Global Economic Environment : International Competition Go Global ! Global Economic Environment : International Competition By Stephen Ong Edinburgh Napier University Business School Visiting Professor, College of Management, Shenzhen University 12 August 2012

Agenda 1. International trade theories 2. Competitive advantage of nations 3. Porter’s Diamond

Learning Objectives  To discuss the underlying factors which contribute to competitive success in international markets.  To analyse the basis for national competitive advantages in establishing specific globally competitive industries.

Laissez-Faire vs. Intervention  Trade theory helps answer  What products should we import and export?  How much should we trade?  With whom should we trade?  Laissez-faire approach  Free trade theories – absolute advantage and comparative advantage  Intervention approach  Mercantilism and neomercantilism

Laissez-Faire vs. Intervention International Operations and Economic Connections

Theories of Trade Patterns  Theories explore  country size  factor proportions  country similarity  Theories explore trade competitiveness  Product life cycle  Diamond of national advantage

Trade Theories and Business What Major Trade Theories Do and Don’t Discuss: A Checklist

Factor Mobility Theory  A country’s competitiveness depends on  quality and quantity of production factors  Land  Labour  Capital

Interventionist Theories  Theories that support government intervention in the flow of trade  Mercantilism  Neomercantilism

Mercantilism  Mercantilism countries should export more than they import  Maintain a favourable balance of trade  trade surplus  Avoid an unfavourable balance of trade  trade deficit

Neomercantilism  Neomercantilism run an export surplus to achieve social or political objectives

Free Trade Theories  Two theories that support free trade  Absolute advantage theory  Comparative advantage theory  Market forces should determine trade  specialization

Theory of Absolute Advantage  Theory of absolute advantage  different countries produce some goods more efficiently than others  Free trade brings  Specialization  natural advantage  acquired advantage  product technology  process technology  Greater efficiency  Higher global output

Theory of Absolute Advantage Production Possibilities under Conditions of Absolute Advantage

Theory of Comparative Advantage  Theory of comparative advantage  free trade can increase global output even if one country has an absolute advantage in the production of all products  Consider  comparative advantage  absolute disadvantage

Theory of Comparative Advantage Production Possibilities under Conditions of Comparative Advantage

Theories of Specialization: Assumptions and Limitations  Theories of specialization make assumptions that may not be valid  full employment  economic efficiency  division of gains  two countries, two commodities  transport costs  statics and dynamics  services  production networks  mobility

How Much Does A Country Trade?  Theory of country size  large countries depend less on trade than small countries  Large countries usually  export a smaller portion of output and import a smaller part of consumption  have higher transportation costs for foreign trade

What Does A Country Trade?  Factor proportions theory  factors in relative abundance are cheaper than factors that are relatively scarce  But  production factors are not homogenous  labour  Process technology  capital versus labour

What Does A Country Trade? Worldwide Trade by Major Sectors

Choosing Trading Partners  Country similarity theory  most trade occurs among developed countries  share similar market characteristics  produce and consume much more than developing countries  Trading partners are affected by  Cultural similarity  Political relations between countries  Distance

Product Life-Cycle Theory Raymond Vernon 1966  Optimal location in the world to produce a product changes as the market for the product matures  Growth in demand and production in advanced nations shifts to developing nations  Developed nations over time shifts from being an exporter to an importer  Globalization and integration of the world economy makes this theory less relevant

Product Life Cycle Theory  The product life cycle theory  the production location of certain manufactured products shifts as they go through their life cycle  Four stages 1.Introduction 2.Growth 3.Maturity 4.Decline

Product Life Cycle Theory Life Cycle of the International Product

Product Life-Cycle Theory

New Trade Theory  Emerged in the 1970’s when economists questioned the assumption of diminishing returns to specialization  When substantial economies of scale are present, the returns on specialization will result in  increased productivity and lower unit costs  ability to enhance economies of scale increases  Trade is mutually beneficial because it allows for the:  specialization of production  realization of scale economies and “learning effects”  greater variety of goods produced  decrease in the average costs of goods

Economies of Scale and First Mover Advantage  Industries with high fixed costs require a substantial proportion of the world demand to spread fixed costs over a large volume and to utilize specialized assets  World market may only support a few competitors First Mover Advantage  economic and strategic advantages to early entrants  ability to capture economies of scale and low cost structure  scale-based cost advantage can create entry barriers

Implications of New Trade Theory  Nations may benefit from trade even when they do not differ in resource endowments or technology  A nation may predominate in the export of a good simply because it has one or more firms among the first to produce that good which creates entry barriers  Those economies of scale that result from first mover advantage translate into a comparative advantage  Some argue that it justifies government intervention and strategic trade policy

Theory of National Competitive Advantage Michael Porter 1990  Attempts to analyze the reasons for a nation’s competitive advantage in a particular industry  Studied 100 industries in 10 nations  Identified four major attributes promote or impede the competitive advantage of a nation

