Institutions should foster innovation, says expert

The mix of institutions that best determine an economy's ability to develop differs from nation to nation.

Institutions make an impact on innovativeness in the economy, which further makes an impact on productivity, says Edmund S Phelps, McVickar Professor of Political Economy at the Columbia University.

Institutions like company law and corporate governance rules and financial devices like stock exchanges and corporate bond markets can be expected to foster innovation, he says.

Phelps was delivering a lecture organised by the Indian Council for Research in International Economic Relations (ICRIER).

Some economic institutions, like workers' councils, big banks and job protection legislation, however, can be expected to restrict or intervene in facilitating innovation, investment or competition.

"A country's economic performance, thus how attractive and rewarding the economy is for its participants, is, at bottom, a matter of dynamism, of innovation, its spread and its directions," says Phelps.

Innovations normally increase productivity, which in turn, raises wages and this widens peoples' choices of careers and goods.

"Institutions play a role here," he says, adding that to assess the effectiveness of the institutions, one can look at three levels of innovational activity. The first is adoption of innovations, new products and methods for sale or copying from domestic producers and importers.

The second is adaptation for domestic use by entrepreneurial entities. This involves imitation, alteration or extension of technologies and concepts created and introduced abroad.

The third is the origination of innovations, beginning most often with the home market, though less so post-globalisation.

Adopting closed the internal gap between the economy's average technological practice and its best proactive while adapting closed the external gap between an economy's best practice and the international best.

An economy's dynamism therefore depended on the presence of institutions which facilitated and motivated adoption and adaptation and origination in exceptional cases.