The economics of technological change and Innovation

UNUMerit course – 2006

Bart Verspagen Eindhoven Center for Innovation Studies (Ecis), Eindhoven University of Technology

(former Merit…)

b.verspagen@tm.tue.nl

A general outline of the course

� The central thing you will learn is how economistsanalyze technological change or innovation

� The course does not deal very explicitly with development, but it aims to provide tools and theories that can be applied to development issues

� Topics: history (today, lecture 6), microeconomics (lectures 2 and 3), macroeconomics (lectures 4-8), empirical work (lecture 5 and others), policy (lecture 9) and an insight into the scholarly community (lecture 10)

Today’s lecture

� Topic: conceptual frameworks used in the theory of technological change and innovation– 1: basic notions, concepts and frameworks (and

stories illustrating them)– 2: a grand theory of innovation and the economy

(arising out of part 1)

1. Technology as an economic factor

� Concepts of technological change– paradigms– causation and the chain linked model

� Motivation: what is special about technology and why does it deserve our attention?– Public good features– Risk and uncertainty

Concepts (Schumpeter)

� Invention – Innovation – Diffusion� Incremental - Radical

Major innovations (or basic innovations)

Innovation yearQuinine 1820Isolated conduction 1820Rolled wire 1820Cartwright's loom 1820Steam locomotive 1824Cement 1824Puddling furnace 1824Pharma fabrication 1827Calciumchlorate 1831Telegraphy 1833Urban gas 1833

Innovation yearSpinning machine 1764Steam engine 1775Automatic band loom 1780Sliding carriage 1794Blast furnace 1796Steam ship 1809Whitney's method 1810Crucible steel 1811Street lighting (gas) 1814Mechanical printing press 1814Lead chamber process 1819

Incremental innovation

Unifying concepts

� Paradigms and trajectories� Chain-linked model

Technological paradigms and trajectories

� Analogy to Kuhn’s philosophy of science� Paradigm: “model and pattern of solution of

selected technological problems, based on selected principles from the natural science and on selected material technologies” (Dosi)

� Trajectory: ‘normal’ technological change along a paradigm, closely associated to a ‘goal’ for technological development that springs from a certain problem

Technological paradigms and trajectories

� breakthroughs and incremental innovations– productivity change– pervasive technological change (ICT)– collective innovation

� Institutional context (techno-economic paradigm, Carlota Perez)

� Complex interaction between breakthrough S&T, incremental innovation, economic motives and institutional context: causality?

Causation? Demand pull or technology push

� Who initiates innovation projects: the R&D department or the marketing department? Is innovation a reaction to user demand, or does it create demand?

� Technology push– linear model from technology to market

� Demand pull– linear model from market to technology

The laser

� Charles Townes on the laser:“Bell’s patent department at first refused to patent the our amplifier

or oscillator for optical frequencies because, it was explained,optical waves had never been of any importance to communication and hence the invention had little bearing on Bell System interests”

Technology push

� Example: laser invented without direct application, now applied in a wide range (telecom, medical, music, science)

� R&D split into basic, applied and development– specialization pattern of institutions carrying out

R&D� implications:

– large firms have an advantage because science takes resources

Horseshoes and ‘How the West was won’

� Jacob Schmookler found that the intensified use of horses when the West of the U.S. was colonized led to a great increase in the number of patents on horseshoes

Demand pull

� Innovation as a response to profit opportunities

� Jacob Schmookler– patent data– horseshoes– statistical analysis of causality investment -

patents� critique: needs and demand

The chain linked model (Kline & Rosenberg)

Special characteristics of technology

� Public goods aspects (IBM vs Apple): spillovers

� Risk and uncertainty (the Comet)

IBM vs Apple

IBM vs Apple

IBM vs Apple

� Market shares

0

5

10

15

20

25

30

35

40

45

1981

1983

1985

1987

1989

1991

1993

1995

1997

Bron: Harvard Business School Apple case studies 1992 & 1998

IBM vs Apple

� Winners & losers?

0

1

10

100

1000

1985 1987 1989 1991 1993 1995 1997

IBM

Apple

Microsoft

CompaqIntel

Bron: Worldscope database

Technology a public good?

