Executive Thought Leadership

Return on Innovation

Investments in innovation within developing countries result in greater economic benefits than similar investments in developed countries.

Developing countries likely enjoy faster economic growth from their innovation investments than developed countries, according to Laza Kekic, director of Country Forecasting services at the Economist Intelligence Unit (EIU) in London. Kekic contributed to a 2007 report called “Innovation: Transforming the way business creates,” based on researchconductedby EIU and sponsored by Cisco.

Nigel Holloway, director in the Americas for Industry and Management Research at EIU, discussed the emerging-country advantage recently in an interview with Kekic.

Holloway: When we look at the evidence, is there a clear-cut relationship between innovation and growth?

Kekic: At the microeconomic level—the firm level—the overwhelming majority of studies point to a positive relationship between innovation and economic performance measured in a variety of ways. This was also true in the study that we undertook. On the other hand, when we look at other studies at the macroeconomic level—the country level—the evidence tying growth and innovation becomes more ambivalent. If we look at the relationship in one-dimensional terms, that is if we compare innovation and growth and don’t allow for other variables, and graph the two, the relationship seems negative.

Holloway: What did we do in this study to pin down the relationship between innovation and growth?

Kekic: We set up a model in which we related growth for a large sample—64 countries in this study—and we controlled for various other standard determinants of growth, such as investment rates, the level of schooling in a country, macroeconomic variables, the regulatory index, and so on. Only by controlling for these other influences on growth could we reliably try to assess the impact of innovation. Once we included these control variables—and we measured growth for these countries over the past 10 years—we determined that innovation is positively related to economic growth in the sample of countries.

Holloway: Were there other interesting findings from this model?

Kekic: Yes. There was one very interesting finding, and I would call it an apparent paradox. We found that less developed countries seem to get a disproportionately high return on their innovation. Per unit of innovation, the return in terms of increased output or growth was higher the less developed the country was. Most economic studies and most economists assume almost as a truism that domestic innovation is really only important for the richest countries and that poor countries basically import technology and grow on the basis of imported technology, imported innovation. Therefore, any innovation effort they undertake is at best a wasted effort. Our results are totally counter to that. They show that not only is there a significant return to innovation amongst less developed countries, the returns are apparently disproportionately higher for them than for developed countries.

Holloway: Is this the case for all emerging countries, or just a few?

Kekic: In our sample of 64 countries, about 40 were emerging markets. This study did not include the poorest economies in sub-Saharan Africa or very specific economies that depend on, say, just energy exports. Otherwise, this was a representative sample of emerging markets.

Holloway: What are the implications of that finding?

Kekic: The implications are quite profound: it does make sense for developing countries to foster domestic innovation. One quite convincing explanation is that countries cannot effectively absorb imported technologies into a void. The more domestic innovation base they have, the more efficient they will be at, for example, absorbing imported technology. This is especially important because the chief engine of their growth will still be based on imported technology.

Holloway: How did you actually measure innovation in the study?

Kekic: We basically measured innovation performance or innovation outputs, as we called it, by measuring international patent data. We used three different types of patent data and arrived at similar results. We experimented with alternative measures such as citations in scientific journals worldwide, survey evidence from business executives, and scientific literature, and they all correlated highly with the patent data.

Holloway: And how does all of this tie into the research?

Kekic: We looked at what we call direct inputs, which were things like the number of qualified people, scientists and engineers, and the level of R&D, both official and private sector. And then we looked at things that we call innovation enablers, which were the overall business, economic, and social environment measured in a variety of ways. The implication is that increasing these inputs will have a positive effect on innovation performance. What this means to emerging markets is that even if their innovations are inefficient—if per-innovation inputs result in fewer outputs than those of developed countries—their innovation will likely have a disproportionately positive impact on growth. Thus, contrary to some criticism of innovation efforts in the Chinas and Indias, proposing that they may not be the best use of their resources, it seems that these efforts might actually be quite fruitful. In China, for example, where other sources of growth, such as accessing cheap labor, will sooner or later become exhausted, this might be quite an efficient way for them to sustain their high growth rates.

Holloway: What are the main lessons emerging countries can learn from the study?

Kekic: Countries can do things to enhance their innovation performance. Their performance is not just a product of uncontrolled market forces. Countries can improve the environment through regulatory changes, decreasing tax burdens, and stimulating entrepreneurship. Fostering R&D in their economies, training scientists and engineers, and similar policies can also have a positive impact on innovation performance. And for poorer countries, innovation is quite a fruitful activity. Not all their growth stems from imported technology. There are apparently strong returns to growth from domestic innovation, which we hypothesize stems from the interaction between domestic innovation and domestic R&D with imported technology.