Innovation Policy Adjustment in Liberal and Social-Market Economies

Innovation process have different ways in liberal and social-market economies. In the liberal the most important are market apply and new technology based on development research. In the social-market the most important is efficiency of innovation systems (national and regional) which creates fundamental processes for knowledge and research development.

1. Introduction

Innovation and economic systems are closely interwoven. Systemic factors have a major bearing on the mechanisms of innovation and, vice versa, innovations influence economic systems. Innovation mechanisms and their significance for the economy should be viewed in the light of economic changes resulting from: liberalization of economic flows, institutional regulation, structure of an economy, innovative potential and economic policy. How each of these elements works varies depending on economic conditions.

As far as the character of innovations and their possible applications in business are concerned, two antithetical systems can be identified. Firstly, there is the system of social-market economy, in which economic decisions are frequently effected by non-market institutions (government, state institutions). Secondly, there is the liberal system, in which entities are affected primarily by the market, whereas the state is merely a partial regulator. Each system creates a specific innovation mechanism that is a reflection of its distinct economic preferences. Social-market economy is characterized by a high level of capital intensity, which is matched by a high accumulation of R&D expenditure. The liberal system, on the other hand, has a superior mechanism of assimilating and implementing new solutions. Therefore, it can be assumed that innovation mechanisms follow from the economic system, and that economic policy stimulates innovation – it does so to a greater extent in the case of the liberal system than in the case of etatism. Thus it is possible to claim that innovation mechanisms depend on the degree of alignment between an economic system and the directions of development and development objectives under the conditions of an open economy.

2. Innovation processes in open economy

Innovation processes are instrumental for economic development because of their considerable impact on efficiency. As follows from the theory of TFP [Parente, Prescott, 2000, p. 54], it is possible to take into account the type of economic policy of a given country and thus to create a model of economic system that functions on the basis of innovation.

In the context of the above proposition a modern function of production growth could be:


The technology component of TFP is common for particular countries as the stock of available knowledge does not differ from country to country11. Efficiency, meanwhile, is different and results from the characteristics of economic policies and institutional systems.

Of great significance are: the character of fiscal and monetary policy, the degree of openness of an economy, the job market, innovation policy, competitiveness and the legal system. Efficiency level below 1 shows that the analyzed economy’s production is beneath its potential, i.e. the economy is beneath the production possibilities frontier, which implies differences in the TFP level.

As follows from the Parente-Prescott model of relative efficiencies, one should assume that only such a production function is available in an economy. Therefore, analysis of technological development and a theory of development must use an aggregate production function containing modern development factors, which enables the distinction of two types of activities that define innovation: 1) how particular technological elements function, 2) how particular production units are selected. Certainly, many of these interactions share some characteristics and show similar dependencies.

The essence of technological innovation is a reduction in the number of workers or necessary equipment and thus a decrease in expenditure. This relationship implies that technological processes must be managed with the supremacy of capital over labor.

The other type of activity – selection of production units – introduces the parameter of efficiency along with the capital comprised of both material and intangible components.

Utilization of these elements is the choice of the best technology and a way to regulate the flow of production factors in a situation when productivity is on the rise. It is a kind of regulatory law used to restrict the application of particular technologies. Empirical data show that this kind of influence is more widespread than the first one.

The Parente-Prescott model can also be used to explain the process of catch-up of some economies and their dynamics within relatively short periods of time. Such countries as Botswana, China, Japan, South Korea or Taiwan, after the Second World War, were capable of doubling their standards of living within less than a decade. This concerned, however, poorly developed countries as in highly developed economies changes in the level of income happened much more slowly. The reasons behind such high dynamics of economic processes was a relative increase in efficiency, as well as transformation of those economies towards greater openness.

Taking into consideration the characteristics and dependencies of the Parente-Prescott model, it can be assumed that innovation encompasses all the technological and economic changes in the production process, in its broad sense, that lead to a drop in unit costs. Categories that reflect technical and technological change are investment in material and human capital, R&D expenditure, as well as investment in promotion of new solutions leading to increased efficiency, competitiveness and more rapid economic growth. These elements must function under the conditions of an open economy and global markets. Thus internal conditions of technological progress and its adaptive capacity (technology transfer) should be a reflection of the current economic policy (including innovation policy).

