Innovation systems in Metropolitan Regions of developing countries

During 2015 Frank Waeltring and I were commissioned by the GIZ Sector Project “Sustainable Development of Metropolitan Regions” (on behalf of the German Federal Ministry for Economic Cooperation and Development (BMZ), Division 312 – Water, Urban Development, Transport) to write a discussion paper about a hands-on approach to innovation systems promotion in metropolitan regions in developing countries. The discussion paper can be found here.

Frank (left) and Shawn (right) in front of the Berlin Wall Memorial

This assignment was a great opportunity for us to reflect on Frank’s experience on structural change in territorial economic development and my experience on industrialization and innovation systems in developing countries. We also had to think hard about some of the challenges of using a bottom up innovation systems logic in developing countries, as such an approach would rely heavily on the ability of local public management to coordinate strategic activities aimed to improve the dynamics between various public and private stakeholders. It was great to reflect on our past Local Economic Development experience and our more recent work on innovation systems, industrial upgrading and complexity thinking.

A key aspect of this discussion document was to think long and hard about where to start. We know many economic development practitioners in cities are often overrun by demands from both politicians and industries for support. We also know that by selecting promising sectors based on past data and assumptions about job and wealth creation often end in little impact and much frustration. We agreed that an innovation systems approach must be aimed at stimulating the innovative use of knowledge, so we decided to not start with a demand focus (assuming the officials are already responding to some of the demand) or with statistics but a knowledge application focus. The use, generation and recombination of knowledge is central to the technological upgrading of regions, industries, institutions and societies. From our experience in promoting innovation systems and our recent research into non-consensus based decision making (this is where you do not select target sectors based on consensus or assumptions about growth potential, but you look at emergent properties in the system) we decided to start with three questions to understand the dynamics of knowledge flows in the region:

1. Which enterprises, organisations and even individuals are using knowledge in an innovative way? Obviously this question is not simple and can only be answered by reaching out in the local economy to institutions, firms and individuals.
2. Which stakeholders are actively accumulating knowledge from local or external sources? Again, this is an exploration.
3. Who are individuals or organisations that know something about unique problems (challenges, demands, constraints) in the region? These could be buyers, supply chain development officials, public officials, engineers or even politicians that are willing to articulate unique demands on the regional economy that might not have been responded on by local (or external) enterprises.

These three questions are treated as an exploration that will most likely be most intensive at the start. In our experience economic development practitioners should constantly be asking themselves these questions when working on any form of private sector upgrading.

A second dimension is about assessing the interplay between institutions and industries and its effect on innovative behavior within regions. Who is working with whom on what? Why? What are the characteristics of the life cycles or maturity of various kinds of stakeholders in the region? Thus we are trying to understand how knowledge “flows” or is disseminated in the region. While some knowledge flows are obvious, perhaps even formal, some knowledge flows could be more tacit and informal. For instance, while knowledge flows from education is quite formal, the informal knowledge exchange that takes place at social events is much more informal, yet very important.

Apart from the identification of the dynamics and interrelations between the industries and the different locations, one other key factor is to identify the drivers of change who want to develop the competitive advantages of the region.

We also present our technological capability upgrading approach as six lines of inquiry, some of which have been covered in earlier posts on this weblog:

1. The company-level innovation capability and the incentives of firms to innovate, compete, collaborate and improve, in other words the firm-level factors affecting the performance of firms and their net-works of customers and suppliers. These include attempts within firms to become more competitive and also attempts between firms to cooperate on issues such as skills development, R&D, etc.
2. The macroeconomic, regulatory, political and other framework conditions that shape the incentives of enterprises and institutions to develop technological capability and to be innovative.
3. Investigation of the technological institutions that disseminate knowledge.
4. The responsiveness and contribution of training and education organisations in building the capacity of industry, employees and society at large.
5. Investigation not only of the interaction and dynamics between individual elements in the system, but of the whole system.
6. Exploring poorly articulated needs or unmet demands that are not visibly pursued by the innovation system.

We, and of course our GIZ colleagues of the Sector Project Sustainable Development of Metropolitan Regions, are very keen to engage with the readers on these ideas? Please post your comments, questions to this weblog so that we can have a discussion.

Best wishes, Shawn and Frank (Mesopartner)

 

 

Series: Building technological capability

In the next few posts I will focus on building technological capability in developing countries. I am specifically thinking of Sub-Saharan Africa as I write these posts, but I am sure that some of the ideas will be relevant to my colleagues working in other parts of the world.

