THE ECONOMIC COMPLEXITY OF TECHNOLOGICAL CHANGE

1. THE ECONOMIC COMPLEXITY OF TECHNOLOGICAL CHANGE THE GOVERNANCE OF TECHNOLOGICAL KNOWLEDGE FOR INNOVATION AS AN EMERGING PROPERTY OF SYSTEM DYNAMICS CRISTIANO ANTONELLI Università di Torino & Collegio Carlo Alberto DIPARTIMENTO DI ECONOMIA, UNIVERSITA’ DI TORINO & BRICK (Bureauof Research in Complexity, Knowledge, Innovation), COLLEGIO CARLO ALBERTO

2. Schumpeter, J. A. (1947b), The creative response in economic history, Journal of Economic History 7,149-159. “What has not been adequately appreciated among theorists is the distinction between different kinds of reaction to changes in ‘condition’. Whenever an economy or a sector of an economy adapts itself to a change in its data in the way that traditional theory describes, whenever, that is, an economy reacts to an increase in population by simply adding the new brains and hands to the working force in the existing employment, or an industry reacts to a protective duty by the expansion within its existing practice, we may speak of the development as an adaptive response. And whenever the economy or an industry or some firms in an industry do something else, something that is outside of the range of existing practice, we may speak of creative response. Creative response has at least three essential characteristics. First, from the standpoint of the observer who is in full possession of all relevant facts, it can always be understood ex post; but it can be practically never be understood ex ante; that is to say, it cannot be predicted by applying the ordinary rules of inference from the pre-existing facts. This is why the ‘how’ in what has been called the ‘mechanisms’ must be investigated in each case. Secondly, creative response shapes the whole course of subsequent events and their ‘long-run’ outcome. It is not true that both types of responses dominate only what the economist loves to call ‘transitions’, leaving the ultimate outcome to be determined by the initial data. Creative response changes social and economic situations for good, or, to put it differently, it creates situations from which there is no bridge to those situations that might have emerged in the absence. This is why creative response is an essential element in the historical process; no deterministic credo avails against this. Thirdly, creative response –the frequency of its occurrence in a group, its intensity and success or failure- has obviously something, be that much or little, to do (a) with quality of the personnel available in a society, (b) with relative quality of personnel, that is, with quality available to a particular field of activity relative to the quality available, at the same time, to others, and (c) with individual decisions, actions, and patterns of behavior.” (Schumpeter, 1947: 149-150).

3. A) From reactivity to creativity. Agents are reactive, i.e. agents can react to unexpected and unpredictable changes and change their production and utility functions, hence their technologies and preferences are endogenous. The characteristics of the local context into which agents are embedded play a crucial role to assess whether their reaction is adaptive or actually creative. In the former case agents will simply move on the existing maps of isoquants and indifference curves. In the latter, instead, agents can effectively change their location in the knowledge, technology and regional space, according to their own specific characteristics and the features of local endowments, including the network of transactions and interactions into which they are embedded.

7. I Out-of-equilibrium Out-of-equilibrium ∏ FIGURE 2. THE QUADRATIC RELATIONSHIP BETWEEN PROFITS AND INNOVATION Source: Antonelli and Scellato, 2009

8. B) Knowledge externalities and interactions. The amount of knowledge externalities and interactions available to each firm influences the actual possibility to make the reaction of firms adaptive as opposed to creative and able to introduce localized technological changes. Each agent has access only to local knowledge interactions and externalities, i.e. no agent knows what every other agent in the system at large knows. Location in a multidimensional space, in terms of distance among agents and their density, matters. Agents are localized within networks of transactions and interactions which are specific subsets of the broader array of interactions and transactions that take place in the system. Positive feedbacks take place when the external conditions into which each firm is localized, enable the creative reaction of each firm to engender the actual introduction of innovations and feed the introduction of further innovations by a larger number of agents so that technological change becomes a generalized and collective process.

9. C) Localized technological change. Agents are rooted in a well defined set of characteristics that stem from the quasi-irreversibility of their tangible and intangible inputs, including their location in the multidimensional space. At each point in time, however, agents can switch, i.e. change the structure of their inputs and their location, but only with the investment of dedicated resources. Specifically agents, at each point in time, can change, within a limited ray, their knowledge, their technology and the structure of their interactions. Technological change is inherently localized: each agent can innovate, but only in the surroundings of its original multidimensional location, in technical space, when positive feedbacks in regional and knowledge space are at work. Hence agents are heterogeneous. They are characterized by distinctive and specific characteristics concerning both their competence, the endowment of tangible and intangible inputs and their location in the space of interactions.

