Swedish Thesis Draft

Swedish Innovation Policy
Swedish Innovation Policy

Benjamin Holloway
Hamilton College

Swedish Innovation Policy Holloway 2
Table of Contents

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Acronyms and Abbreviations
BERD Business Expenditure on Research and Development
BRDIS Business Research and Development Innovation Survey
BSA Bank Support Authority Bill
EU European Union
FDI Foreign Direct Investment
GATT General Agreements on Tariffs and Trade
Gazelles High Growth Enterprises
GERD Gross Domestic Expenditure on Research and Development
GDP Gross Domestic Product
HEI Higher Education Institutes
HERD Higher Education Expenditure on Research and Development
HGE High Growth Enterprises
IP Intellectual Property
OECD Organization for Economic Cooperation and Development
R&D Research and Development
SME Small and Medium Sized Enterprises
TFP Total Factor Productivity
VC Venture Capital
WTO World Trade Organization

Introduction

Financial crises have been occurring for as early as the 14
th
century (Encyclopedia
Britannica), but history continues to repeat itself. Financial crises are often seen as black swan
events in that they are unprecedented and unexpected; however, analyses of financial crises
reveal that they are endemic to market-driven globalization and financial liberalization and occur
for largely the same reasons. To exemplify this point, this paper will begin by presenting the
reader with a puzzle. Two separate financial crises will be outlined and the reader will have to
figure out in which countries they occurred. This brief exercise will reveal how closely related
some financial crises can be, despite occurring in different time periods in vastly different
countries.
In 2008, a financial crisis occurred in country Y, which not only crippled the economy of
country Y, but also caused a global economic recession. The deregulation of market sectors,
most notably the financial sector, combined with the invention of new financial instruments such
as Collateralized Debt Obligations lead financial institutions to take a number of unregulated
financial risks. Government policy to lower interests rates to around one percent in years prior to
the crisis allowed for the availability of easy credit to all types of investors, which lead to
financial institutions becoming highly leveraged, as well as discouraging investment in treasury
bills and pushing investors to find returns in other securities. Rapid investment into capital
markets, with real estate being the focal point, caused a real estate asset bubble to form. Falling
asset prices and the eventual burst of this asset bubble combined with high levels of loan defaults
lead to a credit lockup, which not only impacted country Y, but also the global economy.
Government intervention was necessary and billions of dollars have been spent in an effort to
correct for this market failure. Country Y is beginning to slowly recover, but remnants of this
crisis are still present.
Country X also incurred a devastating financial crisis, which crippled their economy.
Despite years of rapid growth in the Post WWII era, the combination of deregulation of key
market sectors, rapid credit expansion, unprecedented increase in asset prices, the creation and
burst of an asset bubble, again caused a major recession to occur in this economy. Similar to
Country Y, the failure of this economy largely hinged on market deregulations and the
availability of credit, which, combined with the burst of a large asset bubble, disrupted capital
markets caused creditors to be unable to repay loans. This financial crisis impacted the economy
and government intervention was necessary. During the time of the crisis Country Xs GDP went
down by five percent and unemployment skyrocketed, causing the worst economic crisis in the
country since the 1930s (Ekonomifakta, 2014).
It is clear that country Y is the US and the financial crisis described is the recent 2008 US
financial crisis; however, the second country is more ambiguous. Country X is the Scandinavian
country of Sweden. In the early 1990s Sweden had a financial crisis that was nearly identical in
structure to the 2008 US financial crisis. The only difference between the two crises has been the
ability of Sweden to recover so effectively from their crisis, while many other countries have
struggled in comparison. Not only was Sweden able to recover effectively, they have
continuously worked to create stability within their country and in turn is ranked as one of the
most stable prosperous, and happiest countries in the world according to many OECD indices.
As financial crises continuously occur around the world, it becomes easy to consider financial
crises isolated events; however, analyzing these crises structural similarities is crucial to better
understanding how to prevent them and how to pursue policies that lead to a swift economic and
social recovery.
Sweden is consistently ranked as one of the best countries in the world to live in and the
OECD better life index ranks Sweden as the fourth best country in the world in terms of overall
life satisfaction (OECD, 2012). Sweden has a robust universal health care system, one of the
lowest poverty rates in Europe (3.7%) (Inequality Watch, 2013) and an excellent work-life
balance (OECD, 2012). Sweden emerged from the 2008 financial crisis relatively unscathed
(Michigan State, 2012), has exceptionally high levels of political transparency and is among the
most socially equal countries in the world (OECD, 2012, p.41). In February 2013, The
Economist published a special report titled: The next supermodel: Politicians from both right and
left could learn from the Nordic countries, which praised the Swedish welfare state and
suggested that other industrialized nations could benefit from adopting Swedens model.
Although Sweden faced a number of issues after their financial crisis in the early 1990s, it is
evident that their mix of fiscal stimulus and government intervention has allowed them
effectively navigate another global financial crisis in 2008, but to regain economic stability in a
short amount of time.
In contrast, most other countries have struggled after the 2008 US recession. For
example, the US has struggled to regain its stature after the financial crisis. Although a direct
comparison cannot be made, as the two countries differ in size and political structure,
questionable policy choice and political gridlock do not bode well for a strong and swift US
recovery. A report from the Congressional Research Service believes that although economic
recovery has been on a positive track since 2009, the pace has been uneven and has slowed
significantly in 2011. The stock market has recovered from its lows, and employment has
increased moderately, but on the other hand, significant economic weakness remain evident,
particularly in the balance sheet of households, the labor market, and the housing sector. The
report also cites additional concerns such as slow pace of GDP growth, a labor market that is
treading water, and tepid consumer spending (Elwell, 2013, p.4).
In their article Is the 2007 US Sub-Prime Financial Crisis So Different? An International
Historical Comparison, Carmen M. Reinhart and Kenneth S. Rogoff examine factors such as
asset prices, real economic growth, and public debt in five countries which have all had financial
crises including Spain (1977), Norway (1987), Finland (1991), Sweden (1991), and Japan
(1992). Reinhart and Rogoff conclude that While each financial crisis no doubt is distinct, they
also share striking similarities in the, run-up of asset prices, in debt accumulation, in growth
patterns, and in current account deficits (Reinhart, Rogoff, 2008, p. 342). This brief examination
of financial crises begs the question: If the 1990 Swedish financial crisis and the 2008 global
financial crisis were so similar, what has Sweden done to recover so successfully? What methods
or policies did Sweden pursue that allowed it to rebound effectively from its financial crisis?
This paper will posit that Swedish government support for innovation is one of the major drivers
of growth and has allowed Sweden to rebound effectively from their financial crisis and to
sustain growth for the past two decades.
This paper seeks to prove the impact of innovation policy on the effective recovery of
Sweden from its financial crisis. The main hypothesis of this paper is that government policy
fostering innovation is crucial to economic and social growth, especially during times of
economic turmoil. In order to best measure how innovative Sweden is this paper will examine a
collection of data from a variety of data aggregators and although it is impossible to provide
quantitative data on exactly how innovation impacts economic growth, this paper will examine
the key linkage that expenditures on R&D in various sectors leads to innovation, which in turn
drives economic growth. It will also examine some of the other tangentially related aspects of
support for innovation and whether or not Sweden has adequately supported these organizations.
This paper will not ignore the impact of monetary and fiscal policies on Swedens economic and
social recovery; however, it will primarily focus on innovation and policies targeted at
innovation as this is what has differentiated Swedens approach to economic recovery and is
what has allowed Sweden to be successful.
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Because of the brevity of this paper, the structure of the analysis will rely mostly on
primary and secondary sources to analyze decisions regarding support for innovation policy and
their outcomes. This paper will begin with a literature review that encompasses a variety of
topics but focuses on multiple aspects of innovation policy and the theoretical concepts behind
how innovation drives growth. The main topics that will be covered are this papers definition of
innovation, the role of government in the development of innovation policy, how R&D drives
innovation, appropriate foundations for innovation, and how innovation impacts economic
growth. After this literature is established, this paper will move to an in depth analysis of the
Swedish financial crisis, first outlining the causes of the crisis and then more importantly the
policy choices that Sweden made in order to recover. The majority of this analysis will focus on
policy choices aimed at fostering innovation and will use data to determine the impact of
whether or not these policies had a tangible impact on the economic and social recovery of
Sweden. This paper will then examine the possibility of adapting the Swedish model to other
countries as well as analyze whether or not innovation policy truly had an impact on Swedens
economic recovery.
Financial crisis are often a consequence of globalization, as globalization leads to
financial liberalization, which can destabilize the economies of developing countries. Due to the
rise in globalization as well as the increasing interconnectedness of the global financial system,
financial crises are no longer limited to the countries they occur in. In 1997, the Asian financial
crisis originated in Thailand; however, it quickly spread to the rest of Asia, having a drastic
impact on a number of countries capital markets (Balaam and Dillford, 2011, p. 181). In 2008,
the US financial crisis would eventually spread to the entire world and led to a global economic
downturn. This paper aims to analyze the Swedish response to financial crises because of
Swedens ability to recover so successfully from the two financial crises they have endured.
While it may be impossible to accurately predict when and where financial crises will occur,
knowledge of what policies are most useful in recovery from financial crises, would be an
extremely powerful for economists and policy makers around the world. This paper aims to
research Sweden and draw conclusions, which could be potentially applied to economic
structures around the world. This paper will now focus on examining relevant literature to
innovation policy and how it impacts innovation, R&D spending, and economic growth.
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The literature review for this paper is comprised of multiple sections, each aimed at
establishing the foundations for the critical analysis of Swedish innovation policy. It will begin
with a brief description of what innovation is and how it will be utilized within the context of this
paper. Next it will address the question of whether or not government intervention is even
necessary in fostering the growth of innovation, and will show that government support is
crucial. This paper will then examine potential policy choices countries can utilize to promote
innovation as well as examine the linkage between R&D and innovation. Next will be a brief
section discussing the creation of an innovative environment within countries. Lastly, this
literature review will briefly examine a few of the common economic theories regarding
innovation and how it can affect economic growth.
