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Swedish Innovation Policy

Swedish Innovation Policy

Benjamin Holloway

Hamilton College



Swedish Innovation Policy Holloway 2

Table of Contents

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Acronyms and Abbreviations

BERD Business Expenditure on Research and Development

BRDIS Business Research and Development Innovation Survey

BSA Bank Support Authority Bill

EU European Union

FDI Foreign Direct Investment

GATT General Agreements on Tariffs and Trade

Gazelles High Growth Enterprises

GERD Gross Domestic Expenditure on Research and Development

GDP Gross Domestic Product

HEI Higher Education Institutes

HERD Higher Education Expenditure on Research and Development

HGE High Growth Enterprises

IP Intellectual Property

OECD Organization for Economic Cooperation and Development

R&D Research and Development

SME Small and Medium Sized Enterprises

TFP Total Factor Productivity

VC Venture Capital

WTO World Trade Organization




Introduction

Financial crises have been occurring for as early as the 14th century (Encyclopedia

Britannica), but history continues to repeat itself. Financial crises are often seen as “black swan”

events in that they are unprecedented and unexpected; however, analyses of financial crises

reveal that they are endemic to market-driven globalization and financial liberalization and occur

for largely the same reasons. To exemplify this point, this paper will begin by presenting the

reader with a puzzle. Two separate financial crises will be outlined and the reader will have to

figure out in which countries they occurred. This brief exercise will reveal how closely related

some financial crises can be, despite occurring in different time periods in vastly different

countries.

In 2008, a financial crisis occurred in country Y, which not only crippled the economy of

country Y, but also caused a global economic recession. The deregulation of market sectors,

most notably the financial sector, combined with the invention of new financial instruments such

as Collateralized Debt Obligations lead financial institutions to take a number of unregulated

financial risks. Government policy to lower interests rates to around one percent in years prior to

the crisis allowed for the availability of easy credit to all types of investors, which lead to

financial institutions becoming highly leveraged, as well as discouraging investment in treasury

bills and pushing investors to find returns in other securities. Rapid investment into capital

markets, with real estate being the focal point, caused a real estate asset bubble to form. Falling

asset prices and the eventual burst of this asset bubble combined with high levels of loan defaults

lead to a credit lockup, which not only impacted country Y, but also the global economy.

Government intervention was necessary and billions of dollars have been spent in an effort to




correct for this market failure. Country Y is beginning to slowly recover, but remnants of this

crisis are still present.

Country X also incurred a devastating financial crisis, which crippled their economy.

Despite years of rapid growth in the Post WWII era, the combination of deregulation of key

market sectors, rapid credit expansion, unprecedented increase in asset prices, the creation and

burst of an asset bubble, again caused a major recession to occur in this economy. Similar to

Country Y, the failure of this economy largely hinged on market deregulations and the

availability of credit, which, combined with the burst of a large asset bubble, disrupted capital

markets caused creditors to be unable to repay loans. This financial crisis impacted the economy

and government intervention was necessary. During the time of the crisis Country X’s GDP went

down by five percent and unemployment skyrocketed, causing the worst economic crisis in the

country since the 1930s (Ekonomifakta, 2014).

It is clear that country Y is the US and the financial crisis described is the recent 2008 US

financial crisis; however, the second country is more ambiguous. Country X is the Scandinavian

country of Sweden. In the early 1990s Sweden had a financial crisis that was nearly identical in

structure to the 2008 US financial crisis. The only difference between the two crises has been the

ability of Sweden to recover so effectively from their crisis, while many other countries have

struggled in comparison. Not only was Sweden able to recover effectively, they have

continuously worked to create stability within their country and in turn is ranked as one of the

most stable prosperous, and happiest countries in the world according to many OECD indices.

As financial crises continuously occur around the world, it becomes easy to consider financial

crises isolated events; however, analyzing these crises structural similarities is crucial to better




understanding how to prevent them and how to pursue policies that lead to a swift economic and

social recovery.

Sweden is consistently ranked as one of the best countries in the world to live in and the

OECD better life index ranks Sweden as the fourth best country in the world in terms of overall

life satisfaction (OECD, 2012). Sweden has a robust universal health care system, one of the

lowest poverty rates in Europe (3.7%) (Inequality Watch, 2013) and an excellent work-life

balance (OECD, 2012). Sweden emerged from the 2008 financial crisis relatively unscathed

(Michigan State, 2012), has exceptionally high levels of political transparency and is among the

most socially equal countries in the world (OECD, 2012, p.41). In February 2013, The

Economist published a special report titled: The next supermodel: Politicians from both right and

left could learn from the Nordic countries, which praised the Swedish welfare state and

suggested that other industrialized nations could benefit from adopting Sweden’s model.

Although Sweden faced a number of issues after their financial crisis in the early 1990s, it is

evident that their mix of fiscal stimulus and government intervention has allowed them

effectively navigate another global financial crisis in 2008, but to regain economic stability in a

short amount of time.

In contrast, most other countries have struggled after the 2008 US recession. For

example, the US has struggled to regain its stature after the financial crisis. Although a direct

comparison cannot be made, as the two countries differ in size and political structure,

questionable policy choice and political gridlock do not bode well for a strong and swift US

recovery. A report from the Congressional Research Service believes that although economic

recovery has been on a positive track since 2009, the pace has been uneven and has slowed

significantly in 2011. The stock market has recovered from its lows, and employment has




increased moderately, but on the other hand, significant economic weakness remain evident,

particularly in the balance sheet of households, the labor market, and the housing sector. The

report also cites additional concerns such as slow pace of GDP growth, a labor market that is

“treading water,” and tepid consumer spending (Elwell, 2013, p.4).

In their article Is the 2007 US Sub-Prime Financial Crisis So Different? An International

Historical Comparison, Carmen M. Reinhart and Kenneth S. Rogoff examine factors such as

asset prices, real economic growth, and public debt in five countries which have all had financial

crises including Spain (1977), Norway (1987), Finland (1991), Sweden (1991), and Japan

(1992). Reinhart and Rogoff conclude that “While each financial crisis no doubt is distinct, they

also share striking similarities in the, run-up of asset prices, in debt accumulation, in growth

patterns, and in current account deficits (Reinhart, Rogoff, 2008, p. 342). This brief examination

of financial crises begs the question: If the 1990 Swedish financial crisis and the 2008 global

financial crisis were so similar, what has Sweden done to recover so successfully? What methods

or policies did Sweden pursue that allowed it to rebound effectively from its financial crisis?

This paper will posit that Swedish government support for innovation is one of the major drivers

of growth and has allowed Sweden to rebound effectively from their financial crisis and to

sustain growth for the past two decades.

This paper seeks to prove the impact of innovation policy on the effective recovery of

Sweden from its financial crisis. The main hypothesis of this paper is that government policy

fostering innovation is crucial to economic and social growth, especially during times of

economic turmoil. In order to best measure how innovative Sweden is this paper will examine a

collection of data from a variety of data aggregators and although it is impossible to provide

quantitative data on exactly how innovation impacts economic growth, this paper will examine




the key linkage that expenditures on R&D in various sectors leads to innovation, which in turn

drives economic growth. It will also examine some of the other tangentially related aspects of

support for innovation and whether or not Sweden has adequately supported these organizations.

