Mike Porter Researches

.. easurement problems be addressed. Second, I claim that two of the most consistent (and increasingly explicit) policy agendas of our times, the competitiveness and sustainability agendas, are committed to stimulating, guiding, or directing science and technology to achieve their ends. Each agenda attempts to influence technological and industrial innovation in the narrow sense and each ponders the broader issues of institutional and social innovation, raising a host of questions about ends and means. Third, innovation takes place in systems of public and private institutions and the rules and routines of their behavior.

Innovation research uses notions such as system of innovation (Niosi et al. 1993; Nelson 1993) to describe the social institutions of innovation. The set of distinctions among minor and major forms of technological change employed by evolutionary economists helps to address the level-of-analysis problem that one encounters when searching for the boundaries of a system. Freeman (1992) distinguishes among innovation at the level of the firm, the production system, the technology system, and the technoeconomic paradigm. These distinctions identify progressively larger increments of change in current practices of production, and progressively broader groups of organizations and behaviors taken as reference points.

Incremental innovations are minor cumulative changes continuously occurring in firms which can add up over time to significant improvements in productivity and efficiency. Radical innovations are discontinuities in the production system. Nylon and the oxygen steelmaking process are historical examples. More recently, radical innovations are usually the result of deliberate research and development in enterprises and/or in university and government laboratories (Freeman 1992). Changes of technology system are the result of clusters of radical innovations that create far- reaching changes in technology, affecting several branches of the economy, as well as ultimately giving rise to entirely new sectors. Synthetic materials and the associated manufacturing techniques are examples. Technological revolutions, or change of technoeconomic paradigm, are new technology systems which have such pervasive effects on the economy as a whole that they change the style of production and management throughout the economy (Freeman 1992).

Technological innovation entails organizational, social, or cultural innovation. Fourth, I inquire whether it might be useful to develop and apply a systems of innovation approach in the North American region. The existence of a North American system of innovation may be surmised on the basis of the considerable degree of economic integration that has taken place among the United States, Mexico, and Canada. However, the contours and dynamics of this system have not been well described. Fifth, my discussion focuses primarily on problems of industrial innovation, and the section on sustainability is correspondingly limited. Issues of natural resource management, energy, transportation, sustainable cities, or sustainable agriculture need to be examined from an innovation perspective, but it has not been possible to do it here.

While neither competitiveness nor sustainability (however defined) is imaginable in the absence of innovation, the key issue, in my view, is the degree to which a production system can be both competitive and sustainable in a given context. As North American economic integration proceeds, science and technology policies and private management strategies will respond to the emerging conditions of innovation in the region. Subregional patterns of economic activity will change, and successful social mastery of new configurations of production will be an important skill to acquire. The greening of technology policies and management practices presents a new set of challenges in the context of trade regional liberalization, heightened intra- and inter-regional competition, and increased mobility in factors of production. 2. A North American System of Innovation The notion of system of innovation can be operationalized in terms of financial flows, legal and policy links, and flows of information, science, technology, and people (Niosi et al.

1993). Among the legal and policy measures that are contributing to an integrated North American innovation system are the NAFTA rules governing investment, intellectual property, and technical standards. Among the financial and technology flows is the huge volume of bilateral trade between the United States and its two neighbors, especially intrafirm trade. Among the flows of science are the innumerable linkages between Canada and the U.S. on the one hand and the U.S.

and Mexico on the other. The familiar hub-and- spokes pattern of North American economic interchange, in which the United States’ neighbors entertain extensive interactions with it but very little with each other, is paralleled in patterns of scientific communication.1 A regional system integrator is an actor that aligns and integrates the economic and technological systems of regional members in interaction with them, including bilateral and multilateral trade, direct investment, official development assistance, non market technological collaboration (for example, military), political relationships, provision of services, establishment of trade rules, export of production technology, and export of the software of technological development such as management beliefs, social science paradigms, administrative and technical curricula, information, publications, symbolic reward systems, etc. (Yama*censored*a 1991). These linkages help spread a pattern of growth into related economies. In Asia, the Japanese role of regional integrator may represent an enlargement of the parent-subcontract industrial relation to include newly industrializing countries (Yama*censored*a 1991, 4). In Europe the role of systems integrator is played by a supranational institution, the European Community, its multitude of programs and policies, and the networks of firms and institutions within the regional economic space. The United States, its large firms, and the regional trade rules are the principal innovation system integrators in North America.

