Student Publications

Author: Gideon Gono
Industrial Economics And Economic Development
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1.0 Background

1.1 The problem of the economic development of the poor
countries of the contemporary world is one of the most
widely discussed topics of our time. A number of
international conferences on the subject have been held
and the likelihood of more coming is just as tantamount to
the probability that the sun will rise from the east
tomorrow. Experts in various fields such as economics,
politics, sociology and even engineering have held
startlingly diversified views about the nature of
underdevelopment and poverty, its causes and remedies. It
has however been fully recognised that the nature and
causes of the poverty of the nations` are very complex
and the remedies are neither easy nor quick.

1.2 In as much as prescribing a once off medication to the
problem of poverty is daunting a task unenviable by even
an imaginary cloned social scientist with equal capabilities
in all fields from economics to sociology, it is generally
universally accepted that economic growth as measured by
increased real production plays an integral role in averting
the problem. In this regard, industrial economics as the
branch of economics which basically looks at the


microeconomic contribution of the firm in enhancing
social welfare has a bearing on the economic development
of a country.

1.3 This paper examines the relationship between industrial
economics and economic development. In other words
how does the former feeds both the theoretical and
empirically into the latter.

1.4 Introduction
A few of the most compelling developments in the
economic scenery of the past quarter century have greatly
challenged conventional economic thinking. How do
traditional models, for example gauge up to explaining
phenomena such as the economic miracles that enabled
Japan and Germany to rise out of the ashes of World War
II, only to be besieged by recent slumps in the last decade
of past century?
1.5 How do traditional models explain the sustained growth
and employment creation in the U.S. in recent years while
Europe and Asia stagnated, which only a decade earlier
would have been dismissed as a quixotic dream? How can
traditional models account for IBM, the giant which


dominated the computer industry for a quarter of a
century, suddenly stumbling and giving way to two
upstarts, Microsoft and Intel, that now rank among the
most profitable companies in the world?
1.6 More fundamentally, how can traditional models account
for the precipitous decline of the leading U.S. automobile,
steel, and consumer electronics firms that not long ago
dominated their world markets, and for the equally
impressive rise of U.S. software and biotechnology

1.7 Conventional economics has been remarkably numb on
pressing questions such as these. The most obvious
explanation for this reticence is the inherently static nature
of the discipline. The intellectual heritage of economics is
rooted in equilibrium thinking, yet the common
denominator among the questions posed above is change.
1.8 Traditional static analyses have proven to be more of a
burden than an instrument of enlightenment in making
sense of many of these important issues. The growing gap
between the methods of the economics discipline and their
ability to explain, understand, and predict the most
compelling economic events of our time is alarming. The
validity of the discipline lies in its ability to make sense of


1.9 Perhaps in response to this gap, scholars in the past quarter
century have begun developing alternative frameworks
and methodologies for analyzing economic phenomena
involving change. They seek to explain how and why
firms are diverse and how firms, industries, and regions
change over time. They build on a rich intellectual heritage
dating back to an earlier tradition represented by scholars
such as Josef Schumpeter and Frank Knight.
The phenomena of the afore-said change, is where
industrial economics is fostering its continued existence.

1.10 The genesis of industrial Economics can be traced back to
the beginning of the 20th Century. However, it is in the
1950s that Industrial economics developed as a separate
economic discipline. It emerged as a separate discipline
after the rise of the large modern manufacturing

1.11 Industrial economics as a separate discipline has been
known by two titles
(a) industrial economics
(b) industrial organisation


1.12 According to Scherer and Ross (1990) industrial
organisation is mainly concerned with how productive
activities are brought into harmony with the demand for
goods and services through some organising mechanism
such as a free market and how variations and
imperfections in the organising mechanism affect the
success achieved in satisfying the economy`s wants.

1.13 Ferguson P. (1988) defines industrial economics as the
application of microeconomic theory to the analysis of
firms, markets and industries. Industrial economics is
seen as the elaboration of and development of the theory
of the firm which consists mainly of the analysis of
different market structure and their implications on
economic welfare.

1.14 George Stigler (1968) described the boundaries of
industrial economics:
....there is no such subject as industrial organisation. The
courses taught under this heading have for their purpose
the understanding of the structure and behaviour of the
industries ....of an economy. These courses deal with the
size structure of firms (one or many, concentrated` or
not), the causes ....of this size structure, the effects of
concentration on competition, the effects of competition


upon prices, investment, innovation and so on. But this is
precisely the content of economic theory ­price or
resource allocation.

1.15 Thus, according to Stigler industrial economics also deals


Measurement and hypothesis testing

The analysis of public policy towards

1.16 According to Richard Schmalensee and George Stigler
industrial economics is the study of the supply side of the
economy, particularly those markets in which business
firms are sellers.

1.17 Some industrial economists tend to use the terms industrial
organisation and industrial economics interchangeably but
Carson (1985) tries to distinguish the two. His definition
of industrial economics encompasses both industrial
organisation and what he calls industrial dynamics.

1.18 Industrial dynamics is mainly concerned with the
evolution of the industry as a process in time at both the


macro level, the sector or industry level and the firm

1.19 Industrial organisation is mainly concerned with the
structure of industries at a particular point in time and is
based on the neoclassical theory of the firm.

1.20 Industrial dynamics stems from the work of Alfred
Marshall and the Austrian School. The inclusion of
industrial economics widens the area of investigation in
this field.

1.21 In this paper we shall define we define industrial
economics to mean both industrial dynamics and industrial
organisation which is the study of different market
structure and their implications for economic welfare. We
therefore follow Scherer and Ross, George Stigler and
others` definition of industrial economics/industrial
organization as well as Cason`s industrial dynamics. Of
great concern to our study is the organisation of firms and
markets and how their interactions affect the economic
development process.

1.22 Industrial economics can be studied under the three
following broad areas


Determinants of the behaviour, scale, scope and
organisation of business firms.

1.23 This area spills into both labour economics and corporate

Imperfect competition.
This area basically focuses on market structure,
conduct and performance.

Public policy toward business.
This areas focuses on antitrust (or competition)
policy, regulation and government enterprise.
Recently, other issues have been added such as
liberalisation, privatisation, industrial policies aimed
at affecting technical progress and international

1.24 By and large, industrial economics is concerned with a
free market economic system. It is concerned with the
analysis of industries and markets, and with the behaviour
of firms within those markets. Industrial economics deals
with the interdependence between firms within markets
and the links that exist between market conditions, firm
behaviour and economic performance. Industrial
economics` primary concern is the manufacturing sector


because of its strategic importance in the process of
economic development.

1.25 On the other end of the spectrum, economic development
is defined as a sustainable increase in living standards that
implies increased per capita income, better education and
health as well as environmental protection. Public policy
generally aims at continuous and sustained economic
growth and expansion of national economies so that
'developing countries' become 'developed countries'.
1.26 The economic development process supposes that legal
and institutional adjustments are made to give incentives
for innovation and for investments so as to develop an
efficient production and distribution system for goods and
1.27 Traditionally economists have made little if any distinction
between economic growth and economic development as
such they have been using the terms almost synonymously.
Economic development can be seen as a complex multi-
dimensional concept involving improvements in human
1.28 Critics point out that GDP is a narrow measure of
economic welfare that does not take into account


important non-economic aspects such as more leisure time,
access to health & education, the environment, freedom, or
social justice. Economic growth is a necessary but
insufficient condition for economic development.
Professor Dudley Seers argues that development is about
outcomes, that is, development occurs with the reduction
and elimination of poverty, inequality, and unemployment
within a growing economy.
1.29 Professor Michael Todaro sees three objectives of
Producing more life sustaining` necessities such as
food, shelter, and health care and broadening their
Raising standards of living and individual self
Expanding economic and social choice and reducing
1.30 The UN has developed a widely accepted set of indices to
measure development against a mix of composite
UN`s Human Development Index (HDI) measures a
country`s average achievements in three basic
dimensions of human development: life expectancy,


educational attainment, and adjusted real income
($PPP per person).
UN`s Human Poverty Index (HPI) measures
deprivation using the percent of people expected to
die before age 40, the percent of illiterate adults, the
percent of people without access to health services
and safe water and the percent of underweight
children under five
1.31 In this paper we shall restrict the measurement of
economic development to be the level of Gross Domestic
product a country is able to produce. The behaviour of the
firm under a certain market structure or basic conditions
will affect how much they produce at any given time, will
equally affect the amount of resources that they set are
aside for the purposes of acquiring technology
(innovation). All this will eventually be eventually be
reflected through the amount of output in the country thus
affecting economic development.

2.0 Theoretical Review
2.1 The fundamental problem of economics is trying to afford
solutions the following questions at each point in time;

What products to supply.


How much of each to produce
How scarce resources will be apportioned to
produce each product.
How the end product will be distributed among
the members of society.

2.2 The problems can all be answered in three traditional ways
which encompass
Conformity to tradition -distribution by cultured
practice for example land allocation, peasantry.
Central planning -government decision
Free market economic system -under which
consumers and producers act in response to price
signals generated by the interplay of supply and
demand in more or less freely operating markets.

