Innovation, Recombinant Capital and Public Policy

We examine the nature of innovation from the perspective of the theory of recombinant capital. This approach brings capital formation into the spotlight of the microeconomics of innovation. The focus is upon how innovative entrepreneurs interpret market developments, specify new capital combinations, evaluate them and make markets for the new goods and services produced by these combinations. It is the nexus of all four of these entrepreneurial activities that is essential to the innovation process. We apply the recombinant-capital framework to critique the "systems of innovation" (SI) approach to innovation policy, which underpins policymaking by many national governments and international agencies. The SI approach recommends government intervention to rectify various market failures and "system failures" in innovation processes. We examine both the knowledge and incentive problems implied by the SI policy approach. We examine the implications of our alternative approach for innovation policy and derive heuristics for guiding policy development.