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Study Notes

Economic Growth - Innovation

AQA, Edexcel, OCR, IB

Last updated 22 Mar 2021

Innovation is about putting a new idea or approach into action. Innovation is commonly described as 'the commercially successful exploitation of ideas

We can make a distinction between:

  • Process innovation: This relates to improvements in production processes, the more efficient use of scarce resources - leading to better productive efficiency and a rise in productivity
  • Product innovation: This is the emergence of new products which satisfy our needs and wants - leading to improvements in the dynamic efficiency of markets

Innovation is a stimulus to long-run growth because:

  1. It is a catalyst for investment which helps to shift out the production possibility frontier (PPF)
  2. It is a spur to productivity growth because of its impact on technological progress
  3. Innovation also creates a demand for new products from consumers for example in industries where existing products are nearing the end of their product life-cycle
  4. Effective innovation can establish a unique selling proposition (“USP") for a product – something which the customer is prepared to pay more for. This helps businesses move up the value chain

Social Benefits from Innovation

  • There are positive externalities from technology spill-over effects arising from innovation for example in the pharmaceutical industry where new drugs improve the quality of life and increase life expectancy and also improvements in car manufacture that reduce the risk of injury from accidents.
  • Innovation in low or zero carbon fuels have positive environmental spill overs

Competition and Innovation in Markets

  • William Baumol in The Free-Market Innovation Machine" stressed that businesses use innovation as a 'prime competitive weapon'.
  • Baumol believed that a competitive oligopoly was the best form of market structure to stimulate high levels of research and innovation
  • However, firms do not wish to risk too much innovation, because it is costly, and can be made obsolete by rival innovation.
  • Firms have responded by buying and selling technology licenses and participation in technology-sharing joint ventures with other firms that can pay huge dividends to the economy as a whole.

What are some of the key drivers of innovation in different countries?

  1. Recession (necessity can be seen as the mother of invention)
  2. Tax credits for R&D and lower corporation tax – many countries have chosen this approach
  3. Creative clusters / special economic zones designed to exploit external scale economies
  4. Open Global Trade and Investment – a key driver of innovation for many economists
  5. Migration of skilled and talented workers into businesses / countries
  6. Investment in science & technology sectors (human capital is strongly linked to innovation)
  7. Protection of Intellectual Property so that returns from innovation can be commercialised
  8. Horizontal co-operation between businesses including joint ventures in innovative projects

The public (government) sector and innovation – the Entrepreneurial State

Many people assume encouraging private sector businesses and markets is the most important pathway to increasing rates of innovation.

But this argument can be questioned when one considers the key role that government can play in supporting research that eventually generates significant innovations.

A book “The Entrepreneurial State: Debunking Public vs Private Sector Myths" by economist Mariana Mazzucato argues that the state can often be a more important driver of innovation than the market mechanism.

For example, the US National Science Foundation funded the algorithm that drove Google's search engine and all the technologies which make the iPhone 'smart' are also state-funded including the internet, wireless networks, the global positioning system and touch screen displays.

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