INDUSTRIAL STRATEGYAND BUSINESS PLANNINGIN IRELAND

John Bradley

The Economic and Social Research Institute4 Burlington Road, Dublin 4, Ireland

tel: ++-353-1-667 1525fax: ++-353-1-668 6231email: john.bradley@esri.ieweb: www.esri.ie

October 30th, 2001

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ABSTRACT

Methodological approaches to designing and implementing industrial policy in small openeconomies are examined and some of the very different insights offered by economic andbusiness research perspectives are compared and contrasted. Within the economicperspective, attention is drawn to some of the major advances made over the past twodecades in trade, growth and spatial economic theory, and to their implications for industrialpolicy-making. Examination of the business research perspective draws on a recent attemptby Kotler, et al, 1997 to apply the logic and methodology of business strategy to national-level industrial planning.

It is suggested that a useful way of linking the economic and business perspectives onindustrial policy is by means of three systematizing frameworks. In the chronological orderof their development, these are: Raymond Vernon’s product life cycle-based explanation ofinternational trade and foreign direct investment; Michael Porter’s diamond of competitiveadvantage; and Michael Best’s capabilities and innovation triad. These systematizingframeworks have been very influential in international industrial policy thinking over the lastfour decades in large and small countries and regions, and are especially useful in explainingthe evolution of industrial strategy in the island of Ireland.

Vernon’s simple PLC framework, although apparently superceded by the moresophisticated frameworks of Porter’s diamond and Best’s triad, continues to be relevantand to offer many useful insights into the later frameworks when they have been used toguide the design of industrial strategy in small open developing economies.

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Table of contents

ABSTRACT 2

[1] INTRODUCTION 4

[2] TRADE AND INDUSTRIAL POLICY: ECONOMIC PERSPECTIVE 7

[3] TRADE AND INDUSTRIAL POLICY: BUSINESS STRATEGY PERSPECTIVE 10

3.1 National strategic vision 11

3.2 National strategic postures 14

3.3 National strategic implementation 17

3.4 Summary 18

[4] THREE INFLUENTIAL INDUSTRIAL POLICY FRAMEWORKS 20

[4.1] Vernon’s product life cycle framework 20

[4.2] Porter’s diamond of competitiveness framework 23

[4.3] Best’s capability triad 27

[4.4] Summary on industrial strategy frameworks 30

[5] CONCLUSIONS 32

REFERENCES 34

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[1] Introduction

The original motivation for this paper arose from the experience of carrying out research inNorthern Ireland and in Central and Eastern Europe. In Northern Ireland, the challenge facingindustrial policy makers is to design and implement policies that will produce a faster growthrate than in the rest of the UK, thus promoting convergence. A major constraint is the verylimited range of significant policy instruments, since the region is fully integrated into the UKfiscal and monetary union. In Central and Eastern Europe the challenge is quite different: howto promote good industrial strategies at a time when many institutions and market mechanismsfall far short of the standard considered essential in the economies of the West. In both cases,additional perspectives broader than those of conventional economics appear to be needed toaddress the task of policy-making under extreme constraints (in regions like Northern Ireland)and policy-making under extreme disorganization and uncertainty (in Central and EasternEurope). In this paper we suggest that the perspective of business research can be a very usefulcomplement to economics.

If one attempts to combine the insights of economic and business research perspectives, onequickly becomes aware of the differences between them. Economic policy research, and inparticular trade and macroeconomic research, often tends to be directed at issues andchallenges that arise at the level of regions, nations or even groupings of nations such as theEU. Business policy research, on the other hand, tends to be focused on the performance ofindividual firms or groups of firms. This distinction was highlighted by Michael Porter in hisanalysis of the competitive advantage of nations, when he stressed the point that it is morehelpful to consider firms as competing in industries, not in nations (Porter, 1990, p.619 andp.682). This simple insight lies at the heart of the tensions that can arise between a mainlyregional/national-based perspective of much economic policy and a mainly firm-basedperspective of business researchers, particularly in matters concerning the design and executionof industrial policy.1

At the risk of over simplification, one might stylize economic theories as being useful for thestudy of how a “representative” firm is likely to behave when subjected to changes in the widerexternal policy environment. Business research frameworks, on the other hand, tend to beconcerned with the analysis of the consequences of management actions directed at improvingthe prospects of a “specific” firm within a given (usually fixed) external policy environment.Because of this very basic difference in the main emphasis of their disciplines, economic andbusiness researchers often tend to misunderstand, discount or ignore each other, and sometimesadopt quite dismissive attitudes towards each others’ methodologies.2

How do business researchers delineate their field of enquiry? At the beginning of mosttextbooks on strategic marketing (e.g., Dibb, et al, 1997, p. 1) there is usually an explanatorydiagram made up of three concentric circles, labeled broadly as follows,:

i. The outer business environment; 1 The distinction that we draw is overstated for the sake of emphasis. Nevertheless, it holds better in smallcountries, where the economic research agenda is often heavily influenced by trends in international monetaryand macro economics, and where the area of industrial organization tends to be neglected.2 For example, in a business school course on Global Business Strategies, after a brief review of internationaltrade theory, the conclusion was reached that: “It is little surprise therefore, that practicing managers gain littlefrom the predictions of classical theory. The reality of international business in the 1990s and beyond will befar removed from the 1700s and 1800s when the theory was born”!

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ii. The middle ground of business strategy;iii. The inner ground of business/marketing tactics;

The outer circle contains all the factors that serve to make up the strategic environment overwhich any individual firm has little or no control, and from which emerges the strategicopportunities and threats that face the firm as it operates in the marketplace. It contains all theeconomic and competitive forces that are the domain of the economic policy researcher, inaddition to the forces of technical progress, social forces, legal issues, environmentalprotection rules, and political forces (such as ideology). Business researchers dip into thesematters only when they need to, mainly as sources of opportunities and threats, but it is not theirmain domain of research activity. Economists talk of little else.

The middle circle of business strategy is the domain where much business-oriented research isfocused. Key issues include the determination of a company’s competitive advantage within agiven outer business environment. It also includes the selection of target markets and thepositioning of products and brands within the selected markets. Here, it is common forknowledge and research insights to be systematized into explanatory frameworks. Suchframeworks usually stop well short of being testable paradigms in any scientific sense, butoften take the form of taxonomies of useful and revealing facts and insights. Influentialexamples include Raymond Vernon’s PLC framework explaining the sequential nature of thedifferent stages of industrialization, trade and foreign direct investment (Vernon, 1966);Michael Porter’s diamond, which suggests how policy can be used to create competitiveadvantage even in situations where initial national factor and other endowments areunfavorable (Porter, 1990)3; and Michael Best’s capability and innovation perspective – theCapability Triad – which points to the need for synchronized advances on many fronts ifdynamic growth is to occur (Best, 2001). We return to these frameworks later in Section 4.

The inner circle is the environment of business tactics and encompasses all aspects of the so-called “marketing mix”. Here one has moved away from the wider role of public"environmental" policy and medium to long-term business strategy, and emphasis is placed onthe immediate actions of managers within individual firms (e.g., pricing policy, productdevelopment, promotion activities and distribution channels). There may be a public policyregulatory oversight of this inner business environment to ensure fair play and opencompetition, as well as some targeted aid directed at improving marketing skills of small ornewly formed firms. But actions within the inner environment are normally left to thediscretion of individual firms.

One might characterize a key challenge of industrial policy making in any small nation or regionas that of blending the techniques and insights of the predominantly economic analysis of theouter business environment with those of the business analysis of the middle ground of strategy.These two areas are often studied in isolation from each other by non-overlapping groups ofresearchers.4 When cross references are made between the two areas of research, each

3 Porter’s diamond of national competitive advantage built upon and extended his earlier “five-forces”framework of firm-based competitiveness (Porter, 1985).4 Economists can seldom bring themselves to acknowledge the existence of the contributions of, say, Vernonand Porter. However, only in his most recent work has Porter acknowledged the economic research on spatialissues and clustering by Krugman and others, and even then inadequately (Porter, 1998). Kay, 1991 is anattempt to synthesize.

