Institutions, Innovation and Development-Collected Contributions From Workshop

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Institutions, Innovation and Development-

Collected Contributions from Workshop
Article · September 2009
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Working Paper Series
Department of Business Studies
No. 5, 2009
Institutions, Innovation and Development - Collected

Contributions from Workshop
By
Allan Dahl Andersen, Björn Johnson, Erik Reinert, Esben

Sloth Andersen and Bengt-Åke Lundvall
Institutions, Innovation and Development - Collected Contributions
from Workshop
Allan Dahl Andersen

Aalborg University
E-mail: allanda@business.aau.dk
Björn Johnson
Aalborg University
E-mail: bj@business.aau.dk
Erik Reinert
Esben Sloth Andersen

Aalborg University
E-mail: esa@business.aau.dk
Bengt-Åke Lundvall
Aalborg University
E-mail: bal@business.aau.dk
ISBN 9788791646348
Institutions, Innovation and Development Workshop, Aalborg, May 2008
Preface 2
Contributions 3
1. Institutions, Innovation and Development – A Comment on Erik Reinert’s Quality Index 6

- Allan Dahl Andersen
2. A Note on Institutions as the Root Cause of Development 21

– Björn Johnson
3. Emulation vs. Comparative Advantage: Competing and Complementary Principles

in the History of Economic Policy 30
- Erik Reinert
4. A Note on Erik Reinert’s Schumpeterian–Listian Development Economics 59

- Esben Sloth Andersen
5. Toward Developmental University Systems 74

- Bengt-Åke Lundvall
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Preface
“Is there some action a government of India could take that would lead the Indian economy to grow
like Indonesia’s or Egypt’s? If so, what, exactly? If not, what is it about the “nature of India” that
makes it so? The consequences for human welfare involved in questions like these are simply
staggering: Once one starts to think about them, it is hard to think about anything else - Robert
Lucas” (Lucas 1988).
In May 2008 we organized a workshop on ”Institutions, Innovation and Development” at Aalborg

University (see: http://www.business.aau.dk/wiid/). It was a successful event which resulted in
fruitful and interesting interaction among participants. Another, and more tangible, output of the
workshop is this collection of the working papers published in the working paper series of the
Department of Business Studies, Aalborg University.
The main motivation for the workshop is encapsulated in the quote from Robert Lucas above.
Moreover, it is our conviction that research, within evolutionary economics, on innovation and
technological change holds great potential for explaining and guiding economic development. The
opening statement in the INNOGRIPS workshop on Innovation & Development which was held in
Manchester in April 2008, nicely presents the argument: “Innovation studies have mainly originated
in, and focused on, industrialised economies. In some ways this is not surprising, since much of the
investment and pace-setting in innovation has stemmed from these countries. Though it took a long
time for many economists to realise it, technological innovation has been widely recognised as a
major factor in the growth of these economies. There is now increasing awareness of, and interest
in, the importance of innovation for the so-called “less developed countries” (INNO GRIPS, 2008).
The workshop put attention to themes as learning, innovation and institutional economics. Our
intention was to strengthen research on developmental issues within the IKE-group through the
involvement of other research groups and independent researchers (from inside or outside Aalborg
University) with similar interests. The idea was to stimulate a positive and open atmosphere of
informal interaction and discussion rather than standard presentations. Such a format is moreover
suitable for outlining and/or identifying new important research areas.
The organizing group at Aalborg University consisted of Bengt-Åke Lundvall, Birgitte Gregersen,
Björn Johnson and myself – I served as main coordinator of the event and as editor of this collection
of papers. Participants in the workshop, besides the organizers, were Erik Reinert, Esben Sloth
Andersen, Mammo Muchie, Erik Stubkjær and Jan Holm Ingemand plus a number of attendees.
We are currently in the process of organizing the WIID 2009, which will take place in early May
2009, Aalborg. We hope to repeat last year’s success and keep focusing our attention at the some of
the most relevant challenges for economic research.
Allan Dahl Andersen

Aalborg, February, 2009
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Contributions
Allan Dahl Andersen delivers a comment on Erik Reinert’s quality index of economic activities
which is a central element in his writing. The basic proposition is that some economic activities are
more promising than others with respect to stimulating economic development. On the basis of this
Reinert proposes a quality index of economic activities in the form of a hierarchy in terms of value
creation. Allan Dahl Andersen reflects on the dynamism of this hierarchy and on how value is
created within it. Activities of learning and innovation strongly influences the position of an
economic activity, but wealth can also be derived from more static forms of monopoly. The key
issue is whether the entry barrier to a given activity is based upon imitable or non-imitable factors
and the difficulty in imitating a competitive advantage. Whether firms are able to imitate a given
technology is affected by firm-external factors. Therefore an innovation system approach is
proposed for understanding what determines capability to imitate in a systemic perspective. Within
the latter framework industrial policy is proposed as one mean to change one’s position within the
hierarchy by stimulating learning activities. This contribution takes the form of an approach to
understanding economic development based on the distinction between low-quality and high-
quality economic activities, but the author ends up questioning this distinction because it tends to a
priori categorize a large part industrial activities as non-developmental.
In his contribution Johnson enquires into whether institutions can be considered as the root cause of
development. Institutions have received a lot of attention in the array of development economics
during the last decade, but the most powerful discourse, one which Johnson terms new
institutionalism, regarding institutional research carries within it serious limitations. Within the
latter approach institutions are seen in a “narrow” sense which reflected by a strict focus on
property rights, transaction cost and other good-governance indicators. The research is currently
driven by recently constructed databases of these indicators that allow for quantitative studies of
institutions. Johnson acknowledges that this research enriches development studies but also
encourages cautiousness regarding the interpretation of it. The growth of other strands of literature
(e.g. on common pool resources and social capital) indicates that factors other than good
governance are important for development. Especially the lacking focus on how institutions and
institutional change are geared towards processes of learning and innovation, troubles the author.
The co-evolution of institutions and technology has been and is one key dimension for
understanding economic development – as long as this aspect is not incorporated in new-
institutional research, it can hardly supply us with a root cause of development.
Reinert’s contribution is not representative for but still presents part of his recent book (Reinert,
2007) wherein he outlines a skeleton of an alternative theory of development and international
trade. In the following contribution Esben Sloth Andersen comments extensively on Reinert (2007;
2008) with the intention to light up the potential for (a revival of) Schumpeterian-Listian
development economics. In his contribution Reinert illustrates how the adherence to different
economic principles leads one to very different policy conclusions. Reinert analyzes two different
strands of literature based on “emulation” and comparative advantage, respectively. In the analyzes
he includes various examples of successful and unsuccessful development policies where the former
has always been based on economics of emulation and the latter on comparative advantage. The
economics of comparative advantage fail to both diagnose and treat problems of underdevelopment
because it does not pay attention to the core drivers of capitalistic economies which are innovation
and dynamic competition. Innovation in a broad sense is about qualitative change of economic
activities which is and has been the essence of development. With regard to the polemics of
protective trade policies, he argues that there is a good and a bad use of the infant industry argument
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– protection is not bad per se, the world is more complex. Reinert argues that protective measures
have been part of most successful development histories because it takes time to build industrial
capability. On the other hand free trade has been used as an imperial tool to de-industrialise other
countries.
Sloth Andersen contributed with a document containing extensive comments on Reinert’s general
work (Reinert, 2007) in occasion of the workshop. Moreover, Sloth Andersen, who is an
international expert on the work of Joseph Schumpeter, gives a convincing positioning of Reinert’s
work within both earlier and contemporary literature on development economics. The former
category of research receives primary attention though, especially with respect to the work of
Schumpeter and Friedrich List. Sloth Andersen identifies Reinert’s errand as constructing a new
vision for the “high development economics” (Krugman, 1994) which dominated the literature in
the 1940s and 1950s. Still, Reinert’s work (vision) currently suffers from similar weaknesses as it
did the “high development economics” – the main problem is the lack of formal and analytical
modelling/simplicity, of which Schumpeter was an admirer. In Schumpeter’s spirit Sloth Andersen
formulates a potential research agenda which, according to him, must be taken into account if this
revival of “high” theory is not to suffer the same faith as it did earlier.
At the core of the research agenda, as of the comments, one finds 2 important differences between
the work of Reinert and Schumpeter. One, while Reinert insists on perceiving neo-classical
economics and “the other canon” as incompatible, Schumpeter always pursued a synthesis between
the framework of Walras and one of economic dynamics. According to Sloth Andersen,
Schumpeter would recognise both approaches with a clear emphasis on the primary importance of
dynamics. Two, while Reinert’s methodology consists of a collection of historical case studies rich
on details (in the tradition of the German historical school), Schumpeter had a preference for
analytical simplicity preferably materialized in a (tractable) model.
In the contribution from Bengt-Åke Lundvall, he focuses on the role of universities in developing
countries for economic development. His point of departure is the current international debate on
the role of the university as an entrepreneurial university (the 3rd mission) according to which the
university should be managed as a firm – thus by use of “the logic of the market”. He argues that
use of “the logic of the market” can create contradiction with what is known as the 1st and 2nd
mission of the university – education and research – especially in developing countries. Instead he
proposes another kind of logic – one which is encapsulated in the concept of a developmental
university. The developmental university is defined as being open and it interacts with different
groups in society, including industry. Its primary aim is to contribute to social and economic
development while at the same time safeguarding a certain level of autonomy (from political
interests). Within this logic students are more likely to acquire knowledge that is relevant and
applicable in the context wherein they live. Also, the research agenda in a developmental university
will be geared towards solving local social problems.
The role of universities must be seen within the context of a national innovation system. Hence,
Lundvall proposes a “developmental university system” wherein a division of labour is required in
order to achieve a better performance with scarce resources. The organization of such a system must
take into account the given productive structure and existing demand since it is not obvious that
university graduates will be the group most needed - wherefore the system should also include e.g.
poly-technicians and other ”practical” training. Lundvall suggests that the division of labour
contains universities that, respectively, specialises inter alia in local problem-solving, training and
-4-
connecting with the international research groups and the world research frontier in selected areas.
Lundvall concludes with a reform proposal for universities in developing countries which gives a
crude indication on how they may manage in the global learning economy.
-5-
Institutions, Innovation and Development – A Comment on

Erik Reinert’s Quality Index
I will discuss the relations between institutions, innovation and development with the publication of
Erik Reinert (2007), “Why Rich Countries Got Rich…and Why Poor Countries Stay Poor”, as point
of departure. The publication served as one motivating factor for arranging the workshop and has
been a central element in my PhD work. Throughout this partly introductory chapter, I will refer to
Reinert’s work and to several of the other contributions to the workshop. Moreover, I give an
outline of an approach to both economics and development based on my understanding of
evolutionary economics with institutions, innovation and development as focal points.
During the latest three decades there have been several discussions and discourses within the
mainstream research on development economics. The strength of the neo-classical research
paradigm was the driver behind a mantra that development was all about “getting prices right” in
the 1980s which implied correcting market failures in order to make the optimal resource-allocating
price mechanism do its job properly. Several disappointments in development programs in Latin
America and Africa designed on the basis of “getting prices right” combined with the East-Asian
growth “miracles” left this discourse in a dire state. Moreover, outside the mainstream school of
research a group of “heterodox” scholars discussed “getting the prices wrong” and were
unimpressed by the focus on “new” institutionalism (Amsden 1989; Wade 1990). Their argument
was that the price mechanism may allocate resources smoothly according to a static perception of
the economic system where the qualitative structures at every level remain the same. But, it would
not induce a process of economic development since this implies completely changing the
economic system. Additionally, manipulation with prices via industrial policy may be necessary to
stimulate growth. The latter development affected the mainstream research agenda in the sense that
institutions became the new buzz – “Getting institutions right” was the mantra of the World Bank
et. al. during the 1990s. Still, as Johnson (2008) points out, when one, as the World Bank, defines
institutions as macro stability, private property rights, absence of corruption and violence, then it
does not make much sense to claim that institutions are the source of economic development.
Similar insights led the World Bank’s search process for the holy grail towards considering
knowledge, innovation and technology as important factors for development.
A recent contribution by Erik Reinert (Reinert 2007), which is in line with “getting the prices
wrong”, suggests a new slogan for the troubled research agenda of development economics – it is
about “getting economic activities right”. His point is that some economic activities are better suited
than others for stimulating economic development in a developing country. His points open a
broader and well-known discussion about how industrial structure – mix of economic activities –
relates to economic dynamics, performance and growth. Thus, the argument is that industrial
structure is even more important than both allocative market efficiency and “good institutions” (as
described above). With this as point of departure I describe a approach to economics which pivots
around learning activities and innovation as the most fundamental factors in the process of
economic development.
How one defines objects and phenomena determines which kind of questions one asks and thus
partly which kind of answers one will get. Therefore, it is appropriate to outline the ontology which
underlies the theoretical framework. The theoretical approach can be characterized as “old”
institutional economics (Hodgson 1998) or as evolutionary institutional economics (Andersen
2008). Here a market is a context-dependent institutional set-up, that cannot guarantee optimality.
-6-
Social phenomena are studied as multilevel and multidimensional recursive systems where positive
and negative feedback mechanisms between overlapping and interacting sub-systems are of great
importance (Arthur, Durlauf et al. 1997). The difference from a mainstream approach to economics
can to some extent be understood as a use of the language and metaphors of biology instead of those
from classical physics. This implies that co-evolution between systems and between agents and
structure is to be expected (Arthur 2000). Moreover, the perception of the individual agent as an
omnipotent global “maximizer”, that inspires methodological individualism, is rejected. Instead the
individual is seen as “satisficing”. Satisficing implies that individuals try to optimize relatively to
their different local contexts (constrained both by limited information and by limited information
processing capabilities), which produces the range of variety of people, ambitions, desires and
actions that we observe in the real world (Simon 1983). The economic system is characterized by
“strong uncertainty” which refers to a situation where possible outcomes and the possibility
distributions attached to them are not known ex ante (Verspagen 2003). The basic dynamism of
change in economic systems is thought to arise from processes of mutation, imitation and selection
as proposed by Richard Nelson (Nelson 1995). Furthermore, in terms of vocabulary, institutions
(formal and informal) refer to “the rules of the game” wile organizations (private, public, NGO)
refer to the actors of the game (Edquist and Johnson 1997).
Learning, Innovation and Development

One might argue that a traditional production function, e.g. F(K,L,Land), is merely a static and
descriptive piece of information which says little about how value is created. Instead one should
focus on a function of F(energy, material, knowledge) – processing material creates value but
necessitates energy and the processing is planned according to available knowledge (Boulding
1992). There are feedback loops between the three (especially material processing and knowledge)
which can be called learning. In this respect knowledge can be seen as the most important economic
resource and learning the most important economic activity.
Accepting the above proposition leads to an approach to economic development that pivots around
learning activities (capability building in another terminology) at the level of the individual, the
group, the organisation, the region and the country. The crucial importance of learning is derived
from the insight that knowledge is often the most important resource in the economic system –
hence, learning is all about acquiring, applying and generating knowledge. Technology is a part of
knowledge as a concept. When we understand technology in the broadest sense (e.g. “social
technology”), it is nearly equivalent to knowledge. At the backbone of the history of economic
wealth we find people that via the use of technology have managed to transform a natural resource
into something else that holds a higher value than it did – a value-adding activity. In order to
succeed in a value-adding activity, knowledge about the process of transformation is decisive for
the outcome. The latter is true for all aspects of learning and economic activities – in fact, it is at the
core of development issues. Improving the processing technology, products or the mode of
production via learning can be understood as innovation. Innovation can, in a broad sense, be
defined as doing things in new ways which often emanate from problem-solving activities. When
conditions change and routines no longer work, humans experiment and learn. In a narrower sense,
innovation means developing or adopting new ideas and transform them into new products or
processes. Thus, innovation is the outcome of a process of learning1. Since learning is
1
Innovation is not always an outcome of an intentional learning process. It may be accidental, unintended or
unforeseen.
-7-
predominantly interactive and therefore a process that is socially embedded, it cannot be understood
without considering the institutional and cultural context (Lundvall 1992).
It should be noted that development is a rather imprecise term. Normally one relates development
(in economics) to problems of poverty, macro imbalances, declining terms of trade, commodity
specialization, short life expectancy, illiteracy and lacking human and political rights. The most
common definition today for underdevelopment refers to a poverty line for individuals (less than
$US 1 (or 2) per day) - at the national level, development is defined in terms of income per capita.
Development, as used by Joseph Schumpeter, and in studies of industrial dynamics, refers to
“change” in the economic structure which may lead to improvements or deteriorations of
development indicators. In this spirit I argue that development as structural change is at the heart of
problems of development – that the qualitative characteristics of the economic structure of a given
nation will determine the performance on development indicators. Qualitative change in economic
structures - changing the composition of economic activities or/and their characteristics - is to a
large extent the outcome of innovation2.
The above argument can be linked to what has been called “high development theory” (Krugman
1997). High development theory, whose prime was in the 1950s, argued that structural change is the
key parameter for explaining development and underdevelopment. Famous authors related to this
trend were inter alia Raul Prebisch, Albert Hirschman, Celso Furtado and Hans Singer. They argued
that economic activities are qualitatively different and have different impacts in terms of growth
potential, employment generation, value added and ability to generate increasing returns to scale3.
Related to the international trend regarding research on development economics, the high-
development-theory approach was forgotten inter alia due to the dominance of neo-classical
economics in all spheres of economic research. Especially the aggregate production function
approach to growth advocated by Robert Solow, in which sectoral differences and qualities do not
matter, put this structuralist approach in the grave (Cimoli, Porcile et al. 2005). These ideas
persisted though, in pockets of heterodox economics represented by economic historians and
scholars of technological change. According to these scholars the wealth and poverty of nations has
historically been determined by their capability to change and develop their industrial structure by
use of new knowledge and technology (Rosenberg and Birdzell 1986; Landes 1998).
On the basis of the above, it can be argued that development and underdevelopment to a large
extent are caused by international differences in capability to learn, to innovate and to produce and
apply new technology. The engine of development is changes in productive structures in the pursuit
of value-adding activities. Still, this introductory framework description leaves much to be said –
e.g. which kind of structural change should be targeted? And how can one achieve such structural
change?
Structural Change and Qualitatively Diverse Economic Activities

To come one step closer to understanding why and how some economic activities are more
promising than others, it is helpful to follow Reinert’s lead (2007) in seeing the economic system as
2
Qualitative change is a broader term that structural change since the latter mainly refers to the composition of an
economy – the components can change in terms of quality without the overall structure seems to change even though
there will be causal links. I will mainly adhere to the use of the term qualitative change.
3
What these authors failed to acknowledge was that technical development does not happen automatically – it seems
that they did not pay sufficient attention to the learning divide (Cimoli, 2005).
-8-
a hierarchical system4. Reinert proposes to make a distinction between high and low-quality
economic activities. In a straight-forward manner economic activities with high productivity
growth, high potential for further technological improvement, facing dynamic demand,
characterised by imperfect competition and thus having high barriers to entry are high-quality
economic activities. Low quality-economic activities are characterised by close-to perfect
competition, low productivity growth, limited potential for further technological improvement, low
demand elasticity, barriers to entry based on low wage rather than knowledge and little learning
required, cf. figure 2 in Reinert’s contribution, page 39.
One of the main points made by Raul Prebisch and Hans Singer is that if a country specializes in
producing low-quality products for export and imports high-quality products, it will see its relative
welfare decrease continuously because of detoriating terms of trade. The primary reason is that the
high-quality sectors’ productivity growth rates are much higher than those in the low-quality
sectors. Therefore the country specialized in the latter will face a worsening of its exchange
relation. Hence, productivity growth and levels hold the key – in this case with respect to trade.
High-quality activities produce wealth for several reasons (besides trade effects) which I seek to
explain in the following. Moreover, I suggest a causal link between the concept of high-quality
activities and economic growth at the level of the nation.
Static and Dynamic Rents

If we to begin with consider the hierarchy in a static perspective, then the high-quality activities are
able to generate high incomes to the producers due to barriers to entry. Barriers to entry create rents
that can be reaped by entrepreneurs (Kaplinsky 2005). One can distinguish between static rents and
Schumpeterian (dynamic) rents where static rents build on e.g. natural monopoly and are unlikely to
be eroded over time. Schumpeterian rents arise from a certain mode of production based on a
special type of organizational structure, technology or institutional set-up. Schumpeterian rents are
likely to erode over time due to the presence of imitators and arrival of new modes of production
(Reinert, 2008). In short, some activities hold more value than others because they are difficult to
imitate (given presence of demand).
It is possible to divide the characteristics of economic activities, as proposed by Reinert, into three
broad categories, as can be seen from the table 1. These categories naturally interact in various
ways, cf. table 2. Their relative importance will depend on the given context. Therefore it is difficult
to, a priori, evaluate which “mix” will be “better” at generating economic rents.
4
An international hierarchy can be described for economic activities and countries performing these activities,
respectively. I will first focus on economic activities and later suggest a link to a hierarchy of countries.
-9-
Supply-side, Static Rent Supply-side, Dynamic Rent Demand Conditions Rent

Characteristics -Natural monopoly not imitate- -Temporary monopoly -Dynamic/growing demand
able over time (e.g. oil, historical -Learning -Large scale/niche market
tourism, geography) -Technological progress
-Institutional change
-Organizational change
-Productivity increases
Features Fixed in short run Endogenous comparative Often constantly changing – its
Market conditions advantage – seems to be the more interaction with creation of
Competition mode important dynamic rents very important
Positive feedbacks from learning
Entry Barriers -Non-imitable -Knowledge
Table 1: Categories of Economic Activities
Dynamic Demand
Static Static rents can be a result of earlier dynamics. They Producers need access to demand concerning both
often co-exist. They can be complementary and co- commodities (large scale) and niche (high value)
evolve. products.
Dynamic XXX The quality of demand is important in developing new
products and ideas. The presence of demand is crucial for
launching and gradually enlarging production of new
products.
Table 2: Interaction between the various dimensions
If we consider the hierarchy in a dynamic perspective, we will see that the economic activities at the
top of the hierarchy are changing over time – a life cycle of technologies, products and modes of
production may be discerned. At first a new technology produces super profits due to imperfect
competition, but the super profits are competed away as imitators enter the industry and the
technology subsequently drops down in the hierarchy. The latter mechanism is at the core of
Schumpeter’s understanding of how innovation affects industrial dynamics. Schumpeter himself
described the hierarchy of the economic system as: “the upper strata of society are like hotels which
are…always full of people, but with people who are forever changing” (Reinert, 2008).
It is worth noting that most of the characteristics of a high-quality economic activity, mentioned
above, are based on productivity improvements5. It is important to note that as a mode of production
moves downward the quality index, the productivity of the production mode does not decrease –
rather it grows slower or it looses momentum6. When productivity growth declines, it will be
relatively easier for imitators to catch-up (given that technology is the main entry barrier) – which is
equivalent to the insights from the technology life-cycle theory. Hence, often the source of
Schumpeterian rents is productivity growth (given homogeneous goods) – one needs to
continuously improve productivity to avoid perfect competition which is also known as “the red
queen effect” (Albuquerque, Ribeiro et al. 2006).
5 Dynamic demand is important for generating economies of scale which is defined as falling marginal cost and thus
higher productivity; potential for further technological improvement refers to future improvements in productivity; the
exception is imperfect competition which refers to market structures and position vis-à-vis competitors.
6 Reasons for the downward movement can be (1) imitators are successful and perfect competition market structure is
the result or/and (2) a new and superior mode of production emerges.
- 10 -
Making the link from productivity growth to value-adding activities things are a bit more
complicated. Adding value is to process X7 with a technology that is hard to imitate, but it also
requires that someone values the product – the structure and characteristics of demand. The latter
implies that a value-adding activity is not necessarily subject of significant productivity growth, but
as a niche product it is highly valued (jewellery, special coffee, tourism in the Vatican). In the latter
case a combination of low productivity growth, limited potential for further technological
improvement and low demand elasticity can be characteristics of a value-adding activity if
combined with “unique” barriers to entry (geography, history)8 (Perez 2008). Often economic
activities are characterized by a mixture of the qualities of high and low-value products,
respectively9.
Hence, we have three dimensions for deciding the value of an economic activity which produces, at
least, two obvious questions: (a) how does one achieve (continuous) productivity growth? (b) how
does one enter a market with high-value adding?
Regarding (a), first, one should notice that firms, and not countries, improve their productivity. It
has been convincingly shown that innovation significantly improves firm performance (in terms of
survival rates, turnover and profit) which is an indicator for productivity growth. As said earlier,
innovation is the outcome of a learning process – hence continuously stimulating learning activities
in a firm is the only way to continuously improve productivity and to remain at the upper strata of
the economic hierarchy.
With respect to (b), when the degree of value-added is partly decided by the consumer/user, we
enter the complex area of preferences, price, quality and substitutability. There are basically two
mechanisms; (1) creating demand for one’s product via marketing or (2) product innovation (which
will need marketing and demand as well). With respect to (1) marketing is a highly creative process
which involves organizational, institutional and product innovation. Hence, innovation and learning
activities are very influential for entering/creating value-adding activities10.
Above I gave, via the concepts of static and Schumpeterian rents, a tentative explanation of how
one a priori can evaluate whether an economic activity is a high or low-value activity. It is a
complex matter and certainly there are objections to be made. I made reference to the results
showing that firm performance significantly improves if the firm innovates. Besides stressing the
importance of learning activities (in a broad sense), I did not go into the underlying process of
organizational management within the firm and I will not pursue this question further since it is not
my aim here. Instead, I will now leave the firm level and proceed to discussing factors external to
the firm and how they may affect productivity growth, innovation and learning activities in firms.
Firm behaviour is strongly related to how activities are placed in the quality index . It is firms that
perform these activities and subsequently improve and change them via innovation. Hence, how
firms manage, improve and develop knowledge and technology in certain economic activities
matters greatly for how these activities can be characterized in terms of productivity growth and
7
If X is scarce and only exists in certain areas (natural monopoly) then the processing does not need to be that
complicated to be valuable.
8
But could be much more valuable with a “strategic” approach – more on this later.
9
On a nation level the picture will be mixed. Activities that can be located at the bottom of the quality index may
account for a large part of national employment and make up a significant part of national GDP – such an insight
weakens the strength of a unilateral focus on growth pole sectors, but does not entirely dismiss it.
10 It should be noted though, that firm performance necessarily is relative – thus it depends on the capability of
competitors and institutional set-up.
- 11 -
contribution to GDP. Moreover, if one goes from discussing a hierarchy of economic activities to
discussing an international development hierarchy of nations, it has several implications. Firstly, the
underlying hypothesis is that the more firms (or share of production) in an economy that are located
in high-quality economic activities, the more wealth (or development) it will tend to accumulate.
This hypothesis is behind most work on technological up-grading and leapfrogging where the
presence in “high-tech” sectors is seen as determinant for engaging in a process of economic
development. Secondly, it has been stated that learning and innovation in firms affect their
performance in terms of productivity in production and in terms of entering/creating value-adding
activities. Since both learning and innovation are highly interactionist processes, there are several
firm-external factors that must be taken into account if one seeks an explanation for the positioning
of firms and economies in an economic hierarchy. I will try to do this in the following section.
Linkages, Innovation and Systemic Performance

