Conclusions
Knowledge is a fundamental input to innovation and hence to economic growth. The characteristics of knowledge discussed in this paper – non-rivalry, incomplete excludability, the cumulative nature of knowledge, uncertainty, and lags – suggest the possibility of market failures around knowledge. The key market failures are:
- Spillovers. A firm’s inability to fully capture the benefits of knowledge creation and absorption is likely to lead to under-investment. Spillovers are likely to be greater where knowledge has broad application and is less excludable.
- Competing incentives for creation/diffusion. The often high fixed cost of creating knowledge and the zero marginal cost of use of existing knowledge create a tension between incentives for knowledge creation and diffusion.
The empirical literature provides some support for the existence of market failures, at least in the case of R&D, where quite consistent evidence of spillovers is observed in terms of a large gap between the private and social rates of return. 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.
The important questions to answer are the costs of different policy options, relative to their benefits, and where New Zealand sits relative to the socially optimal levels of knowledge creation/diffusion.
A range of policy and institutional responses have arisen to address market failures around knowledge, and the main options have been outlined in this paper. It is important to keep in mind however that different types of knowledge will possess the characteristics outlined in this paper to varying degrees (particularly for non-excludability), resulting in a continuum of potential for market failure. The extent to which the characteristics of knowledge lead to market failure also depends on the voluntary actions taken by agents in the innovation system.[17] Finally, government interventions to address problems around knowledge also have costs and risks. The key questions thus become (1) what are the estimated costs of different policy options, relative to their benefits[18], and (2) how does the current situation sit relative to the socially optimal levels of knowledge creation and diffusion?
Overall, the theoretical and empirical evidence outlined in this paper provides a rationale for focusing policy attention on issues related to knowledge and innovation. It also outlines a high-level policy framework for evaluating relevant policy and institutional responses. The 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.
