SEMINAR IN ECONOMIC POLICY RESEARCH THESIS Relationship Between Innovation and Economic Growth

By Muniba Khan 5473

and industries. About time. for what we have seen. In the fourth part the empirical analysis is conducted with the help of the econometric framework and finally the last part concludes alongwith the comparison of the performances of the top rated countries with that of Pakistan.the effect of innovation on growth. The first is that innovation makes a significant contribution to growth. This thesis has been designed to study the relevance between innovation and economic growth. There are two main conclusions. on connected economies and on the world economy as the whole. The proof of which has been given through an econometric framework of Regression Analysis. In the third part I have presented the review of the literature in relation to innovation and growth. I have identified variables that affect the dependent variables. In the second part after introduction I have presented the relation between growth and innovation. As dependent variables I have used the GDP growth rate. and to a lesser extent from government-funded research. This paper aims to focus on the evidence of one of those very important factors.ABSTRACT The empirical studies to find the effects of numerous factors on growth are so extensive that even a summary of all would be impossible. for what we have gone through recently. The variables are represented with indexes constructed from an econometric regression. . The second is that there are significant spillovers between countries. firms. Using data from 15 countries selected on the basis of the ranking in the recent Competitiveness Report 2009-2010 (the report of 2011-2012 is due to be published on September 8th 2010). it has become imperative to analyze the affects of particular factors on growth to be able to forecast better and to track the most probable effects of let’s say an act of innovation on an economy.

.........................1 Point of departure and background.......................3 3 Literature review……………………………………………………………....................................................…......................................................................................................................................................................................................................................................1 1...............3 2...............................................................8 6..............................................................2 Growth......................TABLE OF CONTENTS 1 Introduction .......................7 6 Analysis………………… .....3 Appendix C ............8 6.........1 1............................................................................ 11 7 References...............................................................................................4 4 Econometric framework........3 2......................................................................................................................2 2 Innovations as the engine of economic growth .................................................................................. 13 8..................1 Innovation………………………............................................................2 2............................. 12 8 Appendixes..........................2 Data and variables ..................2 Final words......2 Purpose ………………….....................................1 Appendix A 8..........................................................................................................................3 Relation between innovation and growth ................1 Multiple regression.............................................3 Method…………….................................................2 Appendix B 8.................. 1 1...............7 5 Empirical findings ..........................6 4.7 4.................................................................1 Analysis ..............................................................

It is a constant debate that the role for government in the innovation process is naturally limited – that this is a task solely for the private sector. at the same time the world has been a witness to the revolutionizing of business and economy through the power of innovation. Innovation has left a huge impact on the way the businesses are done. otherwise the power mongers of the world would have no reason to impose technological sanctions on other countries. 1. services and business models—is the key to improved standards of living. but in an era of globalized innovation and intensely competitive markets the federal government can and should play an important enabling role in supporting private sector and national innovation efforts. In other words innovation has a very positive effect on an economy and a country. development has therefore led to the complete change of how a business is conducted. an increasing number of economists have come to conclude that innovation— the creation and adoption of new products.2 PURPOSE With the discussion above in mind these problems raised my curiosity. the steep surge in inflations and even steeper decline in production and productivity. or that are an important factor for the growth at which innovations are generated.). almost all the countries of the world that value competitiveness embarked on a journey towards growth through maximum utilization of innovation and research and development activities conducted by the private as well as government sector. power and society. As pointed out by T. In the following essay I have the intention to describe what factors affect the production of innovation in a country. public non-profit motivated actors such as universities and research institutes (many of which. companies and of the lives of individuals through knowledge and innovation.Innovation and its Effect on Economic Growth-Research Paper PART I INTRODUCTION 1. how policies are made and how the business leaders have become responsible to create conducive environments to support and to welcome innovation and to let its effects to spill over for the benefit of the whole economy. I have basically highlighted the factors that have a positive connection to. Soon after the World War II. are funded largely by governments) and government agencies play an important role directly by spending on and doing research. . It witnessed the empowerment of economies. Srinivasan (Entrepreneurship. N. though autonomous. It is true that that the private sector should lead. besides private actors (innovators. for example how well educated the population is or how developed the soft infrastructure is. 1 BACKGROUND 1 For the past two years. The increasing impact of innovation in the economic acceleration.is there a connection? And if so how strong is it and what does it look like? Those were questions that led me in to this thesis’ problem area. entrepreneurs. firms. etc. politics. global financial crises. Furthermore the importance of innovation has become so great that it has created its place on the international and domestic and public agendas. In the last decade. the world has seen the worst ever mortgage crises. Innovation and Growth). innovation and growth .

