Industrial Economics Lecture 8.pptx

Lecture Eight
Technological Progress
Invention, Innovation and Diffusion
 Technological change is a term that is used to
describe the overall process of invention,
innovation and diffusion of technology or
processes.
 It is used in economics to describe a change in
the set of feasible production possibilities.
 The term is redundant with:
 technological development
 technological achievement, and
 technological progress.

 In essence technological change is:
 the invention of a technology (or a process)
 the continuous process of improving a technology
(in which it often becomes cheaper) and its
diffusion throughout industry or society.
 In its earlier days, technological change was
illustrated with the 'Linear Model of
Innovation', which has now been largely
discarded to be replaced with a model of
technological change that involves
innovation at all stages of research,
development, diffusion and use.

 The Schumpeterian trilogy divided the technological
change process into three distinct phases: The
technological change process including:
 the conception of new ideas (invention)
 the process that involves the development of new ideas
into marketable products and processes (the doing of new
things or the doing of things that are already being done in
a new way) (innovation); and
 the stage in which the new products and processes spread
across the potential market (diffusion).
 Three phases of the process of Technological Change
innovation
invention Diffusion

Invention
 Is the creation of something new, or a "breakthrough"
technology.
 It is the initial creation or discovery of an idea or a product.
 The invention of a personal computer can be a best
example. There are numerous such examples in the world.
Innovation
 is a change in the thought process for doing something, or
 it is the useful application of new inventions or discoveries.
 it may refer to an incremental emergent or radical and
revolutionary changes in thinking, products, processes, or
organizations.
 Following Schumpeter (1934), contributors to the scholarly
literature on innovation typically distinguish between
invention, an idea made manifest, and innovation, ideas
applied successfully in practice.

 In many fields, such as the arts, economics and
government policy, something new must be
substantially different to be innovative.
 In economics the change must increase value:
 customer value, or
 producer value.
 The goal of innovation is positive change; to
make someone or something better.
 Innovation leading to increased productivity is
the fundamental source of increasing wealth in
an economy.

 The word "innovation" is often synonymous with the
output of the process.
 However, economists tend to focus on:
 the process itself, from the origination of an idea to its
transformation into something useful, to its
implementation; and
 the system within which the process of innovation unfolds.
 Since innovation is also considered a major driver of
the economy, especially when it leads to new product
categories or increasing productivity, the factors that
lead to innovation are also considered to be critical to
policy makers.
 In particular, followers of innovation economics stress
using public policy to spur innovation and growth.

 Rogers proposes that there are five main
attributes of innovative technologies which
influence acceptance.
 These are relative advantage, compatibility,
complexity, trialability, and observability.
i. Relative advantage: may be economic or non-
economic, and is the degree to which an
innovation is seen as superior to prior
innovations fulfilling the same needs.
 It is positively related to acceptance (i.e., the
higher the relative advantage, the higher the
adoption level, and vice versa).

ii. Compatibility is the degree to which an innovation
appears consistent with existing values, past
experiences, habits and needs to the potential adopter;
a low level of compatibility will slow acceptance.
iii. Complexity: is the degree to which an innovation
appears difficult to understand and use; the more
complex an innovation, the slower its acceptance.
iv. Trialability: is the perceived degree to which an
innovation may be tried on a limited basis, and is
positively related to acceptance.
 Trialability can accelerate acceptance because small-
scale testing reduces risk.
v. Observability: is the perceived degree to which results
of innovating are visible to others and is positively
related to acceptance.

 Joseph Schumpeter defined economic
innovation as:
 The introduction of a new:
 good- that is one with which consumers are not
yet familiar- or of a new quality of a good.
 method of production, which need by no means be
founded upon a discovery scientifically new, and
can also exist in a new way of handling a
commodity commercially.

 The opening of a new market; that is a market
into which the particular branch of manufacture
of the country in question has not previously
entered, whether or not this market has existed
before.
 The conquest of a new source of supply of raw
materials or half-manufactured goods, again
irrespective of whether this source already exists
or whether it has first to be created.
 The carrying out of the new organization of any
industry, like the creation of a monopoly position
(for example through trustification) or the
breaking up of a monopoly position.

Diffusion
 It is the spread of a technology through a society or
industry.
 The diffusion of a technology generally follows an S-
shaped curve as early versions of technology are rather
unsuccessful, followed by a period of successful
innovation with high levels of adoption, and finally a
dropping off in adoption as the technology reaches its
maximum potential in a market.
 Ultimately, it is only the successful diffusion of
innovations which leads to perceptible and widespread
effects on the growth of productivity or trade
competitiveness and on aggregate economic
performance of countries.

