Chapter 2: Literature Review

2.0 Introduction
To answer the proposed research questions about competitiveness, this chapter will
discuss the several theoretical models and literature written about the competitiveness
of nations and their comparison. Next to this there is a discussion about the integration
of information technology and the Creative class in these models.

2.1.1 The competitiveness of Nations

There are several trade theories explaining the trade between countries. Examples
mentioned by Daniels (2004) are:

M ercantilism theory,

Neo mercantilism theory,

Absolute advantage theory,

comparative advantage theory,

County size theory,

Factor proportions theory,

Product Life cycle (PLC) theory,

Country similarity theory,

Dependence theory,

Strategic trade policy theory

Porters Diamond theory.

Each of these theories has a different emphasis as shown in figure 1. M ost of these
theories are country trade theories. Regardless of the advantages a country might gain
by trading, international trade ordinarily will not begin unless companies within that

country have competitive advantages that enable them to be viable traders. Porters
diamond explains why specialized competitive advantages differ between among
countries.

Figure 1: Trade theories

Source: Daniels (2004)

The static factors mentioned in comparative advantage are hard to influence 1. These
factors are: Land, Location, Natural resources (minerals. Energy), Labor, Local
population size. Specialized factors involve heavy, sustained investment 2. This leads
to a competitive advantage, because if other firms cannot easily duplicate these factors,
they are valuable. Specialized factors of production such as skilled labor, capital and
infrastructure are created.

Porter (1990) argues that a lack of resources often actually helps countries to become
competitive (selected factor disadvantage). Abundance generates waste and scarcity
generates an innovative mindset. Such countries are forced to innovate to overcome
their problem of scarce resources.
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Non-key" factors or general use factors, such as unskilled labor and raw materials,
can be obtained by any company and, hence, do not generate sustained competitive
advantage.

The Diamond M odel of Porter introduces the concept of clusters or groups of

interconnected firms, suppliers, related industries and institutions in particular regions.
As a rule competitive advantage of nations has been the outcome of four interlinked
advanced factors and activities between companies in these clusters. And these can be
influenced in a pro-active way by the government. Clustering promotes the
networking of all participants in the value chain.
The phenomenon of upstream and/or downstream industries locating in the same area
is known as clustering or agglomeration. This has the following advantages: potential
technology knowledge spillovers, an association of a region on the part of consumers
with a product and high quality and therefore some market power, or an association of
a region on the part of applicable labor force. Disadvantages: potential poaching of
your employees by rival companies and obvious increase in competition, possibly
decreasing mark-ups1.

Daniels (2004) explains this using the Porter Diamond. Figure 2 illustrates the Porter
Diamond and shows four conditions which are important for competitive superiority:
demand conditions, factor conditions; related and supporting industries; and firm
strategy, structure and rivalry. How these factors are combined affects the
development and continued existence of competitive advantages.

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Firm strategy, structure and rivalr y

Government

Strategy and structure

Goals
Personal goals
Competition among domestic
companies

Factor conditions

Demand conditions

Human Resources
Knowledge
resources
Capital
Physical resources
Infrastructure

Domestic demand
structure
The size of demand
and the form of
growth
Internationalization
of demand

Related and supporting industries

Suppliers and Buyers

Related Industries

Chance
Figure 2: The Diamond Model

2.1.2 Background of Porters diamond

Figure 3 describes how innovative capacity helps to create a productive competitive
environment, which then helps to create prosperity (See Figure 4: Prosperity
illustrated by growth rate of GDP and GDP per capita (PPP)). Nations therefore
compete to offer the most productive environment for businesses as shown in figure 7.

Figure 3: The effect of innovative capacity on competitiveness and prosperity

Source: Porter (2001b)

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How the Innovative capacity is measured is shown in figure 5, and it also highlights
the performance of Taiwan and the Netherlands. Another illustration of the innovative
capacity is the amount of patents a country produces (see

Figure 6: An illustration of innovative capacity by international patenting output). For

a prosperous economy there needs to be a stable political and legal context. The
competitiveness depends on improving the microeconomic foundations of
competitiveness, which are the elements that are mentioned in the Porters Diamond.

Figure 4: Prosperity illustrated by growth rate of GDP and GDP per capita (PPP)

Source: Porter (2001a & 2001b)

Clusters increase the productivity and efficiency because of easier access to

specialized inputs, easier coordination between firms, rapid diffusion of best practices,
visible performance comparisons. Clusters stimulate and enable innovation because of

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better perception of innovation opportunities, assistance in knowledge creation and

ease of experimentation. And Clusters stimulate commercialization opportunities for
new companies and new lines of business are more apparent. Furthermore the
competition is fundamentally enhanced by externalities and linkages across firms,
industries and associated institutions.

Figure 5: The Innovative Capacity Index of Taiwan and the Netherlands.

