This document discusses the productivity puzzle and proposes that a lack of strong dynamic capabilities in firms and ecosystems is a contributing factor. It begins by defining productivity, competitive advantage, and the productivity puzzle. It then contrasts ordinary capabilities focused on efficiency with dynamic capabilities focused on innovation, sensing opportunities, and transforming. The document argues that dynamic capabilities are more important for competitive advantage and productivity growth in knowledge-intensive industries. It also discusses how clustering and regional innovation ecosystems can foster dynamic capabilities and knowledge spillovers. The conclusion is that focusing only on neoclassical views of productivity is too narrow and that entrepreneurship, dynamic capabilities in firms, and supportive ecosystems and governance need to be central to understanding and addressing the

1. The Productivity Puzzle:
Insights from the Dynamic
Capabilities Framework
David J.Teece
UC Berkeley
TusherCenter for the Management of Intellectual Capital
27 September 2017
2017 Babbage Symposium
Cambridge, England
1

2. TABLE OF CONTENTS
I. Introduction
II. The Capabilities Perspective
III. Knowledge intensity & dynamic capabilities
IV. Geography matters too
V. Conclusion
2

3. I. INTRODUCTION
3

4. Productivity & competitive advantage on
related but conceptually distinct
■ Productivity: A measure of output per unit of input
■ Competitive Advantage:The ability of a business to achieve
growth and profitability long-term
4
Highly productive firms may or may not have competitive
advantage & vice-versa

5. What is the productivity Puzzle?
■ Unexplained decline in the growth of productivity over the last
30+ years, especially since GFC
■ Associated wage stagnation
5

6. Two classes of views on productivity
puzzles
1. Reflects transient changes in demand from the GFC… slow
adjustment of capital & labor markets etc.
2. Reflects Persistent or structural, changes including greater
uncertainty and unwillingness to innovate or invest
– Conjecture:What is missing are strong firm-level dynamic
capabilities & associated entrepreneurial management, the
absence in which is due in part to public capital markets and
governance rules which limit the ability of managers to take
the long view and invest accordingly
– This conjecture is consistent with Lazonick’s “ProfitWithout
Prosperity” thesis
6

7. The Productivity/Innovation Nexus is
critical
 Productivity is aided by:
a. Product Innovation which increases demand for the
firms product
b. Process Innovation, which leads to efficiency gains
c. Business Model Innovation which improves the value
proposition to the customer and can also assist the
innovating firms in value capture activities
7

8. Increasing regulation has structural
impacts on productivity too
Growing importance of the service & public sectors with many
“unproductive” activities (i.e. dead weight or near dead weight loss
activities)
 Legal services
 Policing
 Security guards
 Cyber crime experts
 Compliance offices & monitors
 Higher extraction prices for oil & gas (where fracking not
possible) & other minerals (e.g. lithium)
8

9. Productivity is Impacted by Flexible
Resource Allocation*
■ Economic theory suggests that more productive companies are
more able to attract resources relative to less efficient
■ Exit of less efficient firm presumably improves total factor
productivity (TFP)
■ A substantial body of literature demonstrates the importance
of flexible resource allocation to productivity but don’t ask
why poor resource allocation decisions are being made
■ Flexible wages impact productivity**
*Bartelsman et al, 2013; Restucci & Rogerson, 2013
**Blundell,Crawford, & Jin, 2013
9

10. Resource mis-allocation issues:
■ Misallocation of resources occurs if there are impediments to the
movement of resources between & amongst firms & sectors and if the
short run is favored over the long run
■ Restraints on investment by more productive firms can slow the process
of economy wide resource allocation.
– Uncertainty can lead firms to delay investment decisions because
capital investments are often irreversible
– Higher uncertainty reduces firm responsiveness to demand shocks*
■ Disney et al (2003) showed that during the 1980’s & 90’s, industry
“restructuring” (entry, exit, changing market shares of the firm),
explained around 50% of UK productivity growth in manufacturing
*Bloom et al (2007)
10

11. Is resource allocation getting stodgier?
■ A large part of persistent weakness in UK productivity is
accounted for by the fact that the proportion of firms with
shrinking output & flat employment has increased
■ Since the GFC, a large part of the shortfall on labour
productivity is due to slower resource reallocation across firms
(A. Barnett, AdrianChin, et al 2014)
11

12. Productivity of firms that die is lower than
that of existing and new firms
12
Proportion of firms that exited and entered the market Productivity level by age

13. Within-firm productivity of surviving firms
is the most important driver of aggregate
productivity growth
13
Decomposition of annual labour productivity growth

14. Are we asking the question the right way?
■ Does framing industrial policy issues as productivity issues
distract us from more fundamental considerations?
■ Is productivity the right goal for industrial policy?
■ Focusing on one or another form of traditional productivity
analyses deflects attention from entrepreneurship and
innovation
*John Sutton London School of Economics 2012
14
“The proximate cause [of differences in wealth of
nations] lies, for the most part, in the capabilities of the
firm”*

