Jan Fagerberg
8.1 Introduction
Why do some countries maintain higher levels of competitiveness than other countries? What are the crucial factors behind such differences? Which poli-cies can governments pursue to improve the relative performance of their economies? Questions such as these motivate concerns regarding the compet-itiveness of countries. Although the concept of country competcompet-itiveness has proven to be controversial, the importance of the underlying challenges makes it unlikely that this issue will lose the attention of policymakers soon.1 The competitiveness term may be applied at several levels. It may relate to a country, a sector (or industry) within a country, or a singlefirm. When applied to a country it usually takes on a double meaning, relating to both the economic well-being of its citizens, normally measured through GDP per capita, and the trade performance of the country.2When applied to a sector or industry, however, competitiveness is normally defined as export speciali-zation. Hence, a country is said to be competitive in a particular sector if its share in world trade (of products from that industry) is above that of the average for the country. As discussed in greater length by Michael Porter in his book The Competitive Advantage of Nations (1990a), competitiveness on different levels of aggregation may be related. For example,firm- and/or sector-level features may affect competitiveness at the national sector-level and vice versa.
Traditionally, textbook explanations of specialization patterns in interna-tional trade have focused on differences in supply conditions. Countries, it is argued, tend to specialize in areas of production that make intensive use of
factors of production with which the country is relatively well equipped.
However, empirical research has shown that the explanatory power of this type of theory is limited. This initiated an active search for alternative ap-proaches from the early 1960s onward. Many of the new theories which were developed (often labeled‘neo-technological’ theories3) came to focus on dif-ferences in technological capabilities across countries and sectors as the main explanatory factor behind the observed differences in patterns of export specialization. This focus is now widely shared, among many‘mainstream’
economists also, and is supported by a large amount of empirical research.
However, what causes technological capabilities to differ often remains unexplained.
The publication of The Competitive Advantage of Nations by Porter in 1990 led to increasing attention being given to the favorable impact that the domestic market, through ‘advanced domestic users’, may have on the international competitiveness of a country. It was argued that interaction between users and producers of technology acts as a major impetus to technological change. Inter-action, however, involves costs. These reflect, among other things, the stabil-ity of the user–producer relationship and the degree of ‘proximstabil-ity’, defined to include factors such as language, the legal system, the education system, and so on. Hence, most stable user–producer relationships are of a national char-acter. The above, together with the assumption that a country’s comparative advantage in the long run will be in areas where its rates of learning and innovation are high (compared to other countries), suggests that countries in the long run tend to develop comparative advantages in areas where, by a comparative standard, there are many advanced domestic users.
The idea that the domestic market may affect competitiveness positively is by no means a new one: it dates back at least to List (1841). However, neoclassical trade theorists have normally regarded it as ‘theoretically unsound’ and as a cover for protectionism. This chapter presents a critical appraisal of the theoretical and empirical evidence based on the hypothesis of a positive impact of domestic market, through‘advanced domestic users’, on the international competitiveness of a country.
8.2 Why should‘advanced domestic users’ matter?
Most attempts to explain the specialization patterns of countries in interna-tional trade have focused on supply conditions. According to the standard neoclassical theory of international trade, countries ought to specialize in areas of production that make intensive use of factors of production with which the country is relatively well equipped. In spite of the dominant role played by traditional neoclassical theory in this area, there has always been a strand of Competition, Competitive Advantage, and Clusters
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thought that has emphasized learning as a potential source of comparative advantage. This tradition points to the potential effects of relations between firms or sectors, within the domestic economy, on innovation and learning, and the impact of this on the international competitiveness of the country and its specialization pattern in international trade.
