The Role of Innovation in Driving Economic Growth: A Conceptual Framework

The Role of Innovation in Driving Economic Growth: A Conceptual Framework

Shahiszan Ismail^1*, Noor Zahirah Mohd Sidek²

¹Faculty of Business and Management, University Technology MARA, Cawangan Kedah, Kampus Sungai Petani, Malaysia

²Faculty of Business and Management, University Technology MARA, Cawangan Kedah, Kampus Sungai Petani, Malaysia

*Corresponding author

DOI: https://dx.doi.org/10.47772/IJRISS.2025.908000554

Received: 14 August 2025; Accepted: 22 August 2025; Published: 20 September 2025

ABSTRACT

Innovation is widely acknowledged as a key factor of economic growth, yet the mechanisms through which it impacts economic advancement remain inadequately defined, especially within the context of developing economies. This study aims to construct a conceptual framework that demonstrates the role of innovation as a driver of economic growth, focusing on how technological advancements, process improvements, and product developments contribute to sustained economic expansion. This study employs a mixed-method approach, integrating existing literature on economic theory, case studies on industrial innovation, and empirical data on innovation-driven economic metrics. The framework developed here identifies key pathways by which innovation affects growth, including enhancing productivity, fostering competitiveness, and attracting foreign direct investment (FDI). The findings underscore that innovation not only improves productivity within firms but also boosts national economic performance by fostering a competitive market environment, reducing production costs, and facilitating entry into international markets. Furthermore, innovation-driven economies experience higher levels of job creation and increased self-employment opportunities, thus broadening economic participation. The study’s framework has practical implications, suggesting that policymakers should prioritize innovation-friendly policies, such as R&D subsidies, infrastructure investment, and education reform to stimulate a culture of continuous advancement and economic sustainability. However, limitations arise from the framework’s dependence on data primarily from developed economies, which may affect generalizability. Future research should focus on region-specific studies that assess the impact of innovation in diverse economic contexts, thereby refining the relevancy of this framework to various stages of economic development.

Keywords: innovation, economic growth, competitiveness, productivity, development

INTRODUCTION

Innovation refers to the process of generating new ideas, products, services, or methods that significantly improve or transform existing systems and practices. In economic field, innovation is recognized as a fundamental driver of economic growth. By enabling firms and industries to increase efficiency, reduce costs, and develop new markets, innovation boosts productivity and output (European Central Bank, 2024). Consequently, innovation leads to higher gross domestic product (GDP) and creates new employment opportunities. Moreover, innovation is essential for sustaining long-term economic competitiveness, as it fosters entrepreneurship, supports technological advancements, and enhances a nation’s ability to adapt to global market changes (Viima, 2019). Without innovation, economies may stagnate, as they fail to develop in response to technological changes and consumer needs (Maradana et al., 2017).

The primary objective of this article is to present a conceptual framework that highlights the connection between innovation and economic growth. Innovation, defined as the introduction of new ideas, technologies, and processes, plays a critical role in improving productivity, fostering industrial growth, and enhancing competitiveness on a global scale (Surya et al., 2021). By integrating theoretical models and empirical research, this framework seeks to explain how innovation contributes to economic diversification, job creation, and sustainable development. Furthermore, this study will explore the role of innovation in shaping long-term economic paths, particularly in relation to technological advancements and entrepreneurship (Hausman, 2014). The framework will also consider the impact of government policies and institutional support in promoting an innovative ecosystem that drives continuous economic expansion (UP Malaysia, 2020).

The theoretical significance of this study lies in its contribution to understanding the intricate relationship between innovation and economic growth through a conceptual framework. By exploring how innovation fosters productivity, competitiveness, and technological advancements, the study enhances existing economic theories, particularly those related to growth models and the role of knowledge-based economies (Hausman, 2014). Practically, the study holds importance for policymakers, businesses, and entrepreneurs, as it provides insights into the mechanisms through which innovation can drive sustainable economic development and diversification. Furthermore, this study highlights innovation as a key driver of employment, living standards, and industrial growth, positioning it as essential to strategies for innovation-led economic development. (UP Malaysia, 2020).

