Dear all,

I’m in Shanghai, reflecting on China’s rising economic power. In a book I’ve been reading to prepare for the trip, The One Hour China Contrarian Book, there’s the mention of China transitioning from an “investment-based” to a “productivity-based” mode of growth.

By coincidence, just one day before departing I attended a seminar at Mariana Mazzucato’s IIPP in London, during which Reda Cherif and Fuad Hasanov, both senior economists at the IMF, also touted the idea of countries moving “from an investment-based strategy to an innovation-based strategy”. This switch is key to explaining prosperity in countries like South Korea, Taiwan, and Singapore in the latter half of the 20th century.

According to Cherif and Hasanov, countries should avoid investing in an import-substitution strategy. They also should avoid specializing in inward-looking, low-value-added activities such as agriculture and tourism (Hi, France😉🇫🇷). They should avoid mingling with foreign multinational companies, whose technology diffusion to local industries is limited. Instead, countries should aim at export sophistication in high-value-added local activities, notably designing and manufacturing high-tech goods.

I find this prescription misleading at best. It’s based on the past, when cutting-edge innovation was effectively about manufacturing tangible goods. And it comforts today’s elected officials in their prejudices, believing that the frontier is still in heavy engineering (more TGV🚄 and more Airbus🛫).

Those officials, most of them in their 50s, 60s and 70s, learned about innovation when the winners of the day were specialized in high-tech manufacturing. But decades have now passed. The frontier has been pushed further and further away, notably by the transition to the age of ubiquitous computing and networks. And there are some things clearly missing in that reasoning: services and data.

(Notice that services and data are two different things. As explained by PPI’s Michael Mandel, “data is neither a good or service. It’s intangible, like a service, but can easily be stored and delivered far from its original production point, like a good.”)

Indeed we’re still far from understanding what an innovation-based strategy should be about in today’s digital economy. Here are ideas to try and bridge that gap:

1. There is such a thing as innovation in services and data. It’s about improving quality, reaching a larger scale, lowering costs, bundling and unbundling businesses by transforming one’s value chain. Innovation in services is particularly vibrant now that technology and entrepreneurship make it possible to “serve a customer at the highest level of quality and scale, simultaneously”.

2. There is such a thing as exporting services and data. Franchise businesses are a well-known precedent: McDonald’s, a very innovative company (just watch The Founder), is in the business of exporting services for the benefit of the US, where it was originated. And such innovative service businesses are even easier to design and export in the age of ubiquitous computing and networks. As Paul Graham once wrote, data-driven businesses are very similar to restaurant franchises: “McDonald's grew big by designing a system, the McDonald's franchise, that could then be reproduced at will all over the face of the earth. A McDonald's franchise is controlled by rules so precise that it is practically a piece of software. Write once, run everywhere.”

3. Innovation in services and data usually starts with serving customers at home. This is why larger countries are better positioned at this new frontier—provided that they create an environment that fosters tech-driven innovation (just like China👏🇨🇳). Customers can be enterprises as well as consumers: as Mariana Mazzucato discussed in the aforementioned seminar, Denmark is nurturing local businesses specialized in servicing the green industry worldwide—which means Denmark is doing what the French did years ago with Schlumberger: if you can’t specialize in oil production, then specialize in services provided to oil producers.

The reason for the bias against services and data is that we lack frameworks to understand how countries can foster export-based growth with such businesses. High-tech goods can be protected with patents (an indicator frequently used by economists such as Cherif and Hasanov), whereas services and data have a more complicated relationship with intellectual property. But the lesser role of patents in those fields shouldn't matter. You can’t protect financial products with patents, yet New York and London prove that you can add a lot of local value by exporting financial services.

An innovation-based strategy in services and data also goes against the idea that innovation implies employing many workers locally. This isn’t the case in service businesses, which tend to create more jobs abroad than at home as they scale up—because the value chain has to be redeployed closer to the customers. As for data-driven businesses, they’re too new and unfamiliar to be accounted for in cross-border trade, but Michael Mandel has been pioneering interesting reflections here: Data, Trade, and Growth.

But then again, were there ever many local jobs in high-tech manufacturing? Far from it, actually: as demonstrated by Enrico Moretti, most local jobs in high-tech areas have been primarily in low-productivity, local service businesses (more in barbershops that in research labs). Similarly, having an Internet giant capturing global value isn’t just a question of “how many employees do they have”; it’s about the growing ecosystem around that business, both professional (other businesses popping up to help them) and personal (employees and shareholders getting paid and spending money locally).

I don’t know if China will ultimately succeed at exporting its extraordinarily innovative service and data businesses. But when it does, hopefully it will help upgrade our policymakers’ thinking—and it will contribute to designing strategies more in line with how value is created in the digital age.

Warm regards (from Shanghai, China),

Nicolas