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separate group often focuses on the inadequacies of the other’s methodology.5 Seldom are thetwo different perspectives looked at as being entirely complementary and mutually supportive.

This paper presents a review of some of the issues that arise from the economic and businessperspectives on industrial strategy and trade in small open economies, and is organized asfollows. Section 2 deals briefly with the economic perspective, drawing attention to some ofthe major advances made over the past two decades in trade theory, growth theory and spatialeconomics that have influenced economists’ attitudes to industrial policy. Section 3 turns to thebusiness research perspective and examines a recent attempt to apply the logic andmethodology of business strategy to national-level industrial planning (Kotler, et al, 1997). InSection 4 we suggest that a useful way of linking the economic and business perspectives onindustrial policy is by means of three systematizing frameworks: Raymond Vernon’s productlife cycle-based explanation of international trade and foreign direct investment; MichaelPorter’s diamond of competitive advantage; and Michael Best’s capabilities and innovationtriad. In Section 5 we draw some general conclusions and suggest that Vernon’s simple PLCframework, although apparently superceded by the more sophisticated frameworks of Porter’sdiamond and Best’s triad, continues to be relevant and to offer many useful insights into thelater frameworks when they have been used to guide the design of industrial strategy in smallopen developing economies.

5 Business researchers tend to disparage as irrelevant the older approaches to trade and growth theory and toignore the major advances that have been made in recent decades (refer footnote 2 previously). Economiststend to criticize the lack of formal testing of the validity of business frameworks (Kay, 1983).

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[2] Trade and industrial policy: economic perspective

A dominant view within economics is that all one has to do to promote faster growth orconvergence between the regions of any state or between grouping of states is to put in placeeconomic policies that facilitate the free movement of goods and factors of production (i.e.,labour and capital). Within the EU, for example, such a process has been going on since thesigning of the Treaty of Rome. Tariff barriers were removed in the original Common Marketinitiative in 1956. Next, non-tariff barriers such as border controls, restrictive publicprocurement rules and regulations, national technical regulations in the design of goods, etc.,were dismantled during the completion of the Single European Market between 1986 and 1992.In addition, almost all barriers to the free movement of workers (such as visa controls andrecognition of qualifications) and of capital (exchange controls, banking regulation, etc.) havebeen removed, and the adoption of a single currency – the euro – was intended to promoteincreased competition through reducing transactions costs, lowering interest rates andincreasing price transparency. If all these types of policies are implemented, then orthodoxeconomic theory suggests that factor incomes (wages as well as the returns on capital) will tendto converge to a common level across all regions. So, if all markets were competitive, anyinitial regional disparities would eventually vanish and there would be no need for specificinterventionist industrial policies.

The above is the stylized version of economics that tends to be believed by businessresearchers. A reading of much of the business research literature leaves one with a generalimpression that international trade theory stagnated in the late 1970s, and that the insights itgives into modern patterns of trade and foreign direct investment are irrelevant at best, andwrong-headed at worst. The implied irrelevance of other branches of economic theory – suchas growth theory and spatial economics – is presumably even greater, since these topics areseldom referred to at all in business research!

For example, four criticisms of trade theory were made in Porter (1990):

(a) Factor endowment deficiencies are treated as fixed, but it is clear that they are amenable toimprovement with suitable policies;

(b) Countries with similar or identical factor endowments can have deep trade links andexchange identical products, in apparent defiance of theoretical models;

(c) Classical trade theories assume constant returns to scale, identical technologies,homogeneous products and no factor mobility, all manifestly false in the real world;

(d) The focus is always at the national level, and ignores individual corporate strategies.

In the face of these criticisms, business researchers have tended to switch to alternativeframeworks in their search for a more plausible explanation of trade and FDI, such as Porter(1990) or a range of fairly eclectic theories based on market imperfections and networks(McKiernan, 1992, pp. 90-109). However, over the past two decades, three fields ofeconomic research have undergone radical transformation: trade theory (Helpman andKrugman, 1985), growth theory (Grossman and Helpman, 1991), and economic geography(Fujitsa, Krugman and Venables, 1999). The nature of the progress made has been summarizedas follows by Paul Romer:

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“In each of these areas, we have gone through a progression that starts with models based onperfect competition, moves to price-taking with external increasing returns, and finishes withexplicit models of imperfect competition”. (Romer, 1994, p. 19)

Far from being blissfully ignorant of the real world, and indifferent to the practical irrelevanceof their theories:

“Everyone knew that there was lots of intra-industry trade between developed nations and littletrade between North and South. Everyone knew that some developing countries grewspectacularly while others languished. Everyone knew that people do things that lead totechnological change. Everyone knew that the number of locally available goods was limited bythe extent of the market in the city where someone lives and works” (Romer, 1994, p.19)

One of the interesting consequences of the recent advances in the study of trade theory, growththeory and economic geography has been the suggestion that the conditions required forautomatic convergence to take place are increasingly seen as not holding in practice. Recenteconomic research has focused attention on the importance of such factors as the size of thepotential market, the initial level of physical infrastructure, levels of human capital, or on thefact that regions that start off at a structural disadvantage may never converge in any reasonabletime period. Such theories go as far as to suggest that the removal of barriers to trade andfactor movements may actually lead to a relative deterioration rather than an improvement ofsome regions (Krugman, 1991, pp.93-95). This is an area where significant theoreticaladvances have been made in spatial economics (Fujitsa, Krugman and Venables, 1999), a topicclosely linked to the concept of “clustering” that is at the centre of business frameworks due toPorter (1990 and 1998) and Best (1990 and 2001).

It is not our purpose to examine in detail the nature of the advances that have been made inthese new fields of economics or to discuss the technical problems that had to be solved beforea break could be made with the constant returns, perfect competition models of classical theory.We wish merely to draw attention to the fact that many recent advances in economic researchhave not yet been incorporated into the insights and analytical tools of business research. Asmore accessible accounts of the new research begin to percolate into business research, it willbe seen that economic theory is not quite as irrelevant as was thought by business researchers.

Evaluations of Ireland’s transformation during the past three decades have tended to bedominated by the economic perspective, drawing on recent theoretical advances.6 Forexample, five key factors are singled out in Frank Barry’s recent synthesis of the causes of Irishgrowth (Barry (ed.), 1999):

i. A steady build-up of human capital after the educational reforms in the 1960s;

ii. Major improvements in physical infrastructure, particularly since 1989 as a result of theEU Structural Funds;

iii. The extreme openness of the economy, export orientation to fast growing markets andproducts, together with benefits stemming from the completion of the Single EuropeanMarket and from massive foreign direct investment inflows;

6 An exception is the account given by Padraic White in MacSharry and White, 1999, which uses a businessperspective (see Bradley, 2001 for further details).

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iv. The changing demographic structure and the role of inward migration in preventing skillshortages; and

v. A stable domestic macroeconomic policy environment.

In terms of Irish industrial policy, there was a dramatic break with protectionist policies fromthe late 1950s, and much of the artificially sustained inefficient indigenous industry wassubsequently allowed to fail. A tax-based competitive environment was initially created thatwas particularly attractive to foreign direct investment, creating space for improvements in thelevel of domestic physical infrastructure and human capital. These policies, after a slow startin the 1960s and a series of policy blunders in the late 1970s, eventually proved to bespectacularly successful by the mid-1990s.

However logical and persuasive the economic perspective on Irish development experience is,it is worth asking how relevant it is to other small regions and states. Could the Irishconvergence process have been jump-started much earlier in the 1960s? Was the success of theCeltic Tiger the inevitable outcome of a series of mainly economic policy decisions? Howimportant and necessary was the degree of policy autonomy enjoyed by the Irish state? Howimportant were the uniquely close cultural and linguistic relationships with the US, the sourceof most of the FDI into Ireland? How did it come about that a small number of key industrialsectors played such a crucial role in modernization? How are these sectors likely to evolve inthe future? What of new sectors to replace those entering their stage of maturity or decline?Did the Irish economy exploit to the full the gains from EU membership, or did EU membershipforce transformation externally? These and related questions can be addressed to some extentfrom within the economic perspective, but can also be examined within a wider more eclecticperspective of business research, to which we now turn.

