Can institutions explain cross country differences in innovative activity?

• We find a positive effect of institutions on R&D intensity by using 2SLS.
• This effect is robust to alternative measures of variables and estimation techniques.
• Human capital accumulation and financial development enhance this effect.
• Trade openness can neither enhance nor undermine the effect of institutions on R&D.

Motivated by theoretical arguments (see e.g. Romer, 2010 and Mokyr, 2008) that assert a positive impact of institutions on R&D, this paper aims to provide some empirical analysis on the relationship between the two variables. In particular, using a core sample of 98 countries over the period 1996–2009, this paper has found a significant direct effect of institutions on R&D intensity. Countries with better institutions qualities as captured by the World Banks’ Worldwide Governance Indicators (WGI) tend to attract more scientists and engineers into the research field and to spend more on R&D as well. This paper has also found evidence that the effect of institutions varies in different economies characterized by different levels of financial development and human capital accumulation, but stays relatively unchanged across countries with different levels of trade openness.