THE NETHERLANDS
THE EFFECTS OF CULTURE AND
FORMAL INSTITUTIONS ON NATIONAL
RATES OF INNOVATION
Course: Master’s Thesis IB&M Author: S. El-Ajaji Supervisor: dr. M.J. Klasing
Referent: dr. K. van Veen
The Effects of Culture and Formal Institutions on
National Rates of Innovation
Soufian El-Ajaji
Faculty of Economics and Business, University of Groningen, Groningen, The Netherlands
Abstract
This paper assesses the effect culture and formal institutions have on national rates of innovation and their respective relationship. This article analyzes several datasets of culture, formal institutions and innovation from 68 countries spanning over the years 2005 – 2008. I find that high levels of cultural individualism as well as a lack of power distance significantly correlate with national innovation rates. The data suggest that formal institutions such as property rights protection and a country’s rule of law strongly correlate with these rates of innovation as well. Finally, the research confirms that the effect of formal institutions on national rates of innovation depends on the cultural settings within that country.
T
ABLE OF
C
ONTENTS
1. Introduction ... 4
2. Theory & Hypotheses ... 6
2.1. Power Distance ... 8 2.2. Individualism ... 8 2.3. Masculinity ... 9 2.4. Uncertainty Avoidance ... 9 2.5. Pragmatism ... 10 2.6. Indulgence ... 11
2.7. Intellectual Property Protection ... 11
2.8. Rule of Law ... 12
2.9. Interaction Effects ... 12
2.10. Conceptual Model ... 14
3. Control Variables ... 15
3.1. National Income Level ... 15
3.2. Industrial Structure ... 15 3.3. Human Capital ... 15 3.4. Trade Openness ... 16 4. Research Methods ... 17 4.1. Sample ... 17 4.2. Measures ... 17 4.3. Dependent Variable ... 17 4.4. Independent Variables ... 18 4.4.1. Culture ... 18 4.4.2. Formal Institutions... 18 4.5. Control Variables ... 19 4.6. Data Analysis ... 19 4.6.1. Interaction Effects ... 20 5. Results ... 21 5.1. Descriptive Statistics ... 21 5.2 Correlation Matrix ... 22 5.3. Culture ... 24 5.4. Formal Institutions ... 26
5.5. Culture and Formal Institutions ... 28
5.6. Interaction Effects ... 30
6. Discussion ... 32
7. Limitations & Avenues For Future Research ... 33
1. I
NTRODUCTION
Innovation is seen as a critical process for many types of organizations. For existing businesses, innovation is a vital procedure that helps to shape a company’s strategic course of action. For many entrepreneurs, innovation also serves as the basis upon which to either build new or shape existing ventures (Westhead, Wright, & McElwee, 2011). The importance of innovation can also be found in the strategies of many Multinational Enterprises (MNEs). The global context in which MNEs develop and implement business strategies has intensified significantly, with MNEs becoming increasingly concerned with the international placement and performance of R&D facilities (Jones & Davis, 2000).
Governments are similarly aware of the importance of innovation for firms and the presence of entrepreneurship. As a result they have increased their attention towards promoting and providing a favorable environment for innovative activity (Westhead et al., 2011). In light of the prominent position of innovation on the agenda of both government agents and firms, it is important to understand the forces that drive innovation at the national level.
Earlier research has shown that national rates of innovation are associated with a country’s economic environment (Dakhli & De Clercq, 2003; Nelson & Winter, 1977; Vernon, 1966). National income level and industrial structure appear to facilitate rates of innovation at the national level, with a country’s human capital and trade openness playing a significant role as well. However, solely investing in a country’s industrial structure, human capital or trade openness might not be enough to foster innovation in a structural manner (Shane, 1993). National culture is an essential aspect for a country’s innovational output as well. As shown by Shane (1993) and Taylor & Wilson (2012), it is predominantly societies that are individualistic, value low levels of power distance and accept uncertainty that appear to have higher rates of innovation.
In addition to national culture, domestic formal institutions are also of the essence for high national rates of innovation (Porter & Stern, 2002). This is due to the fact that, firms must align their activities towards the rules and legislation of the countries where they are active. Likewise, as innovation requires firms and entrepreneurs to undergo uncertainty, undertake risky behavior and be exposed to expropriation (Lumpkin & Dess, 1996), governments have to facilitate innovation, through, for example, means of intellectual property protection.
innovation. Moreover, this study also aims to explain that the effect of formal institutions on the national rates of innovation depends on the cultural settings.
