Three years ago British ministers joined magazines like the Economist in proudly announcing that Britain was taking over from Germany as Western Europe’s miracle economy. Ours were dynamic growth industries, thriving in a newly competitive environment. Theirs were stuck in a sclerotic corporatism.
In 1990 neither ministers nor journalists are willing to render themselves open to ridicule in this respect. This year Germany’s growth rate is set to be 4.5 per cent. Britain’s will be 1 per cent. Nicholas Ridley’s embarrassing outburst about the German threat has only served to underline that there is now no doubt which is the model, and which the retard.
The fizzling-out of the Thatcher ‘miracle’ is a good time to reflect on the conditions of economic success, and the recent anniversary of Adam Smith’s death makes it all the more appropriate. More than two hundred years after the publication of his Inquiry into the Wealth of Nations there is still remarkably little consensus among academics, politicians and industrialists about what makes for economic success. Despite the continued expansion of economics as a profession, we are not much nearer to understanding why some nations are wealthy and others are not, why the average German earns more than the average Yugoslav and why the average Scot earns less than the average English man or woman.
Michael Porter’s The Competitive Advantage of Nations is audacious (or foolhardy) enough to offer an answer. Its aim is nothing less than a systematic explanation of the wealth of nations, with 52 pages of policy recommendations added on for good measure. Porter is a small industry in his own right. His best-known books, Competitive Advantage and Competitive Strategy, are the brand leaders in business schools throughout the world. Such is his grip on the market that he can afford to steer clear of paperbacks, and employ at least 52 people in researching this book, making it a remarkable exercise in logistics if nothing else. With industrial policy back on the agenda both here and in the USA it has been keenly awaited. For Porter has the great virtue of combining crisp and relatively simple analysis with clear guides to action. Unlike much that is written about economics, his work is relatively non-ideological. Its stated aim, in a typically American way, is to find out what works and why. Porter’s analysis is particularly interesting for anyone who grew up amidst British decline, while foreign brand names spread over our cars, refrigerators and television sets. Politicians, economists and commentators may agree on little else, but few would now dispute that Britain has suffered from a long and profound failure of what Porter calls ‘sustainable competitive advantage’. Nor would many dispute that this relative decline has been the central political issue in Britain for at least thirty years.
Porter’s ambition is to create an analytic framework that can explain national success and failure. Its core is what he calls the diamond: four sets of conditions whose successful interaction leads to sustainable growth. The first involves the strategies of firms, the structures of industry and the conditions of rivalry. Porter lays heavy stress on the importance for Japan of having had several competing firms in cars and later in semiconductors. Rigorous local rivalry enabled companies to compete more effectively abroad. Genuine competitive threats promoted permanent innovation. The second set of conditions are what Porter, echoing Smith and Ricardo, calls factor conditions, such as raw materials, good infrastructures or skilled labour. Switzerland’s mastery of languages has helped it in banking and trade. Singapore’s position on the trade routes between Japan and the Middle East enabled it to become a centre for ship repair. Similarly Britain’s abundant coal and waterways gave it an edge during the Industrial Revolution.
The third set of conditions are those of demand: the structure and level of domestic demand. To take just one example, the fact that Britain has the world’s sweetest tooth and the highest per capita sugar consumption has contributed to our strong competitive position in biscuits and confectionery. In general, more demanding and more discerning consumers are good for industry. The idea – associated with the Reagan Administration – that high standards of product safety, environmental quality or energy efficiency ‘hurt industry’ is shown to be erroneous. Instead, they help the innovation process. Porter cites Sweden as a good example of where ‘environmental sensitivity reinforces national advantage.’
The fourth corner of the diamond is the position of related industries. One industry produces demand for others. A cluster of related industries makes for a stronger base than one that exists in isolation. Japan’s strength in semiconductors helps it in computers. Swedish success in ballbearings builds on its position in specialty steels.
