This paper investigates the dynamics of wages and profits and the influence innovation strategies have on them. The relationships between innovation, productivity, and distribution are modeled and estimated by employing panel data techniques. Two European innovation surveys (1994–96 and 1998–2000) are used with data at both the country and industry levels. Innovation is found to have positive effects on income dynamics beyond the role it has on productivity gains; it may weaken the distribution constraint posed by the competition between profits and wages. Profits are driven by both the Schumpeterian effects of new products and the diffusion effects of new technologies and production processes. Wages tend to grow faster in sectors where innovation expenditure is higher, but the factors affecting wages are different for high- and low-innovation sectors, suggesting that two contrasting models of technological and price competitiveness have important distributional implications.