Innovation and Competitiveness [620263]

Innovation and Competitiveness
Revised Version (August 2003) of Chapter 21for Handbook of Innovation edited by J.
Fagerberg, D.C. Mowery and R.R. Nelson, Oxford University Press, forthcoming
by John Cantwell
(Rutgers University, USA and University of Read ing, UK)

1. Introduction
Traditionally, economists and economic historians since Adam Smith have discussed
economic growth principally in the context of the national level – why some countries
grow faster (in modern terms, acquire the capabilities for sus tained growth that make
them more competitive) and so become wealthier than others. While in neoclassical
economics questions of national competitiveness came to assume a lesser degree of
importance, as attention was shifted away from issues of growth towa rds those of static
resource allocation and efficiency, there was even less concern with the notion of
competitiveness at the firm level. The theory of the (comparative) growth of the firm
was a minority interest of those such as Downie (1958), Penrose (19 59) and Marris
(1964), typically treated as a rather esoteric sub -branch of industrial economics, that
was to be accorded a lesser status in the discipline than the conventional theory of the
firm (which was really a theory of the relationship between the firm and markets). In
recent years two related changes in economics and allied areas of research have been
under way. One is a revival of a more widespread interest in the classical issues of
competitiveness at a national level, and the other is the growin g attention now paid to
competitiveness at the level of industries, regions and firms, in which fields of research
a substantial new literature has emerged. In section 2 the contribution is assessed of the
new literature on competitiveness across countries . Section 3 below examines
innovation and competitiveness at the industry level that connects together firms and
their environment, and section 4 looks at the regional and firm level. Section 5 draws
some conclusions with respect to the interaction between innovative actors, between the
different levels of analysis of competitiveness, and opportunities for future research.
Competitiveness is here taken to mean the possession of the capabilities needed for
sustained economic growth in an internationally comp etitive selection environment, in

2which environment there are others (countries, clusters or individual firms, depending
upon the level of analysis) that have an equivalent but differentiated set of capabilities
of their own. The term competitiveness is al so sometimes taken to necessarily imply as
a result a continuing rise in the living standards of the individuals that are members of a
social group with the required capabilities (notably in this context, to imply a sustained
increase in the living standar ds of the citizens of the country that is suitably competitive
in world markets – see Tyson, 1992). While it is indeed necessarily true that
productivity growth increases incomes on average (that is, per capita income), it may
well be that the process of c apability generation and growth also has a disruptive effect
on the distribution of incomes. This issue is not addressed directly here, since the way
in which innovation affects the employment opportunities of individuals, which is a
major influence upon t heir respective earning capacities, is the subject of Pianta (this
volume).
The winners from innovation are those that construct appropriate capabilities, but
capabilities are localised and nationally differentiated (as explained by Edquist, this
volume), and so there can be many successful players in the competitive game, each to
some extent learning from and interacting with the somewhat alternative paths to
capability creation being taken by others. Put in these terms few could object that the
pursuit of competitiveness through innovation is a laudible objective of national policy,
and indeed an increasingly important objective as the role of innovation has risen in the
modern knowledge -driven economy, even for (actually especially for) countries that
start behind and wish to catch up (Fagerberg and Godinho, this volume).
To be meaningful, competitiveness must be thought of as entailing a relative
comparison of growth rates or benchmarking of performance to assess how well each
participant has done in deve loping the capabilities for innovation and growth, and not
be about the mutual potential for damaging one another (a misleading interpretation of
competitiveness criticised by Krugman 1994a, 1996). It is reasonable to expect that at
least on average, the s pillover benefits for others of a good performance in one location
or by one agent tend to outweigh the costs of that good performance for others. This
argument is largely applicable whether the unit of analysis is countries in the world
economy or firms i n an industry. At a country level the efforts of each national system
of innovation to promote the competitiveness of businesses sited locally are
increasingly complementary as scientific and engineering communities become more

3international, and cross -border knowledge flows are more common (as discussed by
Narula and Zanfei, this volume). Likewise, much of the growth achieved by the leading
corporations in an industry reflects the wider growth of that industry. The competitive
race between firms stimulates innovation, and this innovation lowers costs and
improves product quality in the industry, and thereby increases industry demand. All
firms benefit that contribute successfully to what is often a combined and interactive
process of innovation.

2. Competi tiveness at the national level
When looking at the country level, competitiveness is about the way in which the
pattern of international trade evolves over time to reflect changing patterns of
capabilities and hence competitive advantage (what might be tho ught of as the
evolution in the comparative advantage of countries), rather than about the established
pattern of comparative advantage which is the usual focus of trade theory. While the
earliest theories of trade and growth can be traced back to the clas sical economists, such
dynamic accounts of the paths of international trade and investment were revived in
recent times by the technology gap approach (Posner, 1961) and the product cycle
model (Vernon, 1966). However, a major shortcoming of the product cy cle model was
its reliance upon an overly simplistic demand -driven theory of innovation (which
reflected the spirit of the 1960s, when it was devised), through which the firm was
assimilated to the product, and innovation was supposed to be concentrated in just one
leading country – the US (see Cantwell, 1989, for a further discussion of the model).
Sadly, when the product cycle model broke down in the 1970s, in large part owing to
the re -emergence of multiple centres for innovation in a number of internati onal
industries, the amended versions of the model (Vernon, 1974, 1979) focused upon
considerations of oligopolistic strategy rather than revisiting the underlying theory of
innovation and competitiveness. It was only in the 1980s that scholars based at Su ssex
once again wedded an analysis of structural shifts over time in the pattern of
international trade to a more realistic approach to innovation – see Soete, 1981, Dosi
and Soete, 1988, Dosi, Pavitt and Soete, 1990, and Fagerberg's 1987 paper on structur al
changes in international trade (reprinted as chapter 7 in Fagerberg, 2002).