These four sets of factors interact to foster innovative and efficient industries. Sustainable and rapid growth depends on all four being optimal. Much of Porter’s book consists of applying this analytic framework to explain the economic records of Korea, Italy, Sweden, Japan, Switzerland, Germany, the US and Britain. The diamond is used to explain the success of small regions in Italy – such as Valenza Po and Arrezzo, which account for a $2 bn trade surplus in precious metal jewelry and for nearly half of total world production, or the ceramics industry around Sassuolo, which contributes to Italy’s 60 per cent share of world ceramic exports. It is also used to explain the dynamism of industries ranging from Japanese robotics (which had over 50 per cent of the world market in the mid-Eighties) and German printing (which has 50.2 per cent of world printing-press exports).
Simply by virtue of having four sets of variables rather than one, the scheme provides a more compelling account than the often contradictory ones that focus solely on culture (the hard work of the Germans, the consensual culture of the Japanese, the individualism of the Americans), on industrial relations and a ‘free’ labour market (a difficult case to sustain given the strong unions of Germany or Sweden) or on abundant natural resources. Interestingly, too, it shows how disadvantages can be transformed into advantages: how Japan’s very lack of natural resources forced it to concentrate on adding value, how its lack of space encouraged just-in-time methods, and how the failings of Italy’s transport infrastructure encouraged the creation of more self-sufficient steel mini-mills.
Britain’s relative decline has been the subject of hundreds if not thousands of books. Perhaps it should be no surprise that the analysis here is often both familiar and at first glance deeply depressing. The examples cited of British success range from auctioneering to biscuits. Other countries are notable for their robotics, their electronics and their engineering; we apparently have a wonderful position in gardening equipment.
This is a key indicator of competitive weakness. Despite its unquestionably open economy, Britain has nothing like the number of top-class industries that Germany or Japan enjoys. Our industries are widely spread but lack depth. We are weaker in machinery industries than Italy or Switzerland. Our infrastructures, once the envy of the world, are now a major hindrance. Provision for British training is pitiful at much less than 1 per cent of turnover compared to 2 per cent in Germany and 3 per cent in Japan. And private research and development at 1.19 per cent in 1986 is below Japan (2.19), Germany (1.6) and Sweden (1.7).
More recent figures confirm this story, showing all too clearly that Britain starts the Nineties far behind its competitors. Apart from the chemicals industry, spending on research and development in manufacturing actually fell between 1985 and 1988. Manufacturing investment is now barely above the levels of 1979. Forecasts for 1990 show fixed investment falling in real terms, while it is rising by 9.1 per cent in West Germany and 5.3 per cent in France. Private capital investment is rising by 10.9 per cent in Japan. Britain’s productivity has fallen away from its long-term trend. Meanwhile in our trade with other nations we are still living far beyond our means, with a deficit set to be over £18 bn again this year.
These problems have deep roots. Some are cultural. Few would now dispute that Britain has undervalued industry and that the best talents have gone elsewhere. Porter echoes Martin Wiener and Correlli Barnett in highlighting the corrosive influence of the class system and an inappropriate philosophy of gentlemanly behaviour. Such attitudes have been compounded by the dangerously short time-horizons of key institutions. According to Porter, ‘the structure of the British capital markets has contributed to corporate goals that do not support investment and innovation.’ Instead, there is heavy trading in shares, and a pervasive short-termism that has helped to bring about one of the lowest rates of fixed investment. Short-termism is also manifest in the easygoing way in which Britain lets the rest of the world take over its industries. By 1988 the UK accounted, in value terms, for 73 per cent of all EC takeovers. Vastly more manufacturing firms have been taken over than in Germany or Japan. The last two years have seen foreign takeovers of much of the UK computing industry, of Acorn and Apricot, Istel, INMOS and ICL – takeovers that would be unthinkable in France or even the USA.
The Government’s own Innovation Advisory Board recently showed that 90 per cent of all finance directors view the City as excessively preoccupied with short-term earnings, and that 71 per cent of West German companies spend more than 5 per cent of revenue on R&D, compared to only 28 per cent of British companies. As long ago as 1979, a Financial Times editor wrote that the preference for dividend payments over R&D had ‘proved deadly to a long list of familiar names in manufacturing, and might soon kill off entire industrial sectors’. During the early Eighties this happened. And nothing has been done in the interim to impede short-termism. Porter argues that ‘a long-term bias is in the interests of the national economies’: an argument that has yet to penetrate the Conservatives’ conventional wisdom.
