The Foundations of the Knowledge Economy:

Global Evidence

Carl DahlmanGeorgetown University

Ukraine Knowledge Economy Training Initiative

January 22, 2008

Structure of Presentation

1. What is the Knowledge Economy and Why is it Relevant

2. Foundations of the Knowledge Economy3. Benchmarking Countries in the Knowledge

Economy4. Recent Transformation of Key Developed and

Developing Countries5. What is at Stake?6. Key Strategic Areas for Ukraine7. What is to be Done?

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1. What is the Knowledge Economy? It is an economy that increasingly

bases its economic activity on value enhancing knowledge rather than limited natural resources

Knowledge has always been important

It is becoming more important now because there has been an acceleration in the creation and dissemination of knowledge

Why is it Relevant?

There are many possibilities to leverage growth by making effective use of knowledge that already exists as well as by generating new knowledge

Most new knowledge creation is being led by developed countries

There is risk that developing countries will be falling behind

But to make effective use of knowledge as well as to create relevant knowledge it is necessary to develop appropriate policies, institutions, and capabilities

2. Foundations of the Knowledge Economy

Technological Trends Increasing Importance of Knowledge Growing Technology Intensity of Trade Increasing Globalization and Competition Changing Education Paradigm Major Global Restructuring Changing Nature of Competitiveness

Technological Trends There has been speed up in the generation and

dissemination of knowledge The ICT revolution is becoming an increasingly

important element of the current techno economic structure

It is spawning changes in management and organization of production and distribution

Production and Trade are becoming more knowledge intensive

Innovation and high level human capital are becoming critical elements of competitiveness

The knowledge and innovation markets are global and have big implications for successful participation in the global economy

Investments in Knowledge* now as high % of GDP as Investments in Machinery

and Equipment in Advanced Countries (2002)

012345678

Investmentsin

Knowledge

Investmentsin

Machinery&

Equipment

USSwedenFinlandOECD

*Investments in Knowledge = R&D, Software, and Higher Education; Source OECD 2005

©Knowledge for Development, WBI

Knowledge Intensive Services* Greater % of Gross GDP than Technology Intensive Manufactures in Advanced

Countries (2002)

0

5

10

15

20

25

High andMedium

TechnologyManufactures

KnowledgeIntensiveServices

USEUJapan

*Knowledge Intensive Market Services exclude government and include following services: posts and telecommunications, finance & insurance, business services: Source OECD 2005

©Knowledge for Development, WBI

Changing Structure of World Merchandise Export 1985 vs. 2004: Primary vs. Manuf.

by Tech. Intensity

Products 1985 2004 AnnualGrowth

Rate

1985 %

2004 %

All Products 1,689 7,350 7.6 100.0 100.0

Primary products 391 1,018 4.9 23.2 14.7

Manufactured products

1,244 6,063 8.2 76.8 85.3

Resource based 327 1,148 6.5 19.4 15.6

Low technology 239 1,962 7.9 14.2 15.0

Medium technology 480 2,169 7.8 28.5 29.5

High technology 196 1,643 11.2 11.6 22.4

An Increasingly Globalized and Competitive World Economy

Increasing Globalization Rapid reduction of transportation and communications

costs. Increasing global information (political, cultural, socio

economic) Strong trends towards regional integration (NAFTA, EU,

ASEAN+3) Increasing Competition

Significant trade liberalization is creating larger global market and increased competition

Share of exports and imports to GDP has increased from 40% in 1990 to 58% in 2005

MNCs are becoming the most important agent in global economic activity

MNCs account for more than 50% of global R&D They are responsible for about 2/3 of trade, and organize

and control global supply and distribution systems Value added directly controlled by MNCs is 27% of

global GDP in 2002, and that is an underestimate ©cjd

Changing Education & Training Paradigm

Traditional ModelInformation basedRote learningTeacher directedJust in case Formal education onlyDirective based Learn at a given ageTerminal education

Knowledge Economy ModelKnowledge creation/applicationAnalysis and synthesisCollaborative learningJust in timeVariety of learning modes Initiative basedIncentives, motivation to learnLifelong learning

©Knowledge for Development, WBI

Changes in Job Task-Skill Demands

USA: 1960–98

-10

-8

-6

-4

-2

0

2

4

6

8

10

12

14

16

1969 1974 1979 1984 1989 1994 1998Perc

entil

e C

hang

e

Expert Thinking

ComplexCommunication

Routine Manual

Routine Cognitive

Non-Routine Manual

Source: Autor, Levy, and Murnane (2003) “The Skill Content of Recent Technological Change: An Empirical Exploration,” Quarterly Journal of Economics. © K4D program

Major Global Restructuring Three major components

Unbundling of production of goods to emerging countries facilitated by reduction of transportation costs

Unbundling of tasks to emerging countries facilitated by ICT revolution

Roughly doubling of global labor force participating in export markets with entry of China, India, and former Soviet republics

