Economics of Knowledge-Based Economy

Today, no economy can remain competitive without applying knowledge. Unlike the traditional factors of production, the source of wealth is not finite and bounded.

“The Knowledge Economy is one that relies primarily on the use of ideas rather than physical abilities, and on the application of technology rather than the transformation of raw materials or the exploitation of cheap labor.”

– World Bank on Global Knowledge Economy.

The world is on the verge of another industrial revolution, driven by knowledge this time, not the steam engine or electricity, according to noted MIT economist, Lester C Thurow. True, technological developments in the 20th century are behind the transformation of wealth-creation processes from physically-based to knowledge-based. Today, technology and knowledge are the key factors of production, besides labor and capital. However, it is only over the last two decades that technology and knowledge have been replacing capital and energy as primary wealth-creating assets.

In this new economic era, knowledge has become the primary source of wealth from high-tech knowledge intensive to traditional sectors as well. There are several dramatic developments in recent years which have fundamentally altered the importance of knowledge, and the competitive edge that it gives to those who harness it quickly and effectively.

The knowledge economy produces goods and services effectively, at lower costs, to a greater number of people. The combined effect of advances in computing speed, and competition, innovation and cheaper global communications networks has added massive value to economic production.

However, it is not a new idea that knowledge plays a key role in the economic activity, nor is it a new fact. The use of knowledge has been increasing since industrial revolution. Adam Smith referred to new layers of specialists who are men of speculation and who make important contributions to the production of economically useful knowledge. Nevertheless, the degree of incorporation of knowledge and information into economic activity is now at full spectrum and is inducing profound changes in the global economy and transforming the basis of competitive advantage. Accordingly, we are witnessing the increasing importance of knowledge. The knowledge-based economy (KBE) is emerging from two crucial forces: the rise in knowledge intensity of economic activities and the increasing globalization of economic affairs. The former is being driven by the combined forces of the information technology revolution and the increasing face of technological change. The latter is being driven by national deregulation and by the IT-related communications revolution.

Against this background, knowledge economy can be characterized in terms of the increasing role of knowledge as a factor of production and its impact on organizational learning, skills and innovation. In short, the economy that creates, disseminates and uses knowledge to enhance its growth and competitiveness is a knowledge-based economy (KBE). KBE is also called new economy, weightless economy, the intangible economy and the immaterial economy. Research indicates that KBE comprises four main elements. These four structural forces driving economic transformation are: revolutionary changes in information and communications technology (ICT); rapid scientific and technological advance; global competition; and shifting consumer demand. They constitute the fastest-growing sectors in modern economies—whether measured by value added or employment and job growth.

Economics of KBE

As knowledge has become a new engine for economic prosperity in the 21st century, it fuels new ideas to boost productivity and to create new organizations, new jobs and new wealth. Accordingly, the new economy is driven by new ground rules. Knowledge has fundamentally different characteristics from ordinary commodities. Most importantly, knowledge is a global public good: it is “infinitely expansible” or “non-rival in consumption”. These differences have been changing the whole nature of economic activity and the way we understand it. Danny Quah, Professor of Economics, London School of Economics, outlines that the KBE is different from the traditional economic set-up. He suggests, “First, there is a proliferation of knowledge products that share the infinite expansibility and related characteristics of knowledge. Of particular importance are ICT, including the Internet; intellectual property, including not only patents and copyright, but also branding, development of images, advertising, trademarks and logos; and libraries and databases, both silicon-based electronic compilations of information and bio-technology or carbon-based forms.” Hence the 21st century’s successful economy is characterized by rapid growth of knowledge-based industries, ever-changing consumer demand, continuing growth in the services sector, high productivity and increasing competition in global markets for both its goods and services.

The technological changes are bringing things together which were never imagined earlier. Networks and geographical clusters of organizations are particularly important features of the KBE. Unlike in the industrial economy, the new economy is forcing companies to work with other firms in technology-based alliances. Moreover, the costs of research & development (R&D) are rising and organizations finding it beneficial to spread costs among themselves. On the other hand, consumers become more sophisticated and the goods they demand are more complex. Going by this, organizations have to draw on a wider range of technologies and a broad array of inputs for their R&D. So most large corporations are becoming “multi-technology corporations”, locating themselves around centers of excellence in different countries.