2.3 Another fundamental principle of economics identifies two
main players within an economy ­the producers and the
consumers each with their own set of expectations from
either side.
(a) Producers - who are responsible for the
production of goods and services.
(b) Consumers ­that is society


2.4 What society requires from producers of goods and
services is good performance. Good performance
embodies the following goals:

(1) Decisions as to what, how much and how to
produce should be in two aspects

(a) scarce resources should not be wasted.

(b) Production

qualitatively to consumer demand.

(2) The operations of producers should be
progressive taking advantage of opportunities
opened by science and technology to increase
output per unit of input and to provide
consumers with superior new products, in both
ways contributing to the long run growth of
real incomes.
(3) The operations of producers should facilitate
stable full employment of resources, especially
human resources. Or at a minimum they should
make maintenance of full employment through
the use of macroeconomic policy instruments
excessively difficult.


(4) The distribution of income should be equitable.
Equity implies that producers do not secure
rewards in excess of what is required to call
forth the amount of services supplied.

2.5 Good performance requires maximum satisfaction of all
the four goals. Measuring the degree of extent of
fulfilment of these goals;

(a) magnitude of price-cost margins
(b) rates of change of output per hour of work
(labour productivity)
(c) price levels
(d) the size of gaps between actual and minimum
feasible unit costs
(e) variability of employment over the business

2.6 As its starting view industrial economics recognises that;
(a) in some markets, a monopolist may operate
protected by high barriers to entry
(b) in most industrial markets barriers to entry are
insufficient to exclude all new competition
and/or a number of firms operate in the market.
In some cases some degree of competition


(actual or potential) will exist so that
intermediate imperfect competition outcomes
are cost likely.

2.7 Industrial economics recognises that firms are often
multiplant, multiproduct, multinational oligopolists who;

compete against each other by differentiating their
Shield their innovations behind walls of patents
Reshape entire industries by buying up their
Lobby extensively for preferential treatment from

2.8 Thus, industrial economics recognises that the theory of
competitive market structures although simple to solve for
if an equilibrium exists, in most cases cannot explain the
industry.Industrial economics is thus mainly concerned
with oligopolistic market structures. It seeks to answer the
following questions;

(a) What are the market structures which best
promote efficiency?


What kinds of markets best promote technical

2.9 The prime elements for consideration are
(a) Market
industries are composed of few firms
(b) Product characteristics -firms in some
industries produce homogeneous products,
whereas firms in others distinguish themselves
from competing firms by selling differentiated
(c) Costly activities -firms in an industry are
engaged in repeated costly activities targeted for
the purpose of enhancing the sales of their
brands. Such activities include advertising,
quality control, product differentiation costs
marketing etc.
(d) Research and development -firms allocate
resources for investing cost reducing production
technologies as well as new products.


2.10 Studies in the field of industrial economics have a direct
and continuing influence on the formulation and
implementation of public policies in such areas as;
(a) the choice of between private and public enterprises
(b) the regulation and deregulation of parastatals
(c) the promotion of competition through
(i) the establishment of monopolies and mergers
(ii) adoption of antitrust laws
(iii) free trade policies

2.11 Industrial economics also ensure stimulation of
technological progress through patent grants and subsidies
as well as helping governments and policy advisiors, since
to ensure the raising of industrial performance of their
economies they require an analysis of the inter-relations
between industrial structure, organisation and efficiency.

2.12 At the roots of main stream industrial economics lies a
methodological debate concerning the relationship
between theoretical and empirical analysis, that continues
to the present day. In the ensuing of the debate, two
approaches to the study of industrial economics emerged:\


a. The structure-conduct-performance paradigm which
is highly descriptive and provides an overview of the
entire field propounded by
b. The
microeconomic models to explain firm behaviour
and market structure.

2.13 The Structure-Conduct-Performance

This dorminant framework in industrial economics was
first developed by Mason of Harvard University in the
1930s and then later on elaborated by several other

a. This approach has now become the central study of
industrial economics as it provides an overview of
industrial organisation.

b. The paradigm stipulates casual relationships between
the structure of the market, the conduct of the firms in
the market and their economic performance.
2.14 It was Bain (1956) who decomposed a market into
structure, conduct and performance. The paradigm
contends that an industry`s performance (the success of an


industry in producing benefits for consumers) depends on
the conduct (behaviour of the firms in the market) which
in turn depends on the structure (factors that determine the
competitiveness of a market).

2.15 Structure means -how sellers interact with other sellers,
with buyers and with potential entrants. It describes the
environment within which firms in a particular market
operate.It also defines the product in terms of the potential
number of variants in which the product can be produced.
The major elements of market structure describe ways in
which markets depart from the conditions that describe
perfect competition. These include two aspects;

(a) internal aspects; number of buyers and sellers,
barriers to entry
(b) external aspects; product differentiation,
vertical integration, diversification

2.16 Conduct
This refers to the behaviour (actions) of the firms in the
market; it also refers to the decisions these firms make and
also to the way in which these decisions are taken. It is the
behaviour of the firm in response to conditions imposed by
the market structure. Market conduct refers to how firms


determine their price policy, sales and promotions.
Significant aspects of the firm conduct include;
development; -plant investment; -legal tactics; -product
choice; -collusion; -merger and contracts

2.17 Performance
Performance encompasses the welfare aspect of the market
interaction. It relates to the record of the industry in terms
of the benefits which it generates for its various
stakeholders. It refers to the extent in which firms are able
to satisfy consumer demands in the current. The question
here is whether the firm`s performance enhances economic
welfare. Important aspects of performance include: -
productive efficiency; -allocative efficiency; -equity; -
productive quality; -technical progress; -profits

2.18 An important addition to the structure-conduct-
performance paradigm was the idea of an industry`s basic
conditions. The structure-conduct-performance paradigm



2.19 Basic conditions

These can be divided into two, the supply side and the
demand side conditions;
a. On the supply side the basic structure determining
conditions include;- the location and ownership of
essential raw materials; -nature of the relevant
technology; -the degree of labour unionisation; -product
quality; -the value/weight ratio of the product business
attitudes; -legal framework

b. On the demand side, significant basic conditions
include: -price elasticity of demand at various prices; -
availability of (and cross price elasticity of demand for)
substitutes; -the rate of growth and variability overtime
of demand; -purchase method; the methods employed
by buyers in purchasing (e.g. acceptance of list prices as
given versus solicitation of sealed bids versus
haggling); -the market characteristics of the product


2.20 The whole matrix crumbles down to the fact that the
conditions that exist within a market, exogenous or
endogenous influence the way industry strategize in their
quest to survive which in turn affects the performance of
the whole industry. Economic development is directly
influenced by the performance of the industry via
provision of goods and services.

2.21 Economic Development.
Having looked at the theory of industrial economics, it is
important that we take a road to look at the theories of
economic development, as depending on which theory an
economist may be coming from, industrial economics may
note directly feed into economic development.
2.22 For many lay people, economic development - by which
we mean the analysis of the economic progress of nations -
is what economics as a whole is designed to address. For
modern economists, however, the status of economic
development is somewhat more uncomfortable: it has
always been the maverick field, lurking somewhere in the
background but not really considered "real economics" but
rather an amalgam of sociology, anthropology, history,
politics and, all-too- often, ideology.


2.23 Nonetheless, a number of the greatest economists tried to
venture into the hazy field of economic development
economics where solutions to poverty no-matter how
closer they may be yet they may not be visible. The
subject of economic development dates back to the
classical era of, Adam Smith and indeed, perhaps the
entire Classical School. Schumpeter's first famous book
was entitled a Theory of Economic Development (1911).
2.24 Nonetheless, "economic development", as it is now
understood, really only started in the 1930s when,
prompted by Colin Clark's 1939 quantitative study,
economists began realizing that most of humankind did
not live in an advanced capitalist economic system.
However, the great early concern was still Europe:
namely, postwar European reconstruction and the
industrialization of its eastern fringes - as exemplified by
the pioneering 1943 article of Paul Rosenstein- Rodan and
Kurt Mandelbaum's 1947 tome. It was only some time
after the war that economists really began turning their
concerns towards Asia, Africa and Latin America.
2.25 To this end, decolonization was an important catalyst.
Faced with a new plethora of nations whose standards of
living and institutions were so different from the
European, modern development theory, by which we mean


the analysis not only of growth but also of the institutions
which could induce, sustain and accelerate growth, began
in earnest. Early development theorists - such as Bert
Hoselitz, Simon Kuznets, W. Arthur Lewis, Hla Myint
were among the first economists to begin analyzing
economic development as a distinct subject.
2.26 The post-war formation of the United Nations - and its
attendant agencies, such as the World Bank, the I.M.F., the
I.L.O. and the various regional commissions - proved to be
another important impetus. The commissioning of
numerous studies by these institutions led to the
emergence of a non-academic strand of development

2.27 Development as Growth and Capital-
Early economic development theory was but merely an
extension of conventional economic theory which equated
"development" with growth and industrialization. As a
result, Latin American, Asian and African countries were
seen mostly as "underdeveloped" countries, i.e. "primitive"
versions of European nations that could, with time,
"develop" the institutions and standards of living of
Europe and North America.


