4 Factors Behind an Innovation Economy

Jonathon Avidor of the Northwestern University School of Law and the Kellogg School of Management recently published a timely paper that contained a thorough survey of the leading academic ideas regarding preconditions for encouraging innovation in a nation's economy  by examining the preconditions for Israeli innovation over a 30 year period. His review considered: public R&D grants, human capital acquisition, intellectual property rights, financial reforms, venture capital policy and cultural factors.

The paper also lends fresh empirical support to the notion that these factors can be emulated and distinguished by other governments and organizations (ie. deliberate policy-making or responses to market indicators) and can be distinguished from those which resulted from historical chance (ie. luck). Key public policy lessons and limitations of innovation policy were also discussed.

I'll summarize the conclusions of the paper as follows:

The emergence of an innovation economy requires proper alignment of key factors:

1. economic incentives,

2. access to financial capital,

3. skilled human capital, and

4. unrestricted access to information.


And here's a key point: "Over a 30 year period, Israel created or acquired these necessary building blocks through a combination of focused R&D policies, immigration dynamics, robust education and military training infrastructure, financial reforms, venture capital policy and cultural factors."

Further: "...intelligent policy-making in pursuit of strategic objectives and responses to market conditions combined to play a crucial role in combating market failures and promoting innovation. As a result, important lessons can be learned from the Israeli experience in acquiring each of the four required factors for building an innovation economy."

Israel created proper economic incentives for innovation by: 

  1. reducing the cost of capital through financial reforms and direct R&D support, leading to an increase in the expected value of innovation to inventors; 
  2. increasing the appropriability of inventions by strengthening local intellectual property protections and foreign reciprocity, effectively increasing the expected value of innovation to inventors; and 
  3. increasing the probability of success by providing resources for new entrepreneurs, further increasing the expected value of innovation to inventors.  

Israel developed adequate access to financial capital by:

  1. providing direct R&D grants to industry in a horizontal and neutral, market-led fashion in order to bridge the funding gap caused by information asymmetries, leading to the development of a critical mass of technological advancements and startups; and
  2. building a venture capital industry to provide growth capital and management expertise for startups which have reached the marketing/growth stage.

Israel acquired and developed sufficient human capital by: 

  1. building a large network of academic institutions that were responsive to industrial needs; 
  2. encouraging immigration of skilled engineers and scientists to increase the pool of qualified innovators (perhaps benefitting from a bit of historical luck);
  3. and facilitating an efficient military-civilian transfer of skills and know-how.

And finally, Israel provided adequate access to information by: 

  1. sponsoring knowledge intermediaries, conferences, consortiums between industry and academia, foreign participation in pre-competitive knowledge generation and comprehensive databases with shared information; and 
  2. facilitating an efficient military-civilian transfer of knowledge and technological progress.