Carlsson - On The Nature, Function and Composition of Technological Systems

--Journal of
J Evol Econ (1991) 1:93-118 Evolutionary

Economics
9 Springer-Verlag 1991
On the nature, function and composition

of technological systems
B. Carlsson i and R. Stankiewicz 2
1 Department of Economics, Case Western Reserve University, Cleveland, OH 44106, USA

2 Research Policy Institute, University of Lund, S-220 02 Lund, Sweden
Abstract. This paper suggests that the economic growth of countries reflects their
developmental potential which, in turn, is a function of the technological systems
in which various economic agents participate. The boundaries of technological
systems may or may not coincide with national borders and may vary from one
techno-industrial area to another. The central features of technological systems
are economic competence (the ability to develop and exploit new business oppor-
tunities), clustering of resources, and institutional infrastructure. A technological
system is defined as a dynamic network of agents interacting in a specific eco-
nomic/industrial area under a particular institutional infrastructure and involved
in the generation, diffusion, and utilization of technology. Technological systems
are defined in terms of knowledge/competence flows rather than flows of ordi-
nary goods and services. In the presence of an entrepreneur and sufficient critical
mass, such networks can be transformed into development blocks, i.e. synergistic
clusters of firms and technologies which give rise to new business opportunities.
Key words: Technology - Innovation systems - Development blocks - Networks

- Economic competence
I. Introduction
Since the work by Abramovitz and Solow in the 1950s and by Denison, Kendrick
and many others in the 1960s, it is commonly accepted that technological change
is a main determinant of economic growth. Yet, because of the difficulty of study-
ing technological change using neoclassical models which predominate in the
analysis of economic growth today and which treat technological change as an
exogenous factor, the causal connections between technological change and eco-
nomic growth are still poorly understood. A more dynamic approach in which the
technological base (broadly conceived) is better integrated as an endogenous
factor in the analysis is clearly needed.
94 B. Carlsson and R. Stankiewicz
A promising approach, rooted in the works of Schumpeter and building on the

contributions of the branch of economics known as evolutionary economics
(Nelson and Winter 1982; Hanusch 1988), is to start by focusing on the process
of technological and economic change at the micro level, including the role of the
entrepreneur. In some cases, "micro" may refer to firms or even units within firms,
whereas in other cases it is more appropriately understood as referring to clusters
of firms and technologies which Erik Dahm6n has called development blocks and
which will be more precisely defined below. Proceeding from such a micro base,
we contend that by studying the interdependence between micro units and the
linkages between micro units and entire sectors of the economy, economic growth
at the macroeconomic level can be better understood. In this view, the macro
economy is not simply the aggregate of various micro units but is regarded also
as a complex network of micro relationships. It is the nature and role of technol-
ogy as a base for industrial development and economic growth which is the
primary focus.
To illustrate, consider the case of Sweden. At least through the 1960s, the
industrial development of Sweden was determined largely by an abundance of
natural resources (forest raw materials, iron ore, and hydroelectric power) in
combination with a set of technical innovations (e.g. in the areas of ball bearings,
telephone equipment, and separators) which formed the base (often in the form
of development blocks) upon which the core of Swedish industry was established.
But is has become increasingly evident that the role of natural resources as a
source of economic growth is declining and that, as a result, present and future
industrial development depends primarily on other factors. Technical innovation
is likely to play an even more important role than heretofore. But because of the
increasing globalization and interrelatedness of world markets, innovative activ-
ity, too, tends to become more global. This means, on the one hand, that domestic
innovative activity may not confer the same competitive advantage on domestic
firms as it once did, and on the other, that no country needs to rely as heavily and
exclusively on its own domestic innovative activity as earlier.
This brings into focus the fact that not all economic agents, be they firms,
countries, or other entities, are equally adept at generating new ideas or absorbing
new ideas from outside. The ability to develop and exploit new business opportu-
nities is a central feature of what will be referred to here as economic competence;
this concept will be developed further below. Economic competence is a scarce
and unequally distributed resource whose quality and quantity is an important
determinant of the degree to which successful innovation will take place, thus
expanding the economic opportunity set. Together with the institutional and
organizational framework within which firms operate, it constitutes what we refer
to as the technological system. Institutionally, a technological system may be
described as a network of agents interacting in the economic/industrial area under
a particular institutional infrastructure and involved in the generation, diffusion,
and utilization of technology.
Thus, we take a systems view of technological change, meaning that neither
firms nor innovations, taken individually, can explain economic change. Instead,
they must be viewed as parts of a larger system; various agents interact with each
other, and institutions matter. As Francois Chesnais has pointed out,
while the competitiveness of firms will obviously reflect successful management practice by
entrepreneurs and corporate executives, it will also stem from the strength and efficiencyof a
national economy's productive structure, the corresponding long term trends in the rate and
Technological systems 95
structure of capital investment .... its technical infrastructure and other factors determining the
externalities on which firms can lean (Chesnais 1986).
Since the seminal contributions by Max Weber, the importance of social institu-
tions in economic development has been widely recognized. For example,
Christopher Freeman has recently emphasized the significance of social innova-
tions for both effective generation and economic exploitation of new technologies.
Summing up two centuries of technological and industrial rivalry he writes:
When Britain opened up a major technological gap in the first industrial revolution, this was
related not simply to an increase in invention and scientific activity, important though these
undoubtedly were, but to novel ways of organising production, investment and marketing and
novel ways of combining inventions with entrepreneurship. When Germany and the United
States overtook Britain in the late nineteenth and in the twentieth centuries, their success was
also related to major institutional changes in the national system of innovation, as well as to big
increases in the scale of professional research and inventive activities (Freeman 1987, p. 31).
The purpose of the present paper is to define the concept of "technological
systems," to study their constituent parts, and to suggest some questions and
hypotheses for further research. The more precise linkages between technological
systems and economic growth will be analyzed in subsequent research within the
project of which this paper represents a part. We have chosen an evolutionary
approach because of its ability to bring within a single conceptual framework the
institutional/organizational as well as the cognitive/cultural aspects of social and
economic change.
The paper is organized as follows. We begin by focusing in Section II on the
sources of economic change, namely variety-driven largely by innovation and
diffusion. Section III analyzes the nature and role of institutional and organiza-
tional factors (namely economic competence, "clustering" of resources, networks
and development blocks and their constituent parts, and the institutional infra-
structure) which define technological systems. In Section IV we conclude the
paper by suggesting some hypotheses regarding the structure and dynamics of
technological systems to be further investigated.
II. The sources of economic change
In conventional (production function-based) analyses of economic growth, in-

