18 de Frebrero Diamond Model Developing Economies

Microeconomics of Competitiveness
Session 4:
The Diamond Model in Developing / Transition Economies
Microeconomics of Competitiveness February 5, 2008

Professor Michael E. Porter
This presentation draws on ideas from Professor Porters articles and books, in particular, The Competitive Advantage of Nations (The Free Press, 1990), The Microeconomic Foundations of Economic Development, in The Global Competitiveness Report 2007-08, (World Economic Forum, 2008), Clusters and the New Competitive Agenda for Companies and Governments in On Competition (Harvard Business School Press, 1998), and the Clusters of Innovation Initiative (www.compete.org), a joint effort of the Council on Competitiveness, Monitor Group, and Professor Porter and ongoing research at the Institute for Strategy and Competitiveness. Additional information may be found at the website of the Institute for Strategy and Competitiveness, www.isc.hbs.edu No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, or otherwise - without the permission of Michael E. Porter. Version: February 5, 2008
MOC Session 1 - 2007
Copyright 2006 Professor Michael E. Porter
Prosperity Performance
PPP-adjusted GDP per Capita, 2006
Selected Middle- and Lower-Income Countries

Slovenia South Korea Cyprus
$25,000 $23,000 $21,000 $19,000 $17,000

Argentina Portugal United Arab Emirates
Czech Republic Slovakia Oman Poland Hungary Lithuania
Estonia
$15,000 $13,000 $11,000 $9,000 $7,000 $5,000
Saudi Arabia
Libya
Latvia
$3,000 0.0%
Chile Croatia Panama Russia Malaysia Mexico Costa Rica Romania Thailand Brazil Turkey Dominican Republic Tunisia Colombia Belize Ukraine Venezuela Peru Guatemala Philippines Morocco Egypt Indonesia Ecuador Sri Lanka India Syria El Salvador Vietnam South Africa
China
Cambodia
1.5%
3.0%
4.5%
5.5% 6.0% 6.5%
7.5%
8.5%
Growth of Real GDP per Capita (PPP-adjusted), CAGR, 1996-2006

Source: EIU (2007), authors calculations
Income Inequality
Gini Index
Selected Countries
60
50
40
30
20
10
0
a Br az il C h C os ile ta R ica C hi na Tu U n r R us ited key si St an Fe ate de s ra tio n G ha na La tv Vi ia et na m Li U th ni ua te ni d a Ki ng do m Es to ni a Sp ai n Po la nd Ire la nd R wa nd G er a m an Fi y nl an d C ze Nor wa ch Re y pu b Sw lic ed en
3
Note: Most recent Gini index data available for each country (1999 2003). Czech Republic data is from 1996. Source: World Bank, World Development Indicators, 2007.
ol o
m bi
Labor Force Mobilization

Selected Countries
Employees as % of Population, 2006
0.6
0.5
0.4
0.3
0.2
0.1
0
C TH HIN AI A LA N N D O R W A VI ET Y NA JA M C P ZE IR AN C H E LA N U RE D NI P TE UB D L ST IC A S W TE S ED ES EN TO N KO I A G RE ER A M AN LA Y U TV NI R IA TE D US KI S I A N G D FI OM N LA N G D H C A O ST NA A M RIC AL A AY LI TH SIA UA NI C A HI L BR E AZ IL IN PO DIA LA N TU D R KE Y
Note: Use most recent year available, either 2005 or 2006 Source: The Conference Board and Groningen Growth and Development Centre, Total Economy Database, November 2007
Comparative Labor Productivity

Selected Countries
GDP per employee (PPP adjusted US$), 2006
100,000 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 -1.0%
Mexico Brazil Saudi Arabia Norway Austria France Italy Israel Australia Canada Spain Germany USA Ireland Netherlands Belgium Greece Finland UK Taiwan Denmark Sweden Japan Slovenia
Hong Kong Singapore
New Zealand South Africa Portugal Czech Republic Slovakia
Hungary Croatia Poland Malaysia Thailand
Estonia
Iran
Chile Costa Rica Colombia Indonesia
Tunisia
Lithuania Turkey
Latvia (8.2%)
Egypt
Philippines Sri Lanka Pakistan
China (9.0%) India Vietnam
Bangladesh
3.0% 4.0%
0.0%
1.0%
2.0%
5.0%
6.0%
7.0%
Compound annual growth rate (CAGR) of real GDP per employee (PPPadjusted), 2001-2006
Source: EIU (2007), Saudi Arabia employee data (number persons employed) from ILO LABORSTA (2007)
Competitiveness Master = 2007-11-14.ppt
National Cluster Export Portfolio