In contrast to trends in Asia and Europe, science, technology, and innovation have not been prominent considerations in the discussions about the North American region’s future. Before the present decade, neither Canada, nor the United States, nor Mexico tended to see itself as a member of a North American community or system. Most attention focused instead on the extensive bilateral relationships between Canada and the United States on the one hand, and between Mexico and the U.S. on the other. It was implausible to suggest that North America might evolve into a region possessing a specific, shared identity and continental-scale institutions. Regional economic integration is reshaping the North American economic landscape.

The North American Free Trade Agreement (NAFTA) establishes a framework for a trade regime encompassing one of the largest (about 360 million people) and richest (about $6 trillion) regional markets in the world. NAFTA sets trade rules for a regional economy that has already undergone substantial integration. Canada and the United States have the world’s largest bilateral trade relationship, and the United States is Mexico’s largest trading partner. NAFTA includes provisions for the reduction and eventual elimination of most tariffs affecting commerce among Canada, the United States, and Mexico in commodities, manufactured goods, and services. However, NAFTA goes beyond tariff elimination to establish rules governing trade and investment. The three countries agree not to discriminate against each others’ goods and services, and to eliminate most tariffs over a decade. Customs procedures and temporary entry for business travellers are simplified.

Mexican import licensing procedures are immediately eliminated. The chapter on rules of origin sets out formulae by which Mexican, American, or Canadian products incorporating third-party materials or components can qualify for preferential access to each other’s markets. Under the net cost formula, most products qualify for preferential treatment with 50% North American content. In the case of light vehicles, the figure is 62.5%. This provision is designed to discourage new transplants from using Mexico to supply the U.S. automotive market.

The rules for determining North American content can be complex in practice, and their primary implication for manufacturing is in sourcing practices. NAFTA extends national treatment to member countries’ suppliers of goods and services to public markets. NAFTA signatories agree not to impose offsets or performance requirements in public procurement. Improved tendering and dispute resolution procedures are specified. The rules governing public procurement are broader than those in the GATT procurement code, and NAFTA, in its extension of procurement rules to subnational governments (states, provinces, and municipalities), goes well beyond the Canada-U.S. Free Trade Agreement.

The net result is to liberalize a North American public market of about $70 billion. NAFTA sets rules regarding control over foreign investments. It establishes the principle of national treatment for all three parties regarding investments, establishment of new businesses, acquisition and sale of businesses, and the conduct and operation of businesses. No minimum levels of equity may be imposed on purchases or ownership. No performance requirements (for import substitution, local sourcing, export targets, foreign exchange generation, production sharing, product mandates, hiring of nationals in management positions, or technology transfer) may be imposed on investments from any of the three countries or on any investments from any third country (Article 1106). However, governments may offer advantages to firms in exchange for commitments regarding R, training, expansion, or location of production facilities.

Canada retains the investment screening regime established under CUFTA (the right to review direct acquisition of Canadian controlled firms valued at more than C$ 150 million). No restrictions may be placed on the patriation of profits and transfer payments. Mexico retains a range of investment prohibition privileges in the energy and communication sectors. Unlike CUFTA, NAFTA contains a chapter setting out rules for intellectual property. Chapter 17 applies standards regarding sound recordings, literary and artistic works, software, data, designs, copyright, trademarks, and patents. It makes provisions for enforcing intellectual property rights, and it restrains the parties’ latitude to permit compulsory licensing of patents. NAFTA also contains provisions governing energy, natural resources, agriculture, financial services, technical standards, telecommunications, cultural industries, and transportation services. Like the Agreement’s provisions discussed above, the general thrust is to deregulate and liberalize trade in these industries within North America, and to specify special cases in which governments retain rights to discriminate. Two side agreements cover labor and environmental issues.

