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. © The Author 2012. Published by Oxford University Press on behalf of Associazione ICC. All rights reserved.