Porter's Diamond and Exchange Rates

Abstract * Michael Porter's 1990 study of international competitiveness consistently plays down the possibility of exchange rates (or wage rates) affecting the world market share of individual industries. * Data for six of the countries he studied are inconsistent with that hypothesis. Later data also show a significant change in trade flows for the United States and Japan, primarily in response to exchange rate changes. This paper shows that data for some smaller countries are also inconsistent with his hypothesis. Key words * Exchange rates, international competitiveness, smaller nations, unit labour costs, world market share, Canada, Japan, Sweden, United States. Exchange Rates and International Competitiveness: The Porter Model In assessing Michael Porter's views on exchange rates and if they affect the competitive position of individual industries in a country's share of world markets, it is essential to have some view of what is meant by competitiveness, and also how it can be measured. Three ideas from economics and management are relevant to competitiveness, namely efficiency, economy, and effectiveness. Each of those concepts can be defined briefly, as follows: Efficiency is the extent to which high output is achieved from a given combination of inputs, such as labour, capital (and perhaps purchased materials and services); Economy is the degree to which a given product (or group of products) can be produced at low cost per unit; and Effectiveness is the degree to which the production process or the product produced by a country (and the companies in it) corresponds to longer-term shifts in technology and/or market demand. There are three key characteristics of Michael Porter's approach that need to be pointed out in this assessment. For one thing, Porter has a heavy micro orientation in his research, reflecting his earlier work on corporate strategy. This is reflected in his emphasis in the ten country study (Porter 1990) and in the study for Canada (Porter 1992) on industry and company material on the four elements of the diamond (factor conditions; demand conditions; firm strategy; and related and supporting industries). This can provide detail that is absent in the aggregates, but it is still an open question whether the additional detail is worth the extra cost. (The Canadian study, for example, does not contain any recommendations for either the private or the public sector that had not been made previously by other Canadian studies using other approaches.) A second characteristic is an emphasis on merchandise exports and world market share in assessing competitiveness. However, there has been an emphasis in theory and empirical work in international economics for the last two decades on capital flows as an important influence driving the current account and exchange rates. For example, the role of the federal budget deficit (combined with low personal savings) has encouraged a large capital inflow into the United States, and a related deficit on current account in the balance of payments. The loss in export market shares in a period of a high U.S. dollar was reflected in the data in Porter's ten country study but attributed to micro level determinants. Since 1985, however, the depreciation of the U.S. dollar on a trade weighted basis has led to a revival in U.S. world market shares, but the strength and weaknesses in most elements of the diamond are probably the same now at the level of the firm as in 1985, the last year of data in the study. A third characteristic of the approach by Porter is to play down the importance of exchange rates and wage rates in the determination of competitiveness. In the key tables for the countries studied in the 1990 volume there are no comparative data for wages, price levels or cost levels in manufacturing for the countries studied there (Porter 1990, Table 1. …