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  1. 1. INDUSTRIAL STRATEGY AND BUSINESS PLANNING IN IRELAND John Bradley The Economic and Social Research Institute 4 Burlington Road, Dublin 4, Ireland tel: ++-353-1-667 1525 fax: ++-353-1-668 6231 email: web: October 30th, 2001
  2. 2. ABSTRACT Methodological approaches to designing and implementing industrial policy in small open economies are examined and some of the very different insights offered by economic and business research perspectives are compared and contrasted. Within the economic perspective, attention is drawn to some of the major advances made over the past two decades in trade, growth and spatial economic theory, and to their implications for industrial policy-making. Examination of the business research perspective draws on a recent attempt by 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 on industrial policy is by means of three systematizing frameworks. In the chronological order of their development, these are: Raymond Vernon’s product life cycle-based explanation of international trade and foreign direct investment; Michael Porter’s diamond of competitive advantage; and Michael Best’s capabilities and innovation triad. These systematizing frameworks have been very influential in international industrial policy thinking over the last four decades in large and small countries and regions, and are especially useful in explaining the evolution of industrial strategy in the island of Ireland. Vernon’s simple PLC framework, although apparently superceded by the more sophisticated frameworks of Porter’s diamond and Best’s triad, continues to be relevant and to offer many useful insights into the later frameworks when they have been used to guide the design of industrial strategy in small open developing economies. 2
  3. 3. 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 3
  4. 4. [1] Introduction The original motivation for this paper arose from the experience of carrying out research in Northern Ireland and in Central and Eastern Europe. In Northern Ireland, the challenge facing industrial policy makers is to design and implement policies that will produce a faster growth rate than in the rest of the UK, thus promoting convergence. A major constraint is the very limited range of significant policy instruments, since the region is fully integrated into the UK fiscal and monetary union. In Central and Eastern Europe the challenge is quite different: how to promote good industrial strategies at a time when many institutions and market mechanisms fall 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 to address the task of policy-making under extreme constraints (in regions like Northern Ireland) and policy-making under extreme disorganization and uncertainty (in Central and Eastern Europe). In this paper we suggest that the perspective of business research can be a very useful complement to economics. If one attempts to combine the insights of economic and business research perspectives, one quickly becomes aware of the differences between them. Economic policy research, and in particular trade and macroeconomic research, often tends to be directed at issues and challenges that arise at the level of regions, nations or even groupings of nations such as the EU. Business policy research, on the other hand, tends to be focused on the performance of individual firms or groups of firms. This distinction was highlighted by Michael Porter in his analysis of the competitive advantage of nations, when he stressed the point that it is more helpful to consider firms as competing in industries, not in nations (Porter, 1990, p.619 and p.682). This simple insight lies at the heart of the tensions that can arise between a mainly regional/national-based perspective of much economic policy and a mainly firm-based perspective of business researchers, particularly in matters concerning the design and execution of industrial policy. 1 At the risk of over simplification, one might stylize economic theories as being useful for the study of how a “representative” firm is likely to behave when subjected to changes in the wider external policy environment. Business research frameworks, on the other hand, tend to be concerned with the analysis of the consequences of management actions directed at improving the 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 and business researchers often tend to misunderstand, discount or ignore each other, and sometimes adopt quite dismissive attitudes towards each others’ methodologies.2 How do business researchers delineate their field of enquiry? At the beginning of most textbooks on strategic marketing (e.g., Dibb, et al, 1997, p. 1) there is usually an explanatory diagram 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 small countries, where the economic research agenda is often heavily influenced by trends in international monetary and 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 international trade theory, the conclusion was reached that: “It is little surprise therefore, that practicing managers gain little from the predictions of classical theory. The reality of international business in the 1990s and beyond will be far removed from the 1700s and 1800s when the theory was born”! 4
  5. 5. 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 over which any individual firm has little or no control, and from which emerges the strategic opportunities and threats that face the firm as it operates in the marketplace. It contains all the economic and competitive forces that are the domain of the economic policy researcher, in addition to the forces of technical progress, social forces, legal issues, environmental protection rules, and political forces (such as ideology). Business researchers dip into these matters only when they need to, mainly as sources of opportunities and threats, but it is not their main domain of research activity. Economists talk of little else. The middle circle of business strategy is the domain where much business-oriented research is focused. Key issues include the determination of a company’s competitive advantage within a given outer business environment. It also includes the selection of target markets and the positioning of products and brands within the selected markets. Here, it is common for knowledge and research insights to be systematized into explanatory frameworks. Such frameworks usually stop well short of being testable paradigms in any scientific sense, but often take the form of taxonomies of useful and revealing facts and insights. Influential examples include Raymond Vernon’s PLC framework explaining the sequential nature of the different stages of industrialization, trade and foreign direct investment (Vernon, 1966); Michael Porter’s diamond, which suggests how policy can be used to create competitive advantage even in situations where initial national factor and other endowments are unfavorable (Porter, 1990)3; and Michael Best’s capability and innovation perspective – the Capability Triad – which points to the need for synchronized advances on many fronts if dynamic 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 on the immediate actions of managers within individual firms (e.g., pricing policy, product development, promotion activities and distribution channels). There may be a public policy regulatory oversight of this inner business environment to ensure fair play and open competition, as well as some targeted aid directed at improving marketing skills of small or newly formed firms. But actions within the inner environment are normally left to the discretion of individual firms. One might characterize a key challenge of industrial policy making in any small nation or region as that of blending the techniques and insights of the predominantly economic analysis of the outer 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 of researchers.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, Vernon and Porter. However, only in his most recent work has Porter acknowledged the economic research on spatial issues and clustering by Krugman and others, and even then inadequately (Porter, 1998). Kay, 1991 is an attempt to synthesize. 5