4Part of the inspiration for Fagerberg's research had been that economists sometimes use
the term 'competitiveness' in various different ways, and especially in macroeconomic
policy discussions not always in the way that has been defined here. This chapter is
concerned with innovation and competitiveness, and this is sometimes distinguished as
being about longer term technological competitiveness, as opposed to shorter term price
competitiveness. There are two different ways of discussing competitiveness in the
latter sense of shorter term price competitiveness. In the context of conventional
demand management policy discussions, if (say) lower government borrowing means a
fall in interest rates and so a rise in net outward investment, and if this leads to a decline
in the value of the domestic currency, then the price 'competitiveness' of domestically
produced goods and services can be said to have increased, as export prices fall in
foreign currency terms while import prices rise in domestic currency terms. However,
this type of competitiveness is unlikely to be sustainable, especially if (for example) the
rise in import prices sparks off domestic inflation, or if lower net inward investment has
adverse consequences for domestic productivity growth. The second and for our
purposes more substantive context is the conventional cost -based account of
competitiveness, in which a fall in relative unit labour costs means lower prices (or a
lower rate of inflation), which in turn leads to a rise in exports and fall in imports, and
so an increase in the value of the domestic currency.
Longer term technological competitiveness is more akin to the second of these two
versions of price competiti veness, in supposing that a faster growth of (output and)
exports drives up the domestic currency, rather than it being a falling currency that
promotes net exports. In the context of what is sometimes termed 'non -price'
competitiveness to distinguish it m ore clearly from the kind of cost -based
competitiveness just referred to, innovation and new lines of value creation may mean
higher average prices as an indicator of higher quality, but in any event they lead to a
faster growth of productivity and trade, and thus an upward trend in the value of the
domestic currency. Given what has been said already, it is worth stressing here that in
this perspective the rise in the value of the currency is simply the reflection of
competitiveness, defined as a relatively rapid growth in productivity and the value of
(output and) exports. The rise in the value of the domestic currency is not itself the
achievement of competitiveness (an improvement in the terms of trade that is
essentially a potential side effect resulting from competitiveness). It is also worth

5making explicit that the departures from comparative advantage associated with trade
imbalances are merely a temporary result of competitiveness in this framework, and
again not in themselves the objective of compet itiveness. What is implicitly supposed
here is that faster productivity growth is associated with a rising share of world trade,
and that in this process the growth of exports leads the growth of imports. So net
exports rise until imports catch up, and thi s catching up is facilitated by the consequent
rise in the value of the domestic currency and in domestic wage rates.
Now neo -Schumpeterian approaches to international competitiveness focus on this kind
of process of forging technological competitiveness, which for those whose innovative
efforts are most successful implies a sustainable increase in the share of world trade (or
at the firm level, a sustainable increase in the share of the relevant world market).
However, as has been discussed at length alrea dy, in the Schumpeterian perspective
competition entails the positive sum game of establishing new spheres of value
creation, so innovations expand the overall magnitude of world trade and the world
market. Those that contribute most to this process of exp ansion see their shares rise as
they are responsible for more of the new element of value creation, and not because of a
substitution effect within some fixed total level of world trade or some fixed and given
world market (or even within some steadily exo genously growing world market). In this
context, the neo -Schumpeterian analysis of innovation and competitiveness is unlike
equilibrium growth accounts, even when those accounts incorporate an
acknowledgement of research activity, if investment in innovati on is treated as being
inherently like investment in any other economic activity, and if the only difference
between activities is treated as lying in their wider impact on other activities through
externalities. Instead, in the neo -Schumpeterian story the very nature and purpose of
innovative activity is to disturb and add to the existing circular flow of income
generation, in an experimental and non -equilibrium fashion.
Such neo -Schumpeterian models of innovation and growth might be specified in at least
two alternative ways. The first of these leans heavily on the distinction just drawn
between shorter term price competitiveness and longer term non -price technological
competitiveness. In Fagerberg's (1987, 1988) technology gap formulation of
international competitiveness across countries the impact on growth of national rates of
innovation and distance behind the technology leader are treated primarily as additive
elements, to be added on to the more traditional determinants of economic growth in the

6form of capital accumulation (the share of investment in national output) and relative
unit labour costs. The origins of viewing cross -country growth in this kind of additive
framework can be traced to Abramowitz (1956), Solow (1957) and Denison (1967), for
whom technological improvements (and the productivity growth to which they led)
were an obvious means of accounting for the substantial 'residual' in variations in
growth that remained after allowing for the effect of the increase in factor inputs. So in
this context capital accumulation proxies for the extension of the scale of established
activities, relative unit labour costs capture cost -based 'price' competitiveness, while the
contribution of corporate research and the capacity to catch up through imitati ng the
achievements of a leader represent 'non -price' technological competitiveness.
Table 1 here
Setting the problem up in this way is convenient, as the empirical evidence then
generally suggests that technological competitiveness is more important than the more
commonly considered traditional influences upon competitiveness. Technological
competitiveness is judged to be more significant than relative unit labour costs;
although Krugman (1994b) and Young (1995) point to the continuing importance of
capita l accumulation within this kind of framework. The evidence for three countries –
Japan, the UK and the US – over the period 1960 -73 is illustrated in Table 1. Based on
the estimation of his empirical model of international competitiveness, Fagerberg
(1988) was able to decompose the model's predicted change in each country's share of
world trade (which were reasonably good predictions of the actual changes in market
shares) into four elements, as shown. What emerges is that the traditional consideration
of relative wage costs contributed rather little to overall competitiveness in any of these
countries (although it was statistically significant in all the equations of the model in
which it appeared). In contrast, the growth in indigenous technological capabi lities in
Japan, and the diffusion of foreign frontier technologies, account for a good deal of the
Japanese competitive success of that period. The loss of world trade shares by the UK
and the US over the same period can be attributed mainly to weak capit al accumulation,
and Fagerberg explained this mainly by the drain placed on national resources by the
high shares of military spending in these two countries.
However, when capital accumulation contributes positively to a favourable growth rate,
at least s ome element of it reflects the establishment of new fields of activity, and is a
response to the creation of new innovative opportunities. Therefore, it is not clear that

