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Current Issues in Economics

Lecture 2Knowledge and Social Capital as

production factors

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Knowledge and Social Capital as the production factors

Traditional approach to economic problem: best allocation of scarce resources of labor and capital• Production function

Q = f (L, K ) where L is a quantity of labor, K a quantity of

capital and Q an output of commodities. • Augmented with Total Factor Productivity

Y = A x x A - residual “black box” not an answer but an

accounting gimmick

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Knowledge and Social Capital as the production factors

Knowledge role in the economy:• Knowledge as a dominating substance of a

product (e.g. DVD, apps, software)• Knowledge as source of monopoly

(pharmaceuticals)• Knowledge as source of competitive edge

(lower costs, better product functionality)

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Knowledge and Social Capital as the production factors

How scarce is knowledge?– more in use it becomes more valuable– temporarily when legally protected– scarce by costs of replication (reverse engineering)

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Knowledge and Social Capital as the production factors

• The main difference between a postindustrial knowledge-based economy and a traditional economy using knowledge is in the way knowledge is generated, introduced as innovation and rewarded

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Knowledge and Social Capital as the production factors

Knowledge is not new to the economy and society, sometime has had profound historical impact changing directions of the human history

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Knowledge and Social Capital as the production factors

Answer: a horse stirrupNo stirrup horse for communication onlyWith stirrup medieval tank but more servicemen needed higher costs capture of surplus feudalism However, at some stage became a hindrance to new solutions (cavalry over-lived its usefulness)

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Knowledge and Social Capital as the production factors

PERSONBYTES • The amount of knowledge in the world has

increased tremendously, but our individual capacity to hold it has not.

• Knowledge is now divided into chunks —personbytes—and distributed across people.

• How does the personbyte economy work?

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Knowledge and Social Capital as the production factors

WHO HAS MORE PRODUCTIVE KNOWLEDGE?

AN INUIT?

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Knowledge and Social Capital as the production factors

OR MODERN MAN?

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Knowledge and Social Capital as the production factors

Modern man: but WHY?The answer: progress in division of labor

• Division of labor in the archaic societies: NONE• Each Eskimo could provide food, clothing and

build a shelter (igloo) but societal value just a sum of individual efforts

• Cooperation regulated by tradition

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Knowledge and Social Capital as the production factors

Division of labor in industrial societies• Division of labor in the past centuries in developing

societies by profession oriented on a single product: butcher, baker, teacher, doctor, soldier.

• Economy built on the exchange of products - each participant had a product to offer.

• Societal value increased by specialization but still the sum of individual productivity

• Coordination mostly via market

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Knowledge and Social Capital as the production factors

Division of labor now

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Knowledge and Social Capital as the production factors

Post-industrial societies• Functional, knowledge-based division of labor• None of professional able to produce a

product ready to use• Societal value of labor increased by synergies

across the economy between specialized firms• …but only in well functioning systems

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Knowledge and Social Capital as the production factors

Modern economy is based on smoothly functioning networks of networks. • A modern firm is a network of people with different expertise:

production, logistics, marketing, sales, accounting, human-resource management, and so on. But the firm itself must be connected to a web of other firms – its suppliers and customers

• Firms and households need access to networks that deliver water and dispose of sewage and solid waste. They need access to the grids that distribute electricity, urban transportation, goods, education, health care, security, and finance. Lack of access to any of these networks causes disproportional declines in productivity.

New approach to economic problem: how to create synergy between available resources (positive feedbacks)

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Knowledge and Social Capital as the production factors

Problem of development is the problem of acquiring and using productive knowledge • How is productive knowledge acquired?

–By individuals? –By firms? –By societies?

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Knowledge and Social Capital as the production factors

Chicken and egg problem for knowledge based development• You cannot make watches without watchmakers • You don’t want to be watchmaker if nobody makes

watches • You cannot become a watchmaker because there are

no watchmakers to learn from • You need not only watchmakers but also precision

machinists, marketing teams, etc. How do societies overcome this problem?

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Knowledge and Social Capital as the production factors

How individuals acquire productive knowledge?