However, the disciplines envisaged by these two agreements in case of noncompliance are weak (Shrybman, 1993; Martin 1992). Continental market liberalization necessarily modifies the options available to policymakers to structure national or subnational economic development, and reduces the range of policy instruments available. Because NAFTA establishes new rules of the game for regional trade, it has been called an economic constitution for North America. What are the implications of NAFTA for innovation policy and management? In the first place, NAFTA clearly restrains governments from imposing performance requirements on foreign investors, North American or other, and considerably reduces governments’ latitude to screen foreign direct investment (FDI).1 Also, under NAFTA governments cannot impose performance requirements but may negotiate some kinds of innovation-related performances with firms in exchange for incentives. In the second place, like CUFTA, NAFTA contains no rules governing subsidies, one of the most difficult issues on the trade policy agenda.

Many kinds of government assistance have been labelled subsidies in U.S.-Canada trade disputes, including grants, tax credits, low-interest loans, and unemployment insurance. The subsidy issue was not resolvable during CUFTA negotiations. In the case of NAFTA, the subsidy issue was referred to the GATT, where the recently signed Dunkel text contains rules governing publicly- supported R&D and other kinds of subsidies. Since NAFTA does not cover subsidies, the rules of the game are unclear regarding direct or indirect public involvement in initiatives that help create advantage in the private sector. Given the uncertainty about subsidies, policymakers in Canada and Mexico will probably pay close attention to innovation policy practices in the United States in the belief that American practices will set a de facto standard in the region.

The Clinton administration has adopted a more vigorous approach to promotion of industrial innovation than the two preceding administrations. In the third place, NAFTA is clearly intended to cover the activities of subnational governments, insofar as the respective Federal governments are empowered to commit subnational governments through international agreements. This will have the same effects on state and provincial innovation policies as on national policies in North America. Many states and provinces have developed quite extensive programs and institutions in support of innovation. Similarly, many American cities offer substantial industrial incentives.

Tax and subsidy competition among localities is widespread in North America. European and North American regional trade arrangements shield regional economies from offshore competition. However, the two regional arrangements are based on quite divergent philosophies. Europe has adopted a Keynesian approach to regional economic integration, creating a wide range of institutional arrangements to address economic and social issues. European economic integration involves an attempt to build an administrative framework that takes into account the economic efficiency and collective security needs of the community, by means of the creation of a genuinely mixed economy at the regional level, when it seemed no longer viable on a national level (Deblock and Rioux 1993: 32).

In contrast, NAFTA, like the Canada-U.S. Free Trade Agreement it superseded, largely concentrates on removing barriers to the movement of goods and capital. NAFTA is a negative approach to regional economic integration. It is concerned largely with removing tariff and nontariff barriers to movements of goods, services, and capital. It has no mechanisms to promote positive adjustment to economic integration. Problems of adjustment are largely left to the national governments to resolve.

A regional trade agreement provides preferences among member countries, and fosters intraregional trade at the expense of interregional trade. Continental trade liberalization is precipitating wide discussion in North America about jobs, the environment, and national sovereignty. What are the implications of economic continentalization for science and technology strategies in the region, considering the increasingly integrated continental production system into which the two smaller countries have opted, and considering also the constraints placed by NAFTA on use of a wide range of traditional instruments of industrial and economic policy? The rationale for trade liberalization is well known. Manufacturing firms require economies of scale to compete in global markets, and production efficiencies are determined by relative size of market. Under tariff protection, inefficient, subcritical plants produce short runs of excessively diverse product lines. Access to a large market and increased competition should lead to rationalization and accelerated R&D investments (Daly and MacCharles 1986).

