Knowledge-based Economies in Emerging Europe

STATE INDUSTRIAL POLICY AND HIGH-TECHNOLOGY INDUSTRY IN EMERGING EUROPE

The development of high-technology and knowledge-based industries is viewed as an integral part of producing more stable economic growth in emerging markets in general, and, increasingly, across Emerging Europe (e.g., Rodrik, 2006; UN, 2007; EBRD, 2008). [1] This is because economic growth is highly correlated with the sophistication and composition of the goods that a country produces, with recent studies indicating that countries with diverse and technologically sophisticated production profiles tend to perform better than those without (e.g., Lall, 2000; Imbs and Wacziarg, 2003; Klinger and Lederman, 2004; Hausmann et al., 2005, 2006). Countries with diverse and technologically sophisticated economies might also be viewed as being less vulnerable to some exogenous shocks, such as a sudden decline in commodity prices. However, while the desirability of economic restructuring and the development of high-technology industries are not in doubt, the means to achieving these ends are less clear. Throughout much of the post-communist period, Emerging Europe has been characterized by a general tendency towards a reliance on market mechanisms for economic development as planned economies across the region were dismantled at varying speeds. Recently, however, the role of the state in fostering the emergence of competitive economies oriented to innovative paths of development though state industrial policies (SIPs) has received increased attention across Emerging Europe.

The aim of the research program proposed here is to assess the role of the state in promoting the development of high-technology industries across Emerging Europe. Specifically, this research program proposes to: (a) identify whether state involvement in the promotion of high-technology industries is appropriate; (b) describe precisely what methods are used by states across the region to promote the development of high-technology industries and establish whether state involvement is, or appears likely to be, effective. The object of this research program is thus extremely important as answers to why some countries are more effective at promoting innovative activities than others helps answer broader questions of why some countries are richer than others (Porter, 1990; Landes, 1997). Furthermore, in the context of the ongoing contraction in international economic activity and the concomitant weakening of the previously dominant liberal economic policy agenda, the role of the state in economic affairs is likely to assume even greater importance in both developed and developing countries. If this is so, it is even more important to be able to identify under what conditions state involvement is appropriate and what, if any, policies are likely to yield the best results. To date, there has been very little comparative research conducted on this subject across Emerging Europe, largely due to the prevalence of liberal, market-oriented reforms. [2] Furthermore, the perceived need for SIPs has in many cases only recently been recognized. This leaves a significant gap in the existing literature, and also presents an excellent opportunity to analyze developments as they unfold in what is an increasingly important area of study.

Research questions and methodology

After a period in which most countries within Emerging Europe have largely moved towards economies in which the market is the dominant mechanism of resource allocation, the development of indigenous high-technology, knowledge-based activities are being viewed as being essential to future economic stability and prosperity. In resource rich countries, such as Russia, the state has formulated detailed plans to become competitive in high-technology industries. This is seen as a vital element of economic diversification and also of Russia’s role as an economic power of international significance. [3] In Belarus, the state has implemented a range of policies aimed at establishing it as a prominent economic power based on knowledge-intensive industries. Even in Estonia, a country known previously for the strictly limited role played by the state in economic affairs, a growing consensus has emerged that acknowledges the need for active state intervention to reinvigorate a slowing economy by taking a lead in promoting the development of knowledge-based industries. The research program proposed here suggests a framework for analyzing the role of the state in the promotion of high-technology, knowledge-based industries. This is done in two parts.

Part one: When are state industrial policies appropriate?

Identifying when state industrial policies might be appropriate can be done in two stages. First, it is necessary to establish what level of high-technology activity is currently undertaken by the countries of Emerging Europe in order to establish whether state intervention is required. Doing this requires the compilation of data that measure which activities countries currently undertake. Trade data that measure the composition of industrial exports across the region are an essential element of this; activities that are competitive on the international market act as a good indicator of the general level of innovation within an economy. This element will build on existing research that measures the composition of industrial exports across the region (see Cooper, 2006; Connolly, 2008).