This paper will not ignore the impact of monetary and fiscal policies on Sweden’s economic and

social recovery; however, it will primarily focus on innovation and policies targeted at

innovation as this is what has differentiated Sweden’s approach to economic recovery and is

what has allowed Sweden to be successful.

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Because of the brevity of this paper, the structure of the analysis will rely mostly on

primary and secondary sources to analyze decisions regarding support for innovation policy and

their outcomes. This paper will begin with a literature review that encompasses a variety of

topics but focuses on multiple aspects of innovation policy and the theoretical concepts behind

how innovation drives growth. The main topics that will be covered are this paper’s definition of

innovation, the role of government in the development of innovation policy, how R&D drives

innovation, appropriate foundations for innovation, and how innovation impacts economic

growth. After this literature is established, this paper will move to an in depth analysis of the

Swedish financial crisis, first outlining the causes of the crisis and then more importantly the

policy choices that Sweden made in order to recover. The majority of this analysis will focus on

policy choices aimed at fostering innovation and will use data to determine the impact of

whether or not these policies had a tangible impact on the economic and social recovery of

Sweden. This paper will then examine the possibility of adapting the Swedish model to other




countries as well as analyze whether or not innovation policy truly had an impact on Sweden’s

economic recovery.

Financial crisis are often a consequence of globalization, as globalization leads to

financial liberalization, which can destabilize the economies of developing countries. Due to the

rise in globalization as well as the increasing interconnectedness of the global financial system,

financial crises are no longer limited to the countries they occur in. In 1997, the Asian financial

crisis originated in Thailand; however, it quickly spread to the rest of Asia, having a drastic

impact on a number of countries capital markets (Balaam and Dillford, 2011, p. 181). In 2008,

the US financial crisis would eventually spread to the entire world and led to a global economic

downturn. This paper aims to analyze the Swedish response to financial crises because of

Sweden’s ability to recover so successfully from the two financial crises they have endured.

While it may be impossible to accurately predict when and where financial crises will occur,

knowledge of what policies are most useful in recovery from financial crises, would be an

extremely powerful for economists and policy makers around the world. This paper aims to

research Sweden and draw conclusions, which could be potentially applied to economic

structures around the world. This paper will now focus on examining relevant literature to

innovation policy and how it impacts innovation, R&D spending, and economic growth.

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The literature review for this paper is comprised of multiple sections, each aimed at

establishing the foundations for the critical analysis of Swedish innovation policy. It will begin

with a brief description of what innovation is and how it will be utilized within the context of this




paper. Next it will address the question of whether or not government intervention is even

necessary in fostering the growth of innovation, and will show that government support is

crucial. This paper will then examine potential policy choices countries can utilize to promote

innovation as well as examine the linkage between R&D and innovation. Next will be a brief

section discussing the creation of an innovative environment within countries. Lastly, this

literature review will briefly examine a few of the common economic theories regarding

innovation and how it can affect economic growth.

In order to better understand the innovation policy choices that Sweden has pursued it is

essential to first establish a usable definition of innovation for this paper. While a broad term like

innovation will be impossible to define completely, this section of the literature review will

briefly examine a few scholarly definitions of innovation and synthesize the definitions into an

applied definition of innovation, which will be referred to for the remainder of this paper. It

should be noted that the terms innovation and technological change will be used interchangeably

unless otherwise noted.

Alfred A. Marcus’ paper Policy Uncertainty and Technological Innovation views

innovation as “the introduction of new practices and methods, as the replacement of similar but

less efficient inputs in the production process” (Marcus, 1981, p. 444). The Brookings

Institution, a private nonprofit organization devoted to independent research and innovative

policy solutions, defines innovation as “the process of discovering new ideas and realizing those

ideas at large scale, which change the ways we live and work” (Greenstone, 2011, p. 2). Perhaps

the most comprehensive definition comes from Charles Edquist’s Innovation Policy- A

Systematic Approach. Edquist initially defines Innovation Policy as “public action that influences

technical change and other kinds of innovations. Innovations are new creations of economic




significance of a material of intangible kind” (Edquist, 1997, p. 4). He then later expands on this

definition and states “Innovation is a complex phenomenon, embracing both new processes

(technological and organizational) and new products (goods and services)... these processes

concern not only the emergence, diffusion, and combination of knowledge elements, but also the

translation of these into new products and production processes” (Edquist, 1997, p. 7). Lastly,

economic researcher Hasan Torun describes innovation as, “A complex development of

discoveries and inventions brought into the business sand social environment, successful

innovations are often imitated by other players in the same industry or applied in other

industries” (Torun, 2007, p. 9).

From the above definitions, it is evident that innovation has a number of different

interchangeable qualities and distinctions, yet a few characteristics are present in every

definition. This paper defines innovation as both the invention and implementation of new ideas,

products, and services, which improve economic and social efficiency within a society. In order

to measure innovation, this paper will primarily focus on policies that affect the levels of R&D

as R&D and innovation have a causal relationship. It is important to note that this paper will

discuss policies that affect innovation both directly and indirectly, as government policies, which

can foster innovation, may not explicitly state that as the goal. The next paragraph will briefly

discuss the theory behind technological change as cited by the famous economist Josef

Schumpeter.

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The modern theory of the process of technological change can be traced to the ideas

of economist Josef Schumpeter, who saw innovation as the pinnacle of the modern capitalist

system. Schumpeter believed that capitalists, motivated by both profits and market share,




would continually introduce new products into the markets in order to make profits. They would

then enjoy excess profits for some period of time until subsequent successful innovators ousted

them, a continuing process that Schumpeter coined creative destruction. Invention constitutes the

first development of a scientifically or technically new product or process; however, innovation

is only accomplished when the new product or process is commercialized, or made available on

the market. A firm can innovate without ever inventing if it identifies a previously existing

technical idea that was never commercialized and brings a product or process based on that idea

to market. The invention and innovation stages are carried out primarily in private firms through

a process that is broadly characterized as R&D. Finally, a successful innovation gradually comes

to be widely available for use in relevant applications through adoption by firms or individuals, a

process labeled diffusion. The cumulative economic or environmental impact of new technology

results from all three of these stages, which we refer to collectively as the process of

technological change (Schumpeter, 1947). Schumpeter’s theory of technological change is

crucial to the understanding of why R&D has become an important focus for all profit seeking

organizations. As organizations utilize R&D to create to products and processes, these inventions

can potentially create new markets, spur competition, and allow for greater economic growth.

Schumpeter’s theory makes it clear that R&D is crucial to innovation and thus growth for private

companies; however, there are times when these companies are unable to innovate and there is

the necessity of government interaction to help foster innovation.

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The discussion of the literature in this section will focus on the necessity of government

action on innovation policy as well outline some of the government policies and institutions that

have already been utilized to spur innovation. Although it is widely debated whether or not




government intervention is necessary in terms of market correcting activities, the literature will

discuss how, without outside intervention, R&D spending and innovation tends to be neglected.

