Competitiveness as an Engine for Economic Growth: Implications for Saudi Arabia

Competitiveness as an Engine for Economic Growth: Implications for Saudi Arabia Professor Michael E. Porter Harvard Business School The Global Competitiveness Forum 2008 January 21, 2008 This presentation draws on ideas from Professor Porter s articles and books, in particular, The Competitive Advantage of Nations (The Free Press, 1990), Building the Microeconomic Foundations of Competitiveness, in The Global Competitiveness Report 2006 (World Economic Forum, 2006), Clusters and the New Competitive Agenda for Companies and Governments in On Competition (Harvard Business School Press, 1998), and ongoing research on clusters and competitiveness. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, or otherwise - without the permission of Michael E. Porter. Further information on Professor Porter s work and the Institute for Strategy and Competitiveness is available at www.isc.hbs.edu Version: January 18, 2008, 4pm 1 Copyright 2008 Professor Michael E. Porter

Saudi Arabia s Competitive Position in 2008 The dramatic increase in oil prices has created significant resources and rapid growth for the Saudi economy There is a new level of determination to leverage this opportunity to build a truly competitive economy and diversify beyond natural resources Saudi Arabia can succeed on this path, but only if it is willing to take a strategic approach, make multiple improvements in its business environment, truly open up competition and entrepreneurship in the private sector, and embark on a sustained effort to equip Saudi citizens with new skills, attitudes and mindsets It will be easy to become impatient and distracted by near term economic growth and the ability to support uncompetitive practices and policies 2 Copyright 2008 Professor Michael E. Porter

Saudi Arabia s Long-Term Prosperity Index Values, 1980 = 1.00 GDP per Capita CAGR: -6.1% GDP per Capita CAGR: +0.00% GDP per Capita CAGR: +1.4% Source: Groningen Growth and Development Centre and The Conference Board (2007), Swivel (2007) 3 Copyright 2008 Professor Michael E. Porter

PPP-adjusted GDP per Capita, 2006 $50,000 Norway Prosperity Performance Selected Countries $45,000 $40,000 $35,000 $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 USA Switzerland Denmark Netherlands Austria Belgium Germany France Italy Spain Israel 0% 1% 2% 3% 4% 5% 6% 7% Source: EIU (2007), authors calculations Canada UK Japan Qatar Ireland Australia Iceland Singapore Sweden Kuwait Finland New Zealand Bahrain Slovenia Taiwan Greece Korea Hong Kong Portugal United Arab Emirates Czech Republic Hungary SAUDI ARABIA Oman Argentina Libya Poland Chile South Africa Croatia Mexico Malaysia Iran Lebanon Brazil Tunisia Turkey Algeria Thailand Egypt Jordan Iraq Syria Indonesia (-6.2%) Philippines Pakistan Yemen Growth of Real GDP per Capita (PPP-adjusted), CAGR, 2001-2006 Slovakia Russia China (9.49%) India Vietnam 4 Copyright 2008 Professor Michael E. Porter

What is Competitiveness? Competitiveness is determined by the productivity with which a nation uses its human, capital, and natural resources. Productivity sets the standard of living (wages, returns on capital, returns on natural resources) that a country can sustain It is not what industries a nation competes in that matters for prosperity, but how it competes in those industries Productivity in a national economy arises from a combination of domestic and foreign firms The productivity of local or domestic industries is fundamental to competitiveness, not just that of export industries Nations compete in offering the most productive environment for business The public and private sectors play different but interrelated roles in creating a productive economy 5 Copyright 2008 Professor Michael E. Porter

Sources of Prosperity Inherited Prosperity Prosperity is derived from selling or exploiting inherited natural resources Prosperity is constrained Created Prosperity Prosperity is derived from creating valuable products and services Prosperity is unlimited Government is the central actor in the economy as the owner and distributor of resource wealth Resource revenues allow unproductive policies and practices to persist Government s role gravitates towards the distribution of wealth as interest groups seek a bigger share of the pie Companies are the central actors in the economy Prosperity can only be created by firms Government s role is to create the enabling conditions for productivity and foster private sector development 6 Copyright 2008 Professor Michael E. Porter