Estonia, 1997-2006
0.40% Change In Estonias Overall World Export Share: 0.30% Prefabricated Enclosures and Structures Furniture (0.32%, 0.57%)
Estonias world export market share, 2006
0.30% Transportation and Logistics
Communications Equipment
0.20% Fishing and Fishing Related Products
Forest Products Building Fixtures and Equipment
Construction Services Processed Foods Construction Materials Apparel 0.10% Agricultural Products Automotive Chemical Products Entertainment Biopharmaceuticals 0% Textiles Plastics Footwear
Hospitality and Tourism Oil & Gas
Motor Driven Products Publishing and Printing
Estonias Average World Export Share: 0.10%
Business Services Lighting and Electrical Equipment Heavy Machinery Communication Services Metal Mining and Manufacturing
Production Technology Financial Services Medical Devices Information Technology
-0.06%
-0.03%
0.00%
0.03%
0.06%
0.09%
0.12%
0.15%
0.18%
Change in Estonias world export market share, 1997 2006

Source: Prof. Michael E. Porter, International Cluster Competitiveness Project, Institute for Strategy and Competitiveness, Harvard Business School; Richard Bryden, Project Director. Underlying data drawn from the UN Commodity Trade Statistics Database and the IMF BOP statistics. 6 Competitiveness Master = 2007-11-14.ppt
Exports of US$300 Million =

National Cluster Export Portfolio

Chile, 1997-2006
0.13% Fishing and Fishing Related Products (1.51%, 4.22%) Forest Products
0.11% Agricultural Products
Chiles world export market share, 2006
Furniture 0.09% Transportation and Logistics
0.07%
Metal Mining and Manufacturing (1.73%, 3.99%, $36 billion)
Chiles Average World 0.05% Export Share: 0.49% 0.04% 0.03% 0.10% 0.02% 0% Jewelry, Precious Metals and Collectibles Motor Driven Products Processed Foods Hospitality and Tourism Business Services Chemical Products Building Fixtures and Equipment Heavy Machinery Prefabricated Enclosures and Structures Plastics Construction Materials Tobacco Oil and Gas Communications Equipment Change In Chiles Overall World Export Share: 0.15%
Automotive Publishing and Printing Financial Services Communication Services (-0.41%) Textiles Biopharmaceuticals
-0.25%
-0.20%
-0.15%
-0.10%
-0.05%
0.00%
0.05%
0.10%
0.15%
0.20%
0.25%
0.30%
Change in Chiles world export market share, 1997 2006

Source: Prof. Michael E. Porter, International Cluster Competitiveness Project, Institute for Strategy and Competitiveness, Harvard Business School; Richard Bryden, Project Director. Underlying data drawn from the UN Commodity Trade Statistics Database and the IMF BOP statistics. 7 Competitiveness Master = 2007-11-14.ppt
Exports of US$1.2 Billion =

Innovative Capacity
Innovation Output of Selected Countries
Average U.S. patents per 1 million population, 2002-2006
3.5
Hungary (5.2)
Belgium
Slovenia (8.8) Czech Republic Malaysia Croatia
3.0
2.5
Estonia South Africa
2.0
Greece
1.5
Argentina Russia Latvia Chile
Brazil
Portugal United Arab Emirates Costa Rica Saudi Arabia Poland

India
1.0
Mexico Slovakia
Lithuania
0.5
Thailand Colombia Indonesia Turkey
Romania Philippines
0.0 -20%
-10%
0%
10%
8
20%
30%
40%
50%
CAGR of US-registered patents, 2002 2006

