Competitiveness, Localised Learning and Regional Development: Specialization and Prosperity in Small Open Economies (Routledge Frontiers of Political Economy, No 13)

COMPETITIVENESS, LOCALISED LEARNING AND REGIONAL DEVELOPMENT

It is widely recognised that the performance and development of firms are heavily influenced by their environment and that the conditions that prevail in the local or regional milieu are particularly important. Furthermore, the fact that economic, entrepreneurial and innovative activities tend to agglomerate at certain places, leading to patterns of national and regional specialisation, is increasingly seen to give important insights into the process of firm competitiveness and industrial transformation. Drawing on a rich literature and case study material from selected industries, and elaborating on key concepts such as firms and competencies, industries and industrial systems, and competitiveness and prosperity, the authors set out to answer some broad research questions: • What is competition about in today’s economy, and how is the performance of firms and industries related to space and place? • Why do geographical areas (local milieus, cities, regions, countries) specialise in particular types of economic activity, and why do patterns of specialisation, once in place, tend to be so tremendously durable? • How can high-cost regions in general and small industrialised countries in particular sustain competitiveness and prosperity in an increasingly globally integrated world economy? Competitiveness, Localised Learning and Regional Development points the way out of a dilemma created by recent industrial theory and policy: is it possible for countries which are not destined to be leading high-tech powers to take advantage of the current conjuncture of increasingly open markets? The book includes a foreword by Professor Michael Storper. Peter Maskell is Professor in Regional Economics at Copenhagen Business School, Denmark. Heikki Eskelinen is an economist and Head of the Social Science Department at the Karelian Institute, University of Joensuu, Finland. Ingjaldur Hannibalsson is Associate Professor in Operations Management in the Faculty of Economics and Business Administration at the University of Iceland. Anders Malmberg is Associate Professor at the Department of Social and Economic Geography, Uppsala University, Sweden. Eirik Vatne is Professor in Economic Geography at the Norwegian School of Economics and Business Administration, Bergen, Norway.

ROUTLEDGE FRONTIERS OF POLITICAL ECONOMY 1 EQUILIBRIUM VERSUS UNDERSTANDING Towards the rehumanization of economics within social theory Mark Addleson 2 EVOLUTION, ORDER AND COMPLEXITY Edited by Elias L.Khalil and Kenneth E.Boulding 3 INTERACTIONS IN POLITICAL ECONOMY Malvern after ten years Edited by Steven Pressman 4 THE END OF ECONOMICS Michael Perelman 5 PROBABILITY IN ECONOMICS Omar F.Hamouda and Robin Rowley 6 CAPITAL CONTROVERSY, POST KEYNESIAN ECONOMICS AND THE HISTORY OF ECONOMIC THEORY Essays in honour of Geoff Harcourt Volume one Edited by Philip Arestis, Gabriel Palma and Malcolm Sawyer 7 MARKETS, UNEMPLOYMENT AND ECONOMIC POLICY Essays in honour of Geoff Harcourt Volume two Edited by Philip Arestis, Gabriel Palma and Malcolm Sawyer 8 SOCIAL ECONOMY The logic of capitalist development Clark Everling 9 THE REPRESENTATIVE AGENT IN MACROECONOMICS James E.Hartley 10 BORDERLANDS OF ECONOMICS Essays in honour of Daniel R.Fusfeld Edited by Nahid Aslanbeigui and Young Back Choi 11 VALUE DISTRIBUTION AND CAPITAL Edited by Gary Mongiovi and Fabio Petri 12 THE ECONOMICS OF SCIENCE James R.Wible 13 COMPETITIVENESS, LOCALISED LEARNING AND REGIONAL DEVELOPMENT Specialisation and prosperity in small open economies Peter Maskell, Heikki Eskelinen, Ingjaldur Hannibalsson, Anders Malmberg and Eirik Vatne

COMPETITIVENESS, LOCALISED LEARNING AND REGIONAL DEVELOPMENT Specialisation and prosperity in small open economies

Peter Maskell, Heikki Eskelinen, Ingjaldur Hannibalsson, Anders Malmberg and Eirik Vatne

London and New York

First published 1998 by Routledge 11 New Fetter Lane, London EC4P 4EE Simultaneously published in the USA and Canada by Routledge 29 West 35th Street, New York, NY 10001 Routledge is an imprint of the Taylor & Francis Group This edition published in the Taylor & Francis e-Library, 2002. © 1998 Peter Maskell, Heikki Eskelinen, Ingjaldur Hannibalsson Anders Malmberg and Eirik Vatne All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data Competitiveness, localised learning and regional development: specialisation and prosperity in small open economies/ Peter Maskell…[et al.]. p. cm. Includes bibliographical references (p. ) and index. 1. Regional economics. 2. Economic development. 3. Competition. 4. International economic integration. I. Maskell, Peter. HT388.C66 1998 338.9–dc21 97–17426 ISBN 0-415-15428-6 (Print Edition) ISBN 0-203-03016-8 Master e-book ISBN ISBN 0-203-20272-4 (Glassbook Format)

CONTENTS

viii ix x xi xv

List of figures List of tables and cases About the authors Foreword by Michael Storper Preface

1

Regional specialisation and localised learning— An introduction

1

Points of departure and agenda 1 Firms and competencies 4 Industry and industrial systems 6 Agglomeration, local milieu and localised capabilities 9 Regions and countries 10 Competitiveness and prosperity 12 Outline of the book 14

PART I Ubiquitification, knowledge and localised capabilites 2

Sustainable patterns of specialisation in a globalised economy

17

19

Internationalisation, ‘ubiquitification’ and the knowledge-based economy 19 Convergence and stable patterns of regional and national specialisation 24 Conclusion: ubiquitification and specialisation 28

v

CONTENTS

3

Firm competitiveness through knowledge creation

29

Knowledge creation 29 Tacit and codified forms of knowledge 34 Codification as a second process of ubiquitification 40 Protection of knowledge 42 Enhanced use and creation of knowledge through trustful relations 44 Conclusion: towards an understanding of interactive learning in localised industrial systems 48 4

Localised capabilities and the competitiveness of regions and countries

50

The interaction between territory and economic development 50 The main elements of localised capabilities 53 The creation of localised capabilities 56 Agglomeration and learning 58 Territorial life-cycles 64 Conclusion: knowledge creation and localised capabilities 69 PART II Small countries, localised learning and lack of learning: the cases of furniture, fish and phones 5

Small nations: how to sustain prosperity in open, low-tech economies

73

75

Small versus large economies—a question of openness 75 High-tech and low-tech trajectories 80 Six reasons for a small country to stay low-tech 84 Low-tech competitiveness in high-cost countries? 89 Shared trust: an alternative route to smooth knowledge exchange 92 Conclusion: shared trust and localised learning as a competitive advantage of small countries 97 6

Comfort and competitiveness: the wooden furniture industry Furniture industry: structure and change 99 From ubiquitous resources to unique products: the case of Denmark 105 In the shadow of the dominant cluster: the case of Finland 112 Conclusion: proximity and competitiveness in the furniture industry 118

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CONTENTS

7

Natural resources and the institutional endowment: the fishing industry

120

Setting the scene; or how to exercise property rights on self-propelled property 121 The seafood value chain 124 The geography of supply and demand in the fishing industry 130 Protecting both fish stocks and fishing communities: the case of Norway 134 Liberalisation in order to regain competitiveness: the case of Iceland 140 Conclusion: learning and innovation in the fishing industry 146 8

Footloose communications: the mobile phone industry

151

The restructuring of telecommunications 151 The global framework and what telephony is all about 154 Telecommunications in the Nordic countries: regulations and market structures 157 The route to excellence in mobile telephony: actors, interactions and institutions 159 Preconditions for success 168 Conclusion: is there high-tech potential in small countries after all? 174 PART III Conclusions and policy implications

177

9

179

Towards a learning-based industrial and regional policy

Human action, spatial context and economic development 180 Economic clustering, positive external effects and spatial agglomeration 182 Summing up the main argument: ten conclusions 184 The learning perspective and public policy 185 Fields open for public intervention 190 Final words 193 195 215 246 251

Notes References Author index Subject index

vii

FIGURES

2.1 4.1 5.1 5.2 5.3 5.4 5.5 6.1 6.2 6.3 6.4 7.1 7.2 7.3 7.4 8.1 8.2 8.3 8.4

From vertical integration to the division of labour Industry agglomeration in four Nordic countries Export 1970–1992, high-tech industries Export 1970–1992, low-tech industries Fixed investments 1970–1992, high-tech industries Fixed investments 1970–1992, low-tech industries A small country in a high-tech/cheap labour environment The export share of furniture production in OECD countries in 1970, 1981 and 1992 The value chain in the furniture industry Wooden furniture manufacturing in Denmark in 1992 The regional distribution of value-added in the Finnish furniture industry, 1990–1994 The value chain in the fishing industry Export of fish in 1993 Import of fish in 1993 Catch per fisherman in selected OECD countries Actors and institutions in the telecommunication system Systems structure Cellular system for the reuse of radio frequencies Time of inauguration of the first GSM network in European countries

viii

21 61 83 84 84 85 91 101 104 111 116 126 131 132 143 154 155 156 165

TABLES AND CASES

Tables 5.1 5.2 5.3 6.1 6.2 6.3 6.4 6.5 7.1 7.2 7.3 7.4 7.5 8.1 8.2

Key figures 1992 OECD’s list of high R&D intensity industries for the period 1980–1995 GDP per capita (selected countries) Apparent consumption of furniture per capita in OECD countries in 1970, 1981 and 1992 Production of wooden furniture in Denmark New firms, closures and incumbents in wooden furniture in Denmark 1972–1992 The furniture industry in Finland from the 1970s to the 1990s The two spatial concentrations of the Finnish furniture industry in the mid-1980s Export prices of fish from Norway Inhabitants and occupation in the fishing industry Structure of the fishing fleet in Iceland and Norway Number of firms in related industries in Iceland and Norway Catches by country and county in Iceland and Norway The world’s fifteen largest telecommunications manufacturers in 1994 Telephone market penetration in selected OECD countries

78 81 90 100 106 108 112 116 133 134 136 139 139 152 153

Cases 4.1 6.1 7.1 7.2 8.1 8.2 8.3

Industry agglomeration: rule or exception? IKEA—An early innovator in the furniture system Resource Group International (RGI) Marel Ltd Ericsson Nokia Development pairs

ix

60 102 136 144 161 167 171

ABOUT THE AUTHORS

Heikki Eskelinen is an economist and Head of the Social Science Department at the Karelian Institute, University of Joensuu, Finland. He has specialised in the analysis of regional and industrial development in peripheral regions in northern Europe. Ingjaldur Hannibalsson is Associate Professor in Operations Management in the Faculty of Economics and Business Administration at the University of Iceland. He earned his PhD degree in Industrial Engineering from the Ohio State University in Columbus, USA. He has been the director of the Icelandic Technological Institute, and the Trade Council of Iceland. He has also held other positions in trade and industry and served as chairman of the Department of Business Administration. Anders Malmberg is Associate Professor at the Department of Social and Economic Geography, Uppsala University, Sweden. Between 1990 and 1995 he was co-ordinator of the European Science Foundation research programme on Regional and Urban Restructuring in Europe. His research is concerned with industrial transformation on the one hand and local and regional economic development on the other, primarily in a Nordic and European context. Peter Maskell is Professor in Regional Economics at Copenhagen Business School, Denmark. He is former chairman of the Social Science Research Council of Denmark and member of the European Science Foundation Standing Committee of the Social Sciences. His activities include work on a number of governmental committees and being on the board of several research institutions and private companies. He is presently engaged in the work of the Danish Research Unit on Industrial Dynamics (DRUID). Eirik Vatne is Professor in Economic Geography at the Norwegian School of Economics and Business Administration, Bergen, Norway, and a scientific advisor at the Foundation for Research in Economics and Business Administration, Centre for Energy and Industrial Economics. His research interests are industrial transformation, territorial division of labour, oil and gas industry and small business development. x

FOREWORD Michael Storper

There is a new global economic policy orthodoxy. It consists essentially of recommending that economies adjust to more open markets by bringing their prices into line with global prices. To do this, say the experts, countries should reshape their labour and capital markets, their tax policies and research institutions, as well as management of their private firms, to conform to global best practices. In many countries, this boils down to a recommendation that they dismantle ‘barriers’ to adjustment, many of which include the institutions of the welfare state, legislation which protects the rights of labour unions, and public sector employment levels and conditions. Not all of these recommendations are irrelevant to the reshaping of economies to accommodate current realities; in many countries, some such changes are needed to respond to contradictions which have built up in regulatory structures designed for earlier times. When the orthodox policy recipe is taken to be the complete and only solution to problems of economic performance today, however, a fundamental flaw reveals itself. It is not true that everything orthodoxy considers to be a barrier to the adjustment of local prices to international prices is likely to hinder economic performance. The first such barrier is regulatory in nature. Some regulatory barriers which were instituted in order to achieve such goals as worker protection or wage compression have also had positive economic effects, signalling to the economy in question to take, for example, a high productivity pathway rather than a low-wage and labour-abundant pathway. Moreover, while in some cases, elimination of such barriers is really just a way to use external forces to unblock local political situations (for example in some Latin American countries, where local politics would not permit modernisation of financial institutions, but ‘structural adjustment’ is used as the pretence for so doing), in others, local institutions function well and imposition of the world norm would do harm (for example in Taiwan or even Germany, financial regulation is used effectively to promote development, but does impose barriers to capital mobility). At the very xi

FORWODR

least, there is no blanket case to be made about such nation- and regionspecific regulatory institutions; their reform must be considered on a caseby-case basis, in light of their economic effects on productivity and distribution. Other barriers are not primarily regulatory in nature. They consist of nationally and regionally specific economic practices, both formal and informal in nature. These are practices by which actors generate knowledge and commercialise it; and organise relationships between firms, between firms and the labour market, between banks and other financial institutions and firms, between the domestic (household) sphere and the realm of market-oriented activity, as well as between research and application. Some of them are ‘hard’ factors in development, such as the ways that skills, technologies, or infrastructures have been built up in the past. Some of them are ‘soft’, and include ways of doing business, customs, routines and conventions. It is no longer possible to claim that they are mere residues of ‘tradition’, for many of the most successful regions in Europe have built their recent strength in global markets on the specific ways they have embedded their economic activities in modernised versions of these practices. If we translate this into another language, that of economic geography and trade theory, the problem with the orthodox policy formula is that, by imposing a single formula on all economies, one based on the notion of elimination of barriers to price-cost adjustment, it would attempt to eliminate the specificities on which much economic success has been based. It is not enough to claim that the orthodox package would eliminate only artificial barriers, leaving in place the specificities which stem from natural comparative advantage; much competitive advantage has been constructed by human practices and institutions, in ways that go against the grain of the orthodox analysis. If this humanly constructed specificity is a barrier, then it is the kind of barrier we should all want. It is fully compatible with open markets, allowing economies to build highwage, high-skill employment and to keep themselves out of a race to the bottom via simple price adjustment. Recently, a related argument has been made in still another emerging theoretical language. Growth theory, long plagued by huge residuals in its explanations, has returned to knowledge generally and technology specifically, as the centre of the problem. It is now trying to endogenise these as forces in economic development, as the key processes which make possible true long-term changes in productivity. We are still a long way from having adequate explanations of what makes economically useful knowledge and its practical applications increase, but this seems to be a good general direction for theory and research to take.1 At the most general level, the lessons of this line of thought are that we should

xii

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increase the stock of knowledge in the economy and things will get better. This seems to be true in the long run and at a world scale. But particular places are not the world. It is possible for the world stock of knowledge to be increasing, and for a particular place not to be getting richer or even staying at a given level of wealth. This happens when its knowledge is becoming more ubiquitous, less specific. This bids down the price of its knowledge, and there is nothing that guarantees that demand elasticities will be sufficient to compensate for lower prices. The authors of this book point out, therefore, that as knowledge stocks increase it is important to have not just the ubiquitous type of knowledge, but the specific type which propels favourable place-bound specialisations, and hence defines new advantages in open markets. This is the best form of competitiveness, although standard price-cost competiveness matters as well. One of the pieces of good news about this process comes from another branch of theory, upon which the authors of this book draw heavily: the path-dependent nature of knowledge and know-how accumulation. All these different strands of thought come together into the contemporary ‘increasing returns endogenous growth model’: endogeneity, through practices and institutions which enable specific forms of knowledge and know-how to emerge; and increasing returns through a cumulative and path-dependent dynamic, as long as the local learning process is sustained. This is where the energies of this book are concentrated: What could sustain the dynamic so that increasing returns are not shut off, so that specificity is not overtaken by ubiquity and the downward spiral of costprice competition? Here, the authors draw on recent reflections about what is required to sustain ongoing technological learning. Much of the contemporary ‘systems of innovation’ literature concentrates on this issue. It is the precise way that institutions stimulate the creation of locally specific information, and the ways that they encourage its use and application within national or regional clusters of firms, that is critical. But the great bulk of this literature, not surprisingly, concentrates on the institutions of ‘big science’ and formal research and development, and limits itself to the technology-intensive sectors. By contrast, the Nordic countries have become rich largely without becoming high-tech. They have successfully specialised in low- to medium-technology products, in quality-based niches of industries where locally specific knowledge is the key to their success. Some would reply that the Nordic countries should pursue a high-technology strategy. But the authors of this book make a convincing case that small countries are fundamentally at a disadvantage in breaking into these sectors, where the R&D investments required would be enormous and have extremely long latency periods. The large countries have firms and national research xiii

FORWODR

structures which are so many times the dimension of what would be possible in the Nordic countries that this strategy is doomed to failure from the beginning. Therefore, the kind of local learning process which is feasible for small countries in a world economy is one which would sustain the medium-technology, quality-based production they have already done so well with. Part of this involves attention to their national innovation systems, which mostly are not based on big science but on a marriage between practical know-how and modern techniques of production and organisation of production and marketing. In these systems, the uncodified knowledge has to do both with product design and with ways of making complex production systems work in an efficient, non-bureaucratic way. Thus, and this is one of the critical starting points of this book, these systems are not just the standard fare of institutions, procedures and incentives, but they are also systems of participation of the actors. This book is important not only because it has a state-of-the-art, finely honed analysis of how innovative, learning-based industrial systems work, but because, by explicitly addressing the low- and medium-technology industries, it points the way out of a dilemma created by recent industrial theory and policy—is it possible for the countries which are not destined to be leading high-tech powers to take advantage of the current conjuncture of increasingly open markets? For the Nordic countries, this involves building on what already exists; but for an even larger group of countries, in southern Europe as well as in developing areas, this book carries a realistic, theoretically and empirically grounded message of hope. Michael Storper University of California, Los Angeles, (UCLA), USA and Université de Marne-la-Vallée, France

xiv

PREFACE

This book is the outcome of the collective effort of five scholars who, on and off since 1994, have been engaged in a project on ‘Regional Production Systems’, conducted within the framework of a four-year research programme for the Nordic Institute for Regional Policy Research (NordREFO). We would like to thank the Board of NordREFO for providing the financial support enabling us to engage in this work. Especially we strongly wish to thank Bjarne Lindström, the Director of the Institute, for his visionary and consistent support of the project from the very beginning until the completion of this book. Preliminary results from the project have been published in a series of conference papers, articles in scientific journals and in a volume on ‘Regional specialisation and local environment—learning and competitiveness’ (edited by Heikki Eskelinen, published in NordREFO’s Report Series 1997:3), based on the contributions to a Nordic seminar organised by the project at Rungsted, Denmark, in June 1996. We have gained greatly from discussions with numerous colleagues when presenting preliminary results from the project in various contexts over the last two-and-a-half years. Most of all, the project has benefited from a series of small workshops that we were able to arrange around Europe with the help of Gioacchino Garofoli, John Jørgensen, Kevin Morgan and Michael Storper. We are grateful to them as well as to the almost fifty colleagues who we had the good fortune to meet for in-depth discussions in Pavia, Copenhagen, Cardiff and Rungsted. In addition, Ash Amin, Meric Gertler, Ray Hudson and Michael Storper have given valuable advice at critical stages in the project. Peter Dicken read an earlier version of the manuscript and gave most valuable comments. None of these should, however, be held responsible for any shortcomings in the resulting work. Finally, we wish to thank the organisational executives and private managers in furniture production, fish processing and telecommunications who have taken the time to present their firm or their organisation to

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PREFACE

members of the group and to discuss with us the present competitive developments in their respective industries. The ideas in this book have evolved through a dozen project meetings over a three-year period. All chapters of the book have been extensively discussed by the group in this process, and all co-authors have contributed to, and take joint responsibility for, the entire book. We have therefore chosen to publish it as a jointly written rather than a multiauthored volume. Naturally, there has been a division of labour within the group. Thus, the first five chapters have largely been written by Peter Maskell, mainly in collaboration with Anders Malmberg. Heikki Eskelinen and Peter Maskell did most of the work on Chapter 6, Ingjaldur Hannibalsson and Eirik Vatne on Chapter 7, and Heikki Eskelinen and Anders Malmberg on Chapter 8. The first version of the final chapter was written by Eirik Vatne. Ingjaldur Hannibalsson has been in charge of the computer graphics to produce the figures in the book. The main editorial work rested with Peter Maskell and Anders Malmberg, who also had the responsibility of leading and co-ordinating the research project from which the book emerges. Peter Maskell Heikki Eskelinen Ingjaldur Hannibalsson Anders Malmberg Eirik Vatne Copenhagen, Joensuu, Reykjavik, Uppsala and Bergen April 1997

xvi

1 REGIONAL SPECIALISATION AND LOCALISED LEARNING An introduction

As an academic discipline, economic geography has held a subordinate position in relation to other branches of economics and business studies for many decades. Recently, however, there have been signs of a change. Thus, the influential economist Paul Krugman confessed in the early 1990s that he had spent his ‘whole professional life as an international economist thinking and writing about economic geography, without being aware of it’ (Krugman 1991c: 1).1 Along the same lines Michael E.Porter— whose work on competitive strategy ‘gelled the interests of a generation of scholars’ (Mintzberg 1990:124–125) —declared that his research on business strategy and national competitive advantage suggests that ‘economic geography must move from the periphery to the mainstream’ (Porter 1994:38). What was it, then, that Krugman and Porter, and others like Arthur (1986, 1994) and Enright (1993, 1994) have discovered, which makes them claim that economic geography should occupy a position in the core of the discipline of economics, rather than dwelling at its margin? There seem to be two major concerns, both pointing towards the link between geographical location and industrial performance. The first is that the performance and development of a firm to a considerable extent seem to be influenced by the conditions that prevail in its environment, and that the conditions in the immediate proximity—in the local or regional milieu—seem to be particularly important. The second is that economic, entrepreneurial and innovative activities tend to agglomerate at certain places, leading to patterns of national and regional specialisation. Points of departure and agenda In this book, we will focus on a set of issues related to the impact of geographical location on a firm’s ability to create and sustain competitiveness in an era of increased economic globalisation and, thus, 1

AN INTRODUCTION

increased exposure to international competition. The book has multiple starting points and therefore a broad agenda. It addresses a series of questions related to industrial transformation on the one hand, and the development of regional and national economies on the other. Thus, the point of departure for the book is two broad research questions: • What is competition about in today’s economy, and how is the performance of firms and industries related to space and place? • Why do geographical areas (local milieus, cities, regions, countries) tend to specialise in particular types of economic activity, and why do patterns of specialisation, once in place, tend to be so tremendously durable? In the first part of the book, we adopt a view in which the creation of longterm competitive advantage hinges upon investment and innovation, i.e. in finding better ways to compete by relentlessly upgrading the firm’s products, processes and procedures. Without a sufficient degree of innovation, even a high level of investment is not sufficient to sustain growth for very long, as was unambiguously demonstrated by the Soviet economic experience of 1950–89 (Easterly and Fischer 1994). We start out by focusing on some notable characteristics of the present transformation of the global economy and on the various effects of this transformation on the industrial structure and performance of the member countries of the Organisation for Economic Co-operation and Development (OECD), faced as they are with increasingly fierce competition from the low-cost areas of the world. Throughout the book we focus on the role played by spatial proximity in promoting the competitiveness of firms. This is not to deny that the geographical reach of most firms has been expanding through a number of years and probably will continue to do so in the foreseeable future, nor that circumstances, events and decisions in distant parts of the world heavily influence many firms today.2 Nevertheless, we do assert that the knowledge creation of even the most internationally oriented firms or sectors is at least to some extent influenced by differences in the economic properties of their region(s) of location. Firms are progressively stimulated by and dependent on their local environment in order to retain and increase their competitiveness precisely because of the drive towards internationalisation and the resulting conversion into ubiquities of formerly critically important characteristics of production. Contrary to the notion of a rapid increase in the ratio of industries being ‘footloose’ (COM 1991), we maintain that increased internationalisation might lead to increased embeddedness and dependence on specific institutions at the local, regional or national level. The more we regard the dynamics of industry as driven by interactive and socially embedded innovation and knowledge upgrading, the more 2

REGIONAL SPECIALISATION

urgent does it become to understand the ‘interrelatedness’ or ‘systemic nature’ of economic activity. We argue that the creation, utilisation and recreation of shared knowledge play a crucial role and stress the importance of social relations and specific institutions locally, regionally and nationally (Håkansson 1982; Storper 1993, 1994, 1995). We see the process of interaction between different levels of the economy as leading to the emergence of specific regional and national systems of knowledge creation (Lundvall 1992; Nelson 1993), which retain their role as key features in the emerging knowledge-based economy. While the two questions above are phrased in the most general way, and lend themselves to theoretical analysis at a fairly abstract level, the third main research question approaches a more specific issue: • How can high-cost regions in general and small industrialised countries in particular sustain competitiveness and prosperity in an increasingly globally integrated world economy? Smaller and larger OECD countries follow markedly different development trajectories in the degree in which they are turning towards the production and export of R&D-intensive commodities. Based on data on the trade specialisation of the OECD countries, we show that the smaller OECD countries by and large retain an industrial structure dominated by low-and medium-tech industries. The high-tech route seems up to now to be reserved for the largest economies, notably the US and Japan. At the same time, several of the smaller OECD countries exhibit the highest standards of living in the world. We argue that the low-tech and high-cost small countries to a large extent manage to retain their competitiveness through the existence of localised capabilities, which are difficult to imitate for outsiders, and which are partly based on intense interaction between a limited number of actors within a regional or national industrial system. Thus, in the second part of the book, we focus on some selected industrial systems and their development: furniture production, fish processing and the development of mobile phone systems. The main setting for our empirical cases is the five Nordic countries of Denmark, Finland, Iceland, Norway and Sweden. These are all small and generally sparsely populated countries in the northern periphery of Europe. They share the common trait of having produced fairly elaborate welfare state regimes in the post-war period, and these regimes, although with some marked differences between the individual countries, have been strongly challenged in recent years. Moreover, and more important for our purposes, they are also in most respects open national economies which, against severe odds, have succeeded over the last century to become some of the economically most advanced countries in the world.

3

AN INTRODUCTION

The book should, however, be seen neither as a study of specific industries, nor as a study of the economic prospects of five countries in northern Europe. Rather, our main aim is to put forward a theoretical argument related to the role of localised learning in explaining sustainable patterns of regional specialisation as well as the creation of long-term competitiveness of firms and regions, and to substantiate this argument through some empirical illustrations. Five concepts, or rather five sets of concepts, are so frequently used and so essential for the discussion to follow, that they merit some initial comments in this introductory chapter. These sets of concepts include: firms and competencies; industries and industrial systems; agglomeration, local milieu and localised capabilities; regions and countries; and, finally, competitiveness and prosperity. Firms and competencies In spite of extensive efforts, no generally accepted definition of the firm has yet emerged (Holmström and Tirole 1989; Foss 1994). However, based on the seminal work of Penrose (1959)3 scholars have developed within the last ten to fifteen years what has come to be known as the ‘resource-based view of the firm’ (Lippman and Rumelt 1982; Barney 1986, 1991; Dierickx and Cool 1989; Prahalad and Hamel 1990), distinctively different from earlier schools of thought (Conner 1991; Mahoney and Pandian 1992). Today this has become the leading approach within the discourse of managerial science and industrial organisation, just as it is advancing in importance within heterodox economics. In this line of thinking the underlying conditions for sustained competitive advantages of firms are related to the way in which firms acquire or rent tangible or intangible resources and combine them in building firm-specific competencies (Wernerfelt 1984). Firms survive and thrive, not because of some exogenous market size or industry characteristic, but primarily because of factors within the firm. Empirically this line of argument goes back at least twenty years, to Rumelt’s demonstration that the differences in profitability within the US industries were greater than between the industries. Performance differences must therefore, he maintained, primarily be seen as ‘a function of the firm’s strategy for dealing with growth and diversity’ (Rumelt 1974:150). Firms are not, of course, just furnished with successful strategies and competencies, but also burdened with liabilities of various kinds. Some liabilities consist of former competencies gone bad and turned into rigidities inhibiting the ability of the firm to sustain competitiveness (Leonard-Barton 1992). Furthermore, all incumbents are equipped with a considerable body of what has been labelled the ‘pedestrian resources of the corporation: cash, 4

REGIONAL SPECIALISATION

buildings, telephone systems and so on’ (Montgomery 1995:261). But in the resource-based view of the firm these resources are of little interest, even in cases where they constitute the bulk of the firm’s total assets as shown on its balance sheet. The resource-based view of the firm acknowledges that a whole chunk of trivial resources might often be a necessity for the operation of firms, and that all firms have their weaknesses. The focus of the resourcebased view of the firm is, however, placed elsewhere: on the factors that positively distinguish the firm and make it different from others, enabling it to earn Ricardian rents (Peteraf 1993).4 Defined in relation to its competitors such factors are constituted either by unique resources, which the firm possesses, or by the way the firm is able to combine familiar resources in building distinctive and valuable competencies. Thus, according to the resource-based view of the firm competitiveness can only be built on heterogeneous resources or competencies: on the firm’s access to and control over something wanted by others, or by it being able to do something, which the competitors cannot do as well, as rapidly or as cheaply (Nelson and Winter 1977; Loasby 1990). The heterogeneity may be obtained by the firm acquiring some scarce resource in general demand (like a fishing right, a mineral deposit, a corner location, a wavelength for radio or television transmissions, etc.). Usually, however, heterogeneity is a result of the combination of initially homogeneous resources which through ‘historical success translates into favourable initial asset stock positions which in turn facilitate further asset accumulation’ (Dierickx and Cool 1989:1507). Hence the heterogeneous competencies can be built by the accruement of resources combined and utilised in firm-specific combinations, the co-ordination being perfected through the learning that follows from repetition of tasks (Grant 1991). Even though the theoretical focus is preponderantly endogenous, no firm is completely self-contained in the sense that it can operate regardless of all factors in its environment. Some complementary assets are normally needed (Richardson 1972) and firms engage with each other to obtain these. Firms also need resources acquired in factor markets at a local, regional, national or sometimes even global level. But as long as not all factors are acquired in global markets, the competitiveness of otherwise identical firms diverges as a consequence of the way in which difference in location shows up in their strategy: the additional resources each must acquire on the factor market to effectively serve a particular product market will differ, because the vector of resources each possesses (represented by its core competence) is different…firms primarily acquire resources from their domestic factor markets… A firm’s country of origin will directly affect its choice of strategy. (Collis 1991:51) 5

AN INTRODUCTION

Furthermore, firms might differentiate themselves by their location and — as a consequence—by being able to utilise dissimilar territorially specific resources and capabilities.5 Finally, the firm might accumulate resources and build competencies which make it especially well equipped to become engaged in a process of continued knowledge creation, thereby gaining the approbation of Schumpeterian quasi-rents.6 The resource-based theories of the firm still do not share any common definition of resources on the one hand and capabilities or competencies on the other. Sometimes these concepts are used interchangeably, sometimes they are defined as distinct categories. According to Barney (1991), for instance, capabilities fall within the category of resources which in turn constitutes the fundamental building blocks of the firm’s competitive advantage. Grant, on the other hand, maintains that ‘a capability is the capacity for a team of resources to perform some task or activity. While resources are the source of a firm’s capabilities, capabilities are the main source of its competitive advantage’ (Grant 1991:119). In order to clarify this conceptual disorder, Foss and Eriksen suggest that ‘resources are always tradable, while capabilities are non-tradable. For example, there is no direct market for capabilities such as reputation, core competencies and organisational cultures’ (1995:46), all of which may well be very important for the competitiveness of a firm. While following the suggestion of Foss and Eriksen throughout this book, we make a further distinction by using the concept of ‘capabilities’ exclusively when dealing with territorially defined entities (local milieus, regions, countries) while ‘competencies’ is preferred when talking of firms only. Industry and industrial systems In contrast to the extensive discussions on the concept of the firm, considerably less interest has been devoted to the concept of industry.7 Without much discussion an industry is usually defined on the basis of certain similarities in production technology, product characteristics, service content, etc., or on combinations of these (United Nations, Economic and Social Affairs Department 1968). But if the concept of industry should have any theoretical underpinning at all it must, of course, be more than just a basically arbitrary collection of individual firms sharing some property which without further reflection is assumed to be relevant. A more satisfactory definition will group firms into industries according to whether or not they compete with each other: if two firms do not compete at all, they do not belong to the same industry. However, even at an abstract level many factors must be considered when perceiving an industry as the arena in which competitive advantage 6

REGIONAL SPECIALISATION

is won or lost. In any industry, the nature of competition is embodied in the competitive forces of rivalry among existing competitors, the threat of new entrants or substitute products and services, and the bargaining power of suppliers and buyers. The strength of each competitive force is a function of industry structure, or the underlying economic and technical characteristics of an industry. For example, buyer power is partially a function of strategy (single or multiple sourcing) but also of the division of competence and capacity and the different economies of scale obtainable between the units in a value chain. The latter typically determines differences in numbers and average size between buyer and supplier, and hence how much of a firm’s sales is at risk to any one decision-making unit. The threat of entry depends on how well the incumbents manage the effective allocation of its assets and employment of its input, on the height of barriers to entry (for example brand loyalty, economies of scale, need for distribution channels) and not least on the heights of exit barriers. The latter refers to losses incurred if a firm is forced to leave the industry after a while, and to sell used production equipment, close plants and sack employees, etc. (Baumol and Willig 1981; Baumol, Panzar and Willig 1982; Maskell 1992). When trying to identify theoretically the boundaries of an industry, it might be helpful to consider the situation of monopoly, where no competition is present. In such a case a hypothetical profit-maximising firm, being the only present and future seller of certain goods and services, would impose at least ‘a small but significant and nontransitory’ increase in price (Berg 1996:196). The crucial element is the condition of ‘non-transitory’ price increase. In this hypothetical setting no substitution is possible by providers of other goods and services: they simply do not belong to the industry (as only one firm exists there by definition) and consequently cannot influence the asking price. The only way to eliminate the monopoly-rent and thereby force the price back in line, would be to establish a new firm within the industry, providing the services and products in question. Or, to put it the other way around: if a profit-maximising firm was the sole provider of all goods and services within an industry, and in spite of this apparent monopoly were unable to impose and maintain even a small but significant increase in price, then there is no monopoly, and the delimitation of the industry must be incorrect. An industry can thus be defined as a group of firms producing goods and services to a market where a hypothetical profit-maximising solitary firm would impose an abiding and detectable increase in price. Regardless of its theoretical merits, such an approach is, of course, not without practical difficulties in empirical studies, even when we follow the proposal of Scott and Storper (1992) of using the plant or establishment as the basic building block. Plants may be aggregated into industries based on 7

AN INTRODUCTION

commonalities in terms of output. But even a plant may often use various inputs, perform various functions, and produce various goods or services which fall into different and often partially overlapping industries. In principle, this problem could be minimised by gradually moving towards more detailed industrial divisions, but soon a stage is reached where the industrial classification becomes too detailed, so that each category covers only a fraction of the activity of the business entities under study. Instead, plants or firms as a whole are usually classified according to the most important individually classifiable activity, even in cases where this activity only accounts for a minor share of the total turnover of the firm.8 The relationship between firms in an industry is horizontal: they produce similar output and they are related through competition. Such horizontal relations may take on many forms, from head-on antagonistic price and/or quality competition over more or less formalised agreements on joint developmental work, to temporary collusion. The vertical dimension of an industrial system may be conceived of as a sequence of activities or functions which are combined in order to produce a given output (i.e. a good or service, or a combination of both). There is a long tradition in economic analysis of describing the structure of production in terms of a division of labour held functionally together by networks of input-output linkages (Scott 1995). Such input-output systems are sites of exchange, not just of simple physical goods and services, but also of business information, know-how, technological expertise, etc. The individual functions performed in such a system— logistics, production operations, research and development, marketing and sales, and after sales services, etc. —are thus complementary to each other and co-ordinated, either through the mechanism of market transactions,9 intra-firm planning and control procedures, or some sort of network arrangement, sometimes thought of as an intermediary form of the other two (Richardson 1972; Powell 1990; Räsänen and Wipp 1995). The industry is far from the only possible way to contextualise firms in analyses of transformations in the organisation of production of goods and services. In recent years, it has become increasingly popular to include also other dimensions of interrelatedness in the analysis. Concepts like industrial networks (Håkansson 1989); production complexes (Scott and Storper 1992); value chains (Porter 1990); related and supporting industries (Porter 1990); industry clusters (Porter 1990); development blocks (Dahmén 1988); industrial systems (Saxenian 1994); innovation systems (Lundvall 1992; Nelson 1993); business systems (Whitley 1995); or filières (Toledano 1978) all indicate that individual firms are inter-linked parts of an integrated whole: an industrial system (see Foss 1996 or Malmberg and Maskell 1997). Complications arise, however, as we tend to find both horizontal and vertical relations in every object of study depending on level of 8

REGIONAL SPECIALISATION

aggregation (Storper and Harrison 1991). Furthermore, the many existing systems approaches to industrial change relate to different levels of aggregation — micro, meso and macro—and it is not always very clear to what level various conceptual approaches should be attached. In the empirical case studies reported in the second part of this book, the point of departure is the industry, but we try in each case to include the main element of the wider industrial system—and its institutional context—in the analysis. Agglomeration, local milieu and localised capabilities The issue of agglomeration, the spatial clustering of similar or related industrial activities in particular places, plays a central role in the analysis to follow. The co-location of firms engaged in a given line of business in a particular place, be it a few city blocks, an urban region or small country, seems to be common enough to hold some important insight into how processes of industrial growth and transformation unfold. Most existing theoretical accounts of the spatial agglomeration of related economic activities are, however, far from precise when it comes to defining what kind of relations—horizontal or vertical—link the individual producers in an industrial system. Some accounts of agglomerative behaviour clearly prioritise the horizontal dimension. Others, however, seem to have a model of vertical division of labour in mind when analysing how the spatial configuration of an industrial system, notably the proximity between trading partners, affects the performance of the individual producers—and the system taken as a whole. Most existing accounts seem to include both dimensions, albeit in an implicit rather than an explicit way. Marshall (1890), for instance, proposed three reasons for spatial agglomeration of industry. 1 2 3

It provides a pooled market for workers with specialised skills; it facilitates the development of specialised inputs and services; and it enables firms to benefit from knowledge spill-overs.

The first of Marshall’s three mechanisms refers to a set of horizontally related firms (i.e. similar firms, presumably competing within the same industry), while the second mechanism alludes to the development of activities that are linked vertically, in a chain of suppliers and of purchasers. The third mechanism, knowledge spill-overs, may apply in both cases. In most subsequent theoretical proposals, agglomeration economies are seen to have their roots in processes whereby links between firms, institutions and infrastructures within a geographic area give rise to 9

AN INTRODUCTION

economies of scale and scope: the development of general labour markets and pools of specialised skills; enhanced interaction between local suppliers and customers; shared infrastructure; and other localised externalities (Hoover 1948; Dicken and Lloyd 1990; Enright 1994). A related strand of work emphasises how the low barriers to exchange of knowledge within an area with a specialised industrial profile sometimes lead to the formation of local milieus with a particular propensity to stimulate creative entrepreneurship and innovations (Maillat 1991, 1995). Such ‘innovative milieus’ are characterised by a certain coherence based on common behavioural practices, as well as a ‘technical culture’ —a distinctive way to develop, store and disseminate knowledge, technical ‘know-how’, norms and values—that is linked to a certain type of economic activity (Coffey and Bailly 1996).10 The interaction taking place between firms is embedded in a complex web of relations that link them to suppliers and customers, research institutions, the school system and local authorities. The region or the country is not seen merely as a ‘container’, in which attractive location factors may happen to exist or not, but rather as a ‘created space’, an arena for collective learning through intense interaction between a broadly composed set of actors.11 In this book, we will refer to the specific qualities that render competitive advantages to firms located in particular places or areas as localised capabilities. Such capabilities essentially consist of four main characteristics of a given territory, related to: the institutional endowment; the built structures; the natural resources; and, not least, the knowledge and skills residing there. Agglomeration economies, local milieus and localised capabilities thus link the concepts of firms and industrial systems to two other important concepts in this book: regions and countries. Regions and countries Throughout this book, the term ‘region’ is used to identify sub-national territories only. More often than not, the analysis of such regions has through the last fifty years been conducted in complete separation from the analysis of countries (nations),12 by scholars in separate departments, with different training and publishing in different academic journals. This intellectual division of labour is nevertheless increasingly anachronistic. Recent advancements in economics, especially through contributions by Arthur (1994) and Krugman (1991a, 1991b, 1991c, 1994a), have been extremely important in demonstrating the obsolescence of such separation. Not just in academic circles have new developments influenced the way in which to perceive the distinction between regions and countries. We do not wish to add here to the sometimes heated debate over 10

REGIONAL SPECIALISATION

whether the power of the nation state is withering away as a result of economic globalisation and the erection of supra-national political structure such as the European Union. Recent contributions in this debate include claims that ‘the nation state has rapidly become an unnatural, even dysfunctional, unit in terms of which to think about or organise economic activity’ (Ohmae 1995:42), while others strongly question the validity and accuracy of many of the claims made about ‘globalisation’ and ‘regionalisation’, and argue that the national area and the nation states do have important economical and political roles to play also in the years to come (Hirst and Thompson 1996). While acknowledging the validity of the latter point of view, we do maintain that countries have in important respects become more like regions, and regions more like countries. The voluntary and deliberate inter-linking of independent countries through bi- or multi-lateral agreements reduces the room for manoeuvre and places tight restrictions on the use of many formerly vital national policy instruments. And the erosion of former barriers to international economic interaction does make national economies more exposed to the ups, downs and transformations of the global economy. At the same time, as a consequence of the weakening of the nation state, regions are experiencing an increase in autonomy, sometimes (but not often) formally sanctioned legally (devolution, local autonomy legislation), enabling them to engage in cross-border arrangements of various kinds, thereby circumventing the national authorities. There are, however, still quite obvious and distinct dissimilarities between the power, influence and autonomy of sovereign countries and the parts of such countries. The independence of the latter is normally granted by the ruling bodies of the nation state, i.e. the parliament and the government, and it can be withdrawn by them at their choosing, though sometimes such a process might entail smaller or larger constitutional modification. Nevertheless, from the point of view of economic geography, the differences between regions and countries in political autonomy are increasingly in degree, rather than in kind. Spatially defined entities— whether countries, regions or local milieus13 —will therefore be treated in the following chapters as basically the same: as geographically defined areas influenced by essentially similar economic forces, and often distinguished by some unique combination of features and qualities. In interaction with prevalent economic forces this may give the development in a specific area some peculiar twist, enhancing or curtailing the opportunities for the firms located there. As a result, geographically distinctive trajectories can materialise over time, further differentiating the distribution of opportunities available to people and firms at any two places.

11

AN INTRODUCTION

Competitiveness and prosperity The economic prosperity of regions or countries is associated with their ability to generate or attract economic activities which are able to increase income by performing well on the market. Thus, competitiveness is a concept that attempts to depict the desirable condition to which regions and nations—as well as firms—must aspire if they are not to wither or perish. In using the concept of competitiveness we are not unaware that although its dissemination has been epidemic in the business community and among policy makers, the reception in many academic quarters has at best been lukewarm. Not only have many scholars questioned its usefulness, but some have gone even further in their desire to eliminate the concept completely from the vocabulary of social science (Krugman 1993a). Robert Reich, for instance, declares that: ‘National competitiveness’ is one of those rare terms of public discourse to have gone directly from obscurity to meaninglessness without any intervening period of coherence. (Reich 1990:925) And Michael Porter insists that: The principal economic goal of a nation is to produce a high and rising standard of living for its citizens. The ability to do so depends not on the amorphous notion of ‘competitiveness’ but on the productivity with which a nation’s resources (labour and capital) are employed…. The only meaningful concept of competitiveness at the national level is national productivity. (Porter 1990:6) Porter’s claim is somewhat strange, as productivity is a measure of the rate at which output flows from the use of a given amount of factors of production. It is thus a gauge of the efficiency by which the contemporary best technology is employed. In Reinert’s (1995) stimulating account of the historical unfolding of the concepts of competitiveness and productivity, a number of cases are considered where the firms of a region or a country are the globally most productive in a line of business, but none the less incapable of raising the standard of living for the persons employed or for the community at large. He takes as an illustrative example the extreme case of the US companies that have their baseballs produced by the most productive manufacturers in the world: the Haitians, who make thirty cents an hour when engaged in this activity. He concludes that ‘In spite of its absolute efficiency and large market share in producing baseballs with the state-of-the-art technology (needle and thread), Haiti’s standard of 12

REGIONAL SPECIALISATION

living does not increase’ (Reinert 1995:26). This line of argument implies that, though high productivity is surely important for economic progress, high levels of productivity might infer very low income to some factors of production. Hence, the concept of productivity is certainly not a meaningful substitute for what the term ‘competitiveness’ tries to grasp: a sustained above-average income for all employed factors of production. No such thing as ‘sustained above average factor-income’ would, of course, be possible in a world of perfect competition, where factor-price equalisation would ultimately prove Porter right. If we, however, follow Penrose (1959) and others in believing that imperfect competition prevails, the continuance of disequilibrium quasi-rents will change the picture. Disequilibrium quasi-rents describe an excess of total revenues over total costs which accrue to the firms as profit in the short run, but which would be transformed into a cost or otherwise eliminated in the long run. However, technological improvements can, for instance, create new disequilibria as old ones are obliterated, thus enabling favourably located firms to appropriate still new quasi-rents. Other disequilibrium quasi-rents can be the result of the market power attained and are not easily eliminated. Barriers to entry and exit; sunk costs; economies of scale; asymmetrical and other forms of imperfect information; feedback loops; continuous learning; and technological progress can all contribute to the formation of dynamic disequilibrium quasi-rents. Though disequilibrium quasi-rents might be created in all types of economic activity they are, at any given point in time, unevenly spread across the range of industries. This uneven distribution is partly accidental, and partly created by the intentional efforts of firms and governments, for instance through R&D or other forms of knowledge creation. And firms in such industries are rewarded not only according to the efficiency by which they engage capital and labour—their productivity—but also by their ability to appropriate dynamic disequilibrium quasi-rents. Some regions and countries are, ceteris paribus, usually more prosperous than others, simply because of the superior opportunities for the employees and the authorities to grab some of the rents created. In this light, competitiveness might be defined as:14 the ability of companies, industries, regions, nations or supernational areas to generate, while being and remaining exposed to international competition, relatively high factor income and factor employment levels on a sustainable basis. (Hatzichronoglou 1996:12) Empirical research on actual patterns of economic development has given support to this way of conceptualising competitiveness.15

13

AN INTRODUCTION

Outline of the book The rest of the book is divided into three parts. The first part is predominantly theoretical and consists of three chapters. Chapter 2 addresses the ongoing internationalisation process and the shift towards a knowledge-based economy. In particular, we focus on a situation where several of the previously localised capabilities that gave certain regions distinctive advantages become globally disseminated through what we call a process of ubiquitification. In Chapter 3, we argue that the ability to create new knowledge is the main way through which firms in high-cost regions and countries can survive on the global market place. The importance of knowledge creation is by no means restricted to the socalled high-tech industries. In Chapter 4, we focus on the capabilities of regions and countries, and conclude that the ability to engage in interactive learning processes within localised industrial systems is the main option for sustaining future prosperity in most of the high-cost areas in the hitherto industrialised world. The second part of the book contains four chapters. In Chapter 5, we analyse the differences between larger and smaller industrialised countries. There are distinct differences between larger and smaller industrialised countries, not only in the general degree of openness and exposure to international competition, but also in the extent to which they have shifted towards R&D-intensive, high-tech industries. While a few of the largest OECD countries have indeed a fairly large share of high-tech industries, most small countries by and large retain a low-tech specialisation. A number of rational reasons are identified, which could explain why firms and industries in small countries seem to be reluctant to commit themselves strongly to high-tech. At the same time, several of the small countries continue to display some of the highest GDP per capita levels in the world, while increasingly exposed to competition from lowtech industries in the low-cost areas of the world. We introduce the concept of ‘shared trust’ as one possible explanation of this seeming contradiction. The remaining three chapters in Part II each report on a case study of one selected industrial system. Chapter 6 deals with furniture production, a typical low-tech industry which is still by and large located in the highcost areas of the old industrialised world. In particular, we contrast the long-lasting success of Danish furniture producers with the recent crisis of their counterparts in Finland. In Chapter 7, we analyse the contemporary restructuring of the fish-processing industry. Drawing on experiences from the Icelandic and Norwegian cases, we illustrate how a seemingly simple and homogenous activity—the catching, processing and marketing of fresh and frozen fish—may give rise to radically different development trajectories in terms of efficiency, entrepreneurship, technological 14

REGIONAL SPECIALISATION

development and industrial spin-offs, largely due to differences in regulatory systems, ‘culture’ and traditional values and moral beliefs. Chapter 8 might at first appear to contradict one of our main theses: that small countries face difficulties when trying to invest heavily in high-tech industries. Based on the recent success of Swedish and Finnish producers of mobile phone systems, we try, however, to identify the rather specific preconditions under which such a development can take place. The third part of the book, finally, consists of one single chapter (9) where we summarise the main conclusions of the preceding analysis and bring in some policy issues, as we identify a number of implications of our findings for national, regional and local industrial strategy.

15

Part I UBIQUITIFICATION, KNOWLEDGE AND LOCALISED CAPABILITIES

2 SUSTAINABLE PATTERNS OF SPECIALISATION IN A GLOBALISED ECONOMY Under a system of perfectly free commerce, each country naturally devotes its capital to such employments as are most beneficial to each. (Ricardo 1817:156)

The specific combination of location factors which influences the distribution of economic activity between and within each country or region constitutes the areas’ localised capabilities. This chapter discusses how, and to what extent, the process of internationalisation converts formerly valuable localised capabilities into ‘ubiquities’. We call this a process of ‘ubiquitification’. Ubiquitification may undermine the competitiveness of firms in the high-cost areas of the world. When international markets are opened and when knowledge of the latest production technologies and organisational designs are becoming globally available, firms in low-cost regions are becoming increasingly competitive. From this point of departure, the chapter goes on to consider the present and future development trajectories in an increasingly global economy (COM 1993). In spite of a long-term trend towards overall economic convergence between countries in the OECD area, there is no corresponding trend towards convergence in the industrial structures of countries and regions. On the contrary, individual national and regional economies by and large retain their original patterns of specialisation. Internationalisation, ‘ubiquitification’ and the knowledge-based economy Internationalisation is an uneven and complex process in which, among other things, the production and exchange of commodities gradually expand beyond the territory of the nation state to include still larger parts of the globe (Dicken 1992). The driving forces behind this process of internationalisation are the economies of scale and scope resulting from a deepened ‘territorial 19

LOCALISED CAPABILITIES

division of labour’.1 The process of internationalisation is fuelled by ongoing improvements in the efficiency of international exchange of goods and services.2 These improvements are in turn the result of several mutually reinforcing processes: investments and technological advancements in the systems of transport, communication and capital transfer;3 governmental agreements (GATT, WTO, technical standards) on the reduction of former economic and non-economic barriers (Sykes 1995); expansion in the number, in scale and scope, of cross-border interfirm collaboration and of internationally operating firms (Dunning 1958); and the escalating efficiency in down-stream mass distribution and sales (Kline 1991). Today only a few firms, if indeed any at all, span the entire range of activities necessary to convert a natural resource into a commodity ready for final consumption. The complexity of organising the flow and allocating the human and technical assets in an efficient way will normally exceed the resources and competence of one single firm (Richardson 1972), and this lack of efficiency is revealed when the firm is confronted with the outcome of value chains organised with the participation of a number of firms. Arguably, this holds even for comparatively simple commodities which are not affected by rapid technological shifts (Germidis 1980; Imrie 1986; Harrison and Kelley 1990). Two different theoretical approaches can be identified, both aiming at identifying the main forces influencing the degree of vertical integration in an industry. Adam Smith’s (1776) old dictum that ‘the division of labour is limited by the extent of the market’ was taken up by Stigler (1951), who suggested that the degree of vertical integration would be determined by the size of the industry. As an industry grows, some activities, which were formerly conducted within each firm, might instead be profitably provided by independent firms utilising economies of scale and scope.4 The subdivision of the market enables specialisation and thereby facilitates the subsequent development of knowledge and skills in still more diverse forms. Langlois (1989), on the other hand, must be seen as belonging to the antithetical tradition initiated by Menger (1871), for whom the division of labour is a consequence of the growth of knowledge and its complexity.5 When the industry is small the extent of vertical integration is thus, according to this view, primarily determined by the rate of technological progress. What we experience today is most likely the result of both these suggested processes. The speed of technological development increases in many industries and the cost of overcoming the friction of space is generally declining. As a response, there is a tendency for firms to aim at securing their long-term survival and profitability by concentrating their managerial skills and efforts on the production of goods or services in which they believe they have a future competitive advantage. The flip side 20

PATTERNS OF SPECIALISATION

of the coin is that at the same time they leave the rest of their former activities for others to continue. They thus extend the value chain by turning some of their previous rivals into future suppliers or customers (Fig. 2.1). With the process of internationalisation, each value chain will gradually consist of more and more participating firms, producing for smaller and smaller segments of a geographically expanding market.6 In traditional location theory (Weber 1909), a distinction has been made between, on the one hand, the factors of economic importance for the operation of a firm for which the costs differ significantly between locations, and, on the other hand, the so-called ubiquitous materials, i.e. materials and other production inputs which in practice are available everywhere at more or less the same cost.7 Weber stated that: As regards the nature of the material deposits, some materials employed in industry appear everywhere; they are, for practical purposes, put at our disposal by nature without regard for location. When the whole earth is considered this actually holds true only in the case of air; but when more limited regions are considered, this holds true for many other things. […] Such materials will be called ‘ubiquities’; (Weber 1909:51,8 here in the translation by Friedrich 1929:50–51) Weber used the distinction between localised materials and ubiquities to determine the degree of market-pull on the location of industries: the larger the element of ubiquities in the final product, the more strongly would the potential savings in transportation cost pull the industry away from the sources of raw material towards a location near the customers. The Weberian distinction still holds, even though changes have occurred from time to time in the list of critically important location factors. But for each and every location factor, the former significance of which is shrinking, the position of some other factor will be rising. For instance, when water power dominated as source of energy in most industries, the flow of rivers and streams comprised one of the most prominent location factors. Later coal

Figure 2.1 From vertical integration to the division of labour.