10. D) Recursive dynamics with endogenous structures. The outcome of the creative reaction of each agent and the likelihood of its innovative behavior is strictly dependent on the web of interactions that take place within the system. The introduction of localized technological changes depends upon the extent to which the creative reaction of firms caught in out-of-equilibrium conditions is implemented by the access to knowledge externalities and interactions. Hence at each point in time, the architectural topology of the system, i.e. the meso-characteristics and the structure of interactions of the agents in their relevant multidimensional spaces, plays a key role. The architecture of the system and the structure of interactions, however, is itself endogenous as it is the result of the localized action of agents. Agents can innovate as well as change their location in the multidimensional space, their communication channels, their systems of interactions and their location in the flows of transactions. The introduction of localized innovations changes the structure of the system and hence the amount of externalities. The new levels of externalities affect the new chances of introduction of localized technological changes. The recursive dynamics is set.

11. E) Persistence and path-dependence. When non-ergodicity applies, dynamic processes are characterized by persistence: a little shock at a particular point in time, affects the long-term dynamics of a system. Social and knowledge interactions among creative agents, as well as transactions in the market place, engender generative relations that enable agents to change locally their own production and utility functions. The localized action of agents both in terms of introduction of new technologies and changes in their location engenders phase transitions consisting in qualitative changes determined by small changes in the parameters of the system. As a consequence both technological knowledge and the architecture of the system are changed in a recursive and path dependent process.

12. The limits of knowledge as an economic good • Non appropriability • Non predictability (including the scope of applications) • Non rivality in use • Indivisibility: cumulability and complementarity • Non exhaustibility • Non-tradability • Under-provision and market failure (free-riding) • Tacitness

13. THE RECOMBINANT GENERATION OF TECHNOLOGICAL KNOWLEDGE • TECHNOLOGICAL KNOWLEDGE IS BOTH AN OUTPUT AND AN INPUT • THE GENERATION OF NEW TECHNOLOGICAL KNOWLEDGE CONSISTS IN THE RECOMBINATION OF EXISTING KNOWLEDGE ITEMS BOTH INTERNAL AND EXTERNAL TO EACH FIRM

14. EACH AGENT HAS BOTH A PRODUCTION FUNCTION AND A KNOWLEDGE GENERATION FUNCTION • TK = ( R&Dit,EXTERNAL KNOWLEDGE) • Y = ( K, L, TK) • CT = rK+wL+dR&D+pEK) • p = the cost of external knowledge depends on the characteristics of the system

15. Public, private and collective knowledge Appropriability High Low Accessibility/Connectivity Low High

16. The characteristics of knowledge as a collective good • Technological knowledge is characterized by the complementarity between internal resources and external knowledge • External knowledge is represented by the amount of R&D investments undertaken by the firms and yet the firms are not able to completely appropriate: quasi-appropriability and externalities • Key role of cooperation, technological communication, technology transfer and more generally network-based strategies of the firms • Limited role for IPRs: these cannot be too strong and too extensive in order to allow knowledge diffusion • Pecuniary Knowledge Externalities

17. F) In such a context innovation is an emergent property that takes place when a the complexity is organized, i.e. when a number of complementary conditions enable the creative reaction of agents and makes it possible to introduce innovations that actually increase their efficiency. The dynamics of complex systems is based upon the combination of the reactivity of agents, caught in out-of-equilibrium conditions, with the features of the system into which each agent is embedded in terms of externalities, interactions, positive feedbacks that enable the generation of localized technological change and lead to endogenous structural change. The process is characterized by path dependent non-ergodicity.