Porter has little doubt as to the causes of British industrial weakness. In essence he ascribes it to a failure to value long-term industrial goals, a failure to invest in technologies and in skills – a failure compounded by inappropriate industrial structures. His attention to detail makes him dismissive of extravagant claims of a British miracle, and he points out just how weak Britain is in human resources. By a nice coincidence, his book was published in the same month that a new survey appeared, showing that a smaller proportion of the British work-force has vocational qualifications than is the case in any other country in the European Community, including Portugal and Greece. He also points out that much of the recent inward investment in the UK has been driven by low wages, thus limiting its scope for contributing to the upgrading of the economy. And he doubts the value of broadly-based conglomerates, dominant in much of the British economy, which do little to enhance competitive advantage. The most important conclusion for Britain is hardly revolutionary. Referring to education and training, Porter argues that ‘the rate of social investment must rise substantially.’ This is the paramount priority for the Nineties. Human capital is becoming far and away the crucial determinant of national prosperity.
In terms of regional policy, he argues for the need to build on indigenous skills, to encourage clusters of industries able both to compete against and support one another. His ideal government uses ‘magnets’ such as universities, research laboratories, specialised infrastructures and trained labour pools in order to stimulate innovation. The implication for regional policy is that some planning is essential if the whole is to be more than the sum of its parts, and if a region is not to become home to a random group of firms.
Models of the kind advocated by Porter have proved successful around the world. Perhaps the most famous example is the Japanese policy of building technopolises, cities linking academia, industry and the public sector, radiating outwards from ‘brain centres’ such as Kanagawa or Hamamatsu. The German success with technology-transfer institutions in regions like Baden-Württemburg provides another instance of how government can help in forming networks of collaboration that give shape to the regional economy. France, too, has used telecommunications and other infrastructures, and targeted industrial aids to build up the capabilities of its regions.
Porter is supportive of measures which the present government would see as dangerously interventionist. Government’s best role, he argues, is ‘as a pusher and challenger’ to provide the ‘tools necessary to compete’. It has the responsibility of ‘signalling’, of defining the issues of national importance. These are coy euphemisms for industrial policy – necessarily coy in the US, where industrial policy can only be discussed in the context of national security. Military arguments alone are thought to justify the Pentagon’s massive funding of semiconductors, computers, numerically-controlled machine tools, and, more recently, artificial intelligence and high-definition television – a policy which for many years has sustained the country’s dominance in electronics.
Porter recognises the role of government in helping to create the conditions for national prosperity. But his roots in American culture cause him to shy away from a full appreciation of why states have come to play a leading role in economic development. The UK and the USA were the only countries to develop indigenously: the others developed in response to the industrialisation of the two pioneers, so that the state had to play a role in infrastructure, training, institution-building and capital accumulation. The Anglo-American liberal faith in a minimal state may have been appropriate when the economy was growing. But when an economy faces a crisis of competitiveness and change, the state may be one of the few effective agents of renewal. Even in Britain, where there has been little consistent commitment to industrial policy, it is striking that our most successful sectors – aerospace, pharmaceuticals, television – are precisely the ones where government has played a leading role as customer or funder. The same is to some extent true in the US, which may explain why many Americans have concluded that the first step towards reversing the tide of Japanese, Korean and Taiwanese goods is to seek a more balanced attitude to government than that allowed by the dominant ethos of American business.
