A Cozy Little Swamp of Mediocrity

Attempts to protect companies irrevocably blunt a nation's competitive edge, says Harvard's Michael Porter. It's a lesson Israel must learn.

Prof. Michael Porter got a cold shower last week from the most prestigious economic journal in the world, The Economist. The magazine claimed that his new idea, which we reported on extensively last month, "How to save capitalism" by creating shared value for the firm, society and the community at large, is half-baked at best and a rehash of old ideas at worst.

While bashing Porter, The Economist mentioned the advice he'd given to Libyan leader Muammar Gadhafi and explained that we could have expected much more from the Harvard University professor - since Porter, says the paper, is one of the most important minds in the worlds of business and strategy in the past 30 years.

Michael Porter

The magazine refers to Porter's extensive research on the competitiveness of nations, by virtue of which he came to advise governments and multinationals the world wide.

The Economist agrees with Porter that capitalism's legitimacy is in crisis, which is grounds for worry, and that "corporate responsibility" has become an empty slogan behind which lies very little. (For instance, BP and Enron both trumpeted their great sense of corporate responsibility while causing the environment and investors tremendous damage ). But the magazine claims that for Porter's shared-value idea to have as much impact as his ideas on the competitiveness of nations and companies, he has to do more work.

We felt it necessary to dwell on The Economist's critique not only because of the space we devoted to Porter's theory a month ago on the dreadful way capitalism and "corporate responsibility" are being conducted today. We also dwelled on the tremendous importance of Porter's ideas on competitiveness, the ideas that brought him such lofty status in the business and economic words.

There is one country where Porter's ideas on the competitiveness of nations are completely rejected. A country where a long list of economists, professors and business people have invented a new economic theory, the opposite of Porter's, and they market it successfully.

Prosperity: not a gift of nature, or inheritable

The issue of the competitiveness of nations has preoccupied the most prominent governments, politicians and business leaders because of globalization and the rise of the emerging markets, led by China and India. People from politics on high to the man in the street are increasingly worried about their country's competitive edge, its ability to create growth, jobs, social services, quality of life and opportunity for the young.

In these countries, people in politics, regulation and academia study Porter's insights, obtained after teams of his researchers spent years and years delving into how nations succeed.

Porter has taught thousands of decision-makers that a nation's success and prosperity must be achieved; they cannot be inherited. They are not a gift of nature, nor do they stem from a nation's manpower or its interest rates or currency, as adherents of classic economics may claim. A nation's competitiveness depends on the ability of its industry to innovate and improve. Companies are impelled to gain advantages against their competitors because of pressures and challenges. They benefit from having powerful local competition, aggressive local suppliers and demanding local clients.

Porter's book "On competition" has been translated into 19 languages, including Hebrew. It is read by leaders around the world, in developed and developing countries.

But in Israel, we already know everything. Here in our economic ministries, among our regulators and economists, we have other theories - theories that serve the interests of a handful of big businessmen who embrace the politicians and regulators like a vise.

While Israeli academics laud mergers, consolidation and advantages of size on the grounds that "Israel is so small," Porter explains that the recipe for competitive economies in nations big and small is the opposite. "The presence of strong local rivals is a final, and powerful, stimulus to the creation and persistence of competitive advantage," he writes in his book. This applies to small countries such as Switzerland, where competition between its drugmakers Hoffmann-La Roche, Ciba-Geigy and Sandoz contributed to the global leadership of Swiss pharmaceuticals.

This is true in the United States in computers and software, Porter goes on: "Nowhere is the role of fierce rivalry more apparent than in Japan, where there are 112 companies competing in machine tools, 34 in semiconductors, 25 in audio equipment, 15 in cameras - in fact there are usual double figures in the industries in which Japan boasts global dominance."

The tao of Porter: Battling tooth and nail

Fierce local competition is perhaps the most important of all the conditions, in all countries, for creating a competitive economy. Another key element is interest rates because they affect everything else.

And here we have academics, regulators and politicians arguing the charms of big business groups that would have an advantage against the rest of the world, that would create stability. Porter's research has produced the opposite conclusion.

"Conventional wisdom argues that domestic competition is wasteful," he writes; it leads to duplication of effort and prevents companies from achieving economies of scale. According to that thinking, governments should embrace and support one or two national champions big and strong enough to tackle foreign rivals. "In fact, however, most national champions are uncompetitive, although heavily subsidized .... Static efficiency is much less important than dynamic improvement which domestic rivalry uniquely spurs," Porter sums up.

