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Innovation, Intellectual Property, and Economic Growth

Innovation, Intellectual Property, and Economic Growth

by Christine Greenhalgh, Mark Rogers
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What drives innovation? How does it contribute to the growth of firms, industries, and economies? And do intellectual property rights help or hurt innovation and growth? Uniquely combining microeconomics, macroeconomics, and theory with empirical analysis drawn from the United States and Europe, this book introduces graduate students and advanced undergraduates to the complex process of innovation. By addressing all the major dimensions of innovation in a single text, Christine Greenhalgh and Mark Rogers are able to show how outcomes at the microlevel feed through to the macro-outcomes that in turn determine personal incomes and job opportunities.

In four sections, this textbook comprehensively addresses the nature of innovation and intellectual property, the microeconomics and macroeconomics of innovation, and economic policy at the firm and macroeconomic levels. Among the topics fully explored are the role of intellectual property in creating incentives to innovate; the social returns of innovation; the creation and destruction of jobs by innovation; whether more or fewer intellectual property rights would give firms better incentives to innovate; and the contentious issues surrounding international treaties on intellectual property.

Clearly organized and highly readable, the book is designed to be accessible to readers without advanced economics backgrounds. Most technical materials appear in boxed inserts and appendixes, and numerous graphs and tables elucidate abstract concepts.

  • Provides a comprehensive overview of the economic causes and effects of innovation
  • Covers microeconomics, macroeconomics, theoretical and empirical analysis, and policy
  • Includes up-to-date coverage of trends and policy in intellectual property and research and development
  • Features mathematics appendix and keywords and questions to assist learning and teaching
  • Outline lecture slides are available online

Product Details

ISBN-13: 9780691137995
Publisher: Princeton University Press
Publication date: 01/24/2010
Pages: 384
Product dimensions: 6.00(w) x 9.10(h) x 1.10(d)

About the Author

Christine Greenhalgh is professor of applied economics at the University of Oxford and fellow and tutor in economics at St. Peter's College, Oxford. Mark Rogers is fellow in economics at Harris Manchester College, Oxford, and professor of the economics of innovation at Aston University.

Read an Excerpt

Innovation, Intellectual Property, and Economic Growth

By Christine Greenhalgh Mark Rogers

Princeton University Press

Copyright © 2010 Princeton University Press
All right reserved.

ISBN: 978-0-691-13798-8

Chapter One

The Nature and Importance of Innovation

1.1 Introduction

This chapter begins by defining what economists mean by innovation. Economists have focused on two main types: product and process. A product innovation is the act of bringing something new to the market place that improves the range and quality of products on offer: for example, the Apple iPod is an innovation compared with the Sony Walkman, which was an earlier portable device for playing music. A process innovation is a new way of making or delivering goods or services: for example, going to visit the doctor and recording that you have arrived for your appointment by touching a screen instead of talking to a receptionist. We shall highlight the basis of such innovations in the discovery and development of many types of new knowledge. We begin by outlining the whole supply chain of innovation: from its basis in such activities as scientific invention, mathematical theorems, computing algorithms, and information gathering activity through to the widespread diffusion of this new knowledge embodied in new products and processes within the economy.

Section 1.3 looks at the microeconomic effects of innovation. Using the standard microeconomic concepts of costs, demand, and consumer surplus, the outcome of both process and product innovation are analyzed. Even at this stage we encounter differences depending on the availability of intellectual property rights (IPRs) and the type of market structure of the relevant industry. Section 1.4 looks at the interactive nature of innovation, whereby sectors of the economy can act as both producers and users of innovations. Section 1.5 considers the important question of whether or not the private market can deliver the optimal amount of innovation. If there is market failure, there will be less innovation than the amount society would ideally want. Here we stress two aspects of the process of innovation that suggest possibilities for market failure. The first is that new knowledge-which is created during the innovation process-is what economists term a public good and such goods tend to be underprovided by the private market. The second is that innovation can create positive externalities in the form of spillover benefits to customers and other firms and these cannot be captured as revenue by innovating firms, again leading to underprovision of innovation. Section 1.6 introduces the ways in which public policies, such as subsidies to research and development or the award of IPRs, can, to some degree, restore the efficiency of private firms and markets in the supply of innovation. Finally, section 1.7 briefly introduces an important process whereby firms compete through innovation, which will be discussed in more detail in subsequent chapters.

