Diversity, efficiency and Economic Development

Pier Paolo Saviotti, UMR GAEL, Grenoble, and CNRS GREDEG I2C, Sophia Antipolis,

France.

Acknowledgments

Andreas Pyka Koen Frenken Jackie Krafft

Econ Dev, Stylised facts

STF1) Economic development is characterised by qualitative change.

STF2) The efficiency of existing processes increases in the course of economic development.

STF3) The diversity/variety of the economic system rises during the process of economic development.

Efficiency vs diversity

Efficiency grows when the same type of output is produced with (a) decreasing quantities of all inputs or (b) decreasing costs of all inputs

What happens if the nature of the output changes? Is a pair of shoes costing 100 € produced five times less efficiently than a pair of shoes costing 20 €?

Efficiency vs diversity

In a strict sense comparisons of efficiency are only possible at constant output

The 100€ pair of shoes has higher quality

Efficiency at constant quality

Qualitative and Structural Change

Qualitative change: emergence of new entities, qualitatively different (distinguishable) from the pre-existing ones.

Structural change: change in the structure of the economic system (components + linkages/interactions). Defined at the level of aggregation of industrial sectors. But:

Structural change can occur at lower levels of aggregation.

Qualitative and Structural Change (2)

Structural change can occur for activities and actors as well as for outputs.

Thus also for knowledge, and institutions.

Qualitative change broader than structural change.

Importance of qualitative/structural change.

They affect the composition of the economic system. They are determinants of system performance.

Economic development is a process of transformation, involving both quantitative/efficiency change at constant composition and qualitative change.

Variety

Definition: number of actors, activities and objects required to describe the economic system at a given time

Variable to represent analytically changes in composition.

Diversity Stirling

Diversity overarching phenomenon with three components:

Variety: number of distinguishable entities in a system

Balance: distribution of distinguishable entities in a system

Disparity: extent of difference between any two distinguishable entities

Diversity

All else being equal, the greater the variety the greater the diversity

All else being equal, the more even is the balance the greater the diversity

All else being equal, the more disparate are the represented elements the greater the diversity

Modern phenomena

Most people could only purchase the bare essentials to survive until the end of the XIXth century, and many people still do today

Diversity existed only for the rich But in the XXth century change

Efficiency and Diversity Two complementary forces/trajectories :

growing efficiency growing diversity

Hypothesis 1: The growth in diversity is a necessary requirement for long-term economic development.

Hypothesis 2: Diversity growth, leading to new sectors, and productivity growth in pre-existing sectors, are complementary and not independent aspects of economic development.

Compensation

At constant output growing efficiency + saturating demand possibility to produce all demanded output with declining fraction of resources (labour force) Marxian trap

Emergence of new sectors compensates for the falling capacity of existing sectors to create employment

Growing diversity avoids Marxian trap.

Economic development by the creation of new sectors

A model in which the number of new sectors varies endogenously during economic development

Sector created by an important innovation establishing an adjustment gap (size of the potential market)

Model

First entrepreneur enters the market (expectation of a temporary monopoly) imitators enter rising intensity of competition inducement for further entry falls until exit starts dominating entry. Innovation has become part of the ‘circular flow’ (Schumpeter, 1912-1934)

Sector oligopoly or monopoly Adjustment gap gradually closed (saturated market) Industry life cycle Decline of mature sectors induces entrepreneurs to

look for new opportunities of temporary monopoly, to be found by exploiting new important innovations leading to new niches and sectors.

Competition

Both intra- and inter-sector: Intra- sector: density of product/output

population. Inter- sector: different sectors can provide

comparable services. Entrepreneur induced by expectation of

temporary monopoly to enter. If innovation successful imitation increasing intensity of competition decreasing inducement to enter exit

Model equation

)3(**1 iiiii MAICAGFAk

dt

dN

Search activities

)1

,5exp(1

41 t

iaccDkkt

iSE

Mergers and acquisitions

t

i

t

i

t

it

i AGMCN

kMA11

9

Demand function

i

iii p

YYD

*

Demand (2)

)exp(1

1

1514 ii SEkkY

)exp(1

1

1716 ii SEkkY

)exp(1 1918 ii SEkkp

Number of firms (2)

Life cycle: in each sector Ni first increases rapidly, reaches a maximum, and then falls (oligopoly, monopoly)

But, life cycle driven purely by dynamics of competition and demand (See ILC models).

Shape of life cycle affected by several variables (AGi, Di etc).

-

5

10

15

20

25

30

35

40

45

50

1 101 201 301 401

number of firms

Adjustment gap

-

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

1 101 201 301 401 t

Adjustment Gaps

Intensity of competition

-

1

2

3

4

5

6

1 101 201 301 401 t

Intensity of Competition

Employment

li = ki/Qia = ki/Qi/Ni = (ki*Ni)/Qi

li = Li/Qi

Aggregate employment

-

10

20

30

40

50

60

70

80

90

100

1 101 201 301 401

Aggregate Employment

t

Aggregate employment

0

25

50

75

100

1 251 501 751

Employment trend vs rate of growth of services

-

25

50

75

100

1 101 201 301 401

0.1

0.125

0.25

0.375

0.5

Employment trend for variations of k015

Demand experiments (2)

Increasing the rate of growth of Yi (level of services supplied) Speeds up development raises demand, increases AGi, Changes the shape of the ILC and leads to a more positive employment

growth path.