2.28 As a result, "stage theory" mentality of economic
development dominated discussions of economic
development. As later made famous by Alexander
Gerschenkron (1953, 1962) and, more crudely, Walt W.
Rostow (1960), the stages theories argued that all countries
passed through the same historical stages of economic
development and that current underdeveloped countries
were merely at an earlier stage in this linear historical
progress while First World (European and North
American) nations were at a later stage. "Linear stages"
theories had been developed earlier by German
Historicists, thus it ought not be surprising to find
historians, such as Gerschenkron and Rostow, among its
main adherents.
2.29 More enlightened attempts to arrive at an empirical
definition of the concept of "underdevelopment", as
exemplified by the work of Hollis Chenery, Simon
Kuznets and Irma Adelman, led to the general conclusion
that while there were not explicit "linear stages", countries
tended nonetheless to exhibit similar patterns of
development, although some differences could and did
persist. The task of the development economist, in this
light, was to suggest "short-cuts" by which
underdeveloped countries might "catch up" with the
developed and leap over a few stages.


2.30 By equating development with output growth, early
development theorists, prompted by Ragnar Nurkse
(1952), identified capital formation as the crucial
component to accelerate development. The celebrated
early work on the "dual economy" by Sir W. Arthur Lewis
(1954, 1955) precisely stressed the role of savings in
development. Early Keynesians, such as Kaldor and
Robinson, attempted to call attention to the issue of
income distribution as a determinant of savings and
growth. Even modern Marxians such as Maurice Dobb
(1951, 1960) focused on the issue of savings-formation.
2.31 Of course, savings could themselves be manipulated by
government intervention - as Lewis had intimated and the
Keynesians insisted. Indeed, earlier, Rosenstein-Rodan
(1943) had argued that increasing returns to scale made
government-directed industrialization feasible. The notion
of turning "vicious circles" of low savings and low growth
into "virtuous circles" of high savings and high growth by
government intervention was reiterated by Hans W. Singer
in his doctrine of "balanced growth" and Gunnar Myrdal in
his theory of "cumulative causation". Thus, government
involvement - whether by planning, socio-economic
engineering or effective demand management - was
regarded as a critical tool of economic development.


2.32 Other economists turned to international trade as the great
catalyst to growth. Already Hla Myint, Gottfried Haberler
and Jacob Viner had stressed this avenue - arguing along
lines similar to the classical doctrine of Adam Smith that
trade and specialization can increase the "extent of the
market". However, earlier in the 1930s, D.H. Robertson
had expressed his doubts on this account - and these were
later reiterated by Ragnar Nurkse, H.W. Singer and Rául

2.33 Social Aspects of Economic Development
Although capital-formation never really left the field, the
meaning of the term mutated somewhat over time. T.W.
Schultz, drawing upon his famous Chicago School thesis,
turned away from physical capital accumulation to
emphasize the need for "human capital" formation. This
led to an emphasis on education and training as pre-
requisites of growth and the identification of the problem
of the "brain drain" from the Third World to the First (and,
as would later be stressed, from the private sector to
government bureaucracies). W. Arthur Lewis and Hans W.
Singer extended Schultz's thesis by arguing that social
development as a whole - notably education, health,
fertility, etc. - by improving human capital, were also


necessary pre-requisites for growth. In this view,
industrialization, if it came at the cost of social
development, could never be self-sustaining.
2.34 However, it was really only in 1969 that Dudley Seers
finally broke the growth fetishism of development theory.
Development, he argued, was a social phenomenon that
involved more than increasing per capita output.
Development meant, in Seers's opinion, eliminating
poverty, unemployment and inequality as well. Singer,
Myrdal and Adelman were among the first old hands to
acknowledge the validity of Seers's complaint and many
younger economists, such as Mahbub ul Haq, were
galvanized by Seers's call to redefine economic
development. Thus, structural issues such as dualism,
population growth, inequality, urbanization, agricultural
transformation, education, health, unemployment, etc. all
began to be reviewed on their own merits, and not merely
as appendages to an underlying growth thesis.
2.35 Particularly worthy of note was the resurrection of the
work of Chayanov on the unique structures of peasant
economies. Also emergent, in this period, was a debate on
the very desirability of growth. E.F. Schumacher, in a
famously provocative popular book, Small is Beautiful
(1973), argued against the desirability of industrialization


and extolled the merits of handicrafts economies. As the
world environmental crisis became clearer in the 1980s,
this debate took a new twist as the very sustainability of
economic development was questioned. It became clear
that the very desirability of development needed to be

2.36 Structuralism and its Discontents
Before Seers's complaint, many economists had already
felt extraordinarily uncomfortable with early development
theory and the implicit assumptions behind "stages"
reasoning. A new (or old - depending on one's vantage
point) idea began to germinate - what may be loosely
termed "structuralism". The "structuralist" thesis,
succinctly, called attention to the distinct structural
problems of Third World countries: underdeveloped
countries, they argued, were not merely "primitive
versions" of developed countries, rather they had
distinctive features of their own. As mentioned, Chenery
had argued a similar thesis, but nonetheless focused on the
similarities of experience. The newer structuralists, in
contrast, sought to bring attention to the differences.
Albert O. Hirschmann (1958) was one of the early few


who stressed the need for country-specific analysis of
development - as was stressed later by Dudley Seers.
2.37 One of these distinctive features was that, unlike European
industrialization, Third World industrialization was
supposed to occur while these countries existed alongside
already- industrialized Western countries and were tied to
them by trade. This, speculated a few, could give rise to
distinct structural problems for development.
2.38 Coincidental with H.W. Singer, the UNCLA economist,
Raúl Prebisch, formulated the famous "dependency"
theory of economic development, wherein he argued that
the world had developed into a "center-periphery"
relationship among nations, where the Third World was
regressing into becoming the producer of raw materials for
First World manufacturers and were thus condemned to a
peripheral and dependent role in the world economy. Thus,
Prebisch concluded, some degree of protectionism in trade
was necessary if these countries were to enter a self-
sustaining development path. Import-substitution, enabled
by protection and government policy, rather than trade and
export-orientation, was the preferred strategy. Historical
examples of government-directed industrialization, such as
Meiji Japan and Soviet Russia, were held up as proof that


there was not only one path to development, as had been
implied by the cruder "stages" theories.
2.39 The Prebisch-Singer thesis resounded particularly with
Marxian thinkers - who identified elements of Rosa
Luxemburg's and V.I. Lenin's arguments on imperialism in
it. Breaking with savings-obsessed orthodox Marxian
thinkers such as Dobb, Neo-Marxians such as Paul Baran,
Paul Sweezy, A.G. Frank and Samir Amin took the
Prebisch-Singer thesis, merged it the Luxemburg thesis,
and drew it into the modern era. Many Third World
governments adopted the language and policies of the
structuralists and/or the Neo-Marxians in the 1960s and
1970s, and indeed, the movement seemed to have been
periphery" and "dependency" were the catch-words of the
2.40 However, as time moved on, these policies seemed to fail
to yield their promised fruit, and a Neoclassical (or, more
accurately, Neo-Liberal) countermovement initiated by the
lone voices of P.T. Bauer, I.M.D. Little, Deepak Lal, Bela
Balassa, Anne Krueger and Harry G. Johnson began to
gain more adherents. Their thesis was simple: government
intervention did not only not improve development, it in
fact thwarted it. The emergence of huge bureaucracies and


state regulations, they argued, suffocated private
investment and distorted prices making developing
economies extraordinarily inefficient. In their view, the ills
of unbalanced growth, dependency, etc. were all ascribed
to too much government dirigisme, not too little.
2.41 In recent years, the Neoclassical thesis has gained greater
adherence, particularly in Latin America. However, the
evidence is still ambivalent and disputed. Both
structuralists and counter-structuralists point to fast East
Asian development and disastrous African experience as
proofs of their directly opposing theses.
2.42 Theoritical link between industrial Economic and
economic development
The theoretical linkage between Industrial economics and
economic development is best realizable if one follows the
theory of equating development with output growth- an
early development theory, prompted by Ragnar Nurkse
(1952), in which case capital formation is identified as the
crucial component to accelerate development. This gets us
to the relationship which is given in the figure over leaf.
2.43 The basic conditions that prevail within the economy from
both the demand and supply side determines the markets
structure that eventual prevails within that economy-be it


perfect competition, monopolistic competition, monopoly
or even oligopoly. Bearing in mind that the main goal of
business is to make profit and survive, the prevailing
markets structure influences the need for venturing into
Research and Development or generally to acquire
improved technology which in turn lowers the cost of
production. This important of innovation is captured in the
conduct aspect of our paradigm. The final issue of
performance is where economic development is directly
measurable. Better performance will be manifested
through improved productivity thus increasing the choice
of consumers as well stabilizing the prices which naturally
are some of the indicators of development.


