The Need for a New Paradigm
Why do some nations succeed and others fail in international competition? This question is perhaps the most frequently asked economic question of our times. Competitiveness has become one of the central preoccupations of government and industry in every nation. The United States is an obvious example, with its growing public debate about the apparently greater economic success of other trading nations. But intense debate about competitiveness is also taking place today in such "success story" nations as Japan and Korea. Socialist countries such as the Soviet Union and others in Eastern Europe and Asia are also asking this question as they fundamentally reappraise their economic systems.
Yet although the question is frequently asked, it is the wrong question if the aim is to best expose the underpinnings of economic prosperity for either firms or nations. We must focus instead on another, much narrower one. This is: why does a nation become the home base for successful international competitors in an industry? Or, to put it somewhat differently, why are firms based in a particular nation able to create and sustain competitive advantage against the world's best competitors in a particular field? And why is one nation often the home for so many of an industry's world leaders?
How can we explain why Germany is the home base for so many of the world's leading makers of printing presses, luxury cars, and chemicals? Why is tiny Switzerland the home base for international leaders in pharmaceuticals, chocolate, and trading? Why are leaders in heavy trucks and mining equipment based in Sweden? Why has America produced the preeminent international competitors in personal computers, software, credit cards, and movies? Why are Italian firms so strong in ceramic tiles, ski boots, packaging machinery, and factory automation equipment? What makes Japanese firms so dominant in consumer electronics, cameras, robotics, and facsimile machines?
The answers are obviously of central concern to firms that must compete in increasingly international markets. A firm must understand what it is about its home nation that is most crucial in determining its ability, or inability, to create and sustain competitive advantage in international terms. But the same question will prove to be a decisive one for national economic prosperity as well. As we will see, a nation's standard of living in the long term depends on its ability to attain a high and rising level of productivity in the industries in which its firms compete. This rests on the capacity of its firms to achieve improving quality or greater efficiency. The influence of the home nation on the pursuit of competitive advantage in particular fields is of central importance to the level and rate of productivity growth achievable.
But we lack a convincing explanation of the influence of the nation. The long-dominant paradigm for why nations succeed internationally in particular industries is showing signs of strain. There is an extensive history of theories to explain the patterns of nations' exports and imports, dating back to the work of Adam Smith and David Ricardo in the eighteenth century. It has become generally recognized, however, that these theories have grown inadequate to the task. Changes in the nature of international competition, among them the rise of the multinational corporation that not only exports but competes abroad via foreign subsidiaries, have weakened the traditional explanations for why and where a nation exports. While new rationales have been proposed, none is sufficient to explain why firms based in particular nations are able to compete successfully, through both exporting and foreign investment, in particular industries. Nor can they explain why a nation's firms are able to sustain their competitive positions over considerable periods of time.
Explaining the role played by a nation's economic environment, institutions, and policies in the competitive success of its finns in particular industries is the subject of this book. It seeks to isolate the competitive advantage of a nation, that is, the national attributes that foster competitive advantage in an industry. Drawing on my study of ten nations and the detailed histories of over one hundred industries, I will present in Part I a theory of the competitive advantage of nations in particular fields. In Part II, I will illustrate how the theory can be employed to explain the competitive success of particular nations in a number of individual industries. In Part III, I will use the theory to shed light on the overall patterns of industry success and failure in the economies of the nations we studied and how the patterns have been changing. This will serve as the basis for presenting a framework to explain how entire national economies advance in competitive terms. Finally, in Part IV, I will develop the implications of my theory for both company strategy and government policy, The book concludes with a chapter entitled "National Agendas," which illustrates how the theory can be used to identify some of the most important issues that will shape future economic progress in each of the nations I studied.
Before presenting my theory, however, I must explain why efforts to explain the competitiveness of an entire nation have been unconvincing, and why attempting to do so is tackling the wrong question. I must demonstrate that understanding the reasons for the ability of the nation's firms to create and sustain competitive advantage in particular industries is addressing the right question, not only for informing company strategy but also for achieving national economic goals. I must also describe why there is a growing consensus that the dominant paradigm used to date to explain international success in particular industries is inadequate, and why even recent efforts to modify it still do not address some of the most central questions. Finally, I will describe the study that was conducted so, that the reader will understand the factual foundations of what follows.
There has been no shortage of explanations for why some nations are competitive and others are not. Yet these explanations are often conflicting, and there is no generally accepted theory. It is far from clear what the term "competitive" means when referring to a nation. This is a major part of the difficulty, as we will see. That there has been intense debate in many nations about whether they have a competitiveness problem in the first place is a sure sign that the subject is not completely understood.
Some see national competitiveness as a macroeconomic phenomenon, driven by such variables as exchange rates, interest rates, and government deficits. But nations have enjoyed rapidly rising living standards despite budget deficits (Japan, Italy, and Korea), appreciating currencies (Germany and Switzerland), and high interest rates (Italy and Korea).
Others argue that competitiveness is a function of cheap and abundant labor. Yet nations such as Germany, Switzerland, and Sweden have prospered despite high wages and long periods of labor shortage. Japan, with an economy supposedly built on cheap, abundant labor, has also experienced pressing labor shortages. Its firms have succeeded internationally in many industries only after automating away much of the labor content. The ability to compete despite paying high wages would seem to represent a far more desirable national target.
Another view is that competitiveness depends on possessing bountiful natural resources. Recently, however, the most successful trading nations, among them Germany, Japan, Switzerland, Italy, and Korea, have been countries with limited natural resources that must import most raw materials. It is also interesting to note that within nations such as Korea, the United Kingdom, and Germany, it is the resource-poor regions that are prospering relative to the resource-rich ones.
