1. Introduction

Behind the notion of “knowledge economy” is the idea that intangible assets, and ultimately knowledge, are crucial for economic dynamism and growth performance.

In the grand rethinking of economic growth, the epoch of Modern Growth rests precisely on knowledge and technical progress (Galor 2011). In a similar vein, business historian Peter Drucker had argued that in a “post-capitalist” society, although capitalist institutions will survive, “the basic economic resource […] is no longer capital, nor natural resources […] nor labor. It is and it will be knowledge […] value is now created by ‘productivity’ and ‘innovation,’ both applications of knowledge to work” (Drucker 1993, 8). However, he concedes that the way in which “knowledge behaves as an economic resource, we do not yet fully understand” (Drucker 1993, 183).

Still today the notion of knowledge economy seems to be taken for granted because it is seen as self-explanatory. It is actually the result of a change of perspective on technical progress. Technical progress has long been mainly a question of improvements of capital goods (as embodied technical change). Now it concerns mainly the accumulation of knowledge and the capacity to innovate. The increasing dematerialization of knowledge and the bias towards disembodied technical change have determined the “new” focus on knowledge. Without a doubt this reflects the new reality of technology and industry, from the development of Information and Communication Technologies (ICTs) to digitalization and more recently AI.1

To deal with such a large and complex problem this paper focuses on one question: is the dominant approach appropriate to address the admittedly vague notion of knowledge economy?2

The argument is constructed as follows: section two is an overview of the literature (which is by no means an exhaustive examination). Its purpose is to highlight the different angles from which the question of knowledge and the knowledge economy has been approached. In section three we examine a few well-known theoretical contributions that give a clear picture of the approach of recent economic theory, pointing out the different kinds of knowledge this literature has identified.

Section four begins to articulate a possible alternative approach. Discussing knowledge as a social phenomenon and the goals of economic progress we highlight the narrow focus and the exclusive reliance on the market of the dominant approach. The stylized facts of modern production and consumption offer a better starting point. Section five focuses on the growing importance of collective or “non-strictly” private goods produced by knowledge-based industries. That brings in sharp relief the question of externalities. In advanced industrial economies market failure is pervasive, but it arises for reasons quite different from those customarily considered. It concerns economic growth. To introduce the new kind of market failure section five begins examining Bator’s (1958) careful discussion of private and public goods. Section six elaborates on the stylized facts of consumption and production. Collective goods and “private-public” goods are the bulk of modern consumption; at the same time, the knowledge-based industries that produce them are the growing sectors of advanced industrial economies. That gives a clear picture of the knowledge economy.

In the concluding remarks, we touch on two issues: the policies that should attend to these stylized facts and the question of the institutions best suited to the knowledge economy.

2. Some background

Fritz Machlup (1962) provides an early account of the knowledge economy. According to his calculation, in 1959 29% per cent of the GNP in the USA was produced by what he labeled the “knowledge sector.” It included information technologies and information services, research and development, but also education and mass media. We ought to recall that Machlup treated knowledge as an information source, in line with the Austrian economics’ notion of capital. His knowledge sector includes service industries, such as education and mass media, typical of advanced industrial economies.

More than quantifying the knowledge sector, Coase (1974) is concerned with the regulatory framework. Drawing the parallel between the market for physical goods and the market for ideas he uses the latter as an economic framework to discuss issues like freedom of speech and the press. While the difference in the structure of the two markets calls for distinct regulatory approaches, the similarity is that both are subject to distortions. In the market for ideas distortions can occur due to factors like bounded rationality and cognitive limitations, making it difficult for buyers to distinguish between “good” and “bad” ideas.

Clarke (2001) points out the salient features of the knowledge economy. Knowledge management is required to make use of data and information and in turn it needs to be integrated into business strategy. He also noted the importance of knowledge communities of practice involved in elaborating intellectual activities. Smith (2002, 6) directly asks the question: what is the knowledge economy? He argues that in the new knowledge-based economy “the role and significance of knowledge as an input to economic processes has fundamentally changed”. As a result: ”there are basic changes in economic functioning, and changes in the economic rules of the game, for both business and policymakers.” This new concept, notes Smith, survived the 2000 burst of the Internet bubble. Although often used by international organizations such as the OECD, the term “is at best a widely used metaphor” rather than a clear concept (Smith 2002, 6). Smith then presents and discusses four approaches. The first rests on the idea that knowledge is quantitatively and qualitatively more important than before as an input; the second on the idea that knowledge has become more important as a product, traded by new forms of activity. A third view stresses the rising importance of codified knowledge.3 A fourth approach focuses on the technological changes in ICT, since innovation in computing and communications changes both physical constraints and the cost structure.4