Raw materials
Price elasticity
Rate of growth
Product durability
Marketing type
Business attidudes
Purchase method
Cyclical and seasonal

Number of sellers and buyers
Product differentiation
Barriers to entry
Cost structures
Vertical Intergration
Number of sellers and buyers

Number of sellers and buyers
Product differentiation
Barriers to entry
Cost structures


Vertical Intergration

Pricing behaviour
Product strategy
Research and innovation
Legal tactics

Production and allocative efficiency (growth)
Full employment

3.0 Empirical Reveiw

3.1 In this section we bring together the empirical prose that
has looked at the various facets of industrial economics


notably innovation as the prime driver of improved
production systems which in turn positively affect
economic development through enhanced industrial
performance. At first glance, the approaches may seem
disparate in that they cover different subjects using
different approaches and methodologies.

3.2 However, what links this generation of empirical prose is
the focus on change as a central phenomenon. Innovative
activity, one of the central manifestations of change, is at
the heart of much of this work. Entry, growth, survival,
and the way firms and entire industries change over time
are linked to innovation. The dynamic performance of
regions and even entire economies is linked to how well
the potential from

3.3 The contributions included in this volume can be grouped
based on a number of perspectives and lines of research.
These perspectives span the firm, the industry, the region,
and the country, as well as the interactions among all of


3.4 The Startup of New Firms

Why are new firms started? The traditional, equilibrium-
based view is that new firms to an industry, whether they
be startups or firms diversifying from other industries,
enter when incumbent firms in the industry earn
supernormal profits. By expanding industry supply, entry
depresses price and restores profits to their long-run
equilibrium level.
3.5 Thus, in equilibrium-based theories entry serves as a
mechanism to discipline incumbent firms. The papers in
this section probe empirically this characterization of
entry. They also develop and evaluate alternative
characterizations of entry based on innovation and costs of

3.6 Paul Geroski in What do we know about entry, distills a
series of stylized facts and results from the empirical
literature on entry. Four-digit SIC industries regularly
experience substantial entry by small startup firms. These
firms have high failure rates, and survivors often take
more than a decade to reach the size of incumbents.
3.7 Entry within industries tends to occur in bursts that are
related to innovation but are not closely tied to the


profitability of incumbents, and entry has limited effects
on industry price-cost margins and incumbent behavior.
Geroski concludes that entry is less a mechanism for
keeping prices down and more a mechanism for bringing

3.8 In Spin-Offs and the New Firm Formation Process,
David Gavin analyzes the circumstances that lead
employees of incumbent in USA firms to start their own
firms in an industry. In reviewing evidence from a large
number of industries, he finds such spin-offs are more
likely in younger industries whose technology is more
embodied in human rather than physical capital and which
are composed of more specialized market niches.
3.9 In a chapter from his book, Innovation and Industry
Evolution, David Audretsch analyzes the factors that
influence the rate of new firm startups. He finds that such
startups are more likely in industries in which small firms
account for a greater percentage of the industry`s
innovations. This suggests that firms are started to
capitalize on distinctive knowledge about innovation that
originates from sources outside of an industry`s leaders.


3.10 In Entry, Industry Growth and the Micro-Dynamics of
Industry Supply, J. Hause and G. Du Reitz develop a
theory of entry based on firm costs of adjustment to
growth. Consistent with their model, they find that entry is
greater in industries subject to greater growth in

3.10 Sources and Implications of Diversity

Market competition is generally thought to pressure less
efficient firms either to copy their more successful rivals
or to exit. Thus, strong selection forces exist to reduce
diversity among firms in the same industry. Nevertheless,
considerable diversity exists within industries. The papers
in this section explore the nature, sources, and implications

3.11 Walter O , in his article Heterogeneous Firms and the
Organization of Production, Walter O asks why firms
vary in size within industries and why larger firms are
more capital intensive, have higher capital utilization rates,
invest more in new equipment, and employ more educated,
salaried, and full-time workers who receive more training
and greater wages and fringe benefits.


3.12 Size differences are related to the types of needs firms
service. Differences in internal structure are related to
differential abilities of entrepreneurs and the need for
entrepreneurs to monitor workers. More able entrepreneurs
head larger firms and have a higher opportunity cost to
monitor workers and thus engage in various practices to
economize on monitoring costs, which includes using
more capital intensive methods of production and

3.13 Wesley Cohen and Steven Klepper explore the sources of
variation within industries in the intensity of firm R&D
efforts, defined as the ratio of R&D expenditures to size.
They conjecture that variations in R&D intensity reflect
differences in the expertise possessed by firms and the
effect of firm size on the returns from R&D. Modeling the
acquisition of expertise as a random process; they show
how their theory can explain a number of features of the
distributions of firm R&D intensities within industries.
3.14 The theory also provides a non-causal explanation for
long- observed relationships across industries in mean
R&D intensity, market concentration, and the coefficient
of variation of R&D intensity and for the inverse
relationship across firms between R&D productivity and



3.15 The Size Distribution of Firms

While in most industries firms periodically change rank in
terms of their size, the size distribution of firms within
industries and even whole economies almost always
assumes a predictable form, which is highly positively
skewed. The papers in this section explore the dynamic
process that could give rise to such a distribution.

3.16 In The Size Distribution of Business Firms, Herbert
Simon and Charles Bonini continue a tradition initiated by
Robert Gibrat in which the growth of firms is
conceptualized as a random process. They show that if in
each period the distribution of firm growth rates is the
same for all firms above a minimum size and the birth rate
of new firms is constant over time, then a positively
skewed steady-state size distribution emerges that
conforms closely with industry and economy firm-size
distributions. The parameters of the distribution for each
industry provide a natural way to measure industry market
structure, and departures from the predicted size
distribution at small firm (or plant) sizes provide a way of
inferring the minimum efficient size firm (or plant).


3.17 Using data for the steel, petroleum, rubber tire, and
automobile industries for various periods, in Entry,
Gibrat`s Law, and the Growth of Firms Edwin Mansfield
probes the stochastic framework used by Simon and
Bonini. He shows that allowing the probability of failure
and the variability of firm growth rates to decline with
firm size can accommodate his findings that the mean and
variance of firm growth rates among surviving firms
declines with size. He also finds support for a model in
which the probability of firms changing rank in an
industry`s size distribution declines with the age of the
industry and the degree of inequality of the industry`s size

3.18 In the last paper in this section entitled Selection and the
Evolution of Industry, Boyan Jovanovic develops a
model in which the stochastic factor underlying firm
growth rates is noisy signals about relative firm
efficiencies. Young firms have less experience and
respond more sensitively to signals, which Jovanovic
shows can account for smaller firms having higher
probabilities of failure and higher and more variable
growth rates. The theory can also explain other patterns,
including why more concentrated industries tend to have
more stability over time in firm rates of return, greater


variability in firm rates of return at a moment in time, and
higher rates of return enjoyed by larger firms.

3.19 Growth

As the selections in the prior section indicate, firm growth
patterns can provide discriminating evidence regarding the
forces shaping industry market structure. The papers in
this section dig deeper empirically into the firm growth
process in order to develop a greater understanding of the
forces governing the firm-size distribution and industry

3.20 In The Relationship between Firm Size and Firm Growth
in the U.S. Manufacturing Sector, Bronwyn Hall explores
growth patterns among publicly traded manufacturing
firms. She demonstrates that the tendency for mean firm
growth rates to decline with size is robust to two
econometric problems that could spuriously contribute to
this pattern--errors in measuring firm size and sample
selection due to small firms having higher failure rates.

3.21 In The Growth and Failure of U.S. Manufacturing
Plants, Timothy Dunne, Mark Roberts, and Larry
Samuelson investigate further the size-growth relationship


as well as other influences on the mean and variance of
growth rates using Census data on all U.S. manufacturing
plants. They find that the failure rate and the mean and
variance of the growth rate for nonfailing plants decline
with size and age for both plants owned by single and
multi-plant firms.
3.22 When all plants, including failing plants which are
assigned a growth rate of--100%, are considered,
however, the patterns change. Their most striking finding
is that for plants owned by single-plant firms mean firm
growth rates continue to decline with size, but for plants
owned by multi-plant firms the decrease of failure with
size overwhelms the decline in growth rates with size for
non-failing plants, leading the mean growth rate for all
plants to increase with size for larger and older plants.
These older and larger plants of multi-plant firms have
distinctively low failure and high growth rates.

3.23 In the third paper, Gibrat`s Legacy, John Sutton reviews
theoretical and empirical work on firm growth and failure
rates and on the firm-size distribution and develops a
stochastic model for the firm-size distribution that can
accommodate the most distinctive patterns. His model is
similar to Simon and Bonini`s but relaxes their growth
assumption by assuming only that firm growth in absolute


terms (not the rate of growth) is a nondecreasing function
of firm size. His model yields a lower bound relationship
for the firm-size distribution that is well satisfied by
industries in the UK, US, and Germany. The model
implies a positively skewed firm-size distribution, with
industry concentration dependent on the extent to which
absolute firm growth increases with firm size.
3.24 Survival
Growth is one aspect of the performance of firms. Another
that is closely linked to growth is survival. The papers in
this section explore empirically the characteristics of
entrants and the industries that enter that influence

3.25 In New Firm Survival: New Results Using a Hazard
Function, David B. Audretsch and Talat Mahmood find
that the survival of new establishments in the
manufacturing sector depends on establishment and
industry conditions. The hazard of exit appears to be
related to the degree of scale economies in an industry,
with the hazard greater the more capital intensive the
industry entered and the smaller the establishment at entry
relative to an estimate of the industry`s minimum efficient
size plant. The hazard of exit is also greater in more


innovative industries and when unemployment is high.

