Critue of Porter's national diamond in his 1990s book Competitive Advantage of Nations (CAN).

by dorialex (student)

University Degree Business and Administrative studies

Severe critiques (Krugman, 1994, Rugman et al. 1992, Reich, 1990) have been made to the concept of national “diamond”, developed by Porter in his 1990’s book “Competitive Advantage of Nations” (CAN). The model attempts to explain how nations gain and sustain competitive advantage. Although Porter’s book was groundbreaking (Grant, 1991), and had a major impact on the literature considering the dozens of reviews which followed, it failed to fulfill its ambitions (Davies et al., 2000). In fact, the model represents a useful tool to analyse current situation but has little to say about causes that led to such situations because of its limited concern with historical factors. Moreover, it fails to provide a strategic prediction on how a nation or industry can gain and sustain competitive advantage.

This essay briefly presents the concepts that lie at the heart of CAN and the structure of the “diamond”. Then, it outlines the limitations of the model as proposed by Porter, and focuses on three of the major ones:

a) Scope: doubts about existence of national diamonds, considering growing importance of transnational corporations in an increasingly globalised market environment (Rugman, 1991, 1992 & 1993, Krugman, 1994);

b) Role of government and State's economic policies: failure to give the appropriate importance to the State, which has a major role and can influence success or failure of a nation (Metcalfe, 1991 & De Man, 1994);

c) Theoretical limitations: comparative versus competitive advantage, definition of nation's success (productivity), obsession with national advantage (Krugman, 1994);

This paper supports the thesis of "diamond" model's failure to meet its analytical claims. The elaboration outlines the theoretical limitations and seems to suggest that the "diamond" model resembles a check-list which does not consider several key issues. The discussion draws from late development theory and globalisation literature to identify elements that can integrate Porter's model to add meaning and theoretical strenght to it. For example, the paper considers Stone & Ranchhod's proposal of a quantitative advancement as an integrative framework that extends Porter's diamond model.

To empirically support the discussion, a wide range of comparative industrial examples is used. Furthermore, the essay focuses on three countries such as Italy, Germany and China, which are used as extended examples to provide a more effective development of the thesis.

After dedicating himself to the concept of competitive advantage at the industry and firm level (Porter, 1980 & 1985), Porter decided to extend the analysis to a larger entity: the nation. When, in 1990, he came out with CAN, it was an attempt to analyse the sources of competitive advantage of a nation and claimed to provide an explanation of how to enhance competitiveness at the national level (Davies et al., 2000). Thus, it made several assertions, which can be briefly summarised around three major points:

The success of a national economy cannot be based on the comparative advantage it already has and on the basic factors. Instead, in order for the advantage to be sustainable, it has to be based on advanced factors which result from an upgrade of the national industries via innovation, differentiation and marketing;
Competitive advantage of a nation rests on the existence and the capability of industrial clusters. The success of the nation economy is therefore based upon the effectiveness of these local clusters, formed by firms, which benefit from interrelations, networking and resource sharing systems within their home-base. The success of these industrial clusters is in turn based upon strong diamonds which are in place in the home-base;
Outward Foreign Direct Investment (FDI) is a sign of economical strenght and prosperity, while inward FDI reflects a weakness of the national economy.

These are the main proposals brought forward by Porter in 1990 to explain competitive advantage of a nation. It can be argued that the dominant point relates to the role of industrial clusters, because Porter argues that their existence and success drives the competitiveness of the country. Their success is shaped by variations in four components of the national business environment:

1) Factor (Input) Conditions. High quality, efficient and specialised inputs to business consist on: natural endowments (resources), human resources, capital availability, physical infrastructure, administrative infrastructure (e.g.: registration, licensing), information infrastructure (e.g.: economic data, disclosure requirements), scientific and technological infrastructures;

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2) Context for Firm Strategy and Rivalry. Local rules and incentives that encourage investment and productivity (e.g.: privileged taxation agreements, incentives for capital investments, intellectual property protection), vigorous local competition which drives innovation and differentiation (e.g.: barriers to entry, openness to foreign competition);

3) Demand Industries. Demanding and sophisticated local consumers and needs drives specialisation and quality improvement, and can also anticipate foreign consumer potential interest in a product. Challenging quality, safety and environmental standards of the home based demand push the industries to implement effective R & D and upgrade their products;

4) Related and Supporting Infdustries. Capable, locally based suppliers and supporting industries mean efficiency of the vertical integration of a company within its industrial cluster. The presence of organised, cooperative clusters rather than isolated firms is vital to ensure effective networking and resource sharing systems.