Until now the arguments for one’s (firm or nation) position in an international economic hierarchy
related to Reinert’s quality index have rested upon firm performance generated by factors internal to
the firm, but there are other important factors that are external to the firm. In this section I will
discuss how firm-external factors can affect innovation and learning in firms - hence, focus is on
dynamic rents. Following the vocabulary in Reinert (2007), I will operate with the term increasing
returns to scale when discussing firm-external factors11.
Increasing Returns and Industry Dynamics

At the firm-external level, increasing returns to scale implies that individual firms benefit from
interacting with other actors (firms, universities, government)12. It has been shown that firms that
collaborate with other firms and/or research institutes have a higher propensity to innovate
(Lundvall 2001). Also, technologies can increase their productivity by interacting/integrating with
other technologies. It is obvious that the definition of increasing returns to scale is hard to capture.
Dosi (1988) refers to this phenomena as “untraded interdependencies among sectors, technologies,
and firms that take the form of technological complementarities, "synergies", flows of stimuli, and
constraints that do not entirely correspond to commodity flows. For example, knowledge and
expertise about continuous chemical processing may allow technological innovations in food
processing even when the latter do not involve any chemical inputs”.
At nation-state level one can imagine that an economy containing several economic activities
(sectors) that are able to feed upon the dynamics of one another, will be able to create synergy
effects among them and promote economic development at the national level (Reinert, 2007)13.
11 Here I treat increasing returns to scale as a systemic phenomena, which implies that the whole is larger than the sum
of its components – that interaction between system components generates a performance that individual components
would not be able to realize.
12
At the level of the individual firm, increasing returns to scale is defined as: increase all inputs with factor 1, if output
increases more than a factor 1, production is subject to increasing returns to scale. It is thus a term used to capture
productivity improvements (via change) in the firm generated by the systemic interaction between the components of
the firm (employees, organizational structure, technology, knowledge and external conditions).
13
The sectors per se do not need to be characterized by increasing returns but it would most likely increase the strength
of the dynamism. The strength and endurance of the process will also depend on linkages between sectors,
technological complementarities and general level of capabilities.
- 12 -
The latter idea corresponds to an approach that sees economic development as a chain of structural
disequilibria (Hirschman 1958; Dahmén, Carlsson et al. 1991). This entails focusing on the
transformation of economic structure, which means focusing on changes through time within and
among micro entities. The basic idea is that complementarity exists among technological,
economical and related factors. In a disequilibrium optic, these complementarities often produce
bottlenecks or structural tensions. If e.g. a new field of technological opportunities arises which
makes it profitable to restructure the economy/firm, then positive pressures will arise for new
investments to be made (changed perception of future profit opportunities)14. Once these
complementary investments are in place, the development potential is released. When the
complementary investments in turn produces further structural tensions in other parts of the
economy, then we have a development bloc. A development bloc refers to a sequence of
complementarities which by way of a series of structural tensions (disequilibria), may result in a
balanced situation or in a new structural tension (Dahmén 1994). The source of structural tension or
disequilibrium is most often new knowledge and new opportunities – innovation. It is obvious that
linkages in terms of demand-pull and supply push, is a prerequisite for the above-described
mechanism. The link to overall economic performance is evident, as Dosi (1988) puts it:
“Whenever these technological externalities - in the form of specific infrastructures, skill
availability, competences embodied in local firms, easier information about new production inputs -
reproduce through time as a sort of dynamic increasing returns, they also help explain the
differentiation in the technological capabilities, rates of innovation, and rates of diffusion among
regions and countries”. Hence, producing (dynamic) increasing returns (whose both initiating and
momentum-keeping factor is innovation) in the economic system is an important aspect of
economic growth and development.
I argue that the above described systemic increasing returns can arise in any (social) system, be it a
group of individuals, technologies or firms15 – this positive interactionist or synergy (among
components) effect arises from complementarity among these components16. One critical
prerequisite for this synergy effect, is that components must not be identical – hence, diversity is
needed in order to generate the above described process.
Increasing Returns and Diversity

The dynamism of the development bloc described above is mediated through linkages between
diverse actors in the economic system – diverse actors. The diversity of economic actors further
helps to explain the process of structural change via innovation and learning.
The basic idea is that bringing together diverse17 elements will “automatically” generate new
constellations (of knowledge)18. The latter, seems intuitively correct if one imagines gathering
people from various parts of the world with different educational, religious, cultural, political and
14
The strength of this pressure depends on the match (of the new opportunities) with prevailing institutional set-up and
quality of entrepreneurs (Dahmén, 1991).
15
Thus including agriculture and resource-based activities.
16
Strength of complementarities, and thus potential for increasing returns, will partially decide the degree to which this
dynamism can be produced.
17 Diversity: a range of many people or things that are very different from each other. Variety: several different sorts
of the same thing.
18
Too diverse components may prove counter productive, though.
- 13 -
social backgrounds in order to discuss the solution to a given problem – the probability that this
group of people would come up with a more creative/different solution than a homogeneous group
is significant (DeBresson 1996). Thus, heterogeneity, more often than homogeneity, produces
creative processes. The emphasis on heterogeneity inter alia comes from Joseph Schumpeter’s
emphasis on innovation as a new (re)combination of known, but diverse components. Aggregated
the insight brought about is that industrial/structural diversity is a good thing (for productivity
improvements), because it increases the potential of an economic system to bring together diverse
bodies of knowledge, which is likely to produce new solutions and ideas (potential innovations).
Given that structural diversity exist in an economic system, then linkages between bodies of
knowledge are a prerequisite for allowing them to interact and produce synergy effects. Thus, one
can argue that the more linkages a firm has to other organizations (across and within sectors), the
better access this firm has to diverse bodies of knowledge and hence a higher probability of
innovating (given firm capability). Lundvall (1985) distinguishes between tangible and non-tangible
flows of products between firms (user and producer – vertical linkages) and argues that “an
important aspect of the innovative process is the exchange of disembodied information between the
producer and the user via information channels. This is another way to state the close relation
between innovation and production”. Thus, input-output relations (tangible and intangible) between
the actors of the economic system (firms, universities and government bodies) and their untraded
interdependencies lie at the centre of the argument of firm externalities19.
The importance of linkages at governing knowledge flows between actors (and thus increasing their
probability to innovation) is an additional valuable point to the argument of the development bloc as
a sequence of economic disequilibria. When a structural tension created by e.g. an innovation,
which lead to the perception of new opportunities for firms, is released (via investments), then it
will produce further structural tensions. This process will must likely change the relations between
firms – some old contacts will wither, and new ones will arise (with new or incumbent firms). It is
thus reasonable to think that the firms involved in this process, will face radical change in their
linkage structure regarding both goods and knowledge20. These new structures will supply firms
with access to new diverse bodies of knowledge, and are thus likely to generate a stream of
innovations that will give further momentum to the development bloc dynamism21.
I will mention one more aspect of diversity in relation to economic development. A vast empirical
literature finds that firms are not a homogeneous group – they are intrinsically different (Dosi,
1988). Referring to the latter paragraph one can argue that diversity is a prerequisite for innovation,
but it is also (i) the result of innovation and (ii) a driver of imitation and diffusion of innovation.
Ad. (i); successful innovation of every sort is by nature asymmetry generating (diversity/variety) on
the firm level. The innovating firm gains an advantage vis-à-vis its competitors. Ad. (ii); the
competitors will need to imitate the innovating firm to compete, which entails a diffusion process of
the innovation. Thus, the innovation creates divergence among firms, which in turn, via competitive
forces, becomes a process of convergence on the industry level (given firm capability). In this sense
processes of innovation, diversity creation and changes in economic structures are mainly
endogenous phenomena that of course interact with and are affected by “external” factors. .
19
Information channels and goods channels are not identical, but tends to overlap – the overlap reflects user-producer
interaction and interaction between innovation system and production systems.
20
This dynamism would not be possible with identical firms.
21
Continuing the argument, supplying firms with access to “new” knowledge is a significant concern for industrial
policy.
- 14 -
Linkages between heterogeneous economic actors are thus very important for producing and
sustaining virtuous circles of qualitative change and economic development. Still, this is be no
means a natural phenomena in the sense that such linkages (not to mention their quality and
content) and derived dynamics occur automatically. They often need to be nurtured and stimulated
through policy – in the following section I propose an innovation-system approach as a framework
for understanding and not least managing these industrial dynamics.
System of Innovation
The development of linkages, innovation, investments and dynamic structural change is not
necessarily an automatic or “natural” process – instead such processes should and can be managed
to some extent. The logic underlying a “system of innovation” (SI) incorporates the elements
discussed above and provides a framework for perceiving the complexity of economic systems – it
serves as a focusing device for identifying problems at all levels22 which is one of its major
strengths. According to a SI approach one must include the micro level (firm performance and
capability), the meso level (sectors, linkages and dynamics), the macro level (stability, finance,
demand, etc.) and the (relevant) institutional set-up at all levels.
The main actors in an SI are firms or entrepreneurs who are able to generate, adopt and apply new
knowledge. They are complemented by government policy and other actors to various extents. In
less developed countries the government is more likely to act as entrepreneur due to
lacking/perverse private investment opportunities (Sloth Andersen, 2008). The main actors in a SI
are firms who are complemented by government policy and other actors to various extents.
Based on the perception that economic performance largely arise from innovation and learning
activities – plus the process of innovation has systemic features and is “interactionist” by nature
(Lundvall, 1992) – some of the most important areas of investigation are generation, imitation,
application and diffusion of new (and economically useful) knowledge and technology. The IS
framework is developed to study and understand these exact mechanisms. The emphasis given to
the interaction between the system of innovation and the system of production reflects that
innovation often takes place via the feedback mechanisms between research and development and
actual production while the initiative could come from both places – one can distinguish between
supply (R&D) and demand/need (production) that interact with one another and with the
surrounding institutional set-up. The SI approach provides an analytic framework for understanding
economic systems and hence learning how to identify, diagnose and proscribe medicine for
economic development.
Strategy for Structural Change – Industrial Policy

How does one change place in the hierarchy? This is of course the million-dollar question in
research on development economics. There are no easy answers but as Reinert (2007) puts it, if one
wishes to understand the determinants of development and underdevelopment one should start with
looking at the successful examples in history. As indicated above, these stories of development are
22
The SI approach has been applied at cluster, local, regional, sectoral, national and global levels – due to the nature of
complex systems (recursive) it is not possible ex ante to decide on which level is “optimal”, it must depend on the
subject-matter of the research.
- 15 -
stories of structural change in the broadest sense. Since the window of opportunity (Perez and Soete
1987) for changing one’s position in the hierarchy is constantly changing then there can be no
straight answer to how such a change can come about. Still, a tool can be devised for how to
maximize one’s probability for moving upwards in the hierarchy. The tool in question can be
termed “industrial policy” in its broadest sense which implies that nearly all other spheres of policy
should be guided by a national development (emulation) strategy.
Within the toolbox of industrial policy I see a distinction between two interrelated strategies.
One strategy is focused on technological catch-up in a concrete sense, as taking advantage of what
is and is concerned with a short-medium term time horizon (“narrow”). It is similar to a firm
strategy in the sense that a goal could be to conquer market shares, upgrade within the known
technology cycle, upgrade within a value chain, decrease dependency or vulnerability with known
technology. This approach focuses more on imitation and diffusion of knowledge rather than
production of new knowledge and radical innovation, but still (radical) institutional innovation is
crucial for successful imitation and diffusion of technology. In this case a relatively clear plan can
be formulated.
The second strategy focuses on long-term adaptation to the production mode of the “learning
economy” and on being prepared for or generating what will be. The latter entails constant focus on
stimulating learning and innovative activities in the realm of economic activities. The long-term
aspect implies that it is difficult to identify strategic areas of interest – to pick winners – wherefore a
“broader” approach to innovation is necessary. An approach that is more geared towards the
production of new knowledge in areas whose commercial potential is not yet known.
Since no clear a priori or generalisable strategy can be formulated in this case, an important point is
to recognize that a strategy is a trial and error process. Hence, one of the more important things, is
to have in place institutions that foster search, trial-and-error and learning processes - also when it
goes wrong, because it inevitable will go wrong to some extent since this is the nature of the game.
Each window of opportunity demands its special institutional set-up, but one aspect that can be
generalised is that learning processes must be stimulated and be at the core of a development
strategy (Mathews 2005).
The link between the two different strategies is encapsulated in the idea of the cumulativeness of
knowledge (Dosi, 1982; 1988). That knowledge is cumulative implies that (1) generating
knowledge via learning takes time (hence, different from information); (2) knowledge is not easily
transferred (absorptive capacity is needed); (3) qua an economic activity one accumulates
specialized knowledge. Point 3, reflects that one is most likely to innovate in the area of one’s
productive specialization – hence the interaction between the system of production and the system
of innovation. Due to the latter insight it is common to talk of the path-dependency, technological
trajectory and development path of a country, region or firm. Thus, it is likely that what is will
influence (though not determine) what will be.
Regardless of strategy and the development path targeted, the performance the national SI will be of
vast importance for whether such a strategy will be achievable. Hence, innovation (and thus
learning) is at the heart of economic development.
- 16 -
Institutions and Innovation

Institutions, as in evolutionary institutionalism (Johnson 1992; Hodgson 1998), are of outmost
importance in relation to innovation on several accounts. The institutional set-up of an economy
makes up the rules of the game, which can be understood as the incentive structure facing an
individual agent. Institutions are much more than an individual’s pay-off matrix, though. They
make up a complex network of formal, informal, social, economic, cultural, political and
international practices and routines that affect and are affected by the actions of organizations and
individuals (co-evolution) – what we call society. Thus, institutions not only constitute the rules of
the game, but also whether these rules are enforced, respected or ignored – how the game is played.
Also, since institutions, as defined here, are endogenous to the economic system, the change,
formation and consolidation of a given institutional set-up is an outcome of the history of an
institutional context.
Institutions affect the innovative performance of a given region in specific manners. For example,
learning, which is a prerequisite for innovation, is predominantly an interactive process and
therefore a process that is socially embedded and cannot be understood without considering the
institutional context. Moreover, institutions channel resources to innovative activities, they support
technological advances, education, resource allocation, the efficiency of the economy as well as
they influence and define the way actors accomplish their tasks and resolve conflicts (Edquist and
Johnson 1997). According to the above institutions geared towards a innovative mode of production
seem to be primary vis-à-vis innovation and technical change per se, but causality has gone and
goes in both directions. An institutional set-up co-evolves with technological change and both “set-
ups” interact with the actions of “independent” (non-deterministic structure) agents.
According to Nelson (1995) economic development involves a process of technical change and
institutional and organizational innovation – this is the foundation of development. There are
several examples in history where institutional change preceded technical change and directly
stimulated economic development. On how the United States and Germany catched-up with
England in the 19th century Fagerberg and Godinho (Fagerberg and Godinho 2005) argue “they did
not achieve this growth by merely imitating the more advanced technologies already in use in the
leading country, but rather did so by developing new ways of organizing production and
distribution, e.g. by innovating”. More recently the catch up of Japan to western productivity levels
during the first half of the twentieth century was associated with a number of very important
organizational innovations that, among other things, totally transformed the global car industry.
Concluding Remarks
Starting from the premise that economic activities are qualitatively different, it was illustrated that
economic development is a process of qualitative change in economic structures. Changes are
brought about via innovations that are the outcome of learning processes wherein knowledge is
absorbed, modified, generated and accumulated.
The learning potential of an economic activity is critical for its position in the quality index since it
reflects room for improvement (via innovation) which may create temporary entry barriers and thus
profits (Schumpeterian rents). Activities subject to Schumpeterian rents tend to be highly complex
in terms of knowledge content and as time passes, firms in these activities accumulates knowledge
that further manifests their leading position. The latter process continues until the growth rate of the
mode of production or technology slows or stops such that imitators can enter the game. A lesson
- 17 -
from the latter insight is that nations should support their industries in these endeavours and aim for
diversity of high-value activities that may produce synergy (also supporting linkage mechanisms).
Hence, according to this logic countries in development should try to get into high-value activities.
Does this logic likewise imply that low-quality activities should be entirely dismissed? That they
are a hindrance for climbing the international hierarchy? Or could they serve as stepping stones for
the first steps on the ladder of development?
How does a country in development manage such a task best? What would the policy advice be?
Build research centres of excellence for nanotechnology? An evolutionary approach to economics
would due to the strength of path dependence, point to the favourability of incremental change or
continuity (Schienstock 2007). The latter implies two lessons for development planning, (i) utilize
the already existing knowledge as a base for entering or developing new high-quality activities and
(ii) that it takes time to develop “technological capabilities” in economic activities wherein one does
not have experience (the Finnish success story was partly the outcome of 15 years of industrial
policy). In both (i) and (ii) stimulating learning is of massive importance.
According to proposition (i) developing countries may operationalize their “own” knowledge base
instead of focusing, 100%, on imitating the developed countries. Since the majority of developing
countries have a “specialization” in (or an economy characterized by) agriculture and primary
production, this hints at the plausibility of what can be called a resource-based development path
(Ramos 1998; Lorentzen 2006; Perez 2008).
- 18 -
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Perez, C. (2008). A Vision for Latin America: A resource-based strategy for technological
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- 20 -
A note on institutions as the root cause of development –

Björn Johnson23
Over the last 10-20 years ’institutions’ have been promoted to a kind of “deep cause” of
development. Institutions are now widely believed to form the preconditions for economic growth
and development - positively and negatively.
The argument is that even if there is a broad consensus that improvement in the quality of labor,
capital accumulation and technical change are crucial drivers of economic growth and development
they are only proximate causes. The deeper question is why some countries are better than other in
improving the quality of labor and stimulating accumulation and innovation.
Older answers to this question concentrate on geography (including natural resources and ecological
factors) and trade. In a recent version of this old argument Jeffrey Sachs and some of his colleagues
have maintained that development is strongly correlated with geographical and ecological variables
such as climate, disease ecology and distance from the coast (Sachs and Mallaney 2002).
Other economists argue that these effects operate predominantly through the institutional set-up.
Geography and ecology may influence the development of institutions, which, then, affect
development. These indirect effects can be both positive and negative.24 There are, they ague, only
very small direct effects from geography to development. In this way they single out institutions as
the most important (in fact the only really important) root factor of development (Rodrik et al,
2004). Institutions are thought to be the vital rules for economic behavior, which enable or
disenable all other development factors. Many factors, for example trade, finance, aid, migration,
ideas and knowledge, may be important but they only work indirectly through the institutions of
society.
To fully recognize institutions as an important development factor represents, in my opinion, an

improvement in development theory. This is, however, often done in a narrow and biased way.
Only a very limited set of institutions are really taken into account and very important ones (maybe
even the most important ones) are neglected. Furthermore, the insistence that institutions are the key
factor in growth and development fails to take on board the argument that institutional and
technological change feed upon each other and that the deep cause of development doesn’t reside in
one single key factor but in the interactions and contradictions between several factors.
Institutions in a narrow sense

The institutional factors, which this new institutional approach to development theory single out as
the most important ones, have to do with property rights and transaction costs. Current development
policy discussions as well as empirical work on institutional indicators seem to be dominated by
this approach.
23
This is a revised version of a paper discussed in a workshop on ‘Institutions, Innovation and Development’ hold at the
Department of Business Studies, Aalborg university in May 2008.
24
A well-known negative effect is the so-called resource curse: natural resources generate rents, rent-seeking behavior
and corruption with adverse effects on development (Sala-i-Maritn and Subramanian 2003). Sachs has answered that
that malaria transmission is directly affected by ecological conditions also after the quality of institutions is taken into
consideration (Sachs 2003).
- 21 -
The article “Order in the Jungle” in The Economist (15. March 2008) is a good example of the
“mainstreaming” of an institutional approach to development. The article discusses how “the rule of
law” has become a “big idea” in economics:
During the Washington consensus in the 1980s it was widely believed that policies for
macroeconomic balance (which, oddly enough, did not seem to include full employment) were the
core of a potent strategy for development. Balancing state budgets, using restrictive monetary and
fiscal policies to curb inflation and adjusting exchange rates to reduce current account deficits were
referred to as “getting policies right”.
Confidence in the Washington consensus was, however, gradually eroded during 1990s, when it
turned out that it didn’t work in many places of the World. It finally crumbled in the wake of the
Asian crisis in the end of the 1990s. It was subsequently and gradually replaced by a new kind of
Washington consensus, which holds that in addition to (the still important) macroeconomic balance,
countries need to “get their institutions right”.
It is, however, not absolutely clear what this implies. “Institutions” is a rather broad and somewhat
vague concept, which most often refer either to stable and durable patterns of economic behavior or,
more restrictively, to the “rules of the game” in the economy. As ‘The Economist’ observes, “the
rule of law” is an important subset of the institutional set-up. It soon came to be regarded as the
perhaps most important part of the rising new star amongst development factors – “good
governance”. In addition to the rule of law this very often used but still somewhat fussy concept
usually includes ‘political accountability’, ‘transparency in policy-making’ and ‘quality of
bureaucracy’ (Kaufmann and Kraay).
It didn’t take long, of course, before economists started to numerically measure the importance of
the rule of law and a rather clear relation between this and the level of income was demonstrated:
The better the rule of law, the richer the country and the other way around. This supported an
increasing reliance on good governance and the rule of law as effective development factors
amongst development aid donors and in the World Bank.
There has, naturally, been a lot of criticism against regarding especially the simplest versions of the
rule of law as the basic precondition for economic development:
First, it is far from easy to define the rule of law clearly. There are different legal traditions in
different countries; for example common law countries and civil law countries. The meaning of
political accountability, transparency and quality in bureaucracy also vary noticeably from country
to country depending on traditions and the existence of complimentary institutions.
Furthermore, there are both ‘thin’ and ‘thick’ definitions of the rule of law. Thin definitions,
concentrate on efficient property rights and institutional traits that reduce transaction costs as the
aspects of the rule of law that stimulate economic growth. Transparent political processes and
efficient administration are often also regarded as part of a thin rule of law. This is a definition,
which seems to fit better with static efficiency than with long run development. But there is a
dynamic dimension there too. For example, Douglass North, who is often (wrongly?) connected to a
thin definition, focuses on how institutions shape incentives. “Efficient property rights”, then, form
individual incentives, which induce people to make growth-inducing decisions. It pays off for
people to save and invest in production, education and so on. In contrast, inefficient property rights
- 22 -
induce rent-seeking25 behavior or even directly economically harmful activities like piracy, violent
crime and warfare.
Thick definitions of the rule of law focus on the institutions, which enhance the capabilities of
people to act in ways that improve their own as well as society’s wellbeing. According to Amartya
Sen (1999) these capabilities include political freedoms, economic facilities, social opportunities,
transparency guarantees and protective security. It is an important aspect of this way of thinking
about capabilities and the rule of law that they also have a value of their own. They are desirable for
their own sake and not only as instruments for economic growth and development. It should be
observed, however, that such a thick definition really goes quite a bit beyond the core meaning the
rule of law and might be better described as a broad institutional approach to development.
The distinction between thin and thick definitions of the rule of law is similar to the distinction,
which has been made between weak and strong institutionalism or between new and old
institutionalism (Coriat and Dosi 1998, Hodgson 1998). New institutionalism is sometimes referred
to as “transaction costs economics”. It investigates, generally, the relation between institutions and
transaction costs26 and, specifically, how institutions may be designed to reduce transaction costs.
Second, there is a criticism regarding the unclear empirical results of the rule of law. The picture is
far from conclusive. Some countries have had impressing growth records without being
unambiguous examples of what usually is meant by the rule of law, for instance, the Soviet Union
until the beginning of the 1970, and China during the last decades. Then again some countries with
fairly strong rule of law traditions have experienced rather long periods with low growth rates. In
fact, this was the case for most OECD countries during the 1970s and 1980s. There have been long
noteworthy swings in growth rates, which can’t be connected to the property rights situation at all.
In addition to this there is the question of cause and effect: Does the rule of law give us high
incomes or do high incomes bring the rule of law – or does it work both ways? The rule of law
seems to be neither a necessary nor a sufficient prerequisite for growth and even less so for
development.
Indicators and indicator biases.

