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Economics of Innovation - lessons Economics of innovation is a multi-disciplinary field. Microeconomics understanding the process and the incentives of a firm to innovate. Macroeconomics innovation as a key driver of economic growth and as a determinant of the economic cycles. Economic policy are there market failures in the innovation process and what should the government do? Business strategy Probability problem is the main problem we analyze. Ho to get profits from innovation. ISTAT (Italia) – EUROSTAT (Eu) The global innovation index (GII) in an annual ranking of countries by their capacity for, and success in, innovation.
What is innovation? It’s the introduction of new ideas that add ‘value’ to a firm’s activities
(The Oslo Manual). N.B. The Oslo Manual contains guidelines for collecting and using data on industrial innovation Technological innovations: Introduction of a new product or a qualitative change in an existing product Process innovation new to an industry Non Technological innovation: Are based on an opening of a new market (to open a new market is an innovation even though is not related to a new product) Development of new marketing strategies They are not related on the introduction of new products, but still on an application of an idea changes in organizational methods and business practices …With “new” we mean with respect to the firm and to the relevant industry/market, it’s related to the firm. Even though a firm operates locally, the important is that the innovation has to be new in the relevant market of action. An innovation is the implementation of a new or significantly improved product (good or service), or process, a new marketing method, or a new organizational method in business practices, workplace organization or external relations. Oslo Manual (OECD 2018): This edition defines an (technological) innovation as “a new or improved product or process (or combination thereof) that differs significantly from the unit's previous products or processes and that has been made available to potential users (product) or brought into use by the unit (process)”. Concerning the innovation process, the Schumpeterian Trilogy has three steps: Invention innovation diffusion The invention is a creation of an idea to do or make something new (profitability not yet verified). It may come out from dedicated effort (research) or simply by “chance”. Abbott Payson Usher defines inventions as the emergence of “new things” which require an “act of insight” going beyond the normal exercise of technical or professional skills. “Inventive acts of insight are “unlearned activities” that result in new organizations of prior knowledge and experience…”, while acts of skill include all “learned activities” that can be undertaken by technicians and engineers who possess the “state of the art” technology in their routine activity.
Innovation is a new product/process commercially valuable. i.e. successfully developed inventions. While inventions can often com from a single ingenious individual, innovation is usually the outcome of a collective effort (e.g. innovation systems). Diffusion is the spread of a new invention/innovation throughout society or at least throughout the relevant part of society. →Without this final step, innovator and society cannot gain full benefits. Some of this represents ‘spillovers’ or ‘positive externalities’. →Diffusion can occur through adoption and/or imitation (not always there is a clear distinction). Science and technology Science: All human activities devoted to the discovery and dissemination of new knowledge through research (generic, undirected). The new knowledge is public good (non-rival in use), hence creates externalities. It may represent the basis for technological advances. Technology: Application of knowledge to fulfill specific needs (usually to ‘production’ by firms driven by profit incentives). Can be a private good: investment (R&D) projects, use of intellectual property and secrecy to exclude others from the use -> it can be expressed by an isoquant or a family of isoquants. Technique: point on the isoquant of the production function. Technological Change (TC): change of the isoquant (of the production function) over time. Technological change in graphic terms K a b L Production function*: Y= f (K;L); Y= output; k= capital; L=labour LINEA GROSSA You can produce combinations of output employing different amount of capital/ labour. Here you have the LOCUS OF POINT, which is the locus of combination and label that provides the same amount of output. This line is not straight, the fact it’s curvilinear it’s because of the assumption of the reducing marginal productivity of factors so the more capital you add to the firm, this capital provides less than proportional amount of ouput The marginal product or marginal physical productivity of an input (factor of production) is the change in output resulting from employing one more unit of a particular input *The production function is a function in which you have the output as a dependent variable (amount of cars for instance), which is a function of the input (ex. capital, materials etc..). So you put all the production factors in this production function and the final function gives you the amount of output. Then when you move from a to b, you can see that in b you have a technological advancement. It means that with this improvement you move from an old isoquant to a new isoquant in which you are able to produce the same quantity with less capital and less labour You increase the productivity Given a production function Y = f(K,L), TC can be: New isoquant= new technology Technique used to produce output Y=combination of a pair of factors on a given isoquant Old isoquant= old technology