What do I mean with technological capability? We see technological capability as going beyond what firms can do, to what societies or parts of society can use or do with technology. It is a capability that is manifest in products and processes, but that arise from a capacity to match a problem or opportunity with technological systems, sub-systems or combinations of systems. This means that technological capability is not only about technological skills (for instance in knowing how to combine different technologies, or what the latest advances are), but also has business and networking skills to identify and recognize opportunities, discover what solutions can fit the context and constraints (like performance specifications, prices, volumes) and how to organize supply, delivery and maintenance. It thus combines all the elements of innovation including product knowledge (understanding components, sub-systems, architectures), process knowledge as well as business knowledge.

To build technological capability in a country or an industry is the result of an ongoing search process where networks of businesses, academia and government officials search for what is possible at reasonable value and margins, what can and what cannot be done within the local context. What can and cannot be done in the local context is a complex issue that is affected by four factors that I will briefly outline below. It is not only an engineering design problem, and it is not only about products and patents. It is not about a lack of knowledge or a lack of PhDs and engineering students. There are several things that must be worked on at the same time but a whole range of actors working towards different goals.

In many instances the public sector is more eager to develop domestic technological capability than the private sector itself. The private sector in Sub Saharan Africa is in most countries fragmented, and search costs as well as coordination costs at the level of products, processes and networks are very high. That is why those that can afford to take risks and that can afford to take a long term view will most certainly benefit disproportionately to those who are driven by short term profits. For instance, local manufacturers of components that invest very little to nothing in R&D cannot be expected to compete in the long run with international or regional competitors who are investing in R&D.

My late friend and business partner, Jorg Meyer-Stamer argued that there are four pillars [1] that technological capability is built on:

1. The skill of the producers to imitate and innovate at product, process and business model levels. This is largely dependent on pressure to compete as well as pressure to collaborate with each other;
2. The economic, political, administrative and legal framework conditions, which determine whether incentives to develop technological capability exist. In the past, it was often not recognised that these incentives do not exist in many developing countries, especially if an import substitution policy relieved companies of all pressure to be competitive or to innovate;
3. Direct support by technology-oriented state institutions or specific types of knowledge intensive service companies – depending on the given development level, the competition situation and the characteristics of a technology branch in the given country. These organizations disseminate technical and expert knowledge between different actors, knowledge domains and industries and play a critical role in the use of and application of tacit and explicit knowledge;
4. Indirect support by the public and private educational system; in addition to a sound basic education it is important that technical training of a suitable quantity and quality is available at the secondary-school level and also in the universities. The private sector often plays a role in short term training aimed at particular technology applications. Overall the responsiveness of the education sector in identifying and responding to changes in how technology is applied, developed or used in society.

The close interaction between these four pillars creates technological capability. Thus technological capability differs between countries and even within countries because the context differs. A single firm may in the short to medium term manage to get a sophisticated product into the market, but to sustain its position it will sooner or later need to tap into the education system, the knowledge networks of intermediaries and technology experts, or in supplier networks. Technological capability is not measured at the level of patents or products developed (this does not measure the system, it measures a single firm), but is best measured at the level of regional or international competitiveness of industries, entrance of new domestic and international competitors, and exports.

What developing countries fail to achieve is to crowd in many firms and industry networks by creating public goods that intensifies competition and that force firms to collaborate on critical issues like skills development, the development of industry specific infrastructure, etc. Despite being a big buyer in many countries, procurement patterns, priorities and performance criteria are not available to domestic producers (until it is too late). The education sector is mainly funded to provide basic and undergraduate education along strict disciplines, not to constantly upgrade the existing workforce to cope with technological shifts and the integration of different knowledge bases. Universities are funded to do research at a product or process level, not to do applied research that will modernize industries. The importance of various networks of technological intermediaries and knowledge providers are overlooked.

The private sector must also shoulder some blame. Industry bodies are often mainly focused on advocating for favorable conditions to protect existing investment or interests, not on increasing local supplier networks or building industries. Firms would often rather collude than collaborate. Industry associations are typically organized via traditional sub-sector structures, while global production is becoming more integrated, multi-disciplinary and application orientated.

In closing, technological capability is not only created through policy. It is not created through industrial or innovation policy, although it helps. It is not created by individual champion firms, although this certainly makes it easier. Technological capability is built as a result of an innovation system where the context matters. Firms able to manage their own internal technology and innovation are essential, but these typical arise out of public funded investment into technology intermediaries, management capability and the overall performance in the education sector. It is not possible to increase the technological capability of a group of firms in a particular industry without looking at the broader context where the four areas outlined earlier shape the outcomes in the medium to long term.

From my experience in assisting to promote technological capability in developing countries an ongoing facilitation effort funded by the public sector AND the private sector is needed to broker collaboration, but also to look at ways that local demand can be met by the broader system in the long term. In many countries and industries the best host for such a process is a technology intermediary attached to an university or a development programme, with a mandate to build networks around local opportunities that is not only about engineering, but also about reducing the costs of finding opportunities, suppliers and suitable technologies.