1.2 What Is Innovation?

Innovation can be defined as the application of new ideas to the products, processes, or other aspects of the activities of a firm that lead to increased "value." This "value" is defined in a broad way to include higher value added for the firm and also benefits to consumers or other firms. Two important definitions are:

Product innovation: the introduction of a new product, or a significant qualitative change in an existing product. Process innovation: the introduction of a new process for making or delivering goods and services.

Some authors have emphasized a third category of innovation, that of organizational change within the firm, but we see this as being naturally included within the second category, as a type of process innovation.

Product innovations may be tangible manufactured goods, intangible services, or a combination of the two. Examples of recent tangible product innovations that have had a very significant impact on the way people live and work are personal computers, mobile phones, and microwave ovens. Intangible products that complement these types of physical equipment include the various pieces of computer software needed to control flows of information through these devices, leading to the delivery of information, the supply of communication services, or the arrival of a correctly heated dinner. Equally, process innovations, which are new ways of making and doing things, can arise from the use of new combinations of tangible and intangible inputs. A robotic machine to assemble cars can deliver welding services with even greater precision than a human welder, but is only as good as its computer control system.

Inherent in the above definitions of innovation is an element of novelty. The question then arises as to how much novelty is enough to identify any change as "innovation." A key issue here is to distinguish innovation, the bringing to market of a truly novel item, from imitation, the adoption of a new technique or design that is already in the market. A product or process can be new to the firm, new to the domestic market, or new to the world market. Clearly, the last of these, global novelty, is sufficient to qualify the product or process as an innovation. For those goods and services that are not internationally traded-whether due to the nature of the product, prohibitive transport costs, or restrictions on trade-the test of being "new to the domestic market" is sufficient to establish that there is an innovation within that economy. In our view, being "new to the firm" is an insufficient test for innovation, as the firm in question may simply be adopting a product design, or a production method, introduced by a competitor. In this book we call this the diffusion of innovation. We define an innovation as new to the firm and new to the relevant market. Whether this relevant market is local or global is dependent on the product or process in question and the degree to which it is traded in a competitive global or local environment.

Another feature of our two definitions of innovation is that the product or process must be introduced into the market place so that consumers or other firms can benefit. This distinguishes an innovation from an invention or discovery. An invention or discovery enhances the stock of knowledge, but it does not instantaneously arrive in the market place as a full-fledged novel product or process. Innovation occurs at the point of bringing to the commercial market new products and processes arising from applications of both existing and new knowledge. Thus we can see that innovation occurs at the kernel of a complex process, preceded by inventions and succeeded by the widespread adoption of the new genre of products by customers, or the adoption of best-practice processes in the majority of firms. We call this final stage diffusion, and it is clear that the benefits of innovation to the economy and its citizens are not fully realized until this has taken place.

Defining Knowledge and Technology

Already we have begun to make continual reference to knowledge and technology. What do economists mean by these terms? Economically relevant knowledge is the whole body of scientific evidence and human expertise that is, or could be, useful in the production and supply of commodities and in the invention and design of new products and processes. Knowledge can be codified, as in a chemical formula or computing algorithm, or it can be tacit, as when a person knows how to do something that is not written down, like mixing and serving a perfect cocktail. When knowledge is embodied in individuals it is often referred to as human capital, to distinguish this valuable asset from physical capital, such as machinery or buildings. For an individual, the acquisition of new skills and knowledge through education and training increases his/her human capital.

Technology encompasses the current set of production techniques used to design, make, package, and deliver goods and services in the economy. So technology is the application of selected parts of the knowledge stock to production activity. Within the firm, the technology used determines its productive capability when combined with other inputs. Inventions and discoveries add to the stock of knowledge that can be applied to production. Some types of innovations, termed process innovations above, add to the available stock of technology for production, while product innovations add to the choice of products facing final customers.

