The New Economics of Competitiveness

The concept of comparative advantage ceases to be useful when intra-industry trade has to be explained. Similar income levels and diverse tastes influence the demand side, while in a monopolistic market structure, economies of scale and special production knowledge might have an effect on the supply side.

Competitive advantage, as explained below, determines market success by means of price or differentiation (via quality, design, origin, etc.). However, price

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competitiveness might not be decisive for intra-industry trade. Competitiveness with respect to quality, design and the like could be more important. Furthermore, overall success in trade (both inter- and intra-industry) is determined by competitive advantage.

In order to be successful in the world market, one has to supply products that are of better quality and design and lower price than competitors’ products. Thus, there is consensus in the concept of competitive advantage over the importance of asserting oneself against many competitors by having a unique selling position (USP).

However, the concept remains elusive and difficult to understand without a theoretical framework. Therefore, the introduction of the dimensions of competitive advantage is a step forward. First, competitiveness exists on both microeconomic and macroeconomic levels of analysis. This influences the unit of analysis, whether nations, firms, sectors, or products. Secondly, competitiveness can have price and quality aspects. Studies should present different ways these aspects could be measured. Thirdly, external forces, such as trade policies of importing countries, can have a direct and indirect influence on exchange. And fourthly, competitive advantage is a rather dynamic concept.

A major strength of the comparative advantage model is that it can be empirically estimated by using the domestic resource cost (DRC) criterion⁷. However, this is just one of the variables to take into account when the complex dynamics of trade are analyzed. These dynamics need a broader theoretical background to explain changes of trade in a globalizing world.

Comparative advantage is related to factor endowments where firms share the same advantages (low utility costs, good climatic conditions, government policies, and availability of human capital and natural resources). These assumptions of comparative advantage are not sufficient to explain high value-added and knowledge-based economies (as found in developed countries) but they are enough to explain factor costs and endowment-based economies (typical in developing countries).

As explained in the models in the second chapter, the assumptions of competitive advantage will not only be useful for explaining value-added and knowledge-based economies, but also factor-endowment-based economies. Competitive advantage

7 Domestic resource cost (DRC): based on a total factor productivity approach. It incorporates the relative scarcity of factors of production through the use of shadow prices.

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assumes the creation of production factors (by technological advances) and the recognition of already existent factors (land, capital, and labor). It also assumes that firms have control over their specific costs, economies of scale, marketing strategies, and technological advances (Mahmood 2000).

A fundamental difference between comparative and competitive advantage is the

“visibility of the hand”. The government, in comparative advantage, is only responsible for maintaining security, minimum standards of welfare, and some specific public utilities and infrastructure. Government policies do not have any effect on prices in a comparative advantage scheme, and the opportunity costs are as they “ought” to be under free trade. On the other hand, in competitive advantage, there is general agreement that the dynamics of governmental distortions affect prices, despite a lack of consensus on a single concept or theory explaining how this happens.

In the short run, resource endowments of comparative advantage stay fixed while governmental policies, exchange rates, and random effects of competitive advantage change prices. Both competitive and comparative advantages allow for changes in resource endowments in the long run. In the case of comparative advantage this is due to the natural movements of the market, while in the case of competitive advantage one has to add governmental policies and private strategies. Thus, contrary to the assumption of the comparative advantage theory, a relatively strong “visible hand” does exist in competitive advantage.

The assumptions of comparative advantage theory are based on free trade under static equilibrium, that is to say, neither trade barriers nor instabilities exist. Obviously, this is far from real conditions of world trade. For example, changes in the markets of developing countries are less responsive than those of developed countries because of structural rigidities and larger imperfections (Mahmood 2000). Some of the differences between northern, developed and southern, developing countries can be seen in the goods they trade internationally. Manufacturing, services and high technology sectors are dominated by developed countries of the north by taking raw materials (subtracting value-added activities) from developing southern countries.

Mahmood (2000) concludes that favorable terms of trade for developed countries are, in part, a consequence of restrictions and obstacles to development and trade of developing

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countries. These issues are particularly important in the competitive advantage theory, though comparative advantage theory does not deal with them. When policies are included (as a source of competitive advantage), it is complementary to comparative advantage theory.

There is a sub-system in traditional (neoclassical) trade theory: the comparative advantage theory according to which trade policies are defined as allocation-distorting, and therefore are not considered part of classical theory. When these “distortions” are included, the result is competitive advantage theory, which rather than being a substitute, should be considered a complementary theory. (Reinert 1994, p. 4). The explanation of trade flows under the concept of competitive advantage moves away from purely economic reasoning and includes more firm- and policy-oriented reasoning.

New trade theory⁸ recognizes that competitive advantage can be shaped by product differentiation, business strategies, and specialization, leading to quasi-monopolies in international markets⁹ and smart policy interventions such as exchange rate and strategic trade policies. Mahmood (2000, p. 245) best summarizes the idea behind the conflict between comparative and competitive advantage when he states:

“The notion of comparative advantage is based on a country’s factor endowments position where no participating firm in an industry has an advantage over another on the basis of factor endowment (public good characteristics). Unlike comparative advantage, competitive advantage is created and owned by individual firms (private good characteristics)…

Clearly, one does not have to choose between one of the two paradigms, for neither are they mutually exclusive nor explicitly separable. Therefore, we argue that it is inappropriate to present competitive advantage as an alternative (substitute) to comparative advantage. The two theories should

8 Competitive advantage theory should be enclosed to the new trade theory according to the interpretation of research of industrial economists. See Krugman (1992, 1995, 1996), Reienert (1994) and Sachwald (1995).

9 Ezeala-Harrison (1999, p. 23) explains how specialization could lead to quasi-monopolies: “the existence of economies of scale, or massive technological leadership advantages for firms in any country could result in those firms emerging as world monopolists in the world market. But then the rapid diffusion of technologies could cause firms in other countries to quickly copy the leading firms and emerge as competing rivals in the world market. The scenario then becomes analogous to the standard case of oligopolistic rivals engaged in strategic game settings in the world market stage, in which case the relative gains from trade accruing to a country would depend more on the successes of the trade 'strategies' adopted than on the comparative advantage (which depends on competitiveness)”.

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be properly viewed as complements rather than competitors in formulation of national trade and industry policies.”

From the above discussion, some preliminary conclusions can be extracted concerning the concepts of competitiveness and competitive advantage. Firstly, a more sophisticated trade theory includes additional determinants to explain the complexities of a globalizing market in a comprehensive way. Secondly, more recent theories of trade start with the theory of comparative advantage, as a basis to explain their principles. Thirdly, the traditional theory described above is not able to sufficiently explain all possible situations of trade. Finally, comparative advantage theory explains, in detail, trade between primary sector-based economies, but recent theories deal more with the manufacturing sector. Looking for new comprehensive theories for developing countries, therefore, becomes problematic, as these are mostly primary-sector-based economies.