While the development of new knowledge is becoming increasingly important in the emerging knowledge-based economy, the impact of technology on growth, jobs and welfare is determined largely by the way in which technology is diffused, absorbed and used throughout the economy. For technological progress to bring not only higher productivity but also economic expansion and new jobs it is pivotal with conditions which allow for industrial restructuring, entry and expansion of small firms, growth of new industries, launching of new products, and mechanisms accounting for effective upskilling of the labour force. This report points to a decline in public support for research and development (R&D), mainly affecting basic, long-term research, and examines the levelling-off in private sector R&D along with changes in its direction away from basic, exploratory research towards more market-driven and short-term innovative efforts. It explores how the special characteristics of national innovation systems impact on the mechanisms for innovation and diffusion of technology, and examines the rationale for policy in this area. A key challenge for policy makers is to co-ordinate measures so as to obtain consistent and credible incentives for firms and individuals. Assessing what works and what does not work in policy, the report identifies "best practices" in specific areas: management of the science base; financial support for industrial R&D efforts; technology diffusion policies and initiatives; policies for new technology-based firms; policies for facilitating growth in new demand; and policies for high-performance workplaces and intangible investment. Despite many initiatives, OECD countries have not yet fully adapted to the characteristics and challenges of knowledge-based economies. Technology policies continue to be too piecemeal, paying insufficient attention to linkages within national innovation systems and to broader structural reforms. They focus too much on the small high-tech segment of the economy and too little on fostering innovation and technology diffusion economy-wide. There is also scope for improving the effectiveness of policies, notably through increased use of market-based instruments and better evaluation. Recommendations are put forward of measures to be taken by individual OECD countries.