What Affects Innovation More: Policy or Policy Uncertainty?

TLDR

The study tests whether policy or policy uncertainty drives technological innovation across 43 countries. The authors employ close presidential elections and ethnic fractionalization as instruments to isolate the effect of policy uncertainty on innovation. Innovation activity is unaffected by the specific policy in place but falls sharply during periods of policy uncertainty, especially for highly cited and exploratory innovations and in innovation‑intensive industries, as fewer inventors patent, suggesting that political compromise promotes innovation.

Abstract

Motivated by a theoretical model, we examine for 43 countries whether it is policy or policy uncertainty that affects technological innovation more. Innovation activities, measured by patent-based proxies, are not, on average, affected by which policy is in place. Innovation activities, however, drop significantly during times of policy uncertainty measured by national elections. The drop is greater for more influential innovations (citations in the right tail, exploratory rather than exploitative innovations) and for innovation-intensive industries. We use close presidential elections and ethnic fractionalization to address endogeneity concerns. We uncover the mechanism underlying the main result by showing that the number of patenting inventors decreases with policy uncertainty. Political compromise, we conclude, encourages innovation.