21

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replaced rivers on the list of significant location factors, but the functioning of the transport system made waterways remain a fairly important factor, until the railroads finally pushed them almost into worthlessness. Today, access to motorways is a far more important location factor than rail-links for most industries. Only in the service industries—mainly tourism—do rivers now play any noticeable locational role. So when the location factors of yesterday disappear down the list, a new list of the currently most prominent location factors automatically takes shape. Traditionally, two processes have determined the shifts in the relative importance of locational factors. Either there has been a cease in demand for a formerly important factor. This may be caused by some innovation in the production process, leading to the use of other inputs from those before or a change in the magnitude of various inputs already being used. Alternatively the supply of a localised input has been changing: natural deposits become exhausted while new sources are discovered elsewhere; labour is becoming scarce where it used to be abundant; suppliers relocate; the geographical concentrations of demand are shifting, etc. As a repercussion of the ongoing internationalisation, a third process has recently emerged, which actively converts formerly localised inputs into ubiquities: a large domestic market is no advantage when transport costs are negligible; when the loyalty of customers to local suppliers is dwindling; and when most trade barriers are eroded. Domestic suppliers of the most efficient production machinery are no longer an unquestioned blessing, when identical equipment is available world-wide, and at essentially the same cost. The omnipresence of organisational designs of proven value makes, furthermore, a long industrial track record less valuable. Hence, the relevance of the Weberian distinction has not tapered off, as internationalisation has progressed and transportation costs have diminished in relation to production costs. On the contrary, the Weberian distinction composes the pivotal linkage between locational theory and modern resource-based theory of the firm. No firm can build competitiveness on ubiquities alone, and little economic progress would be made in any local milieu, region or country, if everyone was able to do exactly the same in all other places at once.9 In order to enhance the competitiveness of firms, a localised capability must thus be valuable, and in order to be valuable it has to be rare.10 Without being rare, there is no way in which a regional or national capability can be valuable. Rarity does not necessarily mean that a capability will enable the firms of the region or the country to benefit from it. If, however, a formerly important and rare localised capability somehow is turned into a ubiquity—making the localised capability equally available at the same cost to all firms more or less regardless of location—the capability loses its importance. Firms whose competitiveness was dependent on it will be penalised in the market just as, at an aggregate level, the established 22

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patterns of regional or national specialisation will be jeopardised.11 In other words: as ubiquities are created, localised capabilities are destroyed. When the internationalisation process gradually converts many previously important location factors into ubiquities, the competitiveness of firms exposed to international competition will increasingly be associated with one of the remaining localised factors, upgraded by the process of internationalisation: labour costs. The intertwined process of internationalisation and ubiquitification thus presents genuinely new opportunities for domestic or foreign firms in some of the low-cost countries of the world, resulting in sometimes extraordinarily high growth rates in these areas.12 In the longer run, modifying factors will, of course, come into play. The surplus on the balance of trade alone will sooner or later lead to an appreciation of the national currencies of the low-cost nations which, ceteris paribus, will bring about a more homogeneous cost regime. In the intermediate period firms in the world’s high-cost areas might easily be eliminated by the process of internationalisation. Their benefit from an expansion in global demand can be more than offset by their loss of competitiveness as previous regional or national capabilities are turned into ubiquities. Firms in high-cost countries cope with such challenges in various ways. Some raise their capital/labour ratio through massive investments, while others out-source or relocate parts or all of their activities to low-cost areas. ‘Automate, emigrate or evaporate’ as the saying goes. Many firms do, however, meet the challenges in a less habitual way by no longer chiefly aspiring to obtain competitiveness through cost reduction, but by generating entrepreneurial (Schumpeterian) quasi-rents through enhanced knowledge creation (Spender 1994). This phenomenon is not new, nor has it passed unnoticed. Many of the classic economists have acknowledged the crucial economic importance of new knowledge since Adam Smith addressed the issue in 1776—and even he is unlikely to have been the first. Surprisingly often, though, the importance placed on knowledge and knowledge creation by economic scholars through time has been pushed into oblivion by later generations. Thus, the explanatory elements of the comparative advantage of countries, which has survived from David Ricardo’s famous chapter ‘On foreign trade’ to contemporary textbooks, contain little if any reference to the theoretical significance he assigned to knowledge. Nevertheless, he pointed out that in a world where all factors of production were fully ubiquitous, localised capabilities and firm-specific competencies would ultimately make a crucial difference: Of two countries having precisely the same population, and the same quantity of land of equal fertility in cultivation, with the same knowledge too of agriculture, the prices of raw produce will be highest in that where the greater skill, and the better 23

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machinery is used in the manufacture of exportable commodities. (Ricardo 1817:171) Thus, what is new is not the phenomenon as such, but the extent to which the phenomenon of knowledge creation influences and shapes the economy—and the extent to which this phenomenon is being acknowledged in economic research. Gradually a knowledge-based economy (OECD 1996a) is materialising, where the competitive edge of many firms has shifted from static price competition towards dynamic improvement, favouring those who can create knowledge faster than their competitors (Porter 1990; Chandler 1992; Patchell 1993). Following Carter (1994), the shift towards a knowledge-based economy might be characterised by three elements: • the growing importance of economic transactions focused on knowledge itself; • the rapid qualitative changes in goods and services; • the incorporation of the creation and implementation of change itself into the mission of economic agents. There is a spatial aspect to this transmutation. Some regional or national settings might turn out to be more predisposed than others to support and advance the knowledge-creation process in the industry of today (Mjøset 1992; Gertler 1995). This adds a new entry to the list of currently important location factors influencing the geographical pattern of industry: the knowledge assets and learning abilities of particular local, regional or national milieus. The issue of creating an innovative ‘culture’ has bit by bit come to attract major interest among policy makers in the field of local, regional and national industrial development, just as it has been a rapidly growing area of interest in the academic discourse of economic geography and related domains. Convergence and stable patterns of regional and national specialisation Once the domestic market for commodities became sufficiently open after the end of World War II, a process of industrial restructuring was set in motion in the small as well as larger countries whereby former differences in levels of productivity, technology and per capita income seem to have gradually decreased (Barro and Sala-i-Martin 1991; Baumol, Nelson and Wolff 1994).13 The average productivity growth rate of the followers, which exceeded that of the US by 2.2 percentage points between 1950 and 1973, was reduced after the general slow-down in 1972 (Abramovitz 24

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1994), but the process of catching up continued and through the whole period the gap was closing (Dowrick and Nguyen 1989). This convergence has, however, only taken place between regions and countries with a somewhat similar economic and social structure, and it thereby epitomises the detachment from Solow’s (1956) original model of unlimited global convergence in per capita income.14 A possible reason why the convergence is confined to the industrialised open economies is given by Nelson and Wright (1994) in a two-fold argument where they claim that: the economic environment facing firms became more similar, first as a result of increasing opportunities for international trade and later because internal economic conditions became more similar. At the same time, other countries caught up with the United States in terms of their investments in scientific and engineering education and in R&D… and continue: [Such] developing technologies will increasingly have under them a codified body of formal science and engineering knowledge accessible to, and only to, those with formal training in the relevant fields. (Nelson and Wright 1994:159, emphasis added) The latter point—the importance of a regional or national ‘receiving system’ which can identify and utilise international technological innovations—is especially important. When some countries continue to have a lower growth rate than others, or when some regions are consistently lagging behind the rest of the regions in a country, this can, at least in part, be attributed to deficiencies in certain aspects of the region’s or country’s localised capabilities.15 Such deficiencies make the region or country unable to take full advantage of improvements otherwise available (Hall and Johnson 1970). This implies that the process of uneven economic development does in fact have an endogenous component16 where physical and human assets or cultural factors, deeply embedded in the social fabric of a region or country, might play an important role. Empirical examples of such phenomena include Dore’s (1973) observation that the divergence in economic performance between Britain and Japan is closely related to dissimilar institutional configurations, or Hirschman’s (1970) application of such institutions as trust and loyalty in untangling the causes behind uneven economic development at a regional and national level.17 Thus, while acknowledging that convergence is not all-embracing, neither regarding countries within the OECD (and certainly not globally), nor concerning regions within countries in the until now most 25

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economically developed part of the world, the empirical evidence is sufficient to state as a fact the existence of an overall long-term tendency towards homogenisation of growth rates. Furthermore, this process of homogenisation also extends to the use of technology between and within the countries and regions of the OECD. One could have expected that this process of overall convergence would have been paralleled by a convergence in industrial structure, such that the process of catching up would gradually make the followers become, so to speak, carbon copies of the leader—that is, the United States and its industrial structure. Recent work, however, concludes that this is certainly not the case. Dosi, Pavitt and Soete (1990), for instance, demonstrate that technological specialisation patterns are, indeed, clearly dissimilar, and continue to be so through extended time periods. Looking at crosscountry patterns of regional specialisation, much the same picture emerges. Both innovative activity, as measured by, for instance, patent data, and the location of individual industries is shown to be highly concentrated (Breschi 1995). In a similar vein, Guerrieri explains that: Most world trade in manufacturing products is today composed of a two-way exchange of fairly similar goods at sectoral level (intra-industry trade) between countries which are increasingly similar in their ‘classical’ factor endowments; however, this has not led to a convergence in the pattern of international trade in the most advanced countries, quite the contrary… Each major country presents a different structure of trade specialization and comparative advantages and these national differences increased rather than diminished in the last two decades. (Guerrieri 1991:28)18 Dalum and Villumsen (1995, 1996) give an even more detailed picture by comparing the specialisation pattern between countries over a considerable period of time, and finding strong evidence for the stability hypothesis: the specialisation patterns of the OECD countries have been ‘sticky’ for several decades. Only Norway and the UK deviated from the stable pattern because of the North Sea oil, while a few countries have always shown rather weak tendencies towards specialisation (Germany, France). But the majority have retained their specialisation pattern. They thus conclude that ‘fairly outspoken national differences in export specialisation patterns in the early 1960s have not disappeared during the following three decades…[and]…specialisation patterns, country by country do not change significantly’ (Dalum and Villumsen 1995:2).

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Many countries have over time even experienced a further specialisation in products in which they already had some market power (Pavitt and Soete 1980). If the industrial specialisation of a region or a country is known ten or twenty years back, it is more likely than not that the same specialisation will characterise the area today. Studying this phenomenon of hysteresis (Elster 1976), a number of detailed empirical investigations of industrialised countries have been conducted in recent years. Archibugi and Pianta, for instance, conclude their analysis by stating that: each country has developed a distinct model of specialization, concentrating its efforts in particular fields where world class capacity has often been developed… There seems to be a specific advantage in a higher degree of specialization…. This advantage emerges regardless of the particular sector in which individual countries concentrate their efforts; in other words, for advanced countries being specialized appears to be even more important than choosing the ‘right’ field. (Archibugi and Pianta 1992:148–50) So Denmark has benefited from being highly specialised in meat and meatproducts through the whole period from 1961 to 1992, Italy from its specialisation in clothing, Japan from consumer electronics, Canada from wood and iron ore, Sweden from paper/pulp and machinery, Iceland from fish, the Netherlands from cut flowers and dairy products, Switzerland from watches, the US from aircraft and some agricultural products. This intelligible path-dependence in the formation of contemporary regional or national patterns of specialisation (Arthur 1986, 1994; Krugman 1991b; Storper 1992) has gradually limited the range of possible avenues which might be taken in the future (Dosi 1990). It is difficult not to agree with Krugman’s observation that: if there is one single area of economics in which pathdependence is unmistakable, it is in economic geography—the location of production in space. The long shadow cast by history over location is apparent at all scales, from the smallest to the largest. (Krugman 1991b: 80) The cumulative location choices that constitute the process of spatial path-dependence allow accidents of history to influence the long-term geographical pattern of industry (Head, Ries and Swenson 1995), thus qualifying Ricardo’s famous statement quoted in the start of this chapter. Based on perceived international developments in demand and 27

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competition and shaped by industry-specific technological trajectories (Dosi 1982), generations of rounds of investments in all these countries have amalgamated with embedded knowledge and other sunk costs in solidifying the once chosen distribution of activities (Teece 1986; Chandler 1992; Dosi and Marengo 1994). ‘Heavy investment in one technological route makes it less likely that alternate, even theoretically more attractive possibilities will be adopted’ (Zysman 1994:9). Even without any major initial advantage, increasing returns from the growth in competence and the utilisation of economies of scale have enabled each region and country to establish an internationally competitive manufacturing industry (Helpman 1984; Krugman 1991a; Tyson 1992). Countries’ comparative advantages are thus seen as being created, rather than as the result of an inherited distribution of localised supplies. As Corden points out, there is little intellectual merit in sticking to the old Ricardian world view, claiming that ‘Switzerland has a comparative advantage in watches because she is watchmaker-intensive or that the United States exports 747s because she is intensive in firms or engineers capable of making 747s’ (Corden 1979:8).19 The patterns of industrial specialisation in Switzerland, the US and almost all other developed countries are simply no longer primarily determined by any inherited endowment, geologically, biologically, or climatologically foreordained, but by competencies and capabilities built over time, channelled into specific trajectories by increasing returns (Young 1928).20 Conclusion: ubiquitification and specialisation Two main arguments have been put forward in this chapter. The first is that the internationalisation process brings with it a process of ubiquitification, i.e. a process in which previously localised factors of production become more or less equally available in different parts of the world. When a localised asset becomes a ubiquity it ceases to form the basis of competitive advantage. The second argument put forward is that patterns of specialisation, at the national as well as the regional level, have been remarkably stable over the last thirty years. Both of these findings may be explained with reference to the localised and ‘sticky’ nature of some forms of knowledge and knowledge creation. Thus, what has so far not been eroded by the ubiquitification is the knowledge, and learning processes, that reside in industrial systems embedded in local milieus. In the next chapter, we will discuss some notable characteristics of knowledge and knowledge creation before, in Chapter 4, we turn to the issue of regions and localised capabilities.

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3 FIRM COMPETITIVENESS THROUGH KNOWLEDGE CREATION Nothing that is worth knowing can be taught. (Oscar Wilde)

This chapter identifies some ways in which firms can maintain and enhance their competitiveness by creating, exchanging and using knowledge, both codified and tacit. It should be stated at the outset that the role of knowledge and knowledge creation in economic activity is regarded in the broadest possible sense in the analyses to follow. It does, of course, include activities such as investment in R&D and the development and adoption of leading-edge technology (discussed further in Chapter 5), but the impact and importance of knowledge creation are by no means restricted to such activities. On the contrary, the aim of this chapter is to establish a theoretical foundation for subsequent analyses of what we may call ‘low-tech learning and innovation’, that is, how firms also in fairly traditional industries may (or may not) be innovative in the way they handle and develop resource management, logistics, production organisation, marketing, sales, distribution, industrial relations, etc.1 Based on an analysis of some general characteristics of knowledge and knowledge creation and a discussion of the distinction between tacit and codified knowledge, we put forward the argument that the codification of tacit knowledge is a process very similar to the process of ubiquitification discussed in Chapter 2. We then go on to discuss how firms can go about protecting their knowledge assets from losing value by codification/ ubiquitification, and how the formation of trust-like relations between firms may be a way to enhance the creation and utilisation of knowledge—and competitiveness. Knowledge creation Although some knowledge may be said to exist a priori, few would deny that the preponderance of all existing knowledge is created by some sort of human effort through history. Such efforts might have been either 29

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deliberate or incidental (Jenkins 1933), and sometimes perhaps even made without full awareness of what has been learned (Thorndike and Rock 1934). But in spite of the accumulated efforts of humanity since the beginning of time, all firms, regions and countries of today probably know only a tiny fragment of what they may find useful to know. And that again constitutes only a fraction of all there is to know (Lundvall 1994). Locke (1690: Book IV, Chapter III, § 22) obviously shared this view when he stated, more than three hundred years ago, that ‘our ignorance [is] infinitely larger than our knowledge’. Common sense might suggest that the fraction of what is known in relation to what there is to know will gradually increase over time. However, the case seems to be the opposite. This is not because of some global obliviousness, but because the unknown expands as we learn (Griliches 1994). Knowledge creation is thus a Sisyphean process with no end or upper limit: the more we increase our knowledge, the greater becomes the interface with the unknown (Machlup 1984). Knowledge distinguishes itself from all other input in the production process by its extraordinary durability: the use of knowledge never reduces the stock. Actually, the use of knowledge often creates new knowledge as an integral part of the performance of all kinds of activities carried out in the firm (Prahalad and Hamel 1990). Firms get more knowledgeable about their products, their production process, their customers and suppliers, etc. as time goes on.2 The empirical results on continuous experience-based costreductions, initiated by the work of the Boston Consulting Group (1970), have led to the all-important, though somewhat reluctant, espousal of such increasing returns into mainstream economics.3 Learning from experience (Kant 1787; Arrow 1962; Lucas 1988), by trial and error (Anderson 1976) and by repetition (Scribner 1986), give rise to incremental improvements in firms and on markets. These improvements accumulate over time,4 and gradually result in new and better ways of doing things (Boldrin and Scheinkman 1988): The overambitious plans of one period will be replaced by more realistic ones; market opportunities overlooked in one period will be exploited in the next. In other words, even without changes in the basic data of the market (i.e. in consumer tastes, technological possibilities, and resource availabilities) the decisions made in one period of time generate systematic alterations in the corresponding decisions for the succeeding period. (Kirzner 1973:10) Experience is, however, no guarantee of innovation or even improvements as the ‘solutions to some surprisingly simple technical 30

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problems appear to have eluded producers, despite centuries of repetitive activity’ (Young 1993: 444). Stagnation is indeed a very stable and sustainable condition, as long as it includes the entire economic system. Furthermore, even the process of piecemeal alterations does not always represent a gradual calibration bringing the firm or the regional or national economy still closer to perfection. Also, wrong conclusions can be drawn by misinterpretation of the facts at hand. Some such faults correct themselves: ‘someone who believes poisonous berries to be nutritious may soon discover the mistake (though perhaps too late for any personal benefit)’ (Loasby 1991:28). Other erroneous deductions, sometimes based on extremely narrow samples, can, however, become widely dispersed, because everyone believes that others have made a sufficient validation, and no lethal or instantaneous consequences prove them wrong.5 As long as all firms share a common delusion the misconception has no competitive consequences (Loasby 1991). But as soon as one single firm acts on the basis of other and perhaps less fallacious ideas, the selection mechanism of the market inaugurates a sometimes rapid change of mind and the emergence of new ways (Winter 1990). The actual process whereby these new ways are emerging will, of course, only in rare cases be carefully monitored by everyone. However, eventually most actors involved in a given line of business will agree that the new ways are superior to the old ones. Much such market-based selection of different approaches to any given problem results in the formation of what Spender (1996) has labelled ‘automatic knowledge’: the possessors know little or nothing of its origin or how they have come to know it, but ‘it’s here’ and ‘it works’ (Baumard 1996). New knowledge can also be created intentionally, as a resourceconsuming effort, for example through public or firm-based R&D activities; meticulous observations; conscientious surveys; prudent inquiries; scrupulous explorations, and in a number of other ways. Sometimes the outcome is of significantly less value than expected, while at other times pleasant surprises occur, partly because it might enhance the ability to absorb and utilise already existing knowledge (Cohen and Levinthal 1989). Still, deliberate knowledge creation is an activity where the necessary relevant information to facilitate rational decision making is absent (Dosi and Orsengio 1988). The time and cost involved in reaching the desired result are difficult to estimate, just as the possible economic gains might easily be distorted by some unforeseen turn of events. Knowledge is, furthermore, in itself always associated with some ambiguity as to what it is really about and what use can be made of it (Reed and DeFillippi 1990; Alvesson 1993).6 Firms seem to handle this basic uncertainty by developing internal procedures and routines when searching for possible solutions. These procedures and routines are based on the firm’s interpretation of its successful behaviour in the past, and they will continue to be reproduced and 31

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reinforced as long as they seem reasonably efficacious (Nelson and Winter 1982; Salais and Storper 1992; Hodgson 1994). Some novel ways of doing things are rejected when the results are confronted with practice, while others function comparatively well and are gradually embedded as part of the internal routines. Routines can be the result of carefully conducted investigations over an extended period of time, though sometimes a nonrandom sample of one seems to be sufficient. Routines allow the firm to economise on finding facts and processing information, just as its procedures simplify the everyday tasks of making decisions (Simon 1982; Heiner 1983). The procedures and routines that a firm develops will determine the distribution of its specific actions within the range of possibilities that are open to it at any given time. Each new round of knowledge creation is strongly influenced by the successes and failures of former rounds, and this limits the range of possible avenues that the firm might take in the time to come (Dosi 1990). ‘Through the joint action of search and selection, the firms evolve over time, with the condition of the industry in each period bearing the seeds of its condition in the following period’ (Nelson and Winter 1982:19). Intentional knowledge creation is thus strongly path-dependent as today’s practices, routines and types of knowledge are related to those of yesterday, just as those of tomorrow will be related to those of today (Arthur 1994), representing ‘the transmission in time of our accumulated stock of knowledge’ (Hayek 1960:27).7 The path-dependence is furthered by the strong element of asset mass efficiency in knowledge creation and accumulation. Firms, regions or countries that already have a large stock of R&D and experience-based know-how, a specialised labour force or infrastructure and so on, are often in a better position to make further break throughs, to add to their existing stock of knowledge, than those that have only a limited initial endowment of such factors. Now and then the process of knowledge creation takes Schumpeterian proportions, and in such cases it reforms or revolutionises the pattern of production by exploiting an invention or, more generally, an untried technological possibility for producing a new commodity or producing an old one in a new way, by opening up a new source of supply of materials or a new outlet for products by reorganising an industry. (Schumpeter 1942:90) Usually, however, knowledge creation is a somewhat humble and unostentatious ongoing, incremental process that rarely leads to dramatic changes in the market situation. Both major, path-breaking innovations and insignificant incremental improvements accumulate in the organisational 32

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structure of the firm as routines and will gradually result in new and better ways of doing things. Other improvements from the process of search and selection are embedded in the individual employees as acquired skills, qualifications and training, while still others are embedded in the fixed capital of the firms through its investments in machinery, etc. Sometimes the process of knowledge creation produces results that are surprisingly successful even for those directly involved in the process. Such results tend to beget routines of extraordinary durability. Success creates internal bonds and firm-specific commitments that can make routines more durable than needed: they are retained and sometimes even aggressively defended long after changes in the external conditions of the firm have made them redundant (Demsetz 1988). It is difficult to unlearn successful habits of the past, even in cases where it is obvious to everyone concerned that they hinder future success (Imai, Nonaka and Takeuchi 1986, Hedberg 1981). Lack of unlearning often goes hand in hand with an increasing resistance towards new ideas, a growing bureaucratic inertia and a general organisational degeneration, especially when the firm is operating in generous markets (Eliasson 1996). Experienced success results in a flatter forgetting curve, and accepted best practices assume a life of their own (Hamel and Prahalad 1994). It is an established fact of life that it is a lot easier to challenge the orthodoxy of others compared with one’s own, and firms are frequently led by their former success into trajectory-specific lockins (David 1985; Arthur 1989; Ghemawat 1991).8 Or in the words of Boisot: experiences work their way into the collective memory and expectations of a culture and remain embodied in institutional arrangements long after they have ceased to serve. They may then obstruct rather than assist the process of social adaption much as early childhood traumas become the source of phobias and pathologies in later adult life. (Boisot 1983:160) Occasionally, regions and countries also get caught in specific, initially successful, ways of doing things, which later events have converted into shackles hindering further progress (Elbaum and Lazonick 1986).9 Entire industries can find themselves in such situations for quite a while, until someone breaks the spell by introducing new ways of doing things. Case studies of differences in plant productivity between competing firms again and again reveal a lack of open channels of communication for passing suggestions of improvements through the filters between departments and between layers of the organisation. Individuals aware of potentially profitable, but unexploited, opportunities find that implicit organisational rules —functioning as self-imposed restrictions—prohibit them from pursuing such opportunities. The existence of internal barriers to change 33

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in the firm might limit the possibility of utilising knowledge that is already present in the organisation, since the barriers create a firm-specific blindness, even to obvious improvements (Flaherty 1994). A world full of clones—or lack of generic variance—provides ample business opportunities to be exploited for any economic agent that is not locked in by the sharing of the conventional disposition (Locke 1690; Hamel and Prahalad 1994). In that way all firms, regions or countries can accommodate smaller or larger pieces of unused knowledge in some form or other because preferences, prices, or routines are not adapted to it (Abernathy, Clark and Kantrow 1983). Conventions, customs and habits epitomise the rampant imperceptiveness towards improvements, accentuated by Kirzner in his stimulating discussion of ‘the social significance of knowledge about which nothing is known’: Ignorance of knowledge that might be spontaneously, undeliberately absorbed can…never be explained in terms of anything other than itself. Such ignorance is simply there. It cannot be accounted for on the grounds of high search and learning costs, since no searching or learning is needed at all even, to repeat, at zero cost…. Ignorance of knowledge that can be absorbed without decision is simply the expression and the evidence of a sheer failure to notice what is there to be seen. It can be given a name—lack of entrepreneurial alertness—but it cannot be explained in terms of the standard economics of micro-theory, the theory of deliberate individual decisions. (Kirzner 1979:145) The activities of entrepreneurs (Burgelman 1985) thus create new business opportunities not only by adding to our stock of knowledge, but also by identifying unused knowledge and converting it to usable forms. The accumulation of useful knowledge in an economy is thus dependent not only on the knowledge creation that takes place in each firm, region or country, but also on the speed with which path-dependent lock-in situations are broken and knowledge-creating activities are restored by the serendipitous or purposeful activities of undogmatic entrepreneurs. Tacit and codified forms of knowledge Initially most pieces of knowledge probably appear in a form which is exclusively tacit (Polanyi 1958, 1966): a person gets an idea10 or becomes aware of some hidden relationship or new opportunity (Cowan and Foray 1996). Such purely tacit knowledge is at first accessible to the individual only, and much new knowledge will remain that way. ‘Since the capacity 34

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to understand varies among individuals there will always be certain things that I cannot communicate to others and vice versa’ (Eliasson 1996:15). Sometimes, however, a piece of knowledge is shared with others, who have the capacity to understand the idea and grasp its implications and importance—be they large or small. Still the knowledge remains in a mostly tacit form existing solemnly within this smaller group of persons, often sharing some common trait, which made the transmittal possible (Vygotsky 1962; Lave and Wenger 1991; Antonelli 1995). Over time, many pieces of knowledge gradually get more codified. Codified knowledge can be communicated by symbols and language, and thus has the necessary features to be ‘tradeable’ (Dosi 1988), if and when the sufficient market conditions occur. What is actually codified depends on the scope of the codification process, whether deliberate or not, and on the idiosyncrasies of the agents involved in the process. Some types of codification can be very personal—like the artist painting an object— without losing value for being so (Boisot 1983). But with further use and re-use most codification loses the personal touch, but not necessarily all idiosyncrasies. Hence, codification is not merely a procedure for relocation of knowledge from one sphere to another (Hatchuel and Weil 1995), but also a metamorphosis whereby the composition of the knowledge is irreversibly changed (Foray and Lundvall 1996). Codification can take place in different ways, some of which are mainly unpremeditated consequences of knowledge being used. Sometimes, for instance, the new approach turns out under closer examination to be representing a general phenomenon, which over the years might become formulated as a universal law or principle. More frequently, the new approach to a problem gets better understood by its use and refinement in practice. Gradually its constituting parts get identified as the new method is broken down to still more elementary segments. With each step of unravelling and simplification, the description of the ingredients in the new approach gets easier, and the prospects improve for communicating them to individuals unacquainted with the specifications of the original problem. Improving the prospect for exchanging codified knowledge does not, however, infer that the receiver of the knowledge can use it immediately and effortlessly. Chess, for instance, is highly codified, but it nevertheless takes a lot of effort to be able to play the game well, even after having learned all the rules (Dreyfus and Dreyfus 1986; Hatchuel and Weil 1995).11 Codification makes exchange easier only in the respect that very little will have to be invested in the relationship between the present owner and the receiver of the knowledge, in order to convey its contents. Much previously tacit knowledge has become codified over time through the increased understanding of its nature when used in different circumstances and by different persons or organisations. Knowing that something is possible often provides enough of a guideline to enable 35

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imitation in ways that do not necessarily violate any legal protection of the original knowledge-owner. Every human-made object testifies by its mere existence that there must be some way to produce it. If the object is valuable, someone different from the initial producer will sooner or later come up with a solution, which might differ slightly from the original production process. Even if ‘very few free technological lunches’ (Pavitt 1987:186) might be obtainable, the cost of imitation will in itself be a sufficient barrier against imitation (Mansfield, Schwartz and Wagner 1981) only in the situations where the value of the initial innovation is limited. By ‘inventing around’ existing legal protection the process of imitation is accompanied by some incremental addition to the knowledge initially used (Pavitt 1987), often also by incorporating feedback from the customer (Kline 1991). New and improved ways of doing old things (like the ‘Fosbury Flop’, the backwards high jump named after its inventor) become the platform for new improvements overnight. Indeed, this combined process of knowledge creation, utilisation and imitation is constantly moving the knowledge frontier and redefines the ways in which firms, regions and countries can maintain and enhance their competitiveness: Markets are self-reproducing social structures among specific cliques of firms and other actors who evolve roles from observing each other’s behaviour. I argue that the key fact is that producers watch each other within a market. Within weeks after Roger Bannister broke the four-minute mile, others were doing so because they defined realities and rewards by watching what other ‘producers’ did, not by guessing and speculating on what the crowds wanted or the judges said. (White 1981:518) According to Porter (1990) the role of domestic, or local, rivalry is particularly important in the context of watching each other within a market. Best practices set by someone who is geographically close to us, and who we know is similar to us in other respects, are not only more visible but create a more direct pressure to catch up than ‘miracles’ achieved by actors who we regard as distant or different in important aspects.12 Besides these mainly unintended or even unanticipated ways of knowledge creation and codification, also quite deliberate efforts might be made (Antonelli 1995). Rent-seeking owners of new or old pieces of knowledge, which they envisage will be valuable to others, can feel a strong incentive to engage in such a process in order to reach these potential customers. Codification is usually needed to embody the knowledge in software or in the hardware of a machine, sold later with some mark-up. The 36

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software or the machine is thus only a medium for the knowledge owner’s appropriation of rents streaming from the knowledge owned. The quest for cost reduction internally in firms might constitute an even stronger incentive for an owner of a piece of tacit knowledge. Without codification the transfer of knowledge will typically take place by demonstration: the owner of the knowledge showing the novice how to behave. Successful codification implies a lasting reduction in the otherwise recurrent costs of communicating knowledge from one individual, department or organisation to another (Zander and Kogut 1995). Codification of knowledge is a step in the process of reduction and conversion which renders the transmission, verification, storage and reproduction of information especially easy. Codified information typically has been organised and expressed in a format that is compact and standardised to facilitate and reduce the costs of such operations. (David 1992b: 220) The more a firm is able to codify its tasks, the less time and money are needed for instruction, guidance, training and supervision of the employees. When Henry Ford in the beginning of the twentieth century achieved a manifold increase in the productivity at his car assembly plant, the main reason was not the invention of the conveyor belt or any other technical device. His innovation was basically organisational—by conducting a meticulous codification of each task which was subsequently apportioned to an unskilled worker, needing only brief training to meet the limited demands of the task at hand.13 Some degree of codification is indispensable in order to obtain economies of scale and scope: The potential economies of scale and scope…are the physical characteristics of the production facility. The actual economies of scale and scope…are organizational. Such economies depend on knowledge, skill, experience and teamwork—on the organized human capabilities essential to exploit the potential of technological processes. (Chandler 1990:24) Furthermore, codification is not just transforming knowledge into a form which increases its economic value. Codified knowledge does often in itself represent a tool for producing new knowledge. The existence of a codified knowledge base reduces the barriers for identifying and filling holes in the existing bulk of knowledge, and makes it easier to cultivate a line of thought still further, or to enrich an already diversified field of techniques, theories and data: 37

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Whenever a new production function has been set up successfully and the trade beholds the new thing done and its major problems solved, it becomes much easier to improve upon it… Innovations are not evenly distributed over the whole economic system at random, but tend to concentrate in certain sectors and their surroundings. (Schumpeter 1939:100–101) This virtue of codified knowledge will in itself act as an incentive for still further codification. Technological progress is therefore to a large extent the result of an interlinked process of knowledge creation and subsequent codification. Codification is thus at the heart of the whole philosophy of industrialisation. Market creation, cost reduction and intensional learning have in common that they are motives for rent-seeking owners of knowledge to engage in a process of codification. One would, perhaps, expect that the accumulated effect of this effort would be a steady increase in the codified knowledgebase, and a corresponding decrease in the volume of seasoned tacit knowledge, still uncodified. This is, however, not the case for many reasons. One reason is that not all pieces of knowledge are in fact potentially codifiable. For instance, such skills as pattern-recognition and flair for design elements can turn out to be non-codifiable (March and Simon 1993).14 They represent the mental equivalent to the combination of knowledge with practice that in a more physical form characterises, for instance many performing arts: A pianist about to play a fast composition such as a Chopin étude does not think, ‘Now I hit A-flat and next…’. He or she merely thinks, ‘Étude #5, Go!’ The rest is programmed in muscles via long practice. If it is not, one is certainly not a skilled pianist. (Kline 1991:480) An expert computer programmer searching for a bug in a program capitalises on his or her knowledge as well as long practice in reading hidden signs and cues, suggesting the location and type of the error. A presumably more familiar type of barrier is seen in situations where the costs of codification evidently exceed the benefits. Such situations can arise from lack of demand for the codified piece of knowledge or from attempts to codify exceedingly complex pieces of knowledge. Certain things, which can be fairly easy to learn, can be very difficult and costly to describe or codify (von Hippel 1994). Even knowledge shared by large groups of people—for instance the knowledge of how to use a language as a means of communication—can not be codified at all easily. Such 38

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knowledge might remain for ages in a more or less tacit form within one or more countries, while linguists struggle to identify and disentangle its intricacies (Polanyi 1958, 1966). Uncertainty might also prevent the total elimination of the tacit knowledge-base. For some pieces of knowledge codification might be profitable, but the lack of sufficient information to calculate the pros and cons leaves this potential untapped and the knowledge uncodified. Other more innate barriers to full codification can also be identified. It appears that some tacit knowledge is almost always required in order to use new codified knowledge (Dreyfus and Dreyfus 1986; Pavitt 1987; Rosenberg 1990; David 1992b; Foray 1992; Gertler 1995), though the reasons for this are not yet completely clear. The fact remains, however, that it is difficult for people to learn certain things without at least some small but significant prior (tacit) knowledge, gained by hands-on experiments and training. In analysing the dissemination of a new technological breakthrough (the laser), Collins (1974:181) noticed how ‘Respondents twice described failed attempts to learn to build the laser from someone who “had all the particulars”, but had not themselves built one.’ His point is that all relevant knowledge cannot be abstracted from the ‘carrier’, regardless of whether a close colleague or a hired informant, or whether the information is delivered in other media, as a film or a written account. Nobody has, for instance, ever been able to use a personal computer just by reading the manual, regardless of how much effort has been committed to making it understandable. But after using the computer for even a short time, the concepts and examples of the manual suddenly make sense and can be understood. The evident requirement of possessing an iota of tacit knowledge before being able to utilise any codified knowledge must, if universally true, necessarily lead to a cumulative growth in the tacit knowledge-base corresponding to the growth in the codified knowledge. The demand for a tacit knowledge-base prior to any transfer of codified knowledge might even help to explain the depressing results of much development aid to regions and countries in the Third World, while other parts of the world experience little difficulty in catching up with the technology used by the most advanced countries, once former barriers are eliminated. When Grossman and Helpman (1991) demonstrate how global access to knowledge leads to increasing convergence in real income growth rates, one might add that any attempt to obtain above-average growth rates will thus depend heavily on the ability to utilise some spatially confined tacit knowledge (Zander 1992; Baumol, Nelson and Wolff 1994). The size and composition of the tacit knowledge-base of a region or country do perhaps constitute fundamental ingredients in its ability to perceive and absorb any valuable innovation generated outside its borders.15 39

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Furthermore, the individual economic agent possessing any piece of knowledge can try to preserve and protect it from becoming generally available. Firms will thus often have a strong economic incentive to protect as much as possible from public dissemination. Publicly funded academic research in a sense represents a different situation. Here, the individual scholar usually has little to gain economically from trying to restrict the dispersal of the new codified knowledge that he or she has come up with. On the contrary, the entire reward system (jobs, income, status, Nobel Prizes) emanates from the process of disseminating knowledge efficiently, and members of the academic world consequently devote much time and effort to publishing their results as rapidly as possible. But even here the codification and dissemination might be kept incomplete deliberately. An article in a professional journal on some new technological breakthrough will, for instance, in many cases not reveal everything: ‘What you publish in an article is always enough to show that you’ve done it, but never enough to enable anyone else to do it. If they can do it then they know as much as you do’ (Collins 1974:176). The speed at which the potential of newly codified knowledge can be utilised by others is not just ‘a purely technical property that depends on the ready availability of channels of communication’ (Boisot 1983:162), but is also influenced by the possessors’ incentive structure. But even if, or when, the process of dissemination is slowed down by such action, neither firms nor individuals can hope to preserve the new codified knowledge forever. Any codification of a piece of knowledge will eventually lead to its diffusion, thereby undermining the present possessor’s possibility to use it as an ingredient in sustaining competitiveness (Allen 1983). When formerly tacit knowledge is converted into an (almost) fully codified form, a process is initiated which will sooner or later—usually sooner—turn it into a ubiquity by making it accessible on the global market. Codification as a second process of ubiquitification The linkage between codification and ubiquitification has severe consequences for the firms in high-cost areas of the world. The more or less immediate effect of codification is the same as for all other former assets which have been turned into ubiquities: the knowledge loses its potential to contribute to the competitiveness of the firm. No firm exposed to international competition and located in a high-cost area can therefore depend solely on already fully codified knowledge. Though the understanding of the linkage is indeed quite novel, the phenomenon as such is not new at all, nor is it especially typical for the present age. It was, for instance, pointed out by Marx (1867), and three quarters of a century ago Marshall noticed that there are: 40

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broad ideas and knowledge, which when once acquired pass speedily into common ownership; and become part of the collective wealth, in the first instance of the countries to which the industries specially affected belong, and ultimately of the whole world … Whether he [the inventor] communicates his results to a learned society, and leaves others to earn money by them, or applies them in practice himself (with or without the protection of a patent), they become in effect the property of the world almost at once. Even if he uses them in a ‘secret process’, enough information about them often leaks out to set others soon on a track near to his own. (Marshall 1919:175, 204) In Chapter 2 some attention was given to the distinction in traditional location theory, between on the one hand the location factors, for which the costs differ significantly between locations, and on the other hand the so-called ubiquities, available everywhere at more or less the same cost. It was shown how the process of internationalisation actively converted some previously important location factors into ubiquities, and how this weakened the actual or potential competitiveness of firms located in the highcost areas of the world. When international factor, capital and commodity markets are opened up, firms in low-cost areas are becoming increasingly competitive. Codification contributes to this process of ubiquitification by making knowledge more easily transferable over space. Knowledge of the latest production techniques and organisational designs, formerly only possessed by a limited number of firms in the high-cost areas of the world, gradually become available globally through codification and subsequent dissemination. Two distinct processes of ubiquitification are thus simultaneously at work in devaluing previously precious regional or national capabilities: the process of internationalisation of factor and commodity markets and the process of codification of knowledge. But if all factors of production, all organisational blueprints, all market information, and all production technologies became readily available in all parts of the world at (more or less) the same price, few possibilities would exist for producing in a highcost environment (Nelson and Winter 1977; Loasby 1990). In high-cost as well as low-cost environments the process of ubiquitification thus erodes some of the potential areas in which a firm can distinguish itself on the market. What is not eroded, however, is the non-tradeable/non-codified result of knowledge creation—the embedded tacit knowledge—that at a given time can only be produced and reproduced in practice. The fundamental exchange inability of tacit knowledge increases its importance as the internationalisation of business 41

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markets proceeds. It is a logical and interesting—though usually overlooked— consequence of the present development towards a knowledge-based economy that the more easily codified (tradeable) knowledge is accessed by everyone, the more crucial does tacit knowledge become in sustaining or enhancing the competitive position of the firm. Hence, the process of ubiquitification will contribute to cripple the competitiveness of firms in high-cost regions and countries of the world if not countervailed and compensated for in some way. In the current knowledge-based economy this infers that firms in the high-cost areas must either shield some valuable pieces of knowledge from becoming globally accessible, or be able to create, acquire, accumulate and utilise codifiable tacit knowledge a little faster than their cost-wise more favourably located competitors. In real-life situations these two different strategies will often be combined in one way or the other, but they are theoretically distinguishable and will be commented on separately here. Protection of knowledge If knowledge could be treated as all other commodities, its extraordinary durability should enable the owner of any piece of knowledge to sell it again and again without reducing his or her stock, and to do so at prices below the customer’s cost of producing it in-house. But quite the contrary does, in fact, apply. Knowledge cannot readily be sold or acquired through the market. The reason lies in the asymmetrical distribution of information between the seller and the buyer regarding the main characteristics of what is offered for sale.16 A potential buyer wants to establish whether the piece of knowledge offered is worth the requested price. First of all the potential customer wants to make sure that the knowledge offered is not already in his or her possession, in which case any asking price will be too high. One unit of any piece of knowledge is clearly enough (Carter 1989), and the price for additional identical units of knowledge is always zero. Next, the potential buyer will want to ascertain the specific merit of the knowledge offered before purchasing it. The problem is that when fully informed of the content of the knowledge offered, the potential buyer has in effect acquired it for free. The awareness of this foreseeable outcome might easily discourage the seller from offering the knowledge on the market in the first place. And, finally, even if the knowledge offered was in fact sold, any one purchaser would be able to destroy the monopoly by starting to reproduce and resell it at little or no cost (Arrow 1962). This likely outcome might also discourage the owner from attempting to sell the knowledge. Hence, the market mechanism might be fine for the allocation of scarce resources, but not for allocation of knowledge, or indeed for the exchange of knowledge (Lundvall 1994). Nevertheless, no modern economy can 42

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exist without a mechanism to ensure the rapid and reasonably frictionless exchange of knowledge between and within the individual decisionmaking units: the firms (Hayek 1945). The conventional method to overcome this problem of market failure is based on creating safeguards to prevent the undermining of the business opportunities of the possessor of knowledge. This can be done in several different ways. One strategy makes the exchange of knowledge dependent on some sort of at least temporary legal protection (patent, registration, trade mark, etc.), which enables the possessor (patent holder) to sell the knowledge according to his preferences, almost as if knowledge was a commodity like all others. The investment required both in time and money to obtain the protection can, however, only be justified if the speed and direction of the process of knowledge creation does not make the protected knowledge obsolete before the costs are recaptured. Such calculations can be very difficult to perform ex ante. Furthermore, the protection gained by patenting, etc. is costly to uphold as violaters must be identified and brought to justice. Finally, the protection offered by patents and other legal measures does not always work, as discussed in the previous chapter: competitors may attempt to apply some small modification to the revealed information of the process or product involved, and thereby circumvent the legal barriers for entering the market (Mansfield, Schwartz and Wagner 1981; Pavitt 1987). Instead of taking on the costs of legal protection, the owners might sink costs in building a reputation for reliability (Milgrom and Roberts 1982; Kreps and Wilson 1982; Cremer 1986) and aim at obtaining returns to scale by cloning the knowledge and embedding it in some tangible or intangible form, which makes it easy to sell, but difficult for buyers to resell without a loss. Examples of firms which may follow this course of action include news agencies; market information bureaus; meteorological departments; credit ratings firms; address labels and telephone numbers services. Firms in all these industries pursue strategies where knowledge is treated mainly as an experience good, but with some credence good characteristics.17 In other lines of business a third strategy is common. Here the safeguards are based on the firm’s ability to combine attractive pieces of knowledge in a way which makes them highly usable for the client, but not for many others. The consultancy business does precisely this, as does (though to a lesser degree) the medical profession, the dentist, the veterinarian, the auditor and the solicitor. Firms in these trades are able to overcome the problem of market failure by making the client a coproducer of the final product. But not nearly all industries are able to accomplish this degree of customisation without loss of competitiveness by diminishing returns of scale. Finally, situations exist where firms can create, possess and utilise a lot of knowledge without being overwhelmingly concerned by the need for 43

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safeguards. The owner of knowledge might simply feel confident that the time necessary for any potential imitator to copy and market the knowledge created in the firm will be significantly longer than the time needed by the owner to create and market new knowledge with a higher perceived customer value (Zander and Kogut 1995). And who cares if someone else will be daft enough to spend good money on imitating yesterday’s advantages? By keeping the pace sufficiently high, the necessity of committing resources to construct safeguards against damaging imitation is eliminated. Thus the firm achieves two objectives simultaneously: it can appropriate Schumpeterian quasi-rents from the knowledge created, while still being cost efficient by evading the economic burden of establishing and maintaining safeguards. These advantageous attributes have, as a matter of fact, made this approach one of the prime driving forces towards the knowledge-based economy discussed in Chapter 2, even though the number of firms which are able to sustain such a process for an extended period of time is surely not large. It is not just incompetence in management that keeps the number at bay. The indefinite nature of knowledge creation also makes any kind of continuous, smooth development highly unlikely. And as a device to enhance the exchange of knowledge between firms, this approach is not particularly helpful. Enhanced use and creation of knowledge through trustful relations The fundamental market failure relating to the exchange of knowledge can, however, be overcome also by a more sophisticated method than the conventional, safeguard-oriented approach. This is done by additionally requiring investments from the potential buyer to match the specific investments made by the potential seller, and demanding that these matching investments should continue during an appreciable span of time. The result of such a procedure is a further relaxation of all existing barriers to the exchange of knowledge between the partners compared to the conventional method. More important, however, is the fact that the sophisticated method furthermore enables the transfer even of some tacit knowledge between the possessor and the buyer. The sophisticated method of overcoming the problem of market failure in knowledge exchange is not so much oriented towards servicing a market of many customers, often unknown to the seller before the transaction. It is more aligned towards the building of reciprocal and gradually more stable arrangements between a limited number of sellers and buyers, where the actors involved gradually come to trust each other, or at least behave as if they trust each other. Thus, trust-based relationships are primarily built, as trust is not a commodity readily available on the market:

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If you have to buy it, you already have some doubts about what you’ve bought. Trust and similar values, loyalty or truth telling …are commodities; they have real practical economic value;… But they are not commodities for which trade on the open market is technically possible or even meaningful. (Arrow 1974:23) When building trust-based relations between firms some forms of tacit knowledge might eventually be exchanged. We propose that four distinctive stages in this process can be identified. 18 The four stages represent a taxonomy of ways to exchange knowledge. All stages will usually have to be travelled sequentially in order to reach the final stage. However, a firm can decide to stop at any one stage when either internal or external circumstances make this advantageous. All firms might also at one and the same time have external business relationships that will belong to different stages. In Stage I, the transfer of knowledge involves the employment of a very old-fashioned, pre-capitalist exchange mechanism: barter. Here knowledge is exchanged directly—without the use of money—between partners who both suspect that they might benefit from obtaining some knowledge that the other possesses. Such pairwise exchange arrangements limit the firm’s possible loss of competitive advantage when making knowledge available to others, though it does not completely eliminate the risk (Carter 1989). Barter implies that each party needs to produce new knowledge in order to get access to new knowledge. Though the use of this old mechanism is not uncommon for exchanging knowledge, for instance within and between academic research groups, it is often very costly and inefficient to use. It is costly both in money and search time because the seller will have to identify a potential buyer, who at the same time wants to exchange knowledge that might be useful. This is inefficient as many potentially beneficial exchanges will not take place simply because buyers and sellers do not find each other. Over time, therefore, a more efficient arrangement often evolves (Stage II), where the partners in one transaction save some or all of the search costs by keeping in contact with each other, thus initiating a ‘dyadic’, stable relationship (Demsetz 1968; Wilson 1975). Every time an exchange of knowledge between the parties takes place thereafter, the cost of the exchange drops further. Former misunderstandings and misinterpretations are gradually eliminated, and the exchange can encompass a still wider range of subtle pieces of knowledge. By repetition of knowledge exchange both parties thus benefit from a decrease in cost and an increase in quality of the knowledge transmitted:

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Knowledge is easier to codify and codified knowledge is easier to diffuse within a community made up of agents who can read the codes…. The ability to produce and receive signals in a language, even a very common one, requires initial and irreversible investments. (Cowan and Foray 1996:10–11) If successful, such dyadic relationships are intensified as both parties contribute in strengthening the bilateral links and dilate their scope to involve several or all layers of the two organisations (Ford 1990; Sabel 1992). Each new link created, each new experience with the partner’s peculiar ways, and each adaptation and modification accomplished in order to facilitate future exchange, all represent the sinking of costs in building inter-organisational competencies. The inter-organisational competence includes the routines and conventions that make the economic system function without much fuss and with accordingly low transaction costs: the costs of persuading, negotiating, co-ordinating, understanding and controlling each step in a transaction between the two firms. Gradually not only fully codified pieces of knowledge are exchanged, but also knowledge with some portion still tacit. As the deepening of the relationship continues, the perception is intensified and the received tacit knowledge better understood. Through ‘continuing association both parties can benefit from the somewhat idiosyncratic investment of learning to work together’ (Eccles 1981; Håkansson and Johanson 1993). Once the element of relation-specific sunk cost is large enough, a qualitative change takes place as the scope for opportunistic behaviour (Williamson 1975) becomes negligible (Stage III). In a dyadic relationship, the accumulated sunk cost makes the partners behave as if they trust each other. Thus: continuity of relationships can generate behaviour on the part of shrewd, self-seeking, or even unscrupulous individuals that could otherwise be interpreted as foolish or purely altruistic. Valuable diamonds change hands on the diamond exchange, and the deals are sealed by a handshake. (Ben-Porath 1980:6) Trust will thus characterise a relationship between business firms when each is confident that the other’s present value of all foreseeable future exchanges exceeds the possible benefits of breaking the relationship. The larger the sunk costs, the greater the confidence and the trust. And trust is a remarkably efficient lubricant to economic exchange, assuaging the

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friction for interaction, co-operation or exchange and creation of knowledge (Storper 1994; Fukuyama 1995). One important consequence is that the flow of knowledge between the two participants does not have to be strictly reciprocal and take place at precisely the same time. By believing that some piece of knowledge offered free of charge today will be repaid at some later moment in some way or another, the exchange of knowledge increases in both speed and intensity (von Hippel 1987). As all the relevant knowledge is seldom available at one place only (Hayek 1945), firms need to gain access to other sources, and to do so with as little effort as possible. By utilising already existing relationships as channels to approach new sources of expertise, both the search cost and the admittance barriers (new rounds of sinking costs) can be minimised. In Stage IV dyadic partnerships interconnect in building network relationships through which each participant might access knowledge while benefiting from the trust-enhancing investments made by the initial sinking of costs in one or a few relationships (your-friend-is-my-friend). With the risk of severing carefully built bonds with intimate business associates if they misbehave, firms in a close-knit business network are placed in a situation where any infringing of trust is so severely penalised that in effect malfeasance becomes a non-option. On the global market for standard goods, where all customers and all suppliers can easily be substituted, an unsatisfied customer has no way of reaching all potential future buyers, and opportunistic behaviour can therefore continue indefinitely. Not so in the business network, where any such wrong-doing will soon be known by all. As Granovetter commented: Malfeasance is here seen to be averted because clever institutional arrangements make it too costly to engage in, and these arrangements—many previously interpreted as servicing an [other] economic function—are now seen as having evolved to discourage malfeasance. Note, however, that they do not produce trust but instead are a functional substitute for it. (Granovetter 1985:489) The collective awareness of this mechanism makes it possible to exchange knowledge even between competitors within a network, to an extent which no outsider can aspire to achieve (von Hippel 1987). All progress in the refinement of inter-organisational routines increases the efficiency by lowering the total transaction costs (Langlois 1992). These include the costs for identifying precisely where the relevant knowledge might be located,19 i.e. the ‘know-who’ in the terminology of Lundvall and Johnson (1994), as well as the costs involved in the extraction, transfer and conversion of knowledge to a usable form in the receiving firm.20 47

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Conclusion: towards an understanding of interactive learning in localised industrial systems In this chapter, we have discussed how firms can maintain and enhance their competitiveness by creating, exchanging and using knowledge. Starting with an analysis of some general characteristics of the process of knowledge creation, linked to uncertainty, incrementalism and path dependence, we went on to discuss the difference between tacit and codified knowledge, and how the process of codification relates to what we have previously discussed as a process of ubiquitification. Furthermore, we have discussed various ways in which firms can protect their knowledge assets from becoming completely ubiquified, and thereby of little or no value as a source of competitive advantage. In particular, we have emphasised how the step-wise building of trust-like relations between actors in industrial systems is an important means to sustain knowledge-based competitive advantage. Thus, we argue that a business environment that enhances trust will always make an economic difference. When the traditional, static, costrelated international competition is superseded by competition based on dynamic improvements and learning (Lundvall 1994), the importance of such an environment can be assumed to increase dramatically (Fukuyama 1995). There is little doubt that the aggregate effect of knowledge sharing on the speed of innovation and economic progress has been largely overlooked until recently (Allen, Hyman and Pinckney 1983; von Hippel 1987): An essential feature of collective invention was the release of technical information to actual and potential competitors. It was this behaviour which allowed cumulative advance…. Hence, one would expect to observe the wilful dissemination of technical knowledge under a variety of circumstances. And, indeed, even a casual acquaintance with recent engineering literature indicates that such a behaviour is rampant today. To the degree that economists have considered this behaviour at all, it has been regarded as an undesirable ‘leakage’ that reduces incentives to invent. That firms desire such behaviour and that it increases the rate of invention by allowing cumulative advance are possibilities not yet explored. (Allen 1983:21) As knowledge increasingly becomes a conspicuous element in the quest for achieving competitiveness the building of, and participation in, such network relations between firms is developing at a faster rate than ever before (Axelsson and Easton 1992). 48

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There is, however, also an opposite side of this trend towards successively more tightly knit business networks: it may lead to increasing difficulties for new firms to break into such networks. By erecting barriers to new firm formation there lies an inherent risk of slowing down the process of industrial renewal, thus frustrating the net gains for the economy taken as a whole. An excessive sinking of costs in solidifying a network might also give rise to risks of lock-in if or when the framework conditions make the old network partners less economically interesting. This potential drawback is less evident when learning is not only interorganisational, but also territorially embedded, i.e. strongly rooted in the specific social and institutional setting of a place, region or country. These issues will be highlighted in the next chapter, which is focused on the possibility of territorially defined ways and means to enhance knowledge creation, while preventing imitation of the firms rent-yielding capacity. It will be argued that the tacitness of the knowledge created in settings where localised, inter-organisational assets are important, prevents dissemination to outsiders. This crucial component may thus contribute considerably to enable firms, regions and countries to maintain competitiveness regardless of whether their specialisation is high-tech or indeed low-tech and help to explain abiding patterns of territorial specialisation.

