Running head: INNOVATION AND ECONOMIC GROWTH 1

Innovation and Economic Growth

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May 27, 2022

Table of Contents
Introduction......................................................................................................................................3

Significance.....................................................................................................................................4

Role of Innovation in Economic Growth: A Macro Perspective.................................................4

Effects..............................................................................................................................................5

Impact and Mechanism....................................................................................................................7

Evidence from Research..................................................................................................................8

Conclusion.....................................................................................................................................10

References......................................................................................................................................12
INNOVATION AND ECONOMIC GROWTH 3

Innovation and Economic Growth

Introduction

As a key generator of economic growth, innovation positively impacts both consumers

and businesses. Innovation in the economic sense refers to creating and implementing new

concepts and technologies that enhance the quality or increase the productivity of goods and

services (European Central Bank, 2017). The invention of the steam engine in the 18th century is

a prime illustration of innovation in action. Railroads changed transportation by introducing

steam engines that could be used in industry. In more recent times, technological advancements

have changed the way businesses manufacture and advertise their goods and services, creating

new markets and business models. According to the European Central Bank (2017), economic

growth is one of the key advantages of innovation. Innovation has the potential to boost

productivity, meaning that the same amount of work can provide more significant results. In

other words, when productivity rises, more goods and services are produced, resulting in a larger

economy. New ideas and technologies are generated and implemented with the same input,

resulting in a more considerable output. As a result of the increased output, wages and the

profitability of businesses are rising (Wolff, 2015). Consumers and businesses alike gain

significantly from increased productivity and innovation. A rise in the pay of workers follows an

increase in productivity. They can purchase more goods and services because they have more

money in their wallets. Businesses can invest and hire more workers because of increased

profitability. When a new technology is first used in the company where it was developed,

innovation typically begins on a modest scale. However, to reap the full benefits of innovation, it

must permeate across the economy and help businesses of all sizes and sectors. The

dissemination of invention is a term used by experts. While Europe has a long history of
INNOVATION AND ECONOMIC GROWTH 4

invention and will likely continue to be an inventive continent in the future, there is room for

improvement in this area (Bilbao‐Osorio & Rodríguez‐Pose, 2004). European R&D expenditures

have been consistently lower than other major advanced economies. It also indicates that

innovation is spreading slowly throughout the Eurozone. According to European Central Bank

(2017), there is a significant variation in productivity between the most productive and the least

productive enterprises. On the other hand, the so-called laggard companies do not benefit

significantly from innovation despite high-performing frontier firms. In light of the above-

discussed information, this report aims to evaluate the role and significance of innovation in

economic growth and analyze its impact and mechanism using evidence from research.

Significance

According to McKinsey (2010), 84% of business leaders believe that innovation will be

critical to their companies' long-term success. Companies place a lot of importance on

innovation, even though it may sound like a buzzword to others. An additional benefit of

innovation is that it helps businesses remain relevant in a competitive marketplace and

contributes to economic growth. New inventions are essential to solving pressing issues, and

developing countries require them now more than ever (Cirera & Sabetti, 2016). Without

innovation, the modern world would not survive (Kline & Rosenberg, 2010). There are times

when innovation can have negative implications, but it leads to beneficial development in most

cases.

Role of Innovation in Economic Growth: A Macro Perspective

For decades, innovation has been a critical weapon in the fight against major social

dangers and risks. For example, the significant increase in CO2 emissions since the Industrial

Revolution has disrupted the global carbon cycle, resulting in a global warming impact
INNOVATION AND ECONOMIC GROWTH 5

(Gougoulias, Clark & Shaw, 2014; Ritchie, Roser & Rosado, 2020). Economic expansion, which

is primarily dependent on population growth, is the driving force of civilization. The population

of wealthy countries is dwindling and becoming older, and this trend is likely to continue

elsewhere in the world. As a result of innovation, these problems can be solved, and society's

ability to respond improves. It is in charge of coming up with new solutions to everyday issues,

often utilizing the most cutting-edge technology available (Taylor Buck & While, 2017). They

simultaneously fulfill a social need and improve capabilities and the utilization of resources. It

takes a wide range of stakeholders to tackle societal challenges.

Economic growth is strongly linked to technological advancement. As the market value

of products and services generated by an economy rises, it is considered to be growing

economically. The real gross domestic product growth rate, or real GDP, is the standard unit of

measurement. More inputs and innovative ways to get more output from the same inputs are two

common approaches to boosting economic production (Rosenberg, 20004). Increased output can

be achieved in either of these two ways. The latter is a good description of innovation's essence.

New ideas and technology that boost production and value while requiring the same input are the

goals of innovation.