More recently, many have argued that competitiveness is most strongly influenced by government policy. This view identifies targeting, protection, export promotion, and subsidies as the keys to international success. Evidence is drawn from the study of a few nations (notably Japan and Korea) and a few large, highly visible industries such as automobiles, steel, shipbuilding, and semiconductors. Yet such a decisive role for government policy in competitiveness is not confirmed by a broader survey of experience. Many observers would consider government policy toward industry in Italy, for example, to have been largely ineffectual in much of the postwar period, but Italy has seen a rise in world export share second only to Japan along with a rapidly rising standard of living.
Significant government policy intervention has occurred in only a subset of industries, and it is far from universally successful even in Japan and Korea. In Japan, for example, government's role in such important industries as facsimile, copiers, robotics, and advanced materials has been modest, and such frequently cited examples of successful Japanese policy as sewing machines, steel, and shipbuilding are now dated. Conversely, sustained targeting by Japan of industries such as aircraft (first targeted in 1971) and software (1978) has failed to yield meaningful international positions. Aggressive Korean targeting in large, important sectors such as chemicals and machinery has also failed to lead to significant market positions. Looking across nations, the industries in which government has been most heavily involved have, for the most part, been unsuccessful in international terms. Government is indeed an actor in international competition, but rarely does it have the starting role.
A final popular explanation for national competitiveness is differences in management practices, including labor-management relations. Japanese management has been particularly celebrated in the 1980s, just as American management was in the 1950s and 1960s. The problem with this explanation, however, is that different industries require different approaches to management. What is celebrated as good management practice in one industry would be disastrous in another. The small, private, and loosely organized family firms that populate the Italian footwear, textile, and jewelry industries, for example, are hotbeds of innovation and dynamism. Each industry has produced a positive trade balance for Italy in excess of $1 billion annually. However, these same structures and practices would be a disaster in a German chemical or automobile company, a Swiss pharmaceutical producer, or an American commercial aircraft manufacturer. American-style management, with all the flaws now attributed to it, produces highly competitive firms in such industries as software, medical equipment, consumer packaged goods, and business services. Japanese-style management, for all its strengths, has produced little international success in large portions of the economy such as chemicals, consumer packaged goods, or services.
Nor is it possible to generalize about labor-management relations. Unions are very powerful in Germany and Sweden, with representation by law in management (Germany) and on boards of directors (Sweden). Despite the view by some that powerful unions undermine competitive advantage, however, both nations have prospered and contain some of the most internationally preeminent firms and industries of any country.
Clearly, none of these explanations for national competitiveness, any more than a variety of others that have been put forward, is fully satisfactory. None is sufficient by itself in rationalizing the competitive position of a nation's industries. Each contains some truth but will not stand up to close scrutiny. A broader and more complex set of forces seems to be at work.
The numerous and conflicting explanations for competitiveness highlight an even more fundamental problem. That is, just what is a "competitive" nation in the first place? While the term is frequently used, it is unusually ill defined. Is a "competitive" nation one in which every firm or industry is competitive? If so, no nation comes close to qualifying. Even Japan, as we will see, has large sectors of its economy that fall far behind the world's best competititors. Is a "competitive" nation one whose exchange rate makes its goods price competitive in international markets? But surely most would agree that nations such as Germany and Japan, that have experienced sustained periods of a strong currency and upward pressure on foreign prices, have enjoyed remarkable gains in standard of living in the postwar period. The ability of a nation's industry to command high prices in foreign markets would seem to be a more desirable national target.
Is a "competitive" nation one with a large positive balance of trade? Switzerland has roughly balanced trade and Italy has had a chronic trade deficit, but both nations have enjoyed strongly rising national income. Conversely, many poor nations have balanced trade but scarcely represent the sorts of economies most nations aspire to Is a "competitive" nation one with a rising share of world exports? A rising share is often associated with growing prosperity, but nations with stable or slowly falling world export shares have experienced strong per capita income growth so that world export share clearly does not tell the whole story. Is a "competitive" nation one that can create jobs? Clearly, the ability to do so is important, but the type of jobs, not merely the employment of citizens at low wages, seems more significant for national income. Finally, is a "competitive" nation one whose unit labor costs are low? Low unit labor costs can be achieved through low wages such as those in India or Mexico, but this hardly seems an attractive industrial model. Each of these measures says something about a nation's industry, but none relates clearly to national economic prosperity.
ASKING THE RIGHT QUESTION
The search for a convincing explanation of both national and firm prosperity must begin by asking the right question. We must abandon the whole notion of a "competitive nation" as a term having much meaning for economic prosperity. The principal economic goal of a nation is to produce a high and rising standard of living for its citizens. The ability to do so depends not on the amorphous notion of "competitiveness" but on the productivity with which a nation's resources (labor and capital) are employed. Productivity is the value of the output produced by a unit of labor or capital. It depends on both the quality and features of products (which determine the prices they can command) and the efficiency with which they are produced.
Productivity is the prime determinant in the long run of a nation's standard of living, for it is the root cause of national per capita income. The productivity of human resources determines their wages, while the productivity with which capital is employed determines the return it earns for its holders. High productivity not only supports high levels of income but allows citizens the option of choosing more leisure instead of long working hours. It also creates the national income that is taxed to pay for public services which again boosts the standard of living The capacity to be highly productive also allows a nation's firms to meet stringent social standards which improve the standard of living, such as in health and safety, equal opportunity, and environmental impact.
