The Competitive Advantage Of Nations

Nonfiction | Book | Adult | Published in 1990

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Summary

Chapter Summaries & Analyses

Preface-Chapter 1

Part 1, Chapter 2

Part 1, Chapters 3-4

Part 2, Chapters 5-6

Part 3, Chapter 7

Part 3, Chapter 8

Part 3, Chapters 9-10

Part 4, Chapters 11-12

Part 4, Chapter 13

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Themes

Index of Terms

Important Quotes

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Part 4, Chapter 13Chapter Summaries & Analyses

Part 4: “Implications”

Part 4, Chapter 13 Summary: “National Agendas”

Based on the analysis in the previous two chapters about the role of firms and government in fostering competitive advantage, Porter now looks at some of the issues facing the national economies he discussed in the text. The first of these is South Korea. Korea is at the investment-driven stage of its development, in which firms compete in some advanced industries but primarily on price. To move to an innovation-driven economy that competes through product quality and differentiation, several changes may be necessary. First, government must resist “the general tendency to intervene in markets to hold back wages and other factor costs” (686). Such policies will only keep Korean firms fixated on price competition and lessen the incentives to upgrade to lower unit labor costs by upgrading productivity. In addition, allowing wage rises will improve the quality of home demand, another problem area for Korea. Home demand could also benefit by easing restrictions on imports and exposing Koreans to more foreign products. Finally, Korea must curb the power of the chaebol—the small group of large, family-owned firms that have dominated the economy—to promote greater competition and access to capital markets for smaller and emerging firms.

In contrast to Korea, Italy is already at the innovation stage of development. However, while it is strong in certain clusters related to fashion and ceramics and in small and medium-sized industries, it is weak and lacks competitive advantage in larger-scale industries, which government often artificially protects. This means that “the potential liberalization of European markets” (691) poses serious challenges to them. At the heart of Italian weakness is poor factor creation. The formal education system in Italy needs upgrading, especially in areas such as computing and mathematics. Universities and postgraduate programs should receive greater focus. In addition, government should increase its investment in research and development. As Porter highlights, Italy currently has some of the lowest rates of spending on research as a proportion of GDP of any advanced nation—almost half that of Sweden, Germany, Japan, or the US. Unless Italy addresses this issue, its firms will lack the technological basis to enter many new industries.

Sweden has been at the innovation-driven economic stage since the beginning of the 20th century. Its leading firms retain competitive advantage, backed by high research and development investment and early internationalization. However, the range of successful industries in Sweden remains narrow, and it creates few new competitive businesses. Part of the reason for this is high personal tax rates, in which “the level of after-tax return is insufficient to induce entrepreneurs to take the risk of starting new companies” (703). High tax rates also reduce the purchasing power of Swedish customers and undermine demand quality. In addition, the large public sector has undermined competition in certain areas such as services and has swallowed up a disproportionate amount of Sweden’s most skilled workers.

Japan transitioned quickly after World War II from a factor-driven to an innovation driven economy. Its firms are world leaders in many areas and are constantly upgrading, and Japan remains a model for successful economic development. Nevertheless, two main issues may emerge as problems for Japan in the medium term. The first is “the large portion of the economy that is unproductive” (705). Agriculture and retail are artificially protected and antiquated—and are held back, as are other aspects of the Japanese economy, by a hostility to imports. This limits consumer choice and fresh competition for domestic firms. More broadly, Japan must guard against the drift toward complacency and a wealth-driven economy. Promoting and guaranteeing competition is one crucial way of doing this.

Switzerland has been an innovation driven and prosperous economy since World War II. Many Swiss firms are international brand names, such as Nestle and Swatch, and Swiss home demand remains highly sophisticated and anticipatory. However, Switzerland is showing signs of a drift toward a wealth-driven economy, as evidenced by a lack of competitiveness between Swiss firms. Exacerbating this problem is underfunding in research and development, where Switzerland spends the lowest proportion of GDP of all the advanced nations Porter studied. In addition, restrictive labor regulations have undermined the competitiveness of Swiss firms. Germany’s position is similar to Switzerland’s. It has enjoyed decades of prosperity and has some of the highest living standards in the world. Nonetheless, productivity growth has slowed, and “signs of a slackening of German dynamism” (716) are evident. German firms have increasingly sought accommodation rather than competition, and Germany lacks investment in new sciences such as biotechnology and computers.