Trade liberalization should induce manufacturers in Canada to rationalize within the North American market, decreasing unit costs and reducing the productivity gap with the United States (ECC, 1988). One expects increased competition to improve the technical and allocative efficiency of firms (Globerman 1990). Thus economic gains from trade liberalization are principally realizable in the presence of productivity growth via attainment of economies of scale, increased internal R&D investments, and a higher rate of technological diffusion within firms and their supplier networks. As for the reorganization of production in North America, the simplest assumption is that of segmented production, with resource extraction, mass assembly operations, and higher R&D and management functions all sited in different locations. However, a much wider range of organizational responses is available to firms, such as just-in-time production (and its implications for proximity to suppliers), strategic alliances, multilocational production strategies, flexible specialization and the like (Eden 1991; 1994). Concern is being voiced that the North American trade regime provides strong incentives for manufacturers to respond to market competition with a low-wage strategy, which will lower incomes and productivity over the long run, rather than [take] the more difficult path of producing quality products more efficiently.1 This would create downward pressures on social and environmental standards in North America. While the objective pursued by conventional trade policy is to increase the allocative or Ricardian efficiency of the economy, the rationale of development-oriented innovation policy is to increase the growth or Schumpeterian efficiency of the economy (Dosi, Zysman, and Tyson 1990, 25). A major task facing policymakers, practitioners, and innovation scholars in North America is to identify plausible routes to technological learning in open economies and assemble a collection of policy instruments that are relatively effective (i.e.

likely to induce technological spillovers into the economy), efficient (i.e. do not entail disproportionately high costs), and acceptable under the prevailing trade regime. 3. Industrial Innovation and Canadian Competitiveness Canada is a trading nation. Approximately 30% Canada’s GDP is generated through international trade, and the combination of imports and exports amounts to half of Canada’s GDP.

Of the G-7 countries, only in Germany does international trade contribute a higher proportion of GDP. Although much of the discussion about innovation in Canada has been pitched in terms of adjustment to globalization, Canada’s international trade is mainly continental. About three-quarters of Canadian trade is with the United States, and more than half of this is intra-firm trade. Furthermore, Canadian international trade is highly concentrated. About 70% takes place via about 50 firms, half of which are of Canadian origin.

The search for competitiveness has created an eager market for indicators, yardsticks, and report cards in Canada. These provide sometimes paradoxical views on the state of Canadian competitiveness. According to the United Nations Human Development Index in 1992, Canadians enjoy the highest quality of life in the world. According to the OECD, Canada recently had the fastest increase in employment among the G-7 countries and the second highest growth rate. But the World Competitiveness Report’s 1993 survey ranked Canada eleventh among twenty-two industrialized countries, down from fourth place just four years earlier. The World Competitiveness Report gave relatively high marks to Canada’s financial system (3d place) and infrastructure (5th place), but low marks to Canadian science and technology strategies (16th place), quality of production technologies (15th place), trade diversification (20th place), quality of management (14th place), and investment in new equipment (21st place).

Of all countries surveyed, only Britain’s manufacturing base had deteriorated more dramatically than Canada’s. Canada has lost an estimated half million manufacturing jobs since 1989, with manufacturing’s share of overall employment falling to about 15%. The unemployment rate is about 11%, and by mid-1990s the net public debt/GDP ratio will have climbed to about 75% – up from about 30% at the beginning of the 1980s. Canada is carrying one of the highest per capita public debts among advanced countries. Canadian competitiveness has been dissected and debated in an avalanche of reports and studies.1 Many believe that Canada’s overall technological effort is too modest, and R expenditures too heavily dependent on the public sector, to help realize Canada’s aspirations to maintain an advanced economy. To get to the bottom of the competitiveness question, in 1990 the Federal government and the Business Council on National Issues commissioned Harvard Business School strategist Michael Porter to apply his renowned diamond analysis to Canada.

