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Page 1: Competitiveness in a globalised world: Michael Porter on the

COMMENTARY

Competitiveness in a globalised world: Michael

Porter on the microeconomic foundations of

the competitiveness of nations, regions, and

firms

Brian Snowdon andGeorge Stonehouse

Newcastle Business School, Northumbria

University, Newcastle upon Tyne, UK

Correspondence:B Snowdon, Division of StrategicManagement and International Business,Newcastle Business School, NorthumbriaUniversity, Newcastle upon TyneNE1 8ST, UK.Tel: þ44 191 227 3932;Fax: þ44 191 227 3682;E-mail: [email protected]

Online publication date: 9 March 2006

AbstractIn this paper, we provide the text of an interview with Professor Michael Porter

discussing his research and ideas relating to the microeconomic foundations of

global competitiveness. The discussion provides a microeconomic perspective

on some of the key issues relating to recent research on competitiveness,productivity, clusters, US economic leadership, economic growth and deve-

lopment.

Journal of International Business Studies (2006) 37, 163–175.

doi:10.1057/palgrave.jibs.8400190

Keywords: economic growth; productivity; competitiveness; competition; clusters

IntroductionFor over 30 years Professor Michael Porter has pioneered the use ofeconomic analysis to investigate important issues relating to‘competitiveness’ at the firm, industry and national level.1 He iswidely regarded as one of the world’s leading authorities on thecompetitive strategy of enterprises, the competitiveness andeconomic development of nations, states, and regions, and theapplication of competitive analysis to a variety of key socialproblems, including those linked to the environment, healthcareand philanthropy.

In June 2001, Harvard University announced the establishmentof the Institute for Strategy and Competitiveness as a majorinternational centre for management education and innovativecurriculum development. This new interdisciplinary researchinstitute, based at Harvard Business School, is headed by MichaelPorter and focuses research on the implications of competitiveforces for company strategy, assessing the competitiveness ofnations, regions and cities, and investigating the impact ofcompetitive capitalism on society and social progress.2

During the last decade there has evolved a welcome congruencebetween the research of Michael Porter and mainstream growththeorists in that there is now much clearer recognition amongeconomists of the importance of sound microeconomic funda-mentals if an investment and innovation-friendly environment isto be created that is conducive to sustainable growth. This is

Journal of International Business Studies (2006) 37, 163–175& 2006 Academy of International Business All rights reserved 0047-2506 $30.00

www.jibs.net

Page 2: Competitiveness in a globalised world: Michael Porter on the

particularly noticeable in the recent contributionsof Baumol (2002), Helpman (2004), the OECD(2004), Sena (2004), the UK Treasury (2004), theWorld Bank (2005), and the development of theWorld Economic Forum’s Global CompetitivenessIndex by Sala-i-Martin and Artadi (2004).3

In this article, we provide the text of an interviewwe conducted with Professor Porter, discussing hiswork and ideas relating to the microeconomicfoundations of global competitiveness and eco-nomic development.4

Interview with Michael Porter

The role of economic analysis in business schoolresearch

On your appointment to the position of UniversityProfessor, Kim Clark, the Dean of Harvard BusinessSchool, paid tribute to you as ‘a pioneer in usingeconomic principles to solve important problems incompetitiveness’. How important was your economicstraining to your later work?

It was fundamental to my work. I see my basicdiscipline as economics, and I see myself as aneconomist. There are certain economic fundamen-tals that influence everything else, and my princi-ple initial contribution was taking some knowledgeof industrial economics and for the first timebringing that perspective into the business strategyfield (Porter, 1980). So I have always tried to bridgetwo fields. I have taken economic theory andconcepts and applied them in a productive way inmore practical settings.

When it came to the issue of competitiveness, what was itthat economists were missing in their analysis?

When I came to looking at competitiveness I foundthat there was virtually nothing in the economicsliterature that addressed the micro aspects ofcompetitiveness. I wanted to find a framework thatwould better capture the full complexity of compe-tition. The The Competitive Advantage of Nations(Porter, 1990) book was a 6-year effort involvingresearch teams in 10 different countries, because wehad to create massive amounts of primary data. Myaspiration has always been to create a two-waydialogue in order to bring from economics someanalytical rigour into management thinking, butalso to bring to economics a deeper understandingabout the nature and deeper reality of competition.

Competition as a unifying theme

You have contributed to a wide variety of fields, includingstrategy, competition and competitiveness, industrialeconomics, innovation, the economic development ofnations, regions and cities, corporate philanthropy andenvironmental issues. Is there a common theme thatconnects your thinking on each of these issues?

There certainly is. The core of all of my work is toestablish a deep and sophisticated understanding ofthe nature of competition in individual markets.How do firms compete in markets? How do theydevelop strategies? How do they gain competitiveadvantage? So that initial core of work was reallyabout firm-level competition. I didn’t even utterthe words ‘government’ or ‘locational factors’.Those issues were not even on the radar at thattime.

Then I got exposed, almost by accident, to theissue of national competitiveness. I was appointedby President Reagan to a commission investigatingthe competitiveness of the United States. I imme-diately started to scratch my head, because there isno simple translation between the competitivenessof a firm and the competitiveness of an economy.Drawing analogies between the competitiveness offirms and the competitiveness of nations involves afallacy of composition that causes tremendousconfusion.5 So when I started mulling this overand over in my mind it became clear to me that inorder to understand the competitiveness of nationsit would be necessary to adopt a bottom-up ormicroeconomic approach.

