This article has originally appeared in the International Market & Competitive Intelligence magazine (July/August 2023)

With giant waves of technological change rocking every corner of the global economy, innovation isn’t a luxury anymore, not even a matter of choice; it’s a means of survival. The mantra “innovate or die” may sound like a cliché, yet it correctly reflects the contemporary business environment, in which companies must relentlessly innovate to just stay in business.

Unfortunately, managing the innovation process in a sustainable way turned out to be difficult for a lot of organizations. Many of them have failed to establish the structure and processes needed to run effective innovation programs and instead are wasting time on chasing the elusive “culture of innovation.”

To be sure, it’s impossible to deny the importance of the human component in any business process, including innovation. But it’s much more important to design and implement actionable corporate policies that boost innovation. There is no need to start from scratch: specific socio-economic factors affecting innovation have long been described in the literature.

When analyzing these factors, I came to a somewhat unexpected conclusion: one of the most powerful drivers of innovation — and the one that draws surprisingly little attention — is freedom. Yes, freedom. Freedom emerges as a common denominator for the factors that boost innovation. The reverse is also true: restrictions on liberties have a chilling effect on the corporate innovation process.

In this article, I’ll present evidence showing that freedom has a positive effect on innovation. I’ll also show that this effect manifests at three major levels: individual, organizational, and national.

Freedom of being yourself

I suspect not many people have heard about employment nondiscrimination acts (ENDAs). ENDAs are US state-level laws that prohibit discrimination based on sexual orientation and gender identity. A 2016 study showed that firms located in US states that have passed ENDAs obtained more patents, a popular measure of innovation, than firms in US states without ENDAs. The result was more pronounced for the firms in human capital-intensive industries, such as technology and finance, and, unsurprisingly, in the states with a large LGBTQ+ population.

Another study, published in 2018, used the same innovation metric, the state-level patenting, to study the effect of two social liberalization policies: the legalization of medical marijuana and same-sex marriages. The study showed that the adoption of these two policies increased state-level patenting. In contrast, the laws imposing restrictions on abortion had a negative effect on innovation in the states that adopted anti-abortion legislation.

I’m not aware of any data indicating that people smoking weed or belonging to LGBTQ+ communities are intrinsically more innovative. Instead, I argue that innovation requires a certain level of individual freedom, including freedom from being discriminated against for whatever reason.

This point echoes the results of a 2015 study describing team building at Google, one of the world’s most innovative companies. The study listed five key factors that set successful Google teams apart; the most important factor of the five was psychological safety, the ability of team members to take risks without feeling insecure or embarrassed.

Given the above findings, what actionable measures can companies undertake? The answer is simple: to energize their diversity, equity, and inclusion (DEI) programs.

The positive effects of diversity on innovation are well documented. Everyone agrees that diverse people bring unique information, perspectives, and experiences — all necessary components of successful innovation. But let’s not overlook another major benefit of a diversified and inclusive marketplace: freedom of being yourself.

Freedom to try and then try again

Economists have long argued that conditions incentivizing employees to innovate must include tolerance for early failures. This allows corporate innovators to take risks at the initial stages of the innovation process — when the rate of unsuccessful experiments is especially high — without facing negative consequences for failed projects.

Available empirical evidence supports this point of view. For example, an analysis of the impact of labor laws on innovation in five countries (the United States, the UK, France, Germany, and India) showed that stronger labor laws — i.e., laws making it more difficult to dismiss workers — positively correlated with a country’s innovation output.

Another study investigated the impact on innovation of the wrongful discharge laws (WDL) in the United States. These laws provide employees with greater protection than employment at will, a common arrangement under which employees can be terminated with or without just cause. The WDL, particularly those that protect employees from termination in bad faith, were found to foster innovation by increasing the employees’ motivation and effort.

These results strongly suggest that corporate innovation is boosted by laws that limit firms’ ability to dismiss employees at will. Experts call this phenomenon an “insurance effect”: feeling increased protection from the negative consequences of failure, employees are more committed to engaging in risky innovative projects.

Companies can capitalize on these findings by modifying their employment policies. For example, they can place employees involved in strategic innovation projects on fixed-term (say, 3-5 years) employment contracts, as opposed to employment at will. Alternatively, the creation of tenure-like job arrangements for the same employees can be considered.

Regardless of specific actions, I insist that providing employees with immunity for failed innovation projects (i.e., giving them the freedom to try and then try again) is a better way to promote innovation than by “celebrating failures.”

It turns out that not only individual innovators, but companies too, enjoy the freedom to fail. This was a conclusion of a 2011 study analyzing the relationship between startups and venture capital (VC) investors. The study examined VCs’ willingness to continue investing in ventures that missed their target milestones. The study showed that startups backed by more failure-tolerant VCs were more innovative, as judged by the number and quality of patents these startups filed. The authors of the study also found that the effect of VC tolerance to failure was much stronger when the failure risk was higher (e.g., in drug discovery) so that VC support was more needed and valued.

Even innovation in large companies benefits from some protection. An analysis of  bankruptcy laws in 12 countries showed that more debtor-friendly bankruptcy codes (i.e., codes favoring firms filing for bankruptcy) had a positive effect on corporate innovation. The debtor-friendly laws are thought to encourage firm-level innovation by keeping the firms’ innovative activities alive even at bankruptcy.

Although local labor laws are largely out of corporate control, companies might consider them when choosing the location for their new innovation centers. And startups, of course, have some leeway in choosing VC firms to work with.

Free countries innovate better

The importance of external factors, such as a host country (or a region within a country), on the firm’s ability to innovate has long been recognized. For example, a 2001 study showed that a relatively small number of characteristics of a nation’s business environment explained a striking difference in innovation outputs between developed and emerging economies. The most notable among those characteristics were the overall human and financial resources a country devotes to R&D; public policies relevant to innovation activity (e.g., IP protection and tax-based incentives for innovation); and the country economy’s openness to trade and investment.

However, there is one more level of influence that is almost never considered: the level of a country’s political freedoms.

Take a look, for example, at the 2019 edition of the Global Innovation Index (GII) which ranks the global innovation performance of approximately 130 economies by using a few dozens of indicators.

Even a brief look at the Index leads to a curious observation: the top of the ranking is heavily populated by countries representing established, mature democracies. The reverse was also true: the bottom of the Index is stacked with countries with an abysmal level of democratic development.

To see if this observation had any statistical significance, I plotted the GII rankings against the political freedom rankings provided by the Democracy Index 2020. (The latter index ranks countries on a scale of 0 to 10, marking them as authoritarian regimes, hybrid regimes, flawed democracies, and full democracies). Indeed, a solid correlation (R² = 0.46) between the two parameters exists indicating that the ability of a country to innovate positively correlates with the level of political freedom in this country. Or, to use a more straightforward language, free countries innovate better.

This finding may have implications for U.S. policymakers when they allocate funds to promote entrepreneurship and innovation abroad. Government officials would be wise to consider the maturity of democratic institutions in recipient countries when anticipating potential returns on innovation investment.

The same is true for domestic spending. Consider the idea to create eight to 10 regional growth centers in the Midwest metro areas of the United States. Central to the idea is the infusion of about $100 billion of federal money over the next 10 years in the form of direct R&D funding, tax and regulatory benefits, and infrastructure support. Concerningly, many of these prospective growth centers are planned to be in the states that have implemented the most restrictive abortion laws (and some other anti-liberal legislation) in the country. Do we expect these centers to become beacons of innovation?

Of course, individual companies may have a limited influence over a country’s level of political freedom. And yet, every company can — and I think should — make its voice heard every time our liberties are in danger be it around the globe or across a state line.