Smith argues that the weakness or complete absence of a definition makes the notion of knowledge economy more rhetorical than analytically useful. Brinkley (2006) attempts to fill the gap presenting concepts and measures that clarify what the knowledge economy is. Knowledge is an economic good, and can thus be a source of competitive advantage. For that reason, there is investment in knowledge, and we have high, middle, and low investment economies. A list of knowledge-based services is introduced to analyze the UK exports in 1995–2005. It includes business, financial, and computer services, together with communication, cultural/media. But the largest share of UK export is that of “knowledge services.” The measures used are the shares of these services in GDP (in OECD countries) and the number of the knowledge sector jobs. He then examines the “process and measures” of innovation, which includes organizational and “presentational” innovation. Indeed, as he argues, defining the knowledge economy is hard because “the commodity it rests on – knowledge – is itself hard to pin down with any precision” (Brinkley 2006, 29). In fact, no single definition can contain all the aspects of the knowledge economy.

The handbook by Rooney and Ninan (2005) highlights concepts and practices. It focuses on social, cooperative, cultural, creative, ethical, and intellectual capital; innovation systems; and knowledge management. It broadens the meaning of knowledge to wisdom, ethics, language, and creative economies.

The literature discusses also the relationship between information and knowledge. Mirowski and Nik-Khah (2017) elaborate primarily the growing importance of information in modern economics and its influence on policy and politics. They argue that the history of microeconomics is better understood as a history of the treatment of information. Stiglitz (1999) argues that knowledge is a global public good. The dilemma is for the states to decide the balance between public provision and private production. Intellectual property rights are necessary to reward research carried out by firm. However, since knowledge (research) is the input in further knowledge, its price is crucial to promote or discourage the pace of innovation. Innovations often incorporate ideas that are part of the common pool of knowledge. Access to knowledge and protection against monopoly rents is also needed. Furthermore, knowledge creates externalities that require cooperative efforts at the international level.

A rather distinct approach argues that knowledge should be treated as “commons,” a resource shared by a group of people that is subject to social dilemmas. Hess and Ostrom (2007) argue that it calls for research into epistemic areas of interests, concerning intellectual property rights, economics, philosophy, sociology, and enduring access of published information.

3. Knowledge in recent economic theory

In addition to the overview above, recent economic theory clarifies the dominant approach to the knowledge economy.

3.1 Knowledge capital

Recalling the pioneer work of Robert Solow and Edward Denison, Andersson and Beckmann (2009) present an analytical framework based on a Cobb-Douglas macro production function: net output depends on the weighted geometric average of different inputs, i.e. quantities of capital. Knowledge is a form of capital coming from investment in R&D (research capital, i.e. the stock of knowledge equal to the accumulated investments in R&D) and investment in education (human capital). According to Andersson and Beckmann (2009) in mature economies the rate of growth of labor supply is often close to zero. The main factors determining growth are then: the marginal productivity of material and knowledge capital; the propensity to save of households, firms and government; the rate of growth of human capital linked to investments in education.

Ultimately, the supposedly epochal change in long-term growth is captured by a new form of capital. Consequently, the knowledge economy is defined by the accumulation of knowledge capital and human capital.

3.2 Endogenous growth and externalities

The models of New Growth Theory (NGT) have in common share some fundamental similarities and in particular the focus on the accumulation of intangibles and technical progress. The production and accumulation of knowledge, together with certain pivotal activities (R&D) and the education system, are the key to endogenous growth.

The first wave of contributions by Romer, Lucas, and Rebelo focused on the non-diminishing returns to investment, the second, started by Romer (1986, 1990) and pursued by Grossman and Helpman (1991) and Aghion and Howitt (1992) incorporates R&D theories and imperfect competition into the growth framework. These arguments are so many ways to maintain that the growth rates of capital, output, and consumption are positive in the long-run and do not depend on any exogenous factor. Indeed, dissatisfaction “with exogenously driven explanations of long-run productivity growth” motivated “the construction of a class of growth models in which the key determinants were endogenous to the model” (Barro and Sala-I-Martin 1995, 38).5

Ultimately, the endogenous dynamic is no longer centered on capital accumulation, but rather on technological knowledge, human capital, product differentiation (Pomini, 1992).6

The accumulation of knowledge has positive external effects caused by the diffusion of technological know-how (Romer 1986); the specialization of production (Romer 1987); the accumulation of human capital (Lucas 1988; Barro 1991); the process of product innovation (Grossman and Helpman 1991). Knowledge externalities in the AK model are discussed by Aghion and Howitt (2009).

