Scienze Regionali Vol. 8 – n. 3, 2009, pp. 101-126 Italian Journal of Regional Science

Thirty Years of Regional Science in Italy Special Issue

Knowledge Economy and Service Activities Riccardo Cappellin* (Paper first received, May 2009; in final form, July 2009) Abstract This paper identifies some paths in the evolution of the international and mainly European literature on service activities, and it seeks to relate them to the emerging interest in the cognitive dimension of innovation processes. In particular, it indicates the contributions of Italian researchers who have actively participated in this international debate and in some cases anticipated new perspectives which have then been adopted by other researchers. A characteristic of these contributions is the link between the analysis of services sectors and the spatial characteristics of Italy, such as the diffusion of industrial districts made up of SME specialized in medium technology sectors and the evolution of the Italian urban system consisting of numerous small and medium-sized cities. Keywords: services, KIBS, innovation, knowledge economy, urbanization economies JEL Classification: R3, L8, O3

Economia della conoscenza e servizi (Articolo ricevuto, maggio 2009; in forma definitiva, luglio 2009) Sommario Il contributo individua alcune linee dell’evoluzione nella letteratura internazionale e soprattutto europea sui servizi e cerca di collegare le stesse con l’interesse emergente sulla dimensione cognitiva dei processi di innovazione. In particolare, esso illustra il contributo dei ricercatori italiani che hanno partecipato attivamente in questo dibattito internazionale e che in diversi casi hanno anticipato prospettive nuove che sono state successivamente adottate da altri ricercatori. Una caratteristica di tali contributi è il collegamento tra l’analisi dei settori dei servizi e le caratteristiche territoriali dell’Italia, come la diffusione dei distretti industriali composti da PMI specializzate in tecnologie intermedie e l’evoluzione del sistema urbano italiano che consiste di numerose città di piccole e medie dimensioni. Parole chiave: servizi KIBS, innovazione, società della conoscenza, economie di urbanizzazione Classificazione JEL: R3, L8, O3

Faculty of Economics, University of Rome ‘Tor Vergata’, Via Columbia 2, 00133 Rome, Italy, e-mail: [email protected]. *

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1. Introduction This paper identifies some paths in the evolution of the international and mainly European literature on service activities, and it seeks to relate them to the emerging interest in the cognitive dimension of innovation processes. In particular, it indicates the contributions of Italian researchers who have actively participated in this international debate and in some cases anticipated new perspectives which have then been adopted by other researchers. A characteristic of these contributions is the link between the analysis of services sectors and the spatial characteristics of Italy, such as the diffusion of industrial districts made up of SME specialized in medium technology sectors and the evolution of the Italian urban system consisting of numerous small and medium-sized cities.

2. The Definition and Measurement of the Tertiary Sector Service activities represent the largest part of employment and internal product in a modern economy. The development of service activities seems to correspond to a new phase in economic development, where the shares in employment of agricultural and industrial activities are decreasing with respect to those of tertiary sectors. Services characterize a “post-industrial society” (Bell, 1974, where, besides the services most closely linked to manufacturing, such as transport, there are the activities in financial and trade intermediation and other modern service activities in the fields of education, health, research, leisure and management. A traditional interpretation links the growth of services to the greater income elasticity of the demand for services with respect to manufactured and agricultural products, according to Engel’s law. By contrast, changes in industrial technologies and organization highlight the importance of intermediate demand for industrial productions and the increasing importance of service activities in the various phases of industrial supply chains. In fact, the externalization of tertiary activities by industrial firms indicates that many new service firms are autonomously developing activities which were previously attributed to internal functions of industrial firms. The “tertiary sector for the industrial system” (Momigliano, Siniscalco, 1980) represents a large share of the overall tertiary sector and records a higher growth rate than those of the tertiary activities for final demand and trade activities. Thus, the employment increase in services is to a large extent related to increased integration between services and industrial productions. The growth of the tertiary sector for the production system has become a specific pattern in the production system’s evolution, and it is a necessary condition for an increase in its efficiency. However, a different approach to measurement of the increasing importance of services is based, not on the outputs of the various sectors, but on the inputs of those same sectors. In fact, the increasing share of service sectors in the national or regional economy (“explicit” tertiary activities) is linked to the increasingly important role of service functions within industrial firms (“implicit” tertiary activities). Cappellin has used an input-output approach to clarify three different measures of 102

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the share of services in the total economy (Cappellin, 1980b; Cappellin, Grillenzoni 1983; Cappellin 1986b): a. services as components of final demand, b. services as production sectors, c. services as production factors. A definition of services based on service occupations enables the analysis to focus on the value of the work performed by service workers within both the service and the industrial sectors, and to exclude the value of the material inputs and manual occupations used within the service sectors. This definition has the advantage of focusing attention on the labour market. It overcomes the distinction between final and intermediate demand for services, or that between “consumer services” and “producer services”. It avoids attributing the growth of services to the outsourcing or externalization of those activities already existing within industrial firms. Moreover, this different definition seems to be particularly suited to studying the spatial distribution of service activities because labour markets have a mainly local character, and it links the process of tertiarisation to the evolution toward the knowledge economy and the increasing role of “knowledge workers” and of education and R&D policies. In a regional and national framework, the development of services affects the development of industrial activities, and it is influenced in its turn by the development of the latter. The industrial base of a region or of an urban area cannot be competitive without modern knowledge-based services. On the other hand, a strong industrial base is crucial for the development of modern service activities. Within the larger tertiary sector, knowledge-intensive business services (KIBS) may be defined as “those services that involve economic activities which are intended to result in the creation, accumulation or dissemination of knowledge” (Miles et al., 1995, p. 18). KIBS are characterised by their heavy reliance on professional knowledge, both codified-explicit and tacit-implicit. They can use their knowledge to produce intermediary services for their clients’ production processes, and they are typically supplied to businesses through strong supplier/user interactions (Miles et al., 1995). Traditionally, service activities have been distinguished from industrial activities by their immaterial or intangible character, which is related to the impossibility of accumulating stocks of output, the contextual character of production and use, the active participation of the client in the production process, and the importance of human resources (Paiola, 2006). While the immaterial characteristic does not apply to many traditional services which have become industrialized, it certainly applies to the case of KIBS. Thus KIBS are characterized by intangibility and interactivity (Miozzo, Soete, 2001). The face-to-face contacts necessary for the exchange of tacit knowledge makes proximity and spatial agglomeration crucial for the delivery and production of KIBS, even in the presence of globalized knowledge flows. KIBS are confronted with the specific problems of their clients. Hence they very often require direct contacts 103

