No money, no honey? Financial versus knowledge and demand constraints on innovation

Abstract

The paper adds to the literature on the barriers to innovation in two ways. First, we assess comparatively what mostly constrains firms’ ability to translate investment in innovation activity into new products and processes, whether it is mainly finance, as most of the literature would suggest, or whether it is mostly knowledge and market-related aspects. Second, we suggest a method to correct for the sample selection bias that often affects empirical contributions to this scholarship. By filtering out firms that are not interested in innovation from those that struggle to engage in it, we obtain a relevant sample of potential innovators, which allows us to analyse the comparative effect of financial and non-financial barriers on innovation success. We find that demand-side factors, particularly concentrated market structure and lack of demand, are as important as financial constraints in determining firms’ innovation failures. This evidence redirects attention from financial to non-financial barriers by considering traditional demand, market structure and regulation factors involved in reduced firm innovation performance. The empirical analysis is based on an unbalanced panel of firm-level data from four waves of the UK Community Innovation Survey (CIS) between 2002 and 2010 merged with data from the UK Business Structure Database.