ECONOMICS AND BUSINESS STRATEGY

International business specialists who come to the subject from an economics perspective, tend to see merit in trying
to meld the economics and business strategy perspectives. Most notable in this respect are, perhaps, the works of
Dunning (1993) and Porter (1990). In Porter, the approach is very firmly based on economic principles, especially those
arising from industrial , In that sense, Porter, as a business strategist, is some distance, in terms of
methodology, from the likes of Mintzberg (1994). The latter emphasises cognitive factors to a much greater degree, and
is therefore more concerned with motivational issues. By contrast, Porter assumes these will be bound in with the usual
economic assumption of self interest. Thus Mintzberg emphasises heavily the imaginative thought processes of the
entrepreneur, especially those at play in constructing a vision of the future form of the enterprise. Porter is more prosaic,
and many key elements of his construction are based on empirical studies of actual market outcomes.
The central construction of Porter (1990) is his ‘diamond’ analysis of the competitive advantage of nations.
Competitive advantage, in Porter’s sense, means the ability of firms in a nation to use their location-bound resources to
compete successfully on international markets. The ‘diamond’ is a schematic diagram which links a nation’s key
industrial characteristics. These are: goods markets; factor markets; firm strategy/structure/rivalry; and
related/supporting industries. They are related by a diamond shaped set of connections, suggesting mutual causation and
reinforcement. At play on these features of a nation’s competitive advantage are systematic influences, from
multinational business activity (MBA) and government, and random influences. Then, according to Porter (1990, p.71)
this diamond sets out the attributes, and their links, which ‘shape the environment in which local firms compete, and
which promote or impede the creation of competitive markets’.
The competitive advantage which a nation achieves, according to analysis based on this diamond, is measured by the
value of its national product and/or its rate of growth, in relation to its principal rival nations. Thus the diamond is
telling us how the range and quality of goods and services supplied by a nation on international markets compete more,
or less, successfully with goods and services of rival nations. In many ways, the construction of Porter’s main line of
argument is a direct extension, to the nation, of his earlier analysis of the competitive advantage of a firm, and how
competitive strategy can best be deployed to achieve it.
Porter’s work has been very influential in presenting a well articulated framework for competition among nations, as
distinct from firms, and is a standard reference on global strategy. What it says is noteworthy in its own right, but also,
as we shall see, bears a strong relationship with an established line of analysis, that can be associated with classical
writings. Global industries are said to have the characteristic that different nations compete within them in a way which
has a significant impact upon national prosperity. This is a direct borrowing of the notion of strategic interaction from
mainstream industrial organization, especially the more game theoretic part of it. So conceived, global strategy must
adopt a worldwide approach to attaining competitive advantage. The principal dimensions of such a strategy, Porter
(1990, p. 55) argues, are configuration and coordination. That is, one asks where, and how, activities are dispersed
across nations, and how are they coordinated.
In his treatment of the deployment of strategy, Porter (1990, p. 54) encapsulates the essentials of his argument in the
statement: ‘This creates scale to amortize R&D costs and to allow the use of advanced production technology’. There is
an emphasis on leadership in the successful pursuit of global strategy, typically from constant innovation, Porter (1990,
p. 65). Thus, a dynamic approach is crucial to the pursuit of competitive advantage: ‘firms that rest on a static
conception of advantage…lose market position’, Porter (1990, p.68). In relating his thought to established economic
analysis, Porter (1990, p. 20) emphasises that ‘competition is dynamic and evolving’ with ‘improvements in innovation
in methods and technology a central element’. This he contrasts with a static, general equilibrium view of competition,
where best returns are sought, with given technology. In brief, Porter is arguing that competition is a process, and
essential to this process is constantly improving how activities are performed.
I do not know whether Porter (1990) in choosing his title The Competitive Advantage of Nations was influenced by
Adam Smith’s (1776) title of his great work The Wealth of Nations, but he might well have been. Indeed, one notes the
resemblance in both method and style. It has often been said that Smith simply drew on received knowledge in
providing his analysis of the wealth of nations. As much has been said too of Porter. Indeed, Dunning (1993, p.106) has
expressed the view that: 'In one sense, there is nothing original in Porter's analysis. Throughout history, a succession of
scholars have attempted to identify and evaluate the supply and demand conditions necessary, for a country to be
competitive in world markets'. Though Dunning also notes the less comprehensive treatment of Porter compared to
others like Smith, there remain similarities. Both Smith and Porter draw skillfully on a variety of analytical ideas of their
contemporaries to create a simple, yet powerful synthesis. In each case, dynamic, rather than static competition, and
continuous innovation, rather than given technology, are central. Indeed, it is not just that innovation is continuous in
each case, but that it is also endogenous.
