Some conceptual issues

Chapter 1 indicated that the main aim of this book is to explore and present some insights into the process of creating and maintaining the capabilities which are needed for attaining and maintaining competitiveness in export markets. For the purposes of this study the concepts of 'capability' and competitiveness in export markets' will need to be clarified.

Competitiveness in export markets implies high levels of productivity. In order to understand the concept of international competitiveness it is useful to revisit the concepts of productivity and efficiency, concepts which are often taken for granted.

The productivity of a production unit is the ratio of its output to its input. Productivity differences are accounted for by differences in production technology, differences in the efficiency of the production process and differences in the environment in which production occurs. Three problems of measurement arise here: the identification of inputs and outputs to be included in the analysis, what weights (prices) should be used in the aggregation process and (if one is comparing actual productivity with what is theoretically achievable) the determination of the potential of the production unit (Lovell, 1993).¹

The efficiency of a production unit is the ratio between the observed and the potential maximum output obtainable from a given input, or the ratio of minimum potential input to the observed input required to produce a given output, Koopmans (1951)² introduced a formal definition of technical efficiency, i.e. a producer is technically efficient if an increase in any output requires a reduction of at least one other output or an increase in at least one input, and if a reduction in any input requires an increase in at least one other input or a reduction in at least one output. Debreu (1951) and Farell (1957)³ introduced a measure of technical efficiency, equal to one minus the maximum equi-proportionate reduction in all inputs which would allow the continued production of given outputs. Debreu/Farell technical efficiency has been shown to be necessary but not sufficient for Koopmans' technical efficiency (Lovell, 1993). Variations in technical efficiency have been attributed to variations in the factors under the control of the producers (managerial input being the most common culprit), while variations in allocative efficiency have been attributed to divergence between expected and actual prices, the persistent over- or under-valuation of prices, discrimination, nepotism and satisfying behaviour.

Two important elements are often missing in discussions of efficiency in the economics literature. First, very little effort has been devoted to integrating the literature on the theory of production under uncertainty into the efficiency measurement literature. Second, the wide literature on the internal organization of the firm has not made any impression on the efficiency measurement literature, despite its obvious relevance for the measurement of producer performance (Lovell, 1993). In their efforts to develop hypotheses on efficiency variation, economists have made little use of insights from the literature on the internal organization of the firm. This book aims to make a contribution to filling this gap by examining various capabilities which are created and built up inside the firm.

International competitiveness has much to do with the ability to export, and in that process trade surpluses can be generated. However, international competitiveness is much more than simply the ability to export or generate trade surpluses, since these can be achieved temporarily through exchange rate action or the reduction of domestic expenditures. For instance, the greater utilization of capacity permitted by the foreign exchange which has become available with the implementation of SAPs in some countries in Africa may be important in the short run but may not necessarily be a source of sustained growth in TFP. In many African countries SAPs have not resulted in significantly greater capacities to produce exports, let alone the unchanged structure of the export sector. What is not yet clear is the extent to which even this availability of foreign exchange is sustainable. Sustainability would have to rest on greater capacity to earn foreign exchange, rather than more generous donor response in support of SAPs (Pack, 1993).⁴

As the experience of South Korea has shown, although export performance has been the main practical measure of progress towards international competitiveness, it has not been sufficient in itself. There are also various dynamic considerations such as the need to accept reformulations in the light of information gained (market signals, perceptions about industrial operations and potentials) during implementation (Pack and Westphal, 1986).

International competitiveness cannot adequately be explained in terms of low labour costs, especially considering the recent experience of countries such as Germany and Switzerland which are maintaining international competitiveness in spite of their high labour costs. Explanations based on natural resource endowments are put in doubt by the success of resource-poor countries such as South Korea and Japan. Explanations based on the level of productivity alone fail to deal with the problems the US economy is facing in some export markets, in spite of being the world leader in productivity levels.

The widely employed approach to the measurement of competitiveness based on prices, costs and exchange rates is losing ground, following a study by Kaldor (1978)⁵ and other studies which show that a drop in relative unit wage costs and in export prices had occurred simultaneously with losses in world export market shares for manufacturing. For the US, this finding was confirmed by the Brookings Institution. Fagerberg (1988)⁶ found that the main factors of international competitiveness were technological advancement and the ability to compete on delivery. In spite of these findings, much of government policy is still based on the cost price approach, neglecting these improved understandings of the role of technology. investment and organizational change.