� Recap:– non-rivalry (or indivisibilities)– non-excludability

� But:– cumulativeness– capability to learn

� Spillovers and investment (incentives)

The Comet airplane

Types of uncertainty

� Scientific� Technological� Commercial� Systems

Strong uncertainty and weak uncertainty

� Neoclassical economic theory can cope well with weak uncertainty by using stochastic mathematics (Arrow)– futures markets for all uncertain outcomes?– Insurance against failures in innovation?– moral hazard and agency problem (manager -

stockholder and cost-plus contracts; trade-off between incentives and buying off uncertainty)

– large firms at an advantage because they undertake many projects (=insurance)

Strong uncertainty and weak uncertainty

� But still, uncertainty leads to underinvestment� And, strong uncertainty (knowing or not

knowing options?)– systems and paradigms

� Evolutionary economic theory can cope well with strong uncertainty by using bounded rationality

Conclusion

� Incentive problem� Theoretical problem (for neo-classical

economics)– bounded rationality, evolutionary economics– full rationality, neoclassical economics– confrontation or convergence?

Technological Revolutions and Economic Development� How do radical technological breakthroughs with

strong uncertainty unfold in historical time?� Long waves� Schumpeter’s theory of long waves� An historical interpretation

Long Wave theory

� Van Gelderen, Marxian economics� Kondratief� Schumpeter� Neo-Schumpeterians: Mensch, Kleinknecht,

Freeman, Soete

Neo-Schumpeterian long wave theory

� The story (wave) starts in a depression– Low (zero) profits, so close to perfect competition

equilibrium– But entrepreneurs are not happy with this situation– A solution: innovation

� Basic innovations cluster in the depression– Monopoly rents due to innovation

� Bandwagon of imitations: rapid economic growth and erosion of monopoly rents– Upswing of the long wave

Dis-equilibrium dynamics

� Creative destruction (business stealing)� Depletion of technological opportunities and

increase in competition lead the economy back to a perfect competition equilibrium– Downswing of the long wave

� Primary, secondary and shorter waves– Speculation (dot.com bubble)

Clustering of innovations?

� Kuznets critique on clustering hypothesis– No evidence– No theoretical explanation

� Explanation: depression trigger� Mensch & Kleinknecht vs Freeman, Soete

and Clark– Clustering of innovations or clustering of diffusion?

The empirical evidence

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1750 1800 1850 1900 1950 2000

Time series of basic innovations (number of innovations per year)

An historical (Freeman/Soete) interpretation

� Successive technological revolutions since the Industrial Revolution, for each of these covering:– A general impression– Technological developments in major driving

sectors– Changes in the organization of the economy

Technological Revolutions

1. The Industrial Revolution (1770 - 1840)2. The age of steam and railways (1840 - 1890)3. Age of electricity and steel (1890 - 1940)4. Fordism and Mass-production (1930/40 -

1980)5. The Information Age (1980/90 - ?)

1. The Industrial Revolution (1770 - 1840)

� Mechanization (process innovation) in a few leading sectors (iron, textiles) in Great Britain

� Technological developments: textiles, iron, steam engines

� Source of finance: own capital (partnerships of inventors and entrepreneurs)

Technology in Textiles - Spinning

� Before the industrial revolution: merchant system: putting out raw material to hand spinners.

� Hargreaves’ ‘spinning jenny’ (1764) was a hand-powered device that could spin multiple threads, but was still mainly applied in cottages (home spinners).

� Arkwright’s water frame (1769) used multiple (3-4) pairs of rollers, and yielded a higher quality yarn more rapidly, the latter because it was operated by water power (hence its name)

� Crompton’s mule (1779) was a combination of the two previous machines (hence the name ‘mule’), and was suitable for mass production of high quality yarn

Conclusion for spinning

� 3 innovations in 15 years led to a 50 fold decrease of hours needed to produce a given amount of yarn

� together with major increases in transportation technology, this implied that British textiles industries were able to capture a large part of world markets

Samuel Crompton

Organizational changes associated with the Industrial Revolution

� First wave of mass production through application of machinery in factories. First these factories were operated by water power, later on by steam power.

� The factory was not only an organizational aspect of technological change, it also implied a major social (and later, political) change by creating a proletariat

� Increased efficiency of transportation (canals, roads) made it possible to realize economies of scale in these factories, and ship manufactured goods to a large market

2. The age of steam and railways (1840 -1890)

� Diffusion of steam power and its application to transport: railways, steam ships

� Joint stock companies as a new form of corporate governance which leads to less dependence on private capital

� spread of industrial revolution to other countries than Britain, such as Belgium, Germany and the United States

� development of electricity, gas, synthetic dyestuffs, and steel

3. Age of electricity and steel (1890 - 1940)

� Electricity takes over from steam as the main source of power, steel takes over from iron

� Further growth of average firm size, leading to monopolies, oligopolies and cartels

� Take-over of world economic and technological leadership by the United States, which had a system based on abundant resources, a large homogenous market, a capitalist spirit

� Shift away from the emphasis on individuals in innovation proces. towards corporate R&D; this is a trend that was initiated in the German and US chemical industries

Steel and its impact

� Steel was used as an input in a whole range of industries, such as building, tin cans (food processing), machinery, weapons, transport equipment.

