Competitive Advantage Of Financial Services Industry

Can the UK government utilise Porter’s theory of a ‘diamond set of national influences’ to protect the competitive advantage of the financial services industry in the UK? Explain your answer.

Introduction

The diamond set of national influences in a porter’s theory helps to understand the comparative position of a nation in global competition. Porter argues that the theory of endowment given by Heckscher and Ohlin are very basic to analysis a nation-state’s competitive advantage. Comparative advantage is too shorter to see as a ‘divine inheritance’. He says that international success in a particular industry is determined by four broad factors which create an environment and enables these firms to compete. The four factors are factor conditions, demand conditions, related and supporting industries and firm structure, strategy and rivalry. These determinants are influenced by the nation’s government and also by chance events.

The role of the government is to:

Boost organisation to increase their performance for example by maintaining strict product standards.

Encourage early demands for advanced schemes.

Focusing on creation of specialised factor.

Stimulation of local rivalry by limiting direct collaboration and imposing antitrust rules and regulations.

The key area of Government in Porter’s model is to influence the four determinants through its policies. In fact, it appears that Government policies have influenced the four factors to such an extent that it alone could be used to analyse trade patterns. Porter says that the polices implemented by the Government creates an simulated national competitive advantage (NCA) and it also helps to remove the pressure on firms which indirectly effects on the firms growth and upgrade is counterproductive (acting against the achievement of the aim). He says that these policies will not succeed because they create a competitive advantage which cannot sustainable in the long run due to the pressures in this competitive marketing environment and continuous improvement. Porter says that the Governments’ role is to reinforce factors not to generate competitive advantage.

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The UK financial sector is mainly consists of retailing industries, banking sector which comprises of commercial banking and multinational foreign banking, the London stock market, mortgage companies and so on. The financial sector of UK is involved in all recessions that have occurred or may occur over time. Usually banks plays major role in providing finance to other sectors of the economy which in turn achieves economic growth.

To function as a profitable concern, every bank must and should follow their own and desired corporate culture. So that their business can function properly and can implement better risk management policies and practises, maintaining good relationships with lending guidelines and policies, have proficient staff that are supportive and work in as a team member so that it is possible for the banks can maintain good bankers and customers relationships and continue to function as a profitable concern. In the event of banks becoming bankrupt (insolvent) i.e., unable to pay debt and crumple. Some superior banks such as the Bank of England must come to help as the banker of the last option, so that they can pay their depositors money in full amount to all the depositors who want their money back. The government should stand as a financial guarantee for the banks to help them out from the event of bankruptcy. This is possible for the Government by making use of the taxpayers money to help them as a short-term measure only until the troubled banks can function normally and do their business properly again. So the UK government can make use of Porter’s theory of a ‘diamond set of national influences’ which helps them to protect the competitive advantage of the financial services. And by taking into account the following five steps to provide competitive advantage for financial sector.

http://ttrammohan.blogspot.com/2009/05/uks-financial-sector.html

The UK government has to make international regulation work. It should not support controlling arbitrage even if it expects to gain in the short run.

It must ensure that the managers and owners of the financial bodies internalise most of the costs of their actions.

It must reject egregious special pleading from the industry. The sector argues that moving derivatives trading on to exchanges might damage innovation. So what? Maximising innovation is a crazy objective. As in pharmaceuticals, a trade-off exists between innovation and safety. If institutions threaten to take trading activities offshore, banking licences should be revoked.

While trying to create a stable and favourable environment for business activities, the UK should try to diversify the economy away from finance, not reinforce its overly strong comparative advantage within it.

Fifth, UK authorities need to ensure that the risks run by institutions they guarantee fall within the financial and regulatory capacity of the British state. They should not let the country be exposed to the risks created by inadequately supported and under-regulated foreign institutions. At the very least, they should not undermine other governments’ efforts to regulate their own institutions.

The Irish Government could do well to heed Porter’s advice, in the author’s view, for a number of reasons. First, the reliance on FDI from the early 1970’s as a key element of industrial policy is fatally flawed as it is an increasingly unlikely foundation to achieve sustainable competitiveness in the long term. The ‘no ties’ financial incentive approach to FDI relied upon in the past provides fewer benefits due to the competitive pressures for mobile investment. However, this cannot be ‘tied’ now as to do so would cause FDI to locate elsewhere. The fierce competitive environment for mobile investment has seen Ireland’s share of FDI fall significantly over the last 15 years. This competition comes from Eastern European countries, China and India – the latter offering labour in abundance and access to high growth markets, France with its more liberalised inward investment rules and the Netherlands and other European countries increasing their tax incentives. There has also been a switch in FDI away from manufacturing to services and a switch from wholly owned sites to strategic alliances and joint- ventures with strong indigenous partners. When strong indigenous partners are not available in Ireland the country has little leverage to compete. As in all markets when competition ensues the price falls and the buyer benefits. In selling Ireland as an industrial location, incentives to the FDI must be increased to compete, investment can be tied to an even lesser degree and overall the ‘margin’ to benefit from FDI falls. Overall it would appear that he country is too heavily dependent on FDI.

Second, Government policies create a ‘grant mentality’ among the indigenous sector when it offers a generous grant environment to firms, as is currently the case. This removes the pressures to innovate and to reinvest in human and physical factors. In the history of industrial development the significant feature of the process of innovation, once begun, is its source of capital funding i.e. retained earnings. This feature is evident across successful companies in different countries. In Ireland successful companies which have built up large reserves have not reinvested that money to upgrade the innovative capabilities of the sector, ” where there has been reinvestment it has been in low skilled sheltered activities in which these companies have already proved successful” (O’Sullivan in O’Hagan 1995). This ‘defender type’ strategy aims to minimise risk and relies on grants and government subsidies as sources for investment funds.

Through these policies and others, Government has impinged on the dynamism needed to create a sustainable NCA based in indigenous industry. This paper agrees with Porter when he states that ” policies implemented without consideration of how they influence the entire system are as likely to undermine national advantage as enhance it”(Porter 1990). There are many lessons to be learnt from the Asian Tigers and their interventionist policies to increase the international competitiveness of indigenous firms and to make them more responsive to the pressures of global competition. This in order to reap the real benefits of international trade.

Conclusion

This paper concludes that Porter’s model is unhelpful to explain the pattern of Ireland’s trade. The competitive environment created by the four determinants does not fit with the statistical NCA. The statistics indicates Ireland’s NCA lies in the ‘high-tech’ industries, however, the factor conditions, demand conditions, related and supporting industries and the structure and strategy of firms do not create a competitive environment that fits these industries – Government policies have artificially created this ‘statistical NCA’. The Government industrial policy of attracting FDI has been responsible for the creation of ‘high-tech’ industries in Ireland and their dominance of the trade statistics is in large part due to the attractive corporation tax rate which create the incentive for Profit Switching Transfer Pricing.

Porter’s model can also be criticised on a number of other points. First, it is an ex-post model and therefore has no predictive powers, also the number of variables involved weakens any predictions, in particular the inclusion of ‘chance’ into the equation; second, Porter uses examples of success to back up his theories but his ‘interpretation’ of the reasons behind the success is subjective in many cases and could be explained by other factors; third because of the number of variables and the inclusion of chance, the model has the ability to explain away evidence which does not agree with its findings and finally he also provides himself with a ‘get-out’ clause when at the end of discussing each determinant he states it will not be effective unless the others reinforce it.

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