90 Book Reviews

Michael E. Porter. The Competitive Advantage of Nations. New York: Free

Press, 1990. 855 pages. Hardbound. UK£ 25.

Trade is a field of economics that is useful for investigating the issue of

economic competitiveness. A nation’s advantages in competing against other
nations are reflected in its performance in international economic transactions.
Earlier theories on trade (Ricardian and Heckscher-Ohlin) analysed a nation’s
inter-sectoral comparative advantage. Due to the intuitive appeal of these
theories, governments have implemented various policies designed to improve
comparative advantage in factor costs by reducing interest rates and resorting to
devaluation, special depreciation allowances, export financing, etc. There is now
a growing awareness that these theories are unrealistic as to many industries,
although they can be useful in explaining broad tendencies apparent in the
patterns of trade.
On the other hand, technology-gap and product-cycle models attempt to
explain absolute advantage based on cross-country variations in technology—an
important departure from the Heckscher-Ohlin world. Absolute advantage refers to
the absolute cost advantage of a nation over another in producing a product. Trade
occurs as a result of a nation’s owning an absolute advantage earned from its
technological lead over another.
The Competitive Advantage of Nations by Michael Porter addresses some very
important issues related to trade in goods and services: Why do some nations
succeed and others fail in international competition? Why are firms based in a
particular nation able to create and sustain competitive advantage against the world’s
best competitors in a particular field?
Porter expresses his strong conviction that a decisive national economic
environment allows firms to create and sustain competitive advantage in particular
fields, and hence in the competitive advantage of nations. He emphasises that
although much can be learned through an economy-wide approach (which reflects
national characteristics) to understand the competitive success of a nation, yet the
industry-specific circumstances, choices, and outcomes overshadow the macro
approach. An industry is where competitive advantage is either won or lost. The
nation influences the ability of its firms to succeed in particular industries. The
outcome of many struggles in individual industries determines the state of a nation’s
economy and its ability to progress. Thus a firm must understand the national
attributes that are most crucial in determining its ability, or inability, to create, foster,
and sustain competitive advantage in international terms.
A nation’s standard of living in the long term depends on its ability to attain a
high and rising level of productivity in the industries in which its firms compete.
This rests on the capacity of its firms to achieve improving quality or greater
efficiency. The influence of the home nation on the pursuit of competitive advantage
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in particular fields is of central importance to the level and rate of productivity

growth achievable. The long-dominant model used to explain the influence of
nations in succeeding internationally in particular industries is showing certain
weaknesses. It is unable to explain why firms based in particular nations are able to
compete successfully in particular industries, nor can it explain why a nation’s firms
are able to sustain their competitive positions over considerable periods of time.
Porter explains, convincingly, why previous efforts to explain the
competitiveness of an entire nation have been unconvincing, and why attempting to
do so is tackling the wrong question—as some see national competitiveness as a
macroeconomic phenomenon, driven by such variables as exchange rates, interest
rates, and budget deficits. Interestingly, many nations have experienced rapidly
rising living standards despite budget deficits (Japan and Korea), appreciating
currencies (Germany and Switzerland), and high interest rates (Italy and Korea). The
view that competitiveness depends on possessing abundant resources has been
contradicted by the most successful trading nations which are resource-poor.
Likewise, the view that competitiveness is the most strongly influenced by
governmental policy (targeting, protection, export promotion, etc.) is not confirmed
by a broader survey of experience conducted by the author.
For Porter, the only meaningful concept of competitiveness at the national
level is the national productivity with which a nation’s resources are employed.
Sustained productivity growth requires that an economy continually upgrade itself. A
nation’s firms must relentlessly improve productivity in existing industries by raising
product quality, adding desirable features (differentiated products), improving
product technology, boosting production efficiency or improving the quality of
factors of production through technological progress. Firms must also develop a
capability to compete in even more sophisticated and new industry segments, where
productivity is generally higher. This also absorbs human resources freed up in the
process of improving productivity in existing fields, say, with the introduction of
automation.
Expanding exports of competitive industries exerts an upward pressure on the
exchange rate, making it more difficult for the relatively less productive industries in
the nation to export. Employing subsidies and protection to maintain such industries
only slows down the upgrading of the economy and limits the nation’s long-term
standard of living. Thus the ability of a nation to export many goods produced with
high productivity, which allows the nation to import many goods involving lower
productivity, is a more desirable target because it translates into higher national
productivity. A fall in the world export share in the high productivity industries is a
danger signal for a national economy. A rising sophistication of exports can support
productivity growth even if overall exports are growing slowly.
To explain “competitiveness” at the national level, one must understand the
determinants of productivity and the rate of productivity growth—inter-linkage of
these determinants is the core of Porter’s theory. To find answers, one should not
92 Book Reviews

focus on the economy as a whole but on specific industries and industry segments.
This is because human resources, for example, which are the most decisive in
modern international competition, must possess high levels of specialised skills in
particular fields and be developed with much effort, just like the development of
commercially successful technology. These are not the result of the general
educational system alone. Competitive advantage is a dynamic and evolving process
and is created and sustained through a highly localised process. Differences in
national economic structure, values, institutions, and histories contribute profoundly
to competitive success. It must be underscored that cost advantage grows as much
out of efficient-to-manufacture product designs and leading process technology as it
does out of factor costs or even economies of scale.
Four broad attributes (hereafter called the “Diamond”) of a nation that shape
the environment in which local firms compete (and which promote or impede the
creation of competitive advantage) are:

1. factor conditions: the nation’s favourable position in factors of production,

and advanced and specialised factors, including communication
infrastructure and highly educated personnel;
2. demand condition: the nature of home demand for industry’s product or
service;
3. related and supporting industries: the presence or absence in the nation of
supplier industries and related industries that are internationally
competitive;
4. firm strategy, structure, and rivalry: the conditions in the nation governing
how the companies are created, organised, and managed, and the nature of
domestic rivalry.

The role of government in national competitive advantage is important in

influencing all four determinants.
Porter suggests that a corporate leader firm must set its sights on creating and
sustaining competitive advantage as measured against the best worldwide
competitors. Firms should aspire to sustain success rather than mere survival or the
temporary profits of harvesting market position. The following principles/ways are
important for both domestic and global competition.

1. Competitive advantage grows fundamentally out of improvement,

innovation, and change. A company should actively seek out pressure and
challenge, not try to avoid them. Some of the ways of doing so are as
follows: sell to the most sophisticated and demanding buyers and channels;
seek out the buyers with the most difficult needs; establish norms of
exceeding the toughest regulatory hurdles or product standards; find
 Book Reviews 93

sources from the most advanced and international home-based suppliers;

treat employees as permanent; establish outstanding competitors as
motivators; identify and serve buyers with the most anticipatory needs;
investigate all emerging new buyers; find the localities whose regulations
foreshadow those elsewhere; discover and highlight the trends in factor
costs; maintain ongoing relationships with centres of research and sources
of the most talented people; study all competitors, especially the new and
unconventional ones; bring some outsiders into the management team; and
serve home buyers who are international and multinational.
2. Competitive advantage involves the entire value system (array of
activities). Close and ongoing interchange within the national cluster are
integral to the process of creating and sustaining advantage. These
interchanges include senior-level management contact, close links with
R&D institutions, reciprocity with researchers for testing new products,
and cooperation in penetrating and serving international markets.
3. Competitive advantage is sustained only through relentless improvement,
continuous technological progress and efforts to differentiate products, and
position in the home and global markets.
4. Sustaining the advantage demands that its sources be upgraded. A firm
should develop advanced human resources and internal technical
capability; have more sources of advantage at its disposal so that the
imitator has more to match. It should make its less sustainable advantages
obsolete: for example, automating away much of the advantage of
relatively low-cost and productive labour. Destroy old advantages by
creating new ones, lest a rival should do so.
5. Sustaining advantage ultimately requires a global approach to strategy.
Penetrate foreign markets. Diversify production and serve sophisticated
buyers and markets. Increase global production and foreign sourcing. Keep
up with technology development abroad. Meet the best competitors.
Locate regional headquarters. Select foreign acquisitions and make
international alliances.
In Porter’s theory, there is a role for government policy to influence national
advantage. However, government does not control the national advantage policy; it
can only influence the “diamond”. The central goal of the policy is to deploy a
nation’s resources with high and rising levels of productivity. The role of the
government here is to stimulate such dynamism and upgrading.
There is a wide range of government policies that have a bearing on national
advantage in some industries. In this regard, education and training policy, science
and technology policy, tax policy, health-care policy, anti-trust policy, regulatory
policy, technical standards, environmental policy, fiscal and monetary policy, trade
policy, provision of hard and soft infrastructure, procurement policies, and many
94 Book Reviews

others are relevant. Government policy has a role in shaping the breadth and
international success of related and supporting industries in the country, and is
integral to the competitive upgrading of other industries. Such policies include the
policies towards the media and cluster formation. Finally, government policy has
much influence on the way in which firms are created, organised, and managed; and
on their goals, and on how they compete.
This book has a strong message for the Pakistani economy, which is suffering
from virtual stagnancy of total factor productivity as follows. Government policies
towards industry in Pakistan must recognise that the “diamond” is a system, which
makes policies in many areas interdependent. At present, a weak linkage has
constrained the development of the economy. There is, thus, a need for progress on
each determinant. Policies in Pakistan often aim to improve one aspect of the
national environment but impose unintended consequences by not addressing the
others.
The Government should not overstate or overplay its role in national
competitive advantage. Past policies have indeed adopted such a course, which has
created an economy of dependent, backward-looking, and ultimately unsuccessful
firms. The Government should recognise those areas in which it has a legitimate
influence in creating the conditions for economic prosperity. As a top priority, the
Government should provide an enabling environment for factor creation and
formation of clusters, which already exist in some form. The Government should
also adopt policies that create an environment conducive to the development and
advantage of industries and do not unnecessarily raise the cost of production. Local
firms should be encouraged to be responsive to modern business and manufacturing
practices.
Zafar Mahmood
Pakistan Institute of Development Economics,
Islamabad.