Source: Porter (2001a & 2001b)

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Figure 6: An illustration of innovative capacity by international patenting output

Source: Porter (2001a & 2001b)

Figure 7: An illustration of the relation between microeconomic competitiveness and

GDP per capita.
Source: Porter (2001a & 2001b)
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However Cluster policy is different from industrial policy. Whereas industrial policy
targets desirable industries or sectors, cluster based policy states that all clusters can
contribute to prosperity, Industrial policy tends to focus on domestic companies,
where cluster policy focuses on any company that can enhance productivity. Industrial
policy intervenes in competition by protection, industry promotion and subsidies,
where Cluster based policy relaxes impediments and constraints to productivity and
emphasizes cross industry linkages and complementarities. Industrial Policy
centralizes decisions at the national level which is different from cluster based policy
which encourages initiative at the state and local level. In short industrial policy tends
to distort competition and cluster based policy tries to enhance competition. The
advantages and disadvantages of industrial policy are also described by Gregory
Noble (2000) and The Industrial Performance Center of the M IT (Fuller, 2003),
though in general the industrial policy of Taiwan is described as positive for Taiwan.

As described in the previous paragraph collaboration is important for cluster building.

There are formal and informal organizations that facilitate the creation and flow of
information, technology and skills and support selected forms of collaboration. They
work through creating relationships that enhance the level of trust, facilitate the
organization of collective action and foster the establishment of common standards.
So they also provide a mechanism to develop a common agenda for a cluster or
economy. In general there are institutions in the private sector, public sector or mixed.
They contain: chambers of commerce, professional associations, religious networks,
school and university networks, advisory councils, competitiveness councils and
technology associations or alliances and government associations. Cluster specific
institutions are industry associations, specialized professional associations and

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societies, alumni groups of core cluster companies, incubators. At the end of the
Analysis chapter there is an interview with one of these institutions.

2.2 National Competitive Advantage in Services

2.2.1 Service Industry
Industrial design can be described as a service. And Porter (1990) places it in the
technology development supporting functions of the Value chain as is illustrated in
figure 8.
He also describes the de-integration of services, meaning firms are increasingly hiring
specialized service suppliers to perform services they used to perform themselves.
This has growing advantages over in-house service suppliers. This is supporting firms
that focus on delivering specialized design services. Services used to be labor
intensive, but nowadays the capital intensity of service firms is growing. Porter (1990)
mentions The most important reason for the transformation of a service firms value
chain is information technology (IT). Service firms use computers or computerized
techniques to perform old (and new) functions, control operations better, and make
employees more productive.

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Figure 8: The Value Chain

Source: Porter (1990)

Services are more and more going global. Porter (1990) mentions that the
internationalization of services is driven by a number of forces:

Similarity of service needs

M ore mobile and informed buyers of services

Rising economies of scale and geographic scope

Greater mobility of service personnel

Greater ability to interact with remote buyers, through telephone, online data
communication, rapid parcel delivery, and a variety of other means, it is
increasingly possible to communicate and engage in the needed interchange
with buyers of services even though they are located in foreign countries
(Porter, 1990)

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Continued wide disparities among nations in the cost, quality, and range of
services available from local firms.

There are three distinctly different links between manufacturing and service
industries that are important to national competitive advantage in these industries:

Buyer/ supplier relationship. This has two implications: without local

manufacturing the demand for services will be limited and the structure of
the industry can strongly influence the type, amount and sophistication.

Services tied to the sale of manufactured goods

M anufactured goods tied to the sale of services.

2.2.2 Factor conditions

Factor condition (The input) can be important in international competition in the
service industry. Especially in a couple of cases:
1

In services where the buyer is attracted to a nation.

Services that are primarily delivered by domestic facilities or personnel

In services delivered through a network of foreign offices.

Porter (1990) mentioned: While less skilled labor is usually unimportant, a nations
stock of specialized, skilled professional and technical personnel is frequently vital
international service competition. The growing complexity and specialization of
many industries mean that advanced factor creation mechanisms are becoming vital to
service competition. Labor shortages or expensive labor is to spur automation and
upgrading of service industries, just as it is in manufacturing. M any services
industries are being revolutionized by new technology, much of it related to
information systems. This technology reduces the labor content of services and makes
service delivery personnel more productive.

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2.2.3 Demand conditions

Porter (1990) says: Demand conditions are perhaps the single most powerful
determinant of national competitive advantage in services today. If a country has
consumers that demand more and specialized services then those service provider
might develop and competitive advantage that they can also export to other countries.
Stringent regulations might create a similar effect when companies learn how to cope
with them.