This is to give an understanding of the forthcoming choice of economic growth model and to the choice of empirical study. First. Policy makers around the world. the introduction/application of technology for the first time in the world). productivity growth is the best aggregate measure of the economic consequences of innovation. OECD. innovation is not restricted to technology and knowledge creation through R&D. Raising productivity is not a matter of working harder or working longer hours. innovation includes not only product and process innovations but encompasses new marketing methods and new organizational approaches. 2. a new marketing method. Second. 2007) Innovation is important because it leads to the development of new products and technologies as well as it drives economic growth. First. However. workplace organization or external relations”. 1. productivity can be increased by raising the value of goods and services produced. even though the latter approach is where most productivity gains come from.1 INNOVATION We can define “innovation” for the purposes of the discussion as “the implementation of a new or significantly improved product (good or service). Second. Second. or process. innovation is not restricted to a “global first” (i. not raising the number of hours worked to achieve which firstly. The material consists mainly of research articles concerning innovation and economic growth.e. or a new organizational method in business practices. PART 2 INNOVATION AS AN ENGINE OF ECONOMIC GROWTH This chapter is aimed to give a theoretical background to the connection between innovations and economic growth. Such a broad view of innovation is appropriate as we are interested in innovation and diffusion of innovation as they affect growth both in developed and developing countries (Trade.Innovation and its Effect on Economic Growth-Research Paper 2 Further it would be interesting to study why some countries are better at getting the innovations to affect the economic growth. Third. mainly the World Development Indicators.3 METHOD The regression is constructed as Multiple Regression and estimated in the program Microsoft Excel and further tested on SPSS. and give short shrift to the second. The productivity of an economy can grow in two different ways. Three points are underlined. stress the first form. The data used in the regression is collected from different research institutes. productivity can grow by producing a given set of goods or services in a more technically efficient manner. Making production more technically efficient requires getting more out of existing work hours. What makes countries such as the US better than China at putting successful innovations on the market? In this study my main purpose is to give a clearer empirical picture of innovation and its connection to economic growth. government should subsidize both R&D and the training of workers in the use of leading-edge technologies. government should . It also contains reports from different research institutes and authorities like Insead and World Economic Forum. innovation and growth. but includes the introduction/application of technology for the first time in a new environment. but also includes implementation or commercialization of advances in technology.

some worrisome global imbalances and modest performances in some of the traditional engines of growth. and the United Kingdom. Switzerland. During 2007 and 2008 they grew more than 6% per year.and innovation-promotion agencies (Boosting productivity.3 THE RELATION BETWEEN INNOVATION AND GROWTH Presently. Despite all this. New Zealand. Countries can benefit from a high degree of external R&D. through acquisition of rights for patents. along with other developing nations. are in a position to give the world economy its biggest boost since the industrial revolution. In recent years many nations. Sweden. wars in Afghanistan and Iraq. the economic wheel is moving forward. What looked as a recent global economic slowdown turned out to be a "rebalancing" of growth. the world economy grew more in the ten past years than in any ten-year period since the Second World War. There are externalities in innovation because countries are unable fully to appropriate the gains from their own innovation. Several advanced countries. and more generic research. The participation of these countries in global economic flows has been increasing at a remarkable pace. This economic expansion has happened in spite of a number of economic and political shocks: the collapse of the stock market bubble in 2000. longer-term. Japan. the Netherlands. sophisticated agencies to support innovation. "it is estimated that in 20 years' time emerging economies will represent nearly two-thirds of global output (again. is being compensated by an apparently solid upswing in the euro area According to several experts. representing now: more than half of total world GDP (if we measure it at purchasing power parity). According to recent analysis by The Economist.2 GROWTH The global economy is on its way to achieving a historic growth record.Innovation and its Effect on Economic Growth-Research Paper 3 help fill the financing gaps in the private R&D process. Iceland. In 2006 developing countries have grown at a near record 7%. which should remain well contained. particularly for higher-risk. There was a major slump in 2009 but the recovery is fast on its way with the growth of the developing countries projected to rise by 5% in 2012. How has the global economy managed to grow so steadily in a time of international uncertainty and recurring economic threats? Part of the answer lies in one single intangible factor: innovation. some private think-tanks termed the last decade as one of its best decades ever. 2001. Ireland.2% since 2000. China and India. it is common to suppose that new technologies are the driving force of the long run productivity growth. at purchasing-power parity)". the escalation of oil and commodity prices. the terrorist attacks of September 11. have either established or significantly expanded separate technology. innovation and growth through a National Innovation Foundation. 2. 2008). 43% of world exports and nearly half of the world's energy consumption. The slowing pace of activity in the US and Japan. With an increase of nearly 5% in 2007. franchising and exchange of goods in which external R&D is incorporated. a break-down in the Doha round of multilateral trade talks. if these trends continue. 2. First. it should spur collaboration between firms and research institutions such as universities. Robert Atkinson and Howard Wial.7% GDP growth in developed economies. Third. including Finland. South Korea. The externalities occur in three main ways. With an annual growth rate of nearly 3. in comparison to a 2. Norway. are creating well-funded. France. technological spillovers reduce the cost of rival firms because of . without great internal expenditures on R&D.