My work started with the question: How do firmscompete? That led me to the ‘cluster’ and ‘dia-mond’ concepts, and a very granular and close-inview of the business environment.6 This approachis complementary to the more traditional top-downapproach to economic development, whichemphasises factors such as institutional develop-ment, trade liberalisation, privatisation, and macro-economic stabilisation. In the same way the workon regions and inner cities is a derivative of thework on nations (Porter, 1995). It turns out thatyou can take the same theory and apply it tonations, regions, and cities, provided you makesome important conceptual adjustments.

Competitiveness and productivity

As you have pointed out, the word ‘competitiveness’leads to much confusion and misunderstanding betweenacademics and non-academics (media, politicians and

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business executives). You also stress that it is importantto distinguish between competitiveness from a firm’spoint of view and competitiveness from a nation’s pointof view. Trade between nations is a positive-sum game,whereas competition between rival firms is a zero-sumgame. The UK is not in competition with China in thesame way that Coke is in competition with Pepsi. In yourwork on the competitiveness of nations, regions and citiesyou focus on productivity as the key to understandingcompetitiveness (e.g. Porter, 1990, 2003). Why isproductivity the key to the competitiveness of nations?

I agree that this confusion between the competi-tiveness of firms and the competitiveness of nationsis widespread. When you look at a firm you need toremember that, barring restrictions, it can operate,produce and sell in any market. Its measure or scorecard of competitiveness is market share and profit-ability. In contrast, when you start to look atlocation I argue, and believe very strongly, thatthe true metric of competitiveness is the produc-tivity of the resources utilised in that location.

Take for example a company making shoes inMassachusetts that is gaining market share, but ispaying its workers only 50 cents an hour wages. Thelow wage makes it competitive in selling shoes, butis not boosting the prosperity of Massachusetts,which would like to have high wages.

So if you are trying to understand what createsthe prosperity of a location you have to see thatthere is a different score card that you need to usecompared with when you are trying to assess thesuccess of a company. Obviously companies andlocations are linked, because companies have tooperate in geographical locations. There has to be asynthesis. But fundamentally you have to see thatthere are two definitions of victory, and that thecompetitiveness of locations is not a zero-sumgame. For a firm operating in a marketplace itsgain in market share is some other firm’s loss ofmarket share.

When you think about competing across loca-tions the situation is different. China competeswith the US only in an indirect sense in terms ofwhether or not it can support and attract produc-tive activity. Nations compete in providing a plat-form for operating at high levels of productivityand therefore attracting and retaining an ampleinvestment in those activities that support highreturns to capital and high wages.

This is a very big issue, and one of the greatproblems in discussing economic development isconfusion about what is meant by competitiveness.

We see the same problem in discussions on themeaning of strategy (Porter, 1996; Stonehouse andSnowdon, 2006). Economists make it worse in somecases when they say things such as ‘Wages felly’ or‘the currency value declinedy making a countrymore competitive.’ That does not map withprosperity, because a fall in wages makes peoplepoorer. Falling wages are not a measure of competi-tiveness but rather a sign of lack of competitiveness.

So I find that my number one job when I amworking with a state, region or country is to geteverybody on board as to the meaning of competi-tiveness, and what the goals are that we are tryingto achieve. In the case of a company it is return oninvested capital; in a region or country it isproductivity measured by value, not productivityin the narrow sense of volume.

You have argued (Porter, 2004), and I quote, that:‘National prosperity is strongly affected by competitive-ness, which is the productivity with which a nation usesits human, capital, and natural resources. Competitive-ness is rooted in a nation’s microeconomic fundamentals,manifested in the sophistication of its companies and thequality of its microeconomic business environmenty Thecentral challenge to the world economy is now micro-economic reform.’ What are the important microeco-nomic reforms that are needed in order to boostproductivity and prosperity?

First of all I want to make it clear that it is importantto acknowledge that there are some overarchingareas of context that can make it easier or harder toinfluence productivity. I am referring here to theneed for macroeconomic stability, and soundpolitical and legal institutions.7 If these are not inplace then the risk-aversion of investors increases,and you cannot increase productivity without acommitment to invest.

So context is important. However, while the rightcontext is necessary, it is not sufficient to raiseproductivity. A country might have the most stablemacroeconomy in the world, and a well-function-ing and accountable democratic political system,but that will not in itself guarantee prosperity. Inmodelling the microeconomic influences on pro-ductivity we emphasise that the ultimate determi-nant of the productivity of the economy is theproductivity of the firms within that economy.When I say ‘firms’ I mean both local firms and alsounits of multinationals that may be located in aparticular country. It is the output per unit oflabour and capital that is going to determine theprosperity of a nation.

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I sometimes make economists angry by saying:‘Only firms can create wealth; governments, NGOsand universities cannot create wealth.’ Only firmscan create wealth when they create a product orservice that they can produce efficiently and sell ata price higher than the cost of production, therebymaking a profit. What allows firms to be productiveis the sophistication of the firms themselves andhow they compete, and also the business environ-ment within which the firms compete.

