From Decreasing to Increasing Returns: the Role of Tacit Knowledge Capital in Firm Production and Industrial Growth

Abstract

This paper integrates a learning model and two production models with endogenous technical change emphasizing the importance of tacit knowledge capital (KC). Individual business firms may experience diminishing returns to their existing tacit KC. However, when these firms update their tacit KC using the dialectical learning process, they can increase their productivity (output per worker) potentially creating a natural externality in their industry. Because firm-level production innovations cannot be perfectly patented or kept secret, tacit knowledge created by one firm can spill over to the industry leading to increasing returns to tacit KC. A conceptual framework is developed showing that increasing the tacit knowledge base of the firm is needed to foster the technical change required to increase productivity in both the firm and corresponding industry. Causes of diminishing returns to existing tacit KC at the firm level are discussed. Also, some pathways to increasing industrial returns to tacit KC are explored.