Effects

The economic growth theory has helped economists understand the importance of

innovation in economic growth. Button (2011) uses the notion of endogenous growth to try to

explain long-term growth in industrialized countries. Using an endogenous approach to growth,

it is possible to analyze a wide range of variables, such as their impact on economic growth,

using econometric analysis. GDP, or the number of goods and services that people are willing to

buy over a certain period, can be used to gauge economic growth. There should be a positive
INNOVATION AND ECONOMIC GROWTH 6

association between economic growth resulting from technological advancement. Economic

growth, company competitiveness, and industrial dynamics are all enhanced when new ideas are

implemented in the workplace.

Scholars from various countries have empirically demonstrated the link between

innovation and economic growth. Early research by Horowitz (1967), for example, indicated that

areas with consistent growth rates of creative activities are linked to regular patterns of economic

growth in the United States. According to Zachariadis (2007), inventive effort significantly

affects productivity and output in OECD countries. Falk (2007) also showed a significant

correlation between GDP per capita and inventive activities in high-tech industries. Less

developed countries have also uncovered data that support this theory. According to Kim and

Lee (2011), innovation in South Korea accounts for 35% of total economic growth. An increase

in R&D spending in China leads to a 0.92 percent GDP growth, according to Peng's (2010)

findings.

There is increasing evidence that economic growth and job creation can be achieved

through innovation and the formation of new businesses. New goods, like voltaic heaps and

electric lights and new ways of arranging work, have expanded the industry. Marx and

Schumpeter's notion of innovation and its link to economic progress may be traced back more

than a century (Florida, Adler & Mellander, 2017). As capitalism grew, Marx contended, new

technologies became a permanent and disruptive factor in economic expansion. To him,

capitalism's advancement was hindered because of a fundamental contradiction between

economic growth and the limits placed on production. Schumpeter brought Marx's theories up to

date by incorporating concepts such as entrepreneurship and innovation. Capitalism's constant

reinvention was made possible by Schumpeter's belief in the power of entrepreneurship and
INNOVATION AND ECONOMIC GROWTH 7

innovation to keep the economy moving forward. His view of innovation and economic

transformation was similar to Marx's in that he saw them as part of a cyclical, disruptive

evolution (Rosenberg, 2011). Schumpeter saw innovation and entrepreneurship as the keys to

reset the economy for extended cycles of economic expansion. The 'development' sector of the

economy – as opposed to the 'circular flow' sector, which is guided by equilibrium – is driving

the uneven trajectory of economic progress. Visionary innovators and entrepreneurs driven by

more than simply financial gain and a desire for autonomy, distinction, and success are at the

heart of progress. Entrepreneurs do not take technology for granted; instead, they work to

influence its course. In capitalism, innovation is the dynamic that allows for bursts of change.

Impact and Mechanism

Education, technological advancement, and economic progress comprise a dynamic

circulation mechanism. Technological advancement and increased educational attainment have a

significant impact on economic growth. There is a direct link between higher education and

technical innovation, positively affecting the economy. As a result, increased education

investment requires a long-term perspective and long-term thinking for speedy success, and

immediate gains should be avoided.

Technological innovation has a vital role to play in economic growth. Still, neoclassical

economists overestimate its role because they treat the endogenous variable as an exogenous one,

fail to distinguish where progress comes from, and overestimate its role in stimulating growth

(Sredojević, Cvetanović & Bošković, 2016). According to the new economic growth hypothesis,

technological innovation is significantly influenced by accumulation and human resource level

elements. Since economic growth theory has been around for so long, there are numerous

subgenres and approaches to studying it. However, there appears to be agreement that technical
INNOVATION AND ECONOMIC GROWTH 8

innovation is the most crucial driver of economic expansion. The relationship between

technological advancement and economic growth is a cause and effect and a two-in-one

interaction (Zhou & Luo, 2018). Technology and growth are interwoven, and such a relationship

implies that technological innovation has a significant part in driving economic growth. As a first

step, the goal of technical innovation is to increase economic growth, which means that

technological innovation is not just another means to that end. Second, economic growth is a

prerequisite for demonstrating technological innovation, as growth in the economy directly

affects technological advancement (Zhou & Luo, 2018). Lastly, there is a direct correlation

between technological advancement and economic growth. Several stages of technological

progress correspond to different stages of economic growth, and these stages correspond to

varying levels of economic development in developed and developing countries.