 

Notes

1 – These four pillars later became the foundation of the RALIS methodology that we use to diagnose and improve innovation systems.

Linking: Rodrik on industrialisation

One of the leading scholars on the topic of industrialization is Prof Dani Rodrik. Two of his recent blogposts are relevant for the readers of my blog.

The most recent post by Prof Rodrik is titled “Premature deindustrialization in the developing world“. In this article he explains that industrialization is affecting the developing world more than the industrial world. This is a brilliant read. The full NBER paper that his blog post is based on can be found here.

Another recent post by Prof Rodrik is about services, manufacturing and new growth strategies. In a presentation that he mentions in this post he argues that many developing countries are focusing too much on unproductive small enterprises that face high costs, but that these same small enterprises often absorb low skilled labour. If I say anything more I will most likely mess up his argument, so take a look for yourself!

The oblique search for new industrial opportunities

Industrial policy is typically set at national level. It is often aspirational and attempting to “stretch” an economy into new kinds of production and value addition. Programmes are designed, targets are set such as doubling manufacturing contribution of x% within 7 years. Therefore it is sometimes disconnected from the present as it seeks a new Status Quo, a different structure of production.

Yet the natural process under which new production activities are created is complex. It is not as simple as finding a market opportunity, finding the right production process, securing funding and launching a business. The economic context, the political climate, the entrepreneurs with the right levels of experience, backing and confidence are all needed. And don’t forget individuals with a desire to expand, take risks and try new things.

Danni Rodrik argues that Industrial Policy should be a search and learning process. Many centrally planned industrial policies even cite Rodrik as they then commence with outlining with great certainty what must be done, by whom, with which resources and to which effect. This logic completely ignores the importance of what exists, and what is possible from here. It ignores that fact that the past matters, and that the current structures are the result of a series of evolutionary steps. Complexity science teach us that these plans ignore the fitness landscape, a landscape that is dynamic and constantly changing. Any attempt to extend the horison further than what is within reach should be treated with great caution. One of the greatest obstacles is the attide towards risk and the optimism of enterprises. I don’t think Rodrik meant the ministers officials must do the search, rather, industry must do the search or at least be actively involved in the search in partnership with government and institutions.

But the search is not about answering a simple question. A more oblique approach is called for (see John Kay, Obliquity). Which means we should set aside targets and indicators, and focus on creating small experiments to introduce more variety and options into the system. It means that finding out that something is not possible is as valueble as figuring out that something else is indeed possible. Taking Rodrik literally, it would mean also giving much more attention to what entrepreneurs are searching for and experimenting with in the background. It requires that we recognise that the current economy is creating what is viable under the current dynamic circumstances, and that only strategies that recognise where we are and what is certainly within reach from here is in fact viable. The challenge for developing economies is that what is possible is typically limited and further constrained by strong ideological bias as to what is possible or desirable. For instance, many South African business owners are trying to shift out of price sensitive markets competing on a basis of low cost skills. Entrepreneurs are moving into knowledge and capital intensive production, with more focus on service and integration. Government is searching for a way to employ people with low skills because its own social programmes and service delivery is not a viable fall back for people with insufficient skills.

The search is not about analysis
Complexity describes a situation where the patterns of what exactly is going on is unclear or shifting. We cannot entirely figure out what is leading to what and what is reinforcing what. Due to the dynamism, we cannot really understand the situation better through analysis. Another way of explaining this, is that a situation is complex when more than one competing hypothesis can with some probability explain what is going on. The only way to make sense of complexity is to try something, actually, try many things. And then see what seems to work better. It means that we start with what we have and who we know (and can trust), and then try a range of things with the simple purpose of seeing what is possible within the current constraints of the economic system. Steps must be taken to reduce risks (for instance by ensuring that the costs of failure are small, or that the experiments try different ways of solving the same problem), but then this whole approach in itself must be recognised to be politically risky.

This is where donors and development partners come in. By assisting developing countries to conduct low key experiments in order to create variety is essential, as development partners can reduce the political risks of their counterparts. This approach will furthermore require the abondenment of targets and indicators as an attempt to measure accountability and progress. A more subjective approach that sets indicators that monitors the overall health or dynamism is needed so that the experimentors can sense when they are indeed making progress. Thus the indicators does not measure success, nor input.

Perhaps then a skunkwork approach to a more complexity sensitive industrial policy approach is needed. Let the normal industrial policy targets and rigmarole be there. Politicions and bureacrats like this sense of certainty and purpose. But allow for some experimentation on the side under the heading “industrial policy research”. Allow this team to work with private sector partners to conduct small experiments to try new business models in an incremental way. For instance, do incubation to try new ways of mineral beneficiation, but without investing in large buildings or expensive equipment. Use what is existing as far as possible, even if it means having the manufacturing done on a contract basis elsewhere in order to test if local demand for the outputs exist.

