7, September 2023

New Insight on Wealth Creation

Sometimes a new book comes along that casts a refreshingly new perspective on an old problem. Such is the case with “Windows of Opportunity – How Nations Create Wealth”  by David Sainsbury (Ref 1). Sainsbury has an interesting background – he was chairman of one of Britain’s largest supermarket chains  and Minister of Science and Innovation in the UK for eight years. What is particularly interesting in his approach is that he brings not only practical ideas but also places them in a theoretical context of economic though and the historical context.

Two schools of thought.

Sainsbury describes the two schools of thought that have tried to explain economic growth as the market efficiency school and the production capability school.  These two schools of thought have been embraced at different points in time by different economists and policymakers.

The market efficiency school  includes Adam Smith, Paul Samellson and Paul Krugman. In this school wealth originates from material sources: land, physical labour and capital. It sees the market as a machine that, with the ‘invisible hand’ of the market, functions as a self organizing system.  So there is no role for government in this school, and all economic activity has equal growth potential. It is the rationale for the laissez-faire approach to business.

The production capability school includes such figures as Alexander Hamilton, Joseph Schumpeter and Friedrich List. This school believe that wealth originates from innovation and creativity, and grows with the accumulation of a stock of knowledge. This school sees different types of economic activity as having different growth potential. It is the rationale for industrial policy.

The dynamic capability theory of economic growth.

Sainsbury’s theory is firmly in the production capability school. He sees the key question raised by economic growth theory is how firms gain competitive advantage over their rivals. They can do this in two ways – by reducing the cost of their product or service through innovation, or using innovation to make their products more attractive to their customers. How well they do this is determined by the capabilities of the firm matched to the market opportunity they see.  This varies between different sectors of the economy.  He distinguishes between two kinds of capability – to maintain the exisiting operation effectively (i.e. doing things right), and to identify and pursue new opportunities (i.e. doing the right things).

He sees that a nation’s standard of living in the long term depends on the ability of  its firms to to attain a high and rising level of value added per capita in the industries in which it competes. To create a competitive advantage a firm needs to be able to identify ‘windows of opportunity’ and have the organizational and technological capabilities to take advantage of it. A firm’s ability to sustain its competitive advantage over time will depend on how quickly its competitors can imitate its strategy.

The theory is very sector specific and places great emphasis on value added per capita. This metric correlates closely with quality of life. Growth by itself is not a useful metric. For example, if the economy grows at 3% and the population grows by 4%, the value added per capita decreases, and the country gets poorer. The growth opportunities and value added per capita are distributed very unequally between sectors. If we look at Canada, the  value added per hour for selected sectors for 2022 is shown in the table below.

 

 

 

 

 

 

 

It’s clear that the highest value added sectors are very capital intensive with few workers. Sainsbury explains that if a person moves from working in a low value added sector to a high value added sector, the value added per capita for the country improves. So, if a proverbial immigrant PhD taxi driver (value added $17/hour) in Canada gets a job with an ICT company (value added $82) Canada’s value added per capita increases.

He also makes the point that while around 80% of the economy is domestic (hairdressers, retail stores, etc.), it is the internationally traded sectors that determine the country’s competitiveness.

Firm capabilities.

The dynamic capability theory places a firm’s development capabilities at the centre of its approach. This is essentially an entrepreneurial activity carried out within the firm (i.e. otherwise called intrapreneurship.)  It has three parts:  first, the identification and assessment of opportunities; second the development of new technological and organizational capabilities to pursue the opportunity; and third, continuous renewal and transformation of the firm. Sainsbury points out that developing these capabilities in a firm is a long term undertaking, at odds with the culture of producing short term financial gains. He argues that firms should rebalance the incentives for executives and place more emphasis on developing organizational capabilities rather than short term financial results.

Government role

Governments need to have a vision of what it wants to achieve and the capability to develop and implement the policies necessary to put it into practice. Sainsbury recounted his experience in the British government where this was not the case. He strongly recommends that governments give priority to developing capabilities and experience and institutional memory in government and to have consistent policies and avoid what he called ‘policy churn’. This includes a capability to evaluate previous policies and learn from them and to learn from the experiences of other countries facing similar issues.

Conclusion

  1. The growth of high value added per capita industries is the key to economic development, and the creation of competitive advantage by innovation is the way to get there.
  2. The key capability that a firm needs to create competitive advantage is an entrepreneurial developmental competence.
  3. Firms should incentivize their executives to build up technological and organizational capabilities to pursue new opportunities and decrease the emphasis on short term financial results.
  4. Governments should build an effective system of policy making. This includes the capacity to evaluate past policies and learn from the experiences of other countries facing similar issues and create an organizational memory.

Peter Josty

Ref 1. “Windows of Opportunity- How nations create wealth” by David Sainsbury, published by Profile Books Ltd., 2020. The book does not appear to be sold in North America but can be obtained online.