  6. 6. separate group often focuses on the inadequacies of the other’s methodology. 5 Seldom are the two 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 business perspectives on industrial strategy and trade in small open economies, and is organized as follows. Section 2 deals briefly with the economic perspective, drawing attention to some of the major advances made over the past two decades in trade theory, growth theory and spatial economics that have influenced economists’ attitudes to industrial policy. Section 3 turns to the business research perspective and examines a recent attempt to apply the logic and methodology of business strategy to national-level industrial planning (Kotler, et al, 1997). In Section 4 we suggest that a useful way of linking the economic and business perspectives on industrial policy is by means of three systematizing frameworks: Raymond Vernon’s product life cycle-based explanation of international trade and foreign direct investment; Michael Porter’s diamond of competitive advantage; and Michael Best’s capabilities and innovation triad. In Section 5 we draw some general conclusions and suggest that Vernon’s simple PLC framework, although apparently superceded by the more sophisticated frameworks of Porter’s diamond and Best’s triad, continues to be relevant and to offer many useful insights into the later frameworks when they have been used to guide the design of industrial strategy in small open developing economies. 5 Business researchers tend to disparage as irrelevant the older approaches to trade and growth theory and to ignore the major advances that have been made in recent decades (refer footnote 2 previously). Economists tend to criticize the lack of formal testing of the validity of business frameworks (Kay, 1983). 6
  7. 7. [2] Trade and industrial policy: economic perspective A dominant view within economics is that all one has to do to promote faster growth or convergence between the regions of any state or between grouping of states is to put in place economic 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 the signing of the Treaty of Rome. Tariff barriers were removed in the original Common Market initiative in 1956. Next, non-tariff barriers such as border controls, restrictive public procurement 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 and recognition of qualifications) and of capital (exchange controls, banking regulation, etc.) have been removed, and the adoption of a single currency – the euro – was intended to promote increased competition through reducing transactions costs, lowering interest rates and increasing price transparency. If all these types of policies are implemented, then orthodox economic theory suggests that factor incomes (wages as well as the returns on capital) will tend to converge to a common level across all regions. So, if all markets were competitive, any initial regional disparities would eventually vanish and there would be no need for specific interventionist industrial policies. The above is the stylized version of economics that tends to be believed by business researchers. A reading of much of the business research literature leaves one with a general impression that international trade theory stagnated in the late 1970s, and that the insights it gives into modern patterns of trade and foreign direct investment are irrelevant at best, and wrong-headed at worst. The implied irrelevance of other branches of economic theory – such as growth theory and spatial economics – is presumably even greater, since these topics are seldom 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 to improvement with suitable policies; (b) Countries with similar or identical factor endowments can have deep trade links and exchange 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 alternative frameworks 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 of economic research have undergone radical transformation: trade theory (Helpman and Krugman, 1985), growth theory (Grossman and Helpman, 1991), and economic geography (Fujitsa, Krugman and Venables, 1999). The nature of the progress made has been summarized as follows by Paul Romer: 7
  8. 8. “In each of these areas, we have gone through a progression that starts with models based on perfect competition, moves to price-taking with external increasing returns, and finishes with explicit models of imperfect competition”. (Romer, 1994, p. 19) Far from being blissfully ignorant of the real world, and indifferent to the practical irrelevance of their theories: “Everyone knew that there was lots of intra-industry trade between developed nations and little trade between North and South. Everyone knew that some developing countries grew spectacularly while others languished. Everyone knew that people do things that lead to technological change. Everyone knew that the number of locally available goods was limited by the 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, growth theory and economic geography has been the suggestion that the conditions required for automatic convergence to take place are increasingly seen as not holding in practice. Recent economic research has focused attention on the importance of such factors as the size of the potential market, the initial level of physical infrastructure, levels of human capital, or on the fact that regions that start off at a structural disadvantage may never converge in any reasonable time period. Such theories go as far as to suggest that the removal of barriers to trade and factor movements may actually lead to a relative deterioration rather than an improvement of some regions (Krugman, 1991, pp.93-95). This is an area where significant theoretical advances have been made in spatial economics (Fujitsa, Krugman and Venables, 1999), a topic closely linked to the concept of “clustering” that is at the centre of business frameworks due to Porter (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 in these new fields of economics or to discuss the technical problems that had to be solved before a 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 research have not yet been incorporated into the insights and analytical tools of business research. As more accessible accounts of the new research begin to percolate into business research, it will be 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 be dominated by the economic perspective, drawing on recent theoretical advances.6 For example, five key factors are singled out in Frank Barry’s recent synthesis of the causes of Irish growth (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 the EU Structural Funds; iii. The extreme openness of the economy, export orientation to fast growing markets and products, together with benefits stemming from the completion of the Single European Market 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 business perspective (see Bradley, 2001 for further details). 8
  9. 9. iv. The changing demographic structure and the role of inward migration in preventing skill shortages; and v. A stable domestic macroeconomic policy environment. In terms of Irish industrial policy, there was a dramatic break with protectionist policies from the late 1950s, and much of the artificially sustained inefficient indigenous industry was subsequently allowed to fail. A tax-based competitive environment was initially created that was particularly attractive to foreign direct investment, creating space for improvements in the level of domestic physical infrastructure and human capital. These policies, after a slow start in the 1960s and a series of policy blunders in the late 1970s, eventually proved to be spectacularly 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 Irish convergence process have been jump-started much earlier in the 1960s? Was the success of the Celtic Tiger the inevitable outcome of a series of mainly economic policy decisions? How important and necessary was the degree of policy autonomy enjoyed by the Irish state? How important were the uniquely close cultural and linguistic relationships with the US, the source of most of the FDI into Ireland? How did it come about that a small number of key industrial sectors played such a crucial role in modernization? How are these sectors likely to evolve in the 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 membership force transformation externally? These and related questions can be addressed to some extent from within the economic perspective, but can also be examined within a wider more eclectic perspective of business research, to which we now turn. 9