“Governance” is in itself a complex concept and the available sets of empirical data are rapidly
growing. This can for example be demonstrated by a visit to the World Bank’s compilation of
governance datasets available at www.worldbank.org/wbi/governance/data. Here governance
indicators are available for over 200 countries. The indicators are divided into six groups: Voice and
accountability, political stability and absence of violence, government effectiveness, regulatory
quality, rule of law, and control of corruption.
The increasing availability of empirical indicators leads to a new situation in institutional analysis.
An inherent reluctance amongst the classical institutional scholars to think about institutions in
purely quantitative terms has lead to a concentration on historical descriptions of the development
25
In this context rent-seeking is defined as ”the pursuit of uncompensated value from other economic agents, in contrast
with profit-seeking, where entitites seek to create value through mutually beneficial economic activity” (IMF 2005).
This distinction may be useful but should not be taken to imply that rent-seeking has been absent from the process of
development of the high income countries of today. On the contrary, rent seeking has played a crucial role in most cases
of successful development. See Reinert (2007) for a discussion.
26
According to Coase (1988) institutions have no role to play in a world without transaction costs.
- 23 -
of institutions as the proper way to handle the confrontation between theories and empirical facts. It
has not been difficult to imagine that the level of income may increase as the result of a doubling of
the input of natural resources, physical capital and even technology, but it has been quite hard to
imagine the effects, or even the meaning, of quantitative variations of institutions. This has, as a
side effect, hampered the development of empirical institutional analysis and formalized
institutional theory. Now, however, there are, rather suddenly, a whole lot of quantitative indicators
waiting to be utilized. This is obviously in itself a positive development. However, there are a
couple of reasons to be careful.
First, there are still some problems of definition. There are many overlaps, dependencies and
ambiguities in the indicators. For example, there are rule based (de jure) indicators as well as result
(or outcome) based (de facto) indicators and there may be difficulties in interpreting them, and the
differences between them, in a clear way. One set of rules about for instance democratic elections or
disclosure of information in the public sector may give very different results in different countries
because of different cultural norms, traditions, historical experiences, etc. One sub-set of the
institutional system affects the outcomes of another subset. A researcher with a limited knowledge
about how the institutions of governance of a specific country fit into the larger institutional
systems and interacts with other institutional rules may not be able to draw the correct conclusions
from an empirical investigation of the effects of some specific property rights. If institutions are
defined and measured without taking their systemic character into accounts the results of empirical
investigation may be very hard to interpret. In institutional analysis context always matter.
Second, it seems clear that the selection of indicators and the definition of which data to collect
have been guided more by new than old institutional theory. Thin rather than thick definitions have
been used and the implicit development strategy is reduction of transaction costs. This means that in
spite of the increasing empirical affluence there is still narrowness in the selection of indicators. The
focus is on the things, which is supposed to enable governments to increase the efficiency of
markets. Furthermore, when collecting data for the indicators you rely heavily on “experts” i.e.
scientists, think-tanks, commercial risk rating agencies and other business-oriented sources of data,
NGOs and public sector organizations. Due to the present pro-market stance amongst almost all
these sources there is a bias. Critical economists or even economists belonging to the classical or
broad institutional tradition, labor unions or left wing political parties are not asked very often.
In addition to these expert based indicators there are also survey based ones in which firms and
individuals are asked about how they as the “final users” of good or bad governance look upon the
matter. This only partially avoids the expert bias since experts are still responsible for the design of
the surveys. In addition to this the fact that firms and households formulate their opinions from the
point of vies of their own situation and their own values introduces other kinds of subjectivities and
biases as well.
In sum, both the question of what to measure and the question of whose views to rely on reflect a
thin and narrow definition of governance, which is biased in favor of a “minimize transaction costs”
development strategy.
As long as the discussion is confined to just “governance” this would perhaps be satisfactory. The
problem is that the term “governance” is implicitly taken to cover the whole set of relevant
institutions. The dictum “institutions rule” is in fact replaced by “governance rules”. In a recent
report on the present state of art of governance indicators the terms governance, institutional quality
- 24 -
and institutions are used interchangeably (Kaufmann and Kraay). This represents a tendency
towards a narrow conceptualization of institutions.
In the World Bank vocabulary governance is primarily about the authority of governments. It is
defined as:
“…the manner in which public officials and institutions acquire and exercise the authority to shape
public policy and provide public goods and services” (World Bank 2007).
This has been made more precise in the report by Kaufmann and Kraay:
“... the traditions and institutions by which authority in a country is exercised. This includes the
process by which governments are selected, monitored and replaced; the capacity of the
government to effectively formulate and implement sound policies; and the respect of citizens and
the state for the institutions that govern economic and social interactions among them”
There is a focus here on a capable state operating under the rule of law. But how should other
“authorities” be treated? In every country there are also the collective or common authority of
different kinds of communities, which are not part of the state or the government. There is a whole
institutional literature about this, especially in relation to so-called common pool resources. (Hanna,
Folke and Mäler 1996, Cristensen and Christensen 2007). Also the lively discussion of the role of
social capital in development testifies to the existence and importance of non-government authority.
The existence and character of trust and social networks may be a very important part of “…the
institutions by which authority in a country is exercised”. Furthermore there are ngo’s and private
national and trans-national firms and organizations, which may operate under influence of some
forms of social responsibility. To equate authority with how governments behave is rather myopic
even in the limited context of governance.
The institutions of the learning economy

Every institutional way of thinking about development has to focus more on some institutions than
on others. There are so many different institutions, which affect so many different things that this is
unavoidable. The problem with much of the new theoretical and empirical interest for institutions is
not that it doesn’t draw all types of institutions into the analysis. Neither it is a problem that good
governance and low transaction costs are regarded as important. Everyone agrees on that. The
problem is that if you are looking at institutions at the root cause of development, it is a bit absurd
not to pay serious attention to how institutions and institutional change are geared to the processes
of learning and innovation. This is the main bias in the new mainstream institutional thinking about
development.
Some scholars from the transaction cost tradition have also noted the importance of learning.
Mantzavinos, North and Shariq (2004) regard institutions as “shared solutions recurrent problems of
social interaction” and they express the important of learning in the following way:
The greatest challenge for social sciences is to explain change – or more specifically social,
political, economic, and organizational change. The starting point must be an account of human
learning, which is the fundamental prerequisite for explaining such change. The ability to learn is
- 25 -
the main reason for the observed plasticity of human behavior, and the interaction of learning
individuals gives rise to change in society, polity, economy and organizations.
A possible starting point in thinking about the role of institutions in development could be the
notion of ‘institutional learning’ when it is taken to include both how learning affects the formation
and change of institutions and how institutions affect different kinds of individual and collective
learning (Johnson 1992). This is in accordance with the tradition to look upon the capitalist market
economy as a process of long-term growth with periods of fast as well as slow growth, which are
connected to structural change. Terms like pre-industrial, industrial and post-industrial capitalism,
the first, the second and the third industrial revolution (Bruland and Mowery, 2005), long waves or
Kondratieff cycles (Kondratieff, 1926), long swings in growth rates (Kuznets, 1971) and techno-
economic paradigms (Freeman, 1992) have been used both by Marxist and non-Marxist scholars in
order to identify periods with different structural characteristics and different modes of
development.
A common assumption behind most of these notions of periods in capitalist development is that
interrelations between technical and institutional change play a crucial role. New technologies
increase the “forces of production” i.e. the power to produce, and thereby the economic possibilities
in society. The institutions, i.e. the durable patterns of interaction between people, determine how
these possibilities are used, including how new technologies are developed. When institutional and
technological change match each other economic growth is fast and the economy appears
successful. When institutional change comes into conflict with the development of technologies,
economic growth becomes sluggish, unemployment increases and the economy appears as prone to
crisis and sharpened conflicts. Economic development includes periods of both high and low
growth and each new high-growth period demonstrates the powers of a new constellation of
technologies and institutions.
It has become quite common to characterize contemporary economies in the North as knowledge
economies or learning economies indicating a new and more important role in growth and
development of knowledge and learning. It can be discussed if knowledge and learning have
increased in importance over time or if they have always been key development factors. Regardless
of that it is clear that we have to indulge in studies of its historical specificities as a learning
economy if we want to understand the capitalist dynamics in the present period. We have to study
the details of the technical, organizational and institutional learning, which are at the root of growth
and development in our era. Furthermore, it is clear that the countries in the South are becoming
more and more connected to the North through the process of globalization. Knowledge transfer
from the North as well as endogenous knowledge creation becomes more and more essential in the
South. Globalization increases the importance of learning in development in several ways as for
example trade, direct investment, finance, intellectual property rights, migration, global public
goods, international organizations and global governance (Goldin and Reinert 2007). The question
is which institutions and what kinds of institution building can create and support the necessary
individual and organizational learning capabilities in the present context of globalization.
Many different institutions are important here:

The institutions of the education system, the R&D system, the technological service system, and the
business service system are concrete and evident examples. The political institutions, which
influence job security, unemployment benefits and social security, may have profound indirect
effect on learning capabilities. The institutions, for example cultural norms, that affect trust,
- 26 -
networking capabilities and conflict resolution are less visible but equally important. The list can
certainly be made much longer.
Where does good governance figure in this connection? How important for the building of learning
capabilities are the institutions, which according to mainstream institutional thinking form the root
factor in development? Nobody really knows. Not much research has been directed towards this
question. It is probably safe to say that they play a complimentary and supporting role and are not
enough in themselves. Learning capabilities and good governance have to be seen in connection
with each other. To some extent they have elements in common. The institutions, which form trust,
cooperation and conflict resolution, are crucial parts of both learning capabilities and good
governance.
Concluding remarks
This short note started with the question: “Are institutions the root cause of development?” The
conclusion is that if institutions are defined as good governance, which new institutional economics
tend to do, the answer has to be negative. If the notion of institutions are taken to include the
institutions that form learning capabilities of the individuals and organizations in society the
conclusion is that the question is to broad and vague to be answerable. Institutions matter and they
are important but to call them the root cause of development is too vague to be of much help and
also exaggerates the present state of knowledge about development. To focus almost exclusively on
how institutions affect transactions costs while regarding reduction of these kinds of costs as the
main development strategy leads one to neglect the interactions and contradictions between
institutions, institutional change and learning which have been emphasized in the institutional
tradition as the main driving force in development.
- 27 -
Literature
Bruland, K., Mowery, D., C., 2005, ‘Innovation through Time’, in Fagerberg, J. , Mowery,D. and
Nelson R. (eds) The Oxford Handbook of Innovation, Oxford University Press.
Coase, R. 1988, The Firm, the Market and the Law, The university of Chicago Press.
Coriat, B. and Dosi, G., 1998, The Institutional Embeddedness of Economic Change, in Nielsen, K.
and Johnson, B. (eds) Institutions and Economic Change, New Perspectives on Markets, Firms and
technology, Edward elgar.
Cristensen,E. and Christensen, P. 2007, Fælleder i forandring, Aalborg Universitetsforlag
Freeman, C., 1992, The Economics of Hope, Pinter Publishers, London and New York.
Goldin, I. and Reinert, K. 2007, Globalization for Development, Palgrave McMillan and the World
Bank.
Hanna, S., Folke, C and Mäler, K.G. 1996, Rights to Nature. Ecological, Economic, Cultural, and
Political Principles of Institutions for the Environment, Island Press
Hodgson, G. M. 1998, The Approaches of Institutioal economics, Journal of Economic Litterature, ,

Vol. XXXVI
Johnson, B. 1992, ‘Institutional learning’, in Bengt-Åke Lundvall (ed.), National Innovation

Systems: Towards a Theory of Innovation and Interactive Learning, London: Pinter Publishers.
Kaufmann, D. and Kraay, A., Governance Indicators: Where Are We, Where Should We Be
Going?, Policy Research Working Paper 4370. The World Bank.
Kondratieff, N.,1926, ‘Die langen Wellen der Konjunktur’, Archiv für Sozialwissenschaft und
Sozialpolitik, Dec. 1926.
Kuznets, S.,1971, Economic Growth of Nations. Total Output and Production Structure, The
Belknap Press of Harvard University Press, Cambridge Massachusetts, London.
Mantzavinos, C., Douglass North and Syed Shariq, 2004, Learning, Institutions, and Economic
performance, Perspectives on Politics, Vol. 2, No 1
Reinert, E. 2007, How rich countries got rich … and why poor countries stay poor, Constable and
Robinson, London.
Rodrik, D., Subramanian, A. and Francesco Trebbi 2004, “Institutions Rule: The Primacy of
Institutions Over Geography and Integration in Economic Development”, Journal of economic
growth vol 9, nr 2.
- 28 -
Sachs, J. D. 2003: “Institutions Don’t Rule: Direct effects of Geography on per Capita Income”,
National Bureau of Economic Research, Working Paper 9490
Sachs, J.D., Malaney, P. 2002, “The Economic and Social Burden of Malaria”, Nature Insight, Vol.
415, no. 6872
Sala-i-Martin, X. and Subramanian, A., 2003, Addressing the Natural Resource Curse: An
Illustration from Nigeria, National Bureau of Economic research, Working Paper 9804.
Sen, A 1999, Development as Freedom, Oxford University Press.
IMF 2005, World Economic Outlook. Building Institutions.
- 29 -
Emulation vs. Comparative Advantage: Competing and

Complementary Principles in the History of Economic Policy -
Erik Reinert
Erik S. Reinert, The Other Canon Foundation, Norway & Tallinn University of Technology,
Estonia27.
This objective of this chapter is to show how economic policies based on completely different
principles – one described as ‘emulation’ and the other as ‘comparative advantage’ – have been
strategically employed in order to achieve economic development when nations have made the
transition from poor to wealthy. It also briefly describes key aspects of the process by which
Europe, through emulation, developed from a collection of fiefdoms ruled by ‘war lords’ into city
states and later to nation-states. It is argued that the timing of the strategic shift from emulation to
comparative advantage is of utmost importance to a nation. Making this policy shift too early will
hamper development much as a late shift will do. It is argued that these principles, although
sometimes under different names, were well known and employed by European nations from the
17th century onwards, in the United States all the way to the end of the 19th century, and that the
Marshall Plan implemented 60 years ago this year, owed its success to putting the principle of
emulation chronologically ahead of comparative advantage.
The Oxford English Dictionary defines ‘emulation’ as ‘the endeavour to equal or surpass others in
any achievement or quality’; also ‘the desire or ambition to equal or to excel’. In 18th century
political and economic discourse, emulation was essentially a positive and active effort, to be
contrasted with envy or jealousy (Hont 2005). In modern terms emulation finds its approximate
counterparts in the terminology of US economist Moses Abramowitz, whose ideas of catching-up,
forging ahead, and falling behind resonate with the same understanding of dynamic competition. In
his 1693 work English economist Joshua Child made the emulative nature of English catching up
very clear: ‘If we intend to have the Trade of the World, we must imitate the Dutch, who make the
worst as well as the best of all manufactures, that we may be in a capacity of serving all Markets,
and all Humors’
By focusing on barter alone, leaving out the dynamics of innovation and competition, Ricardian
trade theory leaves out a core element in what capitalism is all about. There is no forging ahead, nor
is there any falling behind, in Ricardian economics, nor in any other type of economics based on
metaphors of equilibrium. In a Schumpeterian framework, the rents created by innovation and later
eroded by competitors emulating that innovation, represents the core of what capitalism is all about:
relentless innovation in order to create innovation rents, followed by relentless emulation that
dilutes and reduces the same rents. The precondition for Thorstein Veblen’s ‘pecuniary emulation’
is a Schumpeterian ‘technological emulation’. This chapter aims to establish a skeleton for a
Schumpeterian theory of international trade as it relates to uneven economic growth.
A frequent 19th century continental European and US criticism of Ricardian economics is that it
operated with ‘units void of any qualitative characteristics’ (qualitätslose Grössen). This chapter
argues that Ricardian trade theory – by visualizing the world economy as the bartering of labour
27
Much of the discussion on emulation in this paper is owed to my son, Sophus Reinert. His input is most valued, as are
comments from Christopher Freeman, Bonn Juego and Rainer Kattel. The usual disclaimer applies.
- 30 -
hours void of any qualitative factors (importantly also knowledge) – abstracts from and leave out
the qualitative changes – ‘development’ – that take place in human society over time. The
qualitative difference between one labour hour in Silicon Valley and one in African subsistence
agriculture may in fact account for the failure of free trade to even out factor prices of labour in the
two areas.
I argue that in contrast to the Ricardian view, economic theory in Germany and the US until World
War II tended to see economic development as a process of qualitative change. Going back to this
type of theory, it is argued that Ricardian trade theory and today’s standard textbook economics fail
to include these qualitative changes, essentially because they belong to a research paradigm where
the necessary tools are missing. By employing the standard definition of capitalism used before
World War II, rather than the traditional Marxist or the modern neoclassical definitions, an attempt
is made to illustrate situations where and why emulation rather than comparative advantage is
recommendable.
Finally the paper discusses the important timing aspect of the transition from emulation to free
trade. Clearly both free trade and industrialisation will have their special interest groups, and
promoters of both can revert to cronyism and corruption to get their favourite policies accepted. The
US Civil War represents a classic case of infighting between a ‘comparative advantage’ South
insisting on immediate free trade and an ‘emulative’ North insisting on following England’s path to
industrialisation. It is argued that the negative effects from an overdose of emulation are
considerably less than an overdose of premature free trade, a nation will be better off in the long run
if the North rather than the South wins its civil war.
Emulation and ‘management by gut feeling’.

A key argument in this paper is that in many situations emulation is the intuitive gut reaction to a
problem. Therefore emulation – also when it blatantly contradicts ruling trade theory – will tend to
be used in ‘intuitively’ in situations close to home, whereas comparative advantage tends to be
imposed ‘scientifically’ on nations far away. The oxymoronic ‘managed free trade’ is the result of
this tension between home turf intuition (e.g. Europe’s conviction today that they also need a
manufacturer of large commercial airplanes to compete with Boeing) and a simultaneous ‘scientific
conviction’ in Europe that African countries are better off sticking to their comparative advantage in
agriculture. I further argue that the principle ‘first emulation, then comparative advantage’ has been
the strategy followed by all presently wealthy nations, with the possible exception of ’naturally
wealthy’ nations that were void of raw materials and were therefore the first to industrialise. The
Dutch Republic and Venice would be the prime examples of nations that were ‘naturally wealthy’
(Reinert 2007a and 2008).
The following two examples illustrate cases of when choice between comparative advantage and
emulation enters into conflict with our intuitive understanding of how the world works. They echo
the 19th century central European and US criticism of sometimes making recommendations contrary
to what in German philosophy is called ‘der gesunde Menchenverstand’ or ‘common sense’.
Example 1. The economic choice of a Stone Age tribe. If the tribe across the river from your own
has taken the step from Stone Age to Bronze Age, it would be in the interest of your own tribe to
emulate the neighbouring tribe into the Bronze Age rather than stick to its ‘comparative advantage’
in the Stone Age.
- 31 -
Example 2. The 1957 economic choice of President Eisenhower. On October 4, 1957 the Soviet
Union sent a man-made satellite into orbit around the world, creating what was to be called the
Sputnik Shock in the Western World: the discovery of the technological superiority of the Soviet
Union in this field. At the same time the Soviet Union had severe problems in agriculture, in fact
1957 was a year of major drought in the Southern Soviet Union. In October 1957, the Soviet Union,
armed with Ricardian trade theory, could have argued scientifically that the comparative advantage
of the United States was in agriculture, not in space technology. The USA should therefore produce
food, while the Soviet Union should engage in space technology. But in this case President
Eisenhower chose emulation rather than comparative advantage. The establishment of NASA in
1958 was a policy measure in the best spirit of the Enlightenment – it was an institution created in
order to emulate the Soviet Union – but quite contrary to the spirit of Ricardo.
This chapter explains and justifies the mechanisms that explain why the anti-Ricardian intuition in
these two examples is correct, by codifying and explain the dynamic elements of technological
change and progress that create the tacit and intuitive logic of emulation. In both these examples
Ricardian static specialization according to the principles of comparative advantage trade logic
becomes counterintuitive, just as counterintuitive as when the Doha Round assumes that free trade
will benefit African self sufficient farmers just as much as Silicon Valley. In my opinion our lack of
understanding of the principles behind the logic of emulation is largely responsible for the
development problems in the world periphery, particularly in sub-Saharan Africa. Here the principle
of comparative advantage – which no doubt is the best principle among nations on an equal level of
development – is implemented prematurely.
Emulation generally requires initial tariffs, what John Stuart Mill called ‘infant industry protection’.
No businessperson expects an industrial company to make money from day one, he or she is willing
to sustain losses for several years until the company starts making money. The similar logic was
used for centuries as regards industrial systems. A new industry could not be expected to be
profitable immediately. Indeed England protected her manufacturing industry heavily for more than
350 years, the United States only for about 100 years and Korea only for 40 years. However, the
timing of this protection was crucial: the same institution that in one context would cause increased
welfare would, in another context, decrease welfare. Once a certain domestic industrial capacity has
been reached, however, competitiveness can only be maintained through access to larger markets. If
industrial dynamics are to decide, as they did in the United States towards the end of the 19th
century, beyond a certain point the not-so-infant industry – because a) new technology tends to
come with larger capacity and b) because of domestic competitive pressure – will be interested in
freer trade in order to stay competitive. If industrialisation is successful, then, and protection keeps
companies on their toes, the same type of industrial vested interests that once favoured protection,
now will favour freer trade in order to conquer foreign markets. The vested interests behind new
and expanding technologies and a large scale of production will tend to crowd out the less dynamic
ones favouring continued protection, all leading to a ‘natural’ transition from protection to free
trade. However, when ‘bad protection’ (as defined later) dominates, a nation may get stuck with a
sub-scale and technologically mature manufacturing sector. The general rule is, as was observed by
an anonymous Italian political economist travelling in Holland in the 18th century, Tariffs are as
useful for introducing the arts in a country, as they are damaging once these are established’
(Anonymous 1786: 31). This observer in fact constructed a core principle of a Schumpeterian trade
theory based on an underlying assumption on industrial dynamics.
- 32 -
Comparing two sets of countries over a period of fifty years, Figure 1 illustrates the activity-specific
nature of economic growth. Korea was for a long time poorer than Somalia, but was allowed to shift
its comparative advantage away from a ‘natural’ comparative advantage in diminishing returns
activities to a ‘man-made’ comparative advantage in increasing return activities. Singapore was for
a long time poorer than Peru, but takes off in the 1970s. The curve also shows how an inefficient
and overly protected manufacturing sector in Peru produced a higher standard of living than a
deindustrialised Peru. Both cases illustrates the problem of creating ‘middle income countries’:
countries seem to cluster in a successful group and a ‘race to the bottom’ group. This paper suggests
approaches to creating such middle income countries.
- 33 -
Figure 1. Emulation vs. ‘wrong’ comparative advantage.
Korea-Som alia, GDP per Capita 1950-2001
Korea (Rep.) Somalia
16000
14000
12000
10000
8000
6000
4000
2000
Sour ce: or iginal data extr acted f r omAngus Maddi son, The Wor ld Economy, Hi stor i cal Stati sti cs, OECD, Par is, 2003
Peru-Singapore, GDP per Capita 1950-2001
Peru Singapore
22000
20000
18000
16000
14000
12000
10000
8000
6000
4000
2000
0
1950
1951
1952
1953
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Source: original data extracted from Angus Maddison, The World Economy, Historical Statistics, OECD, Paris, 2003
- 34 -
Source: .Reinert, Erik S., Yves Ekoué Amaïzo & Rainer Kattel, ‘The Economics of Failed, Failing
and Fragile States: Productive Structure as the Missing Link’, The Other Canon/Tallinn University
of Technology Working Paper Series, 2007, No. 15.
Renaissance: The Birth of the Politics and Economics of Emulation and

