What is Competitiveness?

By Michael Porter
Harvard University Professor and Director of the Center for Competitiveness

Competitiveness is defined by the productivity with which a nation utilizes its human, capital and natural resources. To understand competitiveness, the starting point must be a nation’s underlying sources of prosperity. A country’s standard of living is determined by the productivity of its economy, which is measured by the value of goods and services produced per unit of its resources. Productivity depends both on the value of a nation’s products and services – measured by the prices they can command in open markets – and by the efficiency with which they can be produced. Productivity is also dependent on the ability of an economy to mobilize its available human resources.

True competitiveness, then, is measured by productivity. Productivity allows a nation to support high wages, attractive returns to capital, a strongcurrency – and with them, a high standard of living. What matters most is not exports per se or whether firms are domestic or foreign-owned, but the nature and productivity of the business activities taking place in a particular country. Purely local industries also count for competitiveness, because their productivity not only sets their wages but also has a major influence on the cost of doing business and the cost of living in the country.

What Matters for Competitiveness

Almost everything matters for competitiveness. The schools matter, the roads matter, the financial markets matter and customer sophistication matters. These and other aspects of a nation’s circumstances are deeply rooted in a nation’s institutions, people and culture. This makes improving competitiveness a special challenge, because there is no single policy or grand step that can create competitiveness, only many improvements in individual areas that inevitably take time to accomplish. Improving competitiveness is a marathon, not a sprint. How to sustain momentum in improving competitiveness over time is among the greatest challenges facing countries.

Creating Wealth at the Microeconomic Level

The cornerstones for economic development have long been considered stable institutions, sound macroeconomic policies, market opening and privatization. Most discussion of competitiveness and economic development is still focused on these areas. It is well understood that sound fiscal and monetary policies, a trusted and efficient legal system, a stable set of democratic institutions, and progress on social conditions contribute greatly to a healthy economy.

I have found that these factors are necessary for economic development, but far from sufficient. These broader conditions provide the opportunity to create wealth but do not themselves create wealth. Wealth is actually created in the microeconomic level of the economy. Wealth can only be created by firms. The capacity for wealth creation is rooted in the sophistication of the operating practices and strategies of companies, as well as in the quality of the microeconomic business environment in which a nation’s companies compete. More than 80 percent of the variation of GDP per capita across countries is accounted for by microeconomic fundamentals. Unless microeconomic capabilities improve, macroeconomic, political, legal, and social reforms will not bear full fruit.

A Flawed View of Competitiveness

Worldwide, the most intuitive definition of competitiveness is a country’s share of world markets for its products. This definition makes competitiveness a zero-sum game, because one country’s gain comes at the expense of others. This view of competitiveness is used to justify intervention to skew market outcomes in a nation’s favor (so-called industrial policy). It also underpins policies intended to provide subsidies, hold down local wages and devalue the nation’s currency, all aimed at expanding exports. In fact, it is still often said that lower wages or devaluation “make a nation more competitive.” Business leaders are drawn to the market-share view because these policies seem to address their immediate competitive concerns.

Unfortunately, this intuitive view of competitiveness is deeply flawed, and acting on it works against national economic progress. The need for low wages reveals a lack of competitiveness, and holds down prosperity. Subsidies drain national income and bias choices away from the most productive use of the nation’s resources. Devaluation results in a collective national pay cut by discounting the products and services sold in world markets while raising the cost of the goods and services purchased from abroad. Exports based on low wages or a cheap currency, then, do not support an attractive standard of living.

The world economy is not a zero-sum game. Many nations can improve their prosperity if they can improve their productivity. There are unlimited human needs to be met if productivity drives down the cost of products and productive work supports higher wages. Thus, the central challenge in economic development is how to create the conditions for rapid and sustained productivity growth. Microeconomic competitiveness should be the central item on the economic policy agenda of every nation.