The Stages of the Innovation Process

The innovation process has a number of stages that can be distinguished, as shown in figure 1.1. At each stage of the process there are activities requiring inputs of knowledge, embodied in skilled personnel and specialized equipment, and investment of time in using these resources. Additionally, each stage, if successful, produces an output, initially intangible in the form of new knowledge but later tangible if applied to goods for sale-although sometimes remaining intangible if applied to some kinds of service activities.

The first stages (1-3) of the innovation process produce basic scientific knowledge, plans for new processes or blueprints, and initial prototypes of new products or processes. This is when we may talk of "inventions being made" and the hard work, or genius, of inventors. All of this activity is frequently lumped together as research and development (R&D), but it represents premarket activity by a variety of agents, including public scientific institutions, universities, lone inventors, and firms. It is only when stage 4 is reached, at the point where there is a marketable product or new process, that innovation is achieved. This phase of commercialization triggers the start of another chain of events, broadly characterized as diffusion (stage 5), which covers the widespread adoption of the new product or process by the market. It is also vital to understand that there is feedback between the various stages: innovation is rarely a linear progression through the stages shown. There is also feedback between the diffusion and innovation stages. As consumers, or other firms, start using the innovations, they often adapt or improve them, or relay information on how to do so back to the innovating firms. This type of refinement, or incremental innovation, is often very important as the initial product or process is rarely perfect.

Incremental innovation can be contrasted with drastic innovation. The first makes a small change to an existing process or product. Drastic or radical innovation introduces a completely new type of production process with a wide range of applications and gives rise to a whole new genre of innovative products. Steam engines, the internal combustion engine, electricity, microprocessors, and the Internet can all be considered examples of drastic innovations. Their introduction dramatically changed the way the economy worked and a huge range of other innovations followed in their wake. Box 1.1 discusses the specific example of the laser, originally invented and patented in the late 1950s. The laser gave rise to a number of drastic product innovations, such as compact discs and laser printers, each of which then underwent a series of incremental innovations. In addition, the laser also led to a number of drastic process innovations, such as the use of lasers in welding and surveying.

For any single innovation, all of the stages 1-4 in this diagram are not always conducted in a single firm. In many sectors of the economy public research institutions and university departments will be contributors to the flow of new knowledge that can be translated by firms into innovations. We shall discuss this relationship between the so-called science base and private industry in chapter 4. Even where the relevant new knowledge is produced commercially there can be a separation of activity across firms. In fields such as biotechnology and pharmaceuticals, specialist firms exist to perform the R&D of stages 1 and 2, while other firms supply stage 3 testing services for potential new drugs. All of these activities can take place at arm's length from the final marketplace, under contract from the firms that will eventually bring successful new products to the market. This merely indicates that specialization and contracting-out can occur in any part of the innovation process, so long as suitable contracts can be written and enforced.

1.3 The Microeconomic Effects of Innovation

We have already seen that there are two main types of innovation: process innovation, the introduction of new techniques for production, and product innovation, the offer for sale of a new type or design of a good or service product. Of course, these two are not always independent: often it is the introduction of a new process that permits the design and development of a range of new products, while the introduction of a new intermediate product permits a purchasing firm to change its production process. For the moment though, let us consider the different nature of the two kinds of innovation to examine how they impact on prices and costs. Their impact will, in turn, depend on the "market structure" in which the firm operates. Market structure refers to the nature of competition between the firms in the market. The two polar cases are "perfect competition," where there are a larger number of firms, and monopoly, where one firm dominates the market.

