Impact of Innovation on Economic Perfomance on Micro and Macro Level - Essay Example

Introduction The continuous race for competitive advantage is impelling organizations and businesses around the world to become increasingly innovative in the manner that they conduct their operations and services. Although the public sector has been traditionally protected from the pressures that their private counterparts have been facing to upgrade their performance, reducing costs and providing better service, they are no longer exempt from the impact of global competitiveness. Because of the increasing demand for better at cost-efficient service by the public sector which were only once experienced in the private sector, the need to innovate therefore is an issue growing in importance for organizations (Deloitte Consulting 2001 quoted in Ross et al 2004, p.1-2). An important illustration is on the use of information and communications technology by firms that wish to go global on their operations: positioning on the foreign market is decidedly an area where the advantages of ICT adoption are most appreciated. “The positive relation derives from the fact that foreign expansion is information intensive and thus favoured with the use of the new, market oriented technologies (a firms web site, for example)” (Basile and Guinta 2004, p.20). ICT tools reduce costs in conducting international transactions, for instance the presentation the firm’s own product, identifying and communicating with potential partners, drawing up of contracts and bankrolling the global transactions.1 Technology is a key factor in the supporting and developing of an economy, in the securing and maintaining of jobs for the population, and most certainly in determining the level of economic welfare experienced by the members of the society. A source of new technology is the society’s search for increased economic efficiency and a sincere desire to reduce the cost that it has to pay for the availability of goods. Whether the purpose of the technology is to improve its effective use of available natural resources or to increase or alter the supply of available resources, it has impacted what people buy (hence created new demand types), what they choose to do with their time (leading to new market for leisure events), what jobs are lost due to changes in the overall economic mix, and possibly the price of other goods that compete with the technologically changed function for raw materials, labour, and the limited capital resources that are available.2 The same justification holds why, according to Matsushita (1986), companies must in turn adapt and change is for economic survival: “if the company cannot make products and ensure services that can compete successfully on the world markets as well as locally, it will face a bleak economic future.  Similarly companies must understand their customers’ needs and expectations to become more competitive to survive”. Morck and Yeung (2001, p.8) cite a few of the relatively clear general facts about innovation: those countries that show more of innovation are better off and expand faster. Similarly, on the company level, those that show more innovation post better financial performance and enjoy higher share prices. According to Lehtoranta (2005, p.5) “research, entrepreneurship, new start-ups, consolidation of businesses, interaction with other companies and financial markets create an environment that is conclusive to innovations.” Furthermore, novel trends in innovative activities are impacted by new technologies, modifications in the existing knowledge base, as well as changes in consumer needs. Morck and Yeung also cite that the primary competition in a knowledge-based economy is competition to innovate first, not competition to cut prices, despite what standard economics holds. This is due to the fact that sole ownership of an innovation provides monopoly power, and the settings provided by perfect competition do not govern innovators here. Monopolies then become the “reward” in their spending in innovation. But these innovation-based monopolies are temporary, for they last only until another innovator makes yesterday’s innovation out of fashion. Determinants of Technological Evolution and Innovation How new technologies develop provides a challenge for economic theory and for public policy. “Theories of technological change have focused both on demand-side factors, which spur innovative activity by increasing the value of new innovations, and supply-side factors, such as scientific advancements that make new innovations possible” (Popp 1998, p.1). In the case of energy-intensive industries such as in petroleum, Popp cites that looking at the determinants that effect energy-efficient innovations is crucial in the conduct of environmental policy in light of the fact that most of the global environmental problems are brought by technological progress (1998, p.2). Ross et al (2004) provide the following table on the key enablers of innovation: Figure 1. The Key Enablers of Innovation (Ross et al 2004, p.4) Also, the theories on induced innovation emphasize the importance of factor prices in influencing the direction technological change takes (Popp 1998, p.4). Binswanger’s (1974) results suggest that factors of production themselves are crucial determinants of innovation: “an increase in the expected total cost of a factor leads to an increase in R&D focused on reducing use of that factor, and that a decline in the productivity of R&D to conserve a factor leads to a decrease in R&D on conserving the factor.” On the contrary, Rosenberg (1982, 1994) stresses the role of the existing base of scientific knowledge to new inventions as it is these breakthroughs that influence the direction