The knowledge-based economy: Profit is all in the mind

Peter Koenig asked DTI economists working on the White Paper what the intellectual underpinnings were for their work. This is a summary.

Knowledge has been the key to economic success for centuries. But in a study to accompany the Government's competitiveness White Paper out next week, the DTI team argue that the role of knowledge in the modern economy is growing rapidly.

The World Bank declared recently: "The balance between knowledge and resources has shifted so far towards the former that knowledge has become perhaps the most important factor determining the standard of living."

The knowledge-driven economy is not just a hi-tech or science-based story. It is just as relevant to textiles manufacturing as it is to electronics or pharmaceuticals, to the Post Office as much as to the City of London, to a corner shop using computerised accounts as much as to Marks & Spencer, the DTI says.

What is behind the changes? The DTI work emphasises four factors. Steady and sometimes startling advances in science and technology, particularly in biotechnology, and the revolution in computer technology are the most obvious. But the changes are also driven by increasingly global competitive pressures and by the new demands created by rising incomes and changing consumer tastes.

The DTI paper surveys the fast-growing economic and business literature on the role of knowledge in the economy. Recent work by economists on the sources of growth puts increasing emphasis on technology, human capital and knowledge, in contrast to earlier models which focused on labour and capital.

Trade specialists and business strategists warn that countries like the UK cannot hope to compete on cost alone. Instead, companies in the more advanced economies need to rely on their knowledge assets - the skills of their workforce, the quality of their design, their brands, and the ingenuity of their R&D. According to research reported in the White Paper, Britain's trade performance has been strongest in industries which use more skilled labour and invest more in R&D. Firms like ICI are recognising this and reinventing themselves as knowledge-driven companies.

Management experts also increasingly emphasise the importance of a firm's "knowledge capital". Companies like Microsoft have stock market valuations that soar far above the physical assets they own. The company's value resides mainly in its skills, its R&D, and its intellectual property. Training and knowledge management is therefore crucial to success, as more and more companies like Unilever, Skandia and BP are recognising.

The knowledge revolution also has implications for location. Michael Porter, the Harvard Business School professor who held talks with Peter Mandelson this week, emphasises the importance of "clusters" - like Silicon Valley, the City of London, or the Italian shoe industry around Milan.

This might seem paradoxical, since the leap in communications technology ought to make location less important. But while that may be true of knowledge that can be codified and written down, it is much less true of the "tacit knowledge" built up and inherent in the business. According to the DTI economists, tacit knowledge is the real source of competitive advantage and its diffusion is much easier in a cluster or network of firms.

The DTI analytical work underpinning the White Paper covers a wide range of issues and raises questions about the sources of competitiveness and about policies towards the regions, inward investment, education and skills, the development of electronic commerce, competition, finance and entrepreneurship.

The forging of legislation based on this work begins on Wednesday when the White Paper is introduced in the House of Commons.