Compensation

The emergence of new sectors (growing variety) can compensate for the falling ability of mature sectors to create employment (Hypothesis 1)

Economic development can be sustainable in the long run.

The internal dynamics of each sector counts as well

Creative destruction

Process of industrial mutation that-if I may use that biological term- incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one ….

….essential fact about capitalism….(p.83) ….perennial gale of creative destruction…

(p. 84) (Capitalism, Socialism and Democracy)

Interpretations

Possible interpretations of creative destruction

For every new innovation created a previous one disappears (Aghion and Howitt), considered by AH the true Schumpeterian character of their model.

This implies: (i) Complete substitution of old by new, (ii) constant output diversity

Diversity and creative destruction

They are not incompatible, but, if variety grows there must be more creation than destruction.

However, even old sectors which survive are not unaffected by the creation of the new. Old sectors/activities are transformed by new ones.

Influence of competition on system performance

Two (ideal) (opposite) types of competition (extremes of a range):

Schumpeterian: do what no one else can do (radical innovation) temporary monopoly

Classical: do the same thing as other competitors but better (i), (ii) (i) more efficient cheaper output (ii) better quality

Intensity of competition

totIIi

totiICi NRN

NNkIC

*

toti

totii NkNk

NNIC

76

*

Overall IC vs IC + Inter-intra balance

0.6

0.7

0.8

0.9

1

0 0.005 0.01 0.015 0.02 0.025 0.03 0.035 0.04 0.045 0.05

5

6

7

8

9

intensity of competition

kIC

Rii

Rate of employment growth vs balance inter-intra-sector competition (Rii) for values of kIC.

-0,005

0

0,005

0,01

0,015

0,02

0,025

0 0,02 0,04 0,06 0,08 0,1

2

3

4

5

6

7

8

9

10

trend of employment

Rii

kIC

Trade-offs

Inter-intra: predominance of intra-sector competition higher probability of temporary monopoly in niches elsewhere than in established sectors.

If only Schumpeterian competition once sector created no imitation

Classical competition production of the new good/service + efficient (cheaper) increased economic weight

Industry life cycle

In our model natural consequence of the dynamics of competition and of demand but not exclusive of other cyclical influences

Different from other ILC models (Process R&D, Dominant designs, Refinement innovation)

Demand - Search activities

)1

,5exp(1

41 t

iaccDkkt

iSE

Demand - Search activities (2)

)exp(1

1

1514 ii SEkkY

)exp(1

1

1716 ii SEkkY

)exp(1 1918 ii SEkkp

Industry life cycle

-

10

20

30

40

50

60

70

80

90

1 251 501 751

k4 = 5 k4 = 7.5 k4 = 10 k4 = 12.5 k4 = 14

-

10

20

30

40

50

60

70

80

90

1 251 501 751 1001

0.01 0.005 0.0075 0.025 0.0125

-

20

40

60

80

100

120

1 251 501 751k14 = 0.1 k14 = 0.5 k14 = 1 k14 = 1.5 k14 = 2

-

20

40

60

80

100

120

140

1 251 501 751

k15 = 0.1 k15 = 0.25 k15 = 0.5 k15 = 0.75 k15 = 1

Industry Life Cycle

The shape, duration and existence of the industry life cycle is greatly affected by parameters affecting demand and search activities

In some cases the shake out virtually disappears (existence)

Micro-Macro dynamics

0

20

40

60

80

100

120

1 251 501 751 1001

0.01 0.005 0.0075 0.025 0.0125

- 10 20 30 40 50 60 70 80 90

1 251 501 751

k5 = 0.005 k5 = 0.0075 k5 = 0.01

k5 = 0.0125 k5 = 0.025

30

35

40

45

50

55

60

1 251 501 751 1001

Linear (0.005) Linear (0.0075) Linear (0.025)

Linear (0.01) Linear (0.0125)

Micro-Macro dynamics (2)

The shape and duration of the ILC affects the macro-economic performance of the economic system

Model parameters affecting demand and search activities can affect (i) the rate of creation of new sectors (ii) the number of firms in each sector (iii) the rate of growth of industrial concentration

Micro-Macro dynamics (3)

As consequence the effects of parameters affecting demand and search activities are often non-linear

Ex: trade-off between faster rate of creation of new sectors and smaller number of firms in each sector.

Efficiency vs diversity

All these (and many other) phenomena are made possible by the complementary combination of efficiency and diversity

More creation than destruction vs growing diversity

Trade-off Schumpeterian (Diversity) classical (efficiency) competition

Influence of ILC (shape etc) on macro dynamics rate sectors + sector size