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Michael Porter’s Competitiveness Framework


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Article in Journal of Industry Competition and Trade · February 2006


DOI: 10.1007/s10842-006-9474-7 · Source: RePEc

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J Ind Compet Trade (2006) 6: 115–136
DOI 10.1007/s10842-006-9474-7

Michael Porter_s Competitiveness Framework—Recent


Learnings and New Research Priorities

Christian H. M. Ketels

Received: 30 June 2005 / Revised: 1 September 2005 / Accepted: 1 February 2006


# Springer Science + Business Media, LLC 2006

Abstract The conceptual framework of competitiveness and clusters introduced by


Michael Porter in his Competitive Advantage of Nations (Free, New York, 1990)
remains exceptionally influential, especially among practitioners. The article
discusses recent learnings about Porter_s conceptual framework from practical
applications and research directly driven by his work. It also outlines developments
in the creation and analysis of empirical datasets and the analysis of policy
processes, two main areas of current research in this field that are likely to increase
in importance. The aim is to provide a coherent and current representation of key
elements of the framework, while also discussing a few misperceptions about the
concept present among practitioners or researchers.

Keywords competitiveness . clusters . business environment . analysis

JEL Classification F23 . L52 . O13 . O57 . R12

Since the term competitiveness entered the public debate in force, it has been
widely used by practitioners but viewed with skepticism by many academics. Caught
in the middle of the debate are policy makers who face the imperative to actually
Bdo something about competitiveness.’’ The result of mixed signals about what
competitiveness is and how it can be improved easily results in inconsistent ad hoc
policies reflecting outdated or misperceived advice. Here we survey recent learnings
related to one of the most popular approaches to competitiveness among
practitioners—the competitiveness framework developed by Michael Porter. The
objective is in the first section to provide a consistent and current discussion of the

C. H. M. Ketels (*)
Institute for Strategy and Competitiveness, Harvard Business School, Ludcke House,
Soldiers Field, Boston, MA 02163, USA
e-mail: cketels@hbs.edu

C. H. M. Ketels
Center for Strategy and Competitiveness, Stockholm School of Economics, Stockholm, Sweden
116 J Ind Compet Trade (2006) 6: 115–136

core elements of the framework and in the second section to report on progress in
two main areas of current research related to this framework. We address a number
of misperceptions about Porter_s framework but do not provide an exhaustive
assessment of the literature.

1 Michael Porter_s competitiveness approach

Porter (1990) outlined his conceptual framework of competitiveness first in The


Competitive Advantage of Nations. This section highlights critical features of
Porter_s concept and ties them to recent practical applications.

1.1 The definition of competitiveness

Debates about competitiveness can remain frustratingly inconclusive if they are not
based on a shared definition of competitiveness. The definition of a conceptual term
such as competitiveness is never true or false in an absolute sense but its
appropriateness can be judged for a specific research or policy question. A shared
definition of competitiveness will thus also reflect a shared view of what it should be
used to analyze. Porter defines the competitiveness of a location as the productivity
that companies located there can achieve. He uses this definition of competitiveness
to understand the drivers of sustainable economic prosperity at a given location.

1.1.1 Productivity

Productivity is the linchpin of Porter_s definition of competitiveness (Porter, 2004).


It takes this central role because productivity is the key determinant of the level of
prosperity a location can sustain over time. Two implications from this focus on
productivity have been highlighted by recent applications: First, there is a
fundamental difference between Bcreated’’ and Binherited’’ prosperity. Porter_s
concept of competitiveness focuses on prosperity Bcreated’’ from economic
activity—activity that creates value by providing products and services at prices
above their cost of production. In contrast, the current prosperity of countries like
Russia and the Arab oil producers depends on Binherited’’ prosperity, i.e., the
exploitation of natural resources. The prosperity of these countries does not reflect
underlying competitiveness but an exchange of inherited—and limited—natural
resource wealth into financial assets. Rather than supporting competitiveness the
evidence suggests that such inherited prosperity often becomes a forceful barrier
against upgrading true underlying competitiveness.
Second, there is a critical difference between Bindividual’’ and Beconomy-wide’’
productivity. Prosperity depends on a country_s economy-wide productivity—the
level of GDP generated for each unit of factor input available for economic activity
at market prices. Individual productivity—the level of GDP generated by each
person (or factor input) actually employed—is only an incomplete measure of this
impact on prosperity. If markets for factor inputs are efficient and all factor inputs
are employed, the two measures of productivity will be the same. If there are
distortions, however, the individual productivity reported in many statistics will
overstate the prospects for prosperity. Countries like Germany and France face this
J Ind Compet Trade (2006) 6: 115–136 117

situation: Relatively few hours worked per employee and significant unemployment,
especially among low skilled workers, underpin a level of individual productivity
(GDP per hour actually worked) that does not fully translate into high prosperity.
The high measured productivity of Germany and France does not reflect
competitiveness but is biased upwards by distortions through the tax system and
labor market policies.
The main rival to the productivity-based definition of competitiveness is the
Bmarket share’’-based definition. It defines competitiveness as the ability to sell on
international markets and is fundamentally concerned with the sustainability of an
economy_s overall external balance. While the external balance is clearly important,
especially for international financial institutions, it is critical to understand that
exports do not automatically indicate of underlying prosperity or productivity
because they are also driven by an economy_s real exchange rate. The two different
definitions of competitiveness can, in fact, lead to exactly opposite policy assess-
ments: In the productivity-based view, a decline in the real exchange rate (because
of wage cuts or nominal devaluation) does not change productivity but rather
indicates insufficient productivity to compete on world markets—it is a sign of low
or decreasing competitiveness. In the market share-based view, a decline in the real
exchange rate sets the stage for an increase in exports and an improvement in the
trade balance and is therefore seen as a precursor to improved competitiveness.
A criticism that disproportionally affects the productivity-based view of
competitiveness with its fundamental interest in prosperity is that it is narrowly
economic and takes no account of social and environmental concerns. In some sense
this is true: the concept makes a clear choice to focus on the problem of what
economic policy can do to achieve higher levels of economic prosperity. This choice
reflects the belief that it is more effective to match each policy goal with specific
policy tools; it makes no claim about the relative importance about these policy
goals. But in another, more practical sense, this intuition about competitiveness and
social/environmental goals as being unrelated is very misleading: social and
environmental problems are often indicators of low productivity in the use of
resources and they tend to be much more pronounced when competitiveness is low
(Porter and Van der Linde, 1995). Furthermore, economic, social and environmen-
tal goals are not mutually exclusive: for a significant range of issues there is an
overlap of polices to increase economic competitiveness and policies to address
social and environmental objectives.