Using such factors as human capital or knowledge in models of development allows to discard the barriers present in the neoclassical Solow model, because accumulation does not depend on final production whose returns are diminishing. Technological progress can be achieved through acquisition of the human capital, allowing unlimited growth of economic values per capita.

The idea of skill-based technological progress is frequently mentioned in discussion of the relationship between international trade and technology transfer. According to Dinopoulos and Segerstrom, liberalization of trade contributes to increased differences of income and to greater specialization, which, in turn, results from endogenous innovation. This model is similar to the one created by Romer and Rivera that accounts for the diversity of endogenous skills across countries. Liberalization of trade (globalization) increases the benefits of R&D expenditure because successful innovation creates opportunities for monopolizing markets on an international scale and for obtaining extraordinary gains.

What is also important, endogenous models use the theory of international exchange, which not only boosts global activity of countries, but also impacts economic competitive-ness, market growth rate and technological level. In open economies technological development happens through technology flow, whereas internal level of accumulation and technical resources is of secondary importance.

The open model of economic growth based on the Solow model assumes the conditions of full diffusion of technological advancement and capital mobility. As a result, long-term market growth rates should be the same across economies and reaching the steady state should be automatic and instantaneous. This is not the case in reality as capital and technology flow does not happen automatically, but is affected by a number of restricting factors. Therefore, the easier the flow of capital and technology, the higher the market growth rate because the inflow of capital raises savings rates, while knowledge diffusion enhances technological progress. The influence of these two factors on growth dynamics is equal since they are substitutive and complementary with each other. In the short term, knowledge diffusion works in the same way as capital inflow, while, at the same time, technological potential determines the inflow of capital investment, which guarantees internal rate of return above the rate of return in the investing country (a reverse situation is also possible, although less likely).

Differences in technological level, therefore, have a bearing on the rate of GDP. The greater the differences in technological level, the faster the growth is. The closer the technology frontier, the more complex the technologies and the higher the cost of their transfer, which slows down diffusion. Absorption of technology depends on the absorption capabilities determined by: R&D expenditure, education, qualifications (innovation and economic policy, the quality and flexibility of the market), propensity for innovation, institutional infrastructure, as well as the degree of economic openness. Another important factor is the ability to cover the costs of absorption and to use it efficiently for economic development.

This resembles Schumpeter’s approach, where innovation is treated as all technological and organizational change aimed at achieving a new, better state of affairs. A factor that is crucial for their its success is the size of R&D expenditure, i.e. capacity for innovative solutions, while the number of implementations and the level of TFP are a reflection of their results.

At the beginning of the 21st century highly developed economies are undergoing profound socio-economic changes. The technology and information revolution has created new sectors based on biotechnology, microprocessors and telecommunication, which entails an entirely novel approach to production and enterprise. An innovation wave has caused the emergence of new kinds of supplier-customer relations, new modes of activity, quality control and team production. Business activity has shifted from the industrial sector to the services sector. Market economies are in the midst of a cycle of, as Schumpeter phrased it, ‘creative destruction’.

Technological advancement sparked off this type of transformation that accelerated along with the progressing liberalization of world economy. Lower costs of transport and communication, more liberal trade and elimination of financial constraints, result in greater flow of goods, services and capital across economies, which is best reflected in the flow of direct foreign investment. All economies have become more open than only twenty years ago. Moreover, fiercer competition has boosted innovativeness.

The contemporary wave of innovation has led to significant qualitative changes in the world economy. Consumption of material and energy in industrial production has decreased. For the last two decades global production growth rate has been higher than the rate at which resources and energy are used. This means that economic growth happens under the conditions of negative income elasticity of demand for natural re-sources and energy resources, which leads to lower demand for these goods in the world economy and thus undermines the income of countries which specialize in exporting them.

