Knowledge has become the main driving force of modern economies and whole societies. Accelerated by powerful information and communication technologies and by globalization, this trend affects countries, organizations and individuals. While it obviously poses risks to many stakeholders, an emphasis on the “knowledge-based economy” offers opportunities to new players in all categories. For advanced industrialized countries with high labor and infrastructure costs, it offers competitive advantages in high-technology industries and efficient service sectors. For transition economies, it offers improved technologies and higher value-added products with closer customer linkages, as well as a path towards sustainable development. For developing countries, it offers opportunities to short-circuit development phases, leapfrog technologies and integrate faster into the global economy.
Information and communications are the prime examples of the key components of the knowledge-based economy. It took more than 100 years to build the fixed-line telephone systems in industrialized countries. In contrast, mobile telephones took only a couple of decades to get 1.5 billion subscribers – a level that now exceeds the worldwide number of fixed-line connections. Bypassing the costs of digging up city streets for telephone cables and marring the countryside with telephone poles, wireless technologies have brought domestic and global connectivity and affordable internet access to sources of knowledge to even the most peripheral regions.
The emergence of the knowledgebased economy has been the subject of intensive research, which shows that the process involves both positive feedback and turbulent evolutions, and virtuous or vicious circles with both winners and losers among individuals, companies, countries and even continents. There is a need for special attention to being socially inclusive and avoiding a digital divide. In high-technology industries, we have seen new worldwide companies emerge rapidly. Typically, their products have short life-cycles, narrow windows of opportunity in time and the need to quickly reach international and even global markets. Consequently, they are characterized by high research budgets and capital-intensive development. Their cost structures are dominated by development and marketing investments rather than by manufacturing and material costs.
International organizations, such as the World Bank and the Davos-based World Economic Forum, have linked the competitive ranking of regions and countries to the state of their knowledge-based economies. Naturally, there is great interest in identifying the factors of success or failure in the creation of new knowledge and its conversion to economic and social benefits, and the World Bank has organized forums on the knowledge economy and published knowledge-economy books on China, India and Finland.
China and India are obvious choices for such study: Both these nations are major drivers of globalization and with billion-plus populations, they need new avenues to harmonious and sustainable development. Not just huge markets and competitive manufacturers, China and India are emerging rapidly as powerful players in research-intensive sectors of the economy. And China offers a unique historic pattern in this regard. The world’s largest economy until the 1700s, it lost its position to Europe and then the United States, partly because the latter were more effective in generating new knowledge and coupling it to economic development. Today, if we extrapolate China’s current eight percent growth rate and adjust the results in terms of purchasing power, China could become the world’s largest economy again as early as 2012.
But Finland is different. A small, peripheral country in northern Europe, it has a population of only five million. (It is ethnically the most homogenous nation in Europe. Interestingly, Finns account for 60 percent of all the people who live north of the Arctic Circle, a fact that may help account for Finland’s hardy determination to adapt when necessary to survive.) So why would the World Bank study Finland and competitiveness? Because in recent years Finland has consistently come out at the top in the competitiveness rankings of the World Economic Forum and in the World Bank’s table of assessment about national performances in the knowledge- based economy. The transformation of Finland has been remarkable, especially considering its starting point amid a severe economic crisis in the early 1990s. Acute balance-of-payments problems coincided with high unemployment, a banking crisis and rapidly mounting foreign debt.
The transformation of Finland has been remarkable, considering its starting point amid a severe economic crisis in the early 1990s
So the example of Finland shows that it is possible to make a profound structural improvement in a short time. What are the elements of this success and what are the lessons learned and what is their applicability to other countries? In establishing its method for assessing countries' performance, the World Bank defined four pillars as the critical basis of a knowledge-based economy: the economic and institutional regime, education, innovation and the information infrastructure.
The four pillars are interconnected and interdependent. They can be disaggregated to more detailed indicators that appear in the World Bank’s Knowledge Assessment Data Bank for all countries. Two pillars merit special discussion here, namely innovation systems and consensus- building for national strategies.
The knowledge-based economy grows with the creation of new knowledge provided by scientific research and technological development and its ability to transform it into economic and social benefits. Research and development can be usefully measured as the share of gross domestic product (GDP) invested in this sector: The average is about 2.4 percent for advanced nations in the Organization of Economic Cooperation and Development. The United States and Japan invest slightly more – about 2.8 percent. For the European Union, the level is about 1.9 percent; the Lisbon Agenda calls for it to rise to three percent by 2010. Recently approved EU financial projections foresee a rise in joint R&D spending by about 50 percent over the next seven years, to a rate of 54 billion. Finland has more than doubled the rate of its R&D spending since the early 1990s, so it now runs about 3.5 percent of GDP.
What are the results of R&D investments and how can they be measured? The classical methods of assessment favor numerical metrics listing scholarly publications and references, advanced degrees and international prizes, patents and the creation of new companies. But the impact of this input on a nation can also be measured in the structural changes of the economy, for example, the share of high-tech products in a country’s output and exports.