That is where the diamond theory comes in(Porter, 1990). This theory tries to look at theimmediate business environment that is surround-ing and influencing the competition process. Thefactors illustrated by the diamond influence theconditions that will have a fundamental impact onthe productive potential of firms: factor inputconditions, demand conditions, the context of firmstrategy and rivalry, and the availability of relatedand supporting industries. The process of economicdevelopment is about improving that diamondso that firms can achieve successively higher levelsof achievement and productivity.

Do the main challenges of economic development changeas a country grows?

Yes, the challenges of economic development doevolve as you ratchet up that process. Economicdevelopment is a sequential process. At low levelsof around $1000 GDP per capita, the constraints onproductivity often evolve around problems withthe infrastructure. When you get to $15,000 GDPper capita you need the institutional and incentivestructure to create original best-in-the-world inno-vations. Therefore, the microeconomic economicchallenge is constantly evolving. The stages ofcompetitive development involve moving frombeing a factor-driven economy to becoming aninvestment-driven economy, and finally to becom-ing an innovation-driven economy (Porter, 2005).

One of your economist colleagues here at Harvard,Alberto Alesina, has recently produced some interestingcollaborative work on the economic determinants of thesize of nations (Alesina, 2003). Increasing globalisationand trade liberalisation reduce the advantages of aparticular region belonging to a large nation in order togain scale economies and other advantages of a largeinternal market. Small nations are more economicallyviable in a globalised world, and the number of countrieshas increased from 74 in 1945 to 193 in 2004! What areyour thoughts on the implications of this line of research?

This is an interesting line of research. One of thepoints that I made in The Competitive Advantage ofNations, and have made many times since, is thatthere is what I call a location paradox. You wouldthink that, in an increasingly globalised world,open international markets and the free flow andexchange of information, ideas and resources, thatlocation would become less important. Thereforevirtually any economic activity can be carried outin any location, within reason. My argument isthat, in the global economy, so long as you havethe clusters – the critical mass – a particular field ofbusiness activity can be extremely efficient andproductive. This does not require a large localmarket; you just need a very high-quality localmarket.

Empirically, if you look at case studies of thecountries that have done well there is a lot evidenceshowing that many small countries have done verywell by integrating themselves into the globaleconomy. Singapore is a classic example. Also, ifyou look at the large countries that are successfulyou find that one of the important reasons for thatsuccess is because those countries effectively makethemselves into several small countries by devol-ving a lot of initiative and authority down to thelocal regional level. One of the big themes in ourwork on competitiveness and economic develop-ment here at the Institute is the importance ofmultiple levels of geography. The classical view wasthat the large nation-state was the key unit forthinking about competitiveness. Now we under-stand that national and international factors areimportant, but a lot of the real action is going on inrelatively small units.

So I am very much in agreement with that generalline of research.

Economists (e.g., Bhagwati, 2002) emphasise ‘compara-tive advantage’ when they explain trade patterns,whereas in your 1990 book The Competitive Advantageof Nations you emphasise ‘competitive advantage’. Inyour 1995 co-authored paper ‘Green and Competitive’(Porter and van der Linde, 1995) you say that ‘Today,globalization is making the notion of comparativeadvantage obsolete’. Why is this the case?

Basically, I argue that traditional trade theory, basedaround the idea of comparative advantage, focuseson a country’s factor endowments of land, labour,and capital. But this is not what is driving thecurrent patterns of trade between nations. Themost obvious limitation of the traditional theory is

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with respect to capital. You no longer need yourown domestic supply of capital. If Estonia or Polandoffers a profitable economic opportunity it can getall the capital it needs from the internationalcapital markets. With respect to labour, it is notso much the quantity of labour that affects yourcompetitiveness in a given field, but rather it isspecialisation and the quality of labour that areimportant. So it is crucial to recognise that theadvantages arise less from inputs in the conven-tional sense, and more from technology and theefficiency with which those inputs are utilised.

I argue that the efficient utilisation of inputs isfundamentally affected by location and proximity.As the globalisation process evolves, what we see ismore subdividing and specialisation of clusters. Tenor 20 years ago there would be a semiconductorcluster in the US and another in Japan. The one inJapan was heavily skewed towards memory chips,whereas the one in the US was skewed towardsmicroprocessors. Now what you see is a clusterspecialising in a narrow set of activities, basedaround manufacturing, for example. If there are 20manufacturing plants you do not see these scat-tered across 20 different countries. They tend to bein a cluster in one location.

So the specialisation process is intensifying, andwe find that even a small economic region canbecome a world player. But this cannot be donewith one firm; you need the cluster – the criticalmass – that gives the externalities and efficiencygains. It is much more efficient for components,machines and backup services to be all in the samelocation.

We now see the outsourcing of more productsthat used to be bundled into the vertically inte-grated firm. I was just at a Board meeting thismorning of a company that is the world leader incomputer-aided design software. Here we are justbeginning to see some outsourcing of developmentactivities rather than manufacturing. We estimatethat only about 30% of the development work canbe outsourced, but even that is a big change fromzero. So instead of having all the R&D people in thedesign cluster we are also going to have designsupport clusters based elsewhere, maybe in India orChina for example.

So we are witnessing an increasing subdividingand specialisation of clusters. Instead of havingthree or four significant clusters in the world wenow have 10 or more. There is an inexorableprocess whereby economic efficiency and produc-tivity rules. The more trade barriers there are in the

world the more other factors rule rather thanproductivity – factors such as the size of the localmarket, military issues and political ties. Becauseproductivity now rules, we see more specialisationand more clusters.

