The Formation of Network and Public Intervention: Theory and Evidence

from the Chilean Experience*

Alessandro Maffioli+

April 30th, 2005

Abstract
The first part of the paper deals with the theoretical foundations of new industrial policy tools aimed at
promoting a process of interacting learning among firms. I discuss the issue at three different levels: first,
I define the theoretical boundaries of my research interest within the considerable economic literature
dealing with industrial networks; secondly, I concentrate on some endogenous growth and development
models, in order to analytically define the existing relationship between firm interactions, knowledge
flows, and productivity. Then, I discuss the relationship between knowledge diffusion and productivity,
with particular emphasis on the fundamental concept of network multiplier. Finally, I carry out a
microeconomic analysis of the motivations that bring firms to interact with each other, and look for a role
for public institutions in promoting such interaction. I discuss in which cases public intervention
promoting the formation of a knowledge-sharing network is justified by the existence of a sort of “market
failure”, and identify which variables are involved.
In the second part of the paper I analyze the most important Chilean networking program, the PROFO
program. The availability of relational data on a significant number of firm networks allows me to
investigate in detail the relationship between network structure, public intervention and firm
competitiveness. The econometric analysis confirms a strong correlation between PROFO firms’
innovativeness and industrial cooperation, proving the existence of an interactive learning process among
participant firms. I used sociometric data to refine my analysis of the impact of the program on the
network multiplier: not only do participant firms also achieve better performance in terms of productivity,
but this performance is quite strongly correlated with firm centrality and network density, which are the
two variables best representing the structure and function of the network multiplier and that, as I
previously mentioned, are strongly affected by PROFO.

Keywords: learning, productivity, public intervention.

JEL classification: D83, O38.

Correspondence: alessandrom@iadb.org, Office of Evaluation and Oversight, IADB, 1350 New

York Avenue N.W., Washington, D.C. 20577

*
I wish to thank José Miguel Benavente, Philip Cooke, Gioacchino Garofoli, Rossella Nicolini, Francesco Parisi,
Wilson Peres and Laura Resini for their comments and suggestions.
+
Inter-American Development Bank
1.1 The boundaries of my research
Generally speaking industrial networks can be considered as systems of firms that are more or
less intensively involved in various kinds of relationships with each other. Although this
definition may appear too wide since it extends from simple client-provider relationships to the
more complex relationships characterising an industrial district, subject to some clarifications it
allows me to focus on the individual and systemic incentive structure that leads to the creation,
development and management of connections. This does not mean that I am not interested in
other relevant dimensions of industrial networks, such as geographical or social factors,1 but
simply that in analysing the role of a public agent in network formation I want to start from a very
simple structure of incentives to creating linkages, that subsequently can be more complicated in
order to consider more determinants.2
As far as the nature of the linkages is concerned, I focus on relations and links that are to some
extent related to the transmission of knowledge and learning processes. This actually means that I
am reducing the field of my investigation to what part of the literature defines “networks of
learning” (Powell, Koput, Smith-Doerr 1996), or to what I call “knowledge-sharing networks”.
Finally, another preliminary clarification is needed. Within the wide range of research works
on industrial networks involving several disciplines, I only consider those studies of industrial
economics mostly affected by the influence of the Social Network Analysis approach. These
studies mainly focus on the impacts of social relations (rather than attributes of actors) on
economic and social outcomes, especially in terms of performances and behaviour. I adopt both
the perspectives that can be used to deal with this issue: the “agent in networks” perspective and
the “networks of agent” perspective. In the former the network is “an observed pattern of
organisation” and the main focus is to explore how the pattern of relationships among the
members of the organisation influences the actor’s behaviour and performance. In the latter, the
global network structure is the main unit of analysis and the attention focuses more on formation,
development and stability problems. These two different perspectives allow me to analyse, on the
one hand, under which conditions policy intervention fosters the formation and development of
networks, on the other hand, the single agent’s incentives that must be modified in order to
achieve these results.

1
If these factors are also taken into consideration, it would be better to speak about “clusters” or even “industrial
districts”.

2
1.2 Knowledge and firm’s competitiveness
In the perspective of analysing the impact that the participation in knowledge-sharing network
has on actor’s behaviour and performance, I adopt a definition of knowledge and learning that
focuses on observable effects. The intuition which this work is based on can be traced back to the
definition of knowledge that Aghion and Howitt gave when discussing the problems related to
knowledge measurement: “we define knowledge in terms of potentially observable behaviour, as
the ability of an individual or group of individuals to undertake, or to instruct, or to otherwise
induce others to undertake, procedures resulting in predictable transformations of material
objects” (Aghion and Howitt 1998: 436). Consequently, the learning process might be defined,
following Schon (1973), as “a change in a person’s or organisation’s capability or understanding
[...] and not simply the acquisition of further information” (Cooke and Morgan 1998: 68).
Given these definitions, a first way of measuring the changes in single actor’s behaviour due to
interactive learning process is to look at their propensity and capability of adopting innovations,
defining innovation as a new combination and application of knowledge in order to improve
product’s quality and upgrade the efficiency of production and managerial processes (Schumpeter
1934, Dosi 1988).3
A significant problem when dealing with innovation as the output of a learning process is how
to measure it. The main “objective measures” of innovation’s output, such as patents, usually
underestimates the relevance of incremental improvements (Rosenberg 1982, Freeman 1994,
Dosi 1997), which might be crucial in interactive learning process. For these reasons, especially
when dealing with survey of SMEs, more “subjective measures” of innovation’s output might be
preferable (Garofoli 1989, 2002).4
A second measure of learning impact on firm’s competitiveness is Total Factor Productivity
(Hulten 2000). In this case, following the endogenous growth approach (Romer 1986),
knowledge is more simply assumed as a production factor. In section 4.4, I analyse more in detail
a specific application of an interactive learning process to this approach.5 The advantage of

2
This mainly means that I do not intend to analyse in depth the wide literature on clusters and industrial districts.
3
The concept of interaction as a source of learning has been widely developed within the context of the National
Innovation System approach (Freeman 1987, Lundvall 1992, Nelson 1993, Metcalfe 1995 and Edquist 1997).
4
In this case the main problem is that “subjective measures” are based of perceptions. Thus a great attention might
be paid in the survey’s selection process.
5
Some important efforts have been made to analytically integrate the concepts of production and innovation. On the
one hand, the learning by doing (Arrow 1962) approach assumes that production generates knowledge and thus that
innovation might be generated by the experience of producing. On the other hand, some efforts have been devoted to
analyse the effects of “product’s quality improving innovation” (Nelson 1964, Jorgenson 1966, Aghion and Howitt

3
measuring the impact of interactive learning in this way is that productivity might be assumed as
a more objective than many innovation measures.

1.3 Knowledge-sharing industrial networks in economic theory6

Keeping these preliminary considerations in mind, I can move on to analysis of the literature
on industrial networks. As previously indicated, my perspective regards industrial networks as
characterised by an intensive interaction taking place across firm boundaries. In this field, one of
the most influential approaches has certainly been Transaction Cost Economics (TCE), as
summarised in many of Williamson’s works (e.g. Williamson 1998). Since this approach deals
with the boundaries between markets and organisations (Coase 1937), industrial networks are
mainly interpreted as a hybrid type of organisation in between markets and hierarchies
(Williamson 1991). Within TCE, the major analytical effort to understand these “hybrid”
industrial organisations has been directed towards the study of alliances and joint-ventures (Teece
1986) and indeed, mainly to large firm interactions.
Despite the great influence the TCE approach had on the analysis of industrial networks, most
scholars have pointed out that it is a static analysis of cost trade-offs, and thus insufficient to
explain firm and network dynamics (Winter 1988, Foss 1993). In fact, since transaction relations
evolve over time, ex-ante expectations of opportunistic behaviour by the agents – a basic
assumption in TCE – might change into mutual trust as agents accumulate experience and are
embedded in a specific social context (Nooteboom 1992).7 Thus, dynamically interpreting a
network as a set of reiterated relations, the emergence of mutual trust among members is likely to
considerably reduce the impact of transaction costs. This significantly decreases the explanatory
capacity of the TCE approach.
Another relevant limitation pointed out by some critics is that the traditional TCE approach
ignores the strategic and organisational learning aspects of networking (Powell, Koput, Smith-
Doerr 1996). This actually means that the TCE approach, in considering only costs, ignores some

1996) on productivity. These models basically suggest that, if firms allocate a portion of their resources to a
stochastic R&D process, they have a non-zero probability of introducing innovations in the goods they use for
production. An innovative factor is one that can more easily be combined and used for production, so if a firm
manages to introduce an innovation, it benefits from a boost in productivity. Evidence of this increased efficiency
effect can be found in the empirical studies by Van Leeuwen and Klomp (2001).
6
The aim of this section is to place the following theoretical analysis within the framework of recent research on
industrial networks. I do not claim to provide a complete survey of this issue, nor all its different specifications.

4
fundamental motives underlying the formation and development of networks: complementarities
of resources, transfer of know-how among parties, accessing a firm’s capabilities and improving a
firm’s own capabilities via interactive learning, and so on.

In order to deal with flows of knowledge and learning, a different approach is indeed required.
For this purpose, the literature identifies at least three complementary perspectives to be used for
analysing industrial networks (Kogut 2000): transaction costs, strategic behaviour and
organisational learning. Given the objective of my work, the latter is surely the most interesting,
though I do not ignore components of the former two. Thus, within the “agent in networks”
perspective, some explanations developed in the last decade to analyse the innovative pattern of
some emerging industries are particularly relevant.
According to the “network of learning” (Powell, Koput, Smith-Doerr 1996) and to the
“interactive learning” approaches (Lundvall 1988 and 1992, Morgan 1996), networks facilitate
organisational learning and act as a locus of innovation. Firms develop connections with each
other not only because they lack resources, as the resource-based view states, but because of the
need to explore and exploit other firms’ knowledge bases. Thus, “organisational learning is both a
function of access to new knowledge and the capabilities of utilising and building on such
knowledge” (Powell, Koput and Smith-Doerr 1996: 118). The learning process is indeed based on
the assumption that the external knowledge reached through collaboration is to some extent
complementary to internal capabilities and it allows the firm to better exploit and build up its own
knowledge (Mowery and Rosemberg 1989, Lundvall 1992, Gabardella and Rullani 1999, Dosi,
Nelson and Winter 2000).8 In such a process, networks are relevant not only because they allow
complementary specific knowledge to be gained, but also because they yield information on
“who knows what”: one of the most important items of information that flows through
connections is about single member capabilities (Lundvall 1996, Gulati 1999), or the “location”

7
This basic objection explains the increasing attention paid by many industrial organization scholars to the issue of
social capital. Among the others, Maskell (2000) pointed out the importance of social capital in reducing inter-firm
transaction costs, bargaining and decision making costs, contracting and control costs.
8
Cluster and industrial district scholars have pointed out that by being embedded in a specific social and cultural
context, industrial networks facilitate both the process of interactive learning and the transfer of tacit knowledge (e.g.
Camagni 1991, Garofoli 1992 and 2002, Mailat 1995, Cooke and Morgan 1998, Belussi and Pilotti 2002, Maskell
2002). In my approach I will not distinguish between “tacit” and “codified” knowledge, since I assume that the
degree of codification of knowledge as well as the reciprocal trust between members could be to some extent
“endogenized” in the model.

5
of external capabilities with reference to the single firm but inside the whole system (Garofoli
1991).
Since connections and interactions may be particularly relevant in the firm’s learning process,
a vast amount of studies have been developed in order to analyse how network participation
affects firm performance. Many scholars, mainly within the evolutionistic tradition, analysed how
knowledge-sharing networks affect performances in terms of innovativeness. Considerable
research has been carried out within the context of the Innovation System approach (Freeman
1987, Lundvall 1992, Nelson 1993, Metcalfe 1995 and Edquist 1997): some of these studies
focused on the impact of linkages with strategic members of the production chain on the firm’s
innovativeness (e.g. Cimoli and Costantino 2000); others deal with more complex kinds of
networks, taking into account geographical, social and sectoral dimensions (e.g. OECD 1999).

Part of the economic literature, mainly affected by the social network approach, refers to a
series of interesting studies on the relationship between firm and network sociometric
characteristics and firms’ performance. Some scholars focused their attention on the efficient
structure of information flows in affecting firm competitiveness (Burt 1992), pointing out the
need for reducing redundant ties. Others paid more attention to whether and to what extent the
stability and intensity of relations affect competitiveness: diverging conclusions on the relevance
of weak or strong ties emerged when more emphasis was devoted either to exploration of new
knowledge (Granovetter 1973) or to coordination among agents.

Recently a branch of game theory dealing with the dynamic evolution of a given network
structure has emerged in the “network of agents” perspective (Jackson 1996 and 2003, Bala and
Goyal 2000). The most interesting aspect of these studies is that they are focused on how single
agent incentives can affect the formation and the dynamic evolution of the sociometric structure.
Particularly important, at least in my perspective, are those studies that define the objective
function of each member in terms of the learning process (Bala and Goyal 2000, Goyal and Vega-
Redondo 2000): firms decide to either link to other partners or not, comparing the benefit they
can achieve in terms of the learning process with the cost of coordinating with other partners.
Within this theoretical framework I will mainly develop my personal approach to public
intervention in creating and sustaining industrial networks.