1.1.2 Location

A second key element of Porter_s definition is its focus on geographic location as a


key determinant of company productivity; a notion it shares with other concepts and
theories interested in the sources of prosperity and growth differences across
countries.
The role of location has been challenged lately by what can be described as the
Bdeath of distance’’-hypothesis (Cairncross, 2001). It argues that the reduction of
transportation and communication costs as well as of many policy barriers to
international trade and investment have made geographical location and proximity
inconsequential for companies. Implicitly, the only difference that would remain
and thus drive investment decisions is the relative costs of operating in various
118 J Ind Compet Trade (2006) 6: 115–136

locations—competitiveness as defined by Porter ceases to matter. Recent experi-


ence suggest however, that such a view leaves companies in a bind: They opt out of
leveraging one of the factors that cannot be easily recreate by their rivals—the
intimate interaction with nearby companies, research institutions, and the unique
access to other aspects of the business environment at their respective locations. As
other features, like access to the best global suppliers, become commonplace in
many industries, these factors tied to location become, however, a core means of
sustainable differentiation and competitive advantage. Policy makers experience
similar consequences: Locations that depend primarily on low local operating costs
to attract economic activity fail to enjoy the prosperity gains possible by specializing
in specific clusters and activities for which a location provides unique conditions.
The clear emerging paradox is that with globalization geographical location is
becoming more rather than less important.
Identifying location as an important factor is not enough; one needs to be specific
about what type of geographical unit or level in mind. Initially, most of the
discussions about competitiveness focused on the national level. This perspective
has changed in recent years. Factors that determine the productivity of a company
differ significantly across sub-national regions with countries; that is one of the
reasons why there are large and often persistent prosperity differences within them.
Sub-national regions are therefore the central geographic level for competitiveness.
But other geographic levels—nations as well as cross-national regions (Ketels and
Sölvell, 2005)—have an important impact on the business environment in these sub-
national regions. Both for analysis and for policy it is therefore important to
consider their different roles and focus on the geographic level with most impact on
the respective priority issues for competitiveness.

1.1.3 Company

Finally, Porter_s framework emphasizes that ultimately on companies can create


prosperity by achieving market prices for their output in excess of the costs of
providing this output. This is not an ideologically motivated statement about the
importance of companies. Instead, it is a critical reminder that changes in economic
policy will only affect prosperity if they translate into changes in the nature and
extent of economic activity undertaken by companies. This notion is often ignored
when the policy reforms themselves are seen as the goal, not the changes within
companies they aim to enable.

1.2 The drivers of competitiveness

Once competitiveness is defined, the critical question becomes to identify the


drivers that empirically affect the level of competitiveness at a given location and
that are thus the most obvious policy levers to employ when upgrading
competitiveness.

1.2.1 Broad categories: Macro- and microeconomic dimensions

At a broad level, Porter distinguishes between two sets of factors that impact
competitiveness (Porter, 2004): The social, political, macroeconomic, and legal
J Ind Compet Trade (2006) 6: 115–136 119

context on the one hand and the microeconomic foundations on the other hand.
Porter_s focus on microeconomic foundations reflects the view that these factors
have traditionally been neglected by policy makers. Without microeconomic
improvements macroeconomic reforms fail to achieve sustainable improvements in
prosperity. Argentina, for example, improved many of their macroeconomic policies
and was subsequently rewarded with significant capital inflows, allowing domestic
consumption to rise. However, parallel improvements in the microeconomic
foundations failed to materialize and the productivity of the Argentine economy
remained low. Over time, high unemployment and a chronic trade deficit under-
mined the macroeconomic reforms and led to a major crisis. Without complemen-
tary improvements in the microeconomic foundations of the economy, even
necessary macroeconomic reforms ultimately had no sustainable effect on compet-
itiveness and failed to be sustainable.
Within the set of microeconomic factors, Porter distinguishes between the
sophistication with which companies operate and the quality of the business
environment. Again both dimensions are important and in their impact on
competitiveness dependent on each other. Empirical findings suggest that significant
imbalances between these two dimensions in a given location can be a constraint on
prosperity (Porter, 2004). Germany, for example, registers higher company
sophistication than business environment quality; an imbalance that is unlikely to
be sustainable and threatens to undermine the quality of company activities in the
country over time.

1.2.2 Microeconomic business environment: The Bdiamond’’

Porter proposed the Bdiamond’’ (Porter, 1990) as an analytical tool to capture the
quality of the business environment at a given location. The experience of working
with the diamond in several distinct locations since then has generated many further
insights into its overall nature and many of its elements.

1.2.2.1 Systemic characteristics of the Bdiamond’’ Competitiveness is affected by a


very long list of individual factors. In any location there are more factors that could
and ultimately need to be upgraded than there is capacity to address at any given
point in time. These factors differ in their current impact on potential productivity
based on the specific set of local conditions present. Policy makers thus face two
challenges: First, they need to identify which factors are critical for improving
competitiveness in the given situation and, second, they need to devise action
strategies to address these priority factors. The diamond is a broad-based,
integrative tool particularly helpful to address the first question; policy makers can
rely on a host of other tools and theories when addressing the second question.
Recent applications of the concept have highlighted the premium put on
balanced strengths across the business environment. Russia, for example, stands
out through its access to a higher number of well-educated researchers and
engineers. But weaknesses across other parts of the business environment limit
the benefits of the labor force skills in terms of prosperity. Despite the solid
macroeconomic performance of Russia based on high oil revenues the micro-
economic competitiveness of the country is too weak to productively deploy these
resources (Figure 1).
120 J Ind Compet Trade (2006) 6: 115–136

Context
Context for
for
Firm
Firm
Strategy
Strategy
and
and Rivalry
Rivalry

+ Successful reforms of taxes and


labor market reforms
~ Slow opening to global
Factor competition
Factor Demand
(Input) ~ Corruption falling, but remains a Demand
(Input) Conditions
Conditions problem Conditions
Conditions
~ Competition and SME policies
largely ineffective
+ Good basic science and
– Insecurity about future policies ~ Consumers’ demand
education system
key concern sophistication is
~ Physical infrastructure increasing
quality only moderate
– Weak legal standards
~ Financial markets Related
Related and
and
improving but still weak Supporting
Supporting
~ Communication Industries
Industries
infrastructure still lagging
– Very weak administrative – Clusters tend to be weak and shallow
infrastructure – Legacy of planned economy still visible in geographic
patterns of economic activity
Source: M. Porter, presentation given in Moscow in 2005

Figure 1 Assessing the Russian business environment.