  10. 10. [3] Trade and industrial policy: business strategy perspective It is not at all obvious that national industrial policy issues can usefully be explored from a business research perspective. But a recent book set out to address this challenge (Kotler, Jatusripitak and Maesincee, 1997 – henceforth, Kotler et al). The basic methodological assumption 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, can benefit 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 the approach will be one of designing a process within which a wide range of techniques can be organized and applied systematically. As with conventional business strategy, what is important is the organizing framework rather than the individual constituent components and techniques, 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 any analyst 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 wide range of business marketing strategy tools to a challenging new problem, namely promoting long-term national welfare as distinct from the welfare of an individual firm. Second, the approach provides another means of addressing the developmental challenges of small open economies like Ireland in a way that highlights some mainly organizational aspects that are glossed over – or simply ignored – in a purely economic-type analysis.7 Indeed, the small open economy in its relationship to the rest of the world economy has many similarities to the relationship 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 main elements: i. First, the issues that arise in formulating a nation’s strategic vision. These include inserting 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 on its strategic thrust, or how it can achieve its stated goals. ii. Second, the range of appropriate strategic postures. This amounts to a business strategy view of a range of policy initiatives that are mainly economic 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. iii. Third, aspects of strategic implementation, which requires consideration of the abilities of government to execute strategic policy and to function in partnership with business; the need 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 a facilitator of economic change, matters that are central to modern business research in Organizational Behaviour and Operations Management (O’Donnell and Teague, 2000). 10
  11. 11. 3.1 National strategic vision Strategic groups and global competition An important reason why groups of nations tend to adopt similar industrial strategies arises from basic similarities in their size and their stages of development. Ireland belongs to a group of smaller industrialized nations, in particular the smaller EU member states, whose main characteristic is that their domestic markets are too small to permit a competitive strategy based 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 in Figure 3.1 below, where: i. They are subject to fierce competition in simple products based on mature technologies from the newly industrialized countries (NICS) of Asia (area A of Figure 3.1). ii. Their indigenous manufacturing is effectively excluded from markets for complex products, based on new technologies, where the “superpowers” are dominant (area C of Figure 3.1).8 Area C is itself increasing as traditional sectors (Benetton in textiles and clothing) themselves adopt new technologies. iii. Area B of Figure 3.1 – the natural domain of smaller industrialized nations - is therefore being squeezed in both directions. Only when their industries are dominated by foreign multi-national enterprises are they likely to be capable of sustaining global competition. These sectors in Ireland – computers, software and pharmaceuticals – are almost all foreign 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 they already have a comparative advantage (obtained either through low cost production capability arising 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 class multi-national enterprises, but these tend to be exceptions in the context of most small countries. 11
  12. 12. new area where the potential benefits may be greater. Kotler et al distinguish four types of strategic 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 a capability 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 that have a relatively low level of wealth but possess, or can develop, strong international competitiveness. The strategic goal is to move up the ladder of relative income per head. For a small nation like the Ireland, with wage levels that were initially low relative to the USA and the 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 wage costs; 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 to encourage inward investment; iii. A strategy of continual improvement in quality and towards ever higher value-added activities. National strengths and weaknesses The central purpose of a SWOT analysis is to “identify strategies that align with, fit or match a company’s resources and capabilities to the demands of the environment in which the company operates” (Hill and Jones, 2001, p.8). Kotler et al adapt the technique for application to national capabilities, and identify five main categories: i. Culture, attitudes and values; ii. Degree of social cohesion; 12
  13. 13. iii. Factor endowments; iv. Industrial organization; v. Government leadership. The degree to which a nation can either develop its own domestic capabilities into manufacturing strengths, or can link its domestic capabilities synergistically to those of other nations, will determine its path of development and success. But a problem with this classification is that four of the five categories are qualitative and vague, and only one – factor endowments – can be rigorously quantified. In the economic research literature, attempts have been 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 are fundamentally related to differences in social infrastructure across countries”. By social infrastructure they mean: “the institutions and government policies that determine the economic environment within which individuals accumulate skills, and firms accumulate capital and produce output” (Hall and Jones, 1999, p.84).9 Differences in the amount and quality of factor endowments 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 at best only be suggestive of insights into why adopting any approach to building national competitive advantage works better in some countries than in others. For example, the same national cultural attitudes and values that were commonly used to explain Japanese capabilities during 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 it did in the less open, less technologically intensive environment of the 1960s, 70s, and 80s. Many of Japan’s strengths have become weaknesses, Its deeply ingrained social and cultural norms seem inconsistent with the innovation, entrepreneurship, and risk taking that are the hallmarks of today’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 obtain additional wealth” (p.143). Threats, by contrast, are: “challenges posed by unfavorable trends or developments economically, politically, or socially that would lead, in the absence of the nation’s defensive action, to a deterioration in wealth” (p.144). Here the analogy with marketing 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 forces and 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 and repudiation of contracts) and a measure of openness to international trade (Hall and Jones, 1999, pp.96-99). 13
