The Role of Government
In the continuing debate over the competitiveness of nations, no topic engenders more argument or creates less understanding than the role of the government. Many see government as an essential helper or supporter of industry, employing a host of policies to contribute directly to the competitive performance of strategic or target industries. Others accept the “free market” view that the operation of the economy should be left to the workings of the invisible hand.
Both views are incorrect. Either, followed to its logical outcome, would lead to the permanent erosion of a country’s competitive capabilities. On one hand, advocates of government help for industry frequently propose policies that would actually hurt companies in the long run and only create the demand for more helping. On the other hand, advocates of a diminished government presence ignore the legitimate role that government plays in shaping the context and institutional structure surrounding companies and in creating an environment that stimulates companies to gain competitive advantage.
Government’s proper role is as a catalyst and challenger; it is to encourage—or even push—companies to raise their aspirations and move to higher levels of competitive performance, even though this process may be inherently unpleasant and difficult. Government cannot create competitive industries; only companies can do that. Government plays a role that is inherently partial, that succeeds only when working in tandem with favorable underlying conditions in the diamond. Still, government’s role of transmitting and amplifying the forces of the diamond is a powerful one. Government policies that succeed are those that create an environment in which companies can gain competitive advantage rather than those that involve government directly in the process, except in nations early in the development process. It is an indirect, rather than a direct, role.
Japan’s government, at its best, understands this role better than anyone—including the point that nations pass through stages of competitive development and that government’s appropriate role shifts as the economy progresses. By stimulating early demand for advanced products, confronting industries with the need to pioneer frontier technology through symbolic cooperative projects, establishing prizes that reward quality, and pursuing other policies that magnify the forces of the diamond, the Japanese government accelerates the pace of innovation. But like government officials anywhere, at their worst Japanese bureaucrats can make the same mistakes: attempting to manage industry structure, protecting the market too long, and yielding to political pressure to insulate inefficient retailers, farmers, distributors, and industrial companies from competition.
It is not hard to understand why so many governments make the same mistakes so often in pursuit of national competitiveness: competitive time for companies and political time for governments are fundamentally at odds. It often takes more than a decade for an industry to create competitive advantage; the process entails the long upgrading of human skills, investing in products and processes, building clusters, and penetrating foreign markets. In the case of the Japanese auto industry, for instance, companies made their first faltering steps toward exporting in the 1950s—yet did not achieve strong international positions until the 1970s.
But in politics, a decade is an eternity. Consequently, most governments favor policies that offer easily perceived short-term benefits, such as subsidies, protection, and arranged mergers—the very policies that retard innovation. Most of the policies that would make a real difference either are too slow and require too much patience for politicians or, even worse, carry with them the sting of short-term pain. Deregulating a protected industry, for example, will lead to bankruptcies sooner and to stronger, more competitive companies only later.
Policies that convey static, short-term cost advantages but that unconsciously undermine innovation and dynamism represent the most common and most profound error in government industrial policy. In a desire to help, it is all too easy for governments to adopt policies such as joint projects to avoid “wasteful” R&D that undermine dynamism and competition. Yet even a 10% cost saving through economies of scale is easily nullified through rapid product and process improvement and the pursuit of volume in global markets—something that such policies undermine.
There are some simple, basic principles that governments should embrace to play the proper supportive role for national competitiveness: encourage change, promote domestic rivalry, stimulate innovation. Some of the specific policy approaches to guide nations seeking to gain competitive advantage include the following.
Focus on specialized factor creation. Government has critical responsibilities for fundamentals like the primary and secondary education systems, basic national infrastructure, and research in areas of broad national concern such as health care. Yet these kinds of generalized efforts at factor creation rarely produce competitive advantage. Rather, the factors that translate into competitive advantage are advanced, specialized, and tied to specific industries or industry groups. Mechanisms such as specialized apprenticeship programs, research efforts in universities connected with an industry, trade association activities, and, most important, the private investments of companies ultimately create the factors that will yield competitive advantage.
Avoid intervening in factor and currency markets. By intervening in factor and currency markets, governments hope to create lower factor costs or a favorable exchange rate that will help companies compete more effectively in international markets. Evidence from around the world indicates that these policies—such as the Reagan administration’s dollar devaluation—are often counterproductive. They work against the upgrading of industry and the search for more sustainable competitive advantage.
The contrasting case of Japan is particularly instructive, although both Germany and Switzerland have had similar experiences. Over the past 20 years, the Japanese have been rocked by the sudden Nixon currency devaluation shock, two oil shocks, and, most recently, the yen shock—all of which forced Japanese companies to upgrade their competitive advantages. The point is not that government should pursue policies that intentionally drive up factor costs or the exchange rate. Rather, when market forces create rising factor costs or a higher exchange rate, government should resist the temptation to push them back down.
Enforce strict product, safety, and environmental standards. Strict government regulations can promote competitive advantage by stimulating and upgrading domestic demand. Stringent standards for product performance, product safety, and environmental impact pressure companies to improve quality, upgrade technology, and provide features that respond to consumer and social demands. Easing standards, however tempting, is counterproductive.
When tough regulations anticipate standards that will spread internationally, they give a nation’s companies a head start in developing products and services that will be valuable elsewhere. Sweden’s strict standards for environmental protection have promoted competitive advantage in many industries. Atlas Copco, for example, produces quiet compressors that can be used in dense urban areas with minimal disruption to residents. Strict standards, however, must be combined with a rapid and streamlined regulatory process that does not absorb resources and cause delays.
Sharply limit direct cooperation among industry rivals. The most pervasive global policy fad in the competitiveness arena today is the call for more cooperative research and industry consortia. Operating on the belief that independent research by rivals is wasteful and duplicative, that collaborative efforts achieve economies of scale, and that individual companies are likely to underinvest in R&D because they cannot reap all the benefits, governments have embraced the idea of more direct cooperation. In the United States, antitrust laws have been modified to allow more cooperative R&D; in Europe, megaprojects such as ESPRIT, an information-technology project, bring together companies from several countries. Lurking behind much of this thinking is the fascination of Western governments with—and fundamental misunderstanding of—the countless cooperative research projects sponsored by the Ministry of International Trade and Industry (MITI), projects that appear to have contributed to Japan’s competitive rise.
But a closer look at Japanese cooperative projects suggests a different story. Japanese companies participate in MITI projects to maintain good relations with MITI, to preserve their corporate images, and to hedge the risk that competitors will gain from the project—largely defensive reasons. Companies rarely contribute their best scientists and engineers to cooperative projects and usually spend much more on their own private research in the same field. Typically, the government makes only a modest financial contribution to the project.
The real value of Japanese cooperative research is to signal the importance of emerging technical areas and to stimulate proprietary company research. Cooperative projects prompt companies to explore new fields and boost internal R&D spending because companies know that their domestic rivals are investigating them.
Under certain limited conditions, cooperative research can prove beneficial. Projects should be in areas of basic product and process research, not in subjects closely connected to a company’s proprietary sources of advantage. They should constitute only a modest portion of a company’s ov