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4 LOCALISED CAPABILITIES AND THE COMPETITIVENESS OF REGIONS AND COUNTRIES The people of today have no shame at lying or breaking their word (…) what the upright call treason the others nowadays call subtlety and cunning, wherefore faith will be destroyed, because one man will put no trust in another. (Honoré Bonet, fourteenth-century advisor to Charles VI of France (Nys 1883:213, quoted in March 1994:48))

In the contemporary political debate it is commonly alleged that the rentseeking firms of the private sector shoulder the principal duty of building and retaining competitiveness. The function of the region or the country is at best supplementary: its task is exclusively to create and uphold a supportive environment, so that the firms located there are not prevented from thriving and expanding. Such a viewpoint represents, however, a rather restricted understanding of competitiveness, ignoring the fundamental interrelatedness between firm and territory. The interaction between territory and economic development Firms interact in markets which, whether designed or self-grown, are undoubtedly social constructions, embedded in territorially specific institutions which define and secure property rights and enable economic transactions. Furthermore, if not regulated, supervised and controlled by painfully constructed public, semi-public or co-operative bodies operating at regional, national or supranational levels, most (if not all) current markets would sooner or later either disintegrate into chaos or deteriorate by the formation of oligopolies. That a functioning market economy is not identical with the mere absence of regulatory regime has been illustrated in a particularly explicit way by the recent transformation process in east and east-central Europe (Grabher and Stark 1997). Well functioning and organised markets for products and production factors must, on the

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contrary, be seen as a (non-tradeable) territorial specific asset: a localised capability. The territorially specific mechanism through which the market is established and upheld is a necessary precondition for gaining competitiveness, though not a sufficient one. Firms become competitive, and retain their competitiveness, by conceiving and implementing strategies which utilise —directly or indirectly—a number of valuable traits and properties of their place of location: the ones that enable them to earn a profit when faced with otherwise similar competitors located elsewhere. All such regional or national traits and properties influencing the competitiveness of a firm or an industry are referred to as the ‘localised capabilities’ of the area in question. In a knowledge-based economy, valuable localised capabilities will primarily be those which increase the ability of firms to create; acquire; accumulate; and utilise knowledge a little faster than their costwise more favourably located competitors. No firm can pursue strategies that entirely disregard the quality and character of the capabilities in the region and country of location. In order to be successful all strategies presuppose the existence of at least some localised capabilities. No firm is thus unequivocally footloose, locatable in any environment whatsoever. Though the localised capabilities restrict the distribution of possible successful strategies that firms might pursue, they do always leave room for discretionary choices ‘related to the propensities [of firms] to accumulate, to take risks, to trade-off present profits for market shares, to search in some directions and not in others, etc.’ (Dosi 1988:125). Nevertheless, the capabilities of a region or country do have a directional effect on the efforts of the firms located there, by supporting and assisting some types of activities while hampering or preventing others. Some firms deliberately incorporate specific parts of the localised capabilities in constructing a consolidated strategy, by acquiring resources primarily from the local factor market and by subsequently building unique competencies on these resources (Collis 1991). This makes good sense. For while the firm-specific strategies might be imitated by a clever competitor located elsewhere, it is a lot more difficult for even the best competitors to confront the abstruseness of the combined strategy, and to disentangle the ambiguity created when integrating various elements of the localised capabilities (Reed and DeFillippi 1990). Even when a competitor in some occasional case turns out to be sufficiently perspicacious it will hardly ever find itself in a position where it can readily modify the localised capabilities in its own home region or home country. Consolidated strategies thus infer safeguards against imitation, and make it advantageous for firms to base even a rather large proportion of their strategy on some localised capability. The strategies and actions of a firm are thus influenced by the capabilities of the area in which it is embedded. The net effects of the specific 51

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combination of the localised capabilities simultaneously spur and confine the development of the firms in the region or the country, thereby exerting a strong—but never deterministic—influence on the future of the area. Accordingly, the capabilities of an area can—in interaction with international market structures and industry-specific technological trajectories — over time result in the formation of specific patterns of specialisation and local demand, subsequently leading to distinctive technological competencies for the firms in the area (Porter 1990; Dosi, Pavitt and Soete 1990). There is a mutual interdependence between the two levels of aggregation touched upon so far: the changes at the level of industry are linked to the level of the region or country through differing time scales (Hudson 1994). Thus the valuable localised capabilities are retained or modified — at least partially as a direct or indirect result of the strategies that the firms located in the area employed in a previous period. The localised capabilities epitomise in this way the succession of economic activity in an area, while at the same time comprising the setting for new rounds.1 The relations of causality function both ways and form a decisive element in originating the durable patterns of territorial specialisation discussed in Chapter 2.2 In order to enhance the competitiveness of firms, the specific localised capabilities of the area of location must represent a combination of assets of significant value and rareness. As the locational demand of firms changes over time, the localised capabilities must adapt and transform in order to remain valuable. Hence, capabilities are not just a passive reflection—an embodied historical recording—of what has happened in the region or country recently or long ago. Localised capabilities are also modified or reconstructed by the deliberate and purposeful action of individuals or groups within or outside the area. Even though most of the localised capabilities reflect the (demands of) present economic agents or bygone economic activities, phenomena of retro-action from the future also play a part. By acting as if all regions and countries must follow basically the same stages on their route towards perfection, policy makers do, for instance, sometimes try to enhance the economic development of an area by producing an imitation of (aspects of) the localised capabilities, not of the laggards, but of what they believe to be the economically most advanced regions or countries, thereby hoping to become attractive themselves to more lucrative and rewarding industries (Hallin and Malmberg 1996). The occurrences of such retroaction phenomena from (what is perceived as) the future of the area are, nevertheless, insignificant compared with the role played by hysteresis in the formation of the capabilities of regions and countries. Besides the genealogical traces from the previous economic development of the area, the activities of entrepreneurs and policy makers, or other phenomena of retro-action, localised capabilities are sometimes also inadvertently influenced by the overspill from the sphere 52

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of other developmental processes of the area. Some of these processes are not unconnected with the industrial development, but are given a completely new economic significance by some unforeseen twist of events. For instance, can simple technical standards, chosen in times when foreign trade was insignificant, later on turn out to be of great relevance for gaining access to certain markets, thus becoming a significant element of the area’s capabilities? economic geography has no concern in general with weights and measures, or money, or banks or the whole technique of trade; but if it can be shown, for example, that the metric system gives Germany an advantage over Great Britain in South American markets, then the metric system becomes to that extent a factor in the geographical division of labour, —that is, it tends to locate the economic complement of the wheat fields and cattle ranches of Argentina in Germany rather than in England. (Robinson 1980:252) Sometimes more sweeping developments outside the realm of economics turn out to have decisive effects for the subsequent economic development of an area. Protestant ethics have influenced the inclination to save and invest (Weber 1904–1905), and changed attitudes and household functions have profoundly enlarged the supply of labour in some regions and countries in the 1960s. Also factors like the successful clerical effort in pre-industrial Sweden to increase literacy have, for instance, been identified as a major stimulus for the subsequent economic development in the country (Sandberg 1979; Markussen 1990; O’Rourke and Williamson 1995b). Over the centuries the general history and economic history of a region or country interact and combine in ways that make any clear distinction less meaningful. The main elements of localised capabilities The capabilities of a region or country may be perceived as consisting of four main elements: • • • •

the the the the

institutional endowment built structures natural resources knowledge and skills.

These elements are all moulded by historical processes. The institutional endowment represents the intricate contemporary interaction between elements of different ages (Braudel 1969), from the very old (religion, 53

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beliefs, values) to the recent (contemporary industry standards, current regulations, etc.). Built structures (buildings and infrastructure) can often be traced back through at least a century, while the natural resources are typically of pre-historic origin. The specific knowledge and skills of an area have normally been created and recreated as part of the history of the region or country (Maurice, Sellier and Silvestre 1982), and from time to time (often marginally) influenced by some deliberate development policy and drive. Likewise, it is hardly controversial to assert that the costs sunk in the built structures are predominantly the tangible result of deliberate, creative human effort. The intangible counterpart consists of the specific institutional endowment created by the interaction of deliberate efforts, as well as by mainly coincidental and inadvertent incidents and circumstances. Following Hodgson,3 institutions: refer to the commonly held patterns of behaviour and habits of thought, of a routinized and durable nature, that are associated with people interacting in groups or larger collectives. Institutions enable ordered thought and action by imposing form and consistency on the activities of human beings. (Hodgson 1994:253) The institutional endowment of a region or country embraces all the rules, practices, routines, habits, traditions, customs and conventions associated with the supply of capital, land and labour and the market for goods and services. It also includes the entrepreneurial spirit and the managerial incentive structure. Finally, it contains the governmental and political traditions and decision-making practices as well as the attitudes and basic values characterising the area: the religion, the moral beliefs and the culture. All institutional endowments are not equally compatible with the needs of the contemporary market economy (Haskell and Teichgraber 1993). The institutional endowment is thus increasingly seen as contributing to the existing differences between regions and countries. In his influential book on ‘national systems of innovation’, Lundvall (1992) argues that the focus upon the national level reflects the fact that countries differ regarding the structure of the production system and regarding the general institutional set-up. Specifically, the basic differences in historical experience, language and culture will be reflected in national idiosyncrasies in: • • • • •

internal organisation forms inter-firm relationships role of the public sector institutional set-up of the financial sector R&D intensity and organisation. 54

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In a somewhat similar vein, Whitley (1995) defines national business systems as particular arrangements of hierarchy-market relations which become institutionalised and relatively successful in particular contexts, and argues that despite the increasing internationalisation of many industries in the past decades, there is evidence that national institutions remain quite distinct and that they reproduce systems of economic organisation which vary significantly between countries. Other scholars (e.g. Cooke 1992; Bianchi and Giordani 1993) have focused their more or less related analyses primarily at the regional level. An illustration of the effect of differences in the institutional endowment at a regional level is given by Putnam (1993), who attempts to explain the uneven regional development within Italy. His main finding is that regions that enjoy effective government and economic growth in the 1990s have inherited a legacy of civic engagement that can be traced back to the early Middle Ages: the regions characterized by civic involvement in the late twentieth century are almost precisely the same regions where cooperatives and cultural associations and mutual aid societies were most abundant in the nineteenth century, and where neighbourhood associations and religious confraternities and guilds had contributed to the flourishing communal republics of the twelfth century. And although those civic regions were not especially advanced economically a century ago, they have steadily outpaced the less civic regions both in economic performance and…in quality of government. (Putnam 1993:162) This line of thinking has obvious policy implications, as the institutional endowment is undoubtedly a constructed part of an area’s capabilities. This is, however, intuitively less certain when considering natural resources. The converse extreme is, none the less, indubitably untrue: that natural resources are entirely ingenuous, unfeigned and unaffected by human action. Merely the act of recognising some property of nature as being a resource—distinguishable from a genuine geological or organic object — infers the application of human knowledge, judgement, values and idiosyncrasies. When rent-seeking firms first emerged, the initial variation in natural resources between regions and countries undoubtedly played a crucial part in ensuring the heterogeneity which is essential for economic progress. Also in the present era some firms locate in order to utilise major deposits of valuable minerals or depletable sources of energy; or to reap the fruits of a fertile land and a favourable climate; or to utilise easy access to commercially important fishing grounds, etc. But even in these cases it 55

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is normally not the abundance of a natural resource in itself that determines the subsequent location pattern of fishery, forestry, agriculture or excavating industries. ‘An increase in price makes previously uneconomic deposits potentially minable. New extraction techniques that lower the costs also shift resources into the recoverable category, and geological exploration shifts resources from the undiscovered into the identified class’ (Slade 1986:107). The same phenomenon applies to agriculture and fishing (as will be discussed in Chapter 7). An especially illustrative study has been conducted for the US on the crucial years from 1880 to 1920 (and with examples from many other countries and periods) first by Wright (1990) and then developed further in David and Wright (1995). They document how natural resource abundance was never a purely geologically pre-ordained, exogenous factor in the history of economic development, but rather an endogenous socially constructed condition, subject to increasing returns and other sources of positive feedback. They group these ‘forces of social construction’ in three broad categories, where the first is related to the development of an infrastructure of public scientific knowledge and the second to investment in mining education. The third category is referred to as the ‘ethos of exploration’, i.e. the broad cultural complex that lies behind the belief and the desirability and feasibility of continuing mineral discoveries, and the accommodating legal and political environments supporting these developments (David and Wright 1995). They further point out the similarities with endogenous growth theories —with their focus on investment and innovation—when showing how increasing returns were obtained by knowledge spilling over from the search and exploitation of one mineral to the other, and by the ‘lumpiness in physical infrastructure investments’ (David and Wright 1995:24). Hence, in economies where the exploitation of depletable or renewable natural resources plays a major role, clearly more is involved than the geological or biological properties only. Hypothetical regions and countries equally equipped with depletable or renewable natural resources will always display economic discrepancies reflecting their different ability to combine and integrate them with the institutional endowment and built structures in a valuable bundle of localised capabilities. The creation of localised capabilities By being the first to move into a new field of technology and specialisation, there is a possibility of obtaining increasing returns from the subsequent growth in competence and the utilisation of economies of scale (Romer 1987). Such first-mover advantages apply not only to firms but also to regions and nations (Krugman 1991b, 1991c). They can give 56

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rise to long-standing differences, not only in the industrial profile between regions and countries, but also in income generated. The initial impetus to what later becomes a highly competitive pattern of territorial specialisation might be a deliberate decision. But while success or failure can easily be determined ex post,4 even the most sagacious find it extremely difficult to assess ex ante the possible longterm results of being the first to do something. So more often than not, some basically arbitrary factors are also involved. In any case the mechanisms of positive feedback may have been sufficiently strong to sustain and guide the progress into a sustainable path. However, the many incremental events, which over time have steered a region or country to occupy an advantageous international position, attaining competitiveness in one or more dynamic and profitable fields, can in practice usually only be reconstructed in a very sketchy and incomplete form, because of the multifarious factors and numerous feedback loops involved. For instance, the strong German position within the advanced chemical industry through most of the twentieth century cannot be contributed to any one source, let alone to any single governmental policy. Rather it has been developed through interaction between, for example, the educational system, the legislation from the period of Kaiser Wilhelm II through the Weimar and Nazi intervals to the post-war parliamentary democracy, the institutions and scientific infrastructure and the credit system (Gerschenkron 1962). In an open economy, the competitiveness of firms will be enhanced by the feedback loops with the localised capabilities. Firms of a certain kind find some localised capabilities more valuable than others. The originally chosen location of an industry might have been basically accidental. But once in place, the specialised locational demands from the firms will influence the future development of the localised capabilities, making it advantageous for the industry to remain in the area, and for outlying firms to relocate (Enright 1994). This result emerges not because of the calculated and conscious choice of the fully informed economic agent (firm) operating on a perfect market. On the contrary, the emerging patterns of industry agglomeration and regional specialisation must be seen as result of the evolutionary process of selection. The selection mechanisms ensure that firms located in areas where the localised capabilities are specially suited to accommodate and satisfy their needs, will have a better chance of survival and growth than similar firms located elsewhere. When firms of a certain kind gradually concentrate in areas with localised capabilities which they find valuable, the demand for future changes in these capabilities usually becomes rather manifest and unconfused. Modifications in the built structures, the skills and competencies of the work-force, or the institutional endowment of the area will all tend to make the (new) localised capabilities even more valuable for the firms located there. Consequently their 57

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competitiveness vis-à-vis competitors located elsewhere is further augmented. Gradually, internationally highly competitive territorial agglomerations of related firms emerge. The phenomenon of territorial specialisation also applies to the process of new firm formation. The ‘transmission mechanism’ (Nelson and Winter 1982), by means of which spin-offs as well as genuinely new firms reproduce and reinforce an already existing industrial profile of an area, can be seen as consisting of two interconnected elements. First, entrepreneurs within a given business sector will concentrate in areas where this sector is already strongly represented5 and where the potential entrepreneur has learnt the necessary trade-specific qualifications and gained the experience needed. Second, during this period of learning he or she has established personal contacts and has become familiar with the local institutions, both of which are prerequisites in order successfully to embark on a new business venture. Incumbents sometimes also relocate in order to utilise spatial differences important for sustaining or augmenting their competitiveness.6 Even assuming that a new firm or an incumbent is completely free in its choice of location, the optimal location would usually be a region or country with a long track record of servicing firms in just that industry: only such a region or country has had the opportunity to develop the desired capabilities. The process of territorial economic development will tend to be highly path-dependent because of relocations and new firm formation in the already principal industry. A well developed local supply base represents, for instance, a set of constraints and opportunities which in practice can be very directional for the possible choices a firm might make,7 just as some distinctive feature of the demand structure in the region or country might further enhance an already exceptional pattern of specialisation. The differences in capabilities between regions or countries will (by definition) be revealed in discrepancies in the competitiveness of firms located there, with long-term consequences for their survival rate. Once in place, localised capabilities will continuously be retained and reinforced by positive feedback loops, as long as they are considered valuable. This was referred to in the previous chapter in terms of asset mass efficiency, and is a common trait in theories of regional economic development, captured by concepts such as external economies of scale, agglomeration economies and cumulative causation. Agglomeration and learning At a national scale such factors were included in the earlier discussion of the reasons behind the ‘sticky’ patterns of national specialisation and for the size-related differences found between larger and smaller 58

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countries. At a regional scale, individual industries tend to agglomerate in areas and places where the localised capabilities are especially well suited to cater for their needs, and where they might benefit from knowledge spill-overs from their neighbours. The proximity between different actors makes it possible for them to create, acquire, accumulate and utilise knowledge a little faster than their cost-wise more favourably located competitors. The agglomerative effect of localised spill-overs is, however, by no means a new phenomenon, though it has received increasing interest recently (Arthur 1986; Krugman 1991a, 1991c; Harrison 1992; Appold 1995; Herrigel 1996; Malmberg 1996; Asheim 1997). It was a major research area in economic geography in the 1960s and 1970s, including studies of the role of information in urbanisation economies (Pred 1977), the role of space in innovation diffusion (Hägerstrand 1967) and the role of personal contacts in decision making and systems of interaction (Törnqvist 1970; Utterback 1974). But given the rapidly increasing research interest being directed towards the causes and effects of spatial agglomeration of related firms and industries, we know surprisingly little of how common and widespread—across countries, regions and industries—this phenomenon is. Indeed, most of our knowledge on the subject is anecdotal in the sense that it is based on detailed analysis of more or less well known cases of a particular industry being strongly embedded in a particular place. The Italian region of Sassuolo in the province of Modena in Reggio Emilia, and the small Spanish town Onda north of Valencia in the region of Castellón are both well known examples of this from the tile industry, with some 70 per cent of the European output (COM 1995). Furthermore, geographical notions such as Silicon Valley, Detroit, Wall Street, Madison Avenue, the City (of London), the M4 Corridor, Prato, Sassoulo, Nuremberg or Pusan all make us associate to a particular type of industry. Most of these are extreme cases, and there is an obvious lack of studies that say something about how common it is that firms in a particular industry actually agglomerate in space. However, Enright (1993, 1994) and Ellison and Glaeser (1994) provide empirical support for the view that similar strong geographical agglomeration characterises a broad spectrum of industries in the US, and Malmberg (1996) reviews some other similar studies.8 In Case 4.1 we shed some empirical light on these issues by using statistical information on manufacturing industries in the Nordic countries.

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Case 4.1 Industry agglomeration: rule or exception? There are many different ways in which an unequal geographical distribution might be measured. However, the Gini index, while being far from perfect, has become the most common way to assess to what degree industries are geographically agglomerated.* It measures the degree to which the regional distribution of one variable (e.g. employment in a particular industry) deviates from the regional distribution of some ‘neutral yardstick’ (e.g. population or, as in the case to be reported here, employment in manufacturing as a whole).† Thus, Gini indices have been calculated for the spatial distribution of manufacturing industries in Denmark, Finland, Norway and Sweden, based on a detailed spatial (some 270 local municipalities in each country) and industrial (some 80 industries) division. A Gini index close to 0.5 indicates extreme agglomeration: all firms in an industry are assembled in one region. An index close to zero, on the other hand, indicates that an industry is evenly distributed among the regions. The calculations indicate that most industries display remarkably agglomerated location patterns. Thus, in Sweden a dozen industries have Gini indices above 0.49, while the median value for the whole set of observations is around 0.46. Similar results are reported in the other Nordic countries. Furthermore, this agglomerated pattern at the level of the individual industry is becoming reinforced over time. Broadly, three out of four industries in the combined four country data set become more agglomerated over time. In Sweden, 63 out of 80 industries exhibit an increasing Gini index between 1970 and 1990, even though it should be admitted that the differences are fairly modest in most cases. The Danish pattern is even more clear-cut. Between 1972 and 1992, no less than 78 out of 82 industries become more agglomerated (rising Gini indices) while only five industries become more dispersed (falling Gini indices). In Finland and Norway, a little more than 50 out of 80 industries become more agglomerated (Fig. 4.1). There is thus evidence indicating that most industries are highly agglomerated and tend to become more so overtime. This is in itself an interesting result. Still, there are some problems in interpreting these results as clear-cut evidence that the kind of agglomerative forces being discussed in this chapter exert a strong influence on the location patterns across a wide range of industries. One obvious drawback is that data for industries defined along the lines of the ISIC classification do (at best) tell us something about horizontally related activities, while the vertical dimension of the industrial system is neglected (see Chapter 1). Another immediate problem is that no fixed ‘bottom line’ can be established, against which to interpret these results. What is a ‘normal’ distribution for an industry over space, and how do we decide when to regard an industry as ‘more agglomerated than normal’? The Gini index only indicates the degree to which an industry deviates from a situation where its employment is distributed over regions precisely in the same way as the entire population or, as in this case, total manufacturing employment. Ellison and Glaeser (1994) discuss this problem in some detail. They argue that what we should look for is ‘excess concentration’, which is determined in relation to ‘random choice’, i.e. the location patterns that would be expected in an industry lacking both agglomerative forces (such as spill-overs or ‘natural advantages’) and centrifugal forces (such as transportation costs with dispersed demand). Random choice can be thought of by using the metaphor of firms choosing locations by throwing darts on a map. Even if firms did choose locations in this way, several of the plants might by chance appear to form a cluster. In fact, according to Ellison and

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Figure 4. Industry agglomeration in four Nordic countries during the 1970s and 1980s. Changes in Gini index and number of plants by industry, ISIC 4-digit level. Note: The time periods available when comparing the data were: Denmark 1972– 1992; Finland 1974–1993; Norway 1977–1986; Sweden 1970–1990. Source: Industrial statistics. Glaeser (1994), one only needs to throw six darts at a map of the US before it is likely that two will hit the same state. Indeed, Ellison and Glaeser have a point when arguing for the use of terms such as agglomeration (localisation, spatial clustering) to be restricted to industries exhibiting levels of concentration beyond those that would be observed if firms had chosen the locations of their plants completely randomly. It is also important to note that there is a strong relation between the size and market structure of an industry and its degree of spatial agglomeration, as measured above. Small industries, i.e. industries with few firms and modest employment, show up as highly concentrated regionally, if measured with the Gini index. For example, in some industries, the majority of all employees work in one of just a handful (or less) of large plants. Given this, we would not want to regard these industries as being localised simply because the majority of their employment is contained in a few regions, each hosting one of these plants. Thus, in Denmark, none of the six most localised industries consists of more than ten plants, nationwide. Therefore, a very high Gini index often may indicate that an industry is small or highly concentrated at the firm/plant level, and this does not necessarily mean that the industry consists of several spatially clustered firms/plants. Furthermore, considerable changes in the Gini index primarily show up in industries that have gone through intense restructuring processes over the twenty-year period. Industries in which the net number of plants increases tend to exhibit a lower Gini index in the early 1990s, compared to twenty years before, and the opposite goes for the (majority of) industries where a large number of plants disappear over the period (Fig. 4.1). This in itself does not mean that agglomerative forces have no impact on the process. It may still be the case that, in a generally shrinking industry, those plants/firms which are located in agglomerations do survive while the ‘outlayers’ are competed out of the market. However, in cases where the high Gini index

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Notes * One of the problems with the Gini index is that it is sensitive to differences in scale and level of aggregation. Thus, for example, one cannot compare the degree of concentration/agglomeration in different populations (industries) if the size and number of regions differ. Other popular measurements of the degree of agglomeration include the Kullback entropy index (Chapman 1970; Hobson and Cheng 1973; Theil 1972). † For calculation procedures, see Madsen (1980) or Ellison and Glaeser (1994). For further discussion on the Gini measure see for instance Pyatt (1967) or Atkinson (1970).

Agglomeration economies are traditionally held to arise because local linkages either lower the cost or increase the revenue (or both) of the firms taking part in such an exchange. Precisely what cost and what revenue is, however, the object of some disagreement. For instance, it is sometimes claimed that the costs of exchanging both goods and services is reduced when firms in an industry agglomerate, and that this process is particularly intense where transaction links tend to be small-scale, unstable and unpredictable, and hence subject to high unit cost (Scott 1983, 1988). This focus on the efficiency and intensity of local transactions of goods and services is somewhat paradoxical, since such linkages between agglomerated firms have proven to be difficult or sometimes even impossible to demonstrate in empirical studies (McCann 1995b; Clark 1993), with the possible exception of the much cited case of the Italian industrial districts (Brusco 1982; Goodman and Bamford 1989; Becattini 1990; Lorenz 1992; Isaksen 1994). For the majority of industries the idea of cost minimisation through agglomeration increasingly lacks credibility in an age of intensified internationalisation. In a knowledge-based economy, agglomerative benefits spring from the need to access knowledge which cannot easily be acquired on the market.9 The benefits of proximity can be translated into a force of agglomeration in relation to firms engaged in interactive learning processes. Indeed, in Chapter 3 it was argued that in an era when codified knowledge is globally disseminated faster than ever before, tacit and

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spatially more ‘sticky’ forms of knowledge are becoming increasingly important as a basis for sustained competitive advantage. Put simply, the more tacit the knowledge involved, the more important is spatial proximity between the actors taking part in the exchange. When long-term national or regional collective learning has taken place in a line of business, the costs of using the market—as opposed to relying only on intra-firm activities—may even sometimes diminish to a point, where a territorially defined industrial configuration of small firms only can become more efficient than a configuration with larger firms, burdened with the cost of internal control and measures against shirking (Alchian and Demsetz 1972). Also Marshall saw these advantages of small scale production: The master’s eye is everywhere; there is no shirking by his foremen or workmen, no divided responsibility, no sending of half-understood messages backwards and forwards from one department to another. He saves much in book-keeping, and nearly all of the cumbrous system of checks that are necessary in the business of a large firm. (Marshall (1890) 1920:284) This efficiency of local market interactions for the exchange of knowledge (see Chapter 3) might be part of an explanation for the ‘somewhat ironic fact that many managers consider internal transactions to be more difficult than external ones, even though vertical integration is pursued for presumed advantages’ as Eccles (1983:28) points out. The importance of agglomeration for the exchange of knowledge has recently been pointed out also by scholars from business and management studies. Most renowned is Porter (1990) who sees his ‘diamond model’ of competitive advantage and the phenomenon of industry agglomeration as being underpinned by flows of information about needs, techniques and technology among buyers, suppliers and related industries. Such flows are greatly enhanced by the proximity and affinity that characterise actors located in the same local milieu. Among the most important facilitators of information flows are, according to Porter (1990): • • • • •

personal relationships due to schooling, military service ties to the scientific community or professional associations community ties due to geographic proximity trade associations encompassing clusters norms of behaviour such as a belief in continuity and long-term relationships.

Further sources of goal congruence and compatibility within clusters are found in the existence of: 63

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• • • • •

family or quasi-family ties between firms common ownership within an industrial group ownership of partial equity stakes interlocking directors national patriotism.

These factors contribute to explain why, for Porter, there is a territorial element in the delimitation of an industry cluster. Proximity/affinity is at the very heart of the definition of the cluster concept, and the country is seen as a proxy for this territoriality. Porter goes further, however, and makes a major point of the fact that there is often an even stronger localisation element involved, and that immediate physical proximity of world-class rivals is so common across countries as to give an important insight into the spatial element of the process of competition. Domestic rivals tend to be located in areas with concentrations of particularly sophisticated and significant customers and suppliers. Territorial life-cycles The competitiveness of firms located in a certain area might be retained and augmented through a number of years through the feedback loop with a particularly suitable bundle of localised capabilities. This does not signify, however, that localised capabilities on which the firms depend can continue forever. Localised capabilities can deteriorate over time, thereby undermining the competitiveness of the firm located in the region or country.10 The two usual suspects are at play: the demand and the supply. The demand for the localised capabilities of the area might have weakened because of substitution. Alternatively the supply of localised input may have altered the quality and undermined the value of an area’s localised capabilities either by asset erosion, lock-in, ubiquitification, or replication. Substitution takes place when, for example, the evolution of new technology in an industry renders some formerly valuable localised capabilities superfluous. Innovations might devalue old investments in, for instance, skills, education and infrastructure, thus undermining the region’s or the country’s capabilities (Barney 1991; Maskell and Malmberg 1995). Skills in fine mechanics ceased to be an asset in watchmaking when the microchip flooded the market. Regions or countries—in which the economic development in the last century was typified by massive sunk costs in channels—were less favoured when the technological development led to the construction of railroads, etc. Asset erosion describes the process by which hitherto important localised capabilities are no longer maintained and reproduced at the same pace or to the same degree (Dierickx and Cool 1989). The transmission mechanism can be curbed by the redirection of indispensable skills towards other types 64

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of jobs, for instance in a swelling public sector, or by changes in attitudes and values away from entrepreneurial activity. The interaction between producers and users can be broken by structural changes (concentration and mergers, buy-outs, closures, etc.), thus obstructing the knowledge creation which was based on the presence of knowledgeable, demanding and critical customers (Lundvall 1985; Lotz 1993; Karnøe 1995). Asset erosion can also imply the exhaustion of imperative natural resources; the congestion of the requisite infrastructure; or the obstruction of the essential channels of communication in ways beyond repair. However, when volatility characterises technologies and markets, the tenacity of localised capabilities usually prevails. And more often than not localised capabilities display a potential of durability exceeding the assets on which they were built: the natural resources available, the specialised pattern of competencies resulting from first mover advantages of long ago, the built structures and the institutional endowment. Regions and countries discover new natural resources, replace decrepit competencies, rebuild obsolete structures and restore outdated institutions. Firms in Detroit have thus retrieved some of their former competitiveness in car manufacturing after years of problems, and the watch industry of Switzerland has recovered and even expanded its share of the world market after restructuring from fine mechanics to the world of the microchip (Coriat and Bianchi 1995). Through a process of incremental replacements the individual assets in the region or country might be modified over time but the fundamental capabilities are preserved, nurtured and enriched with new dynamism and vigour. Once established, localised capabilities do not vanish easily through asset erosion. The role of information flow, visibility and mutual reinforcement within such a local milieu gives rise to a degree of adaptability in retaining the existing patterns of industrial specialisation, already commented on by Marshall: an established centre of specialized skill, unless dominated by a gild or trade-union of an exceptionally obstructive character, is generally in a position to turn to account quickly any new departure affecting its work; and if the change comes gradually, there is no particular time at which strong incitement is offered to open up the industry elsewhere…although even a little obstinacy or inertia may ruin an old home of industry whose conditions are changing; and although the opening out of new sources of supply or new markets for sale may quickly overbear the strength which old districts have inherited from past conditions: yet history shows that a strong centre of specialized industry often attracts much new screwed energy to 65

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supplement that of native origin, and is thus able to expand and maintain its lead. (Marshall 1919:287) Lock-in describes the situation whereby a previously valuable pathdependent development has run out of steam, but without a subsequent corresponding decelerating of the feedback mechanism (David 1985; Arthur 1989). This strongly reduces the ability to administer the necessary continuous adaptations and adjustments of the localised capabilities. When obsolete types of localised capabilities are kept in place, the region or country is hindered from regaining momentum. Normally, a region or country gradually develops its physical, social, institutional and cultural structure in correspondence with the needs of the existing industry. Even if we assume that each round of building new institutions or improving the old is based on, and perfectly adjusted to, the most advanced technological, organisational or market knowledge available at the time, there is always a risk that the resulting localised capabilities in the long run will become an obstacle to future development: a lock-in. Such obstacles may be physical, but, paradoxically, they seem more often to be institutional, social and cultural. Thus, not only firms experience difficulties when they face the need to unlearn successful routines of yesterday (see Chapter 3). Also in regions and countries, the process of unlearning will often necessitate the disintegration and removal of formerly important institutions and built structures which may act as a hindrance to further development. The process of demolishing established institutions or structures may often jeopardise the interests of some individuals or larger groups with the power to prevent or impede the process. Friedrichs (1993), in proposing a theory of urban decline, gives several examples of how local élites, made up of corporate management, trade unions and urban/regional managers or politicians, tend to form alliances that will act to prevent structural change in periods when previously dominating industries decline. By trying to protect their vested interests, they will sometimes prolong the period of crisis and delay the efforts to develop or attract new types of economic activity, and thereby to shift the regional or national economy into a new track. Maybe this is most obvious in traditional ‘mono industrial’ milieus dominated by large firms. In the steel industry, for instance, the ‘Ruhr patriarchate’ in Germany or the ‘steel aristocrats’ in Pittsburgh have played such roles during an extended period.11 Nevertheless, there appears to be a great variation in the ability of regions or countries to unlearn. Evolution and adaptation can seemingly be augmented through the specific institutional endowment, which makes it possible in some regions or countries but not in others to inaugurate new institutions and simultaneously dissolve impeding institutions. In the 66

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movement towards a knowledge-based economy such ‘unlearning’ capabilities might turn out to be of paramount significance for the ability of a region or country to attract firms and participate in sustaining their competitiveness in an already established industry, or to build competitiveness afresh by developing new industries. This phenomenon—that a region or country over time tends to develop institutions which hinder future success, as result of decisions that were in themselves advanced and progressive in their time—is sometimes referred to as penalties of taking the lead (Veblen 1939; Gerschenkron 1962; Heim 1986). Correspondingly, the fact that a region or country has previously been lagging behind, and thus has not developed the structures of the last ‘round of investment’, and the ones before, might in certain cases turn out to become an advantage of backwardness. The absence of physical structures and social institutions adjusted to yesterday’s level of technological and organisational development may become an advantage when trying to implement those of today or tomorrow. Ubiquitification, however, can be much more serious in its consequences as the means to remedy lost advantages do not lie within the area. As discussed in earlier chapters, ubiquitification describes the process by which formerly localised capabilities are actively made practically worthless through a process of more or less instant global dissemination. Reduction of transport costs makes large domestic markets and proximity to first-class suppliers less valuable. Many natural resources and built structures do not wear easily, but ubiquitification can sometimes make them lose most of their former value: when transport costs are sufficiently small the actual location of a deposit of valuable minerals seldom in itself gives rise to a booming local agglomeration of all the facilities needed to produce the production equipment or services demanded. Replication describes the intentional act of copying the valuable capabilities of another country or region. It is evident that governments imitate each other’s successful policies (Cooke 1995), and try to duplicate the built structures, educational programmes and specific institutions of the most advanced economies. Nevertheless, the persisting disparities in generated income between regions and countries of the world through extended periods of time suggest the existence of strong barriers, which are preventing localised capabilities from being instantly imitable.12 When some fear the consequences of ‘locational tournaments’ among countries (David 1984; Oxelheim 1993), the effect of replication barriers is largely overlooked. These barriers against easy replication over space between areas coexist with mechanisms of easy transmittance over time within each area, as shown by the remarkably ‘sticky’ patterns of regional specialisation and industry agglomeration. In an occasional case, imitation over space may, however, be relatively easy if sufficient energy is applied. But in such cases hopeful imitators 67

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often find themselves in an intricate ‘catch–22’ situation: if attractive localised capabilities can relatively easily be imitated by one, they might just as easily be imitated by many, thus turning them into ubiquities and making the efforts of the first imitators useless. So when imitation happens to be easy, it is normally less desirable. Usually imitation is not at all easy because of information asymmetries. How can a potential imitator know which assets constitute an especially appealing localised capability? How can the necessary assets be created or acquired? How can they be combined? How can the desirable coalescence of new institutions be prevented from becoming contaminated by the interaction with the imitator’s old, decrepit or redundant institutions? Questions like these take careful consideration and a lot of effort to answer, if possible at all.13 Furthermore, the complex web of linkages which is woven over time represents in itself a safeguard against the imitation over space of localised capabilities. Its labyrinthine qualities represent an intricate interconnectedness of asset stocks, where some factors are needed in order to utilise others. Actors in a rival area might acquire some of the vital components or ingredients, but will in practice find it difficult to duplicate the more or less incomprehensive pattern of institutions of a more or less tacit nature. Some initial institutions might even over the years mutate or interact in the origination of derivatives with profound influence on the economic development of the region or country. They are ‘in the air’, but not easily contributable to any specific institution, formal or informal. The structural role and specific functioning of the most significant knowledgecreating institutions might even be poorly understood by the economic agents within the region or the country. For instance, the discrepancies between scholars in identifying and decoding the decisive elements in the Italian industrial districts they study are unmistakable, even when the studies draw heavily on interviews with local managers (Harrison 1992). Precisely because of the many institutions involved, the members of the local managerial class have no universal or generally accepted understanding and interpretation of the inner workings behind the apparent locational advantage of their district. The more weighty such tacit elements of knowledge are in the proper functioning of an economic system, the more difficult it will be to imitate: it is simply not transparent to a potential imitator which elements are important and which are not (Lippman and Rumelt 1982). Finally, the aspect of lead time comes into play. The process of imitating the localised capabilities of another region or country suggests acceptance of the role as follower, with the risk of spending time and effort in learning yesterday’s ways and skills. 14 In times of dynamic competition and rapid knowledge creation in many fields, the strategies of mass imitation are becoming even less feasible. Furthermore, as all 68

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capabilities of a region or a country have been developed through a large number of years, the lack of any time compression device will in itself tend to discourage the initiation of any imitation process (Putnam 1993; Teece, Pisano and Shaun 1994; Postrel and Rumelt 1996). In their discussion of barriers against imitation at the firm level, Dierickx and Cool illuminate the phenomenon of time compression diseconomies by the wonderful, classical dialogue between a British lord and his American visitor: ‘How come you got so gorgeous a lawn?’ ‘Well, the quality of the soil is, I dare say, of the utmost importance.’ ‘No problem.’ ‘Furthermore, one does need the finest quality of seed and fertilisers.’ ‘Big deal.’ ‘Of course, daily watering and weekly mowing are jolly important.’ ‘No sweat, just leave it to me!’ ‘That’s it.’ ‘No kidding?!’ ‘Oh, absolutely. There is nothing to it old boy; just keep it up for five centuries.’ (Dierickx and Cool 1989:1507) Any localised capability will always be a function of history, and this sometimes makes it ‘impossible to simply copy best practice even when it is observed’ (Rumelt, Schendel and Teece 1991:16). Conclusion: knowledge creation and localised capabilities In the first part of this book, we have argued that firms have to constantly upgrade their products and processes in order to create long-term competitive advantage. Without a sufficient degree of innovations, even a high level of investment is not enough to sustain growth for very long. Furthermore, firms are dependent on their local environment in order to retain and increase their competitiveness. Ongoing internationalisation might lead to more embeddedness and dependence on specific institutions at the local, regional or national level, rather than to a rapid increase in the ratio of industries being ‘footloose’. Thus, in Chapter 2, we claimed that many previously localised capabilities have become globally disseminated through what we have called a process of ubiquitification, but that patterns of specialisation, at the national as well as the regional level, have still been remarkably stable over the last thirty years. The explanation, so we have argued, lies in the localised and ‘sticky’ nature of some forms of knowledge creation. What have so far not been ubiquified are the knowledge and learning processes that are inherently localised. In Chapter 3, the ability to create new knowledge was seen as the main means by which firms in high-cost regions and countries can survive in 69

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the global market place. The ability to engage in interactive learning processes within localised industrial systems is the main option to sustain prosperity in this context. In particular, the step-wise building of trust-like relations between actors in industrial systems is important. A business environment that enhances trust will always make an economic difference. When the traditional, static, cost-related international competition is superseded by competition based on dynamic improvement and learning, the importance of such an environment can be assumed to increase dramatically. In a knowledge-based economy, network relations between firms are rapidly proliferating. In the present chapter, we have focused on the capabilities of regions and countries. Localised capabilities consist of four main elements: the institutional endowment; the built structures; the natural resources; and, not least, the knowledge and skills. They develop through historical processes, in which many incremental events over time may give a region or country an advantageous position. The competitiveness of firms will be enhanced by the feedback loops with the localised capabilities. Certain firms find some localised capabilities more valuable than others. The originally chosen location of an industry might have been basically accidental. Once in place, however, the specialised demands from the firms will influence the future development of the localised capabilities, making it advantageous for the industry to remain in the area, and even for outlying firms to move there. The emerging patterns of industry agglomeration and regional specialisation are the result of an evolutionary selection process: firms located in areas where the localised capabilities are particularly fitted to satisfy their needs will have higher survival and growth rates than similar firms located elsewhere. Over time, internationally highly competitive territorial agglomerations of related firms emerge. The process of territorial economic development will tend to be highly path-dependent. Localised capabilities are normally more durable than the assets upon which they were built: the natural resources available, the specialised pattern of competencies resulting from first mover advantages of long ago, the built structures and the institutional endowment. Regions and countries discover new natural resources, and they often manage to replace obsolete competencies, built structures and institutions. This does not signify, however, that localised capabilities on which the firms depend are eternal. Localised capabilities may deteriorate over time, and this may undermine the competitiveness of the firm located there. We have identified three main mechanisms through which this may happen: substitution; asset erosion; and lock-in. These mechanisms have one effect in common: they imply that in regions and countries, just like in firms, there is a need for ‘un-learning’, and the process of un-learning will often necessitate the disintegration and removal of formerly important 70

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institutions and built structures which may act as a hindrance to further development. In the next part of the book, we will start by showing that smaller and larger OECD countries differ significantly in the degree in which they are turning towards the production and export of R&D-intensive commodities. The smaller OECD countries largely retain an industrial structure dominated by low- and medium-tech industries, while a rapid shift towards high-tech industries has taken place only in a few of the largest economies, notably the US and Japan. Still, several of the smaller OECD countries belong to the richest countries in the world. The argument to be illustrated in a series of subsequent case studies is that the low-tech and high-cost small countries, like the Nordic countries, manage to retain their competitiveness precisely through the existence of localised capabilities, which are difficult to imitate for outsiders, and which are partly based on intense interaction between a limited number of actors within regional or national industrial systems. In this context, we will argue that the existence of ‘shared trust’ is a specific feature of the small number of interactions that characterise industrial systems which are embedded in a region or in a small country. The tacitness of the knowledge created in settings where localised, inter-organisational assets are important, prevents dissemination to outsiders.

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Part II SMALL COUNTRIES, LOCALISED LEARNING AND LACK OF LEARNING The cases of furniture, fish and phones

5 SMALL NATIONS: HOW TO SUSTAIN PROSPERITY IN OPEN, LOW-TECH ECONOMIES There is nothing small about being a nation. (Vigdis Finnbogadottir, President of Iceland)

One of the attributes presumably affecting the predisposition towards knowledge enhancement of the kind discussed in the first part of this book is the size of the economy in question (Grossman and Helpman 1991). This is one motive for our focusing on regions as an important analytical category when addressing issues of competitiveness through interactive learning processes. It is also a motive for directing particular interest towards some specific features of smaller countries. We argued in the introductory chapter that the difference between countries and regions is increasingly in degree, rather than in kind. This is particularly so for the small countries. Their general degree of openness and exposure to international competition makes them in important respects similar to regions, seen as parts of broader economic and political entities. In this second part of the book, we will start by analysing in this chapter, some distinguishing features of small industrialised countries in general, and the five Nordic countries of Denmark, Finland, Iceland, Norway and Sweden in particular. In subsequent chapters, case studies of some selected industrial systems, where the Nordic countries play important roles, will be presented. Small versus large economies—a question of openness That the size of the regional or national economy exerts some influence on its degree of openness is to be expected. A country encompassing the globe would be fully self-sufficient in all meaningful aspects of the word. And the reverse is equally true: the smaller the country, the more it will have to depend on the others (Robinson 1960; Krugman and Venables 1990, 1995; de la Mothe and Pasquet 1996). It is therefore not surprising that most small developed countries long ago opened their economies and actively advocated the adoption of a 75

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non-tariff, non-barrier world trade system (Balassa 1965; OECD 1995c). Initially their main motive was presumably to acquire the needed inputs and to secure market access for their products. Subsequently the opening of the economy was found also to be a prerequisite for obtaining economies of scale in the production of goods (Bober 1935; Basevi 1970; Müller and Owen 1989; Casella 1995) and intangibles such as knowledge (Archibugi and Michie 1995; Ben-David and Loewy 1996); for curbing domestic monopolies; for enabling additional product differentiation;1 and for ensuring continuous international exposure to enhance overall industrial competitiveness (O’Rourke and Williamson 1995a). Furthermore, the small countries’ complete lack of political or military power to imitate or impede any US-style ‘voluntary trade restraints’, when emerging competitors threaten domestic producers (Brander and Spencer 1983; Borner 1986; McCann 1995a), does point towards the same conclusion. Protectionism is simply not a viable option for small industrialised countries.2 Instead, they aspire to become regions in a broader economic entity with as little loss of political independence as possible: small states like Belgium not only cannot have an independent monetary policy, they cannot permit their prices and costs to get out of line with those of their neighbours, so quickly is the balance of payment likely to respond. (…) The international corporation may subtract something from the economic independence of the small state, but there is little enough to begin with. (Kindleberger 1984:27–28) The focus of most studies of international economics and politics has, precisely because of the limited scope of governmental action in small countries, been placed on the larger entities, which have the option not to view international market changes as unalterable facts (Moore 1966; Waltz 1979; Kennedy 1987; Krugman 1988; Rehn 1996). In his influential analysis, Katzenstein (1985) links the size of the national economy to a certain inclination toward a policy of free trade and openness, and a strong affinity toward corporatism resulting from a general perception in small countries of common fate and the spread of common fears.3 Additionally, he detects in the small countries a penchant for neutrality; a weakness of the political right (see also Amin and Thomas 1996); a dependence on foreign capital to supplement internal savings; and a tenor of domestic political stability induced by the need to secure access to export markets. As a response to their position in the international economy, small countries have developed specific institutions—for instance for rapid exchange rate adjustments, etc. —to maintain competitiveness in key industries and mechanisms compensating domestic losers when readjustment becomes necessary because of imported disruptions, etc. (Korkman 1992; Maskell 1997) —some 76

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of which are fully or partly eroded by the current composition of the internationalisation process. Be this as it may, for the moment there is little doubt that countries de facto differ in many respects, according to the size of the economy. But what exactly might be meant by ‘small’ or ‘large’ countries is, however, the object of long-standing differences of opinion (Fox 1959; Lloyd 1968; Kuznets 1971; Amstrup 1976; Engberg-Pedersen 1983; Walsh 1987; Freeman and Lundvall 1988; McCann 1995a). In order to illustrate empirically some size-related dissimilarities, a distinction is made in Table 5.1 between three groups of industrialised countries, based on the size of the national economy: • Large countries: the US and Japan. • Medium-size countries: Germany, the United Kingdom, Italy, France and Spain. • Small countries: Canada, Australia, New Zealand, Austria, Belgium, the Netherlands, Greece, Portugal, Sweden, Denmark, Finland, Norway and Iceland. The first group is made up of the two economically largest countries in the world by far, each with an annual output in 1992 exceeding US$2,750 billion,4 and a population above 100 million inhabitants. The five mediumsized industrialised countries have an annual output exceeding US$275 billion, and a population above 30 million. The third group, the economically smaller industrialised countries, is defined as a residual. It consists of the remaining thirteen OECD countries with sufficient data. All except Canada, Australia and New Zealand are in Europe, and of the European countries, all are now members of the European Union, except Norway and Iceland who are, however, included in the European Economic Area (EEA). Together, these twenty countries account for roughly 70 per cent of the world economy, whether measured by production volume, value added or exports. The degree of ‘openness’ of the economy of different countries is also demonstrated in Table 5.1 (column 3). The data reveal how foreign trade is more than twice as important for the group of medium-size countries than for the large ones in relation to their total manufacturing output.5 And foreign trade is more than four times as important for the small countries. This economic openness forces the governments of small countries to devote special efforts to secure their balance of trade, just as big capital investments tend to be undertaken with an eye on foreign rather than domestic trade (Hodne 1994). Any disruption and cyclical turn in the international economy is immediately reflected internally, favouring the development of indigenous institutions to compensate losers and to flatten the amplitude of the imported disturbance (Katzenstein 1985). 77

Table 5.1 Key figures 1992

Notes: ‘Openness’ = (export+import)/manufacturing production. ‘Exposure’ = (Exp/Prod) + (1 - Exp/Prod) * (Imp/(Prod - Exp + Imp) * 100. Source: The OECD STAN (STructural ANalysis) Database 1995.

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Firms in smaller countries are, moreover, significantly more exposed to foreign competition than firms in larger countries (Australia being an exception). The simple indicator of international exposure used in Table 5.1 (column 4) rests on the idea that the exported share of production is 100 per cent exposed, and that the share sold on the domestic market is exposed in the same proportion as the import penetration of the market (Hatzichronoglou 1996). The data indicate that firms in medium-size countries are more than twice as exposed as firms in large countries, while firms in small countries are more than three times as exposed. The possibly advantageous long-term effects of a constant high degree of exposure to international competition are sometimes even seen as a triggering factor in the economic development of small countries (Menzel 1980; Menzel and Senghaas 1980; Senghaas 1982; Crouch 1986; O’Rourke and Williamson 1995a). Others have taken such an exposure as a point of departure when explaining how small countries can become and remain competitive by specialising in a limited number of industries (Porter 1990). High-tech and low-tech trajectories The technology-intensive or high-tech industries are not well defined entities in economics. They may, according to Krugman (1992, 1995b), be understood as the industries in which knowledge is a prime source of competitive advantage for the firms, and in which firms invest large resources in knowledge creation. The chosen properties to distinguish the group of such industries must necessarily be somewhat arbitrarily defined (Legler 1986; Abbott 1991; OECD 1993b; Grupp 1995). For lack of better alternatives, the high-tech industries are usually identified on the basis of the effort in research and development in the industry, where the ratio of R&D expenditure to output is interpreted as a measure of the industry’s level of technological sophistication (Marcusen, Hall and Glasmeier 1986).6 This approach is used by the OECD as well the US Department of Commerce and corresponding bodies in many other countries (OECD 1985, 1995b), even if they all more or less explicitly acknowledge that few industries can be considered fully homogeneous with regard to R&D intensity.7 The OECD has regularly calculated the R&D intensity ratio for twentytwo manufacturing sectors in thirteen of its member countries,8 thereby accounting for more than 95 per cent of the industrial R&D performed in the OECD area. For each industry the ratio has been weighted by each country’s share of the total output of the thirteen countries using purchasing power parities to convert to a common currency. Since 1972, the high-tech industries thus defined have included aerospace, computers, electronics and pharmaceuticals9 each with a ratio of R&D expenditure divided by production value above 6 per cent (OECD 80

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1992, 1995a).10 The present classification used by the OECD is shown in Table 5.2. The taxonomy has turned out to be rather stable, and even if the indirect R&D (calculated on the basis of the technical coefficients of input-output tables in the national accounts) was included, it would not have any significant impact on the categorisation of industries. Hence, industries with major R&D content in their products are very likely also to use the most technologically sophisticated production equipment (OECD 1993a), though some major discrepancies do occur.11 The high-tech, research intensive industries are characterised by sharp

Table 5.2 OECD’s list of high R&D intensity industries for the period 1980–1995 (classification of industries: ISIC Revision 2)

Note: The percentages shown for each group of industries is the expenditure on R&D divided by the cost of production (as published in the OECD STAN and ANBERD Databases). Source: OECD (1995a).

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learning curves and a significant degree of internationalisation of supply, production and sales, enabling them to utilise substantial economies of scale. More important, it is widely believed that the strong external economies of high-tech industries give rise to self-reinforced advantages through positive feedback (Arthur 1990). It is also an established fact that these industries have experienced growth rates way above average and expectation over a number of years (Riche, Hecker and Burgan 1983), just as high-tech industries did not experience the same employment decline as other manufacturing industries during the recession at the beginning of the 1980s (Burgan 1985). No wonder that a new international economic dichotomy is envisaged: The new ‘haves’ are those who master high technology and can therefore achieve high standards of living, while the new ‘havenots’ are those who have to be content with the simpler products of technology, where price competition and, therefore, pressure on wages, is the dominant regime. (Braun and Polt 1988:203) By theoretically associating innovation and investment with growth, the literature on ‘increasing returns endogenous growth’ has filled a vacuum by pointing out some hitherto partly overlooked policy areas, where government-induced growth-enhancing improvements might be made. The result has been an international obsession with high-tech industries (Malecki 1991; van Hulst and Olds 1993; Borrus 1993). In an increasing number of countries low-tech is considered demeaning, R&D indicators have become a major object of political interest, and great efforts are devoted to improve a bad relative standing. As this ‘structure snobbery’ (Henderson 1986) has become epidemic the small OECD-countries have tried hard to close the gap with the larger by increasing their domestic R&D/GDP-ratio, and for the period 1980–1989 to 1990–1994 all of the small OECD countries have actually succeeded in both: the ratio has increased and the gap has started to close (OECD 1996c). Still, the data presented in Table 5.1 earlier in this chapter show striking differences between countries regarding their distribution of economic activities in high-tech versus low-tech industries. Together with the large countries, only the United Kingdom had more than 13 per cent of its total manufacturing production in high-tech industries in 1992, as shown in Table 5.1.12 Taken together, the small countries have less than half this ratio in the high-tech industries, but great variation prevails: Sweden, Denmark, the Netherlands and Canada have rather large export ratios in high-tech industries. So have the medium-size countries of France and Germany. Spain is pushing strongly towards the high-tech, and among the medium-size countries only Italy has maintained 82

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a (very profitable) distribution of activities, more akin to the one found in many small countries than to the countries in its own size-group. Even though the level of aggregation in Figure 5.1 conceals more than just marginal variation between sectors, it does illustrate one apparent point: that the large countries systematically have increased the high-tech proportion of their export far more than their smaller brethren (Guerrieri and Milana 1995). And while the large countries are moving rapidly away from low-tech exports, both the medium-sized and the small countries display a much weaker tendency in this direction, though at very different levels. In the small countries, between 38 and 48 per cent of exports have emerged from low-tech industries during the last twenty-two years, while the medium-sized countries’ ratio fluctuated between 24 and 31 per cent, as shown in Figure 5.2. Endogenous growth theories maintain that the building of future competitive advantage will depend mainly on innovation and investment. If this turns out to be true, the large countries appear to be facing a golden future with their massive capital formation in high-tech industries, as shown in Figure 5.3. The outlook for the medium-size and the small countries is conversely bleak, when measured by this yardstick (Edquist and Lundvall 1993). The split between different size groups becomes even more pronounced when we turn our attention to the low-tech industries. The manufacturing sector of the small countries ostensibly shuns allocating the same proportion of their funds into strengthening high-tech activities, unlike their larger counterparts. 13 The small countries undoubtedly display a continued preference for low-tech investments, illustrated in

Figure 5.1 Export 1970–1992, high-tech industries.