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with them in order to conceive solutions by recombining existing knowledge and complementing it with new inputs if necessary. A large share of these interactions, especially in the initial phase of a consulting activity, is characterized by a strong tacit content requiring personal contacts. Proximity (geographical, social, cultural, etc.) is hence helpful in managing these phases (Muller, Zenker, 2001). The case of KIBS indicates the limitations of the traditional approaches to tertiary activities, which were defined according to their residual nature with respect to primary (agricultural) and secondary (industrial) productions; were mainly linked to the growth of consumer demand; and were characterized by lower productivity growth with respect to industrial products. By contrast, KIBS may be defined on the basis of their higher knowledge content. They are oriented to firms, not to consumers, and especially play a key role in the process of innovation in the other sectors while themselves being characterized by an important, though peculiar, process of innovation. In particular, the following types of knowledge-based services can be identified: -- “knowledge-intensive business services” (KIBS) may be defined as services which involve economic activities intended to result in the creation and accumulation or dissemination of knowledge (Miles et al. 1995). They are addressed to firms, but they also include service activities, such as vocational training and mandatory social insurance, delivered to people when they are considered in their function as employees; -- “knowledge-intensive people services” (KIPS). These are consumer services – such as health services or various services in cultural and media industries – which require workers with high knowledge and professional competencies or which make intensive use of modern ICT technologies. In fact, this distinction is often blurred, because service firms must often respond to demand by both other firms and individual persons, as in the case of banks, insurance companies, legal services, and telecommunications. Thus both these service categories which characterize a modern knowledge economy may be included in the broader definition of “knowledge-intensive services” (KIS). This clearly does not exclude that knowledge is increasingly important also in the case of traditional services, both those addressed to the firms, such as logistics and transport, and those addressed to people, such as entertainment industries and large retail distribution. In fact, technological change has been rather important in these activities, and this makes specialized competences based on an higher level of knowledge necessary. The development of services is also linked to the process of globalization. Increasing international competition makes it impossible for developed economies to be competitive on the basis of low production costs alone, and it requires higher quality and the continuous innovation of industrial productions. In particular, it requires a continuous decrease in production costs, the more rapid adaptation of the product’s characteristics to the more complex needs of users, and the continuous 104

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substitution of traditional products with new products able to satisfy the new needs of consumers. These changes require the closer integration of services both in the production of products and their delivery to their external final or intermediate users. The industrial firms of the most developed countries outsource a growing part of manufacturing activities to other firms in countries with lower labour costs. They adopt capital-intensive productive processes with which production cycles can be automated and manual labour substituted. The industrial firms specialize instead in immaterial or tertiary activities such as marketing, design, finance, organization of production, management of the supply chain, transport, and logistics. According to Rullani (2006), industry may become similar to services because it has discovered the importance of linkage with the users of its products, and it develops a service relationship with them, or with qualified segments of them, as in the case of products which are not standardized but may characterize a specific lifestyle or membership of a specific post-modern community. Turning to the supply side of the regional economy, the growing share of tertiary activities is also linked with the increasing role of knowledge, higher education levels, the higher qualification of the labour force, and its increasing preference for non-manual professions. Thus the most developed economies are more competitive in those sectors where highly qualified labour is required, since the latter is relatively abundant in these economies. By contrast, they de-specialize from those manufacturing sectors where unskilled labour is required, since this latter is relatively more scarce in the most developed countries than in the less developed ones. In conclusion, the increasing importance of KIBS in the economy is closely related to changes in demand by final consumers, which is increasingly oriented towards private and public services, to the development of tertiary sectors producing for an intermediate demand, and finally to the development of service occupations or the emergence of “knowledge workers”, both within service firms and within the user firms of the manufacturing sectors.

3. The Demand of Business Services in the Innovation Processes of SMEs SMEs face particular problems in adopting a competitive strategy based on innovation as increasingly needed in developed economies. These constraints concern the lack of credit and risk capital, qualified human resources, technical information, internal R&D, organization of product distribution and in general of qualified technological and managerial capabilities (Bougrain, Haudeville, 2002). This external sourcing of qualified services is systematic in the case of SMEs (IReR, 1979; Boscacci et al., 1986; Boscacci, Cappellin, 1990) and specialised business services may help SMEs by providing the capabilities lacking in these fields. In this case, business services perform a merely complementary role in the adoption of innovation. On the other hand, other business services may have a more proactive role, 105