The only meaningful concept of competitiveness at the national level is national productivity. A rising standard of living depends on the capacity of a nation's firms to achieve high levels of productivity and to increase productivity over time. Our task is to understand why this occurs. Sustained productivity growth requires that an economy continually upgrade itself. A nation's firms must relentlessly improve productivity in existing industries by raising product quality, adding desirable features, improving product technology, or boosting production efficiency. Germany has enjoyed rising productivity for many decades, for example, because its firms have been able to produce increasingly differentiated products and introduce rising levels of automation to boost the output per worker. A nation's firms must also develop the capabilities required to compete in more and more sophisticated industry segments, where productivity is generally higher. At the same time, an upgrading economy is one which has the capability of competing successfully in entirely new and sophisticated industries. Doing so absorbs human resources freed up in the process of improving productivity in existing fields. All this should make it clear why cheap labor and a "favorable" exchange rate are not meaningful definitions of competitiveness. The aim is to support high wages and command premium prices in international markets.
If there were no international competition, the level of productivity attainable in a nation's economy would be largely independent of what was taking place in other nations. International trade and foreign investment, however, provide both the opportunity to boost the level of national productivity and a threat to increasing or even maintaining it. International trade allows a nation to raise its productivity by eliminating the need to produce all goods and services within the nation itself. A nation can thereby specialize in those industries and segments in which its firms are relatively more productive and import those products and services where its firms are less productive than foreign rivals, in this way raising the average productivity level in the economy. Imports, then, as well as exports are integral to productivity growth.
Establishment of foreign subsidiaries by a nation's firms can also raise national productivity, provided it involves shifting less productive activities to other nations or performing selected activities abroad (such as service or modifying the product to address local needs) that support greater penetration of foreign markets. A nation's firms can thus increase exports and earn foreign profits that flow back to the nation to boost national income. An example is the move in the last decade of less sophisticated electronics assembly activities by Japanese firms first to Korea, Taiwan, and Hong Kong, and now to Malaysia and Thailand.
No nation can be competitive in (and be a net exporter of) everything. A nation's pool of human and other resources is necessarily limited. The ideal is that these resources be deployed in the most productive uses possible. The export success of those industries with a competitive advantage will push up the costs of labor, inputs, and capital in the nation, making other industries uncompetitive. In Germany, Sweden, and Switzerland, for example, this process has led to a contraction of the apparel industry to those firms in specialized segments that can support very high wages. At the same time, the expanding exports of competitive industries put upward pressure on the exchange rate, making it more difficult for the relatively less productive industries in the nation to export. Even those nations with the highest standards of living have many industries in which local firms are uncompetitive.
The process of expanding exports from more productive industries, shifting less productive activities abroad through foreign investment, and importing goods and services in those industries where the nation is less productive, is a healthy one for national economic prosperity. In this way, international competition helps upgrade productivity over time. The process implies, however, that market positions in some segments and industries must necessarily be lost if a national economy is to progress. Employing subsidies, protection, or other forms of intervention to maintain such industries only slows down the upgrading of the economy and limits the nation's long-term standard of living.
While international trade and investment can lead to major improvements in national productivity, however, they may also threaten it. This is because exposure to international competition creates for each industry an absolute productivity standard necessary to meet foreign rivals, not only a relative productivity standard compared to other industries within its national economy. Even if an industry is relatively more productive than others in the economy, and can attract the necessary human and other resources, it will be unable to export (or even, in many cases, to sustain position against imports) unless it is also competitive with foreign rivals. The American automobile industry produces more output per man hour (and pays higher wages) than many other U.S. industries, for example, but America has experienced a growing trade deficit (and a loss of high-paying jobs) in automobiles because the level of productivity in the German and Japanese industries has been even higher. American productivity in producing automobiles has also not been sufficiently greater than that of Korean firms to offset lower Korean wages. Similar tests vis-à-vis foreign rivals must be met by more and more activities and industries.
If the industries that are losing position to foreign rivals are the relatively more productive ones in the economy, a nation's ability to sustain productivity growth is threatened. The same is true when activities involving high levels of productivity (such as sophisticated manufacturing) are transferred abroad through foreign investment because domestic productivity is insufficient to make performing them in the nation efficient, after taking foreign wages and other costs into account. Both limit productivity growth and result in downward pressure on wages. If enough of a nation's industries and activities within industries are affected, there may also be downward pressure on the value of a nation's currency. But devaluation, too, lowers the nation's standard of living by making imports more expensive and reducing the prices obtained for the nation's goods and services abroad. Understanding why nations can or cannot compete in sophisticated industries and activities involving high productivity, then, becomes central to understanding economic prosperity.
The preceding discussion should also make it clear why defining national competitiveness as achieving a trade surplus or balanced trade per se is inappropriate. The expansion of exports because of low wages and a weak currency, at the same time as the nation imports sophisticated goods that its firms cannot produce with sufficient productivity to compete with foreign rivals, may bring trade into balance or surplus but lowers the nation's standard of living. Instead, the ability to export many goods produced with high productivity, which allows the nation to import many goods involving lower productivity, is a more desirable target because it translates into higher national productivity. Japan, which exports many manufactured goods in which it has high productivity and imports raw materials and components involving less skilled labor and lower levels of technology, illustrates a nation where the mix of trade bolsters productivity. Similarly, it should be clear that defining national competitiveness in terms of jobs per se is misleading. It is high productivity jobs, not any jobs, that translate into high national income. What is important for economic prosperity is national productivity. The pursuit of competitiveness defined as a trade surplus, a cheap currency, or low unit labor costs contains many traps and pitfalls.
A rising national share of world exports is tied to living standards when rising exports from industries achieving high levels of productivity contribute to the growth of national productivity. A fall in overall world export share because of the inability to successfully increase exports from such industries, conversely, is a danger signal for a national economy. However, the particular mix of industries that are exporting is more important than a nation's average export share. A rising sophistication of exports can support productivity growth even if overall exports are growing slowly.