Geography and clusters

In your work on economic development you havehighlighted the importance of ‘clusters’ and externaleconomies (Porter, 1990, 1998). In economics, severaleconomists have recently began to emphasise theneglected role of geography. For example, the work ofPaul Krugman and Jeffrey Sachs has been very importantin this revival of interest (Krugman, 1997; Sachs, 2003;Snowdon, 2005). To what extent is there a link betweenyour research on economic development and this line ofresearch in economics?

Paul Krugman visited our group here at Harvard inthe second half of the 1980s, and I gave him amanuscript copy of The Competitive Advantage ofNations. He was quite intrigued with it, and I thinkit did have some influence on his thinking withrespect to introducing a geographical dimension totrade theory. Of course, Jeffrey Sachs and I havealready worked very closely together on thepreparation of the Global Competitiveness Report(Porter et al., 2000a, 2001). You are right in sayingthat there is a growing awareness of the influence ofvarious dimensions of geography on the workgoing on in economics (e.g., Yang, 2003).

The other area that is undergoing a revitalisationis regional science. There is a long tradition to thisperspective. For example, there is a beautifulchapter in Alfred Marshall’s Principles of Economicsabout the importance of geography in the compe-titive process (Marshall, 1890). But this kind ofthinking was later squeezed out by the neoclassicaltradition that has dominated economics sinceMarshall. I hope that the new geographical per-spective can be reintegrated into mainstreameconomics.

In my work I try to bring some new focus to thiswork by emphasising the microdimensions tocompetitiveness. I think that this view has becomewidely accepted. Most practitioners working in thefield of economic development now recognise thatthe big missing link was the microeconomic andbusiness side of the equation. Getting the contextright is only part of the story. The microeconomicperspective involves focusing on how the qualityof the business environment influences competiti-veness.

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Where does the idea of clusters fit into this story?

The idea of clusters is a derivative of the diamondtheory, and refers to geographically concentratedgroups of interconnected firms and associatedinstitutions in a similar field. If you believe thatthe four elements of the diamond theory areimportant, then you would expect to observeclusters, because they represent an efficient pro-ductive structure within which firms can operate.

I think there is now widespread acceptance of thewhole notion of cluster-based development, andrecent research has placed increasing emphasis onthe importance of clustering as an important driverof innovation and competitiveness. As we speakthere are literally thousands of cluster initiativesaround the world. In the US we have numerousexamples, which include microelectronics andbiotechnology in Silicon Valley, the auto industryin Detroit, financial services in New York, theaircraft industry in Seattle, and the Hollywoodentertainment cluster (Porter, 2003).

The real challenge that we now face in theeconomic development field is not so much at theconceptual level, but rather is the challenge ofprocess. By that I mean the following: How can weactually organise societies and communities inorder to create change? We have a good idea ofwhat policy levers to put in place, but it’s actuallygetting the job done that is the problem. Thisproblem has to be confronted in democracies whereyou have multiple levels of government and whereyou have a decentralised private sector.

Clusters influence competitiveness in severalways. The geographical concentration of firmsallows more efficient access to specialised suppliers,information and the workforce. Opportunities forinnovation are easier to perceive within clusters.Take the case of the Boston Life Sciences cluster. Inthe Boston area the presence of world-class researchuniversities such as Harvard and MIT, teachinghospitals and biotech companies provides anexcellent environment, conducive to the rapiddevelopment of new ideas.

Clusters also reduce barriers to entry, given thatnew firms have access to an established pool ofresources. A major challenge for any economy is toupgrade the sophistication of its clusters towardsmore advanced high-value activities.

The role of government

You have argued against economic strategies that relytoo heavy on government involvement. But the Asian

tigers – Singapore, Taiwan and South Korea – as well asJapan employed economic development strategies invol-ving significant government interference. However, in thecase of Japan you argue that Japanese governmentintervention is the cause of failure, not success (Porterand Takeuchi, 1999). The new World Bank position onthe role of government argues for a ‘significant butfocused role’ for government (World Bank, 1997). Wheredo you stand on this issue?

Governments have a crucial role to play in estab-lishing macroeconomic stability and providingstable political, legal and social institutions. How-ever, given these prerequisites for prosperity, wethen need to look to the microeconomic level, to thesophistication of firms and the quality of theirmicroeconomic environment. Governments shouldact as a catalyst, helping companies to improve theircompetitive position. With respect to East Asiandevelopment, the country that I know best is Japan,and my co-authored book Can Japan Compete? (Porteret al., 2000b) really grew out of the Competitiveness ofNations work. Even back in the 1980s I was scepticalabout the Chalmers Johnson industrial policy per-spective of Japan’s success (Johnson, 1982), where thegovernment is regarded as having played a key rolein forging Japan’s economic miracle.

Popular explanations of Japan’s recent economic pro-blems have tended to focus on the collapse of the bubbleeconomy, over-regulation, and the mismanagement ofmacroeconomic policy (e.g., Hoshi and Kashyap, 2004).You argue that the problems run much deeper.

Yes, I developed a different view by coming to thisissue from a more microeconomic perspective.Macroeconomic issues are important, but they donot tell the whole story. The problem is deepseated, and rooted in microeconomic inefficiencieslinked to distortions to the competitive process.