  14. 14. But of course, large nation states can also seek opportunities, and face threats, from internal developments within their own domestic economies. Only in small and micro nations like Ireland and Singapore is the global economy completely dominant, and is the health of the domestic (or internal) market almost completely driven by external trade. In the case of Ireland, the early dismantling of tariff barriers ensured that the economy would be forced to adjust rapidly to a more open world trading environment. The rise of the EU (which Ireland joined in 1973) was both an opportunity (in that it gave automatic access to the huge EU market) and a threat (in that there was a risk that Irish manufacturing would find it difficult to compete in the new open market). But the opportunity was realized (mainly through attracting a high level of export-oriented FDI), and the productive capacity of the economy greatly enhanced through imported technology and “learning-by-doing” experience with new productive processes. 3.2 National strategic postures Having reviewed how a nation should go about designing its strategic vision, the second part of Kotler et al’s methodology examines the types of practical policies that would be needed to improve the performance of the national economy. Their range of policy initiatives are mainly economic 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 forces include the emergence of a “borderless” world due to trade liberalization and the emergence of the triad of supranational trading blocs (EU, NAFTA, ASEAN). Global industries have also emerged, which operate in all parts of the world and create a new international division of labour. With falling transportation and telecommunication costs, national economies were destined to become increasingly interdependent, and: "the real economic challenge ... [of the nation] ... is to increase the potential value of what its citizens can add to the global economy, by enhancing their skills and capacities and by improving their 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 by governments. Production tends to be modularized, with individual modules spread across the globe so as to exploit the comparative advantages of different regions. Hence, individual small nations and regions have less power to influence their destinies than in previous periods of industrialization, 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 should direct the inward investment flows into sectors and regions in such a way as to maximize the long-term benefit to the host nation’s economy. The appropriate policies can be considered using three elements of the marketing mix. 14
  15. 15. Product: Just as in the case of designing an attractive product, the attractiveness of the country as a host for FDI is an essential element of strategy. Standard frameworks used for analysis of attractiveness 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 the capital and operating costs of the investor. They include low rates of corporation and other business 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 a good location for investment; the targeting and delivery of specific projects; and the support and servicing of existing investors. Policies to encourage industrial clusters Kotler et al define an industrial cluster as: “a group of industrial segments that share positive vertical and horizontal linkages” (p.201). There are two types of vertical linkages: forward linkages between the focal industry and its downstream industries; backward linkages between the focal industry and its upstream industries. Horizontal linkages connect a focal industry with other 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 driving national competitiveness through the spill-over benefits of user-producer contacts and information 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, in small open economies like Ireland, cluster formation usually has to be fostered explicitly by policy and the promotional agencies. Development of the national industrial portfolio In corporate development, portfolio analysis is used to review the range of existing activities with a view to deciding on entry, exit and continuation strategies. Kotler et al carry the techniques of corporate portfolio analysis over to the analysis of the portfolio of the industries in a nation’s economy. They suggest a three-step process: Identification of industrial development determinants: This involves examination of the determinants of industrial attractiveness (e.g., high value-added per worker, linkages between industries, future competitiveness, export potential, etc.) as well as the ability to compete. The ability to compete, in turn, depends on factor competitiveness and firm competitiveness, and the strategic 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 most elaborate offered anywhere in the world”, and that “these incentives, plus Ireland’s membership of the EC and the excellent marketing efforts of the Industrial Development Authority of Ireland have resulted in hundreds of U.S. companies building plants in Ireland” (Kotler et al, pp.191-92). 15
  16. 16. 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, since infrastructure and human capital tend to generate large public as well as private returns. The improvement in firm competitiveness is mainly the responsibility of businesses (although assisted by the public sector) through entrepreneurship, R&D and investment. The outcome leads to the evolution of the national portfolio of industries. If the portfolio is drawn as an analogue 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 over representation detected. Formulating the industrial vision: For each industry, Kotler et al suggest drawing up an industry planning map, shown in Figure 3.4 below. The three axes include an investment strategy (derived from a standard product portfolio analysis), the market boundary (based on the competitive intensity of the industry as well as the nation’s ability to compete), and the factor intensity of the industry. In the case of Ireland, the industries inherited from the era of protection (1932-1960) were bounded by domestic consumption, used low-skilled labour, and were doomed for “harvesting” after the economy was opened to foreign direct investment in the early 1960s. The early wave of inward investment in medium-technology industries (electromechanical, food processing), was bounded by regional (mainly EU) consumption, used medium-skilled labour and modest capital, and gave rise to selective investing. Later waves of inward investment were in high-technology industries (computers, micro-processor chips, computer peripherals, software, pharmaceuticals, etc.), used a significant proportion of skilled labour, were capital and knowledge intensive, were destined for a global market, and penetrated new and related sectors. 16
  17. 17. 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 government pursued a vigorous policy of attracting suitable export-oriented industries to invest and produce in the country. In the early stages of the FDI strategy, efforts were made to attract a wide range of industries, often in the mature stage of the product life cycle, but as the competitive position of the country improved, a more selective approach was adopted. Today, the support strategies are designed to attract industries that are in the growth stages of their product life cycle, when profitability is high. Other policies A range of other policies are examined by Kotler et al, but are less significant in the case of Ireland. For example, trade policy is no longer an issue, since Ireland is inside the EU and cannot (under EU and WTO rules) experiment with trade-related policies like tariffs and quotas. 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 not very relevant for the mainly export-oriented industries. Ireland pursues policies of improving its 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 differences that 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 context where government policies are largely exogenous, and firms address the challenges of assessing 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’s wealth-building strategy (Kotler et al, pp.329-344). So, this issue is usually examined largely from 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 Irish industrial development agency – the IDA – was constantly scanning the world for inward 17
