Bush’s Team Should Study Creation of Super-Firms

As a Ph.D. candidate at Harvard, Michael E. Porter studied the theory of industrial organization, a field traditionally concerned with explaining why there is less competition in some industries than in others, and with prescribing antitrust and regulatory policies to make these industries more competitive and reduce monopoly profits.

But Porter had a different idea: He turned the subject inside out. Taking the perspective of a businessman inside an industry instead of a government official outside it, Porter asked: How can I make my environment less competitive and make sure that I get some of those monopoly profits?

It was one of those brilliant ideas that seem obvious in retrospect, and it made Porter famous and rich. His book “Competitive Strategy” is the all-time best-seller among serious books on business strategy. Now based at the Harvard Business School, he has become one of America’s most sought-after strategic consultants.

Now Porter has written another book, “The Competitive Advantage of Nations.” It is a massive tome, not recommended for beach reading. But it is important and should give some pause to the Bush Administration’s economic team.

In essence, the book’s thesis is that national advantages in particular industries are created, not given. Rarely does a country export a sophisticated good simply because it has the right resources. Instead, competitive advantage is based on a self-reinforcing set of relationships.

A strong national presence in an industrial “cluster” encourages the formation of a pool of labor with the right specialized skills, the development of supplier industries and sophisticated local demand. The availability of labor, supplies and strong local demand then reinforce the cluster’s advantages.

The origins of an industrial cluster may lie in historical accident, in inspired entrepreneurship or in government policy. Whatever the beginning, the cluster tends to perpetuate itself until bad leadership or bad luck causes it to unravel.

This is not a new thesis--Alfred Marshall said much the same thing a century ago, and similar ideas have been at the heart of the “new trade theory” that has swept through international economics the past decade.

What is new in Porter’s book is the relentless documentation, the parade of case studies, from Danish furniture and Italian tile to Japanese robots and American medical instruments. The book is not fun to read, but it is massively authoritative.

What is the relevance of all this to the Bush Administration?

In many ways the Bush economic team is pretty mild in its ideology. Extravagant supply-side promises are out, and so are radical attempts to dismantle the welfare state. On issues of trade and industrial policy, however, the Bush team remains true believers--bucking a growing tide of contrary opinion.

At a time of increasing concern over America’s technological slump in the face of Japanese competition, Bush’s men want to let the market solve its own problems. Budget director Richard G. Darman and economic adviser Michael J. Boskin want to scrap Sematech, the pioneering (and lightly funded) government-business research consortium in semiconductors. Craig Fields, the mildly pro-industrial-policy head of the Defense Advanced Research Projects Agency, has been demoted.

These are not mischievous moves. They represent an honest conviction that the right way to make America competitive is for the government to get out of the market’s way--that the market will take care of itself.

But that conviction is exactly what Porter’s book ought to undermine. Porter is no protectionist or industrial policy enthusiast. His book, however, documents the pervasive role of exactly the kind of forces that sophisticated protectionists like to invoke to support their claims.

Can a carefully targeted subsidy, or a limited period of infant-industry protection, foster the creation of an industrial cluster that will subsequently be self-reinforcing? Can denial of access to foreign markets, or persistent subsidized foreign competition, cause an otherwise viable industrial cluster to unravel?

The answer to both questions, on Porter’s evidence, is yes. No doubt in practice governments often delude themselves about the viability of the industries they promote, and special interests use the claim of foreign predation to justify pure pork barrel. Nonetheless, after reading Porter it is very difficult to claim that free trade and untrammeled markets make sense as universal principles.

Coincidentally, Porter’s Harvard Business colleague, Alfred Chandler, has just published a landmark work. Few people will think of “Scale and Scope” as a complement to “The Competitive Advantage of Nations,” but to my mind they should be viewed almost as sister books.

Chandler is the world’s leading business historian, famous for his studies of the emergence of the modern corporation. His latest book continues his life’s work with a huge comparative study of the origins of hundreds of large corporations around the world.

And what Chandler finds is a consistent pattern: Great firms emerge by seizing the moment. At a key point in the emergence of a new industry or technology, those firms that are ready to make large investments in production, distribution and organization can establish a lasting advantage over potential rivals, an advantage that can endure for several decades.

Why is this story linked to Porter’s? Because again we get the decisive role of historical contingency. If, at a critical moment in the emergence of a new technology, firms from one country are better prepared than firms from another to make the necessary investments, they can establish an enduring--and profitable--advantage.

Chandler says nothing about industrial policy, or indeed about government policy of any kind. His book, however, like Porter’s, portrays exactly the kind of world economy in which sophisticated government policies can create national advantages that endure long after the policies have ended.

There are compelling political and pragmatic arguments against any large-scale U.S. industrial policy. What Bush’s advisers seem to believe, however, is that basic economic principles, supported by evidence, show that less government intervention is always better. They should read Porter and Chandler, who tell us, sadly, that it ain’t necessarily so.