Innovation, in an essential sense according Dosi (1988) “refers to the search for, and the discovery, experimentation, development, imitation and adoption of new products, new production processes and new organisational set-ups”. Innovation policy is used in the economy to promote economic growth and increase social welfare of a country, and according to Manjon and Merino (2012) patent seeks to serve this purpose. In the knowledge economy, there is an ever-growing dependency for innovation and it has also been argued by many economist that although the use of patents is essential to help the knowledge economy progress through incentives for innovation, several opposing school of thoughts have highlighted problems that patents create. This essay would aim to discuss the ends and means of innovation policy, and further evaluate the market failure and government failure framework and whether or not this policy performs well in the knowledge economy.

Innovation policy such as patent helps innovators or gives a legal right to exclude other people from using there invention. According to OECD (2012) the ultimate objectives of patent policy is to create dynamic knowledge and enhance the competitive advantage of a nation, improve standard of living by maintaining technological advancement. In research and development (R&D) patents are used to solve market failure of underinvestment. It is stated to be a public good, so therefore it is impossible to recover R&D investments and this leads to underinvestment below optimum level (Thompson, 2011). So for instance if an inventor uses his own knowledge to innovate, this would benefit him or her less compared to others, therefore social benefits counterweights private benefit. This alters government to intervene incentivise firms to improve the nation’s competitive advantages.