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.

New series: the role of the service sector in economic development

It is time for me to venture into one of my other favourite topics: the service sector and its role in economic development. With this I am not shifting into promoting  like DVD rentals (don’t worry), I am mainly interested in the knowledge intensive business sector (a.k.a KIBS) and how it enables economic growth and productivity enhancement [1].

Let me start my story.

From an economics perspective, the service sector did not receive much attention from the classical theorists, and it only really came to the fore in the twentieth century. If you are interested to know more about the history, then I can post something on this later.

The service sector is becoming increasingly important in the economies of developed and developing countries. This is not unique to South Africa. While some countries have recognised the importance of strategies to further stimulate the productivity and growth of the service sector, other countries have not yet recognised that the service sector is constrained by a variety of challenges that are unique to this sector. In fact, many countries hope that services will go away. This sector is already a large contributor to jobs and Gross Domestic Product worldwide (not only in OECD countries).

Services are different from goods and require different strategies for development than the primary and secondary sectors which have been traditionally given attention. Although not everybody agrees on how to classify services, it is generally agreed that services are becoming very important in economic development. In some cases manufacturing will not become more productive without more specialised services.

A challenge we face as development practitioners is that data on the service sector in developing countries is unreliable, if it exists at all. For instance, in many countries the engineering services offered by a small engineering firm are recorded under the clients industry in the national accounts. Thus engineering services used by a mine are recorded as mining financial data (thus inflating the primary sector and deflating the tertiary sector in the national accounts). The implication is that the role of the service sector could be much bigger than the formal statistics suggest.

For the manufacturing sector, the service sector, especially knowledge-intensive and business services, is being increasingly recognised as important levers for growth and development of the economy. Knowledge intensive service providers are not only carriers of specialised knowledge; they are also connectors, technology transfer agents and problem solvers.

In many cases developing countries undermine the development of knowledge intensive business services through poorly designed public sponsored business services. Often these services are too generic to really stimulate the growth or increased productivity of the manufacturing sector.

The service sector is also more prone to market failures for many reasons. One of the reasons why poorly developed public services harm the development of knowledge intensive business services is that it is very difficult to compare and value different service offerings (not only between private providers, but also between public and private providers).

Developing countries face the additional challenge that the producer service sector tends to favour countries with higher skill levels or human capital, and shuns countries with large pools of unskilled labour. Due to the close relationship between the service sector and the manufacturing sector, low sophistication of the service sector will also restrain the growth and development of the manufacturing sector. Services often accompany goods in global trade, and service firms are affected by this wherever they are. Thus both the service sector and the manufacturing sector must be upgraded at the same time to overcome the low equilibrium that exists.

The next few posts will delve a little deeper into the service sector

[1] For those that don’t know, my PhD thesis was about market failures in knowledge intensive business services.

The increased importance of knowledge-intensive business services in a knowledge-intensive era

As some of you may know, my PhD research was all about knowledge intensive business services and market failures. In a recent publication I wrote a short piece on knowledge intensive business services that we did not use in the final publication. I thought that perhaps it would be useful to some of my readers if I simply posted it here.

Your thoughts and contributions would be appreciated.

Over the last fifteen years, development practitioners have become more aware of the importance of business services to small enterprises. For many, the essence of the debate about Business Development Services (BDS) was about providing commercially viable ‘business development services’ or BDS to small enterprises. Typically these services related to generic or strategic services (Committee of Donor Agencies for Small Enterprise Development, 2001). In many cases generic (and unappreciated) services were promoted to small enterprises not really interested in competition or improved performance, but in survival. Furthermore, BDS interventions were not always systemic in nature and frequently did not consider how markets function[1]. Value chain practitioners were quick to respond by identifying business services that were needed by actors in value chains, and finding ways to increase commercial transactions in these services in order to strengthen the enterprises.

Almost at the same time an academic debate was going on about the increased importance of knowledge and specialised services as inputs into manufacturing and the rest of the economy (Wölfl, 2000, Wölfl, 2003, Bryson and Daniels, 2007). In the knowledge-based era, business is becoming more knowledge intensive, resulting in certain services being labelled as knowledge-intensive business services or KIBS (Roberts, 2003:130, Toivonen, 2004, Miles, 2007:278). Miles (2007:277) explains that almost all activities in an economy are based on some knowledge, and that all societies are knowledge based. Over time the knowledge intensity not only of manufacturing (and intermediate goods) but also of farming and the service sector has increased. Knowledge-intensive business services are concerned with the collection, analysis and distribution of information and knowledge, and play a significant role in the creation, dissemination and application of knowledge both within and between firms at the level of the region and the nation and internationally (Antonelli, 1999, Andersen et al., 2000, Miles et al., 1995).

The discussion of knowledge in business services should focus on what knowledge services are used for. Miles (2007:277) explains that when people refer to knowledge intensiveness, they refer to highly specialised knowledge, or codified knowledge. This knowledge is about the principles, ‘know why’, and methods that can be generalised across numerous specific situations and problems, and should be contrasted with ‘know-how’ and ‘know-whom’ knowledge which is tied to particular tasks and places.

Miles et al. (1995:ii) define knowledge-intensive business services as services that:

• rely heavily upon professional knowledge;
• supply products which are themselves primarily sources of information and knowledge to their users (for example reports or training consultancy);
• use their knowledge to produce services that are intermediate inputs to their clients (for example communication and computer services);
• own knowledge-generating and information-processing activities;
• are of competitive importance and supplied mainly to other businesses.