In IMAGE 1 there’s the relationship between the prices (P) and the quantity sold (X) in the market. Ultima riga pendente a dx: We have a sloping/pendente line because usually the higher is the price of a given good the lower is the amount of the good demanded by the market and the less is the price the more you have the quantity sold that’s the motivation of the downward sloping line. The first dropped line at sx : it’s the marginal revenue which is a straight line as well as the first with the same intercept but twice the slop of the demand line (=hanno la stessa intercetta vertical ma la curva dei ricavi ha pendenza doppia). The marginal revenue doesn’t gives you the amount sold for a given price, but the amount of increase in revenues. When you increase the amount produced by a given firm, you increase the revenue for selling one unit more. But this increase in revenue has to take into account also the fact that by producing more units you are decreasing the market price of your units sold. This is the fact that you have this downwards line. The more you produce, the less will be the price of your product because the market will pay your good less and less. T he straight marginal lines represent the marginal costs. In this case the marginal cost represents the new technologies. Here the innovation is represented by the ability of the firm to produce a given amount of units/good with lower price. Considerando lo spazio tra c upperbar e c lowerbar: C upperbar is the old producing cost, while c lowerbar is the cost of production when introducing new process innovation In this case the process innovation lowers the marginal cost of production for the firm, with this technology the firm is able to produce a given amount of units at a lower cost. So, this is classical view of production function when the firm has an incentive to produce more units. So, if the dropped line is the marginal revenue cost and it gives you the additional revenues for producing one additional unit more of output, we will have that the optimal amount will be given by the interception of the marginal revenues (dropped line) and the marginal cost (=linea orizzontale di c upperbar) this interception tells you that with this amount of quantity (ovvero X^M cupperbar) the marginal cost is equal to the marginal revenue, and for every additional amount the marginal revenue is lower than the marginal cost. So this means that from this amount of quantity produced the firm has not convenience to produce more units, because the revenues are lower than the costs. (parte tratteggiata tra c upperbar e c underbar). If the firm is able to introduce new technology represented by c underbar, the new output will be the new point of interception between the marginal curve with the new marginal cost.
The first rectangle represents the costs of the firm with the old technology. When the firm introduces a new technology, it can enjoy larger profits because the area of the new profits (the second rectangle of c lowerbar) is larger than the one before. THIS IS AN EXAMPLE OF NON- DRASTIC INNOVATION In image 2 the difference from the image 2 to the image 1 is the difference of the market power of the innovator after he has introduced this innovation. Image 2 is a drastic innovation because with this innovation the firm/innovator can still behave as a monopolist he can sept the optimal quantity that maximizes his profits. By setting this new optimal quantity, the price that maximizes the innovator’s profits is lower than the old average marginal cost; the new price that maximizes the innovator’s profits (ovvero p^M (c lowerbar)) is lower than the old marginal cost (=linea orizzontale grossa di c upperbar). Why is it important to define “drastic” this innovation? Because if for some reason this old technology becomes publicly available by other firms, IN THIS CASE the other firms can’t compete in this market with the innovator because he has the technology to set a price that maximizes his profits and can not be contested by other competitor firms. In this market with this technology, competing firms who produce the same amount of goods with the old technology won’t be able to enter this market because they would produce at an average marginal price higher than the new equilibrium price and the innovator can enjoy monopolist profits. The situation on the left is different because it’s true that also in this case the innovator introduces the process innovation that lower his average marginal costs (the horizontal line in basso c underbar), but the difference is that if the old technology becomes publicly available, new firms can enter and can CONTEST THIS MARKET. This situation is called CONTESTABLE MARKET, so if also other firms can produce with the old technology, the innovator is not able to set anymore a profit maximizing price (as in the case of image 2), so the innovator has no more a monopolist power and the maximum price he will be able to set will be slightly below the old technology, because if he would have introduced a price equal to the new monopolist price, new competitors could have enter in this markets. The revenue function is R= P(Q)Q Price (of the unit sold) x times quantity sold. But remember: the price is a function of the quantity, so the more you produce the lower will be the market price, because the more available is a good on the market, the less are the consumers willing to pay for that normal good. Marginal revenue: MR=R’(Q)=𝛿𝑅/𝛿𝑄=P(Q) + P’(Q)Q with P’(Q)< The marginal revenue MR (the increase in total revenue R) is the price the firm gets on the additional unit sold, less the revenue lost by reducing the price on all other units that were sold prior to the decreased in price. In the special case of linear downward sloped (inverse) demand curve: P=a-bQ (this formula is to define a standard linear demand function). a : the intercept -b: is the slope of the line We have: P’(Q)=𝛿𝑃/𝛿𝑄=-b Then we have: R=P(Q)Q = (a-bQ)*Q = aQ-bQ2 -> Revenue function MR=R’(Q)=𝛿𝑅/𝛿𝑄= a -2bQ-> Marginal Revenue function Hence: in this special case the MR function curve has the same intercept (a) of the inverse demand curve, with twice its negative slope (-2b). Modular vs Architectural innovation Classification proposed by Henderson and Clark (1990)
The average marginal cost is horizontal P1. A process innovation can be represented as a
downwards shift of the costs that move from the level P1 to the level P2, so with competitive
markets all the firms are the same with the same technology, so this process innovation becomes
available to all the firms, so the only ones who gains are the consumers, because the new
equilibrium price is equal to the marginal cost. This means that the area of the consumer surplus
can be defined by the upper dark triangle.