GDP per employee (PPP adjusted US$), 2006 100,000 90,000 80,000 70,000 60,000 Spain Italy Comparative Labor Productivity Selected Countries Austria France Israel Qatar Australia Canada Germany Norway Netherlands USA Belgium UK Denmark Japan Ireland Greece Finland Hong Kong Taiwan Sweden Slovenia Singapore 50,000 40,000 30,000 20,000 10,000 0 SAUDI ARABIA Brazil Mexico New Zealand Portugal Iran Algeria -1.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% Compound annual growth rate (CAGR) of real GDP per employee (PPPadjusted), 2001-2006 Source: EIU (2007), Saudi Arabia employee data (number persons employed) from ILO LABORSTA (2007) South Africa Czech Republic Slovakia Chile Egypt Philippines Pakistan Tunisia Thailand Malaysia Hungary Croatia Poland Turkey (6.4%) China (9.0%) Indonesia Vietnam India (5.3%) 7 Copyright 2008 Professor Michael E. Porter

Employees as % of Population, 2006) Labor Force Mobilization Selected Countries OECD average: 0.47 Middle East average: 0.40 Note: Use most recent year available, either 2005 or 2006 Source: The Conference Board and Groningen Growth and Development Centre, Total Economy Database, November 2007 8 Copyright 2008 Professor Michael E. Porter

Gross Fixed Investment as % of GDP (2006) Fixed Investment Rates Selected Countries China Qatar South Korea Iran Jordan India Singapore Egypt Libya Philippines Indonesia Morocco Algeria Tunisia Turkey Pakistan UAE Lebanon Saudi Arabia Brazil Bahrain US Kuwait Nigeria Syria Oman Yemen CAGR Gross Fixed Investment (as % of GDP), 1990-2006 Source: EIU, 2007. 9 Copyright 2008 Professor Michael E. Porter

Saudi Arabia s Exports Types of Goods and Services Exports ($ Thousands) Export Type Value of Exports, 2006 Growth Rate of Exports, CAGR 1998-2006 Semi-Processed Natural Resources $36.4 Billion 20.3% CAGR Natural Resources Related $201.2 Billion 24.0% Non-Natural Resource Related $19.0 Billion 11.3% Processed Goods $11.7 Billion 16.9% CAGR Services $7.3 Billion 5.6% CAGR Source: Institute for Strategy and Competitiveness International Cluster Competitiveness Project; UN Comtrade; IMF BOP statistics. 10 Copyright 2008 Professor Michael E. Porter

Determinants of Competitiveness Macroeconomic, Political, Legal, and Social Context Microeconomic Competitiveness Sophistication of Company Operations and Strategy Quality of the Microeconomic Business Environment State of Cluster Development A sound macroeconomic, political, legal, and social context create the potential for competitiveness, but is not sufficient Competitiveness ultimately depends on improving the microeconomic capability of the economy and the sophistication of local competition 12 Copyright 2008 Professor Michael E. Porter

Macroeconomic, Political, Legal, and Social Context Saudi Arabia has registered sound macroeconomic policies, but transparency remains limited and inflationary pressures are rising There are ongoing debates about direction and speed of political reforms, which limits predictability and policy stability. Government processes remain complex and have limited transparency The Saudi legal system is in the process of modernization, but concerns remain about uncertainty in judicial decision making Social policies have addressed poverty and basic social needs, but challenges arise in education, gender relations, and the large expatriate community 13 Copyright 2008 Professor Michael E. Porter

Corruption Perception Index, 2007 Low corruption 1 Deteriorating Improving Rank in Global Corruption Index, 2007 SAUDI ARABIA Trinidad & Tobago Belize Bahrain Oman Tunisia Brazil Jordan Qatar United Arab Emirates Turkey China India Algeria High corruption 124 Syria Iran Yemen Pakistan Russia Venezuela Iraq Ecuador Libya Indonesia Nigeria Angola Change in Rank, Global Corruption Report, 2007 versus 2003 Note: Ranks only countries available in both years (124 countries total) Source: Global Corruption Report, 2007 14 Copyright 2008 Professor Michael E. Porter

