Back in the day when I was at university, Michael Porter was the man. Every marketing class I took his theory of competitive advantages was centre stage. In itself quite simple, it says that every company needs a competitive advantage to be successful. This can be achieved by either creating a unique product (differentiation advantage) or cost leadership (cost advantage). If a company does not follow either strategy it would be ‘stuck in the middle’. Taking the car industry as an example: Germany has expensive, unique brands (BMW, Daimler, Audi), while South Korea’s brands compete with solid, cheaper models. The US car industry would be an example of being stuck in the middle.

In true American entrepreneurial spirit, Porter went on to write the book ‘The Competitive Advantage of Nations’. I reckon it was less successful as I never heard about it in any of my economics classes and was able to pick up a copy for DM 10 on sale, not bad for 800 pages!  It is a shame as many European politicians (actually make that all) would have greatly benefitted from reading the book.

Whilst Porter looked at various factors which make nations competitive, ultimately a competitive nation is a country where companies/industries are successful as they have a differentiation or cost advantage.  In plain English a country creates either unique, often pricier products or products at a cheaper price, which often will translate into competing either via know how/innovation or cheap labour cost.

Redefinition of cost advantage over the last 20 years

In Europe, the Southern nations were characterised by cheaper labour costs for many years and hosted such industries as the textile industry. However, the concept of cheap labour has utterly changed over the last 20 years. Whilst the world has not physically expanded, economically it has with Eastern Europe and China/SE Asia joining the economic framework. No guessing where textiles are produced these days! Naturally, the ‘new’ nations started to compete initially via their low labour costs as a result pushing many European nations into a ‘stuck in the middle’ position. Some of these developments were camouflaged by either expanding debt fuelled industries (real estate bubble) or by states compensating for this development by transfer payments and growing debt.  What does that mean for the solution of the Euro crisis?

Nations need ‘product’

As much as companies need ‘product’ which people want to buy, nations need ‘product’. Nations without a competitive advantage will not be able to prosper.  

To build competitive industries is not a short-term effort. However, it is the only route to growth as regaining a cost advantage over Asia or Eastern Europe is unlikely, regardless the outcome of the Euro-zone crisis. Even if some nations might return to their own currency, competing purely on labour cost will be impossible.

This will be clearly harder to achieve for European nations which currently do not have a sufficiently strong position in more value-added industries. Especially as it sometimes feels like the concept of competitive advantage can almost be re-written into: producing products China wants, but can’t produce (BMW, Louis Vuitton) or products which China can produce anyway cheaper and there is no need to bother. The situation is not quite as bad, but it will require structural reforms and investments in education which should make many European nations again more attractive to invest.

Nations like the city state of Singapore have actively (and successfully) pursued  strategies to position themselves in the globalized world, away from competing with cheap labour cost. If a country like Finland which is half of the year in semi- darkness can mange, why should such countries with beauty and sunshine like the Southern European nations not be able to cope?  If nations need advice, Tyler Brule (as of the FT’s Fast Lane) at Monocle magazine has been championing this theme and would probably be happy to advise.

Germany’s economic strength not a given

Germany currently enjoys a stronger economic position than many of its European partners as much of its industry is based on unique, usually technology-based products which enjoy global demand. However, it is not a given that the country will be able to maintain its competitive advantage over the next decade.  Countries like China are gradually moving up the value chain and are building up their technology knowledge, resulting in increased competition in more advanced industries. Hence designing a solution to the Eurozone crisis which will rely on permanent transfer payments from stronger nations to weaker ones is a risky strategy as the economic strength of Germany might be harder to maintain in the future.

Reducing Germany’s competitive advantage is ill-advised

A popular demand, championed among others by FT’s Martin Wolf, is that balance of payments surplus nations (Germany) need to spend more to allow the deficit nations (PIIGS) to balance their books. This requests Germany to increase its consumption and also to allow for higher wages to narrow the competition gap towards other less competitive European nations. The problem with this idea is that goods produced in Europe are not inter-changeable. German machinery producers are more likely to compete with US or Asian companies, than with Greek or Portuguese ones.

Just because German labour cost would become more expensive, buyers won’t shift to Greek cars (there are none), probably neither to French cars as they might rather buy an Asian car. Equally German workers are unlikely to spend their extra earned money on olives (how many olives can one realistically eat?).  So, suggesting Germany should become more uncompetitive will probably only help turning Europe into a complete disaster zone of over-aged and over-indebted nations. Instead, the nations need to take their cue from the first point: nations need product. If you have only a limited amount of products that other nations want to buy, asking stronger nations to become also uncompetitive seems to be an odd way of fixing the problem.

[Please note that all opinions expressed in this blog are the author’s own and do not constitute investment advice.  Click here for full disclaimer]


Author: Anke Richter

Anke is a freelance lecturer and writer. She has over 15 years experience in credit markets as a credit analyst and credit strategist, working for JP Morgan, Deutsche Bank, Mizuho and Calyon where she was Global Head of Capital Markets Research. Throughout her career she has been frequently ranked as credit analyst in investor polls and has been regularly quoted in the financial press. She has lectured on financial markets at universities in the UK and France. Anke started her career as a management consultant in Germany and Latin America. She holds a degree in Business Administration from the University of Cologne as well as being a CFA Charterholder.