Meanwhile, Britain has definitively been in the wealth-driven stage for decades and has seen a decline in living standards as a result. That said, signs of a possible British recovery are emerging due to some privatization and restructuring of industry. Finally, America is at a crossroads. It is drifting into becoming a wealth-driven society. However, it can address this issue by improving human resource and research production and moving away from protectionism to embrace international and domestic competition.

Part 4, Chapter 13 Analysis

While Britain may be the only nation that Porter officially designates as “wealth-driven,” with the self-perpetuating cycle of decline that implies, many advanced nations are drifting toward this state—even the mighty Japan, once the paradigm of economic dynamism. This trend generally stems from a natural effect of industrial success—in other words, having gained prosperity, a nation at any stage can become “intent on defending what they have rather than creating new advantages” (712). While this process may be slow and unintended, the preference for “maintaining instead of improving” (717) can start to root itself in a culture, with disastrous consequences. This manifests in several related ways that cut across all the innovation-driven nations that Porter studied.

The first of these ways is at the level of the individual. With a certain income assured, often backed up by generous welfare states, the motivation for entrepreneurship and risk-taking diminishes. The individual questions the risk or effort necessary to start a business when one can get a well-paid, secure, job in the public sector or an established large company. This is particularly a problem in social-democratic states like Sweden and Germany. Entrepreneurship, as both a cause and effect of this, comes to “lack social prestige” (703). In fact, in Germany, there may even be a shift in perception of such people “from someone who is a driving force in the economy to one who is ‘expropriating’ wealth from others” (719). This social indifference, or opprobrium, is reinforced by high and punitive taxes on incomes. The activities of trade unions reinforce such attitudes of risk aversion and “holding onto what one has.” They often seek to maintain the status quo in terms of jobs and pay and become hostile towards any attempted change or upgrading that affects it.

In addition, firms can fall prey to such conservatism. As Porter notes, “Vision and institution building may be replaced by stewardship” (709). This is a danger in Japan, where the original founders of post-war companies are being replaced by a new class of professional managers. Such managers, as in the US, Switzerland, and Germany, seek “safer” ways of maintaining profits than creating new products, ways of producing, or competing against rivals. This often prefigures moves towards mergers and firm cooperation. Firms buy or work with other firms, and, ironically, justify it on the grounds that globalization requires the cessation of “wasteful” domestic rivalry. However, it instead creates oligopolies with almost guaranteed shares of home markets and little incentive or ability to innovate.

The same goes for many other corporate strategies not based in innovation. Porter points out that US firms are particularly prone to source production to countries with cheaper labor rather than upgrade technology at home. Similarly, “the attraction of diversification remains irresistible in American industry” (731). To maintain profits without the risk of upgrading, firms buy profitable companies in unrelated fields. This temporarily raises stock prices, bringing bonuses for managers, but hurts competitiveness because the old firm lacks the expertise to assimilate the new one. Finally, a disturbing trend in company strategy is what many refer to derisively in Japan as “money games” (709). Companies and individuals become obsessed with maximizing the return on existing wealth—“instead of creating new wealth” (709)—by buying and selling assets and speculating on the rise and fall of prices. Not only is this strategy non-productive for the real economy, but pursued on a large scale it can be dangerous and destabilizing—as demonstrated by the 2008 financial crisis, which was in part caused by speculation and the creation of complex financial “products.”

The third major cause and warning sign occurs on a national level. This can be seen as a nationwide and cultural attempt to “hold onto what we have.” It has manifested in Switzerland in “strict limits on the immigration of skilled personnel” (713) and in Germany in concerns about Polish immigration after the 2004 expansion of the EU. It was also a key factor behind Britain’s “Brexit” vote to leave the EU in 2020. In all these cases, hostility toward “outsiders” stunts potential dynamism and new skills while weakening the nation’s long-run competitive position. Similar forces have been at work in the US. As Porter highlights, “Workers without skills are finding their livelihoods more and more threatened by the lower wages in developing nations” (725). This has led to the rise of economic nationalism in the US and played a part in the 2016 election of Donald Trump. However, protectionist policies in the long run merely delay the need for necessary, and sometimes painful, industry re-adjustments. In addition, they increase the risk that a drift towards becoming wealth-driven turns into a permanent, society-wide condition.