My recent paper on Japan, co-authored withMariko Sakakibara, puts our book on Japan intothe context of the broader literature (Porter andSakakibara, 2004; see also Porter and Sakakibara,2001). The research on Japan was striking because itproved beyond a shadow of a doubt that theaccepted wisdom – that it was government policythat was mainly responsible for Japan’s competi-tiveness – was deeply flawed in almost everydimension. That is not to say that the Japanesegovernment did not do some useful things. Butthey certainly did not do the useful things thatwere being articulated as being representative of thesuccessful industrial policy model of Japan. We

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found that industries where those practices wereprevalent were the ones that were basically failures.In those industries where government policies ledto the restriction of competition we find a lack ofinternational success. The successful Japanese indus-tries turn out to be those where internal competitionis robust. So the Japanese did not find a new, moresuccessful form of capitalism. Our research confirmsthe positive association between vigorous competi-tion and rising productivity and economic success.

There is more debate about South Korea, Taiwanand some of the other East Asian countries. In thosecountries, in many cases, the government wasplaying a fairly aggressive role in directing econom-ic activity.8 But in both South Korea and Taiwanthere were also very powerful micro, diamond-typefactors that were also at work. In my view it wasthese factors, rather than government direction,that played the dominant role in their success.

Let us take the case of South Korea. One of thecentral core concepts in The Competitiveness ofNations and subsequent work is the fundamentalimportance of local rivalry: that is, the need to havemultiple competitors co-located fighting head tohead locally. In South Korea in almost all theimportant industries we had the chaebol, and eachchaebol had a representation in every major indus-try. The same kind of thing happened in Japan. Yes,the Korean government had a role in the overallstory, and tried to do a lot of what it considered tobe useful intervention in the economy. But in eacharea of intervention there was also intense compe-tition, which, in my view, was a far more importantstimulus to economic success.

Given my faith in competition I am a strongbeliever in the need for governments to providestrong anti-trust enforcement with the objective ofenhancing the productivity growth of firms.

The Global Competitiveness Report

For several years now you have been involved with theproduction of the Global Competitiveness Report, whichprovides an annual ranking of nations according to their‘competitiveness’ (Porter et al., 2004, 2005). The reportmakes use of two measures, the Business CompetitivenessIndex and the Growth Competitiveness Index. What is therationale behind these two indicators?

The first indicator, the Business CompetitivenessIndex, is logically prior to the second, and focuseson the current level of sustained productivity thatcan be achieved.9 The Business CompetitivenessIndex, which we used to call the Microeconomic

Competitiveness Index, captures the determinantsof the level of GDP per capita and hence a country’sstandard of living. In this case, you need to haveinformation about the broad set of factors thatinfluence the productive potential of an economy,such as the sophistication of company operationsand strategy, and the quality of the microeconomicenvironment.

The second indicator, the Growth Competitive-ness Index developed by Jeffrey Sachs and JohnMcArthur, tries to capture the dynamism of aneconomy (Porter et al., 2000a, 2001; Blanke andLopez-Claros, 2004). We want to know whether aparticular country has in place the conditions andrequirements that will allow it to move rapidly upthe international competitiveness rankings. Sogrowth competitiveness focuses on factors such asinvestment rates and rates of technological change,both of which respond positively to the stability ofthe macroeconomic environment and the qualityof public institutions.

It is my assertion that you need to look at bothindices, although there is a lot of pressure to rollthese two concepts together to produce a singleindex. Although both indices are highly correlated,there are many productive and prosperous coun-tries that lack dynamism and vice versa. In the2003–2004 Report Chad, Haiti and Angola comeout as the three lowest-ranked countries in both theBCI and GCI. Finland, the US, Sweden and Den-mark come out in the first four positions in boththe BCI and GCI. However, there are countries thatare ranked higher by the GCI than the BCI,including Taiwan, Portugal and Botswana. Thereare also countries that are ranked higher by the BCIthan the GCI, for example France, Germany, Italyand the UK. So if you have a two-by-two matrixthere will be countries in every cell. So I think thatcombining these two measures would suppressuseful information. I am now working on thisproblem with Xavier Sala-i-Martin of ColumbiaUniversity. In fact, there is a conference tomorrowmorning on this very issue. Xavier is thinkingabout how to combine these two indices, whereas Ifavour retaining them as separate but complemen-tary measures of competitiveness (Sala-i-Martin andArtadi, 2004; Snowdon, 2006).

What are the major changes that appear to be taking

place in the global ranking of ‘competitiveness?

Since I have been involved with the GlobalCompetitiveness Report we have seen the increasing

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success of Scandinavian countries – Sweden, Den-mark and Finland – and the stagnation of Japan.Finland is ranked first in both the Growth Compe-titiveness Index and the Business CompetitivenessIndex. On the innovation side we are beginning tosee many more countries that have developed thecapacity for innovation, while the US has recentlyexperienced a slowdown of innovation rates. TheEast Asian economies, in particular South Korea,Singapore and Taiwan, continue to do well, whereasin Latin America economic performance has beenextremely disappointing with the exception of ElSalvador and Chile. In the Middle East Jordan, andto a lesser extent Turkey, has shown dramaticimprovement in the quality of public institutions.In sub-Saharan Africa, with the exception ofBotswana, there is very little progress. Botswanaenjoys the highest ranking in sub-Saharan Africa forthe quality of its public institutions and macro-economic environment, although it lags behindSouth Africa in technology. We are beginning tosee some encouraging progress in some of theformer Soviet Union transition economies, particu-larly in the Baltic states. Again, this in part reflectsthe importance of their geographical location.It is much easier for them to integrate withnearby European Union economies than withthe economies that are located much further east.For example, it is increasing integration withFinland and Sweden that is driving Estonia’seconomy.

