In one of the most interesting economic articles of the past two decades, Jeremy Greenwood and Boyan Jovanovic (1999), argued that the arrival of the information technology revolution in the 1970s created the need for new firm. The technology breakthrough favors new firms for three reasons: (1) awareness and skill; (2) vintage capital; (3) vested interests. The stock market incumbents of the day in both Europe and the United States were not ready to implement the new technologies and it took new firms to bring the technology to market after the mid-1980s. Stock prices of incumbents fell immediately. New capital flowed via venture capital to the startups that built the new industries.
One of the outcomes of this revolution was the restructuring of the traditional field of industrial organization that focused primarily on large firms to startups. The creation of new fields more closely organized around technology, innovation, entrepreneurship, economic geography and organizations to explain the role of new technology and the need for new firms. While this happened in the United States (Google, Amazon, Apple, Facebook, Uber) it did not happen to the same extent in Europe. Why not?
The answer to this question can be found in part due to deficiencies in the two major conceptual frameworks emerging in the 1990s to explain the evolution of this technological revolution. The first was the National Systems of Innovation framework. The main theoretical underpinnings were that knowledge is a fundamental resource in the economy, that knowledge is produced and accumulated through an interactive and cumulative process of innovation that is embedded in a national institutional context. National systems assumed that all of this takes place in existing firms, so there is no role for new firm or entrepreneurship to bring the technology to market. The second concept framework was Porter’s Diamond that defined a system of regional clusters that propelled a country to prominence. The Porter Diamond put the emphasis on supporting institutions that may be missing in a cluster that are needed to incorporate new technologies. However, the Jovanovic insight was missing.
Clusters and National Systems of Innovation had two assumptions in common. First, they both argued that institutional embeddedness was important and second, they both relied on existing firms to implement and deploy the new technologies! Both of these approaches had a large theoretical literature, empirical research and policy recommendations. Because they both left out of their analysis the role of new firms that was Jovanovic’s great insight they were limited in their usefulness for implementing the new information technologies. Why new firms were left out of these approaches is a subject in and of itself.
However, while the approaches did not have a large following in the United States they were immensely popular in Europe, especially National Systems of Innovation. The National Systems approach was in part a Swedish discovery and helps explain both the Scandinavian disdain for startups and the European Union’s unwillingness to view innovation and entrepreneurship in the same unified approach. This theoretical misstep set Europe on a false path in the late 20th century and still haunts Europe as it falls further and further behind the United States and China in the digital age.
This important new book by Sandström, Wennberg and Karlson takes us a long way to try and bring Europe back to the realization that new firms and the financing of them is fundamental to productivity and economic growth.
Greenwood, J. & Jovanovic, B. (1999). The Information-Technology Revolution and the Stock Market. The American Economic Review, 89(2), 116-122.
Professor of Economics and Public Policy,
George Mason University