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and they may stimulate firms to adopt innovations by helping them in designing the changes to be introduced, as in the case of external R&D or engineering services, or management consulting services. All activities which do not belong to the set of core competencies are externalised from the firm and assigned to specialized firms (Antonietti, Cainelli, 2007). Moreover, the outsourcing of high skill-intensive, high-quality goods and services has been encouraged by technological progress and reductions in transport and communication costs. The importance of spatial agglomeration and technology as the determinants of the decision to outsource KIBS at firm level has been shown by Antonietti and Cainelli (2007). These authors use microeconomic data on a repeated cross-section of Italian manufacturing firms for the period 1998-2003 and demonstrate that (i) the propensity to outsource is not affected by labour costsaving reasons but depends directly on the firm’s size and investment in ICT equipment, and is negatively related to the firm’s capital intensity; (ii) the volume of KIBS outsourcing is positively related to investment in R&D, belonging to a relatively dense local production system, and the interaction between R&D and spatial agglomeration, which is particularly evident in mechanical industrial districts. KIBS perform a key function in the phases of analysis and problem-solving for users. This capability is sometimes termed “evaluation” or organizational knowledge. In fact, the particular professional competences of KIBS enable them to identify problems that are often of a very complex nature and that the users themselves are unable to identify and solve. Secondly, KIBS may also provide users with specific solutions that overcome their cognitive deficiencies. This capability is called “synthetic” knowledge and it allows the combination of different pieces of technical or engineering knowledge in the solution of a specific problem (Asheim et al., 2007). Therefore, from an innovation perspective, KIBS perform three types of functions: 1) problem identification and analysis; 2) diagnosis definition and definition of the problem; 3) participation in the problem-solving process. KIBS can thus be termed “co-innovators” with the user firms because they not only provide technical support to users but also cooperate with the latter in innovation. Related to the interactive characteristics of innovation processes is the fact that KIBS are not only based on knowledge and contribute to its generation in user firms but are also key actors in the management of knowledge flows between the various other local actors (Andersson, Hellerstedt, 2008). They perform the function of “intermediaries” in innovation processes as the “best practices” adopted by firms within a sector, and also in different sectors, are made indirectly accessible to other firms characterised by more traditional technologies and organizational routines. KIBS thus facilitate the use of common organizational models and the sharing of technological knowledge among different firms, and especially among the SMEs of a regional innovation system (Muller, Zenker, 2001). KIBS are vital factors of connectivity and receptivity (Antonelli, 1999), and they increase the exchanges of tacit knowledge and localized competences among agents. KIBS use external codified knowledge acquired from university centres, from publications, or from the professional networks to which KIBS firms typically belong (Antonelli 106

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1998). From this perspective, they perform the function of an “immaterial infrastructure” or an “intermediate institution” which facilitates production cooperation in the network of firms, knowledge exchanges, and the internal coherence of a regional innovation system. Services therefore contribute to development of the “relational capital” which characterizes a local production system and stimulates the process of collective learning, together with other well-known linkages, such as labour – force mobility, client/supplier relationships, and the spinning-off of new firms (Capello, Faggian, 2005). That intermediary function is particularly evident in the case of ICT services, because the flexibility and adaptability of communications have made these services crucial for production and for addressing the complexity and turbulence of the external environment (Capitani, Di Maria, 2000). In conclusion, KIBS may a) provide specialized and general support to user firms, b) provide rare competencies to users, c) stimulate innovation, d) train the labour force and improve the capabilities of the human resources within users (Howells, 2006b; Miozzo, Grimshaw, 2005), e) promote indirect links among different user firms by working as intermediaries and bridging institutions and finally f) also learn by interacting with users and providing their services to them (Strambach, 2001; Müller, Zenker, 2001). Hence KIBS firms also have a wider environmental impact than an effect on their direct users. KIBS interact with other KIBS firms and contribute to the social, economic and cultural vitality and international openness of the economy and the local community in which they are located (Bailly, Maillat, 1989), and they ensure the development of networks of small and medium-sized cities outside the large metropolis. In particular, KIBS contribute to the development of new and more sophisticated needs and the overall culture and knowledge in the areas where they are located, and they improve the supply of qualified human resources. They also contribute to the sense of belonging to a given geographical area because they act as intermediaries and establish network relations between firms and local stakeholders (Roma, 2007). From this perspective, KIBS constitute a key factor in explaining why cities drive the transformation of the national economy towards the model of the knowledge economy (Cappellin, 2007). In conclusion, it emerges that KIBS not only represent a necessary complementary factor which facilitates the adoption of innovation by user firms; they also have an active role because they stimulate the innovation of these firms by increasing their internal knowledge bases. In particular, they favour the adoption of organizational or systemic innovation by increasing cohesion in the local economy and promoting the indirect sharing of knowledge among the various sectors of a local economy.