creases in output are due to either increased quantities of inputs or to a residual
which represents a collection of improved quality of inputs and increased efficien-
cy of their use. If the quality or composition of output changes, the analysis breaks
down, usually resulting in various ad hoc adjustments of the estimation proce-
dure. The longer the time period one is interested in, the less likely to hold are the
assumptions built into the production function. If one is interested in economic
change or transformation (i.e., qualitative aspects) and not just increase of a given
type of output ("growth"), one must look for the sources of qualitative change. In
the long run, the most impressive aspect of economic change is not the increase
in a particular type of output (say, output of any particular commodity) but rather
the number of entirely new products and the increased variety of goods and
services over time. Thus, innovation and diffusion of innovations, as well as
variety of goods and services, are fundamental sources of economic change.
1. The importance of variety and the relationship between variety and innovation
"The tendency to variation is a chief cause of progress; and the abler are the undertakers in any
trade the greater will this tendency be" (Marshall 1910, p. 355).
The idea that it is variety (operating under some selective mechanism such as a
market) that drives economic change and that technological innovation is the
chief long-run source of economic variety has been around for a long time but has
only recently been the subject of analysis by economists. As evidenced by the
above quotation, Marshall was aware of the importance of variety. He pointed
out that in the absence of variety, there will be a tendency to diminishing returns:
every economic agent will invest in his current business until no further invest-
ment is judged to be profitable (Marshall 1910, pp. 355-356). Schumpeter, in the
first German edition of the Theorie der wirtschaftlichen Entwicklung (1912), intro-
duced the notion of "new combinations" (new products or processes, new forms
of organization, the emergence of new suppliers or the opening up of new mar-
kets) as the dynamic elements which break the impass of the static economic
circular flow and constitute the heart of economic development. In the second
edition, published in 1926, he introduced the concept of "innovations" in refer-
ring to the new combinations (Heertje 1988, p. 75). The variety created by inno-
vations or new combinations opens up new opportunities.
For a number of reasons which will not be explored here, Schumpeter's
contribution lay largely dormant for several decades. As pointed out in a recent
paper by Metcalfe (1989), it was not until Alchian published a controversial paper
in 1951 that the economic significance of diversity of economic behavior began to
be explored systematically.
Alchian put forward the view that in a world of incomplete information and uncertain foresight
individual behavior is not predictable. Faced with changes in information, say a change in the
price of an input, individual firms will typically react in different ways and may not even react
in the same direction. None the less, Alchian argued, the effects of such changes can still be
predicted at the aggregate, industry, level, once it is recognized that the market mechanism is an
adoption mechanism selecting across different forms of behavior, and that realized profits are the
criterion which drives the selection process (Metcalfe 1989, p. 59).
The central argument in Alchian's analysis is that the focus of economic analysis
should be on the properties of distributions of economic behavior rather than on
the behavior of individuals, and on the presence of differential adaptation of
individual agents, not on individual adaptation. The technological differences
among firms resulting from such behavior drive the process of economic change
(Metcalfe 1989, pp. 59-66).
Other authors, notably Allen (1988), have emphasized diversity among firms
not simply in statistical terms (i.e., as distributions with particular means and
variances) but rather as a result of erratic or divergent behavior of individual
agents.
In an evolutionary landscape of hills and valleys representing levels of functional efficiencyof
different possible organisms, it is the error-maker who can move up a hill, eventually outcompet-
ing a perfectly reproducing rival. And this despite the fact that at each and every instant it would
be better not to make errors, since the majority of these are loss-making (Allen 1988, p. 107).
It is the success of such risk takers which expands the economic opportunity set.
Evolution is the result of two seemingly contradictory processes: the creation
of variety and its successive reduction through selection. Effective long-term
adaptation requires that these two processes be kept in balance.
Selective processes consist of chains of events over time. In the course of its
development, a technology is likely to pass through several different selective
environments; there is a progressive filtering mechanism in operation.
Techno-economic selection takes place in a socio-cultural environment. The
process typically involves interaction and communication among actors. Com-
plex systems rely on hierarchies of selection processes, i.e., they internalize the
variety creation and reduction, thus increasing the efficiency of their learning and
adaptive processes. The function of the market is essentially to create competitive
pressure rather than to test a wide variety of alternatives. The character and
structure of the selective mechanisms constitute important characteristics of tech-
nological systems affecting their innovative ability.
The ways in which markets are organized play an important role. The exten-
sion and scope of markets, their complexity and sophistication, the degree of
concentration, the relative importance of consumer as opposed to industrial mar-
kets, and the ways in which the capital markets function will affect the selective
processes to which technology is subjected. Markets may differ in levels of com-
petitive pressure, in the potential for development of generalized technical solu-
tions as opposed to particular ones, in the dimensions of development they em-
phasize, in the degree of preference for short-term vs. long-run investments, etc.
The nature of the pre-market mechanisms will determine which technical
options will be actually tested in the markets. By pre-market mechanisms we
mean those selective processes which operate chiefly within the firm. The implicit
and explicit technology and business strategies are expressions of these pre-mar-
ket mechanisms. They are the results of the experience accumulated within the
firm and also of the particular business culture which characterizes the economic
system.
In addition to market and pre-market selection mechanisms there is a variety
of non-market or quasi-market mechanisms, such as regulations, standards, and
public procurement policies.
In a recent paper, Arthur (1990) has pointed out that the selection process may
not always be fully "rational" or logical but guided instead by luck or chance. In
an economy functioning strictly according to conventional economic theory, non-
rational solutions are quickly weeded out; there is a strong negative feedback
(diminishing returns) at work which tends to give unique, predictable solutions
and hence ultimate stability. But Arthur suggests a different type of regime where
the selection mechanisms are not always logical and where there is positive feed-
back in the form of increasing returns:
Where positive feedbacks are present, there are usually several possible outcomes or time-paths
the economy can follow; which one the economy "selects" often depends on chance historical
events; there is no guarantee that the best outcome is "selected"; and once economic forces
"select" an outcome, the economy may be locked in to it. Positive feedbacks cause band-wagon
effects, so that if one product or firm or country gets ahead by "chance" it tends to stay ahead:
stability and predictability are no longer guaranteed (Arthur 1990, p. 1)
An example of positive feedback is the video-system market. Two rival systems
(VHS and Betamax) competed initially, with fluctuating market shares. For what-
ever reason ("luck", external circumstances, technical superiority, etc.), the VHS
system obtained a small market share lead. Because of increasing benefits to
market share increased prevalence ~f VHS encouraged video stores to stock
more film titles in VHS than in Betamax - VHS eventually came to dominate the
market (ibid).
The idea that diversity among micro units (e.g. firms) is necessary for stable
growth at the macro level is central also in Burton Klein's recent research (Klein
1977, 1984, 1988).
2. Innovation
There are several sources of diversity in economic life. Their main characteristic
is that they broaden the set of assumptions governing economic decisions. The
removal of barriers to communication opens up new possibilities. The merger of
firms with different technologies and corporate cultures may generate new ideas,
in addition to creating possibilities of exploiting economies of scale and scope.
The elimination of trade barriers which result in increased economic integration
opens up vast new opportunities. This happened in the United States when the
railroad and the telegraph made possible a national and not only local and
regional markets. It happened and is still happening in Europe as a result of the
formation and extension of the European Communities and now the opening up
of Eastern Europe. Migration of people with different skills and heritage can also
expand the opportunity set. But here we will focus on only one particular source
of diversity, namely innovation.
According to Dosi, "innovation concerns the search for, and the discovery,
experimentation, development, imitation, and adoption of new products, new
production processes and new organizational set-ups" (Dosi 1988, p. 222). He
lists five "stylized facts" about innovation:
(1) uncertainty (which is not simply the lack of all the relevant information about
the occurrence of known events but also the existence of techno-economic
problems whose solution procedures are unknown and the inability to predict
precisely the consequences of one's actions);
(2) increasing reliance of major new technological opportunities on advances in
scientific knowledge;
(3) increasing complexity of research and development activities which causes
such activities to be more formally organized rather than carried out by
individual innovators;
(4) increasing role of experimentation in the form of learning by doing and learn-
ing by using; and
(5) the cumulative character of innovative activity (Dosi 1988, pp. 222-223).
As a result of these characteristics, innovation tends to be an interactive process,
sometimes involving both users and producers (von Hippel 1988; Lundvall 1988;
Carlsson and Jacobsson 1990), sometimes involving cooperative efforts among
producers (see e.g. Fusfeld and Haklisch 1987; Link and Tassey 1989; von Hippel
1989), and sometimes organized more loosely in the form of networks (see below).
Clearly, innovative activity is heavily influenced by the organizational and insti-
tutional structures around it.
3. Diffusion
It is the function of invention and innovation to expand the opportunity set for
various economic agents. The impact of the new technology on the economic
system is determined by its diffusion. The characteristics of the diffusion process

