Knowledge, Technology and Economic Growth

Denisa Popescu MGT 397 Searching for the factors that fuel economic growth have long been of interest to economists because the welfare of a country depends on the growth rates of that country. The theoretical basis for the role of technological change and knowledge in economic growth comes from economics where different frameworks have analyzed this relationship. Neoclassical economics and alternative theories, such as new institutionalism theories vary in their perspectives to the contribution of knowledge to economic development, as primary characteristics of knowledge and foresight attributed to individuals. This paper tries to touch upon the underpinning issues in the New World Economic System. The restructuring of production has reintroduced technology and knowledge into the heart of the international order. Therefore, new ways of regulating economies and societies were gradually being implemented in developed and developing countries. In short, the inducement of technology and knowledge place the economic development paradigm back on the drawing board.

Introduction For many yeas, classical and neo-classical theories have been provided one solution-fits all to governments all over the world. The ready-made package of an orthodox economic approach" had advocated a certain core set of reforms as essential in a rapidly globalizing worldminimum standards of macroeconomic stability, liberalization of trade and exchange, and privatization. During the 1980s and 1990s, most developing countries implemented these adjustment policies aimed towards creating new economic opportunities, so that they could share the benefits of globalization. Many lost their jobs and almost their entire life-savings only because the market knows better. The results were disappointing and many observers started wondering about the success of the restructuring programs built upon neoclassical economics and the role of international organizations in reinforcing this ideology. If before, governments in order to build competitive advantage had to restructure their economic fundamentals, e.g., downsizing public sector to satisfy austerity measure, now the core competency for governments centers on the role of knowledge and technology in order to improve the efficiency, competitiveness, and responsiveness of their governments, and hence their democratized governmental institutions.

The traditional approach to economic growth based on the neoclassical economics theory defined Land, Labor and Capital as the key input factors of the economy. Joseph Schumpeter added Technology and Entrepreneurship as two more key input factors that account for a shift in the production function in the early 20th century, moving away from the static approach of Neoclassical Economics. . In the late 20th and the beginning of the 21st century, numerous scholars and practitioners such as Peter Drucker, have identified knowledge as perhaps the most important key input and output factor of economic activity: knowledge is the only meaningful resource today (Drucker, 1993). Recent contributions include Prahalad (1998) that identifies learning, knowledge sharing, and technology integration as three core competencies of todays organizations. Gummesson (1999) asserts that in today competitive environment, knowledge develops into becoming the core driver of competitiveness.

Neoclassical Economics Paradigm The simplest definition of economic growth is an increase in the nation's capacity to produce goods and services. Economic growth, therefore, occurs whenever people take resources and rearrange them in a production process in ways that are more valuable. A useful metaphor for such a rearrangement of production in an economy comes from the kitchen. To create valuable final products, we mix ingredients together according to a recipe. The cooking one can do is limited by the supply of ingredients, and most cooking in the economy produces undesirable side effects. If economic growth could be achieved only by doing more and more of the same kind of cooking, we would eventually run out of raw materials and suffer from unacceptable levels of pollution and nuisance. Human history teaches us, however, that economic growth springs from better recipes, not just from more cooking.1 However, theoretical perspectives and practical experiences have not converged on what these better recipes are supposed to be. On the one hand, theoretical perspectives by their nature are highly partial. Moreover, given the paradigmatic boundaries of mainstream economics, it is assumed that the quantitative static of economic growth is synonymous with the processes of economic development. Problems and questions relevant to various impacts of technology on economic productivities, education and employment, and dynamics of institutional adjustment among others, are kept outside the boundaries of analysis and policy formulation. On the other
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New recipes generally produce fewer unpleasant side effects and generate more economic value per unit of raw material (e.g., natural resources).