7the contribution of the growth of traditional factor inputs can really be cleanly
distinguished from that of innovation, unlike in the logic of a standard production
function approach. So to exclude capital accumulation from the contribution of
technological competitiveness provides only a conservative lower bound estimate of the
significa nce of the latter, and perhaps concedes too much to orthodox sceptics of the
role of innovation in growth and competitiveness. Fagerberg (1988) was aware of this
issue, and so he included a separate equation in his simultaneous system for capital
accumulat ion as a function of the growth of output, which in turn depended as we have
seen upon the increase in technological capacity, so that he acknowledged indirectly the
influence of technological competitiveness upon capital investment. This need to revise
the traditional production function logic becomes especially relevant when trying to
compare innovative or technological 'assimilationist' explanations of (East Asian)
competitive success with those of 'accumulationists', if using aggregate measurements
in the context of substantial structural change (Nelson and Pack, 1999). As we have
already noted, neo -Schumpeterian economists have particularly emphasised the
connection between structural change and growth through innovation.
Table 2 here
Some evidence on w hat distinguished the East Asian growth experience from that of
other countries that sustained similarly high rates of capital accumulation over the
1960 -89 period is set out in Table 2. The table shows 11 countries that enjoyed very
high shares of investm ent in GDP, of over 20%, as indicated in the first column. The
right hand column shows the residuals of a regression across 101 countries of GDP per
capita on the investment share as a proxy measure of the rate of capital accumulation,
and on three other c ontrol variables (a catching up effect proxied by the intial level of
GDP per capita in 1960, the growth of population to capture the availability of labour
supplies, and the proportion of the relevant cohort of the population educated to at least
secondar y school standards). This was part of the study of Nelson and Pack (1999).
What emerges is that among high investment countries, the East Asian tigers – Hong
Kong, Korea, Singapore and Taiwan – stand out as managing to achieve growth rates
well in excess o f what might have been predicted from their favourable rates of capital
accumulation alone. What was different in these economies was their greater ability to
innovate, to upgrade and restructure their indigenous industries, and to learn and absorb
more ef fectively from foreign technologies. Capital accumulation can embody

8innovation to the extent that it is linked to the transformation of the productive activities
being conducted.
So an alternative approach also in the Schumpeterian tradition is to treat t echnological
accumulation and capital accumulation as simply aspects of a common process, rather
than as independent (even if complementary) contributions to growth. In this case
innovation can be seen as driving up profitability and hence lowering the sha re of
wages in output (even though wages are rising faster, and so may be unit labour costs),
which leads to a higher share of investment in output, and so higher capital
accumulation and growth as a result of higher technological accumulation (Cantwell,
1989, 1992). The basic idea here is that in fast growing countries just as an increase in
imports tends to follow an increase in exports with a lag, so wages tend to follow
productivity increases with a lag, enabling innovation to create a fresh source of
profitability and growth. Yet this also suggests that technological competitiveness is in
part cost -based. It should be noted, though, that labour productivity is defined here
simply as the value of output per worker employed, which implies that productivit y
growth is as much attributable to product quality improvements (that raise the value or
unit price of output, as stressed in Fagerberg's approach), as it is to the cost reductions
associated with process improvements. In this alternative neo -Schumpeteria n
formulation we need worry less about the distinction between embodied and
disembodied technological change, or the distinction between improvements in product
quality and delivery times as opposed to improvements in processes that are reflected in
costs and prices.
The renewed interest in international competitiveness and variations in growth rates has
spawned a substantial new literature on cross -country convergence or catching up
versus divergence or falling behind (see eg. Baumol, Nelson and Wolff, 199 4). The
evidence suggests that whether one observes convergence or divergence depends upon
the period studied and the countries selected. In any case, the overall trend in cross –
country variance at a world level may not be the most important issue. Rather than
trying to work out whether East Asian convergence statistically outweighed the effect
of African divergence in aggregate, the issue is more why and how firms in East Asia
had the capabilities to catch up in the period since 1960, while those in Africa did not.
The concepts of a techno -socio -economic paradigm (Freeman and Perez, 1988), or of
an evolution in the institutional characteristics of capitalism (Lazonick, 1991, 1992),

9can be useful in this respect as a means of explaining occasional shifts in technological
leadership or longer term competitiveness, and in the direction of those shifts.
Emphasising again the role of structural change in growth, and in particular during
periods of paradigm change, when the prevailing characteristics of innovation undergo
transformation, helps to explain the existence of windows of opportunity in which the
catching up of selected countries may be especially dramatic. At these times leaders can
have special difficulty in adjusting to the new conditions since they ha ve become most
locked in to the types of innovation favoured under the earlier paradigm, while others
that lie behind initially may find that their rather different institutions and methods of
social organisation are in fact quite well suited to adapting s o as to promote just the
kinds of structural change in which lie now the greatest opportunities for fresh
innovation.