The United Kingdom is another interesting example: Politicians and researchers


have for many years worried about the country_s productivity gap towards the U.S.
and peers in continental Europe (Nickell and Van Reenen, 2002). One possible
candidate for explaining this gap was weak management indicated by lower rates of
investment, innovation, and up-take of advanced managerial practices in the UK
relative to other countries. The analysis based on the Porter framework pointed out,
however, that this management behavior is consistent with a business environment
focus on intense rivalry but weak factor and cluster conditions, where companies
compete on low prices, efficiency, and optimal use of existing assets (Porter and
Ketels, 2003) (Figure 2).
The recent experience also highlighted some similarities between company and
location strategy that proved helpful in using the diamond as a tool to prioritise
critical factors. Like firms, locations need to develop an understanding of their
intended Bpositioning’’, i.e., the set of specific qualities as a place to do business with
which they want to set themselves apart relative to alternative locations. Such a
positioning implies that some elements of the business environment are more
critical than others. An effective competitiveness policy agenda concentrates on
these issues; not on addressing existing relative weaknesses across all business
environment dimensions per se. Policy makers in countries like Ireland and
Singapore have employed this approach: Ireland was positioned as a lean and
efficient location with a hard working, English speaking workforce and excellent
access to the European market. Singapore was positioned as an efficient location for
J Ind Compet Trade (2006) 6: 115–136 121

Competitive
CompetitiveAdvantages
Advantages Competitive
CompetitiveDisadvantages
Disadvantages

Highlyopen
•• Highly opento
tointernational
internationaltrade
tradeand
and •• Weak
Weakand deterioratingphysical
anddeteriorating physical
investment
investment infrastructure
infrastructure

•• Very lowregulatory
Verylow regulatorybarriers
barrierstoto •• Skill
Skilldeficits
deficitsininthe
thelabor
laborforce
force
competition
competitionat
atthe
thenational
nationallevel
level despite
despitefavorable
favorableinternational
international
rankings
rankingsononeducational
educationalachievement
achievement
Sophisticatedcapital
•• Sophisticated capitalmarkets,
markets,
especially
especiallyequity
equitymarkets
markets •• Constrained
Constrainedaccess todebt
accessto debtcapital
capital

•• Low
Lowlevels
levelsofofR&D
R&Dinvestment
investmentand
and
commercialization
commercializationinfrastructure
infrastructure
despite
despitestrong
strongscience
sciencebase
base

Largeregional
•• Large regionaldifferences
differencesininthe
the
quality
qualityof
ofthe
thebusiness
businessenvironment
environment

•• Limited
Limitedpresence
presence/ /effectiveness
effectivenessof
of
institutions
institutionsfor
forcollaboration
collaboration
Source: Porter/Ketels (2003)

Figure 2 The UK business environment.

advanced manufacturing and business services for South East Asia. In both cases
public policy was focused on those parts of the business environment that were
critical with respect to these target positions.
Both countries also illustrate the specific challenges that arise when a location
needs to fundamentally redefine its positioning to reach a higher level of prosperity.
Porter had addressed this issue with the notion of stages of economic development
in 1990. He conveyed the idea that countries compete on distinctly different,
internally consistent sets of underlying qualities as they progress economically.
Countries face challenges and are distinctly vulnerable as they transition from one
stage, in the case of Ireland and Singapore competing on efficiency, to the next
stage, innovation. In addition to the gradual improvements that are characteristic of
progress within a stage, a transition requires simultaneous changes across a wide
range of company practices and public policies. These changes might include
rescinding policies that were crucial to success in the previous stage, for example the
strong role of government in Singapore that initially fostered efficiency but now
becomes a constraint to innovative dynamism.
The character of the diamond as an integrative Btool of tools’’ moves
practitioners away from generic approaches to competitiveness that can result from
a narrowly focused or fad-driven perspective. While many topics currently discussed
in the public and academic arenas—be it governance, investments in education, the
roll-out of micro finance, broad-based entrepreneurship training, or the nurturing of
a Bcreative class’’—are useful, they are not equally relevant to all locations all the
time. Similarly, when Porter_s approach to competitiveness is reduced to cluster
development, one of its more prominent policy prescriptions, it might not address
the factors most critical given a location_s specific positioning and stage of
development. Applying Porter_s conceptual framework to identify the most salient
122 J Ind Compet Trade (2006) 6: 115–136

issues in a location is far more likely to lead to prosperity enhancing decisions than
the search for a Bsilver bullet’’ applicable anywhere anytime. The case of
Kazakhstan is an interesting recent example: Porter advised the country to see
cluster development as one element in a broader strategy of cross-cluster business
environment upgrading to over time grow a diversified private sector. Given the
current situation of Kazakhstan_s economy, an exclusive focus on cluster develop-
ment seemed inappropriate to lead to meaningful change.