Source: USPTO (2008), EIU
45 patents =
Determinants of Competitiveness
Macroeconomic, Political, Legal, and Social Context Macroeconomic, Political, Legal, and Social Context
Microeconomic Competitiveness Microeconomic Competitiveness

Sophistication of Company Operations and Strategy Quality of the Business Environment
State of Cluster Development
A sound macroeconomic, political, legal, and social context creates the potential for competitiveness, but is not sufficient Competitiveness ultimately depends on improving the microeconomic capability of the economy and the sophistication of local competition
20080204 MOC Session 3
Conditions for Competitiveness

Geography, Demographics, Geography, Demographics, History, Culture History, Culture
The Diamond
Context for Context for Firm Firm Strategy Strategy and Rivalry and Rivalry
Macroeconomic, Political, Legal, and Social Context
Factor Factor (Input) (Input) Conditions Conditions
Demand Demand Conditions Conditions
Related and Related and Supporting Supporting Industries Industries
10
Governance Indicators
Selected Countries
Best country in the world
Voice and Accountability Political Stability/No Violence Government Effectiveness Regulatory Quality Rule of Law Control of Corruption
Index of Governance Quality, 2006
Worst country in the world

D G AP NI O TE R D E ST AT ES C HI LE ES TO NI SL A C ZE O VE C H N IA RE PU BL I LI TH C UA NI A LA TV C O IA ST A RI C PO A SO LA U ND TH AF RI CA G H AN A BR AZ C IL O LO M BI A C HI NA R US SI IN A D O N ES IA U
11
FI N
Note: Sorted left to right by decreasing average value across all indicators. The zero horizontal line corresponds to the median countrys average value across all indicators. Source: World Bank (2007)
SI N
LA N
Improving the Business Environment: The Diamond

Local rules and incentives that encourage investment and productivity

e.g. salaries, incentives for capital investments, intellectual property protection
Vigorous local competition

Openness to foreign and local competition
Access to high quality business inputs

Natural endowments Human resources Capital availability Physical infrastructure Administrative infrastructure (e.g. registration, permitting) Information infrastructure (e.g., transparency) Scientific and technological infrastructure
Sophistication of local customers and needs Strict quality, safety, and environmental standards
Availability of suppliers and supporting industries Presence of clusters instead of isolated firms
Successful economic development is a process of successive upgrading, in which the business environment improves to enable increasingly sophisticated ways of competing
12
The Process of Economic Development

Upgrading the Diamond in Developing Countries
2
Factor Factor (Input) (Input) Conditions Conditions Demand Demand Conditions Conditions
1
3
13
The Geographic Distribution of Economic Activity

Legacies of a Planned Economy Legacies of a PlannedLegacies of a PlannedEconomy Economy
Economic policy is centrally directed Economic policy is centrally directed Buyer/supplier linkages were planned Buyer/supplier linkages were planned from a national and Soviet Union from a national and Soviet Union perspective, versus an efficiency perspective, versus an efficiency perspective perspective The relationships between suppliers and The relationships between suppliers and buyers are specified in the production of buyers are specified in the production of defined goods and services defined goods and services The geographic locations of related The geographic locations of related economic activities driven by political economic activities driven by political and security considerations and security considerations Companies are focused on narrow parts Companies are focused on narrow parts of the value chain, lacking marketing of the value chain, lacking marketing and other capabilities and other capabilities
Cluster-based Economy Cluster-based Economy

Economic policy involves significant Economic policy involves significant autonomy and well developed autonomy and well developed institutions at the regional and local level institutions at the regional and local level Regions specialize in terms of the fields Regions specialize in terms of the fields in which they compete in which they compete Clusters leverage externalities across Clusters leverage externalities across firms, universities, and other local firms, universities, and other local organizations that drive productivity and organizations that drive productivity and dynamism dynamism Geographic choices are based on the Geographic choices are based on the economic attractiveness of locations; economic attractiveness of locations; firms co-locate with others to reap firms co-locate with others to reap cluster benefits cluster benefits Company scale and scope is driven by Company scale and scope is driven by economic efficiency, including the economic efficiency, including the ability to access specialized skills ability to access specialized skills available in the surrounding cluster available in the surrounding cluster Small and medium sized companies Small and medium sized companies are an essential part of clusters are an essential part of clusters
14
Stages Of Competitive Development

