Management Decision

How much does innovation matter for economic growth?

Alberto Colino Diana Benito-Osorio Carlos Rueda Armengot

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Alberto Colino Diana Benito-Osorio Carlos Rueda Armengot , (2014),"How much does innovation matter for economic
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How much does innovation matter

for economic growth?

How much does

innovation
matter?

Alberto Colino
Department of Economics, Comillas Pontifical University, Madrid, Spain

313

Diana Benito-Osorio
Department of Management, Rey Juan Carlos University, Madrid, Spain, and

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Carlos Rueda Armengot

Department of Business Organization, Universitat Polite`cnica de Vale`ncia,
Valencia, Spain
Abstract
Purpose The aim of this paper is to gain new insight on the determinants of economic growth.
More precisely, it disentangles the contribution of an increase in the stock of ideas that exceeds the rate
of growth in the steady state and the growth inherent to the steady state.
Design/methodology/approach Following Romer (1990) and Jones (2000, 2002) this paper uses
an aggregate production function. The paper also models the evolution of the stock of ideas following
the generalisation of Jones (1995). The analysis decomposes growth utilising the estimated parameters
inherent to the ideas function.
Findings This article presents a growth accounting exercise that estimates total factor productivity
for three Southern European economies. Systematic comparison of the countries illustrates the
importance of innovation for economic growth. This exercise shows the main growth patterns over the
last 50 years, and highlights the principal determinants by specifying an ideas function.
Originality/value This study yields recent timeframe for explaining per capita income variations
within economies and observed differences across economies.
Keywords Innovation, Economic growth, Total factor productivity, Southern Europe
Paper type Research paper

1. Introduction
One of the most significant yet least understood explanatory factors for the great
expansion in income levels in the European Union in recent years is undoubtedly the
increased efficiency of production processes in the member countries.
Many studies indicate that most of the growth in per capita income in European
economies is due to the evolution of apparent labour productivity and more specifically
to factors that promote efficient use of available resources and facilitate the
incorporation of innovation and technical progress to production processes (Caceres
et al., 2011; Zortea-Johnston et al., 2012), thereby increasing total factor productivity
(Aghion and Howitt, 1992; Caballero and Jaffe, 1993; Eaton and Kortum, 1999;
McGrattan and Schmitz, 1999; Colino et al., 2013). As the production function shows,
over the last 50 years, average growth in the EU has been the result of total stock of
knowledge, the stock of aggregate capital, and the amount of human capital
This paper has been supported by ECO2012-36775 of Spanish Ministry of Economy and
Competitiveness (Spain) and by PRIN2013_CSJ05 of Rey Juan Carlos University.

Management Decision
Vol. 52 No. 2, 2014
pp. 313-325
q Emerald Group Publishing Limited
0025-1747
DOI 10.1108/MD-08-2012-0586

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314

incorporated (Solow, 1994; Timmer et al., 2010). At the same time, economic growth is a
key issue in economic policy making, in strategic research and in entrepreneurial
activity (Nissan et al., 2011; Amoros et al., 2012; Gillis and Castrogiovanni, 2012).
However, if this statement is true for the European aggregate, it is even more so for
southern European economies where technological progress in the 1960 s led to over 2
per cent increases in product per worker, a very significant factor in explaining the real
convergence of these economies.
Despite its quantitative importance for determining the rate of progress in
economies and the efforts made, economists know little about the factors responsible
for increased multifactor productivity, although it is certainly associated with
investment in training and research, organisational factors and capital deepening
(Kaldor, 1961; Shell, 1966; De la Fuente, 1992; Jones and Williams, 1998).
This study presents theoretical and empirical analysis of the possible drivers of
economic efficiency. The theoretical analysis of the Spanish, Italian and Greek
economies uses Romers (1990) proposed growth model that Jones (2002) subsequently
reformulated and applied to the US economy.
Section 2 outlines the main characteristics of the growth model. Section 3 presents
the evolution of the significant variables for subsequent analysis of growth in the
economies under study. Section 4 provides an empirical analysis of the model by
estimating the ideas function and doing a growth accounting exercise. Finally, section
5 presents the conclusions.
2. Economic growth model
Following Romer (1990) and Jones (2000, 2002), the aggregate production function is as
follows:
a
Y t Ast K at H 12
Yt