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4. The Process of Knowledge Creation and Innovation within KIBS Whilst it is widely recognized that KIBS contribute to the innovation of user firms, it is more difficult to distinguish the characteristics of innovation within KIBS. Service firms innovate (Metcalfe, Miles 2000, Gallouj 2002, Carlsson et al., 2002; Hipp, Grupp, 2005; Tether, 2003; Howells, 2006a), but they do not do so through activities which can be classified according to the traditional analytical instruments used in the study of manufacturing industry. In fact, as in the case of SMEs in medium technology sectors (Cappellin, Wink, 2009), in KIBS, too, it is rarely possible to identify R&D formalized activities and precisely measure input and output and then productivity (Cappellin et al., 1987), which is the traditional indicator of technological change. Several studies have shown that R&D activities play only a marginal role in the service sector, and patents are rarely taken out by service firms to protect their innovative output against imitation. In most service sectors, innovation activities are incremental in nature, require substantial human capital investment, and rely upon the acquisition and internal development of ICT. In particular, Cainelli, Evangelista and Savona (2006) examine the links between innovation and economic performance in services, using longitudinal firm-level data based on CIS II (1993-95) and a set of economic performance indicators drawn from the Italian System of Enterprise Accounts (1993-98). The Community Innovation Survey takes into account, besides R&D, other fundamental sources of innovation for service firms, such as activities related to the design of new services, software development, the acquisition of know-how, investment in new machinery (ICT hardware), and training. KIBS are based on types of knowledge (Asheim, Coenen, 2005; Asheim et al., 2007) which differ according to the field of activity: mainly synthetic knowledge in the case of engineering services; symbolic knowledge in the case of advertising services; organizational and evaluation knowledge in the case of management consulting services; while research companies are clearly based on analytic knowledge. Knowledge within KIBS is similar to “combinative knowledge” because it covers a relatively broad range of fields and is highly fungible (Antonelli, 1998). It is suitable for application to diverse problems and types of user firms, and for combination with their internal knowledge. By contrast, the knowledge and competences of customer firms, and especially of SMEs, can be considered as “specialized knowledge” in a localized field. Moreover, decomposition into different modules yields KIBS firms the benefits of a greater division of labour or specialization, so that they can tackle complex problems efficiently and thus enjoy the advantages of economies of scale and scope (Miozzo, Miles, 2003). Two approaches can be identified (Howells, 2006b; Sebastiani, 2006) in the study of innovation in services. According to a first and traditional approach, modern IT technologies constitute the central factor of innovation within services, and they may foster the development of new services or the increased productivity of services. According to a different approach (Bryson, Monnoyer 2004, Tether 2003, 108

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Rullani et al. 2005), services are characterized by the two dimensions of intangibility and interactivity. In fact, the characteristic of intangibility and the informal character of the innovation process determine the difficulties in measuring the input and output of innovation. According to a service-oriented perspective, which applies especially to KIBS, innovation in services is client-oriented. Services are highly differentiated and require client-intensive arrangements in innovation. Service provision implies a close relationship with clients and co-production with the latter. In fact, the characteristic of interactivity indicates that innovation is the outcome of co-production between the producer and the user, determining the difficulty of attributing the innovation’s origin. Gallouj (2002, pp. 40) goes further by noting that if the protagonists believe that the product they are paying for, and from which they are benefiting, is the immediate act of service delivery, then process and product are virtually one and the same thing. In fact, in the case of services, product and process innovations are closely intertwined (Gallouj, Weinstein, 1997; Miles, 2005). Since both the use of an immaterial content made up of different types of knowledge and the use of personalized relationships with the user are characteristics of KIBS, innovation in services consists not only in the use of new types of knowledge base but also in the development of new types of linkage between the producer and the users, as shown by analysis of more than fifty service-firm case studies in Italy (Rullani, 2006). In fact, new services characterized by new types of knowledge and linkages are appreciated by the users, and they determine the willingness to pay prices higher than those of the competing and traditional products and services. It may be stated in general that product innovation within KIBS is more important than process innovation (Muller, Doloreux, 2009), and that product innovation, owing to its customization and the interactive nature of the process of service production and delivery, does not depend on its intrinsic characteristics alone but is also closely related to the specific user of the service considered. Thus innovation in services is characterised by:  -- continuous change and improvement of the quality of a given service delivered to individual customers, -- change in the type of service delivered to the same customer, and change in the customers served. KIBS recombine the knowledge previously acquired, reprocessing and adapting it. This leads to the creation of new innovative services which represent an innovation for the KIBS themselves. The interactive relationships between KIBS and their user firms give rise not only to innovations for the latter but also to the development of experiences, competences, and therefore innovations within the service firms themselves. Thus KIBS themselves can be considered as “innovators” and do not contribute only to the innovative capabilities of their users. In synthesis, the process of knowledge creation within KIBS is interactive and has an incremental and cumulative nature. It requires the combination of diverse 109

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internal and external types of knowledge and close interaction with the user firms, and with other service firms. That is different from the development of formalised research and development activities such as those carried out within university institutions and the research departments of large firms. The process of knowledge creation within KIBS is based on the following sequence: a. application of general knowledge to solve the problems specified by the users; b. gradual generalization of the results obtained from application experiences to develop new knowledge, both tacit and codified, which represents the base for further applications with new customers and to new problems. In particular, the model of new knowledge creation and the generation of innovation in KIBS differs from the “linear model” which assumes an almost automatic sequence from basic research to applied research to development and to innovation. However, it also differs from the “chain linked model” (Kline, Rosenberg, 1986) which envisages a tight relation or feedback between production activities and those of commercialization and research within individual firms. On the contrary, it is characterized by the interaction between different firms and other actors, and it has a “systemic or interactive nature”. In fact, owing to their service or “problem solving” nature, KIBS develop new knowledge and new competences in an informal way on the basis of close relations with their users. This interactive learning process is consequently similar to the innovation process which occurs within a cluster of SMEs (Cappellin, Wink, 2009), or within sectoral supply chains characterized by forms of collaboration (“co-makership”) in innovation between the client and the supplier. In conclusion, the process of innovation in service activities is differentiated from those in manufacturing industry by two characteristics: a) the close complementarity between process and product innovation, b) the interaction between the new product characteristics and change in the behaviour of the user. A third characteristic has a systemic and local nature in that KIBS create the opportunities to innovate for other sectors. In fact, KIBS contribute to changes in the structure of local residents and to the emergence of a knowledge or learning society, thereby inducing changes in needs and the demand for new products or services.