There has been a decline in the importance of cheap labor as a source of comparative ad-vantages. Differences in wages across countries have until recently been a factor that had a major influence on location of businesses. This benefited countries that specialize in traditional labor-absorbing industries. In the 1980s, highly developed countries increasingly started to use automated technologies in traditional industries (clothes and textile industry, shoe industry, iron and steel industry, electronic assembly industry and car industry). As a result, these branches are becoming technology- and capital-intensive. This helps them develop and thrive even in countries with high labor costs. Under such circumstances, advanced technologies are becoming a substitute for cheap labor offered by developing countries.

Innovation in computing technology and data transmission technology (the Internet) reduces costs and shortens communication time, as well as distances between people and societies, thus contributing to the development of the global information network. This creates new quality since information is becoming a factor of production (on an equal footing with labor, capital and material natural resources) that determines a country’s position in the global economy.

Thanks to technology diffusion, an equalization of technological capabilities is taking place in enterprises across countries and, thus, an increase in technological parity can be observed. A similar tendency, labelled as technological convergence, is visible on the national level. In the process of technology diffusion, a key role is played by transnational corporations, thanks to geographical integration of dispersed R&D functions/operations and a subordination of these functions to the global strategies of their mother companies.

It is crucial, therefore, to define the stability of regulatory systems and national institutions in the circumstances of growing competition. It also seems worthwhile to address the question of whether institutional differences between economies are great enough to prevent deregulation processes and international integration from triggering the creation of one uniform economic model.

3. Directions and range of the influence of economic policy on innovation

Diversity of economic systems (liberal and social-market ones) fundamentally alters the conventional view of globalization. The influence of market and non-market institutions leads to the creation of distinct business models. Thus one can conclude that within each economic system there exist characteristic structures and business strategies. Therefore, in liberal economies, firms respond to globalization differently than those from etatist ones. This approach implies that enterprises do not automatically move their premises to low labor cost locations, because these do not always guarantee adequate qualifications or productivity. Moreover, lower cost economies do not offer favorable institutional conditions, which, in turn, define relations among economic entities. Institutional advantages frequently prove more significant than a mere reduction of wage costs.

The last decade of research into the nature and causes of economic growth has confirmed that technological catch-up and increase in productivity are not autonomous processes, but that they depend on tangible and intangible investments in education, knowledge and R&D and related areas. This was the basis of developing countries’ success in narrowing the technology and productivity gap. This is, however not true about all developing countries. It is down to lack of automatism and stability in international techno-logy diffusion. Development-inducing material factors and knowledge have multiple constraints and vary as to the range of influence and that can diminish their effectiveness. Basic knowledge is expanded by empirical experience, trials, aware-ness of side effects and processes of ‘learning by doing’ and ‘routine learning’, which is then diffused in enterprises in the form of training courses, new kinds of activity, experimental research and tests. Differences in technology accumulation emerge in economies and lead to technology gaps and thus to disparate levels of economic development.

Uneven and multidirectional technological development is typical of developing countries. Whereas, thanks to smoother technology diffusion, the catch-up process in Western Europe and in Japan is more fluent than that in the USA. This is a result of better preparation of the national economic systems of these countries for taking advantage of technological globalization. Technology convergence is much more efficient in those economic systems whose internal structures – including money and capital market, production, employment, institutions and economic openness – are conducive to development. However, even efficient catch-up does not eliminate technology gaps. This opens up new possibilities for seeking competitive advantages and maintaining the continuity of technological progress.

Differences in the manner and rate of technology flow are also associated with the type of economic system. With regard to liberalism and etatism, it is possible to point out numerous factors which illustrate the diversity of technology diffusion. A system achieves high efficiency in the area of technology adaptation if two fundamental conditions are fulfilled: economic policy is adjusted to the current openness level and the institutional system of the economy does not hinder innovation.

The influence of economic policy on the level of innovation is manifested in changes in the ways in which technological innovation is financed. An increase in the own funds of firms, accompanied by limiting the role of the state in an economy, leads to a more efficient mechanism for implementing innovation.