While previous investigations have produced intriguing results, this study adds value through several improvements. First, of the few studies that have tested the effects of national culture or formal institutions on innovation, most examined a much smaller number of countries, and only for separate years or brief time spans. To improve upon this, independent quantitative datasets are analyzed for 68 countries spanning a four year time frame of consecutive years. Second, prior statistical research that tested culture and innovation hypotheses (e.g. Shane, 1992, 1993) suffered from data limitations that this study overcomes. For example, often the only data available to previous scholars was a single dataset or measure of innovation. Instead of using simple patent or publication counts to measure innovation, an innovation index measure has been used in this study. The index is computed as the average of three key variables and is scaled by population. These finer measures allow culture, formal institutions and innovation relationships to be probed in greater detail. Furthermore, to assess the strength of the relationship between culture, formal institutions and innovation, the effect of differences in the macroeconomic environment is controlled for.
The results show that high levels of cultural individualism and a lack of power distance strongly correlate with national innovation rates. The data also suggest that formal institutions such as property rights protection and a country’s rule of law significantly correlate with national rates of innovation. Finally, it is also confirmed that the effect of formal institutions on the national rates of innovation depends on the cultural settings. This finding, in particular, implies that the effect of property rights protection on a nation’s innovation rates depends on whether the country can be characterized as an individualistic or collectivistic society.
2. T
HEORY
&
H
YPOTHESES
Innovation has become perhaps the most important source of competitive advantage in advanced economies. Innovation is, as such, widely considered the life blood of corporate survival and growth (Zahra & Covin, 1994). It is further recognized as playing a central role in creating value and sustaining competitive advantage, for both firms and governments. Therefore, in order to both sustain and strengthen the competitive position and level of prosperity, organizations and governments alike must innovate and promote innovation (Baregheh, Rowley, & Sambrook, 2009; Porter & Stern, 2002). Innovation can thus be seen as a key policy for governments and a strategic issue for business organizations. Governments seek to provide the most favorable environment for firms to emerge and locate, while MNEs seek the most favorable location to setup and organize their international R&D activities.
Policies that are put into place by governments and strategies that are developed by business organizations have to fit into a country’s institutional environment. Government actions and the economic activities of firms are, therefore, usually embedded within a society's institutional setting (North, 1990). A nation’s institutional environment, however, can be broken into three parts (Scott, 2008). First are, the regulatory forces, which encompass not only the rules and legislation of a country, but also its industrial agreements and standards. These forces are referred to as rational actor models that are based on sanctions and conformity. The second part identified by Scott (2008) is normative forces, which are based on the social, professional, and organizational interactions within nations. Normative forces interact with what is perceived to be preferred and how things should be done in society. The third part identified by Scott (2008) includes the cognitive forces. This category of the institutional environment includes the subjective constructed rules and meanings that have an impact on the beliefs and actions of the population within that particular environment. The cognitive forces operate primarily at the individual level (Scott, 2008).
The regulatory forces, correspond with a nation’s formal institutions. These are, a set of political, economic and contractual rules that regulate individual behavior and shape human interaction (Yong & Zahra, 2012). Porter & Stern (2002) observed that the innovative activities of firms within a country are strongly influenced by national policy. Innovation policy areas include the level of intellectual property protection, but are also related to the rule of law of a country. The rule of law ensures that governments can monitor, enforce and execute their formal policies and regulations (Rigobon & Rodrik, 2005).
members of one group from another". Culture has been alternatively defined as, “the manner in which a group of people solves problems and reconciles dilemmas” (Trompenaars & Hampden-Turner, 1998), and “the fabric of meaning through which people interpret events around them” (Geertz, 1973). It is clear that a precise definition of culture is hard to pin down, and it remains the subject of intense scholarly debate (Taylor & Wilson, 2012). For the purpose of this paper, however, only a useful working definition is required. That is, the aim is not to evaluate competing definitions of culture, but rather, to test whether specific indicators of national culture and formal institutions correlate with national innovation rates. From the normative and cognitive forces of the institutional environment, it can be observed that culture exists and can be studied at many levels (Jones & Davis 2000). Within the scope of this paper, however, the focus lies on the concept of national culture.
The basis for much of the research over the past two decades on most business and management aspects of national culture has been the work of Hofstede, and others who have built on his original work. Hofstede (1980) initially found that differences in national culture vary substantially along four dimensions: power distance, individualism, masculinity and uncertainty avoidance. Hofstede (1980) found that these cultural values are unequally represented across countries. As such, differences in these values might explain differences in national rates of innovation (Shane, 1993). These four cultural dimensions have been theoretically linked to innovation in previous studies. However, Hofstede, Hofstede, & Minkov (2010) have recently added two additional cultural values, namely pragmatism and indulgence, which, unlike the others, have not yet been linked to innovation.
2.1.
P
OWERD
ISTANCEHofstede (1991) noted that the power distance index dimension expresses the degree to which the less powerful members of a society accept and expect that power is distributed unequally. The fundamental element of this dimension is how a society manages inequalities among people. Members in societies that show signs of a large degree of power distance accept a hierarchical order in which every member has a place and which needs no further justification. Lower power distance countries share power more equally among their members. They tend to have more decentralized decision making processes, and allow superiors and subordinates to consider each other equals.