where At is the total stock of knowledge available to the economy, K t is the stock of
aggregate capital, and HYt is the total amount of human capital engaged in producing
goods (Bils and Klenow, 2000; Mincer, 1974); assuming constant returns to scale for
physical and human capital factors 0 , a , 1; growing returns for the function as a
whole s . 0 and considering A as an additional production factor[1].
The model uses the stock of ideas with the generalisation Jones (1995, 2000)
proposes:
DAt dH lAt Aft ; A0 . 0;

where HAt is the world research effort, obtained as the weighted sum of researchers in
each economy, LAi ; according to the equation:
H At

M
X

huit LAit

i1

where the weight of human capital is u $ 0[2].

The fact that technical progress in a country depends on world scientific knowledge,
with no distinction between the knowledge obtained in the country itself and that
obtained from outside, is undoubtedly one of the limitations on the empirical

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application of the model. However, introducing different scientific developments into

the model separately demands greater theoretical reflection and empirical evidence of
their substitutive or complementary nature.
In relation to the proposed ideas function, the l coefficient expresses performance in
terms of new ideas from the set of existing scientists, whereas f measures the impact of
previous ideas on new ones. Finally, f can be considered a measure of the speed and
breadth with which ideas are diffused. Whereas the anticipated value of l is between 0
and 1, reflecting the inevitable fact that new discoveries partially overlap, f values can
be negative if the most fundamental, obvious ideas were discovered first. Finally, d must
not exceed the threshold of 1, which would reflect instantaneous diffusion of new ideas.
An individuals time can be distributed between the production of goods, ideas or
human capital which can be written as:
LAt Lgt Lt 1 2 lht N t ;

where Lt is full employment. Also lA ; LA =L is defined as the part of the labour force
dedicated to producing ideas (research intensity ratio) and lY ; LY =L:
Finally, population Nt is assumed to grow at a constant exogenous rate n . 0 :
N t N 0 e nt ;

N 0 . 0:

After defining all the elements in the model, it is now possible to obtain an equation for
income per worker and express function (1) in per capita terms, multiplying the factors
by 1/Lt. The result is:
yt

12aa
a
Kt
a
1Yt ht A12
t
Yt

The equation takes the following dynamic form:

^
yt

^
^
^ 
a ^
s ^
K t 2 Y t ht l Yt
At
12a
12a

where the circumflex ^ gy denotes the average change in the logarithm of the
variable between two moments in time.
This equation permits a novel accounting exercise, first, because it expressly
reflects the influence of the capital-product relationship on work productivity, which is
interesting for economies that are very close to the steady state, where this relationship
tends to remain constant. Second, because A must also be simultaneously the
conventional Solow residue and the estimated stock of ideas in order to endogenise
technological progress. That is A must square the accounting calculation and at the
same time be a result of the proposed ideas function[3].
In the steady state, all the terms in the second member of equation (7) must be zero,
except for the last one. However, this last term must be around zero, as it depends on
the rate of increase in scientists which is normally very low, and can be assumed to be
similar to the rate of population increase. In fact, it can be demonstrated that this last
term is gn, where:

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316

s
l
l

12a 12f 12f

depends on the ideas function parameters ( Jones, 2002)[4].

