Macro-economics of Innovation 1

Structural crises of adjustment, business cycles and investment

behaviour (Freeman and Perez, 1988)

Business Cycles 1

• Kondratieve trade cycles (every 30 to 40 years) – revival-boom-recession-depression

• Schumpeter (constellation of innovations in recession and depression points)

• Traditional view: output is a function of capital + labor

• Robert Solow (1956): role of technology in output

Business Cycles 2

• One of the main reasons for cyclical fluctuations in the economy is the instability of investments.

• Such instability is mainly related to the investments in capital goods industries rather than consumer goods industries.

• High capital-intensity and indivisibility of investments tend to multiply investments during boom and diminish during recession.

• Source: Freeman and Perez (1988)

Business Cycles 3

• Concept of Equilibrium in Economics

• Cobb-web theorem

• Excessive investments upset the equilibrium

Investments 1

• Fluctuations in investments are caused by:• External factors – 1) technological innovation, 2)

dynamic growth of population, 3) fluctuations in business confidence and ‘animal spirits’.

• Internal factors – Any initial change in investment gets multiplied as the employees in capital goods industry spend their earnings on consumption goods. This increases the optimism of investors to invest more.

• Source: Freeman and Perez (1988)

Investments 2

• Inventions or scientific discoveries may occur independently of the business cycle, but their appreciable economic introduction will depend on business conditions.

• The periods of stable growth depend more on a general climate of confidence, including belief in the future potential benefits from technical change, rather than on assumptions of perfect information, accurate calculations on the future rate of return of a wide variety of investments.

• Source: Freeman and Perez (1988)

Technical Change 1

• The crucial importance of technical change for investment behavior:

• At certain times technical change appears to undermine confidence and stability, while at others it has the opposite effect.

• At the level of individual innovative investment, studies show that investment in new products and processes has an element of true uncertainty and the outcome cannot be known.

• Source: Freeman (1982)

Technical Change 2

• However, from a business cycle perspective, the analysis cannot be restricted to individual innovation.

• Qualitative aspects and the systems of inter-relatedness of innovations must be taken into account, which under favorable conditions lead to an economic boom.

• Favorable conditions include, complementarities between innovations and the emergence of appropriate infrastructure and institutions that do not restrict diffusion of new technologies.

• On the other hand, as technologies and industries mature, diminishing returns and declining profits may diminish investments.

• Source: Freeman and Perez (1988)

Taxonomy of Innovations 1

• Incremental innovations:• Occur continuously, with varying rates in different

industries and countries, depending on a combination of demand pressures, socio-cultural factors, technological opportunities.

• They are not a result of deliberate R&D, but outcome of inventions and improvements suggested by the production people or proposals by users (‘learning-by-doing’ and ‘learning-by-using’).

• Although their combined effect is very important, no single incremental innovation has dramatic effects.

• Source: Freeman and Perez (1988)

Taxonomy of Innovations 2

• Radical innovations:• Discontinuous events usually as a result of

deliberate R&D in an enterprise or university (e.g. color TVs, Electric typewriters).

• They lead to growth of new markets and investments, but relatively small in aggregate economic impact.

• Source: Freeman and Perez (1988)

Taxonomy of Innovations 3

• Changes of ’technology system’:• Far-reaching changes in technology, affecting

several branches of the economy, as well as giving rise to entirely new sectors.

• A combination of radical and incremental innovations, together with organizational and incremental innovations affecting more than one or few firms (e.g. synthetic materials, petro-chemical innovations, machinery innovations in injection moulding and extrusion)

• Source: Freeman and Perez (1988)

Taxonomy of Innovations 4

• Changes in ‘techno-economic paradigm’ (technological revolutions)

• A major influence on the behavior of the entire economy (pervasive effects). Creates new range of products, services, systems and industries, as well as affects almost all the other branches of the economy.

• Carries with it many clusters of radical and incremental innovations.

• Changes involved go beyond engineering trajectories for specific product or process technologies and affect the input cost structure, and conditions of production and distribution through out the system.

• Source: Freeman and Perez (1988).