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[3] Trade and industrial policy: business strategy perspective

It is not at all obvious that national industrial policy issues can usefully be explored from abusiness research perspective. But a recent book set out to address this challenge (Kotler,Jatusripitak and Maesincee, 1997 – henceforth, Kotler et al). The basic methodologicalassumption of Kotler et al is stated succinctly as follows:

We wish to take the view that a nation can be thought of as running a business and, as such, canbenefit from adopting a strategic market management approach. (Kotler et all, p. ix).

Since Kotler et al’s template is that of strategic marketing management, it is clear that theapproach will be one of designing a process within which a wide range of techniques can beorganized and applied systematically. As with conventional business strategy, what isimportant is the organizing framework rather than the individual constituent components andtechniques, none of which are very novel or innovative in themselves.

There are two main reasons why the work of Kotler et al is of considerable interest to anyanalyst of business strategy who is also interested in aspects of wider economic policy design.First, the approach is novel, ambitious and intriguing, and illustrates the applicability of a widerange of business marketing strategy tools to a challenging new problem, namely promotinglong-term national welfare as distinct from the welfare of an individual firm. Second, theapproach provides another means of addressing the developmental challenges of small openeconomies like Ireland in a way that highlights some mainly organizational aspects that areglossed over – or simply ignored – in a purely economic-type analysis.7 Indeed, the small openeconomy in its relationship to the rest of the world economy has many similarities to therelationship of the individual firm to the industry within which it functions.

The approach adopted by Kotler et al follows standard strategy design. This has three mainelements:

i. First, the issues that arise in formulating a nation’s strategic vision. These includeinserting the nation into its appropriate competitive position in the global marketplace,applying SWOT-type analysis at a national level to access its capabilities, and settling onits strategic thrust, or how it can achieve its stated goals.

ii. Second, the range of appropriate strategic postures. This amounts to a business strategyview of a range of policy initiatives that are mainly economic in nature, e.g., approachesto investment (including R&D, equipment, infrastructure, education and training), spatialpolicies on clustering and concentration, trade policies, conventional macroeconomicpolicies, and institutional arrangements.

iii. Third, aspects of strategic implementation, which requires consideration of the abilities ofgovernment to execute strategic policy and to function in partnership with business; theneed to be aware of trade-offs between different national goals; and the need to ensure co-operation in the international arena.

7 For example, the economic perspective to industrial policy tends to ignore the role of Social Partnership as afacilitator of economic change, matters that are central to modern business research in OrganizationalBehaviour and Operations Management (O’Donnell and Teague, 2000).

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3.1 National strategic vision

Strategic groups and global competition

An important reason why groups of nations tend to adopt similar industrial strategies arisesfrom basic similarities in their size and their stages of development. Ireland belongs to a groupof smaller industrialized nations, in particular the smaller EU member states, whose maincharacteristic is that their domestic markets are too small to permit a competitive strategybased on scale economies and cost reductions other than in highly selective niche sectors.Kotler et al characterize their strategic dilemma as “the small-country squeeze”, illustrated inFigure 3.1 below, where:

i. They are subject to fierce competition in simple products based on mature technologiesfrom the newly industrialized countries (NICS) of Asia (area A of Figure 3.1).

ii. Their indigenous manufacturing is effectively excluded from markets for complexproducts, based on new technologies, where the “superpowers” are dominant (area C ofFigure 3.1).8 Area C is itself increasing as traditional sectors (Benetton in textiles andclothing) themselves adopt new technologies.

iii. Area B of Figure 3.1 – the natural domain of smaller industrialized nations - is thereforebeing squeezed in both directions. Only when their industries are dominated by foreignmulti-national enterprises are they likely to be capable of sustaining global competition.These sectors in Ireland – computers, software and pharmaceuticals – are almost allforeign owned.

Figure 3.1: The small-country squeeze

Source: Kotler et al, 1997

A crucial choice for small nations is whether to encourage specialization in areas where theyalready have a comparative advantage (obtained either through low cost production capabilityarising from scale economies or through experience curve benefits), or to develop strengths in a

8 Countries like Finland (Nokia), the Netherlands (Philips) and Switzerland (Nestle) can sustain world classmulti-national enterprises, but these tend to be exceptions in the context of most small countries.

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new area where the potential benefits may be greater. Kotler et al distinguish four types ofstrategic thrust , and these are shown in Figure 3.2.

Figure 3.2: Strategic thrusts of nations

Source: Kotler et al, 1997, page 164

Policy strategists in Ireland, in view of its very late industrial development, choose to build acapability based on new technologies, and so the strategic thrust falls naturally into the“building” box of Figure 3.2. The “building” strategic thrust is appropriate for nations thathave a relatively low level of wealth but possess, or can develop, strong internationalcompetitiveness. The strategic goal is to move up the ladder of relative income per head. Fora small nation like the Ireland, with wage levels that were initially low relative to the USA andthe wealthier European nations, but high relative to those of the less developed regions in Asia,South America and North Africa, the strategy needed the following features:

i. Competitiveness based on high productivity and quality rather than just on low wagecosts;

ii. Creation of a niche in the global total value chain, assisted by trade liberalization,improvements in human capital and physical infrastructure, and direct incentives toencourage inward investment;

iii. A strategy of continual improvement in quality and towards ever higher value-addedactivities.

National strengths and weaknesses

The central purpose of a SWOT analysis is to “identify strategies that align with, fit or match acompany’s resources and capabilities to the demands of the environment in which the companyoperates” (Hill and Jones, 2001, p.8). Kotler et al adapt the technique for application tonational capabilities, and identify five main categories:

i. Culture, attitudes and values; ii. Degree of social cohesion;

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iii. Factor endowments; iv. Industrial organization; v. Government leadership.

The degree to which a nation can either develop its own domestic capabilities intomanufacturing strengths, or can link its domestic capabilities synergistically to those of othernations, will determine its path of development and success. But a problem with thisclassification is that four of the five categories are qualitative and vague, and only one – factorendowments – can be rigorously quantified. In the economic research literature, attempts havebeen made to quantify the extent to which “soft” factors contribute to national capabilities,measured in terms of productivity. For example, Hall and Jones (1999) test the hypothesis that:“differences in capital accumulation, productivity, and therefore output per worker arefundamentally related to differences in social infrastructure across countries”. By socialinfrastructure they mean: “the institutions and government policies that determine the economicenvironment within which individuals accumulate skills, and firms accumulate capital andproduce output” (Hall and Jones, 1999, p.84).9 Differences in the amount and quality of factorendowments were found only to partially explain productivity differences between nations.The bulk of productivity variation is explained by differences in social infrastructure.

In the absence of a formal approach to national capabilities, the approach of Kotler et al can atbest only be suggestive of insights into why adopting any approach to building nationalcompetitive advantage works better in some countries than in others. For example, the samenational cultural attitudes and values that were commonly used to explain Japanese capabilitiesduring the 1970s and 1980s have been used to explain the Japanese failures of the 1990s:

There are those who question whether Japan can prosper in the turn-of-the-century economy as itdid in the less open, less technologically intensive environment of the 1960s, 70s, and 80s. Manyof Japan’s strengths have become weaknesses, Its deeply ingrained social and cultural normsseem inconsistent with the innovation, entrepreneurship, and risk taking that are the hallmarks oftoday’s competition (Porter, Takeuchi and Sakakibara, 2000, p.181).

National opportunities and threats

Kotler et al define an opportunity as: “an arena in which a nation can create or obtainadditional wealth” (p.143). Threats, by contrast, are: “challenges posed by unfavorable trendsor developments economically, politically, or socially that would lead, in the absence of thenation’s defensive action, to a deterioration in wealth” (p.144). Here the analogy withmarketing strategy tends to become somewhat forced, at least in the case of large economies.

