Innovation and the conditions for growth

September 24, 2015 0 By Gaetano Intrieri

Basically, there are two different approaches to innovation in the economy: the microeconomic and the macroeconomic approach, the first focuses innovation in relation to the company, while the second is concerned with studying how innovation affects the welfare of a country economic system. Generally, the second approach is the resultant of the first.

Innovation in Microeconomics

Before introducing the concept of innovation in the enterprise world, it is necessary to consider the numerous definitions that different economist schools have attributed to the enterprise concept. According to the Neoclassical school idea, although with different interpretations, in enterprise concept there is a constant element: the enterprise/market relationship.

Originally, Neoclassical theory defines the company as a production function alternative to the market, with main focus in profit maximization through the transformation of primary production factors (capital and labor) in goods and services. Figuratively, the enterprise is a “black box” which transforms inputs into outputs. What really distinguishes the enterprise from market is the relational structure: market is the place where relationships are equal, enterprise is the place where relations are authoritarian developed in vertical dimension through the “rule of command”.
Over time, the Neoclassical school attenuates the contrast enterprise/market introducing the “theory of transactions” which defines the firm as a production function which owns a contracts set (nexus) between the entrepreneur and the owners of the inputs used by company activities. These contracts are similar to market contracts, and the optimal size of the company coincides with the maximum number of contracts that the entrepreneur can effectively manage.
Furthermore, the neoclassical theory evolution goes beyond the concept of enterprise as a contracts set and it introduces the idea about enterprise as a process of knowledge accumulation to organize its strategies and to achieve its goals.

Joseph Schumpeter, in his “theory of development”, includes the innovation concept with the enterprise definition. He drops out of the neoclassical theory. According to him, the real objective of the company is not to maximize the profit but to introduce innovative elements to compete in a dynamic way in order to differentiate itself from other firms. Profit maximization is the logical consequence of this process. The innovation creates differentiation from competitors and, ceteris paribus, an innovation oriented company, changes his being “price taker” and meantime it approaches oligopoly or monopoly structures to the market. Indeed the neoclassical conception of perfect competition fails.
Successful innovation is when a company can benefit from a new technological knowledge, determined by R&D internal processes. This in turn, implies that the innovative company changes its size threshold and in this regard, Schumpeter introduces the concept of company Optimum Minimum Size (OMS), which is determined by further production volumes due to the consumer demand growth or to lower cost processes. Therefore, successful innovation is not compatible with the structure of small business.
Innovation can materialize as:
– Product innovation: with regard to both totally innovative products (drastic innovation) and products with specific innovative features for which the consumer feel the difference from others of same species;
– Process and /or organizational innovation: it affects production allowing to use input factors more effectively and with regard to the organizational structure, it identifies new allocations of human resources in order to optimize processes;
Each of these modes of innovation affects the profits of an enterprise:
Product innovation increases the quantity sold, and then the market share or even the selling price;
Process and organizational innovation reduce the unit costs of the product.
In general then, the OMS’s increase, in parallel with the growth of the volumes produced, has a positive effect on the scale economies, thereby reducing the exercise fixed costs.
If we thought over a OMS’s steady growth over time, we would make a mistake. Any form of technological innovation, if on one side is fundamental factor on increasing the company size, on the other it makes the market attractive to potential new entrants and this causes the splitting of the quantity demanded which in turn reduces the OMS’s incumbent companies level. By induction, we can therefore say that if the competitive advantage generated by a successful innovation, initially approaches the target market to oligopoly or monopoly forms, the technological progress, over time, leads the market to a perfect competition. Indeed, the perfect competition is not a pre-determined condition as it is stated by neo-classical theory, but rather, as introduced by Shumpeter, it is the evolution of a growth process strictly linked to the innovation concept.

Innovation in Macroeconomics

The improvement of a country (or macro system) welfare, is closely related to growth, namely to the system ability to develop new wealth to maintain the people well-being at levels higher than the “poverty line”. However it is necessary that the growth would be channeled into a socio-economic structure oriented towards a homogenous welfare, this means that the new wealth generated has to be re-distributed fairly. The paradigm: “growth synonymous with wealth”, not always fits with macro systems environment and whereas, one of the fundamental drivers of growth is innovation often defined by technological progress, it is necessary that the R&D processes act within a country system ensuring conditions for growth consistent with parameters that can ensure harmony among the different social classes. The theme about a sustainable growth model in its social dimension, has enthralled many economists during the last two decades. The Nobel in economics Robert Solow can be considered one of the most important researcher on growth dynamics in the medium term with respect to macro systems. He, through a model suitable to define the national accounts growth, defines the Gross Domestic Product (GDP) of a country as a function of two factors: Capital (K) and Labor (L) and two parameters: α which defines the GDP’s elasticity (or marginal productivity) to K and β which defines the GDP’s elasticity (or marginal productivity) to L. These two parameters define the income share destined respectively to K and L, with β = α-1. Solow, starting from this function also called “Cobb Douglas’ function”, through a series of mathematical steps get to derive the “growth equation”, where he adds to these factors, the “Total Factor Productivity” to identify the technology status of a country, namely its ability to determine the socio-economic and environmental conditions to allow a sustainable and equitable growth. According to Solow, the economic growth parameters are related to the system intrinsic characteristics in which they operate, otherwise all countries would achieve the same level of growth. These features can be traced primarily: to the saving redistributions made by the banking system, to economic policy if it is oriented to stimulate saving or consumption, to the openness level to foreign investors, and finally to the wealth generated by growth re-invested in research and development.
The Solow’s model, does not consider the employment factor assuming a 100% employment rate, but this condition is no realistic to realize in different macro agglomerations. Moreover, in the model we can observe a inconsistency in the dichotomy between aggregate capital and marginal productivity concepts, indeed further schools of thought, despite starting from the model in question, look after to focus the employment rate and the capital/productivity relationship.

The “Neoclassical” approach defines Social Value (SV) the value generated by any type of social innovation. It is the net benefit produced by an innovation excluding the Private Value (PV), namely the profit gained by innovator. So in a market economy, innovation is a excludable good (not available at all system components) to ensure for innovators a private value necessary to cover R&D costs and finance new technology researches. Indeed, if a country wants to spread at macro level the innovations set produced at micro level, moving towards growth in compliance with the market and its natural balance, it has to be able to ensure a sustainable competitive advantage for innovators and pursue a correct social policy redistributing adequately the growth wealth among the different social parts. A first step in this direction would be to plan research clusters in different geographic areas taking account of environmental features to guaranty the best possible terms with respect to research processes. According to Paul Krugman, these technology agglomerations must basically consider three variable sets: the location of production primary factors, the logistic services efficiency, and a level of satisfactory connection between suppliers and manufacturers along a not standardized supply chain process. Then we would be faced with new forms of economic processes which many researchers call “positive external economies” (or agglomeration economies) required for macro structures innovation oriented.

To realize in practice all this, we need a political program which, considering the life cycle of technology clusters, guides and encourages enterprises  towards sites suited to their production processes with the aim of achieving a continuous cumulative process able to create increasing returns. It also needs to prevent the cluster downward phase through a regulation that prevents the congestion and standardization, removing as much further the decline time.

Policies seriously oriented to innovation and to sustainable growth, beyond the ephemeral slogans, they must be able to encourage and guide the organizational structure at the level of micro-system and then, at microsystem level, knowing how to harmonize between different classes social the wealth surplus generated.