1375.0 - Discussion Paper: Measuring a Knowledge-based Economy and Society - An Australian Framework, 2002  
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Contents >> Chapter 2: Theoretical and Economic Perspectives


It is not within the scope of this paper to comprehensively document the changes in economic theory and/or observed changes in national economies which have led to the increasing emphasis on knowledge and to the formulation of the KBE/S concept. Instead, a broad introduction to the area is given in this Chapter and references to further reading are provided in the Bibliography for those interested in following this further.

Various economic models attempt to explain the role of knowledge and technology in growth. The models and theories developed so far tend to fall into one of two types: new growth theories or evolutionary economic theories.

New growth theories

New growth theories attempt to clarify the role of knowledge and technology by incorporating these into the neoclassical production function. A non-technical overview of these theoretical developments can be found in Gera et al (1998), OECD (1996), Rogers (1999) and Smith (1998).

Evolutionary economic theories

Evolutionary economic theories (also referred to as systems theories) encompass a number of streams of thought. "The unifying thread is the perception that innovation, and the technological and organisational changes associated with it, are the key drivers of long-run economic growth" (Bryant and Wells 1998).

Rather than viewing the market as being in a state of static equilibrium, these models specifically acknowledge that the market is constantly changing and that businesses need to innovate in order to adapt to the changing environment. Evolutionary theories therefore do not attempt to incorporate knowledge into a neo-classical equilibrium framework through a production function.

Empirical studies show that knowledge flows around the whole innovation system, i.e. within and between firms, within and between business and academia. In fact, these non-linear knowledge flows are a crucial condition for the generation of novel products, processes and technologies. For such knowledge flows to occur, firms need to be involved in networks or innovation systems. This is where the term 'systems theories' arises (knowledge flows within the whole system, rather than in one direction only from the non-commercial sector to the commercial sector).

The uncertainty associated with knowledge-related investment, and the need for effective networks which enable knowledge to flow easily, point to the importance of high levels of trust both at organisational levels and in macro-level systems. Trust lowers transaction costs and increases certainty. In organisations, trust facilitates teamwork (and hence productivity, innovation and growth) and reduces the need for expensive monitoring. Correspondingly high levels of trust between players in higher level systems will reduce the need for regulatory effort and the imposition of sanctions - productive co-operation and beneficial change will be facilitated.

Bryant and Wells (1998) provide a good overview of some of the different streams of thought in evolutionary economic theories.


As discussed in the Introduction, the proposed ABS framework includes Society. It does so because of the presumed importance of social factors to economic change and the positive and negative impacts of that change on society.

Social elements considered relevant to the framework include:

  • a wide range of general societal characteristics and structures which form part of the context which influences economic growth; they include age structure, health status, income levels and distribution;
  • the direct 'social' effect on knowledge processes which affect the economy; education levels are an obvious example, another example is the presumed impact of social capital because of its importance in facilitating knowledge flows (more information on the relationship of social capital to economic growth can be found in OECD 2000c); and,
  • the effects on society of an increased emphasis on, and use of, knowledge; these can be both positive, for instance, the overall benefits to society of economic growth and easier access to information, and negative, for example, poorer employment prospects for low-skilled workers (a useful analysis of such effects can be found in Lee et al 2002).


At the completion of its two year Growth Project, the OECD concluded that "...to enhance long-term growth, more emphasis should be given to policies focusing on ICT, human capital, innovation and firm creation" (OECD 2001a). Empirical evidence indicated that divergence in growth between OECD countries could be attributed to:
  • investment in ICT
  • increased use of labour
  • rising quality of labour
  • greater efficiency in how labour and capital are combined (multifactor productivity).

The findings of this project have had a significant influence on the framework proposed in Chapter 4. For this reason, some details are provided below.

Genesis of the Growth Project

The OECD Growth Project began in 1999 with a Ministerial Council request to analyse the causes underlying differing economic growth of member nations during the 1990s. There was a particular interest in why the US economy had experienced increased non-inflationary growth relative to most other OECD economies, whilst maintaining low unemployment. The importance of information and communication technology (ICT) had increased in the US and there was evidence of restructuring of enterprises and markets. Levels of economic growth experienced by Australia, Ireland and the Netherlands had also been higher in the 1990s - in contrast to other OECD member nations (OECD 2000a).


Research indicated that, in successful economies, entrepreneurial behaviour was aided by a competitive environment, an efficient labour market and a legal and financial environment which protected intellectual property and supported start-up firms (OECD 2000a).


Productivity in the ICT sector improved economic productivity overall while use of ICT facilitated innovation and increased labour productivity (OECD 2000a). Deregulation of ICT industries encouraged competition and greater access across industries and across regions because of increased investment in infrastructure. Successful economies were more likely to have rapid diffusion of ICT, particularly in service industries where the effects are still being gauged (OECD 2000b).