Kotler et al set out a taxonomy of opportunities and threats that are derived from global forcesand trends. These include:

i. global interdependence; ii. the rise of supranational economic blocs; iii. the increasing power of multi-national enterprises; iv. rapid advances in technology; v. environmental concerns.

9 Social infrastructure is measured using the following proxies: an index of government anti-diversion policies(constructed from measures of law and order, bureaucratic quality, corruption, risk of expropriation andrepudiation of contracts) and a measure of openness to international trade (Hall and Jones, 1999, pp.96-99).

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But of course, large nation states can also seek opportunities, and face threats, from internaldevelopments within their own domestic economies. Only in small and micro nations likeIreland and Singapore is the global economy completely dominant, and is the health of thedomestic (or internal) market almost completely driven by external trade. In the case ofIreland, the early dismantling of tariff barriers ensured that the economy would be forced toadjust rapidly to a more open world trading environment. The rise of the EU (which Irelandjoined in 1973) was both an opportunity (in that it gave automatic access to the huge EUmarket) and a threat (in that there was a risk that Irish manufacturing would find it difficult tocompete in the new open market). But the opportunity was realized (mainly through attracting ahigh level of export-oriented FDI), and the productive capacity of the economy greatlyenhanced through imported technology and “learning-by-doing” experience with newproductive processes.

3.2 National strategic postures

Having reviewed how a nation should go about designing its strategic vision, the second part ofKotler et al’s methodology examines the types of practical policies that would be needed toimprove the performance of the national economy. Their range of policy initiatives are mainlyeconomic in nature, e.g., approaches to investment (including R&D, equipment, infrastructure,education and training), spatial policies on clustering and concentration, trade policies,conventional macroeconomic policies, and institutional arrangements.

Policies to encourage inward investment

The trends in growth of world trade and investment are well known. The driving forcesinclude the emergence of a “borderless” world due to trade liberalization and the emergence ofthe triad of supranational trading blocs (EU, NAFTA, ASEAN). Global industries have alsoemerged, which operate in all parts of the world and create a new international division oflabour. With falling transportation and telecommunication costs, national economies weredestined to become increasingly interdependent, and:

"the real economic challenge ... [of the nation] ... is to increase the potential value of what itscitizens can add to the global economy, by enhancing their skills and capacities and by improvingtheir means of linking those skills and capacities to the world market." (Reich, 1993, p.8).

This process of global competition is organized today mainly by multinational firms and not bygovernments. Production tends to be modularized, with individual modules spread across theglobe so as to exploit the comparative advantages of different regions. Hence, individual smallnations and regions have less power to influence their destinies than in previous periods ofindustrialization, other than by refocusing their economic policies on location factors,especially those which are relatively immobile between regions: the quality of labour,infrastructure and economic governance, and the efficient functioning of labour markets.

Kotler et al emphasize that national policies on FDI should have two objectives (p.189). First,they should obviously be designed to be successful in attracting FDI. Second, they shoulddirect the inward investment flows into sectors and regions in such a way as to maximize thelong-term benefit to the host nation’s economy. The appropriate policies can be consideredusing three elements of the marketing mix.

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Product: Just as in the case of designing an attractive product, the attractiveness of the countryas a host for FDI is an essential element of strategy. Standard frameworks used for analysis ofattractiveness are Porter’s diamond of competitive advantage and Best’s capability triad,which will be examined in Chapter 4.

Price: This includes a wide range of incentives that are designed essentially to lower thecapital and operating costs of the investor. They include low rates of corporation and otherbusiness taxes, and tax holidays; capital grants; training grants; R&D incentives, etc.10

Promotion: Under this heading are included the direct promotion of a country’s image as agood location for investment; the targeting and delivery of specific projects; and the supportand servicing of existing investors.

Policies to encourage industrial clusters

Kotler et al define an industrial cluster as: “a group of industrial segments that share positivevertical and horizontal linkages” (p.201). There are two types of vertical linkages: forwardlinkages between the focal industry and its downstream industries; backward linkages betweenthe focal industry and its upstream industries. Horizontal linkages connect a focal industry withother industries that are complementary in technology and/or marketing.

Porter’s diamond-based framework and Best’s capability triad (to be examined in Section 4)place great stress on the importance of clusters of related and supporting industries in drivingnational competitiveness through the spill-over benefits of user-producer contacts andinformation exchange. In some cases – usually in larger developed economies like the USA,Japan and Germany – clusters start up due to historical chance (Arthur, 1994). However, insmall open economies like Ireland, cluster formation usually has to be fostered explicitly bypolicy and the promotional agencies.

Development of the national industrial portfolio

In corporate development, portfolio analysis is used to review the range of existing activitieswith a view to deciding on entry, exit and continuation strategies. Kotler et al carry thetechniques of corporate portfolio analysis over to the analysis of the portfolio of the industriesin a nation’s economy. They suggest a three-step process:

Identification of industrial development determinants: This involves examination of thedeterminants of industrial attractiveness (e.g., high value-added per worker, linkages betweenindustries, future competitiveness, export potential, etc.) as well as the ability to compete. Theability to compete, in turn, depends on factor competitiveness and firm competitiveness, and thestrategic outcomes are illustrated in Figure 3.3.

10 Kotler et al draw attention to the fact that: “Ireland’s industrial development schemes are among the mostelaborate offered anywhere in the world”, and that “these incentives, plus Ireland’s membership of the EC andthe excellent marketing efforts of the Industrial Development Authority of Ireland have resulted in hundreds ofU.S. companies building plants in Ireland” (Kotler et al, pp.191-92).

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Figure 3.3: National Industrial Capabilities Assessment

Source: Kotler et al, 1997, page 217 (Figure 10.2)

The improvement of factor competitiveness is mainly the responsibility of governments, sinceinfrastructure and human capital tend to generate large public as well as private returns. Theimprovement in firm competitiveness is mainly the responsibility of businesses (althoughassisted by the public sector) through entrepreneurship, R&D and investment. The outcomeleads to the evolution of the national portfolio of industries. If the portfolio is drawn as ananalogue of the so-called Boston Box (with axes showing sectoral growth and sectoral share),then a crude analysis of competitive position can be made and sectors of under and overrepresentation detected.

Formulating the industrial vision: For each industry, Kotler et al suggest drawing up anindustry planning map, shown in Figure 3.4 below. The three axes include an investmentstrategy (derived from a standard product portfolio analysis), the market boundary (based onthe competitive intensity of the industry as well as the nation’s ability to compete), and thefactor intensity of the industry. In the case of Ireland, the industries inherited from the era ofprotection (1932-1960) were bounded by domestic consumption, used low-skilled labour, andwere doomed for “harvesting” after the economy was opened to foreign direct investment in theearly 1960s. The early wave of inward investment in medium-technology industries(electromechanical, food processing), was bounded by regional (mainly EU) consumption, usedmedium-skilled labour and modest capital, and gave rise to selective investing. Later waves ofinward investment were in high-technology industries (computers, micro-processor chips,computer peripherals, software, pharmaceuticals, etc.), used a significant proportion of skilledlabour, were capital and knowledge intensive, were destined for a global market, andpenetrated new and related sectors.

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Figure 3.4: A nation’s industry planning map

Source: Kotler et al, 1997, page 225

Identifying appropriate industrial support strategies: In the case of Ireland, the governmentpursued a vigorous policy of attracting suitable export-oriented industries to invest and producein the country. In the early stages of the FDI strategy, efforts were made to attract a wide rangeof industries, often in the mature stage of the product life cycle, but as the competitive positionof the country improved, a more selective approach was adopted. Today, the support strategiesare designed to attract industries that are in the growth stages of their product life cycle, whenprofitability is high.