In sum, “the model here can be viewed as an equilibrium model of endogenous technological change in which long-run growth is driven primarily by the accumulation of knowledge by forward-looking, profit maximizing agents,” where “new knowledge is assumed to be the product of a research technology which exhibits diminishing returns.” Moreover, “investment in knowledge suggests a natural externality,” since knowledge “cannot be perfectly patented or kept secret” and “may have an increasing marginal product” (Romer 1986, 1003). The model rests on the “assumption of increasing rather than decreasing marginal productivity of the intangible capital good knowledge” (Romer 1986, 1004).

In a further development the accumulation of knowledge is treated as a non-rival good which implies that it can be “accumulated without bound on a per capita basis” and cannot be completely appropriated determining spillover effects. What matters is “the market process by which new knowledge is translated into goods with practical value” (Romer 1990, 72).7

3.3 Intellectual property and competitive analysis

Knowledge accumulation, and the externality it creates, has reignited the debate on intellectual property.

Boldrin and Levine (2002, 209) have argued against a “distorted extension of intellectual property rights” because it “has come to mean not only the right to own and sell ideas but also the right to regulate their use.” Monopoly power (patents, copyright, and other private contracts) has been widely accepted to ensure a reward to inventive activity, in particular to recuperate fixed cost. But “creation is not a fixed cost,” but rather a sunk cost.” It is the cost of producing the first unit. The point is the indivisibility associated with creative activity: “two half-baked ideas do not equal one fully baked idea” (Boldrin and Levine 2002, 210). Although the theory of competition with indivisibilities is not yet fully worked out, competition “often yields the first best.”

Downstream licensing may hurt rather than help innovation: it grants the right to control the use of ideas after sale. Indeed, “only ideas embodied in people or products matter” (Boldrin and Levine 2002, 209). After the first sale intellectual property should not be protected. Producers must be forced to compete with their customers. That is the creative use of markets.8

3.4 Localized knowledge: Learning and innovation

The notion of localized knowledge introduces a noticeable change of perspective. It brings to the fore learning and innovation and distinguishes between science-based generic and applied (tacit, specific, industry-based) knowledge.

According to Antonelli (1998, 1) the new aspects of the knowledge economy are: (a) “the institutional generation of a market for knowledge,” which includes independent firms specializing in the production of technical knowledge and competencies intertwined with the diffusion of ICTs; (b) the internalization of knowledge into the social practices of production. The key point is the elaboration of codes. Elaborating “codes” creates interpretation and thus knowledge. The latter is a social practice, a learning process. Learning is for its nature “localized.” It has space and sectoral dimensions.9

In the innovation theory based on the work of Kenneth Arrow, technological information is a public good, a non-rival, non-excluding resource that can be transferred at a negligible cost. It has a vast array of applications and “it could not be traded without being revealed,” which implies that its value is hard to determine (Antonelli 1998, 2). Technical progress is the result of a flow of technology information generated by scientific research and applied to specific fields by firms. Intellectual property rights permit the appropriation of the benefits of innovation but reduce their socialization. Localized knowledge therefore rests on the interaction between information, knowledge, and skills. It includes “the competencies and the capacity to both use information in the specific context and create further information” (Antonelli 1995, 3). The result of learning internal to the background and experience of the innovator is technical knowledge, which is an appropriable and excluding resource, subject to accumulation and path dependency.

In sum: localized technical knowledge is a mix of generic knowledge, i.e. codified scientific information external to the firm, and tacit knowledge, mostly internal to the firm. The first is available as a public good at a limited cost. It is institutionalized with the rise of a market for knowledge. The second is based on learning processes. It is highly specific and idiosyncratic, therefore difficult and costly to transfer. The top-down deductive process, based on scientific principles, is complemented by the bottom-up inductive process based on direct experience. New knowledge results from the interaction of the two. The overall process highlights the importance of externalities and technological interdependence of firms.10

3.5 Summing up and moving forward

We have seen the rather simple way in which the new focus on knowledge is incorporated into production theory: knowledge becomes a factor of production in the framework of growth accounting. On the other hand, the models of NGT clarify that: (a) the production and use of knowledge are strictly market phenomena; (b) for any analytical purpose knowledge is productive via technical progress; (c) productive knowledge is accumulated by means of purposeful R&D.11

Public knowledge, i.e., the externality linked to the public nature of research findings, may become “productive” when it is turned into new products or productive inputs in industry and commerce. It is not however traded on the market. The discussion of intellectual property and competitive analysis does not introduce any substantial novelty except for calling back the attention to the complexities of Coase’s “market of ideas.”

Localized knowledge affords a clarification of important aspects of technological progress that are ignored (or locked in implicit assumptions) in the competitive analysis. There are different types of knowledge: generic knowledge, applied knowledge, tacit knowledge. Furthermore: the localized nature of cognitive processes adds to the understanding of knowledge a social and institutional dimension. Note however that the firm and its organization constitute the social system of reference.