Characteristics of power distance affecting innovation include the presence and level of social or organizational hierarchy, centralized power, formal vertical communication flows, top down control, formal rules and procedures, and resistance to change (Jones & Davis, 2000; Shane, 1993). Innovative success is expected to be associated with those characteristics defining a low power distance structure, such as less formal hierarchy and control and limited emphasis on rules and procedures to control operations (Jones & Davis, 2000; Thompson, 1967). Conversely, rigid stratification, central power, excessive rules and top down control is generally believed to suppress innovative activity (Jones & Davis, 2000). Therefore the following hypothesis can be proposed:
Hypothesis 1: Less power distant societies will be more innovative than more power distant
societies.
2.2.
I
NDIVIDUALISMHofstede (1991) defined the dimension of individualism as a preference for having primarily a distant social framework in which individuals are expected to be responsible for themselves and their immediate families. As opposed to individualism, collectivism represents a preference for a tightly-knit social framework. Within this social framework, individuals can expect their relatives or members of a particular in-group to look after them in exchange for unquestionable loyalty. A society's position on this dimension is reflected in whether people’s self-image is defined in terms of “I” or “we” (Hofstede, 1991).
the technological lead acquired by several northwestern European countries during the industrial revolution. Florida (2002) further observed that technologically innovative cities and countries depend on a creative class of innovators who are drawn to locales that indulge individualistic behavior. As a result, collectivism and conformity are expected to impede innovation (Taylor & Wilson, 2012). Individualism is expected to foster innovational output, whereas collectivism is expected to hinder national rates of innovation, as such, the following hypothesis can be proposed:
Hypothesis 2: Individualistic societies will be more innovative than collectivistic societies.
2.3.
M
ASCULINITYMasculinity characterizes a preference in society for achievement, heroism, assertiveness and material rewards for success (Hofstede, 1991). The counterpart of this dimension, namely femininity, represents a preference for cooperation, modesty, caring for the weak and quality of life (Hofstede, 1991). Femininity makes society at large more consensus-oriented.
Masculinity is related to two characteristics common to innovative environments (Shane, 1993). First the achievement of rewards and the aim of society members to receive recognition for performance. Second, continuous attention on training and the improvement of the individual. This makes society at large relatively more competitive. These characteristics associated with more masculine societies are usually associated with innovation. The emphasis on group integration as opposed to individual achievement, as found in more feminine societies, is typically believed to be less supportive of innovation (Jones & Davis, 2000). These arguments lead to the following hypothesis:
Hypothesis 3: Masculine societies will be more innovative than feminine societies.
2.4.
U
NCERTAINTYA
VOIDANCEintolerant of unorthodox behavior and ideas (Hofstede, 1991). Uncertainty accepting societies maintain a more relaxed attitude whereby practice counts more than principles.
Typically, characteristics associated with weaker uncertainty avoidance, as represented by an acceptance of competition and colleague dissent, are expected to relate positively to innovative capabilities (Jones & Davis, 2000). Characteristics associated with strong uncertainty avoidance are believed to inhibit innovation (Jones & Davis, 2000). By innovating, managers initiate change, which brings forth uncertainty. Therefore, uncertainty avoiding countries tend to embrace the unknown world of innovation less than uncertainty accepting countries. As such the following hypothesis can be proposed:
Hypothesis 4: Uncertainty avoiding societies will be less innovative than uncertainty accepting
societies.
2.5.
P
RAGMATISMPragmatism refers to how people in both the past and present relate to the fact that much of what happens around them cannot be explained (Hofstede et al., 2010). In societies with a pragmatic orientation, most people do not have a need to explain everything. Pragmatic societies belief that it is impossible to understand the complexity of life in full. The challenge, according to pragmatic societies, is not to know the truth, but to live a virtuous life. These societies believe that truth depends very much on the situation, context and time. Pragmatic societies show an ability to accept contradictions and adapt according to the circumstances, as well as a strong propensity to save and invest, to be thrifty and to persevere in achieving results.
However, in societies with a normative orientation, most people have a strong desire to explain as much as possible. People in such societies are strongly concerned in establishing the absolute truth and have a need for personal stability. They exhibit great respect for social conventions and traditions, a relatively small propensity to save for the future and a focus on achieving quick results.
Overall, pragmatic societies, as opposed to normative societies, have a stronger inclination to investments and perseverance in gaining progress. These are strong characteristics that are needed in an environment for innovation to thrive. The following hypothesis can therefore be proposed:
2.6.
I
NDULGENCEIndulgence allows for relatively free gratification of basic and natural human drives. Indulgent societies encourage the enjoyment of life and having fun. Restraint societies, on the other hand, suppress gratification of needs and embellishments and are characterized by strict social norms.