  18. 18. investment in high technology sectors. Quite often the domestic environment initially was not sufficiently attractive to persuade leading-edge firms to locate in Ireland. But information on firms’ needs were fed back to the Irish government authorities by the IDA, and major policy changes could be executed rapidly. 11 The national wealth creating strategy in Ireland often needs to adapt to the requirements of firms in the global corporate environment, and not the other way around. Hence, the strategic challenges facing small open economies like Ireland are very 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 in Section 4. Among the many roles of the state, the most crucial for the purposes of ensuring an appropriate industrial strategy is its role as “organizer” (Kotler et al, pp.388-93). This involves four elements: Assessing a state’s strengths and weaknesses: The state can play a crucial role in shaping and reshaping 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); sectoral diversification versus sectoral concentration; the optimal pace of change and renewal (shock versus 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 crucial internal relationships are between government and the social partners (i.e., trades unions and employers’ organizations) on the one hand, and with foreign MNEs on the other. The Irish experience shows that, although MNEs often have turnovers larger than the national GDP, the relationship 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 in Ireland takes place almost entirely under the auspices of the EU, where Irish government Ministers and civil servants negotiate with other member states, and are part of external EU negotiations where their domestic interests are affected. 3.4 Summary Kotler et al attempt to connect macroeconomic public policy with the microeconomic behavior of industries, firms and consumers, as well to apply strategic planning to the building of national wealth. For all its faults, it is a study that is useful for economists in that it invites them to place economic research within a wider business strategy framework. This does not always come easily to economists! The other aspect of Kotler et al’s framework involves a careful identification of the role of the state as “strategic organizer”, in the assessment of strengths and weaknesses, in recognizing the trade-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 massive resources were put into the education of electronic engineering and chemistry to create a skilled labour force for potential inward investors (MacSharry and White, 2000, pp. 283-285). 18
  19. 19. relationship, and in ensuring that government-government co-operations maximize domestic wealth creation. It is striking that they do actually assign such an important role to the state in an era when the dead hand of government interference is almost universally castigated, at least in the Anglo-American world. The recent experience of the transition economies of Central and Eastern Europe would tend to confirm their judgment. The role of government as “strategic organizer” in a global economy driven by market forces is very different from the previous role of Communist governments as “central planners”. Government as “strategic organizer” carries out its functions in collaboration with private businesses and not as a substitute for the market economy. The Irish case suggests that where this collaborative role is strongest, industrial development is most rapid. 19
  20. 20. [4] Three influential industrial policy frameworks The success of Ireland’s industrial strategy was due in large part to the innovative and flexible behaviour of government policy makers as well as to the expertise and dynamism of the state’s development agency (the IDA). However, policy makers are usually most effective when they are, so to speak, swimming with the tide of events rather than against it. Irish policy making was, to a considerable extent, pragmatic and opportunistic. But it was characterized by a form of pragmatism that appears to have been singularly in tune with the best thinking on international 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 played in Irish industrial development. It is important to emphasize that these three frameworks are not fully articulated “theories” in the sense used by economists. Rather, they should be regarded as organizing frameworks to guide and direct policy action. They serve to link different explanatory elements in a way that breaks out of the strait-jacket of any narrow exclusive point of view. They tend not to have universal validity, but are sensitive to time and place. They are difficult 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 process where “products come into existence, change in character, and eventually disappear or become altered out of all recognition”.12 Not all products follow a rigid path of birth, growth, maturity and 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 is Vernon (1966). Vernon’s main insight was to link the product life cycle with explanations of international trade and foreign direct investment. Standard trade theory offered little by way of explanation of how US foreign direct investment came to dominate the post-war European economy. Vernon realized that the US home market played a dual role: it was the source of stimulus for the innovating firm as well as the preferred location for the actual development of the innovation. At the early stage of the product life cycle, producers need great freedom and flexibility to modify, test and improve new processes at a time when the preferred production technology has not yet stabilized. Also, demand for innovative products tends to be relatively insensitive to price, so there is less pressure to seek lowest cost production locations. Finally, communications between producers, suppliers and final customers must be facilitated, and argues for a home location. As the product matures, a certain degree of standardization takes place, and this has locational implications. The need for production flexibility declines and there is now a greater concern for lower costs. Also, demand from abroad increases. However, as long as the marginal production cost plus the transport costs of shipping from the US to the foreign market is lower than the average cost of prospective production in the market of import, ceteris paribus, there will be no pressure to invest in foreign production capacity and markets will be served by exports from the US. But as economic and political pressures build up, eventually some production moves abroad, initially into the larger more developed economies like the UK, 12 New Palgrave Dictionary of Economics, 1987. 20
  21. 21. 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 cost considerations become paramount, production ceases in the US, declines in other developed economies, 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 in the 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 for product development and launches to aim at global market coverage from the start, and for elements of the value chain also to be produced abroad from the start. Nevertheless, the product life cycle continues to provide very useful insights into the reasons why certain types of foreign 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 and FDI, drawing attention to the fact that advances in technology had led to product life cycles that were 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 as it 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), influences were spread over many more markets. Vernon referred to these factors as “environmental 21