5. The Spatial Concentration and Mobility of KIBS Service quantity, quality and productivity are more difficult to define and are often uncertain. The input-output relationships of services are different from those of industrial sectors because inputs of raw materials, intermediate products and capital goods are much less important than the labour inputs and the flows of complementary services from other service firms. Tight interdependence between producers and users is typical of the production of a service, contrary to the case of industrial production, because services cannot be stored owing to their immaterial content. Thus service transactions are also more frequent than goods transactions. 110

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A large proportion of these interactions, especially in the initial phase of a consulting activity, are characterized by a marked tacit content requiring personal contacts in particular. Service transactions are usually more complex and necessitate greater reciprocal trust than do transactions concerning industrial products. Moreover, services often require very special human skills and a high immaterial investment which may bind the buyer and the provider of the service together (Cappellin, 1989). Transaction costs are therefore higher for service activities than for industrial firms (Cappellin, 1988; Parr, Wood, 2005) because of the immaterial nature of the output of service firms, and because of the need for a close and active relationship, as well as for bilateral exchanges of knowledge between the supplier and the user in the process of producing a service. In fact, the quality of a service seems to consist mainly in the correspondence between the characteristics of the service provided and the needs of the users. Proximity (geographical, social, cultural, etc.) is consequently helpful in managing these high-qualified services (Muller, Zenker, 2001). Antonietti and Cainelli (2007) argue that spatial agglomeration may play a significant role in the decision to outsource KIBS. Owing to their characteristics, the relocation of such services requires the firm to search for highly specialized markets, where high-skilled personnel is particularly abundant, and where informal face-to-face interactions promote the transmission and re-codification of tacit knowledge. Consequently, industrial districts – characterized by relatively close communities and the existence of agglomeration externalities – may be highly attractive geographic spaces for the externalization of knowledge-intensive activities. This also explains the concentration of KIBS in urban centres. In fact, because transaction costs decrease the lower the geographical distance or the higher the concentration in specific urban centres, cities or central locations have a comparative advantage with respect to rural or peripheral areas in services. The characteristics of the local environment thus affect knowledge creation in KIBS and their quality, competitiveness and growth. KIBS firms are deeply embedded in the regional territory and, unlike industrial firms, they can hardly relocate to other regions and countries. The evolution in the regional location of KIBS has been determined more by the different growth rates of KIBS in the various areas as the result of the different birth and closure rates and the different growth rates of the firms already located in these areas. By contrast, the mobility of KIBS firms and professionals among the various areas is rather limited, and it often occurs across only short distances within the same city or region. Thus explicit relocation decisions by the firms are less important than the implicit location processes related to different growth rates. The development of service activities corresponds to a model of “endogenous growth” and is mainly the result of local entrepreneurship capabilities. The birth of new firms in the service sector is related to a) the start-up of a new activity by an entrepreneur or to b) diversification into new productions by a firm active in other sectors in the same area or to c) the creation by a service firm active in the same 111

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sector but in another area. Only in some cases does it correspond to the externalization of services previously produced in an already-existing industrial and tertiary firm and lead to the creation of a new firm controlled by the parent firm. The birth of new services occurs mainly in the largest urban centres because it is linked to the pre-existing higher levels of services in those areas. In fact there are no services which are completely new, because the new services result from the autonomous production of services previously produced together with other services or result from the differentiation of already-existing services so as to satisfy the needs of users in a new way. A recent characteristic of KIBS is their adoption of a network organization at the regional, national, and in some cases even international, level (Miozzo, Soete, 2001), as in the case of banking services and professional services. In fact, owing to their immaterial nature and the need for close relationships between the producer and the user, KIBS cannot be concentrated into a single centre. They have consequently created networks in order to extend their market areas, but also to promote collaborative relations and to attract rare and highlyskilled human resources. Moreover, these networks are characterized by a vertical service differentiation of the participating firms, and they have rather hierarchical structures. Newlycreated KIBS firms, or less qualified firms, perform the most routine functions, while larger and more centrally located ones are specialized in the most qualified services, which are demanded by users to solve more complex and new problems. This vertical differentiation of services and the differences in the quality of the service as perceived by its users explain the wide disparities in the productivity, prices and wages of KIBS firms.

6. KIBS and the Changing Hierarchy of Urban Systems The theories of city systems sheds light on the relationships between spatial interdependence and competition in the location of economic activities. It also brings out spatial diffusion or concentration and regularities in the spatial structure of a region or of a country, these being synonymous with the production specializations of regions and with regional development disparities (Cappellin, 1980a). Albeit very belatedly with respect to studies on industrial firms, many recent empirical and theoretical studies have greatly developed knowledge about the factors affecting the location decisions of firms in the various service sectors. Central place theories have considered the location of services related to final consumption or consumer services and have indicated the hierarchical character of their location pattern. By contrast, recent studies have focused on the location of producer services, this being determined by intermediate demand rather than by final demand. Various British and Nordic studies (Bryson, Daniels, 1998; Cappellin, 1980a) report that information is the most important factor in the production of

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intermediate services, and they have analysed the effect of information technologies on the accessibility needs of these services. New services may result from the vertical differentiation of service demand because less qualified services may be substituted by new, more qualified and specialised ones, which concentrate in large urban centres. Moreover, a process of vertical and horizontal disintegration may lead to the separation of various services which were previously jointly produced. These new services may choose separate locations and they may concentrate in the largest urban centres (Cappellin, Grillenzoni 1983; Cappellin, 1986a). This process of concentration may be explained with Weber’s agglomeration model when the largest centres are included in the “critical isodapane”, which may be centred on the smaller centres and indicates the distance of the points where the increase in communication costs is equal to the decrease in production costs determined by the concentration of some new services. Otherwise, the higher bid prices that consumers in peripheral areas are willing to pay for services of better quality and greater specialization than the more traditional and undifferentiated ones may compensate for the greater cost due to their transportation from a more distant and larger urban centre. Both these effects are the result of interaction between the higher economies of scale to be exploited in central areas and the decrease of transportation and communication costs. This process may lead to a “filtering upward” of some services in the urban hierarchy (Cappellin, 1986a). In fact, small cities may lose some high quality services which were previously jointly produced together with less specialized and traditional services or with industrial productions in the same firms. Figure 1 - A General Model of the Demand and Supply of Services in Different Urban Centres p, ac