Evidence from Research

Endogenous and evolutionary institutional and neoclassical models agree on the

importance of technological breakthroughs for economic growth. According to both theoretical

approaches, long-term economic growth is driven by technological change (Sredojević,

Cvetanović & Bošković, 2016). Neoclassical economists believe that growth is a fixed process

with clear causality and that policy decision should consider the causes of growth that are time-

invariant. History has a vital role to play when it comes to a company's growth. This means that

the cause-and-effect mechanisms popular at one time may not have the same significance or

impact later. All models of endogenous economic growth have one thing in common: external

influences and non-diminishing returns on production components are both present at the

aggregate level (Sredojević, Cvetanović & Bošković, 2016). The stagnant neoclassical economic

theory was conceptually overthrown by an endogenous growth model, which dispelled the idea
INNOVATION AND ECONOMIC GROWTH 9

that technological advancement is a time-limited phenomenon. When it comes to technical

advancement, knowledge, invention, and training are at the top of the priority list. These

components, along with the primary production variables of labor and capital, generate new

value. Use external influences to allow for non-diminishing returns on production components at

an aggregate level. Endogenous techniques eliminated the main shortcoming of neoclassical

theories, which state that economic progress tends to zero growth in the absence of technological

shocks. As a counterpoint to neoclassical growth models, evolutionary-institutional theories aim

to show that technical innovation is not a separate category from the production function

(Greenhalgh & Rogers, 2010). According to evolutionary growth theorists, the state's conscious

control activities can impact internal forces that drive technological change.

As a result of China's increasing economic clout in recent years, the country's average

living standards are now on par with those of several developed countries. Ever since China's

economic reforms and opening-up began in 1979, the country's economy has grown at an

exponential rate throughout this century (Xiong et al., 2020). With its reliance on export-oriented

and labor-demanding industries, China is exposed to external shocks like the 2008 US subprime

credit crisis and the current US-China trade war. China's officials think that innovation is the

only way to sustain long-term economic growth (Schaaper, 2009; Zhang, 2009). According to

some studies, innovation and GDP growth may not always be directly linked. Some researchers

say local economic growth may be constrained by R&D expenditure (Carlino, Chatterjee &

Hunt, 2007). Despite significant increases in R&D spending, the GDP growth rates of the OECD

countries have been stable for 40 years now.

It is widely accepted that innovation can considerably affect economic growth, job

creation, and the availability of goods and services to a broader population. Despite the focus on
INNOVATION AND ECONOMIC GROWTH 10

macroeconomics, redistribution plans, and financial help, the most reliable way to raise global

living standards for most of the population is through stable economic growth (Aghion, David &

Foray, 2007). Most people on Earth are better affluent than their parents and grandparents,

notwithstanding the upheavals over the last 200 years (Bruton, Ahlstrom & Si, 2015; Ahlstrom,

2015). As a result, hundreds of millions of people have escaped poverty and reached the middle

class in growing economies like China and India (Nair, Ahlstrom & Filer, 2007). Computers,

home healthcare, and mobile phones are examples of disruptive developments that have created

significant new growth in businesses by making previously unavailable goods and services

accessible to those with less education and financial means. Organizations and policymakers in

emerging economies can benefit from a greater grasp of innovation choices.

The link between economic growth and innovation is supported by empirical evidence

(Cameron, 1996). In addition to R&D spending, patenting, and invention counts, this research

addresses the ubiquitous effect of technological spillovers between enterprises, industries, and

countries. Three basic conclusions can be drawn. In the first place, innovation has a significant

impact on the growth of businesses. Research supported by the government has less impact on

the economy than research funded by private companies and industries. These spillovers are

typically localized, meaning that foreign economies benefit substantially less than their

American counterparts do from domestic innovation. Although technology "catch-up" may serve

to equalize output across countries, the process is likely to be lengthy and uncertain and requires

significant domestic innovative effort.

Conclusion

Open innovation has created new cooperation between academic institutions, research

facilities, and businesses. The world's leading R&D investors are working on a wide range of
INNOVATION AND ECONOMIC GROWTH 11

cutting-edge technology. In light of their increasing R&D efforts in recent years and the

contributions of prominent R&D investors, this is clear. The biggest corporate R&D investors

have expanded R&D investment in industries such as engines, automated driving systems, big

data, artificial intelligence (AI), and 3-D printing (Hausmann & Dominguez, 2022). For the

creation of new technology, it is necessary to have a combination of formal codified information

(such as formulas and scientific papers), as well as the tacit or "know-how" that can only be

learned by doing through a protracted process of imitation and repetition. Coded and uncoded

knowledge are essential to research, technology, innovation, and the creation of goods and

services. Nonetheless, the codifiable parts of science and technology are documented in scientific

articles and patents. Indicators of scientific and technological advancement and human skill

development include scientific articles, patents, industries, vocations, and products. Most

economists believe that technology developments are the primary driver of economic growth in

countries, regions, and cities. The key to economic prosperity is the efficient production of more

and better goods and services made possible by technological advancements.

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