The Adam Smith Address: Location, Clusters, and the "New" Microeconomics of Competition
Porter, Michael E., Business Economics
The "new" microeconomics of competition is contained in frameworks that structure the complexity of competition and inform managers of the choices they must make. This address focuses on the role of location, which has shifted from factor endowments and size to productivity and productivity growth; factor inputs are abundant and accessed via globalization. To increase productivity, factor inputs must improve in efficiency, quality and ultimately specialization to particular cluster areas. A cluster is a critical mass of companies in a particular location (a country, state, region or even a city). Governments have significant roles in creating an environment to support rising productivity, and companies have a different agenda than just building offices or factories. The article concludes with the impacts of this approach on contemporary policy issues, especially the environment and inequality.
ADAM SMITH, so many years ago, laid the foundations of economics around the notions of specialization within enterprises, specialization across countries, and the power of unencumbered competition. His pin factory legitimized the place of business and profitmaking in society. In spite of being a discipline founded on an essay about business, however, it is probably fair to say that economics has had its greatest influence outside of the firm. It has guided fiscal, monetary, and international trade policy, and informed public policies in a variety of other areas. More recently, economics has provided powerful tools for practitioners in the capital markets. Other interesting work is beginning to gather steam around internal incentive problems within firms.
In the area of business competition, however, most company leaders would not turn to economics for guiding insights. The role of business economists reflects this state of affairs. Although there are exceptions, business economists by and large concern themselves with general economic conditions, supply and demand forecasting, regulatory issues, and capital market analysis rather than competitive strategy.
The Adam Smith Address itself is an important case in point. Most past addresses were delivered by macroeconomists, and the others focused exclusively on government. In fifteen years, only one address referred to business, much less business competition. The economist was Milton Friedman, and his title was "The Suicidal Impulse of the Business Community."
Why the disconnect? As one who has dedicated an entire career to bridging economics and business, I have found that the barriers lie in a number of areas:
1. Business leaders are interested in answers to the important questions they are facing, not the questions that necessarily advance scholarly literatures.
2. Theories or models that require restrictive assumptions are untenable, because managers cannot hold everything else equal. Standard economic models of firms and product markets have captured little of the complexity and dynamism of actual competition. Managers are looking for ways of addressing important competitive questions that capture the complexities, rather than abstract from them.
3. Economists begin with the presumption that firms are governed by markets, and economic models leave little or no latitude to managers. Managers know that firms have considerable latitude to create buyer value and shape markets.
4. Concerns of businesses go well beyond issues that can be addressed with the preferred tools of the profession.
5. Finally, economists have rarely seen their roles as guiding competitive strategy or, for that matter, helping companies push profits up. Instead, most of us have been trained to take society's perspective, and the bulk of work on competition is policy-oriented and designed to hold profits down.
Fortunately, a growing number of economists, many working in industry and in business schools, are beginning to change this state of affairs. …