have been explored by many people, but the historical comparisons by Paul
David of the diffusion of the computer and the dynamo (David 1989) and that of
the robot and the reaper (David 1985) are particularly illuminating. The charac-
teristics of the diffusion process which stand out in these comparisons of major
innovations reflect the "stylized facts" about innovation as noted above. There is
a significant element of uncertainty because of the existence of initially unsolved
technical and market problems and because of the unknown responses by various
agents. More than anything else, David stresses the protracted time periods re-
quired for substantial market penetration. These, in turn, reflect the historical
contingencies (or path dependency) of each innovation: technical, organizational,
and institutional interrelatedness.
For example, the introduction of the dynamo (electric motor) was dependent
on the transition from direct to alternating current as the standard for electricity
network construction (which in turn was dependent on technical innovations such
as rotary converters). It also depended on reducing the high rates for electric
power via better market organization; this was achieved via consolidation of the
electric power utilities and regulation of their activities on a regional basis. Fur-
ther, the diffusion of electric motors was facilitated by the achievement of scale
economies in manufacturing via standardization of system parameters (such as
AC cycle frequencies) and equipment specifications; this required an active effort
by the electrical equipment manufacturers.
On the user side, potential users encountered a number of difficulties which
had to be overcome: the (anticipated) risks of technical or economic obsolescence,
uncertainties about which particular designs would emerge as industry-wide stan-
dards, problems in arranging financing of novel capital assects, etc. In addition,
the durability (sunk cost) of already existing equipment based on mechanical
power derived from water and steam meant that it took several decades for it to
be phased out and resulted in retrofitting of existing plants; this typically entailed
adding primary electric motors to the existing stock of capital. The retrofitting
was difficult because of the prevailing plant layout and organization. It was
common to have groups of machines, or perhaps an entire plant, hooked onto a
system of belts and shafts driven by water or steam. This system entailed complex
gearing mechanisms and large power losses, both because of gearing and because
all the machines in the system were powered simultaneously, whether they were
in use or not. By contrast, the chief advantages of the electric motor were associ-
ated with "unit drive": one electric motor on each machine, thus avoiding such
power losses and offering built-in flexibility as to speed or rated capacity. But
these advantages were difficult to achieve without a complete re-organization of
the plant (David 1989, pp. 16-22).
This example illustrates many of the problems associated with the diffusion of
any major innovation and demonstrates the necessity of viewing the entire system
into which the innovation is introduced.
IIL Organizational and institutional factors
The foregoing analysis has stressed the importance of the context (economic
environment, historical circumstances, and organizational/institutional factors)
in which the factors causing economic change operate; this is inherent in the
systems view of technological change. We turn now to an examination of these

contextual factors, beginning within the firm and subsequently broadening the
analysis to larger systems.
1. Economic competence
Invention and innovation lead to economic change only to the extent that agents
within the system are successful in taking advantage of the opportunities to which
they give rise. This is where the notion of economic competence enters in.
In neoclassical theory, firms are generally assumed to have perfect knowledge
so as to be able to optimize their behavior. As pointed out by Pelikan (1988), once
it is recognized not only that firms do not have perfect knowledge but also that
they operate with different knowledge bases and under different assumptions
concerning technology, markets, etc., an entirely different theoretical framework
is called for, namely evolutionary theory. 1 Firms differ in the information they
have, in the extent to which they use the knowledge they have, and in how they
use it. They differ in the resources they devote to advancing their knowledge base
and the effectiveness with which they conduct research. They also differ in their
ability to learn from experience; organization and the quality of individuals
matter (Metcalfe 1989, pp. 79-80). Firms differ in their ability to perceive oppor-
tunities and in their willingness to take risks. When opportunistic risk taking
(whose outcome cannot be calculated beforehand) is successful, pressure is put on
other firms to take risks and to be dynamically flexible (able to make changes in
the production process and product mix not programmed beforehand) if they
hope to survive (Klein 1988, p. 96). This is the kind of competition that generates
new opportunities and hence long-term growth, whereas competition in a static
sense tends to reduce the number of options and thereby leads to static equilib-
rium.
What, then, are the factors that might lead to differential adaptiveness in
response to changed circumstances ?
The most obvious and well known answer resides in the phenomenon of bounded rationality.
Individuals do not face the same choice sets because information is not distributed equally to all,
and the capacity to translate information into knowledge differs between them. Differential
capacities to acquire costly information and differential creativity in the use of that information
are the twin pillars of variety in behavior. Extending this argument to organizations reinforces
it considerably. Firms are coalitions of thinking, information-processing individuals each with
their own life experiences and accumulated stock of knowledge. Through its communication and
decision-making structures the firm filters and combines the knowledge of its individual mem-
bers. Different organizational structures then provide a further basis for differential adaptation
to changing circumstances. The firms simply do not perceive the same choice sets: they know
different things about the world they share. At best their optimizations are local and hence
different (Metcalfe 1989, pp. 61-62).
1 For further elaboration on this point, as well as the notion of economic competence more
generally, see Pelikan (1988 and 1989). In particular, Pelikan has stressed the importance and
implications of economic competence as a scarce resource which is itself in need of efficient
allocation; it is therefore fundamental to the nature and functioning of the economic system and
cannot be taken for granted.
The economic competence of a firm may be defined, then, as the sum total of its
abilities to generate and take advantage of business opportunities. It includes the
firm's competence in all areas of its activity, whether defined by function (such as
R & D, engineering, production, marketing, service, and general administration),
product, or market; it certainly includes the ability to perceive new opportunities,
to read and interpret economic signals and adjust accordingly, to learn from
success as well as failure, to coordinate activities, to take the appropriate risks, and
to estimate correctly the limits of the competence of one's own firm and that of
other firms.
In a recent article, Prahalad and Hamel (1990) have elaborated on the "core
competence of the corporation" which they describe as
management's ability to consolidate corporate-wide technologies and production skills into
competenciesthat empowerindividualbusinessesto adapt quicklyto changingopportunities...
Core competenciesare the collectivelearningin the organization,especiallyhow to coordinate
diverse production skillsand integrate multiplestreams of technologies... [C]orecompetence...
is also about the organizationof work and the deliveryof value... Competenciesare the gluethat
binds existing businesses. They are also the engine for new business development.Patterns of
diversificationand marketentry may be guidedby them,not just by the attractivenessofmarkets.
(Prahalad and Hamel 1990, pp. 81-82).
Prahalad and Hamel give the following examples of core competencies: miniatur-
ization as a focus of business strategy at Sony; Honda's emphasis on engines and
power trains; and Canon's competence in optics, imaging, and microprocessor
controls - and their combination - which have enabled the company to obtain a
strong position in markets as seemingly diverse as copiers, laser printers, cameras,
and image scanners (ibid, pp. 82-83).
The concept of"core competencies" comes close to Gunnar Eliasson's notion
of"the firm as a competent team" (Eliasson 1988, 1990) which stresses experimen-
tation and organizational learning via the career paths of key personnel within the
organization. Eliasson (1989) has also emphasized the competence of the multina-
tional firm to "learn" in the international market by perceiving market opportu-
nities (by identifying, interpreting, and quickly acting upon market signals in
various parts of the world) and by constantly monitoring a wide variety of mar-
kets, competitors, and technologies.
It is important to note that in a dynamic (evolutionary) context, economic
competence refers not so much to the set of maximizing or optimizing skills
normally attributed to the firm in static theory as to the qualities which make for
good performance in the long run: to generate opportunities, not just react to
exogenous changes; to make educated guesses and take risks, to maintain flexibil-
ity, and to learn. This is why it is so difficult to define the content of economic
competence.
2. Clustering of resources
It is probably because of the need for interaction among agents with different
competence, background, foresight, etc., that successful innovation seems to
require some form of bunching together or clustering of resources. For example,
the formation of new technology-based firms appears to be heavily concentrated
both in terms of geographic areas (such as Route 128 in Massachusetts and Silicon
Valley in California) and in terms of technologies (e.g. computers, electronics, and
instrumentation) (Utterback 1989, pp. 10-14).
The clustering of a large number of firms in a particular area, whether it is semiconductors,

