Knowledge is generally perceived as a key resource that may ultimately contribute to economic growth. Although knowledge creation constitutes the prerequisite for innovation processes and subsequent economic activities, the underlying mechanisms thereof are not well understood. Whereas the linear model of innovation posits a unidirectional sequence of basic and applied research, current research shows that a fuller model of innovation is needed that considers the cross-fertilization of basic and applied research. The purpose of this chapter is to conceptualize a theoretical model of regional innovation output, taking into account the knowledge flows from basic to applied research and vice versa. We thereby emphasize the role of the government as an enabler and facilitator of knowledge creation and diffusion. Ideally, basic and applied research funding would act synergistically in the production of regional innovation output. This chapter contributes to our understanding of the optimal mix of basic research funding and applied research funding and provides the basis for empirical investigations. It thereby addresses the question how to make best use of basic and applied research resources and derives implications for science and innovation policy.
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