Figure 1. The growth diagnostics framework

Problem: Low levels of private investment and entrepreneurship

Source: Rodrik, Hausmann and Velsaco (2006), p.66

After identifying how countries are performing in high-technology activities it is then necessary to establish the ‘binding constraints’ that are preventing most countries from becoming successful in the production of high-technology, knowledge-intensive products by employing an adapted ‘growth diagnostics’ framework developed elsewhere (Rodrik, Hausmann and Velasco, 2006). The growth diagnostics framework can be conceptualized as a decision tree (see figure 1). In the context of the development of high-technology, knowledge-based activities, it might be asked what keeps private investment in these industries low? Indeed, investment in such industries across Emerging Europe is lower than many other developed and emerging economies (EBRD, 2008). Is it inadequate returns to investment, inadequate private appropriability of returns on investment, or inadequate access to capital? Where it is a case of low returns is it due to insufficient investment in complementary factors of production (e.g. human capital or infrastructure)? Or is it perhaps due to limited access to imported technologies? If the problem is poor appropriability, is it due to high taxation, poorly protected property rights, labour-capital conflicts, or learning and coordination externalities? If the problem is located in inadequate access to finance, is this due to problems with domestic financial markets or external ones?

Employing the growth diagnostics framework across the region requires the collection of cross-national data for indicators at each level of the decision tree. It is then necessary to move down each level of the decision tree to try and identify where obvious constraints to investment exist. For instance, if investment in high-technology, knowledge-based industry is constrained by a high cost of finance, it should be possible to examine data measuring the cost of international or domestic finance. If the cost of domestic finance is high, one should then explore whether this is due to low national savings rate or due to poor intermediation (i.e. a poorly performing financial sector). If the problem is a low savings rate, government intervention would appear to be then best targeted at ameliorating either the incentive to save or through acting a provider of capital that is otherwise expensive to secure. In this way, employing the growth diagnostics framework enables the analyst to identify what, if any, intervention is appropriate to stimulate investment in high-technology industry. Perhaps as importantly, it also enables the analyst to identify is particular policies are aimed at the wrong area. If a country’s constraint is identified as micro-risks such as poorly protected property rights or corruption, spending huge sums on state investment projects might achieve very little. Constructing the data set to facilitate a comprehensive, region wide growth diagnostics exercise would involve collecting data from widely available macro- and micro-economic indicators, firm-level surveys, and assessments by international agencies.

Part two: The effectiveness of state industrial policies in practice

The outcomes from the first part of the project should have helped identify what, if any, state policies would be appropriate for each country. The second part of the proposed research focuses on analyzing the effectiveness of state industrial policies in practice. The effectiveness of state intervention will be analyzed along two dimensions: innovation (in a Schumpeterian sense) and linkages (Hirschman).

Innovation is considered in a broad sense, as the development of new economic activities or new ways of doing existing activities. Consequently, it is important to appreciate the role of not only technological but also of non-technological innovations. For example, developing new marketing networks and innovations in marketing, as well as the development of new organizational practices or structures are often more important than the adoption of new production technologies. Indeed, the ability to derive benefits from new technologies often depends on innovations in distribution and organization occurring simultaneously. The microeconomics literature has tended to focus too much on production, and too little on sales, marketing and distribution. Schumpeter’s concept of ‘new combinations’ captures much better this broad concept of innovation than the usual association of this concept with technological change in production. It is also necessary to go beyond the neo-classical view, in which technological progress is exogenous and technology is often embodied in industrial equipment. On the contrary, the process of absorption of technology by firms is an active and costly process. Furthermore, the development of new activities may be fraught with coordination failures and entry costs vary across sectors. One of the main challenges of industrial policy is thus how to support the development, in a coordinated fashion, of production and technological capabilities in new economic activities. It is in this context that ‘clusters’ of interlinked firms, trading goods and services as well as ideas and personnel, are seen as valuable features of the industrial landscape.