3.26 These relationships hold principally for new startups rather
than diversifying entrants, suggesting environmental
conditions are most determinative of performance of new

3.27 In Life Duration of New Firms, Jose Mata and Pedro
Portugal find that for Portugese entrants, the length of
survival is a function of entrant and industry
characteristics. Similar to Audretsch and Mahmood, they
find that larger entrants survive longer, but the (estimated)
size of the minimum efficient firm in the entrant`s industry
does not affect survival. They also find that the growth rate
of the entrant`s industry positively affects the length of

3.28 Thomas Holmes and James Schmitz in On the Turnover
of Business Firms and Business Managers, analyze the
determinants of the length of survival and the likelihood of
ownership transfers among U.S. small business mainly
organized as sole proprietorships. They develop a model in
which businesses are heterogeneous on two dimensions:
the quality of the business, and the quality of the match
between the skills of the owner/manager of the business


and the needs of the business, with both subject to
temporary random shocks over time.
3.29 They show that the model can explain detailed aspects of
how the age of the business, the tenure of the current
owner, and whether the owner was the founder affect the
hazard of discontinuance of the business and the hazard of
an ownership change in the business, suggesting that
heterogeneity among small businesses plays a key role in

3.30 In the last paper of this section, The Role of Technology
Use in the Survival and Growth of Manufacturing Plants,
Mark Doms, Timothy Dunne, and Mark Roberts exploit
data on 17 advanced production technologies to analyze
how technology usage affects survival and growth among
manufacturing plants in five two-digit SIC manufacturing
industries in which the technologies are used.
3.31 Similar to other studies, older and larger firms have higher
survival rates and lower growth rates, and this persists
even after controlling for differences across plants in their
capital intensity, productivity, and technology usage.
Larger firms tend to be more advanced technologically,
more capital intensive, and more productive, all of which


independently contribute to longer survival and greater
3.32 A possible explanation for all these findings which is
reminiscent of Walter Oi`s model is that firms differ in
terms of managerial efficiency, which conditions their

3.33 Productivity

Improvements in productivity drive economic growth. At
the aggregate level, growth results from active learning,`
which contributes to productivity improvements within
firms, and from market selection or passive learning,
which leads to reallocation of output across firms.
3.34 The papers in this section explore these two mechanisms.
They analyze the effects of entry, exit, and differential
firm growth rates on aggregate productivity growth. They
also probe the factors that influence productivity growth
within firms, including industry conditions and ownership

3.35 Martin Neil Baily, Charles Hulten, and David Campbell in
Productivity Dynamics in Manufacturing Plants,
decompose total factor productivity growth in
manufacturing industries into productivity growth of
continuing plants, entrants, and exits. Although surviving


entrants eventually have greater productivity than exiters,
initially their productivity is comparable to exiters.
3.36 Combined with the relatively small outputs of both groups,
exit and entry contribute little to aggregate productivity
growth. Among continuing plants, they find that the
productivity rankings of plants persists over time, which is
consistent with plants differing in terms of management
quality as discussed in the papers by Oi and Doms, Dunne,
and Roberts. Over time, continuing plants with higher
productivity gain market share, which is an important
contributor to aggregate productivity growth along with

3.37 In Productivity Growth in Chile and Columbia: The Role
of Entry, Exit, and Learning, Lili Liu and James R.
Tybout examine total factor productivity growth in
manufacturing industries in Chile and Columbia in the late
1970s and early 1980s. During this period, Chile
experienced a severe recession and experienced a financial
crisis whereas Columbia experienced more mild cyclical
3.38 Their findings are similar to Baily, Hulten, and Campbell
in that continuing plants differed considerably in
productivity and output was allocated over time to higher


productivity plants, and entry and exit did not contribute
much to growth in aggregate productivity. In contrast to
Baily, Hulten, and Campbell, however, they find some
periods in which higher productivity firms were more
likely to exit.
3.39 This may reflect that financial factors such as liquidity are
more determinative of survival than productivity during
business cycles and financial crises. They also find that
reallocations of output among continuing plants
contributed less to aggregate productivity growth than in

3.40 In Entry, Innovation and Productivity Growth, Paul A.
Geroski explores the factors that account for differences in
total factor productivity growth across U.K. manufacturing
industries over the period 1970-1979. He finds that total
factor productivity growth varied greatly within industries
over time, suggesting that high industry productivity
growth did not persist over time.

3.41 Industries that introduced more innovations and
secondarily experienced greater domestic entry on average
sustained higher productivity growth, whereas industries
subject to greater international entry sustained lower


productivity growth. Entry was interpreted as a measure of
competition, and the effects of domestic entry were
interpreted as indicating that greater competition spurs
productivity growth. Various explanations were offered to
reconcile why international entry was associated with
lower productivity growth if entry in general spurs

3.42 In the final paper of the section, Productivity Changes in
Ownership of Manufacturing Plants, Frank R.
Lichtenberg and Donald Siegel analyze the relationship
between total factor productivity and ownership change.
Focusing on relatively larger U.S. manufacturing plants
that continued producing over the period 1972-1981, they
find that the total factor productivity of acquired plants
was below their industry average prior to acquisition and
declined relative to the industry average for a number of
years prior to acquisition.
3.43 In contrast, after acquisition the total factor productivity of
the acquired plants increased relative to their industry
average for a number of years. Similar to the matching
model in Holmes and Schmitz`s paper on small businesses,
they attribute these patterns to a process in which plants
are transferred to new owners to improve the match


between the skills needed to manage the plant and the
skills of the owner of the plant.
3.44 Persistence

Are industry leaders better able to retain their positions
over time in certain types of industries, and if so why? Are
there particular circumstances that undermine the leaders?
The selections in this section explore these questions,
focusing particularly on how innovation affects the

3.45 In Preemptive Patenting and the Persistence of
Monopoly, Richard Gilbert and David Newbery explore
the circumstances under which a monopolist will
preemptively patent an innovation to deter entry by a
challenger. They consider innovations that are not drastic
in that both the challenger and incumbent would compete
if the challenger innovated first.
3.46 For such innovations, they show that the incumbent will
commit to an R&D strategy in which it develops and
patents the innovation first assuming that the incumbent
earns greater profits from monopolizing the innovation
than allowing the challenger to innovate first and then
competing with the challenger. To be credible, such a
strategy may require the incumbent to commit to the R&D


needed to develop the innovation even if it is profitable not
3.47 In Uncertain Innovation and the Persistence of
Monopoly, Jennifer Reinganum introduces uncertainty
regarding when the incumbent`s and challenger`s efforts to
develop the innovation will succeed, with greater spending
expected to speed up the time of successful innovation.
Prior to successful innovation, the incumbent enjoys
monopoly profits and thus has a greater amount to lose
than the challenger from earlier innovation.
3.48 Consequently, for drastic and near-drastic innovations, the
incumbent spends less than the challenger on R&D and
therefore is less likely than the challenger to innovate first.
Thus, uncertainty in the innovation process can undermine
the incentives for industry leaders to maintain their

3.50 In Uncertain Innovation and the Persistence of
Monopoly: Comment, Richard Gilbert and David
Newbery argue that in Reinganum`s model it is not
uncertainty per se that undermines the tendency for
incumbents to maintain their leadership, but rather other
assumptions that differ from theirs, especially regarding
the timing of moves in the R&D game. Reinganum


assumes simultaneous R&D choices by incumbent and
challenger. They show this renders entry deterrence
unprofitable and consequently Reinganum` s conclusions

3.51 In Uncertain Innovation and the Persistence of
Monopoly: Reply, Jennifer Reinganum acknowledges
that the order of play is the key distinction between her
model and Gilbert and Newbery` s, but questions the
usefulness of modeling incumbents as having first mover
advantages. Even if incumbents can make preemptive
commitments, she argues it is the mechanism underlying
such commitments and not the patent system, as Gilbert
and Newbery claim, that is responsible for the persistence

3.52 Finally, in Preemptive Patenting and the Persistence of
Monopoly: Reply, Richard Gilbert and David Newbery
show that allowing the challenger to be more efficient at
R&D than the incumbent will not necessarily undermine
the incumbent`s incentive to preempt the challenger. They
assume that the incumbent can bargain with the challenger
over monopoly rights to the product and also over the
sources of the challenger`s advantage.