In The Competitive Advantage of Nations (1990) Porter says that a nation’s goal is to improve the standard of living by increasing the growth of industry through increasing industrial productivity and through shifting resources to higher productivity segments. This will normally happen as industry works to reduce unit costs and differentiate products, but industry will not choose to do so unless faced with competition (rivalry) and opportunities for innovation in their markets. Nations are competitive if their firms can engineer not just cost improvements but also differentiation. International rivalry normally pushes firms down product streams toward highly differentiated products. This requires constant innovation on the part of the firm. Internationally competitive firms create a virtuous cycle in which reinvestment drives further growth through innovation and learning. Mass production strategies are abandoned to less-developed countries.

The most appropriate national innovation strategy is one that encourages firms to compete at the high end of the market through innovation, product differentiation, and service delivery, in contrast to sole reliance on traditional cost-cutting, productivity-enhancing measures.2 Porter’s thesis is that national competitive advantage is embedded in a competitive diamond of four essential attributes. These are: Factor conditions (labor, land, natural resources, infrastructure, labor skills, and services to industry); Demand conditions (the quality and strength of home-market demand for local industrial output. Porter attaches considerable importance to the presence of knowledgeable, demanding local customers); Related and supporting industries, especially the presence or absence of internationally competitive suppliers; and Firm strategy, structure and rivalry, which constitute the conditions in which companies are created, organized, and managed. Porter says that firms have a home base where the key strategic decisions are taken and where the core product and process technologies are maintained. He says that if firms do not use their national home base in this way, they do not contribute to competitiveness of the national economy. Porter’s Canadian report, ominously entitled Canada at the Crossroads, argues that Canada is not doing so well in the new competitive environment (Porter, 1991).

Five trends indicate underlying weaknesses: low productivity growth, high unit labor costs, persistently high unemployment, lagging investment in skills and technology upgrading, and an unencouraging macroeconomic climate for productive investments. Porter observes that Canada is deficient in vigorous export industries. Most Canadian exports are in natural resources industries (materials and metals, forest products, and petroleum and chemicals), with some other successful exporters in transportation (mainly automobiles and avionics) and food and beverage industries (Porter, 1991). In other words, Canada is specialized in exports of unprocessed or semi-processed commodities. Many of the sales of the relatively higher value-added exporters, such as chemicals or autoparts, go to a very small number of parent firms in the United States. Porter concludes that in Canada, natural resource factor advantages are more important than innovation-related created advantages, and that an abundance of natural resource-related factors does not necessarily lead to new factor creation, it leads to specialized resource firms.

One might expect an indigenous capital goods industry to service the resource industries, but this has not happened in Canada. Furthermore, Canadian domestic demand plays a minor role in the development of internationally competitive Canadian firms; the American market and American suppliers predominate. Domestic rivalry is usually not significant in internationally competitive Canadian industries, nor do these industries develop local clusters of upstream and downstream linkages. Canadian regional development policies prevent geographical concentration of firms, and foreign direct investment in Canada has reduced the importance of supporting industries through intrafirm transactions or vertical integration. Moreover, Porter notes that few non-North American firms have developed a home base type relationship with Canada. Porter irked defenders of continental economic integration when he suggested that high levels of foreign direct investment in Canada are an impediment to international competitiveness. Canada has one of the highest levels of foreign ownership of industrial assets of any advanced country, raising the question of the extent to which foreign ownership inhibits the development of a national innovation system and, indeed, whether a national innovation system is necessarily preferred to integration into an international system (McFetridge 1993: 320). Porter’s analysis provoked a debate about the appropriateness for small countries of the national diamond competitiveness framework. Canada’s home country diamond does not have the answers to explain Canada’s international competitiveness, say D’Cruz and Rugman (1992), who are concerned with the strategic behavior of MNCs operating from small, open economies.

