Unbundling institutional determinants of innovation

Why are some nations wealthy, while others remain mired in poverty? Prior literature suggests technological innovation and strong institutions are uniquely conducive to long‐term economic growth. Property rights institutions (PRIs) afford protection from expropriation by the government and political elites, while contracting institutions (CIs) allow private parties to conduct commercial transactions. In this study, we systematically examine the relative effects of PRIs and CIs on innovation. Using an instrumental variable (IV) approach and two‐stage least squares regression framework, our results suggest that PRIs have a strong positive effect on innovation, while CIs do not. Constraint on executive, protection from expropriation of the government, and protection of private property are proxies for PRIs, while legal formalism, procedural complexity, and number of procedures are proxies for CIs. We find strong empirical evidence that PRIs have statistically significant effects both on innovation intensity and time lag in innovation adoption, while the impacts of CIs on these measures of innovation are generally insignificant. Our findings are relevant to policymakers today as developing countries look to innovation to reignite their economies and avoid the middle‐income trap.