Such a structural change is clearly visible in Finland. Fifteen years ago hightech exports accounted for about five percent of total exports while the current share is over 20 percent. Before, exports were dominated by forest industries, which still play a major role in the Finnish economy. However, forest products are a cyclical market, which proved risky and led to frequent currency devaluations. That is no longer deemed feasible: Finland has adopted the euro, ruling out devaluations, and the old system had undesirable impacts on economic and social stability.
As Harvard University’s Michael Porter explains in his books, most countries start their economic development in a natural resource-driven phase, then proceed to an investment-driven phase and subsequently aim at a knowledgedriven economy. Finland illustrates this process (see chart above).
The increase in the high-tech share of Finland’s manufacturing has diversified the country’s exports and also created a positive trade balance. It is a structural change of record magnitude, largely based on the success in the telecommunications sector, particularly of the Finnish corporation, Nokia.With worldwide operations, Nokia has become the global leader with about a 35 percent market share in mobile phones. A factor helping set the stage for this success was Finland’s deregulated domestic telecommunications market, a choice that fostered competitiveness rather than protection for the local companies. Nokia was the industrial engine for many developments in the information-andcommunication- technology field. Excellent results were obtained in such related sectors as pulse-rate meters. These successes were often characterized by cluster dynamics combining skills of many research and company teams and niche strategies aiming at the positioning of Finnish products as the global leaders in their specific narrow market sectors.
The key element of a successful innovation system is an appropriate balance between public and private investments as well as between institutional and more competitive types of funding. This is best achieved with independent funding agencies and flexibility of funding instruments. When Finland more than doubled its R&D investments, the additional funds on the public side were put to competitive funding rather than diffusing the resources along conventional institutional channels. This allows rapid shifts in focusing of resources to new fields, a faster system than reorientation of old institutions. It also rewards individual activity and entrepreneurs and enhances multidisciplinary projects and public-private partnerships.Money is often the best persuader, even in the scientific world.
It is crucial for innovation-policy questions to be placed high enough on a nation’s political and corporate agendas. In Finland, the top policy body in this field is the Science and Technology Council, which is chaired by the prime minister and includes the ministers of education and of trade and industries as well as, perhaps most important of all, the finance minister.
In formulating successful national strategies, it is vital to have a working consensus among policy-makers about goals and instruments for achieving them. There are crucial questions. How can decision-makers be convinced of the advantages of long-term structural investments rather than short-term priorities? Finland is an appropriate case study: while in economic crisis in the 1990s, Finland shunned short-term spending on public works (often the chosen option for responding to high unemployment) and instead made longterm structural investments in research and development.
As a result, Finland has succeeded in combining high international competitiveness with a Nordic-style welfare state. Nowadays demographic changes with aging population and increasing global competition are putting new pressures on the old models of the Nordic-style welfare state. But it should be seen as an element of competitiveness to have a well-functioning public sector with minimum level of corruption and to maintain social justice and reasonable social safety-net systems.
Part of the reason Finland was able to embrace this strategy of strong knowledge- based competitiveness was an important institutional innovation over the last 25 years: a series of high-level programs of education and discussion about economic policy and national strategy. The participants have included practically all new members of the parliament, who then go on to become cabinet ministers and political leaders as well as industrial, labor and university leaders, media people and civil servants with active roles in economic policy making. These programs cover fiscal policies and macro-economic instruments related to budget planning and monetary policy, as well as structural topics related to globalization and international integration, industrial sectors and agriculture, education and research policies, energy and the environment.
During its economic crisis in the 1990s, Finland chose long-term structural investments in research and development over short-term public works spending
However, the most important part of these exercises amounted to providing almost a “shadow government” on economic policy-formulation and implementation. Consensus must be found between conflicting goals: on the one hand, economic growth and employment and, on the other hand, the budgetary and trade balances and low inflation-targets. The choice of economic policy instruments – for example, taxation options and investment incentives – is also important. Over the years, these educational and consensus-building programs have generated support for policies aimed at increasing R&D, improving competitiveness and investing in the knowledge-based economy.
This process cannot be carried out overnight, but once a country has started on a virtuous circle, many factors can combine to accelerate movement toward a knowledge-based economy. As the Finnish case shows, this structural change can be accomplished in a relatively short time. But the foundations have to be laid by long-term decisions that shape research, education and systematic innovation and provide guidelines for long-term growth and sustainable competitiveness.
*The Finnish case is reviewed in greater detail in a World Bank book, Finland as a Knowledge Economy – Elements of Success and Lessons Learned. A 23-page summary overview of the book, as well as overviews of the book on China and India, are available online from the World Bank at these web sites:
Jorma Routti is a professor at Helsinki University of Technology and chairman of the firm, Creative Industries Management (CIM). He headed the Directorate-General for Research at the European Commission and was President of Sitra, the Finnish National Fund for Research and Development, in Helsinki.
This article was published in European Affairs: Volume number 7, Issue number 1-2 in the Spring/Summer of 2006.