 Models have frequently started from assumptions about
the decision to invest in innovations.
 They have thus attempted to take account of the
availability of information about innovations and the
degree of perceived risk.
 When an innovation appears, adoption is slow because
few potential users know of it and because its
capabilities are relatively uncertain, its purchase
represents a risk.
 As time passes, more potential users come to hear of
the process and the experience of the initial users
becomes known through the industry, so reducing the
risk to buyers.
 In these conditions, diffusion proceeds more rapidly.

 As sales approaches saturation, the number of
non-users falls with the effect that pace of
diffusion slows once more.
 Thus, when the share of output attributable to
a new process is plotted against time on a
graph, the diffusion path will not follow a
simple straight line but rather an S-shaped (or
sigmoid or logistic) curve.

Figure 7.1: The S-shaped logistic curve and
Diffusion of innovation, the Sigmoid Curve

The Role and Sources of Technology
 According to the Austrian economist, Joseph
Schumpeter, technological change was a major
determinant of industrial change.
 Schumpeter believed that the economic cycles in
capitalistic economies, are the result of rule changing
innovations.
 Innovation is a two headed beast: the introduction of
revolutionary products and services by successful
entrepreneurs is the fundamental force driving
sustained long-term economic growth, but destroys the
power of established institutions and organizations in
the short term.
 He named the process of industrial transformation
through radical innovation as creative destruction.

 Robert Solow won the Nobel Prize in large part for
showing how important technology is to economic
growth.
 Most economists in past had thought of growth as
driven by the accumulation of capital, and by other
changes besides technological improvements (e.g.
increased division of labor).
 But, Solow (1957) found that only 12.5% of measured
growth in output per hour worked (in the US economy
excluding farms during 1909-1949) could be attributed
to increased use of capital equipment.
 The rest of the productivity gain was attributed to
improved production practices and equipment
(technological advance in the strict sense) and to
increased ability of the labor force (technological
advance via the skills of workers).

 Even though available figures are very
imperfect, Productivity growth stems in large
part from spending on research and
development (R&D) and other engineering
improvements.
 Figures show that many leading nations of the
world have increased R&D spending over
time, catching up with the US and the UK.
 Differences between countries allowed
industries to become efficient much more
rapidly in some nations than in others.

 Adoption of new corporate structures is a social
innovation, an organizational technological change that
seemingly did yield both higher productivity and
higher rates of other kinds of technological progress.
 Education has been and remains to be fundamental for
workers to have skills used in innovative progress, and
university-industry linkages have been particularly
important in launching some industries such as the
early German chemical and dyestuffs industries.
 Cartel-busting reduces price which yields short-term
benefits, although cartels sometimes retarded
innovation so getting rid of cartels might have yielded
more invention or innovation.
 Research: “University –industry linkage?????”

 Often, the term invention is used to mean:
 the initial creation or discovery of an idea, while
 innovation is used to mean:
 the commercialization of the idea.
 In practice, the innovation part of the work almost
always requires:
 far more money, and
 far more work by scientists and engineers than the initial
invention.
 For example, the discovery of penicillin by an
individual – Alexander Fleming in 1928 – did not lead
to a commercial product until a massive development
program during World War II, when thousands of
scientists and engineers came up with viable, affordable
production methods.

 Large firms, not small firms or independent inventors,
made commercial production of penicillin a success.
 Large firms seemingly dominate commercial
innovation more than initial invention.
 And the large firms, not the initial inventors, generally
make most or all of the profit.
• What are the ways to:
 encourage the creation of new products?
 improve the features and quality of existing products?, and
 reduce costs of production?
 As part of finding ways to spur technological
improvement, it helps to know some of the
determinants of invention and innovation

1. Firm size
 Do large or small firms innovate more? Why?
2. Individuals who create innovations
 Do inventions and improvements come from
people within a firm? Or
 do they come from customers, suppliers, or
outside inventors?
 What types of inventions/improvements come
from which people?
3. Regional agglomerations of firms
 How does the local community around a firm
affect that firm’s innovative success?

1. Firm Size and Research and Development
 Technological advance, broadly defined, has been the
primary source of economic growth.
 To stimulate economic growth, therefore, the most
promising policies are any means that yield greater
rates of technological progress.
 There are many means to such innovation including:
transfer of skills between nations, education, social
attitudes that support innovation, and national
R&D funds.
 In the end, of course, what matters is the productivity
improvements within the numerous companies (and
government and non-profit organizations) that compose
a productive economy.