microcomputers or biotechnology, are claimed to create external economies of scale by providing
a large base of mobile highly skilled and creative people, by creating economies of suppliers of
silicon wafers, chemicals, or whatever is needed by the primary manufacturers, or simply by
generally stimulating efforts in research, technical creativity and communications (Utterback
1989, p. 16).
These observations are echoed in many studies of innovations. For example, Beije
has found that innovative Dutch companies operating in networks depend on
external information in all phases of the innovation process. He also noted the
interdisciplinary character of innovation, representing the integration of experi-
ence and knowledge from different fields (Beije 1989, p. 15).
In discussing the notion of national systems of innovation (to be defined
below), Freeman also stresses the importance of clusters of firms, innovations,
entrepreneurs, labor skills, and institutional changes. In his view, the industrial
revolution in Britain was attributable not only to an increase in invention and
scientific activity generally but to a cluster of innovations in the textile, iron, and
engineering industries, as well as to new ways of organizing production, invest-
ment, and marketing, and of combining invention with entrepreneurship (Free-
man 1988, p. 330).
What are the essential requirements to achieve the clustering needed for suc-
cessful interaction? Lundvall (1988) argues that geographical and cultural close-
ness facilitates effective interaction and suggests that national borders tend to
enclose networks of technological interaction: common government and heritage
(language, culture, education) facilitate communication within nations, while the
existence of certain obstacles to cross-national flows of labor impedes interna-
tional interaction. Lundvall points out that "[t]he flow of information can only
take place if there exist channels of information through which the message can
pass. Further, a code of i n formation is necessary in order to make the transmission
of messages effective" (p. 354). He also suggests that the nature of interaction
varies among technologies:
When the technology is standardized and reasonably stable, the information exchanged may be
translated into standard codes, and long-distance transmission of information can take place and
involve low costs. Here, user-producer relationships involving units located far away from each
other might be effective.
When the technology is complex and ever changing, a short distance might be important for
the competitiveness of both users and producers. Here, the information codes might be flexible
and complex, and a common cultural background might be important in order to establish tacit
codes of conduct and to facilitate the decoding of the complex message exchanged. The need for
a short distance will be reinforced when user needs are complex and ever changing.
When the technology changes rapidly and radically.., the need for proximity in terms of
geography and culture becomes even more important (Lundvall 1988, p. 355).
This argument is remarkably similar to that put forward by Langlois (1989) in
regard to the degree of vertical integration of activities within firms. Whereas
Stigler (1951) has suggested that the degree of vertical integration is determined
by "the extent of the market" - i.e., vertical disintegration occurs in rapidly
growing markets and integration in contracting markets - Langlois argues that
the degree of vertical integration is determined by the rate of technological pro-
gress, not the rate of growth of the market. When the density of information is
great, when the function and the market of the product are yet ill defined, and
when the degree of standardization of components and parts is low, firms have
to rely on in-house supply. As the product and its production process become
better defined and more standardized, external suppliers emerge and the original
firm can specialize on whatever aspect of the product or process it deems most
strategic.
3. Networks
The fundamental uncertainty involved in innovation leads to a process of search,

experimentation, and satisficing behavior - in short, a learning process. The
information requirements are often unpredictable or unknown, and furthermore
it may not be known whether the required information exists at all. Cooperation
with others may therefore be necessary - but how should it be organized?
The more complex the task, the more one may be forced to rely on the
expertise (competence) of others. The greater the element of uncertainty, the
greater must be the amount of trust between the partners. Integration within
the same firm or hierarchy has the advantage of hierarchical control - but
the question that arises is whether the organization has the required competence,
and whether the requirements are well enough known in advance to judge
whether that is the case. There must be room for both positive and negative
serendipity (unexpected discoveries) thus, the organization surrounding the
search for information has to be flexible. This is where the notion of networks
enters in.
Networks are an intermediate form of organization between hierarchies (in-
ternal organization within entities such as firms) and markets. Their essential
function is the exchange of information. Other resources may be transferred as
well, but the more commodity-like the physical resources being transferred are,
the more efficient is the market mechanism. When the important resource transfer
involves complex information (or know-how), the market does not function well,
and other arrangements have to be made. Sometimes these arrangements involve
in-house activities, e.g. when the information needs are too ill-defined and too
difficult to communicate. But when the information needs become very diverse,
it may be too risky and costly to try to satisfy them in-house. That is when
networks become important. To put it differently, high transaction costs induce
vertical integration in hierarchies, but the need to integrate is counterbalanced by
the need for specialized inputs which can only be obtained from specialists.
Networks make it possible to combine the advantages of vertical integration with
those of specialization.
Networks are often informal rather than formal. Their boundaries may be
difficult to define because various actors will draw different boundaries a a result
of different perspectives, intentions, and interpretations (H~kansson and Johan-
son 1988, p. 370).
Gelsing (1989) identifies four types of industrial networks: (1) user-supplier
relations; (2) the production chain or line of value added (vertical chain);
(3) production complexes (fili6res); and (4) knowledge networks. The difference
between "production complexes" and "knowledge networks" is that the former
focus on the exchange of material resources, whereas the latter focus on informa-
tion and knowledge. Some of the information transferred within knowledge net-
works may be marketed information in the form of staff training programs,
market analyses, technical advice, and tangible goods. However, much of the
information is transferred via informal exchange of ideas among technicians on
unstandardized technical problems, a m o n g purchasing personnel on suppliers of

special components, etc. (Gelsing 1989, pp. 116-120).
Eric von Hippel (1990) has suggested that "stickiness" of information affects
the locus of innovation and problem-solving. He refers to stickiness as
the cost of replicating and transferring data (information, knowledge) independent of the reasons
for such costs, with stickiness being a variable. At one end of the scale are data with zero
stickiness that can be replicated and diffused at a zero cost. At the other end are data that are
so sticky that they cannot be replicated or diffused at any price (von Hippel 1990, pp. 1-2).
D a t a m a y be sticky for a variety of reasons. They may involve proprietary infor-
mation (e.g. trade secrets) which the data possessor is unwilling to divulge. O r they
m a y represent "tacit" knowledge in the form of data encoded or embodied in a
person, organization, or object. Other possibilities are that they may be indexed
in a form difficult to transfer, and that data transmitters and receivers are not
compatible (von Hippel, p. 3). Von Hippel's hypothesis is that
if data needed by a problem-solver are sticky, related problem-solving activity must move to and
among loci of sticky data perhaps repeatedly as problem-solving proceeds. The shirtings in the
locus of problem-solving.., can also affect the locus of innovation, since problem-solving is a
major component of the innovation process (von Hippel, p. 2).
A form of inter-firm cooperation which has m a n y network-like features is the
so-called Keiretsu or business group system in Japan. This is the type of cooper-
ation described by Freeman (1987) in his analysis of what he calls the Japanese
system of innovation. A m o n g the main features of the Keiretsu system are consid-
erable mutual (interlocking) stock ownership, a large bank operating at the center
of the group (providing short and long term loans to m e m b e r firms and often
involved in selecting directors), and a general trading c o m p a n y at the core of the
group engaged in information exchange between buyers and sellers (Imai 1989,
p. 135). The main functions of these groups are to facilitate exchange of informa-
tion, hence reducing uncertainty; coordination of investment decisions, thus re-
ducing risk; and rapid diffusion of new technologies via the linkages between the
business enterprises (Imai 1989, pp. 137-138).
However, beginning with the oil crisis in 1973-1974, these business groups in
Japan began to change. The linkages a m o n g the firms in the business groups
became looser and less formal as information needs rather than stock ownership
became the primary determinant. Thus emerged what Imai calls "network indus-
trial organization."
What is a network ? ... [I]t is a certain form of multi-faceted interorganizational relationship
through which new information is generated.
It is our contention that the crucial strategic consideration for the modern-day firm is not
choosing the 'best' hierarchical organizational form within the fixed boundary of the firm or
choosing the 'best' mixture of internal production/outside purchase. Instead, the crucial consid-
eration must be to build a social and economic context conducive to spontaneous and varied
interactions of people inside and outside the firm. The boundary separating the interior and
exterior of what we term the network-type organization is not constant but is formed and
continuously updated as a result of interactions.
The key to this concept is the generation of new information rather than the execution of
predetermined tasks in an efficient manner. The network is a process in which new information
is generated, and from the new information so generated new relationships and linkages emerge
which, in turn, redefine the network. The essence of the network is this dynamic property rather
than its property as a unit in static analysis (Imai 1989, pp. 124-125).
4. Development blocks
This dynamic concept of networks is closely related to D a h m 6 n ' s notion of