1.2.2.2 Elements of the Bdiamond’’ There is a set of learnings on individual


elements of the diamond, the role of clusters and of local demand conditions in
particular, that have a unique role in Porter_s framework of competitiveness. And
there is a discussion about some elements that are claimed to be missing in the
diamond, government, institutions, culture, and multinational companies in
particular have been named. We discuss these six areas in turn.
First, clusters, the geographic concentration of companies and other institutions
active in a specific economic field (Porter, 1998a,b), are important for competitive-
ness because they are associated with higher levels of firm productivity and
innovation (Porter, 2003). In a static sense, the availability of specialized suppliers
and service providers and access to specialized factor inputs (employees, risk
capital) enable higher performance. In a dynamic sense, pressure from local rivals,
more intimate access to new ideas, and lower costs associated with forming new
companies foster higher productivity growth. Porter_s perspective on clusters has
been shaped by his prior work on company-level competitive advantages and
remains linked to a wider literature on international management (Porter, 1998b;
Doz et al., 2001). Contributions from economic geographers, new geography
economists, and regional scientists provide other perspectives that are, however, in
line or complementary to Porter_s work (Marchionni and Oinas, 2005).
The recent application of Bcluster thinking’’ has provided a more in-depth
understanding of the profile of clusters and the trends shaping them. One important
observation relates to the fundamental difference between clusters that compete
across regions and are free to located anywhere they find advantageous (Porter,
2003 calls them Btraded clusters’’) and clusters for which either of these conditions is
not given (Blocal clusters’’ and Bnatural resource-based clusters’’). While both types
of clusters benefit from the geographic proximity of related and supporting
industries, only traded clusters face direct competition among business environ-
ments across different cluster locations. Traded clusters are particularly important
because they register higher productivity and higher innovative activity than local
clusters. This is one of the reasons why a focus on BClusters of Innovation’’ (Porter
et al., 2001; OECD, 2001) has become quite popular among practitioners. Local
clusters, however, account for a much higher share of employment and thus impact
the cost of living and operating at a location—critical for both prosperity and
competitiveness. The experience of Japan with its nearly exclusive focus on traded
clusters demonstrates the danger of an unbalanced approach aimed solely on
exports (Porter et al., 2000). Natural-resource clusters finally are tied to the location
of the natural resources but often compete globally.
Another observation is that clusters are becoming increasingly specialized as
globalization leads to the readjustment of cluster locations worldwide. When the
notion of clusters was discussed in the 1990s, most people thought about the Silicon
J Ind Compet Trade (2006) 6: 115–136 123

Valley, London, and Hollywood. With few clusters being truly Bworld class,’’ many
locations felt pessimistic about their prospects of developing prosperity through
clusters. The experience since then has shown, however, that the notion of clusters is
relevant to all types of locations. These clusters differ in their focus, economic
impact, and size, but they all exhibit the positive impacts of proximity on company
productivity. Globalization has given even more impetus for specialization across
cluster locations: New clusters develop in developing and transition economies,
either to serve local markets or to provide specific activities within a global network
of cluster locations; old clusters in advanced economies focus on more advanced or
specialized activities or disappear. A good example is the landscape of footwear
clusters around the world, that has moved towards an increasing specialization by
market and value chain focus (Figure 3).
Recent empirical analysis of this trend suggests that the United States, with its
long tradition as an open and integrated market of many competing regions, is
leading other world regions in its level of regional specialization.1 Other empirical
work has confirmed the presence of clusters in less developed or remote regions of
advanced economies, not only in leading metropolitan areas (Porter et al., 2004;
Landabaso, 2001).
The increasingly widespread (Ketels, 2003) use of cluster-thinking in motivation
economic policy has met at least two types of criticism. The first criticism argues that
cluster thinking is dangerously close to Bpicking winners’’ in the tradition of the new
strategic trade policy. Linking the role of clusters back to the competitiveness
framework shows, however, that the two are fundamentally different: Competitive-
ness identifies the degree of competition a cluster is exposed to as one of the critical
factors driving firm productivity; an insight that runs directly against a Bpicking
winners’’-approach that curbs competition. And competitiveness views all clusters as
capable of contributing to prosperity with the specific clusters present at a given
location driven by its local business environment conditions; this is opposite to
Bstrategic trade policy’’ that targets the same high-growth industries with large
knowledge spill-overs, and low price elasticity of demand for any region. While the
cluster concept has been misapplied to defend strategic trade or industrial policy,
there is no legitimate basis for this in the actual concept. The second criticism argues
that the notion of clusters is too vague and its conjectures about higher company
productivity at cluster locations exposed to too little empirical testing (Martin and
Sunley, 2003; European Commission, 2002, 2003). Porter defines clusters by the
existence of geographic proximity among economic activities and linkages affecting
their value creation in a specific economic field. Whether this definition is
appropriate depends on its ability to guide analysis of the issue in question more
effectively than competing definitions. Critics often identify neither the issues that
should be tackled using the cluster definition nor the alternative definitions that it
should be compared to in its ability to provide insights. Porter_s definition needs to
be operationalized in order to conduct empirical work and systematically test the
hypothesis that clusters positively impact company productivity. This is the logical

1
See Midelfart-Knarvik et al. (2004), Aiginger and Pfaffermayr (2004), and Ketels and Sölvell
(2006).
124 J Ind Compet Trade (2006) 6: 115–136

Traded cluster
• Compete across
regions/countries
• Can locate
anywhere
Local clusters
31% of • Strong role of
• Do not compete
employment manufacturing
across regions
42% of income • Critical for income
• Tied to location 68% of
• Dominated by employment 88% of patents
services 57% of income
• More critical for
prosperity than for 11% of patents
income Natural-resource
based clusters
• 1% of employment,
income, and patents

Source: Michael E. Porter, Economic Performance of Regions, Regional Science (2004), Cluster
Mapping Project, Institute for Strategy and Competitiveness, Harvard Business School

Figure 3 The composition of economies.

next step after the initial focus on theory development based on case studies and
one of the priorities that Porter_s work on clusters has led to in the last few years.
Second, local demand conditions are another dimension of the Bdiamond’’ that
has been more widely discussed. Traditionally, demand conditions were thought of
as the size of the local market. Porter adds another perspective by focusing explicitly
on the quality of local demand: Specific customer needs at a given location can
provide companies the unique ability to learn how to serve these needs with
targeted products and services. If local customer needs foreshadow the needs of
customers in other markets, firms that operated locally are likely to have a
competitive edge when they enter new markets. A cluster location is unlikely to be
at the cutting edge of innovation in its field if it does face local demand conditions
that lead the global market. The focus on local demand conditions does not imply
that global market access does not matter. However, while important, it is usually
not a factor that differentiates locations from each other.
Third, government is the first of a number of elements that have been argued to
be missing in the diamond framework. Far from being absent, however, government
influences each element of the business environment at a given location and thereby
impacts all dimensions of the diamond. Much of the advice derived from applying
the diamond is directed at government policy. Furthermore, for policy applications
it is critical to recognize that Bgovernment’’ consists of many distinct agencies and
geographic units with their own impact on the business environment at a given
location, and companies and many other institutions also influence the diamond.
Fourth, the presence and quality of institutions at a location is important for its
business environment; it is not missing but manifests itself throughout a location_s
diamond. Institutions as a general term are, however, too generic a term to be
J Ind Compet Trade (2006) 6: 115–136 125