In order to better understand the innovation policy choices that Sweden has pursued it is
essential to first establish a usable definition of innovation for this paper. While a broad term like
innovation will be impossible to define completely, this section of the literature review will
briefly examine a few scholarly definitions of innovation and synthesize the definitions into an
applied definition of innovation, which will be referred to for the remainder of this paper. It
should be noted that the terms innovation and technological change will be used interchangeably
unless otherwise noted.
Alfred A. Marcus paper Policy Uncertainty and Technological Innovation views
innovation as the introduction of new practices and methods, as the replacement of similar but
less efficient inputs in the production process (Marcus, 1981, p. 444). The Brookings
Institution, a private nonprofit organization devoted to independent research and innovative
policy solutions, defines innovation as the process of discovering new ideas and realizing those
ideas at large scale, which change the ways we live and work (Greenstone, 2011, p. 2). Perhaps
the most comprehensive definition comes from Charles Edquists Innovation Policy- A
Systematic Approach. Edquist initially defines Innovation Policy as public action that influences
technical change and other kinds of innovations. Innovations are new creations of economic
significance of a material of intangible kind (Edquist, 1997, p. 4). He then later expands on this
definition and states Innovation is a complex phenomenon, embracing both new processes
(technological and organizational) and new products (goods and services)... these processes
concern not only the emergence, diffusion, and combination of knowledge elements, but also the
translation of these into new products and production processes (Edquist, 1997, p. 7). Lastly,
economic researcher Hasan Torun describes innovation as, A complex development of
discoveries and inventions brought into the business sand social environment, successful
innovations are often imitated by other players in the same industry or applied in other
industries (Torun, 2007, p. 9).
From the above definitions, it is evident that innovation has a number of different
interchangeable qualities and distinctions, yet a few characteristics are present in every
definition. This paper defines innovation as both the invention and implementation of new ideas,
products, and services, which improve economic and social efficiency within a society. In order
to measure innovation, this paper will primarily focus on policies that affect the levels of R&D
as R&D and innovation have a causal relationship. It is important to note that this paper will
discuss policies that affect innovation both directly and indirectly, as government policies, which
can foster innovation, may not explicitly state that as the goal. The next paragraph will briefly
discuss the theory behind technological change as cited by the famous economist Josef
Schumpeter.
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The modern theory of the process of technological change can be traced to the ideas
of economist Josef Schumpeter, who saw innovation as the pinnacle of the modern capitalist
system. Schumpeter believed that capitalists, motivated by both profits and market share,
would continually introduce new products into the markets in order to make profits. They would
then enjoy excess profits for some period of time until subsequent successful innovators ousted
them, a continuing process that Schumpeter coined creative destruction. Invention constitutes the
first development of a scientifically or technically new product or process; however, innovation
is only accomplished when the new product or process is commercialized, or made available on
the market. A firm can innovate without ever inventing if it identifies a previously existing
technical idea that was never commercialized and brings a product or process based on that idea
to market. The invention and innovation stages are carried out primarily in private firms through
a process that is broadly characterized as R&D. Finally, a successful innovation gradually comes
to be widely available for use in relevant applications through adoption by firms or individuals, a
process labeled diffusion. The cumulative economic or environmental impact of new technology
results from all three of these stages, which we refer to collectively as the process of
technological change (Schumpeter, 1947). Schumpeters theory of technological change is
crucial to the understanding of why R&D has become an important focus for all profit seeking
organizations. As organizations utilize R&D to create to products and processes, these inventions
can potentially create new markets, spur competition, and allow for greater economic growth.
Schumpeters theory makes it clear that R&D is crucial to innovation and thus growth for private
companies; however, there are times when these companies are unable to innovate and there is
the necessity of government interaction to help foster innovation.
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The discussion of the literature in this section will focus on the necessity of government
action on innovation policy as well outline some of the government policies and institutions that
have already been utilized to spur innovation. Although it is widely debated whether or not
government intervention is necessary in terms of market correcting activities, the literature will
discuss how, without outside intervention, R&D spending and innovation tends to be neglected.
The necessity of government intervention into innovation policy is dependent on a few
factors. The first is that historically in times of crisis, business spending on innovation is one of
the first budget areas to be reduced. In a 2009 OECD report titled Policy Responses to the
Economic Crisis: Investing in Innovation for Long Term Growth, authors Dominique Guellec
and Sacha Wunsch-Vincent note that R&D expenditure and patent filings move in parallel with a
countries GDP, thus if the GDP is up R&D expenditure and patent filings are up and vice versa.
Additionally, corporate reports for the fourth quarter of 2008 in many cases show a decline or
slower growth in R&D spending and reports for 2009 confirm the trend. A recent McKinsey
survey of almost 500 large businesses worldwide indicated that 34 percent expect to spend less
on a R&D in 2009 while 21 percent forecast an increase (OECD, 2012, p. 6). The crisis can
however, magnify the competitive advantage of research-intense firms who seize the opportunity
to reinforce market leadership through increased spending on innovation and R&D during an
economic downturn. Many of todays leading firms such as Microsoft or Nokia were born or
transformed in the creative destruction of economic downturns; however, in order for
companies to seize these opportunities, they either need to be well funded or have enough stored
capital in order to take advantage of the competitive advantage gained while investing heavily
into innovative processes during periods of economic turmoil. This is an area where government
facilitation of innovation policy is crucial. Economic downturns presumably cause companies to
spend stored capital on operations vital to their survival rather than on R&D so government
intervention either to spur research within these companies or to help subsidize their
expenditures is key to allow companies to innovate during times of economic uncertainty.
Another area where government intervention is important in fostering innovation is to
avoid issues rising from asymmetric information, which is a situation in which one party in a
transaction has superior information compared to another. This often happens in transactions
where the seller knows more than the buyer, and in this case it pertains to how the government
has more information than private industry regarding laws and regulations. In Robert Keohanes
After Hegemony, Keohane discusses how asymmetrical information makes some actors hesitant
to act or deal in a specific way if they fear a negative consequence. In his article Policy
Uncertainty an Technological Innovation, Alfred Marcus examines the concept of asymmetrical
information as it pertains to policy uncertainty on business decision-making. Marcus analyzes
how businesses are hesitant to pursue risky avenues of research spending when faced with
opaque government policies. Marcus examines a variety of literature on government policies and
regulations across a number of industries and concludes that without certainty about government
policies, business decision makers are unable to assess risk and opportunity and are unwilling to
invest in R&D to develop new technologies (Marcus, 1981, p. 444). At a basic level any lack of
government transparency with regards to policy making, can impact business decision making
and have harmful effects on the ability of private business to pursue innovation opportunities.
Another proponent of government intervention in innovation policy is Thomas Edquist.
In his Innovation Policy A Systemic Approach Edquist discusses how he believes that there are
reasons to complement or correct the market and capitalist actors through public intervention.
Edquist believes that there are two conditions which must be fulfilled in order for there to be
reason for government intervention. The first is that the market mechanism and capitalist actors
must have failed to achieve the objectives formulated, so in this case, this would mean that
companies are not innovating. The second is that government intervention must be able to solve
the issue to the best of its ability, and in the case of innovation policy, the government can do a
lot in order to promote innovation. Edquist then goes on to discuss the two main categories of
policies that government can pursue to solve issues related to the lack of innovation driven
growth. Edquist cites non-market mechanism such as using regulation instead of altering the
mechanisms of supply and demand. This would include policies such as targeted taxation,
subsidies for various goods such as health or education, and public funding of R&D or tax
incentives for R&D activities. The other option is that by improving the functioning of the
markets, which would include polices aimed at creating markets for goods or increasing or
decreasing competition in the markets via deregulation, IP rights, and patent protection. Edquist
believes that at the core, government policies targeted at innovation are very much a matter of
creating, changing, or getting rid of institutions in the form of rules, laws, etc (Edquist, 2007, p.
4)
Proponents of free markets economies rely on the fact that all actors behave rationally.
This rational behavior drives actors to act in order to maximize their own utility, which drives
competition, and thus a successful free market economy. In theory, businesses should realize the
benefits of R&D and pursue it as a means to benefit their business and even in times of economic
downturn companies should continue to invest as they should understand the profits that can be
made after the economy inevitably recovers; unfortunately this is rarely the case. The economist
John Maynard Keynes founded a theory known as paradox of thrift, which exemplified that fact
that actors can still act rationally and still inhibit growth. From the above literature it is evident
that a combination of imperfect information as well as a market failures stemming from a lack of
R&D spending during economic downturns dissuade business from pursuing aggressive research
spending. The only way to foster R&D and thus innovation are government efforts to promote
such activities because left to their own devices, business will refuse to engage in such spending
activities. Even with ample government support, there are still a number of essential foundations,
which are critical for developing an innovative environment within a country.
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Before R&D spending and innovation can be pursued in order to spur economic growth a
country must provide essential business and macroeconomic foundations in order for these
efforts to be successful. In an OECD report titled, OECD Reviews of Innovation Policy: Sweden,
the report states that categories such as a countrys macroeconomic framework, product and
labor market regulations, and the general business environment, which includes things like
competition, business financing opportunities, entrepreneurship, tax system, and general
infrastructure are all crucial for the potential for innovation within a country (OECD, 2012, p.
86). Macroeconomic framework and general business environment refer to the basic functioning
of a market which includes a currency and exchange rate stability, managed inflation, transparent
and enforceable laws as well as general monetary and fiscal responsibilities (World Bank, 2013).
Business environment considers the overall ease maintaining a business as well as factors