The idea that the structure of the domestic economy, or links betweenfirms from different sectors of the economy, may have a bearing on competitiveness has a long tradition in economics. List (1841) in his famous defense for protectionism pointed to the positive impact that such relations may have in the process of industrialization. Perroux (1955), combining a Schumpeter-ian and‘structuralist’ perspective, arrived at similar conclusions in his analysis of industrial development (‘growth-poles’). Hirschman (1958) made ‘linkages’
one of the most influential concepts in development economics. Linder (1961), to whom we will return below, discussed the implications of such relations for trade theory. Mistral (1982), working in the French structuralist–
institutionalist tradition, coined the concept ‘structural competitiveness’ to cover the positive impact that relations between different sectors of the econ-omy have on national export performance.
The precise nature of the assumed relationship between ‘structure’ and competitiveness is of course not the same in all these contributions. Nor is it always clear why some links have a greater positive impact than others. An interesting interpretation is presented by Linder (1961). His argument runs as follows. First, a need that cannot be sufficiently satisfied by existing products arises on the demand side. Since entrepreneurs for various reasons (culture, language, proximity) tend to be better informed about developments in the home market than in markets elsewhere, they will usually be thefirst to react to the demand for new or improved products arising in the domestic market. The outcome of this activity– the innovation – then enters a period of testing and revision in which the home market is assumed to play a critical role.
Whether it is a question of‘critical revision’ of an invention or a product develop-ment work in general, it must be carried out in close contact with the market . . . If, for some odd reason, an entrepreneur decided to cater for a demand which did not exist at home, he would probably be unsuccessful as he would not have easy access to crucial information which must be funnelled back and forth between producer and consumers. The trial-and-error period which a new product must almost inevitably go through on the market will be the more embarrassing costwise, the less intimate knowledge the producer has of the conditions under which his product will have to be used. And, if there is no home demand, the producer will be completely unfamiliar with such conditions. (Linder 1961: 89)
Linder assumes that the introduction of the product in the export market will have to wait for this testing in the home market to be completed. However, if Domestic demand, learning, and The Competitive Advantage of Nations
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the product is successful at home it will probably be a success on the export market too (Linder 1961: 88). The evolutionaryflavor of the argument is quite obvious: entrepreneurs strive to solve problems that arise in their environ-ments (domestic market); learn as possible solutions (innovations) are pro-posed, tested, and improved; and eventually – on the basis of accumulated experience– penetrate foreign markets as well.
Linder has also pointed out that the importance of‘the home market’, as discussed above, varies across countries, sectors, and products. For instance, he did not expect this to be very important in developing (or semi-industrialized) countries, nor did he expect it to contribute much to the explanation of differences in trade performance in standardized (or, more generally, ‘non-innovative’) products (Linder 1961: 90). In these cases he expected other factors to be more important. Thus, what is discussed here is not a general theory of export specialization, but a partial one that may (and should) be combined with other approaches.
Porter (1990a) presented an evolutionary scheme of economic development based on similar ideas. Echoing Linder, he argues that traditional supply factors, although important in the earlier stages of development, are not among the prime determinants of‘competitive advantage’ in more advanced countries, where growth is assumed to be innovation-driven. The most com-petitive industries in an advanced country, he argues, tend to be highly integrated (‘clustered’), both vertically and horizontally, with favorable con-sequences for learning, innovation, and‘competitive advantage’. In Porter’s scheme, this typically starts with integration between customers in traditional industries and suppliers of machinery and other types of advanced equip-ment, then widens through spillovers and feedbacks to and from related and supporting industries (Porter 1990a: 554–5).
Porter, along the lines of Linder, contends that a high degree of integration between customers and suppliers (or users and producers) affects international competitiveness positively. This hypothesis is intuitively appealing, and there is a large amount of descriptive evidence that can be used in its defense (see Porter 1990a). However, in spite of the growing popularity of this approach, many still probably feel that it is a phenomenon in search of a theory.