helpful in policy advice. Porter has especially noted the role of BInstitutions for
Collaborations’’ (Porter and Emmons, 2003), institutions with private and public
participation that focus on mobilizing clusters and regions for competitiveness.
Some related empirical work on institutions affecting competitiveness is discussed in
Section 2.2.2.
Fifth, culture has an important and complex relationship to competitiveness that
is not ignored in the conceptual framework (Porter, 2000). As far as culture is ex-
ogenous, it is like location and history a factor to consider and ideally leverage when
positioning a location. If it is an exogenous factor, however, the discussions sur-
rounding culture and competitiveness are remarkably fruitless: If culture is given and
in a specific location identified as detrimental to competitiveness, what should policy
makers do? Whether culture really is exogenous, however, remains an open debate.
Behavior seen as the consequence of local culture can also be the result of local
incentives and change as quickly as the relative pay-off of that behavior is altered.
Sixth, multinational companies are clearly an important element of clusters and
business environments more broadly. These firms contribute new skills, technolo-
gies, and ideas and provide better channels into other clusters and markets. The
importance of multinationals differs across cluster locations and is likely to be more
critical in emerging cluster locations than in those that are at the global cutting-edge
where multinationals might be more an indicator of their success. Contrary to the
conclusion of some critics (O’Malley and van Egeraat, 2000; Rugman and Verbeke,
2002), there is nothing in the concept of competitiveness and clusters that denies the
important role of multinationals.

2 Competitiveness research and practice: The next steps

While much has been learned about competitiveness in the last few years, there are
many questions that remain. Current research is focused mainly on two areas:
Creating large-scale empirical data sets to systematically test the hypotheses of the
competitiveness framework and developing a conceptual framework for the
implementation of competitiveness policies.

2.1 From theoretical development to empirical analysis

As an applied framework, Porter_s competitiveness concept has always been


informed by experience from many individual case studies. This experience and
the findings from a number of research areas (especially international business
strategy, industrial organization, and economic geography) have provided the
inspiration for the conceptual developments in the last two decades. Competitive-
ness research is now increasingly shifting to systematically operationalizing and
testing the competitiveness framework and its main hypothesis. While individual
case studies combined with economic principles went far in terms of theory
development, there remain many research questions that such case studies cannot
address. Furthermore, as competitiveness and cluster policies increasingly become
an element of mainstream economic policies, the burden of proof required by
practitioners that need to gain public support for their policies is rising.
126 J Ind Compet Trade (2006) 6: 115–136

The empirical work can be organized into three groups: The assessment of
national competitiveness and its influence on prosperity, the mapping of clusters and
their influence on prosperity, and the profiling of cluster and competitiveness
initiatives and their impact on competitiveness.

2.1.1 Competitiveness assessments

There are an increasing number of studies that present empirical assessments of the
competitiveness of national and regional economies.2 They differ widely in the
definition of competitiveness they apply, in their scope in terms of drivers of
competitiveness they look at, and in their geographical coverage. Michael Porter_s
Business Competitiveness Index (BCI), published annually in the Global Compet-
itiveness Report, is for obvious reasons the one most tightly linked to the
competitiveness framework discussed here (Porter, 2004). Since 1998 the BCI
(called the Current Competitiveness Index before 2003) tracks the overall
competitiveness of national economies. Over time, the number of countries covered
has grown to more than 100, representing most of world GDP.
The BCI draws on a survey of business executives that are asked to evaluate the
sophistication of companies and the quality of the business environment at their
own country relative to international competition. Each country is ranked based on
a set of more than 40 questions covering the main dimensions of company behavior
and the diamond. Survey data is used for a number of reasons: First, for many of the
factors relevant for microeconomic competitiveness there is just no other data
available—either not at all, or only with a significant time lag, or only for a small
sample of countries. Second, getting the perspective of business executives that will
based their decisions on the assessment they report—whether in line with
underlying facts or not—has a value in itself. And third, many of the factors that
ultimately drive company behavior and productivity are the complex sum of many
Bhard facts’’ and thus difficult to accurately represent—this is a problem when, for
example, one is trying to get a sense of labor market flexibility by looking at labor
market legislation alone. Survey data also has clear disadvantages: it can reflect
systematic national biases of respondents, overall changes in national business
sentiment unrelated to underlying competitiveness, and can across countries be
based on very different assumptions about the relevant international benchmarks.
Over time, the BCI has increased its rigor to reduce some of these issues. Overall,
experience suggests that survey data such as the one presented in the BCI can play
an important and valuable role in assessing competitiveness, especially by allowing
the public debate to focus on facts rather than on ideological positions.
The BCI data turns out to be fully consistent with key hypotheses derived from
the competitiveness framework. There is a strong correlation between GDP per
capita (the measure used for economy-wide fundamental productivity) and micro-
economic competitiveness (measured by an aggregate score based on the principal
factor across the responses assess company sophistication and business environment

2
The most well known private ones are the Global Competitiveness Report (World Economic
Forum) and the World Competitiveness Yearbook (IMD). The World Bank has developed a
number of very useful data sets on different aspects of microeconomic competitiveness, especially
their BDoing Business’’ data set and their BInvestment climate’’-assessments available through http://
rru.worldbank.org/.
J Ind Compet Trade (2006) 6: 115–136 127

quality, respectively). More than 80% of the variation of GDP per capita across the
sample of countries can statistically be explained by the variation in the BCI score.
This is high relative to many macroeconomic factors and consistent with the notion
that the microeconomic foundations need to be considered when trying to assess
and improve competitiveness, not only the macroeconomic, legal, political, and
social context. The explanatory power and statistical significance of the individual
elements covered in the GCR survey changes by income group. This is consistent
with the notion of different stages in economic development that are more than just
a balanced improvement across all dimensions of competitiveness (Figure 4).
Deviations of individual countries from the level of prosperity expected given
their measured competitiveness give rise to more in-depth analysis of their position
(see Porter, 2004): Factors that can explain the gap are the overall context
(macroeconomic conditions, political and legal framework, legal system (China)),
the geographical location (prosperity of neighbors, access to trading routes), the
access to wealth unrelated to microeconomic competitiveness (natural resource
assets (Norway), foreign aid, or speculative inflows of capital), and the presence of
strong imbalances across different dimensions of competitiveness (Germany ranks
much higher on company sophistication than on business environment quality; the
pattern is opposite in many transition economies). The gap can also be the sign of an
adjustment process where either prosperity has not yet reached its potential after
significant reforms (Baltic EU accession countries) or where the business
environment is perceived to have deteriorated significantly with drops in prosperity
yet to come (Italy) (Figure 5).
For examples of the many cross-national, national, and regional competitiveness
assessments, see Ketels and Sölvell (2005), Department of Trade and Industry
(2003), Forfas/National Competitiveness Council (2005), Centre for Excellence in