DR2’ DR2

DR1’

DR1 SR1

s2

s1

s1’ s2’

Source: Cappellin, 1986a 113

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Moreover, it is possible to demonstrate that the development of service activities does not depend only on demand in the local economy, but also on the capacity to exploit specific advantages in terms of production costs, quality of the labour force, agglomeration economies, access to the communication networks, availability of information, local know-how, and entrepreneurship capabilities (Cappellin, 1989). As indicated in Figure 1 (Cappellin, 1986a) the supply schedule of a specific service in a smaller urban centre (SR2) may be to the right of the supply in a larger urban centre (SR1) because the same unit labour cost corresponds to a larger per-capita consumption level in smaller centres, since agglomeration economies are important in larger centres. On the other hand, the schedule of the per-capita demand of a smaller centre is located to the left of that of a larger urban centre because smaller centres have smaller hinterlands and market areas. Therefore, in the normal case when economies of agglomeration are relevant, the equilibrium per-capita employment level of a specific service in smaller centres is smaller (s2) than in the larger urban centres (s1). However, in the case of diseconomies of agglomeration, it may happen that the per-capita employment level of a specific service in smaller centres (s2’) is greater than in larger urban centres (s1’) because in these latter centres the unit costs may increase more than the increase in the bid prices which consumers are willing to pay in these larger centres. This model is more general than the central place theory. It may explain why the service level of high-order centres is not zero in small urban centres and it may indicate a nonhierarchical geographical distribution of service activities, since individual small urban centres may specialize in the production of specific services. Usually, larger urban centres have a greater per-capita level of overall services and supply those services with higher quality because they are at the centre of a larger potential market area. While pull factors attract the most qualified KIBS into the central areas, push factors related to cost competition or market segmentation seemingly force the less qualified KIBS firms to locate in more peripheral areas, where costs are usually lower and they can be protected by distance. Services may be distinguished according the size of the respective market as follows: services exporting their activities at the national and international level, services with an intermediate market which supply regional users, and services selling in a local market and supplying rather routine services (Ciciotti, 1987). This distinction confirms that the location of services is somewhat independent – at least in the case of the most qualified services, such as KIBS – from the location of demand and is instead determined by the availability of supply-side factors. Ciciotti (1987) applied a model of spatial interaction and a cluster analysis to the urban centres/services matrix – with consideration also of firm size in the case of producer services – and identified various types and a ranking in the case of both consumer services and producer services. This more precise classification of service activities differs from those commonly used and which are based on product types defined according to various theoretical or empirical methodologies. This empirical analysis confirms the results obtained by Cappellin (1983 and 1986a) using location quotients of service employment, and it indicates that centres 114

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of lower rank in terms of population may have a greater service endowment, measured as employees per inhabitant, than centres of higher order. Moreover, smaller urban centres and with smaller service endowments may be specialized in some high quality services. The various urban centres are thus linked by integration relationships because cities of the same demographic size may have different and complementary specializations (Ciciotti, 1987). KIBS concentrate in major urban centres where the accessibility of regional demand and the supply of skilled human resources are highest. Cities are centres of economies or diseconomies of agglomeration. Transaction costs play a crucial role in explaining agglomeration economies (Cappellin, 1988; Parr, Wood, 2005). The industrial economics literature has investigated the role of transaction costs in relationships between industrial firms and service firms and the trade-off between the vertical integration of service activities within large industrial firms, i.e. the hierarchy solution, and their outsourcing, i.e. the market solution. On the other hand, from a spatial perspective, it is important to analyze the relationships between transaction costs and the size of urban centres and the changing organization of the urban system in a country or region, because transaction costs may affect the tradeoff between a concentrated and a dispersed settlement structure. In fact, transaction costs may represent a factor explaining the hierarchy level of the urban system (Cappellin, 1988) different from the concept of economies of scale usually adopted in the central place literature. Transaction costs explain the relationships between larger cities and smaller urban centres because actors concentrate when an overly dispersed location pattern implies excessively high transaction costs. But also the opposite trend may occur, since various factors may explain the crisis of a too concentrated settlement pattern, given that transaction costs may be higher in very large metropolitan areas. Thus, when the number of firms and households increases above a specific threshold, which may vary according to the sector and the period considered, transaction costs may increase, and this may decrease the “localisation” and “urbanisation” economies. Various factors explain why the most appropriate spatial organization form of transactions in the various service sectors and in the labour market may not be a large metropolitan area but rather a polycentric city-region. In fact, a network of interdependent and smaller urban centres within a cityregion may be more efficient than a large compact metropolitan area when the cost of the transfer and processing of information among firms tightly integrated in a specific production sector becomes very high and unmanageable owing to the congestion existing in a large metropolitan area. Secondly, wider social disparities among local actors may reduce belief in common values, the sense of a shared identity, and the spirit of solidarity with respect to a small or intermediate urban centre. Thirdly, the increase in the number of local firms may lead to a decrease in reciprocal loyalty and trust between the buyers and the suppliers. This would reduce the incentive to make specific or idiosyncratic investments, binding the two actors or firms more tightly together and thereby slowing down the innovation process. Fourthly, progress in telecommunications, and especially the decrease in cultural, 115