Israel's regulators and academics try to sell us the arguments of a handful of business groups that there's no need for domestic competition because it would just weaken the business sector against the world. Nonsense, says Porter: Local rivals force each other to cut costs, improve quality and service, and create new products and processes.

"Another benefit of domestic rivalry is the pressure it creates for constant upgrading of the sources of competitive advantage," he writes. The sheer presence of competition cancels the advantages arising from simply being in a particular nation - "factor costs, access to or preference in the home market, or costs to foreign competitors who import into the market." Companies are forced to improve and achieve advantages that are more sustainable.

Israel's failure to create giant companies that sell worldwide is not in doubt. Everybody knows that selling startups won't lead to sustainable prosperity. The solution the business leaders and the academics in their service propose is government help, protection, tax exemptions, shields against competition.

These are precisely the obstacles preventing Israel from developing a competitive economy, as Porter explains so well. "Ironically, it is also vigorous domestic competition that ultimately pressures domestic companies to look at global markets, and toughens them to success in them," he writes. "Local competitors force each other to look outward to foreign markets to capture greater efficiency and higher profitability. And having been tested by fierce domestic competition, the stronger companies are well equipped to win abroad."

Politicians of Ehud Olmert's ilk boast of their help to business, to help the economy flourish. But in fact the protection they give companies and the exemptions they arrange for Israeli businesses are hurting competition and hurting the economy.

"In the continuing debate over the competitiveness of nations, no topic engenders more argument or creates less understanding than the role of the government. Many see government as an essential helper or supporter of industry, employing a host of policies that would directly contribute to the competitive performance of strategic or target industries," Porter writes. Others argue for the free market to be left alone; all both achieve is to irrevocably blunt the national competitive edge.

What's government's role, then? To be a catalyst and challenger, says Porter, to spur companies to raise their aspirations and improve their competitive performance.

Short-term candy or long-term benefit

Government's role is indirect, not direct: It is to create the environment in which companies can achieve a competitive advantage, he says. The problem is that in politics, 10 years is an eternity and subsidies, protection and arranged mergers are short-term candy.

Not only are the necessary policy measures slow, they are often temporarily painful and may even lead to bankruptcies. Strong companies and competition would only ensue later.

Israeli companies complain about the heavy hand of regulation preventing their development, but economic analysis and experience show that the opposite is true: Heavy regulation is the driver of competition and economic prosperity. Government can stimulate domestic demand. Strict regulations concerning products, safety and the environment put pressure on companies to improve quality, upgrade their technology and supply features that would meet the demands of the consumer and society, Porter explains.

Prime Minister Benjamin Netanyahu is about to choose a new antitrust commissioner. Israel's powerful business families are putting terrible pressure on the prime minister and the appointment committee. We must hope Netanyahu understands the importance of choosing a strong, courageous person not only concerning prices for Israeli consumers and the welfare of consumers in general, not only on democracy - but mainly on Israel's competitive status vis-a vis-the rest of the world.

Stifling competition by coddling government monopolies or controlling processes stifles innovation, rendering the industry less dynamic and less able to produce good products. Privatization and abolishing controls won't help unless they are accompanied by vigorous local competition, which requires strong, consistent antitrust policy.

Companies arguing that mergers and acquisitions are good because of globalization aren't unknown in the West. But Porter argues that there too, companies are simply trying to undermine the creation of a competitive advantage, and for the sake of national competitiveness governments must bar such mergers, acquisitions and collusions. If anything, government policy must encourage the advent of new players, domestic and international, he urges.

Israel's economy is riddled with cartels, monopolies and players that bend over backwards not to compete with one another and not to tread on their rivals' turf. It's a cozy little swamp of mediocrity and shallowness in which companies can generate profits, sky-high executive pay and power without innovating, competing or straining. That's exactly how to create an economy that can't compete, says Porter. Society needs to seek out pressures and challenges, not avoid them.

Companies should seek out the most demanding buyers and purchase from the most advanced suppliers, not seek out peaceful stability, subservient customers, dependent suppliers and dormant competitors. If they do that they'll stagnate and ultimately fail.

Most of the biggest companies on the Tel Aviv Stock Exchange operate domestically and have no real competition. Most don't operate abroad and if they do, their results tend to be miserable.

Who will rise up and tell the Israeli people the truth? What politician, regulator or business leader will say what it really takes to make Israel's economy competitive? Or are we doomed to wallow in our swamp of mediocrity, patting ourselves on the back and telling ourselves how wonderful we are?