'development blocks'. While Imai focuses on creation of information and cooper-
ation of various entities, D a h m 6 n stresses the disequilibrium nature o f economic
development, resulting in continually changing relationships a m o n g economic
agents. He defines development block as "a sequence of complementarities which
by way of a series of structural tensions, i.e., disequilibria, m a y result in a bal-
anced situation" (Dahm6n 1989, p. 111). Dosi uses the term "untraded interde-
pendencies" a m o n g sectors, technologies, and firms which take "the form of
technological complementarities, 'synergies', and flow of stimuli and constraints
which do not entirely correspond to c o m m o d i t y flows" but go far beyond inputs
and outputs exchanged in markets (Dosi 1988, p. 226).
Dahm6n illustrates the disequilibrium nature of development blocks in the
following plant analogy:
After a primary underground stage, creating a growth potential, a plant starts growing above the
ground whereas for the time being nothing happens below the soil. After a time this leads to an
unbalanced situation which stops the growth but makes the root system enter a secondary stage
of development. This, in turn, results in a new lack of balance between growth potentials and
actual growth. This sets off a renewed growth of the plant. Such a biological 'development block'
ends up in a stable balance when the plant is capable of shedding new seeds (Dahm6n 1989,
p. 111).
The analogy implies that at the core of a development block is a basic technology
which m a y be referred to as a technological paradigm or "core technology". In
complex development blocks, the core m a y be a cluster of technologies, each of
which follows a particular trajectory. 2
It is precisely the sequence of disequilibria which gives the development block
its dynamic force. It generates tension within the system, varying in strength and
composition over time; it is this tension which creates the development potential.
When that development potential has been fully exhausted - e.g. when the under-
lying technological trajectory has reached maturity (making it difficult for firms
to differentiate themselves further technologically), when the technological
paradigm is superseded by a new paradigm, or when the market potential has
been fully exploited - the dynamic force of the development block expires.
4.1. The necessity o f the entrepreneur
In order for a development block to come into being, there must be not only an
embryo (core) but also a fertile environment, as well as something or someone to
2 Dosi defines "technological paradigm" as follows: "a technological paradigm can be defined
as a 'pattern' for solution of selected techno-economic problems based on highly selected
principles derived from the natural sciences. A technological paradigm is both a set of exemplars
basic artifacts which are to be developed and improved ... and a set of heuristics - 'Where do
we go from here?', 'Where should we search?' 'On what sort of knowledge should we draw?'
etc... Putting it another way, technological paradigms define the technological opportunities for
further innovations and some basic procedures on how to exploit them. Thus they also channel
the efforts in certain directions rather than others: a technological trajectory ... is the activity of
technological progress along the economic and technological trade-offs defined by a paradigm"
(Dosi 1988, pp. 224-225).
get the process started. In the economic realm, the existence or at least the
possibility of the core has to be perceived and the potential for growth (i.e., an ex
ante development block) must be identified. That is the role of the entrepreneur,
G. L. S. Shackle put it this way:
All perception is no doubt an act of interpretation, of finding in, or injecting into sense-impres-
sions a meaning, the collating with them of numberless memories of experience, the seeing in
them of possibilities. This is in its own degree an act of origination. This same activity of thought,
but at an enormously enriched, intensified and out-ranging degree, is what marks the creative
writer, composer or theoretician, and it is what marks the entrepreneur (Shackle, quoted in
H6bert and Link 1989, p. 39)
Thus, the role of the entrepreneur is to provide the spark or the vision that turns
a network into a development block. He must be able to see beyond that which
currently exists to what is possible in the future. He has to perceive the (future)
need, identify the necessary ingredients, secure the resources that may be missing
initially, and communicate his vision to the relevant agents - capitalists, suppliers
of raw materials, people with the required skills, etc. Sometimes this bringing
together of resources and needs can take place in spite of great distances or other
barriers - as witnessed for example in the role of English and Scottish merchant
houses and their Swedish correspondents in converting Swedish subsistence agri-
culture into a thriving export business within a few years in the early 1850s
(Carlsson 1980) - but the chances of success are, of course, much greater if the
network that has to be brought together or activated is much denser. In some
cases, e.g. when the technology is complex and when there are many missing
elements in the required resource set, the entrepreneur or " c h a m p i o n " needs to
command large influence and/or financial resources, such as the U.S. Department
of Defense, Japan's MITI, or a major business firm (first echelon firm or "lead
user"). In other cases, when large parts of the required network are already in
place, the champion needs to muster much more modest resources. It is also
conceivable that in some instances it may not be possible to identify the develop-
ment block until it is already in existence (i.e., ex post).
The role of the U.S. Department of Defense in the development of computers,
numerically controlled machine tools, the atomic bomb, military aircraft, space
vehicles, etc., is well known and well documented. The role of MITI in the
postwar development of Japan is much less understood and subject to much more
varied interpretations. But in our reading of the evidence, the following features
stand out: Vogel (1980) stresses the informal, network-like, aspects of contacts
between MITI and various Japanese business firms, rather than formal, hierarchi-
cal linkages. Allen (1981) emphasizes the dynamic approach advocated by MITI:
"Their policies were designed to furnish the drive and to raise the finance for an
economy that might be created rather than simply to make the best use of the
resources it then possessed" (quoted by Freeman 1988, p. 331). Freeman rein-
forces this view: "The not-so-invisible guiding hand of MITI shaped the long-
term pattern of structural change in the Japanese economy and this influence
was largely exerted on the basis of judgements about the future direction of
technical change and the relative importance of various technologies" (ibid,
p. 331). Furthermore,
[i]n this context the organizing and energizing role of the Japanese forecasting system is impor-
tant. The 'Visions' of the future produced by STA, MITI, NIRA and other government and
private sources do not pretend to be accurate predictions, nor do they commit companies to
inflexible plans. They chart the broad direction of advance for the economy and for technology
and give companies sufficientconfidence in this vision to make their own long-term investments
in research, development, software, equipment and training. In this respect technological fore-
casting plays a role similar to that of project evaluation in sophisticated research-intensive
companies. Nobody believes that it is possible to eliminate uncertainty, but a thorough discus-
sion serves to mobilize resources, to expose difficulties,and bottlenecks, and above all to energize
the participants, secure consensus and heighten awareness (Freeman 1988, p. 344).
As indicated already, a certain disequilibrium (i.e., unexploited development po-
tential) is inherent in any development block or else it ceases to have dynamic
force. But the process also requires a certain kind of balance or coherence. Suc-
cessful firms seem to be characterized by a balanced product portfolio as a basis
for sustained success: firms which attempt to innovate in several unrelated areas
or which are constantly leaping toward new technologies, or unknown markets,
or both, are much less likely to succeed and grow than those which build carefully
around their core strengths and early successes. Absence of or weakness in one or
two elements might not completely inhibit the growth of new firms, but strength
and balance across the entire complex of stimulating factors enhance chances for
success (Utterback 1989, p. 7).
It is interesting to note in this context that the "back to basics" strategy
observed among leading Swedish industrial firms a decade ago (Carlsson et al.
1979) seems to be pursued currently in the United States and in many other
industrial countries as well (Carlsson 1989). The primary impact of the current
wave of mergers and acquisitions in the U.S. seems to be a downsizing and
specialization of firms. Firms seem to shed businesses outside their core areas and
acquire others within, or closely related to, the core. This also suggests an interpre-
tation of the recent finding that firms in the United States, Europe, and Japan tend
to strive for a broadening of their technology base: they may try to do so primarily
in their core businesses (based on their core competencies - see above) (Gran-
strand et al. 1990).
4.2. The requirement of critical mass
Besides the entrepreneur, another prerequisite of a development block is a favor-

able environment. An important aspect of the environment is a certain density
("critical mass") of the resources which have to be pulled together and organized
in the development block. The density may refer to people and ideas as well as
physical resources and infrastructure. This is related to the clustering of resources
noted earlier. Utterback notes that a large number of entries and exits seems to
be necessary in order for a concentration of growing companies to occur in an
industry or region such as those observed in Massachusetts of Silicon Valley
(Utterback 1989, p. 14). Given the trial and error nature of the innovation process
and the characteristics of innovation noted earlier (uncertainty, science base,
complexity, experimental and cumulative character), the risk of failure of individ-
ual ventures is great. Unless there are numerous similar experiments going on, the
results may be too meager to stimulate economic development in any one technol-
ogy area, and unless there is a sufficient number o f attempts in a variety of areas,
economic development may stagnate (see further Pelikan 1988).
Here again the Japanese experience offers interesting insights. The "macro-
entrepreneurial" role of MITI in organizing clusters of firms and technologies into
development blocks has already been mentioned. The role of "network industrial
organization" in Japan as a way to mobilize resources and generate new informa-

