2009 podcast pitelis the competitive advantage

The competitive advantage and catching-up of nations

28 November 2008

The article at a glance

At a time when the global economic slowdown is encouraging countries and companies to introduce neo-protectionist policies – including possible moves by …

The competitive advantage and catching-up of nationsAt a time when the global economic slowdown is encouraging countries and companies to introduce neo-protectionist policies – including possible moves by the new US President-elect to penalise American firms who relocate jobs outside the US – we should not ignore the efforts of smaller developing countries to catch up, says Cambridge Judge Business School’s Dr Christos Pitelis, Reader in International Business & Competitiveness.

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Smaller developing economies already face disadvantages in that the global architecture of many industries is controlled by firms in developed countries, making it difficult for newcomers to get a foothold. On top of that, the current global financial situation means that “the margins of opportunity may be becoming narrower for smaller countries”, according to Dr Pitelis, who is Director of the Centre for International Business and Management at Judge Business School.

But, he argues, even in these tough times western governments and trade organisations should be doing what they can to help smaller economies who are trying to kick-start new, or upgrade existing, business clusters to boost their competitiveness and are looking for foreign direct investment (FDI). Indeed, he points out, “Successful catching-up by smaller developing countries could be made much easier, were the international community to appreciate that such catching-up is good for global economic sustainability.”

Dr Pitelis has worked as a consultant both to national governments and to the European Commission, advising on ways in which smaller countries can diagnose and upgrade their clusters in order to become more competitive. His experiences in countries including Greece, Ireland and Romania – where he helped diagnose the early signs of what would become Bucharest’s IT cluster – helped shape the views that he advances in his new research on ‘The sustainable competitive advantage and catching-up of nations’. This is forthcoming in Management International Review.

Dr Pitelis’s study of the role of FDI and its relationship to clusters in increasing the competitiveness of smaller developing countries is an attempt to bring into standard economic debate ideas derived from the field of strategy. “There is currently a lot of debate about the smallness of countries, and the diversity of their performance,” says Dr Pitelis, “and there is a perception that being small is a bad thing.” His paper disagrees with this ‘the bigger, the better’ view. For it points out that where larger countries can benefit from economies of scale and an ability to encourage diversity of industry, some relatively smaller countries have gained significant competitive advantage by specialising in particular areas – Switzerland, for example, in financial services and Greece in shipping and tourism.

The paper goes on to argue that when governments incorporate into the development strategy for their country policies for building on local capabilities and skills through diagnosing and upgrading clusters, foreign direct investment (FDI) can have a far more useful role to play. However, for smaller countries, attracting FDI is not always easy as they may have to deal with a number of unusual disadvantages. ” … Public sector personnel may be closer to powerful constituents, and be subjected to more (and perhaps conflicting) pressures,” says the paper. “It is more difficult to find qualified human resources in smaller places, trade multilateralism may endanger the bilateral trade concessions from which some small state benefit. In addition, many small states suffer from locational disadvantages (e.g. distance from other developed nations), are landlocked and/or located in areas prone to national disasters.”

But Dr Pitelis adds that smaller developing countries do also often have natural advantages that they can leverage for their own economic benefit: “Potential advantages of smallness include the coincidental, yet common, existence in them of good natural resources (especially in the case of island states), more cohesive populations that allow better adaptation to changing circumstances, and even ‘opportunities for international risk sharing, since the correlation of economic fluctuations in small states with the world business cycle is surprisingly low’,” says the paper.

Some of the advantages they can leverage are historic: “The reasons for the growth of India’s high-technology clusters include the fact that as a result of its past history under British rule, many Indians speak very good English”, says Dr Pitelis. “Another is geographic: the time difference has benefited outsourcing – for example by medical technology firms because customers in the US can send them medical images – scans, for example – to diagnose late in the afternoon, and they will conveniently receive an answer by the time they return to the office the next morning.”

Since the end of central planning, geography has also benefited Romania in ways that would have been very hard to predict 20 years ago. The country’s cheap but educated labour, pristine rural landscapes, and large available number of Caucasian extras has lured many Hollywood film-makers there during this decade, especially after 2003 Civil War epic ‘Cold Mountain’ used Romania as a (cheaper) stand-in for North Carolina.

Such case studies show what can be achieved by countries if they can accurately diagnose their capabilities and comparative advantage and work to capture sustained value from FDI. “I argue that unfettered FDI and unfettered financial flows are never very good,” says Dr Pitelis. “There is a role for FDI – but it can become far more pronounced when it takes place in the context of policy laid down by the government of that developing country to upgrade its national system of innovation. For some emerging economies who want to leverage their advantages, and their positioning, to catch-up with developed countries, part of the answer is a combination of clusters, married to the right type of inward investment that is in line with their competitive advantages.”

In his paper, Dr Pitelis lays out a novel framework for countries on ways of diagnosing their comparative advantage. It looks at how they should position themselves along the spectrum of relative costs versus differentiation; and the vehicles and policies needed to support their competitiveness and sustain value capture. This framework can be of use to all countries, he says, in identifying ways to improve their competitiveness by reducing unit costs, improving differentiation, and strengthening their innovative capabilities.

“For example, a small country – say an island economy – with excellent climate, low costs of labour and little manufacturing … can aim to effect high country differentiation (let’s say as a tourist destination) with good service and low costs. Small countries, with ample time to spare due to lack of employment opportunities could aim to effect differentiation through emphasising service provision, e.g. call centres, IT services, etc.”

But developing economies should not just accept any type of investment, he warns: “Both Singapore and Korea consciously rejected some types of FDI to get away from this; when they were trying to upgrade their economies, they told some investors who wanted to invest in labour-intensive job sectors there that they should go instead to other countries like Taiwan.”

However, in the current climate, a certain amount of emerging neo-protectionism may make it even harder for the next few years for smaller players to catch-up. Dr Pitelis is concerned about World Trade Organisation agreements – like The Agreement on Trade-Related Investment Measures – which he says “narrows the window of opportunity for firms from smaller countries.” (Such agreements outlaw formerly acceptable practices by which smaller economies could stipulate that foreign investors in their country should agree to source 50 per cent of their content, e.g. supplies, locally.) “Catching up by smaller, emerging economies is critical to everyone,” he says, “and we should embrace that.”

Further Reading

Pitelis, C.N. (2009) “The sustainable competitive advantage and catching-up of nations: FDI, clusters, and the liability (asset) of smallness.” Management International Review (forthcoming)