Source: OECD STAN Database.

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.

Figure 5.2 Export 1970–1992, low-tech industries. Source: OECD STAN Database

Figure 5.3 Fixed investments 1970–1992, high-tech industries. Source: OECD STAN Database.

Figure 5.4. 14 This reluctance might signify an impending loss of competitiveness and an inescapable undermining of the present standard of living in these small welfare economies.15 Six reasons for a small country to stay low-tech The fact that small countries tend to abstain from vigorously pursuing the corroborated economic blessings of the new high-tech industries can hardly be conceived of as only an unintended and accidental aggregate outcome of a stable distribution of business opportunities available to the firms there. 84

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Figure 5.4 Fixed investments 1970–1992, low-tech industries. Source: OECD STAN Database.

Rather, it seems to indicate the operation of some mechanism by which it becomes advantageous for small countries to uphold a degree of hesitation before fully participating in a general shift towards high-tech industries. We may identify at least six intrinsic reasons as to why small countries do not display the same thrust towards high-tech industries as do larger countries. First, activities in high-tech industries are closely associated with high risk. Losers as well as winners are to be expected, as the selection of superior products is essentially based on trial and error (Carter 1994). The incomplete information on the distribution of cost and demand might easily compel risk-aversive firms to waive any idea of taking up production, even in situations where such a venture would have been economically advantageous if tried out.16 Only through the activities of many risk-taking entrepreneurs, responding to the ‘scent of pure profit’ in all lines of business, are such ‘hidden’ sources of profits eventually identified. Once such a source is recognised, the problems disappear. But the risk-averseness of firms, and the number of alert and economically capable entrepreneurs are not equally distributed among small and larger countries (Casson 1990). The differences are presumably not due to disparities in the supply of entrepreneurial talent (of which we know very little), but are certainly affected by the obstacles experienced in small countries in obtaining a sufficient market for a specialised and proficient venture capital sector (DeBresson and Lampel 1985). The lack of venture capital will constrain the economic ability of entrepreneurs located there, and truncate the distribution of entrepreneurial efforts in small countries. 85

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A general bias in favour of high-tech industries in larger countries might thus materialise, simply because fewer stones are left unturned. Second, sustaining competitiveness in high-tech industries is not only linked to high risks, but also to high costs. The most successful high-tech corporations of today need continental, or even world-wide, markets to be able to write off in a sufficiently short time ever increasing investment costs caused by ever increasing costs of R&D. Leading-edge technologies require large investments for a considerable time, but may nevertheless result in an only modest turnover, at least in the short run (Grupp 1995). To the already high cost of a successful product or process development project must be added the cost of the ones that fail. Failure can be total or partial, where capital layouts cannot be fully recaptured by the flow of generated profits as the speed of technological development sometimes makes even recently installed production facilities obsolete. New breakthroughs in one R&D unit might make major investments virtually worthless overnight, just as new entry of production capacity might inflict major losses on the investors of yesterday (Guerrieri and Milana 1995). For instance, the market price for the most common memory chip dropped from US$44 in 1994–5 to US$9 in January 1996 and was expected to drop to US$5 by the end of 1996, while the industry was expecting massive losses and cuts in capacity. The modest size of the national economy in small industrialised countries places tight restrictions on the ability to function as a buffer for such ups and downs. Strange (1991), among others, focuses on the technological imperative: that the accelerating speed of innovation requires ever more R&D activity, which in turn further accelerates the speed of technological development (Rehn 1996). Such escalating growth/cost interaction may easily create unwanted allocative distortions in small countries by amassing all available capital, leaving firms in all other sectors to rely much more on foreign capital sources and—related to this—on foreign ownership and control. Industries with solid, long-term prospects, but short-term lower profitability, can thereby be forced out of business to the great disadvantage of the country’s future economic growth if or when the propitious sector runs out of steam due to some later twist of events. Larger countries faced with the same problem (though smaller relative to the economy) may cope by letting the public pay some or all of the development costs. And this is precisely what is happening: all leadingedge technologies are highly subsidised through considerable government procurement (Helpman 1984; Grupp 1995), profound export subsidies (Brander and Spencer 1985), considerable government subventions (sometimes through massive government-funded research programmes) or strong regulatory ‘infant industry’ protection (Haberler 1977). Case studies of the long-term development of individual industries have confirmed this tendency for governmental commitment. For instance, 86

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Scott (1991) demonstrates how the aerospace electronics industry of southern California from the 1940s onwards became the major recipient of contracts from the US Department of Defence. In 1960 alone this amounted to US$3,467 million. No small country can aspire to partake successfully in such a race, even if it is eager to do so. The growth/cost interaction in high-tech industries is so pronounced that Sweden, with massive and generally successful efforts in supporting the domestic technological development through such measures as government procurement (Edquist 1994; Teubal 1987), has probably now exhausted its economic ability to participate in the contest for developing the next generation of advanced military aircraft. Third, the limited size of the relevant labour market will influence the range of industries in which small countries might successfully specialise. While the process of internationalisation has opened the borders for commodities, and has later encompassed services, capital and some types of knowledge, no common international labour market has been established. Distance to their nearest neighbours interacts with political considerations in preventing Australia and New Zealand from becoming part of a larger south-eastern labour market. And in most European countries labour can hardly be considered a mobile factor of production even on a cross-regional scale. International labour migration is, furthermore, insignificant even within the European Union. The actual European crossborder labour mobility involves mainly a limited number of workers engaged in temporary jobs in the construction industry or in the transport sector, together with a modest group of bureaucrats and business executives. This is nowhere near the expectations expressed when this issue was initially discussed before the signing of the treaty of Rome, and it is strikingly different from the situation in the US. Even if a high-tech firm in a small European country was, on the basis of a sufficiently promising idea, able to raise the necessary capital from the international market via the stock exchanges of Tokyo, Frankfurt, London or New York, its full potential could not be realised because labour market rigidities would, early in the process, inhibit the persistent corporate growth which is vital in order to prevent followers from catching up. The volatile nature of high-tech industries simply does not fit the rigid labour market structures and its growth potential cannot unfold given the limited size of the appropriate labour force in small industrialised countries. Fourth, the endogenous growth theories might turn out to be correct when holding that technological spill-overs are primarily domestic (Jaffe, Trajtenberg and Henderson 1993; Ben-David and Loewy 1996).17 For smaller countries, to invest a lot in high-tech R&D might be like trying to fertilise a small field when the wind is blowing: the neighbours benefit most from the effort. If so, the large countries will profit more from any domestic investment made in R&D than smaller countries, where some or even most of the spill-over of any 87

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such investment is likely to nurture its trading partners (Zander and Kogut 1995; Gallon 1995; Fagerberg 1995b). The smaller countries might then be better off by employing their assets in low-tech industries where the spillovers usually can be appropriated and utilised domestically. At the same time they might utilise spill-overs from the efforts of larger countries in high-tech industries (Bayoumi, Coe and Helpman 1996). ‘Nations do not individually need to be innovative, but their advancement depends on their ability to enjoy the spill-overs from the technological and economic advancement of other countries’ (Kogut 1990:79). Fifth, the domestic demand influences the industrial structure as countries, according to the ‘new trade theory’ (Helpman and Krugman 1985), are likely to specialise in sectors and commodities where the domestic market is of particular importance. The home market for hightech commodities only occasionally plays such a role in small countries, in the rare situation when a novel and propitious combination of supply, demand and institutional elements is hatched by the day-to-day workings of the national economy. The probability of such events remains low, however, and domestic demand will usually favour the development of high-tech industries in the large countries. Following Linder (1961)18 and Lundvall (1985), recent detailed case studies from sixteen countries (Fagerberg 1995a, 1995b) confirm this assertion by demonstrating how the demands of advanced domestic users over time cause innovation, and result in international competitive advantage in the developed economies of today. The mere size of the home market for high-tech commodities is thus a restriction on the possibility to play such a role in small countries. Domestic demand will therefore usually favour the development of hightech industries in larger countries. Sixth and finally, at least at the leading-edge, most R&D intensive hightech industries, seem to depend on a disproportionately strong and continued flow of science-based input (Grupp 1995), creating strong ties between science, producers and advanced users in these industries. The lack of a domestic supply base for most, if not all such inputs might inhibit the likelihood of interaction between (foreign) suppliers and (domestic) users in small countries: they are not good sparring partners. Furthermore, a lack of the most advanced local supply may often also impede the access to and use of the latest and commercially most attractive commodities from the high-tech industries by prolonging lead times and increasing costs (Borrus 1993). Each new generation of memory chips is, for instance, only available to customers in many small countries with a considerable time lag, thus delaying the moment at which a firm located there can incorporate it in its own products. This delay—or the cost for the privilege of getting earlier access—can be damaging for efforts to improve the position on final markets for firms from small countries if engaged in high-tech activities, while it matters much less in low-tech 88

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industries, with their less marked emphasis on rapid implementation of the latest technical advancements. Mechanisms such as those six identified above can individually or jointly prevent or restrain small industrial countries from rapidly restructuring towards high-tech. Together they contribute to explain why the small countries display such inordinate predilection for the low-tech industries, compared with the medium-size or large countries. But, as we will show next, the lack of specialisation in high-tech industries does not automatically signify that small countries are abandoned in the backwaters of economic development. Low-tech competitiveness in high-cost countries? If competitive advantage depends mainly on innovation and investment in R&D intensive high-tech industries, then the large countries appear to have much brighter future prospects than the smaller countries with their predominant specialisation in medium- and low-tech industries. Although alien to most assumptions underlying contemporary politics or to the majority of the academic literature on competitiveness, we will in the following build an argument as to why and how it is fully possible to keep up a high level of prosperity while retaining a low-tech industrial specialisation. Without disregarding recent currency crises and public sector deficits, etc., many small countries are economically fairly well off even compared to the medium-sized or larger countries within the OECD (Table 5.3). Thus, while the two large countries display higher per capita income than the other two size groups throughout the period since 1960, the per capita GDP in the group of small countries taken as a whole is roughly at the same level as in the medium-sized countries. In terms of growth in per capita income, the medium-sized countries have done slightly better, however, particularly after 1980. If we look at the five Nordic countries, the sub-group of small countries which are of particular interest in this book, we can note that they show a higher GDP per capita than any other aggregate throughout the period in focus. One possible explanation for this seemingly contradictory result is of course that the aggregate measurement of R&D, which was used as an indicator for identifying high-tech industries, is fallacious or, alternatively, that it is far too crude to give any viable assessment of the knowledge content of industries. This is arguably true in the sense that innovations and, in a broader sense learning, may be of utmost importance for gaining and retaining competitiveness also in some of the so-called low-tech industries. Furthermore, small countries seem, to an even higher degree than the larger countries (Ham and Mowery 1995), to maintain competitiveness by being

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Table 5.3 GDP per capita in US$ (at the price levels and exchange rates of 1990)

Source: OECD (1996b).

able to reap usable results from R&D conducted elsewhere (Coe and Helpman 1993; Sakurai, Ioannidis and Papaconstantinou 1996). They manage to do this through various means such as reverse engineering, network participation and engaging in subcontracting relationships to world leaders or through more conventional market transactions (Gelsing 1992). Additionally, evidence has been collected to show how high-tech products do in fact often play an important role in the economy of a small country even if they are not produced there (Braun and Polt 1988). Indications such as these raise questions as to whether a national specialisation towards high-tech industries is indeed the only way by which mature, developed countries can hope to sustain and augment their economic position. Other trajectories for industrial development might exist which are equally attractive and more economically feasible even in sustaining some of the highest wage levels in Europe (Hughes 1993).19 90

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Thus, there seems to be a ‘low-tech route’ to sustained prosperity in the high-cost regions and countries of the industrialised world, and in subsequent chapters we will try to identify the main characteristics of this route. The central explanatory problem to be addressed may thus be formulated: if the internationalisation process makes ubiquities out of old strongholds in natural resource endowment; production machinery; proximity to major markets; (some) organisational methods; and in educational programmes for the work-force, and if the small countries for a number of reasons have inherent deterrents to engage in R&D-intensive activities, then how can these small, high-cost countries continue to be competitive and prosperous? Or in other words: how can the small industrialised countries survive and prosper when navigating between Scylla and Charybdis; between the superior high-tech competitors in better equipped, larger countries on the one hand, and the increasingly competent low-cost competitors in, for example, South-East Asia on the other? One possible answer is that the level of sophistication and degree of technological advancement differ in character within low-tech industries,

Figure 5.5 A small country in a high-tech/cheap labour environment. Source: Original drawing by Per Marquard Otzen, Copenhagen, Denmark.

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and that the ones found in the developed small countries distinguish themselves by the continuation of improvements resulting from learningby-doing and from interacting with peers (Arrow 1962; Pavitt 1984; Lucas 1988; Nelson and Wright 1992).20 Another possible answer is that interorganisational factors, specific to these countries but beyond the boundaries of the individual firm, contribute decisively to their competitiveness even when producing low-tech commodities. The nature and likely contribution of such localised capabilities were discussed in Chapter 4. In the following section, we add to that discussion by introducing the concept of ‘shared trust’. The type of small number interaction that characterises local or regional milieus in many ways applies to small countries as well. Shared trust: an alternative route to smooth knowledge exchange Economically beneficial learning-by-interaction does in fact exist especially at a local or regional level (von Hippel 1988). Proximity plays a role because firms in the same local or regional milieu can share the same values, background and understanding of technical and commercial problems. Evidence of the economic benefits from a shared institutional endowment can also be traced at a national level. In a recent study, Fagerberg, for instance, concluded that: interaction between users and producers of technology [is] a major impetus to technological change. Interaction, however, involves costs…these are a decreasing function of both the stability of the user-producer relationship and the degree of ‘proximity’, defined to include factors such as language, the legal system, the educational system etc. Hence, most stable user-producer relationships are of a national character. (Fagerberg 1995a: 254) Because of the drive towards internationalisation and the resulting ubiquitification of formerly critical factors of production, firms in the highcost areas of the world are progressively stimulated by, and often even dependent on, localised capabilities in order to maintain and augment their competitiveness. The amalgamation of inputs such as industrial and university R&D, spatial agglomerations of manufacturing firms in related industries, and networks of business service providers often give rise to scale economies in the creation of knowledge, and facilitates the transfer of knowledge between the firms in the area. Some types of knowledge creation depend, however, on a particularly tight interaction with partners in other firms. For instance, DeBresson 92

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(1996) shows that out of some 1,600 major Canadian innovations during the period 1945–1970, less than 10 per cent were the result of a firm’s ‘inhouse’ activities only. The rest involved as many as seven different firms and an average of four different independent organisations. Innovative processes which require a high level of interaction, dialogue and exchange of information may be conducted long distance, but in most cases it is less expensive, more reliable and easier to do so locally (Malmberg, Sölvell and Zander 1996). The propinquity of firms enhances their potential for exchange of codified and—more important—also of tacit knowledge for at least three reasons (Scott and Storper 1992). First, the benefits of proximity are related to the time geography of individuals. As long as it includes at least some element of face-to-face contact, interactive collaboration will be easier the shorter the distance between the participants. The second reason is related to proximity in a social and cultural sense. To communicate tacit knowledge will normally require a high degree of mutual trust and understanding, as discussed in Chapter 3. A common language and shared norms and values play a vital role in this context. Finally, the mechanism of penalising malfeasance within business networks has a territorial equivalent in some regions and countries, if and when two factors are simultaneously present: both the number of actors and the mobility (exits and entries) must be relatively small.21 As the number of parties declines, collusion and bargaining become easier, thereby promoting the fortunes of firms and the orderliness of their markets: As groups shrink, each remaining member acquires a larger stake in the system and has more incentive to help to maintain it…. The expected cost of enforcing agreements, and of collecting the gains they offer, increase disproportionately as the number becomes larger. (Waltz 1979:136) A restricted number of players in the business community in a region or a small country makes it very difficult to behave in an opportunistic manner, without being severely penalised (Douglas 1987). Cheaters are selected to make a convincing reparative gesture for any first-time misdeed, however small (Trivers 1971; Krebs 1970). And in regions and countries where the majority believe that opportunism is penalised, firms act as if they trust each other (Granovetter 1985; Saxenian 1994), enabling them to benefit from the Stage IV type knowledge exchange discussed in Chapter 3.22 If the mobility is sufficiently low,23 the owners and managers of firms in most industries in a region or a small country will know each other either directly or indirectly. New firms are often started by former wage 93

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labourers, well known in the community and well acquainted with the unwritten rules according to which business in the area is conducted. Most managers in larger enterprises will meet regularly and many will have known each other personally for years. Even in sectors dominated by a great number of small and medium-size enterprises, all producers in such environments will have a remarkable degree of knowledge of most other domestic producers in the sector, their main domestic and foreign suppliers and the most important customers. All firms in the sector will typically be organised in at least one association or guild, with its own publications or newsletter and with annual or even more frequent meetings. Many of the managers will have received the same education and training, just as most will have participated in some sort of joint activity at the local, the regional or the national level. The communal history and culture often means that managers share many of the same beliefs, values and convictions, which can make certain types of exchange and corporation easy (Aydalot 1986): firms often compete while at the same time helping each other in overcoming technical problems, by lending materials and swapping surplus capacity or by exchanging information. Lawyers or written contracts are rarely used and most likely never have been, as indicated also by earlier analysis: even when the parties have a detailed and carefully planned agreement which indicates what is to happen if, say, the seller fails to deliver on time, often they will never refer to the agreement but will negotiate a solution when the problem arises as if there never had been any original contract. (Macaulay 1963:61) The relations between firms within a local or regional milieu differ extensively: from rapprochement to detachment and indifference or uncompromising rivalry. A relatively close business environment does not necessarily lend itself to co-operation and interaction. Small firms particularly often envision the fellow producer down the street as their main competitor, and often try hard to outsmart him without damaging the firm’s own reputation. Local rivalry of this kind stimulates the entrepreneurial spirit and reinforces productivity in the region or small country. But even though examples of non-collaborative attitudes are copious, the conduct of firms in these environments is usually constrained by the knowledge of the unattractive consequences of misbehaving. All attempts at opportunistic behaviour will immediately be noticed: overutilising asymmetrical information; passing defective or substandard goods as first class; or creating hold-ups in order to benefit at the expense of others in the local milieu. Information about such misbehaviour will be passed on to everyone, who in the future will tend to take their business 94

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elsewhere. Worse still, by becoming a local outcast the firm is deprived of the flow of knowledge, including its tacit parts, which can prove very difficult to substitute. So even if the business environment in regions and small countries does not force firms to co-operate, if they are not inclined to do so, its intrinsic mechanism for penalising opportunism encourages trustful co-operation and ensures low barriers to the exchange of knowledge, whether codified or tacit. In fortunate circumstances an important transmutation takes place. By their day-to-day operations and established business practices firms in these areas demonstrate their ability and willingness to submit to the local rules of the game.24 As they are thus constantly proving their continued trustworthiness, they also produce or reproduce a ‘local climate’ of shared trust. Shared trust in this way becomes part of the local business culture as a collective investment, the rents of which are appropriated by the firms located there (Axelrod 1981; Coleman 1984; Teece 1986; Winter 1987), though in some areas of the world special rules will apply to newcomers, as a ‘rite of passage’, before they are allowed to enjoy the full benefits of the trust shared (Dei Ottati 1994a, 1994b). Outside such areas, the default is usually distrust, necessitating firms to build trust-based relationships by piecemeal committing themselves economically and socially as described in the preceding section (Ford, Håkansson and Johanson 1986). In local milieus, regions or small nations characterised by shared trust, the default is trust if nothing is known of a firm in advance (Lorenzen 1996). The individual firm inherits an already existing trust-based business environment, built by its predecessors over time (Adler and Jelinek 1986). The localised combination of incentives and penalties acts as the crucial component in a transmission mechanism preparing new generations to accept the inherence and concede to its behaviourial constraints. This localised preparation infers that the initial distribution in demeanour and tenet is profoundly curtailed. And the more a population of firms, managers and workers shares the same preferences—whether related to trust or not— the easier it is for them to bridge communication gaps resulting from economic agents having heterogeneous individual knowledge endowments or heterogeneous preferences, or both (Eliasson 1996). ‘With different knowledge endowments and different preferences (determining individual responses) each individual will be unable to communicate all he knows, and unable to learn everything other agents know or will do’ (Eliasson 1996:15). Thus, shared trust establishes an environment that facilitates the relatively easy exchange of knowledge, as well as augmenting the scale and scope for such exchange by reducing the degree of heterogeneity both in preferences and in individual knowledge endowments. Regarding the latter point—the scale and scope of shared trust—Carter (1989) has suggested that the risks involved in using a piece of knowledge 95

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not completely understood might be unacceptable, and that this in turn might favour a pairwise barter arrangement. But while the risks might be unacceptable when dealing with an unknown third party, the reduced degree of heterogeneity in preferences and individual knowledge endowments within the same social environment make a third party look more like a compatriot than a complete stranger, and must be treated accordingly. This also affects the risks associated with using third-party knowledge which, therefore, might be reduced to an acceptable level. Hence, shared trust resembles built trust as both enable a high-quality knowledge exchange at low costs, even for knowledge partly tacit (Scribner 1986; Sandelands and Stablein 1987; Weick and Roberts 1993). But shared trust has additional qualities. When building trust, firms have to invest in the relationship, establishing tight limitation on the flexibility of networks. Not so in areas of shared trust where it is uncomplicated to relate to new businesses if external or internal circumstances make it propitious, as long as the break up from old partners is done in a proper manner and in accordance with local beliefs of good behaviour. The risk of becoming a victim of a lock-in is thus less for firms utilising shared trust than for firms relying on built trust in network arrangements.25 Regarding the ability to enhance new firm formation, shared trust distinguishes itself favourably from built trust. The more built network relations between firms are consolidated, the more difficulties new firms will have in breaking into the value chain. Even when entrepreneurs come up with genuine new and better ways of doing things, the sunk costs in established relationships between incumbents can act as impregnable barriers, to any market access. In a community of shared trust such barriers do not exist at all, or are considerably less formidable. As the business structure in areas of shared trust is revitalised by a steady flow of newcomers, even the incumbents located there will usually benefit and the overall competitiveness of the area is enhanced. Shared trust, as defined here, does not fit entirely into the ‘stage model’ discussed previously, and might be seen as a separate type of relation between seller and buyer enhancing the prospect of exchanging all forms of knowledge easily. The idea behind the four stages was that firms would normally have to go through each of the preceding stages before reaching the fourth and final stage. Shared trust is obviously different in the sense that a firm may benefit from it ‘just’ by being located in, and accepted as an insider of, the right milieu. Much of the shared knowledge is ‘practical’ (Nyíri and Smith 1988) and therefore difficult to disentangle, decipher and report in any way except by living in the area and performing the tasks of the industry in which the knowledge has been acquired gradually, unwittingly and inadvertently (Baumard 1996). This partakes in making the value of shared knowledge perplexing to understand for outsiders. And as building trust is a timeconsuming process, difficult to condense, 96

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it offers credible protection against imitation: no short cuts are available even for those who may have identified some of its important ingredients. This makes it extraordinarily difficult to imitate and competitiveness based on localised capabilities comprising shared trust will therefore have a tendency to be sustainable (Casson 1991). Conclusion: shared trust and localised learning as a competitive advantage of small countries The concept of shared trust might help to solve the riddle identified earlier in this chapter: that small, open, high-cost countries—like the Nordic ones—have managed to maintain some of the highest standards of living in the world while being primarily engaged in low- or medium-tech economic activity. In the remainder of the second part of this book, we will look in more detail at some processes where shared trust arguably plays a role in maintaining competitiveness, through the presentation of three case studies. Chapter 6 focuses on furniture production, Chapter 7 analyses the contemporary restructuring of the fish-processing industry, while Chapter 8 takes on the rapidly growing mobile phone industry. In all three cases, several of the Nordic countries distinguish themselves by occupying important positions in a European or, in some cases, even global context. At the same time these sectors offer ample opportunities for comparative analyses, since there are great differences in firm performance between the Nordic countries, or sometimes between regions within one country. Furthermore, the selection of these very cases allows us to highlight a number of important issues related to localised capabilities at work: while the first two cases are decidedly low-tech, the third case brings us in to the world of high-tech industry. In two of the cases (fish processing and telecommunications), various forms of public regulations, at the national or supranational level, are or have been of utmost importance, while in the case of furniture their impact is almost negligible. The natural resource base is evidently the basis for competitiveness in one case (fish processing), while it has no impact in the case of mobile phones. Perhaps more surprisingly, it turns out to play a limited role in explaining firm performance in the third case: the wooden furniture industry. What unites all three cases, however, is that processes of learning are intimately related to the creation of sustainable competitiveness and that localised capabilities, notably the institutional endowment, seem to be of utmost importance in this context.

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6 COMFORT AND COMPETITIVENESS: THE WOODEN FURNITURE INDUSTRY If we survey a ship, what an exalted idea must we form of the ingenuity of the carpenter, who framed so complicated, useful, and beautiful a machine? And what surprise must we feel, when we find him a stupid mechanic, who imitated others, and copied an art, which, through a long succession of ages, after multiplied trials, mistakes, corrections, deliberations and controversies, had been gradually improving? (Hume (1779) 1980:36)

The wooden furniture industry is engaged in the manufacturing of objects ‘designed to increase the comfort, utility or beauty of human habitation’ (Hayward 1974a:362). The furniture industry is substantial: in the current taxonomy of more than eighty industries in the European Union (EU), furniture production is presently the eighth largest, employing approximately half a million people (COM 1995).1 The industry has not only maintained its employment in recent decades, but has even experienced a slight growth since 1987, while six out of every seven European industries suffered major job losses (COM 1995). Wooden furniture in itself is a low-tech commodity, which—at a certain level of generalisation—has not been subject to major innovations or radical improvements during the last 5,000 years: ‘An Egyptian folding stool dating from about 1500 BC fulfils the same functional requirements and possesses the same basic features as a modern one’ (Hayward 1974b: 781).2 Furthermore, the production process makes furniture manufacturing a typical low-tech, labour-intensive industry (see Chapter 5). Nevertheless, it continues to flourish, though located in the high-cost countries and regions of Europe.3 This chapter investigates the dynamics and competitive determinants of the wooden furniture industry.4 After an overview of its characteristics in the EU/OECD context, the chapter focuses on two different country cases, 98

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where the competitive development of the furniture industry has been a success story (Denmark) and a failure (Finland). It is shown how the natural resource endowment plays a role that is fairly different from what might be expected, how success and failure in this industry is associated with peculiarities of the national and local institutional endowment, and how the industrial structure has interacted in the creation of specific localised capabilities. Access to the world market and the ability to understand and react to changes in taste and preference seem to be far more important than a localised supply base of abundant materials and semi-finished goods. Finally it is argued that the necessity for a continuous process of learning and exchange of knowledge accounts for the tendency towards agglomeration of the wooden furniture industry to a few regions in most countries. Furniture industry: structure and change5 Furniture is a consumer durable, the consumption of which is characterised by major disparities between economically and culturally different groups and households. The demand for furniture is characterised by a relatively high price elasticity, thus making the industry dependent on economic upturns and downturns (COM 1995). In general, the demand for furniture is influenced by the level of—and the changes in—household income, as well as demographic variables and construction activity: new households mean new demand. Nevertheless, in the developed countries, replacement purchases, based on factors such as changes in taste and income, dominate the market, and here the attractiveness of products from competing industries does play a certain role: when new tourist destinations become available the consumption of furniture drops. When outbreaks of terrorism at popular holiday resorts make families stay home the furniture industry experiences boosting sales. The furniture industry has traditionally been characterised by a clear-cut home market orientation. As a result, country-specific, and in some cases, region-specific demand conditions have been of decisive significance for its development. In particular fittings (for instance, in kitchens and bathrooms) are influenced by culture-bound factors, whereas younger urban households can more easily accept imported furniture with international design into their living rooms. As Table 6.1 illustrates, demand for furniture varies by countries in ways which are difficult to explain solely on the basis of demographic or economic differences.6 It can be assumed that these inherent differences in demand conditions exert both push and pull effects on the international trade of furniture, which has been increasing in recent decades. Exports accounted only for about 7 per cent of the EU production in 1970, but rose to almost 20 per cent in 1992. This has obviously had profound implications for the 99

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Table 6.1 Apparent consumption of furniture (production + import - export) per capita in OECD countries in 1970, 1981 and 1992 (OECD average = 100)

Source: OECD STAN Database 1995; Statistical Yearbook 1984. UNESCO (Table 1.1. Population, area and density 1970–82, estimates of mid-year population), Statistical Yearbook 1994. UNESCO (Table 1.1. Population, area and density 1980–92, estimates of mid-year population).

competitive setting in this branch of industry. Changes in export shares are described in Figure 6.1 for a number of EU and non-EU countries. In the EU countries in 1992, exports of furniture exceeded 30 per cent of production in Denmark, Sweden, Portugal and the Netherlands (Fig. 6.1) —and of these countries only Denmark and Portugal were net exporters of furniture. The biggest producer in Europe, Germany, is still primarily oriented towards the home market, and the proportion of exports remains around the EU average even in Italy. Some furniture producers—mainly in kitchen and office furniture—sell directly to the final customer. However, the vast majority of producers sell their products to specialised or non-specialised retailers, who—as in many other fields of retail—are increasingly organised into chains with a centralised purchasing function. This trend towards market concentration has, of course, drastically strengthened the bargaining power of the distribution sector on behalf of the still very fragmented production sector. Some retailers, like the Swedish IKEA, have even established international distribution chains and are controlling a still larger part of the total European market for home furniture.

100

Source: OECD STAN Database; no data on Ireland and Luxembourg.

Figure 6.1 The export share of furniture production in OECD countries in 1970, 1981 and 1992.

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Case 6.1 IKEA—An early innovator in the furniture system The

basic set-up of the furniture industry—small producers and separate retailers organised in a national context—has not remained unchallenged. IKEA, founded in Sweden by Ingvar Kamprad in 1943, has been an outstanding innovator in the reorganisation of furniture production and distribution (Kinch 1984). Later, imitators of IKEA’s model, such as MFI in the UK, have appeared (Best 1989). Today, IKEA is the world’s largest furniture retailer. Specialising in inexpensive Scandinavian designed furniture, IKEA has some 12,000 employees, 130 fully owned stores in almost thirty countries—visited by over 100 million people every year—and world-wide sales reach well over US$5 trillion. IKEA has thirteen furniture stores and 25 per cent of the market in Sweden. The company is four times bigger than its largest competitor in the US (Olsson 1996). IKEA is only to a limited extent engaged in in-house furniture production, but relies heavily on subcontracting producers for supplies. Most of these are in lowcost countries, and their production relies on economies of scale. The headquarters for IKEA’s international operations has until recently been located in Humlebæk, Denmark, but has now been gradually transferred to the Netherlands. The main design and product development functions as well as extensive training facilities are still located in the small town of Älmhult in south-central Sweden, where the company was originally founded. IKEA’s major competitive strategy, as it has gradually evolved since the 1950s, can be summarised in the following points (Laulajainen (1995), see also Kinch (1984) or Salzer (1994) for more detailed accounts): • IKEA’s in-house design and product development account for the vast majority of its products, and some two-thirds of the products are the same all over the world, sold under typically Swedish product names. • Low prices are achieved through purchasing in large batches and very efficient logistics where the ‘flat packages’ keep transportation and handling costs down. • Marketing by means of a fairly expensive catalogue which is distributed for free world-wide—almost 30 million copies annually. • The customer is expected to be very active, as a ‘salesman’, as well as a transporter and assembler. • The stores are generally located in relatively cheap sites on the outskirts of major cities, often close to a motorway intersection and with extensive parking space. Within the business community, IKEA has become well known for its corporate culture where the vestige of Nordic egalitarianism is unmistakable in the informal management style. The firm’s mission statement—‘Supplying good furniture affordable by everyone’—is actively used in marketing and image creation (Salzer 1994). Its business concept, external locations, inexpensive showrooms, and not offering services such as credits, delivery and assembly, were very different from what was offered by existing retailers in the 1950s, and was not well received by the latter, who responded by trying to cut off IKEA from supplies. A bilateral agreement between the associations of retailers and suppliers had regulated the furniture market in Sweden, and even though it was formally abandoned in 1946, the practice to restrict entry into the business remained in the 1950s, and the members of the association of retailers threatened to boycott suppliers who delivered to IKEA. This left IKEA with small suppliers who were not members of the trade association or had other important buyers, that is, general carpentry shops

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COMFORT AND COMPETITIVENESS rather than the specialised furniture producers. Large suppliers who wanted to sell to IKEA could do so only under special conditions: IKEA could not include their most recent models in the catalogue but were left with obsolete models, and the goods had to be delivered to a neutral address (Kinch 1984). Obviously, this early boycott had a number of consequences. First, it forced IKEA to set up its own design function. It became distinguished for the way in which production (standard wood dimensions) and distribution (flat packages) considerations were allowed to influence design. Second, the boycott meant that IKEA had to look for suppliers outside Sweden. In Denmark, IKEA faced the same problems as in Sweden, since the main Danish firms had other Swedish retailers as important customers. IKEA’s response was from early on to start using suppliers in eastern Europe. Third, as IKEA mainly had to work with small and less experienced suppliers, the company, apart from taking up in-house design, had to assist its suppliers in various ways. Thus, by co-ordinating purchases of raw materials and packaging materials for its independent suppliers, IKEA obtained a discount due to the larger quantities bought. These and other measures meant that the production system contained some elements of a traditional ‘putting out system’, where the buyer furnished materials, work descriptions and in some cases machines and tools as well. In exchange for this increased security, the suppliers developed into subcontractors subordinated to IKEA (Kinch 1984). In general, IKEA utilises the market not for product ideas but as a monitoring device (Best 1989).

Overall, the ongoing changes in the regulatory regime and the structure of the furniture industry have important implications for market entry and competitiveness in small developed countries. Even small-scale local manufacturers are, to an increasing degree, facing competition with distribution networks which have established co-operation with producers from low-cost countries. This setting calls for new strategies in terms of specialisation, customer orientation, entrepreneurial skills and attitude to design. In comparison with many other industries, the furniture industry has been characterised by loose regulatory practices. The current trend is towards the abolition of still existing barriers to trade which have developed in national contexts. In the GATT framework, tariffs on furniture imports have been reduced almost to zero; in the EU, common technical standards for different types of furniture are being negotiated. Even though technological and organisational changes have had profound repercussions on furniture production and distribution in recent decades, the whole furniture industry still remains ‘a compromise between mechanisation, standardisation, and individual craft’ (Edwards 1994:2), making standardisation difficult and undermining the utilisation of most economies of scale. This applies to both of the two distinctive and technologically very different processes of furniture manufacturing—the process of cutting, drilling, shaping, grinding and assembling wood into a piece of furniture, 103

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and the process of coating it with paint or lacquer. Though different skills, suppliers and production equipment are needed, both processes are nevertheless more often than not integrated in the same firm. The main reason for this seems to be that the paints or lacquers are often—at least to some degree—customised to the individual plant, its product range and its paint-spraying equipment, thereby making the painting or lacquering process an important and integrated part of the core competence of firms. In Figure 6.2, the furniture industry is described as an industrial system, identifying sets of related activities in the chain, ranging from the transformation of raw material (timber, metal, plastic, rattan, etc.) and semi-finished products (boards, etc.) to final products (beds, chairs, etc.), and still further to the marketing, sales and distribution of the products to customers. Its basic inputs, moderately skilled workforce, raw materials and machinery are generally accessible anywhere and to anybody. In addition, fixed capital investments are modest in this industry. Thus, it is characterised by low barriers to entry, and most firms are small. They either focus on specific products or have a certain niche in the value chain of the industry. Notwithstanding any existing technological imperatives, the organisation of activities described in Figure 6.2 varies with different national and regional contexts due to different trajectories of competition and market behaviour. The driving forces in the development of the furniture industry include both cost-cutting pressures and market-induced innovation processes. Price reductions are typically sought by means of series production and automation, whereas market-led changes concern

Figure 6.2 The value chain in the furniture industry.

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product differentiation, for instance design and new materials such as environmentally more friendly paints and lacquers. Producers are thus provided with different strategic options. Firms producing commodities less suited for automation for instance often specialise in a limited range of fittings and furniture products for use in bedrooms, lounges, offices, shops, kitchens, gardens, etc. for a more or less targeted group of customers. Other firms function as subcontractors, and use a small or large proportion of their capacity to produce specialised, finished or semi-finished inputs—products like cupboard doors, or front pieces and sides of drawers—to be included in the final product of other furniture producers. The location pattern of the furniture industry displays a high degree of concentration in most western European countries.7 In Germany, furniture production is found mainly in North-Rhine Westphalia, Bavaria and BadenWürttemberg; in Italy, most furniture agglomerations are found in some geographically limited districts in the north of the country (for example Brianza, Cerea-Bovolone and Pesaro), but small agglomerations also exist further south (Poggibonsi in Toscana); in France, Brittany, Ile-de-France and Normandy account for a major share of the production; in Denmark, Jutland dominates the scene as do Vestlandet in Norway, Lahti in Finland, the regions of Småland and Västergötland in southern Sweden, the western part of Flanders in Belgium and North Carolina in the US. This location pattern suggests that spatial clustering provides firms with competitive advantages, although some formerly important furniture agglomerations like the one in London (Best 1989) and in Southern California (Scott 1996), have suffered severely from relocation or deindustrialisation. From ubiquitous resources to unique products: the case of Denmark The furniture industry in Denmark provides an illustration of how countrybased competitive advantages are created, not inherited. The discrepancies in competitiveness between countries can no longer be seen as the main outcome of initial differences in resource endowment, but they are built on factors such as divergent national patterns of demand, and distinct — but basically random—first-mover cost advantages. Thus, even a highcost country such as Denmark can benefit from specialisation in low-tech industries, such as in furniture production. As a result of the vigorous growth of Danish furniture exports since the 1970s, no less than 20 per cent of the export of wooden furniture from the EU is nowadays produced in Denmark, which has only 1.5 per cent of the EU’s population. During the last twenty-five years, Denmark’s market share for wooden furniture in the OECD has always been at least four times higher than its share of all commodities (Dalum 1995a). And while the contribution to the national income has varied substantially over time 105

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in most high-tech sectors, furniture has made notable annual contributions throughout the period. This economically favourable position is obtained even though the Danish furniture industry in most respects is not significantly different from that of other European countries. First, the production processes used in the wooden furniture industry do not in general distinguish Danish producers from their main foreign competitors, nor are the stocks of machinery different from what is accessible throughout Europe.8 Second, Danish producers of wooden furniture do not in general possess any specific property rights (patents, registered designs, trade marks, etc.) by which they are protected from competition. However, producers of standard types of furniture may sometimes benefit by goodwill spill-over from the up-market design segment, although it accounts only for about 10 per cent of the Danish furniture industry. The use of the concept of ‘Scandinavian Design’ by Danish producers in the marketing of low- and medium-price commodities might be seen as a sign of such spill-overs. Third, the competitiveness of Danish producers can hardly be ascribed to the utilisation of any economies of scale or the building of large vertically integrated corporations. In fact, the permanence of the furniture industry’s size structure indicates a lack of many predominant economies of scale. It can be seen in Table 6.2 that the average firm has had approximately thirtyfive full-time employees through a quarter of a century, from 1972 to the present day, in spite of the acquisitions that have recently taken place. Whatever the reasons for this relative stability of the structure might be9 it is a fact that the Danish wooden furniture industry is precisely as dominated by small firms as in many other parts of the world. The dominance of small firms in the Danish furniture industry has not Table 6.2 Production of wooden furniture in Denmark (sales and turnover in million US$)

Notes: ‘Sales’ = sales of products produced in the firm. ‘Turnover’ = sales of products produced in the fir m as well as sales of traded (unmodified) commodities, service and repairs, installation, etc. The Danish currency was very low against the US$ in 1984 influencing the data on turnover and sales in that year. Source: Analysis by Peter Maskell based on unpublished statistical material from Statistics Denmark. Annual exchange rates to US$ are from the OECD STAN Database.

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prevented some types of furniture from being produced in an increasingly automated way—for instance the production and assembly of rectilinear furniture from coated panel boards. This type of production usually requires some degree of subcontracting utilising the well developed interfirm network relations in the industry. The Danish furniture industry has, as a result of these technical and organisational characteristics, obtained the highest productivity in the EU with a value added per employee exceeding US$32,000 in 1993 (COM 1995).10 What is of special interest here is that many inter-firm relationships in the Danish furniture industry have been found to be very deep-rooted and long lasting. In a recent survey11 some 30 per cent of the firms in the Danish wooden furniture industry answered questions regarding the average age of their relations to their main customer and main supplier. Both relations turned out to be amazingly stable: they had known their business partner for as long as thirteen years on average. The survey further showed that the main customer bought 39 per cent of the total output, and that the three main customers (which they had done business with for eleven years on average) bought more than half of the firm’s total output. An almost similar concentration was found on the supply side: the firm’s main supplier delivered 23 per cent of its total purchase, while the three most important suppliers together covered 38 per cent of the input. As many as 82 per cent of the firms further reported that they often interacted with their customers in developing new products, sometimes leading to temporary exchange of personnel, loans of machinery or expertise or co-ordinated investments in production equipment. Nevertheless, barely half had any sort of written contract or other formal legal framework for this interaction. In general, long-lasting relationships facilitate exchange of business information and practices between the existing firms, as discussed in Chapter 3. Another important mechanism is the transmission of business attitudes from one generation of managers and owners of firms to the next, which is secured by the recruitment pattern: new firms are being established mainly by the skilled workers of the industry. These industryborn entrepreneurs seldom have the ability nor the personal interest to expand the firm into a larger and more professionally managed unit, and thus, this recruitment pattern tends to consolidate the industry’s size structure. On the other hand, it is precisely the upbringing in the industry and the often tacit knowledge of these homespun managers that has enabled the industry to overcome the problems of poor quality, rejections, and higher manufacturing costs to a greater degree and more consistently than their foreign competitors. However, there are also drawbacks caused by the dominance of small firms in the industry: the financial vulnerability of small firms and the low level of commercial managerial competence result in a high rate of closures and in a low survival rate of new firms. 107

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Table 6.3 New firms, closures and incumbents in wooden furniture (ISIS(68) 33201) in Denmark 1972–1992 (turnover in million US$)

Source: Analysis by Peter Maskell based on unpublished statistical material from Statistics Denmark. Annual exchange rates to US$ are from the OECD STAN Database.

Table 6.3 shows that the survival rate increases with age and size. But even the group of firms, which have proved their merits by existing for at least four years with more than five full-time employees, has experienced a closure rate of 47 per cent.12 Yet the low entry barriers and the (until now) constant supply of entrepreneurs willing to start producing wooden furniture, have maintained almost the same number of firms—and certainly the same size structure—through several decades. Like most small and medium-size enterprises, the Danish producers of wooden furniture have difficulties in reaching culturally distant markets. The volume of their annual production makes it impossible, or at least very difficult, to build and maintain an internationally oriented sales organisation. In particular, their limited managerial and financial capacity implies that it is burdensome to maintain contacts in formerly important markets during periods of low demand. The resulting export strategies of ‘hit-and-run’ on different markets, as determined by the exchange rates and the development in demand, also imply the risk of being unable to uncommit resources sufficiently quickly when the situation changes. Therefore, many firms in the Danish wooden furniture industry have chosen to commit at least a part of their production capacity to supplying large internationally oriented furniture retailers, such as IKEA. Others join with local producers of supplementary commodities and form some kind of temporary or more permanent combined sales organisation. For instance, this strategy was utilised when many furniture companies had to shift their marketing focus from the US onto Germany as a result of the dollar’s depreciation in the mid-1980s. Thus, a group of firms can at the same time be competitors in the labour or input market, rivals in some product markets and companions in others. The apparent paradox between the structural vulnerability of the wooden furniture industry on the one hand, and its sustained competitiveness in certain areas on the other, could be explained if Ricardo were right after all, and if an especially favourable domestic 108

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resource endowment were present. Such an environment could include many highly specialised suppliers of input and investment goods, thus permitting the wooden furniture producers to engage in a close and mutually beneficial exchange of ideas and experiences (Lundvall 1985). The utilisation of such domestic knowledge creation might then explain their competitive advantage vis-à-vis producers with a less favourable industrial environment. But regardless of its obvious theoretical attractiveness a closer look at the Danish industrial environment does not lend much support to such an explanation. The most important input to the wooden furniture industry is softwood, of which more than 85 per cent is imported (Schultz et al. 1995), primarily from the other Nordic countries.13 In some cases, the relationship between a Danish furniture producer and a supplier of softwood in another Nordic country might develop into a well integrated part of the value chain, but this arrangement is not typical. Usually, a Danish furniture manufacturer buys timber from a wholesale company, which tends to have a strong bargaining position in relation to a foreign supplier. Another potential domestic source of competitiveness would be a strong domestic supply base of wood processing machinery (cutting, shaping, grinding, etc.). While many such local producers did exist once, it is not the case any more. Before the war approximately half the machinery in the furniture industry was produced in Denmark, but today more than 90 per cent is imported, mainly from Italy and Germany. The remaining Danish producers of wood processing machinery are all small and traditional metalworking enterprises. They have not yet been able to bridge the technology gap to the world of electronics. Their globally operating competitors on the other hand have already been producing computeraided wood processing machinery for some time now, even with imageprocessing abilities. The market share of Danish furniture-related machine producers is thus likely to continue to fall. The same high import penetration applies to paint spraying machinery, where Italian producers presently dominate the market. The paint and lacquer used for wooden furniture are, however, partly produced in Denmark, though mostly by branch plants of the large multinational producer Akzo Nobel, while other foreign producers are represented with their own distributing and service enterprises (Becker, Klinten, Hesse Ling, Vortle). The increased environmental pressure in recent years on the wooden furniture industry to reduce its emission of volatile organic compounds (VOCs), has resulted in rapidly growing demand for new types of paints and lacquers with a high content of solids or based on water creating improved market possibilities for local producers with a high service profile (e.g. Hygæa). The interaction has been intense between the wooden furniture industry and the producers of paint and lacquer or their local representatives, in order to ensure the same surface quality (durability, colour, coverage, shine, thickness, etc.) as 109

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before. Within this specific area, a process of knowledge creation has often been embarked upon which sometimes is seen to have made a difference by enhancing the competitiveness of the firms involved. One might surely wonder why the competitiveness of such an industry has not been eroded long ago by imitation from competitors more favourably located in terms of costs. However, the absence of any strong domestic environment of specialised suppliers of machinery or wood—with the paint and lacquer industry as a possible exception—might imply that the revealed international competitiveness of the many small producers originates from their superior ability to create and accumulate knowledge internally or inter-organisationally through their day-to-day operations in areas such as product development, purchasing, production organisation, handling of labour relations and marketing. If the perceived results of these learning processes were continuously adjusted in interaction with customers, suppliers and other actors in their business environment, a sustainable industry-specific competitiveness might be the result. Furthermore, there might be some important extra-firm, but intraindustry and intra-regional, elements of asset mass efficiency, condensing the effects of a common culture, a specific language, and a set of informal, but essential economic institutions.14 As shown in Figure 6.3, the Danish wooden furniture industry is strongly localised, mainly in a few counties in Jutland. In addition, it has experienced a pronounced relocation and agglomeration in the years of increasing international exposure since the early 1970s. The spatial clustering can contribute to the overall competitiveness of the wooden furniture industry through various mechanisms. The most visible agglomerative force is the cost reduction associated with easier access to specialised supply of complementary products or services (Richardson 1972): auditing, finance, transport, repairs, logistics, market research, marketing, data processing or design. An easy access to supply of raw materials and intermediary products or machinery and other production equipment might also be of major importance in upgrading competitiveness. The more subtle agglomerative force is associated with learning, as discussed in Chapter 3. Everything else being equal, interactive collaboration will be less costly and smoother, the shorter the distance between the participants. By knowing each other personally the channels for close interaction are established.15 However, in order to communicate some partly tacit knowledge, a high degree of mutual trust and understanding will normally be required. This in turn is related not only to language but also to shared values and ‘culture’. Such trust relations between firms will have to be built and that takes time. Time compression diseconomies are thus also an important factor hindering competitors’ imitation of established successful behaviour (Dierickx and Cool 1989). However, in small number situations a business 110

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Figure 6.3 Wooden furniture manufacturing in Denmark in 1992 (ISIC (68) = 33201). Source: Maskell (forthcoming), based on unpublished data from Statistics Denmark.

culture can come into existence—as discussed in Chapter 5 —where insiders can reap the benefits of locating in a region characterised by some valuable degree of shared trust. Interviews with managers in the Danish wooden furniture industry (Ranis and Hansen 1995) show that inter-firm resources and other localised capabilities influence the economic development of the region by being ‘in the air’, but at the same time are almost impossible for strangers to understand, codify, capture and imitate. Given such difficulties of imitation, firms having access to the localised capabilities can benefit over considerable periods of time. Furthermore, these localised capabilities are not easily eroded, and will to some extent be transferable 111

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over time: their use leads to their reproduction and their transmission from one generation to the next (Henriksen 1995). This transferability over time, but not over space, can sometimes make country- and regionspecific differences in competitiveness very long-lasting. And the Danish wooden furniture industry seems to have been on this kind of successful development track at least since the early 1970s. In the shadow of the dominant cluster: the case of Finland The difference between Denmark and Finland is striking. In 1970, Finland’s share of exports of furniture production was second highest of the OECD countries—just behind Denmark. But while Danish exports have grown from about 20 per cent of the production value in 1970 to 75 per cent in 1992, the Finnish share of exports has remained at about the same level in these decades, and has even been declining from 1981 to the early 1990s, whereas imports soared. Table 6.4 gives an overview of the Finnish wooden furniture industry.16 Why then has Finland, with its bounteous supply of high-quality timber resources and its long track record of world-class designers, been losing out in an industry like furniture production? Which pertinent characteristics of the Finnish wooden furniture industry hindered a Danish-type development? One part of the explanation has to do with the Finnish industry operating on especially generous markets (Eliasson 1996). From the 1950s onwards17 the urbanisation of the country—especially the so-called Great Move in 1960–1975—contributed to the expansion of the construction Table 6.4 The furniture industry in Finland from the 1970s to the 1990s

Notes The data on the number of firms and employment include only firms with at least five employees. The exports, imports and apparent consumption are from the OECD STAN Database (1995). The Gini coefficient is based on employment data, 197 labour market districts. Figures on exports/production concern the years 1970– 1981 and 1992. Source: Statistics Finland. Yearbook of Industrial Statistics, vol. 1. (various years); OECD STAN Database 1995 and unpublished statistical material from Statistics Finland.