knowledge spillovers and technological substitution in the process of economic growth. Second. Endogenous growth models emphasize the importance of knowledge. where growth is driven by enhancements to capital and labor inputs. 1996) The attraction of innovation as a determinant of growth in empirical research is its straightforward measurement. network externalities may arise because the payoffs to the adoption of innovations may be complementary. several authors also show the importance of the R&D returns. The connection between human capital and regional growth is supported by a wide body of empirical evidence at the national and regional levels. profit-maximizing agents and is therefore endogenously determined. 1992) illustrate the function of R&D as a growth engine. and movement of skilled labor to other firms. 2005) PART 3 LITERATURE REVIEW Both theoretical and empirical literatures have shown that investments in R&D are crucial for economic growth. and demonstrate the reason why government must have a role in achieving an optimum level of R&D. The latest class of models developed in this tradition has arisen from the works of Romer (1986. particularly at the firm and industry level. Aghion and Howitt. whether in terms of quantity or quality and productivity. Grossman and Helpman (1991) and Aghion and Howitt (1992). 1991. and economic growth through his endogenous growth model. a lot of models (Romer. Grossman and Helpman. (Innovation and economic growth. Researchers may use either input measures such as R & D expenditures or innovation outcomes such as patents (the way it has been done in this paper). Investments in R&D have been shown to be an important indicator of innovation activity of a country (Ulla Hytti & Pekka Stenholm) Technology and talent have long been seen as driving forces of economic growth. arguing that investments in human capital generate spillovers and increasing returns. innovation and economic growth: Evidence from GEM data. In the theoretical side. productivity growth results from intentional innovation by rational. The seminal Lucas (1988) endogenous regional model noted that cities function to transfer knowledge and generate powerful human externalities that increase productivity and spur growth. even if there are no technological spillovers. human capital. Studies on the impact of technological innovation on growth have been predominantly based on the neo-classical tradition established by Solow (1956). researchers have begun to examine growth that is endogenously determined by technical change resulting from decisions of profit-maximizing agents. A large body of empirical work has evolved from this focus on technological progress and innovation. 1990). . These studies have established that the level of technological innovation contribute significantly to economic performance. Solow (1957) long ago argued that economic growth relies upon technological change. conceptually parallel to Schumpeter's early growth theory (Entrepreneurship. 1990. More recently. In contrast to the Solow-like models. G Cameron.Innovation and its Effect on Economic Growth-Research Paper 4 knowledge leaks. Third. In the empirical side. the innovator does not appropriate all the social gains from innovation unless she can price discriminate perfectly to rival firms (through licensing) and/or to downstream users. imperfect patenting. Romer (1986) established the connection between knowledge.

