‘Competitive’ Vs. ‘Comparative’ Advantage A Brief Lesson from Michael Porter’s (1990) book

Competitive advantage: creating and sustaining superior performance

Recently the leading role of the agricultural sector to growth in Ethiopia has been challenged by the service and manufacturing sectors. This is partly due to the government’s policy that focuses on the development of the industrial sector, as stipulated in the Growth and Transformation Plan (GTP). In the last 10 years, the average growth of the agriculture sector was roughly 8Pct, while the industrial and service sectors grew at average annual growth rate of 14 and 13Pct, respectively. Thus, the contribution of the agricultural sector to the official growth of the country in the last ten years has been 50Pct, leaving the rest to the service (36Pct) and industrial (14Pct) sectors. Yet the bulk of Ethiopia’s population, more than 80Pct, works in the agricultural sector.
The disparity between the contribution of the agricultural sector to the gross domestic product (GDP) and the amount of people working in the field shows how low the productivity (output per person or per land) in agriculture is. Notwithstanding this growth and focus on the industrial sector, there is a marked absence of structural transformation in the economy because the industrial sector is just about 13Pct of the GDP, of which the manufacturing sector is about half of this figure.
This has been the case for the last 40 years. The absence of structural transformation means the country is still primarily agrarian (46Pct of GDP), but recently the service sector (43Pct of GDP) has begun to contribute significantly to the country’s development. This shows that the government’s focus on industrialization or manufacturing is legitimate.
However, the important question is what should be the nature of such focus. I think Michael Porter’s work on ‘competitive advantage of nations’ is crucial in this respect. Porter’s work has influenced the strategies of a diverse group of countries, such as Japan, Finland, Estonia, Portugal, Singapore, Costa Rica, Nicaragua, Mexico and Rwanda as well as the state of South Carolina and various councils and regions in the United States.
It is also interesting to note Porter’s idea in the context of the dominant neoliberal or neoclassical ‘comparative advantage’ theory that the media and many economists love to discuss. If one follows this theory, Ethiopia is good in coffee, hides and skins, among other products, which indicate that the country has comparative advantage in these items and should focus on that rather than manufacturing as the government is currently doing.
Yet, one cannot bring about structural transformation by focusing on coffee and hides and skins. Michael Porter’s theory is thus important. Porter begins by asking: why do some nations succeed and others fail in international competition? How can we explain why Germany is the home base for world leading makers of printing presses and luxury cars?
Why is the tiny country of Switzerland the home base many companies in pharmaceuticals, chocolate and trading?
There are no convincing explanations of this from standard neoclassical comparative advantage theories. Today international goods are increasingly skill-intensive. Factor comparative advantage is an incomplete explanation of trade in particular in industries involving sophisticated technologies and highly skilled employees–precisely those factors most important for a national productivity and structural transformation and hence competitiveness in global market.
However, there were also conflicting explanations for national competitiveness. Some see it as macroeconomic phenomena, yet nations enjoyed rapidly rising living standards despite budget deficits (Japan, Italy and Korea), appreciating currency (Germany and Switzerland) and high interest rates (Italy and Korea).
Others argue that competitiveness is a function of cheap and abundant labour. Yet, nations such as Germany, Switzerland and Sweden have prospered despite high wages and long periods of labour shortages. The most successful trading nations such as Germany, Japan, Switzerland, Italy and Korea have been countries with limited resources. Other explanations such as government intervention and management practice are not robust enough to explain contrasting realities.
Porter contends that regarding the source of national and firm competitiveness, we never asked the right question. The right question, according to him, is not to ask about ‘competitive nations’ as opposed to the right question of ‘national productivity’. Productivity is the source of prosperity (or higher living standards). It is related to the productivity of how resources are combined, the quality and features of products and how they are efficiently produced.
The challenge is then to know how high levels of productivity could be attained continuously. Sustained productivity growth requires that an economy continuously upgrade itself (by raising product quality, improving product technology or boosting productive efficiency). Trade is essential to bolster productivity. Japan, which exports manufactured goods because it has high productivity and imports raw material and components involving less skilled labour and lower level of technology, illustrates a nation where the mix of trade can bolster productivity.
If we take a recent Ethiopian example, the giant Chinese shoe maker, Hujian Group, that came to Ethiopia and setup its factory in Dukem, could have increased its profit by 22Pct because compared to China, labor is cheaper in Ethiopia by 22 Pct. However, it can’t attain this level of rise in its profit because working in Ethiopia has raised its logistic cost (port, customs, power, management time, etc) eight-fold.
Thus, as a country we need to work on our competitiveness (productivity) not only for making our manufacturing policy successful and hence bring about structural transformation, but also to attract investment to the country. Our competitiveness and hence productive record so far is not impressive because we have not focused our policies on improvement.
Thus, seeking the explanation for competitiveness at the national level is to answer the wrong questions. What we must understand instead is the determination of productivity and the rate of productivity growth. To find answers, we must focus not on the economy as a whole but on specific industries and industry segments.
Competing internationally may involve exports or locating some company activities abroad. To achieve competitive success, firms must possess a competitive advantage in the form of lower cost or differentiated (or unique) products that command premium prices. As the famous late Austrian economist Joseph Schumpeter recognized many decades ago, there is no ‘equilibrium’ in competition. Competition is a constantly changing landscape in which new products, new ways of marketing, new production processes and whole new market segments emerge. This means improvement and innovation in methods and technology are central elements of competitiveness and productivity where firms play a central role in the process of creating competitive advantage.
If we meet this challenge, then our firms will engage in the global market through exporting to amplify their home-based advantages and offset home-based disadvantages through global strategy that tap selectively into advantages available in other nations that includes big markets, economies of scale, costly domestic policies, global network that add to and sustain home-base advantages, among others. As policymakers, the government needs to focus on that and measure its success by the level of competitive advantage (productivity) our firms have attained.

3rd Year • July 16 – August 15 2015 • No. 29

Alemayehu Geda (Prof.)

is a professor of economics at Addis Ababa University. He can be reached via ag11226@gmail.com

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