Introduction
This essay will analyze and discuss how trade theory can be used to explain the competitiveness of locations. To address this issue, it is vital to understand what is meant by competitiveness of location and Trade theory.
Trade theories provide insight about favourable market locales for exports as well as well as potentially successful products. It also helps to increase understanding about government trade policies and predict how these policies might affect a company's competitiveness. No single trade theory explains all trade patterns (Daniels et al, 2004). On the other hand, Competitiveness has been viewed from the micro (firm) and the macro (nation) perspective. From the micro economic perspective, the idea of competitiveness is based on the ability of firms to compete, develop, and be cost effective or profitable while at the macro level, competitiveness resides in the ability of firms to constantly and profitably produce products that meet the needs of an open market in terms of price, quality, etc. Economies of scale and specialisation are also the reason for trade in new trade theory, unlike the classical theory of comparative advantage. The macro economic concept of competitiveness is much more poorly defined and more vigorously contested. Although improving a nation's or regions competitiveness is regularly presented as an essential goal of economic policy .However, critiques have argued as regards what it means and if it is even reasonable to talk of competitiveness at a macro economic level at all. The lack of an accepted definition of competitiveness on a macro level is in itself one source of opposition to the concept of macro-economic competitiveness; essentially the argument is that it is dangerous to base economic policy around such a vague concept which accepts varied interpretations and perception (Prof. R.L. Martin, Cambridge). Firms must meet these requirements if it is to remain in business, he more competitive a firm is to its rivals, the greater chance its has in gaining market share.
Adam Smith (1776) and David Ricardo (1817) were the first to argue against the mercantilist ideology in favour of free trade and also show the positive impact free trade will have on an economy.
In 1817, David Ricardo took Adam Smith's theory one step further by exploring what might happen when one country has an absolute advantage in the production of all goods. According to Ricardo's theory of comparative advantage, it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries. The logic with Ricardo's theory is that the more abundant a factor is, the lower its cost. Therefore differences in factor endowments of various countries, explains differences in factor costs, which results in different comparative advantages (Sung Cho, Chang Moon, 2000).
To contrast Ricardo's view, Heckscher and Ohlin(1933) argued that comparative advantage arises from dissimilarities in national factor endowments and that Countries will export goods that make intensive use of those factors that are locally abundant and import those goods that make intensive use of factors that are locally scarce. For instance, China which has large force of labour will concentrate on producing labour intensive goods, while a country like Netherlands which has relatively more capital, will specialize in the production of capital intensive goods. The Heckscher-Ohlin theory of factor endowment was a great contribution to the literature on trade, in that it was one of the first international trade theories that was predicated on national differences in factors of production such as land, labour and capital. Unfortunately, this theory makes the assumption that factor prices depend largely on the factors themselves. It does not take into consideration the realities of the marketplace such as the role of governments or external forces on factor markets, such as trade blocs (Ragasamy, 2003). Although traditional trade theories focused on factor endowments as a basis of trade amongst trading nations and their limitations, gains were acquired, bearing in mind that these industries might have been in the intra or inter industry trade. I conclude therefore that the traditional trade theories can be used to explain the competitiveness of locations since there are advantages or gains derived by trading nations, firms and companies involved in business transactions.
Due to the ambiguity of the traditional trade theories, other economists such as Leontief have developed alternative theories of international trade because the H-O model does not work well in real world. According to Leontief no single theory could help us understand trade theory. The increasing diversity of international trade has, however led to emergence of new theories which are useful in explaining some special cases of international trade which is significantly important as regards the subject of discussion (competitiveness of locations). H-O trade theories can also be used to explain the competitiveness of location since at some point there is trade transaction locally and nationally and, competitive advantages derived. To further analyse and discuss the subject as regards the competitiveness of locations, the next paragraphs will focus on the new trade theories.
In the mid-1960s, Raymond Vernon proposed the product life-cycle theory that suggested that as products mature, both the location of sales and the optimal production location will change affecting the course and direction of trade. According to the Product life cycle theory of trade, the production location moves from one country to another depending on the stage in the product's life cycle.This theory was used to show the behaviour of US export manufactures. The outcome of this theory suggests that a new product will first be produced in a technologically advanced country using skilled labour, and then sold to the home market at first but when the product reaches its maturity state in the home market; the firm begins to export the product. As it becomes standardized, mass production is initiated using unskilled labour; this gives the firm low cost advantage and economies of scale (Lai Yuen Poh).