What is clear is that the analysis of knowledge remains confined to the operation of the market. This limits the understanding of the knowledge economy that is exclusively considered from the lenses of the market. To approach the problem in a different perspective let’s begin by posing some questions: Should we conclude that knowledge accumulation, technical progress and innovation governed by markets are the appropriate way to characterize the knowledge economy? Economic theory focuses on productive knowledge. But what is “productive knowledge” in advanced industrial economies?

4. A different perspective on the knowledge economy

4.1 The social nature of knowledge

A different perspective begins considering that knowledge may be produced through non-market channels. Although it may have, and often has, market effects, that type of knowledge is not a market phenomenon.

We are looking at a kind of knowledge that flows from social interaction and participation into social networks. Knowledge may be acquired through communication in some sort of “community.” In this respect, the creation and diffusion of knowledge in financial markets is quite telling. Karin Knorr Cetina (2010) has spoken of financial markets as a “conversation” of transactions, a result of social communication. Ultimately knowledge depends on trust and social communication.

Note also that the technical change resulting from purposeful R&D investment is one thing, quite another is knowledge as imagination and creativity. These most likely do not depend on any commercial use, nor on markets. Knowledge in the form of ideas and creative work is the result of the development of intellect and social interaction. We could think of that as knowledge associated with the development of individuals and society. Ideas and creativity are the intangible assets of the “creative class” (Florida 2002). To give another example would be the development of Artificial Intelligence extending into a question such as: how long it might be before machines come up with something creative, something imaginative like that of art and culture (Du Sautoy 2020)?

The notion of knowledge economy should conceivably include also this type of knowledge that goes beyond the accumulation of human capital and R&D investment. This aspect of knowledge is furthered in a society permeated by communication and images stimulating new ideas. The social nature of knowledge re-proposes in a different light the question of knowledge as a public good. In the dominating approach knowledge that is not appropriated determines an externality. As such it cannot be privately accumulated or patented, although it can become “productive,” i.e., put at a commercial use. Socially produced knowledge has a similar effect. This speaks to the complexity involved in technical change and innovation. In this respect, it is appropriated to recall the importance of serendipity, i.e., the casual, serendipitous nature of major discoveries. The actual path of research and scientific discovery highlights examples where the relationship between discoveries, ideas, and new products is far from being deterministic.

At this point a few notes from the history of economic thought may help.

Bertram Schefold (2009) argues that Socrates refused any practical attitude towards knowledge and argued against the use of knowledge by the Sophists for private gains. In XIV century Arab philosophy, the notion of growth of knowledge was associated with arts and poetry. Max Weber observed that Calvinism fostered rationalization. It envisaged an aesthetic, rational society, but the result was competition in commodities and knowledge production. We had rational progress, rather than knowledge in the sense of personal culture.

The modern human capital notion introduced by Jacob Mincer implies investment with a private return on knowledge. Specialized knowledge gives rise to patents, while general knowledge is that embodied in the National Systems of Innovation. Economists understandably focused on technical progress, but the economic and social peculiarities of knowledge must be kept in mind. New knowledge creates information asymmetries and implicit knowledge. It follows that knowledge cannot be traded as any other commodity. Thus, market for knowledge must be limited and requires control. Still, ideas must be financed, and the theory of innovation suggests that the process requires investments, while it might risk failure.

Ultimately there seems to be a fundamental distinction between knowledge as a mean “to gain economic power” and knowledge as personal culture. In other words, we can draw the line between knowledge for its own sake, or rather for the light and pleasure it provides, and knowledge pursued for the fruits it brings. However, early in the game, Machlup warned that the distinction between light and fruits, ideas and economic utilization, might not be so compelling, or useful. The fruits can be a better life, with more pleasure and leisure time.

4.2 Knowledge and economic progress

This raises the question of the goals and meaning of economic progress. Alfred Marshall argues that economic progress is not about wealth only, but also about human well-being, which is the true goal of progress.

Technical knowledge is one aspect of knowledge, but in “industrial life” the spread of education and “a wide knowledge of the world” also matter (Caldari and Nishizawa 2020, 106). Note also that “a student who allows his thoughts to be much influenced by monetary considerations […] is not likely to exercise the best influence of which he is capable in elevating thought or even increasing knowledge” (Caldari and Nishizawa 2020, 84).

While consistently referring to technical knowledge when dealing with production and business, knowledge is associated with the pursuit of better life and the development of a fully rounded human being, indeed a “gentleman.” Thus, the importance for individuals’ growth of education, including the arts and education beyond schooling.

For Marshall “the aim of school education was not only the transfer of knowledge, but also […] the education of character, faculties and activities […] By the same token, a variety of non-school institutions were relevant to education” (Opocher 2009, 13). That knowledge is not immediately productive. It pertains rather to the idea of a “nobler life.” Still, it has an effect on economic progress, and an important one. “Like education, and partially by means of education, more leisure, more intellectual and moral cultivation, better social intercourse would be an independent source of productivity increase, so that the reduction of working hours (at constant wages) need not reduce output” (Opocher 2009, 14).