Building institutions that supports knowledge flows to industry

It sounds like a cliche to state that manufacturing has changed a lot in the last 30 years. Yet people often say this without thinking of how it has changed. It is not just about the size of our manufacturers, or the increased competition from Asia or elsewhere. It is also not about the sophisticated equipment and the tremendous range of products that are now available to consumers. An important aspect of manufacturing change is the dependence on knowledge from internal and external experts, or Knowledge Intensive Business Services (KIBS). These knowledge experts include engineers, product developers, process experts, industry experts or logistical experts. While in a country like Germany, there are many public, academic and private specialists to go around and assist manufacturers to tweak their processes or solve specific problems, in developing countries we have a bigger challenge. Knowledge intensive services are prone to several market failures, and therefore it is important that we consider the role, importance and challenges that these knowledge services have.

Let me just state upfront that despite my PhD research focusing on the importance of knowledge services in the manufacturing sector, I am hesitant to treat the “knowledge economy” as something separate as it is often done in the South. The increasing importance of many different kinds of knowledge throughout the economy is pervasive. Just ask a commercial farmer in Africa how they have had to change their farming practices in the last 3 decades. It is almost unthinkable that 30 years ago a person could start commercial farming without a tertiary education or at least one highly experienced supervisor. The same goes for manufacturing.

There is a big difference between generic Business Development Services (BDS) and Knowledge Intensive Services. While with BDS our problem is to get good all-rounders to provide services to enterprises where it is very hard to determine the real value of the service offering, in Knowledge Intensive Services the service is very specific to a certain (technical) problem, it is deep knowledge and the value (and cost) is usually very clear. Firms that know what they are doing need knowledge intensive service providers to fill in the gaps where deep knowledge is needed, a BDS provider is typically out of their depth with a manufacturing enterprise that are trying to be competitive.

• The first challenge we have with intensive or specific knowledge is scale. When just a few manufacturers use more advanced equipment in a country there is a good chance that few service providers, experts or technicians will be available. In market failure terms, this is called an indivisibility (you cant divide the cost of the expert easily between different enterprises, or just take a small piece of the expert). It could also be about scale (not enough business to justify the emergence of a specialized service provider). It is often difficult for manufacturers to coordinate their use of expert service providers, or to coordinate the procurement of similar equipment that makes the development of a pool of service providers possible. This is called a coordination failure and it is pervasive in our developing economies.

• A second challenge is that many manufacturers are hesitant to search outside their firm. This is often due to costs (which includes the time spent to find the right expert), but also because for so long manufacturers had everything they needed in-house. In South Africa, many of our older firms are hesitant to use “consultants” because they don’t trust them. This could be described as a market failure around asymmetrical information or adverse selection.

One way to increase the availability of knowledge intensive service provision in a developing country is through the connection between academic institutions, public funded industry support programmes and industries themselves. This requires that technical or knowledge experts are able to be released from certain teaching or research duties to work with firms. This is often very difficult due to the high student load in many of our African universities. I am often astounded by the world class research capacity and expertise that are hidden inside universities that are desperately needed in industry. This failure has many names, but in market failure terms it is called a public goods failure, in other words, public funds are not used to overcome persistent market failures in industry.

A second and parallel strategy should be to make sure that the Meso level organizations (which include universities and higher education institutions) are concentrating on overcoming the market failures in industries and in firms. In developing countries these Meso organizations, meant to address specific performance issues at firm or industry level, are more focused on securing and spending national (or international) funding than to become valuable and responsive to the needs of industry. To get the Meso organizations focused on the plight of firms requires an industrial and modernization policy that is focused on building the right economic and industry supporting institutions – this cannot be done just by merely implementing projects or programmes – it must be systemic. With right I mean relevant and equipped with high level experts that understand and can relate to the issues in industry.

This phenomena of the disconnect between public knowledge services and the need of industry is more widespread than you would think in our developing countries. It is a public good failure that undermines the well being of our economies. I believe this is also an ideological failure, because governments tries to use their funds to provide incentives or prioritize certain kinds of behavior both in the public sector and in the private sector. Instead of responding to what is emerging or what is needed in the private sector, the public sector tries to prioritize what it believes to be ideal. The result is that the firms that are most able to create jobs and wealth are left without public support.

In Mesopartner we will be working on consolidating our experience in bottom up industrial policy. We will work closely with research organizations and development partners around the world to strengthen and develop a body of knowledge on how some of these issues can be addressed in the developing world. We do this by developing a theme where instruments, concepts, theories and practice can be integrated. If you are interested in participating in this process, or have experience to share, please give us a shout.

I have previously written about this some years ago in the post about the service sector  and about the increased importance of knowledge intensity here.