Economic policy independently influences three basic elements of an economy: allocation of resources, distribution of income and economic stability. Specific fiscal and financial instruments are used to effect a higher dynamics of technological advancement and economic growth. These are: tax policy, public expenditure, interest rates and legal regulations. Their long-term impact on economic mechanisms is multifaceted and not always economic in character. The above mentioned instruments stimulate:
– know-how transfer to countries where resource efficiency is low;
– accumulation of material and human capital;
– technological progress;
– technology transfer.

Assessment of the effects of economic policy on economic growth necessarily involves the assumption of a long-term perspective. This paradigm is an alternative to the earlier neoclassical one, where long-term growth resulted exclusively from short-term, exogenous factors.

Links between economic policy and technological progress are of great variety. The most direct and clearest one is the fiscal policy. This concerns particularly the allocative significance of taxes (choice between free time and work, between consumption and savings, the possibility to compare average rates of return in various branches of industry) and the influence of the level of taxes on production factors accumulation. The theory of endogenous growth assumes the possibility of the accumulation of human and material capital. The multidirectional character of fiscal mechanisms can, on the one hand, discourage savings (a drop in material capital accumulation), but, on the other hand, it can stimulate the development of human capital.

Given a certain tax structure, an economic system will evolve towards changes in production processes in order to create an appropriate technology structure (optimal use of material and human capital). However, excessive trust in tax mechanisms can lead to a restricted capacity to create and absorb new technologies, or even to lower competitiveness due to limited participation of a country’s enterprises in international markets. Of great importance for accumulation and technological progress are tax reliefs, which promote investment in material and human capital and boost innovation.

The financing of public expenditure, both through taxes and loans, results in the fact that the public sector uses resources differently than the private sector. This activity will be efficient if the ‘social benefit’ of public expenditure outweighs private opportunity cost. Public expenditure can displace private sector output (the crowding-out effect), but it can also improve its productivity (the externality effect). Aggregate social benefit must be defined as the sum of both of these effects. The output created as a result of the crowding-out effect of public expenditure depends on the relative marginal productivities between the public and private sectors. The externality effect of public expenditure facilitates growth by boosting private sector productivity. A higher rate of technological progress can, therefore, be achieved by a higher level of public expenditure.

4. Institutional influence on the innovation systems in different types of economies

The institutional settings of an economy enable a selection of stimuli that help to choose and mould skills and knowledge for maximum benefit. Thus institutions influence the structure of production factors, knowledge and capital accumulation, technology, efficiency, technology progress and the organization of production.

Therefore, it is possible to list a number of institutions which contribute to innovation and technology progress. These are institutions that are concerned with the following areas: research and science system, education system, R&D activity support, participation of the state in financing and creating innovation. These activities must be adequately supported by means of economic policy instruments, whose efficiency is dependent on the type of the economic system. The most important instruments of this kind are: patent law and intellectual property, streamlining cooperation of science, business and the state, promotion of capital accessibility, creation of venture funds and research and development policy. To make these activities efficient, support institutions should be stable and predictable. They also should assist enterprises in assessing the risk of investments.

The role of institutional factors has changed in the last few decades due to a greater role of the market and greater competition, as well as a more limited role of the government in economic processes. In particular OECD countries this process happened with various intensity, which was reflected in the alterations in the structure of property, the role of the market in allocation decisions, as well as in the degree of entrepreneurship. These factors variously influenced entire economic systems.

Institutional settings best reflect differences between economies. As Aoki claims, the efficiency of an economic system is connected with mutual influence of the particular elements that comprise its institutional structure. Smooth functioning of each of these elements is necessary for the efficiency of the others.

Economies that follow the liberal policy pattern strive to increase the role of the market in business decision making. This is why they are more dependent on money and capital flows. The reverse is true about etatist economies, where emphasis is placed on the protection of the job market at the expense of efficiency level. All things considered, it is possible to group economies according to the presented criteria.

A characteristic feature of liberal economies is the tendency for longer working hours, lower social spending and greater diversity of income. Whereas etatist countries tend to shorten working time, increase state participation in social insurance and have less income diversity.

