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CRIC Project - Analysis of Innovation Flows Using Input-Output Tables (Project completed)

The Problems Addressed
Theoretical Approaches
Empirical Work and Data Sources
Key Results and Outcomes
Significance of Results and Outcomes
Key Publications

The Problems Addressed

In the past, business services, and indeed services in general, have been seen as a peripheral sector relative to manufacturing industry and of relatively minor importance in understanding the nature of production in capitalist societies. This is partly as a result of theories of economic development that placed services as a tertiary category after everything else had been accounted for (for example, the Fisher-Clark model). This is also one of the reasons why the service sector is such a heterogeneous category. Now that services dominate modern economies their role is seen as an increasingly important component of overall economic activity (Miles, 1993).

Of course manufacturing still matters a great deal, but the role that services play in economic development is taking on an increased importance. This is especially the case with respect to the concept of a 'knowledge economy' and hence knowledge based services in particular. Policy makers are increasingly concerned with institutions being able to adapt to the rapidly changing nature of production as well as the nature of non-material production. For instance, 'the role of technology needs to be seen in the context of an ongoing transformation of OECD economies from industrial to knowledge-based economies where the creation and distribution of knowledge underpins the process of growth' (OECD 1998: 55). KIBS in particular are now seen by some to play a pivotal role in several respects: such as contributing to innovation and knowledge in a wider economic sense; helping to transform firms into learning organisations; or facilitating flows of knowledge and information from one sector to another (including manufacturing). The interaction of KIBS with other firms is now seen as potentially profitable for all parties concerned (see, for instance, Hauknes 1998, part 1, pp.50-51). (Defining the Role of Knowledge-Intensive Business Services in the Economy)

If one views the economy from a network-oriented perspective, it becomes clear that certain services have a crucial role to play in mediating between and contributing to production in other sectors. The development and flow of knowledge and information within an economic system is to a large extent facilitated by firms with characteristics of KIBS. Enhanced communication and crossover between knowledge based and non-knowledge based entities can then become a vital adjunct to enhanced performance.

Theoretical Approaches

Several scholars emphasise the idea that learning and knowledge are essential to the efficient operation of the economy as a whole (Lundvall, 1992, 1998, Lundvall and Borrás 1998, Lundvall and Johnson 1994). A recent paper has also shown that learning at the employee level is taking place to a significantly greater extent in knowledge intensive service sectors than in other sectors of the British economy (Tomlinson 1999a). This implies that from a learning economy perspective the growth rate of human capital of service workers is outstripping that of other employees which also raises important issues for employment policy. What should be done about workers who are falling behind in this regard? There are thus positive and negative aspects of the growth of KIBS that must be addressed.

There are two major reasons why services' interactions (and KIBS' interactions in particular) are important to study. First there is the concept of 're-penetration' and second the idea of 'co-production'. The use of these concepts allows us to understand aspects of the economic models described below. By re-penetration we mean the idea that a service firm can adopt new ideas or utilise new technology and then re-penetrate older structures and transform their capabilities. For example:

"… the traditional professional services are often intensive and advanced users of new IT, and there is some cross-over from traditional professional services to KIBS, reflecting the general process of knowledge-intensification. "Spin-offs" and new firm formation occur where KIBS emerge from traditional professional services. For example, professionals with experience of new technology - in particular IT - establish vertical niche markets promoting the application of technology into their old specialisms (or sometimes to their old clients)."

(Tomlinson and Miles, 1999.)

In the 1980s many service firms were created as a result of increased outsourcing by manufacturing enterprises. This in part led to the phenomenon of re-penetration. It must also be borne in mind that this re-penetration by services is not new. It has happened at several junctures in history where economic and social change has rendered old structures redundant (see Berg 1994, Tomlinson 1999b). What is different now is the proliferation of new technologies (such as ICTs, the internet etc.) along with socio-economic changes (such as globalisation) that are enabling new forms of services to thrive even in some developing countries.

The second important phenomenon to consider is co-production. Several innovations in services and manufacturing take place as a result of the interaction of different firms. According to Miles (1996: 29) KIBS transactions involve two types of learning: the service firms themselves learn about their clients' operations and requirements, while the client learns about the service firm and the services on offer. Both sides emerge with a better understanding of their problems as a result of the knowledge generated by the interaction. In other words innovation is often a co-production resulting from the interactions between more than one enterprise - very often including a service enterprise. (See Innovation in Service Systems: Airports, Outsourcing of R&D and Analysis of Innovation Performance of Small Firms)

Empirical Work and Data Sources

How do these two phenomena manifest themselves in national accounts? One of the ways in which the analysis of knowledge, as transmitted or facilitated by KIBS, has been carried out at CRIC is through the use of input-output tables from various OECD countries. Input-output tables show the flows of goods and services from every sector to every other sector in the economy at a specific point in time. Thus flows of goods and services can be traced between sectors and their relative contributions to economic output, value-added or productivity can be estimated. So if the phenomena of re-penetration and co-production lead to any real gains in efficiency with respect to KIBS then the volume of transactions between knowledge based sectors should be correlated with higher performance (in terms of productivity, say) in the consuming sectors.

