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Connecting global chains

John Houghton, Information Age

15/02/2007 11:36:31

Most followers of the economic debate are by now familiar with the ideas of "clusters". Developed as an idea in the 1980s, they came to fame after US business strategy expert Professor Michael E. Porter published his 1990 book The Competitive Advantage of Nations. Famous clusters include Hollywood, London's "City" financial district and the gaggle of leather fashion companies such as Gucci gathered together in northern Italy.

Australia's best-known clusters are in the wine industry - the Barossa, Hunter and Yarra valleys. Porter argues that these clusters arise from a "paradox of location". "The enduring competitive advantages in a global economy," he wrote in 1998, "lie increasingly in local things - knowledge, relationships, and motivation that distant rivals cannot match."(1)

But as Professor John Houghton's paper (2) for CEDA's Competing from Australia project points out, location is losing some of its power to explain the world economy. World economic production is restructuring, with China and India rising in prominence as both low-cost producers and major markets. In both manufacturing and services, competition is driving an endless quest for greater efficiency and innovation.

The result is that, in Houghton's words, "production of both goods and services is becoming increasingly fragmented and geographically dispersed". In a supply chain world, goods and services are made up of inputs from all over the world.

"In a knowledge economy," says Professor Houghton, "few firms can alone command the range and depth of competencies necessary to continuously innovate. As a result, they are becoming more dependent upon alliances with other firms and research institutions with complementary technology and knowledge assets. Hence, leading firms are becoming increasingly involved in a network of relationships." This is sometimes called "alliance capitalism", he notes.

Adds Houghton: "At the same time, the increasing complexity of products and the increasing drive to offer differentiated, service-enhanced products is forcing firms to integrate supply chains and changing the nature of competition in such a way as to encourage greater cooperation and collaboration. There is, in short, mounting pressure for firms to link into increasingly complex value chains or production systems."

This pressure towards specialisation and differentiation shows up in figures on intra-industry trade - that is, exports and imports of goods within the same industry - and in intra-firm trade. Although intra-industry trade is difficult to measure, it appears to be growing at 4 to 5 per cent per year. Intra-industry trade made up almost 70 per cent of total manufacturing trade in the OECD between 1996 and 2003.

The pressure towards specialisation is accentuated by what Houghton notes is a "revolution" in trade and investment in services, driven by the continuing rise of information and communications technologies (ICTs). New technology is not only making many tasks portable, he notes, but allowing them to be simplified, making them easier to relocate. Between 2001 and 2003, he notes, foreign direct investment flowed to services at 2.8 times the rate at which it flowed to manufacturing.

Houghton also points to the growing investment in R&D by foreign affiliates of multinational firms. Between 1995 and 2001 the growth of foreign affiliate R&D in manufacturing in OECD countries was more than twice that of total R&D expenditure. Multinational firms are now estimated to account for two-thirds of OECD business R&D, he says.

The computing industry offers the perfect example of these changing industrial patterns. For decades it has been famous for the way it has gathered expertise together in an otherwise unremarkable corner of northern California known as Silicon Valley. The area was home to the grandfather of all computer chip companies, Fairchild Semiconductor, and to Xerox's famed Palo Alto Research Centre (PARC); today Hewlett-Packard, Apple, Adobe and Sun all live there. The area acquired its "Silicon Valley" tag more than a third of a century ago, and other economies have tried and failed to emulate its success for decades.

No one doubts that clustering remains important in computing: the latest addition to Silicon Valley's star roster is a little Internet start-up called Google. But in recent years computing has also become known for its use of sophisticated supply chain management. Though Apple, Hewlett-Packard and other Silicon Valley firms are considered supply chain management leaders, the poster child of supply chain management is Dell Computer - a firm based not in Silicon Valley but in obscure Round Rock, Texas. Dell sells its computers direct to customers via the Web and the telephone, sourcing parts from Taiwan and China and assembling them into computers everywhere from Nashville to Limerick to Penang in a just-in-time system that founder Michael Dell says is based on rapid communications flows across the company.(3 )

Dell does little R&D of its own, but supply chain partners like Intel and AMD invest huge sums in activities like semiconductor chip design. And this activity, once concentrated in Silicon Valley, is now global: the UN Conference on Trade and Development (UNCTAD) estimates that "from practically nothing in the mid-1990s, the contribution of Southeast Asia and East Asia to global semiconductor design reached almost 30 per cent in 2002."

That global chains are becoming more and more important carries mixed messages for Australia. Australia is a low-trade country in general and a small intra-industry trader: for instance, intra-industry trade makes up just 46 per cent of our total manufacturing trade, well down on that OECD average of 70 per cent.

Says Houghton: "These trends raise very real challenges for Australia. As global production systems restructure, it is likely to become increasingly difficult to connect with, and participate in, those systems". He concludes that Australia "must consider shifting policy emphasis from the creation of local linkages and clusters, towards the creation of global linkages and participation in global production systems." Where clusters do grow, their growth will become increasingly reliant on successful global linkages.

On the other hand, Australia has struggled to create new clusters over the years.4 Rather than intense gatherings of talent, our economy of just 20 million people features spikes of exceptional achievement. Seen from this perspective, the new world of global supply chains offers opportunities as well as threats.

1 Michael E. Porter, "Clusters and the new economics of competition", Harvard Business Review, Nov/Dec 1998. 2 John Houghton, Connecting to the Global Chains: Australia's participation in the new wave of globalisation, CEDA Competing from Australia Paper 1, November 2006. 3 Michael Dell, "The Dell model," Australian Chief Executive magazine, CEDA July 2004. 4 See, for example, Don Scott-Kemmis et al., No Simple Solutions: How sectoral innovation systems can be transformed, ANU, 2005, p. 25.

Professor John Houghton is Director of the Information Technologies and the Information Economy program, Centre for Strategic Economic Studies, Victoria University, Melbourne. David Walker CEDA Policy and Communications Director

Adapted from CEDA Competing from Australia Paper 1, Connecting to the Global Chains: Australia's participation in the new wave of globalisation. This report first appeared in Australian Chief Executive magazine and is reprinted by permission.

[sidebar]

About Competing from Australia

Connecting to the Global Chains is the first product of a CEDA research project titled Competing from Australia. This project looks at Australia's capacity to trade and attract investment.

The project will produce electronic papers and a new CEDA Growth collection of papers and topic overviews.

So what does Competing from Australia seek to do?

Australia's economy has thrived over the past decade on a combination of strong consumer demand and investment directed to the internal economy, and rising overseas demand for commodities.

But beyond the commodities-producing sector, Australia's trade and investment performance has been less than impressive. And several observations raise questions about Australia's capacity to trade and invest vigorously in the 21st century global economy.

• New economic thinking suggests that distance is a powerful impediment to economic development, and to the development of knowledge-based economies in particular - and Australia is the most isolated large economy in the world.

• The ability of firms to learn from suppliers and from customers, and to draw on a large pool of talented and experienced experts, seems more important than ever before - and Australia is a small country far away from the largest pools of customers and suppliers. • Global supply chains, often centred on large multinational "platform" companies, play an increasingly important role in world trade and investment - and Australia lacks "platform" companies. • The ability to create technological and process innovation is increasingly seen as central to advanced economies' growth capacity - and Australia performs poorly on a number of innovation indicators.

How do these challenges affect Australia? How can Australia overcome them? These are the questions that Competing from Australia seeks to answer.