  22. 22. changes” (the decline in the role of the US home market due to convergence of income levels throughout the developed world), and “network spread” (much earlier transfer of technology between a global network of self-standing MNE subsidiaries). Vernon suggested that multi-national enterprises could usefully be classified into two different ideal types. First, “global scanners” innovate and transfer technology instantaneously and costlessly between any parts of the globe, and there is little or no explanatory role for a product cycle hypothesis. But, of course, the acquisition and dissemination of technology is not costless. Second, “global standardizers” consist of firms that develop and produce a line of relatively standardized products which respond to a homogeneous world demand rather than to the 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 and pharmaceuticals. Such firms can save on the costs of segmented market research, and benefit from economies of scale in global production. With respect to the role of the product cycle, Vernon pointed out that two opposing forces operated for firms who are “global standardizer’s”: “Firms in (the first) category, innovating for a global market, are obliged to play their innovation gambles for relatively heavy stakes. Accordingly, they can be expected to maintain the central core of their innovational activities close to headquarters, where complex face-to-face consultation among key personnel will be possible; in this respect, such firms are likely to perform consistently with 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 both advanced industrialized countries and developing countries, and to cross-haul between plants for the 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 “global standardizers” (spread across both of the above categories) in the fields of computers, related software, pharmaceuticals and chemicals. Success in attracting these firms to Ireland came primarily from the fact that they were initially targeted by the IDA at a relatively early stage in their (technological) life cycle, immediately after the new product development stage. For example, as early as 1979 the IDA was among the first national agency to lobby the Apple computer company to produce outside their US home based and to come to Ireland (MacSharry and White, 2000, pp.202-03). The subsequent systematic targeting of the makers of each individual component of computers – keyboards, hard disks, cables, mice, printers – as well as software, meant that the rapid growth of the modern manufacturing sector was heavily concentrated on a narrow range of technologies at early stages of the product life cycle. In this sense, the process represented a classic example of the PLC model of foreign direct investment.13 Vernon’s PLC framework was proposed at a time when conventional trade theory appeared to offer little or no insight into why and how FDI occurred. Although it stepped outside the scope of contemporary economic theory, subsequently Krugman proposed a simple general- 13 A detailed analysis of the Irish computer sector is available in Bradley (2001). 22
  23. 23. equilibrium model of product cycle trade (Krugman, 1979), and the product cycle has recently been 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 of technical change. Economic models are conventionally designed to study the kinds of technical change which increased production efficiency of a given range of goods. The PLC stressed the role of technical change in the development of new products. Hence, the economic issue underlying the PLC concerns the nature of international trade when the pattern of trade is determined by a continuing process of innovation and technology transfer. Krugman constructed a stylized model that consists of two countries: an innovating North and a non-innovating South. Innovation takes the form of the introduction of new products which can be produced immediately in North but only after a lag in South. This is simply assumed in Krugman’s model, but can be rationalized in terms of a more skilled labour force, external economies and social capital. The lag in adoption of new technology by South is what gives rise to trade. The implications that emerge from Krugman’s model are very different from those of conventional (pre-1980) trade theory. New industries continually emerge in the developed North region and continually disappear in the face of low wage competition from the less developed South. Thus, the decline of industries in the developed North will be a recurrent event and is efficient in terms of the world economy. Also, developed countries must continually innovate, not just to grow, but even to maintain their real incomes. For less developed countries, the model implies that the transfer of technology, in addition to direct benefits, brings indirect benefits of improved terms of trade. However, success by the less developed South in accelerating their adoption of new technology can leave workers in the North worse off and hence create protectionist pressures. The work of Grossman and Helpman (1991) generalizes the treatment of industrial innovation as the engine of long-run growth. Particular attention is given to interdependencies between the learning processes in the industrialized North and the developing South. As in the case of Krugman’s model, most learning in the South takes the form of imitation of technologies previously developed in the North, rather than invention of entirely new products and processes. Such imitation gives rise to product-cycle trade, as goods initially are invented and produced in the North, and then copied and exported by the South. An interesting question concerns feed-backs between the processes of industrial learning: does faster imitation by the South impede innovation in the North, and does more rapid technological advance in the North spill over to the rate of growth in the South? What Grossman and Helpman show is that Southern imitation tends to reduce the Northern monopoly power and slows innovation in the North. But in addition, the faster the rate of Southern 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 in their local factor markets, and have higher profits. But when the North produces both traditional 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 23
  24. 24. the US dominated the design of advanced products. Michael Porter set out to address a series of wider questions: “Why (do) firms from a particular nation establish leadership in particular new industries? What happens when demand originates simultaneously in different nations? Why is innovation continuous in many national industries and not a once-and-for-all event followed by inevitable standardization of technology as the product cycle theory implies? … How can we explain why some 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 the environment in which national firms compete (Figure 4.2), with an ancillary role played by governments and by chance. Factor conditions refer to the availability and quality of the factors of production such as skilled labour, infrastructure, etc. Demand conditions refer to the nature of local and external demand for the industry's product or service, where local demand can play a vital role in encouraging product innovation and improvement. Related and supporting industries refer to the presence or absence of supplier industries and related industries that are also internationally competitive. Firm strategy, structure and rivalry refer to 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 were different stages of competitive development during which different elements of the diamond came into play (Figure 4.3). 24
  25. 25. Figure 4.3: Porter’s stages of competitive development (Porter, 1990) At the early stages, competitive development is driven by factor conditions, and draws on low cost labour and/or abundant natural resources. The next stage is investment driven, and draws from factor conditions, demand conditions as well as firm strategy, structure and rivalry (i.e., from three of the four diamond elements). In the next stage, competitiveness is innovation driven, and draws systematically from the entire diamond. Using Porter’s four-stage development process, one can classify a range of national development strategies as shown in Table 4.1. Table 4.1: Porter’s stages of national competitive development Key driver Source of competitive advantage Country examples Factor Basic factors of production (e.g., South Korea, Singapore and conditions natural resources, lower skilled Ireland (before 1980s) labour) Investment Capital equipment, transfer of Japan (during 1960s) technology South Korea (during 1980s) Ireland (after 1980s) Innovation All four elements of Porter’s Germany, Sweden (post-war) “diamond” 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 the emphasis he places on the interactions between the four elements of competitiveness and the detailed study of individual successful nations, regions and industries that illustrate these interactions at work. In particular, his approach has strong implications for the design and execution of national industrial policy (Porter, 1990, chapter 12), and provides a useful checklist of what types of policy intervention are likely to improve the individual elements of the diamond as well as their interaction. The analytical work of Michael Porter on competitive advantage has been highly influential in the recent reformulations of Irish industrial 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 of Ireland (Culliton, 1992), and by the Northern Ireland Growth Challenge (NIGC, 1995). 25