of technological change. For example, the invention of microcomputer chips led to the development of a generation of electronic equipment (Popp 1998, p.4). Finally, Popp finds in the same study that energy prices have a strong positive impact on new innovations in the energy technology fields studied, that the reaction to energy prices is quick and the expected value of research is important in determining the level of innovative activity. Also, “positive impact of energy prices on new innovations suggests that environmental taxes and regulations not only reduce pollution by changing behaviour away from polluting activities, but also by encouraging the development of new technologies that make achieving pollution control goals less costly in the long-run” (Popp 1998, p.29). In support to the above findings did Garnsey (2004, p.8) found out in her study that innovations (though mainly funded by public expenditure in this case) opened opportunities for new entrants who later became the agents of change. “In networked industries, new technologies are subject to network externalities, with the processes of selection and propagation fundamentally linked. In a highly networked industry like the PC industry, markets tip towards the dominant technology (towards MS-DOS and the PC).” Lee also found out that ownership structure is also found to be an important determinant of innovation – “private limited and public limited firms are twice more likely to innovate compared to sole proprietorship firms” (Lee 2004, p.1) There is also a negative relationship between the propensity to innovate and the share of exports in sales. However, Lee’s study showed that innovation is not related to the extent of foreign vs. local ownership of firms but showed that the capacity to innovate is positively correlated with market concentration (2004, p.9). The Market and the Determinants of Change Tracey-White quotes that the main role markets assume is to facilitate the movement of goods and services between producers and consumers. In a developed wholesale market system, assembly and wholesaling of produce often occurs most efficiently, which then assists in price formation for domestic produce (1999, p.14). According to Garnsey (2003, p.6), “public investment in knowledge-based sectors creates positive externalities.” In the event that individual firms fail, dynamic processes extend beyond the new technology now in “spill over” to surpass knowledge-recycling and resource reconfiguration to bring about wider economic returns. Markets also change to adapt to the changing demand and supply level (Landell-Mills and Porras 2002, p.6). Tracey-White (1999, p. 12) quotes that pressures for change in marketing systems can be derived from two sources: internal factors within the market system and from external sources. “Internal changes take place due to the changing organizational structure of commerce in the market.” Examples may include rising production levels, modifications to commercial trading trends (e.g. private companies taking over government-owned companies), the increasing influence of supermarkets, and the emergence of professional specialised wholesalers. Changes in operational practices might emerge in markets which may involve the introduction of new mechanical methods (Tracey-White 1999, p.12-13). Meanwhile, the main external causes for change are “demographic factors, which may include an overall increase in population of a city as a result of migration and natural growth” (Tracey-White 1999, p.13). This can overwhelm the market capacity and the road system, emergence of population shifts within cities and the suburbs, and changes in the location and nature of workplaces. Changing transportation patterns will have a crucial impact through increased traffic growth which leads to resulting congestion. “Changes can also be precipitated by new legislation and greater public awareness, such as new town planning controls and zoning regulations, new environmental impact and energy conservation controls; and increasing consumer-protection laws” (Tracey-White 1999, p.13). Implications of Technology Strategies in the Market In the case of Italian firms, Basile and Guinta, (2004, p.4) cite that the introduction of information and communication technology (ICT, henceforth) led to a faster rate in market integration (due to lower trade costs, freer capital and labour flows), the adoption of a fixed exchange rate (lira returned to the Exchange Rate Mechanism in 1996) which all acted like as powerful shocks in the economy. In turn, this modified how these firms operate, particularly impacting the industrial districts (ID, henceforth) firms. “External Marshallian economies not longer appear to be a sufficient engine to sustain growth, while exports seem by now insufficient to contrast the increasing competitive pressure of newly industrialised countries (Basile and Guinta 2004, p.4). In his study on the impact of energy prices on energy-efficient innovations in the United States from 1970 to 1994, Popp quotes that “demand-pull theories of innovation cite that higher energy prices lead to the development of more energy-saving technologies.” Increased energy prices in effect make energy-efficient inventions more valuable, either due to bigger energy savings or energy-efficient inventions will be larger. Conversely, he also cites that technology-push theories hold that existing scientific knowledge plays in determining the direction of technological change takes” (Popp 1998, p.3). On the other hand, using 24 Britain case studies and United States cases as comparators, Garnsey (2003, p.3) cites that “firms’ responses to their production constraints were a source of their technological breakthroughs” Technologies developed