such as availability of capital, strictness of regulation, availability of capital to be loaned or
invested, and a stable infrastructure which includes availability of electric, wifi, and
transportation which are essential to the basic functioning of a business. It cites the significance
of these foundations as three fold: Innovation requires a long time horizon and a stable
environment in which to conduct research. The process of researching and developing a new
product or process can take years, which is why stability is crucial. R&D and innovation are
benefited by a stable macroeconomic environment, which instills confidence that markets will be
relatively unchanged in the medium to long run. Second a consistent and transparent regulatory
framework allows for confidence in long-term investment in research. Lastly, when frameworks
are insufficient they are likely to reduce the effectiveness of policies designed to foster
innovation. In addition to the general framework that was outlined above, there is also the
necessity for policy framework and support for human capital aspects of innovation. People need
to be empowered to innovate and this can be the result of education and training systems should
equip people with the foundations to learn and develop the broad range of skills needed for
innovation (OECD, 2012, p. 86).
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This section will discuss some of the policy actions that governments can take in order to
foster R&D spending and innovation. In the article An Overview of Public Policies to Support
Innovation Jaumotte and Pain analyze the most efficient ways for government policy to act in
order to support innovation and list the five most useful as being fiscal support for R&D,
fostering University-industry linkages, intellectual property rights, availability of capital, and
human resources for science and technology. Regarding fiscal support for R&D, Pain and
Jaumotte define this as public money, which is used to support basic and applied research for
both public and private organizations. These can be applied in the form of direct grants as well as
indirect methods such as tax credits or incentives. University-industry government support for
higher education institutions help develop linkages between basic research undertaken in
universities utilize that knowledge to drive innovation within private companies. The protection
of IP rights is also crucial as Pain and Jaumotte mention that strong intellectual property rights
serve as a reward mechanism and an incentive for investors. The government can play an integral
role in both linking public research institutions with private corporations as well as enacting laws
to protect an inventors intellectual property. Availability of capital encompasses a number of
topics but it centers on the availability of capital from external parties for companies to utilize to
conduct R&D. This includes both the availability of government funding as well as the
availability of funding from other private donors and the overall ease and attractiveness of
investing in a certain country. Lastly, Pain and Jaumotte discuss what they call human resources
for science and technology, which consists of an adequately skilled workforce to work on R&D
projects and to develop new innovations. They find that it is important to have a technically
skilled and knowledgeable labor force; however, they acknowledge that it can take multiple
years to develop a skilled workforce. In attempting to determine the effectiveness of each of the
specific categories, Pain and Jaumotte believe that direct and indirect fiscal support are the most
effective policy changes whereas IP rights and educational linkages to industry are less
significant. They see availability of capital as a necessary government function for innovation,
but does not have a significant impact unless completely absent. While Pain and Jaumotte
emphasize fiscal stimulus in R&D, their analysis of University-industry linkages is brief and at
times contradictory. Pain and Jaumotte downplay the significance of University-industry
linkages, but they are in favor of having a well-educated labor force to drive R&D. What Pain
and Jaumotte fail to address in their article is that government funding to public universities in
utilized in a variety of ways, including strengthening institutions to allow them to provide a
higher level of education to their students. Economist Martin Falks article What Drives Business
R&D Intensity Across OECD Nations, finds clear evidence of the impact between spending on
education and innovation (Falk, 2004, p. 10).
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A majority of the literature so far has discussed how R&D is crucial for innovation, but it
has never fully explained this theory. This section will briefly introduce the theories behind how
R&D is a key driver for innovation. In an article by Coe and Helpman titled International R&D
Spillovers the authors first acknowledge the view that commercially oriented innovation efforts
are a major engine of technological progress and productivity growth (see Romer, 1990;
Grossman and Helpman, 1991). They believe that innovation feeds on knowledge that results
from cumulative R&D experience on the one hand, and it contributes to this stock of knowledge
on the other. Consequently an economys productivity level depends on its cumulative R&D
effort and on its effective stock of knowledge, with the two being inter-related. Coe and
Helpman go further and posit that in a world with international trade in goods and services,
foreign direct investment, and an international exchange of information and dissemination of
knowledge, a countrys productivity depends on its own R&D as well as on the R&D efforts of
its trade partners (Coe and Helpman, 1995, p. 860).
Data from the National Science Foundation's 2008 Business R&D and Innovation Survey
or BRDIS provide a link between R&D and innovation by examining data drawn from a
sampling of countries in the US. The BRDIS data finds that there is the large difference in
innovation incidence when companies with R&D activity are compared to those without any
R&D activity. Companies with R&D exhibit far higher rates of innovation than non-R&D
companies. Around 47,000 of the estimated 1.5 million for-profit companies performed and/or
funded R&D in 2008. According to the survey data, 66 percent of all these companies were
product innovators in the 200608 period, and 51% were process innovators. There is also
indication that the companies with the most R&D (those in the $50$100 million and $100
million or more annual R&D categories) report the highest incidence of innovation: 76 percent
and 81percent, respectively, for products in 200608, and 69 percent and 71 percent for
processes. Companies without any R&D activity dominate the 1.5 million companies (about 97
percent of all companies), but their incidence of innovation is far lower: about seven percent
reported being product innovators in 200608, and about eight percent process innovators
(National Science Foundation). From this study it is clear that there is a definite link between
R&D and innovation. The next section will examine how this R&D spending translates into
innovation and how innovation spurs economic growth.
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Many economists have studied the economic impact that technological change has had on
an economy, but the two most relevant for this paper are Robert Solows exogenous growth
model and Paul Romers endogenous growth model. Robert Solows economic model of long-
run economic growth attempts to explain economic growth by looking at both capital and labor
accumulation (Solow, 1957, p. 314). Although Solow primarily focused his attention on the
process of capital formation and how that would be a primary driver of growth, Solow along
with other economists realized the inevitability of a decline in the marginal product of capital,
which would lead to stagnation within an economy. To remedy this, Solow began to research the
impact of technological change and growth on an economy and Solows model famously
predicted that 85 percent of economic growth derives from technological advancement, rather
than the accumulation of capital and labor. Romers model, which is based on Solows, diverges
from Solows by treating technological change as endogenous rather than exogenous.
Endogenous growth is an economic theory, which argues that economic growth is generated
from within a system as a direct result of internal processes. More specifically, the theory notes
that the enhancement of a nation's human capital will lead to economic growth by developing
new forms of technology and more efficient means of production. Exogenous growth assumes
that external factors rather than internal ones within an economic system primarily determine
economic growth. According to this view, given a fixed amount of labor and static technology,
economic growth will cease at some point, as ongoing production reaches a state of equilibrium
based on internal demand factors (Grossman and Helpman, 1995, p. 861). Romers approach is
that part of the labor force works in the research and development sector, where they develop
and implement new ideas and technologies Those new ideas increase the stock of knowledge and
ideas in economy, which makes the other factors, capital and labor, more productive (Romer,
1991). Although this is a simplified economic model, it is widely accepted as the foundation for
how innovation and technological enhance economic growth.
Grossman and Helpman in their article Endogenous Innovation in the Theory of Growth,
agree with the Solow and Romer in that focusing on advances in technology, rather than
properties of aggregate production and capital accumulation, are a better means of squaring the
production of their models with charting persistent growth. They believed that the Earths
relatively fixed stock of natural resources would impart diminishing returns if the inputs were
forever combined to produce a fixed set of goods by unchanging methods. Grossman and
Helpman then move to discussing the endogeneity of the technological progress and whether or
not innovation is driven by scientific breakthroughs, which would cause it to move at a speed
independent to that of broader economic growth, or whether or not it is driven by private
investment. After aggregating information form a variety of different sources, Grossman and
Helpman conclude that firms invest in new technologies when they have seen opportunities to
generate profits and that a large proportion of the scientific research conducted is financed by
private industry (Grossman and Helpman, 1994, p. 26).
Although most of the literature on innovation impacting economic growth is theoretical,
there have been models and studies designed to translate these theories into qualitative data.
Camerons article Innovation on Economic Growth examines the work of a number of different
economists and attempts to calculate the impact of innovation on total factor productivity. In
economics total factor productivity or TFP is a variable, which accounts for effects in
total output not caused by traditionally measured inputs of labor and capital. If all inputs are
accounted for, then TFP can be taken as a measure of an economys long-term technological
change or technological dynamism. Cameron believes that the economic output of these
variables can be derived in two distinct ways, the first is to use a measure of the stock of R&D
capital in a regression of the level of TFP and the second is to use a measure of R&D intensity in
a regression of the change in TFP. Utilizing the first method, Cameron cites the work of
Griliches whose studies found that there was a strong link between R&D capital stock and outlet,
which was roughly measured as a one percent increase in the R&D capital causing a rise in
output of between .5 percent and .1 percent. Using the second method, Cameron, citing the work
of Mansfield, found that R&D also had an impact of productivity growth, and that investment
into R&D can have a social return between a 20-50 percent (Cameron, 1996, p. 4).
The literature review has defined innovation and the theory of technological change and
explained the necessity of government intervention to support innovation and some of the
various methods in can employ to do so. It then discussed the necessary business and
macroeconomic foundations for innovation as well as how R&D is the most relevant variable to
examine when determining what drives innovation. It then concluded that assuming the presence
of R&D spending and thus innovation, that innovation leads to economic growth. The next
section of this paper will begin with a brief background of Swedish financial crisis and an
overview of what caused the Swedish financial crisis of the 1990s. It will then shift to an
overview of some of the major policy choices Sweden has made as they recovered from their
early financial crisis and how those policies continue to allow them to experience positive
growth.
D$7E9,#-2%