The main point I should like to make in this article is that the phenomenon of globalization, including its strengths
and weaknesses, can be better understood by reference to classical analysis. By this, I do not mean simply the reading of
the classics, notably Smith (1776). More than this, I mean interpreting the classics through a modern lens, (Reid,
1985,1987). Two particular points at which classical analysis seems to have an advantage, in terms of understanding and
interpreting globalization, are as follows: first, the treating of system-wide behaviour in an historical epoch as part of a
stage in the evolution of societies; second, the treating of competition as a process over time, involving profit seeking
and innovation, in the face of disequilibrium conditions. I shall treat in turn stadial analysis, and then competition, in
what follows.
Smith developed a stadial analysis (i.e. an analysis in terms of a sequence of stages) of societal evolution, with his
four stages being hunting, pasturage, agricultural and commercial. This laid the basis for further work on stadial analysis
by Scottish enlightenment figures, including Adam Ferguson and William Robertson. This stadial approach was also a
great influence on Marx, who in his economic analysis, at least, was something of a conservative. He borrowed much,
largely unmodified, from classical writings. Economists have continued to find stadial analysis appealing, two notable
contributors of the twentieth century being by Rostow (1960) and Hicks (1969). Since they wrote, serious work has
been devoted to identifying possible (and new) stages of society, such as the post-industrial order identified by Bell
(1974). In the radical economics literature, a common reference point (for viewing the beginning of globalization as a
new stage in societal evolution) is Lenin's (1939) analysis of imperialism. In essence, the features Lenin identified for
this new stage were the growth of large monopolies in advanced industrial nations, the rise from amongst their numbers
of a few capital rich countries, and their seeking of profitable outlets for excess capital. When he first identified this
stage 'at the threshold of the twentieth century', in fair measure the empirical observations he made were sound.
However, the prescriptive judgments superimposed on these observations have been, viewed from the threshold of the
twenty first century, less than far sighted. His reference to 'a shell which must continue in a state of decay'8 has been less
than prophetic. One hundred years later, what we recognize now as globalization - what Lenin, in anticipating it, called
imperialism - is very much a vigorous focus for societal change and wealth creation. Indeed, it seems likely that we have
only just begun to see the beginning of the potential impact of globalization, viewed in terms of a societal stage.
In my own treatment of the stadial analysis of Smith (Reid 1989 a, b), each stage is taken to be consistent with a
certain constitutional order9. That order will stay in place until all economic potential that it may possess becomes
exhausted. The conclusion of a societal stage, that is the stationarity of part of a growth sequence, has then been
signaled, and forces of self interest tend to come into play stimulating a new constitutional order. What seems apparent,
is that globalization as a societal stage, is far from exhausted, in terms of its economic potential. As a stage, its unique
characteristic is that it goes beyond the institution of any single nation state. Previous stages appear to have been past
features of nation states. Thus feudal, mercantile, industrial and post-industrial stages were experienced by nation states.
Advanced economies all seem to have gone through these stages, though not all at the same time. Suppose we admit
globalization, as a stage which, arguably, comes after the post-industrial. By its nature, a plurality of states is now
simultaneously participating in the progression of this stage. This convergence of nation states on one stage has come
about because of the advances in information storage, processing and handling which occurred in the latter part of the
twentieth century. The sharing of nation states in this process has diminished the significance of states per se, and
increased the significance of the information forms that bind them together in a common experience. As the CSGR put
it10 'globalization as knowledge constitutes a new reality and renders redundant the language and imagery of a statecentric
world'.
In the progression of the stage of globalization, a process of competition is at work. In the same way as a Smithian
perspective is helpful in embedding globalization in a stadial analysis, so too it is helpful, I would argue, in
characterising the form that competition takes within this stage. What I have to say on this issue can at least in part be
expressed in algebra. However, to keep the reasoning accessible, I have confined the relevant mathematics to an
Appendix.