Improving the Business Environment: The Diamond Factor (Input) Conditions Access to high quality business inputs Natural endowments Human resources Capital availability Physical infrastructure Administrative infrastructure (e.g. registration, permitting) Information infrastructure (e.g., transparency) Scientific and technological infrastructure Context for for Firm Strategy and and Rivalry Local rules and incentives that encourage investment and productivity e.g. salaries, incentives for capital investments, intellectual property protection Vigorous local competition Openness to foreign and local competition Related and and Supporting Industries Availability of suppliers and supporting industries Presence of clusters instead of isolated firms Demand Conditions Sophistication of local customers and needs Strict quality, safety, and environmental standards Successful economic development is a process of successive upgrading, in which the business environment improves to enable increasingly sophisticated ways of competing 15 Copyright 2008 Professor Michael E. Porter

Ranking, 2007 (of 178 countries) Ease of Doing Business Saudi Arabia Favorable Unfavorable Saudi Arabia per capita GDP rank: 48 Saudi Arabia Doing Business rank: 23 Saudi Arabia 2010 goal: 10 Median Ranking, Middle East Source: World Bank Doing Business (2008) 16 Copyright 2008 Professor Michael E. Porter

Saudi Arabian Business Environment Selected Advantages and Disadvantages, 2007 Competitive Advantages Relative to GDP per Capita Quality of electricity supply 40 Quality of port infrastructure 42 Air transport infrastructure quality 43 Reliability of police services 45 Competitive Disadvantages Relative to GDP per Capita Stringency of environmental regulations 101 Business costs of corruption 89 Buyer sophistication 81 Quality of management schools 73 Quality of private property rights 72 Absence of trade barriers 69 Decentralization of economic policymaking 69 Local equity market access 65 Quality of math and science education 65 Local availability of specialized research 65 and training services Quality of primary education 64 Financial market sophistication 63 Availability of scientists and engineers 57 Effectiveness of antitrust policy 57 Intensity of local competition 53 Quality of scientific research institutions 51 Note: Rank versus 127 countries; overall, Saudi Arabia ranks 48 th in 2006 PPP adjusted GDP per capita and 51 h in Business Competitiveness. Only 2007 data available. Source: Institute for Strategy and Competitiveness, Harvard University (2007) 17 Copyright 2008 Professor Michael E. Porter

2006 GDP per Capita (PPP- adjusted) 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Ranking Microeconomic Competitiveness Business Competitiveness Index, 2007 Libya Argentina Greece Bahrain Kuwait Italy Spain SAUDI ARABIA Russia South Africa Chile Ukraine Costa Rica Brazil Thailand Colombia Peru China Tunisia Jordan India Pakistan Kenya Philippines Indonesia NigeriaTanzania Hong Kong Iceland Australia Ireland Canada France Taiwan Japan Malaysia Norway Variation in BCI score 45,000 United States explains 82% of variation in GDP per Qatar 40,000 capita Venezuela Poland Slovenia Portugal Cyprus Czech Republic Hungary Latvia Slovakia Lithuania Estonia Israel New Zealand Korea Switzerland Denmark Finland Sweden Germany Saudi Arabia s Ranking Global Competitiveness Index Business Competitiveness Index 35 51 Low Business Competitiveness Index High Source: Global Competitiveness Report 2007 18 Copyright 2008 Professor Michael E. Porter

Enhancing Cluster Development Tourism Cluster in Cairns, Australia Public Relations & Market Research Services Travel agents Tour operators Local retail, health care, and other services Food Suppliers Property Services Restaurants Attractions and Activities e.g., theme parks, casinos, sports Local Transportation Souvenirs, Duty Free Maintenance Services Hotels Airlines, Cruise Ships Banks, Foreign Exchange Government agencies e.g. Australian Tourism Commission, Great Barrier Reef Authority Educational Institutions e.g. James Cook University, Cairns College of of TAFE Industry Groups e.g. Queensland Tourism Industry Council Sources: HBS student team research (2003) - Peter Tynan, Chai McConnell, Alexandra West, Jean Hayden 19 Copyright 2007 Professor Michael E. Porter