In perfectly competitive markets the markets perfectly compete with each other and the price is
only one AND the only one equilibrium price is when the marginal cost is equal to the demand! So
the price is equal to the marginal cost.
Guardando la demand curve quelli più a dx sono coloro che vogliono pagare di più per un
determinato bene, mentre se ci spostiamo a sx ci sono quelli che vogliono pagare meno.
What is the effect of Process innovation for a monopoly? In case of a monopoly there’s only one production and the firm is able to set the optimal quantity and prize that maximizes his own profits. In this case a process innovation lowers the marginal and average cost, so we have a higher quantity produced with a lower price as before. In this case the gain for the consumer is lower than before and you have also an increase profit for the innovator. Consumers are better off but not as in the case of the perfect competitive market and also the innovator is better off. New product demand curve: temporary monopoly in the new created market We have to distinguish between drastic innovation and incremental innovation. In drastic innovation it’s created a new competitive market, so for a while the innovator will have a monopolist power. So the first situation is a new temporarily monopoly A product innovation represented by a shift in existing demand curve: increased willingness to pay in the existing market. The innovation doesn’t disrupt the old market but in this case the incremental innovation increase the willingness to pay of the consumers in the existing market, we’re still in the CPUmarket but since the microprocessor is more powerful, cheaper and smaller, you have a new generation of better computer so consumer will be willing to pay more for the same amount of product. Leontief’s input-output flow matrix
Used for measuring the interaction of each sector in a given economy to see how much each sector in a given economy is independent on each other. It was used mainly in a centralized economy in order to have an overview on how much input were required to produce a give amount of product. It was used in the Soviet Communist economy, for example to understand if we want to double or triple the quantity produced, how many machineries and still do we need? In modern economy this matrix is seen in this way: if we’re going to introduce a product innovation in the sector of machinery, how much this product innovation will translate as a process innovation in other sectors and a final innovation in the consumer sector? If a govern wants to incentivize innovation in the still sector in this matrix is able to provide the govern with what would be the impact of the innovation in this sector over the other sector. Because if the machinery sector introduces a new product innovation, this product innovation will translate as a new intermediary good for the other sectors, so they’ll be able to innovate as well, so they’ll have a new innovation in terms of intermediary goods Technological vs. non technological innovations Organizational Innovations: significant changes in the management and internal organization of the firm or in the external relationships with others (e.g. new alliances, M&A, etc.) Marketing Innovation: adoption of significantly improved marketing strategies OECD (2005) Oslo Manual Definitions Organizational Innovation: A new organizational method in business practices, workplace organization or external relations. Examples: New business organization practices (Supply Chain Management, Business Reengineering, Knowledge Management, etc.…) Marketing Innovation: A new marketing method involving significant changes in product design or packaging, product placement, product promotion or pricing. Examples: social media marketing. Innovation in the History of Economic Though The development of how different economists have analyzed innovation in their work and in a very generic terms can be divided in two historical periods: the phase before Schumpeter and the phase after Schumpeter. The first phase is characterized by an implicit analysis, and it’s related to the Classical economics: the main figures are Adam Smith, David Ricardo, and Alfred Marshall. The second phase is characterized by an explicit core analysis, and it divides itself in two schools of thought: -neoclassical/orthodox school (“mainstream economics”) -the evolutionary/heterodox (“neo-Schumpeterian economics”) schoolthey analyze innovation in a more dynamic way adopting tools used in biology to analyze the emergence of new species of animals and plants.