The research gap addressed in this study arises from the limited understanding of how innovation directly contributes to economic diversification and long-term competitiveness, particularly in developing nations. While there is significant literature relating innovation to economic growth, few studies offer a comprehensive conceptual framework that captures the multidimensional influence of innovation across industries and economies. This paper aims to fill that gap by presenting a robust model that clarifies the relationship between innovation, economic diversification, and sustainable development, particularly in emerging markets. The key objectives are to explore how innovation drives economic growth, assess its role in fostering competitiveness, and provide practical recommendations for policymakers to enhance innovation ecosystems.

The structure of this study begins with an introduction emphasizing the importance of innovation in modern economies and the need for a conceptual framework. Following this, the literature review explores existing studies on innovation and economic growth. The methodology section presents the approach used to develop the framework, followed by an analysis of case studies that illustrate its practical application. The final sections discuss the implications of the findings and offer conclusions along with recommendations for future research.

LITERATURE REVIEW

The discussion on innovation theories in economic development has significantly evolved, with various paradigms contributing to our understanding of how innovation drives economic progress. Schumpeter’s theory of innovation, which suggests that innovation is the primary factor for economic development, emphasizes the role of the entrepreneur in disrupting established markets through new products, processes, and business models. Schumpeter conceptualized this transformative process as creative destruction, wherein outdated industries and practices are displaced by innovative solutions, reshaping economic structures and market dynamics (Courvisanos & Mackenzie, 2014). More recent theoretical advances highlight the need for comprehensive policy frameworks that support innovation and entrepreneurship (Braunerhjelm & Henrekson, 2023), and empirical studies confirm a strong correlation between innovation and economic growth across European countries (Maradana et al., 2017). These insights underscore the critical importance of building complete support for innovation to sustain development (Borowiecki et al., 2019).

Previous research has consistently underscored the critical role of innovation in stimulating economic growth, highlighting its multifaceted impact across various economic contexts. A study by Maradana et al. (2017) established a long-run relationship between innovation and per capita economic growth in 19 European countries, demonstrating that increased innovation efforts lead to higher GDP. Dempere et al. (2023) studied innovation’s impact on GDP, self-employment, and foreign direct investment (FDI) using data from 120 countries. They found that innovation boosts GDP but lowers self-employment and has no significant effect on FDI. Collectively, these studies illustrate that innovation is not merely a contributor to economic growth but a fundamental mechanism through which economies evolve and adapt to changing global landscapes, emphasizing the need for policies that encourage innovative activities across all sectors.

Innovation plays an important role in addressing economic challenges and enhancing productivity across various sectors. It acts as a key element, especially during recessions or stagnation, by enabling new business models and streamlining operations. Fagerberg, Srholec, and Verspagen (2010) define innovation as efforts to develop improved products and processes, which foster competitiveness and productivity growth. Courvisanos and Mackenzie (2014) emphasize how innovative entrepreneurs drive economic dynamism and adaptability to changing markets, reinforcing innovation’s role in economic resilience. From a policy standpoint, OECD (2023) highlights digital transformation as a critical pathway for productivity gains and sustainable innovation strategies. Furthermore, the World Bank (2017) underscores that addressing low innovation in developing economies is essential to overcoming structural limitations and enabling inclusive growth. In short, these perspectives affirm that cultivating a culture of innovation is fundamental to navigating contemporary economic landscapes and securing future growth.

In order to support this study on the role of innovation in stimulating economic growth, several key theories can be employed. Firstly, the endogenous growth theory posits that technological advancements, driven by innovation, are a central engine of economic growth. This theory suggests that investments in human capital, innovation, and knowledge can lead to sustained economic expansion (Maradana et al., 2017). Referring to endogenous growth theory, Schumpeter’s creative destruction, and disruptive innovation theory collectively connects the link between innovation and economic growth. Based on endogenous growth theory, current studies such as Wang et al. (2023) demonstrate how technological standardization stimulates economic expansion through innovation pathways, confirming the theory’s relevance in modern economies. Schumpeter’s model of creative destruction explains how new innovations replace outdated processes and products, fostering a dynamic and adaptive economy (Berlingieri et al., 2025). Similarly, disruptive innovation theory emphasizes how emerging technologies can displace established leaders, enhancing competition and economic efficiency (Pang & Abdullah, 2024). These complementary frameworks reveal that innovation, productivity, and economic growth are deeply connected, where increases in innovation generate new economic opportunities, raise productivity, and sustain growth. Furthermore, these theories provide a robust foundation for understanding how innovation not only fuels development but also reshapes industries and markets for the future (OECD, 2023).