The Houston Oil and Gas Cluster Upstream Downstream Oil & Natural Gas Exploration & Development Oil & Natural Gas Completion & Production Oil Transportation Gas Gathering Oil Trading Gas Processing Oil Refining Gas Trading Oil Distribution Gas Transmission Oil Wholesale Marketing Gas Distribution Oil Retail Marketing Gas Marketing Oilfield Services/Engineering & Contracting Firms Equipment Suppliers (e.g. Oil Field Chemicals, Drilling Rigs, Drill Tools) Specialized Technology Services (e.g. Drilling Consultants, Reservoir Services, Laboratory Analysis) Subcontractors (e.g. Surveying, Mud Logging, Maintenance Services) Business Services (e.g. MIS Services, Technology Licenses, Risk Management) Specialized Institutions (e.g. Academic Institutions, Training Centers, Industry Associations) 20 Copyright 2007 Professor Michael E. Porter

2% Saudi Arabia s Average World Export Share: 1.92% National Cluster Export Portfolio Saudi Arabia, 1997-2005 Plastics Saudi Arabia s world export market share, 2005 1.5% Chemical Products Business Services 1% Prefabricated Enclosures and Structures 0.5% Construction Materials Processed Foods Oil and Gas (5.49%, 14.99%) $162 billions 0% Building Fixtures and Equipment Metal Mining and Manufacturing Motor Driven Products Automotive / Medical Devices Agricultural Products Textiles Jewelry, Precious Metals and Collectibles Leather and Related Products Communications Equipment Biopharmaceuticals Change In Saudi Arabia s Overall World Export Share: +1.09% Change in Saudi Arabia s world export market share, 1997 2005 Exports of US$1.2 Billion = Source: Prof. Michael E. Porter, International Cluster Competitiveness Project, Institute for Strategy and Competitiveness, Harvard Business School; Richard Bryden, Project Director. Underlying data drawn from the UN Commodity Trade Statistics 21 Database and the IMF BOP statistics. Copyright 2007 Professor Michael E. Porter

Improving Company Sophistication Relative Position of Saudi Arabian Companies, 2007 Competitive Advantages Relative to GDP per Capita Control of international distribution 19 Production process sophistication 32 Value chain breadth 34 Competitive Disadvantages Relative to GDP per Capita Extent of staff training 77 Reliance on professional management 71 Degree of customer orientation 69 Extent of marketing 68 Prevalence of foreign technology 62 licensing Extent of regional sales 61 Extent of incentive compensation 56 Breadth of international markets 52 Capacity for innovation 49 Nature of competitive advantage 49 Willingness to delegate authority 47 Note: Rank versus 127 countries; overall, Saudi Arabia ranks 48 th in 2006 PPP adjusted GDP per capita and 51 h in Business Competitiveness. Only 2007 data available. Source: Institute for Strategy and Competitiveness, Harvard University (2007) 22 Copyright 2007 Professor Michael E. Porter

Geographic Influences on Competitiveness World World Economy Economy Broad Broad Economic Economic Areas Areas Groups Groups of of Neighboring Neighboring Nations The Neighborhood Nations Nation Nation States, States, Provinces Provinces Metropolitan Metropolitan Areas Areas Regional Economies Rural Rural Areas Areas 23 Copyright 2007 Professor Michael E. Porter

Saudi Arabia s Provinces % Social Security recipients below/above national average % Labor force participation above/below national average Source: Saudi Arabian Monetary Authority (SAMA) report, 2007 24 Copyright 2007 Professor Michael E. Porter

The Neighborhood Middle East Economic coordination among neighboring countries can significantly enhance competitiveness Integration with neighbors offers greater opportunities than participation in broader economic forums 25 Copyright 2007 Professor Michael E. Porter

The Process of Economic Development Shifting Roles and Responsibilities Old Model New Model Government drives economic development through policy decisions and incentives Economic development is a collaborative process involving government at multiple levels, companies, teaching and research institutions, and private sector organizations Competitiveness must become a bottoms-up process in which many individuals, companies, and institutions take responsibility Every community and cluster can take steps to enhance competitiveness The private sector must become more engaged in competitiveness to improve rapidly 26 Copyright 2007 Professor Michael E. Porter

Towards a Competitiveness Agenda for Saudi Arabia Create a culture of productivity in Saudi Arabia Continue improving political and legal stability and transparency Pursue a sustained program to upgrade the Saudi business environment, sequencing priorities based on binding constraints Upgrade company sophistication and foster entrepreneurship and the development of SMEs Pursue a comprehensive policy for cluster development Expand information, openness, and transparency throughout the economy Develop and implement distinct strategies for each Saudi Arabian province Achieve regional economic coordination and integration with Arab neighbors Achieving competitiveness will require a sustained effort over a decade or more 27 Copyright 2007 Professor Michael E. Porter