Other policies

A range of other policies are examined by Kotler et al, but are less significant in the case ofIreland. For example, trade policy is no longer an issue, since Ireland is inside the EU andcannot (under EU and WTO rules) experiment with trade-related policies like tariffs andquotas. Irish macroeconomic policies are carried out within the constraints of EU membership,and are of limited importance for business strategy since the level of domestic demand is notvery relevant for the mainly export-oriented industries. Ireland pursues policies of improvingits physical infrastructure, within the context of EU regional (or Structural Fund) aid. Finally,the institutional framework is quite homogeneous and displays none of the dramatic differencesthat apply in regions of Asia, Africa and South America.

3.3 National strategic implementation

At the level of the individual firm or corporation, strategy is usually formulated in a contextwhere government policies are largely exogenous, and firms address the challenges ofassessing the business portfolio, identifying strategic goals, and redefining the business domain.The crucial role of management is to formulate a corporate strategy that aligns with the nation’swealth-building strategy (Kotler et al, pp.329-344). So, this issue is usually examined largelyfrom the point of view of domestic corporations adjusting to national strategy. In Ireland,however, causality as often as not runs in the opposite direction. In other words, the Irishindustrial development agency – the IDA – was constantly scanning the world for inward

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investment in high technology sectors. Quite often the domestic environment initially was notsufficiently attractive to persuade leading-edge firms to locate in Ireland. But information onfirms’ needs were fed back to the Irish government authorities by the IDA, and major policychanges could be executed rapidly.11 The national wealth creating strategy in Ireland oftenneeds to adapt to the requirements of firms in the global corporate environment, and not theother way around. Hence, the strategic challenges facing small open economies like Ireland arevery different from those facing large developed nations like the US, Japan, Germany, France,the UK. Such issues are best treated within policy frameworks, which will be considered inSection 4.

Among the many roles of the state, the most crucial for the purposes of ensuring an appropriateindustrial strategy is its role as “organizer” (Kotler et al, pp.388-93). This involves fourelements:

Assessing a state’s strengths and weaknesses: The state can play a crucial role in shaping andreshaping the conditions within which the market operates.

Recognizing trade-offs between policy options: The dilemmas to be faced here are complex,and involve issues such as efficiency (or growth) versus equity (or redistribution); sectoraldiversification versus sectoral concentration; the optimal pace of change and renewal (shockversus gradualism); inward investment versus domestic “bootstrapping”, etc.

Building a healthy business-government relationship: When this relationship is with locally-owned businesses, political tensions can easily arise. But in the case of Ireland, the crucialinternal relationships are between government and the social partners (i.e., trades unions andemployers’ organizations) on the one hand, and with foreign MNEs on the other. The Irishexperience shows that, although MNEs often have turnovers larger than the national GDP, therelationship can be mutually beneficial and MNEs have a long record of providing long-term,relatively secure and well-paid employment.

Enhancing government-government co-operation: Government-government co-operation inIreland takes place almost entirely under the auspices of the EU, where Irish governmentMinisters and civil servants negotiate with other member states, and are part of external EUnegotiations where their domestic interests are affected.

3.4 Summary

Kotler et al attempt to connect macroeconomic public policy with the microeconomic behaviorof industries, firms and consumers, as well to apply strategic planning to the building ofnational wealth. For all its faults, it is a study that is useful for economists in that it invitesthem to place economic research within a wider business strategy framework. This does notalways come easily to economists!

The other aspect of Kotler et al’s framework involves a careful identification of the role of thestate as “strategic organizer”, in the assessment of strengths and weaknesses, in recognizing thetrade-offs between different policy options, in building a co-operative business-government

11 A case of information feed-back was the transformation of the Irish university system, where massiveresources were put into the education of electronic engineering and chemistry to create a skilled labour forcefor potential inward investors (MacSharry and White, 2000, pp. 283-285).

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relationship, and in ensuring that government-government co-operations maximize domesticwealth creation. It is striking that they do actually assign such an important role to the state inan era when the dead hand of government interference is almost universally castigated, at leastin the Anglo-American world. The recent experience of the transition economies of Centraland Eastern Europe would tend to confirm their judgment. The role of government as “strategicorganizer” in a global economy driven by market forces is very different from the previous roleof Communist governments as “central planners”. Government as “strategic organizer” carriesout its functions in collaboration with private businesses and not as a substitute for the marketeconomy. The Irish case suggests that where this collaborative role is strongest, industrialdevelopment is most rapid.

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[4] Three influential industrial policy frameworks

The success of Ireland’s industrial strategy was due in large part to the innovative and flexiblebehaviour of government policy makers as well as to the expertise and dynamism of the state’sdevelopment agency (the IDA). However, policy makers are usually most effective when theyare, so to speak, swimming with the tide of events rather than against it. Irish policy makingwas, to a considerable extent, pragmatic and opportunistic. But it was characterized by a formof pragmatism that appears to have been singularly in tune with the best thinking oninternational industrial policy frameworks.

In this section we discuss the characteristics of three such frameworks: Vernon’s product life-cycle, Porter’s competitiveness diamond, and Best’s triad; and explore the role that they playedin Irish industrial development. It is important to emphasize that these three frameworks are notfully articulated “theories” in the sense used by economists. Rather, they should be regarded asorganizing frameworks to guide and direct policy action. They serve to link differentexplanatory elements in a way that breaks out of the strait-jacket of any narrow exclusive pointof view. They tend not to have universal validity, but are sensitive to time and place. They aredifficult to test a priori, but are, in effect, tested in the market place of policy action.

[4.1] Vernon’s product life cycle framework

A powerful concept in business analysis is the product life cycle (PLC), defined as a processwhere “products come into existence, change in character, and eventually disappear or becomealtered out of all recognition”.12 Not all products follow a rigid path of birth, growth, maturityand decline. Nevertheless, the product life cycle – in spite of all its vagaries and imperfections– served as an anchor for much of the early post WW2 work on industrial strategy.

The seminal paper on the role of the PLC in explaining international investment and trade isVernon (1966). Vernon’s main insight was to link the product life cycle with explanations ofinternational trade and foreign direct investment. Standard trade theory offered little by way ofexplanation of how US foreign direct investment came to dominate the post-war Europeaneconomy. Vernon realized that the US home market played a dual role: it was the source ofstimulus for the innovating firm as well as the preferred location for the actual development ofthe innovation. At the early stage of the product life cycle, producers need great freedom andflexibility to modify, test and improve new processes at a time when the preferred productiontechnology has not yet stabilized. Also, demand for innovative products tends to be relativelyinsensitive to price, so there is less pressure to seek lowest cost production locations. Finally,communications between producers, suppliers and final customers must be facilitated, andargues for a home location.

As the product matures, a certain degree of standardization takes place, and this has locationalimplications. The need for production flexibility declines and there is now a greater concernfor lower costs. Also, demand from abroad increases. However, as long as the marginalproduction cost plus the transport costs of shipping from the US to the foreign market is lowerthan the average cost of prospective production in the market of import, ceteris paribus, therewill be no pressure to invest in foreign production capacity and markets will be served byexports from the US. But as economic and political pressures build up, eventually someproduction moves abroad, initially into the larger more developed economies like the UK,

12 New Palgrave Dictionary of Economics, 1987.

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France, Germany, but soon even to smaller and less developed economies like Ireland.Eventually, as the product fully matures and perhaps enters a declining phase, low costconsiderations become paramount, production ceases in the US, declines in other developedeconomies, and concentrates in low cost developing economies.

The above process is illustrated in Figure 4.1, taken from Vernon, 1966, p. 199.

Figure 4.1: Trade, foreign investment and Vernon’s product life cycle

Today, of course, the world economy is not dominated to the same extent by the US as it was inthe 1950s and 1960s. While products can still be developed initially in home markets (e.g.,Personal Computers in the USA, consumer electronics in Japan), it is more common now forproduct development and launches to aim at global market coverage from the start, and forelements of the value chain also to be produced abroad from the start. Nevertheless, theproduct life cycle continues to provide very useful insights into the reasons why certain types offoreign direct investment locates in Ireland, as well as why they eventually depart.