As such, societies where indulgence prevails are more likely to have a higher diversity in consumer demand relative to restraint societies. Myers & Marquis (1969) found that increased diversity in consumer demand fosters innovation. The nature of indulgent societies should create an environment that facilitates innovation better than in restraint societies. The following hypothesis can therefore be proposed:
Hypothesis 6: Indulgent societies will be more innovative than restraint societies.
2.7.
I
NTELLECTUALP
ROPERTYP
ROTECTIONInnovation reflects an organization’s tendency to engage in and support new ideas. It requires different types of entities, such as MNEs or entrepreneurs, to experiment, take novel decisions and engage in creative processes that may result in new products, services or technological processes (Lumpkin & Dess, 1996). Organizations that pursue innovation, therefore, find themselves in a position of taking risks, as they are more often than not required to venture into the unknown and to commit a relatively large portion of their assets to the innovation process (Baird & Thomas, 1985). If the environment in which the innovation process takes place or the country where the innovation is being marketed fails to provide protection against intellectual property breaches, organizations will not feel inclined to pursue risk taking behavior, as required for innovation. This is because in an environment with low levels of intellectual property protection, innovations can easily be copied or stolen, which leaves the organizations that took the risk to develop the innovation empty-handed. These risks for expropriation are particularly high in technological industries (Oxley, 1999).
patented technologies to local firms (e.g., for drug patents in India and the Philippines), sometimes at very low royalty rates (Oxley, 1999).
Societies with higher levels of protection for intellectual property rights might therefore encourage more innovation, in comparison to societies with relatively lower levels of protection. This is due to the fact that protection against intellectual property infringement lowers the risk for technological leakage, piracy or other forms of expropriation and thus incentivizes innovative behavior. Based on these arguments, the following hypothesis can be proposed:
Hypothesis 7: Societies with higher levels of intellectual property protection will be more innovative
than societies with lower levels of intellectual property protection.
2.8.
R
ULE OFL
AWSolely having written rules and legislation may not be sufficient. Policies such as protection against infringement of intellectual property rights also require adequate specification and enforcement of the rules and legislation. Institutions and governments must therefore be able to monitor, enforce and execute those policies. Any of which, if problematic, could thereby increase the potential for leakage of valuable intellectual property.
Policies for protecting intellectual property should be backed by a strong rule of law (Rigobon & Rodrik, 2005), in order that a favorable environment for innovation can be facilitated at the country level. The following hypothesis can therefore be proposed:
Hypothesis 8: Societies with higher levels of rule of law will be more innovative than societies with
lower levels of rule of law.
2.9.
I
NTERACTIONE
FFECTSexpected that the effect of formal institutions on national rates of innovation will be dependent on the culture of that country.
Culture is to some extent formed through a country’s heritage, which is the defining factor for its conventions, codes of conduct and norms of behavior. Formal institutions, such as intellectual property protection and the rule of law are in turn formed, defined and enforced based on national culture. As a result, the same formal institutions that exist in societies with different cultural values can produce different outcomes (North, 1990). Innovation intensity within a country, therefore, depends on the interaction between public sector policies and national culture (Porter & Stern, 2002). These arguments bring forth the following hypothesis:
Hypothesis 9: The effect of formal institutions on a nation’s rate of innovation depends on the
NATIONAL RATES
OF INNOVATION
CULTURE
FORMAL INSTITUTIONS
2.10.
C
ONCEPTUALM
ODELBased on findings within the theoretical framework, the following conceptual model can be created.
Figure 1: Conceptual model.
3. C
ONTROL
V
ARIABLES
In order to provide both a fair measure and to assess the strength of the relationship between culture, formal institutions and innovation, variables that control for national differences in the macroeconomic environment have been included in the analysis. The macroeconomic factors that researchers suggested to have an influence on national rates of innovation are national income level, industrial structure, human capital and a country’s trade openness.
3.1.
N
ATIONALI
NCOMEL
EVELIt is argued that innovation is more common in nations with a relatively high national income level (Vernon, 1966). Shane (1993) mentions two main reasons for this argument. The first is that innovation requires skilled engineers and scientists, who are more likely to be found in developed economies due to the greater financial resources of universities and laboratories located there. The second reason is that the ability of wealthy nations to market products is greater than that of countries with lower levels of national income. This shows that a nation’s income level should have a positive effect on national rates of innovation.
3.2.
I
NDUSTRIALS
TRUCTUREIt is also important for this study to account for national differences in industrial structure, given that innovation is more common in some industries than in others (Nelson & Winter 1977). For example, industries that produce physical products show higher rates of innovational change than the services industry. In turn, countries also differ in the degree to which they possess firms representing these different industries.
3.3.
H
UMAN CAPITALHuman capital is an important variable to take into account for assessing a nations national innovation rates, because innovation can be viewed as one of the most important aspects of knowledge creation (Collinson, 2000). Plessis (2007) takes it a step further to argue that the creation of new knowledge and ideas facilitates innovation. Innovation requires a certain set of capabilities and knowledge to produce something novel. Countries with a strong knowledge base and capabilities will use resources more efficiently and so will be more innovative (Darroch, 2005).
