Authors: Kyriaki Kafka

Title: Uncertainty Shocks, Economic Institutions and Innovation Performance

Abstract

The effect of uncertainty on economic activity varies, with the main consequence of the formation of attitudes and actions that deviate from the framework of rationalization and maximization of wealth and prosperity. At the same time, the strong presence of uncertainty influences the development of modern production models.

The main assumption addressed in this paper is that increasing uncertainty in economies leads to a reduction in innovation performance, while the institutional background has a critical role on this process. Thus, this paper aims to examine whether uncertainty is a critical factor for innovation, especially in the wake of the recent global financial crisis and the current Covid-19 pandemic, and more specifically the extent to which uncertainty is a key deterrent to R&D spending, creativity and innovation. At the same time the paper sheds light on the critical role that institutional background has over this process.

The analysis of this paper is based on annual data on innovation, economic institutions and economic uncertainty. The analysis period is from 1997 to 2021. The total countries under investigation are 22 based on the restrictions on the data regarding economic uncertainty.

Regarding innovations, various measures are used which are related to innovation input or output, such as patent applications, spending on R&D, number or researchers per 1000 individuals and number of Government researchers. Data are derived mainly from the World Bank. To measure Economic Uncertainty the Economic Policy Uncertainty index prepared by Baker et al. (2016) and other researchers is used. Moreover, economic institutions are taken into account using the Economic Freedom of the World Index prepared by the Fraser Institute.

The climate of uncertainty increases when significant uncertainty crises are observed on dates of significant political and economic turmoil. Especially since the onset of the crisis and during the outbreak of the Covid-19 pandemic, the global economy has been hit by a number of uncertainty shocks. High uncertainty levels have significant effects on innovation performance of the economies. The institutional background has an important role on this process acting as a safeguard or an enhancer under conditions of high uncertainty.