What determines economic prosperity? In answering this important question, a large body of research demonstrates that the development of new products and services as well as the improvement of existing production strategies is one of the most important determinants of economic growth (e.g. Mocker 1992, Grossman and Helpman 1993, Kogan et al. 2017, Wu and Hao 2022). . In fact, many of the products and services we value most today were not even available decades ago.
The local socio-economic environment is crucial for determining the innovation capacity of individuals and organizations, to cluster areas leading innovation activities where local conditions are more conducive to innovation (Chatterji et al. 2014). As a result, local and national governments make substantial efforts and expend huge resources on designing and implementing policies aimed at encouraging innovation. For example, the White House strategy for American innovation in 2015 stated that “[n]The time has come for the federal government to invest in seeds that will enable the private sector to create future industries and jobs and ensure that all Americans benefit from the innovative economy ”(National Economic Council and OSTP 2015).
In a new research paper, we study the role of inclusive organizations in creating a supportive environment for innovation (Donges et al. 2022). We use the term ‘inclusive institution’ (as opposed to ‘attractive institution’) to refer to institutions that provide broad access to economic opportunities, rather than benefiting a small number at the expense of many (North 1991 Acemoglu and Robinson 2012).
Studying this question experimentally is challenging because some areas may have both better institutions and more innovation, but this does not mean that the former is the cause of the latter. To examine whether the implementation of more inclusive institutions later leads to further innovation, we study a historical setting: the early adoption of inclusive institutions by the French in those parts of Germany after the French Revolution of 1789. Figure 1 shows the geographical dimension. French occupation and its length.
Institutional inclusion is measured by an index that includes four major reforms implemented by the French to reduce the power of the local German elite, including the abolition of the guilds and the introduction of the French. Code Civil, The abolition of slavery, and agricultural reform (Acemoglu et al. 2011). These reforms have created more equal playing fields for economic opportunities, reducing barriers to entry and reducing distortions in labor and commodity markets. Figure 2 shows the regional differences in institutional inclusion based on the institutional index, which measures how many years the institutional reforms outlined in each German county have been implemented. The map shows that in the Rhineland, the region with the longest period of French occupation, the value of the institutional index is highest due to the implementation of the initial reforms.
We examine that locations with more inclusive entities due to French occupation have subsequently created more high-value patents per capita, which we use as our main proxy for innovation. Figure 3 shows the spatial distribution of patenting activity.
Importantly for our study, the motives behind the French occupation were military and geo-strategic, not economic. Napoleon wanted to expand the French border to create a regional buffer between France and his rival Austria-Hungary and Prussia. This meant that the French did not simply choose to occupy German territories with the greatest potential for future innovation. This argument is underlined by the fact that, after the French defeat, Prussia sought to annex the Saxon state, which at the time was considered one of the richest German territories with high potential for economic growth. However, the United Kingdom and Austria-Hungary did not want to give Prussia such an economic power. Therefore, it was agreed that Prussia would annex the Rhineland and Westphalia. These territories seemed to be less economically promising by the then rulers, but they implemented inclusive institutions in the early days due to French occupation.
We show that there were significantly more patents per capita in the counties around 1900, with more inclusive establishments due to the French occupation. The magnitude of the estimated effects is large. In the baseline specification, we find that the longest-running counties of French occupation, which were previously enforced by better institutions, had more than twice as many patents per capita by 1900 as the uncultivated counties with more extracting establishments. In order to ensure that results are not due to occupied territories (even if only by chance), we use our hand-collected data particles to account for possible alternative explanations. Importantly, we see that results are not driven by differences in local economic development.
We also examine whether the French profession has encouraged innovation through channels other than institutions, including culture and knowledge transfer, trade and market integration, the presence of intellectual elites, income inequality, access to money, or patent law differences. However, despite controlling for a large number of potentially confusing effects, the picture that emerges is one where inclusive organizations play a central role in promoting innovation.
Since our analysis relies on patents for measuring innovation, there may be concerns that even if there is no change in the level of innovation, better organizations can lead patent growth. This is because the courts can work more efficiently in place of better institutions, making the legal protections granted by patents more effective. To show that our results are about innovation and not just patented, we have collected data on innovative products displayed at two world fairs (1876 and 1893) as a non-patent-based proxy for innovation. Using this alternative proxy for innovation, we find significant positive impact of organizations on local innovation output.
In tracing the impact of our search for economic growth, we show that the impact of inclusive enterprises was particularly pronounced on innovation in chemical and electrical engineering, two high-tech sectors of the Second Industrial Revolution (Mokyr 1992; Landes 2003).
We study the determinants of innovation in the German Empire, as this historical setting gives us a diversity of institutional standards within a single country. However, the results of our study can have far-reaching implications for understanding the determinants of innovation. Even today, countries may be able to stimulate innovation by creating more inclusive and efficient legal systems with lower transaction costs. According to the Economist Intelligence Unit’s 2021 Democracy Index report, “less than half of the world’s population (45.7%) now live in some form of democracy, a significant decline from 2020 (49.4%).” Our research suggests that the lack of inclusive institutions in large parts of the world means that many of the world’s potential for innovation remains untapped (see also Bekkers and Góes 2022 for a discussion of how geopolitical conflict may affect innovation).
Our research further suggests that reforms and policy innovations aimed at increasing competition and creating an equal-playing field may be particularly useful, even in developed countries. Like the guild or trade licenses in Imperial Germany, today there are institutions like professional licenses that limit competition. Withdrawal of such restrictions may encourage innovation.
By the early 19th century, Germany was economically and technologically backward compared to other Western European countries. By the end of the century, however, Germany had become the leading industrial country in the high-tech industry, especially in chemical and electrical engineering, with highly innovative and internationally competitive companies. In this regard, developing and emerging economies may find it extremely useful to implement the kind of inclusive institutions we study in our research paper, as it may make them more innovative and help them in technological frontiers.
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