Norway United States


35,000
y = 1549.9x2 + 8603.4x + 11188
R2 = 0.8064 Iceland Canada Denmark
30,000 Ireland Switzerland
Austria Netherlands
Belgium
Italy France UK Finland
2003 GDP per Sweden
Capita 25,000 Taiwan
(Purchasing Singapore
Power Adjusted) Current prosperity above
Spain
sustainable level New Zealand
Greece
20,000 Cyprus Slovenia Israel
Malta Portugal S Korea
Czech Rep
15,000 Hungary
Slovak Rep. Estonia
Poland
Argentina Lithuania
Croatia South Africa
10,000 Chile Malaysia
Uruguay Russia Mexico Brazil
Bulgaria Turkey Tunisia
Bosnia
5,000 Paraguay Jamaica China Current prosperity below
Jordan sustainable level
Bolivia Vietnam Ghana Indonesia India
Ethiopia Malawi Kenya
0
Business Competitiveness Index
Source:Global Competitiveness Report 2004

Figure 4 Business competitiveness index 2004.


128 J Ind Compet Trade (2006) 6: 115–136

Location Governance Natural resources Other factors

Overperformer Underperformer Mix


Why is prosperity so high Why is prosperity so low What are the countervailing forces

China

Norway

Germany

Note: Effect of each factor normalized by the average of all countries


Source: Global Competitiveness Report 2004 data

Figure 5 Business competitiveness report 2004.

Management (2006), Council on Competitiveness (2006), and Massachusetts


Technology Collaborative (2005).

2.1.2 Cluster mapping

The empirical identification of clusters is a prerequisite for analyzing their presence


across geographies, potential changes in their profile, and their impact on
productivity and prosperity. A number of attempts to statistically define clusters
have undertaken in the past utilizing other methodologies and with different scope
in terms of data. The Cluster Mapping Project,3 initiated by Michael Porter, is again
the one most directly based on the competitiveness framework discussed here. The
cluster definitions it has generated have subsequently been applied in Canada,
Sweden, the 10 most recent EU members, and Kazakhstan.4
The Cluster Mapping Project identifies detailed groups of industries as
constituents of clusters based on their actual employment co-location patterns
across U.S. regions. The U.S. was selected for development of empirical cluster
definitions because of its large and integrated home market that can be assumed to
have led to locational patterns driven by economic considerations and the
availability of high quality data at a detailed industry level. The analysis proceeded

3
More information on the Cluster Mapping Project and data on U.S. clusters is available at http://
data.isc.hbs.edu/isc/index.jsp.
4
Information is available at http://www.competeprosper.ca/ (Canada), http://www.ivorytower.se/
(Sweden), and http://www.cluster.kz/page.php?lang=2 (Kazakhstan). The data on the new EU
member countries will be published by the European Commission within the next few months.
J Ind Compet Trade (2006) 6: 115–136 129

in three broad steps: First, industries that showed clear patters of geographical
concentration in employment where identified. It turned out that about two thirds of
employment is in industries that are distributed across U.S. regions roughly in line
with the total labor force. One third of employment, however, is in industries clearly
concentrated in specific geographic regions. Second, industries that had geograph-
ically concentrated employment patterns were organized into clusters according to
their empirical co-location. This process resulted in the definition of more than 40
traded clusters. Other industries were organized by their interdependencies with
activities in local and natural resource-driven clusters. Third, for each U.S. region a
data set was created that shows employment and employment change (as well as
other performance indicators like wages) for all industries organized by cluster. This
results in cluster specialization maps indicating the regional presence and
performance of clusters.
The cluster data thus derived turns out to be fully consistent with key hypotheses
on the role of clusters derived from the competitiveness framework (Porter, 2003).
First, the level of wages, productivity, and innovation (as measured by patenting) is
higher in traded clusters than in local and natural resource-driven clusters. Second,
regions with a higher share of employment in traded clusters in which they are
specialized (i.e., where the region has a higher share of national employment than
the region_s overall share in national employment) register higher wages in the
traded cluster sector as well as overall higher regional wages. Third, an increase in
the share of regional employment in clusters in which the region is specialized is
positively correlated to wage growth. All these results are consistent with the notion
that geographic concentration does provide economic benefits and point towards
the role of traded clusters as key engines of regional economies. Fourth, within
clusters, a higher regional share of employment in the cluster is related to a higher
relative wage. And finally, for the average U.S. region only 26% of the differences
of its average regional wage to the average U.S. wage are explained by the
composition of clusters they are in, while 74% are explained by the sum of their
performance in each individual cluster present in their region. These results point
towards the importance of critical mass rather than generic industry characteristics
for the economic benefits individual clusters can provide to a regional economy.
The cluster mapping data can be used on the level of an individual location to
analyze the cluster portfolio of the regional economy (Ketels, 2005). It can also be
used to identify the largest clusters in a wider economic region, where large refers to
a combination of absolute employment, share of the region_s employment, and
relative specialization of the region in the cluster (specialization quotient) measured
by the share of the cluster in the region_s employment divided by the share of the
cluster in the total employment of all regions (Ketels and Sölvell, 2006). Future
work will ideally be able to draw on further economic performance data in addition
to employment to capture value creation and overcome the current bias versus less
employment-intensive clusters (Figures 6 and 7).

2.1.3 Competitiveness and cluster policy assessment

The most recent field for empirical work is the impact assessment for competitive-
ness and specifically cluster-based policies. The challenge for such an assessment is
130 J Ind Compet Trade (2006) 6: 115–136

Share in Swedish
Cluster Employment, Change in Stockholm’s overall share of
2003 National Cluster Employment: -0.5%
60%
Financial Services
Biopharmaceuticals
50%

Communication Equipment Business Services

40% Publishing & Printing


Tourism
Information Technology
Transportation & Logistics
Distribution Services
30%
Stockholm
Analytical Share of
Education & Knowledge Creation Instruments Swedish
Cluster
20% Heavy Construction Services
Employment,
2003: 22.9%

10%

0%
-15% -10% -5% 0% 5%
Change of Share in National Cluster Employment, 1995-2003
Note: Bubble size is proportional to employment levels
Source: Statistics Sweden (2005), author’s calculations

Figure 6 Stockholm cluster portfolio.

that the economic performance of an economy or a cluster depends on many factors,


most of which are not targeted or controlled by the policy initiative that needs to be
assessed.
A number of European regions under the leadership of Catalonia, Spain have
recently launched the BFoundation Clusters and Competitiveness’’ that provides an
assessment tool based on the competitiveness framework discussed here.5 They aim
is to use survey data to track changes in dimensions of the business environment
targeted by the cluster efforts as well as the perceived quality of different policy
programs themselves. This is a relatively new effort and it will take some time until
the results can be assessed.

