Innovation is an important driver of improvements in productivity. But what drives innovation itself? This chapter looks at the reasons for the significant variation seen in the rates of innovation of individual countries and sectors, as documented in Chapter 1.
Various factors influence firms’ incentives and ability to innovate, ranging from the prevalence of corruption to the availability of an adequately skilled workforce and access to finance. Some of these factors are internal, reflecting either characteristics of the firm (its size or age, for instance) or decisions made by the firm (such as the decision to compete in international markets or the decision to hire highly skilled personnel). Other factors are external and shape the general business environment in which firms operate (such as customs and trade regulations).
In some cases, the two are closely related: each firm makes personnel decisions that determine its ability to innovate, but these decisions are, in turn, strongly influenced by the prevailing skills mix and the availability of a sufficiently educated workforce in the region where the firm operates. Similarly, Chapter 4 shows that the local banking structure (an element of the external environment) has an impact on firms’ funding structures (an internal aspect), which then affects innovation. Even if firms share the same business environment, they will not necessarily make the same business decisions, and these decisions will influence their innovation activity.
This chapter examines internal and external drivers of innovation, looking at both firm-level and country-level evidence. The firm-level analysis builds on the first two stages of the model discussed in the previous chapter, which explained firms’ decisions to engage in research and development (R&D) and introduce new products or processes. This analysis uses a rich set of data looking at firms’ perceptions of the business environment. The data were collected as part of the EBRD and World Bank’s fifth Business Environment and Enterprise Performance Survey (BEEPS V) and the Middle East and North Africa Enterprise Surveys (MENA ES) conducted by the EBRD, the World Bank and the European Investment Bank. The country-level analysis uses a large sample of countries, including those from the transition region, to explain both innovation at the technological frontier (measured as the number of patents per employee) and the innovation intensity of exports (a broad measure of innovation and the adoption of technology that was introduced in Chapter 1).
The chapter starts by considering drivers of innovation within an individual firm, looking first at firm-level characteristics (such as a firm’s size and ownership structure), before turning to decisions made by firms (such as the decision to export or the decision to conduct R&D). The analysis then moves on to external factors, first comparing innovative firms’ perception of the business environment with the views of non-innovative firms. These views guide the discussion of the key external factors that affect innovation outcomes at country level.