Evolving Nature of International Competitive Position
FactorFactorDriven Economy Driven Economy
Competitive Advantage Low-cost basic factor conditions (low-skilled labor, natural resources, geographic location) Companies compete on price in commodity markets or in producing goods and services for others Companies have limited roles in the value chain, focusing on assembly, labor intensive manufacturing, and resource extraction Technology is assimilated through imports, FDI, and imitation The economy is highly sensitive to world economic cycles, commodity prices, and exchange rates
InvestmentInvestmentDriven Economy Driven Economy

Competitive Advantage The ability to produce standard products and services of high quality using efficient methods but at lower wages than advanced economies The economy is concentrated on manufacturing and outsourced service exports, though many firms continue to serve OEM customers There is heavy investment in efficient infrastructure and modern production processes Companies extend capabilities more widely in the value chain Technology is accessed through licensing, joint ventures, FDI, and imitation, but local capacity to improve and develop technology is developed
15
InnovationInnovationDriven Economy Driven Economy

Competitive Advantage Companies produce innovative products and services at the global technology frontier Companies compete with distinctive strategies that are often global in scope The national diamond is characterized by strengths in all areas together with the presence of deep clusters The economy has a high service share, and is resilient to external shocks
Source: Porter, Michael E., The Competitive Advantage of Nations, The Free Press, 1990
Stages Of Competitive Development

Shifting Policy Imperatives
Factor-Driven Factor-Driven Economy Economy
InvestmentInvestmentDriven Economy Driven Economy
InnovationInnovationDriven Economy Driven Economy
Cost of Inputs
Macro, political, and legal stability Efficient basic infrastructure Lowering the regulatory costs of doing business
Productivity
Local competition Market openness Advanced infrastructure Incentives and rules encouraging productivity Cluster formation and activation
Unique Value
Advanced skills Scientific and technological institutions Incentives and rules encouraging innovation Cluster upgrading
Source: Porter, Michael E., The Competitive Advantage of Nations, Macmillan Press, 1990
16

Typical Starting Point for Developing Countries
Building the Diamond

Factor Conditions
Successful Economic Development Erect the basic foundations for business activity Ensuring public safety and rule of law Functioning administrative infrastructure, including efficient regulatory processes and secure property rights Business-related information Improve the quality and increase the efficiency of utilizing existing factor inputs Natural resource pricing and conservation Physical infrastructure efficiency Quality and reach of public education Efficiency of labor markets Rate of national savings Widen the array of factor inputs available locally Upgrade the factor quality of factors to higher levels Enhance factor specialization around clusters to move to more advanced states of development
High reliance on the availability of low wage, unskilled labor and natural resources
Lack of capital Low savings Capital flight
Inefficient public administration and regulatory processes which are subject to corruption
Underdeveloped infrastructure, capital markets, and educational system Most technology is externally supplied and controlled
Low productivity
17
Context for Context for Firm Strategy Firm Strategy and Rivalry and Rivalry

Context for Firm Strategy and Rivalry
Successful Economic Development
Achieve political and (macro)economic stability Create a multifaceted approach to reducing corruption -- Transparency, civil service reform, enforcement Eliminate internal governmental impediments to competition
End monopoly government licenses and concessions Phase out government price controls, entry controls, and locational restrictions Open state monopolies to competition Privatize state-owned companies
Typical Starting Point for Developing Countries

High levels of political and economic instability High capital costs and short time horizons Opportunistic practices by firms Competition blunted by monopoly concessions, state-owned companies, corruption, and heavy government intervention Companies protected from foreign competitors Monopolistic companies are dominant or cartels divide the market Any local rivalry occurs largely on price
Begin an irreversible process of opening the economy to foreign competition, including FDI Create and implement an effective competition policy Develop an effective legal structure and enforcement mechanisms for intellectual property Reduce investment hurdle rates and lengthen time horizons Move beyond price cutting and product imitation to encompass availability and differentiation E. Porter Copyright 2006 Professor Michael