The necessity of government intervention into innovation policy is dependent on a few

factors. The first is that historically in times of crisis, business spending on innovation is one of

the first budget areas to be reduced. In a 2009 OECD report titled Policy Responses to the

Economic Crisis: Investing in Innovation for Long Term Growth, authors Dominique Guellec

and Sacha Wunsch-Vincent note that R&D expenditure and patent filings move in parallel with a

countries GDP, thus if the GDP is up R&D expenditure and patent filings are up and vice versa.

Additionally, corporate reports for the fourth quarter of 2008 in many cases show a decline or

slower growth in R&D spending and reports for 2009 confirm the trend. A recent McKinsey

survey of almost 500 large businesses worldwide indicated that 34 percent expect to spend less

on a R&D in 2009 while 21 percent forecast an increase (OECD, 2012, p. 6). The crisis can

however, magnify the competitive advantage of research-intense firms who seize the opportunity

to reinforce market leadership through increased spending on innovation and R&D during an

economic downturn. Many of today’s leading firms such as Microsoft or Nokia were born or

transformed in the “creative destruction” of economic downturns; however, in order for

companies to seize these opportunities, they either need to be well funded or have enough stored

capital in order to take advantage of the competitive advantage gained while investing heavily

into innovative processes during periods of economic turmoil. This is an area where government

facilitation of innovation policy is crucial. Economic downturns presumably cause companies to

spend stored capital on operations vital to their survival rather than on R&D so government

intervention either to spur research within these companies or to help subsidize their

expenditures is key to allow companies to innovate during times of economic uncertainty.




Another area where government intervention is important in fostering innovation is to

avoid issues rising from asymmetric information, which is a situation in which one party in a

transaction has superior information compared to another. This often happens in transactions

where the seller knows more than the buyer, and in this case it pertains to how the government

has more information than private industry regarding laws and regulations. In Robert Keohane’s

After Hegemony, Keohane discusses how asymmetrical information makes some actors hesitant

to act or deal in a specific way if they fear a negative consequence. In his article Policy

Uncertainty an Technological Innovation, Alfred Marcus examines the concept of asymmetrical

information as it pertains to policy uncertainty on business decision-making. Marcus analyzes

how businesses are hesitant to pursue risky avenues of research spending when faced with

opaque government policies. Marcus examines a variety of literature on government policies and

regulations across a number of industries and concludes that without certainty about government

policies, business decision makers are unable to assess risk and opportunity and are unwilling to

invest in R&D to develop new technologies (Marcus, 1981, p. 444). At a basic level any lack of

government transparency with regards to policy making, can impact business decision making

and have harmful effects on the ability of private business to pursue innovation opportunities.

Another proponent of government intervention in innovation policy is Thomas Edquist.

In his Innovation Policy – A Systemic Approach Edquist discusses how he believes that there are

reasons to complement or correct the market and capitalist actors through public intervention.

Edquist believes that there are two conditions which must be fulfilled in order for there to be

reason for government intervention. The first is that the market mechanism and capitalist actors

must have failed to achieve the objectives formulated, so in this case, this would mean that

companies are not innovating. The second is that government intervention must be able to solve




the issue to the best of its ability, and in the case of innovation policy, the government can do a

lot in order to promote innovation. Edquist then goes on to discuss the two main categories of

policies that government can pursue to solve issues related to the lack of innovation driven

growth. Edquist cites non-market mechanism such as using regulation instead of altering the

mechanisms of supply and demand. This would include policies such as targeted taxation,

subsidies for various goods such as health or education, and public funding of R&D or tax

incentives for R&D activities. The other option is that by improving the functioning of the

markets, which would include polices aimed at creating markets for goods or increasing or

decreasing competition in the markets via deregulation, IP rights, and patent protection. Edquist

believes that at the core, government policies targeted at innovation are “very much a matter of

creating, changing, or getting rid of institutions in the form of rules, laws, etc” (Edquist, 2007, p.

4)

Proponents of free markets economies rely on the fact that all actors behave rationally.

This rational behavior drives actors to act in order to maximize their own utility, which drives

competition, and thus a successful free market economy. In theory, businesses should realize the

benefits of R&D and pursue it as a means to benefit their business and even in times of economic

downturn companies should continue to invest as they should understand the profits that can be

made after the economy inevitably recovers; unfortunately this is rarely the case. The economist

John Maynard Keynes founded a theory known as paradox of thrift, which exemplified that fact

that actors can still act rationally and still inhibit growth. From the above literature it is evident

that a combination of imperfect information as well as a market failures stemming from a lack of

R&D spending during economic downturns dissuade business from pursuing aggressive research

spending. The only way to foster R&D and thus innovation are government efforts to promote




such activities because left to their own devices, business will refuse to engage in such spending

activities. Even with ample government support, there are still a number of essential foundations,

which are critical for developing an innovative environment within a country.

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Before R&D spending and innovation can be pursued in order to spur economic growth a

country must provide essential business and macroeconomic foundations in order for these

efforts to be successful. In an OECD report titled, OECD Reviews of Innovation Policy: Sweden,

the report states that categories such as a country’s macroeconomic framework, product and

labor market regulations, and the general business environment, which includes things like

competition, business financing opportunities, entrepreneurship, tax system, and general

infrastructure are all crucial for the potential for innovation within a country (OECD, 2012, p.

86). Macroeconomic framework and general business environment refer to the basic functioning

of a market which includes a currency and exchange rate stability, managed inflation, transparent

and enforceable laws as well as general monetary and fiscal responsibilities (World Bank, 2013).

Business environment considers the overall ease maintaining a business as well as factors

such as availability of capital, strictness of regulation, availability of capital to be loaned or

invested, and a stable infrastructure which includes availability of electric, wifi, and

transportation which are essential to the basic functioning of a business. It cites the significance

of these foundations as three fold: Innovation requires a long time horizon and a stable

environment in which to conduct research. The process of researching and developing a new

product or process can take years, which is why stability is crucial. R&D and innovation are

benefited by a stable macroeconomic environment, which instills confidence that markets will be

relatively unchanged in the medium to long run. Second a consistent and transparent regulatory




framework allows for confidence in long-term investment in research. Lastly, when frameworks

are insufficient they are likely to reduce the effectiveness of policies designed to foster

innovation. In addition to the general framework that was outlined above, there is also the

necessity for policy framework and support for human capital aspects of innovation. People need

to be empowered to innovate and this can be the result of education and training systems should

equip people with the foundations to learn and develop the broad range of skills needed for

innovation (OECD, 2012, p. 86).

