Building the Microeconomic Foundations of Prosperity Findings from the Business Competitiveness Index 1 MICHAEL E PORTER Harvard University Competitiveness has become a central preoccupation of both advanced and developing countries in an increasingly open and integrated world economy Despite its acknowledged importance the concept of competitiveness is often misunderstood Here we define competitiveness concretely show its relationship to a nation s standard of living and outline a conceptual framework for understanding its causes The Business Competitiveness Index BCI based on this conceptual framework provides a data rich approach to measuring and analyzing the fundamental competitiveness of a large number of countries in a comparative context This year s BCI includes 101 countries up from 80 last year Our aim is to rank country competitiveness across countries identify individual countries competitive strengths and weaknesses reveal the trends in competitiveness in the global economy and extend our basic knowledge about the sources of competitiveness and the process of economic development Most discussion of competitiveness and economic development is still focused on the macroeconomic political legal and social circumstances that underpin a successful economy It is well understood that sound fiscal and monetary policies a trusted and efficient legal system a stable set of democratic institutions and progress on social conditions contribute greatly to a healthy economy However these broader conditions are necessary but not sufficient They provide the opportunity to create wealth but do not themselves create wealth Wealth is actually created in the microeconomic level of the economy rooted in the sophistication of actual companies as well as in the quality of the microeconomic business environment in which a nation s firms compete Unless these microeconomic capabilities improve macroeconomic political legal and social reforms will not bear full fruit Beginning in 1998 we began an effort to examine statistically the microeconomic foundations of competitiveness and prosperity across a wide array of countries This is a daunting task given the need to measure and compare the complex array of national circumstances that support a high and sustainable level of productivity The effort aims to move beyond the examination of broad aggregate variables typical of most economic growth analyses and provide a framework for countries and companies to understand their detailed competitive strengths and weaknesses It also aims to be as rigorous as possible verifying the importance of variables statistically and using statistical techniques to weight the contribution of individual variables Finally we know that improvement in competitiveness is not a simple linear process but one where nations at different levels of development face different challenges and priorities This effort aims to highlight these differences 1 2 Building the Microeconomic Foundations of Prosperity CHAPTER 1 2 1 1 2 Building the Microeconomic Foundations of Prosperity 2 The Business Competitiveness Index seeks to explore the underpinnings of a nation s prosperity measured by its level of GDP per capita The focus of this index is on whether current prosperity is sustainable and on the specific areas that must be addressed if GDP per capita is to achieve higher levels in the future A separate Growth Competitiveness Index GCI discussed in the previous chapter of this Report examines the sources of GDP per capita growth which is more dependent on investment rates and other macroeconomic policies The sustainable level of current GDP per capita and its rate of growth will be related in the long term but each area requires its own distinctive policy agenda We have renamed the BCI this year to highlight its focus on firms and productivity However the conceptual framework and statistical approach follow that of the previous reports and the findings are fully comparable with previous Microeconomic Competitiveness Index results The analysis here is pragmatic making use of the best available data and econometric methods even though both are far from perfect We also confront the challenge of establishing the direction of causality given limited time series data However even if definitive tests of causality are not yet possible understanding the microeconomic correlates of prosperity remains crucial There may be a natural tendency for some microeconomic conditions to improve as GDP per capita increases but the large observed differences across countries even countries at similar income levels reveal that this improvement is far from automatic Despite the statistical challenges and the addition of 21 mostly low income countries mainly from Africa to the sample of countries the statistical findings overall are remarkably stable and robust compared with the Global Competitiveness Report 2002 2003 GCR and earlier Reports We expand this year s analysis to include an analysis of natural resource endowments and their role in competitiveness a crucial issue especially for developing countries The results again provide strong support for the importance of microeconomic competitiveness for economic development and prosperity Our findings also verify the striking and regular pattern of microeconomic changes that accompany economic development The Business Competitiveness Index proves to account for 83 percent of the variation across countries in the level GDP per capita 2 remarkably high given the addition of so many low income countries These findings highlight the pressing need to better incorporate microeconomic competitiveness agenda into efforts to stimulate economic growth In advanced countries which have largely gotten their macro policies right it is micro reform that holds the key to reversing unemployment problems to growing exports and to translating economic growth into a rising standard of living In developing countries microeconomic failures nullify macroeconomic and social programs again and again By accessing global capital markets countries can engineer spurts of growth through macroeconomic stabilization and financial reforms that bring in floods of capital and create the illusion of progress as construction cranes dot the skyline Without microeconomic reforms however growth will be snuffed out as exports and jobs fail to materialize wages stagnate and the return on investments proves disappointing This disappointment and the
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