Porter’s belief in competition is not tempered by a recognition of the complementary role of co-operation both in Japanese industry and in the very areas of Northern Italy which so impress him. His analytic framework limits his appreciation of how bitter rivalry can coincide with co-operation in research, or of why Japanese and Korean policy has been designed to limit competition to a viable number of firms, usually linked through combines of one sort or another. On these issues Michael Best’s The New Competition is a welcome corrective to Porter. Best shows how competition and co-operation interact in the most successful economies of our times. He emphasises the role of trust in economic life, which many would see as essential to the characteristic economic forms of the Nineties – the joint venture, the collaborative research project and the long-term relationship between supplier and buyer. Porter may be right to suggest that the fashion for ‘using alliances as a strategy will only ensure a company’s mediocrity’, but this is surely more because alliances tend to be used as a superficial, temporary and defensive measure.
One of Porter’s colleagues in the pages of the Harvard Business Review has suggested another key weakness in his approach. Gary Hamel has made the point that successful strategies for the future cannot be discerned from the study of what was successful in the past. The idea that the US or UK can simply analyse ‘what works and why’, and then apply the lessons in the domestic context, is methodologically flawed. Strategies cannot be reused; those based on imitation ‘are transparent to competitors who have already mastered them’. Hamel is scathing about Porter’s predilection for neat analytic frameworks and ‘generic strategies’, and argues that the key to success is to use a strategy which is new. He even goes so far as to suggest that as ‘“strategy” has blossomed, the competitiveness of Western companies has withered.’
Hamel’s other major theme – the significance of core competences, or collective learning – is another useful complement to the Porter diamond. It suggests that any nation or firm seeking to develop a strategy must start, not from the surface facts about industries and products, but from an appraisal of its underlying abilities. Only by developing competences, perhaps in computing, in machine skills or in communications, can a country ensure long-term competitiveness as products and industries change. Hamel’s thesis seems to be corroborated by the Japanese experience. Japan has only been successful because its peculiarly cohesive political and administrative élite was willing to ignore the advice of many of the economists who followed Adam Smith in arguing that industrial strategy should go with the grain of existing factor advantages. Where economists argued that Japan should concentrate on labour-intensive low-skill industries, the Government chose instead to emphasise dynamic comparative advantage, the deliberate accumulation of factor advantages. Its aim was to build up core competences in new areas: steel in the Fifties, motor manufacture in the Sixties, computers in the Seventies, aviation in the Eighties. For well over twenty years, a strong emphasis has been placed on building up strength in the knowledge industries. As Porter himself puts it, ‘national prosperity is created, not inherited ... a national competitiveness depends on the capacity of its industry to innovate and upgrade.’
A book on national advantage comes as something of a surprise at a time when much of the world’s attention is focused on the erosion of national sovereignty, both by transnational associations like the EC and by the spread of the transnational firm. There is also renewed interest in the characteristics of regional economies, such as Catalonia, Wales or Bavaria, which may follow a different path from that of the nation of which they are part. National industrial policies in Western Europe have had to change to reflect the reality of more global markets and greater regional disparities, not to mention new EC rules on such things as competition and public purchasing. Moreover, as Robert Reich has argued, capital is now so international and cosmopolitan that it is meaningless for governments to concentrate solely on supporting national capital. There is no obvious reason why the US Government should spend its energy advocating greater openness in Japan’s markets for products that Motorola manufactures in South-East Asia, or for that matter, why Britain should not campaign for Japanese cars made in Britain to have access to European markets.
It is probably inevitable that such an ambitious book should have weaknesses and gaps, and that its central analytic device, the diamond, should be open to question. Why not include the financial-industrial structure as one of the corners of the diamond, for instance? Why not government policy and structure – a factor highlighted recently by Paul Kennedy in his argument that the USA’s division of powers precludes the single-minded policies that might be necessary for industrial regeneration? Still, the virtues of the book outweigh its defects. It demonstrates that government does have a critical role to play in these matters. It demolishes the crude market arguments so often made by ministers in the present British government, even while acknowledging the virtues of the competitive market. It shows how success can be forged out of unpromising materials, and it calls into question those naive free-market nostrums which squeeze a 20th-century reality into 18th-century conceptual boxes. Neoclassical economics presents a world of equilibrium: like the real one, Porter’s is a world of continuous change, in which no one can afford to stand still and the need for innovation is among the few certainties.
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