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industry and furniture production. However, the demand conditions, which conditioned the growth of furniture production, were not especially favourable for the upgrading of its competitiveness. Largescale production by a few dominant firms was the leading business concept of those years of growth when first-generation city dwellers, who were not necessarily very sophisticated consumers, furnished their flats with standard sofas. Exports to the USSR were another factor, which probably did not set high demands for improving quality or customisation and other relevant dimensions of competitiveness. Only the important deliveries of mainly office furniture to the public sector were fairly demanding in terms of quality, though here as well long-series production prevailed. And this section of the Finnish furniture producers has in fact performed relatively well even in international markets. Nevertheless, the development trajectory of large production runs, standard products and modest quality was in sharp contrast to the contribution which some Finnish innovators had made in the development of furniture materials and design in earlier decades (Edwards 1994).18 Furthermore, effective competition from imported furniture is a relatively new phenomenon in Finland. It has until recently been constrained by the vertical integration of the biggest domestic producers, which have controlled the furniture industry system up to their own distribution chains. Under these conditions, foreign producers found it difficult to find retail outlets, and their interest in building their own distribution networks in a small, culturally different market was understandably limited. An indication of this setting is the fact that IKEA from neighbouring Sweden did not open its first facility in Finland until 1996, after having run successful operations in tens of countries on four continents. Seen in a long-term perspective, the constraints on imports have sheltered domestic producers from the continuous pressure to upgrade their competitiveness. Another factor of great importance has to do with the institutions governing the use of Finland’s abundant timber resources. These institutions have over time been established and refined in order to increase the overall competitiveness, not of the wooden furniture industry, but of the backbone of the national economy: the forest industries, including especially the manufacturing of pulp and paper.19 The functional system, which has developed in Finland around the key products of the forest industry, is an archetype of a cluster of industries (Porter 1990). In addition to the producers of pulp, paper, paperboard and sawn wood, it includes engineering workshops, special input producers, chemical firms, various service producers and the forestry itself. The mechanical and chemical wood-processing industries constitute approximately one-third of the country’s total exports. The paper and pulp industries account for about three-quarters of the exports of the woodprocessing industries. 113

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Paper and pulp thus dominate the wood-processing industries, giving rise to institutional practices on the timber market regarding such important factors as the quality classification and pricing of roundwood. In addition, the paper and pulp industries have even had a long-term impact through their heavy influence on the success criteria of the country’s silviculture by not distinguishing between quality classes of relevance for furniture production. The key function of sawmills is to make wood usable for paper and pulp production, whereas further processing of sawn wood becomes an activity of secondary importance, not being a part of the strategic core competence of the volume leaders in the forest cluster. With a demand of approximately 1 per cent of the total production of sawn wood in Finland, the domestic furniture industry has remained a marginal customer. The main problem for the Finnish wooden furniture industry is thus the adverse effects which the dominating paper and pulp industry has created for a viable endogenous development. Probably, this supply-side condition and the further influence of the paper and pulp industry on the factor markets have provided the Finnish furniture industry with an additional impetus towards vertical integration and largescale production, which in turn has restrained its ability to adopt new ways once the former generous market conditions deteriorated and foreign competition stiffened. The influence of the paper and pulp industries on Finnish macroeconomic policies was an important conditioning factor for the competitiveness of the furniture industry. Major price fluctuations in international paper and pulp markets have led to serious problems of price competitiveness and profitability, and thus far these have been solved by means of depreciation of the Finnish currency. 20 Not surprisingly, the consequences have been felt in the whole economy, changing competitive conditions overnight and making long-term competitive strategies difficult to develop and maintain in the furniture industry as well as in several other consumer-oriented export industries (Tikkanen 1995). After each major devaluation, exporting has been relatively easy and effortless, but domestic inflationary pressures, in the context of the so-called devaluation cycle, have soon undermined price competitiveness necessitating still further depreciations. The repercussions of the dominant forest cluster in the Finnish economy are not limited to the factors discussed above. They have also made themselves felt as cultural phenomena, resulting from the fact that the large paper firms have created certain idiosyncrasies in business behaviour: technological processes and scale economies are emphasised, labour relations are hierarchic and controlled by strict rules penalising small firms, and markets and prices are seen as given parameters. This kind of business recipe (Whitley 1995) is an important part of the shadow that the forest cluster has cast on an industry such as furniture production, 114

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where the recipe for success on international markets is quite different. So even though several hundreds of small family firms21 have tried to create a niche of their own, they are under the constant influence of the few dominating large-scale firms.22 Concentration prevails not just regarding firm size, but also in locational behaviour. The Finnish furniture industry is even more strongly localised than its Danish counterpart. Two geographically very small regions dominate: the Lahti region in southern Finland and Suupohja in western Finland together accounted for more than half of the total output in 1990 (Fig. 6.4). The two agglomerations differ, however, regarding firm size, production concepts and market orientation. The Lahti region is by far the largest in terms of employment in the furniture industry and contains the two largest firms, while the Suupohja region has the largest number of firms (Table 6.5).23 Given the important position of these two spatial concentrations in the Finnish furniture industry, it is obvious that the problem of declining competitiveness is at least partly associated with the structural and institutional peculiarities of these particular regions. Indeed, both these local industrial systems of furniture production seem to have been locked into some structural characteristics and institutionalised practices, which have left important resources under-utilised, and which have undermined interfirm learning processes. The Lahti region developed its role as the leading furniture producer in Finland between the two World Wars. In 1926, there was only one producer of furniture in Lahti, whereas in 1938 there were 26 which utilised both the abundant supplies of high-quality birch in the vicinity and the local tradition of craftsmanship. Gradually Lahti became an important junction of the expanding domestic transport network and in the 1930s, the local furniture industry developed rapidly, and even cooperation with designers was developed as a precondition to the opening towards export markets in western Europe (Sarantola-Weiss 1995). In the post-war period the biggest enterprises of the industry—with Asko (established 1918) and Isku (established 1928) in the forefront— developed vertically integrated production systems which ranged from sawmills and chipboard factories to retailing, facilitating the utilisation of scale economies and limiting import competition. Even small firms tried to manage long chains of production activity by themselves in order to escape the unpleasant and unrewarding role of becoming a subcontractor to the large firms whenever they were out of production capacity. According to interviews concerning the local industrial atmosphere, the widely accepted approach to customer—supplier relationships in the Lahti region has been based on the assumption that the large and the small firms are adversaries. This has resulted in limited information flows, a large supplier base in the case of large firms, and purchasing on the basis of

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Figure 6.4 The regional distribution of value-added in the Finnish furniture industry, 1990–1994. Source: Unpublished data of regional accounting, Statistics Finland (1996).

Table 6.5 The two spatial concentrations of the Finnish furniture industry in the mid-1980s

Source: Laaksonen and Rajala (1987).

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price and frequent switching of orders to keep suppliers ‘on their toes’. Obviously, the atmosphere of mistrust, faithlessness and mutual frustration has not been beneficial to long-term quality improvement and the process of mutual learning (Kautonen 1995, 1996). In contrast, there have been no large firms in the second spatial concentration of the Finnish furniture industry, the predominantly rural Suupohja district where the age-old joiner tradition has been the basis of the industry and individual competence has been emphasised. In many cases furniture production in Suupohja has remained a part of the traditional rural pluri-activity in earning supplementary income from any possible source.24 Not surprisingly the family businesses’ perceptual distance to export markets has been vast, accustomed as they were to door-to-door deliveries to domestic customers of ‘rustic antique furniture’ and other similar products (Laaksonen and Rajala 1987). Clearly, the location of furniture production has become more decentralised in Finland since the 1970s (see Table 6.3 and Fig. 6.4.). This is partly due to regional policy measures, which have been relatively effective for this industry characterised by low barriers to entry. The regional deconcentration has become more prominent especially in the 1990s when the major, large firms of the leading region, Lahti, were extraordinarily hard hit by a free fall of domestic demand, losing more than 600 jobs. Even the small and medium-sized furniture companies lost about 300 jobs, leading to major changes in age-old practices such as the formation of joint export groups, a wider utilisation of subcontracting arrangements and the introduction of flexible production technologies. Also several public-funded projects increased the transfer of new technology to furniture producers and co-operation between firms was encouraged through semi-public organisations (Kautonen 1996). Overall, the Lahti case demonstrates that a regional agglomeration is no guarantee of success in the furniture industry. In its heyday, Lahti had by far the strongest concentration of furniture industry in the Nordic countries. However, this agglomeration did not support localised technological and organisational learning processes, and without such localised capabilities it lost competitiveness. In sum, the problems of the Finnish furniture industry seem to be associated with the characteristics of both the national and regional/local operational environment. The dominant role of the forest cluster in the national economy has undermined the potential significance of domestic raw material supply, and set institutional and cultural constraints on the industries at the margin of the cluster, including furniture production. The following years will show whether the restructuring resulting from the crisis in the 1990s has lead to an overhaul of age-old practices—and to an evolution of a new concept of success. 117

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Conclusion: proximity and competitiveness in the furniture industry The comparison of the Danish and Finnish furniture industry supports the view that subtle competitive factors can be crucially important. Factors such as labour costs, raw material supply and spatial clustering, which are all directly observable, would seem to provide Finland with a stronger position. However, some intervening factors, presumably based on interactive technological and organisational learning processes, have made Danish firms more competitive in furniture production. In the Finnish case, the business recipe which has proved successful in some sectors such as paper production, has rather been an impediment to success in some other sectors. The benefits of proximity can contribute to spatial agglomeration of industrial activities. In places which are characterised by interactive learning, knowledge tends to become embedded, not only in individual skills and in the routines and procedures of organisations—or rather in the manifold interrelations that make up the milieu. However, not all agglomerations are results of such processes, and—as the spatial concentrations of the Finnish furniture industry illustrate—localised production systems can be locked in by the development of routines and practices which gradually lead to the loss of competitiveness. It is difficult to unlearn practices which have proved to be successful in the past, even if they hinder future development, and firms are frequently led by their former success into trajectory-specific lock-in situations. Against this perspective, the essence of a crisis is that knowledge-creating activities have to be initiated once again. This process does not necessarily have to start from scratch: it is probably easier to get rid of unsuccessful path-dependent practices in a situation where the focus has to be on resources and opportunities which have remained under-utilised in the past. In the whole economy, the accumulation of competence is thus dependent both on continuous learning processes in advancing industrial systems, and on the speed at which lock-in situations are broken and intra-and inter-firm knowledge-creation activities are given new vigour in the right direction. The difference between the country-specific developments suggests that it is problematic to transplant some recipes for success from one place to another. Only by having developed a bundle of valuable competencies difficult to imitate, can firms, regions and countries hope to maintain their long-term competitiveness. Processes of growth in these industries are based on specific constellations of intra-firm assets and inter-firm supporting institutions, just as processes of decline begin when such unique constellations lose value.

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Though this conception limits the policy conclusions which can be drawn from the comparative study of the furniture industry in Denmark and Finland, it points at the crucial importance of developing and maintaining localised capabilities which enhance competence and increase competitiveness even in low-tech industries.

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7 NATURAL RESOURCES AND THE INSTITUTIONAL ENDOWMENT: THE FISHING INDUSTRY Fish fuck in it. (W.C.Fields, when asked why he never drank water)

Fish constitutes an important ingredient in the present production of food in the world. On a global scale, 16 per cent of the total human intake of animal proteins was attributable to fish in 1988 (FAO 1992). Fishing and fish processing is geographically highly concentrated to specific communities in the coastal areas of relatively few countries. The fate of these communities and the fish-processing industry are closely connected with the natural resources of the sea, and the way in which these resources are handled (COM 1996). From an economic point of view the fishing industry is somewhat peculiar. The input—the fish—is at its highest value when fresh, before processing starts. Furthermore, private property rights do not exist, resulting in widespread ‘tragedies of the commons’ (Hardin 1968). So while other industries deregulate (cf. Chapter 8), an increased public intervention and regulation is urgently needed in fishing to maximise output. Because the industry is based on natural resources to meet basic needs for food, this industry is also related to space, time and social life in a more complex way than ‘modern’ industries. Fishing is more than an economic activity, it is also a way of life deeply embedded in the long history of coastal settlement. These and other unusual aspects are considered in this chapter, but its main aim is to illustrate how the territorially specific institutional endowment interacts with the natural resources, augmenting the competitiveness of some areas, while abating the competitiveness of others. As fishing and fish processing are basically low-tech, natural resourcebased and rather labour intensive activities, the possibility of success for firms in high-cost countries decreases. New localised capabilities must be developed to sustain and augment the 120

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competitiveness of firms within the fishing industries in such countries. A major element is the modification of the existing institutional endowment. Incentives to innovate and invest in the creation of new knowledge must be enhanced, in order to understand complex ecological systems and to catch and process the fish as efficiently as possible. New managerial efforts must be directed to implement technological innovations and improve both organisation and marketing. Principles of sustainable capacity must guide the restructuring of the fishing fleet and the processing industry. Most important, however, is the formation of a new regime of regulation to secure sustainable, bio-economic harvest at the highest possible level. This chapter starts out with an account of the principal issues and critical components of the regulatory regime characterising the industry. It is followed by a sketch of the main elements of the industry and its geography, and goes on to illustrate the interaction between specific national regulatory regimes and the competitiveness of the industry. It concludes by taking a closer look at the interaction between the localised capabilities and knowledge creation in the industry. Setting the scene; or how to exercise property rights on self-propelled property Fish is a renewable resource with strong biological limitations on how this natural resource is exploited. A sustained harvest demands that the limits of self-renewal are not exceeded. With small catches from a large stock, the regeneration of the stock is not a problem. With large catches over time the stock can be threatened by total depletion. A sustainable resource utilisation and an economically sound management of this industry therefore demand some regulation of the harvesting as soon as the catch capacity reaches a certain level. From time immemorial fishing has been open to everyone for the purpose of feeding the family or clan, or to obtain commodities like grain or salt through barter. With the development of trade, communities specialising in fishing grew up along the coasts of most nations. As long as the annual bio-economic growth was larger than the harvest the principle of free access did not cause any problem. But when technological development expanded both the operational radius and the capacity of the fishing fleet, competition for a limited resource entered the industry and conflicts between fishermen with different equipment and from different regions and countries became manifest. In exploitation of renewable natural resources one can usually count on the self interest of the owner of the resource to act in a way which ensures future yields. As long as this is the case the interest of the individual will be in broad accordance with the interests of society. In 121

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agriculture, forestry and other land-based industries the present value of all future yields will normally by far exceed the value of spoiling the land through overutilisation. Through carefully developed systems of property rights the owner of the farm can rest assured that they will personally benefit from behaving sensibly today. This does not, however, apply to the exploitation of marine resources where no clear regime of property rights to the resources has developed1 and in unregulated waters everybody has the right to exploit the stock. If one actor decides to stop fishing to save the stock for next year’s harvest, there is no guarantee that others will do the same. Quite the opposite usually happens, as the logic of this situation gives good reasons for the other actors to catch even more. This kind of self-seeking rationale will of course end in an undesirable situation with a breakdown of the reproducing capacity of the stock and in the worst case to the depletion of the whole stock. In fishing ‘the tragedy of the commons’ is thus created by the free access to the natural resource, but also by low barriers of entry to exploit the resource.2 It is obvious that the ongoing process of new entry, new investments and technological advancements in efficiency will eventually lead to the depletion of all economically attractive stocks and even to the irreversible extinction of some species. But without property rights this does not translate into individual incentives to reduce catches. Rather, the tragedy is seen as the inevitable outcome of the activities in the industry. As long as it does not seem to occur in the immediate future, the industry tends to ignore such worries. ‘In the long run we are all dead’ as Keynes (1923:65) once remarked—though presumably without thinking especially of fish.3 Nevertheless, different groupings within and outside the industry have spent a lot of effort on finding ways to create some sort of a feedback mechanism to make it advantageous for the actors to stop over-fishing. As all such schemes hinge on the creation of property rights it became very early in the process an issue for national governments—especially those where fishing industries were or could be of importance. These coastal countries started in the 1950s to fight for the legal right to fish in the waters closest to their own shoreline. A seminal event towards such an end was the establishment of 200-mile exclusive economic marine zones as part of international law in the 1970s —with Iceland being one of the front runners. Fish feed directly or indirectly on micro-organisms (plankton) brought towards the surface by sea currents when faced with the large alteration in water depth between the ocean floor and the submerged coastal shelf. Such geological and oceanographic structures, with most of the fertile and economically important fishing grounds, usually lie within 200 miles of the coast. Since this addition to international law was generally acknowledged, it has been the political and legal task of national governments (and the EU on behalf 122

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of its member countries) to define a regime of regulation within the national zones, which can protect and control the fish stock.4 A third of the oceans and over 90 per cent of the known marine resources is now under state control.5 The establishment of public property rights within the respective 200mile zones represents, however, only a partial solution to the tragedy of the commons. The reason is that fish do not stay in one place through their lifetime. They swim, sometimes over considerable distances (Agüero and Gonzales 1996). Worse still, they have a disturbing habit of passing through the exclusive zones of several countries, as well as through unregulated, ‘open’ fishing waters. Furthermore, it is not viable to claim a legal property right to a particular marine individual. It is simply hopeless to identify the individual fish and inconceivable to control where a particular fish is swimming in the open sea. Even for whole stocks of fish, identification and territorial control is arduous with available technology. If the individual fish cannot be identified, the regulations must be based on quantities, that is, on fishing quotas (Cheung 1970; Furubotn and Pejovich 1972; Hampton 1987). The life-cycle of many important species involves a migration pattern where the fish is born and grows up at the coast, taken by ocean streams out into the open ocean to feed before it returns to the coast as an adult ready to spawn. The bio-mass is maximised if the fish is harvested after it becomes sexually mature. At that time the stock also moves to the coast and is within easy reach. But actors operating from one country can find it tempting to fish all the passers-by they can, regardless of any global ecological and economical considerations. The tragedy of the commons is thus finally solved only with some transnational agreement covering all the waters in which a stock moves through the lifetime of its members, and the 200-mile exclusive economic zone is only a first step in this direction. It is never easy either to decide on or to operate transnational regulatory regimes. But it is especially complicated when they are based on some bio-economic prediction of stock growth to determine how many of each species are available for catching (Hannesson 1993). It has been estimated that 60–70 per cent of the decline in catches is due to overfishing. However, many mechanisms besides the size of the stock and catches influence the growth rate. Ocean currents, water temperature, vertical water circulation and light determine the production of fish food such as plankton or shellfish.6 All the underlying variables of a complex biological system are not easily accommodated within the limits of some clause in an international treaty. Small wonder that the distribution of quotas between countries perpetually becomes a battleground where the diplomatic manoeuvring evolves around the usual hard economic realities and power relations, strongly flavoured with a mixture of more or less valid scientific arguments. 123

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Regardless of such international turmoil, the introduction of individual quotas to each vessel has gradually proved its worth. In northern waters individual quotas for certain species were first introduced in the 1970s in the Norwegian fleet after heavy overfishing due to new technology. Iceland followed shortly after (1975) and in both countries the regulations have been very strict thereafter. National research institutes in Iceland and Norway recommend yearly a total quota for each species and these recommendations are mostly followed scrupulously. As a result stocks are growing again and the yields are steadily rising. In the EU on the other hand, quotas are almost always larger than recommended by researchers, and as a result the resource crisis is still severe in most EU waters. Such spatial differences in the success of regulatory efforts are linked to economical as well as broader, historical features. Because of the distance to competitors the fishermen of Iceland and Norway had for centuries a sort of monopoly of the local marine resources which might have taught them a lesson of sustainability the hard way: that yield one year had something to do with actions in the past and not only with natural cycles of the stock or changes in oceanographic conditions. And when the economic life of a whole country or many of its regions evolves around a single industry, it is probably relatively easy to create common consensus for the importance of protecting the resource base. The governments of Iceland and Norway thus had a direct economic interest in managing complex ecological systems, and in allocating resources to knowledge creation in oceanography and ecological systems, in marine life and multi-stock management. The acceptance of public intervention is eased by an egalitarian political structure that distributes the burden of regulations equally on the individual fishermen or vessels, and provides compensation for temporal economic problems of the individual fishermen. The seafood value chain Marine resources are the basic input to the fish processing industry. A mix of coastal and deep sea vessels land catches of different species. This extraction part of the total value chain is globally characterised by enormous over-investments. FAO (1992) has estimated the total revenue of the landed catch of the world’s fishing fleet of today7 to be only US$70 billion.8 This is less than half of break even. The annual operating cost alone of the same fleet is estimated to be US$124 billion, so that US$54 billion must be covered by national or EU subsidies. Furthermore, in most countries no rent is paid for the harvest of these resources. Applying, for instance, the Australian ratio of gross revenues to rent, the global fisheries should add US$25 billion to the operating deficit of US$54 billion. Thus the competitiveness of the whole global fishing industry is hampered by the burden of US$79 billion annually—more than the total revenue—as a 124

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result of an inefficient fleet structure, over-investment and a lack of effective fishery management.9 Once the fish is landed it has to be brought to the consumer. Utilising the marine resources in earlier times demanded costly and slow transportation, necessitating preservation in order to maintain quality. Major improvements in transportation and cooling technology in recent years have also opened up the export of fresh fish from the northern part of Europe to markets in central Europe and even the US and Japan.10 In most industries the output is more valuable than the input. The difference pays the workers, management and shareholders, just as it is used to compensate for the depreciation of the plant, etc. However, the input in the fishing industry—the fish—is often at its highest value when fresh, before processing starts. A fresh fish is higher priced than a frozen fish, a fresh fillet is higher priced than a frozen fillet. But it is also the case that fish sold as fresh fillet costs more than whole fish in many markets. This unusual state of affairs is, of course, a direct consequence of the short span of time in which a fresh fish remains fresh, and thus keeps its high perceived customer value. If supply and demand coincided in time and space, no processing would be necessary. But the time has passed when the housewife went to the food market for the daily supply of food. Most customers prefer semi-processed fish such as fresh fillet, and many ask for further processed seafood for convenient cooking at home or in institutions where seafood is prepared or served. Regions rich in marine resources are often found far away from the main markets for seafood, and the landing of catches does not completely correspond to the pattern of demand. Hence, some processing is required in order to expand the durability of the product by preventing or postponing decay. This processing thus increases the time through which the product can be consumed, just as it can add new and attractive attributes to the product (taste, easy to prepare, etc.). The main value chain in the fishing industry can be illustrated as shown in Figure 7.1. The processing part of the industry can be divided into four sectors: • a traditional sector, where fish is cured: salted, dried or smoked (8 per cent);11 • a sector for production of fish oil and fish meal (28 per cent); • a sector for canned seafood (12 per cent); • a sector for freezing and production of frozen products, including fillets (24 per cent). Traditionally, fish for human consumption has been cured (salted, dried or smoked) to make storage and transportation possible. The profitability of the salting and drying of fish varies from year to year depending on

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Figure 7.1 The value chain in the fishing industry.

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market prices. This trade is very specialised. For example, only a few countries such as Italy, Portugal, Nigeria or Brazil consume dried fish or stock fish. This production is really low-tech, partly dependent on natural weather conditions and highly localised. To improve profitability the production of consumer packed products has been expanded, but salting and drying at sea has not been a success. The production of fish meal and fish oil is based on low value species or on catches exceeding the current market demand—as reflected for instance in prices below the EU intervention price. To be competitive in this industry one needs access to large quantities of low value fish, knowledge of the available processing technology and product specialisation. This sector of fish processing has thus always been the most capital intensive of all, and also in recent years innovative regarding refinements in production processes and upgrading of the end products. Though rich in protein, the taste and smell earlier made the products unsuitable for human consumption and the only commercial alternative left for this nutrient was to use it as animal feed, and for a while also as fertiliser. Today, commercially available technology exists to convert fish meal and fish oil into products fot general human consumption, and frontedge technology is becoming increasingly important for firms with a highcost location in order to stay competitive. American canning technology gradually found its way to other developed countries before the turn of the century. The technology was often adjusted locally to species available and new machines were developed for smoking and laying sprats, bits of herring or anchovies in tins filled with olive oil or marinade. In spite of this, the canning process was relatively labour intensive. European centres for canning were found for instance in the Basque region on the north coast of Spain, in the UK and in Norway, where competitiveness was strong because of good access to cheap, fresh raw materials and cheap labour. Most of the Norwegian production was exported to the US, Australia or South America and sold in finer grocery stores under own brand names and with particularly colourful labels. Conventional production and canning were both based on labourintensive processes with modest scale economies, low to medium capital input and an artisan flexibility in production to adjust to the seasonal cycle of landed fish. Both the Norwegian and the Swedish canning cluster survived until the 1960s when a rise in labour cost forced most of this industry out of business. In the early twentieth century icing of fish was also common to delay decay, but the most popular method of preserving fish in recent decades has been freezing. The balance between the (traditional) canning technology and the (modern) freezing technology was tilted by the fact that many consumers consider fish in a can to be less ‘fresh’ than frozen 127

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fish. Freezing technology in itself is a simple technique, but it requires considerable mechanical installations for freezing and storing with only moderate economies of scale. With the gradual introduction of freezing technology in the fishing industry from the 1930s,12 the processing industry became more stable, but also more capital intensive. Before freezing, the fish has to be washed, gutted, headed, skinned, boned, cut, cleaned and controlled. It involves a preparation line, a filleting line and could also involve a production line for prepared meals.13 Much can now be automated on combined lines. This requires a combination of complex knowledge from the mechanical and electronic sciences in the development of numerically controlled processing equipment. Market information on the shape and quality of the products in demand is also important when manufacturing machinery. This will add image processing to the technologies contained in a modern freezing plant.14 As processing lines and freezing equipment are installed in more and more of the most efficient vessels, the land-based freezing plants are gradually shifting towards processing customer tailored fillets, species usually caught in small quantities only (such as plaice), or species formerly used mainly for the production of fish meal and fish oil (such as capelin and herring). But as continuous supply requires continuous catches, larger vessels not dependent on weather or the seasonal cycles of coastal fishing are best suited to serve large filleting and freezing factories on shore. The introduction of freezing technology has also influenced the whole structure of the food industry. Historically, the development of freezing technology and food processing in general was geared towards agricultural products in the US, the UK and Germany. Vegetables, red meat and chicken were the most important inputs for automated production lines producing frozen products. Thus the basic freezing technology was developed for this huge segment where very large volume producers were required to make the best use of the technology. The subsequent growth of large transnational companies like Nestlé and Unilever, now dominating the food industry, is at least partly a result of these technology-related demands. The volume also enabled the producers to establish well known trademarks. Furthermore, frozen food products require a freezing chain from the factory throughout the distribution system to warehouses and further on to the retailer. This necessitates huge, co-ordinated investments. The weakest link was the shops, and large food distributors and producers bought market access by placing freezing counters for their products in the shops. Thus the larger food producers gained additional competitive advantage through economies of scale and by having exclusive access to the retail outlet space. Given a well developed distribution chain there are economies of scope in mixing frozen agricultural products and seafood. Distributors only selling seafood are therefore at a disadvantage compared to companies selling a wide variety of frozen products. At the same time, for 128

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the present the large retailing chains are subsequently winning market power over the manufacturers of food. In many domestic markets, and soon also on a European scale, a few gigantic retailers will decide who is allowed onto the shelves of the shops. With no strong brand name as a backing most small producers of frozen seafood will therefore be forced to produce on contracts for groups with a tremendous bargaining power. The consequences for the profitability of the small processors are obvious. Transporting fish to the main markets has traditionally been a separate activity taken care of by specialised firms, but as distribution gains importance some vertical integration or close network relationship must be anticipated (see Chapter 3). This will especially be the case for firms engaged in the growing high-value cross-continental markets for fresh fish where the quality level must be maintained in a co-ordinated manner from harvesting, through processing and distribution to the retailers. Related industries are also important. The fishing and fish processing industries are an important market for ship designers, shipbuilders, repair yards, producers of gear and winches, as well as search and communication equipment. Innovative activity at sea is dependent on demanding fishermen and a skilled engineering industry able to translate the needs of specialised fishing into products which can stand the harsh environment of the northern waters. A diversified marine construction industry is therefore an important part of an innovative milieu for constructing fishing vessels and developing fishing gear. With a large merchant fleet, strong traditions in shipbuilding and new experiences from building offshore oil and gas installations, the Norwegian marine-based engineering industry has a unique position. Strong related industries in other food processing sectors are important to producers of freezing and filleting machinery, packaging materials and packaging systems, as well as the technological development of the fishing industry. Suppliers’ innovations support the pursuit of higher productivity and better quality, necessary for improved competitiveness and profitability of the industry. The national mix of technical and commercial knowledge from a large food processing industry and an innovative machine industry was significant, for example, in Germany, the US and to a certain extent in Denmark. Most of the equipment on a filleting line in fishing countries such as Norway and Iceland has traditionally been German or Danish. Finally, deliberate knowledge creation includes surveying fish stocks and learning about their feeding patterns, growth and migration, as well as oceanographic research. Conflicts between commercial fishing and conservation of marine wildlife adds importance to knowledge of multistock management. Even more complicated are the disputes about total protection of whales and seals. As these species eat enormous amounts of fish they are included in the ecosystem and therefore also in the multi129

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stock problem. With unlimited growth of whale and seal numbers the amount of exploitable stocks for human consumption will be smaller and as a consequence hurt the economy of nations such as Iceland and regions like northern Norway. To find a balance of protection and harvesting will require generic knowledge in which the public sector has an important role to play. The geography of supply and demand in the fishing industry The supply of seafood is determined by a number of factors of which the most important is the natural biological productivity of the oceans and coastal waters. In 1993 the world catch and culture of fish exceeded 100 million metric tons (FAO 1995). Many potentially important fishing waters in the southern hemisphere have been clearly under-utilised until recently. The increased use of modern production technology (vessels, gear, processing) is now showing in rising catches and exports in many developing countries, and the quality gap between producers in developed and developing countries is getting smaller. While in 1970 the developing countries accounted for 27 per cent of the catch and 32 per cent of exports, they now account for more than half of both catches and exports, mainly from countries in Asia.15 In the northern hemisphere Japan, Korea, Russia, the US and Canada all participate in the harvest of the biologically productive fishing grounds of the northern Pacific. Another very biologically productive fishing area is the north Atlantic, which produces roughly one-third of the total export value of seafood in the world (FAO 1995). The US16 and Norway head this list, followed by Denmark, the Netherlands, Iceland and Canada (FAO 1995).17 The three Nordic countries, Norway, Denmark and Iceland, have a 6 per cent share of the global catches, but 20 per cent of seafood exported globally comes from these three countries (including Greenland and the Faroes). Norway has a big fishing fleet and considerable processing of fish, and aquaculture along the coast has grown very rapidly during the last decade. Denmark has a considerable fish processing industry which uses catches from its own vessels as well as imported fish. Both the catches and export are smaller in Iceland, but their relative importance for the national economy is much higher. The Nordic stronghold in the export of fish products is very visible in a European context, as shown in Figure 7.2. The present global supply could thus be much higher, without increased danger of stock depletion, but exclusively through better resource management; reduction in the share of fish used to feed animals; less destructive fishing techniques; better input-output ratio in aquaculture, etc. Addi

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Figure 7.2 Export of fish in 1993 in millions of US$. Source: FAO (1996).

tional sources of supply also loom as bio-engineers conceive new or more productive species. The use of fish as a source of human food has increased from 40 million metric tons in 1970 to more than 70 million metric tons (FAO 1995). The share of fish as a source of animal protein consumed by humankind is 29 per cent in Asia and 19 per cent in Africa, but much lower in developed countries with a few exceptions, such as Japan and Iceland. Servicing these markets requires high quality products demanding a lot of skills in all steps of the value chain: catching, handling, processing, transporting and retailing. The main future growth in demand is expected from the

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developing countries, as a result of population growth and improvements in the standard of living.18 By far the most important (and profitable) single markets are Japan and the EU, each importing one-third of all internationally traded fish products, followed by the US with 14 per cent. Within Europe the import structure is highly skewed towards the Catholic countries, reproducing a trade pattern going back to the early Middle Ages (Fig. 7.3). The demand for seafood is inversely linked to that of meat products. Fish as a nutrient has, for instance, to compete with substitutes like chicken, which is now being produced under highly efficient factory conditions. Such production methods place tight restrictions on the profitability of the

Figure 7.3 Import of fish in 1993 in millions of US$. Source: FAO (1996).

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fishing industry as long as households in the European and North American high-volume markets accept the quality of the product, and the conditions under which it is produced.19 The gradual internationalisation of an originally local industry has severely increased the competition between firms located in different parts of the world, utilising distinct natural resources. Substitution is now taking place within the fishing industry between different species of fish with different cost structures. For instance, fish from Iceland or Norway now has to compete with pollack from Alaska and salmon from Chile, both of which are species that can be processed with large-scale, cost-efficient equipment. Additionally, the dramatic concentration in recent years in the wholesale and retail trade has decreased the bargaining power of the fishing industry. Rapidly growing purchasing groups—often retail chains— both in Europe and North America are giving the many relatively small suppliers of seafood a hard time. Several purchasing groups have developed their own private labels, enabling them to shift easily from one supplier to another, which in itself contributes to cut profits in the fishing industry. Furthermore, as suppliers in low-cost countries are picking up on quality, these purchasing groups automatically use their power to demand price reductions from their current suppliers—usually located in the small high-cost countries of northern Europe. Table 7.1 illustrates the ever increasing competitive environment in this particular trade. The more dependent on the fishing industry, the higher the pressure on these countries to improve efficiency. The intentional creation of new knowledge—and its subsequent utilisation in the fishing industry—is one important strategy open to such countries. Another is the adjustment of the industry’s regulatory framework Table 7.1 Export prices of fish from Norway, 1980 = 100. Corrected for inflation

Source. FNL (The National Federation of Fishing Industries), Norway 1995.

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thus changing its incentive structure. As an institutional endowment has been incrementally developed over time significant differences between regions and countries appear. It is therefore not surprising that the specific response to new external conditions displays major dissimilarities. The fisheries management systems and regulations differ. Understanding changes in competitiveness in this sector thus invites an analysis of the implications of regulation and innovation. Protecting both fish stocks and fishing communities: the case of Norway Less than 1 per cent of the total number of 4.3 million Norwegians are occupied with fishing and even less in fish processing. A meagre 0.7 per cent of the country’s GDP was produced in the fishing sector—almost half of which came from the new aquaculture industry—but almost 8 per cent of the export could be related to seafood in 1994. Nevertheless, many Norwegian regions are very dependent on this industry. The northernmost county of Norway is even more dependent on fishing than Iceland (Table 7.2), though fewer are working in the fish processing industry. In countries like the UK, the Netherlands and Spain, fishing developed early on into a deep sea activity, using large vessels to harvest fish far away from the coast. Trawler companies were formed and as a consequence the fishermen were getting poorer and politically impoverished. Fishing became increasingly capital intensive as the vessels got bigger and started to utilise modern technology and economies of scale. Not so in Norway, where a natural rhythm brought enormous numbers of economically attractive species close to the coasts, maintaining the feasibility of smallvessel fishing. Work was done manually by the Table 7.2 Inhabitants and occupation in the fishing industry by country and county (Norway), 1994

Note: *Iceland: man year, Norway: main occupation. Source: Central Bureau of Statistics, Norway; Fishery Statistics, Icelandic Fisheries Association.

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fisherman’s family or by a flexible workforce hired by a trader for a season when large quantities of fish were landed. The annual fluctuations in catches gave rise to shifting workloads through the seasons which alternated with the work pattern of agriculture. Fishing thus became a part-time occupation for peasants and a corner-stone for the economy of the integrated agro/fishing-economy (Brox 1966). This economically viable system has preserved parts of old common law, long gone in other fields of society: while old rights for free men to hunt and settle on unused land gradually gave way to private ownership, coastal communities maintain a collective right to harvest the stocks of marine resources demarcated by traditions and earlier practices.20 Under these circumstances, an important part of regulations will be guided by protecting historical rights and accessibility to the resources for certain groups and denying access for others. The activities will tend to be regulated in a way which keeps the cost of entry low and open for individuals as free operators of fishing boats. By implication there is, therefore, a preference for small scale, low-tech equipment. A political struggle in 1923 ended in banning non-family (big capital) interests in the primary sector of this industry. Only active fishermen are allowed to own a fishing vessel in Norway and even today the owner of a ship, be it a small boat or a large trawler, is the skipper on board. This historical background strongly influences the way in which any legal protection of the stock of fish can be conducted today. If access to the sea has to be limited, quotas must be distributed per capita or in accordance with historical catches. This is precisely what is done: quotas are issued to licensed vessels 21 in correspondence with the vessel’s previous catches of demersal fish, subject to negotiations between the state and the fishermen’s organisations. But regional considerations have also to be taken into account. While a less publicly regulated system would be acceptable to the flexible ocean-going fleet of western Norway (especially the county of Møre and Romsdal), it would constitute a threat to the small-scale coastal fleet of especially the northernmost counties of Troms and Finnmark, bordering Russia. In Table 7.3 the share of large vessels in the fishing fleet illustrates the relative difference between counties in Norway, but also the quite different structure of the Icelandic fleet. Iceland is particularly strong in factory trawlers and Norway in purse-seine vessels used for pelagic fishing. Compromises thus have to be reached which can satisfy different regions and different groups of vessels and tackle. One likely outcome is an allocation of a larger proportion of the annually available catches to the coastal fleet of northern Norway and a reduction in catches for the more mobile and efficient southern fishing fleet, just as long—liners should be protected from trawlers fishing on the same ground.

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Table 7.3 Structure of the fishing fleet, Iceland 1994, Norway 1995

Note: *Iceland: man year, Norway: main occupation.

Source: Central Bureau of Statistics, Norway; Fishery Statistics, Icelandic Fisheries Association.

As stocks are growing, most of ‘the insiders’ can earn an acceptable income from fishing. However, the emphasis on historical rights and a demand that only active fishermen be given a licence to buy a boat with fishing rights will subsequently eliminate free entry in favour of a system of quasi property rights to the marine resources. Matching available resources with catching capacity and the traditional, common law rights both partake in barring newcomers from entry. So through clever stock management and the quota system there is now enough fish for all licensed fishermen, though the fish is not a common resource any more. By continuing to include regional policy considerations in the regulation of the fishing sector and—partly as a consequence of this—keeping quotas non-transferable, the structure will become increasingly inflexible and probably also increasingly inefficient.22 The largest fishing company in the world in the white fish sector is now American, forced out of Norway in the 1980s partly because of regulations and restrictions on capitalistic behaviour in the sector (see Case 7.1). Several Norwegian family-owned factory trawler companies also migrated to other countries. Jobs and resources are lost in the most efficient and mobile parts of the sector, while many small coastal communities are kept alive, and their small-scale, ecologically adjusted fleet preserved.

Case 7.1 Resource Group International (RGI) Resource Group International (RGI) is the world’s largest producer of white fish products with more than 10 per cent of the global catches. RGI is, however, not an old company. It can be traced back only to 1982 when a Norwegian fisherman bought an American, round fish trawler and started fishing in the icy waters of Alaska. The economic success of this venture enabled the

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NATURAL RESOURCES assembly of a rapidly growing fleet of factory trawlers based on the fishing of Alaska pollack. In this fishing the authority sets a total quota for the season. When the fishing is opened it is the competition between all participant vessels which decides the catches. When the total quota is taken the fishing is stopped. This form of regulation favours large and technologically advanced vessels able to fish in rough weather, over a long time and with large capacity. On board processing and freezing allow for continuous fishing as long as the fishing is open. Fillet production combined with production of surimi (base for production of, for example, crab sticks), roe harvested in season and entrails for fish meal and fish oil products, also allow for little waste and an efficient use of the raw material. Nevertheless, the company’s highly effective trawler fleet has brought them in conflict with environmental groups such as Greenpeace who accuse RGI of emptying the oceans. American Seafood Company, as part of RGI’s seafood division, was founded in 1988 based on Norwegian and American expertise in the white fish fisheries. The company constructed some of the most advanced and productive fishing vessels ever developed. Due to American legislation marine vessels have to be built in the US. Nevertheless 25 per cent of the Alaskan trawler fleet is built in Norway. To get around the Act, an American-built hull is reconstructed into a factory trawler in Norway. American Seafood also operates in the Russian Far East and in South America, fishing on quotas bought in these countries. American Seafood de Argentina operates in South America. Several of the factory trawlers used outside US waters are fully constructed in RGI’s Norwegian shipyards. In Europe, Norway Seafoods organise RGI’s fishing interests. Here ownership of fishing vessels is highly restricted. Even more so is the operation of factory trawlers. RGI’s activity in the Nordic countries is therefore mostly restricted to onshore activities. Norway Seafoods includes two producers of fresh and frozen products of white fish, Melbu Fish in northern Norway and Thorfisk in Denmark, one producer of fresh and frozen pelagic fish and salmon, Skaarfish in western Norway, and a producer of smoked fish products, Norlax in Denmark. As brand name and distributor of consumer products the Norwegian firm Frionor is the group’s marketing organisation in the consumer market. Most of the rapid expansion of RGI comes from acquisitions and mergers made possible by the huge profits earned in the American fisheries. The company is also operating in real estate and in distribution focused on consumer products. The American shoe producer Brooks Sports and Norwegian Helly Hansen, a producer of outdoor apparel, are both included in the distribution division. In 1996, RGI merged with the second largest construction group in Norway, Aker, and thereby added construction of offshore and submarine installations for oil and gas development and cement production to their activities. In the process of this merger, Norway Seafoods was lifted into AKER-RGI which is a Norwegian registered firm. This was a necessary action to get the permission to own a Norwegian fish processing company like Melbu Fish and its attached trawlers. Still, the use of the trawlers is very restricted and tied to Melbu’s onshore fillet factories. This merger also included Stord International, a big producer of turnkey plants for the fish processing industry. AKER-RGI has also bought the majority of the shares in the Danish firm Atlas Industries. Together the new Atlas-Stord forms the largest producer of turnkey plants and machinery for fish meal and oil plants in the world. The most prominent competitor with Atlas-Stord is Kværner Eureka which is part of the largest construction company in Norway. American Seafood Company is an American firm and RGI a holding company registered in some tax haven. The dominant shareholders of AKER-RGI as well as RGI and American Seafood are Norwegians. The two entrepreneurs, Mr Røkke and

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Seen from the point of view of common law such regulations seem right and fair. Yet, from a national property right point of view, such a policy is not in accordance with good resource management of marine or human resources. By sensible regulation the fish stocks can be managed and firms with the appropriate technology can be operated profitably without subsidies. Under those conditions the fisheries cannot be burdened with too many social responsibilities such as creating employment in isolated areas. In spite of examples of market-led success it is obvious from this description that the quest for the status quo in the Norwegian fishing sector is very strong. The fishermen still deliver their catches to a cooperative which negotiates with exporters and producers on behalf of the collective. The co-operatives had, and still have, the right to decide a minimum price if no agreement is reached. Unfortunately the resulting prices are not necessarily in correspondence with the demand-supply equilibrium and the system does not ensure that the market signals are transferred to the primary function in the chain. As a result conflicts have emerged between buyers and sellers leading step-by-step towards marketrelated pricing of fish. Lately the liberalisation of the export trade has caused an emerging integration of the land-based industry. Larger constellations come forward as mergers and acquisitions gradually form multi-plant and multi-product companies with well established brand names and distribution channels. This also includes acquiring processing plants in Denmark, Germany or France in order to overcome the tariff barriers surrounding the EU market.23 Norwegian producers could also utilise their learning experience from fishing activities in other fields of the manufacturing industry. The traditional strength of the Norwegian shipbuilding and metalworking industries unfolds in the field of fishing vessels and fishing equipment as well as in equipment for fish oil and fish meal production (Table 7.4). The table also reveals the limited number of Norwegian producers of equipment for the fish processing industry. A fruitful interaction has taken place in Norway between the large shipping industry and the offshore petroleum industry which requires supply ships, drilling rigs and production platforms. Moreover, the Norwegian government has had a policy to match the international terms of

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Table 7.4 Number of firms in related industries, Iceland 1996, Norway 1992

Source: Own data.

Table 7.5 Catches by country and county, Iceland 1994, Norway 1995

Note: * Million US$. Source: Central Bureau of Statistics, Norway, Icelandic Fisheries Association.

financing and supports the ship-building industry’s exports, though it does not make the subsidies available to the Norwegian fishing industry. The Icelandic fishing industry on the other hand has benefited, as Norwegianbuilt fishing vessels have been competitive in price and at the same time technologically advanced. Most of the American factory trawlers catching white fish are built in Norway or equipped with Norwegian technology, and many Russian trawlers have been renovated with Norwegian technology.24 It might seem strange that a country has developed an innovative and highly efficient marine-related equipment industry which corresponds neither with the manufacturing of equipment for the processing industry (Table 7.5) nor with the national fishing fleet. It is, however, basically explained by the fact that strict regulations in Norway since the early 1980s have limited the possibility of the Norwegian vessel owners taking advantage of technological developments related to boat design in their own country. The fish farming sector is another case where innovative activity, learning and investments have resulted in a steep rise in productivity and a fast fall in production costs. As a pioneer both in technology and marketing with a particularly well suited natural environment for 139

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aquaculture, Norway has developed into the largest producer of farmed salmon in the world. Even though generic marketing has expanded markets extensively, over-production is a problem as well as price stability. In the primary sector—the fish farm—regulation is still strict. Capacity and location are regulated by the government, but rules concerning ownership and competition have been liberalised. As a result vertical integration is allowed and processing and marketing of farmed fish are organised as ‘normal’ capitalistic operations. Another special case is related to the herring fisheries. Most of the catches are taken by larger purse-seine boats and industrial trawlers. Collectively they own the Herring Sales Association (Sildesalgslaget). This organisation operates four out of ten oil and meal factories and owns a research institute (SSF). They operate a sales organisation (Norsildmel) in co-operation with the privately owned oil and meal processing industry. Through this quasi-integration the fishermen, as the ‘owners’ of the raw material, have been forced to find a more profitable way to catch, transport, process and develop commercial products. Strong focus on R&D, innovation in fish farming and strategic control over the value chain have been part of the success of this industry. Two Norwegian firms produce turnkey plants and special processing equipment for the industry. The largest recently bought their Danish competitor and is now the largest producer of turnkey plants for oil and meal production in the world. Agglomeration has taken place as two large and some smaller producers of nutrients for fish farming are located in the same region as the majority of oil and meal factories. The largest is now part of a Dutch group, but the aqua-food division is operated out of Norway. A longstanding interaction between these sectors has led to the development of a world-class integrated production system. Economies of scale are pronounced, but there is a problem of matching scale with needed seasonal and regional flexibility to adjust to the variable supply of fish. Liberalisation in order to regain competitiveness: the case of Iceland The world’s most fishery-dependent country is the micro state of Iceland, with only 265,000 inhabitants. In 1994, 11 per cent of the employment, 16 per cent of the GDP, and fully 75 per cent of the country’s exports were directly related to this industry. Nevertheless, the standard of living in Iceland is one of the highest in the world. This is in no way a self-evident situation. Rather one would expect Iceland to belong to the large group of low-income/low-cost countries with a low standard of living, like most of the other countries that depend heavily on a single low-tech industry. It is in such an area that the squeeze from powerful customers and lowcost competitors is felt most strongly, and thus where one must 140

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anticipate finding the most drastic measures to restore competitiveness. It is, furthermore, clear that without the resource base there would be no fishing industry in Iceland. Historically this industry has developed much the same way as in Norway. First by a small-scale coastal fleet, fishermen’s cooperatives, export monopolies and common access to the resources for all Icelandic citizens. Stiffer competition in world markets and the monoculture of the Icelandic economy led to a liberalisation of the industry. Iceland allowed full vertical integration of the industry and left few restrictions on the expansion of the large-scale ocean-going fleet. Lately four main changes can be identified in the macroeconomic and regulatory framework surrounding the Icelandic fishing industry: • The termination of the former economic policy with devaluations whenever the fishing industry had economic difficulties. • The abolition of selective industrial assistance and subsidies. • The removal of former export restrictions. • The introduction of the quota system. By law all vessels in Iceland above 10 gross register metric tons (GRT) had to be licensed—a limit later lowered to 6 GRT. The total allowable catch for each species was decided and divided among the vessels according to each vessel’s previous catches of demersal fish. Most important was the introduction as early as 1979 of an individually transferable quota system (Árnason 1996).25 By making quotas transferable, the Icelandic regulatory regime gets close to a pure market-based system of managing public property rights. In such a system the most efficient actors would gain licences to harvest the publicly owned resource, thus creating strong incentives to further increase the efficiency of the domestic industry. As the processing industry owned many of the fishing vessels the quotas did not just affect the vessels, but also the industry on shore. As was to be expected, the introduction and vigilant operation of such a quota system led to a general shake-out in the industry. A wave of bankruptcies has reduced the number of actors at sea as well as onshore. The surviving firms have, with some overlaps, pursued one of three different types of managerial response. One group chose habitually to do what they had always done, though the limited quotas now forced them to fish outside the national economic zone. A few even turned to investments abroad in fishing and fish processing. Another group of firms pursued in situ efficiency. To be efficient in fishing is partly based on professional knowledge of finding and catching the fish, but foremost on having cost-efficient equipment and a streamlined organisation. Through mergers and specialisation of processing plants they obtained increased economies of scale and scope. Vertical or horizontal integration was followed by new forms of co141

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operation—like inter-firm stock purchases—in order to improve the utilisation of existing production capacity. Contacts with equipment suppliers are utilised to a greater extent than before to improve the efficiency of the production processes. The third group showed an increased interest in product development, emphasising increased value added or focused on marketing in order to identify the currently highest paying customers. Few firms were formerly active in R&D, though many depended on a firm-specific knowledge base which was developed through practice or interaction with the export houses and equipment manufacturers. Even large firms in the industry displayed a feature usually only associated with small and medium-size companies: an owner who is also the manager in charge, and who does not want to recruit employees with better formal education than his own. Their background and practical approach to problems inferred that only very rarely were university or technically educated individuals employed at the plant or in sales and management. As a response to the changing competitive conditions firms have now started to hire more professional staff both for management and development of products and processes. Regardless of the strategy chosen by the firms in the vanguard, others were quick to follow once a successful track had been identified. When one firm had achieved good results by, for instance, investing in fisheries abroad or by fishing in distant waters, others soon did the same. This learning by imitation was favoured by the small size of the economy, making localised learning easy. Information flows relatively freely through the fisheries community and personal relationships are very common in the industry. Furthermore, important information about successes and failures was disseminated through the downstream exporters: Icelandic Freezing Plants and Iceland Seafood. These gatekeepers to international markets were jointly owned by the many processing plants. The export organisations did more than develop trademarks and get access to markets. Because of their size and position in the value chain they became responsible for coordinating almost all production of frozen seafood in the country, and they had a strong self-interest in making sure that no piece of information on market response or production practices remained unused. When Iceland (together with Norway) became a member of the European Economic Area in 1993, former government regulations as to who could export which species to which countries were all abandoned. As a result the number of exporters increased and producers were free to export all their products directly. The largest exporters responded by expanding their activities abroad and have been able to grow despite fierce competition for fish in the domestic market. Former negative attitudes towards internationalisation—and an inbred fear of foreigners— gradually diminished. Firms that had not been in contact with the final 142

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customers established those contacts in order to start in-house product development. More difficult operating conditions thus forced the firms to increase their professionalism and loosen their dependence on their exporters. As a consequence of the industry’s response to re-regulation, Icelandic fishing firms have now probably become the most efficient in the world (Fig. 7.4). The average age of the Icelandic fleet of today is much lower than that of the Norwegian which also contributes to its efficiency. In Iceland, several innovative and highly internationally competitive firms have emerged in the manufacturing of equipment for the processing industry. The success of the manufacturers of processing equipment depends on the application of electronics and software to solve problems faced by processors both onshore and at sea. As the processing was not regulated by the government the increased profitability of at-sea processing paved the way for new solutions to keep costs down in a highcost environment. The movement of a vessel and the limited space available for processing necessitated new solutions. The development of a scale that could be used on board vessels was a turning point for some Icelandic firms, which have become world leaders in the manufacturing of processing equipment for both on land and at-sea processing (see Case7.2).26

Figure 7.4 Catch per fisherman in US$ in selected OECD countries. Source: Review of Fisheries in OECD countries, 1995 edition, OECD (1996); Central Bureau of Statistics, Norway; National Economic Institute, Iceland.

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Case 7.2 Marel Ltd Marel Ltd is a fast growing, profitable company located in Iceland. Its turnover in 1997 is expected to be US$60 million. Marel has 450 employees, 20 of them at subsidiaries in Halifax, Seattle and Kansas and 200 in Denmark. Eighty per cent of Marel’s production is exported and the main markets are Norway, the US, Canada and Russia. Established in 1983, Marel, followed the path of many entrepreneurs: money soon became short and in the mid-1980s the firm had to be refinanced. The idea behind Marel’s activities is an electronic scale that scientists at the University of Iceland developed in the late 1970s. As the manufacturers of traditional mechanical scales did not see the opportunities in electronic weighing, Marel got a head start. And while its competitors had to go through an extensive process of unlearning old skills and ways Marel’s employees had no experience in mechanical weighing. Furthermore, Marel’s internal organisation was from the beginning designed for the demands of the field of electronics. A major breakthrough for the company came in 1985 when it introduced a marine scale to be used on board vessels. More than 2,000 marine scales have been delivered since 1986 to thirty countries and Marel’s world-wide market share is 60 per cent. One thousand scales have been sold to customers on Russia’s east coast and Marel has more than a 90 per cent market share in that area. In some cases, for example when processing valuable products such as fish roe and crabs, the investment in a marine scale has a pay back of a few days, as the scale reduces the need for surplus weight and guarantees a minimal variation in the weight of products that the customers have ordered. Based on the original electronic scale, Marel’s product assortment has grown because of the firm’s constant emphasis on R&D. Of Marel’s turnover, 15 per cent goes into R&D. Marel co-operates with the University of Iceland, Icelandic research institutes, the Icelandic export organisations and individual processors in its R&D activities. Following the electronic scales came continuous weighing, weight grading systems, flow processing lines and production control software including ProPlan, an expert system for production managers in fish processing plants. Applications of digital technology have led the firm into computer vision that is used for shape grading and intelligent portioning. Recently the firm has been an active participant in European research projects, e.g. ROBOFISH, for which Marel provides computer vision technology. The robot removes a fish from a conveyor belt and locates it in a de-heading machine. In order to know the location of the fish the robot uses computer vision. A firm in Iceland will start testing the robot soon in its processing, but it is expected that the pay back period will be less than one year. Marel’s emphasis has been on development, assembly and marketing. Its policy was to subcontract as much manufacturing as possible. In recent years, in-house manufacturing has increased as some of its subcontractors have not been interested in growing at the same rate as Marel. In one case Marel bought a subcontractor’s production facility, which it now operates at its headquarters. Marel’s strive for increased quality has also led to the application of new technologies that are not available elsewhere in Iceland. The production system at Marel has consisted of a job shop and an assembly line. The firm is automating its production and changing over to a cell-based manufacturing system. Recently Marel presented its technology to meat processing firms. After some development the firm has started to supply equipment to poultry and pork proces

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NATURAL RESOURCES sing firms in the US and Brazil. In 1996 Marel established a subsidiary, ‘Marel USA’, in Kansas which services the meat industry. Marel was able to enter an old industry with new technology. Competing with established firms using old technology would have been impossible. Electronics specialists searched for applications for the new technology in the dominating industry of Iceland. Specialising in fisheries applications created Marel’s success as the local industry and local R&D institutions reinforced the firm’s intensive R&D efforts. The fisheries cluster in Iceland was of utmost value during the first ten years of Marel’s existence, but the concentration on fisheries applications probably delayed the firm’s development of other applications. Marel has developed world-class know-how in designing and manufacturing processing systems that optimise the utilisation of raw materials and labour. Without its software, Marel would not be able to sell its hardware. The case of Marel shows that the emergence of high-tech firms in low-tech economies is possible when the firms operate at the forefront of existing knowledge.

The old knowledge base within the fishing industry was not sufficient for progress. Being most dependent on the income generated in fishing, Iceland has taken the lead in replacing the old regulatory regime with a quota system, where only the fittest had a chance to survive. As a result many firms started experimenting, some with success while others failed. Due to the small size of the country and the willingness of the fisheries community to exchange knowledge, pitfalls could be avoided. The result is a different industrial structure. The firms in the industry use high-tech processes to produce low-tech products that are competitive in global markets—despite the high cost level in Iceland compared to many competing countries. To further increase profitability many firms have expanded their operating space from being local to becoming global. However, the fact remains that most of the processing equipment used in the fishing industry in Iceland is imported. It is in such fields where the small country disadvantages are unveiled: the basic technology used in fillet production and freezing has world-wide applications with substantial economies of scale and scope. It was developed elsewhere and is available everywhere. Faced with ubiquitous basic technology the competitive efforts of both Norway and Iceland are limited to segments directly linked to activities developed in the North Atlantic context. They are, for example, extremely good at large-scale pelagic fishing in rough weather conditions far away from the shore. Both have also succeeded in niches such as developing technology for onshore processing (Iceland) or advanced shipbuilding (Norway).

