The Competitive Advantage Of Nations

The Competitive Advantage of Nations is a 1990 work of economics by American author Michael E. Porter, a Harvard Business School professor and expert in corporate competitive strategy whose influential works are frequently cited in business and economics. In this book, Porter dismantles traditional economic theories about how well a nation fares in global competition (factor costs and macro-economic policy) and proposes a model that focuses on active and malleable factors of business rather than passive, immutable properties of geography. He holds that what gives certain nations a competitive advantage in advanced industries is primarily the quality of factors such as labor, infrastructure, and home demand (that is, demand for a product within the home nation)—and the strength of related and supporting industries. Porter then uses this theory to analyze the most advanced world economies, including Germany, Japan, the US, and the UK. He argues that the UK has drifted into a non-competitive “wealth-driven” society, while other nations are in danger of doing so. Only by taking measures to strengthen the four determinants of national competitiveness, he suggests, can they avoid Britain’s fate.

This guide uses the 1990 Palgrave edition.

Summary

Before the work of Porter and others who developed the field of competitive advantage, a nation’s level of success relative to its neighbors was evaluated using the economic theory of comparative advantage. In this version of national growth, what affects a nation’s standing are five relatively unchangeable factors: land, location, natural resources, labor, and population size and trends. Porter argues that viewing national competitiveness in this way encourages the idea that economic opportunity in the global marketplace is something to be passively watched. Instead, he proposes a totally different paradigm.

For Porter, the concept of national productivity is not a meaningful term because countries don’t compete like businesses do.

This means that understanding national competitiveness starts with individual companies’ performance, aggregating these solitary results into “clusters”—groups of firms that are interconnected because they belong to related industries (and may have supplier/client relationships) and are often geographically linked. When these clusters and their relative productivity form the basic building blocks of evaluating national advantage, it follows that a nation’s companies must always improve themselves through innovation, higher productivity and efficiency, and improved product quality and differentiation—and that the role of the government is to encourage this constant self-improvement.

In Porter’s Diamond model, being able to predict or evaluate cluster activities relies on a 4-factor system:

1. Firm Strategy, Structure, and Rivalry

For a company to grow, its structure and business strategy must synergize with the local business environment. Direct competition with other firms ideally propels each individual company to use the skills and resources necessary to increase innovation and productivity—and to try to beat its local rivals. When several companies experience this kind of stimulus, their cluster thrives.

2. Demand Conditions

When a local market consists of customers who demand high quality, differentiated products, companies trying to fulfill these demands will necessarily be forced to innovate to survive. As a result, a company that thrives in a competitive and aggressively demanding local marketplace will also do well on the global market because it will have honed its products.

3. Related and Supporting Industries

All companies rely to some degree on suppliers for parts, raw materials, and the exchange of information—and usually participate in this cycle as both suppliers’ customers and suppliers themselves. When a company’s supply chain firms are productive, high-quality businesses themselves with the ability to thrive in the local and global market, that company will also enjoy increases to its own efficiency, productivity, and innovation.

4. Factor Conditions

Of course, it matters what natural resources, infrastructure, population skills, capital, and land are available to a given cluster and to a nation. Porter emphasizes the “specialized factors” of skilled labor, capital, and infrastructure, which are harder to generate quickly because they require long-term investment and cultivation. Consequently, clusters that have access to these specialized factors have an advantage over those that don’t. Conversely, factors such as resources and land are easier to work around through trade or technological innovation, so they matter less to competitive advantage.

Using this model, Porter argues that the role of the government should be to support national competitiveness by encouraging rivalry and domestic competition and by promoting strict environmental and safety regulations—to help companies create extremely high-quality products that can compete successfully in the global marketplace. Additionally, Porter advises companies to rise to challenges and innovate to upgrade their strategies and products. All of this should combine to boost other economic sectors and create jobs.

