High Quality vs. Low-Cost Bargain: The Current Dichotomy! (V). Issues with the National Competitive Advantage Theory (Part C)
Have a beautiful first week of February 2021. Today we will cover the philosophic issues that Eleonora Escalante Strategy has discovered at Porter’s National Competitive Advantage Theory (NCAT). As we described last week, Porter´s objective with this framework was really alluring: he wished to understand why some social groups, economic institutions, and nations advance and prosper, meanwhile others don’t. He started by asking himself questions, and his approach was directly from the “industrial organization” economics rationale.
Porter framed the term of the social group under a territory of people called a “nation”, and he stated (and this has been the motto of NCAT since then): “the only meaningful definition of competitiveness at the national level is national productivity”. And national productivity means to be able to produce “well”, “more”, “cheaper” through “competitiveness”. Porter´s high-quality philosophy of products and services changed to “enough philosophy”, and little by little given the budget restrictions, the “enough philosophy” has been left behind, particularly by the new generations. After 40 years, the NCAT (NCAT means National Competitive Advantage Theory) has evolved to become a “low-cost” philosophy of life. And that is why at the moment, everyone dismisses the high-quality long-term view (which means expensive), in exchange for a disposable “low-cost” copy or generic short-term view (which means bargain).
Porter wrote in 1985: “a nation’s wealth or prosperity is a sum of all the wealth creation of its companies grouped under several industries”. Let me explain this: Each company of us in a specific country, belongs to an industry. My boutique consulting house is part of two industries, (1) the Publishing industry and (2) the professional, scientific and technical services industry. Each of us belongs to a specific industry, economic sector, and more specifically to an economic subsector. So, if you add all the value creation of all companies in an industry, then each industry’s economic performance can be measured in several indicators. And if we add all the industries of a nation, here we have a total amount of wealth created in a country. According to NCAT, the level of wealth created by each industry is determined by the degree of its competitiveness. Let me explain this, with three examples of three nations that have been implementing the NCAT as of the 1990s:
- First, a middle-east nation: This is a “command kingdom economy”, which creates wealth in the oil and gas extraction and mining of resources. Since the decade of 1940, the only production base of this country has been petroleum, cooper and its minerals. This country is one of the most agile countries when it comes to the gas industry efficiencies. But domestically this country´s political economic system has not re-invested its profits in the population, neither has diversified its domestic (home base) manufacturing, neither has invested capital in other economic sectors and/or public infrastructure. In addition, this nation has not improved the quality of life for the poor, and the majority of its population lives in tiny homes of 6 meters x 10 meters (60 m2), that do not qualify as the minimum standard of the global middle-class. This country has 89% of people living as low-class poor citizens (with less than US$20,000 dollars per year or US$1,666 per month).
- Second: An European country with aggregated wealth in the industries of agriculture, forestry, fishing and hunting. Even though this country has been recognized globally as the pioneers and top manufacturers in agriculture, it has utilized the best machinery production technologies imported from Germany, Japan and Switzerland. This country holds a good information technologies level of consumption domestically, and it is very modern because tourism has pushed the limits of its public infrastructure. Still, this nation has more than 40% of its population living as low-class poor citizens (with less than US$20,000 dollars/year or US$1,666 per month), for european standards.
- Third: a huge leading Asian country, with 1.398 billion inhabitants, baptized as the factory of the world, has excelled in production plants or manufacturing of everything you can think of, a range of products from each and all the economic sub-sectors (textile, apparel, leather, wood product, paper, chemical, plastics, metals, machinery, computer and electronics, furniture, electrical and transportation, equipment, etc). This country is a state directed economy, and even though it has reduced its extreme poverty numbers since 1990, still it shows an incidence of national poverty of 41.3% ( of multidimensional poverty) measured in 2019 by the Oxford Poverty and Human Development Initiative (OPHI). In June 2020, one of the prime ministers of this country, was cited by the Economist stating: “There are still some 600m people [whose] monthly income is barely 1,000 yuan”. Since 1,000 yuan is worth only about US$140/month, this means that around 43% of the population earns in terms of pppd, only US$4.66/day. Poverty in this nation, abounds particularly in rural areas.
The last three countries have been implementing Porter´s NCAT since 1990. The three countries described are excelling in their industries, wealth is created through its productivity and competitiveness strategy, but wealth doesn´t get reinvested to provide prosperity for the bottom line of the population.
If you visit these three countries, we will be amused to find super tech development cities, modern buildings (usually leased to Multinational Corporations) which are shown as the “model of modernity and prosperity”. But if you stay longer, and take a bus to middle-class or below neighborhoods; or as a visitor, you decide to visit the rural areas, the inequality of wealth is abysmal. We wonder: Is the NCAT wrong? After 30 years of implementation? Or is it that the NCAT is not enough? Or is it that NCAT applied only for shareholder value, works only with a certain type of countries, of a similar political-economic system? Or is it that the NCAT premise is simply for “industry performance”, without caring for “improving the quality of life” of the vulnerable population. What is happening?