The liberal character of an economy creates a specific mechanism of technological progress and technology transfer. Broadly speaking, it happens through transference of scientists or engineers from one company to another (or from research institutions to the private sector). This is facilitated by the flexibility of the job market. R&D personnel brings with them their technical expertise, experience and knowledge of the given market. In liberal economies, technology transfer is based on an efficient use of innovation and on benefits from patents. Technology progress occurs in those branches which offer more opportunities of commercializing its results. This approach clearly shows the tremendous importance of venture capital, which allows to realize numerous high risk projects that, if successful, yield good rates of return. Success in one field covers the losses sustained in other investments. Research consortia and science cooperation between enterprises play a considerably smaller role than they do in etatist economies. In spite of this there exist a number of institutions whose aim is to aid the functioning of the economic system.

The institutional system of the job market that allows enterprises to cut operational costs through limiting employment complementary to the financial market, which makes it possible to use financial funds provided that profits are achieved. Comprehensive education, in turn, is complementary to a flexible job market, which enables technology transfer and high factor mobility. Such a system of dependencies guarantees high efficiency of cooperation in the fields of R&D and technology transfer.

International economic liberalization is accompanied by a greater flow of foreign investment in search of new markets and sources of raw materials. Obviously, this phenomenon more frequently concerns enterprises that operate in liberal economies, whose primary objective is lower costs than is the case in firms from etatist economies. This is so because they try to find appropriate institutional settings or adequate qualifications. The institutions of liberal economies can also be of interest for firms in implementing innovation and technology transfer because they need support in this respect. This explains the fact that large firms from highly developed countries invest in liberal economies (Nissan in the USA, Honda and Deutsche Bank in Great Britain). Meanwhile, certain types of business are moved to etatist economies as firms seek institutional protection in terms of quality control, qualifications, innovation capacity or stable investment conditions (General Motors in Germany).

Liberal economies have a greater propensity for market deregulation since they focus on high efficiency, which causes considerable resistance from workers’ unions against this purely market-oriented philosophy. This is not the case in etatist economies, which restrict deregulation and aim to strengthen institutions that support systemic regulations of business. On the other hand, liberalization of international trade does not exclude institutional differences across countries.

Social-market economies follows a different, unique innovation path. This also means that particular economies face diverse conditions in which their innovation (institutional) systems function, which has a bearing on the transformation on entire economic systems and their competitive position.

The differences between innovation systems are caused by their environment to a greater extent than by external factors. Consolidation and development of innovation are impossible without political and economic influence. Nevertheless, under the circumstances of globalisation, it is difficult to assess what elements of innovation systems have the highest chance of survival and growth. This usually depends on the participants of those systems (enterprises), their innovation performance, technology transfer, as well as on their future competitive position in international markets.

Institutional settings plays a major role here because its tools are an integral part of innovation change. They should be stable, complex (support for innovation cannot happen independently of support for technology transfer) and co-ordinated since institutions should participate in the creation and diffusion of technical innovation and must closely co-operate, with one institution as the coordinator of the entire process. Taking the above into consideration, one can distinguish two strictly interrelated processes that determine the efficiency of innovation systems in social economies: development of enterprise sector and market environment; their influence on the innovation capacity of companies and technological infrastructure; institutional support for transfer of technology and its role in creating efficient management structures capable of enhancing internal and external competitiveness and co-operation.

When analysing these processes, one must take into account the interdependencies between the spheres of science, technology and entrepreneurship, as well as their institutional and macroeconomic aspects. It is institutions that make it possible to monitor business environment and to introduce changes in the way business entities operate. What is more, they play a crucial role in determining the competitive ability of companies and the pace of economic development.

In order to specify the structural and institutional conditions for the creation of innovation systems in social economies, it is necessary do conduct an in-depth analysis of national and regional innovation systems. A comparison of these systems in highly developed countries makes it possible to establish the structure and significance of institutional segments, which include:
– companies and their innovation capacities, including their vertical relationships with suppliers and customers;
– universities and public research and development laboratories, their ability to create general knowledge realising the educational mission and catering for the demand of the business sector;
– economic policy oriented towards education of the labour force, creating pro-development climate in the macroeconomic financial and trading system, and strengthening the trust in financial institutions and the rule of law.

The dynamics of this system can be explained by the growing role of science in the economy: the so-called ‘science push effect’.