Seeking to explain "competitiveness" at the national level, then, is to answer the wrong question. What we must understand instead is the determinants of productivity and the rate of productivity growth. To find answers, we must focus not on the economy as a whole but on specific industries and industry segments. While efforts to explain aggregate productivity growth in entire economies have illuminated the importance of the quality of a nation's human resources and the need for improving technology, an examination at this level must by necessity focus on very broad and general determinants that are not sufficiently complete and operational to guide company strategy or public policy. It cannot address the central issue for our purposes here, which is why and how meaningful and commercially valuable skills and technology are created. This can only be fully understood at the level of particular industries. The human resources most decisive in modern international competition, for example, possess high levels of specialized skills in particular fields. These are not the result of the general educational system alone but of a process closely connected to competition in particular industries, just as is the development of commercially successful technology. It is the outcome of the thousands of struggles for competitive advantage against foreign rivals in particular segments and industries, in which products and processes are created and improved, that underpins the process of upgrading national productivity I have described.
Competitive Advantage in Industries
Our central task, then, is to explain why firms based in a nation are able to compete successfully against foreign rivals in particular segments and industries. Competing internationally may involve exports and/or locating some company activities abroad. We are particularly concerned with the determinants of international success in relatively sophisticated industries and segments of industries involving complex technology and highly skilled human resources, which offer the potential for high levels of productivity as well as sustained productivity growth.
To achieve competitive success, firms from the nation must possess a competitive advantage in the form of either lower costs or differentiated products that command premium prices. To sustain advantage, firms must achieve more sophisticated competitive advantages over time, through providing higher-quality products and services or producing more efficiently. This translates directly into productivity growth.
When one looks closely at any national economy, there are striking differences in competitive success across industries. International advantage is often concentrated in narrowly defined industries and even particular industry segments. German exports of cars are heavily skewed toward high-performance cars, while Korean exports are all compacts and subcompacts. Denmark's modest share of world exports in vitamins consists of a substantial share in vitamins based on natural substances and virtually no position in synthetic vitamins. Japan's strong position in machinery comes mostly from general-purpose varieties, such as CNC machine tools, while Italy's is derived from often world-leading positions in highly specialized machines for particular end-user applications such as leather working or cigarette manufacturing. Increased trade has led to increased specialization in narrowly defined industries and in segments within industries. Were it not for protection, which sustains firms and entire national industries with no real competitive advantage, the differences among nations in competitive position would be even more apparent.
Moreover, in many industries and especially in distinct segments of industries, competitors with true international competitive advantage are based in only a few nations. The influence of the nation seems to apply to industries and segments, rather than to firms per se. Most successful national industries comprise groups of firms, not isolated participants, as my earlier examples illustrate. Leading international competitors are not only frequently located in the same nation but are often found in the same city or region within the nation. National positions in industries are often strikingly stable, stretching over many decades and, in some of our case studies, for over a century. Isolated successes can often be explained by different target segments, or by government subsidy or protection that means that the isolated national producer is not a real success at all (as in automobiles, aerospace, and telecommunications). Industries and segments of industries, then, will be the focus of our enquiry. Clearly, powerful influence of the nation is apparent in international competition in particular fields, which is important not only to firms but to national economic prosperity.
CLASSICAL RATIONALES FOR INDUSTRY SUCCESS
There is a long history of efforts to explain international success in industries in the form of international trade. The classical one is the theory of comparative advantage. Comparative advantage has a specific meaning to economists. Adam Smith is credited with the notion of absolute advantage, in which a nation exports an item if it is the world's low-cost producer. David Ricardo refined this notion to that of comparative advantage, recognizing that market forces will allocate a nation's resources to those industries where it is relatively most productive. This means that a nation might still import a good where it could be the low-cost producer if it is even more productive in producing other goods. As I have discussed, both absolute and relative advantage are necessary for trade.
In Ricardo's theory, trade was based on labor productivity differences between nations. He attributed these to unexplained differences in the environment or "climate" of nations that favored some industries. While Ricardo was on the right track, however, the focus of attention in trade theory shifted in other directions. The dominant version of comparative advantage theory, due initially to Heckscher and Ohlin, is based on the idea that nations all have equivalent technology but differ in their endowments of so-called factors of production such as land, labor, natural resources, and capital. Factors are nothing more than the basic inputs necessary for production. Nations gain factor-based comparative advantage in industries that make intensive use of the factors they possess in abundance. They export these goods, and import those for which they have a comparative factor disadvantage. Nations with abundant, low-cost labor such as Korea, for example, will export labor-intensive goods such as apparel and electronic assemblies. Nations with rich endowments of raw materials or arable land will export products that depend on them. Sweden's strong historical position in the steel industry, for example, developed because Swedish iron ore deposits have a very low content of phosphorous impurities, resulting in higher-quality steel from blast furnaces.
Comparative advantage based on factors of production has intuitive appeal, and national differences in factor costs have certainly played a role in determining trade patterns in many industries. This view has informed much government policy toward competitiveness, because it has been recognized that governments can alter factor advantage either overall or in specific sectors through various forms of intervention. Governments have, rightly or wrongly, implemented various policies designed to improve comparative advantage in factor costs. Examples are reduction of interest rates, efforts to hold down wage costs, devaluation that seeks to affect comparative prices, subsidies, special depreciation allowances, and export financing addressed at particular sectors. Each in its own way, and over differing time horizons, these policies aim to lower the relative costs of a nation's firms compared to those of international rivals.
THE NEED FOR A NEW PARADIGM
There has been growing sentiment, however, that comparative advantage based on factors of production is not sufficient to explain patterns of trade. Evidence hard to reconcile with factor comparative advantage is not difficult to find. Korea, having virtually no capital after the Korean War, was still able eventually to achieve substantial exports in a wide range of relatively capital-intensive industries such as steel, shipbuilding, and automobiles. Conversely, America, with skilled labor, preeminent scientists, and ample capital, has seen eroding export market share in industries where one would least expect it, such as machine tools, semiconductors, and sophisticated electronic products.