Writing in 1979, Vernon provided a reassessment of the role of the PLC in explaining trade andFDI, drawing attention to the fact that advances in technology had led to product life cycles thatwere much shorter than in the earlier era (Vernon, 1979). In addition, the activity of multi-national enterprises (MNEs) was no longer dominated to the same extent by US corporations asit was in the two decades after WW2. Hence, in terms of demand (the initial market stimulus)and supply (the initial skills needed to design and produce sophisticated products), influenceswere spread over many more markets. Vernon referred to these factors as “environmental

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changes” (the decline in the role of the US home market due to convergence of income levelsthroughout the developed world), and “network spread” (much earlier transfer of technologybetween a global network of self-standing MNE subsidiaries).

Vernon suggested that multi-national enterprises could usefully be classified into two differentideal types. First, “global scanners” innovate and transfer technology instantaneously andcostlessly between any parts of the globe, and there is little or no explanatory role for a productcycle hypothesis. But, of course, the acquisition and dissemination of technology is notcostless. Second, “global standardizers” consist of firms that develop and produce a line ofrelatively standardized products which respond to a homogeneous world demand rather than tothe distinctive needs of individual markets. This obviously includes such commodities as oil,chemicals and crude metals, but has also come to include transport equipment, computers andpharmaceuticals. Such firms can save on the costs of segmented market research, and benefitfrom economies of scale in global production.

With respect to the role of the product cycle, Vernon pointed out that two opposing forcesoperated for firms who are “global standardizer’s”:

“Firms in (the first) category, innovating for a global market, are obliged to play their innovationgambles for relatively heavy stakes. Accordingly, they can be expected to maintain the centralcore of their innovational activities close to headquarters, where complex face-to-face consultationamong key personnel will be possible; in this respect, such firms are likely to perform consistentlywith the product cycle pattern” (p.262):

and firms in the second category:

“Seeking to exploit scale economies, they are likely to establish various component plants in bothadvanced industrialized countries and developing countries, and to cross-haul between plants forthe assembly of final products. That pattern will be at variance with product cycle expectations”(p. 263).

The bulk of FDI that has located in Ireland appears to consist predominantly of “globalstandardizers” (spread across both of the above categories) in the fields of computers, relatedsoftware, pharmaceuticals and chemicals. Success in attracting these firms to Ireland cameprimarily from the fact that they were initially targeted by the IDA at a relatively early stage intheir (technological) life cycle, immediately after the new product development stage. Forexample, as early as 1979 the IDA was among the first national agency to lobby the Applecomputer company to produce outside their US home based and to come to Ireland (MacSharryand White, 2000, pp.202-03). The subsequent systematic targeting of the makers of eachindividual component of computers – keyboards, hard disks, cables, mice, printers – as well assoftware, meant that the rapid growth of the modern manufacturing sector was heavilyconcentrated on a narrow range of technologies at early stages of the product life cycle. In thissense, the process represented a classic example of the PLC model of foreign directinvestment.13

Vernon’s PLC framework was proposed at a time when conventional trade theory appeared tooffer little or no insight into why and how FDI occurred. Although it stepped outside the scopeof contemporary economic theory, subsequently Krugman proposed a simple general-

13 A detailed analysis of the Irish computer sector is available in Bradley (2001).

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equilibrium model of product cycle trade (Krugman, 1979), and the product cycle has recentlybeen incorporated into new theories of growth (Grossman and Helpman, 1991).

Krugman recognized that the PLC is basically a model that is driven by a specific kind oftechnical change. Economic models are conventionally designed to study the kinds of technicalchange which increased production efficiency of a given range of goods. The PLC stressed therole of technical change in the development of new products. Hence, the economic issueunderlying the PLC concerns the nature of international trade when the pattern of trade isdetermined by a continuing process of innovation and technology transfer.

Krugman constructed a stylized model that consists of two countries: an innovating North and anon-innovating South. Innovation takes the form of the introduction of new products which canbe produced immediately in North but only after a lag in South. This is simply assumed inKrugman’s model, but can be rationalized in terms of a more skilled labour force, externaleconomies and social capital. The lag in adoption of new technology by South is what givesrise to trade.

The implications that emerge from Krugman’s model are very different from those ofconventional (pre-1980) trade theory. New industries continually emerge in the developedNorth region and continually disappear in the face of low wage competition from the lessdeveloped South. Thus, the decline of industries in the developed North will be a recurrentevent and is efficient in terms of the world economy. Also, developed countries mustcontinually innovate, not just to grow, but even to maintain their real incomes. For lessdeveloped countries, the model implies that the transfer of technology, in addition to directbenefits, brings indirect benefits of improved terms of trade. However, success by the lessdeveloped South in accelerating their adoption of new technology can leave workers in theNorth worse off and hence create protectionist pressures.

The work of Grossman and Helpman (1991) generalizes the treatment of industrial innovationas the engine of long-run growth. Particular attention is given to interdependencies between thelearning processes in the industrialized North and the developing South. As in the case ofKrugman’s model, most learning in the South takes the form of imitation of technologiespreviously developed in the North, rather than invention of entirely new products andprocesses. Such imitation gives rise to product-cycle trade, as goods initially are invented andproduced in the North, and then copied and exported by the South. An interesting questionconcerns feed-backs between the processes of industrial learning: does faster imitation by theSouth impede innovation in the North, and does more rapid technological advance in the Northspill over to the rate of growth in the South?

What Grossman and Helpman show is that Southern imitation tends to reduce the Northernmonopoly power and slows innovation in the North. But in addition, the faster the rate ofSouthern imitation, the smaller the share of innovative products manufactured in the North. So,Northern producers who are fortunate enough to escape imitation will find fewer competitors intheir local factor markets, and have higher profits. But when the North produces bothtraditional and innovative goods, Southern imitation can diminish innovation incentives.

[4.2] Porter’s diamond of competitiveness framework

Raymond Vernon had set out to explain why the US was a leader in so many advanced goods.His PLC framework provided a dynamic theory of trade and outward FDI in a context where

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the US dominated the design of advanced products. Michael Porter set out to address a seriesof wider questions:

“Why (do) firms from a particular nation establish leadership in particular new industries? Whathappens when demand originates simultaneously in different nations? Why is innovationcontinuous in many national industries and not a once-and-for-all event followed by inevitablestandardization of technology as the product cycle theory implies? … How can we explain whysome nations’ firms are able to sustain advantage in an industry and others are not?” (Porter,1990, p.17)

His answers identify four broad attributes (the competitiveness "diamond") that shape theenvironment in which national firms compete (Figure 4.2), with an ancillary role played bygovernments and by chance. Factor conditions refer to the availability and quality of thefactors of production such as skilled labour, infrastructure, etc. Demand conditions refer to thenature of local and external demand for the industry's product or service, where local demandcan play a vital role in encouraging product innovation and improvement. Related andsupporting industries refer to the presence or absence of supplier industries and relatedindustries that are also internationally competitive. Firm strategy, structure and rivalry referto the national conditions governing how companies are created, organized, and managed.

Figure 4.2: Porter’s diamond of competitive advantage (Porter, 1990)

Although the diamond itself is not a dynamic system, Porter suggested that there weredifferent stages of competitive development during which different elements of the diamondcame into play (Figure 4.3).

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Figure 4.3: Porter’s stages of competitive development (Porter, 1990)

At the early stages, competitive development is driven by factor conditions, and draws onlow cost labour and/or abundant natural resources. The next stage is investment driven, anddraws from factor conditions, demand conditions as well as firm strategy, structure andrivalry (i.e., from three of the four diamond elements). In the next stage, competitiveness isinnovation driven, and draws systematically from the entire diamond.

Using Porter’s four-stage development process, one can classify a range of nationaldevelopment strategies as shown in Table 4.1.

Table 4.1: Porter’s stages of national competitive development

Key driver Source of competitive advantage Country examplesFactorconditions

Basic factors of production (e.g.,natural resources, lower skilledlabour)

South Korea, Singapore andIreland (before 1980s)

Investment Capital equipment, transfer oftechnology

Japan (during 1960s)South Korea (during 1980s)Ireland (after 1980s)

Innovation All four elements of Porter’s“diamond”

Germany, Sweden (post-war)Japan (since 1970s)Italy (since early 1970s)Ireland (post 2000)?

