Diversity, efficiency and Economic Development

1. Diversity, efficiency and Economic Development Pier Paolo Saviotti, UMR GAEL, Grenoble, and CNRS GREDEG I2C, Sophia Antipolis, France.

2. Acknowledgments • Andreas Pyka • Koen Frenken • Jackie Krafft

3. Econ Dev, Stylised facts • STF1) Economic development is characterised by qualitative change. • STF2) The efficiency of existing processes increases in the course of economic development. • STF3) The diversity/variety of the economic system rises during the process of economic development.

4. Efficiency vs diversity • Efficiency grows when the same type of output is produced with (a) decreasing quantities of all inputs or (b) decreasing costs of all inputs • What happens if the nature of the output changes? Is a pair of shoes costing 100 € produced five times less efficiently than a pair of shoes costing 20 €?

5. Efficiency vs diversity • In a strict sense comparisons of efficiency are only possible at constant output • The 100€ pair of shoes has higher quality • Efficiency at constant quality

6. Qualitative and Structural Change • Qualitative change: emergence of new entities, qualitatively different (distinguishable) from the pre-existing ones. • Structural change: change in the structure of the economic system (components + linkages/interactions). Defined at the level of aggregation of industrial sectors. But: • Structural change can occur at lower levels of aggregation.

7. Qualitative and Structural Change (2) • Structural change can occur for activities and actors as well as for outputs. • Thus also for knowledge, and institutions. • Qualitative change broader than structural change.

8. Importance of qualitative/structural change. • They affect the composition of the economic system. They are determinantsof system performance. • Economic development is a process of transformation, involving both quantitative/efficiency change at constant composition and qualitative change.

9. Variety • Definition: number of actors, activities and objects required to describe the economic system at a given time • Variable to represent analytically changes in composition.

10. Diversity Stirling • Diversity overarching phenomenon with three components: • Variety: number of distinguishable entities in a system • Balance: distribution of distinguishable entities in a system • Disparity: extent of difference between any two distinguishable entities

11. Diversity • All else being equal, the greater the variety the greater the diversity • All else being equal, the more even is the balance the greater the diversity • All else being equal, the more disparate are the represented elements the greater the diversity

12. Modern phenomena • Most people could only purchase the bare essentials to survive until the end of the XIXth century, and many people still do today • Diversity existed only for the rich • But in the XXth century change

13. Efficiency and Diversity • Two complementary forces/trajectories : • growing efficiency • growing diversity • Hypothesis 1: The growth in diversity is a necessary requirement for long-term economic development. • Hypothesis 2: Diversity growth, leading to new sectors, and productivity growth in pre-existing sectors, are complementary and not independent aspects of economic development.

14. Compensation • At constant output  growing efficiency + saturating demand  possibility to produce all demanded output with declining fraction of resources (labour force)  Marxian trap • Emergence of new sectors compensates for the falling capacity of existing sectors to create employment • Growing diversity avoids Marxian trap.

15. Economic development by the creation of new sectors • A model in which the number of new sectors varies endogenously during economic development • Sector created by an important innovation establishing an adjustment gap (size of the potential market)

16. Model • First entrepreneur enters the market (expectation of a temporary monopoly) imitators enter  rising intensity of competition  inducement for further entry falls until exit starts dominating entry. Innovation has become part of the ‘circular flow’ (Schumpeter, 1912-1934) • Sector  oligopoly or monopoly • Adjustment gap gradually closed (saturated market) • Industry life cycle • Decline of mature sectors induces entrepreneurs to look for new opportunities of temporary monopoly, to be found by exploiting new important innovations leading to new niches and sectors.

17. Competition • Both intra- and inter-sector: • Intra- sector:  density of product/output population. • Inter- sector: different sectors can provide comparable services. • Entrepreneur induced by expectation of temporary monopoly to enter. If innovation successful  imitation  increasing intensity of competition  decreasing inducement to enter  exit

18. Model equation

19. Search activities

20. Mergers and acquisitions

21. Demand function

22. Demand (2)

23. Number of firms (2) • Life cycle: in each sector Ni first increases rapidly, reaches a maximum, and then falls (oligopoly, monopoly) • But, life cycle driven purely by dynamics of competition and demand (See ILC models). • Shape of life cycle affected by several variables (AGi, Di etc).

24. Adjustment gap

25. Intensity of competition

26. Employment • li = ki/Qia = ki/Qi/Ni = (ki*Ni)/Qi • li = Li/Qi

27. Aggregate employment

28. Aggregate employment

29. Employment trend vs rate of growth of services

30. Demand experiments (2) • Increasing the rate of growth of Yi (level of services supplied) • Speeds up development • raises demand, • increases AGi, • Changes the shape of the ILC • and leads to a more positive employment growth path.

31. Compensation • The emergence of new sectors (growing variety) can compensate for the falling ability of mature sectors to create employment (Hypothesis 1) • Economic development can be sustainable in the long run. • The internal dynamics of each sector counts as well

32. Creative destruction • Process of industrial mutation that-if I may use that biological term- incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one …. • ….essential fact about capitalism….(p.83) • ….perennial gale of creative destruction…(p. 84) (Capitalism, Socialism and Democracy)

33. Interpretations • Possible interpretations of creative destruction • For every new innovation created a previous one disappears (Aghion and Howitt), considered by AH the true Schumpeterian character of their model. • This implies: (i) Complete substitution of old by new, (ii) constant output diversity

34. Diversity and creative destruction • They are not incompatible, but, if variety grows there must be more creation than destruction. • However, even old sectors which survive are not unaffected by the creation of the new. Old sectors/activities are transformed by new ones.

35. Influence of competition on system performance • Two (ideal) (opposite) types of competition (extremes of a range): • Schumpeterian: do what no one else can do (radical innovation)  temporary monopoly • Classical: do the same thing as other competitors but better (i), (ii) • (i) more efficient  cheaper output • (ii) better quality

36. Intensity of competition

37. Overall IC vs IC + Inter-intra balance

38. Rate of employment growth vs balance inter-intra-sector competition (Rii) for  values of kIC.

39. Trade-offs • Inter-intra: predominance of intra-sector competition  higher probability of temporary monopoly in niches elsewhere than in established sectors. • If only Schumpeterian competition once sector created no imitation • Classical competition  production of the new good/service + efficient (cheaper)  increased economic weight

40. Industry life cycle • In our model natural consequence of the dynamics of competition and of demandbut not exclusive of other cyclical influences • Different from other ILC models (Process R&D, Dominant designs, Refinement innovation)

41. Demand - Search activities

42. Demand - Search activities (2)

43. Industry life cycle

44. Industry Life Cycle • The shape, duration and existence of the industry life cycle is greatly affected by parameters affecting demand and search activities • In some cases the shake out virtually disappears (existence)

45. Micro-Macro dynamics

46. Micro-Macro dynamics (2) • The shape and duration of the ILC affects the macro-economic performance of the economic system • Model parameters affecting demand and search activities can affect • (i) the rate of creation of new sectors • (ii) the number of firms in each sector • (iii) the rate of growth of industrial concentration

47. Micro-Macro dynamics (3) • As consequence the effects of parameters affecting demand and search activities are often non-linear • Ex: trade-off between faster rate of creation of new sectors and smaller number of firms in each sector.

48. Efficiency vs diversity • All these (and many other) phenomena are made possible by the complementary combination of efficiency and diversity • More creation than destruction vs growing diversity • Trade-off Schumpeterian (Diversity) classical (efficiency) competition • Influence of ILC (shape etc) on macro dynamics  rate sectors + sector size