18. THE RECURSIVE AND PATH DEPENDENT PROCESS OF LOCALIZED TECHNOLOGICAL CHANGE ECONOMIC, INSTITUTIONAL, INDUSTRIAL, REGIONAL AND KNOWLEDGE STRUCTURE (t) KNOWLEDGE INTERACTIONS AND PECUNIARY KNOWLEDGE EXTERNALITIES ENABLE THE ACCESS TO EXTERNAL KNOWLEDGE AND THE RECOMBINANT GENERATION OF NEW KNOWLEDGE FIRMS STRATEGIES AND INDUSTRIAL DYNAMICS IN PRODUCT AND FACTOR MARKETS, CREATION OF NEW MARKETS, NEW LINKS LOCALIZED TECHNOLOGICAL CHANGES ECONOMIC, INSTITUTIONAL, INDUSTRIAL, REGIONAL AND KNOWLEDGE STRUCTURE (t+1) STRUCTURE AND ARCHITECTURE (t+1)

19. INNOVATION: NOVELTY AND PRODUCTIVITY DTFP INNOVATION NOVELTY PATENT R&D Innovation is a productivity enhancing novelty

22. Knowledge Externalities • In the last decade the analytical framework of new growth theory has been challenged by the ‘discovery’ of the costs required for the exploration, identification, absoprtion and exploitation of external knowledge. • Firstly, knowledge does not spill over spontaneously, but it requires dedicated resources to be exploited  imitation costs, absorbtion costs, networking costs. • Secondly, externalities are not exogeneous: they can be threatened by a number of factors. Negative effects may stem from congestion of technological activities (lock-in, inertia, redundant interactions, explosion of communication costs). • Not only too little, but also too much proximity can be detrimental to the accumulation of technological knowledge. Similalry, the variety of technological activities within the system is likely to shape the effects of knowledge externalities.

23. Pecuniary Knowledge Externalities • Such evidence suggests that firms need to put dedicated efforts and to commit of economic resources for the access to and the effective exploitation of external knowledge. • The notion of pecuniary knoweldge externalities allows for accounting for both boosting and limiting factors affecting the working knowledge externalities. • Pecuniary externalities consist of the indirect interdependences among actors that take place via the price system. • They apply when firms acquire inputs (and sell output) at costs (prices) that are lower (higher) than equilibrium levels because of specific structural factors.

24. Pecuniary Knowledge Externalities • We apply this notion, well distinct from that of technological externalities, and articulate its implications for the analysis of technological knowledge as an economic good. • We put emphasis on the costs that firms have to bear to access and exploit knowledge externalities. Therefore knowledge cannot be characterized as a public good. When knowledge is understood as a collective good, externalities cannot be but pecuniary. • Both the enhancing and the constricting factors influencing pecuniary knowledge externalities, depend upon the density of innovative agents co-localized in the same region. • The larger is the density of innovative agents and the larger is the opportunity to access their knowledge spillovers, but is also clear that the larger is the density of innovative agents and the larger are the costs of using them.

25. KNOWLEDGE EXTERNALITIES AND KNOWLEDGE INTERACTIONS • Knowledge is both an input and an output • External knowledge is a necessary input into the recombinant generation of new knowledge • Technological knowledge has a strong tacit component • Knowledge interactions are necesary to access external knowledge

26. THREE TYPES OF KNOWLEDGE EXTERNALITIES • M.A.R. KNOWLEDGE EXTERNALITIES stem from intrindustrial interactions typically within industrial dustricts • JACOBS KNOWLEDGE EXTERNALITIES stem from horizontal interindustrial interactions typically within cities • VERTICAL KNOWLEDGE EXTERNALITIES stem from user-producer transactions-cum-interactions within industrial filieres

27. A model of TFP with knowledge externalities • (1) T = ( IKa EKb) with a+b =1 • (2) C = pIK + uEK • (3) a/b IK/EK = u/p • (4) Y = A ( Ig Td ) with g+d =1 • (5) C = cI + sT • (6) g/d I/T = s/c • (7) A= Y / I* T* • (8) A = f (T’/T*) • (9) T’/T* = g (u / u*) • (10) A = h (g(u/u*)) • (11) dA/dt > 0 • if, where and when • (12) d (u*-u)/dt =0 or >0

28. KNOWLEDGE EXTERNALITIES ARE ENDOGENOUS • KNOWLEDGE EXTERNALITIES ARE EXTERNAL TO EACH FIRM BUT INTERNAL TO THE SYSTEM AND DEPEND UPON THE NETWORKS OF INTERACTIONS AND TRANSACTIONS THAT RELATE EACH AGENT TO THE OTHERS • KNOWLEDGE EXTERNALITIES ARE INTRINSICALLY PATH DEPENDENT

