The empirical literature

In the empirical literature, there is widespread agreement on

the importance of innovation activities, human capital, product market and

labor market reforms for economic growth (OECD, 2003a). The number of

scholars using dynamic panel data methods to investigate the sources of

differences in growth rates among industrialized countries is growing. Caselli,

Esquivel and Lefort (1996) introduced the panel approach into the empirical

growth literature. Similar techniques have been applied in growth research by

Bond et al. (2001) and, among others, Beck et al. (2000). Most studies use

five-year averages of the variables in order to eliminate short-run fluctuations.

The aim of this paper is to provide some new insights on the determinants

of economic growth in OECD countries. Particularly, we investigate the

impact of specialization in R&D industries, innovation activity and government

size in a growth equation controlling for human capital, investment

ratio, time and country fixed effects. In addition, the growth contribution of

the volatility of growth is examined. We estimate the growth equation using a

dynamic Generalized-Method-of-Moments (GMM) panel estimator. The

dynamic GMM panel estimator has a number of advantages compared to

cross-sectional estimators: it accounts for country fixed effects and allows us

to control for endogeneity of all explanatory variables. Following Bond et al.

(2001), we use the system GMM estimator rather than the more usual

first-differenced GMM estimator. Bond et al. (2001) and Blundell and Bond

(1998) show that first-differenced GMM estimator performs poorly in finite

samples and produces biased coefficients if the sample size is small or if the

time series is highly persistent, as is the case with R&D intensity and technological

specialization. We use data for 21 OECD countries with data

averaged over each of the five-year periods between 1970 and 1999.

Previous empirical research suggests that innovation activity measured as

the change in R&D intensity is one of the most significant factors affecting

differences in GDP and productivity growth (Coe and Helpman, 1995;

Bassanini et al., 2001; Guellec and Van Pottelsberghe, 2004). Using panel

data for 16 OECD countries, Guellec and van Pottelsberghe (2004) find that

the long-run elasticities

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