Based on the reviewed studies, the key literature on innovation and economic growth has been synthesized into Table 1.1, which outlines the authors, methodologies, key variables, and major findings relevant to this research. This tabular format enables a clear comparison of research designs and results, highlighting consistent patterns as well as areas for further exploration.

Table 1.1 Summary of Key Literature on Innovation and Economic Growth

METHODOLOGY

This study adopts a qualitative conceptual analysis approach to develop a comprehensive framework for understanding the role of innovation in driving economic growth. Rather than relying on primary data collection, the research synthesizes existing empirical findings, theoretical models, and policy reports to construct a framework that captures the dynamic interactions between innovation drivers and economic performance. This approach is particularly suited for studies aiming to consolidate diverse strands of literature into a coherent explanatory model.

The methodology involves three main steps. First, an extensive literature review was conducted, focusing on studies published between 2020 and 2024, to identify the most recent and relevant evidence on innovation’s impact on economic growth. Second, findings were systematically categorized according to three dimensions: innovation inputs, innovation outputs, and economic growth indicators. Finally, these categories were integrated into a conceptual model that reflects both direct and indirect pathways linking innovation activities to economic outcomes. The conceptual framework developed here is not only grounded in current academic discourse but also incorporates policy-oriented insights, ensuring its relevance to both researchers and practitioners.

Proposed Conceptual Framework

Description of the Proposed Conceptual Framework Linking Innovation and Economic Growth

The proposed conceptual framework illustrates the dynamic relationship between innovation and economic growth. It posits that innovation acts as a catalyst for economic advancement, where inputs such as research and development (R&D) and human capital significantly contribute to creating new products and services. This framework is structured to demonstrate how innovation not only enhances productivity and competitiveness among firms but also ultimately translates into broader economic indicators, such as Gross Domestic Product (GDP) growth. By emphasizing the interconnectedness of these elements, the framework highlights the critical role that a robust innovation ecosystem plays in driving sustainable economic development (Danta & Rath, 2024; Cammeraat et al., 2021).

Key Components of the Framework

The key components of this framework include innovation inputs, innovation outputs, and economic growth indicators. As shown in Figure 1.1, the proposed conceptual framework emphasizes the central role of innovation inputs which particularly R&D and human capital in generating innovation outputs that drive productivity and economic expansion. This illustrates the pathway through which innovation fosters long-term competitiveness and national growth. Innovation inputs (refer Figure 1.1) such as R&D investments and the quality of human capital are fundamental as they foster an environment conducive to innovation. R&D activities lead to technological advancements and enhanced workforce capabilities, while human capital provides the necessary skills and knowledge for effective innovation (Danta & Rath, 2024). Innovation outputs encompass new products and services that arise from these inputs, which can significantly enhance a firm’s market position and stimulate consumer demand.

Figure 1.1 Proposed Conceptual Framework Innovation–Growth Linkages

Note: Generated by Napkin (https://www.napkin.io).

Explanation of the Relationships Between Innovation Drivers and Economic Performance

The relationship between innovation drivers and economic performance is multifaceted. High levels of investment in R&D and a skilled workforce not only led to the development of innovative products and services but also enhance overall productivity within firms. This, in turn, supports GDP growth as more efficient production processes and superior products meet consumer demand. Additionally, a vibrant innovation environment attracts further investment and talent, creating a virtuous cycle of growth and innovation (Cammeraat et al., 2021; Boons & Lüdeke-Freund, 2013). These complementary frameworks reveal that innovation, productivity, and economic growth are deeply intertwined: increases in innovation generate new economic opportunities, elevate productivity, and drive sustained growth. Altogether, they provide a robust foundation for understanding how innovation not only fuels development but also reshapes industries and markets for the future (OECD, 2023). The summary regarding relationships between innovation drivers and economic growth explain in figure 1.2. Figure 1.2 further clarifies how innovation drivers directly influence economic outcomes. It demonstrates that investments in R&D and workforce skills do not only create new technologies but also generate positive spillovers that enhance productivity, strengthen competitiveness, and expand GDP.