Finally: Knowledge is not linked to the operation of the market only, Marshall insists on the importance of institutions for true progress.

4.3 Shifting focus: the stylized facts of the knowledge economy

We would argue that the approach of economic analysis is both too narrow and too large to enhance our understanding of the knowledge economy.

It is too narrow because it ignores the social nature of knowledge. The production of knowledge mimics neoclassical production theory; knowledge becomes a factor of production, a form of capital. But that neglects the importance of knowledge that is not the result of R&D and cannot be appropriated. That is part of a different investigation, which probably intersects and to some extent overlaps with knowledge as a form of “commons.” Indeed, when appropriately considered, innovation itself is fueled by much more than narrowly defined technical progress, as some hints on the nature of localized knowledge suggest. Furthermore: The goals of economic progress bring into the analysis the question of the productivity of knowledge. Knowledge has purposes that go beyond production, i.e., well-being. And yet, even a better life is “productive” bringing forward for instance innovation. The point is that socially produced knowledge and economic progress, are fueled and feed-back on each other in a complex and hard to define social process.

But the economic analysis of knowledge is also too general, and in fact too generic, to effectively help to penetrate the question of the knowledge economy. It does not help to understand the forms knowledge takes and the way knowledge shapes specific industries, in fact the most important industries of advanced industrial economies. This is why the proposed research approach stirs away from the attempt of defining the knowledge economy. Those who tried have concluded that the only sensible approach is to highlight partial and distinct aspects of the problem. But we want also to overcome the largely rhetorical use of the term. Anchoring the analysis to the stylized facts of advanced economies seems promising: it affords a general macroeconomic view of the problem, and a noticeable focus on the specific knowledge shaping different branches of industry. The features of distinct industries can then be seen in a unifying framework.

We are referring to two characteristics of advanced industrial economies: (a) the growing importance of collective and “private-public” goods in the composition of aggregate consumption; (b) the presence of many knowledge-industries although not those customarily associated with Hi-Tech. Nevertheless, knowledge is essential to the characteristics and quality of the services provided, which are often difficult to define strictly private goods.

It follows that this approach to the knowledge economy implies to first reconsider the problem of externalities. Notoriously their presence raises the problem of market failure.12 The uncertain boundaries of market failure are the starting point of a profound change of perspective on both knowledge and externalities.

5. Market failure: old and new

5.1 “The Anatomy of Market Failure”

In his classic article, Bator (1958) observes that in the real world many things violate the so-called duality theorem of welfare economics, i.e., the correspondence between Pareto efficiency and market performance. The literature on the causes is “rich but confusing. It abounds in mutually reinforcing and overlapping descriptions and explanations of market failure: external economies, indivisibility, non-appropriability, direct interaction, public goods, atmosphere, etc. In a sense, our problem is simply to sort out the relations among these” (Bator 1958, 356).

In fact, external economies “belong to a more general doctrine of direct interaction. Analytically, it implies the non-independence of various preference and production functions. Its effect is to cause a divergence between private and social cost-benefit calculation” (358). But what gives rise to “direct interaction”? Research has focused on the divorce of scarcity from effective ownership. However: “Does non-appropriability then explain all direct interaction?” (361). To an extent it does, and yet, “it diverts attention from some deeper issues” (361). Do radio programs and bridges involve direct, i.e., nonprice, interaction? “Does not the introduction of a new program directly affect my and your consumption possibilities, in ways other than a change in relative prices?” (362). Bator concludes that “it is more useful to broaden rather than restrict”, letting “externality” denote any situation where some Paretian costs and benefits remain external to decentralized cost-revenue calculations in terms of prices.

Bator recalls that Samuelson has shown that pure public goods exist or at least there are outputs with “important ‘public’ qualities, [that] renders any kind of price-market routine virtually useless for […] organizational decentralization” (370).13

The relevance of the externality is due precisely “to the ‘public’ qualities of a great many activities. For example, the externality associated with the generation of ideas and knowledge is due in good part to the public character of these ‘commodities’” (370). Note that actual externalities are often “blends.” As the example of radio programs suggests, “most things are multidimensional, and more than one dimension may matter” (377).

