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On competitiveness
OMEGA Int. J. of Mgmt Sci., Vol. 20, No. 1, pp. i-v, 1992 Pergamon Press plc. Printed in Great Britain
EDITORIAL On Competitiveness FOLLOWING his very successful book Competitive Advantage [1], in which Michael Porter devoted his energy to the question of "creating and sustaining superior performance" of industrial enterprises, he turns his attention to the national scene in a later volume, entitled The Competitive Advantage of Nations [2]. His interest in this topic was aroused in the mid-eighties when he served as a member of the President's Commission on Industrial Competitiveness of the United States. The intriguing question of why some countries are more successful than others has exercised the minds of m a n y investigators. This is not just a theoretical issue for economists in ivory towers to explore, but m a y well have m a n y political ramifications for governments seeking to formulate industrial policies. The question is evidently not an easy one, as Porter soon found out: "What became clear to me during the term of the Commission was that there was no accepted definition of competitiveness. To firms, competitiveness meant the ability to compete in the world markets with a global strategy. To many members of Congress, competitiveness meant that the nation had a positive balance of trade. To some economists, competitiveness meant a low unit cost of labor adjusted for exchange rates. Partly because of these differences, much energy has been expended in the United States debating whether there is a competitiveness problem at all." [2, p. xii] Porter argues that "cheap labor and a 'favorable' exchange rate are not meaningful definitions of competitiveness", that "defining national competitiveness as achieving a trade surplus or balanced trade per se is inappropriate", and further that "the pursuit of competitiveness defined as a trade surplus, a cheap currency, or low unit labor costs contains m a n y traps and pitfalls". And he concludes that "seeking to explain 'competitiveness' at the national level, then, is to answer the wrong question. What we must understand 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." [2, pp. 7-9] So far so good. Making sense of aggregated national statistics is at best of limited benefit in trying to evaluate industrial performance and at worst can be a crude and misleading tool in the hands of policy makers.
ii
Editorial
It is only by disaggregation of statistical data to the level of industrial sectors and even to the level of individual firms, and indeed by concentrating on any given product (since it is the product that is sold in the market place in the face of competititon), that beneficial insights can be obtained. Admittedly, the aggregated national statistics are both useful and important indicators of what happens in the economy at large, such as movements in trade volumes and balance of payments, levels of employment, money supply and consumer credit, corporate investment and consumer spending, price indices and inflation. But by its very nature, the compilation process of these statistics conceals a great deal of information, without which an analysis in depth of industrial performance cannot be undertaken. Porter is right, therefore, to question whether the term "competitiveness" means anything when referring to a whole country [2, p. 3] and to suggest that one should start "from individual industries and competitors and build up to the economy as a whole." [2, p. xiii]. His advocacy is summarized as follows: "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 the 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... The only meaningful concept of competitiveness at the national level is national productivity." [2, p. 6] The conclusion is puzzling, to say the least. If "competitiveness" is a questionable concept at the national level, largely because of the difficulty of defining and measuring it, in what way is "national productivity" any better? Not only does it rely on aggregated data from diverse industries involving diverse products manufactured in several locations and sold in many markets, but it combines a variety of factor inputs. To bring together all the disparate bits of information and combine them into a c o m m o n numerator for total aggregated output and a c o m m o n denominator for total aggregated input involves many assumptions and conventions that are hardly conducive to achieving clarity. If "national competitiveness" is too fuzzy a concept for the analysts, so is "national productivity". To reject the first and substitute it with the second does not enhance the quality of the analysis. If competitiveness is best sought and
Omega, Vol. 20, No. 1
understood at the level of industrial sectors and individual enterprises, so must productivity. Perhaps it is also appropriate to point out that the two are not alternative concepts aimed at describing the same thing: productivity is a measure o f efficiency with which resources are employed; competitiveness is the ability o f a firm to secure a market share against competition. Hence the two concepts are not synonymous and may to some extent be regarded as cause and effect, so that increasing productivity is generally expected to result in an enterprise becoming more competitive. However, competitiveness does not depend on productivity alone, as we shall see below. Furthermore, although Porter does not think much of "competitiveness" as a national attribute of great consequence, he seems happy to pursue the concept of "competitive advantage" at the national level, as can be seen from the following: "We defined international success by the 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." [2, p. 25] In the light of these difficulties, it is not surprising that Porter should add the understatement "Measuring the true competitive advantage statistically is challenging", but he proceeds to do it nonetheless: "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 based on skills and assets created in the home country for the statistical phase of the research." [2, p. 25]. In a footnote he adds that "an industry was designated as competitive if its share of world exports exceeded the nation's average share of world exports and the industry had a positive trade balance." [2, pp. 778-779]. Needless to say, such arbitrary and questionable measures can hardly infuse confidence in the results. After 800 pages of detailed (and at times tediously repetitive) discussions and arguments, the reader is none the wiser about how competiitive advantage is to be defined, let alone measured. The consequences of having a competitive advantage are highlighted often enough, namely achieving a high standard of living for the citizens of the country, creating conditions that yield high wages and opportunities for leisure pursuits, securing high prices for the country's goods in foreign countries, as well as improving the level of key economic indicators. But a measure of competitive advantage, and the identification of the causes for achieving it, seem to have eluded 800 pages of discourse.