Economic Growth
It’s commonly said that capitalism arrived in the United States with the first boats to land on North
American shores. We can even more confidently say that industrial policy arrived with the same
boats to Europe as did the Renaissance. Instrumental in creating the Renaissance – literally re-birth
– were philosophers from the Byzantine Empire who brought both the texts of classical Greek
philosophy, particularly adding Plato to Aristotle who had been known earlier, and a new religious
interpretation of Man as a creative being to Italy (Reinert & Daastøl 1997). The most influential of
these philosophers from Byzantium was Georgios Gemistos Plethon (ca. 1360-1452) whose lectures
in Florence inspired Cosimo Medici to establish a Renaissance milestone: the Platonic Academy.
Plethon, the contemporary living individual who more than anyone else influenced Renaissance
philosophy, also brought with him a view on economic policy: “Plethon praised protectionist policy
as a means to stimulate a Byzantine economy suffering from the competition of Italian industry and
trade”.28
In a somewhat macabre way, Plethon’s economic policy and the plight of his dead body together
illustrate the most important principle of Europe’s successful economic policy during the last 500
years: the policy of emulation (Hont 2005, Reinert 2007a). “The propensity for emulation….is of
ancient growth and is a pervading trait of human nature”, said Thorstein Veblen in his Theory of the
Leisure Class (Veblen 1899, chapter 5). In 20th century economics emulation tended to be limited
to Veblen’s “pecuniary emulation” on an individual level, to “keeping up with the Joneses” in terms
of consumption. Starting in the Renaissance, and even more self-consciously during the
Enlightenment, from the point of view of a city-state or nation-state, emulation on the production
side was a perquisite for emulation of consumption.
In his 1913 works on Luxury and Capitalism and War and Capitalism Werner Sombart (1913a and
1913b) outlines the role of emulation both through luxury, where art was an important element, and
by the way of warfare for the development of capitalism29. Just as trade later was seen as ‘war by
other means’, also emulation in luxury and in war were intertwined. There is no reason to believe
that Leonardo da Vinci (1452-1519) – who was born near Florence the year Plethon died – was less
proud of his ingenious war machines than of his wonderful art. In fact the rulers’ patronage of art
was part of a competition between states not unlike war. Artists were patronised by rulers for
similar reasons as were mercenaries, as tools for catching-up and forging ahead to use the language
of Moses Abramowitz.
Sigismondo Malatesta (1417-1468), the ruler of Rimini, was one of the worst and most violent
tyrants of the Renaissance. At the same time, he shared and promoted the Renaissance cult of art
and letters (Hutton 1926). Sheltering many humanists and poets at his court, Malatesta epitomizes
the Renaissance when it can be argued that economic emulation and capitalism consciously was
promoted in order to channel human passions and activities away from violence into more
28
The Oxford Dictionary of Byzantium, Vol. 1, page 673.
29
Sombart 1928 gives the complete story. See Mitchell 1929 for an English résumé.
- 35 -
constructive activities. This point is made brilliantly by Albert Hirschman in his book The Passions
and the Interests (1977)
In 1438, the same year Plethon lectured in Florence, Sigismondo Malatesta was engaged in a
serious game of emulation with Florence. That year Malatesta brought Filippo Brunelleschi, the
father of Renaissance architecture, to Rimini. Two years earlier Brunelleschi had finished the
Florence cathedral. Subsequently, the greatest architectural theorist of the age, Leon Battista
Alberti, led a team of distinguished designers in remodelling an ancient Franciscan basilica into a
church-monument to Sigismondo and his ancestors, transforming it into an edifice without parallel
in the peninsula. In this temple, now known as the Tempio Malatestiano, famous artist Piero della
Francesca adorned the interior with a fresco and a painting of Sigismondo (now in the Louvre) , and
Florence’ most admired sculptor Agostino di Duccio embellished the building with the most
important work of his career. Sigismondo Malatesta epitomizes at the same time on the one hand
the most barbaric violence and the most refined art of the Renaissance.
Later in life, after most Italian states – including the Papal State – had turned violently against him,
Sigismondo Malatesta sought new fortune as general for Venice in its war against the Ottoman
Empire, as a field commander in Peloponnesus (1464-1466). On his way home, Malatesta engaged
in what was by then a traditional European act of emulation: adding to the prestige of a city through
acquiring body parts of saints. The most spectacular and at the same time most successful act of
emulation through dead bodies took place in the year 828 when Venetian sailors stole the body of
St. Mark from Alexandria. St. Mark was later made the patron saint of the city, where the cathedral
built above his crypt still dominates the city today.
It was typical of Sigismondo Malatesta and his time that when he returned from Peloponnesus in
1465, he brought as a souvenir back to Rimini not the traditional hallowed remains of some Eastern
Christian Saint but, as one text says ‘induced by the mighty love with which he burned for men of
learning’, he brought back to Europe the bones of Georgios Gemistos Plethon; the man who with
Plato also brought industrial policy to Europe. The last ‘primitive’ war lord in Europe had the
remains of Plethon buried in the Tempio Malatestiano in Rimini. Sigismondo Malatesta – The
Mastiff of Rimini – testifies to the role of emulation in three key areas in creating and shaping
modern capitalism: the emulation in war and in luxury (as shown by Sombart), and the emulation in
learning (in what Veblen called ‘idle curiosity’). And, we might add, as a Veblenian example of the
conspicuous consumption that came to characterize capitalism, Malatesta exhibited Plethon’s stone
coffin outside the main church in Rimini. There it is still to be found today.
Novelty, Diversity, Scale, Synergy: Bringing non-Ricardian elements

back in.
When Adam Smith bent the tree that became economics, several economic factors that had been
prominent until then became peripheral. These were the most important insights of Renaissance and
Enlightenment economics: novelty (innovation), diversity (heterogeneity), scale (increasing
returns), and synergy. Although the labour theory of value can be traced back all the way to Arab
historian and economist Ibn Khaldoun (1331-1406), compared to his predecessors Adam Smith’s
greatest innovation was reducing production and trade into one single unit of measurement: labour.
A higher theoretical level of abstraction was achieved by abstracting from the complications and
vicissitudes inherent to production. Based on Smith, a generation later David Ricardo constructed
- 36 -
his theory of international trade and comparative advantage with the bartering of labour hours of
identical quality as the key feature of the world economy.
In order to appreciate the history of economic policy, it is necessary to re-create a theoretical

structure putting back in the key elements left out by Ricardo, or perhaps more accurately stated, by
his followers. Pre-Smithian economics would not have accepted that the international economy
could possibly be represented as a system centred around the barter of labour hours. Pre-Ricardian
logic had an underlying understanding that what a country produces would determine how wealthy
it was: if all stockbrokers are wealthier than all the personnel cleaning their offices, a nation of
stockbrokers will be considerably wealthier than a nation of cleaning personnel. Any static
Ricardian gain from specialisation will in this case be totally dwarfed by the qualitative and
activity-specific differences between the profession of being a stockbroker and cleaning floors.
I suggest the elements that Ricardian economics left out of the profession can be captured under the
headings of Novelty, Diversity (heterogeneity), Scale, and Synergy and the interaction between
these factors. Novelty, or innovation, is at any point in time focused in few activities, in the stone
industry in the Stone Age and in cotton spinning during the First Industrial revolution. This creates
Diversity or heterogeneity as a key feature of economic life (Audretch 2004), and as we shall
discuss below technological change and increasing returns – although very different phenomena –
in practice novelty and scale often come packaged as Siamese twins. In a world with oligopolistic
competition some economic activities may catapult the real wages of a nation relative to others
(Ireland is a recent example, see Reinert 2007a, see also the examples of Korea and Singapore in
Figure 1), while other nations specialise in activities bereft of innovation and novelty, seriously
limiting the possibilities for growth (classical maquila industries). When judged with the standard
canon perfect-competition model, successful development projects are indeed gigantic ‘market
failures’ (compare Cimoli, Dosi, Nelson & Stiglitz 2006: 2). The models of the standard canon,
assuming diminishing returns and perfect competition, in fact describe the situation in raw material
producing poor countries much more accurately than they describe the situation in the rich world.
Pre-Smithian economics saw economic growth and welfare as a synergy-based phenomenon, and
that the existence and strength of such synergy is determined by the presence or not of novelty and
diversity. This perspective is still exceedingly relevant in order to understand the world distribution
of wealth and poverty. We shall return to this when discussing Johann Heinrich von Thünen’s
economic theories.
Facing diversity and heterogeneity forces choices upon the researcher. Between a position where all
human beings are alike as economic agents (‘perfect information’) and dealing with 6 billion unique
individuals, finding an appropriate level of abstraction for analysis is difficult. This presents the
economics profession with a trade off between relevancy and accuracy, as Schumpeter says ‘the
general reader will have to make up his mind, whether he wants simple answers to his questions or
useful ones – in this as in other economic matters he cannot have both’ (Schumpeter in Zeuthen
1932). In the spirit of Schumpeter’s first book (Schumpeter 1908) one should first put a question
and then enter into theory at a level of abstraction where one is likely to find an answer to the
question. If the question we want explained is one of diversity in development experience between
countries, a theory that – as Ricardian trade theory – a priori excludes all diversity is unlikely to be
of much help. By reducing the world economy to the bartering of labour hours of identical quality,
Ricardian trade theory excluded the diversities and hierarchies that are an inherent part of any
productive system. In fact it may be argued that the conclusion of standard trade theory, economic
- 37 -
harmony and factor price equalisation, is in fact already built into the assumptions on which this
theory rests. A theory that starts out with no diversity is not likely to have diversity as an outcome.
Another problem related to this emerges from what Abramowitz calls the ‘factor-bias’ of economic
development. Different economic activities also have different factor-biases. Oil refining has a
much stronger bias towards the use of capital and knowledge than does the production of slippers.
Likewise, the indivisibility and scale-bias of an oil refinery also pulls in the same direction: barriers
to entry (Baine 1956) in petroleum refining are likely to establish much higher wages there than in
the slipper factory, regardless of skill level. As a Ugandan politician once told me, the barriers to
entry and monopolistic competition in the production of beer in Uganda produce wage levels among
brewery cleaning personnel approaching that of high government officials. And nepotism
flourishes.
Diversity: Economies as Hierarchies.

Adding a dynamic dimension to this we can use Nathan Rosenberg’s observation that technological
change at any point in time tends to be focused in certain areas (Perez 2002, 2004). Figure 2
establishes a Quality Index of Economic Activities that attempts to bring together the qualitative
elements, static and dynamic, from which Ricardian trade theory abstracts. The Quality Index pulls
together the factors that explain why the world’s most efficient producers of a low-tech product as
baseballs – in Haiti or Honduras – has a real wage that is only a fraction of the wage of the world’s
largest producer of golf balls. A tiny static gain from trade through specialisation may indeed be
completely overshadowed by the loss one nation suffers from specialising at the bottom of the
hierarchy of skills. This is an attempt to codify the Myrdalian notion that increased specialisation
and trade may indeed increase rather than decrease international wage differentials.
- 38 -
Figure 2
The Quality Index of Economic Activities
innovations
new technologies
Dynamic imperfect competition

(high-quality activity) Characteristics of high-quality
activities
•new knowledge with high market value
•steep learning curves
•high growth in output
•rapid technological progress
•high R&D-content
•necessitates and generates learning-by-
doing
•imperfect information
Shoes (1850-1900) •investments come in large chunks/are
divisible (drugs)
•imperfect, but dynamic, competition
•high wage level
Golf balls
•possibilities for important economies of scale
and scope
•high industry concentration
Automotive paint •high stakes: high barriers to entry and exit
•branded product
•produce linkages and synergies
•product innovations
•standard neoclassical assumptions irrelevant
Characteristics of low-quality activites

•old knowledge with low market value
•flat learning curves
•low growth in output
•little technological progress
•low R&D-content
•little personal or institutional learning required
House paint •perfect information
•divisible investment (tools for a baseball
Shoes (2000) factory)
•perfect competition
•low wage level
Baseballs •little or no economic of scale /risk of
diminishing returns
•fragmented industry
•low stakes: low barriers to entry and exit
Perfect competition
•commodity
(low-quality activity)
•produce few linkages and synergies
•process innovations, if any
•neoclassical assumptions are reasonsable
proxy
This hierarchy argument comes in two parts, one essentially static one and a dynamic and
developmental one. First the static argument: By failing to differentiate qualitatively between
- 39 -
different units of labour hours, standard trade theory fails to account for the qualitative differences
between economic activities. We fail to grasp the fact that the real world consists of hierarchies of
different sorts, within companies and institutions and between them. These processes that go on
inside and between firms are themselves driven by emulation, internally through competitive
educational systems and hiring policies based on merit and externally through market competition.
Consider the following example to illustrate the relationship between hierarchies and standard of
living. We abstract from geography and assume a world economy consisting only of hospital
services, we could create a world economy where all the specialised medical staff lived in one
country, all the registered nurses in another, and all the cleaning personnel in a third. Seeing this
economy in purely Ricardian terms – as labour hours void of any qualities – makes us believe that
free trade will tend to equalize incomes between cleaning personnel and medical doctors. In fact the
opposite – factor price polarization – is likely to be the case. Cleaning personnel would utilise
technologies that are simple compared to those higher in the hospital hierarchy, and their incomes
would of course be much lower. Dividing doctors, nurses, and cleaning staff equally between the
nations of the world would be the best strategy to even out world income. Putting the children of the
cleaning personnel in the same schools as those of the medical doctors would maximise social
mobility. If they are placed in different countries, the socially mobile children of cleaning personnel
who manage to get an education as a doctor will migrate to the rich countries in order to maximise
his or her income. As Gunnar Myrdal predicted, frequently the market in this way tends to enlarge
already existing differences in income rather than to narrow them.
The logic that a nation could upgrade in a hierarchy of skills in the same way that a person could is
found in US economist Daniel Raymond, whose 1820 book heavily influenced the establishing of
the protectionist American System of Manufactures. Through the early decades of the 19th century
England was the only country with a comparative advantage in manufacturing, and it was fairly
obvious that she used Ricardo’s logic in an attempt to prevent other countries from industrializing.
The frequent response from other countries that followed her path to industrialisation, was a biblical
quote, Joshua 9: 23, pointing precisely to the fact that the world economy corresponded to a
hierarchical structure: ‘.. and now, cursed are ye, and none of you is cut off from being a servant,
even hewers of wood and drawers of water, for the house of my God.' Today’s wealthy nations
followed England into industrialisation, against the recommendations of Ricardo’s trade theory,
because they did not wish to be at the bottom of the world’s economic hierarchy as ‘hewers of wood
and drawers of water’.
It is now time to introduce dynamics into the hierarchy, as illustrated by the dynamics inside figure
2. From both sides of the political spectrum, Karl Marx and Joseph Schumpeter agree on the
sterility of capital alone as a source of wealth. Innovations, rather than savings and capital per se,
drive welfare forwards. The world economy functions similarly to Alice in Wonderland, where one
of the strange figures tells Alice: ‘this is how fast you have to run here in order to stand still’: only
constant innovations sustain welfare. Once the builders of sailing ships topped the world hierarchy
of ship builders, but they were pushed down after the steam engine and the diesel engines were
invented. The world’s best producer of kerosene lamps would soon become poor with the advent of
electricity. Status quo leads inevitably to poverty as technical change pushes old technologies, and
those who stick to them, further down in the economic hierarchy. This is of course precisely what
makes the capitalist system so dynamic, but this mechanism also contributes to creating such
differences between rich and poor countries. By introducing ‘emulation’ as an alternative to
‘comparative advantage’ it is possible to introduce these dynamics into trade theory.
- 40 -
Schumpeter used a metaphor to describe society as a dynamic hierarchy: ‘the upper strata of society
are like hotels which are ... always full of people, but people who are forever changing’
(Schumpeter 1934: 156). The dynamics of radical technological change give rise to great fortunes
and a new circulation of elites. Henry Ford brings in new technology and new management and
creates a financial fortune. A new set of people joins the upper strata as production capital matures
into financial capital while entrepreneurial management at Ford’s yield to professional
management. A couple of generations later, a similar development takes place at Microsoft. Edwin
Gay, the founder and first Dean of Harvard Business School, developed a dynamic vision of
economic history based on these cycles: ‘it was, he concluded, a record of swings of the pendulum
between periods when social controls dominated, and periods dominated by the actions of
aggressive individuals. The former periods were static, characterized by security and stability. The
latter periods, ushered in by the introduction of new tools, weapons, or other forces, were controlled
by the powerful individuals who introduced these forces’ (Cruikshank 1987: 29).
In fact the Schumpeterian cycles suggested by Gay clearly correspond to the patterns of techno-
economic paradigms of Carlota Perez (Perez 2002). In Perez scheme, economic development
consists of what in my terminology are ‘productivity explosions’, technological breakthroughs that
produce explosive increases in labour productivity. Figure 3 shows the productivity explosion of
the First Industrial Revolution, that of cotton spinning.
Figure 3
A quantum jump in productivity
The mechanization of cotton spinning in the first paradigm
Ave annual 30,0

increase in
productivity
25,0
20,0
15,0
10,0
5,0
0,0
EJD318-LWT-G
1750 1800 1850 1900 1950 2000 2050
Source: Carlota Perez

Years
Novelty and Scale: Accounting for Qualitative Change.

During the two periods of most dramatic qualitative change in economic history – both during the
First and the Second Industrial Revolution – the economics profession developed ways of
describing the change that was taking place. They created theories of stages of qualitatively
- 41 -
different historical periods. Such stage theories have been used in most of the social sciences
(Reinert 2000). In my view, if they do not become mechanical exercises they are useful tools for
understanding technological and institutional change. In the history profession the material from
which Man’s tools were made (e.g. stone or bronze) has become universally accepted as the basis
for establishing early historical periods: the Stone Age (Mesolithic, Neolithic), the Bronze Age. The
extreme focus on trade – rather than production – in Ricardian theory excludes this perspective. A
lay-person, having been explained the idea of factor-price equalisation, being asked whether or not
free trade between a Stone Age tribe and Silicon Valley was likely to cause factor-price equalisation
is likely to predict that it would not. Human intuition overrules Ricardian theory, and correctly so.
The stage theories born during the First Industrial Revolution – those of the early Adam Smith
teaching in the 1750s – follow Man first as a hunter and gatherer, then as a shepherd of
domesticated animals, then as a farmer, finally to reach the stage of commerce. Most significantly,
English classical economists tended from the late 18th century on to concentrate their analysis on the
last stage of evolution, on commerce – on supply and demand and on prices – ra ther than on
production. During the 19th century, German and US economists insisted on a very different
interpretation of the development stages. To them the previous stages were all built on ways of
producing goods, and they saw it as a grave mistake to classify the next stage of development in
terms of commerce rather than in terms of production. This theoretical difference of opinion
essentially laid the foundation for how 19th century German and US economic policy came to differ
from that prescribed by English theory.
Ronald Meek (1976: 219) argues that ‘there was a certain sense…in which the great eighteenth-
century systems of ‘classical’ political economy in fact arose out of the four stage theories.’30 In
spite of this, today any idea of economic stages is peripheral, almost alien, to much of the
economics profession. Seen from this perspective, the requirements of each new stage of
development – each new mode of production – will require different mentalities and different
institutions. I have argued that the protracted discussion on the role of institutions largely has failed
to recognize the importance of the arrows of causality moving from the mode of production to the
institutions. In other words, as is consistent with Veblen’s view on institutions – but contrary to that
of the Washington Institutions – the fact that industrialisation requires and causes institutional
change is much more important than that institutional change causes industrialisation (Reinert
2007b).
The two types of stage theories above – Adam Smith’s vs. the German and US theories – produce
vastly different economic policies. It is intuitively obvious that a hunting and gathering tribe will
not be able to compete successfully with an industrial society, therefore ‘emulation’ into the same
technological ‘age’ as the world’s leading nation was a prerequisite before free trade ‘comparative
advantage’ may take over as a guiding principle.
The logic accompanying such theories of qualitative economic change is that free trade is always
beneficial between nations at the same level (stage) of development. Bringing back an old
UNCTAD term, we could say that exchanging industrial goods for other industrial goods (both
produced under increasing returns) represents ‘symmetrical trade’ which is beneficial to both
parties, while exchanging raw materials (produced under diminishing returns) for industrial goods
(produced under increasing returns) represents ‘asymmetrical trade’ and is only beneficial to the
30
Emphasis in original.
- 42 -
industrialised partner. We have argued elsewhere that the theories of ‘good’ and ‘bad’ trade that
represented the mainstream of Enlightenment economics were based precisely on this same
principle (Reinert & Reinert 2005).
- 43 -
Table 1. The Economic Stages seen after the Second Industrial Revolution (Ely 1903).
From the From From From the From

