Incentives and Uncertainty: An Empirical Analysis of the Impact of Demand on Innovation

Abstract

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.

Keywords: Demand, Product innovation, Process innovation, Market size

JEL Classification: O31, O33