Introduction
Innovation and technological progress are widely recognised in the economics literature as key drivers of long-run economic growth. In the end, growth is about knowledge and ideas coming to fruition: inventing a new product, developing a new service, establishing a better way to manage a business, and so on.
The special characteristics of knowledge raise a number of issues and challenges for government policy.
Policymakers therefore need a rigorous understanding of the everyday concept of ‘knowledge’. But as we shall see, ideas are different from other types of goods. The special characteristics of knowledge raise a number of issues and challenges for policy. In particular, the benefits of a new idea are often experienced much more widely than simply by the person who came up with the idea. How does this affect the incentives for someone to spend time and energy creating an idea in the first place?
The current paper is the outcome of an internal Treasury project, the motivation for which was twofold. First, the importance of knowledge and innovation for long-run growth suggest the need for a thorough understanding of the underlying economics of knowledge. And second, New Zealand does not perform particularly well on some key indicators of innovation in the economy; in fact, innovation is one of the few underlying areas where we look weak (Economic Indicators Report, 2005). It was hoped that a better understanding of the theoretical and empirical literature around knowledge would provide a sound basis for further policy work on innovation, both within Treasury and across the wider public sector.
The paper begins by proposing a working definition of knowledge. We then discuss the main economic characteristics that this definition of knowledge entails and the possible problems (ie, market failures) that may arise as a consequence. Following this, the paper goes on to explore the linkages between knowledge, innovation and R&D, and looks in some detail at the empirical evidence on private vs social returns to R&D and what this evidence suggests about knowledge spillovers. Finally, we conclude with a discussion of broad policy implications.
It should be noted that the approach taken in this paper is to focus on knowledge from a firm’s perspective – ie, to look at how knowledge is created and used by firms as an input to production. This reflects the intent to consider the importance of knowledge through an economic-growth lens.
