Japan is the world’s most innovative nation, followed by Switzerland, the US and Sweden, according to Innovation: Transforming the way business creates, a new report from the Economist Intelligence Unit, sponsored by Cisco.

The Economist Intelligence Unit compiled a ranking of 82 economies based on their level of innovation in 2002-06 and, using the methodology described below, predicted how the ranking would change in 2007-11. The top four will maintain their positions, according to the forecast, while China will move up five places to 54th and Mexico will climb six places to 39th.

The aims of the study were to analyse the importance of innovation, then determine which countries innovate the best and why. To achieve this, the Economist Intelligence Unit compiled the ranking and also conducted a survey of 485 senior executives worldwide on their opinions regarding innovation. Answers from the survey were used to set the weightings for the factors that drive innovation and to examine how and where companies innovate.

Heightened global competition is forcing governments and companies to find new ways to increase productivity, and this is creating renewed interest in the need to innovate. But there is no single, best method to do so. The countries at the top of the ranking are large and small; some value rote learning, while others emphasise spontaneity. All of the leading nations stress the use of government policies to encourage innovation, along with education systems that produce large numbers of scientists and engineers.

“The message for governments is that there is no substitute for good education, nor for policies that encourage investment in IT and communications infrastructure,” says Nigel Holloway, the editor of the report. “For companies, the process of renewal should, if anything, be accelerated. The proportion of total sales from new products and services needs to increase.”

The main findings include:

• Innovation has a beneficial effect on both national economic growth and on corporate performance. The evidence of such benefits is stronger at the microeconomic than at the macroeconomic level.

• The survey panel cited a broad range of factors to explain what makes a country innovative, with the top determinants being technical skills of the workforce (92% of respondents) and quality of IT/telecommunications infrastructure (also 92%).

• China has more favourable conditions for innovation than India. With annual expenditure of US$136bn on R&D, China now outspends Japan. However, in the sphere of innovation, there is a “small country advantage”: 12 of today’s top 25 countries in the ranking have a population of less than 10 million.

• The return on innovation is estimated to be proportionately higher in middle-income countries such as Mexico and China than among richer countries. This suggests that the former group of economies may be able to catch up with the latter. Although middle-income countries need imported technology, the speed with which they absorb it may depend on their own domestic innovation performance.

• At the corporate level, the survey found that among firms where innovation is identified as critically important, 46% of respondents say their firms perform better than their peers; only 32% of the firms that do not think innovation is critically important perform better than their peers.

• Among respondents who say their firm’s R&D is equal to at least 5% of revenue, 44% say their company performs better than its peers. This compares with 35% among those who say their firm spends less than 5% of revenue on R&D.

• Among firms surveyed that are based in, or are closely connected to, a high-tech cluster such as Silicon Valley, 56% say they performed better than their peers; only 36% of firms outside of a high-tech cluster performed better than their peers.

“It is becoming quite clear that in order to remain competitive, innovation must become a priority at both the national and business level,” said Roger W. Farnsworth, Cisco’s director of Executive Thought Leadership. “Understanding the contributors to and enablers of innovation is critical to success in today's interactions-based economy.”

The report is one of three studies conducted by the Economist Intelligence Unit for Cisco that describe the development of the “interactions” economy, in which customers, suppliers, owners, workers and others go beyond mere transactions to exchange information for mutual benefit. The other two research projects investigate the role of collaboration and personalisation in the interactions economy.