Abstract: This paper uses the panel data of 283 prefecture-level cities during 2001-2011 to explore the role of market environment and intellectual property rights protection in regional innovation activities. Our empirical results show that both the Demonstration effect which is stemmed from the demand in technology markets and the protection effect which measures the degree of intellectual property right protection are important determinants of regional innovation. In other words, those two effects alone could explain 3/4 of the variance in regional innovation activities. We showed that, those two effects influence the innovation by directly raising the input of R&D. Those results are robust even we controlled other variables that are mentioned in the literature. We conclude that promoting the rule of law and building a fairly competitive market would be essential to increase the innovation level, promote China's industry upgrade and economy transformation.

Key words: technology transaction, intellectual property protection, regional innovation activities, rule of law