3. Competitiveness at the industry level – the nexus of relationships between firms
and their environment
When speaking of shifts in com petitiveness between firms or between different national
groups of firms that constitute the major players in an international industry, Mowery
and Nelson (1999) prefer the term industrial leadership, so as to emphasise that such
leadership may be due as m uch to the national or regional environment in which firms
operate, or to institutions that are specific to an industry, and not just to factors that are
purely internal to the firms in question. From detailed historical case studies of the
evolution of na tional industries, they conclude that competitiveness derives from the
contributions of each of, and the interactions between, firms, regions and countries, and
the sectoral support systems that connect these different levels of analysis. Their
account pro vides a clear justification for a section that covers competitiveness at the
international industry level, rather than attempting to move directly from the country
level to the firm level.
In this framework the factors that are thought to influence competi tiveness may be
grouped under the headings of resources or capabilities, institutions (notably for higher
education and science, and in financial systems), markets or demand conditions, and
inter-company networks. Models that are based at the level of the evolution of particular
products or technologies, or which are predicated on a notion of competence -destroying

10innovation (when moving from one type of product or technology to another that
represents a radical departure from the past), may each have some relevance. Yet
Mowery and Nelson argue that this applicability is limited when dealing the
performance of large multi -product firms over very long periods of time. Likewise, the
policy debate surrounding the relationship between government policy intervent ions and
trends in competitiveness is overly polarised, when each side of the debate has in mind a
rather simple model of that relationship (or lack of a relationship) which may apply at
some places and at certain times, but cannot be universally applied i n the way that some
advocates seem to imagine.
The relationships that exist between the development of the technological capabilities in
firms that are responsible for competitiveness and the institutions of the wider society
vary from one country to anoth er, but in particular they tend to be different in countries
that belong to an already leading industrialised group and those that are attempting to
catch up with them (see also Fagerberg and Godinho, this volume). It is noticeable that
there have been a g reater number of cases in which governments in catching up
economies, partly through measures of domestic protection, have contributed more
actively to the fostering of capabilities in local infant industries and in indigenous
companies. This was true of t he US and Germany when they were catching up with
Britain in the nineteenth century (Landes, 1969), it was true of Japan when it was
catching up with the West during the twentieth century (Ozawa, 1974), and it was true
of Korea when it was catching up afte r 1960 (Enos and Park, 1988). It is true that there
are occasionally other cases of catching up economies, like those of Singapore or
Mexico in recent years, that have taken advantage instead of various aspects of trade
liberalisation. However, what is mos t noticeable in all these instances of successful
catching up is that the trade policies of governments were merely part of a much wider
package of support for the longer term nourishment of capabilities in indigenous firms.
Since the emergence of science -based industries towards the end of the nineteenth
century this has meant especially investing in science and higher education, in the
training of engineers, and in the learning of skills more widely (Freeman and Louça,
2001). Equally important, where ther e were measures of trade protection local firms
accepted their part of the bargain to invest very substantially in capability creation in an
outward -looking and export -oriented fashion, rather than simply remaining an

11inefficient enclave as in so many othe r cases of protectionism or so -called import –
substituting industrialisation.
Of course, the institutional structures of catching up economies changed markedly (and
any protectionist measures were largely reversed) as their firms caught up and
themselves so metimes forged ahead and became innovative leaders in their own right.
This is perhaps the most vivid illustration of the general observation that the
development of technological capabilities in firms and the character of the institutions
that support the se competitive efforts in the wider society tend to co -evolve with one
another (Nelson, 1995), through a process of continual interaction. Another perspective
on these interrelated national systems for the construction of competitiveness is offered
by Port er (1990), as represented through the four corners of a diamond of factor
conditions, demand conditions, related and supporting industries, and firm strategy,
structure and rivalry. In Porter's view the capacity of firms to innovate depends
critically on h aving sufficient domestic rivalry in their own home country of origin, but
also on the presence of spillovers between firms associated with localised clusters (to
which issue we return below). In other words, innovation requires an appropriate mix of
inter-firm rivalry and cooperation or exchange (Richardson, 1972). Lazonick (1993) has
argued that when confronted with a major new competitive challenge from some new
source of innovation from outside, domestic industries may need to shift this balance
away fr om rivalry and towards cooperation in order to respond effectively. To express
this another way in the light of the trend towards globalisation mentioned earlier, it may
be that firms in some national industry may need to increasingly collectively focus th eir
efforts in what they do locally (as opposed to activities they may locate abroad) to be
better mutually aligned with whatever may be the fields of particular local excellence or
of specialisation in innovation. This would have the effect of tending to reinforce
national patterns of comparative advantage in innovation.
As has been mentioned already, with the emergence of science -based industries over a
century ago the need for an infrastructure that suitably supports relevant education, skill
formation a nd training became critical to the competitiveness of industries, and is
widely believed to have become more important still in the modern techno -socio –
economic paradigm associated with computerisation and information processing. For
firms to be able to cr eate capabilities requires costly and difficult internal learning
processes, but these in their turn depend upon having suitable organisational and