Figure 1.2 Summary of relationships between innovation drivers and economic performance.

Note: Generated by Napkin (https://www.napkin.io).

Integration of Conceptual Mapping and Framework Visualization

Figure 1.3 presents a high-level conceptual map generated by Scopus AI, clustering the innovation-growth literature into three major streams which are innovation systems, economic growth models, and theoretical foundations. These clusters underpin the theoretical grounding of this study: the innovation systems cluster emphasizes the link between innovation inputs (e.g., R&D investment and human capital) and outputs, echoing the framework’s emphasis on how innovation inputs generate new products, services, and technological capabilities. The economic growth models cluster reflects empirical methods and outcome measures such as GDP and productivity which aligning with how innovation outputs drive broader economic indicators. The theoretical foundations cluster highlights endogenous growth theory and the intricate processes through which innovation sustains economic performance.

Figure 1.3 Conceptual Mapping of Innovation–Economic Growth

Note. Generated with Scopus AI conceptual mapping tool (Elsevier, 2024).

Innovation’s Impact On Economic Growth

Case studies where innovation has spurred economic growth

Innovation-led strategies have underpinned growth in several economies. Higher levels of innovation often lead to increased exports of technology-related products, positively impacting trade. As countries open to international trade, they tend to experience faster economic growth, innovate more, improve productivity, and provide higher incomes and more opportunities to their citizens (The World Bank, 2018). In Europe, Nordic members and innovation leaders identified in the European Innovation Scoreboard such as Sweden and Finland which combine sustained research funding, digital readiness, and human-capital quality to achieve above-average innovation performance tied to growth and resilience (European Commission, 2024; OECD, 2023). Smaller digital frontrunners like Estonia demonstrate how e-government and platformized public services can catalyze private-sector innovation and spur firm formation (World Bank, 2020). Together these cases illustrate that coherent innovation systems institutions, skills, finance, and diffusion channels matter as much as R&D outlays (OECD, 2023; WIPO, 2024).

In developing economies, innovation often takes unique forms that significantly contribute to growth. For example, in Vietnam, foreign direct investment in electronics has facilitated technology transfer and export diversification, boosting industrial growth (Nguyen & Luu, 2020). Similarly, Malaysia’s Digital Economy Blueprint (MyDIGITAL) illustrates how government-led strategies can accelerate digital adoption and fintech innovation (Economic Planning Unit Malaysia, 2021). These examples show that innovation in developing contexts extends beyond high-tech industries, shaping economic growth through financial inclusion, industrial upgrading, and digital transformation.

Analysis of how innovation influences productivity, job creation, and technological advancements

Innovation raises multifactor productivity by enabling new products, better processes, and faster diffusion of general-purpose technologies (OECD, 2023). At the firm level, R&D and complementary intangibles (skills, data, organizational capital) lift efficiency and quality, while at the macro level, innovation deepens capital, upgrades value chains, and expands export sophistication (Dempere, 2023; European Commission, 2024). Employment effects are heterogeneous: technology adoption can displace routine tasks yet creates new occupations and demand in complementary services, often yielding net gains when education and active labor policies help workers transition (OECD, 2023). Technological advances, including AI, clean energy, and advanced manufacturing, diffuse and generate spillovers more rapidly when supported by integrated regulatory, data, and financial ecosystems (WIPO, 2024; OECD, 2023).