5.2 Another kind of market failure: collective goods

To be sure, we can read Bator’s remarks as going beyond the framework of welfare economics. The questions he uncovers are paving the way to the problems raised by “collective goods.” Note for instance the importance of “direct interaction,” the many “public” qualities of many activities; the fact that “most things are multidimensional, and more than one dimension may matter.” Not to mention that “the externality associated with the generation of ideas and knowledge is due in good part to the public character of these ‘commodities.’”14

We can start from a simple question: are the public dimensions of goods closely analyzed, especially considering the changes in the composition of aggregate consumption? Let’s start from standard definitions. Based on the criteria of rivalry and excludability, public goods appear to be the polar opposite of private goods (see appendix).15

The basic idea of a public good can help economists to state clearly the difference between T-shirts and lighthouses. If nobody can charge a fee, or that might be done only in specific circumstances, the market incentives will not ensure that the good will be produced in a sufficient quantity, or it may not be produced at all. That may happen even if the good is useful and desired. Market supply will then tend to be less than what would be desirable from a social point of view. But the distinction between public and private goods is not the only way to approach market failure. If we consider what we can call collective or jointly consumed goods (their collective nature being the result of joint consumption) the focus shifts to consumption-based externalities, which are virtually excluded by the discussion of private goods (see appendix).

I can eat a hamburger without involving you or anyone else (after I’ve bought it), but I can’t make a telephone call unless someone answers. Yet a telephone is both rivalrous and excludable. For a student to take a class, there must be other students; to take the bus, there must be a bus route, a list of destinations; for the theater, or the concert, there must be an audience. (If I am the only person in the audience, the experience is different.) Flu shots and vaccinations – both are both rivalrous and excludable – benefit the individual receiving them, but they obviously have a public health aspect that benefits the whole community. Listening to a song or watching a movie means participating in a cultural activity with many other listeners or viewers; part of the experience will be sharing the experience and comparing reactions.

In these areas of consumption there are significant economies of scale, but also network externalities. Your telephone is more useful, more valuable, the more other people sign up for service. The fact that others subscribe and buy the service makes your service more useful, because there are more people and places you can call. The same holds for credit cards, and the Internet. Note that these increases in benefits are not additive; they are generally multiplicative. For instance, everyone on the network benefits from everyone’s further education and every educated person benefit from a larger network. Subscribers to the electric power network likewise benefit when more sign up, but this time because of the per unit costs fall.

The distinction between internal-external can also be redefined. Internal can be broadly understood as everything that while affecting the competitive situation, therefore the adjustment for the agents external to the transaction, remains internal to the market system. External would then mean “outside the market but still part of the economy, or part of the society that influences the economy” (Nell 2013, 9). Especially anything that affects productivity will be important, affecting the public interest. That takes us into the realm of macroeconomics.

In sum: collective (jointly consumed) goods, as opposed to private (individual) goods, have a specific relation to market and market production: many have externalities and may have increasing returns. These externalities are not of the kind customarily studied under the head of market failure. The key point of our analysis is the inherently social nature (in the sense of development taking place within the domain of social interaction) of this kind of consumption expenditure. This goes back to what Bator (1958) says, that externalities belong to the doctrine of direct interaction.16

Social interaction is at the basis of yet another phenomenon, although its definition is less clear: the increasing public dimension of private goods. Many private goods have evolved in ways that have led them to have public dimensions. This echoes Bator remarks on the public character of many activities. We could call these private-public goods. Given the difficulty of identifying and classifying the various externalities and public dimensions we will simply suggest here that this is an additional phenomenon, and it should be incorporated in our macro analyses, along with their attendant externalities, even when these are hard to measure, or even define precisely.

We can conclude that: (a) in face of joint consumption and more generally externalities in consumption the conventional categories and the distinction between private and public goods become inadequate; (b) the new focus on externalities follows from a different understanding of market failure that concerns economic growth. That is why we should speak of macroeconomic externalities.

5.3 The macro aspect of externalities

A macroeconomic externality affects the working of the macroeconomy – the value of the multiplier, for example, or the level of productivity. A household welfare externality impacts the welfare of households, either in general or in certain spheres, and a market externality affects the equilibrium values of prices and quantities in the market. To ascertain these impacts requires identifying and classifying the various externalities and public dimensions something that resembles to a research program well beyond the purpose of the present work. Nevertheless, some fundamental aspects of the problem can at least be outlined.

The first thing to note is that these externalities are varied. Second, they need to be analyzed for their nature and their impact. Some of these effects are specific, as with the externalities offered by a new medicine, specific features offered to specific groups, others may be quite general – as with the effects of reducing air pollution, affecting a wide public. The effects of some of them are accounted for in their initial impact, but for others the major impact may come in secondary or even tertiary effects, as when a shift to renewable energy or an increase in conservation reduces greenhouse gas emissions and slows the move to global climate change.

When considering the prospects of sustained growth, it will be important to analyze the impacts of externalities on one another, and on economic advance, thus directly addressing the questions of stability and dynamics.