hand, in terms of practical experiences, the wide variations in history, politics and other distinct characteristics of nations are the main reasons behind failures that reside in an orthodox growth type. As a result, there is currently a good deal of discussion about the need to revise the mainstream "neoclassical synthesis and theories of economic growth: Since 1975, the neoclassical synthesis has been fighting over survival" (Blanchard, 1987:636). My main concern is confined to neoclassical growth theory itself where the siege is being directed by neoclassical economists themselves, namely, the static nature of production function.2 The origin of this issue can be traced back to the observation by Robert Solow, which indicated that some 87 percent of production was unaccounted for by simple increases in factor inputs, namely labor, capital and land (Sollow, 1957). Since his observation, the part of growth that cannot be explained is called the Solow Residual or the growth of total factor productivity (TFP).3 To solve the TFP problem, he sought explanations elsewhere and proposed to address the "residual of our ignorance" through the introduction of the "exogenous" force of technological change. To make practical experience fit into the picture, he also assumed (beside an exogenous technological change) equal technological opportunities across different countries. Over time, according to neoclassical economics, all countries will achieve convergence between the levels of per capital income between different countries. This happens because identical technologies across countries are readily available. To make the exogenously of technology fit, Solows theory made a giant frog leap over practical issues by assuming that there is an inverse relationship between the capital-labor ratio and productivity of capital. This simply implies that poor countries with small amounts of capital per head can grow at a faster rate than rich countries which possess large amounts of capital per head. Solow's contribution, however, presented not a solution, but rather an intensified contention. Critics of Solow's framework sought to make technology endogenous to the growth process. Prominent economists, interestingly from the neoclassical school such as Maurice Scott, and Robert Lucas among others, began to work out the solution. In an excellent review of the literature, Maurice Scott engages in an academic refute of previous theories (Scott, 1989). Rather
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In the most conventional form, production is defined as a function of three factors, namely, Land, Capital and Labor. All other factors become irrelevant. Moreover, capital is not defined clearly; that is, it is physical capital or financial capital that is involved in the production function. 3 TFP is defined as the difference between output growth and the (share-weighted) growth rates of capital and labor inputs.

remarkably, Scott writes:". . . the whole mistake by the orthodoxy is to apply a comparative static analysis to a dynamic situation and to throw the whole of the resulting error into the black box labeled 'technical progress'"(Scott, 1989: xxxiv). To overcome Solow's analytical error, Scott "abandons exogenous technological progress and the aggregate production function"(Scott, 1989: 146). To make technological change endogenous to the system, Scott relies heavily on gross investment and technological progress as one and the same thing. From this it follows that the technological change in Scott's model relates to "undertaking investment which itself creates and reveals the further opportunities"(Scott, 1989: xxxiii ). Nevertheless, in-depth and explicit discussions of technological change are avoided. The void is especially apparent in the lack of any discussion of the socioeconomic origins and consequences of technological change, problems of accessibility to technology and more importantly, the role of technology in the production process and consequently the development of a nation. In short, conventional analysis obfuscates the role of technological change in the overall process of economic evolution, which includes the dynamics of economic transformation. Perhaps the problem with the neoclassical approach resides in the overriding obsession with model building. As Scott concedes, the complexity of the real world may be such that the attempt to portray it by a model simple enough to have analytical solutions, or diagrammatic solutions, is foredoomed to failure"(Scott, 1989: 127). Indeed, one of the main problems with neoclassical theory is the fact that it ignores the timedependent production function for technological advances. Some have proposed new theories, i.e. the New Institutional Economics (hereafter NIE4) as an alternative to the world portrayed by neoclassical economics. New Institutionalism Economics (NIE) Part of the problem with the neoclassical approach is the partiality of conventional wisdom. Indeed, scholars who were outside the academic norms such as Schumpeter pointed to different directions. Actually, it was Schumpeter (1934) that articulated the important role of entrepreneurs and technology for both economic development and knowledge diffusion. In a market-orientated economy, economic development is based on firms ability to gain and
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The NIE includes several streams, principal among them Coase and North institutionalism theory, the endogenous growth theories (or New Growth Theory) of Romer , the evolutionary theory of Nelson and Winter, the transaction costs economics of Oliver Williamson. .

maintain competitive advantage in market. Especially in a developing country, the entrepreneur has a special role in economic development since knowledge diffusion becomes an important process for development with acquiring industry-specific knowledge through learning by doing.

All NIE-related theories recognize that knowledge is imperfect and assumes bounded rationality and strong uncertainty. NIE theorists relate economic growth to increasing returnswhere the more production occurs, the greater is productive efficiencyand to technological progress where advances in science and knowledge are what drive economic growth. The core argument is that induced production of innovative knowledge that depends on research and development and building up experience through learning earning by doing is a mechanism that causes income divergences between rich and poor countries. According to NIE, it is not necessary that income per capita will converge across world economies like neoclassical theory has concluded.