18
Demand Demand Conditions Conditions Typical Starting Point for Developing Countries


Demand Conditions
Successful Economic Development
Improve local demand quality:
Expand buyer information and increase consumer protection against poor-quality products Open the market to foreign products Phase out restrictions and tax biases against sophisticated products
Undifferentiated products/commodities are the principle exports Unsophisticated local demand

Low average income levels Little information Limited selection Overwhelming focus on price
Product and service designs are imitated or licensed from abroad Lax product, health, safety and environmental standards Large home demand, where it is present, distracts attention from developing internationally competitive products
Raise product, safety, health, and environmental standards towards international levels Use government procurement to stimulate the supply of higher quality products Facilitate exports to neighboring countries or other countries where needs are similar Support cluster formation in areas where local demand is relatively advanced due to history, customs, culture, or geography Set policies that foster early demand for more advanced products and services
19

Related and Supporting Industries
Typical Starting Point for Developing Countries Isolated exporting firms and industries Local suppliers are scarce and uncompetitive Most sophisticated machinery, components, and more advanced equipment and services must be imported Clusters are shallow or non-existent
Unproductive local suppliers create disadvantages for downstream industries
Successful Economic Development Open market access to foreign suppliers of sophisticated components, machinery, and services Seek FDI that attracts world class suppliers to support and deepen emerging local clusters Establish programs to support improvements in the local supplier base
Inefficient vertical integration reflects the lack of local suppliers and barriers to imported inputs
Well-developed clusters are important to move beyond lower-middle income levels
Early export successes often occur in industries with weak inter-industry linkages
20
Improving Company Sophistication

Relative Position of Estonian Companies, 2007
Competitive Advantages Relative to GDP per Capita Degree of customer orientation Reliance on professional management 25 26 Competitive Disadvantages Relative to GDP per Capita Value chain breadth Breadth of international markets Control of international distribution Nature of competitive advantage Prevalence of foreign technology licensing Extent of regional sales Capacity for innovation Extent of marketing Company spending on research and development Extent of incentive compensation Production process sophistication Extent of staff training Willingness to delegate authority 46 45 45 45 40 39 35 35 33 31 30 29 29
Change up/down of more than 5/10 ranks since 2002
Note: Rank versus 74 countries; overall, Estonia ranks 30th in 2006 PPP adjusted GDP per capita and 25h in Business Competitiveness. Source: Institute for Strategy and Competitiveness, Harvard University (2007)
21
Factor (Input) Conditions

Estonias Relative Position 2007
Competitive Disadvantages Relative to GDP per Capita 3 7 16 18 18 21 21 22 22 24 24 24 26 27 27 28
Competitive Advantages Relative to GDP per Capita Laws relating to ICT Decentralization of economic policymaking Ease of access to loans Quality of primary education Quality of math and science education Cooperation in labor-employer relations Venture capital availability Quality of port infrastructure Efficiency of legal framework Quality of telephone/fax infrastructure Judicial independence Low business costs of corruption Local equity market access Quality of scientific research institutions Financial market sophistication Overall infrastructure quality
Availability of scientists and engineers Air transport infrastructure quality Reliability of police services Railroad infrastructure Quality of electricity supply Quality of management schools University/industry research collaboration
49 40 33 32 31 31 29
22
Demand Conditions
Competitive Advantages Relative to GDP per Capita Government procurement of advanced technology products Stringency of environmental regulations 18 27
Competitive Disadvantages Relative to GDP per Capita Buyer sophistication Presence of demanding regulatory standards 38 31
23
Related and Supporting Industries

Competitive Disadvantages Relative to GDP per Capita 26 Local supplier quantity Local availability of process machinery Local supplier quality 43 43 33
Competitive Advantages Relative to GDP per Capita Local availability of specialized research and training services
24
Context for Firm Context for Firm Strategy Strategy and Rivalry and Rivalry
Context for Strategy and Rivalry

Competitive Disadvantages Relative to GDP per Capita 14 24 28 Extent of market dominance Lack of favoritism in decisions of government officials Property rights Efficacy of corporate boards Effectiveness of antitrust policy 34 32 32 31 29
Competitive Advantages Relative to GDP per Capita Absence of trade barriers Intensity of local competition Intellectual property protection
25
Ease of Doing Business