Danny Quah suggests, “Technological changes are bringing consumers ever closer. In the traditional industrial economy, knowledge is the first point in a chain running through intellectual property protection in the form of patents and then into machinery and manufacturing for producing goods for consumers. In the knowledge economy, the chain disappears and consumers and knowledge producers interact directly with each other. This is the real ‘death of distance’: not in the sense that ICT reduces the importance of physical geography but as closing the gap between knowledge producers and consumers.”

Countries which are encouraging their people’s education, life-long learning and investing heavily in research and development (R&D) are well positioned to take advantage of emerging global markets. Countries like the US, Australia, Finland, Ireland, Canada, and Singapore are experiencing the growth of the Internet and other related technologies and have become the catalysts for the creation of KBE. Most of these countries are experiencing strong GDP growth as a result. In the new economy, a country’s capacity to take advantage of the knowledge economy depends on how quickly it can become a ‘learning economy’.

Importance of Intellectual Capital

Economic success in today’s KBE increasingly depends upon the effective utilization of intellectual capital such as employees’ knowledge, skills, innovative potential, as well as their ability to continuously improve those processes. Besides, intangible investments like R&D, innovation, knowledge creation and fertilization, marketing and advertising expenditures are now unanimously considered the most important determinants of performance. Across the globe, these strengths are largely recognized as the most important sources of organizations’ competitive advantage. For instance, the mighty software mogul, Microsoft’s physical assets are a tiny proportion of its market capitalization.

However, the way the KBE demands skills, many workers simply cannot cope with. Employment in the KBE is characterized by increasing demand for more highly-skilled workers, also called knowledge workers. They are also defined “symbolic analysts”, because they manipulate symbols rather than machines. For instance, software engineers and bank workers, fashion designers and researchers from academia and industry, teachers and policy analysts etc., are labeled as knowledge workers. They are playing a vital role in developed countries. In the US, more than 60% of workers are knowledge workers. Unlike the industrial economy, they are so much at a premium that more and more of them choose to work on their own, for profit rather than a wage.  Against this, global free labor markets have begun to break with long-held, socially-dear traditions of compensation and governance in order to reward and manage knowledge workers as the knowledge age demands.  Bill Gates, CEO of Microsoft, says, “The war for talent gets tougher and tougher.”

Challenges

The rapid dissemination of ICT has changed the way we live and work and the way in which businesses create value. There is no doubt that the KBE has brought renewed growth and dynamism, but it has also brought about a disturbing increase in economic inequality. Apart from the danger of growing digital divide, there is also growing a knowledge divide. According to Ms Ruth Kagia, Director, Education, Human Development Network, The World Bank, “there are striking disparities between the rich and poor countries in their investment and capacity in science and technology. The poorest regions of the world have the lowest access to information and communication resources.” She suggests, “The poor regions can leverage opportunities leapfrogging as the dynamics of a KBE are better understood. In the 21st century, workers need to be lifelong learners, adapting continuously to changed opportunities and labor market demands of the KBE.” Irrespective of geographical boundaries and natural resources, the creation and profitable deployment of new knowledge is the key source of competitive advantage for any modern economy. Joseph Stiglitz, Senior Vice President and Chief Economist, The World Bank suggests, “government has an important role in facilitating changes in the new economy: for example, through the provision of education, by encouraging creativity and risk-taking and by helping to develop institutions, including introducing appropriate regulatory and tax environment.”

India as Knowledge Economy

India’s inherent strengths are behind making India a Knowledge Economy. The key ingredients include a critical mass of skilled, English-speaking knowledge workers, and, of course, a well-functioning political system. So, the future of India is linked to the knowledge industries. Indian culture values knowledge highly and that cultural value is the main drive of India as a knowledge economy. However, this will depend on how it will nurture and grow its human resources. A recent World Bank report on ‘India and the Knowledge Economy: Leveraging Strengths and Opportunities’ suggests, “Indian can no doubt reap tremendous economic gains by developing policies and strategies that focus on making more effective use of knowledge to increase the overall productivity of the economy and the welfare of its population. In so doing, India will be able to improve its international competitiveness and join the ranks of countries that are making a successful transition to the knowledge economy.”

Presently, ICT-enabled services are important industrial drivers. Apart from pharmaceutical industry’s increasing importance, India is benefiting economically from nanotechnology-based industries. The World Bank report recommends to create and sustain an effective knowledge economy. India must undertake systemic integration of reforms in the following areas to strengthen its competitive advantage. These include strengthening the economic and institutional regime, creating an efficient innovation system, and building a dynamic information infrastructure.

N Janardhan Rao,  Senior Economist.