After laying out this framework, Porter uses it to examine 10 nations—chosen specifically to vary in size, government policy, geographical features, and world region—and shows the combination of factors that work together to create internationally competitive climates. These chapters tend to be repetitive and of most interest to a specialized reader—so much so that the book’s introduction offers a map for reading the book out of order to avoid the repetition.

Following the book’s brief introduction are 13 chapters. This guide contains nine analysis sections, each covering one or two chapters, based on their length and importance. In the introduction and Chapter 1, Porter defines national competitive advantage as international success in high-technology, high-productivity industries. He emphasizes that traditional theories of competition, based on comparative costs of labor, natural resources, and capital, are insufficient to explain success in these areas. Instead, he advocates for a new theory that recognizes the technologically evolving nature of advanced industries.

In Chapter 2, Porter examines the theoretical underpinnings of competitive advantage for firms. This is a function of a company’s strategy relative to the industry structure within which the company competes. Firms compete within this structure through either pursuing lower costs or differentiating their products. Chapter 3 looks at the main factors that determine why firms are successful in certain national contexts. The first of these is production quality. Advanced factors like universities or research facilities are more significant than basic factors like unskilled labor or access to raw materials. The second determinant is the quality of demand and having sophisticated or anticipatory home demand. The final two determinants are the strength of related and supporting industries and the degree of rivalry between domestic firms. Chapter 4 explores the interrelations between these factors and how they reinforce one another.

Chapter 5 looks at four different successful industries: the German printing press industry, the American patient monitoring equipment industry, the Italian ceramic tile industry, and the Japanese robotics industry. Porter finds that they all have high levels of domestic rivalry and sophisticated home demand, which helped each develop from beginnings based on chance. They maintained this success through continual upgrading, strong supporting industries, and overcoming basic factor disadvantages.

Chapter 6 explores the growing importance and internationalization of the service industry and the factors underpinning competitive success there. Chapter 7 gives a broader account of national competitive advantage by examining the economies of four post-war economic “winners”: the US, Sweden, Switzerland, and Germany. The first three benefited from having their industrial bases unharmed in the war while those of other powers were devastated. This allowed firms in these countries to supplant foreign competition in many established industries while gaining significant first-mover benefits in emerging industries. In contrast, the German economy suffered huge damage, but traditional German strengths overcame this adversity and created an environment for renewed innovation.

Chapter 8 looks at three countries—Japan, Italy, and South Korea—whose economies emerged in the 1970s and 1980s to challenge the established economic powers. All benefited from selective factor disadvantages that spurred innovation and investment, which dovetailed with other nation-specific advantages—such as anticipatory demand in Japan, sophisticated demand in Italy, and a highly educated workforce in Korea—to create competitive advantage. Chapter 9 discusses two national economies, the UK and the US, that have been in decline since the 1970s. In both cases, the reasons for this decline were poor standards of education, deteriorating home-demand quality, and business cultures that prioritized short-term profit over long term investment. Chapter 10 outlines the four general stages of economic development—factor-driven, investment-driven, innovation-driven, and wealth-driven—that nations undergo.

Chapter 11 looks at the practical implications of Porter’s theory for companies. He argues that firms can best exploit a successful national context by supporting advanced factor creation, including investment in research, and by developing relationships with universities. They can also seek out the most sophisticated demand and work with supplier industries to encourage them to internationalize. Finally, firms can identify and try to outdo their strongest rivals. Chapter 12 explores the implications for government policy. Government’s strongest role is in factor creation via investment in education, research, and infrastructure. Government can also influence demand by acting as a sophisticated buyer and by creating stringent product quality and safety standards. Chapter 13 explores some of the issues raised in Chapters 11 and 12 for the nations studied. Korea needs to move away from reliance on factor costs. Italy needs to improve its infrastructure and reduce the role of the state in industry. Japan, Switzerland, Sweden, Germany, and the US must address the drift towards becoming wealth-driven societies, which they can achieve by reversing the trend towards oligopoly in industry and providing more incentives for new business creation.