue that the effective deployment of technology, in conjunction with policies that promote competition, are far more important for productivity and innovation than R&D spending itself.

Why, they ask, hasn't Europe spawned a company like Google or Facebook or Amazon?

Professor Nicholas Crafts, director of the Research Centre on Competitive Advantage in the Global Economy at the University of Warwick in England, notes that for the typical European country 90 percent of the R&D that contributes to productivity growth is conducted abroad.

Andrew Wyckoff, director of science, technology and industry at the Organisation for Economic Cooperation and Development, an inter-governmental think tank in Paris, agrees that innovation depends on much more than R&D.

It also requires things such as software, human capital, intellectual property and organisational know-how at company level.

Unfortunately, countries on the periphery of the euro zone are also not doing a great job measured according to these intangible assets. As Wyckoff put it: They have difficulty sustaining their efforts in this area.

In a detailed study of the innovation potential in the three euro zone countries that have had to accept an international bailout, Deutsche Bank researchers Antje Stobbe and Peter Pawlicki ranked their prospects in the same order as the bond market does: Ireland scores best, followed by Portugal. Greece brings up the rear.

HEADWINDS

Ireland spends below the EU average on R&D but is well positioned because of its high-tech strengths in information technology, medical technology and pharmaceuticals, buttressed by strong links between companies and academic institutions, Deutsche says.

Innovation in Portugal is stifled by low skills. It is near the top of the league in the number of doctoral graduates, but poor tertiary and secondary education acts as a barrier to the production of high-value goods and services. Employment in knowledge-intensive sectors is far below the EU average.

David Haugh, head of the OECD's Portugal desk, agreed that education shortcomings, though being addressed, were one reason why Portugal had been unable to adapt quickly when traditional industries such as textiles ran into stiff competition from eastern Europe, China and north Africa.

Poorly trained workers find it harder to switch industries and jobs and redirecting the education system could take decades to bear fruit. No wonder that Portugal has logged annual growth of less than 1 percent in the past decade.

Portugal is moving in the right direction, but it's got a lot of things it needs to do on the structural reform side, Haugh said. Some of them will pay off in the short run; in the long run, we see reforms in education as perhaps having the largest payoff.

Unlike Portugal, the environment for innovation in Greece has improved only slightly in recent years, Deutsche said. There are too few innovation and research projects worthy of being funded, and the education system is not imparting the right skills and qualifications.

There is little potential to leverage the development of fast-growing industries with high productivity levels, Stobbe and Pawlicki said.

What is to be done?

Waugh stressed the importance of a supportive business environment and said exposing companies to greater competition would spur them to innovate to stay in business.

His OECD colleague Wyckoff said Europe needed to attain scale by removing the barriers to cross-border collaboration in science and innovation.

Deutsche's researchers highlighted the urgency for companies in traditional industries in Greece and Portugal such as tourism and textiles to embrace a culture of innovation.

In the short run, with the crisis countries desperate for growth, foreign direct investment could play a key role in helping both countries to attract modern technology and management methods.

But to do so the underlying business conditions will have to be overhauled: a comprehensive economic strategy has to include a modernisation of the public sector and the implementation of structural reforms, Stobbe and Pawlicki concluded.

(Editing by Mike Peacock)