More broadly, much of world trade takes place between advanced industrial nations with similar factor endowments. At the same time, researchers have documented the large and growing volume of trade in products whose production involves similar factor proportions. Both types of trade are difficult to explain with the theory. A significant amount of trade also involves exports and imports between the different national subsidiaries of multinational firms, a form of trade left out of the theory.
Most important, however, is that there has been a growing awareness that the assumptions underlying factor comparative advantage theories of trade are unrealistic in many industries. The standard theory assumes that there are no economies of scale, that technologies everywhere are identical, that products are undifferentiated, and that the pool of national factors is fixed. The theory also assumes that factors, such as skilled labor and capital, do not move among nations. All these assumptions bear little relation, in most industries, to actual competition. At best, factor comparative advantage theory is coming to be seen as useful primarily for explaining broad tendencies in the patterns of trade (for example, its average labor or capital intensity) rather than whether a nation exports or imports in individual industries.
The theory of factor comparative advantage is also frustrating for firms because its assumptions bear so little resemblance to actual competition. A theory which assumes away a role for firm strategy, such as improving technology or differentiating products, leaves firms with little recourse but to attempt to influence government policy. It is not surprising that most managers exposed to the theory find that it assumes away what they find to be most important and provides little guidance for appropriate company strategy.
The assumptions underlying factor comparative advantage were more persuasive in the eighteenth and nineteenth centuries, when many industries were fragmented, production was more labor- and less skill-intensive, and much trade reflected differences in growing conditions, natural resources, and capital. America was a leading producer of ships, for example, in no small part because of an ample wood supply. Many traded goods were such products as spices, silk, tobacco, and minerals whose availability was limited to one or a few regions.
Factor costs remain important in industries dependent on natural resources, in those where unskilled or semiskilled labor is the dominant portion of total cost, and in those where technology is simple and widely available. Canada and Norway are strong in aluminum smelting, for example, largely because of a geography that allows the generation of cheap hydroelectric power. Korea rose to prominence in the international construction of simple infrastructure projects because of its pool of low-cost, highly disciplined workers.
In many industries, however, factor comparative advantage has long been an incomplete explanation for trade. This is particularly true in those industries and segments of industries involving sophisticated technology and highly skilled employees, precisely those most important to national productivity. Ironically, just as the theory of comparative advantage was being formulated, the Industrial Revolution was making some of its premises obsolete. As more and more industries have become knowledge-intensive in the post-World War II period, the role of factor costs has weakened even further.
Technological Change. More and more industries do not resemble those that the theory of comparative advantage was built on. Economies of scale are widespread, most products are differentiated, and buyer needs vary among countries. Technological change is pervasive and continuous. Widely applicable technologies such as microelectronics, advanced materials, and information systems have rendered obsolete the traditional distinction between high and low technology industries. The level of technology employed in an industry often differs markedly between firms in different nations.
Technology has given firms the power to circumvent scarce factors via new products and processes. It has nullified, or reduced, the importance of certain factors of production that once loomed large. Flexible automation, which allows for small lot sizes and easy model changes, is reducing the labor content of products in many industries. Access to state-of-the-art technology is becoming more important than low local wage rates. In the 1980s, manufacturing firms often moved production to high labor cost locations (to be close to markets), not the reverse. The usage of materials, energy, and other resource-based inputs has been substantially reduced or synthetic substitutes developed. Modern materials such as engineering plastics, ceramics, carbon fibers, and the silicon used in making semiconductors are made from raw materials that are cheap and ubiquitous.
Access to abundant factors is less important in many industries than the technology and skills to process them effectively or efficiently. For example, Sweden's low phosphorous content iron ores were an advantage as long as the technology of steelmaking had difficulty dealing with impurities. As steelmaking technology improved, however, the phosphorous problem was solved, nullifying Sweden's factor advantage.
Comparable Factor Endowments. Most of world trade takes place among advanced nations with broadly similar endowments of factors. Many developing nations have also achieved a level of economic development that means that they too possess comparable endowments of many factors. Their workforces have the education and basic skills necessary to work in many industries. The United States, for example, certainly no longer occupies the unique position in skilled labor that it once did. Many other nations now also have the basic infrastructure, such as telecommunications, road systems, and ports, required for competition in most manufacturing industries. Traditional sources of factor advantage favoring advanced nations have been diminished in the process.
Globalization. Competition in many industries has internationalized, not only in manufacturing industries but increasingly in services. Firms compete with truly global strategies involving selling worldwide, sourcing components and materials worldwide, and locating activities in many nations to take advantage of low cost factors. They form alliances with firms from other nations to gain access to their strengths.
Globalization of industries decouples the firm from the factor endowment of a single nation. Raw materials, components, machinery, and many services are available globally on comparable terms. Transportation improvements have lowered the cost of exchanging factors or factor dependent goods among nations. Having a local steel industry, for example, is no longer an advantage in buying steel. It may well be a disadvantage if there are national policies or pressures that promote purchasing from high-cost domestic suppliers.
Capital flows internationally to credit-worthy nations, which are not restricted to locally available funds. Korea, as I noted earlier, has achieved an international position in a range of capital-intensive industries such as steel, automobiles, and memory chips, despite beginning with virtually no capital in the 1950s. Similar inflows of funds characterized such nations as Britain, the United States, Switzerland, and Sweden many years earlier. Even technology trades on global markets, though usually with a lag. Where specific factor advantages are difficult to access via markets, multinational firms can locate subsidiaries there.
While many factors are increasingly mobile, however, trade persists. This apparent paradox provides an important insight that will be developed in what follows. It is where and how effectively factors are deployed that proves more decisive than the factors themselves in determining international success.