3.53 Assuming the transaction costs of the latter do not exceed
the transactions costs of the former, the incumbent will
secure the basis for the challenger`s advantage and
preempt the challenger as long as transaction costs do not

3.54 In excerpts from his book, Profits in the long run,
Dennis Mueller investigates empirically the extent to
which industry leaders maintain their profitability over
time. He finds considerable persistence in above and
below average firm rates of return over the period 1950-
1972 among the largest firms in the U.S. economy.
3.55 Estimated long-run firm rates of return were regressed on
industry concentration and estimated firm long-run market
shares, entered both alone and interacted with industry
advertising and R&D intensity, to explore the determinants
of persistent profitability. The estimates indicate that firms
with greater market share earned persistent above average
returns in (only) advertising and R&D intensive industries.
3.56 These findings suggest that R&D (and advertising)
competition contributes to greater persistence in industry


3.57 In Explaining the attacker`s advantage: technological
paradigms, organizational dynamics, and the value
network, Clayton Christensen and Richard Rosenbloom
consider the kinds of innovations in disk drives that
favored entrants over industry leaders. In contrast to
various theories, they find that nonincremental innovations
that required new types of technical expertise or that
altered the interrelationship of components did not
consistently undermine the leaders.
3.58 Industry leaders sometimes pioneered these innovations
and entrants and lesser incumbents later adopted them,
suggesting that it was not the ability of the leaders to
preempt challengers, as in Gilbert and Newbery` s model,
that enabled them to maintain their position. Innovations
that were pioneered by entrants and undermined
incumbents were ones that led to new types of disk drives
that appealed primarily to new users.
3.59 In contrast to Reinganum` s model, these innovations were
not drastic in that they did not challenge the sales of
incumbent firms, and thus incumbents did not have less
incentive than challengers to develop them. Christensen
and Rosenbloom explain their findings as reflecting that
the attention of firms tends to be captured by their
customers, which makes incumbents slow to pursue



3.60 Evolution
A number of the papers attest to the considerable turnover
of firms that typically occurs in industries. They also
indicate that in certain types of industries a few firms
capture a large market share and maintain it over time. The
papers in this section explore the factors which affect the
number of firms in an industry and the market share of the

3.61 In The Evolution of New Industries and the Determinants
of Market Structure, Steven Klepper and Elizabeth
Graddy analyze the evolution of the number of producers
and industry output and price in 46 narrowly defined new
product industries.
3.62 Characteristic of the product life cycle, the products
exhibit an initial rise and then shakeout in the number of
producers and also a dampening over time in the
percentage growth in output and fall in price. These
patterns are explained using a model that features random,
persistent firm cost differences, limited firm growth and
imitation of more efficient rivals, and sunk entry costs.


3.63 The share of output accounted for by the industry`s leaders
in the model is determined by the pace and severity of the
evolutionary process, which is shaped by systematic
factors governing firm growth and imitation and stochastic
factors conditioning the cost advantage of the early

3.64 In Industrial Organization and New Findings on the
Turnover and Mobility of Firms, Richard Caves notes
how the new findings on business turnover suggest,
consistent with Klepper and Graddy, the importance of
both stochastic and systematic factors in shaping an
industry`s market structure. Industries that are R&D and
advertising intensive appear to be especially susceptible to
becoming oligopolies.
3.65 In Sutton`s model of endogenous sunk costs the returns to
both R&D and advertising depend on the size of the
market, which is similar to Klepper`s model of the
industry life cycle in which the returns to R&D depend on
the size of the firm. In both models, an escalation process
occurs in which successful firms expand their R&D and/or
advertising, enabling only the largest firms to survive and
thus contributing to the evolution of an oligopolistic
market structure. Both models are consistent with


Mueller`s findings on the persistence of firm.profits.

3.66 As Sutton recounts in Chapter 4 of his book, Sunk Costs
and Market Structure, his model implies that as the size of
the market increases, the share of output accounted for by
the leaders will decline to zero in industries characterized
by production scale economies but will be bounded away
from zero in advertising intensive industries. He tests this
prediction by examining the market structure of 20 food
and drink industries in six countries of varying size.
3.67 Consistent with the theory, in the largest countries the
lower bound of the share of output accounted by the
leading firms approached zero in the less advertising
intensive industries but remained well above zero in the

3.68 In chapter 2 of his book, Scale and Scope, Alfred Chandler
recounts the emergence in the late nineteenth and early
twentieth century of the large industrial enterprise. Such
enterprises were concentrated in the food, chemicals,
petroleum, primary metals, machinery, and transportation
equipment industries. They exploited economies of scale
and scope made possible by new methods of production
and integrated into marketing and distribution, the supply


of inputs, and R&D to exploit fully the potential of the
new production technologies.
3.69 Firms that were first to make the large capital investments
and establish the necessary organizational structures to
manage the new large scale enterprises were difficult for
latecomers to compete with because of the large
investments needed to match their efficiencies and the
uncertainty inherent in such investments. Their industries
evolved to be oligopolies which they dominated for many
years, pointing again to the role played by
marketing/advertising and R&D in shaping industry

3.70 In the last selection in this section, Technology and
market structure, John Sutton explores why all R&D
intensive industries do not experience an escalation
process that leads to an oligopolistic market structure. He
shows that such a process will not necessarily occur if
besides improving the quality of existing products, R&D
can be also be used to develop new product varieties with
distinctive markets.
3.71 This is consistent with Christensen and Rosenbloom`s
findings that incumbent firms are slow to develop new
product variants appealing to new users. Consistent with


the theory, the four-firm concentration ratio among R&D
intensive manufacturing industries is consistently high
when the leading product of the industry accounts for a
large percentage of its sales but can be quite low in
industries in which no product commands a large share of

3.72 Regional Evolution

The preceding sections provide both a theoretical
framework as well as empirical evidence suggesting that
the evolution of firms and industries play an important role
in generating new knowledge and commercializing that
new knowledge.
3.73 It is the drive to deviate from the existing products and
processes -- to innovate -- that makes what appears to be a
stable industrial structure when viewed from a static
framework actually remarkably turbulent when viewed
through the dynamic lens described in the previous
3.74 In fact, the capacity for an economy to generate and
commercialize new knowledge is the driving force in the
new economic growth theory. This new growth theory,
posited by Paul Romer and Paul Krugman, among others,


focuses on the positive externalities associated with
3.75 In these theories, which have been supported by a wave of
empirical studies, there is an important paradox associated
with the knowledge externality. This paradox involves the
geographic dimension. Knowledge spills over from the
source where it is produced, but at the same time the
geographic extent of the spillover is geographically
bounded. An important implication is that geographic
proximity is important in accessing knowledge spillovers.

3.76 This insight from the new economic growth theory means
that geographic space, as well as product space, plays a
key role in the production and commercialization of new
economic knowledge. In particular, regions represent a
different unit of observation in which knowledge is
organized and innovative activity occurs.

3.77 The first article in this section focuses on Growth in
Cities and is by Edward L. Glaeser, Hedi Kallal, Jose A.
Scheinkenman and Andrei Schleifer. They link the
performance of economic activity to the organization of
economic activity for a geographic unit of observation --
the city. Economic performance is measured by the growth
rate of the city.


3.78 They provide systematic evidence that the growth rates of
cities are shaped by the underlying organization of
economic activity. In Innovation in Cities: Diversity,
Specialization and Localized Monopoly, Maryann P.
Feldman and David B. Audretsch provide systematic
empirical evidence demonstrating that the dynamic
economic performance of cities, measured in terms of
innovative activity, is shaped by the underlying structure
of economic activity in terms of(1) greater diversity and
less specialization, and (2) a greater degree of competition
within the city.
3.79 Diversity apparently promotes innovative activity because
it is complementary differences that generate valuable
Competition among firms for the ideas embodied in these
economic agents results in a greater degree of innovative

3.80 The final paper of the section, by Glenn Ellison and
Edward L. Glaeser, examines Geographic Concentration
in U.S. Manufacturing Industries: A Dartboard Approach.
Ellison and Glaeser introduce a model in which localized
industry-specific spillovers, natural advantages, and pure
random chance all contribute to geographic concentration.


3.81 They then test the hypothesis that observed levels of
geographic concentration exceed those expected to occur
solely due to random chance. The empirical evidence
provides a strong confirmation that localized spillovers
play an important role in shaping the geographic
concentration of industries.
3.82 As for the first two papers of this section, Ellison and
Glaeser` s results suggest that the geography plays an
important role in explaining the evolution of industries,
especially in industries where knowledge plays an

3.83 Learning and Adaptation

The performance of firms can improve over time as firms
learn about how to perform better and also as the mix of
firms changes. The former type of improvement has been
dubbed active learning. It can result from learning by
doing in which firms discover how to do things better
through experience in production. It can also result from
firms exploring how to improve their performance through
activities such as research and development.


3.84 The latter type of improvement has been dubbed passive
learning. As modeled by Jovanovic, it can occur through
a process of selection in which less efficient firms exit as
they learn through experience about their relative
efficiency. The papers in this section explore these two
types of learning.

