Newswise — A new study from a University of Iowa researcher finds that state borders matter when it comes to developing innovative businesses.

According to the study, the three most important components of an innovative economy are the presence of significant private venture-capital funding, government funding, and robust research universities. Those states that are strong in all three see a 16-fold increase in product innovation over states that are weak in all three.

“Industry, academia, and government are the ingredients of the ‘secret sauce’ that fosters innovation,” says Shagun Pant, assistant professor of finance in the Tippie College of Business and co-author of the study. “Firms have an advantage based on the state they’re in.”

The study looked at medical device development as a proxy for overall economic innovation. Researchers studied how firms responded to Medicare approval of new devices, a “positive shock” that sets off a wave of research and development by companies to design, manufacture, and market a product that will be paid for by the government for millions of Medicare recipients.

Pant says most medical device firms are small to medium-sized businesses that rely heavily on outside financing to bring a new product to market. Much of that financing comes in the form of private venture-capital investment and public funding—in this case, grants from the National Institutes of Health (NIH).

The researchers tracked the development of devices approved by the FDA and patented with the federal government from 1986 to 2014 and analyzed where the financing for those devices came from. The study found the largest number of approved devices were developed by firms located in states that had the most venture capital, NIH grant funding, and universities to assist in research and development.

“The highest levels of innovation are accomplished when all three supply-side factors are concentrated in one place,” says Pant, noting that venture capital turns out to be the most important segment, followed by research universities.

The study found that the five most innovative states for medical devices were California, New York, Massachusetts, Illinois, and Texas. Pant says those states all have innovation clusters, where established businesses can access ample venture capital funding and government support, while nearby research universities provide facilities with the latest technology and brain power.

She says each of the three legs tends to reinforce the others, so as each one strengthens, it attracts more people with investment capital and innovative ideas.

The study found Iowa was in 22nd place. Pant says that while the University of Iowa and Iowa State University establish a solid base for research universities, the state scores low in private venture capital and public funding.

Pant says the study suggests that targeted government incentives can encourage innovation in industries beyond medical devices.

“An increase in demand through Medicare approval helps foster innovation in the medical device industry, and this implies that regulators can provide incentives, such as solar systems tax or electric car tax breaks, that lead to a positive shift in the demand curve in other industries as well,” she says.

Pant says ongoing support for public universities is critical to establishing an innovation culture because they train skilled labor, provide a platform for collaboration, and serve as incubators for new firms. A proposed innovation center at the UI would be a step toward creating a more innovative culture throughout the state, she says, attracting people with capital and ideas who are willing to take risks.

Pant’s study, “Innovation: The interplay between demand-side shock and supply-side environment,” was co-authored with Ivalina Kalcheva of the University of California, Riverside, and Ping McLemore of the Federal Reserve Bank of Richmond. It will be published in the March 2018 issue of the journal Research Policy.

Journal Link: Research Policy, March 2018