Address the Weaknesses and Binding Constraints in the Business Environment Business regulation Financial markets Stringency of quality, safety and environmental standards Openness of competition Market information Education and skills development Innovative capacity 28 Copyright 2007 Professor Michael E. Porter

Upgrade Company Sophistication and Foster Entrepreneurship Create a national campaign to foster entrepreneurship and support SME development Expand corporate disclosure Strengthen corporate governance Introduce best practices in terms of operational efficiency Utilization of information technology Quality improvement and certification A culture of learning and innovation Upgrade human resources Create more focused Saudi business groups Improve private sector institutions and expand the role of the private sector in economic development 29 Copyright 2008 Professor Michael E. Porter

Create a Comprehensive Policy for Cluster Development The Industrial Development Strategy has an explicit focus on cluster development Current cluster development policy should extend to the entire economy, including domestic industries and all the provinces Realign government economic development policies around clusters 30 Copyright 2007 Professor Michael E. Porter

Clusters and Economic Policy Business Attraction Education and Workforce Training Export Promotion Market Information and Disclosure Clusters Science and Technology Investments (e.g., centers, university departments, technology transfer) Standard setting Specialized Physical Environmental Stewardship Infrastructure Natural Resource Protection Clusters provide a framework for organizing the implementation of public policy and public investments towards economic development 31 Copyright 2008 Professor Michael E. Porter

Create a Comprehensive Policy for Cluster Development The Industrial Development Strategy has an explicit focus on cluster development, a major strength Cluster development policy should extend to the entire economy, including domestic industries and all the provinces Realign government economic development policies around clusters The Economic Cities program should be directly tied to the cluster development program Science-based clusters will be slow to develop. The focus should be on making existing and emerging Saudi clusters more knowledge intensive 32 Copyright 2008 Professor Michael E. Porter

Diversifying the Saudi Arabian Economy Grow exports in related clusters Leverage unique Saudi Arabian strengths and niche positions Leverage the large domestic market Widen participation in existing clusters Upgrade existing export products 33 Copyright 2008 Professor Michael E. Porter

Growth Opportunities within Clusters Saudi Arabian Chemical Cluster Strong Export Share Organic Chemicals Inorganic Chemicals Packaged Chemicals Chemically Based Ingredients Synthetic Fibers Misc. Crude Materials Pesticide and Other Agricultural Chemicals Miscellaneous Mineral Products Explosives Dyeing, Tanning and Coloring Materials Weak Export Share Losing Market Share Gaining Market Share Source: International Cluster Competitiveness Project, Institute for Strategy and Competitiveness, Harvard Business School 34 Copyright 2008 Professor Michael E. Porter

Grow Current Niche Positions Leading Saudi Arabian Export Industries outside of Clusters, 2005 Industry (Processed Products) Cluster Market Share Change in Market Share Export Volume Carpets and other textile floor coverings, woven Textiles 5.6% 3.7% 142,479 Sheep, lamb skin leather Leather and Related Products 3.9% 2.6% 42,787 Other forms of unvulcanized rubber Construction Materials 3.0% 2.9% 15,971 Drawn, blown glass in sheets Building Fixtures and Equipment 2.4% 1.6% 7,020 Asbestos-cement and fiber-cement materials Construction Materials 1.9% 0.2% 47,977 Cast, rolled glass in sheets Building Fixtures and Equipment 1.8% -6.3% 14,633 Portland cement, aluminous cement and similar products Construction Materials 1.7% -0.4% 129,918 Bridges and bridge-sections Prefabricated Enclosures and Structures 1.6% -4.0% 8,387 Towers and lattice masts Prefabricated Enclosures and Structures 1.6% -0.9% 19,143 Miscellaneous articles of pulp, paper and paperboard Forest Products 1.5% 0.4% 218,347 Other metal structures and parts Prefabricated Enclosures and Structures 1.4% 1.0% 266,167 Rubber, textile yarn, cord Textiles 1.3% 1.3% 3,841 Jute, other textile bast fibers Textiles 1.2% 1.2% 105 Preparations for hair Biopharmaceuticals 1.1% 0.3% 86,847 Goat or kid skin leather Leather and Related Products 1.1% 0.8% 6,561 Silk Textiles 1.1% 3,444 Sands, natural not metal bearing Construction Materials 1.0% 0.8% 10,976 Paper and paperboard, corrugated, creped, crinkled Forest Products 1.0% 0.7% 34,473 Gold, non-monetary, excluding ores Jewelry, Precious Metals and Collectibles 0.9% 0.9% 478,006 Prefabricated buildings Prefabricated Enclosures and Structures 0.9% -1.0% 53,163 35 Copyright 2008 Professor Michael E. Porter

