Innovation Policy

In our continuing series of presentations on “New Sources of Economic Growth,” we are thrilled to announce the final topic: “Innovation Policy”. With this topic, we conclude the foundational presentations of the workshop.

Throughout the workshop, we have delved into a diverse array of subjects crucial for comprehending and fostering economic growth. These encompass:

I. The Fundamentals of Economic Growth

II. Strategy and Strategic Foresight

III. Management Strategies and Organizational Dynamics

IV. Economic Complexity

V. Innovation Policy

This topic follows John Van Reenen’s teaching material.

The main questions asked are:

Why should governments intervene?

  • Due to a higher social than private return to innovation.
  • There are multiple market failures. For example, Research and Development (R&D) is (partially) non-excludable. “Public good” nature of knowledge means that those who do R&D only get a small part of the social benefit. There are frictions in other markets, as the requiring financing of large and uncertain research costs under asymmetric information.  
  • Focus on spillovers and their identification. Positive spillovers due to imitation, intertemporal benefits and users with surplus captured by consumers/downstream firms. Negative spillovers due to business stealing, duplicate Research and Development, intertemporal cost including “fishing out” ideas.

How should governments intervene?

  • Innovation policies
    • Demand-Side
      • Taxation
      • Direct R&D grants
    • Supply-Side
      • Human capital (STEM, University, immigration)
      • Other (competition and trade)
  • Diffusion policies

We observed that in advanced economies, TFP has been decreasing during the past two decades, while for developing countries it has, on average, increased. We covered the main determinants of TFP indexes, which includes innovation, education, market efficiency, infrastructure, and institutions, across countries and periods. We reviewed the drivers of aggregate productivity between pushing out the technological frontier and catching up to the frontier either through the diffusion of technology and reducing misallocation.

Based on information from US firms between 1977 and 2012, we saw that most labour productivity growth comes from the within-firm component (between 39 and 77 percent) and the exit component (between 23 and 68 per cent). In contrast, the between component is small or even negative, generally not more than 6 percent of productivity growth. Likewise, entry seems to have only a modest effect on labour productivity growth, accounting for at most 11 percent in 1982–1987.

Which spillover dominates is an empirical issue. Empirical evidence suggests strong role for positive knowledge spillovers. Social return to R&D is > 3 times larger than the private return. Implies large private under-investment. 

Sometimes it is possible to free ride off other countries, but adapting more advanced technologies still requires adaptation capacities. For more technological advanced countries, the free-riding options are more limited.  

R&D knowledge spillovers critical to justification for public policy intervention.

  • Direct effect of R&D on performance hard to measure.
  • Indirect effects even harder!
    • Direct effect is how firm I outcomes (e.g., TFP) depend on firm i inputs (e.g., R&D).
    • Indirect effect is how firm I outcomes on ALL other firm j’s inputs.
    • Serious curse of dimensionality!

Many other econometric issues with identifying peer effects, even if we only had one known peer (cf. Manski, 1993).

Evidence shows the presence of both technology spillovers and product market rivalry effects of R&D. Technology effects dominate, so “too little” R&D overall. Consistent with bulk of empirical work, but what policies can help bridge the gap between social and private returns to R&D?

The Innovation Policy Lightbulb summarizes the demand and supply policies reporting the quantity of evidence, the conclusiveness of this evidence, the net benefit of the policy, the time frame, and the effect of inequality. 

The evidence included in the presentation shows, for demand-side policies, that direct R&D grant increases R&D and innovation in the medium-run, while tax credits have the same effects in the short-run with more effectiveness and therefore a larger net benefit, with both policies increasing income inequality. Meanwhile, patent box does not have a conclusive effect and its net benefit is negative. 

Meanwhile, supply-side policies show that skilled immigration has positive effects with a large net benefit and operating in the short to medium-run and decreases income inequality. University STEM supply is more effective than university incentives, with greater net benefit, but having effects in the long run, and contributing to reduce income inequality. There is medium evidence that exposure policies positively contribute to innovation, with a medium net benefit yielding returns in the long-run and reducing inequalities. There is strong evidence that trade and competition increase innovation with a medium net benefit operating in the medium run but increasing income inequality. In summary, human capital policy acts on the supply side, so it is more attractive than “demand side” tax/subsidy policies. Lower risk of increasing equilibrium costs (and inequality) and some evidence of successful interventions but it has some limitations. For example, Less of an empirical literature than demand side policies, policies will take longer to have an effect and there could be leakage issues.

The presentation summarizes many relevant papers, showing in detail the effects of policies on R&D and innovation, explaining the channels through which the benefits arise.

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