Innovation, Venture Capital and Globalization: the Role of Public Policies

Creating more innovative and dynamic economies is one of the fundamental challenges facing both advanced and emerging market economies. An important ingredient of this involves the creation of entrepreneurial firms which can quickly translate creative ideas and scientific discoveries into viable products. These firms, however, need financing because it takes time and money to turn ideas into marketable products. However, investing in these types of activities is risky as a lot of new ideas simply don’t work out in practice. Because of these risks, banks tend to avoid lending to these types of firms. There is, however, a small segment of the financial sector referred to as the venture capital market that specializes in finding and developing these entrepreneurial businesses. This paper provides an overview of this important financial sector and concludes that public policies have historically been quite important in nurturing a venture capital industry as it is an area characterized by numerous market imperfections. From these experiences some lessons are drawn as to what actions governments can take to overcome the obstacles in establishing a venture capital market which can adequately finance dynamic new companies. It is also emphasized that although obtaining finance is often a significant constraint it is nevertheless just as important to ensure that the other ingredients for entrepreneurship are also present; these include a proper regulatory and legal framework including protections for intellectual property, low start-up costs with minimum paper work, a favourable tax regime, and a well-educated workforce. More generally, it is pointed out that the policies needed to promote innovation in advanced economies may not be appropriate for catching-up economies.