 Studies of innovation by firms have checked to
see whether small or large firms innovate more.
 Joseph Schumpeter, in the 1940s, pointed to the
importance of productivity growth and new
products in driving economic advance, and
argued that the traditional focus on reducing anti-
competitive practices was misplaced.
 In fact, he argued that large firms and
monopolies (by which he also meant oligopolies)
are the primary source of rapid economic
progress!

 By trying to stop anticompetitive practices,
Schumpeter argued, economists and governments
were irreparably damaging the economy!
 Economic growth and the creation of new
products were supposedly being harmed by
governments limiting the power of
monopolists.
 If Schumpeter was right, we could have been
living today in a world with much cheaper prices,
and far more new and useful technologies than
exist, if past governments had been supportive of
large corporations and monopolies.

• Why might bigger or smaller firms tend to do
more R&D? To begin answering the question,
consider some of the factors that affect how
much R&D a firm does:
Technological opportunity: In different
industries or product markets, there are different
amounts of opportunity to create important new
technologies.
For example, there seems to be more
technological opportunity today in the
biotechnology or software industries than in the
cloth manufacturing industries.
Technological opportunity is sometimes known as
a “technology push” factor.

 Demand for technology: Regardless of
technological opportunity, progress may slow
when there is little economic demand for a
technology.
 For example, with the switch from horse and
carriage travel to automobile travel, the
development of new patents related to horseshoes
plummeted.
 (A horseshoe is a U-shaped metal bar nailed to
the bottom of horses’ hooves, so that the hooves
don’t wear out).
 People’s willingness to pay for a new technology
is sometimes known as a “demand pull” factor.

Appropriability: Can firms “appropriate” the
monetary returns to R&D? One of the
Webster’s dictionary definitions for
appropriate is: “To set apart for, or assign to, a
particular person or use, in exclusion of all
others…”
If patent rights are strong, both small and
large firms should be able to appropriate the
returns to R&D, i.e. capture the profits that
could come from the inventions and
innovations created during the R&D.

If patent rights are weak, either (1) other firms
copy the invention or innovation; (2) other firms
develop minor variations of the new technology
and patent the variations instead, thus “patenting
around” another firm’s patent and continuing
down the path of development; or (3) large firms
with strong investments in the technology can
maintain dominance by having large numbers of
patents and copyrights, and by defending them
legally, so that new firms are kept out of the
market and find it impractical to develop new
technologies.
Availability of financing: Do firms have enough
money to fund R&D?

 Absorptive capacity: Do firms have the capacity to
“absorb” information about new technologies
developed in other firms or by academic researchers?
 The extent to which a firm has the relevant R&D
personnel and other resources needed to absorb new
technologies from outside the firm is called its
“absorptive capacity.”
 Incentives from cost-spreading: Consider two firms,
producing 100 and 10,000 automobiles per year
respectively.
 Suppose a project to design a new production machine,
thus cutting production cost per car by Birr 1, costs Birr
10,000.

For the smaller firm, the project would not be
worthwhile, because it would take 100 years
of producing 100 cars per year to pay back the
development cost of Birr 10,000.
 But for the large firm, the project pays for
itself in one year, and in future years saves Birr
10,000 per year.
 Thus, the fixed cost of R&D may be spread
over the number of units sold, giving an
advantage to larger firms.

 In addition to which firms do more R&D, with
empirical data it helps to ask why some firms
may seem to do more R&D.
 In particular, a firm’s:
 “propensity to patent”, or
 relatedly its potential to publish the results of
R&D, influences how much it seems to do R&D.
 In some industries, firms need to patent a lot,
whereas in other industries it makes more
sense to keep R&D results secret.

 Also, different firms may have managers who are
more or less keen on patenting or restrictive about
publishing.
 Larger firms tend to have more incentives than
smaller firms to improve and streamline existing
technologies.
 Hence, large firms often pursue large numbers of
minor improvements to products and
manufacturing processes.
 If an invention comes from smaller firms,
commercialization (or “innovation”) still takes a
lot of effort, which may be carried out with help
from larger firms.

 But, what does the empirical evidence on firm
size, industry concentration, and R&D look
like?
 Some of Schumpeter’s notions were labeled
“the Schumpeterian hypothesis” by other
economists.
 In particular, the Schumpeterian hypothesis is
that larger firms are better at producing
innovations than small firms.