Ranking, 2007 (of 178 countries)
Estonia, 2007
Favorable
Median Ranking, Eastern and Central Europe
Unfavorable
160 140 120 100 80 60 40

Estonias per capita GDP rank: 25
20 0
Doing Business Trading Across Borders Dealing with Licenses Starting a Registering Enforcing Business Property Contracts Paying Taxes Protecting Investors Getting Credit Closing a Employing Business Workers
Source: World Bank Report, Doing Business (2008)

26
The Diamond in Developing Countries

Summary
The diamond framework applies to economies at all stages of economic development The specific conditions and action recommendations generated from applying the framework, however, differs dramatically across countries and stages of development Developing countries must raise the macro / political / legal / social context to a minimum level to have a chance for sustained development Developing countries have weaknesses across many diamond dimensions Strategies that address only one element of the diamond are of limited effectiveness in producing growth
A focus on macroeconomic elements or trade liberalization alone is ultimately unsustainable if not supported by broader upgrading of the microeconomic fundamentals Reliance on microeconomic upgrading alone will often be severely compromised by significant challenges in macroeconomic, political, or legal context
Diamond improvements should be sequenced to address the binding constraints to productivity at each income level
27

18 de Frebrero Diamond Model Developing Economies

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Microeconomics of Competitiveness

Microeconomics of Competitiveness February 5, 2008

Copyright 2006 Professor Michael E. Porter

Selected Middle- and Lower-Income Countries

$25,000 $23,000 $21,000 $19,000 $17,000

Czech Republic Slovakia Oman Poland Hungary Lithuania

$15,000 $13,000 $11,000 $9,000 $7,000 $5,000

5.5% 6.0% 6.5%

Growth of Real GDP per Capita (PPP-adjusted), CAGR, 1996-2006

Copyright 2006 Professor Michael E. Porter

Labor Force Mobilization

Copyright 2006 Professor Michael E. Porter

Comparative Labor Productivity

Hong Kong Singapore

New Zealand South Africa Portugal Czech Republic Slovakia

Hungary Croatia Poland Malaysia Thailand

Chile Costa Rica Colombia Indonesia

Philippines Sri Lanka Pakistan

China (9.0%) India Vietnam

Copyright 2008 Professor Michael E. Porter

National Cluster Export Portfolio

Estonias world export market share, 2006

0.30% Transportation and Logistics

0.20% Fishing and Fishing Related Products

Forest Products Building Fixtures and Equipment

Hospitality and Tourism Oil & Gas

Motor Driven Products Publishing and Printing

Estonias Average World Export Share: 0.10%

Production Technology Financial Services Medical Devices Information Technology

Change in Estonias world export market share, 1997 2006

Exports of US$300 Million =

National Cluster Export Portfolio

0.11% Agricultural Products

Chiles world export market share, 2006

Furniture 0.09% Transportation and Logistics

Metal Mining and Manufacturing (1.73%, 3.99%, $36 billion)

Change in Chiles world export market share, 1997 2006

Exports of US$1.2 Billion =

Slovenia (8.8) Czech Republic Malaysia Croatia

Estonia South Africa

Portugal United Arab Emirates Costa Rica Saudi Arabia Poland

Thailand Colombia Indonesia Turkey

CAGR of US-registered patents, 2002 2006

Microeconomic Competitiveness Microeconomic Competitiveness

State of Cluster Development

Copyright 2006 Professor Michael E. Porter

Conditions for Competitiveness

Macroeconomic, Political, Legal, and Social Context

Factor Factor (Input) (Input) Conditions Conditions

Demand Demand Conditions Conditions

Related and Related and Supporting Supporting Industries Industries

20080204 MOC Session 3

Copyright 2006 Professor Michael E. Porter

Index of Governance Quality, 2006

Worst country in the world

Improving the Business Environment: The Diamond

Local rules and incentives that encourage investment and productivity

Demand Demand Conditions Conditions

Vigorous local competition

Access to high quality business inputs

Related and Related and Supporting Supporting Industries Industries

Copyright 2006 Professor Michael E. Porter

The Process of Economic Development