© The Pakistan Development Review 56:4 (Winter 2017) pp. 297–317 Institutions and Innovation: Evidence from Countries at Different Stages of Development ZAFIR ULLAH KHAN, ANWAR HUSSAIN, and NASIR IQBAL * This paper empirically analyses the impact of institutions, both formal and informal, on innovation performance of sampled countries at different stages of development. Data of 72 sampled countries on Research and Development Expenditures, numbers of article published, human capital, trade openness, internet users are collected from United Nations Educational, Scientific and Cultural Organisation (UNESCO), International Country Risk Guide (ICRG) and World Bank database. Formal and informal institutions indexes are constructed using data from Country Risk Guide and The World Value Survey (WVS). Fixed effect and System GMM technique are used to estimate the dynamic relationship between innovation performance and institutional indexes. The study finds positive significant effect of institutions on innovation in case of aggregate sample of developed and developing countries. However, the effects of formal institutions are more significant in case of sample of developed countries, while in developing countries informal institutions are found more effective than formal institutions in affecting innovation performance. The results also show that both formal and informal institutions are supplementary to each other in case of developing countries. Therefore, it is suggested that focus should be given to informal institutions. Moreover, collective initiatives be encourage in developing countries to have diverse ideas from different sectors of the countries. In addition, developing countries should initiate collaborative research projects with technologically advanced countries research and education institutions so as to learn from each other’s ideas and experiences. Keywords: Formal Institutions, Informal Institutions, Innovation 1. INTRODUCTION Institutions are considered as main drivers of Innovation [Aghion and Howitt (1992); Grossman and Helpman (1990)]. However, in the knowledge-based economy, some of the features of each society influence the ability of an economic system to adapt and translate the innovative efforts into development of new ideas. Institutions are defined as the rules of the game in society. In other words, institutions are humanly developed constraints that shape human interaction [North (1990)]. It consists of both formal and informal institutions. The former means constitution, law, rules and regulation put in place by the government, while the latter means values, norms, honesty, and religiosity which promote cooperative behaviour in society that ultimately result in the Zafir Ullah Khan <zafirpide@gmail.com> is PhD Student at Pakistan Institute of Development Economics, Islamabad. Anwar Hussain <anwar@pide.org.pk> is Assistant Professor at Pakistan Institute of Development Economics, Islamabad. Nasir Iqbal <nasir@pide.org.pk> is Assistant Professor at Pakistan Institute of Development Economics, Islamabad.