Profits, R&D, and innovation — a model and a test

In this article, we propose an integrated view of the mechanisms supporting the Schumpeterian "engine of progress." We investigate—at the industry level—the interconnections between three key relationships shaping the dynamics of innovation and economic performance: first, the ability of industries’ R&D efforts to turn out successful innovations; second, the ability of innovations to lead to high entrepreneurial profits; and third, the commitment of industries to invest profits in further technological efforts. We build a simultaneous three-equation model exploring the determinants of industries’ R&D intensities, innovative turnover, and profit growth, highlighting the complexity of relationships, reciprocal influences, and feedback loops. The model is empirically tested at the industry level—for 38 manufacturing and service sectors—on 8 European countries for two periods from 1994 to 2006. The results show that the model effectively accounts for the dynamics of R&D, innovation, and profits of European industries.