Thus, adding or subtracting the value of growth in the steady state to the second
member of equation (7), gives the following equation which is the basis for the growth
accounting exercise:
 s ^

^
^
^ 
a ^
^
yt
K t 2 Y t ht l Yt
At 2 gn gn
8
12a
12a
This is the equation estimated on the following pages for Spain, Italy and Greece. In the
equation, transition dynamics must account for a high proportion of the growth
because as already noted; annual growth in the steady state must be very low.
Finally, although we have considered a parametric approach, it is important to note
that this paper connects to Data Envelopment Analysis (DEA) in several ways. DEA is
a non-parametric method for identifying efficient production frontiers and evaluating
the relative efficiency of decision-making units, each of which is responsible for
converting multiple inputs into multiple outputs, and has become an important way to
evaluate efficiency. The most important connection with DEA is that DEA uses
multiple output and input variables and allows the aggregation of several financial
statistics, as well as being a frontier estimation technique, which does not require the
specification of functional form of the model (non-parametric approach) (Golany and
Thore, 1997; Prieto and Zofio, 2007[5]).
3. Evolution of the significant variables
The annual accumulative growth rates for 1960-2009 of the variables in equation (8)
required for the subsequent analysis are shown in Table I.
Before analysing the growth paths followed by the studied economies it is worth
examining one of the variables in Table I. The term lY is calculated as the rate of
growth of the proportion of the work force employed in producing goods, obtained as
the 1 - lA growth rate. The path of this variable shows a slight decline in the study
period due to the increase in research intensity but, as the proportion of labour
dedicated to research is very small, this decrease is non-significant.
See Table I for the annual cumulative growth rates between 1960-2009 of the
variables in equation (5) used in the subsequent analysis.
The data reveals the greater similarity between the countries that started in 1960
from a position of relative backwardness (i.e. Spain and Greece) than with other
Southern European countries (Maddison, 1995). These economies show similar rates of
growth, higher than those of Italy, with a positive growth differential in product per
worker in the five decades studied. Growth rates are particularly high in the first part
of the study period (i.e. 1960-1976) when the Spanish and the Greek economies
registered rates of more than 6 per cent a year in increased product per worker
whereas in the Italian economy the rates were around 5 per cent.
Similarly, upward movement in the other variables is clearly more pronounced in these
economies, especially in the first part of the period under consideration. In this regard,
evolution of the R&D effort measured by the population dedicated to such activities is
particularly important. Thus R&D jobs grew at an annual rate of just over 6 per cent in

n~
^
lA

K2Y
lY
^
h
^
A
^
HA
Dl h

y^
^

Spain
1977-2009

0.0612
0.0091
0.0221
0.0118
0.0000
2 0.0001
0.0069
0.0123
0.0425
2 0.0089
0.0578
0.0665
0.0274
0.0251
1960-2009
0.0111
0.0190

1960-1976
0.0259
0.0156
2 0.0001
0.0105
0.0075
0.0637
0.0260

1960-2009
0.0515
0.0089
2 0.0001
0.0050
0.0417
0.0520
0.0139

1960-1976
0.0128
0.0118
2 0.0001
0.0075
2 0.0005
0.0346
0.0145

Italy
1977-2009
0.0252
0.0109
2 0.0001
0.0066
0.0130
0.0405
0.0143

1960-2009
0.0738
0.0125
0.0000
2 0.0024
0.0697
0.0485
2 0.0051

1960-1976

Sources: Authors elaboration from Heston et al. (2011), OECD, National Science Board (2009), Barro and Lee (2000)

Product per worker

Capital-product ratio
Labour input
Human capital
Total factor productivity
R&D jobs
Annual variation in lh
G-5
G-5 employment
Research intensity

Variables

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1960-2009
0.0305
0.0061
20.0001
0.0049
0.0223
0.0603
0.0083

Greece
1977-2009
0.0096
0.0027
20.0001
0.0087
20.0002
0.0660
0.0151

How much does

innovation
matter?
317

Table I.
Annual growth rates,
1960-2009

Spain and Greece whereas in Italy growth in this area was much more moderate, at
around 4 per cent for the entire period. This growth is mirrored by the expansion in Total
Factor Productivity (TFP) in the Spanish and Greek economies in the first part of the
period, but not throughout the entire period as the ongoing increase in innovation effort
does not lead to further increases in TFP in the Spanish economy (see Figure 1).