tion within clusters of firms can be illustrated in the following way:
The Japanese system seems particularly well adapted to take advantage of the enormous poten-
tial of information technology for several reasons:
(1) the systems approach to process and product design;
(2) the flexibility of the industrial structure;
(3) the capacity to identify crucial areas of future technological advance at national and enterprise
level;
(4) the capacity to mobilize very large resources in technology and capital in pursuit of strategic
priorities;
(5) the horizontal flow of information within and between firms (Freeman 1988, p. 334).
At the level of the individual firm, "reverse engineering" seems to have played an
important role in the industrial development of Japan, not only as a system
designed for quick acquisition, adoption, adaption and diffusion of new technol-
ogy but also as a way to organize clusters of expertise. The reverse engineering
scheme seems to have reinforced the relatively close integration of various func-
tions of the firm (technology, production, marketing, finance, and management)
which is characteristic of many leading Japanese firms and which is achieved
through job rotation in combination with life-long employment within the same
firm. The resulting system has provided a hospitable environment for new tech-
nology and has increased the probability of creating a fertile in-house environ-
ment for development of genuinely new technology. Freeman notes that when the
Japanese are drawing ahead today in important new technologies, they do so not
simply or even mainly due to the scale of their R & D but due to social and
institutional changes (Freeman 1988, p. 330).
The combination of a high level of general education and scientific culture with thorough
practical training and frequent up-dating in industry is the basis for flexibility and adaptability
in the work-force and high-quality standards. The Japanese system of industrial training is
distinguished further by its close integration with product and process innovation. The aim is to
acquaint those affected by technical change with the problems that are likely to arise, and give
them some understanding of the relationship between various operations of the firm. This again
greatly facilitates the horizontal flow of information. Thus the 'systems' approach is inculcated
at all levels of the work-force and not only at top management level (Freeman 1988, p. 340).
The work by Utterback and colleagues on the formation of technology-based
firms in Sweden largely confirms these observations on Japan. They found that it
was not primarily government programs designed to help new firms which were
the most important factors in their success. Instead, they found that other environ-
mental factors played a much larger role: support for education and research, and
general community standards, particularly in health, social benefits, and the envi-
ronment (Utterback 1989, p. 7). At the firm and industry level, they found that
large firms in Sweden play a highly creative role in providing technology, people,
finance, and especially early markets for new firms, and that networking of coun-
seling of entrepreneurs by senior and more experienced managers in large firms
who have had parallel experiences provided important assistance to new technol-
ogy-based firms (Utterback, pp. 19-20).
But Utterback also notes the danger inherent in the increasing role played by
large firms in the Swedish economy - at a time when the largest firms tend to be
shrinking in other countries (see Carlsson 1989):
The most clearly negative factor that the researchers discovered.., is the degree to which the
positive motivation of people in Sweden to take risks in creating new manufacturing firms and
to make them grow to significant size appears to be declining... In sum, it appears that the
Swedish economy is becoming increasingly reliant on fewerand larger enterprises as the source
of its continuing creativity and competitive potential in international markets and at home
(Utterback 1989, p. 17).
5. Institutional infrastructure
Institutions are the normative structures which promote stable patterns of social
interactions/transactions necessary for the performance of vital societal func-
tions. Institutions reduce social uncertainty and prevent or mitigate conflicts
between different value systems. They do so by structuring or segmenting various
spheres of activity and subjecting them to specific regimes (Burns and Flam 1987).
These regimes may be formal and embodied in legislation or informal and im-
plicit. In either case they must be supported by effective social sanctions. Crucial
for the survival and effectiveness of institutions is their legitimacy.
By the institutional infrastructure of a technological system we mean a set of
institutional arrangements (both regimes and organizations) which, directly or
indirectly, support, stimulate and regulate the process of innovation and diffusion
of technology. The range of institutions involved is very wide. The political
system, educational system (including universities), patent legislation, institutions
regulating labor relations are among many arrangements which can influence the
generation, development, transfer, and utilization of technologies. It is conve-
nient to discuss this infrastructure under two main headings: (i) the basic econom-
ic institutions and the role of government; and (ii) the system of production and
distribution of knowledge (the R & D system).
5.1. The basic economic institutions and the role of government
As pointed out earlier, the effective technological change presupposes a balance

between the mechanisms which create variety in the techno-economic systems and
those which bring about selection of successful variants and assure the necessary
degree of system integration and stability. When this balance obtains, the socio-
economic system exhibits a high degree of adaptability and dynamic efficiency.
However, this happy state of affairs is constantly threatened by certain tendencies
inherent in the economic and social systems. Among the more important mecha-
nisms leading to the loss of evolutionary adaptiveness in the capitalist market
economies are: (i) the transition from dynamic to static efficiency in maturing
industries (Klein 1977; Abernathy and Utterback 1978); (ii) rigidities in invest-
ment patterns over long periods of time (Schumpeter 1939; Mensch 1975); (iii)
limitations on competition due to monopolistic tendencies, protectionism, etc.
and (iv) the general ossification of the institutional structure due to the growth of
entrenched vested interests (Olson ! 982). The resulting loss of dynamic efficiency
affects all aspects of the economic life but is perhaps most damaging to en-
trepreneurship and innovation.
The fluidity and adaptability of the economic system can be re-established
"spontaneously" through crises, economic or political. However, they can also be
maintained and strengthened by appropriate institutional design and policy. In-
deed, the sustained technological adaptiveness of an economy is very much a
function of its basic institutions, i.e. those regulating property rights, fundamen-
tal features of market organization, capital supply, collective bargaining, indus-

trial and corporate organization, etc. For obvious reasons it is not possible here
to spell out all the complex relationships linking these institutional factors to the
process of technological and economic change. We will therefore limit ourselves
to briefly mentioning a few which appear particularly significant.
Starting with the "supply side" of the evolutionary model we can identify a
number of features of the institutional system which contribute to the creation of
technological variety, i.e. the pool of technological opportunities. The societal
arrangements for the creation and distribution of knowledge are of crucial impor-
tance in this context - they will be discussed in greater detail in a later part of this
section. Here we shall focus on another key aspects of technological change - the
uncertainty and risk inherent in the innovative processes.
The technological and entrepreneurial variety on the aggregate or macro level
is the principal means of coping with uncertainty in an evolutionary economy. On
the micro-level, however, the uncertainty translates into risks which have to be
borne by the individual actors/entrepreneurs. It was shown by Arrow (1962) that
to the extent such risks cannot be effectively absorbed by the actors, the realized
level of innovative activities may be lower than socially desirable. It is therefore
necessary to create mechanisms which absorb and diffuse some part of the risks
incurred by individual actors. These mechanisms can operate at the level of
corporate organization, or on a more aggregate social level. Among the latter, the
following institutional arrangements are particularly important: (i) the nature and
mode of operation of capital markets; (ii) the fiscal policies (including taxation);
(iii) the public procurement policies; (iv) the direct subsidy and insurance schemes
sponsored by government designed to encourage the entrepreneurial activity; and
finally (v) the production and distribution of relevant economic and technological
information.
On the "demand side" of the evolutionary model one should mention a whole
range of policies and institutions which aim at the creation and preservation of
efficient selection mechanisms. Among the most important ones are (i) the legis-
lation and rules regarding markets and competition, especially the antitrust legisla-
tion; related to them (ii) the legal and institutional arrangements which regulate
the conditions of entry of new firms into established industries and finally (iii) the
complex set of arrangements which regulate the access to markets and foreign
trade.
It is one of the key functions of government to establish and maintain the
institutional arrangements conducive to dynamic efficiency of the economy. Dif-
ferent countries use different mixes of institutional arrangements and policies.
Indeed, during the postwar period we have witnessed several waves of institu-
tional experiments and innovations in the industrial countries aiming at improv-
ing their technological and industrial strength and competitiveness.
5.2. Production and distribution of knowledge
The effective organization of production and distribution of knowledge and

competence is by far the most intricate institutional issue related to the promotion
of technological change. It arises out of certain fundamental features of knowl-
edge.
The generic character of much of R & D leads to major externalities in the