After WWII, the rebuilding of war-torn Europe favored Swedish industry because the
Swedish labor force was intact and Swedish production facilities were undamaged. At the end of
the decade, Sweden saw growth of the national economy in a time of worldwide economic
stagnation. Sweden used what they coined the Swedish model, which constituted a middle way
between unrestricted capitalism and a centrally planned economy in order to create a balanced
domestic economy. In the beginning, the Swedish model, appeared to work very well and
between 1960 and 1965, the economy reached its peak with a yearly GDP growth average of 5.3
percent and a productivity growth average of 5.6 percent per year; however, in the 1980s,
Swedish policymakers initiated deregulation of many market sectors with the intention of
improving the functionality of the Swedish economy. This wave of deregulation would be the
catalyst for the Swedish financial crisis (Ekonomifakta, 2014).
The main deregulatory measure was taken in November 1985, which was when the
quantitative restrictions on the volume of bank lending were abolished. Banks were suddenly
able to lend freely without being hampered by regulatory restrictions. They entered into a fierce
competition for market shares by recklessly offering loans to households and firms. A lending
boom started in 1985-86, channeling cheap credit to asset markets, primarily to the real estate
market. As a result, there was a rapid increase in asset prices, which began the formation of an
asset bubble around the housing market. After a few years of economic growth, the economy
was halted in 1989-90 and turned into a bust as a result of a combination of events. Interest rates
rose internationally and rising interest rates exerted strong upward pressure on Swedish interest
rates. An additional interest rate shock emerged when the Swedish central bank, the Riksbank,
raised nominal interest rates to defend the pegged krona rates against recurring speculative
attacks in 1989-92.
Within a couple of years, after-tax interest rates rose to levels that were much higher than
borrowers had anticipated a few years earlier. This sharp increase in the real interest rate caused
asset price deflation and wealth losses, forcing an adjustment of portfolios, which led to falling
private consumption, falling investments and rising private savings. The harder households and
firms tried to improve their wealth position by selling assets and increasing savings, the deeper
the crisis became. The sell-out of property forced down property prices, which, in turn, triggered
new sales, and the number of bankruptcies increased at a dramatic rate. As the Swedish Krona
was overvalued due to high wage and price inflation during the preceding boom, the export
sector encountered major problems causing unemployment to rise, tax revenues to decline, and
public expenditures to rise due to the workings of automatic stabilizers. Eventually the Swedish
government allowed the krona to float, which caused depreciation and receding domestic interest
rates, halted the downturn of the Swedish economy. Compared to the record of all major crises in
Swedish economic history, the crisis of the 1990s was one of the most costly in terms of output,
industrial production and employment foregone. The crisis undermined the financial system and
threatened the existence of major banks. This forced the government to act, thus laying the
foundations for the Swedish economic recovery (Jonung, 2009, p. 2-4).