iii
iv
Editorial
In fact, the key to competitiveness is hidden in one short sentence at the beginning of the book: "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." [2, p. 10]. The rest, as they say, is mere flannel. Competitiveness, as indicated above, is the ability to stand up to competitors and sell products or servics in the market place, assuming that a demand for these products or services exists or can be created. If comparable products are available from competitors, then competitiveness is solely dependent on the ability of the enterprise to reduce unit cost. If the products of competitors are not comparable in their design and specifications, or are not perceived by customers to be comparable, then competitiveness is enhanced by a policy of product differentiation. Even then unit cost continues to be important for large segments of the market. A Rolls-Royce is certainly different from a Ford and many a customer would be happy to pay much more for the former than for the latter, but when the price differential becomes excessive for a customer to bear, he/she may reluctantly abandon a dream of owning a RollsRoyce and be content to buy a Ford instead. Product differentiation is, therefore, a means by which management may seek to alleviate competitive pressure on unit cost, but trying to achieve premium prices by product differentiation may only succeed up to point, beyond which the unit cost cannot be ignored. This is why Porter's exhortations to governments to forget about low wages and low exchange rates are often misplaced. It is not that governments like to maintain low wages and low exchange rates p e r se. They are conscious, though, of the fact that these two factors are important in reducing or controlling the level of unit cost, so that particular products which are undifferentiated in export markets, or cannot be made sufficiently differentiated, continue to remain competitive. In this context product differentiation is not confined to product design and functional specifications, but includes many other attributes, such as quality and reliability, prompt supply, after-sales service and terms of trade. In the absence of product differentiation, unit cost becomes the prime factor that determines competitiveness. Another point about low wage rates that concerns any government is that for products involving a high labour content, wage costs can make the difference between keeping production within the country's boundaries or letting it migrate, with detrimental consequences for local employment levels, to other countries offering cheaper labour. In the same vein, no government aspires to maintain a low exchange rate as a primary national objective; in fact, a country has much to gain from a high exchange rate that can lead to potentially high revenues for the country's exports while having to pay less for imports. Thus, preferment for a low exchange rate is merely a manifestation of a desire to ensure that the country's products can compete on price in the export markets.
Omega, Vol. 20, No. 1
v
What Porter and other commentators need to stress is that low wages and low exchange rates can only be regarded as short-term measures to bolster competitiveness. However, they carry the distinct danger of tending to protect enterprises from becoming more efficient. Each time a government takes action to lower the country's exchange rate, it automatically reduces the wage rates in comparison with those prevailing in competing economies, thereby providing a cushion to employers by maintaining a low unit cost for exports. Unless enterprises take drastic action during the respite to become more efficient in the use of resources (and this is where productivity comes in), and/or to create product differentiation, the short-term competitive advantage is soon eroded, putting renewed pressure on the government for further reductions in the exchange rate and thereby for a repetition of the downward cycle. Repeated devaluations provide short-term respites, but cannot ensure long-term competitiveness; to achieve that, industry and individual enterprises need to develop the dual strategies of low unit cost and product differentiation. Productivity is obviously an important component in this process, but it is only a part of a much wider canvass. High productivity is a necessary but not a sufficient condition to ensure competitiveness. As for a role for government, the scope for seeking to affect directly the development and implementation of the dual strategies for enterprises to achieve competitiveness must be very limited. Instead, a government needs to provide the frameworks that encourage enterprises to develop initiatives and take risks. These frameworks include a constant updating and improving of existing infrastructures to ensure that the industrial, logistic, social, legal and financial systems can cope with the changes that are imposed on industry by new technology and by evolving market and trading conditions, as well as the provision of training and education programmes that prepare the workforce for the task at hand and for the future. This leaves open the question as to whether government should adopt a strategy of overt intervention to support or suppress selected industrial sectors as part of an overall economic policy, and here opinions are bound to diverge, depending on strongly held political philosophies and convictions of the various protagonists. SAMUEL EILON
Chief Editor REFERENCES 1. Porter ME (1985) Competitive Advantage--Creating and Sustaining Superior Performance. Free Press, New York. 2. Porter ME (1990) The Competitive Advantage of Nations. Macmillan, New York.