Technology - electricity� based on scientific advances by Benjamin Franklin, Allesandro

Volta and Michael Faraday in the 1830s� technological use as a power source based on the generator (or

dynamo) and the use of electricity in electric motors, these were developed in continental Europe in the mid 1800s

� application in a wide range of uses, such as lighting, factories, domestic appliances, transport (metro, trams), Thomas Edison is the prime inventor and initiator of the use of electric power

� in the factory, the electric motor brought flexibility compared to the steam engine: no longer did the whole factory depend on a single steam engine, but now each machine tool could have its own power source (electric motor)

4. Fordism and mass production (1930/40 - 1980)� Initiated in the US, mass production was based on

the organization of work around an assembly line. This was first applied in the Ford motor car factory

� The success of mass production depends on the availability of large markets with sufficient demand, the circumstances in the US (1920s) were right, later on a worldwide scale in the postwar period

� Associated with mass production is the rise of the multinational company

Technology - Internal Combustion Engine� Developed as an alternative to the steam engine by Lenoir (1859),

commercially implemented by Otto (1878).� The technical director of Otto’s firm was Daimler, who started a firm of

his own in 1882, together with Maybach. They applied internal combustion engines to a number of vehicles (bicycles, boats, carriages), which led to the automobile in 1889.

� Other sources of power were available for the automobile, such as steam and electricity

� Which power source ‘won’ depended on many factors, among which infrastructure (gasoline stations, etc.), the range (as in current discussions around the electric car), but above all in the economies of scale associated with Ford’s mass production system (lock-in?)

Technology/Organization - ‘Fordism’

� In the (European) craft-based system, each product was developed and fit separately; in mass production, standardization and interchange-ability of parts is essential (the Colt revolver is an early American example)

� Ford’s assembly line was based on the method of ‘engineering management’ of Taylor, who broke each job down into its constituent motions, analyzed these to determine which were essential, and timed the workers with a stopwatch. With superfluous motion eliminated, the worker, following a machinelike routine, became much more productive.

� Fordism led to degradation of the quality of work (boredom)

Charlie Chaplin in ‘Modern Times’

5. The information Age (1980/90 - ?)� A shift from material (mass-produced)

products to intangible products (services)� The rise of information processing

machinery� A network society?� productivity paradox (‘we see computers

everywhere, except in the statistics on productivity’ - R.M. Solow) Charlie Chaplin in the

Information Age (IBM commercial)

Technology - Computers, electronics and telecom� Computers (developed by both sides in WW II) were

continually improved by developments in electronics: first based on electron tubes, later on transistors, and then on integrated circuits and microchips

� In the 1980s, technological convergence between telecommunications, computers and electronics.

� Rapid diffusion through almost all sectors of the economy from the 1980s onwards.

Organizational change: A network society?� An alternative to large scale mass production (Fordism) was launched

in the Japanese automobile industry: Lean Production (or ‘Toyotism’); this was based on flexible production methods, just-in-time delivery (to reduce costs of storage), subcontractors networks (small firms),worker-involvement and skill-development.

� With ICTs, communication becomes easier, and networks (e.g. subcontractors in Lean Production) become more important (Silicon Valley, Manuel Castells)

An attempt at some conclusions

� There is a very long lag between invention, and the diffusion ofa major innovation through the economic system, major innovations introduced in one ‘technology revolution’ may diffuse on a larger scale only in the next one (e.g., electricity, steam, internal combustion engine)

� There are important qualitative changes in the way in which technological progress is ‘organized’ (individual inventors, corporate R&D, networks), as well as differences between technologies and sectors (R&D arose in chemicals)

� Technological developments are linked in a complex causal mechanism with changes in the organization of the firm, productive system and the economy/society at large (infrastructure, Fordism, Toyotism)

� Take-over of technological leadership at the level of countries occurs at the breakpoint of technological revolutions, the ‘innovation system’ of the new leader is an important input to the new technological wave