Here it comes the essence of this subject. The issues that Eleonora Escalante Strategy has identified with the NCAT come from the observation of the impact of its implementation during the last 40 years. These are philosophically carried and need to be empirically tested not just with numbers or data analysis, but with multidisciplinary teams of different category backgrounds. The reason why our company is always telling and repeating decision-makers to pause, repair our business and economic frameworks to be reviewed and refreshed is so simple: we have lost the compass of trade, and the compass of globalization in the pursue of productivity and competitiveness. As a civilization, we have lost sight of what is really important, in the quest to generate more revenues, profits, and sustained growth. Our business systems want to replace human beings with machines, robots, and automatic things. Meanwhile, 74% of the population still is not considered Middle-Class (or is earning less than US$28,800/year per household of 4 members. We can´t continue into the 4th Industrial revolution of the robots and NAIQIs (Nanotechnologies, Artificial Intelligence (including automation), Quantum Supremacy and the Internet), without any type of consideration for the rest of developing countries which are around 100 to 300 years behind the most industrialized economies who are building the NAIQIs cutting edge… Philosophically, we argued that the UBI (Universal Basic Income) also doesn´t work if you don´t belong to the richest countries on earth either.
Let me rephrase the last paragraph in the list of issues: Each issue is shown in a question mark format (in bold and color green).
1. The NCAT model was carried out around 40 years ago (in the 1980s) by observing the top developed nations of that time: Denmark, Germany, Italy, Japan, Korea, Singapore, Sweden, Switzerland, the United Kingdom, and the United States. It was not framed conceptually under consideration for any of the particularities of developing nations. The 10 nations utilized by Porter to demonstrate its theory were countries with a certain degree of institutional strength in its market economies and democracies; with a high will to execute a certain degree of fair legal systems that protected property rights, intellectual property (patents, copyrights, trademarks) and more importantly, human rights. These 10 countries were the highest of all in the ranking of the later United Nations Human Development Index. In addition, these 10 countries were already innovating in technology (at every level, given their high education standards, particularly coming from its scientists and educated people). In countries as such, the innovation reached top rankings, because they had the required political system with strong protection for intellectual property. Any country that doesn´t have property rights protection for its citizens, loses entrepreneurial activity based on innovation. How could it be that the NCAT was rolled out as a global free trade theory, without considering the specific issues of the developing nations?
2. Shareholder value has been the measure to lead wealth and prosperity according to the NCAT. Anyone who has studied something about accounting and finance knows that profits measured in absolute terms, in reality, are not the measure for value´s growth in a company. Shareholder value is, and it is for Porter´s, the pivotal element for his theory. To create long-term shareholder value or “sustained growth” is the basis for the NCAT theory. When we land into these terms, sustained growth as a measure of wealth and prosperity of a nation means to grow in revenues and profits over an extended period of time while total shareholders returns (share price and dividend reinvestment) exceed the cost of capital. When we examine the shareholder value of a nation, we go immediately to GDP ratios, which do not tell us exactly what is the sustained growth of the nation, which requires at least three criteria:
- Measure of the Country Revenues (inflation adjusted)
- Measure of the Country Earnings (inflation adjusted)
- Earnings of the country must be more than the cost of capital over a long extensive period of time (let´s say 15 or 20 years)
On top of the discrepancies between GDP indicators and the real measures of the country´s revenues, earnings, and return over invested capital; the measure “maximize shareholder value” shouldn´t be applied as the only measure for wealth or prosperity of a nation. If we still hold a planet in which 74% of the global population lives with multidimensional poverty, or is poor, or lives with less than US$28,800 dollars per year per household. How could it be that the NCAT proposes the indicator of wealth as sustained growth based on GDP ratios, without considering to include how to increase the quality of life of the population, or at least the size of the Middle-Class with US$28,800/year per household?
3. Confusion of the term competitiveness with the term productivity. During the last 40 years, the application of NCAT has been to promote high productivity based on competitiveness. This is not congruent. Productivity is a measure of the efficiency with which resources are used (basic factors and advanced factors all bundled), while competitiveness is usually interpreted as the ability to secure market share against the competition, either domestically and internationally. European countries (the same 10 countries studied by Porter to contribute with the NCAT), have reached higher levels of advanced factors, even though their basic factors are limiting their growth as a nation. The European Union is nothing else than the answer to try to function as a block (following the rationale of bigger is better) to reach competitiveness against other bigger countries. Despite, it, Europe has been stagnant in its growth, for more than a decade, regardless that it holds efficient industries. How could it be that Europe is so slow when it comes to sustained growth? Before the pandemic, Europe has been growing at much lower rates than other nations that are applying the NCAT? Ironically, Europeans are the most sophisticated complex societies when it comes to advanced factors, clusters implementation, demand conditions, firm structure, and government facilitation. Why do other countries seem to be more competitive than Europe, countries which are competing with less advanced factors than the European?