EDITORIAL On Competitiveness FOLLOWING his very successful book Competitive Advantage [1], in which Michael Porter devoted his energy to the question of "creating and sustaining superior performance" of industrial enterprises, he turns his attention to the national scene in a later volume, entitled The Competitive Advantage of Nations [2]. His interest in this topic was aroused in the mid-eighties when he served as a member of the President's Commission on Industrial Competitiveness of the United States. The intriguing question of why some countries are more successful than others has exercised the minds of m a n y investigators. This is not just a theoretical issue for economists in ivory towers to explore, but m a y well have m a n y political ramifications for governments seeking to formulate industrial policies. The question is evidently not an easy one, as Porter soon found out: "What became clear to me during the term of the Commission was that there was no accepted definition of competitiveness. To firms, competitiveness meant the ability to compete in the world markets with a global strategy. To many members of Congress, competitiveness meant that the nation had a positive balance of trade. To some economists, competitiveness meant a low unit cost of labor adjusted for exchange rates. Partly because of these differences, much energy has been expended in the United States debating whether there is a competitiveness problem at all." [2, p. xii] Porter argues that "cheap labor and a 'favorable' exchange rate are not meaningful definitions of competitiveness", that "defining national competitiveness as achieving a trade surplus or balanced trade per se is inappropriate", and further that "the pursuit of competitiveness defined as a trade surplus, a cheap currency, or low unit labor costs contains m a n y traps and pitfalls". And he concludes that "seeking to explain 'competitiveness' at the national level, then, is to answer the wrong question. What we must understand 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." [2, pp. 7-9] So far so good. Making sense of aggregated national statistics is at best of limited benefit in trying to evaluate industrial performance and at worst can be a crude and misleading tool in the hands of policy makers.
ii
Editorial
It is only by disaggregation of statistical data to the level of industrial sectors and even to the level of individual firms, and indeed by concentrating on any given product (since it is the product that is sold in the market place in the face of competititon), that beneficial insights can be obtained. Admittedly, the aggregated national statistics are both useful and important indicators of what happens in the economy at large, such as movements in trade volumes and balance of payments, levels of employment, money supply and consumer credit, corporate investment and consumer spending, price indices and inflation. But by its very nature, the compilation process of these statistics conceals a great deal of information, without which an analysis in depth of industrial performance cannot be undertaken. Porter is right, therefore, to question whether the term "competitiveness" means anything when referring to a whole country [2, p. 3] and to suggest that one should start "from individual industries and competitors and build up to the economy as a whole." [2, p. xiii]. His advocacy is summarized as follows: "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 the 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... The only meaningful concept of competitiveness at the national level is national productivity." [2, p. 6] The conclusion is puzzling, to say the least. If "competitiveness" is a questionable concept at the national level, largely because of the difficulty of defining and measuring it, in what way is "national productivity" any better? Not only does it rely on aggregated data from diverse industries involving diverse products manufactured in several locations and sold in many markets, but it combines a variety of factor inputs. To bring together all the disparate bits of information and combine them into a c o m m o n numerator for total aggregated output and a c o m m o n denominator for total aggregated input involves many assumptions and conventions that are hardly conducive to achieving clarity. If "national competitiveness" is too fuzzy a concept for the analysts, so is "national productivity". To reject the first and substitute it with the second does not enhance the quality of the analysis. If competitiveness is best sought and
Omega, Vol. 20, No. 1
understood at the level of industrial sectors and individual enterprises, so must productivity. Perhaps it is also appropriate to point out that the two are not alternative concepts aimed at describing the same thing: productivity is a measure o f efficiency with which resources are employed; competitiveness is the ability o f a firm to secure a market share against competition. Hence the two concepts are not synonymous and may to some extent be regarded as cause and effect, so that increasing productivity is generally expected to result in an enterprise becoming more competitive. However, competitiveness does not depend on productivity alone, as we shall see below. Furthermore, although Porter does not think much of "competitiveness" as a national attribute of great consequence, he seems happy to pursue the concept of "competitive advantage" at the national level, as can be seen from the following: "We defined international success by the 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." [2, p. 25] In the light of these difficulties, it is not surprising that Porter should add the understatement "Measuring the true competitive advantage statistically is challenging", but he proceeds to do it nonetheless: "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 based on skills and assets created in the home country for the statistical phase of the research." [2, p. 25]. In a footnote he adds that "an industry was designated as competitive if its share of world exports exceeded the nation's average share of world exports and the industry had a positive trade balance." [2, pp. 778-779]. Needless to say, such arbitrary and questionable measures can hardly infuse confidence in the results. After 800 pages of detailed (and at times tediously repetitive) discussions and arguments, the reader is none the wiser about how competiitive advantage is to be defined, let alone measured. The consequences of having a competitive advantage are highlighted often enough, namely achieving a high standard of living for the citizens of the country, creating conditions that yield high wages and opportunities for leisure pursuits, securing high prices for the country's goods in foreign countries, as well as improving the level of key economic indicators. But a measure of competitive advantage, and the identification of the causes for achieving it, seem to have eluded 800 pages of discourse.