2.2.4 Related and supporting industries

Porter (1990) talks about: The presence of national competitive advantage in related
or supporting industries spawns other service industries just as it does in
manufacturing industries. A particular important group of supporting industries to
many services is that involving information technology. National advantage in
complementary manufactured goods or other services pulls through demand in some
service industries. The presence of internationally competitive industries in a nation
has a triple-barreled benefit for national advantage in related service industries: it
provides sophisticated buyers at home, creates a base of demand abroad, and pulls
through linked services. Since design services are a supporting function in the value
chain it can also help to improve the whole value chain.

2.2.5 Firm strategy, structure, and rivalry

Porter (1990) continuous: Unimpeded, vigorous domestic rivalry creates a fertile
environment in which to grow world class service firms. Competition in most
service industries involves attention to detail, constant introduction of new service
variations, and the need of high levels of responsiveness to buyers. A group of
domestic rivals provides an essential ingredient to success in this sort of industry
environment.

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Service industries tend to grow out of small, entrepreneurial start-ups rather than
large-scale entries. The services sector, with its preponderance of smaller
companies and fragmented industry structures, is particular prone to government
intrusion. Regulations that protect small businesses or otherwise influence small
business activity are common. If these regulations retard the introduction of
technology, delay or block the creation of new services, retard the consolidation of
localized service industries into national ones, inhibit foreign competition, or mute
domestic rivalry, they will all but eliminate the possibility that the nation will achieve
international competitive advantage in the service industries affected.
Points regarding Strategy 1: Domestic capital markets affect the strategy of firms.
Some countries capital markets have a long-run outlook, while others have a shortrun outlook. Industries vary in how long the long-run is. Individuals Career Choices:
Individuals base their career decisions on opportunities and prestige. A country will
be competitive in an industry whose key personnel hold positions that are considered
prestigious.
Points regarding Structure2: the best management styles vary among industries. Some
countries may be oriented toward a particular style of management. Those countries
will tend to be more competitive in industries for which that style is suited.
Points regarding Rivalry 3: Intense competition spurs innovation. International
competition is not as intense and motivating: there are enough differences between
companies and their environments to provide handy excuses to managers who were
outperformed by their competitors
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2.2.6 Government
Porter (1990 p.265) explains: A heavy direct government role in a service industry is
usually a reliable indication that a nation will have a modest international presence.
Those nations with the greatest government involvement in providing services, such
as Italy, Germany, and Sweden, are amongst the weakest nations in terms of
international service position. Developing a policy or innovation policy is therefore
something that should be handled with care to achieve the right purpose.

According Porter (1990): The government plays a role as a catalyst and challenger in
Porters diamond model; to encourage - or push - companies to raise their aspirations
and move to higher levels of competitive performance ". Governments can
influence all four of Porters determinants through:

a. Subsidies to firms, directly (money) or indirectly (through infrastructure).

b. Tax codes applicable to corporation, business or property ownership.
c. Educational policies that affect the skill level of workers.
d. Focus on specialized factor creation.
e. Enforce tough standards. (Establish high technical and product standards
including environmental regulations.)

Through these actions, it becomes clear which industries they are choosing to help
innovate.

2.2.7 Chance
The role of chance in the model is the way random events can either benefit or harm a
firms competitive position. These can be: major technological breakthroughs or
inventions, acts of war and destruction, or dramatic shifts in exchange rates.

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2.2.8 The Diamond as a System

The points on the diamond constitute a system and are self-reinforcing.

Domestic rivalry for final goods stimulates industry that provides specialized
intermediate goods. Competition leads to more sophisticated consumers who come to
expect upgrading and innovation. The diamond promotes clustering.
How does the agglomeration become self-reinforcing?

1. When a large industry is present, it will increase the supply of specific

factors (i.e.: workers with industry-specific training) since they will tend to
get higher returns and less risk of losing employment.
2. At the same time, upstream firms will invest in the area. They wish to save
on transport costs, tariffs, inter-firm communication costs, inventories, etc.
3. The same is true for downstream firms.
4. Finally, producers in related industries will also invest. This will trigger
subsequent rounds of investment.

2.2.9 Clustering and service industries

Clusters are concentrations of companies that reached a critical mass and that produce
together all elements of the value chain. Porter (1990) says: Service industries are an
integral part of clusters. Competitive service industries help spawn or upgrade
supplier and buyer industries. Competitive manufacturing industries also stimulate
international success in linked services. Italys design services firms, which design
cars, footwear, apparel, and many other products for foreign clients, grew out of
Italys strong manufacturing industries in these fields. In services such as

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manufacturing, clusters tend to be associated with specialized schools or

concentrations of strong university programs in a field.

2.2.10 Services and national economic development

Services are just as valuable as manufacturing to the national economic development.
Also in services characterized by type 3 competition (see 2.2.2 Factor conditions) in
which many of the jobs are overseas. Porter (1990 p. 267) explains: International
success in services also leads to an inflow of foreign profits on a base of modest
foreign direct investment compared to manufacturing.