F2$86<)<

There are a number of factors that contribute to a countrys ability to innovate. Strong
infrastructure with access to internet, electricity, and transportation, a stable market economy
with incentives for competition and property rights, and government transparency are all crucial
to the innovation within an economy; however, none of these factors are what distinguish
Swedens recovery and sustained success from financial crises. Despite having no R&D
incentives and few tax breaks for innovation, Sweden has the highest level of R&D intensity, a
measure of an economy's relative degree of investment in generating new knowledge, in the
world (Europe.eu, 2009). Sweden also has extremely high levels of both business expenditure on
R&D and higher education spending on R&D, which are indicators of an innovative society
(Trading Economics, 2013). The rest of this paper will examine how the Swedish government
has driven innovation by supporting the development of business, which has lead to high levels
of R&D investment and intensity within businesses, which has then lead to innovation and thus
economic growth. It is impossible to prove exactly how innovation impacts growth; however,
this paper will examine the linkages between R&D, innovation, and Swedens economic
performance and will reveal that innovation is a major component of Swedens economic
recovery. This paper will first analyze the immediate response of the Swedish government,
which was to reinvigorate the financial sector.
The Swedish bank restructuring policy is the foundation for both the economic recovery
of Sweden and for innovation policy as a whole. Financial stability as well as access to lending
are crucial to the formation of businesses and are an important part of the infrastructure that can
contribute to innovation. The first action that Sweden took was to allow the government to
intervene in the financial sector and to assist failing banks. In 1992, the Swedish government
announced a state bank guarantee, which stated that depositors and debtors of Swedish
commercial loans were to be fully protected from any future losses on their claims. The Swedish
government assured debtors that banks and other credit institutions could meet their
commitments on a timely basis. Swedish banks were heavily dependent on foreign financing of
their activities so the purpose of this was to ensure the stability of the payment system and to
safeguard the supply of credit. This stop-gap measure proved highly beneficial, as it expanded
the options for the Swedish Central Bank or Riksbank to support banks regardless of their
financial position. The blanket guarantee had clearly positive effects, as it prevented bank runs
from both international or domestic sources, and it gave the Riksbank the opportunity to more
actively support the failing banks (Englund, 1999, p. 94).
In December 1992, the Swedish parliament passed a Bank Support Authority Bill or
BSA, which created a government backed support group which was aimed at funding the
Swedish banks with as much capital as necessary in order to prevent them from collapse. The
BSA was given an unlimited budget, which signaled a full government support to bank relief
(Jonung, 2009, p. 11). The BSA divided the banks into three categories and provided each
category with a different level of financial assistance. Banks that were likely to recover on their
own were suggested to try and find private investors and utilize the government as sparsely as
possible. Aid was available to these banks, but it was not encouraged. In the second group, the
BSA distributed aid packages aimed at improving the liquidity within the bank and supporting
them in case their capital adequacy ratio fell below nine percent. Banks that were unlikely to
succeed required a large amount of state involvement, which usually resulted in the buyout and
subsequent liquidation of these institutions. In addition to this policy, two organizations,
Securum and Retriva were set up to manage bad debts of failing financial institutions. As the
Swedish government bought up bad debt from failed financial institutions, they would assign it
to one of these two asset managers. These organizations would in turn set a price floor for the
debt, ensuring continued liquidity in the markets (Englund, 1999, p. 17).
Overall the combination of these policies has been highly effective for the swift recovery
of Sweden financial services industry. The announcement of the bank guarantee allowed for
continued foreign support for the banks and prevented any runs on the banks being made. The
BSA provided a blend of support for banks, which conformed to the needs of each specific bank.
At the end of the crisis the state calculated its investments into the economy as 71 billion SEK
with the total cost for the taxpayer being 35 billion SEK or 2.1 percent of the GDP in 1997.
Although it is difficult to measure the effectiveness of Swedish restructuring policy, one of the
greatest indicators of success was the lack of fiscal costs to the Swedish taxpayers. At the end of
the crisis it was anticipated that it would take nearly 15 years for the 35 billion SEK to be repaid;
however, after only four years the burden on the tax payers was repaid in full (Jonung, 2009, p.
15). With the exception of the 2008 financial crisis, Swedish GDP has been growing consistently
since the crisis in the 1990s with an extraordinary growth rate of 5.5% in 2010, only two years
after the most recent crisis (tradingeconomics.com, 2013).
As discussed earlier in this analysis, Swedens immediate action, both during and after its
1990s financial crisis were to reinvigorate the financial sector of its economy. The bailout of the
financial sector was important for the obvious reasons of providing macroeconomic stability for
the economy, but it is also crucial for the formation of new business. Stable financial institutions
act as commercial lenders for most small and medium sized institutions, and the lack of available
capital can prevent the formation of new businesses, which can limit innovation.
Swedens efforts to reform the financial sector have led to Sweden having the fourth
highest success rating (excluding gazelles or HGEs) for obtaining loans out of all OECD
countries. Figure one shows how Sweden ranks as one of the top countries in the OECD in
terms of SMEs success rates of obtaining bank loans.