318

4. Empirical analysis
In this section, we use Romer and Jones model to perform a growth accounting exercise
from the estimates of the ideas function parameters. These parameters provide an
estimation of the ideas stock, which we can compare with the series of total productivity
of factors obtained as a residue of equation (6) and examine the goodness of fit.
To split up the sources of economic growth in the following section, we need to
estimate the characteristic ideas function parameters, that is, the parameters that
appear in equation (2). We also need to find a value for s which indicates the
contribution of the total stock of knowledge in the economy.
As regards of this last aspect and without being able to observe the ideas directly,
the s parameter cannot be identified. Therefore we proceed to normalise it according to
the expression s 1 which involves A entering the production function as neutral
technical progress in Harrods sense.
It is more complicated to obtain values for the g parameter which, remember, is a
combination of ideas function parameters:

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Figure 1.
Evolution of total factor
productivity, 1960-2009

s
l
l

:
12a 12f 12f

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We have two alternative methods for obtaining gamma values as proposed by Jones
(2002).
The first of these methods, justified in the aforementioned article, consists in
obtaining a value for g that equals the ratio between the total factor productivity
growth rates (A) and employment in R&D (HA), so that stationary productivity growth
occurs. Thus, using the data in Table I we calculate an upper limit for the value of g.
An alternative method for achieving gamma is based on the estimation of the
characteristic ideas function parameters using a discrete model. The analysis decomposes
growth utilising the estimated parameters inherent in the ideas function, that is, the
parameters in equation (8) in the model (Myro et al., 2008) using a discrete model:
log Bt log At 1t

DAt1 dH lAt Aft ;

10

where Bt is the total productivity of the factors calculated as indicated above and At is an
unobservable variable. In equation (9), At relates to Bt through the error term 1t
distributed with mean zero and constant variance , i.i.d.0; s2 :
Knowing the values of variables Bt and HAt, we then estimate the equations system
with the non-linear least squares method to obtain values for the ideas function
parameters (10).
The growth accounting exercise follows the classic exercises associated for example
with Solow (1956, 1957) and Mankiew et al. (1992), but with an essential difference, in
that TFP growth is determined endogenously in the model itself. As noted in section 2,
growth breakdown is based on equation (8) for which we already have all the necessary
variables and estimation of the g parameter. All that is needed now are the values for
the a and c parameters. As a represents the participation of capital in national income,
we adopt the commonly accepted value of 1/3. The c parameter is obtained from
microeconomic evidence and corresponds to that estimated by Mincer (1974). Thus, we
assign a value of 0.07 which indicates that an additional year of education has a direct
effect on a 7 percentage point increase in productivity.
This paper uses all the elements in equation (8) to then decompose growth for Spain,
Italy and Greece (see the results in Table II).
It is possible to break down the growth in productivity between 1960 and 2009 due to
the increase in the stock of ideas (A) into two parts. The first, and undoubtedly the most
important, reflects an increase in the stock of ideas that exceeds the rate of growth in the
steady state, whereas the second accounts for growth inherent in the steady state.
Growth due to transition dynamics that is, associated to increases in work force
qualifications (lA) and the stock of ideas (A) is most significant in the recent evolution
of Southern European countries. Thus, growth due to these factors (g) is responsible
for approximately 80 per cent of the increase in apparent labour productivity between
1960 and 2009 for Italy and Greece, although not for the Spanish economy, where these
factors are less important.
Many studies in EU countries or regions highlight the importance of different
variables according to area, region or period, and this diversity in the definition of the
object of study, and consequently in the results obtained, impedes the comparison of
results or invalidates the comparison. In this vein, Tondl (1999) analysed Greece, Spain

How much does

innovation
matter?
319

Table II.
Growth accounting
exercise, 1960-2009
0.0259
0.0252
0.0305

(100.0)
(100.0)
(100.0)

(30.2)
(21.6)
(10.1)

K 2 Y

0.0078
0.0054
0.0031

a
12a

2 0.0001
2 0.0001
2 0.0001

lY
( 2 0.4)
( 2 0.3)
( 2 0.3)

