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Markets and Innovation: A Theory Victor Nee, Jeong-han Kang, and Sonja Opper Presented at The Conference on Chinese Capitalism A.D. White House, Cornell University, April 20-21, 2007

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Conference on Chinese Capitalism

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Page 1: Nee  Kang  Opper

Markets and Innovation: A Theory

Victor Nee, Jeong-han Kang, and Sonja Opper

Presented at The Conference on Chinese CapitalismA.D. White House, Cornell University, April 20-21, 2007

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Economic sociology of innovation

Human inventiveness is the essence of the entrepreneurial spirit in modern capitalism.

Schumpeter’s ([1912] 1934) conceived of the entrepreneur in the image of the bold and imaginative innovator pioneering “new combinations” that undermine time-honored business models and practices.

Schumpeterian view of the independent entrepreneur as innovator focused attention on sources of entrepreneurship,

Marx emphasized the systemic dynamics of innovation in capitalist

economies, as in his stance that capitalism “cannot exist without constantly revolutionizing the instruments of production” (Marx and Engels, 1847).

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Economic sociology of innovation

More recently, innovation conceived as an outgrowth of competitive market pressures on capitalists has attracted new attention in the research on innovation (Baumol 2002).

The question is not what conditions optimize the entrepreneurial behavior of individual agents (Weber, [1904-05] 1958; Burt, 1992), but why do competitive market pressures explain innovation as a routine activity of firms?

► Our approach:

Not competition per se, but a broader concept of marketization helps to understand different levels of innovativeness across economic systems.

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Realignment of InterestsRealignment of Interests

Economic sociology of innovation

A Focus on Political and Economic Actors in Markets is key to explaining the shift to innovation as a routine activity of firms

Institutional Change from Command Economy to a Market Capitalist Economy involves realignment of the interests and power of political and economic actors

Command Economy

Market Economy

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A Theory of Innovation

The aim: • to specify a theory of innovation general in scope; • our focal interest is to explain the rise of innovations caused by the shift to

market allocation in transitional economies;• transitional economy provide a wide-range in variability of innovation

caused by persistent political control over resource allocation within the firm and by the shift to competitive markets.

Building blocks: • Three propositions specifying mechanisms explaining the propensity to

innovate (I-III), • Two propositions (IV-V) explaining the linkage between innovations and

marketization.

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A Theory of Innovation

The incentive proposition:Markets offer incentive to inno-vate insofar as rewards for performance depend on a match of quality and price.

The opportunity proosition:The market mechanism provides opportunities for entrepreneurs and firms to identify new markets and prospects for profit making.

The competition proposition:The greater the competition, the more firms are compelled to innovate or die.

QD

Quality

Price

A

B

0

C

D

U1

U2

U3

PD

Un

N

QN

PN

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A Theory of Innovation

The power proposition:Marketization diminishes the relative power of political actors and empowers economic actors – firm and entrepeneurs.

The politics proposition:When political actors remain emposered to allocate resources in firms there will be fewer innovations and more delays in bringing innovation projects to new products.

This is because:• rent-seeking in government-controlled political markets is often the more

lucrative form of innovation (Rona-Tas 1996; Walder 2003);• lack the commitment to hard budget constraints, and hence the capacity for

effective ex post screening required for divesting from innovation projects (Qian and Xu 1998).

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Derived hypotheses:

Hypothesis 1:

Investment in innovation, or innovative capacity as its consequence, increasingly determines innovation as markets mature.

Hypothesis 2:

R&D networks increasingly help innovation as market matures.

Hypothesis 3:

State-owned and collective owned firms show lower innovation levels than privatized firms or private de-novo firms.

Hypothesis 4:

With proceding marketization, political involvement (state ownership) will have an increasingly negative impact on a firm‘s innovativeness.

