Innovation and demand in industry dynamics: R&D, new products and profits

The links between three interconnected elements of the Schumpeterian sources of economic change are explored, conceptually and empirically, and related to the role played by demand factors. First, we examine the commitment of industries to invest profits in cumulative R&D efforts; second, the ability of industries’ R&D to introduce to new products in markets; third, the impact of new products on entrepreneurial profits. We consider the nature and variety of innovative efforts-distinguishing in particular between strategies of technological and cost competiveness-and we introduce the role of demand in pulling technological change and supporting profits. We develop a simultaneous three-equation model and we test it at industry level-for 38 manufacturing and service sectors- on six European countries over two time periods from 1994 to 2006. The results show that the model effectively accounts for the dynamics of European industries and highlights the interconnections between the different factors contributing to growth.