Implications Returns to labor in developed countries are decreasing

because of doubling of global labor force with entrance of newly emerging countries

Returns to capital are increasing because of expansion of labor force and ability to operate globally

Job security is decreasing Increasing tension between objectives of MNCs and

national interests

Changing Nature of Competitiveness

Competitiveness traditionally based on Capital and labor costs Costs of inputs and infrastructure services General business environment and ease of doing

business (including macro stability, taxes, x rate, etc) Superiority in technology or management

But it is increasingly being based on Ability to redeploy resources to take advantage of those

changing opportunities Quality, skills and flexibility of labor force (and

management) Ability to constantly keep up with rapidly changing

technological and organizational advances Ability to make effective use of information technologies

to reduce transactions costs and improve capacity to respond quickly to changing opportunities and threats

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Changing Nature of Competitiveness (cont)

Greater value added now comes from knowledge and information

As a result there is increased attention across countries on Improving their overall business environment

and the flexibility and speed of their economies to respond to rapidly changing circumstances

Improving education and skills systems Improving their innovation systems Improving their information infrastructure

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3. The Four Pillars of the Knowledge Economy

Education

InnovationInformation

Infrastructure

Interconnected

Interdependent

Economic and Institutional

Regime

EIR provides incentives for the efficient creation, dissemination, and use of existing knowledge

An educated and skilled

population that can use

knowledge effectively

Innovationconsisting of

organizationsthat can tap

into the stockof global

knowledge,assimilate

and adapt it andcreate local knowledge

To facilitate the effective communication, dissemination, and processing of information. ©cjd

Benchmarking Countries in the Knowledge Economy: The Knowledge Assessment Methodology

KAM: 83 structural/qualitative variables to benchmark performance on 4 pillars

Variables normalized from 0 (worst) to 10 (best) for 140 countries and 9 regions

www.worldbank.org/kam Basic scorecard for 14 variables for two points in time,

1995 and most recent Knowledge economy index (KEI) which includes 3

variables for each of the four pillars: Economic and institutional regime: tariff and non-tariff barriers,

rule of law, regulatory quality Education: literacy, secondary and tertiary enrollment rates Innovation: researchers in R&D, scientific and technical scientific

publications, and patents in the US ICTs: fixed and mobile phone lines per 1000 people, computer per

1000, internet users per 10,000 ©cjd

Basic Scorecard

Knowledge Economy Index

Economic and Institutional Regime Sub-Index

Education Sub-Index

Information & Communication Technologies Sub-Index

Innovation Sub-Index (Unweighted)

Innovation in Context of Developing Countries Innovation should not be considered

narrowly just as R&D to move the global frontier

It should be understood as new to the country, new to the sector, even new to the firm

Developing countries, like Ukraine, will get a much higher return from effectively tapping into global knowledge through trade, foreign direct investment, technology licensing, foreign education, etc than just from own R&D

Broad Innovation Scorecard

4. Recent Transformation of Key Developed and Developing Economies

Developed Triad: US, Europe, Japan Exemplary European Examples:

Finland and Ireland The Four East Asian Newly

Industrialized economies Developing Country Giants: China

and India

United States: technological leader building on large market, flexible institutions, and entrepreneurship

The US is the dominant Knowledge Economy in the World Is the largest single country market Spends the most on education (especially higher education and

continuous training) Spends the most on research and development Largest home to multinationals Reaps tremendous gains from scale economies and first mover

advantage The US show tremendous ability to restructure

Thanks to great flexibility of capital and labor markets Tremendous ability for technical, institutional and organizational

innovation Strong entrepreneurial and risk taking culture

But other countries/regions are catching up EU is now larger economic market Other countries are catching up in tertiary education and R&D Even US multinationals are now becoming more global than American

companies Is beginning to suffer from over reach in Iraq fiasco and lose hearts

and minds of many parts of world

European Community: building large internal market to compete with US

Part of the rational for creation of EU was to create large market to get economies of scale to compete with US

First was progressive trade integration Then common currency area now covering most EU countries Now working on integration in services and in regulatory

mechanisms, but has proved more difficult-note failure of EU constitution in 2006

Also expanded from EU 15 to EU 25 countries in 2004 EU launched ambitious Lisbon Plan in 2001 to make EU the

“most knowledge intensive” region in the world by 2010 Included creation of European Research Area and many framework

programs to promote joint R&D across countries and increase innovation efforts

Also included European Education Area with many programs to integrate education and training programs across countries

In spite of many advances plan is falling short of goals Productivity increases and use of information technology in Europe

have not kept up with advances in US Few countries that were not already meeting R&D goals are

significantly expanding spending to plan levels

Japan: producer oriented economy leveraging re-engineering and manufacturing capability