Knowledge-intensive business services can be classified into two broad classes. First is the social and institutional knowledge involved in many traditional professional services, with the emphasis on problem solving or applying rules and procedures (Miles, 2007:280). Accounting or communication services typically fall into this class. Second is the knowledge that has risen to the fore in recent years, which is more focused on science and technology. These services often deal with artefacts and the real world, such as aircraft, engineering, construction and infrastructure. There are services such as architectural design that often combine these two classes of services.

Kox and Rubalcaba (2007:31-34) explain that business services also play an important role in national innovation systems by performing the following functions:

• They develop technological advances through engineering and other fields.
• They develop non-technological innovations in areas such as accounting, organisational development and consultancy.
• They diffuse knowledge between firms by spreading ‘best practice’ information.
• They play an important role in surpassing human capital indivisibilities[2]. This is especially important for small and medium sized enterprises that could previously (due to internal economies of scale) not afford access to certain professional services.

Many of the services mentioned in this section operate at the frontiers of new technologies and are essential for the success of other high-technology industries (Di Cagno and Meliciana, 2005).

However, there is a tendency for business services, especially the more specialised services, to be concentrated in urban areas. This means that firms have access to specialised services and are able to outsource less critical business activities, while concentrating on their core business areas. The service providers who serve these businesses play an important role in diffusing knowledge between firms.

Sources

ANDERSEN, B., HOWELLS, J., HULL, R., MILES, I. & ROBERTS, J. (2000) Knowledge and innovation in the new service economy, Cheltenham, Edward Elgar.

ANTONELLI, C. (1999) The microdynamics of technological change, New York, NY, Routledge.

BRYSON, J. R. & DANIELS, P. W. (2007) The handbook of service industries. IN BRYSON, J. R. & DANIELS, P. W. (Eds.). Cheltenham, Edward Elgar.

COMMITTEE OF DONOR AGENCIES FOR SMALL ENTERPRISE DEVELOPMENT (2001) Business development services for small enterprises: principles for donor intervention. Washington, DC, Committee of Donor Agencies for Small Enterprise Development, The World Bank SME Dept, The World Bank Group.

DI CAGNO, D. & MELICIANA, V. (2005) Do inter-sectoral flows of services matter for productivity growth? An input/output analysis of OECD countries. Economics of Innovation and New Technology, 14, :149–171.

KOX, H. L. M. & RUBALCABA, L. B. (2007) Analysing the contribution of business services to European economic growth. Bruges European Economic Research Papers. Belgium, College of Europe.

MILES, I. (2007) Knowledge-intensive services and innovation. IN BRYSON, J. R. & DANIELS, P. W. (Eds.) The handbook of service industries. Cheltenham, Edward Elgar.

MILES, I., KASTRINOS, N., BILDERBEEK, R., DEN HERTOG, P., HUNTINK, W. & BOUMAN, M. (1995) Knowledge-intensive business services. Users, carriers and sources of innovation. Brussels, European Commission, European Innovation Monitoring System (EIMS).

ROBERTS, J. (2003) Competition in the business services sector: implications for the competitiveness of the European economy. Competition and Change, 7, :127-146.

TOIVONEN, M. (2004) Expertise as business – long term development and future prospects of knowledge-intensive business services (KIBS). Department of Industrial Engineering and Management. Helsinki, Helsinki University of Technology (Espoo, Finland).

WÖLFL, A. (2000) The service economy. Business and industry policy forum series. Paris, Organisation for Economic Co-operation and Development.

WÖLFL, A. (2003) Productivity growth in service industries: an assessment of recent patterns and the role of measurement. OECD Science, Technology and Industry Working Papers. Paris, OECD Publishing.

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[1] This is the topic that I dealt with extensively in my PHD dissertation.

[2] Indivisibilities refer to the difficulty of subdividing something into smaller parts. For instance, it is not possible to divide an engineer into smaller pieces. You either appoint an engineer, or you cannot afford to. With the emergence of the knowledge-intensive service sector, a small enterprise cannot gain access to a service provider for a fraction of the cost of appointing a full-time engineer.

Finance now SA’s biggest sector

In a new report by the SA Institute for Race Relations (SAIRR), it is reported that the financial sectors contribution to the country’s GDP in 2008 was 22%, the manufacturing sector 19%, while government itself added 15%. Mining is at 9.5% and agriculture at 3.3%. The report confirms statistics from Statistics South Africa that shows that Gauteng now contributes 34% to the national GDP, with KZN at 17% and the Western Cape with 14.5%

Traditionally the manufacturing sector is the largest contributor but over the last decade this contribution is declining, while the business and financial services sector grows. If you think of it, South Africa has a really advanced knowledge intensive business sector, and strangely this sector is not recognised as a strategic asset by the government. This business and finance sector is closely related to manufacturing, as well as other financial services. Aside from this 1st class service sector, there is a whole consulting and NGO sector that has emerged to supply state-subsidised services to small enterprises. Unfortunately, the services of these service providers, nor the customers that they serve, are competitive.  And because these services are often driven by templates and recipes, they are not knowledge-intensive. For small enterprises to take markets from larger competitors, or for local firms to excel in the region and globally, they need knowledge intensive services. Something that is expensive, but valuable. OK, I got a bit side tracked there!

The point is that the knowledge intensive inputs into manufacturing is increasing. This implies that South Africa is shifting from simple manufacturing (where few intermediary services are required) towards integrated or advanced manufacturing, where a lot of business service (or intermediary) inputs are required. My research earlier this year showed that some manufacturing enterprises in the electronics and metals sector are depending on more than 50 of their product value from contributions from specialised service providers. Wow!

So if you are working with manufacturing enterprises, wean them from wanting to use free or subsidised services and get them to engage with specialists. There is no other way to compete!