Standpoint Bücher’s Hildebrand’s Labor Giddings’s
of Standpoint Standpoint Standpoint Standpoint
Production
1. Hunting Slaughter Luck
and Fishing of Magic
Indepen- Truck Enemies,
2. Pastoral dent Economy Woman’s
Domestic Labor, and Sacrificial
Economy Beginning
of Slavery
3. Agri- Slavery and Slave
cultural Serfdom Labor
4. Handicraft Town Money Free Labor
Economy Economy governed by Trade
Custom
5. Industrial National Individual
(1) Universal Economy Contract
Compe- with
tition as Credit Increasing
an ideal Economy Regulation
(2) Concen- (World by Statute Capitalistic
tration Economy)
Group
(3) Integra- Contract
tion and Regula-
tion by
Statute
Source: Ely (1903), reproduced in Reinert(2000). Ely himself adds ‘World Economy” to Bücher’s
system.
- 44 -
In his four-volume work on the history of economic thought in the United States, Joseph Dorfman
describes this very well when accounting for the attitude towards free trade in the Unites States
around 1830:
‘Of course, free trade is the ideal, and the United States will proclaim the true cosmopolitan
principles when the time is ripe. This will be when the United States has a hundred million
people and the seas are covered with her ships; when American industry attains the greatest
perfection, and New York is the greatest commercial emporium and Philadelphia the
greatest manufacturing city in the world; and when ‘no earthly power can longer resist the
American Stars.’ Then ‘our children’s children will proclaim freedom of trade throughout
the world, by land and sea.’ (Dorfman, Vol. II, p. 581)31
Dorfman here explains the principle that I argue has been the path taken by all industrialised
nations: an initial state of protective emulation has been a mandatory passage point for all presently
in industrial nations. With the possible exception of the early ‘naturally rich countries’ (Venice and
the Dutch Republic) all presently rich nations have been through a period of protection. The
sequencing has always been ‘emulation’ before ‘comparative advantage’ (Reinert 2007a & 2008).
Integrating nations at different stages of development creates a form of integration that we could
call ‘asymmetrical’ (see Reinert & Kattel 2004 for a taxonomy of types of integration). When this
form of integration is done rapidly through shocks, an apparent but important anomaly may be
observed. However, the relatively low intensity of communication between Ricardian trade theory
and microeconomic bookkeeping creates blind spots for such phenomena, although the macro-
economic impact may be huge. When two nations at widely different technological levels integrate,
the first casualty is the most advanced economic activity in the least advanced nation. I have
refereed to this as the Vanek-Reinert effect, and argued that it represents one of the mechanisms of
primitivisation that accompany premature globalization. This Vanek-Reinert effect in turn
contributes to falling employment for skilled people, to factor price polarization and migration of
skilled labor. The effect can be observed already with the unification of Italy during the late 19th
century.
The mechanisms behind this effect are relatively straightforward. Abruptly freeing imports creates a
shock in terms of reduced demand for national production. The companies with the highest relative
fixed costs compared to variable costs are the hardest hit by this on their profit and loss statement.
The companies that still have a high amount of machinery and equipment to be amortized are hit
long before mature industries with depreciated machinery. Young industries that are cash-starved
are hit long before mature cash-cows. All of this contributes to the opposite effect of what one
would want: a too rapid economic integration leads to the loss of precisely those industries one
would wish to promote, modern industries employing new technologies. The last economic activity
to be hit from a free trade shock is subsistence agriculture where people simply withdraw from
market activities back into self-sufficiency.
31
We should note that the ‘cosmopolitan principles’ was the term used to refer to Ricardian economics, against which
Friedrich List coined the term ‘National Economics’ (which still is the term for economics in Sweden). The other
‘protest term’ against the ‘cosmopolitan principles was ‘Social Economics’ (as economics was referred to in Norwegian
until very recently) because the cosmopolitan principles, just like today, tended to disregard serious social
consequences.
- 45 -
Diversity and Synergy: Heinrich von Thünen’s Stages Simultaneously

Spread Across Geography.
In the process of re-introducing geography into economics (as in the works of Paul Krugman)
German economist Heinrich von Thünen is the main protagonist. Thünen (1783–1850) drew a map
of civilized society, with four concentric circles around a core of increasing returns activities – the
city32. Moving outwards from the city core, the use of capital gradually decreased and the use of
nature gradually increased. Near the city the most perishable products are produced; dairy products,
vegetables and fruit, and grain for bread is produced further out, and in the periphery there is
hunting in the wilderness. Economists today have rediscovered Thünen’s approach to economic
geography, but many totally miss the crucial point he stresses, that the increasing returns city
activities needed tariff protection in order to get the entire system to function. Thünen understood
that the development machine at the core of the concentric circles – the urban increasing returns
industries (manufacturing) – needed, for a time, both targeting, nurturing and protection. In other
words, the presence of an emulating city would determine the standard of living also in the rest of
the country, in the ‘outer circles’.
Thünen drew the stage theories we have already discussed on to a map where the most ‘modern’
sector, manufacturing, formed the city core, and the most ‘backward’ sector, hunting and gathering,
furthest from the city, formed the periphery; moving away from the city, the use of nature increases
and the use of capital decreases. Only the city has authentic increasing returns, free from Nature’s
flimsy supply of resources of different qualities.
As one moves outwards from the city, man-made comparative advantage (subject to increasing
returns) gradually diminishes and nature-made comparative advantage (subject to diminishing
returns) increases. As we move outwards in the circles, the carrying capacity of the land in terms of
population also diminishes. The population density in the city is infinitely greater than that of the
hunting and gathering areas.
The importance of the linkages and synergies for agricultural development, seeing the benefits
accruing to agriculture from the proximity of manufacturing, was perhaps the most important new
insight in economics during the early 1700s. ‘Husbandry… is never more effectually encouraged
than by the increase of manufactures’ says David Hume in his History of England (1767, vol. III).
Thünen’s model pictures all the ‘stages’ of development inside one nation state, one labour market,
one school and university system, one social security system. The synergies that David Hume
points to are partly the result of an equal access to basic institutions and government services
accruing to the hunters in the outermost circle as well as to the city dweller. The local city market
does to national agriculture what an international market can never do. Proximity to a city in the
same labour market, rather than abroad, assures employment for the second and third son on the
farm. The wage pressure from the city activities makes labour more expensive in the countryside,
allowing for technological change that would never be profitable with low wage rates. The
proximity to the city gives access to advanced technology and expertise that a rural-only nation
would never achieve. All in all von Thünen’s model provides a useful picture for development as a
32
The inventor of the concentric circles to explain to the role of cities was Johann Heinrich Gottlob von Justi, in his
Gesammelte Politische und Finanzschriften über wichtige Gegenstände der Staatskunst, der Kriegswissenschaften und
des Cameral- und Finanzwesens, 1761-64, vol 3, p. 449 and following.
- 46 -
synergy between town and countryside. Further in this chapter we shall show that this insight was a
key argument for the launching of the 1947 Marshall Plan.
Novelty and Scale: Understanding Capitalism and the Absence of

Economic Development
In the post-Cold War setting we are increasingly made aware of nation-states with radically
different political structures than Western democracies, ‘fragile’, ‘failed’, or ‘failing’ states ruled by
‘war lords’ such as Somalia or Afghanistan. Going back to pre-Cold war German and American
theories of capitalism, it was generally considered that such political structures were products of
particular ‘modes of production’ (a term in no way exclusive to Marxism). As we shall see below,
such states were defined as not being part of ‘capitalism’. During the 20th century Fordist mass
production was the dominant mode of production in Europe and what the League of Nations called
‘areas of recent settlement’ (United States, Canada, Australia, New Zealand), but not in the
colonies. I argue in this section that neo-classical economics describe the world economy in a way
that misses out key aspects of capitalism as a system of production.
An important transition in human economic history was the gradual one from a ‘clan economy’
(Sippenwirtschaft) based on self sufficiency to a barter economy where handicraft production
(‘production made to order’) replaced self-sufficiency (‘production made for own use according to
need’). This town-based handicraft production, as its name implies, was based on small scale, and
any success in rent-seeking came more as the result of guild collusion than from ‘natural’ market
power. In this situation it could be argued, as Adam Smith did, that freer markets would result if
collusion could be kept under control. ‘Perfect competition’ was to a considerable extent feasible.
The first industrial revolution that took place while Adam Smith was writing changed that. The
industrial revolution brought with it a gradual transition from ‘handicraft’ (implying ‘production
made to order’) to ‘industrial production’ (implying ‘production for an unknown group of
consumers’).33
This development implied use of technologies where economies of scale (in order words: fixed
costs) increased heavily over time. These huge fixed costs created barriers to entry (a discussion
started by Bain 1956) that made perfect competition no longer feasible. The transition from town
economies to national economies was made possible by a larger division of labour – potentially
favourable both to producer and consumer – because of the lower costs originating in technical
change and increasing returns. A greater degree of impersonality – no longer knowing the person
who produced your shoes – was the price society and the individual had to pay for getting cheaper
shoes. On the production side capitalism was a system driven by technological change and
increasing returns. While perfectly distinguishable in theory, as they tend to develop over time
increasing returns and technical change are in fact so intertwined that they are often inseparable.
The technology Ford used to produce cars was never available for a car producer who wanted to
produce profitably at a household or village level. Schumpeter therefore coined a term which is
extremely useful for the study or economic history: ‘historical increasing returns’ (a combination of
both)
This combined technology/scale phenomenon hit different economic activities at different points in
time, but when it hits it hits in an explosive way. Figure 3 shows the ‘productivity explosion’ in
33
Werner Sombart here builds on the analysis of Karl Bücher.
- 47 -
cotton spinning during the First Industrial Revolution. In the industries that had been hit by this
combined scale/technological change phenomenon, no return to perfect competition would be
possible. The ‘minimum efficient size’ of operations (to use Alfred Chandler’s term) would create a
pattern of competition where scale of operations created barriers to entry and consequently a type of
competition that was by definition oligopolistic. The successful result of taming the imperfect
competition between these huge players would, as John Kenneth Galbraith always pointed out, be a
societal balance of countervailing powers between ‘big business’, ‘big labour’ and ‘big
government’.
The transition from ‘handicraft’ (implying ‘production made to order’) to ‘industrial production’
(implying ‘production for an unknown group of consumers’) also implied a transition from
‘production in order to make a living’ to ‘production for profit’. Competition became a relentless
game of oligopolistic innovation and emulation, seeking the rents that could be harvested from
successfully getting a share of the oligopoly. As long as the rents are Schumpeterian rents that are
slowly eroded rather than static rents, this rent-seeking is in fact a core mechanism explaining
capitalist dynamics. Of course, as the airline industry has shown in recent years, such oligopolistic
games can also cause entire industries to run at a loss for years. The same fixed costs that create
barriers to entries also create barriers to exit.
Werner Sombart’s Definition of Colonies not being Part of Capitalism.

During the Cold War two different definitions of capitalism crystallized. First: in the ‘free world’,
capitalism gradually came to be defined as a system of private ownership of the means of
production, where all coordination outside of firms is left to the market. This developed into a
definition that excludes any reference to production: as long as they bartered without central
planning one would almost assume that a Stone Age tribe could be considered ‘capitalist’. Second:
in Marxism capitalism was mainly defined as system defined by a relationship between two classes
in society, the owners of the means of production and the workers.
However, a third definition of capitalism exists, a definition that dominated until the Cold War, a
definition that was crowded out because it could not be neatly placed along the right-left-axis. If we
follow German economist Werner Sombart’s definition of capitalism, instead of that of the Cold
War, we get an understanding of why capitalism – as it is defined today – is a system where it is
possible to specialise in being rich, or in being poor.
Werner Sombart considers capitalism as a kind of historic coincidence, a coincidence brought

together by a whole range of circumstances. Still, he is quite clear that economic wealth is a result
of its being willed, a result of a conscious policy. The driving forces of capitalism, which create
both the foundation and the conditions for the system, are, according to Sombart (1928):
1. The entrepreneur, who represents what Nietzsche calls the ‘capital of human wit and will’, the
human agent who takes the initiative to have something produced or traded.
2. The modern state, which creates the institutions enabling improvements in production and
distribution, that creates the incentives that make the vested interest of the entrepreneur coincide
with the vested interests of society at large. Institutions encompass everything from legislation to
infrastructure, patents to protect new ideas, schools, universities, and standardization e.g. of units of
measurements.
- 48 -
3. The machine process, i.e. what was long called industrialism: mechanisation of production
creating higher productivity and technological change with innovations under economies of scale
and synergies. This concept is very close to what we today call the ‘national innovation system’
(associated with Christopher Freeman, Bengt-Åke Lundvall, and Richard Nelson).
In Sombart’s definition of capitalism, the rich countries were those who emulated the leaders into
the industrial age. With capitalism defined in this way, it is actually correct to say that the rich
countries are the ones that joined the mode of production called capitalism.
When these elements are in place, in order to function, capitalism demands – still according to
Sombart – the following ancillary elements to be able to develop fully:
1. Capital
2. Labour
3. Markets
These three elements – the very core of standard economic theory – are, according to Sombart, not
at all the driving forces of capitalism, they are just auxiliary factors to the main driving forces.
Without the driving forces, the ancillary elements – capital, labour, and markets – are sterile. Both
Marx and Schumpeter agree that capital in itself, without innovations and without entrepreneurship,
is sterile.
The most interesting aspect of this pre Cold War definition of capitalism is that with this approach
capitalism had not reached the colonies. At its core colonialism was a technology policy: A key
aspect of colonial policy was to prohibit manufacturing there. The following quote from English
economist Joshua Gee, from his 1729 work, Trade and Navigation of Great Britain Considered, is
typical of colonial economic policy:
‘That all Negroes shall be prohibited from weaving either Linnen or Woollen, or spinning or
combing of Wooll, or working at any Manufacture of Iron, further than making it into Pig or Bar
iron: That they be also prohibited from manufacturing of Hats, Stockings, or Leather of any Kind…
Indeed, if they set up Manufactures, and the Government afterwards shall be under a Necessity of
stopping their Progress, we must not expect that it will be done with the same Ease that now it
may’.
The rebellion against these anti-emulation policies – which are less racist than they sound because
they were also applied against the predominantly white settlements in North America at the time –
has in all cases been accompanied by a strategy of emulation into manufacturing industries.
Decolonisation meant embarking on a programme of industrialisation. Not all of these attempts
were equally successful, but if human welfare – rather than free trade per se – is our goal we have to
face the fact that in a majority of countries real wages were considerably higher when an
‘inefficient’ manufacturing sector was present than when it was not.
Not all protectionism is equally efficient. How Rich Countries got Rich... and How Poor Countries
Stay Poor (Reinert 2007a, appendix IV) establishes two ideal types of protectionism, ‘good’ (‘East
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Asian’) protectionism and bad (‘Latin American’) protectionism34. In many poor countries
protectionist policies were clearly of the ‘bad’ kind, but this ‘bad’ protectionism produced real
wages about twice as high the wage level after ‘structural adjustments’ and deindustrialization. Data
reproduced in Reinert (2007a) makes it evident that maximising world trade clearly is not the same
as maximising world real wages. The Washington Consensus system of ‘conditionalities’ created an
anti-emulation effect.
Also within Europe anti-emulation policies were very frequent. Venice prohibited the migration of
her skilled glass workers from finding work abroad with the penalty of death, while England for
many years prohibited the export of machinery. If we see the debate on when to stop protection –
when to switch from emulation to comparative advantage – as perhaps the most important economic
debates in the times to come, the English machine case provides an interesting insight: England
only stopped the export prohibition of machinery when the English machine producers themselves
successfully argued that if they were restricted from competing on the world markets they would
lose ground to foreign machine producers. In other words, if the kind of protection employed is
what we define as ‘good protection policies’, ‘market forces’ can to some extent be relied on for
signalling a to free trade and ‘comparative advantage’. Successful emulation provides the seeds of
its own destruction, and the key underlying mechanism is Schumpeter’s ‘historical increasing
returns (the combination of technological change and increasing returns).
I have argued (Reinert 2007a) that the only time Adam Smith uses the term ‘invisible hand’ in the
Wealth of Nations it is precisely when describing such a transition from emulation to comparative
advantage. Smith praised the Navigation Acts protecting English manufacturing and shipping
against Holland, arguing “they are as wise… as if they had all been dictated by the most deliberate
wisdom” and holding them to be “perhaps, the wisest of all the commercial regulations of
England”. The term ‘invisible hand’ is used only when it supports the key import substitution goal
of mercantilist policies, when – after successful emulation – the English consumer preferred
domestic industry to foreign industry. This could only happen when ‘the market’ had taken over the
role previously played by protective measures, and national manufacturing no longer needed such
protection. Because Adam Smith tends to be used more these days to provide ideology than to
provide theoretical solutions to contemporary problems, we have not seen that he can be
legitimately also seen is a mercantilist who truly understood the transition from emulation to
comparative advantage. Successful emulation through protection has been a mandatory passage
point in all capitalist countries, but it must at one point yield to free trade.
The economist who more than anyone else had the transition from protectionism and free trade at
the very core of his theoretical edifice was Friedrich List. He was the visionary of a united Europe,
when emulation through protection had successfully reached all nations of Europe. The 1846
Repeal of the Corn Laws was at the time understood as an attempt by the English to convince the
rest of the world that their free trade in agricultural products meant that the rest of the world should
adopt immediate free trade in manufacturing. In fact List had always argued for free trade in corn
(Reinert 1998).35
34
See also Dosi, Freeman & Fabiani (1993) for a similar concept.
35
Modern agricultural protectionism originates only towards the very end of the 19th century, and is not an emulation
project. At the early stages of industrialization it was generally argued that the farmers were much better off than the
industrial workers because they had enough food. When workers rights and the embryonic welfare state had been
established, it was discovered that now the city was in exploiting the poor farmers who had to be protected from the
even poorer farmers abroad. It is extremely important to understand the very different motivations behind the two types
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The Marshall Plan (1947) as the Last Successful Project of Emulation.

In June 1947, in a speech delivered at Harvard, US Secretary of State George Marshall announced a
re-industrialization plan for a war-torn Europe - later called the Marshall Plan. This plan represents
the logic of emulation at its most creative: compared to the United States, Europe did not have a
comparative advantage in industrial production. In spite of this – and totally contrary to Ricardian
principles – a generous infusion of capital as well as tolerance of needed developmental policies
ensured the rebirth of modern Europe as an industrial state.
In the next couple of decades, as the same type of economic development policy spread in Asia
following the Korean War, the Marshall Plan developed into what is probably the most successful
economic development assistance project in human history. Politically, it created a cordon sanitaire
of wealthy countries from Western Europe to Northeast Asia, successfully containing the spread of
communism, while ensuring rapid growth throughout the world during what has been termed the
post-war ‘Golden Age’.
Apart from its historical importance, it is worth taking a fresh look at the Marshall Plan because it
delivers valuable insights to the logic of emulation that have relevance today. First, it is important to
recall that the Marshall Plan represented a complete reversal of the preceding Morgenthau Plan,
named after Treasury Secretary Henry Morgenthau Jr. Germany had started two world wars, and in
his 1945 book, Germany is Our Problem, Morgenthau had announced a de-industrialization plan
‘converting Germany into a country principally agricultural and pastoral’ to make sure it could
never again go to war.
By late 1946, however, economic hardship and unemployment in Germany were worrying the
allies, and former President Herbert Hoover was sent there on a fact-finding mission. Hoover’s third
report of March 18, 1947 noted: ‘There is the illusion that the New Germany left after the
annexations can be reduced to a “pastoral state”. It cannot be done unless we exterminate or move
25,000,000 people out of it.’ He well understood that a purely agricultural country would only be
able to sustain a much smaller population than a mixed agrarian and industrial nation.
Faced with the real possibility of an excess of people in need of work that a loss of industry would
bring, the only option was to re-industrialize, which is what the Marshall Plan facilitated. Less than
three months later, Marshall’s early June speech reversed policy. Germany and the rest of Europe
were to be re-industrialized with policies that, in practice, included heavy-handed economic
interventions such as high duties, quotas, and import prohibitions. Free trade was there, but it was
envisaged as viable only after reconstruction and international competitiveness had been achieved.
George Marshall’s short speech made four other important points. In describing how Germany’s
economy had ground to a halt, Marshall noted the breakdown of trade between city and countryside:
‘The farmer has always produced the foodstuffs to exchange with the city dweller for the other
necessities of life’, stressing ‘This division of labor is the basis of modern civilization.’ With this,
Marshall recalled centuries-old European economic insight: the only wealthy nations were those
with cities that held a manufacturing sector. ‘The remedy lies in breaking the vicious circle and
of protectionism. I have previously referred emulative manufacturing protection as ‘aggressive protectionism’ and to
agricultural protectionism as ‘protective protectionism’.
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restoring the confidence of the European people.’ Marshall’s use of the expression ‘vicious circle’
was to become the vogue in development economics in the 1950s and 1960s.
‘Our policy is directed not against any country or doctrine but against hunger, poverty, desperation,
and chaos. Its purpose should be the revival of a working economy in the world so as to permit the
emergence of political and social conditions in which free institutions can exist’, said Marshall.
Contrary to today’s conventional wisdom, Marshall argued that free institutions emanate from
certain productive arrangements, not the other way around.
Marshall was also very insightful about how to ensure that aid would be truly developmental. ‘Such
assistance, I am convinced, must not be on a piecemeal basis as various crises develop. Any
assistance that this Government may render in the future should provide a cure rather than a mere
palliative.’ Unfortunately, much of today’s ostensible development initiatives are palliative,
ignoring Marshall’s caveat.
During recent decades, structural adjustment and forced trade liberalization have created effects
similar to that of the Morgenthau Plan in many countries. While some large nations – like China
and India – that had protected their industries for half a century and had given high level education
to significant portions of their populations have benefited from globalization, most of the other
developing countries saw their real wages virtually halved by de-industrialization and unfettered
global competition. Incipient industrialization in many parts of Africa regressed. During the last 20
years, premature and sudden exposure to world markets has brought about a steady loss of industry,
decline in agriculture and de-population in many regions now subject to immiserizing vicious
circles.
We must rediscover the ancient art of emulation that died out some time in the 1970s. More
attention must be paid to rebuilding the productive structure of poor nations. This process requires a
simultaneous build-up of the supply and demand sides – of productive capacity and purchasing
power – as the European economies did during the crucial decades following Marshall’s speech in
June 1947. This seemingly roundabout development road is, in fact, the only one that can create a
lasting peace.
The very last traces of Marshall-plan logic was the integration of Spain into the European Union
during the 1980s, gradually lowering tariffs and making sure that the Spanish automotive industry
with its layers of suppliers survived. When the former centrally planned economies were integrated
into Europe some two decades later, the medicine was shock therapy which left large parts of
Eastern Europe virtually de-industrialised. The economies of the European periphery, in countries
like Moldova, have many similarities to Third World peripheries (Reinert & Kattel 2004).
Conclusion: Industrial Policy and Poverty

Based on an analysis of the last 500 years of the history of economic policy, this chapter argues that
all countries that have moved from poor to wealthy has done so by going through a period of
‘emulation’ – of infant industry protection – in order to get into the areas where technological
progress is concentrated at the time. This has been a ‘mandatory passage point’ in human history.
This emulative stage reduces the asymmetry in knowledge and technologies between rich and poor
countries. The lack of skills and the lack of markets combine to make any ‘technology transfer’
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simply not profitable without these added incentives (‘vicious circles’). Only after this step has been
achieved, it will be in the interest of the catching up country to specialise ‘symmetrically’ according
to its comparative advantage within the leading paradigms.
I have compared attempts to achieve this transition without ‘artificial’ incentives to a business
person expecting a new industrial company to make money from day one of operations. Something
that only happens in theory. Amazon.com’s many years in red ink may be compared to a nation
weaning itself from ‘industrial start-up costs’.
Starting with the economic theory of Antonio Serra in 1613 economic development has been
associated with economic activities subject to increasing returns and a large division of labour
(Reinert & Reinert 2005). I have labelled these Schumpeterian activities, contrasting them with
Malthusian activities that only produce poverty.
Characteristics of Characteristics of
Schumpeterian Activities Malthusian Activities.
(= ‘good’ export activities) (= ‘bad’ export activities if no Schumpeterian sector
present)
Increasing Returns Diminishing Returns
Dynamic imperfect ‘Perfect competition’

competition (commodity competition)
Stable prices Extreme price fluctuations
Generally skilled labour Generally unskilled labour
Creates a middle class Creates ‘feudalist’ class structure
Irreversible wages Reversible wages

(‘stickiness’ of wages)
Technical change Technical change

leads too higher wages tends to lower price
to the producer to consumer
(‘Fordist wage regime’)
Creates large synergies Creates few synergies

