Out-of-equilibrium profit and innovation

Innovation is the result of intentional decision-making that takes place in out-of-equilibrium conditions. Profitability is a reliable indicator of equilibrium conditions, far better than competition, as it integrates the effects of out-of-equilibrium conditions in both product and factor markets. The farther the profitability from the average, the deeper the out-of-equilibrium conditions. The farther away the firm from equilibrium, the stronger the likelihood for innovation to take place. The hypothesis of a U-shaped relationship between levels of profitability and innovative activity, as measured by the rates of increase in total factor productivity (TFP), is articulated and tested. The evidence from a large sample of 7000 Italian manufacturing firms in the years 1996-2005 confirms the presence of a quadratic, convex relationship between profitability and the growth rates of TFP.