Regional innovation systems (RIS) evolve like any other system. Thanks to current, dynamic signals from the market, it is possible to spot the changes and pinpoint their exact nature. RISs often depart from the traditional structural construction for the sake of new forms of obtaining knowledge and information. The traditional ‘one best way’ approach, dating back to Fordism, saw innovation as a hierarchical process, based on knowledge production centres which passed knowledge on to subordinate contractors. Nowadays, it is rather a network system: a web of mutual relationships between several independent groups.

The RIS model is under constant influence of structural change or current trends in the global economy, as well as of a number of endogenous factors. Unstable external environment and the fierce competition from other regions make it necessary to continually come up with fresh innovations in order to strengthen the competitive position. What could be of tremendous help are new competition strategies based on knowledge.

The above approach to induced innovation demonstrates how R&D expenditure is realised. Enterprises choose such types of innovation which differs in terms of the intensity of production factor utilisation. Relative changes in the prices of production factors show which innovation projects can be implemented so as to achieve the cost reduction criterion. Projects which are optimal as regards the factor prices can prove undesirable when other aspects are taken into account, e.g., increased salaries.

Social learning consists mainly in the relationships that enterprises establish with other entities. They can assume various forms: (i) the relationships among companies (co-operation, competition, supplies); (ii) the relationships between firms and institutions (co-operation, dependence), and (iii) the relationships between enterprises and individual creators of knowledge (information, co-operation).

RISs consist of two subsystems. The subsystem of application and exploitation of knowledge encompasses firms, their customers, suppliers, competitors and collaborators (often functioning in clusters). The enterprises are connected by vertical and horizontal linkages. The other subsystem is one of creation and diffusion of knowledge. It is comprised of a number of educational institutions (universities, learning centres) and research institutions (innovation centres, technology transfer units, patent offices etc.) which play an intermediary role in providing technologies and personnel.

A major role is also played by political institutions which shape the innovation processes in a given region by providing operating procedures and financial resources, and by creating regional innovation policy. In a properly functioning RIS, all these entities form a network of dependencies and interactions regarding the flow of knowledge, resources and qualifications.

All these interrelations are tremendously important for the innovation potential and competitive position of RISs. Internal connections concerning knowledge flows are believed to be of great significance in innovative regions, but interactions with external bodies as regards support for the development of knowledge seem no less relevant.

A number of data indicate that enterprises which belong to such networks gain access to knowledge (both codified and context-related) and information from increasingly varied sources. Besides, the co-operation between knowledge makers and knowledge users is becoming far wider and more intensive.

Liberal and social-market economies offer z different ways to gain innovation development. Its depend on the institutional settings. In liberal markets the most activity is on applying research, in social-market economy on knowledge accumulation. But the enterprises need both. Many investors looking for new markets with the many market convenience and with pro-innovation institutional setting. Therefore a part of world’s technological investments flow to liberal market and the others to social markets economies. It depends on the level of technological development and possibilities of particular countries to use knowledge and research.

5. Conclusions

Economic systems use various types of making and diffuse innovation. These types are shaped by the ways in which new technologies are created. Economies focus on the microeconomic aspect of diffusion and utilization, while creation of new technologies shifts the production possibilities frontier in the qualitative sense. Economic policy of innovation systems is all about creating a conducive environment for the introduction of technological advancements.

As a result of technological progress and globalization, the manner in which firms operate shifts towards knowledge. Production structure also evolves and knowledge-based branches are gaining importance. Therefore, it is becoming essential for the dynamics of economic growth to take advantage of those factors that enable firms, wherever they are located, to obtain knowledge. This, on the one hand, enhances innovation and competitiveness, and, on the other hand, allows to lower costs and increase efficiency.

Innovation process have different ways in liberal and social-market economies. In the liberal the most important are market apply and new technology based on development research. In social-market one the most important is efficiency of innovation systems (national and regional) which create a fundamental processes for knowledge and research development (R&D).

The enterprises should decide which aspect of functioning is more important and its needed for most efficient process of innovation development.

Robert W. Ciborowski (University of Bialystok, Poland)

15 November 2016 Library


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