It is assumed that the development of new technology in many cases requires close communication and interaction between the users and produ-cers of technology (Lundvall 1985, 1988). To achieve this end, a channel– and a common code– of communication must exist. The establishment of chan-nels and codes of communication involvesfixed costs, and this implies that in a stable user–producer relationship, the cost per transaction is decreasing. This is clearly an argument for keeping relationships stable. Furthermore, lower transaction costs are likely to lead to a higher volume of transactions. Hence, a higher rate of innovation might be expected in a market characterized by Competition, Competitive Advantage, and Clusters
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enduring user–producer relationships, compared to a more ‘atomistic’ market structure. To the extent that the parties of a stable user–producer relationship can prevent the (immediate) diffusion to others of the innovations they make, as seems likely, they may (for some time at least) keep the benefits for them-selves.4Indeed, the fact that the relationship is of an enduring character, and is recognized as such by both parties, may significantly increase the probabil-ity of appropriating the benefits. Thus, a stable user–producer relationship may be interpreted as an institution that reduces the costs– and increases the pace– of innovation and learning, while at the same time making it easier to appropriate the economic benefits.5As a result, the competitive position of participatingfirms is likely to improve. To some extent, this holds for both users and producers. This assumption has much in common with the approach of the ‘national system of innovation’ (Lundvall 1992a, Edquist 1997), stressing the importance of ‘user–producer relationships’ (Lundvall 1992b) and‘networks’ (Håkansson 1987; Gelsing 1992).
However, the importance of stable relationships may vary across industries.
It should be expected to be of special importance in industries characterized by complex and user-specific technology. In these cases, the need for close communications and interaction between users and producers of technology is likely to be large, and the costs of establishing new relationships of this kind high. In other cases, products and technologies may be highly standardized:
both transaction costs and the need for enduring user–producer relationships will be low.
To the extent that this type of interaction takes place mainly within country borders, this should be expected to affect patterns of export specialization (or comparative advantage) across countries as well. Since, as pointed out by both Linder and Porter, the costs associated with communication and interaction increase with distance and differences in culture, language, institutional set-tings, and so on, this may be a reasonable assumption to make. Porter even holds that the importance of the domestic market for competitive advantage is growing.
While globalization of competition might appear to make the nation less impor-tant, instead it seems to make it more so. With fewer impediments to trade to shelter uncompetitive domesticfirms and industries, the home nation takes on growing significance because it is the source of the skills and technology that underpin competitive advantage. (Porter 1990a: 19)
However, it may also be argued that the increasing role of multinationals in world production has reduced the costs of communication and interaction significantly, and that the Linder–Porter hypothesis therefore was more rele-vant in the past than it is now. The empirical evidence presented in this chapter may shed some light on this controversy.
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Furthermore, not all ‘user–producer relationships’ promote innovation to the same extent. Lundvall suggests that:‘Being closely linked to conservative users having a weak technical competence might be a disadvantage for a producer, and vice-versa’ (Lundvall 1988: 355–6). Thus, the mere existence of a home market for a particular product or technology is not enough to generate the necessary innovations and, hence, comparative advantage. A necessary condition is that domestic users are both sophisticated and demanding.
Another issue raised by Porter is the extent to which a competitive market structure is a necessary condition for the positive impact of user–producer interaction on competitiveness. He argues that: ‘Favorable demand condi-tions . . . will not lead to competitive advantage unless the state of rivalry is sufficient to cause firms to respond to them’ (Porter 1990a: 72). Porter seems to be most concerned with competition among producers (suppliers) of technol-ogy.6However, a similar argument holds for the user side: users that are under continuous pressure to improve their performance are more likely than others to demand improvements from their suppliers. As Porter points out:
One competitive industry helps to create another in a mutually reinforcing pro-cess. Such an industry is often the most sophisticated buyer of the products and services it depends on. Its presence in a nation becomes important to developing competitive advantage in supplier industries. (Porter 1990a: 149)
8.3 Empirical methods and evidence
In this section we will discuss the available evidence and problems related to empirical testing. First, it may be noted that‘the home market hypothesis’ (or the Linder–Porter hypothesis) commands considerable empirical support at a descriptive level. Andersen et al. (1981a) provide a good illustration of this point by showing that in the case of Denmark, which is a large exporter of agricultural products, the three engineering products with the highest special-ization index (called‘revealed comparative advantage index’; Balassa 1965) all belong to the group‘agricultural machinery’. Similar examples can be found for other countries. For instance, Sweden has been shown to be specialized in both pulp and paper and machinery for that sector, and Norway in both shipping/fishing, shipbuilding, and so on. (Andersen et al. 1981a). In The Competitive Advantage of Nations (1990a), Porter presents a large amount of historical evidence and descriptive statistics on export specialization that can be interpreted in support of the Linder–Porter hypothesis. These descriptive case studies are often interesting and perceptive, but it is of course difficult to know how representative they are.