Gazelles and HGEs are rapidly growing industries, which are defined as companies that
are increasing their revenues by at least twenty percent annually for four years or more
(Investopedia). Most other companies are typically SMEs or small and medium enterprises.
Small business is often thought of as a driver of economic growth, so their ability to easily obtain
financing is a key to innovation. Although Gazelles and HGEs are as successful in obtaining
traditional loans from Swedish banks, they are also aided by the strong venture capital and
business angel environment in Sweden.
Venture Capital or VC is money provided by investors to startup firms and small
businesses with perceived long-term growth potential. Business angels provide the same function
as VC firms with the exception that they are usually high wealth individuals investing into
startup firms and small business whereas VC is usually sourced from large VC funds, which are
run like investment firms. Venture capital is how most rapidly growing companies with potential
Figure 1

for high growth are funded and almost all of the famous tech companies today, including
Facebook, Twitter, and Google, were funded by VC. According to the OECD, in 2009 Sweden
had the third largest venture capital and business angel industries and were only behind the US
and Israel in terms of percent of GDP committed to VC activities.

The availability of VC funding has helped Sweden earn the reputation as a highly
innovative country and it has fostered the growth of famous tech startups King, the creator of the
popular mobile game Candy Crush, and Spotify, one of the worlds largest music streaming
services. After recording $567.6 million in profit last year as its revenue rose eleven-fold to
nearly $1.9 billion, King recently went public on the New York Stock Exchange and was valued
at $7.1 billion (Jarzemsky, 2014). Despite the apparent effectiveness of VC in Sweden, levels of
VC have been declining in recent years because of Swedens status as relatively small market for
VC activity; however, Sweden has adapted by ensuring that companies are still funded via FDI.
Figure 2

Its commitment to open trade and ability to provide a stable platform for investments make it a
desirable location for global investments.
Because of Swedens size and location, historically it has always relied on foreign
imports and exports to support its economy. Its commitment to open trade has been a crucial
factor in Swedens ability to overcome its small domestic market and peripheral geographic
location to become a highly industrialized and successful country. Openness to the global
economy has allowed for capital flows as well as flows of knowledge and were important to the
development of the country. Sweden was one of the earlier joiners of the EU and is an active
member of the WTO and GATT. Swedens dedication to open trade and participation in the
global economy is evident and Sweden has been eager to attract FDI to its economy. FDI can
impact an economy in a variety of ways including efficiency gains via technological transfers,
supply chain and distribution synergies, HR and management improvements, and increased
competition among others (OECD, 2009, p. 80). Swedens efforts to attract FDI have been
successful as it has high levels of inward and outward FDI stocks.

In
Figure 3

2011, the OECD reports that Swedens inward FDI stocks were 63 percent and outward stocks
were 67 percent as compared to the averages of 30 percent and 39 percent respectively. Although
these levels of FDI are high, they are largely the result of Sweden intentionally marketing itself
as a place for FDI. Sweden maintains lower than average FDI restrictions on foreign ownership
and screening requirements, a debt rate of only 49.2 percent of GDP, and a strong financial
sector they represent themselves as an attractive place for investment (OECD, 2009, p. 81).
Sweden also has a corporate tax rate this is among the lowest in the world, which also aids in
attracting FDI. However financial infrastructure is just the beginning of what drives FDI in
Sweden. It is the government support for business, which has led to high levels of innovation and
R&D intensity, which has helped Sweden become one of the most financially stable and
economically prosperous countries in the world.
The Swedish government has developed Sweden into an innovative country in a variety
of different aspects. As mentioned in the prior section, their development of a stable economic
landscape has allowed for easy lending, access to VC funding, and FDI, which are all crucial
aspects to starting a business; however, these factors, while a necessary foundation, are not
particularly unique to Sweden. While simple in concept, they are difficult to establish effectively,
especially in the wake of a financial crisis and deserve to be analyzed when considering how the
environment for high levels of innovation is established; however, what makes the Swedish
approach unique are the ways in which the Swedish Government supports business. They do not
support it in traditional ways such as tax breaks for specific industries or a low regulation
environment, but they foster the development of specific areas, most notably developing
businesses and education, which has led to their increased abilities to innovate.
According to the World Bank, Sweden ranks as one of the best places to do business in
the world. Starting a business requires just three procedures, preregistration, registration, and
post registration. For example the three steps would be first to obtain a written statement from a
Swedish bank certifying that the total cash amount to be paid for shares has been deposited in an
account, second to submit an online application to the Swedish Companies Registration Office
and obtain the registration certificate, and last to Register with the Swedish Tax Agency (World
Bank, 2012). These three processes take an average of sixteen days and cost just .5 percent of
average income per capita. In comparison the US has six procedures and it costs 1.5 percent of
average income per capita. It should be noted that data for starting a business in the US varies
from state to state. The information used in this paper is based on starting a company in New
York City; however, this is most likely different depending on which state the business is started
in (World Bank, 2012).

Figure 4

Source: Source: World Bank, Doing Business database

Swedens average income per capital is roughly $55,000 so starting a business would cost
around $300. Once the business is up and running, other aspects of running the business are
easier in Sweden than in comparison to other countries. From figure four above, Sweden ranks
highly in a number of categories related to business operation such as paying taxes, trading
across borders, and dealing with construction permits to mention a few. Despite that, it is by no
means an absolute leader in terms of global ease of business, in fact it actually ranks below the
US in a number of categories.

As one can see from figure five, Sweden is ranked higher than the US in a number of categories
related to conducting business. The only areas where it has an advantage are in getting electricity
and trading across borders. Despite this it is important to keep in mind that the US is ranked
fourth overall in ease of doing business while Sweden is ranked fourteenth and considering
Swedens size, they still rank at the top of their respective size class. One of the key facts which
draws business to Sweden over other countries, including ones which rank highly in terms of
ease of doing business are its exceptionally low corporate tax rate.
Figure 5

Sweden is known for having a very low corporate tax rate, which they have continued to
lower. Swedens recent change to lower the tax rate to 22 percent (McBride, 2012) makes
Swedens corporate tax rate among the lowest in the world and only tenths of a percent behind
Switzerland. In comparison the US ranks at one of the highest in the OECD at 39.2 percent
combined and the OECD average is around 26 percent. Swedens decision to cut the tax rate was
for a variety of reasons; however, in their official press release, the government stated, this is to
improve the conditions for new jobs and investments in Sweden. The significant lowering of
corporate tax is expected to strengthen the investor climate and growth in Sweden (Gustafsson,
2012).