3.85 The first article is a seminal contribution by Michael
Spence on The Learning Curve and Competition.
Spence considers the nature of firm and industry evolution
when firms learn by doing, which causes the firm`s unit
costs to fall over time as a function of its cumulative

3.86 Spence shows that the true marginal cost of production in
each period for a monopolist with a limited horizon and a
zero discount rate is its marginal cost of production at the
end of its lifetime, which it should equate with its marginal
revenue in each period to maximize its profits. He
considers the evolution of the number of producers when
there are multiple potential entrants with exogenously
determined entry times and bounded learning. Using
different equilibrium concepts, he shows that a moderate
rate of learning yields the most concentrated industry


3.87 In The Learning Curve, Technology Barriers to Entry,
and Competitive Survival in the Chemical Processing
Industries, Marvin Lieberman considers the importance
of learning by doing in the entry and survival of producers
in 39 chemical product industries. If costs decline with
experience, then potential entrants should be at a greater
disadvantage the larger the cumulative output of
incumbent firms.

3.88 The likelihood of entry, however, was not related to the
cumulative output of incumbents, which Lieberman
attributes to widespread technology licensing in most of
the products. The hazard of firm exit was greater the larger
the cumulative output of the leading producer, though,
suggesting that learning did affect firm performance.

3.89 In Selection versus evolutionary adaptation: Learning and
post-entry performance, John Baldwin and Mohammed
Rafiquzzaman consider how learning affected the survival
and growth of de novo entrants in the Canadian
manufacturing sector. They find that the performance of
entrants improved through the greater exit of less efficient
entrants and to a limited extent through the improvement
in the performance of surviving entrants. The latter type of


learning was greater in industries in which the initial
performance of entrants relative to incumbents was worse.

3.90 In New Firm Survival and the Technological Regime,
David Audretsch also considers the survival of de novo
entrants into the U.S. manufacturing sector. He finds that
over a 10-year period the survival rate of entrants was
lower in industries which were more capital intensive and
in which the leading firms were larger (a proxy for the
degree of production scale economies).

3.91 Alternatively, survival rates were greater in industries in
which smaller firms had higher innovation rates relative to
larger firms, suggesting that technological opportunities
play an important role in enabling entrants to compete with
incumbent firms. These effects were not apparent for
shorter periods, suggesting that it takes some time before
entrants can assess their competitive standing.

3.92 In the last paper in this section, Empirical Implications of
Alternative Models of Firm Dynamics, Ariel Pakes and
Richard Ericson consider the importance of active and
passive learning. They distinguish between the two types
of learning according to whether cross-sectional variations
in firm size are related to initial firm size after controlling


for cross-sectional variations in firm size in the immediate

3.93 Using data for Wisconsin firms in the manufacturing and
retail sectors for the period 1978-1986, they find support
for passive learning in retailing and active learning in
manufacturing, which suggests greater volatility in relative
firm profitability over time in manufacturing than

3.94 In summing up it has been empirically shown that
innovation plays an integral role in the performance of an
industry as it improves the production systems and in turn
lowers the cost of production. It has however been equally
shown that firms are more innovative in an environment
where there is competition, in other words when the
market is more free.

4.0 The case for Zimbabwe

4.1 Zimbabwe's manufacturing sector has historically played
an important role in the economy. As a well diversified
and strongly linked with other sectors of the economy,
particularly agriculture, mining and construction,


manufacturing has been contributing significantly to gross
national output, export earnings and employment.

4.2 The diversity of the sector has a historically legacy which
came as a response to international sanctions, imposed in
1965 to the Rhodesian regime. The sanctions compelled
the regime to embark on widespread controls on both
external and internal trade. At independence in 1980, the
new Government thus inherited a highly controlled

4.3 During the rest of the decade after independence, most of
these controls were maintained. In practice, the policy was
one of import substitution (IS) similar to that of many
other developing countries. The centerpiece of the IS
policy was regulation of foreign trade. All foreign
exchange earnings and capital inflows had to be
surrendered to the Reserve Bank, and the distribution of
foreign exchange to importers was mainly done
administratively through the Direct Local Market
Allocation (DLMA).

4.4 Companies were allowed to apply twice a year for the
right to import certain goods and services. The DLMA
worked as a system of import quotas where the size of the


quotas varied over time. One consequence of the DLMA
was that once companies were in the system they could be
quite certain to continue receiving foreign exchange
allocations. The reason was that imported inputs are
required for production so removing companies from the
DLMA for a year would have had devastating effects on
the manufacturing sector.

4.5 Since there by definition was a shortage of foreign
exchange, this made entering the DLMA quite difficult. As
a result there were relatively few firms entering and
exiting the manufacturing sector, making turnover-based
productivity gains small or nonexistent.

4.6 Since practically all investments in Zimbabwe require
imported capital goods, a consequence of the import
controls was that the authorities effectively controlled
investments as well. In view of the excess demand for
foreign currency generated by the IS strategy, the only
sensible investment policy was to channel import licenses
to a limited numbers of producers of each type of good.

4.7 This resulted in the creation of a number of oligopolistic
and monopolistic markets; in mid-1980s about 50% of all
goods manufactured in Zimbabwe were produced by one


company and 80% by three companies or less (UNIDO
1986). Hence, Zimbabwean producers were not only
protected from international competition but also from
domestic competition. To restrain firms from taking
advantage of their market power, price controls were
widely used.

4.8 These were in general based on cost-plus, and permissible
margins were gazetted. An implication of the price
controls was that for many firms higher costs meant higher
profits in dollars. Selling the goods was usually not a
problem because rationing generated excess demand. The
economic structural adjustment program was launched at
the end of 1990. Two of its major components were trade
liberalization and deregulation of domestic markets.

4.9 Government control over allocations of foreign exchange
and import licenses was to be dismantled gradually over
five years by sequentially putting import goods on an
Open General Import License (OGIL) list; such goods
could be imported in any quantity without import permits.

4.10 However, the original plan was altered after a couple of
years and OGIL was replaced by the Export Retention
Scheme (ERS) as the main policy instrument. The ERS


allowed exporters to retain part of their export earnings in
the form of import certificates and sell these at a market-
determined price. During the course of the reform the
foreign exchange allocations were reduced, and in January
1994 the DMLA, ERS, and OGIL were all abolished.
Since then the exchange rate has been determined largely
by market forces, although with occasional interventions
by the Reserve Bank.

4.11 The creation of a foreign exchange market implied that
restrictions on domestic demand for imports disappeared,
and that local companies became exposed to foreign
competition. Nevertheless, some protection remained in
the form of import tariffs, although they had played a
minor role before liberalization.

4.12 The average tariff rate was only about 20%, but the
structure was complicated and the maximum rate was 90%
(for cars). In addition there was an import surtax of 20%
(RPED, 1993). Apart from a reduction in the surcharge to
10% in 1994, there was little advance in tariff reform until
1997 when a new tariff system was introduced with the
aim of removing distortions in the old regime.


4.13 The deregulation of the domestic markets included
removal of the price controls in the goods market,
reduction of government`s involvement in wage setting
and introduction of new labor regulations making it
cheaper and easier to retrench employees, and
liberalization of the financial markets. Substantial progress
was made in all these areas: Almost all price controls were
abolished during the first years of ESAP.

4.14 The labor market underwent profound changes already in
1990, as wages in general became determined by
collective bargaining and retrenchment no longer required
ministerial approval (Ncube, 1998). And in the financial
markets, the majority of the interest rates were deregulated
already by 1991. A remarkable improvement was realized
as industry responded to the regulation. Manufacturing
contributed close to 30% OF GDP by 1992.

4.15 However, from the late 90s, Zimbabwe`s industrial sector
like any other sectors of the economy has been swimming
through a frozen ocean making her manoeuvring
techniques fall short from being able to take her to the
shores of the sea. The Zimbabwean economy is now
currently getting close to a decade in a recession, with no
signs of recovery.


4.16 The causes of the crisis are complex, as they have
economic, political and social dimensions. Unemployment
is currently estimated at a historic high of over 70 percent,
while year-on-year inflation is over 1200%. These
problems have negatively affected the operations of the
manufacturing sector,"

4.17 The industrial sector has been seeing its contribution to the
GDP falling with each successive year. Several reasons
have been sited include inter-alia
· Poor economic policy choices
· Policy inconsistency
· Constraints from poor state or inadequacy of
infrastructure ­ roads, electricity, coal, railways, fuel
· Continuing suspicions between Business and
· Low business confidence
· High country risk factor
· Excessive foreign currency shortage making
procurement of raw materials difficult
· Successive droughts which have seen the limited
foreign exchange being prioritized for importation of
food than raw materials
· Unutilized industrial capacity


· Uncertainty on property rights
· Uncertainty surrounding the land reform
· Poor performance of the agricultural sector

4.17 The figure below indicates the performance of the
manufacturing sector from 1990.

Manufacturing as % of GDP
(Source : CSO)
% 30.0
·Output down 7.5% in 2001 - lowest since 1985
·Further 15% decline projected for 2007
·Share of GDP peaked at 27% in 1992 to 12.5% in 2000

4.18 Overally the GDP figures of the country have also been
falling in tandem with the poor performing manufacturing
sector. This is shown by the figure below.


