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.

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