6
1.4 Networks, knowledge and productivity: in search of a production function
In a world of ties and connections among firms, public institutions may work as a catalyst,
bringing firms closer together and facilitating the transmission of knowledge, thus raising the
value of the network as a whole and the efficiency of each member. The interesting issue is that
such an effect can be obtained through the interaction of a relatively limited number of
enterprises, which then develop, as a result of such contacts, technical and communication skills
that can benefit further firms.
One major problem has always been to identify a synthetic representation of the effect that the
formation of knowledge-sharing networks may have on firm level efficiency, in other words,
identifying a production function that takes into account the interactive learning process. One
basis for the theoretical modelling of this effect can be found in recent works in the field of
endogenous growth theory (Barr 2000), which further elaborates Romer’s popular growth model
(Romer 1986). In this section I will briefly overview both works in order to set an adequate
background for my analysis.9
In 1986, Paul Romer wrote a now famous article, presenting a growth model that relies on
technological progress to explain growth in a completely new way. Departing from exogenous
growth models such as Ramsey (1928), Cass (1965) and Koopmans (1965), he sought a new
paradigm where a general equilibrium would exist and be computable in the presence of long-run
growth, independently from occasional shocks. The path to this result goes through the presence
of increasing returns, but since it is evident that physical factors such as capital and labour show
decreasing returns, Romer introduced knowledge as a third capital good, assuming its production
function has increasing marginal product.
When specifying the firm’s production equation, Romer uses a modified Cobb-Douglas
function: all the physical inputs (such as capital, labour or natural resources) are collected in an
input vector xi and enter the production function in fixed amounts. The latter is quite a strong
hypothesis, but no loss of generalisation comes from its incorporation. The role of immaterial
inputs, and of knowledge in particular, is expanded: they enter the production function not only
via the “level of technology” multiplier (A) used in exogenous growth models, but also as an

9
My purpose is not to develop a macro model, since the problems that I analyse are at micro and meso level. Thus, I
do not enter in to the debate on endogenous growth versus development theory. The aim of this part of my work is
mainly to identify some theoretical instruments that allow analysing the role of public intervention in network
formation.

7
aggregate input (K, or the total amount of knowledge in the system). The production function is,
thus, as follows:

yi = A * F (K, xi) (1)

In his recent paper examining the Ghanaian manufacturing sector, Barr (2000) has
complicated Romer’s assumptions with some specifications typical of the evolutionist approach.
Inserting the model within the context of network analysis, Barr argues that due to imperfections
in the knowledge transmission process, not all the knowledge present in the system reaches every
agent. Thus, the firm’s production function would not depend only on the aggregate level of
knowledge, K, but also on the amount of knowledge specific to firm i, ki. In short:

yi = A * F (ki, K, xi) (2)

The interesting aspect of this model lies in the dynamics of firm-specific knowledge
accumulation: according to Barr, every agent is able to transmit only a percentage δ (<1) of his
initial knowledge k0 to other agents;10 furthermore, not all agents are in direct communication
with all the others, and thus the number and distribution of ties between agents (µ) becomes
important in the dynamics of knowledge transmission (e.g. the fewer agents lying on the path
between agent x and agent y, the more knowledge from x will reach y). Another important factor
to determine the amount of knowledge present in the network is the total number of agents (n), or
size of the network. Consequently, each firm’s production function does not include the whole
amount of knowledge, K, but only that part of it, which is accessed by the firm through direct and
indirect connections.11

10
In my work I mainly refer to knowledge transmission capabilities of agents. Nevertheless, the decay effect in the
interactive learning process might be effectively described also by assuming that the agents have limited capabilities
of absorbing external knowledge (Cohen and Levinthal 1990). The concept of “cognitive distance” between agents
might be also adopted as a synthetic way of considering both transmission and absorptive capabilities (Nooteboom
2000).
11
K will enter the production function of each firm only if the network is perfect, i.e. all the possible ties are formed.
Some could argue that in a perfectly connected network some linkages could be redundant. This is especially clear in
the case of a very low level of decay: if δ ≈ 1 in terms of knowledge transmission, the indirect connections have the
same value as direct connections. As I will show later the value of decay depends on several factors, such as social
trust and cultural and professional proximity. Since in this work I do not deal with the problem of the most efficient
structure of a network, but just with the problem of network creation and reinforcement, I do not consider the
problem of redundancy of linkages.

8
 In observance of the network dynamics described above, Barr defines a new variable, wi as

the amount of external knowledge reaching a single firm. wi is specified as the product of the

already available knowledge, k i , and a “network multiplier” h, which depends on structural

factors δ, µ, and n, the knowledge transmission capability of the firm, the overall intensity of firm
relations, and the total number of firms present in the area, respectively. Thus:

wi = h(n, δ , µ ) * k i (3)

Under these new assumptions the production function takes the following shape:

yi = A * F (ki, wi, xi) (4)

The new model provided by Barr is very interesting because it includes network dynamics, a
recent field of investigation, which allows for more realistic modelling of empirical effects. It is
for this reason that I chose this production function as the theoretical starting point for my
analysis of the role of networking policies in economic development.

Within the model just described, public agents can play their role in basically two ways.12
First, they may have a “socialising” function, thus increasing the number of ties among firms: for
example, two or more entrepreneurs from the same sector getting to know each other during
management training classes offered by a University, or in the context of a publicly-funded
cooperation project (e.g. collective technical research). Secondly, they may help to increase a
firm’s transmission capability through the “codification” of latent information present in the
firm.13 Such codification may be required and even actively facilitated by external agents
providing consulting services, or firm-specific training. Thus, through a rise in µ and δ, public
agents can increase the network multiplier, which is in turn positively related to the firms’ total
productivity.
These new opportunities for affecting efficiency may be well captured by a redefinition of the
concept of Total Factor Productivity (TFP) at firm level (Hulten 2000). The TFP was developed
as an alternative to traditional growth models to explain the persistent differences in income

12
Remember that I am not considering the knowledge creation role, captured by increases in A.
13
For more information on the codification of firm competences, see e.g. Winter (1987).

9
between world countries. Being a simple, synthetic explanation, it has also encountered wide
success in fields apart from development economics, and is today a generally used indicator of
growth capability at all levels. The idea it rests upon is that, since production growth rates cannot
be satisfactorily explained by the growth rates of the production factors, there must be an
independent “input combining competence”, its level specific to each country, region or firm. A
common way to measure TFP is the Solow Residual, which defines TFP as the growth rate of the
level of technology (A), and calculates it residually from the other input and production growth
rates.
Extending Barr’s conclusions, I can also include in the TFP the dynamic benefits of the
increase in knowledge “fluidity”, calculated as the growth rate of wi, (which is directly dependent
on the network multiplier h). This effect was previously unaccounted for, and it synthetically
captures the further impact of training and consulting activities on a firm’s, sector’s, or country’s
productivity and growth at country, sector and firm level.

1.5 Network formation and public intervention

As I have shown in the previous sections, there are at least three factors that can affect the
benefit a firm obtains from participating in an industrial network. First of all, the number of firms
that are potentially part of the network. If each firm brings a specific knowledge component, then
the larger the network, the greater will be the externalities affecting a member. However, network
size alone is not enough to guarantee that the whole sum of firm-specific bits of knowledge is
available for all firms. Thus, the second factor affecting the impact of network participation on
firm productivity is the structure of the network itself, i.e. the distribution of ties among its
members.14 Finally, given the size and structure of the network, the impact on a single firm will
increase with the increase of knowledge flows among subjects. The intensity of such flows
depends on the network members’ capability to transmit and receive information, which is the
capability to codify firm-specific knowledge, allowing it to be shared.15

14
The structure and structural properties of a network can be defined through many indicators developed by the
branch of the literature called Social Network Analysis. Such indicators include, among others, density, centrality
and distance measures (Wasserman Faust 1994). See Annex 1 for definitions of these concepts.
15
As previously pointed out, I do not wish to elaborate here on the debate over the distinction between tacit and
codified knowledge (Polany 1967, Breschi and Lissoni 2001, Belussi and Pilotti 2002). Nevertheless, since I consider
that there is a decay effect in the transmission of knowledge, a certain grade of “tacticness” in knowledge is
implicitly assumed.

10
 It is thus clear that a firm’s choice whether or not to participate in a given network can be
analysed as a “social decision”. Social decisions are those decisions that depend on the decisions
of others and that influence the decisions of others (Shy 2001). Hence, such behaviours cannot be
reduced to conventional economic choices.
In this part of my work, I focus on the incentive structure that can lead firms to form a network
and, more importantly, on how the intervention of a public actor can modify such incentives.16
For this purpose, I introduce a series of conceptual simplifications in order to deal with the
phenomenon analytically. Such assumptions will then be gradually removed, getting closer to
actual reality. My purpose here is not to solve network formation problems in detail, but rather to
show in which cases public intervention is justified by the existence of a “market failure”, and to
identify what are the variables it can exert its influence on.
In general terms, I assume that firms can be viewed as homogeneous “knowledge consumers”,
and that knowledge availability may only rise through interaction with other individuals. In
addition, I assume that the benefits that firms achieve by sharing knowledge are mainly non-rival,
which does not strictly mean that firms cannot be competitors, but only that one firm’s benefit
does not imply any worsening for the others.17 This stylised representation allows me to use the
models developed in the emerging “network formation” literature (Jackson 1996 and 2003, Bala
and Goyal 2000), which has been developed within the wider framework of game theory.
More specifically, I chose to adopt the following basic assumptions: (i) there exist n firms,
each with a starting knowledge endowment ki ; (ii) the initial knowledge endowment is fixed and
equal to 1 for all firms ( ki = k = 1 ); (iii) firms can acquire additional knowledge exclusively

through interactions with other individuals. The only form of interaction permitted is network
participation; (iv) firms can only transfer a percentage δi of their own knowledge, and can only do
so through direct interaction; (v) the knowledge transmission capability is fixed and equal to δ ;18
(vi) in order to participate in the network, firms must pay a connection cost c for each direct link
they initiate. In general terms, the decision of a firm on whether or not to initiate links in a

16
Here I adopt a simplified definition for the concept of a public actor: she is an agent whose utility depends
exclusively on the maximization of systemic benefit.
17
This assumption is quite realistic taking into account that I mainly refer to SMEs. It has been widely demonstrated
that for this kind of firm the co-existence of cooperation and competition is more likely to occur (see for example Di
Tommaso and Dubbini 2000).
18
It might be assumed that the capability of transmitting knowledge increases during the learning process, as the
absorptive capacity does (Cohen and Lavinthal 1990). This assumption may lead to a more cumulative learning
process. For simplicity I do not consider this effect.

11
network (or, in a systemic view, the decision of a group of firms whether or not to connect to a
network) depends on the following payoff structure:

⎧k i + wi − ci When forming connections

Πi = ⎨ (5)
⎩k i When remaining isolated

where ki is the value of firm-specific knowledge stock, wi is the value of the benefit each firm
gains from issuing connections and therefore accessing the knowledge of the connected firms,
and ci represents the cost of issuing and maintaining ties19. For the purpose of this work, we can
think of such costs as maintenance expenses which arise from the need to coordinate with
directly-linked firms.20 Therefore, the ith firm’s decision on whether to join the network depends
on the comparison of the benefits deriving from the two states (the payoff for the connecting
decision must be greater than that of the non-connecting one21), which results in wi – ci > 0 .
To analyse the payoff structure in detail, I consider the problem of the formation of a network
of “knowledge consuming” firms as a non-cooperative game like the “two way flow model”
developed by Bala and Goyal (Bala and Goyal 2000).22 I initially consider a single simultaneous
game where firms must choose which connections to initiate, and with whom. I also assume that
firms are able to transfer all their specific knowledge through direct links (which means that
δ = 1 ). A possible linear specification of the payoff for agent i is:

Π i = µ i − µ id c (6)

19
Thus, in this model knowledge is the output of a dynamic process that requires the investment in specific resources
(Arrow 1994).
20
It might be assumed that link formation costs increase with centrality (coordination costs) and actors’
heterogeneity (selection and codification costs) (Maskell and Lorenzen 2003).
21
Note that a firm can initiate many different sets of connections, but that due to the presence of costs it will try to
achieve the greatest benefit (deriving from indirect connections) with the smallest number of direct connections.
22
This means that the link between i and j is non-directional and that the benefits of sharing knowledge accrue to
both the agents, though just one of the two connected member bears the cost of initiating the link. For further detail
see Annex 1.

12
 where µ i is the number of firms observed by the ith firm23, and µ id is the number of firms

with which it initiated a direct link. When µ id = 0 the payoff is equal to 1, since a firm only

observes itself.
Under these assumptions, two possible Nash equilibria might arise (Bala and Goyal 2000): if
c ∈ (0,1) (that is when connection costs are so low that there is a net gain from the first connection
with another isolated firm) a complete network is created spontaneously from firm interactions,
while no links are created if c > 1 . This first, simple conclusion suggests that a network does not
arise from simple firm interactions, though the social (and also the individual firm’s) net benefit
from network formation would be positive (that is when c ∈ (1, n − 1) , since costs greater than n –
1 would result in the non-optimality of even the most cost-efficient network)24.
From the social point of view, the fact that a network does not arise when c ∈ (1, n − 1) is an
inefficient result. This occurs because if no network is formed the amount of final knowledge in
the system is equal to n, the sum of firm-specific knowledge units, while if a complete25 network
arises, the amount of systemic knowledge equals n2 (proof in Annex 2 a).
This social inefficiency leaves some room for the intervention of a public actor, that is an actor
whose payoff is determined by the benefits produced in the system as a whole. Such an actor can
have three functions: a) it can be a “pure catalyst”; b) it can be a coordinator, who partially covers
the connection costs incurred by firms; c) it can be a codifier, who is able to modify the intensity
in the transmission of knowledge within the network.

1.6 The “pure catalyst” effect

To analyse the case of the “pure catalyst”, I assume that one of the n agents in the system
(called pc) has the following social-oriented payoff:

n
Π pc = ∑ µ i − µ pc
d
c (7)
i =1

23
In the context of the Social Network Analysis, a firm “observes” all firms it is directly or indirectly connected to,
including itself. Hence, if a firm initiates no links whatsoever, it still observes itself and has access to its own specific
knowledge.
24
More precisely, the non-cooperative game between the potential members of the network has two strict Nash
equilibria: a “centre-sponsored star” network when 0 < c < 1 and an empty network (a network with no connections)
when c > 1. These results have been proved by Bala and Goyal (2000).
25
A complete network is one where any member observes all members (see Annex 1).

13
 Given this payoff structure, I can demonstrate that the empty network is no longer a Nash
equilibrium, even when c ∈ (1, n − 1) . In fact, due to the payoff structure of pc, if c < n the centre-
sponsored network created by the catalyst is a better alternative than the empty network for all
players, including pc. The only condition for the network to develop in presence of a “pure
catalyst” is that the cost of a single connection be smaller than the sum of firm-specific
knowledge units possessed by all actors ( c < n ). In the extremely simplified case presented so
far, the network would develop directly as a “centre sponsored” network with the catalyst in the
middle. Thus, the highest cost that a catalyst may have to pay when developing a network is
indeed c(n − 1) (proof in Annex 2 b).

