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Cambridge Journal of Economics Advance Access originally published online on June 7, 2008
Cambridge Journal of Economics 2008 32(6):927-946; doi:10.1093/cje/ben021
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© The Author 2008. Published by Oxford University Press on behalf of the Cambridge Political Economy Society. All rights reserved.

Incentives and uncertainty: an empirical analysis of the impact of demand on innovation

Roberto Fontana and Marco Guerzoni*

* University of Pavia & CESPRI, Bocconi University, Italy and Schiller Universität, Germany, respectively. The authors would like to thank participants at the DRUID 2007 Summer Conference, Copenhagen, and SPRU 40th Anniversary Conference at the University of Sussex (UK) where previous versions of the paper were presented. We also thank two anonymous reviewers for commenting on an earlier draft of the paper. The usual disclaimers apply

Address for correspondence: Roberto Fontana, Department of Economics, Via San Felice 5, 27100, Pavia, Italy & CESPRI, Bocconi University, Via Sarfatti 25, 20136, Milano, Italy; email: roberto.fontana{at}unibocconi.it

We study the impact of demand on innovation. By focusing on a sample of small- and medium-sized enterprises in several industries and European countries, we analyse how demand stimulates innovation by providing economic incentives and reducing uncertainty. Considering the size of the market as a proxy for the presence of demand, we find support for the idea that the presence of incentives stimulates innovation. This is particularly true for process innovation. In considering interaction with customers as a way to reduce uncertainty, we find that firms that see customers as the most important sources of information for both innovation ideas and completion, tend to introduce product innovations. Firm size, R&D expenditure and sectoral effects also matter.

Key Words: Demand • Product innovation • Process innovation • Market size

JEL classifications: O31, O33

Manuscript received March 12, 2007; final version received January 21, 2008.


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