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This section will discuss some of the policy actions that governments can take in order to

foster R&D spending and innovation. In the article An Overview of Public Policies to Support

Innovation Jaumotte and Pain analyze the most efficient ways for government policy to act in

order to support innovation and list the five most useful as being fiscal support for R&D,

fostering University-industry linkages, intellectual property rights, availability of capital, and

human resources for science and technology. Regarding fiscal support for R&D, Pain and

Jaumotte define this as public money, which is used to support basic and applied research for

both public and private organizations. These can be applied in the form of direct grants as well as

indirect methods such as tax credits or incentives. University-industry government support for

higher education institutions help develop linkages between basic research undertaken in

universities utilize that knowledge to drive innovation within private companies. The protection

of IP rights is also crucial as Pain and Jaumotte mention that strong intellectual property rights

serve as a reward mechanism and an incentive for investors. The government can play an integral

role in both linking public research institutions with private corporations as well as enacting laws

to protect an inventor’s intellectual property. Availability of capital encompasses a number of




R&D is a key driver for innovation. In an article by Coe and Helpman titled International R&D

Spillovers the authors first acknowledge the view that commercially oriented innovation efforts

are a major engine of technological progress and productivity growth (see Romer, 1990;

Grossman and Helpman, 1991). They believe that innovation feeds on knowledge that results

from cumulative R&D experience on the one hand, and it contributes to this stock of knowledge

on the other. Consequently an economy’s productivity level depends on its cumulative R&D

effort and on its effective stock of knowledge, with the two being inter-related. Coe and

Helpman go further and posit that in a world with international trade in goods and services,

foreign direct investment, and an international exchange of information and dissemination of

knowledge, a country’s productivity depends on its own R&D as well as on the R&D efforts of

its trade partners (Coe and Helpman, 1995, p. 860).

Data from the National Science Foundation's 2008 Business R&D and Innovation Survey

or BRDIS provide a link between R&D and innovation by examining data drawn from a

sampling of countries in the US. The BRDIS data finds that there is the large difference in

innovation incidence when companies with R&D activity are compared to those without any

R&D activity. Companies with R&D exhibit far higher rates of innovation than non-R&D

companies. Around 47,000 of the estimated 1.5 million for-profit companies performed and/or

funded R&D in 2008. According to the survey data, 66 percent of all these companies were

product innovators in the 2006–08 period, and 51% were process innovators. There is also

indication that the companies with the most R&D (those in the $50–$100 million and $100

million or more annual R&D categories) report the highest incidence of innovation: 76 percent

and 81percent, respectively, for products in 2006–08, and 69 percent and 71 percent for

processes. Companies without any R&D activity dominate the 1.5 million companies (about 97




percent of all companies), but their incidence of innovation is far lower: about seven percent

reported being product innovators in 2006–08, and about eight percent process innovators

(National Science Foundation). From this study it is clear that there is a definite link between

R&D and innovation. The next section will examine how this R&D spending translates into

innovation and how innovation spurs economic growth.

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Many economists have studied the economic impact that technological change has had on

an economy, but the two most relevant for this paper are Robert Solow’s exogenous growth

model and Paul Romer’s endogenous growth model. Robert Solow’s economic model of long-

run economic growth attempts to explain economic growth by looking at both capital and labor

accumulation (Solow, 1957, p. 314). Although Solow primarily focused his attention on the

process of capital formation and how that would be a primary driver of growth, Solow along

with other economists realized the inevitability of a decline in the marginal product of capital,

which would lead to stagnation within an economy. To remedy this, Solow began to research the

impact of technological change and growth on an economy and Solow’s model famously

predicted that 85 percent of economic growth derives from technological advancement, rather

than the accumulation of capital and labor. Romer’s model, which is based on Solow’s, diverges

from Solow’s by treating technological change as endogenous rather than exogenous.

Endogenous growth is an economic theory, which argues that economic growth is generated

from within a system as a direct result of internal processes. More specifically, the theory notes

that the enhancement of a nation's human capital will lead to economic growth by developing

new forms of technology and more efficient means of production. Exogenous growth assumes

that external factors rather than internal ones within an economic system primarily determine




economic growth. According to this view, given a fixed amount of labor and static technology,

economic growth will cease at some point, as ongoing production reaches a state of equilibrium

based on internal demand factors (Grossman and Helpman, 1995, p. 861). Romer’s approach is

that part of the labor force works in the research and development sector, where they develop

and implement new ideas and technologies Those new ideas increase the stock of knowledge and

ideas in economy, which makes the other factors, capital and labor, more productive (Romer,

1991). Although this is a simplified economic model, it is widely accepted as the foundation for

how innovation and technological enhance economic growth.

Grossman and Helpman in their article Endogenous Innovation in the Theory of Growth,

agree with the Solow and Romer in that focusing on advances in technology, rather than

properties of aggregate production and capital accumulation, are a better means of squaring the

production of their models with charting persistent growth. They believed that the Earth’s

relatively fixed stock of natural resources would impart diminishing returns if the inputs were

forever combined to produce a fixed set of goods by unchanging methods. Grossman and

Helpman then move to discussing the endogeneity of the technological progress and whether or

not innovation is driven by scientific breakthroughs, which would cause it to move at a speed

independent to that of broader economic growth, or whether or not it is driven by private

investment. After aggregating information form a variety of different sources, Grossman and

Helpman conclude that firms invest in new technologies when they have seen opportunities to

generate profits and that a large proportion of the scientific research conducted is financed by

private industry (Grossman and Helpman, 1994, p. 26).

Although most of the literature on innovation impacting economic growth is theoretical,

there have been models and studies designed to translate these theories into qualitative data.




Cameron’s article Innovation on Economic Growth examines the work of a number of different

economists and attempts to calculate the impact of innovation on total factor productivity. In

economics total factor productivity or TFP is a variable, which accounts for effects in

total output not caused by traditionally measured inputs of labor and capital. If all inputs are

accounted for, then TFP can be taken as a measure of an economy’s long-term technological

change or technological dynamism. Cameron believes that the economic output of these

variables can be derived in two distinct ways, the first is to use a measure of the stock of R&D

capital in a regression of the level of TFP and the second is to use a measure of R&D intensity in

a regression of the change in TFP. Utilizing the first method, Cameron cites the work of

Griliches whose studies found that there was a strong link between R&D capital stock and outlet,

which was roughly measured as a one percent increase in the R&D capital causing a rise in

output of between .5 percent and .1 percent. Using the second method, Cameron, citing the work

of Mansfield, found that R&D also had an impact of productivity growth, and that investment

into R&D can have a social return between a 20-50 percent (Cameron, 1996, p. 4).

The literature review has defined innovation and the theory of technological change and

explained the necessity of government intervention to support innovation and some of the

various methods in can employ to do so. It then discussed the necessary business and

macroeconomic foundations for innovation as well as how R&D is the most relevant variable to

examine when determining what drives innovation. It then concluded that assuming the presence

of R&D spending and thus innovation, that innovation leads to economic growth. The next

section of this paper will begin with a brief background of Swedish financial crisis and an

overview of what caused the Swedish financial crisis of the 1990s. It will then shift to an

overview of some of the major policy choices Sweden has made as they recovered from their




early financial crisis and how those policies continue to allow them to experience positive

growth.

D$7E9,#-2%

After WWII, the rebuilding of war-torn Europe favored Swedish industry because the

Swedish labor force was intact and Swedish production facilities were undamaged. At the end of

the decade, Sweden saw growth of the national economy in a time of worldwide economic

stagnation. Sweden used what they coined the “Swedish model,” which constituted a middle way

between unrestricted capitalism and a centrally planned economy in order to create a balanced

domestic economy. In the beginning, the “Swedish model,” appeared to work very well and

between 1960 and 1965, the economy reached its peak with a yearly GDP growth average of 5.3

percent and a productivity growth average of 5.6 percent per year; however, in the 1980s,

Swedish policymakers initiated deregulation of many market sectors with the intention of

improving the functionality of the Swedish economy. This wave of deregulation would be the

catalyst for the Swedish financial crisis (Ekonomifakta, 2014).

