Innovation policy in an open economy: A normative framework for strategic and tactical issues

In this paper we present a normative analysis of innovation policy grounded in traditional economic principles which responds to the Schumpeterian critique of previous efforts in the neoclassical vein. Focusing directly on specific policy issues we pursue our analysis in two main directions, investigating the role of government in developing an infrastructure for innovation, and the optimal design of support schemes for R&D projects. The analysis suggests that while the structural and developmental issues stressed by the Schumpeterian school are of fundamental importance, identification of disparities between social and private gains, the "market failure" approach, provides an invaluable tool for understanding and formulating innovation policy. Focusing our attention on such factors as economics of scale, the incidence of externalities, and the Supranormal profits offered by imperfectly competitive markets, it provides a rational and realistic basis for anticipating where and how government intervention on behalf of industrial innovation is likely to be most effective. We view our contribution as a step towards bridging the gap between the neoclassical mainstream of economic analysis and the practice of innovation policy.