Supporters of the model highlight the comprehensiveness of the "diamond" as an advantage in explaining national economy's success, because it encompasses basic and advanced factors (Smith, 1993). Similarly, other believe that Porter's work represents an extraordinary "bridge" between economics and management (Grant, 1991).

However, criticisms seem to find much more space in the literature post-CAN, perhaps suggesting that critiques dominate the debate.

The structure of the diamond captures almost every factor intervening in the national industrial process, and this is per se a first critique to it (Davies et al. 2000). In other words, the framework is identified with a "set of commonplaces" (ibid). Others asked themselves the rhetoric question of how such an empty and meaningless model was to be given any importance (Miller, 1990). It can be argued that these critiques do not seem to be constructive ones. For this reason, this paper focuses on other more constructive criticisms, which evaluate potential solutions.

Rugman and Verbeke (1993) insist on the failure to take into account the international dimension of competition. While it can be argued that Porter has the "alibi" of having wrote CAN in 1990 in the sense that, since then, globalisation and internationalisation of trade acquired more importance than they had until 1990. Nevertheless, Rugman and Verbeke (1993) argue that the international dimension cannot be underestimated, and contradict the "single diamond" model presented by Porter advocating a "multiple diamonds" model as well as the incorporation of the SWOT analysis to take into account international threats and opportunities in order to broaden the scope of the framework. The international aspect is fundamental in explaining a nation economy's success. For example, while it is true that industrial clusters are important in that they might drive industrial developments, they are not always closed. A multinational firm such as BMW draws several advantages from established industrial chemical and engineering clusters in the southern Germany's clusters. However, it also draws advantages from the Italian expertise in manufacturing mini-steel components and from principles of lean manufacturing from Japanese firms such as Toyota. A country such as China send his young students to Europe and the US so that they can benefit from more developed and advanced education systems: however, those students represent a Chinese national resource because they might go back to their country and work in the national industries. Therefore, the global scope cannot be removed from the analysis of national competitive advantage. Furthermore, the increasing amount of industries moving from the developed countries (USA, UK, Italy) to the BRIC nations (Brazil, India, China and Russia) has changed the global environment in which nations operate. Growing importance of transnational corporations undermines the validity of the initial diamond model. In fact, in a globalised environment, some argue that national single diamonds do not even exist, because transnational corporations may benefit from strenght of one diamond's corner in four different countries: for instance, Lottomatica (leader in the gaming and hi-tech sector) benefits from cheap labour from developing countries (Poland), managerial and logistic expertise in its home base (Italy), hi-tech hedge and innovative R&D in the US (Providence, RI) and packaging and designing in advanced plants in Florida. Therefore, this essay echoes Rugman's et al (1993) concerns about limitations of the scope of the analysis, and tends to support Brouthers and Brouthers (1997) and Chang Moon et al. (1998) suggestion that "double and multiple diamonds" are superior to "single diamond". Brouthers et al., (1997) examine the case of Netherlands, identifying similar trends to the ones mentioned in the above example, or that clusters are open rather than close and interact between each other in the international marketplace and that multinationals have the opportunity to pick advantages from several "diamonds". As claimed by Rugman et al. (1991) and by Oz (2002), multi-diamond models are especially useful in analysing small countries.

Reich (1991) echoes these scepticism towards the concept of single national "diamond" shaping the success of clusters driving national success: he talks about the existence of ‘National champions...global webs...no particular connection to any single nation’.

