Large knowledge-intensive investments – drivers, effects and the role of public policy

This report presents a definition of large knowledge-intensive investments (LKI). It then
surveys research on the drivers as well as effects of LKI, and provides conclusions with regards to the conditions for, and role of, public policy in promoting such investments. The purpose is to provide the Swedish government with evidence and knowledge to support
and develop the government’s work on supporting innovation and structural change of
businesses in Sweden. What are large knowledge-intensive investments and why are they important?

The term “large knowledge-intensive investments” (LKI) is not an established term in the research literature, and there is no integrated research literature on the topic. However, there is a clear need for a discussion of LKI that accounts for how globalization and technological developments have changed the conditions for different types of activities in different places, and also accounts for the growing role of intangible assets in the
economy. These developments have implications for the conditions for, as well as role of, public policy in supporting LKI and form the backdrop for the definition of LKI developed in the report.
Defining LKI The definition of LKI that is developed in the report is based on three starting points. First, the rise of global value chains and the growing fragmentation of activities implies that it is
problematic to build definitions based on industry classifications.

There is a growing need for a more fine-grained approach that departs from the firm-level and considers the functional orientation of the activities in question. Second, in the modern economy, knowledge-intensive activities comprise a broader set of
activities than R&D. A narrow focus on R&D risks to miss out on several relevant activities. To capture knowledge-intensity we suggest a focus on intangible assets, which include a) computerized information, such as software and databases, b) innovative
property, such as R&D and design, and c) economic competencies, such as training, market research and branding. Third, an investment may give rise to both direct and indirect effects. The size of an
investment should therefore be judged based on a combination of a) the extent of resources that is created or mobilized as a direct result of the investment decision and b) the extent of possible positive indirect effects associated with the investment. Indirect effects include a multitude if spillover effects, such as up- and downstream effects in the value chain.These considerations lead to the following conceptual definition of LKI:

A large knowledge-intensive investment (LKI) is an investment in an activity that is characterized by large and continuous investments in intangible assets within the activity and/or give rise to such investments in up- or downstream activities. Intangible assets comprise (i) computerized information, (ii) innovative property
and (iii) economic competencies. Large refers first and foremost to the extent of resources that is created or mobilized as a direct result of the investment decision, but also to the magnitude of the potential for positive indirect effects.

Empirical application

An empirical application is developed which aim to identify LKI-related firms in Sweden.The report develops 11 different conditions for LKI-related activities based on information on firms’ industry of operation, education qualification of employees, type of education of
employees as well as the composition of employees in terms of occupations. The data is based on Swedish firm-level data comprising 44,176 firms with more than 10 employees.

The results show that 42 % of the firms do not qualify for any of the 11 LKI-conditions, whereas 27 % qualify with regards to at least one condition and only 6 % qualify with respect to at least three conditions. Firms that can be claimed to be related to LKI-related
are in other words unevenly distributed in the economy, but they have a number of specific characteristics. They are more likely to be (or be affiliated to) multinational firms and are
also more likely to be engaged in international trade. LKI-related firms are also concentrated to Sweden’s three metropolitan areas (Stockholm, Göteborg and Skåne county). In summary, among the population of Swedish firms, there are rather few firms that constitute the core with regards to LKI-related activities. The vast majority of the firms with strong ties to LKI-related activities are firms operating in knowledge-intensive services industries.

Drivers of LKI

There are two broad motives for the location of those activities in (global) value chains that are associated with R&D and other knowledge-intensive activities; (i) market-seeking and (ii) asset-seeking. Investments that are driven by market-seeking motives are drawn by factors such as market size and market growth, as well as possibilities to adapt products and services to local conditions. Asset-seeking motives are about access to local resources in the form of e.g. technology, knowledge and qualified human capital.

While research activities are primarily located with regards to asset-seeking motives, development activities are to a greater extent driven by market-seeking motives, and different types of knowledge-intensive activities follow different location logics. For example, R&D-related activities may be divided into three different types with different location logics: 1) local development centers are primarily driven by market size and growth but also local access to qualified labor, 2) global development centers can in
principle be located anywhere and influenced by the balance between labor costs and access to qualified labor, 3) global research laboratories are dependent by excellence in terms of knowledge and technology as well as markets at the forefront. The research
literature further shows that, across the board, asset-seeking motives have grown in importance over time.

