Innovation is key to economic growth and is critically important in contemporary economies. It helps the economy on multiple fronts, namely, economic growth, global competitiveness, financial systems, quality of life, infrastructural development, employment, and openness to trade.. There are many studies exploring the link between innovation and economic growth, and most of these studies have confirmed a positive relationship between the two, both directly and indirectly. However, most of these previous studies investigate the relationship between innovation and economic growth without looking at the direction of Granger causality. Hence, this paper makes an attempt to examine the direction of causality between innovation and economic growth in the European Economic Area (EEA) countries for the period 1989-2014.
This study uses three different innovation indicators, namely, number of patents (residents), number of patents (non-residents), and researchers in research and development (R&D) activities. We first deploy unit root and cointegration to know the existence of long-run equilibrium relationship between innovation and economic growth. Subsequently, we deploy vector auto-regressive model to test the Granger causalities between these two variables. The study finds the presence of both unidirectional and bidirectional causality between innovation and economic growth. These results vary from country to country, depending upon the types of innovation indicators that are used in the empirical investigation process. The policy implication of this study is that economic policies should recognise the differences in innovation and economic growth in order to maintain sustainable development in EEA countries.
