How can innovation best be promoted? This is a question that developed and developing countries alike seek to answer in order to enhance competitiveness, productivity, employment, and growth.

In a major interdisciplinary research program, the Financing of Innovation (2013–2018), at the Ratio Institute in Sweden, critical conditions for innovation have been studied in a systematic way, combining detailed quantitative modeling of all Swedish companies with a large number of case studies. Echoing international studies on the same topic, results show that innovation policy needs to focus more on supplying the right competencies and on improving the institutions of the market economy rather than on various targeted interventions such as financial support or research and development (R&D) subsidies for particular types of firms. Markets rather than bureaucrats are thus decisive for an innovation policy for growth.

Innovation is about the commercialization of new knowledge through entrepreneurship. Hence, favorable conditions for new firms and well-functioning markets are central to innovation policy. The evidence suggests however that a lack of financial capital is not the biggest problem for (new) innovative companies. Since the major sources of “competent” capital evident to spur the creation and growth of new innovative companies comes from founder(s)’ own savings, business angels, or venture capital (VC), lower taxation on entrepreneurship and personal incomes produce more “competent capital” than various types of subsidies. Further the effects of direct public support for companies seldom match the expectations of policymakers. Instead, political attempts to solve alleged market failures often create various type of policy failures such as skewed incentives, unfair competition and regulatory capture.

Our studies show that, in Sweden, the greatest potential for enhanced conditions for innovation comes instead from (a) improving the general institutional conditions of market-related competitive conditions and the supply of human capital and skills (“competence”) through a better-functioning labor market and educational system, (b) moderating the frequently increasing regulatory burden, and (c) addressing infrastructure problems.

Generally, policy focus needs to shift away from an inputbased logic toward an output-based logic. Instead of focusing public support on what is presumed to lead to innovation, policy should prioritize overseeing the basic institutions of the market economy and removing various obstacles to innovation. Instead of maintaining a large and expensive bureaucratic system of governmental subsidies for private firms (“input-related” policies), more emphasis is needed on attending to “outputs” in terms of growing the number of innovative firms and their impact.

An innovation policy for growth must put greater emphasis on entrepreneurship and the overall institutional conditions for enterprises. A reform process with such a focus would undoubtedly yield much stronger long-term improvements in the innovative capacity of the Swedish economy.