The Czech government considers innovation policy a key component of the effort to improve the business environment. This paper underscores the importance for the Czech Republic of expanding R&D activities that have a potential for commercial innovation. It also points to the relevance of good general business conditions in encouraging research and ensuring that the economy benefits from the international diffusion of innovation. Concerning targeted policies, the need for structural reforms to improve the research and innovation environment is described. The paper looks at options to create a coherent governance framework for public R&D and to make the allocation of research funds efficient. Assessment of changes in R&D tax allowances and the strategy for giving direct support to innovative SMEs is also made. Finally, the paper considers what reforms are needed to help the creation of stronger science-industry links and the take-off of the venture capital and "business angels" market. This Working Paper relates to the 2006 OECD Economic Survey of the Czech Republic (www.oecd.org/eco/surveys/Czech).