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Sets out the economic analysis behind the ‘Innovation and research strategy for growth’. Draws on recent results from innovation economics, recent policy-related studies, and new innovation data. Whilst innovation is the central source of economic growth, it is changing its scope and forms. Investigates innovation as a system and looks at policy challenges on the need to facilitate knowledge flows, maintain a high-grade knowledge infrastructure, support business investment in conditions of uncertainty, and build an innovating public sector.