12technical skills in the management and workforce on which they rely. The composition
of skills in the workfo rce of the home base of firms is therefore critical to the success or
failure of countries that are trying to catch up, but it also becomes a central influence
upon the fields in which any national group of firms has its specific pattern of
comparative adv antage in innovation and capability creation. Of course, this is not just a
one-way street, since the types of investments and commitments to training that are
made by firms themselves in the course of learning, the professional associations they
help to f orm, and the pressures they place upon governments and others imply again a
process of co -evolution between firms and their environment in this respect too.
Table 3 here
Table 3 helps to illustrate the significance of education and skills in the catching u p of
the four East Asian tiger economies (see also Fagerberg and Godinho, this volume).
Korea stands out as having surpassed even the commitment of the traditional
industrialised countries to higher education in the natural sciences and mathematics. Yet
a key to the success of these countries as a group lies more in the investments they have
undertaken in support of engineering graduates – while Hong Kong lies behind the
industrialised group (and this may help to account for why its local learning and
upgra ding has been more limited than in the other three, as discussed by Lall, 2001),
Singapore is above the industrialised country average, and Korea and Taiwan are way
ahead of that average for tertiary level engineering enrolments as a proportion of the
popu lation. Other developing countries are generally well behind the achievements in
engineering education of the tiger economies, although the Philippines, Argentina and
Mexico have at least matched the position of Hong Kong. Considering the enormous
size of its population, it is also clear that China has been catching up fast in this area.
The Japanese and German systems are known to focus on a broad and deep skill base by
emphasising the acquisition of general engineering skills and the good standard of basi c
education of the population as a whole, while the US and UK systems tend to be more
elitist and focus on the development of higher end skills over a narrower range of
people (Prais, 1995, Lazonick and O'Sullivan, 1997, Lazonick, 1998). This helps to
explain why the Japanese and German fields of comparative advantage in innovation
(and thus, of competitive advantage) include motor vehicles and engineering that rely
(and have increasingly come to rely) on a broad skill base, while the US and UK
advantages i nclude aerospace, software, pharmaceuticals, biotechnology and medical

13equipment that rely on very highly skilled individuals and an intensive research and
design effort.
When examining the extent of path -dependency in the specific technological traditions
of national groups of large firms, and in their patterns of technological specialisation as
a measure of their relative contributions to each of the major international industries
(the cross -sectoral pattern of their technological competitiveness), some c ross-border
interdependencies appear to emerge. This raises again the issue of whether or not there
have been any elements of convergence across countries, but in this context in the
specific mix of strengths and weaknesses in international industries, rat her than in
aggregate productivity or performance. Examining patterns of technological
specialisation among national groups of the largest firms from six countries (the US,
Germany, the UK, France, Switzerland and Sweden) based on their patterns of
corpora te patenting, it has been observed that these profiles are path -dependent and tend
to persist to some extent even over periods of 60 years, from the interwar period to the
present day (Cantwell, 2000). This may be taken to imply that the positive effect o n the
continuity of collective technological trajectories of inter -company technological
cooperation and spillovers within national groups has tended to outweigh the negative
effect of mobility in cross -company distributions of activity. There is some evi dence
that through the evolution in these patterns of technological competence that has
occurred, certain national groups have come somewhat closer to one another than they
were in the past, or they have changed in similar ways. Indeed, it might be argued that
the six national groups examined can now be divided into three clusters of two
countries each.
Table 4 here
The first cluster comprises the largest US and UK firms, in which the profile of
technological competence can be characterised as being resour ce-based, oil -related and
defence -related. It is increasingly also health -related. As shown in Table 4, in the US
case since the interwar period a continuing comparative advantage in innovative
activity in the largest industrial firms has been sustained i n the oil, food products,
rubber products, aerospace (defence and larger scale transport systems) and building
materials industries. The greatest continuing strengths for the largest British companies
over the same historical period has been in textiles, other transport (defence) and oil
since the 1930s. Thus, it can be argued that there has been some convergence in the

14profiles of the US and UK innovation systems (Vertova, 1998). UK firms have also
seen a post -war shift into technological competence in the pharmaceutical industry,
although it can be claimed that this too represents the revival of a much earlier
nineteenth century tradition in biological and medical technologies. In any event,
consistent with the overall UK or US pattern of technological development, the British
pharmaceutical industry had links with the food industry, unlike in Germany in which it
derived purely from the chemicals industry (Cantwell and Bachmann, 1998). In the US
there has been a related post -war continuation and strengt hening of the medical
instrument industry (grouped under professional and scientific instruments in Table 4),
and a more recent move into biotechnology, although this has not yet been reflected in a
comparative advantage in the pharmaceutical industry as a whole.
The second cluster is that of the German and Swiss -owned corporate groups, in which
technological development since the end of the nineteenth century has been largely
science -based, and revolved around the dominance of the chemicals industry. In t he
post-war period this has been increasingly complemented by engineering excellence,
although some recent commentators have seen this direction of change (as opposed to a
move into the other science -based area of electronics) as a weakness of the modern
German innovation system (Albach, 1996; Audretsch, 1996). The leading German
firms have held a consistent focus on development in the chemicals and metal product
industries, with some recent shift towards industries more reliant on engineering -based
techno logies, linked in part to the emergence of a wider range of innovative smaller
specialist supplier companies. The Swiss concentration historically on chemicals and
pharmaceuticals makes it a microcosm of (part of) the German innovation system,
which has a lso been shifting in the direction of engineering excellence.
The third cluster may be more a matter of coincidence than due to any historical,
geographical or cultural ties, involving as it does the French and Swedish national
groups of companies. This g rouping has emphasised infrastructural types of
technology, spanning engineering, construction, transport and communications systems,
and some recent moves into health care. In the French case comparative advantage in
large firm innovation has been sustai ned since the interwar years in metal products,
rubber products and building materials, while some earlier strengths in electrical
communications technologies have been subsequently consolidated. This
infrastructural orientation is less reliant upon large scale private corporate R&D than

15the German system has been, but is not as resource -oriented as the US or UK company
systems of technological development. Swedish technological excellence has also been
engineering -based (and has become increasingly so) a round the metals and vehicles
industries, but it has been shifting more closely towards the French pattern with the
recent rise of development in the areas of telecommunications and pharmaceuticals.
The apparent convergence of certain national systems of l arge firm innovation with
continuing differentiation between these clusters of groupings may be an aspect of the
rise in technological interrelatedness and interlinked systems of technologies, which
have eroded the more highly specialised national systems of the past. Hence, the
significance of technological lock -in and path -dependency in each respective system has
still been accompanied by some selected convergences between particular national
groups.