3.4.
T
RADEO
PENNESS4.
R
ESEARCH
M
ETHODS
4.1.
S
AMPLESince this study has been designed to research the determinants of innovation at the national level, a wide range of countries has been included in the study sample. The aim that was set prior to deciding the composition of the sample was that every geo-economic region would be represented. The sample countries have therefore been selected from Africa, Asia and the Pacific, Western Europe, Central and Eastern Europe, the Middle East, North America, South America and Scandinavia. In total, data was gathered for 68 countries.
4.2.
M
EASURESMost of the earlier studies that have tested the effects of national culture or formal institutions on innovation examined several separate years. In contrast, I have focused on gathering data for several consecutive years. For this study, data has been collected from 2005 to 2008. The aim was to use data from the last phase prior to the emergence of the global financial crisis. The data has subsequently been averaged in order to capture development over a longer period of time.
4.3.
D
EPENDENTV
ARIABLEInstead of using solely patent or research publication counts to measure innovation, an innovation index measure has therefore been used. This innovation index has been retrieved from the World Bank’s knowledge for development database. The index is computed as the average of three key variables. The first key variable is, the total royalty payment and receipt, second the patent applications granted by the US patent and trademark office and third are the scientific & technical journal articles. This index, furthermore, is scaled by population, thus represents per capita values.
4.4.
I
NDEPENDENTV
ARIABLESThe independent variables used in this study have been specified as a nation’s culture and formal institutions. To assess and measure culture at the national level, Hofstede’s cultural dimensions have been used. The formal institutions identified as having an impact on national rates of innovation are the levels of intellectual property protection and the rule of law within a country.
4.4.1. CULTURE
Hofstede identified six cultural values: power distance, individualism, masculinity, uncertainty avoidance, pragmatism, and indulgence. Hofstede, analyzed a large database of employee value scores collected within IBM between 1967 and 1973. The data covered more than 70 countries, from which Hofstede first used the 40 countries with the largest groups of respondents and afterwards extended the analysis to 50 countries and 3 regions. Subsequent studies validating the earlier results include such respondent groups as commercial airline pilots and students in 23 countries, civil service managers in 14 countries, up-market consumers in 15 countries and elites in 19 countries. In the last edition of the research, scores on the six cultural dimensions are listed for 76 countries (Hofstede et al., 2010). Primarily based on replications and extensions of the IBM study on different international populations.
4.4.2. FORMAL INSTITUTIONS
The second variable related to formal institutions has been stated as a country’s rule of law. For this variable, rule of law data has been collected from the World Bank’s worldwide governance indicators.
4.5.
C
ONTROLV
ARIABLESFour additional key variables have been identified as control variables, namely national income level, industrial structure, human capital and a country’s trade openness. The national income level is quantified as the Gross Domestic Product (GDP) per capita based on purchasing power parity (PPP) and is expressed in international Dollar rates. The reason PPP rates have been used is to account for differences in purchasing power based on differences in currency rates. By basing the GDP per capita on PPP rates, an international Dollar has the same purchasing power in GDP as the Dollar has in the United States. This data can be found in the World Bank’s international comparison program database.
To account for a nation’s industrial structure, the World Bank’s industry value added as a percentage of GDP variable has been used. This dataset can be accessed through the World Bank’s national accounts data files. For measuring human capital, data from Barro & Lee (2010) was collected. Human capital is expressed through the average years of education of a country’s citizens.
Finally, to measure the level of international trade and trade openness of a country, merchandise trade as a percentage of GDP was used. This control variable can be found in the World Trade Organization & World Bank GDP estimates database (which is managed by the World Bank).
4.6.
D
ATAA
NALYSISThe effect of cultural values and formal institutions on national rates of innovation was examined by using least squares multiple regression analysis with the macroeconomic variables included as controls. The least squares method was selected because the innovation variables approximate normally distributed variables.
To test the relation between both culture and innovation and formal institutions and innovation at the country level, each variable was first tested separately without control variables. The variables that showed a significant relationship were then put into a regression that included the control variables. The cultural and formal institutions variables were first considered separately.
4.6.1. INTERACTION EFFECTS
To assess the interaction effect, the model put forward by Kline (1998) was followed. The interaction effect mentions that the effect of one explanatory variable depends upon the value of another explanatory variable (Moore et al., 2009).
The model diagrammed in Figure 2 shows three causal paths that feed into the outcome variable. Path A and B measure to what extent culture and formal institutions have an effect on the national rates of innovation, whereas Path C (which concerns the interaction effect) measures whether the effect of formal Institutions on the national rates of innovation depends on the cultural values present within that country.
As depicted in figure 2, interaction terms needed to be computed, in order to measure the interaction effect. The interaction terms were created from the product of the cultural and formal institutions variables (culture x formal institutions), as illustrated. The hypothesis for the interaction effect is supported if the interaction, Path C, is significant.