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Conclusion: learning and innovation in the fishing industry When the ‘American Monarch’ left the shipyard in Norway in autumn 1996, the chairman of RGI proudly presented a technologically highly sophisticated vessel with all kinds of advanced equipment to find, catch and process fish. The vessel has the largest catch and processing capacity in the world, said to be 250 metric tons a day. The processing capacity is similar to that of a very large onshore filleting factory. In addition, the investment includes a surimi plant which takes care of all the waste from the fillet production and all by-catches so all marine resources harvested are used for human consumption. Around 300 people are employed and the vessel itself cost US$56 million. In a normal industry this would be state-of-the-art technology and the most efficient processing technology available. For companies in global competition such facilities would be a necessity in an industry producing standard products and basically competing on price. Yet small-scale fishermen in Chile or Norway, France or Malaysia would call ‘American Monarch’ a monster. Greenpeace will attack this and other similar vessels as the main reason for over-fishing and depletion of stocks. Many governments will not allow such vessels to operate inside their jurisdiction for resource management and political reasons. Anthropologists and geographers see the use of such vessels as threatening a thousandyear-old culture, suspending thousands of jobs in marginal regions and moving people and economic activities from small settlements along the coast to larger cities such as Seattle, where most of the Alaskan trawler fleet have their home base, or Murmansk, where the Russian north Atlantic trawler fleet is located. The trawler companies themselves regard their behaviour as perfectly rational from a technological, economical and also ecological point of view. They loudly protest against being held responsible for overfishing. They do, as in the Alaskan pollack fishery, keep within the quotas allocated by the different governments in question. In many countries quotas are transferable as they are in Iceland. In nations such as New Zealand, quotas can be bought for a period from the government or from private companies in control of a quota. So it must be up to the government to manage the degree of exploitation of the stock. Within the legal and ecologically sustainable limits a competitive trawler company would say that it should be up to competition and the efficiency of the different units participating, to decide who will make a profit and who will be forced out of business, as in all other competing industries. There is no doubt that massive fishing in unregulated waters is harmful to the sustainability of marine resources and that such fishing is basically carried out by large trawlers from the developed world. It is also true that 146

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lack of policing, under-reporting of catches and destruction of small and protected fish is a large problem for the industry and that the large vessels partly due to their equipment, partly due to their capacity and need to cover large capital costs, are one of the main sources of the depletion of stocks. However, it is also true that high capacity and efficiency do not necessarily cause overfishing and ecological disasters. It is equally true that small-scale fishing is not necessarily the best way to protect stocks and reach a sustainable state of management. A clever regulation regime is needed if the actions of large numbers of fishermen are to be kept in accordance with the principle of sustainability. Because the world resources of marine life mostly are under national control, the sophistication of the national regulating regime is the first corner-stone of a competitive industry. As the northern countries of Norway and Iceland control oceans of very high productivity, the first principle would be to regulate the catches in accordance with a bio-economically optimal level. What such an optimum is, is easier to spell out theoretically than to tell in practice. Too many variables are unknown or behave in unpredictable ways. Conservative quotas are therefore important. Next it is important to regulate the capacity of the national fleet in accordance with this total quota. As higher capacity means increased pressure to overfish, a reduction of the fleet would be important. Adding new capacity in one part of the fishing fleet will mean in consequence that the same capacity has to be taken out in other parts. In a competitive economy, such as the Icelandic economy, this will usually mean from the small-scale operators. Many of them have to leave the industry to allow enough fish for the large efficient unit. In a regulated economy like the Norwegian economy, the total quotas are politically divided between the coastal fleet and the ocean fleet. A new trawler in the Norwegian fishing fleet has to replace another trawler with a quota as long as quotas are not transferable. In this respect only fishermen already inside the industry can replace their own allocated capacity. For obvious reasons this will affect the dynamics of the industry. In Iceland ‘normal’ capitalist behaviour moves the industry towards a capitalintensive, integrated industry where more of the processing is moved from onshore to offshore facilities. Iceland is also experiencing an internationalisation both in fishing and in processing. As the industry restructures, new capabilities are developed when operating an integrated fishing industry competing on the global market. This includes operation and management of a fleet of factory trawlers, also outside Icelandic jurisdiction, co-ordinating fishing with marketing and feeding market signals back to the processing function. It also includes a more sophisticated division of labour on board the fishing vessels and in the offices organising production and selling the products world-wide. But 147

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these adaptations to a competitive and innovation driven industry also have a price. More and more of the national fortune of marine resources is controlled by a few companies. Smaller communities on the west coast of Iceland are under constant threat. The social stratification is changing towards a less egalitarian society. Due to overfishing and strong regulations in recent years most of the capital intensive trawler fleet now also operates in international unregulated waters and some have bought quotas inside the 200-mile exclusive economic zones of other countries. The unregulated fishing has caused conflicts with several nations, Norway included, and criticism from environmental organisations damages Iceland’s reputation as an ecologically well managed fishing nation. However, the majority of the Icelandic people support the radical changes and see them as necessary to keep up this enormously important source of income for the country. The Norwegian policy is in sharp contrast to the Icelandic. Here political interventions and regulations are facing all kinds of operations, not only the determination of the size of the total quota. In Norway the trawler fleet was not allowed to expand at the expense of the coastal fleet. The efficient trawler fleet of Norway was thus forced out of the country as national quotas were below the level necessary to meet the costs of operating capital-intensive vessels. Fishing in unregulated waters and purchasing of quotas in other national commercial zones were options used by some trawlers, but many vessels ended up in New Zealand, outside Africa or in Argentina where they are still operating, registered under another flag and often in joint ventures with local interests. As a result, Norwegians were not out of business, just out of the country. This has obviously had an important impact on the related industry in the country. New experiences were gained in foreign waters and fed back as new demands on the Norwegian shipbuilding and equipment industry. Under a foreign flag, trawler companies could develop under the strong influence of owners still located in Norway. So the global experience and a demand for sophisticated search and catch technology returned to the builders and the equipment producers, even if the factory fleet was almost banned from fishing inside Norwegian waters. Many of the Norwegian owners of larger vessels moved their activities long ago away from local waters. They have constantly challenged the existing technology. First by operating all along the long Norwegian coast, then in the open oceans of the North Atlantic and the icy waters off Greenland and the Svalbard zone. When stocks were over-exploited they moved to new unexploited species never used in commercial fishing. As long as the customers moved on, the related industry was given the dynamic input to be innovative and learn by experience how to build and operate modern integrated factory trawlers and specialised long liners or shell trawlers. As regulations partly stopped the construction of new 148

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capacity and reduced profits needed for reinvestment in domestic firms, Norwegians abroad and the Irish, British and Icelandic fishing industry went on challenging these related industries to the benefit of innovativeness and competitiveness on the international scene. So even if the regulation of the Norwegian fleet has introduced a static element in the structure, the capabilities of the related industry have developed into an international standard. These processes have been highly localised. One region in Norway dominates fishing, processing and construction. The entrepreneurial spirit, Protestant ethics, lack of farmland, historical connection to many European countries and a large migration to the US all contribute to the success of the region. The Icelandic capabilities have mainly developed at sea. Most of the successful manufacturing firms have initially been dependent on a niche product for use on vessels. A window of opportunity opened with the introduction of micro-electronics in former mechanical products. This opportunity was taken good care of through an open dialogue with the user—the operators of fishing vessels—and combined with generic knowledge of micro-electronics. Iceland also has strong and long connections to other nations, partly through the educational system. Many young people from Iceland are trained in Nordic or Anglo-American universities. State-of-the-art technology and commercial knowledge have been transplanted into the operation of the Icelandic fishing industry. Norway also seems to have its strongest capabilities connected to operations at sea. The harsh environment of the northern waters has been a challenge demanding innovativeness and high flexibility. The strong resource dependence of human settlement and welfare has been an important reason why it has been easier to develop a functioning regulatory regime in these waters than is found in many other regions of the world. In Iceland this dependence is so strong that fishing policy is the most important part of Icelandic politics and the base of the welfare of the whole nation. No other activity can support fishing, but fishing should be able to bear a welfare state on its shoulders. So, even if restructuring and commercialisation of the Icelandic fishing industry is disputed, regional policy and onshore jobs have to give way to national wealth creation. The size of the country also makes it easier to handle these disputes. In Norway, fishing policy is not that important on the national scene, even if it was the fishing policy of the EU which is said to have provoked Norway to abstain from joining the European Union. Professor Ottar Brox illustrates the political sentiment in northern Norway towards the southern part of the country in the title of his book, From Common to Colony (1984). The north—south conflict revolves mainly around fishing policy and in deciding who should be allowed to harvest and manage the natural resources of the north. The north strongly 149

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opposes economic efficiency as the ruling principle in fishing policy. They regard the resources outside their coast as belonging to the people of the north rather than to the state. They challenge the economic rationality and prefer equality, small-scale structure and regional stability as guiding principles of the fishing policy. This voice for status quo may be one reason why so few related activities of the dynamic type have developed there.27 For the country this is the most important explanation for why Norway does not follow the path of Iceland and other nations and develop a fully-fledged capitalist fishing industry. As long as the overall regulations keep the marine reproduction rate up and other nations out of Norwegian waters, the main challenge is to regulate capacity so that there is enough fish to share among all insiders. This would secure a reasonably profitable activity, at least as long as the prices on the world market are not dropping further. But the pressure from nations who rationalise their industry will challenge the future profitability of the Norwegian industry and slowly change the attitude towards rationalisation and restructuring. Onshore, dramatic restructuring is under way. Offshore, restructuring is more of a challenge.

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8 FOOTLOOSE COMMUNICATIONS: THE MOBILE PHONE INDUSTRY When an inventor in Silicon Valley opens his garage door to show off his latest idea, he has 50 per cent of the world market in front of him. When an inventor in Finland opens his garage door, he faces three feet of snow. (J.U.Nieminen, CEO of Nokia-Mobira, July 1984, cited in van Tulder 1988:169)

The restructuring of telecommunications Mobiles phones—or cellular phones as they are called in some parts of the world—have received an exceptionally warm welcome. This new device has in less than a decade gone from being a rare extravagance for the yuppies of the 1980s to everyday capital goods of ordinary people. Thus, for example, by the mid-1990s roughly every third household in the Nordic countries had at least one mobile phone. The popularity of this product is not surprising. It enables the user to avoid the rigidity of fixed appointments, making last minute changes possible. It makes the difficulty of remembering everything on the shopping list a problem of the past. It has increased the reachability of family members and businesses alike. The sky-rocketing of sales has, of course, been boosted by the fact that mobile phone network operators during extended periods have been subsidising the handsets by several hundred US dollars, and prices for network services have steadily gone down. The global supply of telecommunications equipment is highly concentrated, with a dozen or so firms accounting for a vast share of world sales. Until recently, it was possible to distinguish between two groups of firms: a majority group operating in protected national markets and a smaller group with a global orientation forced upon them because of the limited size of their domestic markets (Morgan and Sayer 1988). Thus, the largest equipment manufacturers are mainly from the US, Germany, France and Japan. Among the top fifteen companies in terms of size only three are

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Table 8.1 The world’s fifteen largest telecommunications manufacturers in 1994

Source: TelecomObserver (WWW).

based in small countries (Table 8.1). Two of the three—Ericsson of Sweden and Nokia of Finland—stand out from the rest on account of their extraordinarily high recent growth rates. Both companies have experienced a major breakthrough in mobile telephony which has contributed more than anything else to their expansion in recent years. The Nordic strength in mobile telephony has been built in spite of a presumable lack of domestic demand. The Nordic countries comprise domestic markets of very modest size, even if the income of each household is above the OECD average. Furthermore, enormous sums have over the years been sunk in fixed structures by the public telecom administrations (generally referred to as ‘PTTs’, as most of them initially started out as Post, Telegram and Telephone administrations). The aim was to ensure that every household was connected to the wired telephone network, even in the remotest parts of each country where the distance between neighbours may be tens of kilometres. This grand effort has made the Nordic countries some of the most developed in the world, not only in terms of the quality of service provision but also in the standard of the telecommunications infrastructure (Table 8.2). And, though often depreciated by now, the fixed network still has to be maintained. Given these sunk costs the Nordic PTTs nevertheless managed, in collaboration, to develop a joint standard for automatic mobile telephony. The Nordic Mobile Telephone (NMT) system was, in the early 1980s, the most advanced system in the world. And two firms managed to become

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Table 8.2 Telephone market penetration in selected OECD countries

Source: Statistical Yearbook 1992, United Nations and various other sources.

world leaders of the rapidly growing—and technologically dynamic — mobile phones industry: Ericsson broke out of the ‘national club system’ at an early stage to become a world leading supplier of most types of telecom equipment, while Nokia managed, over a thirty-year period, to transform itself from a domestic paper, rubber and cable company, to a leading world producer of mobile phones and other types of telecom equipment.1 Our main argument, to be developed below, is that these developments cannot be fully explained with reference to managerial skills, though these are of utmost importance in this industry. 2 We maintain that the competitiveness of these Nordic companies in telecommunications in general, and in mobile telephony in particular, would not have been achieved had they not established an advantage by taking the lead. This advantage, in turn, was based on a form of collaborative effort utilising elements of what we have already discussed in terms of shared trust and exchange of tacit knowledge across firm borders as well as between business and government on a mainly informal level. This chapter consists of four main sections. First, we give a general overview of recent and contemporary processes of change in the global telecommunications sector. Second, we give a brief account of the specific 153

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structure of the telecommunications system of the Nordic countries. Third, we describe in a somewhat more detailed manner how Nordic actors came to be forerunners in the development of mobile phone systems. In doing so, we try to identify the main actors, interactions and socio-institutional structures that can be argued to account for the development leading up to this position. Finally, we focus on a set of specific preconditions that seem to be necessary, if not sufficient, to allow for the success. In particular, we emphasise the conditions related to path-dependence and interrelations between producers of telecommunications equipment, on the one hand, service operators and state regulators on the other. The global framework and what telephony is all about The telecommunications industry consists of two main elements: the provision of network services and the supply of equipment (Fig. 8.1). Major changes, in terms of internationalisation and corporate restructuring, have recently taken place among the equipment suppliers, but these changes are to a significant degree reactions to the dynamics of the teleservice sector. Within telecommunications equipment, there is a difference between public infrastructure and private or consumer premises equipment. Public telephone networks are basically made up of four elements: (1) the equipment installed on the subscriber’s premises and the terminals at the end of the line, such as handsets, facsimiles, data terminals or pagers; (2) transmission technology carrying signals between the central office switches and the subscriber’s equipment (handset, etc.); (3) the central office switches, which today are often large computers that assign calls to the correct destination; and (4) transmission technology carrying signals between switches through wires of copper or glass fibre and sometimes also via satellite or fixed radio links. Only the first two of the four elements in the traditional telephone

Figure 8.1 Actors and institutions in the telecommunication system. Source: After Mölleryd (1996).

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Figure 8.2 Systems structure.

network are changed when going mobile: instead of a fixed local wire loop a local network of radio transceivers is built, linked by fixed radio link or old wire technology to the central switch. And instead of more or less immovable and permanent installations the subscriber’s equipment is portable handsets and terminals linking with radio waves to the closest transceiver. The central switches and their multi-lateral connections are essentially unchanged, though some adjustments might be necessary. Thus the majority of traffic to or from a mobile phone is still on the ‘old’ network. The network transceivers usually have an almost circular catchment area with a diameter of a few kilometres in urban areas, surrounded by similar catchment areas of other transceivers, thus forming a cellular structure. Each transceiver is allocated a specific frequency different from all transceivers surrounding it. Such a ‘cluster’ of cells all using different frequencies is the main building block when constructing transceiver networks, as the same frequencies can then be used over and over again. This principle is illustrated in Figure 8.3, where each letter indicates a transceiver using the same frequency. The principle greatly increases the number of subscribers able to use each frequency simultaneously without their calls interfering with each other. For most of the twentieth century, telecommunications services were operated and regulated by public monopolies in most countries. Partly as a result of this, the market for telecommunications was less international 155

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Figure 8.3 Cellular system for the reuse of radio frequencies for mobile phones.

than for many other industries until the 1970s. Instead, it was ‘dominated on the demand side by a public monopsony and on the supply side by a national “club” of private manufacturers’ (Morgan and Sayer 1988). Since then, far-reaching changes have taken place: notably deregulation and privatisation among PTTs, and mergers among major equipment manufacturers in private industry (Charles 1996). Changes in the relationship between equipment manufacturers and service providers coincided with radical change in telecommunications technology from an electromechanical to an electronic digital system. Such changes have profound impacts on the type of equipment provided, on production processes, on corporate organisation and on the nature of markets. A key development taking place alongside the technological change has been the liberalisation of the state regulated service sector in many countries, including the Nordic ones. Following Charles (1996) we can identify a number of processes involved in this liberalisation: • the erosion of the monopoly power of PTTs through the establishment of alternative services by new operators (who are less likely to imitate the procurement policies of their incumbents); • the complete liberalisation of the market of all subscriber equipment rented or sold; • a process of harmonisation of technical standards to reduce non-tariff barriers to trade; • opening up of national markets by legal requirements for international tender (e.g. through EU legislation) of all public procurement above certain amounts; • changes in corporate culture as a result of increased competitive • increased separation of service provision and service regulation. pressure; 156

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The cumulative effects of these processes have been an opening of domestic markets for communication equipment and services as market entry barriers have been reduced together with the public control over communication services. Consequently, international trade has grown faster in telecommunications than in most other industries since the early 1980s. Small industrialised countries have historically tended to have more developed telecommunications infrastructures than larger ones. Whether measured by per capita number of telephones, number of telephone lines or number of mobile phones, small countries such as Sweden, Finland, Norway and Denmark generally occupy the top positions (van Tulder 1988, see also Table 8.2). The high degree of coverage in these countries not only reflects the purchasing power of the private sector, but also that restrictions on the minimum efficient size for the PTTs made it a necessity to enrol all possible subscribers in the national territory. Not just the PTTs, but even more so the producers of telecommunication equipment in small countries were first to confront the limitations of limited domestic markets, and thus embarked on a process of internationalisation earlier than their competitors in larger countries (Nilsson, Dicken and Peck 1996). Telecommunications in the Nordic countries: regulations and market structures Since 1993, Sweden has been one of the world’s most deregulated markets with respect to telecommunications. That year, the Swedish PTT (Televerket) was transformed into a limited company, Telia.3 In 1995, competition intensified strikingly, as numerous foreign operators entered the Swedish market. Three new firms sought national coverage: Tele2, Telenordia and France Telecom. Tele2, controlled by the Kinnevik Group with historical roots in the Swedish metal and forest industries, was the first telecom competitor in Sweden and is still the largest, with approximately 20 per cent of the long distance traffic. Tele2 is currently the only land line competitor that accepts household customers. Telenordia is owned jointly by the (former state monopoly) PTTs of Denmark, Norway and the UK. Telenordia entered the market in 1995 and aims to compete with Tele2 for the second place in Sweden, as does France Telecom. Sweden has been one of few countries with three independent competitors on the market for mobile telephony in the Global System for Mobile communications (GSM), and in addition a fourth nationwide licence was awarded in 1996, which will further increase competition in this arena. In Finland, legislation regarding the telecommunications industry is also very liberal. Subscriber equipment has been sold under free market 157

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conditions since the 1980s, and the telecommunications services sector has been open for international competition since 1994.4 Finnish telecommunications networks have evolved in a multi-operator environment, and have had a rather exceptional market structure. In terms of network services, there has for a long time been a balanced duopoly between the state-owned national operator Telecom Finland (the former PTT), on the one hand, and the almost 50 local telephone companies and their joint consortium Finnet (previously called Telegroup Finland), on the other. Both these two main Finnish telecom operators operate local, long distance, international and mobile networks as well as data transfer networks. The state-owned electricity company, IVO, came into the telecom race in long distance calls after the liberalisation of the sector by establishing TELIVO, which has subsequently been acquired by the Swedish Telia as its bridgehead in the Finnish telecom market. This market structure, with several competing network operators, is believed to have put pressure on the technical development of networks. Moreover, it has certainly meant a rapid change in the internal practices in the former state monopoly. The Finnish telecommunications equipment industry consists of clusters of generic, large-scale firms and networks of specialised small and medium-sized enterprises. An important propulsive factor leading to rapid growth in the 1990s is the interaction between the telecluster and other industries such as forestry, energy and metals, who are advanced end users of the telematics. In the other Nordic countries the restructuring of the telecommunications sector has been slower and the equipment manufacturers are less important. In Norway, the PTT (Televerket) was transformed in 1994 from a public corporation into a limited company: Telenor AS.5 There are so far no domestic competitors and Telenor AS still has a formal monopoly on basic voice telephony and basic telecom infrastructure, but these two remaining monopoly areas are expected to wither away as formal entry barriers to the Norwegian market are eliminated. Telenor Mobil AS is Telenor’s player in the market for mobile services, which includes mobile telephony of the GSM (digital) and NMT (analogue) standards with more than 700,000 mobile subscribers. Penetration by mobile telephones in Norway was by the mid-1990s among the highest in the world (Table 8.1). There are a number of medium-sized Norwegian firms in the telecom equipment sector. Simonsen Elektro was a pioneer in developing the GSM mobile phone during the 1980s but failed in the end. NERA AS develops and manufactures telecom equipment in the area of transmission and radio link, and satellite systems. Denmark was deregulated only by mid-1996, after which a private company, Tele3, entered the market for fixed telephony. Prior to deregulation there was only Tele Denmark—the Danish PTT—and the private GSM competitor Sonofon. There is a successful cluster of firms in 158

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radio communication in northern Denmark. It consists of a dozen small and medium-sized—but growing—domestic and foreign firms, and the proliferation of this cluster is an interesting case in its own right. Not least because a closer analysis indicates the important role to be played by publicly financed local knowledge institutions—in this case the Aalborg University—for the development of a ‘technology district’ in the 1980s (Dalum 1995b). In the following, we will look in more detail at the role played by the Nordic countries generally in the development of mobile phone technology, and the competitive success of Ericsson and Nokia in this sector. The next section reviews the early development of land-based mobile radio communication, primarily in Sweden, and the work which since the end of the 1940s has been carried out by the Swedish PTT (Televerket) in the domain of mobile phones.6 The route to excellence in mobile telephony: actors, interactions and institutions The introduction of the analogue NMT standard is the usual explanation for the subsequent Nordic success story in the mobile phone market. Thus, the end of 1981 saw the opening of a new completely automatic mobile phone system common for the Nordic countries. This Nordic Mobile Telephone system (NMT), was the result of a ten-year development project, in the form of a joint venture by the public-owned Nordic PTTs. The NMT system had outstanding properties and received a highly positive reception in the Nordic countries. In the early 1990s, there were 460,000 mobile phone subscribers in Sweden alone. The system attracted great interest and also achieved success internationally. The development of the NMT system At the end of the 1940s the demand for frequencies for the traditional land-based mobile radio network increased. This network was mainly used for public or private operational purposes (rescue, police, repair, etc.). Also the demand for its further connection to the telephone network became more apparent. The Swedish PTT began experiments on mobile phones with the aim of devising an automatic system. It became the first fully automatic mobile phone system in the world and was named after its designer, Mr Lauhrén. An experimental installation was set up in Stockholm in 1951. Systems were built in Stockholm and Gothenburg and went into public service in 1956. In the mid-1950s, Mr Berglund at the Radio Department of the Swedish PTT presented a ‘tone code principle’ which meant that a particular selection tone was exclusively identified with the mobile station. 159

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Berglund’s system allowed a simplified construction with the use of transistors as active components. An experimental installation was set up in Stockholm in 1961 and the official start of the permanent system in Stockholm (the largest city) and Gothenburg (the second largest city) took place in 1965. A third system of this type was introduced in Malmö (the third largest city) in 1967. Berglund’s system was suitable for local networks but not for country-wide extension. Lauhrén’s and Berglund’s systems were used side by side throughout the 1960s. However, the need for a country-wide mobile phone system became increasingly urgent. The Swedish PTT set up a working group to specify the desirable and imaginable properties of a new, automatic mobile telephone system. The group’s report in August 1967 formed the foundation for subsequent developments. At the end of the 1960s, development work started for parts of the new system. At the same time, the demand for a mobile telephone system outside the major centres of population was so great that there was an option to build a country-wide service as quickly as possible. The only possibility at the time was a manually serviced system, which was put into operation at the end of 1971. In Finland, the construction of the first country-wide system (car radio telephone network, ARP) was started by the PTT from 1969 onwards, although the first local systems had been introduced already in 1956. The new system covered most of the country by 1971, when the specifications concerning terminals and other equipment were declared (Putus 1995). Its first-mover advantage has only slowly been worn down. It has, in fact, stayed in operation throughout the NMT and GSM booms, still having around 11,000 subscribers in 1996. At the 1969 session of the biannual Nordic Telecommunications Conference7 a new initiative was taken. It was proposed that the Nordic PTTs should consider developing a common mobile phone system. This resulted in a Nordic working group which, with the assistance of various subgroups, specialists and consultants, was able to create the protospecifications for a common Nordic system. The task force further took part in designing the system and after 1975 system tests were carried out. At the same time it became increasingly clear that the NMT ought to be put into operation in the early 1980s. The growing number of subscribers using the manual system made the costs and problems associated with manually operated systems increase rapidly. The fact that the users of the manual system had become aware of the mobile phone’s potential was believed to give the new system a head start. By the mid-1970s, some basic technologies were, however, still not fully developed. Especially inhibiting were a number of uncertainties about the design of a mobile phone switch for directing calls to their final destination. It took several years of work before this problem was solved.8 160

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In late 1978, the Nordic PTTs signed contracts for the purchase of switches and base station equipment. The Swedish firm Magnetic and Mitsubishi of Japan got the order for base stations, while Ericsson was chosen to supply the switches. The definitive technical demand specifications for mobile stations were issued in 1980 and the testing of various types began in 1981.

Case 8.1 Ericsson The Swedish company, Ericsson, is the main Swedish actor within the field of telecommunications. By Nordic standards it is a giant corporation with 85,000 employees in more than a hundred countries. The company’s combined expertise in switching, radio and networking make it a world leader in telecommunications. Net sales in 1995 amounted to more than US$12,000 million. Ericsson is active in almost all sectors of the telecommunications field. The company is divided into five business areas: • • • • •

Public Telecommunications (systems and services for transmitting voice, data, text and images over public networks). Radio Communications (mobile telephone systems, mobile telephones, mobile voice-and-data communications systems and paging systems). Business Networks (private networks, wireless business communication, data networks and telephone equipment, planning and installing communications and data networks). Components (micro-electronics, optical and microwave technology, cables). Microwave Systems (aeronautical and missile technology, microwave and satellite communications and defence communications).

These five business areas have common core technologies and strategy. They cooperate closely and to a considerable extent provide one another with products and services. Ericsson’s home base is in the Stockholm region of Sweden, but production is divided among some fifty units world-wide, though with the majority in Sweden and Europe. The introduction of GSM has also meant a rapid growth for Ericsson, where radio communications soon became the prime business area, with about half of total sales. More than 20,000 Ericsson employees work in the radio communications business area world-wide. Thus, in the last few years, mobile telephony/radio communications have surpassed the AXE switches as Ericsson’s major business area and profit-maker. The largest portion of Ericsson’s radio communication business comes from network infrastructure and terminal equipment. The company was one of the suppliers of the world’s first commercial cellular network systems—NMT—and is still at the forefront of mobile telephony today. Ericsson is one of the few companies that can supply mobile networks for practically all major analogue and digital standards. The company is also among the top three suppliers of mobile telephones. In addition to supplying network hardware and software and terminal equipment, Ericsson provides a range of services to support mobile operators’ business, including consultancy, design, engineering, performance measurement, training and operation and maintenance services. Ericsson is the leading developer and supplier of GSM and DCS 1800 digital

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In particular the open standard of the NMT system made the Nordic mobile phone market highly competitive. As the Nordic PTTs had no commercial interest in manufacturing—nor had any legal possibility to subtract royalties from producers of equipment—they had no property rights to protect and thus no incentive to produce a closed standard, concealing technical specifications and protocols. On the contrary, their incentive was to create a platform of intense competition between manufacturers to boost technological progress and thus increase the demand for their own supply of network services. And as seen in many other fields, the mere existence of a standard opens up new interactions between firms and makes technological progress faster (Farrell and Saloner 1985). Already at the beginning of the 1980s ten ‘pilot producers’ were present in the Nordic market, including companies such as Phillips and GE, which entered by means of acquisitions in Denmark (Pulkkinen 1996). Thus, when the NMT system was officially inaugurated in Sweden in October 1981, there were already five different approved mobile handsets on the market, and new producers soon followed, supplying additional models. The new technology aroused great interest among the large international telecommunication equipment manufacturers. Thus, in the early 1980s the Nordic countries had become by far the largest market in mobile phones, enabling still further specialisation and economies of scale, as well as shorter pay-back time on R&D. In continental Europe and in Japan protectionist national policies still prevailed, and prevented producers from obtaining the benefits of mass markets. The medium-sized countries of Germany, France and Italy developed their own standards between 1983 and 1986. Initially this was not completely unsuccessful, as the main German player, Siemens, managed to export its C-NET technology to Portugal and South Africa (Pulkkinen 1996). However, the systems developed in France and Italy were not put into use in any other country. The same applied to the Japanese system. 162

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So while the giant equipment manufacturers of western Europe and the PTTs of the larger countries neither succeeded in creating sufficient domestic markets,9 nor were successful in developing major exports, the NMT was put into use in tens of European and Asian countries in the 1980s and 1990s. Already by the end of the 1980s the American and Nordic technological systems were accepted even in France and Italy. One might say that a determining reason for the maintenance of the Nordic countries’ early lead was the fact that some obvious competitors in the mobile phone race at a crucial stage were prevented from creating the necessary volume by the protectionist policies of their country of location. The traditional openness of small countries (see Chapter 5) combined with a general trend towards deregulation to form a specific localised capability to be utilised by the most efficient producers located there. And though Kindleberger (1984:26) might be generally right when stating that harmonisation ‘reduces the sovereignty of [small] states by making them conform to a general standard. The smaller the country, the less its capacity to produce change in the standard’ he has most certainly been off the mark when it comes to leading-edge commercial telecommunication. And the lack of internationally accepted standards would penalise the small countries far more than their larger counterparts. GSM: a global system for mobiles? The beginnings of the GSM standard can be traced back to 1982, when the European Conference of Posts and Telecommunications (CEPT) established a working party to develop standards for a pan-European, digital mobile network. The working party was called Groupe Spéciale Mobile (GSM) — hence the name of the standard, which has subsequently been redefined to mean Global System for Mobile communications. The definition of the GSM standard thus began before most European countries had even started to implement analogue cellular networks: at this time, no one had any idea how popular mobile telephony would prove to be. As a pan-European standard, GSM required the availability of a common radio spectrum in all countries, and the European Commission issued a directive which required member states to reserve certain radio frequencies for GSM. When the work on the specifications first began, the main perceived benefits of GSM were two-fold. First, it would allow users to shift between GSM networks in different countries, using the same phone and phone number to make and receive calls wherever they went (‘roaming’). Second, the GSM standard had the aim of creating a large single market for mobile telephone networks, and for the cellular phones themselves. This was expected to stimulate the European telecommunication industry, promote open competition between suppliers and drive down prices, which is what happened. A further envisioned benefit of GSM was that it 163

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would create networks with much higher capacities than existing analogue standards. This also happened. The digital GSM technology is at least three times more efficient in its use of the radio spectrum than analogue networks. When analogue mobile phone systems like the NMT began to grow beyond all expectations during the late 1980s, the need for the extra capacity of GSM became all the more urgent. Even before the first GSM networks came into operation in 1992, it was clear that the extra capacity of GSM would still not be sufficient to meet the demand for mobile telephone services. As a result, a further set of frequencies— 75 MHz in the 1800 MHz band—were allocated for digital mobile telephone services in Europe. This was three times the bandwidth initially allocated for GSM.10 The higher frequencies generally had a shorter range, making the new frequencies suitable primarily for dense urban environments. For the network operators, one important aspect of GSM was that it standardised the components of the network, and the interfaces between them. Most analogue networks were completely proprietary systems—all the components, such as switching systems, radio base stations and network management systems—had to be bought from one supplier in order to work properly as a network. GSM allowed operators to shop around for different components in the network, knowing that there would be no compatibility problems. The first GSM networks came into service in 1992, with the Nordic countries among the front runners. By mid-1995, seventy-five networks were in service, in forty-five countries, serving around eight million subscribers. This represents a rapidly growing proportion of the world’s total mobile phone users and more than half a million new subscribers a month have joined GSM networks in recent years (Fig. 8.4). Originally specified as a pan-European digital cellular standard, GSM has spread much further afield. Half of the ‘GSM countries’ today are outside Europe: networks are operational in nearly all the Gulf states, as well as in South Africa, Hong Kong, China, Singapore, Australia and New Zealand. In August 1995, 138 operators in seventy-seven countries signed a Memorandum of Understanding on GSM and are implementing, or planning to implement, networks. GSM is also beginning to make its way into the US, where other technologies have dominated so far, and where no common standard has been agreed. The global success of GSM has resulted in important economies of scale, reducing the cost of both network infrastructure and mobile phones. GSM was at first perceived as a premium service, because of the extra functionality (such as international roaming and data communications) it offered compared with analogue networks. In fact, end-user pricing of both phones and services often competes favourably with that of analogue networks.

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Figure 8.4 Time of inauguration of the first GSM network in European countries. Source: Based on data from Teletechnics Afield (http://www.teletechnics.com/cellular.html).

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Mobile phones in Sweden and Finland In September 1992 Comviq launched one of the world’s first commercial GSM networks in Sweden. Telia Mobitel and Europolitan soon followed. After a meagre first year, GSM has become a great success. It is calculated that more than 25 per cent of all Swedes, and 35 per cent of all Swedish households, owned a mobile phone by the beginning of 1997, and the market is increasing rapidly. Telia Mobitel, belonging to the former Swedish PTT, is considered to be the largest operator in terms of number of subscribers and volume of the operations. But there are strong runners up. Comviq is a company within the Kinnevik Group that has invested heavily (not least in subsidising handsets) to become the cheapest mobile network operator, offering its services to ‘ordinary people’. Europolitan AB is the third GSM operator, owned by two of the world’s largest mobile phone network operators, the American company Air Touch Communications and the British Vodafone. Exact figures on the number of subscribers to Swedish GSM networks are hard to obtain, since the GSM operators are either very secretive or boasting. Towards the end of 1996, the number of subscribers would be in the order of 500,000–600,000 subscribers each for Telia Mobitel and Comviq, and less than half that for Europolitan. There has been tremendous competition in the Nordic GSM market, as well as in some other European GSM markets for subscriber equipment. Over extended periods, the purchase of handsets has for instance been subsidised by the network operator by as much as US$500. As in many other countries, handsets have been given away almost for free—at prices less than US$0.1—to those willing to sign a standard half or full year contract with a network operator with no real obligation. As the marginal cost of any new subscriber is close to zero, the network operators feel confident that they will be able to regain the cost of the subsidy by the stream of income generated by all future calls made by the subscriber. Several smaller firms supplemented Ericsson by playing a notable role in the development of the mobile phone systems. Firms like Allgon, Magnetic, Radiosystem and SRA were all involved in the development of base stations for the NMT system and also in later phases. Some have since become integrated with Ericsson through acquisitions. The Finnish economy has, as was discussed in Chapter 6, to a high degree been dominated by the forest-based industries and related engineering industries. Since the early 1980s, however, the electronics industry has emerged as another corner-stone of Finland’s manufacturing production and exports, with telecommunications accounting for a large, and growing, share (Hernesniemi, Lammi and Ylä-Anttila 1996). The 1990s has seen a strong growth in mobile telephony, and by the end of 1996 there were more than 1.3 million subscribers to NMT or GSM 166

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networks in a country of five million inhabitants. Telecom Finland has some 90 per cent of this market, while Finnet has the remaining 10 per cent. In sharp contrast to Sweden, Finnish operators have not been subsidising mobile handsets which has naturally delayed the shift to the GSM system. Thus NMT 900 did not lose its position as Finland’s largest mobile network until 1996.

Case 8.2 Nokia The major Finnish actor in telecommunications is Nokia. The total net sales of this internationalised group are over US$8,000 million and it employs more than 32,000 people in some forty-five countries. Over the last ten years the group has succeeded in continuously expanding its market shares in most areas of the telecommunications business. Nokia was founded in 1865 with the establishment of a forest industry enterprise in south-western Finland. This enterprise ran a sawmill on the Nokia river, hence the company name. In 1966, Nokia was merged with the companies Finnish Rubber Works Ltd and Finnish Cable Works to form Nokia Corporation. Nokia entered the telephone industry in the 1960s, and it was only at the beginning of the 1980s that Nokia started to strengthen its position in the telecommunications and consumer electronics markets. Currently, the Nokia Group comprises Nokia Telecommunications, Nokia Mobile Phones and Nokia General Communications Products. Nokia Telecommunications develops and manufactures infrastructure equipment and systems for cellular and fixed networks. Nokia has become a globally leading supplier of digital cellular networks and has supplied more than fifty operators in thirty countries throughout Europe and the Asia-Pacific region. This field of activity accounts for some 30 per cent of Nokia’s total turnover. Nokia General Communications Products focuses on offering multimedia equipment, interactive digital satellite and cable terminals, PC and work station monitors as well as accessories and components for mobile phones. This business area accounts for almost 30 per cent of total turnover. The remaining 40 per cent of the group’s turnover comes from Nokia Mobile Phones, which is presently (1997) Europe’s largest and the world’s second largest manufacturer of cellular phones. Nokia offers a broad range of mobile phones for the digital and analogue cellular markets, with sales in more than 120 countries. The Nokia Group claims to have the largest market share in Europe in the mobile telephone equipment market and the second largest in the US (Nokia 1995). Nokia has been a pioneer in new mobile phone products and solutions. Due to its development work in cellular phone products, Nokia now plays a technologically leading role in this industry world-wide. The company was the first manufacturer to introduce cellular phones for all digital standards in 1994. Seen as a case of corporate restructuring, Nokia’s metamorphosis from a paper, rubber and cable company to a leading European producer of telecommunications is remarkable. As late as 1974 Nokia was a cable company (more than 50 per cent of turnover), then it grew as a diversified conglomerate, from 1984 electronics became dominant, and it has specialised in telecommunications business from 1993 onwards (Lovio 1996). Alliances and acquisitions have been important in Nokia’s entry into the telecommunications sector.

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SMALL COUNTRIES The production of mobile phones started in Finland in the early 1970s for the ARP network. There were four competitors in the very beginning: Salora (a private television producer), Nokia, AGA (later a part of Ericsson) and Televa (a state-owned electronics company). In 1975, Nokia and Salora reorganised their activities, and the production of mobile phones was transferred to Salora. The next step was taken four years later, when these two companies established a joint venture on a 50:50 basis. This company, Mobira, became a part of Nokia in 1982. Nokia and Televa formed a joint venture in switching technology in 1977. Nokia bought the majority stake in 1981, and a few years later the whole company (Putus 1994, 1995). As a result of the above-mentioned developments and some important acquisitions such as LK-Products (a private pioneering firm in car phone technology), Nokia prepared itself for the NMT boom of the 1980s. Mobira was expanded to Nokia Mobile Phones and the former subsidiary Telefenno to Nokia Cellular Systems. After a considerable success, the rapid expansion led to a crisis at the end of the 1980s. This was to a major degree due to the incompatibility between the organisation of the Nokia telecommunications activity and the demands of the growing markets. The metamorphosis took place in the early 1990s when Nokia committed itself to the specialised global telecommunications business in the context of the GSM. It became a pioneer in directing the image of mobile phones towards the ordinary consumer. In this pursuit, the qualities of the Nordic market were important: the first mass markets were created in these countries. Even if the total market was small, high penetration rates gave feedback from consumers. In fact, it was seen as important that the operators did not give phones free, because this practice cuts the link between the producer and the final consumer. From Nokia’s perspective, it was important that the diffusion of mobile phones was relatively slow in comparison to several other consumer products (televisions, etc.). In this way, capacity constraints in production and distribution could be overcome (Pulkkinen 1996).

In addition to Nokia’s success (see Case 8.2), there are several small and medium-sized firms which have focused on special products (such as Benefon in up-market NMT phones), and are world leaders in their respective market, for instance, in paging and voice mail systems, cable television equipment and components for video conference systems (Hernesniemi, Lammi and Ylä-Anttila 1996). Preconditions for success Without any doubt, competitiveness in the telecommunications industry is driven by innovations and technological progress. Companies like Ericsson and Nokia have succeeded, and continue to succeed, on the market by presenting products with qualities that do not exist beforehand, or where the perceived customer value is larger than products offered by competing firms. Of course, cost-related issues are—perhaps increasingly—important in this industry and the relative weakness of the Swedish and Finnish currencies since 1992 have in recent years helped these companies. However, the basis for long-term competitiveness is still

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the ability to develop continuously new generations of more advanced products. Ericsson has been in this industry for more than a century. Nokia, in contrast, started out in other lines of business and entered telecommunications only during the last three decades. While Ericsson has gradually developed its core competencies and technologies over a very long time period, some of the major technological assets that underpin Nokia’s contemporary competitiveness have initially been developed by other firms, and subsequently been acquired by Nokia. What is to be explained, then, is how this innovative capacity emerges. One crucial factor is, of course, the high degree of R&D in these firms. In the case of Ericsson some 15 per cent of annual turnover, while somewhat less in Nokia. It may, however, be questioned whether the success is exclusively ‘a testament to management strength and flexibility’ (Rehn 1996:312) or whether some other explanatory factors should be included. At least six such—partly interrelated—supplementary elements should perhaps be considered: • • • •

the importance of history/path-dependence the liberalisation of former regulatory regimes the existence of strong ‘development pairs’ the intricate balance between too much and too little exposure to global competition • the decisive role of ‘strategic’ public sector intervention/regulation • the role of ‘geographical determinism’. First, it is clear that history matters also in the case of telecommunications. While this new industry is certainly high-tech, it is at the same time a special case within the electronics industry. With its roots going back to the electrical industries of the late nineteenth century, it is connected to one of the oldest parts of the sector. While most other firms from that time have remained in the field of heavy electro-mechanical activity, telecommunications differs by having achieved the transition to a purely digital and electronic technology. This is one major reason why the sector, in terms of corporate structure and spatial organisation, stands out from other types of electronic industry—and indeed from the bulk of high-tech manufacturing (Charles 1996). Thus, for example, Ericsson’s central office switch was originally developed in the 1970s for analogue, wired technology, but almost accidentally it turned out to be relatively simple to modify for digital and mobile systems.11 In the case of Nokia it is worth noting that there has been more continuity at the level of establishments, which have created resources for the subsequent mobile phone success, than at the corporate

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level. The competencies were distributed between a number of localised actors brought together by new managerial arrangements. Second, in many analyses of the contemporary dynamism of the telecommunications sector, a lot of emphasis is put on the decisive role of deregulation and privatisation of former monopolies. For example, Rehn, in his analysis of the Finnish telecoms cluster concludes: In a nutshell, the competitive advantage of the Finnish telecoms cluster is derived from two sources: firstly, from the market structure that has encouraged competition, and secondly, the more random, but increasingly determined emphasis on technological development. (Rehn 1996:310) Undoubtedly, a liberal attitude of the state, free competition and the need for tele-services—because of long distances and sparse population—has in this phase of capitalism exercised a strong stimulus towards the progression within telecommunications. Early experiments with mobile phone technologies and the creation of the NMT network in the Nordic countries brought advanced knowledge of mobile networks and phones. The advanced domestic market has made it possible for companies to be pioneers also in the international market, even during the fast introduction of GSM networks. In the Finnish case, the telecommunication operators have been instrumental in triggering the development in telecommunication technology, and in the production of telecommunications equipment by using open specifications from the very beginning. The large number of private telephone companies (there were some 850 at the high point in the 1930s) and the indirect competition between two business groups, Telecom Finland and Finnet, is assigned a key role in the success of the sector (Rehn 1996). Furthermore, the deregulation of the sector, as well as an ethos of technological excellence in the field of telecommunications have had an impact. While there might be some truth in this conclusion, the emphasis on the importance of a non-regulated telemarket overlooks the fact that most major breakthroughs that underpin today’s competitive success—for example, Ericsson’s AXE switches or the NMT mobile phone system— were achieved in a much more regulated context. We may, therefore, assume that long-lasting and trustful relations between a few dominating actors, to which we will turn next, may turn out to be innovative, also in a fairly regulated context. The interaction between a private supplier and a strong (often public) customer allows for the pooling of resources and focus of efforts that make for major technological breakthroughs. The collaboration among well established and long-lasting ‘development pairs’ seems to be of significance (see Case 8.3). 170

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Thus third, the success of the equipment manufacturers is very much dependent on their interaction with network operators. This is a typical case of industrial complementarity (Richardson 1972): firms in separate industries, each with their own distinct fields of competence, need each other in order to develop and serve a new market. No rubber tyre manufacturer or steel tube producer could hope to develop and market a successful mountain bike, without engaging in close co-operation with the other. The same applies to equipment manufacturers and network operators in telecommunications. Their core competencies are too far apart to make a joint venture feasible. No firm can hope to be among the world best in high-tech manufacturing as well as in public service provision.12 So the selection mechanism of the market tends to keep these two organisational fields wide apart. Yet, they need to co-operate intimately in order to develop the market. Localised capabilities enabling or even enhancing such co-operation will always make a difference when it comes to first-mover advantages. For example, the development of AXE was carried out in a joint venture between Swedish Telecom and Ericsson—the company Ellemtel— where both parties contributed equal shares of capital and engineering skills (Vedin 1992, Lindmark 1995). This type of relationship is also characterised by strong personal connections between individuals ‘on different sides of the table’. In the small developed countries it is certainly not unusual that people move between different roles during their career: from (private) supplier to (public or private) customer and to (public) regulating authority. The small country malfeasance-controlling environment (see Chapter 4) is usually in itself sufficient to ensure an absence of the obvious problems inherent in such relocations (for example bribes and other forms of corruption).

Case 8.3 Development pairs Strong public/private ‘development pairs’ are found in a number of industries: for example between the ASEA (now part of ABB) and the Swedish Power Board in the area of power transmission. Fridlund (1993, 1994) presents detailed analyses of several major development projects where an urgent local problem—such as overcoming the ‘inverted geography problem’ of Swedish power supply, with 80 per cent of the resources for hydroelectric power in the north and 80 per cent of the demand in the south—triggered a search for a transmission technology in the inter-war period which, once arrived at, gave ASEA a strong position on the global markets. By including in the analysis the biographies of the individuals who were instrumental in various development projects on either the customer or the supplier side, some interesting results are arrived at. Thus, for example, out of twenty-three young men who were admitted to the School of Electrical Engineering of the Royal Institute of

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In the development of the Finnish telecommunications industry, the development pair setting was not originally clear. There were, in fact, in the 1970s several (both privately- and state-owned) companies and alliances which tried to build up a dominant position in the electronics and telecommunications field by means of various partnerships. Later, one partner (Nokia) was able to take the lead. It was also competent to utilise its specific position in the narrow base of the country’s industrial structure. Nokia grew to become one of the few companies having sufficient resources to respond in an effective way to national technology programmes and later to international (the European Union, etc.) programmes. Equipment manufacturers have two types of customers— network operators and users of these services. Nokia’s recent success is very much based on the attention it has devoted to the latter group. The Nordic market has been a suitable testing ground. From this wider perspective, the idea of development pairs is again relevant: a small country (such as Finland) might create the right domestic environment through modifications in the institutional endowment—as discussed in Chapter 4 —but without a spearhead company (such as Nokia) there is no way it can participate in the hightech game (Kuisma 1996). Fourth, there is the issue of exposure to competition. The drawback of dense networks between suppliers and operators is the risk of evolving into ‘clubs for mutual admiration’ as the experience from many European countries suggests: several national champions in telecom industry have been laggards in technological and organisational development. If a government—or a PTT—joins hands with a private manufacturer in development projects and other forms of collaboration,13 other measures have to be taken to avoid this risk. In Sweden, the government seems to have been very much aware of this risk since it early on implemented some rather extreme measures to expose the major domestic producers to international competition, as it was stipulated that the largest supplier— Ericsson—was not allowed to sell private telecom equipment on the Swedish market. Domestic supply and demand were ensured while the best endowed firms were forced to become international actors. This extreme form of regulatory pressure deprived Ericsson of its home market, and forced the company to internationalise its operations at a time when most telecom equipment producers worked in more or less protected domestic markets (Sölvell, Zander and Porter 1991). This harsh regulation undoubtedly contributed to Ericsson’s early internationalisation, which in turn has an impact on its contemporary international competitiveness. 172

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Furthermore, the Swedish government’s procurement agency, StatTel, has in recent years played an important role to the same end. Apart from its obvious goal to procure telecommunications for the Swedish government and state authorities, its role is also to push for cheaper and better telecommunications by helping to keep up competition. Thus, in 1993 France Telecom won a US$100 million contract for Datapac traffic.14 Overall, it seems indisputable that the inflow of foreign companies to the Nordic market in the NMT era was an important impetus for further developments. Fifth, in the telecommunications industry, the role of various types of standards, protocols and regulations is important. It is a fact that standards are not easily changed once they have been accepted by the market, as technologies tend to be locked in.15 Not surprisingly, therefore, governments try to set standards for technologies while in their infancy, as standard setting is often an important policy tool when it comes to increasing industrial competitiveness. If a government manages to set a proper standard at the right time, then its domestic industry may radically strengthen its international market position. In practice, however, government policy makers lack the experience to set ideal standards at just the right moment (Grindley 1995, Rowen 1993). They need contact with users and producers, and within an environment of shared trust and many formal and informal channels for exchange of ideas and plans, such inherent weakness can be redressed and turned to a first-mover advantage. It is interesting to note that both the mobile phone systems undet discussion here—the NMT and the GSM systems—emerged from attempts to create common system specifications for several countries: the Nordic ones in the first case, and on a European scale in the second. Without doubt, the Nordic producers have benefited from the fact that their public authorities have been actively contributing to standards. In particular, this applies to the NMT which got access to a market place much wider than its original home base. In contrast to most other countries, Sweden has moved from a situation of very modest to more detailed regulation in the telecommunications sector. Until 1993, when a new telecommunication bill and a revised broadcasting bill were passed, the legal framework was very limited and made up of a combination of parliamentary decisions on telecommunication policies, statutes for the PTT and the radio law. What this meant in practice was that the PTT also acted as the regulator, as there was no separate regulatory body. From the late 1970s, this system was increasingly questioned, as it meant that the same actor—Televerket—was at the same time the main user of the public land net, and the authority that was to decide whether to allow other actors to enter. Since 1993, there has been a separate body within the National Post and Telecom Agency, which deals with standardisation issues and licences.

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Finally, when trying to explain the Nordic strength in telecommunications one cannot totally ignore the role played by ‘purely geographical’ factors. We gave an example of this in the case of power transmission above, and similar factors apply to telecommunications as well. One should of course be extremely cautious when advancing argument in the field of ‘geographical determinism’. Still, it does not seem too far-fetched to assume that some geographical features of the Nordic countries—the sparse population and huge distances—may have increased the demand for telecommunications generally, and perhaps mobile systems in particular. In particular, the low frequency used by the initial analogue NMT system gave very large catchment areas, but also had very low capacity regarding the number of subscribers who were able to use each transceiver simultaneously. It thus favoured locations, regions and countries with sparse population and few large built-up areas. However, the hypothesis ‘the longer the distance between telephone boxes, the greater the potential penetration for mobile phones’ is clearly too straightforward here. The mobile phone has turned out to be a distinctive product with its own qualities. Conclusion: is there high-tech potential in small countries after all? Is there, after all, a high-tech route to prosperity for small nations such as the Nordic ones? Cases considered in this chapter seem to indicate that there are indeed possibilities for small countries to compete, even in industries where the need for R&D investment is huge, and the pace of technological development is high, provided that certain specific preconditions are fulfilled (see Chapter 5). First, high-tech, without doubt, implies high risks. Thus, the old players tend to get newcomers under control in high-tech activities by utilising, among other things, massive R&D investments, scale economies and acquisitions. We have probably not yet seen this backlash in the telecommunications field. But most likely it will come in some not too distant future when the old giants within telecommunications feel fit to use their corporate financial strength to secure themselves a solid position as dominant global leaders in this new field as well. Second, high-tech is expensive, and easily exceeds the financial resources available in small companies and countries. Nokia is a borderline case in this respect: its telecommunications business, and electronics previously, has been profitable only in exceptional years, most notably from 1993 onwards. The company was particularly patient in waiting for rewards from its long-term commitment in these new fields, and in fact it came close to the brink in the early 1990s.

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Third, the scarcity problem of small-country markets does not concern only the availability of capital, but of human resources as well. In the Finnish case, labour market bottlenecks have been a serious problem in this high-tech development, even though domestic competition for talents has been limited due to the dominance of the forest sector, which— fortunately for Nokia—was hit by serious recession in the 1990s. Nevertheless, Nokia has had to rely on off-the-shelf standard components and technology to a far greater extent than most of its competitors, rather than on in-house developed technology. As it was, this requisite strategy turned out to be increasingly advantageous as the asking price on the international market for standard components and technology kept dropping relative to the cost of in-house development. Furthermore, it turned out that although the high content of standard components should make Nokia’s products easier to imitate by followers, the rapid introduction of new models and new features made imitation less attractive and the economic consequences less damaging for Nokia, than might have been the case otherwise. Fourth, as argued in Chapter 5, the loss of spill-overs can also be a serious obstacle to cumulative high-tech development in a small country. In the case of the Nordic telecom industry, the hectic pace of technological development in rapidly changing market conditions has required intensive contacts between relevant partners. The proximity of subcontractors and R&D activities from the days of public monopolistic PTTs has thus been an asset, which has maximised the possible national spill-overs. Fifth, although the domestic or Nordic market has been a tiny fraction of the relevant market during the GSM boom, the peculiarities of its demand conditions have compensated for the small size: The high purchasing power of many Nordic households has enabled producers of mobile phones in these countries to penetrate user groups (students, children, the elderly, etc.) and learn about their particular needs and preferences long before such buyers emerged on other mass markets. The high penetration rate of mobile phones has created a useful test market for products and related services. Finally, the scarcity of potential R&D resources is a fact of life in a small country, and it inevitably leads to specialisation. This can also be seen in the case of telecommunications. For instance, Nokia’s share of R&D investments in Finland is so large that there is simply no space for many similar firms, at least not in the short run. In addition, the strategy of the company has been adapted to these circumstances: it has always been a fast second, rapidly utilising new technological and organisational practices which have been developed elsewhere. All in all, at least for the time being, the constraints on high-tech development are circumvented in this particular field of industry.

