Technology and Know-How in the Wealth of Nations

It has long been recognized that economic prosperity rests in some measure upon knowledge and its useful application. Many economic historians have emphasized the role of technology and organization in economic development. Nonetheless, until recently many economic theories have surprisingly underplayed the role of invention, knowledge accumulation, and knowledge transfer in economic development. The study of innovation and knowledge transfer has been regrettably relegated to a backwater in main- stream economics as well as in the other social sciences.

In recent years, several structural changes have occurred in global economies that have modified the nature of what is stra- tegic and have served to highlight the importance (to the business enterprise and to nation states) of knowledge and its management. This is what I now address.

1. Liberalization of Markets

Since the Kennedy rounds of trade negotiations in the 1960s, markets for goods and services have become increasingly global. Tariff and non-tariff barriers have been lowered. While the world is far from being properly characterized as having adopted free trade, significant progress has been made. Final goods, interme- diate goods, and factors of production flow globally with far more freedom than in earlier times. Restrictions on knowledge transfers by both importers and exporters have also been relaxed.

Accordingly, firms cannot so rapidly earn supra-competitive returns by locating behind trade barriers. Transportation costs have also fallen, and information about market opportunities often dif- fuses instantaneously. Together, these developments have reduced the shelter previously afforded to privileged positions in domestic markets. Competition has been sharpened.

2. Expansion of What’s Tradable

Markets have not only liberalized, but also have been created for many types of “intermediate” products where markets hitherto didn’t exist. This has been most amplified in securities markets where swaps and swaptions, index futures, program trading, but- terfly spreads, puttable bonds, eurobonds, collateralized mortgage bonds, zero-coupon bonds, portfolio insurance, and synthetic cash are now commonplace. This sudden burst of financial innovation began but 20 years ago, propelled by the move to floating exchange rates, the need to manage risk better, and the opportunity to tap into global pools of capital. It has been aided by developments in computer and information technology, which have enabled the design of new financial products and the execution and monitoring of myriads of complex transactions. Also contributing has been the desire to minimize taxation.

In addition, firms have shown greater affection for outsourc- ing as suppliers take advantage of the growth in the number of potential suppliers at home and abroad. In the petroleum industry, for instance, markets exist not only for many grades of crude oil and refined products, but also for a range of intermediate products (such as oxygenates) which were hitherto rarely traded. More- over, certain forms of intellectual property are “exchanged” (cross- licensed) or sold with far greater frequency than was hitherto experienced.9

3. Strengthening of Intellectual Property Regimes

Intellectual property is an aspect of property rights which augments the importance of know-how assets. Knowledge assets are often inherently difficult to copy; moreover, like physical assets, some knowledge assets enjoy protection against theft under the intellec- tual property laws of individual nation states. In advanced nations, these laws typically embrace patents, trademarks, trade secrets, and copyright.

Intellectual property systems have been strengthened since the 1980s, both in the USA and abroad. Moreover, intellectual property is not just important in the new industries—such as microelectron- ics and biotechnology—it remains important in pharmaceuticals and chemicals and is receiving renewed interest in more mature industries such as petroleum and steel.

The growth of information technology has also amplified the importance of intellectual property and has injected intellectual property into new contexts. For example, it is not uncommon to discover the foundations of corporate success for wholesalers and retailers buried in copyrighted software and in information technology supporting order entry and logistics.

4. The Growing Importance of Increasing Returns

Contemporary textbook understandings of how  markets  oper- ate and how firms compete has been derived from the work of economists such as Marshall and Chamberlain. These views assume diminishing returns and assign industry participants identical pro- duction functions (implying the use of identical technologies by all competitors) where marginal costs increase. Industry equi- librium with numerous participants arise because marginal-cost curves slope upwards, thereby exhausting scale and advantages at the level of the firm, making room for multiple industry par- ticipants. This conceptual apparatus was useful for understanding eighteenth-century English farms and nineteenth-century Scottish factories and even twentieth-century American manufacturing. However, major deficiencies in this view of the world have been apparent for some time—it is a caricature of the firm. Moreover, knowledge is certainly not shared ubiquitously and passed around amongst firms at zero cost.10

In this century, developed economies have undergone a trans- formation from largely raw material processing and manufacturing activities to the processing of information and the development, application, and transfer of new knowledge. As a consequence, diminishing returns activities have been replaced by activities characterized by increasing returns. The phenomenon of increasing returns is usually paramount in knowledge-based industries. With increasing returns, that which is ahead tends to stay ahead. Mech- anisms of positive feedback reinforce the winners and challenge the losers. Whatever the reason one gets ahead—acumen, chance, clever strategy—increasing returns amplify the advantage. With increasing returns, the market at least for a while tilts in favor of the provider that gets out in front. Such a firm need not be the pioneer and need not have the best product.

5. The Impact of New Information Technology

New information technology is dramatically assisting in the sharing of information. Learning and experience can be much more readily captured and shared. Knowledge learned in the organization can be catalogued and transferred to other applications within and across organizations and geographies. Rich exchange can take place inside the organization, obviating some of the need for formal structures. Distribution costs can sometimes be lowered, as with digital music which can be downloaded from the Internet.

Furthermore, network computing, supported by an advanced communications infrastructure, can facilitate collaborative entre- preneurialism by stripping out barriers to communications. It chal- lenges existing organization boundaries, divisions, and hierarchies and permits formal organization to be more specialized and respon- sive. Interorganizationally, networked organizations have blurred and shifting boundaries, and they function in conjunction with other organizations. The networked organization may be highly “virtual”, integrating a temporary network of suppliers and cus- tomers that emerge around specific opportunities in fast-changing markets. Recurrent reorganization becomes the norm, not the exception.

6. Implications

These developments suggest a different dynamic to competition and competitive advantage. The expansion of markets illustrates the point. Since markets are a great leveler, competitive advantage at the level of the firm now flows mainly from the ownership and successful deployment of non-tradable assets. Competitive advan- tage cannot be built by producing undifferentiated products using undifferentiated components, undifferentiated labor, and globally sourced financial capital. This is because if all inputs can be accessed by all, competition will eliminate economic profits. The paradox is that the domains in which competitive advantage can be built nar- rows as markets expand. Not even human resources can provide the basis for competitive advantage for a country if the skills at issue can be accessed by all in an open labor market. Of course, this is generally not the case.

The class of assets that is especially difficult, although not impos- sible, to trade involves knowledge assets and, more generally, competences. The market for know-how is riddled with imper- fections and markets are seriously faulted as institutional devices for facilitating trading in many areas of technological and man- agerial know-how. Hence, the development of many types of new markets has made know-how increasingly salient as a differen- tiator, and therefore as a source of the competitive advantage of firms. This can be expected to remain so until know-how becomes more commodity-like. This may happen for some com- ponents of intellectual property, but it is unlikely to be a common phenomenon.

The strengthening of intellectual property rights is an important counterforce to the growing ease of imitation. As the diffusion of knowledge and information accelerates, intellectual property becomes more salient. While intellectual property can be traded, and can sometimes be invented around, in many jurisdictions it cannot be infringed with impunity and without penalty.

Source: Teece David J. (2009), Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth, Oxford University Press; 1st edition.

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