Long-term and short-term effects of innovation on the economy

In the short run, innovation can concentrate gains in frontier firms, widen dispersion, and require adjustment costs in skills and organization (OECD, 2023). Over the long run, however, sustained innovation investment compounds into durable productivity growth, higher real incomes, more diversified export baskets, and improved resilience to shocks (European Commission, 2024; WIPO, 2024). Technological progress translates into broad-based growth when policies combine support for invention with diffusion through SME adoption, standards, and open data alongside inclusive measures that enhance human-capital development and cross-sector mobility (OECD, 2023; Dempere, 2023).

Challenges In Linking Innovation To Economic Growth

Within the proposed conceptual framework which suggests that innovation inputs (e.g., R&D and human capital) generate outputs (new products, services) that ultimately drive economic growth where the translation from innovation to growth is often hindered by systemic barriers. Funding limitations such as the “valley of death” impede scale-up, especially in emerging economies where venture capital is scarce. Policy and regulatory constraints such as including weak intellectual property rights, inconsistent innovation governance, and misaligned industrial policies can reduce incentives for investment and slow technology diffusion. Additionally, talent shortages (particularly in STEM and digital skills) limit firms’ capacity to absorb and implement innovative technologies. These barriers particularly affect how to measure spatial and direct impacts in empirical models. If R&D investment or skilled labor are unevenly distributed, then estimating innovation’s effects using GMM or spatial econometric models may understate or misattribute their true national and regional contributions.

Furthermore, even when innovation activity exists, there may be disconnects between innovation efforts and broader economic outcomes, especially when diffusion mechanisms, absorptive capacities, or institutional support are weak. For example, regions with underdeveloped innovation ecosystems may fail to benefit from nearby R&D spillovers, and enterprises pursuing innovation may not translate improvements into productivity gains due to inadequate organizational structures. These disconnects create “innovation–outcome gaps”, where large investments in innovation do not appear in GDP or productivity metrics. Although many countries invest heavily in innovation, the outcomes are not always reflected in productivity gains. For instance, in developing economies, weak institutions and limited absorptive capacity often prevent innovation efforts from translating into economic growth (Cirera & Maloney, 2017). Similarly, Dempere et al. (2023) found that innovation boosts GDP but has little effect on foreign direct investment and may even reduce self-employment, showing that outcomes can be uneven. These examples demonstrate that innovation requires strong diffusion mechanisms and institutional support to close the “innovation–outcome gap”.

CONCLUSION

Implications for Policymakers and Researchers

Policymakers can adopt specific strategies to strengthen innovation-led growth. These include providing R&D tax incentives for SMEs to stimulate local innovation activity (OECD, 2023), creating innovation hubs and incubators to support startups with financing and mentorship (World Bank, 2017), and expanding digital infrastructure such as affordable broadband and 5G networks to enable wider technology adoption (Arnold et al., 2023). In addition, integrating innovation-focused training into education systems and strengthening intellectual property rights would help build human capital and investor confidence (Cirera & Maloney, 2017). Such concrete measures ensure that innovation policies translate into tangible economic outcomes rather than remaining broad aspirations. For researchers, the framework highlights the importance of employing multi-dimensional and spatially sensitive models, particularly those that examine how institutional quality, market size, and technological diffusion moderate the innovation–growth relationship.

Future Research Directions

Future studies should extend this framework by investigating the role of green innovation and environmental sustainability within endogenous growth models, aligning with emerging Schumpeterian adaptations (Zhang & Sun, 2023). Research should also explore knowledge spillover dynamics, particularly how innovation clusters and diffusion patterns shape regional economic outcomes (Spence & Smith, 2024). Moreover, sector-level and firm-level analyses would provide deeper insights into the micro-foundations of innovation. Comparative longitudinal studies across developing economies undergoing digital transitions, R&D intensification, and trade integration will further validate and refine the framework. In addition, although this study develops a conceptual framework, future work should complement it with empirical validation. Small-scale econometric testing, sectoral datasets, or country-specific case studies could be employed to assess the framework’s robustness and generalizability across different economic contexts.

ACKNOWLEDGEMENTS

The authors acknowledge the support of Universiti Teknologi Mara (UiTM), Kedah Branch, Malaysia, for providing facilities and financial assistance for this research.

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