Should Public Policy Reward R&D Inputs, Outputs or Both?

Encouraging innovation is an important part of the bottom line for many state and local technology-based economic development programs. The advantages or "spillover effects" of growing localized knowledge economies or concentrations of researchers and technology firms has been studied by academia for more than two decades. Much of the attention of that analysis and of subsequent public policy has been on the knowledge or process side of innovation.

For instance, tax credits for R&D investments, present in more than 45 states based on SSTI research, reward almost any R&D expenditures by firms when, according to a recent working paper by Carmine Ornaghi at the Universidad Carlos III de Madrid, spillovers from product innovations are greater than those derived from process innovation. Spillovers in Product and Process Innovation: Evidence from Manufacturing Firms, which warrants additional research to confirm or refine its findings, suggests public policies targeted more exclusively toward encouraging product innovations by firms may be more effective and beneficial than a current portfolio of policies.

Most studies focus on the notion that technological innovation is inherently process oriented; or, in other words, the knowledge capital acquired by a firm improves the process through which input is changed into output. However, this overlooks an important element of innovation concerning upgrading the quality of existing products.

Ornaghi's research adds a demand equation to the standard production function model traditionally used and focuses more heavily on the output side of innovation by introducing a notion of operative R&D capital. The result is Ornaghi finds "that technological diffusion of product innovations is larger than the one of process innovations both in magnitude and pervasiveness." This finding implies the common approach of studying production can only contribute to part of the understanding about spillovers, Ornaghi argues.

Additionally, Ornaghi makes the following observations:

• Larger firms are more likely to adopt technologies developed at smaller firms than smaller firms may adopt technologies developed at larger firms.
• Knowledge spillovers are less important than internal R&D for productivity enhancement in firms.
• Industrial proximity plays a fundamental role for the technological diffusion of process innovations. And,
• Learning from rivals plays a fundamental role when it comes to improving the quality of the product.

Ornaghi concludes, "From our estimations, it emerges that the average gap between private and social rates of return is higher for product innovation than for process innovation. This suggests the opportunity of a different public policy towards taxation of R&D investments or government subsidies to R&D activities depending on the type of innovation that firms are focused on. More evidence is obviously required before moving in this direction."

The study analyzes data on more than 2,000 Spanish manufacturing firms from 1990 to 1998, using a database that details firms' individual input, R&D expenditure, types of innovation achieved and other demand-related variables.

Spillovers in Product and Process Innovation: Evidence from Manufacturing Firms can be downloaded at: http://docubib.uc3m.es/WORKINGPAPERS/WE/we023213.pdf