The same forces that have made factor advantages less decisive have also made them often exceedingly fleeting. Competitive advantage that rests on factor costs is vulnerable to even lower factor costs somewhere else, or governments willing to subsidize them. Today's low labor cost country is rapidly displaced by tomorrow's. The lowest-cost source for a natural resource can shift overnight as new technology allows the exploitation of resources in places heretofore deemed impossible or uneconomical. Who would think, for example, that Israel, mostly desert, could become an efficient agricultural producer? In factor cost-sensitive industries, leadership often shifts rapidly as such industries as apparel and simple electronic goods attest.
Those industries in which labor costs or natural resources are important to competitive advantage also often have industry structures that support only low average returns on investment. Since such industries are accessible to many nations seeking to develop their economies because of relatively low barriers to entry, they are prone to too many competitors (and too much capacity). Rapidly shifting factor advantage continually attracts new entrants who bid down profits and hold down wages. (Incumbents are disadvantaged but locked in by specialized assets.)
Developing nations are frequently trapped in such industries. Nearly all the exports of less developed nations tend to be tied to factor costs and to competing on price. Development programs often target new industries based on factor cost advantages, with no strategy for moving beyond them. Nations in this situation will face a continual threat of losing competitive position and chronic problems in supporting attractive wages and returns to capital. Their ability to earn even modest profits is at the mercy of economic fluctuations.
If factor comparative advantage does not explain national success in most industries, policies based on altering factor costs will often prove ineffective. Managing industry wage rates is irrelevant in industries where labor content is small. Subsidies of any kind will have little leverage where competition is based on quality, rapid product development, and advanced features rather than price.
The Threads of a New Explanation
While the insufficiency of factor advantage in explaining trade is widely accepted, what should replace or supplement it is far from clear. A range of new explanations for trade has been proposed. One is economies of scale, which give the nation's finns that are able to capture them a cost advantage that allows them to export. The presence of economies of scale provides a rationale for trade, even in the absence of factor advantages. Economies of scale in producing individual product varieties can also explain trade in similar goods. The same basic reasoning can be applied to other market imperfections such as technological change requiring substantial R&D and a learning curve in which costs decline with cumulative volume. The nation's firms that can exploit these imperfections will export.
Economies of scale and other market imperfections are indeed important to competitive advantage in many industries. However, present theory leaves the most significant question for our purposes unanswered. Which nation's firms will reap them and in what industries?
For example, in global competition, finns from any nation can gain scale economies by selling worldwide. It is not at all clear which nation's firms will do so. The evidence on actual industries confirms this indeterminacy: Italian firms reaped the economies of scale in appliances, German finns in chemicals, Swedish finns in mining equipment, and Swiss firms in textile machinery. Having a large home market, often cited as an advantage, offers little explanation; none of these countries had the largest home demand for the products involved, though the firms became world leaders. Even in large nations, any simple connection between economies of scale and international success is tenuous. In Japan, for example, there are numerous competitors in most scale-sensitive industries (there are nine Japanese automobile producers, for example), fragmenting the home market. But many of these firms have reached substantial scale by selling abroad. This sort of indeterminacy applies to all types of market imperfections.
Other efforts to go beyond comparative advantage have been based, in one way or another, on technology. Ricardian theory, in which trade is based on differing labor productivity among nations in producing particular goods, rests on technology differences in a broad sense. A more recent version of this line of thinking is the so-called "technology gap" theories of trade. According to these theories, nations will export in industries in which their firms gain a lead (gap) in technology. Exports will then fall as technology inevitably diffuses and the gap closes.
Technological differences are indeed central to competitive advantage, but Ricardian and technology gap theories again leave unanswered the questions that most concern us here. Why does a productivity difference or technology gap emerge? Which nation's firms will gain it? And why do certain firms from a certain nation often preserve technological advantages for many decades in an industry, instead of inevitably losing their lead as technology gap theories would suggest?
Other promising lines of inquiry have suggested a role for a nation's home market in explaining success in trade. The most comprehensive is Raymond Vernon's "product cycle" theory. Vernon set out to explain why the United States was a leader in so many advanced goods. He argued that early home demand for advanced goods meant that U.S. firms would pioneer new products. American companies would export during the early phases of industry development and then establish foreign production as foreign demand grew. Eventually, foreign firms would enter the industry as technology diffused, and both foreign firms and the foreign subsidiaries of American companies would export to the United States.
The product cycle notion represents the beginnings of a truly dynamic theory and suggests how the home market can influence innovation. However, it still leaves many questions of central importance to us here unanswered. As Vernon himself has recognized, the United States no longer corners the market for advanced goods, nor has it ever. The more general question is why firms from particular nations establish leadership in particular new industries. What happens when demand originates simultaneously in different nations, as is common today? Why do nations with a more slowly developing or small home market for a product often emerge as world leaders? Why is innovation continuous in many national industries and not a once-and-for-all event followed by inevitable standardization of technology as the product cycle theory implies? Why does the inevitable loss of advantage in Vernon's theory not take place in many industries? How can we explain why some nations' firms are able to sustain advantage in an industry and others are not?
A final important line of inquiry has sought to explain the emergence of the multinational corporation, or company with operations in more than one nation. Multinationals compete internationally not only by exporting but through foreign investment. Their prominence means that trade is no longer the only important form of international competition. Multinationals produce and sell in many countries, employing strategies that combine trade and dispersed production. Recent estimates suggest that a significant portion of world trade is between subsidiaries of multinationals, and that a meaningful fraction of the imports of advanced nations is accounted for by imports from the subsidiaries of a nation's own multinationals. National success in an industry increasingly means that the nation is the home base for leading multinationals in the industry, not just for domestic firms that export. In computers, for example, America is home base for IBM, DEC, Prime, Hewlett-Packard, and other U.S. companies that have facilities and subsidiaries spread widely in Europe and elsewhere.