4. NCAT and Poverty. The NCAT stresses that industries with higher investments in infrastructure, R&D, technologies, and labor-skilled people are the fountain for wealth or value creation for a nation. This idea seems good on paper but in reality, since the NCAT is driving shareholder value, and not integral value creation, it is almost impossible to go beyond the private or private-public entities’ profits. Each company (usually multinational corporations) is only caring for their own profits, revenues, and return of invested capital; using the labor (skilled or not) at the cheapest possible cost (given their quest for efficiency). In consequence, nothing is left for the improvements of the conditions of life of the population that work in these industries. While the “agility” theory came to help the NCAT, the fact that theoretically, the shareholder value (and even its last decade reviewed version of shared value) is driving the NCAT, makes it impossible to NCAT to overcome poverty at all levels of society. How could it be that the NCAT is creating social inequality, regardless that it helps to reduce extreme poverty?
5. The NCAT quest for productivity has left the high quality only for those high-tech manufacturers (and their respective nations) that are using NAIQIs for the sake of producing more by reducing costs. That is why the most sophisticated machinery and equipment are being developed in highly industrialized nations, not in the developing ones. The whole purpose of educating people as a source of competitive advantage is being barred or what is more, it is being obstructed for the future of the developing nations. If nations adopt the NAIQIs in their full deployment, the layoffs of people won´t end up there. In the past, employees were expelled from companies, but in one way or another, another job was around the corner. At the moment, removing people will mean to don´t replace the job in other industries, not just at the bottom line of manufacturing, but also at the middle-manager levels. A new machine or an automated process or robot will replace our jobs, And the NCAT is also behind this. How could it be that the NCAT is working against the principles of advanced factors in which it was originally created?. And what is worst, we are pushing the frontiers of humanity, making machines more efficient than humans, without any type of boundaries for NAIQIs?
6. Is Something better than nothing? The NCAT came to our free-trade world exactly when there was a lack of theories to predict the pattern of international trade. In addition, this theory was embraced as the flag for free trade, it was accepted blindly by many countries where modern slavery was still real and the conditions of extreme poverty abounded everywhere. The application of the NCAT filled a hole, to raise economies that had nothing, to something. But something is not always the best. How could it be that 40 years later, we are still applying NCAT with an orthodox and conformist view, without realizing that “something” shouldn´t be the goal, but the “best we can”?
7. Competitiveness inside a nation (or outside it) without intellectual property protection kills innovation and entrepreneurship. Innovation is the engine for growth. And when it comes to innovation, we are not talking about new products only, but also new processes, new organizations, new management practices and new strategies. For example, if a developing nation doesn’t have intellectual property laws (including enforcement), it is difficult for innovators to build their own initiatives, that may be copied and produced at the sound of a snap, before being launched internationally.
8. Type of Industries. There are certain industries (given their own nature) that are more labor-intensive than others. There are certain industries that require more initial investment capital than others. There are certain industries in which a high degree of know-how is required, meanwhile others in which the hand-made quality is demanded. What has worked for the industries located in Silicon Valley, California during the last 50 years, may not apply to other industries. It is impossible to believe that the rate of transformation that technology companies use to reinvent themselves based on the newest and sophisticated tech available, is the way to go for other industries. It is crazy to believe that the whole world can adapt and reinvent itself as much as Intel, or Apple or Google, or any other company from the Silicon Valley industries. The NCAT, was used as an umbrella for high-tech and communication companies, how could it be that what functions for tech want to be rolled out to all industries without any type of discernment?
I will stop here. On Friday we will finalize this topic number 3 (I still have 4 more issues from my observations). We will continue next week with topic number 4 (from the point of view of customer´s choices), according to our outline schedule.
Again, it is my aim to be constructive about the NCAT. All these issues have been observed, not just by me, but by many other economists. I am sure, even by the same Porter, the creator of the theory. But it is clever to proceed to fix all these contradictions, beyond the “shared value initiative”, which is a good step to remediate the situation. But still, for us, the shared value initiative without the meaning of integral value (instead of maximizing shareholder value) sounds like just applying a bandage with tape, rather than curing the infection. Thank you for reading to me. See you on Friday.
Sources of reference cited in this article:
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