The first piece of work done by CRIC in this field (Tomlinson 1997) treated various knowledge intensive service inputs as separate factors of production along with fixed capital and labour in equations of similar form to the well known Cobb-Douglas production function. This is an attempt to show that these 'knowledge' inputs to other sectors are significantly related to production. In later work, Tomlinson (2000) hand, presents a modified version of the above approach. Rather than applying a production function in the traditional way he considers the interaction of labour with two types of intermediate goods ('material' and 'non-material'). The rationale for this being that the only way to produce output is by labour interacting with material goods (i.e. from manufacturing) and/or using knowledge and information (reflected in the purchases from KIBS). So the assumption is that labour within each sector interacts with intermediate material goods consumed in the production process as well as knowledge intensive business services.

Key Results and Outcomes

Using data from several countries it has been shown that there generally appears to be a highly significant positive relationship between gross output and productivity and the value of knowledge intensive business services purchased by each sector. Our analyses indicate that there are underlying economic gains relating to the intensity of consumption of communication and business services. However, some caution must also be exercised with respect to the growth of KIBS. The promotion of the unfettered expansion of these types of services without any consideration for the economic network of which they form a part would not necessarily be beneficial. Tomlinson (2000) compared the growth and development of services in Japan and the UK over time. Although there has been steady growth in the KIBS sector in Japan it is smaller and it has been expanding at a slower rate than in the UK. However, the analysis of input-output tables revealed that the impact that KIBS had on the Japanese economy was far more effective even as far back as 1970 than it was in the UK. In the UK case the impact of KIBS was negligible using 1979 data and only became significant using 1990 data. So the impact of KIBS is weaker in the UK even though they appear much more developed than in Japan as figure 1 shows.

Levels of the impact of KIBS derived from models of gross output and productivity in the UK and Japan

These results indicate that the impact of KIBS in Japan on output and productivity has been much more efficient and stable even though KIBS form a smaller proportion of the economy and have a relatively slow growth rate. In both 1980 and 1990 Japan had a higher coefficient on both models. The impact of KIBS in the UK appears to be approaching, but has still not reached, Japanese levels. The implications of this analysis are that the growth of KIBS in itself will not necessarily lead automatically to major improvements in economic efficiency.

Significance of Results and Outcomes

The analyses of KIBS undertaken so far imply a broadening of the study of economic performance to include the role of services as components of economic networks, learning economies and systems of innovation. Rather than maintaining artificial divisions between manufacturing and non-manufacturing sectors, certain services appear to have an essential role in improving economic efficiency. It has been demonstrated that there are underlying links between productivity, value added, and output and the input of KIBS, but there are important national differences to be considered. A narrow focus on manufacturing performance without considering producer services would be somewhat inappropriate.

Policy must address these issues as soon as possible for it is far from clear what the effects of the growth of KIBS or an increasing reliance on non-material production will be in the long term. The UK-Japanese analysis revealed that there are substantial differences between countries with respect to KIBS' contribution. This implies that the nature and embeddedness of KIBS within national or regional systems of innovation could be a key factor regarding long term national economic performance.

We know that in many European countries there is rapid change taking place and the expansion of knowledge based services is proceeding apace. In order to create efficient innovation networks it would be foolhardy to neglect the role of services in economic development. It is crucial for governments to tap into this expansion effectively by providing a useful and flexible framework within which services can operate and interact with the economy as a whole. Services as drivers of innovation are becoming essential for maintaining growth and competitiveness. In terms of regional policy, for example, the promotion of KIBS in less developed areas should be a priority. More recent CRIC work has in fact suggested that even less developed countries, such as those in Asia and Latin America, are benefiting from the service sector even though it is relatively underdeveloped (Tomlinson 1999b). One way of stimulating the economic development of backward regions might be to foster consortia of firms interacting strongly with KIBS enterprises as a central hub. New institutional arrangements and regulatory frameworks will prove increasingly necessary to support the efficiency of the linkages between KIBS and other economic and non-economic entities. The main traditional focus of economic policy on manufacturing needs to be modified. Business services clearly have a new role to play in economic growth that will now be addressed by CRIC's future programme.

Key Publications

Tomlinson M (1999a) 'The learning economy and embodied knowledge flows in Great Britain', Journal of Evolutionary Economics, Vol.9, No.4, pp.431-451.

Tomlinson M (1999b) 'Services and economic development: A network approach', paper presented at the MIT workshop on 'Innovation in Services', Massachusetts Institute of Technology, October 28-29.

Tomlinson, M., (2000), 'Information and technology flows from the service sector A UK-Japan comparison', in Miles, I. and Boden, M. (eds.) Services in the knowledge based economy, London: Pinter.

Tomlinson, M. and Miles, I. (1999), 'The career trajectories of knowledge workers', in Mobilising human resources for innovation: Proceedings from the OECD workshop on science and technology labour markets, DSTI/STP/TIP(99)2/FINAL, OECD: Paris.

Windrum, P. and Tomlinson, M. (1999), 'Knowledge-intensive services and international competitiveness: a four country comparison', Technology Analysis and Strategic Management, 11(3): 391-408.

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