Knowledge, R&D, and innovation

A useful way of thinking about the role knowledge plays in innovation is to consider what processes drive a firm’s innovation performance (and ultimately productivity), and what factors influence each of these processes. This discussion is not intended to be exhaustive, but to identify the key features of innovation by firms.

Innovation at the firm level depends on creating, absorbing, and applying knowledge.

The diagram below sets out the drivers of a firm’s innovation performance: ability to accumulate knowledge and ability to apply that knowledge, where knowledge can be accumulated by either creating new knowledge or absorbing existing knowledge. These different processes are discussed in turn below.

Figure 1 – Firm-level processes that drive innovation

Knowledge creation

Knowledge creation is the process of coming up with new ideas. The most obvious method of knowledge creation is formal R&D, defined by the OECD’s Frascati Manual as follows: “Research and experimental development (R&D) comprise creative work undertaken on a systematic basis in order to increase the stock of knowledge, including knowledge of man, culture and society, and the use of this stock of knowledge to devise new applications.” (OECD 2002) However knowledge can also be created informally, such as through on-the-job idea generation.

Factors influencing knowledge creation within the firm will include the amount of R&D being performed, the effectiveness/efficiency of that R&D, the level of human capital, and the firm’s organisational structure and incentives for informal innovative activity.

Knowledge absorption

Knowledge absorption is the process of acquiring knowledge from outside the firm, such as from universities, public research organisations, other domestic firms, or from overseas. Absorption is important because the vast majority of new knowledge is created outside any particular firm. In fact, for a small country like New Zealand, the majority of world knowledge is created outside of the country – for example, less than 0.2 percent of OECD R&D expenditure occurs within New Zealand.

Firms can apply some external knowledge immediately, but in most cases they will require some internal capability to (a) be aware that it has been created elsewhere, (b) make sense of it, (c) realise its applicability to the firm, and (d) adapt it to the New Zealand context.

Factors influencing knowledge absorption include human capital, R&D capability, linkages with external sources of knowledge (eg, universities, public research organisations, or other firms), and access to “embodied” knowledge, such as through imported capital equipment (DeLong & Summers, 1991). The excludability of existing knowledge – for example, in terms of legal intellectual property protection – will also have an important influence on knowledge absorption.

Knowledge application

Finally, knowledge application is the process of using accumulated knowledge to create value for the firm, through commercialisation of a new good or service, or implementation of a production process for example. This process is by no means trivial, and is likely to require different capabilities to those involved in knowledge creation or absorption – for example, good business management, marketing skills, and so on.

How important is R&D for successful innovation?

Clearly, R&D is not the only driver of innovation performance, nor is it the only mechanism available for creating new knowledge. The importance of R&D relative to other drivers of innovation is an empirical question, albeit a difficult one to answer.

On balance, the evidence suggests that R&D is an important input into innovation, via both knowledge creation and knowledge absorption.

The evidence does suggest, however, that there is a strong link between business R&D and the level of patenting activity^[7], which is one widely-used measure of innovation performance and may give some indication of the potential value of new knowledge – if we assume that knowledge with commercial value is more likely to be patented. There is also evidence that business R&D in particular is positively linked with economic growth (eg, OECD Growth Study 2001).

On the other hand, there does not seem to be as strong an association between business R&D and the level of reported innovation in firms – based on survey measures of the proportion of firms that have introduced a new product or process^[8]. It is difficult to know how best to interpret this finding however, since the survey measures do not give a very clear idea of the value of the innovations that have been introduced.

As well as being an important driver of knowledge creation, the evidence suggests that R&D helps to facilitate knowledge absorption (see Griffith, 2000). This is presumably because carrying out R&D within a firm (or within a country) leads to greater awareness and understanding of external knowledge, and also increases the capability (eg, through higher human capital) to apply this knowledge.

On balance, we think the evidence suggests that R&D is an important input into innovation, via both knowledge creation and knowledge absorption, but other factors are also likely to be important. R&D also has at least two other features that make it of interest from a policy perspective. First, there are relatively well-established systems for measuring it (unlike more “informal” mechanisms for knowledge creation, which are difficult to measure and compare across countries) and therefore it is likely to be a useful indicator for policy purposes. And second, there is good empirical evidence of spillovers from at least some types of R&D. This evidence is discussed in the next section.