 The notion is that, if the hypothesis is right, the
values of [(R&D spending or output) / (firm
size)] should be bigger for larger firms.
 The name “R&D intensity” is used to mean
(R&D spending) / (firm size), since firms with
higher values are in a sense doing research and
development more intensively.
 Different studies found that bigger firms tend
to have bigger R&D budgets and more R&D
results (such as patents).

 The real question they posed was, however,
whether R&D intensity increases with firm
size.
 It turns out that R&D intensity varies a lot from
company to company for reasons that seem to
have little relation with size.
 Specifically, most of the variance in companies’
R&D/size measures can be attributed to variables
other than size.
 Characteristics of particular industries, such as
the nature of the technology and its
appropriability, explain much of the variance.

• specifically, above a low threshold in size,
R&D intensity seems to be roughly constant
regardless of firm size.
• Similarly, in more concentrated industries
(which typically have bigger firms), there tend
to be higher R&D budgets, but there is little
relationship between industry concentration
and R&D intensity, and R&D intensity seems
roughly unrelated with industry concentration

 Finally, it was found that the R&D output of firms per
unit of size actually seems to decline with firm size!
 For example, the number of patents produced each year
per employee in a company or per Birr spent on
research actually seems to be smaller in the bigger
companies!
 Thus, it seemed, perhaps the bigger companies are
actually less efficient than the smaller companies!
 With this sort of empirical evidence, many researchers
took the view that Schumpeter’s notions were wrong,
and small companies are better sources of R&D.
 Even people who had originally been champions of the
Schumpeterian view (such as Mike Scherer) seemed to
adopt this view.

• While larger firms may do more research than
smaller firms, this may not apply to case like
where firms can appropriate returns to
innovation, or where firms can rapidly expand
to any amount of output.
• Is such cases, small firms would be expected
to have the same incentive as large firms to do
R&D.

Other Determinants of R&D
• Lots of issues are more important than size in
determining which firms innovate more.
1. The industry in which firms participate:
Suppose you compare the aerospace industry
versus the soft drinks industry.
 It’s no surprise that aerospace firms have
bigger R&D budgets, in absolute terms or as a
percent of sales or profits, than soft drink firms.
2. The culture of the firm, how it’s organized,
and the skills of people in the firm: Some firms
have a belief in being technology leaders, while
others pay more attention to costs or marketing.

 Some firms involve factory workers in
coming up with ideas to improve the
production line, while others separate the jobs
of their engineering staff and line workers.
 Some firms have executives, scientists, and
engineers with the necessary skills to succeed
with a technology; others don’t.
 Consider firms in the same industry with
similar culture, organization, and employee
skills. Among these firms, large size seems
beneficial for some types of innovation:

a. Firms with large market shares seemingly have
the advantage for the many incremental changes
that improve a product and reduce its
manufacturing cost.
b. Small firms, however, are relatively free of
bureaucratic problems and incentive problems
that may get in the way of major inventions.
 The managers of large firms are often charged
with blocking important inventions that have
little to do with a firm’s existing products or
markets, or especially those that would replace
the firm’s existing products, because they want to
focus on what the firm already does.

• Economists have discussed some of the issues
that help to determine which firms and
individuals are the sources of invention.
 The conclusion from various case studies is
that major inventions come from many sources
– large firms, small firms, and individuals.
Thus, it would be wrong to think that large
firms are necessary for invention to occur.
2. Individuals who Create Innovations:
• The ideas for an invention or innovation often
come from outside the firm that puts the
innovation into practice.

 Thus, a firm’s contacts with customers and
suppliers, and its openness to ideas from those
sources, may influence its rate of innovation.
 Also, of course, the specific individuals
involved in companies help determine how
successful a company can be at innovation.
 Some of the economists who analyzed the
sources of innovation (and invention) found
that often the ideas for innovations came not
from the company that put the innovations into
products, but from customers or suppliers of
the company.

 An important concept in theories of industry
concentration is that of heterogeneity between firms.
• The term heterogeneity simply means differences,
which could involve differences in size, research skills,
managerial capabilities, etc.
• Some theories assume that heterogeneity in terms of
the capabilities of managers and of
engineers/researchers remains fixed over time, that is, a
rating could be assigned to each firm when it starts up,
telling how good that firm is in terms of the capability
of its personnel, and the rating remains over time.
• Such fixed heterogeneity of personnel can explain some
interesting facts about industrial competition.

3. Regional Agglomerations of Firms:
 A regional agglomeration occurs when firms
locate near each other.
 Agglomerations might have many advantages
for the success of companies at R&D and at
competition more generally.
 Nearness by itself, however, may not
guarantee an advantage.