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Part III CONCLUSIONS AND POLICY IMPLICATIONS

9 TOWARDS A LEARNING-BASED INDUSTRIAL AND REGIONAL POLICY In the making of a more competitive ‘home base’ it is worth recalling the limits of the nation state… [nothing] can alter the fact that the role of government in the development of competitive advantage can only be marginal, indirect and long-term. Thus, results are measured not in years but in decades. (Kay 1994:13, quoted in Rehn 1996:346)

We began this book arguing that as a global economy emerges, more and more production factors and inputs become ubiquitous, available at more or less the same cost in different parts of the world. The cheapening of transportation and the development of world-wide telecommunication services, combined with a well developed functional and territorial division of labour, make it possible for most firms to take advantage of cheap ore from Australia, labour-intensive subcontracting in China, well designed computers from Taiwan, sophisticated machinery from Germany and Italy or high quality services from global consultants like Arthur Andersen. The integration of the European market will, among other things, even out current regional differences in energy prices and national taxation. While capital, raw materials, components and end products move rapidly and cheaply over the surface of the earth, only human beings and human social institutions seem to meet fundamental barriers to mobility. As a consequence, the cost of labour and the quality of human knowledge have become one of few factors diverting spatially. For low-cost countries this process has been an opener to international markets, radically enhancing the potential for economic growth. For high-cost countries the challenges are more profound and point in the direction of more emphasis on human interaction and knowledge creation. In this closing chapter, we will do two things. First, in the following three sections we summarise our main theoretical and empirical findings and draw some general conclusions. Second, in the two final sections, we

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discuss the implications of our analysis in the context of industrial and regional policy. Human action, spatial context and economic development Today, many scholars and politicians suggest that the high-tech route to prosperity is the only way for advanced nations. At the same time, we have shown that many high-income countries, in particular small countries, do not reveal any particular competitive strength in these new sectors of the economy. On the contrary, we can see that the competitive strength of these nations by and large remains connected to traditional ‘low-tech’ industries. In the case of the Nordic countries, this very much relates to industries that utilise (or that historically have utilised) natural resources. The richness of the natural resource endowments has structured the way these economies have developed and steered the technological and industrial development into specific trajectories or paths. However, we have suggested that the competitive strength of these industries today is not related first and foremost to the natural resource endowments. Over time the factors of production have been upgraded in such a way that the natural resource in itself is not the basic competitive force. Rather, the knowledge and competencies of the firm to meet customer needs, and find new organisational, technological and institutional arrangements, are at the core of the dynamic development of competitive strength in these industries. As a result it is seldom only the cost of the tangible or intangible inputs which decide if a company is competitive or not. It is more a matter of organisational talents in the firm; of its ability to understand and adopt knowledge; to combine new and existing technology; to innovate; to read market signals; to adjust to the needs of the customer, etc. Competitiveness is first and foremost developed through the diverse endogenous competencies of the firm, including its ability to learn, unlearn and relearn.1 Also in economic geography we can see such changes reflected in a renewed interest in the characteristics of the local environment of firms, i.e. what in previous chapters has been discussed under the heading of localised capabilities. Institutional layouts, regulatory arrangements and creative thinking form the base upon which high productivity and competitive power can be built.2 As traditionally important inputs, once localised, are gradually turned into ubiquities, research interest has turned towards the study of human skills, knowledge creation, path dependence and social embeddedness (Storper and Scott 1995). All are increasingly seen as crucial elements guiding the economic development of local milieus, regions and countries together with what we so far rather loosely 180

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have called culture. Being more specific we might follow MacDowell and define culture as: a set of ideas, customs and beliefs that shape people’s actions and their production of material artefacts, including the landscape and the built environment. Culture is socially defined and socially determined. Cultural ideas are expressed in the lives of social groups who articulate, express and challenge these sets of ideas and values, which are themselves temporally and spatially specific. (MacDowell 1994:148) The material base of a specific economy, its social conventions and institutions interact with human agents and shape the culture of the area. At the same time this culture takes part in shaping the conventions and institutions of the economy (Saxenian 1994). The specific culture is expressed in conventions as a set of commonly accepted rules for social behaviour (Storper 1992). Economic life and human action are thus deeply rooted in social systems, and it is difficult to understand economic processes without some perception of the social actions and social institutions at the core of the economy (Nelson and Winter 1982; Hodgson 1988; Granovetter and Swedberg 1992). Even though conventions can be expressed as formal rules and written procedures or through well established institutions in a specific community, they are often not articulated, but nevertheless still regulate social interaction in a ‘hidden’ way through routines or unwritten ‘laws’. Commonly accepted rules like these will structure human agency. They are the underlying form of collective order which direct social behaviour in specific directions, but not necessarily in a deterministic way. Cultural ideas and values are further linked to the establishment, reproduction and restructuring of power relations of the agents in the economy. In which way and with what speed conventions can be challenged and changed are important elements in the ability of social systems to adapt to a capitalistic world under constant change. The renewed interest in knowledge creation and in the institutionalisation of knowledge is very much a product of a shift in economic life away from a linear development path towards a more chaotic and volatile economy, where innovations become a crucial factor of competitiveness. Some geographical environments are endowed with a structure as well as a culture which seem to be well suited for dynamic and economically sound development of knowledge, while other environments can function as a barrier to entrepreneurship and change. The cultural context of a specific social system influences the competence of individuals’ ability to ‘read’ and interpret contemporary 181

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incidents in their environment, but also to identify elements of the unknown, and reveal what could actually become known (Thrift 1983).3 In this respect human actions and the competencies of firms are structured in a much larger social context than the confined system of specific organisations. Economic activity, knowledge and innovations in a local milieu, a region or a country correspond with the social and material structures of that particular area, and the ‘system integration’ of the area in a larger national or international context. Taking human agency and structural context as the starting point for understanding the production and reproduction of economic life in spatial entities, such as local milieus, regions or countries, has great influence on the way we think about economic phenomena in economic geography. Less emphasis will be put on factors such as the access to raw materials, distance to markets, or transportation costs, while more interest will be directed towards labour and its specific knowledge, social meaning, normsystems, innovative activities, etc. In a modern, globalised world there also exists a continuous reflective interaction between institutions or cultures at all levels. A crucial point is whether it is the local, regional, national, or global culture which is the basic determinant for the shaping of localised conventions and the development of a local social culture. The whole discourse on industrial districts emphasises the local level as the most important territorial level especially for small firm development (Brusco 1992; Storper 1992; Saxenian 1994). In endogenous growth theory a mixture of the regional and national level is discussed, while the national level is the most frequent frame of reference in evolutionary economics. In the strategic management literature the nation state, and to some extent the meso-level, is seen as a crucial determinant for developing the competitive strength of individual firms. The discussion in the previous chapters leads us to favour a rather pragmatic view and argue that it is the contextual situation of each firm and industry that will define which geographical level will be of most importance in the knowledge creation, and where governmental efforts of improvement might be directed. Economic clustering, positive external effects and spatial agglomeration Marshall’s description of ‘external economies…secured by the concentration of many small businesses of similar character in particular localities’ ((1890) 1920:216) evokes a functional division of labour made possible by geographical proximity. A local labour market could produce particular skills. A localised production system could develop economies of scale as well as new and more efficient technologies. Such an

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environment could also facilitate the exchange of information and the diffusion of technological and commercial knowledge. Thus, positive external effects and increasing returns are important factors included in the phenomenon called agglomeration economies. In Marshall’s mind, externalities are scale economies ‘dependent on the general development of the industry’ ((1890) 1920:314).4 Under such circumstances the private profitability of an investment might underestimate its social utility, and the optimal size of the firm would be reduced (Robinson 1965).5 Profitability and competitiveness are not only functions of the internal actions of a particular firm, but also induced, via the more general process of technological development, trading and information linkages to other firms. Innovations might often drive the process, but externalities diffuse growth impulses and promote further technological development.6 Also in the newer endogenous growth models, internal conditions in an economy—rather than external demand conditions—are the most important growth stimulating factors. In these models, economies of scale exist in relation to the production of human capital or knowledge and technology (Romer 1986; Krugman 1991a). In other words, the marginal productivity of capital grows as the stock of capital expands. The creation, accumulation and utilisation of knowledge often also produce externalities, whereby new knowledge spills over to the economy at large, and often also becomes accessible to outsiders. Hence, not only creativity and entrepreneurship become important with the shift towards a knowledge-based economy, but also an institutionalised protection of innovations. Without legal or social barriers to diffusion, developed knowledge will soon leak out to competitors as externalities and deprive rent-seeking private firms of the incentive to invest in knowledge creation, to the disadvantage of their region or country of location. By establishing and policing property rights to knowledge already created, governments protect innovations and regulate economic behaviour. More importantly they also stimulate investments in further knowledge creation, thereby further embedding innovative firms and sometimes even their whole related production systems in their region or country of location. Demand impulses from the home market are also important in the creation of knowledge, just as a regionally and nationally well developed functional division of labour is of utmost importance in creating dynamic learning externalities and in utilising economies of scale and scope also in knowledge creation. The local business environment functions as a social context which not only produces scale economies through external relations and offers an efficient division of labour (including specialisation economies), but also makes it possible to economise on transaction costs, and promotes entrepreneurship and innovations and the development of dynamic learning externalities and technological spill-over.7 183

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Summing up the main argument: ten conclusions The essence of the arguments put forward in this book can be summarised as follows.

1

2

3

4

5

6

Human agency and individual entrepreneurship are necessities for bringing change and development into the economy. Developing innovative products or process technologies, new administrative routines or marketing channels, etc., are at the heart of economic entrepreneurship. Only the human subject, individually or in groups, can act socially or construct machines able to act on instruction. Innovative activities are basically an incremental process where new ideas and physical artefacts are added to and combined with existing ones. Radical innovations sometimes occur and open up new avenues for innovative activities. Such ‘windows of opportunity’ are important aspects of entrepreneurship. The ability to be at the right place at the right time, spatially as well as socially and institutionally, belongs to the mastery of entrepreneurship, but it also contributes to its nature of randomness. Learning is an important aspect of innovation and the development of knowledge. Learning processes are cumulative and take place in a timespace context. They include the structured scientific approach to knowledge stored in written reports and procedures, as well as knowledge learned through practice and subsequently embedded in local routines. Learning processes involve the development of technological, social, organisational and financial skills. The cumulative investments in specific physical infrastructure such as industrial sites, buildings, transportation or communication networks, etc., all form part of the physical landscape, with which social action has to interact. This is an important part of the localised capabilities which can enable or disable learning and economic development. Social institutions as organisations, regulations and educational systems are other important elements of such localised capabilities. Their development is again cumulative, adding new insights or ideas while reproducing or transforming the social institutions of an economy. This also includes the development of a local culture and its openness to change. Trust as well as rivalry and acceptance of experimentation, failure and success are all important characteristics of a culture open to learning, knowledge creation and innovativeness. The need for experimentation and the stochastic nature of innovations call for a critical mass of resources of a different kind if the learning process should end in a commercial success. Access to information, skills and financial resources and an ease in combining 184

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7

8

9

10

old and new knowledge are important aspects of critical mass. The need to develop many parallel new projects of innovation is another. Many have to fail before a few will succeed. Experiences from failures should be fed into the learning process again as individual as well as collective knowledge. Knowledge generation, innovativeness and new firm formation many times include a situation of asymmetric information. The entrepreneur possesses the often tacit knowledge upon which an innovation builds. But external actors, not least agents in control of financial resources, seldom have the same information. They have to calculate risk in circumstances of market failure. A cumulative learning process can, however, develop competent capital where above-average insights in the dynamics of the dominating industry, locally, regionally or nationally, reduce the uncertainty when calculating the pros and cons associated with financing new firm formation. Cumulative learning processes of a different kind very often produce technological spill-over or external economies of scale, which can be more or less diffused and may be seen as a public good. The timespace context of a firm determines the degree to which the firm can take advantage of these economies as the diffusion is constrained both by institutional, social and spatial barriers. The cumulative nature of knowledge creation and the specificity of firm development will over time restrict the technological development of a firm or a related production system to business areas which are technologically related to the existing activities. Path-dependence will be the result and this contributes to explain the stability in specialisation and trade patterns. Finally, we have emphasised the importance of the private—public interface, following from the fact that some inputs to a learning economy are by necessity collectively produced. This, for instance, includes most of the physical and educational infrastructure, as well as social institutions such as the protection of property rights. A certain social stability is, furthermore, often a necessary condition for a prolific and systematic learning process to occur.

The learning perspective and public policy The whole discourse of localised capabilities, path-dependence and knowledge creation argues for a ‘bottom up’ approach to policy. Endogenous factors—specific to a firm, an industry, a region or a country—will increase in importance as dynamic elements of learning, innovation, skills and entrepreneurship exceed the value of yesterday’s localised, but now increasingly ubiquitous, factors like raw material, 185

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energy, manpower or capital. Competitive strength can be pro-actively enhanced through human action: by individuals working in firms and public institutions, and sometimes even by entrepreneurs operating outside the formal labour market. Innovativeness and entrepreneurship imply an eye for ‘windows of opportunity’, whether in the form of emerging markets or technologically: in the skills of combining tangible and intangible inputs in new ways with a higher perceived customer value than previously. Entrepreneurship is risktaking socially as well as economically. Investments in knowledge creation therefore have to be protected and rewarded in some way or other. Public intervention could be necessary to protect a free and fair competitive environment and assist in securing that any profits, which might be rendered from investing in knowledge creation, can be accrued by the entrepreneur, and not by a bunch of free riders or Johnny-come-latelies. It is a crucial task for the public sector to implement the basic predictability of a functioning market and help markets to operate efficiently through monitoring and establishing the formal and informal institutions necessary. For the economy taken as a whole, learning and knowledge production are important elements in expanding the economy and in creating wealth without consuming more natural resources or using more labour or capital. As always when externalities are at play, learning and knowledge production could, however, sometimes be an unprofitable activity for private actors. As a result, private firms would benefit by refraining from investing in knowledge creation, but at the expense of the society, thus calling for public intervention. A major function of the public sector is therefore to increase the ability of the economy to change, learn and unlearn, as well as to create and maintain a combination of policies which can develop generic knowledge useful for industry. Policy of the dynamic kind has to be deeply embedded in the specific web of institutions of a particular industrial system and has as a goal to create unique, tacit knowledge and localised capabilities. This dynamic understanding of human action and learning as the corner-stone of economic development is largely at odds with the traditional, mainly redistributive regional policy. The traditional policy, not least in countries like the Nordic ones, has had the intention of infinitely compensating firms or industries in some regions for what are perceived as being the disadvantages of ‘remoteness’ or an otherwise uncomfortable location. Direct subsidies or tax reliefs to diminish transport costs or to attract investments are typical elements in various incentive packages applied to preserve settlements and jobs in less favoured regions. Though general support for all firms or industries in that particular region will not distort competition internally in the region, it obviously represents a cost that the society has to cover. This cost is related to the direct subsidies given to firms, industries or regions, but is also related to the distortion of 186

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competition, putting the bill in the pocket of the consumers. There is also a cost to society through the tax burden put on the shoulders of those who are not necessarily benefiting from the policy. However, it is usually not possible to make any trustworthy costbenefit assessment as to whether the current costs of a given policy exceed the present value of all foreseeable and all unpredicted advantage that might flow from it in the future. Furthermore, many political programmes have intentionally only a symbolic effect on firm behaviour, wealth generation or income distribution. They do not primarily serve an economical, but a political purpose, as political action and engagement are often required to symbolise governmental vigour. This seems especially to be the case when the apparently successful regional policies of one country are rapidly duplicated in many others, regardless of whether or not the sufficient preconditions for success are present. A giant zero sum game is usually created, where the only fundamental effect is that some of the cost of running a manufacturing industry in a country is transferred from the private to the public sector, but without any relative advancement in competitiveness. For instance, the successful archetypical science park or growth centre did emerge as a result of specific historical events and distinct institutional endowments before any political intervention came about. Later duplicates of the superficial and instantly apparent characteristics and attributes of such entities were bound to give insignificant results as the deeper and more fundamental institutional and interactive mechanisms were not copied, and could not be copied. No wonder that purely politically constructed developmental programmes led to disappointing results as they did not take such realities into consideration. A more critical scrutiny of new policy instruments such as free zones, science parks, growth centres, etc., will reveal many incidents where the costs are large while the gains can be difficult to detect. However, rather than arguing for a higher degree of cost effectiveness we focus on the profoundly conserving effect of all prevailing redistributional regional policies: their raison d’être being the ambition to permanently reproduce any existing structure of firms, industries and settlements. Thus, traditional demand-side regional policies may find their legitimacy in perfectly sound arguments related to welfare, egalitarianism, defence, health, etc., but hardly in economic reasoning, and certainly not as a tool to gain competitive strength in a knowledge-based globalised economy. A learning perspective on regional policy will, on the contrary, be aiming at change, restructuring, dynamics and—first and foremost—at augmenting the ability of firms, industries and regions to create, accumulate and utilise knowledge. In order to do so, public policy must enhance the creation of a multitude of competencies in both private and public institutions, and promote an integration of knowledge from different bodies into commercial activities. 187

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Initially, such a knowledge-based policy will be more inclined to focus on a sector, and the functional division of labour, rather than on geography and the territorial division of labour. But because much learning is so dependent on human action and on the social and structural environment of the firm, its localised habitat—its local milieu, region or country—is of great importance for the assembly of the resources needed for augmenting the contemporary industrial development.8 But at the end of the day it is up to the market—and not to bureaucrats or policy makers—to decide which firms, industries or regions will be most successful. Contrary to traditional redistributional regional policy, the approach following the arguments of localised learning plays along with forces creating unbalanced economic development. This is, however, less controversial than it might seem at first, because the unbalanced economic knowledgebased development does not necessarily produce immutable patterns of spatial inequality. And learning certainly does not comprise some inherent compulsion towards creating or maintaining territorial dichotomies of a centre-periphery nature. So even when scale economies and positive externalities of learning might lead to increasing returns to scale, the policies to enhance the creation, accumulation and utilisation of knowledge do not solely favour already prosperous major centres, bypassing the hitherto less favoured regions. As demonstrated in the case studies presented in earlier chapters of this book, significant and thriving export industries are basically located in what have become known as peripheral regions. The emerging knowledge-based economy represents genuinely new and profound opportunities for endogenous economic development, even for the until now less developed regions and countries. The aim of a policy based on knowledge creation would be to promote learning and innovation in firms, industries and regions on equal terms. Public policy should be directed at enhancing the ability of firms and industries to involve themselves in dynamic competence building regardless of location. Firms in regions with a weak production and supply of competence should be helped to access already existing knowledge and — primarily—to learn to create, accumulate and utilise knowledge internally or together with their business partners. This approach is thus far from the neo-liberal ‘hands-off’ view of public policy as almost totally counter-productive, only creating friction in the economy and misallocation of resources. 9 And though the tendency towards free market operations, international competition, and supplyside economics is shared, the knowledge-based view acknowledges that a functioning market economy is not identical to the mere absence of regulatory regime (see Chapter 4). Well functioning and organised markets for products and production factors must, on the contrary, be seen as a (non-tradable) territorially specific asset: a localised capability. Only when it is seen as an obligation and responsibility of the national government 188

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and the regional authorities to ensure such conditions can the full potential of more elaborate, knowledge enhancing policies be obtained. Furthermore, even hard-core contemporary conservatives seldom deny that market failures are a fundamental part of the capitalist economic system, and that policy measures are therefore always needed to adjust and modify the economy when producing results that are suboptimal or otherwise undesirable. Two important aspects of market failure are asymmetry of information related to the capital market and underinvestment in the ‘competence market’ partly due to external effects. Information asymmetries are particularly serious in cases of entrepreneurial projects where new and tacit knowledge is at the core. The entrepreneur would possess most of the information about the specifities of the proposed technology and its market potential. It would be a problem for the investor on the other hand to ‘see the cards’ of the entrepreneur and calculate risk correctly. As a result, the rent that the investor demands for entering into such a project would be high or even prohibitive. As a consequence, profitable projects do not find capital and socially valuable projects are not launched. The market supplying knowledge to firms consists of a complex web of public and private actors, providing codified as well as tacit knowledge. Very often competence is highly embodied in individual people as tacit knowledge accomplished through a complex learning process. To access knowledge of this kind a firm has to employ competent personnel or educate their own employees in a particularly clever way. However, in many industries deep and very specific knowledge will not be needed at the same rate throughout the year, but only once in a while. External access to competence is therefore also very important. As knowledge is difficult to transfer, face-to-face communication is often needed as external competence has to be integrated with the internal competence of the firm. As discussed at length in Chapter 3, transfer of knowledge demands some degree of trust before it is possible to share sensitive information. Often a communicative arrangement with partners will also take the form of interorganisational accord to be of value for both parties. It is therefore very much due to the skills of the company, its ability to attract knowledgeable personnel and the way the firm accesses external resources through interorganisational arrangements which will determine the firms’ total available stock of competence at any given time. One general conclusion to be made from the discussion so far is that successful public policy must conform to the market processes, not try to work against them. This means investing in infrastructure; education and knowledge production; regulating competition and the economy in a way that encourages development of new knowledge embodied in products and processes not easy to copy; promoting the import of generic knowledge of specific importance for industries/knowledge segments where localised 189

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capabilities are present in the area, and at the same time helping to diffuse generic knowledge rapidly and efficiently to all relevant parts of the local business community. All such policies participate in creating a vibrant context for learning, innovation and industry development. As we have asserted previously in this book, the competitiveness of firms depends on localised capabilities which are specialised (rare); possible to commercialise (valuable); not easy to imitate; and not subject to substitution. Policy instruments should promote the production of such capabilities. Small nations cannot, however, be expected to succeed in all industries or indeed in all fields within an industry. This implies that the bulk of political involvement in economic development must be directed towards the improvement of the competencies of firms and industries which already have proved to be competitive and able to continuously enhance their competencies in interaction with specific localised capabilities. The market—and not any well-meaning governmental official—is picking the winners, subsequently to be backed by industry-specific policy measures. Regional and industrial policies aiming at strengthening such industryspecific localised capabilities must therefore always be differentiated policies, with limited policy spill-overs from one industry or region to the next. For instance, there might be a need for a heterogeneous supply of highquality expertise and carefully adjusted and inter-linking institutions in order to help solve complex problems specific to an industry. Broad policies, with universal regional or sectorial coverage, are often impotent policies, unable to obtain the degree of specificity necessary for building valuable localised capabilities, and thus incapable of contributing to the competitiveness of firms and industries in the knowledge-based economy. Fields open for public intervention The internationalisation of the economy strongly restrains governments from intervening in the market through macro-economic measures. The GATT— WTO agreement and the dynamics of the European Union confine the possible areas of intervention in most European countries. The introduction of the European Monetary Union will further limit the scope for independent monetary and fiscal policies in the individual member states. What is left for public influence is very much in the field of domestic supply: in organising the national and regional economies in a way that enhances competitiveness for the firms and industries located there. Policies directed towards improving physical and educational infrastructure are usually the least controversial. New capacity for transport and communication reduces the friction of space still further, while investments in the quality of education on all levels enhance the ability of the work-force to meet the demands of the emerging knowledge-based economy. 190

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The public sector may also support an import of generic knowledge in specific fields where the country already has localised capabilities without major problems. This will include high-quality universities and research institutions and support for international exchange for fast pick up of front technology or knowledge. For a small country, specialisation is necessary and as we have argued, the focus of this policy in small nations would be more to implement new technology in existing industries than developing new industries. Such a policy is already more or less in operation in parts of the technological or science policy, but should also include new generic knowledge from economics and management science. Furthermore, there is a need for a well functioning diffusion policy so that important new knowledge is adopted by the actors in need of such knowledge. First, education should bring generic knowledge to individuals. Recruitment of highly educated personnel is the best way to transfer knowledge from one system to another. Next, university extension services, liaison officers or private consultants at the national and regional level may bridge the gap between the university system and the firms. In small nations a centralised, national policy will be best to produce deep knowledge attractive for the firms. Such a policy is well accepted already. As an isolated policy measure it is easy to copy. However, to develop links between the public and the private sector which open up for fruitful communication and a capacity to blend generic knowledge with tacit knowledge already in use in the firm is difficult and depends very much on the knowledge base of the firm as well as the public knowledge system. Cultural and formal skills on both sides are therefore important and a well functioning institutional arrangement is necessary to make it work. This is difficult to develop and even more difficult to imitate. The use of high-tech knowledge in low- or medium-tech industries is important. It modifies products and makes the process more efficient (for example, the use of semi-conductors in old products; composite materials in the metal industry; advanced machinery in furniture production; satellite navigation and communication on fishing vessels; bio-technology in fish farming; new fibres in fishing nets and so on). But this also demands skills to understand the usefulness of new knowledge and how it could be combined with the existing technology of the firm. Adoption of new knowledge is therefore very much dependent on the skills and competence of individuals in the firm, as well as on the institutional environment of the firm. Easy access to highly qualified consultants is becoming increasingly important—especially regarding the access to industry-specific knowledge. As the commercial basis for maintaining a full range of very specialised consultants is only seldom present in small countries, publicly funded institutions might be established to support firms in accessing new knowledge through adoption and adaptation.

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Entrepreneurship is risky, but very important if a dynamic process of experimenting and learning is to be possible. For the economy as such it is important that many try, in order that some may succeed. For the many who do not succeed a culture of acceptance has to be present. A public financial support system should be available to take down the risk to a level where it will also be of interest to private investors who risk their money in new ventures. It is of particular importance to support longstanding equity for new firms which could provide the firm with capital over the period of developing prototypes and into commercialisation. Developing an entrepreneurial culture is also important and could be supported by some policy instruments locally as well as nationally. But mostly it has to do with long-developed practices in an economy and the societal behaviour of the successful. Other instruments more easy to imitate would be a generous depreciation of investments in R&D or start-ups, etc. Networking or inter-organisational relations are of utmost importance in combining complementary competence and sharing external effects. Interfirm relations are important for developing specialised competence or core skills and a well-functioning division of labour. Inter-firm arrangements are also important in developing trust among partners. Proximity of some sort—cultural, technological or spatial—helps to promote openness and innovative sharing of knowledge. Again this is an area where imitation is not easy. Inter-organisational relations develop by experience. The public sector could not do much here, but could be an instrument to facilitate meetings between firms and individuals and support programmes to join companies in common projects to develop market links; use of generic competence; developing technology; etc. Innovativeness and learning are dependent on a heterogeneous mix of localised capabilities characterising the region or country. A critical mass of suppliers of competence and entrepreneurs is important if the dynamic of an industrial system is to function well. This will need a clustered industrial development, functionally as well as spatially. Again the public sector could support investigations searching for missing capacity or competence and encourage new entries to join the system. It is important to accept that successful business development is cumulative and will add to the growth of a particular sector or region. A welfare policy of distributing growth to other sectors or regions by blocking development in one particular region, for example, by cutting support to or dismantling dedicated public institutions or even worse to force firms to relocate, will work against the idea of ‘learning-based regional development’. Regions or sectors which are not able to learn, change and develop will lose competitive power and find it difficult to develop a dynamic business sector. In a learning perspective it is first and foremost the responsibility of the local population and its agents in the private and public sectors to see that they develop the right competence 192

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and sustain their economic base. In all aspects, public intervention can only have a marginal influence on the development if there are no local agents to carry out a dynamic, change-oriented development. In many ways public regulations in other sectors such as environmental policy, should be constructed in such a way that they create strong incentives for firms to innovate and to solve problems, rather than just conform to the standards set by the government. New technological solutions could help to solve pollution problems and at the same time be an avenue for new business development. Final words In this book, we have analysed the impact of geographical location on firms’ ability to create and sustain competitiveness in an era of economic globalisation. In the introductory chapter, we raised three broad questions that have directed our line of argument throughout the book. The first question was related to what competition is about in today’s economy, and how the performance of firms and industries is related to space and place. The second was concerned with why geographical areas tend to specialise in particular types of economic activity and why patterns of specialisation are so durable. The third question, finally, directed our interest to the particular small-country characteristics with which we have been preoccupied in the second part of the book: how can high-cost regions in general, and small industrialised countries in particular, sustain competitiveness and prosperity in an increasingly integrated world economy? In a way, we have provided the same answer to all three questions: it has to do with knowledge creation and with the development of localised capabilities that promote learning processes. This answer is, of course, neither entirely original, nor fully exhaustive. Rather than being a definite statement, the analyses and conclusions presented should thus be regarded as a draft for a new research agenda in economic geography. The issues at focus—industrial location and competitiveness, regional specialisation, agglomeration, and the creation of economic prosperity in regions and countries—are indeed far from new. However, what is needed now is a change in the direction in which to look for the answers, and it is to this change that the present volume is hopefully contributing. There is in the present volume, and in the vast literature that we have been referring to and borrowing from, a fairly elaborate theoretical account of how industrial transformation comes about and why the analysis of the economic development of a region or a country cannot be separated from the localised social, cultural and institutional structures with which it is intimately related. The weak point, in our analyses as well as generally in contemporary research in economic geography and 193

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neighbouring disciplines, is empirical validation. The literature is certainly not rich in empirical evidence, for example regarding when and under what circumstances localised collaboration and/or competition facilitate learning (Glasmeier and Fuellhart 1996). There are various reasons for this. One is obviously that this is after all a fairly new avenue of research, at least in economic geography. Another is that rigorous testing presupposes an element of ‘vulgarisation’ of the theoretical argument put forward and this, in itself, is certainly repelling for some. Within the field of economics scholars often hold that ‘if you can’t count it, it doesn’t count’ Holsti (1969). But economic geographers have in recent years been more inclined to subscribe to the counter argument ‘if you can count it, that ain’t it’. Still, there is simply a need to go beyond the case study approach in order to be able to come up with answers to more specific questions such as: Under what circumstances does spatial proximity between collaborating or rivalling firms make them perform better? Do industrially specialised regions generally develop better than diversified regions? Do knowledge spill-overs mainly follow functional or territorial paths? Is it the local, regional or national level which is the most important in defining innovation or knowledge systems? What kinds of positive external effects are spatially mobile, and which are immobile and only shared by institutions included in a specific territory? Are some factors immobile in the early phase of the product/innovation cycle and made mobile later? If nothing else, these are important questions in the context of spelling out the policy implications of knowledge-based industrial and regional development. The fact that most countries and regions seem to retain their once adopted specialisation over extensive periods, despite radical overall institutional and technological change, is astonishing and indeed merits further consideration. So does the counter-intuitive fact that low-tech industries sometimes continue to prosper in high-cost environments while common sense, as well as mainstream economic theory, would have us believe the opposite. In trying to explain and understand these and related phenomena, we regard ‘the localised learning route’ as the most promising to explore further.

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FOREWORD 1

It does not by itself resolve the painful economics of adjustment, of course, with its many pitfalls and distributional victims.

1 REGIONAL SPECIALISATION AND LOCALISED LEARNING 1

2

3

4

Subsequently, Krugman has published a series of books and articles where he re-addresses a broad range of basic topics in economic geography (see e.g. Krugman 1991a, 1991b, 1993b, 1995). For a review of much of this work, see Martin and Sunley (1996). In the international business literature, there is a long-lasting debate concerning if and to what degree transnational firms can ‘create proximity across space’, i.e. if they by means of implementing organisational routines, cultures, and communications and control systems can make for integration between various business units located in different geographic milieus. See Malmberg, Sölvell and Zander (1996) for a more elaborate discussion. Penrose contended: ‘Thus, a firm is more than an administrative unit; it is also a collection of productive resources the disposal of which between different uses and over time is determined by administrative decision’ (Penrose 1959: 24). ‘Earnings in excess of break-even are called rents, rather than profits if their existence does not induce new competition’ (Peteraf 1993:180). Ricardian rents—named after David Ricardo (1772–1823)—is a subgroup of disequilibrium quasi-rents by which an excess (or supranormal) profit (total revenues over total costs) can be appropriated by the possessor of some property (a mineral deposit, farm land, corner shop) in the short run, but which is usually eliminated or converted into cost in the long run. Farmland yielding above average crops will earn the owner an excess profit, but when sold will fetch an above average price making the buyer of the land no better off than if buying less fertile land at a lower price. While Ricardian rents are due to the uniqueness of inputs, other disequilibrium quasi-rents can be the result of output restrictions on intermediate or final products markets ( = monopoly rents) or emerge from innovation (Schumpeterian or entrepreneurial rents), see later in this chapter. The focus on Ricardian rents distinguishes the

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5 6 7

8

resourcebased approach from the mainstream structure-conduct-performance approach of strategy (Mason 1939), where the source of rent is market power (Teece, Pisano and Shuen 1990; Scherer and Ross 1990). These possibilities will be expanded on in Chapter 4. This aspect will be further discussed in Chapter 3. Most approaches lack a theoretical foundation for the concept of ‘an industry’. Contemporary microeconomic theory, for instance, assigns an unambiguous meaning to ‘industry’ only in the cases of perfect competition and perfect monopoly, as pointed out by Nightingale (1978). Outside these theoretical extremes there is no theoretical concept to which the term ‘industry’ can usefully be applied (Berg 1996:196). If all economic activity was distributed at random between plants, no competition-related delineation of industries could be established. The reason for clustering must be sought in the constraints imposed on firms by their environment; perceived market trajectories, and currently employed technology. Even more important, however, is the way firms consolidate the external factors with their own resources when building a coherent managerial strategy in order to obtain the degree of heterogeneity needed to survive and prosper. No firm has ever been recorded shifting from producing medical services to producing sweatshirts or to producing both products simultaneously. Or, as Freeman and Boeker (1984:80) put it:

I ndividual firms are often not entirely free to generate unique strategies. There is a strategic choice involved when one decides to open one kind of business or another. This choice is more or less fixed at firm founding and is constrained by an environment which permits less than free will in strategic choice. A bank selling hamburgers at some of its teller windows would be viewed by all as inconsistent. Structural stability usually prevails even in tempestuous intervals of numerous closures and an excessive formation of new firms. The coherence requirement functions as a buffer which subdues and moderates the effects of external disruptions. The subsequent changes that take place over time in the distribution of activities within a firm therefore only seldom result in a repositioning between clusters once established. This stability in the clustering of activities is utilised when constructing taxonomies of industries, and gives meaning to the industry studies. 9 It might be noted that the discourse of institutional economics regards market processes as embedded in political and social institutions (North 1990) created by politics and government (Zysman 1993). In Marxian economics, institutions, governments and politics are seen as outcomes of the inner workings of the market. 10 Thrift (1983) discusses how institutions structure the information that is disseminated over space and between classes and groups, and shows how knowledge gets distorted and misappropriated when confronted with recipients with a different background. 11 Even if there are strong links between the analysis of innovative milieus and the analysis of industry agglomeration, the analytical problem in focus is not identical. A milieu may be innovative even if it is not made up of a large number of vertically or horizontally related firms. Thus it is fully possible to consider a milieu where the institutional endowment tends to encourage entrepreneurial behaviour over a broad range of industries, such that the milieu must be regarded as innovative even though there is no obvious

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12 13

14

15

specialisation in one particular type of activity (see Andersson 1985). And the opposite is equally possible, a milieu may consist of a number of firms in a particular industry—or firms linked through vertical buyer—supplier relations —but still exhibit very limited innovative potential. This distinction was far less frequent earlier in the century (Marshall 1919; Robinson 1931). The definition of concepts such as ‘local’ or ‘regional’ are notoriously vague. A local milieu may thus be a country—this is indeed the normal use of the concept in the international business literature—but it could also be an urban region, or any functionally defined sub-national entity—the way in which it is used in this book. The precise delimitation of the local or regional milieu in geographical terms need not necessarily be a crucial point. It is often sufficient to state that it refers to a segment of territory characterised by a certain coherence based on common behavioural practices linked to its local institutions and culture, industrial structure and corporate organisation. The definition is inspired by Scott and Lodge (1985:15) and Cohen and Zysman (1987:60–61) and it is now gaining ground also in international economic organisations like the OECD and in the academic literature (Storper 1994). The inclusion of both firms and countries in the definition of competitiveness is very different from the formerly accepted view that ‘competitiveness has different meanings for the firm and the national economy’ (Cohen 1994: 195), see also Krugman (1994b, 1994c). Kaldor (1978) was perhaps the first to show that firms in some of the world’s most successful countries have increased their global market shares even during periods when total factor costs have been rising (like Japan and Switzerland). During the same time period, 1963–1973, other countries (the UK and the US) lost global market shares while at the same time reducing their labour costs and their relative export prices.

2 SUSTAINABLE PATTERNS OF SPECIALISATION IN A GLOBALISED ECONOMY 1 2

3

4 5 6

The concept of ‘territorial division of labour’ is older than one would guess, since it was initially introduced almost two hundred years ago by Torrens (1808:9). Based on Tobin’s (1969) q-theory of investment, Baldwin and Forslid (1996) have recently illustrated six such links between trade liberalisation and economic growth. Tobin’s q is defined as the market value of a firm’s assets (liabilities side) divided by the replacement cost valuation of those assets (assets side). Already a century ago, it was recognised that ‘Transport is so easy in the present day that the concentration of an industry may occur at points very far removed from the places of production of the raw materials’ (Cunningham 1902:502). Obviously the productivity of transport services has grown considerably since then. For movements of capital, the process has been even more dramatic as former government regulations and old habits have withered. See also Coase (1937), Levy (1984) and McBride (1983) on this. For a further discussion see Kaldor (1985), Loasby (1991) and Hodgson (1993). Before deciding to outsource some activity formerly produced in-house, management will have to consider the related risks of opportunistic behaviour on behalf of future suppliers and customers (Williamson 1985; Langlois 1986; Alchian and Woodward 1988; Hodgson 1988). This is especially the case when

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the firm in some way becomes dependent on them for lack of alternatives. The firm might try to minimise the risks of opportunism by engaging the futuresupplier or customer in some form of legal, financial or proprietary relationship or by building long-term trust relations. This question will be further dealt with in Chapters 3 and 4. 7 Building on an existing tradition (Loria 1888, 1908; Maunier 1908), Alfred Weber later extended his original contribution (1909) to a ‘locational theory under general and under capitalistic conditions’ (1923). For a short sketch and discussion of Weber’s theory see Predöhl (1928), Friis and Maskell (1980) and Gregory (1982). 8 In Weber’s original wording, the definition goes like this:

Die Materialien, die in der Industrie verwandt werden, können für die großen Verhältnisse der Praxis angesehen ‘überall’ vorkommen, von der Natur also—eben im Großen angesehen—ohne Rücksicht auf den Ort zur Verfügung gestellt werden. Was ganz allgemein d.h. für alle Plätze der Erde ja eigentlich nur von der Luft gilt, für enger begrenzte Gegenden, die man zum Gebiet abgeschlossener Standortsbetrachtung machen kann, aber auch für viele andere Dinge…. Solche Materialien mögen ‘Ubiquitäten’ heißen,…. (Weber 1909:51) 9 This wording deliberately echoes the characteristic element of the resourcebased view of the firm, highlighted in Chapter 1. 10 This discussion can be seen as a new reflection of Menger’s (1871) old statement that free goods cannot possess value. 11 This causality has in a way already been pointed out by Marshall ((1890) 1920:355) who insists that: ‘Every locality has incidents of its own which affect in various ways the methods of arrangement of every class of business that is carried on in it… The tendency to variation is the chief cause of progress.’ 12 It must be kept in mind that just as the group of ‘high-cost areas’ consists of a broad variety of entities, so does the group of ‘low-cost areas’. An informative account of some of these differences within the countries of South-East Asia is given by Zysman, Doherty and Schwartz (1996), while Young (1994) shows that much of the growth in South-East Asia can be explained by factor accumulation and reallocation of resources. 13 In a recent study it is argued that the implicit assumptions underlying statements of convergence mainly (but not exclusively) at the regional level are ‘methodologically flawed’, in principle as well as in measurement terms (Cheshire and Carbonaro 1997:36–7). 14 The persistent and growing divergence in income per capita between the developed and the less developed countries certainly also challenges mainstream neoclassical growth theory more generally. One of the attractive features of the endogenous growth approach, is its broader menu of factors which can influence the outcome, including a ready allowance for divergence in growth between regions and countries. 15 Such inadequacies reside in what Abramovitz (1986) terms the ‘social capability’ of the region or country. The social capability concept can be seen as an element of what we discuss in Chapter 4 in terms of the institutional endowment of an area.

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Whether the explanatory emphasis should be placed on endogenous or exo genous factors has been subject to a long-lasting controversy in regional economics and in development theory. During the late 1970s and the 1980s this battle was especially intense in the clash between neoclassical equilibrium theory and neo-Marxist dependency theory. Some of this literature, however, overlooks the fact that concepts such as trust and loyalty bear quite different meanings and connotations in different parts of the world. See for instance Dogan (1994) or Fukuyama (1995) on this. These conclusions are drawn on the basis of an entire world-trade matrix using UN and OECD statistical sources on import-export flows from 1970 onwards for 80 countries (OECD and COMECON member countries, NICs and LDCs) at different levels of aggregation: 400 product classes, 98 sectors and 25 commodity groups. Intellectually, Linder (1961) was the first to challenge the notion that if a country exports relatively much of a certain commodity, it will import relatively little of it, thus acknowledging the possibility of intraindustry trade. Actually the point was made by Kaldor (1970) more than a quarter of a century ago that even though some regions have specialised in capitalintensive industries ‘it is sensible—or perhaps more sensible—to say that capital accumulation results from economic development as that it is a cause of development’ (Kaldor 1970:339). Recently, advancement in the so-called ‘increasing returns endogenous growth models’ (Romer 1987, 1990; Sala-i-Martin 1990, Rivera-Batiz and Romer 1991; Grossman and Helpman 1991, 1993) has, however, questioned whether all types of specialisation are equally advantageous for a country. These theories focus on the returns on inputs that can be accumulated, and treat the rent-seeking innovative efforts of firms as a cardinal mechanism of technological progress and productivity growth. As the resources devoted to purposive knowledge creation are determined by the ability to appropriate the resulting Schumpeterian quasirents, and as this ability is not only the result of the firms’ own competencies but also of the institutional endowment of the region or country in which the activity takes place, localised capabilities become an intrinsic part of the core of the new endogenous theories of growth. However, in current versions of this new growth theory, the learning propensity is usually modelled by R&D expenditure only, thereby focusing the scholarly and political interest on the development in each country’s share of innovative-intensive industries, i.e. its ranking and share within the so-called high-tech industries.

3 FIRM COMPETITIVENESS THROUGH KNOWLEDGE CREATION 1

2

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In particular, these are interesting issues in the light of the specific dilemma of small countries that is identified in Chapter 5: a low- and medium-tech industrial structure can be successfully reproduced in a high-cost environment only if there are some compensatory advantages in that environment, and we argue that the ability for ‘localised learning’ may well be such a major advantage. Although knowledge might appear abundant it represents no challenge to the fundamental notion of scarcity in economic theory (Menger 1871) as the competence to create, acquire and utilise knowledge will always be restricted (North 1994). Firms, regions or countries which can employ new knowledge faster than their competitors will always have an advantage. Rumelt, Schendel and Teece (1991) draw attention to the changes made, for instance, in Scherer’s mainstream reference textbook on industrial economics, between the first and second edition (appearing in 1970 and 1980

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respectively). The third edition (written jointly with Ross), published in 1990, contains an abundance of material on learning-by-doing, going back to the experiences of building frames to the B-29 bomber of World War II, where unit costs declined on an average by almost 30 per cent with each doubling of cumulative output (Scherer and Ross 1990:98). In the words of Hume ((1779) 1980:36): ‘Many worlds might have been botched and bungled, throughout an eternity, ’ere this system was struck out; much labour lost; many fruitless trials made; and a slow but continued improvement carried on during infinite ages in the art of world-making’. The phenomenon is identified by Thrift (1983:45) as the second of five types of interrelated ‘unknowing’: knowledge known in a distorted way only; knowledge taken for granted as ‘true’ or ‘natural’; knowledge being hidden for some in the society; knowledge not being understood; and knowledge really unknown and not possible to know. Ambiguity differs from uncertainty by the fact that it cannot be reduced by the collection of more facts. Even when knowledge is put to use, some degree of ambiguity often remains regarding the precise nature of the means—ends relationship. On the resulting origination of ‘rationality-surrogates’ see Meyer and Rowan (1977). In his earlier work Hayek (1945) emphasised the importance of knowledge of particular circumstances of time and place—that is information of a particular applicability—as opposed to scientific knowledge, which is information of general applicability (see Hirshleifer 1973:34). Imai, Nonaka and Takeuchi (1986:373) attribute an important part of Japan’s economic success to the ability to unlearn former organisational or institutional rigidities through the acceptance of managerial declarations of a state of emergency or crisis, which makes radical changes easier to swallow. See also Nonaka (1988) and Nonaka and Takeuchi (1995) on this. Johnson (1992:29) makes a distinction between ‘just forgetting’ and ‘creative forgetting’, thus emphasising the role of unlearning as part of the knowledge-creating process. This aspect will be elaborated further in Chapter 4. This point of departure is by no means new, but can be traced at least to Descartes ((1641) 1934) who used the term ‘idea’ for whatever was conceived by the understanding. Just as experts in unscrambling Rubic’s Cube (Heiner 1983) follow a hierarchical sequence of moves which are largely independent of the initial position, so will skilled players of chess routinely memorise ‘a large collection of possible patterns of the pieces, together with procedures for exploiting the relations that appear in these patterns’ (Hodgson 1988:82). If Saab Automobile, as a hypothetical example, managed to reduce the number of working hours for assembling a car radically, it would have an instant effect on Volvo’s efforts to do the same in their nearby plant in south-western Sweden (or vice versa), while a similar achievement by a car manufacturer in Japan or Korea will tend to be partly attributed to the very different social and institutional setting in which they work and will therefore not lead to the same immediate response on behalf of the two Swedish firms. Ford, of course, first and foremost employs Smith’s ((1776) 1979:112) observation that ‘the division of labour by reducing every man’s business to one simple operation, and by making this operation the sole employment of his life, necessarily increases very much the dexterity of the workman’. This supposition has, however, yet to be fully corroborated. Christensen (1996) takes the first important steps in this direction by establishing a distinction between four generic categories of innovative assets of the firm—scientific

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research assets, process innovative assets, product innovative application assets and aesthetic design assets—each of which consist of a unique combination of resources, technical capabilities and managerial competencies within the firm. This contingency will be considered further in Chapter 5. In a perfect market all agents have free access to all information needed, and the market for knowledge is therefore imperfect by definition. Perfect markets are constituted by large numbers of price-taking anonymous buyers and sellers supplied with perfect information [which] function without any prolonged human or social contact between the parties. Under perfect competition there is no room for bargaining, negotiating, remonstration or mutual adjustment and the various operators that contract together need not enter into recurrent or continuing relationships as a result of which they would get to know each other well. (Hirschman 1982:1473)

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Or, as Loasby (1976:5) has earlier noticed: ‘If knowledge is perfect and the logic of choice complete and compelling then choice disappears; nothing is left but stimulus and response. If choice is real, the future cannot be certain; if the future is certain, there can be no choice.’ The distinction is based on how easy it is for a customer to experience the essential attribute of the product (Tirole 1988). The three categories in this taxonomy are: search goods, where all significant product characteristics are available before the purchase of the good (Nelson 1970); experience goods, where the most important product characteristics can only be known after the product has been obtained and used (Nelson 1970); and credence goods, where the full information of the properties and quality of the product might never be known, even after the product has been consumed or used as planned (Darby and Karni 1973). The authors use as examples the style of a dress (search good); the taste of a can of tuna fish (experience good); and medical services (credence goods). he possibility of an additional fifth stage will be discussed in Chapter 5. A desired piece of knowledge can be located at many different points in the network, which thus have some resemblance with the concept of ‘heterarchies’ used in the management literature to describe big and complex organisations (Bartlett, Doz and Hedlund 1990) or the concept of ‘structure in general’ used by Pelikan (1988). These four stages towards the evolution of a network of firms, interrelated through trustful relations, is largely compatible with the so called ‘interaction’ or ‘network’ approach to inter-firm relations which is developed in e.g. Johanson and Mattsson (1985), Ford, Håkansson and Johanson (1986), Håkansson and Johanson (1992), and Håkansson (1982, 1989).

4 LOCALISED CAPABILITIES AND THE COMPETITIVENESS OF REGIONS AND COUNTRIES 1

In this mechanism of feedback a selection takes place whereby not all ingredients of an area’s total localised capabilities will influence its economic development at one and the same time (Lodge and Vogel 1987; Casson 1993). Precisely which of the totality of existing factors become active in determining

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the future development has so far been left to be studied by historians, and no systematic economic theorising has to our knowledge been conducted in this field. See Massey’s (1979, 1984) account of how successive rounds of investment create a layered structure which gradually makes a shift between different forms of spatial divisions of labour. The definition quoted here is not fundamentally at odds with the founding father of institutionalism, Thorstein Veblen, who perceived institutions as ‘settled habits of thought common to the generality of men’ (Veblen 1919: 239), nor with many later scholars. Hamilton, for instance, finds that institutions ‘connote a way of thought or action of some prevalence and permanence, which is embedded in the habits of a group or the customs of a people. (…) Institutions fix the confines of and impose form upon the activities of human beings’ (Hamilton 1932:84). Sometimes it is not only possible to identify the initial impulse to move in a certain direction, but also the main actors involved. Hall and Markussen (1985), for instance, disentangle the history of Silicon Valley along these lines. Success stories such as this have, together with the theoretical progress within new trade theory, given inspiration to thoughts of a possible predatory trade policy, whereby the relative position of an area could be raised at the expense of another (Brander and Spencer 1983, 1985; Krugman 1987, 1995a) by deliberately establishing first mover advantages. The phenomenon can be illustrated with data on new firm formation in Denmark. Consider a matrix, where all the 208 sectors in manufacturing industry are placed on one axis and the twelve Danish counties (including the greater Copenhagen area) on the other. Though the majority of the cells of the matrix were empty, 87 per cent of the new firms established between 1972 and 1992 were found in ‘occupied cells’ e.g. in the same sector and region as at least one incumbent firm (see Maskell 1994). This holds even though the corporate strategic ‘logic’ can sometimes impair the specific role of the region of location as noted earlier (Hallin and Malmberg 1996). For a further discussion on competition between territorially defined entities see Krugman (1994b, 1994c). A supply base can be seen as the localised capability to provide parts, components, subsystems, materials and equipment technologies available for new products and process development, as well as the structure of relations among firms that supply and use these elements. The supply base shapes the possibilities confronting users by enabling or deterring access to appropriate technologies in a timely fashion at a reasonable price. (Borrus and Zysman 1997:43)

8 It should also be noted that seemingly contradictory evidence has emerged in recent years. Thus, Baptista and Swann (1995) and Appold (1995) find no agglomerative economies when looking at supplier relations and innovative activity. However, the applied methodology will probably never reveal the existence of or be able to explain why firms in an industry do in fact agglomerate. Building on secondary sources, Krugman states that ‘Within the United States, the localization of industry has by most measures been declining since the 1940s, suggesting that local feedback loops have increasingly become national instead; probably national loops are becoming international as well’ (Krugman 1992: 17). In Europe, Molle (1997) finds no long-term

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agglomerative tendencies when studying the locational pattern between 1950 and 1990 for all industries in the present fifteen member countries of the EU. But his level of analysis (very large regions) would obfuscate even strong regional movements. This tendency to emphasise the learning aspect of agglomeration—rather than cost minimisation—is also reflected in the most recent works on the Italian industrial districts (Bellandi 1995) and on American high-tech industries (Markusen, Hall and Glassmeier 1986). Chapman and Walker (1990) show how the industrial base of New England deteriorated. In the nineteenth century it was one of America’s most important industrial regions. Towards the end of the century the region experienced a growing concentration in the production of textiles and shoes, while other sectors diminished. In the inter-war period the regional economy developed into a disaster. In the post-war years the region lost ground to the rest of the US. However, around 1960 new activities based on local skills and local educational infrastructure emerged, and were gradually developed into booming R&D-based industries. There has been no development from the old sectors themselves. In his analysis of changes in the rate of economic growth and development at the level of the nation state, Olson (1982) presents further evidence to suggest that vested interest increasingly encumbers economies during periods of stability, and therefore results in a deceleration of economic growth (see North 1994). See Kogut (1990) and Kogut and Zander (1992) for a different approach to this discussion. The discussion is closely related to—and inspired by—Dierickx and Cool (1989). However, they consider imitation related to the individual firm, and not a geographical area. This point has previously been made in the theoretical debate within development economics: One aspect of development strategy that is all too often overlooked is related to the desired structure of consumption to which the society should aspire. If the goal is to ‘catch up with the rich countries’, and ‘to close the widening gap’, then the consumption patterns to which the society implicitly aspires are those of the developed countries. The ends of development, therefore, will be essentially imitative. But suppose it is precisely this imitative pattern which underlies the mechanisms of dependence? (Girvan 1973:27)

5 SMALL NATIONS: HOW TO SUSTAIN PROSPERITY IN OPEN, LOWTECH ECONOMIES 1

When barriers to trade coexist with economies of scale, small countries will tend to specialise in goods for which the international demand is rather standardised, while larger countries will seize the advantages of product differentiation. See Melchior (1995) who, based on new trade theory, renders an updated foundation for this ‘standard goods hypothesis’ initially conceived by Drèze (1960).