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organizational, and institutional distances, may determine a decrease in transaction costs between two distant firms and reduce the need for spatial concentration. Hence cities may have different optimal sizes according to the magnitude of transaction costs (Cappellin, 1988). Different spatial patterns may coexist at the same time, and the urban structure of a country or a region is usually organised by a complex network whereby larger urban centres coexist with small urban centres, and the balance between large and small cities may vary across various countries and periods. Research should investigate the implications of these various factors for the optimal size of cities and for the evolution of the structure of city systems. Urban policies should seek to exploit the potential of decentralization and participation without losing the advantages of diversity and agglomeration. An urban system may be defined as a dynamic and highly interconnected system where the forms of vertical and horizontal links change according to the evolution of external conditions, and also to the emerging cases of spatial indifference related to the decay of spatial constraints. Cities, like the units in a neural network, are able to process the great quantity of information and knowledge which is produced by the system (Diappi, Ottanà, 1994). Globalization is accelerating both productive transformations and economic development processes, giving rise to greater specialization and diversity in the economic and territorial system. The urban and regional system has grown increasingly polycentric, and regional and urban hierarchies tend to shrink as relations and firm and city networks intensify under the effects of globalization. There are two processes which explain the diversification of the territorial system. First, the conversion of national urban systems into a European urban system introduces change in inter-urban relations, producing greater diversity in the economic, political and institutional functions of cities and regions within a more interactive and closely-related urban system. Second, a greater variety of products and activities reduces the concentration of productive and commercial functions in the largest cities or urban regions because of agglomeration diseconomies. This dynamic may lead to the creation of more flexible urban systems and to a decrease in historical urban hierarchies. The diffusion of modern ICT communications and the great improvement in international transport – in particular air transport and communication – have favoured the development of medium-sized cities and flattened the hierarchy in urban systems. In Europe, and particularly in Italy, medium-sized cities which once acted only as service centres in support of their respective industrial districts have experienced a remarkable improvement in living standards, so that their life quality is now similar to that in large cities. A study of the geography of tertiary activities in Italy (Roma, 2007) indicates that the points of excellence in these activities are somewhat scattered across the national territory, rather than being concentrated in the few major cities, and that medium-sized cities have rather large diversified bases of services. Some intermediate cities have been able to achieve high international openness, and other cities have diversified their strong industrial bases towards new modern business service 116

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activities. Many cities have successfully organized major events and cultural festivals, and this has contributed to the development of lifestyles and services which once characterized only the largest metropolitan areas.

7. The Contribution of KIBS to Urban Development The economy of cities is characterized by its large-scale specialization in service activities and the higher shilled labour force with respect to the national average. The increasing importance of services in the national economy has been accompanied by the greater importance of cities; and services perform an increasingly strategic role as the economic bases of cities. Since the massive de-industrialisation of urban economies during the 1970s and 1980s, the economic engine of cities has changed. In particular, cities have anticipated the rest of the economy by undergoing profound changes in labour markets and in relationships among firms. Cities are the core of the far-reaching sectoral transformation of the national and international economy into the model of the “knowledge economy”; and the competitive advantage of cities and regions is determined by the more rapid adoption of innovation (Wood, 2006; Cappellin, 2007). While most studies have examined the transition to the knowledge economy at the national level, in the various sectors and in the various geographical clusters, still required is better understanding of the workings of knowledge networks within and among city-regions and in modern knowledgeintensive service (KIS) activities. Services are a key factor in making a city attractive and competitive. A city should become able to respond innovatively and efficiently to the increasing and changing demand for goods and services by its citizens as new needs emerge in various fields, such as education, health, welfare assistance, environment, free time, and mobility. This is also important in the medium-sized urban centres of peripheral areas because the provision of modern services to industrial firms is necessary for global territorial competition (Bailly, Maillat, 1989). Moreover, services have a key role in the organization of the tight networking among a city’s various stakeholders which represents a factor in a city’s competitiveness and has complex social and economic impacts on urban development (Senn, 2007). In general, cities perform six different roles within the economy, society, and territory: they are centres of agglomeration and urbanization economies, incubators of innovation, gateways to interregional links, centres of a shared culture and identity, living environments, and political and administrative centres. The relationship between services and the urban economy can be analysed in each of these six different aspects. First, cities are centres of agglomeration due to the workings of economies of scale in services and the close interaction among the various specialised services. Moreover, according to Jacob’s concept of urban externalities, the larger market for services in cities allows for greater specialization and a higher diversification of the various services provided. This effect relates to the function