The Effects of Process Innovation

The essential effect is one of cost reduction in production. In economics, total costs are divided into fixed and variable costs and, in turn, we can define average costs (ACs) and marginal costs (MCs). Figure 1.2 shows a simple case where, before the innovation, firms have costs [AC.sub.1] and [MC.sub.1], which are equal (meaning there are no fixed costs). The demand curve for the industry is shown (and we will assume that this is unchanged in the case of a process innovation). If the industry is perfectly competitive, we assume that there are many firms, and each of these will set their price equal to [MC.sub.1], hence the output produced and sold is [Q.sub.1] (at price [P.sub.1]). Economists refer to the consumer surplus as a measure of benefit-it is the area between the demand curve and price-and this is the shaded area in figure 1.2. The process innovation is assumed to reduce the average or marginal cost of production. In our simple case, marginal and average costs are equal, so we can illustrate the impact of the process innovation by a fall to [AC.sub.2] = [MC.sub.2]. This also means that the price to consumers has fallen (to [P.sub.2]) and the consumer surplus has risen (it is now the area above [P.sub.2] and below the demand curve). It is important to note that there are no IPRs in this example. If the market is perfectly competitive, all knowledge about production is assumed to be known by all firms. Hence, as soon as the process innovation occurs we assume that all firms immediately start to use it (the problems with this assumption are discussed in chapter 7). In such a case there is no financial incentive to undertake R&D targeted toward creating the process innovation. Note that this occurs since prices are equal to marginal costs and average costs. This means that there are no economic profits to reward the innovator.

The above case considered a perfectly competitive market with many firms selling an identical product. Given this situation, and the assumption of immediate knowledge diffusion, there is no financial incentive to develop a process innovation. Process innovations could occur if they originated by chance or were made by those unmotivated by financial incentives. Consider now a world where IPRs exist and where any process innovation could receive perfect protection. If one firm in the industry developed the process innovation discussed above, and secured a patent on it, it would be possible for that firm to undercut the price charged by any other firm. The innovator could produce and sell the good for a price [P.sub.1] - [epsilon] (where [epsilon] is a small number). At this price it would sell almost [Q.sub.1], meaning that the profits it could make are approximately ([P.sub.1] - [epsilon] - [AC.sub.2]) ? [Q.sub.1]. Even if the innovator did not want to produce all of the market demand, in principle it could license its process innovation to all other firms and receive royalties equal to these profits. Introducing patents certainly increases the financial incentive to innovate.