2.2 From a concept of competitiveness to a concept of competitiveness policy

Economic concepts start out describing and analyzing economic reality. It then
takes an additional step to turn their implications and findings into policy. This
additional step, while sometimes deemed trivial by researchers, is often complex in
reality. The experience of applying the competitiveness framework in many
different countries and regions underline this challenge. Developing a better
understanding of the policies and processes that are effective in improving
competitiveness has therefore become the second priority for research.
The work in this area has been focused mainly on two areas. First, the conceptual
framework of competitiveness itself provides a number of implications for an

5
For more information see http://www.clustercompetitiveness.org/.
J Ind Compet Trade (2006) 6: 115–136 131

Region
Region Cluster
Cluster Employment
Employment
Schleswig-Holstein
Schleswig-Holstein (DE)
(DE) Financial
Financial Services
Services 60,423
60,423
Västsverige
Västsverige (SE)
(SE) Automotive
Automotive 43,168
43,168
Hamburg
Hamburg (DE)
(DE) Financial
Financial Services
Services 42,420
42,420
Etelä-Suomi
Etelä-Suomi (SF)
(SF) Forest
Forest Products
Products 40,722
40,722
Stockholm
Stockholm (SE)
(SE) Business
Business Services
Services 38,283
38,283
Östra
Östra Mellansverige
Mellansverige (SE)
(SE) Metal
Metal Manufacturing
Manufacturing 28,706
28,706
Mecklenburg-Vorpommern
Mecklenburg-Vorpommern (DE) (DE) Hospitality
Hospitality and
and Tourism
Tourism 26,538
26,538
Warminsko-Mazurskie
Warminsko-Mazurskie (PL) (PL) Processed
Processed Food
Food 21,831
21,831
Norra
Norra Mellansverige
Mellansverige (SE)
(SE) Metal
Metal Manufacturing
Manufacturing 21,240
21,240
Oslo
Oslo og
og Akershus
Akershus (NO)
(NO) Business
Business Services
Services 17,966
17,966
Småland
Småland med
med öarna
öarna (SE)
(SE) Metal
Metal Manufacturing
Manufacturing 16,995
16,995
Warminsko-Mazurskie
Warminsko-Mazurskie (PL) (PL) Building
Building Fixtures,
Fixtures, Equipment
Equipment and
and Services
Services 14,431
14,431
Norra
Norra Mellansverige
Mellansverige (SE)
(SE) Forest
Forest Products
Products 13,674
13,674
Islands
Islands (IS)
(IS) Fishing
Fishing and
and Fishing
Fishing Products
Products 11,931
11,931
Agder
Agder og
og Rogaland
Rogaland (NO)
(NO) Oil
Oil and
and Gas
Gas Products
Products and
and Services
Services 10,752
10,752
Länsi-Suomi
Länsi-Suomi (SF)
(SF) Metal
Metal Manufacturing
Manufacturing 10,090
10,090
Note: “3 Star” defined as >10.000 employees, > 10% of regional employment, and specialization quotient > 2
Source: Institute for Strategy and Competitiveness, author’s calculations for the 2005 State of the Region-Report, Stockholm: Vinnova/BDF

Figure 7 Three STAR-clusters in the Baltic Sea Region.

appropriate policy approach. Second, there is increasing empirical evidence from


cluster initiatives and other types of institutions that have been used to upgrade
competitiveness and that can now be assessed.

2.2.1 Competitiveness policy: Implications of the core concepts

A first implication concerns the need for competitiveness policy to be based on a


new model of cooperation between the public and the private sector (Porter, 1998a,
b). As discussed above, competitiveness depends on a wide array of factors, some
controlled by government, others by companies. The knowledge of companies is
necessary to identify which of these factors turn out to be the current bottlenecks
limiting productivity and productivity growth. Once these priorities are identified, a
broad coalition of public (different government agencies at different geographic
levels, other public institutions like universities and research organizations), private
(companies as well as industry associations) and hybrid institutions are necessary to
mount effective activities that address them. This provides a policy context very
different to macroeconomic decisions that can be taken and implemented by a small
set of actors in national government.
The need for a new model of cooperation among the public and private sector is
also a reason for the important role of cluster-based competitiveness efforts. Cluster
efforts are a forum that allows discussions that can be much more pragmatic,
focused on the specific problems companies face in a given clusters, rather than the
broad political exchanges about the small number discussed between government
and large business associations, that are forced to focused on the small set of issues
relevant for all companies, like taxation. While these issues clearly are important,
there are many others regarding the microeconomic foundations of competitiveness
that are as well and that usually do not get discussed in the high-level debate.
Cluster efforts allow companies across different but related industries to realize
132 J Ind Compet Trade (2006) 6: 115–136

common interests, instead of focusing only on ways to change their relative


competitive position. Furthermore, cluster efforts can bring new important
participants such as universities into the policy debate who, despite their clear
impact on competitiveness, have often not been active in this context.
A second implication concerns the organization of competitiveness policies
within government agencies themselves. Competitiveness is cross-cutting issue that
is affected by decisions made in many different government agencies and even by
decisions outside the realm of economic policies. Competitiveness should thus
become a strategic objective to organize individual policies, not a new policy
alongside innovation policy, small-business development, FDI attraction, etc. The
problems the European Commission has experienced in trying to achieve its Lisbon
competitiveness goals through activities of a few Directorates (especially DG
Enterprise), but without much overall coordination on competitiveness-relevant
policies reveals the perils present. The success of the Finnish Innovation and
Technology Council chaired by the Prime Minister indicates the potential that a
more integrated policy approach can have.
A third implication derives from the long-term nature of competitiveness:
BCompetitiveness is a marathon, not a sprint’’6 Creating a policy making structure
that reconciles the need for policy that is consistent over longer periods of time with
the much shorter time frame of the political cycle is a clear challenge with no simple
solution. Jose Maria Figueres, the former President of Costa Rica, argues that in his
country competitiveness (as well as education and the environment) had become
part of the national mission.7 Different political parties could argue about which
policies were best to achieve competitiveness, but the importance of competitiveness
as a goal is never in doubt. Institutions that are at least partly removed from politics
are another way to support long-term policies; we discuss some of them below.