(linkages, clusters)
This chapter argues that neo-classical economics and Ricardian trade theory fundamentally
misrepresent the very nature of capitalism. Ricardian barter of qualitatively identical labour hours –
the very core of the present international economic order – fails to identify the process of relentless
rent-seeking through innovation and emulation that is economic development. Trade theory fails to
- 53 -
differentiate between dynamic societies where such change is imbedded both in the products and in
the labour of nations and static ones, and therefore arrives at counterintuitive proposals.
‘Perfect competition’ ceased to be a feasible proposition already during the First Industrial
Revolution. A combination of technical change and increasing returns (Schumpeter’s ‘historical
increasing returns’) increased ‘minimum efficient size’ of operations and consequently barriers to
entry and exit, making oligopolistic competition the name of the game in manufacturing industries.
‘Rent-seeking’ in a sea of oligopolistic competition is consequently what capitalism is all about. As

labour also became oligopolistic through unionisation, the stage was set for a system of big
business, big labour, and big government (Galbraith 1956 & 1983). Regulations aiming at a ‘just’
degree of imperfect competition turned this system into one of triple rent seeking: capital, labour
and government ‘colluded’ to share the oligopolistic rents. Minimum wages are important tools for
insuring such a ‘collusive distribution’ of the rents from innovations.
The presently wealthy nations have all been through a stage where they employed a strategy of
emulation into the paradigm-carrying activities of the day. The Marshall Plan – the giant plan for
reindustrialising Europe after World War II – was the last big emulation plan that opened up for
successful free trade later. Presently the United States and European economies are emulating each
other in creating gigantic rent-seeking machines based on very oligopolistic competition – like
Boeing and Airbus. As a rapidly increasing part of world trade takes place in patented goods – i.e.
legalised rent-seeking – it is almost indecent of First World economists to suggest that Third World
countries should not be allowed to engage in industrial policies that produce rent-seeking. This is a
blatant example of double standards: the strategy ‘perfect competition for you and imperfect
competition for us’ was the core of an industrial policy called colonialism. The Third World will
increasingly see the present stance as neo-colonialism.
Both vested industrial interests and plain institutional inertia will easily lead to keeping the strategy
of emulation in place longer than warranted before comparative advantage takes over. India and
China are probably both examples of that. However, if we compare the situation of India and China
on the one hand and Somalia and Tanzania – both nations richer that Korea and Singapore 50 years
ago – on the other, the cost of keeping the strategy of emulation in place too long is infinitely
smaller than that of never embarking on it. Capitalism is rent-seeking. Choosing between the option
of keeping a system of industrial rent-seeking that is too static, thus creating an economic system
that is less than optimally dynamic, is infinitely better than failing on the opposite side with no
emulation, but unemployment, hunger and disease as is the case of fragile, failing and failed states
in Africa and elsewhere. Failing on the side of keeping the protective barriers too long leads us to
live pleasantly in a country like Argentina in 1995. Failing to embark on emulation at all leads us to
live in a country like Somalia in 1995. The choice is not really difficult.
I have argued that by establishing ‘free trade’ uncompromisingly as the linchpin of the World
Economic Order we have closed our eyes to many of the trade-offs that actually face us when we
make economic decisions. As the absoluteness of the Gold Standard blocked Keynesian reforms for
many years in the 1930s, the absoluteness of Free Trade plays a similar role today. I have argued
that while ‘emulation’ is the logical intuitive choice in many situations, the counterintuitive choice
of ‘comparative advantage’ is more than often imposed on countries far away. To use the term
coined by US economist Thorstein Veblen, Ricardian economics may ‘contaminate our instincts’.
Not only that, in my view Ricardian trade theory is also about to contaminate our ethics. By seeing
- 54 -
rent-seeking through import restrictions as something close to the cardinal economic sin, we may
actually indirectly favour other forms of rent-seeking that may be even less palatable. During the
US Civil War the South would be our ethical choice because they were in favour of free trade.
Rent-seeking in the South was based on something else, on slavery. The North on the other hand
based their economic policy on rent seeking through import substitution. Who would we favour
today, rent seeking through import substitution or through low-wage slavery?
As did the United States after the defeat of the South in the Civil War, after World War II many
countries raised their standards of living through an active industrial policy of the Schumpeterian
kind described in this paper. When protection was abruptly radically reduced or removed with the
structural adjustment programmes of the Washington Consensus, in some countries starting already
in the 1970s, real wages fell precipitously in a large number of countries from Peru to Africa,
Moldova and Mongolia (Reinert 2007a). Clearly in many countries industrial policies were
inefficient, but historically the only reasonable reaction to having an inefficient manufacturing
sector is to make it more efficient, through the promotion of more competition internally or from
countries at similar levels of development. And, centuries of experience (Steuart 1776, List 1841)
insist that whatever changes are made to industrial policy should be made slowly – not through
shock therapy – in order to allow companies to adjust their productive structures.
- 55 -
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A note on Erik Reinert’s Schumpeterian–Listian Development

Economics
Esben Sloth Andersen
DRUID and IKE, Aalborg University
The engine of economic development

The title of Erik Reinert’s (Reinert2007) recent book—How Rich Countries Got Rich … and Why
Poor Countries Stay Poor—nicely summarises the twin problems of what has been called
development economics. His answers to the problems are largely found in what may be called a
Schumpeterian–Listian approach to development economics. In a simplified version of this
approach, “development” (or “evolution”) has always involved the attempts of fiscal states to
improve the position of their national economies in the world economy. The tool for this
improvement is the “increasing returns sector”, i.e., the dynamical part of the economy consisting of
a changing part of manufacturing as well as an increasing part of services. If a national economy
contains such a sector, it can integrate in the world economy based on the principles of comparative
advantage. However, if the sector is weak or does not exist in an economy, the very same principles
lead to a vicious cycle of underdevelopment and poverty.
Reinert’s idea of the “increasing returns sector” as the engine of development is not easy to
grasp. With his early background in the Boston Consulting Group, he is thinking in terms of
historical learning curves of industrial production or what Schumpeter called “historical increasing
returns returns”. His thinking also has some similarity with that of post-Keynesian accounts for the
engine of growth. It might have been easier to grasp his basic idea if he had made reference to, for
instance, Nicolas Kaldor’s enormous emphasis on increasing returns in his later works would have
been enlightening (see King, King1994); but references could also have been made to works of
Pasinetti, Thirlwall, or Cornwall. Without this broader context, Reinert’s “quality index” of
economic activities might be very difficult to grasp for many of his readers. Nevertheless, a deeper
understanding of the apparently idiosyncratic Figure 1 is crucial for evaluating his book. The
argument is that each industry has a period in which its location in a country or region promotes
growth and development. For the shoe industry, this period was the last half of the nineteenth
century (Reinert, Reinert2007, 137–40). The fact that poor countries took over shoe production later
is an indication that there was nothing more to learn and that no further development could emerge
from shoes. Today, the production of golf balls might promote development while the production of
baseballs is a sign of underdevelopment.
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Figure 1: Reinert’s “quality index” of economic activities.

Source: Reinert (Reinert2007, 317). Copyright: Erik S. Reinert.
The nursing and protection of an “increasing returns sector” was for centuries a core aim of
mercantilist policies of states that aimed at improving their position in the international economic
system. However, although development-promoting mercantilism is a central theme of the book,
Reinert does not try to glorify the actions of the fiscal states. The policies of successful states were
often, at least in the past, intended to increase the tax base for hegemonic policies that included
expansion by war. However, the national policies were even more often characterised by a short-
termism that created serious financial troubles and very little development.
Earlier states with such short-termism were likely to be conquered by more developed countries,
but presently economic trouble leads to the intervention of the World Bank and the World Trade
Organisation. According to Reinert, these Washington institutions do not promote long-term
development. Instead, the “Washington Consensus” has led to a destruction of the weak results of
developmental efforts. Reinert (Reinert2007, 295) characterised this “a crime against of a
considerable percentage of humanity” that consists in “the perhaps irreversible deindustrialization—
the killing of the increasing returns sector—of the periphery”. The formula for killing weak and
immature industries that are still based on protection and subsidies is simple: quick liberalisation.
However, the enormous waste of skills and organisational structures can only be understood on the
basis of a historically oriented theory that emphasises industrial activity as the key factor needed in
the process of development. We can obtain a quick summary of Reinert’s book by considering the
title of one of the related books by Ha-Joon Chang (Chang2003). The title of this book is Kicking
Away the Ladder: Development Strategy in Historical Perspective. Reinert’s book could have had
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the same title. He argues that the poor countries are today deprived of the “ladder” by which the
rich countries previously grew rich.
Reinert suggests that the short-termism and lack of historical sense that characterises the
“Washington Consensus” has been part and parcel of major parts of the economics discipline ever
since the French physiocrats and Adam Smith. The lacking recognition of the developmental
importance of the “increasing returns sector” is especially clear in the Ricardo’s theory of
international specialisation and in Samuelson’s (Samuelson1948a; Samuelson1949) theory of factor
price equalisation through international trade in the Heckscher–Ohlin model. The way these
theories have been used for policy advice is an example of what Schumpeter called “the Ricardian
Vice”. This “Vice” is not the application of simple models but the application of inadequate
models. Shortly before he died, Schumpeter (Schumpeter1954, 472) argued that the practice of
using inadequate models by his students at Harvard University reflected that they “lack the
historical sense”. Since they lacked the faculty (sense) of perceiving history, their models also
lacked historical meaning (sense).
In contrast, the leading contributors to the development economics of the 1940s and 1950s had
the historical sense. Reinert’s book is designed to resurrect this sense by means of polemics against
anti-historic approaches and by positive contributions. The latter includes an attempt to reconstruct
“the Other Canon” that has related to the developmental strategies of fiscal states since the early
start in Renaissance Italy. To reconstruct this “canon”, Reinert moves back in the history of thought
from early development economics via Schumpeter and List to the Enlightenment and the
Renaissance. At the same time, he collects a series of case stories of “Schumpeterian Mercantilism”
that can be used to promote the historical sense of theorists and policy makers. However, he does
not systematically explore the huge task of developing the often very loose contributions of “the
Other Canon” to a cumulatively developing toolbox of scientific analysis. The reason is probably
that his aim is to promote the vision that can guide subsequent research.
Reinert and Schumpeter on the history of economics

After the English manufacturing industry had emerged as the world leader, the English state could
largely drop the protectionism that had promoted this position and enjoy the benefits of free trade as
well as the theories that supported it. In contrast, laggards like Germany and the USA developed the
industrial policies of the mercantilist tradition. Furthermore, some of their economists, not least
Friedrich List (List1983; List1909), refined the related theories like the “infant industry argument”
for “educational” protectionism in relation to manufacturing industry and made polemics against
British classical economics. List’s alternative principles are emphasised by Reinert. These
principles might be summarised in the following way:
1. The preconditions for wealth, democracy and political freedom are all the same: a diversified
manufacturing sector subject to increasing returns.
2. Economic growth and welfare is the result of dynamical and competence-promoting
synergies within a nation state
3. The synergies are found within the manufacturing sector as well as between it and the sectors
of agriculture, transport, trade, and government.
4. The synergies are “dynamical external economies” and can only be captured by long-term
nation building (nationalism)
5. Symmetrical international integration: A nation first industrialises under some state protection
and is then gradually fully integrated with nations at the same level of development.
Reinert study of this type of thinking was apparently his starting point for an extensive study of
the “Other Canon” within the history of economics (see Figure 1). He convincingly demonstrates
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that that this type of knowledge- and production-oriented thinking had deep roots and that it existed
long enough to influence the emergence of development economics in the 1940s and 1950s. An
early peak performance was provided by the Italian economist Antonio Serra, that in some respects
is clearer than later contributions by, e.g., List and Myrdal. Actually, Serra presented in the early
seventeenth century a pioneering account for systemic economic underdevelopment and
development based on the dismal economic performance of his native Naples and the success story
of Venice (Reinert, Reinert1999, 291–294).
There are many more contributions to “the Other Canon”, and Reinert (Reinert2007, 10) has
bought most of them for his extensive research library as they have become available—partly by the
selling-out from the unique Baker Library of Harvard University that he explored while studying at
Harvard Business School. Thereby, he may be said to have made the same type of study that
Schumpeter had performed in the Baker Library when producing his monumental History of
Economic Analysis. There is, however, a major difference between Schumpeter’s and Reinert’s
study of the history of economics.
Reinert (Reinert2007, 4) is trained in the case study method that is intensively applied at Harvard
Business School (and explicitly introduced as a way of exploiting the methodology of the German
Historical School). He seems not least interested in providing a collection of case studies of broadly
conceived mercantilist policy and the related theorising. This account focusses on the work of
Friedrich List but it ranges from Italian Renaissance to the Bismarckian policies of the late
nineteenth century.
Figure 2: Reinert’s genealogy of the knowledge- and production-based “Other Canon of Economics”.
Source: Reinert (Reinert2007, 33). Copyright: Erik S. Reinert.
In contrast, Schumpeter’s History focussed on the analytical progress of theoretical economics

and only used policy debates to provide information on the background for theoretical work.
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Although he is one of the few leading economists who took mercantilism seriously and considered
it a major contributor to the emergence of the science of economics (together with a broadly
conceived scholasticism), he did not make a dichotomy similar to Reinert’s “standard economics”
and “reality economics”.
Instead Schumpeter distinguished between (1) the economics serving the study of the
functioning and administration of a largely given economic system and (2) the economics that
focussed on the mechanisms of irreversible transformation of economic systems. While the former
activity had to some extent developed into a science that cumulatively improves theoretical tools,
the latter has hardly showed any analytical progress since Antonio Serra and similar early
contributors from the European Continent (which Schumpeter praises highly). Since he produced a
history of the cumulative improvement of tools of economic analysis, he has surprisingly little to
tell about later developments of “the Other Canon” of transformation economics.
Schumpeter’s readers should not consider the gradual disappearance of “the Other Canon” from
the exposition of History as based on a value judgement. He obviously considered the problems of
transformation—or development or evolution—as by far the most important ones, and he
emphasised the very limited range of the results of neoclassical economics. However, what had
basically been obtained by Gustav von Schmoller and his followers in the German historical school
was also rather pedestrian from the viewpoint of a born theorist: the hugely increased quantity and
quality of economically and politically relevant data. What had not been obtained—even by
Sombart, Spiethoff, and Max Weber—was cumulatively improvable theoretical tools.
Werner Sombart (Sombart1902) tried to combine Marx’s evolutionary “logic” with historical
fact in the two large volumes on Modern Capitalism, of which the latter volume was called Theorie
der kapitalistischen Entwicklung. Sombart’s book presented an idiosyncratic mix of theoretical
sketches and historical facts that, according to Schumpeter (Schumpeter1954, 816–817n), “even
out-Schmollered Schmoller”. Although this book “shocked professional historians by its often
unsubstantial brilliance … it was in a sense a peak achievement of the historical school, and highly
stimulating even in its errors”.
Sombart’s idiosyncratic book seems to have provided one of the challenges for the early
Schumpeter (Schumpeter1912): he wanted to create a systematic theory of capitalist economic
evolution, a theory that was intended to be cumulatively improvable (and to some extent extensible
to evolutionary sociology and evolutionary political science). Although these goals have only
recently been fulfilled and only in a partial way (see, e.g., Hanusch and Pyka, Hanusch2007),
Schumpeter spent a lifetime on the project and much interesting material—even on “Schumpeterian
Mercantilism”—can be found scattered in his works.
Although Schumpeter—in contrast to Reinert—emphasised the importance of neoclassical
economics, he did not reject the historical, statistical and sociological contributions of the historical
school. Actually, when Schumpeter summed up the “fundamental fields” of economics in his
History of Economic Analysis, he selected one field related to neoclassical economics (basic
economic theory) and three fields related to the historical school (history, statistics, and economic
sociology). Furthermore, his overall model of the scientific process emphasised the role of “vision”
of the type that not only characterised his own work but also that of List (see Figure 3; adapted from
Andersen, Andersen2007e).
Reinert and “Schumpeterian Mercantilism”

Reinert’s starting point for entering development economics is to a large extent the study of the
history of industrially oriented trade policy and the related trade theory. This study has an emphasis
on the theory of practice of what has been called “mercantilism”. Ever since Adam Smith,
mercantilism has been ridiculed by most leading economists as the alchemy of the balance of
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payments. However, Reinert follows the lead of Schumpeter by trying to rescue the insights of the
economists of the mercantilist traditions and reducing Smith to the role a somewhat dubious
system-builder.
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Figure 3: The scientific process according to Schumpeter

(Schumpeter1954, Part I; Schumpeter1989b).
This is partly done by demonstrating that “[p]romoting new knowledge was a fundamental
driving force for the economic policies of the Renaissance—and later of all realökonomisch
mercantilism, cameralism and Colbertism” (Reinert, Reinert1999, 276). He characterises this aspect
of the state’s promotion of economic growth as “Schumpeterian” mercantilism. It is obvious that
this “dynamic and knowledge-producing rent-seeking—or Schumpeterian Mercantilism—had in
many cases degenerated into static rent-seeking. (p. 301). However, it seems clear that the
mercantilist tradition—from the Italian city states of the Renaissance and onwards—focussed on the
causes of the relative economic strength of the European states. The key cause for the increase in
knowledge, skills and competitiveness was the creation of a strong and developing manufacturing
sector.
According to most mercantilists, the manufacturing sector was not only supposed to create
exports and substitute imports. It also served as an engine of growth through its internal
development and its influence on the productivity of the sectors of agriculture and transport: “For
centuries manufacturing was synonymous with the combination of technological change, increasing
returns and imperfect competition” (Reinert, Reinert2007, 6). Furthermore, the direct military
relevance of parts of the manufacturing sector was obvious to everyone and the indirect
consequence of underdevelopment was normally submission under a more developed country.
Reinert (p. 77) emphasises one of the consequences of submission: “Colonies were regions
where … synergetic interaction was not intended to take place … The prohibition of manufacturing
industries—whether explicit or de facto—is the key element in any colonial and neo-colonial
policy.” Since Ricardo’s theory of international specialisation told that manufacturing does not
matter, it served to make this policy morally defensible. However, it was definitely not used if it
prescribed England to deindustrialise in important areas.
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A major task for Reinert is to collect the tools that promote the analysis of the described
phenomena. With respect to the elements of this toolbox he to some extent agrees with, for instance,
John Mathews (Mathews2005), whose list of classics includes the economic historian Gerschenkron
(latecomer industrial dynamics), the political economist Akamatsu (the flying geese patterns of
industry transfer from country to country), and not least Hirschman and other development
economists (increasing returns, forward and backward linkages, etc.). However, although Reinert
obviously likes a mixed analytical toolbox, he also wants to create some coherence. Here
Schumpeter’s work and the post-Schumpeterian literature are major sources of inspiration.
If Schumpeter had been confronted with the label “Schumpeterian Mercantilism” and if he had
been able to overcome his rejection of both terms as being imprecise, then he might have said that
“[w]e are [here] dealing with a particular range of problems and our schema [Schumpeter’s basic
model] has been devised to serve it” (Schumpeter, Schumpeter1939a, 235). In the Schumpeterian
model of economic evolution, the state can either act as entrepreneur or as provider of some of the
parameters [“data”] for entrepreneurial action. Thus he does not need to a separate category of
“statecraft—mercantilist or other”. It is already included, but it is included at a highly abstract level.
A more concrete analysis might be developed by taking the starting point in Schumpeter’s
(1991a) “The Crisis of the Tax State” and other of his papers on economic sociology (like
Schumpeter, 1991c). However, such an effort is definitely not a simple one. Schumpeter’s
sociological papers were written for the occasion and we need to reconstruct their basic logic. For
instance, the tax state is described as “parasitic” and it only gradually becomes understandable why
the relationship between the state and the economy also be a symbiotic one of the type described by
Reinert. Here we are, however, helped by scattered and historically oriented remarks.
Schumpeter (Schumpeter1939a, 234) criticism of the concept of mercantilism is summarised in
the following remark: “we have constructed a historical entity called Mercantilism and endowed it
with a set of consistent principles”, but this historical entity does not “embody any set of definite
economic aims or principles.” Although no unified mercantilist set of policies existed, it is clear
that, especially in Germany, “the prince and his bureaucracy became for centuries the dominant
factor in economic life” (Schumpeter, Schumpeter1939a, 234).
In the German situation, it can be said that it was “the state rather then the entrepreneur which
initiated modern industry” (p. 235). Apart from the many cases in which the state “directly filled the
entrepreneurial function, … it conditioned enterprise by reshaping the institutional framework …
and by fostering it in various ways, some of which in fact come within what we usually understand
by mercantilist policy.”
In France, Colbertism meant that the “bourgeoisie was scientifically exploited and protected—
like game in a well-ordered park—in such a way as to … serve the splendor of the prince, the court,
and the army”. Since “a maximum of surplus [was] being sucked up to finance the great center of
expenditure” (p. 235), the “scientific” promotion of exploitable manufacturing capabilities was
subject to strong limitations.
However, the state functioned differently during the last of Schumpeter’s Kondratieff waves—
“The Neo-Mercantilist Kondratieff”—which he dates from 1897. Here we see the problematic
nature of the aggressive, colonising, and war-preparing “Neo-Mercantilism” of the European states
of his youth (Schumpeter, Schumpeter1991b, 199–208). However, we also find the less aggressive
strategy for industrial development of the relatively underdeveloped Austrian-Hungarian Empire,
which was designed by the Koerber government in the beginning of the twentieth century. I have
found no evidence that Schumpeter followed his teacher Böhm-Bawerk, who had been a member of
the Koerber government, in rejecting this strategy that was never fully implemented (Gerschenkron,
Gerschenkron1977).
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Schumpeter would probably largely have classified the relatively concrete treatment of
mercantilist statecraft as “economic sociology”. However, although he made significant
contributions to this field (Schumpeter, Schumpeter1991), he never treated the problems of
underdevelopment and state-promoted industrial evolution systematically. Presently, Reinert’s
(Reinert2007) book seems to be the closest approximation to what Schumpeter might have written
as a follow-up of Antonio Serra’s analysis—of we ignore much of the book’s policy-oriented
polemics and put its scientific polemics in a more guarded format.
Bringing Schumpeter to development economics

Schumpeter’s (Schumpeter1989a, 328) apparently naive remedy for most economists’s lack of
historical sense was the production of “a large collection of industrial and locational monographs”
that emphasised innovation and entrepreneurship. If economists sensed the stylised facts revealed
by such “detailed historical case studies” (p. 325), they would ultimately produce models that were
radically different from those that they actually developed. Here Schumpeter thought of models of
business cycles and growth, but his views also applies to the development economics that emerged
immediately after World War II.
It was history-related theories that quickly became the trade mark of much of development
economics. Actually, all the producers of what Paul Krugman (Krugman1994a) has called the “high
development theory” of the 1940s and 1950s had the historical sense. The reason is not least that
many of them—like Hans Singer, Albert O. Hirschman, Paul Rosenstein-Rodan, Gunnar Myrdal,
François Perroux, Paul Streeten, and Alexander Gerschenkron—were brought up with the long-term
economic problems of Continental Europe and often combined a background in neoclassical
economics with one in the German historical school.
Let us take Singer as example. He had studied at the University of Bonn with both Schumpeter
and the leading historical economist Spiethoff before studying with Keynes in Cambridge and
gained experience as a development consultant. This mixed background helped Singer (Singer1950)
to produce the theory of the declining terms of trade and factor prices of underdeveloped countries
specialising in standard commodities. The historical consequence is an unequal distribution of the
gains of trade and the—very difficult—solution is to change the specialisation of poor countries.
However, his mixed background as well as his emphasis on the complexity of the problems of
underdevelopment mean that he cannot be categorised as member of Neoclassical Economics or the
Historical School or Keynesian Economics or some type of Schumpeterian Economics. Thus his
work shows surprisingly little direct influence of Schumpeter and Keynes (Toye, Toye2006).
Furthermore, Singer emphasised the need of transcending even his own views—as did Hirschman
(Rodwin and Schön, Rodwin1994) and Myrdal (Steeeten, Streeten1998).
The praiseworthy pluralism—some would say eclecticism—of the founding fathers did not
promote development economics as a discipline. Their pupils needed simplification and lacked the
historical sense. This meant that the field of development economics tended to disintegrate because
of a lack of a common core; and this disintegration was promoted by the lack of success stories
from the prime regions of interest (Latin America and Sub-Saharan Africa) and by the shrinkage of
the funding of development research.
Hirschman (Hirschman1981) wrote an essay on “The Rise and Fall of Development Economics”
with a complex argument. In contrast, Krugman (Krugman1994a) gave a simple explanation and
suggested the opposite movement: “The Fall and Rise of Development Economics”. His
explanation of the fall is the lack of disciplined modelling and a new rise presupposes clear
foundations of development economics by means of formalised reconstructions of some of the
results of the founding fathers. Then it will become clear to which extent the more complex
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explanations are needed and to which extent the simpler accounts by textbook economics are
sufficient.
Reinert has an additional explanation for the decline of development economics and the
conditions for its revival. According to him, the problem is that the intellectual climate of the Cold
War implied that “reality-based economics—the historical schools of Europe and the institutional
school in the United States—were crowded out and virtually disappeared” (Reinert, Reinert2007,
34); and it was replaced by “the canonical sequence of Smith, Ricardo, Marx, etc. [that] still
constitutes the skeleton for most teaching and scholarly discussion” (p. 300). The solution is to
bring “the Other Canon” of “Reality Economics” back to economics (p. 33). Thereby Reinert seems
to support Hodgson’s (Hodgson2001a) attempt of to bring “history” back to economics, but it
should be emphasised that the predominant static institutionalism is part of the problem while it is
only dynamic and evolutionary institutionalism that might provide a solution to the crisis of
development economics. Furthermore, Krugman’s remedy should not be forgotten.
At the meeting of the American Economic Association that took place a few days before
Schumpeter’s death early in 1950, he discussed development economics with Hans Singer
(Singer1989). Schumpeter had earlier told his former student that the problems of
underdevelopment were purely political and not the topic of economic theory. However, now that
he saw Singer’s (Singer1950) preliminary results, he wished him luck with the endeavour.
Nevertheless, the early Singer did not think it possible to apply Schumpeter’s (Schumpeter1934)
Theory of Economic Development. Instead, Singer (Singer1953, 19–20) used this book to define
development economics both negatively and positively (relating to the 1952 version of Wallich,
Wallich1958):
1. Singer emphasises that while the agents of economic development in Schumpeter’s theory are
innovating and pioneering private entrepreneurs, government is the most likely agency of
economic development in many underdeveloped countries.
2. While Schumpeter assumes changes in production functions due to new products or
processes, Singer emphasises that economic development through the introduction and
adaptation of products and methods.
3. The generating force of Schumpeter’s economic development is found in the supply side of
the market while Singer’s generating force in the desire for increased consumption.
Singer’s ways of formulating the difference between Schumpeterian theory and the problems of
development economics were unfortunate because they ignored the necessary mix between private
and governmental entrepreneurship, the innovation characteristics of the much of the introduction
of technologies from abroad, and the need of a relative independence of the supply side in order to
serve the ultimate goal of increased consumption. The linkage theory of Hirschman
(Hirschman1958) was also made ineffective by translating it from its original Schumpeter-like
perspective of facilitating interdependent entrepreneurship to a matter of maximising linkages in the
sense of input–output tables of developed countries. Such shifts away from a Schumpeterian world
created an enormous confusion in the development economics community (Brookfield1975).
On this background, one of the recipes for a resurrection of development economics seems to be
an increased—and carefully thought out—dose of Schumpeterian perspectives. This also seems to
have been the conclusion of later Singer, who about Schumpeter’s book stated stated that “I realise
now more clearly than in earlier years how deeply relevant many of its [TED’s] themes are to the
development of poor countries and the problems of underdeveloped countries.” He especially
pointed at three themes that had originally been de-emphasised but that “now seem to me the key to
the problems of development in poor countries” (Singer, Singer1997a, 131):
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1. Schumpeter brought out “the great importance of technology, innovation, access to