1.7 The “coordination” effect

In order to deal with the coordinating function, I use a more intuitive approach. I assume that
the public actor is not a potential member of the network, but rather an external entity, which can
modify the structure of firms’ payoffs. In particular, when the network is socially desirable but
does not spontaneously arise, that is when c ∈ (1, n − 1) , the public actor will announce that it is
willing to cover part of the connection and coordination costs26. The announcement will be made
before the game takes place, and it will be defined as follows: for each direct connection initiated
by a firm, the coordinator will give that firm a fixed amount s. The players’ payoff then becomes:

Π i = µ i − µ id (c − s ) (8)

Since the coordinator (co), maximises the social benefit its payoff is:

n n
Π co = ∑ µ i − ∑ µ id c (9)
i =1 i =1

26
Some examples of how a public operator can cover parts of the coordination costs among firms are funding
programmes that privilege larger groups of firms and programmes where the public operator bears the costs of a non-
firm coordinator over a given time frame. Both functions can be found in the Programa de Fomento (PROFO)
implemented by the Chilean government.

14
 The announcement will be credible and effective if c − s < 1 , that is, when the connection cost
net of subsidy is smaller than the benefit deriving from the first connection to an isolated firm.
Therefore, the public actor will decide for a subsidy s = c − 1 + ε . It is easy to see that, from the
standpoint of firms, this case is equivalent to the original spontaneous network formation case
( c ∈ (0,1) ): the empty network is no longer a Nash equilibrium (see Bala and Goyal, 2000 pp.
1205).27 Given equation (5), I can also analyse the incentive for the coordinator to announce its
willingness to pay by comparing its payoff in the case of no intervention, implying an empty
network among enterprises, and the case of the most expensive connected network. From this
analysis I can conclude that the announcement will always be made when s < n − 1 + ε (proof in
Annex 2 c).

1.8 The “codification” effect

So far, I have shown that a public operator carrying out a “socialising” function by becoming a
catalyst or a coordinator can effectively solve a sort of “market failure” in the spontaneous
network formation mechanism28. In order to investigate further roles a public actor might play to
promote the rise of a connected network, I must now remove some of the simplifying
assumptions.
First of all, I introduce a decay in knowledge transmission, by assuming that δ < 1 (firms can
now only transfer a fraction of their own knowledge through direct links). If I leave the other
assumptions unchanged, each firm’s payoff becomes:

n
Π i = ∑δ D (i , j )
− µ id c (10)
j =1

where D(i, j ) is the geodesic distance29 between firm i and firm j.

Note that this formulation allows us to formally define the network multiplier we analysed in
equation (3). For each firm the network multiplier equals:

27
Given that the public actor does not usually observe the payoff function and a firm’s connection cost, determining
the minimum subsidy that causes connections to occur is a highly complex matter.
28
Obviously, the two functions can be carried out simultaneously by a single operator, with evident positive effects
on network formation. I do not formally deal with this joint adoption here.
29
The geodesic distance between two points in a network is the number of links on the shortest path connecting such
points. Fore more details see Annex 1.

15
 hi = ∑ δ D (i , j )
(11)
j ≠i

now, by defining some measurement of the average geodesic distance between all network
members, D (i, j ) 30, I can derive:

h = (n − 1)δ D
(12)

Turning back to the payoff analysis, a firm’s decision on whether to initiate a link depends not
only on connection costs, but also on the level of decay in knowledge transmission. Given the
functional forms I adopted, the condition for the empty network to be a Nash equilibrium is a
31
combination of connection costs and decay that results in c > δ . The possibility that costs
might assume such a value identifies a new function for the public actor in network formation.
For the case at hand, all comparisons will be made only between the empty network and
complete, star-shaped networks: all other forms of connection will be ignored32. First, it is
necessary to check if the connected network is socially better than the empty one when the latter
is a Nash equilibrium. Looking at firms’ payoffs, I can derive that a star network is socially and
individually efficient when δ < c < 2δ + (n − 2)δ 2 .33 In this case public intervention can try to
modify the decay value δ. Thus a new function, which I will call “codifier”, appears. The
previous two roles are still valid under the new assumptions, although some formal complications
are required.
Let the codifier be a member of the network, who can increase its own knowledge
transmission capability above the average level ( δ cd > δ ) by investing an amount I cd = f (n − 1)
before the game is played. Icd increases with the number of other potential members of the

30
An approximation of the average geodesic distance has been suggested in the literature (Barr 2000), and it is the
inverse of network density (see Annex 1).
31
Actually, if δ < c < δ + (n − 2 )δ 2 two strict Nash equilibrium are possible, the periphery-sponsored star network
and the empty network (Bala and Goyal 2000: 1215-1217). Yet, I assume that the public actor will try to prevent all
those cases where a connected network would be socially optimal but there is at least one chance that an empty
network turns out. So, the public actor will not be satisfied with the coexistence of two strict Nash equilibria in this
case.
32
Such limitation allows for a simpler discussion of the results with no loss of generality.

16
network. I assume a linear specification of this investment I cd = i (n − 1) .34 Once again I keep

within the usual parameter boundaries: c < 1 and c > δ . Under these assumptions, if the outcome
of the investment is such that δ cd > c , then all network members will decide to initiate a single
connection with the codifier. The codifier will choose whether to make the initial investment by
comparing the social payoff in the empty network case with the one in the complete, periphery-
sponsored star network case. If the latter is greater then the former, then he will invest.35
Expressed as formulas:

i < δ + δ cd [1 + (n − 2 )] − c (13)

It is evident from (13) that the higher the number of network participants is, the more likely it
is for the “codifier” to pay for the initial investment (proof in Annex 2 d).

33
Given the formal complexity of the model with decay, here I only deal with some boundary cases that work as
examples.
34
I may assume, for example, that the “codifier” makes an investment in order to analyse the characteristics of other
potential members of the network and increases its capacity for transferring knowledge to them. This is a quite
normal pre-assessment activity that has characterised the start up of many local development agencies.
35
Remember that the codifier’s payoff profile includes the benefits for society as a whole

17
2.1 Networking policies in Chile: the case of the PROFO program
Many innovative tools aimed at promoting industrial networks were introduced in Chile during
the 1990s. Furthermore, apart from programs directly aimed at fostering the creation of linkages,
associativity has been one of the most widely used approaches for implementing several measures
of the Chilean policy for. In this context, the PROFO program has without doubt played a major
role. It is one of the largest programs in terms of resources and outreach, and certainly the
instrument where the concepts of networking, cooperation and collective efficiency were most
explicitly adopted. In fact, one of the main hypotheses underlying the design of the PROFO
program is that “…the main problem for Chilean SMEs is not their size but rather their
isolation…” (Benavente and Crespi 2001). Thus, it is clear that among the basic ideas inspiring
the “designers” of PROFO, the concept of linkages, as developed by a wide industrial economic
literature from Hirshman onwards (Hirshman 1958), and collective efficiency, played a major
role. In addition, the analysis of the particular structure and functioning of the program
highlighted the importance ascribed by its designers not only to the achievable economies of
scale and scope in solving business problems, but also to the sharing of information and
knowledge.
From the analysis carried out in the first part and previous empirical works on this topic (Dini
2001, Benvente and Crespi 2001), some of the program’s institutional characteristics stand out as
being strategic. First of all, the role of the Intermediate Agent (IA) is crucial. During the
preparatory stage the IA acts as a selector of projects and participants and, to some extent, as a
catalyst for potential participants, given that it is in charge of evaluating the potential associativity
of applicants and, if necessary, of reducing or integrating the group. Thus, a first prototype of
public intervention covered by the program is a catalyst function. A second strategic role is that
played by the Project Manager (PM) hired in the PROFO stage. She is clearly a coordinator and
she has emerged as a crucial player in securing the success of a project, which depends both on
the adequacy of the manager’s personal skills for the specific content of a project and on the
continuity of her role (Dini 2001).36 The relevance of the technical skills of the manager in
addition to her organizational capabilities might be interpreted as a sign of a “codification effect”.

36
Projects that experienced a high turnover of project managers are more unlikely to be successful (Dini and Stumpo
2002).

18
 Figure 2.1 schematically summarises the different phases of the networking process
implemented with the PROFO program. The catalyzing function of the Intermediate Agent (IA)
usually affects both the already linked firms and the isolated ones (Figure 2.1, quadrant 1).37

Figure 2.1 – The PROFO networking process

1 - Before the program 2 - Preparatory Stage

e e

a d a d
IA

b c b c
3 -PROFO stage 4 – After the program
e e

a d a d
PM

b c b c
Source: prepared by the author

Then, when the potential network has been identified and analysed by the IA, firms have to
develop a common project and thus have to start sharing knowledge, under the supervision of the
IA. Thus to some extent, in the preparatory stage the IA mainly plays a catalyzing role, even
though she also acts as a codifier and coordinator. The former function emerges when the IA
analyses the potential partners and sustains them in reciprocally understanding their potential and
weakness; the latter emerges when she coordinates the potential partners in the definition of the
common project. In the PROFO stage, the Project Manager (PM) takes over the central function
of the IA. Although she is not a real member of the network, in order to represent her
coordinating function I include her in the network as a sort of “virtual” member, who facilitates
the linkages and reduces the connection costs that firms have to bear (Figure 2.1, quadrant 3).

37
In the SNA literature these are defined as components of the network (see Scott 1991and Wasserman and Faust
1994).

19
Obviously enough, during the program the number of connections among the identified potential
members increases. After the end of the program the number of linkages among firms is higher
than before, but it is probably lower than during the program, since the members might tend to
reduce redundant linkages or expel unnecessary members (Figure 2.1, quadrant 4).
Taken together, these institutional characteristics make the program a very interesting case for
evaluating the effects of public intervention in the network creation process. In this chapter, I will
attempt to identify some quantitative evidence for this process and I will analyze the effectiveness
of the PROFO’s networking process in affecting firms’ performance through the network
multiplier. Once again I will take into consideration both productivity and innovativeness, the
latter mainly as evidence of changes in the firm’s behaviour that could affect medium and long-
run productivity. Although I have shown that PROFO could be associated with different
prototypes of networking actor, the following analysis will focus on the “coordination effect”,
which actually seems to be the true peculiarity of the program.

2.2 Methodology and data selection

During 2001, CORFO asked the University of Chile to carry out a second evaluation of the
PROFO program.38 To achieve this goal, a specific survey was implemented. The University of
Chile allowed me to participate in designing the survey and defining the questionnaire.
The first step in the data collection process was to analyse the CORFO’s database of PROFO
projects, in order to identify the population object of the evaluation. The working group decided
to evaluate firms whose PROFO stage finished between 1999 and 2000, so as to have at least one
year of post-program experience. This criterion led to the identification of 102 PROFO projects
and 646 participant firms, including 18 projects and 75 firms that had also participated in the first
evaluation program. Thus, 571 new firms participating in 84 different networks were interviewed
and included in the sample as participating firms. In order to evaluate the impact of the program,
once again the methodological benchmark of the social experiment, in the context of “non-
experimental” evaluation design (Benavente and Crespi 2001), was adopted. As I have already
pointed out, this means reproducing ex-post the conditions of an experiment in which the results
of a group of firms “treated” with the program are compared with those of another, “non-treated”
group (the so-called control group). For this purpose, the control group has to be selected in order
to reproduce ex-post the probability of being treated as those of the participating group. In the

20
case of PROFO, the matching process was carried out in two phases: first of all by analysing the
ex-ante distribution (i.e. before participating in the program) of the participating group in terms of
size, sector and localization and then selecting a control group that had the same distribution in
the three considered dimensions. These two groups of firms were then interviewed and the
collected information was the basis for the statistical analysis carried out in the first part of this
chapter. Finally, since not all the firms interviewed provided data on their productivity and both
samples were significantly reduced, a statistical re-matching of the two samples was necessary
when evaluating the impact of the program on productivity.
Figure 2.2 shows how the two samples are matched from the sectoral point of view.39

Figure 2.2 – Sample distribution by CAE sectors

50% 50%
45%
40% 40%
35%
30% 30%
25%
20% 20%
15%
10%
10%
5%
0%
0% A C D2 D4 D6 D8 D10 E G I K M R
A C E G I K M R

Participant Non-participant Participant Non-participant

Source: author’s calculations on the basis of PROFO Survey Database

In terms of size the two samples have a very similar distribution, as shown by the total column
in Table 2.2. Looking at the joint distribution by sector and by size, participant firms are slightly
larger in the manufacturing and services sector.

38
The first was held in 1996 (see Benavente and Crespi 2001).
39
Although the two groups are matched, a higher concentration of participant firms in agricultural activities is quite
evident. This phenomenon is due to the size of some agricultural networks included in the evaluation. This might
introduce a bias in the statistical evaluation of the comparative behaviour of the two groups, probably leading to a
slight undervaluation of the innovativeness of participant firms. Other mismatches within the tertiary sector do not
seem to be so relevant.

21
 Table 2.2 – Sample distribution by sector and by size
PROFO Non-PROFO
Primary Manufacturing Services Total Primary Manufacturing Services Total
Micro 59.5% 30.8% 39.0% 49.4% 56.1% 41.7% 54.7% 50.5%
Small 37.2% 46.9% 57.0% 42.9% 41.5% 50.0% 38.5% 43.5%
Medium 2.9% 18.5% 4.0% 6.7% 2.4% 8.3% 6.8% 5.9%
Large 0.3% 3.8% 0.0% 1.1% 0.0% 0.0% 0.0% 0.0%
100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Source: author’s calculations on the basis of PROFO Survey Database

Finally, Figure 2.3 show the geographical distribution of the two samples. The most significant
difference between the two samples is the relatively higher concentration of the control group in
the Metropolitan Region, while the participant group is slightly more concentrated in the centre-
southern regions (VIII, IX, X).40

Figure 2.3 – Sample distribution by Region

0.4

0.3

0.2

0.1

0
I II III IV V VI VII VIII IX X XI XII RM

Participant Non-participant

Source: author’s calculations on the basis of PROFO Survey Database

Between the end of 2002 and the first part of 2003, a group of researchers interviewed the 943
firms of the two groups on the basis of a closed answer questionnaire. The questionnaire was
structured into four sections. The first one is devoted to general information about firms, such as
name, address, tax ID, sector code and so on.

