Roles of Formal Institutions and Social Capital in Innovation Activities: A Cross-Country Analysis

Abstract

This paper investigates the roles of formal institutions and social capital in countries’ innovation activities. The sample consists of 62 developed and developing countries, using the ordinary least squares robust standard error estimations, instrumental variable (IV) estimators, and quantile regression. The empirical results indicate that formal institutions and social capital complement one another in influencing countries’ innovations level. In terms of the relative importance of both in promoting innovation activities, the social capital has greater role compared to formal institutions. Furthermore, the empirical result suggests that innovation level tends to be higher in countries with higher social capital. We also use the quantile regression to estimate whether the relationship among formal institutions, social capital, and innovation differs at different points in the conditional distribution of innovation. The results demonstrate that formal institutions yield a significant positive impact only after exceeding in 50th quantile, whereas social capital do so at lower 10th quantile. Therefore, in addition to a policy focus on improving the formal institutions, countries with a low level of innovation should enrich social capital in their promotion of innovation activity.

Key Words:

• Innovation
• institutions
• social capital
• instrumental variable (IV)
• endogeneity test

Jel Classification:

• O31
• O43

Notes

1. Such works include Wang (2013), who investigated the influence of institutional quality, particularly a political risk indicator, on innovation intensity. In his works, he used informal institutions indicators, such as latitude, ethnolinguistic diversity, crops, mortality, and engfrac, as an instrument for institutions. This setting of an econometric model implies that informal institutions have an impact on innovation only through formal institutions. Based on his empirical analysis, he found that institutions have a significant direct effect on R&D.

2. The inverse U-shaped relationship between competition and innovation was empirically proven by Aghion et al. (2005).

3. Similar work has been done by Berkowitz et al. (2015), who found that property rights have a significant impact on firm value. Thus, a sound legal framework would encourage innovation activities.

4. Jorde and Teece (1990) and Van Waarden (2001) discussed the risk and uncertainty in innovation.

5. Busse and Hefeker (2007) found that political risk-based indicators such as government stability, internal–external conflict, corruption and ethnic tension, law and order, democratic accountability, and bureaucracy quality are significant determinants for foreign direct investment inflow, especially for developing countries.

6. However, Balsmeier and Delanote (2015) find that only young innovative firms benefit from stronger property rights protection.

7. Here, Gur and Bjornskov (2016) found that social trust has a positive effect on delegation. Hence, higher social trust could minimize monitoring costs in an innovative project.

8. The OECD defined social capital as “networks together with shared norms, values and understandings that facilitate co-operation within or among groups”. The networks can be real-world links between groups or individuals, that is, networks of friends, networks of families, networks of former colleagues, etc. Our shared norms, values, and understandings are less concrete than our social networks.

9. Works such as Galbraith (1977) and Gresov and Stephens (1993) have also suggested that inter-unit links among organizations enable the transfer of knowledge.

10. The sources for the suggested instrumental variable are also retrieved from La Porta et al. (1999).

11. In addition, Torgler and Schneider (2007) used religion empirically as an instrument for institutional quality to test its influence on the shadow economy.

12. Works such as La Porta et al. (1999), Glaeser and Shleifer (2002), and Chong and Zanforlin (2000) found empirical support for the British-origin legal system promoting institutional quality.

13. We would like to thank Lee (2013) for sharing the informal institutions (social capital) datasets.

14. The datasets have been used by Lee (2013), Ibrahim and Law (2014), Wang and Steiner (2015), and Zhang (2015).

15. Among 72 countries with social capital assembled, we selected only 62 due to data unavailability in other variables. The list of sample countries is presented in Table A5, the appendix.

16. In this study, we used patent application per labor as a measurement for innovation. This is due to limited data on R&D expenditures, especially for developing countries. In addition, we would like to highlight the role of institutions on innovation output rather than input; the volume of R&D expenditures is not necessarily associated with successful innovation.

17. This includes the sub-indicators of institutions, namely, democratic accountability, government stability, bureaucracy quality, corruption, and law and order. The sub-indicators of social capital are trust, norms, networks, and social structure.

Additional information

Funding

We are grateful for the financial support from the Group Putra Grant (GP-IPB 2014) [grant number 9440902] Universiti Putra Malaysia.