Japan was leading world in competitiveness in 1970s and 1980s

Initially absorbed foreign knowledge Then developed superior production system with just in time, multi-skilling,

multi-tasking and flexible specialization, and life-long employment This was an autonomously led development, with little foreign direct investment. Rapidly expanded share in global economy, with rapid advances in auto and

electronics industry Japan had major financial crisis in 1991 and unlike Finland

(financial crisis in 1991) and Korea (financial 1997) still has not fully recovered growth momentum

Failed to tackle necessary structural reforms in finance , education, and distribution systems

Failure from excessive focus on growth of market share w/o sufficient emphasis on profitability and sustainability

Was not sufficiently innovative in basic science Nevertheless Japan still very technologically strong country

Second largest R&D spender Strong technological innovator-growing leadership in autos, capital goods,

energy efficiency Home to many successful multinationals

Exemplary European Examples

Finland (from natural resource to knowledge based country)

Major financial and exchange crisis in 1990/91 with collapse of Soviet Union

Crisis lead to creation of national vision based on investment in telecommunication technologies

Government lead increase in R&D investment & ICT engineers

Private sector followed and deepened ICT and forestry clusters

Became one of most globally competitive economies Ireland (from poorest of Europe to one of richest

based on FDI, software and ICT Was poor agricultural economy until 1970s Developed national vision with respect to entry into EC Invested heavily in higher education and attracted

European oriented FDI Also developed knowledge based service sector as well as

tourism

East Asian NIES: Different entry points and leveraging strategies

Korea and Taiwan (more technologically autonomous a la Japan)

Korea: resource poor economy becomes global competitor by investing in education and skills and technologically strong domestic conglomerates

Taiwan: plugs into global production networks and moves up global value chains, with help of Chinese Diaspora

Hong Kong and Singapore (FDI dependent) Hong Kong: leverages its human resources as free

trade entrepot service economy for trade with China and node of global production system in East Asia

Singapore: leverages its human resources by strategically attracting FDI with value increasing activities by investing in human resources and trade infrastructure

China: Becoming the World’s Manufacturing Hub Speed, scale and scope of China’s entry into global system

unprecedented in history Second largest economy in ppp terms since 1994 when passed Japan Third largest merchandise exporter since 2005 when passed Japan Will pass US in merchandise exports by end 2007

Initially based high investment rate and tapping into global knowledge through

Trade FDI Technology licensing Early start in basic and secondary education

But moving rapidly up technology ladder through massive investments

Tertiary education (now largest # of tertiary students in world) R&D (now second largest in PPP terms-surpassed Japan end 2006) Physical infrastructure

Strong global competitor advantage not just low cost labor but also

Skills, knowledge, logistics Being plugged into global production system through FDI and Diaspora

India: Becoming the World’s Off shoring Service Center

India increased rate of growth From 2-3% Hindu rate of growth of 1950-1980s To 6% in 1990s To 8% last three years

Post 2000 increase due to Great success in post Y2K ICT service exports Having made early investments in elite English speaking

engineering schools Growth of business and financial services

India is becoming a knowledge intensive service economy with services, pharmaceuticals, and auto parts as main drivers

Has offset constraints of poor infrastructure and bureaucratic constraints on physical trade through possibilities opened up by ICT enabled services

5 .What is at Stake for Ukraine?

Given present trends, where will Ukraine be 10, 20, 30 years from now?

Will it have increased the income and welfare of its inhabitants, and its role in the world?

Will there be many world class knowledge driven companies who can open new opportunities

Or will Ukrainian companies be left behind and become marginalized?

Weakness in all the fundamental elements of growth and competitiveness

Relatively weak government and institutions Low savings and investment Weak human capital particularly new skills and life long learning Weak ICT infrastructure and use Weak innovation in terms to tapping global knowledge

6. Key Strategic Areas for Ukraine Ukraine needs to develop more explicit

strategies to improve competitiveness and to benefit more from participation in global economy

These strategies need to pay more attention to:

Economies of scale in regional markets Quality of institutions and market Education and high level skills Innovation, not just R&D, but tapping global knowledge Effective use of information and communication technologies Trade logistics

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7. What is to be done? The objective of this training seminar is to

Provide an overview of some of the key global trends of the knowledge economy

Give an initial assessment of where Ukraine stands in this new very competitive, demanding and dynamic international environment

Give some examples of strategies of different countries are using to deal with the challenges

Stimulate thinking about some of the key strategic issues Ukraine needs to focus on to improve its competitiveness in this context

Successful strategies depend on leadership and on good coordination between private sector, civil society and government

That requires developing a common vision, and strong implementation and monitoring capability

EndCarl J. Dahlman

Luce Professor of International Affairs and Information Technology

Georgetown UniversityEmail: cjd42@georgetown.edu

Telephone: 202 687 8045

©cjd

Ukraine’s Knowledge Economy Index Compared to other Regions

Ukraine: Current vs 1995

Ukraine and Russia