Summary

Knowledge is a key driver of long-run economic growth...

Innovation is a key driver of long-run economic growth and depends on the accumulation and application of knowledge. Knowledge can be thought of as a type of instruction or recipe that sets out how a good or service can be produced. Unlike standard economic commodities, knowledge has a number of special characteristics. Most importantly, knowledge is non-rival, meaning that once an idea has been developed, others can use the idea at no additional cost. In addition, knowledge is characterised to varying degrees by an inability to exclude others from using a particular idea, by uncertainty in the results of research, and by lags between when ideas are first formed and when they can be used commercially. Knowledge is also cumulative in nature: it builds on past knowledge.

…but markets alone may fail to deliver the best  outcome for society…

These characteristics together create the potential for markets on their own to fail in delivering the best outcome for society. Specifically:

• knowledge can ‘spill over’ to those who did not create it, resulting in a social return to knowledge creation that is greater than the private return; and
• there is a tension between providing incentives to create knowledge, and encouraging knowledge to be made widely available after it has been created.

The empirical literature on returns to R&D provides support for the existence of knowledge spillovers, as observed in a large and consistent gap between the private and social rates of return to R&D investment. New Zealand-specific evidence is limited, but also finds some evidence of spillovers. Overseas studies suggest that New Zealand’s small size may reduce the returns to R&D investment, while distance from the technology frontier may increase them.

…suggesting a role for government in specific interventions.

A variety of institutions and policies have evolved to address potential problems around knowledge creation and diffusion, including intellectual property rights, open science, subsidies for private R&D, and subsidising the supply of human capital. All of these interventions have costs and risks as well as potential benefits: the key questions thus become (1) what are the estimated costs of different policy options, relative to their benefits, and (2) how does the current situation sit relative to the socially optimal levels of knowledge creation and diffusion?. This paper is intended to provide a basis for further and more detailed analysis of specific policy proposals, with a view to improving New Zealand’s innovation performance and raising its rate of sustainable economic growth.