production of knowledge. This implies that private investment in R & D is likely
to be suboptimal and justifies public support of basic R & D (Nelson 1959). The
limited appropriability of knowledge has to do with the inherently leaky character
of information, its intangibility and person-boundedness, the presence of multiple
competing sources of knowledge, and the peculiarities o f knowledge transactions.
The latter include the competence asymmetry between the producers and users of
knowledge, posing the problem of quality control, the high assimilation costs of
information, the requirements that knowledge be disclosed before it is sold, etc.
The failure to effectively appropriate knowledge diminishes the incentives to
create it in the first place. The inefficiency of knowledge transactions affects
negatively both the production and diffusion of new knowledge.
The complexities of setting up an institutional system which can reconcile the
contradictory features of the knowledge production and distribution process have
been characterized by Nelson as follows:
One can see the task of institutional design as somehow to get the best of both worlds. Establish
and preserve property rights, at least to some degree, where profit incentives are effective in
stimulating action, and where the costs of keeping knowledge private are not high. Share
knowledge where it is of high cost not to do so, and the costs in terms of diminishing returns are
not too small. Do the work cooperatively, or fund it publically, and make public those aspects
of technology where the advantages of open access are the greatest, or where proprietary claims
are most difficult to police (Nelson 1988, p. 315).
6. Technological systems
We are now ready to state more explicitly what we mean by "technological

system". A technological system may be defined as a network of agents interacting
in a specific economic/industrial area under a particular institutional infrastructure
or set o f infrastructures and involved in the generation, diffusion, and utilization
of technology. Technological systems are defined in terms of knowledge/compe-
tence flows rather than flows of ordinary goods and services. They consist of
dynamic knowledge and competence networks. In the presence of an entrepreneur
and sufficient critical mass, such networks can be transformed into development
blocks, i.e. synergistic clusters of firms and technologies within an industry or a
group o f industries.
Thus, technological systems are multi-dimensional. In most cases the constit-
uent elements (knowledge/competence networks, industrial networks/develop-
ment blocks, and institutional infrastructure) are spacially correlated. The na-
tion-state constitutes a natural boundary o f many technological systems. Some-
times, however, it may make more sense to talk about a regional or local techno-
logical system than about a national one: Route 128 and Silicon Valley are
regional, not national systems. In yet other cases the technological systems are
international, even global. Where the boundaries are drawn depends on the
circumstances, e.g. the technological and market requirements, the capabilities of
various agents, the degree of interdependence among agents, etc.
When their boundary is defined in terms of the national institutional infra-
structure, the technological systems, as defined here, have much in c o m m o n with
the concept o f "National Systems o f Innovation" as defined by Freeman (1988)
and Nelson (1989). Nelson deals primarily with the composition and characteris-
tics of the national system of industrial research and development, emphasizing

institutional factors such as property rights through which firms appropriate
returns to their investments in innovation and the set of institutions and govern-
ment policies influencing industrial R & D, particularly the role of universities.
Freeman's analysis of the Japanese system of innovation focuses on three main
elements: (1) the role of central government, especially MITI; (2)technology
sharing among firms in Japan, especially within clusters of firms in the Keiretsu
system; and (3) the role of social and educational innovations (Freeman 1988).
Our concept of technological system differs from "National Systems of Inno-
vation" primarily in three ways. First, whereas the former refer to specific techno-
industrial areas, the latter refer to the national system in all areas as a whole.
Secondly, the boundaries of technological systems do not necessarily coincide
with national boundaries. They may well be different from one techno-industrial
area to the next. Thirdly, by making more explicit and putting greater emphasis
on microeconomic aspects, particularly (a) the role of economic competence and
(b) knowledge networks and development blocks, rather than on institutional
infrastructure, we bring into focus the problem of adoption and utilization of
technology as contrasted with that of generating and distributing knowledge. If
economic competence is a scarce and unequally distributed resource (as we believe
it is), creating more knowledge within a nation or region may or may not result
in improved economic performance.
IV. Concluding remarks and hypotheses for further research
This definition of technological systems opens up a whole new set of questions for
empirical investigation. Among these questions are the following: (a) What are, in
fact, the boundaries of technological systems, and how are they determined ? How
and why do they differ among techno-industrial areas? (b) What are the most
pertinent aspects of institutional infrastructure in each techno-industrial area?
(c) Who are the important actors? (d) What is the role of the nation/state in the
context of technological systems whose boundaries may be either more narrowly
(e.g. regional) or more broadly (international) defined than those of the nation?
It is possible, based on the work already carried out within the research project
on "Sweden's Technological System and Future Development Potential," to for-
mulate some hypotheses, or at least conjectures, with regard to the questions just
posed. 3 The emergence and evolution of technological systems is a function of
many factors. At present, two groups of such factors appear particularly impor-
tant: (i) the changing character of technology (cf. Section 11.2 above) and (ii) inter-
national economic integration.
It seems quite clear that the relative importance of generic, articulated knowl-
edge is increasing, particularly in the most dynamic areas of technology. There are
several reasons for this. The most important seem to be the increasing complexity
and growing "scientification" of technology which manifests itself with particular
3 The study is a multi-year project involvingeconomists, engineers, and sociologists at Chalmers

University of Technology, the Industrial Institute for Economic and Social Research (IUI),
and the Research Policy Institute (RPI) at the University of Lund, under the direction of Bo
Carlsson, Case Western Reserve University.
Technologicalsystems 113
clarity in the science-derived basic technologies in electronics, materials technolo-

gies, and biotechnology. This phenomenon has a number of important conse-
quences (Stankiewicz 1990):
I. It accelerates the pace of development by making the heuristic of technical
R & D more efficient and effective.
2. It allows the physical insights underlying a new technology to be general-
ized, thus enhancing its generic character.
3. It increases the level of articulation and thus transferability of technical
knowledge. And, last but not least:
4. It enhances the fusibility of technologies, i.e. the ease with which they can
be integrated into complex systems.
Among the results of these developments are: (i) increasing instability of tech-
nological paradigms, (ii) increasing complexity of technologies, and, at the same
time, (iii) increasing technological commonalities between hitherto unrelated
spheres of techno-economic activity (Stankiewicz, ibid.). Expressed in the termi-
nology of evolutionary economic theory, the above trends contribute to increas-
ing the technological variety by both enriching the technological "gene-pool" and
by facilitating the recombination of the elements of the pool.
The decreasing segmentation of the technological knowledge-pool due to the
cognitive developments has important counterparts at the institutional and orga-
nizational level. The professionalization and academization of technology is both
a result of and an active promoter of the growth of generic technical knowledge.
It also enhances international communication and homogenization of educa-
tional practices. It calls for and facilitates international standardization. In addi-
tion, the diminishing language and cultural barriers, together with improved
means of communication, play a significant role in the process of cultural integra-
tion of technologies.
These trends in technology coincide with and reinforce the process of interna-
tionalization in the global economy. The emergence of global markets and in-
creasing importance of multinational firms are consequences of this trend. We are
now witnessing the logical conclusion of this process: the beginnings of an inter-
national R & D infrastructure.
Increasing complexity and "scientification" of technology influence not only
the boundaries and composition of technological systems. Along with the other
"stylized facts" about innovation (uncertainty, increasing role of experimentation,
and cumulative character of innovative activity), they are also major determinants
of the interaction or dynamics among the various agents within the technological
systems. The dynamics are essentially a function of the level and content of
economic competence on the part of various agents within the system. Despite
increasing "scientification" (creation of generic knowledge) and internationaliza-
tion, one can easily observe that the ability to take advantage of new technology
varies considerably. It is constrained by the economic competence of the agents.
In the absence of such competence, no agglomeration of resources will be success-
ful. Nor can economic competence be acquired instantly; it is cumulative in
character, often tacit, and must be acquired through a process of learning and
experimentation which inevitably takes time.
What are the consequences of these broad trends for the structure and dynam-
ics of technological systems and their role in the economy ? To answer this ques-
tion we need to consider at least the following points:

1. the changing characteristics of "development blocks"
2. the changing relationships between industrial networks and the institutional
infrastructure; and
3. the changing role of the state in the process of technological change.
Development blocks have been and continue to be diverse in character. However,
one might venture the following hypothesis about the historical evolution of the
blocks: The old style blocks tended to be based primarily on the access to (a) raw
materials; (b) the technology to process the materials and (c) a dynamic local
market. The presence of these three elements tended to foster latent synergies
which could be exploited by introduction of certain technical innovations. Cur-
rently, the major new development blocks seem to have been increasingly based
on (a) access to new basic technologies; (b) integrative systems competence and (c)
access to international markets.
The need to access new basic technologies places novel demands on the R & D
systems. Given the increased complexity of technology, there is a growing depen-
dence of companies on their environment in terms of both infrastructure and
industrial networking. The infrastructure itself must now function as an interface
facilitating access to the international technology pool. This interfacing functions
rather than mere internal knowledge production and distribution become critical
factors even in the large countries. The early recognition of this fact has certainly
contributed to the success of Japan.
For these reasons, it is necessary to reassess the roles in the process of eco-
nomic growth of the local as well as extended technological and industrial envi-
ronments. What sort of linkages are necessary to achieve the necessary critical
mass of a technological enterprise? Which kinds of knowledge and competence
flows are best organized locally and which can be handled at a distance ? What
sort of connections are best handled by companies themselves, and which require
intermediaries in the infrastructure ?
Above we have emphasized the growing importance of the international di-
mension of the technological systems. On the other hand, we have also noted that
the geographical, cultural, and political proximity continues to be important
when intimate and extensive communication is required for the effective organiza-
tion of economic activity. Several hypotheses could be advanced to resolve this
seeming contradiction. It is possible that local networks are particularly impor-
tant in the early chaotic stages of the development of a technology (cf. Lundvall
1988) while the more distant links work better in the later, more orderly stages of
the innovation process. It could be expected that the local networks will be
particularly important as sources of a broad range of technological competencies,
the need for which is sporadic and difficult to predict. They can be easily im-
provised, and the communication costs per se are low. The more distant con-
tacts, on the other hand, require a greater degree of preparation and organization.
They are costly and will be maintained only in specialized areas of permanent
importance for the actors involved. The extent to which the costs of such links can
be reduced by creating organizational channels constitutes another important
question. If they can be reduced to a significant extent, the entire geography of
technological systems can be transformed. The role in this context of multi-
national companies and of international intercompany alliances is still poorly
understood.
Regardless of the precise answers to these questions, it seems clear that both
the extended selective networks and the dense local environments are essential
features of a firm's environment. Companies will seek environments characterized
by high technological density and diversity and, if necessary, migrate to them. The
failure to create such environments will lead to a progressive weakening of the
technological and industrial strength of a country. This said, it is important to
emphasize that high technological density and diversity are properties of regions
rather than countries. They are the results of local agglomeration of industrial,
technological and scientific activities. At the heart of such agglomerations one
usually finds a "knowledge industry" consisting of universities, engineering schools,
R & D laboratories of large companies, small R & D firms, government laborato-
ries, a variety of consulting firms, and other forms of activities whose primary
output is knowledge and competence. These local agglomerations of industrial
and technological activity constitute dense nodes in a web of local and distant
contacts maintained by the actors involved. One important set of links is created
by academic institutions which establish close communication with similar envi-
ronments throughout the world. Government initiatives, such as national pro-
grams, provide another set of linkages. The third set consists of links cultivated by
the individual companies of which the multinationals are particularly important.
Thus the national technology policy must deal with two somewhat divergent
problems: (1) the promotion of local technological agglomerations of sufficient
critical mass; and (2) the promotion of effective integration with the emerging
international technological systems.
In dealing with these problems one must answer a wide range of questions
including: How many such agglomerations can a country of a given size sustain?
What should be their character? How can their development be stimulated? How
should the problem of resulting regional imbalances be handled ? How should the
national R & D infrastructure be integrated with those of other countries? How
can foreign firms be encouraged to locate their R & D activity within the country's
technological centers? How can one organize and encourage various forms of
international technical cooperation ? These and similar questions are critical for
all countries today but have special significance for the smaller industrial nations.
It is important to recognize, however, that national technology policy can
address only a part of the problem. To the extent that the boundaries of the
technological systems do not coincide with national borders, national policies
may not be effective. Also, and probably even more importantly, it is the economic
competence of the agents within the system that determines ultimate success or
failure. Given the tacit character of much economic competence, only the business
units themselves can take the appropriate action. This is illustrated in a recent
analysis of the world computer industry: the decline of the U.S. and European
computer industries relative to that of Japan can not be attributed to failure of
national technology policy or R & D infrastructure but rather to the failure of the
firms within the industry to choose appropriate strategies, to build up their com-
petence, and to form cooperative networks (Ferguson 1990).
In the light of what has been said here about the importance of variety,
clustering of resources, and critical mass for the creation of effective technological
systems, it may be claimed that small countries find themselves in a position of
hopeless disadvantage compared with large ones. Indeed, if technological systems
are locked into the relatively closed national systems, small countries such as
Sweden or Switzerland could never achieve the same level of technological and
economic performance as, say, the United States or Japan, and they would be
progressively "squeezed out" of the international markets for technologically
advanced goods and services. Yet it is an empirical fact that, at least up to now,
some of the smaller industrial nations have been remarkably successful in holding
their own, technologically and economically, against larger and more powerful
competitors.
There are at least two possible explanations for this. One is that if the national
economic systems are becoming more open and the technological systems more
international, there exists a possibility for the small countries to neutralize some
of the limitations of size. Secondly, small countries (or at least some of them) m a y
in fact have certain advantages relative to the large ones, because (a) they are less
constrained by nationalistic ambitions which create the need for sulf-sufficiency;
and (b) several of them have developed organizational and cultural features which
make them particularly effective operators in the international system. Countries
like Sweden, Switzerland and the Netherlands are characterized by: (i) very large
share of exports in their G N P ; (ii) great importance in their economies of domes-
tically based multinationals; (iii) integration of companies in the international
industrial networks; and (iv) scientific and technical communities well linked to
the international centers of excellence. Whether these countries will be able to
further develop and exploit these advantages is an important question for the
future and hinges largely on the extent to which the boundaries of technological
systems coincide with national borders.
Acknowledgements. This paper was written within the framework of the research project "Swe-
den's Technological System and Future Development Potential" financed by the Swedish Na-
tional Board for Technical Development (STU) and the Swedish Board of Research Councils
(FRN) whose generous support is gratefully acknowledged. We would also like thank our
colleagues within the project, especially Gunnar Eliasson, Anders Granberg, and Staffan Jacobs-
son, as well as Zoltan Acs, Pavel Pelikan and Frank Stafford, for constructive criticism of earlier
versions of the paper.
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--Journal of

J Evol Econ (1991) 1:93-118 Evolutionary

On the nature, function and composition

1 Department of Economics, Case Western Reserve University, Cleveland, OH 44106, USA

Key words: Technology - Innovation systems - Development blocks - Networks

A promising approach, rooted in the works of Schumpeter and building on the

II. The sources of economic change

In conventional (production function-based) analyses of economic growth, in-

system is determined by its diffusion. The characteristics of the diffusion process

IIL Organizational and institutional factors

systems view of technological change. We turn now to an examination of these

The clustering of a large number of firms in a particular area, whether it is semiconductors,

The fundamental uncertainty involved in innovation leads to a process of search,

unstandardized technical problems, a m o n g purchasing personnel on suppliers of

This dynamic concept of networks is closely related to D a h m 6 n ' s notion of

4.1. The necessity o f the entrepreneur

4.2. The requirement of critical mass

Besides the entrepreneur, another prerequisite of a development block is a favor-

organization" in Japan as a way to mobilize resources and generate new informa-

5.1. The basic economic institutions and the role of government

As pointed out earlier, the effective technological change presupposes a balance

tal features of market organization, capital supply, collective bargaining, indus-

5.2. Production and distribution of knowledge

The effective organization of production and distribution of knowledge and

The generic character of much of R & D leads to major externalities in the

We are now ready to state more explicitly what we mean by "technological

tics of the national system of industrial research and development, emphasizing

IV. Concluding remarks and hypotheses for further research

3 The study is a multi-year project involvingeconomists, engineers, and sociologists at Chalmers

clarity in the science-derived basic technologies in electronics, materials technolo-

tion we need to consider at least the following points:

Mensch G (1975) Das technologische Patt - Innovationen/iberwinden die Depression. Umschau

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