Human capital

The importance of human capital in the innovation process underlies the demand for increased skills, including teamwork and cognitive skills, and lifelong learning in order to adapt to continuous change (OECD 2000b). The impact of knowledge accumulation on productivity underscores the importance of adequate education systems which also provide spillover effects to society. It may require investment in the knowledge base of economies, by supporting the science sector and R&D for example, to take full advantage of technologies (OECD 2000a).


The first Growth Project report indicated that multifactor productivity (MFP) growth had accelerated in the high growth economies as capital and labour inputs improved (OECD 2000a). Although US growth was modest, trend growth rose throughout the decade and MFP strengthened in the second half of the 1990s combined with a rapid rise in capital stock. The convergence by OECD economies to US levels of gross domestic product (GDP) per capita was reversed despite a slow convergence of labour productivity, and with higher labour productivity experienced by some OECD economies. Labour productivity gains, in many cases, represented shedding low skilled labour and rapid substitution of capital for labour (OECD 2000a).

In respect of labour productivity, research suggested that higher growth rates in output were accompanied by improvements in the utilisation of labour in the US, Ireland, Netherlands, Norway and Australia. 'Traditional' factors, such as the ability of countries to employ their labour force, may lie behind the disparities in growth patterns across the OECD as well as some new factors, largely related to the diffusion of ICT. New ICT equipment used in many sectors has had an impact on human capital formation. Data suggest that the first wave of adoption of this technology in the US was accompanied by a significant shift towards more skilled workers (OECD 2000e).

Innovation and knowledge flows

Innovation of products, processes and organisational structure has been assessed as a critical component in the success of firms. Related to this is the increased importance of fluidity of knowledge flow between individuals, firms, organisations and also between national economies. Knowledge networks reduce the cost of R&D and speed up the innovation process. Empirical studies have shown the success of collaboration in the discovery, application and diffusion of technologies. Foreign direct investment (FDI) has been recognised as a means of importing innovation (OECD 2000b).

Conclusions arising from the Growth Project

The final Growth Project report The New Economy: Beyond the Hype (OECD 2001b), contains the major conclusions from the two year project. They are as follows:
  1. 'ICT is an enabling technology. Governments should: focus policy efforts on increasing the use of new technology; increase competition and continue with regulatory reform in the telecommunications industry to enhance the uptake of ICT; ensure sufficient competition in hardware and software to lower costs; build confidence in the use of ICT for business and consumers; and, make e-government a priority.'

  2. 'Foster an innovative environment: give greater priority to basic research; improve the effectiveness of government funding of innovation; make greater use of competitive funding and evaluation in supporting public research; tackle new challenges in intellectual property regimes; and, remove barriers and regulations that limit effective interaction between universities, firms and public laboratories.'

  3. 'Prioritise policies to enhance human capital (the skills and competencies embodied in labour): invest in high-quality early education and child care; raise completion of basic and vocational education and improve the quality of the system; improve school-to-work transition; strengthen the links between higher education and the labour market in a cost-effective way; provide wider training opportunities; and, reduce obstacles to workplace changes and give workers a greater voice.'

  4. 'Foster an entrepreneurial climate: promote access to financing; facilitate firm entry and exit; review and assess the relevance and effectiveness of government support programmes; and, encourage an entrepreneurial spirit in society.'

  5. 'Assure that economic and social fundamentals are in place: preserve macro-economic stability; encourage openness; make financial systems more supportive of innovation; mobilise labour resources; and, address the redistributive implications of structural change.'


Changes which have highlighted the increasing importance of knowledge have been observed in several economies (Gera et al 1998; Houghton and Sheehan 2000; Lamberton and Neutze 1999; OECD 2001a; Gera and Weir 2001). A number of these changes are described below:
  • growth in demand for high-skilled workers, with an increased emphasis on cognitive skills, the development of ideas and life-long learning;
  • prevalence of information and communications technologies resulting in:
    • emergence of new arrangements of work, production, shopping and education,
    • increased codification of knowledge, and
    • decreased costs of knowledge dissemination;
  • increased openness of the world economy, leading to increases in trade (especially in knowledge-intensive exports), foreign direct investment (FDI) and knowledge transfer;
  • internationalisation of production requiring increased knowledge to control and integrate business units;
  • changing composition of production in more advanced economies, with movements towards services and away from manufacturing, and a movement towards higher value-added services;
  • increased participation in international and domestic networks (and/or geographic or industry clusters) for the exchange of products, capital and knowledge, e.g. joint ventures, non-equity agreements and less formal inter-firm collaborations; and
  • increased interest in R&D and other aspects of innovation.

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