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In spite of the large amount of descriptive evidence available, there has been a dearth of statistical work done to test the hypothesis. This is not surprising, given the complexities involved. To test the hypothesis, a relatively large number of exporting sectors, as well as domestic users of the products from these sectors, must be identified and defined. While this may be easy in theory, it is more difficult in practice, since the available statistics are not collected for this purpose: most‘advanced’ products are not classified accord-ing to users, and even when this is the case it is not always easy to find internationally comparable data for users on a sufficiently disaggregated level. Furthermore, assuming that these problems can be solved, we have to establish what we mean by an‘advanced user sector’, and decide how this can be distinguished empirically from a less advanced one. To the best of our knowledge, there are only a few empirical studies that manage to overcome these complexities, to which we will now turn: Andersen et al. (1981a), Fagerberg (1995), and Beise-Zee and Rammer (2006).
The hypothesis tested by Andersen et al. is as follows: If internationally competitive producers exist in one sector of the economy, and these producers buy their technology from another sector of the economy, the latter sector should also be expected to be internationally competitive as well. For instance, if a country specializes in exporting agricultural products, it should be ex-pected to specialize in exporting agricultural machinery too. Thus, in the interpretation of Andersen et al., ‘advanced user sectors’ are identified as sectors in which the country has a comparative advantage. This interpretation has the advantage of enabling us to use the same data source, trade statistics, and the same index of revealed comparative advantage (Balassa 1965) to measure the strength of both‘producer’ (export) sectors and ‘user’ (home market) sectors. The problem, of which Andersen et al. were well aware, is that this interpretation introduces a bias toward products where the trade statistics allow a link to be made. For‘producer’ sectors (or products), this implies that most of them belong to the group ‘specialized machinery’, where users in most cases are relatively well specified. On the user side, the consequence is that users in the non-trading sectors of the economy (or in other sectors not covered by the international trade statistics) are excluded from the investiga-tion. For instance, the link between technology producers and public-sector users cannot be taken into account.
Let X denote exports, i the exporting country, and j the export product. The index of revealed comparative advantage (S) for country i in product j can be presented as follows:
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where n=1, . . . i, . . . ,N, and m=1, . . . j, . . . M. Then the model considered by Andersen et al. may be presented as follows:
Stij¼ fðStikÞ ð2Þ
where k denotes the home market for product j and t denotes year.
The exact form of the functional relationship (equation 2) was not specified by Andersen et al. They chose instead to use the Spearman rank correlation coefficient to test the hypothesis of a positive correlation between export specialization (measured by equation 1) in selected engineering products and their associated‘user’ sectors. The data set consisted of data for thirteen pairs of producer–user sectors for nine to eleven OECD countries and for selected years 1954–72. In general, a positive correlation was found to exist between the two rankings, but the level of significance was in most cases rather low. Of the thirteen pairs included in the main test presented by Andersen et al., only three exhibited significant correlations following tradi-tional statistical criteria: aircraft engines/aircraft, agricultural machinery/food, and textile machinery/textiles.
Thus, the results presented by Andersen et al., although not inconsistent
Thus, the results presented by Andersen et al., although not inconsistent