The Competitive Advantage Of Nations

Advanced factors may be the most important determinant of firm success. Excellent infrastructure, human resources, and technology not only benefit a nation and an industry but can be what makes a company world leading. However, firms typically under-invest in all these things. As Porter points out, the reason for this relates to the “free rider problem” (593). As he writes, “Firms hesitate to make such investments because employees leave, technology is copied, and infrastructure cannot be kept proprietary” (593). In other words, other firms can free-ride on, or gain the benefits from, the factor investment of the investing firm without having to themselves invest anything. Something called “the prisoner’s dilemma” captures such a situation. In this scenario, it would be better for all the firms in a national cluster to invest, than for them all not to invest. However, if all the other firms invested, it would be better for any one firm not to invest because they would then gain the benefits of investment without paying for them. Realizing this, all the firms try to free-ride and nobody invests, which ensures the worst outcome for everybody.

Fortunately, some potential solutions exist. One is for firms to work together on investment projects, as already happens sometimes in research and development. This means that all the firms in a cluster would be obliged to contribute to research that benefits them all and would reap the economies of scale from multiple participants. However, it has several drawbacks. As Porter notes, “Firms do not necessarily contribute their best scientists and engineers to such projects” (635). Firms may still attempt to gain the benefits of collective research while providing minimal effort. In this way, a subtle continuation of the free-rider and prisoner’s dilemma problems continue. As Porter notes, “cooperative projects among firms are also notoriously hard to manage” (636) because of conflicting authority and motives. In addition, genuine cooperation runs the risk of dulling rivalry and even leading to collusion.

As such, a more effective solution involves government. National governments are uniquely suited to overcoming this problem because they represent a collective interest rather than that of any individual agent. They can enforce the optimal level of investment without worrying that anyone else is “cheating.” Further, this can be achieved through the collective resource of tax revenues. Thus, all firms must contribute, as well as benefiting. That said, important caveats are still necessary here. As Porter writes, “Governmental efforts at creating specialized factors run the risk of creating the wrong factors at the wrong time” (627). While basic factor creation, like that of roads and schools, can be left to government alone, more advanced factors, like technological research or higher education, requires industry cooperation to avoid misallocating resources. Government bureaucracies, not subject to market signals, can be slow to recognize emerging areas of research or skills that will be important to industry. An example is new training and research needed in IT and computer programming. They should also emphasize research at universities over government laboratories because, with the former, research is more easily diffused by the “relative openness of the university setting” (632)—and because more commercial spin-offs and start-ups are likely there than in government laboratories.

However, one major drawback to government involvement in factor creation is “the long time horizon” (682) of investment in education and research. Such policies, even when properly implemented and sufficiently funded, can take potentially a decade before bearing obvious fruit. In addition, short-term factors (e.g., business cycles lasting three or four years or macro-economic shocks like currency or energy price fluctuations) often obscure these gains. Understandably then, governments looking for re-election may pay more attention to the latter. They may also reach for short-term “vote-winning” policies, which affect these macro-economic variables, such as currency devaluation, tax-cuts, or large scale, conspicuous infrastructure projects. These are all at the expense of attention to government’s proper role in improving factors. Indeed, they may deepen the problem by taking pressure off firms to press for factor improvement. However, they also show why continuity in government is important. Political parties and voters need to adopt a long-term view and consensus about investment if their nation’s firms are to succeed.