This has both positive and normative implications for growth. “Openness” to new ideas. capabilities. a few studies have looked at the roles played by other measures of innovation. resources etc. creating opportunities for economic rent. but it may decrease the growth attributable to knowledge. This will raise the average rate of growth attributable to research. because they firstly have to reach the same level of the firms with the leading-edge technology and only after they can compete in order to achieve the leadership in the industry (Scopelliti. etc. Each innovation consists of a new line of intermediate goods that can be used to produce final output more efficiently than before. Pakistan can not be out rightly compared to USA. 2009). Peter Howitt. Therefore. other innovations are spun-off and more entrepreneurs enter the economic system. In positive terms. Growth results exclusively from technological progress. which in turn results from competition among research firms that generate innovations.Innovation and its Effect on Economic Growth-Research Paper 5 The developed economies today are increasingly based on knowledge and innovation. The principle reason for this has to with a fundamental characteristic of innovation: that every new innovation consists of a new combination of existing ideas. in terms of economic growth through innovation. is considered essential for innovation projects. Studies by Geroski (1989) and Budd and Hobbis (1989) conclude that patenting. 1942) by causing constant disturbances to an economic system in equilibrium. This clearly explains the reason behind massive growth of those countries whose investment in R&D is comparatively lesser. and imports of machinery from abroad (assumed to embody the latest technology) have a significant and positive effect on productivity (Gavin Cameron. In the knowledge-based economy the emphasis on knowledge as the driver of economic growth is evident. the prospect of a high level of research in the future can deter research today by threatening the fruits of that research with rapid obsolescence. markets. technology and learning. it can be compared to India who started its development process with Pakistan. The innovative activity of entrepreneurs feeds a creative "destruction process" (Schumpeter. 1990) creates losses as well as gains. obsolescence creates a negative externality from innovations. The emergence of the information society has contributed with improved ways for distribution of innovations through communications such as the Internet (OECD 1996 p 1 &7). and manufacturing processes. The early work of Schumpeter (1911) established conceptually the "entrepreneur as innovator" as a key figure in driving economic development. which has a history of over 250 years. the more research will be undertaken. solutions. it has to be kept in mind that they are leveled in terms of innovative capability. because the only way for society to engage in more research is to take labor out of manufacturing (Philippe Aghion. In adjusting to equilibrium. Schumpeter's theory predicts that an increase in the number of entrepreneurs leads to an increase in economic growth. The average growth rate and its variability are also affected by the extent of knowledge in the manufacturing sector of the economy. Technological progress (Philippe Aghion. The greater the coefficient of knowledge. In this way. 1990) While the main focus of empirical research has been the effect of R&D on productivity. Alessandro Diego. while comparing the countries. especially in its early phases. 1998). The firms with an initially lower technology cannot immediately acquire a technological leadership through innovation. by rendering obsolete old goods. In normative terms. Focus is set on the role of information. Peter Howitt. skills. and hence a tendency for the generation of too much growth. Applied mechanically on a population of countries this logic . However.

We can apply this by a Pearson correlation coefficient (otherwise known as ‘R’) to each independent variable. which tended to reduce it. 2003). which have to compensate for small internal resources by being good at interacting with the outside world. to closely monitor each other’s steps. as resulting from two sources. and search widely for new ideas. imitation and other efforts related to the commercial exploitation of technology. and imitation. as driving forces of growth. innovation. we can predict the dependent variable. Y = Predicted dependent variable value A = The value of Y when all Xs are zero B = The coefficients corresponding to dependent variables X = The independent variables n = The number of independent variables E = an Error term By forecasting the independent variables. R-Squared = (B’X’Y’-nAVG(Y)^2)/(Y’Y-nAVG(Y)^2) Where. modern countries are not closed systems comparable to isolated populations of ancient times.Innovation and its Effect on Economic Growth-Research Paper 6 might perhaps be taken to imply that large countries should be expected to be more innovative than small countries? However. which enhanced the difference. to ascertain that the relationships are not coincidental. innovation. the relationship between these variables and the dependent variables can be expressed as. X’. From this. often labelled “technology gap” focusing on explaining such differences in economic growth across countries at different levels of development. Fagerberg (1987. inputs and sources of inspiration. Y’ = Matrixes of all possible combinations of B. we must first assess the correlation between the dependent and the individual independent variables. The method looks at how a number of variables have affected a dependent variable historically. However. However. the growing complexity of the knowledge bases necessary for innovation means that even large countries increasingly depend on external sources in their innovative activity (Jan Fagerberg. Those variables with a high R-squared should then be used for multiple regression. Arguably. PART 4 ECONOMETRIC FRAMEWORK 4. The same correlation coefficient can be applied to multiple independent variables to ascertain how much of the change in dependent variable can be explained by changes in all independent variables. Posner (1961) explained the difference in economic growth between two countries. This set the stage for a long series of contributions. at different levels of economic and technological development. by necessity.1 MULTIPLE REGRESSION Multiple regression can be utilized for forecasting purposes. B’. This greatly enhances the innovativeness of the countries. Y = A + B1X1 + B2X2 + ….. this is of particular importance for smaller countries. X and Y respectively . + BnXn + E Where . This tells us how much a change in the dependent variable can be explained by the independent variable. Countries have learnt. 1988) identified three factors affecting “why growth-rates differ”.