2.2.11 limitations of the Porter Diamond

Daniels (2004) writes: the existence of four favorable conditions does not guarantee
that an industry will develop. And Noble (2000) writes about other limitations: that
companies have the increased ability to attain market information, production factors
and supplies form abroad. At the same time they face more competition from foreign
production and foreign companies. So if any of the four conditions is missing
domestically, it does not mean it inhibits companies from being globally competitive.
The Porters diamond theory is also based on case studies.

2.3 The influence of Information Technology

As mentioned before the capital intensity of services is growing because of
information technology (IT) and it is helping to make them more productive. Figure 9
shows how all elements of the value chain in a firm can be enhanced by using
information and communication technology (ICT).

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Administration and management: Electronic scheduling and messaging systems

Support
activities

Human resources: Workforce planning systems

Technology: Computer aided design systems
Procurement: Computerized ordering systems

P rimary
activities

Inbound
Logistics

Operations

Sales and
Marketing

Service

Outbound
Logistics

Automated
warehous e
systems

Computer
controlled
machining
systems

Computerized
ordering
systems

Equipment
maintenance
systems

Automated
shipment
scheduling
systems

Suppliers
suppliers

Suppliers

Firm

Distributors

Firm
Value
Chain

Customers

Figure 9: Leveraging Technology in the Value Chain

Source: Laudon (2006 p.88)

In recent years these components have proven to increase efficiency in companies. In
this research this enhancement of the infrastructure is especially mentioned. Porters
model does not mention it explicitly but is open for it as is shown in the following
citation.
Porter (1990 p.244): There is an imperative to de-integrate and to use outside service
providers. Service industry used to be labor intensive, but is now changing to more
capital intensive. The most important reason for the transformation of service firm
value chains is information technology. this in turn has accelerated the
internationalization of service competition.
Other mentions it explicitly as virtual clusters or as e-clusters. As Hansen (2004)
mentions Internet technologies, like infrastructure applications, platforms, broadband,
enable business processes, research institutes and government to be networked. The
Concept of cluster building gets a new dimension because innovative TIM ES
(telecommunication, information technology, multimedia, entertainment, security)

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technologies provide new technology possibilities to support the process of cluster

building, Independent of time and location the actors of a cluster are able to take part
in processes of information, communication and transaction with internal or external
partners of a cluster. Whether the cluster is able to meet competition depends on its
capacity to digitize the internal cluster processes and the processes between different
clusters.
The cluster might thus expand beyond its geographical location. Porter (1990, p.158)
describes a paradox concerning the regional clustering and the process and underlines
implicitly the e-clustering approach: while classical factors of production are more
and more accessible because of globalization, competitive advantage in advanced
industries is increasingly determined by differential knowledge, skills, and rates of
innovation which are embodied in skilled people and organizational routines. The
process of creating skills and the important influences on the rate of improvement and
innovation are intensely local. Paradoxically, then, more open global competition
makes the home base more, not less, important
Hansen (2004) mentions the following positive effects of e-clustering:

E-clustering accelerate the distribution of knowledge

The transaction costs are reduced by e-clusters

E-clusters provide for an infrastructure

The processes of e-clusters produce economies of scale

The e-cluster causes external economies

The e-cluster produces economies of specialization

An e-cluster stimulates competition and cooperation

The internationalization of the economic and cluster specific relations is enforced

by e-clusters

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Since the Industrial Design services industry is a knowledge based service, eclustering or virtual clustering will have big effect on the cluster forming.

2.4. The creative class

A different theory about the attractiveness of regions is proposed by Richard Florida.
Florida (2002) has identified a new class of workers which he called the creative class.
He suggests that this highly mobile class is stimulated to work in certain areas if they
are attractive enough to this class. He measures the creative potential of areas with the
creativity index, constituted of the following factors:

Creative class share of the workforce (Talent), which can be measured by:
o Share of Creative core
o Share of Creative professionals
o Share of Bohemians

High Tech index:, which can be measured by for example:

o M ilken institutes Techpole index

Innovation, which can be measured by:

o Patents and copyrights per capita
o High tech patents per capita

Diversity, which can be measured by;

o Gay Index: as a reasonable proxy for an areas openness to different
kinds of people and ideas (Tolerance)
o Ethnical diversity
o Lifestyle amenities: for authentic experience. Not instant office
complexes and retail stores with acres of parking lots

According Florida economic growth and development is dependent on the three Ts of

Technology, Talent and Tolerance.

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Porter (1998) mentions in his article about clusters and the new economics of
competition that enduring competitive advantage in a global economy more and more
dependent on local things like: knowledge, relationships and motivation. Floridas
theory can fit with this; with a large share of creative class in an area they will have
more relation to each other and motivation to compete and compare with each other
and that means there will be knowledge spill over. These all can be advantageous for
cluster forming.

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