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of cities as incubators of innovation (Cappellin, 2007) and to the creation of new firms in various KIBS sectors. Third, cities are characterized by a strong identity and common culture which increase trust among economic actors and decrease transaction costs in exchanges among the various specialized KIBS firms (Cappellin, 1988). This increase in geographical and cognitive proximity facilitates the transfer of knowledge (Antonietti, Cainelli, 2007; Koch, Strotman, 2008). Fourth, cities are gateways for international and interregional communication, and KIBS are located in cities because of their greater openness to international relations, flows of specialized knowledge, and access to a wider regional and interregional market. Fifth, cities are also living environments, and they comprise pools of skilled labour owing to the preference of high-skilled workers for urban lifestyles (Wiig Aslesen et al., 2004). Citizens and firms within cities are users and consumers which express new needs and demand for new products and services (Cappellin, 2007). In fact, the close connection between potential clients expressing new complex needs, on the one hand, and firms and organizations endowed with advanced capabilities and open to forms of collaboration with other firms and organizations, on the other, is a powerful stimulus to innovation. Thus cities are also lead markets which furnish crucial opportunities for the development of new economic activities and the birth of new firms. Finally, cities are administrative centres, and the development of KIBS is closely related to the governance functions of public administrations, given that these latter regulate the field of KIBS activities and require KIBS as intermediaries (Miles et al., 1995) in the management of relations between the public sector and private industrial firms. In fact, urban services, and in particular public utilities or network services, require strong relationships between the public and private sectors if they are to be produced efficiently (Senn, 2007). Services are a key policy field in which to promote the vitality of urban centres. However, urban policies and spatial planning may also be key instruments for the development of knowledge-intensive services (Cappellin 2007). They are important not only in the organization of the physical dimension through, for example, the creation of office buildings and of interregional transport infrastructures, but also for the introduction of urban public services which may improve the quality of urban living and the attractiveness of cities to high-skilled workers. Urban policies may promote the development of knowledge and innovation networks within a city-region and close economic integration between industrial and service firms, and among service firms. Urban policies should focus on the various structural characteristics of knowledge networks, such as the intensity and nature of knowledge and information flows. the characteristics of the nodes such as firms, public administration, consumers, associations, geographical areas – the efficiency of the soft and hard infrastructures or bridging institutions facilitating interactions, the actual form of the networks in the various sectors and city regions, and the change and long-term trends in the form of those networks. 118

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Strategic fields for policy intervention, and also for future research, are the connections between, on the one hand, labour demand by industrial and service firms characterized by increasing requirements for flexibility, relational skills, intersectoral openness, autonomy and self-responsibility, and on the one hand, the labour supply, characterized by new skills and professional curricula, and the new needs and demand for new products and services expressed by users and urban residents. In conclusion, urban policies and future research should focus on problems which may hinder the development of modern knowledge-intensive services in urban areas, such as the existence of many new but only scattered needs, and the segmentation of local markets for new goods and services, low accessibility due to traffic congestion, low receptivity due to differences and excessive cognitive distances, tensions and conflicts, scant common identity due to deep diversities, fragmentation and high population mobility/turnover, low creativity due to the predominance of a short-term speculative perspective and a lack of long term commitment, poor governance capabilities due to a lack of coordination and the fragmentation of decision-making bodies.

8. Conclusions This study has sought to tie together the dimensions of the contribution made by KIBS to innovation in client firms, SMEs in particular, innovation within KIBS themselves, and spatial proximity in KIBS development. In particular, it has sought to identify the role of Italian contributions to the international literature. According to a recent international survey (Mueller, Doloreux, 2007), Italian contributions have been, together with those by British and French authors, the most frequent in the European literature on KIBS since its beginnings in the early 1990s. In particular, since the pioneering studies on definition and measurement of KIBS (Momigliano, Siniscalco, 1980), Italian researchers have contributed by focusing on the role of intermediate demand and on the complementarity between KIBS and tertiary activities within manufacturing firms (i.e. “implicit services”) and the role of service occupations both internally and externally to industry (IReR, 1979; Cappellin, 1980b; Boscacci et al. 1986). While Italian studies on KIBS have dealt with the issues of innovation and agglomeration considered in various other international contributions, they are characterized by a close relationship with the Italian literature on industrial economics and regional economics, focusing on the key role of manufacturing SMEs and industrial clusters (Capitani, De Maria, 2000; Antonietti, Cainelli, 2007). In particular, Italian studies have been among the first to establish a link between industrial and geographical research on KIBS with the new studies on knowledge creation (Antonelli, 1998 and 1999; Rullani, 2005 and 2006; Cainelli et al. 2006) and on localized processes of collective learning and networking.

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Unlike the international literature mainly focused on the industrial and technological dimension of producer services, Italian research has extensively considered the regional and urban dimension of producer services (Cappellin, 1980a and 1986a; Ciciotti 1987; Diappi, Ottanà, 1994). Moreover, while to date international authors have only attempted to analyze the location of KIBS and the factors explaining their emergence and growth, various Italian studies have explicitly avoided identification of the growth of KIBS with the role performed by major city regions with a significant and increasing global reach. Rather than merely highlighting the urban concentration of KIBS, Italian studies have explicitly related the spatial diffusion of KIBS to the complex and flexible relationships between larger and smaller urban centres (Cappellin, Grillenzoni, 1983; Cappellin, 1986a and 1988; Ciciotti, 1987) and the changing structure of national and European urban systems, making explicit reference to the well-known theories of urban hierarchy. They have shown not only the role of urban agglomerations as seedbeds for KIBS concentration but also the effects of urban agglomeration diseconomies in favouring smaller cities, and especially the functions performed by KIBS in the economic and social development of cities. The development of KIBS has been explicitly related not only to spatial proximity to clients but also to factors operating on the supply side, such as transaction costs, exchanges of tacit knowledge (which represent the key input to KIBS), emerging occupations in local labour markets, and in general the structure and configuration of regional knowledge bases. While Italian research on KIBS in the early 1990s was based on empirical surveys conducted on various industrial and metropolitan regions, unlike in other countries, and Germany in particular, still lacking in Italy is extensive national empirical research based on a large sample of KIBS firms. And the recent evolution of KIBS in Italy has still to be examined, notwithstanding the increasing role of the tertiary sector in determining the overall growth of employment and product in an emerging knowledge economy. Finally, a further area for future research is indicated by the persistent failure of both the international and Italian literature to provide guidelines on the role that regional policies and especially urban policies may perform in promoting KIBS, which are a major component of a modern economy, and how to use KIBS as means to promote social and economic development, regional international competitiveness, and urban quality.

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