Competing
in
Capabilities
The Final Element…
• Since elements of know-how do not map one-toone 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.
FIX Strategy (investment cost c)
X
Unit Cost
Z
Y
C
c
X
Z
Y
C
c
A
B
C
D
FLEX Strategy (investment cost 2c > C)
Recall:
X
Y
Trajectories
Z
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 expost
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.
Globalization Revisited:
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
Policy Lessons: A Few Illustrative Points
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 autocomponents).
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 autocomponents).
- 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 autocomponents).
- Governments’ role in capability building: the CII example;
the USAID and IFC approach.
- The French Debate and ‘Social Europe’.
The Bigger Picture
• The bottom billion…
• Prospects for sub-Saharan Africa
• Trade liberalization re-visited
 Free Trade
Free Trade
UB
II
II
III
III

b (i)
b (ii)
v/u
Case (a)
v/u
Case (b)
From Globalisation to Global
Recession
• Will the pace of globalisation now slow
down?
• The big issue : the spectre of
protectionism