to solve critical problems became a key resource seeking for competitive advantage. “Constraints making it necessary to enlist allies in the venture provided new access to resources.” From Garnsey’s study, as complexities in the firm’s production increases and as more production constraints come into play, solutions to new critical problems faced will eventually spur more technological breakthroughs. However, the study also found out that growth problems are common in new but resource-limited firms, thus, investor expectations of continuous growth are unrealistic (2003, p.6). Interlinkage and the need for networking of ideas and services due to increased demand and information search prompt companies to merge or create alliances. “Entrepreneurs alert to shifting possibilities for new resource creation have turned constraints to advantage, for example by developing partnerships or reinventing the business model to seize new opportunities” (Garnsey 2005, p.6). Garnsey’s et al’ (2004) review on the emergence of IT sectors in the US revealed how dynamic processes in networked industries result in markets tipping towards the competing technology that rapidly achieves a critical mass of customers. New companies with closed proprietary technologies were eliminated or eventually lowered to functioning levels like in the case of Laser-Scan, Acorn and Psion. However, growth has been better maintain non-tipping markets such as industrial Ink Jet Printing and security software. “Experienced entrepreneurial teams (e.g. ARM, CSR) now aim to create alliances to support their technology standard” (Garnsey 2004, p.4). Markets also respond to make room to accommodate technological innovations. In the case of the industrial revolution, the air drill was created to aid large scale construction. Subways and elevated trains were created to speed up transportation within the cities. 3 An illustration on how the structure and technological environment of a specific market evolved during the industrial revolution can be seen from the key 19th century information technology, the telegraph. By the middle of the nineteenth century, breakthroughs in communication and transportation provided by the telegraph and the railroads formed ways for exchanging information and goods over great distances. This effectively increased the area these markets might be established. The expansion of areas over which rapid communication and transportation were possible allowed, for the first time, resulted to the development of large scale national markets. Furthermore, the reduction in time and cost for communication favoured markets because decreases in communication costs benefit communication-intensive markets. The growth in market areas created by the telegraph and railroad also provided the impetus for the emergence of large scale integrated firms. Finally, the expansion of market areas and thus the potential number of buyers, according to Chandler (1977), encouraged producers to increase their production (Benjamin et al.1986, p.7-9). On the firm level, in the case of the Malaysian manufacturing sector, Lee (2004) found econometric evidence that “large firms are more likely to take on technological changes compared to smaller firms.” Intuitively, these larger firms are more capable of handling shocks in the economy, i.e., sudden changes in factor prices, that they can nonetheless try other innovative approaches so as to reduce the new set of costs faced while still maintaining profits. Schumpeter (1942) argues that large monopolistic firms are the best innovators because they can invest their monopoly profits to fund research into innovations. Competitive firms do not have the luxury of abundant monopoly profits and so are unable to spend on innovations. Since innovative activity is seen to cause a country’s living standards to rise, monopolies that sustain a higher innovation rate are therefore in the public’s interest. Hence, the more monopolies (that is of course, in the form of patents) that a government can provide its entrepreneurial environment; the technological environment of the market is likely to be shaken by more innovations. Foreign market penetration also determines how firms should adapt in response to changing market conditions. Basile and Guinta’s (2004, p.5) probit analysis of the effect of foreign market penetration (measured in terms of foreign expansion index or FEI) revealed that “in the new technological and economic scenario traditional factors of industrial district (ID) firms competitive advantage are losing weight, while new ones are emerging.” Scale economies also become the trend: while size is not a constraint to mere export activities, large firms seem to perform better in terms of advanced internationalization techniques. Conclusion The tighter and more competitive business environment is driving firms to innovate in order to maintain their existence as a market player. However, as more firms innovate, the struggle to maintain their share in the market in turn gets other firms to innovate, capturing everybody to be part of a complex economic cycle. As seen from the literature reviewed, technological change, or appropriately innovation is a shock in itself to market dynamics. Policy making systems geared towards promoting market equilibrium in light of the ever changing trend in technology should eye on maintaining the health of the business market environment. Ideally, technological change can also be seen as a factor that can displace the inefficient firms. However, it must also be noted that policy systems must ensure that continuous innovation will not ultimately lead to adverse effects (e.g. pollution, global warming) as cited above. 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