International competitiveness is a multi-dimensional concept embracing the ability to export, the efficient use of resources and increasing productivity which ensures rising living standards for a nation. The international competitiveness of a nation is indicated by its ability to produce goods and services that meet the requirements of international markets under conditions of fair trade while maintaining and raising the real incomes of its citizens. In this context, it has been suggested that competitiveness may be indicated by at least four indicators: labour productivity, real wage growth, real returns on capital, and position in world trade (OECD, 1992a).⁷

International competitiveness is influenced by three factors: the macroeconomic environment. the ability to use and develop technology to reduce costs, improve product quality and generate new products and the ability to market products successfully. The debate on competitiveness implies a role and responsibility for government, not only in ensuring a stable macroeconomic environment but also in influencing technological development and marketing.

International competitiveness can be attained by exerting efforts at various levels: actions taken at firm level, actions and policies adopted at industry level and macroeconomic policies adopted at national level. In his review of recent writings by American authors on the competitiveness issue, Nelson (1992)8 has recognized these three levels and classified the literature in three clusters: authors who take firms as competitors and focus on factors that are internal to firms, authors who focus on the macroeconomic policy variables, and the cluster of authors who focus on active industrial policy by governments. Nelson has rightly viewed these three clusters of literature on competitiveness as complementary. While detailed comparative studies of firms have demonstrated that many American firms can do a lot on their own to become more competitive, they have found strong similarities among firms in the same country and inter-country differences regarding the structure, behaviour and performance of firms. This points to the importance of the environment (industrial policy and macroeconomic policy) in which the firms are operating. The authors who focus on active industrial policy have demonstrated that non-convexities and externalities are present in many industries, especially where technical advance is important. The field of industrial organization has traditionally viewed an industry (its unit of analysis) in terms of the firms that constitute it and its government regulators. However, recent research results make it possible to view industries as systems involving a mix of institutions (e.g. private firms, industry associations and professional societies, public R&D institutions and training institutions) which are in many ways complementary.

Although the approach adopted in this book emphasizes factors that are internal to firms, factors that are external to the firms (at industry or national level) are addressed as important complements.

It may be difficult to obtain adequate data to measure costs or efficiency. Subject to data availability, various proxies could be used to give reasonable indications of the relative and absolute levels of efficiency. The following indicators could be used selectively, according to the availability of data: export performance over time, productivity gains over time (labour productivity, total factor productivity), domestic resource costs and the effective rate of protection. The inadequacy of some of these static measures is well known. For instance, it has been pointed out that the use of domestic resource cost measures (DRCs) to establish the extent of international competitiveness is inadequate. Even if an investment or intervention achieves a low DRC, this does not necessarily mean that the effort will be socially profitable. The present discounted value of producers' surplus after international competitiveness is achieved will need to be compared with the discounted cost of protection (representing foregone consumers' surpluses) and any excess of production cost (e.g. R&D) over the international prices of the protected commodity (Pack, 1993). However, this caution is perhaps superfluous, since such comparisons are not known to have been used to guide major investment decisions in the technologically advanced countries. The difficulty of any attempt to use this criterion would be aggravated by the need to grapple with unquantifiables such as learning effects (including intra- and inter-firm) and many R&D spill-overs. A more serious weakness of DRCs is that high DRCs do not distinguish between the various sources of inefficiency, i.e. between allocative inefficiency (along the isoquant) and technical inefficiency (outside the best-practice isoquant or inside the production frontier). In addition, the DRCs do not reveal the dispersion of TFPs within an industry. Such dispersions indicate the potentials for TFP improvement through the inter-firm diffusion of technology.

Efforts have also been made to identify patterns in the manufacturing and management processes which seem to account for differential performance and competitive gaps and to deduce how the outcome has been influenced by the histories of the firms and how they have been evolving over time. A regionally and/or internationally competitive firm is not only one which has eliminated the competitive gap but also one which has gained some mastery of the key components of its production and exporting activity. In this sense, it will be necessary to try to understand the dynamic features which reflect the presence or absence of continuous struggle to attain excellence. To the extent that this study is investigating an essentially dynamic phenomenon, static criteria such as sales, quality, return on investment or prices of stocks can at best tell only part of the story, since they will not adequately capture the dynamics of firm development of capabilities. If these measures are observed over time they may capture some of the dynamics but they will need to be supplemented by more qualitative measures. Some of these measures are: whether the firm has innovative management, whether it exhibits unique ways of doing business, its degree of flexibility in dealing with changing environments, and whether the management of the firm has a vision.