[Mapping the European knowledge base of socio-economic impact studies of IST _ Chapter 1 by Mika Naumanen — VTT Technology Studies DRAFT VERSION —Not to be quoted nor distributed 13,Mapping the European knowledge base of socio-economic Impact studies of ISTS _____ Chapter 1 Conditions for Technological Development and innovation in IST 1. Schools of Thought 1.4. Traditional micro- ind macroeconot theory The basis of mainstream neo-classical economics is constituted by the production function approach. The firm is seen as a functional relationship between inputs and outputs of production. The questions posed are those on the optimality in the allocation of resources and the respective incentives of firm behavior. Microeconomic theory has established the conditions under which an efficient allocation can be achieved. These conditions are to a great extent the same that underlie what economists call “perfect competition” or “competitive markets". Macroeconomic growth models aim at explaining the constituents of ‘economic growth and why the growth rates differ from one country to another Neoclassical economics With respect to innovation policy, the central concept in traditional microeconomic theory is that of market failure. A market failure is said to occur if markets fail to achieve the most efficient allocation of resources. In neoclassical models, the innovation is presented as an exogenous element. The flow of innovations has weighty economic consequences, as it determines the results obtained from production processes, but it is not seen as affected by them (Teece 1988). In these models, technologies arising from the innovative activities are considered information-intensive goods (Arrow 1962a), In accordance with these assumptions, firms cannot go beyond the technological limits established by their productive function, these being determined exogenously, nor can they modify the attributes of the products they make, other than in respect of prices and quantities. Faced with technological changes, firms react instantly, since they are assumed to have perfect information about all existing technologies, which can be acquired on the open market and assimilated without need for a prior learning process. Macroeconomic growth ‘The macroeconomic growth is historically determined by such factors as physical capital, labor, and technical progress. In a neo-classical growth model by Solow (1956), technical progress is the most critical factor for the sustainable economic growth of a country. However, traditional neo-classical growth models cannot explain why the growth rates differ from one country to another, and why rich and poor countries may coexist in a world economy. In recent years, a large literature on “endogenous growth” models (Romer, 1986; Lucas, 1988 and Rebelo, 1991) has explored the idea that investment in knowledge and learning can affect long-run growth rates. These endogenous growth models have tried to clarify the fundamental factors of the growth rate divergence by describing the internal mechanism through which the technical progress is endogenously determined as an “engine of economic growth”, For example, it has been pointed out that the productivity of human resources in future periods depends on current assignments (Lucas 1988, 17). In this literature, R&D vestments are always central to growth. However, the results are at present ambiguous about the effects that R&D subsidies have on growth. JOURNALS, ASSOCIATIONS, ORGANIZATIONS AND INDIVIDUALS. The traditional micro and macro economic approaches are discussed in all economics based joumals, which are not devoted to other schools explicitly. In the innovation and technological developments, contributions can be found, for example, in Journal of Political Economy, Economic Joumal, Scandinavian Journal of Economics, Oxford Review of Economic Policy and Information Economics and Policy. At a macro level, economic growth, its constituents and the competitive advantage of nations is discussed in Journals tike DRAFT VERSION — Not to be quoted nor distributed 14Mapping the European knowiedge base of socio-economic impact studies of ISTs Chapter 1 ‘American Economic Review and Journal of Economic Growth. In venturing and financing of new entrepreneurial companies, important references are Journal of Business Venturing and ‘Small Business Economics. 1.2, Dynamic approaches The term “dynamic’ is used here to reflect succinctly a great number of characteristics of the technological innovation process, such as path dependency, cumulative nature, irreversibility, technological interrelatedness, tacitness. These have been noted by evolutionary historians and economists (Dosi 1982, 1988, Nelson and Winter 1982). Studies of dynamic approaches take into account the active part played by actants, whether individuals or organizations, in determining the pace and direction of technological progress. Work done from this angle has developed models permitting the representation of the competition arising between technologies and social agents as historical processes in which equilibrium is never attained. The principal contributions from these approaches come from evolutionary economics and the work of evolutionary historians. Though to a lesser extent, the development of new industrial economics and the social constructivism school within sociology also permit certain dynamic angles on the process of technological innovation (Nieto 2003). ‘New industrial economics Since the early 1980s, the field of new industrial economics moved away from the idea of perfect competition. It did that by invoking the structure-conduct-performance approach, where besides prices other means of competition, that is, marketing, R&D etc. play a role for determining firm behavior. With the arrival of game-theory as a formal tool of analysis, the explicit investigation of firm interactions became possible (Dasgupta and Stiglitz 1980, Scherer 1967). In these models, bidirectional relationships are established and it is recognized that the strategic behavior of firms in respect of technology can modify the structure of an industry. The starting point is the assumption that structures determine the strategies of firms, but it is accepted that as time goes by, businesses transform their industrial environment. It is also recognized that firms’ conduct can be influenced by results obtained in the past (Tirole 1988). The majority of theoretical models analyses questions with respect to the conditions and incentives necessary for firms to engage in cooperation in R&D and the welfare properties of the different possible solutions Evolutionary economics Unlike neoclassical models, which concentrate on analyzing static equilibrium situations, evolutionary models pursue an attempt to represent the dynamic nature of the process of innovation. These approaches are consistent with Schumpeter’s concept of economic development in which the process of innovation occupies a central position and constitutes the principal explanatory element. Accordingly, competition is preeminently a differentiating process, in which firms attempt to establish control over markets by developing new products, and new processes. Firms seek competitive advantage on the one hand by continuous development of technologically differentiated products, and on the other by changing processes so as to generate these products with competitive cost structures. This is in ‘contradiction to the conditions of “perfect competition” and to firm behaviors, which are conventionally presumed to follow from those conditions. In their seminal study, Nelson and Winter (1982) show that this competitive innovation process generates ‘a plausible explanation for economic growth, Evolutionary historians Evolutionary angles have also been influential in studies carried out by historians of technology (Basalla 1988, Mokyr 1990). In them, analogies are drawn between organic species and technological knowledge. It is assumed that the appearance of a new piece of technological know-how is comparable to the appearance of a new species. With these analogies as a starting point, @ theoretical framework has been defined, which allows DRAFT VERSION — Not to be quoted nor distributed 15,