Wealth Erosion of competitive advantage UK (post-war)USA, Switzerland, Sweden (since 1980s)

Source: Kotler et al, 1997 (adapted)

Porter's main contribution to explaining the nature of competitive advantage lies in theemphasis he places on the interactions between the four elements of competitiveness and thedetailed study of individual successful nations, regions and industries that illustrate theseinteractions at work. In particular, his approach has strong implications for the design andexecution of national industrial policy (Porter, 1990, chapter 12), and provides a usefulchecklist of what types of policy intervention are likely to improve the individual elementsof the diamond as well as their interaction. The analytical work of Michael Porter oncompetitive advantage has been highly influential in the recent reformulations of Irishindustrial strategies.14 However, early Irish industrial strategy in the area of attracting high

14 Porter’s approach was used to great advantage by the Industrial Policy Review Group in the Republic ofIreland (Culliton, 1992), and by the Northern Ireland Growth Challenge (NIGC, 1995).

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technology sectors in many ways anticipated Porter's later formalization of his "diamond"framework (Bradley, 2001).

After more than a decade of impressive growth, a degree of uncertainty has begun to colourindustrial strategic thinking in Ireland. Porter's competitive framework - the current businessstrategy orthodoxy throughout most of the developed and developing world - suggested that acountry like Ireland could implement a strategy in a sequence of separate stages: factor driven;investment driven; and innovation driven (Figure 4.3 above). The first stage lasted almost 25years in Ireland, from the late 1950s to the mid 1980s, and was "factor" driven, based onpolicies of low rates of corporation tax, low wages, and subsidized capital formation. Thesecond stage has lasted from the late 1970s to the late 1990s, during which there has beenmassive public and private investment in plant, infrastructure and human capital, co-fundedgenerously through EU regional aid from 1989 onwards. Policy-makers are now seeking toshift to Porter's third (innovation driven) stage. But this has exposed some of the limitations ofan industrial strategy that came to be based largely on foreign direct investment.

Of particular interest in the context of small economies such as Ireland is the fact that Porterassigns great significance to indigenous firms and local markets. More ominously, heasserts that:

“A development strategy based solely on foreign multinationals may doom a nation toremaining a factor-driven economy” (Porter, 1990, p.679)

and that

“Except when it is largely passive, widespread foreign investment usually indicates that theprocess of competitive upgrading in an economy is not entirely healthy because domestic firmsin many industries lack the capabilities to defend their market positions against foreign firms.… Inbound foreign investment is never the solution to a nation’s competitive problems”.(Porter, 1990, p. 671)

Debate on the wisdom and sustainability of the Irish strategy has raged over this importantissue. In its crudest interpretation, Porter is simply re-stating the implication of Vernon’searly work on the PLC. In other words, if Ireland displays behavior like the less developedregion in Vernon’s model of the PLC (see above), it will always remain an underdevelopedcountry that competes in low cost production of maturing products. But we have seen thatVernon modified his framework considerably, and took account of the fact that the world –viewed narrowly as a productive system – became less rigidly divided into region-specificproduction processes and product technologies. But an even greater degree of integration ofpolicy appears to be needed in a "borderless" world. We now examine one such framework,due to Michael Best.

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[4.3] Best’s capability triad

What Michael Best offers in his capabilities and innovation perspective - henceforth, thecapability triad - is a new and sophisticated strategic framework for the development ofindustrial policy. The grounds for this synthesis were laid in his earlier book on The NewCompetition, which was directed more at the limitations of the conventional neoclassicaltheory of the firm than at the dominant business taxonomies and frameworks (Best, 1990). In arecent report written for the Northern Ireland Economic Council (Best, 2000), he has appliedthis framework to Northern Ireland, but of course it is equally relevant to other regions andcountries. His latest book, The New Competitive Advantage (Best, 2001), uses it to explain therevival of the Massachusetts Route 128 technology complex and the rise of the electronicsindustry in Malaysia.

Best’s capability triad is based on the interaction of three core elements: a business model,production capabilities and skill formation (Figure 4.4). The business model element of thetriad describes how entrepreneurial firms grow, based on the creation of new firms throughtechnology diversification, inter-firm networks based on open systems, and regionalspecialization based on technological capabilities. The production capabilities element of thetriad integrates ideas from operations management and operations strategy into a logical systemof production system models that drive home the lesson that competitive strategy andproductive systems are bound together. The skill formation element of the triad, in addition toproviding a vital direct input into production, is what serves to enhance the synergisticinteraction of the first two elements: the business model and production capabilities.

Figure 4.4: Best’s capability triad (Best, 2001)

Perhaps the most daunting aspect of the capability triad is that it treats the scope for publicpolicy as being almost completely and seamlessly blended into the detailed mechanics ofchange processes that occur within private firms.15 In this framework, as well as in Porter'sdiamond, public policy and private entrepreneurial actions do not operate in isolation fromeach other, but need to become mutually reinforcing. Only in one element of the capability triad- skill formation - is there some scope for a partially separable and transparent role for publicpolicy, namely, to ensure that the right mix of education and skills is produced to accommodate

15 The theorizing about firms’ behaviour in Best’s work draws on the work of Coase (1937), Penrose (1959)and Williamson (1970) rather than on the orthodox neoclassical theory (see Foss (1999) for a recent survey).

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the changing demands of the economy as it develops. Even here, the links between public andprivate activity are crucial.16

An obvious question to ask is how the capability triad, if indeed it is a universal process, hasoperated to produce phenomenal growth in some regions (Route 128, Malaysia and Ireland),but less in others (Northern Ireland). On the one hand, how much is due to domestic policyinitiatives, where there may be some degrees of freedom and scope for action? On the otherhand, how much is due to autonomous localized systems that operate within the private sector(operations systems, entrepreneurial skills, social capital), which are less amenable to directpolicy influence? In the case of Ireland, as it addresses the new challenges being faced by thecomputer sector, an initial fear might be that the capability triad (as well as Porter's"diamond") functions as a "closed" system that explains success or failure, but – rather likemeteorology and the weather– does not permit one to have much influence over the outcome.However, any such fear is unfounded, and the logic of the capability triad provides bothstructure and content to strategy design.

Strategy has been defined as: "the evolution of a central idea through continually changingcircumstances”. (Welch, 2001, p. 448). The central idea proposed by Best is that industrialstrategy should be guided by the capability triad. For example, towards the end of his report onNorthern Ireland industrial strategy, Best sets out policy proposals for how such a strategymight be taken forward, and we illustrate these schematically in Figure 4.5. For the purposesof exposition, three proposals are portrayed as being directed mainly at improving the businessmodel aspect of the triad; three at the capability development element; and two at the skillformation element. Of the remaining two proposals, one concerns a general need to linkimprovements in all elements of the triad; and one concerns a very specific need for synergiesbetween technology management and skill formation.

How are policy makers likely to react to Professor Best’s ten policy proposals? Some willbuy into the organizing framework and direct their energies towards the search for what onemight call “triad-compatible” practical policy initiatives. But others may react with frustrationthat the proposals do not resemble the usual detailed shopping list of very specific policyrecommendations that often dominate orthodox policy documents. For example, how helpful isit, they may well ask, to be exhorted to “concentrate on entrepreneurial firms”? In isolation,such a recommendation is only a pious aspiration. But in the context of the matrix of proposalsfocused on the three interacting elements of the capability triad, this recommendation opens thefloodgates for detailed policy work on how it should be implemented in practice.

16 For example, a recent ESRI study (Denny et al, 2000) showed that for different types of trainingintervention, those closely linked to the market were most effective in combating unemployment while incontrast, training of a more general nature did not, on its own, appear to have an enduring beneficial effect.