employment in services. By choosing the period between 1995 and 2008 I could collect data for almost all the variables during that time period. The most evident problem is that variables that would be interesting to include in the indexes are hard to quantify and also that the research in this area is relatively new. Some of the results that have been derived from individual study of Australia suggest a positive correlation between various innovations and development in general. The selected variables that define innovation in any economy include patent applications. businesses newly registered. R$D expenditure and public spending on education PART 5 EMPIRICAL FINDINGS The data has been analyzed country wise individually to understand the relationship between various innovations and development the latter taken as dependent variable. F-Statistics = (R Squared/(K-1))/((1-R Squared)/(n-k)) Where.04 a 95. the number of variables and the number of observations. for this reason independent variables with high level of Multicollinearity with other independent variables are omitted from the analysis (as a rule of thumb the R-Sq of 90% would indicate this). A Study of the independent variable suggest that there’s a greater relationship between GDP growth and trade and employment ratio to population however the overall size of the sample limited a better understanding and most of the R-Squared values weren’t significant enough to . can lead to high variance in the slope estimation (B). This is known as “Multicollinearity”. It is often used to compare models involving different numbers of coefficients. 4. A critical point along the distribution can be found given a degree of confidence required. trade (as a % of GDP). If the F – statistics is above this point then the analysis can be deemed statistically significant at this level of confidence. K = Number of independent variables n = Number of observations Independent variables that are highly correlated themselves.95 % of change in annual GDP was explained by 11 of the independent variables adjusted for sample size bias and the analysis was significant. The standard statistical significance of the multiple regression can be tested with a F-Test which can be derived from a normal probability distribution. The formula Adj R-Sq = (1-(1-R-Sq)*((n-1)/(n-k))). Therefore. lending interest rate. The variables that I have chosen have been selected on the basis of theories concerning innovation. FDI. With an R – Squared value of 0. total employment to population ratio.2 DATA AND VARIABLES The data has been evaluated over 14 times periods which were chosen given the supply of data.99 and standard error of 0. the reader should bear in mind that the variables that are included in the index were chosen from a limited range of variables. researchers.Innovation and its Effect on Economic Growth-Research Paper 7 The adjusted R-Squared is calculated by correcting for the number of independent variables in multiple regression analysis. internet users.

the airplanes. seat belts and a vast list of innovations under its flag and has rightfully placed itself at the higher performers at the innovation index. PART 6 6. cell phones. Austria. Similarly the European countries like Holland. The results could not show a total positive relation because of the small sample size and the unavailability of some data. fertilizers. dynamite. telephone. The Multicollinearity analysis of various independent variables amongst them had various important things to suggest an understanding that there is a high correlation between Researchers (per million people) and expenditure on research and thereafter patent applications and employment and the number of internet users and employment to population ratio with the figures staying above 50%. Norway. Sweden has refrigerator. Denmark. light houses. LCD technology and so much more that it isn’t very surprising that out of all the Nobel prizes given in the world. pace maker. The most competitive states are ranked the highest because competitiveness comes from innovation and the results clearly show that most of these countries’ growth rests on their innovativeness. radar. MP3. the Concorde. burglar alarm. As a rule of thumb R-squared values below 50% suggest a low correlation. United Kingdom has had a gift of innovations in the field of forensics and medicine. Denmark. Reaping the benefits of such innovations and inventions that America finds its self at the top of the food chain as the lone super power and the lone power monger. DNA. Finland. the car. finger printing. stem cell technology. Belgium etc have maintained their active presence in the extensive fields of technology. However in various other cases the Multicollinearity was not as significant and most of the reading suggest a below 50% results. MRI. The overall finding was that innovation impacts significantly the growth of the country. the internet and most of the things we cannot survive without. aspirin. With x-ray. radio telescope and not to forget the infamous birth control have allowed the British civilization to put itself amongst the top of economic and social successes of all times. the computer. . The statistical findings of the other countries is given descriptively in Appendix B and the statistical working is attached in Appendix C. propellers.1 ANALYSIS America has always been the leading innovator of all times. www.. penicillin. British haven’t been behind and were trying to catch up with their innovations and their much rivaled Americans.Innovation and its Effect on Economic Growth-Research Paper 8 conclude a positive correlation. wrenches. hard disks. FDI and the patent applications proving that China’s growth is not due to its innovation due to research and development but due to the trade and imports of other countries. In the case of China the correlation is low in R&D expenditure and the number of researchers however the figures are over 50% in trade. stealth technologies. genetics. over 10 percent have gone to Germany in the past 15 years alone. vitamins. France. cathode ray tubes. Germany has always been the hub of well oiled machinery. spark plugs. electric motors.