5.
R
ESULTS
This section begins with a presentation of the descriptive statistics, which is followed by a correlation matrix. Thereafter the results of the relation between culture, formal institutions and the national rates of innovation are shown. This section concludes with the results of the interaction effects.
5.1.
D
ESCRIPTIVES
TATISTICSTable 1 shows the descriptive statistics used for this study. Even though Hofstede’s traditional cultural dimensions span a larger set of countries than was used for this paper, the newer cultural dimensions (such as pragmatism and indulgence) are not available for the same number of countries. Therefore, for all the variables used in this research, 68 countries that represent all of the geo-economic regions are included. This sample group of 68 countries was selected from Africa, Asia and the Pacific, Western Europe, Central and Eastern Europe, the Middle East, North America, South America and Scandinavia.
TABLE 1: DESCRIPTIVE STATISTICS
Variables
Sample
Minimum
Maximum
Mean
Std. Deviation
5.2
C
ORRELATIONM
ATRIXTABLE 2: CORRELATION MATRIX
Variables Power
distance
Individualism Masculinity Uncertainty avoidance
5.3.
C
ULTUREWhen running regressions with Hofstede’s cultural dimensions, each dimension is first assessed separately on significance with the national rates of innovation as the dependent variable. As can be seen in table 3, three out of the six cultural dimensions show a significant relationship with the national rates of innovation. The power distance cultural dimension shows a negative significance relationship at the 1% level, with a beta coefficient of -0,602. The second cultural dimension that showed a significant relationship with the national rates of innovation is individualism. With a positive effect (0,668), individualism shows a significant relation at the 1% level as well. Pragmatism similarly showed positive significance (0,429) at the 1% level with respect to the national rates of innovation.
TABLE 3: EFFECTS OF CULTURE ON NATIONAL RATES OF INNOVATION
Variables Only power distance Only individua-lism Only masculinity Only uncertainty avoidance Only pragmatism Only indulgence Power distance -0,068*** (0,011) Individualism 0,068*** (0,009) Masculinity -0,003 (0,015) Uncertainty avoidance -0,003 (0,013) Pragmatism 0,042*** (0,011) Indulgence 0,015 (0,013) Observations 68 68 68 68 68 68 Adjusted R² 0,353 0,437 -0,015 -0,014 0,172 0,008
Culture & innovation (*** p<0.01, ** p<0.05, *p<0.1).
Table 4 further tests what effect economic factors have on the relationship between culture and national rates of innovation. The cultural dimensions are first put separately in a regression with the economic factors as control variables. In the last column of the table, the remaining significant cultural dimensions are combined in a regression that includes the full set of control variables. As can be seen, both power distance (-0,120) at the 10% level and individualism (0,200) at the 1% level continue to show a significant relationship even when accounting for the economic factors, while pragmatism loses its significance when the economic factors are added as control variables. As a result, hypothesis 5 can be rejected.
TABLE 4: EFFECTS OF CULTURE AND ECONOMIC FACTORS ON NATIONAL RATES OF
INNOVATION
Variables Power distance + Economic factors Individua-lism + Economic factors Pragmatism + Economic Factors Power distance + Economic factors + Trade openness Individua-lism + Economic factors + Trade openness Power distance + Individua-lism+ Economic factors + Trade openness Power distance -0,014* (0,007) -0,014* (0,008) -0,005 (0,009) Individualism 0,020*** (0,007) 0,022*** (0,008) 0,020** (0,009) Pragmatism 0,006 (0,006) National income level 8,156E-005*** (0,000) 8,356E-005*** (0,000) 8,974E-005*** (0,000) 8,002E-005*** (0,000) 8,058E-005*** (0,000) 7,751E-005*** (0,000) Human capital 0,432*** (0,069) 0,364*** (0,073) 0,425*** (0,075) 0,432*** (0,070) 0,358*** (0,073) 0,361*** (0,074) Industrial structure 0,008 (0,015) 0,021 (0,016) 0,007 (0,015) 0,008 (0,015) 0,022 (0,016) 0,022 (0,016) Trade openness 0,001 (0,002) 0,001 (0,002) 0,002 (0,002) Observations 68 68 68 68 68 68 Adjusted R² 0,820 0,833 0,813 0,817 0,831 0,829Culture, innovation & economic factors (*** p<0.01, ** p<0.05, *p<0.1).
economic factors and a country’s trade openness as control variables. This could be due to the fact that the two variables are highly correlated. Individualism, on the other hand, does show a significant relation (0,196) in the same regression, at the 5% level. As such, hypothesis 1 can be partially accepted and hypothesis 2 can be fully accepted.
It is also interesting to note the strong significance of the economic factors in relation to the national rates of innovation. The national income level and a nation’s human capital demonstrate strong positive and significant relations, both at the 1% level, even when regressed with the full set of variables.