Is it an interest in the actual ranking of countries and

changes in those league tables that attracts your

involvement with this research?

The main reason why I am involved with the GlobalCompetitiveness Report is not so much that I aminterested in the actual rankings of countries;rather, I am interested in the data. If you acceptthe micro view of competitiveness that I advocate,then you very quickly come to understand thatthere are many dimensions of the environment of acountry that affect competitiveness. There are notone or two but hundreds of important factors. Theschools matter, macroeconomic and political stabi-lity matters, clusters matter, and so on. For many ofthose factors it is almost inconceivable that you canget rigorous and consistent international data.During the Competitiveness of Nations body ofresearch, except for some work we did with tradestatistics we could never do any empirical testing.Instead we looked at massive numbers of in-depth

case studies of countries, regions and clusters. It wasfrom these studies that the theoretical frameworkevolved. What the Global Competitiveness Reportdata have allowed us to do is to begin seriousstatistical analysis, for example on demand condi-tions. A lot of people argue that local demandconditions are irrelevant in a global economybecause countries have access to the global market.In the dynamic cluster-based view of economicdevelopment the local market remains important,and we need data to confirm this view. We alsoneed additional country data so that we can do abetter job of benchmarking and comparing countryperformance.

Global economic leadership and the USeconomy10

The United States has been the dominant economy in theworld throughout the 20th century. Towards the end ofthe 1980s many commentators were pronouncing thedemise of the US economy relative to the performance ofJapan and the European Union. For example, LesterThurow of MIT wrote Head to Head (Thurow, 1992),where he presented a very pessimistic scenario withrespect to US economic performance compared withJapan and the European Union. This has to go down inpublishing terms as very bad timing, because during the1990s the Japanese economy stagnated while severalmajor European economies, in particular France, Ger-many and Italy, experienced high unemployment andvery disappointing growth performance. In contrast, afterrecovering from the 1991 recession, US economicperformance for a decade was spectacular, with RobertGordon even referring to the US economy as the‘Goldilocks’ economy (Gordon, 1998).

In a recent paper Nick Crafts of the London School ofEconomics argues that the major European economiesare no longer catching up with the United States (Crafts,2004). Do you think that the US can maintain itsposition as the dominant world economy throughout thetwenty-first century given the well-documented rise ofcountries such as China and India?

I think that the US is likely to sustain its position asthe single leading economy for quite some time tocome. I think that Japan has had a severe setback,although there are unmistakable signs that it is nowrecovering. There is no question that China is on avery robust path, with spectacular rates of economicgrowth, although we must remember that it is stillbuilding up from a very low level (Tseng and Cowen,2005). When we look at patenting per capita in

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China it is still only something like 0.2 patents permillion people, whereas in the US it is something like300 or 400 per million. China’s biggest wild card is itspolitical future, which remains problematic. Also,many of the investments currently being made arenot likely to earn a good return, as many of themhave been based on faith in China’s large andgrowing internal market.

India is a more difficult case, because its politicalstructure and system are more complex in terms ofpolicies. India’s economy is still riddled withdistortions and inefficiencies, although they havemade considerable progress since the reform pro-gramme began.11

But, taking all things into consideration, I still seethe US as a very dynamic and innovative economy.The big strength of the US is its resilience and itsability to deal with problems. When some problemarises in the US, once it is perceived as a problem, itis dealt with. The ‘savings and loans crisis’ is a goodexample of this, when restructuring and write-offssoon had the industry on its feet again. Thecontrast here with Japan is striking, where delayand indecision characterise their approach to acrisis in the hope that it will somehow go away.

What are the main challenges facing the US economy?

The big problem facing the US is the humanresource situation. At the university and scienceand technology level things are great, even if the USinevitably will be less dominant in the future giventhe catch-up effect. The US has a tremendousinfrastructure and talent at this level (Porter et al.,2002). The US population is also very computerliterate. However, the average worker is not neces-sarily much better than the average worker in Indiaor China.

Looking to the future, the US is not graduatingenough engineers, and there are not enough newpeople going into science and technology. Duringthe last 10 years there has been a massive effort toimprove the public schools system. Unthinkablerevolutionary things have begun to happen. Forexample, in Massachusetts, the most liberal state,every kid has to pass a test to get out of high school.In the old days no competency was required. It wasa case of ‘You have been here long enough, off yougo’ (laughter).

But to deal effectively with this problem will takenot a couple of years, but decades. The level oftechnological dominance enjoyed by the US hasallowed us to paper over this issue, but in an

increasingly competitive and globalised world, thisproblem will be increasingly exposed in terms ofreduced competitiveness. I attended a board meet-ing this morning of a big manufacturing companythat produces very sophisticated software packagesfor the oil industry, allowing them to makecomplicated designs that can be electronicallytested. There is a specific test that can be taken tomeasure your competence as an engineer in usingthis technology, and one of the directors commen-ted that his Houston engineers were scoring around25, whereas the engineers located in Bangalorewere scoring around 90! That is worrisome. Now ofcourse those Bangalore engineers are only a tinyfraction of India’s workforce, but with a populationof one billion that will still amount to a lot ofpeople.