Porter’s Diamond of National Advantage  The diamond of national advantage  Four conditions are important for gaining and maintaining competitive superiority 1.Demand conditions 2.Factor conditions 3.Related and supporting industries 4.Firm strategy, structure, and rivalry

Porter’s Diamond of National Advantage The Diamond of National Competitive Advantage

32 Porter’s Diamond Fig 4.6  Success occurs where the diamond is most favorable  Diamond is mutually reinforcing and interdependent  Chance and government can influence the national diamond

Determinants of National Competitive Advantage 1.Factor endowments  nation’s position in factors of production (skilled labor or infrastructure) necessary to compete in a given industry 2.Demand conditions  nature of home demand for industry’s product/service 3.Related and supporting industries  presence or absence in a nation of supplier industries or related industries that are nationally competitive 4.Firm strategy, structure and rivalry  conditions in the nation governing how companies are created, organized, and managed  nature of domestic rivalry

1. Factor Endowments (Heckscher-Olin) Basic Factors  natural resources  climate  location  demographics Advanced Factors  communications  skilled labor  research  technology

35 Relationship of Basic to Advanced Factors  Basic factors can provide an initial advantage  Basic factors must be supported by advanced factors to maintain competitive advantage  If weak basic factors, the government must invest to upgrade advanced factors  Advanced factors are more likely to lead to competitive advantage  Advanced factors are the result of investment by people, companies, government

2. Demand Conditions  Demand creates:  competitive capabilities  sophisticated and demanding consumers  Demand impacts quality and innovation

3. Related and Supporting Industries  Creates clusters of supporting industries that are internationally competitive  Must also meet requirements of other parts of the Porter’s Diamond

4. Firm Strategy, Structure and Rivalry  Management ‘ideology’ and structure of the firm can either help or hurt the firm  Presence of domestic rivalry and strong competitors improves a company’s competitiveness

Evaluating Porter’s Theory  If Porter is right:  his model should predict the actual pattern of international trade in the world  countries should be exporting products from those industries where all four components of the diamond are favourable  Countries should be importing goods from those industries where the components are not favourable  Too soon to tell

Implications for Business  Location implications:  Disperse production activities to countries where they can be performed most efficiently  First-Mover implications:  Invest substantial financial resources in building a first-mover or early-mover advantage  Policy implications:  Promoting free trade is generally in the best interests of the home-country, although not always in the best interests of the firm

Why Production Factors Move  Factor mobility theory  focuses on why production factors move, the effects of that movement on transforming factor endowments, and the impact of international factor mobility on world trade  Capital and labour move internationally to  gain more income  flee adverse political situations

Effects of Factor Movements  Factor movements alter factor endowments  Factor movements can be substantial for some countries, and insignificant for others  The movement of labour and capital are intertwined  Pros and cons of outward and inward migration  Brain drain  Remittances

Trade and Factor Mobility  There are pressures for the most abundant factors to move to areas of scarcity  The lowest costs occur when trade and production factors are both mobile

Trade and Factor Mobility Unrestricted Trade, Factor Mobility, and the Cost of Tomatoes

Trade and Factor Mobility  Factor mobility through foreign investment often stimulates trade because of  the need for components  the parent’s ability to sell complimentary products  the need for equipment for subsidiaries

In What Direction Will Trade Winds Blow?  Issues to consider 1.Displacement of jobs as developed countries shift production to more rapidly developing countries 2.Relationships among land, labour, and capital will continue to evolve 3.Continued trend toward a more finely tuned specialization of production among countries

In What Direction Will Trade Winds Blow?  Monitor  As economies grow, efficiencies of multiple production locations also grow because they can all gain sufficient economies of scale  Small-scale production methods may enable countries to produce many goods efficiently for their own consumption  Output from 3D printers  Services are growing more rapidly than products as a portion of production and consumption within developed countries

Conclusion “Made in one or more of the following countries: …. The exact country of origin is unknown” Integrated Circuit label

Casestudy : TESCO 1.Read and prepare the Casestudy on TESCO (Johnson, Whittington & Scholes (2011)) for discussion and presentation next week. 2.Identify and evaluate the challenges facing TESCO’s global expansion by conducting External Environment, Industry, Competitor analysis, SWOT and Porter’s Diamond analysis of overseas locations.

Core Reading  Juleff, L, Chalmers, A.. and Harte, P. (2008) Business Economics in a Global Environment, Napier University Edinburgh  Daniels, J.D., Radebaugh, L.H. and Sullivan, D.P. (2012) International Business: Environments and Operations. 14 th edition, Pearson

Next Week’s Discussion: Next Week’s Discussion: Comparative advantage of nations ► Reading  “Can the US bring jobs back from China?” Businessweek 30 June 2008  DISCUSSION Discuss the different national competitive advantages of the USA, China and Germany in manufacturing capabilities.

Questions?