A. Smith
1776 “An Inquiry into the Nature and Causes of the Wealth of Nations”
- Invention and technological change are considered important factors creating the wealth of nations.
- Invention follows from the division of labour (famous example of the pin factory) which is the major source of economic wealth.
- But Smith reckoned that it was the division of labour per se rather than the invention that was the main driving force in creating the wealth of nations.
David Ricardo
1817 «On the Principles of Political Economy and Taxation»
Robert Solow: Was the first mainstream economist to demonstrate the huge importance of technological change: “Gross output per man hour doubled over the interval 1909 – 1949, with 87,5% of the increase attributable to technical change and the remaining 12,5% to the increased use of capital”.
The evolutionary school J. A. Schumpeter (1883-1950)
He is the most important writer on the economics of innovation. He was the first one to analyze in a comprehensive and systematic way the role of innovation in modern industrial economies. 1912 The Theory of Economic Development: An inquiry into profits, capital, credit, interest and the business cycle -> he coined the term: “creative destruction” 1942 Capitalism, Socialism and Democracy He emphasized the role of innovation (and the entrepreneur) as key competitive factor. “It is not [price] competition which counts but competition from the new commodity, the new technology, the new source of supply, the new type of organization …”
Christopher Freeman (1921 – 2010)
He has founded the Sussex Policy Research Unit (SPRU) the first institute in Europe focusing on innovation. He was also a strong supporter of the idea that innovation economics has to be an interdisciplinary discipline. I.e. to understand innovation processes one has to use contributions form other disciplines than economics such as engineering, management, sociology, psychology, philosophy, and many others. He is also the inventor (with B.A. Lundvall e R. Nelson) of the important concept of National Innovation Systems which covers the synergies in the innovation processes undertaken by private actors together with all kinds of institutions (e.g. governments, universities etc.) in an economy. Other influential economists of the Evolutionary School Nathan Rosenberg: The innovation incentive can be either demand pull (driven by sophisticated consumers) and technology push (driven by research, discoveries and new technologies). Richard Nelson and Sidney Winter: authors of the very influential book “An Evolutionary Theory of Economic Change” (1982) in which they present several evolutionary innovation models with firms (characterized by heterogeneity, bounded rationality, routines) and market mechanism for mutation and selection. Eric von Hippel: has important contributions in the fields of informal know-exchange (innovation networks) and in the demand side phenomena of the innovation processes where he coined the notion of democratizing innovation.
The evolutionary school: Paul David
Paul David is one of the originators of the idea of path dependence in the economics of innovation: the equilibrium to which an economic process converges depends on historical path (accidents) that may lead to lock-in effects. This strongly contrasts with the idea of neoclassical economics where the “optimal” equilibrium is always attained independently of the initial conditions or “path followed” (ex. QWERTY keyboard remained like this also then the resolution of the mechanical problem) The evolutionary school: Giovanni Dosi Giovanni Dosi: He introduced the concept of technological paradigm (TP) (taken from the concept of scientific paradigm by Khun). Scientific para. Are a set of rules to solve problems, standard protocols “TP is the general outlook on the problems (faced by firms) and the specific knowledge related to their solutions”. Paradigm shifts are rare events which become likely when the technological opportunities are depleted and increasingly bottlenecks of further development appear. Only in these periods major or radical innovation might become possible which then shape a new technological paradigm NB: Interesting reading (optional) on new technological paradigms on cloud computing.
