The report by UN agency World Intellectual Property Index (WIPO) and INSEAD business school ranked 141 countries using 84 indicators.
Switzerland took the top spot for the second year running, followed by Sweden and Singapore.
Switzerland scored particularly well in areas including research and development, creative output and ecological sustainability.
"The quality of its scientific and research institutions, coupled with numerous scientific and technical publications, good linkages between academia and firms, and a skilled labour force stand ou," the report said.
Switzerland did however display "relative weaknesses in its business environment, as captured by its relatively poor showing in the ease of starting a business and of resolving insolvency."
Report author Soumitra Dutta said that although European countries were "clear leaders in innovation performance", southern European countries continued to suffer from the effects of the global economic crisis and unresolved structural problems.
"You can see economies that are not doing so well: Spain, Italy and Portugal... performing at a lower level then you would expect given their gross domestic product (GDP)," Dutta said.
Some eastern European countries, meanwhile, were "performing at a higher level" than might be expected given their income, added Dutta, citing the Czech Republic, Hungary, Serbia and Latvia.
Dutta also warned that leading emerging economies -- the so-called BRICS countries Brazil, China, India, Russia, and South Africa -- needed to invest in innovation to live up to their potential.
Developed countries tended to dominate the higher rankings of the report, the Global Innovation Index (GII), due to factors such as good schools and modern infrastructure. But some poorer income countries also appeared to be making progress.
Paraguay, one such low-income economy, had created high levels of output from "islands of excellence", said Dutta, along with India and Moldova.