  26. 26. 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 colour industrial strategic thinking in Ireland. Porter's competitive framework - the current business strategy orthodoxy throughout most of the developed and developing world - suggested that a country 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 25 years in Ireland, from the late 1950s to the mid 1980s, and was "factor" driven, based on policies of low rates of corporation tax, low wages, and subsidized capital formation. The second stage has lasted from the late 1970s to the late 1990s, during which there has been massive public and private investment in plant, infrastructure and human capital, co-funded generously through EU regional aid from 1989 onwards. Policy-makers are now seeking to shift to Porter's third (innovation driven) stage. But this has exposed some of the limitations of an 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 Porter assigns great significance to indigenous firms and local markets. More ominously, he asserts that: “A development strategy based solely on foreign multinationals may doom a nation to remaining a factor-driven economy” (Porter, 1990, p.679) and that “Except when it is largely passive, widespread foreign investment usually indicates that the process of competitive upgrading in an economy is not entirely healthy because domestic firms in 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 important issue. In its crudest interpretation, Porter is simply re-stating the implication of Vernon’s early work on the PLC. In other words, if Ireland displays behavior like the less developed region in Vernon’s model of the PLC (see above), it will always remain an underdeveloped country that competes in low cost production of maturing products. But we have seen that Vernon 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-specific production processes and product technologies. But an even greater degree of integration of policy appears to be needed in a "borderless" world. We now examine one such framework, due to Michael Best. 26
  27. 27. [4.3] Best’s capability triad What Michael Best offers in his capabilities and innovation perspective - henceforth, the capability triad - is a new and sophisticated strategic framework for the development of industrial policy. The grounds for this synthesis were laid in his earlier book on The New Competition, which was directed more at the limitations of the conventional neoclassical theory of the firm than at the dominant business taxonomies and frameworks (Best, 1990). In a recent report written for the Northern Ireland Economic Council (Best, 2000), he has applied this framework to Northern Ireland, but of course it is equally relevant to other regions and countries. His latest book, The New Competitive Advantage (Best, 2001), uses it to explain the revival of the Massachusetts Route 128 technology complex and the rise of the electronics industry 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 the triad describes how entrepreneurial firms grow, based on the creation of new firms through technology diversification, inter-firm networks based on open systems, and regional specialization based on technological capabilities. The production capabilities element of the triad integrates ideas from operations management and operations strategy into a logical system of production system models that drive home the lesson that competitive strategy and productive systems are bound together. The skill formation element of the triad, in addition to providing a vital direct input into production, is what serves to enhance the synergistic interaction 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 public policy as being almost completely and seamlessly blended into the detailed mechanics of change processes that occur within private firms.15 In this framework, as well as in Porter's diamond, public policy and private entrepreneurial actions do not operate in isolation from each 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 public policy, 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). 27
  28. 28. the changing demands of the economy as it develops. Even here, the links between public and private activity are crucial.16 An obvious question to ask is how the capability triad, if indeed it is a universal process, has operated 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 policy initiatives, where there may be some degrees of freedom and scope for action? On the other hand, 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 direct policy influence? In the case of Ireland, as it addresses the new challenges being faced by the computer 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 like meteorology 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 both structure and content to strategy design. Strategy has been defined as: "the evolution of a central idea through continually changing circumstances”. (Welch, 2001, p. 448). The central idea proposed by Best is that industrial strategy should be guided by the capability triad. For example, towards the end of his report on Northern Ireland industrial strategy, Best sets out policy proposals for how such a strategy might be taken forward, and we illustrate these schematically in Figure 4.5. For the purposes of exposition, three proposals are portrayed as being directed mainly at improving the business model aspect of the triad; three at the capability development element; and two at the skill formation element. Of the remaining two proposals, one concerns a general need to link improvements in all elements of the triad; and one concerns a very specific need for synergies between technology management and skill formation. How are policy makers likely to react to Professor Best’s ten policy proposals? Some will buy into the organizing framework and direct their energies towards the search for what one might call “triad-compatible” practical policy initiatives. But others may react with frustration that the proposals do not resemble the usual detailed shopping list of very specific policy recommendations that often dominate orthodox policy documents. For example, how helpful is it, 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 proposals focused on the three interacting elements of the capability triad, this recommendation opens the floodgates 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 training intervention, those closely linked to the market were most effective in combating unemployment while in contrast, training of a more general nature did not, on its own, appear to have an enduring beneficial effect. 28
  29. 29. Figure 4.5: Policy proposals linked to the capability triad Apply principle of systems integration Concentrate on Business entrepreneurial firms model Diffuse high performance work organisation Foster open networks Administer the research, technology development Skill Capability triad: and innovation infrastructure formation Policy proposals Link visible and invisible colleges Develop technology management capabilities Capability Partner with firms bringing development inward investment to advance capabilities Integrate mission-driven diffusion agencies with industrial policy goals Integrate technology management and skill formation Based on Best, 2000, pp.68-76 How many of the existing Irish firms are truly entrepreneurial, or could become so in the future? Should the Irish development agencies attempt to pick entrepreneurial winners? Conventional economic advice exhorts us to leave this task to market forces. But Best’s detailed review of policy design and implementation in the Massachusetts Route 128 area and in Malaysia, provide convincing evidence that there is indeed a crucial strategic organizing role for government in order to ensure the creation of conditions that favour the growth of a population of entrepreneurial firms. At the very least, such a role should be used by governments 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 sectors where 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 future desirable 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 29