Growth Through Related Clusters Jewelry & Precious Metals Apparel Footwear Fishing & Fishing Products Distribution Services Financial Services Leather & Related Products Business Services Agricultural Products Transportation & Logistics Publishing & Printing Oil & Gas Education & Knowledge Creation Chemicl Products Plastics Hospitality & Tourism Information Tech. Medical Devices Entertainment Aerospace Vehicles & Defense Analytical Instruments Tobacco Biopharmaceuticals Communications Equipment Note: Clusters with overlapping borders or identical shading have at least 20% overlap (by number of industries) in both directions. Lightning & Electrical Equipment Prefabricated Enclosures Building Fixtures, Equipment & Services Power Generation Motor Driven Products Furniture Heavy Construction Services Aerospace Engines Textiles Heavy Machinery Construction Materials Forest Products Production Technology Metal Manufacturing Sporting & Recreation Goods Automotive Processed Food 36 Copyright 2007 Professor Michael E. Porter

Develop Distinctive Strategies in each Saudi Arabia Province Regional development should follow a hub and spoke model to link rural areas to the nearest urban center Improving social service delivery and physical infrastructure across all provinces are important preconditions for regional economic development Each region needs a distinctive economic plan that reflects its location, assets, and existing economic activity Economic policy formulation and implementation should be gradually decentralized Government capability in each province needs to be upgrading over time 37 Copyright 2008 Professor Michael E. Porter

Enhancing the Economic Cities Concept The economic cities can become an important tool for Saudi Arabian development However, they also symbolize the challenges that the country needs to address Tabuk Economic City Tabuk Al Jowf Proposed Locations for Economic Cities Ha'il Northern Borders Prince Abdulaziz bin Musaid Economic City They have been planned centrally, not by the regions themselves They focus on infrastructure rather than skills and institutions Economic cities have an unclear relation to clusters and the surrounding regional economy They ask for private sector action but have been designed by the government Note: Exact physical location of Economic Cities still to be determined Knowledge Economic City King Abdullah Economic City Madinah Makkah Al- Baha Jizan Economic City Qassim Asir Jizan Riyadh Najran Eastern Province Eastern Province Economic City 38 Copyright 2008 Professor Michael E. Porter

Develop a Regional Competitiveness Strategy with Arab Neighbors The Gulf Cooperation Council can be an important complement to competitiveness efforts at the national level Many aspects of the business environment can be enhanced by coordination and integration with neighboring countries The region needs to shift from rhetoric to action Due to its size and resources, Saudi Arabia should take a leadership role 39 Copyright 2008 Professor Michael E. Porter

Defining an Economic Strategy for Saudi Arabia National Value Proposition What is the unique competitive position of Saudi Arabia given its location, legacy, existing strengths, and potential strengths? What roles in the world, the broad economic area, and the neighborhood? What unique value as a business location? For what range and types of businesses, activities in the value chain, and clusters can Saudi Arabia be competitive? 40 Copyright 2007 Professor Michael E. Porter

Towards a Strategic Positioning for Saudi Arabia Strengths to Build Upon Natural resource endowments Largest and most populous economy in the Middle East Location between Europe, Asia, and Africa Distinct cultural traditions Significant accumulated capital Saudi Arabia has outlined an ambitious action agenda to enhance competitiveness It will be important to set priorities and sequence steps to reflect the realities of Saudi Arabia s economy Fundamental changes in the capabilities and attitudes of many Saudi citizens will be needed to achieve the desired transformation of the Saudi Arabian economy 41 Copyright 2007 Professor Michael E. Porter