Starting with meager facilities of its own. We now turn out attention to some countries that show a substantial deviation from the trend we witnessed above. For example. We witnessed the biggest cache of FDI. machine and vehicle technology and the father of quality products and production in the world. Taiwan. Pakistan since its inception has been unlucky when it came to innovation. The lone Nobel Prize winner was driven out on the basis of religion and politics form this free county who later on went to Italy to prove his capabilities. investment in human capital and infrastructure is minimal in the country and therefore there always is an acute shortage of quality worker and labor. different type of ores. The country is rich with natural resources like oil. copper. social and security environment. space optimization. still we see the country without the basic necessities like power. communication. the world’s most top peaks and the weathers of all colors. The innovation in the country has mostly been in terms of policies set by the government. the world’s largest population is one economic power that scares even the strongest of economies. They have always remained as the quality bench mark for the rest of the world to be followed. investment. opening of banks. politics and governance were all captured and held by such people who felt threatened by anyone else enjoying economic improvement. salt. The natural resources remain unexplored and unutilized and where expensive power is being produced on expensive rental power plants while it could have been produced almost for free. water and food for its people. soy bean cultivation. Yet. rice cultivation. They have a long record of R&D and innovations that have been of extreme economic benefits and growth. businesses and a stock market which made and broke records every day and a GDP growth rate in double figures. Then the investment in education. and several other fields. but innovations indeed have benefited the Chinese economy and dictated the way of life. we have noticed Pakistan as the world’s second fastest growing economy after Singapore about 4 years ago. rowing. industries are closing down doe to the exponential increase in the cost of production and the deteriorating political. gun powder. gas. paper etc may not have had that a great impact on changing the world. but the invention of noodles.Innovation and its Effect on Economic Growth-Research Paper 9 medicine. uranium. gas. China has been a good innovator. . coal. similarly Australia. which more often become the reason for the corrupt to do more and the end users to suffer. dams. we notice a trend. a huge coast line. Britain etc. lacquer.a trend that can be summarized as ‘’ countries who have innovated have had its great impact on its growth and overall wellbeing’’very understandable indeed. the government’s decision to control and highly tax the import of imported vehicles was an innovative step aimed to focus on the growth of local industry was turned into a scam by the car manufacturers in Pakistan my making cartels and monopoly in collaboration with high-ups in the government and politics. The land. of all the bad and worst as above. bio-technology. Japan is the pioneer of production lines. Korea. time motion study. compass. gold. The factories. Singapore and similar countries have performed extremely well in the recent past. China. For all of the countries mentioned above. it went into the hands of feudal lords who made it sure that no one but them benefited from anything that the country could offer. daggers. Therefore the educated and much talented people of this county have always opted to drain out and work for more welcoming economies like America. the factories.