5.4.
F
ORMALI
NSTITUTIONSTable 5 presents the findings for assessing the relationship between formal institutions and national rates of innovation. The property rights protection variable shows a consistent level of significance and a positive relationship (0,835) with the national rates of innovation.
When the macroeconomic control variables are included, property rights protection shows a strong positive relationship (0,382) at the 1% level. If the international trade variable is added to the regression, property rights protection continues to show a significant relation (0,381) at the 1% level. Similarly, the rule of law also shows a continuing positive significance level (0,839) with national rates of innovation. After adding the control variables, the rule of law also demonstrates a positive significance (0,379) at the 1% level. With the full set of control variables included in the regression, the rule of law remains significant (0,385) at the 1% level.
However, when property rights protection and a country’s rule of law are added to the regression, the property rights protection variable loses its significance. The fact that both variables are strongly correlated could explain why property rights protection becomes insignificant when the rule of law is included in the same regression. The rule of law, on the other hand, appears to be significant (0,307) at the 10% level, even after property rights protection is included in the same regression together with the full set of control variables. Therefore hypothesis 7 can be partially accepted and hypothesis 8 can be fully accepted.
TABLE 5: EFFECTS OF FORMAL INSTITUTIONS AND ECONOMIC FACTORS ON NATIONAL RATES OF INNOVATION
Variables Only property protection Only Rule of Law Property protection + Economic Factors Rule of Law + Economic Factors Property protection+ Economic Factors+ Trade openness Rule of Law+ Economic Factors+ Trade openness Property protection +Rule of Law+ Economic Factors+ Trade openness Property protection 1,227*** (0,100) 0,562*** (0,119) 0,560*** (0,120) 0,156 (0,200) Rule of Law 0,073*** (0,006) 0,033*** (0,006) 0,033*** (0,006) 0,027** (0,011) National income 4,840E-005*** (0,000) 6,248E-005*** (0,000) 4,981E-005*** (0,000) 6,535E-005*** (0,000) 5,905E-005*** (0,000) Human capital 0,399*** (0,062) 0,316*** (0,064) 0,398*** (0,062) 0,311*** (0,064) 0,325*** (0,067) Industrial structure 0,015 (0,013) 0,022 (0,013) 0,015 (0,014) 0,023* (0,013) 0,022 (0,013) Trade openness -0,001 (0,002) -0,002 (0,002) -0,002 (0,002) Observations 68 68 68 68 68 68 68 Adjusted R² 0,692 0,700 0,860 0,869 0,858 0,869 0,868
5.5.
C
ULTURE ANDF
ORMALI
NSTITUTIONSAfter presenting the statistical evidence, it can be seen that out of all of the cultural dimensions, only individualism appears to be significant with the full set of control variables. Out of the formal institutions variables, only rule of law came out to be significant when the full set of control variables are included. Table 6 summarizes the results when individualism and rule of law are being put in the same regression.
Without the macroeconomic controls, both variables show to be significant. Individualism shows a positive relation (0,181) with respect to the national rates of innovation, as does the rule of law variable (0,716). However, when the economic factors are included as controls, only rule of law appears to stay significant (0,338). The rule of law variable also stays significant (0,385) when including a country’s trade openness to the regression. This shows that the effect of individualism on the national rates of innovation appears to weaken when the broader environment is being considered.
TABLE 6: EFFECTS OF CULTURE, FORMAL INSTITUTIONS AND ECONOMIC FACTORS
ON NATIONAL RATES OF INNOVATION
Variables Individualism + Rule of Law
Individualism + Rule of Law + Economic Factors
Individualism + Rule of Law + Economic Factors
+ International trade Individualism 0,018** (0,009) 0,010 (0,007) 0,008 (0,007) Rule of Law 0,062*** (0,008) 0,029*** (0,007) 0,033*** (0,006) National income 6,224E-005*** (0,000) 6,535E-005*** (0,000) Human capital 0,288*** (0,066) 0,311*** (0,064) Industrial structure 0,028** (0,014) 0,023* (0,013) Trade openness -0,002 (0,002) Observations 68 68 68 Adjusted R² 0,713 0,872 0,869
Table 7 assesses the same regressions as in table 6, but using an alternate measure for the dependent variable. Instead of using the innovation index from the World Bank’s knowledge for development database, table 7 shows regressions through which R&D expenditure as a percentage of GDP is being used as the dependent variable. The variable can be accessed through the world development indicators database of the World Bank.
This table shows slightly different results compared to table 6. For example, individualism appears not to be significant, whereas the rule of law variable shows to be significant even with the full set of control variables. This is similar to the results recorded in table 6. However differences can also be seen in the individual macroeconomic control variables. Whereas in table 6 both the national income level and a country’s human capital show significance levels, in table 7 only the national income level together with the industrial structure of a country appear to be significant when using the alternative measure for national rates of innovation.