Figure 6
Corporate tax is the tax that is levied on the profit of a firm, with different rates used for different
levels of profits. The full implications of the corporate tax are too extensive to be covered in
detail, but at a basic level the corporate tax rate has a large affect on the global competitiveness
of business as well as how attractiveness a business is to foreign investors. A low corporate tax
rate, combined with the ease of starting and maintaining a business helps to attract both domestic
and foreign investment and promotes business foundation. Most importantly, it allows
companies to retain more of their profits, which can potentially be used to fund additional
research into R&D. Although R&D expenditures are not the only possible use of additional
profit, Swedish companies have a history of being highly innovative and this is reflected by their
R&D spending. Ericson, a Swedish communications technology and services company, has over
35,000 patents, 25,300 R&D employees, and spends $4.9 billion on R&D per year, which
accounts for 14.4 percent of Ericssons sales revenue (Mawad, 2013, Ericsson, 2013). Ericsson
also ranks 28
th
in the world in terms of R&D spending, which is highly significant considering
that Ericsson is smaller than many of the other countries on this list. It is also interesting to note
that Switzerland, a country that also has a very low corporate tax rate, also has two companies
(ranked sixth and seventh in the world) with very high R&D budgets, which is a testament to the
benefits of low corporate tax rates. In comparison, Apple, one of the most valuable company in
the world, ranks 46
th
on the list spending a little over four billion dollars a year on R&D. It is
very difficult to dissect exactly how a company spends its money; however, from the sampling of
cases examined here, it is evident that countries whose have low corporate tax rates promote
increased savings by companies, which translate into greater R&D spending.
R&D spending can best be broken down into Gross Domestic Expenditures on Research
and Development or GERD and Business Expenditures on Research and Development or BERD.
The combination of businesses, which are taxed at a low rate and thus encouraged to retain
profits, the relative ease of running a business, and both the capital and knowledge inflows from
FDI as well pressure from global competition, foster a perfect environment for companies to
invest heavily into R&D in an attempt to innovate, and that is exactly what has happened in
Sweden. Swedens BERD ranks among the highest in the world at 2.34 percent of GDP and it
continue to grow. Figure seven shows not only the total GERD is almost completely comprised
of BERD, but also how BERD has increased so significantly since the 1990s financial crisis.

Figure 7


It is also interesting to note how insignificant government expenditure on research and
development or GOVERD is in terms of total expenditure on R&D. As stated earlier in this
paper, the Swedish government gives very few direct incentives for innovation and instead
focuses on strengthening the components, which allows innovation to thrive. In a document titled
Sweden Innovation Policy, released by the Swedish government offices, state that the first
priority of government support for the development of the innovative climate in Sweden is to
promote well-functioning framework conditions for innovation. In the official document it states:
Well-functioning, appropriate and stable framework conditions, incentives and means of
control form the basis of a good innovation climate. Examples of such framework
conditions are stable state finances, free and open markets with effective competition,
functioning trade, regulations and structures for taxation, labor market, markets,
education and research systems, and infrastructure. Other examples are laws and
regulations pertaining to contracts and procurement. Suitable systems for intellectual
property protection are of considerable importance. Not only public rules and regulations
are relevant standardization, for example, is handled to a great extent by private actors.
Norms and attitudes to creativity, the capacity for innovation and general
entrepreneurship in society are other examples of framework conditions for innovation
(Swedish government office, 2012, p. 19).

It is evident that Swedens main efforts in fostering innovation are to focus on the
framework for innovation, rather than direct benefits. However, that is not to say that Sweden
does not believe in these, just that they play a lesser role. Under the third of the three innovation
policies titled Direct Measure Targeting Innovation Processes, the Swedish government states:
Targeting innovation processes can take the form of financing of innovation activities and
entrepreneurship, and advocacy e.g., providing advice or support to collaborative
projects for research and innovation. They may also be a matter of financing knowledge
and innovation infrastructures such as incubators, the formation of clusters or networks,
and test and demonstration facilities. The main point is that the guidelines presented in
the section. The road to a world-class innovation climate in 2020 can primarily be
implemented through prioritization within existing financial boundaries (Swedish
government office, 2012, p. 20).

An analysis of these two responses is interesting in that it clearly exhibits to Swedens desire to
avoid direct funding of innovation in place of supporting the foundation for innovation. Even
under its direct innovation section, the Swedish government claims that innovation can be
implemented through existing financial boundaries. Considering that one of the most widely
used ways of encouraging R&D is via tax breaks and subsidies on R&D, Sweden takes an
interesting approach and appears to focus more on supporting and funding policies that allow
business to spend money on R&D rather than the government. This success of this approach is
reflected not only by Swedens high level of BERD, but also in its levels of R&D intensity.
R&D intensity is defined as most widely used measures of innovation inputs. R&D
intensity (R&D expenditure as a percentage of GDP) is used as an indicator of an economy's
relative degree of investment in generating new knowledge. As figure eight shows Sweden has
by far the highest level of R&D intensity as well as BERD in comparison to the US, other OECD
countries, and comparative Nordic countries. The amount of R&D intensity is indicative of how
innovative Sweden is. In addition to R&D being driven by BERD, HERD or higher education
expenditure also drives it into R&D, and while the Swedish government does not give many
direct benefits to ether BERD or HERD, they help to provide the structure for it become
successful.


Figure 8

Sweden has 50 higher education institutions or HEIs, with about half of them granting
PhDs. Of the 50 universities, around 80 percent are publicly funded and Sweden consistent
ranking by the EU Innovation Scoreboard as having a high proportion of higher education
graduates highlights Swedens emphasis on higher education and support of research (Swedish
Ministry of Enterprise, Energy and Communications, 2013, p. 15). Sweden placed five
universities into the top 200 global universities according to the Academic Ranking of World
Universities, with its Karolinksa Institute, taking the highest position at 44
th
in the world.
Interestingly, many of Swedens universities are also focused on both the sciences and on
research.
Karolinksa Institute is Swedens top medical university and accounts for about 40 percent
of all medical research conducted at Swedens HEIs. Sweden also has a public university
dedicated to technology and innovation called the Royal Institute of Technology (Kunglga
Tekniska Hgskolan). The school divides into five primary areas of research, energy,
information and communication technology, materials, life science, and transport and their goal
is to deliver focused, results-oriented study that meets the needs of governments and industries
grappling with unprecedented threats, as well as promising new opportunities. The platforms
enable faculty to weave together systems, policy and technology research into visionary
solutions, they seed leading-edge interdisciplinary research projects and they oversee the
development of young researchers with the skills necessary to thrive in changing environments
(KTH.se). Swedens Chalmers University of Technology presents itself as an entrepreneurial
university, which educates aims to strengthen entrepreneurial skills and foster innovation within
students. Since its inception in 1997 approximately 50 companies have been formed in which
former Chalmers students are the CEO and 42 percent of Chalmers alumni start businesses. All
three of the aforementioned Universities are heavily funded by the Swedish government.
Research at most Swedish universities is financed through the state via both competitive and
noncompetitive grants. In 2011, the Ministry for Education and Research allocated 14 billion
SEK for university research and other institutions provide additional 6 billion SEK to Swedish
Universities. Grants are distributed by the Swedish government based on quality indicators with
a view to increasing the relevance and competitiveness of university research. The indicators
include the fraction of third party funding of R&D, the number of publications, and the number
of citations. The goal of this model is to create incentives for universities and colleges to favor
the research areas in which excellent research is already being performed and research in which
they are able to be competitive globally. In 2012, publicly funded research amounted to just over
SEK 37 billion, or 1.04 percent of GDP. Around 75 percent of all of Swedens research is
financed by companies (OECD, 2012, p. 169).
In addition to direct funding from government grants, there are also many Swedish
foundations, which also help fund research within an educational setting. The Swedish Research
Council allocated SEK 4.56 billion in 2012 for research in the natural sciences, technology,
medicine, humanities and social sciences, among other fields. Formas, the Swedish Research
Council for Environment, Agricultural Sciences and Spatial Planning allocated 1.02 billion SEK
in 2012 for research in environment matters, agricultural sciences and spatial planning. Lastly
Vinnova, the Swedish Agency for Innovation Systems, allocated two billion SEK in 2012
primarily for research in technology, transportation, communication, and working life (Swedish
government office, 2012, p.174-175).
Government support for HEIs focused on research and innovation, combined with
competitive grants which not only fund these universities, but push them to excel, have led to
high levels of HERD, a large number of researchers in R&D, and a strong connection between
universities research and private companies, all of which are crucial for innovation. Although the
government is not providing any form of direct funding to stimulate innovation, the funding on
education, especially on education targeted on research and linking that research to private
institutions in crucial for innovation. In addition to providing funding for public institutions, the
Swedish government has also developed academic curriculum with research in mind. According
to the Swedish government website, Swedish higher education is characterized by students
taking responsibility for their own studies and for having a strong, yet informal relationship
wither their professors. Sweden aims to be one of the most R&D intensive countries in the world
(Sweden.se).
:#278-<)#2