  30. 30. going to be dominated by the role of the market. 17 As firms move up the production capabilities 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 the advisability 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 the barriers that Ireland’s small firm (SME) economy faces in moving up the production capabilities spectrum towards best industrial operations practice. In order to advance the debate on industrial policy in Ireland, it may be useful to map the essential elements of any policy analysis and recommendations into Best's capability triad framework. 18 Many benefits would flow from such a mapping. The completeness and closure of 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 logical framework for dialogue and debate within the Irish Social Partnership. A rich database of international industrial experience (from Route 128, Malaysia, the so-called Third Italy) would become 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 organizing rigor from economic theory, it will provide a means of synthesizing insights from both approaches. The most important policy implication to emerge from Best’s capability triad framework is that any overall programs of change in the area of industrial policy require the close integration of the change programs in each of the elements of the triad: “Rapid growth involves coordinated organizational changes in each of three domains: the business model, production capabilities, and skill formation. … The three domains are not separable and additive components of growth, but mutually interdependent sub-systems of a single developmental process. … No one of the three elements of the Capability Triad can contribute to growth 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 the triad before growth can take off. Porter, on the other hand, had suggested that the elements of his diamond could be picked off one by one, leading to a sequential process of growth, as illustrated in Figure 4.3 above. Although Best’s framework requires a degree of sophistication and co-ordination for policy makers that is more demanding than Porter’s framework, it appears to be more soundly based on a close integration of insights from economics and business and does not suffer as much from the “big economy” perspective of much of Porter’s work. [4.4] Summary on industrial strategy frameworks One must approach these three policy frameworks with an understanding of their historical origins and their necessary simplifications. Unlike scientific theories, where a single wrong prediction 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 that there is a role for the state, but this is likely to be dominated by the activities of the individual firms themselves. 18 Best's capability triad can also be considered within the wider concept of a learning region. An application to the Øresund region of southern Sweden and Denmark is described in Maskell and Törnqvist, 1999. 30
  31. 31. observations, these three frameworks simply look at industrial development issues from different perspectives, and place emphasis on different factors. The PLC stresses the primacy of the country that provides the source of FDI, and the dependency of the host countries. This had more universal acceptance in the 1950s and 1960s than it does today, but it continues to apply to small open economies like Ireland, Portugal, Greece, as well as the newly liberalized transition economies of Central and Eastern Europe. The Porter diamond explains the development process in a world that consists of many relatively large and developed economies, and takes up where the PLC leaves off. But it continues to insist that sustained development is crucially dependent on the domestic market, and cannot be based simply on supply chain linkages to the global economy. The capability triad of Best selects a very different set of factors that it asserts are the primary causes of development, and further requires simultaneous advances in all three. The logic of each of these three frameworks has operated in Ireland in overlapping ways, with differing degrees of emphasis at different times. 31
  32. 32. [5] Conclusions Luck plays a large part in industrial strategy. The expected external conditions needed to support success do not always conveniently arrive, and their absence may frustrate otherwise admirable policy initiatives. Nor is the true significance of the internal elements of a strategy always fully understood even by its own designers. But luck and chance, however random, can be handled best within well thought out and coherent frameworks that take full account of the nature of the external environment (opportunities and threats) as well as realistic views of domestic 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 public and private sectors to bring focus and synergy to the disparate policies that make up broad industrial strategy in a small open economy like Ireland. At the risk of oversimplification of what are very complex issues, what the recent industrial performance in Ireland shows is that the intelligent combination of economic policy and business strategy can generate huge synergies in terms of rapid national growth and convergence. To achieve these synergies requires a degree of economic policy autonomy that can be used, for example, to protect workers who lose their jobs in declining sectors and who require extensive retraining for other occupations. But more importantly, policy autonomy needs to be directed at addressing weaknesses shown up by frameworks such as Porter’s and Best’s. In the autumn of 2001, hardly a week passes without gloomy news about another electronics plant downsizing its labour force or closing. In this paper we have probed deeper into some of the background issues involved. Clearly, there is more going on in the Irish computer sector today 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 and technological factors that have begun to affect the Irish computer industry adversely, and these underlying strategic concerns need to be better understood. The high technology sector, in particular computers and electronic components, is predominantly foreign owned. Hence, the forces that drive innovation in products and manufacturing processes tend to originate in the USA rather than in Ireland. It is this feature that presents the most serious threat to the survival and progress of the sector. A hint of how the IDA is moving to deal with this incipient maturity problem was contained in a 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 than necessarily 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 the basis for the earlier success of Dell in creating a high profit computer firm in an area that looked as if it was reaching maturity in the late 1980s. Enterprise 2010 appears to envisage a wider application of global outsourcing, with Ireland at the high added-value core of production activities. An obvious problem with this strategy is that while it may be suitable for electronics or certain types of pharmaceuticals, it may not always be suitable for alternative types of manufacturing activity, such a bio-technology. Furthermore, Porter’s framework suggests that this approach is fraught with difficulties and would leave Ireland vulnerable to changes in technology. Best’s framework suggests that such an approach will require a very 32
  33. 33. high standard of integration and excellence in all aspects of the economy. Either way, the suggested new approach of marketing Ireland as a “network” location in a type of post- industrial age will be a major challenge. 33
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