The main deregulatory measure was taken in November 1985, which was when the

quantitative restrictions on the volume of bank lending were abolished. Banks were suddenly

able to lend freely without being hampered by regulatory restrictions. They entered into a fierce

competition for market shares by recklessly offering loans to households and firms. A lending

boom started in 1985-86, channeling cheap credit to asset markets, primarily to the real estate

market. As a result, there was a rapid increase in asset prices, which began the formation of an

asset bubble around the housing market. After a few years of economic growth, the economy

was halted in 1989-90 and turned into a bust as a result of a combination of events. Interest rates




rose internationally and rising interest rates exerted strong upward pressure on Swedish interest

rates. An additional interest rate shock emerged when the Swedish central bank, the Riksbank,

raised nominal interest rates to defend the pegged krona rates against recurring speculative

attacks in 1989-92.

Within a couple of years, after-tax interest rates rose to levels that were much higher than

borrowers had anticipated a few years earlier. This sharp increase in the real interest rate caused

asset price deflation and wealth losses, forcing an adjustment of portfolios, which led to falling

private consumption, falling investments and rising private savings. The harder households and

firms tried to improve their wealth position by selling assets and increasing savings, the deeper

the crisis became. The sell-out of property forced down property prices, which, in turn, triggered

new sales, and the number of bankruptcies increased at a dramatic rate. As the Swedish Krona

was overvalued due to high wage and price inflation during the preceding boom, the export

sector encountered major problems causing unemployment to rise, tax revenues to decline, and

public expenditures to rise due to the workings of automatic stabilizers. Eventually the Swedish

government allowed the krona to float, which caused depreciation and receding domestic interest

rates, halted the downturn of the Swedish economy. Compared to the record of all major crises in

Swedish economic history, the crisis of the 1990s was one of the most costly in terms of output,

industrial production and employment foregone. The crisis undermined the financial system and

threatened the existence of major banks. This forced the government to act, thus laying the

foundations for the Swedish economic recovery (Jonung, 2009, p. 2-4).




F2$86<)<

There are a number of factors that contribute to a country’s ability to innovate. Strong

infrastructure with access to internet, electricity, and transportation, a stable market economy

with incentives for competition and property rights, and government transparency are all crucial

to the innovation within an economy; however, none of these factors are what distinguish

Sweden’s recovery and sustained success from financial crises. Despite having no R&D

incentives and few tax breaks for innovation, Sweden has the highest level of R&D intensity, a

measure of an economy's relative degree of investment in generating new knowledge, in the

world (Europe.eu, 2009). Sweden also has extremely high levels of both business expenditure on

R&D and higher education spending on R&D, which are indicators of an innovative society

(Trading Economics, 2013). The rest of this paper will examine how the Swedish government

has driven innovation by supporting the development of business, which has lead to high levels

of R&D investment and intensity within businesses, which has then lead to innovation and thus

economic growth. It is impossible to prove exactly how innovation impacts growth; however,

this paper will examine the linkages between R&D, innovation, and Sweden’s economic

performance and will reveal that innovation is a major component of Sweden’s economic

recovery. This paper will first analyze the immediate response of the Swedish government,

which was to reinvigorate the financial sector.

The Swedish bank restructuring policy is the foundation for both the economic recovery

of Sweden and for innovation policy as a whole. Financial stability as well as access to lending

are crucial to the formation of businesses and are an important part of the infrastructure that can

contribute to innovation. The first action that Sweden took was to allow the government to




intervene in the financial sector and to assist failing banks. In 1992, the Swedish government

announced a state bank guarantee, which stated that depositors and debtors of Swedish

commercial loans were to be fully protected from any future losses on their claims. The Swedish

government assured debtors that banks and other credit institutions could meet their

commitments on a timely basis. Swedish banks were heavily dependent on foreign financing of

their activities so the purpose of this was to ensure the stability of the payment system and to

safeguard the supply of credit. This stop-gap measure proved highly beneficial, as it expanded

the options for the Swedish Central Bank or Riksbank to support banks regardless of their

financial position. The blanket guarantee had clearly positive effects, as it prevented bank runs

from both international or domestic sources, and it gave the Riksbank the opportunity to more

actively support the failing banks (Englund, 1999, p. 94).

In December 1992, the Swedish parliament passed a Bank Support Authority Bill or

BSA, which created a government backed support group which was aimed at funding the

Swedish banks with as much capital as necessary in order to prevent them from collapse. The

BSA was given an unlimited budget, which signaled a full government support to bank relief

(Jonung, 2009, p. 11). The BSA divided the banks into three categories and provided each

category with a different level of financial assistance. Banks that were likely to recover on their

own were suggested to try and find private investors and utilize the government as sparsely as

possible. Aid was available to these banks, but it was not encouraged. In the second group, the

BSA distributed aid packages aimed at improving the liquidity within the bank and supporting

them in case their capital adequacy ratio fell below nine percent. Banks that were unlikely to

succeed required a large amount of state involvement, which usually resulted in the buyout and

subsequent liquidation of these institutions. In addition to this policy, two organizations,




Securum and Retriva were set up to manage bad debts of failing financial institutions. As the

Swedish government bought up bad debt from failed financial institutions, they would assign it

to one of these two asset managers. These organizations would in turn set a price floor for the

debt, ensuring continued liquidity in the markets (Englund, 1999, p. 17).

Overall the combination of these policies has been highly effective for the swift recovery

of Sweden financial services industry. The announcement of the bank guarantee allowed for

continued foreign support for the banks and prevented any runs on the banks being made. The

BSA provided a blend of support for banks, which conformed to the needs of each specific bank.

At the end of the crisis the state calculated its investments into the economy as 71 billion SEK

with the total cost for the taxpayer being 35 billion SEK or 2.1 percent of the GDP in 1997.

Although it is difficult to measure the effectiveness of Swedish restructuring policy, one of the

greatest indicators of success was the lack of fiscal costs to the Swedish taxpayers. At the end of

the crisis it was anticipated that it would take nearly 15 years for the 35 billion SEK to be repaid;

however, after only four years the burden on the tax payers was repaid in full (Jonung, 2009, p.

15). With the exception of the 2008 financial crisis, Swedish GDP has been growing consistently

since the crisis in the 1990s with an extraordinary growth rate of 5.5% in 2010, only two years

after the most recent crisis (tradingeconomics.com, 2013).

As discussed earlier in this analysis, Sweden’s immediate action, both during and after its

1990’s financial crisis were to reinvigorate the financial sector of its economy. The bailout of the

financial sector was important for the obvious reasons of providing macroeconomic stability for

the economy, but it is also crucial for the formation of new business. Stable financial institutions

act as commercial lenders for most small and medium sized institutions, and the lack of available

capital can prevent the formation of new businesses, which can limit innovation.




for high growth are funded and almost all of the famous tech companies today, including

Facebook, Twitter, and Google, were funded by VC. According to the OECD, in 2009 Sweden

had the third largest venture capital and business angel industries and were only behind the US

and Israel in terms of percent of GDP committed to VC activities.