0.0105
0.0066
0.0049

(40.7)
(26.4)
(16.2)

Note: Number in brackets show the percentage contributions to the increase in apparent labour productivity
Source: Authors elaboration

0.117
0.321
0.371

0.0059
0.0123
0.0203

(22.9)
(48.7)
(66.6)

A 2 gn

320

Spain
Italy
Greece

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0.0015
0.0007
0.0021

gn
(6.0)
(2.9)
(6.8)

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and Italy, the same countries as this study but in the years 1975 1994, and their
non-comparable results show that the stock of public investment and the level of
education acted as factors that promoted economic growth. Other works (i.e. Badinger
and Tondl, 2002; Baugelsdijk and Noorderhaven, 2004; Tondl and Vuksic, 2004) are not
comparable because they look at a different set of countries[6].
5. Conclusions
The above analysis suggests several conclusions. First, it seems that for the last five
decades, growth in apparent labour productivity in the Southern European economies
is mainly due to the evolution of TFP associated principally with innovation and
technical progress. The determinant factors therefore merit more in-depth
examination. Thus, in the proposed model, the evolution of TFP has a fairly good
fit when we specify an ideas function in which the worldwide stock of ideas is
proportional to the worldwide research effort, which in turn is proportional to the total
population in the most innovative countries.
Second, the growth accounting exercise reveals the importance of transitional
dynamics in explaining the evolutionary path followed by these economies. Thus,
transitional dynamics alone explains around 80 per cent of labour productivity growth in
Italy and Greece between 1960 and 2009, whereas in the Spanish economy it represents
around 65 per cent. Due to low initial levels, and despite great efforts from these three
countries, investment in qualified labour and research must continue, as current levels are
still well below those of the most advanced countries in the world. As this study shows,
Spain, Italy and Greece have benefited from the transfer of technology from the worlds
most innovative countries. Nevertheless, the deceleration in growth of the worldwide
stock of ideas since 1980 has noticeably reduced growth rates in these economies, thereby
indicating the need for an examination of the impact of domestic R&D on growth.
Finally, an endogenous growth theory implication is that economic policies that
embrace competition, technological process, openness, and innovation will promote
growth. Therefore, economies that cease to transform themselves are destined to stray
from the path towards economic growth. The countries need to engage in the
never-ending process of economic development if they are to enjoy continued prosperity.
We must acknowledge that our work is subject to some limitations. The most
important of these is that we only analyse a data sample for the period 1960 2009.
This time frame allows us to isolate our results from the impacts of the subsequent
financial crisis, such as abandoned or delayed investments, but has the drawback of
preventing us from capturing recent important events. In addition, in the 1990 s, one of
the most important debates in the history of growth and development came to the fore.
In fact, some authors shifted gears and began emphasising that the analysis of the
sources of growth embedded in the neoclassical growth model has serious
methodological shortcomings. Nowadays, two decades after the publication of
Krugmans (2013) paper, it is important to review the state of this debate and evaluate
how much the profession has learnt from it (Felipe, 2006). Paul Krugman criticised
endogenous growth theory as nearly impossible to verify empirically because too much
of the theory involved making assumptions about how unmeasurable things affected
other unmeasurable things. One of the main failings of endogenous growth theories is
the collective failure to explain conditional convergence reported in the empirical
literature (Jeffrey and Warner, 1997), and that new growth theory has proven no more

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successful than exogenous growth theory in explaining the income divergence between
the developing and developed worlds (Parente, 2001). This makes the interpretation of
standard growth accounting exercises a difficult task, and using the concept of TFP for
policy purposes is risky.