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Transition to dynamic capitalism in China

Emerging incentives, opportunities and competition:

Immediate incentives via dua-track reforms (growing out of the plan), Diversification of ownership forms, Lowering of regulatory market entry barriers, Growing competition led to relatively low market concentration ratios

Effect on R&D:

R&D activities at the firm level grow (60% of R&D-funds are located by firms/comparable with US; Germany, Switzerland),

Increase of R&D cooperations often embedded in regional technology and high-tech programs (e.g. The Torch program),

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Transition to dynamic capitalism in China – some macro evidence

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2 4 6 8 10Marketization Index

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Transition to dynamic capitalism in China – some macro evidence

19.49

381.00

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77.30

15.43

177.07

20.1614.26

29.09

55.78

22.2929.76

36.4230.78

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86.71

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hebei

Mean value of patent per 1 million population (1995-2003)

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Transition to dynamic capitalism in China – some macro evidence

010

000

2000

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pate

nts

.5 .6 .7 .8 .9State Owned Production / Total Gross Industrial Output

Marketization < 5

010

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2000

030

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.2 .4 .6 .8 1State Owned Production / Total Gross Industrial Output

Marketization > 5

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Microlevel Evidence

Data: World Bank Investment Climate Surveys conducted in overall 23

Chinese cities in 2002 and 2003 (N=3948); Firm-level data (state-owned, mixed and private firms), 10 industrial and service sectors, Marketization index (Fan et al); we sort three clusters of marketization

Model: Probit, robust clustered on cities.

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Microlevel evidence

Firm characteristics

Founded before reform, size, financial leverage, city

Competition

Market share >10%

Competitiors in main business, competitiors in main business sqaured, firm exports, sector

Network cooperationLocated in industrial parkMember of business associationCooperation with firm, university, research institute

Research activitiesFirm holds a patentFirm conducts R&DR&D to sales ratio

Political control:SOEState-ownership share (25%; 26-50%; 51-99%; 100%)

Strategic innovationPatent grantedProduct innovation

Passive innovationProcess innovation, Introduction of new quality control

Independent variablesDependent variables

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Results: Hypothesis 1 – on role of innovation activities

++-***--++*-***+++-R&D to sales ratio

++***+***+***+***+***+***+***+***+*++Con-ducts R&D

++++*+***+***+**++***+***+***

+***

Patents granted in pre-ceding years

cl3cl2cl1cl3cl2cl1cl3cl2cl1cl3cl2cl1

Quality control innovationProcess innovationProduct innovationPatent

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Results: Hypothesis 2 – on the role of networks

++***+**++***+***++***+***+++R&D coop with RI

+***-+***+-+++**+**+***+**-R&D coop with university

+**+*+***+**+**+***+***+***+***+-+*R&D coop. with firm

++**+***++*+***+**+***+***++*+Business asso-ciation

+**+***+*+++**+***-+***+-+***Industrial park

Cl3cl2Cl1cl3cl2cl1cl3cl2cl1cl3Cl2cl1

Quality Cotrol InnovationProcess innovationProduct innovationPatent

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Hypothesis 3+4: innovation and politics

+*-++***-**-*-**-*--*-+<99%

+--***-+---*----*<100%

+-***-+***--+--***-***+*-<50%

+--++*-+----+<25%

--**++-+-++---SOE

cl3cl2Cl1cl3cl2cl1cl3cl2cl1cl3cl2cl1

Quality control innovationProcess innovationProduct innovationpatent

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Summary results

NoNoYes (for more than 50% state share)

Yes (for 1% to 99% state share)

H4: Ownership-marketization hypothesis

NoNo Yes(for more than 25% state share)

Yes (for more than 25% state share)

H3: Ownership hypothesis

YesYesYesYesH2: Network hypothesis

YesYesYesYesH1: R&D hypothesis

Quality control innovation

Process Innovation

Product innovation

Patent

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Conclusion

In sum: strong evidence for our theory for strategic innovation in the form of

patent activities and product market innovation;• It is not simply competition, but the level of marketization as a distinct

concept that partly drives the effectiveness of R&D activities and network cooperations

• Effects of political control vary depending on the level of marketization;

In contrast, politics and power seem to have a different effect for cost-saving innovations, such as process and management innovations.