4. Competitiveness at the regional and firm levels
The significance of the 'regional dimension' of an innovation system has emerged as
another aspect of an interactive model (Kline and Rosenberg, 1986) that emphasises the
relationships of local companies with knowledge sources external to the firm – see also
Asheim and Gertler (this volume). Such relationships – between firms and the science
infrastructure, between producers and users of innovations at an inter -firm level,
between firms and the wider institutional environment – are strongly influenced by
spatial proximity mechanisms that favour processes of polarisation and cumulativeness
(Lundvall, 1988; von Hippel, 1989). Furthermore, the employment of informal channels
for knowledge diffusion (of so -called tacit or uncodified knowledge) provides another
argument for the tendency of innovation to be geographically confined (Hägerstrand,
1967; Lundvall, 1992). The lack of existant capabilities in weaker regions hampers the
potential for inter -regional technology diffusion (Fagerberg, Verspagen and Caniëls,
1997).
Table 5 here
Some evidence on the extent of the locational concentration of the corporate capabilities
for innovation that underpin competitiveness in Europe is set out in Table 5. It shows
that except in the case of Germany in which there are four maj or regions that are each
responsible for 13% or more of the innovative capacity of the largest companies, of

16which the leading region accounts for 27%, in all the other European economies the
equivalent share of the biggest region is around 50% or higher. This represents a quite
remarkable geographical concentration of innovative capacity, far more than the extent
of concentration of population or the total value of output. Given therefore that the
interactions between the development of technological capab ilities by firms and the
supporting institutions found in their environment takes place mainly in such regionally
bounded areas, this section begins by discussing the relationship between regional
concentrations of activity or 'industrial districts' and th e competitiveness of individual
firms ( Malmberg, Sölvell and Zander, 1996, Porter and Sölvell, 1998, Enright, 1998,
Scott, 1998).
One particular aspect of regional systems that is underlined here is their interplay with
the international dispersion of the creation of new technology and the new innovatory
strategies of multinational corporations (MNCs), which have been associated with a
restructuring of MNC technological operations at a subnational level. On the one hand,
as seen above, there are general ex ternal economies and spillover effects which attract
all kinds of economic activities in certain regions and determine, in the case of
corporate integration, the localisation of new research units. These centripetal forces
strengthen the inter -border intra -firm integration and the feedback of knowledge,
expertise and information which occurs within networks of affiliates. On the other hand,
sector -specific localisation economies intensify intra -border sectoral integration,
implying local external networks b etween affiliates, indigenous firms and local non –
market institutions. By tapping into local knowledge and expertise, foreign affiliates
gain a competitive advantage which can not only be exploited locally but may also be
transferred back to the parent com pany, enhancing its global technological competence.
Thus, Narula and Zanfei (this volume) refer to the recent shift away from asset –
exploiting and towards asset -augmenting investments by MNCs, which is typically
associated with a greater dispersion of inn ovative activity in the international network of
an MNC. However, the nature of the relationship between MNC international
innovation systems and local systems varies across regions (Cantwell and Iammarino,
2000, 2001). This entails different types of regi onal strategy for technological
competitiveness.
Evidence has now emerged that the choice of foreign location for technological
development in support of what is done in the home base of the MNC depends upon

17whether host regions within countries are either major centres for innovation or not
(termed ‘higher order’ or ‘lower order’ regions by Cantwell and Iammarino, 2000).
Whereas most regions are not major centres and tend to be highly specialised in their
profile of technological development, and hence at tract foreign -owned activity in the
same narrow range of fields; in the major centres much of the locally -sited innovation of
foreign -owned MNCs does not match very well the specific fields of local
specialisation, but is rather geared towards the developm ent of general purpose
technologies (GPTs) that are core to cross -industry innovation today (notably
information and communication technologies, ICT) or in the past (notably mechanical
technologies). The need to develop such GPTs is shared by the firms of all industries,
and the knowledge spillovers between MNCs and local firms in this case may be inter –
industry in character. Thus, ICT development in centres of excellence is not the
prerequisite of firms of the ICT industries, but instead involves the eff orts of the MNCs
of other industries in these common locations.
Table 6 here
Turning to competitiveness at the level of an individual firm, the determinants of cross –
company growth summarised in Table 6 derive from a cross -sectional regression
analysis of 143 of the world's largest firms between 1972 -82 (Cantwell and Sanna –
Randaccio, 1993). As has been remarked earlier, a key aspect of innovation and growth
in the firm has to do with the largely industry -specific environment that firms have in
common and wh ich regulates their individual behaviour and partially reflects their
mutual interactions (Levin, Cohen and Mowery, 1985). Thus, the growth of demand and
of technological opportunities in their own industry are key influences on corporate
performance.
It is curious that although the work of Penrose and Downie mentioned at the start of this
chapter emphasised issues of the creation of firm -specific capabilities and intra -industry
competitive rivalry, until quite recently even that minority of economists that did work
on firm growth paid relatively little attention to these issues. However, now the notion
of corporate competence has moved centre stage in the strategic management literature
(see Lam, this volume). Penrose had argued that the competitive advanta ges of a firm
derive essentially from the cumulative and incremental learning experience of its
management team, which experience differentiates it from other firms. The
distinctiveness of the firm's accumulated experience and knowledge determines the set