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Table of Contents

Preface xi

References xvi

I The Nature of Innovation 1

1 The Nature and Importance of Innovation 3

1.1 Introduction 3

1.2 What Is Innovation? 4

1.3 The Microeconomic Effects of Innovation 9

1.4 Interaction between Producers and Users of Innovation 16

1.5 Innovations and Market Failure 17

1.6 Restoring Incentives to Invent and Innovate 23

1.7 Firms Competing through Innovation 28

1.8 Conclusion 29

References 30

2 The Nature and Role of Intellectual Property 32

2.1 Introduction 32

2.2 Why Are Intellectual Property Rights Awarded? 32

2.3 Patents 34

2.4 Trademarks 39

2.5 Designs and Utility Models 43

2.6 Copyright 45

2.7 Further Questions about IPRs 49

2.8 Conclusions 53

References 55

3 The Measurement of Innovation, Productivity, and Growth 57

3.1 Introduction 57

3.2 How Can Innovation Be Measured? 58

3.3 Illustrations of Innovation Statistics 64

3.4 Productivity at the Firm, Industry, and Economy Level 70

3.5 Comparing Productivity and Growth across Countries 74

3.6 Conclusion 80

References 82

II The National Innovation System 85

4 The National Innovation System 87

4.1 Introduction 87

4.2 The National Innovation System 87

4.3 The Central Role of R&D 88

4.4 The Government-University Axis 92

4.5 The University-Business Axis 95

4.6 The Government-Business Axis 103

4.7 National Innovation Systems in Emerging Markets 106

4.8 Conclusions 110

References 112

5 Innovative Firms and Markets 116

5.1 Introduction 116

5.2 Entrepreneurship and New Firms 116

5.3 Innovation and Firms 119

5.4 Markets and Innovation 121

5.5 Empirical Evidence on the Returns to Innovation 132

5.6 Evidence on Interactions between Competition and Innovation 140

5.7 Conclusions 142

References 145

6 Intellectual Property Rights and Firms 149

6.1 Introduction 149

6.2 How Can Firms Benefit from IPRs? 150

6.3 Exploring the Returns to IPRs 152

6.4 Markets for IPRs 157

6.5 Costs of Obtaining and Enforcing IPRs 160

6.6 IPR Strategies 162

6.7 Empirical Studies on the Value of IPRs 164

6.8 Conclusions 171

References 173

7 Diffusion and Social Returns 177

7.1 Introduction 177

7.2 Modeling the Rate of Adoption of an Innovation 179

7.3 Statistical Evidence on Rates of Adoption 186

7.4 Spillovers and Social Returns to Innovation 190

7.5 Empirical Studies of Social Returns 199

7.6 Spatial Dimensions of Spillovers 204

7.7 Conclusions 205

References 207

III The Macroeconomics of Innovation 211

8 Models of Economic Growth 213

8.1 Introduction 213

8.2 The Neoclassical Growth Model 215

8.3 Endogenous Growth Models 225

8.4 Evolutionary and Other Models 237

8.5 Conclusions 239

References 241

9 Innovation and Globalization 243

9.1 What Is Globalization? 243

9.2 World Trade in Historical Perspective 245

9.3 Theories of Trade and Growth 246

9.4 International Knowledge and Technology Flows: Theory and Evidence 250

9.5 International Financial Flows 256

9.6 International Aspects of IPRs 260

9.7 Conclusions 263

References 266

10 Technology, Wages, and Jobs 268

10.1 Introduction 268

10.2 Microeconomic Models of Innovation and Labor Markets 268

10.3 Innovation and Labor Markets; Evidence from Firms 275

10.4 Macroeconomic and Trade Models of Innovation and Labor Markers 280

10.5 Conclusions 289

References 291

IV Economic Policy 295

11 Microeconomic Policies to Promote Firm-Level Innovation 297

11.1 Introduction 297

11.2 Is the Intellectual Property System Working? 297

11.3 Incentive Systems for Encouraging Firm-Level R&D 313

11.4 Other Innovation Policies 317

11.5 Conclusions 323

References 325

12 Macroeconomic Issues and Policy 329

12.1 Introduction 329

12.2 Macroeconomic Evidence on IPRs and Economic Growth 330

12.3 Trade-Related Aspects of Intellectual Property (TRIPS) 334

12.4 Intellectual Property Rights, Exhaustion, and Parallel Imports 340

12.5 Piracy and Counterfeit 342

12.6 R&D in the Global Economy 344

12.7 International Migration of Skilled Labor 346

12.8 Conclusions 347

References 349

Mathematical Appendix 353

A.1 Production Functions 353

A.2 Present Discounted Value 354

A.3 Derivatives 355

A.4 Marginal Products and Diminishing Returns 356

A.5 Accumulation Equations and Growth Rates 357

A.6 Logarithms and Production Functions 358

A.7 Differential Equations and a Catch-up Model 358

A.8 Estimating Production Functions 359

Refereces 360

Index 361

What People are Saying About This

David Audretsch

This important book breaks new ground in identifying and analyzing the key ingredients driving economic growth. By weaving together the links between intellectual property and innovative activity and their ultimate impact on growth, Greenhalgh and Rogers provide a new and original framework for guiding both public policy and future scholarship, one that is compelling and accessible.
David Audretsch, Max Planck Institute of Economics and Indiana University


This excellent book fills a need for an undergraduate- and master's-level text on the economics of innovation, one that covers both the micro- and macroeconomic aspects. It will also be useful reading for anyone who wants an introduction to the way economists analyze topics such as research and development incentives and innovation, and how these factors contribute to growth.
Bronwyn H. Hall, University of California, Berkeley, and University of Maastricht

Roberto Verganti

Greenhalgh and Rogers have gifted us with a comprehensive perspective on the micro- and macroeconomics of innovation. This is a precious companion for all those who want to achieve a deeper understanding of the complex dynamics of innovation.
Roberto Verganti, author of "Design-Driven Innovation"


The authors have achieved the remarkable feat of comprehensively summarizing the extensive and diverse literature on the sources, types, and effects of modern innovation. The book will appeal to advanced undergraduates and master's-level students and is likely to become a standard reference and text for courses in innovation, management strategy, and global business.
Keith E. Maskus, University of Colorado at Boulder

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