For example the Personal computers started in 1984 in the U.S, moved to its mature stage by 1999, and reached a standardized stage by 2002.After which they were being replaced by better machines and memory. Desktops were also being replaced by laptops and notebooks models. What PLC theory does imply is to say that when a foreign market is huge enough to sustain local production, foreign direct investment (FDI) will occur. This theory clearly explains the competitiveness of locations.
However, with the proliferation of multinational companies in the international business environment; the international product life cycle model may become unsuitable for the new industrialised economy. But "if innovating firms can scan their home markets, chances are increased that their first production facility will also be located in the home market. Therefore, the propensity of clusters in the home market is fortified by the fact that there are some well recognized economies to be captured by an innovating team that is brought together in a common place"(Sung Cho, Chang Moon, 2000).
Trade comprises of inter industry and intra industry trade. Intra industry trade helps to explain trade of manufactured goods among developed countries like Japan and United States. Economies of scale are derived here if there is free trade in the industry. On the other hand, inter industry trade reflects on comparative advantages. According to H-O model, trade might not occur in inter industry trade because of identical factor endowment. However, if there are economies of scale, there would be benefits of trade from specialization between countries involved trade. Economies of scale and international trade makes it possible for countries to produce goods more efficiently without sacrificing variety of goods (Sung Cho, Chang Moon, 2000), from discussion above, one would agree that competitiveness of locations are explained. Helpman and Krugman's model of new trade theory in the proceeding paragraph will attempt to explain how trade theory can be used to explain competitiveness of locations.
New trade theory suggests that because of economies of scale i.e unit cost reductions associated with a large scale of output, and increasing returns to specialization in some industries, there are likely to be only a few profitable firms because firms with first mover advantages (the economic and strategic advantages that accrue to many entrants into an industry) will develop economies of scale and create barriers to entry for new entrants.
Helpman and Krugman (1985) trade model can be used to explain competitiveness of locations. This model focused on geographical concentration of MNC'S producing verities of products. This model assumed two sectors, one producing a finished differentiated good, the other a homogeneous good. According to Grimwade (2000;p112)"a company may shift its production of a particular good or just a particular stage in the production process to another country to take advantage of differences in costs or a more favorable environment". In addition, Markusen (1984) cited by Grimwade (2000) argued that the motive of foreign direct investment (FDI) by multinational enterprise is to obtain economies of scale from multi-plant production. These economies of scale are usually associated with fixed cost of providing certain activities, R&D, marketing and distribution. Furthermore, the existence of transportation cost, tariff barriers to trade and the geographical location encourage production in that region. Good examples multinational enterprises who engage in such operations are Ford and General Motors which have production facilities in Brazil and Thailand, building vehicles not just for local markets but for the wider provincial markets of South America and Southeast Asia. Intel's global semiconductor production, for instance has R&D facilities in the United States, wafer fabrication plants in Ireland and Israel, and microchip assembly plants in Costa Rica and the Philippines. Similarly, IBM also operates wholesale trade outlets in many countries. To date, most researchers believe that MNE'S engage in trade in order to gain access to host-country markets or to exploit international factor cost differences (Hanson et al, 2001).Hence one could conclude that this trade model does explain competitiveness of locations.
With new trade theory there is a switch in emphasis from exchange efficiency to productive efficiency. In new trade theory, factors such as labour force skills, level of Technology, economies of scale, agglomeration economies, and strategic actions of economic agents in technological and institutional innovations are reasons for trade with the aim to obtain advantages and economic growth. The product lifecycle trade theory shows that competitiveness of locations can be acquired unlike the traditional trade theory which relies on factor endowment. (Prof. R.L. Martin, Cambridge). The next paragraph will deal with Michael Porter's strategic trade contribution who examined competitiveness of industries on a global basis.
Porter's (1990) Competitive Advantage of Nations is a newer addition to the literature that also recognizes the importance of factors of production. It is one of the few models in international business research that illustrates what comprises national competitiveness within a given industry.