The broad line of reasoning is as follows. In the search for global competitive advantage, a market leader takes the
initiative in terms of innovation and price setting. To keep the argument simple (and, actually, not too far from reality) it
is assumed that unit costs (and marginal costs) are constant and equal, up to capacity output. Competition is dynamic
and profit-seeking. It occurs over a sequence of time periods, and innovation is only undertaken if it offers a profit
advantage. Price is a mark-up on direct costs, with the margin creating a discretionary surplus which can be allocated to
R & D. The discovery and implementation of a profit making innovations are aspects of the advanced division of labour,
sometimes called 'the division of thought', Casson (1988).
The above paragraph is directly based on classical reasoning. However, it is also consistent with Porter's analysis,
outlined above, of the search for international competitive advantage. The analytics of this approach can be developed
informally as below. For more detail, the reader is referred to the Appendix.
The market leader engages in a strategy of price cutting, innovation, and capacity expansion. It determines what price
will prevail in the market by setting a constant mark-up on unit cost. This mark-up creates a fungible surplus which
allows discretion to be exercised e.g. over the distribution of profit from surplus or the allocation of surplus to R & D
activity. Innovation is cost reducing, and capacity expanding. By its adoption and implementation, it is implied that the
profit generated exceeds that in the previous time period. In this sense a kind of 'satisficing' approach is implied, with
the market leader seeking improved performance, rather than the will o' the wisp of optimal performance.
If the unit cost at capacity of the market leader is tracked over time, its locus has a form which identifies discrete
points on a falling long run unit cost curve. In this sense, by pushing on innovation, lowering unit cost, and expanding
capacity, the market leader is exploiting dynamic scale economies. This, based on classical reasoning, is precisely the
picture envisaged by Porter. It clearly also involves, as he suggests in his own analysis, the amortization of R & D
expenditure over a greater scale of output, cf. Porter (1990, p.54).
In pursuing competitive advantage in this way, the market leader puts following firms at a competitive disadvantage.
They operate at lower scales of operation, with higher unit costs. Margins are constantly squeezed by the downward
pressure on price exerted by the market leader. There is a kind of hierarchy of leaders and followers, with (in the
starkest scenario) no variations in relative position, and life getting harder the further you go down the hierarchy. If an
element of chance is introduced into the innovation process, this creates at least some prospect for firms 'close' to the
market leader, in terms of technology, being able to 'leap-frog' the current leader or higher ranked followers.
If global market demand is increasing less rapidly than the sum of capacities of all firms active in this sector, then the
most disadvantaged followers will tend to be forced out of the market. Indeed, if demand were static, this process would
be rapid, and increased concentration of industrial output would ensue, followed by ultimate monopolisation. This is the
doomsday scenario predicted in the radical critique of globalization, which in turn has its roots in Lenin's earlier analysis
of imperialism.
However, there are reasons to think that this stagnation of demand will not occur. The roots of the argument, which
explain why this may not happen, are to be found in the work of Young (1928), and especially, Kaldor (1970, 1972).
What Young and Kaldor have pointed out is that technologies of the sort we have been discussing display dynamic
increasing returns. This effect is entirely destructive of competition in a neoclassical sense, as no 'general equilibrium'
may exist. If it does, it may be unstable. This leads to an important alternative view of the competitive process which
may be dubbed 'cumulative causation'. As Young (1928, p.533) put it 'change becomes progressive and propagates itself
in a cumulative way'. In a nutshell, the argument is that the increased surpluses which market leaders enjoy, as they
press on with innovation, and enjoy greater scale economies, create induced investments which increase effective
demand. Thus the cycle of increased scale, greater economies, enlarged surpluses, increased demand, is reinforcing,
hence the term 'cumulative causation'. The conditions under which this will occur were sketched by Young, tightened up
by Kaldor, and expressed with reasonable precision by Hahn (1989). Essentially, the conclusion of Hahn (1989, p.53) is
that Kaldor overstated his theoretical case, which had been expressed very strongly, in phrases like 'there are no resource
constraints in the long run'. However, with certain forms of expectations and increasing returns, 'cumulative causation'
can occur. Kaldor (1970) himself, in introducing his argument in a regional context, was also at pains to point out that
the mirror image of cumulative causation, and the so called 'virtuous circle' of growth, increasing returns, and further
growth, is the 'vicious circle' of decline, increasing costs and further decline. Indeed he pointed out that virtuous circles
and vicious circles could develop side by side in different regions which were part of an integrated economy. In doing
so, he deployed classical analysis to anticipate North-South problems of the globalized economy.