chapter  1
Innovation, knowledge and technology in late development
Pages 18

Developing countries are characterized by a variety of underdeveloped markets3 such as the input markets for skilled and unskilled labour, capital, foreign exchange, product market for consumers as well as intermediate and capital goods (Bhalla, 2001). In the context of innovation promotion, institutional failures include the inability to provide knowledge inputs such as extension services for standards setting, testing,4 metrology, quality and information, intellectual property (IP), vocational, technical and skill training, and scientific and technological laboratories that could be private or public research organizations. A variety of non-market avenues are necessary contrary to the pure market view, because as Lundvall (1988) and others suggest, market alone is a poor filter for firm-level technical change, which is the locus of production and innovation. For a long time, neoclassical economics has grappled with problems of acquiring information as well as the challenge of imperfect information and asymmetry of information (Stiglitz, 1994). The limitations of the approaches to deal with these problems has led to the emergence of a new branch of information-theoretic approach to economics, which has laid the foundations of transaction cost economics (Williamson, 1979, 1985) and a new theory of the firm (Grossman and Hart, 1986; Hart and Moore, 1990; Hart, 1995). As opposed to the market failure approach, not only is it important to understand how and through what mechanisms an economy processes information, but also it is critical to understand how new information is accessed, processed and through which mechanisms it can be efficiently allocated within economies. This, in effect, is the critical interface between innovation and development. Asymmetries of information, as Stiglitz (1994, p. 35) rightly puts it, “. . . gives rise to information asymmetries in many markets other than insurance market, futures market and the market for used cars.” However, the extraordinary focus on the market failure approach to analyse problems of innovation has meant that other non-market coordination mechanisms that are particularly important for innovation have been consistently ignored from the treatment of the subject in the literature. Poignant rebuttal to the market failure approach that takes the price system to be the most appropriate mechanism to allocate resources and gives a limited role to governments to correct market failures that arise from ill-defined property rights with simple tools, was provided by the success stories of the East Asian economies. Indeed, governments have deployed innovation policies to redesign and re-engineer institutions and organizations as in the case of East Asian economies and transition countries of former Eastern Europe.5 In all these instances, state actions have involved correcting and complementing markets where they were functioning imperfectly or incompletely and creating new ones where they are absent. These myths about markets as well as new and important evidence on the role of the state reinforce the need for a rethink of what the role of the government should be in creating dynamic economies in a global system that has become more complex, knowledge-based and innovation-driven. Innovation is notably weak and suffers from poor systemic coordination in developing countries.