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Productivity and Innovation are the only things that can drive Long-run Growth

Posted on January 26, 2017 by Tom McDonnell

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The world is changing and Ireland’s industrial and enterprise strategies will have to evolve if we wish to thrive in this new reality. One constructive step that the Irish government can take is to renew its focus on innovation policy with a view to building a world class National System of Innovation. Technological change and innovation have long been of fundamental interest to economists because of the belief that sustainable long-run economic growth and development along with improvements in quality of life depend on the ability of the economy to produce and diffuse new innovations.

What do we mean by innovation? Innovations are usually combinations of two or more existing ideas that manifest as new products or services, new processes, new markets, new sources of supply or even new organisations.

Useful ideas, unlike labour, land and capital, are non-rivalrous in use and explain economic growth by giving rise to economies of scale. The greater the spread or diffusion of economically useful ideas the greater the economy-wide benefits Yet inherent characteristics of knowledge mean that a self-regulating market will invest less than the socially optimal amount in knowledge generating activities. This provides a rationale for public investments in Research and Development (R&D) and other knowledge generating and diffusing activities.

The government will always be the innovation system’s key actor. Governments can use fiscal and other policies to address systemic market failures related to the underproduction and slow diffusion of knowledge and innovation. It can also support enterprises in the development of their own innovative and absorptive capacities. Finally, the government plays a key role in the development of innovation inputs most importantly through its funding of R&D, education, and knowledge infrastructure. The Irish government’s Innovation 2020 strategy commits to a research intensity target of 2% of GDP with one quarter of this coming from public investment in R&D.

While it is unwise to conflate innovation with R&D or to treat innovation as a linear process, it is notable that Ireland invests significantly less in R&D than do other similar small open economies in Western Europe. Government outlays are also below the OECD and EU averages. In addition, Ireland invests significantly less than peer countries on education per pupil, and Ireland has one of the weaker broadband networks in Western Europe.

Ireland is not a world leader when it comes to innovation according to most metrics with much innovative activity confined to multinational firms. Investment intensity in knowledge-based capital is in the bottom half of OECD countries for which data are available, and while Ireland is making progress in building up its scientific capabilities, its innovative capacity remains weaker than in other small advanced economies. These are concerns given the possible long-term implications for Ireland’s innovative competence and by extension Ireland’s prospects for productivity led growth.

These issues are discussed at length in the most recent NERI Working Paper which you can find here. Seminar slides are attached here.

Posted in: Government SpendingInvestment

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