40
These differences might slightly affect the results of the comparative analysis of innovativeness, which is based
just on the basic matching procedure. Once again, if any bias occurs, this will probably lead to an underestimation of
the results of the group less concentrated in the Metropolitan Region, that is the participant group, given the potential
higher opportunities offered by the closeness to the capital.

22
 The second section includes data on the economic performance of firms – such as value of
production, employment and investment – in the period 1998-2001. These data are at the basis of
the econometric analysis of the impact of the program on firm-level productivity.
The third section provides some information on firms’ innovative activities. More specifically,
the questionnaire deals with innovation from two different perspectives: changes occurring within
firms and changes occurring in the relations with agents outside firms. In the first case, three
functional areas were analysed: the firm’s management, production process, and products. In the
second case, three types of external relations were taken into account: commercial relations,
financing and source of technological innovation. For each of these areas and types, firms had to
indicate within a closed set of detailed alternatives what changes had been introduced and their
relevance for overall competitiveness.41 In addition, some information on determinants and
obstacles to innovation activities were also collected.
Finally, the last part of the questionnaire was devoted to analysing participant opinions on the
program. In this section I introduced some questions that allowed collection of relational data, i.e.
information on the quantity and quality of links within the network and on their evolution. This
allowed me to develop the most innovative part of my analysis: the relation between sociometric
characteristics of the networks and firms’ performances.

2.3 Evolution of network structure

In this section I concentrate on how the structure of networks can affect firm-level results in
terms of innovativeness. In order to deal with this fundamental aspect, at least from the
perspective of my approach, some relational data of participating firms were collected. In
particular, firms involved in the program were asked to indicate the degree and value of their
linkages within each different network (Wasserman and Faust 1994). The information was
specified in three fundamental dimensions: commercial, technological and financial linkages. The
respondents were asked to indicate how many connections they formed with other PROFO
partners, the intensity of these linkages and the evolution of relations during the period of
participation in the program.

41
As I will explain later, a quite different approach has been adopted with regard to the source of technological
innovation.

23
 I will now briefly define the indicators that will be used from now on. In the case of
commercial relations the respondents were asked to indicate:
− TRD1: with how many other members of the network they traded in goods and services;
− TRD2: with how many other members of the network they exchanged commercial
information.
In terms of technological relations, participants were asked to declare:
− TEC1: how many other members of the network they usually exchanged technological
information with;
− TEC2: how many other firms’ production plants they visited within the network;
− TEC3: with how many other members exchange of skilled workers occurred;
− TEC4: with how many partners they carried out joint R&D activities.
Finally, with reference to financial relations, participants were asked to indicate:
− FIN1: with how many other partners they exchanged financial resources;
− FIN2: with how many other partners they created a new independent firm.
In all cases participant were asked to give also an evaluation of relevance and definition of
linkages dynamic. Relevance was evaluated with the same four-grade system previously defined.
Dynamic was measured by asking the respondent to indicate the quantity and relevance of
relations before, during and after the program.
In order to summarize and evaluate the characteristics of different networks, I use the
Standardized Actor Degree Centrality Index (CD), as defined in the case of non-directional
relations (Wasserman and Faust 1994): 42

d (i )
C D (i ) = (2.1)
mg − 1

where d(i) is the degree of firm i, that is the number of linkages declared by firm i, and mg is
the total number of firms belonging to the network. This indicator ranges from 0 when the firm is
isolated, to 1 when firm i is connected to all the other members of the network. In the Social
Network Analysis literature, an actor with a high centrality level, as measured by its degree, is

42
The choice of this option was dictated by the fact that firms were asked to identify “with how many PROFO
partners they usually exchanged goods, information and financial resources”. The term exchange implies a bilateral
relation that fits well with the definition of non-directional relations.

24
“where the action is” in the network. Others should recognize this actor as a major channel of
relational information, indeed, a crucial cog in the network. In the present work, I attribute to this
indicator a more limited meaning: it indicates more the “vivacity” of each member, rather than its
prestige within the network.43 Throughout my work, I calculate the average value of the CD for
each network and use it as a proxy for the density of the network (DN). This approximation is due
to the fact that in order to calculate the density index I would need to know the complete
sociomatrix of each network. This would involve knowing not only how many other firms each
member is connected to, but also the names of these firms.
Moving on to the analysis, I firstly report some statistics on the structure of the networks.
Since the number of studied networks is quite large (571 firms distributed in 84 networks), in this
phase I mainly analyse average figures.

Table 2.4 – General structure of linkages

Average Density Index*
Before During After ∆% A/B**
TRD1 0.164 0.382 0.287
∆% 133.2% -24.8% 75.5%
TRD2 0.183 0.437 0.308
∆% 138.7% -29.6% 68.1%
TEC1 0.136 0.362 0.264
∆% 165.4% -27.1% 93.5%
TEC2 0.182 0.441 0.278
∆% 141.6% -37.0% 52.2%
TEC3 0.029 0.079 0.064
∆% 169.9% -19.3% 117.7%
TEC4 0.034 0.075 0.064
∆% 118.7% -15.4% 85.1%
FIN1 0.065 0.229 0.148
∆% 253.3% -35.4% 128.1%
FIN2 0.042 0.243 0.147
∆% 474.2% -39.5% 247.3%
* I do not consider the centrality index since its average value calculated on the whole sample is equal to the average of
the density index calculated on the whole sample.
** (DN After/ DN Before) – 1
Source: author’s calculations on the basis of PROFO Survey Database

Tables 2.4 and 2.5 show some interesting results. First, the program confirms its significant
effect in improving linkages between the participating firms both in terms of quantity (see Table
2.4) and in terms of quality (see Table 2.5). From the quantitative point of view, the general trend

43
In the case of directional networks an alternative measure of the relevance of a node in a network is the Prestige
Indicator, which is calculated as the Degree Centrality Index but just considering the “passive” connection.

25
in all the indicators is a substantial increase in the average density when comparing the structure
before accessing the program and during the program, and then a decrease when comparing
during with after the end of the program. This trend is not surprising and is perfectly consistent
with the process described in Figure 2.1: the strong increase of linkages in the before-during
comparison reflects both the “catalysing effect” of the Intermediate Agent during the preliminary
stage and the “coordination effect” of the Project Manager during the PROFO stage. The slight
decrease of linkages in the during-after comparison might reflect a rationalisation process of the
network’s structure. Nevertheless, the most interesting result comes from comparing the values of
average centrality and density before and after attending the program. In all the cases, the data
show a significant increase. Even after public coordination of the network is discontinued, firms
maintain the higher-level associativity they reached because of the program.

Table 2.5 – General value of linkages

Average Intensity Evaluation*
Before During After ∆% A/B**
TRD1 2.183 2.420 2.486
∆% 10.9% 2.7% 13.9%
TRD2 2.055 2.369 2.405
∆% 15.3% 1.5% 17.0%
TEC1 2.228 2.433 2.512
∆% 9.2% 3.2% 12.7%
TEC2 2.260 2.523 2.529
∆% 11.6% 0.2% 11.9%
TEC3 1.660 2.186 2.295
∆% 31.7% 5.0% 38.3%
TEC4 1.917 2.099 2.217
∆% 9.5% 5.6% 15.6%
FIN1 2.176 2.446 2.420
∆% 12.4% -1.1% 11.2%
FIN2 2.561 2.549 2.904
∆% -0.5% 13.9% 13.4%
* Average grade attributed to the intensity of linkages (1 = low; 2 = Medium; 3 = High 4 = very high).
** (Intensity After/ Intensity Before) – 1
Source: author’s calculations on the basis of PROFO Survey Database

These results are confirmed and even reinforced by taking into account data on the quality of
the linkages (see Table 2.5). In this case the general trend is a constant increase of the perceived
relevance of the ties within the network, with just two marginal exceptions in the financial
indicator. Once again, the before-after comparison shows a significant positive increase in all the
indicators.

26
 Taken together, quantitative and qualitative results suggest that public coordination
significantly affected the firm’s ability to create and maintain relevant linkages with other firms
and provide good evidence of the positive potential for the role of a public agent in creating,
fostering and consolidating knowledge-sharing networks.

2.4 Network structure and public coordination

Given these first important empirical pieces of evidence, I now move on to analyse the
relationship between the evolution of network structure and public coordination and the impact of
network structure and public coordination on innovation.
Evaluating the level of public effort in coordinating networks involves a fairly complex
estimation. First of all, given that this variable is not directly observable, it is necessary to
identify a good proxy.
One hypothesis is to use the amount of funds received by each PROFO network, since this
amount also includes the cost of the coordinating agent. Nevertheless there are some problems
that make this variable too biased for my purpose: first, it is impossible, since data are
confidential and not available, to distinguish between the percentage of public funds devoted to
coordination and the percentage devoted to financing the whole project. This proxy thus
overestimates coordination in high-value projects and underestimates it in low-value projects.
Since low-value projects could involve a large group of small firms, where there is a significant
problem in coordinating actors, this distortion does not seem marginal. Secondly, the financing of
coordination activities does not strictly involve a real coordinating effort. Clearly, this is a minor
problem compared to the first and it is also usual in all efforts to evaluate the impact of a public
action carried out by an “external” agent. Finally, the public coordination activities are not
implemented just by the Project Manager financed by the project’s funds, but to some extent also
by the executives of the Intermediate Agencies and directly by the executives of CORFO’s local
agency. Because of all these problems I do not use the total amount of public funds as a proxy for
coordination.
A second alternative could be to use the number of “project meetings” carried out by each
PROFO group. In the survey three pieces of information related to this issue were collected: the
average number of “project meetings” per year; the percentage participation of respondents; and
the estimated percentage participation of other members. Some characteristics of this variable
make it definitely more appropriate for my purposes than the funds received by each project: first

27
of all it is directly related to the coordination activities carried out in each network. The number
of meetings required to deal with a common project is an increasing function of the ratio between
a project’s complexity and participant capabilities and, indeed, shows more homogeneously the
need for a coordinating agent. Secondly, it is clearly more related to the creation and
strengthening of linkages among the members. Finally, it allows the participation of each firm in
coordination activities to be identified, since the rate of participation in project meetings is
available.
However, this variable also shows some problems. The main one is that the number of
meetings that could be organized per year is negatively related to the size of the network. Since
this difficulty involves a greater coordination effort, I decided to take into account this aspect
simply by multiplying the number of meetings by the number of members of the group.44 In
brief, I use the following indicators:

CORi = met g * m g (2.2)

PARi = met i * m g (2.3)

where metg is the average number of “project meetings” carried out in network g, meti is the
number of meetings attended by firm i and mg is the number of members of the network g.

Table 2.6 – Network evolution and public coordination

∆ Centrality - Coordination a ∆ Density – Coordination a
TRD1 0.1749 *** 0.2225 ***
TRD2 0.0433 0.2442 ***
TEC1 0.0893 ** 0.2581 ***
TEC2 0.1244 *** 0.2044 ***
TEC3 0.0425 0.2459 ***
TEC4 0.0567 0.3538 ***
FIN1 0.1293 *** 0.0785 *
FIN2 0.1094 *** 0.2127 ***
a
Spearman correlation index
***significant at the 1% level, ** 5%, * 10%
Source: author’s calculations on the basis of PROFO Survey Database

44
A more complex indicator should be adopted in order to deal with the problem of dimension, but the results do not
change.

28
 In order to evaluate how public coordination affected the network structure, I consider the
statistical relationship between coordination activity and the before-after evolution of a single
firm’s centrality index and of the density index of each network. More specifically, I analysed the
Spearman Correlation Index (Conover 1999) between the PAR indicator and the ratio between
the centrality index before and after participating in the program, and the relationship between the
COR indicator and the density index before and after participating in the program in all the
dimensions of potential linkages previously defined. Table 2.6 shows the results.
First of all, it is worth noticing that the correlation between coordination and density is
definitely more robust than between participation and centrality. On the one hand, this is due to
the tendency of respondents to overstate their participation in the program. On the other hand, the
density index takes into consideration average changes within the network and, thus, reduces the
impact of firm-specific factors that affect the cooperation decision. Because of this, I mainly
consider the results in terms of density.
Exercising proper caution, the results quite clearly show a positive correlation between
coordination activities and an increase in the number of linkages between firms in all the
considered dimensions. As expected, the correlation indexes are positive, but quite low and
sometimes not significant. This is due to the fact that there are many other factors that can affect
the evolution of the social characteristics of the networks (firm-specific capabilities, propensity to
cooperate, entrepreneurs’ level of education etc.). Furthermore, public coordination seems to not
only affect soft cooperation, such as the sharing of commercial (TRD2) and technological
information (TEC1), but also more committing cooperation such as joint R&D activities (TEC4)
and the setting up of a new company (FIN2).
Taken together these considerations offer further evidence of the effectiveness of the program.
In fact, if one of the main objectives of PROFO is to reduce the isolation of Chilean SMEs by
providing support in coordinating their activities with other potential partners, what actually
occurred is that the deeper the coordination activities, the better were the results in terms of
creation of long-run linkages, that is linkages that survived even after the end of the program.