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2 By this we are not denying that protectionism or a deliberate rigging of domestic markets to distort prices might be in the national interest in certain phases of a country’s economic development. For a further discussion see List (1841), Spencer and Brander (1983) and Fallows (1993). 3 While strongly supported in Czada’s (1987:29–30) empirical analysis of many small countries, Katzenstein’s ‘virtual equation of smallness with corporatism’ has been severely criticised by Hicks, who finds the whole argument ‘strained’ (Hicks 1988:136). Crouch (1986) gives a brief introduction to some of the literature on difference in degree of corporatism between countries. 4 The term ‘billion’ is used here to denote a thousand million (109). 5 It has been shown that the home country bias diminishes over time, even for the largest countries. After controlling for sizes of exporter and importer, their direct distance (Great Circle Distance between major cities), geographical position and possible linguistic ties, Wei (1996) has thus been able to demonstrate how the average country of the OECD gradually reduces its use of home-produced commodities while increasing its share of imports from an otherwise identical foreign country. For the period 1982–1995 a typical member country of the EU reduced its home country bias in relation to other countries of the EU by as much as 50 per cent. Trail and da Silva (1996) argue that there is a need for a more complex measure than trade performance in order to fully measure the degree of international competitiveness. This is certainly correct, but even the inclusion of production data will not have any great effect on the overall picture, nor on the conclusions drawn in this book. 6 The national R&D expenditure is, of course, difficult to associate directly with the national growth rate when the R&D activities of globally operating firms are geographically unevenly distributed. ‘Swedish firms’ R&D efforts in Sweden might raise their competitiveness in high-tech products, but the firms do not find Sweden the most suitable location for high-tech production’ (Blomström 1990:102). This problem is not overcome by the product-based definitions of high-tech industries. 7 Laestadius (1996) offers a critique of this approach which is supported with detailed studies of the building in high-cost environments of world-class competitiveness in several low-tech sectors. 8 The countries used for the period 1980–1995 are Australia, Canada, Denmark, Finland, France, Germany, Italy, Japan, the Netherlands, Norway, Sweden, the United Kingdom and the United States (OECD 1992). Austria, Belgium, Greece, Iceland, Ireland, Luxembourg, Portugal, Spain, Switzerland, Turkey and New Zealand are also members of the OECD, and recently Mexico (1994) the Czech Republic (1995) and Hungary (1996) have joined. 9 Until 1987, instruments and electrical machinery were also included in the group of high-technology industries (OECD 1992). 10 One of the shortcomings of focusing exclusively on R&D expenditure in a particular sector is, of course, that some industries might do little R&D themselves, while simultaneously purchasing highly R&D-intensive intermediate and capital inputs from other sectors domestically or abroad (Klette 1994). See also Zander and Kogut (1995) on this. 11 North Sea oil is, for instance, not in any way a high-tech product, but a lot of R&D has been done by independent engineering consultants and by the firms supplying the drilling and storage equipment. 12 The high-tech industrial content of the export of Ireland (not included in the OECD STAN Database) is also above average due to the many foreign-owned firms producing components and electronics.

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The increased ratio of domestic R&D as a percentage of GDP has apparently not influenced the aggregate profile of fixed investments in these countries. Although most small countries have a high degree of specialisation in products based on natural resources the specific specialisation of a small country like Austria is very different from the specialisation in the Benelux countries, which again is different from the Nordic countries. The specific products that dominate the Nordic countries include metal and ore; paper and pulp; fish and wood. For a further discussion on divergence versus convergence in specialisation patterns, see Dalum and Villumsen (1996). See also Kristensen and Levinsen (1983) and Stankiewicz (1982). Both these contributions are important forerunners for the present discussion by introducing the main line of argument. This is in essence what Kirzner (1992:169) has labelled ‘Hayek’s Knowledge Problem B’: problems of market failure, which emanate from the dispersion of information, and which do not inevitably get solved. Fagerberg (1995c: 5) finds that this might be seen as a particular formulation of a more general prediction of the ‘new trade theory’ (Helpman 1984). Countries with small domestic markets may face a disadvantage in industries where economies of scale prevail if products are differentiated or there are barriers to trade. Linder maintains that ‘It is a necessary, but not sufficient, condition that a product be consumed…in the home country for this product to be a potential export product’ (Linder 1961:87). Even though great scepticism has been voiced (Dore 1973), the literature on business history lends some support to the view that equally profitable technological regimes might coexist (Broadberry 1995). Lewchuk (1986), for instance, shows how a large group of British car producers profited for several decades from the conscious selection of an evidently ‘inferior’ technology. The resulting productivity of using skilled labour and low capital intensity was below that of their US competitors (and below that of Ford’s plants in Britain), but as monitoring the degree of exertion of skilled labour was rather easy they saved money on supervision, as well as on payments of interest for the capital outlay. Many suggestions of other possible answers have, of course, been put forward over the years. Not least scholars and policy makers from the large or mediumsized countries argued that Europe especially should get its act together and follow the high-tech road of the US and Japan (see among many others for instance Marcum 1986). They tend, however, to overlook the fact that at least some of the smaller countries are doing quite well as it is. On the other hand it is difficult not to agree with Crafts’ conclusion that ‘Undue attention is paid to R and D as opposed to learning as a source of productivity improvement and to patents and market size as opposed to other determinants of the profitability of innovation’ (Crafts 1996:45). It is precisely this ‘smallness’ of regions which in our mind makes them the ‘nexus of untraded interdependencies’ (Storper 1995). Building on the works of Axelrod (1981, 1984), Dupuy and Torre (1996) demonstrate how the tit-for-tat strategies are facilitated by proximity between actors. Low geographical mobility is one important factor which decisively differs between Europe and the US. The discussion here has many similarities with Brusco’s analysis of the Italian industrial districts:

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it may be stated that an industrial district is a set of companies located in a relatively small area; that the said companies work, either directly or indirectly, for the same end market; that their shared range of values and body of knowledge is so important that they define a cultural environment; and that they are linked to one another by very specific relations in a complex mix of competition and co-operation. (Brusco 1992:177–178) 25

Both features can be seen as representing the advantages of ‘weak ties’ in Granovetter’s (1973) terminology.

6 COMFORT AND COMPETITIVENESS: THE WOODEN FURNITURE INDUSTRY 1 Furthermore, including firms smaller than twenty workers employed will increase the employment in the EU wooden and metal furniture from 581,500 persons to 842,880 persons in 1993 (COM 1995:18–3). According to COM (1995:12) the seven largest industries (out of approximately eighty listed) in the European Union in 1994 were (with the employment growth 1987–1994 shown in brackets) ‘Assembly of motor vehicles’ 1,026,234 (-15.4 %); ‘Telecom equipment’ 769,424 (-15.7 %); ‘Processing of plastic’ 759,541 (14.6 %); ‘Clothing’ 721,328 (-16.4 %); ‘Tools and finished metal goods’ 719,025 (-3.6 %); ‘Basic industrial chemicals and petrochemicals’ 530,453 (-19.0 %); ‘Parts of motor vehicles’ 475,481 (-6.0 %). 2 While the basic features of the product have changed little, a number of innovations in production have of course taken place. See, for instance, West and Sinclair (1992). 3 The competitiveness of its US counterpart in southern California is apparently doing less well (Scott 1996). Competition from the economically less developed countries has always been negligible in furniture production, though some progress has taken place in selected areas (Dowds 1989). 4 The chapter deals primarily with the wooden furniture industry, though some of the sources used differ with regard to the delineation of the industry. The varying criteria concern such characteristics as firm size (many small firms are not included in industrial statistics), users (household versus office furniture), links with a construction industry (furniture, fixtures), and raw materials (wooden versus non-wooden). Wooden furniture accounts for about threequarters of the total EU production in furniture. Metal furniture has traditionally been considered to be a distinct industry, separate from wooden furniture and upholstery (sections 316.6 and 467 respectively in the EU industrial classification system NACE). However, since 1993 changes in the NACE classification system (Rev. 1) have meant that all types of furniture are placed under the same heading regardless of materials used. 5 COM (1995) and the OECD Structural Analysis (STAN) Database 1995 are the main sources of statistical information here. 6 These figures from the OECD STAN Database 1995 and official population statistics are in line with the results from case studies and other, broader, analyses like McKinsey Global Institute’s (1994), though the statistical coverage of the industry might differ slightly from one source to the other (e.g. Portugal sometimes being included, sometimes not). Specific factors such as crossborder trade and mail orders might explain outliers.

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In addition to COM (1995) see also Oliver (1966), Senn (1985), Kozul (1993), Eskelinen and Kautonen (1997), Isaksen and Spilling (1996), Scott (1996), Maskell (forthcoming), Merlo and Fodde (1996). Generally, production of machinery for the furniture industry is mainly located in Germany and Italy. Of the upstream industries, production of the most important raw material, timber, is in most cases spatially separated from the furniture production itself. This holds even though a certain amount of customisation will always take place when installing larger or more complex machinery at a plant. Following Stigler (1951) and Langlois (1989), the long-term growth of the market for wooden furniture, and respectively, the lack of any rapid technological progress would be possible explanations. Of the other EU countries only Germany, Italy and Belgium reached productivity levels beyond US$25,000 in 1993. All figures on productivity include the manufacturing of metal furniture, which, however, is insignificant in Denmark. The survey was conducted in 1996 by Statistics Denmark (Danmarks Statistik) on behalf of the EU Commission and EUROSTAT. Of the 369 firms in the Danish wooden furniture industry in 1972, 297 also existed in 1976. Of these 297 firms 139, that is 47 per cent, were closed before 1992. The imports of softwood in 1994 were, according to Schultz et al. (1995), mainly from Sweden (1.3 million cubic metres); Finland (0.7 million cubic metres); Poland (0.1 million cubic metres); Norway (0.05 million cubic metres); Russia (0.04 million cubic metres), and other countries (0.07 million cubic metres). See also Kjær (1996) and Scott (1996) on this. In the words of Lundvall (1988:354) a ‘flow of information can only take place if there exist channels of information through which the message can pass. Further, a code of information is necessary in order to make the transmission of messages effective’. The Finnish case is discussed in more detail primarily in Eskelinen and Kautonen (1997) and Kautonen (1995, 1996). The early development history of the Finnish furniture industry was characterised by distinctive phases. The two World Wars especially led to major breakups with the past in terms of location and market orientation (SarantolaWeiss 1995). The work of the architect and designer Alvar Aalto and his followers was known but its commercial utilisation remained a minor activity. Lammi (1996) and Kärkkäinen (1996) discuss the historical development and current status of the Finnish forest cluster and the main operators, while Hernesniemi, Lammi and Ylä-Anttila (1995) give a detailed overall account of industrial clusters in Finland. See the case of Icelandic fish exports discussed in Chapter 7. Medium-sized firms have been almost non-existent. The dichotomy in the Finnish industry between the many small and the few very large firms was further aggravated in the early 1990s when some important medium-sized companies ceased to exist. In 1993 the share of the three largest firms was about 40 per cent of the total output (Talouselämä 1993). There are about 160,000 inhabitants in the Lahti region (labour market district). It has been a home market oriented industrial centre, where mechanical woodprocessing, clothing and engineering have been important industries. The

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Suupohja region in western Finland consists of five rural municipalities with some 50,000 inhabitants altogether. Compare the discussion on fishing in northern Norway in Chapter 7.

7 NATURAL RESOURCES AND THE INSTITUTIONAL ENDOWMENT: THE FISHING INDUSTRY 1 The UN system tries to reach an agreement, but conflicts of interest between coastal states and inland states, as well as between economically more and less developed countries, have until now blocked a consensus. 2 If, for instance, the capital or knowledge needed in fishing had led to the emergence of a global monopoly, this entity would have a self-interest in preserving the fish stocks. But a combination of virtually free entry globally, and absence of any functional system of property rights, results in a multitude of individually operating and economically independent actors who will harvest from the same stock. And when one stock of fish is over-exploited the most efficient and mobile production units of the fishing fleet can simply move on to other parts of the world’s oceans where other stocks are still left to be exploited. The mere existence of unregulated fishing waters constitutes a strong incentive to increase the size and technology content of the vessel in order to be able to move to such waters if and when the stocks caught so far become depleted. There is, furthermore, a cumulative causation in this upscaling as the larger, more capital-intensive and technologically advanced vessels have to be operated year round to obtain a reasonable pay-back time on the capital invested. And though this might be a superior strategy for the individual actor, it also accelerates the depletion of stocks because the wastage of the stock (through the catches and subsequent discharge of under-sized and protected species) is often larger than with the equipment used on smaller vessels. 3 Then again, perhaps he actually was thinking in this general direction as the continuation of his famous quote reads: ‘Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again’ (Keynes (1923) 1971:65). 4 Some nations like Morocco, Namibia, Mauritania and Greenland do not have the means to utilise the full fishing potential within their zone. Instead they sell licences to the highest international bidder, thereby substantially increasing their national income. In the recent history of humanity it has not often happened that a country can become richer without any national investment or innovation whatsoever, but purely by reaping the windfall gain from changes in international law. 5 On land all resources are usually seen as public property if they are not protected by explicit (private) property rights. At sea this is not an obvious solution. Depending on location (inside or outside national jurisdiction) and the legal system of different nations, resources in the ground like minerals, oil or gas or resources in the oceans such as seaweed or minerals on the bottom of the sea all belong to either the first to claim them or to the nation state, both of which can trade the rights at will as if they were a commodity. Not so with marine resources, where the norm is that the nation state is still the sole legal owner within its economic zone. As the owner of an economic resource, economists would advise the state to charge a rent for the use of the stock, as a landlord would to people who wished to farm his or her land or live in his or her house (Hannesson 1993). This kind of Ricardian rent (fish rent) would

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6

7 8 9

10

11 12

13

be identical to the owner’s profit if the owner exploited the resource himself. If the owner (the state) on the other hand licenses the right to exploit the stock to others, the maximum rent he could hope to earn under fixed market prices would be the profit earned by those given a licence, as nobody would pay more than what they expect to keep when all the costs including return on capital have been paid. The national policy in this case would be to maximise the total fish rent, under the restrictions of sustainable fishing. The rent should be used to cover the cost of managing and monitoring the stocks, policing the seas and maintaining the regulation policy. The rest of the fish rent should be used for the good of all citizens, being collective owners of the resource. Under these circumstances it would be in the public interest to develop an efficient fishing industry, using as few resources as possible to harvest the bioeconomically optimal catch. Assuming that the market price is not influenced by these actions, the profits would be maximised and society would earn the maximal rent. If, on the other hand, the fishing industry is inefficiently organised and operated or if market prices are very low, the country as an owner would be left with nothing for letting others exploit the resource. The location and magnitude of this production will again influence the patterns of migration and growth of the fish stock. The plunder of the stock by predators of other species also has an influence on its size. Plankton is eaten by capelin, capelin by cod and cod by whale. A more complex set of variables will therefore influence the size and the productivity of a particular stock. The total investment in the fishing fleet is estimated at US$320 billion in 1989 (FAO 1992). The term ‘billion’ is used here to denote a thousand million (109). Many countries have improved their fisheries management in recent years and efficiency is increasing, but much still remains to be done. A few countries account for the greatest quantity of catch and associated cost, while a few species make up for the largest amount of value. Some countries contribute greatly to the cost but catch small quantities and mainly low-value species like herring and capelin. Other countries harvest basically high-value species like cod or haddock with an efficient and low-cost fishing fleet. Almost the whole Norwegian production of farmed salmon is sold fresh to markets such as France or Germany and an increasing share of the export of cod, mackerel and herring is exported as fresh fillets. Due to technological changes an Icelandic firm may buy fish from a Russian trawler and have it processed in France for the Brazilian market. A Norwegian fish farmer could slaughter salmon on Monday and a customer in Tokyo will eat sushi from fresh salmon on Thursday. This high-profit market is, however, still in the making, and the world consumption of fresh fish is still concentrated in the coastal countries in which the fish was initially landed. The figures in brackets indicate the percentage of world total in live weight in 1993 (FAO 1996). Freezing technology was developed in the inter-war period both in Germany and the UK. The technology was introduced in the Nordic context during the Second World War by the Germans in Norway and by the Americans in Iceland. The most important products are whole-frozen fish, block-frozen fillets and individually frozen fillets. Frozen fish fingers and ready meals also exist. A block of frozen fillets is an intermediary product supplying the food industry in many countries with raw material. A whole-frozen fish can be stored for later consumption or processing.

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15

16

17

18

19

20

The use of these technologies demands heavy investment of capital and requires continuous use of the facilities. A steady flow of fresh fish is thus economically desirable but difficult to achieve, partly because of natural variations (bad weather, few catches) and partly because of the time used to fill the fishing vessel and bring the fish ashore. Only by moving the processing activity to the fishing grounds can the inherent ‘lumpiness’ in supply be evened out. Accordingly, the profitability of the processing of frozen fillets at sea in large trawlers is usually much higher than if frozen fillets were produced onshore. Even though the developing countries’ own consumption of protein and fat from fish has been steadily increasing in volume, their share of the global catch for domestic consumption has not increased proportionally, especially not of the valuable species. A considerable protein export thus continues from the developing to the developed countries, mainly from the Far East, where Thailand (US$3,404 million), China (US$1,542 million) and Indonesia (US$1,419 million) are the major exporters. Of the total US catch of 5,939,000 metric tons in 1993, roughly half was caught in the Atlantic. Even acknowledging differences in value between the average fish caught in the Pacific, the Mexican Gulf and the Atlantic it might be expected that around half the exports of US$3,179 million in 1993 consisted of fish caught in the north Atlantic. On a world scale Norway was number eleven, Denmark number thirteen and Iceland number fifteen in metric tons of fish caught in 1994. In global exports Norway was the third largest, Denmark the fourth largest and Iceland the eleventh largest exporting country by value in the same year. In the coming years until 2025, the world’s population is expected to increase by 50 per cent while the supply of food needs to increase by 100 per cent, in order to provide adequate nourishment for everyone (Verbanic 1995). Though the developed countries’ share of the global imports of fish products is expected to decrease, these countries still consume more than 80 per cent of the internationally traded fish when measured in value. Furthermore, the fishing industry will probably never be able to reach the same levels of productivity as other parts of the food industry, even if it tried hard. Its relatively low productivity is not only a reflection of bad managerial practices, bad configuration of the value chain or lacking investments or innovations. It is also the outcome of inherent and inescapable characteristics of the industry. Fishing inherently has to adjust to natural cycles and harsh weather conditions which create much more turbulent supplies of raw material than in most other industries. Fishing, therefore, needs a more flexible production system than is generally necessary in the food industry. Flexibility in a system is never free, but shows on the balance sheet as extra costs and under-utilised production capacity during longer or shorter parts of the year. In line with this logic everybody belonging to a coastal community had the individual privilege to use this resource without any charge. Fishing is a way of life and an important part of the economy and settlement structure in many regions in the country. Not only has the population of coastal areas until recently been strongly dependent on marine resources for food, trade and petty cash in a subsistence economy, but fishing has constituted the base for a cultural tradition deeply embedded in social life and the social stratification of many communities. Just by the number of voters, the traditional coastal fishing had strong political support. Fishing policy, therefore, also became

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23

24

25 26 27

synonymous with regional policy, and even with national economic policy under certain conditions. By law all decked boats have to be licensed. Individual quotas are only transferable in the ocean fishing sector according to strict rules, though a possibility to combine quotas exists. Utilising this possibility could lead to the scrapping of old boats and the construction of modern vessels without expanding catching capacity. The trade barriers are increasing with processing, running from 2 per cent of the commodity value up to 20 per cent. The existence of such barriers not only explains Denmark’s huge import of raw fish and huge subsequent export of fish products, it also contributes to explaining why the processing industry is so relatively weak in Norway. This success of Norwegian technology comes back as a boomerang as the highly efficient factory fleets of the US, Iceland and Russia can accept lower prices for the standard fillet in the world market. This is good for the consumer, bad for onshore producers particularly in high-cost countries and maybe also harmful for fish stocks in unregulated waters. Iceland joins New Zealand in this approach. We would like to thank Dr Geir Gunnlaugsson, managing director of Marel Ltd, for receiving the group and providing information for our work. The University of Tromsø and related research institutes are the dominant agents in developing technological and commercial capabilities in the north. Here many innovations have been developed, but the private sector of the north is mostly non-active in R&D.

8 FOOTLOOSE COMMUNICATIONS: THE MOBILE PHONE INDUSTRY 1

2

3

The electronics division comprised only 4 per cent of Nokia’s net sales in 1967, growing to 14 per cent in 1980, 61 per cent in 1989 and finally reaching 100 per cent in 1997. In the same period the cable works division reduced its contribution to net sales from almost half (49 per cent) in 1967, to zero twenty years later (with 35 per cent in 1980 and 19 per cent in 1989). The paper products division and the rubber works division suffered a similar fate, going from 20 and 27 per cent, respectively, of net sales in 1967, to 32 and 19 per cent in 1980, ending at 14 and 5 per cent in 1989 (Lovio 1996). Attempts to analyse processes of change in any part of the telecommunications sector from an economic or business strategy perspective run into two types of problem. First, it is difficult to avoid getting stuck in ‘technicalities’ when trying to describe and analyse the industrial dynamics of this sector. These are related to the increasingly sophisticated and integrated technologies involved, but also to the complex regulatory systems that surround the sector. The second problem is that it is impossible to understand the dynamics of one particular part of the sector—in our case mobile telephony—without including the main elements of the sector as a whole. The technological spill-overs are numerous and cross-utilisation of skills is important. In the brief account to follow, we try as far as possible to avoid technicalities, and we give initially a schematic overview of the telecommunications system as a whole—globally and in the Nordic countries—before going into the actual mobile phone case. The shares of Telia are owned by the government but it is generally believed that they will be sold off in a few years’ time.

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4 The operators are controlled by the Ministry of Transport and Communications, whose objective—manifest in its regulatory decisions and procurement policy—is to secure long-term competitiveness in telecommunications services. 5 As in the other Nordic former public telecommunication monopolies the Norwegian state continues to hold all shares in Telenor AS. 6 For a more detailed account see Gerdes (1991), Lindmark (1995) or Mölleryd (1996). 7 Joint Nordic institutions like this have been very common, especially since the Second World War, either outside or inside the legal framework of the Nordic Council: a co-operative body set up in 1952 between the parliaments of the five Nordic countries. Many Nordic institutions are still very active, though increasingly the emphasis is laid on participation in various bodies and committees within the European Union. 8 The front runner was the AXE switch, developed by Ellemtel, a joint venture between Ericsson and the Swedish PTT. 9 The US analogue Advanced Mobile Phone System (AMPS) is an exception, but the digital version (D-AMPS) was not put to general use outside the US. 10 GSM operates on the frequencies between 890 MHz and 915 MHz for handset to base and between 935 MHz and 960 MHz for traffic from base to the mobile phone = 2 * 25 MHz bandwidth (Walker and Gardner 1990). A new standard, called DCS 1800, was specified for the new frequencies. DCS 1800 uses virtually all the GSM specifications—which means that GSM network components can be used in DCS 1800 networks. Only the radio base transceiver stations, and the mobile phones themselves, need a different specification. DCS 1800 allows scope for still more capacity—and more competition—in mobile telephony services. Particularly the targeting of DCS 1800 services directly towards private consumers rather than business users has turned out to be successful. 11 The development history of Nokia’s DX200 switch is essentially similar. 12 It is more likely that the divided managerial efforts of two such incompatible fields of competence within a single organisation, as well as the difference in appropriate business culture and fitting business partners, would jointly result in suboptimal behaviour in such a hypothetical hybrid. 13 In Sweden, the telecommunications systems were developed early, jointly between Ericsson and the Swedish PTT. An agreement was made which meant that public switching equipment and telephones for the Swedish market were to be manufactured by Teli, owned by the PTT, while Ericsson should manufacture for foreign markets. Thus, until the 1980s, telephones were manufactured by Teli for a monopolised home market. After deregulation, Teli tried to build up international positions, but this failed and in 1988 production of telephones was closed in Sweden. Ericsson had closed its production of ordinary telephones several years earlier (Sölvell, Zander and Porter 1991). 14 In 1996 the international consortium ‘Global One’ (including France Telecom, Deutche Telekom and Sprint Corporation of the US) won most of the government Virtual Private Network (VPN) order. ‘Global One’ will co-operate with one of the three Swedish GSM operators to meet the needs for future mobile solutions. It is believed that the order will have a major impact on the Swedish telecom market over the years to come, not only due to its size but also because StatTel traditionally puts very high technical demands on the suppliers. 15 This is a situation very similar to the one described by David (1985).

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9 TOWARDS A LEARNING-BASED INDUSTRIAL AND REGIONAL POLICY 1

2

3

4

Carlsson and Stankiewicz (1995) would call this the economic competence of the firm, thereby including its ability to develop and take advantage of a new business opportunity; its R&D activities; its production, marketing, management, finance or after-service; knowledge about market segments, products; its skills to see new opportunities; learning from its own or others’ failure; calculating risks; seeing the limits of its own competence while knowing what valuable knowledge other actors can provide. The intention here is not to argue that space in itself has an independent and direct influence on human behaviour. Knowledge about the spatial location of an object alone does not make it fruitful to deduce anything about that object. On the other hand economies can be studied as spatial phenomena constituted under specific material and social conditions (Werlen 1993). But the outcome of human action is dependent on the way social life is linked to the material world of natural resources, built environment and the human body, and thereby to spatial location or territorial context. In other words, it is social action and social structures created by earlier actions which constitute social life in space-specific social systems, not the place understood as a spatial object. An important task in economic geography is therefore to relate economic activities to a material base, to human agency, former practices and the established institutions as they appear in space-specific contexts. It is through the process of transformation or reproduction of language, of knowledge, of the unknown and specific power relations in a society, that alternative cultural and social formations can be developed or, alternatively, blocked (Pred 1990). In Pigou’s welfare theory, on the other hand, externalities are present only if there is a divergence between private and social costs caused by imperfect markets (Pigou (1920) 1928, see also Coase 1960). A third contribution to the understanding of positive external effects is Scitovsky’s concept, pecuniary external economies. It refers to a situation under imperfect competition where economic actors are mutually interdependent through market transactions: Investment in an industry leads to an expansion of its capacity and may thus lower the prices of the factors used by it. The lowering of product prices benefits the users of these products; the rising of the factor prices benefits the suppliers of the factors. When these benefits accrue to firms, in the form of profits, they are pecuniary external economies. (Scitovsky 1954:147)

5

The French economist Perroux developed arguments on agglomeration and economic clustering based on Schumpeter’s analysis of innovations and economic growth combined with Scitovsky’s analysis of externalities (Perroux 1950). In his analysis, focus was directed toward dynamic growth processes and the importance of innovations, entrepreneurship and diffusion of technology. In an evolutionary perspective, disequilibrium is the only realistic approach to the analysis of growth and economic change (Nelson and Winter 1982). As Scitovsky showed, the profit of a firm is therefore a function of its own transactions plus the transactions of other firms.

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6 There is a particular problem related to the confusion of economic and territorial space. Even if economic development is clustered functionally to particular sectors of the economy, there is not a clear correlation that spatial agglomeration will follow. 7 A particular geographical problem consists of identifying the territorial boundaries of these processes and in what sense geography matters in the diffusion of specific types of spill-over. 8 We have in previous chapters of the book argued for the existence of a strong tendency towards path-dependent development and clustered growth processes. Specifically this seems to be true in economic space, but also in many instances in geographical space, where many processes, still only incompletely understood, can take part in shaping the spatial mobility/ immobility of human communication and economic transactions. Depending on these processes some inter-human or inter-organisational arrangements will demand geographical proximity, while others only necessitate social proximity, and a third set of arrangements could be standardised and formalised in such a way that neither social nor geographical proximity is needed to activate a transaction. The more complex and non-routinised the interaction between parties, the more there will be a need for social proximity. Spatial proximity will also promote social interaction and this is one important reason why specific economic functions and processes cluster in geographical space. 9 Economic policy, according to this view, should restrict itself to fiscal policy, concentrate on developing a well functioning infrastructure of public goods and police the market in such a way that market failures disappear, for example through labour policy (‘crush the unions’) and competition policy (‘break up monopolistic behaviour’).

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245

AUTHOR INDEX

Abbott, T.A. 80 Abernathy, W.J. 34 Abramovitz, M. 24 Adler, N.J. 95 Agüero, M. 123 Alchian, A.A. 63 Allen, R.C. 40, 48 Alvesson, M. 31 Amin, A. 76 Amstrup, N. 77 Andersen, J.R. 30 Antonelli, 35, 36 Appold, S.J. 59 Archibugi, D. 27, 76 Arnason, R. 141 Arrow, K. 30, 42, 45, 92 Arthur, W.B. 1, 10, 27, 32, 33, 59, 66, 82 Asheim, B. 59 Atkinson, A.B. 62 Axelrod, R. 95 Axelsson, B. 48 Aydalot, P. 94 Bailly, A. 10 Balassa, B. 76 Bamford, J. 62 Barney, J. 4, 6, 64 Barro, R.J. 24 Basevi, G. 76 Baumard, P. 31, 96 Baumol, W.J. 7, 24, 39 Bayoumi, T. 88 Becattini, G. 62 Ben-David, D. 76, 87 Ben-Porath, Y. 46 Berg, G.C. 7

Best, M.H. 102, 103, 105 Bianchi, P. 55 Bianchi, R. 65 Bober, M.M. 76 Boisot, M. 33, 35, 40 Boldrin, M. 30 Borner, S. 76 Borrus, M. 82, 88 Brander, J.A. 76, 86 Braudel, F. 53 Braun, E. 82, 90 Breschi, S. 26 Brox, O. 135, 149 Brusco, S. 62, 182 Burgan, J.U. 82 Burgelman, R.A. 34 Callon, S. 88 Carter, A.P. 24, 42, 45, 85, 95–6 Casella, A. 76 Casson, M. 85, 97 Chandler, A.D. 24, 27, 37 Chapman, G.P. 62 Charles, D. 156, 169 Cheng, B. 62 Cheung, S. 123 Clark, G.L. 62 Clark, K.B. 34 Coe, D.T. 88, 90 Coffey, W.S. 10 Cohen, W.M. 31 Coleman, J.S. 95 Collins, H.M. 39, 40 Collis, D.J. 5, 51 Conner, K.R. 4 Cooke, P. 55, 67

246

AUTHOR INDEX

Cool, K. 4, 5, 64, 69, 110 Corden, W.M. 28 Coriat, B. 65 Cowan, R. 34, 46 Cremer, J. 43 Crouch, C. 80 Dahmén, E. 8 Dalum, B. 26, 105, 159 David, P. 33, 37, 39, 56, 66, 67 DeBresson, C. 85, 92–3 DeFillippi, R.J. 31, 51 Dei Offati, G. 95 Demsetz, H. 33, 45, 63 Dicken, P. 10, 19, 157 Dierickx, I. 4, 5, 64, 69, 110 Dore, R. 25 Dosi, G. 26, 27, 31, 32, 35, 51, 52 Douglas, M. 93 Dowrick, S. 25 Dreyfus, H. 35, 39 Dreyfus, S. 35, 39 Dunning, J.H. 20 Easterly, W. 2 Easton, G. 48 Eccles, R. 46, 63 Edquist, C. 83, 87 Edwards, C.V. 103, 113 Elbaum, B. 33 Eliasson, G. 33, 35, 95, 112 Ellison, G. 59, 60–1, 62 Elster, J. 27 Engberg-Pederson, P. 77 Enright, M.J. 1, 10, 57, 59 Eriksen, B. 6 Fagerberg, J. 88, 92 Farrell, J. 162 Fischer, S. 2 Flaherty, M.T. 34 Foray, D. 34, 35, 39, 46 Ford, D. 46, 95 Foss, N.J. 4, 6, 8 Fox, A.B. 77 Freeman, C. 77 Fridlund, M. 171 Friedrich, C.J. 21 Friedrichs, J. 66 Fuellhart, K. 194 Fukuyama, F. 46, 48 Furubotn, E.G. 123

Gelsing, L. 90 Germidis, D. 20 Gerschenkron, A. 57, 67 Gertler, M.S. 24, 39 Ghemawat, P. 33 Giordani, M.G. 55 Glaeser, E.L. 59, 60–1, 62 Glasmeier, A. 80, 194 Gonzales, E. 123 Goodman, E. 62 Granovetter, M. 47, 93, 181 Grant, R. 5, 6 Griliches, Z. 30 Grindley, P. 173 Grossman, G.M. 39, 75 Grupp, H. 80, 86, 88 Guerrieri, P. 26, 83, 86 Haberler, G. 86 Hägerstrand, T. 59 Håkansson, H. 3, 8, 46, 95 Hall, G. 25 Hall, P. 80 Hallin, G. 52 Ham, R.M. 89 Hamel, G. 4, 30, 33, 34 Hampton, J. 123 Hannesson, R. 123 Hansen, M.B. 111 Hardin, G. 120 Harrison, B. 9, 20, 59, 68 Haskell, T.L.H. 54 Hatchuel, A. 35 Hatzichronoglou, T. 13, 80 Hayek, F.A. 32, 43, 47 Hayward, C.C. 98 Head, K. 27 Hecker, D.E. 82 Hedberg, B. 33 Heim, C.E. 67 Heiner, R.A. 32 Helpman, E. 28, 39, 75, 86, 88, 90 Henderson, D. 82 Henderson, R. 87 Henriksen, L.B. 112 Hernesniemi, H. 166, 168 Herrigel, G. 59 Hirschman, A.O. 25 Hirst, P. 11 Hobson, A. 62 Hodgson, G.M. 32, 54, 181

247

AUTHOR INDEX

Hodne, F. 77 Holmström, B.R. 4 Holsti, O.R. 194 Hoover, E.M. 10 Hudson, R. 52 Hughes, K.S. 90 Hulst, N.van 82 Hume, D. 98 Imai, K.I. 33 Imrie, R.F. 20 Ioannidis, E. 90 Isaksen, A. 62 Jaffe, A.B. 87 Jelinek, M. 95 Jenkins, J.G. 30 Johanson, J. 46, 95 Johnson, B. 47 Johnson, R. 25 Kant, I. 30 Kantrow, A.M. 34 Karnøe, P. 65 Katzenstein, P.J. 77, 80 Kautonen, M. 117 Kay, J. 179 Kelley, M. 20 Kennedy, P. 76 Keynes, J.M. 122 Kinch, N. 102–3 Kindleberger, C. 76, 163 Kirzner, I.M. 30, 34 Kline, S.J. 20, 36, 38 Kogut, B. 37, 44, 88 Korkman, S. 76 Krebs, D.L. 93 Kreps, D.M. 43 Krugman, P.R. 1, 10, 12, 27, 28, 56, 59, 75, 76, 80, 88, 183 Kuisma, M. 172 Kuznets, S. 77 Laaksonen, M. 116, 117 Lammi, M. 166, 168 Lampel, J. 85 Langlois, R.N. 20, 47 Laulajainen, R. 102 Lave, J. 35 Lazonick, W. 33 Legler, H. 80 Leonard-Barton, D. 4

Levinthal, D.A. 31 Linder, S.B. 88 Lindmark, S. 171 Lippman, S.A. 4, 68 Lloyd, P.E. 10 Lloyd, P.J. 77 Loasby, B.J. 5, 31, 41 Locke, J. 30, 34 Loewy, M. 76, 87 Lorenz, E.H. 62 Lorenzen, M. 95 Lotz, P. 65 Lovio, R. 167 Lucas, R.E. 30, 92 Lundvall, B- Å. 3, 8, 30, 35, 42, 47, 48, 54, 65, 77, 83, 88, 109 Macaulay, S. 94 McCann, P. 62, 76, 77 MacDowell, L. 181 Machlup, F. 30 Madsen, P.A. T. 62 Mahoney, J.T. 4 Maillat, D. 10 Malecki, E.J. 82 Malmberg, A. 8, 52, 59, 64, 93 Mansfield, E. 36, 43 March, J.G. 38, 50 Marengo, L. 27 Markusen, A. 80 Markussen, I. 53 Marshall, A. 9, 40–1, 63, 65–6, 182–3 Marx, K. 40 Maskell, P. 7, 8, 64, 77, 106, 108, 111 Maurice, M. 54 Menger, C. 20 Menzel, U. 80 Michie, J. 76 Milana, C. 83, 86 Milgrom, P. 43 Mintzberg, H. 1 Mjøset, L. 24 Mölleryd, B.G. 154 Montgomery, C.A. 4 Moore, B. 76 Morgan, K. 151, 156 Mothe, J. de la 75 Mowery, D.C. 89 Müller, J. 76 Nelson, R.R. 3, 5, 8, 24, 25, 32, 39, 41, 58, 92, 181

248

AUTHOR INDEX

Nguyen, D. -T. 25 Nilsson, J.E. 157 Nonaka, I. 33 Nyíri, J.C. 96 Ohmae, K. 11 Olds, B. 82 Olsson, J. 102 OíRourke, K.E. 53, 76, 80 Orsengio, L. 31 Owen, N. 76 Oxelheim, L. 67 Pandian, J.R. 4 Panzar, J.C. 7 Papaconstantinou, G. 90 Pasquet, G. 75 Patchell, J. 24 Pavitt, K. 26, 36, 39, 43, 52, 92 Peck.J. 157 Pejovich, S. 123 Penrose, E.T. 4, 13 Peteraf, M.A. 5 Pianta, M. 27 Pisano, G. 69 Polanyi, M. 34, 39 Polt, W. 82, 90 Porter, M.E. 1, 8, 12, 13, 24, 36, 52, 63– 4, 80, 113, 172 Postrel, S. 69 Powell, W.W. 8 Prahalad, C.K. 4, 30, 33, 34 Pred, A. 59 Pulkkinen, M. 162, 168 Putnam, R.D. 55, 69 Putus, A. 160, 168 Rajala, A. 116, 117 Ranis, T. 111 Räsänen, K. 8 Reed, R. 31, 51 Rehn, O. 76, 86, 169, 170–1, 179 Reich, R. 12 Reinert, E.S. 12, 13 Ricardo, D. 19, 23–4, 108 Richardson, G.B. 5, 8, 20, 110, 171 Riche, R.W. 82 Ries, J. 27 Roberts, J. 43 Roberts, K.H. 96 Robinson, E.A. G. 75 Robinson, E. van D. 53

Robinson, J. 183 Rock, R.T. 30 Romer, P.M. 56, 183 Rosenberg, N. 39 Rowen, D. 173 Rumelt, R.P. 68, 69 Sabel, C. 46 Sakurai, N. 90 Sala-i-Martin, X. 24 Salais, R. 32 Saloner, G. 162 Salzer, M. 102 Sandberg, L.G. 53 Sandelands, L.E. 96 Sarantola-Weiss, M. 115 Saxenian, A. 8, 93, 181, 182 Sayer, A. 151, 156 Scheinkman, J.A. 30 Schendel, D. 69 Schultz, N. 109 Schumpeter, J.A. 32, 38 Schwartz, M. 36, 43 Scott, A.J. 7, 8, 62, 86–7, 93, 105, 180 Scribner, S. 30, 96 Sellier, F. 54 Senghaas, D. 80 Shaun, A. 69 Silvestre, J. -J. 54 Simon, H.A. 32, 38 Slade, M.E. 56 Smith, Adam 20, 23 Smith, B. 96 Soete, L. 26, 52 Solow, R.M. 25 Sölvell, O. 93, 172 Spencer, B.J. 76, 86 Spender, J.C. 23, 31 Stablein, R.E. 96 Stigler, G.J. 20 Storper, M. 3, 7, 8, 9, 27, 32, 46, 93 180, 181, 182 Strange, S. 86 Swain, A. 50 Swedberg, R. 181 Swenson, D. 27 Sykes, A.O. 20 Takeuchi, H. 33 Teece, D.J. 27, 69, 95 Teichgraber, R.F. 54 Teubal, M. 87

249

AUTHOR INDEX

Theil, H. 62 Thomas, D. 76 Thompson, G. 11 Thorndike, E.L. 30 Thrift, N.J. 182 Tikkanen, H. 114 Tirole, J. 4 Toledano, J. 8 Törnqvist, G. 59 Trajtenberg, M. 87 Trivers, R.L. 93 Tulder, R. van 151, 157 Tyson, L. D’ A. 28 Utterback, J. 59 Veblen, T. 67 Vedin, B. -A. 171 Venables, A.J. 75 Villumsen, G. 26 von Hippel, E. 38, 47, 48, 92 Vygotsky, L.S. 35 Wagner, S. 36, 43 Walsh, V. 77 Waltz, K.N. 76, 93

Weber, A. 21 Weber, M. 53 Weick, K.E. 96 Weil, B. 35 Wenger, E. 35 Wernerfelt, B. 4 White, H.C. 36 Whitley, R. 8, 55, 114 Williamson, J.G. 53, 76, 80 Williamson, O.E. 46 Willig, R.D. 7 Wilson, D.T. 45 Wilson, R. 43 Winter, S.G. 5, 31, 32, 41, 58, 95 181 Wipp, R. 8 Wolff, E.N. 24, 39 Wright, G. 25, 56, 92 Ylä-Anttila, P. 166, 168 Young, A. 28, 31 Zander, I. 39, 93, 172 Zander, U. 37, 44, 88 Zysman, J. 28

250

SUBJECT INDEX

ABB 171 agglomeration 9–10, 57; learning and 58–64; spatial 182–3 AKER-RGI 137 American Monarch 146 American Seafood Company 137 ARP Network 160, 168 ASEA 171–72 asset mass efficiency 32, 58 assets: erosion (territorial life-cycles) 64–6; ubiquitification 19–24, 28–9, 40–2 asymmetric information 13, 42–4, 68, 185, 189 ‘automatic knowledge’ 31 AXE switches 161, 170–71 barriers to knowledge codification 39– 40, 47 Boston Consulting Group 30 built structures 52, 53, 56, 57, 65, 67, 70 business systems 8 buyer power 7 canning process (fishing industry) 127 capabilities 5–6; see also localised capabilities capital: competent 185, 189; labour ratio 23; marginal productivity of 183 cellular phones 151–75 civic traditions/regions 55 codification, ubiquitification linkage 29, 40–2, 48

codified knowledge 29, 34–40, 45–6, 48, 62, 93 communications see telecommunications comparative advantage 28 competencies 4–6, 192 competent capital 185, 189 competitive advantage 1, 2, 6–7, 20, 62, 63; furniture industry (Denmark) 105–12; low-tech small countries 80, 83, 88–9, 97 competitiveness 180; firm 29–49; fishing industry (Iceland) 140–5; low-tech (in high-cost countries) 89–92; prosperity and 12–13; proximity and 2, 59, 62–4, 118–19; of regions and countries 50–71 Comviq 166 convergence, specialisation and 24–8 corporatism 76 cost minimisation (agglomeration) 62 costs: high-tech industries 86; of policy 186–7; sunk 13, 27, 46–7, 96, 152; transaction 46, 47, 183; transport 21– 2, 67, 182 countries 10–11; localised capabilities and competitiveness 50–71 credence goods 43 culture/cultural context 180–2, 184 cumulative causation 58 deglomeration 61

251

SUBJECT INDEX

demand: domestic 88, 152; fishing industry 130–4; furniture industry 99–100; for localised capabilities 64 Denmark: fishing industry 130; furniture industry 105–12, 118; telecommunications industry 158–9 deregulation (telecommunications) 156– 8, 170–1 development blocks 8 development pairs 169–70, 171 disequilibrium quasi-rents 13 dissemination process 40 division of labour 8, 9, 10, 21, 183; functional 187; international 75; territorial 19–20, 179, 182, 188 domestic demand: for mobile phones 152; new trade theory 88 dyadic relationships (knowledge exchange) 45–7 economic clustering (learning-based policy) 182–3 economic development: learning-based policy 180–2; territory and (interaction) 50–3 economic prosperity 12–13, 75–97 economies of scale 7, 9, 37, 56, 58, 76, 82, 182–3, 188; external 185 fishing industry 128, 134, 140, 141, 145; furniture industry 106, 114; localised capabilities and 10, 19–20, 28, 56, 58 economies of scope 9–10, 19–20, 37, 183; fishing industry 128, 141, 145 endogenous growth theories 56, 82, 83, 87–8, 182, 183 entrepreneurs/entrepreneurship 34, 52, 58, 183–6, 189, 191–2 Ericsson 152–3, 159, 161–2, 166, 168–72 European Conference of Posts and Telecommunications (CEPT) 163 European Economic Area (EEA) 77, 142 European Monetary Union 190 European Union 77, 87, 98, 99–100, 149, 190 evolutionary economics 182 exchange of knowledge 41–4, 63, 118, 182; Gaster 145; shared trust 92–7, 153, 189; stages 45–7, 93 experience, learning from 30–1 experience goods 43

exports: fishing industry 126, 127, 130, 131–2, 133, 139, 140, 142–3; furniture 99–101, 105–6, 108, 112, 114; international comparison 78–80, 82– 4 external economies of scale 58 externalities (positive external effects) 182–3, 188 factory trawlers 135, 136–8, 147–8 FAO 120, 124, 130–2 feedback loops 13, 57, 58, 64, 70 feedback mechanism 66, 122 filières 8 Finland: furniture industry 112–18; mobile phones 152–3, 157–60, 166–72, 174–5 Finnet 158, 167, 170 firm competitiveness 4–6, 29–49 first-mover advantages 56–7, 105, 170 fish farming sector 139–40 fish stocks and fishing communities (Norway) 134–40 fishing fleet 121, 124–5, 135–6, 139, 141, 143, 147–9 fishing industry 120; geography of supply/demand 130–4; Iceland (case study) 140–5; learning and innovation 146–50; Norway (case study) 134–40; property rights 121–4; value chain 124–30 food processing industry 129 Ford Motor Company 37 forest industries (Finland) 113 France Telecom 157, 173 freezing process 126, 127–9 furniture industry 98; Denmark (case study) 105–12; Finland (case study) 112–18; proximity and competitiveness 118–19; structure and change 99–105 GATT 20, 103, 190 GDP per capita (international comparison) 89–90 generic knowledge 189, 190–1 Gini index 60, 61–2 global framework (telecommunications) 154–7 globalisation 11 globalised economy 19–28 government: intervention 190–3;

252

SUBJECT INDEX

procurement policies 86–7, 172–3 Groupe Spéciale Mobile systems 157, 158, 160–8, 171, 173, 175 Growth theories, endogenous 56, 82, 83, 87–8, 182, 183 GSM 157, 158, 160–8, 170, 173, 175 Herring Sales Association 140 heterogeneous resources/competencies 5 high-cost environment 41–2, 89–92 high-tech: economies 78–84; in fishing industry 143–5; knowledge 191 horizontal integration 141 horizontal relations 8, 9 human action 180–2 human agency 180–2, 184 hysteresis 27, 52 Iceland (fishing industry) 122, 124, 130, 136, 139, 140–5, 147–8, 149–50 IKEA 100, 102–3, 108, 113 imitation 36, 44, 51, 110–11; replication 67–9 industrial networks 8 industrial policy, learning-based 179–94 industrial structure 26, 88 industrial systems 6–9; localised 48–9 industry agglomeration (Nordic countries) 59–62 industry clusters 8 infant industry protection 86 information asymmetry 13, 42–4, 68, 185, 189 infrastructure investment 56, 184, 190 innovation 2, 10, 22, 25, 56, 184, 194; knowledge creation and 29–49, 181, 183, 185–6; learning and (fishing industry) 121, 143–50; national systems of 8, 54; in small low-tech economies 75–97; in telecommunications 151–75 input-output systems 8 institutional endowment 53–5, 56, 57, 65, 66, 70 intentional knowledge creation 31–2 inter-organisational competencies 46 inter-organisational relations 192 interactive learning 62–3, 75; in localised industrial systems 48–9 international division of labour 75 internationalisation process 2, 19–24, 41

investment 2, 44, 82, 83–4, 85, 121; in infrastructure 56, 184, 190 ISIC classification 60–61, 158 Kinnevik Group 157, 166 knowledge: asymmetric information 13, 42–4, 68, 185, 189; -based economy 3, 19–24, 44, 51, 62, 188, 190; codified 29, 34–42, 45–6, 48, 62, 93; diffusion policy 185, 191; dissemination 40; enhanced use of 44–7; exchange see exchange of knowledge; generic 189, 190–1; learning see learning; protection of 42–4; skills and (localised capabilities) 53–4, 57, 70; spillovers 9, 59, 175, 183, 185, 194; tacit 34–40; unused 33–4 knowledge creation 2–3, 6, 13, 23–4, 28, 80, 92–3, 193; firm competitiveness and 29–49; fishing industry 129–30, 133; innovation and 29–49, 181, 183, 185–6; localised capabilities and 65, 69–71, 121 Kullback entropy index 62 labour costs 23 labour market size 87 Lahti region (Finland) 115–17 large economies (openness) 75–80 lead time 68–9, 88 learning: agglomeration and 58–64; based industrial and regional policy 179–94; continuous 118; from experience 30–1; innovation and 121, 143–50; interactive 48–9, 62–3, 75; localised 1–15, 97 life-cycles, territorial 64–9 local milieus 10, 11, 65 localised capabilities 10, 25, 111–12, 170, 189–90, 193; competitiveness of regions/countries 2, 50–71; creation of 56–8; fishing industry 120–1; knowledge creation and 65, 69–71, 121; main elements 53–6; ubiquitification 19–24, 28, 40–2 localised industrial systems, interactive learning in 48–9 localised learning: regional specialisation and 1–15; shared trust (competitive advantage) 97 location factors 21–3, 24, 41

253

SUBJECT INDEX

location pattern 105 lock-in (in territorial life-cycle) 66–7 low-cost environments, ubiquitification process in 41–2 low-tech: high-cost countries 89–92; industries 180, 191; small economies (sustaining prosperity) 75–97 manufacturing industries 59–62 Marel Ltd (case study) 144–5 market: failure 43, 44, 185, 189; interactions 63; mechanism 8, 42–3; power 13, 26, 129; structures (Nordic telecommunications) 157–9 medium-sized economies 77–80 medium-tech industries 191 Mitsubishi 161 mobile phones 151–75 monopoly/monopoly-rent 7 nation state 11, 19, 182 national competitiveness 12 national specialisation 23, 58–9; convergence and 24–8 national systems of innovation 8, 54 natural resources 52–4, 56, 65, 67, 70, 180; institutional endowment and (fishing industry) 120–50 networks 8, 47, 49, 70, 107, 192 new firms (formation) 58, 185 new trade theory 88 NMT system see Nordic Mobile Telephone system Nokia 152–3, 159, 167–8, 169, 170, 172, 174–5 Nordic countries: industry agglomeration 59–62; mobile phones in 151–75 Nordic Mobile Telephone system (NMT) 152, 158, 159–63, 166–8, 170, 173–4 Norway: fishing industry 124, 130, 134– 40, 146–7, 148–50; telecommunications industry 158 OECD 2, 3, 14, 19, 24, 25–6, 71, 76–9, 80–5, 89–90, 98, 100–1, 105–6, 108, 112, 143, 152–3 open economies 57; small (sustaining prosperity) 75–97 opportunistic behaviour 46, 47, 93–5

paper and pulp industries (Finland) 113–14 patents 43 path-dependence 27, 32, 34, 58, 66, 70, 118, 154, 185 pattern-recognition 38 Philips 162 positive external effects (learning-based policy) 182–3, 188 positive feedback 56, 57, 58, 82 private-public interface 185–90 privatisation (telecommunications) 156, 170–1 product differentiation 76, 104–5 production complexes 8 productivity 12–13, 24, 180 profit maximisation 7 property rights 50, 183, 185; fishing industry 120, 121–4, 136, 138 prosperity: competitiveness and 12–13; sustaining (low-tech economies) 75– 97 protectionism 76, 86, 162, 163 proximity 92, 93, 182, 192; competitiveness and 2, 59, 62–4, 118–19 PTTs 152, 156–60, 162–3, 166, 172–3, 175 public good 185 public policy, learning perspective and 185–90 public regulation see regulation quasi-rents 6, 13, 23, 44 quota system (fishing industry) 121–3, 124, 135–6, 141, 145–8 regional policy, learning-based 179–94 regional specialisation 4, 23, 57, 59, 67, 70; convergence and 24–8; localised learning and 1–15 regions 10–11; localised capabilities and competitiveness of 50–71 regulation 193; telecommunications 155–9, 171–3 related and supporting industries 8; in fishing industry 129 relocation 58 rents 5, 7, 49, 95; quasi-rents 6, 13, 23, 44; seeking behaviour 36–7, 38, 50, 55, 183 replication (in territorial life-cycle) 67–9

254

SUBJECT INDEX

research and development 3, 13, 25, 29, 32; mobile phones 162, 169, 174–5; in small low-tech economies 78–82, 86, 89–98 resource-based view of the firm 4–6 Resource Group International (RGI) 136–8, 146 retro-action phenomena 52 risk 85 routines 66; inter-organisational 47; procedures and 31–2, 181

sustaining prosperity (in open low-tech economics) 75–97 Sweden (mobile phone industry) 152–3, 157, 159–62, 166–73 system integration 182 systems structure (telecommunications) 155

science-based input (high-tech industries) 88–9 seafood value chain 124–30 search costs 47 search goods 43 search and selection process 32–3 shared trust 71, 110–11; knowledge exchange 92–7, 153, 189; localised learning and (competitive advantage) 97 Siemens 162 small nations (sustaining prosperity) 75–97 social context/systems 181–2, 183 social institutions 184 spatial agglomeration 9–10; learning and 58–64, 182–3 spatial context (learning-based policy) 180–2 specialisation 65–6; sustainable patterns 4, 19–28, 193; territorial 23–8, 52, 57– 8; ubiquitification and 28; see also national specialisation specialised inputs/services 9 specialised skills 9 strategic management 182 strategies, firm-specific 51 subcontracting 105, 107, 117, 175 substitution: in fishing industry 132–3; in territorial life-cycles 64 sunk costs 13, 27, 46–7, 96, 152 supply: base (local) 58; in fishing industry (geography of) 130–4; of localised input 64 sustainable capacity (fishing industry) 121 sustainable patterns of specialisation 4, 19–28, 193 sustained competitive advantage 62

tacit knowledge 29, 34–40, 44–6, 48–9, 62–3, 68, 71, 93, 110, 153, 185, 189 technical culture 10 technical standards 20, 53 technological progress/development 20 technological spill-overs 87–8, 175, 185 technology 52, 56; competitiveness and 29–49; in fishing industry 143–5; mobile phones (Nordic countries) 151–75 Telecom Finland 158, 167, 170 telecommunications (Nordic mobile phones): actors and institutions 154; development 159–68; global framework 154–7; high-tech potential (in small countries) 174–5; regulations and market structures 157–9; restructuring of 151–4; success (preconditions) 168–74 telephones, mobile (in Nordic countries) 151–75 Televa 168 Televerket 157, 158, 159, 160 Telia 157, 158 territorial division of labour 19–20, 179, 182, 188 territorial life-cycles 64–9 territorial specialisation 23–8, 52, 57–8 territorially specific institutions 50–1 territory, economic development and (interaction) 50–3 time compression diseconomies 69, 110 ‘tragedy of the commons’ 120–3 transaction costs 46, 47, 183 transmission mechanism (new firms) 58, 64–5 transport: activity (fishing industry) 129; costs 21–2, 67, 182; systems 21–2 Treaty of Rome 87 trust 70, 184, 192; shared see shared trust; trustful relations 44–7, 48

255

SUBJECT INDEX

ubiquitification 19–24, 92; codification process 29, 40–2, 48; specialisation and 28; in territorial life-cycle 67 ubiquitous materials 21 uncertainty 39, 185; routines and 31–2 unlearning process 66, 70 unused knowledge 33–4 value chain 7, 8, 20, 21; in fishing industry 124–30, 142; in furniture industry 104, 109

venture capital 85 vertical integration 20, 21, 63, 106, 114, 115, 129, 140, 141 vertical relations 8, 9 volatile organic compounds (VOCs) 109 welfare policy 192 wood processing machinery 109 wooden furniture industry see furniture industry WTO 20, 190

256