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Competitive Advantage and Comparative Advantage

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1 Competitive Advantage and Comparative Advantage
Howard Davies

2 The ‘C’ word!! The word ‘competitiveness’ is ubiquitous - to be heard and read everywhere It is usually a cloak for confused thinking The purpose of this lecture is to help you think more clearly around the issues involved

3 Different meanings of competitiveness
‘Competitiveness’ as a country’s market share (especially of exports) ‘Competitiveness’ as low wages and prices relative to other places (wages and exchange rates) ‘Competitiveness’ as productivity -national income per head ‘Competitiveness’ as a kind of market structure - many firms, free entry, no price controls THESE ARE COMPLETELY DIFFERENT THINGS BUT POLITICIANS AND BUSINESS PEOPLE OFTEN MUDDLE THEM UP!!

4 Can We Decide Which Meaning is Most Important?
Competitiveness is a ‘good thing’ and an end result THEREFORE Competitiveness as productivity -national income per head - is the most important/meaningful interpretation

5 Unfortunately, this is often confused
In Michael Porter’s Competitive Advantage of Nations (1990) he begins by agreeing with the ‘productivity’ interpretation BUT he then says that ‘competitiveness’ is determined at industry level (OK) and measures it by their export market share (NOT OK - productivity has been lost sight of!) AND he claims that his theory of ‘competitive advantage’ has made the economists’ idea of ‘comparative advantage’ outdated

6 Why should we care? Because Porter’s CAN has been very influential - especially amongst policymakers and businesspeople Because it has encouraged those policymakers to adopt wasteful or even potentially disastrous policies (high -tech in Hong Kong and Indonesia’s aircraft industry).Businesspeople use it to justify government intervention on their behalf .

7 How to be more clear? Examine the basic concept of comparative advantage Examine Porter’s analysis of ‘competitive advantage’ to distinguish between the useful ideas and the confusion

8 The principal of comparative advantage
the only proposition in social science to be true and non-trivial! Paul Samuelson - Nobel prizewinner Dates back to David Ricardo 1817

9 The principal of comparative advantage
Consider the case of two countries and two products, where country A is more efficient than country B in the production of BOTH products. BOTH countries can gain (have higher income and consumption possibilities) if they each specialize to some extent in producing one product and trade it in exchange for the other EACH country will specialize in the product for which the opportunity cost is lower. That will be the product that can be produced by making most intensive use of the resource that the country has in relative abundance

10 A current example of comparative advantage?
The US is more efficient in the production of BOTH toys and machine tools than China BUT machine tool production requires a large amount of capital and skilled labour while toys can be made with little capital and unskilled labour The US has abundant capital and skilled labour, China has abundant unskilled labour.

11 A current example of comparative advantage?
In the US, machine tools are cheaper than in China in terms of the number of toys that could be made with the same resources. e.g. the US could make two more machine tools with the resources needed to make 10,000 Barbie dolls. China could make only one. In China, toys are cheaper than in the US, in terms of the number of machine tools that must be sacrificed to make one more toy. same example - China can make 10,000 Barbie dolls with the resources needed to make 1 machine tool. The US can only make 5,000.

12 A current example of comparative advantage?
The principal of comparative advantage predicts that if there are no barriers to trade China will specialize in toys and sell them to the US, which will specialize in machine tools and sell them to China The principal also shows that total income for the two countries combined will be higher after trade, and therefore they can both gain.(simple diagram can help here) TRADE IS NOT A ZERO-SUM GAME WHERE ONE WINS AND ONE LOSES!!! (Business people often see it this way, as it is true at firm level)

13 So what is ‘competitive advantage’?
Porter claimed to replaced the ‘outdated’ concept of competitive advantage with ‘competitive advantage’ What is ‘competitive advantage’? TWO elements in Porter’s analysis a stage model of economic development the ‘diamond model’

14 The Stage Model of Economic Development: 4 Stages
Factor-driven stage compete on low-cost labour or natural resources low wages, poor country ‘competitive advantage’ drives solely from factor conditions China today

15 The Stage Model of Economic Development:4 Stages
Investment-driven stage heavy capital investment in factories and infra-structure ‘competitive advantage’ based on cost through scale economies and state-of -the art manufacturing standard of living higher but still relatively low Singapore today?

16 The Stage Model of Economic Development:4 Stages
Innovation-driven stage firms compete overseas on the basis of innovation ‘true prosperity’ is reached only in this stage the ‘diamond’ is fully in place US today

17 The Stage Model of Economic Development:4 Stages
Wealth-driven stage economy run by stewards not entrepreneurs less belief in the value of competition less motivation to innovate national goals focus on distribution of wealth not making it Europe, UK(?) US in future

18 The ‘diamond’ To reach ‘true prosperity’ and the innovation driven stage all 4 corners of the ‘diamond’ must be in place in the ‘home base’ country. FACTOR CONDITIONS specialized factors, skilled labour DEMAND CONDITIONS the most sophisticated consumers RELATED AND SUPPORTING INDUSTRIES ‘clusters’ of suppliers, consultants, users FIRM STRATEGIES AND STRUCTURES intense rivalry amongst domestic firms

19 The Consequences of These Ideas?
Governments have used them to support intervention designed to push countries to the ‘innovation-driven’ stage by ‘up-grading’ when that is inconsistent with their comparative advantage: Habibie on Indonesia’s ‘need’ for an aircraft industry!! Hong Kong trying to develop ‘clusters’ for Chinese medicine Science Parks everywhere!! Self-interested parties using the ideas to have government funds diverted towards them

20 So what is wrong with that?
Porter’s ideas are factually wrong!! It is not necessary to reach the innovation-driven stage to have a high level of income Abu Dhabi, Brunei, Australia, Canada, New Zealand, Kuwait - RESOURCE DRIVEN Hong Kong, Singapore,Switzerland - INVESTMENT DRIVEN ‘Clusters’ do not need to be in place for industries to be successful (high productivity or exporting)

21 In conclusion on Porter?
Porter’s claim to have replaced the ‘outdated’ concept of ‘comparative advantage’ with ‘competitive advantage’ is not justified INDEED, the stages model is just an application of the comparative advantage model combined with a simple ‘story’ of growth RESOURCE DRIVEN- comparative advantage is in resources - specialize and export those. INVESTMENT-DRIVEN -you have more capital - your c.a. shifts INNOVATION-DRIVEN - you are on the technological frontier, with very high wages - innovation is your c.a.

22 What About the Competitiveness Index?
According to IMD in Switzerland Hong Kong ranks 45 out of 49 in “competitiveness”. “Poor performance” attributed to low R&D spending and limited attention to technology An index made by adding up scores for a range of attributes A useful source of data - the rankings are totally without meaning!! IS THE ECONOMY PRODUCING MORE OUTPUT PER PERSON? is the only index that counts Hong Kong excels at that, even today when we are all so “depressed”

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