2.5 Network structure and firms’ innovativeness

This last section deals with the analysis of the relationship between changes in the network
structure, affected by public coordination, and the performance of firms in terms of innovation.
To this end, I analyse the relation between the sociometric characteristics of each firm (its

29
centrality and the density of the network it belongs to) and its innovativeness, measured by an
indicator that measures not only the “entry level” of innovativeness, but also its perceived
intensity.45 This allows me to analyse in more depth the program’s impact on the innovative
pattern of participant firms and to compare it with the control group, where data are available.
More specifically, I consider the following index:

4 4
i
GE = ∑ ni ∑n i (2.4)
i =1 4 i =0

where GE stands for Grade Evaluation, and ni is the number of firms that chose the ith class.
The indicator ranges from 0 in the case where all firms expressed a zero evaluation to 1, when all
the firms expressed an evaluation of 4. Since each area of innovation accounts for different
possible changes, I also report the area’s average GE value for both the participant and the non-
participant firms. This Innovativeness Index (IND) has been calculated as follows:

Pk Pk
⎛ 4 i 4
⎞
INDk = ∑ (GE ) j Pk = ∑ ⎜ ∑ ni ∑ n ⎟⎠ i Pk (2.5)
j =1 j =1 ⎝ i =1 4 i =0 j

where k is the area of innovation (for example managerial innovation), Pk is the number of
possible changes accounted in the k area, j ranges between 1 and Pk and defines the single
possible change (for example the introduction of tools for strategic planning) and ni is the number
of innovations that were attributed to the ith class. Since IND actually is the average of GE in
each area of innovation, it also varies between 0 and 1.
Since the sociometric characteristics are clearly not sufficient to explain the relative
innovativeness of a firm, I could check for other firm-specific characteristics that might affect
firms’ activity. Specifically, I estimate for each area of innovation the following two equations:

INDi = α + β 1 AGEi + β 2 SIZ i + β 3 CEN i + β 4 PARi + β 5 DSETi + ε i (2.6)

INDi = α + β 1 AGEi + β 2 SIZ i + β 3 DEN i + β 4 CORi + β 5 DSETi + ε i (2.7)

45
In order to convert the qualitative scale used throughout this questionnaire into a numeric one, I associate to the
classes “low”, “medium”, “high” and “very high” the grades 1, 2, 3 and 4 while the grade 0 was attributed to the
classes “null” and “do not apply”.

30
 where SIZ is the firm’s size in terms of number of workers; DSET is a vector of dummy
variables related to the sector of the firm; AGE is the age of the firm, CEN is the Centrality Index
of the firm; DEN is the density of the network which the firm belongs to; PAR is an indicator of
the firm’s participation in public coordination activities, as previously defined; COR is an
indicator of public coordination activity as previously defined. The firm’s sociometric
characteristics are calculated taking into account all the specifications adopted in this work, as
well as the area of potential innovation. This means that equations (2.6) and (2.7) could be
estimated considering four areas of innovation where the IND indicator is available (process
innovation, product innovation, changes in commercial external relations, changes in financial
external relations) and in each case considering eight different relational dimensions.
With regard to innovation, I focus my attention on the two main traditional areas of innovative
activity: process and product innovation. However, I chose to consider both centrality and
density, since they represent slightly different perspectives. The first just defines the “vivacity” of
a firm within the network, and thus its ability to initiate links with other partners, and can affect
its ability to innovate (or is correlated with its ability to innovate). Thus, a positive and significant
sign of the coefficient of the centrality variable can be interpreted in two complementary ways:
on the one hand, more linkages mean more availability of knowledge and, thus, more possibilities
of innovating; on the other hand, the more active a firm is in developing linkages with external
agents, the more it innovates.
On the other hand, density allows more in-depth evaluation of the general impact of
knowledge flows, and of other resources among the network’s participants, on innovative
activities at firm level. In this case, I do not only consider the number of linkages issued by each
firm, but also the overall average “connectivity” of each network. This makes it possible to
evaluate different performance not only with reference to the “vivacity” of each single agent, but
also with reference to the level of development of the “society” in which each firm participates.
Thus, a positive and significant value of the coefficient of the DEN variable could be interpreted
as follows: firms participating in a more connected network, and this does not automatically
imply that firms forming most of the ties, are more innovative because of the higher level of
specific knowledge they can access.

31
 Let me first consider process innovation. Tables 2.7 and 2.8 show the results of the estimation
of equations (2.6) and (2.7). The eight columns refer to the dimension in which the sociometric
characteristics of the networks are measured.

Table 2.7 – Network structure and firm-level process innovation: equation 6 (a)
TRD1 TRD2 TEC1 TEC2 TEC3 TEC4 FIN1 FIN2
Constant 0.147** 0.146** 0.122** 0.135** 0.130** 0.142** 0.131** 0.169***
(0.0567) (0.0573) (0.0565) (0.0560) (0.0559) (0.0549) (0.0560) (0.0573)
AGE -0.036*** - 0.038*** - 0.036*** -0.041** -0.027*** -0.028** -0.037*** -0.036***
(0.0125) (0.0126) (0.0124) (0.0123) (0.0124) (0.0122) (0.0123) (0.0127)
SIZ 0.058*** 0.059*** 0.053*** 0.055*** 0.057*** 0.055*** 0.054*** 0.061***
(0.0069) (0.0068) (0.0069) (0.0067) (0.0066) (0.0065) (0.0068) (0.0066)
CEN 0.059** 0.040* 0.100*** 0.099*** 0.189*** 0.231*** 0.107*** -0.035
(0.0231) (0.0219) (0.0224) (0.0222) (0.0387) (0.0373) (0.0236) (0.0232)
PAR 0.024*** 0.025*** 0.027*** 0.026*** 0.023** 0.021** 0.027*** 0.023**
(0.0091) (0.0091) (0.0090) (0.0090) (0.0090) (0.0089) (0.0090) (0.0092)

Obs. 515 515 514 515 515 515 515 513

F-statistics 10.21 9.84 11.71 11.70 12.12 13.70 11.78 9.75
2
R 0.1826 0.1774 0.2042 0.2037 0.2095 0.2305 0.2048 0.1763
2
Adjusted R 0.1647 0.1594 0.1867 0.1863 0.1922 0.2137 0.1874 0.1582
(a)
Sectoral dummy coefficients are omitted; ***significant at the 1% level, ** 5%, * 10%

Source: author’s calculations on the basis of PROFO Survey Database

Data on process innovation provide quite clear evidence of the impact of network structure on
the innovative pattern of firms. The coefficients of the centrality and density variables are
positive and strongly significant in almost all the regressions, with only two exception: TRD2,
which is the relational dimension focused on commercial information flows (weakly significant
in terms of centrality and not-significant in terms of density) and FIN2, which is the dimension
focused on joint-venture development (not-significant in terms of centrality and negatively
significant in terms of density). As expected, technological linkages seem to be particularly
significant, and mainly those related to exchanges of skilled labour (TEC3) and those related to
joint R&D activities (TEC4). The former is particularly noteworthy. Given the low mobility of
labour, this factor to some extent allows evaluation of the potential impact of localized
externalities on the innovative activities of firms. As pointed out by the extensive literature on
cluster and industrial districts, access to the same “pool” of skilled labour and “exchange” of

32
human resources is one of the most effective channels through which specific non-rival
knowledge is transmitted within a network (see among the others Maskell 2000, Belussi and
Pilotti 2002, Garofoli 2002).

Table 2.8 – Network structure and firm-level process innovation: equation 7 (a)
TRD1 TRD2 TEC1 TEC2 TEC3 TEC4 FIN1 FIN2
Constant 0.089 0.151** 0.035 0.080 0.097 0.110 0.049 0.175
(0.0719) (0.0774) (0.0763) (0.0711) (0.0683) (0.0671) (0.0731) (0.0710)
AGE -0.036*** -0.039*** -0.037*** -0.041*** -0.025** -0.027** -0.033*** -0.038***
(0.0123) (0.0126) (0.0123) (0.0122) (0.0122) (0.0119) (0.0122) (0.0124)
DIM 0.054*** 0.058*** 0.049*** 0.052*** 0.052*** 0.050*** 0.053*** 0.058
(0.0067) (0.0068) (0.0068) (0.0067) (0.0065) (0.0065) (0.0067) (0.0067)
DEN 0.116*** 0.014 0.155*** 0.117*** 0.352*** 0.428*** 0.138*** -0.059**
(0.0364) (0.0329) (0.0335) (0.0292) (0.0593) (0.0612) (0.0335) (0.0285)
COR 0.033*** 0.025** 0.042*** 0.036*** 0.027** 0.026** 0.040** 0.024**
(0.0118) (0.0128) (0.0126) (0.0118) (0.0113) (0.0112) (0.0120) (0.0117)

Obs. 536 529 529 536 536 536 536 532

F-statistics 9.96 8.93 11.23 10.61 12.68 14.15 10.71 9.26
2
R 0.1730 0.1596 0.1928 0.1822 0.2102 0.2290 0.1836 0.1638
2
Adjusted R 0.1556 0.1417 0.1757 0.1650 0.1936 0.2128 0.1664 0.1461
(a)
Sectoral dummies’ coefficient are omitted; ***significant at the 1% level, ** 5%, * 10%

Source: author’s calculations on the basis of PROFO Survey Database

These results confirm the two main hypotheses tested in this section: first of all, firms which
invest more in creating and developing linkages within the network obtain better results in terms
of process innovation; secondly, firms which participate in more connected networks obtain
better results in terms of process innovation. As already pointed out, in the first case it is more
difficult to established a strong cause and effect relationship between innovativeness and
“sociality”, nevertheless in the second case it seems clearer that a higher density of relationships
means it is easier to access more specific knowledge and, thus, greater innovativeness of
participants.
Among the other control variables, the estimation of the impact of public coordination
activities (COR) and of a firm’s attendance in public coordination (PAR) on innovation activities
shows positive and significant (at least slightly significant) coefficients in all the regressions. This
means that coordination activities are important not only indirectly through the creation and

33
development of linkages among participating firms, but also directly. Otherwise, I would expect a
non-significant coefficient for this variable. Thus, consistently with my predictions (see Figure
2.1), the program quite clearly produces both a “coordination effect” and a “codification effect”.
The variable AGE, which represents the age of the firm, has a negative and significant coefficient
in all the regressions, indicating that new firms seem to be more innovative than the older ones.
Finally, all the regressions show a positive and significant correlation between the size of the
firms (SIZ) and their performance in terms of process innovation.

Moving on to product innovation, Tables 2.9 and 2.9 show quite a similar picture.

Table 2.9 – Network structure and firm-level product innovation: equation 6 (a)
TRD1 TRD2 TEC1 TEC2 TEC3 TEC4 FIN1 FIN2
Constant 0.010 0.009 0.002 0.009 0.007 0.011 0.009 0.017
(0.0146) (0.0145) (0.0145) (0.0146) (0.0146) (0.0144) (0.0147) (0.0150)
AGE -0.002 -0.003 -0.001 -0.003 -0.0003 -0.0001 -0.002 -0.002
(0.0032) (0.0033) (0.0032) (0.0032) (0.0032) (0.0032) (0.0032) (0.0033)
DIM 0.012*** 0.012*** 0.010*** 0.012*** 0.012*** 0.012*** 0.012*** 0.013***
(0.0018) (0.0018) (0.0018) (0.0018) (0.0017) (0.0017) (0.0018) (0.0018)
CEN 0.023*** 0.015*** 0.034*** 0.024*** 0.048*** 0.058*** 0.022*** -0.005
(0.0060) (0.0057) (0.0058) (0.0058) (0.0101) (0.0098) (0.0062) (0.0060)
PAR 0.004** 0.005** 0.006** 0.005** 0.004* 0.003 0.005** 0.004*
(0.0024) (0.0024) (0.0023) (0.0024) (0.0023) (0.0023) (0.0024) (0.0024)

Obs. 515 514 514 515 515 515 515 513

F-statistics 10.09 9.21 12.17 10.58 10.89 11.66 9.80 8.42
R2 0.1808 0.1679 0.2105 0.1879 0.1923 0.2032 0.1766 0.1570
2
Adjusted R 0.1629 0.1497 0.1932 0.1702 0.1747 0.1857 0.1586 0.1374
(a)
Sectoral dummy coefficients are omitted; ***significant at the 1% level, ** 5%, * 10%

Source: author’s calculations on the basis of PROFO Survey Database

Both the density data and the centrality data confirm the strong effect of network structure on
the improvement and creation of new products. A higher number of connections, both active and
passive, in the different relational dimensions analysed, imply a higher level of innovativeness
(with the only exception of FIN2).
Also in this case, the most effective relationships seem to be those related to the development
of common R&D activities (TEC4) and the exchange of skilled labour (TEC4).

34
 Once again the innovative capability of firms is positively related to their size, while firms’
age does not show a significant impact on product innovation. Compared with process
innovation, the role of public coordination seems significantly less relevant: despite the positive
sign, the coefficients of PAR and COR are rarely significant. As I have already pointed out in the
previous sections, this result is not surprising, since it is quite consistent with the objectives of the
program.

Table 2.10 – Network structure and firm-level product innovation: equation 7(a)
TRD1 TRD2 TEC1 TEC2 TEC3 TEC4 FIN1 FIN2
Constant 0.006 0.029 0.001 0.007 0.012 0.016 0.007 0.030
(0.0189) (0.0203) (0.0200) (0.0187) (0.0181) (0.0180) (0.0194) (0.0186)
AGE -0.002 -0.003 -0.003 -0.003 0.0002 -0.0004 -0.002 -0.003
(0.0032) (0.0033) (0.0032) (0.0032) (0.0032) (0.0032) (0.0032) (0.0033)
DIM 0.011*** 0.012*** 0.010*** 0.011*** 0.011*** 0.010*** 0.011*** 0.012***
(0.0018) (0.0018) (0.0018) (0.0018) (0.0017) (0.0017) (0.0018) (0.0017)
DEN 0.032*** 0.006 0.039*** 0.027*** 0.077*** 0.080*** 0.023** -0.010
(0.0095) (0.0086) (0.0088) (0.0077) (0.0157) (0.0165) (0.00889) (0.0075)
COR 0.005 0.002 0.006* 0.005* 0.003 0.003 0.005 0.002
(0.0031) (0.0033) (0.0033) (0.0031) (0.0030) (0.0030) (0.0032) (0.0031)

Obs. 536 529 529 536 536 536 536 532

F-statistics 8.64 7.75 9.82 8.77 9.95 9.95 8.15 7.74
2
R 0.1536 0.1415 0.1728 0.1555 0.1728 0.1729 0.1460 0.1406
2
Adjusted R 0.1358 0.1232 0.1552 0.1378 0.1555 0.1555 0.1280.1 0.1224
(a)
Sectoral dummy coefficients are omitted; ***significant at the 1% level, ** 5%, * 10%

Source: author’s calculations on the basis of PROFO Survey Database

As mentioned before, the relational data were collected not only in terms of the existence or
not of a certain number of linkages, but also for the perceived intensity of these relationships. I
will now test the impact of network structure considering not only the existence of linkages
among PROFO participant, but also the perceived intensity of these linkages.
In order to investigate this further factor, I need to modify the centrality and density indicators.
According to Social Networks Analysis (Wasserman and Faust 1994), it is possible to include the
intensity of linkages in the Standardized Actor Degree Centrality Index (CD) simply by
multiplying the firm’s degree by the average intensity of the linkages. Thus I can define a Valued
Actor Degree Centrality Index (CVD) as follow:

35
 d (i ) × v (i ) 4
CV D (i ) = (2.8)
mg − 1

where v (i ) is the average grade attributed by firm i to linkages with other PROFO members.
The grade is normalized dividing by four, in order to maintain the indicator in a range between 0
and 1.