 Some of the characteristics that seem to be
necessary for regional agglomeration to give an
advantage include:
– Openness and ease in interchange of ideas among
engineers and managers;
– Readily available start-up money, especially from
previously successful entrepreneurs; Close
involvement and assistance from investors;
– Close links between university research and
educational programs;
– Firms working closely with local government and
volunteering executives’ time to try to resolve regional
problems;
– Cooperation among firms particularly when special
needs arise; etc.

 There are agglomeration economies related to
innovation.
 For instance, cities with diverse economies
may tend to grow, whereas cities focused
primarily on a single industry may stagnate if
the single industry ceases to grow or collapses.
 Diverse economies have more ability to spin
off new kinds of business when profit
opportunities exist.

 Cities with diverse economies may be an especially
likely and supportive environment for spin-off of new
businesses, because the diversity of businesses makes
available many different skills, ideas, interests, and
resources needed to start many different types of new
businesses.
 Diversity of knowledge and assets allows people to
come up with new business approaches.
 In contrast, if almost all firms in a city were
specialized in, say, cotton spinning and weaving, then it
may be very hard to create new kinds of non-cotton
business when the cotton industry becomes unable to
compete with producers in other nations.

Patents and Patent Protection
 A patent is a set of exclusive rights granted by
a state (national government) to an inventor or
their assignee for a limited period of time in
exchange for a public disclosure of an
invention.
 It usually refers to a right granted to anyone
who invents or discovers any new and useful
process, machine, article of manufacture, or
composition of matter, or any new and useful
improvement thereof.

 A patent is not a right to practice or use the
invention.
 Rather, it provides the right to exclude others from
making, using, selling, offering for sale, or
importing the patented invention for the term of
the patent subject to the payment of maintenance
fees.
 A patent is, in effect, a limited property right that
the government offers to inventors in exchange
for their agreement to share the details of their
inventions with the public.
• Like any other property right, it may be sold,
licensed, mortgaged, assigned or transferred,
given away, or simply abandoned.

 The procedure for granting patents, the
requirements placed on the patentee, and the
extent of the exclusive rights vary widely
between countries according to national laws and
international agreements.
• Typically, however, a patent application must
include one or more claims defining the
invention which must be new, non-obvious, and
useful or industrially applicable.
• The exclusive right granted to a patentee in most
countries is the right to prevent others from
making, using, selling, or distributing the
patented invention without permission.

• Patents are legal instruments intended to
encourage invention by providing a limited
"monopoly" to the inventor (or their assignee)
in return for the disclosure of the invention.
• The underlying assumption being invention is
encouraged because an inventor can secure
exclusive rights, and therefore a higher
probability of financial rewards in the market
place.

 The publication of the invention is mandatory to
get a patent.
• Keeping the same invention as a trade secret,
rather than disclose by publication, could prove
valuable well beyond the time of any limited
patent term, but at the risk of congenial invention
through third party.
• Some research suggests rather than encouraging
invention, patents can hinder development,
lower R&D investments, and decrease overall
economic output.
• In these models, collaboration and information
sharing has a strong impact on new product
development and innovation.

• In most modern nations, there is an established system
for protecting intellectual property, the product of a
person or company's originality and creativity.
• The broadest protection of this sort is the copyright.
• Copyrights are intended to protect "original works of
authorship" that are in a tangible form.
• This includes paintings, books, movies, choreographed
dances (if the steps are written down), music,
architecture and all other sorts of art.
• For a set length of time, these works cannot be copied
or reproduced without the copyright-holder's
permission.

• Copyrights do not protect the ideas put forth by a
particular piece of art; they only protect the way
in which those ideas are presented.
• In the United States and many other countries,
any original work of authorship is automatically
copyrighted as soon as it is created.
• Other sorts of intellectual-property protection are
much narrower in scope.
• Trademarks protect designs and phrases that
businesses use to distinguish their product from
other companies' products, and trade secrets
protect proprietary information that must be kept
secret in order for a business to profit (the recipe
for Coca-cola, for example).

• Of all of the forms of intellectual-property
protection, patents are the most complex and
tightly regulated.
• Patents are basically copyrights for inventions.
Unlike copyrights, patents protect the idea or
design of the invention, rather than the tangible
form of the invention itself.
• Consequently, patenting something is a much
trickier procedure than copyrighting
something.

• Thank you for your attention
@ being an economist in all
your journey!!!

Industrial Economics Lecture 8.pptx

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