The impact of innovation on the economy

About Innovation - May 2018

Innovation is often touted as the main driving force behind economic growth for much of the developed world. But how exactly does innovation contribute to economic prosperity? In this article, we’ll look at the fundamental reasons why innovation is important for economic growth and we’ll also look at three ways it can be promoted to help ensure we maintain a healthy innovative economy in the future.


impact of economic growth


What counts as innovation?

Before we move on it’s probably a good idea to establish what we mean by innovation. Fortunately, the European Central Bank (ECB) makes this easy for us. The ECB defines innovation as “the development and application of technologies to improve goods and services or make their production more efficient.”

A good example of innovation from history would be the development of the steam engine by James Watt. Watt didn’t invent the steam engine, he merely improved on the design of Thomas Newcomen’s 1712 device. Watt’s improvements allowed steam engines to become more efficient and cost-effective to run, thereby paving the way for the industrial revolution that would transform the British economy and much of the developed world over the next half-century.

A more contemporary example is the invention of the smartphone by Apple. This device created a whole new industry, which according to data from Statista, is now worth around $478 billion and growing at a rate of 9.4% each year. Smartphones also spawned several other industries including the app and mobile game development industry which is currently worth around $77 billion a year.

But innovation is not limited to big-ticket items such as smartphones or steam engines, they can be small and seemingly insignificant, but can still lead to productivity gains and new markets being developed. A good example would be the Post-it note, developed by Arthur Fry to help him find key pages in his hymn book.

Fry used a glue developed by his colleague Spencer Silver at 3M. Upon its development, no application could be found for the glue which sticks to any surface but doesn’t bond with it. That was until Arthur Fry used it for his easy use hymn book page marking system. Now Post-it notes are sold in over 100 countries around the world with over 50 billion of them made each year.


example innovation drives the economy

Why is innovation important?

The innovations mentioned above help explain why innovation is an important aspect of a modern developed economy. One of the biggest benefits of innovation is that it can lead to higher productivity in the workplace. So for every input, there is a greater output as more goods and services are produced, this leads to growth in the underlying economy and allows new markets to be created to replace old ones.

These are the three steps to the innovation cycle:


– New ideas are developed which create new products or services that lead to efficiency gains or new markets being explored.


– Increased efficiency allows companies to generate greater output for the same input. For example; an innovation allows a baker to produce 12 loaves of bread instead of 10 for the same number of hours worked. This innovation has therefore led to a 20% gain in productivity.


– Increased productivity means increased profits for the company which can then be reinvested to provide further growth, explore new markets or develop further innovations to provide more growth.

How does innovation take effect?

Innovation usually starts small, think about Arthur Fry and his Post-it notes. The first company to benefit from the innovation is the company that created it or was the first to spot the opportunity and apply it. But if an innovation is to affect the economy of a large developed country, it has to spread across companies of all sizes and sectors, economists call this process the diffusion of innovation (DOI).

The diffusion of innovation consists of four stages; the creation of the innovation, communication channels, time, and social influence. The most important part of this process is time, the DOI does not happen simultaneously, it follows a process of adopters from early adopters to laggards. Early adopters are those that are keen to try new things and often display different characteristics to later adopters, such as a willingness to take risks and embracing change. Early adopters are key to the DOI process, without them it is unlikely any innovation would leave the shed where it was created.


 The four stages of adoption are:

Early adopters

– Usually risk-takers who are keen to try new things and are seen as leaders in their industry.

Early majority

– These people adopt new innovations before the average person but usually require evidence of benefits before making a decision.

Late majority

– Skeptical by nature, they require innovations to be adopted by the vast majority before committing. When an innovation has progressed to the late majority it is said to have reached critical mass and will be adopted by the vast majority of people.

Laggards –

Very conservative and skeptical of change, laggards are the last to adopt innovations and will do so only when it becomes obvious that not using the innovation will cause their business to be left behind.

The degree to which a company or industry adopts a new innovation and the speed this happens is dependent on the number of productivity benefits the innovation brings and the ease with which it can be used. An innovation that offers clear productivity benefits while being easy to use will be adopted at a faster rate by the early majority, who are key if an innovation is to progress along the DOI path.

 How can innovations be promoted in the economy?

Now we know that maintaining an innovative edge is key if the economy is to continue growing in the future, it is important that we know how to incubate and promote innovations successfully so that the broader economy can benefit from them. There are three key areas that need to be explored including: improved education, increased spending on research and development and improved access to funding for entrepreneurs to bring innovations to market.

At F.Initiatives, we can help with the latter, by helping to fund innovation through the management of R&D tax incentives. Our team of R&D Tax Credit consultants have the technical and financial expertise, combined with years of experience and a proven methodology, to help fund your next great innovation. Contact one of our UK based consultants today to see how we can help.


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