More musing about technology and development

Some time ago a friend who was asked to advise a developing country about entry into international ICT markets wondered why they did not seek to enter high on the "value chain" but rather sought to begin with relatively labor-intensive, low-profit-margin operations with the hope of getting to more profitable operations in the future. His was a good question.

That seems to have been the path used by Singapore in entering the computer printer field and by India in pharmaceuticals. Yet would it not be smarter to skip the low profit margin areas and go directly for the gold? I can think of a couple of possible answers.

One is that value chains are complex, and it would be very difficult to enter in such a way as to appropriate the lions share of the profits. Rather a firm seeking to do so needs to enter at some point where it has a competitive advantage and then build the forward and backward linkages it needs to compete more broadly. There is a lot of tacit knowledge in a production process, and a new entrant has to master this knowledge. Developing countries often have some obvious advantages: low cost labor, some (like India) have underutilized highly educated workers, linkages to existing elements of the value chain (such as Irish linkages to Irish Americans during the 1990's or linkages from former colonies to former colonial centers), or specialized market access.

Another answer is that the current occupants of the most profitable niches in value chains will fight to retain their profitable niches. Clearly there are many examples of new entrants into value chains eventually eating the lunches of the firms previously dominating those chains. A dominant firm would seem more likely to accept a newcomer firm if the newcomer took over a low profitability portion of the value chain. In fact, for a vertically integrated firm, the allocation of profits among portions of the value chain may be somewhat arbitrary. Calving off a portion of the value chain to a low cost partner while assigning that portion a low profitability may result in higher profits for the core functions maintained by the dominant firm.

Now of course entrepreneurs in developing countries would love to replicate the success of Microsoft, eBay or Amazon. These were all tiny firms and they took on IBM and mass marketing megafirms and won. This kind of success seems to come when a firm gets in on the ground floor of a disruptive technology. Long wave theory suggests that such opportunities are relatively rare, and that the process of elaborating the industry built around such a technology can last decades.

Exploitation of the economic opportunities inherent in disruptive technologies, even when they exist, demands an entrepreneurial culture, sources of investment capital willing to accept high risk, and scientists willing to utilize their specialized knowedge to develop the derivative technologies. This latter point in turn suggests that there needs to be an active fundamental research community to assure that there are scientists available to act as gatekeepers for innovations in disruptive technology.

It turns out that there are a lot of places that have these ingredients in abundance and are hoping that their citizens will get the early adopter advantage due to those who first hop on to ride the wave of the next disruptive technology. Very few of these places are in poor countries, although some are forming in newly industrializing countries.