The evolutionary school It was insipred fom the work of Schumpeter. The term Evolutionary is generally used to refer to:
- The neo-Schumpeterian economics: for its view of technical change and industrial dynamics as evolutionary processes. “[We shall designate by the term Economic Evolution] The changes in the economic process brought about by innovation, together with all their effects, and the response to them by the economic system” (Schumpeter, 1939, BC, Vol.I, p.86)
- The Evolutionary school originated by Nelson and Winter (1982) for the analogies of their models with Darwin’s Evolutionary Theory (heterogeneity: firm’s technology and practices = genotypes, strategies = phenotypes, market competition = selection mechanism)
- Other heterodox schools Aim: do develop a theory of Evolutionary Economics alternative to the (neoclassical/mainstream) one based on general equilibrium (and other assumptions). Evolutionary and neoclassical schools: main differences. Neoclassical Evolutionary Equilibrium assumption Non a-priori Equilibrium assumption Interest for both statics and dynamics Innovation processed and dynamics Minor attention on adjustments Transition processes are important Technology is seen as Information (freely available to others) Technology as knowledge (learning) Learning: acquisition of new information Learning: costly cognitive activity, (learning by doing, problem-solving) Homogeneity (representative firm) Competences and heterogeneity Rational agents (optimization) Bounded rationality (satisficing) Minor importance for firms’ history and context Firms’ history and their context are very important R&D e learning are devoted to create new knowledge, create something new that creates advantages for the innovator. R&B is performed by large firms. New knowledge is the main sources of innovation, but it’s created with R&D and learning. Public goods Market failure is “the economic situation defined by an inefficient distribution of goods and services in the free market” (Investopedia). We talk about private markets, which work quite well under certain conditions, but in practice most of these conditions fail. Market failure occurs when individuals, acting in rational self-interest, produce a socially inefficient or less than optimal outcome. From an economic standpoint, there is a problem in the private provision of a particular category of goods, often called public goods, since they are available to all, even to those who do not pay for them (free riders). Buyers do not directly pay for public goods (although they often pay for them indirectly, e.g. through taxes) nor do private producers provide them, since they receive no revenues from the sales, so there is a market failure by private markets in allocating the resources to produce public goods. Characteristics of a public good: In distinguishing between private and public goods, it is useful to introduce 2 concepts: non excludability and non-rivalry in consumption. o Non-Rivalry in consumption/use: A good/service is non-rival (or non-rivalrous) if its consumption by one consumer doesn’t prevent the simultaneous consumption by other consumers or if the consumption by one party doesn’t
Each individual intensifies exploitation because he/she receives a direct profit from this. Yet, each individual bears only a share of the costs resulting from over-exploitation of the common good. However, if an individual refrains from over-exploiting the ‘commons’, he is still doomed to pay his share of the costs due to the over-exploitation activities of the other members of the group. Therefore, there is no direct advantage to be gained from refraining from over-exploitation and the best strategy would be to continue overexploitation of the common good. So, the resource is fated to become extinct without a “coordination” in the intensity of the exploitation by the individuals. This problem is known as the “tragedy of the commons” (Ostrom et al., 1994) or the “tragedy of the unmanaged commons” (Hardin, 1994). Characteristics of knowledge Knowledge is an economic good, you pay to have access to a particular knowledge, and it involves a cost when you apply knowledge Definition: Economically relevant knowledge is the whole body of scientific evidence and human expertise that is, or could be, useful in the production and supply of commodities and in the invention and design of new products and processes (Greenhalgh and Rogers, 2010). Knowledge can be: Ø Codified: something that can be “written down” and transmitted to other people according to some “codified” (and shared) language: as in a chemical formula or computing algorithm. It’s most of the scientific knowledge today. It’s hardly excludable. Ø Tacit: as when a person knows how to do something that is not written down, like mixing and serving a perfect cocktail. The difference of the taste is all the tacit knowledge and skills that the other barman knows and wasn’t able to put down on a sheet. Your skills are not good as his. When knowledge is embodied in individuals it is often referred to as human capital, to distinguish this valuable asset from physical capital, such as machinery or buildings. This kind ok knowledge it’s most likely to be excludable. For an individual, the acquisition of new skills and knowledge through education and training increases his/her human capital. Another type of knowledge is cumulative knowledge Cumulativeness: Measure of the incremental nature of technical knowledge, both tacit ad codifiable. You use knowledge to build additional knowledge, and this new knowledge might refine and/or modify the existing one. Knowledge-based economy T he wealth of a given nation doesn’t rely mainly on economic resources of raw materials or natural resources, but they rely on human capital (educate and skill people that can apply this knowledge to introduce innovation). Knowledge is non-rival and a club good! It has costs of acquisition. The more people use a knowledge, not only knowledge doesn’t decrease, but controversary increases. It’s more specific than information (that can sometimes be useless) Knowledge is different from information for being specific, complex and cumulative! With information good you don’t have costs of acquisition (a gossip has 0 marginal costs) and if I’m a journalist and I want to public this information, after sharing the economic value of the information is lost, anyone can publish this information now! Information-> No relevant costs of reproduction and transfer (free-scale property). Knowledge -> Potential high cost related to the transmission (e.g. teaching) and acquisition (e.g. learning) of knowledge (no free-scale property stricto sensu) Knowledge as a “quasi” public good Non-rivalry (all “information goods” are inherently non-rival, due to the tiny cost of reproduction): ‒ Once produced, “The marginal costs of [re-producing] knowledge that already exists is zero. “ (R. Nelson, 1959)→ no incentives to invest in innovation (free riding).
