7.1 The analysis in this document explains why knowledge should be seen as the driver of prosperity, both now and in the future. It examines how the development of the knowledge driven economy is profoundly affecting the goods and services produced and the way firms behave, how they are organised and their relations with their employees and with other firms. The analysis supports the new focus on knowledge and the policy proposals found in Our Competitive Future: Building the Knowledge Driven Economy.

7.2 An underlying theme is the rapid pace of change. Developments in science and technology and ICT offer huge potential for creating new products, processes and services and thus for increasing productivity. Innovation is speeding up. Goods can be distributed more quickly and cheaply around the world. Information products such as recorded music, film, TV programs and computer software can be distributed at minimal marginal cost. Managers have to think of ever more ingenious ways of creating and exploiting knowledge assets to secure competitive advantage, improve productivity and stay ahead of the competition. They have to understand and interpret more information, develop more complex products and processes, and operate in more markets.

7.3 The challenge for the UK is to make the most of the opportunities that the development of the knowledge driven economy presents. In a world of global competition, a country like the UK cannot compete on cost alone but must concentrate on high value-added goods and services and the component of production that cannot easily be transferred - namely, the skills of the workforce and the tacit knowledge possessed by employees and embedded in corporate systems and culture.

7.4 In many ways, the increasing dependence on knowledge has implications for the nature of the firm and for business strategy. For example:

• It gives small firms new opportunities to access international markets without the need for a global marketing network.

• It permits more contracting out of activities, particularly those based on codified knowledge,and creates possibilities for new forms of organisation such as ÒvirtualÓ companies.

• In order to remain competitive firms need to be more flexible and more innovative, managing their knowledge assets more effectively to derive new sources of competitive advantage.

• Businesses which depend on few physical assets but are strongly reliant on the skills of their staff are becoming more mobile and less attached to their country of origin.

• Firms may have to collaborate and network more, particularly on new technologies, and strengthen their links to the science and engineering base, sharing equipment and often people.

7.5 For policymakers, the pace of change poses new challenges too. Governments must be sensitive to the changing needs of business in order to understand how policy can go with the grain of the market and be most effective. The approach must not be one of heavy-handed intervention, nor can the development of the knowledge driven economy be left entirely to the market. There is a clear role for government in addressing market failures to promote science and technology, foster enterprise and innovation, develop education and skills, facilitate collaboration and promote modern competitive markets. Specific policy initiatives are set out in the White Paper.

7.6 Many of the features of the knowledge driven economy have only recently risen to prominence in the economics and business literature. Further research is required in many areas, for example in the valuation of intangible assets, the benefits of clusters and networks, the role of IPR and competition policy in promoting innovation and the implications of the growing importance of industries producing information and knowledge goods.

7.7 This paper has also reviewed how the UK is performing. We have strengths in some sectors and are well placed in some respects to exploit the opportunities of the knowledge driven economy. But in other areas we fall short.

7.8 Benchmarking our performance is important. The Government believes this is best done by drawing on a range of experience and expertise, not least because many of the activities that the analysis in this paper shows are rising in importance are hard to quantify reliably. For those that can be quantified, and appear in the official statistics, measurement is often in its infancy.

7.9 The White Paper includes a proposal to develop a new set of competitiveness indicators to measure the UK’s progress. The Secretary of State for Trade and Industry is appointing a Competitiveness Council to advise him on these indicators and other issues. A new Cabinet Committee on Productivity and Competitiveness will review the UK’s performance against the indicators each year and decide what further policies are required to keep the UK on track.

7.10 There are many possible approaches to benchmarking. One possible structure, based loosely on a model adopted in Massachusetts,(76) would be to include indicators of:

• the business environment - measures of macroeconomic stability, progress on supply side reforms and business perceptions of the UK

• resource indicators - measures of human and physical capital, technology and R&D

• innovation process indicators - measures of commercial exploitation of science and technology, entrepreneurship, diffusion of knowledge across borders and between firms

• results - GDP per head, productivity, employment, incomes, and measures of sustainable development.