According to A.J. Smith (2010),"Porter (1990a) advanced a new theory to explain national competitive advantage. The main question he attempts to answer is why some countries are more successful in particular industries than others. He identifies four classes of country attributes (which he calls the National Diamond) that provide the underlying conditions or platform for the determination the national competitive advantage of a nation. These are factor conditions, demand conditions, related and support industries, and company strategy, structure and rivalry"
As regards factor conditions, industries require appropriate supply of it in their home country if they are to be successful and valuable in elucidation industries' performances. Factors also need to be distinct at a much more disaggregated level than the usual concept of land, labour and capital. Broad distinctions may be drawn between 'basic' factors such as climate and skilled labour which are inherited and advanced factors such as computer scientists or telecommunications infrastructures which have to be created in-between generalized factors that can be deployed to a wide range of industries and specialised factors that cannot. While the adequate supply of suitable factor may aid an industry to compete (e.g. Denmark's success in furniture reflects a pool of graduate furniture designers. Selective factors on the other hand can also be disadvantageous since it can lead to shortages and high costs for basic factors. However, this may have a stimulating effect. For instance, Italy's expensive capital and energy, and their lack of local raw materials, forced its private steel producers to develop mini-steel mill technology, in which they have become world leaders.
Demand conditions by consumers in a country's home market can affect an industry's ability to compete internationally through various mechanisms. First example is where an industry will has an advantage in market segments that are more important at home than in another place; e.g. Swedish firms lead in high voltage electricity distribution over long distances because of their experience in serving their distant and energy-intensive steel and paper industries. Secondly, stylish and demanding buyers pressure companies into meeting and producing high standard products; e.g. Japanese consumers' value space-saving, this gives Japanese firms a lead in a range of compact products. Similarly, America's long distances have led to competitive strength in the production of very large truck engines. Thirdly, industries in a country can gain if the demand of its buyers at home anticipates the demands of buyers in other countries, thereby giving the country a lead in learning how to meet those demands. The Japanese consumer and government for example, forced firms in Japan to make energy-saving products before energy costs became more important elsewhere. Americans' desire for convenience (fast food) has spread elsewhere, giving an advantage in fast food industry. In each of these examples giving above, it is not the size of the home market which is significant, but the degree to which it encouraged firms to innovate. A large home market which meets demand conditions will be supportive of international competitiveness, on the contrary , a large market in which home demand are not met , may simply encourage firms to focus on their undemanding local buyers, leading to stagnation and inability to sell in other countries. However, Saturation of the domestic market might provide the spur which prompts firms to go abroad, forcing them to compete in the global market if they are to grow. (Davis&Ellis, 2000)
Related and supporting industries formulate the third part of porter's diamond. Industries in a country can compete well internationally if there are 'clusters' of industries in the home country, which are linked to one another through vertical or horizontal integration amongst competitive supplying and buying sectors or common customers and distribution channels or technologies. Denmark for instance has a cluster in 'health' and 'home' products while Sweden has clusters in sectors linked to paper-making, and Germany in chemicals, metal-working, transportation and printing respectively.
The fourth part of porter's diamond deals with strategies and structures of home base firms, and the degree of rivalry amongst them. If the national environment of a country favours small firms owned by family members, as in Italy for instance, the country will be competitive in industrial sectors that are fragmented with limited economies of scale. Similarly,when executives of firms that have an engineering background, as in Germany for example, competition will be concentrated in sectors that have high technical or engineering content. Another example to illustrate the fourth part of porter's diamond is where a company's goal and objective is short-term but because of government control and capital-raising mechanisms that are in place nationally, the country will tend to be successful in new industries with the prospect of quick returns. On the other hand, where a company's goal is long-term, they will be better off in industries which require consistent re-investment due to the national environment.
Although porters diamond' is the central focus, allowance is made for two other factors, 'chance' and 'government'. Chance may include unpredictable technological discontinuities, wars and other unforeseen events that are not part of the diamond itself, but may alter conditions within it. Government on the other hand also has a role to play, but only by affecting the parts of porter's diamond.
The industries which are successful in competing in locations or regions of trade are those whose competitive strategies are appropriate from their development stages.
Conclusion:
Trade theories from Adam Smith to the new trade theories can be used to explain competitiveness of locations since there are economies of scale derived from trade transactions. The new trade theory however, embraces a wider area in explaining competitiveness of locations.
Competitiveness is a key concern for policy makers in various countries and regions. Its growing significance is due to changes in the nature of global competition. As a result there is increased pressure on many firms and regions to design sustainable strategies to support and improve wealth. There is a wide debate around the notion of competitiveness, frequently leaving policy makers without credible guidelines on how to tackle these challenges.
I n the new trade theory, Porter have employed verbal descriptions and logical analysis rather than the arithmetical models which governs the economic profession because his aim is to present actionable and available counsel to practitioners.
Finally, competitiveness will always be a key subject for policy makers in years ahead. And where necessary, an improvent on the debate among researchers on the factors underpinning competitiveness will be made, with the most effective analytical tools and concepts available to them.