The availability of VC funding has helped Sweden earn the reputation as a highly

innovative country and it has fostered the growth of famous tech startups King, the creator of the

popular mobile game Candy Crush, and Spotify, one of the worlds largest music streaming

services. After recording $567.6 million in profit last year as its revenue rose eleven-fold to

nearly $1.9 billion, King recently went public on the New York Stock Exchange and was valued

at $7.1 billion (Jarzemsky, 2014). Despite the apparent effectiveness of VC in Sweden, levels of

VC have been declining in recent years because of Sweden’s status as relatively small market for

VC activity; however, Sweden has adapted by ensuring that companies are still funded via FDI.

Figure 2




Its commitment to open trade and ability to provide a stable platform for investments make it a

desirable location for global investments.

Because of Sweden’s size and location, historically it has always relied on foreign

imports and exports to support its economy. Its commitment to open trade has been a crucial

factor in Sweden’s ability to overcome its small domestic market and peripheral geographic

location to become a highly industrialized and successful country. Openness to the global

economy has allowed for capital flows as well as flows of knowledge and were important to the

development of the country. Sweden was one of the earlier joiners of the EU and is an active

member of the WTO and GATT. Sweden’s dedication to open trade and participation in the

global economy is evident and Sweden has been eager to attract FDI to its economy. FDI can

impact an economy in a variety of ways including efficiency gains via technological transfers,

supply chain and distribution synergies, HR and management improvements, and increased

competition among others (OECD, 2009, p. 80). Sweden’s efforts to attract FDI have been

successful as it has high levels of inward and outward FDI stocks.

In

Figure 3




2011, the OECD reports that Sweden’s inward FDI stocks were 63 percent and outward stocks

were 67 percent as compared to the averages of 30 percent and 39 percent respectively. Although

these levels of FDI are high, they are largely the result of Sweden intentionally marketing itself

as a place for FDI. Sweden maintains lower than average FDI restrictions on foreign ownership

and screening requirements, a debt rate of only 49.2 percent of GDP, and a strong financial

sector they represent themselves as an attractive place for investment (OECD, 2009, p. 81).

Sweden also has a corporate tax rate this is among the lowest in the world, which also aids in

attracting FDI. However financial infrastructure is just the beginning of what drives FDI in

Sweden. It is the government support for business, which has led to high levels of innovation and

R&D intensity, which has helped Sweden become one of the most financially stable and

economically prosperous countries in the world.

The Swedish government has developed Sweden into an innovative country in a variety

of different aspects. As mentioned in the prior section, their development of a stable economic

landscape has allowed for easy lending, access to VC funding, and FDI, which are all crucial

aspects to starting a business; however, these factors, while a necessary foundation, are not

particularly unique to Sweden. While simple in concept, they are difficult to establish effectively,

especially in the wake of a financial crisis and deserve to be analyzed when considering how the

environment for high levels of innovation is established; however, what makes the Swedish

approach unique are the ways in which the Swedish Government supports business. They do not

support it in traditional ways such as tax breaks for specific industries or a low regulation

environment, but they foster the development of specific areas, most notably developing

businesses and education, which has led to their increased abilities to innovate.




According to the World Bank, Sweden ranks as one of the best places to do business in

the world. Starting a business requires just three procedures, preregistration, registration, and

post registration. For example the three steps would be first to obtain a written statement from a

Swedish bank certifying that the total cash amount to be paid for shares has been deposited in an

account, second to submit an online application to the Swedish Companies Registration Office

and obtain the registration certificate, and last to Register with the Swedish Tax Agency (World

Bank, 2012). These three processes take an average of sixteen days and cost just .5 percent of

average income per capita. In comparison the US has six procedures and it costs 1.5 percent of

average income per capita. It should be noted that data for starting a business in the US varies

from state to state. The information used in this paper is based on starting a company in New

York City; however, this is most likely different depending on which state the business is started

in (World Bank, 2012).

Figure 4Source: Source: World Bank, Doing Business database




Sweden’s average income per capital is roughly $55,000 so starting a business would cost

around $300. Once the business is up and running, other aspects of running the business are

easier in Sweden than in comparison to other countries. From figure four above, Sweden ranks

highly in a number of categories related to business operation such as paying taxes, trading

across borders, and dealing with construction permits to mention a few. Despite that, it is by no

means an absolute leader in terms of global ease of business, in fact it actually ranks below the

US in a number of categories.

As one can see from figure five, Sweden is ranked higher than the US in a number of categories

related to conducting business. The only areas where it has an advantage are in getting electricity

and trading across borders. Despite this it is important to keep in mind that the US is ranked

fourth overall in ease of doing business while Sweden is ranked fourteenth and considering

Sweden’s size, they still rank at the top of their respective size class. One of the key facts which

draws business to Sweden over other countries, including ones which rank highly in terms of

ease of doing business are its exceptionally low corporate tax rate.

Figure 5




Sweden is known for having a very low corporate tax rate, which they have continued to

lower. Sweden’s recent change to lower the tax rate to 22 percent (McBride, 2012) makes

Sweden’s corporate tax rate among the lowest in the world and only tenths of a percent behind

Switzerland. In comparison the US ranks at one of the highest in the OECD at 39.2 percent

combined and the OECD average is around 26 percent. Sweden’s decision to cut the tax rate was

for a variety of reasons; however, in their official press release, the government stated, “this is to

improve the conditions for new jobs and investments in Sweden. The significant lowering of

corporate tax is expected to strengthen the investor climate and growth in Sweden” (Gustafsson,

2012).

Figure 6




Corporate tax is the tax that is levied on the profit of a firm, with different rates used for different

levels of profits. The full implications of the corporate tax are too extensive to be covered in

detail, but at a basic level the corporate tax rate has a large affect on the global competitiveness

of business as well as how attractiveness a business is to foreign investors. A low corporate tax

rate, combined with the ease of starting and maintaining a business helps to attract both domestic

and foreign investment and promotes business foundation. Most importantly, it allows

companies to retain more of their profits, which can potentially be used to fund additional

research into R&D. Although R&D expenditures are not the only possible use of additional

profit, Swedish companies have a history of being highly innovative and this is reflected by their

R&D spending. Ericson, a Swedish communications technology and services company, has over

35,000 patents, 25,300 R&D employees, and spends $4.9 billion on R&D per year, which

accounts for 14.4 percent of Ericsson’s sales revenue (Mawad, 2013, Ericsson, 2013). Ericsson

also ranks 28th in the world in terms of R&D spending, which is highly significant considering

that Ericsson is smaller than many of the other countries on this list. It is also interesting to note

that Switzerland, a country that also has a very low corporate tax rate, also has two companies

(ranked sixth and seventh in the world) with very high R&D budgets, which is a testament to the

benefits of low corporate tax rates. In comparison, Apple, one of the most valuable company in

the world, ranks 46th on the list spending a little over four billion dollars a year on R&D. It is

very difficult to dissect exactly how a company spends its money; however, from the sampling of

cases examined here, it is evident that countries whose have low corporate tax rates promote

increased savings by companies, which translate into greater R&D spending.




R&D spending can best be broken down into Gross Domestic Expenditures on Research

and Development or GERD and Business Expenditures on Research and Development or BERD.