29. M L N X1 D E O F P A B G H C I X2 ENDOGENEOUS KNOWLEDGE EXTERNALITIES

30. PATH DEPENDENCE VERSUS PAST DEPENDENCE • BOTH PATH DEPENDENCE AND PAST DEPENDENCE ARE NON-ERGODIC • PAST DEPENDENCE APPLIES WHEN THE DYNAMICS OF THE PROCESS IS SET AT ITS BEGINNING AND NO EVENT CAN CHANGE IT (Single Markov Chains) • PATH DEPENDENCE TAKES PLACE WHEN SMALL EVENTS ALONG THE PROCESS CAN CHANGE ITS DYNAMICS (Multiple Transition Probability Matrixes)

31. Knowledge governance Knowledge governance consists in the set of rules, procedures, modes and protocols that organize the use of knowledge in an economic system. It includes a variety of institutional factors that qualify the architecture of relations, ranging from the extremes of pure transactions to pure interactions, including hierarchical coordination within firms, and, most importantly transactions-cum-interactions. The quality of knowledge governance mechanisms at work, at each point in time, within each economic system, can be seen as the spontaneous result of a systemic process of polycentric governance (Ostrom, 1990; 2005, 2010; Ostrom and Hess, 2006).

32. Knowledge governance The working of knowledge governance mechanisms, at each point in time, within each economic system, can be seen as the spontaneous result of a systemic process of polycentric governance where the interaction between a myriad of actors is able to implement the emergence of structured and viable modes of coordination that are able to complement or substitute the imperfect allocation of property rights: knowledge governance mechanisms change across time as the architecture of its elements is the object of different forces that act in diverse relations and reflect the changing weights within the system. A variety of localized paths to organizing and managing at the system level the use of the existing technological knowledge as an input into the recombinant generation of new technological knowledge and the consequent introduction of total factor productivity enhancing technological change can emerge and consolidate, according to the institutional setting of each system and its path dependent characteristics. Knowledge governance plays a key role in the organization of the system of interactions and transactions that make possible the access and use of existing knowledge within an economic system.

33. THREE TYPES OF KNOWLEDGE GOVERNANCE • KNOWLEDGE GENERATION IN UNIVERSITY, BANKS PROVIDE THE FUNDS, ENTREPRENEURS PERFORM EXPLOITATION (XIX CENTURY) • THE CORPORATION COMBINES GENERATION AND EXPLOITATION, UNIVERSITY PROVIDE TUITION AND BASIC RESEARCH (XX CENTURY) • THE GENERATION TAKES PLACE IN UNIVERSITY, FOR INCREMNTAL RESEARCH IS FUNDED BY CORPORATIONS, VENTURE CAPITAL SECURE THE EXPLOITATION OF RADICAL BREAKTHROUGH (XXI CENTURY?)

34. COMPULSORY LICENSING: A SOLUTION TO THE THE TRADE-OFF OF INTELLECTUAL PROPERTY REGIMES?? • Compulsory licensing is an important institutional innovation that improves the knowledge governance and can help fostering the pace of generation of technological knowledge and the rate of introduction of technological innovations. So far, the markets for the products that embody new knowledge have been considered the exclusive perspective to implement the analysis of the effects of compulsory licensing. Much progress can be done applying the tools of the economics of knowledge to the analysis the role of compulsory licensing directly in the generation of new knowledge. Recent advances in the economics of knowledge have confirmed the medieval wisdom according to which to make knowledge it is necessary to stand on giants’ shoulders. The generation of new technological knowledge is possible only if the stock of existing knowledge can be used as an input. All barriers and delays in the access to existing knowledge risk to reducing the capability to generate new technological knowledge. Intellectual property right regimes based upon exclusivity may increase the incentives to generate new technological knowledge but reduce the efficiency and the actual viability of the knowledge generation process. The costs of the reduction in the access to existing knowledge are larger the larger the scope of application of new technology. Compulsory licensing for technological knowledge can increase the rate of generation of new technological knowledge, only if the appropriate level of royalties is identified. The paper contributes the debate with a simple model that enables to identify the correct levels of royalties for compulsory licensing analyzing the generation of knowledge rather than the markets for the products that embody it.