To be applicable to Canada, the Porter model needs to be corrected for the nature of foreign direct investment in Canada, the value added in Canada’s resource industries, and the relevance of Canada’s home country diamond in an integrated North American economic system (ibid.). In a stream of publications, Rugman and D’Cruz have put forward a series of critiques of the Porter model in particular and of the more generally held belief in Canada that policies to promote indigenous manufacturing or high technology firms firms are critically important. D’Cruz’s and Rugman’s analysis of Canadian competitive advantage is based on the recognition that most Canadian firms are concentrated in sectors or production phases in which cost reduction is the primary competitive strategy. Canada’s ten leading export industries are automobiles, pulp and paper, vehicle components, commercial vehicles, non-edible agricultural products, non-ferrous metals, crude oil, cereal products, natural gas, and motors, turbines, and pumps. With the exception of the automotive sector, Canadian export performance is not determined by an ability on the part of its manufacturing sector to compete in international markets.

It depends instead upon the output of the natural resource sectors (D’Cruz and Rugman 1992: 21). Also, Rugman and D’Cruz take issue with Porter’s selection of strategic industrial clusters. In Fast Forward: Improving Canada’s International Competitiveness (1991), they identify ten subregional clusters accounting for the bulk of Canadian GDP and note that seven of the ten clusters are in the resource sector or in wage-sensitive production phases of manufacturing.1 They view competitiveness in these industries as largely determined by productivity growth, which in turn is driven by factor costs, especially wage and capital costs. In other words, indigenous advanced-technology development is not regarded as important in these sectors’ competitiveness. The problem of staples-driven economic development is the central theme of Canadian economic history.

Trade in primary products is a very slowly growing segment of world trade. This is partly because barriers to entry are relatively low, encouraging exports from the Third World and soon from the former Soviet Union. Of equal concern is the phenomenon of dematerialization of production, in which information-rich, highly engineered components such as optical fibers, ceramics, or high- strength composites replace simple commodity-based components.2 Because of competition and dematerialization of production, the long-term trend for commodity prices is down. In 1992 the Economist reported that real commodity prices were at their lowest level since the magazine began calculating an all-item index in 1845 (Pestieau 1993: 2). Canada has specialized its international trade in a small range of slow-growth commodities concentrated in the North American market. Canadian resource firms typically develop firm-specific process innovations which provide advantage. They maintain technical currency through procurement of foreign machinery, licenses, patents, and foreign producers, and when they do undertake R it is frequently abroad. Thanks to their cultural or geographic proximity to American and British technology markets, Canadian multinationals are probably among the fast ‘technology followers’ (Niosi 1983, 189). However, compared to their competitors in other countries, Canadian firms distinguish themselves by choosing to compete more on the basis of cost than on the basis of innovation.

For example, a recent study of innovation strategies in the Canadian non-ferrous metals sector found that R spending had declined in the 1980s, remaining at less than one percent of sales, while R spending in comparable Japanese and European firms had doubled to more than two percent of sales (SCC 1992b). This behavior reflects deliberate strategy, not just costs of production. According to Japanese and Finnish managers of mining companies quoted in the study, conventional business operations generating half or more of total revenues received only a small fraction of the R budget, while research on higher value-added activities – new materials and new products – received up to ninety percent of the R budget.3 A second key shortcoming of the Porter model when applied to small, open economies, according to Rugman and D’Cruz (1993), is that one cannot measure the international competitiveness of smaller countries in terms of export shares because much of the business of smaller countries is conducted abroad (through foreign direct investment) within the larger triad markets of the United States, E.C. and Japan – where the action is. Porter does not count overseas sales by the subsidiaries of Canadian-owned multinationals in export share data, giving the impression of poor Canadian export performance.

Dunning (1993) points out that there are three kinds of cross-border commercial interactions: arm’s length trade, inter-firm cooperative agreements, and foreign direct investment. He argues that Porter has substantially underestimated the importance of globalized production, especially the cross-border value added activities of transnational firms, much of which takes place as intrafirm trade. Canada is an important exporter of capital. Canadians invest abroad almost as much per capita as Americans. Between 1987 and 1991 about $5.4 billion was invested in the country annually, while about $6.6 billion was invested outside the country annually. In 1990 the foreign direct investment stock in Canada stood at $125.3 billion and the Canadian direct investment stock abroad stood at $86.7 billion (U.N. 1993).

In 1990 Canada had some 1300 indigenous MNCs. Even the r.