2.2.2 Institutions in competitiveness policy: Empirical observations

A number of different types of institutions have been created in order to implement


competitiveness policies. The first and most numerous ones are cluster initiatives—
organized efforts by government agencies, companies, and others to improve the
competitiveness in a specific regional cluster. The Cluster Initiative Greenbook
(Sölvell et al., 2003), a survey of more than 250 managers of such initiatives,
provides the first set of systematic insights into the structure of these efforts. Cluster
initiatives are active in activities to improve the sophistication of companies, to
strengthen linkages among companies, and to upgrade the cluster-specific business
environment in which they operate. Their specific action agenda differs strongly
from case to case, reflecting the different barriers to higher productivity across
clusters. Cluster initiatives seem to be more effective if their underlying cluster is
strong at their location, the general business environment is strong, regional
government is a competent partner, and the level of trust among companies and
government is high. These findings suggest that cluster initiatives are a critical
element in competitiveness efforts that profit from being integrated into a wider
6
Michael E. Porter quote.
7
Interview with Jose Maria Figueres at the Institute for Strategy and Competitiveness, March 4,
2002.
J Ind Compet Trade (2006) 6: 115–136 133

agenda for competitiveness upgrading. Cluster initiatives often have government


playing an important role in convening cluster initiatives, providing the majority of
initial operating funds, and participating in the implementation of action recom-
mendations. Private companies in turn play an important role in setting the priorities
for the cluster initiative and over time provide an increasing share of financing. An
upcoming study of cluster initiatives in developing and transition economies shows a
surprising degree of similarity in the structure of such efforts across economies at
different stages of development (Ketels et al., 2006).8
Two other types of institutions have also been prominent in the debate:
Competitiveness councils and competitiveness institutes. Competitiveness councils
bring together key decision-makers from the public and private sector and operate
as a steering committee for cluster initiatives and other initiatives focusing on
specific cross-cutting issues affecting competitiveness. Porter was involved in the
Governor_s Council on Economic Growth and Technology in Massachusetts and a
number of countries including Ireland and Singapore have in the meantime created
Competitiveness Councils. US AID has also supported the formation of such
Councils in countries such as Croatia and Sri Lanka. There is little systematic data
on the empirical structure and impact of these councils. The case experience
available suggests, however, that competitiveness councils can be an effective way to
govern competitiveness efforts. Competitiveness institutes are focused on the neutral
assessment of regional and cluster competitiveness over time as a way to enable
outside impact on competitiveness policy. Such institutes have been launched or are
being planned in, for example, Colombia,9 Singapore, and the Basque Country in
Spain. Given the need for more systematic data and policy assessment in the area of
competitiveness these institutes could become an important factor in the debate.

3 Concluding comments

Competitiveness is a key issue for policy makers in many countries and regions. Its
growing importance is fuelled by changes in the nature of global competition that
have increased the pressure on many locations to design sustainable strategies to
support and improve prosperity. There is a significant amount of debate surround-
ing the concept of competitiveness, often leaving policy makers without clear
guidance on how to address the challenges they face. This paper has outlined recent
thinking and on-going research related to one of the most prominent concepts of
competitiveness, the framework developed by Michael Porter.
Porter_s work uses a vernacular that is distinct from the one used by many
economists; he employs verbal descriptions and logical reasoning rather than the
mathematical models which dominate the economic profession. One reason for his
more qualitative approach is his objective is to provide actionable and accessible
advice to practitioners. Additionally, while mathematical models (such as the
literature on the new economic geography) have developed considerably over the
last decade, they still have to strip out much of the complexity of reality in order to

8
Specific examples can be found in some recent analyses of cluster policies in central and Eastern
Europe; see Möhring (2005), Ketels and Sölvell (2006).
9
For further information on the Colombian institute see http://cec.uniandes.edu.co/cms/home/
134 J Ind Compet Trade (2006) 6: 115–136

be tractable. As a result these models shed light on some but not all situations,
particularly where it is unclear from the outset which way one should look to find
the solution. The diamond is useful precisely in these situations. Despite the
difference in language it should be noted that Porter_s competitiveness framework is
fully grounded in economic principals. In particular, it is based on the notion that
fierce rivalry on open markets is at the core of a competitive economy.
Porter_s applied focus highlights blind spots of traditional economic models that
economists tend to ignore. One is the observation that while market forces will
translate a helpful context for companies into higher prosperity, this process can
take a long time, might not be linear, and could be subject to multiple Bequilibrium’’
outcomes depending on initial conditions and the specific sequence of actions.
Helping to speed up this process and trying to enable the best possible outcome is
fundamentally different from intervening to reverse market forces. The other
observation is that, despite the recent interest in location, many economic models
use to give policy advice do not adequately capture the complexities of an existing
economy with all its legacies and institutional details, and not in a location- and
history-free economy of a theoretical model.
Misunderstandings about Porter_s competitiveness framework not only occur
among researchers but among practitioners. A significant number of politicians
drawn to his approach, especially in Europe, are from the center-left, while
politicians from the center-right tend to be more skeptical. At the core of their
different reactions is a debate about the appropriate role of government: The first
group sees an important role for government in the economy and perceives Porter_s
work as a modern justification for this view, while the second group is skeptical
because it has the suspicion that Porter_s work is used to provide cover for a wide
array of harmful government interventions. The conceptual framework of compet-
itiveness provides no basis for wide-spread government interventions and is firmly
based on open competitive markets. More importantly, it moves beyond the
traditional debate that characterizes government as a generally positive or negative
factor: It acknowledges that government controls many but not all levers that affect
the ability of companies to operate productively. Government is thus an important
player influencing competitiveness by enabling market rivalry to become more
effective in terms of value creation rather than curbing market forces. Competi-
tiveness will remain a central occupation for policy makers in coming years. And
continuing and, where necessary, improving the effectiveness of the debate among
researchers on the factors underpinning competitiveness will be critical to provide
them with the most effective analytical tools and concepts available.

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