iii
iv
Editorial
In fact, the key to competitiveness is hidden in one short sentence at the beginning of the book: "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." [2, p. 10]. The rest, as they say, is mere flannel. Competitiveness, as indicated above, is the ability to stand up to competitors and sell products or servics in the market place, assuming that a demand for these products or services exists or can be created. If comparable products are available from competitors, then competitiveness is solely dependent on the ability of the enterprise to reduce unit cost. If the products of competitors are not comparable in their design and specifications, or are not perceived by customers to be comparable, then competitiveness is enhanced by a policy of product differentiation. Even then unit cost continues to be important for large segments of the market. A Rolls-Royce is certainly different from a Ford and many a customer would be happy to pay much more for the former than for the latter, but when the price differential becomes excessive for a customer to bear, he/she may reluctantly abandon a dream of owning a RollsRoyce and be content to buy a Ford instead. Product differentiation is, therefore, a means by which management may seek to alleviate competitive pressure on unit cost, but trying to achieve premium prices by product differentiation may only succeed up to point, beyond which the unit cost cannot be ignored. This is why Porter's exhortations to governments to forget about low wages and low exchange rates are often misplaced. It is not that governments like to maintain low wages and low exchange rates p e r se. They are conscious, though, of the fact that these two factors are important in reducing or controlling the level of unit cost, so that particular products which are undifferentiated in export markets, or cannot be made sufficiently differentiated, continue to remain competitive. In this context product differentiation is not confined to product design and functional specifications, but includes many other attributes, such as quality and reliability, prompt supply, after-sales service and terms of trade. In the absence of product differentiation, unit cost becomes the prime factor that determines competitiveness. Another point about low wage rates that concerns any government is that for products involving a high labour content, wage costs can make the difference between keeping production within the country's boundaries or letting it migrate, with detrimental consequences for local employment levels, to other countries offering cheaper labour. In the same vein, no government aspires to maintain a low exchange rate as a primary national objective; in fact, a country has much to gain from a high exchange rate that can lead to potentially high revenues for the country's exports while having to pay less for imports. Thus, preferment for a low exchange rate is merely a manifestation of a desire to ensure that the country's products can compete on price in the export markets.
Omega, Vol. 20, No. 1
v
What Porter and other commentators need to stress is that low wages and low exchange rates can only be regarded as short-term measures to bolster competitiveness. However, they carry the distinct danger of tending to protect enterprises from becoming more efficient. Each time a government takes action to lower the country's exchange rate, it automatically reduces the wage rates in comparison with those prevailing in competing economies, thereby providing a cushion to employers by maintaining a low unit cost for exports. Unless enterprises take drastic action during the respite to become more efficient in the use of resources (and this is where productivity comes in), and/or to create product differentiation, the short-term competitive advantage is soon eroded, putting renewed pressure on the government for further reductions in the exchange rate and thereby for a repetition of the downward cycle. Repeated devaluations provide short-term respites, but cannot ensure long-term competitiveness; to achieve that, industry and individual enterprises need to develop the dual strategies of low unit cost and product differentiation. Productivity is obviously an important component in this process, but it is only a part of a much wider canvass. High productivity is a necessary but not a sufficient condition to ensure competitiveness. As for a role for government, the scope for seeking to affect directly the development and implementation of the dual strategies for enterprises to achieve competitiveness must be very limited. Instead, a government needs to provide the frameworks that encourage enterprises to develop initiatives and take risks. These frameworks include a constant updating and improving of existing infrastructures to ensure that the industrial, logistic, social, legal and financial systems can cope with the changes that are imposed on industry by new technology and by evolving market and trading conditions, as well as the provision of training and education programmes that prepare the workforce for the task at hand and for the future. This leaves open the question as to whether government should adopt a strategy of overt intervention to support or suppress selected industrial sectors as part of an overall economic policy, and here opinions are bound to diverge, depending on strongly held political philosophies and convictions of the various protagonists. SAMUEL EILON
Chief Editor REFERENCES 1. Porter ME (1985) Competitive Advantage--Creating and Sustaining Superior Performance. Free Press, New York. 2. Porter ME (1990) The Competitive Advantage of Nations. Macmillan, New York.