What Affects Innovation More: Policy or Policy Uncertainty?

Motivated by a theoretical model, we examine for 43 countries whether it is policy or policy uncertainty that affects technological innovation more. Innovation activities, measured by patent-based proxies, are not, on average, affected by which policy is in place. Innovation activities, however, drop significantly during times of policy uncertainty measured by national elections. The drop is greater for more influential innovations (citations in the right tail, exploratory rather than exploitative innovations) and for innovation-intensive industries. We use close presidential elections and ethnic fractionalization to address endogeneity concerns. We uncover the mechanism underlying the main result by showing that the number of patenting inventors decreases with policy uncertainty. Political compromise, we conclude, encourages innovation.