‒ The use of new knowledge by an imitator doesn’t reduce the stock of knowledge of the innovator, even though it can reduce his profits: the stock of knowledge in non-rival (in consumption) but its intrinsic value is rival. Non excludability: if you want to make more excludable a codified knowledge, you can use: ‒ Formal/legal tools such as Intellectual Property Rights (IPRs). ‒ Informal/strategic tools such as secrecy and lead time. ‒ Specificity and Tacit elements involved in technological know-how. ‒ Indivisibility and Complexity ® increased cost of appropriation/imitation. More precisely, according to the nature of knowledge:
- (CODIFIED) Basic/general knowledge → + similar to a public good (non-rival + non excludable)
- (TACIT) Applied/specific knowledge → + similar to a club good or a private good with externalities. Features of knowledge emphasized by the Neoclassical approach These features of knowledge affect the innovation processes:
- High fixed costs for generation but only low or zero costs of reproduction and diffusion.
- High risk: Risk averse actors may underinvest in innovation activities. Knightian Uncertainty : all possible states of nature are not known. The vector, containing all states of nature is changing, entry probabilities are not known.
- Moral hazard: Innovation is difficult to be contracted out because the knowledge afterwards can be made available to competitors. Innovation processes cannot be insured, shifting of risks is impossible.
- Appropriability problem : Public good features cause free-rider problem. Free-riding consists in imitation. Kenneth Arrow: Innovation as an economic good:
- Knowledge has public good features (non-excludability and non- rivalry).
- Knowledge is intangible (knowledge = information), from this follows that copying, imitating and spreading of knowledge is “easy” (e.g. downloading a piece of software) and “free” (zero marginal cost).
- Technological spillovers: knowledge generated by one company can be used by other companies.
- Difficulties in trading knowledge: To know the value of knowledge, you need to know the knowledge. However, if the knowledge is revealed, you will no longer pay for it.
- -> Arrow’s Paradox: “Any information obtained... should, from a welfare point of view, be available free of charge.... This ensures optimal utilization of the information, but of course provides no incentive for investment in research” (Arrow, 1962, p. 616). Innovation: a market failure problem The public good features of new knowledge cause spillover effects: The new knowledge becomes available to third parties by spillovers. As these third parties do not contribute to the costs of R&D (Research and Development), the incentives to engage in R&D are below the social optimum. Neoclassical innovation economics focuses exclusively on the incentives to invest in R&D so- called incentive- oriented approach. Public subsidies to innovative firms (Figure 1.6) are an example of instruments to restore the optimal level of R&D investments under the incentive-oriented approach spiegazione slide 12 Market failures: remedies Public provision of basic knowledge (E.g. through Universities and Public Laboratories -> general purposes and benefits for all society)
- Subsidies, R&D Tax credits and Public Incentives (e.g. Prizes). Problems: – How to identify research projects that worth to be financed? – How to distinguish R&D from other expenditures of the enterprise?