Table 2.11 and 2.12 show the results of adopting the CVD in the estimation of equation (6) and
(7) for process innovation. As expected, the coefficients of density and centrality remain positive
and significant in all the regressions. In addition, comparing the estimator calculated on the basis
of non-valued linkages and the valued ones, there is a clear increase in all the coefficients of
different measures of centrality and density.

Table 2.11 – Network structure and firm-level process innovation: equation 6(a)
TRD1 TRD2 TEC1 TEC2 TEC3 TEC4 FIN1 FIN2
Constant 0.183*** 0.183** 0.167*** 0.182*** 0.157*** 0.179*** 0.175*** 0.194***
(0.0525) (0.0526) (0.0521) (0.0520) (0.0515) (0.0512) (0.0520) (0.0531)
AGE -0.038*** - 0.042*** - 0.038*** -0.042*** -0.023* -0.030** -0.040*** -0.039***
(0. 0122) (0.0122) (0.0120) (0.0121) (0.0121) (0.0120) (0.0120) (0.0123)
DIM 0.055*** 0.054*** 0.051*** 0.054*** 0.053*** 0.053*** 0.052*** 0.061***
(0.0065) (0.0065) (0.0065) (0.0065) (0.0064) (0.0063) (0.0065) (0.0066)
CEN 0.101*** 0.103*** 0.152*** 0.120*** 0.346*** 0.379*** 0.155*** 0.012
(0.0309) (0.0300) (0.0294) (0.0270) (0.0555) (0.0610) (0.0325) (0.0339)
PAR 0.019*** 0.020** 0.021** 0.020*** 0.017** 0.017** 0.022*** 0.020**
(0.0083) (0.0083) (0.0082) (0.0082) (0.0080) (0.0081) (0.0082) (0.0084)

Obs. 540 539 539 540 540 540 540 539

F-statistics 10.24 10.34 11.97 11.23 13.28 13.25 11.54 9.06
2
R 0.1759 0.1755 0.1999 0.1896 0.2167 0.2163 0.1939 0.1591
2
Adjusted R 0.1587 0.1603 0.1832 0.1727 0.2004 0.2000 0.1771 0.1415
(a)
Sectoral dummy coefficients are omitted; ***significant at the 1% level, ** 5%, * 10%

Source: author’s calculations on the basis of PROFO Survey Database

This actually means that not only the number of connections matters in affecting the
innovative results of firms, but also their intensity. More specifically, the most significant

36
increase in impact occurs in the two areas where the program was most effective in promoting the
average intensity (or relevance) of linkages between firms: the flows of commercial information
(TRD2), whose coefficients for centrality and density increase by 158% and 729% respectively,
the exchange of skilled labour (TEC3), +83% and +26%, and cooperation in R&D activities
(TEC4), + 64% and +71%.

Table 2.12 – Network structure and firm-level process innovation: equation 7(a)
TRD1 TRD2 TEC1 TEC2 TEC3 TEC4 FIN1 FIN2
Constant 0.067 0.099 0.035 0.089 0.108 0.106 0.042 0.150**
(0.0716) (0.0763) (0.0756) (0.0737) (0.0678) (0.0673) (0.0727) (0.0710)
AGE -0.034*** -0.038*** -0.039*** -0.040*** -0.023* -0.028** -0.033*** -0.038***
(0.0122) (0.0125) (0.0123) (0.0122) (0.0121) (0.0119) (0.0122) (0.0125)
DIM 0.053*** 0.055*** 0.050*** 0.053*** 0.052*** 0.051*** 0.052*** 0.058***
(0.0066) (0.0068) (0.0067) (0.0066) (0.0065) (0.0064) (0.0066) (0.0067)
DEN 0.207*** 0.116** 0.213*** 0.149*** 0.443*** 0.730*** 0.218*** 0.014
(0.0491) (0.0454) (0.0432) (0.0357) (0.0701) (0.1056) (0.0484) (0.0445)
COR 0.035*** 0.033** 0.043*** 0.034*** 0.025** 0.028** 0.041*** 0.026**
(0.0117) (0.0127) (0.0126) (0.0117) (0.0113) (0.0112) (0.0120) (0.0118)

Obs. 536 529 529 536 536 536 536 532

F-statistics 10.79 9.62 11.53 10.75 13.17 14.02 11.06 8.81
2
R 0.1847 0.1700 0.1970 0.1842 0.2166 0.2274 0.1884 0.1571
2
Adjusted R 0.1675 0.1523 0.1799 0.1670 0.2002 0.2112 0.1714 0.1393
(a)
Sectoral dummy coefficients are omitted; ***significant at the 1% level, ** 5%, * 10%

Source: author’s calculations on the basis of PROFO Survey Database

The relevance of connection intensity is quite evident also in the case of product innovation
(see Table 2.13 and 2.14): all the coefficients of centrality and density indicators are significantly
higher than in the case without intensity evaluation.
Once again the largest increase occurred for flows of commercial innovation (+127% in terms
of centrality and +527% in terms of density). Compared with the case of process innovation, it is
worth noting the higher impact of traditional backward and forward linkages on product
innovation, when intensity of relation is taken into account (+52% and +91%).

37
 Table 2.13 – Network structure and firm-level product innovation: equation 6 (a)
TRD1 TRD2 TEC1 TEC2 TEC3 TEC4 FIN1 FIN2
Constant 0.015 0.014 0.010 0.015 0.010 0.015 0.014 0.018
(0.0137) (0.0137) (0.0136) (0.0136) (0.0136) (0.0136) (0.0137) (0.0139)
AGE -0.002 -0.003 -0.002 -0.004 -0.001 -0.001 -0.003 -0.003
(0.0032) (0.0032) (0.0031) (0.0032) (0.0032) (0.0032) (0.0032) (0.0032)
DIM 0.011*** 0.011*** 0.010*** 0.011*** 0.011*** 0.011*** 0.011*** 0.012***
(0.0017) (0.0017) (0.0017) (0.0017) (0.0017) (0.0017) (0.0017) (0.0017)
CEN 0.035*** 0.034*** 0.045*** 0.038*** 0.081*** 0.080*** 0.038*** 0.010
(0.0080) (0.0078) (0.0077) (0.0070) (0.0147) (0.0162) (0.0086) (0.0089)
PAR 0.004* 0.004** 0.005** 0.004* 0.004 0.004* 0.005** 0.004*
(0.0022) (0.0022) (0.0021) (0.0021) (0.0021) (0.0021) (0.0022) (0.0022)

Obs. 540 539 539 540 540 540 540 539

F-statistics 9.71 9.74 11.45 10.65 10.95 10.30 9.92 7.88
2
R 0.1682 0.1689 0.1929 0.1815 0.1858 0.1767 0.1713 0.1412
2
Adjusted R 0.1509 0.1516 0.1760 0.1645 0.1689 0.1596 0.1541 0.1233
(a)
Sectoral dummy coefficients are omitted; ***significant at the 1% level, ** 5%, * 10%

Source: author’s calculations on the basis of PROFO Survey Database

Table 2.14 – Network structure and firm-level product innovation: equation 7 (a)
TRD1 TRD2 TEC1 TEC2 TEC3 TEC4 FIN1 FIN2
Constant -0.001 0.013 0.003 0.005 0.014 0.014 -0.0002 0.023
(0.0187) (0.0199) (0.0199) (0.0184) (0.0178) (0.0178) (0.0192) (0.0185)
AGE -0.001 -0.003 -0.003 -0.003 0.001 -0.0004 -0.001 -0.003
(0.0032) (0.0033) (0.0032) (0.0032) (0.0032) (0.0032) (0.0032) (0.0033)
DIM 0.010*** 0.011*** 0.010*** 0.010*** 0.010*** 0.010*** 0.010*** 0.012***
(0.0017) (0.0018) (0.0018) (0.0017) (0.0017) (0.0017) (0.0017) (0.0018)
DEN 0.061*** 0.037*** 0.051*** 0.046*** 0.099*** 0.154*** 0.049*** 0.016
(0.0129) (0.0119) (0.0114) (0.0093) (0.0147) (0.0162) (0.0128) (0.0116)
COR 0.006* 0.004 0.006** 0.005* 0.003 0.003 0.006** 0.003
(0.0031) (0.0033) (0.0033) (0.0030) (0.0030) (0.0030) (0.0032) (0.0031)

Obs. 536 529 529 536 536 536 536 532

F-statistics 9.79 8.72 9.83 9.95 10.40 10.55 8.91 7.75
R2 0.1705 0.1565 0.1730 0.1728 0.1791 0.1814 0.1576 0.1409
2
Adjusted R 0.1531 0.1385 0.1554 0.1554 0.1619 0.1642 0.1399 0.1227
(a)
Sectoral dummy coefficients are omitted; ***significant at the 1% level, ** 5%, * 10%

Source: author’s calculations on the basis of PROFO Survey Database

38
2.6 Concluding remarks
To conclude this section, I will summarize the main implications of the empirical analysis
presented above. Firstly, it shows fairly strong evidence for the program’s effectiveness in
accomplishing one of its main objectives: to reduce the isolation of Chilean SMEs through the
creation and strengthening of industrial linkages. In fact, all the “before-after” estimators showed
significant increases both in the quantity and in the quality of stable relationships among the
members of each network. As I showed in Chapter 4, the participation in resource-sharing
networks and, in particular, in knowledge-sharing networks, could significantly affect firms’
learning processes and improve their innovative and productive performance. All these
considerations mean one can be reasonably sure that the increase in linkages is due to public
intervention. As mentioned before, the case of the PROFO program fits well with the theoretical
definition of a “coordination effect”. In this particular case, intervention by the public agent
mainly consists in providing potential (or effective) members of a network with financial and real
support in coordinating their joint activities.46 The statistical data analysis shows that there is a
positive and significant correlation between “densification” of networks and public coordination
activities. This result seems strongly consistent with other analyses of public networking policies,
which have shown the coordinating agent is crucially important in determining the success of this
kind of program (Dini 2001).47 Finally, through econometric analysis I demonstrate the
relationships between innovativeness and industrial cooperation. In this case it is worth noting
that the positive effect occurs both as a consequence of the firm’s ability to exploit the
opportunity to increase and improve its linkages with other firms and as consequence of simply
taking part in a well-connected network. The latter result is particularly significant because it is
clear evidence of the existence of network externalities: the greater the number of connected
members in a network48, the greater is the benefit for each participant in terms of accessible
knowledge.

46
Actually, when the Project Manager provides a real service support, a “codifying effect” can also occur. Despite
the relevance of this effect, in this section I almost ignore it and consider the PROFO program mainly as a
coordinating action.
47
In this context the “agentes articualtores” program is particularly interesting. It is also managed by CORFO and is
directly aimed at improving the capabilities of public and private coordinating agents.
48
Sometimes in social network studies the members of a network are defined as connected agents. In this case I
consider firms participating in the same PROFO project as members of a network but I analyze their social
characteristics from different point of view. I assume that a firm could be a member of a network even if it is not
connected in any other way than simple participation in the project.

39
2.7 Econometric analysis of the program’s impact on productivity
In this section I analyse the impact of the PROFO program on productivity. The effectiveness
of the program in improving firm-level productivity had already been analysed in a previous
evaluation of its pilot phase (Benavente and Crespi 2001). In my work I basically maintain the
same methodology, but analyse the effectiveness of the program on a wider sample of firms.
While it is important to update the evaluation of the program, I focus on an aspect that was
neglected in the previous analysis and that plays a key role for understanding the potential of
networking policy. As already done with reference to the innovativeness of firms, I analyse how
the sociometric characteristics of a firm participating in a knowledge-sharing network can affect
its productivity.
For this purpose, I proceed step-by-step, first analysing the overall impact of the program on
productivity by comparing results obtained from a sample of participant firms. I carry out this
evaluation both using panel data methodology and a before-after difference evaluation. Once the
general impact of participation in the program has been evaluated, I study how firm centrality and
network density affect productivity. In accordance with the theoretical framework defined in
Chapter 4, I expect that higher network density affects firms’ productivity by increasing the so-
called network multiplier. More specifically, I consider the following production function:

yi = A * F (ki, wi, xi) (2.9)

where wi = h(n, δ , µ ) * k i is the network multiplier. Since the program demonstrated a certain

effectiveness in creating and fostering linkages among members in the PROFO networks, I
expect a significant impact of the program on the network multiplier and, thus, on productivity.
There are three channels through which the program can affect the network multiplier: first of all,
by acting as a catalyst it increases the opportunities for creating new linkages by encouraging
firms to develop a common project in order to receive financing and by identifying and
connecting potential participants to this project. With reference to the multiplier, this actually
means increasing n, that is, the number of potential partners of a firm. Secondly, by financing
some coordinating activities, the program significantly reduces connection costs, thus promoting
the creation of linkages, that is an increase of µ. Finally, the program reduces the level of decay
(δ) of knowledge transmission through the qualitative improvement of relationships among the
members of a network.

