The role of innovation for growth is strengthened by advances in new technologies, and a greater focus on knowledge creation and use.  Much of the rise in living standards is due to innovation, as has been the case since the Industrial Revolution. Today, innovative performance is a crucial factor in determining competitiveness and national progress. Moreover, innovation is important to help address global challenges, such as climate change and sustainable development. But it is the application of advances in technology, in conjunction with entrepreneurship and innovative approaches to the creation and delivery of goods and services, which translates scientific and technological advances into more productive economic activity. This results in economic growth if market structures and the regulatory environment enable the more productive activities to expand. This said, the innovative effort itself, including formal research and development, remains the sine qua non of growth.

Evidence suggests that innovative effort is on the rise as a share of economic activity. Investment in knowledge has grown more rapidly than investment in machinery and equipment since the mid-1990s in most developing countries, and has surpassed the latter in a few countries such as Finland and the United States.  R&D intensity of the economy has risen significantly in a number of smaller developing nations, but remains more or less unchanged in the underdeveloped countries (such as Africa) as a whole since 1995.  But intellectual assets taken as a whole, a concept seeking to aggregate measures of human capital, R&D and capacity to conduct it, patent valuations as well as intangible assets such as brand value or firm-specific knowledge are rapidly becoming the key to value creation through a number of channels. Improvements in the skill composition of labor play an important role in productivity growth.

Studies suggest that investment in R&D is associated with high rates of return. And investments in software have also contributed significantly to business performance and economic growth, accounting for as much as one-third of the contribution of ICT (information and communications technology) capital to GDP growth since 1995 in China, India, Canada, Australia, Denmark, France, Netherlands, Sweden and the United States.

The importance of innovation has further, been reinforced both by globalization and by rapid advances in new technologies, notably ICTs, which have enabled new forms of competition and opened new markets for the creation and delivery of innovative products and services. Globalization has also increased the pressure on the developed nations to move up the value chain and engage in a continuous process of adjustment and innovation.

There has been a significant increase in R&D effort in a number of the developing economies.  Albeit, starting from a low base, the associated growth of R&D capabilities in a number of major emerging market economies is making them competitive destinations for cross-border R&D.  At least China among them is now a key global player in R&D in terms of absolute size as well as growth rates, with Gross Expenditure in R&D reaching USD115 billion in 2005 (at PPPs), compared to USD227 billion in the EU or USD118 billion in Japan in 2005.  India and Brazil are still behind but are slowly playing catch-up in this game.

As a result, major emerging market economies are no longer simply low value added producers but are adding their weight to the creation and commercialization of innovative products, processes and services. Trade data on the four most significant economies (Brazil, Russia, India and China; “BRIC”) show that these have become more active in higher technology industries over the past decade.

At the same time, many of the already developed economies around the world are facing difficulties in strengthening innovation. While, these developments make it even more urgent for the developed nations to move up the value chain, many of them face difficulties in strengthening innovation performance.

For example, progress along these lines under the aegis of the Lisbon strategy of the European Union has been slow. Nevertheless, the most recent evidence suggests that the renewed Lisbon Strategy may have had some success in helping to improve the European Union's performance in innovation and R&D.  Earlier OECD analysis (Sheehan & Wyckoff, 2003) has shown the economic and structural implications of policy initiatives to increase the R&D intensity of the economy, which is one of the key elements of the Lisbon strategy, and underlined the difficulty inherent in using R&D targeting as an indicator where success requires implementing policies across a broad range of domains, from R&D funding and entrepreneurship to immigration and education, to product, financial and labor market regulation.  Recent OECD analysis has shown that increases in R&D intensity and innovation are driven by a wide range of factors, including:

• Reduction of anti-competitive product market regulations, which stimulates business R&D and strengthens the incentives to innovate. Moreover, a low level of restrictions on foreign direct investment is important, as it can improve cross-border knowledge transfers.
• Stable macroeconomic conditions and low real interest rates which encourage the growth of innovation activity by creating a stable and low-cost environment for investment in innovation.
• Availability of internal and external finance.
• An expansion in public research, which can support business sector research, although expanding both at the same time will require efforts to raise the supply of human resources.
• Fiscal incentives, which can be effective in raising R&D, especially when firms face financial constraints. Tax relief for private R&D is often found to provide a stronger stimulus to business R&D than direct government support. This may be because much direct support for R&D is aimed at meeting government objectives, such as energy security or defense, and not at stimulating private R&D.
• Openness to foreign R&D, which is associated with higher productivity growth, especially when domestic R&D investment and capabilities are also high.

Innovation as a competitive advantage

Now, it is interesting to see that, over the last decade, there has been an increased focus on innovation in many businesses.  Much of this has been driven by several factors, including

• An increased rate of change in competition, especially the growing capabilities of India and China.
• Cost of information has fallen as the web has become more fully adopted, and consumers are demanding more.
• Focus on cost-cutting and outsourcing is reaching it's logical conclusion. Most of the things that could be cut, trimmed or outsourced have been. Many businesses in the US are relatively lean, and are turning to growth and differentiation.

All of these factors contribute to the need for innovation.  However, there are numerous trends that suggest innovation is important in the near future as well.

• The focus on global warming means new technologies are required to reduce emissions.
• Health care reform around the world, mean new demands on an antiquated health care system. As an example, the US Government is straining to provide services that the population expects and demands.  
• The banking sector is ripe for change and disruption.

All of these factors suggest a significant amount of change is in store for our government and for major businesses.  None of this is going unnoticed in the hallowed halls of major corporations.  Booz and Company has just released its yearly Innovation survey, and more than ever, innovation is moving from an interesting sideshow in most organizations.  Now, innovation is being recognized as offering a competitive advantage, perhaps one of the few sustainable advantages, and CEOs and executives are taking note. The survey points out that over 90% of the executives surveyed said innovation was critical to the success of their firms as they prepared for the market and economy to improve. One executive went so far as to say "the recession was a catalyst for increased innovation".  Booz listed three reasons why they felt companies have continued to invest in innovation during the economic downturn:

1. Innovation is becoming a core component of overall corporate strategy.
2. Recognition that product development cycles are longer than recessionary periods.
3. Many see the recession as an opportunity to build advantages over their competitors.

One of the biggest impediments to innovation continues to be the "constraints of the product development lifecycle".  The product development life cycle in many industries is simply too long and too cumbersome, and any opportunity to shorten the development life cycle could mean real rewards.  Conversely, any slacking off could mean falling behind the competition.  So, what we see, is Innovation is gradually moving from an occasionally interesting sideshow that is not focused and not strategic, to becoming a key focus of senior executives as they realize that only innovation can help the firm continually grow and differentiate. Innovation is rapidly becoming a capability or enabler that strengthens and focuses the corporate strategies, and should over time become a key enabler to many corporate goals and strategies.  Once more firms create a continuous capability for innovation and modify their cultures to embrace innovation; we should see the real transition occur.  It is interesting to see that more and more firms are placing more emphasis on innovation at a strategic level and are starting to look at different modes of Innovation, such as Open source Innovation, albeit Innovation.