innovation and ability and the means of linking innovation with the production process in the
form of new products or new processes or the development of new markets.”
2. In Schumpeter, the “emphasis placed on the fact that development represents a disruption of
familiar and traditional processes of stationary circulation, arousing resistances and hurting
established interests.”
3. Schumpeter tried to depict the self-transformation of the economic system by entrepreneurial
initiative and Singer relates this to notions of “self-reliance, self-sustaining growth,
dependency, backwash effects and all that! ”
The great thing about Reinert’s (Reinert2007) contribution is that it serves to bring attention to
these three Schumpeterian themes of development economics while at the same time keeping his
emphasis on the state and its promotion of a wealth-creating sector characterised by increasing
returns. The similarity between the approaches of Reinert and Schumpeter is obvious from Figure 4
(adapted from Andersen, Andersen2007e).
Although Reinert emphasises the inspiration from the German historical school and other types
of history-friendly social science, he acknowledges the Marxian challenge. Furthermore, he puts
much emphasis on what is presently called Elite Theory to promote an activist and creative image
of human behaviour while at the same time including the role of routine behaviour and vested
interests.
However, Reinert seems to have replaced neoclassical economics by Industrial Policy. As we
shall see in the next section, policy issues have a place in the Schumpeterian account for the
scientific process. With respect to neoclassical economics, the difference is largely a matter of style.
Actually, Schumpeter (Schumpeter194242, Part II) used the same style in Capitalism, Socialism
and Democracy. However, I guess that he in more scholarly works would, for instance, have
praised the factor price equalisation theorem of his student and friend Paul Samuelson—and then
use it as limiting case that beautifully serves as the starting point for summarising main mechanisms
the often radically different realities.
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Figure 4: Schumpeter’s evolutionary pivot as well as the

main sources and components of his analytical work
Schumpeter’s design of his theory of capitalist economic evolution might to some extent be seen
as following Krugman’s (Krugman1994a) recipe for overcoming “the fall of development
economics”. He tried to overcome the weaknesses of the German historical school by developing a
relatively simple model by means of the formal tools available for him. These were not least the
tools provided by Léon Walras and the rest of neoclassical economics (Figure 1). However, he
reinterpreted these tools in the light of the stylised vision of economic history wanted to implement,
a vision that to some extent was based on the facts collected by the historical school. For instance,
he did not apply Reinert’s strategy of rejecting equilibrium analysis. Instead, he reinterpreted
general economic equilibrium as reflecting a lock-in to a certain stage of growth and development.
It is in this setting that the Schumpeterian entrepreneur enters the model.
The interests of ordinary economic agents are in many ways locked to the existing circular flow
of economic life while the profit expectations of the entrepreneur is connected to the troublesome
period of transformation of the circular flow. When the basic resistance has been overcome by the
pioneering entrepreneur, the bandwagon of imitators and bankers turn to expectation-based
behaviour, and finally ordinary economic agents are forced to follow the lead. This process leads to
a picture of economic evolution, or economic development, as taking the form of innovative
revolutions punctuated by quasi-equilibrium episodes.
This story presupposes a heterogeneity of economic agents that has been abstracted away by
both classical economics and neoclassical economics. Therefore, it was crucial for Schumpeter to
apply to his evolutionary economics the elusive elite theory that ranges from Nietzsche to Sombart
and Pareto. Here he found a dichotomy between routine behaviour and creative behaviour as well as
ideas of human motivation that explained extraordinary effort of an apparently risk-seeking type.
Schumpeter also used elite theory as a way of breeding life into Marxian vision of the self-
transformation of economic and social life—a vision whose implementation had largely been
strangled by Marx’s dependence on the tools of Ricardian economics. Although it can be argued
that the Schumpeterian vision was similarly strangled by its dependence of the tools of Walrasian
economics, his dependence on elite theory helps us to recognise clearly his attempts to change the
available analytical tools.
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List or Schumpeter: the choice of a label

Reinert relates his work to high development theory but he fails to emphasise that the followers of
that line of thought fell into the trap of too easy structuralism and institutionalism. This difficulty of
development economics is to some extent similar to a major difficulty of innovation systems
studies. The literature on national systems of innovation (Lundvall, Lundvall2007) tends to be too
systemic, too structuralist, and too institutionalist. Although this tendency might have been
necessary to get such studies started, there is a serious need of adding a more historical approach
emphasising the creation and recreation of national systems of innovation.
Schumpeterian One strategy for reaching this historical activism is to perform the difficult
intellectual task of combining theories of entrepreneur-driven development with the more or
less systemic theories (Radosevic, Radosevic2007). This strategy might be called
Schumpeterian, a label that covers much more than Joseph Schumpeter (Schumpeter1934).
Listian An apparently different strategy is to study the creation and recreation of innovation
systems as reflecting state actions for national development. This strategy is followed by
Reinert (Reinert2007) and Chang (Chang2007; Chang2007a). Although such authors might
be characterised as techno-mercantilists or techno-protectionists, these policy-oriented labels
bring more heat than light since the approach is not tightly bound to any particular policy. It
is more fruitful to characterise the approach as Listian, although Reinert’s notion of the
“Other Canon” emphasised that the label is not constrained to Friedrich List (List1909).
Schumpeterian—Listian However, the Listian label is not really sufficient to cover the efforts
of Reinert and Chang since the inspiration from the tradition to which List belongs has also
led to studies characterised by static institutionalism. Therefore, their approach that tries to
capture the history of, and present possibilities for, the creation of dynamic industrial
capabilities by relatively weak states might better be characterised as Schumpeterian–Listian
Development Economics.
Schumpeterian as covering Listian When considering the scale and scope of both
Schumpeter’s work and the subsequent neo-Schumpeterian, or post-Schumpeterian, literature,
it might even be possible to simply talk about their contributions as promoting a jump
forward of Schumpeterian Development Economics.
When trying to name the analytical game, we remark that “Schumpeterian development
economics” might seem as a contradiction in terms since Schumpeter apparently concentrated on
advanced capitalism. In contrast, “Listian development economics” might seem appropriate since
List concentrated on the developmental “ladder”. Nevertheless, the name “Schumpeterian–Listian
development economics” overcomes the problem that List has often been used in a primitive
structuralist and institutionalist way that needs to be overcome. The simplest solution, however, is
to consider “Schumpeterian development economics” as containing “Listian” principles. This name
emphasises that Listian principles must be reconsidered in a coherent framework that might be
delivered by a combination of evolutionary economics, evolutionary sociology, and evolutionary
political science.
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Literature
Andersen, Esben Sloth (2007): Schumpeter’s evolution: Emergence and extension of a dramatic
theory of economic and social evolution as reflected in his major books, Research report, 309
pages, Department of Business Studies, Aalborg University.
Brookfield, Harold (1975): Interdependent Development, London: Methuen.
Chang, Ha-Joon (2003): Kicking Away the Ladder: Development Strategy in Historical Perspective,
London: Anthem.
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Toward Developmental University Systems

Paper presented at IKE-Workshop on Institutions, Innovation and Development
Aalborg University May 6 2008
Bengt-Åke Lundvall
Department of Business Studies
Aalborg University, Denmark
E-mail address: bal@business.aau.dk
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Preface
This paper represents work in progress. It refers to different institutional set ups linking universities
to the economy and to society. In this version there is too little on how universities function in less
developed countries and I have mobilised Judith Sutz and Claes Brundenius to join as co-authors
for the next version in order to repair on this weakness. It should end as a contribution to an Elgar
handbook on innovation and economic development.
Introduction
Over the last 20 years growing attention has been given to how universities may increase their
contribution to economic growth and international competitiveness (OECD 1984; Rosenberg and
Nelson 1994; Yusuf and Nabeshima 2007). This emphasis on the economic impact of universities
reflects a change in the interpretation of what drives economic development and growth, often with
reference to the concept ‘the knowledge-based economy’. It raises important questions for how to
design university systems especially in developing countries where universities tend to gather
within and around them scarce knowledge and skills with a potential to contribute to economic
development.
Most of the recent debate has focused of on ‘the third mission’ of universities.36 While the
traditional functions of research and training are taken for granted the idea that university research
should engage in direct interaction with external groups and interests has dominated the recent
debate. When combined with the strong emphasis on the economic dimension the main attention
has ended up to be on the university-industry interface and on commercialisation of knowledge
created within universities.
In this chapter we argue that the debate is not well founded in stylized facts and that it is
characterised by contradictions and lack of clarity. For instance commercialisation is sometimes
assumed to be synonymous with increased ‘openness’ of universities while it may actually lead to
the opposite of openness. We also see the current neglect of the two original missions in the current
debate as highly problematic. Educated graduates remain the major channel through which
knowledge is diffused to the rest of society and the way education is organised is of critical
importance for how students contribute to ‘the third mission’. A broad research base is necessary in
order to make sure that what students learn gets continuously updated.
In the developed part of the world there has been a growing attention to ‘the entrepreneurial
university’ that is engaged in national and local problem solving - sometimes the focus is narrowly
on market-oriented interaction with industry. In this paper we will build upon the alternative idea of
establishing ‘the developmental university’ – a term that we borrow from Rodrigo Arocena and
Judith Sutz (2005). The developmental university, as we define it, is open and interacts with
different groups in society, including industrialists but it is not operating according to the logic of
making profit. Its major aim is to contribute to social and economic development while at the same
time safeguarding a certain degree of autonomy.
While globalisation processes make universities more ‘universal’ – they become more involved in
global networks and exposed to global performance criteria such as frequency of international
publications - the pressure on them to contribute to the society that feeds them is also growing. It is
therefore important to consider what kind of tasks that universities in developing countries should
fulfill. To answer this question we need to see universities as parts of the over all innovation
system. Seen in this light it becomes clear that a differentiation of functions at different levels of
the system may be the most adequate response to the challenges that universities in developing
36
In the recent book with the title ‘How universities promote economic growth’ edited by World Bank economists none
of the 17 chapters is focused on Higher Education (Yusuf and Nabeshima 2007).
- 75 -
countries face. There is a need to differentiate functions between universities and other knowledge
institutions, as well as between and within universities. This is the only way to respond to the
contradictory requirements that universities are confronted with in the current era.
In the ‘developmental university system’ some universities may become hubs in a global
knowledge network while others might become hubs in national and regional developmental
networks with a stronger emphasis on problem orientation both in research and education. To
organise universities, including their mutual networking and interaction, according to this logic so
that they contribute to economic and social development is a difficult task and it will often call for
radical reform in the basic functions of education and research as well as in the interface with
external users of knowledge. Therefore the current debate, where the focus is almost exclusively
upon reforms aiming at the commercialisation of new discoveries, is misleading.
Factors behind the commercialisation drive

There are several reasons why universities have come under strong pressure to become more market
oriented. One is related to public finance. As academic programs have expanded to become mass
education the share of total government expenditure that goes to universities tends to grow. Since
other posts on the public budget have stronger advocates in the electorates the idea that universities
could become self-financing through student fees and through selling intellectual property has
become increasingly attractive for governments. International organisations such as the World Bank
and OECD have pushed in the same direction on the basis of their general pro-market bias.
An alternative route to reduce expenditures at the federal/central level has been to decentralise some
of the expenditure to regional or local authorities. This will often be combined with requirements
for universities to legitimise their activities and demonstrate that they contribute to regional or local
economic developments. These trends have led universities not to rethink their research and
education program but rather to set up new specific administrative functions aiming at marketing
intellectual property, at commercialising education through new MBA-programs and at networking
with regional actors. A new generation of ambitious administrators have entered into these new
administrative functions and they have become a significant pressure group at regional, national and
international level for expanding their own fields of responsibility. Leaders within universities have
realised that such activities may give more good will among politicians and raise less resistance
than attempts to reform the ordinary research and education programs.
New conceptualisations of the knowledge based economy

A different set of drivers that coincides in tiem with the increasing financial pressure has to do with
the new discourses related to ‘the knowledge-based economy’. The ‘mode 2’ production of
knowledge perspective assumes that universities increasingly compete with other knowledge
creating organisations and that the traditional academic ways of producing and assessing the value
of knowledge have become obsolete. ‘Triple-helix’ perspectives present the commercialisation of
universities and the intensified university-industry interaction as something that neither can or
should be avoided. As we shall show in a later section, misleading versions of innovation system
analysis that emphasise science as only source of innovation have also resulted in exaggerated
expectations of what universities are able to contribute to the innovation process. These new sets of
ideas have given legitimacy to governments that want to reduce their contribution to the finance of
universities and they have provided local university leadership with new ideologies supporting their
attempts to make their universities both more ‘entrepreneurial’ and more ‘commercial’.
The ‘examplary reality’ behind these generalisations is a combination of new developments in
biomedical research and the Bayh Dole-act of 1980 in the US. In the biomedical field the ‘distance’
from research taking place within the university laboratory to a patent that can be sold with
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substantial profit to a pharmaceutical company is very short. The Bayh Dole act gave new
opportunities for universities to make money on the knowledge they created in house through
patenting and the US’ relative success in developing the university-industry relationships has been
ascribed to this new legal framework.
While the new perspectives thus have a certain foundation in recent trends in the economy they also
tend to give a crude and one-sided picture of how the relationships between knowledge, innovation
and economic growth have changed. Outside biomedical research it is still exceptional that
scientific breakthroughs have a direct application in the form of profitable patents and it is worth
noting that even in the case of biomedical research the impact on economic growth from the
advance of knowledge remains limited and uncertain (Mowery et al 2005; Nelson 2006; Pisano
2006). The most thorough analysis of the impact of the Bayh Dole act does not support the idea that
the successful university-industry relationships originated from this act (Mowery 2007).
In the next sections I will present a different interpretation of major changes in the innovation
process and discuss implications for university systems in developing countries.
The Learning Economy

In the public debate knowledge is increasingly presented as the crucial factor in the development of
both society and the economy. In a growing number of publications from the European Commission
and OECD it is emphasised that we currently operate in ‘a knowledge-based economy’. For several
reasons the term ‘the learning economy’ is more adequate when it comes to characterise the current
phase of socio-economic development (Lundvall and Johnson 1994).
The basic assumption behind this concept is very simple. It is that, working together, technological
developments, globalisation and political processes of deregulation have led to an acceleration of
the speed of technical and economic change. Consequently, access to any given knowledge base is
less important for the economic success of firms and individuals, than their ability to rapidly
acquire new competences as they get confronted with new types of problems. New knowledge is
created at an increasing rate, but the quantity of economically relevant knowledge is also being
reduced as knowledge becomes obsolete at a faster pace than before.
This acceleration in economic change is reflected in different indicators. The life cycle of new
products becomes shorter. New production processes are diffused more rapidly than before. For
employees, work tasks change character, and many will have to change employer more often than
before. In a report from the Danish Ministry of Education, a German study is cited, maintaining that
just one year after the exam, half of what a computer engineer has learnt has become obsolete. The
‘halving time’ of what has been learnt in the education system is longer for other specific
professions but on average, it is argued, it is about 8 years (Ministry of Education 1998, p. 56f.).
This speed up of the rate of change is strongly connected both to the emergence of new forms of
organisation and to changes in the demand for skills. Organisational forms that make it possible to
reduce the time lag from the birth of an idea to its realisation tend to be more widely adopted and
make firms more performant. The most important new organisational traits that promote innovation,
sometimes referred to as characterising ‘the learning organisation’, reduce the number of levels in
the hierarchy, enhance horizontal communication inside and outside the organisation and
decentralise decisions to lower levels in the organisation. For these traits to become effective in
speeding up innovation and coping with rapid change, the employees need new combinations of
professional and personal skills.
Innovation research in the 1980s was helpful in clarifying the limitations of a linear model of
innovation by introducing a systemic perspective where the demand side was given a much more
prominent and appropriate role (Lundvall 1985; Kline and Rosenberg 1986). ‘The third generation
innovation model’ needs to give more attention to the organisational dimension (Caraca et al,
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forthcoming). The innovative performance of firms is increasingly depending upon the design of
internal organisation and networking with external parties. An early study foreboding such a
perspective was the Sappho study (Rothwell 1972; Rothwell 1977).
The triple helix and ‘mode 2’ knowledge production perspectives tend to focus on the direct
knowledge flow from university to industry and in their analyses there is a tendency that the
organisational dimension of industry remains hidden in a ‘black box’. We will argue that the new
context and the impact it has on the business sector have major implications for what kind of inputs
that industry requires from universities and other knowledge institutions.
Why we need a broad definition of the innovation system

There has been a distortion of the innovation system concept as compared to the original versions as
developed by Christopher Freeman and the IKE-group in Aalborg. Policy makers and scholars have
applied a narrow understanding of the concept and this has given rise to so-called ‘innovation
paradoxes’ which leave significant elements of innovation-based economic performance
unexplained.37 Such a bias is reflected in studies of innovation that focus only on science-based
innovation and on the formal technological infrastructure and in policies aiming almost exclusively
at stimulating R&D efforts in high-technology sectors (Lundvall 2007b).
Without a broad definition of the national innovation system encompassing individual,
organizational and inter-organizational learning, it is impossible to establish the link from
innovation to economic growth. A double focus is needed where attention is given not only to the
science infrastructure, but also to how business is organised and to institutions/organisations that
support competence building in labour markets, education and working life. This is especially
important in the current era of the globalizing learning economy (Archibugi and Lundvall 2001).
We see one major reason for this distortion in the uncomfortable co-existence in international
organisations such as OECD and the EC of the innovation system approach and the much more
narrow understanding of innovation emanating from standard economics (Eparvier 2005).
Evolutionary processes of learning where agents are transformed and become more diverse in terms
of what they know and what they know how to do are not reconciliable with the rational
‘representative agents’ that populate the neoclassical world (Dosi 1999). Actually, we regard the
neglect of ‘learning as competence-building’ as the principal weakness of standard economics and
the narrow definitions of innovation systems reflect a negative spill-over from this misdirected
abstraction.
Both Mode 2 knowledge production (Gibbons et al 1994) and the Triple Helix approach focus on
science and the role of universities in innovation. When they present themselves or are applied by
policy makers, not as analysing a subsystem within, but as full-blown alternatives to the innovation
system approach (Etzkowitz and Leydesdorff 1995; Etzkowitz and Leydesdorff 2000), these
approaches contribute to the distortion. These perspectives capture processes linking science and
technology to innovation – below we refer to these processes as STI-learning. The fact that science
and codified knowledge become increasingly important for more and more firms in different
industries – including so-called low-technology ones – does not imply that experience-based
learning and tacit knowledge have become less important for innovation. To bring innovations,
including science-based innovations, to the market organisational learning, industrial networks as
37
Over the last century there has been focus on the European Paradox referring to the fact that Europe is strong in
science but weak in innovation and economic growth. Similar paradoxes have been argued to exist in countries such as
The Netherlands, Finland and Sweden. In a recent OECD-report a general result is that for the countries included in the
study it can be shown that those that ‘perform well’ in terms of STI-indicators do not perform well in terms of
innovation (OECD 2005, p. 29). This indicates that what is registered is not a paradox but a systematic weakness in the
theoretical analysis and the indicators upon which it is built (Lundvall 2007).
- 78 -
well as employee participation and competence building are more important than ever. We refer to
these processes as DUI-learning.
Innovation requires a combination of science-based and experience-based

learning
The need to make use of a broad definition of the innovation system can be illustrated by an
analysis based upon data on innovation performance at the firm level – see table 1. The analysis
makes use of a unique combination of survey and register data for Danish firms and it demonstrates
that firms that engage in R&D without establishing organizational forms that promote learning and
customer interaction are much less innovative than firms that are strong both in terms of STI- and
DUI-learning (Jensen et al 2007).
Table 1 is the outcome of an analysis of survey and register data for almost 700 Danish firms and it
presents different variables related to the propensity to introduce new products or services. We use
sector, size and form of ownership as control variables but the focus is upon a variable indicating
the mode of innovation in the firm. We distinguish between firms that are strong in science-based
learning, firms strong in organizational learning, firms that are strong in both respects and we use
those firms that are weak in both respects as the benchmark category. To construct this variable we
pursue a cluster analysis grouping the firms in the four categories.
- 79 -
Table 2: The probability that firms develop a new product or a new service
Odds ratio Coefficient Odds ratio Coefficient ** =

Variables estimate estimate estimate estimate signifi
STI Cluster 3.529 1.2611** 2.355 0.8564** cant at
the
DUI Cluster 2.487 0.9109** 2.218 0.7967** .01
level
*=
DUI/STI Cluster 7.843 2.0596** 5.064 1.6222** signifi
cant at
Business services 1.433 0.3599 the
.05
Construction 0.491 -0.7120* level
As
Manuf. (high tech) 1.805 0.5905* indic
ators
Manuf.(low and med. tech) 1.250 0.2229 of
tech)
stron
Other services 0.747 -0.2923
g
scien
100 and more employees 1.757 0.5635*
ce-
50-99 employees 0.862 -0.1481 base
d
Danish group 0.859 -0.1524 learn
ing
Single firm 0.521 -0.6526* we
use
Customised product 1.378 0.3203 R&D
-
Pseudo R2 0.1247 0.1247 0.1775 0.1775 expe
nditu
N 692 692 692 692
re,
prese
nce of employees with academic degree in natural science or technology and collaboration with
scientists in universities or other science organizations. As indicators of experience-based learning
we take the use of certain organizational practices normally connected with learning organizations
such as ‘interdisciplinary workgroups’ and ‘integration of functions’ together with ‘closer
interaction with customers’ – to signal learning by interacting and a focus on user needs.
We use firms that only make weak efforts to support science-based and experience-based learning
as our benchmark cluster and the odds ratio estimate indicates how much higher the propensity to
innovate is among firms strong in respectively one or both of the modes of learning. The results
reported in table 2 show that firms that combine the two modes are much more prone to innovate
than the rest. It shows that the effect remains strong also after introducing control variables related
to size and sector.
The analysis illustrates why narrow definitions of national innovation systems that focus only upon
science-based innovation are of little relevance when it comes to understand the performance of
firms and national innovation systems. This is not least important when it comes to analyse the
barriers and opportunities for economic development in poor countries (Arocena and Sutz 2000b;
Cassiolato, Lastres and Maciel 2003). A Master thesis (Garcia-Zarco 2007) presented recently at
- 80 -
Aalborg university shows that the combination of DUI and STI-learning is critical in Bolivia one of
the poorest of the Latin American countries. On the basis of interviews with more than 60 firms he
concludes the analysis:
“In short I can conclude that this study confirms that in Bolivia, it is the firm that combines a strong
version of the STI-mode with a strong version of the DUI-mode that excels in innovation; in product
innovation to certain extent but especially in process of production innovation.” (op cit p. 89).
Those arguing strongly for linking university activities to innovation through markets tend to build
upon a narrow understanding of the innovation process as basically linked to science. This is true
both for triple helix and for mode 2 adherents. The fact that experience-based learning based on
doing, using and interacting (DUI) and tacit knowledge remains fundamental for innovation is
neglected.
The one-side focus on the STI-chain (moving from science to technology and to innovation) is
misleading when it comes to design innovation policy. Also it gives rise to undue expectations on
what universities could and should contribute to the innovation process. The focus on universities as
sources of codified knowledge gives a biased perspective on how universities may best contribute to
the innovation process. The experience-based tacit know-how that graduates obtain while working
with problem solving and research is best transferred through firms’ hiring university graduates -
not through university patents. Finally, as we shall see below, in order to prepare students for their
participation in the DUI-mode universities should organise education programs so that they
contribute not only to professional skills but also to the formation of so-called personal skills.
How to organise universities in a less developed economy?