and practical experience, directed to producing new materials, products and devices; to installing new processes, systems or services; to improving substantially those already produced or installed. Science = codified, general, undirected, a-finalized Technology = tacit, specific, directed, finalized Output: Science = new models/formulas/principles and (testable) general laws. Technology = projects, machines, products, specific knowledge
Sources of Innovation: learning
Not only R&D also non formalized learning (e.g.: learning by doing) and specific knowledge are key sources for innovation. Traditionally, learning has been considered as an automatic process without costs, as a sort of by-product of the production process and/or coming from experience -> increasing production skills. This most famous type of learning is c alled “Learning by doing” → reduction of the average production costs as a function of the total output produced (Q) or time (experience). A person learns how to do something by doing a specific task. There are also: learning by interacting, learning by using, learning by searching, learning by monitoring. Knowledge from learning tend to remain inside the firm (specific and embodied in the routines), more a private type and more easier excludable than the type of knowledge created by R&B. Limited spillovers (e.g. trough workers mobility) and limited appropriability problems (no public good, no freeriding as with R&D). Types of learning A. Learning by searching (internal) - Learning through dedicated activities (R&D) – Basic Research, Applied Research, Development B. Learning by monitoring the advancements of Science and Technology (external) -E.g. through external scientific consultancy form experts of the filed C. Learning by Doing (LBD) (internal) - Learning as a by product of the production process. It comes from experience in production. It can be measured by C =αQ^β. C=average cost, α=cost of the first unit produced; The learning curve is curvilinear, at some point at a given amount produced you don’tt learn so much, t decreases that’s why you have a non linear relationship. You can apply logarithm because the quantities are larger than 0. The logarithm is logC = logα + β logQ Q is a variable bigger than 0. Q=Q^th unit of output produced; β<0= non-linear cost decrease from experience. If you don’t have Q, you can put just Time as an independent variable. You’re measuring how to save cost by learning how to produce that good in a more efficient way. You can also capture how to improve the quality of the product you’re producing, so how to produce marginal improvements. Slide 33 lecture 2: you can see how the quantity affects the average cost. In optical equipment we have a learning fast at the beginning and flat with the quantity produced you gain advantage on the imitators at the first stage. In the second the learning curve is flatter, so the learning is slower. Here the only weapon if the innovator is to gain the knowledge as fast as possible before an imitator takes it. The learning rate is very important because imitator ci mettono un po’ di tempo in order to understand your product and to produce the rival good that imitates your innovation, so before being challenged by the imitator the innovator has a time advantage (lead time advantage). By the time the imitator will be able to produce your good, you’ll be able to produce the same good with lower costs. Log-linearization of the model -> OLS estimation
- Learning economies (dynamic) conceptually different form scale economies (static and linked to the optimum scale of production-> lower incidence of the fixed costs as the quantity produced increase).
- If Q is not available, T can be used.
- It may not be an automatic process. Firms need to invest in learning..
- Learning by Doing may also produce a constant flow of incremental innovations->first mover advantage over imitators. However, the increase in the quality of the product is usually ignored in formal models of learning by doing. D. Learning by Using (LBU) (internal) - Learning as a by product of the use/consumption of durable goods. It’s another increased knowledge about some particular innovation coming from a repeated use. You can improve a product learning more on the characteristic of the product you’re producing from user experience. It can be divided into two types: pure/non embodied and embodied LbU. Pure/Non embodied LbU (=knowledge is collected by true data) can be defined either as the understanding of: “the performance the components and materials within a complex system” and “the interaction of the complex system with the environment” that cannot be fully understood ex-ante by the producer (e.g. through scientific models or simulation/testing in labs) but only ex-post through knowledge coming from repeated use by costumers. Examples: maintenance and improvements of Turbo-JET engines, machine tools, software (automatic error reports), and other durable goods with system complexity or high fixes cost and long time to market. EXAMPLE: You let airlines using your engine and then collet their data and use them to produce a more powerful engine. You can use the engine under the conditions that I can collect your data. But we have also an embodied learning by using: Embodied learning by using: Improvements not only from the producer who use the machinery, but also from sophisticated consumer (lead users) with expertise that use the product
- ‘…lead users of a novel or enhanced product, process or service are those displaying two characteristics with respect to it: lead users face needs that will be general in the marketplace – but face them months or years before the bulk of that marketplace encounters them, and lead users are positioned to benefit significantly by obtaining a solution to those needs.’ (Von Hippel, 2005) Lead users: costumers that are aware of their needs and have a strong incentive to fulfill them by exploiting their creativity and technical knowledge of the product itself (technical competence + incentive to innovate). Examples: Open Source software development, snowboard, mountain bike. Improvements can be developed and incorporated directly by lead users, or they can push producers to do so. The innovation is introduced mainly by the consumers. E. Learning by interacting and from spillovers (external) -Spillovers from suppliers, costumers, co- operation with partners – Intra-industry (e.g. spillovers come form competitors) – Inter-industry (cross- fertilization) but also from collaborative networks. Learning from spillovers spillover is gained by being located in that particular cluster and you simply absorb knowledge by monitoring the activity of other firms. Se un ingegnere passa da un’azienda all’altra, this represents a sort of knowledge acquisition of the second firm grazie all’assunzione dell’ingegnere mobility of human capital and absorptive capacity.