Linkages are crucial to ‘systemic competitiveness’ – i.e., with competitiveness that goes beyond the individual firm to become a feature of certain sectors in specific regions or of whole regions and countries. The development of linkages has both supply and demand side effects. The latter determine the magnitude of macroeconomic multipliers; the former are associated with the positive externalities that different economic agents generate among themselves through cost reductions induced by economies of scale and scope in production, lower transport and transaction costs (economies of agglomeration), the induced provision of more specialized inputs or services (economies of specialization), and the sharing of knowledge between firms and the development of human capital that can move between firms (knowledge spillovers). This implies that developing domestic linkages is more important than integration into world markets per se, and that not all patterns of integration into international markets have the same effect on economic growth (see Wade, 2004). Thus, the countries that profit most from foreign direct investment are those whose domestic firms and institutions build domestic technological capability, both through investment in own research and development and workforce education and training, and through linkages created between domestic firms and foreign affiliates. Moreover, a successful export strategy is highly dependent on how the export sectors are integrated with other domestic economic activities, not least in terms of employment generation.

Analyzing the success of state industrial policies in promoting the development of high-technology, knowledge-based industries along these two dimensions will require several detailed case-studies of state intervention in practice across the region. Examining how state policies affect the development of innovation and linkages in target industries offers a simple framework for determining how effective state industrial policies are. If little progress is made in stimulating innovation or linkages in a target industry, that set of policies might be considered a failure. The results of any analysis of the effectiveness of specific state industrial policies should help develop the growth diagnostics framework developed in part one by testing its predictions/conclusions. This framework should also yield insights into the broader National Innovation Systems that exist across the region. The concept of National Innovation Systems (NIS) suggests that “understanding the linkages among the actors involved in innovation is key to improving technology performance”, and that “innovation and technical progress are the result of a complex set of relationships among actors producing, distributing and applying various kinds of knowledge” (OECD, 1997, p.9). The innovative performance of a country is thus largely contingent on how these actors relate to each other as elements of a collective system of knowledge creation and use as well as the technologies they use. The case studies proposed here should act as a good indicator of the general health and vibrancy of a country’s broader NIS.

Three case studies located in contrasting economic systems are proposed. First, SIP in Russia will be examined. Recent developments in Russia have committed the government to heavy intervention within a number of high-technology, knowledge-intensive industries. This study will focus on one of these industries (e.g. nanotechnology) and assess how state intervention affects the performance of that industry in terms of stimulating the development of more innovative activities and encouraging the development of linkages. Belarus is also proposed as a case study. An economy that has previously been noted for the limited role attached to the market has recently been the subject of a range of targeted incentives by the state to stimulate high-technology, innovative industries. This study proposes examining the Information and Communication Technology (ICT) sector within Belarus which has been a target of these improved incentives. Finally, Estonia, an economy notable for the previously small role played by the state in the economy has indicated that it is formulating its own industrial policy that is aimed at developing knowledge-based activities. All three case-studies would require a close examination of developments within the chosen sector within each country.

Richard has a background in Political Science and Political Economy, with degrees from the University of Essex and the Centre for Russian and East European Studies (CREES) at the University of Birmingham. Richard’s doctoral research explored the role of the international economy and domestic industrial structure in shaping political developments across post-communist Europe.

[1] This term Emerging Europe is employed here to describe the countries of the post-communist region.

[2] For example, greater attention has been paid to industrial policy in East Asia and Latin America in the 1970s and 1980s.

[3] See: MER (Ministerstvo ekonomicheskogo razvitiya Rossiyskoy Federatsii), Kontseptsiya dolgsrochnogo sotsial’no-ekonomicheskogo razvitiya Rossiiskoy Federatsii (Concept of Long-Term Social-Economic Development of the Russian Federation). Moscow, Russia: MER, June 2008 [www.economy.gov.ru/wps/portal/e-russia], accessed August 12, 2008.

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