Surprising. The outsourcing of call centers and the web hosting has given the best to India. gets its products made from china. It made a great amount of business from the products indeed. The economic crisis did hurt its growth and businesses but not as much as the rest of the world. Japanese TV sets are now made in china. made in America are sold to Americans on the phone or on the web from India. the cheapest cost of production areas can be exploited and every good opportunity can be exploited for the benefit of the business. Similarly. China enjoys the healthiest economy and the highest growth rate in the world. The innovation in technology.but no surprise. the most lucrative markets can be reached. when a product is sold in America. as china its growth rates have been very good and its economy has been in a boom for several years now. How does it work? Let’s analyze. and was ranked 43rd in the GII 2009-2010. it directly gives a positive effect to the Chinese economy. HP. 37 on the Global Innovation Index -2008-2009. It sells its products to every corner of the world and is able to flood the well regulated international markets with its low quality and cheap products. the cheapest labor can be reached. and every major American product is made in china. it has the cheap raw material edge and it has all the factors present in it for the other countries to be attracted to benefit from it and also to offer their products to the huge Chinese markets. China was ranked no. India too on the other hand has been average on the innovation scales but at the same time. iPhone. The economy has seen a steady growth and the business and services have seen a steady improvement. and the major portion of everything in the world is being made and supplied by china. The world was suffering from a slump recently and china was fighting hard to keep its growth rate in control to maintain the inflation rate in check. it has the labor edge. American products. Therefore the spill-over effect of an innovation becomes the reason for the positive growth of china and also due to the huge potential market for goods and services that it has to offer. the raw material for British medicines come from china. information technology and communication has shrunk the world in to a global village where everything is in reach for everyone. the top performer of GII 2009-2010. money is made in India. Therefore all the innovators of the world are on the look for cheaper places with cheaper labor and cheaper resources and raw material and easy laws. Dell. Why? Because china has the cost edge. an educated and talent workforce has helped it to become . American company Apple came up with cutting edge innovations like iPod. iPad. German cars have Chinese parts. so in essence every iPad or iPod that Apple sells. they get it made from china. Of course. Intel. and that’s where the cheap and educated labor class of India has played a huge role in its economic growth. yet we witness its growth rate has been more than the top performer USA of the 2008-2009 period and Iceland. but is it just American economy that has benefited from those innovations? No! Turn the products around and we see that they are all made in china.Innovation and its Effect on Economic Growth-Research Paper 10 It is surprising that with not much of its innovation. the cheapest suppliers can be reached. Therefore India has been extremely successful in using its world’s 2nd largest population to attract business for it being cheap and being the 2nd largest potential market for goods and services offered by the companies across the world. Finland comes up with a new Nokia handset. Countries like Pakistan. China and India have deviated from the trend for reasons that could be explained by the innovation and technology itself.

For the past two centuries.Innovation and its Effect on Economic Growth-Research Paper 11 a big market for web development. but it actually enables other economies to benefit from it sizably. . and technology embodied in capital and intermediate inputs. and movement of skilled labor to other firms. Third. In this new era. Fourth.”(Steve Jobs American Entrepreneur Apple co-Founder) I completely agree with this. 6. Increased education and economic growth have improved the capacity of developing countries to offer new products and services. Innovation can originate anywhere. imperfect patenting. software development and similar technological services for the foreign countries and companies. “Innovation distinguishes between a leader and a follower. each firm will benefit from both its own R&D/innovation. Though the benefits of R&D are widespread. Modern communications and transportation technologies allow these countries to share advances with consumer across the globe. the US has been the world-leader in developing innovative products and services. scientific literature. stepping on toes occurs because congestion or network externalities arise when the payoffs to the adoption of innovations are substitutes or complements. A number of externalities arise in the innovation process. First. As a result. technology licenses. Second. the domestic science base and research carried out by foreign governments and foreign firms. the innovator does not appropriate all the social gains from innovation unless she can price discriminate perfectly to rival firms (through licensing) and/or to downstream users. the standing on shoulders effect of technological spill-over reduces the costs of rival firms because of knowledge leaks. the economic benefits of an innovation are not reaped by the innovator alone. and personal contacts provide the means for research results to diffuse throughout the domestic and world economy. And in some cases the economic costs of the beneficiaries may be much less to the actual innovator as the initial cost of R&D gets avoided and it is much easier to produce and follow an innovation of someone else. Economists calculate that approximately 50% of US annual GDP growth is attributed to increases in innovation. It obviously indicates that innovation is the key driving growth and prosperity. but not alone. great ideas-regardless of where they originate-are less likely to be lost in our increasingly interconnected world. as well as the research results/innovation of other firms. It is not a coincidence that countries such as USA or Japan are the world’s top economies because their allocation of resources into creating innovation is massive. Patents. the creative destruction effect means that new ideas make old production processes and products obsolescent.2 FINAL WORDS It indeed is true that innovation leads to and results in positive effects over an economy. the surplus appropriability problem means that even if there are no technological spill-over.

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