Overall GDP Growth 1986 - 2003
(Source : CSO, 2003)

4.19 In concluding this section, the Zimbabwean manufacturing
sector does not have any better prospects for as long has
the economic environment has not been improved to
ensure the existence of basic conditions that promote the
venturing into acquisition of technology which improves
the production systems.

5.0 Implications on policy

5.1 Poor industrial performance is easily noticeably as its
effects tend to impact more on economic development
through depleted production base which protrude out of
the bag through increasing inflation levels, company
closures, high unemployment, a huge budget deficit as the


tax base shrinking. However the process of poor industrial
performance cascades from our basic conditions, market
structure, condunct performance paradigm.

5.2 I am certainly sure that it will become the first miracle in
the world if we put through soil into a grinding and we get
maize-meal as our output. In the same way, an upset of the
basic conditions under which industry performs results in
alterations to the existing market structure which in turn
affect the conduct of the firms and overall we get poor

5.3 All the problems that have been sited above as some of the
problems affecting the manufacturing sector in Zimbabwe
fall under the basic conditions as identified by Bain(1956)
in the seminal theory of Industrial economics-the
Structure-Conduct-Performance ­Paradigm.

5.4 The preceding sections of this volume have laid out the
building blocks of a strikingly different view of the
organization of firms and industries than is offered by
conventional economics. A coherent framework emerges
where the evolution of firms and industries over times is
shaped by the drive to innovate. At the heart of this new
framework is the process of change.


5.5 What emerges is a view of the organization of firms and
industries in motion, where new firms are started to
commercialize new ideas, many of those new firms fail,
fewer of them survive and prosper, and even fewer rise to

5.6 How does the role of public policy differ between the
more conventional view of industrial economics and the
evolutionary framework provided in this volume? Under
the traditional view, the role of public policy is to provide
a mechanism for reaping the gains yielded by large-scale
production while mitigating abuses associated with market
5.7 The policy debate in the literature has focused on antitrust
(competition policy in Europe), regulation, and public
ownership. What these three instruments have in common
is that they all constrain the freedom of firms to contract.
5.8 The role of public policy towards business is strikingly
different when viewed through the dynamic lens of this
evolutionary framework. Rather than focusing on
mechanisms to constrain firms, public policy is oriented
towards creating institutions and linkages that generate and
commercialize new knowledge. Thus, in the evolutionary


view the role of public policy is essentially enabling in
5.9 This very different view of public policy becomes clear in
the final section of the Volume, which is devoted to the
role of public policy. The first paper, by Wesley M. Cohen
and Steven Klepper, examines The Tradeoff between
Firm Size and Diversity in the Pursuit of Technological
Progress. Cohen and Klepper identify a potential role for
public policy in generating a diversity of approaches by
facilitating the startup of new firms.
5.10 They suggest that diversity or heterogeneity across firms is
an important force in generating innovative activity.
However, given the scale advantages associated with size,
industries will tend to have too little diversity without the
injection of diversity by new firms. Public policy can
make an important contribution in generating diversity by
promoting the startup of new firms. In Some Lessons
from the East Asian Miracle, Joseph Stiglitz explains how
public polices in East Asia contributed to rapid growth and

5.11 Stiglitz points out that public policy in most East Asian
countries had three essential goals -- developing
technological capabilities, promoting exports, and building


the domestic capacity to manufacture a range of
intermediate goods. He then argues that a set of policies
were implemented that rather than trying to replace
markets, as has been the case in the former Soviet Union,
public policy was instead oriented towards creating
markets where they did not exist and complementing
existing markets. In addition, there was targeted
investment in education and the production and
commercialization of knowledge.

5.12 The final paper is a summary of a series of studies
investigating the impact of national systems of innovation
on the dynamic performance of countries. In National
Innovation Systems: A Retrospective on a Study, Richard
R. Nelson describes how national policies help shape the
dynamic performance of countries.
5.13 There are three important lessons learned from Nelson`s
collection of studies that are instructive for the role that
public policy can play in guiding the processes of
The first is that the innovative capacity of a country
is shaped not by a narrow technology policy but
rather by a much broader range of institutions and


policies influencing a broad spectrum of the
The second is that the process by which firms and
industries evolve other time is strongly influenced by
that national system of innovation.
The third is that there is no singular superior national
system of innovation; rather each country tends to
develop a unique set of institutions that yield a
particular innovative advantage.
5.14 Taken together, these three articles included in this section
make a strong case not only that public policy can play an
important role in shaping the direction of economic
development, but that the appropriate role of public policy
is very different in an evolutionary context than in a static
one. These papers show that public policy

5.15 In light of the empirical approved role of public policy in
ensuring greater industrial performance, it is proposed
· The authorities take it upon their shoulders to create
an environment that promote the continued existence
of industry.

· Improve efficiency in transport services and utilities


· Improve link between SIRDC and industry to
translate research into commercial products

· Restore business confidence through policy

· Adopt tariff structure that supports import
substitution & value addition through enhancing
importation of technology

· Revamp the agricultural sector to ensure its feeding
role to the manufacturing sector is restored thus
promoting growth

· Establish a clear exchange rate policy that is fair for
all economic agents that are part to the transaction.

· Removal of price distortions

6.0 Conclusion
6.1 From the afore-analysis it has been ascertained that though
economic development takes a whole lot of achievements
ranging from health, leisure, low infant mortality rates and
equity among a battery of other requirements, economic
growth as measured by the real changes in Gross domestic
product remains an important indicator of the subject. In
that regard there is great need that Zimbabwean authorities


realize the role played by industrialization in achieving
economic growth.
The country has not much to show in the way of
contemporary industrialization, including agricultural
development. The attainment of food security has
remained elusive, because the country has not reached
adequate levels of agricultural productivity, nor made
significant investments in downstream processing or other
related agro-based industries.
6.2 The lack of industrial development results in high levels of
unemployment which have led to the brain drain of
varying magnitudes in different sectors of the economy. A
large number of universities have been established at great
national cost, but lack of industrialization makes it
impossible to offer to the high level of trained manpower
relevant employment opportunities to sustain or retain
them. University graduates, if trained in science and
technology (S&T) related disciplines and provided with
adequate incentives and facilities, could constitute the
national force for driving innovation.

6.3 The attainment of certain thresholds of scientific and
technological competence enhances the innovation


capability of a country to compete globally and to rank
among the leading global knowledge societies.
6.4 Successful modern day industrialization requires:
an environment that promotes and fosters innovation;
input resources, including scientific and technological
investment capital; and
narrowing the digital divide through acquisition of
information and communication technologies (ICTs).
6.5 For a country to pursue an effective strategy toward
industrialization, there is need to build consensus in policy
formulation process so that all the requirements for policy
implementation are identified and agreed upon by all
stakeholders. Setting realistic priority targets should
accompany the process.
6.6 It is important that all parties to the dialogue commit
themselves to upholding the policy guidelines agreed
upon. Relevant government departments should be
assigned specific roles to play in furthering policy
6.7 The policy framework should make appropriate provisions
to facilitate buy-in options for private sector stakeholders


and should include provisions for promoting and
sustaining technological innovations to raise agricultural
productivity and support downstream processing and other
related agro-industries as these will in turn give the big
push to industrialization-a pre-requisite for economic

6.8 It is also important to launch a national industrialization
drive which has to be under-girded by a strong innovation
policy framework. There may be an initial requirement for
a programme that facilitates capacity building in
technological competencies that will support the
absorption of imported technology to use under license or
after paying patents fees.

6.9 There may also be a need to promote the diffusion of
newly acquired/developed or adapted technology among
the relevant stakeholder constituencies. The economic
dividends accruing from such knowledge-based production
systems can bring about economic development in a
6.10 The current aggressive competition in global markets can
best be met by developing a strong national innovation
culture. Most products now have short life cycles on the


market and need to be constantly upgraded so as to
maintain their market appeal. The ability to constantly re-
engineer product lines by innovation increases the
prospects of scoring comparative market advantage.

6.11 A sustained innovation programme requires that R&D be
promoted and adequately funded. Such a measure will
sharpen the technical literacy of the country and more
specifically R&D professionals. Adequate remuneration
packages and other incentives would help to retain
national talent so that they can focus on generating
innovation products that can contribute to economic
6.12 The state should therefore provide an enabling
environment to allow R&D institutions and industry to
interact freely and creatively. A system of incentives,
including tax incentives, should be used to encourage the
involvement of the private sector in funding R&D work.
6.13 Universities, research institutions and entrepreneurs should
be encouraged and supported to access overseas training to
develop the expertise and technological capacity to meet
the national requirements for innovation. This goal can be
attained if the policy and priority instruments are
supported at the highest levels of government.


6.14 To ensure that the innovation system operates to facilitate
sustainable economic and industrial development, the
policy framework must ensure that there is a balance
between basic, applied and nationally targeted research.
National needs are best met if innovation stimulates
greater productivity and diversification of product lines.

Without industrialisation economic development shall
remain elusive.

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