The Knowledge Economy: the policy challenges Luc Soete University of Maastricht MERIT Knowledge Economy Forum III, The World Bank and the Government of Hungary, Improving Competitiveness Through a Knowledge-Based Economy, Budapest, March 23-26, 2004.

Outline First: a brief overview of some of the concepts relevant to the Knowledge-Based Economy, growth and international competitiveness Second, some learning from the past: knowledge enlightenment and development catching-up Third, main policy implications for the position of the ECA-countries within the framework of the emergence of a global knowledge-based economy

1. Trade, specialisation and growth Once there was economic paradise Physical distance and welfare loss Free trade as optimal solution: nothing else but the application to the international world of free market principles International specialisation, international competitiveness and growth Technology/knowledge an external factor: accessible to all at no costs

(Neo-)Classical view on technology/ knowledge Technological change drives economic growth (as in both classical and neo-classical theory) in agriculture in industry, but is diverse. continuous as in case of Boston learning curve, incremental improvements radical, sometimes “clusters” of interrelated technologies general purpose technologies Hence sometimes a smooth incremental process, sometimes accompanied by a lot of creative destruction (large turnover of firms, employees, managers)

Supply dominated view Black box vision “not to be opened except by scientists and engineers” (Freeman) Supply features of technologies imply that public support could be justified for basic research where social rate of return is higher than private one so that private firms underinvest in such research It are various supply bottlenecks associated with the distribution of the gains from technology which are likely to create mismatches (Ricardo’s famous reference to technological unemployment)

Knowledge-based economy and development Demand based view: knowledge/technology investments (of whatever form) are the result of endogenous decisions by firms, entrepreneurs, employees: support for uptake, diffusion, etc. Technology internationally accessible but crucial importance of tacit knowledge (human capital, learning, organisational knowledge) Particular role of ICT on codification of knowledge and tradability of services: new windows of opportunity for catching-up

2. Learning from the past: knowledge and catching-up Neo-classical dominance in trade theory after Heckscher and Ohlin till the 70’s and the emergence of new trade theory Technology accounts of trade flows provided the essential challenge and ingredient for new trade (and later on new growth) theory From trade to foreign investment and entry: what we know from the trade and development literature

The geographic outspreading of technologies as they mature Source: Wells L (1972) A schematic presentation of the U.S. trade position in the product life-cycle U.S. position

1234 Experience & know-how 1234 Capacity to use unskilled labor Relative importance of locational advantages 1234 Dynamic advantages Comparative (static) advantages High Low Scientific knowledge 1234 Source: Based on Perez and Soete (1988) Hirsch S (1967) CHANGING REQUIREMENTS FOR ENTRY AS TECHNOLOGIES EVOLVE TO MATURITY

Potential for market growth 1234 Profit making capacity 1234 Space for productivity improvement 1234 High Low Investment cost (production facilities) 1234 Source: Based on Perez (2003) The limits of mature technologies for development: DECREASING POTENTIAL OF TECHNOLOGIES AS THEY EVOLVE TO MATURITY

UNDERSTANDING BEHAVIOR AT THE CORE (Perez, 2003): Phases of evolution of a product and its industry Changing focus, structure and basis for competition PHASES 1. Introduction Stretching technology Pushing the market ceiling Finding cost advantages RATIONALIZATION RELOCATION SHAKE-OUT and CONCENTRATION Stable structure of industry (possibly oligopoly) Scale of firm Financial power Market capture Non-price factors 2. Early growth3. Late growth 4. Maturity PRODUCTPROCESSMARKET POWERSTRETCHING Degree of technological maturity and market saturation Time Basis for competition Stage of industry Main focus Process efficiency and quality Cost reduction (prices) Market expansion (segments) Brand differentiation Distribution chanels DEVELOPMENT OF INDUSTRY in fierce competition ESTABLISH PRODUCT and market segments Fight for dominant design Product design Market access

PRODUCTION AGREEMENTS JOINT VENTURES, LICENSES AUTONOMOUS COPY REJUVENATING INNOVATIONS Cost advantages, finance Learning and/or copying capabilities Profit enhancing attractions through markets, externalities and/or cost advantages ADVANTAGEOUS OR PROTECTED ROLE IN THE STRUCTURE OF A WORLD FIRM COMMERCIAL REPRESENTATIVE, PARTS PRODUCER OTHER (depending on paradigm) Competence as supplier Access to resources and/or markets Knowledge Local know-how for “niche” AUTONOMOUS ENTRY IN “FREE” COMPETITION MODERNIZE TRADITIONAL INDUSTRY PHASES 1. Introduction2. Early growth3. Late growth 4. Maturity Time CHANGING WINDOWS OF OPPORTUNITY FOR ENTRY (Perez 2003) Character of entry Basis for entry AS A COMPLEMENT AS PART OF STRUCTURE AS STRETCHING SOLUTION PROBABLY NONE Interest in developing country firms Degree of technological maturity and market saturation

Learning from the past Industrial enlightenment: why island of knowledge development became an industrial revolution in 19 th Century (Mokyr, 2003) Importance of interaction between “les savants et les fabriquants”: need for scientific proof on the part of manufacturers, need/hunger for application and understanding of scientific principles (Diderot’s encyclopedia, Lunar Society). Importance of knowledge diffusion for economic development and catching-up

3. Policy challenges for the ECA countries Further liberalisation of trade in goods and services, including financial deregulation Information and global “codified” knowledge diffusion (e.g. the entire genetic constitution of the human species, its genome, is available to all on the Web): “ICT” the first form of “global” technological change (David and Foray, 2002) Knowledge divide is more than ever linked to human capital or tacit knowledge

Old Globalisation trends: what’s new? In terms of trade or investment flows: not much but nevertheless major differences –Trade expansion driven by regional integration Sometimes government induced (EU) Sometimes business induced (ASEAN) –Trade in services –Direction of trade flows Triad dominant but with large imbalances Emerging outside BRICS Large parts more or less excluded

“New” Globalisation trends Central increased tradability of “intangibles”: –Finance No longer complement of trade or FDI flows Agglomeration effects traditional financial centres –International alliances between firms: Production, after sales/marketing R&D, Mergers and acquisitions –Diffusion of information and knowledge Through public organisations and transfer institutions Through formal contractual arrangements (licences, technological payments) –Migration/mobility of human “tacit” knowledge

Policy challenges Positioning of ECA countries within these new global trends, in particular with respect to knowledge-based activities Progress in absolute terms impressive, but in relative terms position has deteriorated New knowledge challenges: FDI are moving out to China, India… FDI bypassing ECA countries, in spite of tax-free zones Human capital is moving out Need for national knowledge anchorage policies

Role of Nation State –Quality of institutions is ultimately what matters –Importance of comparative learning: best practice cases; why not use open method of coordination to improve performance –“Activating” knowledge: at labour, education, university level at financial, entrepreneurial and human capital level –Investing in knowledge infrastructure crucial for global access to knowledge and keeping scientists and engineers (see EU evidence)