VEnture Capital And Innovation: Which Is First?

Policy-makers typically interpret positive relations between venture capital (VC) investments and innovations as evidence that VC investments stimulate innovation (VC-first hypothesis). This interpretation is, however, one-sided because there may be a reverse causality that innovations induce VC investments (innovation-first hypothesis): an arrival of new technology increases demand for VC. We analyze this causality issue of VC and innovation in the US manufacturing industry using both total factor productivity growth and patent counts as measures of innovation. We find that, consistent with the innovation-first hypothesis, total factor productivity growth is often positively and significantly related with future VC investment. We find little evidence that supports the VC-first hypothesis.