With its small size, peripheral location geographic, and the occurrence of two financial
crisis in the past twenty years, Sweden has not operated under ideal conditions for economic
growth and prosperity; however, their targeted focus on promoting innovation is what has helped
to lead them to success. Despite the significance of innovation on the economic growth of a
country, it is inaccurate to say that innovation was the sole determinant of success. At the outset
of this paper, the hypothesis regarding Swedish innovation was that innovation alone was what
differentiated Swedens economic recovery from most countries and innovation is what has led
to their success. This paper also argued that because of Swedens direct government support for
innovation, that innovation in Sweden was being heavily funded in comparison to other
developed nations. Neither of these hypotheses are correct; however, they were not entirely
incorrect either.
Although it cannot be quantitatively measured in terms of economic output, innovation is
an important driver of economic growth, global competitiveness, and social growth as well.
Consider some of the issues that the world faces today whether it be an incurable illness such as
cancer, or access to clean water. Now think about how these problems could be solved. Perhaps
Pfizer, after years or research finally finds a method that cures all forms of cancer, or GE creates
new water purification filters, which purifies sources of formerly non-potable water. These
solutions not only benefit the companies and promote economic growth, but they benefit society
as a whole. Innovation is a necessity for the advancement of our society.
With that being said, innovation cannot be fostered in the absence of necessary
foundations. Beyond basic economic and infrastructural foundations there need to be capital
mobility, incentives to do business, an educated workforce, and business spending on R&D, in
order for innovation to become feasible. This paper has found that despite the absence of many
direct R&D incentives such as tax breaks or direct grants to business, Sweden is regarded as such
a highly innovative country because they understand the key components which foster
innovation and how to support them in order to create a vibrant innovative environment. Sweden
has created a stable macroeconomic environment and has opened its borders to trade, which has
allowed the free flow of capital from foreign countries to help fund its innovative endeavors. In
addition they have supported a business friendly environment with low tax rates and few
restrictions to starting or operating a business, which has also greatly aided business
development. Lastly they have given generous support to higher education institutions, which
has created an educated and capable workforce. This educated workforce, combined with
connections between universities and companies have allowed for high levels of innovation in
the private sector. Despite the abundance of direct government support which was anticipated at
the outset of this paper, it can be concluded that the Swedish governments is extremely conscious
of fostering innovation within Sweden and is supporting innovation in a variety of ways.
Interestingly, and unlike other countries they have not gone the traditional route of providing
direct R&D subsidies, which is what most other highly innovative countries have done. There is
speculation that Sweden will change this is future years and one would posit that this would only
strengthen their innovation presence around the globe.
The second question this paper attempted to answer was to prove whether or not
innovation has truly lead to economic growth and a swift recovery after the financial crisis in
Sweden. Unfortunately this question has proved to be unanswerable both by this paper as well as
my economists and political science scholars around the world. Because of the sheer amounts of
inputs into an economy, it is very difficult to isolate innovation as a sole variable and to
determine its impact. As mentioned earlier in this paper, there have been economists who have
attempted to isolate innovation such as Romer and Solow as well as others whose research was
based on determining quantitatively how innovation affected economic growth; however, in all
these cases the researchers are using simplified models which exclude multiple factors. While
this question cannot be completely answered, it is safe to say that innovation plays a defined role
in economic growth and that there are strong correlations between innovation and growth. To
continue with an earlier example, if Pfizer creates a miracle cancer curing drug it is likely that
they will need to expand their operations and hire more employees. They will also generate
profits, which will be reused by the company in a variety of ways, but also paid to employees.
These employees will then go a spend the money and because consumer spending is the largest
determinant of economic growth, the innovation of Pfizers new cancer drug will have far
reaching ramifications for the economy (Livingston, 2011). In addition, Pfizers innovation spurs
competition which encourages the same process to happen, both domestically as well as around
the world. Finally, society as a whole benefits as they are now healthier and rid of a malicious
illness. While this is just a hypothetical situation, economic theory posits that at a basic level this
is how firms operate and this process has been repeated many times in the past.
So far this paper has concluded by examining Swedens successful approach to
innovation and how innovation, despite being difficult to measure quantitatively, plays a definite
role in economic growth if not a major one. The last question that was posited at the outset of
this paper was, can Swedens approach to innovation and economic growth be translated to other
countries? While an in depth answer to this question is reserved for another paper, a brief answer
is that some aspects of it can be while others would be more difficult to determine. In theory
Swedens approach should be able to be adopted by all others countries. In order to foster
innovation, Sweden has simply focused on supporting the fundamentals to innovation, which has
led to their success; however, Sweden is different from many other countries, which makes the
translation of their approach to economic recovery difficult. Sweden is a small and ideologically
homogenous society, which has made the expansion of the welfare state and the development of
their innovation policies easier. Regarding Swedish society, Nima Sanadaji states, the one-
solution-fits-all systems of the welfare state are typically less disruptive in a strongly
homogeneous social environment, since most of the population has similar norms, preferences,
and income levels (Sanandaji, 2011, p. 18). These similar norms and preferences can to lead to
increased efficiency when making policy decisions, which has been exhibited by Sweden many
times. In the 1990 financial crisis, The two political parties at the time both agreed to put the
good of the country over political issues and came to an agreement that nearly all policies
regarding the financial crisis could be passed with little opposition by the opposing party as long
as there was complete transparency in the policy creation (Jonung, 2009, p.7). Sweden is unique
is the way that it is structured and most other countries do not share these characteristics.
This brief analysis raises a number of other questions, which could be researched for a
better analysis of recovery methods from economic crises. The biggest question that was raised
by the previous paragraph is whether or not Swedens political and economic structure makes its
method of economic recovery feasible for other countries to adopt. The Economist, along with
many other political scientists have commented on how the Swedish model is an ideal standard
for all developed countries to adopt; however, Sweden uniqueness may make this more difficult
than it would appear. Another topic that could be addressed is a comparative analysis between
Sweden in the decade after it 1990s financial crisis versus the US, a decade after its 2008 crisis.
While analyst are quick to draw comparisons between the recent 2008 financial crisis and past
crises, it is important to consider that the US is only six years removed from its crisis and is still
actively working to recover. A comparative analysis between countries, after being removed
from their crises by a similar amount of time would also be an interesting project to undertake.
Swedens methods of economic recovery might not be transferable to other countries, but
that does not make them insignificant. In an increasingly globalized world marked by financial
liberalization across many countries, it is without a doubt that financial crisis will continue to
occur far into the future. Swedens recovery from both its 1990s crisis as well as the 2008 crisis
set a gold standard for how financial crisis should be handled. In addition, Swedens success also
benefits those around it can use its domestic prosperity to help pull other struggling nations from
their financial woes. Swedens success has not come from luck, but rather a disciplined and
practical financial approach fiscal policy, which in a time of global economic uncertainty, is a
policy that all countries can adopt.
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