6. Modern consumption and knowledge-based industries

The “macro” market failure we have identified above is most important because collective goods and private-public goods are an increasing share of modern consumption. The goods/services in question are not “commodities,” though they have been “commodified.” Their characteristics obstruct or misdirect the market. But these characteristics are the result of knowledge that is the basis of the industries that produce them. These intertwined phenomena are crucial for the understanding of the knowledge economy.

The fact is that in advanced industrial economies as per capita income increases basic subsistence goods take up less of households’ budgets. In the 1890s, the categories food, clothing, shelter and fuel made up over 90% of the American average household budget (Nell 1998, chap. 2). The new goods/services are in the areas of communication, information, education, entertainment, travel and tourism, and health. It is then arguable that as household incomes rise, the composition of consumption shifts to goods and services that are not strictly private goods. The public dimension and externalities are much more important.

The change of perspective goes hand in hand with a redefinition of “knowledge-based” industries. Whereas in the dominant approach these industries are almost exclusively the Hi-tech sector (surely ICTs and Pharmaceuticals), we have now a larger set of industries.

Consider for instance the entertainment (radio, television, cinema) and culture industry. Aren’t these industries part of what we can call the knowledge economy? They depend however on a type of knowledge that we can characterize as general and creative. In fact, the kind of knowledge associated with art and culture. And that is not independent from the intellectual and emotional development of individuals in society. Note therefore that, despite the use of technology and the massive digitalization (Schiller 2014), the industry relies on a different kind of knowledge than that of Hi-Tech. In other words, being a knowledge-intensive industry does not mean to be science/research-based industries the way Hi-Tech is.

What about education and the health industry? Aren’t they another case of massive use of knowledge, in fact knowledge industries per excellence?

In the case of education, one cannot fail to notice the importance of ICTs. Think of online teaching, which received a further tremendous impulse by the Covid-19 pandemics. However, the crucial role of knowledge in defining the quality of education goes well beyond the investment in technology.

The health industry also suggests a complicated relationship between knowledge, technical progress and final services. Hospital and medical services are increasingly capital-intensive activities. Advanced medical and surgical equipment embody the latest advances in science and technology. That is no doubt linked to ICTs and medical biotech. However, the “industry of the future,” as labeled by Fogel (2004), is driven by forces quite distinct from technical progress, such as the aging of population and the increased quality/complexity of healthcare services. But just as surely the industry will involve a substantial increase in government spending and government regulation. It is hard to see how purely private incentives can provide what is needed.17

7. Concluding remarks

The new focus on knowledge of economic theory mirrors some of the features of advanced industrial economies, such as the rise of Hi-Tech and the knowledge sector. We have questioned the idea that this by itself can guide the understanding of the knowledge economy.

The transformation of advanced industrial economies has at the forefront the production of goods/services satisfying higher order needs. That can be done only by industries in which knowledge, in forms specific to each industry, is the essential input. Second, refocusing the attention on the stylized facts of modern consumption and production, one cannot fail to notice that the output of the expanding consumers industries is largely made of collective goods and services and private-public goods. Precisely the characteristics of these goods/services and the collective nature of services, such as health and education, are the source of positive externalities, as the example the interdependence of individuals consuming these services indicates.

Exploiting the positive externalities that this pattern of economic expansion engenders requires incentives that cannot come from the operation of the market. Positive externalities – and the goals of economic progress – require a rethinking of policy. In an institutional framework lacking a well-thought-out public policy, ripping off these benefits might be impossible. More accurate views on the knowledge economy can support such a policy. That gives additional force to the call for a larger and different role of government in economic development (Mazzucato 2013). It also raises the question of the institutions best suited to a knowledge economy.

We would argue that, although admittedly requiring more elaboration, the approach outlined above offers a more promising perspective on the knowledge economy than the exclusive focus on the knowledge sector and technical progress.

Appendix

Excludable Non-excludable
Rivalrous: Private goods Common goods
Non-Rivalrous: Club goods Public goods

Private goods are those whose costs and benefits are internal to the market. The costs of producing private goods are borne completely by the suppliers; the benefits go exclusively to the purchasers/consumers. Public goods are at the opposite end of this spectrum. Common goods are natural resources – fish in the sea, common pastures, oil, coal, and so on. Notoriously a major issue for common goods is the “tragedy of the commons”; since there is no cost to using the commons, it is difficult under many conditions to control and prevent overuse – overfishing, overgrazing – which leads to higher than “optimal” usage, but more importantly, over time, to exhaustion of the stock of resources. In the case of public goods, there is a related problem, that of the “free rider,” who uses the public goods, but avoids paying or contributing to its maintenance. Club goods are goods that any member of the “club” can use, without diminishing any other member’s enjoyment of the good. Think of the patrons of a cinema or members of a club.