15. II. THE
CAPABILITIES
PERSPECTIVE
15

16. Staying on top is harder
16

17. 17
OrdinaryCapabilities bring “best practices”,
but “best practices” don’t suffice to bring
competitive advantage
 Routines / standard operating procedures are key to ordinary
capabilities
 Ordinary capabilities reflect technical efficiency in operations and
administration
 “Best practices” reflect strong ordinary capabilities, but are the
smaller part of the “productivity” story
 Imitation by rivals is enabled by
 More information in the public domain
 Better business school training
 Management consultants
 The result of rapid imitation and deeper uncertainty is that staying
on top is harder and innovation & entrepreneurship is even more
critical

18. 18
Dynamic Capabilities (which require more than
best practice) help grow a firm’s profitability &
secure competitive advantage & associated
productivity growth
“The ability of an organization and its management to integrate, build,
and reconfigure internal and external competences to address rapidly
changing environments” (Teece et al., 1997: 516)
High-order capabilities are more strategic & can be thought of as falling
in three categories:
Sensing
Identification of
opportunities &
threats at home
and abroad
Transforming
Continuous renewal
and periodic major
strategic shifts
Seizing
Mobilization of
resources to
deliver value and
shape markets

19. Firm growth requires dynamic capabilities
■ The importance of sensing and seizing is now reflected in
mainstream economics where “demand differences” are shown to
impact marketplace success
■ A recent empirical study concluded that “virtually all firm growth
can be attributed to firm appeal”
■ “Appeal” references a shift in demand, whether from innovative ne
products or simply a change in consumer preferences
C.Holtman et al, “Quantifying the Sources of Firm Heterogeneity”, QJE, (2016)
19

20. Copyright Teece 2015
Ordinary capabilities are widely diffused amongst leading firms:
The operations portion of the automobile business has been thoroughly
optimized over many decades, doesn’t vary much from one automobile company
to another, and can be managed with a focus on repetitive process. It requires
little in the way of creativity, vision or imagination. Almost all car companies do
this very well, and there is little or no competitive advantage to be gained by
“trying even harder” in procurement, manufacturing or wholesale.
Competitive advantage requires dynamic capabilities:
Where the real work of making a car company successful suddenly turns
complex, and where the winners are separated from the losers, is in the long-cycle
product development process, where short-term day-to-day metrics and the
tabulation of results are meaningless*
*Bob Lutz, former vice chairman at General Motors, Wall Street Journal, June 11, 2011
From OrdinaryTo Dynamic Capabilities In Autos

21. • Strategic “fit” over the long run
(evolutionary fitness)
• Sensing, seizing, shaping and
transforming
• Difficult ; inimitable
• Competitive advantage
(high profits, wages, & growth)
• Efficiency in basic business
functions (“technical fitness)
• Operational, administrative,
and governance
• Relatively easy; imitable
• Competitive weakness
(low profits & wage stagnation)
Ordinary
Capabilities
(Best Practice)
Dynamic
Capabilities
(Best Strategy)
21
OrdinaryVs. Dynamic Capabilities
Purpose
Tripartite
schemes
Imitability
Outcome

22. Key talent implications
■ Strong ordinary capabilities requires technicians, good
engineers, and financial analysts
■ Strong dynamic capabilities requires creative engineers,
designers, entrepreneurs, leaders, plus a governance system
that allows them to succeed
22

23. III. KNOWLEDGE
INTENSITY &
DYNAMIC
CAPABILITIES
23

24. Dynamic capable firms are likely
knowledge intensive
■ Inter-firm inequality (in employee compensation) has become
greater and more persistent as firms sort themselves into
knowledge intensive and labor intensive firms*
■ Inter-firm differences amongst firms are becoming more
persistent**
*Bloom 2017
**Furman & Orszag, 2015
24

25. Innovation & entrepreneurship drives
productivity growth, even more so in the
knowledge economy than in the industrial
economy
25
Industrial Economy Priorities Knowledge Economy Priorities
Raw Materials Natural Resources, Labor,Capital Ideas, Intellectual Capital
Customer Focus Mass production Mass Customization based on
information technology and
product design
Organization Large corporations, economies of
scale
Entrepreneurs, small scale, free
agents, networks
Success Factors Labor, quantity, low cost, stability,
control, R&D
Talent, speed, innovation,
entrepreneurship, flexibility,
customization, R&D, business
model innovation

26. Digitization and the sharing economy
may have an impact too
■ There has been an explosion of digital services on the internet
(Google,AirBnB, Uber). The value of these innovations is
difficult to assess and quantify
■ Consumers get more out of the same…un-measurable
productivity increase?
■ The best firms continue to do better
■ Revenue per employee (labor productivity) explodes with the
winners
26

27. 27

28. IV. GEOGRAPHY
MATTERSTOO
28

29. Regional differences also help provide
clues
■ Why does geography matter?
■ Proximity/colocation helps creativity and innovation
■ Clustering is therefore important to productivity
■ What can we learn from Cambridge economists of the past?
29

30. Innovating Firms tend to cluster
I. Definition of Clusters:
• Geographic concentrations of a critical mass of
interconnected companies and supporting institutions
• Shared advantages through aggregation of expertise and
specialized resources
II. Dynamics inside of Clusters:
New firms constantly being launched (e.g. Facebook,Twitter)
Rapidly growing mature businesses (Google,Apple)
Reinvention of mature companies (IBM, Intel)