• Increased schooling alone is not generating the expected income pay-off

• Even the science-based jobs require apprenticeship

• The tricks of the trade are acquired from experienced senior workers

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Knowledge and Social Capital as the production factors

How do firms acquire productive knowledge?

THE BIRTH OF SUCCESSFUL INDUSTRIES • a successful firm is established • employees learn from the firm • employees leave the firm to set up new firms • spin-offs are often much more successful than other

firms… • ... and generate a new wave of spin-offs A CLUSTER OF HIGH PERFORMING FIRMS ARISE

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Knowledge and Social Capital as the production factors

HOW DO SOCIETIES ACQUIRE PRODUCTIVE KNOWLEDGE?

– Productive knowledge is tacit: very hard to acquire – Knowledge resides in the brains of people.– It is easier to move the brains than the knowledge – As a result, knowledge diffuses only slowly and across narrow

channels – ... and requires teams with complementary skills – In a world of increasing complexity, teams become more and more

intricate – This makes the coordination problem exponentially harder

What the world needs is mobility, diversity and stability

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Knowledge and Social Capital as the production factors

Bad news 1: throwing money on the problem is not a solution

More money spent on R&D will not generate more knowledge to be used by producers to build knowledge based economy

Embarrassing failure of Lisbon Agenda

ConsumerProducerR&D

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Knowledge and Social Capital as the production factors

Bad news 2 – human skills (practical knowledge) are not so flexible as we think

• You will not teach an old dog new tricks: human capital is very specific to the industry in which people work

• Germany: 50% of those leaving an industry go to related industries that represent just 2.8% of all employment in the country

• Economic diversity matters and this is not to be changed overnight

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Knowledge and Social Capital as the production factors

Bad news 3: Social capital which has profound impact on development changes very slowly and changes may have unexpected outcomes:Cultural dimension: Trust Tolerance Dialogue Diversity MobilityInstitutional dimension: Good laws Effective institutions Professional administration staff

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Knowledge and Social Capital as the production factors

trust index

GNP/capita

inn. index

power dist.

individualizmmasculinity

uncertainty

pragmatizm

indulgence

0

50

100

PolandGermanyUK

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Knowledge and Social Capital as the production factors

Conclusion: transition to more productive knowledge-based economy is: • strongly path dependent and • systemic – cannot by introduced piece by

pieceBoth conditions contradictive or at least very difficult to meet at the same time

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Knowledge and Social Capital as the production factors

World Bank four pillars of KE:• Economic and institutional framework - good

governance at the macro and enterprise levels.• Human resource development – growing pool of

knowledge workers and technology literate workforce.• Information society - ICT infrastructure and computer

literacy.• National innovation systems - resources, institutions

and incentives for developing and implementing domestic and foreign innovations.

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Knowledge and Social Capital as the production factors

World Bank lessons learned:• There is no one single model of a successful

transformation to KE. Nations respond to the challenge of this transformation in different ways, depending on the differences of their history and culture, national priorities, economic status, size, geography and population.

• Yet, all countries have to confront similar issues: how best to maximize the economic and social benefits, and minimize the risks of transformation

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Knowledge and Social Capital as the production factors

Size the moment: Ireland• Challenge: become a competitive EU member• Opportunity: English, educated young

population, US Diaspora• Risks: marginalized late comer in EU• Response: Opening to ICT FDI, using EU

structural funds

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Knowledge and Social Capital as the production factors

Size the moment: Israel• Challenge: accommodate 1 million immigrants

from FSU• Opportunity: highly educated professionals• Risks: no market skills, disappointment • Response: Technological Incubators Model -

provide support services and resources in advancing ideas from a conceptual stage to viable, working enterprises.

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Knowledge and Social Capital as the production factors

Size the moment: Finland • Challenge: collapse of the SU market• Opportunity: excellent education, hard-work

ethics, Nokia• Risks: cut-throat competition in ICT markets,

high labor costs, market rigidities• Response: top-level ownership of KE Agenda,

Foundation for Finnish Inventions, spreading KE beyond Nokia