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Figure 4.5: Policy proposals linked to the capability triad

Businessmodel

Skillformation

Capabilitydevelopment

Capability triad:Policy proposals

Concentrate onentrepreneurial firms

Diffuse high performancework organisation

Foster open networks

Administer the research, technology development and innovation infrastructure

Link visible andinvisible colleges

Develop technology management capabilities

Partner with firms bringinginward investment to advance capabilities

Integrate mission-driven diffusion agencies with industrial policy goals

Apply principle of systems integration

Integrate technologymanagement and skillformation

Based on Best, 2000, pp.68-76

How many of the existing Irish firms are truly entrepreneurial, or could become so in thefuture? Should the Irish development agencies attempt to pick entrepreneurial winners?Conventional economic advice exhorts us to leave this task to market forces. But Best’sdetailed review of policy design and implementation in the Massachusetts Route 128 area andin Malaysia, provide convincing evidence that there is indeed a crucial strategic organizingrole for government in order to ensure the creation of conditions that favour the growth of apopulation of entrepreneurial firms. At the very least, such a role should be used bygovernments to avoid implementing policies that work against the rise of entrepreneurial firms,such as maintaining a system of grants that bails out failing firms or attracts firms into sectorswhere the preconditions for open networking do not exist. At best, it should encourage policy-makers to send clear signals about the characteristics that they wish to foster in a futuredesirable industrial structure.

Turning to the second recommendation in Figure 4.5, how should public policy be designed to“diffuse high performance work organization”? Here the role of government is almost always

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going to be dominated by the role of the market.17 As firms move up the productioncapabilities spectrum, they tend to be rewarded by higher profits and increased market share.But this proposal can be made into one element of a public policy filter in order to judge theadvisability of targeting a firm or a class of firms for policy attention. Also, a policy of“fostering open networks” (as in the third recommendation in Figure 4.5) will address thebarriers that Ireland’s small firm (SME) economy faces in moving up the productioncapabilities spectrum towards best industrial operations practice.

In order to advance the debate on industrial policy in Ireland, it may be useful to map theessential elements of any policy analysis and recommendations into Best's capability triadframework.18 Many benefits would flow from such a mapping. The completeness and closureof the strategy would be easier to check. The nature of the required accommodating fiscal,monetary, social and other policies would become more transparent and provide a logicalframework for dialogue and debate within the Irish Social Partnership. A rich database ofinternational industrial experience (from Route 128, Malaysia, the so-called Third Italy) wouldbecome easier to access and use as benchmarks to evaluate Ireland’s progress. And finally,since the capability triad speaks the language of practical business but draws its organizingrigor from economic theory, it will provide a means of synthesizing insights from bothapproaches.

The most important policy implication to emerge from Best’s capability triad framework is thatany overall programs of change in the area of industrial policy require the close integration ofthe change programs in each of the elements of the triad:

“Rapid growth involves coordinated organizational changes in each of three domains: the businessmodel, production capabilities, and skill formation. … The three domains are not separable andadditive components of growth, but mutually interdependent sub-systems of a singledevelopmental process. … No one of the three elements of the Capability Triad can contribute togrowth independently of mutual adjustment processes involving all three elements” (Best, 2000,p.2).

In a sense, Best’s framework requires a type of “critical mass” of change in each element of thetriad before growth can take off. Porter, on the other hand, had suggested that the elements ofhis diamond could be picked off one by one, leading to a sequential process of growth, asillustrated in Figure 4.3 above. Although Best’s framework requires a degree of sophisticationand co-ordination for policy makers that is more demanding than Porter’s framework, itappears to be more soundly based on a close integration of insights from economics andbusiness and does not suffer as much from the “big economy” perspective of much of Porter’swork.

[4.4] Summary on industrial strategy frameworks

One must approach these three policy frameworks with an understanding of their historicalorigins and their necessary simplifications. Unlike scientific theories, where a single wrongprediction can cause rejection and replacement by a new theory that encompasses old and new

17 The progress made in Ireland under Partnership 2000 in private sector workplace innovation suggests thatthere is a role for the state, but this is likely to be dominated by the activities of the individual firmsthemselves.18 Best's capability triad can also be considered within the wider concept of a learning region. An applicationto the Øresund region of southern Sweden and Denmark is described in Maskell and Törnqvist, 1999.

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observations, these three frameworks simply look at industrial development issues fromdifferent perspectives, and place emphasis on different factors. The PLC stresses the primacyof the country that provides the source of FDI, and the dependency of the host countries. Thishad more universal acceptance in the 1950s and 1960s than it does today, but it continues toapply to small open economies like Ireland, Portugal, Greece, as well as the newly liberalizedtransition economies of Central and Eastern Europe. The Porter diamond explains thedevelopment process in a world that consists of many relatively large and developedeconomies, and takes up where the PLC leaves off. But it continues to insist that sustaineddevelopment is crucially dependent on the domestic market, and cannot be based simply onsupply chain linkages to the global economy. The capability triad of Best selects a verydifferent set of factors that it asserts are the primary causes of development, and furtherrequires simultaneous advances in all three. The logic of each of these three frameworks hasoperated in Ireland in overlapping ways, with differing degrees of emphasis at different times.

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[5] Conclusions

Luck plays a large part in industrial strategy. The expected external conditions needed tosupport success do not always conveniently arrive, and their absence may frustrate otherwiseadmirable policy initiatives. Nor is the true significance of the internal elements of a strategyalways fully understood even by its own designers. But luck and chance, however random, canbe handled best within well thought out and coherent frameworks that take full account of thenature of the external environment (opportunities and threats) as well as realistic views ofdomestic capabilities (strengths and weaknesses). Policy frameworks such as those of Vernon,Porter and Best do not provide all the answers. But they help policy makers in both the publicand private sectors to bring focus and synergy to the disparate policies that make up broadindustrial strategy in a small open economy like Ireland.

At the risk of oversimplification of what are very complex issues, what the recent industrialperformance in Ireland shows is that the intelligent combination of economic policy andbusiness strategy can generate huge synergies in terms of rapid national growth andconvergence. To achieve these synergies requires a degree of economic policy autonomy thatcan be used, for example, to protect workers who lose their jobs in declining sectors and whorequire extensive retraining for other occupations. But more importantly, policy autonomyneeds to be directed at addressing weaknesses shown up by frameworks such as Porter’s andBest’s.

In the autumn of 2001, hardly a week passes without gloomy news about another electronicsplant downsizing its labour force or closing. In this paper we have probed deeper into some ofthe background issues involved. Clearly, there is more going on in the Irish computer sectortoday than a simple contraction in demand arising as a result of a transient global recession.However important the demand-side factors may be, there are additional supply-side andtechnological factors that have begun to affect the Irish computer industry adversely, and theseunderlying strategic concerns need to be better understood. The high technology sector, inparticular computers and electronic components, is predominantly foreign owned. Hence, theforces that drive innovation in products and manufacturing processes tend to originate in theUSA rather than in Ireland. It is this feature that presents the most serious threat to the survivaland progress of the sector.

A hint of how the IDA is moving to deal with this incipient maturity problem was contained ina recent review of industrial promotion strategy (Enterprise 2010) prepared by Forfás:

“The emerging new business model is leading to a new pattern of international investment,with corporations selecting the best location for each particular activity, rather thannecessarily putting integrated projects in a single location” (Enterprise 2010, page 2).

This type of splitting between firms of activities in the supply chain is well known, and was thebasis for the earlier success of Dell in creating a high profit computer firm in an area thatlooked as if it was reaching maturity in the late 1980s. Enterprise 2010 appears to envisage awider application of global outsourcing, with Ireland at the high added-value core ofproduction activities. An obvious problem with this strategy is that while it may be suitable forelectronics or certain types of pharmaceuticals, it may not always be suitable for alternativetypes of manufacturing activity, such a bio-technology. Furthermore, Porter’s frameworksuggests that this approach is fraught with difficulties and would leave Ireland vulnerable tochanges in technology. Best’s framework suggests that such an approach will require a very

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high standard of integration and excellence in all aspects of the economy. Either way, thesuggested new approach of marketing Ireland as a “network” location in a type of post-industrial age will be a major challenge.

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