The US has also got itself into a tangle ondiversity, and the proliferation of lawsuits, not tomention geopolitical issues such as the war onterrorism. But on balance, taking everything intoconsideration, I think that the US is going toremain quite competitive and dynamic for theforeseeable future.

Earlier this year Greg Mankiw was heavily criticised forarguing that outsourcing was probably a plus for the USeconomy in the long run.12 His comments provoked anoutburst of criticism, from both Democrats and Repub-licans, concerned about the number of jobs lost since thePresident took office. Do you agree with Mankiw on theimpact of outsourcing?

There are two types of outsourcing: one that reflectstrue economic efficiencies and another that reflectsfailures and flaws in the US economy. For example,we have a mediocre education system. There are nomore engineering graduates today than there were5 years ago, despite the increasing technologicalintensity of the US economy. So we are losing somejobs because we do not have an adequate supply ofhighly skilled people in the right areas. Therefore,we have to make sure that the outsourcing isgenerating efficiency rather than reflecting failuresand distortions that have been generated withinthe US.13

How would you assess recent European economicperformance?

European economic performance has been a bigdisappointment, with a few exceptions, mainly onthe fringes.

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Do you include the UK as one of your exceptions?

Yes, I believe that the UK has had a remarkableturnaround, although there is a question abouthow to sustain the progress (Porter and Ketels,2003). I think there is a dynamism and a will-ingness to try new things that makes Britain arefreshing place to visit. In fact all the dynamismseems to be located on the periphery – in theScandinavian countries, the UK and several of theaccession countries. There seems to be a lot moregoing on in the UK than in the other majoreconomies of Europe such as Germany and France,which are in a mess. But the UK now faces thechallenge of transforming itself into an economythat produces high-value products and services.The evidence indicates that UK companies are notallocating sufficient resources to innovation andmodern managerial practices. In the study thatChristian Ketels and I did for the DTI we identifiedsix priority areas that we considered crucial for theenhancement of UK competitiveness. These were:increased public investment, including education,transport infrastructure and building up scientificand technological capacity; improvements in com-petition policy; cluster development; a strengthen-ing of the regional focus of policy; the developmentof new institutions that facilitate private sector leddevelopment; and a redirection of company strate-gies towards an emphasis on innovation and thedevelopment and production of high-value goodsand services. The recent success of the UK has hadmuch to do with the introduction of market-basedreforms during the past 25 years. The UK now needsa new approach that will upgrade its competitive-ness based on innovation.

Culture and economic performance

You have a recent interesting paper on the impact ofculture entitled ‘Attitudes, Values, Beliefs and theMicroeconomics of Prosperity’ (Porter, 2000). The impactof culture on economic performance and businesspractices has always provoked great controversy (e.g.,Temin, 1997). What role does culture play in thedetermination of economic progress?

I think that economic culture is very heavilyderived from the incentives and reality that peopleface. For example, the Japanese are legendary forbeing very energy efficient. But that behaviour hasmore to do with the pricing signals and strictenergy efficiency standards that the Japanese facethan it has to do with Japanese culture. In other

words, culture reflects context. I am therefore fairlyoptimistic that culture can be changed, because it isnot inherent but learned, and because culturederives from what is rewarded in society. Therefore,changing the rules will lead to a change in culture. Ifyou live in a society where rent-seeking behaviour isrewarded, then you will inevitably see such beha-viour becoming widespread (Baumol, 2002). But thisdoes not mean that the population of this countryare inherently unproductive because of culture.

Going back to the case of China, it seems clear that theirmove from being an increasingly productive society tobecoming an increasingly innovative society will involve asignificant cultural leap.

Yes, but you could say the same thing about Japan. Iactually did a video conference yesterday withBeijing University. They are one of the affiliatesthat teaches my competitiveness course. I was veryimpressed with the questions that the students raised,so it is clear that China has immense potential.

The role of ‘business intellectuals’

You are widely recognised as one of the world’s leading‘business intellectuals’ in rankings that include bothacademics and practitioners. It is also clear that you careabout how people think and how they behave. Isinfluencing thinking the most important role that‘business intellectuals’ can fulfil?

I firmly believe that my fundamental role is tocreate ideas and to change the way that peoplethink. My fundamental goal is to change theframework – to change the perspective of the waythat people look at a problem. Most things in lifeare driven by ideas. In my case I am not writing andaddressing my work primarily to the academiccommunity and literature. I see my main role asaiming to change practice, whether it be thepractice of government officials setting economicpolicy or that of business leaders setting companystrategy. This is deeply embedded in me after beinghere at Harvard Business School for so many years. Ialways felt that I had to engage in practice.

How does this philosophy work out?