The combination of businesses, which are taxed at a low rate and thus encouraged to retain

profits, the relative ease of running a business, and both the capital and knowledge inflows from

FDI as well pressure from global competition, foster a perfect environment for companies to

invest heavily into R&D in an attempt to innovate, and that is exactly what has happened in

Sweden. Sweden’s BERD ranks among the highest in the world at 2.34 percent of GDP and it

continue to grow. Figure seven shows not only the total GERD is almost completely comprised

of BERD, but also how BERD has increased so significantly since the 1990s financial crisis.

Figure 7




It is also interesting to note how insignificant government expenditure on research and

development or GOVERD is in terms of total expenditure on R&D. As stated earlier in this

paper, the Swedish government gives very few direct incentives for innovation and instead

focuses on strengthening the components, which allows innovation to thrive. In a document titled

Sweden Innovation Policy, released by the Swedish government offices, state that the first

priority of government support for the development of the innovative climate in Sweden is to

promote well-functioning framework conditions for innovation. In the official document it states:

Well-functioning, appropriate and stable framework conditions, incentives and means ofcontrol form the basis of a good innovation climate. Examples of such frameworkconditions are stable state finances, free and open markets with effective competition,functioning trade, regulations and structures for taxation, labor market, markets,education and research systems, and infrastructure. Other examples are laws andregulations pertaining to contracts and procurement. Suitable systems for intellectual property protection are of considerable importance. Not only public rules and regulationsare relevant standardization, for example, is handled to a great extent by private actors. Norms and attitudes to creativity, the capacity for innovation and generalentrepreneurship in society are other examples of framework conditions for innovation(Swedish government office, 2012, p. 19).

It is evident that Sweden’s main efforts in fostering innovation are to focus on the

framework for innovation, rather than direct benefits. However, that is not to say that Sweden

does not believe in these, just that they play a lesser role. Under the third of the three innovation

policies titled Direct Measure Targeting Innovation Processes, the Swedish government states:

Targeting innovation processes can take the form of financing of innovation activities andentrepreneurship, and advocacy – e.g., providing advice or support to collaborative projects for research and innovation. They may also be a matter of financing knowledgeand innovation infrastructures such as incubators, the formation of clusters or networks,and test and demonstration facilities. The main point is that the guidelines presented inthe section. The road to a world-class innovation climate in 2020 can primarily beimplemented through prioritization within existing financial boundaries (Swedishgovernment office, 2012, p. 20).

An analysis of these two responses is interesting in that it clearly exhibits to Sweden’s desire to




avoid direct funding of innovation in place of supporting the foundation for innovation. Even

under its direct innovation section, the Swedish government claims that innovation can be

implemented through existing financial boundaries. Considering that one of the most widely

used ways of encouraging R&D is via tax breaks and subsidies on R&D, Sweden takes an

interesting approach and appears to focus more on supporting and funding policies that allow

business to spend money on R&D rather than the government. This success of this approach is

reflected not only by Sweden’s high level of BERD, but also in its levels of R&D intensity.

R&D intensity is defined as most widely used measures of innovation inputs. R&D

intensity (R&D expenditure as a percentage of GDP) is used as an indicator of an economy's

relative degree of investment in generating new knowledge. As figure eight shows Sweden has

by far the highest level of R&D intensity as well as BERD in comparison to the US, other OECD

countries, and comparative Nordic countries. The amount of R&D intensity is indicative of how

innovative Sweden is. In addition to R&D being driven by BERD, HERD or higher education

expenditure also drives it into R&D, and while the Swedish government does not give many

direct benefits to ether BERD or HERD, they help to provide the structure for it become

successful.




Figure 8




Sweden has 50 higher education institutions or HEIs, with about half of them granting

PhDs. Of the 50 universities, around 80 percent are publicly funded and Sweden consistent

ranking by the EU Innovation Scoreboard as having a high proportion of higher education

graduates highlights Sweden’s emphasis on higher education and support of research (Swedish

Ministry of Enterprise, Energy and Communications, 2013, p. 15). Sweden placed five

universities into the top 200 global universities according to the Academic Ranking of World

Universities, with its Karolinksa Institute, taking the highest position at 44th in the world.

Interestingly, many of Sweden’s universities are also focused on both the sciences and on

research.

Karolinksa Institute is Sweden’s top medical university and accounts for about 40 percent

of all medical research conducted at Sweden’s HEIs. Sweden also has a public university

dedicated to technology and innovation called the Royal Institute of Technology (Kunglga

Tekniska Högskolan). The school divides into five primary areas of research, energy,

information and communication technology, materials, life science, and transport and their goal

is to “deliver focused, results-oriented study that meets the needs of governments and industries

grappling with unprecedented threats, as well as promising new opportunities”. The platforms

enable faculty to weave together systems, policy and technology research into visionary

solutions, they seed leading-edge interdisciplinary research projects and they oversee the

development of young researchers with the skills necessary to thrive in changing environments

(KTH.se). Sweden’s Chalmers University of Technology presents itself as an entrepreneurial

university, which educates aims to strengthen entrepreneurial skills and foster innovation within

students. Since its inception in 1997 approximately 50 companies have been formed in which

former Chalmers students are the CEO and 42 percent of Chalmers alumni start businesses. All




three of the aforementioned Universities are heavily funded by the Swedish government.

Research at most Swedish universities is financed through the state via both competitive and

noncompetitive grants. In 2011, the Ministry for Education and Research allocated 14 billion

SEK for university research and other institutions provide additional 6 billion SEK to Swedish

Universities. Grants are distributed by the Swedish government based on quality indicators with

a view to increasing the relevance and competitiveness of university research. The indicators

include the fraction of third party funding of R&D, the number of publications, and the number

of citations. The goal of this model is to create incentives for universities and colleges to favor

the research areas in which excellent research is already being performed and research in which

they are able to be competitive globally. In 2012, publicly funded research amounted to just over

SEK 37 billion, or 1.04 percent of GDP. Around 75 percent of all of Sweden’s research is

financed by companies (OECD, 2012, p. 169).

In addition to direct funding from government grants, there are also many Swedish

foundations, which also help fund research within an educational setting. The Swedish Research

Council allocated SEK 4.56 billion in 2012 for research in the natural sciences, technology,

medicine, humanities and social sciences, among other fields. Formas, the Swedish Research

Council for Environment, Agricultural Sciences and Spatial Planning allocated 1.02 billion SEK

in 2012 for research in environment matters, agricultural sciences and spatial planning. Lastly

Vinnova, the Swedish Agency for Innovation Systems, allocated two billion SEK in 2012

primarily for research in technology, transportation, communication, and working life (Swedish

government office, 2012, p.174-175).

Government support for HEIs focused on research and innovation, combined with

competitive grants which not only fund these universities, but push them to excel, have led to




high levels of HERD, a large number of researchers in R&D, and a strong connection between

universities research and private companies, all of which are crucial for innovation. Although the

government is not providing any form of direct funding to stimulate innovation, the funding on

education, especially on education targeted on research and linking that research to private

institutions in crucial for innovation. In addition to providing funding for public institutions, the

Swedish government has also developed academic curriculum with research in mind. According

to the Swedish government website, Swedish higher education is characterized by students

taking responsibility for their own studies and for having a strong, yet informal relationship

wither their professors. Sweden aims to be one of the most R&D intensive countries in the world

(Sweden.se).