31. 31
Intellectual heritage of clusters analysis can
be traced back to Cambridge
■ 19th century Cambridge economist
Alfred Marshall remarked upon the
“concentration of specialized
industries in particular localities”*
*Alfred Marshall, Principals of Economics, 1890
Alfred Marshall

32. 32
Marshall: “GREAT ARETHEADVANTAGESWHICH PEOPLE FOLLOWING
THE SAME SKILLORTRADE GET FROM NEIGHBORINGTO ONE
ANOTHER” (1890)
Elements:
• Ready availability of skilled labor
• Growth of supporting and ancillary trades
• Specialization up & down the value chain
• Knowledge spillovers: Benefits aren't priced and are in one sense “free” to
all firms located in the cluster… spillovers drive productivity for all
Perhaps there is also a “manufacturing commons”*
*Pisano & Sheih
The pillars of Marshallan type clusters reference
“External Economies”

33. Components of a (modern) Cluster of
Innovation

34. Low likelihood of vibrant clusters
Strong Regional
Clusters
Strong Firm-level
Dynamic Capabilities,
resources, and
entrepreneurship
Strong National
Systems of
Innovation
Medium likelihood of vibrant clusters
High likelihood of vibrant clusters
Foundations of Innovation Enhancement
& Productivity Improvement

35. 35
Examples of Clusters
 Chemical clusters in Germany and German speaking Switzerland
 Silicon Glen, Scotland
 Cambridge cluster in healthcare, life science, and IT & computer services
& design
 Pharmaceutical cluster straddling Pennsylvania
 Wine cluster in Napa & SonomaValley in California
 Financial services clusters in London & NewYork
 Super yacht clusters inAuckland, New Zealand &Via Reggio, Italy
 Boston Route 128 electronics & biotech cluster
 Electronics, internet biotech & high-tech cluster in Northern California
(“SiliconValley”)

36. The Birth of Clusters… Getting Started
 Clusters of innovation emerge from a continuous process of
technology commercialization:
 Clusters result from start-ups, and the continued growth and
metamorphosis of more mature businesses
 High velocity of business activity is a characterization of a dynamic
cluster
 Cities and clusters grow because learning is facilitated by close
interaction and information exchange
 Entrepreneurs are key drivers
 These issues are not yet tied into the productivity debate

37. Pillars of an Innovation Cluster
■ Entrepreneurs
■ Established Companies
■ Universities
■ State of Mind/Culture
■ Linkages
 Venture Capital
 Service Providers
 Management
 Government

38. 38
Entrepreneurs
• Effectuate “new combinations”
Schumpeter, 1943
• “Pursue opportunities beyond the resources
they control”
Stevenson, 1974

39. 39
Why does “SiliconValley” succeed? strong
ecosystem exists & continually re-invents
itself!

40. Largest “SiliconValley” Firms
1982
1. Hewlett-Packard
2. National Semiconductor
3. Intel
4. Memorex
5. Varian
6. Environtech*
7. Ampex
8. Raychem*
9. Amdahl*
10. Tymshare*
*no longer existed in 2002
2002
1. Hewlett-Packard
2. Intel
3. Cisco*
4. Sun*
5. Solectron
6. Oracle
7. Agilent*
8. Applied Materials
9. Apple
10. Seagate Technology
Also: Maxtor*, Palm*,Google*,
Cadence*, Adobe*,Yahoo*
*didn’t exist in 1982
2012
1. Apple
2. Hewlett Packard
3. Intel
4. Cisco Systems
5. Google
6. Oracle
7. eBay
8. Synnex
9. Applied Materials
10. Gilead Sciences

41. Michael Porter’s (Harvard) most impactful statement was that the
competitive advantage of a nation is:
1. Hardly ever built on inherent factors of production (land, labor,
capital) but on created competitive advantages* and
capabilities**
2. The competitive advantage of nations is not just “created” out of
thin air; the mechanisms of creativity are rooted in firms with
strong dynamic capabilities occupying vibrant ecosystem
buttressed by strong national & regional institutions
*Cohen,Teece,Tyson & Zysman
**Sutton,Teece
“Created” CompetitiveAdvantage drives
productivity

42. V. CONCLUSION
42

43. 43
Dynamic capabilities lie at the core of
corporate success, & corporate success lies at
the core of national competitiveness
1. Strong ordinary capabilities (operations, administration,
governance) are necessary but not sufficient for long-run (financial)
success
2. Strong dynamic capabilities are both necessary and sufficient for
long-run (financial) success
3. Learning is at the core of all capability building
Productivity & enterprise growth depends on management doing the
right things more than doing things right

44. ■ The neoclassical productivity debate is too narrow to properly
inform national and regional productivity
■ Entrepreneurial capabilities (in small & big firms), ecosystem, &
governance issues need to be brought center stage… which will
likely require governance changes
■ A viable Brexit industrial strategy is visible through the lens of
the dynamic capabilities/ecosystem framework
■ Absent a reframing, profits without prosperity will continue
44
Time to reframe the debate