Core to the increasing returns paradigm is the concept of knowledge and technology are being regarded as any other capital good, not just as an exogenous factor to the economic and social system, i.e. market externalities. Increasing returns means that where more production occurs, the greater is the productive efficiency (Romer, 1994). The best example provided by the literature and practical experience is related to the production of software. While the initial costs of producing software are usually high due to research and development investments, the costs per unit are low. Moreover, network-effects, relating to the consumption of a particular good, occur whenever the benefits of consuming that good depend positively on the number of individuals who do so. Network-effects are an example of increasing returns to scale because of the characteristics of knowledge that differentiate it from other factors of production: non-rivalry and non-excludability. The non-rival aspect of the knowledge means that it can be shared by many people without diminishing the amount available to other consumers. Thus, knowledge can be applied and shared by anyone without losing its value unless there are barriers such as absorptive capacity or patents. This also explains the non-excludable characteristics of knowledge, where as long as the producer of knowledge is not willing to enforce intellectual property rights, he cannot prevent non-payers from using it. Langlois (1994) argues that unlike the neoclassical theory that perceives production as a matter of combining inputs according to known blueprints, the NIE sees the economic activity as requiring skills and organizations where economic actors must struggle with the limitations to human

knowledge such as the tacit aspect of knowledge as described by Michael Polanyi. Let me explain. The neoclassical growth theories emphasize the role of individuals as optimizing agents with unlimited ability to collect and process information. In the neo-classical world, exchange of goods is voluntary transactions between large number of independent, fully-informed agents that act upon their profit-maximizing behavior with no barriers to entry or exit into the marketplace. Thus, the neo-classical result of efficient market can be achieved when negotiation among individuals is costless, particularly, since individuals behaviors are bounded by the postulate of instrumental rationality which reinforced the notion that parties can realize the gains from an exchange of goods and services in a market place. NIE maintains the fundamental assumptions of scarcity and competition as the fundamental element of exchange but looks at the institutions to provide the rules and routines for the developing of strategies, by inducing co-ordination and also cooperation among economic agents (North, 1995). The NIEs power of persuasion lies on the fact that it partially abandons the neo-classical assumption of instrumental rationality and rely on institutions to reduce uncertainty that most likely occurs in the absence of informational requirements and institutional arrangements by establishing a stable structure for human interactions. The consequent of refutation of instrumental rationality lead to the conclusion that individuals perception of real world is imperfect, and there is a limited capacity by which to process information, the so-called bounded rationality. To correct such an insufficiently one requires better, and more accurate information to eliminate uncertainty in economic exchange. In retrospect, development processes do not take place in a vacuum but rather have profound institutional and cultural roots. As Douglas North stated, the central issue of economic history and of economic development is to account for the evolution of political and economic institutions that create an economic environment that induces increasing productivity (North, 1992: 98). More over, economic agents are not perfectly rational actors due to the limited information which they have, and due to their limited data processing and communication capacity. In this respect, economic agents must make decisions within that organizational and institutional environment, and of course they do not always conform to the theoretical prescriptions of conventional economic models. Thus, in my opinion, the NIE is a most suitable theory in the context of the current global economic situation since perfectly competitive market conditions are not reflected in the real world.

Conclusions As for other areas for future research, I have tried to identify a variety of useful studies that could be undertaken. First, we should note that the new concepts developed by NIE have proved most valuable to our understanding of the nature and policy implications of what has come to be called the knowledge economy. However, there is a need to further develop empirically relevant NIE models that can be used in policy-making. One of the arguments made in favor of neoclassical economics is that they have simplified the real world in return for the ability to empirically predict the future states of a system. Also, there has to be more convergence of the two views, so that the development strategies are based on a more realistic view of the economy that its operation and functioning are flexible, less ad hoc, and more adaptable to the changing global environment. The performance of such an economy can lead to the reduction of wasteful process, improve national capacity, increase learning, reinforce networks and promote cooperation among the actors. The generation of new forms of economic governance through more flexible and adaptive institutions leads cities, countries and regions to optimize their competitive advantage and thus simulate economic growth.

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