Effects of LKI

LKI are associated with different types of direct and indirect effects. Beyond the creation of local jobs and expansion of the tax base, they may also lead to new business relations, higher productivity of local businesses, spillovers of technological and organizational knowledge as well as entrepreneurship e.g. in the form of spinoffs. The research literature suggests that such types of indirect effects are stimulated by labor mobility, the conditions of entrepreneurship, economic proximity (or relatedness), the strategies of the investing firm as well as the overall framework conditions. These are so-called enabling factors for positive indirect effects of LKI.

Large cities play a growing role for the location of LKI. Both drivers as well as effects of LKI are increasingly associated with large and dense cities with thick labor markets. This does not imply that more rural areas and the countryside does not play a role, but it does
imply that their linkages and couplings to larger cities become more important. It also implies rising demands on cities to be able to host and accommodate LKI.

Prerequisites for LKI policy

Following the development of global value chains, the conditions and prerequisites for policy development aimed at promoting LKI have changed significantly. Firms’ location decisions are increasingly asset-seeking, and there is a more fragmented and heterogeneous
distribution of business functions across places.

From a policy perspective, this development has two implications. First, LKIs move from being one-off occurrences towards becoming an integral part of an ongoing and long-term relationship-building. Second, domestic policy initiatives aimed at LKI will become
increasingly affected by corresponding policy initiatives in other places and countries, due to the increased mobility of knowledge-based investments. In a sense, global value chains form international networks between places, some of which harbor knowledge-intensive activities. This calls for increased coordination between different policy domains, for instance between internationalization and innovation policies.

Policy-related research suggest there are strong reasons for attracting LKIs with large potential for positive spillover effects and comparatively low international mobility, because these are, to a greater extent, anchored in the place where they are established. The effects of a high-mobility LKI with large potential for spillovers may never be realized if it is re-located.

Policy initiatives can be broadly divided into two groups: those aimed at attracting a specific type of investment and those aimed at improving a region’s general attractiveness for knowledge-intensive activities. While the former group consists of subsidies and
directed support, the latter includes activities that affect all (concerned) actors within the region, i.e. framework conditions. The main message from the research literature is that both types of policies have their own merit, but subsidies and directed support can never substitute shortcomings in the general framework conditions.
Against this backdrop, it is possible to formulate seven specific deliberations for formulating LKI policy instruments and balancing a policy mix to support LKIs:
1. Is the policy goal geared towards asset-seeking or market-seeking investments?
2. Is the policy instrument aimed at attracting specific investments or improving the
general attractiveness of the region?
3. Is the policy focused on incoming or outgoing investments?
4. Is the policy aimed at preparatory (pre-) or follow-up (post-) work related to
5. Is the policy geared towards science- or market-centered knowledge-intensive
6. Is the policy aimed at top-down or bottom-up development?
7. Is the policy nationally or regionally demarcated?

The role of public policy in promoting LKI Based on the contents of this report, it is possible to draw three general conclusions about
the changing role of public policy in promoting LKI, and how it is likely to continue to change in the future.

First, the distribution and organization of knowledge-intensive activities is becoming more heterogeneous, fragmented and globalized. This changes the conditions under which public
policy work to promote LKI. There is an increasing need for common and basic conditions for knowledge-intensive activities, and at the same time it is becoming increasingly harder to find a one-size-fits-all solution for directed support and subsidies.

Second, knowledge-intensive investments have moved from being one-off occurrences towards becoming part of long-term relationships in the light of the growing mobility of knowledge-based capital. At the same time, Swedish policy-making aimed at LKI is
becoming increasingly affected by, and dependent on, the corresponding policy-making in other countries as firms divide and distribute their activities in global value chains.

Third, the fragmentation and globalization of different functions of firms and value chains, combined with an increased importance of knowledge-based capital and a growing complexity (mutual dependences) between businesses and public policy, imply an
increased uncertainty in the planning horizon for public policy. This in turn calls for increased experimentation, feedback and evidence-based evaluation in policy-making on all levels. These three broad conclusions make-up common denominators throughout the report.

Large knowledge-intensive investments – drivers, effects and the role of public policy

Serial number: PM 2019:13

Reference number: 2019/13

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