Techno-Economic Paradigm 1

• A new techno-economic paradigm develops initially within the old, showing its decisive advantages during the ‘down-swing’ phase of the previous Kondratiev cycle.

• A combination of inter-related product and process, technical, organizational and managerial innovations, embodying a quantum jump in potential productivity for all or most of the economy and opening up an unusually wide range of investment and profit opportunities.

• The organizing principle of each successive paradigm is to be found not only in a new range of products and systems, but most of all in the dynamics of relative cost structure of all possible inputs to production.

• Source: Freeman and Perez (1988)

Key Factor• In each new techno-economic paradigm, a particular input or set of

inputs become the key factor of that paradigm and fulfills the following conditions:

• 1) Clearly perceived low and rapidly falling relative cost – only major and persistent changes have the power to transform the decision rules and procedures for engineers and managers.

• 2) Apparently almost unlimited availability of supply over long periods: temporary shortages may occur, but no major barriers to long-term increase in supply. Essential for major investment decisions.

• 3) Clear potential for the use or incorporation of the new key factor in many products and processes throughout the economic system, either directly or through related innovations, which reduce the cost, change the quality of capital equipment, labor inputs and other inputs to the system (e.g. oil, microelectronics).

• Source: Freeman and Perez (1988).

Kondratieve Cycles 1

• 1770s to 1830s (industrial revolution to hard times).

• Main industries: textiles, Iron-working.• Key factors: cotton and pig iron.• Emerging sectors: steam engines, machinery• Limitations: scale, process control and

mechanization, limitations of hand tools.• Technological leaders: Britain, France, Belgium.• Emerging countries: German States and the

Netherlands.• Source: Freeman and Perez (1988)

Kondratieve Cycles 2

• 1830s to 1880s (Victorian prosperity to Great depression).

• Main industries: steam power. shipping and railways.• Key factors: coal and transport.• Emerging sectors: steel, electricity, synthetic dye stuffs.• Limitations: inflexibility of location in the case of water

power, scale, reliability and range of applications.• Technological leaders: Britain, France, Belgium,

Germany, USA.• Emerging countries: Italy, The Netherlands, Switzerland,

Austria-Hungary.• Source: Freeman and Perez (1988)

Kondratieve Cycles 3

• 1880s to 1930s (Belle epoque to Great depression).• Main industries: Electrical and heavy engineering.• Key factors: Steel• Emerging sectors: automobile, telecommunications, oil.• Limitations: steel as an engineering material in terms of

strength, durability and precision.• Technological leaders: Germany, USA, Britain, France,

Belgium, Switzerland and the Netherlands.• Emerging countries: Italy, Austria-Hungary, Canada,

Sweden, Denmark, Japan, Russia.• Source: Freeman and Perez (1988)

Kondratieve Cycles 4

• 1930s to 1980s (Golden age of growth to crisis of structural adjustment).

• Main industries: automobiles, aircraft, petro-chemicals.• Key factors: Energy (particularly oil)• Emerging sectors: computers, NC machines,

pharmaceuticals.• Limitations: Fordist mass production, limitations of scale

of batch productions.• Technological leaders: USA, Germany, Sweden,

Switzerland.• Emerging countries: East Europe, Korea, Brazil, India,

China.• Source: Freeman and Perez (1988)

Kondratieve Cycles 5

• 1980s to Present (Golden age of growth to crisis of structural adjustment).

• Main industries: ICT, software.• Key factors: electronic chips• Emerging sectors: biotechnology, fine chemicals.• Limitations: energy-intensity and material-intensity.• Technological leaders: Japan, USA, Germany, Sweden,

Taiwan, Korea.• Emerging countries: Brazil, Mexico, China, India.• Source: Freeman and Perez (1988)

Features of New Techno-economic Paradigm

• A new best-practice form of organization• New skill profile in the labor force• A product mix with intensive use of low-cost key factor• New radical and incremental innovations substituting the new key

factor• A new pattern in the location of investment• A wave of infrastructural investment• Emergence of new innovator-entrepreneur-type small firms• Concentration of the large firms in the branches producing the key

factor• anew pattern of consumption of goods and services and new types

of distribution and consumer behavior• Source: Freeman and Perez (1988)