The second important limitation of the "diamond" discussed in this essay relates to the underestimation of the role of government in shaping economic success of a nation (Metcalfe, 1991). Porter is against any government intervention in national economy (Davies et al., 2000) and disencourages this practice. While "government" has been added an external factor forming the "diamond" (with chance), it still does not seem to have the importance it deserves. At this stage, late development theory can perhaps add meaning to Porter's analysis of nations competitive advantage. Late development theory asserts that countries such as China which experienced a late industrialisation saw the government occupying a primary role in such evolution. For example, in China, the form of semi-free (or semi-controlled) economic policy implemented as a heritage of communism is at the heart of China's extraordinary productivity. Moreover, the government influences key factors such as exchange rates (debate on lower versus higher valuation of the yuan: US versus China's government), which shape the country's success in international trade. Similarly, the "diamond" model seems to underestimate the power of the State in terms of incentives to enhance productivity. For example, Italy is under the spotlight because of it historical tendency to make use of public spending and economic reforms (e.g.: pensions) to influence the economy's performance. Furthermore, the Italian government has recently implemented an educational reform, which might have a lasting impact on quality of education as it cuts resources to universities which "produces" the graduates needed by national industries to innovate. Similarly, France and UK conservative governments are likely to implement educational cuts policies. Whether these policies are correct are or not, they suggest that government have an important role in influencing factor conditions.

Finally, the last major limitation of Porter's model discussed in this paper relates to the theoretical and conceptual confusions which arise elaborating Porter's work. Firstly, the confusion between competitive and comparative advantage: Porter seems to snob the outdated concept of comparative advantage, while countries such as China and Russia based their success upon comparative advantages such as cheaper labour and abundance of natural resources. Moreover, the concept of comparative advantage is a fundamental one for economists, who disdained Porter's theory. Porter's misunderstanding of comparative advantage (Davies et al., 2000) lead him to an excessive focus on competitive national advantage. Krugman's critique is extremely harsh in this sense, because in 1994 he defines Porter's thesis as "a dangerous obsession with national competitive advantage".

While not every contribution made by the initial Porter is to reject, the current paper presented major criticisms, which have been made to it. However, it has to be reminded that locality and industrial clusters are still determinants of national advantage. For example, the car's manufacturing cluster in Stuttgart allows firms such as Daimler - AG to benefit from the innovatory and productivity hedge, which meant market leadership to be established abroad thanks to product upgrading. Similarly, comparing the Italian and the US wine industries, it is apparent that the Italian wine industry, benefited enormously from established clusters in the northern and Tuscany regions. These locational clusters allowed Italian wine makers to produce high quality wine and to build a loyal base of consumers. It ultimately led them to sustain competition with Gallo (USA) wine, which benefits from standardisation, lower costs because of economies of scale and globalised brand. Italian wine is renowned in the world for its quality, and US currently have a significant trade deficit with Italy in respect to wine, because they import from Italy more than they are able to export to Italy. Thus, locality and clustering still are very important factors that shape the performance of a national economy, which is measured in terms of productivity and per-capita GDP (standard of living).

This point made, Porter's model has several limitations as discussed above. These limitations regard its theoretical foundations and its empirical effectiveness. Ellis and Davies conclude that, according to a major portion of the literature, national competitiveness as analysed by Porter's diamond in CAN is more of a checklist and has little to say about origins of competitive advantage and on ways to sustain it. Rather than a guide to achieve advantage, it is a comprehensive tool to explain a posteriori why certain nations have been successful. But, for instance, it does not provide explanations about why some other countries did not.

For these reasons, the thesis supported in this paper is that Porter's diamond model to explain national competitiveness must be looked at considering the time of its creation: it can be useful to understand the importance of locality and clustering, but cannot consider these as the only factors driving national competitiveness. Therefore, a suggested approach is to integrate the model with the advancements proposed by its detractors in the last two decades, some of which have been discussed above. A more quantitative approach (Stone et al. 2007) is recommended, with the inclusion of multiple diamonds to take into account the extra-national aspect of competition as advocated by Rugman and Brouthers. In addition, a more important role should be given to governments, which can significantly influence national competitiveness (e.g.: China & Japan) (De Man, 1994 & Metcalfe, 1991). These extensions could perhaps increase the scope and usefulness of the initial framework.

The final thought goes to the future of the concept of "national competitiveness": because we are going to an increasingly globalised, unbounded world (Ohmae, 1990), where free movement of capital and goods is already effective, perhaps this concept is destined to lose every meaning. In addition, new markets are likely to open in our dynamic and rapidly evolving world: for example, a greater concern should be placed on the economical consequences in Japan, following the earthquake, and on future developments in the Arab world, which is experiencing a wave of popular revolutions to gain freedom and democracy.

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