There are many problems for the policy maker responsible for higher education. Some problems
have to do with funding, efficient administration and the quality of teachers and graduates. Here we
will focus on one specific set of problems related to the high degree of separation of the higher
education from the rest of society. We believe that shortening this distance is a key to getting
positive results from investment in higher education in less developed economies.
One of the most important insights from innovation research is that the innovation process is
interactive (Christensen and Lundvall 2005). Transforming a new idea into a marketable product
involves teamwork and inter-organisational interaction with customers and knowledge institutions.
In a context of accelerating change, general skills that support learning become increasingly
important.
What matters for the performance of a graduate is a combination of professional and specialised
knowledge acquired through reading books and following lectures and a set of so called general
skills and especially the capacity to communicate, cooperate and interact with others. In a less
developed economy such skills involve the ability to interact efficiently in a cultural environment
quite different from the academic context.
General competences are sometimes referred to as ‘personal’ and sometimes as ‘workplace skills’.
This terminology is problematic since it gives the impression that they are something separate to be
added on after the university training has been concluded. One way to make the transition to
working life less painful for graduates is for universities to take more responsibility for the
formation of general skills.
As can be seen from Table 2, Danish survey data illustrates that there is a close connection between
firms engaging in organisational change and their demand for ‘social skills’. When managers in
firms engaged in organisational change are asked about what kind of competences they require they
tend to give much more weight to social skills than managers in firms that do not engage in
organisational change.
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Table 2 shows that while there is stronger demand for ‘professional skills’ in firms establishing new
forms of organisation the gap is much less in this category than it is in the category ‘general skills’.
Firms that engage in organisational change, emphasize the requirement that employees can
communicate and collaborate internally and externally.
Table 2: Changes in task content for employees in the period 1993-95 for firms that
have made organisational changes (outside the parentheses), compared with firms
that have not made organisational changes (in parentheses).
More Less Unchanged No answer
a. Independence of work 72,6 (37,1) 4,2 (2,7) 2,0 (3,8)
21,2 (56,3)
b. Professional qualifications 56,4 (36,3) 7,5 (5,3) 33,3 (53,8) 2,8 (4,4)
c. Routine character of tasks 5,6 (8,2) 41,8 (15,5) 45,0 (67,1) 7,7 (9,1)
d. Co-operation with colleagues 59,1 (27,1) 5,8 (4,5) 31,8 (63,3) 3,2 (5,0)
e. Co-operation with management 64,9 (28,6) 5,9 (4,2) 26,1 (62,2) 3,1 (4,9)
Source: Lundvall (2002a)
This implies that the teaching at the universities needs to be adjusted in order to prepare the students
for communication and co-operation with other categories of workers and experts. The way students
study and learn at university affects their social skills when they exit as graduates and so does the
broader cultural context of the university. In the modern literature on learning this relates to the idea
of learning as moving from the periphery to the centre of communities of practise (Wenger 1998).
The idea of education as a process where you fill empty bottles, the form of which is determined
elsewhere, is as widely shared as it is inadequate (Guile 2003).
University education everywhere has inherited old forms of transmitting knowledge to students
such as series of lectures, often in big crowded rooms, referring to standard textbooks, often based
upon the reality of the US or the UK. We would argue that this method of learning is highly
inefficient. One problem is the lack of relevance of the substance seen in relation to the concrete
context and this problem is of course most dramatic in less developed countries. Research focused
on domestic problems attempting to adopt research methods and tools to the local context may be
helpful to develop more relevant teaching material.
The second problem is that this traditional learning form does not prepare students to use the theory
and methods in a real life context and neither does it replicate the kind of learning that is required in
a future professional life. In professional life most learning takes place through problem solving,
often in a context of collaboration with others with a different background. More widespread use of
problem-based learning and combining theoretical work with periods of practical work are obvious
responses to these problems.
We believe that this consideration is especially important in less developed countries where
universities tend to select a small group of the population among the elite to become the new elite.
Elite education in narrowly defined disciplines may be detrimental to innovation even if it takes
place at ‘centres of excellence’. Both the socialisation and the selection functions are important for
what kind of scientists and engineers that are produced by the national system of higher education.
The way students learn to become proficient in a specific discipline or profession is thus crucial for
how they will function in their future functions.
This also implies that we need a concept and indicators of ‘quality’ with several dimensions when
we evaluate education outcomes. PISA-tests in mathematics, physics and language capabilities
need to be combined with tests of ‘interactive capabilities’. A high level of the first type of
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capability is of limited value for innovation if the level for the second type is low. A principal task
for higher education is to contribute to collective entrepreneurship – i.e. to general skills supporting
an interaction with others resulting in innovation.
University industry collaboration

As part of a strategy characterised by openness to society University- Industry collaboration may
offer both economic advantages and advantages for the research. Contract research for firms,
informal consulting for firms and many other forms of collaboration connecting research to industry
may take place without seriously undermining the autonomy of the university. But the collaboration
needs to take place on the basis of some degree of autonomy for universities.
It should be accepted that the mode of knowledge production is different in the world of academia
and the world of industry. In Academia the major incentive is global fame and/or social
commitment and the outcome is knowledge to be shared worldwide. In the world of industry the
major incentive is profit and economic expansion and the outcome is knowledge to be protected so
that competitors do not get access to it.38 It might be true, as argued by the Mode 2 perspective, that
there has been a certain weakening of the academic mode. But it is obvious that in the case where it
was completely eroded and became identical with the business mode the impact on the creation of
knowledge, the diffusion of knowledge and the quality control of knowledge would be disastrous.
There are three major negative consequences of taking the market orientation of universities too far.
First, installing intellectual property rights on outcomes of academic research cannot avoid having a
negative effect on knowledge sharing within and outside the university and it undermines the
academic ideal of open access to knowledge. In Garnsey (2007) representatives of major US
corporations operating outside the biomedical field are cited for their worries that the new strong
emphasis on intellectual property rights tends to undermine the access to knowledge embodied in
universities.
Second, in ‘the knowledge-based economy’, it is critically important for the function of the
economy and society to have access to an institution that is credible when it comes to critically
assess and validate ‘what is reasonably reliable knowledge’. There are, as I see it, no serious
alternatives to universities when it comes to fulfil this function and subordinating to economic or to
political interests makes them less reliable as judges and referees. This is why we argue that
entrepreneurial and developmental universities need to be left some degree of autonomy. The
balance between integrating activities in society and retaining some autonomy is difficult and we
see a parallel to how Woolcock (1998) outlines a similar balance for ‘the developmental state’.
Third, as universities become simultaneously more international in their scope and more market
oriented they will come under the scrutiny of WTO and European competition regulators. The long-
term outcome of this might be that, since fundamental research and normal higher education cannot
be clearly separated from their commercialised activities, public funding for these core activities
may become classified as illegal subsidies of business activities. This would undermine the very
foundation of the knowledge-based society.
The third mission and higher education

It is far from obvious that the best way to form the competence of students is to isolate them on
campus for three to five years and exclusively expose them to academic teaching for this period.
Laboratory work and construed case material do not establish sufficient links between theory and
38
In a recent interview Gary Pisano gives a succinct statement on major differences ‘Science and business work
differently. They have different cultures, values, and norms. For instance, science holds methods sacred; business
cherishes results. Science should be about openness; business is about secrecy. Science demands validity; business
requires utility. So, the tensions are deep.’
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practise. In most disciplines and professions students can enhance their learning by being
confronted to problems outside university. Periods of fieldwork or practical work periods related to
the object of study are useful in preparing students for a future career. Educational programs may be
organised in such a way that students contribute to the third mission of the university and at the
same time profit from the experience in terms of learning. Long educations may be split up into
parts with periods of practical activity in between.
It is often neglected that the success of ‘third mission’ programs will reflect not only the supply side
but also the demand side. For instance, firms without personnel with a higher education will not be
prepared to/capable to interact with universities. Educating graduates in such a way that they find
employment in industry is therefore a key also to strengthen university-industry collaboration.
Danish data show that firms with higher education employees are more prone to collaborate with
universities and other knowledge institutions than firms without. For small firms the probability of
intensifying the co-operation with a science institution is significantly higher (Lundvall 2002a).
One important way to increase the interest of firms to hire academic personnel and on this basis to
collaborate with universities is to establish exchange already during the study period. A
complementary policy response could be time-limited, marginal employment subsidies to private
firms that hire their first employee with a higher education.
Actually the very idea of presenting the bridging to the environment as a separate ‘third mission’
might have had a negative impact on the renewal of universities. The developmental university may
be seen as one where the original missions have been transformed in such a way that there is not
need for a separate third mission.
Reforming teaching and learning at the developmental university

To realise the developmental university several reforms might be called for in relation to education.
Changes in the finance of universities that give students government state guaranteed loans that they
will have to pay back only when they begin to earn a stable income have been introduced with
success in Tanzania. The result would be less unequal social access to university studies.
Study programs of high quality are needed not only for engineers and scientists. In the developing
economy well-trained public administrators with a certain professional pride are important. It is
important that graduates in these fields leave university with a commitment to promote social and
economic development. It should also be realised that the university should not be the only
institution offering advanced training. Colleges for vocational training at the secondary and tertiary
level may be as important for economic development as universities. Universities may contribute by
training competent teachers for the over all school system.
The organisation of the study program may combine traditional teaching through lectures and
seminars with problem based learning. Information technology may be used to support the learning
taking place but full scale distant learning may not be realistic. Students can get insight in
mathematics, language and information technology by reading textbooks and following lectures and
seminars. To learn to use them such forms of teaching should be combined with problembased
learning.
Stimulating students to work with problems in society and business is helpful in establishing links
between the university and the environment. It also serves as a way to diminish the cultural gap
between academia and the reality that students will meet when they finish their studies and look for
a job. Integrating in study programs periods of internships in relevant organisations outside campus
has similar functions.
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Reforming research at the developmental university

It is neither realistic nor useful to establish a one to one relationship between the research agenda of
the university and the local needs of society. There are fields of research that need to be promoted
in order to upgrade the content of education in the same fields. There is also a need for basic
research to support applied research. On the demand side there are many users who do not need the
kind of knowledge that is developed at a university. And sometimes the only relevant users will
have to be found abroad. It might be more effective to establish non-academic technical institutes
with a responsibility for diffusing specific technologies to small and medium sized firms than it
would be to link such firms directly with university research. Such institutes may have links to
technical faculties at the university.
Nonetheless there is ample room for universities to exploit the advantages that closer interaction
with research users offer. In order to orient national research toward solving a specific set of
problems (medical, environmental, working conditions, infrastructural etc.) specific public funds for
research may be earmarked to promote collaborations between universities and user communities in
the respective field. To work with a mission may stimulate and raise the quality of the research
teams. It is sometimes forgotten that the US-government through its defence and health budgets
have subsidised knowledge creation more massively than any other country in the world.
A general willingness among scholars to take on the problems of the real world and to contribute to
the solution of social and economic problems need to be supported by an adequate incentive
structure. Limiting the evaluation of research to counting international publications has as
advantage simplicity and transparency. But it does not stimulate scholars to engage in activities that
cannot immediately be transformed into such publications. For scientific journals analysis of local
problems unique for less developed countries are of little interest. Creativity research has shown
that extrinsic incentives tend to crowd out intrinsic motivation and thereby undermine creativity.
Therefore universities should consider other means of reward for scholars than income
differentiation. Access to research funds and time to do research are often more stimulating as
rewards for good performance than a wage increase.
To focus research more on missions relevant for national and regional development does not make
the need to engage in global networking less urgent. In order to be at the front of scientific
knowledge it is absolutely fundamental to be connected to international networking. If resources
allow it there should be at least one national research team that operates in international networks in
each major field of knowledge. Ideally there should be two since competition is an effective driver
also when it comes to promote good research
How to stimulate a reform movement

In this paper we have indicated that the recent wave of establishing a specific third mission at the
university has substituted for necessary reform of education and research that open them up in
relation to the rest of society. One way to stimulate on-going reform would be through the use of
the budget mechanism. Each university that wants its share of public finance might be required
regularly to present a development plan – for instance a five-year plan (Lundvall 2002b):
Such a development plan would typically take into account and plan for:
• Making explicit the basic values of the university and explain how values are reflected in the
organisation of scientific work, teaching and learning.
• Specifying how core activities contribute to social and economic development. Setting up
operational targets to be realised over the coming period.
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• Positioning the basic functions of teaching and doing research in relation to other national
and foreign universities.
• Specifying the division of labour and alliances in relation to other national knowledge
institutions.
• Defining core functions combined with out-sourcing of peripheral activities - particularly

activities that have a negative impact on the main tasks of the universities.
• Specifying incentives and evaluation principles that ensure the balance between teaching
involvement, scientific work and interaction with the outside world.
• Pedagogic renewal in order to prepare the students for the learning economy, where
interdisciplinary, problem solving, co-operation and communication is emphasised.
• Development of a system for life-long learning for own graduates and for others groups in
the population who need an upgrading of their competences.
The ideal process of establishing such a plan would be one that involves all those that are active at
the university and build upon the insights and experiences of students, professors and
administrators. It would also be one developed in a dialogue with a wide set of users.
Such individual development plans offer universities and the teams and departments that constitute
them a chance to define what they see as their own objectives for the coming period. Objectives and
targets will certainly give some weight to international publishing but there will be room for
variation between research teams, department and universities when it comes to balance the
contributions to the international publication versus contributions to solving regional or national
development problems. This is important because diversity in the knowledge infrastructure is a
major source of innovation and adaptation.
Institutional diversity as solution to dilemmas

Universities are facing a difficult dilemma in the learning economy. On the one hand, the speed up
of change and the growing pressure to move quickly from new scientific results to innovation in
certain fields such as biotechnology calls for a more agile and flexible organisation of university
activities. Traditional modes of organisation, characterised by sharp and rigid borders between
disciplines and isolation from society at large are being challenged and alternatives have to be
developed. There is a real need for strengthening the interaction with the rest of society. On the
other hand there is a need to ensure some degree of autonomy and especially to protect the principle
of open science. This Gordian knot may be cut with ‘institutional differentiation’ between, and
within, institutions concerned with knowledge production and knowledge diffusion (Lundvall
2002b).
In a well functioning university system the strategic unit is the team defined by a common field of
research and sometimes by shared responsibilities for teaching and sometimes with its own set of
- 86 -
external users. Differentiation might mean flexibility in the use of time for the individual team
member, over the career, where there are periods of slow, in depth, research as well as periods of
education and periods of intense interaction with external users of research. Within the team a
flexible division of labour may be established giving excellent researchers more time for research
and excellent teachers more time to teach.
Reconciling research on local problem and global networking

In the developing countries another dilemma that may call for diversity is the conflict between a
focus on local development and on being active in global research networks. In many developing
countries the prevailing ‘university models’ are the world leading US-universities in the Boston and
the San Francisco area, or possibly the universities in Cambridge or Oxford. The idea that each
single university should become a world centre of excellence is attractive in the sense that it gives
strong emphasis to quality and meritocracy in contrast to corrupt practises and mediocrity. But it is
not all for the good. A very bad replica of the star universities may be detrimental to economic
development. We believe that there is another US-model that could give more useful inspiration and
this is the land university with its extension services.
The first of these regional universities were established around 1860 with the direct purpose to
contribute to regional development and they were supported by regional civil society and by the
federal as well as state and local authorities. In the 20th century they started to combine research
and higher education with an active extension system for distributing useful knowledge to the
region. The extension service was not only aimed at the business sector, including farmers, it also
aimed at giving education to housewives and adults in general. We think that universities of this
kind may produce graduates better equipped to contribute to problem solving and innovation in less
developed regions and countries than the standard research university.
It may be combined with establishing one or more national universities that consciously try to link
up with ‘global networks of excellence’. But it is obvious that establishing such elite universities
always will result in ‘brain drain’ – at least as long as the domestic demand for advanced
knowledge remains limited. For such universities it is therefore important to socialise students in
such a way that they graduate with a certain pride of country and university brand to give them
some roots in their home country.
The national universities may be linked through collaborative network agreements to the regional
universities and job descriptions for professors may include that they should serve at both in order
to give regional universities updated knowledge about frontier research. Regional universities
should be stimulated to develop advanced research in niches where they reveal strength or in areas
where regional demand is strong. Such local forms of excellence should be rewarded on line with
the excellence of the national university.
Conclusions
The concept of university is a European invention. Originally it referred to institutions in charge of
education linked to the Catholic Church. The university concept changed form and content several
times since the Middle Age and the modern university have inherited characteristics both from
Poly-technical Universities established under the Napoleon era and from the Humboldt University
where education and research for the first time were systematically combined.
The form and function of universities in developing countries differs depending on their history but
for almost all of them the university arrived as an institutional import from the West (Altbach
1989). In spite of common roots national university systems are dramatically different in important
respects. This is true also for Europe where attempts are made to harmonise the systems and to
build a European Research Area. It is even more so for countries in the South.
- 87 -
To illustrate there are specific issues and problems on the agenda of university reform in China,
India, Brasil, Russia and South Africa. Each of these big emerging economies have ended up with
university systems with unique characteristics regarding the interaction between university and
industry as well as regarding the commitment of universities to economic development. We believe
that they can learn from each other in terms of their respective experiences and this is the major
objective of the socalled BRICS-project coordinated by José Cassiolato (Cassiolato 2007).
The break down of Soviet Union left the university system in Russia in a crises that lasted ten years
and is not yet resolved. Lack of funding led to a siphoning of human resources away from the
university system and it is only recently that there has been some revival in this respect. Many of
the remaining problems are inherited from the Soviet era. Academies of Science have an unclear
status and there is a need so reform the organisation of the science system. There is a separation
between education taking place at universities and research taking place in separate institutions and
organisations. The demand for scientific knowledge from the enterprise sector is very low. One
barrier for efficient interaction between universities and society is that there is little trust in society
as a whole.
In China since1985 reforms of research organisations gave universities a stronger position in
research and to some degree they have taken over the responsibilities and resources from
Government Research Institutes. The reforms stimulated universities first to link up with industry as
customer. Gradually as this proved difficult they were allowed to engage in entrepreneurial
activities and universities began to start and manage their own enterprises. Universities may get
funding for basic science from mission-oriented programs in Health, Energy etc. Public
procurement is becoming increasingly important. The major concern now is how to enhance the
creativity science and business and to promote ‘endogenous innovation’. China has introduced laws
of the Bayh Dohle type giving universities the right to intellectual property.
Also in India the role of universities has changed over the last decades. Until 1980 there was a
tendency to copy the soviet model with big central institutes and the objective to be self reliant in
big science areas such as nuclear power. But in parallel there has always been a discourse regarding
the need to promote research that contributed to the well-being of the majority of the population
who live in villages. Since 1990s research activities at universities have been strengthened. Both in
China and in India foreign direct investment is attracted by the growing number of high quality
workers with higher education.
There are almost 200 public higher education institutions in Brazil and some of state universities are
dominating research and graduates in terms of output and quality. In general the links between
universities and industry are limited but in certain high technology cluster such as the one in
Campinas intense co-operation and networking is taking place. There are many new central and
regional policy initiatives aiming at strengthening the interaction between universities and industry.
In connection with the liberation South Africa assigned a broad agenda of tasks in their universities.
Universities should contribute not only to the building of scientific capabilities but also to the
solution of fundamental problems in society. This is made more complex in an economy where a
big proportion of the population are engaged in activities outside the formal economy. On major
problem is that higher education has to be paid for by students and that it is especially expensive in
engineering training programs.
While there are major differences across the Brics-countries there are also some similarities. In all
these countries there is currently a major concern to link universities more closely to industry. But
in all cases the most important barrier for establishing such a link seems to be the lack of demand.
China has been most successful in transforming their university system and here it was done
through allowing and even stimulating universities to create ‘in house demand’ through starting up
- 88 -
their own enterprises. Today there is growing agreement that this should be seen as a ‘second-best’
solution.
Public investment in science and education will offer a social rate of return as far as there is a
positive spillover from the use of educated workers and from knowledge created at universities. The
spillover will only be realised if there is a demand for graduates and for advanced knowledge.
Therefore it is interesting to note that a country such as China now in its effort to stimulate
‘endogenous innovation’ is putting more emphasis on public procurement and on technology
programs that address societal needs. If such programs were combined with reforms of university
that link them more closely to social and economic development we think that it would stimulate
both the process of knowledge creation and the development process.
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- 90 -
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Institutions, Innovation and Development - Collected

Allan Dahl Andersen, Björn Johnson, Erik Reinert, Esben

Allan Dahl Andersen

Esben Sloth Andersen

1. Institutions, Innovation and Development – A Comment on Erik Reinert’s Quality Index 6

2. A Note on Institutions as the Root Cause of Development 21

3. Emulation vs. Comparative Advantage: Competing and Complementary Principles

4. A Note on Erik Reinert’s Schumpeterian–Listian Development Economics 59

5. Toward Developmental University Systems 74

In May 2008 we organized a workshop on ”Institutions, Innovation and Development” at Aalborg

Allan Dahl Andersen

Institutions, Innovation and Development – A Comment on

Learning, Innovation and Development

Structural Change and Qualitatively Diverse Economic Activities

Static and Dynamic Rents

Supply-side, Static Rent Supply-side, Dynamic Rent Demand Conditions Rent

Table 1: Categories of Economic Activities

Linkages, Innovation and Systemic Performance

Increasing Returns and Industry Dynamics

Increasing Returns and Diversity

Strategy for Structural Change – Industrial Policy

Institutions and Innovation

A note on institutions as the root cause of development –

To fully recognize institutions as an important development factor represents, in my opinion, an

Institutions in a narrow sense

Indicators and indicator biases.

The institutions of the learning economy

Many different institutions are important here:

Cristensen,E. and Christensen, P. 2007, Fælleder i forandring, Aalborg Universitetsforlag

Hodgson, G. M. 1998, The Approaches of Institutioal economics, Journal of Economic Litterature, ,

Johnson, B. 1992, ‘Institutional learning’, in Bengt-Åke Lundvall (ed.), National Innovation

Sen, A 1999, Development as Freedom, Oxford University Press.

IMF 2005, World Economic Outlook. Building Institutions.

Emulation vs. Comparative Advantage: Competing and

Emulation and ‘management by gut feeling’.

Figure 1. Emulation vs. ‘wrong’ comparative advantage.

Korea-Som alia, GDP per Capita 1950-2001

Korea (Rep.) Somalia

Peru-Singapore, GDP per Capita 1950-2001

Renaissance: The Birth of the Politics and Economics of Emulation and

Novelty, Diversity, Scale, Synergy: Bringing non-Ricardian elements

In order to appreciate the history of economic policy, it is necessary to re-create a theoretical

Diversity: Economies as Hierarchies.

Dynamic imperfect competition

Characteristics of low-quality activites

Ave annual 30,0

1750 1800 1850 1900 1950 2000 2050

Source: Carlota Perez

Novelty and Scale: Accounting for Qualitative Change.

From the From From From the From

Diversity and Synergy: Heinrich von Thünen’s Stages Simultaneously

Novelty and Scale: Understanding Capitalism and the Absence of

Werner Sombart’s Definition of Colonies not being Part of Capitalism.