The Competitive Advantage Of Nations

Porter states that “in the innovation stage, the full ‘diamond’ is in place” (552). When a nation is at the highest stage of competitive advantage, in which it continually innovates in a broad range of advanced industries, all the determinants of national advantage are present—and they are mutually re-enforcing. Leading firms in end-product industries help encourage world-class supplier industries like machinery to serve them. Conversely, world-class supplier companies elevate the quality of end-product firms. Success in world markets causes national income to rise and has a knock-on effect on home demand. As Porter notes, “Consumer demand becomes increasingly sophisticated because of rising personal income, higher levels of education,” and an “increasing desire for convenience” (553). Firms can therefore gain a further edge because increasingly discerning consumers demand the latest and highest-quality products and services. Finally, government has the resources from higher tax revenues—and the will—to invest in advanced factor creation in conjunction with industry, which recognizes the importance of long-term investment and works cooperatively with government toward the common goal of higher productivity.

However, the same processes can work in reverse. When a nation starts to lose competitive advantage and transitions to becoming a “wealth-driven economy” (556), the virtuous cycle described becomes a viscous one. This process starts, as Porter argues, when “the motivation of investors, managers, and individuals shift in ways that undermine sustained investment and innovation” (556). This may result from satiation. After generations of high income and material success, a culture of complacency sets in. The incentives to strive for higher standards in industry, and the sense of why this matters, though keenly felt in the past, weaken. It could also be linked to the diminishing marginal utility of income and a focus on other, non-material values in new generations. A symptom may be, as in Britain and the US, a sense that working in industry is no longer prestigious. Further evidence is a reduced interest in practical, industry-oriented aspects and areas of education.

Whatever the spark, once this malaise begins, it is hard to arrest. The very wealth and early industry success that helped breed a culture of complacency serves at first to mask that a problem exists. Disguising the loss of competitive advantage in advanced industries is the fact that in the short-term, profits in those firms may fall only slowly because of “the momentum created by customer loyalties and established market positions” (557). Customers take time switching to better-quality, more efficiently produced foreign goods. Indeed, profits may rise. This may result from mergers or chronic under-investment, which allows for higher short-term dividend pay-outs. Finally, wealth driven nations can still maintain positions in non-cutting-edge industries and those related to luxury, leisure, or wealth management, as the continued success of financial service and entertainment industries in the UK and US illustrates. In fact, some may even sell or justify this as a positive development, holding that the decline of industry and the relative rise of services is part of an inevitable and beneficial transition to a “post-industrial” or “service-based” society. Such arguments further hinder remedial action to address the problem.

Meanwhile, the underlying cycle of decline continues. As Porter highlights, “industries that are no longer innovating become poor buyers for the industries that supply them” (557). Supplying and related firms decline because they no longer are faced with cutting-edge demand. This in turn weakens, due to poorer inputs, the initial buyer industries. Such problems can then spill over into politics. Competitively weakening, but still large and powerful, firms try “to insulate themselves by influencing government policy” (556). Prompted by fears of mass lay-offs, government may respond by offering subsidies or imposing import tariffs. This temporary salve makes home firms even less competitive.

Almost as bad, it wastes precious and diminishing national resources. With lower tax revenues due to falling national income, and increased spending on welfare due to growing unemployment, industry subsidies draw scarce funds away from essential investment in factor creation. Education and infrastructure quality, the root of many of the nation’s problems, deteriorate further. The nation’s firms fall further behind. In addition, strife between workers and management increases. With pressure on wages and profits, both sides fight over a shrinking national income and struggle to maintain previous positions. In the end, nobody wins. Aside from small groups that control past accumulated wealth, society becomes increasingly poor, divided, and beset by social problems. Whether, and how, a nation can address such a malaise is the topic of the next three chapters.