Multinational status is a reflection of a company's ability to exploit strengths gained in one nation in order to establish a position in other nations. Multinationals are most common, outside of natural resources involving scarce deposits, in industries with differentiated products and high research intensity, where successful firms have skills and know-how that can be exploited abroad. Multinationals are frequently described as companies without countries. They can and do operate (and produce goods) anywhere it suits them.
The role of multinationals must indeed be integral to any comprehensive effort to explain competitive success in an industry. Yet explaining the existence of multinationals, the focus of much previous work, leaves the essential questions for our purposes, unanswered. Multinationals that are the leading competitors in particular segments or industries are often based in only one or two nations. The important questions are why and how do multinationals from a particular nation develop unique skills and know-how in particular industries? Why do some multinationals from some nations sustain and build on these advantages and others do not?
TOWARD A NEW THEORY OF NATIONAL COMPETITIVE ADVANTAGE
The central question to be answered is why do firms based in particular nations achieve international success in distinct segments and industries? The search is for the decisive characteristics of a nation that allow its firms to create and sustain competitive advantage in particular fields, that is, the competitive advantage of nations.
The globalization of industries and the internationalization of companies leaves us with a paradox. It is tempting to conclude that the nation has lost its role in the international success of its firms. Companies, at first glance, seem to have transcended countries. Yet what I have learned in this study contradicts this conclusion. As earlier examples have suggested, the leaders in particular industries and segments of industries tend to be concentrated in a few nations and sustain competitive advantage for many decades. When firms from different nations form alliances, those firms based in nations which support tree competitive advantage eventually emerge as the unambiguous leaders.
Competitive advantage is created and sustained through a highly localized process. Differences in national economic structures, values, cultures, institutions, and histories contribute profoundly to competitive success. The role of the home nation seems to be as strong as or stronger than ever. While globalization of competition might appear to make the nation less important, instead it seems to make it more so. With fewer impediments to trade to shelter uncompetitive domestic firms and industries, the home nation takes on growing significance because it is the source of the skills and technology that underpin competitive advantage.
Any new theory of national advantage in industries must start from premises that depart from much previous work. First, firms can and do choose strategies that differ. A new theory must explain why firms from particular nations choose better strategies than those from, others for competing in particular industries.
Second, successful international competitors often compete with global strategies in which trade and foreign investment are integrated. Most previous theories have set out to explain either trade or foreign investment. A new theory must explain instead why a nation is home base for successful global competitors in a particular industry that engage in both. Many of the underlying causes of exports and foreign investment prove to be the same.
The home base is the nation in which the essential competitive advantages of the enterprise are created and sustained. It is where a firm's strategy is set and the core product and process technology (broadly defined) are created and maintained. Usually, though not always, much sophisticated production takes place there. Firms often perform other activities in a variety of other nations.
The home base will be the location of many of the most productive jobs, the core technologies, and the most advanced skills. The presence of the home base in a nation also stimulates the greatest positive influences on other linked domestic industries, and leads to other benefits to competition in the nation's economy I will explore. The nation that is the home base will also usually enjoy positive net exports.
While the ownership of firms is often concentrated at the home base, the nationality of shareholders is secondary. As long as the local company remains the true home base by retaining effective strategic, creative, and technical control, the nation still reaps most of the benefits to its economy even if the firm is owned by foreign investor's or by a foreign firm. Explaining why a nation is the home base for successful competitors in sophisticated segments and industries, then, is of decisive importance to the nation's level of productivity and its ability to upgrade productivity over time.
A new theory must move beyond the comparative advantage to the competitive advantage of a nation. It must explain why a nation's firms gain competitive advantage in all its forms, not only the limited types of factor-based advantage contemplated in the theory of comparative advantage. Most theories of trade look solely at cost, treating quality and differentiated products in a footnote. A new theory must reflect a rich conception of competition that includes segmented markets, differentiated products, technology differences, and economies of scale. Quality, features, and new product innovation are central in advanced industries and segments. Moreover, cost advantage grows as much out of efficient-to-manufacture product designs and leading process technology as it does out of factor costs or even economies of scale. We must understand why finns from some nations are better than others at creating these advantages, so essential to high and rising productivity.
A new theory must start from the premise that competition is dynamic and evolving. Much traditional thinking has embodied an essentially static view focusing on cost efficiency due to, factor or scale advantages. Technological change is treated as though it is exogenous, or outside the purview of the theory. As Joseph Schumpeter recognized many decades ago, however, there is no "equilibrium" in competition. Competition is a constantly changing landscape in which new products, new ways of marketing, new production processes, and whole new market segments emerge. Static efficiency at a point in time is rapidly overcome by a faster rate of progress. But Schumpeter, like the other researchers I have noted, stopped short of answering the central question that concerns us here. Why do some firms, based in some nations, innovate more than others?
A new theory must make improvement and innovation in methods and technology a central element. We must explain the role of the nation in the innovation process. Since innovation requires sustained investment in research, physical capital, and human resources, we must also explain why the rate of such investments are more vigorous in some nations and not others. The question is how a nation provides an environment in which its firms are able to improve and innovate faster than foreign rivals in a particular industry. This will also be fundamental in explaining how entire national economies progress, because technological change, in the broad sense of the term, accounts for much of economic growth.
In a static view of competition, a nation's factors of production are fixed. Firms deploy them in the industries where they will produce the greatest return. In actual competition, the essential character is innovation and change. Instead of being limited to passively shifting resources to where the returns are greatest, the real issue is how firms increase the returns available through new products and processes. Instead of simply maximizing within fixed constraints, the question is how firms can gain competitive advantage from changing the constraints. Instead of only deploying a fixed pool of factors of production, a more important issue is how firms and nations improve the quality of factors, raise the productivity with which they are utilized, and create new ones. Where factors are mobile and can be tapped through global strategies, moreover, the efficiency and effectiveness with which factors can be used become even more central. Answers to these questions will emerge as decisive in understanding why nations succeed in particular industries.