:#278-<)#2

With its small size, peripheral location geographic, and the occurrence of two financial

crisis in the past twenty years, Sweden has not operated under ideal conditions for economic

growth and prosperity; however, their targeted focus on promoting innovation is what has helped

to lead them to success. Despite the significance of innovation on the economic growth of a

country, it is inaccurate to say that innovation was the sole determinant of success. At the outset

of this paper, the hypothesis regarding Swedish innovation was that innovation alone was what

differentiated Sweden’s economic recovery from most countries and innovation is what has led

to their success. This paper also argued that because of Sweden’s direct government support for

innovation, that innovation in Sweden was being heavily funded in comparison to other

developed nations. Neither of these hypotheses are correct; however, they were not entirely

incorrect either.




Although it cannot be quantitatively measured in terms of economic output, innovation is

an important driver of economic growth, global competitiveness, and social growth as well.

Consider some of the issues that the world faces today whether it be an incurable illness such as

cancer, or access to clean water. Now think about how these problems could be solved. Perhaps

Pfizer, after years or research finally finds a method that cures all forms of cancer, or GE creates

new water purification filters, which purifies sources of formerly non-potable water. These

solutions not only benefit the companies and promote economic growth, but they benefit society

as a whole. Innovation is a necessity for the advancement of our society.

With that being said, innovation cannot be fostered in the absence of necessary

foundations. Beyond basic economic and infrastructural foundations there need to be capital

mobility, incentives to do business, an educated workforce, and business spending on R&D, in

order for innovation to become feasible. This paper has found that despite the absence of many

direct R&D incentives such as tax breaks or direct grants to business, Sweden is regarded as such

a highly innovative country because they understand the key components which foster

innovation and how to support them in order to create a vibrant innovative environment. Sweden

has created a stable macroeconomic environment and has opened its borders to trade, which has

allowed the free flow of capital from foreign countries to help fund its innovative endeavors. In

addition they have supported a business friendly environment with low tax rates and few

restrictions to starting or operating a business, which has also greatly aided business

development. Lastly they have given generous support to higher education institutions, which

has created an educated and capable workforce. This educated workforce, combined with

connections between universities and companies have allowed for high levels of innovation in

the private sector. Despite the abundance of direct government support which was anticipated at




the outset of this paper, it can be concluded that the Swedish governments is extremely conscious

of fostering innovation within Sweden and is supporting innovation in a variety of ways.

Interestingly, and unlike other countries they have not gone the traditional route of providing

direct R&D subsidies, which is what most other highly innovative countries have done. There is

speculation that Sweden will change this is future years and one would posit that this would only

strengthen their innovation presence around the globe.

The second question this paper attempted to answer was to prove whether or not

innovation has truly lead to economic growth and a swift recovery after the financial crisis in

Sweden. Unfortunately this question has proved to be unanswerable both by this paper as well as

my economists and political science scholars around the world. Because of the sheer amounts of

inputs into an economy, it is very difficult to isolate innovation as a sole variable and to

determine its impact. As mentioned earlier in this paper, there have been economists who have

attempted to isolate innovation such as Romer and Solow as well as others whose research was

based on determining quantitatively how innovation affected economic growth; however, in all

these cases the researchers are using simplified models which exclude multiple factors. While

this question cannot be completely answered, it is safe to say that innovation plays a defined role

in economic growth and that there are strong correlations between innovation and growth. To

continue with an earlier example, if Pfizer creates a miracle cancer curing drug it is likely that

they will need to expand their operations and hire more employees. They will also generate

profits, which will be reused by the company in a variety of ways, but also paid to employees.

These employees will then go a spend the money and because consumer spending is the largest

determinant of economic growth, the innovation of Pfizer’s new cancer drug will have far

reaching ramifications for the economy (Livingston, 2011). In addition, Pfizer’s innovation spurs




competition which encourages the same process to happen, both domestically as well as around

the world. Finally, society as a whole benefits as they are now healthier and rid of a malicious

illness. While this is just a hypothetical situation, economic theory posits that at a basic level this

is how firms operate and this process has been repeated many times in the past.

So far this paper has concluded by examining Sweden’s successful approach to

innovation and how innovation, despite being difficult to measure quantitatively, plays a definite

role in economic growth if not a major one. The last question that was posited at the outset of

this paper was, can Sweden’s approach to innovation and economic growth be translated to other

countries? While an in depth answer to this question is reserved for another paper, a brief answer

is that some aspects of it can be while others would be more difficult to determine. In theory

Sweden’s approach should be able to be adopted by all others countries. In order to foster

innovation, Sweden has simply focused on supporting the fundamentals to innovation, which has

led to their success; however, Sweden is different from many other countries, which makes the

translation of their approach to economic recovery difficult. Sweden is a small and ideologically

homogenous society, which has made the expansion of the welfare state and the development of

their innovation policies easier. Regarding Swedish society, Nima Sanadaji states, “the one-

solution-fits-all systems of the welfare state are typically less disruptive in a strongly

homogeneous social environment, since most of the population has similar norms, preferences,

and income levels (Sanandaji, 2011, p. 18). These similar norms and preferences can to lead to

increased efficiency when making policy decisions, which has been exhibited by Sweden many

times. In the 1990 financial crisis, The two political parties at the time both agreed to put the

good of the country over political issues and came to an agreement that nearly all policies

regarding the financial crisis could be passed with little opposition by the opposing party as long




as there was complete transparency in the policy creation (Jonung, 2009, p.7). Sweden is unique

is the way that it is structured and most other countries do not share these characteristics.

This brief analysis raises a number of other questions, which could be researched for a

better analysis of recovery methods from economic crises. The biggest question that was raised

by the previous paragraph is whether or not Sweden’s political and economic structure makes its

method of economic recovery feasible for other countries to adopt. The Economist, along with

many other political scientists have commented on how the “Swedish model” is an ideal standard

for all developed countries to adopt; however, Sweden uniqueness may make this more difficult

than it would appear. Another topic that could be addressed is a comparative analysis between

Sweden in the decade after it 1990s financial crisis versus the US, a decade after its 2008 crisis.

While analyst are quick to draw comparisons between the recent 2008 financial crisis and past

crises, it is important to consider that the US is only six years removed from its crisis and is still

actively working to recover. A comparative analysis between countries, after being removed

from their crises by a similar amount of time would also be an interesting project to undertake.

Sweden’s methods of economic recovery might not be transferable to other countries, but

that does not make them insignificant. In an increasingly globalized world marked by financial

liberalization across many countries, it is without a doubt that financial crisis will continue to

occur far into the future. Sweden’s recovery from both its 1990s crisis as well as the 2008 crisis

set a gold standard for how financial crisis should be handled. In addition, Sweden’s success also

benefits those around it can use its domestic prosperity to help pull other struggling nations from

their financial woes. Sweden’s success has not come from luck, but rather a disciplined and

practical financial approach fiscal policy, which in a time of global economic uncertainty, is a

policy that all countries can adopt.




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