TABLE 7: EFFECTS OF CULTURE, FORMAL INSTITUTIONS AND ECONOMIC FACTORS
ON NATIONAL RATES OF INNOVATION
Variables Individualism + Rule of Law
Rule of Law + Economic Factors
Rule of Law + Economic Factors + International trade Individualism 0,007 (0,005) Rule of Law 0,023*** (0,005) 0,016*** (0,005) 0,017*** (0,005) National income 2,361E-005*** (0,000) 2,968E-005*** (0,000) Human capital 0,009 (0,051) -0,003 (0,048) Industrial structure -0,001 (0,011) 0,002 (0,010) Trade openness -0,004*** (0,001) Observations 64 64 64 Adjusted R² 0,495 0,535 0,586
5.6.
I
NTERACTIONE
FFECTSThe interaction effect between individualism and rule of law does not appear to be significant. Other combinations have also been assessed for interaction effects between the cultural dimensions and formal institutions variables that appeared to be individually significant. The interaction effects “power distance x rule of law”, “power distance x property rights protection”, “pragmatism x rule of law” and “pragmatism x property rights protection” have been tested, but no significant interaction effects have been found.
TABLE 8: INTERACTION EFFECTS REGARDING NATIONAL RATES OF INNOVATION
Variables Individualism x Rule of Law Individualism x property protection Individualism x property protection + Economic factors Individualism x property protection + Economic factors + Trade openness Individualism x rule of Law 0,000 (0,000) Individualism 0,036 (0,027) 0,083** (0,027) 0,055** (0,026) 0,060** (0,026) Rule of Law 0,070*** (0,014) Individualism x property protection -0,010* (0,005) -0,007* (0,004) -0,008** (0,004) Property protection 1,465*** (0,251) 0,787*** (0,199) 0,856*** (0,220)
National income 5,220E-005***
6.
D
ISCUSSION
This paper offers a framework for analyzing the effects and relationships of culture and formal institutions regarding national rates of innovation. This framework has been established first by studying the extent to which culture and formal institutions separately have an effect on the national rates of innovation, then by testing whether the effects of formal institutions on the national rates of innovation depends on the cultural settings within that country.
The results have shown that out of the Hofstede cultural dimensions, individualism relates significantly to the national rates of innovation. The same is true for the level of power distance within a country, which has a lesser but still significant relationship to innovation on the national level. Interestingly, the research also points out that the cultural dimensions found to be significant in earlier research, such as individualism and power distance, fade when they are either controlled for macroeconomic factors or put on the same regression as the formal institutions variables. This could, however, be because the variables themselves are correlated.
As for the relation between formal institutions and national rates of innovation, the research revealed that primarily the rule of law relates positively to the innovational output of a country. The same is true for the level of property protection and its relationship with national rates of innovation, albeit to a slightly lesser extent.
The results of testing the interaction effects between culture and formal institutions in relation to the national rates of innovation showed that the effect of formal institutions on national innovation depends on the country’s cultural setting. This means that the same formal institutions that exist in societies with different cultural values can produce different outcomes.
7.
L
IMITATIONS
&
A
VENUES
F
OR
F
UTURE
R
ESEARCH
Most research that accounts for culture within an economic context leans on the Hofstede dimensions. The cultural variables have not, however, been safe from criticism. It is primarily argued that Hofstede’s traditional cultural dimensions are outdated, given that they were originally measured in the early 1980s. To overcome this, future research could include several rival cultural measures from other scholars such as Schwartz (2006) and Project GLOBE (House, Hanges, Javidan, Dorfman, & Gupta, 2004).
Furthermore, this study uses data that has been averaged over the years 2005 to 2008. Measures of innovative output are, however, subject to some random fluctuations (Porter & Stern, 2002). To average the data over this timeframe, does smooth out the year-to-year variation. Nonetheless, statistical tests based on averages are usually too high when applied to individual years (Moore et al, 2009). In addition, since most data has been gathered from the World Bank, the reliance on a single data source also exposes a source bias limitation.
Although the available data and statistical procedures both face limitations, the results lead to interesting avenues for future research. The data shows that the effect of intellectual property rights protection on national innovation rates depends on whether societies share an individualistic or collectivistic cultural environment. Future research could therefore be directed towards whether there is a higher risk of expropriation of innovation in collectivistic societies than in individualistic societies. Focusing on this point could explain the interaction effect between individualism and intellectual property rights protection, and help to determine if they are substitutes or complements. Innovation is seen as a very important source of competitive advantage for both governments and firms. It is also apparent as a result of both this study and earlier research that the national innovation rates are higher in relatively more individualistic societies. An interesting avenue for further research would therefore be, to assess how social capital relates to individualism and a nation’s effort to strive for high rates of innovation. This could lead to results that can explain whether there is a negative side for governments to strive for high national innovation rates, in addition to determining if innovation necessarily offers better value for society.
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