Competing

in

Capabilities

Phase III

• Re-adjusting to an enlarged world market

• Concentration and Shakeout in the Global Economy

Closer to Home

• Adjustment and survival in US manufacturing… the Schott-Bernard study

So who survives?

- Key feature of survivor is switching across

(5-digit SIC) industries

- Which brings us to a third (and last) element of Capability

- And to a fundamental theoretical question

The Final Element…

• Since elements of know-how do not map one-to-one into products, it follows that any set of capabilities may imply a relative advantage in producing products other than those currently offered…

• So the third and final element of capability is ‘flexibility’

• We can see this using the (simplest possible) example of the ABC model above

Investing in Capability

We consider a model in which a firm can choose between mastering directly the know-how required to manufacture a specific product, or alternatively investing in the know-how of underlying technologies which will allow it to learn (at relatively low additional cost) how to produce certain specific products.

The Model:

- Demand is concentrated in any period on a single product variety. Offering this variety yields payoff 1 in this period.

- Only one firm is active (on each ‘island’ submarket).

- Over successive periods, a switch may occur to the next product in the sequence X, Y ……

- Whether such a switch occurs is determined by the indicator variable x (1 = switch, 0 = stay).

Strategies:

Initially demand is for X. On entering, a firm can pay a setup cost C to produce X (the FIX strategy) or a setup cost 2c>C to acquire know-how elements A and B (the FLEX strategy). The firms payoff is the discounted sum of profits less costs.

X ZY

X ZY

FIX Strategy (investment cost c)

FLEX Strategy (investment cost 2c > C)

A B C D

Unit Cost

C

c

C

c

Recall:

Z

Y

Trajectories

X

W

If the firm chooses FIX and demand switches, it competes on equal terms with n potential entrants, and has probability 1/n of being the (sole) supplier of the new good. With probability 1 – (1/n) it exits.

If the firm chooses FLEX, the incremental cost of producing the next good is lower than the setup cost of a new entrant. The FLEX firm will remain as incumbent.

The market over time:

Consider a set of independent (‘island’) submarkets, each with a single (FLEX or FIX) incumbent.

A firms choice of FLEX or FIX depends on its belief as to whether (one or more) switch(es) will occur.

best for FIX

best for FLEX

Model A: We assign beliefs over the hidden probability p

Results: There is a zone where some firms play FLEX… and a zone where all firms play FIX

Model B: No expectations can be formed. No ex-ante expected profit

can be defined. Instead we define a (series of) action(s) as

‘reasonable if they are ex-post undominated on some trajectory.

We assume all reasonable (sequences of) action(s) will be chosen by some (subset) of potential entrants.

The Main Result

In Model B:

As T

- FLEX dominates on almost all trajectories with probability p

arbitrarily close to 1.

The Main Result

In Model B:

As T

- FLEX dominates on almost all trajectories with probability p

arbitrarily close to 1.

- In the neighbourhood of the zone I/II boundary, FLEX is LESS

profitable ex post on almost all trajectories.

Policy Lessons: A Few Illustrative Points

- A ‘basic’ lesson: improving the general ‘business climate’ reduces non-wage costs and is equivalent to a rise in the capability of all the country’s firms.

Policy Lessons: A Few Illustrative Points

- A ‘basic’ lesson: improving the general ‘business climate’ reduces non-wage costs and is equivalent to a rise in the capability of all the country’s firms.

- ‘Big push’ fallacies: governments are not good at picking winners. Capabilities grow slowly.

Policy Lessons: A Few Illustrative Points

- A ‘basic’ lesson: improving the general ‘business climate’ reduces non-wage costs and is equivalent to a rise in the capability of all the country’s firms.

- ‘Big push’ fallacies: governments are not good at picking winners. Capabilities grow slowly.

- A controversial issue: for big countries, ‘Domestic Content Requirement’ can tilt the speed of domestic capability building. (China and India in auto-components).

Policy Lessons: A Few Illustrative Points

- A ‘basic’ lesson: improving the general ‘business climate’ reduces non-wage costs and is equivalent to a rise in the capability of all the country’s firms.

- ‘Big push’ fallacies: governments are not good at picking winners. Capabilities grow slowly.

- A controversial issue: for big countries, ‘Domestic Content Requirement’ can tilt the speed of domestic capability building. (China and India in auto-components).

- Governments’ role in capability building: the CII example; the USAID and IFC approach.

Policy Lessons: A Few Illustrative Points

- A ‘basic’ lesson: improving the general ‘business climate’ reduces non-wage costs and is equivalent to a rise in the capability of all the country’s firms.

- ‘Big push’ fallacies: governments are not good at picking winners. Capabilities grow slowly.

- A controversial issue: for big countries, ‘Domestic Content Requirement’ can tilt the speed of domestic capability building. (China and India in auto-components).

- Governments’ role in capability building: the CII example; the USAID and IFC approach.

- The French Debate and ‘Social Europe’.

Policy Lessons: A Few Illustrative Points

The Bigger Picture

• The bottom billion…

• Prospects for sub-Saharan Africa

• Trade liberalization re-visited

Free Trade

II

III

Free Trade

III

BU

v/u

b (i) b (ii)

v/u

Case (a) Case (b)

II

From Globalisation to Global Recession

• Will the pace of globalisation now slow down?

• The big issue : the spectre of protectionism