Private Public
Joint Consumption Telephone Defense, traffic lights
Individual Consumption T-shirts, Hamburger Lighthouse

Notes

  1. Andersson and Beckmann (2009) observe that knowledge was rarely analyzed as such by economists before the 1980s. The recent interest is related to the expansion of education, the rapid growth of knowledge-based industries (including producer services) and R&D. [^]
  2. To just give an idea of the complexity of the problem, let’s recall that the paper touches on theoretical notions that are the object of classic contributions. Knowledge and human capital have been notoriously investigated by Gary Becker and Kenneth Boulding. More recently imperfect (asymmetric) information, market failure and the role of the public sector have been extensively investigated by Joseph Stiglitz. Externalities and property rights have been discussed by Pigou and Coase. [^]
  3. “Thus, Abramowitz and David argue that perhaps the single most salient characteristic of recent economic growth has been the secularly rising reliance on codified knowledge as a basis for the organisation and conduct of economic activities” (Smith 2002, 8). [^]
  4. “Lundvall and Foray argue a more sophisticated view: ‘Even if we should not take the ICT revolution as synonymous with the advent of the knowledge-based economy, both phenomena are strongly interrelated […] the ICT system gives the knowledge-based economy a new and different technological base which radically changes the conditions for the production and distribution of knowledge as well as its coupling to the production system’” (Smith 2002, 9). [^]
  5. The AK model (Rebelo 1991) illustrates clearly the main point of endogenous growth theory. The relationship between output and capital depends on a positive constant which stands for the level of technology. To sustain growth in the long run the production function must be linear in the factor determining growth. This implies broadening the notion of capital to include all the factors of production. In other words, there is no scarcity of capital ruling over the growth process. “The global absence of diminishing returns may seem unrealistic, but the idea becomes more plausible if we think of K in a broad sense to include human capital” (Barro and Sala-I-Martin 1995, 39). [^]
  6. Starting from different theoretical premises Bonifati (2002) explains the relatively weak correlation between investment and productivity, widely believed to be positive and strong, arguing that increasing returns are generated by technological development and new knowledge, which are not captured by the growth of physical capital. The test concerns the desegregated US manufacturing industry over the period 1960–1994. [^]
  7. Aghion (1994, 7) has argued that the contribution of New Growth Theory is “predominantly technical in nature. It is now possible to deal with increasing returns and imperfect competition in dynamic general equilibrium models which are simple as those developed in the recent industrial organization literature. This technological breakthrough has in turn made it possible to formalize a number of existing ideas concerning growth and development.” As for NGT breakthrough, Cesaratto has pointed out that the variety of factors considered by endogenous growth theory “is merely superimposed on a very traditional view of economic growth” (1999, p. 788). Kurz (2013, chap. 5) maintains that the advancement consists in focusing not on (physical) capital accumulation, but on innovative capacity spurred by appropriable knowledge and technological externalities. [^]
  8. For a discussion of intellectual property rights in IT see Harison (2008). [^]
  9. Localized knowledge has become part of the literature on local-regional development (the learning region). The institutional and social aspects of innovation are analyzed in the literature on “the national systems of innovation” (Lundvall 1992). [^]
  10. The belief that scientific knowledge is public and technological knowledge is proprietary is questioned by research in the field of biology (Harvey and McMeekin 2007). [^]
  11. Lotfi (2020) has pointed out that during the twentieth century R&D has become an ordinary and necessary business expense, although regulators treat it as it were a capital investment like any other. [^]
  12. “Typically, at least in allocation theory, (by ‘market failure’) we mean the failure of a more or less idealized system of price-market institutions to sustain ‘desirable’ activities or to stop ‘undesirable’ activities. […] ‘Activities’ broadly defined, to cover consumption as well as production” (Bator 1958, 351–52). [^]
  13. In a 2017 article Maxime Desmarais-Tremblay reexamines Samuelson’s (and Musgrave’s) contribution to the theory of public goods. The paper argues that while Samuelson’s mathematical work is crucial, the “standard textbook definition” of public goods is significantly shaped by Musgrave’s emphasis on non-rivalry and non-excludability. [^]
  14. Note also Bator’s remark about “the inadequacies of market calculations in a setting of growth” (379). [^]
  15. The analysis here adapts materials developed with E.J. Nell and published in Nell (2013). [^]
  16. Much of what can be said for collective goods applies also at least to some extent to “third party social goods” and “correcting” or “offsetting” goods (goods and services which are produced to offset the effects of the consumption of other goods) (Nell 2013, 8). [^]
  17. It can be noted that our knowledge-based industries are often part of the public sector. This echoes the so-called Wagner law. In 19th century Adolph Wagner argued that the increasing share of the public sector in gross domestic product was a tendency that were to continue. [^]

Competing Interests

The author has no competing interests to declare.

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