40
 In order to evaluate the general impact of the program I use two different methodologies of
estimation. Since all the interviewed firms, both participant and not participant, were asked to
provide data on production, employment and investment for four years starting from the year
before entering into the program, or the period 1998 –2001,49 I estimate a simple Cobb Douglas
production function with the addition of a dummy variable indicating the participation to the
program. More in detail the estimated equation is:

ln Yit = α i + β1 ln EMPit + β 2 ln INVit + β 3 DPROi + ε it (2.10)

where Y is production, EMP is employment and DPRO is a dummy variable reflecting

participation in the program. Since data on capital are not available, I consider the cumulated
investment in the period (INV) as a proxy for physical capital. This estimation allows the average
productivity of each factor to be evaluated, together with the average total factor productivity
(TFP) of both participant and non-participant firms. It is not possible to draw any conclusion on
the impact of the program on productivity, but just to describe the average productive structure of
the two groups. I estimate equation (10) both with a simple OLS model and with a random effect
model controlling with the Hausman test (Hausman 1978) the efficiency of the panel
estimations.50
Table 2.29 shows that, considering the whole sample of participant and non-participant firms,
non-participant firms in general terms show a higher level of productivity, since the coefficient of
the dummy variable estimating equation (10) is negative and statistically significant. Since this
gap might depend on the higher concentration of agricultural firms in the PROFO group, I control
for this effect introducing in (10) a dummy for agricultural sector.

ln Yit = α i + β1 ln EMPit + β 2 ln INVit + β 3 DPROi + β 4 DAGRi + ε it (2.11)

By specifying the agricultural sector, it stands out that firms belonging to it have a
significantly lower TFP, as shown by the negative and significant coefficient of DAGR (see
Table 2.15). The dummy for PROFO participation becomes non-significant, confirming that the

49
Actually the period 1998-2001 regards also the majority of participant firms.

41
lower average productivity of the PROFO firms shown by equation (2.10) is actually due to the
relatively higher concentration of agricultural firms, while in the non-agricultural sector there are
not significant differences. This also suggest that given the reduction of available observation in
terms of production, a statistical re-matching of the two sample, participant and non-participant,
is needed in order to correctly evaluate the impact of the program.

Table 2.15 – Panel data regression of production function

(10) Pool (10) Panel (11) Pool (11) Panel
Constant 11.511*** 13.710*** 12.623*** 14.655***
(0.138) (0.201) (0.1368) (0.2055)
LnEMP 0.898*** 0.555*** 0.931*** 0.565***
(0.046) (0.033) (0.0429) (0.0325)
LnINV 0.169*** 0.017*** 0.146*** 0.016***
(0.008) (0.027) (0.0078) (0.0026)
DPROFO -0.418*** 0.540*** -0.235** -0.286
(0.0185) (0.332) (0.1103) (0.2240)
DAGR -2.471*** -2.682***
(0.1082) (0.2215)

Included 3246 3264 3246 3246

Observations
Wald-Chi2 343.06*** 514.25***
R2 (Overall) 0.2704 0.2043 0.3714 0.2888
Hausman test 902.35*** 1,000.84***
***significant at the 1% level, ** 5%, * 10%
Source: author’s calculations on the basis of PROFO Survey Database

As already mentioned the previous analysis does not allow the impact of the program on
productivity to be evaluated. To this end, I need an estimator that permits the performance of
participant firms to be compared with those of the control group, following the methodology of a
social experiment in a “non-experimental” evaluation design. The most efficient estimator in this
case is the “difference in difference” estimator (Benavente and Crespi 2001; Heckman, Ichimura,
Smith and Todd 1998): firstly, it avoids overestimating the impact of the program as in the case
of a simple before-after estimator;51 secondly since it is an estimation in first differences, it

50
Since the main variable I consider is a dummy variable, I excluded the utilization of the fixed effect methodology.
51
The Before-After estimator evaluates the impact of a program by simply comparing the performance of
participants before and after participation.

42
allows controlling for heterogeneity within the two groups. More specifically, I will estimate the
following equations:

(lnYit A
− lnYitB ) = αi + β1 (ln EMPit A − ln EMPitB ) + β2 ln INVit + εit (2.12)

(lnYit A
− lnYitB ) = αi + β1 (ln EMPit A − ln EMPitB ) + β2 ln INVit + β3 DPROi + εit (2.13)

where the Before-After estimator of TFP is given by the constant of equation (2.12), which is
estimated only for the participant group. Results are reported in Table 2.16.
In terms of a simple Before-After estimation of the productivity performance of firms
participating in the program, an increase of total factor productivity of around 15% can be found,
as shown by the constant’s coefficient in the first regression. This result just shows that
participant firms increased their total factor productivity during the period when they were
participating in the program. The basic problem of using this estimator is that it is unreasonable to
argue that the increase is totally or mainly due to participation in the program. To this end, as
suggested by the experimental methodology, I need to compare my sample of “treated” subjects
with a sample of non-treated subjects, which is the control group. The estimation of equation (13)
on the whole sample allows this aim to be accomplished. In particular, the dummy variable
coefficient indicating participation in the program (DPROFO) is a fair proxy for the impact of the
program on TFP. Thus, taking into account the “difference in difference” estimator, the impact of
the program falls to a 10% higher rate of TFP growth for participant firms, compared with the
Before-After estimator.

43
 Table 2.16 – Productivity differences estimator
Before-After (12) Differences in differences Differences in differences
(13) matched (13)
Constant 0.147*** 0.087** 0.074
(0.0435) (0.0469) (0.0506)
DIF_EMP 0.513*** 0.517*** 0.515***
(0.0810) 0.0627242 (0.0638)
LnINV 0.009** 0.005* 0.005*
(0.0036) (0.0030) (0.0030)
DPROFO 0.101** 0.109**
(0.0471) (0.0498)

Obs. 453 700 664

F-statistics 24.95*** 26.62*** 26.16***
R2 0.0998 0.1026 0.1063
Adjusted R2 0.0958 0.0987 0.1022
***significant at the 1% level, ** 5%, * 10%
Source: author’s calculations on the basis of PROFO Survey Database

Finally, since not all the firms interviewed provided data on their productivity and both groups
were significantly reduced, a re-matching of the two samples is probably required. The
fundamental idea of the matching methodology is to analyse a sub-sample of firms, both
participant and non-participant, that on the basis of their observable characteristics before
possible participation in the program, had the same probability of participating in the program. In
order to do this I take the following steps: firstly I estimate a Probit model that on the basis of
employment, production, industrial sector and geographical location define the probability of
participating in the PROFO program. Then, on the basis of this model I attribute to each observed
firm its ex-ante probability of participating in the program. Finally, I plot the Kernell probability
density distribution of both groups of firms. As it is shown in Figure 2.4(a), within the sub-
sample of firms with productivity observations, participant firms have a definitely higher ex-ante
probability of participating in the program. This is also confirmed by a strongly significant
Kolomogorov-Smirnov test of equality on the two distributions, i.e. the two distributions are not
equal.52

52
The probability of the PROFO group participating is higher than that of the control group with a significance of
1% (p-value 0.000).

44
 Figure 2.4 – ex-ante probability of participating in PROFO
(a) (b)
nopart part nopart part

6 6

4 4

2 2

0 0
.2 .4 .6 .8 1 .4 .6 .8 1
Pr(dprofo) Pr(dprofo)

Source: author’s calculations on the basis of PROFO Survey Database

By eliminating the extreme values in the two distributions, i.e. 36 observations in 700, I obtain
two more overlapping distributions, as shown by Figure 2.4(b), whose equality is also confirmed
by a non-significant Kolmogorov-Smirnov test.53 Thus, estimating equation (2.13) on the new
dataset, I obtain the results reported in the third column of Table 2.16. These results clearly
confirm the previous conclusions regarding the effectiveness of the program, showing an 11%
higher rate of increase of TFP for participant firms.
Thus, as emerged during the evaluation of the pilot phase (Benavente and Crespi 2001), not
only was the program effective in promoting the innovativeness of the participant firms, but also
in fostering their productivity, at least considering the results of the evaluation through the
“experimental” methodology.

Although evaluation of the program’s effectiveness is an important issue, it is not the only or
main objective of my work, even in terms of productivity analysis. The fact that participation in
the program implies better performance in terms of productivity is already quite strong evidence
for the importance of the network multiplier remaining in equation (2.9). Nevertheless, to better
understand the effectiveness of the network multiplier in a program like PROFO, an evaluation of
how the sociometric characteristics of participant firms affect productivity is needed. In order to

53
This actually means that neither of the two groups has a higher probability of participating ex-ante (combined K-S
p-value = 0.334).

45
do this, I estimate how the firm’s centrality and the network’s density affect the results of
participants. This exercise allows me to verify if productivity performances actually depend on
how an agent is directly or indirectly connected with other agents. In a first stage I use a simple
random effect panel data54 estimation of the following two equations:

ln Yit = α i + β1 ln EMPit + β 2 ln INVti + β 3CENit + β 4 DSETit + ε it (2.14)

ln Yit = α i + β1 ln EMPit + β 2 ln INVti + β 3 DENit + β 4 DSETit + ε it (2.15)

Where CEN stands for the firm’s centrality index, DEN for the density of each PROFO
network and DSET is a sector dummy variable. What I expect from this estimation is a measure
of how, on average, firm-level productivity was affected by the sociometric characteristics of
each firm and of the network they belong to during participation in the program. In this case I
chose to include in the analysis just the commercial and technological relational dimension.

Table 2.17 – Panel data regression sociometric impact on production: equation 14

TRD1 TRD2 TEC1 TEC2 TEC3 TEC4
Constant 3.911 4.097 3.982 4.027 4.030 3.986
(4.8097) (4.8044) (4.8156) (4.8100) 4.8008 (4.8089)
LEMP 3.606*** 3.587*** 3.600*** 3.587*** 3.620*** 3.628***
(0.0648) (0.0651) (0.0652) (0.0656) (0.0646) (0.0647)
LINV 0.039** 0.040** 0.039** 0.043*** 0.042*** 0.049***
(0.0165) (0.0164) (0.0166) (0.0164) (0.0164) (0.0164)
CEN 1.604*** 1.640*** 1.347*** 1.334*** 3.021*** 1.997***
(0.3008) (0.2797) (0.3012) (0.2793) (0.5942) (0.5953)

Obs. 2855 2851 2851 2855 2855 2855

Wald-Chi2 3295.91*** 3289.68*** 3258.58*** 3281.90*** 3285.24*** 8863.50***
2
R (Overall) 0.3363 0.3383 0.3353 0.3359 0.3401 0.3372
***Significant at the 1% level, ** 5%, * 10%; Sectorial Dummies omitted.
Source: author’s calculations on the basis of PROFO Survey Database

54
I use a random effect rather than a fixed effect panel since the former allows me to control for sectorial dummies.

46
 Table 2.18 – Panel data regression sociometric impact on production: equation 15
TRD1 TRD2 TEC1 TEC2 TEC3 TEC4
Constant 3.721 3.942 4.018 3.662 4.137 4.057
(4.8140) (4.8623) (4.8671) (4.8057) (4.8150) (4.8186)
LEMP 3.585*** 3.520*** 3.556*** 3.547*** 3.607*** 3.617***
(0.0651) (0.0664) (0.0665) (0.0664) (0.0645) (0.0647)
LINV 0.032** 0.034** 0.039** 0.061*** 0.029** 0.040**
(0.0166) (0.0167) (0.0170) (0.0163) (0.0166) (0.0165)
DEN 2.578*** 2.664*** 1.814*** 2.001*** 6.314*** 4.797***
(0.4298) (0.3844) (0.4175) (0.3344) (0.9363) (0.9622)

Obs. 2855 2827 2827 2855 2855 2855

Wald-Chi2 3316.99*** 3216.15*** 3146.24*** 3312.67*** 3341.49*** 3291.05***
2
R (Overall) 0.3335 0.3325 0.3271 0. 3387 0.3378 0.3357
***Significant at the 1% level, ** 5%, * 10%; Sectorial Dummies omitted.

Source: author’s calculations on the basis of PROFO Survey Database

From Tables 2.17 and 2.18, the relevance of centrality and network density on firm-level
productivity is clearly evident. In all the considered dimensions the coefficients of centrality and
density are positive and significant, and particularly in the cases of “stronger” relationships, such
as in the case of TEC3 (exchange of skilled workers) and TEC4 (joint R&D) as explanatory
variables. This result is strongly consistent with the prediction of the theoretical model on the
structure of the multiplier.

To conclude my work, I also take into consideration an estimate of network-structure impact

on productivity in first differences. The objective of this further exercise is to analyse whether
increased network participation due to the program generated a noticeable improvement in firm-
level productivity. To this end, I estimate the following equation:

(lnYit A
− lnYitB ) = αi + β1 (ln EMPit A − ln EMPitB ) + β2 ln INVit + β3 (CENit A − CENitB ) + εit (2.16)

(lnYit A
− lnYitB ) = αi + β1 (ln EMPit A − ln EMPitB ) + β2 ln INVit + β3 (DENit A − DENitB ) + εit (2.17)

47
 Table 2.19 – Network structure and firm-level productivity – differences estimations: equation 16
TRD1 TRD2 TEC1 TEC2 TEC3 TEC4
Constant 0.117** 0.114** 0.119** 0.117** 0.128** 0.127**
(0.0506) (0.0506) (0.0505) (0.0506) (0.0506) (0.0506)
DIFLEMP 0.535*** 0.519** 0.527** 0.524** 0.540*** 0.540***
(0.0943) (0.0947) (0.0946) (0.0946) (0.0950) (0.0947)
LINV 0.009** 0.009** 0.009** 0.010** 0.010** 0.010**
(0.0043) (0.0042) (0.0043) (0.0042) (0.0043) (0.0043)
CEN 0.195* 0.224** 0.217* 0.213** 0.062 0.136
(0.1086) (0.1031) (0.1172) (0.1098) (0.2053) (0.2410)

Obs. 402 402 402 402 402 402

F-statistics 1505 1560 1512 1512 1389 1397
2
R 0.1019 0.1052 0.1023 0.1031 0.0948 0.0953
2
Adjusted R 0.0951 0.0984 0.0955 90.063 0.0880 0.0885
***Significant at the 1% level, ** 5%, * 10%; Sectorial Dummies omitted.