18of opportunities for growth which it perceives ahead of its rivals when screening the
external environment (the growth of demand and technological opportunities in its
industry). Corporate technological competitiveness is the principal advantage of this
kind associated with differentiated learning (Cantwell, 1989, Teece, Pisano and Shuen,
1997). A higher technological capability lowers the unit costs and raises the demand
curve of the firm at a given rate of growth, and it facilitates new entry into related
product lines. A more technologically competent firm is able to utilise its existing
experience to lower the costs of expanding its managerial and technical team in related
areas. Technological competitiveness comes out as one of the most statistically
significant influences upon firm growth of the variables listed in Table 6. In that large
firm study it was measured by the firm's share of patenting in its industry relative to its
market share (of industry output), both in terms of the relevant world indus try.

5. Conclusions
To return to where this chapter began, competitiveness derives from the creation of the
locally differentiated capabilities needed to sustain growth in an internationally
competitive selection environment. Such capabilities are created through innovation,
and because capabilities are varied and differentiated, and since the creative learning
processes for generating capabilities are open -ended and generally allow for multiple
potential avenues to success, a range of different actors may improve their
competitiveness together. Innovation is a positive sum game that consists of the efforts
often of many to develop new fields of value creation, in which on average the
complementarities or spillovers between innovators tends to outweigh nega tive
feedback or substitution effects, even if there are generally at least some actors that lose
ground or fail. The basic conclusion is that efforts to promote competitiveness through
innovation can rarely be understood in isolation from what others are achieving at the
same time. This applies whether we are speaking of countries, of national groups of
firms in an industry, of sub -national regions, or of individual companies. Indeed, it is
worth emphasising that the degree of interaction between innovator s in search of
competitiveness has tended to rise substantially historically, and has attained new
heights in recent years.

19Firms are less independent than they were, and that they now all float in a much deeper
sea of background knowledge, which Nelson (1 992) refers to as the 'public' element of
technology. There are at least four aspects to this – inter -company knowledge flows
have increased, there is a growing role for governments and other non -corporate
institutions in knowledge development and transfer , the importance of science for
technology has risen and diversified in its impact, and there has been a tendency
towards more rapid codification and the formation and spreading of professional and
scientific communities. We can now think of firms and the individuals aboard them like
ships floating in a sea of public knowledge which connects them, or more accurately
potentially public knowledge since the extent that they can draw upon it depends upon
their own absorptive capacity and on their membership of the appropriate clubs
(whether inter -company alliances or professional associations and the like). Over time,
especially since 1945, firms have been designed to float deeper down in the water, but
they still always leave a critical part comprising their ow n tacit capabilities above the
surface, which does not sink down or fall into the general mass. Indeed, holding
stronger capabilities above the surface is positively related to the depth to which one can
reach below the surface, both for the absorptive cap acity to extract complementary
knowledge and for the extent to which one contributes oneself to the public knowledge
pool. Universities and governments have increasingly contributed to the sea of public
knowledge as well. Additionally, among firms that del iberately cooperate through
technology -based alliances personnel can be exchanged so as to coordinate learning
efforts.
The sharing of knowledge between firms implies not just that technology must be
developed through an interactive social and cultural evo lution rather than through a
biological evolutionary process involving competition between genetically independent
entities, but also that followers and innovative adapters may stand to make greater gains
than the original leaders in some new field of tech nological endeavour. For example,
knowledge developed in one context may ultimately prove to have a bigger impact in
another, which was not foreseen by the originator or even perhaps initially by the most
innovatively successful recipients. Firms also devo te now much greater effort to
attempts to understand their own technological practice and that of others. Codification
of knowledge is the outcome of a conscious effort, shifting back the dividing line
between what is potentially public and what is tacit ( Cohendet and Steinmueller, 2000;

20Cowan, David and Foray, 2000). So firms that become especially adept at codification
may find that this is a source of competitive advantage since they can then more readily
draw on the public pool.
To engage in this inter -company interaction fruitfully, firms must maintain an adequate
diversification of their in -house technological efforts, since the closer that knowledge is
to the proprietary interests of a firm the more likely that it will only be shared in return
for som ething else that is probably technologically complementary, which is what each
firm needs to join the relevant corporate club (Cantwell and Barrera, 1998). The
entrepreneurial function has not been eliminated but it is more institutionally embedded
in an a bility to network and make new connections (see Grodal and Powell, this
volume) .
The interaction effects between innovators has been further compounded by the role of
ICT as a means of combining fields of knowledge creation that were previously kept
largel y apart (or what Kodama, 1992, terms technology fusion, and has led to the
creation of new fields such as bioinformatics). ICT thus broadens the field for potential
innovation by linking formerly separate areas of innovative activity. ICT potentially
combi nes the variety of technological fields themselves and so increases the scope for
wider innovation.
So, in the light of these recent changes in emphasis in the context for innovation and
competitiveness, how can we re -evaluate some of the earlier literatur e in the field that
has been summarised here? Which lines of research have perhaps run out of steam for
the time being, and which offer the most promising new avenues or opportunities for
future research? The revival of the classical issues of competitiven ess at a national level
(section 2) has been useful in that it represents a return of interest into the major
questions of the wealth of nations, which are of primary importance from a social
viewpoint. However, this new literature has also exposed the lim itations of trying to
tackle what are really issues of structural change at an aggregate level. It might perhaps
be judged that we have gone about as far as we can for now with purely cross -country
models. It may well be for this reason that the focus of t he latest research has tended to
shift to the industry and firm levels, allowing for (indeed now emphasising more) the
scope for technological interactions between firms and industries, so as not to lose sight
of the wider context or the aggregate effects.