322

Notes
1. The assumption of constant returns to scale for physical and human capital factors is
undoubtedly a limitation, but it is rooted in neoclassical growth theory, and with very little
adaptation assumed in Solows growth model. In Solows (1994, p. 48), words The
assumption of constant returns to scale is a considerable simplification (. . .). But it is not
essential to the working of the model. We develop this research in accordance with this
tradition.
2. In the proposed ideas function, the coefficient l expresses return in terms of new ideas from
the existing set of scientists and w measures the impact of previous ideas on new ideas.
Finally, d is a measure of the speed and breadth of dissemination of ideas. Whereas the
expected value for l is between 0 and 1, reflecting the inevitable partial overlap of new
scientific discoveries, the values of w may be negative, when discovery of the most
fundamental, obvious ideas comes first. Finally, d must not exceed the maximum value of 1
which would signify instantaneous dissemination of new ideas.
3. In fact, given that the exponents of the ideas function are not known, it is impossible to
estimate A without reference to Solows residue.
4. This means that in the proposed model long-term growth depends on the ideas function
parameters, apart from the population increase.
5. For a review of the DEA literature, see Seiford (1996) and Lovell (1993).
6. In these studies other factors are signaled as potential economic growth determinants.
Among them, we can point out endogenous growth factors, trade intensity, technology
transfer and technological catching-up with the technology leader.

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Appendix. Data sources
.
Gross domestic product. The data on Gross Domestic Product at constant 2005 prices have
been calculated from Eurostat (Statistical Annex of the journal European Economy).
.
Human capital. The data for the average years of total schooling of the population aged 25
or over come from De la Fuente and Domenech (2001) and Barro and Lee (2010). The data
appendix is available at: www.barrolee.com/data/dataexp.htm
.
Scientists and engineers engaged in R&D. The data from 1965 to 1980 are from National
Science Board (1993, 2009). For years after 1980 the source is the OECD. National Science
Board is available at: www.nsf.gov/statistics/

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Total employment. The starting point is the total number of employees in 1960, according
to Labour Force Statistics, OECD. The annual series from 1961 to 2009 have been obtained
by applying to that initial number the variation rates provided by Eurostat in European
Economy.
Physical capital. The stock of fixed capital has been calculated using the perpetual
inventory method, applying 4 per cent depreciation to the 1960 stock. The 1960 values
come from OECD and have been adjusted for various errors by estimating a linear
relationship between GDP per capita and the capital-labour relation.
Investment. Gross capital investment at constant 2005 prices has been calculated from
Eurostat (European Economy Annex).

About the authors

Alberto Colino is currently an Assistant Professor at Comillas Pontifical University in Madrid.
He gained a Msc in Economics (2005) and PhD in Economics (2010) at the University of Essex
(UK). Since 2012, he has been a member of the Editorial Board of the International Journal of
Criminology and Sociology. Additionally, he is a reviewer for the Journal of Peace Research,
Defence and Peace Economics, Service Industries Journal, Management Decision and the
European Journal of International Management. His areas of interest are on industrial
organisation, economic growth, the economics of technological change and business
management. Accordingly, he has publications in journals indexed in the Journal of Citation
Reports as Applied Economics, Journal of Peace Research, Defence and Peace Economics,
Management Decision and Technological Forecasting and Social Change. Alberto Colino is the
corresponding author and can be contacted at: acolino@cee.upcomillas.es
Diana Benito-Osorio holds a PhD in Business Economy and is Associate Professor at the
Department of Management in Rey Juan Carlos University, Madrid. Her main research interests
and work are in: corporate strategy, especially in internationalisation and product
diversification, conciliation of the family and work life and education innovation. She is
author and coauthor of different papers and chapters of books, conferences and posters
published in national and international journals, congresses and workshops. Her last
publications in relevant journals are in Management Decision, International Entrepreneurship
Management Journal, Journal of World Business and Technological Forecasting and Social
Change and she serves as reviewer too. She has been a visiting scholar in different institutions in
Chile and Spain.
Carlos Rueda Armengot holds a PhD in Management from the University of Valencia and is
Assistant Professor at Polytechnic University of Valencia. His research interests are focused on
entrepreneurship, human resource management and organisational economics. He has
previously published in relevant journals such as Management Decision, Service Industries
Journal, Service Business, Journal of International Change Management, International
Entrepreneurship and Management Journal and International Journal of Manpower, among
others, and he also serves as a reviewer.

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