Source: author’s calculations on the basis of PROFO Survey Database

Table 2.20 – Network structure and firm-level productivity – differences estimations: equation 17
TRD1 TRD2 TEC1 TEC2 TEC3 TEC4
Constant 0.101** 0.097 0.087* 0.103** 0.129** 0.123**
(0.0515) (0.0509) (0.0504) (0.0511) (0.0509) (0.0509)
DIFLEMP 0.531*** 0.498*** 0.507*** 0.535*** 0.542*** 0.542***
(0.0941) (0.0941) (0.0929) (0.0940) (0.0947) (0.0948)
LINV 0.008** 0.008* 0.006 0.009** 0.010 0.010
(0.0043) (0.0043) (0.0043) (0.0042) (0.0043) (0.0043)
DEN 0.427** 0.546*** 0.790*** 0.427** 0.064 0.036
(0.1856) (0.1725) (0.1895) (0.1703) (0.3393) (0.3461)

Obs. 402 396 396 402 412 402

F-statistics 1581 16.62 19.32 16.17 1387 1386
R2 0.1065 0.1128 0.1288 0.1086 0.0946 0.946
Adjusted R2 0.0997 0.1060 0.1221 0.1019 0.0878 0.878
***Significant at the 1% level, ** 5%, * 10%; Sectorial Dummies omitted.

Source: author’s calculations on the basis of PROFO Survey Database

These estimations (see Table 2.19 and 2.20) provide further evidence of the relevance of
network structure on productivity. The coefficients of centrality and density are always positive
and mostly significant. Surprisingly enough, in this case the most robust results are related to the
“softer” relationships (TRD1, TRD2, TEC1, TEC2), while coefficients of centrality and density

48
are not significant when “stronger” relationships, such as TEC3 and TEC4, are taken into
account.55 This is probably due to the significant reduction of available observations when data in
first differences are analysed; on the other hand, it might be due to the fact that more complex
connections, like exchanges of skilled labour and joint R&D activities, are more unlikely to be
maintained over time and after the end of the program.

Taken together, these results allow some significant conclusions to be drawn. As stated at the
beginning of this section, the size of the network multiplier depends on the density of the network
which firms belong to. The fact that relationships based on sharing of knowledge significantly
affect productivity levels and trends is strong evidence for the importance of participation in a
stable, dense and coordinated knowledge-sharing network. Furthermore, the strategic role of the
program in supporting coordination of the networks and, thus, in promoting their creation and
fostering their development, is robust evidence of the role that can be played in developing these
kinds of networks by a public agent.

2.8 Conclusions
The main objective of my work was to better understand the impact that the formation of
knowledge-sharing networks might have on SME competitiveness and the role that public policy
makers might have in the creation, development and fostering of this particular type of industrial
organisation.
For this purpose, I first looked for a synthetic conceptualization of the efficiency benefits that
firms might achieve by sharing specific and non-rival knowledge. I found the network multiplier
concept was particularly suitable for my aims, since it allows very general analysis of the impact
that an interactive learning process might have on firm-level efficiency. The network multiplier
shows that a firm’s productivity – and to some extent also its innovativeness – does not only
depend on its specific internal endowment of knowledge, but it also depends on the amount of
external knowledge that is available and, above all, accessible in the system where firms operate.
Moreover, it makes it possible to better specify how each single firm could benefit from this
external resource. When external knowledge is not exogenously assumed, but results from a
process of interactive learning where each firm learns from other members connected to the
system, firms are induced to create knowledge-sharing linkages to increase their own efficiency.

55
In fact the same occurs when financial relationships are considered.

49
The potential benefits of this process depend on the size, quality and social structure of the
“system” or network where a firm participates or might participate.
In fact, firms’ decisions to increase their connectivity are more complex. On the one hand,
creating linkages is not without costs: in order to participate in interactive learning processes,
firms have to bear the cost of coordinating with each other. Hence, the benefits of learning –
which depends on absorptive capacity – must be higher than this cost. On the other hand, firms
face a social decision, since an individual firm’s choice whether to create linkages and participate
in networks depends on, and influences, the decisions of other potential members. Thus, even
considering the simplest and most favourable assumptions on agents’ rationality and ability to
transfer and acquire knowledge, the formation of linkages is unlikely to efficiently occur just on
the basis of single agent incentives.
Analysing the problem within the context of a non-cooperative game provides quite strong
theoretical evidence on this issue: the free interaction of perfectly rational and informed agents
does not necessarily lead to the creation of a knowledge-sharing network, even in cases where
each firm might achieve significant net benefits from the interactive learning process, as well as
the overall industrial system.
From this important result, which I defined as a “market failure” in network creation, there is
clearly room for the intervention of public-oriented actors. In fact, assuming that an actor
receiving a social payoff can take part in the decisional process to create a network, I can
determine theoretical evidence for the appropriateness of intervention and identify some stylized
prototypes of public intervention in this field. With reference to the first issue, I showed that a
socially-oriented agent intervening on the variables that determine the payoff to potential network
participants can eliminate the inefficient results – both at social and single agent level – of non-
formation of the network. The variables that have to be affected are those that determine the level
of the network multiplier (i.e. the potential size of the network, the value of firms’ specific
knowledge, the capability of transmitting/acquiring knowledge and the sociometric structure of
the network) and the connection and coordination costs. If a public actor has the capabilities and
the resources for modifying at least one of these factors, it can remove the inefficiencies that
might arise from the simple interaction of individually oriented agents.
In addition, identification of the factors on which the public agent has to intervene, allows me
to identify three typical effects of public intervention, or, in other words, three prototypes of
networking policies. When the public agent recognizes that connection costs are too high from

50
the point of view of the single firm, it can decide to intervene directly as a catalyst, itself bearing
all connection costs, or indirectly financing a network coordinator who reduces the costs borne by
firms. In other cases, the public agent might believe that the main problem is not just the
connection costs, but also firms’ capabilities to transfer and absorb external knowledge. These
capabilities depend on firms’ internal skills – and in this sense might be correlated with the
endowment of specific knowledge – and on external factors, such as social cohesion and cultural
similarity. Focusing on the former, the public agent can decide to invest its resources to increase
firms’ capabilities to transfer and acquire knowledge and offer itself as a hub in the interactive
learning process. In this case, I said that the public agent acts as a codifier.
Other public actions can obviously affect the variables that determine the decision to form
linkages: education and vocational training might increase an individual firm’s knowledge
endowment or learning capabilities and, thus, affects the incentive to take part in an interactive
learning process; a public agent with a specific knowledge endowment significantly higher than
the firms’ average, such as a research centre or a technological institute, can play a role very
similar to that of the codifier. I did not analyse these cases in depth since they can be analysed by
adding some further specifications to the framework of the three prototypes described earlier, and
they do not directly deal with public networking policies but just with public policies that affect
the process of network formation.

The second part of the paper provides robust evidence for the main theoretical propositions of
my work. From the empirical analysis, it can be seen that the PROFO program plays an effective
role in fostering the creation and improvement of knowledge-sharing linkages among firms and
that this process results in firms enjoying better performance, both in terms of innovativeness and
in terms of productivity.
Public intervention, mainly through coordinating support, allows the isolation of participant
firms to be significantly reduced: all the considered estimators show a significant increase both in
the quantity and in the quality of stable relationships among the members of PROFO networks.
The statistical data analysis shows that there is a positive and significant correlation between the
“densification” of networks and public coordination activities, demonstrating the central role of
the program in increasing and enhancing linkages. The econometric analysis shows a strong
correlation between PROFO firms’ innovativeness and industrial cooperation, proving the
existence of an interactive learning process among participant firms. This learning process is

51
probably the basis of the performance achieved by PROFO firms in terms of innovativeness, as
shown in the first part of the chapter.
In the last section I provide some evidence of the impact of the program on the size and
structure of the network multiplier: not only participant firms achieved better performance,
including productivity gains, but performance is quite strongly correlated with firms’ centrality
and network density, that is the two variables that best represent the structure and functioning of
the network multiplier.

52
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57
ANNEX 1 – SOCIAL NETWORK ANALYSIS DEFINITIONS

Non-directional relations: the connection between the node i and the node j cannot be
distinguished from the connection between the node j and the node i.

Degree of a node: the number of links that are incident with it. Equivalently, it is the number of
other nodes adjacent to it. It ranges from a minimum of 0 to a maximum of n-1.

d (i )
Degree centrality of a node: the proportion of nodes that are adjacent to the i node: C D (i ) = .
n −1
C D (i ) is independent of n and thus can be compared across agents belonging to networks of
different size.

Density of a network: the proportion of possible connections actually realised in a network. Since
⎛ n⎞
in a network of n members there are ⎜⎜ ⎟⎟ = n(n − 1) 2 possible unordered pairs of nodes, and thus
⎝ 2⎠
n(n − 1) 2 possible non-directional connections, the density of a network is equal to:
L
DN = where L is the total number of links initiated within the network.
n(n − 1) 2

Minimal two-way flows (tw) connected network: a network g is minimally connected if for all the
i and j members of the network there is a continuous path of connections between them and (a)
there does not exist a cycle within g, i.e. q ≥ 3 members {j ,...., j }⊂ g
i q such as

g j1, j 2 = ... = g jq , j1 = 1 and (b) g i , j = 1 implies g j ,i = 0 for any pair of agents i,j in g (Figure A.1).

Geodesic distance: the shortest path between two nodes is referred to as a geodesic. The geodesic
distance or simply distance between two nodes is defined as the length of a geodesic between
them (that is the number of hedges that compose the geodesic) and is denoted by d (i, j; g ) . In
Figure A.1, the distance between a and d is equal to 3, while in Figure A.2 it is equal to 1.

Figure A – minimally connected networks

(the bullet on the edge identifies the node issuing the connection)

58
 A.1 A.2
e d

a c c e
d a

b b

Source: prepared by the author

Star-connected network: a minimally connected network where the maximum geodesic distance
between agents is minimised and equal to 2. Figure B.1 represents a centre-sponsored star
network, since the central node initiates all the connections. Figure B.2 represents a periphery

Figure B – Centre-sponsored and Periphery-sponsored star

(the bullet on the edge identifies the node issuing the connection)
B.1 B.2

d d

c e c e
a a

b b

Source: prepared by the author

59
ANNEX 2 – PROOFS

(a) Basic assumptions

Using the same linear payoff structure that I adopted, Bala and Goyal (2000) identify three
parameter ranges of importance with reference to the connection cost,: “if c ∈ (0,1) , the agent i
will be willing to form a link with agent j for the sake of j’s information alone, When
c ∈ (1, n − 1) , agent i will need to observe some additional agents to induce him to form a link
with j. Finally, if c > n − 1 then the cost of link formation exceeds the total benefit of information
in the rest of society. Here, it is a dominant strategy not to form a link with any agent” (Bala and
Goyal 2000: 1190).
I argue that in the range c ∈ (0, n − 1) there is always room for the formation of some networks
that produce social and individual benefits. From the social point of view every efficient network,
that means a complete network where no redundant connections are formed, and thus a minimally
connected network such as a star network, is a better solution than the empty network for every
n n
c < n . In fact, considering a social payoff function equal to Π sc = ∑ µ i − ∑ µ id c , in the case of
i =1 i =1

E
an empty network social payoff is equal to Π sc = n , while in the case of a complete star network

it is equal to Π sc = n 2 − (n − 1)c . Thus, the complete star network is socially preferable when
C

n 2 − (n − 1)c > n , that means c < n and, indeed, also when c ∈ (1, n − 1) .
From the single agent’s point of view, first of all one has to keep in mind that several potential
minimally-connected networks56 can be created through the issuing of just one connection by (n –
1) k agents. In this case, the payoffs for members are asymmetric, since for the (n –1) k agents it

is Π k = n − c and for the j agent it is Π jj = n . Nevertheless, since for all the i ∈ {k , j} the payoff
C C

E
of the empty network is Π i = 1 , the complete star network is strictly preferable when c < n − 1 .

(b) The “pure catalyst” effect

In order to demonstrate that the empty network is not a Nash equilibrium in presence of a pc
agent, I compare the payoff of the pc agent in the case of the empty network with the most

56
See Annex 1.

60
expensive solution for the pc agent, i.e. a centre-sponsored network where all the connections are
paid by pc.
E
In the case of the empty network, the pc’s payoff is Π pc = n , since the overall value of
systemic knowledge is equal to the sum of the specific knowledge endowments of each firm
(assumed equal to 1) and no connection costs have to be paid.
In the case of the centre-sponsored network totally financed by pc, her payoff is

Π pc = n 2 − (n − 1)c . Thus, for the pc, financing all connections is a better solution than the empty
C

network when n 2 − (n − 1)c > n , which means c < n . This means that the centre-sponsored
network is a better solution then the empty network. Thus, the empty network is no longer a Nash
equilibrium.

(c) The “coordinator” effect

Following Bala and Goyal, when c ∈ (0,1) the network emerges spontaneously as a minimally-
connected network (2000: 1202-1209). Thus, if the actual connection costs paid by members is
equal to (c − s ) ∈ (0,1) , because of the contribution of the coordinator (s), the network emerges
spontaneously as a minimally-connected network even though c ∈ (1, n − 1) .
Since a minimally-connected network emerges, the coordinator in fact faces the following

payoff: Π co = n 2 − (n − 1)c . As in the pc case, the payoff for an empty network would be Π co = n .
C E

Then, also for the coordinator providing support, the former would be preferable when c < n .
Since the subsidy is s = c − 1 + ε , I can derive that c = s + 1 − ε . Substituting this expression in
the general condition for granting the subsidy ( c < n ), I obtain that s < n − 1 + ε .

(d) The “codification” effect

The co-existence of the two strict Nash equilibria, the periphery-sponsored star network and
the empty network, has already been demonstrated by Bala and Goyal (2000: 1215-1217).
The codifier’s investment decision may be demonstrated as follows. In the case of an empty
E
network the codifier’s payoff is again Π cf = n . If she decides to invest in order to reduce her
decay in knowledge transmission and to let a periphery-sponsored network emerge, her payoff is:

Π cf = n + (n − 1)δ + (n − 1)δ cd + (n − 1)(n − 2)δ δ cd − (n − 1)i − (n − 1)c . Thus, the decision on the
C

limit of the investment arises from the comparison of the two payoffs, which means

61
n + (n − 1)δ + (n − 1)δ cd + (n − 1)(n − 2)δ δ cd − (n − 1)i − (n − 1)c > n , from which the condition

i < δ + δ cd [1 + (n − 2)] − c can be easily derived.

62