Finally, since firms play a central role in the process of creating competitive advantage, the behavior of firms must become integral to a theory of national advantage. A good test of a new theory is that it makes sense to managers as well as to policy makers and economists. From a manager's perspective, much of trade theory is too general to be of much relevance. A new theory must give firms insight into how to set strategy to become more effective international competitors. It is these challenges that I have set out to meet.
To investigate why nations gain competitive advantage in particular industries and the implications for firm strategy and for national economies, I conducted a four-year study of ten important trading nations:
* United Kingdom
* United States
Included were the three leading industrial powers, the United States, Japan, and Germany, as well as several other nations chosen to vary widely in size, government policy toward industry, social philosophy, geography, and region. Much attention has been directed at Asian nations in recent years, and Japan, Korea, and Singapore were investigated here. However, European nations provide equally interesting and important insights. An array of European nations was included in the study, among them several nations such as Switzerland and Sweden engaged in a remarkable amount of international trade for their size. The study was limited to ten nations solely because of time and resource constraints. Together, the ten nations studied accounted for fully 50 percent of total world exports in 1985. An overview of some of their salient features is provided in Table 1-1.
The focus of the research was on the process of gaining and sustaining competitive advantage in relatively sophisticated industries and industry segments. These hold the key to high and rising productivity in a nation, and are the least understood using established theory. The nations chosen for study were ones that already compete successfully in a range of such industries or, in the case of Korea and Singapore, show signs of an improving ability to do so. Korea and Singapore were selected from the group of rapidly growing, newly industrialized countries (NICs) because they have very different patterns of industry success and different mixes of government policies. Korea, in particular, has enjoyed the most rapid and sustained upgrading of competitive positions of any NIC.
Most studies of national competitiveness have focused on a single nation or have relied on bilateral comparisons, often with Japan. While much has been learned from this research, such an approach can only take us so far and can be misleading. The findings of bilateral comparisons often prove to be lacking in robustness when a third or fourth nation is added to the investigation. In studies that compare the United States and Japan, for example, Japanese cooperative research projects are frequently identified as an essential factor underpinning Japanese competitive success. Such studies have served as the justification for suggesting the practice elsewhere. Yet Germany and Switzerland, among other nations, seem to sustain competitive advantage in all sorts of industries without cooperative research. Also, Japanese cooperative projects, as I will describe later, are important for reasons different from those often supposed? By studying nations with widely different circumstances, I hope to isolate the fundamental forces underlying national competitive advantage from the idiosyncratic ones.
The research was conducted by a group of over thirty researchers, most of whom were natives of, and based in, the nation they were studying. A common methodology was employed in each nation. The study was conducted with the assistance and support of the cooperating organizations that have been identified in the Preface. They included government entities such as the Japanese Ministry of International Trade and Industry, private financial institutions like the Deutsche Bank, educational institutions such as the Institute of International Business of the Stockholm School of Economics, and a publication, The Economist. Cooperating organizations provided needed infrastructure, assistance in gaining access to companies and other institutions within the nation, and sometimes also local research help.
Mapping the Successful Industries in National Economies
In each nation, the study consisted of two parts. The first was to identify all (or as many as possible) of the industries in which the nation's firms were internationally successful, using available statistical data, supplementary published sources, and field interviews. We were concerned with all types of industries in the economy, including agricultural, manufacturing, and service industries. Most previous studies have excluded services, but international competition in them is increasingly prevalent and important. Though data on services are still scarce and much about national competitive positions had to be gleaned from interviews and fragmentary published sources, service industries were included both in the national profiles as well as among the industries chosen for detailed study.
The basic unit of analysis was the narrowly defined industry or distinct segment within an industry. National advantage is increasingly concentrated in particular industries and even industry segments, reflecting their specific and differing sources of competitive advantage. Within the limits of available data, we sought the least aggregated industry definitions.
We defined international success by a nation's industry as possessing competitive advantage relative to the best worldwide competitors. Because of the existence of protection, subsidy, differing accounting conventions, and the prevalence of border trade with neighboring countries, many potential measures of competitive advantage can be misleading. Neither domestic profitability, nor the size of the industry or the leading company, nor the existence of some exports is a reliable indicator of competitive advantage. Measuring the presence of true competitive advantage statistically is challenging.
We chose as the best measures of international competitive advantage either (1) the presence of substantial and sustained exports to a wide array of other nations and/or (2) significant outbound foreign investment b
Competitive Advantage of Nations
Based on research in ten leading trading nations, The Competitive Advantage of Nations offers the first theory of competitiveness based on the causes of the productivity with which companies compete. Porter shows how traditional comparative advantages such as natural resources and pools of labor have been superseded as sources of prosperity, and how broad macroeconomic accounts of competitiveness are insufficient. The book introduces Porter’s “diamond,” a whole new way to understand the competitive position of a nation (or other locations) in global competition that is now an integral part of international business thinking. Porter's concept of “clusters,” or groups of interconnected firms, suppliers, related industries, and institutions that arise in particular locations, has become a new way for companies and governments to think about economies, assess the competitive advantage of locations, and set public policy.
Even before publication of the book, Porter’s theory had guided national reassessments in New Zealand and elsewhere. His ideas and personal involvement have shaped strategy in countries as diverse as the Netherlands, Portugal, Taiwan, Costa Rica, and India, and regions such as Massachusetts, California, and the Basque country. Hundreds of cluster initiatives have flourished throughout the world. In an era of intensifying global competition, this pathbreaking book on the new wealth of nations has become the standard by which all future work must be measured.
- Free Press |
- 896 pages |
- ISBN 9780684841472 |
- June 1998