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If innovation can be formalized as a process, how does it take place?
High tech sectors: pharmaceutical, computers,… Medium/High-tech secors: chemicals, machinery and electrical equipment Medium/Low-tech sectors: recorded media, coke and refined petroleum Low-tech sectors: food, beverages, tobacco products… On the basis of these dimensions Pavitt (1984) created a taxonomy of sectoral patterns of technical change, examining each industry group to see what were the dominant patterns of production and use of process and product innovations. He initially identified four distinct groups of industries in terms of their technology acquisition and use.
Pavitt studied 4 main sectors:
Supplier dominated (textiles, printing, food and beverages, agricolture , services, ....) These firms rely a lot on innovations coming from the suppliers
- Prevalence of small/medium firms
- Innovation objective: lowering production costs
- Firms contribute only marginally to technological innovation (they mostly receive new technologies embodied in materials and components from specialized suppliers)
- Almost no patenting (knowledge generated from learning by doing/using)
- Low barriers to entry Scale intensive (durable goods, automotive)
- Prevalence of large/medium firms
- Innovation objective: lowering production costs, new processes (large scale economies) and products.
- Innovation sources: both external (ex: outsourcing of new designs) and internal (R&D) • Patents on products and secrecy on processes
- High barriers to entry because of the dimension of these firms Specialized suppliers (precision instruments, machinery)
- Prevalence of small specialized firms
- Innovation objective: performance improvement, reliability and customization of products
- Innovation sources: internal (R&D, experience) and external (interactions with clients)
- High level of appropriability (tacit, specific, complex knowledge), because you have a huge amount of knowledge
- Medium barriers to entry Science based (electronics, pharmaceuticals)
- Presence of both large (diversified) and small/medium (specialized) firms.
- Innovation sources: Internal R&D (or R&D with Universities and PROs)
- High technological opportunities and patenting.
- High barriers to entry (knowledge cumulativeness)
- High intensity of technological innovation Innovation and its implications can be measured and analysed. There are many problems, since the innovation process is lengthy and complex, which is subject to a large amount of uncertainty in its output – Without measurement & analysis, understanding and policy will be based on rhetoric, anecdote and lobbying. In a nutshell, economists try to act as natural scientists. However, in economics, experiments (field or lab) are difficult and hardly reproducible, hence the best viable alternative is to rely on observational data (like astronomy) to validate theories. Therefore, economists (should) try to act as good statisticians: they (try to) provide robust empirical evidence characterizing observed phenomena and construct theories explaining and surviving to this empirical evidence The main advantage of R&D is that you can track not only the investment effort of a given firm, but also the absorbing capacity /using the cumulativeness ). The disadvantages are: The link with innovation outputs is
uncertain and delayed (ex: time lag in pharmaceuticals) – Relevant for Science-based sectors, not for other sectors such as services (or supplier-dominated and scale-intensive Pavitt sectors). – R&D mostly performed by large firms. – R&D expenditures are not easily defined (see Frascati Manual), not always reported in the balance sheets. – Tend to be affected by the economic cycle (pro-cyclicality). Patents are property rights (granted by the governments), they protect innovations. You can use these pack and data in different ways:
- of patent applications at the firm, industry, country level over time
- of patents weighted by the number of subsequent citations that the patents receive
- of citations from one patent to another -> an imperfect but useful map of the links between these “bits” of output or knowledge (more on this in next lectures) Trademarks are an indicator of new product innovation and marketing activity, which tend to react to economic conditions, and not of inventive effort, which is more continuous -> represent minor innovations than patents, such as new varieties of existing products, as there is no novelty test. Advantages of patents as indicators: – They represent inventions (output), sometimes before their commercialization (innovations). – Their novelty is assessed by examiners. – High frequency data (day by day) – Very detailed information on the technological content – Cross country coverage (national and international patent offices) Disadvantages : – Not all inventions later become innovations (no commercialization) – Their value is highly skewed – Different patent propensity across sectors and countries – Strategic use of patents (patent trolls) – Not all innovations can be patented – Cross country differences in legislation Even though patents are used a lot (=moreover in large firms), in some other sector (=the size of the firm is medium or small) innovation is protected with other.