21When recasting the analysis at an industry level (section 3), we now know a good deal
about historical shifts in patterns of industrial leadership between countries, about the
role of education and skills in catching up economies, and how particular kinds of skills
help to account for inter -industry discrepancies in innovative potential. Arguably we
still know too little about the interaction between governments, non -business
institutions and firms (especially large firms) in the process of establishing
competitiveness. In particular, we would like to know more about university -industry
(science -technology) interaction over a wider range of countries, beyond the relatively
clear picture that we have for the US (see Mowery and Sampat, this volume). The
conte xt here is what seems to be the growing significance of a local science base for the
construction of corporate capabilities and hence competitiveness, including and perhaps
especially in latecomer economies. Note that this newly emerging view reverses the
'traditional' perspective that developing countries should concentrate on (organisational
innovation in) lower skill activities, and leave science to the largest most developed
economies.
Coming to competitiveness at the firm or cluster level (section 4), the latest research has
also had a renewed focus on the role of inter -company interaction in knowledge creation
and innovation, especially in sub -national regional areas, and through alliances or
cooperative agreements. Here we now know more of the details of the localised
character of innovation, and of the steady growth in technology -based alliances as a
means of facilititating competitiveness through knowledge exchange and spillovers.
Work on firm size and innovation or growth seems to have rather run ou t of steam for
now, at least insofar as it had regarded individual firms as quite independent entities.
We need to know more about the specificities of knowledge flows between regions and
between firms, of how and where technological knowledge is sourced b y firms, and
then how such knowledge is effectively combined in networks of interrelated innovation
within and between firms. This is surely an exciting agenda for further research.

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26Table 1 – The decomposition of the pr edicted growth in national market shares
from an estimated empirical model of cross -country competitiveness, for 1961 -73

Country Japan UK USA

Growth in technological
capabilities 66.9 6.9 -0.6
Rise in relative unit
labour costs -0.9 0.8 1.6
Initial technological
capabilities (catch up) 20.9 15.9 7.3
Investment as share of GDP,
and growth of world demand 16.5 -39.8 -38.2
Total growth in market
share (predicted by model) 103.3 -16.2 -29.8

Source: Fagerberg (1988).

27Table 2 – Actual growth rates ac hieved by countries, 1960 -89, over and above that
predicted by (inter alia) their rates of capital accumulation

Investment/GDP (%) Actual minus predicted growth
rate of GDP per capita

Hong Kong 27.3 0.031
Korea 24.9 0.032
Singapore 34.3 0.017
Taiwan 25.0 0.047
Gabon 40.0 -0.030
Algeria 35.0 -0.026
Greece 24.2 0.008
Panama 24.0 0.002
Portugal 23.7 -0.002
Jamaica 25.0 -0.037
Ireland 22.2 0.011

Source: Nelson and Pack (1999).

28Table 3 – Educational enrolments in technical subjects at tertiary level as a % of
the total population in selected countries, in 1995 or closest year available

Natural science, maths Engineering
and computing (%)

Japan 0.07 0.39
France 0.53 0.09
Germany 0.39 0.49
UK 0.31 0.38
USA 0.39 0.31

Hong Kong 0.20 0.25
Singapore 0.10 0.47
Korea 0.56 0.98
Taiwan 0.24 0.86

Indonesia 0.02 0.11
Malaysia 0.07 0.07
Philippines 0.22 0.33
Thailand 0.14 0.19
China 0.03 0.10
India 0.10 0.02
Argentina 0.21 0.29
Brazil 0.09 0.10
Mexico 0.06 0.27

Source: Lall (2001).

29Table 4 – The industries in which the largest nationally owned firms have
persistently held comparative advantage in innovation, in 1920 -39 and 1978 -95

US-owned UK-owned
Food and drink Textiles
Office equipment and computing Other transport equipment
Other tr ansport equipment Coal and petroleum products
(other than motor vehicles)
Rubber and plastic products
Non-metallic mineral products
Coal and petroleum products (oil)
Professional and scientific instruments

German -owned Swiss -owned
Chemicals Chemic als
Pharmaceuticals Pharmaceuticals
Metal products Mechanical engineering
Motor vehicles

French -owned Swedish -owned
Metal products Mechanical engineering
Rubber and plastic products
Non-metallic mineral products

Source: Cantwell (2000).

30Table 5 – The shares of patenting of the largest industrial firms attributable to
research facilities located in the biggest single region of selected European
countries, in 1969 -95

Belgium (Flanders -Brussels) 78.6
France (Île de France) 57.9
Germany (No rdrhein Westfalen) 27.0
Italy (Lombardia) 52.3
Netherlands (South Netherlands) 62.7
Sweden (Stockholm -Östra Mellansverige) 49.5
Switzerland (Basel) 57.5
UK (South East England) 46.9

Source: Cantwell and Iammarino (2001), and (for Germany) Cantwell ,
Iammarino and Noonan (2001).

31Table 6 – The statistically significant determinants of comparative growth among
the world's largest industrial firms, 1972 -82

Regressor Sign of coefficient

Growth of own -industry demand +
Growth of own -industry techn ological opportunities +
Firm size –
Firm-specific technological competitiveness +
Degree of market power +
Relative multinationality within own -industry +
Increase in multinationality over period +

Source: Cantwell and Sanna -Randaccio (1993).