Usually the way it works is that I will do somethinking and some research, then I will go and try itout in a real company or a city, region or country.It’s a kind of iterative process. I try and use anyideas that I develop. That is very important to me. Ialso want to speak to my fellow academics and

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shape the way they write and think, becausecommunication with other scholars is a very impor-tant way of disseminating ideas. But the biggest testof my work always comes when I ask myself thequestion ‘Does this idea really connect and resonatewhen we confront actual practice?’ Here at HarvardBusiness School we are encouraged and rewarded fortaking this approach, whereas at many other busi-ness schools the natural focus is on publishingpapers primarily for the academic community.Having said all this, I have written many such papersmyself, and indeed I am back writing articles foreconomics journals as I did at the start of my career. Ihave three or four in the pipeline, and I love doingthat work. Some of my best days are those when Ifeel that I have completed some work that scholarswill value. But in order to achieve that, particularlygiven the way that I attack problems, I feel that therehas to be a connection with actual practice.

Is this vision shared by your colleagues?

It is often very difficult to persuade youngermembers of the Faculty that it is changing theworld that is important rather than just commu-nicating with fellow academics with scholarlyarticles. There is a tremendous pressure in USacademia to publish scholarly papers, and usuallyit is quite difficult to break away from the existingstructure of that literature and develop ideas thatare orthogonal to the mainstream. This makes itmore difficult to achieve true innovation.

What is your secret for developing innovative ideas?

I think real innovation in ideas requires thebridging of different disciplines. I see my work asintegrative. This is what I was trying to do with myearly work on strategy and competitiveness. Peopleon the strategy side thought I had landed fromMars, and even economists thought my work was alittle Martian (laughter). It is important thatuniversities create the right structure and environ-ment to facilitate innovative thinking. Here atHarvard we have tried really hard to encourageinnovative thinking, and we are very proud of whathas been achieved during the last 25 years. We havesome outstanding scholars here now, such as RobertMerton, whereas before the 1980s Harvard BusinessSchool was associated with the case study approach.14

Notes1Michael Porter is the Bishop Lawrence University

Professor at Harvard Business School.

2Detailed information relating to Professor Porter’sresearch, publications, and the activities of theInstitute for Strategy and Competitiveness, can befound at www.isc.hbs.edu.

3For a discussion of the World Economic Forum’sGlobal Competitiveness Index see Snowdon (2006).Snowdon and Vane (2005) provide an extensivesurvey of modern growth theory.

4We interviewed Professor Porter in his office at theInstitute for Strategy and Competitiveness, HarvardBusiness School, on 27 May 2004.

5Paul Krugman, one of the world’s leading interna-tional trade theorists, has also been prominent indrawing attention to this confusion. See Krugman(1993, 1994, 1996).

6The ‘diamond’ concept (Porter, 1990, Chapter 3)refers to the determinants of national competitiveadvantage of industries, or industry segments, andincludes the impact of: (1) demand conditions; (2)firm strategy, structure and rivalry; (3) factor condi-tions; and (4) the presence of related and supportingindustries. A ‘cluster’ is defined by Porter as a‘geographically concentrated group of interconnectedfirms and associated institutions in a similar field’.

7On the importance for economic growth of macro-economic stability see Taylor (1996). On the importanceof institutions see Snowdon and Vane (2002), Rodrik(2003) and Acemoglu and Johnson (2005).

8For a recent discussion of industrial policy in EastAsia see Hernandez (2004).

9For the most recent analysis of ‘business competi-tiveness’ see Porter (2005).

10Economic leadership is defined by productivityperformance. See Nelson and Wright (1992) andKrugman (2000).

11For a discussion of the impact of India’s re-forms on economic performance, see Panagariya(2004).

12Gregory N. Mankiw is Professor of Economics atHarvard University, and from 2003 to 2005 wasChairman of the US President’s Council of EconomicAdvisors. In a White House statement on 9 February2004 Mankiw commented that: ‘Free trade is good forAmerica. The truth is when a good or service isproduced at lower cost in another country, it makessense to import it rather than to produce it domes-tically’.

13For an excellent assessment of the economicimpact of outsourcing on the US and other developedeconomies see Bhagwati et al. (2005).

14In 1997 Robert Merton was awarded the NobelPrize in Economics for developing a new method todetermine the value of financial derivatives.

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About the authorsBrian Snowdon is Principal Lecturer in Economicsat Newcastle Business School, Northumbria Uni-versity, Newcastle Upon Tyne, UK. His mainresearch interests are in the areas of macroeco-nomics and international growth and develop-ment. As well as numerous articles in academicjournals, he has authored/co-authored 10 books inthe area of economics including: Conversations with

Leading Economists: Interpreting Modern Macroeco-nomics (Edward Elgar, 1999); Conversations onGrowth, Stability and Trade (Edward Elgar, 2002);An Encyclopaedia of Macroeconomics (Edward Elgar,2002). His most recent book, Modern Macroeco-nomics: Its Origins, Development and Current State,was published by Edward Elgar in March, 2005.

George Stonehouse is Professor of Strategic Man-agement and Associate Dean of Newcastle BusinessSchool, Northumbria University, Newcastle UponTyne, UK. He is Honorary Professor of the StateUniversity of Management, Moscow, Russia andVisiting Professor at the University of InternationalBusiness and Economics, Beijing, People’s Republicof China. He researches in the areas of strategy,knowledge, creativity and learning in an inter-national context, and has authored/co-authoredthree books and numerous articles in these areas.He is actively engaged in consultancy and trainingwith a number of leading organizations.

Accepted by Nicolai Juul Foss, Departmental Editor.

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